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

Overview and Consolidated Results of Operations

In 2016, revenues and segment profit grew by 3% and 4%, respectively, despite challenging and weaker than expected end markets, most notably the business jet and commercial helicopter markets. We continued to invest in our businesses through the ongoing development of new products and services, and the completion of several strategic business acquisitions to support growth and create long-term shareholder value. Financial highlights of 2016 include the following:

· Generated $988 million in cash from operating activities of our manufacturing businesses.

· Invested $677 million in research and development activities, $446 million in capital expenditures and $186 million in business acquisitions.

· Returned $263 million to our shareholders through share repurchases and dividend payments.

· Initiated a plan to restructure and realign our businesses to improve overall operating efficiency and to better position our businesses for the future, which resulted in special charges of $123 million.

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

							% Change
(Dollars in millions)		2016		2015		2014		2016		2015
Revenues	$	13,788	$	13,423	$	13,878		3%		(3)%

Revenues increased $365 million, 3%, in 2016, compared with 2015, largely driven by increases in the Industrial, Textron Systems and Textron Aviation segments, partially offset by lower revenues at the Bell segment. The net revenue increase included the following factors:

· Higher Industrial revenues of $250 million, primarily due to higher volume of $168 million, largely in the Fuel Systems and Functional Components product line, and the impact from acquired businesses of $121 million.

· Higher Textron Systems revenues of $236 million, primarily due to higher volume of $106 million in the Marine and Land Systems product line and $77 million in the Unmanned Systems product line.

· Higher Textron Aviation revenues of $99 million, primarily due to the impact from an acquired business of $66 million and higher volume and mix of $42 million, largely the result of higher Citation jet volume of $165 million, partially offset by lower turboprop volume.

· Lower Bell revenues of $215 million, primarily due to a decrease in commercial revenues of $269 million, largely reflecting lower aircraft deliveries.

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.

Cost of Sales and Selling and Administrative Expense

							% Change
(Dollars in millions)		2016		2015		2014		2016		2015
Cost of sales	$	11,311	$	10,979	$	11,421		3%		(4)%
Gross margin as a percentage of Manufacturing revenues		17.5%		17.7%		17.1%
Selling and administrative expense	$	1,304	$	1,304	$	1,361		—		(4)%

In 2016, cost of sales increased $332 million, 3%, compared with 2015, largely due to higher volume at the Textron Systems, Industrial and Textron Aviation segments, and an increase from acquired businesses. These increases were partially offset by lower volume at the Bell segment and favorable cost performance across all of our manufacturing segments. Selling and administrative expense was unchanged in 2016, compared with 2015.

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.

Interest Expense

							% Change
(Dollars in millions)		2016		2015		2014		2016		2015
Interest expense	$	174	$	169	$	191		3%		(12)%

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 increased $5 million, 3%, in 2016, compared with 2015, primarily due to higher average debt outstanding. In 2015, consolidated interest expense decreased $22 million, 12%, compared with 2014, primarily due to favorable borrowing costs and lower average debt outstanding.

Special Charges

Special charges recorded in 2016 by segment are as follows:

(In millions)		Severance Costs		Asset Impairments		Contract Terminations and Other		Total Special Charges
Textron Systems	$	15	$	34	$	13	$	62
Textron Aviation		33		1		1		35
Industrial		17		2		1		20
Bell		4		1		—		5
Corporate		1		—		—		1
	$	70	$	38	$	15	$	123

In 2016, we initiated a plan to restructure and realign our businesses by implementing headcount reductions, facility consolidations and other actions in order to improve overall operating efficiency across Textron. As part of this plan, Textron Systems will discontinue production of its sensor-fuzed weapon product by the end of the first quarter of 2017, resulting in headcount reductions, facility consolidations and asset impairments within its Weapons and Sensors operating unit. Historically, sensor-fuzed weapon sales have relied on foreign military and direct commercial international customers for which both executive branch and congressional approval is required. The political environment has made it difficult to obtain these approvals. Within our Industrial segment, the plan provides for the combination of our Jacobsen business with the Textron Specialized Vehicles businesses, resulting in the consolidation of certain facilities and general and administrative functions and related headcount reductions. In addition, we initiated restructuring actions, principally headcount reductions, in our Textron Aviation segment, as well as other businesses and corporate

functions. The total headcount reduction related to restructuring activities is expected to be approximately 1,700 positions, representing approximately 5% of our workforce.

We expect to incur additional pre-tax charges under this plan in the range of $17 million to $47 million, primarily related to contract termination, severance, facility consolidation and relocation costs. The remaining charges are expected to primarily be in the Industrial, Textron Systems and Textron Aviation segments. We anticipate the plan to be substantially completed by the end of the first half of 2017. Total expected cash outlays for restructuring activities are estimated to be approximately $100 million to $120 million, of which $22 million was paid in 2016 and the remainder will be paid in 2017.

In 2014, we executed a restructuring program in our Textron Aviation segment to align the Cessna and acquired Beechcraft business, reduce operating redundancies and maximize operating efficiencies. We recorded special charges of $41 million related to these restructuring activities in 2014, along with $11 million of transaction costs from the acquisition of Beechcraft.

Income Taxes

				2016		2015		2014
Effective tax rate				3.8%		28.1%		29.1%

In 2016, our effective tax rate was significantly lower than the U.S. federal statutory tax rate of 35%, largely due to a settlement with the U.S. Internal Revenue Service Office of Appeals for our 1998 to 2008 tax years. This settlement resulted in a $206 million benefit recognized in continuing operations and a $113 million benefit in discontinued operations. For a full reconciliation of our effective tax rate to the U.S. federal statutory tax rate of 35% see Note 13 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 special charges. 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 25% of our 2016 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 described 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)		2016		2015		2014		2016		2015
Revenues	$	4,921	$	4,822	$	4,568		2%		6%
Operating expenses		4,532		4,422		4,334		2%		2%
Segment profit		389		400		234		(3)%		71%
Profit margin		7.9%		8.3%		5.1%
Backlog	$	1,041	$	1,074	$	1,365		(3)%		(21)%

Textron Aviation Revenues and Operating Expenses

Factors contributing to the 2016 year-over-year revenue change are provided below:

(In millions)								2016 versus 2015
Acquisitions							$	66
Volume and mix								42
Other								(9)
Total change							$	99

Textron Aviation’s revenues increased $99 million, 2%, in 2016, compared with 2015, primarily due to the impact from an acquisition of a repair and overhaul business in the first quarter of 2016, and higher volume and mix of $42 million. The increase in volume and mix was largely due to higher Citation jet volume of $165 million, partially offset by lower turboprop volume. We delivered 178 Citation jets and 106 King Air turboprops in 2016, compared with 166 Citation jets and 117 King Air turboprops in 2015. The portion of the segment’s revenues derived from aftermarket sales and services represented 31% of its total revenues in 2016, compared with 29% in 2015, largely resulting from the acquisition.

Textron Aviation’s operating expenses increased $110 million, 2%, in 2016, compared with 2015, largely due to higher net volume as described above and additional operating expenses resulting from the acquisition. These increases were partially offset by improved cost performance of $64 million, largely attributable to lower research and development costs and lower compensation expense.

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.

Textron Aviation Segment Profit

Factors contributing to 2016 year-over-year segment profit change are provided below:

(In millions)								2016 versus 2015
Performance and other							$	65
Volume and mix								(49)
Inflation and pricing								(27)
Total change							$	(11)

Segment profit at Textron Aviation decreased $11 million, 3%, in 2016, compared with 2015, primarily as a result of the mix of products sold and the unfavorable impact from inflation and pricing of $27 million. These decreases were partially offset by favorable performance and other of $65 million, largely attributable to lower research and development costs and lower compensation expense.

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.

Textron Aviation Backlog

Textron Aviation’s backlog decreased $33 million, 3%, in 2016 and $291 million, 21%, in 2015. The decrease in 2015 was primarily due to deliveries on military contracts.

Bell

							% Change
(Dollars in millions)		2016		2015		2014		2016		2015
Revenues:
V-22 program	$	1,151	$	1,194	$	1,771		(4)%		(33)%
Other military		936		839		860		12%		(2)%
Commercial		1,152		1,421		1,614		(19)%		(12)%
Total revenues		3,239		3,454		4,245		(6)%		(19)%
Operating expenses		2,853		3,054		3,716		(7)%		(18)%
Segment profit		386		400		529		(4)%		(24)%
Profit margin		11.9%		11.6%		12.5%
Backlog	$	5,360	$	5,224	$	5,524		3%		(5)%

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 2016 year-over-year revenue change are provided below:

(In millions)								2016 versus 2015
Volume and mix							$	(225)
Other								10
Total change							$	(215)

Bell’s revenues decreased $215 million, 6%, in 2016, compared with 2015, primarily due to the following factors:

· $269 million decrease in commercial revenues, primarily due to lower aircraft deliveries, as we delivered 114 commercial aircraft in 2016, compared with 175 aircraft in 2015.

· $43 million decrease in V-22 program revenues, primarily due to lower aircraft deliveries, as we delivered 22 V-22 aircraft in 2016, compared with 24 V-22 aircraft in 2015.

· $97 million increase in other military revenues, primarily reflecting higher H-1 program revenues, as we delivered 35 H-1 aircraft in 2016, compared with 24 H-1 aircraft in 2015.

Bell’s operating expenses decreased $201 million, 7%, in 2016, compared with 2015, primarily due to lower net sales volume as described above.

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 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.

Bell Segment Profit

Factors contributing to 2016 year-over-year segment profit change are provided below:

(In millions)								2016 versus 2015
Volume and mix							$	(46)
Performance and other								32
Total change							$	(14)

Bell’s segment profit decreased $14 million, 4%, in 2016, compared with 2015. The unfavorable impact from volume and mix was primarily due to lower commercial aircraft deliveries, while the favorable performance and other was largely the result of lower research and development costs.

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.

Bell Backlog

Bell’s backlog increased $136 million, 3%, in 2016, while it decreased $300 million, 5%, in 2015. The decrease in 2015 was primarily related to the commercial business.

Textron Systems

							% Change
(Dollars in millions)		2016		2015		2014		2016		2015
Revenues	$	1,756	$	1,520	$	1,624		16%		(6)%
Operating expenses		1,570		1,391		1,474		13%		(6)%
Segment profit		186		129		150		44%		(14)%
Profit margin		10.6%		8.5%		9.2%
Backlog	$	1,841	$	2,328	$	2,790		(21)%		(17)%

Textron Systems Revenues and Operating Expenses

Factors contributing to the 2016 year-over-year revenue change are provided below:

(In millions)								2016 versus 2015
Volume							$	200
Acquisitions								32
Other								4
Total change							$	236

Revenues at Textron Systems increased $236 million, 16%, in 2016, compared with 2015, primarily due to higher volume of $106 million in the Marine and Land Systems product line and $77 million in the Unmanned Systems product line, and the impact from an acquisition of $32 million.

Textron Systems’ operating expenses increased $179 million, 13%, in 2016, compared with 2015, primarily due to higher volume as described above.

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.

Textron Systems Segment Profit

Factors contributing to 2016 year-over-year segment profit change are provided below:

(In millions)								2016 versus 2015
Performance							$	43
Volume and mix								13
Other								1
Total change							$	57

Textron Systems’ segment profit increased $57 million, 44%, in 2016, compared with 2015, primarily due to improved cost performance and higher volume as described above.

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.

Textron Systems Backlog

Backlog at Textron Systems decreased $487 million, 21%, in 2016, and $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)		2016		2015		2014		2016		2015
Revenues:
Fuel Systems and Functional Components	$	2,273	$	2,078	$	1,975		9%		5%
Other Industrial		1,521		1,466		1,363		4%		8%
Total revenues		3,794		3,544		3,338		7%		6%
Operating expenses		3,465		3,242		3,058		7%		6%
Segment profit		329		302		280		9%		8%
Profit margin		8.7%		8.5%		8.4%

Industrial Revenues and Operating Expenses

Factors contributing to the 2016 year-over-year revenue change are provided below:

(In millions)								2016 versus 2015
Volume							$	168
Acquisitions								121
Foreign exchange								(35)
Other								(4)
Total change							$	250

Industrial segment revenues increased $250 million, 7%, in 2016, compared with 2015, primarily due to higher volume of $168 million and the impact from acquired businesses of $121 million. The increase in volume was primarily related to the Fuel Systems and Functional Components product line, largely reflecting automotive industry demand in Europe.

Operating expenses for the Industrial segment increased $223 million, 7%, in 2016, compared with 2015, primarily due to the impact from higher volume as described above and additional operating expenses from acquired businesses.

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 currency exchange rates.

Industrial Segment Profit

Factors contributing to 2016 year-over-year segment profit change are provided below:

(In millions)								2016 versus 2015
Inflation, net of pricing							$	19
Foreign exchange								(12)
Volume								11
Performance and other								9
Total change							$	27

Segment profit for the Industrial segment increased $27 million, 9%, in 2016, compared with 2015, largely due to a $19 million favorable impact from inflation, net of pricing, primarily in our Specialized Vehicles and Equipment product line, and higher volume as described above, partially offset by an unfavorable impact of $12 million from changes in foreign currency exchange rates.

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 currency exchange rates.

Finance

(In millions)				2016		2015		2014
Revenues			$	78	$	83	$	103
Segment profit				19		24		21

Finance segment revenues decreased $5 million in 2016, compared with 2015, and $20 million in 2015, compared with 2014, primarily attributable to lower average finance receivables. Finance segment profit decreased $5 million in 2016, compared with 2015, primarily due to lower average finance receivables. In 2015, Finance segment profit increased $3 million, compared with 2014, primarily due to lower provision for loan losses.

Finance Portfolio Quality

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

(Dollars in millions)						December 31, 2016		January 2, 2016
Finance receivables*					$	946	$	1,105
Nonaccrual finance receivables						87		84
Ratio of nonaccrual finance receivables to finance receivables						9.20%		7.60%
60+ days contractual delinquency					$	40	$	69
60+ days contractual delinquency as a percentage of finance receivables						4.23%		6.24%

* 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)						December 31, 2016		January 2, 2016
Manufacturing group
Cash and equivalents					$	1,137	$	946
Debt						2,777		2,697
Shareholders’ equity						5,574		4,964
Capital (debt plus shareholders’ equity)						8,351		7,661
Net debt (net of cash and equivalents) to capital						23%		26%
Debt to capital						33%		35%
Finance group
Cash and equivalents					$	161	$	59
Debt						903		913

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.

In 2016, Textron entered into a senior unsecured revolving credit facility that expires in September 2021 for an aggregate principal amount of $1.0 billion, of which up to $100 million is available for the issuance of letters of credit. At December 31, 2016, there were no amounts borrowed against the facility and there were $11 million of letters of credit issued against it. This facility replaced the existing 5-year facility, which had no outstanding borrowings and was scheduled to expire in October 2018.

We also maintain an effective shelf registration statement filed with the Securities and Exchange Commission that allows us to issue an unlimited amount of public debt and other securities. In March 2016, we issued $350 million in 4.0% Notes due March 2026 under this registration statement.

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)				2016		2015		2014
Operating activities			$	988	$	1,038	$	1,097
Investing activities				(621)		(496)		(2,065)
Financing activities				(146)		(308)		552

In 2016, cash flows provided by operating activities was $988 million, compared with $1,038 million in 2015, a 5% decrease. This decrease was primarily the result of changes in working capital, which included lower customer deposits of $257 million largely related to performance-based payments on certain military contracts in the Bell segment, along with a $34 million reduction in dividends received from the Finance group. These decreases were partially offset by a $75 million increase in cash proceeds from the settlements of corporate-owned life insurance policies and $42 million in lower payments for taxes and pension contributions as disclosed below.

Cash flows provided by operating activities was $1,038 million in 2015, compared with $1,097 million in 2014, a 5% decrease. 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.

Net tax payments were $163 million, $187 million and $266 million in 2016, 2015 and 2014, respectively. Pension contributions were $50 million, $68 million and $76 million in 2016, 2015 and 2014, respectively.

Investing cash flows included capital expenditures of $446 million, $420 million and $429 million in 2016, 2015 and 2014, respectively. Investing cash flows also included cash used for acquisitions of $186 million and $81 million in 2016 and 2015, respectively, as well as a $1.5 billion aggregate cash payment to acquire Beechcraft in 2014.

Total financing cash flows included proceeds from long-term debt of $345 million in 2016 and $1.4 billion in 2014, most of which was used to finance a portion of the Beechcraft acquisition. In 2016, 2015 and 2014, financing activities also included the repayment of outstanding debt of $254 million, $100 million and $559 million, respectively.

Share Repurchases

Under a 2013 share repurchase authorization, we repurchased an aggregate of 6.9 million, 5.2 million and 8.9 million shares of our outstanding common stock in 2016, 2015 and 2014, respectively, for $241 million, $219 million and $340 million, respectively.

On January 25, 2017, we announced the adoption of a new plan authorizing the repurchase of up to 25 million shares under which we intend to purchase shares of Textron common stock to offset the impact of dilution from share-based compensation and benefit plans and for opportunistic capital management purposes. This new plan has no expiration date and replaced the existing plan adopted in 2013 that had 4.0 million remaining shares available for repurchase.

Dividends

Dividend payments to shareholders totaled $22 million, $22 million and $28 million in 2016, 2015 and 2014, 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 $29 million and $63 million in 2016 and 2015, respectively.

Finance Group Cash Flows

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

(In millions)				2016		2015		2014
Operating activities			$	11	$	30	$	5
Investing activities				142		197		255
Financing activities				(51)		(259)		(217)

The Finance group’s cash flows from operating activities included net tax payments of $11 million, $11 million and $23 million in 2016, 2015 and 2014, respectively.

Cash flows from investing activities primarily included collections on finance receivables totaling $292 million, $351 million and $456 million in 2016, 2015 and 2014, respectively, partially offset by finance receivable originations of $173 million, $194 million and $215 million, respectively.

Cash used in financing activities included payments on long-term and nonrecourse debt of $203 million, $256 million and $345 million in 2016, 2015 and 2014, respectively, which were partially offset by proceeds from long-term debt of $180 million, $61 million and $128 million, respectively. In 2016 and 2015, dividend payments to the Manufacturing group totaled $29 million and $63 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)				2016		2015		2014
Operating activities			$	1,014	$	1,094	$	1,211
Investing activities				(523)		(388)		(1,919)
Financing activities				(168)		(504)		335

In 2016, cash flows provided by operating activities was $1,014 million, compared with $1,094 million in 2015, a 7% decrease. This decrease was primarily the result of changes in working capital, which included lower customer deposits of $257 million largely related to performance-based payments on certain military contracts in the Bell segment. These decreases were partially offset by a $75 million increase in cash proceeds from the settlements of corporate-owned life insurance policies and $42 million in lower payments for taxes and pension contributions as disclosed below.

Cash flows provided by operating activities was $1,094 million in 2015, compared with $1,211 million in 2014, a 10% decrease. 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.

Net tax payments were $174 million, $198 million and $289 million in 2016, 2015 and 2014, respectively. Pension contributions were $50 million, $68 million and $76 million in 2016, 2015 and 2014, respectively.

Investing cash flows included capital expenditures of $446 million, $420 million and $429 million in 2016, 2015 and 2014, respectively. Investing cash flows also included cash used for acquisitions of $186 million and $81 million in 2016 and 2015, respectively, as well as a $1.5 billion aggregate cash payment to acquire Beechcraft in 2014. Collections on finance receivables totaled $44 million, $67 million and $91 million in 2016, 2015 and 2014, respectively.

In 2016, 2015 and 2014, cash used in financing activities included the repayment of outstanding long-term debt of $457 million, $356 million and $904 million, respectively, and share repurchases of $241 million, $219 million and $340 million, respectively. Total financing cash flows also included proceeds from long-term debt of $525 million and $61 million in 2016 and 2015, respectively, and $1.6 billion in 2014, most of which was used to finance a portion of the Beechcraft acquisition.

Captive Financing and Other Intercompany Transactions

The Finance group provides financing primarily to purchasers of new and pre-owned Textron Aviation aircraft and Bell helicopters manufactured by our Manufacturing group, otherwise known as captive financing. In the Consolidated Statements of Cash Flows, cash received from customers is reflected as operating activities when received from third parties. However, in the cash flow information provided for the separate borrowing groups, cash flows related to captive financing activities are reflected based on the operations of each group. For example, when product is sold by our Manufacturing group to a customer and is financed by the Finance group, the origination of the finance receivable is recorded within investing activities as a cash outflow in the Finance group’s statement of cash flows. Meanwhile, in the Manufacturing group’s statement of cash flows, the cash received from the Finance group on the customer’s behalf is recorded within operating cash flows as a cash inflow. Although cash is transferred between the two borrowing groups, there is no cash transaction reported in the consolidated cash flows at the time of the original financing. These captive financing activities, along with all significant intercompany transactions, are reclassified or eliminated from the Consolidated Statements of Cash Flows.

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

(In millions)				2016		2015		2014
Reclassification adjustments from investing activities:
Cash received from customers			$	248	$	284	$	365
Finance receivable originations for Manufacturing group inventory sales				(173)		(194)		(215)
Other				(31)		(1)		(41)
Total reclassification adjustments from investing activities				44		89		109
Reclassification adjustments from financing activities:
Dividends received by Manufacturing group from Finance group				(29)		(63)		—
Total reclassification adjustments to cash flow from operating activities			$	15	$	26	$	109

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 2016, 2015 and 2014 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 December 31, 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:
Debt	$	2,793	$	363	$	614	$	702	$	1,114
Interest on borrowings		649		130		212		146		161
Pension benefits for unfunded plans		387		27		49		46		265
Postretirement benefits other than pensions		317		35		61		52		169
Other long-term liabilities		472		96		122		97		157
Liabilities not reflected in balance sheet:
Purchase obligations		2,619		2,019		535		58		7
Operating leases		439		79		122		83		155
Total Manufacturing group	$	7,676	$	2,749	$	1,715	$	1,184	$	2,028

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 2017, we expect to make approximately $28 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 2018 through 2021 are estimated to be in the range of approximately $75 million to $150 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 38% of the purchase obligations we disclose represent purchase orders issued for goods and services to be delivered under firm contracts with the U.S. Government for which we have full recourse under customary contract termination clauses.

Finance Group

The following table summarizes the known contractual obligations, as defined by reporting regulations, of our Finance group as of December 31, 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	$	604	$	64	$	427	$	59	$	54
Subordinated debt		299		—		—		—		299
Interest on borrowings		181		22		31		17		111
Total Finance group	$	1,084	$	86	$	458	$	76	$	464

At December 31, 2016, the Finance group also had $79 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 December 31, 2016:

(In millions)				2016		2015		2014
Gross favorable			$	106	$	111	$	132
Gross unfavorable				(23)		(33)		(37)
Net adjustments			$	83	$	78	$	95

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 2016, the assumed expected long-term rate of return on plan assets used in calculating pension expense was 7.58%, compared with 7.57% in 2015. For the last five 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 2016 would have increased pension cost for our domestic plans by approximately $30 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 2016, the weighted-average discount rate used in calculating pension expense was 4.66%, compared with 4.25% in 2015. For our domestic plans, the

assumed discount rate was 4.75% in 2016, compared with 4.25% in 2015. A 50 basis-point decrease in the weighted-average discount rate would have increased pension cost for our domestic plans by approximately $33 million in 2016.

The trend in healthcare costs is difficult to estimate, and it has an important effect on postretirement liabilities. The 2016 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 2016, we assumed a trend rate of 7.25% for both medical and prescription drug healthcare rates and assumed this rate would gradually decline to 5.0% 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.