Textron - 10-Q quarterly report FY2017 Q2

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

Commission File Number 1-5480

Textron Inc.

(Exact name of registrant as specified in its charter)

(401) 421-2800

(Registrant’s telephone number, including area code)

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

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

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

Large accelerated filer  [  ü ]                                       Accelerated filer  [ __ ]                                       Non-accelerated filer  [ __ ]

Smaller reporting company  [ __ ]                                       Emerging growth company  [ __ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ __ ]

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

As of July 14, 2017, there were 264,713,726 shares of common stock outstanding.

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TEXTRON INC.

Index to Form 10-Q

For the Quarterly Period Ended July 1, 2017

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PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

TEXTRON INC.
Consolidated Statements of Operations (Unaudited)

See Notes to the Consolidated Financial Statements.

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TEXTRON INC.

Consolidated Statements of Comprehensive Income (Unaudited)

See Notes to the Consolidated Financial Statements.

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TEXTRON INC.

Consolidated Balance Sheets (Unaudited)

See Notes to the Consolidated Financial Statements.

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TEXTRON INC.

Consolidated Statements of Cash Flows (Unaudited)

For the Six Months Ended July 1, 2017 and July 2, 2016, respectively

See Notes to the Consolidated Financial Statements.

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TEXTRON INC.

Consolidated Statements of Cash Flows (Unaudited) (Continued)

For the Six Months Ended July 1, 2017 and July 2, 2016, respectively

See Notes to the Consolidated Financial Statements.

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TEXTRON INC.

Notes to the Consolidated Financial Statements (Unaudited)

Note 1.  Basis of Presentation

Our Consolidated Financial Statements include the accounts of Textron Inc. (Textron) and its majority-owned subsidiaries.  We have prepared these unaudited consolidated financial statements in accordance with accounting principles generally accepted in the U.S. for interim financial information.  Accordingly, these interim financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements.  The consolidated interim financial statements included in this quarterly report should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016.  In the opinion of management, the interim financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for the fair presentation of our consolidated financial position, results of operations and cash flows for the interim periods presented.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

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

Use of Estimates

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

We periodically change our estimates of revenues and costs on certain long-term contracts that are accounted for under the percentage-of-completion method of accounting.  These changes in estimates increased income from continuing operations before income taxes in the second quarter of 2017 and 2016 by $9 million and $10 million, respectively, ($6 million after tax, or $0.02 per diluted share for both periods).  For the second quarter of 2017 and 2016, the gross favorable program profit adjustments totaled $23 million and $19 million, respectively, and the gross unfavorable program profit adjustments totaled $14 million and $9 million, respectively.

The changes in estimates decreased income from continuing operations before income taxes in the first half of 2017 by $3 million ($2 million after tax, or $0.01 per diluted share) and increased income from continuing operations before income taxes in the first half of 2016 by $39 million ($25 million after tax, or $0.09 per diluted share).  For the first half of 2017 and 2016, the gross favorable program profit adjustments totaled $43 million and $53 million, respectively, and the gross unfavorable program profit adjustments totaled $46 million and $14 million, respectively.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, that outlines a five-step revenue recognition model based on the principle that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The standard is effective as of the beginning of 2018 for public companies and may be adopted either retrospectively or on a modified retrospective basis. We expect to apply the standard on a modified retrospective basis, with a cumulative catch-up adjustment recognized at the beginning of 2018.

Based on our review and analysis of our contracts through the end of the second quarter of 2017, we believe that the standard will primarily impact our Bell and Textron Systems segments, which have long-term production contracts with the U.S. Government as these contracts currently use the units-of-delivery accounting method; under the new standard, these contracts will transition to a model that recognizes revenue over time, principally as costs are incurred, resulting in earlier revenue recognition.  In 2016, approximately 25% of our revenues were from contracts with the U.S. Government.

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We do not expect that the new standard will have a significant impact on revenue recognition for our Textron Aviation and Industrial segments.  For these segments, we expect to continue to primarily recognize revenue for contracts at the point in time when the customer accepts delivery of the goods provided.

We are currently evaluating the new disclosure requirements of the standard and expect to complete our assessment of the cumulative effect of adopting the standard in the fourth quarter of 2017.  Our evaluation of the standard will continue through the adoption date, including any impacts related to new contracts awarded and any new or emerging interpretations of the standard.  We are in the process of implementing changes to business processes, systems and internal controls required to implement and account for the new standard.

In February 2016, the FASB issued ASU No. 2016-02, Leases, that requires lessees to recognize all leases with a term greater than 12 months on the balance sheet as right-to-use assets and lease liabilities, while lease expenses would continue to be recognized in the statement of operations in a manner similar to current accounting guidance.  Under the current accounting guidance, we are not required to recognize assets and liabilities arising from operating leases on the balance sheet.  The new standard is effective for our company at the beginning of 2019 and early adoption is permitted.  Entities must adopt the standard on a modified retrospective basis whereby it would be applied at the beginning of the earliest comparative year.  While we continue to evaluate the impact of the standard on our consolidated financial statements, we expect that it will materially increase our assets and liabilities on our consolidated balance sheet as we recognize the rights and corresponding obligations related to our operating leases.

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

In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.  This standard requires companies to present only the service cost component of net periodic benefit costs in operating income in the same line as other employee compensation costs, while the other components of net periodic benefit costs must be excluded from operating income. In addition, only the service cost component will be eligible for capitalization into inventory.  This standard is effective for our company at the beginning of 2018.  The reclassification of the other components of net periodic benefit cost out of operating income must be applied retrospectively, while the change in the amount companies may capitalize into inventory can be applied prospectively. We are evaluating the impact of this standard and do not expect it to have a material impact on our consolidated financial statements.

Note 2.  Business Acquisitions

On March 6, 2017, we completed the acquisition of Arctic Cat Inc. (Arctic Cat), a publicly-held company (NASDAQ: ACAT), pursuant to a cash tender offer for $18.50 per share, followed by a short-form merger.  Arctic Cat manufactures and markets all-terrain vehicles, side-by-sides and snowmobiles, in addition to related parts, garments and accessories.  The cash paid for this business, including repayment of debt and net of cash acquired, totaled $316 million.  Arctic Cat provides a platform to expand our product portfolio and increase our distribution channel to support growth within our Textron Specialized Vehicles business in the Industrial segment.  The operating results of Arctic Cat are included in the Consolidated Statements of Operations since the closing date.

We allocated the consideration paid for this business on a preliminary basis to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date.  We expect to finalize the purchase accounting as soon as reasonably possible during the one-year measurement period.  Based on the preliminary allocation, $213 million has been allocated to goodwill, related to expected synergies and the value of the assembled workforce, and $75 million to intangible assets, which includes $18 million of indefinite-lived assets related to tradenames. The definite-lived intangible assets are primarily related to customer/dealer relationships and technology, which will be amortized over 8 to 20 years. We determined the value of the intangible assets using the relief-from-royalty and multi-period excess earnings methods, which utilize significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy.  Under these valuation methods, we are required to make estimates and assumptions about sales, operating margins, growth rates, royalty rates and discount rates based on anticipated cash flows and marketplace data.  Approximately $5 million of the goodwill is deductible for tax purposes.

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

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

Note 8.  Debt

Under our shelf registration statement, on March 6, 2017, we issued $350 million of fixed-rate notes due March 15, 2027 that bear an annual interest rate of 3.65%.  The net proceeds of the issuance totaled $347 million, after deducting underwriting discounts, commissions and offering expenses.

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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 would use in pricing the asset or liability based on the best information available in the circumstances.  Valuation techniques for assets and liabilities measured using Level 3 inputs may include methodologies such as the market approach, the income approach or the cost approach and may use unobservable inputs such as projections, estimates and management’s interpretation of current market data.  These unobservable inputs are utilized only to the extent that observable inputs are not available or cost effective to obtain.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

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

Our foreign currency exchange contracts are measured at fair value using the market method valuation technique.  The inputs to this technique utilize current foreign currency exchange forward market rates published by third-party leading financial news and data providers.  These are observable data that represent the rates that the financial institution uses for contracts entered into at that date; however, they are not based on actual transactions so they are classified as Level 2. At July 1, 2017 and December 31, 2016, we had foreign currency exchange contracts with notional amounts upon which the contracts were based of $610 million and $665 million, respectively.  At July 1, 2017, the fair value amounts of our foreign currency exchange contracts were a $10 million asset and a $10 million liability.  At December 31, 2016, the fair value amounts of our foreign currency exchange contracts were a $7 million asset and a $17 million liability.

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

Assets Recorded at Fair Value on a Nonrecurring Basis

During the periods ended July 1, 2017 and December 31, 2016, the Finance group’s impaired nonaccrual finance receivables of $22 million and $44 million, respectively, were measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3).  Impaired nonaccrual finance receivables represent assets recorded at fair value on a nonrecurring basis since the measurement of required reserves on our impaired finance receivables is significantly dependent on the fair value of the underlying collateral.  For impaired nonaccrual finance receivables secured by aviation assets, the fair values of collateral are determined primarily based on the use of industry pricing guides.  Fair value measurements recorded on impaired finance receivables were not significant for both the second quarter and first half of 2017 and 2016.

Assets and Liabilities Not Recorded at Fair Value

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

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

Note 10.  Accumulated Other Comprehensive Loss and Other Comprehensive Income (Loss)

The components of Accumulated Other Comprehensive Loss are presented below:

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

*These components of other comprehensive income (loss) are included in the computation of net periodic pension cost.  See Note 11 of our 2016 Annual Report on Form 10-K for additional information.

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Note 11.  Special Charges

In the third quarter of 2016, we initiated a plan to restructure and realign our businesses by implementing headcount reductions, facility consolidations and other actions in order to improve overall operating efficiency across Textron.  In connection with this plan, we recorded special charges of $12 million in the second quarter of 2017 and $27 million in the first half of 2017.  Since the inception of the 2016 plan, we have incurred a total of $76 million of severance costs, $59 million of asset impairments and $15 million in contract terminations and other costs.  Of these amounts, $61 million was incurred at Textron Systems, $57 million at Textron Aviation, $26 million at Industrial and $6 million at Bell and Corporate. This plan is largely complete with additional pre-tax charges in the range of $5 million to $20 million expected in the second half of 2017, primarily related to contract terminations, facility consolidation and relocation costs.  The total headcount reduction under this plan is expected to be approximately 2,000 positions, representing approximately 5% of our workforce.

In connection with the acquisition of Arctic Cat, as discussed in Note 2, we initiated a restructuring plan in the first quarter of 2017 to integrate this business into our Textron Specialized Vehicles business within the Industrial segment to reduce operating redundancies and maximize efficiencies.  As a result of this plan, we recorded $19 million of restructuring charges in the first quarter of 2017, largely related to change-of-control provisions.  In addition, we recorded $4 million of acquisition-related transaction and integration costs in the first half of 2017.  We expect to complete this plan in the second half of 2017 and estimate that we will incur total special charges of approximately $30 million related to Arctic Cat.

Special charges recorded in the second quarter and first half of 2017 for both of these plans are as follows:

*Primarily related to favorable contract negotiations in the Textron Systems segment.

We expect cash payments for both restructuring plans to be approximately $40 million in the second half of 2017.  Severance costs generally are paid on a lump-sum basis and include outplacement costs, which are paid in accordance with normal payment terms.

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Note 12.  Commitments and Contingencies

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

Note 13.  Segment Information

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

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

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated Results of Operations

An analysis of our consolidated operating results is set forth below. A more detailed analysis of our segments’ operating results is provided in the Segment Analysis section on pages 18 to 23.

Revenues

Revenues increased $93 million, 3%, in the second quarter of 2017, compared with the second quarter of 2016, largely driven by increases in the Industrial and Bell segments, partially offset by lower revenues at the Textron Aviation and Textron Systems segments.  The net revenue increase included the following factors:

·                  Higher Industrial revenues of $109 million, primarily due to the impact from the acquisition of Arctic Cat described in the Segment Analysis section below.

·                  Higher Bell revenues of $21 million, primarily due to an increase in other military revenues of $118 million, largely related to higher H-1 deliveries, partially offset by a decrease in V-22 program revenues of $86 million, primarily reflecting lower aircraft deliveries.

·                  Lower Textron Aviation revenues of $25 million, primarily reflecting lower military and commercial turboprop volume.

·                  Lower Textron Systems revenues of $10 million, primarily due to lower volume of $92 million in the Weapons and Sensors and the Unmanned Systems product lines, partially offset by higher volume of $88 million in the Marine and Land Systems product line.

Revenues decreased $15 million in the first half of 2017, compared with the first half of 2016, largely driven by decreases in the Textron Aviation and Bell segments, partially offset by higher revenues at the Industrial and Textron Systems segments.  The net revenue decrease included the following factors:

·                  Lower Textron Aviation revenues of $146 million, primarily due to lower volume and mix of $165 million, largely the result of lower military and commercial turboprop volume.

·                  Lower Bell revenues of $96 million, primarily due to a decrease in V-22 program revenues of $69 million, largely reflecting lower aircraft deliveries.

·                  Higher Industrial revenues of $149 million, primarily due to the impact from the acquisition of Arctic Cat.

·                  Higher Textron Systems revenues of $82 million, primarily due to higher volume of $120 million in the Marine and Land Systems product line, partially offset by lower volume of $56 million in the Weapons and Sensors and the Unmanned Systems product lines.

Cost of Sales and Selling and Administrative Expense

Manufacturing cost of sales and selling and administrative expense together comprise our operating expenses. Cost of sales increased $101 million, 3%, in the second quarter of 2017, compared with the second quarter of 2016, primarily related to the acquisition of Arctic Cat.  In the first half of 2017, cost of sales increased $50 million, compared with the first half of 2016, primarily due to an increase from acquired businesses, largely the acquisition of Arctic Cat, partially offset by favorable performance, primarily at Bell, and lower net volume as described above.  Gross margin as a percentage of Manufacturing revenues decreased 90 basis points in the first half of 2017, compared with the first half of 2016, primarily due to lower margin at Textron Systems, which included the impact of an unfavorable program adjustment of $24 million recorded in the first quarter of 2017.

Selling and administrative expense increased $25 million, 8%, in the second quarter of 2017, and $26 million, 4%, in the first half of 2017, compared with the corresponding periods of 2016, primarily due to an increase from acquired businesses, largely related to the acquisition of Arctic Cat.

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Special Charges

In the third quarter of 2016, we initiated a plan to restructure and realign our businesses by implementing headcount reductions, facility consolidations and other actions in order to improve overall operating efficiency across Textron.  In connection with this plan, we recorded special charges of $12 million in the second quarter of 2017 and $27 million in the first half of 2017.  Since the inception of the 2016 plan, we have incurred a total of $76 million of severance costs, $59 million of asset impairments and $15 million in contract terminations and other costs.  Of these amounts, $61 million was incurred at Textron Systems, $57 million at Textron Aviation, $26 million at Industrial and $6 million at Bell and Corporate. This plan is largely complete with additional pre-tax charges in the range of $5 million to $20 million expected in the second half of 2017, primarily related to contract terminations, facility consolidation and relocation costs.  The total headcount reduction under this plan is expected to be approximately 2,000 positions, representing approximately 5% of our workforce.

In connection with the acquisition of Arctic Cat, as discussed in Note 2, we initiated a restructuring plan in the first quarter of 2017 to integrate this business into our Textron Specialized Vehicles business within the Industrial segment to reduce operating redundancies and maximize efficiencies.  As a result of this plan, we recorded $19 million of restructuring charges in the first quarter of 2017, largely related to change-of-control provisions.  In addition, we recorded $4 million of acquisition-related transaction and integration costs in the first half of 2017.  We expect to complete this plan in the second half of 2017 and estimate that we will incur total special charges of approximately $30 million related to Arctic Cat.

Special charges recorded in the second quarter and first half of 2017 for both of these plans are as follows: