Lockheed Martin Corporation (NYSE:LMT) Q4 2022 Earnings Call Transcript

Lockheed Martin Corporation (NYSE:LMT) Q4 2022 Earnings Call Transcript January 24, 2023

Operator: Good day, everyone, and welcome to the Lockheed Martin Fourth Quarter and Full Year 2022 Earnings Results Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Maria Ricciardone Lee, Vice President of Investor Relations. Please go ahead.

Maria Ricciardone Lee: Thank you, John, and good morning. I’d like to welcome everyone to our fourth quarter and full year 2022 earnings conference call. Joining me today on the call are Jim Taiclet, our Chairman, President and Chief Executive Officer; and Jay Malave, our Chief Financial Officer. Statements made in today’s call that are not historical fact are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities laws. Actual results may differ materially from those projected in the forward-looking statements. Please see today’s press release and our SEC filings for a description of some of the factors that may cause actual results to differ materially from those in the forward-looking statements.

We have posted charts on our website today that we plan to address during the call to supplement our comments. These charts also include information regarding non-GAAP measures that may be used in today’s call. Please access our website at www.lockheedmartin.com and click on the Investor Relations link to view and follow the charts. With that, I’d like to turn the call over to Jim.

Jim Taiclet: Thanks, Maria, and good morning, everyone. Hope you’ve all had a good start to the new year, and I thank you for joining us on our fourth quarter 2022 earnings call as we review our results, key business area accomplishments and our outlook for 2023. I’d like to begin with a few highlights from the quarter and from the year, and then Jay will review the financials in a more detailed manner. Lockheed Martin had a strong close to 2022. All of our business areas met or exceeded our prior expectations, resulting in a 2022 full year sales of $66 billion, segment operating profit of $7.2 billion and earnings per share of $21.66. Our free cash flow for the year of $6.1 billion also came in above our prior expectation, while backlog for the year increased to $150 billion, driven by all-time record orders for Lockheed Martin.

Our financial results included more than $1.7 billion of independent research and development investments, or IRAD, a new high watermark for the company. We also continue to modernize and streamline our operations to increase efficiencies and reduce costs. Significant capital projects include our ongoing investment in what we call One Lockheed Martin transformation or 1LMX. This is our multiyear internal project to transform our business processes and systems from end-to-end. By implementing new digital tools in our operations and expanding our use of model-based engineering to enhance our speed to market and our cost competitiveness. In 2022, we completed a majority of the detail design for our new systems and business processes. And for 2023, we expect to complete the detailed design and implementation road maps that go with it, and then we’ll transition to the system build and configuration phase over the next couple of years.

These IRAD and capital investments accelerate the capabilities our customers need and for our operations to efficiently and effectively meet those needs. From a capital return perspective, we delivered approximately $11 billion to shareholders in 2022 via share repurchases of $7.9 billion and dividends of $3 billion. During the fourth quarter specifically, we entered into a $4 billion accelerated share repurchase program, and we’ve retired approximately 7 million shares under that agreement so far. We expect to complete our remaining repurchase authorization of $10 billion over the next few years, consistent with our focus to deliver free cash flow per share growth to you, the investor. These operational and financial results created significant value for our shareholders, ending the year with a total shareholder return of 40%.

I will touch briefly now on the Department of Defense, or DoD, budget. In late December, Congress signed the FY ’23 Omnibus spending bill into law, appropriating $858 billion for National Defense, including $817 billion for the DoD-based budget. This reflects approximately 10% growth year-over-year for both national defense and the DoD-based budget. The law also represents a 6% or $45 billion increase from the President’s budget request for DoD. These appropriations enabled us, along with the Joint Program Office, to finalize the contract for the production and delivery of up to 398 F-35 for $30 billion in Lots 15 and 16, including the option for Lot 17. Further, several other of Lockheed Martin programs received the funding levels necessary to drive the growth outlook we previously identified, including our combat rescue helicopter, the C-130J, Blackhawk, CH-53K and FAAD.

We view this funding outcome as positive for the future, and our current expectation is that growth will materialize over the longer term, starting in 2024. Let’s now turn to the four growth pillars: programs of record, hypersonics, classified activities and new awards. With regard to programs of record, there were several important developments in key signature programs in our fourth quarter. On the F-35, the definitization of Lots 15 to 17, as I mentioned a minute ago, included the first F-35 aircraft to be produced for Belgium, Finland and Poland. We received authorization to procure long lead items for Lot 18 F-35 aircraft for the U.S. Air Force, Marine Corps, Navy and U.S. allies as well. We also formally welcome Germany, the ninth foreign military sales country, to the F-35 Lightning II program.

And earlier in January, Canada officially became an F-35 operator as the country selected the aircraft to replace its aging fighter fleet. We continue to expect deliveries of the F-35 to ramp to 156 by 2025. Despite the temporary pause in flight operations and corresponding suspension of engine deliveries that began in December and resulted in the delivery of just 141 F-35s in 2022, seven shy of our expectation of 148 before the engine issue was discovered. Also in the quarter, the U.S. Navy authorized the CH-53K King Stallion heavy-lift helicopter to enter full rate production and then its deployment phase. This important milestone allows the program to proceed beyond low-rate initial production. And this achievement attests to our long-standing partnership with the U.S. Marine Corps and instills confidence and stability in Sikorsky’s diverse domestic supply chain.

In addition, at Sikorsky, international demand for the Black Hawk remains strong. Last week, the Australian Army announced it will acquire 40 UH-60M Black Hawk helicopters to replace its current multi-role helicopter fleet. Deliveries are expected to begin for Australia this year. Further, the Lockheed Martin built Orion exploration class spacecraft launched on NASA’s ARTEMIS 1 and completed a 25-day flight test, slashing down off the coast of California. This successful mission takes us one step closer to the first woman and first person of color setting foot on the moon. On its journey, Orion traveled more than 1.4 million miles through deep space and surpassed records for total distance. It traveled 270,000 miles from home and the farthest distance from earth by a spacecraft designed to carry humans.

We look forward to the next stages of the program with seven additional missions under contract. Turning to hypersonics. In December, Lockheed Martin Missiles and Fire Control and the U.S. Air Force successfully conducted a hypersonic-boosted flight test of the Air-Launched Rapid Response Weapon. This was the first launch of a full prototype operational missile, meeting all its objectives for the test, including reaching speeds of greater than 5 times the speed of sound. With regard to classified programs, we achieved successful milestones across multiple business areas in 2022 and grew 5% year-over-year. We continue to expect growth in classified that will outpace the rest of the portfolio over the next several years. And finally, at new awards, Lockheed Martin’s Next-Generation Interceptor, or NGI, continues to make progress.

In late October, we announced the delivery of the first NGI flight software package to the Missile Defense Agency, providing the framework of software development tools, process workflows, scripts and environments. The delivery was ahead of schedule and is a critical step on the path for flight testing and fielding. This program remains a focused competition for Lockheed Martin with the first NGI forecast for delivery in 2027. With regard to the Future Long Range Assault Aircraft, or FLRAA, competition, we were disappointed in the U.S. Army’s decision. And upon review, we determined a formal protest by Sikorsky on behalf of Team Defiant to be the best course of action. We continue to believe that Defiant X with its increased speed, range, manoeuvrability and survivability is the transformational and most cost-effective aircraft that best meets the selection criteria for this competition.

Sikorsky remains one of two competitors for the other component of the Future Vertical Lift initiative that’s called the Future Attack Reconnaissance Aircraft, or FARA, which is currently expected to be awarded in 2025. The first RatorX-competitive prototype is over 90% complete and has more than 65% of its acceptance testers already done. Sikorsky is the only company with a representative FARA technology demonstrator aircraft. I saw it fly down at West Palm Beach a few months ago. It’s amazing, the S97 RAIDER, which has completed more than 110 flight hours. In November, Norway became the first international customer for our new TPY 4 radar. It’s the first software-defined radar that outperforms in target detection, mission diversity and transportability.

Norway is going to receive eight of Lockheed Martin’s TPY-4 RAIDERs with options for three additional RAIDERs. Finally, backlog ended 2022 at $150 billion with book-to-bill at 1.2 times and increases in every business area across Lockheed Martin. This strong demand signal bodes well for future growth over the longer term for our company. So these four pillars will guide us as we face a challenging geopolitical environment and apply growth and integrated capabilities mindset to everything we do here. As conflict continues in Ukraine, unfortunately, and projected global threats require coordinated efforts to protect the U.S. and our allied territories, ongoing progress in our 21st Century Security vision will enable the acceleration of advanced capabilities to defer these threats and drive effective Joint All Domain Operations for our military service customers.

In the fourth quarter, we continued to announce and expand strategic agreements with America’s leading commercial digital companies, such as IBM’s Red Hat, to advance artificial intelligence innovation on Lockheed Martin military platforms; and for Microsoft, with whom we’re going to help power classified cloud advanced technologies for the Department of Defense. Microsoft’s latest secure framework will make Lockheed Martin the first non-government entity to independently operate inside the Microsoft Azure Government Secret Cloud, ushering in a new era of cloud opportunities for the industry. As we look ahead, demand for Lockheed Martin platforms and systems is strong in the United States and abroad. We continue to expect 2023 sales about the same level as we discussed back in October.

We also continue to expect a return to sustained top line growth in 2024 and beyond as headwinds diminish in our program mix, the supply chain continues to recover and our signature programs grow. Free cash flow per share will remain a key focus as we maximize returns for you, our shareholders. 2022 is a year of great accomplishments for our company in the face of a lot of dynamic challenges. The outstanding achievements of our teams resulted from real deep commitments across our business areas and better cooperation among them as well as our corporate functions to develop, produce and deliver world-class systems to our country and its allies. Our progress this year is a testament to the dedication of our 116,000 team members and the values we all share.

So with that, let me hand it off to Jay to give more color on the financials, and we’ll join you later to answer your questions. Jay?

Jay Malave: Thanks, Jim, and good morning, everyone. Today, I will walk you through our consolidated results for 2022, additional business area detail and offer a first full look at 2023 guidance. As I highlight our results, please follow along with the web charts we have posted with our earnings release today. Let’s begin with Chart three, an overview of our consolidated 2022 financials. Lockheed Martin followed up a solid third quarter with a strong finish to 2022, highlighted by 7% year-over-year sales growth in the fourth quarter and effectively managed a turbulent year impacted by COVID and supply chain disruptions as well as inflation levels not seen in decades. Besides sales, we also exceeded our expectations for segment operating profit, earnings per share and free cash flow, all while absorbing incremental headwinds tied to restructuring activities within RMS and mark-to-market losses in our investment portfolios.

We also booked record orders in 2022, resulting in 11% growth to an ending backlog of $150 billion. In addition to our orders on F-35, we experienced a surge in new interest for our industry-leading security solutions, such as in classified programs in Space and in Missiles and Fire Control, where we booked approximately $1.5 billion in orders, reflecting increased demand to replenish U.S. stocks and enhance security positions globally. And we delivered on our commitment to boost shareholder returns by deploying nearly $11 billion to shareholders through share repurchases and dividends while making significant investments in our businesses. Taken together, these results demonstrate the perseverance of our dedicated employees to perform in challenging environments and support our expectations for 2023 and beyond.

Taking a closer look at full year results with consolidated sales and segment operating profit on Chart four. Sales came in higher than expected by nearly $750 million, limiting the decline to 2% year-over-year and essentially recovering to the sales guidance we had originally communicated last January. The stronger-than-expected performance was broad-based across all four business areas and reflects strong coordination with supplier partners to drive material throughput and program schedule performance as well as some favourable award timing, which drove additional revenue. Segment operating profit declined 2% year-over-year but also finished higher than expected by almost $50 million driven by the higher sales. Operating margins settled at 10.9%, slightly lower year-over-year and versus expectations based on lower net favourable profit adjustments.

Moving to earnings per share on Chart five. Adjusted earnings per share grew 2% for the year as the benefit from share repurchases overcame headwinds from lower segment profit and FAS/CAS pension income. Moving to cash flow on Chart six. We delivered $6.1 billion of free cash flow for the year while investing almost $1.7 billion in CapEx at a ratio of 1.4 times depreciation. We also ended the year with nearly $1.5 billion of accelerated payments to our suppliers, maintaining our commitment to a resilient supply chain. As I noted earlier, 2022 represented a significant year of cash deployment. In total, we returned 178% of free cash flow to shareholders in 2022, leveraging our performance and strong balance sheet while still investing for our anticipated growth trajectory in 2024 and beyond.

Okay. Moving to segment results and starting with Aeronautics on Chart seven. Full year sales grew 1% year-over-year primarily driven by increases in our classified programs, partially offset by lower F-35 production volume. Operating profit increased 2% driven by higher net favourable profit adjustments more than offsetting the impact of the lower volume. For the year, backlog at Aeronautics grew 15%. As mentioned, Aeronautics completed the F-35 Lot 15 through 17 negotiations and secured production volumes while providing the services with a value proposition that combines the highest performance at affordable cost. Looking at Missiles and Fire Control on Page eight. Sales decreased 3% driven primarily by lower volume on our special ops sustainment program following the Afghan withdrawal, along with lower volume on sensors programs.

Segment operating profit was down 1% with lower favourable profit adjustments primarily on PAC-3. For the year, backlog increased 6% on the back of tactical missile strength. At Rotary and Mission Systems on Page nine, sales decreased year-over-year by 4% driven primarily by a non-recurring revenue event in our training business in 2021 along with lower C6ISR and Black Hawk volume at Sikorsky. Operating profit decreased 7%, following Sikorsky and C6ISR volume and lower favourable profit adjustments on the Black Hawk program. Backlog grew 4% in 2022, led by the Defense of Guam award, where RMS will be the lead integrator of the multi-domain air and missile defense system as well as stronger Sikorsky orders. Turning to Chart 10 in our Space business area.

Sales decreased 2% due to the 2021 renationalization of the AWE program, partially offset by growth on a Next-Generation Interceptor program and national security space. Operating profit decreased 8% with lower net profit adjustments, partially offset by higher equity earnings from United Launch Alliance. Backlog grew 16% based on strong classified program captures and Orion orders. So all told, a strong finish to the year. So let’s now shift to 2023 on Page 11. Before introducing our expectations, I’d like to inform you of a reporting change in segment operating profit starting in 2023. We will report purchased intangible asset amortization expense in unallocated corporate expense below segment operating profit. Previously, intangible amortization was included in segment operating profit.

This change will not impact total earnings, and we believe the change provides a more accurate view of operating performance for each of our four business areas. The impact is approximately 40 basis points on our 2023 expectations, consistent with the impact in previous years. Our 2023 financial outlook includes the impact of this change, and you can find supporting data for these adjustments in the appendices of our web charts as well as in the earnings release. Okay, let’s get into the outlook for 2023. We continue to expect sales to be in the range of $65 billion to $66 billion and the midpoint is slightly below 2022. Speaking to the timing of sales this year, we expect the first quarter to be our lowest quarter of the year, ramping up quarter-over-quarter as we did in 2022.

Segment operating profit for 2023 normalized for intangible asset amortization has improved what we thought — from what we thought in October. And we now estimate only 10 basis points of headwind from 2022 with segment operating margins at 11.1% under our new reporting. We currently expect $2.1 billion of FAS/CAS income in 2023. It’s estimated to be roughly $100 million lower in ’22, excluding the impact from our pension transfer transaction. Our earnings per share is expected to be between $26.60 and $26.90 for ’23 with the year-over-year reduction to adjusted EPS primarily driven by lower segment operating profit in FAS/CAS income, partially offset by the benefit from a lower share count. Our free cash flow estimate for 2023 is greater to or equal than $6.2 billion and assumes continued enactment of the R&D tax capitalization.

This increase of $100 million to cash generation, along with our share repurchase guide of another $4 billion, highlights our continued focus on increasing free cash flow per share for our shareholders. This projected combination of higher free cash flow and a lower share count lead to a mid-single-digit growth expectation in free cash flow per share in 2023. Okay. On Chart 20 — on Chart 12, let’s sum it all up. We closed out 2022 with a strong finish with operating momentum and a robust backlog, which have us well positioned to resume growth in 2024 and beyond. We also placed a premium on leveraging our strong cash generation and balance sheet to increase cash returns to our shareholders with a significant increase to share repurchases. Across all four business areas, our breadth of development, production and sustainment programs continue to drive a foundation of growth and sustained high performance.

And we will work actively with our customers to meet their increasing demands and mission requirements looking ahead to the future. Our investments for growth, value and efficiency are aligned with our strategy for technology advancement and improved synergies across Lockheed Martin. So in closing, we believe the business is well positioned for long-term growth and value creation for our shareholders. With that, John, let’s open up the call for Q&A.

Operator: And first go the line of David Strauss with Barclays. Please go ahead.

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Q&A Session

David Strauss: Good morning, everyone. Thanks for taking the question. Jim, I wanted to ask you about, you highlighted the headwinds that you have in terms of your program mix in ’23 is the reason for flattish sales. Could you quantify what that number is in terms of the headwind and what programs specifically you’re looking at? And then as a quick follow-up, the FY ’23 budget came in, I think, a fair amount better than you were anticipating plus ops on F-35 and C-130. How might that change what you’ve previously said with regard to the reacceleration in growth in 2024? Is it better than low single digit now? Thanks.

Jay Malave: So David, let me take the first one and then kick over the second part of your question to Jim and just really talk in the context of ’23 and what’s going to be different in 2024. In 2023, when you look at it, we’ve got continued growth in our four pillars, really the programs of record that Jim had mentioned. But we do have some specific unique items to 2023, and I’ll give you an example. For example, in aero. On the F-35, we continue to expect mid-single-digit growth in sustainment on the program. But we are expecting also a mid-single-digit decline in production as deliveries catch up to the material that we had purchased in prior years. Similarly, on the F-16, we’re going to see continued growth in production to roll out our backlog, but we are seeing a reduction in modernization and sustainment programs on the F-16.

So as those — both of those normalize in 2023 going into 2024, they will no longer be headwinds, which will continue to allow for growth in Aeronautics, particularly in the F-35 sustainment and on F-16 production. Similarly, like MFC, what we saw in 2022 and it carries over a little bit to 2023 is some of the areas where we see the higher demand from a production level, particularly in programs of record, things like PAC-3, it’s taken us a little bit longer than we originally expected to ramp up. And so we’re going to see gradual improvement in supply chain as well as our internal operations in ’23 with stronger growth in 2024. At RMS, CH-53 will double deliveries in ’24 versus ’23. And ’23 versus ’22 is pretty much flat deliveries. We also see probably some Black Hawk growth in ’24 as well.

And what we’re going through right now is the transition for multiyear 9 to multiyear 10 in RMS and Sikorsky specifically. So those are all things that we think will lift from ’24 relative to ’23, and those are headwinds that are really unique to 2023.

Jim Taiclet: Yes. And as far as where the defense budget came out, David, it really aligns with our view in our company about the nature of the geopolitical threat, the need to modernize U.S. and allied forces to continue to hopefully deter armed conflict beyond the sad and unfortunate situation in the Ukraine that’s already happened and the fact that there’s bipartisan support in Congress to do just that. So we’ve been expecting all along in our kind of long-range plan that the U.S. government and Congress would step up to meet the reality of the global geopolitical situation. And that’s exactly what played out in the budget process for FY ’23. We also expect that same reality to continue to sadly exist again in the next budget cycle, which is happening even now in — for 2024. So we don’t see the circumstances the fundamentals changing. Therefore, we also believe that the continued robustness of the defense budget is going to be a reality as well.