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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

 

 

 

 

Form 10-Q

 

 

 

 

 

 

 

 

(Mark One)

[ X ]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 27, 2014

 

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 1-5480

 

 

Textron Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

05-0315468

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

 

40 Westminster Street, Providence, RI

02903

 

 

(Address of principal executive offices)

(Zip code)

 

 

(401) 421-2800

(Registrant’s telephone number, including area code)

 

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  ü  No     

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   ü  No____

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer  [  ü ]       Accelerated filer  [      ]       Non-accelerated filer  [      ]       Smaller reporting company  [      ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes        No   ü

 

As of October 10, 2014, there were 276,048,870 shares of common stock outstanding.

 



Table of Contents

 

TEXTRON INC.

 

INDEX

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

Consolidated Statements of Operations (Unaudited)

3

 

Consolidated Statements of Comprehensive Income (Unaudited)

4

 

Consolidated Balance Sheets (Unaudited)

5

 

Consolidated Statements of Cash Flows (Unaudited)

6

 

Notes to the Consolidated Financial Statements (Unaudited)

 

 

Note 1.

Basis of Presentation

8

 

Note 2.

Business Acquisitions

9

 

Note 3.

Retirement Plans

11

 

Note 4.

Earnings per Share

11

 

Note 5.

Accounts Receivable and Finance Receivables

12

 

Note 6.

Inventories

14

 

Note 7.

Accrued Liabilities

14

 

Note 8.

Debt

15

 

Note 9.

Accumulated Other Comprehensive Loss and Other Comprehensive Income

15

 

Note 10.

Commitments and Contingencies

17

 

Note 11.

Derivative Instruments and Fair Value Measurements

17

 

Note 12.

Income Tax Expense

18

 

Note 13.

Segment Information

19

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

20

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

32

Item 4.

Controls and Procedures

32

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

33

Item 6.

Exhibits

34

 

Signatures

34

 



Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  FINANCIAL STATEMENTS

 

TEXTRON INC.
Consolidated Statements of Operations (Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In millions, except per share amounts)

 

September 27,
2014

 

 

September 28,
2013

 

September 27,
2014

 

 

September 28,
2013

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Manufacturing revenues

 

  $

3,405

 

 

  $

2,871

 

  $

9,701

 

 

  $

8,492

 

Finance revenues

 

25

 

 

33

 

81

 

 

106

 

Total revenues

 

3,430

 

 

2,904

 

9,782

 

 

8,598

 

Costs and expenses

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

2,845

 

 

2,473

 

8,077

 

 

7,193

 

Selling and administrative expense

 

304

 

 

245

 

959

 

 

820

 

Interest expense

 

47

 

 

41

 

141

 

 

134

 

Acquisition and restructuring costs

 

3

 

 

 

39

 

 

 

Total costs and expenses

 

3,199

 

 

2,759

 

9,216

 

 

8,147

 

Income from continuing operations before income taxes

 

231

 

 

145

 

566

 

 

451

 

Income tax expense

 

71

 

 

47

 

174

 

 

124

 

Income from continuing operations

 

160

 

 

98

 

392

 

 

327

 

Income (loss) from discontinued operations, net of income taxes

 

(1

)

 

1

 

(4

)

 

4

 

Net income

 

  $

159

 

 

  $

99

 

  $

388

 

 

  $

331

 

Basic earnings per share

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

  $

0.57

 

 

  $

0.35

 

  $

1.40

 

 

  $

1.18

 

Discontinued operations

 

 

 

 

(0.02

)

 

0.01

 

Basic earnings per share

 

  $

0.57

 

 

  $

0.35

 

  $

1.38

 

 

  $

1.19

 

Diluted earnings per share

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

  $

0.57

 

 

  $

0.35

 

  $

1.39

 

 

  $

1.15

 

Discontinued operations

 

 

 

 

(0.02

)

 

0.01

 

Diluted earnings per share

 

  $

0.57

 

 

  $

0.35

 

  $

1.37

 

 

  $

1.16

 

Dividends per share

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

  $

0.02

 

 

  $

0.02

 

  $

0.06

 

 

  $

0.06

 

 

See Notes to the consolidated financial statements.

 

3



Table of Contents

 

TEXTRON INC.

Consolidated Statements of Comprehensive Income (Unaudited)

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In millions)

 

September 27,
2014

 

 

September 28,
2013

 

September 27,
2014

 

 

September 28,
2013

 

Net income

 

$

159

 

 

$

99

 

$

388

 

 

$

331

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

Pension and postretirement benefits adjustments, net of reclassifications

 

17

 

 

64

 

62

 

 

127

 

Deferred gains/losses on hedge contracts, net of reclassifications

 

(5

)

 

2

 

2

 

 

(11

)

Foreign currency translation adjustments

 

(43

)

 

12

 

(47

)

 

3

 

Other comprehensive income (loss)

 

(31

)

 

78

 

17

 

 

119

 

Comprehensive income

 

$

128

 

 

$

177

 

$

405

 

 

$

450

 

 

See Notes to the consolidated financial statements.

 

4



Table of Contents

 

TEXTRON INC.

Consolidated Balance Sheets (Unaudited)

 

(Dollars in millions)

 

September 27,
2014

 

 

December 28,
2013

 

Assets

 

 

 

 

 

 

Manufacturing group

 

 

 

 

 

 

Cash and equivalents

 

$

 430

 

 

$

1,163

 

Accounts receivable, net

 

1,150

 

 

979

 

Inventories

 

4,081

 

 

2,963

 

Other current assets

 

539

 

 

467

 

Total current assets

 

6,200

 

 

5,572

 

Property, plant and equipment, less accumulated depreciation and amortization of $3,662 and $3,463

 

2,442

 

 

2,215

 

Goodwill

 

2,020

 

 

1,735

 

Other assets

 

2,509

 

 

1,697

 

Total Manufacturing group assets

 

13,171

 

 

11,219

 

Finance group

 

 

 

 

 

 

Cash and equivalents

 

81

 

 

48

 

Finance receivables, net

 

1,308

 

 

1,493

 

Other assets

 

179

 

 

184

 

Total Finance group assets

 

1,568

 

 

1,725

 

Total assets

 

$

 14,739

 

 

$

12,944

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

Manufacturing group

 

 

 

 

 

 

Short-term and current portion of long-term debt

 

$

 383

 

 

$

8

 

Accounts payable

 

1,135

 

 

1,107

 

Accrued liabilities

 

2,375

 

 

1,888

 

Total current liabilities

 

3,893

 

 

3,003

 

Other liabilities

 

2,451

 

 

2,118

 

Long-term debt

 

2,474

 

 

1,923

 

Total Manufacturing group liabilities

 

8,818

 

 

7,044

 

Finance group

 

 

 

 

 

 

Other liabilities

 

238

 

 

260

 

Debt

 

1,111

 

 

1,256

 

Total Finance group liabilities

 

1,349

 

 

1,516

 

Total liabilities

 

10,167

 

 

8,560

 

Shareholders’ equity

 

 

 

 

 

 

Common stock

 

36

 

 

35

 

Capital surplus

 

1,432

 

 

1,331

 

Treasury stock

 

(302

)

 

 

Retained earnings

 

4,416

 

 

4,045

 

Accumulated other comprehensive loss

 

(1,010

)

 

(1,027

)

Total shareholders’ equity

 

4,572

 

 

4,384

 

Total liabilities and shareholders’ equity

 

$

 14,739

 

 

$

12,944

 

Common shares outstanding (in thousands)

 

276,195

 

 

282,059

 

 

See Notes to the consolidated financial statements.

 

5



Table of Contents

 

TEXTRON INC.

Consolidated Statements of Cash Flows (Unaudited)

For the Nine Months Ended September 27, 2014 and September 28, 2013, respectively

 

 

 

Consolidated

 

(In millions)

 

2014

 

2013

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

388

 

$

331

 

Less: Income (loss) from discontinued operations

 

(4)

 

4

 

Income from continuing operations

 

392

 

327

 

Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities:

 

 

 

 

 

Non-cash items:

 

 

 

 

 

Depreciation and amortization

 

325

 

285

 

Deferred income taxes

 

(41)

 

74

 

Other, net

 

80

 

38

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(55)

 

(178

)

Inventories

 

(370)

 

(443

)

Other assets

 

24

 

(51

)

Accounts payable

 

(120)

 

(25

)

Accrued and other liabilities

 

137

 

(276

)

Income taxes, net

 

61

 

(96

)

Pension, net

 

31

 

(17

)

Captive finance receivables, net

 

107

 

257

 

Other operating activities, net

 

(2)

 

2

 

Net cash provided by (used in) operating activities of continuing operations

 

569

 

(103

)

Net cash used in operating activities of discontinued operations

 

(3)

 

(5

)

Net cash provided by (used in) operating activities

 

566

 

(108

)

Cash flows from investing activities

 

 

 

 

 

Net cash used in acquisitions

 

(1,580)

 

(53

)

Capital expenditures

 

(255)

 

(300

)

Finance receivables repaid

 

77

 

157

 

Proceeds from sales of receivables and other finance assets

 

37

 

152

 

Other investing activities, net

 

(4)

 

13

 

Net cash used in investing activities

 

(1,725)

 

(31

)

Cash flows from financing activities

 

 

 

 

 

Proceeds from long-term debt

 

1,187

 

412

 

Principal payments on long-term and nonrecourse debt

 

(462)

 

(997

)

Increase in short-term debt

 

25

 

96

 

Purchases of Textron common stock

 

(302)

 

 

Settlement of convertible notes

 

 

(215

)

Proceeds from settlement of capped call

 

 

75

 

Dividends paid

 

(17)

 

(16

)

Other financing activities, net

 

33

 

16

 

Net cash provided by (used in) financing activities

 

464

 

(629

)

Effect of exchange rate changes on cash and equivalents

 

(5)

 

(8

)

Net decrease in cash and equivalents

 

(700)

 

(776

)

Cash and equivalents at beginning of period

 

1,211

 

1,413

 

Cash and equivalents at end of period

 

$

511

 

$

637

 

 

See Notes to the consolidated financial statements.

 

6



Table of Contents

 

TEXTRON INC.

Consolidated Statements of Cash Flows (Unaudited) (Continued)

For the Nine Months Ended September 27, 2014 and September 28, 2013, respectively

 

 

 

Manufacturing Group

 

Finance Group

 

(In millions)

 

2014

 

2013

 

2014

 

2013

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

Net income

 

$

378

 

$

300

 

$

10

 

$

31

 

Less: Income (loss) from discontinued operations

 

(4)

 

4

 

 

 

Income from continuing operations

 

382

 

296

 

10

 

31

 

Adjustments to reconcile income from continuing operations to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

 

Non-cash items:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

315

 

271

 

10

 

14

 

Deferred income taxes

 

(25)

 

29

 

(16)

 

45

 

Other, net

 

69

 

69

 

11

 

(31

)

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

Accounts receivable, net

 

(55)

 

(178

)

 

 

Inventories

 

(344)

 

(459

)

 

 

Other assets

 

38

 

(40

)

(14)

 

(11

)

Accounts payable

 

(120)

 

(25

)

 

 

Accrued and other liabilities

 

145

 

(262

)

(8)

 

(24

)

Income taxes, net

 

57

 

(101

)

4

 

5

 

Pension, net

 

31

 

(12

)

 

(5

)

Dividends received from Finance Group

 

 

30

 

 

 

Capital contributions paid to Finance Group

 

 

(1

)

 

 

Other operating activities, net

 

(2)

 

2

 

 

 

Net cash provided by (used in) operating activities of continuing operations

 

491

 

(381

)

(3)

 

24

 

Net cash used in operating activities of discontinued operations

 

(3)

 

(5

)

 

 

Net cash provided by (used in) operating activities

 

488

 

(386

)

(3)

 

24

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

Net cash used in acquisitions

 

(1,580)

 

(53

)

 

 

Capital expenditures

 

(255)

 

(300

)

 

 

Finance receivables repaid

 

 

 

307

 

558

 

Finance receivables originated or purchased

 

 

 

(123)

 

(164

)

Proceeds from sales of receivables and other finance assets

 

 

 

37

 

152

 

Other investing activities, net

 

(12)

 

19

 

(18)

 

40

 

Net cash provided by (used in) investing activities

 

(1,847)

 

(334

)

203

 

586

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

Proceeds from long-term debt

 

1,093

 

150

 

94

 

262

 

Principal payments on long-term and nonrecourse debt

 

(201)

 

(312

)

(261)

 

(685

)

Increase in short-term debt

 

25

 

96

 

 

 

Purchases of Textron common stock

 

(302)

 

 

 

 

Settlement of convertible notes

 

 

(215

)

 

 

Proceeds from settlement of capped call

 

 

75

 

 

 

Dividends paid

 

(17)

 

(16

)

 

(30

)

Capital contributions paid to Finance group

 

 

 

 

1

 

Other financing activities, net

 

33

 

16

 

 

 

Net cash provided by (used in) financing activities

 

631

 

(206

)

(167)

 

(452

)

Effect of exchange rate changes on cash and equivalents

 

(5)

 

(8

)

 

 

Net increase (decrease) in cash and equivalents

 

(733)

 

(934

)

33

 

158

 

Cash and equivalents at beginning of period

 

1,163

 

1,378

 

48

 

35

 

Cash and equivalents at end of period

 

$

430

 

$

444

 

$

81

 

$

193

 

 

See Notes to the consolidated financial statements.

 

7



Table of Contents

 

TEXTRON INC.

Notes to the Consolidated Financial Statements (Unaudited)

 

Note 1.  Basis of Presentation

 

Our Consolidated Financial Statements include the accounts of Textron Inc. (Textron) and its majority-owned subsidiaries.  On March 14, 2014, we completed the acquisition of all of the outstanding equity interests in Beech Holdings, LLC, which included Beechcraft Corporation and other subsidiaries, (collectively “Beechcraft”). The results of Beechcraft have been included in our consolidated financial statements only for the period subsequent to the completion of the acquisition. As a result, the consolidated financial results for the nine months ended September 27, 2014 do not reflect a full nine months of Beechcraft operations.

 

We have prepared these unaudited consolidated financial statements in accordance with accounting principles generally accepted in the U.S. for interim financial information.  Accordingly, these interim financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements.  The consolidated interim financial statements included in this quarterly report should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 28, 2013.  In the opinion of management, the interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for the fair presentation of our consolidated financial position, results of operations and cash flows for the interim periods presented.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

 

Our financings are conducted through two separate borrowing groups.  The Manufacturing group consists of Textron consolidated with its majority-owned subsidiaries that operate in the Bell, Textron Systems and Industrial segments, and the recently formed Textron Aviation segment, which includes the legacy Cessna segment and the acquired Beechcraft business. The Finance group, which also is the Finance segment, consists of Textron Financial Corporation (TFC) and its consolidated subsidiaries. We designed this framework to enhance our borrowing power by separating the Finance group. Our Manufacturing group operations include the development, production and delivery of tangible goods and services, while our Finance group provides financial services. Due to the fundamental differences between each borrowing group’s activities, investors, rating agencies and analysts use different measures to evaluate each group’s performance.  To support those evaluations, we present balance sheet and cash flow information for each borrowing group within the Consolidated Financial Statements.  All significant intercompany transactions are eliminated from the Consolidated Financial Statements, including retail and wholesale financing activities for inventory sold by our Manufacturing group and financed by our Finance group.

 

Use of Estimates

We prepare our financial statements in conformity with generally accepted accounting principles, which require us to make estimates and assumptions that affect the amounts reported in the financial statements.  Actual results could differ from those estimates.  Our estimates and assumptions are reviewed periodically, and the effects of changes, if any, are reflected in the Consolidated Statements of Operations in the period that they are determined.

 

During 2014 and 2013, we changed our estimates of revenues and costs on certain long-term contracts that are accounted for under the percentage-of-completion method of accounting.  These changes in estimates increased income from continuing operations before income taxes in the third quarter of 2014 and 2013 by $10 million and $4 million, respectively, ($6 million and $2 million after tax, or $0.02 and $0.01 per diluted share, respectively). For the third quarter of 2014 and 2013, the gross favorable program profit adjustments totaled $25 million and $12 million, respectively, and the gross unfavorable program profit adjustments totaled $15 million and $8 million, respectively.

 

The changes in estimates increased income from continuing operations before income taxes in the first nine months of 2014 and 2013 by $69 million and $13 million, respectively, ($43 million and $8 million after tax, or $0.15 and $0.03 per diluted share, respectively).  For the first nine months of 2014 and 2013, the gross favorable program profit adjustments totaled $90 million and $30 million, respectively, and the gross unfavorable program profit adjustments totaled $21 million and $17 million, respectively.  Gross favorable program profit adjustments in the second quarter of 2014 included $16 million related to the settlement of the System Development and Demonstration phase of the Armed Reconnaissance Helicopter (ARH) program which was terminated in October 2008.

 

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers,” that outlines a comprehensive five-step revenue recognition model based on the principle that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services.  Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption. This ASU is effective for our

 

8



Table of Contents

 

company at the beginning of fiscal 2017; early adoption is not permitted. We are currently evaluating the new guidance to determine the impact it is expected to have on our consolidated financial statements, along with the transition method we expect to utilize.

 

Note 2.  Business Acquisitions

 

2014 Beechcraft Acquisition

On March 14, 2014, we acquired Beechcraft for an aggregate cash payment of $1.5 billion that included a repayment of a portion of Beechcraft’s working capital credit facility at closing. We financed a portion of the purchase price with the issuance of $600 million in senior notes on January 30, 2014 and by drawing $500 million under the five-year term loan agreement entered into on January 24, 2014.  The balance was paid from cash on hand.

 

Beechcraft is a leading manufacturer of business, special mission, light attack and trainer aircraft, including the King Air turboprops, piston-engine Baron and Bonanza, and the T-6 trainer and AT-6 light attack military aircraft. Beechcraft also has a global network of both factory-owned and authorized service centers.  The acquisition of Beechcraft and the formation of the Textron Aviation segment provide increased scale and complementary product offerings, allowing us to strengthen our position across the aviation industry and enhance our ability to support our customers.

 

The consideration paid for this business was allocated on a preliminary basis to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date, which have been subsequently adjusted as estimates are being finalized.  Due to the size and breadth of this acquisition, additional time is necessary to complete the purchase accounting related to the fair values of certain assets and liabilities.  We will finalize the purchase accounting as soon as reasonably possible during the one-year-measurement period allowed under generally accepted accounting principles.  Any potential adjustments to the preliminary fair values could be material.  Our allocation of the purchase price is presented below.

 

(In millions)

 

 

 

Accounts receivable

 

$

118

 

Inventories

 

770

 

Other current assets

 

175

 

Property, plant and equipment

 

258

 

Intangible assets

 

581

 

Goodwill

 

226

 

Other assets

 

171

 

Accounts payable

 

(143

)

Accrued liabilities

 

(282

)

Other liabilities

 

(396

)

Total net assets acquired

 

$

1,478

 

 

Goodwill of $226 million was primarily related to expected synergies from combining operations and the value of the existing workforce, and intangible assets of $581 million included unpatented technology related to original equipment manufactured parts and designs and customer relationships valued at $373 million and trade names valued at $208 million.  The unpatented technology and customer relationships assets have a life of 15 years, resulting in amortization expense in the range of approximately $17 million to $31 million annually.  Substantially all of the trade names intangible asset has an indefinite life and therefore is not subject to amortization.

 

We acquired tax-deductible goodwill of approximately $260 million in this transaction.  We also recorded unrecognized tax benefits of approximately $95 million at the acquisition date.

 

In connection with the integration of Beechcraft, we initiated a restructuring program in our Textron Aviation segment in the first quarter of 2014 to align the Cessna and Beechcraft businesses, reduce operating redundancies and maximize efficiencies. We expect to incur costs for this program related to employee terminations, facility consolidations, contract terminations and other transition-related costs, and estimate that this program will result in charges of approximately $35 million in 2014.  We expect to incur additional costs in 2015, but do not expect these costs to be material.   In the third quarter and first nine months of 2014, we recorded charges of $3 million and $28 million, respectively, related to restructuring activities that were included in the Acquisition and restructuring costs line on the Consolidated Statements of Operations.  In addition, we incurred transaction costs of $11 million during the first quarter of 2014 related to the acquisition that were also included in the Acquisition and restructuring costs line.

 

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Other 2014 Acquisitions

During the first nine months of 2014, we made aggregate cash payments of $101 million for the following acquisitions:

 

Industrial

·                  Tug Technologies Corporation, a manufacturer of ground support equipment in the aviation industry, acquired on May 2, 2014.

·                  The assets of Dixie Chopper, a manufacturer of zero-turn radius mowers for the commercial and residential markets, acquired on February 6, 2014.

 

Textron Systems

·                  ProFlight, LLC, a pilot training operation, acquired on July 2, 2014.

 

Actual and Pro-Forma Impact from 2014 Acquisitions

The operating results for the 2014 acquisitions are included in the Consolidated Statement of Operations since their respective closing dates.  From the closing dates through September 27, 2014, revenues related to these acquisitions totaled $435 million and $993 million for the three- and nine-month periods, respectively.  The cost structures of Beechcraft and Cessna have been significantly integrated since the acquisition of Beechcraft, therefore, it is not possible to separately report earnings for this acquisition.  The earnings related to the other 2014 acquisitions were not significant.

 

The unaudited supplemental pro-forma data included in the table below presents consolidated information as if our 2014 acquisitions had been completed on December 30, 2012.  This pro-forma information should not be considered indicative of the results that would have occurred if the acquisition and related financing had been consummated on December 30, 2012, nor are they necessarily indicative of future results as they do not reflect the potential realization of cost savings and synergies associated with the acquisition.

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In millions, except per share amounts)

 

September 27,
2014

 

September 28,
2013

 

September 27,
2014

 

September 28,
2013

 

Revenues

 

$

3,430

 

$

3,308

 

$

10,145

 

$

9,907

 

Income from continuing operations, net of income taxes

 

169

 

78

 

462

 

279

 

Diluted earnings per share from continuing operations

 

$

0.60

 

$

0.28

 

$

1.64

 

$

0.98

 

 

Certain pro-forma adjustments were made to reflect the allocation of the preliminary purchase price to the acquired net assets including depreciation and intangible amortization expense, resulting from the valuation of tangible and intangible assets, and amortization of inventory fair value step-up adjustments, along with the related tax effects.  The pro-forma results for 2013 were also adjusted to include transaction and restructuring costs of $3 million and $39 million for the three- and nine-month periods, respectively, related to the Beechcraft acquisition; these costs were excluded from the 2014 pro-forma results. In addition, the pro-forma results exclude the financial impact related to Beechcraft’s emergence from bankruptcy in 2013.

 

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Note 3. Retirement Plans

 

We provide defined benefit pension plans and other postretirement benefits to eligible employees.  The components of net periodic benefit cost for these plans are as follows:

 

 

 

Pension Benefits

 

Postretirement Benefits
Other Than Pensions

 

(In millions)

 

September 27,
2014

 

September 28,
2013

 

September 27,
2014

 

September 28,
2013

 

Three Months Ended

 

 

 

 

 

 

 

 

 

Service cost

 

$

27

 

$

33

 

$

1

 

$

1

 

Interest cost

 

86

 

72

 

5

 

5

 

Expected return on plan assets

 

(117)

 

(104

)

 

 

Amortization of prior service cost (credit)

 

3

 

4

 

(5)

 

(6

)

Amortization of net actuarial loss

 

28

 

46

 

 

2

 

Net periodic benefit cost

 

$

27

 

$

51

 

$

1

 

$

2

 

Nine Months Ended

 

 

 

 

 

 

 

 

 

Service cost

 

$

81

 

$

100

 

$

3

 

$

5

 

Interest cost

 

250

 

218

 

15

 

15

 

Expected return on plan assets

 

(345)

 

(314

)

 

 

Amortization of prior service cost (credit)

 

11

 

11

 

(16)

 

(11

)

Amortization of net actuarial loss

 

84

 

138

 

1

 

5

 

Net periodic benefit cost

 

$

81

 

$

153

 

$

3

 

$

14

 

 

Note 4.  Earnings Per Share

 

In February 2014, we entered into an Accelerated Share Repurchase agreement (ASR) with a counterparty and repurchased 4.3 million shares of our outstanding common stock from the counterparty for $150 million. The initial delivery of shares resulted in an immediate reduction of the outstanding shares used to calculate the weighted average common shares for basic and diluted earnings per share. The ASR is scheduled to settle in December 2014. Upon final settlement of the ASR, we may receive additional shares or pay additional cash or shares, at our option, based on the daily volume weighted average market price (VWAP) of our common stock over the course of the calculation period, less a discount. We intend to settle any amount payable by us in shares. At September 27, 2014, based on the VWAP through that date, we would be required to issue to the counterparty approximately 278,000 shares to settle the ASR. For accounting purposes, the ASR is considered a treasury stock purchase for the 4.3 million shares delivered to us by the counterparty, and a forward contract indexed to our common stock for the shares to be delivered upon settlement, if any. The forward contract is not required to be separately accounted for as a derivative.

 

We calculate basic and diluted earnings per share (EPS) based on net income, which approximates income available to common shareholders for each period. Basic EPS is calculated using the two-class method, which includes the weighted-average number of common shares outstanding during the period and restricted stock units to be paid in stock that are deemed participating securities as they provide nonforfeitable rights to dividends. Diluted EPS considers the dilutive effect of all potential future common stock, including stock options and shares that would have been delivered if the ASR were settled at September 27, 2014. In addition, for the first nine months of 2013, prior to the maturity of our convertible notes on May 1, 2013 as disclosed in Note 7 of our 2013 Annual Report on Form 10-K, diluted EPS included the shares that could have been issued upon the conversion of the notes and upon the exercise of the related warrants.

 

The weighted-average shares outstanding for basic and diluted EPS are as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In thousands)

 

September 27,
2014

 

September 28,
2013

 

September 27,
2014

 

September 28,
2013

 

Basic weighted-average shares outstanding

 

278,860

 

281,525

 

280,096

 

278,296

 

Dilutive effect of:

 

 

 

 

 

 

 

 

 

Stock options

 

1,892

 

185

 

2,027

 

221

 

ASR

 

278

 

 

301

 

 

Convertible notes and warrants

 

 

 

 

6,226

 

Diluted weighted-average shares outstanding

 

281,030

 

281,710

 

282,424

 

284,743

 

 

Stock options to purchase 2 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding for both the three and nine months ended September 27, 2014, as their effect would have been anti-dilutive.  Stock options to purchase 6 million and 5 million shares of common stock outstanding are excluded from our calculation

 

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of diluted weighted-average shares outstanding for the three and nine months ended September 28, 2013, respectively, as their effect would have been anti-dilutive.

 

Note 5.  Accounts Receivable and Finance Receivables

 

Accounts Receivable

Accounts receivable is composed of the following:

 

(In millions)

 

September 27,
2014

 

December 28,
2013

 

Commercial

 

$

849

 

$

654

 

U.S. Government contracts

 

329

 

347

 

 

 

1,178

 

1,001

 

Allowance for doubtful accounts

 

(28)

 

(22

)

Total

 

$

1,150

 

$

979

 

 

We have unbillable receivables, primarily on U.S. Government contracts, that arise when the revenues we have appropriately recognized based on performance cannot be billed yet under terms of the contract.  Unbillable receivables within accounts receivable totaled $124 million at September 27, 2014 and $163 million at December 28, 2013.

 

Finance Receivables

Finance receivables by classification are presented in the following table:

 

(In millions)

 

September 27,
2014

 

December 28,
2013

 

Finance receivables held for investment

 

$

1,329

 

$

1,483

 

Allowance for losses

 

(56)

 

(55

)

Total finance receivables held for investment, net

 

1,273

 

1,428

 

Finance receivables held for sale

 

35

 

65

 

Total finance receivables, net

 

$

1,308

 

$

1,493

 

 

Credit Quality Indicators and Nonaccrual Finance Receivables

We internally assess the quality of our finance receivables based on a number of key credit quality indicators and statistics such as delinquency, loan balance to estimated collateral value and the financial strength of individual borrowers and guarantors.  Because many of these indicators are difficult to apply across an entire class of receivables, we evaluate individual loans on a quarterly basis and classify these loans into three categories based on the key credit quality indicators for the individual loan.  These three categories are performing, watchlist and nonaccrual.

 

We classify finance receivables as nonaccrual if credit quality indicators suggest full collection of principal and interest is doubtful.  In addition, we automatically classify accounts as nonaccrual once they are contractually delinquent by more than three months unless collection of principal and interest is not doubtful.  Recognition of interest income is suspended for these accounts and all cash collections are used to reduce the net investment balance.  We resume the accrual of interest when the loan becomes contractually current through payment according to the original terms of the loan or, if a loan has been modified, following a period of performance under the terms of the modification, provided we conclude that collection of all principal and interest is no longer doubtful.  Previously suspended interest income is recognized at that time.  Accounts are classified as watchlist when credit quality indicators have deteriorated as compared with typical underwriting criteria, and we believe collection of full principal and interest is probable but not certain.  All other finance receivables that do not meet the watchlist or nonaccrual categories are classified as performing.

 

A summary of finance receivables categorized based on the credit quality indicators discussed above is as follows:

 

(In millions)

 

September 27,
2014

 

December 28,
 2013

 

Performing

 

$

1,111

 

$

1,285

 

Watchlist

 

117

 

93

 

Nonaccrual

 

101

 

105

 

Total

 

$

1,329

 

$

1,483

 

Nonaccrual as a percentage of total finance receivables

 

7.60%

 

7.08%

 

 

We measure delinquency based on the contractual payment terms of our loans and leases.  In determining the delinquency aging

 

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category of an account, any/all principal and interest received is applied to the most past-due principal and/or interest amounts due.  If a significant portion of the contractually due payment is delinquent, the entire finance receivable balance is reported in accordance with the most past-due delinquency aging category.

 

Finance receivables by delinquency aging category are summarized in the table below:

 

(In millions)

 

September 27,
2014

 

December 28,
2013

 

Less than 31 days past due

 

$

1,165

 

$

1,295

 

31-60 days past due

 

94

 

108

 

61-90 days past due

 

41

 

37

 

Over 90 days past due

 

29

 

43

 

Total

 

$

1,329

 

$

1,483

 

 

Accrual status loans that were greater than 90 days past due totaled $4 million at September 27, 2014 and $5 million at December 28, 2013.  At September 27, 2014 and December 28, 2013, 60+ days contractual delinquency as a percentage of finance receivables was 5.27% and 5.39%, respectively.

 

Loan Modifications

Troubled debt restructurings occur when we have either modified the contract terms of finance receivables for borrowers experiencing financial difficulties or accepted a transfer of assets in full or partial satisfaction of the loan balance.  The types of modifications we typically make include extensions of the original maturity date of the contract, delays in the timing of required principal payments and deferrals of interest payments. The changes effected by modifications made during the first nine months of 2014 and 2013 to finance receivables were not material.

 

Impaired Loans

On a quarterly basis, we evaluate individual finance receivables for impairment in non-homogeneous portfolios and larger balance accounts in homogeneous loan portfolios. A finance receivable is considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement based on our review of the credit quality indicators discussed above. Impaired finance receivables include both nonaccrual accounts and accounts for which full collection of principal and interest remains probable, but the account’s original terms have been, or are expected to be, significantly modified. If the modification specifies an interest rate equal to or greater than a market rate for a finance receivable with comparable risk, the account is not considered impaired in years subsequent to the modification. Interest income recognized on impaired loans was not significant in the first nine months of 2014 or 2013.

 

A summary of impaired finance receivables, excluding leveraged leases, and the average recorded investment is provided below:

 

(In millions)

 

September 27,
2014

 

December 28,
2013

 

Recorded investment:

 

 

 

 

 

Impaired loans with related allowance for losses

 

$

78

 

$

59

 

Impaired loans with no related allowance for losses

 

53

 

78

 

Total

 

$

131

 

$

137

 

Unpaid principal balance

 

$

135

 

$

141

 

Allowance for losses on impaired loans

 

23

 

14

 

Average recorded investment

 

116

 

155

 

 

A summary of the allowance for losses on finance receivables that are evaluated on an individual basis and on a collective basis is provided below. The finance receivables included in the table below excludes leveraged leases in accordance with generally accepted accounting principles.

 

(In millions)

 

September 27,
2014

 

December 28,
2013

 

Allowance based on collective evaluation

 

$

33

 

$

41

 

Allowance based on individual evaluation

 

23

 

14

 

Finance receivables evaluated collectively

 

$

1,077

 

$

1,226

 

Finance receivables evaluated individually

 

131

 

137

 

 

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Table of Contents

 

Allowance for Losses

We maintain the allowance for losses on finance receivables at a level considered adequate to cover inherent losses in the portfolio based on management’s evaluation. For larger balance accounts specifically identified as impaired, a reserve is established based on comparing the expected future cash flows, discounted at the finance receivable’s effective interest rate, or the fair value of the underlying collateral if the finance receivable is collateral dependent, to its carrying amount. The expected future cash flows consider collateral value; financial performance and liquidity of our borrower; existence and financial strength of guarantors; estimated recovery costs, including legal expenses; and costs associated with the repossession and eventual disposal of collateral. When there is a range of potential outcomes, we perform multiple discounted cash flow analyses and weight the potential outcomes based on their relative likelihood of occurrence. The evaluation of our portfolio is inherently subjective, as it requires estimates, including the amount and timing of future cash flows expected to be received on impaired finance receivables and the estimated fair value of the underlying collateral, which may differ from actual results. While our analysis is specific to each individual account, critical factors included in this analysis are industry valuation guides, age and physical condition of the collateral, payment history and existence and financial strength of guarantors.

 

We also establish an allowance for losses to cover probable but specifically unknown losses existing in the portfolio. The allowance is established as a percentage of non-recourse finance receivables, which have not been identified as requiring specific reserves. The percentage is based on a combination of factors, including historical loss experience, current delinquency and default trends, collateral values and both general economic and specific industry trends. Finance receivables are charged off at the earlier of the date the collateral is repossessed or when no payment has been received for six months, unless management deems the receivable collectible.

 

A rollforward of the allowance for losses on finance receivables is provided below:

 

 

 

Nine Months Ended

 

(In millions)

 

September 27,
2014

 

September 28,
2013

 

Balance at the beginning of period

 

$

55

 

$

84

 

Provision for losses

 

7

 

(23

)

Charge-offs

 

(11)

 

(9

)

Recoveries

 

5

 

11

 

Transfers

 

 

(1

)

Balance at the end of period

 

$

56

 

$

62

 

 

Note 6.  Inventories

 

Inventories are composed of the following:

 

(In millions)

 

September 27,
2014

 

December 28,
2013

 

Finished goods

 

$

1,646

 

$

1,276

 

Work in process

 

2,791

 

2,477

 

Raw materials and components

 

555

 

407

 

 

 

4,992

 

4,160

 

Progress/milestone payments

 

(911)

 

(1,197

)

Total

 

$

4,081

 

$

2,963

 

 

Note 7.  Accrued Liabilities

 

We provide limited warranty and product maintenance programs, including parts and labor, for certain products for periods ranging from one to five years. Changes in our warranty and product maintenance liabilities are as follows:

 

 

 

Nine Months Ended

 

(In millions)

 

September 27,
2014

 

September 28,
2013

 

Accrual at the beginning of period

 

$

223

 

$

222

 

Provision

 

240

 

203

 

Settlements

 

(240)

 

(210

)

Acquisitions

 

65

 

 

Adjustments*

 

(8)

 

(3

)

Accrual at the end of period

 

$

280

 

$

212

 

* Adjustments include changes to prior year estimates, new issues on prior year sales and currency translation adjustments.

 

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Note 8.  Debt

 

On January 24, 2014, we entered into a five-year term loan agreement with a syndicate of banks in the principal amount of $500 million. On January 30, 2014, we issued $250 million in 3.65% notes due 2021 and $350 million in 4.30% notes due 2024 under our shelf registration statement.  Upon the closing of the Beechcraft acquisition on March 14, 2014, we fully drew down on the five-year term loan and used the cash, along with the net proceeds of the issuance of the notes, to finance a portion of the acquisition.  During the third quarter of 2014, we repaid $200 million of the five-year term loan.

 

Note 9.  Accumulated Other Comprehensive Loss and Other Comprehensive Income

 

The components of Accumulated Other Comprehensive Loss are presented below:

 

(In millions)

 

Foreign
Currency
Translation
Adjustments

 

Pension and
Postretirement
Benefits
Adjustments

 

Deferred
Gains/Losses
on Hedge
Contracts

 

Accumulated
Other
Comprehensive
Loss

 

For the nine months ended September 27, 2014

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

93

 

$

(1,110)

 

$

(10)

 

$

(1,027

)

Other comprehensive income (loss) before reclassifications

 

(47)

 

9

 

(4)

 

(42

)

Amounts reclassified from Accumulated Other Comprehensive Loss

 

 

53

 

6

 

59

 

Other comprehensive income (loss)

 

(47)

 

62

 

2

 

17

 

Ending balance

 

$

46

 

$

(1,048)

 

$

(8)

 

$

(1,010

)

For the nine months ended September 28, 2013

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

81

 

$

(1,857)

 

$

6

 

$

(1,770

)

Other comprehensive income (loss) before reclassifications

 

3

 

 

(9)

 

(6

)

Amounts reclassified from Accumulated Other Comprehensive Loss

 

 

127

 

(2)

 

125

 

Other comprehensive income (loss)

 

3

 

127

 

(11)

 

119

 

Ending balance

 

$

84

 

$

(1,730)

 

$

(5)

 

$

(1,651

)

 

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Table of Contents

 

The before and after-tax components of Other Comprehensive Income are presented below:

 

(In millions)

 

Pre-Tax
Amount

 

Tax
(Expense)
Benefit

 

After-Tax
Amount

 

For the three months ended September 27, 2014

 

 

 

 

 

 

 

Pension and postretirement benefits adjustments:

 

 

 

 

 

 

 

Amortization of net actuarial loss*

 

$

28

 

$

(10

)

$

18

 

Amortization of prior service credit*

 

(2

)

1

 

(1

)

Pension and postretirement benefits adjustments, net

 

26

 

(9

)

17

 

Deferred gains/losses on hedge contracts:

 

 

 

 

 

 

 

Current deferrals

 

(9

)

3

 

(6

)

Reclassification adjustments

 

2

 

(1

)

1

 

Deferred gains/losses on hedge contracts, net

 

(7

)

2

 

(5

)

Foreign currency translation adjustments

 

(39

)

(4

)

(43

)

Total

 

$

(20

)

$

(11

)

$

(31

)

For the three months ended September 28, 2013

 

 

 

 

 

 

 

Pension and postretirement benefits adjustments:

 

 

 

 

 

 

 

Amortization of net actuarial loss*

 

$

48

 

$

(18

)

$

30

 

Amortization of prior service credit*

 

(2

)

1

 

(1

)

Amendment to postretirement benefit plan

 

55

 

(20

)

35

 

Pension and postretirement benefits adjustments, net

 

101

 

(37

)

64

 

Deferred gains/losses on hedge contracts:

 

 

 

 

 

 

 

Current deferrals

 

3

 

(1

)

2

 

Deferred gains/losses on hedge contracts, net

 

3

 

(1

)

2

 

Foreign currency translation adjustments

 

8

 

4

 

12

 

Total

 

$

112

 

$

(34

)

$

78

 

For the nine months ended September 27, 2014

 

 

 

 

 

 

 

Pension and postretirement benefits adjustments:

 

 

 

 

 

 

 

Amortization of net actuarial loss*

 

$

85

 

$

(30

)

$

55

 

Amortization of prior service credit*

 

(5

)

3

 

(2

)

Amendment to postretirement benefit plan

 

15

 

(6

)

9

 

Pension and postretirement benefits adjustments, net

 

95

 

(33

)

62

 

Deferred gains/losses on hedge contracts:

 

 

 

 

 

 

 

Current deferrals

 

(7

)

3

 

(4

)

Reclassification adjustments

 

9

 

(3

)

6

 

Deferred gains/losses on hedge contracts, net

 

2

 

 

2

 

Foreign currency translation adjustments

 

(46

)

(1

)

(47

)

Total

 

$

51

 

$

(34

)

$

17

 

For the nine months ended September 28, 2013

 

 

 

 

 

 

 

Pension and postretirement benefits adjustments:

 

 

 

 

 

 

 

Amortization of net actuarial loss*

 

$

143

 

$

(51

)

$

92

 

Amendment to postretirement benefit plan

 

55

 

(20

)

35

 

Pension and postretirement benefits adjustments, net

 

198

 

(71

)

127

 

Deferred gains/losses on hedge contracts:

 

 

 

 

 

 

 

Current deferrals

 

(11

)

2

 

(9

)

Reclassification adjustments

 

(3

)

1

 

(2

)

Deferred gains/losses on hedge contracts, net

 

(14

)

3

 

(11

)

Foreign currency translation adjustments

 

6

 

(3

)

3

 

Total

 

$

190

 

$

(71

)

$

119

 

*These components of other comprehensive income are included in the computation of net periodic pension cost.  See Note 11 of our 2013 Annual Report on Form 10-K for additional information.

 

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Note 10.  Commitments and Contingencies

 

We are subject to legal proceedings and other claims arising out of the conduct of our business, including proceedings and claims relating to commercial and financial transactions; government contracts; alleged lack of compliance with applicable laws and regulations; production partners; product liability; patent and trademark infringement; employment disputes; and environmental, safety and health matters.  Some of these legal proceedings and claims seek damages, fines or penalties in substantial amounts or remediation of environmental contamination. As a government contractor, we are subject to audits, reviews and investigations to determine whether our operations are being conducted in accordance with applicable regulatory requirements. Under federal government procurement regulations, certain claims brought by the U.S. Government could result in our suspension or debarment from U.S. Government contracting for a period of time. On the basis of information presently available, we do not believe that existing proceedings and claims will have a material effect on our financial position or results of operations.

 

Note 11.  Derivative Instruments and Fair Value Measurements

 

We measure fair value at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  We prioritize the assumptions that market participants would use in pricing the asset or liability into a three-tier fair value hierarchy.  This fair value hierarchy gives the highest priority (Level 1) to quoted prices in active markets for identical assets or liabilities and the lowest priority (Level 3) to unobservable inputs in which little or no market data exist, requiring companies to develop their own assumptions.  Observable inputs that do not meet the criteria of Level 1, which include quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets and liabilities in markets that are not active, are categorized as Level 2.  Level 3 inputs are those that reflect our estimates about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.  Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach and may use unobservable inputs such as projections, estimates and management’s interpretation of current market data.  These unobservable inputs are utilized only to the extent that observable inputs are not available or cost effective to obtain.

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

We manufacture and sell our products in a number of countries throughout the world, and, therefore, we are exposed to movements in foreign currency exchange rates.  We utilize foreign currency exchange contracts to manage this volatility.  Our foreign currency exchange contracts are measured at fair value using the market method valuation technique.  The inputs to this technique utilize current foreign currency exchange forward market rates published by third-party leading financial news and data providers.  These are observable data that represent the rates that the financial institution uses for contracts entered into at that date; however, they are not based on actual transactions so they are classified as Level 2.  At September 27, 2014 and December 28, 2013, we had foreign currency exchange contracts with notional amounts upon which the contracts were based of $753 million and $636 million, respectively.  At September 27, 2014, the fair value amounts of our foreign currency exchange contracts were a $7 million asset and a $15 million liability.  At December 28, 2013, the fair value amounts of our foreign currency exchange contracts were a $2 million asset and a $15 million liability.

 

We primarily utilize forward exchange contracts which have maturities of no more than three years.  These contracts qualify as cash flow hedges and are intended to offset the effect of exchange rate fluctuations on forecasted sales, inventory purchases and overhead expenses.  At September 27, 2014, we had a net deferred loss of $8 million in Accumulated other comprehensive loss related to these cash flow hedges.  Net gains and losses recognized in earnings and Accumulated other comprehensive loss on cash flow hedges, including gains and losses related to hedge ineffectiveness, were not significant in the periods presented.

 

We hedge our net investment position in major currencies and generate foreign currency interest payments that offset other transactional exposures in these currencies. To accomplish this, we borrow directly in foreign currency and designate a portion of foreign currency debt as a hedge of a net investment. We record changes in the fair value of these contracts in other comprehensive income to the extent they are effective as cash flow hedges.  Currency effects on the effective portion of these hedges, which are reflected in the foreign currency translation adjustments within Accumulated other comprehensive loss, were not significant in the periods presented.

 

Our Finance group has entered into interest rate exchange contracts to mitigate exposure to changes in the fair value of its fixed-rate receivables and debt due to fluctuations in interest rates.  These interest rate exchange contracts are not exchange traded and are measured at fair value utilizing widely accepted, third-party developed valuation models.  The actual terms of each individual contract are entered into a valuation model, along with interest rate data, which is based on readily observable market data published by third-party leading financial news and data providers.  At September 27, 2014 and December 28, 2013, we had interest rate exchange contracts with notional amounts upon which the contracts were based of $162 million and $229 million, respectively.  The fair value amounts of our interest rate exchange contracts were a $1 million asset and a $3 million liability at September 27, 2014.  At December 28, 2013, the fair value amounts of our interest rate exchange contracts were a $2 million asset and $5 million liability.

 

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Our exposure to loss from nonperformance by the counterparties to our derivative agreements at September 27, 2014 was minimal.  We do not anticipate nonperformance by counterparties in the periodic settlements of amounts due. We historically have minimized this potential for risk by entering into contracts exclusively with major, financially sound counterparties having no less than a long-term bond rating of A.  The credit risk generally is limited to the amount by which the counterparties’ contractual obligations exceed our obligations to the counterparty.  We continuously monitor our exposures to ensure that we limit our risks.

 

Assets Recorded at Fair Value on a Nonrecurring Basis

During the periods ended September 27, 2014 and December 28, 2013, the Finance group’s impaired nonaccrual finance receivables of $55 million and $45 million, respectively, were measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3).  Impaired nonaccrual finance receivables represent assets recorded at fair value on a nonrecurring basis since the measurement of required reserves on our impaired finance receivables is significantly dependent on the fair value of the underlying collateral. For impaired nonaccrual finance receivables secured by aviation assets, the fair values of collateral are determined primarily based on the use of industry pricing guides. Fair value measurements recorded on impaired finance receivables resulted in charges to provision for loan losses totaling $5 million and $16 million for the three and nine months ended September 27, 2014, respectively, and $3 million and $8 million for the three and nine months ended September 27, 2013, respectively.

 

Assets and Liabilities Not Recorded at Fair Value

The carrying value and estimated fair values of our financial instruments that are not reflected in the financial statements at fair value are as follows:

 

 

 

September 27, 2014

 

December 28, 2013

 

(In millions)

 

Carrying
Value

 

Estimated Fair
Value

 

Carrying
Value

 

Estimated Fair
Value

 

Manufacturing group

 

 

 

 

 

 

 

 

 

Long-term debt, excluding leases

 

$    (2,760

)

$     (2,959

)

$    (1,854

)

$     (2,027

)

Finance group

 

 

 

 

 

 

 

 

 

Finance receivables held for investment, excluding leases

 

1,072

 

1,102

 

1,231

 

1,290

 

Debt

 

(1,111

)

(1,112

)

(1,256

)

(1,244

)

 

Fair value for the Manufacturing group debt is determined using market observable data for similar transactions (Level 2).  At September 27, 2014 and December 28, 2013, approximately 76% and 70%, respectively, of the fair value of term debt for the Finance group was determined based on discounted cash flow analyses using observable market inputs from debt with similar duration, subordination and credit default expectations (Level 2). The remaining Finance group debt was determined based on observable market transactions (Level 1). Fair value estimates for finance receivables held for investment were determined based on internally developed discounted cash flow models primarily utilizing significant unobservable inputs (Level 3), which include estimates of the rate of return, financing cost, capital structure and/or discount rate expectations of current market participants combined with estimated loan cash flows based on credit losses, payment rates and expectations of borrowers’ ability to make payments on a timely basis.

 

Note 12.  Income Tax Expense

 

Income tax expense equated to an effective income tax rate of 30.7% for both the three and nine months ended September 27, 2014, compared with the U.S. federal statutory income tax rate of 35.0%.  The difference between the statutory and the effective income tax rate was primarily due to benefits from income attributable to international operations in countries with lower tax rates.

 

Income tax expense equated to an effective income tax rate of 32.4% and 27.5% for the three and nine months ended September 28, 2013, respectively, compared with the U.S. federal statutory income tax rate of 35.0%.  For the nine months ended September 28, 2013, the difference between the statutory and the effective income tax rate was primarily due to benefits from income attributable to international operations in countries with lower tax rates and a favorable impact of four percentage points, resulting from the retroactive reinstatement and extension of the Federal Research and Development Tax Credit as part of the American Taxpayer Relief Act of 2012 enacted on January 2, 2013.

 

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Note 13.  Segment Information

 

We operate in, and report financial information for, the following five business segments: Bell, Textron Systems, Industrial, Finance and the recently formed Textron Aviation segment as discussed in Note 1.

 

Segment profit is an important measure used for evaluating performance and for decision-making purposes.  Segment profit for the manufacturing segments excludes interest expense, certain corporate expenses and acquisition and restructuring costs related to the Beechcraft acquisition.  The measurement for the Finance segment includes interest income and expense along with intercompany interest expense.  Our revenues by segment and a reconciliation of segment profit to income from continuing operations before income taxes are as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In millions)

 

September 27,
2014

 

September 28,
2013

 

September 27,
2014

 

September 28,
2013

 

REVENUES

 

 

 

 

 

 

 

 

 

Manufacturing group

 

 

 

 

 

 

 

 

 

Textron Aviation

 

$

1,080

 

$

593

 

$

3,048

 

$

1,861

 

Bell

 

1,182

 

1,162

 

3,174

 

3,136

 

Textron Systems

 

358

 

405

 

1,003

 

1,256

 

Industrial

 

785

 

711

 

2,476

 

2,239

 

 

 

3,405

 

2,871

 

9,701

 

8,492

 

Finance segment

 

25

 

33

 

81

 

106

 

Total revenues

 

$

3,430

 

$

2,904

 

$

9,782

 

$

8,598

 

SEGMENT PROFIT

 

 

 

 

 

 

 

 

 

Manufacturing Group

 

 

 

 

 

 

 

 

 

Textron Aviation

 

$

62

 

$

(23

)

$

104

 

$

(81

)

Bell

 

146

 

131

 

383

 

395

 

Textron Systems

 

27

 

35

 

100

 

107

 

Industrial

 

53

 

52

 

213

 

188

 

 

 

288

 

195

 

800

 

609

 

Finance segment

 

5

 

13

 

16

 

47

 

Segment profit

 

293

 

208

 

816

 

656

 

Corporate expenses and other, net

 

(22)

 

(34

)

(103)

 

(109

)

Interest expense, net for Manufacturing group

 

(37)

 

(29

)

(108)

 

(96

)

Acquisition and restructuring costs

 

(3)

 

 

(39)

 

 

Income from continuing operations before income taxes

 

$

231

 

$

145

 

$

566

 

$

451

 

 

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Item 2.               MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview and Consolidated Results of Operations

 

On March 14, 2014, we completed the acquisition of Beech Holdings, LLC, which included Beechcraft Corporation and other subsidiaries, (collectively “Beechcraft”).  The acquired Beechcraft business and the legacy Cessna segment were combined to form a new segment named Textron Aviation. The results of Beechcraft have been included in Textron’s consolidated financial statements only for the period subsequent to the completion of the acquisition. As a result, the consolidated financial results for the nine months ended September 27, 2014 do not reflect a full nine months of Beechcraft operations.

 

An analysis of our consolidated operating results is set forth below.  A more detailed analysis of our segments’ operating results is provided in the Segment Analysis section on pages 22 to 27.

 

Revenues

 

 

 

Three Months Ended

 

Nine Months Ended

 

(Dollars in millions)

 

September 27,
2014

 

September 28,
2013

 

September 27,
2014

 

September 28,
2013

 

Revenues

 

$

3,430

 

$

2,904

 

$

9,782

 

$

8,598

 

% change compared with prior period

 

18%

 

 

 

14%

 

 

 

 

Revenues increased $526 million, 18%, in the third quarter of 2014, compared with the corresponding period of 2013, as revenue increases in the Textron Aviation, Industrial and Bell segments were partially offset by lower revenues in the Textron Systems and Finance segments. The net revenue increase included the following factors:

 

·                  Higher Textron Aviation revenues of $487 million, primarily due to a $398 million impact from the Beechcraft acquisition and $80 million in higher volume, largely resulting from higher Citation jet volume.

·                  Higher Industrial segment revenues of $74 million, primarily due to a $39 million impact from acquisitions and $36 million in higher volume, largely in the Fuel Systems and Functional Components product line.

·                  Higher Bell revenues of $20 million, primarily reflecting a $158 million increase in V-22 program volume due to an increase in deliveries and higher product support and other volume, partially offset by lower other military and commercial volume primarily reflecting lower aircraft deliveries.

·                  Lower Textron Systems revenues of $47 million, primarily due to lower volume, principally reflecting lower vehicle deliveries in the Marine and Land Systems product line.

·                  Lower Finance revenues of $8 million, primarily attributable to gains on the disposition of finance receivables held for sale during 2013.

 

Revenues increased $1,184 million, 14%, in the first nine months of 2014, compared with the corresponding period of 2013, as revenue increases in the Textron Aviation, Industrial and Bell segments were partially offset by lower revenues in the Textron Systems and Finance segments.  The net revenue increase included the following factors:

 

·                  Higher Textron Aviation revenues of $1.2 billion, primarily due to a $924 million impact from the Beechcraft acquisition and $233 million in higher volume, largely resulting from higher Citation jet volume.

·                  Higher Industrial segment revenues of $237 million, primarily due to $113 million in higher volume, largely in the Fuel Systems and Functional Components product line, and a $97 million impact from acquisitions.

·                  Higher Bell revenues of $38 million, primarily due to a $208 million increase related to the V-22 program reflecting product support and other volume, partially offset by lower commercial and other military volume primarily reflecting lower aircraft deliveries. The decrease in other military volume was partially offset by $41 million related to the settlement of the System Development and Demonstration (SDD) phase of the Armed Reconnaissance Helicopter (ARH) program, which was terminated in October 2008.

·                  Lower Textron Systems revenues of $253 million, largely due to lower volume in the Marine and Land Systems product line of $172 million, reflecting lower vehicle deliveries, and in the UAS product line of $103 million, reflecting the timing of deliveries.

·                  Lower Finance revenues of $25 million, primarily attributable to gains on the disposition of finance receivables held for sale during 2013.

 

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Table of Contents

 

Cost of Sales and Selling and Administrative Expense

 

 

 

Three Months Ended

 

Nine Months Ended

 

(Dollars in millions)

 

September 27,
2014

 

September 28,
2013

 

September 27,
2014

 

September 28,
2013

 

Operating expenses

 

$

3,149

 

$

2,718

 

$

9,036

 

$

8,013

 

Cost of sales

 

2,845

 

2,473

 

8,077

 

7,193

 

% change compared with prior period

 

15%

 

 

 

12%

 

 

 

Gross margin percentage of Manufacturing revenues

 

16.4%

 

13.9%

 

16.7%

 

15.3%

 

Selling and administrative expenses

 

$

304

 

$

245

 

$

959

 

$

820

 

% change compared with prior period

 

24%

 

 

 

17%

 

 

 

 

Manufacturing cost of sales and selling and administrative expenses together comprise our operating expenses. Cost of sales increased $372 million, 15%, in the third quarter of 2014, and $884 million, 12%, in the first nine months of 2014, compared with the corresponding periods of 2013, largely due to the impact of acquired businesses, primarily Beechcraft.  In the third quarter and first nine months of 2014, gross margin increased as a percentage of Manufacturing revenues largely due to improved leverage resulting from higher revenues primarily in the Textron Aviation segment.

 

Selling and administrative expense increased $59 million, 24%, and $139 million, 17%, in the third quarter and first nine months of 2014,