Good day, ladies and gentlemen, and welcome to the Raytheon Technologies Third Quarter 2020 Earnings Conference Call. My name is Joelle, and I'll be your operator for today. As a reminder, this conference is being recorded for replay purposes. On the call today are, Greg Hayes, Chief Executive Officer; Toby O'Brien, Chief Financial Officer; and Neil Mitchill, Corporate Vice President, 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.

Okay. Thank you, Joelle, and good morning, everyone. For those of you following along, we're on Slide 2 of the webcast, just to spend a minute talking a little bit about the current environment. We've now passed the six month mark as Raytheon Technologies and I would tell you, I'm proud of the job the team has done with the integration, despite the fact that most of the work has to be done remotely. We obviously continue to operate in the midst of one of the most difficult times the industry has seen. But we remain focused on delivering for our customers and protecting the health and safety of our people. Through the pandemic, we continued to invest in technology and innovation that's going to drive long-term growth while also maintaining a disciplined approach to capital allocation and implementing tough but necessary cost reductions, including some structural cost actions that we will talk about later. Notwithstanding that environment, we delivered solid results in the quarter and we're pleased with the progress we've made with our merger integration and the decisive actions that will position us to emerge from the pandemic in a position of strength. Sales for the quarter were in line with expectations and adjusted EPS and free cash flow were better than expected. In fact, free cash flow was significantly better than expected at about $1.2 billion. On the defense side, backlog remains robust, over $70 billion. We've had exceptional bookings this year and we expect both of our RIS and RMD businesses to end 2020 with record backlog. At the same time, we continue to focus on what we can control.

Okay. Thanks, Greg. I'm on Slide 4. While commercial aero headwinds persisted in Q3, our performance was generally better than we had expected. Adjusted sales were $15 billion, up about $400 million sequentially over Q2 including the stub period. Adjusted EPS was $0.58, better than our expectations, driven by acceleration of our cost mitigation actions and continued strength of military volume at Pratt and Collins. The lower effective tax rate in the quarter also contributed to a few cents of improvement. On a GAAP basis, EPS from continuing operations was $0.10 per share, down year-over-year and included $0.48 of net non-recurring and/or significant items and acquisition accounting adjustments. This includes a net gain on dispositions of $0.17 per share, which was more than offset by $0.27 of acquisition accounting adjustments, primarily related to intangible amortization, $0.26 related to charges due to the current economic environment, driven by the COVID-19 pandemic and $0.12 of restructuring. Free cash flow of $1.2 billion was better than expected and included about $600 million of merger costs, restructuring, and tax payments on divestitures. The better than expected cash flow was driven primarily by the timing of collections at RMD as well as in our commercial aero businesses and accelerated realization of our cash conservation actions, including inventory reductions at Collins. Moving to Slide 5, let me share with you a few data points that demonstrate the resiliency of our portfolio. Bookings at RIS and RMD have been exceptionally strong over the last year as demonstrated by the trailing 12-month book-to-bill ratios, where both businesses are well above 1, positioning us for continued growth across our franchises, both domestically and internationally. About 40% of the backlog at these businesses is for international customers. And military sales growth at Collins and Pratt continues to be very strong with organic sales growing 8% and 11% in the quarter, and that's on top of 10% and 13%, respectively, in the first half of the year.

Thanks, Toby. Starting with Collins Aerospace on Slide 6, adjusted sales were $4.3 billion in the quarter, down 34% on an adjusted basis and down 33% on an organic basis, driven primarily by the adverse impact of COVID-19 on the industry. By channel, commercial OEM sales were down 44%, driven principally by the impact of COVID-19, the continued 737 MAX grounding, and the anticipated declines in legacy programs. Commercial aftermarket sales were down 52%, driven by a 51% decline in parts and repair, a 67% decline in provisioning, and a 44% decline in modifications and upgrades. Partially offsetting the headwinds in the commercial channels, defense sales were up 4% on an adjusted basis and up 8% organically, with strength across many of our key platforms and product lines. Adjusted operating profit of $73 million was down $1.2 billion from the prior year and slightly better than our expectations for the quarter. Cost management actions, including lower E&D, continued synergy capture, and drop-through on higher defense sales were more than offset by lower commercial OEM and aftermarket sales and fixed cost headwinds. Looking ahead to the fourth quarter, we see Collins' fourth quarter sales and operating profit in line with Q3 and for the year, organic military sales are now expected to be up high single digit. Shifting to Pratt & Whitney, on Slide 7, adjusted sales of $3.8 billion were down 34% on an organic basis and down 28% on an adjusted basis, also driven by the adverse impact of COVID-19 on the industry. Commercial OEM sales were down 30%, driven by lower deliveries across Pratt's large commercial engine and Pratt Canada platforms, with the exception of the PW800 which saw a slight growth in the quarter. Commercial aftermarket sales were down 51% in the quarter. Growth in the GTF aftermarket volume was more than offset by the impact of a reduction in legacy large commercial engine shop visit inductions of about 55% and a 37% reduction in Pratt Canada shop visits.

Okay. Thanks, Neil. I'm on Slide 10. Let me give you a little perspective on the current environment as we look to close out the year. As we've seen throughout the year, military program growth remains robust, both domestically and internationally, and is contributing to our defense sales growth and our defense backlog. This backlog provides the foundation for future growth as we look ahead. As Greg mentioned, we also continue to execute on our previously initiated actions, including both synergies from our recent merger and the continuation of the Collins integration synergies, and we're well ahead of the targets we set in Q1 for our cost and cash actions, with only 35% of our cost and about 25% of cash actions to go in the fourth quarter. Turning to the macro factors, commercial aero end markets remain uncertain. We saw a slight improvement in global travel in the third quarter and our Q4 expectations anticipate a slight improvement above Q3 levels. We are continuing to track air traffic trends and the condition of airlines on a daily basis, but the recovery remains slow. With that said, let me tell you how we see Q4. As we think about what this means for our business as a whole, we continue to see a gradual recovery in our commercial aero businesses beginning in Q4, combined with an expected ramp at RIS and RMD contributing to Q4 company sales of between $16.2 billion and $16.4 billion. Moving to adjusted EPS, the continued defense growth, gradual demand recovery in commercial aero, and realization of additional synergies and cost actions are expected to drive EPS of $0.65 to $0.70 per share. Just a couple of things to keep in mind. We have provided an updated outlook on some below the line items as well as an update to the RIS and RMD outlooks in the webcast appendix. Also keep in mind that the fourth quarter will include about a $0.04 impact due to the incremental expenditures associated with the implementation of COVID protocols across our businesses, bringing the full-year cost to about $0.16 or in line with our previous expectations. Now turning to free cash flow, we continue to expect full year pro forma 2020 free cash flow of roughly $2 billion. This includes an outflow of about $1.2 billion for merger costs, restructuring, and tax on dispositions as we have previously discussed. In summary, we expect the fourth quarter to be another challenging quarter for our commercial aerospace segments, but continue to expect strong growth from our defense businesses. So, with that, I'll hand it back over to Greg to wrap things up.

Okay, thanks, Toby. So, first of all, let's just talk about priorities and then we'll get to Q&A. Obviously, first and foremost, it's the health and safety of all of our employees and keeping those people safe is job number one. And I'd be remiss if I didn't say thank you to all those folks who continue to come to the office, come to the factories, meet our customers' commitments. Yeomen's work and really the shoutout to the great work that's been done over these last six months. Of course, customers remain at the heart of everything we do, and this is about customer centricity and solving our customers' most difficult technical challenges remains our mission. And of course, keeping the supply chain healthy and robust is essential. On top of that, of course, we need to continue to invest in technology and product innovation. Even in these difficult times, we continue to spend money on next generation technology, both on the commercial aero and on the defense side of our business. Of course, we're going to continue to execute on the integration and deliver the synergies that we've committed to, the $1 billion plus that we'll see at the corporate offices from the Raytheon UTC merger as well as the $600 million of synergies that we've committed to from the Rockwell Collins acquisition. We are also of course going to continue to drive structural cost reduction. We've talked about a couple of those already, but there are more out there and we're going to continue to drive that as we always do. And lastly, we're going to remain disciplined in our capital deployment and maintain strong liquidity. Obviously, with $10 billion on the balance sheet at the end of the quarter, we feel very good about where we are, but we're going to remain disciplined. We do remain committed to the $18 billion to $20 billion of capital return to shareholders during the first four years of the merger, and we see that path very clearly today. So, with that, let's stop and Joelle, let's take some questions.

Thank you. The first question will come from the line of Peter Arment with Baird. Your line is now open.

Yes, good morning, Greg, Toby, Neil.

Good morning, Peter.

Maybe this is just for Toby and maybe Greg you may comment about it. Just trying to get a clarification on the unfavorable contract adjustment at Pratt & Whitney, I think $543 million. Can you give us maybe some more details on that and just what we expect if this is related to kind of power by the hour contracts, how we see that playing out? Thanks.

Sure. So, there were three pieces to this, Peter. All of them were non-cash. So the charge was all non-cash related. They were all distinct and unique to specific circumstances. In one case, we secured a longer term, which will end up resulting in more predictable efforts on our part and a longer contract, which extends the life of that particular fleet. So that's good for the customer and good for us. The second one here, we revisited our estimates of flight patterns in light of the COVID-19 pandemic related to one customer and made an adjustment related to that. And then the last part of this, we took an impairment charge on some assets associated with a program where we've seen the development pushed out to the right or delayed. So three different situations, but all in total all non-cash related.

Thank you. Our next question comes from Carter Copeland with Melius Research. Your line is now open.

Hey, good morning, gentlemen.

Good morning, Carter.

Greg, maybe correct me if I heard you wrong, did you say 20% to 25% square foot reduction? Did I get that number right?

That is correct. We've got about 31 million square feet of office space. The original goal is to take about 10% of that out as part of the merger. We think we can more than double that with the kind of the new working arrangements that we've all become accustomed to. So the office of the future as we call it will be a mix of both office as well as people that will be working remotely.

So, if I think about that across the segments, obviously I guess as part of the evolution in the cost reduction, it would be much larger than that in the commercial side of the aerospace businesses, but it seems like a big number.

It seems like a big number, Carter, and look, the fact we had 31 million square feet of office space seems like a really big number to me, but at the same time, for these last six months, as I've toured the country and visited facilities where we've got literally a handful of folks working there and everybody else is being efficient working remotely, it became very apparent. We don't need all the space. And I think the ability to work remotely with the technology that we have without losing productivity is essential in our go-forward plan. So there is a significant amount of cost to take out. Obviously we're going to start with our least offices and we've got a plan over the next five years to reduce that significantly. And again that's easy cost savings in my mind.

The Pratt consolidation and the new facility is simply a consolidation of our footprint aimed at cost reduction, without any insourcing efforts involved.

No, there is a whole series of things that Pratt is doing associated with this new facility we're building down in North Carolina. Some of it will be in-sourcing work from the supply chain, some of it will involve moving work from high cost to lower cost locations. Again, this is a multi-year program, but it's absolutely essential. We need the capacity because eventually demand will return and I think by the time this comes online in late 2023, we should see a return to kind of normalcy in commercial aerospace and Pratt will be well positioned with a much lower cost, much more automated production facility.

Okay, great. Thanks for the color, Greg.

Thanks, Carter.

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

Hey, good morning, guys.

Hey, Ron.

Greg, maybe a bigger strategic question following up on your last comment. If you're thinking about the market getting back to some level of normalcy late '23, '24 or something like that and you look at your own balance sheet and you compare it to that of your competitors, particularly in the engine business, how are you going to use that balance sheet as we go into the recovery to your advantage? You look at Rolls, they seem kind of impaired. GE is a shadow of what they once were. So Pratt is sitting here with the strongest balance sheet in the industry, so how do you think about that?

So, I think there is a couple of thoughts, Ron. Obviously, we were not going to go out and buy. We don't need to do any big M&A. I'll say that first and foremost. We will be opportunistic. There are a few things out there from a technology standpoint that you'll see us doing here. But those are, I would say, relatively low dollar types of transactions. It really just fills in some blanks in the canvas. The next opportunity I think is going to be, do we go back to share buyback. I think you will see that start up again next year. We think with the balance sheet that we've got, with the cash on hand, with the sale of Forcepoint now, there will be plenty of cash to start that back up next year. And if you think about the other thing we're going to try and do on the Pratt side is, we're going to continue to try and gain market share. And I don't mean to be reckless about it, but over the last year and a half or so, we picked up about 12 points of market share. We went from 43% to about 55% on the A320 family. And we think that's a reflection both of the technology as well as the efficiency that you're getting with the GTF engine. So we're going to use the advantage that we have to continue to gain market share and we're also going to continue to invest. And I think, Ron, as you know this, you have to invest for the long term. It takes 10 years to develop an engine. It takes years and years to develop new radar systems, new weapon systems, and so we have to stay on the leading edge of technology. I want to use the dollars that we have to continue to strengthen the leading position we have in those markets.

Great. Thank you.

Thanks, Ron.

Thank you. Our next question comes from Doug Harned with Bernstein. Your line is now open.

Good morning. Thank you.

Hey, Doug.

I wanted to understand more about your outlook for the aftermarket at Pratt, especially considering the $400 million adjustment related to pandemic cost reductions that Toby mentioned. How do you view these adjustments moving forward, especially given the uncertainty about the recovery? When do you see these adjustments as necessary, and when might they shift to being more standard issues if this situation continues for two or three years?

So, Doug, let me clarify. As we reviewed all of Pratt's contracts and the long-term contracts that Collins has this quarter, three specific contracts stood out as needing adjustments based on our perspective of when commercial air traffic might return to normal. We've examined everything, and I don't anticipate many other similar instances; these adjustments are quite unusual in scale. Some of these contracts were quite burdensome, particularly the early GTF contracts that were affected by the pandemic and the decline in traffic, making these adjustments necessary. The reality is we don't foresee a return to normal passenger traffic levels until at least mid-2023, which means the expected flying hours will not materialize. If conditions improve, there could be potential benefits from some of these contracts. We believe we have addressed the downside risk with the adjustments we've made. The same goes for the impairments we recorded last quarter at Collins. We’re confident that we have effectively sized everything now in line with our expectations for the recovery, which is clearly not going to be quick; it’s going to be a slow, gradual process. For context, Pratt's shop visits this quarter were down about 55%. While this is an improvement from the 64% decline we faced in the second quarter, it will take time to reach the levels we saw in 2019, and this all factors into the contract adjustments.

Is it fair to say that your sense is that even though we may face a challenging Q4, possibly even Q1, the adjustments you've made now suggest we are not likely to see another round of those based on your observations in the market?

Well, I can never say never, but I would tell you, based on the assumptions that we've made in terms of this very slow recovery of air traffic and again our models pretty much mirror what IATA has been doing in terms of the recovery trajectory. Obviously what's going on right now with the resurgence of COVID is pressure testing those, but even with this second or third wave, whatever you want to call it, we still feel pretty comfortable with the models that we've used to make these contract adjustments to look at the impairment analysis are all pretty rock solid. Toby, any...

No, I think that's right, Greg. I mean, Doug, we're very comfortable with where we are, what we've taken adjustments on it. As Greg just described, I'll just reiterate his point. We can never say never because as an example, in our assumptions here, we have an assumption as an example that there will be a vaccine at a point in time. And obviously if that pushes right, keeps pushing right and people don't feel comfortable back to flying, then we'd have to revisit things. But the teams have done a good job working with our commercial customers to assess their situation. And again, as Greg said, we believe we've captured everything that we know about here through the Q3 results.

Okay, thank you.

Sure.

Thank you. Our next question comes from Sheila Kahyaoglu with Jefferies. Your line is now open.

Thank you. Good morning, everyone.

Hi, Sheila.

Hi. My question was on Collins. How do we think about 1% margins in the quarter? And perhaps the contraction relative to peers is much steeper and I appreciate there is some idle facility costs in there too. Can you maybe bridge the profit decline today and how we think about that improvement back-to-high teens eventually?

Sheila, thanks, it's Neil. How are you doing? We're obviously watching the Collins margins. There's a lot of great cost reduction going on within the business, taking E&D down. Obviously, the head count merit furloughs. But I think when I think about the Collins margin story, this is really what you're seeing here is really strong aftermarket drop through that's not occurring right now. So we feel very good about the cost actions that are in place at Collins. And when that volume does return, and remember, typically that's about a six month lag from kind of when traffic recovers, we should start to see really good incremental margins at the Collins business. But I think they have taken all the right actions right now within their portfolio to address the immediate cost headwinds. We should see that come back as the market comes back. I don't know, Toby, if there was more that you wanted to add there?

No, I think you hit that right on. I mean, we saw 55% decrementals at Collins in Q2, right, and that's taken into account, as Neil said, the cost actions that we've implemented to-date. And it's a reflection of the strength of that aftermarket and how strong the business units within Collins are, and 100% reinforce what Neil said. We should see the opposite on the upswing. There may be a lag, that six to nine month lag that Neil talked about and the mix of business, right. The mix of the revenue could skew things in any given quarter. But generally speaking, we'd expect to recapture that on the upside.

Sheila, I would just make two other points. Obviously, the aftermarket at Collins is very profitable. I think everybody knows this, especially on the software side. And obviously we don't have the ADSP mandates this year, which is again a big chunk of the margin degradation. The other thing I just want to emphasize what Toby said. We have been burning down backlog at Collins. And so even though the aftermarket is down, I don't know, 50%, 55% here, we have been burning down backlog, getting past due. I don't expect we're going to see an upturn in aftermarket until sometime next year. Even if we start to see a recovery in the fourth quarter in commercial air traffic, which is still a question mark, I don't think anybody should be focused on 2021 to see a big uptick in the commercial aftermarket, primarily at Collins because there's a lot of excess material out there. There's a lot of folks still trying to do what they can to minimize costs. So this is not a one quarter, two quarter problem. It's going to be here for a while, but it is exactly as we had laid out in our outlook. So I wouldn't worry about other than the fact that everybody just needs to be aware, this is not a quick recovery in the aftermarket.

Okay, thank you so much.

Thank you. Our next question comes from Myles Walton with UBS. Your line is now open.

Thanks. Good morning.

Hi, Myles.

You talked about the structural cost and you have Slide 3 in the deck and maybe it's just me, but I'm trying to reconcile the cost initiatives to long-term structural savings. And I know you did that with the Pratt turbine facility, but is there a way that you can sort of simplify all the actions you're doing and talk about it in the construct of run rate savings that you will be able to benefit from on an ongoing basis versus temporary cost reductions that come back into the system as you release temporary furloughs or pay merit deferrals and things like that?

Myles, you raised an important point regarding the savings this year, which include one-time cost reductions. For example, Pratt is implementing 15 furlough days, and Collins has a similar approach. These cost reductions may pose challenges as we plan for next year. There are merit deferrals along with the furloughs, which will impact next year's planning. On a positive note, we have reduced about 20% of the workforce in the commercial aerospace sector this year. I estimate that about half of this workforce reduction will return as demand increases. It’s important when you discuss this with Chris Calio at Pratt and Steve Timm at Collins Aerospace that we aim to prevent the other half from returning. This strategy will provide us with leverage when air traffic returns to normal levels. Although we face some challenges next year due to temporary cost cuts, there are also long-term structural cost reductions being made. This primarily involves overhead reductions, such as downsizing procurement, flattening management layers, and decreasing overhead across various areas. Ultimately, this should lead to a more efficient organization over time.

Is it perhaps that half of the cost initiatives are structural?

So, I think the thing I'd add in, Myles, Greg focused a lot on the labor-related or employee-related cost there, right. Remember, we had a bucket around E&D reduction and also discretionary cost, right? So I think those two elements of our $2 billion, I think, you'd expect that we'd be able to sustain those so that there would be no headwind or tailwind, generally speaking, in 2021 relative to those two buckets. We would expect a favorable in 2021. We'd expect, related to all the employee-related actions, when you net the puts and takes, maybe $100 million, $200 million of favorability or tailwind, all else equal in 2021.

Okay, thank you.

Sure.

Thank you. Our next question comes from Kristine Liwag with Morgan Stanley. Your line is now open.

Hi, good morning, everyone.

Good morning.

Greg, with cash generation stable, how do you think about investing in next generation technology and sustainability? I mean, after COVID-19, carbon emissions in aviation would still be an industry issue. How do you think of investments in capabilities like hydrogen powered aircraft, especially with Pratt's long history with hydrogen?

Yes, so that's actually a great question. Hydrogen obviously is a zero-emission fuel. It's got better power density than Jet A. It does have a little bit of a storage problem on aircraft. You can't put hydrogen tanks into the wings of an aircraft. So what you're talking about from a commercial aerospace standpoint is probably a 2035 or so entry into service of a hydrogen-powered aircraft. We continue to work with that. For us, on the engine side, whether you're burning Jet A or whether you're burning hydrogen, it is not that different technical problem and I think we're pretty well positioned there to help with the aircraft OEMs as the exporters. Airbus has an active program on hydrogen, I suspect going well as well. But again, we're sitting here in 2020, that is a 15-year time horizon. We're going to continue to invest because, as you say, sustainability will be an issue. Now the GTF, we are in a long way, right. There was a 16% better fuel burn, about 50% better on the emissions. Even that, we've recognized we've got to do better. So, we're going to invest in hydrogen. We're also going to invest in hydrogen on the defense side because I think what you'll see is VOD money will come faster than some of the money that the commercial OEMs want to invest in this. So, we're well positioned. We've got the technology. And I think it is the future of aviation, but it's a way out.

Thanks, Greg.

Thank you. Our next question comes from Robert Stallard with Vertical Research. Your line is now open.

Thanks so much. Good morning.

Good morning, Rob.

Good morning.

Toby, a technical question for you. Obviously a better than expected on the Q3 cash flow, but you didn't raise the cash guidance for the year. So I was wondering if you could explain some of the moving parts there.

Yes. So, as Greg mentioned and I did, I mean, we're real pleased with what the teams have been able to do around cash flow, in particular. The favorability here that we saw in the quarter, primarily timing related at RMD and Collins related to customer collections. And we also saw some inventory reductions ahead of schedule, primarily at Collins and a little bit of favorability on the timing of some cash tax payments. But again, real strong performance. When we think about the year and we maintain the $2 billion, as you said, we think we have some flexibility there, some opportunity, again timing related around collections. We may be looking at potentially funding discretionary pension contribution that we're considering and still be able to deliver the $2 billion in the pro forma free cash flow. So we're feeling good about it for the year, highly confident delivering that along with some of the flexibility that I just mentioned.

That's great. Thank you.

Sure.

Thank you. Our next question comes from David Strauss with Barclays. Your line is now open.

Thanks. Good morning, everyone.

Good morning, David.

I guess, Greg, first of all, any sort of update on the MAX, when do you expect to start shipping there? And a follow-up on cash flow. I think, Greg, you had previously mentioned in some public appearance that you expect significant growth in adjusted earnings next year. How are you thinking about cash flow next year once you add back the $1.2 billion to $1.4 billion one-time cost that are running through cash flow this year? Would you expect free cash flow to actually grow next year off that base? Thanks.

Let me begin with the MAX and then Toby will address your cash question. However, I want to clarify that we will not be providing guidance for 2021 today, so you'll need to wait while we navigate through this. Regarding the MAX, we have completed the delivery of all the black label software, and those installations are currently underway. Europe has already granted the certificate for the MAX to return to flight. We anticipate that US airlines will start returning the MAX to service by late November or early December. This is very encouraging news for the long term. However, it is not expected to significantly affect Collins next year. As mentioned, we have already delivered most of the inventory required for next year's production ramp-up. Currently, we estimate that about 80% of the inventory has been delivered to Boeing to support production in 2021. Consequently, you will see a gradual increase in 737 production at Collins, but it will be relatively small in the latter half of the year.

Regarding cash, we are confident in the business's ability to generate cash flow as we continue to recover from the pandemic. We remain committed to returning $18 billion to $20 billion to shareholders. Overall, we expect cash in 2021 to improve compared to this year. While I won't provide a specific number, I want to highlight a few considerations for 2021. Many of the cost savings from our cash actions this year are likely to be sustainable next year, essentially leading to a similar performance year-over-year. However, we will have some non-recurring cash items amounting to $1.2 billion to $1.4 billion, with $500 million to $600 million possibly carrying over to next year, which could pose a challenge. In terms of capital expenditures, we aim to maintain operational spending similar to 2020 levels. Given our strong cash flow this year, we might consider a discretionary pension contribution. Although pension contributions will still be positive next year, they won't be as strong, with around $850 million in headwinds due to higher required contributions. Depending on how this year unfolds, we may address this challenge and anticipate some additional spending related to structural actions, particularly concerning new facilities and office space, as well as synergies, potentially around $0.5 billion. For working capital, we expect to see improved turnover in 2021, believing we can sustain current levels until volumes begin to recover. There are many variables at play, and this year we have seen strong cash flow from the defense sector, though some of that may be timing-related. The sustainability of this cash flow will need to be considered for 2021. Ultimately, one of the biggest factors will be the shape of the recovery and how volume returns will affect cash flows. We will provide further details during our Q4 call in January.

Thank you. Our next question comes from Robert Spingarn with Credit Suisse. Your line is now open.

Hi, good morning.

Good morning.

Good morning.

Toby, just wanted to follow up on what you're talking about with cash flow. Maybe set a base on the defense side, if we could shine a little light there. But if we think about Raytheon free cash flow $3.6 billion last year and UTX defense cash has to be fairly substantial and again they're both growing this year. Can we think about 2020 defense free cash flow ballpark $5 billion? Is that a fair place to be before we then start factoring in everything you just talked about?

2020 defense cash flow including Pratt and Collins?

Yes.

So, I think what we've said, Rob, and this hasn't changed too much, right, maybe a little bit, but we had talked about the $3.5 billion, $3.6 billion that you mentioned for Raytheon in kind of from 2019 and seeing that play out here this year. I think we'd also said that back in 2019 that Pratt and Collins component was close to $4 billion last year. Obviously, a big impact to that this year. We are seeing strength this year on the Raytheon side of the house, particularly at RMD with collections. And again, the question is, will that continue here in the fourth quarter and provide some flexibility. But that's really give and take between '20 and '21 obviously, right, if that happens to continue. And then for this year, we had also said Pratt and Collins combined including the military was around breakeven, give or take, right. And again, we're seeing things play out generally that way with a little bit of favorability on the legacy Raytheon side going forward. I don't know if I'd get into the $5 billion. I think that's maybe a bridge too far right now to go that far with overall defense cash flow.

And then just, Greg, a clarification. You mentioned a lot of excess material, I think you were talking about Collins. But just in general, are you seeing more USM activity now than earlier in the pandemic and what's the trend on that?

I'm sorry, could you clarify if you're referring to usable material?

Used serviceable material. Yes, competing with your spares at both businesses, I suspect.

Yes. We are closely monitoring the situation. There has been a significant increase in used material primarily due to a number of retirements. On the Pratt & Whitney side, this mainly involves older models like the Pratt 2000 and PW4000, which are approaching the end of their useful life. We weren't seeing much aftermarket demand before due to the availability of serviceable material, but now there is a lot more on the market. The GTF isn't seeing the same levels, and we are still managing that situation. Regarding the V model, it's still in operation and remains one of the more efficient options, so we don’t have major concerns about serviceable material for Pratt at this time. We will keep monitoring it over time. The Collins side is more complex, with a wider range of products. There is serviceable material available, and I believe it is already having an impact, which is one reason why aftermarket performance is down. This situation contributes to our cautious outlook on the recovery trend in Collins aftermarket. Everyone is making efforts to conserve cash, even to the extent of cannibalizing aircraft to keep others operational. Until we see a return to normal operations and airlines can achieve positive cash flow, I expect we will continue to experience pressure from serviceable material. However, this is already reflected in our numbers and will persist for some time.

Thank you.

I'll just add one thing to that. Greg mentioned it at the aftermarket, the way it's performing right now. One of the reasons it is, is because time of material is down, but visits under contract are there, the customers have paid for those as the engines have flown and they are coming into the shop with a slightly different work scope. But we do like our position with those engines that are under contract and that will position us well for continued aftermarket when the recovery occurs. So, we're going to take one more question, Joelle, and then we'll wrap up the call.

Thank you. And that question comes from Noah Poponak with Goldman Sachs. Your line is now open.

Hey, good morning.

Good morning, Noah.

In whatever year global air traffic is back to 2019 levels, without speculating or specifying that year, just whatever year that is, in that year, do your pre-pandemic merged company cash flow targets stand?

I wish my crystal ball was that clear. What I will tell you, Noah, is that there will be a divergence in terms of the timing for when you see 2019 levels of air traffic or passenger traffic recover. There will probably be a six to nine month delay before we see our overall aftermarket business on the commercial side pick back up. At the same time, I think we feel really good about the defense side of the business. So whatever year that is, will things be back to normal, who knows? All I would say is, we're going to position ourselves so when the recovery does come, we're in a much better position from a cost standpoint. So in fact, cash may actually be good by the time that recovers, just because of all the costs that we've taken out of the business. But clearly the aftermarket will be the bellwether in terms of when we see a full return to normalcy.

We may get there in different way than we had envisioned when the merger was contemplated, to Greg's point, and if we don't, it would just be that, call it, six month delay, because of the timing of the aftermarket. But other than that, all else equal, knowing what we know today, I think your statement would directionally be correct.

Okay, great. And then just one clarification for the items you gave us for cash flow next year, Toby.

Yes.

If I heard you correctly, you were describing working capital as being approximately flat year-over-year on the balance sheet. So approximately no change on the balance sheet and therefore the bridge from EBITDA to free cash flow for the year would be better in 2021 compared to 2020 by whatever this final few billion dollars of negative working capital is going to be in 2020.

What we are indicating is that with the measures we've implemented this year, where we are three quarters of the way through and have significantly reduced inventory by nearly $1 billion, we believe that by the end of the year, we will be in a position to maintain that level and see improvements in our turnover in 2021 as we begin to experience a recovery in volume.

So basically, is it the case that you do not expect any major year-over-year change in working capital on the balance sheet '21 versus '20?

Right now, that's our initial assumption, but as Greg mentioned, we'll provide a more detailed update in January. We wanted to give you an overview of the major factors involved, even though we don't have guidance or an outlook for 2021 yet. Any of these factors could change slightly, but...

And working capital is always a moving target. I'm just trying to figure out such a giant number again like it was this year or...

No, I think, give or take for now, I would say, your thought process is okay.

Okay, thanks very much.

Yes, sure.

Okay, thank you all for listening. Just a wrap up thought. I know everybody's mind is focused on the pandemic and the significant impact it's had on commercial air traffic and on our commercial businesses. Clearly difficult times, but I would remind everyone, two-thirds of our business is defense related and those businesses remain strong with over $70 billion of backlog. That defense business also gives us the ability to continue to invest through this cycle and to make sure that we have the right technologies for the future. So, I know it's tough out there, but I think everybody should keep in mind, we're in this for the long term. We've got great liquidity, great cash position, and great people, and great technology. So, with that, thank you all for listening. Neil and the crew will be around all day today and tomorrow to take any follow-up questions. Have a great day and stay safe. Take care.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.