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 June 30, 2012

 

OR

 

o     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 x No o

 

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 x No o

 

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 x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

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

 

As of July 13, 2012, there were 280,941,251 shares of common stock outstanding.

 

 

 



Table of Contents

 

TEXTRON INC.

 

INDEX

 

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

Consolidated Statements of Operations (Unaudited)

3

 

Consolidated Statements of Comprehensive Income (Unaudited)

4

 

Consolidated Balance Sheets (Unaudited)

5

 

Consolidated Statements of Cash Flows (Unaudited)

6

 

Notes to the Consolidated Financial Statements (Unaudited)

 

 

Note 1:

Basis of Presentation

8

 

Note 2:

Retirement Plans

9

 

Note 3:

Earnings per Share

9

 

Note 4:

Accounts Receivable and Finance Receivables

10

 

Note 5:

Inventories

13

 

Note 6:

Debt

14

 

Note 7:

Accrued Liabilities

14

 

Note 8:

Commitments and Contingencies

14

 

Note 9:

Derivative Instruments and Fair Value Measurements

14

 

Note 10:

Segment Information

17

 

 

 

 

Item 2.

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

19

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

32

Item 4.

Controls and Procedures

32

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

32

Item 6.

Exhibits

33

 

Signatures

33

 



Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  FINANCIAL STATEMENTS

 

TEXTRON INC.

Consolidated Statements of Operations (Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions, except per share amounts)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

Revenues

 

 

 

 

 

 

 

 

 

Manufacturing revenues

 

$

2,964

 

$

2,695

 

$

5,759

 

$

5,148

 

Finance revenues

 

55

 

33

 

116

 

59

 

Total revenues

 

3,019

 

2,728

 

5,875

 

5,207

 

Costs, expenses and other

 

 

 

 

 

 

 

 

 

Cost of sales

 

2,435

 

2,225

 

4,747

 

4,280

 

Selling and administrative expense

 

283

 

295

 

591

 

599

 

Provision for losses on finance receivables

 

(7

)

12

 

(3

)

24

 

Interest expense

 

53

 

61

 

108

 

123

 

Total costs, expenses and other

 

2,764

 

2,593

 

5,443

 

5,026

 

Income from continuing operations before income taxes

 

255

 

135

 

432

 

181

 

Income tax expense

 

82

 

43

 

139

 

58

 

Income from continuing operations

 

173

 

92

 

293

 

123

 

Loss from discontinued operations, net of income taxes

 

(1

)

(2

)

(3

)

(4

)

Net income

 

$

172

 

$

90

 

$

290

 

$

119

 

Basic earnings per share

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.61

 

$

0.33

 

$

1.04

 

$

0.44

 

Discontinued operations

 

 

(0.01

)

(0.01

)

(0.01

)

Basic earnings per share

 

$

0.61

 

$

0.32

 

$

1.03

 

$

0.43

 

Diluted earnings per share

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.58

 

$

0.29

 

$

0.99

 

$

0.39

 

Discontinued operations

 

 

 

(0.01

)

(0.01

)

Diluted earnings per share

 

$

0.58

 

$

0.29

 

$

0.98

 

$

0.38

 

Dividends per share

 

 

 

 

 

 

 

 

 

Common stock

 

$

0.02

 

$

0.02

 

$

0.04

 

$

0.04

 

 

See Notes to the consolidated financial statements.

 

3



Table of Contents

 

TEXTRON INC.

Consolidated Statements of Comprehensive Income (Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

Net income

 

$

172

 

$

90

 

$

290

 

$

119

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Recognition of prior service cost and unrealized losses on pension and postretirement benefits

 

21

 

15

 

42

 

33

 

Foreign currency translation

 

(16

)

7

 

(13

)

23

 

Deferred gains on hedge contracts, net of reclassifications

 

(3

)

(2

)

(3

)

 

Comprehensive income

 

$

174

 

$

110

 

$

316

 

$

175

 

 

See Notes to the consolidated financial statements.

 

4



Table of Contents

 

TEXTRON INC.

Consolidated Balance Sheets (Unaudited)

 

(Dollars in millions)

 

June 30,
2012

 

December 31,
 2011

 

Assets

 

 

 

 

 

Manufacturing group

 

 

 

 

 

Cash and equivalents

 

$

898

 

$

871

 

Accounts receivable, net

 

917

 

856

 

Inventories

 

2,759

 

2,402

 

Other current assets

 

704

 

1,134

 

Total current assets

 

5,278

 

5,263

 

Property, plant and equipment, less accumulated depreciation and amortization of $3,216 and $3,097

 

2,027

 

1,996

 

Goodwill

 

1,630

 

1,635

 

Other assets

 

1,510

 

1,508

 

Total Manufacturing group assets

 

10,445

 

10,402

 

Finance group

 

 

 

 

 

Cash and equivalents

 

13

 

14

 

Finance receivables held for investment, net

 

2,006

 

2,321

 

Finance receivables held for sale

 

244

 

418

 

Other assets

 

360

 

460

 

Total Finance group assets

 

2,623

 

3,213

 

Total assets

 

$

13,068

 

$

13,615

 

Liabilities and shareholders’ equity

 

 

 

 

 

Liabilities

 

 

 

 

 

Manufacturing group

 

 

 

 

 

Current portion of long-term debt

 

$

507

 

$

146

 

Accounts payable

 

886

 

833

 

Accrued liabilities

 

1,837

 

1,952

 

Total current liabilities

 

3,230

 

2,931

 

Other liabilities

 

2,668

 

2,826

 

Long-term debt

 

1,809

 

2,313

 

Total Manufacturing group liabilities

 

7,707

 

8,070

 

Finance group

 

 

 

 

 

Other liabilities

 

200

 

333

 

Due to Manufacturing group

 

249

 

493

 

Debt

 

1,810

 

1,974

 

Total Finance group liabilities

 

2,259

 

2,800

 

Total liabilities

 

9,966

 

10,870

 

Shareholders’ equity

 

 

 

 

 

Common stock

 

35

 

35

 

Capital surplus

 

1,133

 

1,081

 

Retained earnings

 

3,536

 

3,257

 

Accumulated other comprehensive loss

 

(1,599

)

(1,625

)

 

 

3,105

 

2,748

 

Less cost of treasury shares

 

3

 

3

 

Total shareholders’ equity

 

3,102

 

2,745

 

Total liabilities and shareholders’ equity

 

$

13,068

 

$

13,615

 

Common shares outstanding (in thousands)

 

280,828

 

278,873

 

 

See Notes to the consolidated financial statements.

 

5



Table of Contents

 

TEXTRON INC.

Consolidated Statements of Cash Flows (Unaudited)

For the Six Months Ended June 30, 2012 and July 2, 2011, respectively

 

 

 

Consolidated

 

(In millions)

 

2012

 

2011

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

290

 

$

119

 

Less: Loss from discontinued operations

 

(3

)

(4

)

Income from continuing operations

 

293

 

123

 

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

 

 

 

 

 

Non-cash items:

 

 

 

 

 

Depreciation and amortization

 

183

 

195

 

Provision for losses on finance receivables held for investment

 

(3

)

24

 

Portfolio losses on finance assets

 

41

 

44

 

Deferred income taxes

 

85

 

57

 

Other, net

 

6

 

79

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(67

)

36

 

Inventories

 

(387

)

(276

)

Other assets

 

24

 

(51

)

Accounts payable

 

57

 

110

 

Accrued and other liabilities

 

(317

)

(230

)

Captive finance receivables, net

 

117

 

106

 

Other operating activities, net

 

(4

)

2

 

Net cash provided by operating activities of continuing operations

 

28

 

219

 

Net cash used in operating activities of discontinued operations

 

(3

)

(2

)

Net cash provided by operating activities

 

25

 

217

 

Cash flows from investing activities

 

 

 

 

 

Finance receivables originated or purchased

 

(19

)

(110

)

Finance receivables repaid

 

336

 

422

 

Proceeds on receivable sales

 

69

 

257

 

Capital expenditures

 

(158

)

(169

)

Proceeds from sale of repossessed assets and properties

 

48

 

72

 

Other investing activities, net

 

30

 

29

 

Net cash provided by investing activities

 

306

 

501

 

Cash flows from financing activities

 

 

 

 

 

Increase in short-term debt

 

 

189

 

Payments on long-term lines of credit

 

 

(940

)

Principal payments on long-term and nonrecourse debt

 

(393

)

(511

)

Proceeds from issuance of long-term debt

 

88

 

265

 

Dividends paid

 

(11

)

(11

)

Other financing activities, net

 

12

 

(1

)

Net cash used in financing activities

 

(304

)

(1,009

)

Effect of exchange rate changes on cash and equivalents

 

(1

)

11

 

Net increase (decrease) in cash and equivalents

 

26

 

(280

)

Cash and equivalents at beginning of period

 

885

 

931

 

Cash and equivalents at end of period

 

$

911

 

$

651

 

 

See Notes to the consolidated financial statements

 

6



Table of Contents

 

TEXTRON INC.

Consolidated Statements of Cash Flows (Unaudited) (Continued)

For the Six Months Ended June 30, 2012 and July 2, 2011, respectively

 

 

 

Manufacturing Group

 

Finance Group

 

(In millions)

 

2012

 

2011

 

2012

 

2011

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

264

 

$

171

 

$

26

 

$

(52

)

Less: Loss from discontinued operations

 

(3

)

(4

)

 

 

Income (loss) from continuing operations

 

267

 

175

 

26

 

(52

)

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

 

 

 

 

 

 

 

 

 

Dividends received from Finance Group

 

315

 

179

 

 

 

Capital contribution paid to Finance Group

 

(240

)

(112

)

 

 

Non-cash items:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

170

 

180

 

13

 

15

 

Provision for losses on finance receivables held for investment

 

 

 

(3

)

24

 

Portfolio losses on finance assets

 

 

 

41

 

44

 

Deferred income taxes

 

57

 

50

 

28

 

7

 

Other, net

 

50

 

66

 

(44

)

13

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

Accounts receivable, net

 

(67

)

36

 

 

 

Inventories

 

(388

)

(279

)

 

 

Other assets

 

26

 

(51

)

(2

)

(3

)

Accounts payable

 

57

 

110

 

 

 

Accrued and other liabilities

 

(162

)

(210

)

(155

)

(20

)

Other operating activities, net

 

(4

)

2

 

 

 

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

 

81

 

146

 

(96

)

28

 

Net cash used in operating activities of discontinued operations

 

(3

)

(2

)

 

 

Net cash provided by (used in) operating activities

 

78

 

144

 

(96

)

28

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

Finance receivables originated or purchased

 

 

 

(114

)

(244

)

Finance receivables repaid

 

 

 

548

 

662

 

Proceeds on receivable sales

 

 

 

69

 

257

 

Capital expenditures

 

(158

)

(169

)

 

 

Proceeds from sale of repossessed assets and properties

 

 

 

48

 

72

 

Other investing activities, net

 

2

 

(42

)

29

 

37

 

Net cash provided by (used in) investing activities

 

(156

)

(211

)

580

 

784

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

Increase in short-term debt

 

 

189

 

 

 

Payments on long-term lines of credit

 

 

 

 

(940

)

Intergroup financing

 

245

 

(395

)

(245

)

395

 

Principal payments on long-term and nonrecourse debt

 

(139

)

(13

)

(254

)

(498

)

Proceeds from issuance of long-term debt

 

 

 

88

 

265

 

Capital contributions paid to Finance group under Support Agreement

 

 

 

240

 

112

 

Other capital contributions paid to Finance group

 

 

 

 

40

 

Dividends paid

 

(11

)

(11

)

(315

)

(179

)

Other financing activities, net

 

11

 

(1

)

1

 

 

Net cash provided by (used in) financing activities

 

106

 

(231

)

(485

)

(805

)

Effect of exchange rate changes on cash and equivalents

 

(1

)

10

 

 

1

 

Net increase (decrease) in cash and equivalents

 

27

 

(288

)

(1

)

8

 

Cash and equivalents at beginning of period

 

871

 

898

 

14

 

33

 

Cash and equivalents at end of period

 

$

898

 

$

610

 

$

13

 

$

41

 

 

See Notes to the consolidated financial statements.

 

7



Table of Contents

 

TEXTRON INC.

Notes to the Consolidated Financial Statements (Unaudited)

 

Note 1:  Basis of Presentation

 

Our consolidated financial statements include the accounts of Textron Inc. 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 December 31, 2011.  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 Inc. consolidated with its majority-owned subsidiaries that operate in the Cessna, Bell, Textron Systems and Industrial segments.  The Finance group, which also is the Finance segment, consists of Textron Financial Corporation (TFC), its consolidated subsidiaries and three other finance subsidiaries owned by Textron Inc.  We designed this framework to enhance our borrowing power by separating the Finance group.  Our Manufacturing group operations include the development, production and delivery of tangible goods and services, while our Finance group provides financial services.  Due to the fundamental differences between each borrowing group’s activities, investors, rating agencies and analysts use different measures to evaluate each group’s performance.  To support those evaluations, we present balance sheet and cash flow information for each borrowing group within the consolidated financial statements.  All significant intercompany transactions are eliminated from the consolidated financial statements, including retail and wholesale financing activities for inventory sold by our Manufacturing group and financed by our Finance group.

 

Use of Estimates

 

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

 

During 2012 and 2011, 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.  The changes in estimates increased income from continuing operations before income taxes in the second quarter of 2012 and 2011 by $12 million and $10 million, respectively, ($8 million and $7 million after tax, or $0.03 and $0.02 per diluted share, respectively).  For the second quarter of 2012 and 2011, the gross favorable program profit adjustments totaled $23 million and $21 million, respectively, and the gross unfavorable program profit adjustments totaled $11 million for each quarter.

 

The changes in estimates increased income from continuing operations before income taxes in the first half of 2012 and 2011 by $16 million and $24 million, ($10 million and $15 million after tax, or $0.04 and $0.05 per diluted share, respectively).  For the first half of 2012 and 2011, the gross favorable program profit adjustments totaled $40 million and $42 million, respectively, and the gross unfavorable program profit adjustments totaled $24 million and $18 million, respectively.

 

8



Table of Contents

 

Note 2:  Retirement Plans

 

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

 

 

 

Pension Benefits

 

Postretirement Benefits
Other Than Pensions

 

(In millions)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

Three Months Ended

 

 

 

 

 

 

 

 

 

Service cost

 

$

29

 

$

32

 

$

1

 

$

2

 

Interest cost

 

76

 

82

 

7

 

8

 

Expected return on plan assets

 

(102

)

(98

)

 

 

Amortization of prior service cost (credit)

 

4

 

4

 

(3

)

(2

)

Amortization of net loss

 

30

 

19

 

1

 

3

 

Net periodic benefit cost

 

$

37

 

$

39

 

$

6

 

$

11

 

Six Months Ended

 

 

 

 

 

 

 

 

 

Service cost

 

$

59

 

$

64

 

$

3

 

$

4

 

Interest cost

 

152

 

164

 

13

 

16

 

Expected return on plan assets

 

(203

)

(196

)

 

 

Amortization of prior service cost (credit)

 

8

 

8

 

(6

)

(3

)

Amortization of net loss

 

59

 

38

 

3

 

6

 

Net periodic benefit cost

 

$

75

 

$

78

 

$

13

 

$

23

 

 

Note 3:  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, restricted stock units and the shares that could be issued upon the conversion of our convertible notes and upon the exercise of the related warrants.  The call options purchased in connection with the issuance of the convertible notes and the capped call transaction entered into in 2011 are excluded from the calculation of diluted EPS as their impact is always anti-dilutive.

 

Upon conversion of our convertible notes, as described in Note 8 of our 2011 Form 10-K, the principal amount would be settled in cash, and the excess of the conversion value, as defined, over the principal amount may be settled in cash and/or shares of our common stock.  Therefore, only the shares of our common stock potentially issuable with respect to the excess of the notes’ conversion value over the principal amount, if any, are considered as dilutive potential common shares for purposes of calculating diluted EPS.

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

(In thousands)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

Basic weighted-average shares outstanding

 

281,114

 

277,406

 

280,568

 

276,882

 

Dilutive effect of:

 

 

 

 

 

 

 

 

 

Convertible notes and warrants

 

14,021

 

36,838

 

13,960

 

39,275

 

Stock options and restricted stock units

 

412

 

964

 

552

 

1,104

 

Diluted weighted-average shares outstanding

 

295,547

 

315,208

 

295,080

 

317,261

 

 

Stock options to purchase 7 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding for the three and six months ended June 30, 2012, as the exercise prices were greater than the average market price of our common stock for the periods.  Stock options to purchase 3 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding for both the three and six months ended July 2, 2011, as the exercise prices were greater than the average market price of our common stock for the periods.  These securities could potentially dilute EPS in the future.

 

9



Table of Contents

 

Note 4:  Accounts Receivable and Finance Receivables

 

Accounts Receivable

 

Accounts receivable is composed of the following:

 

(In millions)

 

June 30,
2012

 

December 31,
2011

 

Commercial

 

$

577

 

$

528

 

U.S. Government contracts

 

358

 

346

 

 

 

935

 

874

 

Allowance for doubtful accounts

 

(18

)

(18

)

Total accounts receivable, net

 

$

917

 

$

856

 

 

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 $213 million at June 30, 2012 and $192 million at December 31, 2011.

 

Finance Receivables

 

Finance receivables by product line, which includes both finance receivables held for investment and finance receivables held for sale, are presented in the following table.  Beginning this quarter, we are reporting our captive business as one product line, which primarily includes aviation finance receivables, and to a limited extent, golf equipment finance receivables.

 

(In millions)

 

June 30,
2012

 

December 31,
2011

 

Captive

 

$

1,753

 

$

1,945

 

Golf Mortgage

 

244

 

381

 

Timeshare

 

203

 

318

 

Structured Capital

 

149

 

208

 

Other liquidating

 

23

 

43

 

Total finance receivables

 

2,372

 

2,895

 

Less: Allowance for losses

 

122

 

156

 

Less: Finance receivables held for sale

 

244

 

418

 

Total finance receivables held for investment, net

 

$

2,006

 

$

2,321

 

 

Credit Quality Indicators and Nonaccrual Finance Receivables

 

We internally assess the quality of our finance receivables held for investment portfolio based on a number of key credit quality indicators and statistics such as delinquency, loan balance to estimated collateral value, the liquidity position of individual borrowers and guarantors and default rates of our notes receivable collateral in the Timeshare product line.  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 held for investment as nonaccrual if credit quality indicators suggest full collection is doubtful.  In addition, we automatically classify accounts as nonaccrual once they are contractually delinquent by more than three months unless collection is not doubtful.  Cash payments on nonaccrual accounts, including finance charges, generally are applied to reduce the net investment balance.  We resume the accrual of interest when the loan becomes contractually current through payment according to the original terms of the loan or, if a loan has been modified, following a period of performance under the terms of the modification, provided we conclude that collection of all principal and interest is no longer doubtful.  Previously suspended interest income is recognized at that time.

 

Accounts are classified as watchlist when credit quality indicators have deteriorated as compared with typical underwriting criteria, and we believe collection of full principal and interest is probable but not certain.  All other finance receivables held for investment that do not meet the watchlist or nonaccrual categories are classified as performing.

 

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

 

 

 

June 30, 2012

 

December 31, 2011

 

(In millions)

 

Performing

 

Watchlist

 

Nonaccrual

 

Total

 

Performing

 

Watchlist

 

Nonaccrual

 

Total

 

Captive

 

$

1,491

 

$

150

 

$

112

 

$

1,753

 

$

1,558

 

$

251

 

$

136

 

$

1,945

 

Timeshare

 

73

 

4

 

126

 

203

 

89

 

25

 

167

 

281

 

Structured Capital

 

144

 

5

 

 

149

 

203

 

5

 

 

208

 

Other liquidating

 

9

 

 

14

 

23

 

25

 

 

18

 

43

 

Total

 

$

1,717

 

$

159

 

$

252

 

$

2,128

 

$

1,875

 

$

281

 

$

321

 

$

2,477

 

% of Total

 

80.7

%

7.5

%

11.8

%

 

 

75.7

%

11.3

%

13.0

%

 

 

 

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

 

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

 

 

 

June 30, 2012

 

December 31, 2011

 

(In millions)

 

Less
Than
31 Days
Past Due

 

31-60
Days
Past Due

 

61-90
Days
Past Due

 

Over
90 Days
Past Due

 

Total

 

Less
Than
31 Days
Past Due

 

31-60
Days
Past Due

 

61-90
Days
Past Due

 

Over
90 Days
Past Due

 

Total

 

Captive

 

$

1,571

 

$

43

 

$

71

 

$

68

 

$

1,753

 

$

1,758

 

$

69

 

$

43

 

$

75

 

$

1,945

 

Timeshare

 

171

 

10

 

 

22

 

203

 

238

 

3

 

 

40

 

281

 

Structured Capital

 

149

 

 

 

 

149

 

208

 

 

 

 

208

 

Other liquidating

 

15

 

 

 

8

 

23

 

35

 

 

 

8

 

43

 

Total

 

$

1,906

 

$

53

 

$

71

 

$

98

 

$

2,128

 

$

2,239

 

$

72

 

$

43

 

$

123

 

$

2,477

 

 

We had no accrual status loans that were greater than 90 days past due at June 30, 2012 or at December 31, 2011.  At June 30, 2012, the 60+ days contractual delinquency as a percentage of finance receivables held for investment was 7.94%, compared with 6.70% at December 31, 2011.

 

Loan Modifications

 

Troubled debt restructurings occur when we have either modified the contract terms of finance receivables held for investment for borrowers experiencing financial difficulties or accepted a transfer of assets in full or partial satisfaction of the loan balance.  The types of modifications we typically make include extensions of the original maturity date of the contract, extensions of revolving borrowing periods, delays in the timing of required principal payments, deferrals of interest payments, advances to protect the value of our collateral and principal reductions contingent on full repayment prior to the maturity date.  The changes effected by modifications made during the first half of 2012 to finance receivables held for investment were not material, primarily as a result of the reclassification of the Golf Mortgage finance receivables from the held for investment classification to the held for sale classification at December 31, 2011.

 

Impaired Loans

 

We evaluate individual finance receivables held for investment in non-homogeneous portfolios and larger accounts in homogeneous loan portfolios for impairment on a quarterly basis.  Finance receivables classified as held for sale are reflected at the lower of cost or fair value and are excluded from these evaluations.  A finance receivable is considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement based on our review of the credit quality indicators discussed above.  Impaired finance receivables include both nonaccrual accounts and accounts for which full collection of principal and interest remains probable, but the account’s original terms have been, or are expected to be, significantly modified.  If the modification specifies an interest rate equal to or greater than a market rate for a finance receivable with comparable risk, the account is not considered impaired in years subsequent to the modification.  There was no significant interest income recognized on impaired loans in the first half of 2012 or 2011.

 

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A summary of impaired finance receivables, excluding leveraged leases, is provided below:

 

 

 

Recorded Investment

 

 

 

 

 

 

 

(In millions)

 

Impaired
Loans with
No Related
Allowance for
Credit Losses

 

Impaired
Loans with
Related
Allowance for
Credit Losses

 

Total
Impaired
Loans

 

Unpaid
Principal
Balance

 

Allowance
For Losses
On Impaired
Loans

 

Average
Recorded
Investment

 

June 30, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Captive

 

$

28

 

$

85

 

$

113

 

$

119

 

$

23

 

$

121

 

Timeshare

 

95

 

62

 

157

 

214

 

29

 

195

 

Other liquidating

 

1

 

12

 

13

 

23

 

9

 

14

 

Total

 

$

124

 

$

159

 

$

283

 

$

356

 

$

61

 

$

330

 

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Captive

 

$

47

 

$

94

 

$

141

 

$

144

 

$

40

 

$

149

 

Timeshare

 

170

 

57

 

227

 

288

 

38

 

315

 

Golf Mortgage

 

 

 

 

 

 

232

 

Other liquidating

 

3

 

12

 

15

 

59

 

9

 

30

 

Total

 

$

220

 

$

163

 

$

383

 

$

491

 

$

87

 

$

726

 

 

Allowance for Losses

 

We maintain the allowance for losses on finance receivables held for investment at a level considered adequate to cover inherent losses in the portfolio based on management’s evaluation and analysis by product line.  For larger balance accounts specifically identified as impaired, including large accounts in homogeneous portfolios, a reserve is established based on comparing the carrying value with either a) the expected future cash flows, discounted at the finance receivable’s effective interest rate; or b) the fair value of the underlying collateral, if the finance receivable is collateral dependent.  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/foreclosure 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 portfolios is inherently subjective, as it requires estimates, including the amount and timing of future cash flows expected to be received on impaired finance receivables and the estimated fair value of the underlying collateral, which may differ from actual results.  While our analysis is specific to each individual account, critical factors included in this analysis vary by product line and include the following:

 

·                  Captive - industry valuation guides, age and physical condition of the collateral, payment history, and existence and financial strength of guarantors.

·                  Timeshare - historical performance of consumer notes receivable collateral, real estate valuations, operating expenses of the borrower, the impact of bankruptcy court rulings on the value of the collateral, legal and other professional expenses and borrower’s access to capital.

 

We also establish an allowance for losses by product line to cover probable but specifically unknown losses existing in the portfolio. For homogeneous portfolios, including Captive, the allowance is established as a percentage of non-recourse finance receivables, which have not been identified as requiring specific reserves.  The percentage is based on a combination of factors, including historical loss experience, current delinquency and default trends, collateral values and both general economic and specific industry trends.  For non-homogeneous portfolios, such as Timeshare, the allowance is established as a percentage of watchlist balances, as defined on page 10, which represents a combination of assumed default likelihood and loss severity based on historical experience, industry trends and collateral values.  In estimating our allowance for losses to cover accounts not specifically identified, critical factors vary by product line and include the following:

 

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·                  Captive - the collateral value of the portfolio, historical default experience and delinquency trends.

·                  Timeshare - individual loan credit quality indicators such as borrowing base shortfalls for revolving notes receivable facilities, default rates of our notes receivable collateral, borrower’s access to capital, historical progression from watchlist to nonaccrual status and estimates of loss severity based on analysis of impaired loans in the product line.

 

Finance receivables held for investment are written down to the fair value (less estimated costs to sell) of the related collateral when the collateral is repossessed and are charged off when the remaining balance is deemed to be uncollectible.

 

A rollforward of the allowances for losses on finance receivables held for investment is provided below:

 

(In millions)

 

Captive

 

Golf
Mortgage

 

Timeshare

 

Other
liquidating

 

Total

 

For the six months ended June 30, 2012

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

101

 

$

 

$

40

 

$

15

 

$

156

 

Provision for losses

 

 

 

2

 

(5

)

(3

)

Charge-offs

 

(26

)

 

(13

)

(1

)

(40

)

Recoveries

 

7

 

 

 

2

 

9

 

Ending balance

 

$

82

 

$

 

$

29

 

$

11

 

$

122

 

For the six months ended July 2, 2011

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

123

 

$

79

 

$

106

 

$

34

 

$

342

 

Provision for losses

 

14

 

(1

)

10

 

1

 

24

 

Charge-offs

 

(26

)

(4

)

(28

)

(10

)

(68

)

Recoveries

 

6

 

 

 

8

 

14

 

Transfers

 

 

 

 

(13

)

(13

)

Ending balance

 

$

117

 

$

74

 

$

88

 

$

20

 

$

299

 

 

A summary of the allowance for losses on finance receivables that are evaluated on an individual and on a collective basis is provided below.  The finance receivables reported in this table specifically exclude $149 million and $281 million of leveraged leases at June 30, 2012 and July 2, 2011, respectively, in accordance with authoritative accounting standards.

 

 

 

June 30, 2012

 

July 2, 2011

 

 

 

 

 

 

 

Allowance

 

Allowance

 

 

 

 

 

Allowance

 

Allowance

 

 

 

Finance

 

Based on

 

Based on

 

Finance

 

Based on

 

Based on

 

 

 

Receivables Evaluated

 

Individual

 

Collective

 

Receivables Evaluated

 

Individual

 

Collective

 

(In millions)

 

Individually

 

Collectively

 

Evaluation

 

Evaluation

 

Individually

 

Collectively

 

Evaluation

 

Evaluation

 

Captive

 

$

113

 

$

1,640

 

$

23

 

$

59

 

$

143

 

$

2,009

 

$

44

 

$

73

 

Timeshare

 

157

 

46

 

29

 

 

322

 

188

 

86

 

2

 

Golf Mortgage

 

 

 

 

 

294

 

325

 

44

 

30

 

Other liquidating

 

13

 

10

 

9

 

2

 

28

 

54

 

9

 

11

 

Total

 

$

283

 

$

1,696

 

$

61

 

$

61

 

$

787

 

$

2,576

 

$

183

 

$

116

 

 

Note 5:  Inventories

 

(In millions)

 

June 30,
2012

 

December 31,
2011

 

Finished goods

 

$

1,288

 

$

1,012

 

Work in process

 

2,260

 

2,202

 

Raw materials

 

449

 

399

 

 

 

3,997

 

3,613

 

Progress/milestone payments

 

(1,238

)

(1,211

)

 

 

$

2,759

 

$

2,402

 

 

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Note 6: Debt

 

At June 30, 2012, the principal amount of our convertible senior notes was $215 million. Our common stock price exceeded the $17.06 per share conversion threshold price set forth for these convertible notes for at least 20 trading days during the 30 consecutive trading days ended June 30, 2012. Accordingly, these notes are convertible at the holder’s option through September 30, 2012. We may deliver shares of common stock, cash or a combination of cash and shares of common stock in satisfaction of our obligations upon conversion of the convertible notes. Based on a June 30, 2012 stock price of $24.87, the “if converted value” exceeds the face amount of the remaining notes by $192 million; however, after giving effect to the exercise of the related outstanding call options and warrants, the incremental cash or share settlement in excess of the face amount would result in either a 6 million net share issuance or a cash payment of $149 million, or a combination of cash and stock, at our option.

 

Note 7: Accrued Liabilities

 

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

 

 

 

Six Months Ended

 

(In millions)

 

June 30,
2012

 

July 2,
2011

 

Accrual at the beginning of period

 

$

224

 

$

242

 

Provision

 

124

 

111

 

Settlements

 

(123

)

(116

)

Adjustments to prior accrual estimates

 

(4

)

(7

)

Accrual at the end of period

 

$

221

 

$

230

 

 

Note 8:  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; compliance with applicable laws and regulations; production partners; product liability; employment; 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 being suspended or debarred 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.

 

On February 7, 2012, a lawsuit was filed in the United States Bankruptcy Court, Northern District of Ohio, Eastern Division (Akron) by Brian A. Bash, Chapter 7 Trustee for Fair Finance Company against TFC, Fortress Credit Corp. and Fair Facility I, LLC.  TFC provided a revolving line of credit of up to $17.5 million to Fair Finance Company from 2002 through 2007.  The complaint alleges numerous counts against TFC, as Fair Finance Company’s working capital lender, including receipt of fraudulent transfers and assisting in fraud perpetrated on Fair Finance investors.  The Trustee seeks avoidance and recovery of alleged fraudulent transfers in the amount of $316 million as well as damages of $223 million on the other claims.  The Trustee also seeks trebled damages on all claims under Ohio law.  We intend to vigorously defend this lawsuit, and on April 20, 2012, TFC moved to dismiss all claims in the complaint.  That motion is still pending.  An estimate of a range of possible loss cannot be made at this time due to the early stage of the litigation.

 

Note 9:  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

 

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Table of Contents

 

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

 

The assets and liabilities that are recorded at fair value on a recurring basis consist primarily of our derivative financial instruments, which are categorized as Level 2 in the fair value hierarchy.  The fair value amounts of these instruments that are designated as hedging instruments are provided below:

 

 

 

 

 

 

 

Asset (Liability)

 

(In millions)

 

Borrowing Group

 

Balance Sheet Location

 

June 30,
 2012

 

December 31,
2011

 

Assets

 

 

 

 

 

 

 

 

 

Interest rate exchange contracts*

 

Finance

 

Other assets

 

$

16

 

$

22

 

Foreign currency exchange contracts

 

Manufacturing

 

Other current assets

 

5

 

9

 

Total

 

 

 

 

 

$

21

 

$

31

 

Liabilities

 

 

 

 

 

 

 

 

 

Interest rate exchange contracts*

 

Finance

 

Other liabilities

 

$

(9

)

$

(7

)

Foreign currency exchange contracts

 

Manufacturing

 

Accrued liabilities

 

(1

)

(5

)

Total

 

 

 

 

 

$

(10

)

$

(12

)

*Interest rate exchange contracts represent fair value hedges.

 

The Finance group’s interest rate exchange contracts are not exchange traded and are measured at fair value utilizing widely accepted, third-party developed valuation models.  The actual terms of each individual contract are entered into a valuation model, along with interest rate and foreign exchange rate data, which is based on readily observable market data published by third-party leading financial news and data providers.  Credit risk is factored into the fair value of these assets and liabilities based on the differential between both our credit default swap spread for liabilities and the counterparty’s credit default swap spread for assets as compared with a standard AA-rated counterparty; however, this had no significant impact on the valuation at June 30, 2012.  At June 30, 2012 and December 31, 2011, we had interest rate exchange contracts with notional amounts upon which the contracts were based of $770 million and $848 million, respectively.

 

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 June 30, 2012 and December 31, 2011, we had foreign currency exchange contracts with notional amounts upon which the contracts were based of $680 million and $645 million, respectively.

 

Fair Value Hedges

 

Our Finance group enters into interest rate exchange contracts to mitigate exposure to changes in the fair value of its fixed-rate receivables and debt due to fluctuations in interest rates.  By using these contracts, we are able to convert our fixed-rate cash flows to floating-rate cash flows.  The amount of ineffectiveness on our fair value hedges and the gain (loss) recorded in the Consolidated Statements of Operations were both insignificant in the first half of 2012 and 2011.

 

Cash Flow Hedges

 

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.  The primary purpose of our foreign currency hedging activities is to manage the volatility associated with foreign currency purchases of materials, foreign currency sales of products, and other assets and liabilities in the normal course of business.  We primarily utilize forward exchange contracts and purchased options with maturities of no more than three years that qualify as cash flow hedges and are intended to offset the effect of exchange rate fluctuations on forecasted sales, inventory purchases and overhead expenses.  At June 30, 2012, we had a net deferred gain of $5 million in Accumulated other comprehensive loss related to these cash flow hedges.  Net gains and losses recognized in earnings and Accumulated other comprehensive loss on these cash flow hedges, including gains and losses related to hedge ineffectiveness, were not material in the three and six months ended June 30, 2012 and July 2, 2011.  We do not expect the amount of gains and losses in Accumulated other comprehensive loss that will be reclassified to earnings in the next twelve months to be material.

 

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Table of Contents

 

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 net investments. We also may utilize currency forwards as hedges of our related foreign net investments. We record changes in the fair value of these contracts in other comprehensive income to the extent they are effective as cash flow hedges.  If a contract does not qualify for hedge accounting or is designated as a fair value hedge, changes in the fair value of the contract are recorded in earnings.  Currency effects on the effective portion of these hedges, which are reflected in the foreign currency translation adjustment account within other comprehensive income, produced a $4 million after-tax gain for the first half of 2012, resulting in an accumulated net gain balance of $22 million at June 30, 2012.  The ineffective portion of these hedges was insignificant.

 

Assets Recorded at Fair Value on a Nonrecurring Basis

 

The fair value measurement adjustments recorded during the first half of 2012 and 2011 for each asset class measured on a nonrecurring basis are presented in the gain (loss) columns below, along with the balance of the asset class measured at fair value at the end of each period.  These assets are in the Finance group and were measured using significant unobservable inputs (Level 3).

 

 

 

 

 

 

 

Gain (Loss)

 

 

 

Balance at

 

Six Months Ended

 

(In millions)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

Finance receivables held for sale

 

$

244

 

$

180

 

$

44

 

$

(14

)

Impaired finance receivables

 

110

 

407

 

(7

)

(50

)

Repossessed assets and properties

 

138

 

91

 

(32

)

(18

)

 

Finance Receivables Held for Sale — Finance receivables held for sale are recorded at fair value on a nonrecurring basis during periods in which the fair value is lower than the cost value.  There are no active, quoted market prices for these finance receivables.  At June 30, 2012, our finance receivables held for sale represents the Golf Mortgage portfolio.  Fair value of this portfolio was determined based on the use of discounted cash flow models to estimate the price we expect to receive in the principal market for each pool of similar loans, in an orderly transaction.  The discount rates utilized in these models are derived from prevailing interest rate indices and are based on the nature of the assets, discussions with market participants and our experience in the actual disposition of similar assets.  The cash flow models also include the use of qualitative assumptions regarding the borrower’s ability to pay and the period of time that will likely be required to restructure and/or exit the account through acquisition of the underlying collateral.  We utilize revenue and earnings multiples to determine the expected value of the loan collateral. The range of multiples used is based on bids from prospective buyers, inputs from market participants and prices at which sales have been transacted for similar properties.  The gains on finance receivables held for sale for the six months ended June 30, 2012 are primarily the result of the payoff and sale of loans at prices in excess of the values established in previous periods.

 

Based on our qualitative assumptions, we separate the loans into three categories for the cash flow models.  In the first category, we include loans that we assume will be paid in accordance with the contractual terms of the loan.  In the second category, we include loans where we perceive that the borrower has less of an ability to pay, and we assume that the loan will be restructured and resolved typically over a period of one to four years.  For the third category, we assume that the borrower will default on the loan and that it will be resolved within an average of 24 months.  The fair values of these finance receivables are sensitive to variability in both the quantitative and qualitative assumptions.  Changes in the borrower’s ability to pay or the period of time required to restructure and/or exit accounts may significantly increase or decrease the fair value of these finance receivables, and, to a lesser extent, fluctuations in discount rates and/or revenue and earnings multiples could also change the fair value of these finance receivables.

 

Impaired Finance Receivables — 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 our Captive impaired nonaccrual finance receivables, fair values of collateral are determined based on the use of industry pricing guides.  Our Timeshare impaired nonaccrual finance receivables largely consist of notes receivable loans to developers of resort properties which are collateralized by pools of consumer notes receivable.  Fair values of collateral are estimated using cash flow models incorporating estimates of credit losses in the consumer notes pools and the developer’s ability to mitigate losses through the repurchase or replacement of defaulted notes.  Fair value measurements recorded on impaired finance receivables resulted in charges to provision for loan losses and primarily related to initial fair value adjustments.

 

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Table of Contents

 

Repossessed assets and properties — Repossessed assets and properties in the table above primarily include both golf and hotel properties and aviation assets at June 30, 2012.  The fair value of our golf and hotel properties is determined based on the use of discounted cash flow models, bids from prospective buyers or inputs from market participants.  The fair value of our aviation assets is largely determined based on the use of industry pricing guides.  If the carrying amount of these assets is higher than their estimated fair value, we record a corresponding charge to income for the difference.

 

Assets and Liabilities Not Recorded at Fair Value

 

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

 

 

 

June 30, 2012

 

December 31, 2011

 

(In millions)

 

Carrying
Value

 

Estimated
Fair Value

 

Carrying
Value

 

Estimated
Fair Value

 

Manufacturing group

 

 

 

 

 

 

 

 

 

Long-term debt, excluding leases

 

$

(2,189

)

$

(2,536

)

$

(2,328

)

$

(2,561

)

Finance group

 

 

 

 

 

 

 

 

 

Finance receivables held for investment, excluding leases

 

1,750

 

1,676

 

1,997

 

1,848

 

Debt

 

(1,810

)

(1,749

)

(1,974

)

(1,854

)

 

Fair value for the Manufacturing group debt is determined using market observable data for similar transactions or Level 2 inputs.  At June 30, 2012 and December 31, 2011, approximately 43% and 53%, respectively, of the fair value of term debt for the Finance group was determined based on observable market transactions (Level 1).  The remaining Finance group debt 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 held for investment were determined based on internally developed discounted cash flow models primarily utilizing significant unobservable inputs (Level 3), which include estimates of the rate of return, financing cost, capital structure and/or discount rate expectations of current market participants combined with estimated loan cash flows based on credit losses, payment rates and expectations of borrowers’ ability to make payments on a timely basis.

 

Note 10:  Segment Information

 

We operate in, and report financial information for, the following five business segments: Cessna, 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 and certain corporate expenses.  The measurement for the Finance segment includes interest income and expense along with intercompany interest expense.  Provisions for losses on finance receivables involving the sale or lease of our products are recorded by the selling manufacturing division when our Finance group has recourse to the Manufacturing group.

 

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Table of Contents

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

(In millions)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

REVENUES

 

 

 

 

 

 

 

 

 

Manufacturing Group

 

 

 

 

 

 

 

 

 

Cessna

 

$

763

 

$

652

 

$

1,432

 

$

1,208

 

Bell

 

1,056

 

872

 

2,050

 

1,621

 

Textron Systems

 

389

 

452

 

766

 

897

 

Industrial

 

756

 

719

 

1,511

 

1,422

 

 

 

2,964

 

2,695

 

5,759

 

5,148

 

Finance Group

 

55

 

33

 

116

 

59

 

Total revenues

 

$

3,019

 

$

2,728

 

$

5,875

 

$

5,207

 

SEGMENT OPERATING PROFIT

 

 

 

 

 

 

 

 

 

Manufacturing Group

 

 

 

 

 

 

 

 

 

Cessna

 

$

35

 

$

5

 

$

29

 

$

(33

)

Bell

 

152

 

120

 

297

 

211

 

Textron Systems

 

40

 

49

 

75

 

102

 

Industrial

 

61

 

55

 

134

 

116

 

 

 

288

 

229

 

535

 

396

 

Finance Group

 

22

 

(33

)

34

 

(77

)

Segment profit

 

310

 

196

 

569

 

319

 

Corporate expenses and other, net

 

(20

)

(23

)

(67

)

(62

)

Interest expense, net for Manufacturing group

 

(35

)

(38

)

(70

)

(76

)

Income from continuing operations before income taxes

 

$

255

 

$

135

 

$

432

 

$

181

 

 

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Table of Contents

 

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

 

Consolidated Results of Operations

 

Revenues

 

 

 

Three Months Ended

 

Six Months Ended

 

(Dollars in millions)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

Revenues

 

$

3,019

 

$

2,728

 

$

5,875

 

$

5,207

 

% change compared with prior period

 

11

%

 

 

13

%

 

 

 

Revenues increased $291 million, 11%, in the second quarter of 2012, compared with the corresponding period of 2011.  This increase was due to revenue increases in the Bell, Cessna, Industrial and Finance segments that were partially offset by lower revenues in the Textron Systems segment.  The net revenue increase included the following factors:

 

·                  Higher Bell revenues of $184 million, largely due to higher commercial aircraft volume.

·                  Higher Cessna revenues of $111 million, primarily due to higher Citation jet volume.

·                  Increased Industrial segment revenues of $37 million, primarily due to higher volume, mostly reflecting higher market demand in the Fuel Systems and Functional Components and Golf and Turf Care product lines, partially offset by unfavorable foreign exchange primarily related to the weakening of the euro.

·                  Higher Finance revenues of $22 million due to lower portfolio losses and favorable net valuation adjustments related to the non-captive business, partially offset by a decline in revenues attributable to lower average finance receivables of $1.2 billion.

·                  Lower Textron Systems revenues of $63 million, primarily due to lower volume in the Weapons and Sensors and Land & Marine product lines.

 

Revenues increased $668 million, 13%, in the first half of 2012, compared with the corresponding period of 2011, as revenue increases in the Bell, Cessna, Industrial and Finance segments were partially offset by lower revenues in the Textron Systems segments.  The net revenue increase included the following factors:

 

·                  Higher Bell revenues of $429 million, largely due to higher commercial aircraft volume and higher volume in our military programs.

·                  Higher Cessna revenues of $224 million, primarily due to higher Citation jet volume.

·                  Increased Industrial segment revenues of $89 million, primarily due to higher volume, mostly reflecting higher market demand in the Fuel Systems and Functional Components and Golf and Turf Care product lines, partially offset by unfavorable foreign exchange primarily related to the weakening of the euro.

·                  Higher Finance revenues of $57 million as favorable net valuation adjustments related to the non-captive business and lower portfolio losses offset a decline in revenues attributable to lower average finance receivables of $1.3 billion.

·                  Lower Textron Systems revenues of $131 million, primarily due to lower volume across all product lines.

 

Cost of Sales and Selling and Administrative Expense

 

 

 

Three Months Ended

 

Six Months Ended

 

(Dollars in millions)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

Operating expenses

 

$

2,718

 

$

2,520

 

$

5,338

 

$

4,879

 

% change compared with prior period

 

8

%

 

 

9

%

 

 

Cost of sales

 

$

2,435

 

$

2,225

 

$

4,747

 

$

4,280

 

% change compared with prior period

 

9

%

 

 

11

%

 

 

Gross margin percentage of Manufacturing revenues

 

17.8

%

17.4

%

17.6

%

16.9

%

Selling and administrative expense

 

$

283

 

$

295

 

$

591

 

$

599

 

% change compared with prior period

 

(4

)%

 

 

(1

)%

 

 

 

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Table of Contents

 

Manufacturing cost of sales and selling and administrative expenses together comprise our operating expenses.  Changes in operating expenses are more fully discussed in our Segment Analysis below.

 

Consolidated manufacturing cost of sales as a percentage of Manufacturing revenues was 82.2% and 82.6% in the second quarter of 2012 and 2011, respectively.  On a dollar basis, consolidated manufacturing cost of sales increased $210 million, 9%, in the second quarter of 2012, compared with the corresponding period of 2011, principally due to higher net sales volume in the Bell, Cessna and Industrial segments, partially offset by lower net sales volume at Textron Systems.  Cost of sales was favorably impacted at the Industrial segment due to the impact of foreign exchange on direct materials and labor of $27 million, largely due to fluctuations with the euro.  In the second quarter of 2012, gross margin increased as a percentage of Manufacturing revenues primarily due to favorable product mix at Bell and improved leverage on higher volume at the Bell, Cessna and Industrial segments.

 

Consolidated manufacturing cost of sales as a percentage of Manufacturing revenues was 82.4% and 83.1% in the first half of 2012 and 2011, respectively.  On a dollar basis, consolidated cost of sales increased $467 million, 11%, in the first half of 2012, principally due to higher net sales volume in the Bell, Cessna and Industrial segments, partially offset by lower net sales volume at Textron Systems.  Cost of sales was favorably impacted at the Industrial segment due to the impact of foreign exchange on direct materials and labor of $33 million, largely due to fluctuations with the euro.  In the first half of 2012, gross margin increased as a percentage of Manufacturing revenues primarily due to favorable product mix at Bell and improved leverage on higher volume at the Bell, Cessna and Industrial segments.

 

On a consolidated basis, selling and administrative expense decreased $12 million, 4%, to $283 million in the second quarter of 2012, compared with the corresponding period of 2011. For the first half of 2012, selling and administrative expense decreased $8 million, 1%, to $591 million, compared with the corresponding period of 2011.  These changes were largely driven by a $10 million and $20 million reduction in operating expense at the Finance segment in the second quarter and first half of 2012 compared with the corresponding periods of 2011, respectively, primarily associated with the exit of the non-captive business.

 

Backlog

 

(In millions)

 

June 30,
2012

 

December 31,
2011

 

Bell

 

$

6,739

 

$

7,346

 

Cessna

 

1,526

 

1,889

 

Textron Systems

 

2,653

 

1,337

 

 

Backlog increased $1.3 billion at Textron Systems in the first half of 2012 largely due to additional orders in the Unmanned Aircraft Systems (UAS) and Land & Marine product lines.  Backlog at Bell and Cessna decreased $0.6 billion and $0.4 billion, respectively, in the first half of 2012, primarily reflecting deliveries in excess of orders.

 

Segment Analysis

 

We operate in, and report financial information for, the following five business segments: Cessna, 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 and certain corporate expenses.  The measurement for the Finance segment includes interest income and expense along with intercompany interest 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.  Acquisitions refer to the results 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.  Cost 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.

 

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Table of Contents

 

Approximately 31% of our 2011 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 refer 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.

 

Cessna

 

 

 

Three Months Ended

 

Six Months Ended

 

(Dollars in millions)

 

June 30,
2012

 

July 2,
2011

 

June 30,
2012

 

July 2,
2011

 

Revenues

 

$

763

 

$

652

 

$

1,432

 

$

1,208

 

Operating expenses

 

728

 

647

 

1,403

 

1,241

 

Segment profit (loss)

 

35

 

5

 

29

 

(33

)

Profit margin

 

4.6

%

0.8

%

2.0

%

(2.7

)%

 

Cessna Revenues and Operating Expenses

 

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

 

(In millions)

 

Q2 2012
versus
Q2 2011

 

YTD 2012
versus
YTD 2011

 

Volume

 

$

116

 

$

227

 

Other

 

(5

)

(3

)

Total change

 

$

111

 

$

224

 

 

In the second quarter of 2012, Cessna’s revenues increased $111 million, 17%, compared with the corresponding period of 2011, primarily due to higher Citation business jet volume reflecting a modest recovery in the jet market, which had a $101 million impact.  We delivered 49 Citation jets in the second quarter of 2012, compared with 38 jets in the corresponding period of 2011.  During the second quarter of 2012, the portion of Cessna’s revenues derived from aftermarket sales and services represented 26% of Cessna’s revenues, compared with 29% in the second quarter of 2011.

 

In the first half of 2012, Cessna’s revenues increased $224 million, 19%, compared with the corresponding period of 2011, primarily due to a $176 million impact from higher Citation business jet volume reflecting a modest recovery in the jet market and an increase of $24 million resulting from higher aftermarket volume, primarily due to part sales.  We delivered 87 and 69 Citation business jets in the first half of 2012 and 2011, respectively.  During the first half of 2012, the portion of Cessna’s revenues derived from aftermarket sales and services represented 28% of Cessna’s revenues, compared with 31% in the first half of 2011.

 

Cessna’s operating expenses increased by $81 million, 13%, in the second quarter of 2012, compared with the corresponding period of 2011, primarily due to higher direct material cost and manufacturing overhead of $61 million and $24 million, respectively, resulting from higher sales volume.

 

Cessna’s operating expenses increased by $162 million, 13%, in the first half of 2012, compared with the corresponding period of 2011, primarily due to higher direct material cost and manufacturing overhead of $122 million and $46 million, respectively, resulting from higher sales volume.

 

Cessna Segment Profit

 

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

 

(In millions)

 

Q2 2012
versus
Q2 2011

 

YTD 2012
versus
YTD 2011

 

Volume

 

$

33

 

$

59

 

Other

 

(3

)

3

 

Total change

 

$

30

 

$

62

 

 

21