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

Overview and Consolidated Results of Operations

For Textron, 2015 was a year of solid execution across our business segments. We improved operational performance enabling us to increase profitability despite an overall decline in revenues. In addition, we continued our strategy of development and investment in new products to position our businesses for future growth. Several highlights of 2015 include the following:

· Improved gross margin by 60 basis-points from 17.1% to 17.7%.

· Grew segment profit to $1.3 billion, a 3% increase, despite a 3% decline in revenues.

· Raised diluted earnings per share from continuing operations by 16%, from $2.15 to $2.50.

· Generated $1.0 billion in cash from operating activities of our manufacturing businesses.

· Increased our investment in research and development activities by 12% to $778 million.

· Invested $420 million in capital expenditures and $81 million in complementary acquisitions.

· Returned $241 million to our shareholders through share repurchases and dividend payments.

· Reduced our debt-to-capital, net of cash ratio to 26% from 33%.

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 20 to 27.

Revenues

								% Change
(Dollars in millions)		2015		2014		2013		2015	2014
Revenues		$	13,423	$	13,878	$	12,104	(3)%	15%

Revenues decreased $455 million, 3%, in 2015, compared with 2014, as decreases in the Bell and Textron Systems segments were partially offset by higher revenues in the Textron Aviation and Industrial segments. The net revenue decrease included the following factors:

·	Lower Bell revenues of $791 million, largely due to a decrease of $577 million in V-22 program revenues, primarily reflecting lower aircraft deliveries, a decrease of $193 million in commercial revenues, largely related to a change in mix of commercial aircraft sold during the period, and lower commercial aftermarket volume of $92 million.
·	Lower Textron Systems revenues of $104 million, primarily due to lower volume in the Unmanned Systems product line, largely reflecting lower deliveries in the fourth quarter.
·	Higher Textron Aviation revenues of $254 million, primarily due to the first quarter impact of the Beechcraft acquisition of $219 million and higher volume and mix of $35 million. We completed the acquisition of Beechcraft on March 14, 2014, and as a result, 2014 does not reflect a full twelve months of its revenues.
·	Higher Industrial segment revenues of $206 million, primarily due to higher volume of $357 million, largely in the Fuel Systems and Functional Components product line, and the impact from acquisitions of $103 million, partially offset by an unfavorable foreign exchange impact of $240 million.

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.

Cost of Sales and Selling and Administrative Expense

								% Change
(Dollars in millions)		2015		2014		2013		2015	2014
Operating expenses		$	12,283	$	12,782	$	11,257	(4)%	14%
Cost of sales			10,979		11,421		10,131	(4)%	13%
Gross margin as a percentage of Manufacturing revenues			17.7%		17.1%		15.4%
Selling and administrative expenses		$	1,304	$	1,361	$	1,126	(4)%	21%

Manufacturing cost of sales and selling and administrative expenses together comprise our operating expenses. Cost of sales decreased $442 million, 4%, in 2015, compared with 2014, largely due to lower volume at the Bell segment and a $217 million favorable foreign exchange impact mostly from the strengthening of the U.S. dollar against the Euro, partially offset by higher volume at the Industrial segment, and an increase from acquired businesses, primarily Beechcraft. The 60 basis-point improvement in gross margin was largely driven by the Textron Aviation segment, primarily reflecting the net impact of the Beechcraft acquisition, which includes the benefit of the integrated cost structure of Beechcraft and Cessna, and lower amortization of fair value step-up adjustments related to acquired Beechcraft inventories.

Selling and administrative expense decreased $57 million, 4%, in 2015, compared with 2014. Significant factors contributing to the decrease in expense include a favorable impact from ongoing cost reduction activities at the Bell Segment and lower share-based compensation expense of $22 million, which were partially offset by an increase from acquired businesses, primarily Beechcraft.

Manufacturing 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 the Textron Aviation segment.

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 the Textron Aviation segment.

Acquisition and Restructuring Costs

In 2014, we executed a restructuring program in our Textron Aviation segment 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, along with $11 million of transaction costs, which were included in the Acquisition and restructuring costs line on the Consolidated Statements of Operations.

Interest Expense

								% Change
(Dollars in millions)		2015		2014		2013		2015	2014
Interest expense		$	169	$	191	$	173	(12)%	10%

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 $22 million, 12%, in 2015, compared with 2014, primarily due to favorable borrowing costs and lower average debt outstanding. In 2014, consolidated interest expense increased $18 million, 10%, 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.

Income Tax Expense

Our effective tax rate was 28.1%, 29.1% and 26.1% in 2015, 2014 and 2013, respectively. 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 domestic manufacturing deduction and the research and development credit. The jurisdictions with favorable tax rates that have the most significant effective tax rate impact in the periods presented include Canada, Germany, United Kingdom, 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. This credit was subsequently extended in 2014 and in 2015, resulting in a 1.5% reduction in our effective tax rate for each year.

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, 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. Revenues generated by acquired businesses are reflected in Acquisitions for a twelve-month period. 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 24% of our 2015 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)		2015		2014		2013		2015	2014
Revenues		$	4,822	$	4,568	$	2,784	6%	64%
Operating expenses			4,422		4,334		2,832	2%	53%
Segment profit (loss)			400		234		(48)	71%	—
Profit margin			8.3%		5.1%		(1.7)%
Backlog		$	1,074	$	1,365	$	1,018	(21)%	34%

Textron Aviation Revenues and Operating Expenses

Factors contributing to the 2015 year-over-year revenue change are provided below:

(In millions)																	2015 versus 2014
Acquisitions																	$	219
Volume and mix																	35
Total change																	$	254

Textron Aviation’s revenues increased $254 million, 6%, in 2015, compared with 2014, primarily due to the first quarter impact of the Beechcraft acquisition of $219 million and higher volume and mix of $35 million. We delivered 166 Citation jets and 117 King Air turboprops in 2015, compared with 159 Citation jets and 113 King Air turboprops in 2014. The portion of the segment’s revenues derived from aftermarket sales and services represented 29% of its total revenues in 2015, compared with 30% in 2014.

Textron Aviation’s operating expenses increased $88 million in 2015, compared with 2014, primarily due to the incremental operating costs related to the Beechcraft acquisition and higher volume, partially offset by lower amortization of $51 million related to fair value step-up adjustments of acquired Beechcraft inventories sold during the period.

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 $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 $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.

Textron Aviation Segment Profit (Loss)

Factors contributing to 2015 year-over-year segment profit change are provided below:

(In millions)																	2015 versus 2014
Performance and other																	$	119
Volume and mix																	47
Total change																	$	166

Segment profit at Textron Aviation increased $166 million, 71%, in 2015, compared with 2014, primarily due to an increase in performance and other, reflecting the net profit impact from the Beechcraft acquisition, which includes the benefit of the integrated cost structure of Beechcraft and Cessna, and lower amortization of $51 million related to fair value step-up adjustments as described above. Segment profit was also favorably impacted by higher volume as well as the mix of products sold.

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.

Textron Aviation Backlog

Textron Aviation’s backlog decreased $291 million, 21%, in 2015, primarily due to deliveries on military contracts. In 2014, backlog increased $347 million, 34%, which included the impact of the Beechcraft acquisition.

Bell

								% Change
(Dollars in millions)		2015		2014		2013		2015	2014
Revenues:
V-22 program		$	1,194	$	1,771	$	1,755	(33)%	1%
Other military			839		860		959	(2)%	(10)%
Commercial			1,421		1,614		1,797	(12)%	(10)%
Total revenues			3,454		4,245		4,511	(19)%	(6)%
Operating expenses			3,054		3,716		3,938	(18)%	(6)%
Segment profit			400		529		573	(24)%	(8)%
Profit margin			11.6%		12.5%		12.7%
Backlog		$	5,224	$	5,524	$	6,450	(5)%	(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 2015 year-over-year revenue change are provided below:

(In millions)																	2015 versus 2014
Volume and mix																	$	(807	)
Other																	16
Total change																	$	(791	)

Bell’s revenues decreased $791 million, 19%, in 2015, compared with 2014, primarily due to the following factors:

·	$577 million decrease in V-22 program revenues, primarily reflecting lower aircraft deliveries, as we delivered 24 V-22 aircraft in 2015, compared with 37 V-22 aircraft in 2014.
·	$193 million decrease in commercial revenues, largely related to a change in mix of commercial aircraft sold during the period, reflecting lower sales activity across the commercial helicopter market, and $92 million of lower aftermarket volume. Bell delivered 175 commercial aircraft in 2015, compared with 178 commercial aircraft in 2014.
·	$21 million decrease in other military, which included $41 million recorded in the second quarter of 2014 related to the settlement of the SDD phase of the ARH program. Bell delivered 24 H-1 aircraft in both periods.

Bell’s operating expenses decreased $662 million, 18%, in 2015, compared with 2014, primarily due to lower net sales volume as described above and the favorable impact of ongoing cost reduction activities.

As a result of cost reduction actions announced in April 2015, Bell incurred approximately $40 million in severance and benefit costs during the second quarter of 2015. The initial impact of the restructuring on Bell’s segment profit in the second quarter of 2015 was not significant due to cost savings from headcount reductions and the impact of including a portion of these costs in our indirect cost rates. These actions reduced Bell’s headcount by approximately 1,100 employees representing approximately 12% of the Bell workforce at that time.

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. 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 lower net volume as described 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.

Bell Segment Profit

Factors contributing to 2015 year-over-year segment profit change are provided below:

(In millions)																	2015 versus 2014
Volume and mix																	$	(223	)
Performance and other																	94
Total change																	$	(129	)

Bell’s segment profit decreased $129 million, 24%, in 2015, compared with 2014, primarily due to a $223 million unfavorable impact from lower volume and mix and a $16 million favorable program profit adjustment in 2014 related to the ARH program, as described above. Volume and mix was partially offset by favorable performance and other of $94 million, largely related to ongoing cost reduction activities.

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 as described above. Favorable performance primarily reflected our cost reduction activities in 2014 as well as unfavorable performance in 2013.

Bell Backlog

In 2015, Bell’s backlog decreased $300 million, 5%, primarily related to the commercial business. In 2014, Bell’s backlog decreased $926 million, 14%, primarily due to V-22 aircraft deliveries in excess of orders.

Textron Systems

								% Change
(Dollars in millions)		2015		2014		2013		2015	2014
Revenues		$	1,520	$	1,624	$	1,665	(6)%	(2)%
Operating expenses			1,391		1,474		1,518	(6)%	(3)%
Segment profit			129		150		147	(14)%	2%
Profit margin			8.5%		9.2%		8.8%
Backlog		$	2,328	$	2,790	$	2,803	(17)%	—

Textron Systems Revenues and Operating Expenses

Factors contributing to the 2015 year-over-year revenue change are provided below:

(In millions)																	2015 versus 2014
Volume																	$	(105	)
Other																	1
Total change																	$	(104	)

Revenues at Textron Systems decreased $104 million, 6%, in 2015, compared with 2014, primarily due to lower volume in the Unmanned Systems product line.

Textron Systems’ operating expenses decreased $83 million, 6%, in 2015, compared with 2014, primarily due to lower volume as described above, partially offset by an unfavorable mix of products delivered in 2015.

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 Unmanned Systems’ fee-for-service program. Operating expenses also included the impact of costs related to acquisitions.

Textron Systems Segment Profit

Factors contributing to 2015 year-over-year segment profit change are provided below:

(In millions)																	2015 versus 2014
Volume and mix																	$	(24	)
Performance																	8
Other																	(5		)
Total change																	$	(21	)

Textron Systems’ segment profit decreased $21 million, 14%, in 2015, compared with 2014, primarily resulting from lower volume and unfavorable product mix in 2015.

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 Unmanned Systems’ fee-for-service program.

Systems Backlog

Textron Systems’ backlog decreased $462 million, 17%, in 2015, primarily due to deliveries in excess of orders in the Weapons and Sensors and Unmanned Systems product lines.

Industrial

								% Change
(Dollars in millions)		2015		2014		2013		2015	2014
Revenues:
Fuel Systems and Functional Components		$	2,078	$	1,975	$	1,853	5%	7%
Other Industrial			1,466		1,363		1,159	8%	18%
Total revenues			3,544		3,338		3,012	6%	11%
Operating expenses			3,242		3,058		2,770	6%	10%
Segment profit			302		280		242	8%	16%
Profit margin			8.5%		8.4%		8.0%

Industrial Revenues and Operating Expenses

Factors contributing to the 2015 year-over-year revenue change are provided below:

(In millions)																	2015 versus 2014
Volume																	$	357
Foreign exchange																	(240		)
Acquisitions																	103
Other																		(14	)
Total change																	$	206

Industrial segment revenues increased $206 million, 6%, in 2015, compared with 2014, primarily due to higher volume of $357 million and the impact from acquisitions of $103 million, partially offset by an unfavorable foreign exchange impact of $240 million mostly related to the strengthening of the U.S. dollar primarily against the Euro. Higher volume reflected a $283 million increase in the Fuel Systems and Functional Components product line, primarily due to automotive industry demand in Europe and North America, and a $74 million increase in the Other Industrial product lines.

Operating expenses for the Industrial segment increased $184 million, 6%, in 2015, compared with 2014, largely due to the impact from higher volume as described above and additional operating expenses from acquisitions of $105 million, partially offset by a favorable impact of $225 million from changes in foreign exchange rates.

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 an 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.

Industrial Segment Profit

Factors contributing to 2015 year-over-year segment profit change are provided below:

(In millions)																	2015 versus 2014
Volume																	$	42
Performance																	(15		)
Foreign exchange																	(15		)
Other																		10
Total change																	$	22

Segment profit for the Industrial segment increased $22 million, 8%, in 2015, compared with 2014, largely due to the impact from higher volume as described above, partially offset by unfavorable performance of $15 million and an unfavorable impact of $15 million from changes in foreign exchange rates.

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.

Finance

(In millions)		2015			2014			2013
Revenues		$	83		$	103		$	132
Segment profit		24			21			49

Finance Revenues

Finance segment revenues decreased $20 million in 2015, compared with 2014, primarily attributable to average finance receivables being lower by $187 million.

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 Profit

Finance segment profit increased $3 million in 2015, compared with 2014, primarily due to lower provision for loan losses.

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 as 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 Portfolio Quality

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

(Dollars in millions)		January 2, 2016			January 3, 2015
Finance receivables*		$	1,105		$	1,254
Nonaccrual finance receivables		84			81
Ratio of nonaccrual finance receivables to finance receivables		7.60		%	6.46		%
60+ days contractual delinquency		$	69		$	57
60+ days contractual delinquency as a percentage of finance receivables		6.24		%	4.55		%

* Excludes finance receivables held for sale.

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 2, 2016			January 3, 2015
Manufacturing group
Cash and equivalents		$	946		$	731
Debt		2,697			2,811
Shareholders’ equity		4,964			4,272
Capital (debt plus shareholders’ equity)		7,661			7,083
Net debt (net of cash and equivalents) to capital		26		%	33		%
Debt to capital		35		%	40		%
Finance group
Cash and equivalents		$	59		$	91
Debt		913			1,063

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 2, 2016, there were no amounts borrowed against the facility, and there were $33 million of letters of credit issued against it. We also 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.

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)		2015			2014			2013
Operating activities		$	1,038		$	1,097		$	658
Investing activities		(496		)	(2,065		)	(624		)
Financing activities		(308		)	552			(240		)

Cash flows provided by operating activities was $1,038 million in 2015, compared with $1,097 million in 2014, a decrease of 5%. This decrease was largely due to a change in working capital, partially offset by higher income from continuing operations of $94 million and dividends received from the Finance group of $63 million in 2015. A significant factor contributing to the decrease in cash flows related to working capital was a reduction in customer deposits of $304 million at Textron Aviation, largely reflecting advance deposits received on military contracts in 2014 for 2015 deliveries.

Cash flows from operating activities increased $439 million during 2014, compared with 2013, largely due to a 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 $187 million, $266 million and $223 million in 2015, 2014 and 2013, respectively. Pension contributions were $68 million, $76 million and $194 million in 2015, 2014 and 2013, respectively.

Cash flows used in investing activities included capital expenditures of $420 million, $429 million and $444 million in 2015, 2014 and 2013, respectively. In 2014, investing cash flows also included a $1.5 billion aggregate cash payment to acquire Beechcraft.

In 2015, 2014 and 2013, cash flows used in financing activities included the repayment of outstanding debt of $100 million, $559 million and $528 million, respectively. In 2014, cash flows from financing activities included proceeds from long-term debt of $1.4 billion, most of which was used to finance a portion of the Beechcraft acquisition.

Share Repurchases

Under a 2013 share repurchase authorization, we repurchased an aggregate of 5.2 million shares of our outstanding common stock for $219 million in 2015 and an aggregate of 8.9 million shares of our outstanding common stock for $340 million in 2014.

Dividends

Dividend payments to shareholders totaled $22 million, $28 million and $22 million in 2015, 2014 and 2013, respectively.

Dividends from the Finance group are included within cash flows from operating activities for the Manufacturing group as they represent a return on investment. Dividends paid by the Finance group were $63 million and $175 million in 2015 and 2013, respectively.

Finance Group Cash Flows

The cash flows from continuing operations for the Finance group are summarized below:

(In millions)		2015			2014			2013
Operating activities		$	30		$	5		$	66
Investing activities		197			255			624
Financing activities		(259		)	(217		)	(677		)

In 2015, 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 $(11) million, $(23) million and $49 million in 2015, 2014 and 2013, respectively.

Cash flows from investing activities primarily included collections on finance receivables and proceeds from sales of receivables and other finance assets totaling $389 million, $499 million and $853 million in 2015, 2014 and 2013, respectively, partially offset by financial receivable originations of $194 million, $215 million and $271 million, respectively.

Cash used in financing activities included payments on long-term and nonrecourse debt of $256 million, $345 million and $743 million in 2015, 2014 and 2013, respectively, which were partially offset by proceeds from long-term debt of $61 million, $128 million and $298 million, respectively. In 2015 and 2013, dividend payments to the Manufacturing group totaled $63 million and $175 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)		2015			2014			2013
Operating activities		$	1,094		$	1,211		$	813
Investing activities		(388		)	(1,919		)	(264		)
Financing activities		(504		)	335			(742		)

Cash flows provided by operating activities was $1,094 million in 2015, compared with $1,211 million in 2014, a decrease of 10%. This decrease was largely due to a change in working capital, partially offset by higher income from continuing operations of $93 million. A significant factor contributing to the decrease in cash flows related to working capital was a reduction in customer deposits of $304 million at Textron Aviation, largely reflecting advance deposits received on military contracts in 2014 for 2015 deliveries.

Cash flows from operating activities increased $398 million during 2014, compared with 2013, largely due to a 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 $198 million, $289 million and $174 million in 2015, 2014 and 2013, respectively.

Cash flows from investing activities included capital expenditures of $420 million, $429 million and $444 million in 2015, 2014 and 2013, respectively. In 2014, cash flows from investing activities also included a $1.5 billion aggregate cash payment to acquire Beechcraft. Collections on finance receivables and proceeds from sales of receivables and other finance assets totaled $105 million, $134 million and $368 million in 2015, 2014 and 2013, respectively.

Cash used in financing activities included $219 million and $340 million of share repurchases in 2015 and 2014, respectively. In 2015, 2014 and 2013, financing activities also include the repayment of outstanding long-term debt of $356 million, $904 million and $1.3 billion, respectively. Cash flows from financing activities also included proceeds of $1.6 billion from long-term debt in 2014, most of which was used to finance a portion of the Beechcraft acquisition, and proceeds of $448 million from long-term debt in 2013.

Captive Financing and Other Intercompany Transactions

The Finance group finances retail purchases and leases for new and pre-owned aircraft and helicopters 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 adjustments included in the Consolidated Statement of Cash Flows are summarized below:

(In millions)		2015			2014			2013
Reclassifications adjustments from investing activities:
Finance receivable originations for Manufacturing group inventory sales		$	(194	)	$	(215	)	$	(248	)
Cash received from customers		284			365			485
Other		(1		)	(41		)	27
Total reclassifications adjustments from investing activities		89			109			264
Reclassifications adjustments from financing activities:
Dividends received by Manufacturing group from Finance group		(63		)	—			(175		)
Total reclassifications adjustments to cash flow from operating activities		$	26		$	109		$	89

Under a Support Agreement between Textron and TFC, Textron is required to maintain a controlling interest in TFC. The agreement, which was 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 2015, 2014 and 2013 to maintain compliance with the support agreement.

Contractual Obligations

Manufacturing Group

The following table summarizes the known contractual obligations, as defined by reporting regulations, of our Manufacturing group as of January 2, 2016:

								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					$	2,701		$	262		$	513		$	687		$	1,239
Interest on borrowings						626			128			211			154			133
Pension benefits for unfunded plans						371			26			49			44			252
Postretirement benefits other than pensions						364			40			71			59			194
Other long-term liabilities						477			92			134			105			146
Liabilities not reflected in balance sheet:
Purchase obligations						2,847			2,038			730			60			19
Operating leases						380			74			101			74			131
Total Manufacturing group					$	7,766		$	2,660		$	1,809		$	1,183		$	2,114

Pension and Postretirement Benefits

We maintain defined benefit pension plans and postretirement benefit plans other than pensions as described 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 2016, we expect to make approximately $33 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 2017 through 2020 are estimated to be in the range of approximately $60 million to $125 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 30% 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 2, 2016:

								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					$	573		$	135		$	278		$	95		$	65
Subordinated debt						299			—			—			—			299
Securitized debt						41			20			17			3			1
Interest on borrowings						201			33			31			18			119
Total Finance group					$	1,114		$	188		$	326		$	116		$	484

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 2, 2016, the Finance group also had $28 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 2, 2016:

(In millions)		2015			2014			2013
Gross favorable		$	111		$	132		$	51
Gross unfavorable			(33	)		(37	)		(22	)
Net adjustments		$	78		$	95		$	29

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, there is no impairment, and no further analysis is performed. Otherwise, the amount of the impairment is 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 is 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 2015, the assumed expected long-term rate of return on plan assets used in calculating pension expense was 7.57%, compared with 7.60% in 2014. For the last four years, the assumed rate of return for our domestic plans, which represent approximately 91% of our total pension assets, was 7.75%. A 50 basis-point decrease in this long-term rate of return in 2015 would have increased pension cost for our domestic plans by approximately $29 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 2015, the weighted-average discount rate used in calculating pension expense was 4.25%, compared with 4.92% in 2014. For our domestic plans, the assumed discount rate was 4.25% in 2015, compared with 5.00% for 2014. In the second quarter of 2015, our Bell segment announced cost reduction actions that resulted in a headcount reduction that was deemed a curtailment. As a result, we remeasured Bell’s pension plan incorporating a 50 basis-point increase in our discount rate to 4.75%. A 50 basis-point decrease in the weighted-average discount rate that includes the remeasurement would have increased pension cost for our domestic plans by approximately $34 million in 2015.

The trend in healthcare costs is difficult to estimate, and it has an important effect on postretirement liabilities. The 2015 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 2015, we assumed a trend rate of 7.50% for both medical and prescription drug healthcare rates and assumed this rate would gradually decline to 5.00% by 2024 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.

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.