Leidos Holdings (LDOS) FY2025 Earnings Quality Report

Grade: F — Major Red Flags

Framework: Schilit *Financial Shenanigans* + Beneish M-Score + forensic accounting principles

Data: SEC EDGAR 10-K (Filed February 17, 2026, fiscal year ended January 2, 2026) + Yahoo Finance

Auditor: Deloitte & Touche LLP — Unqualified opinion (1 critical audit matter: revenues under cost-to-cost method)

One-line verdict: Leidos is a well-run government-services contractor with genuinely improving operations, but the balance sheet carries the legacy of the 2016 IS&GS acquisition plus continuing M&A. Revenue grew 3% to $17.17B, operating margin expanded from 11.0% to 12.3%, and operating income rose 15% to $2.11B. Cash from operations climbed to $1.75B, free cash flow hit $1.63B, and CFFO/NI is 1.21. On almost every income-statement and cash-flow dimension this is an A-grade business. The F is driven by two balance-sheet checks: cash of $1.11B covers only 21% of $5.24B total debt, and goodwill + intangibles of $6.8B equal 138% of equity. Plus a $2.4B announced acquisition of Entrust on January 23, 2026 (with a $1.4B bridge facility) that will push leverage higher in FY2026. The MD&A itself states: "For the next 12 months, we anticipate that we will be able to meet our liquidity needs, including servicing our debt, through cash generated from operations, available cash balances, borrowings from our commercial paper program and, if needed, sales of accounts receivable and borrowings from our revolving credit facility."

A Government-Services Pure Play Turning the Corner

Per Item 7, Leidos "is an industry and technology leader serving government and commercial customers" with 47,000 global employees. The MD&A names the five NorthStar 2030 growth pillars: "space and maritime; energy infrastructure; digital modernization and cyber; mission software; and managed health services." Four reportable segments: National Security & Digital, Health & Civil, Commercial & International, and Defense Systems.

The customer concentration is extreme: "We generated approximately 87% of our total revenues from contracts with the U.S. government in both fiscal 2025 and 2024." And specifically: "Revenues under contracts with the DoW [Department of War, formerly DoD] and U.S. Intelligence Community, including subcontracts under which the DoW or the U.S. Intelligence Community is the ultimate purchaser, represented approximately 49% and 48% of our total revenues for fiscal 2025 and 2024."

The MD&A discloses a post-balance-sheet acquisition that will reshape FY2026: "On January 23, 2026, Leidos, Inc. entered into a stock purchase agreement to acquire all of the shares of Entrust for a purchase price of $2.4 billion in cash... we entered into an agreement with Citigroup Global Markets Inc., which provides for a senior unsecured 364-day bridge loan facility in an aggregate principal amount of $1.4 billion." The revolver was simultaneously upsized from $1.0B to $1.5B — explicit preparation for the Entrust close.

Financial Performance: Margin Expansion Across All Segments

From the MD&A results-of-operations table:

Per the MD&A: "the increase was primarily due to program wins and a net increase in volumes, partially offset by the completion of certain contracts." The 130 basis point operating margin expansion is a meaningful structural improvement.

Segment detail from the MD&A:

Three of the four segments benefited from comparative weakness in the prior period (UK write-downs, Defense write-downs, and program setups). The underlying Health & Civil margin gain is the most durable-looking.

Cash Flow: The Quality Signal

Per the MD&A: "Net cash provided by operating activities increased $315 million for fiscal 2025 as compared to fiscal 2024. The increase was primarily due to an increase in tax benefits from the impacts of the OBBBA legislation and favorable changes in net working capital, partially offset by the timing of payroll and employee benefit payments."

OBBBA (One Big Beautiful Bill Act) tax changes were specifically cited as a meaningful FY2025 cash benefit. The MD&A states: "We anticipate our income tax payments will decrease by approximately $91 million in fiscal 2026, as compared to our estimates prior to the OBBBA enactment." This is a tailwind for reported cash — real but one-time in nature.

Free cash flow of $1.63B was the highest in the four-year trend. Capital intensity is very low (CapEx / revenue = 0.7%) — the business is people-and-software heavy, not capital heavy.

Balance Sheet: The Legacy M&A Overhang

From the MD&A liquidity section:

Debt breakdown from the MD&A: "In fiscal 2025, we issued and sold $500 million 5.40% and $500 million 5.50% senior unsecured notes maturing in March 2032 and March 2035, respectively... The proceeds from the issuance of the notes were used to retire the $500 million senior unsecured notes due May 2025 and repurchase $500 million outstanding shares of common stock in an accelerated share repurchase ('ASR') agreement." Plus "a prepayment on our senior unsecured term loan of $450 million and a $500 million payment to discharge the $500 million notes due May 2025."

Per the screening engine, total debt per Yahoo Finance is $5,235M (which includes short-term components and operating lease liabilities). The C4 check compares cash to that total-debt figure: $1,108M / $5,235M = 21%.

C4 fails at 21% cash-to-debt. This is not a crisis ratio — the company has $1.0B of undrawn revolver (now $1.5B) plus an active commercial paper program, and the MD&A confirms: "We were in compliance with all covenants as of January 2, 2026." But the screening framework treats any cash coverage below 50% as a structural vulnerability.

D1 fails at 138% goodwill+intangibles to equity. The goodwill dates primarily to the 2016 acquisition of Lockheed Martin's IS&GS business plus subsequent M&A (Dynetics, Gibbs & Cox, Kudu Dynamics). Per the MD&A: "Backlog at January 2, 2026, includes $149 million acquired through the acquisition of Kudu Dynamics." Each bolt-on adds more goodwill relative to tangible assets.

The Entrust acquisition will make D1 worse. A $2.4B cash acquisition funded with a $1.4B bridge loan will add meaningful goodwill and raise debt by roughly $1.4B, producing a pro-forma goodwill+intangibles/equity ratio that is materially higher than 138%. Cash/debt will also deteriorate.

Backlog is a legitimate forward-looking asset: total backlog of $49.0B at January 2, 2026 (funded $9.69B, unfunded $39.35B) versus $48.4B a year earlier (recast to include sole-source IDIQ estimates). Note the disclosure change: "Effective fiscal 2025, we changed our backlog policy to include estimated future revenue on task orders expected to be awarded under sole source indefinite delivery/indefinite quantity ('IDIQ') contracts in our reported backlog. As a result, unfunded backlog increased $4,836 million from our prior year annual report amounts." This is a transparent disclosure but worth noting — the comparable prior-year figure was restated upward by $4.8B.

The 18-Point Screening

Revenue Quality

Revenue quality is clean. Cash flow grew well ahead of revenue, which is the opposite of every accrual-manipulation pattern.

Expense Quality

The 120bp gross-margin expansion per the screening engine is attributed in the MD&A to "program wins and a net increase in volumes on certain programs" — operating leverage on a fixed cost base.

Cash Flow Quality

Balance Sheet

Acquisition Risk

Manipulation Score

M-Score components: DSRI 0.974, GMI 0.931, AQI 0.973, SGI 1.031, DEPI 0.965, SGAI 0.986, TATA -0.022, LVGI 0.944. GMI below 1.0 (gross margin improving) and LVGI below 1.0 (leverage actually declining year-over-year) are both clean signals. TATA of -0.022 is near-zero — accruals are not driving earnings.

Key Risks from the 10-K

1. U.S. Government Budget Exposure

The risk factors lead with customer concentration: "We depend on government agencies as our primary customers and if our reputation or relationships with these agencies were harmed, our future revenues and growth prospects could be adversely affected." And: "A decline in the U.S. government budget, changes in spending or budgetary priorities or delays in contract awards may significantly and adversely affect our future revenues and limit our growth prospects." With 87% of revenue from the U.S. government and 49% from DoW/IC, a meaningful budget cut or continuing-resolution shutdown is a direct revenue risk.

The MD&A gives real-time evidence: "On February 3, 2026, the House of Representatives passed five of the six remaining appropriations bills to fund the federal government for fiscal year 2026. On February 13, 2026, the Homeland Security bill was not passed and DHS was shutdown until another continuing resolution is agreed upon." Government shutdowns directly stall billings on cost-plus contracts.

2. Critical Audit Matter: Cost-to-Cost Revenue Recognition

Deloitte's critical audit matter is revenue on cost-to-cost contracts: "The Company recognizes revenue on certain contracts with customers over time using a method that measures the extent of progress towards completion of a performance obligation, principally using a cost-input method (referred to as the cost-to-cost method). Under the cost-to-cost method, revenue is recognized based on the proportion of total costs incurred to estimated total costs-at-completion (EAC)... A performance obligation's EAC includes all direct costs such as materials, labor, subcontract costs, overhead and a ratable portion of general and administrative costs. In addition, an EAC of a performance obligation includes future losses estimated to be incurred on onerous contracts, as and when known. The accounting for these contracts involves judgment, particularly as it relates to the process of estimating total revenues and costs for the performance obligation."

Deloitte specifically tested whether "adjustments were the result of changes in facts and circumstances and not estimates that were previously inaccurate." The MD&A explicitly calls out "a net decrease in contract write-ups in the current year" in NS&D as a headwind, and "a net increase in write-ups on certain programs primarily within the managed health services business" as a tailwind in Health & Civil. The segment performance swings are materially dependent on EAC revisions, which is precisely what Deloitte's CAM is designed to address.

3. Organizational Conflicts of Interest

The filing flags an unusual issue for a contractor with broad reach: "Application of the U.S. government's organizational conflict of interest (OCI) rules could limit our ability to successfully compete for new contracts or task orders, which would adversely affect our results of operations." As Leidos grows across DoW, DHS, VA, and IC simultaneously, OCI rules increasingly constrain which contracts it can bid.

4. Audit and Cost Adjustment Risk

The risk factors: "As a U.S. government contractor, our partners and we are subject to reviews, audits and cost adjustments by the U.S. government, which could adversely affect our profitability, cash position or growth prospects if resolved unfavorably to us." DCAA audits can reach back years and claw back previously-billed amounts.

5. Entrust Acquisition Execution Risk

Per the risk factors: "We have made and continue to make acquisitions, investments, joint ventures and divestitures that involve numerous risks." The $2.4B Entrust acquisition is substantially larger than recent bolt-ons (Kudu Dynamics was a $293M net-cash deal). Per the MD&A: "On January 23, 2026, Leidos, Inc. entered into a stock purchase agreement to acquire all of the shares of Entrust for a purchase price of $2.4 billion in cash, subject to customary adjustments... In connection with the stock purchase agreement, we entered into an agreement with Citigroup Global Markets Inc., which provides for a senior unsecured 364-day bridge loan facility in an aggregate principal amount of $1.4 billion."

6. Cybersecurity

The filing flags cybersecurity: "Cybersecurity breaches and other information security incidents could negatively impact our business and financial results, impair our ability to effectively provide our services to our customers and cause harm to our reputation or competitive position." This is acute for a company handling classified government data.

7. Classified Contracts Opacity

The risk factors: "We have classified contracts with the U.S. government, which may limit investor insight into portions of our business." The National Security & Digital segment (44% of revenue) has substantial classified content that investors cannot independently verify.

Summary

Grade: F, but the underlying business is genuinely improving. Two balance-sheet checks fail (C4 at 21% cash/debt, D1 at 138% goodwill/equity), and that is enough to trigger the critical-fail F grade. But the income-statement and cash-flow story is strong: 130bp operating margin expansion, CFFO/NI of 1.21, FCF of $1.63B, and an M-Score of -2.61 that is comfortably clean.

The two red flags reflect the legacy cost of acquisition-led growth. The 2016 IS&GS acquisition of Lockheed's services business plus Dynetics, Gibbs & Cox, and more recent bolt-ons loaded the balance sheet with goodwill. Deloitte's critical audit matter — cost-to-cost revenue recognition — is the appropriate concern for a government contractor whose segment margins depend heavily on EAC revisions. Three of four segments showed margin improvement that the MD&A explicitly attributed to comparisons against prior-year write-downs, which means a portion of the "margin expansion" is a base-effect phenomenon rather than a durable improvement.

The Entrust acquisition announced on January 23, 2026 — $2.4B cash with a $1.4B bridge facility — will immediately worsen both C4 and D1. By the time the FY2026 10-K is filed, leverage will be meaningfully higher. Watch the deleveraging trajectory carefully. If operating cash flow continues at $1.6–1.8B and the company holds to 1% dividend/buyback pace while deleveraging, the balance sheet can absorb the Entrust deal. If FCF compresses due to a government shutdown or OBBBA tax tailwind unwinding, the pro-forma leverage becomes uncomfortable.

**Disclaimer**: This report is based on Leidos Holdings' FY2025 10-K filed with SEC EDGAR. This is NOT investment advice.

Data: SEC EDGAR 10-K + Yahoo Finance

Auditor: Deloitte & Touche LLP (Unqualified opinion, 1 critical audit matter — cost-to-cost revenue recognition)

Fiscal year ended: January 2, 2026