TEXTRON INC, 10-K filed on 2/25/2010
Annual Report
Document and Company Information (USD $)
In Millions, except Share data in Thousands
Feb. 13, 2010
Year Ended
Jan. 2, 2010
Jul. 4, 2009
Document And Company Information [Abstract]
 
 
 
Entity Registrant Name
 
TEXTRON INC 
 
Entity Central Index Key
 
0000217346 
 
Document Type
 
10-K 
 
Document Period End Date
 
01/02/2010 
 
Amendment Flag
 
FALSE 
 
Current Fiscal Year End Date
 
01/02 
 
Entity Well-known Seasoned Issuer
 
Yes 
 
Entity Voluntary Filers
 
No 
 
Entity Current Reporting Status
 
Yes 
 
Entity Filer Category
 
Large Accelerated Filer 
 
Entity Public Float
 
 
$ 2,512 
Entity Common Stock, Shares Outstanding
272,621.01 
 
 
Consolidated Statements of Operations (USD $)
In Millions, except Per Share data
Year Ended
Jan. 2, 2010
Jan. 3, 2009
Dec. 29, 2007
Consolidated
 
 
 
Revenues
 
 
 
Manufacturing revenues
$ 10,139 
$ 13,287 
$ 11,520 
Finance revenues
361 
723 
875 
Total revenues
10,500 
14,010 
12,395 
Costs, expenses and other
 
 
 
Cost of sales
8,468 
10,583 
9,099 
Selling and administrative
1,344 
1,606 
1,545 
Special charges
317 
526 
Provision for losses on finance receivables
267 
234 
33 
Interest expense
309 
448 
507 
Interest income
(6)
(16)
(23)
Gain on sale of assets
(50)
Total costs, expenses and other
10,649 
13,381 
11,161 
Income (loss) from continuing operations before income taxes
(149)
629 
1,234 
Income tax expense (benefit)
(76)
305 
368 
Income (loss) from continuing operations
(73)
324 
866 
Income from discontinued operations, net of income taxes
42 
162 
51 
Net income (loss)
(31)
486 
917 
Basic earnings per share
 
 
 
Continuing operations
(0.28)
1.32 
3.47 
Discontinued operations
0.16 
0.65 
0.20 
Basic earnings per share
(0.12)
1.97 
3.67 
Diluted earnings per share
 
 
 
Continuing operations
(0.28)
1.29 
3.40 
Discontinued operations
0.16 
0.65 
0.20 
Diluted earnings per share
(0.12)
1.94 
3.60 
Manufacturing Group
 
 
 
Income (loss) from continuing operations
133 
785 
721 
Income from discontinued operations, net of income taxes
42 
162 
51 
Net income (loss)
175 
947 
772 
Finance Group
 
 
 
Costs, expenses and other
 
 
 
Provision for losses on finance receivables
267 
234 
33 
Income (loss) from continuing operations
(206)
(461)
145 
Net income (loss)
$ (206)
$ (461)
$ 145 
Consolidated Balance Sheets (USD $)
In Millions
Jan. 2, 2010
Jan. 3, 2009
Dec. 29, 2007
Dec. 30, 2006
Manufacturing Group
 
 
 
 
Assets
 
 
 
 
Cash and cash equivalents
$ 1,748 
$ 531 
 
 
Accounts receivable, net
894 
894 
 
 
Inventories
2,273 
3,093 
 
 
Other current assets
960 
584 
 
 
Assets of discontinued operations
58 
334 
 
 
Total current assets
5,933 
5,436 
 
 
Property, plant and equipment, net
1,968 
2,088 
 
 
Goodwill
1,622 
1,698 
 
 
Other assets
1,905 
1,465 
 
 
Total assets
11,428 
10,687 
 
 
Liabilities
 
 
 
 
Current portion of long-term debt and short-term debt
134 
876 
 
 
Accounts payable
569 
1,101 
 
 
Accrued liabilities
2,027 
2,609 
 
 
Liabilities of discontinued operations
138 
195 
 
 
Total current liabilities
2,868 
4,781 
 
 
Other liabilities
3,127 
2,926 
 
 
Long-term debt
3,450 
1,693 
 
 
Total liabilities
9,445 
9,400 
 
 
Consolidated | Series A, $2.08 Preferred stock
 
 
 
 
Shareholders' equity
 
 
 
 
Preferred stock
 
 
 
 
Consolidated | Series B, $1.40 Preferred stock
 
 
 
 
Shareholders' equity
 
 
 
 
Preferred stock
 
 
 
 
Finance Group
 
 
 
 
Assets
 
 
 
 
Cash and cash equivalents
144 
16 
 
 
Finance receivables held for investment, net
5,865 
6,724 
 
 
Finance receivables held for sale
819 
1,658 
 
 
Other assets
684 
946 
 
 
Total assets
7,512 
9,344 
 
 
Liabilities
 
 
 
 
Other liabilities
866 
540 
 
 
Deferred income taxes
136 
337 
 
 
Debt
5,667 
7,388 
 
 
Total liabilities
6,669 
8,265 
 
 
Consolidated
 
 
 
 
Assets
 
 
 
 
Cash and cash equivalents
1,892 
547 
531 
780 
Total assets
18,940 
20,031 
 
 
Liabilities and shareholders' equity
 
 
 
 
Liabilities
 
 
 
 
Total liabilities
16,114 
17,665 
 
 
Shareholders' equity
 
 
 
 
Common stock (277.4 million and 253.1 million shares issued, respectively, and 272.3 million and 242.0 million shares outstanding, respectively)
35 
32 
 
 
Capital surplus
1,369 
1,229 
 
 
Retained earnings
2,973 
3,025 
 
 
Accumulated other comprehensive loss
(1,321)
(1,422)
 
 
Total shareholders' equity including cost of treasury shares
3,056 
2,866 
 
 
Less cost of treasury shares
230 
500 
 
 
Total shareholders' equity
2,826 
2,366 
3,507 
2,649 
Total liabilities and shareholders' equity
$ 18,940 
$ 20,031 
 
 
Consolidated Balance Sheets (Parenthetical) (USD $)
Share data in Millions, except Per Share data
Jan. 2, 2010
Jan. 3, 2009
Shareholders' equity
 
 
Series A cumulative convertible preferred stock , Dividend rate
$ 2.08 
$ 2.08 
Series B convertible preferred dividend stock, Dividend rate
1.40 
1.40 
Consolidated
 
 
Shareholders' equity
 
 
Common stock, shares issued
277.4 
253.1 
Common stock, shares outstanding
272.3 
242.0 
Statements of Shareholders Equity (USD $)
In Millions
Consolidated | Common Stock
Consolidated | Capital Surplus
Consolidated | Treasury Stock
Consolidated | Retained Earnings
Consolidated | Accumulated Other Comprehensive Loss
Consolidated | Series A, $2.08 Preferred stock
Consolidated | Series B, $1.40 Preferred stock
Consolidated
12/31/2006 - 12/29/2007
 
 
 
 
 
 
 
 
Balance
$ 26 
$ 1,786 
$ (4,740)
$ 6,211 
$ (644)
$ 4 
$ 6 
$ 2,649 
Net income (loss)
 
 
 
917 
 
 
 
917 
Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
 
 
 
57 
 
 
57 
Deferred gains (losses) on hedge contracts
 
 
 
 
53 
 
 
53 
Pension adjustments
 
 
 
 
96 
 
 
96 
Reclassification adjustments
 
 
 
 
38 
 
 
38 
Reclassification due to sale of Fluid & Power
 
 
 
 
 
 
 
 
Pension curtailment
 
 
 
 
 
 
 
 
Total other comprehensive income
 
 
 
 
 
 
 
1,161 
Impact of adoption of new accounting standards
 
 
 
(11)
 
 
 
(11)
Retirement of treasury shares
(10)
(770)
4,911 
(4,123)
 
(2)
(6)
Stock split issued in the form of a stock dividend
16 
 
 
(16)
 
 
 
Dividends declared ($0.85, $0.92 and $0.08 per share for 2007, 2008 and 2009, respectively)
 
 
 
(212)
 
 
 
(212)
Share-based compensation
 
41 
 
 
 
 
 
41 
Purchase of convertible note hedge
 
 
 
 
 
 
 
 
Equity component of convertible debt issuance
 
 
 
 
 
 
 
 
Issuance of common stock and warrants
 
 
 
 
 
 
 
 
Exercise of stock options
 
101 
 
 
 
 
 
101 
Purchases of common stock
 
 
(295)
 
 
 
 
(295)
Issuance of common stock under employee stock plans
 
38 
 
 
 
 
46 
Redemption of preferred stock
 
 
 
 
 
 
 
 
Income tax impact of employee stock transactions
 
27 
 
 
 
 
 
27 
Balance
32 
1,193 
(86)
2,766 
(400)
3,507 
12/30/2007 - 1/3/2009
 
 
 
 
 
 
 
 
Balance
32 
1,193 
(86)
2,766 
(400)
 
 
3,507 
Net income (loss)
 
 
 
486 
 
 
 
486 
Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
 
 
 
(195)
 
 
(195)
Deferred gains (losses) on hedge contracts
 
 
 
 
(73)
 
 
(73)
Pension adjustments
 
 
 
 
(803)
 
 
(803)
Reclassification adjustments
 
 
 
 
14 
 
 
14 
Reclassification due to sale of Fluid & Power
 
 
 
 
35 
 
 
35 
Pension curtailment
 
 
 
 
 
 
 
 
Total other comprehensive income
 
 
 
 
 
 
 
(536)
Impact of adoption of new accounting standards
 
 
 
 
 
 
 
 
Retirement of treasury shares
 
 
 
 
 
 
 
 
Stock split issued in the form of a stock dividend
 
 
 
 
 
 
 
 
Dividends declared ($0.85, $0.92 and $0.08 per share for 2007, 2008 and 2009, respectively)
 
 
 
(227)
 
 
 
(227)
Share-based compensation
 
50 
 
 
 
 
 
50 
Purchase of convertible note hedge
 
 
 
 
 
 
 
 
Equity component of convertible debt issuance
 
 
 
 
 
 
 
 
Issuance of common stock and warrants
 
 
 
 
 
 
 
 
Exercise of stock options
 
39 
 
 
 
 
 
39 
Purchases of common stock
 
 
(533)
 
 
 
 
(533)
Issuance of common stock under employee stock plans
 
(66)
119 
 
 
 
 
53 
Redemption of preferred stock
 
 
 
 
 
 
 
 
Income tax impact of employee stock transactions
 
13 
 
 
 
 
 
13 
Balance
32 
1,229 
(500)
3,025 
(1,422)
 
 
2,366 
1/4/2009 - 1/2/2010
 
 
 
 
 
 
 
 
Balance
32 
1,229 
(500)
3,025 
(1,422)
2,366 
Net income (loss)
 
 
 
(31)
 
 
 
(31)
Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
 
 
 
23 
 
 
23 
Deferred gains (losses) on hedge contracts
 
 
 
 
67 
 
 
67 
Pension adjustments
 
 
 
 
(25)
 
 
(25)
Reclassification adjustments
 
 
 
 
21 
 
 
21 
Reclassification due to sale of Fluid & Power
 
 
 
 
 
 
 
 
Pension curtailment
 
 
 
 
15 
 
 
15 
Total other comprehensive income
 
 
 
 
 
 
 
70 
Impact of adoption of new accounting standards
 
 
 
 
 
 
 
 
Retirement of treasury shares
 
 
 
 
 
 
 
 
Stock split issued in the form of a stock dividend
 
 
 
 
 
 
 
 
Dividends declared ($0.85, $0.92 and $0.08 per share for 2007, 2008 and 2009, respectively)
 
 
 
(21)
 
 
 
(21)
Share-based compensation
 
30 
 
 
 
 
 
30 
Purchase of convertible note hedge
 
(140)
 
 
 
 
 
(140)
Equity component of convertible debt issuance
 
134 
 
 
 
 
 
134 
Issuance of common stock and warrants
330 
 
 
 
 
 
333 
Exercise of stock options
 
 
 
 
 
 
 
 
Purchases of common stock
 
 
 
 
 
 
 
 
Issuance of common stock under employee stock plans
 
(210)
270 
 
 
 
 
60 
Redemption of preferred stock
 
 
 
 
(2)
 
(1)
Income tax impact of employee stock transactions
 
(5)
 
 
 
 
 
(5)
Balance
$ 35 
$ 1,369 
$ (230)
$ 2,973 
$ (1,321)
$ 0 
$ 0 
$ 2,826 
Statements of Equity (Parenthetical) (USD $)
Year Ended
Jan. 2, 2010
Jan. 3, 2009
Dec. 29, 2007
Consolidated | Retained Earnings
 
 
 
Dividends declared per share $0.85, $0.92 and $0.08 in the year 2007, 2008 and 2009 respectively
$ 0.08 
$ 0.92 
$ 0.85 
Consolidated Statements of Cash Flows (USD $)
In Millions
Year Ended
Jan. 2, 2010
Jan. 3, 2009
Dec. 29, 2007
Manufacturing Group
 
 
 
Cash flows from operating activities
 
 
 
Net income (loss)
$ 175 
$ 947 
$ 772 
Income from discontinued operations
42 
162 
51 
Income (loss) from continuing operations
133 
785 
721 
Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities:
 
 
 
Dividends received from Finance group
349 
142 
135 
Capital contributions paid to Finance group
(270)
(625)
Non-cash items:
 
 
 
Depreciation and amortization
373 
360 
282 
Goodwill and other asset impairment charges
144 
11 
Other, net
112 
103 
87 
Deferred income taxes
(61)
51 
Changes in assets and liabilities:
 
 
 
Accounts receivable, net
17 
15 
(38)
Inventories
810 
(648)
(436)
Other assets
(157)
(21)
(43)
Accounts payable
(535)
276 
35 
Accrued and other liabilities
(183)
(56)
387 
Other operating activities, net
14 
Net cash provided by operating activities of continuing operations
738 
407 
1,144 
Net cash provided by (used in) operating activities of discontinued operations
(17)
(14)
64 
Net cash provided by operating activities
721 
393 
1,208 
Cash flows from investing activities
 
 
 
Net cash used in acquisitions
(109)
(1,092)
Net proceeds from sale of businesses
(14)
Capital expenditures
(238)
(537)
(369)
Other investing activities, net
(50)
Net cash provided by (used in) investing activities of continuing operations
(288)
(637)
(1,469)
Net cash provided by investing activities of discontinued operations
211 
471 
58 
Net cash provided by (used in) investing activities
(77)
(166)
(1,411)
Cash flows from financing activities
 
 
 
Increase (decrease) in short-term debt
(869)
867 
(42)
Proceeds from long-term lines of credit
1,230 
Payments on long-term lines of credit
(63)
Proceeds from issuance of long-term debt
595 
348 
Principal payments on long-term debt
(392)
(348)
(50)
Proceeds (payments) on borrowings against officers' life insurance policies
(412)
222 
Intergroup financing
(280)
(133)
Proceeds from issuance of convertible notes, net of fees paid
582 
Purchase of convertible note hedge
(140)
 
 
Proceeds from issuance of common stock and warrants
333 
Proceeds from option exercises
40 
103 
Excess tax benefit on stock options
10 
24 
Purchases of Textron common stock
(533)
(304)
Dividends paid
(21)
(284)
(154)
Net cash provided by (used in) financing activities of continuing operations
563 
(159)
(75)
Net cash used in financing activities of discontinued operations
(2)
(2)
Net cash provided by (used in) financing activities
563 
(161)
(77)
Effect of exchange rate changes on cash and cash equivalents
10 
(6)
18 
Net increase (decrease) in cash and cash equivalents
1,217 
60 
(262)
Cash and cash equivalents at beginning of year
531 
471 
733 
Cash and cash equivalents at end of year
1,748 
531 
471 
Finance Group
 
 
 
Cash flows from operating activities
 
 
 
Net income (loss)
(206)
(461)
145 
Income (loss) from continuing operations
(206)
(461)
145 
Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities:
 
 
 
Non-cash items:
 
 
 
Depreciation and amortization
36 
40 
40 
Provision for losses on finance receivables held for investment
267 
234 
33 
Portfolio losses on finance receivables
162 
Valuation allowance on finance receivables held for sale
(15)
293 
Goodwill and other asset impairment charges
180 
Other, net
(30)
Deferred income taxes
(204)
(94)
(7)
Changes in assets and liabilities:
 
 
 
Other assets
(5)
18 
19 
Accrued and other liabilities
166 
(54)
36 
Other operating activities, net
25 
11 
(4)
Net cash provided by operating activities of continuing operations
196 
167 
262 
Net cash provided by operating activities
196 
167 
262 
Cash flows from investing activities
 
 
 
Finance receivables originated or purchased
(3,659)
(11,879)
(13,124)
Finance receivables repaid
4,804 
11,245 
11,863 
Proceeds on receivables sales, including securitizations
644 
631 
994 
Capital expenditures
(8)
(10)
Proceeds from sale of repossessed assets and properties
236 
22 
23 
Retained interests
117 
15 
Purchase of marketable securities
(100)
Other investing activities, net
11 
10 
(35)
Net cash provided by (used in) investing activities of continuing operations
2,153 
(64)
(281)
Net cash provided by (used in) investing activities
2,153 
(64)
(281)
Cash flows from financing activities
 
 
 
Increase (decrease) in short-term debt
(768)
(649)
(370)
Proceeds from long-term lines of credit
1,740 
Payments on long-term lines of credit
Proceeds from issuance of long-term debt
323 
1,461 
1,878 
Principal payments on long-term debt
(3,771)
(1,574)
(1,344)
Intergroup financing
280 
133 
Capital contributions paid to Finance group under Support Agreement
270 
625 
Capital contributions paid to Cessna Export Finance Corp.
40 
Dividends paid
(349)
(142)
(135)
Net cash provided by (used in) financing activities of continuing operations
(2,235)
(146)
29 
Net cash provided by (used in) financing activities
(2,235)
(146)
29 
Effect of exchange rate changes on cash and cash equivalents
14 
(1)
Net increase (decrease) in cash and cash equivalents
128 
(44)
13 
Cash and cash equivalents at beginning of year
16 
60 
47 
Cash and cash equivalents at end of year
144 
16 
60 
Consolidated
 
 
 
Cash flows from operating activities
 
 
 
Net income (loss)
(31)
486 
917 
Income from discontinued operations
42 
162 
51 
Income (loss) from continuing operations
(73)
324 
866 
Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities:
 
 
 
Non-cash items:
 
 
 
Depreciation and amortization
409 
400 
322 
Provision for losses on finance receivables held for investment
267 
234 
33 
Portfolio losses on finance receivables
162 
Valuation allowance on finance receivables held for sale
(15)
293 
Goodwill and other asset impairment charges
144 
191 
Other, net
82 
103 
87 
Deferred income taxes
(265)
(43)
(3)
Changes in assets and liabilities:
 
 
 
Accounts receivable, net
17 
15 
(38)
Inventories
803 
(662)
(453)
Other assets
(152)
(14)
Accounts payable
(535)
276 
35 
Accrued and other liabilities
(20)
(110)
443 
Captive finance receivables, net
177 
(291)
(299)
Other operating activities, net
31 
25 
Net cash provided by operating activities of continuing operations
1,032 
764 
985 
Net cash provided by (used in) operating activities of discontinued operations
(17)
(14)
64 
Net cash provided by operating activities
1,015 
750 
1,049 
Cash flows from investing activities
 
 
 
Finance receivables originated or purchased
(3,005)
(10,860)
(11,964)
Finance receivables repaid
4,011 
10,630 
11,059 
Proceeds on receivables sales, including securitizations
594 
518 
917 
Net cash used in acquisitions
(109)
(1,092)
Net proceeds from sale of businesses
(14)
Capital expenditures
(238)
(545)
(379)
Proceeds from sale of repossessed assets and properties
236 
22 
23 
Retained interests
117 
15 
Purchase of marketable securities
(100)
Other investing activities, net
13 
21 
(22)
Net cash provided by (used in) investing activities of continuing operations
1,728 
(408)
(1,464)
Net cash provided by investing activities of discontinued operations
211 
471 
58 
Net cash provided by (used in) investing activities
1,939 
63 
(1,406)
Cash flows from financing activities
 
 
 
Increase (decrease) in short-term debt
(1,637)
218 
(412)
Proceeds from long-term lines of credit
2,970 
Payments on long-term lines of credit
(63)
Proceeds from issuance of long-term debt
918 
1,461 
2,226 
Principal payments on long-term debt
(4,163)
(1,922)
(1,394)
Proceeds (payments) on borrowings against officers' life insurance policies
(412)
222 
Proceeds from issuance of convertible notes, net of fees paid
582 
Purchase of convertible note hedge
(140)
 
 
Proceeds from issuance of common stock and warrants
333 
Proceeds from option exercises
40 
103 
Excess tax benefit on stock options
10 
24 
Purchases of Textron common stock
(533)
(304)
Dividends paid
(21)
(284)
(154)
Net cash provided by (used in) financing activities of continuing operations
(1,633)
(788)
89 
Net cash used in financing activities of discontinued operations
(2)
(2)
Net cash provided by (used in) financing activities
(1,633)
(790)
87 
Effect of exchange rate changes on cash and cash equivalents
24 
(7)
21 
Net increase (decrease) in cash and cash equivalents
1,345 
16 
(249)
Cash and cash equivalents at beginning of year
547 
531 
780 
Cash and cash equivalents at end of year
$ 1,892 
$ 547 
$ 531 
Summary of Significant Accounting Policies
Summary of Significant Accounting Policies
Note 1. Summary of Significant Accounting Policies
Principles of Consolidation and Financial Statement Presentation
Our Consolidated Financial Statements include the accounts of Textron Inc. and its majority-owned subsidiaries. As discussed in Note 2, on April 3, 2009, we sold HR Textron, and in November 2008, we completed the sale of our Fluid & Power business unit. Both of these businesses have been classified as discontinued operations, and all prior period information has been recast to reflect this presentation.
Our financings are conducted through two separate borrowing groups. The Manufacturing group consists of Textron Inc. consolidated with its majority-owned subsidiaries that operate in the Cessna, Bell, Textron Systems and Industrial segments. The Finance group, which also is the Finance segment, consists of Textron Financial Corporation (TFC), its subsidiaries and the securitization trusts consolidated into it, along with two other finance subsidiaries owned by Textron Inc. We designed this framework to enhance our borrowing power by separating the Finance group. Our Manufacturing group operations include the development, production and delivery of tangible goods and services, while our Finance group provides financial services. Due to the fundamental differences between each borrowing group’s activities, investors, rating agencies and analysts use different measures to evaluate each group’s performance. To support those evaluations, we present balance sheet and cash flow information for each borrowing group within the Consolidated Financial Statements.
Our Finance group provides captive financing for retail purchases and leases for new and used aircraft and equipment manufactured by our Manufacturing group. In the Consolidated Statements of Cash Flows, cash received from customers or from securitizations is reflected as operating activities when received from third parties. However, in the cash flow information provided for the separate borrowing groups, cash flows related to captive financing activities are reflected based on the operations of each group. For example, when product is sold by our Manufacturing group to a customer and is financed by the Finance group, the origination of the finance receivable is recorded within investing activities as a cash outflow in the Finance group’s statement of cash flows. Meanwhile, in the Manufacturing group’s statement of cash flows, the cash received from the Finance group on the customer’s behalf is recorded within operating cash flows as a cash inflow. Although cash is transferred between the two borrowing groups, there is no cash transaction reported in the consolidated cash flows at the time of the original financing. These captive financing activities, along with all significant intercompany transactions, are reclassified or eliminated in consolidation.
We have evaluated subsequent events up to the time of our filing with the Securities and Exchange Commission on February 25, 2010, which is the date that these financial statements were issued.
Use of Estimates
We prepare our financial statements in conformity with generally accepted accounting principles, which require us to make estimates and assumptions that affect the amounts reported in the financial statements. Estimates are used in accounting for, among other items, finance receivables, long-term contracts, inventory valuation, residual values of leased assets, allowance for credit losses on receivables, the amount and timing of future cash flows expected to be received on impaired loans, product liability, workers’ compensation, actuarial assumptions for the pension and postretirement plans, future cash flows associated with goodwill and long-lived asset valuations, and environmental and warranty reserves. Our estimates are based on the facts and circumstances available at the time estimates are made, historical experience, risk of loss, general economic conditions and trends, and our assessments of the probable future outcomes of these matters. Actual results could differ from those estimates. Our estimates and assumptions are reviewed periodically, and the effects of changes, if any, are reflected in the Consolidated Statements of Operations in the period that they are determined.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and short-term, highly liquid investments with original maturities of three months or less.
Revenue Recognition
We generally recognize revenue for the sale of products, which are not under long-term contracts, upon delivery. For commercial aircraft, delivery is upon completion of manufacturing, customer acceptance, and the transfer of the risk and rewards of ownership. Taxes collected from customers and remitted to government authorities are recorded on a net basis within cost of sales.
When a sale arrangement involves multiple elements, such as sales of products that include customization and other services, we evaluate the arrangement to determine whether there are separate items that are required to be delivered under the arrangement that qualify as separate units of accounting. The total fee from the arrangement is then allocated to each unit of accounting based on its relative fair value, taking into consideration any performance, cancellation, termination or refund-type provisions. Fair value generally is established for each unit of accounting using the sales price charged when the same or similar items are sold separately. We recognize revenue when the recognition criteria for each unit of accounting are met.
Long-Term Contracts — Revenues under long-term contracts are accounted for under the percentage-of-completion method of accounting. Under this method, we estimate profit as the difference between the total estimated revenues and cost of a contract. We then recognize that estimated profit over the contract term based on either the costs incurred (under the cost-to-cost method, which typically is used for development effort) or the units delivered (under the units-of-delivery method, which is used for production effort), as appropriate under the circumstances. Revenues under all cost-reimbursement contracts are recorded using the cost-to-cost method. Revenues under fixed-price contracts generally are recorded using the units-of-delivery method; however, when the contracts provide for periodic delivery after a lengthy period of time over which significant costs are incurred or require a significant amount of development effort in relation to total contract volume, revenues are recorded using the cost-to-cost method.
Our long-term contract profits are based on estimates of total contract cost and revenue utilizing current contract specifications, expected engineering requirements and the achievement of contract milestones, including product deliveries. Certain contracts are awarded with fixed-price incentive fees that also are considered when estimating revenues and profit rates. Contract costs typically are incurred over a period of several years, and the estimation of these costs requires substantial judgment. We review and revise these estimates periodically throughout the contract term. Revisions to contract profits are recorded when the revisions to estimated revenues or costs are made. Anticipated losses on contracts are recognized in full in the period in which the losses become probable and estimable.
Our Bell segment has a joint venture with The Boeing Company to provide engineering, development and test services related to the V-22 aircraft, as well as to produce the V-22 aircraft, under a number of separate contracts with the U.S. Government (the “V-22 Contracts”). This joint venture agreement creates contractual, rather than ownership, rights related to the V 22. Accordingly, we do not account for this joint venture under the equity method of accounting. We account for all of our rights and obligations under the specific requirements of the V-22 Contracts allocated to us under the joint venture agreement. Revenues and cost of sales reflect our performance under the V-22 Contracts with revenues recognized using the units-of-delivery method. We include all assets used in performance of the V-22 Contracts that we own, including inventory and unpaid receivables, and all liabilities arising from our obligations under the V-22 Contracts in our Consolidated Balance Sheets.
Finance Revenues — Finance revenues include interest on finance receivables, direct loan origination costs and fees received, and capital and leveraged lease earnings, as well as portfolio gains/losses. We recognize interest using the interest method to provide a constant rate of return over the terms of the receivables. We generally suspend the accrual of interest income for accounts that are contractually delinquent by more than three months. In addition, detailed reviews of loans may result in earlier suspension. We resume the accrual of interest when the loan becomes contractually current and recognize the suspended interest income at that time. Cash payments on nonaccrual accounts, including finance charges, generally are applied to reduce loan principal.
Revenues on direct loan origination costs and fees received are deferred and amortized to finance revenues over the contractual lives of the respective receivables and credit lines using the interest method. When receivables are sold or prepaid, unamortized amounts are recognized in finance revenues. Portfolio gains/losses include gains/losses on the sale or early termination of finance assets and impairment charges related to repossessed assets and properties and operating assets received in satisfaction of troubled finance receivables.
Leases — Certain qualifying noncancelable aircraft and other product lease contracts are accounted for as sales-type leases. Upon delivery, we record the present value of all payments (net of executory costs and any guaranteed residual values) under these leases as revenues, and the related costs of the product are charged to cost of sales. For lease financing transactions that do not qualify as sales-type leases, we record revenues as earned over the lease period.
Finance Receivables Held for Sale
Finance receivables are classified as held for sale based on a determination that there no longer is the intent to hold the finance receivables for the foreseeable future, until maturity or payoff, or there no longer is the ability to hold the finance receivables until maturity. Our decision to classify certain finance receivables as held for sale is based on a number of factors, including, but not limited to, contractual duration, type of collateral, credit strength of the borrowers, the existence of continued contractual commitments and the perceived marketability of the finance receivables. On an ongoing basis, these factors, combined with our overall liquidation strategy, determine which finance receivables we have the positive intent to hold for the foreseeable future and which finance receivables we will hold for sale. Our current strategy is based on an evaluation of both our performance and liquidity position and changes in external factors affecting the value and/or marketability of our finance receivables. A change in this strategy could result in a change in the classification of our finance receivables. As a result of the significant influence of economic and liquidity conditions on our business plans and strategies, and the rapid changes in these and other factors we utilize to determine which assets are classified as held for sale, we currently believe the term “foreseeable future” represents a time period of six to nine months. We also believe that unanticipated changes in both internal and external factors affecting our financial performance, liquidity position or the value and/or marketability of our finance receivables could result in a modification of this assessment.
Finance receivables held for sale are carried at the lower of cost or fair value. At the time of transfer to held for sale classification, we establish a valuation allowance for any shortfall between the carrying value, net of all deferred fees and costs, and fair value. In addition, any allowance for loan losses previously allocated to these finance receivables is reclassified to the valuation allowance account, which is netted with finance receivables held for sale on the balance sheet. This valuation allowance is adjusted quarterly through earnings for any changes in the fair value of the finance receivables below the carrying value. Fair value changes can occur based on market interest rates, market liquidity and changes in the credit quality of the borrower and value of underlying loan collateral. If we determine that finance receivables classified as held for sale will not be sold and we have the intent and ability to hold the finance receivables for the foreseeable future, until maturity or payoff, the finance receivables are reclassified to held for investment at the lower of cost or fair value at that time.
Finance Receivables Held for Investment
Finance receivables are classified as held for investment when we have the intent and the ability to hold the receivable for the foreseeable future or until maturity or payoff. Finance receivables held for investment are generally recorded at the amount of outstanding principal less allowance for loan losses.
Provisions for losses on finance receivables held for investment are charged to income in amounts sufficient to maintain the allowance at a level considered adequate to cover losses in the portfolio. We evaluate the allowance by examining current delinquencies, characteristics of the existing accounts, historical loss experience, underlying collateral value, and general economic conditions and trends. In addition, for larger balance commercial loans, we consider borrower specific information, industry trends and estimated discounted cash flows. Finance receivables held for investment generally are written down to the fair value (less estimated costs to sell) of the related collateral at the earlier of the date when the collateral is repossessed or when no payment has been received for six months. Finance receivables are charged off when they are deemed to be uncollectible.
Inventories
Inventories are stated at the lower of cost or estimated net realizable value. We value our inventories generally using the first-in, first-out (FIFO) method or the last-in, first-out (LIFO) method for certain qualifying inventories where LIFO provides a better matching of costs and revenues. We determine costs for our commercial helicopters on an average cost basis by model considering the expended and estimated costs for the current production release.
Costs on long-term contracts represent costs incurred for production, allocable operating overhead, advances to suppliers, and, in the case of contracts with the U.S. Government, allocable research and development and general and administrative expenses. Since our inventoried costs include amounts related to contracts with long production cycles, a portion of these costs is not expected to be realized within one year. Pursuant to contract provisions, agencies of the U.S. Government have title to, or security interest in, inventories related to such contracts as a result of advances, performance-based payments and progress payments. Such advances and payments are reflected as an offset against the related inventory balances.
Customer deposits are recorded against inventory when the right of offset exists. All other customer deposits are recorded in accrued liabilities.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost and are depreciated primarily using the straight-line method. Land improvements and buildings are depreciated primarily over estimated lives ranging from four to 40 years, while machinery and equipment are depreciated primarily over one to 15 years. We capitalize expenditures for improvements that increase asset values and extend useful lives.
Intangible and Other Long-Lived Assets
At acquisition, we estimate and record the fair value of purchased intangible assets primarily using a discounted cash flow analysis of anticipated cash flows reflecting incremental revenues and/or cost savings resulting from the acquired intangible asset using market participant assumptions. Amortization of intangible assets with finite lives is recognized over their estimated useful lives using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise realized. Approximately 35% of our gross intangible assets are amortized using the straight-line method, with the remaining assets, primarily customer agreements, amortized based on the cash flow streams used to value the asset.
Long-lived assets, including intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the carrying value of the asset held for use exceeds the sum of the undiscounted expected future cash flows, the carrying value of the asset is generally written down to fair value. Long-lived assets held for sale are stated at the lower of cost or fair value less cost to sell. Fair value is determined using pertinent market information, including estimated future discounted cash flows.
Goodwill
We evaluate the recoverability of goodwill annually in the fourth quarter or more frequently if events or changes in circumstances, such as declines in sales, earnings or cash flows, or material adverse changes in the business climate, indicate that the carrying value of a reporting unit might be impaired. The reporting unit represents the operating segment unless discrete financial information is prepared and reviewed by segment management for businesses one level below that operating segment (a “component”), in which case such component is the reporting unit. In certain instances, we have aggregated components of an operating segment into a single reporting unit based on similar economic characteristics. Goodwill is considered to be potentially impaired when the carrying value of a reporting unit exceeds its estimated fair value. Fair values are established primarily using discounted cash flows that incorporate assumptions for the unit’s short- and long-term revenue growth rates, operating margins and discount rates, which represent our best estimates of current and forecasted market conditions, current cost structure, anticipated net cost reductions, and the implied rate of return that we believe a market participant would require for an investment in a company having similar risks and business characteristics to the reporting unit being assessed. When available, comparative market multiples are used to corroborate discounted cash flow results.
Pension and Postretirement Benefit Obligations
We maintain various pension and postretirement plans for our employees globally. These plans include significant pension and postretirement benefit obligations, which are calculated based on actuarial valuations. Key assumptions used in determining these obligations and related expenses include expected long-term rates of return on plan assets, discount rates and healthcare cost projections. We evaluate and update these assumptions annually in consultation with third-party actuaries and investment advisors. We also make assumptions regarding employee demographic factors such as retirement patterns, mortality, turnover and the rate of compensation increases.
We recognize the overfunded or underfunded status of our pension and postretirement plans in the Consolidated Balance Sheets and recognize changes in the funded status of our defined benefit plans in comprehensive income in the year in which they occur. Actuarial gains and losses that are not immediately recognized as net periodic pension cost are recognized as a component of other comprehensive (loss) income (OCI) and amortized into net periodic pension cost in future periods.
Derivative Financial Instruments
We are exposed to market risk primarily from changes in interest rates and currency exchange rates. We do not hold or issue derivative financial instruments for trading or speculative purposes. To manage the volatility relating to our exposures, we net these exposures on a consolidated basis to take advantage of natural offsets. For the residual portion, we enter into various derivative transactions pursuant to our policies in areas such as counterparty exposure and hedging practices. All derivative instruments are reported at fair value in the Consolidated Balance Sheets. Designation to support hedge accounting is performed on a specific exposure basis. For financial instruments qualifying as fair value hedges, we record changes in fair value in earnings, offset, in part or in whole, by corresponding changes in the fair value of the underlying exposures being hedged. For cash flow hedges, we record changes in the fair value of derivatives (to the extent they are effective as hedges) in OCI, net of deferred taxes. Changes in fair value of derivatives not qualifying as hedges are recorded in earnings.
Foreign currency denominated assets and liabilities are translated into U.S. dollars. Adjustments from currency rate changes are recorded in the cumulative translation adjustment account in shareholders’ equity until the related foreign entity is sold or substantially liquidated. We use foreign currency financing transactions, including currency swaps, to effectively hedge long-term investments in foreign operations with the same corresponding currency. Foreign currency gains and losses on the hedge of the long-term investments are recorded in the cumulative translation adjustment account with the offset recorded as an adjustment to the non-U.S. dollar financing liability.
Product and Environmental Liabilities
We accrue product liability claims and related defense costs on the occurrence method when a loss is probable and reasonably estimable. Our estimates are generally based on the specifics of each claim or incident and our best estimate of the probable loss using historical experience and considering the insurance coverage and deductibles in effect at the date of the incident.
Liabilities for environmental matters are recorded on a site-by-site basis when it is probable that an obligation has been incurred and the cost can be reasonably estimated. We estimate our accrued environmental liabilities using currently available facts, existing technology, and presently enacted laws and regulations, all of which are subject to a number of factors and uncertainties. Our environmental liabilities are undiscounted and do not take into consideration possible future insurance proceeds or significant amounts from claims against other third parties.
Research and Development Costs
Research and development costs that are either not specifically covered by contracts or represent our share under cost-sharing arrangements are charged to expense as incurred. Research and development costs incurred under contracts with others are reported as cost of sales over the period that revenue is recognized.
Income Taxes
Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying tax rates expected to be enacted for the year in which we expect the differences will reverse or settle. Based on the evaluation of available evidence, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that we believe it is more likely than not that we will realize these benefits. We periodically assess the likelihood that we will be able to recover our deferred tax assets and reflect any changes in our estimates in the valuation allowance, with a corresponding adjustment to earnings or OCI, as appropriate. In assessing the need for a valuation allowance, we look to the future reversal of existing taxable temporary differences, taxable income in carryback years, the feasibility of tax planning strategies and estimated future taxable income. We recognize net tax-related interest and penalties for continuing operations in income tax expense.
Discontinued Operations
Discontinued Operations
Note 2. Discontinued Operations
On April 3, 2009, we sold HR Textron, an operating unit previously reported within the Textron Systems segment, for $376 million in cash proceeds. The sale resulted in an after-tax gain of $8 million after final settlement and net after-tax proceeds of approximately $280 million.
In November 2008, we completed the sale of the Fluid & Power business unit and recorded an after-tax gain of $111 million. We received approximately $527 million in cash proceeds from the sale, along with a six-year note with a face value of $28 million. In connection with the final settlement of the transaction in the third quarter of 2009, we also received a five-year note with a face value of $30 million, which had no significant impact on the net gain from disposition. These notes are recorded in the Consolidated Balance Sheet net of a valuation allowance.
The HR Textron and Fluid & Power businesses met the discontinued operations criteria and have been included in discontinued operations for all periods presented in our Consolidated Financial Statements. At January 2, 2010, the assets and liabilities of our discontinued businesses primarily relate to income taxes. At January 3, 2009, the assets of our discontinued businesses included $167 million of goodwill, $66 million in inventory, $30 million in accounts receivables, $27 million in property, plant and equipment and $44 million in other assets. Liabilities of our discontinued operations at January 3, 2009 included accounts payable and accrued expenses and other liabilities, primarily related to income taxes. Upon the sale of Fluid & Power, we retained sponsorship of a defined benefit pension plan for former employees and retirees of the U.K.-based businesses. No additional benefits can be earned under this plan.
Revenue, results of operations and gains on disposal for our discontinued businesses are as follows:
                         
(In millions)   2009     2008     2007  
Revenue
  $ 48     $ 796     $ 830  
 
                 
Income (loss) from discontinued operations before income taxes
    (2 )     63       69  
Income tax expense (benefit)
    (38 )     12       20  
 
                 
Operating income from discontinued operations, net of income taxes
    36       51       49  
Net gain on disposals, net of income taxes
    6       111       2  
 
                 
Income from discontinued operations, net of income taxes
  $ 42     $ 162     $ 51  
 
                 
We generally use a centralized approach to the cash management and financing of our manufacturing operations and, accordingly, do not allocate debt or interest expense to our discontinued businesses. Any debt and related interest expense of a specific entity within a business is recorded by the respective entity. General corporate overhead previously allocated to the businesses for reporting purposes is excluded from amounts reported as discontinued operations.
Business Acquisitions, Goodwill and Intangible Assets
Business Acquisitions, Goodwill and Intangible Assets
Note 3. Business Acquisitions, Goodwill and Intangible Assets
Goodwill
The changes in the carrying amount of goodwill, by segment, are as follows:
                                                 
                    Textron                    
(In millions)   Cessna     Bell     Systems     Industrial     Finance     Total  
Balance at December 30, 2006
  $ 322     $ 17     $ 311     $ 368     $ 169     $ 1,187  
Acquisitions
          1       857       11             869  
Foreign currency translation
                      13             13  
Other
                (17 )                 (17 )
 
                                   
Balance at December 29, 2007
    322       18       1,151       392       169       2,052  
Acquisitions and purchase price adjustments
          (5 )     (44 )                 (49 )
Adjustment related to business sold
                (134 )                 (134 )
Transfers
          17       (17 )                  
Impairment
                            (169 )     (169 )
Foreign currency translation
                      (2 )           (2 )
 
                                   
Balance at January 3, 2009
    322       30       956       390             1,698  
Impairment
                      (80 )           (80 )
Foreign currency translation
                      2             2  
Other
                2                   2  
 
                                   
Balance at January 2, 2010
  $ 322     $ 30     $ 958     $ 312     $     $ 1,622  
 
                                   
We recorded an impairment charge of $80 million in 2009 based on lower forecasted revenues and profits related to the effects of the economic recession on the Golf & Turfcare reporting unit. In 2008, based on current market conditions and the plan to downsize the Finance segment, we recorded an impairment charge of $169 million to eliminate all goodwill at the Finance segment. See Notes 10 and 12 for more information on these charges.
Acquired Intangible Assets
Our acquired intangible assets are summarized below:
                                                         
            January 2, 2010     January 3, 2009  
    Weighted-                                          
    Average                                          
    Amortization     Gross                     Gross              
    Period     Carrying     Accumulated             Carrying     Accumulated        
(Dollars in millions)   (In years)     Amount     Amortization     Net     Amount     Amortization     Net  
Customer agreements and contractual relationships
    13     $ 407     $ (77 )   $ 330     $ 407     $ (43 )   $ 364  
Patents and technology
    10       101       (43 )     58       112       (35 )     77  
Trademarks
    19       34       (14 )     20       37       (12 )     25  
Other
    8       19       (15 )     4       18       (13 )     5  
 
                                           
 
          $ 561     $ (149 )   $ 412     $ 574     $ (103 )   $ 471  
 
                                           
Amortization expense totaled $52 million in 2009, $53 million in 2008 and $23 million in 2007. Amortization expense is estimated to be approximately $50 million, $49 million, $48 million, $46 million and $43 million in 2010, 2011, 2012, 2013 and 2014, respectively.
Acquisitions
On November 14, 2007, we acquired a majority ownership interest in United Industrial Corporation (UIC), a publicly held company, pursuant to a cash tender offer of $81 per share. UIC operates through its wholly owned subsidiary, AAI Corporation (AAI). AAI is a leading provider of intelligent aerospace and defense systems, including unmanned aircraft and ground control stations, aircraft and satellite test equipment, training systems and countersniper devices, and has been integrated into our Textron Systems segment. In December 2007, we completed the acquisition and obtained 100% ownership of UIC for a total cost of $1.0 billion. The results of operations for this business are included in our Consolidated Statements of Operations since the acquisition date. Pro forma information has not been included as the amounts are immaterial.
The intangible assets we acquired with UIC represent primarily customer agreements and contractual relationships with a weighted-average useful life of 13 years. We have allocated the purchase price of this business to the estimated fair value of the net tangible and intangible assets acquired, with any excess recorded as goodwill. Approximately $64 million of the goodwill is deductible for tax purposes. In 2008, the goodwill and intangible amounts were adjusted to reflect the final fair value adjustments, which resulted in a reduction of goodwill of $49 million, net of deferred taxes, and an increase in intangible assets of $14 million.
Accounts Receivable
Accounts Receivable
Note 4. Accounts Receivable
Accounts receivable is comprised of the following:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Commercial
  $ 470     $ 496  
U.S. Government contracts
    447       422  
 
           
 
    917       918  
Allowance for doubtful accounts
    (23 )     (24 )
 
           
 
  $ 894     $ 894  
 
           
We have unbillable receivables on U.S. Government contracts that arise when the revenues we have appropriately recognized based on performance cannot be billed yet under terms of the contract. Unbillable receivables within accounts receivable totaled $170 million at January 2, 2010 and $157 million at January 3, 2009. Long-term contract receivables due from the U.S. Government exclude significant amounts billed but unpaid due to contractual retainage provisions.
Finance Receivables and Securitizations
Finance Receivables and Securitizations
Note 5. Finance Receivables and Securitizations
Our Finance group manages and services finance receivables for a variety of investors, participants and third-party portfolio owners. We do not have a retained financial interest or credit risk in the performance of the serviced portfolio, and, therefore, performance of these portfolios is limited to billing and collection activities. A reconciliation of our managed and serviced finance receivables to finance receivables held for investment, net is provided below:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Total managed and serviced finance receivables
  $ 8,283     $ 12,173  
Less: Nonrecourse participations sold to independent investors
    765       820  
Less: Third-party portfolio servicing
    463       532  
 
           
Total managed finance receivables
    7,055       10,821  
Less: Securitized receivables
    30       2,248  
 
           
Owned finance receivables
    7,025       8,573  
Less: Finance receivables held for sale
    819       1,658  
 
           
Finance receivables held for investment
    6,206       6,915  
Allowance for loan losses
    (341 )     (191 )
 
           
Finance receivables held for investment, net
  $ 5,865     $ 6,724  
 
           
Finance receivables held for investment at January 2, 2010 and January 3, 2009 include approximately $629 million and $1.1 billion of receivables that have been legally sold to special purpose entities (SPE), which are consolidated subsidiaries of TFC. The assets of the SPEs are pledged as collateral for their debt, which is reflected as securitized on-balance sheet debt in Note 8. Third-party investors have no legal recourse to TFC beyond the credit enhancement provided by the assets of the SPEs.
Our finance receivables are diversified across geographic region, borrower industry and type of collateral. At January 2, 2010, 70% of our managed finance receivables were distributed throughout the U.S., compared with 77% at the end of 2008. The most significant collateral concentration was in general aviation, which accounted for 35% of managed receivables at the end of 2009 and 26% at the end of 2008. Industry concentrations in the resort and golf industries accounted for 19% and 18%, respectively, of managed receivables at January 2, 2010, compared with 13% and 16%, respectively, at the end of 2008.
Finance receivables include installment contracts, revolving loans, golf course and resort mortgages, distribution finance receivables, and finance and leveraged leases. Installment contracts and finance leases have initial terms ranging from two to 20 years and are secured by the financed equipment, and, in many instances, by the personal guarantee of the principals or recourse arrangements with the originating vendor. Installment contracts generally require the customer to pay a significant down payment, along with periodic scheduled principal payments that reduce the outstanding balance through the term of the loan. Finance leases include residual values expected to be realized at contractual maturity. Leases with no significant residual value at the end of the contractual term are classified as installment contracts, as their legal and economic substance is more equivalent to a secured borrowing than a finance lease with a significant residual value. In the contractual maturities table in the “Finance Receivables Held for Investment” section below, contractual maturities for finance leases classified as installment contracts represent the minimum lease payments, net of the unearned income to be recognized over the life of the lease. Total minimum lease payments and unearned income related to these contracts were $1.0 billion and $194 million, respectively, at January 2, 2010 and $1.2 billion and $299 million, respectively, at January 3, 2009. Minimum lease payments due under these contracts for each of the next five years are as follows: $199 million in 2010, $182 million in 2011, $147 million in 2012, $121 million in 2013 and $82 million in 2014. Minimum lease payments due under finance leases for each of the next five years are as follows: $88 million in 2010, $66 million in 2011, $41 million in 2012, $17 million in 2013 and $9 million in 2014.
Revolving loans and distribution finance receivables generally mature within one to five years, and, at times, convert to term loans that contractually amortize over an additional one to five years. Revolving loans are secured by trade receivables, inventory, plant and equipment, pools of timeshare interval resort notes receivables, finance receivable portfolios, pools of residential and recreational land loans and the underlying property, and, in many instances, by the personal guarantee of the principals. Distribution finance receivables generally are secured by the inventory of the financed distributor and include floorplan financing for third-party dealers for inventory sold by the E-Z-GO and Jacobsen businesses.
Golf course, timeshare and hotel mortgages are secured by real property and generally are limited to 75% or less of the property’s appraised market value at loan origination. Golf course mortgages have initial terms ranging from five to 10 years with amortization periods from 15 to 25 years. Golf course mortgages consist of loans with an average balance of $6 million and a weighted-average remaining contractual maturity of three years. Timeshare and hotel mortgages generally represent construction and inventory, or operating property loans with an average balance of $9 million and a weighted-average remaining contractual maturity of three years.
Leveraged leases are secured by the ownership of the leased equipment and real property and have initial terms up to approximately 30 years. Leveraged leases reflect contractual maturities net of contractual nonrecourse debt payments and include residual values expected to be realized at contractual maturity.
Finance Receivables Held for Investment
The contractual maturities of finance receivables held for investment at January 2, 2010 were as follows:
                                                                 
                                                    Finance Receivables  
    Contractual Maturities     Held for Investment  
(In millions)   2010     2011     2012     2013     2014     Thereafter     2009     2008  
Installment contracts
  $ 383     $ 333     $ 363     $ 358     $ 261     $ 811     $ 2,509     $ 2,787  
Revolving loans
    288       430       242       131       49       43       1,183       1,208  
Golf course, timeshare and hotel mortgages
    209       298       176       178       63       162       1,086       1,206  
Distribution finance receivables
    650       125       12       4       2             793       647  
Finance leases
    102       77       79       28       5       112       403       608  
Leveraged leases
    (2 )     3       (6 )     (9 )     1       326       313       459  
 
                                               
 
  $ 1,630     $ 1,266     $ 866     $ 690     $ 381     $ 1,454       6,287       6,915  
 
                                                   
Allowance for credit losses and valuation allowance
                                                    (422 )     (191 )
 
                                                           
 
                                                  $ 5,865     $ 6,724  
 
                                                           
Finance receivables often are repaid or refinanced prior to maturity, and, in some instances, payment may be delayed or extended beyond the scheduled maturity. Accordingly, the above tabulations should not be regarded as a forecast of future cash collections. Finance receivable receipts related to distribution finance receivables and revolving loans are based on historical cash flow experience. Finance receivables held for investment include certain amounts previously classified as held for sale that have an $81 million valuation allowance.
The net investments in finance leases, excluding leases classified as installment contracts, and leveraged leases are provided below:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Finance leases:
               
Total minimum lease payments receivable
  $ 395     $ 557  
Estimated residual values of leased equipment
    183       259  
 
           
 
    578       816  
Less unearned income
    (175 )     (208 )
 
           
Net investment in finance leases
  $ 403     $ 608  
 
           
Leveraged leases:
               
Rental receivable, net of nonrecourse debt
  $ 378     $ 493  
Estimated residual values of leased assets
    152       229  
 
           
 
    530       722  
Less unearned income
    (217 )     (263 )
 
           
Investment in leveraged leases
    313       459  
Deferred income taxes
    (238 )     (350 )
 
           
Net investment in leveraged leases
  $ 75     $ 109  
 
           
Nonaccrual and Impaired Finance Receivables
We periodically evaluate finance receivables held for investment, excluding homogeneous loan portfolios and finance leases, for impairment. Finance receivables classified as held for sale are reflected at fair value and are excluded from this assessment. A finance receivable is considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired finance receivables are classified as either nonaccrual or accrual loans. Nonaccrual finance receivables include accounts that are contractually delinquent by more than three months for which the accrual of interest income is suspended. Impaired accrual finance receivables represent loans with original terms that have been significantly modified to reflect deferred principal payments, generally at market interest rates, for which collection of principal and interest is not doubtful.
The impaired finance receivables are as follows:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Impaired nonaccrual finance receivables
  $ 984     $ 234  
Impaired accrual finance receivables
    217       19  
 
           
Total impaired finance receivables
  $ 1,201     $ 253  
Less: Impaired finance receivables without identified reserve requirements
    362       71  
 
           
Impaired nonaccrual finance receivables with identified reserve requirements
  $ 839     $ 182  
 
           
Our nonaccrual finance receivables include impaired finance receivables, as well as accounts in homogeneous loan portfolios that are not considered to be impaired but are contractually delinquent by more than three months. A summary of these finance receivables and the related allowance for losses by collateral type is as follows:
                                                 
    January 2, 2010     January 3, 2009  
                    Allowance                     Allowance  
                    for Losses                     for Losses  
            Impaired     on Impaired             Impaired     on Impaired  
    Nonaccrual     Nonaccrual     Nonaccrual     Nonaccrual     Nonaccrual     Nonaccrual  
    Finance     Finance     Finance     Finance     Finance     Finance  
Collateral Type (In millions)   Receivables     Receivables     Receivables     Receivables     Receivables     Receivables  
Timeshare notes receivable*
  $ 259     $ 254     $ 53     $ 78     $ 74     $ 9  
General aviation aircraft
    286       272       46       17       6       2  
Golf course property
    166       165       27       107       107       25  
Resort construction/inventory
    104       104                          
Dealer inventory
    88       68       14       43       34       3  
Hotels
    78       78       7                    
Other
    59       43       6       32       13       4  
 
                                   
Total
  $ 1,040     $ 984     $ 153     $ 277     $ 234     $ 43  
 
                                   
 
*   Finance receivables collateralized primarily by timeshare notes receivable also may be collateralized by certain real estate and other assets of our borrowers.
The increase in nonaccrual finance receivables primarily is attributable to the lack of liquidity available to borrowers in the timeshare portfolio, weaker general economic conditions and depressed aircraft values. The increase in timeshare notes receivable includes one $203 million account, of which $120 million is collateralized by notes receivable and $83 million is collateralized by several resort properties, which are included in the resort construction/inventory line above.
The average recorded investment in impaired nonaccrual finance receivables was $603 million in 2009, $143 million in 2008 and $53 million in 2007. The average recorded investment in impaired accrual finance receivables amounted to $136 million in 2009, $34 million in 2008 and $31 million in 2007. Nonaccrual finance receivables resulted in the Finance segment’s revenues being reduced by $53 million, $16 million and $7 million for 2009, 2008 and 2007, respectively.
Captive and Other Intercompany Financing
Our Finance group provides financing for retail purchases and leases for new and used aircraft and equipment manufactured by our Manufacturing group. The captive finance receivables for these inventory sales that are included in the Finance group’s balance sheets are summarized below:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Installment contracts
  $ 1,462     $ 1,468  
Finance leases
    388       544  
Distribution finance
    72       33  
 
           
Total
  $ 1,922     $ 2,045  
 
           
Operating agreements specify that our Finance group has recourse to our Manufacturing group for certain uncollected amounts related to these transactions. Our Manufacturing group has established reserves for losses on its balance sheet within accrued and other liabilities for the receivables it guarantees. These reserves are established for amounts that potentially are uncollectible or if the collateral values are considered insufficient to cover the outstanding receivable. If an account is deemed uncollectible and the collateral is repossessed by our Finance group, our Manufacturing group is charged for the deficiency. If the collateral is not repossessed, the receivable is transferred from the Finance group’s balance sheet to the Manufacturing group’s balance sheet. The Manufacturing group then is responsible for any additional collection efforts. When this occurs, any related reserve previously established by the Manufacturing group is reclassified from accrued or other liabilities and netted against the receivable or asset transferred from the Finance group.
In 2009, 2008 and 2007, our Finance group paid our Manufacturing group $0.6 billion, $1.0 billion and $1.2 billion, respectively, related to the sale of Textron-manufactured products to third parties that were financed by the Finance group. Our Cessna and Industrial segments also received proceeds in those years of $13 million, $18 million and $27 million, respectively, from the sale of equipment from their manufacturing operations to our Finance group for use under operating lease agreements. At January 2, 2010 and January 3, 2009, the amounts guaranteed by the Manufacturing group totaled $216 million and $206 million, respectively, on which the Manufacturing group had reserves for losses of $17 million and $21 million, respectively.
During the fourth quarter of 2008, the Manufacturing group utilized its commercial paper borrowings to lend cash to the Finance group, and in 2009, the Manufacturing group agreed to lend the Finance group, with interest, funds to pay down maturing debt. The interest rate on these borrowings at January 2, 2010 and January 3, 2009 was 7.00% and 4.03%, respectively. As of January 2, 2010 and January 3, 2009, the outstanding balance due to the Manufacturing group was $447 million and $133 million, respectively. These amounts are included in other current assets for the Manufacturing group and other liabilities for the Finance group in the Consolidated Balance Sheets.
Finance Receivables Held for Sale
As a result of the plan to reduce finance receivables, $1.7 billion of the owned finance receivables were classified as held for sale in December 2008. During 2009, we reclassified $878 million of finance receivables, net of a $188 million valuation allowance, from held for sale to held for investment following efforts to market the portfolios and progress made through orderly liquidation. We also reclassified $421 million of other finance receivable portfolios, net of a $43 million valuation allowance, from held for investment to held for sale as a result of unanticipated purchase inquiries. Due to the nature of these inquiries, we determined a sale of these portfolios would be consistent with our goal to maximize the economic value of our portfolio and accelerate cash collections. During the fourth quarter of 2009, we recorded certain finance receivables previously sold to the Distribution Finance securitization in our balance sheet as discussed in the “Securitizations” section below. In connection with these finance receivables, $359 million were classified as held for sale and were sold during the quarter.
As of January 2, 2010, $819 million of owned finance receivables were classified as held for sale. Finance receivable sales accounted for a significant portion of the reduction in finance receivables held for sale, primarily related to the distribution finance and asset-based lending portfolios. We received proceeds approximating our carrying value for each of these transactions. The remaining finance receivables held for sale primarily are comprised of assets in the distribution finance, golf mortgage and asset-based lending portfolios and include $84 million of finance receivables in the golf equipment portfolio. Subsequent to year-end, in January 2010, we completed another sale of distribution finance receivables that further reduced these finance receivables by approximately $200 million and generated proceeds in excess of our carrying value.
Securitizations
During 2009, we had one significant off-balance sheet financing arrangement. The distribution finance revolving securitization trust was a master trust that purchased inventory finance receivables from the Finance group and issued asset-backed notes to investors. Approximately $1.4 billion of the outstanding notes issued by the distribution finance securitization trust were repaid through finance receivable collections. During the fourth quarter of 2009, a reduction in the pace of finance receivable collections triggered a corresponding change in required cash distributions, which provided us the ability to repurchase the finance receivables resulting in the consolidation of the securitization trust on our balance sheet. As a result, the finance receivables held by the securitization trust were recorded at their fair value of $720 million, $635 million of debt issued by the securitization trust was recorded on our balance sheet and $85 million of retained interests were removed from the balance sheet. TFC then made a capital contribution to the trust sufficient to repay its $635 million of outstanding debt; following the repayment, the remaining receivables were legally conveyed to TFC and the trust was dissolved.
Inventories
Inventories
Note 6. Inventories
Inventories are comprised of the following:
                 
(In millions)   January 2,
2010
    January 3,
2009
 
Finished goods
  $ 735     $ 1,081  
Work in process
    1,861       1,866  
Raw materials and components
    613       765  
 
           
 
    3,209       3,712  
Progress/milestone payments
    (936 )     (619 )
 
           
 
  $ 2,273     $ 3,093  
 
           
Inventories valued by the LIFO method totaled $1.3 billion and $2.0 billion at January 2, 2010 and January 3, 2009, respectively. Had our LIFO inventories been valued at current costs, their carrying values would have been approximately $414 million and $363 million higher at those respective dates. Inventories related to long-term contracts, net of progress/milestone payments, were $366 million at January 2, 2010 and $741 million at January 3, 2009.
Property, Plant and Equipment, net
Property, Plant and Equipment, net
Note 7. Property, Plant and Equipment, Net
Our Manufacturing group’s property, plant and equipment, net are comprised of the following:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Land and buildings
  $ 1,426     $ 1,289  
Machinery and equipment
    3,208       3,235  
 
           
 
    4,634       4,524  
Accumulated depreciation and amortization
    (2,666 )     (2,436 )
 
           
 
  $ 1,968     $ 2,088  
 
           
Assets under capital leases totaled $218 million and $194 million and had accumulated amortization of $36 million and $30 million at the end of 2009 and 2008, respectively. Depreciation expense for the Manufacturing group totaled $317 million in 2009, $302 million in 2008 and $256 million in 2007.
We have incurred asset retirement obligations primarily related to costs to remove and dispose of underground storage tanks and asbestos materials used in insulation, adhesive fillers and floor tiles. There is no legal requirement to remove these items, and there currently is no plan to remodel the related facilities or otherwise cause the impacted items to require disposal. Since these asset retirement obligations are not estimable, there is no related liability recorded in the Consolidated Balance Sheets.
Debt and Credit Facilities
Debt and Credit Facilities
Note 8. Debt and Credit Facilities
Our debt and credit facilities are summarized below:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Manufacturing group:
               
Short-term debt:
               
Commercial paper (weighted-average rate of 6.4%)
  $     $ 867  
Current portion of long-term debt
    134       9  
 
           
Total short-term debt
    134       876  
 
           
Long-term senior debt:
               
Medium-term notes due 2010 to 2011 (average rate of 9.85%)
    13       17  
4.50% due 2010
    128       250  
Credit line borrowings due 2012 (weighted-average rate of 0.96%)
    1,167        
6.50% due 2012
    154       300  
3.875% due 2013
    345       429  
4.50% convertible senior notes due 2013
    471        
6.20% due 2015
    350        
5.60% due 2017
    350       350  
7.25% due 2019
    250        
6.625% due 2020
    240       219  
Other (average rate of 3.65% and 3.93%, respectively)
    116       137  
 
           
 
    3,584       1,702  
Current portion of long-term debt
    (134 )     (9 )
 
           
Total long-term debt
    3,450       1,693  
 
           
Total Manufacturing group debt
  $ 3,584     $ 2,569  
 
           
Finance group:
               
Commercial paper (weighted-average rate of 5.64%)
  $     $ 743  
Other short-term debt
          25  
Medium-term fixed-rate and variable-rate notes*:
               
Due 2009 (weighted-average rate of 4.07%)
          1,534  
Due 2010 (weighted-average rate of 2.09% and 3.85%, respectively)
    1,635       2,315  
Due 2011 (weighted-average rate of 2.94% and 4.42%, respectively)
    419       727  
Due 2012 (weighted-average rate of 4.43%)
    52       52  
Due 2013 (weighted-average rate of 4.49% and 4.82%, respectively)
    578       578  
Due 2014 (weighted-average rate of 5.07%)
    111       111  
Due 2015 and thereafter (weighted-average rate of 4.07% and 4.98%, respectively)
    232       41  
Credit line borrowings due 2012 (weighted-average rate of 0.91%)
    1,740        
Securitized on-balance sheet debt (weighted-average rate of 1.45% and 3.09%, respectively)
    559       853  
6% Fixed-to-Floating Rate Junior Subordinated Notes
    300       300  
Fair value adjustments and unamortized discount
    41       109  
 
           
Total Finance group debt
  $ 5,667     $ 7,388  
 
           
 
*   Variable-rate notes totaled $1.4 billion and $2.5 billion at January 2, 2010 and January 3, 2009, respectively.
The Manufacturing group had a weighted-average interest rate on commercial paper borrowings of 4.6% and 4.3% in 2009 and 2008, respectively. The Finance group had a weighted-average interest rate on commercial paper borrowings of 4.37% and 3.63% in 2009 and 2008, respectively.
Both borrowing groups extinguished through open market repurchases an aggregate of $745 million in outstanding debt securities prior to maturity during 2009, resulting in gains of $54 million. Also in 2009, both borrowing groups completed separate cash tender offers for up to a $650 million aggregate principal amount of five separate series of outstanding debt securities with maturity dates ranging from November 2009 to June 2012. In completing these tender offers, we extinguished an aggregate of $587 million of outstanding debt securities with maturity dates ranging from 2009 to 2012 and recognized a loss of $1 million in 2009.
The following table shows required payments during the next five years on debt outstanding at January 2, 2010:
                                         
(In millions)   2010     2011     2012     2013     2014  
Manufacturing group
  $ 134     $ 18     $ 1,326     $ 950     $ 5  
Finance group
    1,738       506       1,895       672       197  
 
                             
 
  $ 1,872     $ 524     $ 3,221     $ 1,622     $ 202  
 
                             
On July 14, 2009, a finance subsidiary of Textron Inc. entered into a credit agreement with the Export-Import Bank of the United States that established a $500 million credit facility to provide funding to finance purchases of aircraft by non-U.S. buyers from Cessna and Bell. The facility is structured to be available for financing sales to international customers who take delivery of new aircraft by December 2010. At January 2, 2010, we had $179 million in outstanding notes under this facility that are due in 2015 and thereafter.
Our aggregate $3 billion in committed bank lines of credit historically have been in support of commercial paper and letters of credit issuances only. In February 2009, due to the unavailability of term debt and difficulty in accessing sufficient commercial paper on a daily basis, we drew the available balance from these credit facilities. Amounts borrowed under the credit facilities are due in April 2012. There were no borrowings outstanding related to these lines of credit at the end of 2008.
4.50% Convertible Senior Notes
On May 5, 2009, we issued $600 million of 4.50% Convertible Senior Notes (Convertible Notes) with a maturity date of May 1, 2013 and interest payable semiannually on May 1 and November 1. The Convertible Notes are convertible at the holder’s option, under certain circumstances, into shares of our common stock at an initial conversion rate of 76.1905 shares of common stock per $1,000 principal amount of Convertible Notes, which is equivalent to an initial conversion price of approximately $13.125 per share. Upon conversion, we have the right to settle the conversion of each $1,000 principal amount of Convertible Notes with any of the three following alternatives: (1) shares of our common stock, (2) cash or (3) a combination of cash and shares of our common stock.
The Convertible Notes are convertible only under the following certain circumstances: (1) during any calendar quarter commencing after June 30, 2009 and only during such calendar quarter if the last reported sale price of our common stock for at least 20 trading days during the 30 consecutive trading days ending on the last trading day of the preceding calendar quarter is more than 130% of the applicable conversion price per share of common stock on the last trading day of such preceding calendar quarter, (2) during the five-business-day period after any 10 consecutive trading day measurement period in which the trading price per $1,000 principal amount of Convertible Notes for each day in the measurement period was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate, (3) if specified distributions to holders of our common stock are made or specified corporate transactions occur or (4) at any time on or after February 19, 2013.
Our common stock price exceeded the conversion threshold price of $17.06 per share for at least 20 trading days during the 30 consecutive trading days ended December 31, 2009. Accordingly, the notes are convertible at the holder’s option through March 31, 2010. We may deliver shares of common stock, cash or a combination of cash and shares of common stock in satisfaction of our obligations upon conversion of the Convertible Notes. We intend to settle the face value of the Convertible Notes in cash. We have continued to classify these Convertible Notes as long-term based on our intent and ability to maintain the debt outstanding for a least one year through the use of various funding sources available to us.
The net proceeds from the issuance of the Convertible Notes totaled approximately $582 million after deducting discounts, commissions and expenses. The Convertible Notes are accounted for in accordance with generally accepted accounting principles, which require us to separately account for the liability (debt) and the equity (conversion option) components of the Convertible Notes in a manner that reflects our non-convertible debt borrowing rate. Accordingly, we recorded a debt discount and corresponding increase to additional paid-in capital of approximately $135 million as of the date of issuance. We are amortizing the debt discount utilizing the effective interest method over the life of the Convertible Notes, which increases the effective interest rate of the Convertible Notes from its coupon rate of 4.50% to 11.72%. Transaction costs of $18 million were proportionately allocated between the liability and equity components.
Concurrently with the pricing of the Convertible Notes, we entered into convertible note hedge transactions with two counterparties, including an underwriter and an affiliate of an underwriter of the Convertible Notes, for purposes of reducing the potential dilutive effect upon the conversion. The initial strike price of the convertible note hedge transactions is $13.125 per share of our common stock (the same as the initial conversion price of the Convertible Notes) and is subject to certain customary adjustments. The convertible note hedge transactions cover 45,714,300 shares of common stock, subject to antidilution adjustments. We may settle the convertible note hedge transactions in shares, cash or a combination of cash and shares, at our option. The cost of the convertible note hedge transactions was $140 million, which was recorded as a reduction to additional paid-in capital. Separately and concurrently with entering into these hedge transactions, we entered into warrant transactions whereby we sold warrants to each of the hedge counterparties to acquire, subject to anti-dilution adjustments, an aggregate of 45,714,300 shares of common stock at an initial exercise price of $15.75 per share. The aggregate proceeds from the warrant transactions were $95 million, which was recorded as an increase to additional paid-in capital.
We incurred cash and non-cash interest expense of $38 million in 2009 for these Convertible Notes. As of January 2, 2010, the unamortized discount amount, including issuance costs totaled $129 million, resulting in a net carrying value of $471 million for the liability component.
Securitized On-Balance Sheet Debt
In 2008, the Finance group amended the terms of its aviation finance securitization, resulting in the consolidation of the special purpose entity. This special purpose entity holds finance receivables previously sold as well as third-party notes under a revolving credit facility. These third-party notes are reflected within securitized on-balance sheet debt.
6% Fixed-to-Floating Rate Junior Subordinated Notes
In 2007, the Finance group issued $300 million of 6% Fixed-to-Floating Rate Junior Subordinated Notes, which are unsecured and rank junior to all of its existing and future senior debt. The notes mature on February 15, 2067; however, we have the right to redeem the notes at par on or after February 15, 2017 and are obligated to redeem the notes beginning on February 15, 2042. The Finance group has agreed in a replacement capital covenant that it will not redeem the notes on or before February 15, 2047 unless it receives a capital contribution from the Manufacturing group and/or net proceeds from the sale of certain replacement capital securities at specified amounts. Interest on the notes is fixed at 6% until February 15, 2017 and floats at the three-month London Interbank Offered Rate + 1.735% thereafter.
Financial Covenants
Under a Support Agreement, Textron Inc. is required to ensure that TFC maintains fixed charge coverage of no less than 125% and consolidated shareholder’s equity of no less than $200 million. In addition, TFC has lending agreements that contain provisions restricting additional debt, which is not to exceed nine times consolidated net worth and qualifying subordinated obligations. Due to certain charges as discussed in Note 12, on December 29, 2008, Textron Inc. made a cash payment of $625 million to TFC, which was reflected as a capital contribution, to maintain compliance with the fixed charge coverage ratio required by the Support Agreement and to maintain the leverage ratio required by its credit facility. Additional cash payments of $270 million in 2009 and $75 million on January 12, 2010 were paid to TFC to maintain compliance with these covenants.
Derivatives
Derivatives
Note 9. Derivatives
Our exposure to loss from nonperformance by the counterparties to our derivative agreements at the end of 2009 is minimal. We do not anticipate nonperformance by counterparties in the periodic settlements of amounts due. We historically have minimized this potential for risk by entering into contracts exclusively with major, financially sound counterparties having no less than a long-term bond rating of A. The credit risk generally is limited to the amount by which the counterparties’ contractual obligations exceed our obligations to the counterparty. We continuously monitor our exposures to ensure that we limit our risks.
Fair Value Hedges
Our Finance group enters into interest rate exchange agreements to mitigate exposure to changes in the fair value of its fixed-rate receivables and debt due to fluctuations in interest rates. By using these agreements, we are able to convert our fixed-rate cash flows to floating-rate cash flows.
Cash Flow Hedges
We manufacture and sell our products in a number of countries throughout the world, and, therefore, we are exposed to movements in foreign currency exchange rates. The primary purpose of our foreign currency hedging activities is to manage the volatility associated with foreign currency purchases of materials, foreign currency sales of products, and other assets and liabilities created in the normal course of business. We primarily utilize forward exchange contracts and purchased options with maturities of no more than 18 months that qualify as cash flow hedges.
These are intended to offset the effect of exchange rate fluctuations on forecasted sales, inventory purchases and overhead expenses. At the end of 2009, we had a net deferred gain of $27 million in OCI related to these cash flow hedges. As the underlying transactions occur, we expect to reclassify a $4 million gain into earnings in the next 12 months and $23 million of gains in the following 12-month period.
Net Investment Hedges
We hedge our net investment position in major currencies and generate foreign currency interest payments that offset other transactional exposures in these currencies. To accomplish this, we borrow directly in foreign currency and designate a portion of foreign currency debt as a hedge of net investments. We also may utilize currency forwards as hedges of our related foreign net investments. Currency effects on the effective portion of these hedges, which are reflected in the cumulative translation adjustment account within OCI, produced a $15 million after-tax loss in 2009, resulting in an accumulated net loss balance of $12 million at the end of 2009. The ineffective portion of these hedges was insignificant.
Stock-Based Compensation Hedges
We historically have managed the expense related to certain stock-based compensation awards using cash settlement forward contracts on our common stock. The use of these forward contracts modifies compensation expense exposure to changes in the stock price with the intent to reduce potential variability. Cash received or paid on the contract settlement is included in cash flows from operating activities, consistent with the classification of the cash flows on the underlying hedged compensation expense. In January 2010, we discontinued hedging our stock-based compensation awards and did not enter into any new forward contracts.
Fair Values of Derivative Instruments
The fair values of derivative instruments for the Manufacturing group are included in either other current assets or accrued liabilities in our balance sheet. For the Finance group, derivative instruments are included in either other assets or other liabilities. The notional and fair value amounts of our derivative instruments are provided below:
                                 
    Notional Amount     Asset (Liability)  
(In millions)   2009     2008     2009     2008  
Derivatives designated as hedging instruments
                               
Assets
                               
Finance group:
                               
Interest rate exchange contracts
  $ 1,333     $ 2,055     $ 43     $ 112  
Cross-currency interest rate exchange contracts
    161       140       18       21  
Manufacturing group:
                               
Foreign currency exchange contracts
    696       30       54       2  
Forward contracts for Textron Inc. stock
    22             7        
 
                       
Total included in other current or other assets
  $ 2,212     $ 2,225     $ 122     $ 135  
 
                       
Liabilities
                               
Finance group:
                               
Interest rate exchange contracts
  $ 32     $ 32     $ (3 )   $ (7 )
Cross-currency interest rate exchange contracts
    4       5       (1 )     (1 )
Manufacturing group:
                               
Foreign currency exchange contracts
    80       839       (5 )     (41 )
Forward contracts for Textron Inc. stock
          130             (98 )
Commodity contracts
          54             (4 )
 
                       
Total included in accrued or other liabilities
  $ 116     $ 1,060     $ (9 )   $ (151 )
 
                       
Derivatives not designated as hedging instruments
                               
Finance group:
                               
Foreign currency exchange contracts
  $ 531     $ 536     $ (13 )   $  
Interest rate exchange contracts
          336             (13 )
Manufacturing group:
                               
Foreign currency exchange contracts
    224       170       3       (43 )
 
                       
Total derivatives not designated as hedging instruments
  $ 755     $ 1,042     $ (10 )   $ (56 )
 
                       
For our fair value hedges, the effect of the derivative instruments is recorded in the Consolidated Statements of Operations, and the gain (loss) for each respective period is provided in the following table:
                     
(In millions)   Gain (Loss) Location   2009     2008  
Finance group
                   
Interest rate exchange contracts
  Interest expense   $ (13 )   $ 120  
Interest rate exchange contracts
  Finance charges     10       (7 )
For our cash flow hedges, the amount of gain (loss) recognized in OCI and the amount reclassified from accumulated other comprehensive loss into income during each period is provided in the following table:
                                         
                    Effective Portion of Derivative  
    Amount of Gain(Loss)     Reclassified from Accumulated  
    Recognized in OCI     Other Comprehensive Loss  
    (Effective Portion)     into Income  
(In millions)   2009     2008     Gain(Loss) Location     2009     2008  
Manufacturing group
                                       
Foreign currency exchange contracts
  $ 65     $ (67 )   Cost of sales   $ 3     $ 8  
Forward contracts for Textron Inc. stock
    6       (21 )   Selling and administrative     6       9  
Finance group
                                       
Interest rate exchange contracts
    (4 )     (5 )   Interest expense     (4 )     (2 )
The amount of ineffectiveness on our fair value hedges is insignificant. During the third quarter of 2009, certain foreign currency exchange contracts no longer were deemed to be effective cash flow hedges resulting in a gain of $11 million. These contracts were unwound through the purchase of forward contracts directly offsetting the terms of the undesignated hedges.
We also enter into certain other foreign currency derivative instruments that do not meet hedge accounting criteria and primarily are intended to protect against exposure related to intercompany financing transactions. For these instruments, the Manufacturing group reported in selling and administrative expenses a gain of $14 million in 2009 and a loss of $49 million in 2008. Our Finance group reported a loss of $107 million and $6 million in selling and administrative expenses in 2009 and 2008, respectively, which were largely offset by gains resulting from the translation of foreign currency denominated assets and liabilities.
Fair Values of Assets and Liabilities
Fair Values of Assets and Liabilities
Note 10. Fair Values of Assets and Liabilities
We measure fair value at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The assumptions that market participants would use in pricing the asset or liability (the “inputs”) are prioritized into a three-tier fair value hierarchy. This fair value hierarchy gives the highest priority (Level 1) to quoted prices in active markets for identical assets or liabilities and the lowest priority (Level 3) to unobservable inputs in which little or no market data exist, requiring companies to develop their own assumptions. Observable inputs that do not meet the criteria of Level 1, and include quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets and liabilities in markets that are not active, are categorized as Level 2. Level 3 inputs are those that reflect our estimates about the assumptions market participants would use in pricing the asset or liability, based on the best information available in the circumstances. Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach and may use unobservable inputs such as projections, estimates and management’s interpretation of current market data. These unobservable inputs are utilized only to the extent that observable inputs are not available or cost-effective to obtain.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The table below presents the assets and liabilities measured at fair value on a recurring basis categorized by the level of inputs used in the valuation of each asset and liability:
                                                 
    January 2, 2010     January 3, 2009  
(In millions)   Level 1     Level 2     Level 3     Level 1     Level 2     Level 3  
Assets
                                               
Manufacturing group
                                               
Foreign currency exchange contracts
  $     $ 57     $     $     $ 2     $  
Forward contracts for Textron Inc. stock
    7                                
Finance group
                                               
Derivative financial instruments
          61                   133        
 
                                   
Total assets
  $ 7     $ 118     $     $     $ 135     $  
 
                                   
Liabilities
                                               
Manufacturing group
                                               
Forward contracts for Textron Inc. stock
  $     $     $     $ 98     $     $  
Foreign currency exchange contracts
          5                   84        
Finance group
                                               
Derivative financial instruments
          17                   21        
 
                                   
Total liabilities
  $     $ 22     $     $ 98     $ 105     $  
 
                                   
Valuation Techniques
Foreign currency exchange contracts are measured at fair value using the market method valuation technique. The inputs to this technique utilize current foreign currency exchange forward market rates published by third-party leading financial news and data providers. This is observable data that represent the rates that the financial institution uses for contracts entered into at that date; however, they are not based on actual transactions so they are classified as Level 2. We record changes in the fair value of these contracts, to the extent they are effective as cash flow hedges, in OCI. If a contract does not qualify for hedge accounting or is designated as a fair value hedge, changes in the fair value of the contract are recorded in earnings.
Cash settlement forward contracts are measured at fair value using the market method valuation technique. Since the input to this technique is based on the quoted price of our common stock at the measurement date, it is classified as Level 1. Gains or losses on these instruments are recorded as an adjustment to compensation expense.
The Finance group’s derivative contracts are not exchange traded. Derivative financial instruments are measured at fair value utilizing widely accepted, third-party developed valuation models. The actual terms of each individual contract are entered into a valuation model, along with interest rate and foreign exchange rate data, which is based on readily observable market data published by third-party leading financial news and data providers. Credit risk is factored into the fair value of derivative assets and liabilities based on the differential between both our credit default swap spread for liabilities and the counterparty’s credit default swap spread for assets as compared with a standard AA-rated counterparty; however, this had no significant impact on the valuation at the end of 2009 and 2008 as most of our counterparties are AA-rated, and the vast majority of our derivative instruments are in an asset position.
Assets Recorded at Fair Value on a Nonrecurring Basis
The table below presents the assets that are measured at fair value on a nonrecurring basis that had measurement adjustments in 2009 and 2008. These assets were measured using significant unobservable inputs (Level 3) and include the following at the end of each period in which they were measured at fair value:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Manufacturing group
               
Goodwill
  $ 61          
Finance group
               
Finance receivables held for sale
    819     $ 1,658  
Impaired finance receivables
    686       139  
Other assets
    126          
 
           
Total assets recorded at fair value during the year
  $ 1,692     $ 1,797  
 
           
Goodwill — In the fourth quarter of 2009, we performed our annual goodwill impairment test using the annual operating plan for 2010 along with its long-range forecast that was submitted to management in connection with our annual strategic planning process. This information indicated a more delayed recovery from previous estimates for the Golf & Turfcare reporting unit, as the economic recovery is proceeding slower than originally anticipated. Golf membership and revenue per round of golf played have continued to decline in North America, and new course construction has been significantly delayed in the rest of the world, resulting in a negative impact to the Golf & Turfcare reporting unit’s outlook. Using discounted cash flows, we determined that the fair value of the Golf & Turfcare reporting unit had dropped to a level below its carrying value. Accordingly, we performed the required Step 2 calculation to determine the fair value of the reporting unit’s assets and liabilities in order to perform a purchase price allocation. In performing this analysis, we used assumptions that we believe a market participant would utilize in valuing the assets and liabilities of the business. Valuation methods used included the income and market approach depending on the nature of the asset/liability. Our calculation supported a goodwill amount of $61 million and required the impairment charge to reduce the carrying amount by $80 million.
Finance Receivables Held for Sale — Finance receivables held for sale are recorded at the lower of cost or fair value. Finance receivables held for sale are recorded at fair value on a nonrecurring basis during periods in which the fair value is lower than the cost value. At January 2, 2010, finance receivables held for sale were recorded at fair value with a $104 million valuation allowance. In the fourth quarter of 2008, upon initial reclassification of these receivables to held for sale, we estimated the fair value to be $293 million less than the carrying value, net of the $44 million allowance for loan losses attributable to these portfolios. This net adjustment was recorded within special charges in 2008. See Note 5, regarding the change in classification of certain finance receivables in 2009. The majority of the finance receivables held for sale were identified at the individual loan level. Golf course, timeshare and hotel mortgages classified as held for sale were identified as a portion of a larger portfolio with common characteristics based on the intention to balance the sale of certain loans with the collection of others to maximize economic value. The decrease in the fair value of the finance receivables held for sale was $14 million in 2009.
There are no active, quoted market prices for our finance receivables. The estimate of fair value was determined based on the use of discounted cash flow models to estimate the exit price we expect to receive in the principal market for each type of loan in an orderly transaction, which includes both the sale of pools of similar assets and the sale of individual loans. The models we used incorporate estimates of the rate of return, financing cost, capital structure and/or discount rate expectations of current market participants combined with estimated loan cash flows based on credit losses, payment rates and credit line utilization rates. Where available, the assumptions related to the expectations of current market participants are compared with observable market inputs, including bids from prospective purchasers of similar loans and certain bond market indices for loans of similar perceived credit quality. Although we utilize and prioritize these market observable inputs in our discounted cash flow models, these inputs rarely are derived from markets with directly comparable loan structures, industries and collateral types. Therefore, all valuations of finance receivables held for sale involve significant management judgment, which can result in differences between our fair value estimates and those of other market participants.
Impaired Finance Receivables — Finance receivable impairment is measured by comparing the expected future cash flows discounted at the finance receivable’s effective interest rate, or the fair value of the collateral if the receivable is collateral dependent, with its carrying amount. If the carrying amount is higher, we establish a reserve based on this difference. This evaluation is inherently subjective as it requires estimates, including the amount and timing of future cash flows expected to be received on impaired finance receivables and the underlying collateral, that may differ from actual results. Impaired nonaccrual finance receivables are included in the table above since the measurement of required reserves on our impaired finance receivables is significantly dependent on the fair value of the underlying collateral. Fair values of collateral are determined based on the use of appraisals, industry pricing guides, input from market participants, our recent experience selling similar assets or internally developed discounted cash flow models. In 2009 and 2008, fair value measurements recorded on impaired finance receivables resulted in a $165 million and $63 million, respectively, charge to provision for loan losses and primarily were related to initial fair value adjustments.
Other assets — Other assets include repossessed assets and properties and operating assets received in satisfaction of troubled finance receivables. The fair value of these assets is determined based on the use of appraisals, industry pricing guides, input from market participants, our recent experience selling similar assets or internally developed discounted cash flow models. For repossessed assets and properties, which are considered assets held for sale, if the carrying amount of the asset is higher than the estimated fair value, we record a corresponding charge to income for the difference. For operating assets received in satisfaction of troubled finance receivables, if the sum of the undiscounted cash flows is estimated to be less than the carrying value, we record a charge to income for any shortfall between estimated fair value and the carrying amount. In 2009, fair value measurements recorded on these assets resulted in a $41 million charge to Finance revenues in the Consolidated Statements of Operations.
In connection with the cancellation of the Citation Columbus development program, we recorded a $43 million impairment charge in the second quarter of 2009 to write off capitalized costs related to tooling and a partially constructed manufacturing facility, which we no longer consider to be recoverable. The fair value of the remaining assets was determined using Level 3 inputs and was less than $1 million. See Note 12 for more detail regarding these charges.
Assets and Liabilities Not Recorded at Fair Value
The carrying amounts and estimated fair values of our financial instruments that are not reflected in the financial statements at fair value are as follows:
                                 
    January 2, 2010     January 3, 2009  
    Carrying     Estimated     Carrying     Estimated  
(In millions)   Value     Fair Value     Value     Fair Value  
Manufacturing group
                               
Debt, excluding leases
  $ (3,474 )   $ (3,762 )   $ (2,438 )   $ (2,074 )
Finance group
                               
Finance receivables held for investment, excluding leases
    5,159       4,703       5,665       4,828  
Retained interest in securitizations, excluding interest-only strips
    6       6       188       178  
Investment in other marketable securities
    68       55       95       78  
Debt
    (5,667 )     (5,439 )     (7,388 )     (6,507 )
Fair value for the Manufacturing group debt is determined using market observable data for similar transactions. We utilize the same valuation methodologies to determine the fair value estimates for finance receivables held for investment as described above for finance receivables held for sale.
Investments in other marketable securities represent notes receivable issued by securitization trusts that purchase timeshare notes receivable from timeshare developers. These notes are classified as held-to-maturity and are held at cost. The estimate of fair value was based on observable market inputs for similar securitization interests in markets that currently are inactive.
In 2009 and 2008, approximately 54% and 82%, respectively, of the fair value of term debt for the Finance group was determined based on observable market transactions. The remaining Finance group debt was determined based on discounted cash flow analyses using observable market inputs from debt with similar duration, subordination and credit default expectations.
Shareholders Equity
Shareholders' Equity
Note 11. Shareholders’ Equity
Capital Stock
We have authorization for 15 million shares of preferred stock with no par value and 500 million shares of $0.125 par value common stock. In December 2009, we elected to redeem all outstanding shares of our $2.08 Cumulative Convertible Preferred Stock, Series A and our $1.40 Convertible Preferred Dividend Stock, Series B. As part of the redemption, approximately 45,600 and 21,300 shares of Series A and Series B preferred stock, respectively, were converted at the stated conversion rate (8.8 for Series A and 7.2 for Series B) into approximately 554,000 shares of common stock, and the remaining unconverted shares were paid in cash at the stated redemption rate. At the end of 2008 and 2007, we had approximately 67,000 and 72,000 shares, respectively, of Series A issued and outstanding and approximately 34,000 and 36,000 shares, respectively, of Series B issued and outstanding.
Outstanding common stock activity for the three years ended January 2, 2010 is presented below:
                         
(In thousands)   2009     2008     2007  
Beginning balance
    242,041       250,061       251,192  
Purchases
          (11,649 )     (5,902 )
Exercise of stock options
    10       1,147       3,404  
Conversion of preferred stock to common stock
    556       60       89  
Issued to Textron Savings Plan
    5,460       2,060       994  
Common stock offering
    23,805              
Other issuances
    400       362       284  
 
                 
Ending balance
    272,272       242,041       250,061  
 
                 
Reserved Shares of Common Stock
At the end of 2009, common stock reserved for the conversion of convertible debt, the exercise of outstanding stock options and warrants, and the issuance of shares upon vesting of outstanding restricted stock units totaled 143 million shares. See the “4.50% Convertible Senior Notes” section in Note 8 for information on our convertible debt.
Income per Common Share
In the first quarter of 2009, we adopted the new accounting standard for determining whether instruments granted in share-based payment transactions are participating securities. This new standard requires us to include any unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) as participating securities in our basic earnings per share calculation. We have granted certain restricted stock units that are deemed participating securities under this new standard, and, as a result, prior period basic and diluted weighted-average shares outstanding have been recast to conform to the new calculation. The adoption of this standard reduced our basic and diluted earnings per share by $0.01 in 2008, and there was no impact in 2007.
We calculate basic and diluted earnings per share based on net income, which approximates income available to common shareholders for each period. Basic earnings per share is calculated using the two-class method, which includes the weighted-average number of common shares outstanding during the period and restricted stock units to be paid in stock that are deemed participating securities. Diluted earnings per share considers the dilutive effect of all potential future common stock, including convertible preferred shares, Convertible Notes, stock options and warrants and restricted stock units in the weighted-average number of common shares outstanding. The weighted-average shares outstanding for basic and diluted earnings per share are as follows:
                         
(In thousands)   2009     2008     2007  
Basic weighted-average shares outstanding
    262,923       246,208       249,792  
Dilutive effect of convertible preferred shares, stock options and restricted stock units
          4,130       5,034  
 
                 
Diluted weighted-average shares outstanding
    262,923       250,338       254,826  
 
                 
In 2009, the potential dilutive effect of 8 million weighted-average shares of restricted stock units, stock options and warrants, convertible preferred stock and Convertible Notes was excluded from the computation of diluted weighted-average shares outstanding as the shares would have an antidilutive effect on the loss from continuing operations. In addition, stock options to purchase 7 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding in 2009 as the exercise prices were greater than the average market price of our common stock for those periods. These securities could potentially dilute earnings per share in the future.
Other Comprehensive Income (Loss)
The before and after-tax components of OCI are presented below:
                         
            Tax        
    Before-Tax     (Expense)     Net-of-Tax  
(In millions)   Amount     Benefit     Amount  
2007
                       
Foreign currency translation adjustment
  $ 44     $ 13     $ 57  
Deferred gains on hedge contracts
    75       (22 )     53  
Pension adjustments
    73       23       96  
Reclassification adjustments
    55       (17 )     38  
 
                 
Other comprehensive income
  $ 247     $ (3 )   $ 244  
 
                 
2008
                       
Foreign currency translation adjustment
  $ (210 )   $ 15     $ (195 )
Deferred losses on hedge contracts
    (91 )     18       (73 )
Pension adjustments
    (1,298 )     495       (803 )
Reclassification due to sale of Fluid & Power
    31       4       35  
Reclassification adjustments
    25       (11 )     14  
 
                 
Other comprehensive loss
  $ (1,543 )   $ 521     $ (1,022 )
 
                 
2009
                       
Foreign currency translation adjustment
  $ 16     $ 7     $ 23  
Deferred gains on hedge contracts
    90       (23 )     67  
Pension adjustments
    6       (31 )     (25 )
Pension curtailment
    25       (10 )     15  
Reclassification adjustments
    30       (9 )     21  
 
                 
Other comprehensive income
  $ 167     $ (66 )   $ 101  
 
                 
Accumulated Other Comprehensive Loss
The after-tax components of accumulated other comprehensive loss are presented below:
                                 
            Pension and     Deferred        
    Foreign     Post-     Gains        
    Currency     retirement     (Losses)        
    Translation     Benefits     on Hedge        
(In millions)   Adjustment     Adjustments     Contracts     Total  
Balance at December 30, 2006
  $ 125     $ (779 )   $ 10     $ (644 )
Other comprehensive income
    57       96       53       206  
Reclassification adjustments
          58       (20 )     38  
 
                       
Balance at December 29, 2007
    182       (625 )     43       (400 )
Other comprehensive loss
    (195 )     (803 )     (73 )     (1,071 )
Reclassification due to sale of Fluid & Power
    2       33             35  
Reclassification adjustments
          31       (17 )     14  
 
                       
Balance at January 3, 2009
    (11 )     (1,364 )     (47 )     (1,422 )
Other comprehensive income (loss)
    23       (25 )     67       65  
Pension curtailment
          15             15  
Reclassification adjustments
    (2 )     20       3       21  
 
                       
Balance at January 2, 2010
  $ 10     $ (1,354 )   $ 23     $ (1,321 )
 
                       
Special Charges
Special Charges
Note 12. Special Charges
Special charges include restructuring charges of $237 million and $64 million in 2009 and 2008, respectively. In 2009, special charges also includes a goodwill impairment charge of $80 million in the Industrial segment. In the fourth quarter of 2008, in connection with our decision to sell the non-captive portion of our Finance business, we incurred an initial mark-to-market adjustment of $293 million that was made when we classified certain finance receivables from held for investment to held for sale and a goodwill impairment charge in the Finance segment of $169 million, which are both included in special charges. There were no special charges in 2007.
Special charges by segment are as follows:
                                                         
    Restructuring Program                
            Curtailment             Contract                     Total  
    Severance     Charges,     Asset     Terminations     Total     Other     Special  
(In millions)   Costs     Net     Impairments     and Other     Restructuring     Charges     Charges  
2009
                                                       
Cessna
  $ 80     $ 26     $ 54     $ 7     $ 167     $     $ 167  
Finance
    11       1             1       13             13  
Corporate
    34                   1       35             35  
Industrial
    6       (4 )           3       5       80       85  
Bell
    9                         9             9  
Textron Systems
    5       2             1       8             8  
 
                                         
 
  $ 145     $ 25     $ 54     $ 13     $ 237     $ 80     $ 317  
 
                                         
2008
                                                       
Cessna
  $ 5     $     $     $     $ 5     $     $ 5  
Finance
    15             11       1       27       462       489  
Corporate
    6                         6             6  
Industrial
    16             9             25             25  
Textron Systems
    1                         1             1  
 
                                         
 
  $ 43     $     $ 20     $ 1     $ 64     $ 462     $ 526  
 
                                         
Restructuring Program
In the fourth quarter of 2008, we initiated a restructuring program to reduce overhead costs and improve productivity across the company, which includes corporate and segment direct and indirect workforce reductions and streamlining of administrative overhead, and announced the exit of portions of our commercial finance business. This program was expanded in 2009 to include additional workforce reductions, primarily at Cessna, Corporate and Bell, the cancellation of the Citation Columbus development project, the streamlining and reorganization of senior management and the consolidation of certain operations at Cessna. By the end of 2010, we expect to have eliminated approximately 10, 800 positions worldwide representing approximately 25% of our global workforce since the inception of the program. As of January 2, 2010, we have terminated approximately 10,400 employees and have exited 23 leased and owned facilities and plants under this program.
We record restructuring costs in special charges as these costs are generally of a nonrecurring nature and are not included in segment profit, which is our measure used for evaluating performance and for decision-making purposes. Severance costs related to an approved restructuring program are classified as special charges unless the costs are for volume-related reductions of direct labor that are deemed to be of a temporary or cyclical nature. Most of our severance benefits are provided for under existing severance programs, and the associated costs are accrued when they are probable and estimable. Special one-time termination benefits are accounted for once an approved plan is communicated to employees that establishes the terms of the benefit arrangement, the number of employees to be terminated, along with their job classification and location, and the expected completion date.
We recorded net curtailment charges of $25 million for our pension and other postretirement benefit plans in the second quarter of 2009, as our analysis of the impact of workforce reductions on these plans indicated that curtailments had occurred and the amounts could be reasonably estimated. The curtailment charge for the pension plan is primarily due to the recognition of prior service costs that were previously being amortized over a period of years.
Asset impairment charges include a $43 million charge recorded in the second quarter of 2009 to write off assets related to the Citation Columbus development project. Due to the prevailing adverse market conditions and after analysis of the business jet market related to the product offering, Cessna formally canceled the Citation Columbus development project in the second quarter of 2009. Cessna began this project in early 2008 for the development of an all-new, wide-bodied, eight-passenger business jet designed for international travel that would extend Cessna’s product offering as its largest business jet to date. This development project had capitalized costs related to tooling and a partially constructed manufacturing facility, of which $43 million was considered not to be recoverable.
Since the inception of the restructuring program, we have incurred the following costs through January 2, 2010:
                                         
            Curtailment             Contract        
    Severance     Charges,     Asset     Terminations     Total  
(In millions)   Costs     Net     Impairments     and Other     Restructuring  
Cessna
  $ 85     $ 26     $ 54     $ 7     $ 172  
Finance
    26       1       11       2       40  
Corporate
    40                   1       41  
Industrial
    22       (4 )     9       3       30  
Bell
    9                         9  
Textron Systems
    6       2             1       9  
 
                             
 
  $ 188     $ 25     $ 74     $ 14     $ 301  
 
                             
An analysis of our restructuring reserve activity is summarized below:
                                         
            Curtailment             Contract        
    Severance     Charges,     Asset     Terminations        
(In millions)   Costs     Net     Impairments     and Other     Total  
Provision in 2008
  $ 43     $     $ 20     $ 1     $ 64  
Non-cash settlement
                (20 )           (20 )
Cash paid
    (7 )                       (7 )
 
                             
Balance at January 3, 2009
  $ 36     $     $     $ 1     $ 37  
Provision in 2009
    152       25       54       13       244  
Reversals
    (7 )                       (7 )
Non-cash settlement and loss recognition
          (25 )     (54 )           (79 )
Cash paid
    (133 )                 (11 )     (144 )
 
                             
Balance at January 2, 2010
  $ 48     $     $     $ 3     $ 51  
 
                             
Severance costs generally are paid on a lump sum basis or on a monthly basis over the severance period granted to each employee and include outplacement costs, which are paid in accordance with normal payment terms. Contract termination costs generally are paid upon exiting the facility or over the remaining lease term.
The specific restructuring measures and associated estimated costs are based on our best judgment under prevailing circumstances. We believe that the restructuring reserve balance of $51 million is adequate to cover the costs presently accruable relating to activities formally identified and committed to under approved plans as of January 2, 2010 and anticipate that all actions related to these liabilities will be completed within a 12-month period. We estimate that we will incur approximately $30 million in additional pre-tax restructuring costs in 2010, most of which will result in future cash outlays. The additional costs are expected to primarily include relocation costs at Cessna as it consolidates certain operations, severance in the Cessna segment and $3 million in severance for the Finance segment. We expect that the program will be substantially completed in 2010; however, we expect to incur additional costs to exit the non-captive portion of our commercial finance business over the next two to three years, which are estimated to be within a range of $7 million to $17 million, primarily attributable to severance and retention benefits.
Other Charges
In the fourth quarter of 2009, we recorded a goodwill impairment charge of $80 million for the Golf & Turfcare reporting unit, which is part of our Industrial segment. See Note 10 for more information on this charge.
In the fourth quarter of 2008, we made a decision to exit the non-captive portion of the commercial finance business of our Finance segment, which is being effected through a combination of orderly liquidation and selected sales and is expected, depending on market conditions, to be substantially complete over the next two to three years. We recorded a pre-tax mark-to-market adjustment of $293 million against owned receivables that were classified as held for sale due to this exit plan based on our estimate of the fair value of these receivables at that time. In addition, based on market conditions and the plan to downsize the Finance segment, we recorded a $169 million impairment charge to eliminate all goodwill in the Finance segment.
Share-Based Compensation
Share-Based Compensation
Note 13. Share-Based Compensation
Our 2007 Long-Term Incentive Plan (the “Plan”) succeeds the 1999 Long-Term Incentive Plan and authorizes awards to our key employees in the form of options to purchase our shares, restricted stock, restricted stock units, stock appreciation rights, performance stock awards and other awards. Options to purchase our shares have a maximum term of 10 years and generally vest ratably over a three-year period. Restricted stock unit awards generally vest one-third each in the third, fourth and fifth year following the year of grant. These awards generally were paid in shares of common stock until the first quarter of 2009, when we began issuing restricted stock units settled in cash only; these awards vest in equal installments over five years. Since 2008, all restricted stock units have been issued with the right to receive dividend equivalents. A maximum of 12 million shares is authorized for issuance for all purposes under the Plan plus any shares that become available upon cancellation, forfeiture or expiration of awards granted under the 1999 Long-Term Incentive Plan. No more than 12 million shares may be awarded pursuant to incentive stock options, and no more than 3 million shares may be awarded pursuant to restricted stock or other “full value” awards intended to be paid in shares. The Plan also authorizes performance share units paid in cash based upon the value of our common stock. Payouts under performance share units vary based on certain performance criteria generally measured over a three-year period. The performance share units vest at the end of three years.
Through our Deferred Income Plan for Textron Executives (the “DIP”), we provide participants the opportunity to voluntarily defer up to 25% of their base salary and up to 100% of annual, long-term incentive and other compensation. Effective January 1, 2008, the maximum amount deferred for annual, long-term incentive and other compensation decreased to 80%. Elective deferrals may be put into either a stock unit account or an interest bearing account. We generally contribute a 10% premium on amounts deferred into the stock unit account. Executives who are eligible to participate in the DIP who have not achieved and/or maintained the required minimum stock ownership level are required to defer annual incentive compensation in excess of 100% of the executive’s annual target into a deferred stock unit account and are not entitled to the 10% premium contribution on the amount deferred. Participants cannot move amounts between the two accounts while actively employed by us and cannot receive distributions until termination of employment.
Compensation costs for awards with only service conditions that vest ratably are recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award.
The compensation expense that has been recorded in net income for our share-based compensation plans is as follows:
                         
(In millions)   2009     2008     2007  
Compensation (income) expense
  $ 81     $ (78 )   $ 150  
Hedge expense (income) on forward contracts
    2       100       (53 )
Income tax expense (benefit)
    (30 )     29       (51 )
 
                 
Total net compensation cost included in net income
  $ 53     $ 51     $ 46  
 
                 
Less net compensation costs included in discontinued operations
                1  
 
                 
Net compensation costs included in continuing operations
  $ 53     $ 51     $ 45  
 
                 
Share-based compensation costs are reflected primarily in selling and administrative expenses. Compensation expense includes approximately $9 million, $20 million and $23 million in 2009, 2008 and 2007, respectively, representing the attribution of the fair value of options issued and the portion of previously granted options for which the requisite service has been rendered.
Stock Options
The stock option compensation cost calculated under the fair value approach is recognized over the vesting period of the stock options. The weighted-average fair value of options granted per share was $2, $14 and $14 for 2009, 2008 and 2007, respectively. We estimate the fair value of options granted on the date of grant using the Black-Scholes option-pricing model. Expected volatilities are based on implied volatilities from traded options on our common stock, historical volatilities and other factors. We use historical data to estimate option exercise behavior, adjusted to reflect anticipated increases in expected life.
The weighted-average assumptions used in our Black-Scholes option-pricing model for awards issued during the respective periods are as follows:
                         
    2009     2008     2007  
Dividend yield
    1 %     2 %     2 %
Expected volatility
    50 %     30 %     30 %
Risk-free interest rate
    2 %     3 %     5 %
Expected term (in years)
    5.0       5.1       5.5  
The following table summarizes information related to stock option activity for the respective periods:
                         
(In millions)   2009     2008     2007  
Intrinsic value of options exercised
  $     $ 28     $ 85  
Cash received from option exercises
          40       103  
Actual tax benefit realized for tax deductions from option exercises
          10       27  
Our income taxes payable for federal and state purposes have been reduced by the tax benefits we receive from employee stock options. The income tax benefits we receive for certain stock options are calculated as the difference between the fair market value of the stock issued at the time of exercise and the option price, tax effected. The tax impact of the tax deduction in excess of the related deferred taxes is presented in the Consolidated Statements of Cash Flows as financing activities.
Stock option activity under the Plan is summarized as follows:
                                                 
    2009     2008     2007  
            Weighted-             Weighted-             Weighted-  
            Average             Average             Average  
    Number of     Exercise     Number of     Exercise     Number of     Exercise  
(Shares in thousands)   Options     Price     Options     Price     Options     Price  
Outstanding at beginning of year
    9,021     $ 38.51       9,024     $ 35.37       10,840     $ 31.88  
Granted
    859       6.50       1,692       53.46       1,860       45.87  
Exercised
    (10 )     19.45       (1,147 )     34.26       (3,410 )     29.93  
Canceled, expired or forfeited
    (1,325 )     36.16       (548 )     41.86       (266 )     36.26  
 
                                   
Outstanding at end of year
    8,545     $ 35.67       9,021     $ 38.51       9,024     $ 35.37  
 
                                   
Exercisable at end of year
    6,177     $ 35.82       5,774     $ 32.45       5,395     $ 29.63  
 
                                   
At January 2, 2010, our outstanding options had an aggregate intrinsic value of $10 million and a weighted-average remaining contractual life of six years. Our exercisable options had no significant aggregate intrinsic value and a weighted-average remaining contractual life of five years at January 2, 2010.
Restricted Stock Units
For restricted stock units paid in stock that were issued prior to 2008, the fair value is based on the trading price of our common stock on the grant date, less required adjustments to reflect the fair value of the awards as dividends are not paid or accrued on these units until the restricted stock units vest. For restricted stock units issued in 2009 and 2008, cash dividends are paid on a quarterly basis prior to vesting. The fair value of the units paid in stock is based solely on the trading price of our common stock on the grant date. The weighted-average grant date fair value of restricted stock units paid in stock that were granted in 2008 and 2007 was approximately $53 and $45 per share, respectively. No restricted stock units paid in stock were granted in 2009.
Activity for restricted stock units paid in stock is as follows:
                 
            Weighted-  
            Average  
    Number of     Grant Date  
(Shares in thousands)   Shares     Fair Value  
Outstanding at beginning of year, nonvested
    2,441     $ 43.83  
Vested
    (962 )     39.87  
Forfeited
    (329 )     45.24  
 
           
Outstanding at end of year, nonvested
    1,150     $ 46.74  
 
           
Share-Based Compensation Awards
The value of the share-based compensation awards that vested and/or were paid during the respective periods is as follows:
                         
(In millions)   2009     2008     2007  
Subject only to service conditions:
                       
Value of shares, options or units vested
  $ 42     $ 47     $ 38  
Intrinsic value of cash awards paid
    1       10       10  
Subject to performance vesting conditions:
                       
Value of units vested
    21       10       46  
Intrinsic value of cash awards paid
    10       40       42  
Intrinsic value of amounts paid under DIP
    1       3       4  
As of January 2, 2010, we had not recognized $50 million of total compensation cost associated with unvested awards subject only to service conditions. We expect to recognize compensation expense for these awards over a weighted-average period of approximately two years.
The fair value of share-based compensation awards accounted for as liabilities includes performance share units, retention awards, restricted stock units payable in cash and DIP stock unit awards. The fair value of these awards is based on the trading price of our common stock, less adjustments to reflect the fair value of certain awards for which dividends are not paid or accrued until vested, and is remeasured at each reporting period date.
Retirement Plans
Retirement Plans
Note 14. Retirement Plans
Our defined benefit and defined contribution plans cover substantially all of our employees. A significant number of our U.S.-based employees participate in the Textron Retirement Plan, which is designed to be a “floor-offset” arrangement with both a defined benefit component and a defined contribution component. The defined benefit component of the arrangement includes the Textron Master Retirement Plan (TMRP) and the Bell Helicopter Textron Master Retirement Plan (BHTMRP), and the defined contribution component is the Retirement Account Plan (RAP). The defined benefit component provides a minimum guaranteed benefit (or “floor” benefit). Under the RAP, participants are eligible to receive contributions from Textron of 2% of their eligible compensation but may not make contributions to the plan. Upon retirement, participants receive the greater of the floor benefit or the value of the RAP. Both the TMRP and the BHTMRP are subject to the provisions of the Employee Retirement Income Security Act of 1974 (ERISA).
We also have domestic and foreign funded and unfunded defined benefit pension plans that cover certain of our U.S. and foreign employees. In addition, several defined contribution plans are sponsored by our various businesses. The largest such plan is the Textron Savings Plan, which is a qualified 401(k) plan subject to ERISA in which a significant number of our U.S.-based employees participate. Our defined contribution plans cost approximately $96 million in 2009, $110 million in 2008 and $82 million in 2007.
We also provide postretirement benefits other than pensions for certain retired employees in the U.S., which include healthcare, dental care, Medicare Part B reimbursement and life insurance benefits.
Periodic Benefit Cost
The components of our net periodic benefit cost and other amounts recognized in OCI are as follows:
                                                 
                            Postretirement Benefits  
    Pension Benefits     Other than Pensions  
(In millions)   2009     2008     2007     2009     2008     2007  
Net periodic benefit cost:
                                               
Service cost
  $ 116     $ 141     $ 127     $ 8     $ 8     $ 8  
Interest cost
    310       302       271       38       40       39  
Expected return on plan assets
    (386 )     (404 )     (369 )                  
Amortization of prior service cost (credit)
    18       19       18       (5 )     (5 )     (4 )
Amortization of net loss
    10       19       40       8       15       20  
Curtailment and special termination charges
    34                   (5 )            
 
                                   
Net periodic benefit cost
  $ 102     $ 77     $ 87     $ 44     $ 58     $ 63  
 
                                   
Other changes in plan assets and benefit obligations recognized in OCI (including foreign exchange):
                                               
Amortization of net loss
  $ (10 )   $ (19 )   $ (40 )   $ (8 )   $ (15 )   $ (20 )
Net loss (gain) arising during the year
    (93 )     1,329       (30 )     24       (32 )     (52 )
Amortization of prior service credit (cost)
    (48 )     (19 )     (18 )     10       5       4  
Prior service cost (credit) arising during the year
    26       7       44       2       (27 )     (5 )
 
                                   
Total recognized in OCI
  $ (125 )   $ 1,298     $ (44 )   $ 28     $ (69 )   $ (73 )
 
                                   
Total recognized in net periodic benefit cost and OCI
  $ (23 )   $ 1,375     $ 43     $ 72     $ (11 )   $ (10 )
 
                                   
We estimate that the net loss and prior service cost for the defined benefit pension plans that will be amortized from OCI into net periodic benefit costs in 2010 will be $34 million and $23 million, respectively. The estimated net loss and prior service credit for postretirement benefits other than pensions that will be amortized from OCI into net periodic benefit costs in 2010 will be $11 million and $4 million, respectively. OCI also includes $1 million, $9 million and $13 million of amortization of net loss and prior service cost and $35 million, $12 million and $31 million of net loss and prior service costs arising during 2009, 2008 and 2007, respectively, related to discontinued operations.
Obligations and Funded Status
All of our plans are measured as of our fiscal year-end. The changes in the projected benefit obligation and in the fair value of plan assets, along with our funded status, are as follows:
                                 
                    Postretirement Benefits  
    Pension Benefits     Other than Pensions  
(In millions)   2009     2008     2009     2008  
Change in benefit obligation:
                               
Benefit obligation at beginning of year
  $ 5,088     $ 5,202     $ 636     $ 714  
Service cost
    116       141       8       8  
Interest cost
    310       302       38       40  
Amendments
    26       8       2       (27 )
Plan participants’ contributions
                5       5  
Actuarial losses (gains)
    (42 )     (205 )     22       (31 )
Benefits paid
    (300 )     (295 )     (67 )     (73 )
Foreign exchange rate changes
    29       (52 )            
Curtailments
    (1 )     (13 )     2        
 
                       
Benefit obligation at end of year
  $ 5,226     $ 5,088     $ 646     $ 636  
 
                       
Change in fair value of plan assets:
                               
Fair value of plan assets at beginning of year
  $ 3,574     $ 5,026     $     $  
Actual return on plan assets
    473       (1,139 )            
Employer contributions
    51       41              
Benefits paid
    (300 )     (295 )            
Dispositions
    (40 )                  
Foreign exchange rate changes
    25       (59 )            
 
                       
Fair value of plan assets at end of year
  $ 3,783     $ 3,574     $     $  
 
                       
Funded status at end of year
  $ (1,443 )   $ (1,514 )   $ (646 )   $ (636 )
 
                       
Amounts recognized in our balance sheets for continuing operations are as follows:
                                 
                    Postretirement Benefits  
    Pension Benefits     Other than Pensions  
(In millions)   2009     2008     2009     2008  
Non-current assets
  $ 51     $ 47     $     $  
Current liabilities
    (22 )     (18 )     (63 )     (63 )
Non-current liabilities
    (1,472 )     (1,543 )     (583 )     (573 )
Recognized in accumulated other comprehensive loss:
                               
Net loss
    1,851       1,844       131       115  
Prior service cost (credit)
    150       172       (23 )     (35 )
Assumptions
The weighted-average assumptions we use for our pension and postretirement plans are as follows:
                                                 
                            Postretirement Benefits  
    Pension Benefits     Other than Pensions  
    2009     2008     2007     2009     2008     2007  
Net periodic benefit cost:
                                               
Discount rate
    6.61 %     5.99 %     5.63 %     6.25 %     6.00 %     5.66 %
Expected long-term rate of return on assets
    8.58 %     8.66 %     8.63 %                  
Rate of compensation increase
    4.36 %     4.48 %     4.45 %                  
Benefit obligations at year-end:
                                               
Discount rate
    6.19 %     6.28 %     5.99 %     5.50 %     6.25 %     6.00 %
Rate of compensation increases
    4.00 %     4.47 %     4.44 %                  
We have estimated an initial medical cost trend rate of 7% in 2009, which we assume will decrease to 5% by 2019 and then remain at that level. For the initial prescription drug cost trend rate, we have estimated a rate of 10% in 2009, which we assume will decrease to 5% by 2019 and then remain at that level. These assumed healthcare cost trend rates have a significant effect on the amounts reported for the postretirement benefits other than pensions. A one-percentage-point change in these assumed healthcare cost trend rates would have the following effects:
                 
    One-     One-  
    Percentage-     Percentage-  
    Point     Point  
(In millions)   Increase     Decrease  
Effect on total of service and interest cost components
  $ 4     $ (3 )
Effect on postretirement benefit obligations other than pensions
    37       (33 )
Pension Benefits
The accumulated benefit obligation for all defined benefit pension plans was $4.8 billion at January 2, 2010 and $4.7 billion at January 3, 2009, which includes $317 million and $297 million, respectively, in accumulated benefit obligations for unfunded plans where funding is not permitted or in foreign environments where funding is not feasible. Pension plans with accumulated benefit obligations exceeding the fair value of plan assets were as follows:
                 
(In millions)   2009     2008  
Projected benefit obligation
  $ 5,084     $ 4,867  
Accumulated benefit obligation
    4,685       4,463  
Fair value of plan assets
    3,590       3,323  
Pension Assets
The expected long-term rate of return on plan assets is determined based on a variety of considerations, including the established asset allocation targets and expectations for those asset classes, historical returns of the plans’ assets and other market considerations. We invest our pension assets with the objective of achieving a total rate of return, over the long term, sufficient to fund future pension obligations and to minimize future pension contributions. We are willing to tolerate a commensurate level of risk to achieve this objective based on the funded status of the plans and the long-term nature of our pension liability. Risk is controlled by maintaining a portfolio of assets that is diversified across a variety of asset classes, investment styles and investment managers. All of the assets are managed by external investment managers, and the majority of the assets are actively managed. Where possible, investment managers are prohibited from owning our stock in the portfolios that they manage on our behalf.
For U.S. plan assets, which represent the majority of our plan assets, asset allocation target ranges are established consistent with our investment objectives and the assets are rebalanced periodically. Our target allocation ranges are 27% to 41% for domestic equity securities; 11% to 22% for international equity securities; 11% to 42% for debt securities; 5% to 11% for private equity partnerships and 9% to 15% for real estate. For foreign plan assets, allocations are based on expected cash flow needs and assessments of the local practices and markets. The target asset allocation ranges for our foreign plans are 25% to 65% for equity securities; 25% to 53% for debt securities and 0% to 17% for real estate.
The fair value of total pension plan assets by major category and level in the fair value hierarchy, as defined in Note 10, at January 2, 2010 is as follows:
                         
(In millions)   Level 1     Level 2     Level 3  
Cash and cash equivalents
  $ 9     $ 116     $  
Equity securities:
                       
Domestic
    863       409        
International
    519       220        
Debt securities:
                       
National, state, and local governments
          473        
Corporate debt
          428        
Asset-backed securities
          148        
Private equity partnerships
                313  
Real estate
                285  
 
                 
Total
  $ 1,391     $ 1,794     $ 598  
 
                 
Cash equivalents and equity and debt securities include co-mingled funds, which represent investments in funds offered to institutional investors that are similar to mutual funds in that they provide diversification by holding various debt and equity securities. Since these co-mingled funds are not quoted on any active market and are valued based on the relative dispersion of the underlying debt and equity investments and their individual prices at any given time, they are classified as Level 2. Debt securities are valued based on same day actual trading prices, if available. If such prices are not available, we use a matrix pricing model with historical prices, trends and other factors.
Private equity partnerships represent investments in funds, which, in turn, invest in stocks and debt securities of companies that, in most cases, are not publicly traded. These partnerships are valued using income and market methods that include cash flow projections and market multiples for various comparable companies.
Real estate includes owned properties and investments in partnerships. Owned properties are valued using certified appraisals at least every three years, which then are updated at least annually by the real estate investment manager, who considers current market trends and other available information. These appraisals generally use the standard methods for valuing real estate, including forecasting income and identifying current transactions for comparable real estate to arrive at a fair value. Real estate partnerships are valued similar to private equity partnerships, with the general partner using standard real estate valuation methods to value the real estate properties and securities held within their fund portfolios. We believe these assumptions are consistent with assumptions that market participants would use in valuing these investments.
The table below presents a reconciliation of the beginning and ending balances for fair value measurements that use significant unobservable inputs (Level 3) by major category:
                 
    Private Equity     Real  
(In millions)   Partnerships     Estate  
Balance at beginning of year
  $ 290     $ 394  
Actual return on plan assets
               
Related to assets still held at reporting date
    16       (117 )
Related to assets sold during the period
    (1 )     (2 )
Purchases, sales and settlements, net
    8       10  
 
           
Balance at end of year
  $ 313     $ 285  
 
           
Estimated Future Cash Flow Impact
Defined benefits under salaried plans are based on salary and years of service. Hourly plans generally provide benefits based on stated amounts for each year of service. Our funding policy is consistent with applicable laws and regulations. In 2010, we expect to contribute approximately $20 million to fund our qualified pension plans and foreign plans. We do not expect to contribute to our other postretirement benefit plans. Benefit payments provided below reflect expected future employee service, as appropriate, and are expected to be paid, net of estimated participant contributions. Benefit payments do not include the Medicare Part D subsidy we expect to receive. Benefit payments are based on the same assumptions used to measure our benefit obligation at the end of fiscal 2009. While pension benefit payments primarily will be paid out of qualified pension trusts, we will pay postretirement benefits other than pensions out of our general corporate assets as follows:
                         
            Post-        
            retirement     Expected  
            Benefits     Medicare  
    Pension     Other than     Part D  
(In millions)   Benefits     Pensions     Subsidy  
2010
  $ 337     $ 69     $ (4 )
2011
    342       69       (4 )
2012
    347       68       (4 )
2013
    354       67       (4 )
2014
    359       66       (4 )
2015 - 2019
    1,919       289       (15 )
Income Taxes
Income Taxes
Note 15. Income Taxes
We conduct business globally and, as a result, file numerous consolidated and separate income tax returns in the U.S. federal, various state and non-U.S. jurisdictions. For all of our U.S. subsidiaries, we file a consolidated federal income tax return. Income (loss) from continuing operations before income taxes is as follows:
                         
(In millions)   2009     2008     2007  
U.S.
  $ (229 )   $ 598     $ 1,090  
Non-U.S.
    80       31       144  
 
                 
Total
  $ (149 )   $ 629     $ 1,234  
 
                 
Income tax expense (benefit) for continuing operations is summarized as follows:
                         
(In millions)   2009     2008     2007  
Current:
                       
Federal
  $ 160     $ 317     $ 328  
State
    17       16       20  
Non-U.S.
    (8 )     14       51  
 
                 
 
    169       347       399  
 
                 
 
                       
Deferred:
                       
Federal
    (238 )     (61 )     7  
State
    (22 )     5       (24 )
Non-U.S.
    15       14       (14 )
 
                 
 
    (245 )     (42 )     (31 )
 
                 
Income tax expense (benefit)
  $ (76 )   $ 305     $ 368  
 
                 
The current federal and state provisions for 2009 include $85 million of tax related to the sale of certain leverage leases in the Finance segment for which we had previously recorded significant deferred tax liabilities. The tax is expected to be paid over a period of years in accordance with a prior settlement with the Internal Revenue Service.
The following table reconciles the federal statutory income tax rate to our effective income tax rate:
                         
    2009     2008     2007  
Federal statutory income tax rate
    (35.0 )%     35.0 %     35.0 %
Increase (decrease) in taxes resulting from:
                       
State income taxes
    0.4       2.3       1.0  
Goodwill impairment
    18.5       8.4        
Non-U.S. tax rate differential
    (13.5 )     (5.7 )     (0.5 )
Valuation allowance on contingent receipts
    (7.3 )     (0.5 )      
Research credit
    (4.7 )     (1.9 )     (0.8 )
Unrecognized tax benefits and related interest
    (4.1 )     3.4       1.2  
Change in status of subsidiary
    (3.6 )     5.0        
Manufacturing deduction
    (3.1 )     (2.8 )     (1.6 )
Equity hedge loss (income)
    0.5       6.2       (1.5 )
Other, net
    0.9       (0.8 )     (3.0 )
 
                 
Effective income tax rate
    (51.0 )%     48.6 %     29.8 %
 
                 
The amount of income taxes we pay is subject to ongoing audits by U.S. federal, state and non-U.S. tax authorities, which may result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is highly judgmental. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions for which it is more likely than not that a tax benefit will be sustained, we record the largest amount of tax benefit with a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. Interest and penalties are accrued, where applicable. If we do not believe that it is not more likely than not that a tax benefit will be sustained, no tax benefit is recognized.
Our future results may include favorable or unfavorable adjustments to our estimated tax liabilities due to closure of income tax examinations, new regulatory or judicial pronouncements, or other relevant events. As a result, our effective tax rate may fluctuate significantly on a quarterly and annual basis.
Our unrecognized tax benefits represent tax positions for which reserves have been established. Unrecognized state tax benefits and interest related to unrecognized tax benefits are reflected net of applicable tax benefits. A reconciliation of our unrecognized tax benefits, excluding accrued interest, is as follows:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Balance at beginning of year
  $ 324     $ 367  
Additions for tax positions related to current year
    9       24  
Additions for tax positions of prior years
    11       4  
Reductions for tax positions of prior years
    (43 )     (71 )
Reductions for expiration of statute of limitations
    (1 )      
Reductions for settlements with tax authorities
    (6 )      
 
           
Balance at end of year
  $ 294     $ 324  
 
           
At January 2, 2010 and January 3, 2009, approximately $208 million and $210 million, respectively, of these unrecognized tax benefits, if recognized, would favorably affect our effective tax rate in any future period. The remaining $86 million and $114 million, respectively, in unrecognized tax benefits are related to discontinued operations. Unrecognized tax benefits were reduced in 2009 and 2008 primarily due to the sale of CESCOM assets and the HR Textron and Fluid & Power sales. We do not expect the amount of the unrecognized tax benefits disclosed above to change significantly over the next 12 months.
In the normal course of business, we are subject to examination by taxing authorities throughout the world, including major jurisdictions such as Belgium, Canada, Germany, Japan, the United Kingdom and the U.S. With few exceptions, we no longer are subject to U.S. federal, state and local income tax examinations for years before 1997 and no longer are subject to non-U.S. income tax examinations in our major jurisdictions for years before 2004.
During 2009, 2008 and 2007, we recognized net tax-related interest totaling approximately $12 million, $31 million and $20 million, respectively, in the Consolidated Statements of Operations. At January 2, 2010 and January 3, 2009, we had a total of $114 million and $102 million, respectively, of net accrued interest included in our Consolidated Balance Sheets.
The tax effects of temporary differences that give rise to significant portions of our net deferred tax assets and liabilities were as follows:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Deferred tax assets:
               
Obligation for pension and postretirement benefits
  $ 767     $ 826  
Accrued expenses*
    219       217  
Deferred compensation
    197       194  
Allowance for credit losses
    146       90  
Valuation allowance on finance receivables held for sale
    71       135  
Loss carryforwards
    60       63  
Foreign currency translation adjustment
    41       31  
Other, net
    225       156  
 
           
Total deferred tax assets
    1,726       1,712  
Valuation allowance for deferred tax assets
    (210 )     (175 )
 
           
 
  $ 1,516     $ 1,537  
 
           
Deferred tax liabilities:
               
Leasing transactions
  $ (468 )   $ (601 )
Amortization of goodwill and other intangibles
    (147 )     (157 )
Property, plant and equipment, principally depreciation
    (115 )     (99 )
Inventory
    (7 )     (31 )
Change in status of non-U.S. subsidiary
          (22 )
 
           
Total deferred tax liabilities
    (737 )     (910 )
 
           
Net deferred tax asset
  $ 779     $ 627  
 
           
 
*   Accrued expenses includes warranty and product maintenance reserves, self-insured liabilities, interest and restructuring charges.
The valuation allowance against our deferred tax assets is due to the uncertainty of realizing the related benefits. Deferred tax liabilities decreased in 2009 primarily due to the sale of certain leverage leases in the Finance segment.
The following table presents the breakdown between current and long-term net deferred tax assets:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Current
  $ 315     $ 266  
Non-current
    600       698  
 
           
 
    915       964  
 
           
Finance group’s net deferred tax liability
    (136 )     (337 )
 
           
Net deferred tax asset
  $ 779     $ 627  
 
           
We have net operating loss and credit carryforwards at the end of each year as follows:
                 
    January 2,     January 3,  
(In millions)   2010     2009  
Non-U.S. net operating loss carryforwards with no expiration
  $ 157     $ 154  
Non-U.S. net operating loss carryforwards expiring through 2024
    18       34  
State credit carryforwards beginning to expire in 2018
    11       14  
The undistributed earnings of our non-U.S. subsidiaries approximated $335 million at January 2, 2010. We consider the undistributed earnings, on which taxes previously have not been provided, to be indefinitely reinvested; therefore, tax is not provided on these earnings. It is not practicable to estimate the amount of tax that might be payable on these earnings in the event they no longer are indefinitely reinvested.
Commitments and Contingencies
Commitments and Contingencies
Note 16. Commitments and Contingencies
We are subject to legal proceedings and other claims arising out of the conduct of our business, including proceedings and claims relating to commercial and financial transactions; government contracts; compliance with applicable laws and regulations; production partners; product liability; employment; and environmental, safety and health matters. Some of these legal proceedings and claims seek damages, fines or penalties in substantial amounts or remediation of environmental contamination. As a government contractor, we are subject to audits, reviews and investigations to determine whether our operations are being conducted in accordance with applicable regulatory requirements. Under federal government procurement regulations, certain claims brought by the U.S. Government could result in our being suspended or debarred from U.S. Government contracting for a period of time. On the basis of information presently available, we do not believe that existing proceedings and claims will have a material effect on our financial position or results of operations.
ARH Program Termination
On October 16, 2008, we received notification from the U.S. Department of Defense that it would not certify the continuation of the Armed Reconnaissance Helicopter (ARH) program to Congress under the Nunn-McCurdy Act, resulting in the termination of the program for the convenience of the government. The ARH program included a development phase, covered by the System Development and Demonstration (SDD) contract, and a production phase. We submitted our claim for the termination costs for the SDD contract in October 2009 and believe that these costs are fully recoverable from the U.S. Government.
Prior to termination of the program, we obtained inventory and incurred vendor obligations for long-lead time materials related to the anticipated Low Rate Initial Production (LRIP) contracts to maintain the program schedule based on our belief that the LRIP contracts would be awarded. We have since terminated these vendor contracts and are negotiating to settle our termination obligations. In October 2009, we filed a claim with the U.S. Government to request reimbursement of costs expended in support of the LRIP program. On December 17, 2009, we received a decision from the Contracting Officer of the Department of the Army that denied this claim in its entirety. We plan to appeal this decision in the first quarter of 2010. At January 2, 2010, our reserves related to this program totaled $50 million, which we believe are adequate to cover our exposure.
Environmental Remediation
As with other industrial enterprises engaged in similar businesses, we are involved in a number of remedial actions under various federal and state laws and regulations relating to the environment that impose liability on companies to clean up, or contribute to the cost of cleaning up, sites on which hazardous wastes or materials were disposed or released. Our accrued environmental liabilities relate to disposal costs, U.S. Environmental Protection Agency oversight costs, legal fees, and operating and maintenance costs for both currently and formerly owned or operated facilities. Circumstances that can affect the reliability and precision of the accruals include the identification of additional sites, environmental regulations, level of cleanup required, technologies available, number and financial condition of other contributors to remediation, and the time period over which remediation may occur. We believe that any changes to the accruals that may result from these factors and uncertainties will not have a material effect on our financial position or results of operations.
Based upon information currently available, we estimate that our potential environmental liabilities are within the range of $43 million to $173 million. At January 2, 2010, environmental reserves of approximately $77 million have been established to address these specific estimated potential liabilities, including $18 million for sites related to our discontinued operations. We estimate that we will likely pay our accrued environmental remediation liabilities over the next five to 10 years and have classified $15 million as current liabilities. Expenditures to evaluate and remediate contaminated sites for continuing operations approximated $7 million, $15 million and $7 million in 2009, 2008 and 2007, respectively, and discontinued operations expenditures totaled $4 million and $2 million in 2009 and 2008, respectively.
Leases
Rental expense approximated $100 million in 2009, $106 million in 2008 and $100 million in 2007. Future minimum rental commitments for noncancelable operating leases in effect at January 2, 2010 approximated $65 million for 2010, $51 million for 2011, $43 million for 2012, $33 million for 2013, $27 million for 2014 and a total of $167 million thereafter.
Loan Commitments
At January 2, 2010, the Finance group had $350 million of unused commitments to fund new and existing customers under revolving lines of credit, construction loans and equipment loans and leases. These commitments generally have an original duration of less than three years, and funding under these facilities is dependent on the availability of eligible collateral and compliance with customary financial covenants. Since many of the agreements will not be used to the extent committed or will expire unused, the total commitment amount does not necessarily represent future cash requirements. We also have ongoing customer relationships, including manufacturers and dealers in the distribution finance product line, which do not contractually obligate us to provide funding; however, we may choose to fund under certain of these relationships to facilitate an orderly liquidation and mitigate credit losses.
Research and Development
Research and Development
Note 17. Research and Development
Company-funded and customer-funded research and development costs are as follows:
                         
(In millions)   2009     2008     2007  
Company-funded
  $ 401     $ 465     $ 358  
Customer-funded
    443       501       446  
 
                 
Total research and development
  $ 844     $ 966     $ 804  
 
                 
Our customer-funded research and development costs primarily are related to U.S. Government contracts, including development contracts for the V-22, H-1, Intelligent Battlefield Systems and the Unmanned Aircraft System, and, prior to termination, the ARH and VH-71.
Guarantees and Indemnifications
Guarantees and Indemnifications
Note 18. Guarantees and Indemnifications
During 2009, we entered into contracts to sell used aircraft that entitle the customer to resell the aircraft back to us at predetermined values ranging from 80% to 100% of the customer’s purchase price for a limited period of time, generally not exceeding 24 months for used aircraft and 36 months for used fractional share interests. Revenue recognition on these sales has been deferred and totaled $186 million at January 2, 2010.
In connection with the disposition of certain businesses, we indemnified the purchasers for remediation costs related to pre-existing environmental conditions to the extent they exist at the sold locations and certain retained litigation matters. In addition, we have other obligations arising from sales of businesses, including representations and warranties and related indemnities for tax and employment matters. We have estimated the fair value of uncapped indemnifications at approximately $21 million, which is reflected as a liability in our Consolidated Balance Sheet. The maximum potential payment cannot be determined for these uncapped indemnifications, while the maximum potential payment related to capped obligations is $17 million. The fair value of the capped obligations is estimated to be insignificant. At January 2, 2010, we did not believe there were any capped or uncapped matters that could have a significant adverse effect on our financial position, results of operations or liquidity. During 2009 and 2008, we incurred approximately $5 million and $2 million, respectively, in environmental remediation costs related to these guarantees.
We enter into software license agreements with customers through our Overwatch Systems business. These software license agreements generally include certain provisions for indemnifying customers against liabilities if our software products infringe a third party’s intellectual property rights. To date, we have not incurred any material costs as a result of such indemnifications and have not accrued any liabilities related to such obligations. The risk that we will be required to perform on any of these indemnifications is low.
In June 2009, we received notification that the VH-71 helicopter program was terminated for convenience by the U.S. Government, and the related performance guarantee was canceled in October 2009.
Warranty and Product Maintenance Contracts
We provide limited warranty and product maintenance programs, including parts and labor, for certain prod