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

Overview and Consolidated Results of Operations

Our revenues increased 15% in 2014 reflecting the success of our strategy of investing in new products and complementary acquisitions. Several highlights of the year include the following:

· Invested $694 million in research and development activities demonstrating our continued commitment to expand our current product lines across our businesses.

· Invested $1.6 billion in strategic acquisitions along with $429 million in capital expenditures.

· Delivered strong cash flow performance as manufacturing operating cash flows from continuing operations increased 67% to $1.1 billion.

· Grew segment profit by 26% to $1.2 billion.

· Raised diluted earnings per share from continuing operations by 23%.

On March 14, 2014, we completed the acquisition of Beech Holdings, LLC, which included Beechcraft Corporation and other subsidiaries, (collectively “Beechcraft”); this business and the legacy Cessna segment were combined to form a new segment named Textron Aviation. We also made seven acquisitions in the Industrial and Textron Systems segments, which complemented our products and services. The results of these acquisitions are included in Textron’s consolidated financial statements only for the period subsequent to the completion of each acquisition and do not reflect a full year of operations.

An analysis of our consolidated operating results is set forth below. A more detailed analysis of our segments’ operating results is provided in the Segment Analysis section on pages 21 to 28.

Revenues

(Dollars in millions)		2014			2013			2012
Revenues	$	13,878		$	12,104		$	12,237
% change compared with prior period		15	%		(1)	%

Revenues increased $1.8 billion, 15%, in 2014, compared with 2013, as increases in the Textron Aviation and Industrial segments were partially offset by lower revenues in the Bell, Textron Systems and Finance segments. The net revenue increase included the following factors:

· Higher Textron Aviation revenues of $1.8 billion, primarily due to a $1.5 billion impact from the Beechcraft acquisition and a $263 million increase in volume, largely related to Citation jets.

· Higher Industrial segment revenues of $326 million, primarily due to $181 million in higher volume, largely in the Fuel Systems and Functional Components product line, and a $142 million impact from acquisitions.

· Lower Bell revenues of $266 million, largely due to a $183 million decrease in commercial revenues reflecting lower sales activity across the commercial helicopter market, and $99 million in lower other military volume, largely related to the H-1 program reflecting lower aircraft deliveries and production support.

· Lower Textron Systems revenues of $41 million, primarily due to lower volume of $233 million in the Marine and Land Systems product line, reflecting lower vehicle deliveries, partially offset by higher volume of $130 million in the Unmanned Systems product line and a $62 million impact from acquisitions.

· Lower Finance revenues of $29 million, primarily attributable to gains on the disposition of finance receivables held for sale during 2013.

Revenues decreased $133 million, 1%, in 2013, compared with 2012, as decreases in the Textron Aviation, Finance and Textron Systems segments were partially offset by higher revenues in the Bell and Industrial segments. The net revenue decrease included the following factors:

· Lower Textron Aviation revenues of $327 million, primarily due to lower Citation jet volume of $384 million and CitationAir volume of $114 million, partially offset by higher aftermarket volume of $65 million and higher pre-owned aircraft volume of $53 million.

· Lower Finance revenues of $83 million, primarily attributable to an unfavorable impact of $46 million from lower average finance receivables and a decrease of $25 million in revenues related to the resolution of a Timeshare account in 2012.

· Lower Textron Systems revenues of $72 million, largely due to lower volume of $51 million in the Marine and Land Systems product line and lower volume of $28 million in the Unmanned Systems product line.

· Higher Bell revenues of $237 million, largely due to higher volume of $163 million in our military programs, primarily reflecting higher V-22 deliveries and aftermarket volume, and $74 million of higher commercial revenues, largely due to higher aircraft volume.

· Higher Industrial segment revenues of $112 million, primarily due to higher volume of $58 million and the impact from acquisitions of $46 million.

Cost of Sales and Selling and Administrative Expense

(Dollars in millions)		2014		2013		2012
Operating expenses		$	12,782	$	11,257	$	11,184
Cost of sales		11,421		10,131		10,019
% change compared with prior period		13%		1%
Gross margin as a percentage of Manufacturing revenues		17.1%		15.4%		16.7%
Selling and administrative expenses		1,361		1,126		1,165
% change compared with prior period		21%		(3)%

Manufacturing cost of sales and selling and administrative expenses together comprise our operating expenses. Cost of sales increased $1.3 billion, 13%, in 2014, compared with 2013, largely due to the impact of acquired businesses, primarily Beechcraft. In 2014, gross margin as a percentage of manufacturing revenues increased 170 basis points largely due to improved leverage resulting from higher revenues primarily at Textron Aviation.

Selling and administrative expense increased $235 million, 21%, in 2014, compared with 2013, largely related to businesses acquired in the past year and compensation expense. These increases were partially offset by $28 million in severance costs incurred in 2013 in connection with a voluntary separation program at Textron Aviation.

Manufacturing cost of sales increased $112 million, 1%, in 2013, compared with 2012, primarily due to higher volume at Bell and the impact from businesses acquired in 2013, partially offset by lower sales at Textron Aviation and Textron Systems. In 2013, gross margin as a percentage of manufacturing revenues decreased 130 basis points primarily due to unfavorable performance at Bell, largely due to manufacturing inefficiencies associated with labor disruptions resulting from negotiations with bargained employees and with the implementation of a new enterprise resource planning system in the first quarter of 2013, as well as lower Citation jet and CitiationAir volume at Textron Aviation.

Selling and administrative expenses decreased $39 million, 3%, in 2013 compared with 2012, largely due to a reduction in administrative expenses of $26 million and lower provision for loan losses of $20 million at the Finance segment, both primarily associated with the non-captive business. Selling and administrative expense was also impacted by $28 million in severance costs incurred in 2013 at Textron Aviation, which were largely offset by a $27 million charge from an unfavorable arbitration award in 2012 at Textron Aviation.

Acquisition and Restructuring Costs

In connection with the integration of Beechcraft, we initiated a restructuring program in our Textron Aviation segment in the first quarter of 2014 to align the Cessna and Beechcraft businesses, reduce operating redundancies and maximize efficiencies. During 2014, we recorded charges of $41 million related to these restructuring activities that were included in the Acquisition and restructuring costs line on the Consolidated Statements of Operations. In addition, we incurred transaction costs of $11 million in 2014 related to the acquisition that were also included in the Acquisition and restructuring costs line. We expect to incur additional restructuring costs in 2015, but do not expect these costs to be material.

Interest Expense

(Dollars in millions)		2014		2013		2012
Interest expense		$	191	$	173	$	212
% change compared with prior period		10%		(18)%

Interest expense on the Consolidated Statement of Operations includes interest for both the Manufacturing and Finance borrowing groups with interest related to intercompany borrowings eliminated. Consolidated interest expense increased $18 million, 10%, in 2014, compared with 2013, primarily due to a $31 million impact related to financing the Beechcraft acquisition, partially offset by $9 million of lower interest expense due to the maturity of our convertible notes in the second quarter of 2013. In 2013, consolidated interest expense decreased $39 million, 18%, compared with 2012, primarily due to lower average debt outstanding.

Income Tax Expense

Our effective tax rate was 29.1% in 2014, 26.1% in 2013 and 30.9% in 2012. This rate generally differs from the U.S. federal statutory tax rate of 35% due to certain earnings from operations in lower-tax jurisdictions throughout the world, as well as the research credit. The jurisdictions with favorable tax rates that have the most significant effective tax rate impact in the periods presented include Canada, Germany, Belgium and China. We have not provided for U.S. taxes for those earnings because we plan to reinvest all of those earnings indefinitely outside of the U.S.

In 2013, our effective tax rate was reduced by approximately 4.0% due to the tax benefit recognized upon the retroactive reinstatement and extension of the Federal Research and Development Tax Credit for the period from January 1, 2012 to December 31, 2013. In 2014, this credit was extended through the end of 2014, resulting in a 1.5% reduction in our effective tax rate.

For a full reconciliation of our effective tax rate to the U.S. federal statutory tax rate of 35% see Note 12 to the Consolidated Financial Statements.

Segment Analysis

We operate in, and report financial information for, the following five business segments: Textron Aviation, which consists of the legacy Cessna segment combined with the recently-acquired Beechcraft business, Bell, Textron Systems, Industrial and Finance. Segment profit is an important measure used for evaluating performance and for decision-making purposes. Segment profit for the manufacturing segments excludes interest expense, certain corporate expenses and acquisition and restructuring costs related to the Beechcraft acquisition. The measurement for the Finance segment includes interest income and expense along with intercompany interest income and expense.

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 and acquisitions. Additionally, changes in segment profit may be expressed in terms of mix, inflation and cost performance. Volume changes in revenues represent increases/decreases in the number of units delivered or services provided. Pricing represents changes in unit pricing. Foreign exchange is the change resulting from translating foreign-denominated amounts into U.S. dollars at exchange rates that are different from the prior period. Acquisitions refers to the revenues generated from businesses that were acquired within the previous 12 months. For segment profit, mix represents a change due to the composition of products and/or services sold at different profit margins. Inflation represents higher material, wages, benefits, pension or other costs. Performance reflects an increase or decrease in research and development, depreciation, selling and administrative costs, warranty, product liability, quality/scrap, labor efficiency, overhead, product line profitability, start-up, ramp up and cost-reduction initiatives or other manufacturing inputs.

Approximately 28% of our 2014 revenues were derived from contracts with the U.S. Government. For our segments that have significant contracts with the U.S. Government, we typically express changes in segment profit related to the government business in terms of volume, changes in program performance or changes in contract mix. Changes in volume that are discussed in net sales typically drive corresponding changes in our segment profit based on the profit rate for a particular contract. Changes in program performance typically relate to profit recognition associated with revisions to total estimated costs at completion that reflect improved or deteriorated operating performance or award fee rates. Changes in contract mix refers to changes in operating margin due to a change in the relative volume of contracts with higher or lower fee rates such that the overall average margin rate for the segment changes.

Textron Aviation

								% Change
(Dollars in millions)		2014		2013		2012		2014	2013
Revenues		$	4,568	$	2,784	$	3,111	64%	(11)%
Operating expenses		4,334		2,832		3,029		53%	(7)%
Segment profit (loss)		234		(48)		82		—	—
Profit margin		5.1%		(1.7)%		2.6%
Backlog		$	1,365	$	1,018	$	1,062	34%	(4)%

Textron Aviation Revenues and Operating Expenses

Factors contributing to the 2014 year-over-year revenue change are provided below:

(In millions)		2014 versus 2013
Acquisitions		$	1,480
Volume		263
Pricing		41
Total change		$	1,784

Textron Aviation’s revenues increased by $1.8 billion, 64%, in 2014, compared with 2013, primarily due to the impact of the Beechcraft acquisition of $1.5 billion and higher volume of $263 million. The increase in volume was primarily the result of higher Citation jet volume of $344 million, partially offset by lower CitationAir volume of $78 million related to exiting our fractional share business. We delivered 159 Citation jets and 113 King Air turboprops in 2014, compared with 139 Citation jets in 2013. During 2014, the portion of the segment’s revenues derived from aftermarket sales and services represented 30% of its total revenues, compared with 33% in 2013.

Textron Aviation’s operating expenses increased by $1.5 billion, 53%, in 2014, compared with 2013, primarily due to the incremental operating costs related to the Beechcraft acquisition, and higher net volume as described above. Textron Aviation’s operating expenses exclude acquisition and restructuring costs incurred across the segment as a result of the Beechcraft integration, which are reported separately and are discussed in the Acquisition and Restructuring Costs section above.

Factors contributing to the 2013 year-over-year revenue change are provided below:

(In millions)		2013 versus 2012
Volume		$	(373	)
Acquisitions		33
Other		13
Total change		$	(327	)

In 2013, Textron Aviation’s revenues decreased $327 million, 11%, compared with 2012, primarily due to lower Citation jet volume of $384 million and lower CitationAir volume of $114 million, largely related to the wind-down of our fractional share business. These decreases were partially offset by higher aftermarket volume of $65 million, largely due to increased service demand, and higher pre-owned aircraft volume of $53 million. We delivered 139 Citation jets in 2013, compared with 181 jets in 2012. During 2013, the portion of Textron Aviation’s revenues derived from aftermarket sales and services increased to 33%, compared with 25% in 2012, due to higher aftermarket volume and the impact of lower Citation jet revenues.

Textron Aviation’s operating expenses decreased $197 million, 7%, in 2013, compared with 2012, primarily due to lower volume as discussed above. The volume-related decrease in operating expenses was partially offset by $37 million of operating costs incurred by service centers acquired at the beginning of 2013 and $33 million of inflation, largely due to higher pension expense of $17 million. Operating expenses in 2013 were also impacted by $28 million in severance costs incurred during the first half of the year in connection with a voluntary separation program offered to qualifying salaried employees and a reduction of certain direct production positions due to an adjustment of our production schedule. Operating expenses in 2012 included a $27 million charge from an unfavorable arbitration award.

Textron Aviation Segment Profit (Loss)

Factors contributing to 2014 year-over-year segment profit (loss) change are provided below:

(In millions)		2014 versus 2013
Performance and other		$	117
Volume		89
Pricing and inflation		48
2013 Voluntary Separation Program		28
Total change		$	282

Textron Aviation segment profit increased $282 million in 2014, compared with 2013, primarily due to an increase in Performance and other, higher volume as described above, favorable pricing and inflation and $28 million in severance costs incurred in 2013. During the second quarter of 2014, the cost structures of Beechcraft and Cessna were significantly integrated, and as a result, Performance and other reflects the net profit impact of Beechcraft, including the benefit of the integrated cost structure. Performance and other also includes amortization of $63 million in 2014, related to fair value step-up adjustments of acquired inventories sold during the periods.

Factors contributing to 2013 year-over-year segment profit (loss) change are provided below:

(In millions)		2013 versus 2012
Volume		$	(99	)
Inflation, net of pricing		(21		)
Other		(10		)
Total change		$	(130	)

Textron Aviation’s segment profit decreased $130 million in 2013, compared with 2012, primarily due to a $99 million impact from lower volume as described above and $21 million in inflation, net of pricing, largely due to higher pension expense of $17 million. Segment profit was also impacted by $28 million in severance costs incurred in 2013, largely offset by a $27 million charge from an unfavorable arbitration award incurred in 2012.

Textron Aviation Backlog

Textron Aviation’s backlog increased $347 million, 34%, in 2014 and decreased $44 million, 4%, in 2013. The increase in 2014 included the Beechcraft acquisition.

Bell

								% Change
(Dollars in millions)		2014		2013		2012		2014	2013
Revenues:
V-22 program		$	1,771	$	1,755	$	1,611	1%	9%
Other military		860		959		940		(10)%	2%
Commercial		1,614		1,797		1,723		(10)%	4%
Total revenues		4,245		4,511		4,274		(6)%	6%
Operating expenses		3,716		3,938		3,635		(6)%	8%
Segment profit		529		573		639		(8)%	(10)%
Profit margin		12.5%		12.7%		15.0%
Backlog		$	5,524	$	6,450	$	7,469	(14)%	(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 2014 year-over-year revenue change are provided below:

(In millions)		2014 versus 2013
Volume and mix		$	(300	)
Other		34
Total change		$	(266	)

Bell’s revenues decreased $266 million, 6%, in 2014, compared with 2013, primarily due to the following factors:

· $183 million decrease in commercial revenues, largely related to lower volume reflecting lower sales activity across the commercial helicopter market. Bell delivered 178 commercial aircraft in 2014, compared with 213 commercial aircraft in 2013.

· $99 million decrease in other military volume, primarily related to the H-1 program, largely reflecting lower aircraft deliveries and production support. Lower volume was partially offset by $41 million recorded in the second quarter of 2014, related to the settlement of the SDD phase of the ARH program, which was terminated in October 2008. Bell delivered 24 H-1 aircraft in 2014, compared with 25 aircraft in 2013.

· $16 million increase in V-22 program revenues, reflecting higher product support volume of $115 million. This increase was largely offset by lower aircraft deliveries, as we delivered 37 V-22 aircraft in 2014 compared to 41 V-22 aircraft in 2013.

Bell’s operating expenses decreased $222 million, 6% in 2014, compared with 2013, primarily due to the lower net volume as discussed above. In addition, Bell experienced favorable profit adjustments on its long-term contracts, primarily driven by cost reduction activities in 2014 as well as unfavorable performance in 2013 as discussed below.

Factors contributing to the 2013 year-over-year revenue change are provided below:

(In millions)		2013 versus 2012
Volume		$	193
Other		44
Total change		$	237

Bell’s revenues increased $237 million, 6% in 2013, compared with 2012, due to the following factors:

· $144 million increase in V-22 program volume largely due to higher aircraft deliveries, as we delivered 41 V-22 aircraft in 2013, compared with 39 aircraft in 2012. In addition, military aftermarket volume was higher by $35 million, reflecting increased support of fielded aircraft.

· $74 million increase in commercial revenues, largely due to higher aircraft volume, as we delivered 213 aircraft in 2013, compared to 188 aircraft in 2012. This increase was partially offset by lower commercial aftermarket revenues of $50 million, largely due to lower volume, which in part, resulted from the conversion to a new enterprise resource planning system in the first quarter of 2013.

· $19 million increase in other military volume, reflecting higher H-1 deliveries. We delivered 25 H-1 aircraft in 2013, compared with 24 H-1 aircraft in 2012.

Bell’s operating expenses increased $303 million, 8%, in 2013, respectively, compared with 2012, largely due to higher volume as described above and $68 million in unfavorable performance, which included $27 million in lower favorable profit adjustments on its long-term contracts. The unfavorable performance was largely due to manufacturing inefficiencies associated with labor disruptions resulting from negotiations with bargained employees and with the implementation of a new enterprise resource planning system in the first quarter of 2013. On October 13, 2013, Bell reached a new five-year collective bargaining agreement with the United Automobile, Aerospace and Agricultural Implement Workers of America (UAW) and UAW Local 218 which represents these employees.

Bell Segment Profit

Factors contributing to 2014 year-over-year segment profit change are provided below:

(In millions)		2014 versus 2013
Volume and Mix		$	(72)
Performance		23
Other		5
Total change		$	(44)

Bell’s segment profit decreased $44 million, 8%, in 2014, compared with 2013. The impact of volume and mix was largely driven by lower commercial volume and an unfavorable mix of commercial aircraft deliveries, partially offset by a $16 million favorable program profit adjustment related to the ARH program described above. Favorable performance primarily reflected our cost reduction activities in 2014 as well as unfavorable performance in 2013 as described above.

Factors contributing to 2013 year-over-year segment profit change are provided below:

(In millions)		2013 versus 2012
Performance		$	(68)
Volume and mix		(10)
Other		12
Total change		$	(66)

Bell’s segment profit decreased $66 million, 10%, in 2013, respectively, compared with 2012, primarily due to unfavorable performance as described above. Segment profit was also impacted by an unfavorable mix of commercial aircraft deliveries.

Bell Backlog

Backlog decreased $926 million, 14%, at Bell during 2014, primarily due to V-22 aircraft deliveries, in excess of orders. In 2013, Bell’s backlog decreased $1.0 billion, 14%, primarily due to deliveries on the V-22 and H-1 programs that exceeded orders.

Textron Systems

								% Change
(Dollars in millions)		2014		2013		2012		2014	2013
Revenues		$	1,624	$	1,665	$	1,737	(2)%	(4)%
Operating expenses		1,474		1,518		1,605		(3)%	(5)%
Segment profit		150		147		132		2%	11%
Profit margin		9.2%		8.8%		7.6%
Backlog		$	2,790	$	2,803	$	2,919	—	(4)%

Textron Systems Revenues and Operating Expenses

Factors contributing to the 2014 year-over-year revenue change are provided below:

(In millions)		2014 versus 2013
Volume		$	(106)
Acquisitions		62
Other		3
Total change		$	(41)

Revenues at Textron Systems decreased $41 million, 2%, in 2014, compared with 2013, primarily due to lower volume in the Marine and Land Systems product line of $233 million, reflecting fewer vehicle deliveries, partially offset by higher volume in the Unmanned Systems product line of $130 million and a $62 million impact largely related to the acquisition of two flight simulation and training businesses in December 2013.

Textron Systems’ operating expenses decreased $44 million, 3%, in 2014, compared with 2013, primarily due to lower volume as described above, as well as the impact of a $15 million charge recorded in 2013 related to the fee-for-service program described below. Operating expenses also included the impact of costs related to acquisitions.

Factors contributing to the 2013 year-over-year revenue change are provided below:

(In millions)		2013 versus 2012
Volume		$	(76	)
Other		4
Total change		$	(72	)

Revenues at Textron Systems decreased $72 million, 4%, in 2013, compared with 2012, primarily due to lower volume in the Marine and Land product line of $51 million and in the Unmanned Systems product line of $28 million.

Textron Systems’ operating expenses decreased $87 million, 5%, in 2013, compared with 2012, primarily due to improved performance reflecting the favorable impact of lower profit adjustments, including $22 million in lower fee-for-service program charges discussed below, along with cost reduction initiatives across most product lines. Operating expenses were also impacted by lower volume as described above.

In 2013 and 2012, we recorded $15 million and $37 million, respectively, in unfavorable program profit adjustments related to start-up and engine performance issues for Unmanned System’s fee-for-service program. As a result of the engine performance issues, during the third quarter of 2013 we transitioned the manufacture of the engines to our Lycoming business, which has resulted in improved performance.

Textron Systems Segment Profit

Factors contributing to 2014 year-over-year segment profit change are provided below:

(In millions)		2014 versus 2013
Performance		$	22
Volume		(12		)
Other		(7		)
Total change		$	3

Segment profit at Textron Systems increased $3 million, 2%, in 2014, compared with 2013, primarily driven by $22 million of improved performance, partially offset by $12 million from lower volume as described above. Performance primarily reflects the impact of unfavorable profit adjustments in 2013, including a $15 million charge related to the fee-for-service program described above.

Factors contributing to 2013 year-over-year segment profit change are provided below:

(In millions)		2013 versus 2012
Performance		$	58
Volume and mix		(33		)
Other		(10		)
Total change		$	15

Segment profit at Textron Systems increased $15 million, 11% in 2013 compared with 2012, largely due to improved performance reflecting the favorable impact of lower profit adjustments, including $22 million in lower fee-for-service program charges, along with cost reduction initiatives across most product lines. This improved performance was partially offset by lower volume as described above.

Industrial

								% Change
(Dollars in millions)		2014		2013		2012		2014	2013
Revenues:
Fuel Systems and Functional Components		$	1,975	$	1,853	$	1,842	7%	1%
Other Industrial		1,363		1,159		1,058		18%	10%
Total revenues		3,338		3,012		2,900		11%	4%
Operating expenses		3,058		2,770		2,685		10%	3%
Segment profit		280		242		215		16%	13%
Profit margin		8.4%		8.0%		7.4%

Industrial Revenues and Operating Expenses

Factors contributing to the 2014 year-over-year revenue change are provided below:

(In millions)		2014 versus 2013
Volume		$	181
Acquisitions		142
Other		3
Total change		$	326

Industrial segment revenues increased $326 million, 11%, in 2014, compared with 2013, primarily due to higher volume of $181 million and the impact from acquisitions of $142 million, primarily within our Specialized Vehicles and Equipment product line. Higher volume resulted from a $142 million increase in the Fuel Systems and Functional Components product line, principally reflecting automotive industry demand in North America and Europe, and a $39 million increase in the Other Industrial product lines.

Operating expenses for the Industrial segment increased $288 million, 10%, in 2014, compared with 2013, largely due to the impact from higher volume as described above and additional operating expenses from recently acquired businesses.

Factors contributing to the 2013 year-over-year revenue change are provided below:

(In millions)		2013 versus 2012
Volume		$	58
Acquisitions		46
Other		8
Total change		$	112

Industrial segment revenues increased $112 million, 4%, in 2013, compared with 2012, largely due to higher volume of $58 million and the impact from acquisitions of $46 million within our Tools and Test Equipment product line. Higher volume resulted from a $32 million increase in the Other Industrial product lines, mostly due to higher market demand in the Specialized Vehicles and Equipment product line, and a $26 million increase in the Fuel Systems and Functional Components line, reflecting higher automotive industry demand in North America.

Operating expenses for the Industrial segment increased $85 million, 3%, in 2013, compared with 2012, largely due to higher volume and a $43 million impact from acquisitions. Operating expenses were also impacted by improved performance of $27 million associated with the Fuel Systems and Functional Components product line, which was partially offset by $16 million of inflation in this product line, reflecting higher compensation and material costs.

Industrial Segment Profit

Factors contributing to 2014 year-over-year segment profit change are provided below:

(In millions)		2014 versus 2013
Volume and mix		$	20
Performance		15
Other		3
Total change		$	38

Segment profit for the Industrial segment increased $38 million, 16%, in 2014, compared with 2013, largely due to the impact from higher volume as described above. Profit was also impacted by improved performance of $15 million, primarily driven by the Fuel Systems and Functional Components product line.

Factors contributing to 2013 year-over-year segment profit change are provided below:

(In millions)		2013 versus 2012
Performance		$	39
Volume		9
Inflation, net of pricing		(22		)
Other		1
Total change		$	27

Segment profit for the Industrial segment increased $27 million, 13%, in 2013, compared with 2012, primarily due to improved performance of which $27 million was associated with the Fuel Systems and Functional Components product line. The $22 million unfavorable impact from inflation, net of pricing, was primarily in the Fuel Systems and Functional Components product line, reflecting higher compensation and material costs.

Finance

(In millions)		2014			2013			2012
Revenues		$	103		$	132		$	215
Segment profit		21			49			64

Finance Revenues

Finance segment revenues decreased $29 million in 2014, compared with 2013, primarily attributable to a $31 million impact from gains on the disposition of finance receivables held for sale during 2013. These gains resulted from the payoff of loans in amounts, and sale of loans at prices, in excess of the values established in previous periods.

Finance segment revenues decreased $83 million in 2013, compared with 2012, primarily attributable to an unfavorable impact of $46 million, attributable to lower average finance receivables of $834 million. Revenues during 2013 were also lower by $25 million due to the resolution of a Timeshare account that returned to accrual status in 2012.

Finance Segment Profit

Finance segment profit decreased $28 million in 2014, compared with 2013, primarily due to a change in provision for loan losses of $29 million, largely reflecting reserve reversals in 2013 primarily related to the non-captive business, and the impact from gains on finance receivables held for sale described above. These decreases in segment profit were partially offset by lower administrative expense of $19 million in 2014, primarily associated with the exit of the non-captive business.

Finance segment profit decreased $15 million in 2013, compared with 2012, primarily resulting from the resolution of a Timeshare account in 2012 as described above, as well as an unfavorable impact of $25 million in net interest margin from lower average finance receivables. These decreases were partially offset by lower administrative expenses of $26 million and lower provision for loan losses of $20 million, largely related to the downsizing of the non-captive business.

Finance Portfolio Quality

The following table reflects information about the Finance segment’s credit performance related to finance receivables.

(Dollars in millions)		January 3, 2015			December 28, 2013
Finance receivables		$	1,254		$	1,483
Nonaccrual finance receivables		81			105
Ratio of nonaccrual finance receivables to finance receivables		6.46		%	7.08		%
60+ days contractual delinquency		$	57		$	80
60+ days contractual delinquency as a percentage of finance receivables		4.55		%	5.39		%

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)	January 3, 2015		December 28, 2013
Manufacturing group
Cash and equivalents	$	731	$		1,163
Debt		2,811			1,931
Shareholders’ equity		4,272			4,384
Capital (debt plus shareholders’ equity)		7,083			6,315
Net debt (net of cash and equivalents) to capital		33%			15%
Debt to capital		40%			31%
Finance group
Cash and equivalents	$	91	$		48
Debt		1,063			1,256

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 October 2018 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 January 3, 2015, there were no amounts borrowed against the facility, and there were $35 million of letters of credits issued against it.

We maintain an effective shelf registration statement filed with the Securities and Exchange Commission that authorizes us to issue an unlimited amount of public debt and other securities. Under this shelf registration statement, in January 2014, we issued $250 million of 3.65% notes due 2021 and $350 million of 4.30% notes due 2024. We also entered into a five-year term loan agreement with a syndicate of banks in the principal amount of $500 million. Upon the closing of the Beechcraft acquisition on March 14, 2014, we fully drew down on the five-year term loan and used the cash, along with the net proceeds of the notes issued, to finance a portion of the acquisition. The balance of the Beechcraft acquisition purchase price was paid from cash on hand. During the third quarter of 2014, we repaid $200 million of the five-year term loan. Also under the shelf registration statement, in November 2014, we issued $350 million of 3.875% notes due 2025. Subsequently, prior to year-end, we prepaid $350 million of 6.2% notes which were due in March 2015.

Manufacturing Group Cash Flows

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

(In millions)		2014			2013			2012
Operating activities		$	1,097		$	658		$	958
Investing activities		(2,065		)	(624		)	(476		)
Financing activities		552			(240		)	29

Cash flows from operating activities increased $439 million during 2014, compared with 2013, largely due to a favorable change in working capital, higher income from continuing operations of $120 million and lower contributions of $118 million to our pension plans, partially offset by $175 million of dividends received from the Finance group in 2013. Working capital was

favorably impacted by an increase of $226 million in customer deposits, primarily at Textron Aviation, and a $174 million increase in cash from accounts receivable, largely at Bell, partially offset by an increase in net tax payments of $43 million. Net tax payments were $266 million and $223 million in 2014 and 2013, respectively.

We generated $658 million in cash from operating activities in 2013 on $914 million in Manufacturing group segment profit and $470 million of income from continuing operations. The $300 million decrease in cash flows from operating activities from 2012 was largely due to a $429 million impact related to working capital requirements and $64 million in lower income from continuing operations, which were partially offset by $211 million in lower contributions to our pension plans in 2013. The most significant change within working capital was a $230 million unfavorable impact resulting from net tax payments of $223 million in 2013, compared to net tax refunds of $7 million in 2012. In addition, we had $165 million in cash inflows related to changes in inventory levels, largely at Textron Aviation, which was more than offset by $264 million of cash outflows from changes in accounts receivable and accounts payable. The change in inventory levels at Textron Aviation was primarily related to lower pre-owned inventory, partially offset by higher inventory in support of new sales.

Pension contributions were $76 million, $194 million and $405 million in 2014, 2013 and 2012, respectively.

In 2014, cash flows from investing activities included a $1.6 billion aggregate cash payment for Beechcraft and seven other acquisitions within our Industrial and Textron Systems segments. Cash flows from investing activities in 2013 included $196 million of cash used for acquisitions of businesses within our Industrial and Textron Systems segments and two service centers in our Textron Aviation segment. Cash flows from investing activities also included capital expenditures of $429 million, $444 million and $480 million in 2014, 2013 and 2012, respectively.

Cash flows from financing activities in 2014 included proceeds from long-term debt of $1.4 billion, most of which was used to finance a portion of the Beechcraft acquisition, partially offset by the repayment of $559 million of outstanding debt. In 2013, cash flows used in financing activities primarily consisted of the repayment of $528 million of outstanding debt, including the settlement of our convertible notes, which was partially offset by proceeds from long-term debt of $150 million. In 2012, we generated cash from financing activities, largely due to the receipt of $490 million from the Finance group in payment of its intergroup borrowing, partially offset by $272 million in share repurchases and $189 million in payments on our outstanding debt.

Dividends

Dividend payments to shareholders totaled $28 million, $22 million and $17 million in 2014, 2013 and 2012, respectively.

Share Repurchases

During 2014, under a 2013 share repurchase authorization, we repurchased an aggregate of 8.9 million shares of our outstanding common stock for $340 million. In 2012, under a 2007 share repurchase authorization, we repurchased 11.1 million shares of our outstanding common stock for $272 million.

Capital Contributions Paid To and Dividends Received From the Finance Group

Under a Support Agreement between Textron and TFC, Textron is required to maintain a controlling interest in TFC. The agreement 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 $200 million. Cash contributions paid to TFC to maintain compliance with the Support Agreement and dividends paid by TFC to Textron Inc. are detailed below:

(In millions)		2014			2013			2012
Dividends paid by TFC to Textron		$	—		$	175		$	345
Capital contributions paid to TFC under Support Agreement		—			—			(240		)

Due to the nature of these contributions, we classify these contributions within cash flows used by operating activities for the Manufacturing group in the Consolidated Statements of Cash Flows. Capital contributions to support Finance group growth in the ongoing captive finance business are classified as cash flows from financing activities. The Finance group’s net income is excluded from the Manufacturing group’s cash flows, while dividends from the Finance group 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 are summarized below:

(In millions)		2014			2013			2012
Operating activities		$	5		$	66		$	5
Investing activities		255			624			934
Financing activities		(217		)	(677		)	(918		)

In 2014 and 2013, the Finance group’s cash flows from operating activities were primarily impacted by changes in net taxes paid/received. Net tax (payments)/receipts were $(23) million, $49 million and $(43) million in 2014, 2013 and 2012, respectively.

Cash flows from investing activities primarily included finance receivables repaid and proceeds from sales of receivables and other finance assets totaling $499 million, $853 million and $1.3 billion in 2014, 2013 and 2012, respectively, partially offset by financial receivable originations of $215 million, $271 million and $331 million, respectively.

Cash used in financing activities included payments on long-term and nonrecourse debt of $345 million, $743 million and $426 million in 2014, 2013 and 2012, respectively, which were partially offset by proceeds from long-term debt of $128 million, $298 million and $106 million, respectively. In 2013 and 2012, dividend payments to the Manufacturing group, net of capital contributions received, totaled $174 million and $105 million, respectively. In 2012, the Finance group also made cash payments of $493 million to the Manufacturing group related to intergroup borrowings.

Consolidated Cash Flows

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

(In millions)		2014			2013			2012
Operating activities		$	1,211		$	813		$	935
Investing activities		(1,919		)	(264		)	378
Financing activities		335			(742		)	(781		)

Cash flows from operating activities increased $398 million during 2014, compared with 2013, largely due to a favorable change in working capital, lower contributions of $118 million to our pension plans and higher income from continuing operations of $107 million. Working capital was favorably impacted by an increase of $226 million in customer deposits, primarily at Textron Aviation, and a $174 million increase in cash from accounts receivable, largely at Bell, partially offset by an increase in net tax payments of $115 million and lower net cash receipts from captive finance receivables of $87 million. Net tax payments were $289 million and $174 million in 2014 and 2013, respectively.

During 2013, cash flows from operating activities decreased $122 million, compared with 2012, largely due to a $133 million impact related to working capital requirements and lower earnings, which were partially offset by a $206 million impact of lower contributions to our pension plans in 2013. Significant changes within working capital included a $138 million unfavorable impact resulting from net taxes paid between the periods as net tax payments were $174 million and $36 million in 2013 and 2012, respectively, and $264 million of cash outflows related to changes in accounts receivable and accounts payable. These cash outflows were partially offset by $198 million of cash inflows related to changes in inventory levels, largely at Textron Aviation, and a $141 million impact from lower captive finance receivables.

In 2014, cash flows from investing activities included a $1.6 billion aggregate cash payment for Beechcraft and seven other acquisitions within our Industrial and Textron Systems segments. Cash flows from investing activities in 2013 included $196 million of cash used for acquisitions of businesses within our Industrial and Textron Systems segments and two service centers in our Textron Aviation segment. Cash flows from investing activities also included capital expenditures of $429 million, $444 million and $480 million in 2014, 2013 and 2012, respectively. Collections on finance receivables and proceeds from sales of finance receivables and other finance assets totaled $134 million, $368 million, and $848 million in 2014, 2013 and 2012.

Cash flows from financing activities in 2014 included proceeds of $1.6 billion from long-term debt, most of which was used to finance a portion of the Beechcraft acquisition, partially offset by the repayment of $904 million of outstanding debt. In 2013 and 2012, financing activities primarily consisted of the repayment of outstanding long-term debt of $1.3 billion and $617 million, respectively, partially offset by proceeds from the issuance of long-term debt of $448 million and $106 million, respectively. Cash used in financing activities also included $340 million and $272 million of share repurchases in 2014 and 2012, respectively.

Captive Financing and Other Intercompany Transactions

The Finance group finances retail purchases and leases for new and pre-owned aircraft and equipment manufactured by our Manufacturing group, otherwise known as captive financing. In the Consolidated Statements of Cash Flows, cash received from customers or from the sale of receivables 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 and elimination adjustments included in the Consolidated Statement of Cash Flows are summarized below:

(In millions)		2014			2013			2012
Reclassifications from investing activities:
Finance receivable originations for Manufacturing group inventory sales		$	(215	)	$	(248	)	$	(309	)
Cash received from customers and the sale of receivables		365			485			405
Other		(41		)	27			(16		)
Total reclassifications from investing activities		109			264			80
Reclassifications from financing activities:
Capital contributions paid by Manufacturing group to Finance group		—			1			240
Dividends received by Manufacturing group from Finance group		—			(175		)	(345		)
Other		—			(1		)	(3		)
Total reclassifications from financing activities		—			(175		)	(108		)
Total reclassifications and adjustments to cash flow from operating activities		$	109		$	89		$	(28	)

Contractual Obligations

Manufacturing Group

The following table summarizes the known contractual obligations, as defined by reporting regulations, of our Manufacturing group as of January 3, 2015:

					Payments Due by Period
(In millions)		Total			Year 1			Years 2-3			Years 4-5			More Than 5 Years
Liabilities reflected in balance sheet:
Long-term debt		$	2,816		$	8		$	766		$	562		$	1,480
Interest on borrowings		747			128			242			176			201
Pension benefits for unfunded plans		392			26			49			46			271
Postretirement benefits other than pensions		413			45			79			65			224
Other long-term liabilities		650			121			194			76			259
Liabilities not reflected in balance sheet:
Purchase obligations		3,370			2,651			677			28			14
Operating leases		438			73			104			68			193
Total Manufacturing group		$	8,826		$	3,052		$	2,111		$	1,021		$	2,642

Pension and Postretirement Benefits

We maintain defined benefit pension plans and postretirement benefit plans other than pensions as discussed in Note 11 to the Consolidated Financial Statements. 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 2015, we expect to make approximately $54 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 estimates for each of the years from 2016 through 2019 are estimated to be in the range of approximately $65 million to $155 million under the plan provisions in place at this time.

Other Long-Term Liabilities

Other long-term liabilities included in the table consist primarily of undiscounted amounts in the Consolidated Balance Sheet as of January 3, 2015, representing 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. 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 33% 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 January 3, 2015:

					Payments Due by Period
(In millions)		Total			Year 1			Years 2-3			Years 4-5			More Than 5 Years
Liabilities reflected in balance sheet:
Term debt		$	665		$	82		$	363		$	115		$	105
Subordinated debt		299			—			—			—			299
Securitized debt		98			46			35			9			8
Interest on borrowings		227			37			47			21			122
Total Finance group		$	1,289		$	165		$	445		$	145		$	534

Securitized debt payments do not represent contractual obligations of the Finance group, and we do not provide legal recourse to investors who purchase interests in the securitizations beyond the credit enhancement inherent in the retained subordinate interests.

At January 3, 2015, the Finance group also had $33 million in other liabilities that are payable within the next 12 months.

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 to the Consolidated Financial Statements, which includes other significant accounting policies.

Long-Term Contracts

We make a substantial portion of our sales to government customers pursuant to long-term contracts. These contracts require development and delivery of products over multiple years and may contain fixed-price purchase options for additional products. We account for these long-term contracts under the percentage-of-completion method of accounting. Under this method, we estimate profit as the difference between total estimated revenues and cost of a contract. The percentage-of-completion method of accounting involves the use of various estimating techniques to project costs at completion and, in some cases, includes estimates of recoveries asserted against the customer for changes in specifications. Due to the size, length of time and nature of many of our contracts, the estimation of total contract costs and revenues through completion is complicated and subject to many variables relative to the outcome of future events over a period of several years. We are required to make numerous assumptions and estimates relating to items such as expected engineering requirements, complexity of design and related development costs, product performance, performance of subcontractors, availability and cost of materials, labor productivity and cost, overhead and capital costs, manufacturing efficiencies and the achievement of contract milestones, including product deliveries, technical requirements, or schedule.

Our cost estimation process is based on the professional knowledge and experience of engineers and program managers along with finance professionals. We update our projections of costs at least semiannually or when circumstances significantly change. Adjustments to projected costs are recognized in earnings when determinable. Anticipated losses on contracts are recognized in full in the period in which the losses become probable and estimable. 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.

At the outset of each contract, we estimate the initial profit booking rate. The initial profit booking rate of each contract considers risks surrounding the ability to achieve the technical requirements (for example, a newly-developed product versus a mature product), schedule (for example, 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 costs aspects of the contract. Likewise, 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 of the estimates are subject to change during the performance of the contract and, therefore, may affect the profit booking rate. When adjustments are required, any changes from prior estimates are recognized using the cumulative catch-up method with the impact of the change from inception-to-date recorded in the current period.

The following table sets forth the aggregate gross amount of all program profit adjustments that are included within segment profit for the three years ended January 3, 2015:

(In millions)		2014			2013			2012
Gross favorable		$	132		$	51		$	88
Gross unfavorable		(37		)	(22		)	(73		)
Net adjustments		$	95		$	29		$	15

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.

If the reporting unit’s estimated fair value exceeds its carrying value, the reporting unit is not impaired, and no further analysis is performed. Otherwise, the amount of the impairment must be determined by comparing the carrying amount of the reporting unit’s goodwill to the implied fair value of that goodwill. The implied fair value of goodwill is determined by assigning a fair value to all of the reporting unit’s assets and liabilities, including any unrecognized intangible assets, as if the reporting unit had been acquired in a business combination. If the carrying amount of the goodwill exceeds the implied fair value, an impairment loss would be recognized in an amount equal to that excess.

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 2014, the assumed expected long-term rate of return on plan assets used in calculating pension expense was 7.60%, compared with 7.56% in 2013. For the last three years, the assumed rate of return for our domestic plans, which represent approximately 90% of our total pension assets, was 7.75%. A 50-basis-point decrease in this long-term rate of return in 2014 would have increased pension expense for our domestic plans by approximately $27 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 2014, the weighted-average discount rate used in calculating pension expense was 4.92%, compared with 4.23% in 2013. For our domestic plans, the assumed discount rate was 5.00% in 2014, compared with 4.25% for 2013. A 50-basis-point decrease in this discount rate in 2014 would have increased pension expense for our domestic plans by approximately $29 million.

The trend in healthcare costs is difficult to estimate, and it has an important effect on postretirement liabilities. The 2014 medical and prescription drug healthcare cost trend rates represent the weighted-average annual projected rate of increase in the per capita cost of covered benefits. In 2014, we assumed a trend rate of 6.60% for both medical and prescription drug healthcare rates and assumed this rate would decrease to 5.00% by 2021 and then remain at that level. See Note 11 to the Consolidated Financial Statements for the impact of a one-percentage-point change in the cost trend rate.

Warranty and Product Maintenance Liabilities

We provide limited warranty and product maintenance programs, including parts and labor, for certain products for periods ranging from one to five years. A significant portion of these liabilities arises from our commercial aircraft businesses. We also may incur costs related to product recalls. We estimate the costs that may be incurred under warranty programs and record a liability in the amount of such costs at the time product revenue is recognized. Factors that affect this liability include the number of products sold, historical costs per claim, contractual recoveries from vendors, and historical and anticipated rates of warranty claims, including production and warranty patterns for new models. During our initial aircraft model launches, we typically incur higher warranty-related costs until the production process matures, at which point warranty costs moderate. We assess the adequacy of our recorded warranty and product maintenance liabilities periodically and adjust the amounts as necessary. Adjustments are made to accruals as claim data and actual experience warrant. Should future warranty experience differ materially from our historical experience, we may be required to record additional warranty liabilities, which could have a material adverse effect on our results of operations and cash flows in the period in which these additional liabilities are required.

Income Taxes

Deferred income tax balances reflect the effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and their tax bases, as well as from net operating losses and tax credit carryforwards, and are stated at enacted tax rates in effect for the year taxes are expected to be paid or recovered. Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including the future reversal of existing taxable temporary differences, taxable income in carryback years, available tax planning strategies and estimated future taxable income.

The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which may result in proposed assessments. Our estimate of the potential outcome for any uncertain tax issue is highly judgmental. We assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date. For those tax positions for which it is more likely than not that a tax benefit will be sustained, we record the largest amount of tax benefit with a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. Interest and penalties are accrued, where

applicable. We recognize net tax-related interest and penalties for continuing operations in income tax expense. If we do not believe that it is more likely than not that a tax benefit will be sustained, no tax benefit is recognized. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities due to settlement of income tax examinations, new regulatory or judicial pronouncements, or other relevant events. As a result, our effective tax rate may fluctuate significantly on a quarterly and annual basis.