BAIRD 2026 GLOBAL INDUSTRIAL CONFERENCE - RTX CORP

Okay. Thanks. Good morning, everyone. My name is Peter Arm. I'm the Senior Aerospace Defense Analyst here at Baird. Very happy to have with us RTX. And with us from RTX, we have Neil Mitchell, who's the Chief Financial Officer. Neil, thanks again for supporting the conference. A longtime supporter, so really appreciate your support. Neil's going to make a few opening comments, and then we'll get into a little Q&A. So, Neil, welcome. Of course. Thank you, Peter. It's great to be here. Good evening. Good morning. Good afternoon, everybody. Before I get started, just a couple of legal matters. I'm going to make some forward-looking statements today, so please consult our SEC filings for a commentary on our risks affecting our business. But maybe more importantly, you know, I think most of you probably know who RTX is. We are a leading aerospace and defense company. We have three industry-leading businesses, Pratt & Whitney, Collins Aerospace, and of course Raytheon. Very well positioned in the A&D sector, incredible demand for all of our products, and very excited about our future. Year to date, we've had very strong financial and operational performance. I think we'll talk a little bit about that, Peter. And of course, we're looking at the fourth quarter here with about 51 days to go, and we're right on track. Back on the third quarter call, we were able to take up our top and our bottom line as well as our free cash flow, so there's no change to our outlook today. Just to reiterate it, we expect sales for the year to be between $97 and $97.5 billion. That's going to be up 10% to 11% organically. Adjusted earnings per share of between $7.65 and $7 and 75 cents a share and free cash flow between $9 and $9.2 billion. Again, no outlook, no changes to our outlook today as we look towards the end of the year. I'd say globally, the demand for all of our products remains incredibly strong. That's reflected in our $340 billion backlog. And so our focus right now is squarely on execution. Obviously, there's noise in the macro, but today we're focusing on what we can control. And we think we've got that well understood as we finish this year and look into 2027. So again, long term, very confident in the business, the momentum and the backlog and see top line and bottom line growth and free cash flow expansion again in 2027 Back to you. Great summary. So let's just start with you. You really had a strong Q3. You raised your outlook. As you mentioned, $97 to $97.5 billion on the top line. And you raised that as well. So as you close the year, maybe what are the key kind of operating milestones you're watching? And where do you see the guy in the greatest opportunity and the risk against kind of your updated outlook? Sure. So, just mentioned, you know, feeling really good about where we are in the fourth quarter here. We're one month behind us already. You know, all of what we need to deliver is obviously in our backlog and in our shops right now. It's flowing through. So, it's squarely on the execution of delivering products to our customers. So, as we think about the OE, that's about being ready for the ramp. You know? I think we're, you Know, doing very well, particularly at Collins, meeting our customers' needs there. And on the aftermarket, we've seen no changes to our customers' buying behavior there. You've heard the airlines over the last couple of weeks talk about, you know, what they're seeing and the resilience in the consumer demand. And so we're seeing that play through as well in the fourth quarter. And then on the defense side, again, just execution. So as you kind of convert that to delivering financial results, you know, most of that performance is going to come on the back of getting stuff out the door from a cash flow perspective. it's really going to be about collections. At this point in the year, you know, we do expect our inventory to come down a little bit as we exit 2026, but most of that will get hung up on the balance sheet. So it's vraiment about collections from our customers to deliver our cash for the year. Got it. So good momentum as we think about exiting the year? So if we think About 27, and I know you're not giving formal guidance until January, but you have pointed to sales and earnings growth operational margin expansion higher free cash flow all the things we love but of course but maybe give some thoughts on the you know drivers of those top and bottom line around you know kind of broad brushstrokes of 27 sure you're right I'm not gonna give our full outlook for 27 today we'll do that on our January call but I did mention a few things on our third quarter earnings call maybe I'll just sort of reiterate a couple of the moving pieces you know directionally that we see today. So obviously starting from a really strong position with the backlog, you know, really across the business. So we expect to see top line growth, expect to see that drop to the bottom line. The segments will all see operational profit growth and operational margin expansion, you know taking into consideration a couple of the one-time items that we mentioned on the call in particular the IEPA refunds that won't repeat. But you know, if you just kind of break down the business on the OE side, the production ramp is pretty clear to us right now. We're seeing that not just in the narrow body, but, you know, clearly in the narrow body aircraft category, but also in our business jet business, our general aviation, helicopters, really, you knows, seeing continued rampant demand there across the commercial aerospace platforms. On the defense side, the demand is very, very clear. Raytheon in particular, probably a little over 80% of what we think we'll deliver next year in terms of sales is in our backlog. 85% of that or more is fully funded. So even in an environment where we have a continuing resolution, we feel really good about sort of the backstop on delivering those sales for 27 and on the aftermarket I already mentioned the fact that you know we're monitoring just like everybody you know the price of of jet fuel and consumer behavior and airline behavior but we've seen no changes to that in the fourth quarter so while the compares get a little bit more difficult because we've been going through such a tremendous growth period you know we still see growth in the after market and I think that's that's further backstopped by a couple of things you know at Pratt & Whitney it's all about getting our geared turbofan you know and engines off the ground and there remains a backlog of engines and so our shop visits are sold out through 2027 so I feel really good about the aftermarket you know from that perspective the V2500 which powers the legacy you know V320 CEOs also very stable you know we've seen 800 shop visits or we'll see 800 shop visits this year. We're going to see about the same number next year on a higher content as we go through heavier overhauls on those engines over the next couple of years because half of those engines haven't even seen their second overhaul, which is their heaviest content. So we feel really well positioned on the Pratt-Whitney side. And then Collins is indexed a little bit more to revenue passenger kilometers, But nonetheless, the growing out-of-warranty installed base, which today sits at over $105 billion, continues to grow. And we continue to support the fastest-growing platforms that are more fuel-efficient, so particularly in demand in this environment, with twice the content that we had on legacy platforms. And so Collins, too, sits in a very solid position. And we'll continue to watch the macros like everyone else, but feel really good about sort of the top line. On the bottom line, I mentioned that we'll see operational margin improvement at all three segments. So we're not done with where we think the full potential of RTX is from a margin perspective. There'll be a couple of headwinds. They're sort of one-timers. We won't have the $0.25 of adjusted earnings per share, IEPA benefit repeat in 27. And then on the last earnings call, I talked a little bit about a cash pension headwind of about $100 million from a cash perspective. If I think about the P&L impact of pension income, it's probably going to be about a $0.30, $0,035 headwind in this rising interest rate environment. But operationally, we'll see adjusted earnings per share grow and the margins expand. Got it. Got it, perfect. So to support all this growth, you're generating a lot of cash. Obviously, there's a lot of working capital as well along supporting that. Maybe think about, you know, how much working capital is needed to kind of support this growth and how you're thinking about that. That's a really good question, Peter. You know, in an environment like this where we've got such a tremendous backlog, we have really good visibility to what the next several years of our deliveries are. And, you Know, we continue to see this strength play through in the aftermarket, too. And you can't sell something you don't have. And so we've put a lot of focus over the last several years in refining our sales, inventory, and ops planning process so we can get better connected and get better flow from our supply chain and through our factories and to our customers. We continue to sit on what we call sold overdue. So there's backlog of things that are placed on order that we need to deliver. So to support that, I do expect us to have a little bit of working capital build as we look into 2027. That said, it's supporting, you know, continued organic growth. Big picture from a cash flow perspective next year. Again, I mentioned a few things on the third quarter call. We've got some, you Know, called non-recurring items. The first is, you Now, powdered metal. We're coming down the payment curve, you Know, significantly there. so we expect about a $500 million tailwind from 26 to 27 from, you know, satisfying those obligations. Which, by the way, came in exactly where you were talking about or even a little lower right from three years ago. It's been right on track, Peter. I mean, you guys don't get enough credit for that, but I mean it certainly came tracking exactly what you were thinking. Definitely appreciate that. A lot of hard work at the Pratt & Whitney team to make that happen. But, you Know, we see that coming down, So that'll be a tailwind as we turn to 27. We won't have the IEPA refunds repeat. That was about a $350 million benefit to cash for 26, and $50 million of that will happen here in the fourth quarter. And the pension headwind of $100 million. Those things sort of net to about a$50 million tailwind. So I'd call that, you know, break-even-ish. At the bottom line, you Know, we'll see segment operating profit grow. And we're going to support this growing demand with higher investments on the capital side. A lot of that will be funded, and I'm sure you have some questions on the munitions framework agreements and the UCAs that we signed. But, you know, we do expect some higher investments as we get into 27, but net-net, we'll see cash flow grow between 26 and 27. Perfect. That's a perfect transition, a shift of defense. You've converted four munition framework into potentially, I guess, $70 billion in contracts, Tomahawk, AMRAAM, booked in Q3, SM6, SM3 in October. How should we think about the revenue building through the capacity phase toward full rate production, you know, around 2030, I think, is when that rate is going to be? And beyond those awards, where does international demand most likely convert next? Good question. A couple of thoughts. First of all, we're really happy with the fact that we're able to move from framework agreements into undefinitized contracts. These are binding contracts. They have robust terms in them. And a lot of hard work between ourselves and the Department of War went into, you know, getting those things converted into contracts. And so we're now off, started, you now, investing to capacitize, working with the supply chain to get them on board. That'll be a really important part of success here. So overall, really good business for Raytheon. It gives Raytheons 10 years of visibility to the demand for these critical munitions. And more importantly, it gives the same signals to our supply chain, which we need to come along with us throughout this entire journey so that they can capacitize as well. And so all of that is underway. Importantly, these contracts give us some protections that were really important to us. And we got that included in the contracts, where if the funding or the volumes or other things change on the government side, we're protected on the downside. So we can confidently make these investments now and into the future. And if something were to change, we'd be able to recover that under the contract terms. But that's not the intent of either us or the U.S. government. This is stuff that is in high demand from the customer, obviously, and both us and our customer are incentivized to perform and make these contracts last through its duration. In terms of how it's going to happen, how it'll be accounted for, just like all of our defense contracts. So on a cost-to-cost basis, we'll recognize revenue as we start to incur costs. We have a collaborative funding agreement in place in this contract, meaning essentially it'll be cash flow neutral until we get into the production phase of the contract where we start to deliver goods. And then we get paid the residual amount for the work that we performed in delivering the munitions. So as I kind of think about that over the next three years, we'll start to make investments in capital. We'll start To make investments In our supply chain. we'll support you know we've already placed purchase orders for tooling and equipment we will get funding that'll show up you know sort of in our contract accounting math over the next couple of years and then of course we'll get long lead material that starts to come in and as we do that you'll start to see some revenue and profit over the long term as we drive through into that production phase you know the last seven years say of the next 10 year period these contracts have the opportunity to be, you know, margin accretive to where Raytheon sits even today. And so, you Know, we're in the mid-12% margins today. But as we drive, you Now, the scale and the efficiencies through the production phase of these contracts, we think these are, you Knew, likely to drive margins upward from where we sit. And the international piece, and when do you think that's going to convert? International, really important. So somewhat maybe overlooked in the Q3 results was the fact that we booked $9 billion of international awards in the third quarter alone. On a year-to-date basis through the end of September, Raytheon's international bookings are two and a half times larger than they were for the same period in 2025. So tremendous momentum already, and we see more opportunities ahead of us on the international side. If you exclude the munitions framework, the two contracts, the Tomahawk and AMRAAM contracts we entered into in the third quarter from our backlog, Raytheon's backlog is 52% international. So really good mix. That will help, too, with the margins. And I see more opportunity as we look ahead. I mean, it's Patriot radar systems. It's our next generation LTAMS radar systems, it is the GemT missile, which is the effector. both of those systems. It's Coyote, our counter UAS system that's been highly effective. I could go on and on. Standard Missile, we're really seeing a lot of traction, you know, around the globe, Europe, Middle East, and Asia-Pac. So the next 10 years, we see those budgets growing internationally. And because of our presence in each of those markets, we have a strong localized presence as well, we're pretty confident that we'll continue to see that, you know, demand for these products. Got it. So to support all this growth, obviously, you've got to make some investments in your supply chain and kind of help think about that. So where are the most important bottlenecks today, if we think aboutthat? And milestones that maybe you're telling your supply chain or when they need to be ready? You know, and how you're kind of, I guess, treating the contract funding approach, largely, you know, upfront cash, things of that nature. Sure. So, you know, as I said before, the supply chain needs to come along with us all along the way. And we have a dedicated team stood up in particular at Raytheon to deal with this massive amount of munitions that we plan to deliver over the next 10 years. And so we've been working with the supply chain for the past year to start to tell them about the volumes and get them under contract. So one of the most important milestones will be getting the supply chain under contract. The key areas of the supply chain, I'd say that we're focused are no different than the things we've been talking about for, you know, five or six years now, frankly. The good news is the first one is rocket motors and propulsion. You know, we've identified three new suppliers and they come on board in the next couple of years. And so they're well on their way in terms of, you know, creating an alternate source for the volumes that we'll see under these programs. Castings is another area. You know, we talk about it a lot on the engine side, but it's just as important on the munitions side. So we're seeking alternative sources of supply for things that are casting and make up the missile bodies, et cetera. You know last year alone Raytheon brought on 150 new suppliers as alternative sources. So again, work that's in process, but more to do. And I'd say that's another key milestone. How many alternate sources do we identify for things that in the past we've been able to get away with sole source, but with this level of volume and these production rates, we're going to need to have more than one source. And, of course, microelectronics. So these are very sophisticated pieces of equipment that we sell, and it's high volume to us, but lower volume relative to the industry. So, again, putting in place agreements to secure the supply there is really important. I think as we look at other milestones in terms of delivering here, it's really about, I talked about the supply chain. It's about capacity as well. Not just our capacity, but the capacity deeper into the supply chains. So we are measuring and will continue to be measuring the pace at which the supply chain and we enhance and increase our both capacity and throughput through productivity initiatives along the way. So that'll be a really important thing. And then as we bring material receipts in, we've experienced double digit material receipt increases year over year, all of this year. that'll be another metric you know as we get deeper into the you know the preparation time here for production that we'll be monitoring to make sure that we've got the stuff we need to get the equipment out the door on schedule got it let's move over to the commercial side in in q3 r2x commercial we sales were up 10% year-over-year how should we think about the next leg for with Boeing an Airbus kind of ramps, the balance between kind of installed and spare engines at Pratt and any kind of remaining constraints that you're thinking about on the production plans? Sure. I'll hit this one quickly. I mean, we are aligned with the OEM manufacturers, you know, generally speaking here. And I'd say, you Know, historically, that wasn't always the case. You know, I think we would, you Now, Collins has done a really nice job staying in step with their OEMs, Boeing in particular. And we've talked a lot about what we're doing at Pratt Whitney. You know, it's been a balancing act of material between OEM, MRO, SPARES, as you've mentioned. You know the demand for all three of those things remains strong. And it'll continue to be a balancing Act as we as we go forward. But we will continue to increase our output to Airbus this year, as we will next year. And then with the residual material that's available, we'll be balancing that between MRO and the spare engine pool. You know, we're continuing to see a lot of demand for spares, as you'd expect. This fleet is going to continue to grow very substantially, the geared turbofan fleet, over the next, you know, decade. And so, you Know, over time, the spare ratio will normalize, but the spare volume will continue to growth. So I think, you know, no changes here today and expect to be on track as we, you know, enter into. It's good to be in sync with the OAs on this. I would say our Pratt Whitney Canada business, which is the small engine business, same thing. The demand there across all of their end marks remains very, very strong. And, you Know, we're constrained on the materials, but we're continuing to, you know, grow in that business as well on all fronts. So Q3 in the aftermarket, you grew 16%, I think, organically on commercial after. And that was despite a little bit of lower RPKs. So a lot of resilience, big install base, probably some price. Think about things. So how are you thinking about, like, in this environment, if airlines start trimming capacity or you see retirements pick up, where would you guys see that first? Or, you know, you have an enormous install base. But, you Know, how are we thinking about that? Sure. As you said, it's a very diverse installed base, so I think that helps. By the way, we've seen 16% organic growth on a full nine-month basis this year, too. So really strong aftermarket growth. I do expect the compares to get difficult, but we still see growth. There's some things that are, I think, unique and helpful about our current installed base that help to support the aftermarket. We talked about Pratt already, so we won't go deep here. But, you know, obviously the GTF aftermarket pretty sold, you know, sold out for next year for sure and beyond. V2500 is stable. The Legacy older engines also pretty stable, very high content there. Collins is where, you Know, it's a little more indexed, as I mentioned earlier, to the revenue passenger kilometers. But with the increasing content we have there, you Know, more and more engines coming off a warranty. Because keep in mind, we had significant OE growth over the last four years. And so every year, the population of aircraft that come out of the warranty period is bigger than the year before. And, so long as we continue to see robust revenue passenger traffic, we're going to continue to seeing aftermarket come from that. Pricing is another lever, as you pointed out. And as we all know, the cost of materials is going up and we're doing everything we can to pass that along to our customers in the confines of our contracts. So, So, you know, we got to be cautious here like everybody and watch, you know, the behavior of our customers. But as I said, we've seen no change to that so far. And there's some structural things that make our installed base, I think, very resilient, you Know, over the near term. Yeah. And also the V2500 recovery still is, you Know, it's very strong. It's very good. You know, 800 inductions this year, right on track through the end of the third quarter. See the same level of demand, you Know, as we head into next year. you know, retirements have been in line with what we've expected. You know, there are going to be retirements. That's not a surprise to us or the industry, but that's all been planned. I'd call it a structural decline. And as I mentioned, the content on these overhauls gets heavier and heavier along with the pricing that we're able to put forth there. So we still see a lot of life in the V2500. That's great. On GTF, so your output on the MRO side has increased more than 35%. AOGs have been a little, you know, they've been stable sequentially. How do you expect the, you know AOG reduction and kind of what milestones should we watch as we think about 27? Good question. You know, we continue to make a lot of good progress there. We'd always want that to be a little faster than it has been. But I would say, you know, as is typical in the third quarter, coming off of the summer travel season, we always see higher level of removals of engines from airplanes as they go into a bit of a lull before you get back into the holiday season. So we expected that, and that was sort of reflected in the AOG number. We continued to drive MRO output. As you said, it was up 35% on the PW1100. That's the A320 version of the GTF in the third quarter. It's up about 30% on a year-to-date basis. We expect that to continue in the fourth quarter. So AOGs should trend down in the fifth quarter. And continue to trend down into 2027. And I'd say from a financial perspective, that's all been contemplated in our outlooks. And as we talked about just a few minutes ago, in our powder metal reserves. Yeah, so it's unfair to ask this question with little time remaining, but, you know, on productivity and margins, when you think about the size of RTX, right, just, you Know, there's a lot of moving parts, but, You know, you think about a business like Collins, like, is there still structural runway there in the margin? Is there opportunities that you guys see just, You Know, for that business? And then how do we think about just kind of as mix moves around, as OE gets bigger, you Now, how are you thinking about kind of the balance between productivity and margin? Sure, really good question. I mean, there's a few things I'm pretty excited about at RTX. One is our products. They're exceptional. Two is the momentum that we have and the demand. And three is the fact that we're not at our full potential. And by that, I mean we're Not at our Full Financial Potential. And with respect to margins, as I kind of quickly kind of go around the businesses, Collins, we've talked about being a 19% to 20% margin business. So a really strong third quarter. they're making all the right decisions you know very strong focus on structural cost reduction that will have a compounding effect over the next several years we've got the aftermarket that drops through at margins that are accretive to the portfolio and you've got oe which we've been talking about for a long time driving you know enhanced absorption of our fixed overhead costs all those things continue to give us confidence that we can get collins back into that range if not higher over the next several years. At Pratt Whitney, again, it really hinges on the gear turbofan aftermarket. You know, we've got the GTFA, the next version of the gear turbo fan in production, in service, ramping production over the last couple of years, and the hot section plus, which is the kit that will bring 90 to 95% of that benefit to the engine. So all those things will you know help to expand time on wing and over the longer term we'll play through the margins and our long-term contracts to drive those margins into where I see you know low to mid-teen entitlement for Pratt Whitney of course Raytheon we talked about getting over 12 percent you know our outlook for this year at the midpoint is 12.8 percent we're not capping the business there talked about the potential benefit from the munitions agreements you know with it we have the international mix and so you know we see continued tailwind there great so in our last couple minutes here cap allocation probably a great place to end generating a lot of cash so how are you balancing kind of the reinvestment debt reduction dividends potential buybacks obviously you did a major buyback three years back right supply chain resilience would you acquire a supplier rather than partner with one? How are you thinking about just cap allocation in one big bucket, I guess? Really good question. It starts with the ability to generate a lot of free cash flow. We see that continuing. We expect our free cashflow generation capability to continue to be between 90 and 100% of adjusted net income as we look over the long term. So we'll generate a lot of cash, and that's after investing a lot in the business. So priority number one, investment in research and development, ours, the customers, capital, you know, this year it'll be over $10 billion worth and we expect that to continue. So that's priority number one. Priority number two, I would say, is the dividend. You know, we've been committed to the dividend, we remain committed to the dividend and we'll continue to grow the dividend You know this year we've talked about paying down debt and we will do that and wrap up the debt that we took out to do that accelerated to share or purchase. And then it comes down to, you know, choices between M&A, Bolton. We love the portfolio that we have today. We'll probably do a little pruning. You've seen a couple things get announced, but we're always looking for Bolton technologies. And that, of course, using the playbook that you're used to seeing us use over the long term in returning capital to shareholders. Terrific. Neil, thank you so much. Thank you, everyone, for joining us. Neil. Thanks again for supporting the conference. Appreciate it.