TEXTRON INC, 10-Q filed on 7/31/2009
Quarterly Report
Document and Company Information (USD $)
In Millions, except Share data
Jul. 18, 2009
6 Months Ended
Jul. 4, 2009
Document And Company Information [Abstract]
 
 
Entity Registrant Name
 
Textron Inc. 
Entity Central Index Key
 
0000217346 
Document Type
 
10-Q 
Document Period End Date
 
07/04/2009 
Amendment Flag
 
FALSE 
Amendment Description
 
N/A 
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
270,236,965 
 
Consolidated Statements of Operations (USD $)
In Millions, except Per Share data
3 Months Ended
Jul. 4, 2009
6 Months Ended
Jul. 4, 2009
3 Months Ended
Jun. 28, 2008
6 Months Ended
Jun. 28, 2008
Segment Manufacturing Group Member
 
 
 
 
Income (loss) from continuing operations
 
$ 99 
 
$ 440 
Income from discontinued operations, net of income taxes
 
47 
 
14 
Net income (loss)
 
146 
 
454 
Series A, $2.08 Preferred stock | Consolidated
 
 
 
 
Preferred Stock Dividends per share
0.52 
1.04 
0.52 
1.04 
Segment Finance Group Member
 
 
 
 
Provision for losses on finance receivables
 
163 
 
67 
Income (loss) from continuing operations
 
(118)
 
35 
Net income (loss)
 
(118)
 
35 
Consolidated
 
 
 
 
Manufacturing revenues
2,526 
4,930 
3,507 
6,599 
Finance revenues
86 
208 
177 
391 
Total revenues
2,612 
5,138 
3,684 
6,990 
Cost of sales
2,101 
4,100 
2,775 
5,209 
Selling and administrative
340 
686 
393 
784 
Interest expense, net
75 
157 
101 
216 
Provision for losses on finance receivables
87 
163 
40 
67 
Gain on sale of assets
(50)
Special charges
129 
161 
Total costs, expenses and other
2,732 
5,217 
3,309 
6,276 
Income (loss) from continuing operations before income taxes
(120)
(79)
375 
714 
Income tax expense (benefit)
(58)
(60)
125 
239 
Income (loss) from continuing operations
(62)
(19)
250 
475 
Income from discontinued operations, net of income taxes
47 
14 
Net income (loss)
(58)
28 
258 
489 
Basic earnings per share, Continuing operations
(0.23)
(0.07)
1.00 
1.90 
Basic earnings per share, Discontinued operations
0.01 
0.18 
0.03 
0.06 
Basic earnings per share
(0.22)
0.11 
1.03 
1.96 
Diluted earnings per share, Continuing operations
(0.23)
(0.07)
0.98 
1.87 
Diluted earnings per share, Discontinued operations
0.01 
0.18 
0.03 
0.05 
Diluted earnings per share
(0.22)
0.11 
1.01 
1.92 
Dividends per share of common stock
$ 0.02 
$ 0.04 
$ 0.23 
$ 0.46 
Series B, $1.40 Preferred stock | Consolidated
 
 
 
 
Preferred Stock Dividends per share
0.35 
0.70 
0.35 
0.70 
Consolidated Balance Sheets (USD $)
In Millions, except Share data
Jul. 4, 2009
Jan. 3, 2009
Consolidated
 
 
Cash and cash equivalents
$ 1,885 
$ 547 
Total assets
19,844 
20,031 
Total liabilities
16,924 
17,665 
Preferred stock
Common stock
35 
32 
Capital surplus
1,406 
1,229 
Retained earnings
3,043 
3,025 
Accumulated other comprehensive loss
(1,258)
(1,422)
Total shareholders' equity including cost of treasury shares
3,228 
2,866 
Less cost of treasury shares
308 
500 
Total shareholders' equity
2,920 
2,366 
Total liabilities and shareholders' equity
19,844 
20,031 
Common shares outstanding (in thousands)
270,051 
242,041 
Segment Manufacturing Group Member
 
 
Cash and cash equivalents
1,396 
531 
Accounts receivable, net
839 
894 
Inventories
3,001 
3,093 
Other current assets
471 
584 
Assets of discontinued operations
58 
334 
Total current assets
5,765 
5,436 
Property, plant and equipment, less accumulated depreciation and amortization of $2,574 and $2,436
2,005 
2,088 
Goodwill
1,697 
1,698 
Other assets
1,858 
1,465 
Total assets
11,325 
10,687 
Current portion of long-term debt and short-term debt
876 
Accounts payable
721 
1,101 
Accrued liabilities
2,193 
2,609 
Liabilities of discontinued operations
119 
195 
Total current liabilities
3,039 
4,781 
Other liabilities
2,892 
2,926 
Long-term debt
3,354 
1,693 
Total liabilities
9,285 
9,400 
Segment Finance Group Member
 
 
Cash and cash equivalents
489 
16 
Finance receivables held for investment, net
6,553 
6,724 
Finance receivables held for sale
613 
1,658 
Other assets
864 
946 
Total assets
8,519 
9,344 
Other liabilities
376 
540 
Deferred income taxes
206 
337 
Debt
7,057 
7,388 
Total liabilities
$ 7,639 
$ 8,265 
Consolidated Balance Sheets (Parenthetical) (USD $)
In Millions
Jul. 4, 2009
Jan. 3, 2009
Segment Manufacturing Group Member
 
 
Accumulated depreciation and amortization
$ 2,574 
$ 2,436 
Consolidated Statements of Cash Flows (USD $)
In Millions
6 Months Ended
Jul. 4, 2009
Jun. 28, 2008
Consolidated
 
 
Net income (loss)
$ 28 
$ 489 
Income from discontinued operations
47 
14 
Income (loss) from continuing operations
(19)
475 
Depreciation and amortization
197 
199 
Provision for losses on finance receivables held for investment
163 
67 
Portfolio losses on finance receivables
60 
Asset impairment charges
52 
Gains on extinguishment of debt
(39)
Share-based compensation
18 
27 
Amortization of interest expense on convertible notes
Deferred income taxes
(126)
(33)
Accounts receivable, net
70 
(90)
Inventories
75 
(644)
Other assets
(12)
103 
Accounts payable
(382)
229 
Accrued and other liabilities
(193)
19 
Captive finance receivables, net
84 
23 
Other operating activities, net
55 
19 
Net cash provided by (used in) operating activities of continuing operations
394 
Net cash used in operating activities of discontinued operations
(12)
(31)
Net cash provided by (used in) operating activities
(4)
363 
Finance receivables originated or purchased
(1,950)
(5,818)
Finance receivables repaid
2,505 
5,257 
Proceeds on receivables sales, including securitizations
184 
507 
Net cash used in acquisitions
(100)
Capital expenditures
(113)
(194)
Proceeds from sale of property, plant and equipment
Proceeds from sale of repossessed assets and properties
127 
Purchase of marketable securities
(100)
Other investing activities, net
64 
(1)
Net cash provided by (used in) investing activities of continuing operations
819 
(439)
Net cash provided by (used in) investing activities of discontinued operations
261 
(6)
Net cash provided by (used in) investing activities
1,080 
(445)
Increase (decrease) in short-term debt
(1,628)
34 
Proceeds from long-term lines of credit
2,970 
Payments on long-term lines of credit
(28)
Proceeds from issuance of long-term debt
16 
1,122 
Principal payments on long-term debt
(1,435)
(933)
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
38 
Purchases of Textron common stock
(134)
Dividends paid
(10)
(106)
Net cash provided by (used in) financing activities of continuing operations
250 
21 
Net cash used in financing activities of discontinued operations
(2)
Net cash provided by (used in) financing activities
250 
19 
Effect of exchange rate changes on cash and cash equivalents
12 
12 
Net increase (decrease) in cash and cash equivalents
1,338 
(51)
Cash and cash equivalents at beginning of period
547 
531 
Cash and cash equivalents at end of period
1,885 
480 
Manufacturing group
 
 
Net income (loss)
146 
454 
Income from discontinued operations
47 
14 
Income (loss) from continuing operations
99 
440 
Dividends received from the Finance group
184 
142 
Capital contribution paid to Finance group
(88)
Depreciation and amortization
178 
180 
Asset impairment charges
52 
Share-based compensation
18 
27 
Amortization of interest expense on convertible notes
Deferred income taxes
(3)
Accounts receivable, net
70 
(90)
Inventories
81 
(632)
Other assets
(44)
76 
Accounts payable
(382)
229 
Accrued and other liabilities
(256)
27 
Other operating activities, net
34 
28 
Net cash provided by (used in) operating activities of continuing operations
(52)
435 
Net cash used in operating activities of discontinued operations
(12)
(31)
Net cash provided by (used in) operating activities
(64)
404 
Net cash used in acquisitions
(100)
Capital expenditures
(113)
(188)
Proceeds from sale of property, plant and equipment
Other investing activities, net
(18)
Net cash provided by (used in) investing activities of continuing operations
(129)
(287)
Net cash provided by (used in) investing activities of discontinued operations
261 
(6)
Net cash provided by (used in) investing activities
132 
(293)
Increase (decrease) in short-term debt
(869)
82 
Proceeds from long-term lines of credit
1,230 
Payments on long-term lines of credit
(28)
Principal payments on long-term debt
(30)
(47)
Payments on borrowings against officers life insurance policies
(410)
Intergroup financing
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
38 
Purchases of Textron common stock
(134)
Dividends paid
(10)
(106)
Net cash provided by (used in) financing activities of continuing operations
791 
(167)
Net cash used in financing activities of discontinued operations
(2)
Net cash provided by (used in) financing activities
791 
(169)
Effect of exchange rate changes on cash and cash equivalents
11 
Net increase (decrease) in cash and cash equivalents
865 
(47)
Cash and cash equivalents at beginning of period
531 
471 
Cash and cash equivalents at end of period
1,396 
424 
Segment Finance Group
 
 
Net income (loss)
(118)
35 
Income (loss) from continuing operations
(118)
35 
Depreciation and amortization
19 
19 
Provision for losses on finance receivables held for investment
163 
67 
Portfolio losses on finance receivables
60 
Gains on extinguishment of debt
(39)
Deferred income taxes
(123)
(41)
Other assets
26 
20 
Accrued and other liabilities
63 
(8)
Other operating activities, net
21 
(9)
Net cash provided by (used in) operating activities of continuing operations
72 
83 
Net cash provided by (used in) operating activities
72 
83 
Finance receivables originated or purchased
(2,234)
(6,338)
Finance receivables repaid
2,873 
5,690 
Proceeds on receivables sales, including securitizations
184 
617 
Capital expenditures
(6)
Proceeds from sale of repossessed assets and properties
127 
Purchase of marketable securities
(100)
Other investing activities, net
61 
(6)
Net cash provided by (used in) investing activities of continuing operations
1,011 
(134)
Net cash provided by (used in) investing activities
1,011 
(134)
Increase (decrease) in short-term debt
(759)
(48)
Proceeds from long-term lines of credit
1,740 
Proceeds from issuance of long-term debt
16 
1,122 
Principal payments on long-term debt
(1,405)
(886)
Intergroup financing
(112)
Capital contributions paid to Finance group
88 
Dividends paid
(184)
(142)
Net cash provided by (used in) financing activities of continuing operations
(616)
46 
Net cash provided by (used in) financing activities
(616)
46 
Effect of exchange rate changes on cash and cash equivalents
Net increase (decrease) in cash and cash equivalents
473 
(4)
Cash and cash equivalents at beginning of period
16 
60 
Cash and cash equivalents at end of period
$ 489 
$ 56 
Basis Of Presentation
Basis of Presentation
Note 1: Basis of Presentation
Our consolidated financial statements include the accounts of Textron Inc. and all of its majority-owned subsidiaries, along with any variable interest entities for which we are the primary beneficiary. 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 3, 2009. 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 evaluated subsequent events up to the time of our filing with the Securities and Exchange Commission on July 31, 2009, which is the date that these financial statements were issued.
Our financings are conducted through two separate borrowing groups. The Manufacturing group consists of Textron Inc. consolidated with all of its majority-owned subsidiaries that operate in the Cessna, Bell, Textron Systems and Industrial segments, except for the entities comprising the Finance group. The Finance group consists of Textron Financial Corporation along with the entities consolidated into it. 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 that is financed by our Finance group.
As discussed in Note 4: Discontinued Operations, 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.
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, 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 the first half of 2009 to include additional workforce reductions, primarily at Cessna, and the cancellation of the Citation Columbus development project. We expect to eliminate approximately 10,000 positions worldwide representing approximately 23% of our global workforce at the inception of the program. As of July 4, 2009, we have exited 11 owned and leased facilities and plants under this program.
Restructuring costs by segment are as follows:
                                         
    Severance   Curtailment   Contract   Asset   Total
(In millions)   Costs   Charges, Net   Terminations   Impairments   Restructuring
 
Three Months Ended July 4, 2009
                                       
 
Cessna
  $ 38     $ 26     $ 1     $ 52     $ 117  
Industrial
    4       (4 )     1             1  
Finance
    4       1                   5  
Corporate
    3                         3  
Textron Systems
    1       2                   3  
 
 
  $ 50     $ 25     $ 2     $ 52     $ 129  
 
 
                                       
Six Months Ended July 4, 2009
                                       
 
Cessna
  $ 64     $ 26     $ 1     $ 52     $ 143  
Industrial
    5       (4 )     1             2  
Finance
    6       1       1             8  
Corporate
    5                         5  
Textron Systems
    1       2                   3  
 
 
  $ 81     $ 25     $ 3     $ 52     $ 161  
 
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. These net curtailment charges are based primarily on the headcount reductions through the end of the second quarter. 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. We will continue to evaluate additional workforce reductions as they take place to assess additional potential curtailments that may occur.
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 cancelled 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 is considered not to be recoverable.
Since inception of the program, we have incurred $225 million in restructuring costs with $124 million in severance, $72 million in non-cash asset impairment charges, $25 million in net pension and other postretirement benefit plan curtailment non-cash charges and $4 million in contract termination costs. Of these amounts, $148 million was incurred at Cessna, $35 million in the Finance segment, $27 million in the Industrial segment, $11 million at Corporate and $4 million at Textron Systems.
An analysis of the restructuring program and related reserve account is summarized below:
                                         
    Severance   Curtailment   Contract   Asset    
(In millions)   Costs   Charges, Net   Terminations   Impairment   Total
 
Balance at January 3, 2009
  $ 36     $     $ 1     $     $ 37  
Provisions
    81       25       3       52       161  
Non-cash settlement
          (25 )           (52 )     (77 )
Cash paid
    (65 )           (1 )           (66 )
 
Balance at July 4, 2009
  $ 52     $     $ 3     $     $ 55  
 
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 $55 million is adequate to cover the costs presently accruable relating to activities formally identified and committed to under approved plans as of July 4, 2009 and anticipate that all actions related to these liabilities will be completed within a 12-month period. We estimate that we will incur approximately $40 million in additional pre-tax restructuring costs in 2009 that will result in future cash outlays, primarily attributable to severance payments related to additional workforce reductions throughout the company. We expect that the program will be substantially completed by the end of 2009.
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 4,     June 28,     July 4,     June 28,  
(In millions)   2009     2008     2009     2008  
 
Three Months Ended
                               
 
Service cost
  $ 30     $ 35     $ 2     $ 3  
Interest cost
    79       76       10       10  
Expected return on plan assets
    (98 )     (101 )            
Amortization of prior service cost (credit)
    4       5       (2 )     (2 )
Amortization of net loss
    2       5       2       4  
 
Net periodic benefit cost
  $ 17     $ 20     $ 12     $ 15  
 
 
                               
Six Months Ended
                               
 
Service cost
  $ 63     $ 71     $ 4     $ 5  
Interest cost
    155       152       19       21  
Expected return on plan assets
    (195 )     (203 )            
Amortization of prior service cost (credit)
    9       10       (3 )     (3 )
Amortization of net loss
    8       9       4       8  
 
Net periodic benefit cost
  $ 40     $ 39     $ 24     $ 31  
 
Due to the magnitude of the workforce reductions under the restructuring program discussed in Note 2: Special Charges, in the second quarter of 2009, we determined that a curtailment had occurred in certain pension and other postretirement benefit plans. Accordingly, we recorded a net curtailment charge of $25 million, reflecting the recognition of prior service cost of $30 million related to the pension plans and $5 million of prior service credits related to other postretirement benefit plans. In addition, we re-measured the plans that had the curtailments and revised our assumptions accordingly. The discount rate for these plans was increased from 6.25% to 7.0%, while other assumptions remained consistent with year-end assumptions. As a result of the curtailment and revised discount rate, we recorded a reduction in our unrealized losses of approximately $130 million through other comprehensive loss.
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 cash. The sale resulted in an after-tax gain of $7 million and net after-tax proceeds of approximately $275 million.
In November 2008, we completed the sale of our Fluid & Power business unit and received approximately $527 million in cash, a six-year note with a face value of $28 million and may receive up to $50 million based on final 2008 operating results that would be primarily payable in a six-year note. During the first quarter of 2009, the final settlement of this transaction was extended until later this year.
Results of our discontinued businesses are as follows:
                                 
    Three Months Ended   Six Months Ended
    July 4,     June 28,     July 4,     June 28,  
(In millions)   2009     2008     2009     2008  
 
Revenue
  $     $ 236     $ 48     $ 447  
 
Income (loss) from discontinued operations before income taxes
  $     $ 14     $ (1 )   $ 25  
Income tax expense (benefit)
    (4 )     6       (41 )     11  
 
 
                               
 
    4       8       40       14  
Gain on sale, net of income taxes
                7        
 
Income from discontinued operations, net of income taxes
  $ 4     $ 8     $ 47     $ 14  
 
In the first half 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 for the periods is provided below:
                                 
    Three Months Ended   Six Months Ended
    July 4,     June 28,     July 4,     June 28,  
(In millions)   2009     2008     2009     2008  
 
Net income (loss)
  $ (58 )   $ 258     $ 28     $ 489  
Other comprehensive income, net of income taxes:
                               
Unrealized gain on pension, net of income taxes of $48
    82             82        
Pension curtailment, net of income taxes of $10
    15             15        
Recognition of prior service cost and unrealized losses on pension and postretirement benefits
    5       10       12       20  
Deferred gains (losses) on hedge contracts
    38             30       (17 )
Net deferred loss on retained interests
    (7 )     (1 )     (9 )      
Foreign currency translation and other
    32       13       34       (5 )
 
Comprehensive income
  $ 107     $ 280     $ 192     $ 487  
 
Earnings Per Share
Earnings per Share
Note 6: Earnings per 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 computation of basic earnings per share pursuant to the two-class method. In 2008, we granted restricted stock units that include nonforfeitable rights to dividends once declared. Accordingly, with the adoption of this new standard, these restricted stock units are considered participating securities and are included in our calculation of basic earnings per share using the two-class method.
Prior period basic and diluted weighted-average shares outstanding have been recast to conform to the new calculation. The adoption of this standard resulted in a $0.01 reduction in diluted earnings per share from continuing operations for the second quarter of 2008, and had no impact on the first half of 2008.
We calculate basic and diluted earnings per share based on income available to common shareholders, which approximates net income for each period, and the restricted stock unit participating securities. We use the weighted-average number of common shares outstanding during the period and the 2008 restricted stock units discussed above for the computation of basic earnings per share using the two-class method. Diluted earnings per share includes the dilutive effect of convertible preferred shares, stock options and restricted stock units in the weighted-average number of common shares outstanding. The 2008 restricted stock units are included in the diluted weighted-average shares outstanding by virtue of their inclusion in basic weighted-average shares outstanding using the two-class method as described above. This result is more dilutive than if we had used the treasury stock method to calculate diluted weighted-average shares outstanding for these restricted stock units.
The weighted-average shares outstanding for basic and diluted earnings per share are as follows:
                                 
    Three Months Ended   Six Months Ended
    July 4,   June 28,   July 4,   June 28,
(In thousands)   2009   2008   2009   2008
 
Basic weighted-average shares outstanding
    264,091       250,039       255,261       249,674  
Dilutive effect of convertible preferred shares, stock options and restricted stock units
          4,541             4,917  
 
Diluted weighted-average shares outstanding
    264,091       254,580       255,261       254,591  
 
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. A weighted average of approximately 11 million units of restricted stock and options to purchase common stock were anti-dilutive for the three and six months ended July 4, 2009, and were not included in the computation of diluted earnings per share for these periods. These securities could potentially dilute basic earnings per share in the future.
On May 5, 2009, we issued 4.50% Convertible Senior Notes (the “Notes”) due 2013, as discussed in Note 9: Debt. In connection with the issuance of these notes, we entered into a warrant transaction with the note underwriters to sell common stock warrants. The initial strike price of these warrants is $15.75 per share of our common stock and the warrants cover an aggregate of 45,714,300 shares of our common stock. If our closing stock price exceeds this strike price, this number of shares will be dilutive. It is our intention to settle the face value of the Notes in cash upon conversion/maturity.
Concurrently with the offering and sale of the Notes, we also offered and sold to the public under the Textron Inc. registration statement 23,805,000 shares of our common stock for net proceeds of approximately $238 million, after deducting discounts, commissions and expenses.
Accounts Receivable Finance Receivables and Securitizations
Accounts Receivable Finance Receivables and Securitizations
Note 7: Accounts Receivable, Finance Receivables and Securitizations
Accounts Receivable
                 
    July 4,   January 3,
(In millions)   2009   2009
 
Accounts receivable – Commercial
  $ 474     $ 496  
Accounts receivable – U.S. Government contracts
    391       422  
 
 
    865       918  
Allowance for doubtful accounts
    (26 )     (24 )
 
 
  $ 839     $ 894  
 
Finance Receivables
We evaluate finance receivables on a managed as well as owned basis since we retain subordinated interests in finance receivables sold in securitizations resulting in credit risk. In contrast, 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. Our Finance group manages and services finance receivables for a variety of investors, participants and third-party portfolio owners. A reconciliation of our managed and serviced finance receivables to finance receivables held for investment, net is provided below:
                 
    July 4,   January 3,
(In millions)   2009   2009
 
Total managed and serviced finance receivables
  $ 9,868     $ 12,173  
Less: Nonrecourse participations sold to independent investors
    (793 )     (820 )
Less: Third-party portfolio servicing
    (430 )     (532 )
 
Total managed finance receivables
    8,645       10,821  
Less: Securitized receivables
    (1,195 )     (2,248 )
 
Owned finance receivables
    7,450       8,573  
Less: Finance receivables held for sale
    (613 )     (1,658 )
 
Finance receivables held for investment
    6,837       6,915  
Allowance for loan losses
    (284 )     (191 )
 
Finance receivables held for investment, net
  $ 6,553     $ 6,724  
 
Finance receivables held for investment at July 4, 2009 and January 3, 2009 include approximately $0.6 billion and $1.1 billion, respectively, of finance receivables that have been legally sold to special purpose entities and are consolidated subsidiaries of Textron Financial Corporation. The assets of these special purpose entities are pledged as collateral for $484 million and $853 million of debt at July 4, 2009 and January 3, 2009, respectively, which is reflected as securitized on-balance sheet debt.
In connection with our fourth quarter 2008 plan to exit portions of the commercial finance business, we classified certain finance receivables as held for sale. Following an effort to market the portfolios held for sale and the progress made in liquidating our portfolios, we believe that we will be able to maximize the economic value of a portion of the finance receivables held for sale through orderly liquidation rather than selling the portfolios. Accordingly, since we now intend to hold a portion of these finance receivables for the foreseeable future, we have reclassified $654 million and $65 million, net of valuation allowances, from the held for sale classification to held for investment during the first and second quarter of 2009, respectively. The remaining balance of these reclassified finance receivables was $697 million, net of a $144 million valuation allowance at July 4, 2009.
We periodically evaluate finance receivables, excluding homogeneous loan portfolios and finance leases, for impairment. A loan 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 loans are classified as either nonaccrual or accrual loans. Nonaccrual loans include accounts that are contractually delinquent by more than three months for which the accrual of interest income is suspended. Impaired accrual loans 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.
At July 4, 2009, impaired loans include $585 million of nonaccrual loans for which we have established specific reserves of $134 million based on our review of the loan and the estimated fair value of the collateral. At January 3, 2009, we established $43 million in specific reserves on $182 million of nonaccrual loans. The impaired loans included within finance receivables held for investment are as follows:
                 
    July 4,   January 3,
(In millions)   2009   2009
 
Impaired nonaccrual loans
  $ 629     $ 234  
Impaired accrual loans
    96       19  
 
Total impaired loans
  $ 725     $ 253  
 
Nonaccrual finance receivables include impaired nonaccrual loans and accounts in homogeneous loan portfolios that are contractually delinquent by more than three months. At July 4, 2009 and January 3, 2009, nonaccrual finance receivables totaled $683 million and $277 million, respectively. The increase is primarily attributable to the lack of liquidity available to borrowers within the resort finance business and to a significant increase in delinquent accounts, combined with weakening collateral values in the captive finance business.
Securitizations
Our Finance group has historically sold its distribution finance receivables to a qualified special purpose trust through securitization transactions. Distribution finance receivables represent loans secured by dealer inventories that typically are collected upon the sale of the underlying product. The distribution finance revolving securitization trust is a master trust that purchases inventory finance receivables from the Finance group and issues asset-backed notes to investors. Through a revolving securitization, the proceeds from collection of the principal balance of these loans can be used by the trust to purchase additional distribution finance receivables from us each month. Proceeds from securitizations include amounts received related to the incremental increase in the issuance of additional asset-backed notes to investors, and exclude amounts received related to the ongoing replenishment of the outstanding sold balance of these short-duration finance receivables. In the first half of 2009, we had no proceeds from securitizations, compared with $250 million in the first half of 2008.
Generally, we retain an interest in the assets sold in the form of servicing responsibilities and subordinated interests, including interest-only securities, seller certificates and cash reserves. We had $110 million and $191 million of retained interests on our Consolidated Balance Sheets associated with $1.2 billion and $2.2 billion of off-balance sheet finance receivables in the distribution finance securitization trust as of July 4, 2009 and January 3, 2009, respectively. At July 4, 2009, the trust had $1.2 billion in asset-backed notes. Cash received on retained interests totaled $42 million and $29 million in the first half of 2009 and 2008, respectively. Total net pre-tax gains (losses), including impairments were $(20) million and $15 million in the second quarter of 2009 and 2008, respectively, and $(27) million and $30 million, in the first half of 2009 and 2008, respectively. See Note 12: Fair Values of Assets and Liabilities for disclosure of the fair value estimates for retained interests in securitizations and the impairments recorded on the interest-only securities and other retained interests in the first half of 2009.
Inventories
Inventories
Note 8: Inventories
                 
    July 4,   January 3,
(In millions)   2009   2009
 
Finished goods
  $ 1,281     $ 1,081  
Work in process
    1,850       1,866  
Raw materials
    623       765  
 
 
    3,754       3,712  
Progress/milestone payments
    (753 )     (619 )
 
 
  $ 3,001     $ 3,093  
 
Debt
Debt
Note 9: Debt
4.50% Convertible Senior Notes
On May 5, 2009, we issued $600 million of 4.50% Convertible Senior Notes (the “Notes”). The Notes have a maturity date of May 1, 2013 and interest is payable semi-annually on May 1 and November 1. The Notes are convertible, under certain circumstances, at the holder’s option, into shares of our common stock, at an initial conversion rate of 76.1905 shares of common stock per $1,000 principal amount of 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 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 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 ten consecutive trading day measurement period in which the trading price per $1,000 principal amount of 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. As of July 4, 2009, none of the conditions permitting conversion of the Notes had been satisfied.
The net proceeds from the issuance of the Notes totaled approximately $582 million after deducting discounts, commissions and expenses. The 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 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 Notes which increases the effective interest rate of the 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 Notes, we entered into convertible note hedge transactions with two counterparties, including an underwriter and an affiliate of an underwriter, of the Notes, for purposes of reducing the potential dilutive effect upon the conversion of the Notes. 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 Notes) and is subject to certain customary adjustments. The convertible note hedge transactions cover 45,714,300 shares of common stock, subject to anti-dilution 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 $10 million for these Notes in the second quarter of 2009. As of July 4, 2009, the unamortized discount amount was $144 million, resulting in a net carrying value of $456 million for the liability component.
Credit facility
On July 14, 2009, a newly formed, wholly-owned finance subsidiary of Textron entered into a credit agreement with the Export-Import Bank of the United States which establishes 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.
Guarantees And Indemnifications
Guarantees and Indemnifications
Note 10: Guarantees and Indemnifications
As disclosed under the caption “Guarantees and Indemnifications” in Note 18 to the Consolidated Financial Statements in Textron’s 2008 Annual Report on Form 10-K, we have issued or are party to certain guarantees, including a performance guarantee related to the VH-71 helicopter program. In June 2009, we received notification that the VH-71 helicopter program was terminated for convenience by the U.S. Government. As of July 4, 2009, there has been no other material change to our guarantees.
Warranty and Product Maintenance Programs
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.
Changes in our warranty and product maintenance liabilities are as follows:
                 
    Six Months Ended
    July 4,   June 28,
(In millions)   2009   2008
 
Accrual at the beginning of period
  $ 278     $ 312  
Provision
    81       95  
Settlements
    (117 )     (96 )
Adjustments to prior accrual estimates
    1       (8 )
Other adjustments
          (3 )
 
Accrual at the end of period
  $ 243     $ 300  
 
Commitments And Contingencies
Commitments and Contingencies
Note 11: 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.
The Internal Revenue Service (IRS) has challenged our tax positions related to certain lease transactions within the Finance segment. During the third quarter of 2008, the IRS made a settlement offer to numerous companies, including Textron, to resolve the disputed tax treatment of these leases. Based on the terms of the offer and our decision to accept the offer, we revised our estimate of this tax contingency. Final resolution of this matter will result in the acceleration of future cash payments to the IRS, which we expect will occur over a period of years in connection with the conclusion of IRS examinations of the relevant tax years. At July 4, 2009, $198 million of federal tax liabilities were recorded on our Consolidated Balance Sheet related to these leases.
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 are in the process of establishing the termination costs for the SDD contract, which we believe will be 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 have initiated negotiations to settle our termination obligations, which we estimate may cost up to approximately $80 million. We continue to evaluate the utility of the related inventory to other Bell programs, customers, or vendors. This review and the related discussions with vendors are ongoing. We estimate that our potential loss resulting from our LRIP-related vendor obligations will be between approximately $50 million and $80 million. At July 4, 2009, our reserves related to this program totaled $50 million. We intend to provide a termination proposal or separate claim to the U.S. Government to request reimbursement of costs expended in support of the LRIP program.
Fair Values Of Assets And Liabilities
Fair Values of Assets and Liabilities
Note 12: 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. 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
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.
                                                 
    July 4, 2009   January 3, 2009
(In millions)   (Level 1)     (Level 2)     (Level 3)     (Level 1)     (Level 2)     (Level 3)  
 
Assets
                                               
Manufacturing group
                                               
Foreign currency exchange contracts
  $     $ 25     $     $     $ 2     $  
Finance group
                                               
Derivative financial instruments, net
          60                   112        
Interest-only securities
                3                   12  
 
Total assets
  $     $ 85     $ 3     $     $ 114     $ 12  
 
Liabilities
                                               
Manufacturing group
                                               
Forward contracts for Textron Inc. stock
  $ 7     $     $     $ 98     $     $  
Foreign currency exchange contracts
          8                   84        
 
Total liabilities
  $ 7     $ 8     $     $ 98     $ 84     $  
 
The table below presents the change in fair value measurements for our interest-only securities that used significant unobservable inputs
(Level 3):
                                 
    Three   Six
    Months Ended   Months Ended
    July 4,   June 28,   July 4,   June 28,
(In millions)   2009   2008   2009   2008
 
Balance, beginning of period
  $ 3     $ 52     $ 12     $ 43  
Net gains for the period:
                               
Increase due to securitization gains on sale of finance receivables
          21             42  
Change in value recognized in Finance revenues
                      1  
Change in value recognized in other comprehensive income
    2       (2 )     (1 )      
Impairments recognized in earnings
    (2 )           (8 )      
Collections
          (18 )           (33 )
 
Balance, end of period
  $ 3     $ 53     $ 3     $ 53  
 
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 in 2009. These assets were measured using significant unobservable inputs (Level 3) and include the following as of July 4, 2009:
         
(In millions)        
 
Finance group
       
Finance receivables held for sale
  $ 613  
Impaired loans
    451  
Retained interests in securitizations, excluding interest-only securities
    110  
Other assets
    75  
 
Finance Receivables Held for Sale - Finance receivables held for sale are recorded at the lower of cost or fair value. We recorded a $12 million increase to the valuation allowance for the held for sale portfolio to reflect changes in fair value in the first half of 2009, of which $11 million was recorded in the second quarter of 2009. There was no change to the methodology used to determine fair value for these receivables during 2009. See Note 7: Accounts Receivable, Finance Receivables and Securitizations, regarding the change in classification of certain finance receivables from held for sale to held for investment in 2009.
Impaired Loans - Loan impairment is measured by comparing the expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the loan 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 loans and the underlying collateral, which may differ from actual results. The measurement of required reserves on these loans is largely dependent on significant unobservable inputs including the fair value of the underlying collateral, which are determined utilizing either appraisals, industry pricing guides, input from market participants, our recent experience selling similar assets or internally developed discounted cash flow models. Fair market value adjustments totaled $85 million in the second quarter of 2009 and $117 million in the first half of 2009, primarily related to initial fair value adjustments for loans impaired during the respective period.
Retained Interests in Securitizations, Excluding Interest-only Securities — Retained interests in securitizations represent our subordinated interest in finance receivables sold to qualified special purpose trusts. The portion of our retained interests related to interest-only securities is recorded at fair value on a recurring basis, while the remaining retained interests are recorded at fair value on a nonrecurring basis. We estimate fair value upon the initial recognition of the retained interest based on the present value of expected future cash flows using our best estimates of key assumptions — credit losses, prepayment speeds, forward interest rate yield curves and discount rates commensurate with the risks involved. These inputs are classified as Level 3 since they reflect our own judgment regarding the assumptions market participants would use in pricing these assets based on the best information available in the circumstances as there is no active market for these assets.
We review the fair values of the retained interests using a discounted cash flow model and updated assumptions, and compare such amounts with the carrying value. At July 4, 2009, the key economic assumptions used in measuring the retained interests related to the distribution finance revolving securitization included an annual rate for expected credit losses of 2.85%, a monthly payment rate of 12.1% and a residual cash flow discount rate of 12.9%. Net charge-offs as a percentage of distribution finance receivables was 3.81% for first half of 2009, compared with 1.94% for the full year of 2008. The 60+ days contractual delinquency percentage for distribution finance receivables was 5.74% and 2.08% at July 4, 2009 and January 3, 2009, respectively.
During the second quarter of 2009, we recognized a $31 million other-than-temporary impairment of our retained interests, excluding interest-only securities. Of this amount, $18 million was charge to income primarily due to credit losses, representing a decrease in cash flows expected to be collected on these interests for the distribution finance revolving securitization. The remaining $13 million impairment charge was recognized in other comprehensive income as it is attributable to an increase in market discount rates. Since we have the intent and ability to hold these retained interests to maturity, changes in market discount rates do not affect our ultimate realization of our investment.
Other assets — Other assets include repossessed assets and properties and operating assets received in satisfaction of troubled finance receivables. The fair value of repossessed assets and properties and operating assets received in satisfaction of troubled finance receivables 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. Fair value measurements recorded during the three and six months ended July 4, 2009 on these assets resulted in an $18 million and $22 million charge, respectively, recorded to Finance revenues in the Consolidated Statement of Operations.
In connection with the cancellation of the Citation Columbus development program, we recorded a $43 million in impairment charge 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 2: Special Charges for more detail regarding these charges.
Assets and Liabilities 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 4, 2009   January 3, 2009
    Carrying   Estimated   Carrying   Estimated
(In millions)   Value   Fair Value   Value   Fair Value
 
Manufacturing group
                               
Debt
  $ (3,265 )   $ (2,954 )   $ (2,438 )   $ (2,074 )
Finance group
                               
Finance receivables held for investment
    5,615       4,747       5,665       4,828  
Retained interest in securitizations, excluding interest only securities
    6       6       188       178  
Investment in other marketable securities
    80       60       95       78  
Debt
    (7,057 )     (6,087 )     (7,388 )     (6,507 )
 
In accordance with disclosure requirements, debt and finance receivables held for investment in the table above exclude leases. 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.
In the second quarter of 2009, certain retained interests in securitizations were recorded at fair value as discussed in the preceding section and, accordingly, are not reflected in the above table.
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 are currently inactive.
At July 4, 2009 and January 3, 2009, approximately 63% 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.
Derivatives
Derivatives
Note 13: Derivatives
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.
Cash Flow Hedges
We experience variability in the cash flows we receive from our Finance group’s investments in interest-only securities due to fluctuations in interest rates. To mitigate our exposure to this variability, our Finance group enters into interest rate exchange, cap and floor agreements. The combination of these instruments converts net residual floating-rate cash flows expected to be received by our Finance group to fixed-rate cash flows. Changes in the fair value of these instruments are recorded net of the income taxes in other comprehensive income (OCI).
Our exposure to loss from nonperformance by the counterparties to our derivative agreements at July 4, 2009 is minimal. We do not anticipate nonperformance by counterparties in the periodic settlements of amounts due. We have historically 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 recent uncertainty in the financial markets has negatively affected the bond ratings of all of our counterparties, and we continuously monitor our exposures to ensure that we limit our risks. The credit risk generally is limited to the amount by which the counterparties’ contractual obligations exceed our obligations to the counterparty.
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 4, 2009, we had a deferred gain of $4 million in OCI related to these cash flow hedges, which we expect to reclassify into earnings in the next 18 months as the underlying transactions occur.
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 $33 million after-tax loss, leaving an accumulated net loss balance of $17 million. We recorded a $1 million after tax gain in selling and administrative expenses in the first half of 2009 on the ineffective portion of these hedges.
Stock-Based Compensation Hedges
We manage 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.
Fair Values of Derivative Instruments
                                 
    Assets   Liabilities
    July 4,   January 3,   July 4,   January 3,
(In millions)   2009   2009   2009   2009
 
Derivatives designated as hedging instruments
                               
Fair value hedges
                               
Finance group
                               
Interest rate exchange contracts
  $ 65     $ 112     $ (12 )   $ (7 )
 
Total fair value hedges
    65       112       (12 )     (7 )
 
Cash flow hedges
                               
Manufacturing group
                               
Foreign currency exchange contracts
    18       2       (8 )     (41 )
Forward contracts for Textron Inc. stock
                (7 )     (98 )
Finance group
                               
Cross-currency interest rate exchange contracts
    12       21       (1 )     (1 )
 
Total cash flow hedges
    30       23       (16 )     (140 )
 
Total derivatives designated as hedging instruments
  $ 95     $ 135     $ (28 )   $ (147 )
 
Derivatives not designated as hedging instruments
                               
Manufacturing group
                               
Foreign currency exchange contracts
  $ 7     $     $     $ (43 )
Finance group
                               
Foreign currency exchange contracts
                (7 )      
Interest rate exchange contracts
                      (13 )
 
Total derivatives not designated as hedging instruments
  $ 7     $     $ (7 )   $ (56 )
 
The fair values of derivative instruments for the Manufacturing group are included in either other current assets or accrued liabilities on our Consolidated Balance Sheets. For the Finance group, they are included in either other assets or other liabilities.
The effect of derivative instruments designated as fair value hedges is recorded in the Consolidated Statements of Operations. The gain (loss) for each respective period is provided in the following table:
                                         
            Three Months Ended   Six Months Ended
            July 4,   June 28,   July 4,   June 28,
(In millions)   Gain (Loss) Location   2009   2008   2009   2008
 
Finance group
                                       
Interest rate exchange contracts
  Interest expense, net   $ (19 )   $ (37 )   $ (15 )   $ 13  
Interest rate exchange contracts
  Finance charges     8       1       6       (1 )
 
For our cash flow hedges, the amount of gain (loss) reclassified from accumulated other comprehensive income into income (the effective portion) is provided in the following table:
                                         
            Three Months Ended   Six Months Ended
(In millions)   Gain (Loss) Location   July 4,
2009
  June 28,
2008
  July 4,
2009
  June 28,
2008
 
Manufacturing group
                                       
Foreign currency exchange contracts
  Cost of sales   $ (4 )   $ 1     $ (9 )   $ 4  
Forward contracts for Textron Inc. stock
  Selling and administrative     (2 )     2       (4 )     6  
 
The amount of ineffectiveness on our fair value and cash flow hedges is insignificant. The amount of gain (loss) in accumulated other comprehensive income (the effective portion) at the end of each period is provided below:
                 
    July 4,   June 28,
(In millions)   2009   2008
 
Manufacturing group
               
Foreign currency exchange contracts
  $ 8     $ 21  
Forward contracts for Textron Inc. stock
    (4 )      
 
We also enter into certain 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 a gain in selling and administrative expenses of $8 million and $25 million for the three and six months ended July 4, 2009, respectively, and a loss of $2 million and $10 million for the three and six months ended June 28, 2008. Our Finance group reported a loss of $52 million in selling and administrative expenses for the three and six months ended July 4, 2009 and a $3 million loss for the six months ended June 28, 2008.
Recently Issued Accounting Pronouncements
Recently Issued Accounting Pronouncements
Note 14: Recently Issued Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 166, “Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140.” This standard eliminates the concept of a qualifying special-purpose entity (QSPE) and its exclusion from consolidation by the primary beneficiary in that variable interest entity (VIE) or the transferor of financial assets to the VIE. The new accounting guidance also requires that former QSPEs be reevaluated for consolidation. This standard is effective beginning in the first quarter of 2010 and early application is prohibited. The adoption of this standard may result in the consolidation of our off-balance sheet securitization trusts, which hold our securitized finance receivables and debt. As our off balance-sheet securitization trusts are winding down in conjunction with our liquidation plan, we are currently assessing the impact the adoption of this standard may have on our financial position, results of operations and liquidity when we are required to adopt it next year.
Also in June 2009, the FASB Issued SFAS No. 167, “Amendments to FASB Interpretation No 46(R).” This standard changes the approach to determining the primary beneficiary of a VIE and requires companies to more frequently assess whether they must consolidate VIEs. This standard is effective beginning in the first quarter of 2010 and early application is prohibited. The adoption of this standard is not expected to have any significant impact on our financial position or results of operations.
Segment Information
Segment Information
Note 15: 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 from continuing operations before income taxes are as follows:
                                 
    Three Months Ended   Six Months Ended
    July 4,     June 28,     July 4,     June 28,  
(In millions)   2009     2008     2009     2008  
 
REVENUES
                               
MANUFACTURING:
                               
Cessna
  $ 871     $ 1,501     $ 1,640     $ 2,747  
Bell
    670       698       1,412       1,272  
Textron Systems
    477       467       895       986  
Industrial
    508       841       983       1,594  
 
 
    2,526       3,507       4,930       6,599  
FINANCE
    86       177       208       391  
 
Total revenues
  $ 2,612     $ 3,684     $ 5,138     $ 6,990  
 
SEGMENT OPERATING PROFIT
                               
MANUFACTURING:
                               
Cessna (a)
  $ 48     $ 262     $ 138     $ 469  
Bell
    72       68       141       121  
Textron Systems
    55       60       107       127  
Industrial
    12       44       3       85  
 
 
    187       434       389       802  
FINANCE
    (99 )     13       (165 )     55  
 
Segment profit
    88       447       224       857  
Special charges
    (129 )           (161 )      
Corporate expenses and other, net
    (45 )     (43 )     (80 )     (84 )
Interest expense, net for Manufacturing group
    (34 )     (29 )     (62 )     (59 )
 
Income (loss) from continuing operations before income taxes
  $ (120 )   $ 375     $ (79 )   $ 714  
 
 
(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.