Earnings Call Transcript - RTX Q1 2022

Operator, Operator

Good day, ladies and gentlemen. Welcome to the Raytheon Technologies First Quarter 2022 Earnings Conference Call. My name is Ludie, 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 the Raytheon Technologies website. Please note, except where otherwise noted, the company will speak the results from continuing operations, excluding acquisition, accounting adjustments and net nonrecurring and/or significant items often referred to by management as other significant items. The company also reminds listeners that the earnings and cash flow expectations and any forward-looking statements provided in this call are subject to risks and uncertainties. RTC's SEC filings provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. Once the call becomes open for questions, we ask that you limit your first round to one question per caller to give everyone the opportunity to participate. With that, I will now turn the call over to Mr. Hayes.

Gregory Hayes, CEO

Thank you, Ludie, and good morning, everybody. Before I get into the results, I want to spend a minute to address the Russian invasion of Ukraine. I know it's first and center on everybody's mind. It's been devastating to see these tragic events unfold, and our thoughts and prayers are with the Ukrainian people. We, of course, have ceased all of our business activities with Russia in line with global sanctions, and we remain committed to supporting our allies and ensuring the safety of our people around the world. This event, more than any other, demonstrates our unique responsibility as a global company trusted with supporting our customers as they navigate a complex geopolitical landscape, and we remain focused on honoring that mission. All right. Let me turn to the first quarter. As you saw from the press release, we're off to a good start for the year. On the commercial aerospace side, we remain optimistic about the market recovery, despite a slower than expected start to the year due to the impact of Omicron and increased geopolitical tensions. That said, air traffic is rebounding again in many markets around the world. In the U.S., passenger traffic through TSA checkpoints remained steady versus Q4 at about 1.8 million passengers per day in the quarter. Importantly, it averaged over 2 million passengers per day in March, a significant increase from last year and nearly 90% of what we saw in 2019. So recovery is in sight. On the defense side, we're very pleased with the enacted '22 DoD budget, and we're encouraged by the President's most recent fiscal '23 budget request of $773 billion. The proposed budget includes broad-based support across our key programs and technology investments in cyber, space, missiles, missile defense systems, and others, and we expect the enacted budget could be even higher to account for inflation and the many unfunded priorities identified by the services. Looking internationally, our allies are also increasingly prioritizing defense spending with a focus on defensive systems, which we are uniquely positioned to support. Resilient commercial air traffic, coupled with growing global defense budgets and our strong backlog continue to support our long-term outlook for our businesses and gives us confidence in our ability to drive top-line growth and margin expansion over the next several years...

Neil Mitchill, CFO

Well, thanks, Greg. I'm on Slide 3. As Greg noted, we delivered adjusted earnings per share and free cash flow that exceeded our expectations for the quarter. Sales of $15.7 billion were in line with our expectations and up 4% organically versus the prior year. Our performance in the quarter was primarily driven by the continued recovery of domestic and short-haul international air travel that was partially offset by continued supply chain constraints across our businesses. Adjusted earnings per share of $1.15 was up 28% year-over-year and ahead of our expectations, primarily driven by commercial aftermarket at Collins, $0.04 of commercial OE timing at Pratt and other corporate items, including lower tax expense, which more than offset the supply chain constraints. On a GAAP basis, EPS from continuing operations was $0.74 per share and included $0.41 of acquisition accounting adjustments and net significant and/or nonrecurring items, which included $0.14 of charges associated with the impact of global sanctions on Russia. Free cash flow of $37 million was better than our expectations of an outflow of $500 million, driven primarily by working capital, most notably the timing of collections during the quarter. Finally, let me give you an update on our synergy progress. During the quarter, we achieved incremental gross cost synergies of about $90 million, putting us on track to achieve $335 million of incremental cost synergies for the full-year. With that, let me hand it over to Jennifer to take you through the segment results, and I'll come back and share our thoughts on the rest of 2022.

Jennifer Reed, Vice President of Investor Relations

Thanks, Neil. Starting with Collins Aerospace on Slide 4. Sales were $4.8 billion in the quarter, up 10% on an adjusted basis and up 11% on an organic basis, driven primarily by the continued recovery in the commercial aerospace end markets. By channel, commercial aftermarket sales were up 39%, driven by a 73% increase in provisioning, a 43% increase in parts and repair, and a 11% increase in modification and upgrades. Sequentially, commercial aftermarket sales were up 5%. Commercial OE sales were up 12% with strength in narrow-body, offsetting expected headwinds from lower 787 deliveries. Military sales were down 12%, driven primarily by supply chain constraints and expected declines in F-35 volume. Adjusted operating profit of $584 million was up $252 million from the prior year, driven by higher commercial aftermarket and OE volume that more than offset lower military sales volume and higher SG&A expense. Looking ahead, as a result of ceasing activities with Russia, we now expect Collins full-year sales to be about $375 million lower than our prior expectations but still expect their sales to grow in low double-digits. However, we maintain Collins full-year operating profit range of up $650 million to $800 million versus 2021. Shifting to Pratt & Whitney on Slide 5. Sales of $4.5 billion were up 12% on an adjusted basis and up 13% on an organic basis, driven primarily by the continued recovery of the commercial aerospace industry...

Neil Mitchill, CFO

Thank you, Jennifer. I'm on Slide 8. Let me give you some perspective on how we're thinking about the environment as we look ahead. I'll start with some of the positives. Despite the impact of COVID variants early in the year, we continue to expect that the commercial aerospace recovery will remain resilient and will drive growth in commercial aftermarket and narrow-body OE deliveries this year. Notwithstanding the fact that global RPMs grew roughly four points less than we expected in the first quarter, Commercial aftermarket grew in line with our expectations as operators began preparing their fleets for the summer travel season. At the same time, we're closely monitoring China domestic and international traffic. As I've said before, our outlook assumes a significant improvement in wide-body traffic during the balance of the year. That said, we continue to expect commercial traffic to return to 2019 levels by the end of next year. On the defense side, as Greg mentioned, we are optimistic about the President's fiscal '23 budget request, which included a 5% base budget increase in the modernization accounts where our investments in technology and innovation are well aligned to the administration's priorities and our major programs are well supported. While it's too early to quantify today, all of our businesses are positioned to support the expected growth in U.S. and international defense spending. On the cost reduction front, we remain laser-focused on driving operational excellence to deliver further margin expansion, including $1.5 billion of total gross cost synergies. On the challenges side, we continue to see global supply chain, inflation, and labor availability pressures across our businesses. While we saw increasing risk in these areas during the first quarter, we remain focused on mitigation actions and expect supply chain constraints will ease later in the year.

Gregory Hayes, CEO

Okay. Thanks, Neil. Just a couple of thoughts here on our '22 priorities, which remain essentially unchanged. Obviously, we remain focused on supporting our customers, our employees, suppliers, and communities so that we can execute our mission of defending democracy and connecting the world. Today's environment reinforces the need for us to invest in innovative technologies to remain competitive, to drive industry leadership, and to deliver the right solutions for our customers. We'll do this while driving operational excellence and remaining disciplined with our capital, including meeting our capital return commitments. We remain committed to doing all of this responsibly as evidenced by the publication of our first RTX ESG report yesterday, which builds upon our long history of best practices in this area. Earlier this month, we celebrated the two-year anniversary of our merger. I'm very proud of what we've accomplished together so far, and I want to thank all of our employees for their efforts during this very difficult and challenging period. I'm confident in the investment thesis we laid out at the investor conference last May. Our franchises are strong. We operate in resilient markets, and we have great technology. Importantly, we have experienced leadership focused on operational excellence and delivering on our long-term commitments. With that, let me open up the call for questions.

Myles Walton, Analyst

Thanks. Good morning. Greg or Neil, could you comment on the gradients of the supply chain constraints you saw in the first quarter as you look to the second quarter? In particular, the two items of Pratt commercial engines and rocket motors. I know you've talked about recovery by year-end, but have you passed the point of low and you're seeing improvements sequentially?

Gregory Hayes, CEO

Yes, Myles, thanks for the question. We had a problem with our structural casting supplier where we were not able to get castings into our MRP schedule. That resulted in about 70 engines moving out of the first quarter. That problem is not behind us, but we are working with that supplier to recover, and we'll get most of the way there by the end of the year, but it is not without its challenges. Like everybody else, our suppliers are seeing a shortage of labor as well as inflation in their own businesses. The impact on the rocket motor side remains problematic. We have a recovery plan that we work with every day. We have a number of our folks that are at their facilities every single day working through this, making sure we're being prioritized, but the recovery is not going to happen this year. I think we are so far behind on rocket motors that it may well stretch into the 2023 timeframe. We're working with other suppliers to requalify other rocket motors, but it's a long process to do that.

Robert Spingarn, Analyst

Well, hi. Good morning.

Gregory Hayes, CEO

Good morning, Rob.

Neil Mitchill, CFO

Good morning, Rob.

Robert Spingarn, Analyst

I have a few questions regarding defense. Jennifer mentioned a projected sales growth profile of low to mid single-digit at RMD moving forward. Does this include the additional demand that you mentioned is anticipated from Europe? Specifically, will the army be replacing the current 1,400 stingers that were sent to Ukraine, and will this be done through a sole source contract or possibly a competitive follow-on contract?

Gregory Hayes, CEO

Yes. Let me start with that. As far as looking at the sales forecast for RMD, that does not contemplate any upside that we see from replenishment of stocks. We're working through all that, trying to understand the timing. We won't see any of that benefit this year, but as we think about the next couple of years, as we see the budgets continue to increase and the replenishment orders come in, we expect to see a benefit to the RMD top-line, which will take that number up somewhat. We're currently producing stingers for an international customer, but we have limited stock of material for stinger production. We've been working with the DoD for weeks. We're actively trying to resource some of the material, but unfortunately, DoD hasn't bought a stinger in about 18 years. Some of the components are no longer commercially available, and we will need to redesign some of the missile's electronics.

Peter Arment, Analyst

Good morning Greg, Neil, Jennifer.

Neil Mitchill, CFO

Good morning, Peter.

Peter Arment, Analyst

Hey Greg, can you give us maybe some color on just where you are on the narrow-body build rate side? It seems like that's a big part of the positives for this year. And are you seeing running into any supply chain issues on that front? Thanks.

Gregory Hayes, CEO

Yes, Peter, I think the biggest supply chain challenge that we're seeing as it relates to the narrow body recovery goes to Pratt & Whitney regarding GTF production. We had the structural castings issue that caused first quarter rates to be lower than expected. That will improve as we go throughout the year. We see supply chain constraints across the commercial portfolio, affecting electronics, aluminum, and titanium. The challenges as we think about Russia impacted our titanium supplies, and we are looking to resource a lot of material. While this won't impact narrow-body production delivery rates this year, it could going into next year. We're working closely with both Airbus and Boeing on their production rates, and if they increase demand, we will find a way to support it.

Neil Mitchill, CFO

Peter, maybe I could add a couple of points here, too. Just from a financial perspective, as you think about the sales impact of the Russia situation on the narrow-body, Collins expects commercial OE now to be up mid to high teens year-over-year, while Pratt expects commercial OE to be up low teens.

Robert Stallard, Analyst

Thanks so much. Good morning.

Gregory Hayes, CEO

Good morning, Rob.

Neil Mitchill, CFO

Good morning.

Robert Stallard, Analyst

Neil, maybe just a follow-up on your Russia comment there. I was wondering if you could give us a bit more detail on this hit to revenues that you're anticipating in 2022, because I wouldn't expect Airbus and Boeing to not remarket planes, for example. Is this all coming on the aftermarket and on BizJet?

Gregory Hayes, CEO

Yes, Rob, if you consider that Russia represents about 4% of global RPMs, which is not a large figure, it makes up roughly 1.5% of our total sales, translating to around $900 million annually. We will offset some of this through increased sales in other areas, but we will lose sales related to aftermarket activities in Russia. At Pratt, we are not shipping engines to Russia. While Airbus may find alternatives for those, we still lose some spare part sales connected to those engines. We have carefully analyzed the sales impact, and although we anticipate some mitigation through cost reductions, we still expect a significant earnings hit of approximately $200 million.

Neil Mitchill, CFO

To think about the profile of that $225 million a quarter in each of the next three quarters; we had about $80 million of sales did not materialize in the first quarter due to this impact. Pratt Canada also sells helicopter engines into Russia, impacting the OE. From a split perspective, Collins is about 60% aftermarket and 40% OE; at Pratt, 10% aftermarket, but really heavy on the OE side at 90%.

Ronald Epstein, Analyst

Yes. Good morning Greg.

Gregory Hayes, CEO

Good morning, Ron.

Ronald Epstein, Analyst

Maybe just following on that supply chain team. How are you guys handling the titanium situation? I mean, Russia was a somewhat important supplier for you guys. I mean, are you just looking to move that all domestic? And how are you thinking about it?

Gregory Hayes, CEO

Ron, that is a great question. The biggest challenge as we think about the global sanctions on Russia is that we did have significant portions of titanium forgeings and castings coming from Russia. The good news is, we started advanced purchasing back in the fourth quarter to get ahead of some of the sanctions. So we have inventory for a good chunk of that throughout the end of this year. There are some components, especially at Pratt Canada, where it will take time to resource, impacting some of our customer deliveries this year. We're working through identifying those challenges and finding second sources, but it's going to cause delays on some deliveries this year.

Sheila Kahyaoglu, Analyst

Good morning guys. Thank you for the time.

Gregory Hayes, CEO

Good morning.

Sheila Kahyaoglu, Analyst

Maybe on a more upbeat note, can we talk about profitability? It was pretty good, 50% incrementals in the quarter and guidance sort of implies flattish for the rest of the year. What's going on there? Are you just mitigating for risk with supply chain? And now that the two-year lock has expired with the merger, how are you thinking about the portfolio overall?

Neil Mitchill, CFO

Let me start with the financial piece. We had strong margins for Collins in the quarter, driven by a strong aftermarket. We don't expect that to sustain itself at quite that level as the year progresses. Similarly, like last year, we had phased expenditures, furloughs, and those types of items become a headwind as you go further into the year. We still expect mid-30s for the next several quarters, with a strong aftermarket boosting those margins. Greg?

Gregory Hayes, CEO

Just a comment on portfolio rationalization. We haven't been sitting still for the last two years. We've been looking across the portfolio, and while we were somewhat hamstrung because of the merger, we are actively looking today for both acquisitions and divestitures. The acquisitions will probably be technology-related and smaller dollar similar to what we did last year. We're going to look at the Collins portfolio for potential divestitures, focusing on those with lower growth and margin profiles. We expect to complete that analysis in the next six to nine months.

David Strauss, Analyst

Thanks. Good morning.

Neil Mitchill, CFO

Good morning.

Gregory Hayes, CEO

Good morning, David.

David Strauss, Analyst

Greg, on the Collins side, any visibility out of Boeing to go above 31 a month on MAX? And where are you today on 87 and the outlook for production to start moving back up again there?

Gregory Hayes, CEO

That's a great question for Boeing when they release earnings. We're in lockstep with Boeing on production schedule. They have discussed 31 a month, and we're able to support that level and even higher. Regarding 787 production, we expect to see improvements as the year progresses, and Boeing has been transparent with us about their delivery and production forecasts, and it's reflected in the guidance we've given for Collins.

Kristine Liwag, Analyst

Hey, good morning guys.

Gregory Hayes, CEO

Good morning.

Kristine Liwag, Analyst

On the large commercial engine castings issue at Pratt, is this related to aluminum casting or titanium casting? And also with the raw material and labor inflation, are there threshold limits on how much you're able to pass through to customers?

Gregory Hayes, CEO

Those are primarily titanium castings from our supplier that are impacting us. These are structural castings, which means you can't really start building most of the engine until you get the castings in, which is the hold-up. Regarding raw material and labor inflation, many of our commercial aerospace supply contracts have long-term agreements. Historically, we see about $150 million of inflation every year, but there will be an extra $200 million this year that we need to offset through cost reduction or negotiations. We typically have dead band pricing requiring us to absorb initial inflation, and only after that can we pass through some costs to customers.

Neil Mitchill, CFO

That $0.04 benefit we realized in the first quarter is likely going to be a $0.04 headwind as we go through the second quarter and get production back on track.

Doug Harned, Analyst

Good morning, thanks.

Neil Mitchill, CFO

Good morning, Doug.

Gregory Hayes, CEO

Good morning.

Douglas Harned, Analyst

If we go back to last summer, you all talked about a five-year CAGR for defense in the sort of 3% to 5% range top line. We are now seeing stronger defense budgets. How do you see that trajectory now? Is there upside from there? We haven't seen a backlog increase yet, but does this change how you see that five-year outlook?

Gregory Hayes, CEO

Yes, Doug, as we think about this, the President's budget request for '23 of $773 billion did not anticipate the Russian invasion of Ukraine. We were seeing an increase in defense spending before this, so the trajectory is better than what we had expected. The need for modernization and deterrence is clear. There will be upward pressure on sales guidance, but we may not see the benefits until '23 or '24. We will update everyone later this year with our thoughts on the defense outlook.

Noah Poponak, Analyst

Hi, good morning everyone.

Gregory Hayes, CEO

Good morning, Noah.

Noah Poponak, Analyst

Neil, could you spend a minute on the progression of the margin through the year at the other segments, the way you did at Collins? It looks like RIS is fairly steady through the year, but then RMD needs a big step up to get into the 150 to 200 range.

Neil Mitchill, CFO

As I said earlier, the 11% in the first quarter is a low point of the year for RMD. We need to get to a range of 13% to 14% margins, which has been an achievable target for that business before. This will come from improved mix and productivity realizations as we progress through the year. We expect to see sequential increases in the margin at RMD throughout the year, with Q1 as the low point.

Michael Maugeri, Analyst

Thanks, good morning everyone.

Gregory Hayes, CEO

Good morning.

Michael Maugeri, Analyst

Neil, following on a couple of prior questions on the slower GTF deliveries at Pratt. With the supply chain issues, is it just Pratt or are there broader implications on A320? Is there a change in thought about peak negative engine margin and breakeven cash flow on GTF?

Neil Mitchill, CFO

I don't see any change to our thinking around peak negative engine margin or breakeven on GTF. The supply chain issues we're discussing are more acute in the defense side right now. Our suppliers had high absenteeism, affecting production across Collins and RIS and RMD, but we're slowly recovering in March and April.

Ken Herbert, Analyst

Hi, good morning. Thank you.

Gregory Hayes, CEO

Thank you, Ken.

Ken Herbert, Analyst

I wanted to ask about China. The traffic data and events in China so far in April have not been encouraging. Can you help us think about the full-year assumptions for international travel and how we've seen changes in this outlook?

Gregory Hayes, CEO

Yes, Ken, that's an understatement about China. China accounts for about 16% of global RPMs, and their domestic market is seriously down due to lockdowns. However, we expect this will be temporary as previous lockdowns have led to traffic rebounding after about 30 to 60 days. We still expect the aftermarket recovery for wide-body international travel to return to roughly 75% of pre-pandemic levels by year-end. A significant recovery will depend on traffic to Japan and Australia, which we expect to materialize.

Kristine Liwag, Analyst

Great, thank you guys.

Gregory Hayes, CEO

Thank you. Go ahead, Ludie.

Operator, Operator

Yes, thank you. We have reached the end of our Q&A session. I would like to hand the call back to Mr. Greg Hayes for the closing remarks. Thank you.

Gregory Hayes, CEO

Thanks, Ludie. Thanks all for listening today. As always, Jennifer and the IR team are available all day to answer any and all questions you might have. Thank you. Stay healthy, and we'll see you all soon. Take care. Bye.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.