TEXTRON INC, 10-Q filed on 7/29/2010
Quarterly Report
Document and Entity Information (USD $)
In Millions, except Share data
Jul. 17, 2010
6 Months Ended
Jul. 3, 2010
Document and Entity Information [Abstract]
 
 
Entity Registrant Name
 
TEXTRON INC 
Entity Central Index Key
 
0000217346 
Document Type
 
10-Q 
Document Period End Date
 
07/03/2010 
Amendment Flag
 
FALSE 
Document Fiscal Year Focus
 
2010 
Document Fiscal Period Focus
 
Q2 
Current Fiscal Year End Date
 
01/01 
Entity Well-known Seasoned Issuer
 
Yes 
Entity Voluntary Filers
 
No 
Entity Current Reporting Status
 
Yes 
Entity Filer Category
 
Large Accelerated Filer 
Entity Public Float
 
$ 4.4 
Entity Common Stock, Shares Outstanding
274,212,816 
 
Consolidated Statements of Operations (Unaudited) (USD $)
In Millions, except Per Share data
3 Months Ended
Jul. 3, 2010
6 Months Ended
Jul. 3, 2010
3 Months Ended
Jul. 4, 2009
6 Months Ended
Jul. 4, 2009
Manufacturing group [Member]
 
 
 
 
Income (loss) from continuing operations
 
$ 155 
 
$ 99 
Income (loss) from discontinued operations, net of income taxes
 
(3)
 
47 
Net income (loss)
 
152 
 
146 
Finance group [Member]
 
 
 
 
Costs, expenses and other
 
 
 
 
Provision for losses on finance receivables
 
99 
 
163 
Income (loss) from continuing operations
 
(78)
 
(118)
Net income (loss)
 
(78)
 
(118)
Consolidated [Member]
 
 
 
 
Revenues
 
 
 
 
Manufacturing revenues
2,653 
4,787 
2,526 
4,930 
Finance revenues
56 
132 
86 
208 
Total revenues
2,709 
4,919 
2,612 
5,138 
Costs, expenses and other
 
 
 
 
Cost of sales
2,188 
3,963 
2,099 
4,097 
Selling and administrative expense
299 
585 
340 
686 
Provision for losses on finance receivables
44 
99 
87 
163 
Interest expense
69 
140 
77 
160 
Gain on sale of assets
 
 
 
(50)
Special charges
10 
22 
129 
161 
Total costs, expenses and other
2,610 
4,809 
2,732 
5,217 
Income (loss) from continuing operations before income taxes
99 
110 
(120)
(79)
Income tax expense (benefit)
18 
33 
(58)
(60)
Income (loss) from continuing operations
81 
77 
(62)
(19)
Income (loss) from discontinued operations, net of income taxes
(3)
47 
Net income (loss)
82 
74 
(58)
28 
Basic earnings per share
 
 
 
 
Continuing operations
0.30 
0.28 
(0.23)
(0.07)
Discontinued operations
 
(0.01)
0.01 
0.18 
Basic earnings per share
0.30 
0.27 
(0.22)
0.11 
Diluted earnings per share
 
 
 
 
Continuing operations
0.27 
0.26 
(0.23)
(0.07)
Discontinued operations
 
(0.01)
0.01 
0.18 
Diluted earnings per share
0.27 
0.25 
(0.22)
0.11 
Dividends per share
 
 
 
 
Common stock
$ 0.02 
$ 0.04 
$ 0.02 
$ 0.04 
Consolidated Balance Sheets (Unaudited) (USD $)
In Millions, except Share data in Thousands
Jul. 3, 2010
Jan. 2, 2010
Manufacturing group [Member]
 
 
Assets
 
 
Cash and equivalents
$ 1,021 
$ 1,748 
Accounts receivable, net
970 
894 
Inventories
2,480 
2,273 
Other current assets
1,125 
985 
Total current assets
5,596 
5,900 
Property, plant and equipment, less accumulated depreciation and amortization of $2,730 and $2,666
1,900 
1,968 
Goodwill
1,616 
1,622 
Other assets
1,887 
1,938 
Total assets
10,999 
11,428 
Liabilities
 
 
Current portion of long-term debt
136 
134 
Accounts payable
710 
569 
Accrued liabilities
1,807 
2,039 
Total current liabilities
2,653 
2,742 
Other liabilities
3,220 
3,253 
Long-term debt
2,900 
3,450 
Total liabilities
8,773 
9,445 
Finance group [Member]
 
 
Assets
 
 
Cash and equivalents
170 
144 
Finance receivables held for investment, net
4,725 
5,865 
Finance receivables held for sale
535 
819 
Other assets
694 
684 
Total assets
6,124 
7,512 
Liabilities
 
 
Other liabilities
1,039 
866 
Deferred income taxes
150 
136 
Debt
4,247 
5,667 
Total liabilities
5,436 
6,669 
Consolidated [Member]
 
 
Assets
 
 
Cash and equivalents
1,191 
1,892 
Total assets
17,123 
18,940 
Liabilities and shareholders' equity
 
 
Liabilities
 
 
Total liabilities
14,209 
16,114 
Shareholders' equity
 
 
Common stock
35 
35 
Capital surplus
1,331 
1,369 
Retained earnings
3,036 
2,973 
Accumulated other comprehensive loss
(1,335)
(1,321)
Total shareholders' equity including cost of treasury shares
3,067 
3,056 
Less cost of treasury shares
153 
230 
Total shareholders' equity
2,914 
2,826 
Total liabilities and shareholders' equity
17,123 
18,940 
Common shares outstanding (in thousands)
274,091 
272,272 
Consolidated Balance Sheets (Unaudited) (Parenthetical) (USD $)
In Millions
Jul. 3, 2010
Jan. 2, 2010
Manufacturing group [Member]
 
 
Assets
 
 
Accumulated depreciation and amortization
$ 2,730 
$ 2,666 
Consolidated Statements of Cash Flows (Unaudited) (USD $)
In Millions
6 Months Ended
Jul. 3, 2010
Jul. 4, 2009
Consolidated [Member]
 
 
Cash flows from operating activities:
 
 
Net income (loss)
$ 74 
$ 28 
Income (loss) from discontinued operations, net of income taxes
(3)
47 
Income (loss) from continuing operations
77 
(19)
Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used in) operating activities:
 
 
Non-cash items:
 
 
Depreciation and amortization
187 
197 
Provision for losses on finance receivables held for investment
99 
163 
Portfolio losses on finance receivables
50 
60 
Deferred income taxes
11 
(126)
Other, net
55 
69 
Changes in assets and liabilities:
 
 
Accounts receivable, net
(94)
70 
Inventories
(217)
75 
Other assets
127 
(12)
Accounts payable
152 
(382)
Accrued and other liabilities
(356)
(193)
Captive finance receivables, net
159 
84 
Other operating activities, net
 
22 
Net cash provided by (used in) operating activities of continuing operations
250 
Net cash used in operating activities of discontinued operations
(3)
(12)
Net cash provided by (used in) operating activities
247 
(4)
Cash flows from investing activities:
 
 
Finance receivables originated or purchased
(270)
(1,950)
Finance receivables repaid
990 
2,505 
Proceeds on receivables sales, including securitizations
343 
184 
Capital expenditures
(83)
(113)
Net cash used in acquisitions
(43)
 
Proceeds from sale of repossessed assets and properties
66 
127 
Other investing activities, net
36 
66 
Net cash provided by (used in) investing activities of continuing operations
1,039 
819 
Net cash provided by (used in) investing activities of discontinued operations
 
261 
Net cash provided by (used in) investing activities
1,039 
1,080 
Cash flows from financing activities:
 
 
Payments on long-term lines of credit
(502)
(28)
Principal payments on long-term debt
(1,491)
(1,435)
Proceeds from issuance of long-term debt
28 
16 
Decrease in short-term debt
 
(1,628)
Proceeds from long-term lines of credit
 
2,970 
Payments on borrowings against officers life insurance policies
 
(410)
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
 
Dividends paid
(11)
(10)
Net cash provided by (used in) financing activities of continuing operations
(1,974)
250 
Effect of exchange rate changes on cash and equivalents
(13)
12 
Net increase (decrease) in cash and equivalents
(701)
1,338 
Cash and equivalents at beginning of period
1,892 
547 
Cash and equivalents at end of period
1,191 
1,885 
Manufacturing group [Member]
 
 
Cash flows from operating activities:
 
 
Net income (loss)
152 
146 
Income (loss) from discontinued operations, net of income taxes
(3)
47 
Income (loss) from continuing operations
155 
99 
Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used in) operating activities:
 
 
Dividends received from the Finance group
215 
184 
Capital contribution paid to Finance group
(146)
(88)
Non-cash items:
 
 
Depreciation and amortization
170 
178 
Deferred income taxes
32 
(3)
Other, net
55 
108 
Changes in assets and liabilities:
 
 
Accounts receivable, net
(94)
70 
Inventories
(217)
81 
Other assets
122 
(44)
Accounts payable
152 
(382)
Accrued and other liabilities
(277)
(256)
Other operating activities, net
(1)
Net cash provided by (used in) operating activities of continuing operations
166 
(52)
Net cash used in operating activities of discontinued operations
(3)
(12)
Net cash provided by (used in) operating activities
163 
(64)
Cash flows from investing activities:
 
 
Capital expenditures
(83)
(113)
Net cash used in acquisitions
(43)
 
Other investing activities, net
(17)
(16)
Net cash provided by (used in) investing activities of continuing operations
(143)
(129)
Net cash provided by (used in) investing activities of discontinued operations
 
261 
Net cash provided by (used in) investing activities
(143)
132 
Cash flows from financing activities:
 
 
Payments on long-term lines of credit
(502)
(28)
Intergroup financing
(212)
133 
Principal payments on long-term debt
(11)
(30)
Decrease in short-term debt
 
(869)
Proceeds from long-term lines of credit
 
1,230 
Payments on borrowings against officers life insurance policies
 
(410)
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
 
Dividends paid
(11)
(10)
Net cash provided by (used in) financing activities of continuing operations
(734)
791 
Effect of exchange rate changes on cash and equivalents
(13)
Net increase (decrease) in cash and equivalents
(727)
865 
Cash and equivalents at beginning of period
1,748 
531 
Cash and equivalents at end of period
1,021 
1,396 
Finance group [Member]
 
 
Cash flows from operating activities:
 
 
Net income (loss)
(78)
(118)
Income (loss) from continuing operations
(78)
(118)
Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used in) operating activities:
 
 
Non-cash items:
 
 
Depreciation and amortization
17 
19 
Provision for losses on finance receivables held for investment
99 
163 
Portfolio losses on finance receivables
50 
60 
Deferred income taxes
(21)
(123)
Other, net
 
(39)
Changes in assets and liabilities:
 
 
Other assets
26 
Accrued and other liabilities
(79)
63 
Other operating activities, net
 
21 
Net cash provided by (used in) operating activities of continuing operations
(11)
72 
Net cash provided by (used in) operating activities
(11)
72 
Cash flows from investing activities:
 
 
Finance receivables originated or purchased
(471)
(2,234)
Finance receivables repaid
1,350 
2,873 
Proceeds on receivables sales, including securitizations
343 
184 
Proceeds from sale of repossessed assets and properties
66 
127 
Other investing activities, net
38 
61 
Net cash provided by (used in) investing activities of continuing operations
1,326 
1,011 
Net cash provided by (used in) investing activities
1,326 
1,011 
Cash flows from financing activities:
 
 
Intergroup financing
232 
(112)
Principal payments on long-term debt
(1,480)
(1,405)
Proceeds from issuance of long-term debt
28 
16 
Decrease in short-term debt
 
(759)
Proceeds from long-term lines of credit
 
1,740 
Capital contributions paid to Finance group
146 
88 
Dividends paid
(215)
(184)
Net cash provided by (used in) financing activities of continuing operations
(1,289)
(616)
Effect of exchange rate changes on cash and equivalents
 
Net increase (decrease) in cash and equivalents
26 
473 
Cash and equivalents at beginning of period
144 
16 
Cash and equivalents at end of period
$ 170 
$ 489 
Basis of Presentation
Basis of Presentation
Note 1: Basis of Presentation
Our consolidated financial statements include the accounts of Textron Inc. and its majority-owned subsidiaries. We have prepared these unaudited consolidated financial statements in accordance with accounting principles generally accepted in the U.S. for interim financial information. Accordingly, these interim financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. The consolidated interim financial statements included in this quarterly report should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended January 2, 2010. In the opinion of management, the interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for the fair presentation of our consolidated financial position, results of operations and cash flows for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. We have reclassified certain prior period amounts to conform to the current period 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 is also the Finance segment, consists of Textron Financial Corporation, its subsidiaries and the securitization trusts consolidated into it, along with three 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. All significant intercompany transactions are eliminated from the consolidated financial statements, including retail and wholesale financing activities for inventory sold by our Manufacturing group and financed by our Finance group.
Special Charges
Special Charges
Note 2: Special Charges
In the fourth quarter of 2008, we initiated a restructuring program to reduce overhead costs and improve productivity across the company and announced the exit of portions of our commercial finance business. Our restructuring program primarily includes corporate and segment direct and indirect workforce reductions and the consolidation of certain operations. By the end of 2010, we expect to have eliminated approximately 11,200 positions worldwide representing approximately 26% of our global workforce since the inception of the program. As of July 3, 2010, we have terminated approximately 10,800 employees and have exited 27 leased and owned facilities and plants under this program.
Since the inception of the restructuring program in the fourth quarter of 2008, we have incurred the following costs through July 3, 2010:
                                         
                            Contract    
    Severance   Curtailment   Asset   Terminations    
(In millions)   Costs   Charges, Net   Impairments   and Other   Total
 
Cessna
  $ 99     $ 26     $ 54     $ 9     $ 188  
Industrial
    22       (4 )     9       3       30  
Bell
    10                         10  
Textron Systems
    7       2             1       10  
Finance
    31       1       11       3       46  
Corporate
    38                   1       39  
 
 
  $ 207     $ 25     $ 74     $ 17     $ 323  
 
Restructuring costs by segment for the second quarter of 2010, compared with the second quarter of 2009, are as follows:
                                         
    Severance     Curtailment     Asset     Contract     Total  
(In millions)   Costs     Charges, Net     Impairments     Terminations     Restructuring  
 
Three Months Ended July 3, 2010
                                       
 
Cessna
  $ 6     $     $     $     $ 6  
Textron Systems
    1                         1  
Finance
    2                   1       3  
 
 
  $ 9     $     $     $ 1     $ 10  
 
 
                                       
Three Months Ended July 4, 2009
                                       
 
Cessna
  $ 38     $ 26     $ 52     $ 1     $ 117  
Industrial
    4       (4 )           1       1  
Textron Systems
    1       2                   3  
Finance
    4       1                   5  
Corporate
    3                         3  
 
 
  $ 50     $ 25     $ 52     $ 2     $ 129  
 
Restructuring costs by segment for the first half of 2010, compared with the first half of 2009, are as follows:
 
    Severance     Curtailment     Asset     Contract     Total  
(In millions)   Costs     Charges, Net     Impairments     Terminations     Restructuring  
 
Six Months Ended July 3, 2010
                                       
 
Cessna
  $ 14     $     $     $ 2     $ 16  
Bell
    1                         1  
Textron Systems
    1                         1  
Finance
    5                   1       6  
Corporate
    (2 )                       (2 )  
 
 
  $ 19     $     $     $ 3     $ 22  
 
 
                                       
Six Months Ended July 4, 2009
                                       
 
Cessna
  $ 64     $ 26     $ 52     $ 1     $ 143  
Industrial
    5       (4 )           1       2  
Textron Systems
    1       2                   3  
Finance
    6       1             1       8  
Corporate
    5                         5  
 
 
  $ 81     $ 25     $ 52     $ 3     $ 161  
 
An analysis of our restructuring reserve activity is summarized below:
                         
    Severance     Contract        
(In millions)   Costs     Terminations     Total  
 
Balance at January 2, 2010
  $ 48     $ 3     $ 51  
Provisions
    21       3       24  
Reversals
    (2 )           (2 )
Cash paid
    (28 )           (28 )  
 
Balance at July 3, 2010
  $ 39     $ 6     $   45  
 
We estimate that we will incur approximately $25 million in additional restructuring costs during the second half of 2010, primarily for consolidation and relocation costs of Cessna’s facilities and severance costs at the Cessna and Finance segments, most of which will result in future cash outlays. We expect that the program will be substantially completed in 2010; however, we expect to incur up to $7 million in 2011 related to exit of the non-captive portion of our commercial finance business primarily attributable to severance. Additionally, in connection with the liquidation of a Canadian entity within the Finance segment, we expect to take a non-cash after-tax charge of about $78 million to reclassify the entity’s cumulative currency translation adjustment amount within other comprehensive income to the income statement. Accordingly, the reclassification of this amount will have no impact on shareholders’ equity. The timing of this non-cash charge is expected to occur in the second half of 2010 once we have substantially liquidated the assets held by the entity.
Retirement Plans
Retirement Plans
Note 3: Retirement Plans
We provide defined benefit pension plans and other postretirement benefits to eligible employees. The components of net periodic benefit cost for these plans are as follows:
                                 
                    Postretirement Benefits  
    Pension Benefits Other Than Pensions
    July 3,     July 4,     July 3,     July 4,  
(In millions)   2010     2009     2010     2009  
 
Three Months Ended
                               
 
Service cost
  $ 31     $ 30     $ 2     $ 2  
Interest cost
    79       79       8       10  
Expected return on plan assets
    (92 )     (98 )            
Amortization of prior service cost (credit)
    4       4       (1 )     (2 )  
Amortization of net loss
    9       2       3       2  
 
Net periodic benefit cost
  $ 31     $ 17     $ 12     $ 12  
 
 
                               
Six Months Ended
                               
 
Service cost
  $ 62     $ 63     $ 4     $ 4  
Interest cost
    158       155       16       19  
Expected return on plan assets
    (184 )     (195 )            
Amortization of prior service cost (credit)
    8       9       (2 )     (3 )
Amortization of net loss
    18       8       6       4  
 
Net periodic benefit cost
  $ 62     $ 40     $ 24     $ 24  
 
Discontinued Operations
Discontinued Operations
Note 4: Discontinued Operations
On April 3, 2009, we sold HR Textron, an operating unit previously reported within the Textron Systems segment, for $376 million in net 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. Also, in the first quarter of 2009, we had a $34 million tax benefit from the reduction in tax contingencies as a result of the HR Textron sale and a valuation allowance reversal on a previously established deferred tax asset.
Comprehensive Income
Comprehensive Income
Note 5: Comprehensive Income
Our comprehensive income, net of taxes, is provided below:
                                 
    Three Months Ended   Six Months Ended
    July 3,     July 4,     July 3,     July 4,  
(In millions)   2010     2009     2010     2009  
 
Net income (loss)
  $ 82     $ (58 )   $ 74     $ 28  
Other comprehensive income (loss):
                               
Recognition of prior service cost and unrealized
losses on pension and postretirement benefits
    10       5       20       12  
Unrealized gain on pension, net of income taxes of $48
          82             82  
Pension curtailment, net of income taxes of $10
          15             15  
Deferred gains (losses) on hedge contracts
          38       7       30  
Net deferred loss on retained interests
          (7 )           (9 )  
Foreign currency translation and other
    (32 )     32       (41 )     34  
 
Comprehensive income
  $ 60     $ 107     $ 60     $ 192  
 
Income Tax Expense (Benefit)
Income Tax Expense (Benefit)
Note 6: Income Tax Expense (Benefit)
For the three and six months ended July 3, 2010, income tax expense for continuing operations totaled $18 million and $33 million, respectively, and equated to an effective income tax rate (provision on income) of 18.2% and 30.0%. In the second quarter of 2010, the rate was lower than the statutory rate primarily due to $10 million in benefits related to changes in the functional currency of two Canadian subsidiaries due to the termination of qualified business status for one subsidiary and a Quebec legislative change for another subsidiary. For the first half of 2010, the effective tax rate included the write-off of an $11 million deferred tax asset related to a change in the tax treatment of the Medicare Part D program related to U.S. health-care legislation enacted in the first quarter, partially offset by $10 million in benefits related to changes in the functional currency of two Canadian subsidiaries noted above.
For the three and six months ended July 4, 2009, the income tax (benefit) for continuing operations totaled $(58) million and $(60) million, respectively, and equated to an effective income tax rate (benefit on loss) of 48.3% and 75.9%. In the second quarter of 2009, the rate was higher than the statutory rate primarily due to a $5 million benefit on the reversal of a valuation allowance resulting from a change in management’s assessment of the realizability of a deferred tax asset in one of our Canadian subsidiaries and $3 million in research and development credits. For the first half of 2009, the effective tax rate included a $10 million benefit from the adoption, for Canadian tax purposes, of the U.S. dollar as the functional currency for a Canadian subsidiary, a $14 million reduction in unrecognized tax benefits due to the recognition of a capital gain in connection with the sale of CESCOM and a $7 million reduction in a valuation allowance related to contingent payments on a prior year transaction.
Earnings Per Share
Earnings Per Share
Note 7: Earnings Per Share
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. This method includes the weighted-average number of common shares outstanding during the period and restricted stock units to be paid in stock, which are deemed participating securities as they provide nonforfeitable rights to dividends. 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:
                                 
    Three Months Ended   Six Months Ended
    July 3,     July 4,     July 3,     July 4,  
(In thousands)   2010     2009     2010     2009  
 
Basic weighted-average shares outstanding
    274,098       264,091       273,636       255,261  
Dilutive effect of Convertible Notes, stock options and
warrants and restricted stock units
    28,299             28,133        
 
Diluted weighted-average shares outstanding
    302,397       264,091       301,769       255,261  
 
Stock options to purchase 6 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding for the three and six months ended July 3, 2010 as the exercise prices were greater than the average market price of our common stock for the periods. These securities may dilute earnings per share in the future. Diluted weighted-average shares outstanding for the three and six months ended July 4, 2009 equal basic weighted-average shares outstanding, as we incurred losses from continuing operations in each of these periods.
Accounts Receivable and Finance Receivables Held for Investment
Accounts Receivable and Finance Receivables Held for Investment
Note 8: Accounts Receivable and Finance Receivables Held for Investment
                 
    July 3,     January 2,  
(In millions)   2010     2010  
 
Accounts receivable - Commercial
  $   554     $ 470  
Accounts receivable - U.S. Government contracts
    436       447  
 
Gross accounts receivable
    990       917  
Allowance for doubtful accounts
    (20 )     (23 )
 
Accounts receivable, net
  $ 970     $ 894  
 
 
               
Finance receivables held for investment
  $ 5,077     $ 6,206  
Allowance for loan losses
    (352 )     (341 )  
 
Finance receivables held for investment, net
  $ 4,725     $ 5,865  
 
The activity in the Finance group’s allowances for loan losses is provided below:
                                 
    Three Months Ended   Six Months Ended
    July 3,     July 4,     July 3,     July 4,  
(In millions)   2010     2009     2010     2009  
 
Reserve at the beginning of period
  $ 365     $ 220     $ 341     $ 191  
Provision for losses
    44       87       99       163  
Net charge-offs
    (57 )     (23 )     (88 )     (70 )  
 
Reserve at the end of period
  $ 352     $ 284     $ 352     $ 284  
 
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 the lower of cost or 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. We do not use the cash basis method to recognize interest income on these receivables. Impaired accrual finance receivables represent loans with original terms that have been or are expected to be significantly modified to reflect deferred principal payments, generally at market interest rates, for which collection of principal and interest is not doubtful.
Our impaired finance receivables are as follows:
                 
    July 3,     January 2,  
(In millions)   2010     2010  
 
Impaired nonaccrual finance receivables
  $ 817     $ 984  
Impaired accrual finance receivables
    195       217  
 
Total impaired finance receivables
    1,012       1,201  
Less: Impaired finance receivables without identified reserve requirements
    293       362  
 
Impaired nonaccrual finance receivables with identified reserve requirements
  $ 719     $ 839  
 
Allowance for losses on impaired nonaccrual finance receivables
  $ 181     $ 153  
 
The average recorded investment in impaired nonaccrual finance receivables was $922 million and $417 million in the first half of 2010 and 2009, respectively. The average recorded investment in impaired accrual finance receivables amounted to $118 million and $62 million in the first half of 2010 and 2009, respectively.
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. At July 3, 2010 and January 2, 2010, nonaccrual finance receivables totaled $876 million and $1.04 billion, respectively. The reduction in nonaccrual finance receivables primarily reflects the resolution of several significant accounts through repossession of collateral, restructure of finance receivables and cash collections, partially offset by new finance receivables identified as nonaccrual in 2010.
Inventories
Inventories
Note 9: Inventories
                 
    July 3,     January 2,  
(In millions)   2010     2010  
 
Finished goods
  $   872     $ 735  
Work in process
    2,145       1,861  
Raw materials
    541       613  
 
 
    3,558       3,209  
Progress/milestone payments
    (1,078 )     (936 )  
 
 
  $ 2,480     $ 2,273  
 
Debt
Debt
Note 10: Debt
On May 5, 2009, we issued $600 million of 4.5% Convertible Senior Notes with a maturity date of May 1, 2013 as discussed in Note 8 to the Consolidated Financial Statements in Textron’s 2009 Annual Report on Form 10-K. For at least 20 trading days during the 30 consecutive trading days ended June 30, 2010, our common stock price exceeded the conversion threshold price set forth for these Convertible Notes of $17.06 per share. Accordingly, the notes are convertible at the holder’s option through September 30, 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 at least one year through the use of various funding sources available to us.
Guarantees and Indemnifications
Guarantees and Indemnifications
Note 11: Guarantees and Indemnifications
As disclosed under the caption “Guarantees and Indemnifications” in Note 18 to the Consolidated Financial Statements in Textron’s 2009 Annual Report on Form 10-K, we have issued or are party to certain guarantees. As of July 3, 2010, there has been no material change to these guarantees.
We provide limited warranty and product maintenance programs, including parts and labor, for certain products for periods ranging from one to five years. We estimate the costs that may be incurred under warranty programs and record a liability in the amount of such costs at the time product revenue is recognized. Factors that affect this liability include the number of products sold, historical and anticipated rates of warranty claims, and cost per claim. We assess the adequacy of our recorded warranty and product maintenance liabilities periodically and adjust the amounts as necessary. Additionally, we may establish warranty liabilities related to the issuance of aircraft service bulletins for aircraft no longer covered under the limited warranty programs.
Changes in our warranty and product maintenance liabilities are as follows:
                 
  Six Months Ended
    July 3,     July 4,  
(In millions)   2010     2009  
 
Accrual at the beginning of period
  $ 263     $ 278  
Provision
    83       81  
Settlements
    (113 )     (117 )
Adjustments to prior accrual estimates
          1  
 
Accrual at the end of period
  $ 233     $ 243  
 
Commitments and Contingencies
Commitments and Contingencies
Note 12: 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.
On April 6, 2010, a jury in the Philadelphia Common Pleas Court returned verdicts against Avco Corporation, which includes the Lycoming Engines operating division, for $24.7 million in compensatory damages and $64 million in punitive damages in an aviation products liability case involving a 1999 accident. Judgment has not been entered pending post-trial motions. While the ultimate outcome of the litigation cannot be assured, we strongly disagree with the verdicts and intend to appeal the verdicts if our post-trial motions are unsuccessful. We believe that it is probable that the verdicts will be reversed through the appellate process.
Derivative Instruments and Fair Value Measurements
Derivative Instruments and Fair Value Measurements
Note 13. Derivative Instruments and Fair Value Measurements
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. We prioritize the assumptions that market participants would use in pricing the asset or liability (the “inputs”) 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 exists, 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 only utilized 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
Our assets and liabilities that are recorded at fair value on a recurring basis consist of derivative financial instruments, which are categorized as Level 2 in the fair value hierarchy. The notional and fair value amounts of these instruments that are designated as hedging instruments are provided below:
                                     
      Notional Amount   Asset (Liability)
        July 3,     January 2,     July 3,     January 2,  
(In millions)   Borrowing Group   2010     2010     2010     2010  
 
Assets
                                   
Interest rate exchange contracts*
  Finance   $ 655     $ 1,333     $ 41     $ 43  
Cross-currency interest rate exchange contracts
  Finance     140       161       29       18  
Foreign currency exchange contracts
  Manufacturing     542       696       44       54  
 
Total
      $ 1,337     $ 2,190     $ 114     $ 115  
 
Liabilities
                                   
Interest rate exchange contracts*
  Finance   $ 366     $ 32     $ (8 )   $ (3 )
Foreign currency exchange contracts
  Manufacturing     22       80       (2 )     (5 )
 
Total
      $ 388     $ 112     $ (10 )   $ (8 )
 
*Represents a fair value hedge.
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, these instruments are included in either other assets or other liabilities.
The Finance group’s interest rate exchange contracts are not exchange-traded and 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 these 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 to a standard AA-rated counterparty; however, this had no significant impact on the valuation as of July 3, 2010.
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.
Fair Value Hedges
Our Finance group enters into interest rate exchange contracts 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 contracts, we are able to convert our fixed-rate cash flows to floating-rate cash flows. The amount of ineffectiveness on our fair value hedges is insignificant. The effect of these contracts is recorded in the Consolidated Statements of Operations, and the gain (loss) for each respective period is provided in the following table:
                                     
        Three Months Ended Six Months Ended
        July 3,     July 4,     July 3,     July 4,  
(In millions)   Gain (Loss) Location   2010     2009     2010     2009  
 
Interest rate exchange contracts
  Interest expense   $ 9     $ (19 )   $ 19     $ (15 )
Interest rate exchange contracts
  Finance charges     (7 )     8       (11 )     6  
 
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 July 3, 2010, we had an accumulated net deferred gain of $27 million in other comprehensive income (OCI) related to these cash flow hedges. As the underlying transactions occur, we expect to reclassify a $12 million gain into earnings in the next 12 months and $15 million of gains into earnings in the following 12-month period.
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. We record changes in the fair value of these contracts in OCI to the extent they are effective as cash flow hedges. 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. Currency effects on the effective portion of these hedges, which are reflected in the cumulative translation adjustment account within OCI, produced a $45 million after-tax gain in the first half of 2010, resulting in an accumulated net deferred gain of $33 million at July 3, 2010. There was no ineffectiveness related to these hedges in 2010.
For our cash flow hedges, the amount of gain (loss) recognized in OCI and the amount reclassified from accumulated other comprehensive loss into income for the Manufacturing group for the respective periods is provided in the following table:
                                     
    Amount of Gain (Loss)      
    Recognized in OCI   Effective Portion of Derivative Reclassified from
  (Effective Portion)   Accumulated Other Comprehensive Loss into Income
    July 3,     July 4,         July 3,     July 4,  
(In millions)   2010     2009     Gain (Loss) Location   2010     2009  
 
 
Three Months Ended
                                   
 
Foreign currency exchange contracts
  $ (1 )   $ 38     Cost of sales   $ 4     $ (4 )
Forward contracts for Textron stock
              Selling and administrative expense     (1 )     (2 )
 
 
Six Months Ended
                                   
 
Foreign currency exchange contracts
  $ 5     $ 31     Cost of sales   $ 7     $ (9 )
Forward contracts for Textron stock
          (4 )   Selling and administrative expense     (1 )     (4 )
 
Derivatives Not Designated as Hedges
The Manufacturing group enters into certain foreign currency exchange contracts 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 expense a gain of $6 million and $14 million for the three and six months ended July 3, 2010, respectively, and $8 million and $25 million for the three and six months ended July 4, 2009, respectively. These gains were offset by the revaluation of the intercompany financing transactions.
The Finance group also utilizes foreign currency exchange contracts that do not meet hedge accounting criteria and are intended to convert certain foreign currency denominated assets and liabilities into the functional currency of the respective legal entity. Gains and losses related to these derivative instruments are naturally offset by the translation of the related foreign currency denominated assets and liabilities. For these instruments, the Finance group reported in selling and administrative expense a gain (loss) of $4 million and $(3) million for the three and six months ended July 3, 2010, respectively, and a $52 million loss for the three and six months ended July 4, 2009. These gains (losses) were largely offset by gains (losses) resulting from the translation of foreign currency denominated assets and liabilities.
The notional and fair value amounts of the derivative instruments that are not designated as hedging instruments and are categorized as Level 2 in the fair value hierarchy are provided below:
                                     
        Notional Amount   Asset (Liability)
        July 3,     January 2,     July 3,     January 2,  
(In millions)   Borrowing Group   2010     2010     2010     2010  
 
Foreign currency exchange contracts
  Finance   $ 251     $ 531     $ 1     $ (13 )
Foreign currency exchange contracts
  Manufacturing     45       224       1       3  
 
Total
      $ 296     $ 755     $ 2     $ (10 )
 
Counterparty Credit Risk
Our exposure to loss from nonperformance by the counterparties to our derivative agreements at July 3, 2010 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.
Assets Recorded at Fair Value on a Nonrecurring Basis
The table below presents those assets that are measured at fair value on a nonrecurring basis that had fair value measurement adjustments during the first half of 2010 and 2009. These assets were measured using significant unobservable inputs (Level 3) and include the following:
                                 
                    Gain (Loss)
    Balance at   Six Months Ended
    July 3,     July 4,     July 3,     July 4,  
(In millions)   2010     2009     2010     2009  
 
Finance Group
                               
Finance receivables held for sale
  $    421     $      613     $     (15 )   $     (12 )
Impaired finance receivables
    519       451       (104 )     (117 )
Other assets
    87       185       (26 )     (22 )
Manufacturing Group
                               
Other assets
                      (43 )
 
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 July 3, 2010, finance receivables held for sale totaled $535 million and included portions of golf mortgage, distribution finance and asset-based lending portfolios, along with $119 million of captive finance receivables in the golf equipment portfolio. The majority of the finance receivables held for sale were identified at the individual loan level. Golf course 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. During the first quarter of 2010, we sold $208 million of finance receivables classified as held for sale in the distribution finance product line and recorded a $13 million gain related to this sale. Total gains related to receivable sales were $17 million for the first half of 2010.
In the first quarter of 2010, we increased the captive golf equipment finance receivables held for sale by $144 million to a total of $225 million, as a result of inquiries we received to purchase finance receivables in this portfolio. During the second quarter, we came to a preliminary agreement to sell approximately $120 million of these finance receivables; this sale is expected to close in the third quarter of 2010. As a result, we reclassified the remaining $105 million of captive finance receivables to held for investment. We believe this activity is consistent with our goal of maximizing the economic value of our portfolio.
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, to 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, which may differ from actual results. Impaired nonaccrual finance receivables represent assets recorded at fair value on a nonrecurring basis since the measurement of required reserves on these 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. Fair value measurements recorded on impaired finance receivables are recorded within provision for losses on finance receivables.
Other assets – Other assets in the Finance group include repossessed assets and properties, operating assets received in satisfaction of troubled finance receivables and other investments, which are accounted for under the equity method of accounting and have no active, quoted market prices. 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 our other investments, the discounted cash flow models incorporate assumptions specific to the nature of the investments’ business and underlying assets and include industry valuation benchmarks such as discount rates, capitalization rates and cash flow multiples. 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 earnings for the difference. For operating assets received in satisfaction of troubled finance receivables and other investments, if the sum of the undiscounted cash flows is estimated to be less than the carrying value, we record a charge to earnings for any shortfall between estimated fair value and the carrying amount.
For the Manufacturing group, in the second quarter of 2009, we recorded a $43 million impairment charge to write off capitalized costs that were no longer considered recoverable upon the cancellation of a development program at Cessna.
Financial Instruments Not Recorded at Fair Value
The carrying value and estimated fair values of our financial instruments that are not reflected in the financial statements at fair value are as follows:
                                 
    July 3, 2010   January 2, 2010
    Carrying     Estimated     Carrying     Estimated  
(In millions)   Value     Fair Value     Value     Fair Value  
 
Manufacturing Group
                               
Debt, excluding leases
  (2,926 )   $ (3,191 )   (3,474 )   $ (3,762 )
Finance Group
                               
Finance receivables held for investment, excluding leases
    4,193       3,830       5,159       4,703  
Retained interest in securitizations
                6       6  
Investment in other marketable securities
    59       57       68       55  
Debt
    (4,247 )     (4,081 )     (5,667 )     (5,439 )
 
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 used 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 amortized cost. The estimate of fair value was based on observable market inputs for similar securitization interests in markets that are currently inactive.
At July 3, 2010 and January 2, 2010, approximately 39% and 54%, 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.
Segment Information
Segment Information
Note 14: Segment Information
We operate in, and report financial information for, the following five business segments: Cessna, Bell, Textron Systems, Industrial and Finance. Segment profit is an important measure used for evaluating performance and for decision-making purposes. Segment profit for the manufacturing segments excludes interest expense, certain corporate expenses and special charges. The measurement for the Finance segment includes interest income and expense and excludes special charges. Provisions for losses on finance receivables involving the sale or lease of our products are recorded by the selling manufacturing division when our Finance group has recourse to the Manufacturing group.
Our revenues by segment and a reconciliation of segment profit to income (loss) from continuing operations before income taxes are as follows:
                                 
    Three Months Ended   Six Months Ended
    July 3,     July 4,     July 3,     July 4,  
(In millions)   2010     2009     2010     2009  
 
REVENUES
                               
Manufacturing Group
                               
Cessna
  $    635     $    871     $    1,068     $    1,640  
Bell
    823       670       1,441       1,412  
Textron Systems
    534       477       992       895  
Industrial
    661       508       1,286       983  
 
 
    2,653       2,526       4,787       4,930  
Finance Group
    56       86       132       208  
 
Total revenues
  $    2,709     $    2,612     $    4,919     $    5,138  
 
SEGMENT OPERATING PROFIT
                               
Manufacturing Group
                               
Cessna (a)
  $    3     $    48     $ (21 )   $    138  
Bell
    108       72       182       141  
Textron Systems
    70       55       125       107  
Industrial
    51       12       100       3  
 
 
    232       187       386       389  
Finance Group
    (71 )     (99 )     (129 )     (165 )
 
Segment profit
    161       88       257       224  
Special charges
    (10 )     (129 )     (22 )     (161 )
Corporate expenses and other, net
    (17 )     (45 )     (54 )     (80 )
Interest expense, net for Manufacturing group
    (35 )     (34 )     (71 )     (62 )
 
Income (loss) from continuing operations before income taxes
  $    99     $ (120 )   $    110     $ (79 )
 
(a)   During the first quarter of 2009, we sold the assets of CESCOM, Cessna’s aircraft maintenance tracking service line, resulting in a pre-tax gain of $50 million.