Q2 2021 Raytheon Technologies Corp Earnings Call
Good day, ladies and gentlemen, and welcome to the Raytheon Technologies' second quarter 2021 earnings Conference call.
My name is Tabitha and I'll be your operator for today.
As a reminder of this conference is being recorded for.
And the purposes.
On the call today are Greg Hayes, Chairman and Chief Executive Officer, Neil Mitchell, Chief Financial Officer, and Jennifer Reed, Vice President of Investor Relations.
This call is being carried by a bunch of Internet and there is a presentation available for download from Raytheon technologies website.
Site at Www Dot Archie ex dotcom.
Please note, except where otherwise noted the company will speak to results from continuing operations, excluding net nonrecurring and on.
The significant items and acquisition accounting adjustments operating ROE for 2 by management as other significant items.
Items.
The company also reminds listeners that the earnings and cash flow expectations any other forward looking statements provided in this call are subject to risks and uncertainties.
Our T sees the SEC filings, including its forms 8-K, 10-Q, and 10-K provide details unimportant factor.
Factors that could cause actual results to differ materially from anticipated and forward looking statements.
Once the call open for questions. We ask that you limit your round to force for 1 question per caller to give everyone. The opportunity to participate to ask a question you will need to press star 1 on your telephone true.
Yourself from Cube press the pound key.
You may ask further questions by re inserting yourself into queue as time permits with that I'll turn the call over to Mr. Hayes.
Thank you and good morning.
And everyone.
And I'm on the slide 2 of the of the deck for those of you following along.
So a couple of months ago, we held our first Investor day, as Raytheon technologies and.
On that day, we laid out our 2020.5 goals to deliver strong top line growth margin expansion and at least $10 billion and free cash flow by 2025, all while continuing to invest and our businesses and return significant cash to.
Our shareowners.
We continue to be confident of the future because of our strong franchises, the resilient markets and which we operate our innovative technologies and our relentless focus on operational excellence and cost reduction, which will drive margin expansion and strong cash flows into the future and.
We continue to see encouraging.
Current trends across our market.
Our confidence and our ability to achieve these targets remains strong and as you saw at the end of May of the department of defense for at least the fiscal year 'twenty 2 budget request, which was generally in line with our expectations with respect to our portfolio of products and the investments, we're making and differentiator technologies, including.
The missile defense and space based systems next generation propulsion Olson and hypersonic <unk>.
Major of our T X programs fared well overall.
Overall, the modernization funding remains at near historic highs of requested funding for these programs is favorable to the overall D O D modernization of request when.
Compared to last year's plan for fiscal year 'twenty 2.
It's also worth noting that the overall classified funding request, which supports a significant part of our intelligence of the space portfolio was also very well supported.
So I'd say, we're well positioned for the administration's priorities driven by our innovative technologies.
And capabilities to address the evolving threat environment.
This is demonstrated of course by the significant awards, we received this quarter, which included over $1 billion and classified bookings at RIS and 2 important franchise wins that our missile and defense business, where we were awarded almost $2 billion for the warm range standoff weapon.
And of our L RSO and.
And the billion 3 for the next generation interceptor.
And also we should note that the Patriot franchise remains robust as evidenced by Switzerland, and becoming the 18th of partner nation to select the Patriot Air Defense system.
At the same time commercial air traffic demand continues to gain.
And momentum across many of our domestic markets.
As global economies reopen and vaccinations increase.
And the U S daily travellers throughout the TSA checkpoints of averaged over $2 million per day in July and that's more than doubled since January of this year.
That said, we are monitoring the COVID-19 and variance of the.
<unk> and travel and there's still work to do on global vaccinations and on international border reopening.
Alright with that let's turn to slide 3 and just talk about Q2 for a moment of if we can.
And you saw from our press release, the strong performance during the quarter with sales at the high end of our expectations and adjusted EPS.
And free cash flow exceeding those expectations that we laid out for you last quarter.
Strong execution against the increasingly favorable backdrop enabled us to deliver top and bottom line growth on both the year over year and of sequential basis.
And so given our performance year to date and the recent trends across your end markets were going to raise the low end of our full.
Our sales outlook by $500 million to a new range of $64.4 billion to $65.4 billion.
And we're also going to raise and tightened our adjusted EPS outlook with the new range of $3.85 to $4 per share and we are increasing our free cash flow outlook to a range of $4, 5% of 5 billion.
For the year.
I'm pleased with the strong orders, we saw on the quarter, which grew our company backlog to a record $152 billion net of 3% increase since the first quarter.
Our defense book to Bill was the strong 112, resulting in the defence backlog of over 66 billion and commercial backlog increased.
Full year, 3 and a half billion in the quarter.
On the capital allocation front, we repurchased 632 million shares, bringing us to over $1 billion and share repurchase year to date and we're on track and meet our commitment of buying back at least $2 billion of shares for the year.
We also continued to execute on the merger.
Kris migration activities.
And given our substantial progress and the robust pipeline of opportunities, we're going to raise our gross cost synergy target by another $200 million to $1.5 billion and.
And that $1.5 billion will be realized and the first for years following the merger.
Now, 50% more than our original synergy commitment.
<unk> and there is great execution by the team, but I would tell you we're not done yet.
Everything there is always more to do.
In addition to making good progress on our synergy targets. We're also making significant progress on our structural cost reduction projects.
<unk> heard about back and our May meeting.
We have of pipeline with hundreds of opportunities, including the previously.
The announced actions that we're working across the business.
Let me just give you a couple of examples of what we are doing.
And our Collins Aerostructures business.
And as scheduled over 125 lean events this year and they're focused on specifically, reducing the tack time labor time for the <unk> hundred 20, neo and to sell.
We've invested in the lean events such as these throughout the pandemic because they've allowed the aerostructures business to reduce the cell manufacturing time by over 75% of.
Of course.
Our normal goal here is about and 87% learning curve. These lean events allow us to exceed that and the incredible ways.
And we continue.
And on the overhaul capability and drive turnaround time across the geared turbofan network. The team has made good progress this year demonstrated of 15% of turnaround time and improvement over the past year, but importantly, the are on track to drive of 30% reduction by the end of this year.
These improvements are the direct result of repair infrastructure development and additional.
Productivity improvements across the network and.
Including the application of lean principles and the shop design as well as automation.
Our strong culture of operational excellence has enabled of course by the core operating system and significant investments and digital technology and other strategic projects.
Altogether.
And to build these initiatives will save over $5 billion and cost through 2025.
So you can see the market fundamentals are strong we're laser focused on operational excellence and our key franchises are driving strong financial performance. So with that let me turn it over to Neil and Jennifer to take you through Q2 and.
The next and the year Neil.
Thanks, Greg I'm on slide 4.
As you could expect I'm pleased with where we landed for the quarter, we exceeded our expectations for both of adjusted earnings per share and free cash flow sales were $15.9 billion, which was at the high end of our outlook range and up 10% organically.
Versus prior year on an adjusted pro forma basis, and up 4% sequentially. Our strong performance was driven by the momentum and commercial aerospace and continued growth and defense adjust.
Adjusted earnings per share of $1. <unk> was ahead of our expectations, primarily driven by commercial aftermarket and contract related settlements at Collins.
But also better than expected performance at Pratt RF and RMB.
On a GAAP basis earnings per share from continuing operations was <unk> 69 per share and included 34 of acquisition accounting adjustments and net significant and nonrecurring items.
Free cash flow of $966 million.
And exceeded our expectations, primarily due to the continuation of better than expected collections and lower than expected capital expenditures.
Before I hand, it over to Jennifer Let me give you a little color on our synergy progress, we achieved $185 million of incremental gross cost synergies and the quarter, bringing our year to date savings.
And to $390 million and given the pace that we realize the synergies on to date, we're increasing our 2021 cost synergy target by $50 million, which brings our new target to the year for the year to $660 million.
Collins also achieved nearly $50 million of further acquisition synergies and the quarter.
Bringing total Rockwell Collins acquisition related savings to nearly $560 million since the deal closed in November of 2018, and we now expect Collins to meet their $600 million acquisition synergy target in 2021, a year of head of a year ahead of schedule. So great work by the Collins team on that front.
So with that I'll hand, it over to Jennifer to take you through the segment results and I'll come back and talk a bit about the outlook Jennifer.
Starting with Collins aerospace on slide 5 sales of our $4.5 billion and the quarter up 6% on an adjusted basis, driven primarily by the recovery of the commercial aerospace.
History, and up 11% on an organic basis by channel commercial aftermarket sales were up 24% driven by a 30% increase and parts and repair a 16% increase and modifications and upgrades and a 15% increase and provisioning sequentially.
Commercial aftermarket sales were up 15% with growth and all 3 channels, most notably provisioning, which grew at 40% and parts and repair which grew 14%.
Commercial OE sales were up 8% from the prior year, driven principally by the recovery of the commercial aerospace and.
<unk> <unk> growth and narrow body regional and business Jets was particularly offset by expected declines in like the body sales and.
And military sales were down 7% on an adjusted basis to the prior year divestitures and down 1% organically on a tough compare macao, calling and military.
Sales were up 10% and the same period last year.
Adjusted operating profit of $518 million with better than expected and was up $494 million from the prior year, driven primarily by higher commercial aftermarket and OE sales the benefit of continued cost reduction actions as well as favorable.
The industry contract settlements that were worth about $50 million.
Looking ahead, we continue to expect Collins full year sales to be down mid to down low single digit with higher expected commercial aftermarket volumes offsetting slightly less than expected OE deliveries.
And given the favorable mix and the.
First half of the year, the commercial recovery and the benefit of cost containment measures, we are increasing and Collins full year operating profit outlook to a new range of up 100 million to $275 million versus prior year.
Shifting the Pratt and Whitney on slide 6.
Sales of 4.
<unk> 3 billion were up 19% on an adjusted basis and up 21% on on organic basis, primarily driven by the recovery of the commercial aerospace industry.
Herschelle aftermarket sales were up 41% and the quarter with legacy large commercial engine shop visits up 56% and Pratt.
Canada shop visits up 18% as expected. We also saw continued ramp and DTF shop visits in the quarter.
OEM sales were up 30% driven by higher GTS deliveries within Pratt large commercial and in business and general aviation platforms at Pratt Canada Mill.
The military.
<unk> sales were down 3% also on a tough compare given pratt's military sales were up 11% and the same period last year.
Our continued ramp and the F 135, sustainment was more than offset by lower material input on production program adjusted operating profit of $96 million was slightly.
Better than expected and was up $247 million from the prior year, driven primarily by higher commercial aftermarket sales and favorable shop visit mix. Looking ahead, we continue to expect Pratt's full year sales to be up low to mid single digit and we are increasing the low end of.
Slightly below year operating profit outlook by $25 million to a new range of down $50 million to up $25 million versus 2020.
Turning now to slide 7.
Sales were $3.8 billion up 12% versus the prior year on an adjusted basis.
On an adjusted pro.
From a basis, including the pre merger stub period sales were up 6% driven by strength and airborne ISR programs within sensing and effects as well as strength in the classified cyber programs within cyber training and services adjusted operating profit and the quarter of of 400.
<unk> hundred $15 million was slightly better than expected and was up $86 million year over year on an adjusted pro forma basis, driven primarily by program efficiencies. The quarter also benefited from a gain on a real estate transaction.
<unk> had $4 billion of bookings and the quarter, resulting in strong book to build.
Build of 113, and a backlog of $19.4 billion significant bookings included approximately $1.1 billion on classified programs as well as several other notable awards, including the stars follow on award for the FAA to implement a terminal on the nation's system and in the airports and.
And our first production award for the U S. Navy next generation Jammer mid band system that utilizes RPX industry, leading gallium nitride technology, it's worth noting that we continue to expect <unk> full year book to bill to be about 1 <unk>.
Turning to RF full year outlook.
We continue to expect sales to grow low to mid single digit and we're increasing the low end of our asses operating profit outlook by $25 million to a new range of up $150 million to $1.75 million.
Versus adjusted pro forma 2020.
Turning now to slide 8 RMB sales were up $4 billion.
Up 15% to prior year on adjusted basis on an adjusted pro forma basis, which again includes pre merger stub period sales were up 9% driven primarily by higher volume on the international Patriot programs.
And on storm breaker program, both of which included liquidation of pre contract costs.
Adjusted operating profit of $532 million was slightly better than expected and was up $121 million versus prior year on an adjusted pro forma basis due to favorable mix and higher program efficiencies R&D.
$6.1 billion of bookings and the quarter, resulting and exceptionally strong book to build of 155 and a backlog of $29.7 billion and addition to the franchise awards that Greg discussed R&D also had a number of other notable awards and the quarter.
We also continue to expect RMS.
Had 6 full year book to bill to be about 1 turning to RMB <unk> full year outlook. We continue to expect sales to grow low to mid single digit and we're increasing the low end of RMB of operating profit by $25 million to a new range of up $50 million to $75 million versus 2020 on an adjusted pro forma.
Basis, I'll turn it back to Neal to provide some color on the rest of the year.
Thanks, Jennifer I'm on slide 9 let me update you on how we see the current environment as we looked at the second half of the year.
Starting with our commercial end markets as I've discussed many times before the shape of the commercial recovery remains critical to our outlook.
That said we.
We're encouraged by the pace of the vaccine distribution and continued signs of improving the air travel demand and many domestic markets. However, we continue to see international air traffic and border reopening and recover slower than we had expected around the world keep in mind about 65% of 2019 Air travel was international and <unk>.
While the first half of the year was a little stronger.
And we're seeing signs of strong summer travel, we still need to see the reopening of international borders and the return of long haul routes to drive continued sequential aftermarket growth and the second half of the year.
Looking longer term, we continue to expect commercial air traffic and returned to 2019 levels by the end of 2023 with domestic and narrow body fleets recovering.
During before international and wide body fleets.
Moving to our defense end markets. We were pleased with what we saw on the fiscal year 'twenty 2 defense budget request, and we remain confident and our ability to grow our defense businesses as we look ahead.
Shifting to operational excellence as Greg mentioned, we are increasing our gross merger cost synergy target of 1.
And it is $5 billion.
And thats driven by higher savings from the corporate segment consolidations as well as additional procurement and supply chain savings interest.
Same time, we're maintaining a focus on implementing our core operating system and driving structural cost reduction across the businesses.
And finally, our financial flexibility.
On underpinned by a strong balance sheet, which supports our investments and the business and our capital deployment commitments.
So, let's turn to slide 10.
Following our strong first half, we're confident and our full year outlook as Greg discussed, we're bringing up the low end of our sales range by $500 million and where.
Our adjusted earnings per share range.
The $3.85 to $4 per share are up about 33 cents from the midpoint of our prior outlook.
Half of the increase comes from the segments, primarily Collins and the other half is from 13th of tax improvement and about <unk> <unk> of lower corporate tax items, the 13th tax benefit is driven by.
And going optimization of the company's legal and financing structure that we expect to realize discreetly in the third quarter.
On the cash side, given the improved earnings outlook, we now expect free cash flow and the range of 4.5% of $5 billion for the year.
And finally, it's worth mentioning that we've included an updated segment outlook as.
The on updated outlook for some of the below the line items in the webcast dependencies with that I'll hand, it back to Greg to wrap things up.
Okay. Thanks Neil.
So we're on the final slide here.
Slide 11, and I just want to reiterate our priorities for 2021 and again no surprises here he is priority.
<unk> remains the same that is the first and foremost of continued to support our employees our customers and their.
The suppliers and communities during the pandemic and to keep our employees safe.
Our team is dedicated to solving our customers' most complex problems by investing and differentiated technologies to capitalize on our strong.
Franchises at the same time, we're going to continue to execute on the integration and deliver the cost synergies and we're committed to operational excellence to drive further structural cost reduction across all of our businesses.
And finally as Neil said, we are of very strong balance sheet, combining their cash generation.
And bind with our cash generating capability.
The abilities provides financial flexibility to support investments and our business and our commitment to returning capital to shareowners, including at least 20 billion to shareowners and the first for years following the merger.
So with that let me go ahead and open it up for questions Tabitha.
And the answers at this time and Tau Alpha.
Okay.
As a patient and you were asked the limit yourself to 1 question per.
First question comes from the line of Myles Walton with UBS.
Hey, good morning.
Greg you mentioned the the GTS on improvement that Youre doing on the cost side and I was just.
Curious could you talk about the losses that you are currently incurring.
On a per to unit.
How much of an improvement the.
Cost reduction efforts are actually translating to unit costs and then maybe just as you look out the glide slope.
Losses on the engine and I think the prior.
The comments were around peaking in 2025 and.
And just maybe size.
And how far off you are.
From that peak.
Sure Myles Thanks, I'll take this 1 it's Neil and good morning.
First of all.
If you think about the second quarter the.
Pratt Whitney large commercial lines of business saw very slight year over year decline and the OE operating profit so we're making really.
For your progress driving cost out of the engine in spite of much lower volumes and we had previously <unk>.
Expected, so I feel good about that and as you look at the rest of the year of the team continues to drive down the cost curve and we will see slight cost improvement year over year and again in spite of some significant absorption headwind that we're dealing with.
Good too.
Today's volumes versus what we were expecting pre pandemic looking a little bit further out we do continue to see some.
And some upward pressure on negative engine margin as the volumes increase.
But we do see that as a positive sign frankly, those are investments, we're making and the future aftermarket not.
And not going to get into quantifying that today.
Relative we do see OE volumes going up and the 2025 time period.
And the Pratt and Whitney team is aggressively working cost reduction actions to contain that negative engine margin and an appropriate level.
And I ask the question. Okay. Your next question comes on the line of Ron Epstein with.
But okay.
Yes.
Morning, guys.
Good morning.
And.
Can you speak a bit about.
What youre thinking on midterm growth on defense for the business and then.
We saw and the quarter and in particular and Europe Foreign <unk>.
Military.
And think about the industry did well and you guys did well with the order.
On the Patriot, but but what do you think and midterm for the defense business growth. So if we step out a couple of years from now not just next year, but if we go out maybe 3 or 4 years from now.
And I think it's pretty much what we had talked about back in May right, which is and we're gonna probably.
Sales for the low to mid single digit organic growth across all of the defense businesses and as you know.
That's the mix of both U S. The defense spending and as well as international and obviously on the international side.
We've seen a little bit of and impact this year with the with the pandemic and the havoc and Thats done.
Probably seen budgets, but at the same type of I think we continue to see strong backlog, there and interestingly the Switzerland, what both the F 30, fives and the Patriot defense system. So the defense business internationally remains good the backlog as we said remains strong over $66 billion at the end of the quarter.
I think we easily see the kind of 3% to 5% growth.
And of the mid tier of I'll call. It out through 2025, because who knows beyond that but again, it's all about having the right technology for I would say the next conflict not the last conflict and that means having.
The.
Space.
So the technology is it means hypersonic weapons. It means cyber weapons all of those things that are good and want to enable us to help the war fighter and whatever that next conflict might be.
Thank you.
Thanks for.
Your next question comes from.
Face basis, Sheila <unk> with Jefferies.
Good morning, guys. Thank you for the time on ceilings.
The other.
And so the better outlook at Carlin and 25 of it of the 275 range seems to be quite productivity. How do we think about what drove that given the top line and really hasnt changed and just on first half margins ex.
The Atlanta.
The contract settlements or about 9% and it implies second half margins are so.
And why the contraction and the second half and how do we how do we just think about the improvement of that day.
Sheila I'll start.
First of all I think on the Collins side of the way I would think about the second quarter.
Profit was really driven by higher aftermarket drop through and part I'd say substantially it was due to that we have.
Also did realize about $35 million of cost reduction.
Dropped to the bottom line combined with some about the same number.
From from productivity and mix.
So those are those are really the key drivers of the reason youre not seeing the that.
And that the overall sales go up for RPX is recall, we had a very very broad range on on the on the sales coming end of the year. Most of that range was attributed to aftermarket risk. We're halfway through the year now we're derisking that.
We've taken up the bottom end of $1 billion 6 months into the year as you think about that $500 million increase.
About $200 million of that I would attribute to Collins of.
A little bit less and that the Pratt and Whitney.
And then we also are seeing some improvement on the bottom and.
Probably.
30, or so million dollars at RIS and the rest of at RMB. So.
As I look at the rest of the year and you think about the margins. There's a couple of things I just want to highlight for you we had about <unk> <unk> of.
And I would call it onetime items in the second quarter that I don't expect to repeat and the second.
Half of the year 3 of those sense for at Collins dos contract settlements that we called out.
We also had on a penny and raf's related to a land sale and then.
And another penny.
Within RMB as well given some contract pre contract.
Liquidations that went through driving about 70 basis points of margin expansion and RMB. So as you think about the second half of the year and Collins, and particular, probably $75 million to $100 million of E&E headwind and the second half.
Remember, we have been cautious in terms of the phasing of our discretionary.
Spending will see that ramp up now that we're seeing the strength on the aftermarket and we had furloughs and place for the first half of the year of Collins. Those are now expired and so they'll have that incremental cost as you head into the second half of the year.
Thanks, so much.
The next question comes from the line of Robert Stallard.
And with vertical research.
Thanks, so much good morning, Rob.
Good morning.
And maybe just the follow up on on Sheila's question, you did see a very big sequential increase and the Collins off the market in Q2 compared to Q1, but it seems like youre, a little bit cautious about extrapolating that.
Going forward, so there and if you go on to a little bit more color on what you actually saw in Q2, and why perhaps a little bit squishy about and is continuing and the second half.
Excuse me, let me let me, let me start there Rob I think.
And what surprised us in Q2 was how quickly the.
The commercial aftermarket came back, especially.
<unk> in China and in the U S and you've heard US talk historically about expecting the typically of 6 month delay from the time, we start seeing the rpms recover until the time, we start seeing the aftermarket recover the.
The anomaly. This year is the airlines are actually spending money ahead of the recovery and in anticipation.
Surgeons and demand, which was exactly what they had been seeing and.
And so the the second quarter was much much better and I think that anybody had expected going into this especially as we think back to January or sort of you're putting the plans together for the year and.
And so as we think about the back half of the year of.
A lot of that pent up demand we.
We think has already been satisfied here in Q2.
But I would also tell you the of the bigger part of oncology you got to remember is 40% to 45% of their aftermarket is wide body and that is the piece that we do not see recovering here and the back half and.
Again, you'll see summary openings, we hope some trans Atlantic routes reopened here and the third quarter.
And into the fourth quarter, the Trans Pacific is pretty well still shut down the inter Asia long haul routes are pretty well still shut down and so that's kind of the governor I would tell you on the back half of it Collins is the.
And the long haul wide body marketplace. So again strong domestic demand and the U S strong domestic demand.
And China, starting to see some of that and Europe now, but it's really the wide body that is I would say the overall governor on the back half.
Yes, and let me let me just add a couple of other points to I think 1 of the things that was very notable and the second quarter was the 40% sequential growth and provisioning. So again I think thats all the airlines.
And and ready for the expected increase in demand here and the second half of the year. So that's a watch item as we kind of think about the back half on the aftermarket side and I'm talking Collins and particular, we had 15% sequential growth as you pointed out really strong growth here and the second quarter as we look at the the next 2 quarters.
<unk> getting more about 5% sequential growth and again, that's off of a higher base here and the second quarter and still ahead of what we were talking about back in January So we're seeing that improvement, but that's sort of what we're calibrating and our and our forecasting as we look at things today.
That's very helpful. Thank you.
Your next.
And thank him from the line of Noah <unk> with.
And with Goldman Sachs.
Hey, good morning, everybody.
Good morning.
Hey, just and the.
The legacy Raytheon and defense segment margins.
Those have improved notably over the last few quarters.
And.
And.
And I understand you had the.
Acquisition accounting reset there we can see that they were higher in the past before that and we can see what your future targets are.
Just wondering how linear that improvement can continue to be the guidance implies they stepped up.
A question and.
And the back half versus the second quarter, but given what youre doing on the cost side and given the.
Steady recovery from the acquisition accounting input and again, where that long term target is it's.
It's not clear to me why that would happen.
So let me try to share a little bit of perspective on that first.
As we think about the first half of the year of the margins bolt and <unk> and R&D are strong stronger than we had expected.
Youll recall and the first quarter I commented on a couple of items and R&D. We had the pension tailwind. We also had some international mix. We also here and the second quarter and RMB had some.
I think contracts that were awarded that resulted in us liquidating some costs that had accumulated on the balance sheet and how we can recognize the revenue and profit on that so those those couple of things and R&D are providing some uplift in the first half of the year that we don't expect to repeat and the second half of the year and at RIS I pointed out that debt asset sale that we.
We had and the second quarter as well if you take that out for RIS Youll see margins and the back half of the year that are fairly consistent with what we just saw on the second quarter now from a productivity perspective, we are seeing improved productivity and it's about $50 million each and.
And those 2 segments, so where.
And that goes as the year.
The news, we will see that as a function of.
Hundreds of the Acs being done each quarter, but we are seeing net improvement in the underlying.
Productivity.
And the net favorable way.
But keep in mind at RMB as we've talked about back at our Investor Day, you will see a mix shift and the products.
And the margins and the second half of the year as we get into more and more.
Fms sales so that's sort of the margin story on the defense business very pleased.
And with where they're heading and still see.
Longer term the TARP.
<unk> that we set out in may and achieving those.
Thank you.
Your next question comes from the line of Carter Copeland of Melius research.
Hey, good morning, gentlemen.
Hey, Neal just so I can make sure. We're all speaking the same language here when you referred to productivity.
Across the 2 segments of the 50 million.
Are you, saying that the growth or excuse me the net.
The cumulative adjustments to the Eac's were $50 million and each of those 2 segments.
On a year over year basis, yes, net fees year over year and is the big driver of that Hugh you up the.
The synergy target you realize some incremental cost out for all of the reasons you stated earlier and you're just putting that into the Acs and we're just getting that flowing into Q2, because that's when we sort of put in the plan.
Yes, that's right and Youre seeing sort of that play through and then the natural evolution of us getting further along the percent.
Since we had to reset that back in April of 2020.
But that goodness net goodness is dropping through and the form of <unk>.
AAC favorability there is a lot of iac's that get done every quarter and so sort of.
The net effect of everything, but generally speaking, we're seeing good productivity and.
RF and R&D.
Mrs.
Okay, great. Thank you for the clarification and stick to 1.
Thanks Carter.
Your next question comes from the line of Doug Barnett with Bernstein.
Thank you and good morning.
And Doug good morning.
When when.
And when you talk about how youre looking at.
R&D, how youre modeling traffic trends and.
I think you said by the end of 2023 for traffic to be back on.
How do you think about your aftermarket recovery and Pratt and Collins.
With respect to that trend and in other words, how do you see those lining up on that traffic recovery.
And perhaps and Collins, maybe if you could break it down by what I would say traditional you task Collins' avionics and interiors and that would be really helpful.
Well I guess, if you think about it.
Originally well our forecast would say that we don't see a complete return.
Turn of air traffic to pre Covid levels until 2024.
We had expected pretty much just do see as we have historically that kind of 6 months delay from the aftermarket recovery tracking the RPM recovery.
It's obviously not the way we've seen it play.
And this year again, because people have been come back there's a lot of pent up demand and I expect we will see the aftermarket pretty much pretty clutch and relying on line with the RPM growth here over the next couple of years as we see that recovery.
I think the the various pieces of the business we will see.
Say of different trajectory, if you think about.
Play out the interiors business for instance, while it's still up sequentially a little bit.
And that business is still suffering from the dearth of wide body.
And departures and so we're not seeing great traction and interiors.
On the avionics front, though we're seeing kind of a normal is.
As expected recovery of the same with I would say some of the legacy.
And you Tech businesses as you call of our power and controls business landing gear wheels, and brakes all of those things recovering.
Pretty much in line with what we're seeing for traffic so.
Again, I think if I think about the 2 or the weakest link and the Collins.
And this is probably interiors, but it will come back we're convinced that we're going to see widebody traffic recover is just going to take some time and again, that's a relatively high margin business. It's it's all customer furnished equipment. So that will that will play out into the the recovery of the margins at Collins as well probably end of that $23.2000 for timeframe.
Yes, let me add a little more color to Greg I agree with all of that.
Maybe making some comments about 2021 year and what we see for the rest of the year and I'll focus on ASM and we saw about a 22% increase and ASM.
And.
From Q1, the Q2 and as I think about going from Q2.
And in Q3, that's probably more on the 30%, 35% range and then starting to level out call. It mid single digit 5% kind of growth from Q3 to Q for getting back to what Greg said, our aftermarket should start to trend with those <unk>.
As we look further out through the recovery.
Yes.
The next question comes from the line of Peter Arment with Baird.
And good morning, everyone nice results.
Hey, Neil.
And on working capital can you, maybe just talk about the progress you're making on the kind of inventory levels and Collins and Pratt and I believe that's kind of the best opportunity for you to share gains.
And for it and is there any kind of change your thinking on long term goals and then maybe just expectations around the free cash flow cadence and the second half.
Yeah. Thanks, Thanks Peter.
So actually I'm very pleased with what we're doing on inventory of both Pratt and Collins with the significant increase in sales that we're seeing.
Of known ramp that we're facing.
<unk> inventory levels of stayed pretty much in line there.
At the company level about $50 million higher than we exited the the.
The first quarter with and obviously some work to do to drive that down in the in the back half of the year as we see the markets strength in here, we'll be making sure that we have that inventory in place.
Could there be a little bit of pressure on that I, suppose, but I'm very happy to see that we're still forecasting inventory turn improvements as we exit the year and good focus on working capital management as you think about our 4 and a half to $5 billion of free cash flow at.
At the midpoint of that range I would say that increment.
And it comes from the improved profit if we're able to get to the higher and that will likely be on slightly improved capex.
And we'll be watching the working capital, but we got the right focus on it when it make sure we're ready for the recovery ready for our customers, but at the same time not bringing in inventory that we don't need in terms of calendar.
Inflation for the second half of the year as I think about the third quarter profile, probably about the same increase in free cash flow that we saw from Q1. The Q2. So again, we're very happy with the collections that we're seeing.
And right now thats sort of how I see third quarter playing out.
On the color.
Calendar. Thanks.
The next question comes from the line of Cristina <unk> with Morgan Stanley.
Hi, good morning guidance.
Wondering if you're seeing.
Neil earlier, you mentioned the variable of 75 for 100 million AMD and calling for the back of over here.
Can you provide more details on what that.
All of things and how much more flexibility you have and deferring the spend.
Sure.
That really is across the Collins portfolio, we did a very deep dive of last year as you would probably expect on where we're spending our A&D and especially through the pandemic. We wanted to make sure that we're focused on.
On the next generation technologies, where we can insert or upgrades into the existing Collins platforms.
I'd say, there's always flexibility around the allocation of those dollars to specific investments, but it's really and our interest to make sure that we spend the money we want to make sure that we do not.
Starving.
Star of any of our businesses I think we're a long ways from doing that.
And Steve Tim talk about investing about 6% of sales over the over the next several years and I think our spending is about right.
We're poised to invest about $6 billion of our own money.
Between capital and E&E over the.
Each of the next 4 years. So there is some flexibility kristine there but.
I do know that we've got a long list of important projects.
<unk> team is aggressively working.
Thanks Neil.
You bet.
Our next question comes from the line of David Joseph Barclays.
Thanks, Good morning, everyone and do it.
Okay.
You highlighted the the.
The sequential ASP growth of Youre expecting in Q3 I guess.
In light of that and maybe talk about what youre seeing so far in terms of July on the aftermarket side and then.
And then Greg.
Since the Investor day, Airbus came out with <unk>.
A much higher potential narrow body production rates as we look out the.
23, $2004.25.
I guess, what do you think of those potential rates and how could that change what you have guided the Collins and.
The look like and out in 2025.
Sure I'll start.
Obviously, we haven't even closed the month of July yet, but we do look at debt data regularly we're seeing continued.
Growth as we.
Head into July and consistent with the forecast that we've got baked into.
And to our outlook.
What I would say.
As we think about.
Perhaps for example, I think of big piece of the second half is in the shop visits we were really happy to see 56% year over year large legacy shop visits as I think about.
Q3 will be.
Probably north of 30% 35%.
And even over 20% growth year over year and the fourth quarter. So some good indicators there we've got pretty good line of sight as we look at the back half of the year, particularly on the Pratt shop visit side.
So David as we as we think about.
The narrow body.
Ramp if you will I think you'll see both Boeing and Airbus are starting to ramp up production.
We were a little surprised I would tell you, but we have been talking to Airbus and I know Gilman company are laser focused on trying to take some market share and so they're being pretty aggressive by showing that.
The 70 to 75.
Aircraft, a month figure out in 2025 and.
I'd tell you, while we're working with Airbus.
And that remains a challenge for us to get to those levels right now where capacities to I think it was <unk> 63 was the it was the latest high point.
And obviously.
<unk>.
We will do whatever we need to to support our customers.
And now whether or not that rate actually materializes I guess will be the question, obviously with the XLR coming along is the <unk> hundred 21, and <unk> I think Airbus has got a great aircraft and the they wanted to take advantage of that.
And the marketplace, but we will.
We'll see.
Again as I think about this the <unk>.
Air traffic is going to grow for 5% of year.
So youre going to continue to see plenty of demand out there for narrow body and the question will be as of <unk> hundred Twenty's or is it 73.7 and.
We're positioned on both obviously a little bit different content on the <unk> hundred 20 with the with the.
And <unk>, but.
We're keeping an eye on all of this and I think we'll work with the supply chain and we'll make sure that we're adequately capacities to be able to serve our customer there and we'll see what happens, but there is plenty of time between now and then to get ready if the ramp actually occurs as quickly as what Airbus hopes.
And sorry much.
The next question comes from the line of Robert Spingarn with Credit Suisse.
Hi, good morning.
Greg you talked about the.
And the surprising second quarter narrow body aftermarket demand and you also talked about the lagging wide body of recovery, but maybe a year from now or even sooner.
If we end up with the vaccines getting traction and we see more long haul traffic strength could we have a surge and demand both for maybe the wide body and narrow body at the same time and and given the head count reductions do you have the capacity to address it in other words put the demand curve turn into a sine wave at some.
On point here.
For from your lips to God's ears.
Let's see.
I think in fact.
We are optimistic that we could see a faster recovery should we get.
A more robust.
Vaccine rollout and keep in mind and the U S and about half of the population.
<unk> is vaccinated is getting to be the same and Europe, China. The vaccine is also taking hold but globally. It's only about 9%. So we've got a long way to go I think the good news is most of the air traffic of course is between China. The U S and Europe, So we could see.
Quicker recovery.
I would tell you that the.
We are.
More than adequately capacities to take advantage of that recovery from an aftermarket perspective is we took all of those cost cuts last year that kind of $2 billion of cost takeout, what we didn't do as close of lot of factories or eliminate a lot of capacity as Neil mentioned before.
And 1 of the overhangs of course and at Pratt and from a cost standpoint is you've got all of those unabsorbed overhead well, that's because we still have the facilities. We can we're still facilities to do with thousands of ease. If we if we saw the that kind of of ramp. This year will probably do 550 of these overhauls, but the capacity still exists at the same.
T F and it's really the same across the columns portfolio, we haven't closed factories and.
And we can bring folks back we can work extra shifts to pick up on the demand and so I'm not actually worried.
If we were to see that kind of a recovery that would be it would be good.
Certainly not what we expect today, but.
We are ready for it.
Thank you.
Your next question comes from the line of Seth Blackman with J P. Morgan.
Hey, thanks, very much and good morning, everyone.
On.
Greg I was wondering if you could maybe put on your business round table hat and.
On the <unk>.
Talk a little bit about we're getting into the second half of the year and.
There is still on a resolution on the R&D tax issue for next year and.
And so I wonder if you could talk about any of the prospects for that and the Congress and.
And b the prospects to get some relief from.
That outside of Congress, maybe with some kind of IRS interpretation of the law that removes customer funded R&D from the from the equation.
Yes, that's a great question Seth as we.
We were very hopeful I would say 3 or 4 months ago as we were thinking about the infrastructure.
Bill as it was winding its way through Congress and.
Clearly as we are having discussions on the hill.
Both the Senate and the house side.
People were very sympathetic to the fact that this R&D amortization language that was in the 2017 jobs Act.
Not helpful in terms of driving the kind of investments that we wanted.
C and technology and so we have we have been pressing folks to include relief on the R&D amortization.
Amortization formula.
And any infrastructure Bill that's out there obviously there is pressure to take the corporate rate up we'll see where that goes but I think we're still hopeful that we will see.
See.
Some type of relief and maybe it comes in December as is typical with the tax extenders.
And that we get some relief here, it's just hard to imagine you want to stop folks from investing in R&D as the economy comes back from the pandemic. So again, we're still hopeful folks of business round table of doing a good.
Job educating the.
The Congress on this and we'll see where it goes but we're not going to give up hope I think the this.
And this is something we just have to get done.
And anything outside of Congress.
We haven't actually explored of regulatory ruling and I haven't seen a pathway for.
The IRS or treasury 2 to change the statutory language of the 2017 jobs Act. So right now I think it's going to require an act of Congress.
Thank you very much.
Yes.
Your next question comes from the line of kind of annual number.
And with Cowen.
Yes.
<unk> much so could you comment on the Biz jet trends at legacy U T X and.
And and also you know you didn't have much of an uptick and commercial OE at Collins, what do you see going forward for the pick up and rates on the Max and the 7.8 and 7 were boeing's.
Thanks, Kevin and their own problems.
Yeah, let me start with some biz jet context, hi, how are you doing today.
Obviously biz jet has rebounded very quickly and so whether thats.
At the affecting the Collins business or the Pratt Canada business, we're seeing very good performance.
<unk> there that I would say combined with general aviation and both are at or near or even slightly above where we were in 2019. So that is a major contributor here.
Part of the Collins.
Q2 performance were seeing it within the Pratt aftermarket as well.
As I think about OE.
We're certainly.
<unk> been seeing that OE growth at both Collins and Pratt.
And as I think about you know the back half of the year, we will start to see 737, Max and start to be a bigger contributor we've talked about.
Being aligned with Boeing's production schedule, but having delivered.
About.
The third of their requirements for this year already and so as we pick up on that debt.
Second third if you will or 2 thirds rather.
That'll start to ramp up.
As we go through the third quarter and more heavily into the fourth quarter and that of course and other step as we get into 'twenty, 2 which Paul will talk more about later in the fall.
You always see picked up also guy on the 770 and Thats down to I think by of a month and fact, it's because of some of these production delays, we think it might be even a little bit slower than that so there is some impact there.
And recall.
Revenue on the that's about $10 million of ship set for the Collins business.
Oh.
There is a little bit of the.
The Governor I would say on on Collins OE.
Even here into the third quarter, and we expect again as Neil said, 1.7 and $3.7 production rates pick up or pick up here as well as we get some of these production issues behind us at the Boeing line.
On.
<unk> hundred 87, and that should that should help the towards the end of the year and into next year.
Thank you.
Your next question comes from the line of Mike <unk> with Wolfe Research.
Hey, good morning, everyone and thanks for the time.
And.
Greg you mentioned, having the.
<unk> technology for the next conflict.
So can you talk about the longer term sort of supply demand balance and your missile business as the Dod customers priority shift back towards peer adversaries.
Asymmetric threats.
Yes, Mike it's an interesting discussion if you think about what the.
And as I said, we talk about having the right technologies for the next conflict.
As we see this the.
The next war and I've said this before it gets for it and cyber space and outer space initially.
We arent going to see.
Land Wars, and Asia or tank battles across Europe, which you are going to see is.
Cyber attacks youre going to see.
And what youre going to see attacks against strategic assets and space to compromised communications and sensing systems.
And being able to defend those assets being able to project and.
And to replenish those of those assets is really what we're focused.
<unk> on across the.
The RT ex portfolio and the other piece of this of course is how do you have assured communications and you hear a lot about Jed <unk> of this joint all domain command and command and control, having assured communications, having reliable Replenishable Comm systems is also part of this and again.
And we play and that really across the business from the sensing systems at RMB 80 of the processing that we do at RIS to some of the communication systems that come out of Collins.
I think we're uniquely positioned there as well so.
Sure.
Look it's a complex battlefield is as we think about.
And there's no 1 single answer.
It's not like we're going to replace all of the missiles. We have with high powered microwaves are of high powered lasers, and it's going to be of layered defense, where youre going to still you're still going the CSM threes and SM 6 is and you are still going to need amiram missiles as well as some things to deal with I would say the emerging threat of hypersonic.
Which we think is primarily going to be high-powered microwave so.
A lot of lots of pull of part there, but I think again, we have technologies and all of those spaces that can differentiate us.
Thank you.
And our last question will come from the line of Matt Akers with Wells Fargo.
Thanks, and good morning.
Touch on the sort of the military engine outlook and wonder.
During the kind of specifically in light of some of the F 35 kind of disruptions we've seen on the aircraft side last year this year and lockheed's comments about maybe a little bit of of slower.
Growth profile.
And going forward and just how we should think about that kind of kind of trending going forward.
Yes, I'll take that.
As we look at the rest of the year for Pratt on the military Andrew because it's pretty steady.
And at or near sort of the rate we need to be on the F 35 engine.
And we're clipping along.
We're not quite halfway through our delivery schedule for the year, but we're pretty close to it. So I would expect the back half of our year to look pretty similar to what the first half day and in terms of engine deliveries and as we've talked in the past, we pretty much see that kind of rate.
Holding steady for the foreseeable future of there and keep in mind too.
Matt It's not just F 35 rate were also on the KC 46 the tanker.
We're going to be on the next generation B 21 is that it goes into flight test and then into production of the next couple of years, So theres more than just <unk> out there and the F 100 on the F 16 remains of opportunity opportunities for us to continue to.
<unk>.
To utilize the platform that literally is 40 years old so.
There's more to the military engine business and just Jeff obviously, it's the biggest piece, but the other pieces are important as well.
Got it thanks guys.
Alright, well. Thank you everyone for listening in today has always Jennifer and team.
We are prepared and ready to take all of your questions. So thanks for listening in and we'll see you guys soon take care and be well bye bye.
Thank you. Thank you, ladies and gentlemen that cause of this conference call you may now disconnect.
Okay.
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Sure.
The next year.
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