RTX Corporation (RTX) Earnings Call Transcript & Summary

Good morning, everyone. I'm Kristine Liwag, the aerospace and defense analyst at Morgan Stanley. Today, we're hosting Raytheon Technologies with CEO, Greg Hayes. Before we begin, I have to read disclosures. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And Greg, thank you very much, and welcome to our Morgan Stanley Virtual Laguna Conference. I'll turn it over to you.

Okay. Thank you, Kristine, and good morning, everyone. I'm sure everyone would agree that it'd be nicer to be in Laguna Niguel this morning than on the telephone doing these webcasts. But next year, I'm confident we'll all be back together. I've just got a few opening comments to start things off and then we'll move into Q&A. But of course, like Kristine, I'll have to make the lawyers happy by reading a disclaimer here. I may make some forward-looking statements here, such as comments on future plans, objectives, expected performance. These are, of course, subject to risks and uncertainties that could cause our actual results to differ materially. And you should consult our SEC filings for a description of those risks and uncertainties. Okay. Mr. Jimenez, our GC, will be happy. All right. First of all, let me start out to say we're not going to issue guidance for the year, given all the uncertainty in the recovery of commercial air traffic. But I will reiterate what we said on the last earnings call, Q3 earnings should be more or less in line with Q2 earnings. Free cash flow, on the other hand, should be positive in Q3. And that's a little bit better than our break-even thinking of a couple of months ago. And for the year, we still see free cash flow of around $2 billion. So no surprises, in fact, a little bit of good news on the cash front. Okay. With that, we're almost 6 months into being Raytheon Technologies. And now in the midst of this pandemic, with commercial aerospace is facing its very challenging time, it's more clear than ever that the balance of commercial and defense in the aerospace space actually works. To that end, we're focused on 4 things: the health and safety of our people first; of course, meeting our customer commitments; continuing to drive technological innovation, that means investing in the future; and finally, just as importantly, eliminating structural costs in our businesses so that we emerge a stronger, higher-margin business when the air traffic does recover over the next few years. I would tell you the commercial aero team has jumped on this crisis, and they're driving about $2 billion in cost reduction and $4 billion in cash conservation actions this year. These cost actions include the elimination of more than 15,000 positions across our commercial aerospace and corporate organizations. That's roughly a 20% reduction in SG&A at Pratt and about a 12% reduction at Collins. Those headcount reductions are nearly double the previous estimate of around 8,500 that we gave you back in July. And we're not done yet looking for further ways to reduce structural costs in all of our businesses. There's no doubt, of course, the long-term earnings power of RTX is substantial. We continue to be well positioned to deliver value over the long term. And we're going to continue to take a look at structural costs, not just on the commercial side but on the defense side as well. As far as liquidity, we're in a strong position. We closed Q2, as you know, with about $7 billion of cash, $26 billion of net debt. And we've also got revolvers in place of up to $7 billion, so no issues there. On top of that, we've closed 3 divestitures that were required for merger approval. So we received another $2 billion of net proceeds from those transactions. So liquidity, not an issue at all. I think, importantly, we remain committed to the $18 billion to $20 billion of capital returning to shareowners over the next 4 years. We certainly have enough cash and liquidity to maintain the dividend and to begin modest share buyback soon. At the end of the day, Raytheon and UTC came together for 3 simple reasons. It was technology, talent and balance. I would tell you the defense side of our business remains resilient and strong. Both the RIS and R&D had a combined book-to-bill of about 1.2 in the second quarter. And we've got a record backlog of $73 billion on the defense side of our business. And we continue to progress on some of our great franchises. In the second quarter, as you know, RMD booked a $2.3 billion order for TPY-2 radars to the Kingdom of Saudi Arabia and a $300 million order for Standard Missiles-3 from the Missile Defense Agency on top of a $1.4 billion order for a number of classified programs. So great start to the year. It's very strong. I would tell you, the best news is on the defense side is we continue to grow that business. And in fact, this year, we'll probably add or hire about 80 to 100 people. So big reduction on the commercial side, strong growth on the defense side. I think you should also note that our defense technologies and advanced solutions are well aligned with the National Defense Strategy, and we can talk more about that. On the commercial side, of course, Pratt, the combined GTF fleet, has now reached over 5 million revenue flight hours and Collins remains on track to achieve their $600 million of gross cost synergies from the acquisition of Rockwell Collins back in '18. So we have strong businesses, great franchises, great technologies. And each of our businesses is a leader in their respective market. And we already see the potential for significant revenue synergies by combining the technologies across the business to generate some game-changing solutions for our customers. So I believe we truly are stronger together. With that, let me stop and turn it over to Kristine for some questions.

Thanks, Greg, and thank you for providing that color. What is your expectation on the timing and shape of the recovery? You most recently said that you thought commercial air traffic wouldn't return to 2019 levels until at least 2023. Is this still your current thinking?

Yes. I mean I don't think anything has changed in terms of the shape of the recovery. We see a gradual return to flight across all of the commercial markets but probably not a full return to 2019 levels until somewhere around 2023. Now whether that's the beginning of '23 or the end of '23, it really depends upon the timing of the vaccine. I would tell you, as of 9/4, September 4, commercial air traffic is down about 45% globally versus a low of 80% back in March. And China, of course, leading the recovery, they're down about 5% domestically, but still down 74% internationally. Europe is down 43% but down versus 90%. And North America, as you know, is down about 39%, off of a low of 75%. So it's going to be a slow recovery. But we think it's about in line with what we have seen. Just in terms of our own fleet of GTF-powered aircraft, we're extremely confident in the GTF program. We continue to do the durability upgrades. And even in the midst of the pandemic, we see roughly 75% of the A320neo powered or GTF-powered fleet flying. That's up from 65%. And if you look at the A220, the old CSeries, that's being reused roughly 85%. That's up from 75%. The older A320s, the V-powered, they're still up about 60% -- or they're down about -- I'm sorry, they're flying at about 65% from -- of capacity. That's up from 45% back in March. So positive signs, but still a long way to go.

And at this time, we're now over 2/3 through Q3. Can you provide us an update on what you're seeing across your commercial businesses? How do your spares orders and MRO input trends look across Collins and Pratt?

Yes, sure. So let me give you all a little bit of data here just to give you some color on what we're seeing. And I would tell you, it's broadly in line with what we had expected. So through August quarter-to-date, MRO, that's our repair organization inputs at Collins, are down a little over 50%, so slightly better than the down 55% we saw in the second quarter, but more or less in line with our expected recovery trajectory. Also at Collins through August, commercial spare parts orders, again this is where most of the money is made, we're down about 65%. That's also slightly better than what we saw play out in the second quarter. At Pratt, we see third quarter V2500 inductions into the engine center. That's down about 60% and in line with what we saw in Q2. So we're only seeing about 30 shop visits a month versus the 90 that we had seen last year. So as a whole, I would tell you, Collins commercial aerospace aftermarket and Pratt's large commercial engine aftermarket are trending about where we had expected, so no surprises. Maybe just a couple of comments on the defense side. We continue to see defense business' performance in line with the outlook that we previously communicated, with Q4 being the strongest as we deliver on this record backlog, also had exceptional bookings for the first half of the year and some very large contracts. So that will tamp down in the back half here. But we feel good about the prospects of those businesses. So again, no surprises, but just everything generally in line with a very slow commercial recovery.

Greg, maybe switching gears on cost. How are you progressing on your cost and cash actions in Q3? Is there an opportunity for you to achieve more than $2 billion in cost and $4 billion in cash actions in 2020? Should we think about these actions as variable? Or will they be more permanent in nature?

All right, Kristine. Let me try and dissect that down into the various questions. First of all, in the second quarter, you'll recall, we realized about $600 million in benefit of cost reduction. Our original thoughts back in April, when we closed the deal, is we'd only see about 10% of that $2 billion. So we went from a $200 million to a $600 million savings. We should see another 30%, another $600 million, here in Q3 with the balance, the final 40%, in Q4. I think it's important to keep in mind that when we gave those estimates, for instance, back in July, about the $2 billion, that was assuming we take out about 8,500 people or so. Given the slope of the recovery, I think the folks have taken a more aggressive look at headcount. And we're really -- we're pushing through trying to exceed that $2 billion. I'm not ready to give you a number yet. There's a lot of other moving pieces here. But we're going to look for additional savings this year. And again, you're not going to see a big benefit in addition to the $2 billion just because of timing of layoffs. You just don't get a big run rate. But it should generate significant earnings growth next year by having those run rate savings for the full year. I would tell you, the other piece of the puzzle here that we're still trying to sort through is we operate in a number of high-cost locations. And those plants are really -- have a difficult time today, the overhead structure, the cost structure with the significantly reduced volume. So one of the things that we're looking at is which factories make sense for the long term, where can we have the best cost position long term, recognizing we've got some very, very talented folks in all of these locations. And so we're going to go through a process over the next few months of trying to figure out how we can reduce structural costs. But I think we're just getting started on, I would say, the bigger cost actions beyond the $2 billion.

I see. I guess a follow-on to that. In your Q2 earnings call, what you said is that you are evaluating further actions and structural changes to your businesses, and you've alluded to that in your previous comment. And you're adjusting for a more prolonged recovery timeline. Can you just provide more color on what these actions are specifically and when they'll begin?

So some of the actions, as I said, have already begun. I think when we just originally we're going to have about a 10% to 12% reduction in SG&A at Pratt, Chris Calio came to me a month or so ago and said, "This is tougher than what we had thought. We're going to need to take more folks out." And so they will be doing that over the course of the next few weeks. So again, we already started to do some of that. But the problem, of course, if you think about closing a facility or moving a facility, it is a multiyear effort. The paybacks are generally pretty good to about 3 or 4 years for the investment. But you've got a lot of stakeholders to consider. You've got unions that have to be consulted. You've got to make sure that receiving locations are ready. So we're going to be thoughtful about how we do this. We don't want to screw anything up. But we want to make sure that when this pandemic does end, whenever that is, that we're actually in a position to have a lower cost structure than when we started.

I see. That's really helpful, Greg. And switching gears to your customers. What are you hearing from your airline customers? How much are they deferring maintenance and managing green time? How should we think about the impact of older planes, accelerated engine retirements and availability of surplus material?

Okay. Well, obviously, we all -- those are a series of really good questions, Kristine. Let me talk about the airlines. They're obviously in a cash conservation mode right now. And they're doing what they can to defer maintenance and manage their expenses. So if you think about it, to give you [ the Vs ] as an example, about 65% of the fleet is flying today versus last year. And yet the inputs into our overhaul shop are down 65%. So we know people are deferring maintenance. That is they're using up green time on engines. Even if they have engines that need to be overhauled, they're sitting them down and taking it and changing out engines and putting them on aircraft that can continue to fly. So we know that this is a practice. And we're working with all of our customers obviously to try and make sure that we can get through all of this together. And I would tell you is this is really -- it has to be a joint effort. We have to work with them to try and help them reduce maintenance costs in the near term. What will happen, of course, as we've seen in prior downturns, is we will get a big slug of aftermarket, and these engines will all come back. They're time-based overhauls, and that should provide a bow wave of aftermarket activity once the airlines are back on their feet. But again, that is not a today or tomorrow story. That is going to be several years out. And so we're just going to continue to work with them as best we can. Obviously, keeping the fleet flying is the most important thing. And again, I would say there's also a -- there's a bifurcation of the market, and I think everybody is aware of. Narrow-bodies are coming back much more quickly. We see that in China. We see it in Europe. We see it in the U.S., whereas the widebody franchises are having a much more difficult time because they support international travel, which is still down significantly more than domestic. Fortunately, we don't have a lot of engines out there on the widebody. Those are old PW4000 fleet that was on some 330s and some early 777s and 47s. We expect most of those to be retired during the course of the next couple of years. We had already expected that though. I mean those are engines that are averaging 22, 23 years of age. Usually, at 25 years of age, you don't see the engine come through the shop anymore. So there will be some additional retirements. I would tell you all of that has gone into our thinking in terms of where the aftermarket is today though and what the recovery slope looks like. The good news is, as we continue to ship GTF-powered aircraft, we're replacing the fleet of retired engines faster, but we're actually adding more to the fleet than the retirements coming out. So I think it will all be fine. And again, it's all kind of contemplated in our view of how this recovery looks.

Maybe now on defense, how is the pandemic impacting the defense side of the business? Can you give us an update on what you're seeing in the legacy Raytheon and the defense portions of legacy UTAS?