(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations BUSINESS OVERVIEW We are a global premier systems provider of high technology products and services to the aerospace and defense industries. On April 3, 2020, United Technologies Corporation (UTC) completed the Separation Transactions as defined below, and on April 3, 2020, completed the Raytheon Merger as defined below, to form the new company, Raytheon Technologies Corporation. As a result of these transactions, we now operate in four principal business segments: Collins Aerospace Systems (Collins Aerospace), Pratt & Whitney, Raytheon Intelligence & Space (RIS) and Raytheon Missiles & Defense (RMD). Separation Transactions and Distributions. On April 3, 2020, United Technologies Corporation (UTC) (since renamed Raytheon Technologies Corporation) completed the previously announced separation of its business into three independent, publicly traded companies - UTC, Carrier Global Corporation (Carrier) and Otis Worldwide Corporation (Otis) (such separations, the "Separation Transactions"). UTC distributed all of the outstanding shares of Carrier common stock and all of the outstanding shares of Otis common stock to UTC shareowners who held shares of UTC common stock as of the close of business on March 19, 2020, the record date for the distributions (the Distributions). UTC distributed 866,158,910 and 433,079,455 shares of common stock of Carrier and Otis, respectively in the Distributions, each of which was effective at 12:01 a.m., Eastern Time, on April 3, 2020. The historical results of Otis and Carrier are presented as discontinued operations and, as such, have been excluded from both continuing operations and segment results for all periods presented. Throughout this Quarterly Report on Form 10-Q, unless otherwise indicated, amounts and activity are presented on a continuing operations basis. Raytheon Merger. On April 3, 2020, following the completion of the Separation Transactions and the Distributions, pursuant to an Agreement and Plan of Merger dated June 9, 2019, as amended, UTC and Raytheon Company (Raytheon) completed their previously announced all-stock merger of equals transaction (the Raytheon Merger). Upon closing of the Raytheon Merger, Raytheon Company became a wholly-owned subsidiary of UTC, which changed its name to "Raytheon Technologies Corporation." Unless the context otherwise requires, the terms "we," "our," "us," "the Company," "Raytheon Technologies," and "RTC" mean United Technologies Corporation and its subsidiaries when referring to periods prior to the Raytheon Merger and to the combined company, Raytheon Technologies Corporation, when referring to periods after the Raytheon Merger. Unless the context otherwise requires, the terms "Raytheon Company," or "Raytheon" mean Raytheon Company and its subsidiaries prior to the Raytheon Merger. UTC was determined to be the accounting acquirer in the merger, and as a result the financial statements of Raytheon Technologies for the period ended and as of June 30, 2020 include Raytheon Company's financial position and results of operations for the period subsequent to the completion of the Raytheon Merger on April 3, 2020. Raytheon Intelligence & Space (RIS) and Raytheon Missiles & Defense (RMD) follow a 4-4-5 fiscal calendar with results recorded from the April 3, 2020 merger close date through June 28, 2020 while Collins Aerospace Systems (Collins Aerospace) and Pratt & Whitney continue to use a quarter calendar end of June 30, 2020. The historical results of Otis and Carrier are presented as discontinued operations and, as such, have been excluded from both continuing operations and segment results for all periods presented. See "Note 3: Discontinued Operations" within Item 1 of this Form 10-Q for additional information. The current status of significant factors affecting our business environment in 2020 is discussed below. For additional discussion, refer to the "Business Overview" section in Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) in our 2019 Annual Report, which is incorporated by reference in our 2019 Form 10-K, and the "Risk Factors" in Part II, Item IA of our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020. Industry Considerations Our worldwide operations can be affected by industrial, economic and political factors on both a regional and global level. Our operations include original equipment manufacturer (OEM) and extensive related aftermarket parts and services related to our aerospace operations. Our defense business serves both domestic and international customers primarily as a prime contractor or subcontractor on a broad portfolio of defense and related programs for government customers. Our business mix also reflects the combination of shorter cycles in our commercial aerospace spares contracts and certain service contracts in our defense business primarily at RIS, and longer cycles in our aerospace OEM and aftermarket maintenance contracts and on our defense contracts to design, develop, manufacture or modify complex equipment. Our customers are in the public and private sectors, and our businesses reflect an extensive geographic diversification that has evolved with continued globalization. Government legislation, policies and regulations can have a negative impact on our worldwide operations. Government and market-driven safety and performance regulations, restrictions on aircraft engine noise and emissions, government imposed travel restrictions, and government procurement practices can impact our businesses. Table of Conte n ts Collins Aerospace and Pratt & Whitney serve both commercial and government aerospace customers. Revenue passenger miles (RPMs), available seat miles and the general economic health of airline carriers are key barometers for our commercial aerospace operations. Performance in the general aviation sector is closely tied to the overall health of the economy and is positively correlated to corporate profits. Our commercial aftermarket operations continue to evolve as a significant portion of our aerospace operations' customers are covered under long-term aftermarket service agreements at both Collins Aerospace and Pratt & Whitney. These agreements are comprehensive long-term spare part and service agreements with our customers. RIS, RMD, and the defense operations of Collins Aerospace and Pratt & Whitney are affected by U.S. Department of Defense (DoD) budget and spending levels, changes in market demand and the global political environment. Total sales to the U.S. government were $7.3 billion and $2.4 billion for the quarters ended June 30, 2020 and 2019, or 52% and 21% of total sales for those periods, respectively. Total sales to the U.S. government were $9.9 billion and $4.5 billion for the six months ended June 30, 2020 and 2019, or 39% and 20% of total sales for those periods, respectively. Our participation in long-term production, development and sustainment programs for the U.S. government has and is expected to contribute positively to our results in 2020. Impact of the COVID-19 pandemic on results and forward looking impacts In March 2020, the coronavirus disease 2019 (COVID-19) was declared a pandemic by the World Health Organization and a national emergency by the U.S. government. The pandemic has negatively affected the U.S. and global economy, disrupted global supply chains and financial markets, and resulted in significant travel restrictions, mandated facility closures and shelter-in-place and social distancing orders in numerous jurisdictions around the world. Raytheon Technologies is taking all prudent measures to protect the health and safety of our employees, such as practicing social distancing, performing deep cleaning in all of our facilities, and enabling our employees to work from home where possible. We have also taken appropriate actions to help support our communities in addressing the challenges posed by the pandemic, including the production and donation of personal protective equipment. Our business and operations and the industries in which we operate have been significantly impacted by public and private sector policies and initiatives in the U.S. and worldwide to address the transmission of COVID-19, such as the imposition of travel restrictions and the adoption of remote working. Additionally, public sentiments regarding air travel have also had a significant impact. We began to experience issues related to COVID-19 in the first quarter, primarily related to a limited number of facility closures, less than full staffing, and disruptions in supplier deliveries, most significantly in our Collins Aerospace and Pratt & Whitney businesses. However, our customers continued to receive our products and services during the first quarter and the outbreak did not have a significant impact on our operating results for the quarter ended March 31, 2020. In the second quarter of 2020 and subsequent to quarter end, the continued disruption to air travel and commercial activities and the significant restrictions and limitations on businesses, particularly within the aerospace and commercial airline industries, have negatively impacted global supply, demand and distribution capabilities. In particular, the significant decrease in air travel resulting from the COVID-19 pandemic is adversely affecting our airline and airframer customers, and their demand for the products and services of our Collins Aerospace and Pratt & Whitney businesses. Based on recent public data and estimates, revenue passenger miles (RPMs) for the year ended December 31, 2020 could decline by approximately 60% in comparison to the prior year due to the pandemic. As a result, our airline customers have reported significant reductions in fleet utilization, aircraft grounding and unplanned retirements, and have deferred and, in some cases, cancelled new aircraft deliveries. Airlines have shifted to cash conservation behaviors such as deferring engine maintenance due to lower flight hours and aircraft utilization, requesting extended payment terms, deferring delivery of new aircraft and spare engines and requesting discounts on engine maintenance. Some airline customers have filed for bankruptcy due to their inability to meet their financial obligations. Additionally, we are seeing purchase order declines in line with publicly communicated aircraft production volumes as original equipment manufacturer (OEM) customers delay and cancel orders. We continue to monitor these trends and are working closely with our customers. We are actively mitigating costs and adjusting production schedules to accommodate these declines in demand. We have also been taking actions to preserve capital and protect the long-term needs of our businesses, including cutting discretionary spending, significantly reducing capital expenditures and research and development spend, suspending our share buybacks, deferring merit increases and implementing temporary pay reductions, freezing non-essential hiring, repositioning employees to defense work, and furloughing employees when needed. In the quarter ended June 30, 2020, we recorded total restructuring charges of $427 million primarily related to personnel reductions. Thus far, most of these actions have been taken at our Collins Aerospace and Pratt & Whitney businesses. The former Raytheon Company businesses have not experienced significant facility closures or other business disruptions. Given the significant reduction in business and leisure passenger air travel, the number of planes temporarily grounded, and continued travel restrictions that have resulted from the pandemic, we expect our future operating results, particularly those of our Collins Aerospace and Pratt & Whitney businesses to continue to be significantly negatively impacted. Our expectations Table of Conte n ts regarding the COVID-19 pandemic and its potential financial impact are based on available information and assumptions that we believe are reasonable at this time; however, the actual financial impact is highly uncertain and subject to a wide range of factors and future developments. While we believe that the long-term outlook for the aerospace industry remains positive due to the fundamental drivers of air travel demand, there is significant uncertainty with respect to when and if commercial air traffic levels will begin to recover, and whether and at what point capacity will return to and/or exceed pre-COVID-19 levels. Our latest estimates are that this recovery may occur in 2023 or 2024. New information may emerge concerning the scope, severity and duration of the COVID-19 pandemic, as well as any worsening of the pandemic and whether there will be additional outbreaks of the pandemic, actions to contain its spread or treat its impact, and governmental, business and individuals' actions taken in response to the pandemic (including restrictions and limitations on travel and transportation) among others. We considered the deterioration in general economic and market conditions primarily due to the COVID-19 pandemic to be a triggering event requiring us to reassess our commercial aerospace business goodwill and intangibles valuations, as well as our significant assumptions of future cash flows from our underlying assets and potential changes in our liabilities in both the first and second quarters of 2020. In the second quarter of 2020, our revenue at Collins Aerospace and Pratt & Whitney was significantly impacted by the decline in flight hours, aircraft fleet utilization, shop visits and commercial OEM deliveries. In order to evaluate the ongoing impact, we updated our forecast assumptions of future business activity that are subject to a wide range of uncertainties, including those noted above. Based upon our analysis, we concluded that the carrying value of two of our Collins Aerospace reporting units as of June 30, 2020 was greater than its fair value, and accordingly, we recorded a goodwill impairment charge of $3.2 billion in the quarter ended June 30, 2020. Refer to "Note 2: Acquisitions, Dispositions, Goodwill and Other Intangible Assets" within Item 1 of this Form 10-Q for additional information. Additionally, in the quarter and six months ended June 30, 2020 we recorded write-downs of assets in our Collins Aerospace and Pratt & Whitney businesses primarily related to increased estimated credit losses of $237 million and $309 million in the quarter and six months ended June 30, 2020, respectively, a reduction in expected future billings or revenues on commercial contracts, based on a change in estimated customer activity during the current period, of $179 million and $190 million in the quarter and six months ended June 30, 2020, respectively, the impairment of a Collins Aerospace trade name of $17 million and $57 million in the quarter and six months ended June 30, 2020, respectively, and a change in contract estimates related to a shift in overhead costs to military contracts of $44 million in both the quarter and six months ended June 30, 2020. Given the uncertainty related to the severity and length of the pandemic, as well as any worsening of the pandemic and whether there will be additional outbreaks of the pandemic and its impact across the aerospace industry, we may be required to record additional charges or impairments in future periods. Although the impact of COVID-19 on our commercial markets is significant, we currently believe we have sufficient liquidity to withstand the potential impacts of COVID-19. With the completion of the Separation Transactions, the Distributions and the Raytheon Merger, we have a balanced and diversified portfolio of both aerospace and defense businesses which we believe will help mitigate the impacts of the COVID-19 pandemic and future business cycles. Other Matters Global economic and political conditions, changes in raw material and commodity prices, interest rates, foreign currency exchange rates, energy costs, levels of end market demand in construction, levels of air travel, the financial condition of commercial airlines, and the impact from natural disasters and weather conditions create uncertainties that could impact our earnings outlook for the remainder of 2020. With regard to political conditions, the U.S. government suspended Turkey's participation in the F-35 Joint Strike Fighter program because Turkey accepted delivery of the Russian-built S-400 air and missile defense system. The U.S. has imposed, and may impose additional, sanctions on Turkey as a result of this or other political disputes. Turkish companies supply components, some of which are sole-sourced, to our aerospace operations for commercial and military engines and aerospace products. Depending upon the scope and timing of U.S. sanctions on Turkey and potential reciprocal actions, if any, such sanctions or actions could impact our aerospace operations' sources of supply and could have a material adverse effect on our results of operations, cash flows or financial condition. See Part II, Item 1A, "Risk Factors" in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020 for further discussion. The following activity is disclosed as required by Section 13(r)(1)(D) of the Securities Exchange Act of 1934, as amended, as transactions or dealings with the government of Iran that have not been specifically authorized by a U.S. federal department or agency. In January 2020, Raytheon Company inadvertently misdirected a vendor payment for $105,000 to Bank Saderat Iran as the result of a data entry error. Bank Saderat Iran is sanctioned by the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC) as a financial institution owned or controlled by the Government of Iran and is blocked under the Iranian Transactions and Sanctions Regulations (31 CFR Part 560) and Global Terrorism Sanctions Regulations (31 CFR Part 594). The misdirected payment, which occurred prior to the Raytheon Merger, was blocked by Raytheon Company's U.S. bank in accordance with OFAC requirements. Raytheon Company subsequently determined that a data entry error had resulted in its Table of Conte n ts vendor being assigned incorrect bank routing information associated with the sanctioned Iranian bank. Neither Raytheon Company's vendor, nor the intended recipient bank, are or were subject to U.S. government sanctions. On March 2, 2020, Raytheon Company submitted a license request to OFAC seeking release of the blocked funds, and OFAC issued the license on July 1, 2020. Raytheon Company did not receive any revenues or profits associated with the inadvertent payment. CRITICAL ACCOUNTING ESTIMATES Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Management believes the most complex and sensitive judgments, because of their significance to the Condensed Consolidated Financial Statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. The most significant areas involving management judgments and estimates are described below and reflect updates from our 2019 Form 10-K as a result of the Raytheon Merger and Separation Transactions. Actual results in these areas could differ from management's estimates. Long-Term Contract Accounting. We recognize revenue on an over-time basis for substantially all defense contracts and certain long-term aerospace aftermarket contracts. We measure progress toward completion of these contracts on a percentage of completion basis, using costs incurred to date relative to total estimated costs at completion. Incurred costs represent work performed, which correspond with and best depict transfer of control to the customer. Contract costs are incurred over a period of time, which can be several years, and the estimation of these costs requires management's judgment. We review our Estimate at Completion (EACs) on significant contracts on a periodic basis and for others, no less than annually or when a change in circumstances warrant a modification to a previous estimate. Due to the nature of the work required to be performed on many of the Company's performance obligations, the estimation of total revenue and cost at completion is complex, subject to many variables and requires significant judgment by management on a contract by contract basis. As part of this process, management reviews information including, but not limited to, any outstanding key contract matters, progress towards completion and the related program schedule, identified risks and opportunities and the related changes in estimates of revenues and costs. The risks and opportunities include management's judgment about the ability and cost to achieve the schedule including consideration of customer-directed delays or reductions in scheduled deliveries, and technical and other specific contract requirements including customer activity levels and variable consideration based upon that activity. Management's judgment related to these considerations has become increasingly more significant given the current economic environment primarily caused by the COVID-19 pandemic. Management must make assumptions and estimates regarding contract revenue and costs, including estimates of labor productivity and availability, the complexity and scope of the work to be performed, the availability and cost of materials, the length of time to complete the performance obligation, execution by our subcontractors, the availability and timing of funding from our customer, overhead cost rates, estimated aircraft and engine utilization and estimated useful lives of components, among other variables. Cost estimates may also include the estimated cost of satisfying our industrial cooperation agreements, sometimes in the form of either offset obligations or in-country industrial participation (ICIP) agreements, required under certain contracts. These obligations may or may not be distinct depending on their nature. If cash is paid to a customer to satisfy our offset obligations it is recorded as a reduction in the transaction price. Changes in estimates of net sales, cost of sales and the related impact to operating profit are recognized on a cumulative catch-up basis, which recognizes the cumulative effect of the profit changes on current and prior periods based on a performance obligation's percentage of completion in the current period. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations. Our EAC adjustments also include the establishment of loss provisions on our contracts accounted for on a percentage of completion basis. Net EAC adjustments had the following impact on our operating results: Six Months Ended Quarter Ended June 30, June 30, (dollars in millions, except per share amounts) 2020 2019 2020 2019 Operating profit $ (151) $ (69) $ (130) $ (81) Income (loss) from continuing operations attributable to common shareowners (1) (119) (55) (103) (64) Diluted earnings (loss) per share from continuing operations attributable to common shareowners (1) $ (0.08) $ (0.06) $ (0.08) $ (0.07)
(1) Amounts reflect a U.S. statutory tax rate of 21%, which approximates our effective tax rate on our EAC adjustments. As a result of the Raytheon Merger, Raytheon Company's contracts accounted for on a percentage of completion basis were reset to zero percent complete as of the merger date, since only the unperformed portion of the contract at the merger date represents the obligation of the Company. For additional information related to the Raytheon Merger, see "Note 2: Acquisitions, Dispositions, Goodwill and Other Intangible Assets" within Item 1 of this Form 10-Q. Table of Conte n ts
Jul 29, 2020
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