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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL QUARTER ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27559
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TEXTRON FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
DELAWARE 05-6008768
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
40 WESTMINSTER STREET, P.O. BOX 6687, PROVIDENCE, R.I. 02940-6687
(401) 621-4200
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
All of the shares of common stock of the registrant are owned by Textron
Inc.
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TEXTRON FINANCIAL CORPORATION
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Income for the three
and nine months ended September 30, 2002 and 2001
(unaudited)............................................ 2
Condensed Consolidated Balance Sheets at September 30,
2002 and December 29, 2001 (unaudited)................. 3
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2002 and 2001
(unaudited)............................................ 4
Condensed Consolidated Statements of Changes in
Shareholder's Equity through September 30, 2002
(unaudited)............................................ 5
Notes to Condensed Consolidated Financial Statements
(unaudited)............................................ 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................. 15
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK......................................... 22
Item 4. CONTROLS AND PROCEDURES............................. 22
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.................... 23
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TEXTRON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2002 2001 2002 2001
-------- -------- -------- --------
(IN THOUSANDS)
REVENUES
Finance charges and discounts.................... $110,988 $133,039 $321,621 $401,811
Rental revenues on operating leases.............. 6,325 4,505 20,530 13,881
Other income..................................... 39,030 40,342 107,290 96,882
-------- -------- -------- --------
156,343 177,886 449,441 512,574
EXPENSES
Interest......................................... 49,570 66,248 144,726 214,006
Selling and administrative....................... 39,280 41,155 122,805 113,970
Provision for losses............................. 44,380 20,498 99,766 43,387
Depreciation of equipment on operating leases.... 3,347 1,885 10,311 5,609
Special charges.................................. -- 833 -- 2,686
-------- -------- -------- --------
136,577 130,619 377,608 379,658
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES, DISTRIBUTIONS ON
PREFERRED SECURITIES AND CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE................... 19,766 47,267 71,833 132,916
Income taxes....................................... 7,120 16,984 25,750 49,067
Distributions on preferred securities (net of tax
benefits of $198, $195, $589 and $609,
respectively).................................... 368 372 1,093 1,078
-------- -------- -------- --------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE............................. 12,278 29,911 44,990 82,771
Cumulative effect of change in accounting principle
(net of tax benefit of $8,278)................... -- -- 15,372 --
-------- -------- -------- --------
NET INCOME......................................... $ 12,278 $ 29,911 $ 29,618 $ 82,771
======== ======== ======== ========
See notes to condensed consolidated financial statements (unaudited).
2
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 29,
2002 2001
------------- ------------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and equivalents........................................ $ 18,499 $ 18,489
Finance receivables, net of unearned income:
Installment contracts..................................... 2,381,904 2,047,088
Revolving loans........................................... 1,291,305 1,578,922
Golf course and resort mortgages.......................... 938,065 811,951
Distribution finance receivables.......................... 764,493 474,391
Finance leases............................................ 451,542 318,859
Leveraged leases.......................................... 416,874 404,423
---------- ----------
Total finance receivables......................... 6,244,183 5,635,634
Allowance for losses on receivables....................... (152,079) (143,756)
---------- ----------
Finance receivables -- net........................ 6,092,104 5,491,878
Equipment on operating leases -- net........................ 202,485 201,060
Goodwill.................................................... 180,843 203,564
Other assets................................................ 535,130 548,967
---------- ----------
Total assets...................................... $7,029,061 $6,463,958
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
LIABILITIES
Accrued interest and other liabilities...................... $ 352,886 $ 341,394
Amounts due to Textron Inc. ................................ 42,881 29,985
Deferred income taxes....................................... 405,521 357,324
Note payable to Textron Inc. ............................... -- 510,000
Other debt.................................................. 5,212,232 4,188,420
---------- ----------
Total liabilities................................. 6,013,520 5,427,123
---------- ----------
Textron Financial and Litchfield obligated mandatory
redeemable preferred securities of trust subsidiary
holding solely Litchfield junior subordinated
debentures................................................ 27,083 27,480
SHAREHOLDER'S EQUITY
Common stock ($100 par value, 4,000 shares authorized; 2,500
shares issued and outstanding)............................ 250 250
Capital surplus............................................. 573,676 573,676
Investment in parent company preferred stock................ (25,000) (25,000)
Accumulated other comprehensive loss........................ (16,308) (18,793)
Retained earnings........................................... 455,840 479,222
---------- ----------
Total shareholder's equity........................ 988,458 1,009,355
---------- ----------
Total liabilities and shareholder's equity........ $7,029,061 $6,463,958
========== ==========
See notes to condensed consolidated financial statements (unaudited).
3
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
2002 2001
----------- -----------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 29,618 $ 82,771
Adjustments to reconcile net income to net cash provided by
operating activities:
Cumulative effect of change in accounting principle, net
of tax benefit......................................... 15,372 --
Provision for losses...................................... 99,766 43,387
Deferred income tax provision............................. 46,776 21,767
Depreciation.............................................. 21,061 14,061
Amortization.............................................. 7,349 15,829
(Decrease) increase in accrued interest and other
liabilities............................................ (29,748) 36,859
Gains on securitizations.................................. (32,734) (31,669)
Other..................................................... (2,447) (23,004)
----------- -----------
Net cash provided by operating activities......... 155,013 160,001
CASH FLOWS FROM INVESTING ACTIVITIES:
Finance receivables originated or purchased................. (6,678,683) (5,676,749)
Finance receivables repaid.................................. 5,653,361 4,344,874
Proceeds from receivable sales, including securitizations... 440,613 1,230,292
Acquisitions, net of cash acquired.......................... -- (387,524)
Proceeds from disposition of operating leases and other
assets.................................................... 35,712 9,794
Purchase of assets for operating leases..................... (47,243) (9,390)
Proceeds from real estate owned............................. 6,188 --
Other capital expenditures.................................. (13,322) (10,520)
Other investments........................................... 27,159 (5,052)
----------- -----------
Net cash used in investing activities............. (576,215) (504,275)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt.................... 1,379,829 847,275
Principal payments on long-term debt........................ (937,900) (619,434)
Net increase (decrease) in commercial paper................. 606,703 (60,064)
Net (decrease) increase in other short-term debt............ (536,944) 51,284
Proceeds from issuance of nonrecourse debt.................. -- 233,879
Principal payments on nonrecourse debt...................... (52,181) (85,866)
Net increase in amounts due to Textron Inc. ................ 12,896 2,682
Capital contributions from Textron Inc. .................... 6,758 46,756
Dividends paid to Textron Inc. ............................. (57,505) (40,456)
----------- -----------
Net cash provided by financing activities......... 421,656 376,056
Effect of exchange rate changes on cash..................... (444) --
----------- -----------
NET INCREASE IN CASH........................................ 10 31,782
Cash and equivalents at beginning of period................. 18,489 6,498
----------- -----------
Cash and equivalents at end of period....................... $ 18,499 $ 38,280
=========== ===========
See notes to condensed consolidated financial statements (unaudited).
4
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
(UNAUDITED)
INVESTMENT ACCUMULATED
IN PARENT OTHER
COMMON CAPITAL COMPANY COMPRE- RETAINED
STOCK SURPLUS PREF. STOCK HENSIVE LOSS EARNINGS TOTAL
------ -------- ----------- ------------ -------- ----------
BALANCE DECEMBER 30, 2000..... $250 $533,676 $(25,000) -- $400,751 $ 909,677
Comprehensive income:
Net income.................. -- -- -- -- 120,571 120,571
Other comprehensive income
(loss), net of income
taxes:
Unrealized net losses on
hedge contracts........ -- -- -- $(19,359) -- (19,359)
Unrealized net gains on
interest-only
securities............. -- -- -- 566 -- 566
-------- ----------
Other comprehensive loss.... -- -- -- (18,793) -- (18,793)
----------
Comprehensive income.......... -- -- -- -- -- 101,778
Capital contributions from
Textron Inc................. -- 49,010 -- -- -- 49,010
Dividends to Textron Inc...... -- (9,010) -- -- (42,100) (51,110)
---- -------- -------- -------- -------- ----------
BALANCE DECEMBER 29, 2001..... 250 573,676 (25,000) (18,793) 479,222 1,009,355
Comprehensive income:
Net income.................. -- -- -- -- 29,618 29,618
Other comprehensive income
(loss), net of income
taxes:
Foreign currency
translation
adjustments............ -- -- -- (2,552) -- (2,552)
Unrealized net losses on
hedge contracts........ -- -- -- (171) -- (171)
Unrealized net gains on
interest-only
securities............. -- -- -- 5,208 -- 5,208
-------- ----------
Other comprehensive
income................... -- -- -- 2,485 -- 2,485
----------
Comprehensive income.......... -- -- -- -- -- 32,103
Capital contributions to
Textron Inc................. -- 6,758 -- -- -- 6,758
Dividends to Textron Inc...... -- (6,758) -- -- (53,000) (59,758)
---- -------- -------- -------- -------- ----------
BALANCE SEPTEMBER 30, 2002.... $250 $573,676 $(25,000) $(16,308) $455,840 $ 988,458
==== ======== ======== ======== ======== ==========
See notes to condensed consolidated financial statements (unaudited).
5
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The financial statements should be read in conjunction with the financial
statements included in Textron Financial Corporation's Annual Report on Form
10-K for the year ended December 29, 2001. The accompanying unaudited
consolidated financial statements include the accounts of Textron Financial
Corporation (Textron Financial or the Company) and its subsidiaries. All
significant intercompany transactions are eliminated. The consolidated financial
statements are unaudited and reflect all adjustments (consisting only of normal
recurring adjustments) which are, in the opinion of management, necessary for a
fair presentation of Textron Financial's consolidated financial position at
September 30, 2002 and December 29, 2001, and its consolidated results of
operations and cash flows for each of the respective three- and nine-month
periods ended September 30, 2002 and 2001. The results of operations for the
interim periods are not necessarily indicative of the results to be expected for
the full year. Certain prior year balances have been reclassified to conform to
the current year presentation.
NOTE 2. OTHER INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------- ----------------------
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2002 2001 2002 2001
--------- --------- --------- ---------
Securitization gains............. $13,496 $18,108 $ 32,734 $31,669
Servicing fees................... 7,182 4,443 19,680 11,484
Investment income................ 4,214 4,635 14,599 12,092
Prepayment gains................. 3,397 3,924 8,265 9,015
Late charges..................... 2,320 2,665 7,338 7,548
Syndication income............... 1,541 2,666 5,459 9,060
Other............................ 6,880 3,901 19,215 16,014
------- ------- -------- -------
Total other income..... $39,030 $40,342 $107,290 $96,882
======= ======= ======== =======
The Other component of Other income includes custodial fees, commitment
fees, residual gains, insurance fees and other miscellaneous fees, which are
primarily recognized as income when received.
Cash collections on current and prior period securitization gains were $9.7
million and $11.7 million for the three-month periods ended September 30, 2002
and September 30, 2001, respectively, and $25.6 million and $17.5 million for
the nine-month periods ended September 30, 2002 and September 30, 2001,
respectively.
6
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 3. ALLOWANCE FOR LOSSES ON RECEIVABLES
NINE MONTHS TWELVE MONTHS
ENDED ENDED
SEPT. 30, DEC. 29,
2002 2001
----------- -------------
(IN THOUSANDS)
Balance at beginning of period..................... $ 143,756 $115,953
Provision for losses............................... 99,766 81,679
Receivable charge-offs............................. (100,941) (82,272)
Recoveries......................................... 7,071 7,823
Acquisitions and other............................. 2,427 20,573
--------- --------
Balance at end of period........................... $ 152,079 $143,756
========= ========
NOTE 4. MANAGED AND SERVICED FINANCE RECEIVABLES
Textron Financial manages finance receivables for a variety of investors,
participants and third-party portfolio owners.
SEPT. 30, DEC. 29,
2002 2001
---------- ----------
(IN THOUSANDS)
Owned receivables.................................... $6,244,183 $5,635,634
Securitized receivables.............................. 2,184,025 2,332,025
---------- ----------
Total managed finance receivables.................. 8,428,208 7,967,659
Nonrecourse participations........................... 433,988 591,853
Third-party portfolio servicing...................... 533,683 740,246
SBA sales agreements................................. 58,528 49,338
---------- ----------
Total managed and serviced finance receivables..... $9,454,407 $9,349,096
========== ==========
Nonrecourse participations consist of undivided interests in loans
originated by Textron Financial, primarily in vacation interval resorts and golf
finance, which are sold to independent investors.
The third-party portfolio servicing amounts largely represent finance
receivable portfolios of resort developers and third-party securitizations as
well as banks and leasing companies.
Owned receivables include approximately $50 million of noncash finance
receivables which were unfunded at September 30, 2002, as a result of holdback
arrangements. The corresponding liability is included in Accrued interest and
other liabilities on the Condensed Consolidated Balance Sheets.
NOTE 5. LOAN IMPAIRMENT
Textron Financial periodically evaluates finance receivables, excluding
homogeneous loan portfolios and finance leases, for impairment. A loan is
considered impaired when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Impairment is measured by comparing the fair value of a loan to its
carrying cost. Fair value is based on the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's observable
market price or, if the loan is collaterally dependent, at the fair value of the
collateral. If the fair value of the loan is less than its carrying amount, the
Company establishes a reserve based on this difference. This evaluation is
7
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
inherently subjective, as it requires estimates, including the amount and timing
of future cash flows expected to be received on impaired loans, that may differ
from actual results.
The Company suspends the accrual of interest income for accounts that are
contractually delinquent by more than three months, unless collection is not
doubtful. In addition, detailed reviews of loans may result in earlier
suspension if collection is doubtful. Cash payments on nonaccrual accounts,
including finance charges, generally are applied to reduce principal. The
Company had $165.1 million of nonaccrual finance receivables at September 30,
2002, compared to $113.8 million at December 29, 2001. Nonaccrual finance
receivables resulted in Textron Financial's revenues being reduced by
approximately $12.5 million and $7.0 million for the first nine months of 2002
and 2001, respectively. No interest income was recognized using the cash basis
method. Excluding homogeneous loan portfolios and finance leases, the Company
had impaired loans of $108.7 million and $53.9 million at September 30, 2002 and
December 29, 2001, respectively. Impaired loans with identified reserve
requirements were $89.0 million and $53.9 million at September 30, 2002 and
December 29, 2001, respectively. The allowance for losses on receivables related
to impaired loans with identified reserve requirements was $20.0 million and
$10.9 million at September 30, 2002 and December 29, 2001, respectively. The
average recorded investment in impaired loans during the first nine months of
2002 was $90.3 million, compared to $56.7 million in the corresponding period in
2001.
NOTE 6. GOODWILL
On December 30, 2001, Textron Financial adopted SFAS No. 142, "Goodwill and
Other Intangible Assets," which requires companies to stop amortizing goodwill
and certain intangible assets with indefinite useful lives, and requires an
annual review for impairment. Upon adoption, Textron Financial discontinued the
amortization of goodwill. Goodwill amortization expense for the three- and
nine-month periods ended September 30, 2001, was $2.8 million and $8.4 million,
respectively, net of income taxes.
Under SFAS No. 142, Textron Financial was required to test all existing
goodwill for impairment as of December 30, 2001, on a "reporting unit" basis.
The reporting unit represents the operating segment unless, at businesses one
level below that operating segment, discrete financial information is prepared
that is reviewed by management, in which case such component is the reporting
unit. Goodwill is considered to be impaired when the net book value of a
reporting unit exceeds its estimated fair value. Fair values were established
using a discounted cash flow methodology.
As a result of this impairment review of goodwill, Textron Financial
recorded an after-tax transitional impairment charge of $15.4 million ($23.7
million, pre-tax), which is reported in the caption "Cumulative effect of change
in accounting principle." This charge relates to the Franchise Finance division
within the Other segment and is primarily the result of decreasing loan volumes
and an unfavorable securitization market. No impairment charge was appropriate
for this reporting unit under the previous goodwill impairment accounting
standard, which was based on undiscounted cash flows.
Textron Financial also adopted the remaining provisions of SFAS No. 141,
"Business Combinations," on December 30, 2001. For goodwill and intangible
assets reported in connection with acquisitions made prior to July 1, 2001,
these provisions broaden the criteria for recording intangible assets separate
from goodwill and require that certain intangible assets that do not meet the
new criteria, such as workforce, be reclassified into goodwill. Upon adoption of
these provisions, intangible assets totaling $0.9 million were reclassified into
goodwill within the Resort Finance segment.
Goodwill totaled $110.0 million in the Resort Finance segment, $40.6
million in the Asset-based Lending segment, $16.6 million in the Aircraft
Finance segment and $13.6 million in the Other segment at September 30, 2002.
8
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
The impact of discontinuing the amortization of goodwill is presented
below:
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- ---------------------
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2002 2001 2002 2001
--------- --------- --------- ---------
(IN THOUSANDS)
Reported net income.................... $12,278 $29,911 $29,618 $82,771
Add back: amortization, net of taxes... -- 2,808 -- 8,401
------- ------- ------- -------
Adjusted net income.................... $12,278 $32,719 $29,618 $91,172
======= ======= ======= =======
NOTE 7. OTHER ASSETS
SEPT. 30, DEC. 29,
2002 2001
--------- --------
(IN THOUSANDS)
Retained interests in securitizations................... $214,393 $178,599
Investment in equipment residuals....................... 101,078 112,804
Interest-only securities................................ 74,847 78,939
Fixed assets -- net..................................... 47,046 44,680
Repossessed assets and properties....................... 42,260 23,235
Other long-term investments............................. 29,358 24,723
Short-term investments.................................. -- 63,819
Other................................................... 26,148 22,168
-------- --------
Total other assets............................ $535,130 $548,967
======== ========
The Investment in equipment residuals represents the remaining equipment
residual values associated principally with Textron golf and turf equipment
lease payments that were securitized in 2002, 2001 and 2000.
The cost of fixed assets is being depreciated using the straight-line
method based on the estimated useful lives of the assets.
9
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 8. DEBT AND CREDIT FACILITIES
SEPT. 30, DEC. 29,
2002 2001
---------- ----------
(IN THOUSANDS)
Short-term debt:
Commercial paper................................... $1,229,955 $ 623,252
Other short-term debt.............................. 37,511 64,455
Note payable to Textron Inc........................ -- 510,000
---------- ----------
Total short-term debt...................... 1,267,466 1,197,707
Long-term debt:
5.65% -- 5.95% notes; due 2003 to 2007............. 1,151,373 399,503
6.13% -- 6.84% notes; due 2003 to 2007............. 97,657 31,637
7.13% -- 7.67% notes; due 2002 to 2007............. 1,107,085 1,081,223
Variable rate notes; due 2002 to 2007.............. 1,588,651 1,988,350
---------- ----------
Total long-term debt....................... 3,944,766 3,500,713
---------- ----------
Total debt................................. $5,212,232 $4,698,420
========== ==========
The weighted average interest rates on short-term borrowings have been
determined by relating the annualized interest cost to the daily average dollar
amounts outstanding. The combined weighted average interest rate was 2.15%
during the nine months ended September 30, 2002, and 2.01% at September 30,
2002.
Interest on Textron Financial's variable rate notes is predominately tied
to the three-month LIBOR for U.S. dollar deposits. The weighted average interest
rate on these notes, before consideration of the effect of interest rate
exchange agreements, was 2.39% at September 30, 2002.
Textron Financial has bank lines of credit of $1.5 billion, of which $500
million expires in 2003 and $1.0 billion expires in 2006. Textron Financial's
lines of credit, including a $100 million line of credit with Textron, not used
or reserved as support for commercial paper at September 30, 2002, were $370
million. The Company also maintains a C$50 million committed facility, under
which it can borrow an additional C$50 million on an uncommitted basis. At
September 30, 2002, the Company had used C$40 million of the committed portion
of the facility. Textron Financial also has a $25 million UK facility, of which
$14 million remains unused at September 30, 2002. Both the Canadian and UK
facilities expire in 2003. Textron Financial generally pays fees in support of
these lines.
Through its subsidiary, Textron Financial Canada Funding Corp. (Textron
Canada Funding), the Company periodically issues debt securities. Textron
Financial owns 100% of the common stock of Textron Canada Funding. Textron
Canada Funding is a financing subsidiary of Textron Financial with no
operations, revenues or cash flows other than those related to the issuance,
administration and repayment of debt securities that are fully and
unconditionally guaranteed by Textron Financial.
Securitizations are an important source of liquidity for Textron Financial
and involve the periodic transfer of finance receivables to securitization
trusts. At September 30, 2002 and December 29, 2001, the amount of debt related
to these securitization trusts was $1.9 billion and $2.1 billion, respectively.
The terms of certain of the Company's loan agreements and credit
facilities, under the most restrictive covenant, limit the payment of dividends
to $356.8 million at September 30, 2002. In the first nine months of 2002,
Textron Financial declared and paid dividends of $59.8 million and $57.5
million, respectively.
10
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS
Textron Financial has entered into interest rate exchange agreements to
mitigate its exposure to interest rate changes by converting certain of its
fixed rate receivables and debt issues to floating rates. The agreements require
the Company to make periodic fixed rate payments in exchange for floating rate
receipts and vice versa based on specified notional amounts. In the first nine
months of 2002, the Company also entered into a foreign currency exchange
agreement to convert a Y6.0 billion fixed rate note to a $44.8 million variable
rate note. The agreement requires the Company to make U.S. dollar payments based
on LIBOR in exchange for fixed receipts of Yen at specified notional amounts.
The Company has designated these agreements fair value hedges. The Company does
not hold or issue derivative financial instruments for trading or speculative
purposes.
Textron Financial has also entered into interest rate exchange, cap and
floor agreements to mitigate its exposure on interest-only securities resulting
from securitizations. The exchange agreements require the Company to make
periodic variable rate payments in exchange for periodic fixed rate receipts and
vice versa based on specified notional amounts. The interest rate cap and floor
agreements require the Company to make periodic variable rate payments based on
specified notional amounts if interest rates exceed or fall below specified
rates. The Company has designated these agreements cash flow hedges.
In the first nine months of 2002, the Company also entered into foreign
currency exchange agreements to convert $107.0 million of variable rate notes
receivable to C$170.0 million of fixed rate notes receivable to manage foreign
currency exposure by matching these notes receivable to Canadian denominated
debt. The agreements require the Company to make U.S. dollar payments based on
LIBOR in exchange for fixed receipts of Canadian dollars at specified notional
amounts. The Company has designated these agreements cash flow hedges.
As of September 30, 2002, Textron Financial has not incurred or recognized
any gains or losses in earnings as the result of the ineffectiveness or the
exclusion from its assessment of hedge effectiveness of its fair value or cash
flow hedges.
NOTE 10. TEXTRON FINANCIAL AND LITCHFIELD OBLIGATED MANDATORY REDEEMABLE
PREFERRED SECURITIES OF TRUST SUBSIDIARY HOLDING SOLELY LITCHFIELD
JUNIOR SUBORDINATED DEBENTURES
Prior to Textron Financial's acquisition of Litchfield on November 3, 1999,
a trust, sponsored and wholly-owned by Litchfield, issued to the public $26.2
million of mandatory redeemable preferred securities (Preferred Securities). The
trust subsequently invested in $26.2 million aggregate principal amount of
Litchfield 10% Series A Junior Subordinated Debentures (Series A Debentures),
due 2029. The Series A Debentures are the sole asset of the trust. The amounts
due to the trust under the Series A Debentures and the related income statement
amounts have been eliminated in Textron Financial's consolidated financial
statements.
The Preferred Securities were recorded by Textron Financial at the fair
value of $28.6 million as of the acquisition date and the fair value adjustment
is being amortized through June 2004.
The Preferred Securities accrue and pay cash distributions quarterly at a
rate of 10% per annum. The trust's obligation under the Preferred Securities are
fully and unconditionally guaranteed by Litchfield, including, without
limitation, all obligations arising under the Declaration Trust, the Trust
Preferred Securities, the Indenture, the Debentures and the ancillary agreements
entered into in connection with the foregoing. The trust will redeem all of the
outstanding Preferred Securities when the Series A Debentures are paid at
maturity on June 30, 2029, or otherwise become due. Litchfield will have the
right to redeem 100% of the principal plus accrued and unpaid interest on or
after June 30, 2004.
11
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
As a result of the acquisition, Textron Financial has agreed to make
payments to the holders of the Preferred Securities, when due, to the extent not
paid by or on behalf of the trust or the subsidiary.
NOTE 11. ACCUMULATED OTHER COMPREHENSIVE LOSS AND COMPREHENSIVE INCOME
Accumulated other comprehensive loss is as follows:
NINE MONTHS ENDED
---------------------
SEPT. 30, SEPT. 30,
2002 2001
--------- ---------
(IN THOUSANDS)
Beginning of period..................................... $(18,793) --
Foreign currency translation adjustments................ (2,552) --
Transition adjustment due to change in accounting for
derivative instruments and hedging activities, net of
income tax benefit of $6,948.......................... -- $(11,580)
Net deferred loss on hedge contracts, net of income tax
benefits of $1,206 and $4,905, respectively........... (2,010) (8,175)
Amortization of deferred loss on terminated hedge
contracts, net of income taxes of $1,103 and $1,139,
respectively.......................................... 1,839 1,898
Net deferred gain on interest-only securities, net of
income taxes of $3,125 and $5,025, respectively....... 5,208 8,375
-------- --------
End of period........................................... $(16,308) $ (9,482)
======== ========
Comprehensive income is summarized below:
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- ---------------------
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2002 2001 2002 2001
--------- --------- --------- ---------
(IN THOUSANDS)
Net income............................. $12,278 $29,911 $29,618 $82,771
Other comprehensive income (loss)...... 5,144 5,106 2,485 (9,482)
------- ------- ------- -------
Comprehensive income................... $17,422 $35,017 $32,103 $73,289
======= ======= ======= =======
NOTE 12. CONTINGENCIES
There are pending or threatened lawsuits and other proceedings against
Textron Financial and its subsidiaries. Some of these suits and proceedings seek
compensatory, treble or punitive damages in substantial amounts. These suits and
proceedings are being defended by, or contested on behalf of, Textron Financial
and its subsidiaries. On the basis of information presently available, Textron
Financial believes any such liability would not have a material effect on
Textron Financial's financial position or results of operations.
12
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 13. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
During the third quarter of 2002, the Company made a strategic decision to
realign its business units into seven operating segments based on the markets
serviced and the products offered: Aircraft Finance, Asset-based Lending,
Distribution Finance, Golf Finance, Resort Finance, Structured Capital and
Other.
Aircraft Finance provides financing to commercial users of new and used
Cessna business jets and piston-engine aircraft, Bell helicopters and other
general aviation aircraft. Asset-based Lending provides working capital lines of
credit secured by trade accounts receivable and inventory to middle-market
companies and companies in select niche markets. Distribution Finance provides
inventory finance programs for dealers and distributors of Textron manufactured
products and other manufacturer programs in the music, marine, portable spa,
wood stove, lawn and garden, specialty trailer, agricultural equipment, motor
home, manufactured housing and telecommunications industries. Golf Finance
provides first mortgage loans for the acquisition, refinancing and construction
of golf courses and golf resort properties. The segment also includes term
financing and leasing services for Textron products including E-Z-GO golf cars
and Textron Turf Care equipment. Resort Finance provides inventory and notes
receivable financing to developers of vacation interval resorts and recreational
and residential land lots, and to a lesser extent, acquisition and construction
loans to developers. Structured Capital includes leveraged leases and single
investor leases. The Other segment includes franchise finance (loans primarily
to operators of restaurants and convenience stores), media finance (working
capital, acquisition and debt refinancing of broadcast publishing and other
media operators) and small business finance (unsecured lines of credit and term
financing) in addition to liquidating portfolios.
As a result of these segment changes, the financial information for the
three- and nine-month periods ended September 30, 2001, has been restated
reflecting the realignment of the segments.
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- ---------------------
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2002 2001 2002 2001
--------- --------- --------- ---------
(IN THOUSANDS)
Revenues
Resort Finance........................... $ 26,998 $ 23,313 $ 71,317 $ 75,537
Distribution Finance..................... 26,849 17,959 70,661 65,607
Aircraft Finance......................... 20,600 40,162 63,886 100,104
Golf Finance............................. 17,556 15,934 51,335 53,320
Asset-based Lending...................... 16,287 19,248 47,580 59,139
Structured Capital....................... 8,842 7,186 25,752 17,615
Other.................................... 39,211 54,084 118,910 141,252
-------- -------- -------- --------
Total revenues............................. $156,343 $177,886 $449,441 $512,574
======== ======== ======== ========
13
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- ---------------------
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2002 2001 2002 2001
--------- --------- --------- ---------
(IN THOUSANDS)
Income (loss) before special charges,
income taxes, distributions on preferred
securities and cumulative effect of
change in accounting principle (1)(2)
Resort Finance........................... $ 15,533 $ 7,804 $ 35,901 $ 25,111
Distribution Finance..................... 10,265 6,514 25,518 24,014
Aircraft Finance......................... (5,280) 16,058 (2,535) 31,029
Golf Finance............................. 6,253 4,846 14,164 17,613
Asset-based Lending...................... 7,298 7,923 13,259 18,346
Structured Capital....................... 5,524 7,237 12,395 9,602
Other.................................... (19,827) (2,282) (26,869) 9,887
-------- -------- -------- --------
Total income before special charges, income
taxes, distributions on preferred
securities and cumulative effect of
change in accounting principle........... $ 19,766 $ 48,100 $ 71,833 $135,602
Special charges.......................... -- (833) -- (2,686)
-------- -------- -------- --------
Total income before income taxes,
distributions on preferred securities and
cumulative effect of change in accounting
principle................................ $ 19,766 $ 47,267 $ 71,833 $132,916
======== ======== ======== ========
SEPT. 30, DEC. 29,
2002 2001
---------- ----------
(IN THOUSANDS)
Finance assets (3)
Aircraft Finance.......................................... $1,410,371 $1,248,305
Resort Finance............................................ 1,012,721 1,019,842
Golf Finance.............................................. 995,327 837,613
Distribution Finance...................................... 803,583 495,809
Structured Capital........................................ 583,988 565,047
Asset-based Lending....................................... 525,586 548,093
Other..................................................... 1,575,784 1,593,524
---------- ----------
Total finance assets........................................ $6,907,360 $6,308,233
========== ==========
- ---------------
(1) Interest expense is allocated to each segment in proportion to its net
investment in finance assets. Net investment in finance assets includes
deferred income taxes, security deposits and other specifically identified
liabilities. The interest allocated matches, to the extent possible,
variable rate debt with variable rate finance assets and fixed rate debt
with fixed rate finance assets.
(2) Indirect expenses are allocated to each segment based on the use of such
resources. Most allocations are based on the segment's proportion of net
investment in finance assets, headcount, number of transactions, computer
resources and senior management time.
(3) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets; retained interests in
securitizations; investment in equipment residuals and long-term investments
(some of which are classified in Other assets on Textron Financial's
Condensed Consolidated Balance Sheets).
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
TEXTRON FINANCIAL CORPORATION
FINANCIAL CONDITION
Liquidity and Capital Resources
Textron Financial Corporation (Textron Financial or the Company) uses a
broad base of financial resources for its liquidity and capital needs. Cash is
provided from operations and several sources of borrowings, including the
issuance of commercial paper and other short-term debt, sales of medium and
long-term debt in U.S. and foreign public and private markets and junior
subordinated borrowings under a $100 million line of credit with Textron Inc.
(Textron). For liquidity purposes, Textron Financial has a policy of maintaining
sufficient unused lines of credit to support its outstanding commercial paper.
Textron Financial has bank lines of credit of $1.5 billion, of which $500
million expires in 2003 and $1.0 billion expires in 2006. The $500 million
facility includes a one-year term out option, effectively extending its
expiration into 2004. None of these lines of credit were used at September 30,
2002 or December 29, 2001. Textron Financial also maintains a C$50 million
committed facility, under which it can borrow an additional C$50 million on an
uncommitted basis. At September 30, 2002, Textron Financial had used C$40
million of the committed portion of the facility. Textron Financial also has a
$25 million UK facility, of which $14 million remains unused at September 30,
2002. Both the Canadian and UK facilities expire in 2003. Unused lines of
credit, including the $100 million line of credit with Textron, not reserved as
support for commercial paper, were $370 million at September 30, 2002, compared
to $975 million at December 29, 2001. The decrease in the unreserved portion of
the unused lines of credit is mostly attributable to the pay down and
termination of a short-term revolving note agreement with Textron.
Under a shelf registration statement filed with the Securities and Exchange
Commission, Textron Financial may issue public debt securities in one or more
offerings up to a total maximum offering of $3.0 billion. Under this facility,
Textron Financial issued $1.2 billion of term notes in the first nine months of
2002, primarily in the U.S. and Canadian markets, that mature in 2003 through
2007. The proceeds from the issuances were used to refinance maturing commercial
paper and long-term debt. At September 30, 2002, Textron Financial had $1.8
billion available under this facility.
During the first nine months of 2002, Textron Financial received net
proceeds from the securitizations of $185 million of small business finance
receivables (on a revolving basis), $112 million of Resort Finance receivables,
$75 million of Distribution Finance receivables (on a revolving basis) and $38
million of golf equipment receivables. These securitizations provided Textron
Financial with an alternate source of liquidity. Textron Financial used the
proceeds from the securitizations to retire commercial paper. In connection with
the outstanding $238 million revolving securitization of small business finance
receivables, Textron Financial is obligated to repurchase a certain class of
loans if the Company's credit rating drops below BBB. Such loans amounted to $43
million at September 30, 2002. Textron Financial has no other repurchase
obligations in connection with any other securitization transactions. The
Company anticipates that it will enter into additional securitization
transactions during the remainder of 2002.
During the fourth quarter of 2001, certain of Textron Financial's
commercial paper and long-term debt credit ratings were lowered. Although
Textron Financial's borrowing spreads have increased as a result of the
downgrades, Textron Financial continues to have access to the commercial paper,
long-term debt and securitization markets. Further downgrades in Textron
Financial's ratings could increase borrowing spreads or limit its access to
these markets. In addition, Textron Financial's $1.5 billion revolving bank line
of credit agreements contain certain financial covenants with which Textron
Financial must comply in order to maintain its ability to borrow under the
facilities. Textron Financial was in full compliance with such covenants at
September 30, 2002. Textron Financial believes that it has adequate credit
facilities and access to credit markets to meet its financing needs.
Cash flows provided by operations were $155 million during the first nine
months of 2002, compared to $160 million in the corresponding period last year.
The decrease was due principally to the timing of payments
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (CONTINUED)
of accrued interest and other liabilities and a 1% decrease in net income before
depreciation, amortization, provision for losses and the cumulative effect of
change in accounting principle, partially offset by an increase due to the
timing of income tax payments. Cash flows used in investing activities were
funded primarily from the collection of receivables, the syndication and
securitization of receivables and through the issuance of debt.
Textron Financial declared dividends of $59.8 million and paid dividends of
$57.5 million to Textron during the first nine months of 2002, compared to $40.5
million of dividends declared and paid during the corresponding period of 2001.
The increase in 2002 was due to excess capital that resulted from slower than
anticipated receivable growth in the first nine months of 2002 and the return of
capital to Textron associated with the sale of a finance receivable portfolio.
Because the finance business involves the purchase and carrying of
receivables, a relatively high ratio of borrowings to net worth is customary.
Debt as a percentage of total capitalization was 84% at September 30, 2002 and
82% at December 29, 2001. Textron Financial's ratio of earnings to fixed charges
was 1.49x for the nine months ended September 30, 2002, compared to 1.62x for
the corresponding nine months in 2001. Total short-term debt as a percentage of
total debt was 24% at September 30, 2002, compared to 25% at December 29, 2001.
Changes in short and long-term debt are directly related to the duration of the
Company's assets and liabilities.
Finance Assets
Textron Financial's financing activities are confined almost exclusively to
secured lending and leasing to commercial markets. Management believes that the
portfolio avoids excessive concentration of risk through diversification across
geographic regions, industries and types of collateral and among borrowers.
Total finance assets were $6.9 billion at September 30, 2002, up from $6.3
billion at December 29, 2001. The increase in finance assets was mostly due to
Distribution Finance receivables ($308 million), net of a revolving
securitization conduit, Aircraft Finance receivables ($162 million), including
operating lease assets, Golf Finance receivables ($158 million) and franchise
finance receivables ($119 million, primarily reflecting the voluntary
termination of a securitization conduit) within the Other segment, partially
offset by a decrease in small business finance receivables due to a revolving
securitization conduit and the continued liquidation of the portfolios all
within the Other segment.
Finance receivable additions for the first nine months of 2002 were $6.7
billion, compared to $5.7 billion in the corresponding period last year.
Distribution Finance receivable additions increased $1.4 billion, including
portfolio purchases of $257 million. This increase was partially offset by
decreases in other portfolios due to a weaker economic environment.
Nonperforming Assets
Nonperforming assets, which includes independent and nonrecourse captive
finance assets, as a percentage of finance assets, increased to 2.98% ($206
million) at September 30, 2002, compared to 2.13% ($134 million) at December 29,
2001. The $72 million increase in nonperforming assets at September 30, 2002,
compared to December 29, 2001, was largely due to increases in the Aircraft
Finance ($37 million), Other ($25 million), Resort Finance ($17 million),
Distribution Finance ($12 million) and Golf Finance ($3 million) segments,
partially offset by a decrease in the Asset-based Lending segment ($22 million).
The increases in the Other segment primarily include media finance ($17 million)
and syndicated bank loans ($14 million), offset by other liquidating portfolios.
The increase in nonperforming assets in syndicated bank loans is primarily
related to loans to the telecommunications industry, which has experienced
economic weakness. Current economic conditions will likely put continued
pressure on Textron Financial's overall portfolio quality. The allowance for
losses on receivables as a percentage of nonaccrual finance receivables was 92%
at September 30, 2002, compared to 126% at December 29, 2001. The decrease in
the percentage reflects management's assessment of the adequacy of collateral
values supporting the increase in nonaccrual finance receivables at September
30, 2002.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (CONTINUED)
Interest Rate Sensitivity
The Company's mix of fixed and floating rate debt is continuously monitored
by management and is adjusted, as necessary, based on evaluations of internal
and external factors.
Management's strategy of matching interest-sensitive assets with
interest-sensitive liabilities limits Textron Financial's risk to changes in
interest rates and includes entering into interest rate exchange agreements. At
September 30, 2002, interest-sensitive assets in excess of interest-sensitive
liabilities were $467 million, net of $1.2 billion of variable rate interest
rate exchange agreements relating to debt and $222 million of variable rate
interest rate exchange agreements on finance receivables, compared to interest-
sensitive assets in excess of interest-sensitive liabilities of $410 million,
net of $370 million of interest rate exchange agreements relating to debt and
$97 million of interest rate exchange agreements on finance receivables at
December 29, 2001. The increase in interest rate exchange agreements was
directly related to the conversion of fixed rate debt to variable rate debt at
the time of issuance. The Company's net position does not reflect a change in
management's match funding strategy, which is consistent with year-end.
Management believes that its asset management policy provides adequate
protection against interest rate risks. Increases or decreases in interest
rates, however, could have an adverse effect on interest margin. Variable rate
receivables are generally tied to changes in the prime rate offered by major
U.S. banks or LIBOR. Changes in short-term borrowing costs generally precede
changes in variable rate receivable yields. Textron Financial assesses its
exposure to interest rate changes using an analysis that measures the potential
loss in net income, over a twelve-month period, resulting from a hypothetical
change in interest rates of 100 basis points across all maturities occurring at
the outset of the measurement period (sometimes referred to as a "shock test").
Textron Financial also assumes in its analysis that prospective receivable
additions will be match funded, existing portfolios will not prepay and all
other relevant factors will remain constant. This shock test model, when applied
to Textron Financial's asset and liability position at September 30, 2002,
indicated no material effect on Textron Financial's net income and cash flows
for the following twelve-month period.
Financial Risk Management
Textron Financial's results are affected by changes in U.S. and, to a
lesser extent, foreign interest rates. As part of managing this risk, Textron
Financial enters into interest rate exchange agreements. Textron Financial's
objective in entering into such agreements is not to speculate for profit, but
generally to convert variable rate debt into fixed rate debt and vice versa. The
overall objective of Textron Financial's interest rate risk management is to
achieve a prudent balance between floating and fixed rate debt. These agreements
do not involve a high degree of complexity or risk. Textron Financial does not
trade in interest rate exchange agreements or enter into leveraged interest rate
exchange agreements.
Textron Financial manages its foreign currency exposure by funding most
foreign currency denominated assets with liabilities in the same currency. The
Company may enter into foreign currency exchange agreements to convert foreign
currency denominated assets and liabilities into functional currency denominated
assets and liabilities. In addition, as part of managing its foreign currency
exposure, Textron Financial may enter into foreign currency forward exchange
contracts. The objective of such agreements is to manage any remaining exposure
to changes in currency rates. The notional amounts of outstanding foreign
currency forward exchange contracts are nominal.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (CONTINUED)
RESULTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 VS. SEPTEMBER 30, 2001
REVENUES
Three months ended September 30, 2002 vs. September 30, 2001
Third quarter 2002 revenues decreased by $21.5 million, or 12.1%, compared
to the corresponding period in 2001. The decrease in revenues reflects lower
finance charges and discounts of $22.1 million from a lower average yield (7.59%
versus 9.13% in 2001), primarily due to a lower interest rate environment.
Nine months ended September 30, 2002 vs. September 30, 2001
Revenues for the first nine months of 2002 decreased by $63.1 million, or
12.3%, compared to the corresponding period in 2001. The decrease in revenues
reflects lower finance charges and discounts of $80.2 million from a lower
average yield (7.64% versus 9.60% in 2001), primarily due to a lower interest
rate environment, partially offset by higher fee income of $10.4 million,
principally servicing income and investment income, and higher operating lease
rental revenue of $6.6 million. Operating lease rental revenue increased due to
a higher level of average operating lease assets, primarily in the Aircraft
Finance segment.
INTEREST EXPENSE
Three months ended September 30, 2002 vs. September 30, 2001
Third quarter 2002 interest expense decreased by $16.7 million, or 25.0%,
on approximately the same level of average debt outstanding. The lower interest
expense reflects a decrease in the average borrowing rate to 3.89% from 5.16%,
attributable to a lower interest rate environment.
Nine months ended September 30, 2002 vs. September 30, 2001
Interest expense for the first nine months of 2002 decreased by $69.3
million, or 32.1%, on 2.1% higher average debt outstanding. The lower interest
expense largely reflects a decrease in the average borrowing rate to 3.88% from
5.84%, attributable to a lower interest rate environment.
INTEREST MARGIN
Textron Financial's earnings are influenced by the interest margin earned
on finance receivables (i.e., the excess of revenues over interest expense on
borrowings and distributions on preferred securities).
Three months ended September 30, 2002 vs. September 30, 2001
Interest margin for the third quarter of 2002 decreased $4.9 million and 44
basis points (7.03% versus 7.47%), compared to the corresponding period in 2001.
The decrease in interest margin primarily is a result of higher relative
borrowing costs ($3.3 million) and to a lesser extent, lower fee income ($1.3
million).
Nine months ended September 30, 2002 vs. September 30, 2001
Interest margin increased $6.2 million and 2 basis points (6.95% versus
6.93%), for the first nine months of 2002, compared to the corresponding period
in 2001. The increase in interest margin primarily reflects higher fee income
($10.4 million) and the interest margin on higher average finance receivables
($3.5 million), offset by higher relative borrowing costs ($6.6 million), and
lower pricing on finance receivables principally in the Aircraft Finance
segment.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (CONTINUED)
SELLING AND ADMINISTRATIVE EXPENSES
Three months ended September 30, 2002 vs. September 30, 2001
Selling and administrative expenses of $39.3 million decreased $1.9 million
in the third quarter of 2002, compared to the corresponding period in 2001. The
decrease in 2002 principally reflects a reduction in goodwill amortization of
$3.1 million (reflecting the change in accounting principle) offset by an
increase of $1.2 million due to growth in managed finance receivables. Selling
and administrative expenses as a percentage of average managed and serviced
receivables were 1.64% (on an annualized basis) in the third quarter of 2002,
compared to 1.83% in 2001.
Nine months ended September 30, 2002 vs. September 30, 2001
Selling and administrative expenses of $122.8 million increased $8.8
million in the first nine months of 2002, compared to the corresponding period
in 2001. The increase in 2002 principally reflects $10.3 million of higher legal
and collection expenses and $7.8 million due to growth in managed finance
receivables, partially offset by a reduction in goodwill amortization of $9.3
million (reflecting the change in accounting principle). Selling and
administrative expenses as a percentage of average managed and serviced
receivables were 1.76% (on an annualized basis) in the first nine months of
2002, compared to 1.78% in 2001.
PROVISION FOR LOSSES
Three months ended September 30, 2002 vs. September 30, 2001
The provision for losses of $44.4 million for the third quarter of 2002
increased from $20.5 million for the corresponding period in 2001. The increase
reflects higher net charge-offs of $44.1 million in the third quarter 2002,
compared to $18.3 million in the corresponding period of 2001. The increase in
net charge-offs was primarily in the Other ($22.5 million) and Aircraft Finance
segments ($2.7 million). The increase in the Other segment included syndicated
bank loans ($16.5 million), franchise finance ($3.2 million) and other
liquidating portfolios.
Nine months ended September 30, 2002 vs. September 30, 2001
The provision for losses of $99.8 million in the first nine months of 2002
increased from $43.4 million for the corresponding period in 2001. The increase
reflects higher net charge-offs and a strengthening of the allowance for losses
on receivables. Net charge-offs were $93.9 million in the first nine months of
2002, compared to $45.5 million in the corresponding period of 2001. The
increase in net charge-offs was primarily in the Other ($45.0 million) and
Aircraft Finance ($5.9 million) segments, partially offset by a decrease in
Asset-based Lending segment ($6.7 million). The increase in the Other segment
included syndicated bank loans ($17.0 million), small business finance ($10.7
million) and other liquidating portfolios.
Although management believes it has made adequate provision for anticipated
losses, realization of finance assets remains subject to uncertainties.
Subsequent evaluations of nonperforming assets, in light of factors then
prevailing, including economic conditions, may require additional increases in
the allowance for losses for such assets.
OPERATING RESULTS BY SEGMENT
Effective December 30, 2001, Textron Financial adopted Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets". Under this Statement, goodwill and certain assets with indefinite lives
are no longer amortized and must be tested for impairment annually. Textron
Financial also adopted the remaining provisions of SFAS No. 141 "Business
Combinations" on December 30, 2001, which requires intangible assets that do not
meet the new criteria set by this statement to be classified as goodwill upon
adoption. Amortization will continue to be recorded on other intangible assets
not classified as
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (CONTINUED)
goodwill. Pro forma net income excluding amortization of goodwill was $32.7
million and $91.2 million for the three- and nine-month periods ended September
30, 2001, respectively.
During the second quarter 2002, Textron Financial recorded an after-tax
transitional goodwill impairment charge of $15.4 million, which is reported in
the caption "Cumulative effect of change in accounting principle, net of income
taxes" retroactive to the beginning of fiscal year 2002. This after-tax charge
relates to the Franchise Finance division within the Other segment. The
impairment charge in the Franchise Finance division is primarily the result of
decreasing loan volumes and an unfavorable securitization market. No impairment
charge was appropriate for this reporting unit under the previous goodwill
impairment accounting standard, which was based on undiscounted cash flows.
Nine months ended September 30, 2002 vs. September 30, 2001
Segment income below represents income before special charges, income
taxes, distributions on preferred securities and cumulative effect of change in
accounting principle.
Resort Finance income increased $10.8 million reflecting higher interest
margin ($9.0 million) and lower operating expenses ($3.1 million), partially
offset by higher provision for losses ($1.3 million). The increase in interest
margin reflects higher average finance assets ($76 million) and higher fee
income ($2.7 million, largely securitization related income).
Distribution Finance income increased $1.5 million on higher interest
margin ($15.5 million), despite lower average finance assets ($45 million). The
higher interest margin was principally due to increases in revolving
securitization income ($12.2 million) and higher yields offset by lower average
finance assets. This increase in interest margin was offset by higher operating
expenses ($8.6 million) and higher provision for losses ($5.4 million).
Aircraft Finance income decreased by $33.6 million largely reflecting lower
interest margin ($22.2 million) despite $38 million of higher average finance
assets, a write-down of retained interests in securitized assets ($7.1 million)
reflecting lower expected realization on defaulted assets, higher provision for
losses ($8.5 million), partially offset by lower operating expenses ($4.3
million). The lower interest margin is due to competitive pressures inhibiting
the ability to pass on higher borrowing costs related to an increase in interest
rate spreads to benchmark borrowing rates (such as U.S. Treasury rates and
LIBOR).
Golf Finance income decreased $3.4 million reflecting higher expenses ($3.3
million) and higher provision for losses ($1.6 million), partially offset by
higher interest margin ($1.4 million) due to higher average finance assets ($158
million).
Asset-based Lending income decreased $5.1 million reflecting lower interest
margin ($2.5 million) due to lower finance receivable pricing on lower average
finance assets ($14 million) and higher provision for losses ($4.4 million),
partially offset by lower operating expenses ($1.8 million).
Structured Capital income increased $2.8 million principally due to lower
provision for losses ($2.7 million).
Other segment income decreased $36.8 million. The decrease largely reflects
higher provision for losses ($37.8 million), principally due to higher net
charge-offs in syndicated bank loans ($17.0 million), other liquidating
portfolios ($11.1 million) and small business finance ($10.7 million), and
higher operating expenses ($7.4 million), partially offset by higher interest
margin ($8.4 million) largely resulting from the timing of the Small Business
Division acquisition in 2001.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (CONTINUED)
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Three months ended September 30, 2002 vs. September 30, 2001
Third quarter 2002 income before cumulative effect of change in accounting
principle was $12.3 million, $17.6 million or 59.0% lower than the corresponding
period in 2001. The decrease principally reflects a higher provision for losses
($23.9 million) and lower interest margin ($4.9 million), partially offset by
lower operating expenses ($1.9 million).
Nine months ended September 30, 2002 vs. September 30, 2001
Income before cumulative effect of change in accounting principle for the
first nine months of 2002 was $45.0 million, $37.8 million or 45.7% lower than
the corresponding period in 2001. The decrease principally reflects a higher
provision for losses ($56.4 million) and higher operating expenses ($8.8
million), partially offset by higher interest margin ($6.2 million).
SELECTED FINANCIAL RATIOS
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- ---------------------
SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2002 2001 2002 2001
--------- --------- --------- ---------
Net interest margin as a percentage of average
net
investment (1)................................. 7.03% 7.47% 6.95% 6.93%
Return on average equity (2)..................... 4.94% 12.33% 6.06% 11.77%
Return on average assets (3)..................... 0.71% 1.78% 0.89% 1.72%
Ratio of earnings to fixed charges............... 1.39x 1.71x 1.49x 1.62x
Selling and administrative expenses as a
percentage of
average managed and serviced receivables (4)... 1.64% 1.83% 1.76% 1.78%
Operating efficiency ratio (5)................... 37.0% 37.1% 40.5% 38.4%
Net charge-offs as a percentage of average
finance
receivables.................................... 2.89% 1.21% 2.13% 1.04%
SEPT. 30, DEC. 29,
2002 2001
--------- --------
60+ days contractual delinquency as a percentage of finance
receivables (6)........................................... 2.78% 2.24%
Nonperforming assets as a percentage of finance assets
(7)....................................................... 2.98% 2.13%
Allowance for losses on receivables as a percentage of
finance receivables....................................... 2.44% 2.55%
Total debt to tangible shareholder's equity (8)............. 6.33x 5.70x
- ---------------
(1) Represents revenues earned less interest expense on borrowings and
distributions on preferred securities as a percentage of average net
investment. Average net investment includes finance receivables plus
operating leases less deferred taxes on leveraged leases.
(2) Return on average equity excludes the cumulative effect of change in
accounting principle.
(3) Return on average assets excludes the cumulative effect of change in
accounting principle. Average assets include finance receivables, less
allowance for loan losses, operating leases and other assets. Investments in
leveraged leases are not net of deferred taxes.
(4) Average managed and serviced receivables include owned receivables plus
receivables serviced under securitizations, participations and third-party
portfolio servicing agreements.
(5) Operating efficiency ratio is selling and administrative expenses divided by
net interest margin (including other income).
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS -- (CONTINUED)
(6) Delinquency excludes captive receivables with recourse to Textron. Captive
receivables represent third-party finance receivables originated in
connection with the sale or lease of Textron manufactured products.
Percentages are expressed as a function of total Textron Financial
independent and nonrecourse captive receivables.
(7) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets; retained interests in
securitizations; investment in equipment residuals; and long-term
investments (some of which are classified in Other assets on Textron
Financial's Consolidated Balance Sheets). Nonperforming assets include
independent and nonrecourse captive finance assets.
(8) Tangible shareholder's equity equals Shareholder's equity, excluding
Accumulated other comprehensive income or loss, less Goodwill.
Forward-looking Statements
Certain statements in this Form 10-Q and other oral and written statements
made by Textron Financial from time to time are forward-looking statements,
including those that discuss strategies, goals, outlook or other nonhistorical
matters; or project revenues, income, returns or other financial measures. These
forward-looking statements are subject to risks and uncertainties that may cause
actual results to differ materially from those contained in the statements,
including the following: (a) the extent to which Textron Financial is able to
successfully integrate acquisitions; (b) changes in worldwide economic and
political conditions and associated impact on interest and foreign exchange
rates; (c) the level of sales of Textron products for which Textron Financial
offers financing; (d) the ability to maintain credit quality and control costs
when entering new markets; (e) the actions of our competitors and our ability to
respond; (f) our ability to attract and retain qualified and experienced
personnel; (g) Textron Financial's access to debt financing at competitive
rates; and (h) access to equity in the form of retained earnings and capital
contributions from Textron.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding Textron Financial's Quantitative and Qualitative
Disclosures About Market Risk, see "Interest Rate Sensitivity" and "Financial
Risk Management" in Item 2 of this Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Within the 90 days prior to the date of this report, Textron Financial
carried out an evaluation, under the supervision and with the participation of
Textron Financial's management, including its Chairman and Chief Executive
Officer (the "CEO") and its Executive Vice President and Chief Financial Officer
(the "CFO"), of the effectiveness of the design and operation of Textron
Financial's disclosure controls and procedures (as defined in Rule 13a-14(c)
under the Securities Exchange Act of 1934 (the "Act")). Based upon that
evaluation, the CEO and CFO concluded that the Textron Financial's disclosure
controls and procedures are effective in providing reasonable assurance that (a)
the information required to be disclosed by Textron Financial in the reports
that it files or submits under the Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms, and (b) such information is accumulated and
communicated to Textron Financial's management, including its CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Controls
There have been no significant changes in Textron Financial's internal
controls or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.
22
PART II. OTHER INFORMATION
TEXTRON FINANCIAL CORPORATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
- --------
4.1 Indenture dated as of December 9, 1999, between Textron
Financial Corporation and SunTrust Bank (formerly known as
Sun Trust Bank, Atlanta), (including form of debt
securities). Incorporated by reference to Exhibit 4.1 to
Amendment No. 2 to Textron Financial Corporation's
Registration Statement on Form S-3 (No. 333-88509).
4.2 Indenture dated as of November 30, 2001, between Textron
Financial Canada Funding Corp. and SunTrust Bank, guaranteed
by Textron Financial Corporation. Incorporated by reference
to Exhibit 4.2 to amendment No. 1 to Textron Financial
Corporation's Registration Statement on Form S-3 (No.
333-72676).
12 Computation of Ratios of Earnings to Fixed Charges
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended September 30,
2002.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 8, 2002 TEXTRON FINANCIAL CORPORATION
/s/ THOMAS J. CULLEN
--------------------------------------
Thomas J. Cullen
Executive Vice President and Chief
Financial Officer
(Principal Financial Officer)
24
CERTIFICATIONS
I, Stephen A. Giliotti, Chairman and Chief Executive Officer of Textron
Financial Corporation (the "Company") certify that:
1. I have reviewed this quarterly report on Form 10-Q of Textron Financial
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 8, 2002
/s/ STEPHEN A. GILIOTTI
--------------------------------------
Stephen A. Giliotti
Chairman and Chief Executive Officer
25
I, Thomas J. Cullen, Executive Vice President and Chief Financial Officer of
Textron Financial Corporation (the "Company") certify that:
1. I have reviewed this quarterly report on Form 10-Q of Textron Financial
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 8, 2002
/s/ THOMAS J. CULLEN
--------------------------------------
Thomas J. Cullen
Executive Vice President and Chief
Financial Officer
26