Leidos Holdings, Inc. (NYSE:LDOS) Q4 2023 Earnings Call Transcript
Leidos Holdings, Inc. (NYSE:LDOS) Q4 2023 Earnings Call Transcript February 13, 2024
Leidos Holdings, Inc. beats earnings expectations. Reported EPS is $1.99, expectations were $1.73. Leidos Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings, and welcome to Leidos Fourth Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Stuart Davis, of Investor Relations. Stuart, you may begin.
Stuart Davis: Thank you, operator, and good morning everyone. I'd like to welcome you to our fourth quarter and fiscal year 2023 earnings conference call. Joining me today are Tom Bell, our CEO, and Chris Cage, our Chief Financial Officer. Today's call is being webcast on the Investor Relations portion of our website, where you'll also find the earnings release and supplemental financial presentation slides that we are using today. Turning to slide two of the presentation, today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially.
Finally, as shown on slide three, we’ll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides. With that, let me turn the call over to Tom Bell, who will begin on slide four.
Tom Bell: Thank you, Stuart, and good morning everyone. It's good to be with you today to report another strong quarter for Leidos and to put a bow on a very successful 2023. I'll frame my part of our conversation today in three parts. First, our 2023 results; second, the progress we've made towards building a brighter future; and third, what you can expect from us this year. First in our fourth quarter we delivered 8% revenue growth for record quarterly revenue just shy of $4 billion. EBITDA margin was an outstanding 11.4% and we grew non-GAAP diluted EPS at 9% year-over-year. Operating cash was also well ahead of plan. This means we delivered full year results that were above the high end of the guidance we set last quarter.
For the full year revenue growth was 7%. Non-GAAP diluted EPS growth was 11% and operating cash flow growth was 17%. Consistent with my previous commitment to you about disciplined cash management, we repurchased more than $200 million worth of shares in the fourth quarter of 2023. I continue to be very impressed by the people and sound business engine we have here at Leidos and I believe our top and bottom line financial performance over the last three quarters of 2023 just begins to hint at our full potential. Even while affecting our recent organizational realignment, the team ran through the tape to deliver an impressive 2023. I want to thank my leadership team and our 47,000 people who made these results possible through their hard work and dedication to both Leidos and our customers’ missions.
This brings me to my second point, the progress we've made towards building a better future. We're already working well in our new capability focused organization and seeing the first fruits from these changes. For example we're sharing best practices much better across digital modernization programs for greater efficiency and efficacy. In Commercial & International, we're quickly redeveloping our growth playbook, especially internationally, which we'll use to extend several of our business lines outside the United States. And we're aggregating and better leveraging our robust engineering talent across our platform businesses within Defense Systems. As we go through this year, we'll see many more ways this new organizational structure unlocks value.
Chris will describe a few of the tangible financial benefits of this realignment on which we already have line of sight. But the team and I are acting quickly on two additional critical components to building for our future, reinvigorating our business capture prowess and ensuring we remain the best employer of top talent in the market. On the business capture front, we finished the year with a solid book-to-bill ratio of 1.1 times. As we focus on building quality backlog over time, this gives us a Healthy $37 billion backlog, $8.8 billion of which is funded. Still, I believe Leidos has another gear in terms of business capture. And my new chief growth officer has stepped up to his new responsibilities in this regard with vigor. He shares my passion for winning, and we are committed to delivering industry-leading win rates and above market organic growth.
My Chief Technology Officer is aggressively focusing our total IRAD expenditures in select areas to ensure we always have differentiated solutions for our customers. And my HR lead is undertaking an intense effort to rebuild our entire employee value proposition, so we remain the best employer in the market for the best talent. Cindy Gruensfelder joins Leidos to lead our Defense System Sector. She brings extensive Aerospace and Defense leadership expertise and is excited to take this part of our portfolio to the next level. And Dan Antle will rejoin Leidos as General Counsel in April. So he will be able to hit the ground sprinting with us. As a result of these and other changes I've made, 75% of my ELT is now new in new positions or have newly enhanced in more focused areas of responsibilities.
The momentum is building having the right people in the right positions, rightly aligned. Not only is this team rightly aligned to the jobs they now perform, but I've recommended and the board has approved fundamental changes to our incentive compensation plans. This means our incentives are much better aligned to our shareholders and customers' interests. These changes are fully laid out in our upcoming proxy statement, but big picture, you'll see simpler metrics around revenue, profit and cash with increased emphasis on margin, while retaining a heavy focus on relative TSR performance. This brings me to my third point, expectations for 2024. Chris will provide specifics on our 2024 financial commitments in a few minutes. Notably, our guidance fulfills the three-year commitments that were articulated on our previous Investor Day.
We've already exceeded the margin target that we set in 2021, and this level serves as a great foundation from which to grow in the future. Our three-year cash conversion results ought to be right at, at 100% target, which is the right level of performance for our business. And we have clear line of sight to our three-year revenue growth target. While it is important to me that we meet our prior commitments to you, I expect us to do better going forward. Our financial performance should be at or near the top of the industry. And to bring this improved profitable growth trajectory to life, 2024 will include deep strategic analysis within Leidos. Let me summarize this strategy process for you. Each new sector president will bring forward a best-in-class three-to-five year growth and profitability plan for their markets in a today-forward view.
And our growth and technology organizations will work together to create a proprietary hypothesis of the future, a future back look at customer challenges and needs for 2033 and 2028. We'll synthesize these today forward and future back views to identify market gaps and growth opportunities, and choosing among them will enable us to crystallize our new North Star. This process is being engineered to position Leidos to lead the industry in revenue, profit, and cash growth, and we look forward to sharing our plan with you at our next full Investor Day, likely early next year. In the meantime, this year, we'll look forward to opportunities to showcase for you many of the differentiated technology solutions, what I call Golden Bolts, we already use and are creating to solve our customers' most vexing problems.
Finally, you may have already noticed the launch of a new branding campaign for Leidos this year, Making Smart Smarter. While we've gained important name recognition over our first 10 years, this campaign is about capturing brand recognition for Leidos. As you can see in the example on slide five, Making Smart Smarter is centered around our people. How they and the breakthrough technologies they create in a unique ecosystem with our partners and customers truly set Leidos apart from everyone else. With these three simple words, we'll tell the story of the collective intelligence that is uniquely Leidos. Our campaign will catapult understanding of what Leidos does differently and better than anyone else, and also serve as a beacon for present and future, best of the best employees.
In closing, with a growing Promises Made, Promises Kept culture at Leidos, we've put many of the commitments I've made to you over the past nine months in the done category. We've exceeded our 2023 financial commitments. We've enhanced our focus on cost controls and cash generation. We've taken down leverage substantially. We've allocated more capital to shareholders, and we've moved expeditiously to a leaner, more focused organizational structure. By delivering on our 2024 plan, we'll soon put our full 2022 to 2024 Investor Day commitments in the done category also. But we are far from done. We have a busy and productive year ahead of us at Leidos. We will continue to drive toward great full profitable growth, not just revenue growth. We will aggregate our efforts toward better customer outcomes and better business pursuits.
And the new leadership team and I will be working every day to make Leidos not just successful, but awesome in every way for every stakeholder. With that, I'll turn the call over to Chris for more details on our 2023 results and our 2024 outlook. Chris.
Chris Cage: Thanks, Tom, and thanks to everyone for joining us today. Let me echo Tom and express my gratitude to the entire Leidos team for how we executed in 2023. On balance, 2023 was an excellent year, and our financial performance was well ahead of the pace we set for ourselves at the 2021 Investor Day. Turning to slide six, revenues for the quarter were $3.98 billion. Revenues came in stronger than expected as customers continued spending despite a continuing resolution, and Congress acted to avert a government shutdown. In each quarter of ‘23, each segment grew year-over-year. Adjusted EBITDA was $452 million for the fourth quarter for an adjusted EBITDA margin of 11.4%. Health sustained its excellent performance, and we saw good sequential improvement in the Defense Solutions and Civil Segments.
With a keener focus on margins, we exceed our 2021 Investor Day target of 10.5% plus one year ahead of schedule. Non-GAAP net income was $276 million for the quarter and more than $1 billion for the year, which generated non-GAAP diluted EPS of $1.99 for the quarter and $7.30 for the year, increases of 9% and 11% respectively. This strong bottom-line performance came despite a drag from non-operating drivers. The non-GAAP effective tax rate for the quarter came in at 25.2%. Net interest expense was a $2 million tailwind for the quarter based on debt paydown, but a $13 million headwind for the year given the higher interest rate environment. Taken together, tax rate and interest lowered non-GAAP diluted EPS by $0.13 for the quarter and $0.14 for the year.
Now, for an overview of our segment results and key drivers, beginning with the revenues on slide seven. With a lot to cover today, I'll focus on the quarterly figures, but you can also see the full year comparisons on the slide. Defense Solutions revenues were up 7%, driven primarily by digital modernization, especially NGEN, offensive hypersonics and the Sentinel Program. Civil revenues were up 2% compared to the prior year quarter. The primary growth driver in the quarter was infrastructure spending by the FAA. Health continued to be a standout performer. Quarterly revenues increased 17% year-over-year, ending the year north of $3 billion. Higher levels of medical examinations was a key driver, as well as expanding capabilities on DHMSM, increasing group events on RHRP, growing our Social Security Administration work, and breaking into new customer spaces like ARPA-H.
On the margin front, on slide eight, Defense Solutions showed consistently strong profitability growth. Non-GAAP operating margin was 9% for the quarter, up 40 basis points year-over-year. The increase in segment profitability was primarily attributable to improved program execution and disciplined cost management. Civil non-GAAP operating margin was 10.8% for the quarter, compared to 11.2% in the prior year quarter, which had a rich mix of security product sales. What's especially rewarding to see is sequential improvement in Civil margins for three straight quarters. Health non-GAAP operating margin for the quarter was 19%, which was essentially unchanged sequentially after excluding the $14 million Ecoroll adjustment received in Q3. The 470 basis point increase in quarterly margin was primarily driven by increased volumes, greater efficiency, and better program execution in the medical examination business, all of which led to higher incentive awards.
Turning now to cash flow and the balance sheet on slide nine. Operating cash flow for the quarter was $304 million, and free cash flow net of capital expenditures was $226 million. Net cash provided by operating activities benefited from strong collections and working capital management. Day sales outstanding for the quarter was 56, a one-day improvement from the third quarter of 2023, and a two-day improvement from the fourth quarter of fiscal year 2022. For the year, operating cash flow was just shy of $1.2 billion and free cash flow was $958 million for a 95% conversion rate. Excluding the $260 million of one-time cash tax impacts, primarily from Section 174, free cash flow conversion would have been 121%. In the fourth quarter we repurchased $202 million of shares and paid $51 million in dividends.
As of quarter end, we had $777 million in cash and cash equivalents and $4.7 billion in debt. With a leverage ratio of 2.8x gross debt to adjusted EBITDA, we are comfortably below our three-times target. Our strong balance sheet gives us flexibility to return capital to shareholders, and we have 13 million shares remaining under our repurchase authorization. On to the forward outlook on slide 10. For 2024 we expect revenues between $15.7 and $16.1 billion, reflecting growth of 2% to 4% over fiscal year 2023. Customer demand remains strong for our products and solutions, and our programs are well insulated from significant budgetary risk. But we are erring on the side of caution given the realities of the current funding environment. The government is still operating under a continuing resolution.
Although we believe Congress will likely pass a budget within the next month or so, we cannot rule out the possibility of a sequester and the year-long CR. We are also provisioning for a slight temporary revenue headwind as our business leaders shift their team's focus to higher reward opportunities for Leidos. We expect 2024 adjusted EBITDA margin to again be in the mid to high 10% range, above the target that we laid out at our October 21 Investor Day. We remain committed to long-term margin expansion. To begin the year, we are guiding to non-GAAP diluted earnings per share between $7.50 and $7.90 on the basis of 134 million shares outstanding. This is down an average of 4 million shares from fourth quarter levels, based on Q4 repurchases accomplished, and another 500 million of repurchases anticipated in ‘24.
This level of repurchase activity still allows for significant flexibility for additional share repurchases and other responsible capital deployment. Assumed in the EPS guidance is an effective tax rate of 23% and net interest expense of $225 million. Finally, we expect another strong year of operating cash flow at approximately $1.1 billion. Fiscal year 2024 cash flow guidance reflects approximately $60 million of cash tax payments related to the Section 174. 2023 cash performance was exceptional, and we expect conversion to return to normative levels near 100% in ‘24. From a free cash flow perspective, we're targeting capital expenditures of approximately $190 million or about 1.2% of revenues. With broad bipartisan support, the House passed a tax package that restores immediate expensing of R&D costs under Section 174, with retroactive effect to 2022.
The bill has yet to be taken up by the Senate. Our guidance assumes the Section 174 cost capitalization rules remain in place, so we would have additional cash to deploy if the House bill becomes law. In 2024, we'll be operating our new segment structure, and to help your modeling, we recast 2022 and 2023 financials in the new structure and filed them with our press release. Let me spend a few minutes outlining these segments and how we see them performing in 2024. The largest, National Security and Digital, includes core Defense and Intel services, digital modernization for U.S. federal customers, and our Leidos Innovation Center. Flagship programs include NGEN, AEGIS, DES, and large Cyber Analysis and Mission Software Development Contracts with the Intelligence Community.
2023 revenues for this segment were $7.2 billion, up 7% year-over-year, with non-GAAP operating income margin of 10%. In 2024, we expect revenue growth within our guided range, with margins contracting slightly. Long term, we see margin upside with shared resources and best practices across the digital modernization space. The Health and Civil Segment will deliver customer solutions with unique capabilities in the areas of public Health, care coordination, life and environmental sciences, and transportation. Key programs include our disability exam work, DHMSM, National Airspace System Support for the FAA, and our DOE and National Science Foundation based support contracts. Last year, Health and Civil generated $4.2 billion in revenues, up 7% year-over-year, with non-GAAP operating income margin 14.5%.
In 2024 we expect robust growth beyond the corporate average with margins coming down slightly. This segment offers the most potential upside in ‘24 with growing examination volumes. Commercial & International combines our existing SES, Commercial Energy, UK and Australian businesses. Last year Commercial & International generated $2.1 billion in revenues, up 12% year-over-year, with about five points of growth coming from the Airborne Solutions business acquisition, and non-GAAP operating income margin of 7.8%. Based on actions taken in 2023 within SES, an indirect structure tailored to non-federal work, we expect margins to increase in 2024. Revenues however should be relatively stable and reflect a similar seasonal pattern to 2023. Finally, Defense Systems combines our core Dynetics work with our Maritime and U.S. sponsored Airborne Surveillance Support.
In 2023 Defense Systems accounted for $1.9 billion in revenues, up 4% year-over-year, with non-GAAP operating income margin of 8.3%. With additional engineering discipline from the combined organization, we expect to increase margins through better program execution, but revenues should remain relatively flat compared to 2023. In the fourth quarter of ‘23, our customers accelerated Hypersonics Weapon Testing, resulting in pull through work previously scheduled for the first and second quarters of 2024. As a result, the Defense System segment revenues will be backend loaded in 2024. So rolling up to the enterprise level, we expect both revenues and margin to step down from Q4 levels in Q1 and then grow throughout the year. The Q1 step down in margins will outpace that of revenue given the timing of incentive and award fee payments, but we have good line of sight into strong margin performance for the year.
With that, operator, we're ready for some questions.
See also 20 Most Reliable Cars For Seniors and 15 Beauty Treatments That Are Expensive But Totally Worth It.
To continue reading the Q&A session, please click here.
