TEXTRON FINANCIAL CORP - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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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 MARCH 31, 2004

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)

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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.

TEXTRON FINANCIAL CORPORATION

TABLE OF CONTENTS

1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TEXTRON FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(UNAUDITED)

See notes to condensed consolidated financial statements (unaudited).
2

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

See notes to condensed consolidated financial statements (unaudited).
3

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(UNAUDITED)

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)

See notes to condensed consolidated financial statements (unaudited).
5

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. BASIS OF PRESENTATION

The condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements included in Textron
Financial Corporation's Annual Report on Form 10-K for the year ended January 3,
2004. The accompanying condensed 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
condensed 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 March 31, 2004 and January 3, 2004, and its
consolidated results of operations and cash flows for each of the respective
three-month periods ended March 31, 2004 and 2003. 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

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.

NOTE 3. SPECIAL CHARGES

During the fourth quarter of 2003, the Company's management performed a
strategic review of its operations and committed to a plan to restructure the
operations within its corporate headquarters and within each of two core
segments: Asset Based Lending and Resort Finance. As a result of the
restructuring program, two facilities were closed, 85 employees were terminated
and the Company recorded a restructuring charge of $6.3 million. This charge
included $4.1 million of severance costs, $1.5 million in asset impairment
charges, $0.2 million in contract termination costs and $0.5 million in other
associated costs.

The Company paid severance related benefits and other expenses of $6.0
million through March 31, 2004, which were charged against the restructuring
reserve, leaving a balance in the reserve of $0.3 million. The

6

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Company will pay the remaining restructuring costs in 2004. The detail of the
reserve account for the three months ended March 31, 2004, is presented below.

NOTE 4. ALLOWANCE FOR LOSSES ON RECEIVABLES

NOTE 5. MANAGED AND SERVICED FINANCE RECEIVABLES

Textron Financial manages finance receivables for a variety of investors,
participants and third-party portfolio owners.

Third-party portfolio servicing largely relates to finance receivable
portfolios of resort developers and loan portfolio servicing for third-party
financial institutions.

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.

7

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Owned receivables include approximately $51 million of finance receivables
that were unfunded at March 31, 2004, primarily as a result of holdback
arrangements. The corresponding liability is included in Accrued interest and
other liabilities on Textron Financial's Condensed Consolidated Balance Sheets.

NOTE 6. 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
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 $154.3 million of nonaccrual finance receivables at March 31, 2004,
compared to $152.0 million at January 3, 2004. Nonaccrual finance receivables
resulted in Textron Financial's revenues being reduced by approximately $3.9
million and $4.7 million for the first three months of 2004 and 2003,
respectively. No interest income was recognized using the cash basis method.
Excluding homogeneous loan portfolios and finance leases, the Company had
impaired loans of $103.0 million and $98.8 million at March 31, 2004 and January
3, 2004, respectively. Impaired loans with identified reserve requirements were
$54.7 million and $47.4 million at March 31, 2004 and January 3, 2004,
respectively. The allowance for losses on receivables related to impaired loans
with identified reserve requirements was $21.8 million and $17.8 million at
March 31, 2004 and January 3, 2004, respectively. The average recorded
investment in impaired loans during the first three months of 2004 was $100.9
million compared to $123.4 million in the corresponding period in 2003.

Captive finance receivables with recourse that were 90 days or more
delinquent amounted to $41 million at both March 31, 2004, and January 3, 2004,
and were 10.4% and 9.6% of captive finance receivables with recourse,
respectively. Revenues recognized on delinquent accounts with recourse were
approximately $0.8 million and $1.4 million during the first three months of
2004 and 2003, respectively.

8

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

NOTE 7. OTHER ASSETS

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 years 2000 through 2003.

The cost of fixed assets is being depreciated using the straight-line
method based on the estimated useful lives of the assets.

NOTE 8. DEBT AND CREDIT FACILITIES

9

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

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 1.46%
during the three months ended March 31, 2004, and 1.27% at March 31, 2004.

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 2.11% at March 31, 2004.

Textron Financial has committed bank lines of credit of $1.5 billion, of
which $500 million expires in 2004 and $1.0 billion expires in 2008. Textron
Financial's lines of credit, not reserved as support for commercial paper or
utilized for letters of credit at March 31, 2004, were $704 million. During the
first quarter of 2004, the Company established an AUD 100 million facility, of
which AUD 69 million remained unused at March 31, 2004. The Australian facility
expires in 2005. The Company also maintains a CAD 50 million committed facility
under which it can borrow an additional CAD 50 million on an uncommitted basis.
At March 31, 2004, the Company had not used any of this facility. Textron
Financial also has a $25 million multi-currency facility, of which $20 million
remained unused at March 31, 2004. Both the Canadian and multi-currency
facilities expire in 2004. 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 qualified special
purpose trusts. The outstanding amount of debt issued by these qualified special
purpose trusts was $1.9 billion for both periods ending March 31, 2004 and
January 3, 2004.

The terms of certain of the Company's loan agreements and credit
facilities, under the most restrictive covenant, limit the payment of dividends
to $459 million at March 31, 2004. In the first quarter of 2004, Textron
Financial declared and paid dividends of $59 million.

NOTE 9. JUNIOR SUBORDINATED DEBENTURES

Litchfield Financial Corporation (Litchfield), a subsidiary of the Company,
was acquired in 1999. Prior to the acquisition, a trust, sponsored and
wholly-owned by Litchfield, issued $26.2 million of mandatorily redeemable
preferred securities (Preferred Securities) to the public. The Preferred
Securities accrue and pay cash distributions quarterly at a rate of 10% per
annum. The trust subsequently invested the proceeds in $26.2 million aggregate
principal amount of Litchfield 10% Series A Junior Subordinated Debentures
(Series A Debentures), due 2029. Litchfield has the right to redeem 100% of the
principal plus accrued and unpaid interest on the junior subordinated debentures
on or after June 30, 2004. As a result of the acquisition of Litchfield, 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. To the extent that Litchfield redeems the junior subordinated
debentures, or upon maturity of the debentures, the trust is required to redeem
the Preferred Securities.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 requires that an issuer classify certain financial instruments as
liabilities. Many of the instruments included within the Statement's scope, such
as mandatorily redeemable shares, were previously classified as equity. As
required, Textron Financial adopted this Statement

10

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

when it became effective in July 2003 and reported the obligated mandatorily
redeemable securities as a liability and related distributions on preferred
securities prospectively as a component of interest expense.

Subsequent to adoption, on November 7, 2003, the FASB issued FASB Staff
Position (FSP) 150-3, "Effective Date, Disclosures, and Transition for
Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and
Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No.
150, Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity." FSP 150-3 deferred the effective date of SFAS No. 150
for certain mandatorily redeemable noncontrolling interests. Textron Financial's
obligated mandatorily redeemable preferred securities were included in this
deferral. FSP 150-3 states that entities that have already adopted SFAS No. 150
for instruments within the scope of its indefinite deferral shall reverse the
effects of that adoption in the first fiscal period beginning after the date the
FSP was issued.

The adoption of FSP 150-3 in the first quarter of 2004 would have required
Textron Financial to reclassify the obligated mandatorily redeemable securities
back to equity; however, due to the simultaneous adoption of FASB Interpretation
No. 46 (FIN 46), "Consolidation of Variable Interest Entities, an Interpretation
of ARB No. 51" (See Note 12), this reclassification ultimately was not
necessary. Prior to the adoption of FIN 46, the trust was consolidated in the
Company's financial statements and the preferred securities of the trust were
presented as a liability under the caption "Textron Financial and Litchfield
obligated mandatory redeemable preferred securities of trust subsidiary holding
solely Litchfield junior subordinated debentures" on the balance sheet at
January 3, 2004. Under the provisions of FIN 46, the trust is a variable
interest entity of which Litchfield is not the primary beneficiary. Accordingly,
upon adoption of FIN 46, Textron Financial deconsolidated the trust and
presented the Company's obligation to the trust as junior subordinated
debentures on the balance sheet. Since the debentures are the sole asset of the
trust, the deconsolidation had no impact on Textron Financial's financial
position or results of operations.

NOTE 10. ACCUMULATED OTHER COMPREHENSIVE LOSS AND COMPREHENSIVE INCOME

Accumulated other comprehensive loss is as follows:

11

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

Comprehensive income is summarized below:

NOTE 11. CONTINGENCIES

In March 2003, the United States Department of Justice (DOJ) authorized the
filing of a civil action against Textron Financial and its subsidiary,
Litchfield Financial Corporation (Litchfield), and other third parties, arising
from the financing of certain land purchases by consumers through a third-party
land developer commonly known as "Buyer's Source." In the fourth quarter of
2003, the Company executed a settlement agreement with DOJ, which required the
Company to offer affected consumers various options, ranging from cash payments
to forgiveness of debt in exchange for return of the property. The Florida
Attorney General's office also opened a preliminary investigation into
Litchfield's activities relative to Buyer's Source and, while the Company
believes it has good defenses to any potential claims by the State of Florida,
it is engaged in settlement discussions with Florida. On February 3, 2004, in
the Court of Common Pleas for Knox County, Ohio, a purported class action
lawsuit was commenced against the Company and Litchfield, certain of their
current and former officers, and other third-parties, related to the Buyer's
Source matter. Among other claims, the purported class action alleges fraud in
the financing of the third-party land developers described above and seeks
compensatory damages and punitive damages in excess of $10 million. The Company
intends to aggressively defend this litigation. The Company believes that the
purported class action will not have a material effect on the Company's
financial position and results of operations.

On January 22, 2004, Litchfield and its former CFO entered into a
memorandum of understanding, subject to court approval, relating to a pending
class action (DynaCorp litigation) arising from the sale of promissory notes
issued by, and the operation of certain trusts organized by DynaCorp Financial
Strategies Inc. ("DFS"). This class action litigation, which was filed in 2001
in Superior Court in Marin County, California, alleged that DFS and the trusts
engaged in a variety of improper dealings with regard to the sale by the trusts
of notes and the operation of the trusts. During a portion of the time that the
allegedly improper activities occurred, Litchfield extended credit to DFS and
was a shareholder of DFS, and a Litchfield officer was a director on DFS' Board.
The preliminary settlement under the memorandum of understanding was accrued as
part of legal costs and was reflected in Selling and administrative expenses on
the Consolidated Statements of Income for the year-ended January 3, 2004.

There are other 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.

NOTE 12. VARIABLE INTEREST ENTITIES

In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 ("FIN 46" or the "Interpretation"), "Consolidation of
Variable Interest Entities, an Interpretation of

12

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

ARB No. 51." The Interpretation requires the consolidation of variable interest
entities in which an enterprise absorbs a majority of the entity's expected
losses, receives a majority of the entity's expected residual returns, or both,
as a result of ownership, contractual or other financial interests in the
entity. Entities were previously consolidated by an enterprise that had a
controlling financial interest through ownership of a majority voting interest
in the entity.

Subsequent to the original issuance of the Interpretation, the effective
date for entities created or interests obtained prior to February 1, 2003 was
deferred, and in December 2003, the FASB issued a revised version of FIN 46 that
provided clarification of the original Interpretation and excluded certain
operating entities from its scope. Public companies were required to apply the
provisions of this Interpretation specifically to entities commonly referred to
as special-purpose entities (SPE) in financial statement periods ending after
December 15, 2003. The effective date for all other types of entities within the
scope of the Interpretation is for financial statement periods ending after
March 15, 2004.

Textron Financial adopted the revised FIN 46 in the first quarter of 2004.
The adoption did not have any impact on its results of operations or financial
position. See Note 9 for details regarding the deconsolidation of a trust upon
the adoption of FIN 46.

NOTE 13. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

The Company aligns its business units into six operating segments based on
the markets serviced and the products offered: Aircraft Finance, Asset-Based
Lending, Distribution Finance, Golf Finance, Resort Finance and Structured
Capital. In addition, the Company maintains an Other segment (non-core) that
includes franchise finance, media finance and liquidating portfolios related to
a strategic realignment of the Company's business and product lines into core
and non-core businesses.

13

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

TEXTRON FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)

- ---------------

(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 and properties; retained
interests in securitizations; interest-only securities; investment in
equipment residuals; ADC arrangements; and other 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

KEY BUSINESS INITIATIVES AND TRENDS

Portfolio quality was stable during the first quarter of 2004. The
contractual delinquency balance remained unchanged from year-end 2003, while
nonperforming assets increased $3 million to $165 million. The provision for
losses declined 17% in the first quarter of 2004 as compared to the
corresponding period in 2003 due to improving portfolio quality throughout 2003
and into 2004. The Company expects the overall trend of modest improvements in
portfolio quality to continue in 2004; however, the Company could experience an
out-of-trend result in any one quarter.

During the first quarter of 2004, operating efficiency (the ratio of
Selling and administrative expenses divided by Net interest margin) improved to
44.5% from 48.3% for the corresponding quarter in 2003 and 46.8% for the full
year 2003. The improvement reflects an 8% decrease in operating expenses that
resulted from the restructuring program implemented in the fourth quarter of
2003 and lower legal and collection expense from improving portfolio quality.

FINANCIAL CONDITION

Liquidity and Capital Resources

Textron Financial mitigates liquidity risk (i.e., the risk that the Company
will be unable to fund maturing liabilities or the origination of new finance
receivables) by developing and preserving reliable sources of capital. The
Company uses a variety of financial resources to meet these capital needs. Cash
is provided from finance receivable sales and collections, and from many types
of borrowings, including the issuance of commercial paper and term debt in the
public and private markets, as well as finance receivable securitizations. This
diversity of capital resources enhances the Company's funding flexibility,
limits dependence on any one source of funds, and results in cost-effective
funding. In making particular funding decisions, management considers market
conditions, prevailing interest rates and credit spreads, and the maturity
profile of its assets and liabilities.

As part of its commercial paper program, the Company has a policy of
maintaining unused committed bank lines of credit in an amount not less than
outstanding commercial paper balances. These lines of credit have recently been
well in excess of outstanding commercial paper levels, with coverage of 196% and
302% at March 31, 2004 and January 3, 2004, respectively. These lines of credit
currently total $1.5 billion, of which $500 million expires in 2004 and $1.0
billion expires in 2008. The $500 million facility includes a one-year term out
option, effectively extending its expiration into 2005. None of these lines of
credit were used at March 31, 2004, or January 3, 2004. During the first quarter
of 2004, Textron Financial established an AUD 100 million facility, of which AUD
69 million remained unused at March 31, 2004. The Australian facility expires in
2005. Textron Financial also maintains a CAD 50 million committed facility,
under which it can borrow an additional CAD 50 million on an uncommitted basis.
At March 31, 2004, Textron Financial had not used any portion of the facility.
Textron Financial also has a $25 million multi-currency facility, of which $20
million remained unused at March 31, 2004. Both the Canadian and the
multi-currency facilities expire in 2004. Lines of credit not reserved as
support for outstanding commercial paper or letters of credit were $704 million
at March 31, 2004, compared to $966 million at January 3, 2004.

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 $4 billion. Under this registration
statement, Textron Financial issued a $45 million term note during the first
quarter of 2004. The proceeds from this issuance were used to refinance maturing
debt. At March 31, 2004, Textron Financial had $3.6 billion available under this
registration statement.

Cash flows (used) provided by operating activities of continuing operations
were $(12) million during the first quarter of 2004, compared to $73 million in
the corresponding period of 2003. The decrease in cash flows

15

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
was primarily due to the timing of payments of accrued interest and other
liabilities, principally an income tax payment of $60 million in the first
quarter of 2004.

Cash flows provided (used) by investing activities of continuing operations
were $56 million during the first quarter of 2004, compared to $(321) million in
the corresponding period of 2003. These cash flows largely resulted from the
origination, purchase, repayment and sales, including securitizations, of
finance receivables. The cash provided by investing activities during the first
quarter of 2004, was mostly due to higher collections on retained securitization
interests of $34 million, and $22 million of higher collections on finance
receivables and proceeds from sales, net of new finance receivable originations.
The cash used by investing activities during the first quarter of 2003 was
largely the result of $349 million of higher new finance receivable
originations, net of collections on finance receivables and proceeds from sales.

Cash flows (used) provided by financing activities of continuing operations
were $(320) million during the first quarter of 2004, compared to $396 million
in the corresponding period of 2003. The cash used by financing activities
during the first quarter of 2004 principally reflected the use of cash proceeds
generated from the sale of a portfolio in December 2003 to pay down maturing
term debt. The cash provided by financing activities during first quarter of
2003, which was generated through the issuance of term debt ($200 million) and a
net increase in commercial paper ($349 million), was mostly used to fund finance
asset growth.

Net cash used in discontinued operations of $165 million during the first
quarter of 2003 represents the operating and investing activities of the small
business direct portfolio (small business finance) that was sold in December
2003. During the first quarter of 2003, Textron Financial voluntarily terminated
a revolving securitization conduit related to small business finance. The cash
used by this transaction was generated through the issuance of commercial paper
and was not a separate activity of the discontinued operation.

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 81% at March 31, 2004, and
January 3, 2004. Textron Financial's ratio of earnings to fixed charges was
1.79x for the three months ended March 31, 2004, compared to 1.53x for the
corresponding period in 2003. Commercial paper and Other short-term debt as a
percentage of total debt was 19% at March 31, 2004, compared to 12% at the end
of 2003.

During the first quarter of 2004, Textron Financial declared and paid
dividends to Textron of $59.3 million, compared to dividends declared and paid
of $37.3 million during the corresponding period of 2003. The increase in 2004
was due to excess capital that resulted from the continued liquidation of
non-core assets and increased profitability. Textron contributed capital of $2.3
million to Textron Financial in the first quarters of 2004 and 2003, which
consisted of Textron's dividend on the preferred stock held by Textron Funding
Corporation.

Off-Balance Sheet Arrangements

Textron Financial sells finance receivables utilizing both securitizations
and whole-loan sales. As a result of these transactions, finance receivables are
removed from the Company's balance sheet. Despite the reduction in the recorded
balance sheet position, the Company generally retains a subordinated interest in
the finance receivables sold through securitizations, which may affect operating
results through periodic fair value adjustments. The Company also sells
receivables in whole-loan sales in which it retains a continuing interest,
through limited credit enhancement, in the form of a contingent liability
related to finance receivable credit losses and, to a lesser extent prepayment
risk.

The Company utilizes off-balance sheet financing arrangements (primarily
asset-backed securitizations) to further diversify the Company's funding
alternatives. These arrangements are an important source of funding that
provided net proceeds from continuing operations of $174 million in the first
quarter of 2004. Textron Financial has used the proceeds from these arrangements
to fund the origination of new finance receivables and to retire debt. Gains
related to these transactions amounted to $12.6 million and $3.8 million

16

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
during the first quarter of 2004 and 2003, respectively. Of the $12.6 million of
securitization gains in the first quarter of 2004, $7.2 million were related to
recurring finance receivable sales into the Distribution Finance revolving
securitization conduit, while $3.1 million and $2.3 million were related to
incremental finance receivable sales into the Distribution Finance and Aircraft
Finance securitization conduits, respectively. In the first quarter of 2003, the
entire $3.8 million of securitization gains were related to recurring finance
receivable sales into the Distribution Finance revolving securitization conduit.
Cash collections on current and prior period securitization gains were $12.5
million and $9.1 million for the first quarter of 2004 and 2003, respectively.

Managed Finance Assets

Managed finance assets consist of owned finance assets, and finance
receivables that Textron Financial has sold in securitizations or similar
structures and continues to service. Finance assets include finance receivables,
equipment on operating leases -- net of accumulated depreciation, repossessed
assets and properties, retained interests in securitizations, interest-only
securities, investment on equipment residuals, ADC arrangements, and other
long-term investments (some of which are classified in Other assets in Textron
Financial's Consolidated Balance Sheets). The managed finance assets of our
business segments at March 31, 2004, and January 3, 2004 are presented in the
following table.

Managed finance assets within the core businesses increased $88 million,
primarily as a result of growth in the private brands portfolio within
Distribution Finance. This increase was partially offset by higher collections,
net of new finance receivable originations, in Aircraft Finance, the land
finance portfolio and the golf equipment portfolio. The decrease in the Other
segment represents the continued portfolio collections of the liquidating
portfolios.

Nonperforming Assets

Nonperforming assets include nonaccrual finance receivables and repossessed
assets. Textron Financial classifies receivables as nonaccrual and suspends the
recognition of earnings when accounts are contractually delinquent by more than
three months, unless collection of principal and interest is not doubtful. In
addition, earlier suspension may occur if collection is doubtful. Doubt may be
created by payment delinquency, reduction in the obligor's cash flows,
deterioration in the loan to collateral value relationship or other relevant
considerations.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
The following table sets forth certain information about nonperforming
assets and the related percentages of owned finance assets at March 31, 2004 and
January 3, 2004 by business segment.

In general, the Company believes that nonperforming assets will generally
be in the range of 2% to 4% of finance assets depending on economic conditions.
Nonperforming assets were relatively stable at March 31, 2004, as compared to
January 3, 2004, increasing by $3.4 million. The increase was primarily
attributable to the Resort Finance land portfolio ($3.9 million), and
Asset-Based Lending ($3.8 million). This increase was partially offset by an
improvement in Aircraft Finance ($4.8 million). Aircraft values have
historically tracked well with the business cycles of the U.S. economy, although
the effects typically lag changes in the business cycles by about 12 to 18
months. Textron Financial expects that as the economy continues to improve,
aircraft values will follow the trend.

Interest Rate Sensitivity

Textron Financial'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 floating rate assets with floating rate
liabilities limits Textron Financial's risk to changes in interest rates. This
strategy includes the use of interest rate exchange agreements. At March 31,
2004, floating rate liabilities in excess of floating rate assets were $301
million, net of $1.8 billion of interest rate exchange agreements on long-term
debt and $225 million of interest rate exchange agreements on finance
receivables. Classified within fixed rate assets are approximately $1.0 billion
of floating rate loans with index rate floors that are on average 158 basis
points above the applicable index rate (predominately the prime rate). As a
consequence, these assets are classified as fixed rate, and will remain so until
the prime rate increases above the floor rates. Generally, in periods of a low
interest rate environment, the Company has benefited from these interest rate
floor agreements. However, during periods of rising interest rates, this benefit
will dissipate until such time as the prime rate exceeds the floor rates
embedded in these agreements.

Management believes that its asset/liability management policy provides
adequate protection against interest rate risks. Increases in interest rates,
however, could have an adverse effect on interest margin. Variable rate finance
receivables are generally tied to changes in the prime rate offered by major
U.S. banks. 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 March 31, 2004, indicates that an
increase in interest rates of 100 basis points would have a negative impact on
Textron Financial's net income and cash flows of $2.0 million for the following
twelve-month period.

18

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
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 of 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 match-funding objectives. 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
non-functional currency exposures to changes in currency rates. The notional
amounts of outstanding foreign currency forward exchange contracts were $3.1
million at March 31, 2004.

RESULTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2004 VS. MARCH 31, 2003

REVENUES AND NET INTEREST MARGIN

A comparison of revenues and net interest margin is set forth in the
following table.

The decrease in finance charges principally reflects lower average finance
receivables of $503 million, partially offset by a slight increase in pricing.
The increase in other income was mostly due to higher securitization gains in
Distribution Finance ($6.4 million) and Aircraft Finance ($2.3 million),
partially offset by lower other income ($3.3 million). The decrease in interest
expense was attributable to a lower interest rate environment and the maturity
of higher cost debt.

19

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
SELLING AND ADMINISTRATIVE EXPENSES

The decrease in selling and administrative expenses principally reflects
improvements from the Company's restructuring program that was implemented in
the fourth quarter of 2003 ($1.6 million) and lower legal and collection costs
($3.0 million) from improving portfolio quality, partially offset by higher
healthcare costs ($0.7 million).

PROVISION FOR LOSSES

The decrease in the provision largely reflects an improvement in portfolio
quality. Nonperforming assets decreased $57.6 million to $165.4 million at March
31, 2004 from $223.0 million at March 31, 2003, which was the highest level of
nonperforming assets during the last year. The decrease in net charge-offs was
primarily attributable to Asset-Based Lending mostly from a reduction in
telecommunication industry losses and Aircraft Finance reflecting an improvement
in general economic conditions and aircraft values. This decrease was partially
offset by increases in Resort Finance related to the sale of two nonperforming
accounts, and the Other segment primarily reflecting losses on the sale of
nonperforming media accounts ($3.2 million).

Although management believes it has made adequate provision for anticipated
losses, realization of these 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

Segment income presented in the tables below represents income from
continuing operations before income taxes and distributions on preferred
securities.

20

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
Distribution Finance

The increase in Distribution Finance segment income reflected lower
provision for losses and a higher net interest margin, partially offset by
higher selling and administrative expenses. The increase in net interest margin
was primarily due to an increase in other income ($7.9 million) from increased
securitization activity. The decrease in provision for losses represents a
change in reserving requirements for this segment based on strong portfolio
performance as supported by improvements in the 12 and 36-month loss to
liquidation ratios.

Resort Finance

Resort Finance segment income decreased reflecting a higher provision for
losses and higher selling and administrative expenses, partially offset by an
increase in net interest margin. The increase in provision for losses is
primarily related to reserving actions taken on several nonperforming accounts.

Aircraft Finance

The improvement in Aircraft Finance segment income was mostly due to an
increase in net interest margin and lower provision for losses. The increase in
net interest margin reflected an increase in other income ($1.7 million),
primarily as a result of increased securitization activity ($2.3 million), and
lower interest expense from a lower relative borrowing cost ($1.5 million). The
decrease in provision for losses reflects improvement in portfolio quality and
lower portfolio growth.

21

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
Golf Finance

Golf Finance segment income decreased primarily as a result of lower net
interest margin and higher provision for losses. The decrease in net interest
margin was mostly due to lower investment and other income ($2.4 million) and
lower pricing and margin compression ($0.9 million). The decrease in investment
income resulted in lower earnings on retained securitization interests due to
the voluntary liquidation and termination of a golf equipment securitization
conduit in the fourth quarter of 2003, while the decrease in other income was
related to a one-time advisory fee of $1.5 million that was earned in the first
quarter of 2003. The increase in provision for losses reflects higher reserving
requirements related to nonperforming assets.

Asset-Based Lending

Asset-Based Lending segment income decreased principally due to a higher
provision for losses as a result of an increase in nonperforming assets,
partially offset by lower selling and administrative expenses primarily as a
result of the restructuring program implemented during the fourth quarter of
2003.

Structured Capital

Structured Capital segment income increased as a result of higher net
interest margin, primarily due to higher average finance receivables ($54
million).

22

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
Other Segment

Other segment loss decreased reflecting a lower provision for losses and
lower selling and administrative expenses, partially offset by a lower net
interest margin. The decrease in the provision for losses reflects a declining
level of nonperforming assets within the media, franchise and syndicated bank
loan portfolios, which resulted in lower provisioning requirements of $5.5
million, $3.0 million and $1.1 million, respectively. The lower selling and
administrative expenses and lower net interest margin largely reflect the
continued liquidation of the finance receivables within this segment through
portfolio sales and collections. Average finance receivables declined $412
million in the first quarter of 2004 as compared to the corresponding period in
2003.

INCOME FROM CONTINUING OPERATIONS

Income from continuing operations of $20.9 million for the first quarter of
2004 was $5.6 million or 37% higher than the corresponding period of 2003. The
increase was due to a lower provision for losses ($4.2 million), selling and
administrative expenses ($3.6 million) and a slightly lower effective tax rate
($0.2 million), partially offset by a lower interest margin ($0.3 million).

SELECTED FINANCIAL RATIOS

23

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS (CONTINUED)
- ---------------

(1) Represents revenues earned less interest expense on borrowings and operating
lease depreciation as a percentage of average net investment. Average net
investment includes finance receivables plus operating leases, less deferred
taxes on leveraged leases.

(2) Average managed and serviced finance receivables include owned finance
receivables, finance receivables serviced under securitizations,
participations and third-party portfolio servicing agreements.

(3) Operating efficiency ratio is selling and administrative expenses divided by
net interest margin.

(4) Delinquency excludes captive finance receivables with recourse to Textron.
Captive finance 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.

(5) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets and properties; retained
interests in securitizations; interest-only securities; investment in
equipment residuals; ADC arrangements; and long-term investments (some of
which are classified in Other assets on Textron Financial's Condensed
Consolidated Balance Sheets). Nonperforming assets include independent and
nonrecourse captive finance assets.

(6) Tangible shareholder's equity equals Shareholder's equity, excluding
Accumulated other comprehensive income or loss, less Goodwill.

FORWARD-LOOKING INFORMATION

Certain statements in this quarterly report on 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 achieve savings from its restructuring plans; (b)
uncertainty in estimating the amount and timing of restructuring charges and
related costs; (c) changes in worldwide economic and political conditions that
impact interest and foreign exchange rates; (d) the occurrence of further
downturns in customer markets to which Textron products are sold or supplied and
financed or where Textron Financial offers financing; (e) the ability to control
costs and successful implementation of various cost reduction programs; (f) the
impact of changes in tax legislation; (g) the ability to maintain portfolio
credit quality; (h) Textron Financial's access to debt financing at competitive
rates; (i) access to equity in the form of retained earnings and capital
contributions from Textron; and (j) uncertainty in estimating contingent
liabilities and establishing reserves tailored to address such contingencies.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For information regarding Textron Financial's Quantitative and Qualitative
Disclosure 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

We have carried out an evaluation, under the supervision and with the
participation of our management, including our Chairman and Chief Executive
Officer (the "CEO") and our Executive Vice President and Chief Financial Officer
(the "CFO"), of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the "Act")) as of the end of the
fiscal quarter covered by this report. Based upon that evaluation, our CEO and
CFO concluded that our disclosure controls and procedures are effective in
providing reasonable assurance that (a) the information required to be disclosed
by us in the reports that we file or

24

ITEM 4. CONTROLS AND PROCEDURES (CONTINUED)

submit 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 our
management, including our CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure.

There has been no change in our internal control over financial reporting
during the fiscal quarter covered by this report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.

25

PART II. OTHER INFORMATION

TEXTRON FINANCIAL CORPORATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) 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 Textron Financial Corporation's
Registration Statement on Form S-3 (No. 333-108464).
12 Computation of Ratios of Earnings to Fixed Charges
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a)
32.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(b) and 18 U.S.C Section 1350
32.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(b) and 18 U.S.C. Section 1350

NOTE: Instruments defining the rights of holders of certain issues of long-term
debt of Textron Financial Corporation have not been filed as exhibits to
this Report because the authorized principal amount of any one such issues
does not exceed 10% of the total assets of Textron Financial Corporation
and its subsidiaries on a consolidated basis. Textron Financial
Corporation agrees to furnish a copy of each such instrument to Commission
upon request.

(b) REPORTS ON FORM 8-K

No reports on Form 8-K were filed during the quarter ended March 31, 2004.

26

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: May 10, 2004 TEXTRON FINANCIAL CORPORATION

/s/ THOMAS J. CULLEN
--------------------------------------
Thomas J. Cullen
Executive Vice President and Chief
Financial Officer
(Principal Financial Officer)

27