Chris Cage
Chief Financial Officer at Leidos
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. And 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 a good sequential improvement in the Defense Solutions and Civil segments. With a keener focus on margins, we exceeded 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 pay-down, 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 slides. Defense Solutions revenues were up 7%, driven primarily by digital modernization, especially engine, 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 is 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 equitable 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. Days sales outstanding for the quarter was 56, a one-day improvement in 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 2.8 times gross debt to adjusted EBITDA, we are comfortably below our 3 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 billion and $16.1 billion, reflecting growth of 2% to 4% over fiscal year 2023. Customer demand remained 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 the budget within the next month or so, we cannot rule out the possibility of a sequester in the year long CR. We are also provisioning for a slight temporary revenue headwind as our business leaders shift their teams' 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 should allow us 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 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 is 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 will be operating our new segment structure and to help your modeling, we recast 2022 and 2023 financials in the new structure and file 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 US federal customers, and our Leidos Innovation Center. Flagship programs include [Indecipherable] 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 of 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 and international combines our existing SES, commercial energy, UK, and Australian businesses. Last year, Commercial and 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 and 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 in US-sponsored Airborne Surveillance Report. 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 revenue should remain relatively flat compared to 2023. In the fourth quarter of '23, our customers accelerated hypersonic weapon testing, resulting in pull-through work previously scheduled for the first and second quarters of 2024. As a result, the Defense Systems segment revenues will be back-end loaded in 2024.
So rolling up to the enterprise level, we expect both revenues and margins 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.
