UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended September 27, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to
Commission file number 001-33072
(Exact name of registrant as specified in its charter) | ||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||
(Address of principal executive office) | (Zip Code) | ||||
(571 ) 526-6000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading symbol(s) | Name of each exchange on which registered | ||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
☒ | Accelerated filer | ☐ | |||||||
Non-accelerated filer | ☐ | Smaller reporting company | |||||||
Emerging growth company | |||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares issued and outstanding of each of the issuer’s classes of common stock as of October 21, 2019, was 141,563,826 shares of common stock ($.0001 par value per share).
LEIDOS HOLDINGS, INC.
FORM 10-Q
TABLE OF CONTENTS
Part I | Page | |
Item 1. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Part II | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements.
LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 27, 2019 | December 28, 2018 | |||||||
(in millions) | ||||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | $ | ||||||
Receivables, net | ||||||||
Other current assets | ||||||||
Assets held for sale | ||||||||
Total current assets | ||||||||
Property, plant and equipment, net | ||||||||
Intangible assets, net | ||||||||
Goodwill | ||||||||
Operating lease right-of-use assets, net | — | |||||||
Other assets | ||||||||
$ | $ | |||||||
LIABILITIES AND EQUITY | ||||||||
Accounts payable and accrued liabilities | $ | $ | ||||||
Accrued payroll and employee benefits | ||||||||
Long-term debt, current portion | ||||||||
Liabilities held for sale | ||||||||
Total current liabilities | ||||||||
Long-term debt, net of current portion | ||||||||
Operating lease liabilities | — | |||||||
Deferred tax liabilities | ||||||||
Other long-term liabilities | ||||||||
Commitments and contingencies (Notes 20 and 21) | ||||||||
Stockholders’ equity: | ||||||||
Common stock, $.0001 par value, 500 million shares authorized, 141 million and 146 million shares issued and outstanding at September 27, 2019 and December 28, 2018, respectively | ||||||||
Additional paid-in capital | ||||||||
Retained earnings | ||||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ||||
Total Leidos stockholders’ equity | ||||||||
Non-controlling interest | ||||||||
Total equity | ||||||||
$ | $ | |||||||
See accompanying notes to condensed consolidated financial statements.
1
LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 27, 2019 | September 28, 2018 | September 27, 2019 | September 28, 2018 | |||||||||||||
(in millions, except per share amounts) | ||||||||||||||||
Revenues | $ | $ | $ | $ | ||||||||||||
Cost of revenues | ||||||||||||||||
Selling, general and administrative expenses | ||||||||||||||||
Bad debt expense and recoveries | ( | ) | ( | ) | ||||||||||||
Integration and restructuring costs | ||||||||||||||||
Asset impairment charges | ||||||||||||||||
Equity earnings of non-consolidated subsidiaries | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Operating income | ||||||||||||||||
Non-operating (expense) income: | ||||||||||||||||
Interest expense, net | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Other (expense) income, net | ( | ) | ||||||||||||||
Income before income taxes | ||||||||||||||||
Income tax expense | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Net income | ||||||||||||||||
Less: net income attributable to non-controlling interest | ||||||||||||||||
Net income attributable to Leidos common stockholders | $ | $ | $ | $ | ||||||||||||
Earnings per share: | ||||||||||||||||
Basic | $ | $ | $ | $ | ||||||||||||
Diluted | ||||||||||||||||
See accompanying notes to condensed consolidated financial statements.
2
LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 27, 2019 | September 28, 2018 | September 27, 2019 | September 28, 2018 | |||||||||||||
(in millions) | ||||||||||||||||
Net income | $ | $ | $ | $ | ||||||||||||
Foreign currency translation adjustments | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Unrecognized (loss) gain on derivative instruments | ( | ) | ( | ) | ( | ) | ||||||||||
Total other comprehensive loss, net of taxes | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Comprehensive income | ||||||||||||||||
Less: comprehensive income attributable to non-controlling interest | ||||||||||||||||
Comprehensive income attributable to Leidos common stockholders | $ | $ | $ | $ | ||||||||||||
See accompanying notes to condensed consolidated financial statements.
3
LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)
Shares of common stock | Additional paid-in capital | Retained earnings | Accumulated other comprehensive loss | Leidos Holdings, Inc. stockholders' equity | Non-controlling interest | Total | |||||||||||||||||||||
(in millions, except for per share amounts) | |||||||||||||||||||||||||||
Balance at December 28, 2018 | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||||
Cumulative adjustments related to ASU adoption | — | — | — | ||||||||||||||||||||||||
Balance at December 29, 2018 | ( | ) | |||||||||||||||||||||||||
Net income | — | — | — | — | |||||||||||||||||||||||
Other comprehensive loss, net of taxes | — | — | — | ( | ) | ( | ) | — | ( | ) | |||||||||||||||||
Issuances of stock | — | — | — | ||||||||||||||||||||||||
Repurchases of stock and other | ( | ) | ( | ) | — | — | ( | ) | — | ( | ) | ||||||||||||||||
Dividends of $0.32 per share | — | — | ( | ) | — | ( | ) | — | ( | ) | |||||||||||||||||
Stock-based compensation | — | — | — | — | |||||||||||||||||||||||
Balance at March 29, 2019 | ( | ) | |||||||||||||||||||||||||
Net income | — | — | — | ||||||||||||||||||||||||
Other comprehensive loss, net of taxes | — | — | — | ( | ) | ( | ) | — | ( | ) | |||||||||||||||||
Issuances of stock | — | — | — | — | |||||||||||||||||||||||
Repurchases of stock and other | — | ( | ) | — | — | ( | ) | — | ( | ) | |||||||||||||||||
Dividends of $0.32 per share | — | — | ( | ) | — | ( | ) | — | ( | ) | |||||||||||||||||
Stock-based compensation | — | — | — | — | |||||||||||||||||||||||
Other | — | ( | ) | — | — | ( | ) | ( | ) | ( | ) | ||||||||||||||||
Balance at June 28, 2019 | ( | ) | |||||||||||||||||||||||||
Net income | — | — | — | ||||||||||||||||||||||||
Other comprehensive loss, net of taxes | — | — | — | ( | ) | ( | ) | — | ( | ) | |||||||||||||||||
Repurchases of stock and other | ( | ) | ( | ) | — | — | ( | ) | — | ( | ) | ||||||||||||||||
Dividends of $0.34 per share | — | — | ( | ) | — | ( | ) | — | ( | ) | |||||||||||||||||
Stock-based compensation | — | — | — | — | |||||||||||||||||||||||
Balance at September 27, 2019 | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||||
See accompanying notes to condensed consolidated financial statements.
4
LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED) [CONTINUED]
Shares of common stock | Additional paid-in capital | (Accumulated deficit) retained earnings | Accumulated other comprehensive income | Leidos Holdings, Inc. stockholders' equity | Non-controlling interest | Total | |||||||||||||||||||||
(in millions, except for per share amounts) | |||||||||||||||||||||||||||
Balance at December 29, 2017 | $ | $ | ( | ) | $ | $ | $ | $ | |||||||||||||||||||
Cumulative adjustments related to ASU adoptions | — | — | ( | ) | — | ||||||||||||||||||||||
Balance at December 30, 2017 | ( | ) | |||||||||||||||||||||||||
Net income | — | — | — | — | |||||||||||||||||||||||
Other comprehensive income, net of taxes | — | — | — | — | |||||||||||||||||||||||
Issuances of stock | — | — | — | ||||||||||||||||||||||||
Repurchases of stock and other | — | ( | ) | — | — | ( | ) | — | ( | ) | |||||||||||||||||
Dividends of $0.32 per share | — | — | ( | ) | — | ( | ) | — | ( | ) | |||||||||||||||||
Stock-based compensation | — | — | — | — | |||||||||||||||||||||||
Purchase of a non-controlling interest | — | — | — | — | — | ( | ) | ( | ) | ||||||||||||||||||
Balance at March 30, 2018 | |||||||||||||||||||||||||||
Net income | — | — | — | ||||||||||||||||||||||||
Other comprehensive loss, net of taxes | — | — | — | ( | ) | ( | ) | — | ( | ) | |||||||||||||||||
Issuances of stock | — | — | — | — | |||||||||||||||||||||||
Repurchases of stock and other | ( | ) | ( | ) | — | — | ( | ) | — | ( | ) | ||||||||||||||||
Dividends of $0.32 per share | — | — | ( | ) | — | ( | ) | — | ( | ) | |||||||||||||||||
Stock-based compensation | — | — | — | — | |||||||||||||||||||||||
Other | — | — | — | — | — | ( | ) | ( | ) | ||||||||||||||||||
Balance at June 29, 2018 | |||||||||||||||||||||||||||
Net income | — | — | — | — | |||||||||||||||||||||||
Other comprehensive loss, net of taxes | — | — | — | ( | ) | ( | ) | — | ( | ) | |||||||||||||||||
Issuances of stock | — | — | — | — | |||||||||||||||||||||||
Repurchases of stock and other | ( | ) | — | — | ( | ) | — | ( | ) | ||||||||||||||||||
Dividends of $0.32 per share | — | — | ( | ) | — | ( | ) | — | ( | ) | |||||||||||||||||
Stock-based compensation | — | — | — | — | |||||||||||||||||||||||
Purchase of a non-controlling interest | — | ( | ) | — | — | ( | ) | — | ( | ) | |||||||||||||||||
Other | — | — | — | — | — | ||||||||||||||||||||||
Balance at September 28, 2018 | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
See accompanying notes to condensed consolidated financial statements.
5
Nine Months Ended | ||||||||
September 27, 2019 | September 28, 2018 | |||||||
(in millions) | ||||||||
Cash flows from operations: | ||||||||
Net income | $ | $ | ||||||
Adjustments to reconcile net income to net cash provided by operations: | ||||||||
Gain on sale of businesses | ( | ) | ||||||
Depreciation and amortization | ||||||||
Stock-based compensation | ||||||||
Asset impairment charges | ||||||||
Bad debt expense | ||||||||
Other | ||||||||
Change in assets and liabilities, net of effects of acquisitions and dispositions: | ||||||||
Receivables | ||||||||
Other current assets | ( | ) | ( | ) | ||||
Accounts payable and accrued liabilities | ||||||||
Accrued payroll and employee benefits | ( | ) | ( | ) | ||||
Deferred income taxes and income taxes receivable/payable | ||||||||
Other long-term assets/liabilities | ( | ) | ||||||
Net cash provided by operating activities | ||||||||
Cash flows from investing activities: | ||||||||
Proceeds from disposition of businesses | ||||||||
Net proceeds from sale of assets | ||||||||
Acquisitions of businesses | ( | ) | ( | ) | ||||
Payments for property, equipment and software | ( | ) | ( | ) | ||||
Collections on promissory note | ||||||||
Other | ||||||||
Net cash provided by (used in) investing activities | ( | ) | ||||||
Cash flows from financing activities: | ||||||||
Repurchases of stock and other | ( | ) | ( | ) | ||||
Dividend payments | ( | ) | ( | ) | ||||
Payments of long-term debt | ( | ) | ( | ) | ||||
Proceeds from issuances of stock | ||||||||
Payment of tax indemnification liability | ( | ) | ||||||
Payments for non-controlling interest acquired | ( | ) | ||||||
Payments for debt issuance and modification costs | ( | ) | ||||||
Other | ( | ) | ||||||
Net cash used in financing activities | ( | ) | ( | ) | ||||
Net increase in cash, cash equivalents and restricted cash | ||||||||
Cash, cash equivalents and restricted cash at beginning of period | ||||||||
Cash, cash equivalents and restricted cash at end of period | $ | $ | ||||||
See accompanying notes to condensed consolidated financial statements.
6
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1–Nature of Operations and Basis of Presentation
Leidos Holdings, Inc. ("Leidos"), a Delaware corporation, is a holding company whose direct 100 %-owned subsidiary and principal operating company is Leidos, Inc. Leidos is a FORTUNE 500® science, engineering and information technology company that provides services and solutions in the defense, intelligence, civil and health markets. Leidos' domestic 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 and many other U.S. government civilian agencies, as well as state and local government agencies. Leidos' international customers include foreign governments and their agencies, primarily located in Australia and the United Kingdom ("U.K."). Unless indicated otherwise, references to the "Company," "we," "us" and "our" refer collectively to Leidos Holdings, Inc. and its consolidated subsidiaries. The Company operates in three reportable segments: Defense Solutions, Civil and Health. Additionally, the Company separately presents the costs associated with corporate functions as Corporate.
The Company has a controlling interest in Mission Support Alliance, LLC ("MSA"), a joint venture with Centerra Group, LLC. On January 26, 2018, the Company entered into a Membership Interest Purchase Agreement with Jacobs Engineering Group, Inc. ("Jacobs Group"), whereby the Company purchased 100 % of Jacobs Group's 41 % outstanding membership interest in MSA. As a result, Leidos increased its controlling ownership in MSA from 47 % to 88 %. The Company consolidates the financial results for MSA into its unaudited condensed consolidated financial statements.
The unaudited condensed consolidated financial statements also include the balances of all voting interest entities in which Leidos has a controlling voting interest ("subsidiaries") and a variable interest entity ("VIE") in which Leidos is the primary beneficiary. The consolidated balances of the Company’s VIE are not material to the Company’s unaudited condensed consolidated financial statements for the periods presented. Intercompany accounts and transactions between consolidated companies have been eliminated in consolidation.
The accompanying unaudited condensed financial information has been prepared in accordance with the rules of the U.S. Securities and Exchange Commission and accounting principles generally accepted in the United States of America ("GAAP"). Certain disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules. The preparation of financial statements in conformity 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, including those relating to estimated profitability of long-term contracts, indirect billing rates, allowances for doubtful accounts, inventories, fair value and impairment of intangible assets and goodwill, income taxes, stock-based compensation expense and contingencies. These estimates have been prepared by management on the basis of the most current and best available information; however, actual results could differ materially from those estimates.
Effective December 29, 2018, the Company adopted the requirements of Accounting Standards Update ("ASU") 2016-02 using the modified retrospective approach (see "Note 2–Accounting Standards"). Comparative information for the prior fiscal year has not been retrospectively adjusted.
Effective the beginning of fiscal 2019, certain contracts were reassigned between the Civil and Defense Solutions reportable segments (see "Note 19–Business Segments"). While this activity did not have a material impact on the Company's reportable segments, prior year segment results have been recast to reflect this change.
Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation. The Company combined "Dividends payable" and "Income taxes payable" with "Accounts payable and accrued liabilities" on the condensed consolidated balance sheets. Additionally, the Company reclassified bad debt expense from "Selling, general and administrative expenses" to "Bad debt expense and recoveries" on the condensed consolidated statement of income. The Company also separately disclosed "Bad debt expense" on the condensed consolidated statements of cash flows.
7
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which consist of normal recurring adjustments, necessary for a fair presentation thereof. The results reported in these unaudited condensed consolidated financial statements are not necessarily indicative of the results that may be expected for the entire year. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K filed on February 19, 2019.
Note 2–Accounting Standards
Accounting Standards Updates Adopted
ASU 2016-02, ASU 2018-10, ASU 2018-11, ASU 2018-20 and ASU 2019-01, Leases (Topic 842)
In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-02 ("ASC 842"), which supersedes the lease guidance under Leases (Topic 840) and makes several changes, such as requiring an entity to recognize a right-of-use ("ROU") asset and corresponding lease obligation on the balance sheet, classified as financing or operating, as appropriate. The update is effective for public companies for annual and interim reporting periods beginning after December 15, 2018, and should be adopted under the modified retrospective approach.
In July 2018, the FASB issued ASU 2018-10 "Codification Improvements to Topic 842, Leases" to add clarity to certain areas within ASU 2016-02, and ASU 2018-11 "Targeted Improvements", to add an additional and optional transition method to adopt the new leases standard by allowing recognition of a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The ASU also provided lessors with a practical expedient, by class of underlying asset, to not separate non-lease components from the associated lease components, similar to the expedient provided for lessees. In December 2018, the FASB issued ASU 2018-20 "Narrow-Scope Improvements for Lessors" to add clarity to lessors accounting for sales taxes and other similar taxes collected from lessees, accounting for variable payments for contracts with lease and non-lease components and accounting for certain lessor costs. In March 2019, the FASB issued ASU 2019-01 "Codification Improvements" to Leases (Topic 842) to clarify the codification more generally and/or to correct unintended application of guidance. The effective date and transition requirements of these updates are the same as ASU 2016-02.
The Company has elected to adopt certain practical expedients provided under ASC 842, including the options to not apply lease recognition for short-term leases, reassess whether expired or existing contracts contain leases, reassess lease classification for expired or existing leases, reassess initial direct costs, and combine lease and non-lease components in revenue arrangements when (i) the timing and pattern of revenue recognition for the components are the same and (ii) the lease component if accounted for separately, would be classified as an operating lease. The Company did not elect the hindsight practical expedient to determine the lease term for existing leases and in assessing impairment for the ROU assets. The Company also applies a single discount rate to a portfolio of leased assets with similar durations.
Effective December 29, 2018, the Company adopted the requirements of ASC 842 using the modified retrospective approach. Comparative information for the prior fiscal year has not been retrospectively adjusted.
As a result of the adoption of the new standard, the Company recorded $433 million and $486 million of ROU assets and lease liabilities, respectively, primarily due to its operating leases, to the Company's consolidated balance sheets. The standard did not have a material impact on the consolidated statements of income and consolidated statements of cash flows. The Company also recorded a $48 million increase in retained earnings due to the cumulative effect of recognizing the gain, net of taxes, related to the sale of the San Diego properties (see "Note 11–Property, Plant and Equipment").
8
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The cumulative effect of the changes made to the Company's condensed consolidated balance sheet for the adoption of ASU 2016-02 was as follows:
Balance at December 28, 2018 | Adjustments due to ASU 2016-02 | Balance at December 29, 2018 | ||||||||||
(in millions) | ||||||||||||
Assets - non-current: | ||||||||||||
Property, plant and equipment, net | $ | $ | $ | |||||||||
Operating lease right-of-use assets, net | ||||||||||||
Liabilities - current: | ||||||||||||
Accounts payable and accrued liabilities | $ | $ | $ | |||||||||
Long-term debt, current portion | ||||||||||||
Liabilities - non-current: | ||||||||||||
Long-term debt, net of current portion | $ | $ | ( | ) | $ | |||||||
Operating lease liabilities | ||||||||||||
Deferred tax liabilities | ||||||||||||
Other long-term liabilities | ( | ) | ||||||||||
Equity: | ||||||||||||
Retained earnings | $ | $ | $ | |||||||||
Accounting Standards Updates Issued But Not Yet Adopted
ASU 2016-13, ASU 2018-19 and ASU 2019-05, Financial Instruments – Credit Losses (Topic 326)
In June 2016, the FASB issued ASU 2016-13, which eliminates the requirement that a credit loss on a financial instrument be "probable" prior to recognition. Instead, a valuation allowance will be recorded to reflect an entity's current estimate of all expected credit losses, based on both historical and forecasted information related to an instrument. The update is effective for public companies for annual and interim reporting periods beginning after December 15, 2019, and should be adopted using a modified retrospective approach, which applies a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. A prospective approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date and loans and debt securities acquired with deteriorated credit quality. Early adoption is permitted.
In November 2018, the FASB issued ASU 2018-19 "Codification Improvements to Topic 326, Financial Instruments - Credit Losses" to add clarity to certain areas within ASU 2016-13. In May 2019, the FASB issued ASU 2019-05 "Financial Instruments - Credit Losses (Topic 326), Target Transition Relief" which provided transition relief for entities adopting ASU 2016-13 by allowing the election of the fair value option on certain financial instruments. The effective date and the transition methodology for the amendments in these updates are the same as in ASU 2016-13.
9
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 3–Significant Accounting Policies
Leases
Lessee
The Company has facilities and equipment lease arrangements. An arrangement is determined to be a lease at inception if it conveys the right to control the use of identified property and equipment for a period of time in exchange for consideration. ROU assets represent the Company’s right to use an underlying asset over the lease term and lease liabilities represent its obligation to make lease payments arising from the lease.
ROU assets and lease liabilities are recorded on the consolidated balance sheet at lease commencement date based on the present value of the future minimum lease payments over the lease term. As the Company generally does not know the implicit rate for its leases, the discount rate used is the Company’s incremental borrowing rate which is determined based on the rate of interest that the Company would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. An ROU asset is initially measured by the present value of the remaining lease payments, plus initial direct costs and prepaid lease payments, less any lease incentives received before commencement. The remaining lease cost is allocated over the remaining lease term on a straight-line basis unless another systematic or rational basis is more representative of the pattern in which the underlying asset is expected to be used. ROU assets are evaluated for impairment in a manner consistent with the treatment of other long-lived assets.
Certain of the Company’s facility leases contain options to renew or extend the terms of the lease which are included in the determination of the ROU assets and lease liabilities when it is reasonably certain that the Company will exercise the option. The Company's leases may also include variable lease payments such as an escalation clause based on consumer price index rates, maintenance costs and utilities. Variable lease payments that depend on an index or a rate are included in the determination of ROU assets and lease liabilities using the index or rate at the lease commencement date, whereas variable lease payments that do not depend on an index or rate are recorded as lease expense in the period incurred. At September 27, 2019, the Company did not have any lease agreements with residual value guarantees.
As a result of the adoption of ASC 842, the Company elected to not separate non-lease components from lease components and instead account for both components as a single lease.
The related lease payments on the Company’s short-term facilities and equipment leases are recognized as expense on a straight-line basis over the lease term.
Lessor
The Company is a lessor on certain equipment sales-type and operating lease arrangements with its customers. To be considered lease revenue, the contract must contain a specified asset, the Company must not have a substantive substitution right, the customer must have the right to direct the use of the specified asset during the period of use and the customer must have the right to obtain substantially all of the economic benefit of the specified asset.
Certain arrangements may contain variable payments that depend on an index or rate and are measured using the index or rate on the commencement date. Arrangements may also contain options to renew or extend the performance period. Option periods are included in the lease term if the Company determines that it is reasonably certain the customer will exercise an option.
The Company has arrangements that contain both lease and non-lease components. The Company will account for them as one unit of account if the timing and pattern of transfer is identical for both the lease and the non-lease components and the lease component would be classified as an operating lease if accounted for separately. If both criteria are met and the predominant component is a lease, then the entire arrangement will be accounted for in accordance with ASC 842. If the Company accounts for an arrangement both as a lease and non-lease component, then the allocation of consideration for each component will be based the relative standalone sales price.
10
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Changes in Estimates on Contracts
Changes in estimates related to contracts accounted for using the cost-to-cost method of accounting are recognized in the period in which such changes are made for the inception-to-date effect of the changes, with the exception of contracts acquired through a business combination, where the adjustment is made for the period commencing from the date of acquisition.
Changes in estimates on contracts were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 27, 2019 | September 28, 2018 | September 27, 2019 | September 28, 2018 | |||||||||||||
(in millions, except per share amounts) | ||||||||||||||||
Favorable impact | $ | $ | $ | $ | ||||||||||||
Unfavorable impact | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Net impact to income before income taxes | $ | $ | $ | $ | ||||||||||||
Impact on diluted EPS attributable to Leidos common stockholders | $ | $ | $ | $ | ||||||||||||
The impact on diluted earnings per share ("EPS") attributable to Leidos common stockholders is calculated using the Company's statutory tax rate.
Revenue Recognized from Prior Obligations
Revenue recognized from performance obligations satisfied in previous periods was $17 million and $36 million for the quarter and nine months ended September 27, 2019, respectively and $18 million and $84 million for the quarter and nine months ended September 28, 2018, respectively. The changes primarily relate to revisions of variable consideration, including award and incentive fees, and revisions to estimates at completion resulting from changes in contract scope, mitigation of contract risks or due to true-ups of contract estimates at the end of contract performance.
Cash and Cash Equivalents
11
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 4–Leases
Lessee
The Company's ROU assets and lease liabilities consisted of the following:
Balance sheet line item | September 27, 2019 | |||||
(in millions) | ||||||
ROU assets: | ||||||
Finance leases | Property, plant and equipment, net | $ | ||||
Operating leases | Operating lease right-of-use assets, net | |||||
$ | ||||||
Current lease liabilities: | ||||||
Finance leases | Long-term debt, current portion | $ | ||||
Operating leases | Accounts payable and accrued liabilities | |||||
$ | ||||||
Non-current lease liabilities: | ||||||
Finance leases | Long-term debt, net of current portion | $ | ||||
Operating leases | Operating lease liabilities | |||||
$ | ||||||
The Company's total lease cost for the periods presented consisted of the following:
Three Months Ended | Nine Months Ended | |||||||
September 27, 2019 | September 27, 2019 | |||||||
(in millions) | ||||||||
Finance lease cost: | ||||||||
Amortization of ROU assets | $ | $ | ||||||
Operating lease cost | ||||||||
Variable lease cost | ||||||||
Short-term lease cost | ||||||||
Less: Sublease income | ( | ) | ( | ) | ||||
Total lease cost | $ | $ | ||||||
The Company's lease costs are included in "Cost of revenues" and "Selling, general and administrative expenses" within the condensed consolidated statements of income.
Lease terms and discount rates related to leases were as follows:
September 27, 2019 | |||
Weighted-average remaining lease term (in years): | |||
Finance leases | |||
Operating leases | |||
Weighted-average discount rate: | |||
Finance leases | % | ||
Operating leases | % | ||
12
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Other information related to leases was as follows:
Nine Months Ended | ||||
September 27, 2019 | ||||
(in millions) | ||||
Cash paid for amounts included in measurement of lease liabilities: | ||||
Operating cash flows from operating leases | $ | |||
Financing cash flows from finance leases | ||||
Lease liabilities arising from obtaining ROU assets: | ||||
Operating lease liabilities | $ | |||
The Company's future minimum lease commitments of its finance and operating leases on an undiscounted basis, reconciled to the respective lease liability at September 27, 2019, were as follows:
Fiscal Year Ending | Finance lease commitments | Operating lease commitments | ||||||
(in millions) | ||||||||
2019 (remainder of year) | $ | $ | ||||||
2020 | ||||||||
2021 | ||||||||
2022 | ||||||||
2023 | ||||||||
2024 and thereafter | ||||||||
Total undiscounted cash flows | ||||||||
Less: imputed interest | ( | ) | ||||||
Lease liability as of September 27, 2019 | $ | $ | ||||||
On January 24, 2018, the Company entered into a lease agreement with its current lessor for office space in a building to be constructed to function as the Company's new corporate headquarters in Reston, Virginia. The Company will occupy the space for an initial term of 148 months and rent expense will be $11 million for the first lease year, with an annual rent expense increase of 2.5 %. The Company currently expects construction to be completed and to take occupancy of the building by April 1, 2020, at which point the Company's lease agreements for its current corporate headquarters will terminate.
Disclosures related to periods prior to adoption of ASC 842
During the quarter and nine months ended September 28, 2018, the Company had $40 million and $120 million of net rental expense, respectively.
Future minimum lease commitments and sublease receipts, under non-cancelable operating leases in effect at December 28, 2018, were as follows:
Fiscal Year Ending | Capital lease commitments | Operating lease commitments | Sublease receipts | |||||||||
(in millions) | ||||||||||||
2019 | $ | $ | $ | |||||||||
2020 | ||||||||||||
2021 | ||||||||||||
2022 | ||||||||||||
2023 | ||||||||||||
2024 and thereafter | ||||||||||||
Total | $ | $ | $ | |||||||||
13
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Lessor
As of September 27, 2019, the Company had a total net investment in sales-type leases, which relates to lease payment receivables, of $56 million. The current and non-current portions of net investment in sales-type leases are included within "Other current assets" and "Other assets", respectively, on the Company's consolidated balance sheets.
The components of lease income were as follows:
Three Months Ended | Nine Months Ended | |||||||||
Income statement line item | September 27, 2019 | September 27, 2019 | ||||||||
(in millions) | ||||||||||
Sales-type leases: | ||||||||||
Selling price at lease commencement | Revenues | $ | $ | |||||||
Cost of underlying asset | Cost of revenues | |||||||||
Operating loss | ( | ) | ( | ) | ||||||
Interest income on lease receivables | Revenues | |||||||||
$ | ( | ) | $ | ( | ) | |||||
Operating lease income | Revenues | $ | $ | |||||||
Total lease income | $ | $ | ||||||||
As of September 27, 2019, undiscounted cash flows for sales-type and operating leases for the next five years and thereafter are as follows:
Fiscal Year Ending | Sales-type leases | Operating leases | ||||||
(in millions) | ||||||||
2019 (remainder of year) | $ | $ | ||||||
2020 | ||||||||
2021 | ||||||||
2022 | ||||||||
2023 | ||||||||
2024 and thereafter | ||||||||
Total undiscounted cash flows | $ | $ | ||||||
Present value of lease payments as lease receivables | ||||||||
Difference between undiscounted cash flows and discounted cash flows | $ | |||||||
Note 5–Revenues
Remaining Performance Obligations
Remaining performance obligations represent the expected value of exercised contracts, both funded and unfunded, less revenue recognized to date. Remaining performance obligations do not include unexercised option periods and future potential task orders expected to be awarded under indefinite delivery/indefinite quantity ("IDIQ") contracts 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.
As of September 27, 2019, the Company had $10.8 billion of remaining performance obligations, which are expected to be recognized as revenue in the amounts of $2.7 billion, $5.0 billion and $3.1 billion for the remainder of fiscal 2019, fiscal 2020 and fiscal 2021 and thereafter, respectively.
14
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Disaggregation of Revenues
The Company disaggregates revenues by customer-type, contract-type and geographic location for each of its reportable segments. These categories represent how the nature, timing and uncertainty of revenues and cash flows are affected.
Prior year amounts have been recast for the contracts that were reassigned between the Defense Solutions and Civil reportable segments (see "Note 19–Business Segments").
Disaggregated revenues by customer-type were as follows:
Three Months Ended September 27, 2019 | Nine Months Ended September 27, 2019 | |||||||||||||||||||||||||||||||
Defense Solutions | Civil | Health | Total | Defense Solutions | Civil | Health | Total | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
DoD and U.S. Intelligence Community(1) | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Other government agencies(1)(2) | ||||||||||||||||||||||||||||||||
Commercial and non-U.S. customers | ||||||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Three Months Ended September 28, 2018 | Nine Months Ended September 28, 2018 | |||||||||||||||||||||||||||||||
Defense Solutions | Civil | Health | Total | Defense Solutions | Civil | Health | Total | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
DoD and U.S. Intelligence Community(3) | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Other government agencies(2)(3) | ||||||||||||||||||||||||||||||||
Commercial and non-U.S. customers | ||||||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
(1) For the nine months ended September 27, 2019, the Company reclassified $6 million within the Defense Solutions segment from "Other government agencies" to "DoD and U.S. Intelligence Community" to reflect the change in disaggregation of U.S. government customers in the current period.
(2) Includes federal government agencies other than the DoD and U.S. Intelligence Community, as well as state and local government agencies.
(3) For the quarter and nine months ended September 28, 2018, the Company reclassified $9 million and $34 million, respectively, within the Defense Solutions segment from "Other government agencies" to "DoD and U.S. Intelligence Community" to reflect the change in disaggregation of U.S. government customers in the current period.
Disaggregated revenues by contract-type were as follows:
Three Months Ended September 27, 2019 | Nine Months Ended September 27, 2019 | |||||||||||||||||||||||||||||||
Defense Solutions | Civil | Health | Total | Defense Solutions | Civil | Health | Total | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
Cost-reimbursement and fixed-price-incentive-fee | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Firm-fixed-price | ||||||||||||||||||||||||||||||||
Time-and-materials and fixed-price-level-of-effort | ||||||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
15
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three Months Ended September 28, 2018 | Nine Months Ended September 28, 2018 | |||||||||||||||||||||||||||||||
Defense Solutions | Civil | Health | Total | Defense Solutions | Civil | Health | Total | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
Cost-reimbursement and fixed-price-incentive-fee | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Firm-fixed-price | ||||||||||||||||||||||||||||||||
Time-and-materials and fixed-price-level-of-effort | ||||||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Cost-reimbursement and fixed-price-incentive-fee contracts are generally lower risk and have lower profits. Time-and-materials ("T&M") and fixed-price-level-of-effort contracts are also lower risk but profits may vary depending on actual labor costs compared to negotiated contract billing rates. Firm-fixed-price ("FFP") contracts offer the potential for higher profits while increasing the Company’s exposure to risk of cost overruns.
Disaggregated revenues by geographic location were as follows:
Three Months Ended September 27, 2019 | Nine Months Ended September 27, 2019 | |||||||||||||||||||||||||||||||
Defense Solutions | Civil | Health | Total | Defense Solutions | Civil | Health | Total | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
United States | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
International | ||||||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Three Months Ended September 28, 2018 | Nine Months Ended September 28, 2018 | |||||||||||||||||||||||||||||||
Defense Solutions | Civil | Health | Total | Defense Solutions | Civil | Health | Total | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
United States | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
International | ||||||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
In some countries, there is an increased chance for economic, legal or political changes that may adversely affect the performance of the Company's services, sales of products or repatriation of profits. International transactions can also involve increased financial and legal risks arising from foreign exchange variability, imposition of tariffs or additional taxes and restrictive trade policies, and delays or failure to collect amounts due to differing legal systems.
For the quarter and nine months ended September 27, 2019, revenues exclude $58 million and $88 million, respectively, recognized under ASC 842. See "Note 4–Leases" for additional information regarding revenues recognized under ASC 842.
Note 6–Contract Assets and Liabilities
The Company’s performance obligations are satisfied either over time as work progresses or at a point in time. FFP contracts are typically billed to the customer using milestone payments while cost-reimbursable and T&M contracts are typically billed to the customer on a monthly or bi-weekly basis as indicated by the negotiated billing terms and conditions of the contract. As a result, for each of the Company’s contracts, the timing of revenue recognition, customer billings and cash collections results in a net contract asset or liability at the end of each reporting period.
Contract assets consist of unbilled receivables, which is the amount of revenue recognized that exceeds the amount billed to the customer, where right to payment is not just subject to the passage of time. Contract liabilities consist of deferred revenue.
16
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The components of contract assets and contract liabilities consisted of the following:
Balance sheet line item | September 27, 2019 | December 28, 2018 | ||||||||
(in millions) | ||||||||||
Contract assets - current: | ||||||||||
Unbilled receivables(1) | Receivables, net | $ | $ | |||||||
Contract liabilities - current: | ||||||||||
Deferred revenue | Accounts payable and accrued liabilities | $ | $ | |||||||
Contract liabilities - non-current: | ||||||||||
Deferred revenue | Other long-term liabilities | $ | $ | |||||||
(1) Balances exclude $460 million and $381 million determined to be billable at September 27, 2019, and December 28, 2018, respectively.
Revenue recognized for the quarter and nine months ended September 27, 2019 of $11 million and $200 million, respectively, was included as a contract liability at December 28, 2018. Revenue recognized for the quarter and nine months ended September 28, 2018 of $37 million and $164 million, respectively, was included as a contract liability at December 30, 2017 (date of adoption).
Note 7–Acquisitions
On August 15, 2019, the Company completed the acquisition of IMX Medical Management Services, Inc. and its affiliated businesses ("IMX") for preliminary purchase consideration of $95 million, which primarily included $90 million of cash paid and an additional $4 million paid to extinguish IMX's existing term loans and credit facility balances. The acquisition extends the Company's independent medical evaluation coverage area for commercial and federal customers.
The Company recorded $51 million of goodwill (which is deductible for tax purposes) and $42 million of intangible assets. The intangible assets primarily consist of $41 million for customer relationships. The amortization period for the customer relationships is 10 years.
At September 27, 2019, the Company had not finalized the determination of fair values allocated to assets and liabilities, including, but not limited to, intangible assets and accounts payable and accrued liabilities.
Note 8–Divestitures
Health Staff Augmentation Business
On September 12, 2019, the Company's Health segment disposed of its health staff augmentation business that was primarily focused on implementation and optimization services to hospital customers. The Company recorded an immaterial loss, which is primarily comprised of the $15 million sales price less the $12 million carrying value of net assets divested, preliminary net working capital adjustments and transaction related costs. This disposition did not meet the criteria to be classified as a discontinued operation in the Company's financial statements.
Commercial Cybersecurity Business
On February 20, 2019, the Company's Civil segment disposed of its commercial cybersecurity business in order to focus on providing solutions, including cybersecurity, to the Company's core markets of governments and highly regulated industries. In February 2019, the Company received initial proceeds of $171 million. During the quarter ended June 28, 2019, working capital adjustments were finalized, resulting in a final sales price of $166 million. The Company recorded a pre-tax gain on sale of $87 million, net of assets divested of $69 million and $10 million in transaction related costs. The gain was recorded in "Other (expense) income, net" on the condensed consolidated statements of income. This disposition did not meet the criteria to be classified as a discontinued operation in the Company's financial statements.
17
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The major classes of assets and liabilities divested were as follows (in millions):
Receivables, net | $ | |||
Other current assets | ||||
Property, plant and equipment, net | ||||
Intangible assets, net | ||||
Goodwill | ||||
Deferred tax assets | ||||
Total assets divested | $ | |||
Accounts payable and accrued liabilities | $ | ( | ) | |
Accrued payroll and employee benefits | ( | ) | ||
Other long-term liabilities | ( | ) | ||
Total liabilities divested | $ | ( | ) | |
Note 9–Goodwill
The following table presents changes in the carrying amount of goodwill by reportable segment:
Defense Solutions | Civil | Health | Total | |||||||||||||
(in millions) | ||||||||||||||||
Goodwill at December 29, 2017 | $ | $ | $ | $ | ||||||||||||
Foreign currency translation adjustments | ( | ) | ( | ) | ( | ) | ||||||||||
Transfers to assets held for sale | ( | ) | ( | ) | ||||||||||||
Adjustment to goodwill | ( | ) | ( | ) | ||||||||||||
Goodwill at December 28, 2018 | ||||||||||||||||
Goodwill re-allocation | ( | ) | ||||||||||||||
Acquisition of IMX | ||||||||||||||||
Divestiture of health staff augmentation business | ( | ) | ( | ) | ||||||||||||
Foreign currency translation adjustments | ( | ) | ( | ) | ( | ) | ||||||||||
Adjustment to goodwill | ||||||||||||||||
Goodwill at September 27, 2019 | $ | $ | $ | $ | ||||||||||||
The goodwill balances at September 27, 2019, December 28, 2018, and December 29, 2017 included accumulated goodwill impairment losses of $369 million and $117 million within the Health and Civil segments, respectively.
Effective the beginning of fiscal 2019, the Company changed the composition of its Defense Solutions reportable segment, which resulted in the identification of new operating segments and reporting units within Defense Solutions. In addition, certain contracts were reassigned between Civil and Defense solutions reportable segments (see "Note 19–Business Segments"). Consequently, the carrying amount of goodwill was re-allocated among the reporting units for the purpose of testing goodwill for impairment.
In conjunction with the changes mentioned above, the Company evaluated goodwill for impairment using a quantitative step one analysis, both before and after the changes were made, and determined that goodwill was not impaired. There were no goodwill impairments during the nine months ended September 27, 2019 and September 28, 2018.
During the quarter ended March 29, 2019, the Company recorded an immaterial correction of $3 million with respect to the fair value of assets acquired from Lockheed Martin's Information Systems & Global Solutions business ("the Transactions").
18
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 10–Intangible Assets
Intangible assets consisted of the following:
September 27, 2019 | December 28, 2018 | |||||||||||||||||||||||
Gross carrying value | Accumulated amortization | Net carrying value | Gross carrying value | Accumulated amortization | Net carrying value | |||||||||||||||||||
(in millions) | ||||||||||||||||||||||||
Finite-lived intangible assets: | ||||||||||||||||||||||||
Program and contract intangibles | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | ||||||||||||||
Software and technology | ( | ) | ( | ) | ||||||||||||||||||||
Customer relationships | ( | ) | ( | ) | ||||||||||||||||||||
Trade names | ||||||||||||||||||||||||
Total finite-lived intangible assets | ( | ) | ( | ) | ||||||||||||||||||||
Indefinite-lived intangible assets: | ||||||||||||||||||||||||
Trade names | — | — | ||||||||||||||||||||||
Total intangible assets | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | ||||||||||||||
Amortization expense was $43 million and $129 million, for the quarter and nine months ended September 27, 2019, respectively, and $50 million and $151 million for the quarter and nine months ended September 28, 2018, respectively.
Program and contract intangible assets are amortized over their respective estimated useful lives in proportion to the pattern of economic benefit based on expected future discounted cash flows. Customer relationships are amortized on a straight-line basis over their estimated useful lives. Software and technology intangible assets are amortized either on a straight-line basis over their estimated useful lives or over their respective estimated useful lives in proportion to the pattern of economic benefit based on expected future discounted cash flows, as deemed appropriate.
The estimated annual amortization expense as of September 27, 2019, was as follows:
Fiscal year ending | ||||
(in millions) | ||||
2019 (remainder of year) | $ | |||
2020 | ||||
2021 | ||||
2022 | ||||
2023 | ||||
2024 and thereafter | ||||
$ | ||||
19
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 11–Property, Plant and Equipment
Property, plant and equipment, net consisted of the following:
September 27, 2019 | December 28, 2018 | |||||||
(in millions) | ||||||||
Computers and other equipment | $ | $ | ||||||
Leasehold improvements | ||||||||
Office furniture and fixtures | ||||||||
Buildings and improvements | ||||||||
Land | ||||||||
Construction in progress | ||||||||
Less: accumulated depreciation | ( | ) | ( | ) | ||||
$ | $ | |||||||
Depreciation expense was $16 million and $45 million for the quarter and nine months ended September 27, 2019, respectively, and $14 million and $42 million for the quarter and nine months ended September 28, 2018, respectively.
Sale and Leaseback Agreements
Gaithersburg, MD Property
On December 31, 2018, the Company closed the sale and leaseback agreement relating to its land and building in Gaithersburg, MD. The Company received proceeds of $31 million, net of selling costs for the property, which had a carrying value of $31 million. The term of the lease is expected to end during fiscal 2020.
During the quarter ended March 30, 2018, an impairment charge of $7 million associated with this property was recorded within Corporate.
San Diego, CA Properties
On December 28, 2018, the Company closed the sale and leaseback agreement relating to two buildings and the adjacent land in San Diego, CA for consideration of $79 million, net of selling costs. The carrying value of the land and buildings was $14 million. The Company received cash proceeds of $14 million upon closing in December 2018, and received the remaining $65 million cash proceeds in January 2019. The term of the lease is expected to end during fiscal 2036.
Note 12–Fair Value Measurements
The accounting standard for fair value measurements establishes a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: observable inputs such as quoted prices in active markets (Level 1); inputs other than quoted prices in active markets for identical assets or liabilities that are observable either directly or indirectly or quoted prices that are not active (Level 2); and unobservable inputs in which there is little or no market data (e.g., discounted cash flow and other similar pricing models), which requires the Company to develop its own assumptions (Level 3).
The accounting guidance for fair value measurements requires that the Company maximize the use of observable inputs and minimize the use of unobservable inputs in determining fair value. The accounting guidance provides for the irrevocable option to elect, on a contract-by-contract basis, to measure certain financial assets and liabilities at fair value at inception of the contract and record any subsequent changes in fair value in earnings. The Company has not made fair value option elections on any of its financial assets and liabilities.
20
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The Company's financial instruments measured at fair value on a recurring basis consisted of the following:
September 27, 2019 | December 28, 2018 | |||||||||||||||
Carrying value | Fair value | Carrying value | Fair value | |||||||||||||
(in millions) | ||||||||||||||||
Financial assets: | ||||||||||||||||
Derivatives | $ | $ | $ | $ | ||||||||||||
Financial liabilities: | ||||||||||||||||
Derivatives | $ | $ | $ | $ | ||||||||||||
The Company's derivatives consisted of the fair value interest rate swaps on its $450 million, fixed rate 4.45 % senior secured notes maturing in December 2020 and cash flow interest rate swaps on $1.5 billion of the Company's variable rate senior secured term loans (see "Note 13–Derivative Instruments"). The fair value of the fair value interest rate swaps and cash flow interest rate swaps is determined based on observed values for underlying interest rates on the LIBOR yield curve and the underlying interest rate, respectively (Level 2 inputs).
The carrying amounts of the Company's financial instruments, other than derivatives, which include cash equivalents, accounts receivable, accounts payable and accrued expenses, are reasonable estimates of their related fair values. The carrying value of the Company's note receivable of $25 million and $24 million as of September 27, 2019, and December 28, 2018, respectively, approximates fair value as the stated interest rate within the agreement is consistent with current market rates used in notes with similar terms in the market (Level 2 inputs).
As of September 27, 2019, and December 28, 2018, the fair value of debt was $3.1 billion and the carrying amount was $3.0 billion and $3.1 billion, respectively (see "Note 14–Debt"). The fair value of long-term debt is determined based on current interest rates available for debt with terms and maturities similar to the Company’s existing debt arrangements (Level 2 inputs).
On August 15, 2019, the Company recorded non-financial instruments measured at fair value on a non-recurring basis in connection with the acquisition of IMX (see "Note 7–Acquisitions"). The preliminary fair values of the assets acquired and liabilities assumed were determined using Level 3 inputs. As of September 27, 2019, the Company did not have any assets or liabilities measured at fair value on a non-recurring basis.
Note 13–Derivative Instruments
The Company manages its risk to changes in interest rates through the use of derivative instruments. The Company does not hold derivative instruments for trading or speculative purposes. For fixed rate borrowings, the Company uses variable interest rate swaps, effectively converting fixed rate borrowings to variable rate borrowings. These swaps are designated as fair value hedges. For variable rate borrowings, the Company uses fixed interest rate swaps, effectively converting a portion of the variable interest rate payments to fixed interest rate payments. These swaps are designated as cash flow hedges.
The fair value of the Company's interest rate swaps was as follows:
Asset derivatives | ||||||||||
Balance sheet line item | September 27, 2019 | December 28, 2018 | ||||||||
(in millions) | ||||||||||
Fair value interest rate swaps | Other assets | $ | $ | |||||||
Liability derivatives | ||||||||||
Balance sheet line item | September 27, 2019 | December 28, 2018 | ||||||||
(in millions) | ||||||||||
Fair value interest rate swaps | Other long-term liabilities | $ | $ | |||||||
Cash flow interest rate swaps | Other long-term liabilities | |||||||||
$ | $ | |||||||||
21
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The cash flows associated with the interest rate swaps are classified as operating activities in the condensed consolidated statements of cash flows.
Fair Value Hedge
The Company has interest rate swap agreements to hedge the fair value of the $450 million fixed rate 4.45 % senior secured notes maturing in December 2020 (the "Notes"). The objective of these instruments is to hedge the Notes against changes in fair value due to the variability in the six-month LIBOR rate (the benchmark interest rate). Under the terms of the interest rate swap agreements, the Company 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.
The interest rate swaps were accounted for as a fair value hedge of the Notes and qualified for the shortcut method of hedge accounting, which allows for the assumption of no ineffectiveness. The resulting changes in the fair value of the interest rate swaps are fully offset by the changes in the fair value of the underlying debt (the hedged item) (See "Note 14–Debt").
The fair value of the Notes is stated at an amount that reflects changes in the six-month LIBOR rate subsequent to the inception of the interest rate swaps through the reporting date.
The following amounts were recorded on the condensed consolidated balance sheets related to cumulative basis adjustments for fair value hedges:
Carrying amount of hedged item | Cumulative amount of fair value adjustment included within the hedged item | |||||||||||||||
Balance sheet line item of hedged item | September 27, 2019 | December 28, 2018 | September 27, 2019 | December 28, 2018 | ||||||||||||
(in millions) | ||||||||||||||||
Long-term debt, net of current portion | $ | $ | $ | $ | ( | ) | ||||||||||
Cash Flow Hedges
The Company has interest rate swap agreements to hedge the cash flows of a portion of its variable rate senior secured term loans (the "Variable Rate Loans"). The objective of these instruments is to reduce variability in the forecasted interest payments of the Company's Variable Rate Loans, which are based on the LIBOR rate. Under the terms of the interest rate swap agreements, the Company will receive monthly variable interest payments based on the one-month LIBOR rate and will pay interest at a fixed rate. In February 2018, the Company entered into interest rate swap agreements to hedge the cash flows of an additional $250 million of its Variable Rate Loans. The interest rate swap agreements on $1.1 billion of the Company's Variable Rate Loans had a maturity date of December 2021 and a fixed interest rate of 1.08 %. The interest rate swap agreements on $300 million and $250 million of the Company's Variable Rate Loans both had a maturity date of August 2022 and fixed interest rates of 1.66 % and 2.59 %, respectively.
In September 2018, the Company terminated its existing interest rate swaps. The net derivative gain of $60 million related to the discontinued cash flow hedges remained within accumulated other comprehensive loss and is being reclassified into earnings over the remaining life of the original hedges as the hedged variable rate debt impacts earnings.
Additionally, in September 2018, the Company entered into new interest rate swap agreements to hedge the cash flows of $1.5 billion of the Company's Variable Rate Loans. These interest rate swap agreements have a maturity date of August 2025 and a fixed interest rate of 3.00 %. The interest rate swap transactions were accounted for as cash flow hedges. The gain/loss on the swap is reported as a component of other comprehensive income (loss) and is reclassified into earnings when the interest payments on the underlying hedged items impact earnings. A qualitative assessment of hedge effectiveness is performed on a quarterly basis, unless facts and circumstances indicate the hedge may no longer be highly effective.
22
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The effect of the Company's cash flow hedges on other comprehensive loss and earnings for the periods presented was as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 27, 2019 | September 28, 2018 | September 27, 2019 | September 28, 2018 | |||||||||||||
(in millions) | ||||||||||||||||
Total interest expense, net presented in the condensed consolidated statements of income in which the effects of cash flow hedges are recorded | $ | $ | $ | $ | ||||||||||||
Amount recognized in other comprehensive loss | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
Amount reclassified from accumulated other comprehensive loss to interest expense, net | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Note 14–Debt
The Company's debt consisted of the following:
Stated interest rate | Effective interest rate | September 27, 2019(1) | December 28, 2018(1) | |||||||||
(in millions) | ||||||||||||
Senior secured notes: | ||||||||||||
$450 million notes, due December 2020 | $ | $ | ||||||||||
$300 million notes, due December 2040 | ||||||||||||
Senior secured term loans: | ||||||||||||
$690 million Term Loan A, due August 2023 | ||||||||||||
$310 million Term Loan A, due August 2023 | ||||||||||||
$1,131 million Term Loan B, due August 2025 | ||||||||||||
Senior unsecured notes: | ||||||||||||
$250 million notes, due July 2032 | ||||||||||||
$300 million notes, due July 2033 | ||||||||||||
Notes payable and finance leases due on various dates through fiscal 2022 (see Note 2) | 2.85%-5.49% | Various | ||||||||||
Total long-term debt | ||||||||||||
Less: current portion | ||||||||||||
Total long-term debt, net of current portion | $ | $ | ||||||||||
(1) The carrying amounts of the senior secured term loans and notes and unsecured notes as of September 27, 2019, and December 28, 2018, include the remaining principal outstanding of $3,032 million and $3,073 million, respectively, less total unamortized debt discounts and deferred debt issuances costs of $37 million and $43 million, respectively, and a $3 million asset and $3 million liability related to the fair value interest rate swaps (see "Note 13–Derivative Instruments"), respectively.
The interest rate on the Company's senior secured term loans is determined based on the LIBOR rate plus a margin. The margin for the Term Loan A loans ranges from 1.25 % to 2.00 %, depending on the Company's senior secured leverage ratio, and is computed on a quarterly basis. At September 27, 2019, the current margin on Term Loan A was 1.50 % and the margin on Term Loan B was 1.75 %.
23
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The Company made principal payments on its long-term debt of $2 million and $50 million during the quarter and nine months ended September 27, 2019, respectively, and $15 million and $59 million during the quarter and nine months ended September 28, 2018, respectively. This activity included principal payments on its senior secured term loans of $41 million during the nine months ended September 27, 2019 and $15 million and $46 million during the quarter and nine months ended September 28, 2018, respectively. There were no principal payments on the Company's senior secured term loans for the quarter ended September 27, 2019. In April 2018, the Company made a required debt prepayment of $10 million on its senior secured term loans. The prepayment was a result of the annual excess cash flow calculation clause in the Company's credit agreements.
The Company has a revolving credit facility providing up to $750 million in secured borrowing capacity at interest rates determined based upon the LIBOR rate plus a margin that is subject to step-down provisions based on the Company's senior secured leverage ratio. The maturity date of this credit facility is August 2023. As of September 27, 2019, and December 28, 2018, there were no borrowings outstanding under the credit facility.
Amortization of the debt discount and deferred debt issuance costs related to the senior secured term loans and notes, unsecured notes and revolving credit facility was $2 million and $7 million for the quarter and nine months ended September 27, 2019, respectively, and $2 million and $8 million for the quarter and nine months ended September 28, 2018, respectively.
The senior secured term loans and notes, unsecured notes and revolving credit facility are fully and unconditionally guaranteed and contain certain customary restrictive covenants, including among other things, restrictions on the Company's ability to create liens and enter into sale and leaseback transactions under certain circumstances. The Company was in compliance with all covenants as of September 27, 2019.
Note 15–Accumulated Other Comprehensive Loss
Changes in the components of accumulated other comprehensive income (loss) were as follows:
Foreign currency translation adjustments | Unrecognized gain (loss) on derivative instruments | Pension adjustments | Total accumulated other comprehensive income (loss) | |||||||||||||
(in millions) | ||||||||||||||||
Balance at December 29, 2017 | $ | $ | $ | $ | ||||||||||||
Cumulative adjustments related to ASU adoptions | ( | ) | ||||||||||||||
Balance at December 30, 2017 | ( | ) | ||||||||||||||
Other comprehensive loss | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Taxes | ||||||||||||||||
Reclassification from accumulated other comprehensive loss | ( | ) | ( | ) | ||||||||||||
Balance at December 28, 2018 | ( | ) | ( | ) | ( | ) | ||||||||||
Other comprehensive loss | ( | ) | ( | ) | ( | ) | ||||||||||
Taxes | ||||||||||||||||
Reclassification from accumulated other comprehensive loss | ( | ) | ( | ) | ||||||||||||
Balance at September 27, 2019 | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
24
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 16–Earnings Per Share ("EPS")
The following table provides a reconciliation of the weighted average number of shares outstanding used to compute basic and diluted EPS for the periods presented:
Three Months Ended | Nine Months Ended | |||||||||||
September 27, 2019 | September 28, 2018 | September 27, 2019 | September 28, 2018 | |||||||||
(in millions) | ||||||||||||
Basic weighted average number of shares outstanding | ||||||||||||
Dilutive common share equivalents—stock options and other stock awards | ||||||||||||
Diluted weighted average number of shares outstanding | ||||||||||||
Anti-dilutive stock-based awards are excluded from the weighted average number of shares outstanding used to compute diluted EPS.
On February 21, 2019, the Company entered into an Accelerated Share Repurchase ("ASR") agreement with a financial institution to repurchase shares of its outstanding common stock. During the quarter ended March 29, 2019, the Company paid $200 million to the financial institution and received an initial delivery of 2.6 million shares. In April 2019, the Company received the final delivery of 0.6 million shares related to the ASR agreement. The total number of shares that the Company received under the ASR agreement was based on the volume-weighted-average-price of $63.52 per share for the period February 21, 2019 to April 29, 2019. The purchases were recorded to "Additional paid-in capital" in the condensed consolidated balance sheets. All shares delivered were immediately retired.
On August 1, 2019, the Company entered into an ASR agreement with a financial institution to repurchase shares of its outstanding common stock. During the quarter ended September 27, 2019, the Company paid $200 million to the financial institution and received 2.4 million shares related to the ASR agreement. The total number of shares that the Company received under the ASR agreement was based on the volume-weighted-average-price of $84.25 per share for the period August 1, 2019 to September 25, 2019. The purchases were recorded to "Additional paid-in capital" in the condensed consolidated balance sheets. All shares delivered were immediately retired.
During the quarter and nine months ended September 28, 2018, the Company made open market repurchases of its common stock for an aggregate purchase price of $62 million and $162 million, respectively. All shares repurchased were immediately retired.
Note 17–Supplementary Cash Flow Information and Restricted Cash
Supplementary cash flow information, and non-cash activities, for the periods presented was as follows:
Nine Months Ended | ||||||||
September 27, 2019 | September 28, 2018 | |||||||
(in millions) | ||||||||
Supplementary cash flow information: | ||||||||
Cash paid for income taxes, net of refunds | $ | $ | ||||||
Cash paid for interest | ||||||||
Non-cash investing activity: | ||||||||
Fixed asset additions | $ | $ | ||||||
See "Note 4–Leases" for additional supplementary cash flow information related to the Company's leases.
25
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following is a reconciliation of cash and cash equivalents, as reported within the condensed consolidated balance sheets, to the total cash, cash equivalents and restricted cash, as reported within the condensed consolidated statements of cash flows:
September 27, 2019 | December 28, 2018 | |||||||
(in millions) | ||||||||
Cash and cash equivalents | $ | $ | ||||||
Restricted cash | ||||||||
Total cash, cash equivalents and restricted cash | $ | $ | ||||||
The restricted cash is recorded within "Other current assets" in the Company's condensed consolidated balance sheets.
The restricted cash is primarily comprised of advances from customers that are restricted as to use for certain expenditures related to that customer's contract.
Note 18–Income Taxes
For the quarter ended September 27, 2019, the effective tax rate was 24.3 % compared to 13.5 % for the quarter ended September 28, 2018. The increase in the effective tax rate was primarily due to the recording of a valuation allowance related to foreign tax credits in the current quarter and a release of a valuation allowance related to the utilization of a capital loss carryforward in the prior year quarter.
For the nine months ended September 27, 2019, the effective tax rate was 23.5 % compared to 14.3 % for the nine months ended September 28, 2018. The increase in the effective tax rate was primarily due to the recording of a valuation allowance related to foreign tax credits and an increase in unrecognized tax benefits in the current year. Additionally, during the prior year, tax benefits were recognized related to the anticipated sale of the Company's commercial cybersecurity business and the release of a valuation allowance related to the utilization of a capital loss carryforward.
Note 19–Business Segments
The Company's operations and reportable segments are organized around the markets served and the nature of the products and services provided to customers in those markets. The Company defines its reportable segments based on the way the chief operating decision maker ("CODM"), currently its Chairman and Chief Executive Officer, manages the operations of the Company for purposes of allocating resources and assessing performance.
Effective the beginning of fiscal 2019, the Company changed the composition of its Defense Solutions reportable segment to better align the operations within the reportable segment to the customers it serves. 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 the Company's reportable segments, prior year segments results have been recast to reflect this change.
26
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The segment information for the periods presented was as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 27, 2019 | September 28, 2018 | September 27, 2019 | September 28, 2018 | |||||||||||||
(in millions) | ||||||||||||||||
Revenues: | ||||||||||||||||
Defense Solutions | $ | $ | $ | $ | ||||||||||||
Civil | ||||||||||||||||
Health | ||||||||||||||||
Total revenues | $ | $ | $ | $ | ||||||||||||
Operating income (loss): | ||||||||||||||||
Defense Solutions | $ | $ | $ | $ | ||||||||||||
Civil | ||||||||||||||||
Health | ||||||||||||||||
Corporate | ( | ) | ( | ) | ||||||||||||
Total operating income | $ | $ | $ | $ | ||||||||||||
The financial performance measures used to evaluate segment performance are revenues and operating income. As a result, "Interest expense, net," "Other (expense) income, net" and "Income tax expense" as reported in the condensed consolidated financial statements are not allocated to the Company's segments. Under U.S. Government Cost Accounting Standards, indirect costs including depreciation expense are collected in numerous indirect cost pools, which are then collectively allocated to the Company’s reportable segments based on a representative causal or beneficial relationship of the costs in the pool to the costs in the base. As such, the company does not separately disclose depreciation expense on the condensed consolidated statements of income.
Note 20–Contingencies
Legal Proceedings
MSA Joint Venture
On November 10, 2015, MSA received a final decision by the Department of Energy ("DoE") contracting officer for the Mission Support Contract concluding that certain payments to MSA by the DoE for the performance of IT services by Lockheed Martin Services, Inc. ("LMSI") under a subcontract to MSA constituted alleged affiliate fees in violation of Federal Acquisition Regulations ("FAR"). Lockheed Martin Integrated Technology LLC (now known as Leidos Integrated Technology LLC) is a member entity of MSA. Subsequent to the contracting officer's final decision, MSA, LMSI, and Lockheed Martin Corporation received notice from the U.S. Attorney's Office for the Eastern District of Washington that the U.S. government had initiated a False Claims Act investigation into the facts surrounding this dispute, and each of MSA, LMSI and Lockheed Martin Corporation have produced information in response to Civil Investigative Demands from the U.S. Attorney's Office. On February 8, 2019, the U.S. Attorney's office filed a complaint in the United States District Court for the Eastern District of Washington against MSA, Lockheed Martin Corporation, Lockheed Martin Services, Inc. and a Lockheed Martin employee. The complaint alleges violations of the False Claims Act, the Anti-Kickback Act and breach of contract with DoE, among other things. The U.S. Attorney's office had previously advised that a parallel criminal investigation was open, although no subjects or targets of the investigation had been identified. The U.S. Attorney's office has informed MSA that it has closed the criminal investigation.
27
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Since this issue first was raised by the DoE, MSA has asserted that the IT services performed by LMSI under a fixed-price/fixed-unit rate subcontract approved by the DoE meet the definition of a "commercial item" under the FAR and any profits earned on that subcontract are permissible. MSA filed an appeal of the contracting officer's decision with the Civilian Board of Contract Appeals, which was stayed pending resolution of the False Claims Act matter. Subsequent to the filing of MSA's appeal, the contracting officer demanded that MSA reimburse the DoE in the amount of $64 million, which was his estimate of the profits earned during the period from 2010 to 2014 by LMSI. The DoE has deferred collection of $32 million of that demand, pending resolution of the appeal and without prejudice to MSA's position that it is not liable for any of the DOE's $64 million reimbursement claim. The Company has agreed to indemnify Jacobs Group and Centerra Group, LLC for any liability MSA incurs in this matter. Under the terms of the Separation Agreement, Lockheed Martin agreed to indemnify the Company for 100 % of any damages in excess of $38 million up to $64 million, and 50 % of any damages in excess of $64 million, with respect to claims asserted against MSA related to this matter. At September 27, 2019, the Company had a liability of $39 million recorded in the condensed consolidated balance sheets.
Securities Litigation
Between February and April 2012, alleged stockholders filed three putative securities class actions against the Company and several former executives relating to the Company's contract to develop and implement an automated time and attendance and workforce management system for certain agencies of the City of New York ("CityTime"). One case was withdrawn and two cases were consolidated in the U.S. District Court for the Southern District of New York in In Re: SAIC, Inc. Securities Litigation. The consolidated securities complaint asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 based on allegations that the Company and individual defendants made misleading statements or omissions about the Company's revenues, operating income and internal controls in connection with disclosures relating to the CityTime project. The plaintiffs sought to recover from the Company and the individual defendants an unspecified amount of damages class members allegedly incurred by buying Leidos' stock at an inflated price. The District Court dismissed the plaintiffs' claims with prejudice and without leave to replead. The plaintiffs then appealed to the United States Court of Appeals for the Second Circuit, which issued an opinion affirming in part, and vacating in part, the District Court's ruling. The Company filed a petition for a writ of certiorari in the U.S. Supreme Court, which was granted on March 27, 2017. The District Court granted the Company's request to stay all proceedings, including discovery, pending the outcome at the Supreme Court. In September 2017, the parties engaged in mediation resulting in an agreement to settle all remaining claims for an immaterial amount to be paid by the Company. On October 2, 2019, the court issued an order preliminarily approving the settlement. The amounts payable by the Company are covered by an insurance policy.
Greek Government Contract
In 2003, the Company entered into an FFP contract with the Hellenic Republic of Greece to provide a Command, Control, Communications, Coordination and Integration System. The Greek government disputed the contract balance owed to the Company and withheld payment. In 2013, the Company received an arbitral award by the International Chamber of Commerce. In 2017, the U.S. District Court granted an order to enforce the arbitration award and entered judgment in the Company's favor. The Company subsequently commenced enforcement proceedings against the Greek government. On September 10, 2019, the Company received $59 million on behalf of Leidos and its subcontractors, substantially, though not entirely, resolving the Company’s claim.
Arbitration Proceeding
The Company is a party to an arbitration proceeding involving a claim by Lockheed Martin for indemnification for $56 million in taxes attributable to deferred revenue recognized as a result of the Transactions. Based on the arguments advanced to date, the Company believes that the claim appears to be without merit and intends to vigorously defend itself in arbitration. The Company does not believe that a material loss is probable, and has therefore not recorded any liability for this matter.
Other
The Company is also involved in various claims and lawsuits arising in the normal conduct of its business, none of which, in the opinion of the Company's management, based upon current information, will likely have a material adverse effect on the Company's condensed consolidated financial position, results of operations or cash flows.
28
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Other Contingencies
VirnetX, Inc.
On September 29, 2017, the federal trial court in the Eastern District of Texas entered a final judgment in the VirnetX v. Apple case referred to as the Apple I case. The court found that Apple willfully infringed the VirnetX patents at issue in the Apple I case and awarded enhanced damages, bringing the total award against Apple to over $343 million in pre-interest damages. The court subsequently awarded an additional sum of over $96 million for costs, attorneys' fees, and interest, bringing the total award to VirnetX in the Apple I case to over $439 million. Apple appealed the judgment in the Apple I case with the U.S. Court of Appeals for the Federal Circuit and on January 15, 2019, the court affirmed the $439 million judgment. On August 1, 2019, the U.S. Court of Appeals for the Federal Circuit denied Apple’s petition for panel and en banc rehearing, but Apple subsequently filed motions to stay and vacate the judgment, and for leave to file a second petition for rehearing. These motions were denied by the U.S. Court of Appeals for the Federal Circuit on October 1, 2019. It is expected that Apple will file a petition for a writ of certiorari with the Supreme Court of the United States in connection with the Apple I case.
On April 10, 2018, a jury trial concluded in an additional patent infringement case brought by VirnetX against Apple, referred to as the Apple II case, in which the jury returned a verdict against Apple for infringement and awarded VirnetX damages in the amount of over $502 million. On April 11, 2018, in a second phase of the Apple II trial, the jury found Apple's infringement to be willful. On August 30, 2018, the federal trial court in the Eastern District of Texas entered a final judgment and rulings on post-trial motions in the Apple II case. The court affirmed the jury’s verdict of over $502 million and granted VirnetX’s motions for supplemental damages, a sunset royalty and royalty rate of $1.20 per infringing device, along with pre-judgment and post-judgment interest and costs. The court denied VirnetX’s motions for enhanced damages, attorneys’ fees, and an injunction. The court also denied Apple’s motions for judgment as a matter of law and for a new trial. An additional sum of over $93 million for costs and pre-judgment interest was subsequently agreed upon pursuant to a court order, bringing the total award to VirnetX in the Apple II case to over $595 million. Apple has filed an appeal of the judgment in the Apple II case with the U.S. Court of Appeals for the Federal Circuit.
Under its agreements with VirnetX, the Company would receive 25 % of the proceeds obtained by VirnetX after reduction for attorneys' fees and costs. However, the verdicts in these cases remain subject to appeal. In addition, the patents at issue in these cases are subject to U.S. Patent and Trademark Office post-grant inter partes review and/or reexamination proceedings and related appeals, which may result in all or part of these patents being invalidated or the claims of the patents being limited. Thus, no assurances can be given when or if the Company will receive any proceeds in connection with these jury awards. In addition, if the Company receives any proceeds, the Company is required to pay a royalty to the customer who paid for the development of the technology.
The Company does not have any assets or liabilities recorded in connection with this matter as of September 27, 2019.
Government Investigations and Reviews
The Company is routinely subject to investigations and reviews relating to compliance with various laws and regulations with respect to its role as a contractor to federal, state and local government customers and in connection with performing services in countries outside of the United States. Adverse findings could have a material effect on the Company's business, financial position, results of operations and cash flows due to its reliance on government contracts.
As of September 27, 2019, indirect cost audits by the Defense Contract Audit Agency remain open for fiscal 2013 and subsequent fiscal years. Although the Company has recorded contract revenues based upon an estimate of costs that the Company believes will be approved upon final audit or review, the Company cannot predict the outcome of any ongoing or future audits or reviews and adjustments, and if future adjustments exceed the Company's estimates, its profitability may be adversely affected. As of September 27, 2019, the Company believes it has adequately reserved for potential adjustments from audits or reviews of contract costs.
In February 2019, the Company executed an external restructuring advance agreement with the DoD in accordance with provisions of the Defense Federal Acquisition Regulation Supplement, which allows the Company to recover certain specified external restructuring costs.
29
LEIDOS HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 21–Commitments
The Company has outstanding letters of credit of $65 million as of September 27, 2019, principally related to performance guarantees on contracts. The Company also has outstanding surety bonds with a notional amount of $52 million, principally related to performance and subcontractor payment bonds on the Company's contracts. The value of the surety bonds may vary due to changes in the underlying project status and/or contractual modifications. The outstanding letters of credit and surety bonds have various terms with the majority expiring over the remainder of the current fiscal year and the next two fiscal years.
Reston, VA Lease Agreement
On January 24, 2018, the Company entered into a lease agreement with its current lessor for office space in a building to be constructed to function as the Company's new corporate headquarters in Reston, VA (see "Note 4–Leases").
Gaithersburg, MD Lease Agreement
On December 31, 2018, the Company closed the sale and leaseback agreement relating to its land and building in Gaithersburg, MD. (see "Note 11–Property, Plant and Equipment").
San Diego, CA Lease Agreement
On December 28, 2018, the Company closed the sales and leaseback agreement relating to two buildings and the adjacent land in San Diego, CA (see "Note 11–Property, Plant and Equipment").
Note 22–Subsequent Events
On September 30, 2019, the Company paid its $48 million dividend for the quarter ended September 27, 2019. The dividend liability at September 27, 2019 was included within "Accounts payable and accrued liabilities" in the consolidated balance sheets.
30
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 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. 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 periodically through our subsequent quarterly reports on Form 10-Q. 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 the "Company," "we," "us" and "our" refer collectively to Leidos and its consolidated subsidiaries.
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 cross-market 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 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 and many other U.S. government civilian agencies, as well as state and local government agencies. Our international customers include foreign governments and their agencies, primarily located in Australia and the United Kingdom ("U.K."). We operate in three reportable segments: Defense Solutions, Civil and Health. Additionally, we separately present the 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.
Business Environment and Trends
U.S. Government Markets
During the three and nine months ended September 27, 2019, we generated approximately 87% of our total revenues from contracts with the U.S. government. 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.
In September 2018, Congress passed and the President signed a consolidated appropriations bill funding the Departments of Defense, Labor, and Health and Human Services for the full government fiscal year ("GFY") 2019. Earlier in 2018, funding for the Departments of Veterans Affairs and Energy as well as funding for Congress were also enacted. All were funded at increased levels from the previous year.
The remaining seven appropriations bills were operating under a continuing resolution ("CR") until it expired on December 21, 2018. From the expiration of that CR until the passage of a new CR on January 25, 2019 there was a partial U.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.
In March 2019, the President submitted the GFY 2020 budget proposal to Congress. The budget included $750 billion for defense and $563 billion for non-defense spending. The defense budget proposal included $576 billion for national defense and $165 billion for the Overseas Contingency Operations fund.
31
On July 22, 2019, the White House and Congress reached a tentative two-year budget deal to raise spending caps and suspend the debt ceiling until July 2021. Allocations for national defense spending increased to $738 billion in GFY 2020 and to $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.
Congress is currently addressing the passage of appropriations bills for GFY 2020. A CR was enacted on September 27, 2019, providing funding at GFY 2019 enacted levels until November 21, 2019.
International Markets
Sales to customers in international markets represented approximately 8% of total revenues for the three and nine months ended September 27, 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.
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, 2019 | September 28, 2018 | Dollar change | Percent change | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | |||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||||||||
Revenues | $ | 2,835 | $ | 2,575 | $ | 260 | 10.1 | % | $ | 8,140 | $ | 7,547 | $ | 593 | 7.9 | % | ||||||||||||||
Operating income | 249 | 203 | 46 | 22.7 | % | 651 | 561 | 90 | 16.0 | % | ||||||||||||||||||||
Non-operating expense, net | (35 | ) | (33 | ) | (2 | ) | 6.1 | % | (12 | ) | (101 | ) | 89 | (88.1 | )% | |||||||||||||||
Income before income taxes | 214 | 170 | 44 | 25.9 | % | 639 | 460 | 179 | 38.9 | % | ||||||||||||||||||||
Income tax expense | (52 | ) | (23 | ) | (29 | ) | 126.1 | % | (150 | ) | (66 | ) | (84 | ) | 127.3 | % | ||||||||||||||
Net income | $ | 162 | $ | 147 | $ | 15 | 10.2 | % | $ | 489 | $ | 394 | $ | 95 | 24.1 | % | ||||||||||||||
Operating margin | 8.8 | % | 7.9 | % | 8.0 | % | 7.4 | % | ||||||||||||||||||||||
Net income attributable to Leidos common stockholders | $ | 161 | $ | 147 | $ | 14 | 9.5 | % | $ | 486 | $ | 393 | $ | 93 | 23.7 | % | ||||||||||||||
The increase in revenues in constant currency(1) for the three and nine months ended September 27, 2019, was 10.6% and 8.4%, as compared to an actual increase in revenues of 10.1% and 7.9%, respectively. The foreign currency impact was mainly attributable to adverse exchange rate movements in the British pound and Australian dollar when compared to the U.S. dollar.
_________________________________________________________________________________________________________________________________________________________
(1) The non-GAAP measure of constant currency revenues is used to assess the performance of revenue activity without the effect of foreign currency exchange rate fluctuations. We calculate revenues on a constant currency basis by translating current period revenue using the foreign currency exchange rates of the comparable prior year periods. This calculation is performed for all subsidiaries where the functional currency is not the U.S. dollar.
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Segment and Corporate Results
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
Defense Solutions | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | ||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||||||||
Revenues | $ | 1,354 | $ | 1,250 | $ | 104 | 8.3 | % | $ | 3,967 | $ | 3,701 | $ | 266 | 7.2 | % | ||||||||||||||
Operating income | 93 | 89 | 4 | 4.5 | % | 283 | 273 | 10 | 3.7 | % | ||||||||||||||||||||
Operating margin | 6.9 | % | 7.1 | % | 7.1 | % | 7.4 | % | ||||||||||||||||||||||
The increase in revenues for the three months ended September 27, 2019, as compared to the three months ended September 28, 2018, was primarily attributable to new awards and a net increase in program volumes, partially offset by the completion of certain contracts.
The increase in revenues for the nine months ended September 27, 2019, as compared to the nine months ended September 28, 2018, was primarily attributable to new awards and a net increase in program volumes, partially offset by the completion of certain contracts, lower net profit write-ups in the current year and adverse exchange rate movements in the Australian dollar when compared to the U.S. dollar.
The increase in operating income for the three months ended September 27, 2019, as compared to the three months ended September 28, 2018, was primarily due to new awards and favorable program mix, partially offset by lower net profit write-ups in the current quarter.
The increase in operating income for the nine months ended September 27, 2019, as compared to the nine months ended September 28, 2018, was primarily due to new awards and lower amortization of intangibles, partially offset by lower net profit write-ups in the current year.
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
Civil | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | ||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||||||||
Revenues | $ | 973 | $ | 881 | $ | 92 | 10.4 | % | $ | 2,701 | $ | 2,526 | $ | 175 | 6.9 | % | ||||||||||||||
Operating income | 57 | 92 | (35 | ) | (38.0 | )% | 198 | 221 | (23 | ) | (10.4 | )% | ||||||||||||||||||
Operating margin | 5.9 | % | 10.4 | % | 7.3 | % | 8.7 | % | ||||||||||||||||||||||
The increase in revenues for the three months ended September 27, 2019, as compared to the three months ended September 28, 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 and lower net profit write-ups in the current quarter.
The increase in revenues for the nine months ended September 27, 2019, as compared to the nine months ended September 28, 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, 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 decrease in operating income for the three months ended September 27, 2019, as compared to the three months ended September 28, 2018, was primarily due to increased bad debt expense on certain international contracts and lower net profit write-ups in the current quarter.
The decrease in operating income for the nine months ended September 27, 2019, as compared to the nine months ended September 28, 2018, was primarily due to lower net profit write-ups in the current year and increased bad debt expense on certain international contracts, partially offset by lower amortization of intangibles and new awards.
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
Health | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | ||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||||||||
Revenues | $ | 508 | $ | 444 | $ | 64 | 14.4 | % | $ | 1,472 | $ | 1,320 | $ | 152 | 11.5 | % | ||||||||||||||
Operating income | 63 | 52 | 11 | 21.2 | % | 169 | 162 | 7 | 4.3 | % | ||||||||||||||||||||
Operating margin | 12.4 | % | 11.7 | % | 11.5 | % | 12.3 | % | ||||||||||||||||||||||
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The increase in revenues for the three and nine months ended September 27, 2019, as compared to the three and nine months ended September 28, 2018, was primarily attributable to a net increase in program volumes and new awards, partially offset by the completion of certain contracts and the impact of the sale of our health staff augmentation business.
The increase in operating income for the three months ended September 27, 2019, as compared to the three months ended September 28, 2018, was primarily attributable to favorable program mix.
The increase in operating income for the nine months ended September 27, 2019, as compared to the nine months ended September 28, 2018, was primarily attributable to favorable program mix, partially offset by reduced margins on awarded re-compete contracts.
Three Months Ended | Nine Months Ended | ||||||||||||||||||||||||||||
Corporate | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | September 27, 2019 | September 28, 2018 | Dollar change | Percent change | |||||||||||||||||||||
(dollars in millions) | |||||||||||||||||||||||||||||
Operating income (loss) | $ | 36 | $ | (30 | ) | $ | 66 | NM | $ | 1 | $ | (95 | ) | $ | 96 | (101.1 | )% | ||||||||||||
NM - Not meaningful
The increase in operating income for the three months ended September 27, 2019, as compared to the three months ended September 28, 2018, was primarily attributable to the receipt of the Greek arbitration award and lower integration and restructuring costs.
The increase in operating income for the nine months ended September 27, 2019, as compared to the nine months ended September 28, 2018, was primarily attributable to the receipt of the Greek arbitration award, lower integration and restructuring costs and an asset impairment charge in the prior year.
Non-Operating Expense, net
Non-operating expense, net of $35 million for the three months ended September 27, 2019 was consistent with the non-operating expense, net of $33 million for the three months ended September 28, 2018.
Non-operating expense, net for the nine months ended September 27, 2019 was $12 million as compared to $101 million for the nine months ended September 28, 2018. The $89 million decrease was primarily due to the gain recognized on the sale of our commercial cybersecurity business.
Provision for Income Taxes
For the three months ended September 27, 2019, our effective tax rate was 24.3% compared to 13.5% for the three months ended September 28, 2018. The increase in the effective tax rate was primarily due to the recording of a valuation allowance related to foreign tax credits in the current quarter and a release of a valuation allowance related to the utilization of a capital loss carryforward in the prior year quarter.
For the nine months ended September 27, 2019, our effective tax rate was 23.5% compared to 14.3% for the nine months ended September 28, 2018. The increase in the effective tax rate was primarily due to the recording of a valuation allowance related to foreign tax credits and an increase in unrecognized tax benefits in the current year. Additionally, during the prior year, tax benefits were recognized related to the anticipated sale of our commercial cybersecurity business and the release of a valuation allowance related to the utilization of a capital loss carryforward.
Bookings and Backlog
We recorded net bookings worth an estimated $5.2 billion and $11.5 billion during the three and nine months ended September 27, 2019, respectively, as compared to $4.6 billion and $10.5 billion for the three and nine months ended September 28, 2018, respectively.
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The estimated value of our total backlog was as follows:
September 27, 2019 | December 28, 2018 | |||||||
(in millions) | ||||||||
Defense Solutions: | ||||||||
Funded backlog | $ | 2,700 | $ | 2,821 | ||||
Negotiated unfunded backlog | 8,682 | 6,925 | ||||||
Total Defense Solutions backlog | $ | 11,382 | $ | 9,746 | ||||
Civil: | ||||||||
Funded backlog | $ | 2,034 | $ | 2,304 | ||||
Negotiated unfunded backlog | 5,271 | 5,045 | ||||||
Total Civil backlog | $ | 7,305 | $ | 7,349 | ||||
Health: | ||||||||
Funded backlog | $ | 924 | $ | 1,254 | ||||
Negotiated unfunded backlog | 4,321 | 2,483 | ||||||
Total Health backlog | $ | 5,245 | $ | 3,737 | ||||
Total: | ||||||||
Funded backlog | $ | 5,658 | $ | 6,379 | ||||
Negotiated unfunded backlog | 18,274 | 14,453 | ||||||
Total backlog | $ | 23,932 | $ | 20,832 | ||||
The decrease in backlog within the Civil segment was primarily due to $154 million related to the sale of our commercial cybersecurity business in the first quarter of 2019.
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 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. 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, 2019, we had $635 million in cash and cash equivalents. In addition, we have a secured revolving credit facility which can provide up to $750 million in additional borrowing, if required. As of September 27, 2019, there were no borrowings outstanding under the credit facility and we were in compliance with related financial covenants.
At September 27, 2019, and December 28, 2018, we had outstanding debt of $3.0 billion and $3.1 billion, respectively. We made principal payments on our long-term debt of $2 million and $50 million during the three and nine months ended September 27, 2019, respectively, and $15 million and $59 million during the three and nine months ended September 28, 2018, respectively. This activity included principal payments on our senior secured term loans of $41 million during the nine months ended September 27, 2019 and $15 million and $46 million during the three and nine months ended September 28, 2018, respectively. There were no principal payments on our senior secured term loans for the quarter ended September 27, 2019. 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. The notes outstanding as of September 27, 2019, contain financial covenants and customary restrictive covenants. We were in compliance with all covenants as of September 27, 2019.
We paid dividends of $101 million during the nine months ended September 27, 2019, and $48 million and $151 million during the three and nine months ended September 28, 2018, respectively. Our quarterly dividend for the three months ended September 27, 2019, was paid on September 30, 2019.
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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.
Summary of Cash Flows
The following table summarizes cash flow information for the periods presented:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 27, 2019 | September 28, 2018 | September 27, 2019 | September 28, 2018 | |||||||||||||
(in millions) | ||||||||||||||||
Net cash provided by operating activities | $ | 349 | $ | 371 | $ | 823 | $ | 664 | ||||||||
Net cash (used in) provided by investing activities | (102 | ) | 15 | 119 | (94 | ) | ||||||||||
Net cash used in financing activities | (204 | ) | (134 | ) | (565 | ) | (417 | ) | ||||||||
Net increase in cash, cash equivalents and restricted cash | $ | 43 | $ | 252 | $ | 377 | $ | 153 | ||||||||
Net cash provided by operating activities decreased $22 million for the three months ended September 27, 2019, when compared to the prior year quarter, primarily due to $60 million of proceeds received from the termination of interest rates swaps in the prior year quarter, the prefunding of our quarterly dividend and higher tax payments. These activities were partially offset by more favorable timing of working capital changes and $59 million received for the Greek arbitration award.
Net cash provided by operating activities increased $159 million for the nine months ended September 27, 2019, when compared to the prior year, primarily due to more favorable timing of working capital changes, $59 million received for the Greek arbitration award, lower payments for integration and restructuring costs and $24 million of cash paid in the prior year related to our 2016 acquisition. These activities were partially offset by higher tax payments, $60 million of proceeds received from the termination of interest rates swaps in the prior year and the prefunding of our quarterly dividend.
Net cash used in investing activities increased $117 million for the three months ended September 27, 2019, when compared to the prior year quarter, primarily due to $94 million of cash paid related to the acquisition of IMX and $40 million of proceeds received from the settlement of a promissory note in the prior year quarter, partially offset by $12 million of net proceeds received for the divestiture of our health staff augmentation business.
Net cash provided by investing activities increased $213 million for the nine months ended September 27, 2019, when compared to the prior year, primarily due to $183 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, $40 million of proceeds from the settlement of a promissory note in the prior year quarter and higher purchases of equipment and software.
Net cash used in financing activities increased $70 million for the three months ended September 27, 2019, when compared to the prior year quarter, primarily due to a $137 million increase in stock repurchases, partially offset by the timing of dividend and debt payments.
Net cash used in financing activities increased $148 million for the nine months ended September 27, 2019, when compared to the prior year, primarily due to a $248 million increase in stock repurchases, partially offset by the timing of dividend payments and $23 million of cash paid related to a tax indemnification in the prior year.
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 21–Commitments" 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 resources, operations or financial condition.
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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 20–Contingencies" and "Note 21–Commitments" 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 28, 2018. However, we revised our significant accounting policies for the adoption of Accounting Standards Update 2016-02 (see "Note 3–Significant Accounting Policies").
Recently Adopted and Issued Accounting Standards
For a discussion of these items, see "Note 2–Accounting Standards" of the notes to the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q.
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 28, 2018.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our principal executive officer (our Chairman and Chief Executive Officer) and principal financial officer (our Executive Vice President and Chief Financial Officer), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as of September 27, 2019. Based upon that evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the U.S. Securities and Exchange Commission. These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred in the quarterly period covered by this report that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II—OTHER INFORMATION
Item 1. Legal Proceedings.
We have furnished information relating to legal proceedings, and any investigations and reviews that we are involved with in "Note 20–Contingencies" of the notes to the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors.
There were no material changes from the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 28, 2018.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(a) | None |
(b) | None |
(c) | Purchases of Equity Securities by the Company |
On February 16, 2018, our Board of Directors authorized a new share repurchase program of up to 20 million shares of our outstanding common stock. The shares may be repurchased from time to time in one or more open market repurchases or privately negotiated transactions, including accelerated share repurchase transactions. The actual timing, number and value of shares repurchased under the program will depend on a number of factors, including the market price of our common stock, general market and economic conditions, applicable legal requirements, compliance with the terms of our outstanding indebtedness and other considerations. There is no assurance as to the number of shares that will be repurchased, and the repurchase program may be suspended or discontinued at any time at our Board of Directors' discretion.
The following table presents repurchases of Leidos common stock during the quarter ended September 27, 2019:
Period | Total Number of Shares (or Units) Purchased (1) | Average Price Paid per Share (or Unit) | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Repurchase Plans or Programs | Maximum Number of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs | |||||||||
June 29, 2019 - June 30, 3019 | — | $ | — | — | 10,349,982 | ||||||||
July 1, 2019 - July 31, 2019 | 1,847 | 79.56 | — | 10,349,982 | |||||||||
August 1, 2019 - August 31, 2019 | 1,950,440 | 84.25 | 1,948,842 | 8,401,140 | |||||||||
September 1, 2019 - September 27, 2019 | 430,814 | 84.29 | 424,885 | 7,976,255 | |||||||||
Total | 2,383,101 | $ | 84.25 | 2,373,727 | |||||||||
(1) | The total number of shares purchased includes shares surrendered to satisfy statutory tax withholdings obligations related to vesting of restricted stock units. |
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
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Item 6. Exhibits.
Exhibit Number | Description of Exhibit | |
10.1 | ||
31.1 | ||
31.2 | ||
32.1 | ||
32.2 | ||
101 | Interactive Data File. The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |
104 | Cover Page Interactive Data File. The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: October 29, 2019
Leidos Holdings, Inc. |
/s/ James C. Reagan |
James C. Reagan Executive Vice President and Chief Financial Officer and as a duly authorized officer |
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