Q2 2025 Earnings Call Transcript

Good day, ladies and gentlemen, and welcome to the RTX Second Quarter 2025 Earnings Conference Call. My name is Latif, and I will be your operator for today. As a reminder, this conference is being recorded for replay purposes. On the call today are Chris Calio, Chairman and Chief Executive Officer.

Neil Mitchill, Chief Financial Officer; and Nathan Ware, Vice President of Investor Relations. This call is being webcast live on the Internet, and there is a presentation available for download from RTX website at www.rtx.com. Please note, except where otherwise noted, the company will speak to results from continuing operations, excluding acquisition accounting adjustments and net nonrecurring and/or [ second ] items often referred to by management as other significant items. The company also reminds listeners that the earnings and cash flow expectations and any other forward-looking statements provided in this call are subject to risks and uncertainties.

RTX SEC filings, including its forms 8-K, 10-Q and 10-K, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. [Operator Instructions] With that, I will turn the call over to Mr. Calio.

Thank you, and good morning, everyone. We delivered very solid results in the second quarter as we continue to execute in a dynamic operating environment. On the top line, sales were up 9% organically year-over-year, including 16% commercial aftermarket growth, continuing the momentum from Q1. Segment operating profit was up 12% year-over-year, supported by growth across all 3 of our segments. And free cash flow for the quarter was approximately breakeven as we previously discussed, primarily related to the 4-week work stoppage at Pratt in May, which we expect to recover in the second half of this year.

We also continue to see exceptionally strong demand for our products with a Q2 book-to-bill of 1.86 and our backlog now stands at $236 billion up 50% year-over-year and 9% sequentially, driven by several notable wins in the quarter. Pratt booked over 1,000 GTF engine orders, including up to 177 aircraft for Wizz Air and 91 aircraft for Frontier Airlines as they further expand their GTF-powered fleets. And Raytheon booked over $5 billion of integrated air and missile defense awards, including $1.1 billion for [ AM NYMEX ] effectors. This is the largest order in the history of the program, will benefit the U.S. and international customers.

I'll now turn to the current operating environment. In commercial aerospace, OE production was strong and in line with our expectations for the first half of the year and we remain positive on the ramp continuing in the back half, supporting growing demand for our products. Global RPKs are also expected to continue to grow over 5% for the year, which supports low retirement levels and strong commercial aftermarket demand. For example, our V2500 powered aircraft fleet has seen a 1% retirement rate so far this year.

On the defense side the growing need for air dominance is creating unprecedented demand for our core defense products across RTX. The U.S. budget reconciliation legislation that passed earlier this month contains over $150 billion for additional defense spending with about $50 billion of funding for Golden Dome and munitions, again, both core areas for RTX. In longer term, NATO allies have agreed to increase core defense spending to 3.5% of GDP over the next decade with an increased focus on integrated air and missile defense. To support the growing demand across Europe, we continue to expand our regional partnerships.

For example, in the quarter, Raytheon entered into an industrial cooperation agreement with the Spanish Ministry of Defense that will support the production ramp for Patriot in the local region. So overall, demand remains strong across our [indiscernible] end markets and supports continued top line growth across the business. On the trade front, it continues to be fluid, but our outlook on the impact of tariffs has improved for the year as there have been some positive announcements to date such as the U.K. agreement, which provides exemptions for aerospace components. We also continue to improve our ability to mitigate tariff headwinds, including optimizing material flow or possible and through pricing actions.

As a result of these developments and our strong first half performance, we're increasing our adjusted sales outlook for the full year. We're also revising our adjusted EPS outlook to incorporate drop-through on the higher sales, continued cost discipline across the business, and our current assessment of tariff impacts. And for free cash flow, we are maintaining our full year outlook. Neil will take you through these details in a few minutes.

But before he does, let me provide an update on the progress we're making on our strategic priorities on Slide 4. First is executing on our commitments. On the GTF fleet management plan, our financial and technical outlook remains consistent with our prior comments. Isothermal forging output was up 12% versus the prior year and 10% sequentially, which supported a 22% year-over-year improvement in PW1100 MRO output this quarter despite the Pratt work stoppage. And we remain on track for over 30% MRO output improvement for the full year, which is a key enabler to reducing AOGs in the second half.

And at Raytheon, the team is leveraging our core operating system to significantly increase production this year for multiple sectors, including GeM-T, Coyote and AMRAAM. In the quarter, both GMT and Coyote saw output more than double year-over-year. Next is innovating for future growth. Autonomy and AI are significant parts of our RTX cross-company technology road map.

Earlier this month, we announced a new partnership with Shield AI to integrate AI-based sensor and target recognition capabilities and to select Raytheon products. This includes loitering munitions and our multispectral targeting system which is a battle-tested sensor package that provides long-range surveillance and target tracking for a variety of munitions. Also in the quarter, Raytheon announced the collaboration with Kongsberg to co-develop subassemblies of the GhostEye radar. The GhostEye system adapts the fundamental technology of LTAs into a smaller 360-degree solution for advanced medium-range tracking that will detect drones, cruise missiles and other airborne threats.

This system builds on the battle-tested NASAM solution, which has 13 partner countries and over 1,000 intercepts over just the last few years, and it's another example of how we're expanding our regional partnerships in Europe. And lastly, we continue to leverage the breadth and scale of RTX. Across the company, we're implementing our proprietary data analytics and AI platform to accelerate our backlog and increase productivity across our operations. This platform is our digital backbone that connects our enterprise systems, thousands of shop for machines and millions of hours of product data to enable more efficient operations and smarter and faster decision-making.

For example, and Collins Avionics business, our engineers are using this platform to reduce software development times by around 30%, allowing us to deliver faster and more frequent software upgrades to our customers. Shifting to the portfolio. In the quarter, we entered into an agreement to sell Collins, Siemens Precision Products business for $765 million. And yesterday, we completed the $1.8 billion sale of our actuation business.

Both transactions highlight our efforts to focus and invest in our core capabilities with proceeds to be used to further strengthen our balance sheet. Lastly, we raised our dividend by 8% in the quarter, reflecting our confidence in executing our backlog and the long-term cash generation capability of our company. With this dividend increase, we now expect to deliver $37 billion of capital to shareowners from the date of the merger through the end of this year and we remain committed to a long-term capital return policy that includes growing our dividend and returning excess capital to shareowners.

Overall, we continue to make steady progress on our key priorities, and I'm pleased with the performance and momentum through the first half of the year. With that, let me turn it over to Neil to take you through the results and our updated outlook for the full year. Neil?

All right, Chris. Thanks. I'm on Slide 5. In the second quarter, adjusted sales of $21.6 billion were up 9% on both an adjusted and organic basis. Growth was led by strength across all 3 channels with commercial aftermarket up 16%, commercial OE up 7% and Defense up 6%. Segment operating profit of $2.7 billion was up 12%, driven by drop-through on higher volume and improved defense mix, and we saw 30 basis points of consolidated segment margin expansion. Adjusted earnings per share of $1.56 was up 11% from the prior year, driven by segment operating profit growth and a lower effective tax rate.

Earnings per share included approximately $0.06 of higher tariff costs. On a GAAP basis, EPS from continuing operations was $1.22 and included $0.28 of acquisition accounting adjustments and $0.06 of restructuring and other items. As expected, free cash flow was an outflow of $72 million. This included approximately $250 million for powder metal related compensation and $175 million related to tariff impacts.

So overall, our first half results were strong, driven by end market demand and execution across all 3 segments. Now let's turn to Slide 6, and I'll take you through our outlook. Starting with the top line. Given our strong first half performance, we are increasing our full year adjusted sales outlook to a range of $84.75 billion to $85.5 billion up from our prior range of $83 billion to $84 billion.

This translates to between 6% and 7% organic sales growth for the year, up from our prior range of 4% to 6%. Looking at it by channel at the RTX level and adjusting for divestitures, we now expect commercial aftermarket sales to grow low teens, up from our prior outlook of around 10% growth. On the commercial OE side, sales are expected to grow high single digits year-over-year, up from our prior outlook of mid-single digits. And we continue to expect defense sales to grow mid-single digits across the company.

On the bottom line, we continue to improve our ability to mitigate tariff headwinds, including expanding USMCA coverage, qualifying additional parts for military duty-free exemptions and maximizing the use of free trade zones in addition to the items that Chris mentioned. As a result, our current assessment of 2025 tariff costs, net of mitigation is around $500 million, with approximately $125 million already incurred in the first half of the year. In addition, we see the associated cash impact to be around $600 million for the full year, again, a notable improvement. We have incorporated these impacts into our updated full year outlook.

With respect to taxes, we are pleased with several elements of the recently enacted legislation that restores the full expensing of research and development costs and maintain stability in the corporate tax rate and we continue to expect an effective tax rate of 19.5% for the full year. In addition, improved operating performance, including additional profit growth at Raytheon and volume drop-through at Pratt & Collins is providing $0.10 of EPS improvement, which partially offsets the $0.30 tariff headwind. All in, we now see adjusted EPS at a new range of $5.80 to $5.95 for the full year versus our prior range of $6 to $6.15. On free cash flow, we continue to expect between $7 billion and $7.5 billion for the full year as the headwind from tariffs will be offset by the benefit from improved cash taxes.

The primary drivers of our second half cash flow growth will come from segment profit and working capital improvements, including the recovery from the work stoppage at Pratt. With that, let me hand it over to Nathan to take you through the segment results for the second quarter.

Okay. Thanks, Neil. Starting with Collins on Slide 7. In Sales were $7.6 billion in the quarter, up 9% on both an adjusted and organic basis, driven by strength in commercial aftermarket and defense. Adjusting for divestitures, by channel, commercial aftermarket sales were up 13%, driven by a 20% increase in mods and upgrades, a 12% increase in parts and repair and a 9% increase in provisioning. Defense sales were up 11%, driven by higher volume across multiple programs and platforms, including the F-35 and the survivable airborne operations center programs. Commercial OE sales were up 1% versus the prior year as expected lower volume on the 737 MAX was more than offset by higher volume on other platforms, including the 787. Adjusted operating profit of $1.2 billion was up $104 million versus the prior year as drop-through on higher commercial aftermarket and defense volume, favorable defense mix and lower R&D expense more than offset unfavorable commercial OE mix and the impact of higher tariffs across the business.

Turning to Colin's full year outlook. We now expect sales to grow mid-single digits on an adjusted basis and high single digits organically, up from our prior range of up low single digits on an adjusted basis and up mid-single digits organically, driven by strength in commercial aftermarket and defense. With respect to operating profit, we now expect growth between $275 million and $350 million versus 2024 compared to our prior expectation of up between $500 million and $600 million, driven by the expected impact of tariffs which was partially offset by increased volume drop-through. Shifting to Pratt & Whitney on Slide 8. Despite the impact of the 4-week work stoppage that occurred in the quarter, sales of $7.6 billion were up 12% on both an adjusted and organic basis, driven by strength in commercial aftermarket and commercial OE.

Commercial aftermarket sales were up 19% and driven by higher volume in large commercial engines and favorable mix in Pratt Canada. Commercial OE sales were up 15%, driven by favorable mix in large commercial engines and higher Pratt Canada volume. In military engines, sales were flat, driven by F135 volume, including the impact of contract award timing. Adjusted operating profit of $608 million was up $71 million versus the prior year as favorable commercial OE mix, drop-through on higher commercial aftermarket volume and lower R&D expense more than offset unfavorable commercial aftermarket mix, the impact of higher tariffs across the business and the 4-week work stoppage.

Turning to Pratt's full year outlook. We now expect sales to grow low double digits on an adjusted and organic basis an increase from our prior range of up high single digit driven by strength in commercial aftermarket and commercial OE mix. With respect to operating profit, we now expect growth between $200 million and $275 million versus 2024 compared to our prior expectation of up between $325 million and $400 million, driven by the expected impact of tariffs partially offset by increased volume drop-through. Now turning to Raytheon on Slide 9. Sales of $7 billion in the quarter were up 6% on both an adjusted and organic basis driven by higher volume on land and air defense systems, including international Patriot and NASAMs and higher volume on naval programs, including SPY-6 and Evolve Sea Sparrow Missile.

This was partially offset by expected lower development program volume within air and space defense systems. Adjusted operating profit of $809 million was up $100 million versus the prior year, driven by favorable program mix including international Patriot and higher volume. Bookings in the quarter were $9.4 billion, resulting in a book-to-bill of $1.35 and a backlog of $63.5 billion. On a rolling 12-month basis, Raytheon's book-to-bill is 1.49. Other key awards in the quarter included over $1.2 billion for SM3 production and approximately $650 million for SPY-6 production.

Turning to Raytheon's full year outlook. We continue to expect sales to grow low single digits on an adjusted basis and mid-single digits organically with operating profit growth between $225 million and $300 million versus 2024, up from our prior expectation of between $150 million and $225 million, driven by favorable international program mix. With that, I'll hand it back over to Chris for some closing remarks.

Okay. Thanks, Nathan. I'm on Slide 10. We have great momentum across RTX through the first half of the year. We delivered strong top and bottom line growth and our end markets remain robust as seen by our recent customer wins and 1.86 book-to-bill in the quarter, and our backlog now stands at $236 billion. Looking toward the second half of the year. We are focused on what we can control, executing our backlog, driving cost discipline and investing in innovation.

With that, let's open it up for questions.

[Operator Instructions] Our first question comes from the line of Jason Gursky of Citi.

Chris, wondering if you wouldn't spend a few minutes on Raytheon and maybe talk about out the multiyear outlook here. You had a really solid book-to-bill here over the trailing 12-months, as you just highlighted. And you guys highlighted, the upward pressure on budgets, both domestically and internationally, the partnerships that you're setting up in Europe for Patriot production, for example. So just kind of curious when you think, based on the feedback that you're getting from customers, we might begin to see some awards flowing on some of this outlook.

And how quickly you think you can convert that into revenue once you begin seeing words, for example, on Golden Dome. And just kind of the opportunities and challenges that you have ahead of you to convert all of this pipeline and backlog into revenue. Just kind of what the multiyear outlook looks like here from a growth perspective.

Yes. Well, thanks, Jason. And I think you sort of led off with how I would start the story, which is really on the demand profile. I mean, Raytheon did have another very strong quarter of demand, a 1.35 book-to-bill. If you look at their backlog since the end of 2023, it's up about 25%.

And it's in those areas, Jason, that we've said before, are really core, right, integrated air and missile defense, effectors, sensing. You mentioned the international demand, which again, Europe, the 3.5%, that's going to play out over the next decade or so. We continue to see strong demand in MENA region in Asia Pacific, given the INDOPACOM threat. Maybe just think also just about reconciliation.

You mentioned it, $25 billion for Golden Dome, another $25 billion for effectors. We think Golden Dome in particular, is really well aligned with our core capabilities and product portfolio. Again, battle tested and proven systems at each layer. Think Patriot, NASAMS, Coyote, additional levels of potential protection on the coast with our TPY-2 radar and the long-range SM3. And so really, demand across the board.

And our focus this year has really been on ramping. We're going to see significant increases this year on a number of key programs, Gem-T and Coyote going to double in particular, AMRAAM. And so when we talk about ramping, it's about capacity, it's about the supply chain. We're investing about $250 million this year in capacity, Tucson, McKinney, Camden, and we're injecting people into the supply chain, which is, again, why you're seeing material growth for the ninth straight quarter at Raytheon.

So the demand signal is, again, super strong. We continue to form key partnerships in Europe set up second sources, coal production, all the things that help drive this backlog and execute on this demand. I won't speculate on when some of this stuff like Golden Dome turns into sales and awards, but there's a significant opportunity there for us, and we are well positioned and highly engaged in that process.

Our next question comes from the line of Robert Stallard of Vertical Research. Robert.

But I was wondering if you could give us a bit more detail on some of the moving parts you've given in Q2 versus Q1. And whether you've factored in or seen any negative developments on the demand side, particularly from U.S. airlines?

I'll start on the tariff front, Rob, give a little more color there. As we said upfront in the prepared remarks, our initial outlook was $850 million. We've now reduced that to $500 million. About half of that reduction comes from the reduced rates and the pausing.

The other half comes from the improved mitigation actions that we've talked about. I think USMCA think some certain pricing actions, optimizing the flow of material around our network. So that's the tariff piece. And again, as an overall sort of macro look at tariffs, I think countries want to get deals done.

I think there's going to continue to be some escalation in flare ups. That's sort of the nature of how these things work. But I think even with some of the more difficult negotiations that are out there, generally speaking, people want stability. They want predictability and we're confident that those deals will get done.

We haven't seen it at this stage, bleed through into demand. If you just look at the commercial aftermarket here in the first half. Again, really strong 18% organic growth. We've seen increased shop visits in the platforms, both the V2500 and Pratt Canada.

If you look at Collins, all their channels at book-to-bill over 1, some very strong demand on mods and upgrades. And again, on a more macro level, I would say the consumer sentiment index continues to rise, unemployment remains low think the airline commentary has been around a more stable environment, which provides a good platform for continued strength in the aftermarket so again, I think we've got our arms around tariffs as we see them today. and continue to see strength in the market.

And Rob, let me give you a little bit of color on the segments. So if you think about the $500 million, about $275 million pertains to Collins, and that's reflected in their revised outlook at about 225 relates to Pratt & Whitney. And if you think about the second quarter, so what's behind us, we got about $100 million or so behind us, $60 million of it is sitting inside of the Collins numbers in the second quarter and $40 million is sitting inside of the Pratt numbers. And I already mentioned how much cash we've incurred to date in terms of an outflow is about $175 million.

So we got about $425 million to go for the rest of the year.

Our next question comes from the line of Myles Walton of Wolf Research.

Maybe just one clarification first and then a question. So the clarification. In terms of the tariff assumptions, are you assuming that revert on August 1 back to the liberation day levels or the new levels or just they continue at pace where they are? And then the real question is on the reconciliation bill.

If you can just put a finer point on the specific benefit you got from the R&D capitalization reversal and how that proceeds over the coming few years?

Sure. Thanks, Myles, for the question. Just to clarify on the tariff piece. So our $500 million contemplates the rates that are currently in effect today. So we haven't contemplated something going up on August 1 or anything that might transpire after that.

However, I'll make a couple of comments on that. The first is -- should rates change go up, we'll probably see about a couple of months of that hit the income statement. The rest would sit in inventory at the end of the year. We think that between the way we're looking at the year in terms of our risk and opportunities as well as the range we provided in the earnings per share, we'd be able to absorb that.

I would say the same thing on the free cash flow side. So that's why we've got a range around those particular metrics. And as we sit here today, there's still a lot to learn over the next couple of months, and we'll be monitoring that. And of course, as Chris just said, we're working our mitigations to continue to offset any additional headwind that might come.

On the tax side, again, pleased to see the permanent restoration of R&D in particular. As you all know, the tax rules are very complicated. So we're dealing with a number of provisions that are embedded in that legislation. We do see a little bit of income statement headwind this year.

We're offsetting that with some other operational tax items for the year. So no net impact there, keeping our effective tax rate at 19.5%. On the cash side, as you probably all know, this bill was effective as of the beginning of 2025. And so again, a lot of complexities there. We do expect a cash benefit to come this year.

It's fairly moderate. It probably accounts for 25%, 30% of the offset to the tariff headwind that we're seeing this year. But we'll expect that to continue to be a benefit going forward in '26, '27 and '28 as we continue to work through the varying provisions of that bill, including the capitalization versus expensing of research and development and how we handle that and the interplay with some corporate alternative minimum taxes. So very complex, but big picture, it's favorable.

Great to see the corporate tax rate maintained at I think that's really important for American companies to maintain our competitive global edge, and we're continuing to invest research development here in the United States as well as capital, and we get a bonus deduction for that as well from the provision. So all good, and you'll see that in the numbers as we get into next year.

Our next question comes from the line of Scott Deuschle of Deutsche Bank.

P Sorry to ask another question on tariffs. But Neil, should we expect the net impact of tariffs to decline in 2026 relative to 2025, assuming these current rates hold? And then does that net impact decline more for cash than us for EBIT as you go into next year?

Scott, thanks for the question. I don't want to get too far ahead of us for '26. But what I will tell you is that we're continuing to aggressively work the mitigation strategies here. We've been very successful in identifying opportunities to qualify more of our imports under the USMCA provisions, military duty-free exemptions, putting bonds in place for goods that get re-exported. So I think we have a number of things, Chris alluded to, some of the pricing actions as well.

Right now, I would say we've made good progress there. And I'm seeing good traction. Don't want to put a number on it today, but our intent here is to continue to aggressively mitigate these headwinds so that we don't see a larger year-over-year headwind coming into $26 million.

Our next question comes from the line of Sheila Kahyaoglu of Jefferies.

Maybe we could talk about the core business because it performed very well at Pratt. So the guidance is now double-digit aftermarket growth for Pratt after 24% in H1 implies a steep deceleration. How are we thinking about aftermarket, whether it's spares, work scopes, the 22% MRO output on GTF despite the strike and I think you mentioned the V2500 retirements at 1% year-to-date. So maybe just based on GE commentary last week, they're extending their shop visit peak as well.

How are you thinking about volume, profit drop-through on the 2 large commercial engine programs?

Sheila. So I'll sort of pick up to kind of where you were going here. On the MRO output at Pratt, on the GTF1100. Again, we were pretty pleased, up 22% in Q2. You mentioned that's despite sort of the part supply impact from the 4-week work stoppage, also on heavier work scopes, so feel good about that output. And that's key, obviously, continuing to move the AOGs down here in the second half of the year. On the V2500 continue to see sort of strength in that program.

We're obviously halfway through the year and feel really good about the 800 or so shop visits that we forecasted for the year. And I'll tell you, when you look a little bit longer term there, I think that program is going to continue to have strength, frankly, beyond where we thought it would 3, 4 years ago. That platform continues to perform exceptionally well. Demand is there. And even at shop visit potentially start to come down at some point, I think you'll start to see the content go up. So feel really good about GTF and the V2500. And then, of course, there's also Pratt Canada continued strength there in their shop visits and on their portfolio.

So feel good about the Pratt commercial aftermarket story.

And maybe just to put a finer point on some of the changes in our outlook, Sheila. We talked about Pratt sales now being up low double digits for the year. Think about that as about $800 million of the $1.6 billion top line increase at the RTX level at the midpoint. About half of that is going to be aftermarket.

So we now see the aftermarket up mid-teens. We've been working, as you know, to balance our deliveries between installs, spares and so again, we see good growth in the back half as well. The compares get more difficult, not just PAP but also at Collins. About $300 million of the $800 million increase is on the OE side.

We continue to see good mix there, and the rest is sitting in the defense business. So just a little extra color on the Pratt business.

Our next question comes from the line of Ron Epstein of Bank of America.

A little bit about what you're seeing in OE production rates. It does seem we're starting to see some stability and lift in the Boeing narrow-body rates and wide-body rates. And what are you seeing on your end? And then on the Airbus side, it seems like A350 is still kind of challenged and what's that mean for Collins and what's going on with A320.

Rod, let me start maybe a little bit and then Chris can pile on. At Collins, OE growth here in the second quarter. We expected the first half of the year to be a little bit lighter. The compares get a lot easier as we get into the second half of the year, particularly because we're overcoming the Boeing strike from last year.

So at Collins, we're encouraged by the ramp that we're seeing there. We're expecting a little bit of mix headwind as the wide-bodies 787, in particular, as you all know the story there, ramps up in the second half. But I would say, just to put a little color on the Collins segment, I just did Pratt, see about $800 million of sales uplift in our outlook. About $200 million of that is on the OE side because of that strength that we're seeing on the ramp side.

Another $250 million is in the aftermarket just to keep going here and the rest is in defense. We had a really strong year start to the year for the Columns Defense business. Chris, anything you want to add?

I would just agree with the overall sentiment, on, which is I think we are seeing stability in the rates at Boeing, they continue to grow with the focus there on the production system. So that's great. And for Collins, it's just making sure that we stay out of their way and continue to deliver at the rates that they need, making sure that we've got the supply chain in place on some of the constrained material Again, as we've said before in the past, we've got capacity for a much higher rate. So this will just come down to making sure we've got the material where we need it, when we need it, but feel good about that.

And then on the A320 again, continue to ramp there as well, Ron. We had the work stoppage, of course, which impacted a little bit here in the quarter. But again, I think we're going to make that up in the balance of the year. And on the engine side, it really is still about allocating material between MRO and production.

And we work closely with Airbus in doing that because we've got to make sure that we balance the continued ramp there, especially as it relates to structural castings and isothermal forgings with what we need on the MRO side because, again, we got to continue to support that fleet and move the AOGs down here in the second half of the year, which is our plan.

Our next question comes from the line of Seifman of JPMorgan.

Chris, I was wondering, there's been some reports in the press about upgrades at the FAA and the role that RTX might play in that. I was wondering if you could help us out in terms of how to think about that opportunity.

Yes. Absolutely, Seth. FAA modernization, I think, is something that's pretty critical. I think that's a bipartisan sort of agreement. We were pleased to see the funding that was in the reconciliation bill of $12.5 billion, which I think is a pretty good down payment on what you're going to need to overhaul the air traffic system. Again, we play in some very specific areas in there.

We've got very strong market share on the radars that are installed and so there's an opportunity there. There's also opportunity on just the automation that goes into the towers and whatnot, where we have a very strong position. So again, working with the FAA on modernizing and upgrading those systems and then again, there's an opportunity, I think, on the aircraft equipage side. As you know, Collins has a number of packages there that help with ground control and other things that happen on the runway.

So these are all opportunities, I think, that I put into the FAA modernization bucket. Again, a big opportunity for Collins.

Our next question comes from the line of Peter Arment with Baird. Peter.

Neil. Chris, maybe circling back the big picture questions on sort of where we're going, what kind of related [indiscernible] and missile defense activities. There's I was say in the most recent budget request, we kept up for [indiscernible] I was just thinking about the knock-on effects for LTAMS. How do we think about the longer-term production output there as we see a big ramp or are there any impact?

Peter, it was a little bit choppy. I think you were asking me about effector production on Patriot, is that where you were going?

If there's any change in level related to that?

Yes, sure. Well, look, as it relates to just gold and Dom, I think Patriot, we believe, is going to be a very important part of that. especially if you want to make a significant impact over the next 2 to 3 years, I think there are opportunities to take Patriots that are potentially in inventory today, deploy those as part of the Golden ville architecture, of course we'd have to go and then backfill those. And you're seeing Patriot demand all across Europe as well. There's been some recent reporting there. And again, I think that presents an opportunity for Raytheon.

And then on LTAMS, again, we're really pleased to achieve milestone [indiscernible] earlier this year, initiating the production phase there. We delivered about 6 to the U.S. government and the Army has plans to procure any more over the next decade or so. And I think the critical thing there about LTAM is the integration potential it has with Patriot. You've got 19 Patriot countries out there today, leveraging their investment, leveraging the upgrade that they've made by integrating LTAMS with Patriot, I think it could be pretty powerful.

Our next question comes from the line of Kristine Liwag of Morgan Stanley. Kristine.

Chris, Neil and Nathan. Maybe on long-term free cash flow. It sounds like the company's end markets have significant multiyear tailwinds. You've talked about commercial aerospace OE improving.

Aftermarket is still strong. Defense bookings up and your supply chain investment should accelerate earnings in the next few years. So if we think about 90% to 100% free cash flow conversion to net income reversal of some of the working capital you've invested and the end of the GTF cash outflows from the powdered metal issue, should $10 billion be the minimum free cash flow in 2027 and beyond.

Kristine, let me start. Thanks for the question. I know there's a lot of interest in our free cash flow. First of all, I want to emphasize the fact that we're confident in our $7 billion to $7.5 billion for this year.

Obviously, there's work to do in the second half. There's a few things that are going to drive that. Just to remind everyone, we'll see a recovery from the Pratt strike, which is what impacted us here in the second quarter. And that's about $1 billion.

So we expect most of that to recover in the third quarter. We've got a number of delivery milestones that are attached to cash receipts as well, particularly in the Raytheon business. There's some international advances, those can be lumpy, but certainly feel confident those are within the year. And then you'll notice when you get to look at our balance sheet, the receivables are a little higher.

So we expect to collect that naturally here in the third quarter. And then we haven't talked about it, but the contract award timing for Pratt with respect to lots '18 and '19 on the F135 is expected to come into play here in the third quarter, and that will drive some upside in both sales and cash. So starting with this year. Of course, longer term, if you just look at the guidance we provided this year, there's about, call it, $1.2 billion of powdered metal related compensation in the full year.

And if you add that back, you get to about $8.5 billion of what I'd call operational free cash flow that's well over 100% of adjusted net income. And for all the reasons you articulated, continued growth on the OE side, strength in the aftermarket with RPKs continuing to grow in the 3% to 5% range, for example, strong, strong defense backlog, a lot of it sitting in our backlog today. Certainly, I'm not going to put an exact number on it today, but we expect free cash flow over the next several years. And I would add to that, the benefits that I just talked about a little earlier with respect to the tax legislation.

So feeling really confident in the free cash flow generation of the company, and we're starting to see that be more regular occurrence through the quarterly cadence.

Our next question comes from the line of Doug Harned of Bernstein.

This quarter was a very good quarter for Raytheon margins. And some time back, you had a goal of getting those margins up to 12-plus percent, and this was close. Can you talk about how you see this trajectory going forward, given that one of the issues had been on performance on some fixed price development programs, which we were hoping to see get wrapped up. And then the other side of this, you've got a lot more international demand, mature fixed price programs ahead of you.

How should we think about getting to that 12% plus number now?

Doug, let me start here. You've pointed out a number of the positives here, and we agree. We're really happy with the performance in the second quarter. I would attribute that a lot to what I call the base margin on the mix.

Once you have a chance to kind of look at the composition of our sales, you'll see that on a year-over-year basis, our FMS and DCS sales are up almost $500 million. So we're seeing the mix that we've been talking about come out of our backlog and come through the income statement with the margins that we would expect. We also saw -- we'll continue to see balance, if you will, on the productivity. So about $15 million year-over-year productivity year-to-date, starting to turn the quarter there.

But I think what's most important is seeing in the base margins of the programs that we're adding to the backlog. The other important point is in our backlog, you'll note that the foreign composition is up 2 points year-over-year. So again, with the new orders that we're adding, we're seeing it come in with higher margins. So I'd say those bids are being put out there, contemplating the current cost structure for products that are right in our wheelhouse, and we know how to execute on and the supply chain continues to improve.

So all of those create tailwind and will get us on that journey well on that journey to the 12-plus percent margins that we see Raytheon at.

Our next question comes from the line of Gautam Khanna of TD Cowen.

I wanted to ask on the GFTA, if you could just give us an update on how that gets spiraled in both for OE and aftermarket. And if you could also just update us broadly on supply chain.

Sure. So on the GTF advantage, production has already begun. We've got deliveries planned for the -- later in this year towards the end of this end of this year. The cut over, the [ Spiral in, ] as you called it, it's going to happen over a couple of years, and that's to appropriately manage the risk, ensure the production maturity and supply chain stability. And then as you noted, there is the hot section sort of plus package that we're putting together, which is the 35 or so parts of the GTF advantage that we're going to that we're going to kit.

These comprise the majority -- overwhelming majority, almost 90% of the durability improvements from the GTF advantage, and those are going to start to enter into MRO next year. Supply chain overall, I would say, continue to see improvements. I mentioned the structural casting is up over 20% at Pratt. I also mentioned the 9 consecutive growth at Raytheon.

And then at Collins, Again, it's got a huge supply chain network, and we've seen reduced overdue line items about the tune of about 25% so far this year. All really good signs for us. And I would tell you that this is one of the main areas of our core operating system, sitting side by side with our suppliers, making sure they understand our demand, making sure that if there are producibility changes that we can make, is our specification changes that we can make, whatever we can do to sort of help drive throughput in our supply chain are things that core has been really instrumental in helping us get to this level of stability.

Again, more to do. We continue to have ramp up, as I said before, on GTF MRO in the back half of the year. You heard Neil talk about some of the OE growth that we're seeing. So again, not taking our foot by any measure off the pedal. There's a lot to do there.

We feel good about the progress so far in the first half of the year.

Our next question comes from the line of David Strauss of Barclays. David.

Chris, you've highlighted a number of times the -- your forecast for GTF AOGs to come down in the second half of the year. Any sort of quantification of what that might look like in terms of how much we should expect AOGs to come down in the second half of the year? And then just a quick one, if you could touch on some of the nonrecurring items in the quarter, the customer bankruptcy at Pratt and then the extent of the restructuring you're doing at Collins.

On the AOGs, David, I'll just say they stabilized, and we're expecting them to come down meaningfully here in the second half. And that's going to again be on the back of continued growth in MRO output. As I said, to Sheila's question, we were pleased with the 22% increase in Q2, especially given the strike, especially given the work scopes. We've seen improvement in our in-shop turnaround time.

So that's continued to trend positively. But again, we need to continue to see that ramp happen in that 30% increase range as we move through the year. That's going to be the instrumental piece of this.

Yes. Let me pick up on the nonrecurring items. First of all, you saw we had a charge at Pratt & Whitney. We did have an airline customer that filed for bankruptcy, unfortunately. However, we are continuing to work with that customer, as you'd expect.

And over time, I believe that they will continue to utilize our assets and that in the long term, we will likely realize some recovery there. But as a matter of practice we reserve for that when that occurs. So that's that. With respect to Collins, you probably saw in the first quarter, we had a fairly sizable restructuring charge. We're continuing our actions there.

There's a broader effort at Collins to undergo some significant transformation. As you know, we brought a lot of companies together to create Collins, and we've done a lot of work, but there's still more to do. and that work gets harder and harder and more invasive as it relates to footprint and the like. But rightsizing the business, rightsizing the back office reducing our footprint, increasing our automation, those are all projects that Collins is aggressively undertaking right now. And so you saw the first part of the restructuring, which was largely headcount-related and as we continue to work through that, I suspect there'll be some others, too, but I'm not going to get ahead of the team there, but pleased to see what they're focused on right now.

Our next question comes from the line of Scott Mikus of Melius Research.

Neil, Chris, very nice results. I wanted to ask about Pratt and the GTF hot section plus offering. Given that 80% of the GTF fleet is on powered by the hour maintenance agreements, if the customer wants to retrofit to the GTF hot section plus, is that cost being covered by the customer or by RTX and then as you do those retrofits, should we expect favorable EAC adjustments at Pratt from time on wing benefits? Or are those benefits already baked in your margin booking rates there?

Yes. Thanks, Scott. On the hot section plus, again, that will be a customer-by-customer determination. I mean, to be very frank, we've invested heavily in the GTF advantage and, of course, heavily in the hot section plus and so our intention is to get value for those investments as we offer them into MRO. But again, we will look customer by customer, contract by contract and sort of take the right position based on those contracts and on the customer situation. But again, our overall posture is we should be getting value for that investment.

And yes, it is going to have a significant time on wing benefit. As we said, the advantage itself was going to be kind of a 2x time on wing improvement and the hot sections is going to get 90% to 95% of that time on wing benefit. So do expect it to be a significant shot in the arm for the program and for the fleet.

And with respect to the margins, I've talked about the fact that the GTF margins are positive. When you average the last couple of years, they're double digit. We continue to be measured in our approach there. These are long-term contracts.

We don't want to get ahead of ourselves. We've contemplated a certain aspect of time on wing in the base contract assumptions. But we're really excited about this additional option and where it makes sense. We'll be putting that into these engines with the customers.

And to the extent it drives a benefit, we'll see that later in the contract term.

Our next question comes from the line of Gavin Parsons of UBS. Gavin.

Maybe carry through on Pratt margins. What's the right medium-term margin rate for Pratt? And how should we think about kind of the directional GTF services margin expansion, the OE engine loss and spare mix and then other contributors like V2500 and Pratt & Whitney Canada.

A lot there, Gavin. Let me provide a little bit of context. So first of all, I'm pleased to see the margin expanding at Pratt and then overcoming some of the tariff headwind that's important. You think about the growth drivers there, we're going to continue to ramp on the OE side.

That's going to drive a little bit of a headwind over the next couple of years as we put more and more of those engines on wing on new aircraft on the aftermarket, but that's going to continue to grow as well. That's going to grow profitably, and it's going to grow above the composite Pratt margin that you see today. So I expect tailwind to the overall Pratt margins over the next couple of years. Again, I'm not going to put a number on it.

But certainly, the ingredients are there. Chris talked about the V2500. Today, if you asked us a year ago about the outlook on shop visits, it would have been lower. We're seeing improvement in the number of shop visits and the mix. Those are much heavier on the V.

So I see sustained revenue and profit from those aftermarket visits over the next several years as well. All of that, I think, puts us in a position where Pratt's margins continue to expand sequentially as we go through '25, '26, '27. As we've talked about longer term, Pratt is a mid-teens, low to mid-teens business. We've seen those kinds of margins in the past. We've gotten a lot of our engineering and development behind us with respect to the GTF advantage that will start to shift to other priorities.

However, the ingredients are there for growing aftermarket and don't forget about Pratt Canada and the military engine business, both very profitable, above, well above where the Pratt composite margin is today, and those will continue to grow in volume as well, contributing to improved margins in the Pratt business. So all the right ingredients and feeling really confident about the GTF advantage, which will continue to grow and start to overtake that V2500 as those volumes come down late in the decade.

Our next question comes from the line of Noah Poponak of Goldman Sachs.

Chris, you've made a few comments on the call here, suggesting overall aftermarket MRO I guess, engine and outside of the engine are different, but that aftermarket capacity has improved, I guess, has there been a step function improvement in ability to get work through? Or is it more of a stabilization? I'm just curious if you can put a finer point on that. And then, Neil, on the R&D cash and free cash flow, is there any refund or retroactive catch-up?

Or is it pure you had an expense versus amortization mismatch this year and now that's gone.

No. Let me start on the R&D. I mean, it's pretty complicated. And over the last couple of years, we've been getting some refunds on the tax side as it relates to R&D as definitions have been crystallized through the regulation. That said, as it relates to this year's outlook and the improvements, I'd say, like I said, about 25% or so of the free cash flow tailwind comes from the implementation of this new regulation, it's pretty complex in how we're going about doing that because it does drive our taxable income lower with the expensing and the continued amortization of the prior years.

So I won't get into any of the other technical things there. But over time, all of the research and development that we have capitalized and we will continue to incur will be deductible for tax purposes as it relates to the U.S. expenditures. And so that will drive a continued sustained cash tax benefit over the next several years. Chris?

Yes. And on your question, I think you were going is on GTF MRO output. And yes, pleased with the 22% here. And that's -- yes, we've added capacity an additional shops to the GTF network. We've talked about that a few times.

But really, when you think about the growth in output, it's improving the velocity and efficiency in our workhorse existing shops today. Think MTU, think Pratt, think Delta, those are the shops that continue to drive output to drive material into the shop, into shrink the in-shop turn time that I referenced earlier.

Thank you. With that, I would now like to turn the conference back to Nathan Ware.

All right. Thank you, Latif. That concludes today's call. As always, the Investor Relations team, and I will be available for follow-up questions. Thank you all for joining, and have a good day.

This now concludes today's conference. You may now disconnect.