RTX Corporation (RTX) Earnings Call Transcript & Summary

Okay. Thank you. Good morning, everyone. My name is Peter Arment, I'm the senior aerospace defense analyst here at Baird. We're very happy to be hosting Raytheon Technologies this morning. And with -- from Raytheon, we have Executive Vice President and Chief Financial Officer, Toby O'Brien. So Toby, thank you very much for joining us.

Morning, Peter. Glad to be here.

And I know before we get into any kind of recap of Q3 or any other comments, I know you need to make a safe harbor statement. So why don't we do that?

Yes. I'm going to -- I'll do that, Peter. And then maybe just a couple of minutes of up-front comments and then we can jump into the Q&A, if that's good with you.

Yes. That's great. Thanks, Toby.

All right. So first, I need to let everyone know that 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. So with that out of the way, I'd like to start with some brief thoughts on how we thought Q3 went, and I'd say it largely went as expected. We delivered sales that were in line with our expectations. We saw commercial aerospace bouncing around what we think is the bottom of the decline. And our defense businesses performed generally as expected in the quarter. Our adjusted EPS came in a little better than we expected, and that was really due to the accelerated delivery of our cost actions and defense strength at Collins and Pratt. It's worth highlighting that those businesses have been executing on their cost actions really well. We also saw a benefit from our cost synergies from the Raytheon merger and the Collins acquisition as well as a lower effective tax rate. And free cash flow came in exceptionally strong. We were very pleased with the acceleration of our cash actions in the quarter. And we also benefited from the timing of some early collections. We still have a lot of work to do, but the results for the quarter reflect our focus on driving cost out of the business, on conserving cash and continuing to position ourselves for the commercial aero recovery. As we move forward, we still see the benefit of our cost actions, both those we had planned for around the merger and also structural cost reductions, which position us as a leaner, more efficient organization headed into the recovery phase. Looking at Q4, we're on track for the Q4 outlook that we provided on our Q3 call. We continue to see a gradual recovery in our commercial aero businesses beginning in the fourth quarter, combined with an expected ramp at both RIS and RMD, contributing to company sales of between $16.2 billion and $16.4 billion for the quarter and adjusted EPS in Q4 of $0.65 to $0.70. And we are very confident we'll achieve $2 billion of full year pro forma free cash flow. So far in the quarter, we continue to see strength in our cost actions and on collections, which points to having flexibility to consider a discretionary pension contribution. All in all, the recovery so far has largely progressed as we expected. And we would expect Q4 to continue with this trend. I also wanted to quickly comment on the news of a vaccine trial data that came out earlier this week. We're encouraged by the progress being made towards a safe and effective vaccine. We remain hopeful that a vaccine will be widely distributed, carving a path towards a return to public confidence and the normalization in air traffic. And then, lastly, I'm sure you saw our announcement yesterday that we will acquire Blue Canyon Technologies. Blue Canyon Technologies is a leading provider of small satellites and spacecraft systems components and will be part of Raytheon Intelligence & Space. This is a relatively small acquisition for us, about $350 million net of tax benefits, but it's strategic and it will enable us to deliver a broader range of solutions to support our customer space missions. We expect the transaction to close early in 2021. So with that, Peter, we can jump into the Q&A.

Terrific. Thanks so much for that, Toby, the recap on Q3 and what you're expecting for Q4. And I probably have a bunch of questions kind of related to that today. But before -- I first want to just touch upon, before the pandemic, we understood kind of the merits of the merger and why you brought the 2 companies together. So I wanted to start with the question on kind of the way your kind of third quarter earnings call ended, one that I think that's on many investors' minds, which is how we should think about the cash flow generation power here at RTX as you exit this recovery? Putting kind of the pandemic aside, is there anything that you've learned since you've closed the merger that changes your views of the underlying financial strength of Raytheon and your ability to achieve kind of those original free cash flow targets?

Yes. No. Sure. And certainly understand why this is top of mind for folks, right? But let me be very clear. Nothing that we've learned since the close of the transaction has changed our view on the cash flow-generating power of the combined businesses over the long term, period, full stop. Before the pandemic, the RTX pro forma business generated about $7 billion of free cash flow in 2019 and we were on track to deliver $8 billion to $9 billion by 2021. So if not for the pandemic, we would be well on our way to achieving those cash flow targets. Now the pandemic obviously shifted the timing to the right. But again, as we all see, we don't have air travel decline by 80% and not see a related or corresponding impact pushing things to the right. But longer term, as we've said, we remain confident in our ability to get back to the levels of cash flow contemplated for the merger when the commercial traffic recovers. And again, that's a when, not an if. Because at the end of the day, air travel will return. Eventually, folks will feel safe to fly again, especially once there's a widely distributed vaccine. And again, as I just commented, the recent developments have been encouraging there. So in the long term, it will come back, we remain confident in that. So in the meantime, as we've talked about, we're trying to focus on what we can control, right, including aggressively taking out costs. We've talked about, and you've seen, the $2 billion of cost and $4 billion of cash-related actions we implemented earlier this year. On top of that, we talked about on our call the new Pratt facility as well as some more structural actions that we have in the pipeline. We're going to continue to prioritize looking at those investments around future growth. Our goal, as we've said, is to come out of the crisis stronger than when we entered it. It will take a little time, yes, for sure. But then again, you talk to 10, 12 different folks, you're going to get 10, 12 different views of when we'll have a widespread vaccine and then when folks will be good with flying again. But as I said, we're confident that when the commercial aero volumes return, our businesses have that same cash-generating power and capability. And all else equal, some of these additional actions we're contemplating here could even improve upon that.

That's great. And I think that really helps clarify kind of the longer-term expectations for investors. It's really positive to hear that you think the underlying fundamentals of the merger and the business are still intact. Maybe focusing on some of the insights you shared most recently on your third quarter earnings call around how you're thinking about free cash flow for 2021. Maybe can you just walk us through some of those moving pieces and possibly any additional color that you want to add to it.

Yes. Sure. Sure. So the items that we talked about, and I'll kind of recap them here and highlighted on our call, were really the known items we had heading into '21. So let me start there, right? And at a high level, first, we had said we'd expect flat operational CapEx as well as flat end-of-year working capital balances from 2020 to 2021. Finally, our all-in CapEx would be about $5 million to $6 million -- $500 million to $600 million higher, which would account for the new structural investments, such as the new Pratt facility and as well as investing in the transformation of our work space around the office of the future. But these are things that will drive the structural reductions we've discussed. The working capital turns will certainly improve as we see volumes come back. But again, we'll look to hold the working capital balances flat. Now kind of switching gears here for a second, right? There's also the continuation of our restructuring- and merger-related cash cost of about $500 million to $600 million, so coincidental to the prior $500 million to $600 million in value. And that's in line with our expectations. Merger costs will continue as we need to invest to achieve the $1 billion of gross cost synergies related to the merger. And restructuring cash continues next year to pay for some of the actions we've announced this year. You can think of -- when you step back from it, you can think of those items from a cash perspective flat year-over-year when compared to the $1.2 billion to $1.4 billion of cash costs that we've talked about this year related to the taxes on the regulatory-related divestitures as well as, again, restructuring and merger costs that we're seeing here in 2020. So really, it's almost effectively a one-for-one replacement that we're looking at here, albeit with the composition being a little bit different for next year. So the other part we talked about here is expecting about $200 million of net year-over-year tailwind from our employee-related cost actions. We talked about a 15,000-person head count reduction. The full annualized run rate savings of that is about $1 billion. But folks need to keep in mind, on a comp basis year-over-year, some of that was and is being realized in 2020. So there is a reduction for that combined with there are some headwinds as we reinstate merit and have fewer furlough days, which all net to the, call it, $200 million benefit. And then on the pension side, year-over-year, we see an incremental contribution headwind of about $850 million. But again, as I said on our Q3 call and mentioned a few minutes ago here today, we'll look to see where cash is coming in for Q4. And so far, so good. Any strength there over and above the $2 billion outlook that we've talked about will give us flexibility to consider prefunding the pension, which, all else equal, would ultimately improve cash flow next year. And then I know the big piece here, and finally, the last piece, which we're not going to provide any quantitative input on until January, is the earnings growth we expect next year, right? And we are well positioned for organic growth across the defense portfolio. And on the commercial side, with Collins and Pratt, our expectation is based upon current trend lines that we'd see improvement in the commercial businesses there, including the aftermarket as things play out.

Yes. No. That leads me right into where I was going to go with the next step because -- thank you for the color on that, on the cash flow. So how are you thinking about -- I guess let's step back on the commercial aero environment kind of the recovery time line. I know you made a comment, I think everyone was pretty excited to see that news on Monday from Pfizer regarding the vaccine. Has that changed your outlook, how you're thinking about the recovery? And what is Raytheon kind of doing in terms of their expected recovery time line?

Yes. So I think that the answer is no, that our overall outlook and view hasn't changed. Obviously, a vaccine is a step in the process. And again, as I mentioned, very encouraging news at the start of this week around the potential for some improvement from Pfizer relative to their efforts. But again, today, we would still expect that it will take until 2023 before the passenger travel levels rebound to pre-COVID levels. And we've also talked about, and after we can go into this a little bit more if you want, a little bit of a lag of 6 to 9 months for air traffic benefits to show up in the aftermarket. So we continue to monitor the overall situation, not just around a vaccine, again, which had a positive step this week. But the health of the airline, customers, what's happening with retirements, aftermarket behavior, et cetera. And to your point, we're focused on what we can control, right? And that's really regarding what we can do to take out costs and conserve cash. So we feel we're doing the right things that are going to position us to come out of the pandemic, ready to capture the upswing on the recovery as volumes start to improve. And again, bottom line, things aren't changing relative to how we see the recovery and we are confident that we will get the benefit of our cost actions, our cash actions and be ready when the air traffic returns.