Operator: Good day, ladies and gentlemen, and welcome to Northrop Grumman's Fourth Quarter and Year-End 2022 Conference Call. Today's call is being recorded. My name is Norma, and I'll be your operator today. . I would now like to turn the conference over to your host today, Mr. Todd Ernst, Treasurer and Vice President, Investor Relations. Mr. Ernst, please proceed.
Todd Ernst: Thanks, Norma. Good morning, and welcome to Northrop Grumman's Fourth Quarter 2022 Conference Call. We refer to a PowerPoint presentation that is posted on our IR web page this morning. Before we start, matters discussed on today's call, including guidance and outlook for 2023 and beyond, reflect the company's judgment based on information available at the time of this call. They constitute forward-looking statements pursuant to safe harbor provisions of federal securities laws. Forward-looking statements involve risks and uncertainties, including those noted in today's press release and our SEC filings. These risks and uncertainties may cause actual company results to differ materially. Today's call includes non-GAAP financial measures that are reconciled to our GAAP results in our earnings release. On today's call are Kathy Warden, our Chair, CEO and President; and Dave Keffer, our CFO. At this time, I'd like to turn the call over to Kathy. Kathy?
Kathy Warden: Thanks, Todd. Good morning, everyone, and thank you for joining us. The Northrop Grumman team delivered another year of strong performance in 2022, positioning our company for the coming year and beyond. A growing global demand environment and the team's success in capitalizing on competitive opportunities drove exceptional bookings. Top line growth accelerated throughout the year, driven in part by improving labor trends. I'll note that we set our sales and EPS guidance ranges at the beginning of 2022, and even in a dynamic macro environment, we navigated the challenges to deliver at or above the high end of those ranges, and then importantly, to deliver capability for our customers. This performance highlights our solid operating execution, our ability to win new business and the alignment of Northrop Grumman's portfolio to our customers' priorities.
We enter 2023 with a backlog of more than 2x our annual sales. This strong backlog, along with increasing demand and rising global defense budget supports our expectations for continued growth. Given this and supported by robust headcount growth, we have increased our 2023 sales guidance range from our October outlook. We are projecting solid segment margin performance that takes into consideration inflationary pressures and supply chain disruptions, consistent with the expectations we outlined on the October call. And we expect a greater than 20% compound annual growth in our multiyear cash flow outlook that supports continued investments in the business and significant returns of capital to shareholders. Before providing more details on our outlook, I'm going to highlight a few notable achievements from the previous year that underscore the tenets of our long-term strategy and illustrate our positioning for the future.
In 2022, the James Webb Space Telescope proved its status as the world's most powerful space telescope and an engineering marvel. It achieved full operational status, shared first images in July and continues to discover and inspire with its incredible insights into distinct galaxies. This project is just one example of the technology innovation and leadership our team brings to our customers. And it has provided an excellent platform for attracting talent to our industry and our company. In 2022, we continued to win new competitive awards across the company, achieving a book-to-bill ratio of 1.07. Two notable new awards are the space development agencies tracking and transport layers. As our customers look to expand their resilient national security space capabilities, these programs leverage our advanced space solutions for low earth orbit and showcase our ability to compete and win programs across a range of missions.
We also completed over 40 successful launch and space missions in the year, exemplifying our end-to-end capabilities in the space market and our ability to perform at scale. Further, our solid rocket boosters helped propel NASA's base launch system as part of the Artemis 1 mission with the largest human-rated solid rocket boosters ever built. We also received a $2 billion award for GEM 63 solid rocket boosters in support of Amazon's Project Kuiper. Together, SLS and Kuiper validate the robust investments that we've made in solid rocket motor capabilities. We also delivered advanced architectures that integrate sensors to provide unprecedented situational awareness for our customers. One example is our IBCS solution. After successful testing in the fourth quarter, IBCS is poised to transition from LRIP to full-rate production in 2023.
IBCS integrate systems that weren't designed to work together, creating a seamless air and missile defense network and allowing customers to better utilize their defense assets. This capability is needed more than ever to address advanced threats and it's one where we've seen a significant increase in interest across our global customer base with 10 additional countries expressing interest in obtaining this system. We continue to keep our focus on innovating and leveraging our strong position in advanced technology. This includes the development of a new radar for the F-35. This radar is capable of defeating current and projected adversarial air and surface threats and is compatible with variants of the F-35 aircraft. And we capped off a strong year with the historic unveiling of the B-21 Raider.
The B-21 is a multifunctional platform with unmatched range, stealth and survivability, and it will be the backbone of future U.S. air power for decades to come. We continue to perform well on the program and remain on track for first flight later this year. As the program transitions into low rate initial production, we are working to address macroeconomic conditions, especially related to inflation and their impact on material, suppliers and labor. Importantly, I want to highlight that our B-21 unit cost projections remain below the government's independent cost estimates. The program has strong support from the U.S. Air Force, Congress and our suppliers. And in the words of Secretary Austin from last month's rollout, "This aircraft is proof of the department's commitment to building advanced capabilities that will fortify America's ability to deter aggression today, and in the future." Our 2022 achievements underscore the breadth of our portfolio across a wide range of domains and technologies and the strong performance of the entire Northrop Grumman team.
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As we look forward, defense budgets are on the rise, and we see our global customers continuing to seek proven solutions to address rapidly evolving and increasingly sophisticated threats. We are meeting their urgent needs in areas such as air and missile defense solutions, medium and large caliber ammunitions and armaments, advanced radar capabilities and global surveillance to name just a few. And we are partnering to expand our opportunity set and positioning our international business for future growth. We clearly saw increased demand in 2022, and we continue to expect to grow our international business over the next several years. In the U.S., we are encouraged by the continued strong support for National Security, including overwhelming bipartisan support for a 10% spending increase in the fiscal year 2023 defense budget that was passed in December.
Our portfolio and the capabilities we offer are well supported by the administration and Congress. Growing security challenges will test our resolve in ways not seen for a generation, and we are confident this administration and the new Congress will find ways to work together to meet them. We expect the President's fiscal year 2024 budget request to support robust funding for the highest priority capabilities outlined in the National Defense Strategy. And our strategy has positioned us well. We're clearly maintaining our technology leadership and growing our portfolio of offerings, which is aligned to customer priorities. Another key element of our long-term strategy is keeping a laser focus on performance and driving cost efficiencies throughout the business.
The current macroeconomic environment reinforces the importance of doing so. An example of our effort is the implementation of digital solutions across the company. Beyond the benefit of transforming how we design, test and manufacture the next generation of systems, our digital initiatives are streamlining business functions and increasing productivity. We are also optimizing our facilities and consolidating our real estate footprint. Every day, we seek new and innovative ways to drive performance and increased efficiency while remaining agile and meeting our customers' expectations. Our capital deployment strategy supports our business strategy. We are investing to not only drive efficiencies but also to allow our customers to stay ahead of the threat environment.
In 2022, we invested over 7% of revenue in R&D and capital expenditures to provide the capability and capacity needed to address the threats of today and tomorrow. We also continue to return cash to shareholders. Last year, we increased our dividend by 10%, which was the 19th consecutive increase. And during the year, we delivered over $1 billion to shareholders through the dividend and returned another $1.5 billion through share repurchases. So looking forward to 2023, we are well positioned for continued growth, and our revenue outlook has improved from the high $37 billion range we shared in October. We now expect sales to be in the range of $38 billion to $38.4 billion, representing about 4.5% growth at the midpoint. Margins are expected to remain solid in the 11.3% to 11.5% range.
We are projecting strong free cash flow growth that supports our capital deployment strategy. And we expect to return more than 100% of free cash flow to shareholders again in 2023. Our backlog, strong recent global demand growth and our ability to deliver products that address an increasingly complex security environment give us confidence in our outlook. So with that, I'll hand it over to Dave to cover the details of our financial results and more on guidance.
David Keffer: Okay. Thanks, Kathy, and good morning, everyone. I also want to thank our team for another year of strong performance in 2022. We won several new franchise programs, delivered industry-leading top line growth and bolstered our talented workforce, with the addition of over 6,000 net employees during the year. I'll spend a few minutes on our fourth quarter and 2022 results and then discuss our future expectations in more detail, including our long-term cash flow projections. We ended the year with nearly $79 billion in backlog, reflecting strong demand for our products and capabilities. We continue to convert our backlog into revenue at an accelerating rate with fourth quarter sales growth of 16%. This was enabled by our ability to continue strong hiring in Q4 as well as a higher volume of material receipts based on the timing of program demand.
The team did an outstanding job of working with our supply chain to secure program material. And for the full year, our sales grew to $36.6 billion, representing organic growth of 3% and exceeding our prior expectations. Our operating performance and margins remained solid despite the continued pressures of the macroeconomic environment. Our segment operating margin rate was slightly below our expectations at 11.3% in Q4 and 11.6% for the full year due in part to the impacts of inflation, which resulted in a lower level of net earnings adjustments. But margin dollar volume was very strong given the top line outperformance. A positive EAC adjustment in the quarter was on B-21, where we recognized a $66 million pickup on the EMD phase of the program, reflecting our latest assumptions regarding future incentives in that phase.
Continuing with our Q4 results. Our transaction adjusted earnings per share were $7.50, a 25% increase over the same period in 2021. Higher EPS were driven by robust growth in our segment top and bottom lines as well as a lower effective tax rate. The lower Q4 tax rate was driven by the recognition of an $86 million benefit from the resolution of a legacy Orbital ATK tax return, which we previewed in our guidance last quarter. And corporate unallocated costs were also below our expectations due to lower state taxes as a result of the R&D tax amortization law not being deferred. For the full year, our transaction-adjusted earnings per share were $25.54, well ahead of our guidance range. Now turning to cash. We had an extremely strong fourth quarter, consistent with our historical pattern.
For the year, we generated $2.9 billion of operating cash flow and $1.6 billion of transaction-adjusted free cash flow, in line with our expectations. This was inclusive of a full year of cash taxes associated with the R&D tax amortization law as well as our final payment of deferred payroll taxes from the Cares Act legislation. Moving to our pension plans. Slide 7 in our earnings deck includes our latest assumptions. After 3 consecutive years of double-digit asset returns, our plans declined by roughly 15% in 2022, in line with market trends. Our FAS discount rate increased roughly 250 basis points to 5.54%, which was the driver of the mark-to-market pension benefit of $1.2 billion reflected in our GAAP results. These factors are also reflected in our latest pension estimates for 2023 to 2025.
As we previewed last quarter and updated in our slides today, we're projecting a decline in our noncash net FAS pension income and an increase in our estimated CAS recoveries. In total, our pension plans remain strong. As a result of the higher discount rate, our funded status has improved to nearly 100%, and we continue to project minimal cash pension contributions over the next several years. Now turning to 2023 guidance. Our revenue expectations have increased from our prior estimates, with the midpoint representing nearly 4.5% growth on top of the strong level in 2022. We expect Space Systems to remain our fastest-growing business. Sales are projected in the mid-$13 billion range, up over $1 billion from 2022 levels, with GBSD and NGI contributing nearly half of the growth and the rest coming from our broad space portfolio.
Mission Systems sales are expected in the high $10 billion range, up mid-single digits, driven by restricted programs in our Networked Information Solutions business. And we continue to expect flattish sales at both Aeronautics and Defense Systems. While programs like B-21 and IBCS continue to grow, headwinds remain on legacy platforms as systems are retired. We expect Aeronautics and Defense Systems to return to growth in 2024. And similar to our cadence in 2022, we expect first quarter sales of approximately 24% of our full year estimate, with sales ramping again throughout the year. With respect to margins, we expect our 2023 segment operating margin rate to be down roughly 20 basis points from 2022 levels. Challenging macroeconomic conditions, including extended lead times in the supply chain and high levels of inflation continue to put temporal pressure on margins.
And while higher CAS recoveries provide a modest benefit to our cash flow in the coming years that create pressure in our overhead rates and EACs. Similar in nature to what we experienced in the first quarter of 2021 when we recognized a favorable impact from lower projected CAS costs, this could lead to an unfavorable margin impact when we update our rates this quarter. We notionally expect this to have a 10 to 20 basis point impact on the full year. In regard to the B-21 program, we expect the 2023 contract award for the first of 5 LRIP lots with the LRIP phase scheduled to run through approximately the end of the decade. We're continuing to work with our customer to address macroeconomic risks and enhance efficiencies in the program. As we've described in our 10-K, we do not believe that a loss on the LRIP phase is probable and therefore, no such loss is reflected in our results or guidance.
Now turning to our future outlook. We expect our 2023 earnings per share to range between $21.85 and $22.45 based on approximately 153 million weighted shares outstanding. This includes $450 million of net pension income, which represents a $4.30 per share headwind compared to 2022. Partially offsetting this nonoperational headwind is strong growth in segment performance and the lower share count, which adds roughly $0.90 of additional earnings per share and lower purchase intangible amortization largely offsets the higher tax rate. Moving to cash. We expect 2023 adjusted free cash flow between $1.85 billion and $2.15 billion, consistent with our prior outlook as adjusted for current R&D tax law. Although we expect discussions to continue on Capitol Hill, our guidance and multiyear outlook are now based on current tax law for all years and do not include any refunds for R&D taxes paid in 2022.
Capital expenditures are expected to remain elevated at $1.65 billion to $1.7 billion in 2023 and a similar level in 2024 before moderating in 2025 and beyond. This is driven by investments to support several large new business wins from 2022. Our guidance assumes we will not have an extended CR, a breach of the debt ceiling or a prolonged government shutdown as this is our current expectation. Slide 12 in our earnings deck provides our long-term cash outlook, which is predicated on continued top line growth in our business generating strong and gradually expanding operating margins and converting those margins into cash. R&D-related cash tax payments should decline by about 20% per year. As I described, CapEx is expected to remain near 4.5% of sales in 2023 and 2024 before starting to decline in 2025.
After investing in our business, we continue to expect to return more than 100% of our free cash flow to shareholders in 2023 in the form of dividends and share repurchases. And we plan to be in the market for new debt issuance soon to support our capital deployment plans including the refinancing of near-term maturities. In summary, 2022 was another successful year for Northrop Grumman, and we continue to deliver value for our customers, employees and shareholders. And with that, we're ready to take your questions.
