RTX Corporation (RTX) Earnings Call Transcript & Summary

Good morning, everyone. Welcome back to day 2 of the Barclays Industrial Select Conference. I'm David Strauss, aerospace and defense analyst at Barclays, and we're thrilled to have Raytheon Technologies here today to kick us off. And we have Greg Hayes, CEO of Raytheon Technologies here. And just in terms of housekeeping items. On your screen, you should see audience response questions. We would appreciate if you took the time to fill those out, and we're going to share the results with everyone once the conference is over. So with that, I'm going to turn it over to Greg. He has a couple of minutes of opening remarks, and then we'll get into the Q&A portion of the session. Greg, it's all yours. Thanks.

Thank you, David, and good morning, everyone. It's hard to believe a year ago, we were in Miami doing this, and now here we are all at home sequestered for the duration. Before I get into any comments, and I'll keep them brief, I just want to remind everybody about forward-looking statements and comments about future objectives and performance. These are obviously subject to risks and uncertainties and that could cause actual results to differ greatly. And you should look at our most recently filed 10-K for a description of those risks or uncertainties. And so now the lawyers are happy and we can start. Let me just give 2 seconds on 2020. Obviously, an awful year for the commercial airline industry, but a good year for us in terms of our transformation of the portfolio. We've got Otis and Carrier spun off. We completed the merger last April. And things have actually gone much better than I would have expected considering we have over 100,000 people working remotely across the company today. We ended the year about where we thought, a little bit better on sales, a little bit better on EPS and a lot stronger on cash. So I think that all bodes well. Obviously, a little disappointed on the RIS/RMD side. Our military bookings were not what we thought they would be at the end of the year, but we'll see that come back later this year. So again, really strong. On the defense side, overall, $67 billion of backlog. On the commercial aero side, I would say the team did a pretty good job. They took out over $2 billion of cost, implemented about $4.7 billion of cash conservation methods. And that allowed us to end the year with about $9 billion of cash on the balance sheet, which is good news and will allow us to start share buyback here in the first quarter. On the integration, I think again things going really well. We saw about $240 million of run rate savings on the integration last year. We'll see another $600 million plus this year. That's on top of what we're seeing from the Rockwell Collins synergies, which was about $170 million last year and another $80 million, $85 million plus this year. So we're in a good spot financially, solid balance sheet, solid backlog. And all I can say is I'm looking forward to 2021 being a lot better year than 2020. But with that, David, I'll turn it back to you.

All right. Terrific. So let's talk a little bit about 2021. So what are you -- I mean, there's only so much you can control in this environment. What are your priorities as you think about 2021?

Well, I think, obviously, the first priority that all of us have here is to make sure that everybody that's coming to work, everybody that has to be at work and our essential workers are safe, right? So safety remains the #1 priority. It's almost table stakes in my mind. I would say the corollary to that, of course, is continuing to meet customer demand. And we saw some hiccups last year in the supply chain. Obviously, some challenges in terms of meeting customer demand in the pandemic. But so far, so good in terms of we're able to deliver engines, we've been able to deliver on our contracts and we've been able to effectively work from home. I mentioned integration, that will remain a priority for the year. We can get over $600 million of targeted savings this year. We've got all the programs identified, a lot of work yet to do, but we'll get that done. And then, I think, finally, it's really going to be around what we're going to do with cash, capital redeployment. We talked about on the call about of $1.5 billion of share buyback this year. It's kind of a starting point for us. We'll see where the year goes. Obviously, the stock we still believe is undervalued relative to intrinsic value. So we'll continue down that path. We're still, I would tell you, David, focused on this $18 billion to $20 billion that we committed to originally with the merger. And over the first 4 years of the merger, we're going to get $18 billion to $20 billion back. Share buyback will be a piece. The dividend will be a piece, that's about $3 billion a year. And hopefully, if things go well, we'll continue to increase the dividend as we go through these next few years. But again, those are the kind of the high level. It's about employees, it's about customers and really investing for the future.

I wanted to touch on the cost savings side and integration side of things. So where have you seen -- I guess, touching first on the cost savings side. What exactly have you done? How much do you think is structural? And on the integration side, how much upside potential you see ultimately out of the Raytheon integration? And what this all means in terms of getting the, first of all, the aerospace businesses back to kind of pre-pandemic margins and then also the Raytheon businesses back to kind of pre-merger levels in terms of margins.

Yes. There's lots of pieces in that question, but let me start on the integration piece. When we came together, we merged the 2 businesses. Corporate office was the biggest opportunity from an immediate head count standpoint. And so we've reduced corporate head count in the combined companies with over 600. There's still a few hundred more positions that will come out as we complete some of the integration work. And so most of that first year savings was structural in terms of people going out the door. As you think about the big actions this year, the biggest cost savings is going to be from the curtailment of the legacy defined benefit pension plan at Raytheon, and that will give us roughly $300 million plus of savings this year. And again, that's structural. That's every year going forward. We've eliminated that or sunset it after 2022. So that was good news. We're continuing to take costs out of the corporate office. Again, there's a lot of opportunity there. The biggest opportunity in integration this year is going to be though in supply chain. And if you think about it, we spend about $27 billion a year in supply chain. About $10 billion of that is indirect, another $16 billion, $17 billion is direct. We expect to save about $0.5 billion through integration-related activities, cost reduction in the supply chain this year. And again, that's mostly identified and that's entered into long-term agreements. That's taking the best contract terms from both companies and matching them up and getting the savings. So all of that continues a pace as we had expected. I would tell you the $1 billion is just a placeholder. I would fully expect that we're going to overdrive that as we have with all the other acquisitions and mergers that we've done. And as we get closer to the midpoint of this year, I think we'll have a better feel in terms of how high that number can go. But clearly, there's upside to the $1 billion, and that's why I've always called it kind of $1 billion-plus of savings. In terms of the defense businesses getting back to, let's call it, pre-merger levels, I think you'll start to see that in the back half of this year. Not to get into the cost accounting, but obviously, when we merged the businesses, since UTC was the acquiring company from an accounting standpoint, we had to change all of the EACs and all the contracts at legacy Raytheon and zeroed them all out. And so the good news that we had typically seen every quarter in EAC adjustments at Raytheon, that was all wiped out in purchase accounting. That starts to rebuild once we get past the 1 year anniversary. So starting in the second quarter, you should start to see a natural progression in margins as we start to recognize good news on EACs, again, at the legacy Raytheon businesses. As far as the legacy aero businesses, margins will improve this year. I think what we had said was first quarter, really tough, right, because last year's first quarter was a record for the aero businesses. Once we get past first quarter, you're going to start to see, as we see a recovery in air traffic and in the aftermarket, really good incremental margins. I think decremental margins at Collins are 50%, 55%. We would expect incremental margins to be north of 80% as we move into the back half of this year.

Let's touch on that a little bit more. I guess in terms of Collins, I've been a little bit surprised in the cyclicality of the margins. I guess I would have never thought that Collins would get close to breakeven during this. Obviously, the incremental sound like great news. But what -- I mean, what has driven that cyclicality? I mean is it the Interiors business? Maybe you can give a little bit of color on how the individual -- I think there are 6 individual businesses within Collins: Goodrich and BEAV and so on. How those businesses individually have performed and what you're expecting on the other side?

Yes. I think, David, you hit at it. I mean the biggest impact, obviously, is going to be at Collins is in the aftermarket business. And so if you think about Collins aftermarket, without going into the individual businesses, about 45% of that aftermarket comes from wide-bodies, which has been the most impacted segment of the aero market. Another 40%, 45% comes from narrow-bodies and the rest from business jets. Obviously, we saw a big drop in aftermarket. And we saw it -- and I'll remind you, back in 2019, we had the ADS-B updates, upgrades, which was about, I don't know, over $250 million of margin. That did not repeat last year. So that was obviously a headwind. And that is software, and you know what the margins look like on software. So really bad. So that was -- that came out of the Avionics business. On the Interiors business, really, really devastated last year because that is a wide-body business. And as we saw the aircraft deliveries decline, we saw some of the retrofit business just evaporate. And that is also a highly integrated business in terms of we do all the manufacturing, whether it's in the Philippines or whether it's in North Carolina. And we build all the seats, we install them. There wasn't really opportunity to take out, I would say, the fixed cost in that business. It's not like you're buying things from the supply chain that you can just turn off. And so while we eliminated a large number of our folks in the factories, we still had all of that overhead. So Interiors business, devastated. We expect that, that will start to recover later this year, but that will be the slowest of the Collins businesses to recover. And again, keep in mind that even in the Interiors business, what you do on the OE side, the margins aren't that great. But when you're doing the retrofits, especially premium seating, that is a very, very high value-added work, higher-margin work. And so again, that probably doesn't come back until '23 or '24. Clearly, we'll start to see a resurgence. 737 MAX will come back. We'll start to see a pickup there, top and bottom line. But the business is really -- it was surprising how devastating the loss of the aftermarket is. But when your aftermarket margins are very high and you don't have an ability to take out a lot of the fixed costs, that's why we saw the decrementals there around 50%, 55%.

Let's move on and talk a little bit about the outlook for the aftermarket. So appreciate you gave us a ton of color. I wasn't quite expecting that much color on the call. But I think when you boil it down, you were talking about a 10% sequential recovery in the aftermarket, Q2, Q3, Q4. I guess, first question, how you arrived at that. And then second of all, how do you feel about that today? I mean we're not that far past the call, but maybe what you've seen. I'm tracking flight activity, and we've seen a pretty big drop-off around the world here over the last couple of weeks. So number one, how you arrived at that. And number two, how you're feeling about things today.

Well, there was no magic to the outlook. I would tell you, it's pretty much based on what the IATA forecast was for traffic recovery, for RPM recovery and just more importantly, available seat mile recovery. What's happening right now, of course, is planes are flying, but they're not flying very full. So we don't expect to see an increase in available seat miles until the back half of the year, where you might see an increase in RPMs in the summer season. But we factor all of that in. We've been talking to the airlines about when do we need to see overhaul, when are engines going to come back. We're looking at repair input every day. We're talking to the maintenance folks. And we know the planes are out there flying, and we know that they have to come in for service. We know we're going to start to see some of that free up. The whole thing, of course, is based on vaccine availability. And right now, it looks like the rollout, while not great to start, we've got what, 10% of the population's had their first shot already here in the U.S. And we fully expect that by the summer flying season, June, July, the vaccines will be widely available and people will start to fly again, at least domestically. And that means domestically here, domestically in Western Europe and domestically in China. And so we really -- there's going to -- we've kind of bifurcated the recovery. We've got this domestic piece that we think will recover relatively rapidly starting this year going into '22 and then fully back in '23. And then the widebody piece of this probably not starting to recover until late this year and then into '23 and '24 perhaps before we see a full recovery. But again, it's -- I'm not sure if the timing is exactly right. So we said second quarter, we're going to see a 10%, on top of that another 10% in the third and then another 10% in the fourth quarter. We may be off by a quarter. It's one of the reasons when we gave guidance for the year, we talked about $3.40 to $3.70. It's a pretty wide range for us. But it really -- it all boils down to when does that recovery occur. If it happens as we expect, we'll be towards the top end. If it happens later in the year, we'll be towards the bottom end of the range. But that's -- it's just highly variable, and we're just keeping an eye on it. But look, I feel pretty good about where we are in the U.S. on the vaccine. Obviously, China has had a bit of a resurgence. There have been some lockdowns there that has caused their domestic travel to slow down again. Europe, it's variable, I would say, there. But fully expect again that by June, July, you probably ought to see vaccines widely available around the developed economies.

Switching over to talk about the MAX. Can you just remind us of the importance of that platform to your overall aerospace businesses? And kind of where you are today on the MAX and what exactly you're baking in, in terms of a recovery -- production recovery on the MAX this year?

So I think we said this on the call, but we're fully aligned with Boeing, and we believe I think they've got about 162 aircraft in the build plan for the year. Now because we continue to deliver inventory even last year as the plane production was shut down, we won't expect any revenue bump from MAX production until the back half of the year. We've delivered about 1/3 of the full year inventory on 737. And just remember, that's a roughly $2.5 million of shipset of sales to Collins for every 737 that gets delivered, and margins are pretty good on that as well. So part of this back half recovery will be based on the MAX. But again, don't expect that in the first half. That inventory is all sitting on the shelves up in Washington State.

I wanted to touch on the GTF. So of all the engine platforms I track, the GTF utilization is actually the best out there in terms of what's come back during the recovery. Can you just level set us on where we are with the installed base in terms of the retrofit activity? How much of the fleet is up to kind of the current spec? What else is left to do there? And you started to talk about the GTF aftermarket being a positive. I mean when does that really become a -- become meaningful and really begin to help you out relative to the new engine loss side of things?