Q4 2020 Raytheon Technologies Corp Earnings Call

Okay.

Good day, ladies and gentlemen, and welcome to the Raytheon Technologies' fourth quarter, 'twenty and 'twenty earnings Conference call. My name is normal and I'll be your operator for today as.

The reminder of this conference is being recorded for replay purposes on the call today are Greg Hayes, Chief Executive Officer, Toby O'brien, Chief Financial Officer, Neil Mitchell, Corporate Vice President and financial planning analysis and Investor Relations.

And let's call the screen carried live on the Internet and there is the presentation available for download from Raytheon technologies website at Www Dot dot.

Dot com.

Please note, except where otherwise noted the company will speak to results from continuing operations, excluding net non record recurring and non four significant items and acquisition accounting adjustments often referred to by the management of other significant items. The company also reminds listeners that the earnings.

And cash flow expectations and other forward looking statements provided in this call are subject to risks and uncertainties are T. Six SEC filings and fleets. It's forms 8-K, 10-Q, and 10-K provide details on important factors that could cause actual results of <unk>.

Materially from and those anticipated and 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 re inserting yourself into the queue as time permits with that I'll turn the call over to Mr.

Hayes.

Okay, Thank and normal and good morning, everyone and welcome to <unk> 'twenty 'twenty one.

So for those of you following along and the webcast where to start on slide two.

Just taking a look back on 'twenty and 'twenty as painful as it was it's obviously one of the most challenging years of for our company for.

For the commercial aerospace industry at large and for everyone around the globe.

But importantly, it was also transmit transformational year for us because we created and industry, leading aerospace and defense company.

And we're really proud of the way our team managed through the pandemic and continue to support our customers our suppliers and our communities without missing a beat and.

And many areas, we were able to accelerate our progress and we found new ways to increase our productivity that will be of part of how we operate going forward.

So let me go over some of the highlights from 2020 and.

And we'll start with the portfolio of transformation and integration.

We obviously achieved two significant milestones this year by completing the separation of Otis and carrier as Standalone public companies as.

And as well as the merger of that same day on April 3rd with Raytheon Company formed Raytheon technologies.

This was the culmination of a multiyear effort to transform the company into an innovative and focused and leading aerospace and defense company that will define the future of the industry.

And connection with this transformation. We also completed the divestiture of several businesses, including the sale of force point the closed earlier this month.

All of that resulted in net proceeds of over $3 billion further strengthening our financial position.

We continue to strengthen our portfolio with strategic bolt on acquisitions, and we'll continue to evaluate other non core divestitures this year and.

December we completed the acquisition of Blue Canyon technologies, which will now enable us to deliver a broader range of solutions to support our customers' space missions.

And we will of course remain disciplined on M&A.

Looking at our performance, we continued to execute on the integration of both the merger as well as the Rockwell Collins acquisition. So we achieved about $240 million of gross synergies from the merger as well and that's rolled above our initial target of 200 million and of Collins, we achieved about $170 million of incremental cost synergies.

And again above our target for the year of 150 million.

So since the acquisition of Collins and November of 2018, we have seen about $470 million of synergies well on our weight of the $600 million of we had committed to.

On cash we exceeded our cash conservation commitments and fully executed and our cost reduction plans with early and decisive actions that we announced in may of last year for.

For the full year, we achieved about $4 $7 billion of cash conservation as well as more than $2 billion and cost reduction.

And of course, we'll continue to take other structural cost reduction actions, which will cover in more detail a little bit.

So despite the the kantar.

Economic environment of the quarter, we finished the year with better than expected sales earnings and free cash flow free.

Free cash flow was significantly better at 747 million and the quarter and that was driven by exceeding their cash conservation actions as well as strong collections across the portfolio.

And the 747 million is after making $800 million of discretionary pension contributions and December.

So for the full year pro forma free cash flow was $2 3 billion, which we see growing to at least $4 5 billion in 'twenty and 'twenty, one and Toby who'll take you through the full year outlook later in the call.

The aggressive short and long term cost reduction actions that we've taken have enabled us to emerge from 'twenty and 'twenty as a stronger company with a better cost structure and stronger free cash flow generating capabilities.

To be clear when the commercial aerospace markets rebound and I'm confident and our ability to get back to the levels of cash flow contemplated before the pandemic.

And also where the strength of our cash flows and our confidence and the recovery. We remain committed to returning $18 billion to $20 billion of capital to our shareholders of the four years following the merger.

As you saw back in December our board authorized a new $5 billion share buyback program and then 2021, we plan to Opportunistically buy back at least $1.5 billion of shares and we remain fully committed to our dividend and growing our dividend as earnings recover.

Over the past year of defense businesses remained resilient.

The defense backlog ended the year and over $67 billion and our key defense franchises are well funded and aligned with the National defense strategy.

Positioning us for further growth this year and the following.

Turning to our segments, let me share of just a few highlights for the year, we start with Collins.

So the Collins partnering with airline customers to develop some innovative solutions, including Touchless airport kiosks aircraft fixtures and anti viral surface coatings and enhanced air filtration systems to make air travel, even safer and healthier at.

And at Pratt the geared turbofan fleet reached over seven and a half a million of revenue hours and fleet utilization continuing to improve as we exited the year demonstrating the value proposition of this unique engine technology for our customers and.

Importantly, dispatch reliability improved to $99 97 per cent for the fleet.

The Raytheon intelligence and space the team had $4 $3 billion of classified bookings and high technology areas that will drive growth well into the future.

And finally at Raytheon missiles and defense the team delivered at historic flight test, where for the first time ever and SM three block two a missile launched at sea successfully intercepted and destroyed and Intercontinental ballistic missile target outside of the Earth's atmosphere truly extraordinary technology.

So with that let me turn it over to Toby and have them walk you through our financial performance for the quarter Tobey.

Thanks, Greg and moving.

Moving on to slide three let.

Let me first give you an update on some of the key actions, we have taken to rightsize the cost structure of our organization.

First as Greg highlighted we over drove the cost reduction and cash conservation commitments, we set early last year.

And we'll see continued benefits from those actions in 'twenty and 'twenty, one and beyond.

Next on the synergy front excellent momentum there as we exceeded both our our TX and Collins targets in 'twenty and 'twenty, what's the significant increase anticipated in 2021.

We also announced a number of other cost reductions that are more structural in nature.

To start with.

We previously took the difficult actions to reduce commercial head count and Collins and Pratt by 15000.

And to eliminate 4000 contractor roles.

We have recently reduced commercial head count and Collins by another 1500.

And the told her the 16005 hundred and contractors by another 500, bringing the total to approximately 4500 contractors as we continued to position the business for strength as the industry recovers.

Reducing our total commercial Aero head count now by approximately 20%.

And as you've heard we announced perhaps investment and the new airfoil facility and that we are shifting some production of circuit cards to our circuit cards center of excellence.

And we're not just looking at the commercial side of our business for cost reduction.

And our I S were undertaken an initiative to consolidate manufacturing that will yield the footprint consolidation of 280000 square feet and savings of $160 million over a 10 year period and initial planning is underway and the project will be complete by mid 2025.

Additionally, we are taking aggressive steps to reduce our office footprint by up to 25% over the next several years with the 1.6 million square foot reduction expected by the end of this year.

And as always we are continuously looking for other opportunities to permanently reduce cost to position us for even better long term profitability.

Moving onto slide four.

Let me take you through our fourth quarter results, where our performance was better than expected.

Adjusted sales were $16 6 billion.

With all four segments contributing to about $1 6 billion of sequential growth.

Adjusted EPS was <unk> 74 cents better than expected, primarily driven by a lower effective tax rate.

As well as higher than expected commercial volume at Pratt and Collins that was partially offset by an EAC adjustment at RIS and some later timing of awards at our M D.

On a GAAP basis EPS from continuing operations was 10 cents per share and.

And included 64 cents of net nonrecurring and our significant items and acquisition accounting adjustments.

Free cash flow of $747 million was better than expected and included $800 million of discretionary pension contributions as well as approximately $360 million of merger cost restructuring and tax payments on divestitures the.

The better than expected cash flow was driven primarily by exceeding our cash conservation actions, including inventory reductions at Collins as well as stronger collections across all of our businesses.

With that I'll hand, it over to Neil to take you through the segment results and I'll come back and share some perspectives on the year ahead Neil.

Toby starting with Collins aerospace on slide five adjusted sales were $4 4 billion and the quarter down 32% on an adjusted basis and down 31% on an organic basis, driven primarily by the adverse impact of COVID-19 on the industry.

Sequentially sales were up 3% driven by slight growth and commercial OE and aftermarket.

By channel commercial OE sales were down 41% driven principally by the impact of the current environment lower 737, Max and the anticipated declines in legacy programs.

Commercial aftermarket sales were down 48% driven by of 47% decline and parts and repair of 58% decline and provisioning and of 46% decline and modifications and upgrades.

Partially offsetting the headwinds and the commercial channels defense sales were up 1% on an adjusted basis and up 7% organically driven by F 35, as well as growth and our avionics and actuation product lines.

Adjusted operating profit of $89 million was down $1 billion from prior year and slightly better than our expectations for the quarter cost management actions, including lower E&E and SG&A as well as continued synergy capture were more than offset by lower commercial OE and aftermarket sales and fixed cost headwinds.

Shifting to Pratt and Whitney on slide six.

Adjusted sales of $4 $5 billion were better than expected.

Year over year sales were down 20% on an adjusted basis and down 21% down and organic basis also driven by the adverse impact of the current environment on the industry sequentially sales were 19% higher in Q4 than Q3, driven by growth and commercial aftermarket and military.

Commercial OEM sales were down 46% compared to elevated volumes in Q4 2019. This was driven by lower deliveries of across both plants, perhaps large commercial engine and Pratt Canada platforms.

Commercial aftermarket sales were down 32% and the quarter driven by an expected decline and shop visits growth and the G. T. F aftermarket volume was more than offset by the impact of a reduction and legacy large commercial engine shop visit inductions of 52% and a 25% reduction and Pratt Canada shop visits.

Joint strike fighter production continues to drive sales growth and Pratt's military business military sales were up 18% on higher F 35 of production and aftermarket sales across key platforms.

<unk> adjusted operating profit of $105 million was down $365 million from the prior year significant aftermarket volume reductions and fixed cost headwinds more than offset cost containment measures, including sizable G&A and the E&E reductions drop through on higher defense sales and the absence of of prior year contract adjust.

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Turning now to slide seven.

As reported sales were $3 $9 billion or up 3% versus the prior year on a pro forma basis slightly below our expectations due to later than anticipated timing on certain awards that are now expected in 'twenty and 'twenty one.

Sales and the quarter, where the loss were also impacted by expected declines and the Warfighter focus program, which represented about two points of headwind and the quarter.

Reported operating profit and the quarter was $355 million down $70 million year over year on a pro forma basis, primarily due to an unfavorable EAC adjustment of approximately $90 million on of domestic classified fixed price development program keeping.

Keep in mind the percentage of completion reset at the merger day continues to impact the compares for both sales and operating profit at the legacy Raytheon businesses.

Our I S had bookings and the quarter of $3 $9 billion, resulting in a backlog of $18 $7 billion, a year and cigna.

The significant bookings included approximately $950 million on classified programs and approximately 235 million for the production of silent Knight radar systems and spares for the U S Special operations command.

Full year book to Bill on a pro forma basis was 1.07.

Turning now to slide eight.

M D. Adjusted sales were $4 4 billion up about 2% versus prior year on a pro forma basis, but below our expectations principally due to delays and the timing of awards, which are now also expected and 'twenty 'twenty one and.

Additionally, Rmt's reported sales and operating profit were adversely impacted by and adjustment related to direct commercial sales contracts from munitions with the middle east customer, which are subject to regulatory approval.

Furthermore, Rmt's reported operating profit included an unfavorable impact of approximately $516 million related to these contracts for and impairment of certain inventory and associated supplier related obligations and.

Adjusted operating profit, which excludes these contracted impacts was $586 million and again as I mentioned earlier, both sales and operating profit in the quarter included the continued impact of the EAC reset as a result of the merger.

Rmt's bookings and the quarter were approximately $3 $2 billion, resulting in a yearend backlog of nearly $30 billion significant bookings in the quarter included approximately 350, my 355 million from a classified program and several other notable awards over $200 million each.

Full year book to Bill on a pro forma basis was 1.06.

And now I'll turn it back to Toby to provide some more color on the rest of the year.

Thanks, Neil I'm now on slide nine.

Let me give you some perspective on how we see the current environment as we look ahead at 2021.

As you know, we performed exceptionally well on our cost reduction and the cash conservation actions in 2020.

And as I've previously discussed we will see some continued benefit from these actions along with the incremental head count actions at Collins, which will be partially offset by headwinds from the reinstatement of merit increases and reduced furloughs.

So on a net year over year basis, we expect this to be of 300 million dollar benefit in 'twenty and 'twenty one.

On the merger and acquisition synergy front, we expect to deliver an incremental $610 million of growth our T ex synergies and $85 million of incremental Collins synergies this year.

And our liquidity position remains very strong.

And we ended 2020 with about $9 billion of cash on the balance sheet that has been further bolstered by the sale of our force point business that closed earlier this month.

Moving now to the macro factors.

While we and the industry will have a tough compare and the first quarter.

The availability of multiple vaccines is encouraging we.

We expect the pace of the commercial Aero recovery will depend upon the speed and breadth of vaccination rollouts across the world.

As a result, we expect sequential RPM growth to accelerate as we progress through the year.

Consistent with recent travel trends, we expect narrow body and regional traffic to rebound before of wide body.

Particularly due to the continued international border restrictions.

For the third consecutive quarter, we saw continued improvements and utilization across the G. TF powered <unk> hundred 20 neo fleets as.

And as well as solid utilization of the 820 platform and the fleets powered by <unk> the 2500 engines.

Looking longer term, we continue to expect that it will take until at least 2023 for a commercial traffic to return to 2019 levels.

We continue to expect defense program growth to remain robust both domestically and internationally.

We remain confident and our ability to grow those businesses, even in a flat budgetary environment due to our strength with international customers, our innovative technologies and our positions and high growth areas.

With that backdrop, let me tell you how we see the year ahead.

Moving to slide 10, and and our TX level, we expect full year 2021 sales to be between $63 4 billion and $65 4 billion.

And adjusted earnings per share of $3 40 to $3 70.

And as Greg said, we expect free cash flow of approximately $4 5 billion.

Keep in mind with the force point of sale that closed earlier. This month, we have divested four businesses and the last year, which combined create about $1 billion of sales headwind year over year.

I should point out that our ranges for 2021 are a bit wider than we would typically provide driven.

Driven entirely by the macro factors impacting our commercial aero businesses.

With our ranges we are attempting to capture the potential variability we may encounter given the current environment and the speed of the vaccine rollout.

Revenue passenger miles and the behaviors of our customers.

As the year progresses, and as we have more clarity, we would expect to narrow our outlook ranges.

As I mentioned, the first quarter will be a tough compare as the effects of the pandemic did not materialize until Q2.

Therefore in the first quarter, we expect to see declines and our commercial businesses similar to what we saw and the second half of 'twenty and 'twenty.

With that context, we have bifurcated our outlook between what we are expecting in Q1.

Versus the Q2 to Q4 periods.

So for Q1, we see sales and the range of 14.8 to $15 $4 billion.

EPS and the range of 70% to 75 per share.

And we expect to see of cash outflow due to seasonal factors and timing of collections.

We expect the vaccine rollout easing of international travel restrictions and increasing rpms will enable sales growth to accelerate from Q2 onward.

And with total company sales growing between five and 8% on an adjusted basis.

And between 7% and 10% organically on a year over year basis for the Q2 to Q4 period.

As a result, we see EPS growing approximately of $1 10 year over year at the midpoint of our outlook range and the Q2 to Q4 period.

Because of the unique environment, we're facing let me take you through some of the key assumptions and our outlook.

At a macro level, our assumptions for Collins and Pratt are based on vaccines being widely available and the U S by mid year.

That there isn't another wave of the pandemic.

And that Rpm's improved meaningfully during the year.

For example, and order for us to see the high end of our commercial Aero ranges, we need to see sequential RPM improvement throughout the peak summer travel season of.

20% to 30% each quarter, leading to a $40 to 50% year over year improvement.

We are also assuming that load factors improve along with the rpms and corresponding growth and available seat miles, which fuels our aftermarket.

For RMB and RIS, we also expect volume to increase sequentially as we execute on our strong backlog.

And that the Dod budget is implemented without delays.

We also expect sequential margin improvement as our programs for <unk> complete increase and.

And the approach of more normalized pre merger level as we exit 2021.

With that let's move to slide 11 for the segment outlooks.

You'll notice that we've included our sales and operating profit expectations for the year.

Given the tough compare in Q1. We've also included our Q2 to Q4 outlook here as well.

I should note that the major variable for Collins and Pratt this the trajectory and mix of the aftermarket recovery as you would expect.

I'll start with Collins, where we see sales for the year down high to low single digits on an adjusted basis.

And down mid single, but down slightly on an organic basis.

We expect full year operating profit to be in the range of down $275 million to up $25 million versus last year.

I should note that military sales at Collins are expected to be up low to mid single digits organically for the year.

As we think about Q2 to Q4.

We are assuming that we see a 20% to 30% year over year recovery and parts and repair sales and of 15% to 25% recovery of mods and upgrades and provisioning sales that drive total sales growth over the Q2 to Q4 period of mid single to low double digits.

Turning now to Pratt and Whitney.

We expect sales to be flat to up mid single digits for the year and the operating profit to be and the range of down $125 million to up $25 million.

Military sales at Pratt are expected to be down slightly to roughly in line with last year after growing 14% and 2020.

As we think about Q2 through Q4, we expect legacy large commercial engine shop visits to be up 25% to 30% year over year, which drive sales growth over the Q2 to Q4 period of low double digits to mid teens.

Turning to the defense businesses, let me first mentioned and that will talk about these segments on a pro forma basis. First this means we will talk about both segments as though they were part of our TX for all of 2020.

Second we have aligned our reconnaissance and targeting systems and electro optical innovations product lines from RMB segment to RIS to better align the businesses, which we have also recast.

A summary of pro forma 2020 results inclusive of these impacts can be found and the webcast appendix.

And so at Raytheon intelligence and space, we expect full year sales to grow low to mid single digits with strength coming from classified programs and the ISR and space.

And we see operating profit growing $125 million to $175 million.

I should note here that as we look at Q2 to Q4 operating profit is expected to be up $175 million to $200 million.

And at Raytheon missiles, and defense, we expect sales to grow low to mid single digits, driven by volume growth across multiple programs.

The operating profit up 25% to $75 million.

It's also worth noting that as we look at Q2 to Q4 RMB as operating profit is expected to be up $150 to $175 million.

Moving to slide 12, we have provided an outlook for some below the line items.

Also mentioned that we've included a multiyear pension outlook and the webcast appendix.

Now turning to slide 13 for our 2021 and EPS walk starting with the segments. While they are expected to be relatively flat for the year. As you can see that's driven by the tough compare in Q1, we.

We expect the segments to generate a little over 90 cents of EPS growth at the midpoint of the outlook range and the last nine months of the year.

Pension will be a significant tailwind primarily driven by adjustments to legacy plans.

While interest rate movements and favorable asset performance.

Our adjusted effective tax rate in 'twenty and 'twenty, one is expected to be about 19% versus 17, 5% and 2020 <unk>.

Results are and resulting from higher projections of U S income as well as some favorable tax results and 2020 related to prior years, which aren't expected to repeat.

This will result in the <unk> headwind.

And corporate expenses interest and all other will be and 18 headwind at the midpoint of the range, primarily driven by a step up for <unk> as the program continues to achieve its development milestones and 'twenty 'twenty one.

As well as cost to achieve synergies and some higher interest expense all of this brings us to our outlook range of $3 40 to $3 70.

Now turning to free cash flow on slide 14, just a few comments here before I turn it back over to Greg.

As you know, we had $2 3 billion of full year pro forma free cash flow and 2020.

When you take into account the 2021 timers that we've discussed the extra ordinary strength of RMB international collections and the discretionary pension contributions. We made we saw our normalized operational free cash flow of about $3 5 billion and 2020.

From there as I've discussed previously, we expect about $500 million in 'twenty and 'twenty, one cost to achieve our T ex synergies and restructuring and to invest about $600 million and capital to implement structural cost reduction actions that we've announced.

Finally, we expect about $2 $1 billion of operational growth driven by improvements in working capital and operating profit to bring us to our outlook of about $4 5 billion of free cash flow from the full year.

With that I'll hand, it back over to Gregg to wrap things up.

Okay. Thanks, Tobey So I know, there's a lot of data that we just went through as it relates to the 2021 outlook.

Important that you understand the kind of the baseline of of what we're thinking of as we provide the guidance for 'twenty. One obviously first quarter is going to be a very tough compare because of the record Q1, we had in 2020.

But we do remain confident and the full year outlook as well as the recovery and the back half of the year.

Before I go around and the final slide here is the number of 15 for those of you following along but before I go into our priorities. So let me just take a minute to so think of it remember of the Raytheon technologies team for their efforts and navigating a year of unprecedented challenges and particularly those on the production line and those in the skip.

And that came to work every single day during the pandemic to make sure we could meet our customer commitments.

Really.

Credible effort and we thank you all.

Okay, Let's go and let me close on an overview of our priorities first of.

Obviously, we are and have continued to support our employees our customers and our suppliers as we always do we do see brighter days ahead with the rollout of the vaccine, but we will continue to remain vigilant about the health and safety of our employees.

What are the priorities and supporting our employees of course is to promote a more diverse and inclusive of workforce.

The Eni remains high and our agenda and it's an imperative for how we do business.

This will make us a better company a bit of employer and a better member of our community.

To that and I'm pleased to announce the appointment of of Chief diversity Officer, and resold the Dixon, who joined <unk> at the beginning of January.

She is going to accelerate our ongoing initiatives. She is a member of my executive leadership team and she has wasted no time and getting to work.

<unk> is responsible for leading our diversity of equity inclusion strategy and implementing the major initiatives of the four pillars of that strategy that is talent management community engagement public policy and supplier diversity.

The next priority is continuing to invest and develop leading edge technology and innovation.

The key tenant of the merger was identifying ways to leverage our R&D capabilities and innovative technologies across both the commercial aerospace and defense markets and bringing them together to create advanced products and solutions to meet our customers complex and emerging needs.

These technologies and the potential to generate billions of dollars and revenue synergies over their lifetime, and our and key enablers to capturing the full value of the Raytheon technologies mergers.

Executing on the integration of also remains a key priority we remain on track to deliver over $1 billion and gross cost synergies from the Raytheon merger as well as $600 million.

And synergies from the Rockwell Collins acquisition.

We're of course also continuing to be the laser focused on driving structural cost reduction we've already executed on some significant actions and the team is working on a pipeline of additional opportunities.

And of course, we're going to remain disciplined with our capital allocation balance between investments of the business and returning cash to shareowners.

Looking ahead I remain excited about the future of the business as we approach the one year anniversary of the merger closing.

Our balanced and diversified portfolio of industry, leading commercial aerospace and defense businesses.

The resilient across business and economic cycles.

And I am extremely confident the commercial aerospace will recover so not a question of if it's simply a question of when.

And when it does recover our focus on cost productivity and investments and technology will position us to deliver higher margins strong cash flow and significant value to our shareowners and our customers.

So with that I know a lot of data a lot of ground recovered, but let me open it up for questions normal.

Thank you and as a reminder to ask a question. Please press star one and your telephone keypad.

And with yourself from the queue. Please press the pound key.

And the interest of time.

A broader participation.

You limit yourself to one question. The first question will come from the line of David Strauss with Barclays. Your line is open.

Good morning, Thanks, David.

Good morning, Greg Yeah, definitely a lot of day I appreciate taking the couple of hours and go through all of that.

Yes.

Wanted to circle back on Collins, and Pratt and I guess, the Q2 through Q4 guidance.

Can you give us any help and how we should think about kind of the exit margin rate at the end of 2021 is Collins.

Close to dump back close to double digits and as Pratt kind of in the mid single digit range just trying to think about.

Where we exit the year. Thanks.

Yes, David This is Toby and let me start and then and then if Greg wants to add.

He can jump and I think the best way to think about it.

As to talk about and do a little contrast, and compare around decremental and incremental margins.

And the case of call and.

And I'll kind of walk through the full year to give you the complete picture and the case of Collins.

We're going to see Q1 to be similar to what we saw in the back half of the year think of.

The decrementals around 50%.

And given the tough compare and the lower volume.

That said as we progress through the last nine months of the year, including into the back half of the year, we're looking at average 80% incremental margins as the aftermarket.

Recoveries and in combination with the effects of the cost reduction actions that we've taken.

So.

Really good performance there based upon the assumptions that we talked about for the recovery and the case of Pratt a little bit different.

Decrementals and the first quarter of somewhat of Q2 and three of last year around 40%.

And then incremental margins and the Q2, the Q4 timeframe on average about 30% and what you got to remember.

You have the the knock on effect of the higher OE deliveries on the GTS and the negative engine margin debt that has some impact there. So of course as we said we've qualified and gave you our assumptions on what it takes to get this type of improvement, but we.

We feel confident in the range as we provided and the ability of the business is to hit these targets.

Great. Thanks, very much and so very helpful.

Sure. Thanks, David Thank you and our next question comes from Myles Walton of UBS. Your line is open.

Thanks, Good morning, good morning.

The amount of hoping you could.

That's a little bit on slide 13 versus 14, and and the walk from 'twenty to 'twenty one it looks like.

From the operational level, there's not much of a help and the EPS walk, but there's this big operational growth bucket that drives you from $2 3 billion to four and 5 billion on the cash flow side. So maybe you could just unpack that operational growth bucket and why it doesn't show up and the earnings.

Yes, so I think Myles, it's Toby the the.

On page 13, when you look at the first element of that walk the segments. It's essentially flat almost the dollar to the negative right because of Q1 and the tough compare and and as we said about the same.

90 cents at the midpoint of improvement and the second half so really what youre seeing on the.

The EPS is the effects of Q of Q1.

If you go to 14.

So let me try and give you a little color on the $2 1 billion on the operational growth rate really think of it.

And in three buckets of couple of $300 million related to higher operating income another roughly $300 million related to favorable pension performance of.

On our assets right, so over and above the the prepayment that we did another $300 million there and that leaves you with about $1 billion and a 1 billion and a half and Thats really all operational working capital related primarily at the the Aero businesses at Pratt and Collins.

And I'll give you that and to kind of break that down further into two pieces.

If you look at our pro forma financial statements on the face of that it would show that in 2020.

We consumed or working capital was about a $300 million headwind overall and then on the slide you can see we but we bust out the $800 million of RMB favorability on the collections. So if you normalize for that it's more of like 1 billion won and if you were to just hold that constant and have no of.

Erosion and you're going to half of 1 billion billion one benefit in 2021, and then on top of that we've targeted another call it 4% to $500 million of working capital inventory type of improvements that make up the balance of that so well.

Very pleased with how Pratt and Collins, as we mentioned, especially Collins and our opening comments.

Work, the inventory equation and the working capital in 2021 really good results and the second half of the year and we expect to see continued improvement to drive our cash flow and 2021 as well.

That's great, Thanks, and I'll stick to one.

Sure.

Your next question comes from.

Robert Stallard with vertical research your line is open.

Thanks, so much good morning.

Hey, Rob.

Greg I might be totally.

And everything goes to plan in 2021, you're actually going to be adding to the $9 billion of liquidity by the non COVID-19.

As we look into the next you will hear beyond.

And what do you think.

And we'll realistic level of liquidity to have on the balance sheet moving forward.

Let me start and then Toby will correct me.

As you think about it and I think we mentioned this and the earlier comments, we got about $3 billion of excess cash on the balance sheet today because of the divestitures.

And so as you think about 'twenty 'twenty, one will generate say roughly $4 5 billion $3 billion of that goes to pay the dividend and.

And so that is the first priority for free cash flow will use another 1 billion and a half for share buyback and maybe that'll be a little bit more than that we will see but I think and we don't think we need 9 billion on the on the balance of Theres plenty of liquidity, we've got lines of credit out there I would expect you'd see that 9 billion and probably more and the $6 billion.

Range long term, which gives us flexibility whether it's for some bolt on M&A or for some additional share buyback and again I think what's important is we're going to return to the 18 to 20 billion that we had committed to.

But we want to grow the dividend as earnings could continue to improve and we want to be opportunistic. If we continued to see the share price kind of languishing in the and the <unk>, we're going to be aggressive on share buyback and.

And we've got the capability to do that we've got a very strong balance sheet, and we paid down $1 billion of debt.

And the in November we've got another I think of half of $1 billion. This year to pay down but the debt markets are still open and debt is cheap. So we're going to we're going to keep our options open and no big M&A, but obviously share buyback will be the the first for the second priority after the dividend.

Thank you.

Our next question comes from Sheila.

And with Jefferies. Your line is open.

Hey, good morning, guys. Thank you for the time.

I wanted to ask about defense, just given the EAC adjustments that we should be factoring and maybe for 'twenty one.

Margins really expanding therein.

Not really big incremental profit growth.

And maybe Toby if you could touch upon that.

Yeah, So I'll hit on both both businesses.

And this is separately.

And both cases, we do expect to see some sequential improvement and the case of RIS. There still is a little bit of the.

Drag, even though it lessens quarter by quarter because of the EAC reset I think and the.

Our comments, we had the opening comments, we talked about by the time, we're exiting this year and not next year and exiting 2021, we'd expect the EAC reset to be a non factor not talking about it anymore. So you still see a little bit of that.

<unk> RIS you see the same for RMB. The other the other thing that RMB has.

So theyre growing.

The revenue growth is really driven by.

The not the acceleration, but the ramp up on the multi year awards. The SM three SM six multi year awards and there is a little bit of of mix issues. Some of their mature international production programs are.

As expected winding down and so while theyre seeing some improvement.

It is a little bit muted because of those two factors, but longer term, we would expect both of those businesses.

Exiting 'twenty one into 'twenty two knowing what we know today to be able to continue to improve the margins going forward as well.

Okay. Thank you.

Sure.

Our next question comes from Ron Epstein with Bank of America. Your line is open.

Hey, good morning, guys.

And gentlemen.

When you think about all of the the cost actions, you've taken and the realignment of.

Of that how much of that do you see as permanent.

And how much of that is kind of come back when volume comes back and then and.

And along the same lines, how do you think you haven't cut too deep.

And you think of the Engineering force that you got rid of it and so on and so forth and how do you know you didn't kind of cutting into bone.

Well look I think we were aggressive in 2020 in terms of taking cost of us. The Toby took you through the numbers.

We'll have about 'twenty 'twenty 1000 positions will have come out of the organization on the commercial side of the business over the last nine months between contractors and full time employees and clearly on the production side, we'll see some folks added back as volume comes back.

And if you would talk to Steve Tim at Collins, and price Kellwood print, which I will tell you, though is what they don't want to do is bring back all of the indirect and.

And this is Toby was alluding to and we'll see the very strong incremental margins.

And on the upside.

And we did cut R&D.

And again I think that was all appropriate we pushed out some programs.

But that R&D some of that will come back, but I don't think that we have stopped investing and anything thats key to the long term.

And you think about even as we go into 2020, and we're going to invest $5 billion, two and a 5 billion of capped.

Capex and another $2 $5 billion of company funded engineering. So we're going to continue to invest where we need to and we're going to continue to have a very lean.

Cost structure really to support this business going forward and again, we want to do is drive margins higher rate, we still remain committed to the Collins margins up near 20% as the recovery comes the comes through as well as per that kind of the mid teens margin and to do that and they're gonna have to be focused on cost. So.

And we cut deep we cut where we had to but I don't think we have sacrifice the future and anyway.

And I think Ron and the only thing I'd add.

Spot on with what Greg said, even on the head count reductions on the direct side as we continue and advance our focus on automation and digital and how we operate the business, we're obviously going to look to.

And as Greg alluded to right drive the margins and therefore, not necessarily just automatically bring the of.

The direct part of the workforce back and we certainly are going to look to not have any of the.

Indirect comeback and remember that there was about $1 billion worth of.

Labor savings as a result of that and.

Maybe half and half direct and indirect and also all if not most all of that indirect won't come back and some portion of the direct well, but I don't think of it all well.

Okay. Thank you thank.

Thanks, Brian next question comes from Carter Copeland with Melius Research Your line is open.

Hey, good morning, gentlemen.

Good morning.

Greg or Toby I Wonder if you could give us a little bit more color on this.

R&D Dcs contract and and just sort of what happened there in terms of regulatory approval is this.

The contract you are working on expecting approval or a contract with the customer they've got truncated because it's on and just help us understand the.

What went on there and is there any risk of similar sort of contracts.

Happening again and the future yes.

So this is a legacy contract that we had for a customer and the middle East and and obviously, we can't talk about the customer when you go back and look at the 10-K, you can probably figure out.

And what specifically this is but we had taken this contract was a direct foreign sale and we had assumed that we were going to get.

The license to provide these office of weapons systems to the our customer.

With the change in administration.

Comes less likely that we're going to be able to get a license for this and so we appropriately decided that we could no longer support the booking of the contract it's not to say it will ever happen, but we took the I think of conservative view to say given the new administration, it's unlikely we're going to get a license for these offensive weapon systems for the.

This middle eastern customer.

And again this is really the only one we have out there and again. This is an office of west offices, if you're thinking about Patriot and some of the other defense of systems, we have no issues with getting the licenses, but offensive weapons of little bit more difficult and so as we go forward. What we're going to do is we'll work with the the Dod will try and do these through Fms as opposed to through direct foreign and.

Sales to make sure we've got alignment with the Dod and the administration before we book any of these but this is really kind of a it was a big contract, but it is a one off and theres really not much else out there like this.

And the only the only thing I would add Carter to what.

Greg commented on we had to have.

Track record, where we were successful on other similar contracts in the past.

And of obtaining all the approvals even and this one here.

What really flipped us to the fact of of it not be and probable was as Greg said the change and the administration and it was notified under the prior administration.

Just a little bit late in the game.

To get through the process. So R.

Our judgment changed and that we don't believe it's probable and as Greg said we.

Did the proper accounting based upon that change and view.

Okay, that's great and does it signal any change of sorts and your growth expectations and that part of the world.

No no no.

The piece is not going to break it out and the middle East anytime soon so I think it remains of.

The area, where we continue to see solid growth again.

And again, it's just the nature of this weapon system of such that the more difficult to fill a lot of direct basis versus of Fms basis, and this particular product.

Offense and munitions.

Pendency and our revenue profile had been declining year over year.

The volume on this peak, maybe 345 years ago, I may be off by a year or two but.

It certainly.

Not material going forward and we didn't have a material expectation on and contributing to the the results going forward.

Great. Thanks for the color guys sure.

Sure. Thanks. Thank you and next question comes from Noah <unk> with.

And with Goldman Sachs. Your line is open.

Hey, good morning, everyone.

I know.

Just going back to the to the effort to piece together, the the Collins and Pratt segment guidance.

Okay.

I guess to get.

Into both the full year and then also of the two <unk> to <unk> <unk>.

Collins revenue guidance.

It's just it's not a lot of growth in the and the back half. Despite the very easy compares and the potential for air travel to be recovering and basically it looks like that and a low 4 billion quarterly run rate that you stepped down to you would just kind of stay at through the entire year.

And so.

Have you just made very conservative aftermarket assumptions given that has the most kind of the widest range of possible outcomes and.

And the near term and then with the Collins margin on that and 80% Incrementals of Big number I guess, how do you get that with that limited volume recovery and therefore is it safe to keep that next year with the better volume recovery before then settling into something more normal after that.

So and then I'll, let me, let me try and the start in on that and I think what you have to think about in terms of the Collins and Pratt stories on the OE side of the OEM side, you are not going to see much growth and the back half of the year right that really is in fact, we're actually going to see the Colin So I, probably a drop and OE because of the 787 and going from <unk>.

To five aircraft.

EBIT was 737 coming online.

Already delivered about a third of the inventory for the full year production of Boeing. So we're just not going to see a big step up and the OE, So think about that as flat.

On the at the same at the same tools true at Pratt and we expect roughly.

The flat production for <unk> hundred 20, <unk> during the course of the year now there may be some upside if they go from 40 to 47, but we'll see if there's a lot of wait till sitting out there right now so we're prepared to support it if it does but frankly, we think we may be conservative keep in mind that doesn't help margins. It actually hurts margin of OE goes up.

What's important to keep in mind, though is the aftermarket and.

I think we have been.

Optimistic in terms of the the college the aftermarket, but after a tough first quarter, we expect sequentially, 10% growth each quarter and the Collins aftermarket from Q2 to Q3 to Q4 and margins, obviously will get sequentially better because obviously the the.

The.

Aftermarket growth is much better margin than the OE side at the same time.

Provisioning, which is a big piece of the aftermarket of college is probably not going to grow much because.

And that's all tied to OE deliveries. So again I think we've got a pretty decent recovery path on aftermarket could it be better perhaps but keep in mind. We're sitting here at the end of January Q twos got of grow 10% and Q3 that means the air traffic has got to start picking up soon.

And the RPM is going to continue to grow throughout the course of the year.

And so I know of to Greg's point youre going to of that combo, the compounding effect of that sequential quarter over quarter growth.

And you will see in the.

This range share when you unpack it down just to the aftermarket as Greg said, you will see especially as we get towards the end of.

The year, the growth and the aftermarket and both of those businesses.

High teens, 25% to 30% right. So so there is some substantial growth.

Expected from aftermarket and it is the one variable here that we are.

Really trying to assess when we provided the level of the.

And the ranges that we did for the year.

Okay.

Yes.

If I have OA flat and then the defense piece still growing and and aftermarket growing tech.

It's just spitting out higher numbers, but.

Alright.

Yes, I remember of Pratt, though defenses flattish right, we had a real strong growth.

This past year of 2014% so defense it proud of at least is going to be more on the flat side could even be down a tad.

Okay.

Okay, I will I will keep iterating that but I appreciate all of the color. Thanks, so much thanks Noah.

Our next question comes from Kristine the wag with more.

Stanley Your line is open.

Hey, good morning, guys.

And then.

And air traffic recovers how quickly should we expect of commercial aerospace aftermarket the comeback is it a concern.

Or do you expect to see of delay and I guess and put it another way to what degree with these cash conservation and action from airlines affect the.

The pace of that growth.

So I think what we have seen historically is a lag between when we see RPM start to pick up versus when we see aftermarket and start to pick up now we know that the airlines have done a lot in terms of cash conservation in 2020, they have deferred a lot of maintenance they have finished.

Finished their inventory so we're actually expecting to see a quicker rebound at this time and the aftermarkets and what we have seen historically because of the very very deep cuts that the airlines have made and their stock of inventory. So.

It won't be of six months delay, but it may be a few and maybe a quarter off but again, we are already starting to see inputs pick up a little bit as air traffic has started to come back and.

And again, it's simply a matter of time and.

We've got the 10% growth as I said in Q2, Q3, Q4, and it assumes we're going to see RPM growth and that same that same range and youre getting it right Christine notwithstanding what Greg said about where there have been things that have been deferred that may create the demand a little bit earlier typically you would see the rpms increased dry.

Load factors up.

And in turn.

Drive available seat miles up and there is a lag there and because it's really those ASM and of normal environment that are going to drive.

The aftermarket for us and Thats, where historically and as we've referenced before that we have seen.

Potential lag of six months plus or minus one difference here as Greg said, we've got some pent up demand I guess is the way to think of it as well.

A little bit of of mitigate or towards that as we move through the year.

And thank you.

Thank you. Our next question comes from Peter Arment with Baird. Your line is open.

Yes, good morning, Hey, Greg.

And Craig regarding the free cash flow outlook, and the $4 5 billion and.

And we think about just the the onetime structural capex investment outside of that you'd be probably of over or near 100% conversion as you kind of approach. The one year kind of mark on this on the merger how you're thinking about your ability to kind of sustain that kind of a.

100% free cash flow conversion, when we think about the longer term. Thanks.

Yes, Peter I think as we've targeted and as we did prior to the merger. We still think we can be generate $8 billion to $9 billion of free cash flow.

As the market recovers and I think of these these cash conservation actions that we've taken.

Some of the some of this is the structural cost reduction of all of Thats going to help of free cash flow over the long term. So I don't think think about the $4 5 billion normalized if you take out the investments the north of $5 billion, that's going to continue to grow over the next several years back to that.

And Tonight and that we had forecast so.

Theres no impediments and in my mind, the hitting the 100% free cash flow and net income we don't have to make bigger investments and capex.

I'll tell you the one challenge as we look at cash flow and the out years of course is the.

R&D amortization and the change of the tax law, which will force us to capitalize R&D and then amortize that over five years, but we'll see what happens with the corporate taxes.

As of 2022 23 issue not a lot of 'twenty one issue.

I appreciate that thanks, Greg.

Thank you and this concludes our Q&A portion and I would like to turn the call back over to Mr. Hayes for any further remarks.

Okay. Thank you norm and thank you everyone for listening and as always Neil of the whole IR team is available to answer your questions and I wanted to thank you all for listening and the really stay healthy and the B will take care.

Ladies and gentlemen, thank you for your participation in today's conference you May now disconnect everyone have a wonderful day.

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