q.htm

 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
_______________

FORM 10-Q

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal quarter ended June 30, 2007
 
 
OR
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-5480
_______________

TEXTRON INC.

(Exact name of registrant as specified in its charter)
_______________

Delaware
(State or other jurisdiction of
incorporation or organization)
 
05-0315468
(I.R.S. Employer Identification No.)

40 Westminster Street, Providence, RI   02903
401-421-2800
(Address and telephone number of principal executive offices)
_______________

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes  ü   No   
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer   ü    Accelerated filer ___  Non-accelerated filer ___

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

Common stock outstanding at July 14, 2007 – 124,865,625 shares

 


TEXTRON INC.

INDEX


   
Page
PART I.
FINANCIAL INFORMATION
 
     
Item 1.
 
 
3
 
4
 
5
 
7
Item 2.
14
Item 3.
23
Item 4.
23
     
PART II.
OTHER INFORMATION
 
     
Item 2.
24
Item 4.
25
Item 5.
26
Item 6.
26
 
27
     


PART I.  FINANCIAL INFORMATION
 
Item 1.  FINANCIAL STATEMENTS
 
TEXTRON INC.
Consolidated Statements of Operations (Unaudited)
(In millions, except per share amounts)
             
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Revenues
                       
Manufacturing revenues
  $
2,996
    $
2,628
    $
5,750
    $
5,078
 
Finance revenues
   
239
     
192
     
449
     
374
 
Total revenues
   
3,235
     
2,820
     
6,199
     
5,452
 
Costs, expenses and other
                               
Cost of sales
   
2,374
     
2,081
     
4,554
     
4,036
 
Selling and administrative
   
429
     
376
     
801
     
737
 
Interest expense, net
   
124
     
109
     
247
     
203
 
Provision for losses on finance receivables
   
11
      (1 )    
16
     
8
 
Total costs, expenses and other
   
2,938
     
2,565
     
5,618
     
4,984
 
Income from continuing operations before income taxes
   
297
     
255
     
581
     
468
 
Income taxes
    (82 )     (78 )     (168 )     (133 )
Income from continuing operations
   
215
     
177
     
413
     
335
 
Loss from discontinued operations, net of income taxes
    (5 )     (108 )     (7 )     (98 )
Net income
  $
210
    $
69
    $
406
    $
237
 
Basic earnings per share:
                               
Continuing operations
  $
1.72
    $
1.38
    $
3.30
    $
2.59
 
Discontinued operations, net of income taxes
    (0.03 )     (0.84 )     (0.05 )     (0.76 )
Basic earnings per share
  $
1.69
    $
0.54
    $
3.25
    $
1.83
 
Diluted earnings per share:
                               
Continuing operations
  $
1.69
    $
1.34
    $
3.24
    $
2.53
 
Discontinued operations, net of income taxes
    (0.03 )     (0.81 )     (0.05 )     (0.74 )
Diluted earnings per share
  $
1.66
    $
0.53
    $
3.19
    $
1.79
 
Dividends per share:
                               
$2.08 Preferred stock, Series A
  $
0.52
    $
0.52
    $
1.04
    $
1.04
 
$1.40 Preferred stock, Series B
  $
0.35
    $
0.35
    $
0.70
    $
0.70
 
Common stock
  $
0.3875
    $
0.3875
    $
0.775
    $
0.775
 
 
See Notes to the consolidated financial statements.
 
3.


TEXTRON INC.
Consolidated Balance Sheets (Unaudited)
(Dollars in millions)

   
June 30,
2007
   
December 30,
2006
 
Assets
           
Manufacturing group
           
Cash and cash equivalents
  $
631
    $
733
 
Accounts receivable, less allowance for doubtful accounts of $34 and $34
   
1,075
     
964
 
Inventories
   
2,518
     
2,069
 
Other current assets
   
510
     
521
 
Total current assets
   
4,734
     
4,287
 
Property, plant and equipment, less accumulated
depreciation and amortization of $2,258 and $2,147
   
1,807
     
1,773
 
Goodwill
   
1,262
     
1,257
 
Other assets
   
1,264
     
1,233
 
Total Manufacturing group assets
   
9,067
     
8,550
 
Finance group
               
Cash
   
66
     
47
 
Finance receivables, less allowance for losses of $86 and $93
   
8,253
     
8,217
 
Goodwill
   
169
     
169
 
Other assets
   
568
     
567
 
Total Finance group assets
   
9,056
     
9,000
 
Total assets
  $
18,123
    $
17,550
 
Liabilities and shareholders’ equity
               
Liabilities
               
Manufacturing group
               
Current portion of long-term debt and short-term debt
  $
86
    $
80
 
Accounts payable
   
936
     
814
 
Accrued liabilities
   
2,135
     
2,100
 
Total current liabilities
   
3,157
     
2,994
 
Other liabilities
   
2,328
     
2,329
 
Long-term debt
   
1,709
     
1,720
 
Total Manufacturing group liabilities
   
7,194
     
7,043
 
Finance group
               
Other liabilities
   
567
     
499
 
Deferred income taxes
   
492
     
497
 
Debt
   
6,937
     
6,862
 
Total Finance group liabilities
   
7,996
     
7,858
 
Total liabilities
   
15,190
     
14,901
 
Shareholders’ equity
               
Capital stock:
               
Preferred stock
   
10
     
10
 
Common stock
   
26
     
26
 
Capital surplus
   
1,893
     
1,786
 
Retained earnings
   
6,509
     
6,211
 
Accumulated other comprehensive loss
    (564 )     (644 )
     
7,874
     
7,389
 
Less cost of treasury shares
   
4,941
     
4,740
 
Total shareholders’ equity
   
2,933
     
2,649
 
Total liabilities and shareholders’ equity
  $
18,123
    $
17,550
 
Common shares outstanding (in thousands)
   
124,855
     
125,596
 
 
 
See Notes to the consolidated financial statements.

 
4.

 
TEXTRON INC.
Consolidated Statements of Cash Flows (Unaudited)
For the Six Months Ended June 30, 2007 and July 1, 2006, respectively
(In millions)
   
Consolidated
 
   
2007
   
2006
 
Cash flows from operating activities:
           
Net income
  $
406
    $
237
 
Loss from discontinued operations
   
7
     
98
 
Income from continuing operations
   
413
     
335
 
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
               
Earnings of Finance group, net of distributions
   
-
     
-
 
Depreciation and amortization
   
153
     
138
 
Provision for losses on finance receivables
   
16
     
8
 
Share-based compensation
   
18
     
17
 
Deferred income taxes
   
10
     
2
 
Changes in assets and liabilities excluding those related to acquisitions and divestitures:
               
Accounts receivable, net
    (103 )     (109 )
Inventories
    (447 )     (398 )
Other assets
   
49
     
25
 
Accounts payable
   
118
     
257
 
Accrued and other liabilities
   
36
     
58
 
Captive finance receivables, net
    (171 )     (205 )
Other operating activities, net
   
31
     
32
 
Net cash provided by operating activities of continuing operations
   
123
     
160
 
Net cash (used in) provided by operating activities of discontinued operations
    (3 )    
65
 
Net cash provided by operating activities
   
120
     
225
 
Cash flows from investing activities:
               
Finance receivables:
               
Originated or purchased
    (5,964 )     (5,475 )
Repaid
   
5,463
     
4,658
 
Proceeds on receivables sales and securitization sales
   
689
     
50
 
Capital expenditures
    (142 )     (134 )
Proceeds on sale of property, plant and equipment
   
3
     
3
 
Other investing activities, net
   
12
     
38
 
Net cash provided by (used in) investing activities of continuing operations
   
61
      (860 )
Net cash provided by (used in) investing activities of discontinued operations
   
32
      (21 )
Net cash provided by (used in) investing activities
   
93
      (881 )
Cash flows from financing activities:
               
(Decrease) increase in short-term debt
    (145 )    
389
 
Proceeds from issuance of long-term debt
   
1,070
     
1,034
 
Principal payments and retirements of long-term debt
    (992 )     (655 )
Proceeds from employee stock ownership plans
   
69
     
143
 
Purchases of Textron common stock
    (221 )     (598 )
Dividends paid
    (97 )     (147 )
Dividends paid to Manufacturing group
   
-
     
-
 
Capital contributions paid to Finance group
   
-
     
-
 
Excess tax benefits related to stock option exercises
   
12
     
18
 
Net cash (used in) provided by financing activities of continuing operations
    (304 )    
184
 
Net cash used in financing activities of discontinued operations
   
-
      (6 )
Net cash (used in) provided by financing activities
    (304 )    
178
 
Effect of exchange rate changes on cash and cash equivalents
   
8
     
7
 
Net decrease in cash and cash equivalents
    (83 )     (471 )
Cash and cash equivalents at beginning of period
   
780
     
796
 
Cash and cash equivalents at end of period
  $
697
    $
325
 
Supplemental schedule of non-cash investing and financing activities from continuing operations:
               
Capital expenditures financed through capital leases
  $
22
    $
5
 

See Notes to the consolidated financial statements.

 
5.

TEXTRON INC.
Consolidated Statements of Cash Flows (Unaudited) (Continued)
For the Six Months Ended June 30, 2007 and July 1, 2006, respectively
(In millions)
   
Manufacturing Group*
   
Finance Group*
 
   
2007
   
2006
   
2007
   
2006
 
Cash flows from operating activities:
                       
Net income
  $
406
    $
237
    $
76
    $
67
 
Loss from discontinued operations
   
7
     
98
     
-
     
-
 
Income from continuing operations
   
413
     
335
     
76
     
67
 
Adjustments to reconcile income from continuing operations to net cash provided by operating
  activities:
                               
Earnings of Finance group, net of distributions
   
59
     
13
     
-
     
-
 
Depreciation and amortization
   
134
     
119
     
19
     
19
 
Provision for losses on finance receivables
   
-
     
-
     
16
     
8
 
Share-based compensation
   
18
     
17
     
-
     
-
 
Deferred income taxes
    (2 )     (3 )    
12
     
5
 
Changes in assets and liabilities excluding those related to acquisitions and divestitures:
                               
Accounts receivable, net
    (103 )     (109 )    
-
     
-
 
Inventories
    (438 )     (356 )    
-
     
-
 
Other assets
   
24
     
18
     
20
     
1
 
Accounts payable
   
118
     
257
     
-
     
-
 
Accrued and other liabilities
   
24
     
7
     
12
     
51
 
Captive finance receivables, net
   
-
     
-
     
-
     
-
 
Other operating activities, net
   
33
     
28
      (2 )    
4
 
Net cash provided by operating activities of continuing operations
   
280
     
326
     
153
     
155
 
Net cash (used in) provided by operating activities of discontinued operations
    (3 )    
69
     
-
      (4 )
Net cash provided by operating activities
   
277
     
395
     
153
     
151
 
Cash flows from investing activities:
                               
Finance receivables:
                               
Originated or purchased
   
-
     
-
      (6,489 )     (5,996 )
Repaid
   
-
     
-
     
5,795
     
4,974
 
Proceeds on receivables sales and securitization sales
   
-
     
-
     
711
     
50
 
Capital expenditures
    (138 )     (129 )     (4 )     (5 )
Proceeds on sale of property, plant and equipment
   
3
     
3
     
-
     
-
 
Other investing activities, net
    (2 )     (4 )    
10
     
6
 
Net cash (used in) provided by investing activities of continuing operations
    (137 )     (130 )    
23
      (971 )
Net cash provided by (used in) investing activities of discontinued operations
   
32
      (21 )    
-
     
-
 
Net cash (used in) provided by investing activities
    (105 )     (151 )    
23
      (971 )
Cash flows from financing activities:
                               
(Decrease) increase in short-term debt
    (44 )     (123 )     (101 )    
512
 
Proceeds from issuance of long-term debt
   
1
     
-
     
1,069
     
1,034
 
Principal payments and retirements of long-term debt
    (3 )     (3 )     (989 )     (652 )
Proceeds from employee stock ownership plans
   
69
     
143
     
-
     
-
 
Purchases of Textron common stock
    (221 )     (598 )    
-
     
-
 
Dividends paid
    (97 )     (147 )    
-
     
-
 
Dividends paid to Manufacturing group
   
-
     
-
      (135 )     (80 )
Capital contributions paid to Finance Group
   
-
      (18 )    
-
     
18
 
Excess tax benefits related to stock option exercises
   
12
     
18
     
-
     
-
 
Net cash (used in) provided by financing activities of continuing operations
    (283 )     (728 )     (156 )    
832
 
Net cash used in financing activities of discontinued operations
   
-
      (6 )    
-
     
-
 
Net cash (used in) provided by financing activities
    (283 )     (734 )     (156 )    
832
 
Effect of exchange rate changes on cash and cash equivalents
   
9
     
6
      (1 )    
1
 
Net (decrease) increase in cash and cash equivalents
    (102 )     (484 )    
19
     
13
 
Cash and cash equivalents at beginning of period
   
733
     
786
     
47
     
10
 
Cash and cash equivalents at end of period
  $
631
    $
302
    $
66
    $
23
 
Supplemental schedule of non-cash investing and financing activities from continuing operations:
                               
Capital expenditures financed through capital leases
  $
22
    $
5
    $
-
    $
-
 

*Textron is segregated into a Manufacturing group and a Finance group, as described in Note 1 to the consolidated financial statements. The Finance group’s pre-tax income in excess of dividends paid is excluded from the Manufacturing group’s cash flows. All significant transactions between the borrowing groups have been eliminated from the consolidated column provided on page 5.

See Notes to the consolidated financial statements.
 


6.


 
TEXTRON INC.
Notes to the Consolidated Financial Statements (Unaudited)
 
Note 1:  Basis of Presentation
 
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 30, 2006.  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 the entities that operate in the Bell, Cessna and Industrial segments, while the Finance group consists of the Finance segment, comprised of Textron Financial Corporation and its subsidiaries. We designed this framework to enhance our borrowing power by separating the Finance group. Our Manufacturing group operations include the development, production and delivery of tangible goods and services, while our Finance group provides financial services. Due to the fundamental differences between each borrowing group’s activities, investors, rating agencies and analysts use different measures to evaluate each group’s performance. To support those evaluations, we present balance sheet and cash flow information for each borrowing group within the consolidated financial statements. All significant intercompany transactions are eliminated from the consolidated financial statements, including retail and wholesale financing activities for inventory sold by our Manufacturing group that is financed by our Finance group.
 
Note 2:  Inventories
 
 
(In millions)
 
June 30,
2007
   
December 30,
2006
 
Finished goods
  $
785
    $
665
 
Work in process
   
1,794
     
1,562
 
Raw materials
   
463
     
435
 
     
3,042
     
2,662
 
Less progress/milestone payments
   
524
     
593
 
    $
2,518
    $
2,069
 

Note 3:  Finance Receivables

In the first quarter of 2007, we adopted Financial Accounting Standards Board (“FASB”) Staff Position No. 13-2 “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (“FSP 13-2”).  FSP 13-2 requires a recalculation of returns on leveraged leases if there is a change or projected change in the timing of cash flows related to income taxes generated by the leveraged leases.  The impact of any estimated change in projected cash flows must be reported as an adjustment to the net leveraged lease investment and retained earnings at the date of adoption.  Our Finance group has leveraged leases with an initial investment balance of $209 million that we estimate could be impacted by changes in the timing of cash flows related to income taxes.  Upon the adoption, we reduced retained earnings for the $33 million cumulative effect of a change in accounting principle, and reduced our investment in these leveraged leases by $50 million and deferred income tax liabilities by $17 million.

7.


Note 4:  Comprehensive Income
 
Our comprehensive income for the periods is provided below:
             
   
Three Months Ended
   
Six Months Ended
 
 
(In millions)
 
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Net income
  $
210
    $
69
    $
406
    $
237
 
Other comprehensive income:
                               
Currency translation adjustment
   
27
     
-
     
29
      (3 )
Net deferred gain on hedge contracts
   
27
     
12
     
22
     
14
 
Recognition of prior service cost and unrealized losses on
pension and postretirement benefits
   
14
     
-
     
29
     
-
 
Other
    (1 )     (4 )    
-
      (2 )
Comprehensive income
  $
277
    $
77
    $
486
    $
246
 
 
Note 5:  Earnings per Share
 
We calculate basic and diluted earnings per share based on income available to common shareholders, which approximates net income for each period.  We use the weighted-average number of common shares outstanding during the period for the computation of basic earnings per share. Diluted earnings per share includes the dilutive effect of convertible preferred shares, stock options and restricted stock in the weighted-average number of common shares outstanding.

The weighted-average shares outstanding for basic and diluted earnings per share are as follows:

   
Three Months Ended
   
Six Months Ended
 
 
(In thousands)
 
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Basic weighted-average shares outstanding
   
124,851
     
128,453
     
125,013
     
129,185
 
Dilutive effect of convertible preferred shares, stock options
and restricted stock
   
2,285
     
2,841
     
2,357
     
2,817
 
Diluted weighted-average shares outstanding
   
127,136
     
131,294
     
127,370
     
132,002
 
 
Note 6:  Share-Based Compensation
 
The compensation expense we recorded in net income for our share-based compensation plans is as follows:

   
Three Months Ended
   
Six Month Ended
 
 
(In millions)
 
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Compensation expense, net of hedge income or expense
  $
28
    $
18
    $
41
    $
40
 
Income tax benefit
    (17 )     (5 )     (19 )     (18 )
Total net compensation cost included in net income
  $
11
    $
13
    $
22
    $
22
 
Net compensation costs included in discontinued operations
  $
-
    $
1
    $
-
    $
2
 
Net compensation costs included in continuing operations
  $
11
    $
12
    $
22
    $
20
 

8.


Stock option activity under the 1999 Long-Term Incentive Plan for the six months ended June 30, 2007 is as follows:
                         
   
Number of
Options
(In thousands)
   
Weighted-
Average
Exercise
Price
   
Weighted-
Average
Remaining
Contractual
Life
(In years)
   
Aggregate
Intrinsic
Value
(In millions)
 
Outstanding at beginning of year
   
5,420
    $
63.77
             
Granted
   
929
     
91.70
             
Exercised
    (1,159 )    
59.25
             
Canceled, expired or forfeited
    (65 )    
78.25
             
Outstanding at end of period
   
5,125
    $
69.67
     
6.52
    $
104
 
Exercisable at end of period
   
3,275
    $
59.49
     
5.12
    $
99
 
 
There were no significant issuances of stock options in the second quarter of 2007 or 2006.

Note 7:  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 for the three months ended June 30, 2007 and July 1, 2006 are as follows:
 
   
Pension Benefits
   
Postretirement Benefits
Other Than Pensions
 
(In millions)
 
2007
   
2006
   
2007
   
2006
 
Service cost
  $
34
    $
36
    $
2
    $
3
 
Interest cost
   
73
     
69
     
11
     
10
 
Expected return on plan assets
    (99 )     (96 )    
-
     
-
 
Amortization of prior service cost (credit)
   
5
     
4
      (1 )     (2 )
Amortization of net loss
   
12
     
12
     
5
     
5
 
Net periodic benefit cost
  $
25
    $
25
    $
17
    $
16
 
 
The components of net periodic benefit cost for the six months ended June 30, 2007 and July 1, 2006 are as follows:
             
   
Pension Benefits
   
Postretirement Benefits
Other Than Pensions
 
(In millions)
 
2007
   
2006
   
2007
   
2006
 
Service cost
  $
67
    $
71
    $
4
    $
5
 
Interest cost
   
146
     
138
     
21
     
20
 
Expected return on plan assets
    (198 )     (192 )    
-
     
-
 
Amortization of prior service cost (credit)
   
9
     
9
      (2 )     (3 )
Amortization of net loss
   
25
     
24
     
11
     
11
 
Net periodic benefit cost
  $
49
    $
50
    $
34
    $
33
 

Note 8:  Income Taxes

We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109” (“FIN 48”) at the beginning of fiscal 2007, which resulted in an increase of approximately $22 million to our December 31, 2006 retained earnings balance.  FIN 48 provides a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.  Unrecognized tax benefits represent tax positions for which reserves have been established.
 
9.

As of the date of adoption, our unrecognized tax benefits totaled approximately $356 million, of which $225 million in benefits, if recognized, would favorably affect our effective tax rate in any future period.  The remaining $131 million in unrecognized tax benefits are related to discontinued operations.  We do not believe that it is reasonably possible that our estimates of unrecognized tax benefits will change significantly in the next 12 months.

We conduct business globally and, as a result, file numerous consolidated and separate income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions.  In the normal course of business, we are subject to examination by taxing authorities throughout the world, including such major jurisdictions as Belgium, Canada, Germany, the United Kingdom and the U.S.  With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 1997 in these major jurisdictions.

We recognize interest and penalties related to unrecognized tax benefits in income tax expense in our consolidated statements of operations.  At the date of adoption, we had $77 million of accrued interest included in other liabilities on our consolidated balance sheet.

Note 9:  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 private sector 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.

In connection with the 2002 recall of certain of our Lycoming turbocharged airplane engines, a former third-party supplier filed a lawsuit against Lycoming claiming that the former supplier had been wrongly blamed for aircraft engine failures resulting from its crankshaft forging process and that Lycoming’s design was the cause of the engine failures. In February 2005, a jury returned a verdict against Lycoming for $86 million in punitive damages, $2.7 million in expert fees and $1.7 million in increased insurance costs. The jury also found that the former supplier’s claim that it had incurred $5.3 million in attorneys’ fees was reasonable.  Judgment was entered on the verdict on March 29, 2005, awarding the former supplier $9.7 million in alleged compensatory damages and attorneys’ fees and $86 million in alleged punitive damages.  While the ultimate outcome of the litigation cannot be assured, management strongly disagrees with the verdict and believes that it is probable that the verdict will be reversed through the appellate process.
 
The Internal Revenue Service (“IRS”) has challenged both the ability to accelerate the timing of tax deductions and the amounts of those deductions related to certain leveraged lease transactions within the Finance segment.  These transactions, along with other transactions with similar characteristics, have an initial investment of approximately $209 million.  Resolution of these issues may result in an adjustment to the timing of taxable income and deductions that reduce the effective yield of the leveraged lease transactions. In addition, resolution of these issues could result in the acceleration of cash payments to the IRS.  Deferred tax liabilities of $172 million are recorded on our consolidated balance sheet related to these leases at June 30, 2007. We believe that the proposed IRS adjustments are inconsistent with the tax law in existence at the time the leases were originated and intend to vigorously defend our position.

Armed Reconnaissance Helicopter Program
Bell Helicopter is performing under a U.S. Government contract for System Development and Demonstration (“SDD”) of the Armed Reconnaissance Helicopter (“ARH”).  In March 2007, we received correspondence from the U.S. Government that indicated limitations of funding on the ARH SDD contract.  Accordingly, in the first quarter of 2007 we provided for losses of $25 million related to the ARH program, consisting of $7 million in SDD costs and supplier obligations which exceeded the original SDD contract funding limit and $18 million in supplier obligations incurred in the first quarter for long-lead, low-rate initial production (“LRIP”) ARH component production.

10.
 
 
In the second quarter of 2007, the Army agreed to re-plan the ARH program and we reached a non-binding memorandum of understanding (“MOU”) related to aircraft specifications, pricing methodology and delivery schedules for 62 LRIP aircraft in two lots. The re-planned program also included additional funding for SDD costs through the end of the second quarter of 2007, which resulted in recovery of the $7 million in SDD costs previously expensed in the first quarter.  Further, we have agreed to conduct additional SDD activities on a funded-basis.

Based on the plan outlined in the MOU and our related estimates of aircraft production costs, including costs related to risks associated with achieving learning curve and schedule assumptions, it is our best estimate at this time that we will lose approximately $73 million on the production of the 62 LRIP aircraft.  Accordingly, a net charge of $48 million was recorded in the second quarter, reflecting an additional charge of $55 million for LRIP-related costs, offset by the $7 million of SDD cost recovery.  We anticipate that the contract awards will be finalized beginning in 2008, and we expect that these awards will be based on the terms outlined in the MOU.

The U.S. Government continues to have an option related to production of 18 to 36 aircraft under the original ARH program. However, it is unlikely that the option would be exercised before its term expires in December 2007 due to certain additional development requirements under the SDD contract that must be met before the option can be exercised.  As a result, the U.S. Government has agreed in the MOU to include the units under this option within the 62 LRIP aircraft specified in the MOU.

Note 10:  Guarantees and Indemnifications
 
As disclosed under the caption “Guarantees and Indemnifications” in Note 17 to the consolidated financial statements in our 2006 Annual Report on Form 10-K, we have issued or are party to certain guarantees.  As of June 30, 2007, there has been no material change to these guarantees.

We provide limited warranty and product maintenance programs, including parts and labor, for certain products for periods ranging from one to five years.  We estimate the costs that may be incurred under warranty programs and record a liability in the amount of such costs at the time product revenue is recognized.  Factors that affect this liability include the number of products sold, historical and anticipated rates of warranty claims, and cost per claim.  We assess the adequacy of our recorded warranty and product maintenance liabilities periodically and adjust the amounts as necessary.

Changes in our warranty and product maintenance liability are as follows:

   
Six Months Ended
 
 
(In millions)
 
June 30,
2007
   
July 1,
2006
 
Accrual at the beginning of period
  $
315
    $
318
 
Provision
   
93
     
95
 
Settlements
    (89 )     (73 )
Adjustments to prior accrual estimates
   
2
      (19 )
Accrual at the end of period
  $
321
    $
321
 

Note 11:  Recently Announced Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements.” This Statement replaces multiple existing definitions of fair value with a single definition, establishes a consistent framework for measuring fair value and expands financial statement disclosures regarding fair value measurements. This Statement applies only to fair value measurements that already are required or permitted by other accounting standards and does not require any new fair value measurements. SFAS No. 157 is effective for the first quarter of 2008, and we currently are evaluating the impact of adoption on our financial position and results of operations.

11.
 
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment to FASB Statement No. 115.”  SFAS 159 allows companies to choose to measure eligible assets and liabilities at fair value with changes in value recognized in earnings.  Fair value treatment for eligible assets and liabilities may be elected either prospectively upon initial recognition, or if an event triggers a new basis of accounting for an existing asset or liability.  SFAS 159 is effective in the first quarter of 2008, and we currently are evaluating the impact of adoption on our financial position and results of operations.

Note 12:  Segment Information
 
Our four reportable segments are: Bell, Cessna, Industrial and Finance.  These segments reflect the manner in which we manage our operations. Segment profit is an important measure used to evaluate 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.  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.
 
A summary of continuing operations by segment is provided below:
             
   
Three Months Ended
   
Six Months Ended
 
 
(In millions)
 
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
REVENUES
                       
MANUFACTURING:
                       
Bell
  $
915
    $
805
    $
1,854
    $
1,588
 
Cessna
   
1,203
     
1,005
     
2,171
     
1,874
 
Industrial
   
878
     
818
     
1,725
     
1,616
 
     
2,996
     
2,628
     
5,750
     
5,078
 
FINANCE
   
239
     
192
     
449
     
374
 
Total revenues
  $
3,235
    $
2,820
    $
6,199
    $
5,452
 
SEGMENT OPERATING PROFIT
                               
MANUFACTURING:
                               
Bell
  $
59
    $
65
    $
150
    $
134
 
Cessna
   
200
     
153
     
355
     
270
 
Industrial
   
59
     
54
     
119
     
103
 
     
318
     
272
     
624
     
507
 
FINANCE
   
68
     
56
     
120
     
105
 
Segment profit
   
386
     
328
     
744
     
612
 
Corporate expenses and other, net
    (66 )     (48 )     (116 )     (97 )
Interest expense, net
    (23 )     (25 )     (47 )     (47 )
Income from continuing operations before
income taxes
  $
297
    $
255
    $
581
    $
468
 


12.

Note 13: Subsequent Events

On July 18, 2007, the Board of Directors approved a two-for-one split of our common stock, which will be effected in the form of a 100% stock dividend to be distributed on August 24, 2007 to shareholders of record on August 3, 2007.  As a result of the stock split, we will issue approximately 125 million additional shares of common stock to our shareholders.  The stock split will require restatement of all historical shares and per share data in the third quarter of 2007.

Pro forma earnings per share for income from continuing operations amounts on a post-split basis for the three years ended December 30, 2006 would be as follows:

   
2006
   
2005
   
2004
 
Basic
                 
As reported
  $
5.53
    $
3.86
    $
2.73
 
Pro forma (unaudited)
  $
2.76
    $
1.93
    $
1.37
 
Diluted
                       
As reported
  $
5.43
    $
3.78
    $
2.68
 
Pro forma (unaudited)
  $
2.71
    $
1.89
    $
1.34
 

Quarterly unaudited pro forma earnings per share for income from continuing operations amounts on a post-split basis would be as follows:
             
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Basic
                       
As reported
  $
1.72
    $
1.38
    $
3.30
    $
2.59
 
Pro forma
  $
0.86
    $
0.69
    $
1.65
    $
1.30
 
Diluted
                               
As reported
  $
1.69
    $
1.34
    $
3.24
    $
2.53
 
Pro forma
  $
0.85
    $
0.67
    $
1.62
    $
1.27
 

The Board of Directors also approved the retirement of approximately 85 million shares of treasury stock to reduce annual exchange listing costs. The retirement will result in a reduction in treasury stock of approximately $4.9 billion, which is offset by reductions in capital surplus of approximately $764 million and retained earnings of approximately $4.1 billion, with no impact on total shareholders’ equity.


13.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Consolidated Results of Operations

Revenues and Segment Profit

Second Quarter of 2007

Revenues increased $415 million, or 15%, to $3.2 billion in the second quarter of 2007 compared with the corresponding quarter in 2006.  This increase is primarily due to higher manufacturing volume and product mix of $240 million, higher pricing of $83 million, more revenues in our Finance segment of $47 million, favorable foreign exchange impact of $30 million in the Industrial segment and the benefit from acquisitions of $32 million, largely due to Overwatch Systems.  These increases were partially offset by the 2006 divestiture of non-core product lines of $16 million in the Industrial segment.

Segment profit increased $58 million, or 18%, to $386 million in the second quarter of 2007, compared with the corresponding period in 2006.  This increase is primarily due to higher pricing of $83 million, a net benefit from higher volume and product mix of $34 million and more profit in the Finance segment of $12 million.  These increases were partially offset by inflation of $60 million and unfavorable cost performance of $20 million, which included a charge for Bell Helicopter’s Armed Reconnaissance Helicopter (“ARH”) program of $48 million in the second quarter of 2007.

First Half of 2007

Revenues increased $747 million, or 14%, to $6.2 billion in the first half of 2007 compared with the corresponding period in 2006.  This increase is primarily due to higher manufacturing volume and product mix of $397 million, higher pricing of $154 million, more revenues in our Finance segment of $75 million, favorable foreign exchange impact of $65 million in the Industrial segment and the benefit from acquisitions of $59 million, largely due to Overwatch Systems, and the reimbursement of costs related to Hurricane Katrina of $28 million.  These increases were partially offset by the 2006 divestiture of non-core product lines of $32 million in the Industrial segment.

Segment profit increased $132 million, or 22%, to $744 million in the second half of 2007, compared with the corresponding period in 2006.  This increase is primarily due to higher pricing of $154 million, a net benefit from higher volume and product mix of $48 million, favorable cost performance of $23 million and more profit in the Finance segment of $15 million.  These increases were partially offset by inflation of $110 million.  Our favorable cost performance includes the reimbursement of costs related to Hurricane Katrina of $28 million and is net of a charge for Bell Helicopter’s ARH program of $73 million.

Backlog

Backlog in the Cessna and Bell Helicopter businesses grew to $14.0 billion at the end of second quarter of 2007, compared to the end of 2006, reflecting an increase of approximately $1.9 billion at Cessna and $500 million at Bell Helicopter, primarily for the V-22 Lot 11 contract.  At Cessna, new business jet orders outpaced deliveries by 2.5 to 1 in the first half of 2007, essentially filling out the 2008 delivery plan of approximately 470 jets.  In comparison, we expect to deliver about 380 jets in 2007.

Corporate Expenses and Other, net

Corporate expenses and other, net increased $18 million in the second quarter of 2007, compared with 2006, primarily due to $12 million of higher compensation expenses, primarily as a result of our stock price appreciation, and $4 million of higher professional fees.

14.
 
 
Corporate expenses and other, net increased $19 million in the first half of 2007 compared with 2006, primarily due to $5 million of higher compensation expenses, $5 million of increased costs for divested operations and $5 million of higher professional fees.

Income Taxes
 
A reconciliation of the federal statutory income tax rate to the effective income tax rate is provided below:
 

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Federal statutory income tax rate
    35.0 %     35.0 %     35.0 %     35.0 %
Increase (decrease) in taxes resulting from:
                               
State income taxes
   
1.4
     
1.6
     
1.3
     
1.6
 
Foreign tax rate differential
    (1.6 )     (3.7 )     (1.6 )     (3.7 )
Manufacturing deduction
    (1.6 )     (0.6 )     (1.6 )     (0.6 )
Equity hedge income
    (1.9 )     (1.0 )     (1.0 )     (0.9 )
Export sales benefit
   
-
      (1.1 )    
-
      (1.1 )
Canadian functional currency
   
-
     
-
      (0.3 )    
-
 
Favorable tax settlements
    (3.3 )    
-
      (1.7 )     (2.6 )
Other, net
    (0.4 )    
0.4
      (1.2 )    
0.7
 
Effective income tax rate
    27.6 %     30.6 %     28.9 %     28.4 %

The effective tax rate for the full year is expected to be in the range of 31% to 32%.

Segment Analysis

Our four reportable segments are: Bell, Cessna, Industrial and Finance.  These segments reflect the manner in which we manage our operations. Segment profit is an important measure used to evaluate 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.
 
Bell
           
   
Three Months Ended
   
Six Months Ended
 
 
(In millions)
 
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Revenues
  $
915
    $
805
    $
1,854
    $
1,588
 
Segment profit
   
59
     
65
     
150
     
134
 

U.S. Government Business
In the second quarter of 2007, revenues increased $70 million, compared with 2006 primarily due to higher net volume of $50 million and the benefit from acquisitions of $22 million. The volume increase is primarily due to higher V-22 volume of $47 million, more Armored Security Vehicle (“ASV”) deliveries worth $31 million and higher Intelligent Battlefield Systems (“IBS”) volume of $11 million, partially offset by $26 million in lower helicopter spares and service sales, and lower volume of $17 million for Joint Direct Attack Munitions (“JDAM”). Our ASV deliveries are well ahead of last year and a recent order from the U.S. Army will allow us to continue current production levels well into 2008.

In the second quarter of 2007, profit in our U.S. Government business decreased $40 million, compared with 2006, primarily due to unfavorable performance of $45 million. We recorded a $48 million charge in the second quarter of 2007 for the ARH program resulting in higher charges of $42 million over the corresponding quarter of 2006.  In addition, we had lower profitability for the V-22 program of $12 million that was partially offset by
 
15.
 
favorable ASV performance of $11 million. The lower profitability in the V-22 program is primarily due to a $7 million award fee received in 2006. Additionally, higher overhead costs incurred and absorbed into inventory in 2006 have negatively impacted current year V-22 margins. V-22 aircraft delivered in 2007 were in production during 2006 and absorbed higher overhead costs resulting from our prior year investments to improve operational systems. Improved ASV performance reflects overhead improvements of $5 million as well as other manufacturing efficiencies.  

In the first half of 2007, revenues increased $199 million, compared with 2006 primarily due to higher net volume and mix of $137 million, the benefit from acquisitions of $38 million and a cost reimbursement related to Hurricane Katrina of $28 million. The volume increase is primarily due to more ASV deliveries of $94 million, higher H-1 revenue of $59 million, higher V-22 volume of $39 million and higher IBS volume of $26 million, partially offset by $42 million in lower helicopter spares and service sales, and lower volume of $31 million for JDAM.

In the first half of 2007, profit in our U.S. Government business decreased $28 million, compared with 2006. The decrease was primarily due to unfavorable performance of $31 million and the net impact from inflation and pricing of $13 million, partially offset by higher net volume and mix of $13 million. The unfavorable performance reflected higher charges recorded for the ARH program of $64 million and lower V-22 profitability of $20 million, partially offset by the Hurricane Katrina cost reimbursement of $28 million and favorable ASV performance of $11 million.
 
ARH Program - Bell Helicopter is performing under a U.S. Government contract for System Development and Demonstration (“SDD”) of the ARH.  In March 2007, we received correspondence from the U.S. Government that indicated limitations of funding on the ARH SDD contract.  Accordingly, in the first quarter of 2007 we provided for losses of $25 million related to the ARH program, consisting of $7 million in SDD costs and supplier obligations which exceeded the original SDD contract funding limit and $18 million in supplier obligations incurred in the first quarter for long-lead, low-rate initial production (“LRIP”) ARH component production.

In the second quarter of 2007, the Army agreed to re-plan the ARH program and we reached a non-binding memorandum of understanding (“MOU”) related to aircraft specifications, pricing methodology and delivery schedules for 62 LRIP aircraft in two lots. The re-planned program also included additional funding for SDD costs through the end of the second quarter of 2007, which resulted in recovery of the $7 million in SDD costs previously expensed in the first quarter.  Further, we have agreed to conduct additional SDD activities on a funded-basis.

Based on the plan outlined in the MOU and our related estimates of aircraft production costs, including costs related to risks associated with achieving learning curve and schedule assumptions, it is our best estimate at this time that we will lose approximately $73 million on the production of the 62 LRIP aircraft.  Accordingly, a net charge of $48 million was recorded in the second quarter, reflecting an additional charge of $55 million for LRIP-related costs, offset by the $7 million of SDD cost recovery.  We anticipate that the contract awards will be finalized beginning in 2008, and we expect that these awards will be based on the terms outlined in the MOU.  We expect that any contracts for lots subsequent to the initial two LRIP lots will be priced to fully recover costs plus a reasonable profit.

The U.S. Government continues to have an option related to production of 18 to 36 aircraft under the original ARH program. However, it is unlikely that the option would be exercised before its term expires in December 2007 due to certain additional development requirements under the SDD contract that must be met before the option can be exercised.  As a result, the U.S. Government has agreed in the MOU to include the units under this option within the 62 LRIP aircraft specified in the MOU.

Commercial Business
In the second quarter of 2007, commercial revenues increased $40 million, compared with 2006 primarily due to higher pricing of $21 million, the benefit from acquisitions of $10 million and higher volume of $9 million. Higher volume reflects more helicopter deliveries of $39 million, partially offset by lower spares and service volume of $13 million and lower Huey II kit deliveries of $12 million.
 
 
16.

In the second quarter of 2007, commercial profit increased $34 million, compared with 2006 primarily due to higher pricing of $21 million, favorable cost performance of $15 million and lower engineering, research and development expense of $13 million, partially offset by inflation of $10 million.  The lower engineering, research and development expense resulted from the delay of spending for such cost to the second half of 2007.

In the first half of 2007, commercial revenues increased $67 million, compared with 2006 primarily due to higher pricing of $40 million and the benefit from acquisitions of $21 million. Volume increased slightly as higher helicopter deliveries of $52 million were partially offset by lower Huey II kit deliveries of $34 million and lower spares and service volume of $11 million.

In the first half of 2007, commercial profit increased $44 million, compared with 2006 primarily due to higher pricing of $40 million, favorable cost performance of $22 million and lower engineering, research and development expense of $17 million, partially offset by inflation of $19 million and the net impact of unfavorable product mix of $14 million.
 
Cessna
           
   
Three Months Ended
   
Six Months Ended
 
 
(In millions)
 
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Revenues
  $
1,203
    $
1,005
    $
2,171
    $
1,874
 
Segment profit
   
200
     
153
     
355
     
270
 

Cessna has continued to grow its revenues and segment profit due, in part, to its increased international deliveries,  as over half of our 95 Citation business jets in the second quarter of 2007 went to international customers, primarily in Europe and Latin America. We delivered a total of 76 jets in the second quarter of 2006. In May, the Mustang became the first new-generation entry level jet to be certified in Europe. We have continued to ramp up our Mustang production with 10 aircraft delivered in the second quarter of 2007.

Revenues at Cessna increased $198 million in the second quarter of 2007, compared with 2006 due to higher volume of $147 million, primarily related to Citation business jets, and higher pricing of $51 million.  Segment profit increased $47 million at Cessna in the second quarter of 2007, compared with 2006 primarily due to higher pricing of $51 million and the impact of the higher volume of $31 million, partially offset by inflation of $26 million and increased product development expense of $9 million. Favorable warranty performance of $9 million resulting from lower point of sale warranty costs for aircraft sold during the second quarter of 2007, compared with 2006, was offset by other favorable warranty performance of $10 million recorded in 2006.

Revenues at Cessna increased $297 million in the first half of 2007, compared with 2006 due to higher volume of $202 million, primarily related to Citation business jets, and higher pricing of $95 million. Segment profit increased $85 million at Cessna in the first six months of 2007, compared with 2006 primarily due to higher pricing of $95 million and the impact of the higher volume of $47 million, partially offset by inflation of $44 million and increased product development expense of $16 million. Favorable warranty performance of $16 million resulting from lower point of sale warranty costs for aircraft sold during the first half of 2007, compared with 2006, was offset by other favorable warranty performance of $19 million recorded in 2006.

Industrial
           
   
Three Months Ended
   
Six Months Ended
 
 
(In millions)
 
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Revenues
  $
878
    $
818
    $
1,725
    $
1,616
 
Segment profit
   
59
     
54
     
119
     
103
 


17.

Revenues in the Industrial segment increased $60 million in the second quarter of 2007, compared with 2006 primarily due to higher volume of $34 million, favorable foreign exchange impact of $30 million and higher pricing of $13 million, partially offset by the divestiture of non-core product lines of $16 million.  Profit in the Industrial segment increased $5 million in the second quarter of 2007, compared with 2006 mainly due to $13 million of higher pricing, $7 million of improved cost performance and $2 million each in higher volume and favorable foreign exchange, partially offset by $19 million of inflation.

Revenues in the Industrial segment increased $109 million in the first half of 2007, compared with 2006 primarily due to favorable foreign exchange impact of $65 million, higher volume of $52 million and higher pricing of $23 million, partially offset by the divestiture of non-core product lines of $32 million.  Profit in the Industrial segment increased $16 million in the first half of 2007, compared with 2006 mainly due to $26 million of improved cost performance and higher pricing of $23 million, partially offset by $38 million of inflation.

 
Finance
           
   
Three Months Ended
   
Six Months Ended
 
 
(In millions)
 
June 30,
2007
   
July 1,
2006
   
June 30,
2007
   
July 1,
2006
 
Revenues
  $
239
    $
192
    $
449
    $
374
 
Segment profit
   
68
     
56
     
120
     
105
 

The Finance segment continued to grow its managed finance receivables with a 5%, or $507 million, increase since the end of 2006.  In addition, our already strong portfolio quality statistics continued to improve.

Revenues in the Finance segment increased $47 million in the second quarter of 2007, compared with 2006. The increase was primarily due to a $26 million increase related to higher average finance receivables and a $21 million gain on the sale of a leveraged lease investment. Average finance receivables increased primarily due to growth in the aviation, distribution and resort finance businesses, partially offset by an increase in the level of distribution finance receivables sold.

Profit in the Finance segment increased $12 million in the second quarter of 2007, compared with 2006 primarily due to a $21 million gain on the sale of a leveraged lease investment and a $12 million increase related to higher average finance receivables, partially offset by a $12 million increase in the provision for losses and $8 million related to the impact of competitive pricing pressures. The increase in provision for losses is primarily attributable to $5 million of higher provision for losses related to specific reserving actions taken on one account in the media finance portfolio, and a $6 million reduction in 2006 in the rate utilized to establish the allowance for losses in several portfolios due to improvements in credit quality.

Revenues in the Finance segment increased $75 million in the first half of 2007, compared with 2006. The increase was primarily due to a $59 million increase related to higher average finance receivables, a $21 million gain on the sale of a leveraged lease investment and a $15 million increase from a higher interest rate environment, partially offset by $13 million in lower leveraged lease earnings due to an unfavorable cumulative earnings adjustment attributable to the recognition of residual value impairments. Average finance receivables increased primarily due to growth in the aviation, distribution and resort finance businesses, partially offset by an increase in the level of distribution finance receivables sold.
 
Profit in the Finance segment increased $15 million in the first half of 2007, compared with 2006 primarily due to a $28 million increase related to higher average finance receivables and a $21 million gain on the sale of a leveraged lease investment, partially offset by $13 million in lower leveraged lease earnings due to an unfavorable cumulative earnings adjustment attributable to the recognition of residual value impairments, $12 million related to the impact of competitive pricing pressures and an $8 million increase in the provision for losses, largely due to one account.
 
18.


The following table presents information about the Finance segment’s portfolio quality:
             
   
June 30,
   
December 30,
 
(Dollars in millions)
 
2007
   
2006
 
Nonperforming assets
  $
89
    $
113
 
Nonaccrual finance receivables
  $
51
    $
75
 
Allowance for losses
  $
86
    $
93
 
Ratio of nonperforming assets to total finance assets
    1.00 %     1.28 %
Ratio of allowance for losses on receivables to nonaccrual finance receivables
    171.3 %     123.1 %
60+ days contractual delinquency as a percentage of finance receivables
    0.56 %     0.77 %
 
The Finance segment has continued to sustain improvements in portfolio quality as indicated by an improved nonperforming assets percentage and 60+ days contractual delinquency percentage.  Net charge-offs as a percentage of average finance receivables increased to 0.52% during the first half of 2007 as compared with 0.35% for the corresponding period of 2006.  The increase in the percentage reflects charge-off activity in 2007 that primarily relates to accounts for which a specific allowance for losses had been established in previous periods.  As a result of these charge-offs, the allowance for losses on receivables decreased by $7 million in the first half of 2007.  This decrease corresponds with a $24 million decrease in nonaccrual finance receivables during the same period and results in an increase in the allowance for losses as a percentage of nonaccrual finance receivables.
 
Liquidity and Capital Resources
 
Our financings are conducted through two separate borrowing groups. The Manufacturing group consists of Textron Inc., consolidated with the entities that operate in the Bell, Cessna and Industrial segments, while the Finance group consists of the Finance segment, comprised of Textron Financial Corporation and its 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.

Through our Finance group, we provide diversified commercial financing to third parties.  In addition, this group finances retail purchases and leases for new and used aircraft and equipment manufactured by our Manufacturing group, otherwise known as captive financing.  In the consolidated statements of cash flows, cash received from customers or from securitizations is reflected as operating activities when received. However, in the cash flow information provided for the separate borrowing groups, cash flows related to captive financing activities are reflected based on the operations of each group. For example, when product is sold by our Manufacturing group to a customer that is financed by the Finance group, the origination of the finance receivable is recorded within investing activities as a cash outflow on our Finance group’s statement of cash flows.  Meanwhile, the Manufacturing group records the cash received from the Finance group on the customer’s behalf within operating cash flows as a cash inflow on our Manufacturing group’s statement of cash flows. Although cash is transferred between the two borrowing groups, there is no cash transaction reported in the consolidated cash flows at the time of the original financing. These captive financing activities, along with all significant intercompany transactions, are reclassified or eliminated from the consolidated statements of cash flows, as detailed below in the operating cash flows of continuing operations section.

 
19.
 
The debt (net of cash)-to-capital ratio for our Manufacturing group as of June 30, 2007 was 28%, compared with 29% at December 30, 2006, and the gross debt-to-capital ratio as of June 30, 2007 was 38%, compared with 40% at December 30, 2006.  Our Manufacturing group targets a gross debt-to-capital ratio that is consistent with an A rated company.

We have a policy of maintaining unused committed bank lines of credit in an amount not less than outstanding commercial paper balances.  These facilities are in support of commercial paper and letters of credit issuances only, and neither of these primary lines of credit was drawn at June 30, 2007 or December 30, 2006.

Our primary committed credit facilities at June 30, 2007 include the following:
(In millions)
 
Facility
Amount
   
Commercial Paper
Outstanding
   
Letters of Credit
Outstanding
   
Amount Not Reserved as Support for Commercial Paper and Letters of Credit
 
Manufacturing group – multi-year
facility expiring in 2012*
  $
1,250
    $
-
    $
20
    $
1,230
 
Finance group - multi-year
    facility expiring in 2012
  $
1,750
    $
1,624
    $
12
    $
114
 
 
*The Finance group is permitted to borrow under this multi-year facility.
 
At June 30, 2007, our Finance group had $2.7 billion in debt and $475 million in other liabilities that are payable within the next 12 months.
 
Operating Cash Flows of Continuing Operations
     
   
Six Months Ended
 
(In millions)
 
June 30, 2007
   
July 1, 2006
 
Manufacturing group
  $
280
    $
326
 
Finance group
   
153
     
155
 
Reclassifications and elimination adjustments
    (310 )     (321 )
Consolidated
  $
123
    $
160
 

Our consolidated operating cash flows decreased in the first half of 2007 compared with the first half of 2006 primarily due to the timing of payments of accounts payable for the Manufacturing group, as well as a $49 million increase in inventory levels to support continued growth in our Cessna and Bell Helicopter businesses, partially offset by an increase in income from continuing operations and a $40 million decrease in accounts receivable and captive finance receivables.

Reclassifications between operating and investing cash flows and eliminations adjustments are summarized below:
 
   
Six Months Ended
 
(In millions)
 
June 30, 2007
   
July 1, 2006
 
Reclassifications from investing activities:
           
Finance receivable originations for Manufacturing group
inventory sales
  $ (525 )   $ (521 )
Cash received from customers and securitizations for
captive financing
   
354
     
316
 
Other
    (4 )     (36 )
Total reclassifications from investing activities
    (175 )     (241 )
Dividends paid by Finance group to Manufacturing group
    (135 )     (80 )
Total reclassifications and adjustments
  $ (310 )