Earnings Call Transcript
RTX Corp (RTX)
Earnings Call Transcript - RTX Q3 2022
Operator, Operator
Good day, ladies and gentlemen, and welcome to the Raytheon Technologies Third Quarter 2022 Earnings Conference Call. My name is Olivia and I will be your operator for today. As a reminder, this conference is being recorded for replay purposes. On the call today are Greg Hayes, Chairman and Chief Executive Officer; Neil Mitchill, Chief Financial Officer; and Jennifer Reed, Vice President of Investor Relations. This call is being carried live on the Internet and there is a presentation available for download from Raytheon Technologies’ website at www.rtx.com. Please note that the company will speak to results from continuing operations, excluding acquisition accounting adjustments and net non-recurring and significant items often referred to by management as other significant items. The company also reminds listeners that the earnings and cash flow expectations, as well as any other forward-looking statements provided in this call, are subject to risks and uncertainties. Raytheon Technologies’ SEC filings, including its Forms 8-K, 10-Q, and 10-K, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. With that, I will turn the call over to Mr. Hayes.
Greg Hayes, CEO
Thank you, Olivia, and good morning, everybody. As you can see in the press release this morning, RTX had another solid quarter of growth led by commercial aerospace and extremely strong demand for our products with over $22 billion of awards in the quarter. I think it's important to note our balanced aerospace and defense portfolio, along with operational resiliency, remain the key differentiators which enable us to deliver on our commitments despite some near-term macro challenges and uncertainties. I think it's also important to note we've overcome some significant headwinds in 2022 from transitioning out of Russia to record inflation and a strained supply chain. I think it's important, those are short-term issues and while we continue the day-to-day work to mitigate those challenges, we also continue to grow our $168 billion backlogs and invest in the future through over $9 billion of R&D, capital expenditures and customer-funded research and development. Those investments, coupled with strong demand for our systems across each of our businesses, position us for a significant growth runway as the near-term headwinds recede. Before we get to the results, let me just spend a few minutes discussing the trends we're seeing in some of our end markets. On the defense side, no surprises. The elevated threat environment has significantly influenced how the U.S. and our allies are thinking about their defense capabilities and readiness. And as a result, this has driven global defense budgets substantially higher, a trend we expect to continue for the foreseeable future. Just as an example, in Europe, Switzerland recently signed a $6.25 billion contract to buy 36 F-35 jets, modernizing their fleet and driving demand, of course, for our F135 engine through the end of the decade. We're also seeing significant global demand for advanced air defense systems, especially in Eastern Europe, as the conflict between Russia and Ukraine, unfortunately, continues. This includes two of our NASAMS systems, which is a surface-to-air missile system that will help protect the people of Ukraine. And we expect more orders beyond those two to follow shortly. The heightened threat environment continues to drive strong orders. During the quarter, we saw strong domestic and international demand for our products, with a number of significant defense awards, which resulted in a book-to-bill of 1.22 and a backlog that's up about $2 billion sequentially. Of particular note, our Missiles & Defense business was awarded $1 billion to develop the Hypersonic Attack Cruise Missile or HACM for the U.S. Air Force. It's a first-of-its-kind missile that leverages air breathing scramjet propulsion technology and can travel at hypersonic speeds of Mach 5 or greater. Additionally, R&D completed the systems requirement review for the hypersonic glide phase interceptor program prototype. This is designed to protect the United States from increasing hypersonic missile threats. Both of these accomplishments demonstrate that Raytheon Technologies is a leader in the race to develop and deploy operational hypersonic and importantly, counter-hypersonic systems, a key strategic priority for the Department of Defense. RMD also was awarded about $1 billion from the U.S. Air Force, Navy and international customers for advanced AMRAAM, which is the Advanced Medium-Range Air-to-Air Missile. These missiles have been upgraded with the most sophisticated technology needed to maintain the edge over adversaries of the U.S. and our international allies. At RIS, we saw an additional $1.6 billion in classified awards in the quarter. The team was awarded $215 million from the FAA to upgrade their wide area augmentation system to enhance safer air travel in support of the national aerospace system. At Pratt & Whitney, the team recently delivered the 1,000th F135 engine and was awarded over $800 million during the quarter to continue supporting the F135, which is the safest, most capable and best value military jet engine in operation. We're working on the F135 engine core upgrade known as the Enhanced Engine Package or EEP. This will allow the F135 to provide even more thrust, range and electrification to the aircraft. The EEP offers the most cost-effective and lowest-risk solution to enable the F-35's Block 4 upgrade. At Collins, we received a $583 million IDIQ award for the MAPS Gen II program, which maintains the integrity of positioning and timing in a GPS contested or denied environment. And it's an important award to ensure mission success within a more connected battle space. As you can see, the defense pipeline remains robust, and we expect continued order strength in the future as we continue to win key awards to successfully demonstrate our technology leadership and innovation capabilities. Moving to the commercial side, air traffic remains strong as third-quarter global revenue passenger miles reached 75% of 2019 levels. In the U.S., travelers through TSA checkpoints reached 91% of 2019 levels with Labor Day domestic traffic exceeding 2019. We continue to see steady improvement in long-haul international traffic with wide-body hours flown up nearly 40% year-over-year. The strong demand for the commercial aerospace recovery was driving demand for our commercial products and services. We continue to innovate to deliver value for our customers. For example, just a few weeks ago, Pratt began development flight testing of the GTF Advantage engine on the A320neo aircraft in Toulouse, France. The GTF Advantage reduces fuel consumption and CO2 emissions by a total of 17% compared to the prior generation engines, extending the engine's lead as the most efficient power plant for the A320 family. Also during the quarter, Pratt completed the first flight test of the GTF-powered A321XLR or Extra Long Range, two significant milestones for the GTF family of engines. So even with some near-term challenges, we continue to invest in innovation for continued growth in air travel and to meet the strong defense demand. Okay. With that as a background, let's turn to Slide 2, some highlights of the quarter. In the quarter, we delivered another strong organic sales growth of 6%. Adjusted EPS was ahead of our expectations at $1.21, and free cash flow is also ahead of our expectations despite a $1.5 billion additional tax payment we made related to the RMD amortization. Sales growth was again led by strong commercial aftermarket sales that were up 24% over the prior year. However, we continue to see challenges related to supply chain and labor availability in each of our businesses. On the capital allocation front, we repurchased over $600 million of shares in the quarter, putting us at $2.4 billion year-to-date. We remain on track to repurchase at least $2.5 billion for the year. Through the end of the third quarter, we've returned over $12 billion of capital to shareholders since the merger, and we're well on our way to our commitment to return at least $20 billion in the first four years following the merger. Before I hand it over to Neil, notwithstanding the strength in demand that we're seeing across our businesses, the industry-wide challenges we're facing remain the same. You've heard me talk about them before: supply chain, labor, and inflation. We continue to focus on what we can control by proactively managing the businesses through these dynamic times. Let me give you some examples of what we're doing. On the microelectronics front, we're working closely with our distributors and the OEMs to bring more capacity online. We also have direct engagement, which has led to higher deliveries and an acceleration of expected recoveries for certain wafers and chips. At RMD, we're working hand in hand with our rocket motor supplier holding daily senior management meetings to track work in progress and solve technical problems in real-time. We're also leveraging RTX's contract labor agreements to help source labor in our supply base. To mitigate the impacts of inflation, we've been taking multiple actions. For example, we're leveraging our raw material contracts from the business from RTX to get the best prices for our suppliers as well. While supply chain disruptions are frustrating, we are seeing some stabilization and we're encouraged by the demand signals across the business. That said, these headwinds continue to pressure the business. As we finish out the year, just a couple of thoughts. We're going to have to adjust our full-year sales outlook slightly to a new range of $67 billion to $67.3 billion. We're going to bring up the bottom of our adjusted EPS range by $0.10 to $4.70 to $4.80. We continue to see free cash flow of about $4 billion for the year. With that, let me turn it over to Neil and Jennifer to take you through the details.
Neil Mitchill, CFO
Thank you, Greg. Before I get into the full year, let's look at our Q3 results on Slide 3. Sales of $17 billion grew 6% organically versus the prior year with organic growth at Collins, Pratt, and RIS more than offsetting a decline in RMD. The ongoing recovery of commercial air travel and a strong summer travel season drove our aerospace performance while we continue to see challenges in the supply chain, as Greg mentioned. Adjusted earnings per share of $1.21 was down 4% year-over-year but ahead of our expectations on better commercial aero. Segment operating profit growth of 12% was more than offset by the absence of a prior year tax benefit and lower pension income. GAAP earnings per share from continuing operations was $0.94 per share and included $0.27 of acquisition accounting adjustments and restructuring. Free cash flow of $263 million was also ahead of our expectations and included the impact of the $1.5 billion cash payment that Greg just mentioned. On the cost reduction front, we achieved an incremental $105 million of gross merger cost synergies in the quarter, bringing our merger-to-date total to $1.3 billion of our $1.5 billion commitment in the four years following the merger. Before I hand it over to Jennifer, a few comments on our full-year outlook. The commercial air recovery remains robust, and we continue to expect that global RPMs will recover to about 90% of 2019 levels as we exit this year. Domestic and short-haul international travel also remain strong, and we continue to see a steady recovery in long-haul international travel. However, as Greg discussed, while we're seeing some stabilization in certain areas of the supply chain and labor market, these constraints continue to put pressure on our businesses. As a result, we're reducing our full-year RTX sales outlook to a new range of $67 billion to $67.3 billion, which translates to between 5% and 6% organic sales growth. This is down from our prior range of $67.75 billion to $68.75 billion. However, despite the lower sales outlook, we're raising the bottom end of our adjusted EPS range by $0.10 to $4.70 to $4.80 per share from our prior range of $4.60 to $4.80. Continued aftermarket strength, favorable OE mix, and cost containment actions across RTX are partially offsetting lower sales and lower productivity in our defense businesses. You'll also recall that we previously assumed the legislation requiring capitalization of R&D expenses for tax purposes would be repealed or deferred this year. Since that hasn't happened, we realized an EPS benefit of about $0.11 year-to-date and estimate that the full-year impact is about $0.15 per share. And on the cash front, we continue to expect free cash flow of about $4 billion for the full year. In the fourth quarter, we're expecting lower tax payments in several large international receipts. Finally, we provided an updated outlook for the segments and some below-the-line items in the Webcast appendix. So with that, let me hand it over to Jennifer to take you through the third-quarter segment results and updated outlook.
Jennifer Reed, Vice President of Investor Relations
Thanks, Neil. Starting with Collins Aerospace on Slide 4. Sales were $5.1 billion in the quarter, up 11% on an adjusted basis and up 13% organically driven primarily by the continued recovery in commercial aerospace end markets. By channel, commercial aftermarket sales were up 25% driven by a 44% increase in provisioning and a 31% increase in parts and repair, while modification and upgrades were up 3% organically in the quarter. Sequentially, commercial aftermarket sales were up 4%. Commercial OE sales were up 16% versus prior year driven principally by the strength in narrowbody. Military sales were down 6% driven primarily by lower material receipts and decreased volume. Adjusted operating profit of $630 million was up $150 million from the prior year. Drop-through on higher commercial aftermarket and OE more than offset lower volume on military programs as well as higher SG&A and R&D expense. Looking ahead, we continue to see Collins’ full-year sales up low double digits. As a result of stronger commercial aftermarket, we're bringing up the low end of Collins’ adjusted operating profit to a new range of up $750 million to $825 million from the prior range of up $700 million to $825 million versus last year. Shifting to Pratt & Whitney on Slide 5. Sales of $5.4 billion were up 14% on an adjusted basis and up 15% organically with sales growth in large commercial engines in Pratt Canada more than offsetting lower military sales. Commercial OE sales were up 26% driven by favorable mix within Pratt's large commercial engine and Pratt Canada's businesses along with higher GTF and Pratt Canada volume. Commercial aftermarket sales were up 23% in the quarter with growth in both legacy large commercial engine and Pratt Canada shop visits. Sequentially, commercial aftermarket sales were up 14%. In the military business, sales were down 2% driven primarily by lower expected F135 production volume that was partially offset by higher F135 sustainment volume. The adjusted operating profit of $318 million was up $129 million from the prior year. The drop-through on higher commercial aftermarket and favorable military and commercial OE sales mix more than offset higher SG&A and R&D expense. Looking ahead, we continue to expect Pratt sales to be up low teens. We're increasing Pratt's adjusted operating profit to a new range of up $650 million to $700 million from our prior range of up $550 million to $650 million versus 2021, reflecting the strength of the aerospace recovery. Turning now to Slide 6. RIS sales of $3.6 billion were down 3% versus prior year on an adjusted basis driven by the divestiture of the Global Training and Services business. On an organic basis, sales were up 2% versus prior year due to higher classified sales and sensing effects that were partially offset by lower expected sales in command, control and communications, including lower sales in tactical communications programs. Adjusted operating profit in the quarter of $371 million was down $20 million versus prior year. Excluding the impact of the divestiture, operating profit was up $8 million driven primarily by favorable net program efficiencies. RIS had $3.9 billion of bookings in the quarter, resulting in a book-to-bill of 1.18 and a backlog of $17 billion. For the full year, we continue to expect RIS' book-to-bill to be greater than 1. Turning to RIS full-year outlook. A result of ongoing material availability delays and the associated productivity impacts as well as anticipated cost reduction actions and award delays, we are reducing RIS sales to the low end of our prior outlook. We now expect RIS sales to be down mid-single digits from our prior outlook of down mid-single digits to down low single digits on a reported basis versus prior year. On an organic basis, we now expect RIS' sales to be down slightly versus our prior outlook of about flat. As a result of lower sales outlook and program efficiencies, we are reducing RIS' adjusted operating profit to a new range of down $125 million to down $75 million from a prior range of down $50 million to flat versus prior year. Turning now to Slide 7. RMD sales was $3.7 billion, down 6% on an adjusted basis and down 5% organically, primarily driven by continuing delays in material availability and lower volume in land, warfare and Air Defense and Naval Power programs. This was partially offset by higher volume on strategic missile defense programs, including Next-Generation Interceptor development. Adjusted operating profit of $116 million was $74 million lower than prior year driven by unfavorable program mix and lower volume, primarily in Land Warfare and Air Defense programs as well as lower net program efficiencies resulting from continued supply chain and labor constraints. RMD's bookings in the quarter were approximately $5.4 billion, resulting in a book-to-bill of 1.5 and a backlog of $32 billion. For the full year, we now expect RMD's book-to-bill to be at or better than 1.2. As a result of ongoing material availability delays and the associated productivity impacts and cost reduction actions, we now expect RMD sales to be down low single digits versus our prior outlook of up slightly versus 2021. As a result of the lower sales outlook and lower program efficiencies, we are reducing RMD's adjusted operating profit to a new range of down $300 million to down $250 million from the prior range of down $50 million to flat versus 2021. With that, I'll turn it back to Neil.
Neil Mitchill, CFO
Thank you, Jennifer. A lot to cover there. I'm on Slide 8. While we aren't providing our 2023 outlook today, let me tell you how I'm thinking about next year. Overall, we expect another year of organic sales and segment operating profit growth with solid free cash flow generation at RTX. On the positive side, we expect that commercial air traffic will continue to recover and the global demand for our defense products and technologies will remain strong. We expect to exit next year at or above 2019 levels for global air traffic. The significant defense orders we have won should begin to convert to sales. We will continue to drive operational excellence, focused on improving our cost competitiveness. We're using the core operating system to align goals and drive targeted improvements with technology. The collaboration across RTX has already yielded 180 approved projects with a growing pipeline of over 350 future projects, focused on smart factories, automation, and machine upgrades that will apply best practices to further reduce our structural costs. We will leverage our scale, these additional cost reduction opportunities, and pricing to help address the inflation pressures that we expect to remain elevated well into next year. While we are working on many actions across our businesses every day to mitigate the impacts of supply chain constraints and labor availability, we do expect these pressures to continue to persist into next year as well. Additionally, as we sit here today, we see pressure from increasing interest rates and market volatility, anticipating a pension headwind next year that could be about $0.40 on a year-over-year basis due to current market conditions. That said, it's important to note that our U.S. plans remain well funded and have even seen an improvement in their funded status year-to-date. Of course, everyone is watching the geopolitical landscape, energy supply in Europe, the continuing resolution, and the global tax environment. So with that, let me hand it back to Greg for some closing remarks.
Greg Hayes, CEO
Okay. Thanks, Neil. There's a lot going on, a lot of moving pieces. The key takeaways that I hope people get from this is most importantly, our backlog is up $12 billion since the beginning of the year. We're investing $9 billion this year to support the growth that's going to come over these next couple of years. The future remains absolutely bright for RTX. The 2025 commitments that we laid out a year ago remain in sight. We're not backing off from any of those, be it top line, bottom line, or cash. So Neil laid out three challenges that are out there: supply chain, labor availability, and inflation. It's a challenge. There's no doubt about it. We've got 13,000 suppliers, of which about 400 are a problem for us. However, we have deployed teams to almost all of those suppliers to work with them on a daily basis, getting them raw material, giving them contract labor, and providing technical support. On labor availability, it's a challenge. We've hired 27,000 people in '22, roughly 3,000 a month since the beginning of the year. Our total headcount today is over 180,000. The challenge is we still need about 10,000 more people. On inflation, we came into the year expecting about $1.5 billion of cost growth and it turned out to be closer to $2 billion. You couple that with about $200 million of headwind from the cessation of activities in Russia earlier this year, totaling a $700 million headwind we had to overcome. The good news is we've found ways to cut costs across the business with about 500 cost-reduction projects currently in progress. Despite that $700 million, we've maintained guidance for the year. It's been a challenging year and will continue to be tough moving forward. However, we have the tools and personnel to make it happen. I'll stop there and turn it back to the operator for any questions.
Operator, Operator
Our first question is from Peter Arment with Baird.
Peter Arment, Analyst
Greg, could you share your thoughts on the overall expectations for 2023? While I understand you aren't providing formal guidance, The Street is anticipating growth across the board. Do you believe that commercial aerospace will keep recovering, and could we finally see defense begin to translate some of these wins into actual top-line growth? Just a high-level perspective on your view for 2023 would be helpful.
Greg Hayes, CEO
Yes. I think, Peter, you're exactly right. We expect strong growth on the commercial aerospace side to continue. RPMs will continue to recover back to 2019 levels. We're going to see strong OE growth as Boeing and Airbus take up production rates. We expect to see strong aftermarket growth as airlines continue to add capacity and try and maintain the planes they have in flight. So commercial aero, I think it's all good for next year. On the defense side, we will see some growth, but it won't be as robust as we would like. It goes back to the challenges we've discussed, primarily labor availability and some of the supply chain challenges. We should start to see stabilization here in the third quarter regarding supply chain issues, but we have a long way to go. That will be the limiting factor, not the backlog, but rather the availability of materials.
Neil Mitchill, CFO
Yes. Peter, the additional points I would add from a sales perspective align with what Greg said. I agree with him. We expect to see mid- to high single-digit sales growth in 2023, predominantly from our commercial businesses. More importantly, we anticipate segment operating profit growth will exceed the sales growth rate. We expect margin expansion as well next year. You heard me mention the pension headwind in my prepared remarks. We will also have to normalize for a tax rate that will be somewhat higher, as we come off of a year where we expect R&D to be repealed next year, at least that’s our current plan. We'll come back in January with a much clearer look at what the segments are going to look like.
Operator, Operator
Our next question is from Noah Poponak with Goldman Sachs.
Noah Poponak, Analyst
Can you hear me?
Greg Hayes, CEO
Yes.
Noah Poponak, Analyst
Obviously, what's happening with your defense top line is a little surprising, but it can largely be explained by industry-wide factors. I think the margins are maybe more surprising. And obviously, there's absorption from that top-line impact, and we know there's inflation. But it's an industry where the margins really don't move around that quickly, and your peers aren't really seeing that much margin movement versus this kind of quarterly volatility we're seeing from you. So can you maybe just explain that a little further? And then when we look to next year, should we think about your defense segment margins being closer to the '22 level or closer to your longer-term targets?
Neil Mitchill, CFO
I'll start with that one. Noah, I'm not going to comment on next year's margins right now, as we’re focused on getting through the rest of this year. But a couple of thoughts on the margin profile. The first factor dragging down the margins this year relative to our initial expectations is the lack of productivity, primarily due to delays in material receipts, which is jamming up production and development cycles within the businesses, most notably in RMD. We’ve also observed a mix shift in the products. RMD has undergone a product upgrade across many of our platforms, which has negatively impacted margins. We will come through this stage as we transition into more production rate-type contracts. One encouraging observation this quarter is that last quarter, we faced net productivity expenses. However, sequentially, we’ve seen an improvement in productivity of about $140 million. This indicates that productivity for RIS and RMD was positive, albeit not at the levels we're accustomed to seeing. The volume should fill up the factories as we deliver on the anticipated defense backlog, leading to improved productivity. Greg, do you have anything else to add?
Greg Hayes, CEO
No, I think you covered it well. Another contributing factor to our lower margins is that international sales, which are typically more profitable on the defense side, have decreased comparatively. Additionally, some of the newer contracts have lower margins than what we experienced on existing contracts as we transition from Patriot to LTAMDS production, which will see margin depreciation for a few years until we reach stable production rates.
Operator, Operator
Our next question is coming from Sheila Kahyaoglu from Jefferies.
Sheila Kahyaoglu, Analyst
Neil, I want to ask about comms profitability. Guidance implies that margins inflect up 200 bps in Q4 versus about a 12% rate year-to-date on margins. How do you think about the bridge and some of the drivers there as we exit the year? And maybe if you could comment on price and mix actions as well.
Neil Mitchill, CFO
Sure. Yes. We've already seen substantial Collins margin expansion through the first nine months of the year. I expect to see continued improvement as wide-body international traffic recovers. The team has done an excellent job at managing costs as well, and we anticipate doing more of that in the fourth quarter. Looking ahead, we’re considering the pricing actions we've initiated in our Pratt & Whitney business, Collins, and Pratt Canada. We plan to introduce revised pricing early in the year. We expect these increases to be considerably larger than historical pricing increases in the commercial aftermarket business. On the defense side, we’re able to pass a lot of those increases through to government customers as we establish new contracts with them and update our forward pricing rate, so we're actively working through this.
Sheila Kahyaoglu, Analyst
So should we assume a 35%, 40% incremental margin business going forward?
Neil Mitchill, CFO
I think getting out of this year, you'll see muted incremental margins as the comparisons become a little more challenging. But we are on track to return to the 20% margins we committed to during our Investor Day back in 2021.
Operator, Operator
Our next question is from Robert Stallard with Vertical Research Partners.
Robert Stallard, Analyst
Greg, regarding the defense sector, specifically RMD, you find yourself in a unique situation where demand is clearly strong, but supply remains limited. How do you anticipate this developing in the future? When do you expect these factors to balance, and are you experiencing any support from your customers in addressing this?
Greg Hayes, CEO
Look, I think we're all in this together. As we sit here in Washington, and we will be speaking to the folks at DoD tomorrow, there's concern about supply chain challenges. They're establishing DFAS ratings on many things to prioritize supply needs. However, the challenge is not solely a capacity issue. It’s largely about labor availability—how to get trained welders to operate efficiently remains a challenge. That said, we saw about a 5% incremental improvement in our build or kit efficiencies this quarter. We aimed to achieve about a 10-point improvement, and while we won’t meet that target, we hope to reach about a 70% kit fill rate by the end of the year, which is why we had to adjust RMD sales guidance. Moving forward, I anticipate that by next year we should start to see some resolution regarding these constraints, primarily due to the anticipated slowing economy allowing for more labor to flow into the supply chain. However, some specific areas, like rocket motors, might not see a recovery path until the first half of 2024. This is not a short-term fix, and I'm prepared to manage these supply chain issues throughout 2023.
Operator, Operator
Our next question is from Ron Epstein with Bank of America.
Ron Epstein, Analyst
Maybe shifting topics a bit, I believe everyone will be interested in RMD. Greg, could you elaborate on aircraft propulsion technology? You have the geared platform, and your main competitor is developing an unducted fan. What capabilities does the gear possess? What are the potential advancements? How significant is the threat posed by an unducted fan? Additionally, looking ahead to hybrid propulsion and similar technologies, what are your thoughts on their future development?
Greg Hayes, CEO
A long time from now. Let's be clear, right? We're just introducing the Advantage engine, the A320 or the 1100 GTF Advantage engine. That will go into service in 2024, and it will have a very long life cycle—around 30 years. Over the next 20 years, I believe we will likely see a transition toward hybrid electric propulsion, especially in regional jet and turboprop markets. However, it remains challenging to make advanced claims for long-range propulsion beyond Jet A. We are collaborating on technologies such as hydrogen and ammonia to improve efficiency, and SAF represents a viable option, though not carbon-free depending on feedstocks. We're directing significant investment into these advanced technologies, and we are implementing a hybrid electric demonstrator with Collins and Pratt on a regional turboprop. However, I think those technologies are still 15 to 20 years away. For now, we will focus on incremental improvements in the geared platform, which isn't finished yet. The gear can scale up and down, and we have an excellent family of engines today. As we contemplate the next-generation single-aisle engine likely to arrive around 2030, we will introduce the next evolution of the geared engine, which will still rely on jet fuel.
Operator, Operator
Our next question is coming from David Strauss with Barclays.
David Strauss, Analyst
I wanted to see if you could give some initial thoughts on free cash flow in 2023. It looks like 2022 free cash flow will grow about $1 billion, factoring in the R&D hit. So I guess, Neil, you're alluding to probably close to $1 billion of EBIT growth. But I think you have a bit of a pension headwind. I'm not sure what you're expecting for working capital. So maybe some help with the moving pieces on 2023 free cash flow.
Neil Mitchill, CFO
Thanks, David. I'll keep this at a high level, but we will provide more details in January. With the expected operating profit growth, we anticipate that will translate into free cash flow growth. I expect a slight increase in capital expenditures as we finish off some larger investments, particularly with the upgrades of our facilities in Texas at the RIS business and the Asheville facility for Pratt. Moreover, we anticipate inventory to continue to grow as we manage through payables and other components of working capital due to supply chain constraints. We need this inventory to ensure we can support the anticipated increasing aftermarket and OE business. In short, we anticipate organic growth in free cash flow. We're also expecting a tax refund related to the capital payments made this year. I'll leave it at that, but we'll provide a more comprehensive breakdown in January.
David Strauss, Analyst
A quick follow-up on pension, the $0.40. Is that incremental versus this year? I think you were already anticipating a sort of $0.10 incremental hit. Is that $0.40 incremental to that or just $0.40 incremental for this year?
Neil Mitchill, CFO
$0.30 incremental to the $0.10 we had already forecasted. The underperformance is mainly driven by asset returns falling below our ROA, compounded by rising interest rates increasing interest expenses. More details will be presented when we finalize our assumptions by year-end, but that's our current outlook.
Operator, Operator
Our next question comes from Seth Seifman with JPMorgan.
Seth Seifman, Analyst
I wonder if you could talk a little bit about Pratt for a second? And strong results in the quarter had been running about $300 million of profit per quarter year-to-date. I think the guidance indicates a step down to $2.50 or a little below that in the fourth quarter. Now I'm sure when I ask about that, you're going to mention higher engine deliveries. But I mean, I think there was a price increase as well for spares. So how do we think about that evolution of Pratt, why it comes down so much in the fourth quarter, as well as where it goes from here and how much progress Pratt can make in '23 toward the out-year margin target that you have?
Neil Mitchill, CFO
As you correctly pointed out, most of the decline from Q3 to Q4 is attributed to increased commercial engine shipments, which have been postponed to the end of the year. This increase in volume primarily serves as the significant driver of what you observe in the operational profit shift. Looking further ahead, I'm not ready to provide specific forecasts right now. However, I can confirm that we expect OE deliveries from the large engine sector to increase next year according to our customer requirements. We also foresee movement towards the margin goals Pratt set out 1.5 years ago. This progress would rely on a recovering aftermarket, with the V2500s showing considerable strength in conjunction with operational actions aimed at improving efficiency. Our Pratt team is deeply engaged in scrutinizing every aspect of the business to enhance both SG&A and operational costs. Thus, while there’s a lot of work ahead, it’s an encouraging trajectory.
Seth Seifman, Analyst
Great. Just if I could follow up real quickly, the military part of Pratt has been down this year. Can that stabilize or grow again in '23?
Neil Mitchill, CFO
I believe it can stabilize. Yes, we've seen a decline due to lower F135 deliveries, but that has been balanced by growing sustainment revenues. The aftermarket for the F135 engine will continue to grow in the future as well. Thus, we should see stabilization. Similarly, at Collins, military sales have also declined moderately this year, but we expect similar recovery for these segments as we transition into 2023.
Operator, Operator
Our next question is coming from the line of Myles Walton from Wolfe Research.
Myles Walton, Analyst
Neil, I think you mentioned fourth quarter cash would be driven by lower tax payments in several large international receipts. I wonder, are you awaiting government approvals? Is there a timing risk here? And are those international receipts tied to the fourth quarter, mid-13% targeted margin you're looking for at RMD?
Neil Mitchill, CFO
The international cash receipts are not tied to the RMD margin in the fourth quarter. However, there is an inherent risk with every international advance since some of them are quite significant. We believe we will receive them within the year, but if not, it will simply be a timing issue. It is more a monitoring concern rather than a government approval issue. That said, I feel confident in outlining our overall strategies to drive free cash flow. Our cash flow remains robust, despite the $1.5 billion payment, with lowered tax payments expected in the fourth quarter as we wrap up the payments required due to new R&D laws.
Myles Walton, Analyst
Okay. And Greg, just a high level, regarding the U.S. review of the U.S.-Saudi relationship, do you expect any potential impacts on your business?
Greg Hayes, CEO
Currently, we adhere to the guidance of the DoD and State on sales to Saudi Arabia. We continue our work with Saudi Arabia, notably on defense contracts. It's important to highlight our longstanding relationship with the Saudis, whose defensive capabilities, particularly regarding GEM-T missiles for the Patriot anti-missile and anti-aircraft battery, remain critical. We have not identified any impact from discussions in Washington about an immediate suspension of arms sales, as this represents about 1.7% of our total sales. It's not a substantial amount but remains significant as they are a key ally, and I trust we will overcome these diplomatic challenges over time.
Operator, Operator
Our next question is coming from Kristine Liwag with Morgan Stanley.
Kristine Liwag, Analyst
Neil and Greg, you highlighted inflation as a continuing challenge as you look out to 2023. That said, you are expecting margins to expand next year. Can you provide more color on the moving pieces, how much inflation you’re able to pass through to customers, how much you can offset with lower cost, and how we should think about that remaining exposure?
Neil Mitchill, CFO
Kristine, there are numerous factors at play here, and while our projections are not foolproof regarding future inflation rates, we expect elevated inflation to continue into 2023. Thankfully, many suppliers have long-term agreements in place, but these contracts eventually roll over, and we're working on those long-term pricing solutions to mitigate some of the hikes. Regarding our pricing actions already introduced, those are significantly larger than historical increases. On the defense side, we're effectively passing much of that through to our government customers as we reach new contracts. We are taking various project initiatives, with many started years ago, yielding results in our digitalization efforts and operational process enhancements across the company. In summary, we have numerous projects ongoing, but it will take considerable work to lessen the impact of sustained 6%, 7%, or 8% inflation rates.
Greg Hayes, CEO
Yes, Kristine, just to add to that: The most significant inflationary pressure comes from compensation. We allocate approximately $20 billion each year toward compensating our workforce, and over the past decade, we've generally aimed for raises of 3% to 3.5%. We're currently feeling increased pressure on compensation due to market trends. Nonetheless, we always strive for productivity enhancements throughout the business, whether in production facilities, back-office operations, or other processes. This is a coordinated effort, and I'm not overly concerned about margins as we know how to drive costs down effectively. Some of these costs get passed on to government customers through overhead rates, and we’re also aggressive about pricing in our commercial segments. We will continue to monitor inflation trends — I won’t use the word transitory, given our experience — but we plan to remain proactive as we navigate through this.
Operator, Operator
Our next question is coming from Cai von Rumohr from Cowen.
Cai von Rumohr, Analyst
Yes. You indicated that you're going to do at least $2.5 billion in share repurchase for the year even though cash flows are impacted by Section 174. If 174 is pushed out, you clearly get a windfall to cash flow next year—how should we think about share repurchase, given that your long-term outlook seems pretty solid? If you indeed see 174 pushed out, you will have a lot of cash reserves.
Greg Hayes, CEO
Certainly. The uncertainty surrounding Section 174 is a bit concerning since we are hopeful for a tax law change by year-end that could provide a $1.5 billion tax refund early next year. When considering our share repurchase strategy, we remain committed to the $20 billion capital return target we set. This year, we've announced a repurchase of $2.5 billion or more, and I see next year increasing to $3 billion or more. The timing will rely on when we gain clarity on cash flows, particularly regarding Section 174.
Cai von Rumohr, Analyst
But how much of that share of the $3 billion plus would you do if Section 174 is not repealed?
Greg Hayes, CEO
We would still aim to do $3 billion. Our capital allocation plan is firmly anchored, heavily factoring in the $20 billion target. It is important to note that Section 174 presents a timing issue; we will eventually receive those deductions back. Next year, we will see a 20% deduction on the amounts deferred this year, and by 2025, the impact of Section 174 should lessen significantly due to amortization capabilities. While it is essential, it will not drastically impact capital allocation strategies over the next few years.
Operator, Operator
And our last question is coming from the line of Ken Herbert with RBC Capital.
Ken Herbert, Analyst
I just wanted to see if you could provide a bit more detail on Pratt & Whitney. You have a 14% sequential increase in the aftermarket. Can you just talk about where that was from? How much was maybe volume versus price? And how should we think about where you are, specifically in the V2500 sort of shop visit recovery? I know that's a huge part of the story this year and next year. And how much growth did you see in the shop visits this year? How do we think about that going into next year?
Neil Mitchill, CFO
So a couple of thoughts: Most of what you're seeing at Pratt through the third quarter can be attributed to volume. We've discussed that shop visits are up around 20% on a full-year basis, with about 10% growth in the third quarter. We see a good outlook for the fourth quarter as well, meaning the 20% expected growth for the year still holds. Another aspect contributing to the aftermarket was the increased maintenance per shop visit, as aircraft are now flying more consistently compared to previous years. However, we haven’t yet observed the pricing actions reflected in our reported results.
Ken Herbert, Analyst
Great. And the pricing actions — just real quickly: I think as those flow through for 2023, if I understand correctly, you are looking at a little higher step-up in pricing than you realized in '22, correct?
Neil Mitchill, CFO
That is true. Of course, many customers have existing contracts, so some of that increase will be muted. However, several customers do not have the same level of prior agreements, and you'll see that translated into results, which will help us offset the challenges we’re facing.
Operator, Operator
I will now turn the call back over to Mr. Greg Hayes for closing remarks.
Greg Hayes, CEO
Okay. Thank you, and thank you all for listening in. Just a reminder, Jennifer and team will be available today to take on your questions. Also just a note, this is Erin Somers' last earnings call with us. She is moving on to be CFO of our International business for RMD. Congratulations to Erin if you’re speaking with her later today. Thank you all for listening, and we'll see you soon. Take care.
Operator, Operator
Thank you. Ladies and gentlemen, this now concludes today's conference. You may now disconnect. Everyone, have a great day.