RTX Corporation (RTX) Earnings Call Transcript & Summary

Great, everyone. Let's get started. Good morning. I'm Kristine Liwag, Morgan Stanley's Aerospace and Defense analyst. I'm very excited to have our next panelist up on stage Chris Calio, President and CEO of RTX. Thanks, Chris. So before we begin, standard disclosure that you'll memorize at the end of day 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 representative. And you know, I think, Chris, you've got your own disclosures.

Yes. I've got my own that I've got to do. Thank you. Excuse me, I'll just say, obviously, I'll probably be making some forward-looking statements today, and there's some risk and uncertainty associated with that and please consult our SEC filings to learn more about that. And then maybe just to get us rolling, Kristine, here, and then I'll sit through your interrogation here, right, what we feel really good about the performance in the first half of the year, feel really good about the performance across all of our 3 business units and the trajectory that they're on. We're still tracking to the full year guidance that we've outlined for the year. So we feel good about that. And then the story for RTX is really one of demand. Demand on the commercial aerospace side and tremendous demand on the defense side, given the environment out there today. And so our focus each and every day is on executing on that demand. We've $206 billion backlog, again, healthy on both the commercial and defense side, and we are focused on executing that for our customers at the cost, at the quality and on time. That's where our focus is as a management team.

Great, great to know that there's no change to the financial outlook for the year. So maybe, Chris, lately, you've talked about your strategic priorities now that you're CEO of the company. Can you talk more about this and other focus areas you've been spending your time on.

Sure. On the Q2 call, I outlined kind of the 3 key priorities that each and every day we wake up focused on. One is it kind of builds off of what I just said at the opening, executing on our commitments, okay? I mentioned the $206 billion backlog. Our products are in demand, both on the commercial and the defense side. So for us, what does that mean? It's focusing on our core operating system, our operating system that has the lean and continuous improvement tools, making sure that we're improving quality, delivery and the like. Working on our supply chain. Again, supply chain, everyone has been talking about supply chain. We continue to see steady progress there, Kristine, but we're not necessarily where we need to be. But we're seeing quarter-over-quarter improvement and need to keep the focus there. And then capacity. We've got to continue to build capacity to meet the ramp. We've talked at length about the capacity we've put in on the GTF MRO network, and I'm sure we'll talk about that later. But also on the defense side, we've made investments in Camden, Arkansas, in Alabama on the Raytheon side in Spokane for the carbon wheel and brake business. So again, continuing to build the capacity needed to meet that. Second priority would be innovating for future growth. As you all know, we are in a long cycle on both sides of the business. And if you're not continuously investing, you may miss a cycle. And if you miss a cycle in these businesses, you get shut out of some very lucrative business for decades. This year alone, we're going to invest about $7.5 billion in terms of customer and company-funded E&D. We've got 14 cross-technology road maps that have specific funding levels, TRL, technology readiness level goals. When do we need those to be ready for the next-generation platforms. In addition to just the technology development, the investment in innovation in how we design our products and how we build our products. We've talked at length about our connected factory initiative. There's so much data coming off our equipment. We need to continue to understand where we have issues, making sure that we increase equipment uptime. We've connected 26 factories year-to-date, be at 40 by the end of the year. So innovating not only in terms of the product portfolio, but also the factory and our digital footprint. And then lastly, it's continuing to leverage the scale and breadth of RTX. And so what does that mean? When RTX came together in 2020, it was now a pure-play focused aerospace and defense company. We have significant synergies, both cost and technology. And so how do we continue to realize those? There are plenty of opportunities for us. I think I've mentioned one recently. If you just look at our procurement spend, about 35% of our procurement spend is common amongst all 3 business units. So how do we go better leverage that, for instance? And how do we make sure that the technology road map that I just talked about, which is relevant to all 3 business units is being executed in a way until we make sure that we share technology from one business to another to offer our customers the best products. And so it's both on the technology side, but also on the cost side, interrogating all of our cost pools today, where can we do things more centrally as opposed to in each of the business units to drive better cost and better performance.

Thanks, Chris. And maybe digging deeper into the innovation and technology that you highlighted. Can you talk more about what's happening in the next gen propulsion activity? You've had some demonstrator activity and what's going on there and also the GTF advantage? Any color on these programs would be helpful.

Yes. Next-gen propulsion, like we talk about 3 particular areas, Kristine. On the commercial side, we've got the hybrid electric demonstrator that's a collaboration between Collins and Pratt. That continues to show the benefits of hybrid electric, and we see that initially penetrating what we would call like a smaller aircraft segment in more of that Pratt Canada level segment, but ultimately maybe translating into next-gen single-aisle maybe as a hybrid assist or at some corner points. So we continue to invest in that collaboration. You mentioned GTF advantage. Of course, we're going through the development and certification process right now. At the end of the day, that's going to get 4% more for us and another 1% in terms of fuel efficiency. But what -- I will tell you what really, really focused is on the durability of that engine coming out of the box. We have learned our lesson from the prior iterations of the GTF. We want to make sure when this engine comes into service, the time on wing, the LLP life, all the things that the airlines want to see and that we want to see in terms of the financial returns are there. And then I would say on the military side, it's the engine core upgrade on the F135, right, which is all about continuing to keep the F35 relevant as it moves into the high-end fight. We've gotten through the initial preliminary design, had done very well, very good customer feedback. So that program continues on its way, again, keeping the F135 on the F-35 platform well into the future.

Thanks, Chris. And you kicked off your remarks with the demand picture. But let's dig a little deeper to the macro backdrop. Can you talk about what you're seeing in aerospace and the defense end markets? What are the key drivers of growth and key items to watch?

Sure. Why don't I start on the commercial side, Kristine. Okay. So let's talk about OE rates maybe a little more near term. Obviously, the demand is there. I think you think if you look at the Airbus and Boeing backlogs today, like 14,000 aircraft, the demand is there. We are still like many in the industry calibrating with Boeing on what the rates are for '25 and beyond. Obviously, we've got a lot of capacity above and beyond what those rates are today. So it's making sure they were calibrated to where that's going and that we've got the right level of inventory to support that. And we're also now bringing in excess inventory. I would say on the Airbus and Embraer side, mostly because of Pratt aligning on -- continuing to aligning on the allocation between installs to Airbus and the Airframers and Embraer and the support that we need for the fleet given the GTF fleet management program. So that's for spare engines and material for MRO, but if you just step back a little bit longer term on OE there's going to be continued demand. I mean we see 3% to 5% annual RPK growth. If you look at the reports that have come out from the Airframers, you're going to need upwards of 40,000 new aircraft over the next 20 years. So the demand is there. We believe we've got the products to continue to fill that demand. Commercial aftermarket, obviously, a big driver of our profit, a big driver of our 2025 cash plan, I would say, continues to be strong. There's been some gaudy numbers out there the last few years, right? I think we had 23% year-over-year growth last year, 11% in the first quarter, 14% in the second quarter, and that's going to start to normalize a bit as the compares get tougher. But the demand is still there. And if you just step back and look at the underlying fundamentals of our commercial aftermarket, they're really, really strong. Take Collins. Collins has $100 billion worth of its installed base that's out of it's warranty period. Take a look at Pratt & Whitney, Canada, which we truly believe is the premier small engine franchise in the industry. They've got about 68,000 engines in service. About 90% of those are out of their initial warranty period. And then, of course, if you look at Pratt, everyone knows the GTF, but the V2500 continues to be a very strong platform for us and for our customers. About 20% of that fleet hasn't yet had its first shop visit and about 60% of that fleet hasn't had its second shop visit. So just a lot of aftermarket tailwind associated with those programs, so very, very strong. On the defense side, okay. I think everyone understands the global demand picture and how strong it is. And our products are absolutely pivotal to the U.S. and our allies. I'll just give you a statistic to sort of bring this home. If you think about the April 13 attack on Israel, 86% of the UAVs and the cruise missiles that were intercepted during that were intercepted using Raytheon products and effectors. So the Raytheon product portfolio is essential to the U.S. and our allies. If you look at where that spending is going to continue to come from, Kristine, obviously, we've got replenishment from the U.S. and our allies. You're seeing NATO clearly start to get up to those 2% commitments more across the board than they ever have been. You're seeing the Middle East region continue to spend in INDOPACOM, think of Japan, Australia, South Korea. So the demand just because of the global picture and the threat environment, continues to grow there. If you just think about Raytheon in the third quarter. Thus far in the third quarter, we've got about $8 billion of bookings and if you go break that down, it's very clear that people need integrated care in missile defense. That is the key to a lot of what's happening out there today. And Raytheon is supremely positioned in that area and think about Patriot, NASAMS, GEM-T, MRAM, Coyote, counter UAS, which continues to grow in prevalence given the threat environment. So very, very strong demand there. I'd also say on the Raytheon front, they've got a number of what we would consider to be future franchises in the pipeline, think LTAMDS, which is the next-gen Patriot radar, which has 360-degree sensing capability. We're going to continue to make enhancements to existing platforms and do tech refreshes to add capability to respond to some of the threats that we're seeing out there that we've seen in the Ukraine complex. So think MRAM, we're going to continue to add capability to Coyote, the counter UAS because we continue to learn more in the field. And also say hypersonics, our HACM program, continuing to invest in there to extend our leadership in hypersonics. So a fantastic installed base that I would say meets at the moment today, but also franchise programs in the pipeline that are geared towards those advance threats.

And so Chris, just wrapping up on defense. It sounds like you've got solid activity with $8 billion of orders in the quarter, but you've also got visibility into additional programs that would create a positive inflection point, is that fair?

Yes. As I said, just think of -- I'll pick on LTAMDS again, the 360-degree sensing capability is something that is going to be a huge enabler for the U.S. and our allies, right? And that's just starting to come into production. And there are some other programs, LRSO, long strike, that's also going to start coming out of development into production. These are the next-generation advanced capabilities. Again, this is a long-cycle business as a said upfront. We've got to continue to invest so that you're ready to meet the needs of the market and Raytheon's done that.

Great. So maybe pivoting to Collins Aerospace. You had recently a change in leadership. How should we take that into context? Do you expect to see a change in strategy as well? And then also for Collins, you've got pretty good profit year-to-date so far, and cost reduction of the key initiative in terms of getting higher earnings power in the future. Can you talk about additional levers for Collins Aerospace going forward?

Yes. I would say no change in overall approach to Collins. Again, as I said upfront pleased with a great start to the year, about 9% organic sales growth and another 150 basis points of margin expansion. So off to a very, very good start. When we talk about Collins. You have to start with its product positioning and the investments they've made. They have 2x the content on the new generation platforms versus the older platforms. And that translates into, obviously, strong OE growth but also that continued aftermarket growth that I mentioned upfront, $100 billion of out-of-warranty installed base. So they're on premier programs, they've got significant positions on those programs and that translates into aftermarket. To your point, I think there's also some cost runway at Collins. If you just think about how Collins was ultimately created, just kind of go back to the beginning, Hamilton then Goodrich then Rockwell, Rockwell had just acquired B/E and then comes into the United Technologies family at the time. That's a lot of integration and a lot of that is still ongoing and there's still a runway there. I would say we've -- Collins has removed about 14 ERP systems since then, they're moving almost 3 million hours from higher cost to lower cost. They're setting up setters of excellence where they can do things like electronics in 1 location, that feeds all of its business units. So I think that's, again, another enabler. I would also say OE rates as they continue to rise, they said up front that Collins is capacitized for perhaps higher OE rates than we're seeing today just think back to 2019. So as OE rates continue to rise, you're going to see more productivity in the shops and better absorption as well. So all things, that I think, are a tailwind for Collins.

Great. Thanks, Chris. Switching gears, pun intended, to the geared turbofan. As you know, geared turbofan questions would be expected at this point.

Yes. I thought it was going to be #1.

I tried to put it in the middle.

Yes, thank you.

How is the fleet management plan going? And what KPIs should we watch? How is the program progressing?

Yes. No. Thanks, Kristine. Again, no new news since we kind of laid this out in our Q2 call, but I'll just sort of reiterate, no change to the financial or operational assumptions that we laid out last year that we reported on our earnings, I would say. Just start from the top, it always starts with safety. We've done over 6,000 inspections. And our inspection findings and the fallout rate are entirely consistent with what we had assumed they would be. So that's great news. No change to our AOG peak or average during the period. No change to the turnaround time assumptions that are in the period and our customer support agreements continue to be in line with our assumptions as well. Now the single biggest enabler because we get asked a lot, like what can make this -- what can change the trajectory here. The single biggest enabler is MRO output. I was down in Columbus, Georgia last week at our GTF MRO shop, which is frankly one of the better shops within the overall GTF network. And we are doing everything we can to take time out of each of the gates, right? Gate 1 disassembly, gate 2 is where you accumulate your material, gate 3 reassembly, gate 4 test. Of course, the long pole in the tent right now is that gate 2, material accumulation. While we have seen a significant uptick in receipts in structural castings and in forgings, the demand is still huge, as you might imagine, because you need those parts for other parts of your programs as well non-GTF. So again, we continue to fight through what I would say, material flow. When we have material, our network has shown an ability to really compress turnaround times. We've seen significant reductions in the other gates where you're more in control of your own destiny. You're not waiting necessarily for material repairs that come back. And we continue to use our core operating system to take hours and days out of each of those, so that when we do have the materials, you can turn those engines very quickly. So while there are no changes to our assumptions, just know that each and every day, we are looking for opportunities to accelerate getting support to our customers as quickly as we possibly can.

Thanks, Chris. And outside the GTF, focusing back on Pratt, you touched a little bit on what you're seeing in the military activity in the V2500. Can you talk more about the drivers of earnings there and how we should think about their contribution to the segment?

Yes. I think -- that you for teeing that up because when we talk Pratt, we have a tendency just to talk GTF. First of all, other parts of the large commercial engine business and I talk about the V2500. I won't reiterate that but just know that we've seen very, very few retirements in that fleet. That is going to continue to be a very strong contributor of aftermarket sales and profit well into the future. I think we had given some guidance this year for about 800 shop visits, and we're on or about the trajectory to meet that. So it continues to be very strong. . Pratt Canada is probably a business we don't talk enough about, Kristine, I talked about a little bit upfront but you just look at the fundamentals of that business. They are #1 or #2 in virtually all of their segments there. They're still sourced on over 200 platforms, 68,000 engines in service, just a phenomenal installed base with strong positions that are going to continue to yield aftermarket returns well into the future. I had a very strong first half on the aftermarket front. And then on the military engine business, of course, everyone knows about the F135 powering the F-35. And I mentioned the engine core upgrade, keeping that as the engine on the F-35. But it is also on other priority platforms, think B-21, think tanker, F-22, things that are relevant for the fight in the future but also relevant to today. So very strong franchises across the other pieces of Pratt.

Great. And let's pivot back to Raytheon Defense. You've got a pretty good start of the year, 10% organic sales or I guess good organic sales growth, 10% margin in the second quarter. But you've got a $51 billion backlog. What are the key obstacles for you in terms of delivering more -- converting this backlog into revenue? And what are the obstacles for getting margins higher than that 10%?

Yes. So yes, as you said, a strong start to the year for Raytheon, like the trajectory we've seen there in terms of the margin expansion and the like. Again, the story with Raytheon starts with demand. The rolling 12-month book-to-bill is 1.13, you've mentioned the $50 billion backlog. I mentioned the orders we've got here already in Q3. So incredible demand. So for Raytheon, it is all about productivity, material flow and then getting, I would say, our development programs through some key milestones, and we've talked about that over the last year or so. So if you start with material receipts, we've seen 5 straight quarters of growth in material receipts. That's fantastic. That means your shops are getting the material that they need, they can turn product. In many cases, they can shorten their period of performance when they've got the material. That's where you see some of those productivity gains, right? The capacity that we continue to add, I mentioned the capacity we're adding in Arkansas and in Alabama. We are taking the Coyote production up significantly this year given the heightened threat environment and the threat that, that addresses, so again, supply chain capacity. And then again, we've got some development programs that we've talked about, then there's a handful that we need to continue to get through the development milestones and ultimately into production. I would say that we continue to have line of sight to reaching those, but again, once those can get through and in some cases, those were programs where we struggled a bit, but I think we've battled back and now have line of sight to seeing those through and removing those, if you will, as a headwind. So again, the name of the game that Raytheon is how do you execute on that demand? And how do you execute on that backlog, so material, capacity and then, of course, our development programs.

Thanks, Chris. And going back to the RTX level, you guys have put out $36 to $37 billion of capital return that you've reaffirmed. How do we think about your strategy on capital return, what are the priorities here?

Yes. I think you'll see a consistent posture on capital allocation. So thank you the $36 billion to $37 billion by '25, still committed to that. I think the ASR that we've done has been very well executed. You and I talked about that offline a little bit and we are continuing now to meet our commitment on deleveraging and paying down some of that debt. We remain committed to a growing dividend, growing with earnings and then the last piece that I think has probably been more of the UTC story, which was some of that transformative M&A. I don't necessarily see that for us here at RTX. If you think about the portfolio that we've put together, I think it's a fantastic portfolio, as I said, throughout this discussion today. So for us, it's not about adding transformative pieces. It's probably just more around pairing the portfolio, pruning it a little bit to make sure that everything that's in there kind of as we kind of set up our filters for what it means to be an RTX business meets that criteria and where we see opportunities. We had 1 in the second quarter in our Hoist & Winch business. Again some of these are smaller pruning opportunities. We'll take them because, again, continuing to focus the portfolio, I think, will just enhance our ability to drive returns.

Great. And maybe looking at the portfolio, I mean, you touched on this. You've seen a lot of changes to the previous UTC Aerospace business, Goodrich, Rockwell, Collins, B/E Aerospace, and there's also the integration with Raytheon Defense. I mean the past -- plus you've got COVID somewhere in there, too. So there's been a lot of disruption and there's a lot of integration going on with the company. Can you give us an idea what's the state of the portfolio today? Where are you in this integration journey? And ultimately, what do you think is an underappreciated piece of the RTX investment story today?

Yes. No, thank you. I would say we're not here to complain about COVID, but the deal was consummated in COVID so if you think about bringing together one of the largest aerospace and defense deals in the middle of -- right at the beginning of COVID, hampers integration a little bit. We weren't able to see one another, collaborate as effectively perhaps as we wanted to. So it took us a little bit of time to sort of drive the integration. But I would tell you, we absolutely accelerated and caught up cost synergies, met and raised, continue to identify technology synergies. And I would tell you that the focus now is less on integration and more on execution. We obviously did our 4 to 3 combination where we moved pieces of Raytheon into Collins, pieces of Collins into Raytheon to make sure that we were better matched up with the market and the opportunities. That is behind us. And so we really -- feel really, really good about where the portfolio is and where the focus is. You mentioned underappreciated. Again, we're not the kind of people that take out our violin and complain about how we're perceived necessarily. I would just say that the portfolio in our view, is compelling. And again, I'll reiterate it a little bit because we really truly believe this, if you take Collins, it's #1 or #2 on 70% of its product portfolio. It's got significant positions on 110,000 aircraft. And I mentioned a few times now, but it's worth repeating the $100 billion with the installed base that is out of warranty. Pratt, you've got, of course, a very strong GTF backlog still in front of us, a long aftermarket tail still in front of us. GTF advantage that's going to be coming in, V2500, Pratt & Whitney Canada, a premier small engine franchise and then a military engine business that's on all of the priority programs. Then you look at again Raytheon. I'll say it again, it really meets the needs of today and the threats of today. It's got premier sensing ISR and effector technology and portfolio. And then if you step back and say, okay, how do we make sure that we pull that all together effectively. We spend a lot of time focusing on what I would call the connective tissue, our core operating system. Making sure that we're going into our facilities and doing the type of continuous lean activity. Matter of fact, I was just down in Forest, Mississippi, working out a core project with the team there on how do we increase rate? How do we redesign the cell to make sure that we can increase rate, make it easier for the operator, improve versus past yield. These are all the things that we are focused on across the portfolio. Our digital transformation, our Factory 4.0 and again, our technology synergies. These are the connective tissue, if you will, Kristine, that I think will enhance what we can consider a compelling portfolio. And I think at the end of the day, we think this portfolio is in a position to generate significant cash to be able to invest and reinvest as I said upfront because it's a long-cycle business, but also be able to drive returns to our shareholders.

Great. Thanks, Chris. We've got time for 1 last question. So maybe circling back on some of the innovation technology items you talked about earlier, which one of these initiatives are you most excited about?

Yes. We've got a number, I'll just -- instead of going through maybe the 14-point technology role, maybe just sort of the domain areas, sustainability on the commercial side, absolutely, both Collins and Pratt. I would say, advanced propulsion both in commercial and in military. Connected battle space and resilient networks. How do we continue to connect our allies in denied environment. And you'll see that as between Collins and Raytheon. And then there are just a number of what I would call enabling technologies that we're working on across all 3 businesses. Ceramics matrix composites for instance, other ways that we can distribute and dissipate heat in all of our applications. We've got 60,000 engineers across Raytheon, working on these problems. And we've also got a centralized research center that helps prioritize these and make sure that they have broad applicability across the portfolio. So we're really, really excited about the technology portfolio and the tailwind we think it's going to provide.

Well, great. Thank you very much, Chris. Thank you for joining us today this in this lovely Laguna location. With that, this concludes the presentation on RTX this morning. Thank you, everyone.

Have a good day. Thank you, Kristine.