RTX Corporation (RTX) Earnings Call Transcript & Summary

I'm an airlines analyst here at UBS. We're continuing next with Raytheon Technologies. And we're very lucky to have with us Neil Mitchill, the company's CFO. Prior to being named CFO, earlier this year, he served as the corporate VP of FP&A as well as IR. He is also the CFO of Pratt & Whitney prior to being CFO during the transition or just before the transition of Raytheon's merger with United Technologies. So Neil, welcome. Thanks so much for joining us. I think you have some initial comments, and then we'll get right to Q&A after that.

Great. Thank you, Myles. Thank you so much, and good morning, everyone. Let me start out first, as we always do, with some legal disclosures. So today's presentation and discussion may contain some forward-looking statements, such as comments on our 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 okay. With that out of the way, Myles, let me start out with a couple of comments, first, on our Q1 results and our outlook for the year and then hit on a few key points from our recent Investor Day before we get to Q&A. We're pleased with our first quarter performance as you've heard me talk about already. It exceeded our expectations despite the difficult year-over-year compares. We did see momentum building across our businesses during the first quarter, and that does continue. So no change for our full year outlook today, but our Q1 performance did give us the confidence to raise both the low end of our sales and our earnings per share outlook... [Technical Difficulty]

Sorry, Theresa, are you there? I think we may have encountered some technical difficulties. So we're just trying to get Neil back on the line. Those on the webcast, we are trying to get Neil reconnected. So if you can just hang tight. We should have them back in a minute. This is why I should be equipped with COVID jokes. So to those on the webcast, we are trying to reconnect Neil from Raytheon Technologies. Thanks for your patience. Again on the webcast, looks like Raytheon Technologies is dialing in. So please bear with us. I'll use the opportunity to advertise a couple of sessions. We've got one today at noon, which is a panel session with the Elaine Chao, the former Secretary of Labor and Transportation, should be a good opportunity to hear about infrastructure bill and maybe some of the emergent technologies in aerospace that maybe have a way in the future. And then tomorrow, we have an ESG panel on aerospace defense, and that should be a good opportunity to hear about how changes in administration as it relates to climate security might impact the aerospace defense industry. That's at 11:00 tomorrow. Thanks for bearing with us. We are trying to reconnect. So please stand by.

Hello?

Neil, we can hear you.

Is that you, Myles?

We can definitely hear you, if you can hear me.

Yes. Sorry. I'm not sure. Where did I leave off?

Yes. You were actually -- you left right at the first quarter comment, coming out of what was a strong first quarter.

So I didn't get very far, did I?

You did not get very far. But if you can pick up there, I think that will be great. And we'll still make this work in a COVID world.

All right. All right. I think I've got 2 microphones.

Speak one more time, Neil.

Can you hear me?

Perfect. Yes. You're good now.

I think you lost my video. But...

No, that's okay.

We'll try another day. All right. So I'm sorry about that.

No worries.

Welcome to COVID. So let's see. So let me backtrack. I'm sorry. So again, we were pleased with our first quarter performance. That exceeded our expectations despite the difficult year-over-year compares. We did see momentum building across the businesses in the first quarter, and that does continue. No change to our full year outlook today, Myles, but our Q1 performance, as you know, gave us the confidence to raise both the low end of our sales and adjusted earnings per share outlook for the year back in April. So our sales guidance for the year remains now at $63.9 billion to $65.4 billion or up 1% to 3% organic growth year-over-year. And earnings per share is in the range of $3.50 to $3.70 for the year. I continue to expect approximately $4.5 billion of free cash flow for the full year. So again, no change to the full year financial outlook today. But we do still feel very confident in the full year outlook, and we'll continue to monitor that as we wrap up the second quarter in 4 to 6 weeks here or so. So with that, let me summarize a couple of key points from our recent Investor Day. As you know, we have a balanced portfolio of businesses at RTX, brought together by the merger of UTC and Raytheon about a year ago. And our portfolio transformation is essentially complete. We've got 4 leading industry-leading businesses with RIS, RMD, Collins and Pratt. Each of those would be a top 10 A&D business on their own. And we're confident in the future of our business because of the resiliency of the end markets. We believe we're well positioned for growth and focused on operational transformation as we move forward now. And just quickly on the defense side, we expect global defense spending to be slow but steady. But we expect higher growth in the markets where we have a competitive advantage. As you know, we recently got a first look at the U.S. Department of Defense fiscal year '22 budget. And I'm sure we'll talk about that more in a few minutes. On the commercial side, we expect robust growth as the industry continues to recover. We are encouraged by the recent uptick in travel in the U.S. over the holiday weekend. And we continue to monitor international markets, which are lagging a bit. But as expected, we won't likely see that international markets recover until the end of 2023. But the good news is that once that traffic does fully recover to 2019 levels, we do expect to see air traffic continue to grow at about a 5% CAGR as it has done historically prepandemic. We also continue to see opportunities for us to drive continuous innovation across all the markets to accelerate growth in the 4 key areas that we discussed in our Investor Day. We continue to invest about $6 billion a year in the combination of company-funded research and development and CapEx between 2022 and 2025, and that's in addition to nearly $5 billion of customer-funded R&D annually over the same period. We talked a great deal about the other day, revenue synergies. We're investing in those technologies that will enable significant revenue synergies. To date, we've already identified a pipeline of over 300 actionable projects that are worth over $10 billion in incremental revenue, and we believe there's more to come there. As I mentioned, our portfolio transformation essentially is complete. So we're now putting a lot of focus on our operational transformation. We took out over $2 billion of cost last year. Still have plenty of opportunity, I believe, in front of us as we execute on over $5 billion of gross cost reduction initiatives going forward. We'll be relentless in the cost reduction efforts to attack high-cost footprints. These additional cost reduction opportunities will be enabled by our new core operating system that we talked about a couple of weeks ago. This will drive further productivity in our factories, our supply chain and in the back office. And as always, we continue to evaluate the portfolio and the businesses that we own for strategic fit. Well, nothing to say today. We'll continue to evaluate those businesses, and there's a few things we continue to look at. In summary, we're continuing to invest in -- to drive long-term, sustainable sales growth across our portfolio. We expect a robust 6% to 7% 5-year sales CAGR from 2020 through 2025. We expect substantial margin expansion of 550 to 650 basis points over that same period, driven principally by the commercial aero recovery and our focus on cost reduction and defense program execution. And all that should translate to robust free cash flow growth. And by 2025, we expect free cash flow to be over $10 billion. Of course, we'll continue to return cash to shareowners. We've said we will return at least $20 billion to shareowners in the first year -- 4 years following the merger. And we're well on our way to doing that. And lastly, I'm confident that we have the right team in place and the right franchises across our businesses to deliver these results for shareholders over the next several years. So with that, Myles, let me turn it back to you finally for Q&A.

All right. All right, Neil. Well, thanks for being a trooper and getting through the technical issues, first off. Let's start with the defense budget. It did come out in the last couple of weeks. Obviously, about half of your business is currently in the defense arena. How do the assumptions play out versus the reality of the proposal? Are there any puts and takes you'd want to make us aware of?

Yes. So overall, I would say, Myles, we weren't too surprised with the Department of Defense budget request. As we said sort of back in our Investor Day, we expected relatively stable defense spending growth. We saw, what, 1.6% on the top line budget. I think it's important to look at the modernization accounts. Those have the most impact on our business. And I would say the administration held that modernization funding relatively flat, was down about 1 point compared to fiscal '21 levels that were ultimately enacted by Congress. But still, I'd say those accounts are still at historically high levels. And they were even slightly higher than where we had expected from the prior administration's plan for fiscal '22. So no major surprises. There were some puts and takes as you kind of pointed out between the RDT&E account, which was up 5%, and the procurement account, which was down 6%. That said, we believe that the healthy increase in research and development funding does reflect what we've been saying, which is that the administration remains focused on the evolving threat environment. And we believe that, as we talked about a few weeks ago, we're well positioned to provide the products, services, solutions, technology, et cetera, to address those threats that the world and the U.S. see going forward, and we should be able to outperform the top line budget growth rates. So what I would say, Myles, too, is don't forget, we've got a pretty sizable international component to our defense businesses. About 40% of our backlog is international. And so that, that combined with our $65 billion backlog, I think, puts us in a pretty good place.

So sticking to the high level and sort of the incremental news since the Investor Day, Airbus also came out more explicit with what their rate plans are. And so a framing question, what are your thoughts around the OE rates that you're looking to support through your 2025 plan? And vis-à-vis the plan you laid out at Investor Day, how are the rates that Airbus talked about align with your own assumptions?

So good question. We all saw what Airbus said the other day. And here's what I would say. We've been saying all along that we expect the single aisle, narrow-body market to lead the recovery on the OE side. And we believe that too. I'd say Airbus' announcement is another vote of confidence in the narrow-body recovery. When I think about how we're positioned, we've said frequently that we're capitalized for rate 63 thereabouts, as that had been our plan even prior to the pandemic. We were keen to not cut our factory capacity and volumes during the pandemic because we knew that demand will come back. I'm not going to get into specifics today about where we see our ultimate ability to produce. But we're continuing to discuss rates with Airbus and the other OEMs as well. But I would say that our Investor Day assumed rates in the range of rate 63 as you get into 2025, in that period.

Great. So maybe at aerospace aftermarket, which is -- and you alluded to, it was strengthening through the quarter. And I think you mentioned that it was continuing to strengthen here in the second quarter. Maybe just give us some color as to your thoughts as it relates to that for the current period and the remainder of the year.

Sure. So we're watching the recovery like everybody on a week-to-week basis, day-to-day, I guess. But overall, I would say, our view on the recovery continues to track with our expectations. Certainly encouraged by what we're seeing in terms of domestic travel, both from the U.S. and even in some parts around the world. As you know, U.S. departures are only down about 15% versus prepandemic levels. So that's encouraging. China is down about 19%, 20%. That's ebbed and flowed a little bit as well. But generally, good improvement. So I think we're feeling good about that, the vaccine, making good progress there, certainly in developed countries, with still some work to do internationally. So we continue to watch it. But as I think about what that means for our outlook, I feel good about the second quarter. And the sales, EPS and cash ranges we put out there, we said sales would be between $15.5 billion and $16 billion, EPS between $0.90 and $0.95, and free cash flow, about twice what we saw in the first quarter. I would say that April and May, we've seen good trends, continuing trends on the commercial aftermarket. Still got a month ago, so I don't want to get ahead of myself here. But still feel good about where we were talking about just a few months ago. For the full year, again, as I said earlier, still feel good about sales, EPS and achieving about $4.5 billion of free cash flow. We'll come back in July and give another outlook for the rest of the year once we see how the second quarter closes out, which is an important quarter for us, obviously.

Yes. Yes. No. And as you look at the -- across the spectrum guidance for the year, is the aftermarket the biggest swing item that you have in there as you look at it one way or the other to the upside or to be in the range?

It really is, Myles, because as you know, we're monitoring the customer behavior here. What this really comes down to is we had a pretty good first quarter, some good green shoots as the airlines prepare for the summer travel season. And we are watching to make sure we understand whether that's a short-term trend that will have some ebbs and flows to it or it will remain kind of persistent through the rest of the year. And if it remains persistent, then you should expect us to be performing at the higher end of our ranges, for sure. So that's where we are. I think after we get through another month here and we have a good look at bookings for the summer both here and in Europe, in particular, that I think we'll have a better sense for what the rest of the year might look like. But that's the key variable.

Okay. And you had already mentioned it, but I wanted to delve a little bit further into it. The $10 billion target of free cash flow you have for 2025. You laid out in the Investor Day some elements of the walk from 2020 to 2025. But there's still a couple of questions that maybe you can add some clarity to. In absolute terms, how much is working capital portion of that? Or maybe put it in context of going through the walk to get from sort of where you are to where you want to go?

Sure. Yes. So let me give you a few numbers. What I'll do is I'll build off of 2020 the $2.3 billion of free cash flow that we generated in 2020 on a pro forma basis. So the majority of the growth between 2020 and 2025 will come from robust operating profit growth across all of our businesses. But about 80% of that growth will come from our commercial businesses. So that's about $7.3 billion or so. I put out a multiyear chart on the pension key metrics. We'll have about $450 million of pension headwind over that period. And then I mentioned but did not quantify, I'll put a number around it, some lower corporate costs offset by, obviously, higher taxes on the higher operating profit. That will generate a net benefit of about $200 million between 2020 and 2025. And the rest, so call it, what, $650 million or so would come from working capital. And I talked about working capital principally improving in the area of inventory. And I think it's Collins and Pratt, where we have the best opportunity to improve our turns. One of the benefits, I think, of having gone through a ramp prepandemic and now we'll be going through a ramp again is we have a good understanding of where the supply chain is, we should be more targeted in where we have to build buffer inventory, and I think that remains a significant opportunity for us to generate some cash flow over the next several years here.

And then just to sort of drill that one a little bit. The 2020 baseline working capital, was it largely neutral? I know the beginning of the year you thought it would be a headwind, but I think by the end of the year, it is largely neutral. And then the one-off costs that were in 2020, I imagine are in that corporate and working capital bucket as well. Is that the way to think about it?

That's true. Exactly. Yes. We -- that's apples-to-apples comparison, if you will, on the $2.3 billion to $10 billion. Yes.

Okay. Great. And then you raised at the Investor Day the target for capital return to shareholders, $18 billion to $20 billion, now above $20 billion in the first 4 years. Does that contemplate the divestiture of the training and logistics business? And also what happens after 2023 and 2024 and 2025 in terms of capital deployment strategies?

Yes. So we haven't kind of parsed up the cash balance to exclude any proceeds. But I haven't contemplated any major proceeds from the disposition of businesses and our capital deployment ranges at this time. So we'll have to cross that bridge when we get to it. But we do feel very confident that we can get to at least $20 billion of capital return to shareowners over the next several years now. As I've talked about, $12 billion of that will come from dividends, $8 billion from share repurchase. So I feel very confident in those numbers now as we look at the shape of the recovery. Going beyond that, I think, as I said the other day, we've got plenty of optionality. First, our priority is going to be to continue investing in the growth and innovation for the business, that $6 billion that I talked about. So this free cash flow that we get in 2024 and 2025 is all ready, after having invested significantly in the business, and I think that's important. This will give us the flexibility to continue returning cash in the form of dividends, share buyback and potentially bolt-on M&A or debt repayment, wherever we best think that cash is deployed at the time.

Okay. The area that I got a lot of questions on after your Investor Day was around profitability targets, particularly at Pratt. And maybe just focus a bit of the attention there as it relates to the -- obviously, you'll have a big rebound in margins. But that 2025 margin is still constrained, I think, to a large extent, by mix as well as negative engine margin. So maybe lay out some of the headwinds that still exist during that period of time and maybe a little bit more detail on fleshing out the margins and where they're heading at Pratt.

Sure. Yes. So we'll continue to see margin expansion at Pratt, not to the levels we were expecting prepandemic, but we're not at peak Pratt margins in 2025, nor are we for Collins for that matter. But as I think about Pratt, the key drivers of what will drive that expansion is going to be the commercial aftermarket recovery. That will be the biggest part of what we'll see drive margin expansion there, largely on the back of V2500 shop visit activity. Chris Calio talked the other day about shop visits increasing by about 50% from where we expect them to be this year in 2021. So it put you in the range of about 800 or so V2500 shop visits. That's obviously a bit lower than what we were thinking prepandemic. We were thinking about 1,000 shop visits in that time period. I'd say that's what's one of the things that's causing the margin to be a little lower than we had previously expected. But that said, we are working to get those V2500 shop visits back to 1,000 over time. We're encouraged by the cargo. We think that the demand for the wide-body engines, the PW2000s and 4000s will remain a bit stronger. We're working with operators now to extend time on wing there. So that should continue to contribute. And GTF is a bit of a -- obviously, negative engine margin will be a headwind. Chris talked about it peaking in the middle of the decade, 2025 period, again, as volumes continue to ramp back up. And the GTF aftermarket will also increase as we get into those 2025 period. But it will be at a lower margin than our V2500 fleet, principally because these are the first shop visits. We'll still be doing combustor retrofits during that time period. Those will come with some lower margins attached to launch customer contracts and the like, but that should improve as you get to the second half of the decade.

Okay. Okay. And then the 750 or 800 shop visits versus the 1,000, is that a reflection of retirement trends that happened through the crisis? Is it a reflection of management of green time that's going on at the airlines? How would you sort of explain the slightly lower outlook there?

Yes. I think it's a little of both. We certainly have seen airlines manage the green time on aircraft during the last 14, 15 months. And so that is playing into the equation, for sure. We are estimating slightly higher retirements over the period than we were before the pandemic. The good news is the GTF power and aircraft are flying quite a bit even through the pandemic. And so we think that the GTF is the architecture of the future, and we'll be expecting to ship many more of those over the coming years. But we do expect a little bit of retirement activity. I think the jury is still out on how that retirement, those retirements actually play out, Myles. Recall, these are pretty young airplanes. They're 12, 13 years old on average. I think they've got a lot of life left in them. They may switch hands between airlines, but I think that they'll continue to fly. So we'll love to see that could be some upside. But right now, we've taken the posture that some of those will get retired and replaced with newer aircraft.

Okay. And realizing the volume in '25 of GTFs is significantly higher than it was in 2019. But how does the cumulative negative margin relate to that, I guess, $1.2 billion that you all had talked about as being sort of the level of the 2018, 2019 period? How much higher is it?

Yes, it could get a little higher, not much. So I think that is about where we would peak out. Of course, if the volume increases, that will come with more negative engine margin. I always like to think about negative engine margin as an investment. Now it goes through the P&L. But each aircraft that we put out there, it's positive NPV. It's got a highly assured aftermarket stream. So I think it's, net-net, a good thing for us. But we do expect that NEM to creep back up. And with it will come, obviously, the aftermarket. From the existing fleet, there's plenty of engines out there. There's a lot of lease pool engines that we've got to get overhauled as well. But net-net, I think it's all good news for us.

And it does sound like the GTF at this point, the crisis for all the bad actually allowed you to resolve a lot of the in-flight issues and reliability and durability issues, at least to a point where it's really carried, I think, some of the customer relationships. And given how active it's been, the fleet does seem like, at a minimum, it's been an opportunity for Pratt to resolve some of those items that are outstanding.

Yes, you're right. We were really able to take advantage of shop visit activity that was down last year to bring in GTFs and overhaul. I'd say we're nearly 99% complete with retrofitting a couple of the issues that we were facing. We still have an option to upgrade the combustor. We'll do that over the next several years. That will improve time on wing as well. But the engine is performing great, dispatch reliability of 99.97% between the A320, A220 and Embraer models. We've got over 9 million hours of time on these engines. So we're in a good place. We're able to capitalize on the downtime last year. And I think it's positioned our customers in a better place today than they were prepandemic, for sure.

And Collins, the margins there getting to 20%. Curious, could you lay out maybe the dispersion chart in words of how different the profitability is within Collins Aerospace of the businesses? Is there significant dispersion? Is there a high concentration around profit levels? And then maybe in the context of portfolio shaping, after you're through a few years of seasoning, is that an area where, going forward, portfolio shaping might be more active than not?

Sure. So as Steve laid out a couple of weeks ago, Collins is a very large business. It's got over 150 major product lines, very comprehensive product offerings. They've been very successful. And as I think about the businesses, some of the businesses have margins that are well above the 20%, and some are below. But when we look at the portfolio, on balance, they're all very good businesses. I think they complement the suite of products and services that we offer across the platforms. But as you think about it, Avionics and Aerostructures, really strong businesses. Some of our other businesses don't have quite the aftermarket or have more build-to-print type margins. We'll continue to work on those businesses to get the margins up. I'm not going to get into whether we do anything with them at this point. But clearly, great businesses. But yes, a dispersion of margins clearly across the portfolio. I think a couple of other things to point out, Myles, about Collins, we've certainly got a fair amount of military content there. 2020 sales were about 60% commercial, 40% military, the commercial being about split evenly between OE and aftermarket. We've continued to invest a lot of money in new programs and platforms. I think that's what makes Collins a great business that we don't need to wait for the next platform, launch to win the new business. We can invest in upgrades and put retrofits in. You saw that with the success of the ADS-B software update. So it is a very good business, very diverse. I think lastly, I would say, a lot of our Collins products, we manufacture in-house. So last year, we did realize some significant underabsorption. But when that volume comes back, which we're confident that it will, we'll be prepared to deliver on that, and we should get better absorption, and you'll see that in the incremental margins going forward.

Well, I know we encountered a bit of a technical difficulty. But I did have one more question, if I could. And I guess it's -- across the portfolio, you've gone through a crisis. You've taken out an enormous amount of structural -- an enormous amount of cost, some of that being structural. And you laid out the moving pieces of that in the 2025 outlook. But how much more opportunity is there as you go forward from a -- not built into that 2025 plan? Or is the 2025 plan building in more or less the, I would say, best case outcome? But how conservative or aggressive or realistic would you characterize the different elements of the 2025 vision you laid out?

Listen, we're never satisfied with the takeout of cost. So we'll continue to do more and generate more ideas. I would say, we believe our 2025 outlook is robust. It's -- I wouldn't call it aggressive. But I think that it is something that we think is achievable, but it has some stretch in it. That said, we're aligned organizationally to go drive more cost out of the business. I think we will have the opportunity to do that over the next several years. Especially as volume picks up, we'll leverage our core operating system. But I think right now, we'll continue to do cost takeout, look at those high cost factories. That's where there's a big opportunity, I think, is in the footprint area as we move forward, and we'll keep working on synergies. We've been very, very happy with what we've seen with the Raytheon and UTC merger synergies. I expect that we've got more to do there as well. So we're not done yet.

Okay. Well, great. Well, thanks so much for joining us, Neil. Apologies for the technical difficulties. But I appreciate you, as always, being with us here at our conference.

Thanks, Myles. My pleasure. Talk to you soon.

Take care.

Thanks. Bye.