LEIDOS HOLDINGS, INC. The following discussion and analysis ofLeidos Holdings, Inc.'s ("Leidos") financial condition, results of operations and quantitative and qualitative disclosures about market risk should be read in conjunction with the consolidated financial statements and related notes. Unless indicated otherwise, references in this report to the "Company," "we," "us," and "our" refer collectively toLeidos and its consolidated subsidiaries. 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, initiatives, our industry and government budgets and spending. 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 (see "Risk Factors-Forward-Looking Statement Risks" in Part I of this Annual Report on Form 10-K). Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in "Risk Factors" and "Business Environment and Trends." 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. Overview We are a FORTUNE 500® science, engineering and information technology company that provides services and solutions in the defense, intelligence, civil and health markets. We bring domain-specific capability and innovations to customers in each of these markets by leveraging seven core capabilities: cyber; digital modernization; integrated systems; mission software systems; mission support; operations and logistics; and sensors, collection and phenomenology. Our domestic customers include theU.S. Department of Defense ("DoD"), theU.S. Intelligence Community , theU.S. Department of Homeland Security , theFederal Aviation Administration , theDepartment of Veterans Affairs and many otherU.S. government civilian agencies, as well as state and local government agencies. Our international customers include foreign governments and their agencies, primarily located inAustralia and theUnited Kingdom ("U.K."). Less than 10% of our revenues and tangible long-lived assets are generated by or owned by entities located outside ofthe United States . We operate in three reportable segments: Defense Solutions, Civil and Health. Additionally, we separately present the unallocable costs associated with corporate functions as Corporate. Effective the beginning of fiscal 2019, we changed the composition of our Defense Solutions reportable segment to better align the operations within the reportable segment to the customers we serve. This resulted in the identification of new operating segments within Defense Solutions. In addition, certain contracts were reassigned between the Civil and Defense Solutions reportable segments. While this activity did not have a material impact on our reportable segments, prior year segment results have been recast to reflect this change. For additional information regarding our reportable segments, see "Business" in Part I and "Note 24-Business Segments" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.Leidos Holdings, Inc. Annual Report - 31
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PART IIOur significant initiatives include the following: • achieving internal, or non-acquisition related, annual revenue growth
through internal collaboration and better leveraging of key
differentiators across our company and the deployment of resources and
investments into higher growth markets;
• increasing headcount and internal direct labor content on our contract
portfolio;
• continued improvement in our back office infrastructure and related
business processes for greater effectiveness and efficiency across all
business functions; and
• disciplined deployment of our cash resources and use of our capital
structure to enhance shareholder value while retaining an appropriate
amount of financial leverage.
Sales Trend. For fiscal 2019, revenues increased$900 million , or 9% compared to fiscal 2018, primarily due to program wins and a net increase in program volumes, partially offset by programs ended and the impact of the sale of our commercial cybersecurity and health staff augmentation businesses. For fiscal 2018, revenues were$10.2 billion , consistent with fiscal 2017. See "Results of Operations" below for discussion of our individual segment results. Operating Expenses and Income Trend. For fiscal 2019, operating expenses increased by$737 million , or 8%, compared to fiscal 2018. Operating margin for fiscal 2019 was 8.2% compared to 7.3% for fiscal 2018. Operating income was$912 million , a$163 million increase compared to fiscal 2018. The increases in operating margin and operating income were primarily attributable to the receipt of the Greek arbitration award, favorable program mix, decreases in acquisition, integration and restructuring costs and lower amortization of intangible assets. For fiscal 2018, operating expenses decreased by$161 million , or 2%, compared to fiscal 2017. Operating margin for fiscal 2018 was 7.3% compared to 5.5% for fiscal 2017. Operating income was$749 million for fiscal 2018, a$190 million increase compared to fiscal 2017. These changes were primarily attributable to decreases in acquisition, integration and restructuring costs and lower amortization of intangible assets. From a macroeconomic perspective, our industry is under general competitive pressures associated with spending from our largest customer, theU.S. government, and requires a high level of cost management focus to allow us to remain competitive. Although the current Administration has not indicated a desire to reduce spending in the defense and homeland security sectors, the likelihood, extent and duration of current spending levels in these areas remains unclear. We continue to review our cost structure against our anticipated sales and undertake cost management actions and efficiency initiatives where necessary. Business Environment and TrendsU.S. Government Markets In fiscal 2019, we generated approximately 87% of our total revenues from contracts with theU.S. government, either as a prime contractor or a subcontractor to other contractors engaged in work for theU.S. government. Revenues under contracts with theDoD andU.S. Intelligence Community , including subcontracts under which theDoD or theU.S. Intelligence Community is the ultimate purchaser, represented approximately 48% of our total revenues for fiscal 2019. Accordingly, our business performance is affected by the overall level ofU.S. government spending, especially national security, homeland security and intelligence spending, and the alignment of our service and product offerings and capabilities with current and future budget priorities of theU.S. government. FromDecember 21, 2018 until the passage of a new continuing resolution ("CR") onJanuary 25, 2019 there was a partialU.S. government shutdown, which reduced or delayed work on existing contracts and caused delays in other government contracting actions and payments. Prior to the expiration of the January CR,Congress passed appropriations for the seven remaining appropriations bills, thereby completing funding for GFY 2019. OnJuly 22, 2019 , theWhite House andCongress reached a two-year budget deal to raise spending caps and suspend the debt ceiling untilJuly 2021 . Allocations for national defense spending increased to$738 billion in GFY 2020 and$741 billion in GFY 2021. For non-defense programs, spending increased to$632 billion in GFY 2020 and$635 billion in GFY 2021. Overall, the measure increased spending by$323 billion over the limits set under the Bipartisan Budget Act of 2018.Leidos Holdings, Inc. Annual Report - 32
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PART II
On December 20, 2019 , Congress passed and the President signed into law two
consolidated appropriations bills, thereby funding the federal government
through the end of GFY 2020.
On February 10, 2020 , the President submitted the GFY 2021 budget proposal to
Congress , which included discretionary spending levels for defense and
non-defense programs of $741 billion and $590 billion , respectively.
Trends in the U.S. government contracting process, including a shift towards
multiple-awards contracts, in which certain contractors are preapproved using
indefinite-delivery/indefinite-quantity ("IDIQ") and U.S. General Services
Administration ("GSA") contract vehicles, have increased competition for U.S.
government contracts, reduced backlogs by shortening periods of performance on
contracts and increased pricing pressure. We expect that a majority of the
business that we seek in the foreseeable future will be awarded through a
competitive bidding process. For more information on these risks and
uncertainties, see "Risk Factors" in Part I of this Annual Report on Form 10-K.
International Markets
Sales to customers in international markets represented 8% of total revenues for
fiscal 2019. Our international customers include foreign governments and their
agencies, primarily located in Australia and the U.K. Our international business
increases our exposure to international markets and the associated international
regulatory and geopolitical risks.
Recent changes in international trade policies, including higher tariffs on
imported goods and materials, may increase our procurement costs of certain IT
hardware used both on our contracts and for internal use. However, we expect to
recover certain portions of these higher tariffs through our cost-plus
contracts. While we are still evaluating the impact of higher tariffs,
currently, we do not expect tariffs to have a significant impact to our
business.
Key Performance Measures
The primary financial performance measures we use to manage our business and
monitor results of operations are revenue, operating income, cash flows from
operations and diluted earnings per share. Bookings and backlog are also useful
measures for management and investors to evaluate our performance and potential
future revenues. In addition, we consider business performance by contract type
to be useful to management and investors when evaluating our operating income
and margin performance.
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PART II
Results of Operations
Our results of operations for the periods presented were as follows:
Year Ended 2019 to 2018 2018 to 2017
January 3, December 28, December 29, Dollar change Percent Dollar change Percent
2020 2018 2017 change change
(dollars in millions)
Revenues $ 11,094 $ 10,194 $ 10,170 $ 900 9 % $ 24 - %
Cost of 9,546 8,690 8,738 856 10 % (48 ) (1 )%
revenues(1)
Selling, general
and
administrative
expenses:
General and 496 547 573 (51 ) (9 )% (26 ) (5 )%administrative(1)
Bid and proposal 144 136 122 8 6 % 14 11 % Company-funded 49 46 42 3 7 % 4 10 % research and development Bad debt expense (40 ) - 10 (40 ) (100 )% (10 ) (100 )% and recoveries Acquisition, 5 37 139 (32 ) (86 )% (102 ) (73 )% integration and restructuring costs Asset impairment - 7 - (7 ) (100 )% 7 100 % charges Equity earnings (18 ) (18 ) (13 ) - - % (5 ) 38 %
of
non-consolidated
subsidiaries
Operating income 912 749 559 163 22 % 190 34 % Non-operating (46 ) (139 ) (166 ) 93 (67 )% 27 (16 )% expense, net Income before 866 610 393 256 42 % 217 55 % income taxes Income tax (196 ) (28 ) (29 ) (168 ) NM 1 (3 )% expense Net income 670 582 364 88 15 % 218 60 % Less: net income 3 1 (2 ) 2 200 % 3 (150 )% (loss) attributable to non-controlling interest Net income$ 667 $ 581 $ 366 $ 86 15 %$ 215 59 % attributable to Leidos Holdings, Inc. Operating income 8.2 % 7.3 % 5.5 %
margin
NM - Not meaningful
(1) Effective the beginning of fiscal 2018, we established a new
Cost Accounting Standards structure and revised our disclosure statements
accordingly to reflect the related cost accounting practice changes.
Consequently, $185 million was reclassified from "Cost of revenues" to
"Selling, general and administrative expenses" on the consolidated
statements of income for fiscal 2017. For more information, see "Note
1-Nature of Operations and Basis of Presentation" of the notes to the
consolidated financial statements contained within this Annual Report on
Form 10-K.
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PART II
Segment and Corporate Results
Year Ended 2019 to 2018 2018 to 2017
Defense January 3, December 28, December 29, Dollar change Percent Dollar change Percent
Solutions 2020 2018 2017 change change
(dollars in millions)
Revenues $ 5,367 $ 4,966 $ 4,989 $ 401 8 % $ (23 ) - %
Operating 407 353 312 54 15 % 41 13 %
income
Operating 7.6 % 7.1 % 6.3 %
income margin
The increase in revenues for fiscal 2019 as compared to fiscal 2018 was
primarily attributable to new awards and a net increase in program volumes,
partially offset by the completion of certain contracts and adverse exchange
rate movements in the Australian dollar when compared to the U.S. dollar.
The decrease in revenues for fiscal 2018 as compared to fiscal 2017 was
primarily attributable to the completion of certain contracts and adverse impact
of the foreign exchange rate movements between the U.S. dollar and Australian
dollar, partially offset by new awards.
The increase in operating income for fiscal 2019 as compared to fiscal 2018 was
primarily attributable to new awards, the release of a contract reserve and
favorable program mix.
The increase in operating income for fiscal 2018 as compared to fiscal 2017 was
primarily attributable to lower amortization.
Year Ended 2019 to 2018 2018 to 2017
January 3, December 28, December 29, Dollar change Percent change Dollar change Percent change
Civil 2020 2018 2017
(dollars in millions)
Revenues $ 3,729 $ 3,411 $ 3,379 $ 318 9 % $ 32 1 %
Operating 295 284 221 11 4 % 63 29 %
income
Operating 7.9 % 8.3 % 6.5 %
income margin
The increase in revenues for fiscal 2019 as compared to fiscal 2018 was
primarily attributable to new awards and a net increase in program volumes,
partially offset by the impact of the sale of our commercial cybersecurity
business of $74 million , the completion of certain contracts, lower net profit
write-ups in the current year and adverse exchange rate movements in the British
pound when compared to the U.S. dollar.
The increase in revenues for fiscal 2018 as compared to fiscal 2017 was
primarily attributable to new awards, favorable impact of the foreign exchange
rate movements between the U.S. dollar and British pound and a net increase in
program volumes, partially offset by the completion of certain contracts.
The increase in operating income for fiscal 2019 as compared to fiscal 2018 was
primarily attributable to lower amortization of intangibles of $20 million , a
net increase in program volumes, new awards and the impact of the sale of our
commercial cybersecurity business of $7 million , partially offset by lower net
profit write-ups in the current year and a net increase in bad debt expense on
certain international contracts.
The increase in operating income for fiscal 2018 as compared to fiscal 2017 was
primarily attributable to lower amortization and indirect expenditures,
partially offset by a net decrease in program volumes.
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PART II
Year Ended 2019 to 2018 2018 to 2017
January 3, December 28, December 29, Dollar change Percent Dollar change Percent
Health 2020 2018 2017 change change
(dollars in millions)
Revenues $ 1,998 $ 1,817 $ 1,802 $ 181 10 % $ 15 1 %
Operating 242 230 228 12 5 % 2 1 %
income
Operating 12.1 % 12.7 % 12.7 %
income margin
The increase in revenues for fiscal 2019 as compared to fiscal 2018 was
primarily attributable to a net increase in program volumes, new awards and $18
million from our acquisition of IMX Medical Management Services and its
affiliated businesses ("IMX"), partially offset by the completion of certain
contracts and the impact of the sale of our health staff augmentation business
of $78 million .
The increase in revenues for fiscal 2018 as compared to fiscal 2017 was
primarily attributable to a net increase in program volumes and new awards,
partially offset by the completion of certain contracts and lower net profit
write-ups in the current year.
The increase in operating income for fiscal 2019 as compared to fiscal 2018 was
primarily attributable to a net increase in program volumes, partially offset by
reduced margins on awarded re-compete contracts.
The increase in operating income for fiscal 2018 as compared to fiscal 2017 was
primarily due to a net increase in program volumes, partially offset by the
completion of certain contracts, higher investment costs and lower net profit
write-ups in the current year.
Year Ended 2019 to 2018 2018 to 2017
January 3, December 28, December 29, Dollar Percent Dollar Percent
Corporate 2020 2018 2017 change change change change
(dollars in millions)
Operating loss (32 ) (118 ) (202 ) 86 (73 )% 84 (42 )%
Corporate operating loss represents corporate costs that are not directly
related to the operating performance of the reportable segments.
The decrease in operating loss for fiscal 2019 as compared to fiscal 2018, was
primarily attributable to the $52 million net gain recognized upon the receipt
of the Greek arbitration award, lower acquisition, integration and restructuring
costs of $32 million and an asset impairment charge of $7 million in the prior
year.
The decrease in operating loss for fiscal 2018 as compared to fiscal 2017, was
primarily attributable to lower acquisition, integration and restructuring costs
of $102 million , partially offset by increased legal fees and an asset
impairment charge of $7 million .
Equity earnings of non-consolidated subsidiaries
We have certain non-controlling ownership interests in equity method
investments. For fiscal 2019, 2018 and 2017, we recorded earnings of $29
million , $28 million and $27 million , respectively, from our equity method
investments, partially offset by amortization of $11 million , $10 million and
$14 million , respectively.
Non-Operating Expense, Net
Non -operating expense, net decreased $93 million for fiscal 2019 as compared to
fiscal 2018, primarily due to the $88 million gain recognized on the sale of our
commercial cybersecurity business.
Non-operating expense, net decreased $27 million for fiscal 2018 as compared to
fiscal 2017, primarily due to a $33 million promissory note impairment that
occurred during fiscal 2017, partially offset by unfavorable fair value changes
on investments held in our benefit plans.
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PART II
Provision for Income Taxes
Our effective tax rate was 22.6%, 4.6% and 7.4% in fiscal 2019, 2018 and 2017,
respectively. The Company's effective tax rate for fiscal 2019 was favorably
impacted primarily by excess tax benefits related to employee stock-based
payment transactions and federal research tax credits, partially offset by an
increase in valuation allowances arising from foreign withholding tax and an
increase in taxes related to the sale of the commercial cybersecurity business.
The effective tax rate for fiscal 2018 was favorably impacted primarily by a
decrease in valuation allowances arising from the taxable conversion of a
subsidiary and the utilization of capital losses, an increase in deferred tax
assets related to the stock basis of a subsidiary held for sale, excess tax
benefits related to employee stock-based payment transactions and federal
research tax credits.
The effective tax rate for fiscal 2017 was favorably impacted primarily by the
Tax Cuts and Jobs Act's reduction of the federal corporate tax rate from 35% to
21% applied to our fiscal 2017 year-end deferred tax balances and excess tax
benefits related to employee stock-based payment transactions, partially offset
by the impact of certain capitalized transaction costs.
Non-controlling Interest
We have an 88% controlling interest in Mission Support Alliance, LLC ("MSA"), a
joint venture with Centerra Group, LLC , which includes 41% purchased from Jacobs
Group, LLC on January 26, 2018 . We include the financial results for MSA in our
consolidated financial statements. Net income attributable to non-controlling
interest for fiscal 2019 and fiscal 2018 was $3 million and $1 million ,
respectively, compared to net loss attributable to non-controlling interest of
$2 million for fiscal 2017.
Bookings and Backlog
We had net bookings of $14.5 billion and $13.7 billion during fiscal 2019 and
2018, respectively. Net bookings represent the estimated amount of revenue to be
earned in the future from funded and unfunded contract awards that were received
during the year, net of any adjustments to previously awarded backlog amounts.
We calculate net bookings as the year's ending backlog, plus the year's
revenues, less the prior year's ending backlog and any impacts from foreign
currency or acquisitions and divestitures.
Backlog represents the estimated amount of future revenues to be recognized
under negotiated contracts. We segregate our backlog into two categories as
follows:
• Funded Backlog. Funded backlog for contracts with the U.S. government
represents the value on contracts for which funding is appropriated less
revenues previously recognized on these contracts. Funded backlog for
contracts with non-U.S. government entities and commercial customersrepresents the estimated value on contracts, which may cover multiple
future years, under which we are obligated to perform, less revenues
previously recognized on the contracts.
• Negotiated Unfunded Backlog. Negotiated unfunded backlog represents
estimated amounts of revenue to be earned in the future from contracts for
which funding has not been appropriated and unexercised priced contract
options. Negotiated unfunded backlog does not include future potential
task orders expected to be awarded under IDIQ, GSA 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 task orders is
anticipated.
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PART II
The estimated value of our total backlog for the periods presented was as
follows:
January 3, December 28,
2020 2018
(in millions)
Defense Solutions:
Funded backlog $ 2,417 $ 2,821
Negotiated unfunded backlog 9,150 6,925
Total Defense Solutions backlog $ 11,567 $ 9,746
Civil:
Funded backlog $ 1,913 $ 2,304
Negotiated unfunded backlog 5,802 5,045
Total Civil backlog $ 7,715 $ 7,349
Health:
Funded backlog $ 1,083 $ 1,254
Negotiated unfunded backlog 3,725 2,483
Total Health backlog $ 4,808 $ 3,737
Total:
Funded backlog $ 5,413 $ 6,379
Negotiated unfunded backlog 18,677 14,453
Total backlog $ 24,090 $ 20,832
Total backlog at December 28, 2018 included $165 million within our Civil
segment attributable to our held for sale commercial cybersecurity business (see
"Note 7-Divestitures" of the notes to the consolidated financial statements
contained within this Annual Report on Form 10-K).
Bookings and backlog fluctuate from period to period depending on our success
rate in winning contracts and the timing of contract awards, renewals,
modifications and cancellations, as well as foreign currency movements. Contract
awards may be negatively impacted by ongoing industry-wide delays in procurement
decisions and budget cuts by the U.S. government as discussed in "Business
Environment and Trends" in this Annual Report on Form 10-K.
We expect to recognize a substantial portion of our funded backlog as revenues
within the next 12 months. However, the U.S. government may cancel any contract
at any time through a termination for the convenience of the U.S. government. In
addition, certain contracts with commercial or non-U.S. government customers may
include provisions that allow the customer to cancel at any time. Most of our
contracts have cancellation terms that would permit us to recover all or a
portion of our incurred costs and fees for work performed.
Contract Types
Our earnings and profitability may vary materially depending on changes in the
proportionate amount of revenues derived from each type of contract. For a
discussion of the types of contracts under which we generate revenues, see
"Business-Contract Types" in Part I of this Annual Report on Form 10-K. Revenues
by contract type as a percentage of our total revenues for the periods presented
were as follows:
Year Ended
January 3, December 28, December 29,
2020 2018 2017
Cost-reimbursement and fixed-price-incentive-fee 54 % 54 % 56 %
Firm-fixed-price 33 31 28
Time-and-materials and fixed-price-level-of-effort 13 15 16
Total 100 % 100 % 100 %
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PART II
Liquidity and Capital Resources
Overview of Liquidity
As of January 3, 2020 , we had $668 million in cash and cash equivalents. In
addition, we have a secured revolving credit facility which can provide up to
$750 million in secured borrowing capacity, if required. During fiscal 2019 and
2018, there were no borrowings outstanding under the credit facility and we were
in compliance with the financial covenants.
At January 3, 2020 and December 28, 2018 , we had outstanding debt of $3.0
billion and $3.1 billion , respectively. The notes outstanding as of January 3,
2020 , contain financial covenants and customary restrictive covenants. We were
in compliance with all covenants as of January 3, 2020 . During fiscal 2019, 2018
and 2017, we made $80 million , $59 million , and $209 million of principal
payments, respectively, on our long-term debt. This activity included $69
million , $46 million and $76 million of principal payments on our senior secured
term loans during fiscal 2019, 2018 and 2017, respectively. In April 2018 , we
made a required debt prepayment of $10 million on our senior secured term loans.
The prepayment was a result of the annual excess cash flow calculation clause in
our credit agreements. In addition to the required quarterly payments, we
prepaid $130 million on our senior secured term loans during fiscal 2017.
We paid dividends of $198 million for fiscal 2019, 2018 and 2017.
We may from time to time seek to retire or purchase our outstanding debt through
cash purchases in the open market, privately negotiated transactions or
otherwise. Such repurchases, if any, will depend on prevailing market
conditions, our liquidity requirements, contractual restrictions and other
factors. The amounts involved may be material.
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 ("ASR") 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.
During fiscal 2019 and 2018, we entered into ASR agreements with a financial
institution, whereby we paid an aggregate of $400 million and $250 million ,
respectively, and received approximately 6 million and 4 million shares,
respectively, of Leidos outstanding shares (see "Note 19-Earnings Per Share" of
the notes to the consolidated financial statements contained within this Annual
Report on Form 10-K). The purchases were recorded to "Additional paid-in
capital" in the consolidated balance sheets. All shares delivered were
immediately retired.
Additionally, during fiscal 2019 and 2018, we made open market repurchases of
our common stock for an aggregate purchase price of $25 million and $167
million , respectively. During fiscal 2017, there were no open market repurchases
of our common stock.
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 and, if needed, borrowings from our revolving credit
facility.
On January 17, 2020 (the "Closing Date"), we entered into a Credit Agreement
with certain financial institutions, which provides for a senior unsecured term
loan A facility in an aggregate principal amount of $1.9 billion (the "Term Loan
Facility") and a $750 million senior unsecured revolving facility. We used the
proceeds of the Term Loan Facility and cash on hand on the Closing Date to repay
in full all indebtedness, and terminate all commitments, under, and discharge
and release all guarantees and liens existing in connection with the Credit
Agreements entered into in August 2016 . Additionally, on January 31, 2020 , in
connection with the acquisition of Dynetics, Inc. ("Dynetics"), we entered into
a Bridge Credit Agreement with certain financial institutions, which provides
for a senior unsecured 364-day bridge loan facility in an aggregate principal
amount of $1.25 billion (the "Bridge Facility"). We used the proceeds of the
Bridge Facility and cash on hand to fund the purchase of Dynetics and repay in
full all third party indebtedness of Dynetics , terminate all commitments
thereunder and discharge and release all existing guarantees and liens. See
"Note 27-Subsequent Events" of the notes to the consolidated financial
statements contained within this Annual Report on Form 10-K for further details
regarding these transactions.
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PART II
Summary of Cash Flows
The following table summarizes cash flow information for the periods presented:
Year Ended
January 3, December 28, December 29,
2020 2018 2017
(in millions)
Net cash provided by operating activities $ 992 $ 768 $ 526
Net cash provided by (used in) investing
activities 65 (114 ) (71 )
Net cash used in financing activities (709 ) (707 ) (429 )
Net increase (decrease) in cash, cash
equivalents and restricted cash $ 348 $ (53 ) $ 26
Net cash provided by operating activities increased$224 million for fiscal 2019 as compared to fiscal 2018. The increase was primarily due to more favorable timing of working capital changes including higher advance payments from customers,$59 million received for the Greek arbitration award and lower payments for integration and restructuring costs. These activities were partially offset by higher tax payments, the timing of interest payments and$60 million of proceeds received from the termination of interest rate swaps in the prior year. Net cash provided by operating activities increased$242 million for fiscal 2018 as compared to fiscal 2017. The increase was primarily due to lower payments for taxes, integration and restructuring costs and proceeds received from the termination of interest rate swaps. This was partially offset by$24 million of cash paid related to the 2016 acquisition of Lockheed Martin's Information Systems & Global Solutions business ("IS &GS Business"). Net cash provided by investing activities increased$179 million for fiscal 2019 as compared to fiscal 2018. The increase was primarily due to$178 million of proceeds received for the dispositions of our commercial cybersecurity and health staff augmentation businesses,$96 million of proceeds received for the sale of real estate properties and$81 million of cash paid in the prior year related to our 2016 acquisition. These activities were partially offset by$94 million of cash paid related to the acquisition of IMX, higher purchases of property, equipment and software and lower proceeds from promissory notes. Net cash used in investing activities increased$43 million for fiscal 2018 as compared to fiscal 2017. The increase was primarily due to$81 million of cash paid related to the 2016 acquisition of theIS &GS Business, partially offset by$40 million of proceeds from the settlement of a promissory note. Net cash used in financing activities increased$2 million for fiscal 2019 as compared to fiscal 2018. The increase was primarily due to the timing of debt payments and higher stock repurchases, partially offset by$23 million of cash paid related to a tax indemnification in the prior year and the timing of issuances of stock. Net cash used in financing activities increased$278 million for fiscal 2018 as compared to fiscal 2017. The increase was primarily due to$250 million of stock repurchases under the ASR program,$167 million of open market stock repurchases and$23 million of cash paid related to a tax indemnification liability. This was partially offset by$150 million of lower debt payments and$14 million of proceeds received from a real estate financing transaction. 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 26-Commitments" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K. 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 resources, operations or financial condition.Leidos Holdings, Inc. Annual Report - 40
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PART II
Contractual Obligations
The following table summarizes, as of January 3, 2020 , our obligations to make
future payments pursuant to certain contracts or arrangements and provides an
estimate of the fiscal years in which these obligations are expected to be
satisfied:
2025 and
Total 2020 2021 2022 2023 2024 thereafter
(in millions)
Contractual obligations(1):
Long-term debt (including current
portion)(2) $ 3,954 $ 627 $ 206 $ 203 $ 709 $ 102 $ 2,107
Operating lease obligations 516 145 91 74 54 39 113
Finance lease obligations 7 5 1 - - - 1Other long-term liabilities(3) 168 9 23 8 9 7
112
Total contractual obligations
(1) We have excluded purchase orders for services or products to be delivered
pursuant to
recourse under normal contract termination clauses.
(2) Includes total interest payments on our outstanding debt. Interest payments
represent
million of the balance for fiscal 2020, 2021, 2022, 2023 and 2024,
respectively, and
interest payments on our outstanding term loan debt are calculated based on
the stated variable rates of the notes as of
interest payments on our outstanding senior fixed rate secured and unsecured
notes are calculated based on the stated fixed rates and do not reflect the
variable interest component due to the interest rate swap agreements.
(3) Other long-term liabilities were allocated by fiscal year as follows:
liabilities under deferred compensation arrangements are based upon the
average annual payments in prior years upon termination of employment by
participants and other liabilities are based on the fiscal year that theliabilities are expected to be realized. The table above does not include
income tax liabilities for uncertain tax positions of
million of other tax liabilities, as we are not able to reasonably estimate
the timing of payments in individual years due to uncertainties in the
timing of audit outcomes and when settlements will become due. There is no
obligation included for our foreign defined benefit pension plan, as the
plan is overfunded as of
changes in these pension obligations, see "Note 22-Retirement Plans" of the
notes to the consolidated financial statements contained within this Annual
Report on Form 10-K.
Commitments and Contingencies 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 13-Leases," "Note 25-Contingencies" and "Note 26-Commitments" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which are prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP"). The preparation of these financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Management evaluates these estimates and assumptions on an ongoing basis. Our estimates and assumptions have been prepared by management on the basis of the most current and best available information. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions and conditions. We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our results of operations or financial condition. • Revenue Recognition
•
• Income Taxes
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Revenue Recognition
Our revenues from contracts with customers are from offerings including cyber;
digital modernization; integrated systems; mission software systems; mission
support; operations and logistics; and sensors, collection and phenomenology,
primarily with the U.S. government and its agencies. We also serve various state
and local governments, foreign governments and U.S. commercial customers.
We perform under various types of contracts, which include firm-fixed-price
("FFP"), time-and-materials ("T&M"), fixed-price-level-of-effort ("FP-LOE"),
cost-plus-fixed-fee, cost-plus-award-fee, cost-plus-incentive-fee and
fixed-price-incentive-fee contracts.
To determine the proper revenue recognition, we first evaluate whether we have a
duly approved and enforceable contract with a customer, in which the rights of
the parties and payment terms are identified, and collectability is probable. We
also evaluate whether two or more contracts should be combined and accounted for
as a single contract, including the task orders issued under an IDIQ award. In
addition, we assess contract modifications to determine whether changes to
existing contracts should be accounted for as part of the original contract or
as a separate contract. Contract modifications for us generally relate to
changes in contract specifications and requirements and do not add distinct
services, and therefore are accounted for as part of the original contract. If
contract modifications add distinct goods or services and increase the contract
value by an amount that reflects the standalone selling price, those
modifications are accounted for as separate contracts.
Most of our contracts are comprised of multiple promises including the design
and build of software-based systems, integration of hardware and software
solutions, running and maintaining of IT infrastructure and procurement
services. In all cases, we assess if the multiple promises should be accounted
for as separate performance obligations or combined into a single performance
obligation. We generally separate multiple promises in a contract as separate
performance obligations if those promises are distinct, both individually and in
the context of the contract. If multiple promises in a contract are highly
interrelated or require significant integration or customization within a group,
they are combined and accounted for as a single performance obligation.
Our contracts with the U.S. government often contain options to renew existing
contracts for an additional period of time (generally a year at a time) under
the same terms and conditions as the original contract, and generally do not
provide the customer any material rights under the contract. We account for
renewal options as separate contracts when they include distinct goods or
services at standalone selling prices.
Contracts with the U.S. government are subject to the Federal Acquisition
Regulation ("FAR") and priced on estimated or actual costs of providing the
goods or services. The FAR provides guidance on types of costs that are
allowable in establishing prices for goods and services provided to the U.S.
government and its agencies. Each contract is competitively priced and bid
separately. Pricing for non-U.S. government agencies and commercial customers is
based on specific negotiations with each customer. In circumstances where the
standalone selling price is not directly observable, we estimate the standalone
selling price using the expected cost-plus margin approach. We exclude any taxes
collected or imposed when determining the transaction price.
Certain of our cost-plus and fixed-price contracts contain award fees, incentive
fees or other provisions that may either increase or decrease the transaction
price. These variable amounts generally are awarded upon achievement of certain
performance metrics, program milestones or cost targets and can be based upon
customer discretion. We estimate variable consideration at the most probable
amount that we expect to be entitled to, based on the assessment of the
contractual variable fee criteria, complexity of work and related risks, extent
of customer discretion, amount of variable consideration received historically
and the potential of significant reversal of revenue.
We allocate the transaction price of a contract to its performance obligations
in the proportion of its respective standalone selling prices. The standalone
selling price of our performance obligations is generally based on an expected
cost-plus margin approach, in accordance with the FAR. For certain product
sales, we use prices from other standalone sales. Substantially all of our
contracts do not contain a significant financing component, which would require
an adjustment to the transaction price of the contract.
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We recognize revenue on our service based contracts primarily over time as there
is continuous transfer of control to the customer over the duration of the
contract as we perform the promised services. For U.S. government contracts,
continuous transfer of control to the customer is evidenced by clauses in the
contract that allow the customer to unilaterally terminate the contract for
convenience, pay for costs incurred plus a reasonable profit and take control of
any work-in-process. Similarly, for non-U.S. government contracts, the customer
typically controls the work-in-process as evidenced by rights to payment for
work performed to date plus a reasonable profit to deliver products or services
that do not have an alternate use to us. Anticipated losses on service based
contracts are recognized when known. In certain product sales, where the
products have an alternate use, we recognize revenue at a point in time when the
customer takes control of the asset usually denoted by possession and legal
title.
On FFP contracts requiring system integration and cost-plus contracts with
variable consideration, revenue is recognized over time generally using a method
that measures the extent of progress towards completion of a performance
obligation, principally using a cost-input method (referred to as the
cost-to-cost method). Under the cost-to-cost method, revenue is recognized based
on the proportion of total costs incurred to estimated total costs-at-completion
("EAC"). A performance obligation's EAC includes all direct costs such as
materials, labor, subcontract costs, overhead and a ratable portion of general
and administrative costs. In addition, we include in an EAC of a performance
obligation future losses estimated to be incurred on onerous contracts, as and
when known. On certain other contracts, principally T&M, FP-LOE and
cost-plus-fixed-fee, revenue is recognized using the right-to-invoice practical
expedient as we are contractually able to invoice the customer based on the
control transferred to the customer. Additionally, on maintenance (generally
FFP) performance obligations, revenue is recognized over time using a
straight-line method as the control of the services is provided to the customer
evenly over the period of performance.
For certain performance obligations where we are not primarily responsible for
fulfilling the promise to provide the goods or service to the customer, do not
have inventory risk and do not have discretion in establishing the price for the
goods or service, we recognize revenue on a net basis.
Goodwill and Intangible Assets Impairment
Goodwill represents the excess of the fair value of consideration transferred,
plus the fair value of any non-controlling interests in the acquiree, over the
fair value of the net assets acquired and liabilities assumed as of the
acquisition date. Goodwill and intangible assets, net collectively represent 58%
and 63% of our total assets as of fiscal 2019 and 2018, respectively.
Goodwill is not amortized, but instead is tested annually for impairment at the
reporting unit level and tested more frequently if events or circumstances
indicate that the carrying value may not be recoverable. Our policy is to
perform our annual goodwill impairment evaluation as of the first day of the
fourth quarter of our fiscal year. During fiscal 2019 and 2018, we had six and
five reporting units, respectively, for the purpose of testing goodwill for
impairment.
Estimating the fair value of a reporting unit and intangibles requires the
exercise of significant judgment and assumptions including judgments about
expected future cash flows, weighted-average cost of capital, discount rates and
expected long-term growth rates. A significant change to these estimates and
assumptions could cause the estimated fair values of our reporting units and
intangible assets to decline and increase the risk of an impairment charge to
earnings. Intangible assets with finite lives are assessed for impairment
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable.
Intangible assets with indefinite lives are not amortized but are assessed for
impairment at the beginning of the fourth quarter and whenever events or changes
in circumstances indicate that the carrying value may not be recoverable.
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Income Taxes
We account for income taxes under the asset and liability method in accordance
with the accounting standard for income taxes. The asset and liability method
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the carrying amounts
and tax bases of assets and liabilities. Under this method, changes in tax rates
and laws are recognized in income in the period such changes are enacted.
We record net deferred tax assets to the extent we believe these assets will
more likely than not be realized. In making such determination, we consider all
available positive and negative evidence, including future reversals of existing
taxable temporary differences, projected future taxable income, tax planning
strategies and recent results of operations. If we were to determine that we
would be able to realize our deferred income tax assets in the future in excess
of their net recorded amount or would no longer be able to realize our deferred
income tax assets in the future as currently recorded, we would make an
adjustment to the valuation allowance which would decrease or increase the
provision for income taxes.
The provision for federal, state, foreign and local income taxes is calculated
on income before income taxes based on current tax law and includes the
cumulative effect of any changes in tax rates from those used previously in
determining deferred tax assets and liabilities. Such provision differs from the
amounts currently payable because certain items of income and expense are
recognized in different reporting periods for financial reporting purposes than
for income tax purposes.
We recognize liabilities for uncertain tax positions when it is more likely than
not that a tax position will not be sustained upon examination and settlement
with various taxing authorities. Liabilities for uncertain tax positions are
measured based upon the largest amount of benefit that is greater than 50%
likely of being realized upon ultimate settlement. We recognize interest and
penalties related to uncertain tax positions in our income tax expense.
Recently Adopted and Issued Accounting Pronouncements
For a discussion of these items, see "Note 2-Accounting Standards" of the notes
to the consolidated financial statements contained within this Annual Report on
Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks in the normal course of business. Our
current market risk exposures are primarily related to interest rates and
foreign currency fluctuations. The following information about our market
sensitive financial instruments contains forward-looking statements.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to
long-term debt obligations and derivatives. Our policy authorizes, with Board of
Directors' approval, the limited use of derivative instruments to hedge specific
interest rate risks.
Debt and derivatives
At January 3, 2020 and December 28, 2018 , we had $3.0 billion and $3.1 billion ,
respectively, of long-term debt, which included $1.9 billion and $2.0 billion ,
respectively, of senior secured term loans that have variable stated interest
rates that are determined based on the LIBOR rate plus a margin. As a result, we
may experience fluctuations in interest expense.
We have interest rate swap agreements to hedge the cash flows of a portion of
our variable rate senior secured term loans ("Variable Rate Loans"). Under the
terms of the interest rate swap agreements, we receive variable interest
payments based on the one-month LIBOR rate and pay interest at a fixed rate.
During fiscal 2018, we terminated our existing interest rate swaps and entered
into new interest rate swap agreements, which mature in August 2025 and have a
fixed interest rate of 3.00%, to hedge the cash flows of $1.5 billion of our
Variable Rate Loans. The interest rate swap agreements effectively converted a
portion of our variable rate borrowings to fixed rate borrowings. As of
January 3, 2020 , and December 28, 2018 , the fair value of our interest rate swap
agreements with respect to our variable rate senior secured loans was a
liability of $75 million and $32 million , respectively.
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Additionally, we have interest rate swap agreements with respect to all of the
$450 million aggregate principal outstanding on our fixed rate 4.45% notes
maturing in December 2020 . The interest rate swap agreements effectively
converted a portion of our fixed-rate debt to floating-rate debt tied to the
changes in the six-month LIBOR benchmark interest rate. As a result, we may
experience fluctuations in interest expense. Under the terms of the interest
rate swap agreements, we will receive semi-annual interest payments at the
coupon rate of 4.45% and will pay variable interest based on the six-month LIBOR
rate. As of January 3, 2020 , and December 28, 2018 , the fair value of our
interest rate swaps with respect to our fixed rate debt was a $2 million asset
and a $3 million liability, respectively.
The counterparties to these agreements are financial institutions. We do not
hold or issue derivative financial instruments for trading or speculative
purposes. We cannot predict future market fluctuations in interest rates and
their impact on our interest rate swaps. The net hypothetical 10% movement in
the six-month and one-month LIBOR rates would not have a significant impact on
our annual interest expense. For additional information related to our interest
rate swap agreements and debt, see "Note 15-Derivative Instruments" and "Note
16-Debt," respectively, of the notes to the consolidated financial statements
contained within this Annual Report on Form 10-K.
Cash and Cash Equivalents
As of January 3, 2020 , and December 28, 2018 , our cash and cash equivalents
included investments in several large institutional money market funds and bank
deposits. For fiscal 2019 and fiscal 2018, a hypothetical 10% interest rate
movement would not have a significant impact on the value of our holdings or on
interest income.
Foreign Currency Risk
Although the majority of our transactions are denominated in U.S. dollars, some
of our transactions are denominated in foreign currencies. Our foreign currency
exchange rate risk relates to receipts from customers, payments to suppliers and
certain intercompany transactions denominated in currencies other than our (or
one of our subsidiaries') functional currency. Our foreign operations
represented 8% of total revenues for fiscal 2019 and 9% of total revenues for
fiscal 2018 and 2017.
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