Lower taxes drive most of Leidos’s non-GAAP profit growth

Leidos’s non-GAAP diluted earnings per share rose 18.7% to $3.62 in the third quarter. Pre-tax earnings grew more slowly: non-GAAP pre-tax income increased 2.3%, and the four segments’ combined non-GAAP operating income was almost unchanged.¹

Lower tax expense supplied most of the net income increase, while fewer diluted shares amplified the per-share gain. Within operations, gains in Homeland and Intelligence & Digital largely offset a decline in Health. The smaller Corporate loss supplied nearly all the consolidated non-GAAP operating improvement.¹

The tax benefit outruns pre-tax growth

The lower tax expense accounts for 78.6% of the non-GAAP net income increase. Leidos attributes the lower effective tax rate primarily to a larger federal research tax credit and reduced unrecognized tax benefits.¹ The company does not establish how much of the reduction will recur.

GAAP results show the same dependence on tax: pre-tax income slipped from $484 million to $482 million. Net income nevertheless rose by $44 million. GAAP diluted EPS increased to $3.28 from $2.82.¹ Net favorable contract-estimate changes were $23 million versus $20 million, too small a shift to explain the earnings increase.^{1, 2}

Our calculation puts the non-GAAP effective tax rate at 15.1%, down from 23.9% a year earlier.¹ It also fell sequentially, from 21.8% in the first quarter and 20.7% in the second.^{1, 3, 4} Full-year guidance assumes a non-GAAP tax rate of about 20%, compared with the nine-month rate of 19.2%. The annual assumption is above the third-quarter rate but does not establish a specific fourth-quarter rate.^{1, 5}

Non-GAAP net income attributable to common stockholders grew 13.9%, below EPS growth. Diluted shares fell to 125 million from 130 million. That is a decline of about 3.8% on the rounded counts.¹

Corporate supplies the operating gain

The four segments together produced $634 million of non-GAAP operating income, compared with $633 million a year earlier. Corporate’s smaller loss therefore mattered more to consolidated profit growth than the net movement across the businesses.¹

On a GAAP basis, combined segment operating income fell 2.7%, while consolidated operating income rose by $18 million.¹ Leidos attributes the smaller Corporate operating loss primarily to $23 million of lower legal expenses. The filing does not explain why the prior-year expenses were higher.²

Higher financing costs absorbed part of the operating improvement.¹ Net interest expense rose by $16 million, which Leidos links to the senior notes issued in March.^{1, 2} Adjusted EBITDA grew 4.5%. Its margin was 13.9%, compared with 13.8% a year earlier.¹

Acquisitions account for most of the revenue increase

Reported revenue reached $4.63 billion, but the net acquisition and divestiture effect supplied 83.9% of the year-over-year increase. Entrust contributed $142 million, while the organic comparison removes $7 million of divested revenue from the prior-year base. The resulting net transaction effect was $135 million; organic revenue added $26 million.¹

The slowdown in organic growth followed a stronger second quarter.^{1, 4} Leidos credits demand for defense technology, air traffic management and intelligence mission support, alongside Entrust, with offsetting declines in some managed health and federal civilian IT programs. Nine-month reported revenue grew 4.8%; the release does not provide a corresponding nine-month organic growth figure.¹

Health’s profit decline deepens

Health remained the largest segment contributor to GAAP operating income, but its share fell to 41.5% from 54.5% a year earlier.¹ Its quarterly profit declined both sequentially and year over year for a second consecutive quarter.^{1, 3, 4, 6}

Revenue fell 11.7% year over year to $1.068 billion. Leidos’s release attributes the revenue and margin declines to expected program shifts and lower managed health services volumes.¹ The filing adds reduced incentive fees on those programs in the second half of fiscal 2026, without identifying the affected customer programs.²

Contract mix shows where some of the pressure sits: Health’s firm-fixed-price revenue declined, as did its revenue from other U.S. government agencies. Those categories do not identify the programs responsible for the reduced incentive fees.²

Homeland and Intelligence & Digital offset Health’s retreat

Homeland combined acquired scale with organic growth: revenue reached $1.024 billion from $0.775 billion. Organic growth was 14.8%.¹ The filing credits higher volumes, program wins, Entrust and a $10 million favorable currency effect, partially offset by completed contracts.² Leidos attributes improved profitability to a larger mix of higher-margin commercial work and cost management.¹

Homeland’s GAAP operating income was $81 million, compared with $116 million on a non-GAAP basis. The reconciliation removes acquisition, integration and restructuring costs, acquired-intangible amortization and an impairment.¹ The quarter still includes the SES business, so it is not a clean revenue baseline for the fourth quarter following the joint venture closing.^{1, 2}

Intelligence & Digital generated $171 million of GAAP operating income, up 21.3%. Revenue rose from $1.525 billion to $1.546 billion. Leidos attributes the margin improvement to better program execution, including strong award-fee scores, and cost management.¹

Its revenue explanations have different scopes.^{1, 2} The release cites recent contract awards, higher Intelligence Community volumes and expanded scope, offset by reductions in some federal civilian IT programs.¹ The filing discusses the three- and nine-month periods together, citing program wins partially offset by a net volume decline and completed contracts.² Neither document quantifies those opposing movements.^{1, 2}

Defense accumulates backlog ahead of revenue

Defense’s total backlog rose 39.7% year over year, and its funded backlog increased 69.0%.¹ Sequentially, total backlog rose from $12.59 billion in the first quarter to $13.76 billion in the second.^{3, 4} It reached $14.65 billion in the third quarter. That accumulation has yet to produce comparable revenue growth: Defense revenue was $992 million against $959 million a year earlier.¹

Leidos links Defense’s sales growth to demand for air defense, sensing and C5ISR systems.¹ Nine-month operating income remained roughly flat, with program wins and better performance offset by completed higher-margin contracts.² Earlier in the year, the company attributed lower first-quarter profitability to schedule delays on a fixed-price development program.³

Company-wide net bookings rose sequentially to $5.5 billion, but fell 6.8% from the prior-year quarter.^{1, 4, 2} Nine-month bookings increased 15.1%, providing a stronger year-to-date comparison.² Total backlog grew 4.0% year over year, while funded backlog rose 22.0%. Funded work represented 22.3% of the total.¹

The $21 billion of remaining performance obligations is a narrower measure than backlog. It excludes unexercised options and most task orders not yet awarded under indefinite-delivery, indefinite-quantity and similar contract vehicles. Leidos expects to recognize about 64% within 12 months. It expects to recognize about 83% within 24 months. Those estimates do not provide a conversion schedule for the larger backlog balance.²

Named awards show several different kinds of future work. Leidos received a $272 million award from Sierra Space for infrared sensing payloads, onboard signal processing and mission support, placing it in a supplier role. It also booked a $318 million, 12-month sole-source bridge to sustain and enhance MHS GENESIS. The bridge supports continuing work without establishing renewed growth.¹

Leidos received a $27 million low-rate initial production award for 45 AGM-190A Havoc Spear missiles.¹ The company’s November 2 release says initial Havoc Spear deliveries have begun.⁷ Deliveries under the 45-missile award are expected to start in fall 2027. That distinction separates an award from the production and deliveries still ahead.^{1, 7}

Cash returns exceed quarterly free cash flow

Operating cash flow declined 26.4% year over year in the third quarter.¹ Leidos attributes the decrease primarily to working-capital timing, including vendor payments, payroll and employee benefits.² The nine-month comparison was stronger: operating cash flow rose 28.8% to $1.617 billion.¹ The company credits favorable working capital and $148 million of lower tax payments.²

Leidos returned $556 million to shareholders in the third quarter, equivalent to 116.8% of non-GAAP free cash flow.¹ Open-market buybacks totaled $500 million.² The cash-flow statement’s broader repurchases-and-other line was $504 million; it includes items beyond open-market buybacks.^{1, 2} On October 30, the board raised the quarterly dividend to $0.45 per share.¹

Capital spending also increased: nine-month payments for property, equipment and software rose 34.1% to $110 million.¹ Quarter-end cash stood at $630 million, down from $748 million in July. Debt was $6.0 billion at both dates.^{1, 4} Debt was higher than at the start of the year following the March note issuance, while the Entrust acquisition used $2.338 billion net of acquired cash.^{1, 2} The disclosures do not trace the quarter’s buybacks to debt financing.

The SES venture changes the revenue comparison

Leidos closed the SES joint venture transaction on October 5, retaining a 41.5% non-controlling interest.² Altaris affiliates have the right to appoint a majority of the venture’s board.⁸ Leidos will use equity-method accounting and include its share of the venture’s earnings in operating income. Fourth-quarter revenue will be lower than without the transaction.²

SES will not be presented as a discontinued operation, leaving prior periods with revenue from the business. That creates a comparison problem: reported revenue will lose SES sales while the earlier base still contains them.² In April, Leidos projected $625 million of full-year 2026 revenue for the business it would contribute to the venture.⁹ That projection does not establish SES’s actual quarterly revenue, profit or backlog contribution.

Homeland’s October 2 backlog balance predates the closing; the filings do not disclose how much of it, if any, relates to SES. Leidos expects a preliminary non-operating gain of about $100 million in the fourth quarter, but has not stated its treatment in non-GAAP EPS guidance.^{1, 2}

Guidance lowers revenue while raising EPS and cash

Leidos lowered both ends of its annual revenue range after adjusting for the venture and incorporating year-to-date performance and its outlook.¹ August’s guidance had excluded the pending transaction.¹⁰ The company does not separate the SES effect from changes in the operating outlook, so the reduction cannot be assigned wholly to either.

Leidos raised its non-GAAP EPS range at each update, and the operating cash flow forecast rose again in November.^{1, 3, 4, 11} The adjusted EBITDA margin outlook remained in the mid-13% range.¹ The official third-quarter presentation assumes a continuing resolution through 2026 and 126 million weighted-average diluted shares.⁵ The filing says federal funding is secured through December 11, making continued funding beyond that date an assumption of the outlook.^{2, 5}

Subtracting nine-month revenue from annual guidance leaves approximately $4.41 billion to $4.61 billion for the fourth quarter, below the third quarter. This approximation comes from rounded annual guidance; Leidos has not issued a separate quarterly forecast.¹ A prior-year comparison also mixes transaction effects with a quarter Leidos says was hurt by the six-week government shutdown.^{1, 2, 11}

The same subtraction gives approximately $2.47 to $2.67 in fourth-quarter non-GAAP EPS.¹ That is below the prior-year quarter’s $2.76.^{1, 11} EPS is not strictly additive across periods with different share counts, and the expected venture gain’s treatment remains unspecified.^{1, 3, 4, 2} Leidos provides no quarterly bridge that establishes the reasons for the implied step-down.

The annual cash forecast leaves approximately $283 million of fourth-quarter operating cash flow, versus $495 million a year earlier.^{1, 11} That remainder also follows the SES exit, so it does not describe cash generation on an unchanged business base.^{1, 2} The higher full-year earnings outlook therefore coexists with slower organic growth, weaker Health profit and a revenue base that changes again in the fourth quarter.^{1, 4, 2}

This Assessment analyzes Leidos’s earnings releases, Form 10-Q and official presentation slides, supplemented by its recast segment figures, SES transaction disclosures and November 2 missile release. It does not incorporate webcast audio or analyst Q&A. Prior-year segment comparisons use the company’s recast four-segment structure. Non-GAAP measures retain Leidos’s definitions; calculated tax rates divide non-GAAP tax expense by non-GAAP pre-tax income.