Good day, ladies and gentlemen. And welcome to the Raytheon Technologies Second Quarter 2020 Earnings Conference Call. My name is Ursula, and I will be your operator for today. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Ms. Kelsey DeBriyn, Vice President of Investor Relations. Please proceed.

Good morning. And welcome to the Raytheon Technologies second quarter 2020 earnings conference call. With me on the call today are Greg Hayes, our Chief Executive Officer; Toby O’Brien, our Chief Financial Officer; and Neil Mitchell, Corporate Vice President of Financial Planning and Analysis and Investor Relations. This call is being carried live on the internet and there is a presentation available for download from Raytheon Technologies’ website at www.rtx.com. Please note, except where otherwise noted, the company will speak to results from continuing operations excluding net non-recurring and/or significant items and acquisition accounting adjustments, 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. RTC’s 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. Once the call becomes open for questions, we ask that you limit your first round to one question per caller to give everyone the opportunity to participate. You may ask further questions by reinserting yourself into the queue as time permits. With that, I will turn the call over to Greg.

Thanks, Kelsey, and good morning, everyone. I’m on slide two of the webcast here. Let me just begin by providing an update on some of the current priorities and highlights of Q2. As everyone knows, these last several months have been incredibly challenging. However, we remain focused on supporting our key stakeholders, and that starts with ensuring the health and safety of all of our employees. That is our number one priority. We also remain committed to delivering for our customers across commercial aerospace and defense. On the defense side, that means providing our customers with mission-critical products and services in the U.S. and internationally. On the commercial aero side, that means supporting customers during this very difficult time to make sure that planes fly safely, especially as airlines begin to ramp up capacity again. We also continue to engage with our suppliers, ensuring that they have the support needed to maintain stability while also working with them to make their processes more efficient. Just a word on the merger; now we’re just about 100 days into this, and I would tell you that we remain focused on the integration across the organization and on delivering our cost and revenue synergies.

Okay. Thanks, Greg. I’m on slide three. As Greg mentioned, no surprise, Q2 was a challenging quarter. Before going through the second quarter results, it’s worth noting that since the merger completed on April 3rd, our second-quarter results include legacy Raytheon company from that point forward. Adjusted sales were $14.3 billion and better than our expectations due to better volume at Collins, Pratt, and RMD. Adjusted EPS was $0.40, also better than our expectations driven by accelerated progress on our cost mitigation actions in the quarter, favorable volume primarily at Collins and RMD, and the adjustment for certain charges driven by the impact of COVID-19 on the industry and economy. On a GAAP basis, EPS from continuing operations was a loss of $2.56 per share, down year-over-year, which included $2.96 of net non-recurring and/or significant items and acquisition accounting adjustments, of which $2.34 was related to charges due to the current economic environment, primarily driven by the COVID-19 pandemic, with the largest piece being $2.13 related to an impairment of Collins Aerospace goodwill and intangibles, and the remainder attributable to customer bankruptcies, collection risk, and contract charges from anticipated lower future flight utilization. The other $0.62 consists principally of $0.28 of acquisition accounting adjustments, primarily related to intangible amortization, $0.21 of restructuring, and $0.04 of merger and integration-related expenses. Free cash flow was better than expected at an outflow of $248 million, including $165 million of merger cost and restructuring. The better-than-expected cash flow was driven primarily by the timing of advances and collections, as well as accelerated progress on our announced cash mitigation actions, including inventory reduction at Collins. Moving on to slide four. While the second quarter was as challenging as expected, we continue to see a number of trends that confirm the resiliency of our balanced portfolio. Our defense backlog was up versus the first quarter and grew to a new record of $73.1 billion. RIS had a book-to-bill ratio in the quarter of 1.17 and RMD of 1.22, giving us a consolidated RIS and RMD book-to-bill ratio of 1.2. Collins Military and Pratt Military also had strong sales growth in the quarter, growing 10% and 11%, respectively. Positive news that our franchises are healthy and will support solid growth in our defense portfolio for the next few years.

Thank you, Toby. Starting with Collins Aerospace on slide five. Adjusted sales were $4.3 billion in the quarter, down 36% on an organic basis and down 35% on an adjusted basis, driven primarily by the adverse impacts of COVID-19 on the aerospace industry. Commercial OEM sales were down 53%, driven by lower volume across all platforms, including the continued 737 Max grounding and anticipated declines in legacy programs. Commercial aftermarket sales were down 48%, driven by a 45% decline in parts and repair, a 57% decline in provisioning, and a 45% decline in modifications and upgrades. Partially offsetting the headwinds in the commercial channels, military sales were up 10%, driven by strength across key platforms and product lines, including higher F-35 volume. We also saw growth on development contracts in the quarter. Adjusted operating profit of $24 million was down $1.3 billion from prior year, dropped through on higher military sales, aggressive cost management actions including lower A&D and continued synergy capture were more than offset by lower commercial OEM and aftermarket sales and fixed cost headwinds. Shifting to Pratt & Whitney on slide six. Adjusted sales of $3.6 billion were down 32% on an organic basis and down 30% on an adjusted basis, also driven primarily by the pandemic’s impact on OEMs and operators. Commercial OEM sales were down 42%, driven by lower deliveries across Pratt’s large commercial engine and Pratt Canada platforms, with the exception of the PW800, which saw slight growth in the quarter. Commercial aftermarket sales were down 51% in the quarter, growth in the GTF aftermarket was more than offset by the impact of a 64% reduction in legacy large commercial engine shop visit inductions and an approximate 40% reduction in Pratt Canada shop visits. Ramping JSF production continues to drive sales growth at Pratt’s military business. Military sales were up 11% due to higher aftermarket sales across key platforms and increased F-35 production volume. Adjusted operating profit of a loss of $151 million was down $603 million from the prior year. Significant aftermarket volume reductions, fixed cost headwinds, and unfavorable military contract adjustments more than offset drop through on higher military sales, cost mitigation actions, and slightly lower negative engine margin. Turning now to slide seven. RIS reported sales were $3.3 billion, pro forma sales, including the four-day stub period were $3.5 billion. Sales were primarily impacted by expected declines in the Warfighter FOCUS program, which represented a little over 4 points of sales headwind and that was partially offset by higher airborne system sales and broad growth across other RIS programs.

Thanks, Neil. I’m on slide nine now. As you know, there are a number of factors, some headwinds, some tailwinds, and the number of unknowns affecting the macro environment and our business going forward. Let’s start with the positives. Military program growth remains robust, both domestically and internationally, and is contributing to our strong defense sales growth and a record defense backlog, nothing really changing here from our previous expectations. We also continue to execute on important actions to position the business for long-term value creation. Our merger synergies are progressing well, and we remain on track to deliver nearly $200 million of gross RTX synergies and an incremental $150 million of Rockwell Collins acquisition cost synergies this year, which will bring the total for Rockwell to $450 million of our $600 million target. We are also on track to deliver our previously discussed $2 billion of cost savings and $4 billion of cash conservation actions in 2020, and we will continue to manage the business proactively to respond to the current and developing environment. We now expect to realize approximately 30% of our announced cost actions in Q3 and approximately 40% in Q4. This is after we already achieved around 30% of our cost actions in Q2. And as Greg highlighted, our liquidity position remains very strong, and we have ample financial flexibility. It’s no surprise, however, that given COVID-19, the overall macro environment, and commercial air traffic in particular are significant unknowns. We are tracking air travel trends across the globe on a daily basis. While they are generally improving, recovery is slow, and while we continue to monitor these trends, as Greg said, we now see the recovery being protracted over several years, at least through 2023. We also continue to monitor the financial condition of global airlines and the health of the supply chain. Given the significance of these factors on our business, there continues to be too much uncertainty to provide an outlook. But let me tell you how we’re thinking about the second half of the year. Let’s start with Collins. We continue to see commercial OE sales down in line with OEM production levels and aircraft delivery schedules, generally consistent with the decline we saw in Q2. We see Collins commercial aftermarket sales down in line with expected RPM declines and the impact of the ADSB mandate headwinds, where we expect Q3 sales will largely be in line with Q2 plus or minus and expect to see a gradual recovery in Q4. For Pratt, we continue to see commercial OE sales in line with our main OEM customers, similar to what we saw in Q2. While GTF overhaul activity continues as we upgrade to the latest configuration, we expect Pratt’s aftermarket sales to be down given the more than 50% decline in legacy shop visits. We still expect that Pratt Canada will be down in the back half of the year, but not as severely as the large commercial engine business due to the differences in their end markets, with business jet and general aviation markets showing better recovery. Moving to the military portion of Collins and Pratt, we continue to see strength in military sales and still expect to see mid single-digit growth, excluding the impact of the two pending Collins divestitures. So, again, no change here. I will also note, there aren’t any changes to the RIS or RMD sales or adjusted operating profit outlooks that we gave on our first-quarter call. As we think about what this means for our business as a whole, we continue to think Q2 will likely be the lowest quarterly sales and EPS in 2020. Looking at sales in the back half of the year, we would expect sequential sales improvement, modest in Q3 and then better Q4. For EPS, we would expect Q3 to generally be in line with Q2 with some puts and takes, and then a gradual recovery beginning in Q4, as demand begins to return and more of our cost actions are realized. A couple of other items to keep in mind for the second half of the year, as we have discussed, we’ve implemented significant COVID protocols across our businesses and are incurring a number of incremental expenditures associated with the pandemic, including enhanced facility cleaning, employee temperature scanning, higher freight costs, and other COVID-related inefficiencies. We expect around $0.08 of EPS headwind related to these costs for the rest of the year, more than initially expected, bringing the full-year total cost to approximately $0.16 of a headwind. For free cash flow, we still expect pro forma 2020 free cash flow for the full year of roughly $2 billion. This includes an outflow of $1.2 billion to $1.4 billion for merger cost restructuring and cash taxes on dispositions as we have previously discussed. As we think about our cash actions, we still expect to realize the majority of the benefit in the back half of the year, with approximately 30% of our cash actions in Q3 and approximately 45% in Q4. In summary, we expect the rest of the year to be challenging for our commercial aerospace segments, but continue to expect good growth from our defense businesses and we’re positioning the company for a strong recovery. With that, I’ll hand it back over to Greg to wrap things up.

Okay. Thanks, Toby. We’re on slide 10 now and maybe just a couple of points. I think, obviously, a lot going on in the quarter, a lot of uncertainty out there. I think, just to be clear on a couple of things. While there’s a lot of uncertainty, we’re going to remain focused on supporting our employees, our customers, and our suppliers. This includes ensuring the health and safety of our workforce, first and foremost. But also delivering advanced technologies and innovative products for our customers and working with our suppliers to maintain the stability of the supply chain. I guess, it’s important to remember, in the quarter, we still invested $500 million in R&D on the commercial aero side. This is important as we think about the long-term. We’re not going to sacrifice long-term for short-term. We’re going to take some tough cost actions. We’re going to do what we need to do but we’re going to continue to invest for the future. And of course, we’re going to continue to execute on the integration of the merger and the Rockwell acquisition, as Toby said, and we’ve got a clear path to meet or exceed those expected synergies. Also, I think, it is important to remember, we’re going to remain disciplined with our capital, ensuring that we maintain financial flexibility while prioritizing capital areas that will maximize value for our customers and shareholders. Despite all the uncertainty out there, we still remain committed to return $18 billion to $20 billion of cash to our shareholders in the first four years after this merger. As I said, we’re also taking a hard look at the businesses given the environment and the prolonged recovery, and we’re going to take additional actions as we think are appropriate. We will be nimble. We’re going to remain focused on what we can control and we’re going to adapt to the current environment and position our commercial aero businesses for growth while also maintaining solid growth in the defense portfolio. Overall, the opportunities and challenges remain significant, and I’m confident we’re going to emerge from this crisis in a position of strength and deliver sustainable long-term value for our customers, for employees, and our shareholders. So, with that, Ursula, let’s open it up to questions. Thanks, everyone.

The first question will come from Sheila Kahyaoglu with Jefferies.

Hi. Good morning, everyone, and thank you. I guess Greg or Toby, your biggest driver Collins declined 98% year-over-year, yet free cash flow was essentially breakeven. So can you maybe talk about free cash flow trends in aero or commercial? And what you’re seeing in terms of working capital and cost savings? Toby, you mentioned is running at 30% ahead of your 10% target, so any thoughts on those moving pieces and how it relates to free cash flow in 2020 and going forward?

Yeah. So, I’ll take the last part of that first, Sheila, that the $2 billion of cost actions, $4 billion of cash preservation conservation actions are assumed, and they were assumed back in Q1 and the $2 billion for the year. The good news is, we’re seeing accelerated execution on those and realization. Obviously, that helps to derisk the back half of the year. In the quarter, obviously, the drop through of 30% versus we’d expected about 10%, that 20% incremental improvement helps cash flow at both Pratt and Collins. So that was a good guide in the quarter compared to our expectations. And I believe that both Pratt and Collins are also doing a really good job of managing their inventory. I think Collins held it flat through the first part of the quarter and actually saw a little bit of a reduction as we move through to the end of June, which contributed to some of the favorability of the Q2 cash flow there. So things are on or ahead of schedule, but again, really timing related relative to the work, the Pratt and the Collins teams have done to accelerate those actions. And the other thing I’d throw in there, we saw real strong collections from a cash flow point of view on some large international collections at RMD, not the commercial aero side of the house but RMD that favorably impacted Q2 and those were expected in the back half of the year as well.

Hi, Sheila. It’s Greg. I want to point out a couple of things. We generated $1 billion in cash actions in the second quarter without significantly affecting our inventories. We are just beginning to experience the benefits of inventory reduction within the supply chain. By the fourth quarter, we anticipate around $0.5 billion in positive impact from lower material costs. Additionally, we expect to see an increase in savings from headcount reductions. Approximately half of the cost savings in the first and second quarters were related to headcount, and that figure is likely to nearly double by the end of the year. We are taking the necessary actions and are confident that these improvements will carry through for the remainder of the year.

Great. Thank you.

Thanks, Sheila.

Your next question comes from Robert Stallard with Vertical Research.

Thanks so much. Good morning.

Good morning, Rob.

Hi, Rob.

It’s pretty one for Greg, and it’s more of a conceptual question. Basically, we seem 2Q airline activity if you are at RPMs or ASMs down a huge number, 80% or 90%, and your aftermarkets, I think, down around 50%. What’s the risk that aftermarket could actually get worse from here, given this disconnect between the revenues you’ve seen and what the airlines have seen in 2Q?

I think, Rob, it's important to consider the current number of aircraft in operation. We estimate that total flights have decreased by about 50%. While air passenger traffic is down 80%, which is an improvement over the 95% decline previously, there are still planes flying, and that figure is down 50%. Our outlook is primarily based on this. As we analyze the aftermarket segments, certain areas have been affected more than others. For example, spare parts at Collins Aerospace, which significantly impact profitability, experienced a nearly 75% decline in the quarter, while repair services decreased by about 55%. The forecast that Toby mentioned for the latter half of the year anticipates a slight recovery, particularly in Q4. The crucial factor to consider for the second half of the year is whether we'll witness this modest recovery. It's important to note that the recovery will take several years, but at this moment, it's challenging to envision conditions deteriorating beyond what we observed in Q2, especially considering that we still see approximately 50% of current aircraft in operation.

That’s great. Thank you.

Thanks.

Your next question comes from Peter Arment with Baird.

Hi. Yes. Good morning, Greg, Toby.

Hi, Peter.

Greg, just a quick question on sort of when you talk about the cost reductions, have you been able to identify what you think is ultimately going to be permanent versus kind of the temporary actions to give you a real benefit when we think about exiting 2020?

I believe that regarding the cost reductions we observed this quarter, approximately $200 million came from actions related to A&D. We also saw about $100 million from discretionary spending, while the remaining $300 million was primarily related to employee costs. Some of these employee-related expenses will return, particularly those tied to furloughs. For those at the corporate office, there’s a 10% salary reduction along with deferred merit. It's essential to highlight that the commercial aerospace sector has reduced its workforce to around 8,000 positions, and while some jobs may return with increased volume, others will be permanently eliminated. As we anticipate a potential recovery extending into 2023, I'm focusing on examining the structural costs within our aerospace organization, especially in high-cost manufacturing locations. We need to identify opportunities to restructure these businesses later this year. The team is actively reviewing this, and while it will be challenging, this presents an opportunity to modify the overhead structure of our commercial aerospace operations. Unfortunately, it is necessary given the current market conditions.

Appreciate the details. Thanks.

Thanks, Peter.

Your next question comes from Carter Copeland with Melius Research.

Hey. Good morning, team.

Good morning, Carter.

Good morning, Carter.

Good morning.

Greg, I wondered if you could maybe just give us some color on the customer conversations. I mean, it’s got to be especially for Pratt, tough conversations around cash management for most of the airlines. Why don’t you just give us some color on what it is that those customers are seeking to do to the extent that you’re collecting power by the hour, you have power by the hour arrangements? Are you collecting all of those payments or is there any deferment there, anything you can give us there will be helpful? Thanks.

We are collaborating with each of our customers to ensure they have the financial flexibility necessary for long-term sustainability. While I can't provide details about specific customers, I can say that we are being flexible with payment terms and cash flow. A portion of the charges we recorded this quarter reflects the understanding that some receivables may not be collectible due to the current state of the industry. However, when we assess Pratt’s customer base, it's noteworthy that 65% of GTF-powered A-320s and 75% of A-220s are currently operational, while only about 45% of the V's are. Many of the power by the hour contracts, which cover around 80% of GTF-powered aircraft, are still active, and flights continue to operate. Therefore, the outlook isn't entirely negative. We are observing some positive developments and will keep working with our customers to support their viability.

Great. Thank you for the color.

Thanks, Carter.

Your next question comes from David Strauss with Barclays.

Thanks. Good morning.

Good morning.

Good morning.

I wanted to ask about Collins, so the OEM decline is down 53%, obviously, more than, I think, the decline we’re seeing your manufacture production rates. Can you talk about kind of how that breaks down between manufacturer production rates being down, the Max impact, and any sort of stocking you’re seeing? And then, Greg, maybe can you touch on the decrementals that we saw at Collins? I know Collins remains profitable, but the decrementals were pretty big. Do you think this is the kind of the low point or worst point for Collins there? Thanks.

Toby will talk about the decrementals to start out; our decremental margins as you would expect because of the aftermarket down so significantly were north of 50%, I think almost 55% decremental margins. Clearly, this should improve as we go through the quarter, especially as we take additional cost actions to take up some overhead, but the aftermarket is tough. I think if you think about the other issue that you’ve got at Collins is, they have been disproportionately impacted by the slowdown of 737. Recall, we’ve got about $2.5 million of content per 737. With the latest production schedule from Boeing on 737 with this kind of slow ramp in production, I doubt we’ll be shipping any 737 related inventory, probably until the next half of next year. And so while the, overall, I would say, we expect the commercial OEMs to be down roughly 40% or so. You’re going to see a bigger impact at Collins in the near-term as they are going to be more impacted by the 737 than anybody else?

Yeah. And I think, I’d add too, right, your question about the Max and ADSB, right? There are about a point each of headwind going forward, pretty consistent with our prior expectations. And just piling on a little bit what Greg said about the decrementals, not inconsistent with what we had outlined back at Q1. We said north of 50%, as Greg said, about 55% in the quarter, that’s for overall, right, when you take into account, aftermarket would be greater effects of the absorption. We do expect that will improve a little bit as we move through the year, and especially as the cost reduction actions take further hold. And maybe just to complete the equation, Pratt saw about 40% decrementals. Again, pretty much as we expected, not as severe, because of course, they don’t have margin on the large engine shipments from an OE point of view. So, again, even there with Pratt nothing unexpected compared to what we outlined back on the May call.

David, just one other point to keep in mind, so if you think about the Collins numbers. There’s $100 million of cost or charges in the quarter associated with idle facilities. That is the plants that we have that aren’t operating at full capacity. So, again, those decremental margins are all in. So, I think, again, they’re taking cost out, but we got to get after the overheads still.

Great. Thanks very much.

Your next question comes from Ron Epstein with Bank of America.

Yeah. Hey. Good morning, guys.

Hi, Ron. Good morning.

Hi.

Hey, Toby, please dig down a little bit more in the cash, just trying to sort out, when we think about what portion of the cash came from the defense business versus what portion came from the commercial business. I think on a pro forma basis, if you look at last year, is it safe to assume about two-thirds of the performance cash was from defense and maybe one-third from commercial?

Yeah. I mean, I think, the way to think of it, Ron, in the quarter here, right, both Collins and Pratt consume cash, right? The two combined north of $2 billion, right? So, the favorable performance, again, those results were favorably impacted by the cost of actions or they would have been worse, and then we saw real strong collections on the defense side, as I mentioned, with the pulling of some large international payments on the RMD side. And I didn’t mention it earlier, but RIS saw some good quarter-end collection pull as well. So that’s kind of big picture the two sides of the house and how the cash flow played out in the quarter.

And how would you expect that to go maybe for the rest of the year in defense, anyway?

We expect the defense businesses, particularly the legacy RIS and RMD, to continue generating positive cash flow in both Q3 and Q4, with a stronger performance expected in Q4, which aligns with the traditional schedule observed by the legacy Raytheon. I anticipate that Collins will also generate a small amount of positive cash in Q3, while Pratt may have a slight negative cash flow. However, by Q4, both Collins and Pratt are expected to contribute positively to cash flow. Overall, for the remainder of the year, we maintain our pro forma outlook of approximately $2 billion, with Q3 being close to breakeven, possibly slightly positive. It's important to note that we have some non-recurring items and around $500 million in tax payments related to the divestitures mentioned earlier. Therefore, we expect Q3 to be near breakeven with a slight positive trend, and anticipate around $1.8 billion in positive cash flow in Q4.

Great. Thank you very much.

Sure.

Your next question comes from Myles Walton with UBS.

Thanks. Good morning. Hey.

Hi, Myles.

I was wondering if you could maybe in Pratt’s commercial aftermarket down 51. What was large engine versus Pratt Canada? And then the other question, Toby, maybe you can just talk about the working capital that you’re building this year and you’ve talked about it previously as billions of the headwind in this year and just curious if you can make any comments about the relief of that into ‘21 and ‘22?

Let me start with the working capital. We are seeing some encouraging signs regarding inventory in Q2, particularly with Pratt and Collins. Overall, we are pleased with the collections we experienced. Working capital did grow during the quarter mainly due to disbursements surpassing the benefits from collections and inventory management. Based on our actions as part of the $4 billion cost and cash conservation initiatives, we anticipate a significant benefit in the latter half of the year from working capital efforts, particularly concerning inventory, which could range from $500 million to over $800 million, largely driven by Pratt and Collins. Everything is on track for that. Looking ahead to next year, while we won't provide specific quantifications today, we do expect further improvement in working capital. In 2021, we aim to align it with the demand we see, although there is some variability, as we've mentioned regarding the shape and pace of the recovery.

The large commercial aftermarket decreased by about 55%. This was primarily due to a significant drop in PWC2000, which declined by around 80%, and the V, which fell by approximately 60%. However, GTF did not experience a decline. In terms of Pratt Canada, their overall business was down by 40%, and their aftermarket also saw a 40% decrease, with high profit spare parts dropping about 55%.

Okay. Thanks, guys.

Sure.

Your next question comes from Jon Raviv with Citi.

Thank you and good morning. Toby, back at Raytheon, you mentioned there being good visibility on the defense side. Today, you're again discussing strong visibility of growth sustaining for several more years. Can you provide an update on how you see that growth sustainability developing based on your backlog and pipeline? Additionally, how is the company positioned to handle a potential defense recession if budget pressures arise? Thank you.

Certainly. Regarding the future growth visibility, I want to emphasize that our situation remains unchanged. We have recorded another significant backlog and our legacy defense businesses are performing well, evidenced by a strong book-to-bill ratio of 1.55 in Q4 and 1.46 in Q1. Additionally, Pratt and Collins are experiencing good growth this year. We are confident due to the solid backlog, particularly considering the shift towards longer-term programs with multiyear awards for SM-3 IB and SM-6, which enhances our future visibility. When we factor in our funded pipeline, alignment with the national defense strategy, and strong classified bookings that reached $1.4 billion in the quarter, we are on track for over 20% classified this year. This funding is vital for developing future technologies that can lead to new opportunities. Our international business remains robust, accounting for approximately 30% of our operations, highlighted by the $2.3 billion award for KSA TPY-2. We are also progressing well on our LTAMs program, with initial production expected in 2022. Overall, we are very optimistic about our capability to sustain growth in the defense sector over the coming years.

We understand that defense spending is unlikely to increase in the near future due to existing deficits. However, as highlighted, we are well-positioned with a backlog of $73 billion. Additionally, we have significant strengths in classified, cyber, and space sectors, which present many opportunities. While we do not anticipate much growth in the defense budget, we believe that a strong national defense is a bipartisan concern. Regardless of the political leadership, the need for robust national defense will persist, and we are not predicting any negative scenarios for defense in the coming years.

Your next question comes from Noah Poponak with Goldman Sachs.

Hi. Good morning, everyone.

Hi, Noah.

Hi, Noah.

On the aerospace original equipment side of the business, can you just give us a little more detail on whether or not the pull from Boeing and Airbus into their production plan has changed meaningfully versus three months ago? And if you could speak to manufacturer or in particular Max versus non-Max, that’d be helpful?

Well, I would tell you, I don’t think anything has changed materially in the last three months. Obviously, as Boeing has firmed up its 737 Max production schedule. That’s obviously had an impact especially in the near-term on the Collins outlook for OEM deliveries. I would tell you that, Pratt is fully aligned with Airbus deliveries this year and next year. We’ve been out. We’ve talked to every single one of our customers who’s going to be taking GTF powered aircraft, and I think we are fully aligned there. I mean, that’s about a, as we would say, roughly a 40% reduction in GTF volume in the A-320s in the next year and a half here. So, again, I don’t think there’s been any change beyond really beyond the 737 Max.

And that Max change, is it more of a refinement around the specific timing of the return to service or is it a more substantial change than that?

Well, it’s really two things; first of all, it’s just a refinement of the schedule in terms of we expect some time here in the probably end of the third quarter, early fourth quarter that we get their ticket back. Obviously, we’re working with Boeing to make sure that that happens. But also, it’s the ramp that we’re going to see in the production is slower, I think, that anybody had anticipated. On top of that is, as Boeing has gone through and looked at the inventory levels that they have for all of our equipment. That’s what really caused us to take a pause and say, you know what, we probably aren’t going to be shipping much 737 hardware until the back half of 2021. So, again, that’s really been the refinement, if you will, it’s the inventory on hand as well as a little bit slower ramp.

And I would just add, when we look at OE volumes altogether taking Boeing, Airbus, the Pratt Canada customers, it coincidentally is in about that 40% ballpark relative to a year-over-year decline that, Greg referenced relative to Pratt, obviously, there are some puts and takes in there. And as Greg explained, with the Boeing situation, because of the inventory on hand, our future revenue may look a little bit different than their deliveries, but it’s for that factor there.

That’s all really helpful. The inventory alignment is not demand and the RTS is not demand, the slower ramp is in demand. But am I hearing you correctly that that has been a modest change versus a major change?

Yeah. That’s really a modest change, I think, again. It’s just a refinement of the schedule based upon the timing of return to service. And keep in mind that every aircraft that gets delivered today, somebody is also retiring an aircraft. So we’re trying to work with the customers to understand exactly who’s going to take what, when.

Super helpful. Thank you.

Thanks, Jon.

Sure.

Your next question comes from Robert Spingarn with Credit Suisse.

Hi. Good morning. And just on that last note, the visibility, Toby, looks like you’re backing out unfavorable contract adjustments and bad debt expense from Collins and Pratt to get to your adjusted operating profit. So I wanted to ask you how much visibility you have into the sufficiency of those charges and how non-recurring they may actually be in the COVID environment.

Yeah. No. Good question. So, you’re right; we did back out charges in those categories or cost in those categories, it’s about $0.21. They do relate to the economic impact of COVID and the effects on Pratt and Collins. I will tell you, a small portion of these were in our original estimates, okay? But as the quarter evolved, new information came to light, as we talked about, around the timing of recovery, pushing out to ‘23, more airline bankruptcies. And so the reserve amounts and the EACs had a threshold where it was significant enough to be adjusted out of our earnings, given the magnitude and the unique nature of things. I would look at this as being rare and not indicative, right, of our underlying business performance. Because when you look at that, you’re talking $400 million in the aggregate, roughly $200 in each of the two segments. And then on top of that, you mentioned the bankruptcies, right, and I am probably off, but it was at least five in the quarter, right? So in normal periods of time, we’re not looking at five bankruptcies in a quarter, right, if you go back to pre-COVID. We have made these estimates with the best information available, taking all the facts into consideration around bankruptcies, collectability, the effect of the lower flight hours that it has on our EACs, so we’re confident in the values that we recorded here in the quarter and then subsequently adjusted out.

Yeah. I think…

I just… I was going to say that we’ve adopted a cautious approach regarding the customer's ability to pay. Taking these larger charges at this time is quite unusual due to the current circumstances in the industry. While I do not anticipate additional large charges, the unpredictability of major bankruptcies makes it hard to forecast. We aim to be prudent, but not overly severe in our assessments.

Okay. Thank you.

Ursula, we have time for one more question.

Your next question comes from Seth Seifman with J.P. Morgan.

Okay. Thanks very much and good morning.

Hi, Seth.

I wanted to get some more details on the working capital. On a net basis, including defense, the increase was fairly modest this quarter. It seems you anticipate a significant improvement in aerospace in the second half of the year. Should we expect a working capital increase of billions across the company by the end of 2020? Additionally, do you foresee a working capital release opportunity of that size in the coming years, or have you managed to stabilize that?

I won't say we've completely stabilized it, but we are making consistent progress with our efforts to support the $4 billion cash conservation goal, and we've started to stabilize the situation. In Q2, we anticipate a reduction in working capital, particularly in the latter half of the year, possibly with a bias toward Q4, as these initiatives continue to gain traction. Pratt and Collins are effectively managing their supply chain and inputs while ensuring the supply base remains healthy. We expect to see benefits from inventory and working capital reduction by the year's end as part of the $4 billion cash conservation strategy. At the company level, this includes contributions from RMD and RIS on the defense side. We still believe there is an opportunity in 2021 to further reduce working capital in alignment with demand signals related to the recovery's shape and pace.

Great. Thanks very much.

Thanks, Seth.

Okay. Thanks everyone for listening in today. As always, Neil and Kelsey and the Investor Relations team will be around all day to answer whatever questions you might have. Thank you for listening and stay safe. Take care. Bye-bye.

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