RTX Corporation (RTX) Earnings Call Transcript & Summary

Good morning, everyone. We're going to get started with our next session. We have RTX here, Chris Calio, President and COO, incoming CEO, I guess, in May. And with that, I'll turn it over to Chris for some opening remarks, forward-looking statements, and we'll get straight into Q&A.

So good morning, everybody. Dave, thanks for having me. Yes. First, before I get started, just the obligatory comments, but I'm likely to make some forward-looking statements this morning, and those statements are subject to risks and uncertainties. And so please look at our 10-K and SEC filings to get a better sense of those risks and uncertainties. With that, I'll turn it back over to you and you can roll your questions.

All right. Thanks. So you're about, in a couple of months, to step into the CEO role. As you prepare for that, what's your vision for RTX? How will you drive performance and growth from here?

Yes. So when you think about RTX over the last few years, it's really been about the portfolio, obviously creating RTX in April 2020, with a huge merger between UTC and Raytheon. And so we've been obviously very focused on integration and bringing those companies together, in many respects during a difficult period during the pandemic. I would say we feel really good about where the portfolio is today. We feel we've got the right pieces in the right places. If you just think about on both sides of the house, really, really well positioned. Defense franchises that meet the needs of today given the geopolitical uncertainty that's out there, and then well positioned on the fastest-growing commercial platforms, both at Collins and at Pratt. And all of that's culminated into an almost $200 billion backlog, $196 billion by the end of 2023. So I feel really, really good about that. And so now our attention turns to the sort of the near and medium term here, which is executing on that backlog, making sure that we meet the commitments of our customers in terms of on-time delivery, quality, delivering out that backlog at the margins that you and we expect. If you just dig a little bit deeper sort of by business unit, clearly, at Pratt, it's executing on the GTF fleet management plan. I'm sure we'll talk about that a little bit later on powdered metal, but continuing to execute on that within the guidance that we've provided, providing our customers as much lift as we possibly can. On Raytheon, it's about delivering out the backlog at the margins that we said, at improved margins. Obviously, we've had some margin headwind last year. We believe it's only upwards from here. I'll talk a little bit about how we're going to do that. And then at Collins, it's about continuing to drive the incremental margins. And part of that is going to happen through the absorption as the production rates continue to climb, and then part of that is going to be about the structural cost reduction initiatives that we've put into play will continue to take hold and provide benefit. And I think if you look at our investment priorities, they're aligned to those key focus areas that I just talked about. In '23, we did about $10 billion in E&D and CapEx investment, about $7 billion or so in E&D customer and company, $2.5 billion in terms of CapEx. And when you think about where we're deploying that CapEx, it's on things like automating our facilities, continuing to increase capacity in our footprint, so we can continue to meet the demand, and continuing to deploy our CORE Operating System. Again, those are a set of lean tools, it is our business system that we use to continue to drive productivity, efficiency and quality. And then you just think a little bit longer term in terms of creating differentiated technologies, that $7 billion or so that we're investing in E&D. While we've got t goo execute in the near and medium term, this is a long-cycle business. We've got to continue to invest in the long term in terms of advanced capabilities, whether that be advanced materials, electrification, power and thermal management, microelectronics, contested battle space, all of those things that are going to continue to enhance the franchises we have today and build new franchises for tomorrow. So again, a lot of exciting things going on at RTX. I think our priorities are pretty clear. But at the end of the day, we've got a backlog and we've got to go execute on it.

Great. So you talked a little bit about the production ramp on the aero side. Talk about your view of the aero production ramp on the OE side, your view of the aftermarket? And what that looks like for both Collins and Pratt?

Yes. Maybe just step back and talk a little bit about the macro on commercial aerospace. It continues to be very strong. If you just think about we ended the year roughly at 2019 RPK levels, about 5% over versus 2019. On the domestic side, about 5-or-so percent under on, what I would call, long-haul international. So still some work to do there, perhaps some tailwind as that continues to grow. And when you just step back and think of RPKs generally, the way we're modeling this is kind of a 3% to 5% growth annually out through the decade. So continue to believe there's going to be strong demand for the product. If you just think about on the OE side, Airbus, Boeing, what, 14,000 aircrafts in backlog today. Their positions are largely sold out through the decade. They've done a fantastic job driving demand for their product. And we're well positioned on, I think, all those platforms, both Collins and Pratt. If you think about Collins, it has got 2x the content on next-generation platforms as it did on legacy platforms. And when you think of Pratt, obviously, with the GTF, we'll talk about some of the challenges we're working through now, but that program is much larger than we had ever anticipated. I think it will have a much longer run. And so continuing to invest in that architecture and driving the aftermarket will sort of be key to us. And on the aftermarket side, I can say, look, tremendous growth in 2023. I think, overall, it was like 23% year-over-year commercial aftermarket growth on the back, again, of the positions that I just talked about. If you think about 2024, we're thinking about 10% year-over-year commercial aftermarket growth, again, on the back of incredibly strong 23% the year before. So like as we said, we're sort of back to 2019 level. So you start to see that growth moderate a bit, but still, again, very strong 10% year-over-year. And on commercial OE, we're modeling this a 10% to 15% growth year-over-year sort of this year. And if you think of where some of that is coming from, obviously, the GTF deliveries both to our airframers and spares production, about 20% growth year-over-year. And Collins, of course, has a lot of content on Boeing platforms, in particular, 737 MAX. And so we're pretty much calibrated with their guidance in terms of the production environment this year. So again, well positioned, I think, on the fastest-growing platforms that will help us both in terms of OE, and then long aftermarket tails that I think we're going to continue to enjoy.

Supply chain, you've talked a lot about the challenges there, both in your aerospace businesses, but as well as your defense businesses. How much has this kind of held back your growth? And what -- where are the hotspots? What mitigation plans do you have in place to kind of continue to deal with those?

Well, one thing when we talk about a supply chain. We're part of the supply chain.

Yes, you [ are ] the supply chain, too.

I've got a pretty important customer here who would say, like, they need us to step up our performance as far as supply chain. But when I think about our supply chain, in '23, I would say it was a steady progress. Just kind of look across the board, Raytheon had about 8% year-over-year growth in material receipts. We've talked a lot in the past about structural castings at Pratt being an inhibitor, and that growth was about 30% or more year-over-year. Microelectronics was largely sort of out of our way. I think we took some pretty aggressive actions in '21 and '22 to make sure we had the capacity we needed. So those lead times are back, I would say, in the normal space. And then rocket motors. We talked about rocket motors a lot. I would say, towards the end of the year, we start to see sort of a positive trend there. But across all of those value streams that I just talked about, we need continued growth in 2024. I just said we're going to have 20% year-over-year growth on GTF engines, so we're going to need continued growth in structural castings, forgings, the disks. People know that we're ramping up, obviously, the powdered metal production. So again, just from a performance perspective, I think there's more to do there. And if you just look at our 14,000 product suppliers, the large majority of our overdue comes from a fraction of that 14,000. And so we have taken our teams, we've talked about this before, forward deployed them into our supply base, number one, to understand their WIP positions so we have a better sense as to what we can commit to our customers, and in helping them through any engineering issues or quality issues. We're also trying to put more focus on long-term agreements, David. I mean, again, if you look at Pratt and Collins, they're about 80-or-so percent on long-term agreement in their supply chain, Raytheon is much smaller. And so we're trying to take that number up. Again, gives the supply chain visibility into the demand and also gives them the confidence to invest and hire. Now from a cost perspective, I would tell you that it is still a challenge. In 2024, we're projecting about $1.7 billion in inflation. That's about $600 million on the labor front, about $1 billion to $1.1 billion on the product side. So continued headwinds from an inflationary perspective. Some of that is coming from, I would say, pre-pandemic long-term contracts that are rolling off and people wanting to sort of make up a little bit for what they feel like they had to sacrifice during those periods. And so those are ongoing negotiations. Some are suppliers that have significant leverage by virtue of the fact that they're in a very constrained value stream, have unique IP, just have a unique leverage sort of position. And then, again, we're continuing to hold our supply chain as accountable as we possibly can. But sometimes you've got to balance that against the need for continued delivery and material flow. And so we're going to continue to focus on the cost reduction efforts that we've got. Again, there are certain suppliers, given their sort of stature in the value stream, that can get above inflationary-type increases. And so then we've got to control what we can control, which is negotiating where we can, but driving cost reduction throughout our own network, which is again one of the reasons we continue to deploy aggressively our CORE Operating System. The other piece of that equation, of course, this is the pricing, right? We've got to continue to drive pricing to help mitigate a lot of this continued cost pressure that we're seeing in the supply chain. And again, there's only so much that we can do there [indiscernible] we continue to drive that, because I think our customers are getting pricing as well. And then as I said before, about holding the supply chain accountable. Just think about Raytheon last year. We went out and looked at about 70,000 parts [indiscernible]. There's something different we can do here. And ultimately, we're able to resource or dual source about 4,000 of those. So continuing to consolidate with our best-performing suppliers, holding people accountable, also part of the playbook.

Moving over to the GTF, let's take it, I guess, near term and then I'll ask you something longer term. So the last update we heard directly from you on the Q4 call, there was no real update, kind of steady state, other than you talked about the peak AOG kind of leveling out, maybe being a little bit lower. Update us maybe -- update us on the progress there in terms of the ramp-up of this production? How this has progressed like over the last couple of months?

Yes. You may recall, David, that we came out in September and laid out a number of key assumptions and sort of performance metrics that we needed to continue to drive. So overall, I would say, early -- we're still in the early days, obviously, here in Q1, but consistent results with what we had laid out there in terms of our key performance metrics in September. So maybe just to go a little bit deeper there, I would say, we've done a number of inspections, obviously, since that time, both on the GTF and V2500. And those results are consistent with the assumptions that we've been carrying. So that's good. You mentioned peak AOG, the -- [indiscernible] has directed, the AD hasn't -- the final AD has not. Drop [indiscernible] been issued. So that's pushed to the right a little bit. But again, we think some of the airlines -- well, we know some of the airlines have been proactively removing engines, pairing them with other engines to try to mitigate AOGs. But at the end of the day, we think that 350 average still consistent. You mentioned the ramp-up on full life, in metal parts. So today, we are delivering to our airframe customers engines with full life metal parts in accordance with what we had committed to. On the MRO side, we are starting to insert those parts into certain visits, and that's going to ramp throughout the year. And again, it's the powder creation, it's the machining, it's the forging and it's the inspection capacity. Those are the key parts of this value stream as we continue to drive that ramp. And as I said, we're holding serve at this particular time. But that's going to have to continue to ramp throughout the year because we want to insert more and more of these into MRO to try to drive the time on wing. And then the last piece, I guess, would be MRO performance. We've talked about the wing-to-wing turnaround time, that 250 to 300. Again, I would say that remains consistent. If you think about the GTF MRO output last year, it was up about 30% year-over-year, but we need to continue to take that up a notch obviously, given the number of removals. And we're doing all the things that you would expect us to be doing. It's really driving the creation of as many different work scopes as we can. So is there something between a very heavy and a very light that we can bring to bear that will help turn time. Just developing repair capabilities so that you don't always need new parts and have to rely on the supply chain. We developed something like 1,300 GTF repairs in the network last year. And then it's working with our network partners that I would call sort of best practices on turnaround times. As you know, we've got some fantastic partners in our GTF MRO network: MTU, Delta TechOps, Lufthansa and others. And so we share best practices throughout that network to go figure out work scopes, how to take days out of turnaround time, anything we can do to take that 250 to 300 and make it better, to get our customers as much lift as possible. As I said, early days and consistent with what we laid out on our last couple of calls.

Okay. Thinking about the longer term, there are concerns around market share, profitability, particularly around the aftermarket and the long-term service agreements. How do we kind of put all of this that's happening in context of that?

Maybe again, just to step back for a minute, and I alluded to earlier, on the size of the program and the opportunity in front of us. If we think about when you first launched the GTF and the business case that we had associated with it, the volumes today are almost 3x what we had originally anticipated. I think it's going to have a longer run than obviously we thought when the program was launched, and that's great. That means we're going to be able to put more products out there and have a larger installed base and a longer aftermarket run. So if we just step back, feel really good about the prospects on the program and the volumes and where we think we can take it. Obviously, we've got some of these headwinds on powdered metal in front of us right now and in terms of its aftermarket impact. I think we said previously it will cost us about 1 point in terms of GTF aftermarket [ for us ]. But we still believe we can get to teens margins in the GTF aftermarket in that 2025 time frame. And that's on the back of some early entry into service contracts rolling off, that's on the back of continued cost reduction that we've done in our MRO shops, and then, of course, continuing to upgrade the configuration to extend time on wing, right? The longer time on wing, the more shop visits you avoid, the less cost you're putting into those engines. So again, feel good about the trajectory ultimately of the GTF aftermarket as we work through powdered metal, which, of course, it's no small challenge, but if you just think longer term on this program, again, we feel really good about it. You asked about market share. And if you just think about the sales campaigns that we're involved in today, we're out there offering the GTF Advantage. Obviously, when those deliveries come, it's post the Advantage certification. And that will bring additional thrust, additional fuel burn, and all the learnings from what I would call the base program since inception in 2015. We've done a significant amount of testing on the GTF Advantage. And I think our customers understand the benefits that, that can bring. Clearly, they are not happy -- how could they be? -- on the current situation on powdered metal, but as they think sort of forward in terms of their fleet planning, I think they see the benefits of the Advantage. So again, I view that as a positive. I think the market share that we've got today is on or about 40%. We think we can continue to maintain that. And again, I think when you just think about the Advantage and all of that we're putting into it, I think people can see that value. We've got a couple of key milestones here in 2024 on our path to certification. So we do -- we need to continue to see our way through those. But again, feel really good about the engine going forward. And I think one of the questions that people have asked us about, well, hey, do you have to maintain that market share through being really aggressive on pricing? And I think, again, we're selling the Advantage going forward here, the fuel burn, the time on wing, the thrust, and so continue to get pricing. We're not in the early entry phase, the launch phase. And so as these programs continue to age, we continue to get better pricing, I think people see the benefit of the technology we're going to bring.

Great. I wanted to shift over to defense, the other part of your portfolio. You've had some challenges with fixed price development programs. I think the progress is on the Raytheon side since the merger has been kind of slower than expected. I guess, what have you learned from all of this in terms of how you contract? And what's the path to improvement from here for the defense piece of the business?

Yes. Look, I'm sure you're listening to all sort of the defense companies express developments in these sort of 4-letter word. I would say we certainly had our challenges. There's no question about that, and I'll talk about those in a minute. But I don't want folks to think that we are walking away from fixed price development as a general matter. I think we just need to be smarter about it. I think when you think about our headwinds -- Raytheon's headwinds in 2023, profit headwinds, it'd be kind of 2 categories. We talked about this on our earnings call. About 70% of that margin or profit headwind was on fixed-price development contracts. And I would characterize those as us taking on work that not necessarily within our core competency. They were priced to win and with aggressive time lines. And so again, that doesn't -- those contracts only take up about 1% of our backlog. We think those will start to roll off and get sold in the next 12 to 18 months, but we've got some continued work to do to get those behind us. And again, the lessons learned are just as you kind of alluded to in your question, which is we've got to get smarter around our contracting. We don't necessarily need to go and chase work that's outside of our core competency given the demand that's out there today. And again, and I think there's a way -- a disciplined way to go do those contracts with the risks in front of you and the mitigations in the contract. So again, I learned a lot there. I'm sure a lot in the industry have learned over the course of the last couple of years, and we're putting -- bringing those to bear in our contracting process and what we would call our passport process as we evaluate each of these sales campaigns and execute on them. [indiscernible] meetings were 30% in terms of headwinds, I would call that supply chain/inflation. And when you've got on-time delivery issues that ends up extending the period of performance in your contracts, which means you're going to go drive more cost and have potentially negative EACs. And on that one, it kind of goes back to what we were talking about on supply chain. It's -- you got to get a healthier supply chain. And we've talked about the people that we've deployed into our supply chain to help with that, it's getting folks on long-term contracts and getting them back to back with our customers a little bit too often. I think we probably had pricing with our customer and didn't have the supplier locked up and they weren't back-to-back, which kind of leaves you exposed. So again, getting that process more bundled up. And then just overall, kind of working with our customer to have other avenues for adjustment contractually given the inflationary environment. While we've all talked about inflation starting to moderate a bit, it's sticky. And a lot of those prices remain high in our supply chain. We've got to find a way to reflect that in our contractual structure. When I just think about Raytheon, you have to think about the demand for the products, right? The demand is at truly an all-time high. Unfortunately, given the situation we find ourselves in the world, but a $52 billion backlog. So the prospects for the business, the demand, the growth is there. That's the really positive thing. And so for us, it's just about tightening up some of our processes around supply chain, around contracting. And we really believe that we'll continue to drive margins clearly above where they are today. We don't look at the 2025 commitments as the max that that business can do. We think it's got runway beyond that.

So you've talked a lot about your CORE Operating System. I think it has come up for a while. What exactly is that? What have you done in terms of removing costs, improving efficiencies? And how much more runway do you have left with it?

So CORE, customer-oriented results and excellence. It's our business operating system, as I said upfront, it's a set of lean continuous improvement tools that we use in every phase of our business, from the capture phase, to the design phase, to the manufacturing phase, through the aftermarket cycle. We talked before about -- and I think even if you looked at our June Investor Day, that each of our businesses stand up, and talk about examples about where it's being used. If you think about its benefit to us since the merger, we've reduced roughly commodity suppliers by almost 1,300. We've taken out about 16% of footprint in our network. And there's a significant amount of continued opportunity in front of us, David. We've got 25 million hours of assembly tests that we do all across the network. How do we take -- do we take hours and days out of that process? We've got 14,000 product suppliers, as I talked to you about before. So how do we continue to leverage our core resources to make them more efficient. If you go into our shops, where this is particularly alive each and every day, it's about singles and doubles, to use the baseball analogy, right? It's getting a little bit more productive, a little bit more efficient each and every day, and there's sort of a saying that we use, which is "creativity over capital." How do we continue to get better with the resources that we have instead of coming forward saying, hey, we need a new set of tooling or equipment? How do we become more efficient with what we've got using our CORE Operating System to drive that productivity and efficiency? So again, I feel like we've got a lot of runway there. The operating system is really kind of a unification of the ACE system that we had at United Technologies, that we've talked about, and Six Sigma at Raytheon. So a lot of, I would say, overlap. We've taken a best of the best approach and we're driving it hard down into our network. One of the data points that I'll give you is we've got something like 170 or so OE sites across the company, all 3 business units. 60 of those sites combine for -- or account for, I should say, roughly 70% to 75% of our manufacturing hours and our cost. And so we are deploying dedicated teams to those sites, and they all have their own annual productivity sort of plan. But how can you go get another 0.1%, 0.5% better with the CORE Operating System. So again, focusing our resources on those sites that really move the needle for us.

Portfolio and capital allocation, I mean you've -- been a lot of things happening there with the big ASR, a couple of divestitures you've announced that are still pending. So what are the -- as we think about the go forward, what are kind of the next moves? What are your capital allocation priorities from here?

Let's talk portfolio first. Again, as I said upfront, we really like the pieces that we've got today. We think they fit really well. And if you think about our business, a long-cycle business, scale and breadth, truly our competitive advantage. So we like the portfolio. We like the 3 business units and the size that they're in. I feel like we're very complementary from a technology perspective, from a manufacturing perspective. So our focus is not on what I would call big portfolio moves. I feel like we've got the portfolio we need. There's always going to be pruning that we need to do, as you might imagine, David, you referenced a couple of those and divestitures that we're doing. So we're always -- we've always got a portfolio assessment process that's ongoing, whether it be product lines, whether it be sub business units that we're thinking about. Do they fit? Do they have a long aftermarket tail? Do they have differentiated technologies? If not, maybe it's better in somebody else's hands. We'll continue to look for opportunities out there for sort of bolt-on technologies that may be sort of accretive to the portfolio today. We'll be disciplined around that. If you think about the shareholder returns, which I think you alluded to as well, no change to the approach we've taken there. We upped the capital return commitment to $36 billion to $37 billion through 2025, and we're well on our way to satisfying that and no change to the dividend approach. That will grow with profit growth. So I feel like this business can generate significant cash that we can continue to reinvest in the business, in technology, to continue to build franchises for the future.

Great. So with that, can we pull up the audience response system?

It's really comfortable for those of us up here, going through this process.

The hot seat.

Yes, it's great.

Real-time feedback.

I see that as runway.

Next question, please. Okay, I think we have -- is there one more, one or two more? Run through these quickly. Multiple. [indiscernible]. All right. Chris, thank you very much.

David, thank you. Yes, I appreciate the time.