RTX Corporation (RTX) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us this morning for our conversation with Raytheon Technologies' leadership. On the call this morning, we have Greg Hayes, Chief Executive Officer; and Toby O'Brien, the Chief Financial Officer. So without further ado, let me hand it over to Toby.

Thanks, Ron. During the discussions today, both Greg and I may make forward-looking statements such as comments on future plans, objectives and expected performance. These are subject to risks and uncertainties that could cause our actual actions or results to differ greatly. You should consult our SEC filings for a description of those risks and uncertainties. Back to you, Ron.

All right. Great. So just folks who are listening in, if you have a question, you can submit it through the Veracast system or you can -- and -- or you can send something to myself or the team.

So why don't I just kick off the conversation now and let's -- Greg, let's -- how about -- I'll start with this. What are your thoughts on everything that's happening in the world right now with the coronavirus? And what are you doing in response to that? I mean that seems to be right on top of everybody's mind.

Well, Ron, that is probably the question of the day, and we could probably spend the next hour talking about it. But let me tell you how we're thinking about this. There's really 4 things that we're focused on. First of all, it's our employees and it's customers, then it's suppliers, and last and just as importantly, is community response. So for the employees, we've got about 100,000 folks every day showing up in the factories and in the office to continue work on critical programs and to continue to support the customer through deliveries. We got another 95,000 people working from home, and that looks like that is going to continue for quite some time. So we're doing what we can to support that as well. But again, first and foremost, the concern with employees is how do you protect their health and safety. So we've invested in PPE. We've invested in digital scanners, thermal scanners, all sorts of things, relaying out factories and offices. And not an insignificant cost to do that, but it's absolutely essential. And all of that, of course, is, remember, the second reason is our customers. And when I think about our customers, I guess the best way to put it, it's almost like what the Dickens wrote about the Tale of Two Cities, "It's the best of times and it's the worst of times." Our defense customers remain committed to the programs. The defense backlog remains robust. We've got a lot of work to do. I think as we said last week on the conference call, we came into this merger with about $70 billion of military backlog. And we expect both the legacy Raytheon businesses as well as the legacy UTX aero military businesses to grow kind of 5%, 6%, 7% this year despite the coronavirus. On the commercial side, it really is how do you support customers who are in deep, deep financial difficulty. And of course, we're doing whatever it is we can. But first and foremost, we've got to keep planes flying. Even though passenger traffic is down roughly 95% here in the U.S., people are still flying planes. I think capacity is down about 80%, which means planes aren't flying very full, but they are flying, which means we need to support them. And we've got folks out on the road today, making sure that the planes that are out flying continue to fly. But more importantly, to make sure when the recovery begins, that the aircraft are in decent shape, to actually meet the demand as it comes back. And I think, again, that's critically important to say the demand will come back. Thirdly, suppliers. We've got thousands of small business suppliers, many of whom have had to shut down because of the coronavirus. We have been taking the progress payments that we have been getting. The DoD raised it from 80% to 90%. We've pushed all that cash, about $450 million, in the last 2 months out to our suppliers to make sure that they can maintain their financial viability. And of course, we've set up a special office within our supply chain operation to provide logistical support and to provide support to helping them access government funds. The real concern, if I think about anybody here, while the airline customers are going to have a tough time, it is the small business suppliers that I'm most worried about. And then lastly, on the community side, I think we have done a lot in terms of donating PPE, over 1.5 million pieces, to various federal and state governments. We're making face masks additively, about 10,000 a month. We're doing whatever we can. We're also directing donations to feed America because of the food insecurity issues out there. So it's not one thing. It's many things. And above all, I would say, what we're trying to do is remain positive here because we do have a great business. But the commercial side is going to be tough for the next 2 years. And I think everybody understands that.

And Greg, when we think about the near term, and understanding that you're not providing guidance or anything like that. But can you comment on what you're hearing from OEM and airline customers? Is there any way you can offer us maybe a broad framework on how to think about it?

Well, look, I think there's no surprise here. The airlines are fighting for their survival. And so they have come to us, as you would expect, asking us to assist them financially in any way we can. Unfortunately, because they're not buying parts, they're not buying services. We don't have the ability to do much financially for them. I think all of the airline executives that I've spoken to have an inherent belief that this will get better. But it's going to be quite some time before we see kind of a return to normalcy. And so what they have -- what everyone has been telling me is expect at least a 2-year recovery. We probably won't see air traffic back to pre-COVID levels until sometime in 2022. And whether that's the first quarter or the fourth quarter, I don't know. So the airlines are hunkering down for the long term. We're working with them to try and figure out other ways to make passengers feel more safe. It's hard to provide social distancing on an aircraft. And so the question is, is there PPE that we could be providing or assisting them with, other things mechanically that we can do. But ultimately, the airline industry will remain in place. Whether the number of small airlines is still there, it's not clear. You may see further consolidation in the industry. But overall, I think everybody is still optimistic that we will get through this, and that the airlines that do survive will come out much stronger. On the OE side, it's an interesting conundrum. Boeing and Airbus are both cutting back production. They've got a huge backlog, as you know, of narrow-bodies, like 7,000 aircraft. But the question is nobody wants -- or the problem is nobody wants them today. But the OEMs, of course, Boeing and Airbus, have a desire to build aircraft to keep their folks busy and to keep their cost in check. When you're going from building 63 A320s a month down to 35 or something like that, you can imagine the overhead cost balloon. Your cost per aircraft goes up. So the OEMs are highly incentivized to keep building aircraft. But as I said last week, with 55% of the world's fleet parked, I can't imagine there's an airline in the world that needs a brand-new aircraft. It's not to say they won't take some. But I think we're expecting at least a 50% reduction in OE volume across Boeing and Airbus. And we'll see how that plays out as we see how fast the recovery of passengers occurs.

And then when we think about -- and maybe I should direct this to Toby, when we think about the cash headwinds in the short term, how should we think about your free cash flow for this year and for the out-years, if you can say? Can you help us walk through the 2019 pro forma free cash flow to what you said on the recent earnings call for 2020 cash?

Yes. Sure, Ron. So you kind of teed it up well, right? So think of this as a framework, right? It's not necessarily how we would normally discuss cash flow. But given we're not providing an outlook or guidance, I think this would hopefully be helpful for folks. So I'll start with the legacy Raytheon business, which last year, as a stand-alone entity, generated about $3.5 billion of free cash flow. And some puts and takes, as you'd expect, but for 2020, overall, defense remains strong, as Greg pointed out. And we'd expect, on an equivalent basis, the same level from the legacy Raytheon businesses, around $3.5 billion. More back-half weighted, consistent with our typical historical cadence, a little bit of an outflow in Q1 and the majority in Q2 through Q4. Legacy UTC, as we talked about on the call, because of the headwinds from COVID-19, including the working capital impacts, free cash flow for the base businesses there will roughly be breakeven this year. And overall, we said we expect to be cash flow positive. A little bit of additional color on -- in addition to the cash flow for the base businesses. In our assessment for the year, we have about $1.2 billion to $1.4 billion of what I'd call discrete nonrecurring cash costs between Q2 and Q4 that we wouldn't expect to repeat going forward. And the way to think of that is about half of it is separation and merger-related and also some restructuring, the restructuring-related to the COVID actions as well as our integration actions. And the other half is principally tax payments related to the divestitures we're making to meet the regulatory requirements. I'd also point out that the gross proceeds from those divestitures, $2 billion plus, they won't flow through the free cash flow, right, even though the tax payments would be an operating cash flow outflow. And then, again, this is high level, trying to give you a little bit of color. It's not an outlook, right? Trying to give some broad strokes on how we're thinking about the year. Obviously, a lot of variables still out there that could change how some of the math works out by the time of the year is over.

Okay, great.

Ron, I think that's -- the key point here is the liquidity remains strong, right? We've got -- I said this the other day on the phone: We're going to generate enough cash to cover our dividend payments for the rest of the year. On top of that, you've got another $2 billion of net of taxes coming in for -- from the divestitures of the regulatory required divestitures. So you've got plenty of cash here. But more importantly, we've got a $5 billion standby facility. We're going to go out and we're going to be borrowing some more money in the next week or so. And we're going to have plenty of liquidity. So if anybody is worried about cash or liquidity, I think that's just something you can put on the back burner as it relates to RTX.

So maybe I'll kind of pivot back to Greg. I mean, how should we think about your aftermarket exposure at Pratt and Collins? For Pratt, can you go into at least maybe some detail by engine program, if that's possible? And maybe the same for Collins? That's a question that's been coming up a lot with investors.

Yes. So think about Pratt's aftermarket in 3 big buckets, if you will. About half of it, as I said last week, relates to the V2500, and the average fleet is -- average engine is about 11 years old. And half of the fleet has not yet seen its first major overhaul. We expect that, that business will be down significantly in line with not RPMs, but in line with available seat miles or flying hours, if you will. We typically would expect about 1,000 engine inductions a year on the V. Maybe a little bit north of that. So that's roughly 80, 85 a month. And we saw that rate, January, February and it's really to the last week of March. And I think in April itself, it was down like 75%, to 25, 26 engines. So again, we expect that, that will ramp up in line with the return to service of the fleet. Fortunately, it's a relatively new fleet at an average age of 11. So we don't expect a lot of retirements there. The other 25 -- another 25% is related to, let's call it, the legacy PW4000, PW2000 programs. And those are some of the older 777s. There's some A330s in there. There's probably even some old 767s out there and 757s for the PW2000. That -- again, it's highly profitable, and that is the part that I think we are most concerned about in terms of how many of those planes are going to return to service. The good news is with fuel prices at these historically low levels, the need to buy new airplanes to -- for fuel efficiency is pretty much abated by the low fuel cost. So we expect -- we'll see those planes still flying. But those are the ones I would tell you we have our eye on. Then you've got another 25% out there, which is all the other stuff that we do. There's some GP7000. That's the A380s. I think most of those are parked today. And you've got some other legacy engines out there as well to make up that remaining 25%. But overall, I think that the way you need to think about that is, let's say, April was down 75%. That was after the first quarter being up 4%, by the way. For the back -- or for the year -- for the remainder of the year, we think aftermarket at Pratt in total will probably be down around 50%. So what that means is you have to see a slow build of hours -- aircraft hours over the next 8 months or so. I think that is the single biggest question mark that we have is will we -- how quickly will we see a return to, I would say, a 50% kind of flight level from where we are today. Collins is a much different story. Of course, they rely a lot on initial provisioning for aftermarket sales. That's the spares that airlines buy when they take new aircraft. That is going to be down significantly, probably in line with OEM production. So down about 50%, we think, for the year. And the rest of the Collins where, for the most part, is all on condition, which means the more you fly, the more aftermarket that you see. Repair inputs, I think I said this, were down 55% in April in the shops around Collins. And that's a pretty good indicator of what spare parts are going to be down, but it's really -- there's 2 things: there's spare parts and there's initial provisioning. So you can imagine nobody is buying initial provisioning at all this quarter. I don't think we've got anything forecast. And spare parts, again, will only be sold as it relates to what we get back into the repair shops. So those turn times. At Pratt, it's like 90 days to repair an engine. For most of the Collins work, it's like net -- it's about 30 days. So that's a pretty quick turn business. So we'll see that impact right here in the second quarter. Is that helpful?

Yes. That's great. And maybe pivoting to maybe a bigger-picture question. Can you give us an update on how the merger is progressing in the current environment? Because obviously, this has got to make things more challenging. Are your integration plans changing given the pandemic? Or are you still on track to achieve your cost and synergy targets like you thought before the pandemic?

Yes. I would tell you what is amazing to me, Ron, is we got all of this done there. We got the 2 spins done. We got the merger done on time, I mean, to the minute on April 3. And all of that while almost everybody was working from home. The good news is the folks running the integration steering committee, there's really 2 people. There's Jennifer Reed. She's been with us for quite some time. She ran the Sikorsky process a few years back for us. She's had some P&L experience. And then we've also got Paolo Dal Cin, who's our Senior VP of Ops. We have a normal integration steering committee meeting weekly. We're on track to hit what's roughly $1 billion of gross synergies over the first 4 years. This year, that number is a little light. It's less than $200 million. But we remain on track. And the good news is we've got a playbook. And we took it when we started with Goodrich back in 2012. We're using it now with the Collins -- Rockwell Collins acquisition. They got $300 million of their $600 million of synergies in the first year. They get another $150 million this year. What has been amazing to me, though, is just the way we have been able to bring these 2 big businesses together despite the fact that we're not together. And we're doing everything, virtually over Zoom, staff meetings and communication meetings and all of that stuff. But I'd tell you, everybody has got a great attitude. I mean, nobody wanted this pandemic. Nobody wants to be working from home all the time. But the troops have actually been really, really supportive of the whole team. And we haven't seen a culture clash. We haven't seen big drama. What we have seen is people pulling together to try and get through this together. And I think that's probably the great testament to the folks that we've got.

And maybe pivoting back to Toby and peeling back the onion a little bit. Can you help us understand some of the moving pieces in the 2020 RIS and RMD outlook, including how we should think about the EAC reset? And also, what about defense at Pratt and Collins?

Yes. Sure. So I'll reinforce what Greg commented earlier. We obviously have a very balanced business here. 70 -- a record $70 billion in defense backlog, a little over $50 billion of that from RIS and RMD. The franchises that we have, they're well funded, all aligned to the national defense strategy. And a couple of key data points recently at the end of last year, as a reminder, the LTAMDS award; and here, not that long ago, the down-select on LRSO. So things are going well from that perspective. As I mentioned on the call last week, on the earnings call, at the high level, we had talked about, for RIS and RMD, having guided to 6% to 8% sales growth compared to last year and the ability to improve operating income. We did, as a result of some COVID impacts, obviously to a much lesser degree compared to the commercial aero side, lower by about $200 million the RIS and RMD sales. It's a little less than 1%. But operationally, on a full year 2020 basis and for the balance of the year, Q2 through Q4, we see no changes from an operational point of view to the prior outlook there other than the COVID impacts. Now as you said, Ron, there are some changes to the way we will be reporting the numbers for RIS and RMD, and that's all driven by the merger: the related accounting, including the stub period; the period between when we closed our books at legacy Raytheon in Q1 and when the merger took place; the EAC resets; and some purchase accounting impacts. I think a note on the EAC reset. What's important to recall here is this is just timing, right? There is no loss of profit as the profit improvements will now be recognized, effectively, over the remaining life of each program, given that all the EACs are reset to 0 as of April 3. So the cume catch-ups that we had historically seen in legacy Raytheon that could be up to 200 basis points of margin a year. We're not going to get those in chunks. We're going to get them kind of spread out over the next 1.5 years to 2 years. I think, overall, we're confident in the future of defense. And we're not providing an outlook for '21, but what I can say is that given our positioning, the strong backlog, how we're aligned to the NDS, we clearly will be able to grow these businesses going forward. And we won't see these merger-related impacts on the accounting beyond next year. And finally, you pointed out correctly so, right, Pratt and Collins, their top line is about 30%, maybe just a little less than 30% of the overall Collins and Pratt businesses, respectively. And again, as Greg alluded to earlier, we continue to expect the Collins and Pratt defense businesses to grow in the mid-single-digit range organically, which is consistent with what we talked about at the start of the year.

Great. Great. Greg, maybe pivoting to a question around capital deployment strategy. Given the near-term challenges, how should we think about your latest thoughts on returning capital to shareholders? And then, are there any thoughts on M&A? Or is that not possible in this kind of environment? One would think that there could be some interesting opportunities out there, particularly in commercial aerospace, if you take a longer view.

Yes. We're probably not going to get back into the airline business like we were in the '30s, and I would say that is probably a given run. Seriously. Look, on capital deployment, I think there's a couple of things to keep in mind. We had come into the merger, and what we announced this last June. Dr. Kennedy and I committed to an $18 billion to $20 billion return of capital over the first 3 years. We're still committed to $18 billion to $20 billion, but it's going to take us now 4 years to do that. I think the most important -- what underpins our strategy is dividend and dividend growth. We've got a good dividend. We declared that a couple of weeks ago with the Board. The Board is confident in the liquidity going forward. And our goal is to grow the dividend in line with earnings growth over the next few years. So that will underpin a big chunk of that $18 billion to $20 billion. In terms of share buyback, that's probably after the dividend, second priority from a capital redeployment perspective. While cash this year will be a little tighter because, as Toby said, some restructuring and some tax costs and other kind of onetime things. As we look forward, this combined business, RTX should generate a lot of cash in a normal operating environment. But that probably means normal is 2022. And so what I would expect is there might be some modest share buyback next year really depending upon, again, the recovery in the airline industry. But then in years 3 and 4, we would look to, I don't want to say, back up the truck, but look to be as opportunistic as we can in terms of share buyback. Because again, the defense business throws off a lot of cash. The dividend will cost us about $3 billion a year and then growing in line with earnings. But I think, again, that share buyback remains one of the key tools that we have in the coming years to provide returns to the shareowners. As far as M&A, interestingly, we entered the merger with $8.5 billion of cash. We've got $25 billion net debt or so. We've got capacity if something came on to the market to do something. I think, again, it's -- it would have to be the deal of the century for us to think about M&A. But I would never say no if that rare opportunity were to present itself. And as you can imagine, not everybody's got the balance sheet that we have or the liquidity that we have. So I mean if the right opportunity came along, would we do something? We'd sure take a hard look. Unlike Mr. Buffett, I actually do believe that the airline industry is going to come back, and commercial aerospace will return over time. And so if we see a buying opportunity, we're not going to be shy. We're not going to be stupid either, though. So we'll do what makes sense for the long-term prospects of the business.

Just maybe pivoting to a little more focused view for Toby. We're almost halfway through Q2 now. Can you give us an update on what you're seeing across the businesses today?

Yes. Sure. I think at a high level, as we've talked about on the commercial aero side, we're seeing the impacts with reductions at Pratt for engine inductions, down 60%, 70%; the aftermarket on Collins, down between 50% and 60% as we talked about earlier. We're seeing that play out through the month of April and here again into early May. So unfortunately, not surprised by that. Again, on the defense side, as I just alluded to, no operational impacts here in the quarter for RIS or RMD or the Collins and Pratt defense businesses. The Q2 numbers for RIS and RMD will have the impacts that I just discussed around the stub period, the merger accounting, et cetera. And while we do expect to be profitable on an adjusted basis in Q2, certainly, what we're seeing on the metrics on a year-over-year basis are going to be down quite a bit. Again, we talked about that on the call. We see Q2 as close to the bottom, and we're continuing to monitor all the external metrics to see how things play out for the balance of the year. And I would say, Ron, given with April and Q2 kind of being the bottom, as we mentioned, there will be a sizable net cash outflow of free cash in Q2. Again, it's consistent with our thinking on the call, so no change there. The cash actions that we're taking around the $4 billion, as you'd expect, they're largely going to benefit the back half of the year, Q3 and Q4. We may get a little bit of a benefit, maybe up to 10% of the $4 billion in the second quarter. But again, 1/4 of it maybe in Q3, and the balance, over 60%, in Q4. So we see the benefit from that in the back half of the year. Defense will to generate positive cash flow in Q2. And then, of course, the arrow will be negative due to the decline that we're seeing.

Great. So I think we have just kind of ran out of time. There's still a lot of questions to go through. So any folks who've sent in some questions that we didn't get to, I'll forward them on to the team at United Technologies. But...

Raytheon Technologies.

Oops. Sorry, Raytheon Technologies. Sorry about that. Apologies.

Thank you, Ron. I appreciate you taking the time, and we'll make sure everybody stays healthy and safe out there.

Yes, yes. Thanks, guys. Yes. All right. Everybody, I hope you have a good conference.

Thank you.

Thanks. Bye-bye.

Bye-bye.