Raytheon Technologies Corporation (NYSE:RTX) Q4 2022 Earnings Call Transcript

Raytheon Technologies Corporation (NYSE:RTX) Q4 2022 Earnings Call Transcript January 24, 2023

Operator: Good day ladies and gentlemen, and welcome to the Raytheon Technologies Fourth Quarter 2022 Earnings Conference Call. My name is Latif, 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; Chris Calio, Chief Operating 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, except where otherwise noted, the company will speak to results from continuing operations, excluding acquisition accounting adjustment and net non-recurring 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 other forward-looking statements provided in this call are subject to risks and uncertainties. Raytheon Technologies’ SEC filings, including its Form 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. 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. You may ask further questions by reinserting yourself into the queue as time permits. With that, I will turn the call over to Mr. Hayes.

Greg Hayes: Thank you, Latif, and good morning, everyone. I hope you’ve all had a chance to review our press release this morning. Before we get into the highlights, I’d first like to welcome Chris Calio to the call. As you know, Chris has been our Chief Operating Officer for the last year, has been responsible for our business units as well as our operations, engineering and digital functions. Effective March 1, Chris has been elected to the position of President and Chief Operating Officer of RTX. Chris has been instrumental over this past year in driving our focus on operational excellence and delivering for our customers in a very challenging environment. So welcome, Chris. Okay. Let’s go to the webcast slide for Slide 2.

We’ll talk about some of the highlights for 2022. I wanted to tell anybody that 2022 was an incredibly dynamic year. And I’m pleased to say that we were able to achieve, despite facing a number of significant challenges, including transitioning out of Russia, managing record levels of inflation as well as supply chain and labor constraints. With all that as a backdrop, we still delivered $67.1 billion in sales for the full year, which was up 6% organically and adjusted EPS of $4.78, which was up 12% year-over-year. We also returned almost $6 billion of capital to shareowners, which included $2.8 billion of share repurchases. And more importantly, even with the $1.6 billion headwind from the R&D tax legislation, we generated $4.9 billion in free cash flow, which exceeded our expectations.

At the same time, we continue to position the business for sustained profitable growth. In 2022, we captured $86 billion in new bookings, resulting in backlog growth of 12%, a book-to-bill of 1.28 and a near record backlog at the end of the year of $175 billion. Additionally, we were granted over 2,600 patents last year. This places us in the top 10 of companies in the United States for the second consecutive year. While we invested $9 billion in R&D and CapEx, this allowed us to bring new technologies to our market and drive further automation and digitization through each phase of our product lifestyle from design, through development, through manufacturing and product sustainment. Our investment in recent awards supports our mission to create a safer and more connected world, which was especially true in 2022.

Our products and technologies have been instrumental in helping the people of Ukraine defend itself. From the Stinger, Javelin and Excalibur to NASAMS and now Patriot air and missile defense system, we remain in lockstep with the U.S. government to ensure we can continue to support our allies. On the commercial side of the business, we saw continued advancements on our path towards leading the future of sustainable aviation with the start of development flight testing of the GTF Advantage engine, which, as you know, further enhances the GTF’s position as the leader in fuel efficiency and CO2 emissions. Importantly, we also completed the first engine test run for our regional hybrid electric flight demonstrator. This system integrates a 1-megawatt electric motor, which was developed by Collins with a highly efficient Pratt & Whitney fuel burning engine, specifically adapted for hybrid electric operations.

This new engine will reduce fuel burn and CO2 emissions by 30% compared to today’s most advanced regional turboprop aircraft. These types of investments along with strong demand across both the commercial and defense end markets will position us for continued growth as we head into 2023. We’re particularly proud that RTX outperformed among all companies in the Russell 1000 for local U.S. job creation in 2022. RTX leads the industry in employee giving and volunteering, which is a testament to the impact our workforce has in the communities where we work and where we live. Before I turn it over to Chris, I just want to spend a minute to talk about the status of our integration and the next steps as we evolve as a pure-play aerospace and defense company.

As you know, in 2020, we brought together two great companies, UTC aerospace business and Raytheon. With combined strength, scale and capabilities that makes us uniquely equipped to innovate and deliver game-changing technologies and solutions for our customers. As we approach the third anniversary of this merger, we’ve accomplished many of our objectives, including exceeding our original synergy commitment, and we see even more opportunities ahead. So today, we’re starting the next step in our integration and evolution. Our plan is to streamline our structure to a customer-centric organization with three focus segments: Collins Aerospace, Raytheon and Pratt & Whitney. This will better align us with our customers’ needs and allow us to better collaborate on next-generation technology.

There is still a lot of work to be done to make this happen, but let me turn it over to Chris to give you some of the additional details of this transformation and some additional business updates. Chris?

Chris Calio: All right. Thank you, Greg. It’s great to join today’s call, and I’m looking forward to engaging more with everybody. I’m starting here on Slide 3. Over the past year, I’ve been focused with our team on driving operational performance and program execution as well as identifying ways to improve our cost position and to ensure alignment between our investments and our strategic priorities. As Greg noted, our merger integration is nearly complete, having realized gross cost synergies of $1.4 billion. And so we are now in the process of realigning RTX into three business units. Let me give you some additional color around our thinking on this. At its core, this move is about enabling us to better coordinate with our customers, aligning with their needs and collaborating more effectively across our businesses, all of which is feedback we’ve received from our customers.

All of this will ultimately enhance performance, make us even more competitive and allow us to capture additional revenue synergies in areas such as connected battle space. For example, just this past year, we were awarded a phase of the JADC2 effort known as TITAN, where RIS and Collins are working together to deliver this cutting-edge solution to ensure our joint forces have one common operating picture of the battle space. Additionally, this realignment will allow us to better leverage our scale so we can optimize our footprint, improve resource allocation and reduce costs for both RTX and our customers. Now we don’t have a number for you today in terms of cost savings as we are in the early stages of that analysis, but we do believe there are additional material opportunities to be realized.

Connection with this reorganization, Roy Azevedo, President of RIS business, informed us of his plan to retire. Roy will, however, stay on as an adviser over the next several months to help us with this important transformation. Shawn Mural, currently the CFO of RI&S, has been acting President of RIS, effective February 1. While organizational changes like this are never easy, we have demonstrated our ability to successfully execute on these types of initiatives in the past. And many members of the team involved in this process have experienced from our recent portfolio and merger transformations. The exact timing of this change is in final yet, the current plans to make effective during the second half of the year. Until then, we’ll manage the business under our current structure.

Photo by SpaceX on Unsplash

We’ll provide updates on our progress over the coming months. Before I turn it over to Neil to discuss our results for the quarter and the outlook for the year, I want to turn to Slide 4 to share some of our critical assumptions for 2023 and the areas where we’re focused to ensure we execute on our commitments. As Greg mentioned earlier, customer demand for our products and services continues to grow. In Commercial Aerospace, we expect global air traffic to fully recover to 2019 levels as we exit 2023 with continued strength in the U.S. and Europe. This is pretty consistent from what we’re all hearing from the airlines. And like everyone else, we’re keeping a close eye on China, which historically has represented about 14% of global air traffic.

Our working assumption today is that China’s lifting of COVID restrictions continues to be manageable and its traffic levels will remain robust. We also assume traffic in other parts of the world remain resilient. We are, therefore, expecting commercial aftermarket revenue growth across our aerospace businesses to approach 20% in 2023. Commercial production rates are also quickly accelerating. We expect commercial aircraft volumes will be up around 20% year-over-year. On the defense side, our backlog is expected to continue to grow given the heightened and increasingly complex threat environment. In the U.S., we continue to see strong bipartisan support as evidenced by the adoption of the Defense Authorization Bill and the Omnibus Appropriations Bill with a budget of $858 billion, which is up about 10% from 2022.

In overseas, the EU is targeting a €70 billion increase in defense spending over the next three years and Japan will increase their defense budget by 26% this year. Given our current backlog and this continued strength in demand, we remain extremely focused on execution, and I see four key actions that will position us to be successful on this front. One, we continue to grow production capacity to deliver on this backlog as we move through 2023 and 2024. For example, we’ve made investments in key strategic locations like Asheville, North Carolina, for turbine airfoils, the Kinney, Texas for RF and EO/IR products and Bangalore, India to expand the Collins India manufacturing strategy. Second, we, of course, need a skilled workforce to execute our development and production programs.

Labor availability remains a constraint. We’ve made some progress across RTX in Q4 through reduced attrition and other strategic retention and recruiting initiatives. Third, we need to continue restoring health within our supply chain. We’ve actively maintained a physical presence at close to 400 supplier sites. We continue to qualify additional suppliers on key programs. We secured sources of supply for critical commodities. While we are broadly beginning to see our supply chain improve, it is not yet at the levels we need, we are assuming a recovery as we move into the back half of the year. And lastly, we are taking a number of actions to deal with the elevated levels of inflation that everyone is experiencing. For perspective, we are expecting roughly $2 billion of labor and material inflation in 2023.

And we are targeting to more than offset this headwind through higher pricing and aggressive cost reduction actions across all RTX. Some of these actions in the category are blocking and tackling, such as continual process improvement and some are more strategic in nature, such as driving productivity through increasing the amount of connected equipment and automated factory hours. There is no doubt, we’ve got a lot of work in front of us, but I think we all believe we’ve got the right actions identified, and more importantly, the right team in place to do it. So with that, let me turn it over to Neil to look at our financial results and outlook for 2023.

Neil Mitchill: Thank you, Chris. Let’s turn to Slide 5. I’m pleased to see how we finished the year where we continue to see solid growth in organic sales, and adjusted earnings per share and robust free cash flow in the quarter. Fourth quarter sales of $18.1 billion grew 7% organically versus the prior year. This growth was primarily driven by our commercial aerospace businesses as the continued recovery in commercial air traffic more than offset the supply chain and labor challenges we saw during the year. Adjusted earnings per share of $1.27 was in line with our expectations and up 18%, led by the commercial aftermarket at Pratt & Collins, which more than offset the impact of lower productivity in our defense businesses. On a GAAP basis, earnings per share from continuing operations was $0.96 per share and included $0.31 of acquisition accounting adjustments, restructuring and nonrecurring items.

It’s worth noting that both GAAP and adjusted earnings per share had a tax benefit of about $0.06 associated with legal entity and operational reorganizations, which were completed during the quarter. And finally, we had free cash flow of $3.8 billion in the quarter, bringing our total cash generation for the year to $4.9 billion which exceeded our commitment as a result of stronger collections, particularly in international areas across the portfolio. With that, let’s turn to Slide 6, and I’ll get into the segment results. Starting with Collins. At Collins sales were $5.7 billion in the quarter, up 15% on an adjusted basis and up 16% organically, driven primarily by the continued recovery in commercial aerospace end markets. By channel, commercial aftermarket sales were up 21%, driven by a 32% increase in provisioning and a 25% increase in parts and repair, while modifications and upgrades were up 5% organically in the quarter.

Sequentially, commercial aftermarket sales were up 6%. Commercial OE sales were up 20% versus prior year, driven principally by the continued strength in the narrow-body. Military sales were up 5%, driven primarily by improved material receipts, higher volume and new program awards. Adjusted operating profit of $743 million was up $274 million from the prior year as drop-through on higher commercial aftermarket volume and lower R&D expense was more than offset by higher SG&A expense. So shifting to Pratt & Whitney on Slide 7, sales of $5.7 billion were up 10% on an adjusted basis and up 11% on an organic basis, with commercial OE sales growth in large commercial engines in Pratt Canada as well as higher commercial aftermarket volume. Commercial OE sales were up 37%, driven by favorable volume and mix within Pratt’s large commercial engine and Pratt Canada businesses.

Commercial aftermarket sales were up 11% in the quarter with growth in both legacy large commercial and Pratt Canada shop visits. In the military business, sales were down 2%, driven by lower military legacy program aftermarket sales. Adjusted operating profit of $321 million was up $159 million from the prior year, driven primarily by drop-through on higher commercial aftermarket, which included a favorable contract adjustment that was partially offset by higher SG&A and R&D. Turning now to RI&S on Slide 8. Sales of $3.5 billion were down 8% versus prior year on an adjusted basis, driven by the divestiture of the Global Training and Services business in the fourth quarter of 2021. On an organic basis, sales were down 5% versus prior year, driven by command, control and communications, cyber training and services and sensing and effects.

Adjusted operating profit in the quarter of $278 million was down $122 million versus prior year. Excluding the impact of divestitures, operating profit was down $96 million, driven primarily by unfavorable mix, lower net program efficiencies and lower volume. RIS had a $2.9 billion of bookings in the quarter, resulting in a book-to-bill of 0.92 and a backlog of $16 billion and on a full year basis, RIS’ book-to-bill was 0.96. Turning now to Slide 9. R&D sales were $4.1 billion, up 6% on an adjusted basis and up 7% organically, primarily driven by higher volume in Naval Power programs including SPY-6 production, higher volume in Strategic Missile Defense, including Next Generation Interceptor development and higher volume and advanced technology programs.

Adjusted operating profit of $418 million was $68 million lower than the prior year, driven by unfavorable program mix and lower net program efficiencies, partially offset by drop-through on higher volume. RMD’s bookings in the quarter were $6 billion for a book-to-bill of 1.48. And for the full year, RMD’s book-to-bill was 1.37, resulting in a record backlog of $34 billion. So with that, let’s turn to Slide 10 to discuss the financial outlook for the year. At the RTX level, we expect full year 2023 sales of between $72 billion and $73 billion, which represents organic growth of 7% to 9% year-over-year. From an earnings perspective, we expect adjusted earnings per share of $4.90 to $5.05, up 3% to 6% year-over-year. And we expect to generate free cash flow of about $4.8 billion.

I should note, we are not assuming the legislation requiring R&D capitalization for tax purposes will be repealed in our outlook. And as a result, in 2023, we’ll have a cash payment of about $1.4 billion related to the current law. While there are more details on the cash flow walk in the appendix, let me share a few of the moving pieces. First, we are expecting segment operating profit growth. Offsetting that will be increases in working capital, capital expenditures as well as a lower pension cost recovery. Additionally, we’re expecting to buy back approximately $3 billion of RTX shares in 2023, of course, subject to market conditions. Now getting into the details around the earnings per share walk, starting at the segment level, we expect strong operating profit growth of about 20%, which results in about $0.77 of earnings per share growth at the midpoint of our outlook range.

And as Chris noted earlier, this overcomes about $2 billion of material and labor inflation. And with respect to pension, although markets have improved since we spoke in October, pension will still be a substantial year-over-year headwind. Based on actual 2022 asset returns and where discount rates ended the year, that headwind will be about $0.22. Our tax rate in 2023 is expected to be approximately 18% versus the 14.4% we saw in 2022, which will result in a $0.22 headwind. This change is primarily driven by benefits recorded in 2022 that likely won’t repeat in 2023. And to wrap things up, we see about $0.14 of net headwind year-over-year, primarily driven by higher interest and corporate expenses, and all of this brings us to our outlook range of $4.90 to $5.05 per share.

So with that, let’s go to Slide 11 for a little more detail on the segment outlooks. At Collins, we expect full year sales to be up low double digits, primarily driven by continuation of the commercial aero recovery. Military sales at Collins are expected to be up mid-single digits for the year as well. We expect Collins adjusted operating profit to grow between $750 million and $825 million versus last year, and this is primarily driven by drop-through on commercial aftermarket, higher OE production ramp and increased defense volumes. At Pratt & Whitney, we expect full year sales to be up low to mid-teens versus prior year, principally driven by higher OE deliveries in both Pratt’s large commercial engine and Pratt Canada businesses, as well as continued growth in legacy large commercial engines, GTF aftermarket and Pratt Canada shop visits.

Military sales at Pratt are expected to be flat, driven by higher F135 sustainment volume, which will offset lower F135 material inputs. We expect Pratt’s adjusted operating profit to grow between $200 million and $275 million versus last year, primarily on higher aftermarket volume, which is partially offset by a higher large commercial OE delivery impact. Turning to RI&S, we expect full year sales to be flat versus the prior year and adjusted operating profit to be up between $75 million and $125 million, driven by improved net program efficiencies. And in R&D, we expect sales to grow low-to-mid single digits versus 2022 as the effects of the supply chain constraints ease in the back half of the year and for adjusted operating profit to be up between $175 million and $225 million versus prior year, driven by improved net program efficiencies, which will be partially offset by continued mix headwinds.

And finally, higher intercompany activity will increase sales eliminations by about 10% year-over-year. And it’s also worth noting, we’ve included an outlook for some of the below-the-line items and pension in the webcast appendix. So with that, let me hand it back to Greg to wrap things up.

Greg Hayes: Okay, Neil, thanks very much. So we’re going to close out on Slide 12 and take a quick look at our priorities. Obviously, there is no surprises here. As we head into 2023, I would tell you the future remains bright for RTX, especially with a $175 billion backlog and strong demand in all of our end markets. We also know the challenges that we saw in 2022 will continue, and we’ll keep working to mitigate the big three that we continued to focus on: supply chain, labor and inflation. And although we’re monitoring the macro environment, we remain optimistic on the economic outlook as the demand drivers for our businesses remain incredibly strong. As Chris mentioned, we’re actively preparing for the demand ahead by expanding capacity, investing in digital solutions and leveraging automation to unlock efficiencies across our value streams.

We have the right team in place, and we’re making the right investments. And we’re also taking proactive actions to mitigate the risks we see today and to ensure success not just in 2023 but beyond. The streamlining lining of our businesses is just the next step in our journey on leveraging the unique scale and capabilities of RTX to deliver value for our customers and our shareowners. Right now, it’s all about program execution and managing costs. We have the backlog, we have the demand, and we have the technology and our balance between defense and commercial aero will help us navigate into the future. We will, of course, continue to stay disciplined in capital allocation, and we’re going to generate strong free cash flow this year and beyond, all of which enables us to return significant value to our shareowners.

Most importantly, we remain confident in our ability to achieve our 2025 targets. We’re going to provide an update at our upcoming Investor Day, which will be on June 19 at the Paris Air Show. Before I close, I really want to say a special thank you to Roy Azevedo for his many contributions to Raytheon over these past 34 years. Roy has been a key member of our senior leadership team at RTX for the past three years, and we wish him nothing but health and success as he moves into the next phase of his career. So with that, let’s close out the €“ this portion and open it up for questions. Latif?

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Q&A Session

Operator: The first question comes from the line of Robert Stallard of Vertical Research. Please go ahead, Robert.

Robert Stallard: Thanks so much. Good morning.

Greg Hayes: Good morning, Rob.

Neil Mitchill: Good morning.

Robert Stallard: Greg, just like to follow-up on your final comment there on your confidence in 2025, whether there’s confidence has been shaken anyway by this change in the R&D tax legislation but also the supply chain challenges because you basically have to double the cash flow between now and then to get to your target.

Greg Hayes: Rob that is a great question, one that we have been working through over these last couple of months. We obviously thought going into the end of 2022 that the tax legislation, the R&D amortization would get eliminated. Unfortunately, that didn’t happen. That cost us $1.6 billion last year. As Neil said, it will be another $1.4 billion. And as we go into the 2025 time frame, that drag will still be about $1 billion, about $800 million of that is actual net R&D deferral and there’s a couple of hundred million dollars of additional interest expense and financing our little loan to the government. So is all that being equal, we still see €“ and we had always talked about a $10 billion free cash flow in 2025. Realistically, I think that number is going to be $9 billion.

Now most of that growth from, let’s call it, $5 billion this year to $9 billion is going to come from segment operating profit, which should grow between 2022 and 2025 by about $5 billion. And that just assumes an execution on the current demand that we have in backlog, right? That’s €“ there’s nothing else magic about that except the continued return of people flying and the defense budgets remaining very robust. So we see a path to the $9 billion. I don’t see a path to the $10 billion today because of the R&D. But it’s a long time, maybe we hope that people in Washington will understand that they’re making a very, very bad tactical decision here and not allowing us to deduct R&D, but it is the reality that we face today.

Robert Stallard: Right. Thanks, Greg.

Greg Hayes: Thanks, Robert.

Operator: Thank you. Our next question comes from the line of Sheila Kahyaoglu of Jefferies. Your question please, Sheila.

Sheila Kahyaoglu: Hi, good morning, guys, and thank you. Maybe a little bit more focus on 2023. You mentioned 400 suppliers in the supply chain. How are you expecting the supply chain to unravel across both the commercial aerospace and defense segments? And you mentioned $2 billion of inflation headwinds. Can you talk about the impact of pricing on a net basis and across the businesses, maybe where you’re seeing the most impact?

Chris Calio: Hey Sheila, it’s Chris. I’ll start with this one and then invite Neil and Greg to chime in. So let’s talk about supply chain for a minute. Maybe start with the positive, which was €“ saw some stabilization as we exited the year last year. If you look at R&D, material receipts were up 30% Q3 to Q4. Supplier delinquencies were down. At Pratt, we saw some uptick in casting deliveries. So those are some of the green shoots that we saw at the end of the year. But I’ll tell you, it’s not where we need to be, especially for the back half of 2023. The kinds of things that we’re focused on, candidly are the things that we can control. We’ve got the people on site, as you mentioned, and they’re responding to engineering and quality issues, giving us better visibility of what’s going on.