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Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

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

 

For the fiscal year ended January 3, 2015

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

 

(I.R.S. Employer

 

 

incorporation or organization)

 

Identification No.)

 

 

 

40 Westminster Street, Providence, RI

 

02903

 

 

(Address of principal executive offices)

 

(Zip code)

 

 

Registrant’s Telephone Number, Including Area Code: (401) 421-2800

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of Each Class

 

Name of Each Exchange on Which Registered

 

 

Common Stock — par value $0.125

 

New York Stock Exchange

 

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 


 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes  ü   No___

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes        No  ü

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ü ]

 

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   [      ]

(Do not check if a 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

 

The aggregate market value of the registrant’s Common Stock held by non-affiliates at June 28, 2014 was approximately $10.8 billion based on the New York Stock Exchange closing price for such shares on that date. The registrant has no non-voting common equity.

 

At February 7, 2015, 276,834,630 shares of Common Stock were outstanding.

 

Documents Incorporated by Reference

 

 

Part III of this Report incorporates information from certain portions of the registrant’s Definitive Proxy Statement for its Annual Meeting of Shareholders to be held on April 22, 2015.

 

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Table of Contents

 

Textron Inc.

Index to Annual Report on Form 10-K

For the Fiscal Year Ended January 3, 2015

 

 

 

 

 

PART I

 

Page

 

 

 

Item  1.

Business

3

 

 

 

Item  1A.

Risk Factors

10

 

 

 

Item  1B.

Unresolved Staff Comments

15

 

 

 

Item  2.

Properties

15

 

 

 

Item  3.

Legal Proceedings

15

 

 

 

Item  4.

Mine Safety Disclosures

15

 

 

 

PART II

 

 

 

 

 

Item  5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

16

 

 

 

Item  6.

Selected Financial Data

18

 

 

 

Item  7.

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

19

 

 

 

Item  7A.

Quantitative and Qualitative Disclosures About Market Risk

36

 

 

 

Item  8.

Financial Statements and Supplementary Data

37

 

 

 

Item  9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

76

 

 

 

Item  9A.

Controls and Procedures

76

 

 

 

Item  9B.

Other Information

76

 

 

 

PART III

 

 

 

 

 

Item  10.

Directors, Executive Officers and Corporate Governance

76

 

 

 

Item  11.

Executive Compensation

76

 

 

 

Item  12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

77

 

 

 

Item  13.

Certain Relationships and Related Transactions and Director Independence

77

 

 

 

Item  14.

Principal Accountant Fees and Services

77

 

 

 

PART IV

 

 

 

 

 

Item  15.

Exhibits and Financial Statement Schedules

77

 

 

 

SIGNATURES

82

 

2



Table of Contents

 

PART I

 

Item 1. Business

 

Textron Inc. is a multi-industry company that leverages its global network of aircraft, defense, industrial and finance businesses to provide customers with innovative products and services around the world.  We have approximately 34,000 employees worldwide.  Textron Inc. was founded in 1923 and reincorporated in Delaware on July 31, 1967. Unless otherwise indicated, references to “Textron Inc.,” the “Company,” “we,” “our” and “us” in this Annual Report on Form 10-K refer to Textron Inc. and its consolidated subsidiaries.

 

On March 14, 2014, we completed the acquisition of Beech Holdings, LLC, which included Beechcraft Corporation and other subsidiaries (collectively “Beechcraft”).  We combined Beechcraft with our legacy Cessna segment to form the Textron Aviation segment.

 

We conduct our business through five operating segments: Textron Aviation, Bell, Textron Systems and Industrial, which represent our manufacturing businesses, and Finance, which represents our finance business.  A description of the business of each of our segments is set forth below.  Our business segments include operations that are unincorporated divisions of Textron Inc. and others that are separately incorporated subsidiaries.  Financial information by business segment and geographic area appears in Note 15 to the Consolidated Financial Statements on pages 72 through 73 of this Annual Report on Form 10-K.  The following description of our business should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 19 through 36 of this Annual Report on Form 10-K.  Information included in this Annual Report on Form 10-K refers to our continuing businesses unless otherwise indicated.

 

Textron Aviation Segment

Textron Aviation is a leader in general aviation. Textron Aviation manufactures, sells and services Beechcraft and Cessna aircraft, and services the Hawker brand of business jets. The segment has two principal product lines: aircraft sales and aftermarket.  Aircraft sales include business jets, turboprop aircraft, piston aircraft, and military trainer and defense aircraft.  Aftermarket includes parts sales, and maintenance, inspection and repair services.  Revenues in the Textron Aviation segment accounted for approximately 33%, 23% and 25% of our total revenues in 2014, 2013 and 2012, respectively.  Revenues for Textron Aviation’s principal lines of business were as follows:

 

(In millions)

 

2014   

 

2013   

 

2012   

Aircraft sales

$

3,182  

$

1,868  

$

2,318  

Aftermarket

 

1,386  

 

916  

 

793  

Total revenues

$

4,568  

$

2,784  

$

3,111  

 

The family of jets currently produced by Textron Aviation includes the Mustang, Citation M2, Citation CJ3+, Citation CJ4, Citation XLS+, Citation Sovereign+ and the recently certified Citation X+, the fastest civilian jet in the world.  In addition, Textron Aviation is developing the Citation Latitude, a midsize business jet expected to enter into service in 2015, as well as the larger Citation Longitude expected to enter into service in 2017.

 

Textron Aviation’s turboprop aircraft include the best-selling business turboprop family in the world, the King Air, which offers the King Air C90GTx, with recently announced performance enhancements, the King Air 250, available with a new payload upgrade and the King Air 350.  The world’s best-selling utility turboprop, the Cessna Caravan, is used in the United States primarily for overnight express package shipments and for personal transportation.  International uses of Caravans include air taxi service, humanitarian flights, tourism and freight transport.

 

Textron Aviation’s single-engine piston aircraft include the Baron, Bonanza, Skyhawk SP, Turbo Stationair and the high performance TTx. The Turbo Skylane JT-A, Textron Aviation’s first Jet-A fueled piston aircraft is expected to be certified and begin delivering in 2015.

 

Textron Aviation also offers the T-6 trainer and AT-6 light attack military aircraft.  During 2014, Textron Aviation received new orders from the U.S. Government, Mexico and New Zealand for T-6 aircraft.  More than 25 countries now operate the T-6 aircraft as a part of their military training fleet.

 

The Textron Aviation family of aircraft is supported by a global network of 21 service centers operated by Textron Aviation, two of which are co-located with Bell Helicopter, along with 401 authorized independent service centers located in 49 countries throughout the world.  Textron Aviation-owned service centers provide customers with 24-hour service and maintenance. Textron

 

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Table of Contents

 

Aviation provides its customers with around-the-clock parts support and also offers ServiceDirect® for Citation, King Air and Hawker aircraft.  ServiceDirect® delivers service capabilities directly to customer locations with a mobile service unit fleet in the United States, Canada and Europe.

 

Textron Aviation markets its products worldwide through its own sales force, as well as through a network of authorized independent sales representatives.  Textron Aviation has several competitors domestically and internationally in various market segments. Textron Aviation’s aircraft compete with other aircraft that vary in size, speed, range, capacity and handling characteristics on the basis of price, product quality and reliability, direct operating costs, product support and reputation.

 

Bell Segment

Bell Helicopter is one of the leading suppliers of military and commercial helicopters, tiltrotor aircraft, and related spare parts and services in the world.  Revenues for Bell accounted for approximately 31%, 37% and 35% of our total revenues in 2014, 2013 and 2012, respectively.  Revenues by Bell’s principal lines of business were as follows:

 

(In millions)

 

2014

 

2013

 

2012

Military:

 

 

 

 

 

 

V-22 Program

$

1,771

$

1,755

$

1,611

Other Military

 

860

 

959

 

940

Commercial

 

1,614

 

1,797

 

1,723

Total revenues

$

4,245

$

4,511

$

4,274

 

Bell supplies advanced military helicopters and support to the U.S. Government and to military customers outside the United States.  Bell’s primary U.S. Government programs are the V-22 tiltrotor aircraft and the H-1 helicopters.  Bell is one of the leading suppliers of helicopters to the U.S. Government and, in association with The Boeing Company (Boeing), the only supplier of military tiltrotor aircraft. Tiltrotor aircraft are designed to provide the benefits of both helicopters and fixed-wing aircraft.  Through its strategic alliance with Boeing, Bell produces and supports the V-22 tiltrotor aircraft for the U.S. Department of Defense (DoD).  The U.S. Marine Corps H-1 helicopter program includes a utility model, the UH-1Y, and an advanced attack model, the AH-1Z, which have 84% parts commonality between them.

 

Through its commercial business, Bell is a leading supplier of commercially certified helicopters and support to corporate, offshore petroleum exploration and development, utility, charter, police, fire, rescue, emergency medical helicopter operators and foreign governments.  Bell produces a variety of commercial aircraft types, including light single- and twin-engine helicopters and medium twin-engine helicopters, along with other related products.  The helicopters currently offered by Bell for commercial applications include the 206L-4, 407, 407GX, 412EP/EPI, 429 and Huey II. The new 505 Jet Ranger X, a short-light single helicopter, achieved its first flight in late 2014. In addition, Bell continues to develop the 525 Relentless, its first super medium commercial helicopter, and first flight is expected in 2015.

 

For both its military programs and its commercial products, Bell provides post-sale support and service for an installed base of approximately 13,000 helicopters through a network of eight Bell-operated service centers, four supply centers and over 100 independent service centers located in 34 countries.  Collectively, these service sites offer a complete range of logistics support, including parts, support equipment, technical data, training devices, pilot and maintenance training, component repair and overhaul, engine repair and overhaul, aircraft modifications, aircraft customizing, accessory manufacturing, contractor maintenance, field service and product support engineering.

 

Bell competes against a number of competitors throughout the world for its helicopter business and its parts and support business.  Competition is based primarily on price, product quality and reliability, product support, performance and reputation.

 

4



Table of Contents

 

Textron Systems Segment

Textron Systems’ product lines consist of unmanned aircraft systems, marine and land systems, weapons and sensors, simulation, training and other defense and aviation mission support products and services.  Textron Systems is a supplier to the defense, aerospace and general aviation markets, and represents approximately 12%, 14% and 14% of Textron’s revenues in 2014, 2013 and 2012, respectively.  This segment sells its products to U.S. Government customers and to customers outside the U.S. through foreign military sales sponsored by the U.S. Government and directly through commercial sales channels.  Textron Systems competes on the basis of technology, contract performance, price, product quality and reliability, product support and reputation.  Revenues by Textron Systems’ product lines were as follows:

 

(In millions)

 

2014

 

2013

 

2012

Unmanned Systems

$

797

$

666

$

694

Weapons and Sensors

 

264

 

311

 

285

Marine and Land Systems

 

158

 

392

 

443

Simulation, Training and Other

 

405

 

296

 

315

Total revenues

$

1,624

$

1,665

$

1,737

 

Unmanned Systems

Unmanned Systems consists of the Unmanned Systems and Support Solutions businesses.  The Unmanned Systems business has designed, manufactured and fielded combat-proven unmanned aircraft systems for more than 25 years, including the U.S. Army’s premier tactical unmanned aircraft system, the Shadow.  This business’s unmanned aircraft and interoperable command and control technologies provide critical situational awareness and actionable intelligence for users worldwide.  Our Support Solutions business provides logistical support for various unmanned systems as well as training and supply chain services to government and commercial customers worldwide.

 

Weapons and Sensors

The Weapons and Sensors business consists of state-of-the-art smart weapons; airborne and ground-based sensors and surveillance systems; and protection systems for the defense and aerospace industries.  It primarily sells its products to international allies through foreign military sales.

 

Marine and Land Systems

The Marine and Land Systems business is a world leader in the design, production and support of armored vehicles, turrets and related subsystems as well as advanced marine craft.  It produces a family of extremely mobile, highly protective vehicles for the U.S. Army and international allies, and is developing the U.S. Navy’s next generation air cushion vehicle.

 

Simulation, Training and Other

Simulation, Training and Other includes five businesses:  TRU Simulation + Training, Lycoming, Electronic Systems, Advanced Information Solutions and Geospatial Solutions. TRU Simulation + Training designs, develops, manufactures, installs, and provides maintenance of advanced flight training courseware and devices, including full flight simulators, for both rotary- and fixed-wing aircraft for commercial airlines, aircraft original equipment manufacturers (OEMs), flight training centers and training organizations worldwide. Through its training centers, TRU Simulation + Training provides initial type-rating and recurrency training for pilots. Lycoming specializes in the engineering, manufacture, service and support of piston aircraft engines for the general aviation and remotely piloted aircraft markets. Electronic Systems provides high technology test equipment and electronic warfare test and training solutions. Advanced Information Solutions and Geospatial Solutions provide intelligence software solutions for U.S. and international defense, intelligence and law enforcement communities.

 

Industrial Segment

Our Industrial segment designs and manufactures a variety of products under three principal product lines.  Industrial segment revenues were as follows:

 

(In millions)

 

2014

 

2013

 

2012

Fuel Systems and Functional Components

$

1,975

$

1,853

$

1,842

Specialized Vehicles and Equipment

 

868

 

713

 

660

Tools and Test Equipment

 

495

 

446

 

398

Total revenues

$

3,338

$

3,012

$

2,900

 

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Table of Contents

 

Fuel Systems and Functional Components

Our Fuel Systems and Functional Components product line is operated by our Kautex business unit, which is headquartered in Bonn, Germany.  Kautex is a leading developer and manufacturer of blow-molded plastic fuel systems for cars, light trucks, all-terrain vehicles, windshield and headlamp washer systems for automobiles and selective catalytic reduction systems used to reduce emissions from diesel engines.  Kautex serves the global automobile market, with operating facilities near its major customers around the world. Kautex also produces cast iron engine camshafts and develops and produces plastic bottles and containers for food, household, laboratory and industrial uses.  Revenues of Kautex accounted for approximately 14%, 15% and 15% of our total revenues in 2014, 2013 and 2012, respectively.

 

Our automotive products have several major competitors worldwide, some of which are affiliated with the OEMs that comprise our targeted customer base.  Competition typically is based on a number of factors including price, technology, environmental performance, product quality and reliability, prior experience and available manufacturing capacity.

 

Specialized Vehicles and Equipment

Our Specialized Vehicles and Equipment product line includes the products designed, manufactured and sold by our Textron Specialized Vehicles and Jacobsen businesses. Textron Specialized Vehicles, which includes E-Z-GO, Bad Boy Buggies and Cushman, and the recently-acquired TUG Technologies and Douglas Equipment businesses, designs, manufactures and sells golf cars, off-road utility vehicles, light transportation vehicles and aviation ground support equipment. Although Textron Specialized Vehicles is best known for its electric-vehicle technology, it also manufactures and sells models powered by internal combustion engines.  Textron Specialized Vehicles’ diversified customer base includes golf courses and resorts, government agencies and municipalities, consumers, and commercial and industrial users such as factories, warehouses, airports, planned communities, hunting preserves and educational and corporate campuses.  Sales are made through a combination of factory direct resources and a network of independent distributors and dealers worldwide. Textron Specialized Vehicles has two major competitors for golf cars and several other competitors for off-road and light transportation vehicles and for aviation ground support equipment.  Competition is based primarily on price, product quality and reliability, product support and reputation.

 

Jacobsen designs, manufactures and sells professional turf-maintenance equipment, as well as specialized turf-care vehicles.  Brand names include Ransomes, Jacobsen, Cushman and Dixie Chopper, which was acquired in 2014.  Jacobsen’s customers include golf courses, resort communities, sporting venues, municipalities and landscaping professionals.  Products are sold primarily through a worldwide network of distributors and dealers, as well as factory direct. Jacobsen has two major competitors for professional turf-maintenance equipment and several other major competitors for specialized turf-care products.  Competition is based primarily on price, product features, product quality and reliability and product support.

 

Tools and Test Equipment

The Tools and Test Equipment product line includes products sold by businesses that design and manufacture powered equipment, electrical test and measurement instruments, mechanical and hydraulic tools, cable connectors, fiber optic assemblies, underground and aerial transmission and distribution products and power utility products. These businesses also encompass the Greenlee, Greenlee Communications, Greenlee Utility, HD Electric, Klauke, Sherman & Reilly, Rothenberger and Endura brand names, and their products are used principally in the construction, maintenance, telecommunications, data communications, electrical, utility and plumbing industries.  Their products are distributed through a global network of sales representatives and distributors and are also sold directly to home improvement retailers and OEMs.  The businesses operate 13 plants across four countries with almost 50% of their combined revenue coming from outside the United States.  These businesses face competition from numerous manufacturers based primarily on price, delivery lead time, product quality and reliability.

 

Finance Segment

Our Finance segment, or the Finance group, is a commercial finance business that consists of Textron Financial Corporation (TFC) and its consolidated subsidiaries. The Finance segment provides financing primarily to purchasers of new and pre-owned Textron Aviation aircraft and Bell helicopters. The majority of new finance receivables are cross-border transactions for aircraft sold outside of the U.S. New originations in the U.S. are primarily for purchasers who had difficulty in accessing other sources of financing for the purchase of Textron-manufactured products.  In 2014, 2013 and 2012, our Finance group paid our Manufacturing group $215 million, $248 million and $309 million, respectively, related to the sale of Textron-manufactured products to third parties that were financed by the Finance group.

 

The commercial finance business traditionally is extremely competitive. Our Finance segment is subject to competition from various types of financing institutions, including banks, leasing companies, commercial finance companies and finance operations of equipment vendors.  Competition within the commercial finance industry primarily is focused on price, term, structure and service.

 

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Table of Contents

 

Our Finance segment’s largest business risk is the collectability of its finance receivable portfolio.  See “Finance Portfolio Quality” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 28 for information about the Finance segment’s credit performance.

 

Backlog

Our backlog at the end of 2014 and 2013 is summarized below:

 

(In millions)

 

January 3,
2015

 

December 28,
2013

Bell

$

5,524

$

6,450

Textron Systems

 

2,790

 

2,803

Textron Aviation

 

1,365

 

1,018

Total backlog

$

9,679

$

10,271

 

Approximately 52% of our total backlog at January 3, 2015 represents orders that are not expected to be filled in 2015.

 

At the end of 2014, approximately 66% of our total backlog was with the U.S. Government, which included only funded amounts as the U.S. Government is obligated only up to the amount of funding formally appropriated for a contract. Bell’s 2014 backlog included $2.0 billion related to a multi-year procurement contract with the U.S. Government for the purchase of V-22 tiltrotor aircraft.

 

U.S. Government Contracts

In 2014, approximately 28% of our consolidated revenues were generated by or resulted from contracts with the U.S. Government. This business is subject to competition, changes in procurement policies and regulations, the continuing availability of funding, which is dependent upon congressional appropriations, national and international priorities for defense spending, world events, and the size and timing of programs in which we may participate.

 

Our contracts with the U.S. Government generally may be terminated by the U.S. Government for convenience or if we default in whole or in part by failing to perform under the terms of the applicable contract.  If the U.S. Government terminates a contract for convenience, we normally will be entitled to payment for the cost of contract work performed before the effective date of termination, including, if applicable, reasonable profit on such work, as well as reasonable termination costs.  If, however, the U.S. Government terminates a contract for default, generally: (a) we will be paid the contract price for completed supplies delivered and accepted and services rendered, an agreed-upon amount for manufacturing materials delivered and accepted and for the protection and preservation of property, and an amount for partially completed products accepted by the U.S. Government; (b) the U.S. Government may not be liable for our costs with respect to unaccepted items and may be entitled to repayment of advance payments and progress payments related to the terminated portions of the contract; (c) the U.S. Government may not be liable for assets we own and utilize to provide services under the “fee-for-service” contracts; and (d) we may be liable for excess costs incurred by the U.S. Government in procuring undelivered items from another source.

 

Research and Development

Information regarding our research and development expenditures is contained in Note 1 to the Consolidated Financial Statements on page 51 of this Annual Report on Form 10-K.

 

Patents and Trademarks

We own, or are licensed under, numerous patents throughout the world relating to products, services and methods of manufacturing. Patents developed while under contract with the U.S. Government may be subject to use by the U.S. Government. We also own or license active trademark registrations and pending trademark applications in the U.S. and in various foreign countries or regions, as well as trade names and service marks. While our intellectual property rights in the aggregate are important to the operation of our business, we do not believe that any existing patent, license, trademark or other intellectual property right is of such importance that its loss or termination would have a material adverse effect on our business taken as a whole. Some of these trademarks, trade names and service marks are used in this Annual Report on Form 10-K and other reports, including:  Aeronautical Accessories; AAI; acAlert; Ascent; Aerosonde; AH-1Z; Ambush; Arc Horizon; AVCOAT; Bad Boy Buggies; Baron; BattleHawk; Beechcraft; Beechcraft T-6:  Bell; Bell Helicopter; Bonanza; Bravo; Cadillac Gage; Caravan; Caravan Amphibian; Caravan 675; Cessna; Cessna 350; Cessna 400; Cessna Corvalis TTX; Cessna Turbo Skylane JT-A; Cessna Turbo Skyhawk JT-A; Citation; CITATION ALPINE EDITION; Citation Encore+; Citation Latitude; Citation Longitude; Citation M2; Citation Sovereign; Citation X; Citation X+; Citation XLS+; CJ1+; CJ2+; CJ3; CJ3+. CJ4; Clairity; CLAW; Commando; Corvalis; Cushman; DataScout; Dixie Chopper; Eclipse; Excel; Extreme; Extreme Ti-METAL; E-Z-GO; Fury; GTS-1930 Saber, G3 Tugger; GatorEye; Gator Grips; GLOBAL MISSION SUPPORT; Grand Caravan; Greenlee; H-1; HDE; Hawker; Huey; Huey II; iCommand; IE2; Instinct; Integrated Command Suite; Jacobsen; Jet Ranger X; Kautex; King Air; King Air C90GTx; King Air

 

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Table of Contents

 

250; King Air 350; Kiowa Warrior; Klauke; LF; Lycoming; M1117 ASV; McCauley; Mechtronix; Millenworks; Mission Critical Support (MCS): MissionLink (IVHM); Mustang; Next Generation Carbon Canister; Next Generation Fuel System; NGCC; NGFS; Odyssey; On a Mission; OPINICUS; Overwatch; PDCue; Power Advantage; Pro-Fit; ProParts; Ransomes; REALCue; REALFeel; Recoil; Relentless; Rothenberger LLC; RT2; RXV; Scorpion; Sensor Fuzed Weapon; ServiceDirect; Shadow; Shadow Knight; Shadow Master; SkyBOOKS; Skycatcher; Skyhawk; Skyhawk SP; Skylane; SkyPLUS; Sovereign; Speed Punch; Spider; Stationair; ST 4X4; Super Cargomaster; Super Medium; SuperCobra; SYMTX; TDCue; Textron; Textron Aviation; Textron Defense Systems; Textron Financial Corporation; Textron Marine & Land Systems; Textron Systems; TRUESET; TRU Simulation + Training; TUG; Turbo Skylane; Turbo Stationair; UH-1Y; V-Watch Connect; VALOR; V-22 Osprey; V-280; 2FIVE; 206; 407; 407GT; 407GX; 412, 429, 505; 525 and 525 Relentless. These marks and their related trademark designs and logotypes (and variations of the foregoing) are trademarks, trade names or service marks of Textron Inc., its subsidiaries, affiliates or joint ventures.

 

Environmental Considerations

Our operations are subject to numerous laws and regulations designed to protect the environment.  Compliance with these laws and expenditures for environmental control facilities has not had a material effect on our capital expenditures, earnings or competitive position. Additional information regarding environmental matters is contained in Note 13 to the Consolidated Financial Statements on page 71 of this Annual Report on Form 10-K.

 

We do not believe that existing or pending climate change legislation, regulation, or international treaties or accords are reasonably likely to have a material effect in the foreseeable future on our business or markets nor on our results of operations, capital expenditures or financial position. We will continue to monitor emerging developments in this area.

 

Employees

At January 3, 2015, we had approximately 34,000 employees.

 

Executive Officers of the Registrant

The following table sets forth certain information concerning our executive officers as of February 25, 2015.

 

Name

 

Age

 

Current Position with Textron Inc.

Scott C. Donnelly

 

53

 

Chairman, President and Chief Executive Officer

Frank T. Connor

 

55

 

Executive Vice President and Chief Financial Officer

Cheryl H. Johnson

 

54

 

Executive Vice President, Human Resources

E. Robert Lupone

 

55

 

Executive Vice President, General Counsel, Secretary and Chief Compliance Officer

 

Mr. Donnelly joined Textron in June 2008 as Executive Vice President and Chief Operating Officer and was promoted to President and Chief Operating Officer in January 2009. He was appointed to the Board of Directors in October 2009 and became Chief Executive Officer of Textron in December 2009, at which time the Chief Operating Officer position was eliminated.  In July 2010, Mr. Donnelly was appointed Chairman of the Board of Directors effective September 1, 2010.  Previously, Mr. Donnelly was the President and CEO of General Electric Company’s Aviation business unit, a position he had held since July 2005.  GE’s Aviation business unit is a $16 billion maker of commercial and military jet engines and components, as well as integrated digital, electric power and mechanical systems for aircraft. Prior to July 2005, Mr. Donnelly served as Senior Vice President of GE Global Research, one of the world’s largest and most diversified industrial research organizations with facilities in the U.S., India, China and Germany and held various other management positions since joining General Electric in 1989.

 

Mr. Connor joined Textron in August 2009 as Executive Vice President and Chief Financial Officer. Previously, Mr. Connor was head of Telecom Investment Banking at Goldman, Sachs & Co from 2003 to 2008. Prior to that position, he served as Chief Operating Officer of Telecom, Technology and Media Investment Banking at Goldman, Sachs from 1998 to 2003. Mr. Connor joined the Corporate Finance Department of Goldman, Sachs in 1986 and became a Vice President in 1990 and a Managing Director in 1996.

 

Ms. Johnson was named Executive Vice President, Human Resources in July 2012.  Ms. Johnson joined Textron in 1996 and has held various human resources leadership positions across Textron’s businesses, including Senior Human Resources Business Partner for Greenlee and Vice President of Human Resources for E-Z-GO, a position she held from 2006 until joining Bell in 2009.  At Bell, she most recently served as Director of Talent and Organizational Development.  Prior to Textron, Ms. Johnson held roles in human resources, marketing and sales, and finance disciplines at several organizations, including IBM and Hamilton Sundstrand, a United Technologies Company.

 

Mr. Lupone joined Textron in February 2012 as Executive Vice President, General Counsel, Secretary and Chief Compliance Officer.  Previously, he was senior vice president and general counsel of Siemens Corporation (U.S.) since 1999 and general

 

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counsel of Siemens AG for the Americas since 2008.  Prior to joining Siemens in 1992, Mr. Lupone was vice president and general counsel of Price Communications Corporation.

 

Available Information

We make available free of charge on our Internet Web site (www.textron.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

 

Forward-Looking Information

Certain statements in this Annual Report on Form 10-K and other oral and written statements made by us from time to time are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements, which may describe strategies, goals, outlook or other non-historical matters, or project revenues, income, returns or other financial measures, often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “guidance,” “project,” “target,” “potential,” “will,” “should,” “could,” “likely” or “may” and similar expressions intended to identify forward-looking statements. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements.  Given these uncertainties, you should not place undue reliance on these forward-looking statements. Forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update or revise any forward-looking statements.  In addition to those factors described herein under “RISK FACTORS,” among the factors that could cause actual results to differ materially from past and projected future results are the following:

 

·                  Interruptions in the U.S. Government’s ability to fund its activities and/or pay its obligations;

·                  Changing priorities or reductions in the U.S. Government defense budget, including those related to military operations in foreign countries;

·                  Our ability to perform as anticipated and to control costs under contracts with the U.S. Government;

·                  The U.S. Government’s ability to unilaterally modify or terminate its contracts with us for the U.S. Government’s convenience or for our failure to perform, to change applicable procurement and accounting policies, or, under certain circumstances, to withhold payment or suspend or debar us as a contractor eligible to receive future contract awards;

·                  Changes in foreign military funding priorities or budget constraints and determinations, or changes in government regulations or policies on the export and import of military and commercial products;

·                  Volatility in the global economy or changes in worldwide political conditions that adversely impact demand for our products;

·                  Volatility in interest rates or foreign exchange rates;

·                  Risks related to our international business, including establishing and maintaining facilities in locations around the world and relying on joint venture partners, subcontractors, suppliers, representatives, consultants and other business partners in connection with international business, including in emerging market countries;

·                  Our Finance segment’s ability to maintain portfolio credit quality or to realize full value of receivables;

·                  Performance issues with key suppliers or subcontractors;

·                  Legislative or regulatory actions, both domestic and foreign, impacting our operations or demand for our products;

·                  Our ability to control costs and successfully implement various cost-reduction activities;

·                  The efficacy of research and development investments to develop new products or unanticipated expenses in connection with the launching of significant new products or programs;

·                  The timing of our new product launches or certifications of our new aircraft products;

·                  Our ability to keep pace with our competitors in the introduction of new products and upgrades with features and technologies desired by our customers;

·                  Pension plan assumptions and future contributions;

·                  Continued demand softness or volatility in the markets in which we do business;

·                  Difficulty or unanticipated expenses in connection with integrating acquired businesses; and

·                  The risk that anticipated synergies and opportunities as a result of acquisitions will not be realized or the risk that acquisitions do not perform as planned, including, for example, the risk that acquired businesses will not achieve revenue and profit projections.

 

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Item 1A. Risk Factors

 

Our business, financial condition and results of operations are subject to various risks, including those discussed below, which may affect the value of our securities. The risks discussed below are those that we believe currently are the most significant to our business.

 

We have customer concentration with the U.S. Government; reduction in U.S. Government defense spending may adversely affect our results of operations and financial condition.

During 2014, we derived approximately 28% of our revenues from sales to a variety of U.S. Government entities.  Our revenues from the U.S. Government largely result from contracts awarded to us under various U.S. Government defense-related programs. The funding of these programs is subject to congressional appropriation decisions and the U.S. Government budget process which includes enacting relevant legislation, such as appropriations bills and accords on the debt ceiling. Although multiple-year contracts may be planned in connection with major procurements, Congress generally appropriates funds on a fiscal year basis even though a program may continue for several years. Consequently, programs often are only partially funded initially, and additional funds are committed only as Congress makes further appropriations.  If we incur costs in excess of funds committed on a contract, we are at risk for non-reimbursement of those costs until additional funds are appropriated.  The reduction, termination or delay in the timing of funding for U.S. Government programs for which we currently provide or propose to provide products or services may result in a loss of anticipated future revenues that could materially and adversely impact our results of operations and financial condition. Significant changes in national and international priorities for defense spending could impact the funding, or the timing of funding, of our programs, which could negatively impact our results of operations and financial condition.

 

Under the Budget Control Act of 2011, the U.S. Government committed to significantly reduce the federal deficit over ten years. As a result, long-term funding for various programs in which we participate, as well as future purchasing decisions by our U.S. Government customers, could be reduced, delayed or cancelled. In addition, these cuts could adversely affect the viability of the suppliers and subcontractors under our programs. There are many variables in how these budget cuts could be implemented that make it difficult to determine specific impacts; however, we expect that sequestration, as currently provided for under the Budget Control Act, would result in lower revenues, profits and cash flows for our company. Such circumstances may also result in an impairment of our goodwill and intangible assets.  Because our U.S. Government contracts generally require us to continue to perform even if the U.S. Government is unable to make timely payments; if, for example, the debt ceiling is not raised, and, as a result, our customer does not pay us on a timely basis, we would need to finance our continued performance of the impacted contracts from our other resources. An extended delay in the timely payment by the U.S. Government could result in a material adverse effect on our cash flows, results of operations and financial condition.

 

U.S. Government contracts may be terminated at any time and may contain other unfavorable provisions.

The U.S. Government typically can terminate or modify any of its contracts with us either for its convenience or if we default by failing to perform under the terms of the applicable contract.  In the event of termination for the U.S. Government’s convenience, contractors are generally protected by provisions covering reimbursement for costs incurred on the contracts and profit on those costs but not the anticipated profit that would have been earned had the contract been completed.  A termination arising out of our default for failure to perform could expose us to liability, including but not limited to, liability for re-procurement costs in excess of the total original contract amount, net of the value of work performed and accepted by the customer under the contract.  Such an event could also have an adverse effect on our ability to compete for future contracts and orders. If any of our contracts are terminated by the U.S. Government whether for convenience or default, our backlog and anticipated revenues would be reduced by the expected value of the remaining work under such contracts.  We also enter into “fee for service” contracts with the U.S. Government where we retain ownership of, and consequently the risk of loss on, aircraft and equipment supplied to perform under these contracts.  Termination of these contracts could materially and adversely impact our results of operations. On contracts for which we are teamed with others and are not the prime contractor, the U.S. Government could terminate a prime contract under which we are a subcontractor, irrespective of the quality of our products and services as a subcontractor.  In addition, in the event that the U.S. Government is unable to make timely payments, failure to continue contract performance places the contractor at risk of termination for default.  Any such event could result in a material adverse effect on our cash flows, results of operations and financial condition.

 

As a U.S. Government contractor, we are subject to procurement rules and regulations.

We must comply with and are affected by laws and regulations relating to the formation, administration and performance of U.S. Government contracts. These laws and regulations, among other things, require certification and disclosure of all cost and pricing data in connection with contract negotiation, define allowable and unallowable costs and otherwise govern our right to reimbursement under certain cost-based U.S. Government contracts, and restrict the use and dissemination of classified information and the exportation of certain products and technical data. Our U.S. Government contracts contain provisions that allow the U.S. Government to unilaterally suspend or debar us from receiving new contracts for a period of time, reduce the value of existing contracts, issue modifications to a contract, and control and potentially prohibit the export of our products, services and

 

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associated materials.  A number of our U.S. Government contracts contain provisions that require us to make disclosure to the Inspector General of the agency that is our customer if we have credible evidence that we have violated U.S. criminal laws involving fraud, conflict of interest, or bribery; the U.S. civil False Claims Act; or received a significant overpayment under a U.S. Government contract. Failure to properly and timely make disclosures under these provisions may result in a termination for default or cause, suspension and/or debarment, and potential fines.

 

As a U.S. Government contractor, our businesses and systems are subject to audit and review by the Defense Contract Audit Agency (DCAA) and the Defense Contract Management Agency (DCMA).

We operate in a highly regulated environment and are routinely audited and reviewed by the U.S. Government and its agencies such as DCAA and DCMA. These agencies review our performance under contracts, our cost structure and our compliance with laws and regulations applicable to U.S. Government contractors. The systems that are subject to review include, but are not limited to, our accounting, estimating, material management and accounting, earned value management, purchasing and government property systems. If an audit uncovers improper or illegal activities we may be subject to civil and criminal penalties and administrative sanctions that may include the termination of our contracts, forfeiture of profits, suspension of payments, fines, and, under certain circumstances, suspension or debarment from future contracts for a period of time. Whether or not illegal activities are alleged, the U.S. Government also has the ability to decrease or withhold certain payments when it deems systems subject to its review to be inadequate.  These laws and regulations affect how we conduct business with our government customers and, in some instances, impose added costs on our business.

 

Cost overruns on U.S. Government contracts could subject us to losses or adversely affect our future business.

Under fixed-price contracts, as a general rule, we receive a fixed price irrespective of the actual costs we incur, and, consequently, any costs in excess of the fixed price are absorbed by us. Changes in underlying assumptions, circumstances or estimates used in developing the pricing for such contracts may adversely affect our results of operations. Additionally, U.S. Government procurement policies increasingly favor fixed-price incentive-based fee arrangements rather than traditional fixed-price contracts; these fee arrangements could negatively impact our profitability. Other current U.S. Government policies could negatively impact our working capital and cash flow. For example, the government has expressed a preference for requiring progress payments rather than performance based payments on new fixed-price contracts, which if implemented, delays our ability to recover a significant amount of costs incurred on a contract and thus affects the timing of our cash flows.  Under time and materials contracts, we are paid for labor at negotiated hourly billing rates and for certain expenses. Under cost-reimbursement contracts that are subject to a contract-ceiling amount, we are reimbursed for allowable costs and paid a fee, which may be fixed or performance based, however, if our costs exceed the contract ceiling or are not allowable under the provisions of the contract or applicable regulations, we may not be able to obtain reimbursement for all such costs. Under each type of contract, if we are unable to control costs incurred in performing under the contract, our cash flows, results of operations and financial condition could be adversely affected. Cost overruns also may adversely affect our ability to sustain existing programs and obtain future contract awards.

 

Demand for our aircraft products is cyclical and could adversely affect our financial results.

Demand for business jets, turbo props and commercial helicopters has been cyclical and difficult to forecast. Therefore, future demand for these products could be significantly and unexpectedly less than anticipated and/or less than previous period deliveries. Similarly, there is uncertainty as to when or whether our existing commercial backlog for aircraft products will convert to revenues as the conversion depends on production capacity, customer needs and credit availability. Changes in economic conditions may cause customers to request that firm orders be rescheduled or cancelled. Reduced demand for our aircraft products or delays or cancellations of orders could result in a material adverse effect on our cash flows, results of operations and financial condition.

 

We may make acquisitions that increase the risks of our business.

We may enter into acquisitions in an effort to expand our business and enhance shareholder value. Acquisitions involve risks and uncertainties that could result in our not achieving expected benefits.  Such risks include difficulties in integrating newly acquired businesses and operations in an efficient and cost-effective manner; challenges in achieving expected strategic objectives, cost savings and other benefits; the risk that the acquired businesses’ markets do not evolve as anticipated and that the acquired businesses’ products and technologies do not prove to be those needed to be successful in those markets; the risk that our due diligence reviews of the acquired business do not identify or adequately assess all of the material issues which impact valuation of the business or that may result in costs or liabilities in excess of what we anticipated; the risk that we pay a purchase price that exceeds what the future results of operations would have merited; the risk that the acquired business may have significant internal control deficiencies or exposure to regulatory sanctions; and the potential loss of key customers, suppliers and employees of the acquired businesses.  In addition, unanticipated delays or difficulties in effecting acquisitions may prevent the consummation of the acquisition or divert the attention of our management and resources from our existing operations.

 

If our Finance segment is unable to maintain portfolio credit quality, our financial performance could be adversely affected.

A key determinant of the financial performance of our Finance segment is the quality of loans, leases and other assets in its portfolio. Portfolio quality may be adversely affected by several factors, including finance receivable underwriting procedures,

 

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collateral value, geographic or industry concentrations, and the effect of general economic conditions. In addition, a majority of the new originations in our finance receivable portfolio are cross-border transactions for aircraft sold outside of the U.S.  Cross-border transactions present additional challenges and risks in realizing upon collateral in the event of borrower default, which may result in difficulty or delay in collecting on the related finance receivables.  If our Finance segment has difficulty successfully collecting its finance receivable portfolio, our cash flow, results of operations and financial condition could be adversely affected.

 

We may need to obtain financing in the future; such financing may not be available to us on satisfactory terms, if at all.

We may periodically need to obtain financing in order to meet our debt obligations as they come due, to support our operations and/or to make acquisitions. Our access to the debt capital markets and the cost of borrowings are affected by a number of factors including market conditions and the strength of our credit ratings. If we cannot obtain adequate sources of credit on favorable terms, or at all, our business, operating results, and financial condition could be adversely affected.

 

Failure to perform by our subcontractors or suppliers could adversely affect our performance.

We rely on other companies to provide raw materials, major components and subsystems for our products. Subcontractors also perform services that we provide to our customers in certain circumstances. We depend on these suppliers and subcontractors to meet our contractual obligations to our customers and conduct our operations. Our ability to meet our obligations to our customers may be adversely affected if suppliers or subcontractors do not provide the agreed-upon supplies or perform the agreed-upon services in compliance with customer requirements and in a timely and cost-effective manner. Likewise, the quality of our products may be adversely impacted if companies to whom we delegate manufacture of major components or subsystems for our products, or from whom we acquire such items, do not provide components or subsystems which meet required specifications and perform to our and our customers’ expectations. Our suppliers may be less likely than us to be able to quickly recover from natural disasters and other events beyond their control and may be subject to additional risks such as financial problems that limit their ability to conduct their operations. The risk of these adverse effects may be greater in circumstances where we rely on only one or two subcontractors or suppliers for a particular raw material, product or service. In particular, in the aircraft industry, most vendor parts are certified by the regulatory agencies as part of the overall Type Certificate for the aircraft being produced by the manufacturer. If a vendor does not or cannot supply its parts, then the manufacturer’s production line may be stopped until the manufacturer can design, manufacture and certify a similar part itself or identify and certify another similar vendor’s part, resulting in significant delays in the completion of aircraft. Such events may adversely affect our financial results, damage our reputation and relationships with our customers, and result in regulatory actions and/or litigation.

 

Our business could be negatively impacted by information technology disruptions and security threats.

Our information technology (IT) and related systems are critical to the smooth operation of our business and essential to our ability to perform day to day operations.  From time to time, we update and/or replace IT systems used by our businesses.  The implementation of new systems can present temporary disruptions of business activities as existing processes are transitioned to the new systems, resulting in productivity issues, including delays in production, shipments or other business operations.  In addition, we outsource certain support functions, including certain global IT infrastructure services, to third-party service providers. Any disruption of such outsourced processes or functions also could have a material adverse impact on our operations.  In addition, as a U.S. defense contractor, we face certain security threats, including threats to our IT infrastructure, unlawful attempts to gain access to our proprietary or classified information and threats to the physical security of our facilities and employees, as do our customers, suppliers, subcontractors and joint venture partners.  Cybersecurity threats, such as malicious software, attempts to gain unauthorized access to our confidential, classified or otherwise proprietary information or that of our employees or customers, as well as other security breaches, are persistent, continue to evolve and require highly skilled IT resources.  While we have experienced cybersecurity attacks, we have not suffered any material losses relating to such attacks, and we believe our threat detection and mitigation processes and procedures are robust.  Due to the evolving nature of these security threats, the possibility of future material incidents cannot be completely mitigated. An IT system failure, issues related to implementation of new IT systems or breach of data security, whether of our systems or the systems of our service providers or other third parties who may have access to our data for business purposes, could disrupt our operations, cause the loss of business information or compromise confidential information. Such an incident also could require significant management attention and resources and increased costs, and could adversely affect our competitiveness and our results of operations.

 

Developing new products and technologies entails significant risks and uncertainties.

To continue to grow our revenues and segment profit, we must successfully develop new products and technologies or modify our existing products and technologies for our current and future markets. Our future performance depends, in part, on our ability to identify emerging technological trends and customer requirements and to develop and maintain competitive products and services. Delays or cost overruns in the development and acceptance of new products, or certification of new aircraft and other products, could affect our results of operations. These delays could be caused by unanticipated technological hurdles, production changes to meet customer demands, unanticipated difficulties in obtaining required regulatory certifications of new aircraft or other products, coordination with joint venture partners or failure on the part of our suppliers to deliver components as agreed. We also could be adversely affected if our research and development investments are less successful than expected or if we do not adequately

 

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protect the intellectual property developed through these efforts. Likewise, new products and technologies could generate unanticipated safety or other concerns resulting in expanded product liability risks, potential product recalls and other regulatory issues that could have an adverse impact on us. Furthermore, because of the lengthy research and development cycle involved in bringing certain of our products to market, we cannot predict the economic conditions that will exist when any new product is complete. A reduction in capital spending in the aerospace or defense industries could have a significant effect on the demand for new products and technologies under development, which could have an adverse effect on our financial condition and results of operations. In addition, the market for our product offerings may not develop or continue to expand as we currently anticipate. Furthermore, we cannot be sure that our competitors will not develop competing technologies which gain superior market acceptance compared to our products.  A significant failure in our new product development efforts or the failure of our products or services to achieve market acceptance relative to our competitors’ products or services could have an adverse effect on our financial condition and results of operations.

 

We are subject to the risks of doing business in foreign countries.

Conducting business internationally, including U.S. exports, exposes us to additional risks than if we conducted our business solely within the U.S. We maintain manufacturing facilities, service centers, supply centers and other facilities worldwide, including in various emerging market countries.  We also have entered into, and expect to continue to enter into, joint venture arrangements in emerging market countries, some of which may require capital investment, guaranties or other commitments.  We expect that our international business and our investment in emerging market countries will continue to increase. Risks related to international operations include import, export and other trade restrictions; changing U.S. and foreign procurement policies and practices; restrictions on technology transfer; difficulties in protecting intellectual property; increasing complexity of employment and environmental, health and safety regulations; foreign investment laws; exchange controls; repatriation of earnings or cash settlement challenges, competition from foreign and multinational firms with home country advantages; economic and government instability, acts of terrorism and related safety concerns.  The impact of any one or more of these or other factors could adversely affect our business, financial condition or operating results.

 

Additionally, some international government customers require contractors to agree to specific in-country purchases, manufacturing agreements or financial support arrangements, known as offsets, as a condition for a contract award. The contracts generally extend over several years and may include penalties if we fail to perform in accordance with the offset requirements which are typically subjective. We also are exposed to risks associated with using foreign representatives and consultants for international sales and operations and teaming with international subcontractors and suppliers in connection with international programs. In many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by laws and regulations applicable to us, such as the Foreign Corrupt Practices Act. Although we maintain policies and procedures designed to facilitate compliance with these laws, a violation of such laws by any of our international representatives, consultants, joint ventures, business partners, subcontractors or suppliers, even if prohibited by our policies, could have an adverse effect on our business and reputation.

 

We are subject to increasing compliance risks that could adversely affect our operating results.

As a global business, we are subject to laws and regulations in the U.S. and other countries in which we operate. Our increased focus on international sales and global operations requires importing and exporting goods and technology, some of which have military applications subjecting them to more stringent import-export controls across international borders on a regular basis. For example, we sometimes initially must obtain licenses and authorizations from various U.S. Government agencies before we are permitted to sell certain of our aerospace and defense products outside the U.S. Both U.S. and foreign laws and regulations applicable to us have been increasing in scope and complexity. For example, both U.S. and foreign governments and government agencies regulate the aviation industry, and they may impose new regulations with additional aircraft security or other requirements or restrictions, including, for example, restrictions and/or fees related to carbon emissions levels. Changes in environmental laws and regulations, including those enacted in response to climate change concerns and other actions known as “green initiatives,” could lead to the necessity for new or additional investment in product designs or manufacturing processes and could increase environmental compliance expenditures, including costs to defend regulatory reviews. New or changing laws and regulations or related interpretation and policies could increase our costs of doing business, affect how we conduct our operations, adversely impact demand for our products, and/or limit our ability to sell our products and services. Compliance with laws and regulations of increasing scope and complexity is even more challenging in our current business environment in which reducing our operating costs is often necessary to remain competitive. In addition, a violation of U.S. and/or foreign laws by one of our employees or business partners could subject us or our employees to civil or criminal penalties, including material monetary fines, or other adverse actions, such as denial of import or export privileges and/or debarment as a government contractor which could damage our reputation and have an adverse effect on our business.

 

We are subject to legal proceedings and other claims.

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

 

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regulations; production partners; product liability; patent and trademark infringement; employment disputes; and environmental, safety and health matters.  Due to the nature of our manufacturing business, we may be subject to liability claims arising from accidents involving our products, including claims for serious personal injuries or death caused by weather or by pilot, driver or user error. In the case of litigation matters for which reserves have not been established because the loss is not deemed probable, it is reasonably possible that such claims could be decided against us and could require us to pay damages or make other expenditures in amounts that are not presently estimable. In addition, we cannot be certain that our reserves are adequate and that our insurance coverage will be sufficient to cover one or more substantial claims. Furthermore, we may not be able to obtain insurance coverage at acceptable levels and costs in the future.  Litigation is inherently unpredictable, and we could incur judgments, receive adverse arbitration awards or enter into settlements for current or future claims that could adversely affect our financial position or our results of operations in any particular period.

 

Intellectual property infringement claims of others and the inability to protect our intellectual property rights could harm our business and our customers.

Intellectual property infringement claims may be asserted by third parties against us or our customers. Any related indemnification payments or legal costs we may be obliged to pay on behalf of our businesses, our customers or other third parties could be costly. In addition, we own the rights to many patents, trademarks, brand names, trade names and trade secrets that are important to our business. The inability to enforce these intellectual property rights may have an adverse effect on our results of operations. Additionally, our intellectual property could be at risk due to various cybersecurity threats.

 

Certain of our products are subject to laws regulating consumer products and could be subject to repurchase or recall as a result of safety issues.

As a distributor of consumer products in the U.S., certain of our products also are subject to the Consumer Product Safety Act, which empowers the U.S. Consumer Product Safety Commission (CPSC) to exclude from the market products that are found to be unsafe or hazardous. Under certain circumstances, the CPSC could require us to repair, replace or refund the purchase price of one or more of our products, or potentially even discontinue entire product lines, or we may voluntarily do so, but within strictures recommended by the CPSC. The CPSC also can impose fines or penalties on a manufacturer for non-compliance with its requirements. Furthermore, failure to timely notify the CPSC of a potential safety hazard can result in significant fines being assessed against us. Any repurchases or recalls of our products or an imposition of fines or penalties could be costly to us and could damage the reputation or the value of our brands. Additionally, laws regulating certain consumer products exist in some states, as well as in other countries in which we sell our products, and more restrictive laws and regulations may be adopted in the future.

 

The increasing costs of certain employee and retiree benefits could adversely affect our results.

Our earnings and cash flow may be adversely impacted by the amount of income or expense we expend or record for employee benefit plans. This is particularly true for our defined benefit pension plans, where required contributions to those plans and related expenses are driven by, among other things, our assumptions of the expected long-term rate of return on plan assets, the discount rate used for future payment obligations and the rates of future cost growth. Additionally, as part of our annual evaluation of these plans, significant changes in our assumptions, due to changes in economic, legislative and/or demographic experience or circumstances, or changes in our actual investment returns could negatively impact the funded status of our plans requiring us to substantially increase our pension liability with a resulting decrease in shareholders’ equity. Also, changes in pension legislation and regulations could increase the cost associated with our defined benefit pension plans.

 

In addition, medical costs are rising at a rate faster than the general inflation rate. Continued medical cost inflation in excess of the general inflation rate would increase the risk that we will not be able to mitigate the rising costs of medical benefits. Moreover, we expect that some of the requirements of the new comprehensive healthcare law will increase our future costs. Increases to the costs of pension and medical benefits could have an adverse effect on our results of operations.

 

Our business could be adversely affected by strikes or work stoppages and other labor issues.

Approximately 7,100, or 28%, of our U.S. employees are unionized, and many of our non-U.S. employees are represented by organized councils. As a result, we may experience work stoppages, which could negatively impact our ability to manufacture our products on a timely basis, resulting in strain on our relationships with our customers and a loss of revenues. The presence of unions also may limit our flexibility in responding to competitive pressures in the marketplace. In addition, the workforces of many of our suppliers and customers are represented by labor unions. Work stoppages or strikes at the plants of our key suppliers could disrupt our manufacturing processes; similar actions at the plants of our customers could result in delayed or canceled orders for our products. Any of these events could adversely affect our results of operations.

 

Currency, raw material price and interest rate fluctuations may adversely affect our results.

We are exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates, raw material prices and interest rates. Currency variations also contribute to variations in sales of products and services in impacted

 

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jurisdictions. Accordingly, fluctuations in foreign currency rates could adversely affect our profitability in future periods. We monitor and manage these exposures as an integral part of our overall risk management program. In some cases, we purchase derivatives or enter into contracts to insulate our results of operations from these fluctuations. Nevertheless, changes in currency exchange rates, raw material prices and interest rates can have substantial adverse effects on our results of operations.

 

We may be unable to effectively mitigate pricing pressures.

In some markets, particularly where we deliver component products and services to OEMs, we face ongoing customer demands for price reductions, which sometimes are contractually obligated. However, if we are unable to effectively mitigate future pricing pressures through technological advances or by lowering our cost base through improved operating and supply chain efficiencies, our results of operations could be adversely affected.

 

Unanticipated changes in our tax rates or exposure to additional income tax liabilities could affect our profitability.

We are subject to income taxes in both the U.S. and various non-U.S. jurisdictions, and our domestic and international tax liabilities are subject to the allocation of income among these different jurisdictions. Our effective tax rate could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes to unrecognized tax benefits or changes in tax laws, which could affect our profitability. In particular, the carrying value of deferred tax assets is dependent on our ability to generate future taxable income, as well as changes to applicable statutory tax rates.  In addition, the amount of income taxes we pay is subject to audits in various jurisdictions, and a material assessment by a tax authority could affect our profitability.

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

On January 3, 2015, we operated a total of 56 plants located throughout the U.S. and 54 plants outside the U.S.  We own 59 plants and lease the remainder for a total manufacturing space of approximately 23.4 million square feet.  We consider the productive capacity of the plants operated by each of our business segments to be adequate.  We also own or lease offices, warehouses, service centers and other space at various locations. In general, our facilities are in good condition, are considered to be adequate for the uses to which they are being put and are substantially in regular use.

 

Item 3. Legal Proceedings

 

On October 7, 2014, the Federal Aviation Administration of the U.S. Department of Transportation (DOT) issued a Notice of Proposed Civil Penalty to McCauley Propeller Systems, a Division of Cessna Aircraft Company, for alleged violations of DOT’s hazardous materials shipment regulations in connection with the shipment of resin product by air from McCauley’s Columbus, GA facility.  The DOT has proposed a civil penalty of $238,000, and Cessna Aircraft Company is currently negotiating the disposition of the matter.

 

We also are subject to actual and threatened 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, health and safety 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.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

15



Table of Contents

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

The principal market on which our common stock is traded is the New York Stock Exchange under the symbol “TXT.”  At January 3, 2015, there were approximately 10,700 record holders of Textron common stock.  The high and low sales prices per share of our common stock as reported on the New York Stock Exchange and the dividends paid per share are provided in the following table:

 

 

 

2014

 

2013

 

 

High

 

Low

 

Dividends
per Share

 

 

High

 

Low

 

Dividends
per Share

 

First quarter

 

$

40.18

 

$

34.28

 

$

0.02

 

 

$

31.30

 

$

23.94

 

$

0.02

 

Second quarter

 

40.93

 

36.96

 

0.02

 

 

30.22

 

24.87

 

0.02

 

Third quarter

 

39.03

 

35.54

 

0.02

 

 

29.81

 

25.36

 

0.02

 

Fourth quarter

 

44.23

 

32.28

 

0.02

 

 

37.43

 

26.17

 

0.02

 

 

Issuer Repurchases of Equity Securities

The following provides information about our fourth quarter 2014 repurchases of equity securities that are registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended:

 

Period (shares in thousands)

 

Total
Number of
Shares
Purchased 
(1)

 

Average Price
Paid per Share
(excluding
commissions)

 

Total Number of
Shares Purchased as
part of Publicly
Announced Plan 
(1)

 

Maximum
Number of Shares
that may yet be
Purchased under
the Plan

 

September 28, 2014 – November 1, 2014

 

225

 

$

35.90

 

225

 

16,399

 

November 2, 2014 – November 29, 2014

 

 

 

 

 

November 30, 2014 – January 3, 2015

 

320

 

39.66

 

320

 

16,079

 

Total

 

545

 

$

38.11

 

545

 

 

 

 

(1) These shares were purchased pursuant to a plan authorizing the repurchase of up to 25 million shares of Textron common stock that had been announced on January 23, 2013. This plan has no expiration date.

 

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 an initial estimated purchase price of $150 million.  Final settlement of the ASR occurred in December 2014 and resulted in a final average price of $38.90 per share.

 

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Table of Contents

 

Stock Performance Graph

The following graph compares the total return on a cumulative basis at the end of each year of $100 invested in our common stock on December 31, 2009 with the Standard & Poor’s (S&P) 500 Stock Index, the S&P 500 Aerospace & Defense (A&D) Index and the S&P 500 Industrials Index, all of which include Textron. The values calculated assume dividend reinvestment.

 

In 2014, we changed from the S&P Industrial Conglomerates Index to the S&P 500 Industrials Index, which we believe is a better comparator for the performance of our business. We have provided the S&P Industrial Conglomerates Index in the graph below for comparison purposes only.

 

 

GRAPHIC

 

 

 

 

2009

 

2010

 

2011

 

2012

 

2013

 

2014

 

Textron Inc.

 

$

100.00

 

$

126.17

 

$

99.08

 

$

133.26

 

$

198.15

 

$

227.77

 

S&P 500

 

100.00

 

115.06

 

117.49

 

136.30

 

180.44

 

205.10

 

S&P 500 A&D

 

100.00

 

115.11

 

121.19

 

138.84

 

215.08

 

239.90

 

S&P 500 Industrials

 

100.00

 

115.73

 

122.01

 

140.01

 

184.31

 

206.98

 

S&P 500 Industrial Conglomerates

 

100.00

 

118.70

 

119.53

 

143.14

 

201.91

 

203.64

 

 

17



Table of Contents

 

Item 6.  Selected Financial Data

 

(Dollars in millions, except per share amounts)

 

2014

 

 

2013

 

2012

 

2011

 

2010

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

Textron Aviation

 

$

4,568

 

 

$

2,784

 

$

3,111

 

$

2,990

 

$

2,563

 

Bell

 

4,245

 

 

4,511

 

4,274

 

3,525

 

3,241

 

Textron Systems

 

1,624

 

 

1,665

 

1,737

 

1,872

 

1,979

 

Industrial

 

3,338

 

 

3,012

 

2,900

 

2,785

 

2,524

 

Finance

 

103

 

 

132

 

215

 

103

 

218

 

Total revenues

 

$

13,878

 

 

$

12,104

 

$

12,237

 

$

11,275

 

$

10,525

 

Segment profit

 

 

 

 

 

 

 

 

 

 

 

 

Textron Aviation (a)

 

$

234

 

 

$

(48

)

$

82

 

$

60

 

$

(29

)

Bell

 

529

 

 

573

 

639

 

521

 

427

 

Textron Systems

 

150

 

 

147

 

132

 

141

 

230

 

Industrial

 

280

 

 

242

 

215

 

202

 

162

 

Finance (b)

 

21

 

 

49

 

64

 

(333

)

(237

)

Total segment profit

 

1,214

 

 

963

 

1,132

 

591

 

553

 

Corporate expenses and other, net

 

(161

)

 

(166

)

(148

)

(114

)

(137

)

Interest expense, net for Manufacturing group

 

(148

)

 

(123

)

(143

)

(140

)

(140

)

Acquisition and restructuring costs (c)

 

(52

)

 

 

 

 

 

Special charges (d)

 

 

 

 

 

 

(190

)

Income tax (expense) benefit

 

(248

)

 

(176

)

(260

)

(95

)

6

 

Income from continuing operations

 

$

605

 

 

$

498

 

$

581

 

$

242

 

$

92

 

Per share of common stock

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations — basic

 

$

2.17

 

 

$

1.78

 

$

2.07

 

$

0.87

 

$

0.33

 

Income from continuing operations — diluted

 

$

2.15

 

 

$

1.75

 

$

1.97

 

$

0.79

 

$

0.30

 

Dividends declared

 

$

0.08

 

 

$

0.08

 

$

0.08

 

$

0.08

 

$

0.08

 

Book value at year-end

 

$

15.45

 

 

$

15.54

 

$

11.03

 

$

9.84

 

$

10.78

 

Common stock price: High

 

$

44.23

 

 

$

37.43

 

$

29.18

 

$

28.87

 

$

25.30

 

Low

 

$

32.28

 

 

$

23.94

 

$

18.37

 

$

14.66

 

$

15.88

 

Year-end

 

$

42.17

 

 

$

36.61

 

$

24.12

 

$

18.49

 

$

23.64

 

Common shares outstanding (In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Basic average

 

279,409

 

 

279,299

 

280,182

 

277,684

 

274,452

 

Diluted average

 

281,790

 

 

284,428

 

294,663

 

307,255

 

302,555

 

Year-end

 

276,582

 

 

282,059

 

271,263

 

278,873

 

275,739

 

Financial position

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

14,605

 

 

$

12,944

 

$

13,033

 

$

13,615

 

$

15,282

 

Manufacturing group debt

 

$

2,811

 

 

$

1,931

 

$

2,301

 

$

2,459

 

$

2,302

 

Finance group debt

 

$

1,063

 

 

$

1,256

 

$

1,686

 

$

1,974

 

$

3,660

 

Shareholders’ equity

 

$

4,272

 

 

$

4,384

 

$

2,991

 

$

2,745

 

$

2,972

 

Manufacturing group debt-to-capital (net of cash)

 

33

%

 

15

%

24

%

37

%

32

%

Manufacturing group debt-to-capital

 

40

%

 

31

%

44

%

47

%

44

%

Investment data

 

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

429

 

 

$

444

 

$

480

 

$

423

 

$

270

 

Depreciation

 

$

389

 

 

$

349

 

$

336

 

$

343

 

$

334

 

 

(a)          In 2014, segment profit includes amortization of $63 million related to fair value step-up adjustments of Beechcraft acquired inventories sold during the period.

 

(b)          For 2011, segment profit includes a $186 million initial mark-to-market adjustment for finance receivables in the Golf Mortgage portfolio that were transferred to the held for sale classification.

 

(c)           Acquisition and restructuring costs are related to the acquisition of Beech Holdings, LLC, the parent of Beechcraft Corporation, which was completed on March 14, 2014.

 

(d)          Special charges include restructuring charges of $99 million, primarily related to severance and asset impairment charges, and a $91 million non-cash pre-tax charge to reclassify a foreign exchange loss from equity as a result of substantially liquidating a Finance segment entity.

 

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Table of Contents

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview and Consolidated Results of Operations

 

Our revenues increased 15% in 2014 reflecting the success of our strategy of investing in new products and complementary acquisitions. Several highlights of the year include the following:

 

·                  Invested $694 million in research and development activities demonstrating our continued commitment to expand our current product lines across our businesses.

·                  Invested $1.6 billion in strategic acquisitions along with $429 million in capital expenditures.

·                  Delivered strong cash flow performance as manufacturing operating cash flows from continuing operations increased 67% to $1.1 billion.

·                  Grew segment profit by 26% to $1.2 billion.

·                  Raised diluted earnings per share from continuing operations by 23%.

 

On March 14, 2014, we completed the acquisition of Beech Holdings, LLC, which included Beechcraft Corporation and other subsidiaries, (collectively “Beechcraft”); this business and the legacy Cessna segment were combined to form a new segment named Textron Aviation. We also made seven acquisitions in the Industrial and Textron Systems segments, which complemented our products and services.  The results of these acquisitions are included in Textron’s consolidated financial statements only for the period subsequent to the completion of each acquisition and do not reflect a full year of 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 21 to 28.

 

Revenues

 

(Dollars in millions)

 

2014

 

 

2013

 

 

2012    

Revenues

$

13,878

 

$

12,104

 

$

12,237   

% change compared with prior period

 

15

%

 

(1)

%

 

 

 

Revenues increased $1.8 billion, 15%, in 2014, compared with 2013, as increases in the Textron Aviation and Industrial segments were partially offset by lower revenues in the Bell, Textron Systems and Finance segments.  The net revenue increase included the following factors:

 

·                  Higher Textron Aviation revenues of $1.8 billion, primarily due to a $1.5 billion impact from the Beechcraft acquisition and a $263 million increase in volume, largely related to Citation jets.

·                  Higher Industrial segment revenues of $326 million, primarily due to $181 million in higher volume, largely in the Fuel Systems and Functional Components product line, and a $142 million impact from acquisitions.

·                  Lower Bell revenues of $266 million, largely due to a $183 million decrease in commercial revenues reflecting lower sales activity across the commercial helicopter market, and $99 million in lower other military volume, largely related to the H-1 program reflecting lower aircraft deliveries and production support.

·                  Lower Textron Systems revenues of $41 million, primarily due to lower volume of $233 million in the Marine and Land Systems product line, reflecting lower vehicle deliveries, partially offset by higher volume of $130 million in the Unmanned Systems product line and a $62 million impact from acquisitions.

·                  Lower Finance revenues of $29 million, primarily attributable to gains on the disposition of finance receivables held for sale during 2013.

 

Revenues decreased $133 million, 1%, in 2013, compared with 2012, as decreases in the Textron Aviation, Finance and Textron Systems segments were partially offset by higher revenues in the Bell and Industrial segments.  The net revenue decrease included the following factors:

 

·                  Lower Textron Aviation revenues of $327 million, primarily due to lower Citation jet volume of $384 million and CitationAir volume of $114 million, partially offset by higher aftermarket volume of $65 million and higher pre-owned aircraft volume of $53 million.

 

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Table of Contents

 

·                  Lower Finance revenues of $83 million, primarily attributable to an unfavorable impact of $46 million from lower average finance receivables and a decrease of $25 million in revenues related to the resolution of a Timeshare account in 2012.

·                  Lower Textron Systems revenues of $72 million, largely due to lower volume of $51 million in the Marine and Land Systems product line and lower volume of $28 million in the Unmanned Systems product line.

·                Higher Bell revenues of $237 million, largely due to higher volume of $163 million in our military programs, primarily reflecting higher V-22 deliveries and aftermarket volume, and $74 million of higher commercial revenues, largely due to higher aircraft volume.

·                Higher Industrial segment revenues of $112 million, primarily due to higher volume of $58 million and the impact from acquisitions of $46 million.

 

Cost of Sales and Selling and Administrative Expense

 

(Dollars in millions)

 

2014

2013

2012

Operating expenses

 

$

12,782

$

11,257

$

11,184

Cost of sales

 

11,421

10,131

10,019

% change compared with prior period

 

13%

1%

 

Gross margin as a percentage of Manufacturing revenues

 

17.1%

15.4%

16.7%

Selling and administrative expenses

 

1,361

1,126

1,165

% change compared with prior period

 

21%

(3)%

 

 

Manufacturing cost of sales and selling and administrative expenses together comprise our operating expenses. Cost of sales increased $1.3 billion, 13%, in 2014, compared with 2013, largely due to the impact of acquired businesses, primarily Beechcraft.  In 2014, gross margin as a percentage of manufacturing revenues increased 170 basis points largely due to improved leverage resulting from higher revenues primarily at Textron Aviation.

 

Selling and administrative expense increased $235 million, 21%, in 2014, compared with 2013, largely related to businesses acquired in the past year and compensation expense.  These increases were partially offset by $28 million in severance costs incurred in 2013 in connection with a voluntary separation program at Textron Aviation.

 

Manufacturing cost of sales increased $112 million, 1%, in 2013, compared with 2012, primarily due to higher volume at Bell and the impact from businesses acquired in 2013, partially offset by lower sales at Textron Aviation and Textron Systems.  In 2013, gross margin as a percentage of manufacturing revenues decreased 130 basis points primarily due to unfavorable performance at Bell, largely due to manufacturing inefficiencies associated with labor disruptions resulting from negotiations with bargained employees and with the implementation of a new enterprise resource planning system in the first quarter of 2013, as well as lower Citation jet and CitiationAir volume at Textron Aviation.

 

Selling and administrative expenses decreased $39 million, 3%, in 2013 compared with 2012, largely due to a reduction in administrative expenses of $26 million and lower provision for loan losses of $20 million at the Finance segment, both primarily associated with the non-captive business. Selling and administrative expense was also impacted by $28 million in severance costs incurred in 2013 at Textron Aviation, which were largely offset by a $27 million charge from an unfavorable arbitration award in 2012 at Textron Aviation.

 

Acquisition and Restructuring Costs

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.  During 2014, we recorded charges of $41 million related to these 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 in 2014 related to the acquisition that were also included in the Acquisition and restructuring costs line. We expect to incur additional restructuring costs in 2015, but do not expect these costs to be material.

 

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Table of Contents

 

Interest Expense

 

(Dollars in millions)

 

2014

2013

2012

Interest expense

 

$

191

$

173

$

212

% change compared with prior period

 

10%

(18)%

 

 

Interest expense on the Consolidated Statement of Operations includes interest for both the Manufacturing and Finance borrowing groups with interest related to intercompany borrowings eliminated.  Consolidated interest expense increased $18 million, 10%, in 2014, compared with 2013, primarily due to a $31 million impact related to financing the Beechcraft acquisition, partially offset by $9 million of lower interest expense due to the maturity of our convertible notes in the second quarter of 2013.  In 2013, consolidated interest expense decreased $39 million, 18%, compared with 2012, primarily due to lower average debt outstanding.

 

Income Tax Expense

Our effective tax rate was 29.1% in 2014, 26.1% in 2013 and 30.9% in 2012.  This rate generally differs from the U.S. federal statutory tax rate of 35% due to certain earnings from operations in lower-tax jurisdictions throughout the world, as well as the research credit.  The jurisdictions with favorable tax rates that have the most significant effective tax rate impact in the periods presented include Canada, Germany, Belgium and China.  We have not provided for U.S. taxes for those earnings because we plan to reinvest all of those earnings indefinitely outside of the U.S.

 

In 2013, our effective tax rate was reduced by approximately 4.0% due to the tax benefit recognized upon the retroactive reinstatement and extension of the Federal Research and Development Tax Credit for the period from January 1, 2012 to December 31, 2013.  In 2014, this credit was extended through the end of 2014, resulting in a 1.5% reduction in our effective tax rate.

 

For a full reconciliation of our effective tax rate to the U.S. federal statutory tax rate of 35% see Note 12 to the Consolidated Financial Statements.

 

Segment Analysis

 

We operate in, and report financial information for, the following five business segments: Textron Aviation, which consists of the legacy Cessna segment combined with the recently-acquired Beechcraft business, Bell, Textron Systems, Industrial and Finance.  Segment profit is an important measure used for evaluating performance and for decision-making purposes.  Segment profit for the manufacturing segments excludes interest expense, certain corporate expenses and acquisition and restructuring costs related to the Beechcraft acquisition. The measurement for the Finance segment includes interest income and expense along with intercompany interest income and expense.

 

In our discussion of comparative results for the Manufacturing group, changes in revenues and segment profit typically are expressed for our commercial business in terms of volume, pricing, foreign exchange and acquisitions.  Additionally, changes in segment profit may be expressed in terms of mix, inflation and cost performance. Volume changes in revenues represent increases/decreases in the number of units delivered or services provided.  Pricing represents changes in unit pricing.  Foreign exchange is the change resulting from translating foreign-denominated amounts into U.S. dollars at exchange rates that are different from the prior period.  Acquisitions refers to the revenues generated from businesses that were acquired within the previous 12 months.  For segment profit, mix represents a change due to the composition of products and/or services sold at different profit margins.  Inflation represents higher material, wages, benefits, pension or other costs.  Performance reflects an increase or decrease in research and development, depreciation, selling and administrative costs, warranty, product liability, quality/scrap, labor efficiency, overhead, product line profitability, start-up, ramp up and cost-reduction initiatives or other manufacturing inputs.

 

Approximately 28% of our 2014 revenues were derived from contracts with the U.S. Government.  For our segments that have significant contracts with the U.S. Government, we typically express changes in segment profit related to the government business in terms of volume, changes in program performance or changes in contract mix. Changes in volume that are discussed in net sales typically drive corresponding changes in our segment profit based on the profit rate for a particular contract. Changes in program performance typically relate to profit recognition associated with revisions to total estimated costs at completion that reflect improved or deteriorated operating performance or award fee rates. Changes in contract mix refers to changes in operating margin due to a change in the relative volume of contracts with higher or lower fee rates such that the overall average margin rate for the segment changes.

 

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Table of Contents

 

Textron Aviation

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2014

2013

2012 

2014

2013

Revenues

 

$

4,568

$

2,784

$

3,111 

64%

(11)%

Operating expenses

 

4,334

2,832

3,029 

53%

(7)%

Segment profit (loss)

 

234

(48)

82 

Profit margin

 

5.1%

(1.7)%

2.6% 

 

 

Backlog

 

$

1,365

$

1,018

$

1,062 

34%

(4)%

 

Textron Aviation Revenues and Operating Expenses

Factors contributing to the 2014 year-over-year revenue change are provided below:

 

(In millions)

 

2014 versus
2013

 

Acquisitions

 

$

1,480

 

Volume

 

263

 

Pricing

 

41

 

Total change

 

$

1,784

 

 

Textron Aviation’s revenues increased by $1.8 billion, 64%, in 2014, compared with 2013, primarily due to the impact of the Beechcraft acquisition of $1.5 billion and higher volume of $263 million.  The increase in volume was primarily the result of higher Citation jet volume of $344 million, partially offset by lower CitationAir volume of $78 million related to exiting our fractional share business.  We delivered 159 Citation jets and 113 King Air turboprops in 2014, compared with 139 Citation jets in 2013.  During 2014, the portion of the segment’s revenues derived from aftermarket sales and services represented 30% of its total revenues, compared with 33% in 2013.

 

Textron Aviation’s operating expenses increased by $1.5 billion, 53%, in 2014, compared with 2013, primarily due to the incremental operating costs related to the Beechcraft acquisition, and higher net volume as described above. Textron Aviation’s operating expenses exclude acquisition and restructuring costs incurred across the segment as a result of the Beechcraft integration, which are reported separately and are discussed in the Acquisition and Restructuring Costs section above.

 

Factors contributing to the 2013 year-over-year revenue change are provided below:

 

(In millions)

 

2013 versus
2012

 

Volume

 

$

(373

)

Acquisitions

 

33

 

Other

 

13

 

Total change

 

$

(327

)

 

In 2013, Textron Aviation’s revenues decreased $327 million, 11%, compared with 2012, primarily due to lower Citation jet volume of $384 million and lower CitationAir volume of $114 million, largely related to the wind-down of our fractional share business.  These decreases were partially offset by higher aftermarket volume of $65 million, largely due to increased service demand, and higher pre-owned aircraft volume of $53 million.  We delivered 139 Citation jets in 2013, compared with 181 jets in 2012.  During 2013, the portion of Textron Aviation’s revenues derived from aftermarket sales and services increased to 33%, compared with 25% in 2012, due to higher aftermarket volume and the impact of lower Citation jet revenues.

 

Textron Aviation’s operating expenses decreased $197 million, 7%, in 2013, compared with 2012, primarily due to lower volume as discussed above.  The volume-related decrease in operating expenses was partially offset by $37 million of operating costs incurred by service centers acquired at the beginning of 2013 and $33 million of inflation, largely due to higher pension expense of $17 million.  Operating expenses in 2013 were also impacted by $28 million in severance costs incurred during the first half of the year in connection with a voluntary separation program offered to qualifying salaried employees and a reduction of certain direct production positions due to an adjustment of our production schedule.  Operating expenses in 2012 included a $27 million charge from an unfavorable arbitration award.

 

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Table of Contents

 

Textron Aviation Segment Profit (Loss)

Factors contributing to 2014 year-over-year segment profit (loss) change are provided below:

 

(In millions)

 

2014 versus
2013

 

Performance and other

 

$

117

 

Volume

 

89

 

Pricing and inflation

 

48

 

2013 Voluntary Separation Program

 

28

 

Total change

 

$

282

 

 

Textron Aviation segment profit increased $282 million in 2014, compared with 2013, primarily due to an increase in Performance and other, higher volume as described above, favorable pricing and inflation and $28 million in severance costs incurred in 2013.  During the second quarter of 2014, the cost structures of Beechcraft and Cessna were significantly integrated, and as a result, Performance and other reflects the net profit impact of Beechcraft, including the benefit of the integrated cost structure.  Performance and other also includes amortization of $63 million in 2014, related to fair value step-up adjustments of acquired inventories sold during the periods.

 

Factors contributing to 2013 year-over-year segment profit (loss) change are provided below:

 

(In millions)

 

2013 versus
2012

 

Volume

 

$

(99

)

Inflation, net of pricing

 

(21

)

Other

 

(10

)

Total change

 

$

(130

)

 

Textron Aviation’s segment profit decreased $130 million in 2013, compared with 2012, primarily due to a $99 million impact from lower volume as described above and $21 million in inflation, net of pricing, largely due to higher pension expense of $17 million. Segment profit was also impacted by $28 million in severance costs incurred in 2013, largely offset by a $27 million charge from an unfavorable arbitration award incurred in 2012.

 

Textron Aviation Backlog

Textron Aviation’s backlog increased $347 million, 34%, in 2014 and decreased $44 million, 4%, in 2013. The increase in 2014 included the Beechcraft acquisition.

 

Bell

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2014

2013

2012 

2014

2013

Revenues:

 

 

 

 

 

 

 

 

 

V-22 program

 

$

1,771

$

1,755

$

1,611 

1%

9%

Other military

 

860

959

940 

(10)%

2%

Commercial

 

1,614

1,797

1,723 

(10)%

4%

Total revenues

 

4,245

4,511

4,274 

(6)%

6%

Operating expenses

 

3,716

3,938

3,635 

(6)%

8%

Segment profit

 

529

573

639 

(8)%

(10)%

Profit margin

 

12.5%

12.7%

15.0% 

 

 

Backlog

 

$

5,524

$

6,450

$

7,469 

(14)%

(14)%

 

Bell’s major U.S. Government programs at this time are the V-22 tiltrotor aircraft and the H-1 helicopter platforms, which are both in the production stage and represent a significant portion of Bell’s revenues from the U.S. Government.

 

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Table of Contents

 

Bell Revenues and Operating Expenses

Factors contributing to the 2014 year-over-year revenue change are provided below:

 

(In millions)

 

2014 versus
2013

 

Volume and mix

 

$

(300

)

Other

 

34

 

Total change

 

$

(266

)

 

Bell’s revenues decreased $266 million, 6%, in 2014, compared with 2013, primarily due to the following factors:

 

·                 $183 million decrease in commercial revenues, largely related to lower volume reflecting lower sales activity across the commercial helicopter market.  Bell delivered 178 commercial aircraft in 2014, compared with 213 commercial aircraft in 2013.

·                 $99 million decrease in other military volume, primarily related to the H-1 program, largely reflecting lower aircraft deliveries and production support.  Lower volume was partially offset by $41 million recorded in the second quarter of 2014, related to the settlement of the SDD phase of the ARH program, which was terminated in October 2008.  Bell delivered 24 H-1 aircraft in 2014, compared with 25 aircraft in 2013.

·                 $16 million increase in V-22 program revenues, reflecting higher product support volume of $115 million.   This increase was largely offset by lower aircraft deliveries, as we delivered 37 V-22 aircraft in 2014 compared to 41 V-22 aircraft in 2013.

 

Bell’s operating expenses decreased $222 million, 6% in 2014, compared with 2013, primarily due to the lower net volume as discussed above.  In addition, Bell experienced favorable profit adjustments on its long-term contracts, primarily driven by cost reduction activities in 2014 as well as unfavorable performance in 2013 as discussed below.

 

Factors contributing to the 2013 year-over-year revenue change are provided below:

 

(In millions)

 

2013 versus
2012

 

Volume

 

$

193

 

Other

 

44

 

Total change

 

$

237

 

 

Bell’s revenues increased $237 million, 6% in 2013, compared with 2012, due to the following factors:

 

·                 $144 million increase in V-22 program volume largely due to higher aircraft deliveries, as we delivered 41 V-22 aircraft in 2013, compared with 39 aircraft in 2012. In addition, military aftermarket volume was higher by $35 million, reflecting increased support of fielded aircraft.

·                 $74 million increase in commercial revenues, largely due to higher aircraft volume, as we delivered 213 aircraft in 2013, compared to 188 aircraft in 2012.  This increase was partially offset by lower commercial aftermarket revenues of $50 million, largely due to lower volume, which in part, resulted from the conversion to a new enterprise resource planning system in the first quarter of 2013.

·                 $19 million increase in other military volume, reflecting higher H-1 deliveries.  We delivered 25 H-1 aircraft in 2013, compared with 24 H-1 aircraft in 2012.

 

Bell’s operating expenses increased $303 million, 8%, in 2013, respectively, compared with 2012, largely due to higher volume as described above and $68 million in unfavorable performance, which included $27 million in lower favorable profit adjustments on its long-term contracts. The unfavorable performance was largely due to manufacturing inefficiencies associated with labor disruptions resulting from negotiations with bargained employees and with the implementation of a new enterprise resource planning system in the first quarter of 2013.  On October 13, 2013, Bell reached a new five-year collective bargaining agreement with the United Automobile, Aerospace and Agricultural Implement Workers of America (UAW) and UAW Local 218 which represents these employees.

 

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Table of Contents

 

Bell Segment Profit

Factors contributing to 2014 year-over-year segment profit change are provided below:

 

(In millions)

 

2014 versus
2013

 

Volume and Mix

 

$

(72)

 

Performance

 

23

 

Other

 

5

 

Total change

 

$

(44)

 

 

Bell’s segment profit decreased $44 million, 8%, in 2014, compared with 2013. The impact of volume and mix was largely driven by lower commercial volume and an unfavorable mix of commercial aircraft deliveries, partially offset by a $16 million favorable program profit adjustment related to the ARH program described above. Favorable performance primarily reflected our cost reduction activities in 2014 as well as unfavorable performance in 2013 as described above.

 

Factors contributing to 2013 year-over-year segment profit change are provided below:

 

(In millions)

 

2013 versus
2012

 

Performance

 

$

(68)

 

Volume and mix

 

(10)

 

Other

 

12

 

Total change

 

$

(66)

 

 

Bell’s segment profit decreased $66 million, 10%, in 2013, respectively, compared with 2012, primarily due to unfavorable performance as described above.  Segment profit was also impacted by an unfavorable mix of commercial aircraft deliveries.

 

Bell Backlog

Backlog decreased $926 million, 14%, at Bell during 2014, primarily due to V-22 aircraft deliveries, in excess of orders.  In 2013, Bell’s backlog decreased $1.0 billion, 14%, primarily due to deliveries on the V-22 and H-1 programs that exceeded orders.

 

Textron Systems

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2014

2013

2012 

2014

2013

Revenues

 

$

1,624

$

1,665

$

1,737 

(2)%

(4)%

Operating expenses

 

1,474

1,518

1,605 

(3)%

(5)%

Segment profit

 

150

147

132 

2%

11%

Profit margin

 

9.2%

8.8%

7.6% 

 

 

Backlog

 

$

2,790

$

2,803

$

2,919 

(4)%

 

Textron Systems Revenues and Operating Expenses

Factors contributing to the 2014 year-over-year revenue change are provided below:

 

(In millions)

 

2014 versus
2013

 

Volume

 

$

(106)

 

Acquisitions

 

62

 

Other

 

3

 

Total change

 

$

(41)

 

 

Revenues at Textron Systems decreased $41 million, 2%, in 2014, compared with 2013, primarily due to lower volume in the Marine and Land Systems product line of $233 million, reflecting fewer vehicle deliveries, partially offset by higher volume in the Unmanned Systems product line of $130 million and a $62 million impact largely related to the acquisition of two flight simulation and training businesses in December 2013.

 

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Table of Contents

 

Textron Systems’ operating expenses decreased $44 million, 3%, in 2014, compared with 2013, primarily due to lower volume as described above, as well as the impact of a $15 million charge recorded in 2013 related to the fee-for-service program described below.  Operating expenses also included the impact of costs related to acquisitions.

 

Factors contributing to the 2013 year-over-year revenue change are provided below:

 

(In millions)

 

2013 versus
2012

 

Volume

 

$

(76

)

Other

 

4

 

Total change

 

$

(72

)

 

Revenues at Textron Systems decreased $72 million, 4%, in 2013, compared with 2012, primarily due to lower volume in the Marine and Land product line of $51 million and in the Unmanned Systems product line of $28 million.

 

Textron Systems’ operating expenses decreased $87 million, 5%, in 2013, compared with 2012, primarily due to improved performance reflecting the favorable impact of lower profit adjustments,  including $22 million in lower fee-for-service program charges discussed below, along with cost reduction initiatives across most product lines.  Operating expenses were also impacted by lower volume as described above.

 

In 2013 and 2012, we recorded $15 million and $37 million, respectively, in unfavorable program profit adjustments related to start-up and engine performance issues for Unmanned System’s fee-for-service program. As a result of the engine performance issues, during the third quarter of 2013 we transitioned the manufacture of the engines to our Lycoming business, which has resulted in improved performance.

 

Textron Systems Segment Profit

Factors contributing to 2014 year-over-year segment profit change are provided below:

 

(In millions)

 

2014 versus
2013

 

Performance

 

$

22

 

Volume

 

(12

)

Other

 

(7

)

Total change

 

$

3

 

 

Segment profit at Textron Systems increased $3 million, 2%, in 2014, compared with 2013, primarily driven by $22 million of improved performance, partially offset by $12 million from lower volume as described above.  Performance primarily reflects the impact of unfavorable profit adjustments in 2013, including a $15 million charge related to the fee-for-service program described above.

 

Factors contributing to 2013 year-over-year segment profit change are provided below:

 

(In millions)

 

2013 versus
2012

 

Performance

 

$

58

 

Volume and mix

 

(33

)

Other

 

(10

)

Total change

 

$

15

 

 

Segment profit at Textron Systems increased $15 million, 11% in 2013 compared with 2012, largely due to improved performance reflecting the favorable impact of lower profit adjustments, including $22 million in lower fee-for-service program charges, along with cost reduction initiatives across most product lines. This improved performance was partially offset by lower volume as described above.

 

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Table of Contents

 

Industrial

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2014

2013

2012

2014

2013

Revenues:

 

 

 

 

 

 

Fuel Systems and Functional Components

 

$

1,975

$

1,853

$

1,842

7%

1%

Other Industrial

 

1,363

1,159

1,058

18%

10%

Total revenues

 

3,338

3,012

2,900

11%

4%

Operating expenses

 

3,058

2,770

2,685

10%

3%

Segment profit

 

280

242

215

16%

13%

Profit margin

 

8.4%

8.0%

7.4% 

 

 

 

Industrial Revenues and Operating Expenses

Factors contributing to the 2014 year-over-year revenue change are provided below:

 

(In millions)

 

2014 versus
2013

 

Volume

 

$

181

 

Acquisitions

 

142

 

Other

 

3

 

Total change

 

$

326

 

 

Industrial segment revenues increased $326 million, 11%, in 2014, compared with 2013, primarily due to higher volume of $181 million and the impact from acquisitions of $142 million, primarily within our Specialized Vehicles and Equipment product line.  Higher volume resulted from a $142 million increase in the Fuel Systems and Functional Components product line, principally reflecting automotive industry demand in North America and Europe, and a $39 million increase in the Other Industrial product lines.

 

Operating expenses for the Industrial segment increased $288 million, 10%, in 2014, compared with 2013, largely due to the impact from higher volume as described above and additional operating expenses from recently acquired businesses.

 

Factors contributing to the 2013 year-over-year revenue change are provided below:

 

(In millions)

 

2013 versus
2012

 

Volume

 

$

58

 

Acquisitions

 

46

 

Other

 

8

 

Total change

 

$

112

 

 

Industrial segment revenues increased $112 million, 4%, in 2013, compared with 2012, largely due to higher volume of $58 million and the impact from acquisitions of $46 million within our Tools and Test Equipment product line.  Higher volume resulted from a $32 million increase in the Other Industrial product lines, mostly due to higher market demand in the Specialized Vehicles and Equipment product line, and a $26 million increase in the Fuel Systems and Functional Components line, reflecting higher automotive industry demand in North America.

 

Operating expenses for the Industrial segment increased $85 million, 3%, in 2013, compared with 2012, largely due to higher volume and a $43 million impact from acquisitions. Operating expenses were also impacted by improved performance of $27 million associated with the Fuel Systems and Functional Components product line, which was partially offset by $16 million of inflation in this product line, reflecting higher compensation and material costs.

 

Industrial Segment Profit

Factors contributing to 2014 year-over-year segment profit change are provided below:

 

(In millions)

 

2014 versus
2013

 

Volume and mix

 

$

20

 

Performance

 

15

 

Other

 

3

 

Total change

 

$

38

 

 

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Table of Contents

 

Segment profit for the Industrial segment increased $38 million, 16%, in 2014, compared with 2013, largely due to the impact from higher volume as described above. Profit was also impacted by improved performance of $15 million, primarily driven by the Fuel Systems and Functional Components product line.

 

Factors contributing to 2013 year-over-year segment profit change are provided below:

 

 

 

 

(In millions)

 

2013 versus
2012

 

Performance

 

$

39

 

Volume

 

9

 

Inflation, net of pricing

 

(22

)

Other

 

1

 

Total change

 

$

27

 

 

Segment profit for the Industrial segment increased $27 million, 13%, in 2013, compared with 2012, primarily due to improved performance of which $27 million was associated with the Fuel Systems and Functional Components product line. The $22 million unfavorable impact from inflation, net of pricing, was primarily in the Fuel Systems and Functional Components product line, reflecting higher compensation and material costs.

 

Finance

 

 

 

 

 

 

 

 

(In millions)

 

2014

 

2013

 

2012

 

Revenues

 

$

103

 

$

132

 

$

215

 

Segment profit

 

21

 

49

 

64

 

 

Finance Revenues

Finance segment revenues decreased $29 million in 2014, compared with 2013, primarily attributable to a $31 million impact from gains on the disposition of finance receivables held for sale during 2013. These gains resulted from the payoff of loans in amounts, and sale of loans at prices, in excess of the values established in previous periods.

 

Finance segment revenues decreased $83 million in 2013, compared with 2012, primarily attributable to an unfavorable impact of $46 million, attributable to lower average finance receivables of $834 million.  Revenues during 2013 were also lower by $25 million due to the resolution of a Timeshare account that returned to accrual status in 2012.

 

Finance Segment Profit

Finance segment profit decreased $28 million in 2014, compared with 2013, primarily due to a change in provision for loan losses of $29 million, largely reflecting reserve reversals in 2013 primarily related to the non-captive business, and the impact from gains on finance receivables held for sale described above.  These decreases in segment profit were partially offset by lower administrative expense of $19 million in 2014, primarily associated with the exit of the non-captive business.

 

Finance segment profit decreased $15 million in 2013, compared with 2012, primarily resulting from the resolution of a Timeshare account in 2012 as described above, as well as an unfavorable impact of $25 million in net interest margin from lower average finance receivables.  These decreases were partially offset by lower administrative expenses of $26 million and lower provision for loan losses of $20 million, largely related to the downsizing of the non-captive business.

 

Finance Portfolio Quality

The following table reflects information about the Finance segment’s credit performance related to finance receivables.

 

 

 

 

 

 

(Dollars in millions)

 

January 3,
2015

 

December 28,
2013

 

Finance receivables

 

$

1,254

 

$

1,483

 

Nonaccrual finance receivables

 

81

 

105

 

Ratio of nonaccrual finance receivables to finance receivables

 

6.46

%

7.08

%

60+ days contractual delinquency

 

$

57

 

$

80

 

60+ days contractual delinquency as a percentage of finance receivables

 

4.55

%

5.39

%

 

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Table of Contents

 

Liquidity and Capital Resources

 

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 Textron Aviation, Bell, Textron Systems and Industrial segments.  The Finance group, which also is the Finance segment, consists of Textron Financial Corporation 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.

 

Key information that is utilized in assessing our liquidity is summarized below:

 

 

 

 

 

(Dollars in millions)

January 3,
2015

December 28,
2013

Manufacturing group

 

 

 

 

Cash and equivalents

$

731

$

1,163

Debt

 

2,811

 

1,931

Shareholders’ equity

 

4,272

 

4,384

Capital (debt plus shareholders’ equity)

 

7,083

 

6,315

Net debt (net of cash and equivalents) to capital

 

33%

 

15%

Debt to capital

 

40%

 

31%

Finance group

 

 

 

 

Cash and equivalents

$

91

$

48

Debt

 

1,063

 

1,256

 

We believe that our calculations of debt to capital and net debt to capital are useful measures as they provide a summary indication of the level of debt financing (i.e., leverage) that is in place to support our capital structure, as well as to provide an indication of the capacity to add further leverage.  We believe that we will have sufficient cash to meet our future needs, based on our existing cash balances, the cash we expect to generate from our manufacturing operations and other available funding alternatives, as appropriate.

 

Textron has a senior unsecured revolving credit facility that expires in October 2018 for an aggregate principal amount of $1.0 billion, of which up to $100 million is available for the issuance of letters of credit.  At January 3, 2015, there were no amounts borrowed against the facility, and there were $35 million of letters of credits issued against it.

 

We maintain an effective shelf registration statement filed with the Securities and Exchange Commission that authorizes us to issue an unlimited amount of public debt and other securities.  Under this shelf registration statement, in January 2014, we issued $250 million of 3.65% notes due 2021 and $350 million of 4.30% notes due 2024. We also entered into a five-year term loan agreement with a syndicate of banks in the principal amount of $500 million. 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 notes issued, to finance a portion of the acquisition. The balance of the Beechcraft acquisition purchase price was paid from cash on hand.  During the third quarter of 2014, we repaid $200 million of the five-year term loan. Also under the shelf registration statement, in November 2014, we issued $350 million of 3.875% notes due 2025. Subsequently, prior to year-end, we prepaid $350 million of 6.2% notes which were due in March 2015.

 

Manufacturing Group Cash Flows

Cash flows from continuing operations for the Manufacturing group as presented in our Consolidated Statement of Cash Flows are summarized below:

 

 

 

 

 

 

 

 

(In millions)

 

2014

 

2013

 

2012

 

Operating activities

 

$

1,097

 

$

658

 

$

958

 

Investing activities

 

(2,065

)

(624

)

(476

)

Financing activities

 

552

 

(240

)

29

 

 

Cash flows from operating activities increased $439 million during 2014, compared with 2013, largely due to a favorable change in working capital, higher income from continuing operations of $120 million and lower contributions of $118 million to our pension plans, partially offset by $175 million of dividends received from the Finance group in 2013.  Working capital was

 

29



Table of Contents

 

favorably impacted by an increase of $226 million in customer deposits, primarily at Textron Aviation, and a $174 million increase in cash from accounts receivable, largely at Bell, partially offset by an increase in net tax payments of $43 million. Net tax payments were $266 million and $223 million in 2014 and 2013, respectively.

 

We generated $658 million in cash from operating activities in 2013 on $914 million in Manufacturing group segment profit and $470 million of income from continuing operations. The $300 million decrease in cash flows from operating activities from 2012 was largely due to a $429 million impact related to working capital requirements and $64 million in lower income from continuing operations, which were partially offset by $211 million in lower contributions to our pension plans in 2013.  The most significant change within working capital was a $230 million unfavorable impact resulting from net tax payments of $223 million in 2013, compared to net tax refunds of $7 million in 2012.  In addition, we had $165 million in cash inflows related to changes in inventory levels, largely at Textron Aviation, which was more than offset by $264 million of cash outflows from changes in accounts receivable and accounts payable.  The change in inventory levels at Textron Aviation was primarily related to lower pre-owned inventory, partially offset by higher inventory in support of new sales.

 

Pension contributions were $76 million, $194 million and $405 million in 2014, 2013 and 2012, respectively.

 

In 2014, cash flows from investing activities included a $1.6 billion aggregate cash payment for Beechcraft and seven other acquisitions within our Industrial and Textron Systems segments. Cash flows from investing activities in 2013 included $196 million of cash used for acquisitions of businesses within our Industrial and Textron Systems segments and two service centers in our Textron Aviation segment. Cash flows from investing activities also included capital expenditures of $429 million, $444 million and $480 million in 2014, 2013 and 2012, respectively.

 

Cash flows from financing activities in 2014 included proceeds from long-term debt of $1.4 billion, most of which was used to finance a portion of the Beechcraft acquisition, partially offset by the repayment of $559 million of outstanding debt. In 2013, cash flows used in financing activities primarily consisted of the repayment of $528 million of outstanding debt, including the settlement of our convertible notes, which was partially offset by proceeds from long-term debt of $150 million.  In 2012, we generated cash from financing activities, largely due to the receipt of $490 million from the Finance group in payment of its intergroup borrowing, partially offset by $272 million in share repurchases and $189 million in payments on our outstanding debt.

 

Dividends

Dividend payments to shareholders totaled $28 million, $22 million and $17 million in 2014, 2013 and 2012, respectively.

 

Share Repurchases

During 2014, under a 2013 share repurchase authorization, we repurchased an aggregate of 8.9 million shares of our outstanding common stock for $340 million.  In 2012, under a 2007 share repurchase authorization, we repurchased 11.1 million shares of our outstanding common stock for $272 million.

 

Capital Contributions Paid To and Dividends Received From the Finance Group

Under a Support Agreement between Textron and TFC, Textron is required to maintain a controlling interest in TFC.  The agreement also requires Textron to ensure that TFC maintains fixed charge coverage of no less than 125% and consolidated shareholder’s equity of no less than $200 million. Cash contributions paid to TFC to maintain compliance with the Support Agreement and dividends paid by TFC to Textron Inc. are detailed below:

 

 

 

 

 

 

 

 

(In millions)

 

2014

 

2013

 

2012

 

Dividends paid by TFC to Textron

 

$

 

$

175

 

$

345

 

Capital contributions paid to TFC under Support Agreement

 

 

 

(240

)

 

Due to the nature of these contributions, we classify these contributions within cash flows used by operating activities for the Manufacturing group in the Consolidated Statements of Cash Flows.  Capital contributions to support Finance group growth in the ongoing captive finance business are classified as cash flows from financing activities. The Finance group’s net income is excluded from the Manufacturing group’s cash flows, while dividends from the Finance group are included within cash flows from operating activities for the Manufacturing group as they represent a return on investment.

 

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Table of Contents

 

Finance Group Cash Flows

The cash flows from continuing operations for the Finance group are summarized below:

 

 

 

 

 

 

 

 

(In millions)

 

2014

 

2013

 

2012

 

Operating activities

 

$

5

 

$

66

 

$

5

 

Investing activities

 

255

 

624

 

934

 

Financing activities

 

(217

)

(677

)

(918

)

 

In 2014 and 2013, the Finance group’s cash flows from operating activities were primarily impacted by changes in net taxes paid/received. Net tax (payments)/receipts were $(23) million, $49 million and $(43) million in 2014, 2013 and 2012, respectively.

 

Cash flows from investing activities primarily included finance receivables repaid and proceeds from sales of receivables and other finance assets totaling $499 million, $853 million and $1.3 billion in 2014, 2013 and 2012, respectively, partially offset by financial receivable originations of $215 million, $271 million and $331 million, respectively.

 

Cash used in financing activities included payments on long-term and nonrecourse debt of $345 million, $743 million and $426 million in 2014, 2013 and 2012, respectively, which were partially offset by proceeds from long-term debt of $128 million, $298 million and $106 million, respectively. In 2013 and 2012, dividend payments to the Manufacturing group, net of capital contributions received, totaled $174 million and $105 million, respectively. In 2012, the Finance group also made cash payments of $493 million to the Manufacturing group related to intergroup borrowings.

 

Consolidated Cash Flows

The consolidated cash flows from continuing operations, after elimination of activity between the borrowing groups, are summarized below:

 

 

 

 

 

 

 

 

(In millions)

 

2014

 

2013

 

2012

 

Operating activities

 

$

1,211

 

$

813

 

$

935

 

Investing activities

 

(1,919

)

(264

)

378

 

Financing activities

 

335

 

(742

)

(781

)

 

Cash flows from operating activities increased $398 million during 2014, compared with 2013, largely due to a favorable change in working capital, lower contributions of $118 million to our pension plans and higher income from continuing operations of $107 million. Working capital was favorably impacted by an increase of $226 million in customer deposits, primarily at Textron Aviation, and a $174 million increase in cash from accounts receivable, largely at Bell, partially offset by an increase in net tax payments of $115 million and lower net cash receipts from captive finance receivables of $87 million. Net tax payments were $289 million and $174 million in 2014 and 2013, respectively.

 

During 2013, cash flows from operating activities decreased $122 million, compared with 2012, largely due to a $133 million impact related to working capital requirements and lower earnings, which were partially offset by a $206 million impact of lower contributions to our pension plans in 2013. Significant changes within working capital included a $138 million unfavorable impact resulting from net taxes paid between the periods as net tax payments were $174 million and $36 million in 2013 and 2012, respectively, and $264 million of cash outflows related to changes in accounts receivable and accounts payable. These cash outflows were partially offset by $198 million of cash inflows related to changes in inventory levels, largely at Textron Aviation, and a $141 million impact from lower captive finance receivables.

 

In 2014, cash flows from investing activities included a $1.6 billion aggregate cash payment for Beechcraft and seven other acquisitions within our Industrial and Textron Systems segments. Cash flows from investing activities in 2013 included $196 million of cash used for acquisitions of businesses within our Industrial and Textron Systems segments and two service centers in our Textron Aviation segment. Cash flows from investing activities also included capital expenditures of $429 million, $444 million and $480 million in 2014, 2013 and 2012, respectively. Collections on finance receivables and proceeds from sales of finance receivables and other finance assets totaled $134 million, $368 million, and $848 million in 2014, 2013 and 2012.

 

Cash flows from financing activities in 2014 included proceeds of $1.6 billion from long-term debt, most of which was used to finance a portion of the Beechcraft acquisition, partially offset by the repayment of $904 million of outstanding debt.  In 2013 and 2012, financing activities primarily consisted of the repayment of outstanding long-term debt of $1.3 billion and $617 million, respectively, partially offset by proceeds from the issuance of long-term debt of $448 million and $106 million, respectively.  Cash used in financing activities also included $340 million and $272 million of share repurchases in 2014 and 2012, respectively.

 

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Captive Financing and Other Intercompany Transactions

The Finance group finances retail purchases and leases for new and pre-owned aircraft and equipment manufactured by our Manufacturing group, otherwise known as captive financing.  In the Consolidated Statements of Cash Flows, cash received from customers or from the sale of receivables is reflected as operating activities when received from third parties.  However, in the cash flow information provided for the separate borrowing groups, cash flows related to captive financing activities are reflected based on the operations of each group.  For example, when product is sold by our Manufacturing group to a customer and is financed by the Finance group, the origination of the finance receivable is recorded within investing activities as a cash outflow in the Finance group’s statement of cash flows.  Meanwhile, in the Manufacturing group’s statement of cash flows, the cash received from the Finance group on the customer’s behalf is recorded within operating cash flows as a cash inflow.  Although cash is transferred between the two borrowing groups, there is no cash transaction reported in the consolidated cash flows at the time of the original financing.  These captive financing activities, along with all significant intercompany transactions, are reclassified or eliminated from the Consolidated Statements of Cash Flows.

 

Reclassification and elimination adjustments included in the Consolidated Statement of Cash Flows are summarized below:

 

(In millions)

 

2014

 

2013

 

2012

 

Reclassifications from investing activities:

 

 

 

 

 

 

 

Finance receivable originations for Manufacturing group inventory sales

 

$

(215

)

$

(248

)

$

(309

)

Cash received from customers and the sale of receivables

 

365

 

485

 

405

 

Other

 

(41

)

27

 

(16

)

Total reclassifications from investing activities

 

109

 

264

 

80

 

Reclassifications from financing activities:

 

 

 

 

 

 

 

Capital contributions paid by Manufacturing group to Finance group

 

 

1

 

240

 

Dividends received by Manufacturing group from Finance group

 

 

(175

)

(345

)

Other

 

 

(1

)

(3

)

Total reclassifications from financing activities

 

 

(175

)

(108

)

Total reclassifications and adjustments to cash flow from operating activities

 

$

109

 

$

89

 

$

(28

)

 

Contractual Obligations

 

Manufacturing Group

The following table summarizes the known contractual obligations, as defined by reporting regulations, of our Manufacturing group as of January 3, 2015:

 

 

 

 

 

Payments Due by Period

 

(In millions)

 

Total

 

Year 1

 

Years 2-3

 

Years 4-5

 

More Than 5
Years

 

Liabilities reflected in balance sheet:

 

 

 

 

 

 

 

 

 

 

 

Long-term debt

 

$

2,816

 

$

8

 

$

766

 

$

562

 

$

1,480

 

Interest on borrowings

 

747

 

128

 

242

 

176

 

201

 

Pension benefits for unfunded plans

 

392

 

26

 

49

 

46

 

271

 

Postretirement benefits other than pensions

 

413

 

45

 

79

 

65

 

224

 

Other long-term liabilities

 

650

 

121

 

194

 

76

 

259

 

Liabilities not reflected in balance sheet:

 

 

 

 

 

 

 

 

 

 

 

Purchase obligations

 

3,370

 

2,651

 

677

 

28

 

14

 

Operating leases

 

438

 

73

 

104

 

68

 

193

 

Total Manufacturing group

 

$

8,826

 

$

3,052

 

$

2,111

 

$

1,021

 

$

2,642

 

 

Pension and Postretirement Benefits

We maintain defined benefit pension plans and postretirement benefit plans other than pensions as discussed in Note 11 to the Consolidated Financial Statements.  Included in the above table are discounted estimated benefit payments we expect to make related to unfunded pension and other postretirement benefit plans. Actual benefit payments are dependent on a number of factors, including mortality assumptions, expected retirement age, rate of compensation increases and medical trend rates, which are subject to change in future years. Our policy for funding pension plans is to make contributions annually, consistent with applicable laws and regulations; however, future contributions to our pension plans are not included in the above table.  In 2015, we expect to make approximately $54 million of contributions to our funded pension plans and the Retirement Account Plan. Based on our current assumptions, which may change with changes in market conditions, our current contribution estimates for each of the years from 2016 through 2019 are estimated to be in the range of approximately $65 million to $155 million under the plan provisions in place at this time.

 

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Other Long-Term Liabilities

Other long-term liabilities included in the table consist primarily of undiscounted amounts in the Consolidated Balance Sheet as of January 3, 2015, representing obligations under deferred compensation arrangements and estimated environmental remediation costs. Payments under deferred compensation arrangements have been estimated based on management’s assumptions of expected retirement age, mortality, stock price and rates of return on participant deferrals.  The timing of cash flows associated with environmental remediation costs is largely based on historical experience. Other long-term liabilities, such as deferred taxes, unrecognized tax benefits and product liability, warranty and litigation reserves, have been excluded from the table due to the uncertainty of the timing of payments combined with the absence of historical trends to be used as a predictor for such payments.

 

Purchase Obligations

Purchase obligations include undiscounted amounts committed under legally enforceable contracts or purchase orders for goods and services with defined terms as to price, quantity and delivery dates. Approximately 33% of the purchase obligations we disclose represent purchase orders issued for goods and services to be delivered under firm contracts with the U.S. Government for which we have full recourse under customary contract termination clauses.

 

Finance Group

The following table summarizes the known contractual obligations, as defined by reporting regulations, of our Finance group as of January 3, 2015:

 

 

 

 

 

Payments Due by Period

 

(In millions)

 

Total

 

Year 1

 

Years 2-3

 

Years 4-5

 

More Than 5
Years

 

Liabilities reflected in balance sheet:

 

 

 

 

 

 

 

 

 

 

 

Term debt

 

$

665

 

$

82

 

$

363

 

$

115

 

$

105

 

Subordinated debt

 

299

 

 

 

 

299

 

Securitized debt

 

98

 

46

 

35

 

9

 

8

 

Interest on borrowings

 

227

 

37

 

47

 

21

 

122

 

Total Finance group

 

$

1,289

 

$

165

 

$

445

 

$

145

 

$

534

 

 

Securitized debt payments do not represent contractual obligations of the Finance group, and we do not provide legal recourse to investors who purchase interests in the securitizations beyond the credit enhancement inherent in the retained subordinate interests.

 

At January 3, 2015, the Finance group also had $33 million in other liabilities that are payable within the next 12 months.

 

 

Critical Accounting Estimates

 

To prepare our Consolidated Financial Statements to be in conformity with generally accepted accounting principles, we must make complex and subjective judgments in the selection and application of accounting policies.  The accounting policies that we believe are most critical to the portrayal of our financial condition and results of operations are listed below.  We believe these policies require our most difficult, subjective and complex judgments in estimating the effect of inherent uncertainties.  This section should be read in conjunction with Note 1 to the Consolidated Financial Statements, which includes other significant accounting policies.

 

Long-Term Contracts

We make a substantial portion of our sales to government customers pursuant to long-term contracts.  These contracts require development and delivery of products over multiple years and may contain fixed-price purchase options for additional products.  We account for these long-term contracts under the percentage-of-completion method of accounting.  Under this method, we estimate profit as the difference between total estimated revenues and cost of a contract.  The percentage-of-completion method of accounting involves the use of various estimating techniques to project costs at completion and, in some cases, includes estimates of recoveries asserted against the customer for changes in specifications.  Due to the size, length of time and nature of many of our contracts, the estimation of total contract costs and revenues through completion is complicated and subject to many variables relative to the outcome of future events over a period of several years.  We are required to make numerous assumptions and estimates relating to items such as expected engineering requirements, complexity of design and related development costs, product performance, performance of subcontractors, availability and cost of materials, labor productivity and cost, overhead and capital costs, manufacturing efficiencies and the achievement of contract milestones, including product deliveries, technical requirements, or schedule.

 

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Our cost estimation process is based on the professional knowledge and experience of engineers and program managers along with finance professionals.  We update our projections of costs at least semiannually or when circumstances significantly change.  Adjustments to projected costs are recognized in earnings when determinable.  Anticipated losses on contracts are recognized in full in the period in which the losses become probable and estimable.  Due to the significance of judgment in the estimation process described above, it is likely that materially different revenues and/or cost of sales amounts could be recorded if we used different assumptions or if the underlying circumstances were to change.  Our earnings could be reduced by a material amount resulting in a charge to earnings if (a) total estimated contract costs are significantly higher than expected due to changes in customer specifications prior to contract amendment, (b) total estimated contract costs are significantly higher than previously estimated due to cost overruns or inflation, (c) there is a change in engineering efforts required during the development stage of the contract or (d) we are unable to meet contract milestones.

 

At the outset of each contract, we estimate the initial profit booking rate. The initial profit booking rate of each contract considers risks surrounding the ability to achieve the technical requirements (for example, a newly-developed product versus a mature product), schedule (for example, the number and type of milestone events), and costs by contract requirements in the initial estimated costs at completion. Profit booking rates may increase during the performance of the contract if we successfully retire risks surrounding the technical, schedule, and costs aspects of the contract. Likewise, the profit booking rate may decrease if we are not successful in retiring the risks; and, as a result, our estimated costs at completion increase. All of the estimates are subject to change during the performance of the contract and, therefore, may affect the profit booking rate. When adjustments are required, any changes from prior estimates are recognized using the cumulative catch-up method with the impact of the change from inception-to-date recorded in the current period.

 

The following table sets forth the aggregate gross amount of all program profit adjustments that are included within segment profit for the three years ended January 3, 2015:

 

(In millions)

 

2014

 

2013

 

2012

 

Gross favorable

 

$

 132

 

$

 51

 

$

 88

 

Gross unfavorable

 

(37

)

(22

)

(73

)

Net adjustments

 

$

 95

 

$

 29

 

$

 15

 

 

Goodwill

We evaluate the recoverability of goodwill annually in the fourth quarter or more frequently if events or changes in circumstances, such as declines in sales, earnings or cash flows, or material adverse changes in the business climate, indicate that the carrying value of a reporting unit might be impaired.  The reporting unit represents the operating segment unless discrete financial information is prepared and reviewed by segment management for businesses one level below that operating segment, in which case such component is the reporting unit.  In certain instances, we have aggregated components of an operating segment into a single reporting unit based on similar economic characteristics.

 

We calculate the fair value of each reporting unit, primarily using discounted cash flows. These cash flows incorporate assumptions for short- and long-term revenue growth rates, operating margins and discount rates that represent our best estimates of current and forecasted market conditions, cost structure, anticipated net cost reductions, and the implied rate of return that we believe a market participant would require for an investment in a business having similar risks and business characteristics to the reporting unit being assessed.  The revenue growth rates and operating margins used in our discounted cash flow analysis are based on our strategic plans and long-range planning forecasts.  The long-term growth rate we use to determine the terminal value of the business is based on our assessment of its minimum expected terminal growth rate, as well as its past historical growth and broader economic considerations such as gross domestic product, inflation and the maturity of the markets we serve.  We utilize a weighted-average cost of capital in our impairment analysis that makes assumptions about the capital structure that we believe a market participant would make and include a risk premium based on an assessment of risks related to the projected cash flows of each reporting unit.  We believe this approach yields a discount rate that is consistent with an implied rate of return that an independent investor or market participant would require for an investment in a company having similar risks and business characteristics to the reporting unit being assessed.

 

If the reporting unit’s estimated fair value exceeds its carrying value, the reporting unit is not impaired, and no further analysis is performed.  Otherwise, the amount of the impairment must be determined by comparing the carrying amount of the reporting unit’s goodwill to the implied fair value of that goodwill.  The implied fair value of goodwill is determined by assigning a fair value to all of the reporting unit’s assets and liabilities, including any unrecognized intangible assets, as if the reporting unit had been acquired in a business combination.  If the carrying amount of the goodwill exceeds the implied fair value, an impairment loss would be recognized in an amount equal to that excess.

 

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Based on our annual impairment review, the fair value of all of our reporting units exceeded their carrying values, and we do not believe that there is a reasonable possibility that any units might fail the initial step of the impairment test in the foreseeable future.

 

Retirement Benefits

We maintain various pension and postretirement plans for our employees globally.  These plans include significant pension and postretirement benefit obligations, which are calculated based on actuarial valuations.  Key assumptions used in determining these obligations and related expenses include expected long-term rates of return on plan assets, discount rates and healthcare cost projections.  We also make assumptions regarding employee demographic factors such as retirement patterns, mortality, turnover and rate of compensation increases.  We evaluate and update these assumptions annually.

 

To determine the weighted-average expected long-term rate of return on plan assets, we consider the current and expected asset allocation, as well as historical and expected returns on each plan asset class.  A lower expected rate of return on plan assets will increase pension expense.  For 2014, the assumed expected long-term rate of return on plan assets used in calculating pension expense was 7.60%, compared with 7.56% in 2013.  For the last three years, the assumed rate of return for our domestic plans, which represent approximately 90% of our total pension assets, was 7.75%.  A 50-basis-point decrease in this long-term rate of return in 2014 would have increased pension expense for our domestic plans by approximately $27 million.

 

The discount rate enables us to state expected future benefit payments as a present value on the measurement date, reflecting the current rate at which the pension liabilities could be effectively settled.  This rate should be in line with rates for high-quality fixed income investments available for the period to maturity of the pension benefits, which fluctuate as long-term interest rates change.  A lower discount rate increases the present value of the benefit obligations and increases pension expense.  In 2014, the weighted-average discount rate used in calculating pension expense was 4.92%, compared with 4.23% in 2013.  For our domestic plans, the assumed discount rate was 5.00% in 2014, compared with 4.25% for 2013.  A 50-basis-point decrease in this discount rate in 2014 would have increased pension expense for our domestic plans by approximately $29 million.

 

The trend in healthcare costs is difficult to estimate, and it has an important effect on postretirement liabilities.  The 2014 medical and prescription drug healthcare cost trend rates represent the weighted-average annual projected rate of increase in the per capita cost of covered benefits.  In 2014, we assumed a trend rate of 6.60% for both medical and prescription drug healthcare rates and assumed this rate would decrease to 5.00% by 2021 and then remain at that level.  See Note 11 to the Consolidated Financial Statements for the impact of a one-percentage-point change in the cost trend rate.

 

Warranty and Product Maintenance Liabilities

We provide limited warranty and product maintenance programs, including parts and labor, for certain products for periods ranging from one to five years. A significant portion of these liabilities arises from our commercial aircraft businesses.  We also may incur costs related to product recalls.  We estimate the costs that may be incurred under warranty programs and record a liability in the amount of such costs at the time product revenue is recognized.  Factors that affect this liability include the number of products sold, historical costs per claim, contractual recoveries from vendors, and historical and anticipated rates of warranty claims, including production and warranty patterns for new models.  During our initial aircraft model launches, we typically incur higher warranty-related costs until the production process matures, at which point warranty costs moderate.  We assess the adequacy of our recorded warranty and product maintenance liabilities periodically and adjust the amounts as necessary.  Adjustments are made to accruals as claim data and actual experience warrant.  Should future warranty experience differ materially from our historical experience, we may be required to record additional warranty liabilities, which could have a material adverse effect on our results of operations and cash flows in the period in which these additional liabilities are required.

 

Income Taxes

Deferred income tax balances reflect the effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and their tax bases, as well as from net operating losses and tax credit carryforwards, and are stated at enacted tax rates in effect for the year taxes are expected to be paid or recovered.  Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years.  We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including the future reversal of existing taxable temporary differences, taxable income in carryback years, available tax planning strategies and estimated future taxable income.

 

The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which may result in proposed assessments.  Our estimate of the potential outcome for any uncertain tax issue is highly judgmental.  We assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date.  For those tax positions for which it is more likely than not that a tax benefit will be sustained, we record the largest amount of tax benefit with a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information.  Interest and penalties are accrued, where

 

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applicable.  We recognize net tax-related interest and penalties for continuing operations in income tax expense.  If we do not believe that it is more likely than not that a tax benefit will be sustained, no tax benefit is recognized.  However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities due to settlement of income tax examinations, new regulatory or judicial pronouncements, or other relevant events.  As a result, our effective tax rate may fluctuate significantly on a quarterly and annual basis.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Foreign Currency Exchange Risks

Our financial results are affected by changes in foreign currency exchange rates in the various countries in which our products are manufactured and/or sold.  For our manufacturing operations, we manage exposures to foreign currency assets and earnings primarily by funding certain foreign currency-denominated assets with liabilities in the same currency so that certain exposures are naturally offset.  We primarily use borrowings denominated in British pound sterling for these purposes.  In managing our foreign currency transaction exposures, we also enter into foreign currency exchange contracts.  These contracts generally are used to fix the local currency cost of purchased goods or services or selling prices denominated in currencies other than the functional currency.  The notional amount of outstanding foreign currency exchange contracts was approximately $696 million and $636 million at the end of 2014 and 2013, respectively. The impact of foreign currency exchange rate changes on revenues and segment profit for 2014 and 2013 from the prior year was not significant.

 

Interest Rate Risks

Our financial results are affected by changes in interest rates.  As part of managing this risk, we seek to achieve a prudent balance between floating- and fixed-rate exposures.  We continually monitor our mix of these exposures and adjust the mix, as necessary.  For our Finance group, we limit our risk to changes in interest rates with a strategy of matching floating-rate assets with floating-rate liabilities.

 

Quantitative Risk Measures

In the normal course of business, we enter into financial instruments for purposes other than trading.  To quantify the market risk inherent in our financial instruments, we utilize a sensitivity analysis.  The financial instruments that are subject to market risk (interest rate risk and foreign exchange rate risk) include finance receivables (excluding leases), debt (excluding lease obligations) and foreign currency exchange contracts.

 

Presented below is a sensitivity analysis of the fair value of financial instruments outstanding at year-end.  We estimate the fair value of the financial instruments using discounted cash flow analysis and indicative market pricing as reported by leading financial news and data providers.  This sensitivity analysis is most likely not indicative of actual results in the future. The following table illustrates the sensitivity to a hypothetical change in the fair value of the financial instruments assuming a 10% decrease in interest rates and a 10% strengthening in exchange rates against the U.S. dollar.

 

 

 

2014

 

 

2013

 

(In millions)

 

Carrying
Value*

 

Fair
Value*

Sensitivity of
Fair Value

to a 10%
Change

 

 

Carrying
Value*

 

Fair
Value*

Sensitivity of
Fair Value

to a 10%
Change

 

Manufacturing group

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange rate risk

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt

 

$