LDOS Q2 FY2015 Form 10-Q



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________________________________
Form 10-Q
_____________________________________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 1, 2014
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
 
Exact Name of Registrant as Specified in its Charter,
Address of Principal Executive Offices and Telephone Number
 
State or other jurisdiction of
incorporation or organization
 
I.R.S. Employer
Identification No.
001-33072
 
Leidos Holdings, Inc.
 
Delaware
 
20-3562868
 
 
11951 Freedom Drive, Reston, Virginia 20190
 
 
 
 
 
 
(571) 526-6000
 
 
 
 
000-12771
 
Leidos, Inc.
 
Delaware
 
95-3630868
 
 
11951 Freedom Drive, Reston, Virginia 20190
 
 
 
 
 
 
(571) 526-6000
 
 
 
 
_____________________________________________________________

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.
Leidos Holdings, Inc.
Yes  x   No  o
Leidos, Inc.
Yes  x   No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).
Leidos Holdings, Inc.
Yes  x   No  o
Leidos, Inc.
Yes  x   No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Leidos Holdings, Inc.
Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
 
 
 
 
 
 
 
 
 
Leidos, Inc.
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
ý
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Leidos Holdings, Inc.
Yes  o     No  x        
Leidos, Inc.
Yes  o     No  x        
The number of shares issued and outstanding of each issuer’s classes of common stock as of August 29, 2014 was as follows:
Leidos Holdings, Inc.
74,038,021 shares of common stock ($.0001 par value per share)
Leidos, Inc.
5,000 shares of common stock ($.01 par value per share) held by Leidos Holdings, Inc.






Explanatory Note
This Quarterly Report on Form 10-Q is a combined report being filed by Leidos Holdings, Inc. ("Leidos") and Leidos, Inc. Leidos is a holding company and Leidos, Inc. is a direct, 100%-owned subsidiary of Leidos. Each of Leidos and Leidos, Inc. is filing on its own behalf all of the information contained in this report that relates to such company. Where information or an explanation is provided that is substantially the same for each company, such information or explanation has been combined in this report. Where information or an explanation is not substantially the same for each company, separate information and explanation has been provided. In addition, separate condensed consolidated financial statements for each company, along with combined notes to the condensed consolidated financial statements, are included in this report. Unless indicated otherwise, references in this report to the “Company,” “we,” “us,” and “our” refer collectively to Leidos, Leidos, Inc., and its consolidated subsidiaries.







PART I—FINANCIAL INFORMATION
 
Item 1. Financial Statements.

LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
August 1,
2014
 
January 31,
2014
 
(in millions)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
358

 
$
430

Receivables, net
1,094

 
1,082

Inventory, prepaid expenses and other current assets
236

 
256

Assets of discontinued operations
25

 
39

Total current assets
1,713

 
1,807

Property, plant and equipment (less accumulated depreciation and amortization of $324 million and $341 million at August 1, 2014 and January 31, 2014, respectively)
372

 
482

Intangible assets, net
59

 
93

Goodwill
1,207

 
1,693

Deferred income taxes
19

 
15

Other assets
111

 
72

 
$
3,481

 
$
4,162

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
682

 
$
716

Accrued payroll and employee benefits
296

 
285

  Notes payable and long-term debt, current portion
3

 
2

  Liabilities of discontinued operations
10

 
6

Total current liabilities
991

 
1,009

Notes payable and long-term debt, net of current portion
1,329

 
1,331

Other long-term liabilities
204

 
227

Commitments and contingencies (Notes 11 and 12)

 

Stockholders’ equity:
 
 
 
 Preferred stock, $.0001 par value, 10 million shares authorized and no shares issued and outstanding at August 1, 2014 and January 31, 2014

 

Common stock, $.0001 par value, 500 million shares authorized, 74 million and 80 million shares issued and outstanding at August 1, 2014 and January 31, 2014, respectively

 

Additional paid-in capital
1,426

 
1,576

Accumulated (deficit) earnings
(463
)
 
25

Accumulated other comprehensive loss
(6
)
 
(6
)
Total stockholders’ equity
957

 
1,595

 
$
3,481

 
$
4,162


See accompanying combined notes to condensed consolidated financial statements.

1




LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
 
 
Three Months Ended
 
Six Months Ended
 
August 1,
2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions, except per share amounts)
Revenues
$
1,306

 
$
1,457

 
$
2,618

 
$
3,050

Costs and expenses:
 
 
 
 
 
 
 
Cost of revenues
1,119

 
1,293

 
2,260

 
2,666

Selling, general and administrative expenses
87

 
105

 
170

 
232

Goodwill impairment charges
486

 

 
486

 

Intangible asset impairment charges
24

 
30

 
24

 
32

Separation transaction and restructuring expenses

 
19

 
1

 
33

Operating (loss) income
(410
)
 
10

 
(323
)
 
87

Non-operating income (expense):
 
 
 
 
 
 
 
Interest income
1

 
6

 
1

 
10

Interest expense
(20
)
 
(18
)
 
(40
)
 
(38
)
Other (expense) income, net
(1
)
 

 
1

 
1

(Loss) income from continuing operations before income taxes
(430
)
 
(2
)
 
(361
)
 
60

Income tax (expense) benefit
(9
)
 
6

 
(33
)
 
(15
)
(Loss) income from continuing operations
(439
)
 
4

 
(394
)
 
45

Discontinued operations (Note 2):
 
 
 
 
 
 
 
Income (loss) from discontinued operations before income taxes
2

 
60

 
(11
)
 
125

Income tax (expense) benefit
(1
)
 
(22
)
 
4

 
(47
)
Income (loss) from discontinued operations
1

 
38

 
(7
)
 
78

Net (loss) income
$
(438
)
 
$
42

 
$
(401
)
 
$
123

(Loss) earnings per share (Note 8):
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
(Loss) income from continuing operations
(5.93
)
 
0.05

 
(5.25
)
 
0.50

Income (loss) from discontinued operations
0.01

 
0.45

 
(0.10
)
 
0.93

 
$
(5.92
)
 
$
0.50

 
$
(5.35
)
 
$
1.43

Diluted:
 
 
 
 
 
 
 
(Loss) income from continuing operations
$
(5.93
)
 
$
0.05

 
$
(5.25
)
 
$
0.50

Income (loss) from discontinued operations
0.01

 
0.45

 
(0.10
)
 
0.93

 
$
(5.92
)
 
$
0.50

 
$
(5.35
)
 
$
1.43

Cash dividends declared per share
$
0.32

 
$
0.48

 
$
0.64

 
$
4.96



See accompanying combined notes to condensed consolidated financial statements.

2




LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)

 
 
Three Months Ended
 
Six Months Ended
 
August 1, 2014
 
August 2, 2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Net (loss) income
$
(438
)
 
$
42

 
$
(401
)
 
$
123

Other comprehensive income, net of tax

 

 

 

Comprehensive (loss) income
$
(438
)
 
$
42

 
$
(401
)
 
$
123



































See accompanying combined notes to condensed consolidated financial statements.

3




LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(UNAUDITED)

 
Shares of
common
stock
 
Additional
paid-in
capital
 
Accumulated
earnings (deficit)
 
Accumulated
other
comprehensive
loss
 
Total
 
(in millions, except for share amounts)
Balance at January 31, 2014
80

 
$
1,576

 
$
25

 
$
(6
)
 
$
1,595

Net loss

 

 
(401
)
 

 
(401
)
Other comprehensive income, net of tax

 

 

 

 

Issuances of stock, net of cancellations

 
7

 

 

 
7

Shares repurchased and retired or withheld for tax withholdings on equity awards
(6
)
 
(175
)
 
(37
)
 

 
(212
)
Dividends of $0.64 per share

 

 
(50
)
 

 
(50
)
Adjustments for income tax benefits (deficiency)from stock-based compensation

 
(5
)
 

 

 
(5
)
Stock-based compensation

 
23

 

 

 
23

Balance at August 1, 2014
74

 
$
1,426

 
$
(463
)
 
$
(6
)
 
$
957





See accompanying combined notes to condensed consolidated financial statements.

4


LEIDOS HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
Six Months Ended
 
August 1, 2014
 
August 2,
2013
 
(in millions)
Cash flows from operations:
 
 
 
Net (loss) income
$
(401
)
 
$
123

Loss (income) from discontinued operations
7

 
(78
)
Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation and amortization
34

 
51

Stock-based compensation
23

 
30

Goodwill impairment charges
486

 

Intangible asset impairment charges
24

 
32

Restructuring charges, net
1

 
12

Other
4

 
3

  Change in assets and liabilities, net of effects of acquisitions and dispositions:
 
 
 
Receivables
(56
)
 
(126
)
Inventory, prepaid expenses and other current assets
9

 
48

Other assets
(1
)
 
6

Accounts payable and accrued liabilities
(35
)
 
(27
)
Accrued payroll and employee benefits
12

 
(40
)
Income taxes receivable/payable
11

 

Other long-term liabilities
(3
)
 
(2
)
Total cash flows provided by operating activities of continuing operations
115

 
32

Cash flows from investing activities:
 
 
 
Expenditures for property, plant and equipment
(22
)
 
(30
)
Proceeds from sale of assets

 
65

Proceeds from U.S. Treasury cash grant
80

 

Other

 
1

Total cash flows provided by investing activities of continuing operations
58

 
36

Cash flows from financing activities:
 
 
 
Payments of notes payable and long-term debt
(1
)
 
(1
)
Proceeds from real estate financing transaction

 
38

Sales of stock and exercises of stock options
4

 
8

Repurchases of stock
(212
)
 
(17
)
Dividend payments
(48
)
 
(424
)
Other
1

 
2

Total cash flows used in financing activities of continuing operations
(256
)
 
(394
)

See accompanying combined notes to condensed consolidated financial statements.

5


 
Six Months Ended
 
August 1, 2014
 
August 2,
2013
 
(in millions)
Decrease in cash and cash equivalents from continuing operations
(83
)
 
(326
)
Cash flows from discontinued operations:
 
 
 
  Cash provided by operating activities of discontinued operations
3

 
60

  Cash provided by (used in) investing activities of discontinued operations
8

 
(2
)
  Cash used in financing activities of discontinued operations

 
(5
)
Increase in cash and cash equivalents from discontinued operations
11

 
53

Total decrease in cash and cash equivalents
(72
)
 
(273
)
Cash and cash equivalents at beginning of period
430

 
735

Cash and cash equivalents at end of period
$
358

 
$
462


See accompanying combined notes to condensed consolidated financial statements.

6





LEIDOS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
August 1,
2014
 
January 31, 2014
 
(in millions)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
358

 
$
430

Receivables, net
1,094

 
1,082

Inventory, prepaid expenses and other current assets
236

 
256

Assets of discontinued operations
25

 
39

Total current assets
1,713

 
1,807

Property, plant and equipment (less accumulated depreciation and amortization of $324 million and $341 million at August 1, 2014 and January 31, 2014, respectively)
372

 
482

Intangible assets, net
59

 
93

Goodwill
1,207

 
1,693

Deferred income taxes
19

 
15

Other assets
111

 
72

Note receivable from Leidos Holdings, Inc. (Note 6)
1,377

 
1,137

 
$
4,858

 
$
5,299

LIABILITIES AND STOCKHOLDER'S EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
682

 
$
716

Accrued payroll and employee benefits
296

 
285

Notes payable and long-term debt, current portion
3

 
2

Liabilities of discontinued operations
10

 
6

Total current liabilities
991

 
1,009

Notes payable and long-term debt, net of current portion
1,329

 
1,331

Other long-term liabilities
204

 
227

Commitments and contingencies (Notes 11 and 12)


 

Stockholder's equity:
 
 
 
Common stock, $.01 par value, 10,000 shares authorized, 5,000 shares issued and outstanding at August 1, 2014 and January 31, 2014

 

Additional paid-in capital
207

 
207

Accumulated earnings
2,133

 
2,531

Accumulated other comprehensive loss
(6
)
 
(6
)
Total stockholder's equity
2,334

 
2,732

 
$
4,858

 
$
5,299




See accompanying combined notes to condensed consolidated financial statements.

7


LEIDOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

 
Three Months Ended
 
Six Months Ended
 
August 1,
2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Revenues
$
1,306

 
$
1,457

 
$
2,618

 
$
3,050

Costs and expenses:
 
 
 
 
 
 
 
Cost of revenues
1,119

 
1,293

 
2,260

 
2,666

Selling, general and administrative expenses
87

 
105

 
170

 
232

Goodwill impairment charges
486

 

 
486

 

Intangible asset impairment charges
24

 
30

 
24

 
32

Separation transaction and restructuring expenses

 
19

 
1

 
33

Operating (loss) income
(410
)
 
10

 
(323
)
 
87

Non-operating income (expense):
 
 
 
 
 
 
 
Interest income
4

 
6

 
6

 
10

Interest expense
(20
)
 
(18
)
 
(40
)
 
(38
)
Other (loss) income, net
(1
)
 

 
1

 
1

(Loss) income from continuing operations before income taxes
(427
)
 
(2
)
 
(356
)
 
60

Income tax (expense) benefit
(10
)
 
6

 
(35
)
 
(15
)
(Loss) income from continuing operations
(437
)
 
4

 
(391
)
 
45

Discontinued operations (Note 2):
 
 
 
 
 
 
 
Income (loss) from discontinued operations before income taxes
2

 
60

 
(11
)
 
125

Income tax (expense) benefit
(1
)
 
(22
)
 
4

 
(47
)
Income (loss) from discontinued operations
1

 
38

 
(7
)
 
78

Net (loss) income
$
(436
)
 
$
42

 
$
(398
)
 
$
123






















See accompanying combined notes to condensed consolidated financial statements.

8




LEIDOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)

 
 
Three Months Ended
 
Six Months Ended
 
August 1, 2014
 
August 2,
2013
 
August 1, 2014
 
August 2,
2013
 
 
Net (loss) income
$
(436
)
 
$
42

 
$
(398
)
 
$
123

Other comprehensive income, net of tax

 

 

 

Comprehensive (loss) income
$
(436
)
 
$
42

 
$
(398
)
 
$
123





































See accompanying combined notes to condensed consolidated financial statements.

9




LEIDOS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDER’S EQUITY
(UNAUDITED)

 
Shares of
common
stock
 
Additional
paid-in
capital
 
Accumulated
earnings
 
Accumulated
other
comprehensive
loss
 
Total
 
(in millions, except for share amounts)
Balance at January 31, 2014
5,000

 
$
207

 
$
2,531

 
$
(6
)
 
$
2,732

Net loss

 

 
(398
)
 

 
(398
)
Other comprehensive income, net of tax

 

 

 

 

Balance at August 1, 2014
5,000

 
$
207

 
$
2,133

 
$
(6
)
 
$
2,334










































See accompanying combined notes to condensed consolidated financial statements.

10




LEIDOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
Six Months Ended
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Cash flows from operations:
 
 
 
Net (loss) income
$
(398
)
 
$
123

Loss (income) from discontinued operations
7

 
(78
)
Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Depreciation and amortization
34

 
51

Stock-based compensation
23

 
30

Goodwill impairment charges
486

 

Intangible asset impairment charges
24

 
32

Restructuring charges, net
1

 
12

Other
1

 
3

Change in assets and liabilities, net of effects of acquisitions and dispositions:
 
 
 
Receivables
(56
)
 
(126
)
Inventory, prepaid expenses and other current assets
9

 
48

Other assets
(1
)
 
6

Accounts payable and accrued liabilities
(35
)
 
(27
)
Accrued payroll and employee benefits
12

 
(40
)
Income taxes receivable/payable
11

 

Other long-term liabilities
(3
)
 
(2
)
Total cash flows provided by operating activities of continuing operations
115

 
32

Cash flows from investing activities:
 
 
 
Proceeds on obligations of Leidos Holdings, Inc.
55

 

Payments on obligations of Leidos Holdings, Inc.
(310
)
 

Expenditures for property, plant and equipment
(22
)
 
(30
)
Proceeds from sale of assets

 
65

Proceeds from U.S. Treasury cash grant
80

 

Other

 
1

Total cash flows (used in) provided by investing activities of continuing operations
(197
)
 
36

Cash flows from financing activities:
 
 
 
Proceeds on obligations of Leidos Holdings, Inc.

 
8

Payments on obligations of Leidos Holdings, Inc.

 
(441
)
Payments of notes payable and long-term debt
(1
)
 
(1
)
Proceeds from real estate financing transaction

 
38


See accompanying combined notes to condensed consolidated financial statements.

11




 
Six Months Ended
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Other

 
2

Total cash flows used in financing activities of continuing operations
(1
)
 
(394
)
Decrease in cash and cash equivalents from continuing operations
(83
)
 
(326
)
Cash flows from discontinued operations:
 
 
 
  Cash provided by operating activities of discontinued operations
3

 
60

  Cash provided by (used in) investing activities of discontinued operations
8

 
(2
)
  Cash used in financing activities of discontinued operations

 
(5
)
Increase in cash and cash equivalents from discontinued operations
11

 
53

Total decrease in cash and cash equivalents
(72
)
 
(273
)
Cash and cash equivalents at beginning of period
430

 
735

Cash and cash equivalents at end of period
$
358

 
$
462


See accompanying combined notes to condensed consolidated financial statements.

12


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 






Note 1—Summary of Significant Accounting Policies:
Nature of Operations and Basis of Presentation
Leidos Holdings, Inc. ("Leidos") is a holding company whose direct 100%-owned subsidiary is Leidos, Inc., a company focused on delivering science and technology solutions and services primarily in the areas of national security, health and engineering to agencies of the U.S. Department of Defense (DoD), the intelligence community, the U.S. Department of Homeland Security and other U.S. Government civil agencies, state and local government agencies, foreign governments and customers across a variety of commercial markets. Unless indicated otherwise, references to the "Company," "we," "us," and "our" refer collectively to Leidos, Leidos, Inc., and its consolidated subsidiaries.
On September 27, 2013 (the "Distribution Date"), Leidos completed the spin-off of its technical services and enterprise information technology services business into an independent, publicly traded company named Science Applications International Corporation (“New SAIC”). The separation was effected through a tax-free distribution to Leidos' stockholders of 100% of the shares of New SAIC's common stock. On the Distribution Date, New SAIC's common stock was distributed, on a pro rata basis, to Leidos' stockholders of record as of the close of business on September 19, 2013, the record date. Each holder of Leidos common stock received one share of New SAIC common stock for every seven shares of Leidos common stock held on the record date. Prior to the Distribution Date, Leidos Holdings, Inc. was named SAIC, Inc. and Leidos, Inc. was named Science Applications International Corporation.
As a result of the spin-off, the assets, liabilities, results of operations, and cash flows of New SAIC have been classified as discontinued operations for all periods presented. References to financial data are to the Company’s continuing operations, unless otherwise noted. See Note 2-Dispositions for further information.
Immediately following the spin-off, Leidos effectuated a one-for-four reverse stock split of its shares of common stock, so that every four shares of Leidos common stock issued and outstanding were combined and converted into one share of Leidos common stock. Each reference to the number of shares outstanding or per share amounts has been adjusted to reflect the reverse stock split for all periods presented.
The condensed consolidated financial statements of Leidos include the accounts of its majority-owned and 100%-owned subsidiaries, including Leidos, Inc. The condensed consolidated financial statements of Leidos, Inc. include the accounts of its majority-owned and 100%-owned subsidiaries. Leidos does not have separate operations, assets or liabilities independent of Leidos, Inc., except for a note with Leidos, Inc. (the “related party note”), on which interest is recognized. From time to time Leidos issues stock to employees of Leidos, Inc. and its subsidiaries, which is reflected in Leidos’ Condensed Consolidated Statement of Stockholders’ Equity and results in an increase to the related party note. All intercompany transactions and accounts have been eliminated in consolidation.
The accompanying financial information has been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC") 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 and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and combined notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2014. 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. Estimates have been prepared by management on the basis of the most current and best available information at the time of estimation and actual results could differ from those estimates.

13


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





In the opinion of management, the financial information as of August 1, 2014 and for the three and six months ended August 1, 2014 and August 2, 2013 reflects all adjustments, which consist of normal recurring adjustments, necessary for a fair presentation thereof. Operating results for the three and six months ended August 1, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending January 30, 2015, or any future period.
Unless otherwise noted, references to fiscal years are to fiscal years ended the Friday closest to January 31. Fiscal 2015 began on February 1, 2014 and ends on January 30, 2015. The second quarter of fiscal 2015 ended on August 1, 2014.
Separation Transaction and Restructuring Expenses
In anticipation of the spin-off of New SAIC from the Company, the Company initiated an overall spin-off program to align the Company’s cost structure for post-spin-off. In fiscal 2014 the Company reduced headcount, which resulted in severance costs, and reduced its real estate footprint by vacating facilities that are not necessary for its future requirements, which resulted in lease termination and facility consolidation expenses.
Separation transaction and restructuring expenses related to New SAIC, exclusive of any tax impacts, of $15 million and $34 million for the three and six months ended August 2, 2013, respectively, were reclassified as discontinued operations.
The separation transaction and restructuring expenses for continuing operations were as follows:
 
Three Months Ended
 
Six Months Ended
 
August 1,
2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Strategic advisory services
$

 
$

 
$

 
$
2

Legal and accounting services

 

 

 

Lease termination and facility consolidation expenses

 
14

 
1

 
23

Severance costs

 
5

 

 
8

Separation transaction and restructuring expenses in operating income

 
19

 
1

 
33

Less: income tax benefit

 
(8
)
 

 
(13
)
Separation transaction and restructuring expenses, net of tax
$

 
$
11

 
$
1

 
$
20

During the six months ended August 1, 2014, the lease termination and facility consolidation expenses related to an adjustment to the reserve established for loss on leases in connection with revised sublease income assumptions.
For the six months ended August 1, 2014 and August 2, 2013, all separation transaction and restructuring expenses for continuing operations were in the Corporate and Other segment.

14


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 






The following table represents the restructuring liability balance as of August 1, 2014 and summarizes the changes during the period attributable to costs incurred and charged to expense, costs paid or otherwise settled, and any adjustments to the liability:
 
Severance Costs
Lease Termination and Facility Consolidation Expenses
Total
 
(in millions)
Balance as of January 31, 2014
$
1

$
20

$
21

Charges

1

1

Cash payments
(1
)
(9
)
(10
)
Balance as of August 1, 2014
$

$
12

$
12

Receivables
The Company’s accounts receivable include both amounts billed and currently due from customers, and unbilled receivables consisting of costs and fees billable upon contract completion or the occurrence of a specified event, substantially all of which are expected to be billed and collected within one year. Unbilled receivables are stated at estimated realizable value. Since the Company’s receivables are primarily with the U.S. Government, the Company does not have a material credit risk exposure. Contract retentions are billed when the Company has negotiated final indirect rates with the U.S. Government and, once billed, are subject to audit and approval by government representatives. Consequently, the timing of collection of retention balances is outside the Company’s control. Based on the Company’s historical experience, the majority of retention balances are expected to be collected beyond one year and write-offs of retention balances have not been significant.
The Company has extended deferred payment terms with contractual maturities that may exceed one year to commercial customers related to certain construction projects. As of August 1, 2014, the Company had outstanding receivables of $39 million, net of allowance of $9 million, related to one construction project with deferred payment terms, which have not been paid in accordance with the initial payment terms established with the customer. The Company has filed a legal claim to enforce the payment terms as established in the contract. Based on these events, the Company has determined that the receivables are not expected to be collected within the next 12 months. Accordingly, the receivables are classified as non-current in “Other Assets” on the condensed consolidated balance sheet as of August 1, 2014. On August 29, 2014, the Company received a partial payment of $11 million from the customer.
When events or conditions indicate that amounts outstanding from customers may become uncollectible, an allowance is estimated and recorded.
Fair Value Measurements
The carrying value of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate their fair value.
Changes in Estimates on Contracts
Changes in estimates related to certain types of contracts accounted for using the percentage of completion method of accounting are recognized in the period in which such changes are made for the inception-to-date effect of the changes. Changes in these estimates can routinely occur over the contract performance period for a variety of reasons, including changes in contract scope, changes in contract cost estimates due to unanticipated cost growth or retirements of risk for amounts different than estimated and changes in estimated incentive or award fees. Aggregate changes in contract estimates resulted in an increase to operating income of $6 million and an increase

15


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





of $0.06 per diluted share for the three months ended August 1, 2014, and an increase to operating income of $18 million and an increase of $0.15 per diluted share for the six months ended August 1, 2014. Aggregate changes in contract estimates resulted in a decrease to operating income of $27 million and a decrease of $0.19 per diluted share for the three months ended August 2, 2013, and a decrease to operating income of $28 million and a decrease of $0.21 per diluted share for the six months ended August 2, 2013.
Goodwill and Intangible Assets
Goodwill
Goodwill represents purchase consideration paid in a business combination that exceeds the values assigned to the net assets of acquired businesses. Goodwill is not amortized, but instead is tested for impairment at the reporting unit level annually, at the beginning of the fourth quarter and during interim periods whenever events or circumstances indicate that the carrying value may not be recoverable. Goodwill is evaluated for impairment either under a qualitative assessment option or a two-step quantitative approach depending on facts and circumstances of a reporting unit, including the excess of fair value over carrying amount in previous assessments and changes in business environment.
When performing a qualitative assessment, the Company considers factors including, but not limited to, current macroeconomic conditions, industry and market conditions, cost factors, financial performance and other events relevant to the entity or reporting unit under evaluation to determine whether it is more likely or not that the fair value of a reporting unit is less than its carrying amount. If the Company determines that it is more likely than not that a reporting unit’s fair value is less than its carrying amount, a quantitative two-step goodwill impairment test is performed.
In evaluating the first step of the two-step quantitative goodwill impairment test, the estimated fair value of each reporting unit is compared to its carrying value, which includes the allocated goodwill. If the estimated fair value of a reporting unit is more than its carrying value, including allocated goodwill, no further analysis is required. If the estimated fair value of a reporting unit is less than its carrying value, including allocated goodwill, a second step is performed to compute the amount of the impairment by determining an implied fair value of goodwill. The implied fair value of goodwill is the residual fair value derived by deducting the fair value of a reporting unit’s identifiable assets and liabilities from its estimated fair value calculated in the first step. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then the Company records an impairment charge equal to the difference.
The Company estimates the fair value of each reporting unit using both market and income approaches (Level 3 under the accounting standard for fair value measurement).
The market approach consists of the guideline public company method which is a valuation technique where the fair value is calculated based on market prices obtained from a detailed market analysis of publicly traded companies that provide a reasonable basis of comparison for each reporting unit. Valuation ratios are selected that relate market prices to selected financial metrics from comparable companies. These ratios are applied after consideration of adjustments and weightings related to financial position, growth, volatility, working capital movement, and other factors. Due to the fact that stock prices of comparable companies represent minority interests the Company also considers an acquisition control premium to reflect the impact of additional value associated with a controlling interest.
The income approach is a valuation technique where the fair value is calculated based on forecasted future cash flows within the projection period discounted back to the present value with appropriate risk adjusted discount rates, which represent the weighted-average cost of capital ("WACC") for each reporting unit. This includes assessing the cost of equity and debt capital as of the valuation date. In addition, a terminal value is developed for forecasted future cash flows beyond the projection period discounted back to the present value. The forecasts used in the

16


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





Company’s estimation of fair value are developed by management based on known business and market considerations.
The goodwill impairment test process and valuation model is based upon certain key assumptions that require the exercise of significant judgment including judgments for the use of appropriate financial projections, economic expectations, discount rates and WACC as well as using available market data.
An interim goodwill impairment evaluation was performed during the second quarter of fiscal 2015 and resulted in goodwill impairment charges of $486 million for the three and six months ended August 1, 2014. See Note 4-Goodwill and Intangible Assets for further information.
Intangible assets
Intangible assets with finite lives are amortized using the method that best reflects how their economic benefits are utilized or, if a pattern of economic benefits cannot be reliably determined, on a straight-line basis over their estimated useful lives.
Intangible assets with finite lives are assessed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Intangible assets with indefinite lives are not amortized but are assessed for impairment at the beginning of the fourth quarter and whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
Supplementary Cash Flow Information
Supplementary cash flow information, including non-cash investing and financing activities, for the periods presented was as follows:
 
Six Months Ended
 
August 1,
2014
 
August 2,
2013
 
 
Vested stock issued as settlement of annual bonus accruals
$
1

 
$
2

Stock issued in lieu of cash dividends
$
2

 
$
16

Cash paid for interest (including discontinued operations)
$
37

 
$
36

Cash paid for income taxes, net of refunds (including discontinued operations)
$
12

 
$
62

Accounting Standards Updates Adopted
In February 2013, the Financial Accounting Standards Board ("FASB") issued ASU 2013-04: Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date. This standard requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of the provisions of ASU 2013-04 did not have a material effect on the Company's consolidated financial position, results of operations or cash flows.
In March 2013, the FASB issued ASU No. 2013-05, Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. This standard applies to the release of the cumulative

17


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





translation adjustment into net income when a parent either sells a part of or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. In addition, the amendments resolve the diversity in practice for the treatment of business combinations achieved in stages (i.e., step acquisitions) involving a foreign entity. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of the provisions of ASU 2013-05 did not have a material effect on the Company's consolidated financial position, results of operations or cash flows.
In June 2014, the FASB issued ASU No. 2014-12, Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This standard was issued to provide guidance on share based payment awards in which a performance target may be achieved after an employee completes the requisite service period to achieve the award. In some instances, this has led to a performance award being granted subsequent to the employee no longer rendering services to the issuing company. Previously, no guidance had been included in the codification on how to account for these transactions. The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The amendments in this ASU are effective for all entities for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. The amendments may be adopted prospectively or retrospectively. The Company elected to early adopt the provisions of ASU No. 2014-12 and the standard did not have a material effect on the Company's financial position, results of operations, or cash flows.
During the quarter presented, the Company adopted various other accounting standards issued by the FASB, none of which had a material effect on the Company's consolidated financial position, results of operations or cash flows.
Accounting Standards Updates Issued But Not Yet Adopted
In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in the ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial results. Examples include a disposal of a major geographic location, a major line of business or a major equity method investment. In addition, the new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income and expenses of discontinued operations. The new guidance also requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. This disclosure will provide users with information about the ongoing trends in a reporting organization’s results from continuing operations. The amendments in the ASU are effective in the first quarter of 2015 for public organizations with calendar year ends. Early adoption is permitted. The Company is still evaluating the provisions of ASU 2014-08 and its impact on the Company's consolidated financial position, results of operations or cash flows.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the codification. Additionally, this ASU supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts. The guidance's core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the revenue principles, an entity will identify the performance obligations, determine the transaction price, allocate the transaction price to the performance obligations and recognize revenue when the performance

18


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





obligation is satisfied. The ASU further states that an entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The amendments in this ASU are effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016, for public companies. Early adoption is not permitted. The Company is still evaluating the provisions of ASU 2014-09 and its impact on the Company's consolidated financial position, results of operations or cash flows.
Note 2—Dispositions:
Fiscal 2015 Discontinued Operations
In July 2014, the Company committed to plans to dispose of a business primarily focused on full service emergency management consulting for disaster preparedness, response, recovery, and mitigation historically included in the Company's Health and Engineering segment. The sale transaction was completed on August 22, 2014 with cash proceeds received of $19 million.
Fiscal 2014 Discontinued Operations
Separation of New SAIC
As discussed in Note 1, the Company completed the spin-off of New SAIC on September 27, 2013. New SAIC was a subsidiary of Leidos prior to the separation date. At separation, New SAIC made a $295 million dividend payment to Leidos and reimbursed Leidos, Inc. $5 million for financing costs previously advanced to New SAIC to secure a revolving and term credit facility, and Leidos, Inc. made a $26 million capital contribution to New SAIC.
The spin-off was made pursuant to the terms of a Distribution Agreement and several other agreements entered into between the Company and New SAIC on September 25, 2013. These agreements set forth, among other things, the principal actions needed to be taken in connection with the separation and govern certain aspects of the relationship between the Company and New SAIC following the separation. These agreements generally provide, with certain exceptions, that each party is responsible for its respective assets, liabilities and obligations, including employee benefits, insurance and tax related assets and liabilities, whether accrued or contingent, except that unknown liabilities will be shared between the parties in certain circumstances. The agreements also describe the party’s commitments to provide each other with certain services for a limited time to help ensure an orderly transition. The agreements also include the treatment of existing contracts, proposals, and teaming arrangements where New SAIC will jointly perform work after separation on Leidos contracts. While the Company is a party to the Distribution Agreement and the ancillary agreements, the Company has determined that it does not have significant continuing involvement in the operations of New SAIC, nor does the Company expect significant continuing cash flows from New SAIC. 

19


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





The operating results of New SAIC through the Distribution Date, which have been classified as discontinued operations, for the periods presented were as follows:
 
Three Months Ended
Six Months Ended
 
August 1, 2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Revenues
$
12

 
$
1,008

 
$
26

 
$
2,114

Costs and expenses:
 
 


 


 


Cost of revenues
12

 
917

 
26

 
1,915

Selling, general and administrative expenses

 
5

 

 
20

Separation transaction and restructuring expenses

 
15

 

 
34

Operating income
$

 
$
71

 
$

 
$
145

Other Fiscal 2014 Discontinued Operations
Other fiscal 2014 non-strategic dispositions were historically included in the Company's National Security Solutions segment.
In August 2013, the Company committed to plans to dispose of a business primarily focused on technology used to detect if an individual is concealing explosive devices or other hidden weapons. In the first quarter of fiscal 2015, the Company adjusted the carrying values of the business's assets to their fair value based on the estimated selling price of the business (Level 1 fair value measurement). The carrying value exceeded the fair value which resulted in approximately $12 million of impairment charges recorded in discontinued operations. The sale transaction was completed in the second quarter of fiscal 2015 with insignificant cash proceeds received, resulting in an immaterial loss on sale.
In November 2013, the Company sold a certain component of the Company's business focused on machine language translation with insignificant cash proceeds received, resulting in an immaterial gain on sale.
In January 2014, the Company committed to plans to dispose of Cloudshield Technologies, Inc. ("Cloudshield"), previously acquired in fiscal 2011, which is focused on producing a suite of cybersecurity hardware and associated software and services.

20


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





The pre-sale operating results through the date of disposal of the Company’s discontinued operations discussed above, not including the separation of New SAIC, for the periods presented were as follows:
 
Three Months Ended
 
Six Months Ended
 
August 1,
2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Revenues
$
8

 
$
10

 
$
20

 
$
18

Costs and expenses:


 


 


 


Cost of revenues
9

 
10

 
17

 
17

Selling, general and administrative expenses (including impairment charges of $9 million for the six months months ended August 1, 2014)
5

 
10

 
19

 
18

Intangible asset impairment charges

 

 
3

 
2

Operating loss
$
(6
)
 
$
(10
)
 
$
(19
)
 
$
(19
)
Non-operating income (expense)
$
8

 
$
(1
)
 
$
8

 
$
(1
)
Total income (loss) from discontinued operations before income taxes
$
2

 
$
(11
)
 
$
(11
)
 
$
(20
)
Note 3—Acquisitions:
Plainfield Renewable Energy Holdings LLC
On October 11, 2013, the Company and Plainfield Renewable Energy Owner, LLC (“project owner”) entered into a consensual foreclosure agreement pursuant to which the project owners agreed to transfer 100% of the equity interest of Plainfield Renewable Energy Holdings, LLC (“PRE Holdings”) to an indirect wholly-owned subsidiary of Leidos in full satisfaction of certain secured obligations owed by the project owner to the Company. Plainfield Renewable Energy LLC or "Plainfield" was a wholly-owned subsidiary of PRE Holdings. As a result of the entry into the foreclosure agreement, the Company determined that it has the power to direct the activities of the VIE and has the right to receive benefits from or the obligation to absorb the losses of the VIE. Accordingly, the Company was deemed the primary beneficiary of the VIE, resulting in the consolidation of Plainfield as of October 11, 2013 (the "transaction"). The Company also determined that Plainfield met the definition of a business and as such gained control of 100% of PRE Holdings equity through the consensual foreclosure agreement which constituted a change in control accounted for as a business combination.
The Plainfield Renewable Energy Project involves the design, construction, and financing of a 37.5 megawatt biomass-fueled power plant in Plainfield, Connecticut (the "plant"). Connecticut Light & Power will purchase approximately 80% of the power produced by the plant based on a 15-year off-take agreement, utilizing the plant's status as a renewable power source. In addition, there are fuel supply agreements with initial terms of 5 to 15 years and minimum purchase requirements either at prevailing market prices or a set price plus a CPI index.

21


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





At the time the Company became the primary beneficiary of Plainfield, the Company measured the assets acquired and liabilities assumed at their fair values. As a result of the transaction in the third quarter of fiscal 2014, the Company recorded a $32 million loss as bad debt expense in the Company's condensed consolidated statements of income. This was primarily the result of the difference between the estimated fair value of the plant in comparison to the carrying value of the Company's deferred payment term receivables forgiven as of the date of the transaction. In addition, contingent consideration of approximately $3 million remains to be paid as of August 1, 2014, of which $2 million will be paid on the earlier of November 2015 or the successful sale of the plant, and the remainder of which will be paid solely upon the successful sale of the plant.
In July 2014, the Company received a cash grant of $80 million from the U.S. Treasury Department, which was recorded as a reduction to the fixed asset basis of the plant on the condensed consolidated balance sheet, and will be recognized ratably over the life of the plant through reduced depreciation expense. For tax purposes, the tax basis of the plant was reduced by half of the amount of the cash grant. This difference between the excess tax basis of the plant over the book basis resulted in a $27 million deferred tax asset which was recorded as a reduction to the fixed asset basis of the plant. The U.S. Treasury grant also contains a recapture provision that could require the Company to repay funds to the Treasury in certain circumstances which the Company deems not probable.
The aggregate purchase consideration that the Company exchanged for PRE Holdings is as follows (in millions):
Forgiveness of accounts receivable (net of $32 million bad debt expense)
$
105

Contingent consideration
6

Total purchase consideration
$
111

The fair values of the assets acquired and liabilities assumed at the date of acquisition were as follows (in millions):
Property, plant and equipment
$
248

Other assets
8

Notes payable assumed (net of debt discount)
(148
)
Total identifiable net assets acquired
108

Intangible assets
3

Total purchase consideration
$
111


22


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





Note 4—Goodwill and Intangible Assets:
The Company's National Security Solutions ("NSS") and Health and Engineering ("HES") are the reportable segments that contain goodwill. Goodwill is tested for impairment at the reporting unit level annually, at the beginning of the fourth quarter, and during interim periods whenever events or circumstances indicate that the carrying value may not be recoverable. As disclosed in the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 2014, the annual goodwill impairment assessment was completed in the fourth quarter fiscal 2014 and it was concluded that the estimated fair value of all of the Company's reporting units exceeded their carrying value. In the second quarter of fiscal 2015, as part of its normal quarterly procedures, the Company considered both qualitative and quantitative factors associated with each of the Company's reporting units and determined that there were indicators that the carrying values of the Health Solutions and Engineering reporting units may not be fully recoverable due to operating performance shortfalls and forecasted declines of revenues and operating income. The Company performed an interim evaluation for these reporting units that resulted in impairments of the goodwill carrying value.
The changes in the carrying value of goodwill for NSS and HES were as follows:
 
NSS
 
HES
 
Total

 
(in millions)
Goodwill at January 31, 2014
$
788

 
$
905

 
$
1,693

Goodwill impairment charges

 
(486
)
 
(486
)
Goodwill at August 1, 2014
$
788

 
$
419

 
$
1,207

During the second quarter of fiscal 2015, the Health Solutions reporting unit experienced a significant decline in both actual and forecasted revenue volumes primarily in our commercial health consulting business resulting from a reduction in new project opportunities, delayed award decisions, and completion of several larger electronic health records ("EHR") implementation engagements that were not extended or replaced with other projects. The declines were also impacted by delays in legislative compliance deadlines (i.e., ICD-10 and Meaningful Use Stage 2). These events attributed to a significant reduction in our sales pipeline, revenue, and operating income. The nature of our commercial health consulting engagements are short term in nature and the aforementioned events transpired and became known during the second quarter of fiscal 2015 and triggered a revised and lower financial forecast.
During the second quarter of fiscal 2015, the Engineering reporting unit experienced delayed or lost award decisions and reductions in scope on several large engineering construction projects as clients shifted priorities and adjusted their capital expenditure plans that were anticipated to be awarded to the Company during the second quarter of fiscal 2015. The Engineering reporting unit was also impacted by significant reduction in scope of services with an existing client. These events culminated in a significant reduction in our sales pipeline, revenue, and operating income. The aforementioned events transpired and became known during the second quarter of fiscal 2015 and triggered a revised and lower financial forecast.
Based on the unexpected impacts and other unanticipated factors discussed above, the Company conducted an interim goodwill impairment test using the two-step quantitative approach.
As described in Note 1, the Company utilized both the market and income approach as part of the first step of the two-step quantitative goodwill impairment test to determine the estimated fair value of both the Health Solutions and Engineering reporting units (Level 3 fair value measurement).
The Company performed the market approach, guideline public company method, by applying pricing multiples derived from publicly traded guideline companies that are comparable to the reporting units to determine their fair values. The Company utilized enterprise/earnings before interest, taxes, depreciation, and amortization ("EBITDA") multiples and enterprise/revenue multiples which averaged 6.0 and 0.5, respectively, for the Health Solutions

23


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





reporting unit, and 6.8 and 0.4, respectively, for the Engineering reporting unit. In addition, the fair value under the guideline public company method included a control premium of 20%, which was determined based on a review of comparable market transactions.
The income approach was performed by calculating the fair value based on forecasted future cash flows discounted back to the present value, including significant judgments related to the risk adjusted discount rates, terminal growth rates, and weighted-average cost of capital ("WACC"). The projected cash flows were developed by management for planning purposes based on current known business and market conditions as well as future anticipated industry trends. The method included certain cost adjustments that a market participant buyer would not incur to operate the respective reporting units. A terminal value growth rate of 3% and 2% and WACC of 12% and 14% (which includes a specific company risk premium of 2%) were used for the Health Solutions and Engineering reporting units, respectively.
Based on the first step of the two-step quantitative goodwill impairment test, the Company determined that the fair values of the Health Solutions and Engineering reporting units were 62% and 91% of their carrying values, respectively. Due to the fact that indicators of impairment existed, the second step of the two-step quantitative goodwill impairment test was performed to determine the implied fair value of goodwill and the impairment amount of the respective reporting units.
As a result of the second step evaluation, the Company recorded goodwill impairment charges in the Health Solutions and Engineering reporting units of $369 million and $117 million, respectively, for the three months ended August 1, 2014, which represents the difference between the carrying value and the implied fair value. There were no other goodwill impairment charges recorded for the remaining reporting units.
Intangible assets consisted of the following:
 
August 1, 2014
 
January 31, 2014
 
Gross carrying value
 
 Accumulated amortization
 
Net carrying value
 
Gross carrying value
 
Accumulated amortization
 
Net carrying value
 
(in millions)
Finite-lived intangible assets:

 

 

 

 

 

Customer relationships
$
70

 
$
(54
)
 
$
16

 
$
94

 
$
(47
)
 
$
47

Software and technology
65

 
(39
)
 
26

 
65

 
(36
)
 
29

Other
4

 
(1
)
 
3

 
4

 
(1
)
 
3

Total finite-lived intangible assets
139

 
(94
)
 
45

 
163

 
(84
)
 
79

Indefinite-lived intangible assets:


 


 


 


 


 


In-process research and development
10

 

 
10

 
10

 

 
10

Trade names
4

 

 
4

 
4

 

 
4

Total indefinite-lived intangible assets
14

 

 
14

 
14

 

 
14

Total intangible assets
$
153

 
$
(94
)
 
$
59

 
$
177

 
$
(84
)
 
$
93

Amortization expense related to amortizable intangible assets was $5 million and $10 million for the three and six months ended August 1, 2014, respectively, and $11 million and $22 million for the three and six months ended August 2, 2013, respectively.

24


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





For the three months ended August 1, 2014, the Company determined that certain customer relationship intangible assets associated with Vitalize and maxIT were not recoverable due to lower projected revenue and operating income levels from the associated customers. As a result, the Health and Engineering reportable segment recognized an impairment charge of $24 million for the three and six months ended August 1, 2014 to reduce the carrying value of these intangible assets to their estimated fair values. Fair value was estimated using the income approach based on management’s forecast of future cash flows to be derived from the assets’ use (Level 3 under the accounting standard for fair value measurement).
During the three months ended August 2, 2013, the Company determined that certain intangible assets consisting of software and technology, associated with the acquisition of Reveal Imaging Technologies, Inc. in fiscal 2011, were not recoverable due to lower projected revenue levels from the associated products and customers. As a result, the Health and Engineering reportable segment recognized an impairment charge of $30 million to reduce the carrying value of these intangible assets to their estimated fair values. Fair value was estimated using the income approach based on management's forecast of future cash flows to be derived from the assets' use (Level 3 under the accounting standard for fair value measurement). The Company recognized impairment charges for intangible assets of $32 million for the six months ended August 2, 2013.
The estimated annual amortization expense related to finite-lived intangible assets as of August 1, 2014 was as follows:
Fiscal Year Ending January 31
 
 
(in millions)
2015 (remainder of the fiscal year)
$
6

2016
11

2017
10

2018
8

2019
6

2020 and thereafter
4

 
$
45

Actual amortization expense in future periods could differ from these estimates as a result of future acquisitions, dispositions, impairments, the outcome and timing of completion of in-process research and development projects (the assets of which will become amortizable upon completion and placement into service, or will be impaired if abandoned), adjustments to preliminary valuations of intangible assets and other factors.
Note 5—Financial Instruments:
The Company’s cash equivalents were primarily comprised of investments in several large institutional money market funds and bank deposits. There are no restrictions on the withdrawal of the Company’s cash and cash equivalents. The Company’s cash equivalents are recorded at historical cost, which equals fair value based on quoted market prices (Level 1 input as defined by the accounting standard for fair value measurements).
Leidos has a revolving credit facility, which is fully and unconditionally guaranteed by Leidos, Inc., providing for up to $750 million in unsecured borrowing capacity at interest rates determined, at Leidos’ option, based on either LIBOR plus a margin or a defined base rate. During the three months ended May 3, 2013, the maturity date of the credit facility was extended for one additional year to March 2017, as provided for in the terms of the credit facility. As of August 1, 2014 and January 31, 2014, there were no borrowings outstanding under the credit facility.

25


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





The credit facility contains certain customary representations and warranties, as well as certain affirmative and negative covenants. During the three months ended May 3, 2013, the financial covenants in the credit facility were amended to: (i) permit in the calculation of earnings before interest, taxes, depreciation and amortization (EBITDA) the adding back of certain expenses incurred in connection with the Company’s separation transaction; (ii) exclude the effect of debt incurred in connection with the separation transaction for purposes of calculating consolidated funded debt; and (iii) change the ratio of consolidated funded debt to EBITDA that the Company is required to maintain. The financial covenants contained in the credit facility require that, for a period of four trailing fiscal quarters, the Company maintains a ratio of consolidated funded debt, including borrowings under this credit facility, to EBITDA adjusted for other items as defined in the credit facility of not more than 3.25 to 1.0 and a ratio of EBITDA adjusted for other items as defined in the credit facility to interest expense of greater than 3.5 to 1.0. The Company was in compliance with these financial covenants as of August 1, 2014. A failure by the Company to meet these financial covenants in the future would reduce and could eliminate the Company’s borrowing capacity under the credit facility.
The available borrowing capacity on the credit facility may vary each quarter based on the trailing four quarters of EBITDA. If the Company's trailing four quarters of EBITDA declines below a certain threshold in relation to its outstanding debt, the borrowing capacity available under the credit facility reduces. The available borrowing capacity based on the results of the Company's trailing four quarters of EBITDA as of August 1, 2014 was reduced to approximately $450 million.
Other covenants in the credit facility restrict certain of the Company’s activities, including, among other things, its ability to create liens, dispose of certain assets and merge or consolidate with other entities. The credit facility also contains certain customary events of default, including, among others, defaults based on certain bankruptcy and insolvency events, nonpayment, cross-defaults to other debt, breach of specified covenants, Employee Retirement Income Security Act (ERISA) events, material monetary judgments, change of control events and the material inaccuracy of the Company’s representations and warranties. In addition, the Company's ability to declare and pay future dividends on Leidos stock may be restricted by the provisions of Delaware law and covenants in the revolving credit facility.
The Company’s notes payable and long-term debt consisted of the following:
 
Stated interest rate
 
Effective interest rate
 
August 1, 2014
 
January 31, 2014
 
(dollars in millions)
Leidos Holdings, Inc. senior unsecured notes:
 
 
 
 
 
 
 
$450 million notes, which mature in December 2020
4.45
%
 
4.53
%
 
$
449

 
$
449

$300 million notes, which mature in December 2040
5.95
%
 
6.03
%
 
300

 
300

Leidos, Inc. senior unsecured notes:

 

 


 


$250 million notes, which mature in July 2032
7.13
%
 
7.43
%
 
248

 
248

$300 million notes, which mature in July 2033
5.50
%
 
5.78
%
 
296

 
296

Capital leases and other notes payable due on various dates through fiscal 2021
0%-3.7%

 
Various
 
39

 
40

Total notes payable and long-term debt

 

 
$
1,332

 
$
1,333

Less current portion

 

 
3

 
2

Total notes payable and long-term debt, net of current portion

 

 
$
1,329

 
$
1,331

Fair value of notes payable and long-term debt

 

 
$
1,330

 
$
1,350


26


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





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 as defined by the accounting standard for fair value measurements).
The senior unsecured notes contain 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 August 1, 2014.
Note 6—Related Party Transactions:
Leidos, Inc. has fully and unconditionally guaranteed the obligations of Leidos under its $450 million 4.45% notes and $300 million 5.95% notes. These notes have been reflected as debt of Leidos, Inc. in these condensed consolidated financial statements. Leidos, Inc. has fully and unconditionally guaranteed any borrowings under Leidos’ amended and restated revolving credit facility maturing in fiscal 2018. Leidos has fully and unconditionally guaranteed the obligations of Leidos, Inc. under its $300 million 5.5% notes and $250 million 7.13% notes.
Leidos and Leidos, Inc. have a related party note in connection with a loan of cash between the entities, which is adjusted to reflect issuances of stock by Leidos to employees of Leidos, Inc. and its subsidiaries and Leidos Inc.’s payment of certain obligations on behalf of Leidos. The related party note bears interest based on LIBOR plus a market-based premium. Portions of the related party note may be repaid at any time. The note automatically extends for successive one-year periods unless either Leidos or Leidos, Inc. provides prior notice to the other party. As of August 1, 2014, the note receivable from Leidos Holdings, Inc. to Leidos, Inc. was $1.4 billion. The note receivable also includes the distribution of the assets and liabilities of New SAIC of $736 million that occurred at the time of the separation in September 2013.
Note 7—Accumulated Other Comprehensive Loss:
The components of accumulated other comprehensive loss were as follows:
 
August 1,
2014
 
January 31,
2014
 
(in millions)
Foreign currency translation adjustments, net of taxes of $(1) million as of August 1, 2014 and January 31, 2014
$
2

 
$
2

Unrecognized net loss on settled derivative instruments associated with outstanding debt, net of taxes of $3 million as of August 1, 2014 and January 31, 2014
(5
)
 
(5
)
Unrecognized net loss on defined benefit plan, net of taxes of $2 million as of August 1, 2014 and January 31, 2014
(3
)
 
(3
)
Total accumulated other comprehensive loss, net of taxes of $4 million as of August 1, 2014 and January 31, 2014
$
(6
)
 
$
(6
)
Reclassifications from other comprehensive income to net income, relating to foreign currency translation adjustments, unrecognized loss on settled derivative instruments and the unrecognized net gain on the defined benefit plan for the three and six months ended August 1, 2014, were not material. Reclassifications for foreign currency translation adjustments and unrecognized loss on settled derivative instruments are recorded in other income, net, and reclassifications for the unrecognized net gain on the defined benefit plan is recorded in selling, general, and administrative expenses.

27


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





Note 8—(Loss) Earnings Per Share (EPS):
The Company is required to allocate a portion of its earnings to its unvested stock awards containing nonforfeitable rights to dividends or dividend equivalents (participating securities) in calculating EPS using the two-class method.
Unvested stock awards granted prior to fiscal 2013 are participating securities requiring application of the two-class method. In fiscal 2013, the Company began issuing unvested stock awards that have forfeitable rights to dividends or dividend equivalents. These stock awards are not participating securities requiring application of the two-class method, but are dilutive common share equivalents subject to the treasury stock method. Basic EPS is computed by dividing income less earnings allocable to participating securities by the basic weighted average number of shares outstanding. Diluted EPS is computed similar to basic EPS, except the weighted average number of shares outstanding is increased to include the dilutive effect of outstanding stock options and other stock-based awards.
A reconciliation of the income used to compute basic and diluted EPS for the periods presented was as follows:
 
Three Months Ended
 
Six Months Ended
 
August 1, 2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Basic EPS:
 
 
 
 

 

(Loss) income from continuing operations, as reported
$
(439
)
 
$
4

 
$
(394
)
 
$
45

Less: allocation of distributed and undistributed earnings to participating securities

 

 

 
(3
)
(Loss) income from continuing operations, for computing
basic EPS
$
(439
)
 
$
4

 
$
(394
)
 
$
42

Net (loss) income, as reported
$
(438
)
 
$
42

 
$
(401
)
 
$
123

Less: allocation of distributed and undistributed earnings to participating securities

 

 

 
(3
)
Net (loss) income, for computing basic EPS
$
(438
)
 
$
42

 
$
(401
)
 
$
120

Diluted EPS:


 


 


 


(Loss) income from continuing operations, as reported
$
(439
)
 
$
4

 
$
(394
)
 
$
45

Less: allocation of distributed and undistributed earnings to participating securities

 

 

 
(3
)
(Loss) income from continuing operations, for computing
diluted EPS
$
(439
)
 
$
4

 
$
(394
)
 
$
42

Net (loss) income, as reported
$
(438
)
 
$
42

 
$
(401
)
 
$
123

Less: allocation of distributed and undistributed earnings to participating securities

 

 

 
(3
)
Net (loss) income, for computing diluted EPS
$
(438
)
 
$
42

 
$
(401
)
 
$
120



28


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





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. The presentation for the three and six months ended August 2, 2013, gives effect to the one-for-four reverse stock split which occurred after market close on September 27, 2013.
 
Three Months Ended
 
Six Months Ended
 
August 1, 2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Basic weighted average number of shares outstanding
74

 
84

 
75

 
84

Dilutive common share equivalents—stock options and
other stock awards

 

 

 

Diluted weighted average number of shares outstanding
74

 
84

 
75

 
84


For the three and six months ended August 1, 2014, all outstanding common stock equivalents were excluded in the computation of diluted (loss) per share because their effect would have been anti-dilutive due to the net loss for the corresponding periods.

For the three and six months ended August 2, 2013, the declared dividends exceeded current period earnings. Therefore, the Company was in a loss position for computing diluted (loss) per share and all outstanding common stock equivalents were excluded in the computation because their effect would have been anti-dilutive.
The following anti-dilutive stock-based awards were excluded from the weighted average number of shares outstanding used to compute basic and diluted EPS for the periods presented:
 
Three Months Ended
 
Six Months Ended
 
August 1, 2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Stock options
4

 
5

 
4

 
5

Vesting stock awards
3

 
3

 
3

 
3

In December 2013, the Company entered into an Accelerated Share Repurchase ("ASR") agreement with a financial institution to repurchase shares of its outstanding common stock for an aggregate purchase price of $300 million. During the fourth quarter of fiscal 2014, the Company paid $300 million to the financial institution and received an initial delivery of 5.6 million shares of its outstanding shares of common stock for an aggregate value of $255 million. The final delivery of approximately 1.0 million shares for a total value of $45 million under the program was completed during the first quarter of fiscal 2015. The purchase was allocated between additional paid in capital and retained earnings. All shares delivered were immediately retired.
In March 2014, the Company entered into a second Accelerated Share Repurchase agreement with a different financial institution to repurchase shares of its outstanding common stock for an aggregate purchase price of $200 million. During the first quarter of fiscal 2015, the Company paid $200 million to the financial institution and received an initial delivery of 4.5 million shares of its outstanding shares of common stock for an aggregate value of approximately $168 million. The final delivery of approximately 0.8 million shares for a total value of approximately $32 million under the program was completed during the second quarter of fiscal 2015. The purchase was allocated between additional paid in capital and retained earnings. All shares delivered were immediately retired.

29


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





The delivery of 0.8 million and 6.3 million shares of Leidos common stock for both ASR purchases for the three and six months ended August 1, 2014, respectively, reduced the Company's outstanding shares used to determine the weighted average shares outstanding for purposes of calculating basic and diluted EPS for the periods presented.
Note 9—Stock-Based Compensation:
Plan Summaries: At August 1, 2014, the Company had stock-based compensation awards outstanding under the following plans: the 2006 Equity Incentive Plan, the Management Stock Compensation Plan, the Stock Compensation Plan, and the 2006 Employee Stock Purchase Plan (ESPP). Leidos issues new shares upon the issuance of stock awards or exercise of stock options under these plans.
The 2006 Equity Incentive Plan provides the Company's and its affiliates' employees, directors, and consultants the opportunity to receive various types of stock-based compensation and cash awards. The Company has issued stock options, vested stock awards, restricted stock awards including stock units, performance-based awards, and cash awards under this plan.
Stock awards granted under the plan prior to fiscal 2015 generally vest or became exercisable 20%, 20%, 20%, and 40% after one, two, three, and four years, respectively. In fiscal 2015, the Company has begun granting awards that generally vest or become exercisable 25% after one year, two, three, and four years.
Total Stock-Based Compensation. Total stock-based compensation expense and related tax benefits recognized for the periods presented was as follows: 
 
Three Months Ended
 
Six Months Ended
 
August 1,
2014
 
August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Stock-based compensation expense:
 
 
 
 
 
 
 
Stock options
$
1

 
$
3

 
$
3

 
$
5

Vesting stock awards
9

 
12

 
18

 
25

Vested stock awards
2

 

 
2

 

Total stock-based compensation expense recorded in continuing operations
$
12

 
$
15

 
$
23

 
$
30

Total stock-based compensation expense recorded in discontinued operations
$

 
$
6

 
$

 
$
15

Tax benefits recognized from stock-based compensation
$
5

 
$
6

 
$
9

 
$
12

Stock Options
Stock options granted during the six months ended August 1, 2014 and August 2, 2013 have terms of seven years and a vesting period of four years based upon required service conditions, except for stock options granted to the Company’s outside directors, which have a vesting period of one year.

30


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





The fair value of the Company’s stock option awards is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average grant date fair value and assumptions used to determine the fair value of stock options granted for the periods presented were as follows:
 
 
Six Months Ended
 
 
 
August 1,
2014
 
August 2,
2013
 
Options granted (in millions)
 
0.6

 
1.4

*
Weighted average grant-date fair value
 
$
6.14

 
$
6.92

*
Expected term (in years)
 
4.7

 
5.0

 
Expected volatility
 
25.1
%
 
25.0
%
 
Risk-free interest rate
 
1.6
%
 
0.8
%
 
Dividend yield
 
2.9
%
 
3.9
%
 
*Adjusted for additional awards granted for the $4.00 special cash dividend
In March 2013, Leidos' board of directors declared a special cash dividend of $4.00 per share of Leidos common stock and paid an aggregate $342 million on June 28, 2013 to stockholders of record on June 14, 2013. In connection with the special cash dividend, anti-dilutive adjustments were made to all outstanding stock options on the dividend record date to preserve their value following the special cash dividend, as required by the Company's 2006 Equity Incentive Plan. The modifications were made to reduce the exercise prices of the outstanding stock options and to increase the number of shares issuable upon the exercise of each option such that the aggregate difference between the market price and exercise price times the number of shares issuable upon exercise was substantially the same immediately before and after the payment of the special dividend. These adjustments did not result in additional share-based compensation expense, as the fair value of the outstanding options immediately following the payment of the special cash dividend was equal to the fair value immediately prior to such distribution.
As of August 1, 2014, compensation cost related to unvested stock options not yet recognized in the income statement was $8 million and is expected to be recognized over an average period of 1.7 years.
Vesting Stock
Compensation expense is measured at the grant date fair value and generally vests over a four-year vesting period, or seven-year for certain stock awards, based upon required service conditions and in some cases performance conditions. The grant date fair value is based on the closing price of the Company's common stock generally on the day before the date of grant.
During the six months ended August 1, 2014, the Company granted 0.7 million shares of vesting stock at a weighted average grant date fair value of $36.92.
As of August 1, 2014, compensation cost related to unvested shares not yet recognized in the income statement was $66 million and is expected to be recognized over an average period of 1.8 years.

31


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





Performance-Based Awards
The Company grants performance-based stock awards to certain officers and key employees of the Company under the 2006 Equity Incentive Plan. The Company’s performance-based stock awards vest and the stock is issued at the end of a three-year period based upon the achievement of specific performance criteria, with the number of shares ultimately awarded, if any, ranging up to 150% of the specified target awards. If performance is below the threshold level of performance, no shares will be issued. The performance period for performance-based stock awards granted in fiscal 2013 was deemed completed as of the last fiscal quarter prior to the separation of New SAIC with the target shares prorated for the completed period earned. For all of the remaining target shares in the original award, the performance condition was removed and the awards are subject to vesting based on continued employment through the original performance period.
During the six months ended August 1, 2014, the Company granted approximately 50 thousand shares of performance based awards at a weighted average grant date fair value of $36.88.
There were no performance-based stock awards granted in fiscal 2014. For the fiscal 2015 awards granted, one-third of the target number of shares of stock granted under the awards will be allocated to each fiscal year over the three-year performance period and the actual number of shares to be issued with respect to each fiscal year will be based upon the achievement of that fiscal year’s performance criteria.
As of August 1, 2014, compensation cost related to unvested performance-based awards not yet recognized in the income statement was $1 million and is expected to be recognized over an average period of 1.99 years.
Note 10—Business Segment Information:
The Company defines its reportable segments based on the way the chief operating decision maker ("CODM"), currently its chief executive officer, manages the operations of the Company for purposes of allocating resources and assessing performance.
The Company's reportable segments are as follows: National Security Solutions, Health and Engineering, and Corporate and Other.
National Security Solutions provides solutions and systems for air, land, sea, space, and cyberspace for the U.S. intelligence community, the DoD, the military services, and the U.S. Department of Homeland Security. The Company's solutions deliver technology, large scale intelligence systems, data analytics, cyber solutions, logistics, and intelligence analysis and operations support to critical missions around the world. Major customers of National Security Solutions include national and military intelligence agencies and other federal, civilian, and commercial customers in the national security complex.
Health and Engineering provides health systems integration services to implement and optimize the use of electronic health records, apply data analytics and behavioral health research to help enable customers to improve healthcare quality and patient outcomes, detect and prevent diseases, enhance scientific discovery, and reduce costs to the healthcare system. Health and Engineering also provides engineering services and solutions focused on solving energy, environmental, and infrastructure challenges. These include products and solutions in energy generation, efficiency and management, environmental services, securing critical infrastructure, and designing and building construction projects. Major customers of Health and Engineering primarily include the U.S. federal government, state and local governmental agencies, foreign governments, and commercial enterprises in various industries.
Corporate and Other includes the operations of the Company’s internal real estate management subsidiary, various corporate activities, certain corporate expense items that are not reimbursed by the Company’s U.S. Government customers and certain revenue and expense items excluded from the CODM’s evaluation of a reportable segment’s performance.

32


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





The segment information for the periods presented was as follows:
 
Three Months Ended
 
Six Months Ended
 
August 1,
2014

August 2,
2013
 
August 1,
2014
 
August 2,
2013
 
(in millions)
Revenues:

 

 

 

National Security Solutions
$
925

 
$
1,019

 
$
1,869

 
$
2,096

Health and Engineering
381

 
445

 
753

 
962

Corporate and Other

 
(6
)
 
(4
)
 
(6
)
Intersegment elimination

 
(1
)
 

 
(2
)
Total revenues
$
1,306

 
$
1,457

 
$
2,618

 
$
3,050

 
 
 
 
 
 
 
 
Operating income (loss):
 
 
 
 
 
 
 
National Security Solutions
$
78

 
$
72

 
$
155

 
$
143

Health and Engineering
(482
)
 
(3
)
 
(459
)
 
32

Corporate and Other
(6
)
 
(59
)
 
(19
)
 
(88
)
Total operating (loss) income
$
(410
)
 
$
10

 
$
(323
)
 
$
87

Asset information by segment is not a key measure of performance used by the CODM. Interest income, interest expense, and provision for income taxes, as reported in the condensed consolidated financial statements, are not part of operating income and are primarily recorded at the corporate level. Under U.S. Government Cost Accounting Standards, indirect costs including depreciation expense are collected in numerous indirect cost pools which are then collectively allocated out 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.
Note 11—Legal Proceedings:
Timekeeping Contract with City of New York
In March 2012, the Company reached a settlement with the U.S. Attorney’s Office for the Southern District of New York and the City of New York (City) relating to investigations being conducted by the U.S. Attorney’s Office and the City with respect to the Company’s contract to develop and implement an automated time and attendance and workforce management system (CityTime) for certain agencies of the City. As part of this settlement, the Company entered into a deferred prosecution agreement with the U.S. Attorney’s Office, under which the Company paid approximately $500 million and the U.S. Attorney’s Office deferred prosecution of a single criminal count against the Company, which alleged that the Company, through the conduct of certain managerial employees and others, caused the City to significantly overpay for the CityTime system. If the Company complies with the terms of the deferred prosecution agreement, the U.S Attorney will dismiss the criminal count at the end of a three-year period. In August 2012, the Company entered into an administrative agreement with the U.S. Army, on behalf of all agencies of the U.S. Government that confirms the Company’s continuing eligibility to enter into and perform contracts with all agencies of the U.S. Government following the CityTime settlement. The Army has determined that the U.S. Government will have adequate assurances under the terms of the administrative agreement that initiation of suspension or debarment is not necessary to protect the U.S. Government’s interests following the CityTime settlement. Under the terms of the administrative agreement, the Company has agreed, among other things, to maintain a contractor responsibility program having the specific elements described in the administrative agreement, including retaining a monitor and providing certain reports to the U.S. Army. The administrative

33


LEIDOS HOLDINGS, INC.
LEIDOS, INC.
COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 





agreement will continue in effect for five years, provided that the Company may request earlier termination after three years.
Data Privacy Litigation
The Company is a defendant in a putative class action, In Re: Science Applications International Corporation (SAIC) Backup Tape Data Theft Litigation, a Multidistrict Litigation (MDL), in the U.S. District Court for the District of Columbia. The MDL action consolidates for pretrial proceedings the following seven individual putative class action lawsuits filed against the Company from October 2011 through March 2012: (1) Richardson, et al. v. TRICARE Management Activity, Science Applications International Corporation, United States Department of Defense, et al. in U.S. District Court for the District of Columbia; (2) Arellano, et al. v. SAIC, Inc. in U.S. District Court for the Western District of Texas; (3) Biggerman, et al. v. TRICARE Management Activity, Science Applications International Corporation, United States Department of Defense, et al. in U.S. District Court for the District of Columbia; (4)Moskowitz, et al. v. TRICARE Management Activity, Science Applications International Corporation, United States Department of Defense, et al. in U.S. District Court for the District of Columbia; (5) Palmer, et al. v. TRICARE Management Activity, Science Applications International Corporation, United States Department of Defense, et al., in U.S. District Court for the District of Columbia; (6) Losack, et al. v. SAIC, Inc. in U.S. District Court for the Southern District of California; and (7) Deatrick v. Science Applications International Corporation in U.S. District Court for the Northern District of California. The lawsuits were filed following the theft of computer backup tapes from a vehicle of a Company employee. The employee was transporting the backup tapes between federal facilities under an IT services contract the Company was performing in support of TRICARE, the health care program for members of the military, retirees and their families. The tapes contained personally identifiable and protected health information of approximately five million military clinic and hospital patients. There is no evidence that any of the data on the backup tapes has actually been accessed or viewed by an unauthorized person. In order for an unauthorized person to access or view the data on the backup tapes, it would require knowledge of and access to specific hardware and software and knowledge of the system and data structure. The Company has notified potentially impacted persons by letter and has offered one year of credit monitoring services to those who request these services and in certain circumstances, one year of identity restoration services.
In October 2012, plaintiffs filed a consolidated amended complaint in the MDL action, which supersedes all previously filed complaints in the individual lawsuits. The consolidated amended complaint includes allegations of negligence, breach of contract, breach of implied-in-fact contract, invasion of privacy by public disclosure of private facts and statutory violations of the Texas Deceptive Trade Practices Act, the California Confidentiality of Medical Information Act, California data breach notification requirements, the California Unfair Competition Law, various state consumer protection or deceptive practices statutes, state privacy statutes, the Fair Credit Reporting Act and the Privacy Act of 1974. The consolidated amended complaint sought monetary relief, including unspecified actual damages, punitive damages, statutory damages of $1,000 for each class member and attorneys’ fees, as well as injunctive and declaratory relief.
In May 2014, the District Court dismissed all but two plaintiffs from the MDL action and ordered a status hearing before taking up the question of whether the two remaining plaintiffs have stated a legal claim. In June 2014, Leidos and its co-defendant, TRICARE, entered into settlement agreements with the remaining two plaintiffs who subsequently dismissed their claims with prejudice. At this time, Leidos does not expect the other plaintiffs, whose claims were dismissed by the District Court in May, to appeal their dismissal. As of August 1, 2014, the Company has no liability recorded related to these lawsuits.
The Company has been informed that the Office for Civil Rights (OCR) of the Department of Health and Human Services (HHS) is investigating matters related to the incident. OCR is the division of HHS charged with enforcement of the Health Insurance Portability and Accountability Act of 1996, as amended (HIPAA) and the privacy, security and data breach rules which implement HIPAA. OCR may, among other things, require a corrective action plan and impose civil monetary penalties against the data owner (Department of Defense) and, in certain

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situations, against the data owners’ contractors, such as the Company. The Company is cooperating with TRICARE in responding to the OCR investigation.
Derivative and Securities Litigation
Between February and April 2012, six stockholder derivative lawsuits were filed, each purportedly on the Company’s behalf. Two cases have been withdrawn and the four remaining cases were consolidated in the U.S. District Court for the Southern District of New York in In re SAIC, Inc. Derivative Litigation. On June 10, 2013, the District Court dismissed the consolidated complaint with prejudice and on January 30, 2014, the United States Court of Appeals for the Second Circuit affirmed the dismissal.
The Company has also received four stockholder demand letters related to CityTime (one of which is also related to the TRICARE matter described above). An independent committee of the Company’s board of directors reviewed three of the demands and the Company’s lead director has notified all three stockholders’ attorneys, on behalf of the board of directors, that the Company has decided not to pursue the claims outlined in their demand letters. The fourth demand is under review by the independent committee.
Between February and April 2012, alleged stockholders filed three putative securities class actions. 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 names as defendants the Company, its chief financial officer, two former chief executive officers, a former group president and the former program manager on the CityTime program, and was filed purportedly on behalf of all purchasers of the Company's common stock from April 11, 2007 through September 1, 2011. 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. On October 1, 2013, the District Court dismissed many claims in the complaint with prejudice and on January 30, 2014, the District Court entered an order dismissing all remaining claims with prejudice and without leave to replead. The plaintiffs have moved to vacate the District Court's judgment or obtain relief from the judgment and for leave to file an amended complaint.
Greek Government Contract
Background and Arbitration. In May 2003, the Company entered into a firm-fixed-price contract with the Hellenic Republic of Greece (the Customer) to provide a Command, Control, Communications, Coordination and Integration System (the System) to support the 2004 Athens Summer Olympic Games (the Olympics) and to serve as the security system for the Customer’s public order departments following completion of the Olympics.
In November 2008, the Customer accepted the System in writing pursuant to the requirements of the contract. At the time, the Customer determined that the System substantially complied with the terms of the contract and accepted the System with certain alleged minor omissions and deviations. Upon System acceptance, the Company invoiced the Customer for approximately $18 million, representing the undisputed portion of the contract balance owed to the Company. The Customer has not paid this final invoice.
In June 2009, the Company initiated arbitration before the International Chamber of Commerce against the Customer seeking damages for breaches of contract by the Customer. In July 2013, the Company received an arbitral award for approximately $52 million. The Customer has yet to satisfy the arbitral award. The Company is pursuing an enforcement action in U.S. District Court for the District of Columbia. In September 2013, the Customer filed a petition in a Greek court seeking to nullify the arbitral award and to stay enforcement of the award in Greece. A hearing on the Customer's nullification request was held in Greece in April 2014. The parties agreed to a stay of the Company's enforcement action in U.S. District Court until the Greek court issued a ruling on the Customer's nullification request. In June 2014, the Athens Court of Appeals annulled the arbitral award. The Company has a

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right to appeal the annulment decision to the Supreme Court of Greece to have the arbitral award reinstated. The Company is continuing to pursue enforcement of the award in the U.S. District Court as is still its right under U.S. and international law. The outcomes of a possible appeal in Greece and the Company's pending enforcement action are uncertain.
Financial Status and Contingencies. As a result of the significant uncertainties on this contract, the Company converted to the completed-contract method of accounting and ceased recognizing revenues for the System development portion of this contract in fiscal 2006. No profits or losses were recorded on the Greek contract during the three and six months ended August 1, 2014 and August 2, 2013. As of August 1, 2014, the Company has recorded $123 million of losses under the Greek contract, reflecting the Company’s estimated total cost to complete the System, assuming the Greek contract value was limited to the cash received to date. Based on the complex nature of this contractual situation and the difficulties encountered to date, significant uncertainties exist and the Company is unable to reliably estimate the ultimate outcome. The Company may reverse a portion of the losses from the Greek contract if it receives payments as provided in the arbitral award.
As of August 1, 2014, the Comp