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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

 

Form 10-Q

 

 

 

 

 

(Mark One)

[ X ]

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

 

 

 

For the quarterly period ended October 1, 2016

 

 

 

OR

 

 

[    ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to           .

 

Commission File Number 1-5480

 

 

Textron Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

05-0315468

(State or other jurisdiction of incorporation or organization)

 

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

 

40 Westminster Street, Providence, RI

 

02903

(Address of principal executive offices)

 

(Zip code)

 

(401) 421-2800

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes   ü  No____

 

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

 

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

 

Large accelerated filer [  ü ]

Accelerated filer [ ___ ]

Non-accelerated filer [ ___ ]

Smaller reporting company [ ___ ]

 

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

 

As of October 14, 2016, there were 270,208,112 shares of common stock outstanding.

 



Table of Contents

 

TEXTRON INC.

Index to Form 10-Q

For the Quarterly Period Ended October 1, 2016

 

 

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

Consolidated Statements of Operations (Unaudited)

3

 

Consolidated Statements of Comprehensive Income (Unaudited)

4

 

Consolidated Balance Sheets (Unaudited)

5

 

Consolidated Statements of Cash Flows (Unaudited)

6

 

Notes to the Consolidated Financial Statements (Unaudited)

 

 

Note 1.

Basis of Presentation

8

 

Note 2.

Business Acquisitions

9

 

Note 3.

Special Charges

9

 

Note 4.

Retirement Plans

10

 

Note 5.

Earnings Per Share

10

 

Note 6.

Accounts Receivable and Finance Receivables

11

 

Note 7.

Inventories

13

 

Note 8.

Warranty Liability

13

 

Note 9.

Debt

13

 

Note 10.

Derivative Instruments and Fair Value Measurements

14

 

Note 11.

Accumulated Other Comprehensive Loss and Other Comprehensive Income

15

 

Note 12.

Commitments and Contingencies

16

 

Note 13.

Income Taxes

16

 

Note 14.

Segment Information

16

 

 

 

Item 2.

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

17

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

28

Item 4.

Controls and Procedures

28

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

28

Item 5.

Other Information

28

Item 6.

Exhibits

29

 

Signatures

29

 

2



Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  FINANCIAL STATEMENTS

 

TEXTRON INC.

Consolidated Statements of Operations (Unaudited)

 

 

 

Three Months Ended

Nine Months Ended

(In millions, except per share amounts)

 

October 1,
2016

 

October 3,
2015

 

October 1,
2016

 

October 3,
2015

Revenues

 

 

 

 

 

 

 

 

Manufacturing revenues

$

3,231

$

3,163

$

9,903

$

9,437

Finance revenues

 

20

 

17

 

60

 

63

Total revenues

 

3,251

 

3,180

 

9,963

 

9,500

Costs, expenses and other

 

 

 

 

 

 

 

 

Cost of sales

 

2,661

 

2,584

 

8,185

 

7,728

Selling and administrative expense

 

323

 

303

 

949

 

969

Interest expense

 

45

 

41

 

132

 

126

Special charges

 

115

 

 

115

 

Total costs, expenses and other

 

3,144

 

2,928

 

9,381

 

8,823

Income from continuing operations before income taxes

 

107

 

252

 

582

 

677

Income tax benefit (expense)

 

192

 

(76)

 

46

 

(204)

Income from continuing operations

 

299

 

176

 

628

 

473

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

 

122

 

 

120

 

(2)

Net income

$

421

$

176

$

748

$

471

Basic earnings per share

 

 

 

 

 

 

 

 

Continuing operations

$

1.11

$

0.64

$

2.32

$

1.71

Discontinued operations

 

0.45

 

 

0.44

 

(0.01)

Basic earnings per share

$

1.56

$

0.64

$

2.76

$

1.70

Diluted earnings per share

 

 

 

 

 

 

 

 

Continuing operations

$

1.10

$

0.63

$

2.31

$

1.69

Discontinued operations

 

0.45

 

 

0.44

 

(0.01)

Diluted earnings per share

$

1.55

$

0.63

$

2.75

$

1.68

Dividends per share

 

 

 

 

 

 

 

 

Common stock

$

0.02

$

0.02

$

0.06

$

0.06

 

*Income from discontinued operations, net of income taxes for the three and nine months ended October 1, 2016 primarily includes the settlement of a U.S. federal income tax audit.  See Note 13 for additional information.

 

See Notes to the Consolidated Financial Statements.

 

3



Table of Contents

 

TEXTRON INC.

Consolidated Statements of Comprehensive Income (Unaudited)

 

 

 

Three Months Ended

Nine Months Ended

(In millions)

 

October 1,
2016

 

October 3,
2015

 

October 1,
2016

 

October 3,
2015

Net income

$

421

$

176

$

748

$

471

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

Pension and postretirement benefits adjustments, net of reclassifications

 

16

 

22

 

52

 

133

Deferred gains (losses) on hedge contracts, net of reclassifications

 

(2)

 

(1)

 

23

 

(9)

Foreign currency translation adjustments

 

4

 

1

 

8

 

(45)

Other comprehensive income

 

18

 

22

 

83

 

79

Comprehensive income

$

439

$

198

$

831

$

550

 

See Notes to the Consolidated Financial Statements.

 

4



Table of Contents

 

TEXTRON INC.

Consolidated Balance Sheets (Unaudited)

 

(Dollars in millions)

 

 

 

 

 

October 1,
2016

 

January 2,
2016

Assets

 

 

 

 

 

 

 

 

Manufacturing group

 

 

 

 

 

 

 

 

Cash and equivalents

 

 

 

 

$

589

$

946

Accounts receivable, net

 

 

 

 

 

1,139

 

1,047

Inventories

 

 

 

 

 

4,791

 

4,144

Other current assets

 

 

 

 

 

348

 

341

Total current assets

 

 

 

 

 

6,867

 

6,478

Property, plant and equipment, less accumulated
depreciation and amortization of $4,107 and $3,915

 

 

 

 

 

2,568

 

2,492

Goodwill

 

 

 

 

 

2,121

 

2,023

Other assets

 

 

 

 

 

2,318

 

2,399

Total Manufacturing group assets

 

 

 

 

 

13,874

 

13,392

Finance group

 

 

 

 

 

 

 

 

Cash and equivalents

 

 

 

 

 

150

 

59

Finance receivables, net

 

 

 

 

 

969

 

1,087

Other assets

 

 

 

 

 

174

 

170

Total Finance group assets

 

 

 

 

 

1,293

 

1,316

Total assets

 

 

 

 

$

15,167

$

14,708

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

Manufacturing group

 

 

 

 

 

 

 

 

Short-term debt and current portion of long-term debt

 

 

 

 

$

126

$

262

Accounts payable

 

 

 

 

 

1,216

 

1,063

Accrued liabilities

 

 

 

 

 

2,278

 

2,467

Total current liabilities

 

 

 

 

 

3,620

 

3,792

Other liabilities

 

 

 

 

 

1,987

 

2,376

Long-term debt

 

 

 

 

 

2,777

 

2,435

Total Manufacturing group liabilities

 

 

 

 

 

8,384

 

8,603

Finance group

 

 

 

 

 

 

 

 

Other liabilities

 

 

 

 

 

213

 

228

Debt

 

 

 

 

 

919

 

913

Total Finance group liabilities

 

 

 

 

 

1,132

 

1,141

Total liabilities

 

 

 

 

 

9,516

 

9,744

Shareholders’ equity

 

 

 

 

 

 

 

 

Common stock

 

 

 

 

 

36

 

36

Capital surplus

 

 

 

 

 

1,674

 

1,587

Treasury stock

 

 

 

 

 

(774)

 

(559)

Retained earnings

 

 

 

 

 

6,030

 

5,298

Accumulated other comprehensive loss

 

 

 

 

 

(1,315)

 

(1,398)

Total shareholders’ equity

 

 

 

 

 

5,651

 

4,964

Total liabilities and shareholders’ equity

 

 

 

 

$

15,167

$

14,708

Common shares outstanding (in thousands)

 

 

 

 

 

270,134

 

274,228

 

See Notes to the Consolidated Financial Statements.

 

5



Table of Contents

 

TEXTRON INC.

Consolidated Statements of Cash Flows (Unaudited)

For the Nine Months Ended October 1, 2016 and October 3, 2015, respectively

 

 

 

 

 

 

Consolidated

(In millions)

 

 

 

 

 

2016

 

2015

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net income

 

 

 

 

$

748

$

471

Less: Income (loss) from discontinued operations

 

 

 

 

 

120

 

(2)

Income from continuing operations

 

 

 

 

 

628

 

473

Adjustments to reconcile income from continuing operations
to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Non-cash items:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

 

 

 

331

 

332

Asset impairments

 

 

 

 

 

36

 

Deferred income taxes

 

 

 

 

 

30

 

(11)

Other, net

 

 

 

 

 

76

 

78

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

 

 

 

 

(92)

 

(122)

Inventories

 

 

 

 

 

(637)

 

(654)

Other assets

 

 

 

 

 

56

 

6

Accounts payable

 

 

 

 

 

146

 

156

Accrued and other liabilities

 

 

 

 

 

(290)

 

(18)

Income taxes, net

 

 

 

 

 

(216)

 

64

Pension, net

 

 

 

 

 

21

 

61

Captive finance receivables, net

 

 

 

 

 

54

 

58

Other operating activities, net

 

 

 

 

 

2

 

(4)

Net cash provided by operating activities of continuing operations

 

 

 

 

 

145

 

419

Net cash used in operating activities of discontinued operations

 

 

 

 

 

(2)

 

(4)

Net cash provided by operating activities

 

 

 

 

 

143

 

415

Cash flows from investing activities

 

 

 

 

 

 

 

 

Capital expenditures

 

 

 

 

 

(306)

 

(286)

Net cash used in acquisitions

 

 

 

 

 

(179)

 

(81)

Finance receivables repaid

 

 

 

 

 

40

 

66

Other investing activities, net

 

 

 

 

 

53

 

31

Net cash used in investing activities

 

 

 

 

 

(392)

 

(270)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from long-term debt

 

 

 

 

 

520

 

55

Increase in short-term debt

 

 

 

 

 

110

 

Principal payments on long-term debt and nonrecourse debt

 

 

 

 

 

(433)

 

(196)

Purchases of Textron common stock

 

 

 

 

 

(215)

 

(211)

Dividends paid

 

 

 

 

 

(16)

 

(17)

Other financing activities, net

 

 

 

 

 

20

 

25

Net cash used in financing activities

 

 

 

 

 

(14)

 

(344)

Effect of exchange rate changes on cash and equivalents

 

 

 

 

 

(3)

 

(9)

Net decrease in cash and equivalents

 

 

 

 

 

(266)

 

(208)

Cash and equivalents at beginning of period

 

 

 

 

 

1,005

 

822

Cash and equivalents at end of period

 

 

 

 

$

739

$

614

 

See Notes to the Consolidated Financial Statements.

 

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Table of Contents

 

TEXTRON INC.

Consolidated Statements of Cash Flows (Unaudited) (Continued)

For the Nine Months Ended October 1, 2016 and October 3, 2015, respectively

 

 

Manufacturing Group

Finance Group

(In millions)

 

2016

 

2015

 

2016

 

2015

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net income

$

733

$

458

$

15

$

13

Less: Income (loss) from discontinued operations

 

120

 

(2)

 

 

Income from continuing operations

 

613

 

460

 

15

 

13

Adjustments to reconcile income from continuing operations
to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Non-cash items:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

322

 

324

 

9

 

8

Asset impairments

 

36

 

 

 

Deferred income taxes

 

35

 

(3)

 

(5)

 

(8)

Other, net

 

74

 

74

 

2

 

4

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

(92)

 

(122)

 

 

Inventories

 

(639)

 

(661)

 

 

Other assets

 

85

 

(6)

 

(3)

 

12

Accounts payable

 

146

 

156

 

 

Accrued and other liabilities

 

(283)

 

(10)

 

(7)

 

(8)

Income taxes, net

 

(212)

 

58

 

(4)

 

6

Pension, net

 

21

 

61

 

 

Dividends received from Finance group

 

29

 

20

 

 

Other operating activities, net

 

2

 

(4)

 

 

Net cash provided by operating activities of continuing operations

 

137

 

347

 

7

 

27

Net cash used in operating activities of discontinued operations

 

(2)

 

(4)

 

 

Net cash provided by operating activities

 

135

 

343

 

7

 

27

Cash flows from investing activities

 

 

 

 

 

 

 

 

Capital expenditures

 

(306)

 

(286)

 

 

Net cash used in acquisitions

 

(179)

 

(81)

 

 

Finance receivables repaid

 

 

 

220

 

269

Finance receivables originated

 

 

 

(126)

 

(145)

Other investing activities, net

 

5

 

2

 

24

 

36

Net cash provided by (used in) investing activities

 

(480)

 

(365)

 

118

 

160

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from long-term debt

 

345

 

 

175

 

55

Increase in short-term debt

 

110

 

 

 

Principal payments on long-term debt and nonrecourse debt

 

(253)

 

 

(180)

 

(196)

Purchases of Textron common stock

 

(215)

 

(211)

 

 

Dividends paid

 

(16)

 

(17)

 

(29)

 

(20)

Other financing activities, net

 

20

 

25

 

 

Net cash used in financing activities

 

(9)

 

(203)

 

(34)

 

(161)

Effect of exchange rate changes on cash and equivalents

 

(3)

 

(9)

 

 

Net increase (decrease) in cash and equivalents

 

(357)

 

(234)

 

91

 

26

Cash and equivalents at beginning of period

 

946

 

731

 

59

 

91

Cash and equivalents at end of period

$

589

$

497

$

150

$

117

 

See Notes to the Consolidated Financial Statements.

 

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Table of Contents

 

TEXTRON INC.

Notes to the Consolidated Financial Statements (Unaudited)

 

 

Note 1.  Basis of Presentation

 

Our Consolidated Financial Statements include the accounts of Textron Inc. (Textron) and its majority-owned subsidiaries.  We have prepared these unaudited consolidated financial statements in accordance with accounting principles generally accepted in the U.S. for interim financial information.  Accordingly, these interim financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements.  The consolidated interim financial statements included in this quarterly report should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended January 2, 2016.  In the opinion of management, the interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for the fair presentation of our consolidated financial position, results of operations and cash flows for the interim periods presented.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

 

Our financings are conducted through two separate borrowing groups.  The Manufacturing group consists of Textron consolidated with its majority-owned subsidiaries that operate in the 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.  All significant intercompany transactions are eliminated from the Consolidated Financial Statements, including retail financing activities for inventory sold by our Manufacturing group and financed by our Finance group.

 

Use of Estimates

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

 

During 2016 and 2015, we changed our estimates of revenues and costs on certain long-term contracts that are accounted for under the percentage-of-completion method of accounting.  These changes in estimates increased income from continuing operations before income taxes in the third quarter of 2016 and 2015 by $18 million and $14 million, respectively, ($11 million and $9 million after tax, or $0.04 and $0.03 per diluted share, respectively).  For the third quarter of 2016 and 2015, the gross favorable program profit adjustments totaled $21 million and $20 million, respectively, and the gross unfavorable program profit adjustments totaled $3 million and $6 million, respectively.

 

The changes in estimates increased income from continuing operations before income taxes in the first nine months of 2016 and 2015 by $57 million and $68 million, respectively, ($36 million and $43 million after tax, or $0.13 and $0.15 per diluted share, respectively).  For the first nine months of 2016 and 2015, the gross favorable program profit adjustments totaled $74 million and $93 million, respectively, and the gross unfavorable program profit adjustments totaled $17 million and $25 million, respectively.

 

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, that outlines a comprehensive five-step revenue recognition model based on the principle that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In July 2015, the FASB approved a one-year deferral of the effective date of the standard to the beginning of 2018 for public companies, with an option that would permit companies to adopt the standard as early as the original effective date of 2017.  The new standard may be adopted either retrospectively or on a modified retrospective basis whereby it would be applied to new contracts and existing contracts with remaining performance obligations as of the effective date, with a cumulative catch-up adjustment recorded to beginning retained earnings at the effective date for those contracts.  We are currently evaluating the impacts of adoption on our consolidated financial position, results of operations and related disclosures, along with the implementation approach to be used.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases, that requires all leases with a term greater than 12 months be recognized on the balance sheet, while lease expenses would continue to be recognized in the statement of operations in a manner similar to current accounting guidance.  The new standard is effective for our company at the beginning of fiscal 2019 and early

 

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adoption is permitted.  Entities must adopt the standard on a modified retrospective basis whereby it would be applied at the beginning of the earliest comparative year.  We are currently evaluating the impact of adoption on our consolidated financial statements.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses. For most financial assets, such as trade and other receivables, loans and other instruments, this standard changes the current incurred loss model to a forward-looking expected credit loss model, which generally will result in the earlier recognition of allowances for losses.  The new standard is effective for our company at the beginning of fiscal 2020 with early adoption permitted beginning in fiscal 2019.  Entities are required to apply the provisions of the standard through a cumulative-effect adjustment to retained earnings as of the effective date.  We are currently evaluating the impact of adoption on our consolidated financial statements.

 

Note 2.  Business Acquisitions

 

In the first nine months of 2016, we paid $179 million in cash and assumed debt of $19 million to acquire five businesses, net of cash acquired and holdbacks.  Our acquisition of Able Engineering and Component Services, Inc. and Able Aerospace, Inc. (Able) in the first quarter represented the largest of these businesses and is included in the Textron Aviation segment.  Able is an industry-leading repair and overhaul business that provides component repairs, component exchanges and replacement parts, among other support and service offerings for commercial rotorcraft and fixed-wing aircraft customers around the world.  We are in the process of allocating the purchase price and valuing the acquired assets and liabilities for these acquisitions.  Based on the preliminary allocation of the aggregate purchase price for these acquisitions, $97 million has been allocated to goodwill, related to expected synergies and the value of the existing workforce, and $62 million to intangible assets.  Of the recorded goodwill, approximately $43 million is deductible for tax purposes.  The intangible assets are primarily related to customer relationships and technologies, which will be amortized over 10 to 18 years.  The operating results of these acquisitions have been included in the Consolidated Statements of Operations since their respective closing dates.

 

Note 3.  Special Charges

 

Special charges recorded in the third quarter of 2016 are as follows:

 

(In millions)

 

Severance
Costs

Asset
Impairments

Contract
Terminations
and Other

 

Total

Textron Systems

$

13

$

33

$

13

$

59

Textron Aviation

 

34

 

1

 

 

35

Industrial

 

11

 

2

 

 

13

Bell

 

8

 

 

 

8

 

$

66

$

36

$

13

$

115

 

Our Board of Directors approved a plan in the third quarter of 2016 to restructure and realign our businesses by implementing headcount reductions, facility consolidations and other actions in order to improve overall operating efficiency across Textron.  The plan provides for Textron Systems to discontinue production of its sensor-fuzed weapon product, which will generate headcount reductions, facility consolidations and asset impairments within its Weapons and Sensors operating unit. Historically, sensor-fuzed weapon sales have relied on foreign military and direct commercial international customers for which both executive branch and congressional approval is required. The current political environment has made it difficult to obtain these approvals. Within our Industrial segment, the plan provides for the combination of our Jacobsen business with the Textron Specialized Vehicles businesses, resulting in the consolidation of certain facilities and general and administrative functions and related headcount reductions.  As a result of ongoing evaluations, we subsequently decided to take additional restructuring actions, principally headcount reductions, in our Textron Aviation segment, as well as other businesses.  The total headcount reduction related to restructuring activities is expected to be approximately 1,700 positions, representing approximately 5% of our workforce.

 

We expect to incur additional pre-tax charges under this plan of approximately $25 million to $55 million, primarily related to contract termination, severance, facility consolidation and relocation costs. The remaining charges are expected to primarily be in the Industrial and Textron Systems segments.  We anticipate the plan to be substantially completed by March 2017.

 

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An analysis of our restructuring reserve activity under this plan is summarized below:

 

(In millions)

 

 

Severance
Costs

Contract
Terminations
and Other

 

Total

Provision

 

 

$

66

$

13

$

79

Cash paid

 

 

 

(2)

 

 

(2)

End of period

 

 

$

64

$

13

$

77

 

Total expected cash outlays for restructuring activities are estimated to be in the range of $100 million to $120 million, approximately half of which is expected to be expended in 2016 and the remainder in 2017.  Severance costs generally are paid on a lump-sum basis and include outplacement costs, which are paid in accordance with normal payment terms.

 

Note 4.  Retirement Plans

 

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

 

 

Three Months Ended

Nine Months Ended

(In millions)

 

October 1,
2016

 

October 3,
2015

 

October 1,
2016

 

October 3,
2015

Pension Benefits

 

 

 

 

 

 

 

 

Service cost

$

25

$

27

$

74

$

86

Interest cost

 

84

 

82

 

254

 

245

Expected return on plan assets

 

(123)

 

(121)

 

(368)

 

(363)

Amortization of prior service cost

 

4

 

4

 

11

 

12

Amortization of net actuarial loss

 

26

 

35

 

78

 

113

Curtailment and other charges

 

 

 

 

6

Net periodic benefit cost

$

16

$

27

$

49

$

99

Postretirement Benefits Other Than Pensions

 

 

 

 

 

 

 

 

Service cost

$

1

$

1

$

2

$

3

Interest cost

 

4

 

4

 

12

 

12

Amortization of prior service credit

 

(6)

 

(6)

 

(17)

 

(18)

Amortization of net actuarial loss

 

 

1

 

 

1

Net periodic benefit credit

$

(1)

$

$

(3)

$

(2)

 

Note 5.  Earnings Per Share

 

We calculate basic and diluted earnings per share (EPS) based on net income, which approximates income available to common shareholders for each period. Basic EPS is calculated using the two-class method, which includes the weighted-average number of common shares outstanding during the period and restricted stock units to be paid in stock that are deemed participating securities as they provide nonforfeitable rights to dividends. Diluted EPS considers the dilutive effect of all potential future common stock, including stock options.

 

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

 

 

Three Months Ended

Nine Months Ended

(In thousands)

 

October 1,
2016

 

October 3,
2015

 

October 1,
2016

 

October 3,
2015

Basic weighted-average shares outstanding

 

270,560

 

276,334

 

270,703

 

277,317

Dilutive effect of stock options

 

1,539

 

1,705

 

1,348

 

2,083

Diluted weighted-average shares outstanding

 

272,099

 

278,039

 

272,051

 

279,400

 

Stock options to purchase 4 million shares of common stock are excluded from the calculation of diluted weighted average shares outstanding for both the three and nine months ended October 1, 2016, as their effect would have been anti-dilutive. Stock options to purchase 4 million and 2 million shares of common stock are excluded from the calculation of diluted weighted average shares outstanding for the three and nine months ended October 3, 2015, respectively, as their effect would have been anti-dilutive.

 

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Note 6.  Accounts Receivable and Finance Receivables

 

Accounts Receivable

Accounts receivable is composed of the following:

 

(In millions)

 

 

 

 

 

October 1,
2016

 

January 2,
2016

Commercial

 

 

 

 

$

915

$

841

U.S. Government contracts

 

 

 

 

 

255

 

239

 

 

 

 

 

 

1,170

 

1,080

Allowance for doubtful accounts

 

 

 

 

 

(31)

 

(33)

Total

 

 

 

 

$

1,139

$

1,047

 

We have unbillable receivables, primarily on U.S. Government contracts, that arise when the revenues we have appropriately recognized based on performance cannot be billed yet under terms of the contract.  Unbillable receivables within accounts receivable totaled $179 million at October 1, 2016 and $135 million at January 2, 2016.

 

Finance Receivables

Finance receivables are presented in the following table:

 

(In millions)

 

 

 

 

 

October 1,
2016

 

January 2,
2016

Finance receivables*

 

 

 

 

$

1,013

$

1,135

Allowance for losses

 

 

 

 

 

(44)

 

(48)

Total finance receivables, net

 

 

 

 

$

969

$

1,087

 

 

* Includes finance receivables held for sale of $30 million at both October 1, 2016 and January 2, 2016.

 

Credit Quality Indicators and Nonaccrual Finance Receivables

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

 

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

 

Delinquency

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

 

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Finance receivables categorized based on the credit quality indicators and by the delinquency aging category are summarized as follows:

 

(In millions)

 

 

 

 

 

October 1,
2016

 

January 2,
2016

Performing

 

 

 

 

$

807

$

891

Watchlist

 

 

 

 

 

86

 

130

Nonaccrual

 

 

 

 

 

90

 

84

Nonaccrual as a percentage of finance receivables

 

 

 

 

 

9.16%

 

7.60%

Less than 31 days past due

 

 

 

 

$

817

$

950

31-60 days past due

 

 

 

 

 

81

 

86

61-90 days past due

 

 

 

 

 

45

 

42

Over 90 days past due

 

 

 

 

 

40

 

27

60 + days contractual delinquency as a percentage of finance receivables

 

 

 

 

8.65%

 

6.24%

 

Impaired Loans

On a quarterly basis, we evaluate individual finance receivables for impairment in non-homogeneous portfolios and larger balance accounts in homogeneous loan portfolios.  A finance receivable is considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement based on our review of the credit quality indicators described above.  Impaired finance receivables include both nonaccrual accounts and accounts for which full collection of principal and interest remains probable, but the account’s original terms have been, or are expected to be, significantly modified.  If the modification specifies an interest rate equal to or greater than a market rate for a finance receivable with comparable risk, the account is not considered impaired in years subsequent to the modification.  Interest income recognized on impaired loans was not significant in the first nine months of 2016 or 2015.

 

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

 

(In millions)

 

 

 

 

 

October 1,
2016

 

January 2,
2016

Recorded investment:

 

 

 

 

 

 

 

 

Impaired loans with related allowance for losses

 

 

 

 

$

 54

$

 62

Impaired loans with no related allowance for losses

 

 

 

 

 

45

 

42

Total

 

 

 

 

$

 99

$

 104

Unpaid principal balance

 

 

 

 

$

 104

$

 113

Allowance for losses on impaired loans

 

 

 

 

 

13

 

17

Average recorded investment

 

 

 

 

 

96

 

102

 

A summary of the allowance for losses on finance receivables, based on how the underlying finance receivables are evaluated for impairment, is provided below.  The finance receivables reported in this table specifically exclude leveraged leases in accordance with U.S. generally accepted accounting principles.

 

(In millions)

 

 

 

 

 

October 1,
2016

 

January 2,
2016

Allowance based on collective evaluation

 

 

 

 

$

 31

$

 31

Allowance based on individual evaluation

 

 

 

 

 

13

 

17

Finance receivables evaluated collectively

 

 

 

 

$

 786

$

 883

Finance receivables evaluated individually

 

 

 

 

 

99

 

104

 

Allowance for Losses

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

 

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individual account, critical factors included in this analysis include industry valuation guides, age and physical condition of the collateral, payment history and existence and financial strength of guarantors.

 

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

 

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

 

 

 

 

 

 

Nine Months Ended

(In millions)

 

 

 

 

 

October 1,
2016

 

October 3,
2015

Beginning of period

 

 

 

 

$

 48

$

 51

Provision for losses

 

 

 

 

 

(1)

 

(4)

Charge-offs

 

 

 

 

 

(11)

 

(8)

Recoveries

 

 

 

 

 

8

 

10

End of period

 

 

 

 

$

 44

$

 49

 

Note 7.  Inventories

 

Inventories are composed of the following:

 

(In millions)

 

 

 

 

 

October 1,
2016

 

January 2,
2016

Finished goods

 

 

 

 

$

 2,076

$

 1,735

Work in process

 

 

 

 

 

2,958

 

2,921

Raw materials and components

 

 

 

 

 

701

 

605

 

 

 

 

 

 

5,735

 

5,261

Progress/milestone payments

 

 

 

 

 

(944)

 

(1,117)

Total

 

 

 

 

$

 4,791

$

 4,144

 

Note 8.  Warranty Liability

 

Changes in our warranty liability are as follows:

 

 

 

 

 

 

Nine Months Ended

(In millions)

 

 

 

 

 

October 1,
2016

 

October 3,
2015

Beginning of period

 

 

 

 

$

143

$

148

Provision

 

 

 

 

 

58

 

47

Settlements

 

 

 

 

 

(59)

 

(52)

Adjustments*

 

 

 

 

 

(10)

 

(3)

End of period

 

 

 

 

$

132

$

140

 

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

 

Note 9.  Debt

 

On September 30, 2016, Textron entered into a senior unsecured revolving credit facility for an aggregate principal amount of $1.0 billion, of which up to $100 million is available for the issuance of letters of credit. This facility expires in September 2021 and replaced the existing 5-year facility, which had no outstanding borrowings, and was scheduled to expire in October 2018.  At October 1, 2016, there were no amounts borrowed against the new facility.

 

Under our shelf registration statement, on March 11, 2016, we issued $350 million of fixed-rate notes due March 15, 2026 that bear an annual interest rate of 4.0%.  The net proceeds of the issuance totaled $345 million, after deducting underwriting discounts, commissions and offering expenses.

 

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Note 10.  Derivative Instruments and Fair Value Measurements

 

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

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

We manufacture and sell our products in a number of countries throughout the world, and, therefore, we are exposed to movements in foreign currency exchange rates.  We primarily utilize foreign currency exchange contracts with maturities of no more than three years to manage this volatility.  These contracts qualify as cash flow hedges and are intended to offset the effect of exchange rate fluctuations on forecasted sales, inventory purchases and overhead expenses. Net gains and losses recognized in earnings and Accumulated other comprehensive loss on cash flow hedges, including gains and losses related to hedge ineffectiveness, were not significant in the periods presented.

 

Our foreign currency exchange contracts are measured at fair value using the market method valuation technique.  The inputs to this technique utilize current foreign currency exchange forward market rates published by third-party leading financial news and data providers.  These are observable data that represent the rates that the financial institution uses for contracts entered into at that date; however, they are not based on actual transactions so they are classified as Level 2. At October 1, 2016 and January 2, 2016, we had foreign currency exchange contracts with notional amounts upon which the contracts were based of $687 million and $706 million, respectively.  At October 1, 2016, the fair value amounts of our foreign currency exchange contracts were a $5 million asset and an $11 million liability. At January 2, 2016, the fair value amounts of our foreign currency exchange contracts were a $7 million asset and a $28 million liability.

 

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

 

Assets Recorded at Fair Value on a Nonrecurring Basis

During the periods ended October 1, 2016 and January 2, 2016, the Finance group’s impaired nonaccrual finance receivables of $41 million and $45 million, respectively, were measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3).  Impaired nonaccrual finance receivables represent assets recorded at fair value on a nonrecurring basis since the measurement of required reserves on our impaired finance receivables is significantly dependent on the fair value of the underlying collateral.  For impaired nonaccrual finance receivables secured by aviation assets, the fair values of collateral are determined primarily based on the use of industry pricing guides.  Fair value measurements recorded on impaired finance receivables were not significant for both the three and nine months ended October 1, 2016 and October 3, 2015.

 

Assets and Liabilities Not Recorded at Fair Value

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

 

 

October 1, 2016

January 2, 2016

(In millions)

 

Carrying
Value

Estimated
Fair Value

 

Carrying
Value

Estimated
Fair Value

Manufacturing group

 

 

 

 

 

 

 

 

Long-term debt, excluding leases

$

(2,701)

$

(2,905)

$

(2,628)

$

(2,744)

Finance group

 

 

 

 

 

 

 

 

Finance receivables, excluding leases

 

757

 

778

 

863

 

820

Debt

 

(919)

 

(851)

 

(913)

 

(840)

 

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Fair value for the Manufacturing group debt is determined using market observable data for similar transactions (Level 2).  At both October 1, 2016 and January 2, 2016, approximately 75% of the fair value of term debt for the Finance group was determined based on discounted cash flow analyses using observable market inputs from debt with similar duration, subordination and credit default expectations (Level 2).  Fair value estimates for finance receivables were determined based on internally developed discounted cash flow models primarily utilizing significant unobservable inputs (Level 3), which include estimates of the rate of return, financing cost, capital structure and/or discount rate expectations of current market participants combined with estimated loan cash flows based on credit losses, payment rates and expectations of borrowers’ ability to make payments on a timely basis.

 

Note 11.  Accumulated Other Comprehensive Loss and Other Comprehensive Income

 

The components of Accumulated Other Comprehensive Loss are presented below:

 

(In millions)

Pension and
Postretirement
Benefits
Adjustments

Deferred
Gains (Losses)
on Hedge
Contracts

Foreign
Currency
Translation
Adjustments

Accumulated
Other
Comprehensive
Loss

For the nine months ended October 1, 2016

 

 

 

 

 

 

 

 

Beginning of the period

$

(1,327)

$

(24)

$

(47)

$

(1,398)

Other comprehensive income before reclassifications

 

5

 

11

 

8

 

24

Reclassified from Accumulated other comprehensive loss

 

47

 

12

 

 

59

Other comprehensive income

 

52

 

23

 

8

 

83

End of the period

$

(1,275)

$

(1)

$

(39)

$

(1,315)

For the nine months ended October 3, 2015

 

 

 

 

 

 

 

 

Beginning of the period

$

(1,511)

$

(13)

$

18

$

(1,506)

Other comprehensive income (loss) before reclassifications

 

62

 

(22)

 

(45)

 

(5)

Reclassified from Accumulated other comprehensive loss

 

71

 

13

 

 

84

Other comprehensive income (loss)

 

133

 

(9)

 

(45)

 

79

End of the period

$

(1,378)

$

(22)

$

(27)

$

(1,427)

 

The before and after-tax components of other comprehensive income are presented below:

 

 

October 1, 2016

October 3, 2015

(In millions)

Pre-Tax
Amount

Tax
(Expense)
Benefit

After-Tax
Amount

Pre-Tax
Amount

Tax
(Expense)
Benefit

After-Tax
Amount

Three Months Ended

 

 

 

 

 

 

 

 

 

 

 

 

Pension and postretirement benefits adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of net actuarial loss*

$

26

$

(9)

$

17

$

36

$

(12)

$

24

Amortization of prior service credit

 

(2)

 

1

 

(1)

 

(2)

 

 

(2)

Pension and postretirement benefits adjustments, net

 

24

 

(8)

 

16

 

34

 

(12)

 

22

Deferred losses on hedge contracts:

 

 

 

 

 

 

 

 

 

 

 

 

Current deferrals

 

(3)

 

 

(3)

 

(10)

 

2

 

(8)

Reclassification adjustments

 

1

 

 

1

 

9

 

(2)

 

7

Deferred losses on hedge contracts, net

 

(2)

 

 

(2)

 

(1)

 

 

(1)

Foreign currency translation adjustments

 

13

 

(9)

 

4

 

4

 

(3)

 

1

Total

$

35

$

(17)

$

18

$

37

$

(15)

$

22

Nine Months Ended

 

 

 

 

 

 

 

 

 

 

 

 

Pension and postretirement benefits adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of net actuarial loss*

$

78

$

(28)

$

50

$

114

$

(40)

$

74

Amortization of prior service credit*

 

(6)

 

3

 

(3)

 

(4)

 

1

 

(3)

Unrealized gains

 

7

 

(2)

 

5

 

98

 

(36)

 

62

Pension and postretirement benefits adjustments, net

 

79

 

(27)

 

52

 

208

 

(75)

 

133

Deferred gains (losses) on hedge contracts:

 

 

 

 

 

 

 

 

 

 

 

 

Current deferrals

 

17

 

(6)

 

11

 

(28)

 

6

 

(22)

Reclassification adjustments

 

16

 

(4)

 

12

 

18

 

(5)

 

13

Deferred gains (losses) on hedge contracts, net

 

33

 

(10)

 

23

 

(10)

 

1

 

(9)

Foreign currency translation adjustments

 

24

 

(16)

 

8

 

(39)

 

(6)

 

(45)

Total

$

136

$

(53)

$

83

$

159

$

(80)

$

79

 

*These components of other comprehensive income are included in the computation of net periodic pension cost.  See Note 11 of our 2015 Annual Report on Form 10-K for additional information.

 

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Note 12.  Commitments and Contingencies

 

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

 

Note 13.  Income Taxes

 

We recognized an income tax benefit of $192 million in the third quarter of 2016 and $46 million in the first nine months of 2016, largely related to a settlement with the U.S. Internal Revenue Service Office of Appeals for our 1998 to 2008 tax years, which resulted in a $206 million benefit recognized in continuing operations.  We also recognized a $113 million benefit in discontinued operations related to the settlement.  U.S. federal income tax audits have now been settled for all years prior to 2009. Our reserve for unrecognized tax benefits and accrued interest decreased to $183 million and $6 million, respectively, at October 1, 2016, primarily due to the settlement.

 

In addition to the benefit of $206 million noted above, the effective tax rate for the third quarter of 2016 was favorably impacted by $9 million in higher qualified research and development expenses and $7 million from a change in the mix of our earnings from U.S. to non-U.S., which includes jurisdictions with lower tax rates than the U.S. federal statutory rate. Our U.S. earnings declined primarily due to the impact of restructuring activities as discussed in Note 3.

 

Note 14.  Segment Information

 

We operate in, and report financial information for, the following five business segments: Textron Aviation, Bell, Textron Systems, Industrial and Finance. Segment profit is an important measure used for evaluating performance and for decision-making purposes. Segment profit for the manufacturing segments excludes interest expense, certain corporate expenses and special charges.  The measurement for the Finance segment includes interest income and expense.

 

Our revenues by segment, along with a reconciliation of segment profit to income from continuing operations before income taxes, are as follows:

 

 

Three Months Ended

Nine Months Ended

(In millions)

 

October 1,
2016

 

October 3,
2015

 

October 1,
2016

 

October 3,
2015

Revenues

 

 

 

 

 

 

 

 

  Textron Aviation

$

1,198

$

1,159

$

3,485

$

3,334

  Bell

 

734

 

756

 

2,352

 

2,419

  Textron Systems

 

413

 

420

 

1,224

 

1,057

  Industrial

 

886

 

828

 

2,842

 

2,627

  Finance

 

20

 

17

 

60

 

63

Total revenues

$

3,251

$

3,180

$

9,963

$

9,500

Segment Profit

 

 

 

 

 

 

 

 

  Textron Aviation

$

100

$

107

$

254

$

262

  Bell

 

97

 

99

 

260

 

276

  Textron Systems

 

44

 

39

 

133

 

88

  Industrial

 

66

 

61

 

256

 

229

  Finance

 

3

 

6

 

15

 

22

Segment profit

 

310

 

312

 

918

 

877

Corporate expenses and other, net

 

(53)

 

(27)

 

(116)

 

(102)

Interest expense, net for Manufacturing group

 

(35)

 

(33)

 

(105)

 

(98)

Special charges

 

(115)

 

 

(115)

 

Income from continuing operations before income taxes

$

107

$

252

$

582

$

677

 

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

 

Consolidated Results of Operations

 

 

Three Months Ended

Nine Months Ended

(Dollars in millions)

October 1,
2016

October 3,
2015

 

%    
Change

October 1,
2016

October 3,
2015

 

%    
Change

Revenues

$

3,251

$

3,180

 

2%

$

9,963

$

9,500

 

5%

Operating expenses

 

2,984

 

2,887

 

3%

 

9,134

 

8,697

 

5%

Cost of sales

 

2,661

 

2,584

 

3%

 

8,185

 

7,728

 

6%

Selling and administrative expense

 

323

 

303

 

7%

 

949

 

969

 

(2)%

Gross margin percentage of Manufacturing revenues

 

17.6%

 

18.3%

 

 

 

17.3%

 

18.1%

 

 

 

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 19 to 23.

 

Revenues

 

Revenues increased $71 million, 2%, in the third quarter of 2016, compared with the third quarter of 2015, largely driven by increases in the Industrial and Textron Aviation segments, partially offset by lower revenues at the Bell and Textron Systems segments.  The net revenue increase included the following factors:

 

·                 Higher Industrial revenues of $58 million, primarily due to the impact from acquired businesses of $42 million and higher volume of $21 million, largely in the Fuel Systems and Functional Components product line.

·                 Higher Textron Aviation revenues of $39 million, primarily due to the impact from an acquired business of $18 million and higher volume and mix of $17 million, largely due to higher pre-owned aircraft volume.

·                 Lower Bell revenues of $22 million, primarily due to a decrease in commercial revenues of $108 million, largely reflecting lower aircraft deliveries. This decrease was partially offset by an increase in V-22 program revenues of $45 million, primarily reflecting higher aircraft deliveries, and an increase in other military revenues of $41 million, primarily reflecting higher H-1 program revenues.

·                 Lower Textron Systems revenues of $7 million, as higher volume of $25 million in the Marine and Land Systems product line and $19 million in the Simulation, Training and Other product line was more than offset by lower volume of $60 million in the Weapons and Sensors product line.

 

Revenues increased $463 million, 5%, in the first nine months of 2016, compared with the first nine months of 2015, largely driven by increases in the Industrial, Textron Systems and Textron Aviation segments, partially offset by lower revenues at the Bell segment.  The net revenue increase included the following factors:

 

·                 Higher Industrial revenues of $215 million, primarily due to higher volume of $132 million, largely in the Fuel Systems and Functional Components product line, and the impact from acquired businesses of $114 million.

·                 Higher Textron Systems revenues of $167 million, primarily due to higher volume of $81 million in the Unmanned Systems product line, $34 million in the Simulation, Training and Other product line and $27 million in the Marine and Land Systems product line.

·                 Higher Textron Aviation revenues of $151 million, primarily due to higher volume and mix of $101 million, largely the result of higher Citation jet volume of $153 million, partially offset by lower turboprop volume.

·                 Lower Bell revenues of $67 million, primarily due to a decrease in commercial revenues of $196 million, largely reflecting lower aircraft deliveries.  This decrease was partially offset by an increase in other military revenues of $86 million, primarily due to higher H-1 program revenues, and an increase in V-22 program revenues of $43 million, primarily reflecting higher aircraft deliveries.

 

Cost of Sales and Selling and Administrative Expense

Manufacturing cost of sales and selling and administrative expense together comprise our operating expenses. Cost of sales increased $77 million, 3%, in the third quarter of 2016, compared with the third quarter of 2015, largely due to an increase from acquired businesses and higher volume at the Textron Aviation and Industrial segments.  In the third quarter of 2016, the decrease in gross margin percentage was largely driven by an unfavorable impact from the mix of products sold at Textron Aviation.

 

Cost of sales increased $457 million, 6%, in the first nine months of 2016, compared with the first nine months of 2015, largely due to higher volume at the Textron Systems, Industrial and Textron Aviation segments, and an increase from acquired businesses.  In the first nine months of 2016, the decrease in gross margin percentage was largely driven by an unfavorable impact from the mix of products sold at Textron Aviation.

 

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Table of Contents

 

Selling and administrative expense increased $20 million, 7%, in the third quarter of 2016 and decreased $20 million, 2%, in the first nine months of 2016, compared with the corresponding periods of 2015.   The 7% increase in the third quarter of 2016 was largely due to higher share-based compensation expense.

 

Special Charges

Special charges recorded in the third quarter of 2016 are as follows:

 

(In millions)

 

Severance
Costs

Asset
Impairments

Contract
Terminations
and Other

 

Total

Textron Systems

$

 13

$

 33

$

 13

$

 59

Textron Aviation

 

34

 

1

 

 

35

Industrial

 

11

 

2

 

 

13

Bell

 

8

 

 

 

8

 

$

 66

$

 36

$

 13

$

 115

 

Our Board of Directors approved a plan in the third quarter of 2016 to restructure and realign our businesses by implementing headcount reductions, facility consolidations and other actions in order to improve overall operating efficiency across Textron.  The plan provides for Textron Systems to discontinue production of its sensor-fuzed weapon product, which will generate headcount reductions, facility consolidations and asset impairments within its Weapons and Sensors operating unit. Historically, sensor-fuzed weapon sales have relied on foreign military and direct commercial international customers for which both executive branch and congressional approval is required. The current political environment has made it difficult to obtain these approvals. Within our Industrial segment, the plan provides for the combination of our Jacobsen business with the Textron Specialized Vehicles businesses, resulting in the consolidation of certain facilities and general and administrative functions and related headcount reductions.  As a result of ongoing evaluations, we subsequently decided to take additional restructuring actions, principally headcount reductions, in our Textron Aviation segment, as well as other businesses.  The total headcount reduction related to restructuring activities is expected to be approximately 1,700 positions, representing approximately 5% of our workforce.

 

We expect to incur additional pre-tax charges under this plan of approximately $25 million to $55 million, primarily related to contract termination, severance, facility consolidation and relocation costs. The remaining charges are expected to primarily be in the Industrial and Textron Systems segments.  We anticipate the plan to be substantially completed by March 2017.  Expected cash outlays for these activities are estimated to be in the range of $100 million to $120 million, approximately half of which is expected to be expended in 2016 and the remainder in 2017.

 

Income Taxes

We recognized an income tax benefit of $192 million in the third quarter of 2016 and $46 million in the first nine months of 2016, largely related to a settlement with the U.S. Internal Revenue Service Office of Appeals for our 1998 to 2008 tax years, which resulted in a $206 million benefit recognized in continuing operations.  We also recognized a $113 million benefit in discontinued operations related to the settlement.  In addition to the benefit of $206 million, the effective tax rate for the third quarter of 2016 was favorably impacted by $9 million in higher qualified research and development expenses and $7 million from a change in the mix of our earnings from U.S. to non-U.S., which includes jurisdictions with lower tax rates than the U.S. federal statutory rate. Our U.S. earnings declined primarily due to the impact of restructuring activities as discussed above.

 

Backlog

 

(In millions)

 

 

 

 

 

October 1,
2016

 

January 2,
2016

Bell

 

 

 

 

$

 4,944

$

5,224

Textron Systems

 

 

 

 

 

2,208

 

2,328

Textron Aviation

 

 

 

 

 

1,114

 

1,074

Total backlog

 

 

 

 

$

 8,266

$

8,626

 

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Table of Contents

 

Segment Analysis

 

We operate in, and report financial information for, the following five business segments: Textron Aviation, Bell, Textron Systems, Industrial and Finance.  Segment profit is an important measure used for evaluating performance and for decision-making purposes.  Segment profit for the manufacturing segments excludes interest expense, certain corporate expenses and special charges. The measurement for the Finance segment includes interest income and expense.

 

In our discussion of comparative results for the Manufacturing group, changes in revenue 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 revenue 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.  Revenues generated by acquired businesses are reflected in Acquisitions for a twelve-month period.  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 24% of our 2015 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 described 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.

 

Textron Aviation

 

 

Three Months Ended

Nine Months Ended

(Dollars in millions)

 

October 1,
2016

 

October 3,
2015

 

October 1,
2016

 

October 3,
2015

Revenues

$

 1,198

$

 1,159

$

 3,485

$

 3,334

Operating expenses

 

1,098

 

1,052

 

3,231

 

3,072

Segment profit

 

100

 

107

 

254

 

262

Profit margin

 

8.3%

 

9.2%

 

7.3%

 

7.9%

 

Textron Aviation Revenues and Operating Expenses

The following factors contributed to the change in Textron Aviation’s revenues for the periods:

 

(In millions)

 

 

 

 

 

Q3 2016
versus
Q3 2015

 

YTD 2016
versus
YTD 2015

Volume and mix

 

 

 

 

$

 17

$

 101

Acquisitions

 

 

 

 

 

18

 

51

Other

 

 

 

 

 

4

 

(1)

Total change

 

 

 

 

$

 39

$

 151

 

In the third quarter of 2016, Textron Aviation’s revenues increased $39 million, 3%, compared with the third quarter of 2015, primarily due to the impact from an acquisition of a repair and overhaul business in the first quarter of 2016 and higher volume and mix of $17 million, largely due to higher pre-owned aircraft volume. We delivered 41 Citation jets and 29 King Air turboprops in the third quarter of 2016, compared with 37 Citation jets and 29 King Air turboprops in the third quarter of 2015.  The portion of the segment’s revenues derived from aftermarket sales and services represented 30% of its total revenues in both the third quarter of 2016 and 2015.

 

In the first nine months of 2016, Textron Aviation’s revenues increased $151 million, 5%, compared with the first nine months of 2015, primarily due to higher volume and mix of $101 million and the impact from the acquisition.  The increase in volume and mix is primarily due to higher Citation jet volume of $153 million, partially offset by lower turboprop volume.  We delivered 120 Citation jets and 78 King Air turboprops in the first nine months of 2016, compared with 106 Citation jets and 84 King Air turboprops in the first nine months of 2015.  The portion of the segment’s revenues derived from aftermarket sales and services represented 33% of its total revenues in the first nine months of 2016, compared with 32% in the first nine months of 2015.

 

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Table of Contents

 

Textron Aviation’s operating expenses increased $46 million, 4%, and $159 million, 5%, in the third quarter and first nine months of 2016, respectively, compared with the corresponding periods of 2015, largely due to higher volume as described above and additional operating expenses resulting from the acquisition.

 

Textron Aviation Segment Profit

The following factors contributed to the change in Textron Aviation’s segment profit for the periods:

 

(In millions)

 

 

 

 

 

Q3 2016
versus
Q3 2015

 

YTD 2016
versus

YTD 2015

Performance

 

 

 

 

$

 16

$

 19

Inflation, net of pricing

 

 

 

 

 

(8)

 

(15)

Volume and mix

 

 

 

 

 

(15)

 

(12)

Total change

 

 

 

 

$

 (7)

$

 (8)

 

Segment profit at Textron Aviation decreased $7 million, 7%, in the third quarter of 2016, compared with the third quarter of 2015, primarily as a result of the mix of products sold.  Segment profit was also impacted by favorable performance of $16 million, largely attributable to lower research and development costs.

 

Segment profit at Textron Aviation decreased $8 million, 3%, in the first nine months of 2016, compared with the first nine months of 2015, primarily due to the mix of products sold.

 

Bell

 

 

Three Months Ended

Nine Months Ended

(Dollars in millions)

 

October 1,
2016

 

October 3,
2015

 

October 1,
2016

 

October 3,
2015

Revenues:

 

 

 

 

 

 

 

 

V-22 program

$