Leidos Holdings, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of Leidos Holdings, Inc.'s ("Leidos") financial condition, results of operations, and quantitative and qualitative discussion about business environment and trends should be read in conjunction with Leidos' condensed consolidated financial statements and related notes. The following discussion contains forward-looking statements, including statements regarding our intent, belief or current expectations with respect to, among other things, trends affecting our financial condition or results of operations, backlog, our industry, the impact of our merger and acquisition activity, government budgets and spending, our business contingency plans, interest rates and uncertainties in tax due to new tax legislation or other regulatory developments. In some cases, forward-looking statements can be identified by words such as “will,” “expect,” “estimate,” “plan,” “potential,” “continue” or similar expressions. Such statements are not guarantees of future performance and involve risks and uncertainties and actual results may differ materially from those in the forward-looking statements as a result of various factors. Some of these factors include, but are not limited to, the risk factors set forth in our Annual Report on Form 10-K, as updated by the risk factor in this report under Part II, Item 1A. "Risk Factors" and as may be further updated in subsequent filings with the U.S. Securities and Exchange Commission. Due to such uncertainties and risks, you are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to update these factors or to publicly announce the results of any changes to our forward-looking statements due to future events or developments. Unless indicated otherwise, references in this report to "we," "us" and "our" refer collectively to Leidos and its consolidated subsidiaries. Overview Leidos, a member of the Fortune 500®, is a dynamic innovation company that is at the forefront of addressing the world’s most challenging issues in national security and health sectors. With a global workforce of approximately 48,000, Leidos is committed to developing smarter technology solutions, particularly for customers in highly regulated industries. We bring domain-specific capability and cross-market innovations to customers in each of these markets by leveraging five technical core capabilities: digital modernization, cyber operations, mission software systems, integrated systems and mission operations. Our customers include the U.S. Department of Defense ("DoD"), the U.S. Intelligence Community, the U.S. Department of Homeland Security, the Federal Aviation Administration, the Department of Veterans Affairs, National Aeronautics and Space Administration and many other U.S. civilian, state and local government agencies, foreign government agencies and commercial businesses. Beginning in fiscal 2024, we realigned our business and operate in four reportable segments that are focused on specific, defined capability sets we bring to our customers. As a result of this change, prior year segment results and disclosures have been recast to reflect the current reportable segment structure. We now operate in the following reportable segments: National Security & Digital, Health & Civil, Commercial & International and Defense Systems. We also separately present the unallocable costs associated with corporate functions as Corporate (see "Note 10–Business Segments"). Business Environment and Trends U.S. Government Markets During the three and nine months ended September 27, 2024, we generated approximately 87% of total revenues from contracts with the U.S. government, as compared to 87% and 86% for the three and nine months ended September 29, 2023, respectively. Accordingly, our business performance is affected by the overall level of U.S. government spending, especially on national security, homeland security and intelligence, and the alignment of our service and product offerings and capabilities with current and future budget priorities of the U.S. government. On September 26, 2024, Congress avoided a federal government shutdown by passing a continuing resolution that provides government funding through December 20, 2024. The continuing resolution gives lawmakers additional time after the November elections to consider the 12 appropriations bills for government fiscal year 2025, emergency supplemental funding for the recent hurricanes and wildfires, and organize new leadership of the House of Representatives and Senate. Failure to pass the appropriation bills or another continuing resolution by December 20, 2024, will result in a partial or complete federal government shutdown. 24 Table of Contents LEIDOS HOLDINGS, INC. International Markets Sales to customers in international markets represented approximately 8% of total revenues for both the three and nine months ended September 27, 2024, as compared to 9% for both the three and nine months ended September 29, 2023. Our international customers include foreign governments and their agencies. Our international business increases our exposure to international markets and the associated international regulatory and geopolitical risks. Changes in international trade policies, including higher tariffs on imported goods and materials, may increase the procurement cost of certain IT hardware used both on our contracts and internally. However, we expect to recover certain portions of these higher tariffs through our cost-plus contracts. We are currently evaluating the impact of higher tariffs, and do not expect the tariffs to have a significant impact to our business. Results of Operations The following table summarizes our condensed consolidated results of operations for the periods presented: Three Months Ended Nine Months Ended September 27, 2024 September 29, 2023 Dollar change Percent change September 27, 2024 September 29, 2023 Dollar change Percent change (dollars in millions) Revenues $ 4,190 $ 3,921 $ 269 6.9 % $ 12,297 $ 11,458 $ 839 7.3 % Operating income (loss) 516 (336) 852 NM 1,406 260 1,146 NM Non-operating expense, net (46) (52) 6 (11.5) % (142) (167) 25 (15.0) % Income (loss) before income taxes 470 (388) 858 NM 1,264 93 1,171 NM Income tax expense (108) (8) (100) NM (295) (115) (180) 156.5 % Net income (loss) 362 (396) 758 191.4 % 969 (22) 991 NM Net income (loss) attributable to Leidos common stockholders $ 364 $ (399) $ 763 191.2 % $ 970 $ (30) $ 1,000 NM Operating margin 12.3 % (8.6) % 11.4 % 2.3 % NM- Not Meaningful Segment and Corporate Results Three Months Ended Nine Months Ended National Security & Digital September 27, 2024 September 29, 2023 Dollar change Percent change September 27, 2024 September 29, 2023 Dollar change Percent change (dollars in millions) Revenues $ 1,865 $ 1,852 $ 13 0.7 % $ 5,471 $ 5,400 $ 71 1.3 % Operating income 187 170 17 10.0 % 545 487 58 11.9 % Operating margin 10.0 % 9.2 % 10.0 % 9.0 % The increase in revenues for the three and nine months ended September 27, 2024, as compared to the three and nine months ended September 29, 2023, was primarily attributable to program wins and a net increase in volumes on certain contracts, partially offset by the completion of certain contracts. The increase in operating income for the three and nine months ended September 27, 2024, as compared to the three and nine months ended September 29, 2023, was primarily attributable to contract efficiencies, a net increase in volumes on certain contracts and program wins, partially offset by the completion of certain contracts. 25 Table of Contents LEIDOS HOLDINGS, INC. Three Months Ended Nine Months Ended Health & Civil September 27, 2024 September 29, 2023 Dollar change Percent change September 27, 2024 September 29, 2023 Dollar change Percent change (dollars in millions) Revenues $ 1,225 $ 1,055 $ 170 16.1 % $ 3,687 $ 3,097 $ 590 19.1 % Operating income 287 165 122 73.9 % 816 412 404 98.1 % Operating margin 23.4 % 15.6 % 22.1 % 13.3 % The increase in revenues for the three and nine months ended September 27, 2024, as compared to the three and nine months ended September 29, 2023, was primarily attributable to a net increase in volumes and case complexity within the managed health services business, an increase in net write-ups on certain programs and program wins. The increase in operating income for the three and nine months ended September 27, 2024, as compared to the three and nine months ended September 29, 2023, was primarily driven by an increase in volumes and case complexity within in the managed health services business and an increase in net write-ups on certain programs. Three Months Ended Nine Months Ended Commercial & International September 27, 2024 September 29, 2023 Dollar change Percent change September 27, 2024 September 29, 2023 Dollar change Percent change (dollars in millions) Revenues $ 578 $ 552 $ 26 4.7 % $ 1,648 $ 1,588 $ 60 3.8 % Operating (loss) income 41 (646) 687 106.3 % 64 (599) 663 110.7 % Operating margin 7.1 % (117.0) % 3.9 % (37.7) % The increase in revenues for the three months ended September 27, 2024, as compared to the three months ended September 29, 2023, was primarily attributable to programs wins and a net increase in volumes, partially offset by the completion of certain programs. The increase in revenues for the nine months ended September 27, 2024, as compared to the nine months ended September 29, 2023, was primarily attributable to a net increase in volumes and programs wins. This was partially offset by the impact of write-downs on certain programs within our UK operations for which cost and schedule were rebaselined as well as the the completion of certain programs. The increase in operating income for the three months ended September 27, 2024, as compared to the three months ended September 29, 2023, was primarily driven by impairment charges of $679 million recorded in the prior year. The increase in operating income for the nine months ended September 27, 2024, as compared to the nine months ended September 29, 2023, was primarily driven by impairment charges of $679 million recorded in the prior year, programs wins and a net increase in volumes. This was partially offset by the impact of write-downs on certain programs within our UK operations for which cost and schedule were rebaselined as well as the completion of certain programs. Three Months Ended Nine Months Ended Defense Systems September 27, 2024 September 29, 2023 Dollar change Percent change September 27, 2024 September 29, 2023 Dollar change Percent change (dollars in millions) Revenues $ 522 $ 462 $ 60 13.0 % $ 1,491 $ 1,373 $ 118 8.6 % Operating income 37 3 34 NM 92 47 45 95.7 % Operating margin 7.1 % 0.6 % 6.2 % 3.4 % NM- Not Meaningful The increase in revenues for the three and nine months ended September 27, 2024, as compared to the three and nine months ended September 29, 2023, was primarily attributable to programs wins and a net increase in volumes, partially offset by the completion of certain contracts. 26 Table of Contents LEIDOS HOLDINGS, INC. The increase in operating income for the three months ended September 27, 2024, as compared to the three months ended September 29, 2023, was primarily attributable to program wins and improved program execution on certain programs. The increase in operating income for the nine months ended September 27, 2024, as compared to the nine months ended September 29, 2023, was primarily attributable to programs wins, improved program execution and higher integration costs in the prior year. Three Months Ended Nine Months Ended Corporate September 27, 2024 September 29, 2023 Dollar change Percent change September 27, 2024 September 29, 2023 Dollar change Percent change (dollars in millions) Operating loss $ (36) $ (28) $ (8) 28.6 % $ (111) $ (87) $ (24) 27.6 % The increase in operating loss for the three months ended September 27, 2024, as compared to the three months ended September 29, 2023, was primarily attributable to increased general and administrative expenses and legal fees. The increase in operating loss for the nine months ended September 27, 2024, as compared to the nine months ended September 29, 2023, was primarily attributable to increased general and administrative expenses. Non-Operating Expense, net Non-operating expense, net for the three months ended September 27, 2024, was $46 million as compared to $52 million for the three months ended September 29, 2023. The decrease was primarily driven by increased interest income due to higher cash balances. Non-operating expense, net for the nine months ended September 27, 2024, was $142 million as compared to $167 million for the nine months ended September 29, 2023. The decrease was primarily driven by increased interest income due to higher cash balances, lower interest expense driven by commercial paper borrowings in the prior year and favorable exchange rate movements. Provision for Income Taxes For the three months ended September 27, 2024, our effective tax rate was 23.0% compared to (2.1)% for the three months ended September 29, 2023. The increase to the effective tax rate was primarily due to the tax impacts from non-deductible goodwill impairments for the three months ended September 29, 2023, and an increase in unrecognized tax benefits for the three months ended September 27, 2024. For the nine months ended September 27, 2024, our effective tax rate was 23.3% compared to 123.7% for the nine months ended September 29, 2023. The decrease to the effective tax rate was primarily due to the tax impacts from non-deductible goodwill impairments for the nine months ended September 29, 2023, partially offset by a reduced benefit in federal research tax credits for the nine months ended September 27, 2024. In December 2021, the Organization for Economic Cooperation and Development enacted model rules for a new 15% global minimum tax framework (“Pillar Two”). Many governments around the world have enacted or are in the process of enacting Pillar Two legislation. The Pillar Two legislation became effective for certain jurisdictions beginning in fiscal 2024. We will continue to evaluate the impact of the rules as additional legislation gets enacted but currently do not expect them to have a material impact. 27 Table of Contents LEIDOS HOLDINGS, INC. Bookings and Backlog We recorded net bookings worth an estimated $8.1 billion and $15.8 billion during the three and nine months ended September 27, 2024, respectively, as compared to $7.9 billion and $13.8 billion for the three and nine months ended September 29, 2023, respectively. The estimated value of our total backlog was as follows: September 27, 2024 September 29, 2023 Segment Funded Unfunded Total Funded Unfunded Total (in millions) National Security & Digital $ 3,323 $ 16,532 $ 19,855 $ 3,146 $ 14,802 $ 17,948 Health & Civil 1,536 9,835 11,371 2,022 10,141 12,163 Commercial & International 2,631 2,022 4,653 2,586 1,012 3,598 Defense Systems 1,602 3,080 4,682 1,293 3,041 4,334 Total $ 9,092 $ 31,469 $ 40,561 $ 9,047 $ 28,996 $ 38,043 Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts, both funded and unfunded. Backlog does not include unexercised option periods and future potential task orders expected to be awarded under indefinite delivery/indefinite quantity ("IDIQ") contracts, General Services Administration Schedule or other master agreement contract vehicles, with the exception of certain IDIQ contracts where task orders are not competitively awarded and separately priced but instead are used as a funding mechanism, and where there is a basis for estimating future revenues and funding on future anticipated task orders. Backlog estimates are subject to change and may be affected by factors including modifications of contracts and foreign currency movements. Liquidity and Capital Resources Overview As of September 27, 2024, we had $1,185 million in cash and cash equivalents. We have a senior unsecured revolving credit facility which can provide up to $1 billion in additional borrowing, if required. As of September 27, 2024, and December 29, 2023, there were no borrowings outstanding under the revolving credit facility. We had outstanding debt of $4.7 billion at both September 27, 2024, and December 29, 2023. We have a commercial paper program in which we may issue short-term unsecured commercial paper notes ("Commercial Paper Notes") and have maturities of up to 397 days from the date of issuance. As of September 27, 2024, and December 29, 2023, we did not have any Commercial Paper Notes outstanding. We made principal payments, excluding the impacts of our Commercial Paper Notes, on our debt of $5 million and $14 million during the three and nine months ended September 27, 2024, respectively, and $5 million and $2,041 million for the three and nine months ended September 29, 2023, respectively. The activity for the nine months ended September 29, 2023, included a $1,210 million payment to discharge the $1.9 billion 5.77% senior unsecured term loan facility, a $498 million payment to discharge the $500 million 2.95% notes, due May 2023, and a required principal payment of $320 million to discharge the 364-day term loan credit agreement. Our credit facilities, commercial paper notes and senior unsecured notes outstanding as of September 27, 2024, contain financial covenants and customary restrictive covenants. We were in compliance with all covenants as of September 27, 2024. We paid dividends of $51 million and $155 million during the three and nine months ended September 27, 2024, respectively, and $50 million and $150 million during the three and nine months ended September 29, 2023, respectively. Stock repurchases of Leidos common stock may be made on the open market or in privately negotiated transactions with third parties including through accelerated share repurchase agreements. Whether repurchases are made and the timing and actual number of shares repurchased depends on a variety of factors including price, corporate capital requirements, other market conditions and regulatory requirements. The repurchase program may be accelerated, suspended, delayed or discontinued at any time. 28 Table of Contents LEIDOS HOLDINGS, INC. During the three and nine months ended September 27, 2024, we made open market repurchases of our common stock for an aggregate purchase price of $200 million and $450 million, respectively, and $25 million during the nine months ended September 29, 2023.There were no share repurchases for the three months ended September 29, 2023. For the next 12 months, we anticipate that we will be able to meet our liquidity needs, including servicing our debt, through cash generated from operations, available cash balances, borrowings from our commercial paper program and, if needed, sales of accounts receivable and borrowings from our revolving credit facility. Summary of Cash Flows The following table summarizes cash flow information for the periods presented: Three Months Ended Nine Months Ended September 27, 2024 September 29, 2023 September 27, 2024 September 29, 2023 (in millions) Net cash provided by operating activities $ 656 $ 795 $ 1,093 $ 861 Net cash used in investing activities (23) (52) (56) (135) Net cash used in financing activities (257) (249) (644) (470) Net cash provided by operating activities decreased $139 million during the three months ended September 27, 2024, when compared to the prior year quarter. The decrease was primarily due to unfavorable changes in working capital, partially offset by higher earnings and the timing of payroll and employee benefit accruals. Net cash provided by operating activities increased $232 million during the nine months ended September 27, 2024, when compared to the prior year. The increase was primarily due to higher earnings and lower tax payments of $49 million primarily due to payments made in the prior year for the TCJA provision and payroll taxes related to the CARES act. Net cash used in investing activities decreased $29 million and $79 million during the three and nine months ended September 27, 2024, respectively, when compared to the prior year. The decreases were primarily due to lower capital expenditures of $27 million and $66 million for the three and nine months ended September 27, 2024, respectively. Net cash used in financing activities increased $8 million for the three months ended September 27, 2024, when compared to the prior year quarter, primarily due to a $202 million increase in stock repurchases, partially offset by $200 million in commercial paper net proceeds received in the prior year. Net cash used in financing activities increased $174 million for the nine months ended September 27, 2024, when compared to the prior year. The increase was primarily due to a $425 million increase in stock repurchases, a $31 million increase in shares withheld for tax obligations, partially offset by a decrease of $291 million in net payments made on debt activities. Off-Balance Sheet Arrangements We have outstanding performance guarantees and cross-indemnity agreements in connection with certain aspects of our business. We also have letters of credit outstanding principally related to performance guarantees on contracts and surety bonds outstanding principally related to performance and subcontractor payment bonds as described in "Note 11–Commitments and Contingencies" of the notes to the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q. These arrangements have not had, and management does not believe it is likely that they will in the future have, a material effect on our liquidity, capital expenditures or capital resources, operations or financial condition. 29 Table of Contents LEIDOS HOLDINGS, INC. Guarantor and Issuer of Guaranteed Securities Leidos Holdings, Inc. ( “ Guarantor ” ) has fully and unconditionally guaranteed the debt securities of its subsidiary, Leidos, Inc. ( “ Issuer ” ), that were issued pursuant to transactions that were registered under the Securities Act of 1933, as amended (collectively, the “Registered Notes”). The following is a list of the Registered Notes guaranteed by Leidos Holdings, Inc. Senior unsecured Registered Notes issued by Leidos, Inc.: $500 million 3.625% notes, due May 2025 $750 million 4.375% notes, due May 2030 $1,000 million 2.300% notes, due February 2031 $750 million 5.750% notes, due March 2033 Leidos Holdings, Inc. has also fully and unconditionally guaranteed debt securities of Leidos, Inc. that were issued pursuant to transactions that were not registered under the Securities Act of 1933, as amended. The following is a list of unregistered debt securities guaranteed by Leidos Holdings, Inc. Senior unsecured unregistered debt securities issued by Leidos, Inc.: $250 million 7.125% notes, due July 2032 $300 million 5.500% notes, due July 2033 Additionally, Leidos, Inc. has fully and unconditionally guaranteed debt securities of Leidos Holding, Inc. that were issued pursuant to transactions that were not registered under the Securities Act of 1933, as amended. The following is a list of unregistered debt securities guaranteed by Leidos, Inc. Senior unsecured unregistered debt securities issued by Leidos Holdings, Inc.: $300 million 5.950% notes, due December 2040 The following summarized financial information includes the assets, liabilities and results of operations for the Guarantor and Issuer of the Registered Notes described above. Intercompany balances and transactions between the Issuer and Guarantor have been eliminated from the financial information below. Investments in the consolidated subsidiaries of the Issuer and Guarantor that do not guarantee the senior unsecured notes have been excluded from the financial information. Intercompany payables represent amounts due to non-guarantor subsidiaries of the Issuer. Balance Sheet Information for the Guarantor and Issuer of Registered Notes September 27, 2024 December 29, 2023 (in millions) Total current assets $ 2,791 $ 2,464 Goodwill 5,673 5,517 Other long-term assets 1,348 1,241 Total assets $ 9,812 $ 9,222 Total current liabilities $ 2,852 $ 1,983 Long-term debt, net of current portion 4,080 4,663 Intercompany payables 2,966 2,523 Other long-term liabilities 681 599 Total liabilities $ 10,579 $ 9,768 30 Table of Contents LEIDOS HOLDINGS, INC. Statement of Operations Information for the Guarantor and Issuer of Registered Notes Nine Months Ended September 27, 2024 (in millions) Revenues, net $ 7,820 Operating income 652 Net income attributable to Leidos common stockholders 131 Contractual Obligations and Commitments We are subject to a number of reviews, investigations, claims, lawsuits, other uncertainties and future obligations related to our business. For a discussion of these items, see "Note 11–Commitments and Contingencies" of the notes to the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q. Critical Accounting Policies There were no material changes to our critical accounting policies, estimates or judgments during the period covered by this report from those discussed in our Annual Report on Form 10-K for the year ended December 29, 2023. Recently Adopted and Issued Accounting Standards For a discussion of these items, see "Note 1–Basis of Presentation and Summary of Significant Accounting Policies" of the notes to the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q. 31 Table of Contents LEIDOS HOLDINGS, INC. Item 3. Quantitative and Qualitative Disclosures About Market Risk. There were no material changes in our market risk exposure from those discussed in our Annual Report on Form 10-K for the year ended December 29, 2023.