Company Quick10K Filing
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Textron
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$52.14 234 $12,190
10-K 2018-12-29 Annual: 2018-12-29
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TXT 2018-12-29
Part I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Note 1. Summary of Significant Accounting Policies
Note 2. Business Disposition and Acquisitions
Note 3. Goodwill and Intangible Assets
Note 4. Accounts Receivable and Finance Receivables
Note 5. Inventories
Note 6. Property, Plant and Equipment, Net
Note 7. Other Current Liabilities
Note 8. Debt and Credit Facilities
Note 9. Derivative Instruments and Fair Value Measurements
Note 10. Shareholders' Equity
Note 11. Segment and Geographic Data
Note 12. Revenues
Note 13. Share-Based Compensation
Note 14. Retirement Plans
Note 15. Special Charges
Note 16. Income Taxes
Note 17. Commitments and Contingencies
Note 18. Supplemental Cash Flow Information
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions and Director Independence
Item 14. Principal Accountant Fees and Services
Part IV
Item 15. Exhibits and Financial Statement Schedules
Item 16. Form 10-K Summary
EX-10.11D a19-30052_1ex10d11d.htm
EX-21 a19-30052_1ex21.htm
EX-23 a19-30052_1ex23.htm
EX-24 a19-30052_1ex24.htm
EX-31.1 a19-30052_1ex31d1.htm
EX-31.2 a19-30052_1ex31d2.htm
EX-32.1 a19-30052_1ex32d1.htm
EX-32.2 a19-30052_1ex32d2.htm

Textron Earnings 2018-12-29

TXT 10K Annual Report

Balance SheetIncome StatementCash Flow

10-K 1 a19-30052_110k.htm 10-K

Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

[ x ]            ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 29, 2018

or

 

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

 

For the transition period from            to           .

 

Commission File Number 1-5480

 

Textron Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 

05-0315468

(State or other jurisdiction of incorporation or organization)

 

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

 

40 Westminster Street, Providence, RI

 

02903

(Address of principal executive offices)

 

(Zip code)

 

Registrant’s Telephone Number, Including Area Code: (401) 421-2800

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of Each Class

 

Name of Each Exchange on Which Registered

 

 

Common Stock — par value $0.125

 

New York Stock Exchange

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 


 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes  ü   No___

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes        No  ü

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ü ]

 

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 Act).  Yes        No   ü

 

The aggregate market value of the registrant’s Common Stock held by non-affiliates at June 30, 2018 was approximately $16.4 billion based on the New York Stock Exchange closing price for such shares on that date. The registrant has no non-voting common equity.

 

At February 2, 2019, 234,679,051 shares of Common Stock were outstanding.

 

Documents Incorporated by Reference

 

 

Part III of this Report incorporates information from certain portions of the registrant’s Definitive Proxy Statement for its Annual Meeting of Shareholders to be held on April 24, 2019.

 


Table of Contents

 

Textron Inc.

Index to Annual Report on Form 10-K

For the Fiscal Year Ended December 29, 2018

 

 

 

 

PART I

 

Page

 

 

 

Item  1.

Business

  3

 

 

 

Item  1A.

Risk Factors

  9

 

 

 

Item  1B.

Unresolved Staff Comments

15

 

 

 

Item  2.

Properties

15

 

 

 

Item  3.

Legal Proceedings

15

 

 

 

Item  4.

Mine Safety Disclosures

15

 

 

 

PART II

 

 

 

 

 

Item  5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

16

 

 

 

Item  6.

Selected Financial Data

17

 

 

 

Item  7.

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

18

 

 

 

Item  7A.

Quantitative and Qualitative Disclosures About Market Risk

35

 

 

 

Item  8.

Financial Statements and Supplementary Data

36

 

 

 

Item  9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

75

 

 

 

Item  9A.

Controls and Procedures

75

 

 

 

PART III

 

 

 

 

 

Item  10.

Directors, Executive Officers and Corporate Governance

77

 

 

 

Item  11.

Executive Compensation

77

 

 

 

Item  12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

77

 

 

 

Item  13.

Certain Relationships and Related Transactions and Director Independence

77

 

 

 

Item  14.

Principal Accountant Fees and Services

77

 

 

 

PART IV

 

 

 

 

 

Item  15.

Exhibits and Financial Statement Schedules

78

 

 

 

Item  16.

Form 10-K Summary

81

 

 

 

Signatures

 

82

 

2


Table of Contents

 

PART I

 

Item 1. Business

 

Textron Inc. is a multi-industry company that leverages its global network of aircraft, defense, industrial and finance businesses to provide customers with innovative products and services around the world.  We have approximately 35,000 employees worldwide.  Textron Inc. was founded in 1923 and reincorporated in Delaware on July 31, 1967. Unless otherwise indicated, references to “Textron Inc.,” the “Company,” “we,” “our” and “us” in this Annual Report on Form 10-K refer to Textron Inc. and its consolidated subsidiaries.

 

We conduct our business through five operating segments: Textron Aviation, Bell, Textron Systems and Industrial, which represent our manufacturing businesses, and Finance, which represents our finance business.  A description of the business of each of our segments is set forth below.  Our segments include operations that are unincorporated divisions of Textron Inc. and others that are separately incorporated subsidiaries. The following description of our business should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 18 through 34 of this Annual Report on Form 10-K.  Information included in this Annual Report on Form 10-K refers to our continuing businesses unless otherwise indicated.

 

Textron Aviation Segment

Textron Aviation is a leader in general aviation. Textron Aviation manufactures, sells and services Beechcraft and Cessna aircraft, and services the Hawker brand of business jets. The segment has two principal product lines: aircraft and aftermarket parts and services. Aircraft includes sales of business jets, turboprop aircraft, piston engine aircraft, and military trainer and defense aircraft. Aftermarket parts and services includes commercial parts sales, and maintenance, inspection and repair services. Revenues in the Textron Aviation segment accounted for 36%, 33% and 36% of our total revenues in 2018, 2017 and 2016, respectively.

 

The family of jets currently offered by Textron Aviation includes the Citation M2, Citation CJ3+, Citation CJ4, Citation XLS+, Citation Latitude, Citation Sovereign+, and the Citation X+, the fastest civilian jet in the world. The Citation Longitude, a super-midsize jet, achieved provisional type certification in December 2018, which allows operators to begin flight training in preparation for deliveries in early 2019. Textron Aviation is also continuing the development of the Citation Hemisphere, a large-cabin jet.

 

Textron Aviation’s turboprop aircraft include the Beechcraft King Air C90GTx, King Air 250, King Air 350ER and King Air 350i, and the Cessna Caravan and Grand Caravan EX.  The Cessna Denali, a high-performance single engine turboprop aircraft, is expected to achieve its first flight in 2019.  In addition, Textron Aviation is developing the Cessna Skycourier, a twin-engine, high-wing, large-utility turboprop aircraft, which is targeted for first flight in 2019.  Textron Aviation’s piston engine aircraft include the Beechcraft Baron and Bonanza, and the Cessna Skyhawk, Skylane, and the Turbo Stationair.

 

Textron Aviation also offers the T-6 trainer, which has been used to train pilots from more than 20 countries, the AT-6 light attack military aircraft, and the Scorpion. The Scorpion is a highly affordable, multi-mission aircraft designed primarily for the tactical military jet aviation market.  Both the AT-6 and the Scorpion are not yet in production, pending customer orders.

 

In support of its family of aircraft, Textron Aviation operates a global network of 18 service centers, two of which are co-located with Bell Helicopter, along with more than 350 authorized independent service centers located throughout the world. Textron Aviation-owned service centers provide customers with 24-hour service and maintenance. Textron Aviation also provides its customers with around-the-clock parts support and offers a mobile support program with over 70 mobile service units and several dedicated support aircraft. In addition, Able Aerospace Services, Inc., a subsidiary of Textron Aviation, also provides component and maintenance, repair and overhaul services in support of commercial and military fixed- and rotor-wing aircraft.

 

Textron Aviation markets its products worldwide through its own sales force, as well as through a network of authorized independent sales representatives. Textron Aviation has several competitors domestically and internationally in various market segments. Textron Aviation’s aircraft compete with other aircraft that vary in size, speed, range, capacity and handling characteristics on the basis of price, product quality and reliability, direct operating costs, product support and reputation.

 

3


Table of Contents

 

Bell Segment

Bell Helicopter is one of the leading suppliers of military and commercial helicopters, tiltrotor aircraft, and related spare parts and services in the world.  Revenues for Bell accounted for 23%, 23% and 23% of our total revenues in 2018, 2017 and 2016, respectively.

 

Bell supplies advanced military helicopters and support to the U.S. Government and to military customers outside the United States.  Bell’s primary U.S. Government programs are the V-22 tiltrotor aircraft and the H-1 helicopters.  Bell is one of the leading suppliers of helicopters to the U.S. Government and, in association with The Boeing Company (Boeing), the only supplier of military tiltrotor aircraft. Tiltrotor aircraft are designed to provide the benefits of both helicopters and fixed-wing aircraft. Through its strategic alliance with Boeing, Bell produces and supports the V-22 tiltrotor aircraft for the U.S. Department of Defense (DoD), and also for Japan under the U.S. Government-sponsored foreign military sales program.  In 2018, the Bell Boeing V-22 program was awarded a third multi-year contract for the production and delivery of an additional 63 units along with related supplies and services through 2024.  The H-1 helicopter program includes a utility model, the UH-1Y, and an advanced attack model, the AH-1Z, which have 84% parts commonality between them. While the U.S. Marine Corps is the primary customer for H-1 helicopters, we also sell H-1 helicopters under the U.S. Government-sponsored foreign military sales program.

 

Bell is developing the V-280 Valor, a next generation vertical lift aircraft as part of the Joint Multi Role Technology Demonstrator (JMR-TD) initiative. The JMR-TD program is the science and technology precursor to the Department of Defense’s Future Vertical Lift program. Aircraft designed through this initiative will compete to replace thousands of aging utility and attack helicopters for the U.S. Armed Forces over the next decade. The V-280 achieved its first flight in December 2017 and its first cruise mode flight in May 2018, and continues to perform ongoing flight testing.

 

Through its commercial business, Bell is a leading supplier of commercially certified helicopters and support to corporate, offshore petroleum exploration and development, utility, charter, police, fire, rescue and emergency medical helicopter operators, and foreign governments.  Bell produces a variety of commercial aircraft types, including light single- and twin-engine helicopters and medium twin-engine helicopters, along with other related products.  The helicopters currently offered by Bell for commercial applications include the 407GXP, 407GXi, 412EP, 412EPI, 429, 429WLG, 505 Jet Ranger X and Huey II.  In addition, the 525 Relentless, Bell’s first super medium commercial helicopter, continues flight test activities with certification targeted in late 2019.

 

For both its military programs and its commercial products, Bell provides post-sale support and service for an installed base of approximately 13,000 helicopters through a network of six Company-operated service centers, four global parts distribution centers and over 100 independent service centers located in 35 countries.  Collectively, these service sites offer a complete range of logistics support, including parts, support equipment, technical data, training devices, pilot and maintenance training, component repair and overhaul, engine repair and overhaul, aircraft modifications, aircraft customizing, accessory manufacturing, contractor maintenance, field service and product support engineering.

 

Bell competes against a number of competitors throughout the world for its helicopter business and its parts and support business.  Competition is based primarily on price, product quality and reliability, product support, performance and reputation.

 

Textron Systems Segment

Textron Systems’ product lines consist of Unmanned Systems, Marine and Land systems, and Simulation, Training and Other.  Textron Systems is a supplier to the defense, aerospace and general aviation markets, and represents 10%, 13% and 13% of our total revenues in 2018, 2017 and 2016, respectively.  This segment sells products to U.S. Government customers and to customers outside the U.S. through foreign military sales sponsored by the U.S. Government and directly through commercial sales channels.  Textron Systems competes on the basis of technology, contract performance, price, product quality and reliability, product support and reputation.

 

Unmanned Systems

Our Unmanned Systems product line includes unmanned aircraft systems, unmanned surface systems, mission command hardware and solutions, and worldwide customer support and logistics.  Unmanned aircraft systems includes the Shadow, the U.S. Army’s premier tactical unmanned aircraft system, which has surpassed one million flight hours since its introduction, and the Aerosonde Small Unmanned Aircraft System, a multi-mission capable unmanned aircraft system that has amassed more than 300,000 flight hours in commercial and military operations around the world. Unmanned Systems also provides complete systems solutions to its government and commercial customers through comprehensive program management, operational and maintenance training, technical assistance and logistics support, and end-to-end turnkey mission support.

 

4


Table of Contents

 

Marine and Land Systems

Our Marine and Land Systems product line includes advanced marine craft, armored vehicles, turrets and related subsystems, in service with U.S. and international militaries, special operations forces, police forces and civilian entities.  Marine and Land Systems’ primary U.S. Government program is for the development and production of the U.S. Navy’s next generation Landing Craft Air Cushion as part of the Ship-to-Shore Connector program.

 

Simulation, Training and Other

Our Simulation, Training and Other product line includes products and services provided by the following businesses: TRU Simulation + Training, Textron Airborne Solutions, Electronic Systems, Lycoming, and Weapons and Sensors Systems. TRU Simulation + Training designs, develops, manufactures, installs, and provides maintenance of advanced flight training courseware and devices, including full flight simulators, for both rotary- and fixed-wing aircraft for commercial airlines, aircraft original equipment manufacturers (OEMs), flight training centers and training organizations worldwide. Through its training centers, TRU Simulation + Training provides initial type-rating and recurrency training for pilots, as well as maintenance training in its Aviation Maintenance Training Academy. Textron Airborne Solutions, which includes Airborne Tactical Advantage Company, focuses on live military air-to-air and air-to-ship training and support services for U.S. Navy, Marine and Air Force pilots. Electronic Systems provides high technology test equipment, electronic warfare test and training solutions and intelligence software solutions for U.S. and international defense, intelligence and law enforcement communities. Lycoming specializes in the engineering, manufacture, service and support of piston aircraft engines for the general aviation and remotely piloted aircraft markets. Weapons and Sensors Systems offers advanced precision guided weapons systems, airborne and ground-based sensors and surveillance systems, and protection systems for the defense and aerospace industries.

 

In October 2018, TRU Simulation + Training entered into a letter of intent to form a joint venture with FlightSafety International to provide training solutions for Textron Aviation’s business and general aviation aircraft. This transaction is subject to a final agreement and regulatory approvals.

 

Industrial Segment

Our Industrial segment designs and manufactures a variety of products within the Fuel Systems and Functional Components and Specialized Vehicles product lines.  On July 2, 2018, we sold our Tools and Test Equipment businesses that were previously included in this segment as discussed in Note 2 to the Consolidated Financial Statements on page 50 of this Annual Report on Form 10-K. Industrial segment revenues represented 31%, 30% and 28% of our total revenues in 2018, 2017 and 2016, respectively.

 

Fuel Systems and Functional Components

Our Fuel Systems and Functional Components product line is produced by our Kautex business unit which is headquartered in Bonn, Germany and operates over 30 plants in 14 countries.  Kautex is a leading developer and manufacturer of blow-molded plastic fuel systems and advanced fuel systems, including pressurized fuel tanks for hybrid applications, for cars, light trucks and all-terrain vehicles. Kautex also develops and manufactures clear-vision systems for automobiles, selective catalytic reduction systems used to reduce emissions from diesel engines, and other fuel system components, as well as plastic bottles and containers for medical, household, agricultural, laboratory and industrial uses. Additionally, Kautex operates a business that produces cast iron engine camshafts, crankshafts and other engine components. Kautex serves the global automobile market, with operating facilities near its major customers around the world.

 

Our automotive products have several major competitors worldwide, some of which are affiliated with the OEMs that comprise our targeted customer base. Competition typically is based on a number of factors including price, technology, environmental performance, product quality and reliability, prior experience and available manufacturing capacity.

 

Specialized Vehicles

Our Specialized Vehicles product line includes products sold by the Textron Specialized Vehicles businesses under the E-Z-GO, Arctic Cat, TUG Technologies, Douglas Equipment, Premier, Safeaero, Ransomes, Jacobsen, Cushman and Dixie Chopper brands. These businesses design, manufacture and sell golf cars, off-road utility vehicles, recreational side-by-side and all-terrain vehicles, snowmobiles, light transportation vehicles, aviation ground support equipment and professional turf-maintenance equipment, as well as specialized turf-care vehicles.

 

5


Table of Contents

 

These businesses have a diversified customer base that includes golf courses and resorts, government agencies and municipalities, consumers, outdoor enthusiasts, and commercial and industrial users such as factories, warehouses, airports, planned communities, hunting preserves, educational and corporate campuses, sporting venues, municipalities and landscaping professionals. Sales are made through a combination of factory direct resources and a network of independent distributors and dealers worldwide. We have two major competitors for both golf cars and professional turf-maintenance equipment, and several competitors for off-road utility vehicles, recreational all-terrain and light transportation vehicles, side-by-sides and snowmobiles, aviation ground support equipment, and specialized turf-care products. Competition is based primarily on price, product quality and reliability, product features, product support and reputation.

 

Finance Segment

Our Finance segment, or the Finance group, is a commercial finance business that consists of Textron Financial Corporation (TFC) and its consolidated subsidiaries. The Finance segment provides financing primarily to purchasers of new and pre-owned Textron Aviation aircraft and Bell helicopters. A substantial number of the new originations in our finance receivable portfolio are cross-border transactions for aircraft sold outside of the U.S. Finance receivables originated in the U.S. are primarily for purchasers who had difficulty in accessing other sources of financing for the purchase of Textron-manufactured products.  In 2018, 2017 and 2016, our Finance group paid our Manufacturing group $177 million, $174 million and $173 million, respectively, related to the sale of Textron-manufactured products to third parties that were financed by the Finance group.

 

The commercial finance business traditionally is extremely competitive. Our Finance segment is subject to competition from various types of financing institutions, including banks, leasing companies, commercial finance companies and finance operations of equipment vendors.  Competition within the commercial finance industry primarily is focused on price, term, structure and service.

 

Our Finance segment’s largest business risk is the collectability of its finance receivable portfolio.  See “Finance Portfolio Quality” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 27 for information about the Finance segment’s credit performance.

 

Backlog

Our backlog at the end of 2018 and 2017 is summarized below:

 

(In millions)

 

 

 

 

 

December 29,
2018

 

December 30,
2017

Bell

 

 

 

 

$

5,837

$

4,598

Textron Aviation

 

 

 

 

 

1,791

 

1,180

Textron Systems

 

 

 

 

 

1,469

 

1,406

Total backlog

 

 

 

 

$

9,097

$

7,184

 

Backlog excludes unexercised contract options and potential orders under ordering-type contracts, such as Indefinite Delivery, Indefinite Quantity contracts. With the adoption of ASC 606 at the beginning of 2018, as discussed in Note 1 to the Consolidated Financial Statements on page 43 of this Annual Report on Form 10-K, backlog now includes amounts under contracts with the U.S. Government and certain other agreements when contract criteria have been met. Prior to the adoption, our backlog excluded firm orders with the U.S. Government for which funding had not been appropriated. Upon adoption, Bell’s backlog decreased $760 million, largely resulting from the acceleration of revenues upon conversion to the cost-to-cost method of revenue recognition, and Textron Aviation’s backlog increased $170 million.

 

At December 29, 2018, Bell’s backlog included $2.4 billion for its portion of the third multi-year V-22 contract received in 2018 for the production and delivery of 63 units along with related supplies and services through 2024.

 

U.S. Government Contracts

In 2018, approximately 24% of our consolidated revenues were generated by or resulted from contracts with the U.S. Government, including those contracts under the U.S. Government-sponsored foreign military sales program. This business is subject to competition, changes in procurement policies and regulations, the continuing availability of funding, which is dependent upon congressional appropriations, national and international priorities for defense spending, world events, and the size and timing of programs in which we may participate.

 

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Table of Contents

 

Our contracts with the U.S. Government generally may be terminated by the U.S. Government for convenience or if we default in whole or in part by failing to perform under the terms of the applicable contract.  If the U.S. Government terminates a contract for convenience, we normally will be entitled to payment for the cost of contract work performed before the effective date of termination, including, if applicable, reasonable profit on such work, as well as reasonable termination costs.  If, however, the U.S. Government terminates a contract for default, generally: (a) we will be paid the contract price for completed supplies delivered and accepted and services rendered, an agreed-upon amount for manufacturing materials delivered and accepted and for the protection and preservation of property, and an amount for partially completed products accepted by the U.S. Government; (b) the U.S. Government may not be liable for our costs with respect to unaccepted items and may be entitled to repayment of advance payments and progress payments related to the terminated portions of the contract; (c) the U.S. Government may not be liable for assets we own and utilize to provide services under the “fee-for-service” contracts; and (d) we may be liable for excess costs incurred by the U.S. Government in procuring undelivered items from another source.

 

Patents and Trademarks

We own, or are licensed under, numerous patents throughout the world relating to products, services and methods of manufacturing. Patents developed while under contract with the U.S. Government may be subject to use by the U.S. Government. We also own or license active trademark registrations and pending trademark applications in the U.S. and in various foreign countries or regions, as well as trade names and service marks. While our intellectual property rights in the aggregate are important to the operation of our business, we do not believe that any existing patent, license, trademark or other intellectual property right is of such importance that its loss or termination would have a material adverse effect on our business taken as a whole. Some of these trademarks, trade names and service marks are used in this Annual Report on Form 10-K and other reports, including:  A-2PATS; Able Aerospace Services; Able Preferred; Aeronautical Accessories; Aerosonde; Alterra; AH-1Z; Arctic Cat; AT-6; AVCOAT; Baron; Bearcat; Beechcraft; Beechcraft T-6; Bell; Bell Helicopter; BlackWorks McCauley; Bonanza; Cadillac Gage; CAP; Caravan; Cessna; Cessna SkyCourier; Citation; Citation Latitude; Citation Longitude; Citation M2; Citation Sovereign; Citation X+; Citation XLS+; CJ1+; CJ2+; CJ3; CJ3+; CJ4; Clairity; CLAW; Commando; Cushman; Customer Advantage Plans; CUSV; Denali; Dixie Chopper; Eclipse; El Tigre; E-Z-GO; E-Z-GO EXPRESS; FAST-N-LATCH; Firecat; FOREVER WARRANTY; Freedom; Fury; GLOBAL MISSION SUPPORT; Grand Caravan; H-1; HAULER; Hawker; Hemisphere; Huey; Huey II; IE2; Integrated Command Suite; INTELLIBRAKE; Jacobsen; Jet Ranger X; Kautex; King Air; King Air C90GTx; King Air 250; King Air 350; Kiowa Warrior; LF; Lycoming; Lynx; M1117 ASV; McCauley; Mission Critical Support (MCS); MISSIONLINK; Motorfist; MudPro; Mustang; Next Generation Carbon Canister; Next Generation Fuel System; NGCC; NGFS; NightWarden; Odyssey; Pantera; Power Advantage; Premier; Pro-Fit; ProFlight; ProParts; ProPropeller; Prowler; Ransomes; REALCue; REALFeel; Relentless; RIPSAW; RT2; RXV; Safeaero; Scorpion; Shadow; Shadow Knight; Shadow Master; Skyhawk; Skyhawk SP; Skylane; SkyPLUS; Sno Pro; SnoCross; Sovereign; Speedrack; Stampede; Stationair; Super Cargomaster; Super Medium; SuperCobra; Synturian; Team Arctic; Textron; Textron Airborne Solutions; Textron Aviation; Textron Financial Corporation; Textron GSE; Textron Systems; Thundercat; TRUESET; TRU Simulation + Training; TRUCKSTER; TTx; TUG; Turbo Skylane; Turbo Stationair; TRV; TXT; UH-1Y; VALOR; Value-Driven MRO Solutions; V-22 Osprey; V-247; V-280; Wildcat; Wolverine; ZR; 2FIVE; 206; 206L4; 407; 407GXi; 412; 412EPI; 429; 429WLG; 505; 525 and 525 Relentless. These marks and their related trademark designs and logotypes (and variations of the foregoing) are trademarks, trade names or service marks of Textron Inc., its subsidiaries, affiliates or joint ventures.

 

Environmental Considerations

Our operations are subject to numerous laws and regulations designed to protect the environment.  Compliance with these laws and expenditures for environmental controls has not had a material effect on our capital expenditures, earnings or competitive position. Additional information regarding environmental matters is contained in Note 17 to the Consolidated Financial Statements on page 72 of this Annual Report on Form 10-K.

 

We do not believe that existing or pending climate change legislation, regulation, or international treaties or accords are reasonably likely to have a material effect in the foreseeable future on our business or markets nor on our results of operations, capital expenditures or financial position. We will continue to monitor emerging developments in this area.

 

Employees

At December 29, 2018, we had approximately 35,000 employees.

 

Executive Officers of the Registrant

The following table sets forth certain information concerning our executive officers as of February 14, 2019.

 

Name

 

Age

 

Current Position with Textron Inc.

Scott C. Donnelly

 

57

 

Chairman, President and Chief Executive Officer

Frank T. Connor

 

59

 

Executive Vice President and Chief Financial Officer

Julie G. Duffy

 

53

 

Executive Vice President, Human Resources

E. Robert Lupone

 

59

 

Executive Vice President, General Counsel, Secretary and Chief Compliance Officer

 

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Mr. Donnelly joined Textron in June 2008 as Executive Vice President and Chief Operating Officer and was promoted to President and Chief Operating Officer in January 2009. He was appointed to the Board of Directors in October 2009 and became Chief Executive Officer of Textron in December 2009, at which time the Chief Operating Officer position was eliminated.  In July 2010, Mr. Donnelly was appointed Chairman of the Board of Directors effective September 1, 2010.  Previously, Mr. Donnelly was the President and CEO of General Electric Company’s Aviation business unit, a position he had held since July 2005.  GE’s Aviation business unit is a leading maker of commercial and military jet engines and components, as well as integrated digital, electric power and mechanical systems for aircraft. Prior to July 2005, Mr. Donnelly served as Senior Vice President of GE Global Research, one of the world’s largest and most diversified industrial research organizations with facilities in the U.S., India, China and Germany and held various other management positions since joining General Electric in 1989.

 

Mr. Connor joined Textron in August 2009 as Executive Vice President and Chief Financial Officer. Previously, Mr. Connor was head of Telecom Investment Banking at Goldman, Sachs & Co. from 2003 to 2008. Prior to that position, he served as Chief Operating Officer of Telecom, Technology and Media Investment Banking at Goldman, Sachs & Co. from 1998 to 2003. Mr. Connor joined the Corporate Finance Department of Goldman, Sachs & Co. in 1986 and became a Vice President in 1990 and a Managing Director in 1996.

 

Ms. Duffy was named Executive Vice President, Human Resources in July 2017.  Ms. Duffy joined Textron in 1997 as a member of the corporate legal team and has since held positions of increasing responsibility within the Company’s legal function, most recently serving as Vice President and Deputy General Counsel-Litigation, a position she had held since 2011.  In that role she was responsible for managing the corporate litigation staff with primary oversight of litigation throughout Textron. She has also played an active role in developing, implementing and standardizing human resources policies across the Company and served as the senior legal advisor on employment and benefits issues.

 

Mr. Lupone joined Textron in February 2012 as Executive Vice President, General Counsel, Secretary and Chief Compliance Officer.  Previously, he was senior vice president and general counsel of Siemens Corporation (U.S.) since 1999 and general counsel of Siemens AG for the Americas since 2008.  Prior to joining Siemens in 1992, Mr. Lupone was vice president and general counsel of Price Communications Corporation.

 

Available Information

We make available free of charge on our Internet Web site (www.textron.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

 

Forward-Looking Information

Certain statements in this Annual Report on Form 10-K and other oral and written statements made by us from time to time are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements, which may describe strategies, goals, outlook or other non-historical matters, or project revenues, income, returns or other financial measures, often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “guidance,” “project,” “target,” “potential,” “will,” “should,” “could,” “likely” or “may” and similar expressions intended to identify forward-looking statements. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause our actual results to differ materially from those expressed or implied by such forward-looking statements.  Given these uncertainties, you should not place undue reliance on these forward-looking statements. Forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update or revise any forward-looking statements.  In addition to those factors described herein under “Risk Factors,” among the factors that could cause actual results to differ materially from past and projected future results are the following:

 

·     Interruptions in the U.S. Government’s ability to fund its activities and/or pay its obligations;

·     Changing priorities or reductions in the U.S. Government defense budget, including those related to military operations in foreign countries;

·     Our ability to perform as anticipated and to control costs under contracts with the U.S. Government;

·     The U.S. Government’s ability to unilaterally modify or terminate its contracts with us for the U.S. Government’s convenience or for our failure to perform, to change applicable procurement and accounting policies, or, under certain circumstances, to withhold payment or suspend or debar us as a contractor eligible to receive future contract awards;

·     Changes in foreign military funding priorities or budget constraints and determinations, or changes in government regulations or policies on the export and import of military and commercial products;

·     Volatility in the global economy or changes in worldwide political conditions that adversely impact demand for our products;

 

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·     Volatility in interest rates or foreign exchange rates;

·     Risks related to our international business, including establishing and maintaining facilities in locations around the world and relying on joint venture partners, subcontractors, suppliers, representatives, consultants and other business partners in connection with international business, including in emerging market countries;

·     Our Finance segment’s ability to maintain portfolio credit quality or to realize full value of receivables;

·     Performance issues with key suppliers or subcontractors;

·     Legislative or regulatory actions, both domestic and foreign, impacting our operations or demand for our products;

·     Our ability to control costs and successfully implement various cost-reduction activities;

·     The efficacy of research and development investments to develop new products or unanticipated expenses in connection with the launching of significant new products or programs;

·     The timing of our new product launches or certifications of our new aircraft products;

·     Our ability to keep pace with our competitors in the introduction of new products and upgrades with features and technologies desired by our customers;

·     Pension plan assumptions and future contributions;

·     Demand softness or volatility in the markets in which we do business;

·     Cybersecurity threats, including the potential misappropriation of assets or sensitive information, corruption of data or operational disruption;

·     Difficulty or unanticipated expenses in connection with integrating acquired businesses;

·     The risk that acquisitions do not perform as planned, including, for example, the risk that acquired businesses will not achieve revenues and profit projections; and

·     The impact of changes in tax legislation.

 

Item 1A. Risk Factors

 

Our business, financial condition and results of operations are subject to various risks, including those discussed below, which may affect the value of our securities. The risks discussed below are those that we believe currently are the most significant to our business.

 

We have customer concentration with the U.S. Government; reduction in U.S. Government defense spending may adversely affect our results of operations and financial condition.

During 2018, we derived approximately 24% of our revenues from sales to a variety of U.S. Government entities.  Our revenues from the U.S. Government largely result from contracts awarded to us under various U.S. Government defense-related programs. The funding of these programs is subject to congressional appropriation decisions and the U.S. Government budget process which includes enacting relevant legislation, such as appropriations bills and accords on the debt ceiling. Although multiple-year contracts may be planned in connection with major procurements, Congress generally appropriates funds on a fiscal year basis even though a program may continue for several years. Consequently, programs often are only partially funded initially, and additional funds are committed only as Congress makes further appropriations.  Further uncertainty with respect to ongoing programs could also result in the event that the U.S. Government finances its operations through temporary funding measures such as “continuing resolutions” rather than full-year appropriations. If we incur costs in advance or in excess of funds committed on a contract, we are at risk for non-reimbursement of those costs until additional funds are appropriated.  The reduction, termination or delay in the timing of funding for U.S. Government programs for which we currently provide or propose to provide products or services may result in a loss of anticipated future revenues that could materially and adversely impact our results of operations and financial condition. Significant changes in national and international policies or priorities for defense spending, as well as the impact of sequestration, could affect the funding, or the timing of funding, of our programs, which could negatively impact our results of operations and financial condition.  In addition, because our U.S. Government contracts generally require us to continue to perform even if the U.S. Government is unable to make timely payments, we may need to finance our continued performance for the impacted contracts from our other resources on an interim basis.  For example, if the U.S. government is shut down for an extended period of time or the debt ceiling is not raised, our customer may not pay us on a timely basis. An extended delay in the timely payment by the U.S. Government could have a material adverse effect on our cash flows, results of operations and financial condition.

 

U.S. Government contracts may be terminated at any time and may contain other unfavorable provisions.

The U.S. Government typically can terminate or modify any of its contracts with us either for its convenience or if we default by failing to perform under the terms of the applicable contract.  In the event of termination for the U.S. Government’s convenience, contractors are generally protected by provisions covering reimbursement for costs incurred on the contracts and profit on those costs but not the anticipated profit that would have been earned had the contract been completed.  A termination arising out of our default for failure to perform could expose us to liability, including but not limited to, all costs incurred under the contract plus potential liability for re-procurement costs in excess of the total original contract amount, less the value of work performed and accepted by the customer under the contract.  Such an event could also have an adverse effect on our ability to compete for future

 

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contracts and orders. If any of our contracts are terminated by the U.S. Government whether for convenience or default, our backlog and anticipated revenues would be reduced by the expected value of the remaining work under such contracts.  We also enter into “fee for service” contracts with the U.S. Government where we retain ownership of, and consequently the risk of loss on, aircraft and equipment supplied to perform under these contracts.  Termination of these contracts could materially and adversely impact our results of operations. On contracts for which we are teamed with others and are not the prime contractor, the U.S. Government could terminate a prime contract under which we are a subcontractor, irrespective of the quality of our products and services as a subcontractor.  In addition, in the event that the U.S. Government is unable to make timely payments, failure to continue contract performance places the contractor at risk of termination for default.  Any such event could have a material adverse effect on our cash flows, results of operations and financial condition.

 

As a U.S. Government contractor, we are subject to procurement rules and regulations.

We must comply with and are affected by laws and regulations relating to the formation, administration and performance of U.S. Government contracts. These laws and regulations, among other things, require certification and disclosure of all cost and pricing data in connection with contract negotiation, define allowable and unallowable costs and otherwise govern our right to reimbursement under certain cost-based U.S. Government contracts, and safeguard and restrict the use and dissemination of classified information, covered defense information, and the exportation of certain products and technical data. New laws, regulations or procurement requirements or changes to current ones (including, for example, regulations related to cybersecurity) can significantly increase our costs and risks and reduce our profitability. Our failure to comply with procurement regulations and requirements could allow the U.S. Government to suspend or debar us from receiving new contracts for a period of time, reduce the value of existing contracts, issue modifications to a contract, withhold cash on contract payments, and control and potentially prohibit the export of our products, services and associated materials, any of which could negatively impact our results of operations, financial condition or liquidity. A number of our U.S. Government contracts contain provisions that require us to make disclosure to the Inspector General of the agency that is our customer if we have credible evidence that we have violated U.S. criminal laws involving fraud, conflict of interest, or bribery; the U.S. civil False Claims Act; or received a significant overpayment under a U.S. Government contract. Failure to properly and timely make disclosures under these provisions may result in a termination for default or cause, suspension and/or debarment, and potential fines.

 

As a U.S. Government contractor, our businesses and systems are subject to audit and review by the Defense Contract Audit Agency (DCAA) and the Defense Contract Management Agency (DCMA).

We operate in a highly regulated environment and are routinely audited and reviewed by the U.S. Government and its agencies such as the DCAA and DCMA. These agencies review our performance under contracts, our cost structure and our compliance with laws and regulations applicable to U.S. Government contractors. The systems that are subject to review include, but are not limited to, our accounting, estimating, material management and accounting, earned value management, purchasing and government property systems. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions that may include the termination of our contracts, forfeiture of profits, suspension of payments, fines, and, under certain circumstances, suspension or debarment from future contracts for a period of time. Whether or not illegal activities are alleged, the U.S. Government also has the ability to decrease or withhold certain payments when it deems systems subject to its review to be inadequate.  These laws and regulations affect how we conduct business with our government customers and, in some instances, impose added costs on our business.

 

The use of multi-award contracts by the U.S. Government may increase competition and pricing pressure.

The U.S. Government increasingly relies upon competitive contract award types, including indefinite-delivery, indefinite-quantity and multi-award contracts, which have the potential to create greater competition and increased pricing pressure, as well as to increase our cost by requiring that we submit multiple bids. In addition, multi-award contracts require that we make sustained efforts to obtain task orders and delivery orders under the contract. Further, the competitive bidding process is costly and demands managerial time to prepare bids and proposals for contracts that may not be awarded to us or may be split among competitors.

 

Our profitability and cash flow may vary depending on the mix of our government contracts and our ability to control costs.

Under fixed-price contracts, generally we receive a fixed price irrespective of the actual costs we incur, and, consequently, any costs in excess of the fixed price are absorbed by us. Changes in underlying assumptions, circumstances or estimates used in developing the pricing for such contracts may adversely affect our results of operations. Additionally, fixed-price contracts may require progress payments rather than performance-based payments which can delay our ability to recover a significant amount of costs incurred on a contract and thus affect the timing of our cash flows.  Fixed-price incentive-based fee arrangements provide that allowable costs incurred are reimbursable but are subject to a cost-share which could negatively impact our profitability. Under time and materials contracts, we are paid for labor at negotiated hourly billing rates and for certain expenses. Under cost-reimbursement contracts that are subject to a contract-ceiling amount, we are reimbursed for allowable costs and paid a fee, which may be fixed or performance based, however, if our costs exceed the contract ceiling or are not allowable under the provisions of the contract or applicable regulations, we may not be able to obtain reimbursement for all such costs. Under each type of contract, if we are unable to control

 

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costs incurred in performing under the contract, our cash flows, results of operations and financial condition could be adversely affected. Cost overruns also may adversely affect our ability to sustain existing programs and obtain future contract awards.

 

Demand for our aircraft products is cyclical and could adversely affect our financial results.

Demand for business jets, turbo props and commercial helicopters has been cyclical and difficult to forecast. Therefore, future demand for these products could be significantly and unexpectedly less than anticipated and/or less than previous period deliveries. Similarly, there is uncertainty as to when or whether our existing commercial backlog for aircraft products will convert to revenues as the conversion depends on production capacity, customer needs and credit availability. Changes in economic conditions may cause customers to request that firm orders be rescheduled or cancelled. Reduced demand for our aircraft products or delays or cancellations of orders could have a material adverse effect on our cash flows, results of operations and financial condition.

 

We may make acquisitions that increase the risks of our business.

We may enter into acquisitions in an effort to expand our business and enhance shareholder value. Acquisitions involve risks and uncertainties that could result in our not achieving expected benefits.  Such risks include difficulties in integrating newly acquired businesses and operations in an efficient and cost-effective manner; challenges in achieving expected strategic objectives, cost savings and other benefits; the risk that the acquired businesses’ markets do not evolve as anticipated and that the acquired businesses’ products and technologies do not prove to be those needed to be successful in those markets; the risk that our due diligence reviews of the acquired business do not identify or adequately assess all of the material issues which impact valuation of the business or that may result in costs or liabilities in excess of what we anticipated; the risk that we pay a purchase price that exceeds what the future results of operations would have merited; the risk that the acquired business may have significant internal control deficiencies or exposure to regulatory sanctions; and the potential loss of key customers, suppliers and employees of the acquired businesses.

 

If our Finance segment is unable to maintain portfolio credit quality, our financial performance could be adversely affected.

A key determinant of the financial performance of our Finance segment is the quality of loans, leases and other assets in its portfolio. Portfolio quality may be adversely affected by several factors, including finance receivable underwriting procedures, collateral value, geographic or industry concentrations, and the effect of general economic conditions. In addition, a substantial number of the new originations in our finance receivable portfolio are cross-border transactions for aircraft sold outside of the U.S.  Cross-border transactions present additional challenges and risks in realizing upon collateral in the event of borrower default, which may result in difficulty or delay in collecting on the related finance receivables.  If our Finance segment has difficulty successfully collecting its finance receivable portfolio, our cash flow, results of operations and financial condition could be adversely affected.

 

We may need to obtain financing in the future; such financing may not be available to us on satisfactory terms, if at all.

We may periodically need to obtain financing in order to meet our debt obligations as they come due, to support our operations and/or to make acquisitions. Our access to the debt capital markets and the cost of borrowings are affected by a number of factors including market conditions and the strength of our credit ratings. If we cannot obtain adequate sources of credit on favorable terms, or at all, our business, operating results, and financial condition could be adversely affected.

 

Failure to perform by our subcontractors or suppliers could adversely affect our performance.

We rely on other companies to provide raw materials, major components and subsystems for our products. Subcontractors also perform services that we provide to our customers in certain circumstances. We depend on these suppliers and subcontractors to meet our contractual obligations to our customers and conduct our operations. Our ability to meet our obligations to our customers may be adversely affected if suppliers or subcontractors do not provide the agreed-upon supplies or perform the agreed-upon services in compliance with customer requirements and in a timely and cost-effective manner. Likewise, the quality of our products may be adversely impacted if companies to whom we delegate manufacture of major components or subsystems for our products, or from whom we acquire such items, do not provide components or subsystems which meet required specifications and perform to our and our customers’ expectations. Our suppliers may be less likely than us to be able to quickly recover from natural disasters and other events beyond their control and may be subject to additional risks such as financial problems that limit their ability to conduct their operations. The risk of these adverse effects may be greater in circumstances where we rely on only one or two subcontractors or suppliers for a particular raw material, product or service. In particular, in the aircraft industry, most vendor parts are certified by the regulatory agencies as part of the overall Type Certificate for the aircraft being produced by the manufacturer. If a vendor does not or cannot supply its parts, then the manufacturer’s production line may be stopped until the manufacturer can design, manufacture and certify a similar part itself or identify and certify another similar vendor’s part, resulting in significant delays in the completion of aircraft. Such events may adversely affect our financial results, damage our reputation and relationships with our customers, and result in regulatory actions and/or litigation.

 

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Our business could be negatively impacted by information technology disruptions and security threats.

Our information technology (IT) and related systems are critical to the efficient operation of our business and essential to our ability to perform day to day processes.  From time to time, we update and/or replace IT systems used by our businesses.  The implementation of new systems can present temporary disruptions of business activities as existing processes are transitioned to the new systems, resulting in productivity issues, including delays in production, shipments or other business operations. We also outsource certain support functions, including certain global IT infrastructure services, to third-party service providers, and any disruption of such outsourced processes or functions could have a material adverse effect on our operations.  In addition, as a U.S. defense contractor, we face certain security threats, including threats to our IT infrastructure and unlawful attempts to gain access to our information via phishing / malware campaigns and other cyberattack methods, as well as threats to the physical security of our facilities and employees, as do our customers, suppliers, subcontractors and joint venture partners. Attempts to gain unauthorized access to our confidential, classified or otherwise proprietary information or that of our employees or customers, as well as other security breaches, are persistent, continue to evolve and require highly skilled IT resources.

 

We maintain Information Systems Incident Management Standards applicable to all our businesses to ensure information security events and weaknesses associated with information systems are communicated and acted on in a timely manner.  Our enterprise risk management program includes cyber risk/network protection mitigation plans, and our disclosure controls and procedures address cybersecurity and include processes intended to ensure that security breaches are analyzed for potential disclosure. Additionally, we conduct periodic training for our employees regarding the protection of sensitive information which includes training intended to prevent the success of cyberattacks.  Further, our insider trading compliance program addresses restrictions against trading while in possession of material, nonpublic information in connection with a cybersecurity incident.

 

While we have experienced cybersecurity attacks, we have not suffered any material losses relating to such attacks, and we believe our threat detection and mitigation processes and procedures are robust.  Due to the evolving nature of security threats, the possibility of future material incidents cannot be completely mitigated and we may not be successful in detecting, reporting or responding to cyber incidents in a timely manner. Future attacks or breaches of data security, whether of our systems or the systems of our service providers or other third parties who may have access to our data for business purposes, could disrupt our operations, cause the loss of business information or compromise confidential information, exposing us to liability or regulatory action. Such an incident also could require significant management attention and resources, increase costs that may not be covered by insurance, and result in reputational damage, potentially adversely affecting our competitiveness and our results of operations. Products and services that we provide to our customers may themselves be subject to cyberthreats which may not be detected or effectively mitigated, resulting in potential losses that could adversely affect us and our customers. In addition, our customers, including the U.S. Government, are increasingly requiring cybersecurity protections and mandating cybersecurity standards in our products, and we may incur additional costs to comply with such demands.

 

Developing new products and technologies entails significant risks and uncertainties.

To continue to grow our revenues and segment profit, we must successfully develop new products and technologies or modify our existing products and technologies for our current and future markets. Our future performance depends, in part, on our ability to identify emerging technological trends and customer requirements and to develop and maintain competitive products and services. Delays or cost overruns in the development and acceptance of new products, or certification of new aircraft and other products, could adversely affect our results of operations. These delays could be caused by unanticipated technological hurdles, production changes to meet customer demands, unanticipated difficulties in obtaining required regulatory certifications of new aircraft or other products, coordination with joint venture partners or failure on the part of our suppliers to deliver components as agreed. We also could be adversely affected if our research and development investments are less successful than expected or if we do not adequately protect the intellectual property developed through these efforts. Likewise, new products and technologies could generate unanticipated safety or other concerns resulting in expanded product liability risks, potential product recalls and other regulatory issues that could have an adverse impact on us. Furthermore, because of the lengthy research and development cycle involved in bringing certain of our products to market, we cannot predict the economic conditions that will exist when any new product is complete. A reduction in capital spending in the aerospace or defense industries could have a significant effect on the demand for new products and technologies under development, which could have an adverse effect on our financial condition and results of operations. In addition, our investments in equipment or technology that we believe will enable us to obtain future service contracts for our U.S. Government or other customers may not result in contracts or revenues sufficient to offset such investment. The market for our product offerings may not develop or continue to expand as we currently anticipate. Furthermore, we cannot be sure that our competitors will not develop competing technologies which gain superior market acceptance compared to our products.  A significant failure in our new product development efforts or the failure of our products or services to achieve market acceptance relative to our competitors’ products or services could have an adverse effect on our financial condition and results of operations.

 

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We are subject to the risks of doing business in foreign countries.

During 2018, we derived approximately 38% of our revenues from international business, including U.S. exports. Conducting business internationally exposes us to additional risks than if we conducted our business solely within the U.S. We maintain manufacturing facilities, service centers, supply centers and other facilities worldwide, including in various emerging market countries.  Risks related to international operations include import, export and other trade restrictions; changing U.S. and foreign procurement policies and practices; changes in international trade policies, including higher tariffs on imported goods and materials and renegotiation of free trade agreements; impacts related to the pending voluntary exit of the United Kingdom from the European Union (“Brexit”); restrictions on technology transfer; difficulties in protecting intellectual property; increasing complexity of employment and environmental, health and safety regulations; foreign investment laws; exchange controls; repatriation of earnings or cash settlement challenges, competition from foreign and multinational firms with home country advantages; economic and government instability, acts of terrorism and related safety concerns.  The impact of any one or more of these or other factors could adversely affect our business, financial condition or operating results.

 

Additionally, some international government customers require contractors to agree to specific in-country purchases, technology transfers, manufacturing agreements or financial support arrangements, known as offsets, as a condition for a contract award. These contracts generally extend over several years and may include penalties if we fail to perform in accordance with the offset requirements which are often subjective. We also are exposed to risks associated with using foreign representatives and consultants for international sales and operations and teaming with international subcontractors and suppliers in connection with international programs. In many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by laws and regulations applicable to us, such as the Foreign Corrupt Practices Act. Although we maintain policies and procedures designed to facilitate compliance with these laws, a violation of such laws by any of our international representatives, consultants, joint ventures, business partners, subcontractors or suppliers, even if prohibited by our policies, could have an adverse effect on our business and reputation.

 

We are subject to increasing compliance risks that could adversely affect our operating results.

As a global business, we are subject to laws and regulations in the U.S. and other countries in which we operate. International sales and global operations require importing and exporting goods and technology, some of which have military applications subjecting them to more stringent import-export controls across international borders on a regular basis. For example, we sometimes initially must obtain licenses and authorizations from various U.S. Government agencies before we are permitted to sell certain of our aerospace and defense products outside the U.S. Both U.S. and foreign laws and regulations applicable to us have been increasing in scope and complexity. For example, both U.S. and foreign governments and government agencies regulate the aviation industry, and they may impose new regulations with additional aircraft security or other requirements or restrictions, including, for example, restrictions and/or fees related to carbon emissions levels. Changes in environmental and climate change laws and regulations, including laws relating to greenhouse gas emissions, could lead to the necessity for new or additional investment in product designs or manufacturing processes and could increase environmental compliance expenditures, including costs to defend regulatory reviews. New or changing laws and regulations or related interpretation and policies could increase our costs of doing business, affect how we conduct our operations, adversely impact demand for our products, and/or limit our ability to sell our products and services. Compliance with laws and regulations of increasing scope and complexity is even more challenging in our current business environment in which reducing our operating costs is often necessary to remain competitive. In addition, a violation of U.S. and/or foreign laws by one of our employees or business partners could subject us or our employees to civil or criminal penalties, including material monetary fines, or other adverse actions, such as denial of import or export privileges and/or debarment as a government contractor which could damage our reputation and have an adverse effect on our business.

 

We are subject to legal proceedings and other claims.

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.  Due to the nature of our manufacturing business, we may be subject to liability claims arising from accidents involving our products, including claims for serious personal injuries or death caused by weather or by pilot, driver or user error. In the case of litigation matters for which reserves have not been established because the loss is not deemed probable, it is reasonably possible that such claims could be decided against us and could require us to pay damages or make other expenditures in amounts that are not presently estimable. In addition, we cannot be certain that our reserves are adequate and that our insurance coverage will be sufficient to cover one or more substantial claims. Furthermore, we may not be able to obtain insurance coverage at acceptable levels and costs in the future.  Litigation is inherently unpredictable, and we could incur judgments, receive adverse arbitration awards or enter into settlements for current or future claims that could adversely affect our financial position or our results of operations in any particular period.

 

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Intellectual property infringement claims of others and the inability to protect our intellectual property rights could harm our business and our customers.

Intellectual property infringement claims may be asserted by third parties against us or our customers. Any related indemnification payments or legal costs we may be obliged to pay on behalf of our businesses, our customers or other third parties could be costly. In addition, we own the rights to many patents, trademarks, brand names, trade names and trade secrets that are important to our business. The inability to enforce these intellectual property rights may have an adverse effect on our results of operations. Additionally, our intellectual property could be at risk due to cybersecurity threats.

 

Certain of our products are subject to laws regulating consumer products and could be subject to repurchase or recall as a result of safety issues.

As a distributor of consumer products in the U.S., certain of our products are subject to the Consumer Product Safety Act, which empowers the U.S. Consumer Product Safety Commission (CPSC) to exclude from the market products that are found to be unsafe or hazardous. Under certain circumstances, the CPSC could require us to repair, replace or refund the purchase price of one or more of our products, or potentially even discontinue entire product lines, or we may voluntarily do so, but within strictures recommended by the CPSC. The CPSC also can impose fines or penalties on a manufacturer for non-compliance with its requirements. Furthermore, failure to timely notify the CPSC of a potential safety hazard can result in significant fines being assessed against us. Any repurchases or recalls of our products or an imposition of fines or penalties could be costly to us and could damage the reputation or the value of our brands. Additionally, laws regulating certain consumer products exist in some states, as well as in other countries in which we sell our products, and more restrictive laws and regulations may be adopted in the future.

 

The increasing costs of certain employee and retiree benefits could adversely affect our results.

Our results of operations and cash flows may be adversely impacted by increasing costs and funding requirements related to our employee benefit plans. The obligation for our defined benefit pension plans is driven by, among other things, our assumptions of the expected long-term rate of return on plan assets and the discount rate used for future payment obligations. Additionally, as part of our annual evaluation of these plans, significant changes in our assumptions, due to changes in economic, legislative and/or demographic experience or circumstances, or changes in our actual investment returns could negatively impact the funded status of our plans requiring us to substantially increase our pension liability with a resulting decrease in shareholders’ equity. Also, changes in pension legislation and regulations could increase the cost associated with our defined benefit pension plans.

 

Our business could be adversely affected by strikes or work stoppages and other labor issues.

Approximately 7,200, or 28%, of our U.S. employees are unionized, and many of our non-U.S. employees are represented by organized councils. As a result, we may experience work stoppages, which could negatively impact our ability to manufacture our products on a timely basis, resulting in strain on our relationships with our customers and a loss of revenues. The presence of unions also may limit our flexibility in responding to competitive pressures in the marketplace. In addition, the workforces of many of our suppliers and customers are represented by labor unions. Work stoppages or strikes at the plants of our key suppliers could disrupt our manufacturing processes; similar actions at the plants of our customers could result in delayed or canceled orders for our products. Any of these events could adversely affect our results of operations.

 

Currency, raw material price and interest rate fluctuations may adversely affect our results.

We are exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates, raw material prices and interest rates. Fluctuations in foreign currency rates may contribute to variations in revenue and costs in impacted jurisdictions which could adversely affect our profitability. We monitor and manage these exposures as an integral part of our overall risk management program. In some cases, we purchase derivatives or enter into contracts to insulate our results of operations from these fluctuations. Nevertheless, changes in currency exchange rates, raw material prices and interest rates can have substantial adverse effects on our results of operations.

 

We may be unable to effectively mitigate pricing pressures.

In some markets, particularly where we deliver component products and services to OEMs, we face ongoing customer demands for price reductions, which sometimes are contractually obligated. However, if we are unable to effectively mitigate future pricing pressures through technological advances or by lowering our cost base through improved operating and supply chain efficiencies, our results of operations could be adversely affected.

 

Unanticipated changes in our tax rates or exposure to additional income tax liabilities could affect our profitability.

We are subject to income taxes in the U.S. and various non-U.S. jurisdictions, and our domestic and international tax liabilities are subject to the location of income among these different jurisdictions. Our effective tax rate could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in the amount of earnings indefinitely reinvested offshore, changes to unrecognized tax benefits or changes in tax laws, which could affect our profitability. In particular, the carrying value of deferred tax assets is dependent on our ability to generate

 

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future taxable income, as well as changes to applicable statutory tax rates.  In addition, the amount of income taxes we pay is subject to audits in various jurisdictions, and a material assessment by a tax authority could affect our profitability.

 

The Tax Cuts and Jobs Act was enacted on December 22, 2017 and significantly changed U.S. income tax law.   Any additional tax legislation in the United States or elsewhere, could adversely affect our effective tax rate, have a material impact on the value of our deferred tax assets or increase our future U.S. tax expense.

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

On December 29, 2018, we operated a total of 55 plants located throughout the U.S. and 50 plants outside the U.S.  We own 55 plants and lease the remainder for a total manufacturing space of approximately 23.8 million square feet.  We consider the productive capacity of the plants operated by each of our business segments to be adequate.  We also own or lease offices, warehouses, training and service centers and other space at various locations. In general, our facilities are in good condition, are considered to be adequate for the uses to which they are being put and are substantially in regular use.

 

Item 3. Legal Proceedings

 

As previously reported in Textron’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, on February 7, 2012, a lawsuit was filed in the United States Bankruptcy Court, Northern District of Ohio, Eastern Division (Akron) by Brian A. Bash, Chapter 7 Trustee for Fair Finance Company against TFC, Fortress Credit Corp. and Fair Facility I, LLC. TFC provided a revolving line of credit of up to $17.5 million to Fair Finance Company from 2002 through 2007. The complaint alleges numerous counts against TFC, as Fair Finance Company’s working capital lender, including receipt of fraudulent transfers and assisting in fraud perpetrated on Fair Finance investors. The Trustee seeks avoidance and recovery of alleged fraudulent transfers in the amount of $316 million as well as damages of $223 million on the other claims. The Trustee also seeks trebled damages on all claims under Ohio law.  On November 9, 2012, the Court dismissed all claims against TFC.  The trustee appealed, and on August 23, 2016, the 6th Circuit Court of Appeals reversed the dismissal in part and remanded certain claims back to the trial court.  On September 27, 2018, after reconsidering the remanded claims which were based upon civil conspiracy and intentional fraudulent transfer, the trial court granted partial summary judgment in favor of Textron, dismissing the Trustee’s civil conspiracy claim, as well as a portion of the Trustee’s claim for intentional fraudulent transfer, leaving only a portion of the intentional fraudulent transfer claim to be adjudicated.  We intend to continue to vigorously defend this lawsuit.

 

We also are subject to actual and threatened 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, health and safety 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.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

The principal market on which our common stock is traded is the New York Stock Exchange under the symbol “TXT.”  At December 29, 2018, there were approximately 8,300 record holders of Textron common stock.

 

Issuer Repurchases of Equity Securities

The following provides information about our fourth quarter 2018 repurchases of equity securities that are registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended:

 

Period (shares in thousands)

Total
Number of
Shares
Purchased *

Average Price
Paid per Share
(excluding
commissions)

Total Number of
Shares Purchased as
part of Publicly
Announced Plan *

Maximum
Number of Shares
that may yet be
Purchased under
the Plan

September 30, 2018 – November 3, 2018

2,905

$

54.65

2,905

21,812

November 4, 2018 – December 1, 2018

1,910

 

55.76

1,910

19,902

December 2, 2018 – December 29, 2018

2,710

 

49.64

2,710

17,192

Total

7,525

$

53.13

7,525

 

 

* These shares were purchased pursuant to a plan authorizing the repurchase of up to 40 million shares of Textron common stock that was announced on April 16, 2018. This plan has no expiration date.

 

Stock Performance Graph

The following graph compares the total return on a cumulative basis at the end of each year of $100 invested in our common stock on December 31, 2013 with the Standard & Poor’s (S&P) 500 Stock Index, the S&P 500 Aerospace & Defense (A&D) Index and the S&P 500 Industrials Index, all of which include Textron. The values calculated assume dividend reinvestment.

 

GRAPHIC

 

 

 

2013

 

 

2014

 

 

2015

 

 

2016

 

 

2017

 

 

2018

 

Textron Inc.

$

100.00

 

$

115.83

 

$

115.77

 

$

134.09

 

$

156.51

 

$

126.42

 

S&P 500

 

100.00

 

 

114.15

 

 

115.73

 

 

129.57

 

 

157.85

 

 

149.64

 

S&P 500 A&D

 

100.00

 

 

112.09

 

 

118.18

 

 

140.52

 

 

198.66

 

 

180.24

 

S&P 500 Industrials

 

100.00

 

 

112.81

 

 

116.08

 

 

127.82

 

 

156.67

 

 

150.54

 

 

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Item 6.  Selected Financial Data

 

(Dollars in millions, except per share amounts)

 

2018

 

2017

 

2016

 

2015

 

2014

Revenues (a)

 

 

 

 

 

 

 

 

 

 

Textron Aviation

$

4,971

$

4,686

$

4,921

$

4,822

$

4,568

Bell

 

3,180

 

3,317

 

3,239

 

3,454

 

4,245

Textron Systems

 

1,464

 

1,840

 

1,756

 

1,520

 

1,624

Industrial

 

4,291

 

4,286

 

3,794

 

3,544

 

3,338

Finance

 

66

 

69

 

78

 

83

 

103

Total revenues

$

13,972

$

14,198

$

13,788

$

13,423

$

13,878

Segment profit

 

 

 

 

 

 

 

 

 

 

Textron Aviation (b)

$

445

$

303

$

389

$

400

$

234

Bell

 

425

 

415

 

386

 

400

 

529

Textron Systems

 

156

 

139

 

186

 

129

 

150

Industrial

 

218

 

290

 

329

 

302

 

280

Finance

 

23

 

22

 

19

 

24

 

21

Total segment profit

 

1,267

 

1,169

 

1,309

 

1,255

 

1,214

Corporate expenses and other, net

 

(119)

 

(132)

 

(172)

 

(154)

 

(161)

Interest expense, net for Manufacturing group

 

(135)

 

(145)

 

(138)

 

(130)

 

(148)

Special charges (c)

 

(73)

 

(130)

 

(123)

 

 

(52)

Gain on business disposition (d)

 

444

 

 

 

 

Income tax expense (e) 

 

(162)

 

(456)

 

(33)

 

(273)

 

(248)

Income from continuing operations

$

1,222

$

306

$

843

$

698

$

605

Earnings per share

 

 

 

 

 

 

 

 

 

 

Basic earnings per share — continuing operations

$

4.88

$

1.15

$

3.11

$

2.52

$

2.17

Diluted earnings per share — continuing operations

$

4.83

$

1.14

$

3.09

$

2.50

$

2.15

Basic average shares outstanding (in thousands)

 

250,196

 

266,380

 

270,774

 

276,682

 

279,409

Diluted average shares outstanding (in thousands)

 

253,237

 

268,750

 

272,365

 

278,727

 

281,790

Common stock information

 

 

 

 

 

 

 

 

 

 

Dividends declared per share

$

0.08

$

0.08

$

0.08

$

0.08

$

0.08

Book value at year-end

$

22.04

$

21.60

$

20.62

$

18.10

$

15.45

Price at year-end

$

45.65

$

56.59

$

48.56

$

42.01

$

42.17

Financial position

 

 

 

 

 

 

 

 

 

 

Total assets

$

14,264

$

15,340

$

15,358

$

14,708

$

14,605

Manufacturing group debt

$

3,066

$

3,088

$

2,777

$

2,697

$

2,811

Finance group debt

$

718

$

824

$

903

$

913

$

1,063

Shareholders’ equity

$

5,192

$

5,647

$

5,574

$

4,964

$

4,272

Manufacturing group debt-to-capital (net of cash)

 

29%

 

26%

 

23%

 

26%

 

33%

Manufacturing group debt-to-capital

 

37%

 

35%

 

33%

 

35%

 

40%

Investment data

 

 

 

 

 

 

 

 

 

 

Capital expenditures

$

369

$

423

$

446

$

420

$

429

Manufacturing group depreciation

$

358

$

362

$

368

$

383

$

379

 

(a)          At the beginning of 2018, we adopted ASC 606 using a modified retrospective basis and as a result, the comparative information has not been restated and is reported under the accounting standards in effect for these years. See Note 1 to the Consolidated Financial Statements for additional information.

 

(b)          In 2015 and 2014, segment profit included amortization of $12 million and $63 million, respectively, related to fair value step-up adjustments of Beechcraft acquired inventories sold during the period.

 

(c)           Special charges of $73 million were recorded in the fourth quarter of 2018 under a restructuring plan for the Textron Specialized Vehicles businesses within our Industrial segment. In 2017 and 2016, special charges included $90 million and $123 million, respectively, related to our 2016 restructuring plan. We also recorded special charges of $40 million in 2017 related to the Arctic Cat acquisition, which included restructuring, integration and transaction costs. For 2014, special charges included acquisition and restructuring costs related to the acquisition of Beechcraft.

 

(d)          On July 2, 2018, Textron completed the sale of the Tools & Test Equipment product line which resulted in an after-tax gain of $419 million.

 

(e)           Income tax expense for 2017 included a $266 million charge to reflect our provisional estimate of the net impact of the Tax Cuts and Jobs Act. We completed our analysis of this legislation in the fourth quarter of 2018 and recorded a $14 million income tax benefit. In 2016, we recognized an income tax benefit of $319 million, inclusive of interest, of which $206 million is attributable to continuing operations and $113 million is attributable to discontinued operations.  This benefit was a result of the final settlement with the Internal Revenue Service Office of Appeals for our 1998 to 2008 tax years.

 

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Table of Contents

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview and Consolidated Results of Operations

 

For an overview of our business segments, including a discussion of our major products and services, refer to Item 1. Business on pages 3 through 9.  The following discussion should be read in conjunction with our Consolidated Financial Statements and related Notes included in Item 8. Financial Statements and Supplementary Data. An analysis of our consolidated operating results is set forth below, and a more detailed analysis of our segments’ operating results is provided in the Segment Analysis section on pages 21 through 27.

 

At the beginning of 2018, we adopted Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASC 606) using the modified retrospective transition method applied to contracts that were not substantially complete at the end of 2017.  We recorded a $90 million adjustment to increase retained earnings to reflect the cumulative impact of adopting this standard at the beginning of 2018, primarily related to certain long-term contracts our Bell segment has with the U.S. Government that converted to the cost-to-cost method for revenue recognition. Revenues in 2018 for our U.S. Government contracts are primarily recognized as costs are incurred, while revenues for 2017 were primarily recognized as units were delivered. The comparative information has not been restated and is reported under the accounting standards in effect for those periods.  A reconciliation of the financial statement line items impacted for 2018 under ASC 606 to the prior accounting standards is provided in Note 12.

 

2018 Financial Highlights

 

·                  Segment profit increased by 8% to $1.3 billion.

·                  Generated $1.1 billion of net cash from operating activities of continuing operations for our manufacturing businesses.

·                  Completed the sale of the Tools and Test Equipment product line within our Industrial segment and received $0.8 billion in net cash proceeds.

·                  Returned $1.8 billion to our shareholders through share repurchases and dividend payments.

·                  Invested $643 million in research and development activities and $369 million in capital expenditures.

·                  Backlog increased 27% to $9.1 billion. Our backlog includes the award of our third multi-year V-22 contract at Bell for $2.4 billion and increased orders for our commercial aircraft at the Textron Aviation and Bell segments.

 

Revenues

 

 

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2018

 

2017

 

2016

 

2018

 

2017

Revenues

$

13,972

$

14,198

$

13,788

 

(2)%

 

3%

 

Revenues decreased $226 million, 2%, in 2018, compared with 2017, largely driven by the disposition of the Tools and Test Equipment product line within the Industrial segment. The net revenue decrease included the following factors:

 

·                  Lower Textron Systems revenues of $376 million, primarily reflecting lower volume of $159 million in the Marine and Land Systems product line, along with a decrease due to the discontinuance of our sensor-fuzed weapon product in 2017.

·                  Lower Bell revenues of $137 million, primarily due to lower commercial revenues of $91 million, largely reflecting the mix of aircraft sold in the year, and lower military revenues of $46 million.

·                  Higher Textron Aviation revenues of $285 million, due to higher volume and mix of $185 million and favorable pricing of $100 million.

·                 Higher Industrial revenues of $5 million, primarily due to higher volume of $149 million, largely related to the Textron Specialized Vehicles product line, a favorable impact of $57 million from foreign exchange and the impact from the Arctic Cat acquisition of $49 million.  These increases were largely offset by $246 million in lower revenues due to the disposition of the Tools and Test Equipment product line.

 

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Revenues increased $410 million, 3%, in 2017, compared with 2016, largely driven by increases in the Industrial, Textron Systems and Bell segments, partially offset by lower revenues at the Textron Aviation segment. The net revenue increase included the following factors:

 

·                  Higher Industrial revenues of $492 million, primarily due to the impact from the acquisition of Arctic Cat.

·                  Higher Textron Systems revenues of $84 million, primarily due to higher volume of $176 million in the Marine and Land Systems product line, partially offset by lower volume in the other products lines.

·                  Higher Bell revenues of $78 million, primarily due to an increase in commercial revenues of $89 million, largely reflecting higher commercial aircraft deliveries.

·                  Lower Textron Aviation revenues of $235 million, primarily due to lower volume and mix of $307 million, largely the result of lower military and commercial turboprop volume.

 

Cost of Sales and Selling and Administrative Expense

 

 

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2018

 

2017

 

2016

 

2018

 

2017

Cost of sales

$

11,594

$

11,827

$

11,337

 

(2)%

 

4%

Gross margin as a percentage of Manufacturing revenues

 

16.6%

 

16.3%

 

17.3%

 

 

 

 

Selling and administrative expense

$

1,275

$

1,334

$

1,317

 

(4)%

 

1%

 

In 2018, cost of sales decreased $233 million, 2%, compared with 2017, largely resulting from the disposition of the Tools and Test Equipment product line and lower net volume as described above. Selling and administrative expense decreased $59 million, 4%, in 2018, compared with 2017, primarily reflecting the impact from the disposition of the Tools and Test Equipment product line.

 

Cost of sales increased $490 million, 4%, and selling and administrative expense increased $17 million, 1%, in 2017, compared with 2016, primarily due to an increase from acquired businesses, largely Arctic Cat. Gross margin as a percentage of Manufacturing revenues decreased 100 basis points from 2016, primarily due to lower margins at the Textron Systems segment, largely reflecting an unfavorable impact from net program adjustments, and the Industrial segment, which included the impact from the Arctic Cat acquisition.

 

Interest Expense

 

 

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2018

 

2017

 

2016

 

2018

 

2017

Interest expense

$

166

$

174

$

174

 

(5)%

 

 

Interest expense on the Consolidated Statements of Operations includes interest for both the Finance and Manufacturing borrowing groups with interest related to intercompany borrowings eliminated.  Interest expense for the Finance segment is included within segment profit and includes intercompany interest.  Consolidated interest expense decreased $8 million in 2018, compared with 2017, primarily due to lower average debt outstanding.

 

Gain on Business Disposition

On July 2, 2018, we completed the sale of the businesses that manufacture and sell the products in our Tools and Test Equipment product line within our Industrial segment.  We received net cash proceeds of $807 million in connection with this disposition and recorded an after-tax gain of $419 million.

 

Special Charges

In the fourth quarter of 2018, we recorded $73 million in special charges in connection with a plan to restructure the Textron Specialized Vehicles businesses within our Industrial segment. These businesses have undergone significant changes since the acquisition of Arctic Cat as we have expanded the product portfolio and integrated manufacturing operations and retail distribution. In the third quarter of 2018, the operating results for these businesses were significantly below our expectations as dealer sell-through lagged despite the introduction of new products into our dealer network. Based on our review and assessment of the acquired dealer network and go-to-market strategy for the Textron Off Road and Arctic Cat brands in the fourth quarter of 2018, along with a review of the other businesses within the product line, we initiated a restructuring plan. This plan included product rationalization, closure of several factory-direct turf-care branch locations and a manufacturing facility and headcount reductions.  Under this plan, we recorded asset impairment charges of $47 million, primarily intangible assets related to product rationalization, contract termination and other costs of $18 million and severance costs of $8 million.  Headcount reductions totaled approximately 400 positions,

 

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Table of Contents

 

representing 10% of Textron Specialized Vehicles’ workforce. The actions taken under this plan were substantially completed at the end of 2018.

 

In 2017 and 2016, we recorded special charges of $90 million and $123 million, respectively, related to a plan that was initiated in 2016 to restructure and realign our businesses by implementing headcount reductions, facility consolidations and other actions in order to improve overall operating efficiency across Textron. The 2016 plan was completed in 2017. Special charges related to this plan included $97 million of severance costs, $84 million of asset impairments and $32 million in contract terminations and other costs.  Of these amounts, $83 million was incurred at Textron Systems, $63 million at Textron Aviation, $38 million at Industrial, $28 million at Bell and $1 million at Corporate. The total headcount reduction under this plan was approximately 2,100 positions, representing 5% of our workforce.

 

In connection with the acquisition of Arctic Cat, we initiated a restructuring plan in the first quarter of 2017 and recorded restructuring charges of $28 million in 2017, which included $19 million of severance costs, largely related to change-of-control provisions, and $9 million of contract termination and other costs. In addition, we recorded $12 million of acquisition-related integration and transaction costs in 2017.

 

For 2017 and 2016, special charges recorded by segment and type of cost are as follows:

 

(In millions)

 

Severance
Costs

 

Asset
Impairments

 

Contract
Terminations
and Other

 

Acquisition
Integration/
Transaction
Costs

 

Total
Special
Charges

2017

 

 

 

 

 

 

 

 

 

 

Industrial

$

26

$

1

$

19

$

12

$

58

Textron Aviation

 

11

 

17

 

 

 

28

Bell

 

3

 

12

 

8

 

 

23

Textron Systems

 

6

 

16

 

(1)

 

 

21

 

$

46

$

46

$

26

$

12

$

130

2016

 

 

 

 

 

 

 

 

 

 

Industrial

$

17

$

2

$

1

$

$

20

Textron Aviation

 

33

 

1

 

1

 

 

35

Bell

 

4

 

1

 

 

 

5

Textron Systems

 

15

 

34

 

13

 

 

62

Corporate

 

1

 

 

 

 

1

 

$

70

$

38

$

15

$

$

123

 

Income Taxes

 

 

 

 

 

2018

 

2017

 

2016

Effective tax rate

 

 

 

11.7%

 

59.8%

 

3.8%

 

In 2018, our effective tax rate was lower than the U.S. federal statutory tax rate of 21%, primarily due to the disposition of the Tools and Test equipment product line which resulted in a gain taxable primarily in non-U.S. jurisdictions that partially exempt such gains from tax. The effective tax rate for 2018 also reflects a $25 million benefit recognized upon the reassessment of our reserve for uncertain tax positions based on new information, including interactions with the tax authorities and recent audit settlements. In addition, we finalized the 2017 impacts of the Tax Cut and Jobs Act (the “Tax Act”) and recognized a $14 million benefit in the fourth quarter of 2018.

 

Our effective tax rate for 2017 was higher than the U.S. federal statutory tax rate of 35%, largely due to the impact from the Tax Act.  In the fourth quarter of 2017, we recorded a provisional estimate of $266 million for one-time adjustments resulting from the Tax Act.  Approximately $154 million of this provisional estimate represented a charge resulting from the remeasurement of our U.S. federal deferred tax assets and liabilities, and the remainder represented a provision for the transition tax on post-1986 earnings and profits previously deferred from U.S. income taxes.

 

In 2016, our effective tax rate was lower than the U.S. federal statutory tax rate of 35%, largely due to a settlement with the U.S. Internal Revenue Service Office of Appeals for our 1998 to 2008 tax years.  This settlement resulted in a $206 million benefit recognized in continuing operations and a $113 million benefit in discontinued operations.

 

For a full reconciliation of our effective tax rate to the U.S. federal statutory tax rate, see Note 16.

 

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Segment Analysis

 

We operate in, and report financial information for, the following five business segments: Textron Aviation, Bell, Textron Systems, Industrial and Finance.  Segment profit is an important measure used for evaluating performance and for decision-making purposes. Segment profit for the manufacturing segments excludes interest expense, certain corporate expenses, gains/losses on major business dispositions and special charges.  The measurement for the Finance segment includes interest income and expense along with intercompany interest income and expense.  Operating expenses for the Manufacturing segments include cost of sales, selling and administrative expense and other non-service components of net periodic benefit cost/(credit), and exclude certain corporate expenses and special charges.

 

In our discussion of comparative results for the Manufacturing group, changes in revenues and segment profit typically are expressed for our commercial business in terms of volume, pricing, foreign exchange, acquisitions and dispositions, while changes in segment profit may be expressed in terms of mix, inflation and cost performance. Volume changes in revenues for our commercial business represent increases or decreases in the number of units delivered or services provided.  Pricing represents changes in unit pricing.  Foreign exchange is the change resulting from translating foreign-denominated amounts into U.S. dollars at exchange rates that are different from the prior period.  Revenues generated by acquired businesses are reflected in Acquisitions for a twelve-month period, while reductions in revenues from the sale of businesses are reflected as Dispositions.  For segment profit, mix represents a change due to the composition of products and/or services sold at different profit margins.  Inflation represents higher material, wages, benefits, pension service cost or other costs.  Performance reflects an increase or decrease in research and development, depreciation, selling and administrative costs, warranty, product liability, quality/scrap, labor efficiency, overhead, non-service pension cost/(credit), product line profitability, start-up, ramp up and cost-reduction initiatives or other manufacturing inputs.

 

Approximately 24% of our 2018 revenues were derived from contracts with the U.S. Government, including those under the U.S. Government-sponsored foreign military sales program.  For our segments that contract with the U.S. Government, changes in revenue related to these contracts are expressed in terms of volume.  Revenues in 2018 for our U.S. Government contracts are primarily recognized as costs are incurred, while revenues for 2017 and 2016 were primarily recognized as units were delivered. Changes in segment profit are typically expressed in terms of volume and performance; these include cumulative catch-up adjustments associated with a) revisions to the transaction price that may reflect contract modifications or changes in assumptions related to award fees and other variable consideration or b) changes in the total estimated costs at completion due to improved or deteriorated operating performance.

 

Textron Aviation

 

 

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2018

 

2017

 

2016

 

2018

 

2017

Revenues:

 

 

 

 

 

 

 

 

 

 

Aircraft

$

3,435

$

3,112

$

3,412

 

10%

 

(9)%

Aftermarket parts and services

 

1,536

 

1,574

 

1,509

 

(2)%

 

4%

Total revenues

 

4,971

 

4,686

 

4,921

 

6%

 

(5)%

Operating expenses

 

4,526

 

4,383

 

4,532

 

3%

 

(3)%

Segment profit

 

445

 

303

 

389

 

47%

 

(22)%

Profit margin

 

9.0%

 

6.5%

 

7.9%

 

 

 

 

Backlog

$

1,791

$

1,180

$

1,041

 

52%

 

13%

 

Textron Aviation Revenues and Operating Expenses

Factors contributing to the 2018 year-over-year revenue change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2018 versus
2017

Volume and mix

 

 

 

 

 

 

$

185

Pricing

 

 

 

 

 

 

 

100

Total change

 

 

 

 

 

 

$

285

 

Textron Aviation’s revenues increased $285 million, 6%, in 2018, compared 2017, due to higher volume and mix of $185 million and favorable pricing of $100 million.  We delivered 188 Citation jets and 186 commercial turboprops in 2018, compared with 180 Citation jets and 155 commercial turboprops in 2017.

 

Textron Aviation’s operating expenses increased $143 million, 3%, in 2018, compared with 2017, largely due to higher net volume as described above.

 

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Factors contributing to the 2017 year-over-year revenue change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2017 versus
2016

Volume and mix

 

 

 

 

 

 

$

(307)

Other

 

 

 

 

 

 

 

72

Total change

 

 

 

 

 

 

$

(235)

 

Textron Aviation’s revenues decreased $235 million, 5%, in 2017, compared with 2016, primarily due to lower volume and mix of $307 million, largely the result of lower military and commercial turboprop volume. We delivered 180 Citation jets, 155 commercial turboprops and 13 Beechcraft T-6 trainers in 2017, compared with 178 Citation jets, 190 commercial turboprops and 38 Beechcraft T-6 trainers in 2016.

 

Textron Aviation’s operating expenses decreased $149 million, 3%, in 2017, compared with 2016, largely due to lower net volume as described above.

 

Textron Aviation Segment Profit

Factors contributing to 2018 year-over-year segment profit change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2018 versus
2017

Volume and mix

 

 

 

 

 

 

$

65

Pricing, net of inflation

 

 

 

 

 

 

 

57

Performance

 

 

 

 

 

 

 

20

Total change

 

 

 

 

 

 

$

142

 

Segment profit at Textron Aviation increased $142 million, 47%, in 2018, compared with 2017, primarily due to the impact from higher volume and mix of $65 million as described above and the favorable impact from pricing, net of inflation.

 

Factors contributing to 2017 year-over-year segment profit change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2017 versus
2016

Volume and mix

 

 

 

 

 

 

$

(99)

Pricing, net of inflation

 

 

 

 

 

 

 

56

Performance and other

 

 

 

 

 

 

 

(43)

Total change

 

 

 

 

 

 

$

(86)

 

Segment profit at Textron Aviation decreased $86 million, 22%, in 2017, compared with 2016, primarily as a result of lower net volume and mix as described above.  The favorable impact of $56 million from pricing, net of inflation, was largely offset by an unfavorable impact of $43 million from performance and other, largely reflecting higher research, development and engineering costs, which included costs related to the Scorpion program in 2017.

 

Textron Aviation Backlog

Backlog at Textron Aviation increased $611 million, 52%, in 2018 as a result of orders in excess of deliveries.

 

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Bell

 

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2018

 

2017

 

2016

 

2018

 

2017

Revenues:

 

 

 

 

 

 

 

 

 

 

Military aircraft and support programs

$

2,030

$

2,076

$

2,087

 

(2)%

 

(1)%

Commercial helicopters, parts and services

 

1,150

 

1,241

 

1,152

 

(7)%

 

8%

Total revenues

 

3,180

 

3,317

 

3,239

 

(4)%

 

2%

Operating expenses

 

2,755

 

2,902

 

2,853

 

(5)%

 

2%

Segment profit

 

425

 

415

 

386

 

2%

 

8%

Profit margin

 

13.4%

 

12.5%

 

11.9%

 

 

 

 

Backlog

$

5,837

$

4,598

$

5,360

 

27%

 

(14)%

 

Bell’s major U.S. Government programs at this time are the V-22 tiltrotor aircraft and the H-1 helicopter platforms, which are both in the production stage and represent a significant portion of Bell’s revenues from the U.S. Government.

 

Bell Revenues and Operating Expenses

Factors contributing to the 2018 year-over-year revenue change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2018 versus
2017

Volume and mix

 

 

 

 

 

 

$

(155)

Other

 

 

 

 

 

 

 

18

Total change

 

 

 

 

 

 

$

(137)

 

Bell’s revenues decreased $137 million, 4%, in 2018, compared with 2017, primarily due to lower commercial revenues of $91 million, largely reflecting the mix of aircraft sold in the year, and lower military revenues of $46 million. We delivered 192 commercial helicopters in 2018, compared with 132 commercial helicopters in 2017.

 

Bell’s operating expenses decreased $147 million, 5%, in 2018, compared with 2017, primarily due to lower volume and mix as described above and improved performance on military programs described below.

 

Factors contributing to the 2017 year-over-year revenue change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2017 versus
2016

Volume and mix

 

 

 

 

 

 

$

57

Other

 

 

 

 

 

 

 

21

Total change

 

 

 

 

 

 

$

78

 

Bell’s revenues increased $78 million, 2%, in 2017, compared with 2016, primarily due to an $89 million increase in commercial revenues, largely due to higher deliveries as Bell delivered 132 commercial aircraft in 2017, compared with 114 aircraft in 2016.  Military deliveries were largely unchanged in 2017 compared with 2016, as we delivered 22 V-22 aircraft in both years and 38 H-1 aircraft in 2017, compared with 35 H-1 aircraft in 2016.

 

Bell’s operating expenses increased $49 million, 2%, in 2017, compared with 2016, primarily due to higher volume as described above.

 

Bell Segment Profit

Factors contributing to 2018 year-over-year segment profit change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2018 versus
2017

Performance and other

 

 

 

 

 

 

$

60

Volume and mix

 

 

 

 

 

 

 

(50)

Total change

 

 

 

 

 

 

$

10

 

Bell’s segment profit increased $10 million, 2%, in 2018, compared with 2017, due to a favorable impact of $60 million from performance and other, partially offset by an unfavorable impact from volume and mix, largely due to the mix of commercial aircraft sold in the year. The impact from performance and other was largely the result of $77 million in improved performance on military

 

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Table of Contents

 

programs, which included an increase in favorable profit adjustments reflecting retirements of risk related to cost estimates and improved labor and overhead rates, partially offset by higher research and development costs.

 

Factors contributing to 2017 year-over-year segment profit change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2017 versus
2016

Performance and other

 

 

 

 

 

 

$

66

Volume and mix

 

 

 

 

 

 

 

(37)

Total change

 

 

 

 

 

 

$

29

 

Bell’s segment profit increased $29 million, 8%, in 2017, compared with 2016, reflecting a favorable impact from performance and other of $66 million, largely the result of improved manufacturing performance and lower research and development costs, partially offset by an unfavorable impact from volume and mix of $37 million.

 

Bell Backlog

Bell’s backlog increased $1.2 billion, 27%, in 2018.  New contracts received in excess of revenues recognized totaled $2.0 billion, which primarily reflected an increase of $2.4 billion for Bell’s portion of a third multi-year V-22 contract for the production and delivery of 63 units along with related supplies and services through 2024.  This was partially offset by a decrease of $760 million upon the adoption of ASC 606 at the beginning of 2018, largely resulting from the acceleration of revenues upon conversion to the cost-to-cost method of revenue recognition.

 

Bell’s backlog decreased $762 million, 14%, in 2017, primarily due to deliveries on the V-22 and H-1 programs in excess of orders.

 

Textron Systems

 

 

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2018

 

2017

 

2016

 

2018

 

2017

Revenues

$

1,464

$

1,840

$

1,756

 

(20)%

 

5%

Operating expenses

 

1,308

 

1,701

 

1,570

 

(23)%

 

8%

Segment profit

 

156

 

139

 

186

 

12%

 

(25)%

Profit margin

 

10.7%

 

7.6%

 

10.6%

 

 

 

 

Backlog

$

1,469

$

1,406

$

1,841

 

4%

 

(24)%

 

Textron Systems Revenues and Operating Expenses

Factors contributing to the 2018 year-over-year revenue change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2018 versus
2017

Volume

 

 

 

 

 

 

$

(380)

Other

 

 

 

 

 

 

 

4

Total change

 

 

 

 

 

 

$

(376)

 

Revenues at Textron Systems decreased $376 million, 20%, in 2018, compared with 2017, primarily due to lower volume of $159 million in the Marine and Land Systems product line reflecting lower Tactical Armoured Patrol Vehicle program (TAPV) deliveries, along with a decrease due to the discontinuance of our sensor-fuzed weapon product in 2017.

 

Textron Systems’ operating expenses decreased $393 million, 23%, in 2018, compared with 2017, primarily due to lower volume described above.  The decrease in operating expenses in 2018 also included the impact from unfavorable net program adjustments recorded in 2017 described below.

 

Factors contributing to the 2017 year-over-year revenue change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2017 versus
2016

Volume

 

 

 

 

 

 

$

67

Acquisitions

 

 

 

 

 

 

 

10

Other

 

 

 

 

 

 

 

7

Total change

 

 

 

 

 

 

$

84

 

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Table of Contents

 

Revenues at Textron Systems increased $84 million, 5%, in 2017, compared with 2016, primarily due to higher volume of $176 million in the Marine and Land Systems product line, partially offset by lower volume in the other product lines, largely due to the final deliveries of our discontinued sensor-fuzed weapon product in the first half of 2017.

 

Textron Systems’ operating expenses increased $131 million, 8%, in 2017, compared with 2016, primarily due to higher volume as described above and the unfavorable impact from net program adjustments described below.

 

Textron Systems Segment Profit

Factors contributing to 2018 year-over-year segment profit change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2018 versus
2017

Performance and other

 

 

 

 

 

 

$

62

Volume and mix

 

 

 

 

 

 

 

(45)

Total change

 

 

 

 

 

 

$

17

 

Textron Systems’ segment profit increased $17 million, 12%, in 2018, compared with 2017, primarily due to favorable performance and other of $62 million, partially offset by lower volume described above. Performance and other improved largely due to unfavorable program adjustments recorded in 2017 as discussed below.

 

Factors contributing to 2017 year-over-year segment profit change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2017 versus
2016

Performance

 

 

 

 

 

 

$

(28)

Volume and mix

 

 

 

 

 

 

 

(13)

Other

 

 

 

 

 

 

 

(6)

Total change

 

 

 

 

 

 

$

(47)

 

Textron Systems’ segment profit decreased $47 million, 25%, in 2017, compared with 2016, primarily due to unfavorable performance.  Performance reflects an unfavorable impact from net program adjustments compared with 2016, largely due to $44 million of adjustments recorded in 2017 related to the TAPV program.  In 2017, this program experienced inefficiencies resulting from various production issues during the ramp up and subsequent production.

 

Textron Systems Backlog

In 2017, backlog decreased $435 million, 24%, primarily due to deliveries in excess of orders in the Marine and Land Systems product line as TAPV deliveries neared completion, and final deliveries of our discontinued sensor-fuzed weapon product in 2017.

 

Industrial

 

 

 

 

 

 

 

 

% Change

(Dollars in millions)

 

2018

 

2017

 

2016

 

2018

 

2017

Revenues:

 

 

 

 

 

 

 

 

 

 

Fuel Systems and Functional Components

$

2,352

$

2,330

$

2,273

 

1%

 

3%

Other Industrial

 

1,939

 

1,956

 

1,521

 

(1)%

 

29%

Total revenues

 

4,291

 

4,286

 

3,794

 

 

13%

Operating expenses

 

4,073

 

3,996

 

3,465

 

2%

 

15%

Segment profit

 

218

 

290

 

329

 

(25)%

 

(12)%

Profit margin

 

5.1%

 

6.8%

 

8.7%

 

 

 

 

 

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Table of Contents

 

Industrial Revenues and Operating Expenses

Factors contributing to the 2018 year-over-year revenue change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2018 versus
2017

Disposition

 

 

 

 

 

 

$

(246)

Volume

 

 

 

 

 

 

 

149

Foreign exchange

 

 

 

 

 

 

 

57

Acquisition

 

 

 

 

 

 

 

49

Other

 

 

 

 

 

 

 

(4)

Total change

 

 

 

 

 

 

$

5

 

Industrial segment revenues increased $5 million, in 2018, compared with 2017. Higher volume of $149 million, largely related to the Textron Specialized Vehicles product line, a favorable impact of $57 million from foreign exchange, primarily related to the strengthening of the Euro against the U.S. dollar, and the impact of $49 million from the acquisition of Arctic Cat on March 6, 2017, were largely offset by $246 million in lower revenues due to the disposition of the Tools and Test Equipment product line.

 

Operating expenses for the Industrial segment increased $77 million, 2%, in 2018, compared with 2017, primarily due to higher volume described above, the impact from foreign exchange and additional operating expenses from the Arctic Cat acquisition.  These increases were partially offset by lower operating expenses from the disposition of our Tools and Test Equipment product line.

 

Factors contributing to the 2017 year-over-year revenue change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2017 versus
2016

Acquisitions

 

 

 

 

 

 

$

393

Volume

 

 

 

 

 

 

 

77

Foreign exchange

 

 

 

 

 

 

 

27

Other

 

 

 

 

 

 

 

(5)

Total change

 

 

 

 

 

 

$

492

 

Industrial segment revenues increased $492 million, 13%, in 2017, compared with 2016, primarily due to the impact from acquired businesses of $393 million, largely related to the acquisition of Arctic Cat as described below.  Revenues were also impacted by higher volume of $77 million, primarily related to the Fuel Systems and Functional Components product line and a favorable impact of $27 million from foreign exchange, primarily related to the Euro.

 

On March 6, 2017, we acquired Arctic Cat, a manufacturer of all-terrain vehicles, side-by-sides and snowmobiles, in addition to related parts, garments and accessories.  The operating results of Arctic Cat have been included in our financial results only for the period subsequent to the completion of the acquisition. See Note 2 for additional information regarding this acquisition.

 

Operating expenses for the Industrial segment increased $531 million, 15%, in 2017, compared with 2016, primarily due to additional operating expenses from acquired businesses.  The increase in operating expenses was also due to higher volume as described above.

 

Industrial Segment Profit

Factors contributing to 2018 year-over-year segment profit change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2018 versus
2017

Disposition

 

 

 

 

 

 

$

(22)

Pricing and inflation

 

 

 

 

 

 

 

(21)

Performance and other

 

 

 

 

 

 

 

(16)

Volume and mix

 

 

 

 

 

 

 

(13)

Total change

 

 

 

 

 

 

$

(72)

 

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Segment profit for the Industrial segment decreased $72 million, 25%, in 2018, compared with 2017, resulting from the impact of the disposition of our Tools and Test Equipment product line of $22 million, an unfavorable impact of pricing and inflation of $21 million and unfavorable performance and other of $16 million, which were both primarily related to the Textron Specialized Vehicles product line. The unfavorable volume and mix was primarily due to the mix of products sold in the year. Performance and other primarily included additional operating expenses in the first quarter of 2018 due to the timing of the Arctic Cat acquisition and the seasonality of the outdoor power sports business and unfavorable inventory adjustments in the Textron Specialized Vehicles product line, partially offset by a favorable impact of $17 million recognized in the fourth quarter of 2018 related to a patent infringement matter.

 

Factors contributing to 2017 year-over-year segment profit change are provided below:

 

(In millions)

 

 

 

 

 

 

 

2017 versus
2016

Pricing and inflation

 

 

 

 

 

 

$

(23)

Performance and other

 

 

 

 

 

 

 

(10)

Volume and mix

 

 

 

 

 

 

 

(6)

Total change

 

 

 

 

 

 

$

(39)

 

Industrial’s segment profit decreased $39 million, 12%, in 2017, compared with 2016, largely due to an unfavorable impact from pricing and inflation of $23 million, primarily in the Fuel Systems and Functional Components product line, and unfavorable performance and other of $10 million.  Performance and other primarily included the operating results of Arctic Cat, partially offset by favorable performance in the Fuel Systems and Functional Components product line.

 

Finance

 

(In millions)

 

 

 

2018

 

2017

 

2016

Revenues

 

 

$

66

$

69

$

78

Segment profit

 

 

 

23

 

22

 

19

 

Finance segment revenues decreased $3 million and segment profit increased $1 million in 2018, compared with 2017. Finance segment revenues decreased $9 million, in 2017, compared with 2016, primarily attributable to lower average finance receivables, and segment profit increased $3 million in 2017, compared with 2016, primarily due to lower provision for loan losses, partially offset by lower average finance receivables. The following table reflects information about the Finance segment’s credit performance related to finance receivables.

 

(Dollars in millions)

 

 

 

 

 

December 29,
2018

 

December 30,
2017

Finance receivables

 

 

 

 

$

789

$

850

Nonaccrual finance receivables

 

 

 

 

 

40

 

61

Ratio of nonaccrual finance receivables to finance receivables

 

 

 

 

 

5.07%

 

7.18%

60+ days contractual delinquency

 

 

 

 

$

14

$

34

60+ days contractual delinquency as a percentage of finance receivables

 

 

 

 

 

1.77%

 

4.00%

 

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Table of Contents

 

Liquidity and Capital Resources

 

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.

 

Key information that is utilized in assessing our liquidity is summarized below:

 

(Dollars in millions)

 

 

 

 

 

December 29,
2018

 

December 30,
2017

Manufacturing group

 

 

 

 

 

 

 

 

Cash and equivalents

 

 

 

 

$

987

$

1,079

Debt

 

 

 

 

 

3,066

 

3,088

Shareholders’ equity

 

 

 

 

 

5,192

 

5,647

Capital (debt plus shareholders’ equity)

 

 

 

 

 

8,258

 

8,735

Net debt (net of cash and equivalents) to capital

 

 

 

 

 

29%

 

26%

Debt to capital

 

 

 

 

 

37%

 

35%

Finance group

 

 

 

 

 

 

 

 

Cash and equivalents

 

 

 

 

$

120

$

183

Debt

 

 

 

 

 

718

 

824

 

We believe that our calculations of debt to capital and net debt to capital are useful measures as they provide a summary indication of the level of debt financing (i.e., leverage) that is in place to support our capital structure, as well as to provide an indication of the capacity to add further leverage.  We believe that we will have sufficient cash to meet our future needs, based on our existing cash balances, the cash we expect to generate from our manufacturing operations and other available funding alternatives, as appropriate.

 

Textron has a senior unsecured revolving credit facility that expires in September 2021 for an aggregate principal amount of $1.0 billion, of which up to $100 million is available for the issuance of letters of credit.  At December 29, 2018, there were no amounts borrowed against the facility and there were $10 million of letters of credit issued against it. We also maintain an effective shelf registration statement filed with the Securities and Exchange Commission that allows us to issue an unlimited amount of public debt and other securities.

 

Manufacturing Group Cash Flows

Cash flows from continuing operations for the Manufacturing group as presented in our Consolidated Statements of Cash Flows are summarized below:

 

(In millions)

 

 

 

2018

 

2017

 

2016

Operating activities

 

 

$

1,127

$

930

$

901

Investing activities

 

 

 

539

 

(728)

 

(534)

Financing activities

 

 

 

(1,738)

 

(266)

 

(146)

 

In 2018, cash flows provided by operating activities was $1,127 million, compared with $930 million in 2017, a 21% increase, primarily reflecting lower pension contributions of $306 million, higher earnings and a dividend of $50 million received from the Finance group in the first quarter of 2018, which were partially offset by a higher use of net working capital in 2018, largely reflecting a $145 million cash outflow from changes in net taxes paid/received.

 

Cash flows provided by operating activities was $930 million in 2017, compared with $901 million in 2016, a 3% increase, as improvements in working capital, were largely offset by higher pension contributions of $308 million and lower earnings.  Significant factors contributing to the favorable change in working capital included an increase in cash flows of $769 million related to changes in inventory between the periods, principally in the Textron Aviation and Textron Systems segments, $333 million related to changes in customer deposits and $179 million from changes in net taxes paid/received, partially offset by changes in accounts payable and accounts receivable. The increase in cash flows from customer deposits between the periods is primarily related to lower performance-based payments received on certain military contracts in the Bell segment in 2016.

 

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Net tax payments/(receipts) were $129 million, $(16) million and $163 million in 2018, 2017 and 2016, respectively. Pension contributions were $52 million, $358 million and $50 million in 2018, 2017 and 2016, respectively.  In 2017, pension contributions included a $300 million discretionary contribution to fund a U.S. pension plan.

 

In 2018, investing cash flows included net cash proceeds of $807 million from the disposition of the Tools and Test Equipment product line and net proceeds from corporate-owned life insurance policies of $110 million, partially offset by capital expenditures of $369 million.  In 2017, cash flows used by investing activities included capital expenditures of $423 million and a $316 million aggregate cash payment for the Arctic Cat acquisition.  Investing cash flows for 2016 included capital expenditures of $446 million and cash used for acquisitions of $186 million, partially offset by net proceeds from corporate-owned life insurance policies of $87 million.

 

Cash flows used in financing activities in 2018 primarily included $1.8 billion of cash paid to repurchase an aggregate of 29.1 million shares of our outstanding common stock under both a new 2018 share repurchase authorization as disclosed below and a prior 2017 authorization. In 2017 and 2016, financing cash flows included $582 million and $241 million of cash paid, respectively, to repurchase an aggregate of 11.9 million and 6.9 million shares, respectively, of our outstanding common stock under prior share repurchase authorizations. Total financing cash flows in 2017 and 2016 also included the repayment of outstanding debt of $704 million and $254 million, respectively, and proceeds from long-term debt of $992 million and $345 million, respectively.

 

On April 16, 2018, our Board of Directors authorized the repurchase of up to 40 million shares of our common stock.  This repurchase plan was utilized in 2018 for repurchases funded, in part, by the net proceeds of $0.8 billion from the disposition of the Tools and Test product line.  In addition, this plan allows us to opportunistically repurchase shares and to continue our practice of repurchasing shares to offset the impact of dilution from shares issued under compensation and benefit plans.

 

Dividend payments to shareholders totaled $20 million, $21 million and $22 million in 2018, 2017 and 2016, respectively. Dividends received from the Finance group, which totaled $50 million and $29 million in 2018 and 2016, respectively, are included within cash flows from operating activities for the Manufacturing group as they represent a return on investment.

 

Finance Group Cash Flows

The cash flows from continuing operations for the Finance group as presented in our Consolidated Statements of Cash Flows are summarized below:

 

(In millions)

 

 

 

2018

 

2017

 

2016

Operating activities

 

 

$

14

$

(24)

$

11

Investing activities

 

 

 

99

 

140

 

142

Financing activities

 

 

 

(176)

 

(94)

 

(51)

 

The Finance group’s cash flows from operating activities included net tax payments of $17 million, $48 million and $11 million in 2018, 2017 and 2016, respectively. Cash flows from investing activities primarily included collections on finance receivables totaling $226 million, $273 million and $292 million in 2018, 2017 and 2016, respectively, partially offset by finance receivable originations of $177 million, $174 million and $173 million, respectively.

 

Cash flows used in financing activities included payments on long-term and nonrecourse debt of $126 million, $137 million and $203 million in 2018, 2017 and 2016, respectively. In 2017 and 2016, cash flows from financing activities also included proceeds from long-term debt of $44 million and $180 million, respectively. In 2018 and 2016, dividend payments to the Manufacturing group totaled $50 million and $29 million, respectively.

 

Consolidated Cash Flows

The consolidated cash flows from continuing operations, after elimination of activity between the borrowing groups, are summarized below:

 

(In millions)

 

 

 

2018

 

2017

 

2016

Operating activities

 

 

$

1,109

$

963

$

927

Investing activities

 

 

 

620

 

(645)

 

(436)

Financing activities

 

 

 

(1,864)

 

(360)

 

(168)

 

In 2018, consolidated cash flows provided by operating activities was $1,109 million, compared with $963 million in 2017, a 15% increase, primarily reflecting lower pension contributions of $306 million and higher earnings, partially offset by a higher use of net working capital in 2018, reflecting a $114 million increase in net tax payments and $45 million in lower cash flows related to captive financing activities.

 

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Consolidated cash flows provided by operating activities was $963 million in 2017, compared with $927 million in 2016, a 4% increase, as improvements in working capital, were largely offset by higher pension contributions of $308 million and lower earnings.  Significant factors contributing to the favorable change in working capital included an increase in cash flows of $764 million related to changes in inventory between the periods, principally in the Textron Aviation and Textron Systems segments, $333 million related to changes in customer deposits and $142 million of lower net tax payments, partially offset by changes in accounts payable and accounts receivable. The increase in cash flows from customer deposits between the periods is primarily related to lower performance-based payments received on certain military contracts in the Bell segment in 2016.

 

Net tax payments were $146 million, $32 million and $174 million in 2018, 2017 and 2016, respectively.  Pension contributions were $52 million, $358 million and $50 million in 2018, 2017 and 2016, respectively.  In 2017, pension contributions included a $300 million discretionary contribution to fund a U.S. pension plan.

 

Investing cash flows in 2018 included net cash proceeds of $807 million from the disposition of the Tools and Test Equipment product line and net proceeds from corporate-owned life insurance policies of $110 million, partially offset by capital expenditures of $369 million.  In 2017, cash flows used by investing activities included capital expenditures of $423 million and a $316 million aggregate cash payment for the Arctic Cat acquisition.  Investing cash flows for 2016 included capital expenditures of $446 million and cash used for acquisitions of $186 million, partially offset by net proceeds from corporate-owned life insurance policies of $87 million.

 

In 2018, 2017 and 2016, cash used in financing activities included share repurchases of $1,783 million, $582 million and $241 million, respectively, and the repayment of outstanding debt of $131 million, $841 million and $457 million, respectively. Total financing cash flows in 2017 and 2016 also included proceeds from long-term debt of $1,036 million and $525 million, respectively.

 

Captive Financing and Other Intercompany Transactions

The Finance group provides financing primarily to purchasers of new and pre-owned Textron Aviation aircraft and Bell helicopters manufactured by our Manufacturing group, otherwise known as captive financing.  In the Consolidated Statements of Cash Flows, cash received from customers is reflected as operating activities when received from third parties.  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 and is financed by the Finance group, the origination of the finance receivable is recorded within investing activities as a cash outflow in the Finance group’s statement of cash flows.  Meanwhile, in the Manufacturing group’s statement of cash flows, the cash received from the Finance group on the customer’s behalf is recorded within operating cash flows as a cash inflow.  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.

 

Reclassification adjustments included in the Consolidated Statements of Cash Flows are summarized below:

 

 

 

 

 

 

 

 

 

(In millions)

 

 

 

2018

 

2017

 

2016

Reclassification adjustments from investing activities:

 

 

 

 

 

 

 

 

Cash received from customers

 

 

$

199

$

241

$

248

Finance receivable originations for Manufacturing group inventory sales

 

 

 

(177)

 

(174)

 

(173)

Other

 

 

 

(4)

 

(10)

 

(31)

Total reclassification adjustments from investing activities

 

 

 

18

 

57

 

44

Reclassification adjustments from financing activities:

 

 

 

 

 

 

 

 

Dividends received by Manufacturing group from Finance group

 

 

 

(50)

 

 

(29)

Total reclassification adjustments to cash flow from operating activities

 

 

$

(32)

$

57

$

15

 

Under a Support Agreement between Textron and TFC, Textron is required to maintain a controlling interest in TFC.  The agreement, as amended in December 2015, also requires Textron to ensure that TFC maintains fixed charge coverage of no less than 125% and consolidated shareholder’s equity of no less than $125 million.  There were no cash contributions required to be paid to TFC in 2018, 2017 and 2016 to maintain compliance with the support agreement.

 

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Contractual Obligations

 

Manufacturing Group

The following table summarizes the known contractual obligations, as defined by reporting regulations, of our Manufacturing group as of December 29, 2018:

 

 

 

 

Payments Due by Period

(In millions)

 

Total

 

Year 1

 

Years 2-3

 

Years 4-5

 

More Than 5
Years

Debt

$

3,082

$

258

$

1,059

$

14

$

1,751

Purchase obligations not reflected in balance sheet

 

2,571

 

2,032

 

509

 

28

 

2

Interest on borrowings

 

643

 

136

 

205

 

135

 

167

Pension benefits for unfunded plans

 

369

 

27

 

50

 

46

 

246

Postretirement benefits other than pensions

 

250

 

28

 

49

 

41

 

132

Other long-term liabilities

 

345

 

76

 

103

 

54

 

112

Operating leases

 

301

 

64

 

77

 

45

 

115

Total Manufacturing group

$

7,561

$

2,621

$

2,052

$

363

$

2,525

 

Pension and Postretirement Benefits

We maintain defined benefit pension plans and postretirement benefit plans other than pensions as described in Note 14. Included in the above table are discounted estimated benefit payments we expect to make related to unfunded pension and other postretirement benefit plans. Actual benefit payments are dependent on a number of factors, including mortality assumptions, expected retirement age, rate of compensation increases and medical trend rates, which are subject to change in future years. Our policy for funding pension plans is to make contributions annually, consistent with applicable laws and regulations; however, future contributions to our pension plans are not included in the above table.  In 2019, we expect to make approximately $25 million of contributions to our funded pension plans and the Retirement Account Plan. Based on our current assumptions, which may change with changes in market conditions, our current contribution for each of the years from 2020 through 2023 are estimated to be approximately $50 million under the plan provisions in place at this time.

 

Other Long-Term Liabilities

Other long-term liabilities consist of undiscounted amounts in the Consolidated Balance Sheets that primarily include obligations under deferred compensation arrangements and estimated environmental remediation costs. Payments under deferred compensation arrangements have been estimated based on management’s assumptions of expected retirement age, mortality, stock price and rates of return on participant deferrals. The timing of cash flows associated with environmental remediation costs is largely based on historical experience. Certain other long-term liabilities, such as deferred taxes, unrecognized tax benefits and product liability, warranty and litigation reserves, have been excluded from the table due to the uncertainty of the timing of payments combined with the absence of historical trends to be used as a predictor for such payments.

 

Purchase Obligations

Purchase obligations include undiscounted amounts committed under legally enforceable contracts or purchase orders for goods and services with defined terms as to price, quantity and delivery dates. Approximately 37% of the purchase obligations we disclose represent purchase orders issued for goods and services to be delivered under firm contracts with the U.S. Government for which we have full recourse under customary contract termination clauses.

 

Finance Group

The following table summarizes the known contractual obligations, as defined by reporting regulations, of our Finance group as of December 29, 2018:

 

 

 

 

Payments Due by Period

(In millions)

 

Total

 

Year 1

 

Years 2-3

 

Years 4-5

 

More Than 5
Years

Term debt

$

419

$

167

$

190

$

37

$

25

Subordinated debt

 

299

 

 

 

 

299

Interest on borrowings

 

216

 

25

 

37

 

30

 

124

Total Finance group

$

934

$

192

$

227

$

67

$

448

 

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Critical Accounting Estimates

 

To prepare our Consolidated Financial Statements to be in conformity with generally accepted accounting principles, we must make complex and subjective judgments in the selection and application of accounting policies.  The accounting policies that we believe are most critical to the portrayal of our financial condition and results of operations are listed below.  We believe these policies require our most difficult, subjective and complex judgments in estimating the effect of inherent uncertainties.   This section should be read in conjunction with Note 1, which includes other significant accounting policies.

 

Revenue Recognition

A substantial portion of our revenues is related to long-term contracts with the U.S. Government, including those under U.S. Government-sponsored foreign military sales program, for the design, development, manufacture or modification of aerospace and defense products as well as related services.  At the beginning of 2018, we adopted Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (ASC 606) and its related amendments using the modified retrospective transition method, which permitted comparative information to not be restated  This standard primarily impacted our contracts with the U.S. Government as we were required to convert certain contracts from the units-of-delivery method to the cost-to-cost method for revenue recognition. Under ASC 606, while the timing of revenue recognition has changed for many of these contracts and the number of units of accounting, known as performance obligations, have been reduced from the prior standards, the process for establishing and reviewing our revenue and cost estimates is consistent with the prior periods.

 

With the adoption of ASC 606 in 2018, due to the continuous transfer of control to the U.S. Government, we recognize revenue over the time that we perform under the contract.   Selecting the method to measure progress towards completion requires judgment and is based on the nature of the products or service to be provided.  We generally use the cost-to-cost method to measure progress for our contracts because it best depicts the transfer of control to the customer that occurs as we incur costs on our contracts.  Under this measure, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the estimated costs at completion of the performance obligation, and revenue is recorded proportionally as costs are incurred.

 

Prior to the ASC 606 adoption, we accounted for our long-term contracts under the percentage of completion method of accounting.  Under this method, we estimated profit as the difference between total estimated revenues and cost of a contract.  We then recognized that estimated profit over the contract term based on either the units-of-delivery method or the cost-to-cost method (which typically was used for development effort as costs were incurred), as appropriate under the circumstances. Revenues under fixed price contracts generally were recorded using the units-of-delivery method, while revenues under cost-reimbursement contracts were recorded using the cost-to-cost method.

 

Approximately 80% of our 2018 revenues with the U.S. Government were under fixed-price and fixed-price incentive contracts. To the extent our actual costs vary from the estimates upon which the price was negotiated, we will generate more or less profit and could potentially incur a loss.

 

The transaction price for our contracts represents our best estimate of the consideration we expect to receive and includes assumptions regarding variable consideration as applicable.  Certain of our long-term contracts contain incentive fees or other provisions that can either increase or decrease the transaction price.  These variable amounts generally are awarded upon achievement of certain performance metrics, program milestones or cost targets and can be based upon customer discretion.  We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.  Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance, historical performance and all other information that is reasonably available to us.

 

Due to the number of years it may take to complete many of our contracts and the scope and nature of the work required to be performed on those contracts, the estimation of total transaction price and costs at completion is complicated and subject to many variables and, accordingly, is subject to change.  In estimating total costs at completion, we are required to make numerous assumptions related to the complexity of design and related development work to be performed; engineering requirements; product performance; subcontractor performance; availability and cost of materials; labor productivity, availability and cost; overhead and capital costs; manufacturing efficiencies; the length of time to complete the contract (to estimate increases in wages and prices for materials); and costs of satisfying offset obligations, among other variables.  Our cost estimation process is based on the professional knowledge and experience of engineers and program managers along with finance professionals.  We review and update our cost projections quarterly or more frequently when circumstances significantly change.  When estimates of total costs to be incurred on a contract exceed estimates of total sales to be earned, a provision for the entire loss on the contract is recorded in the period in which the loss is determined.

 

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At the outset of each contract, we estimate an initial profit booking rate considering the risks surrounding our ability to achieve the technical requirements (e.g., a newly-developed product versus a mature product), schedule (e.g., the number and type of milestone events), and costs by contract requirements in the initial estimated costs at completion. Profit booking rates may increase during the performance of the contract if we successfully retire risks surrounding the technical, schedule, and cost aspects of the contract. Conversely, the profit booking rate may decrease if we are not successful in retiring the risks; and, as a result, our estimated costs at completion increase. All estimates are subject to change during the performance of the contract and, therefore, may affect the profit booking rate.

 

Increases or decreases in profit booking rates are recognized in the current period and reflect the inception-to-date effect of such changes. Changes in our profit booking rate due to changes in our estimate of the total expected costs, along with changes in the transaction price, are recognized on a cumulative catch-up method of accounting.  This method recognizes the cumulative effect of changes on current and prior periods with the impact of the change from inception-to-date recorded in the current period.  The impact of our gross cumulative catch-up adjustments on revenues and segment profit recognized in prior periods is presented below:

 

(In millions)

 

 

 

2018

 

2017

 

2016

Gross favorable

 

 

$

249

$

92

$

106

Gross unfavorable

 

 

 

(53)

 

(87)

 

(23)

Net adjustments

 

 

$

196

$

5

$

83

 

With the adoption of ASC 606 at the beginning of 2018, a significant portion of our contracts with the U.S. Government converted to the cost-to-cost method for revenue recognition from the units of delivery method.  The cost-to-cost method generally results in larger cumulative catch-up adjustments since revenue is recognized earlier on these contracts requiring the estimation of costs over longer periods of time. Under the units of delivery method that we used for many of our contracts in 2017 and 2016, we had more time to develop and refine our estimates as we were not required to recognize revenue until our products were delivered much later in the contract term.

 

Due to the significance of judgment in the estimation process described above, it is likely that materially different revenues and/or cost of sales amounts could be recorded if we used different assumptions or if the underlying circumstances were to change.  Our earnings could be reduced by a material amount resulting in a charge to earnings if (a) total estimated contract costs are significantly higher than expected due to changes in customer specifications prior to contract amendment, (b) total estimated contract costs are significantly higher than previously estimated due to cost overruns or inflation, (c) there is a change in engineering efforts required during the development stage of the contract or (d) we are unable to meet contract milestones.

 

Goodwill

We evaluate the recoverability of goodwill annually in the fourth quarter or more frequently if events or changes in circumstances, such as declines in sales, earnings or cash flows, or material adverse changes in the business climate, indicate that the carrying value of a reporting unit might be impaired. The reporting unit represents the operating segment unless discrete financial information is prepared and reviewed by segment management for businesses one level below that operating segment, in which case such component is the reporting unit.  In certain instances, we have aggregated components of an operating segment into a single reporting unit based on similar economic characteristics.

 

We calculate the fair value of each reporting unit, primarily using discounted cash flows. These cash flows incorporate assumptions for short- and long-term revenue growth rates, operating margins and discount rates that represent our best estimates of current and forecasted market conditions, cost structure, anticipated net cost reductions, and the implied rate of return that we believe a market participant would require for an investment in a business having similar risks and business characteristics to the reporting unit being assessed.  The revenue growth rates and operating margins used in our discounted cash flow analysis are based on our strategic plans and long-range planning forecasts.  The long-term growth rate we use to determine the terminal value of the business is based on our assessment of its minimum expected terminal growth rate, as well as its past historical growth and broader economic considerations such as gross domestic product, inflation and the maturity of the markets we serve.  We utilize a weighted-average cost of capital in our impairment analysis that makes assumptions about the capital structure that we believe a market participant would make and include a risk premium based on an assessment of risks related to the projected cash flows of each reporting unit.  We believe this approach yields a discount rate that is consistent with an implied rate of return that an independent investor or market participant would require for an investment in a company having similar risks and business characteristics to the reporting unit being assessed.

 

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If the reporting unit’s estimated fair value exceeds its carrying value, there is no impairment, and no further analysis is performed.  Otherwise, an impairment loss is recognized in an amount equal to that excess carrying value over the estimated fair value amount. Based on our annual impairment review, the fair value of all of our reporting units exceeded their carrying values, and we do not believe that there is a reasonable possibility that any units might fail the initial step of the impairment test in the foreseeable future.

 

Retirement Benefits

We maintain various pension and postretirement plans for our employees globally.  These plans include significant pension and postretirement benefit obligations, which are calculated based on actuarial valuations.  Key assumptions used in determining these obligations and related expenses include expected long-term rates of return on plan assets, discount rates and healthcare cost projections.  We also make assumptions regarding employee demographic factors such as retirement patterns, mortality, turnover and rate of compensation increases.  We evaluate and update these assumptions annually.

 

To determine the weighted-average expected long-term rate of return on plan assets, we consider the current and expected asset allocation, as well as historical and expected returns on each plan asset class.  A lower expected rate of return on plan assets will increase pension expense.  For 2018, the assumed expected long-term rate of return on plan assets used in calculating pension expense was 7.58%, compared with 7.57% in 2017.  For the last seven years, the assumed rate of return for our domestic plans, which represent approximately 93% of our total pension assets, was 7.75%.  A 50 basis-point decrease in this long-term rate of return in 2018 would have increased pension cost for our domestic plans by approximately $33 million.

 

The discount rate enables us to state expected future benefit payments as a present value on the measurement date, reflecting the current rate at which the pension liabilities could be effectively settled.  This rate should be in line with rates for high-quality fixed income investments available for the period to maturity of the pension benefits, which fluctuate as long-term interest rates change.  A lower discount rate increases the present value of the benefit obligations and increases pension expense.  In 2018, the weighted-average discount rate used in calculating pension expense was 3.67%, compared with 4.13% in 2017.  For our domestic plans, the assumed discount rate was 3.75% in 2018, compared with 4.25% in 2017.  A 50 basis-point decrease in this weighted-average discount rate in 2018 would have increased pension cost for our domestic plans by approximately $31 million.

 

The trend in healthcare costs is difficult to estimate and has an important effect on postretirement liabilities.  The 2018 medical and prescription drug cost trend rates represent the weighted-average annual projected rate of increase in the per capita cost of covered benefits.  In 2018, we assumed a trend rate of 7% for both medical and prescription drug cost and assumed this rate would gradually decline to 5% by 2024 and then remain at that level.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Foreign Currency Exchange Risk

Our financial results are affected by changes in foreign currency exchange rates in the various countries in which our products are manufactured and/or sold.  For our manufacturing operations, we manage our foreign currency transaction exposures by entering into foreign currency exchange contracts. These contracts generally are used to fix the local currency cost of purchased goods or services or selling prices denominated in currencies other than the functional currency.  The notional amount of outstanding foreign currency exchange contracts was $379 million and $426 million at December 29, 2018 and December 30, 2017, respectively.  We also manage exposures to foreign currency assets and earnings primarily by funding certain foreign currency-denominated assets with liabilities in the same currency so that certain exposures are naturally offset.  We primarily use borrowings denominated in British pound sterling for these purposes.  The impact of foreign currency exchange rate changes on our Consolidated Statements of Operations are as follows:

 

(In millions)

 

 

 

2018

 

2017

 

2016

Increase (decrease) in revenues

 

 

$

57

$

27

$

(36)

Increase (decrease) in segment profit

 

 

 

1

 

(1)

 

(12)

 

Interest Rate Risk

Our financial results are affected by changes in interest rates.  As part of managing this risk, we seek to achieve a prudent balance between floating- and fixed-rate exposures.  We continually monitor our mix of these exposures and adjust the mix, as necessary.  For our Finance group, we generally limit our risk to changes in interest rates with a strategy of matching floating-rate assets with floating-rate liabilities.

 

Quantitative Risk Measures

In the normal course of business, we enter into financial instruments for purposes other than trading.  The financial instruments that are subject to market risk include finance receivables (excluding leases), debt (excluding capital lease obligations) and foreign currency exchange contracts.  To quantify the market risk inherent in these financial instruments, we utilize a sensitivity analysis that includes a hypothetical change in fair value assuming a 10% decrease in interest rates and a 10% strengthening in foreign exchange rates against the U.S. dollar.  The fair value of these financial instruments is estimated using discounted cash flow analysis and indicative market pricing as reported by leading financial news and data providers.

 

At the end of each year, the table below provides the carrying and fair values of these financial instruments along with the sensitivity of fair value to the hypothetical changes discussed above.  This sensitivity analysis is most likely not indicative of actual results in the future.