Textron 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended October 2, 2010
For the transition period from ____ to ____.
Commission File Number 1-5480
(Exact name of registrant as specified in its charter)
40 Westminster Street, Providence, RI 02903
(Address of principal executive offices)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ü No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ü No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No ü
As of October 16, 2010, there were 274,900,552 shares of common stock outstanding.
Consolidated Statements of Operations (Unaudited)
(In millions, except per share amounts)
See Notes to the consolidated financial statements.
Consolidated Balance Sheets (Unaudited)
(Dollars in millions, except share data)
Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended October 2, 2010 and October 3, 2009, respectively
See Notes to the consolidated financial statements
Consolidated Statements of Cash Flows (Unaudited) (Continued)
For the Nine Months Ended October 2, 2010 and October 3, 2009, respectively
See Notes to the consolidated financial statements.
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 January 2, 2010. 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. We have reclassified certain prior period amounts to conform to the current period presentation.
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 is also the Finance segment, consists of Textron Financial Corporation, its subsidiaries and the securitization trusts consolidated into it, along with 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.
Note 2: Special Charges
In the fourth quarter of 2008, we initiated a restructuring program to reduce overhead costs and improve productivity across the company and announced the exit of portions of our commercial finance business. Our restructuring program primarily includes corporate and segment direct and indirect workforce reductions and the consolidation of certain operations. By the end of 2010, we expect to have eliminated approximately 12,200 positions worldwide representing approximately 28% of our global workforce since the inception of the program. As of October 2, 2010, we have terminated approximately 11,100 employees and have exited 28 leased and owned facilities and plants under this program.
Since the inception of the restructuring program in the fourth quarter of 2008, we have incurred the following costs through October 2, 2010:
Special charges by segment for the three months ended October 2, 2010 and October 2, 2009 are as follows:
Special charges by segment for the nine months ended October 2, 2010 and October 3, 2009 are as follows:
In the third quarter of 2010, we substantially liquidated the assets held by a Canadian entity within the Finance segment. Accordingly, we recorded a non-cash charge of $91 million ($74 million after-tax) within special charges to reclassify the entity’s cumulative currency translation adjustment amount within other comprehensive income to the income statement. The reclassification of this amount had no impact on shareholders’ equity.
An analysis of our restructuring reserve activity is summarized below:
We estimate that we will incur approximately $10 million in restructuring costs in the fourth quarter of 2010, primarily related to severance costs at the Cessna and Finance segments, most of which will be paid in the fourth quarter. We anticipate that the program will be substantially completed in 2010; however, we expect to incur additional restructuring costs of up to $15 million in 2011 as we complete the restructuring actions we have already announced, including severance costs related to our exit from the non-captive portion of our commercial finance business and severance and other cash costs related to the consolidation and relocation of Cessna’s facilities.
Note 3: Retirement Plans
We provide defined benefit pension plans and other postretirement benefits to eligible employees. The components of net periodic benefit cost for these plans are as follows:
Note 4: Income Tax Expense (Benefit)
The third quarter 2010 effective tax rate benefit differs from the U.S. Federal statutory rate primarily due to a detriment of 21% related to the nondeductible portion of a cumulative currency translation charge resulting from the substantial liquidation of a Canadian entity within the Finance segment, as discussed in Note 2. This detriment was partially offset by a 16% benefit related to a higher proportion of income attributable to international operations in countries with lower tax rates.
For the nine months ended October 2, 2010, the effective tax rate provision differs from the U.S. Federal statutory rate primarily due to a 36% detriment related to the nondeductible portion of a cumulative currency translation charge resulting from the substantial liquidation of a Canadian entity within the Finance segment and a 27% detriment related to a change in the tax treatment of the Medicare Part D program related to U.S. health-care legislation enacted in the first quarter, offset by a 69% benefit related to changes in the functional currency of two Canadian subsidiaries and benefits related to a higher proportion of income attributable to international operations in countries with lower tax rates.
In the third quarter of 2009, the rate included a 416% benefit attributed to our international operations as a result of favorable tax settlements of prior year tax disputes, partially offset by a 173% detriment for unbenefited losses attributable to CitationAir. For the nine months ended October 3, 2009, the effective tax rate benefit differs from the U.S. Federal statutory rate due primarily to a 34% favorable impact attributed to our international operations as a result of favorable tax settlements of prior year tax disputes and the benefit attributable to the adoption, for Canadian income tax purposes, of the U.S. dollar as the functional currency for one of our wholly-owned Canadian subsidiaries; 14% due to a reduction in unrecognized tax benefits resulting from a capital gain on the sale of CESCOM and 9% due to a reduction in a valuation allowance related to contingent payments on a prior year transaction.
Note 5: Comprehensive Income
Our comprehensive income, net of taxes, is provided below:
Note 6: Earnings Per Share and Shareholders’ Equity
Earnings Per Share
We calculate basic and diluted earnings per share based on net income, which approximates income available to common shareholders for each period. Basic earnings per share is calculated using the two-class method. This method includes the weighted-average number of common shares outstanding during the period and restricted stock units to be paid in stock, which are deemed participating securities as they provide nonforfeitable rights to dividends. Diluted earnings per share considers the dilutive effect of all potential future common stock, including convertible preferred shares, stock options, restricted stock units and the shares that could be issued upon the conversion of our 4.50% Convertible Notes and upon the exercise of the related warrants. The convertible note call options purchased in connection with the issuance of the 4.50% Convertible Notes are excluded from the calculation of diluted EPS as their impact is always anti-dilutive.
Upon conversion of our 4.50% Convertible Notes, as described in Note 9, 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 dilutive potential common shares for purposes of calculating diluted EPS.
The weighted-average shares outstanding for basic and diluted earnings per share are as follows:
Stock options to purchase 7 million shares of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding for both the three- and nine-month periods ended October 2, 2010 as the exercise prices were greater than the average market price of our common stock for the periods. These securities may dilute earnings per share in the future. For the three months ended October 2, 2010, the potential dilutive effect of 23 million weighted-average shares of stock options, restricted stock units and the shares that could be issued upon the conversion of our 4.50% Convertible Notes and upon the exercise of the related warrants was excluded from the computation of diluted weighted-average shares outstanding as the shares would have an anti-dilutive effect on the loss from continuing operations.
For the three and nine months ended October 3, 2009, stock options to purchase 8 million and 9 million shares, respectively, of common stock outstanding are excluded from our calculation of diluted weighted-average shares outstanding as the exercise prices were greater than the average market price of our common stock for the periods. For the nine months ended October 3, 2009, the potential dilutive effect of 3.5 million weighted-average shares of stock options, restricted stock units, convertible preferred stock and the shares that could be issued upon the conversion of our 4.50% Convertible Notes and upon the exercise of the related warrants was excluded from the computation of diluted weighted-average shares outstanding as the shares would have an anti-dilutive effect on the loss from continuing operations.
Shareholders’ Equity - Stock Option Exchange Program>
On April 28, 2010, Textron’s shareholders approved a proposal to allow for a one-time stock option exchange program. The program provided eligible employees, other than executive officers, an opportunity to exchange certain outstanding stock options with exercise prices substantially above the current market price of our common stock for a lesser number of stock options with an exercise price set at current market value and a fair value that was approximately 15% lower than the fair value of the “out of the money” options which they replaced. We believe that this program was necessary to motivate and retain key employees and to reinforce the alignment of our employees’ interests with those of our shareholders. The program commenced on July 2, 2010 and expired on July 30, 2010. As a result of this program, 2.6 million outstanding eligible stock options were exchanged for 1.0 million new options at an exercise price of $20.76. The new options will vest the later of 12 months from the exchange date or the remaining term of the eligible stock option for which it was exchanged. The new options were treated as a modification under the accounting guidance for equity-based compensation. Accordingly, since we discounted the fair value of the new options by 15% of the fair value of the options exchanged, we did not incur incremental expense associated with the modification.
Stock option activity under the 2007 Long-Term Incentive Plan for the nine months ended October 2, 2010 is as follows:
At October 2, 2010, our outstanding options had an aggregate intrinsic value of $13 million and our exercisable options had an aggregate intrinsic value of $5 million.
Note 7: Accounts Receivable and Finance Receivables Held for Investment
We have unbillable receivables 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 $171 million at October 2, 2010 and $170 million at January 2, 2010.
The activity in the Finance group’s allowances for loan losses is provided below:
We periodically evaluate individual non-homogeneous finance receivables held for investment for impairment. We also evaluate portfolios of homogeneous loans and loans in non-homogeneous portfolios that are not specifically identified as impaired for impairment on a portfolio basis, as opposed to on an individual loan basis, and establish the necessary allowance for loan losses 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. Impaired finance receivables are classified as either
nonaccrual or accrual loans. We have suspended the accrual of interest income on nonaccrual finance receivables, which include accounts that are contractually delinquent by more than three months, unless collection is not doubtful, and accounts for which interest has been suspended based on detailed individual review without regard to contractual delinquency. We do not use the cash basis method to recognize interest income on these receivables. Impaired accrual finance receivables represent loans with original terms that have been or are expected to be significantly modified to reflect deferred principal payments, generally at market interest rates, for which collection of principal and interest is not doubtful.
Our impaired finance receivables are as follows:
The average recorded investment in impaired nonaccrual finance receivables was $898 million and $508 million for the nine months ended October 2, 2010 and October 3, 2009, respectively. The average recorded investment in impaired accrual finance receivables amounted to $130 million and $116 million for the nine months ended October 2, 2010 and October 3, 2009, respectively.
Our nonaccrual finance receivables include impaired finance receivables, as well as accounts in homogeneous loan portfolios that are not considered to be impaired but are contractually delinquent by more than three months. At October 2, 2010 and January 2, 2010, nonaccrual finance receivables totaled $876 million and $1.04 billion, respectively. The reduction in nonaccrual finance receivables primarily reflects the resolution of several significant accounts through repossession of collateral, restructure of finance receivables and cash collections, partially offset by new finance receivables identified as nonaccrual in 2010. New finance receivables identified as nonaccrual were primarily comprised of accounts secured by golf course property, aircraft and marinas. The net reductions by collateral type include $93 million for general aviation aircraft, $40 million of dealer inventory, $34 million for golf course property and $20 million for hotels, partially offset by a $38 million increase in accounts secured by marinas.
Note 8: Inventories
Note 9: Debt
On May 5, 2009, we issued $600 million of 4.5% Convertible Notes with a maturity date of May 1, 2013 and concurrently purchased call options to acquire our common stock and sold warrants to purchase our common stock for the purpose of reducing the potential dilutive effect to our shareholders and/or our cash outflow upon the conversion of the Convertible Notes. For more information on these transactions, see Note 8 to the Consolidated Financial Statements in Textron’s 2009 Annual Report on Form 10-K. For at least 20 trading days during the 30 consecutive trading days ended September 30, 2010, our common stock price exceeded the conversion threshold
price set forth for these Convertible Notes of $17.06 per share. Accordingly, the notes are convertible at the holder’s option through December 31, 2010. 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. We intend to settle the face value of the Convertible Notes in cash. Based on an October 2, 2010 stock price of $20.75, the "if converted value" exceeds the face amount of the notes by $348.6 million; however, after giving effect to the exercise of the call options and warrants, the incremental cash or share settlement in excess of the face amount would result in either an 11 million net share issuance or a cash payment of $228.6 million, or a combination of cash and stock, at our option. We have continued to classify these Convertible Notes as long-term based on our intent and ability to maintain the debt outstanding for at least one year through the use of various funding sources available to us.
Note 10: Guarantees and Indemnifications
As disclosed under the caption “Guarantees and Indemnifications” in Note 18 to the Consolidated Financial Statements in Textron’s 2009 Annual Report on Form 10-K, we have issued or are party to certain guarantees. As of October 2, 2010, 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. Additionally, we may establish warranty liabilities related to the issuance of aircraft service bulletins for aircraft no longer covered under the limited warranty programs.
Changes in our warranty and product maintenance liabilities are as follows:
Note 11: 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 April 6, 2010, a jury in the Philadelphia Common Pleas Court returned verdicts against Avco Corporation, which includes the Lycoming Engines operating division, for $24.7 million in compensatory damages and $64 million in punitive damages in an aviation products liability case involving a 1999 accident. Judgment has not been entered pending post-trial motions. While the ultimate outcome of the litigation cannot be assured, we strongly disagree with the verdicts and intend to appeal the verdicts if our post-trial motions are unsuccessful. We believe that it is probable that the verdicts will be reversed through the appellate process.
Note 12. 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 (the “inputs”) 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 exists, requiring companies to develop their own assumptions. Observable inputs that do not meet the criteria of Level 1, and include quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets and liabilities in markets that are not active, are categorized as Level 2. Level 3 inputs are those that reflect our estimates about the assumptions market participants would use in pricing the asset or liability, based on the best information available in the circumstances. Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach, and may use unobservable inputs such as projections, estimates and management’s interpretation of current market data. These unobservable inputs are only utilized 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
Our assets and liabilities that are recorded at fair value on a recurring basis consist of derivative financial instruments, which are categorized as Level 2 in the fair value hierarchy. The notional and fair value amounts of these instruments that are designated as hedging instruments are provided below: