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

Overview

During 2020, the global pandemic caused by the novel coronavirus, known as “COVID-19”, led to worldwide facility closures, workforce disruptions, supply chain destabilizations, reduced demand for many products and services, volatility in the capital markets and uncertainty in the economic outlook. Our operations experienced and continue to experience various degrees of disruption due to the unprecedented conditions surrounding the pandemic. While some of our commercial manufacturing facilities had temporarily closed during the first quarter of 2020 through the latter part of the second quarter due to reduced demand for certain of our products, substantially all manufacturing activities had resumed in the third quarter. In the second half of the year, our commercial businesses have generally experienced an increase in customer demand compared with the first half of 2020. However, demand has not returned to pre-pandemic levels.

In the first quarter of 2020, following the onset of the pandemic, we strengthened our cash position by issuing $650 million in senior debt and by borrowing $500 million under a new 364-Day Term Loan Credit Agreement. We also temporarily suspended share repurchases and took other measures to reduce costs and conserve cash, including employee furloughs at many of our commercial businesses and at corporate headquarters, reducing capital expenditures and delaying certain research and development projects. In the second quarter, we continued most of the measures taken in the first quarter to reduce costs and conserve cash and initiated a restructuring plan at certain of our businesses to further reduce costs. During the remainder of the year, we continued our focus on managing our businesses through the impacts of the pandemic while investing in future products and technologies. Key financial highlights for 2020 include:

• Generated $833 million of net cash from operating activities from our manufacturing businesses.

• Maintained a strong cash position with $2.3 billion in cash and equivalents at the end of the year.

• Invested $317 million in capital expenditures and $549 million in research and development projects.

• Repurchased 4.1 million shares of our common stock.

While we expect our commercial businesses, which have been adversely impacted by the pandemic, to slowly recover with the broader economic recovery, we cannot reasonably estimate when customer demand for our products and services may return to pre-pandemic levels. There are many uncertainties regarding the pandemic, and we continue to closely monitor the impact of the pandemic on all aspects of our business, including how it is impacting our customers, employees, suppliers, vendors, business partners and distribution channels. See Item 1A. Risk Factors for additional risks and uncertainties related to the pandemic’s impact on our business. The ultimate extent of the effects of the pandemic on the company and our consolidated financial position is uncertain and will depend on future developments, including the length and severity of the pandemic, and such effects could exist for an extended period of time, even after the pandemic ends.

For an overview of our business segments, including a discussion of our major products and services, refer to Item 1. Business. A discussion of our financial condition and operating results for 2020 compared with 2019 is provided below, while a discussion of 2019 compared with 2018 can be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended January 4, 2020. The following discussion should be read in conjunction with our Consolidated Financial Statements and related Notes included in Item 8. Financial Statements and Supplementary Data.

Consolidated Results of Operations

												% Change
(Dollars in millions)			2020			2019			2018			2020			2019
Revenues			$	11,651		$	13,630		$	13,972		(15)%			(2)%
Cost of sales			10,094			11,406			11,594			(12)%			(2)%
Gross margin as a percentage of Manufacturing revenues			13.0%			15.9%			16.6%
Selling and administrative expense			1,045			1,152			1,275			(9)%			(10)%
Interest expense			166			171			166			(3)%			3%

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Revenues

Revenues decreased $2.0 billion, 15%, in 2020, compared with 2019. The revenue decrease included the following factors:

• Textron Aviation revenues were lower by $1.2 billion, largely due to lower Citation jet and commercial turboprop volume of $916 million, reflecting a decline in demand related to the pandemic, and lower aftermarket volume of $337 million, reflecting lower aircraft utilization resulting from the pandemic.

• Industrial revenues were lower by $798 million, largely due to lower volume in the Fuel Systems and Functional Components product line, primarily due to manufacturing facility closures in the first half of 2020, and lower volume and mix in the Specialized Vehicles product line, primarily reflecting a decline in demand related to the pandemic.

• Bell revenues were higher by $55 million, due to higher military revenues of $225 million, largely reflecting spares and logistics support, partially offset by lower commercial revenues.

Cost of Sales and Selling and Administrative Expense

Cost of sales decreased $1.3 billion, 12%, in 2020, compared with 2019, largely due to lower net volume and mix described above. The decrease in cost of sales was partially offset by idle facility costs of $142 million, primarily at the Textron Aviation segment, reflecting unfavorable absorption of manufacturing costs attributable to abnormally low production levels resulting from the pandemic and temporary manufacturing facility closures, and a $55 million inventory charge related to the TRU business discussed in Note 17 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. Gross margin as a percentage of Manufacturing revenues decreased 290 basis points in 2020, compared with 2019, primarily due to lower margin at the Textron Aviation segment reflecting unfavorable impacts from the pandemic, including the idle facility costs and inventory valuation charges.

Selling and administrative expense decreased $107 million, 9%, in 2020, compared with 2019, primarily due to cost reduction activities across our manufacturing segments, principally at the Textron Aviation and Industrial segments.

Special Charges

Special charges of $147 million and $72 million in 2020 and 2019, respectively, primarily include restructuring activities and intangible asset impairment charges as described in Note 17 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.

Income Taxes

			2020			2019			2018
Effective tax rate			(9.6%)			13.5%			11.7%

In 2020, the effective tax rate of (9.6)% was lower than the U.S. federal statutory tax rate of 21%, primarily due to an audit settlement with respect to certain state income tax returns that resulted in a $52 million benefit and the favorable impact of research credits. In 2019, the effective tax rate of 13.5% was lower than the U.S. federal statutory tax rate of 21%, primarily due to $61 million in benefits recognized for additional tax credits related to prior years as a result of the completion of a research and development tax credit analysis.

For a full reconciliation of our effective tax rate to the U.S. federal statutory tax rate, see Note 18 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.

Segment Analysis

We operate in, and report financial information for, the following five business segments: Textron Aviation, Bell, Textron Systems, Industrial and Finance. Segment profit is an important measure used for evaluating performance and for decision-making purposes. Segment profit for the manufacturing segments excludes interest expense, certain corporate expenses, gains/losses on major business dispositions, special charges and an inventory charge related to the 2020 COVID-19 restructuring plan, as discussed in Note 17 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. The measurement for the Finance segment includes interest income and expense along with intercompany interest income and expense. Operating expenses for the Manufacturing segments include cost of sales, selling and administrative expense and other non-service components of net periodic benefit cost/(credit), and exclude certain corporate expenses and special charges.

In our discussion of comparative results for the Manufacturing group, changes in revenues and segment profit for our commercial businesses typically are expressed in terms of volume and mix, pricing, foreign exchange, acquisitions and dispositions, inflation and performance. For revenues, volume and mix represents changes in revenues from increases or decreases in the number of units delivered or services provided and the composition of products and/or services sold. For segment profit, volume and mix represents a change due to the number of units delivered or services provided and the composition of products and/or services

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sold at different profit margins. Pricing represents changes in unit pricing. Foreign exchange is the change resulting from translating foreign-denominated amounts into U.S. dollars at exchange rates that are different from the prior period. Revenues generated by acquired businesses are reflected in Acquisitions for a twelve-month period, while reductions in revenues and segment profit from the sale of businesses are reflected as Dispositions. Inflation represents higher material, wages, benefits, pension service cost or other costs. Performance reflects an increase or decrease in research and development, depreciation, selling and administrative costs, warranty, product liability, quality/scrap, labor efficiency, overhead, non-service pension cost/(credit), product line profitability, start-up, ramp up and cost-reduction initiatives or other manufacturing inputs.

Approximately 30% of our 2020 revenues were derived from contracts with the U.S. Government, including those under the U.S. Government-sponsored foreign military sales program. For our segments that contract with the U.S. Government, changes in revenues related to these contracts are expressed in terms of volume. Changes in segment profit for these contracts are typically expressed in terms of volume and mix and performance; these include cumulative catch-up adjustments associated with a) revisions to the transaction price that may reflect contract modifications or changes in assumptions related to award fees and other variable consideration or b) changes in the total estimated costs at completion due to improved or deteriorated operating performance.

Textron Aviation

												% Change
(Dollars in millions)			2020			2019			2018			2020			2019
Revenues:
Aircraft			$	2,714		$	3,592		$	3,435		(24)%			5%
Aftermarket parts and services			1,260			1,595			1,536			(21)%			4%
Total revenues			3,974			5,187			4,971			(23)%			4%
Operating expenses			3,958			4,738			4,526			(16)%			5%
Segment profit			16			449			445			(96)%			1%
Profit margin			0.4%			8.7%			9.0%
Backlog			$	1,603		$	1,714		$	1,791		(6)%			(4)%

Textron Aviation Revenues and Operating Expenses

Factors contributing to the 2020 year-over-year revenue change are provided below:

(In millions)			2020 versus 2019
Volume and mix			$	(1,218)
Pricing			5
Total change			$	(1,213)

Textron Aviation’s revenues decreased $1.2 billion, 23%, in 2020, compared with 2019, largely due to lower Citation jet volume of $688 million and lower commercial turboprop volume of $228 million, reflecting a decline in demand related to the pandemic, and lower aftermarket volume of $337 million, reflecting lower aircraft utilization resulting from the pandemic. We delivered 132 Citation jets and 113 commercial turboprops in 2020, compared with 206 Citation jets and 176 commercial turboprops in 2019.

Textron Aviation’s operating expenses decreased $780 million, 16%, in 2020, compared with 2019, largely due to lower volume and mix described above. A favorable impact from cost reduction activities, including employee furloughs and other actions, was more than offset by $115 million of idle facility costs recognized in the period and higher inventory valuation charges of $60 million, largely resulting from the pandemic. Idle facility costs reflect unfavorable absorption of manufacturing costs attributable to abnormally low production levels resulting from the pandemic and temporary manufacturing facility closures.

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Textron Aviation Segment Profit

Factors contributing to 2020 year-over-year segment profit change are provided below:

(In millions)			2020 versus 2019
Volume and mix			$	(347)
Inflation and pricing			(45)
Performance			(41)
Total change			$	(433)

Textron Aviation’s segment profit decreased $433 million, in 2020, compared with 2019, due to the impact from lower volume and mix described above. Performance includes $115 million of idle facility costs, described above, and higher inventory valuation charges of $60 million, largely resulting from the pandemic, partially offset by a favorable impact from cost reduction activities described above.

Bell

												% Change
(Dollars in millions)			2020			2019			2018			2020			2019
Revenues:
Military aircraft and support programs			$	2,213		$	1,988		$	2,030		11%			(2)%
Commercial helicopters, parts and services			1,096			1,266			1,150			(13)%			10%
Total revenues			3,309			3,254			3,180			2%			2%
Operating expenses			2,847			2,819			2,755			1%			2%
Segment profit			462			435			425			6%			2%
Profit margin			14.0%			13.4%			13.4%
Backlog			$	5,342		$	6,902		$	5,837		(23)%			18%

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 and support stage and represent a significant portion of Bell’s revenues from the U.S. Government.

Bell Revenues and Operating Expenses

Factors contributing to the 2020 year-over-year revenue change are provided below:

(In millions)			2020 versus 2019
Volume and mix			$	41
Other			14
Total change			$	55

Bell’s revenues increased $55 million, 2%, in 2020, compared with 2019, due to higher military revenues of $225 million, largely reflecting spares and logistics support, partially offset by lower commercial revenues. We delivered 140 commercial helicopters in 2020, compared with 201 commercial helicopters in 2019.

Bell’s operating expenses increased $28 million, 1%, in 2020, compared with 2019, primarily due to higher net volume and mix as described above.

Bell Segment Profit

Factors contributing to 2020 year-over-year segment profit change are provided below:

(In millions)			2020 versus 2019
Volume and mix			$	16
Performance and other			11
Total change			$	27

Bell’s segment profit increased $27 million, 6%, in 2020, compared with 2019, primarily due to the impact from higher volume and mix described above, and a favorable impact from performance and other of $11 million. Performance and other includes

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lower research and development and selling and administrative costs, partially offset by $25 million in lower net favorable program adjustments.

Bell Backlog

Bell’s backlog decreased $1.6 billion, 23%, in 2020, primarily as a result of revenues recognized on our U.S. Government contracts in excess of new contracts received.

Textron Systems

												% Change
(Dollars in millions)			2020			2019			2018			2020			2019
Revenues			$	1,313		$	1,325		$	1,464		(1)%			(9)%
Operating expenses			1,161			1,184			1,308			(2)%			(9)%
Segment profit			152			141			156			8%			(10)%
Profit margin			11.6%			10.6%			10.7%
Backlog			$	2,556		$	1,211		$	1,469		111%			(18)%

Textron Systems Revenues and Operating Expenses

Factors contributing to the 2020 year-over-year revenue change are provided below:

(In millions)			2020 versus 2019
Volume			$	(16)
Other			4
Total change			$	(12)

Revenues at Textron Systems decreased $12 million in 2020, compared with 2019, primarily due to lower volume of $36 million in the Simulation, Training and Other product line and $29 million in the Marine and Land Systems product line, partially offset by higher volume of $49 million in the Unmanned Systems product line. Within the Simulation, Training and Other product line, lower volume of $107 million in the TRU Simulation + Training business, largely due to a decline in demand and order cancellations related to the pandemic, was largely offset by higher volumes at other businesses included in this product line.

Textron Systems’ operating expenses decreased $23 million, 2%, in 2020, compared with 2019, primarily due to lower net volume described above.

Textron Systems Segment Profit

Factors contributing to 2020 year-over-year segment profit change are provided below:

(In millions)			2020 versus 2019
Volume and mix			$	13
Performance and other			(2)
Total change			$	11

Textron Systems’ segment profit increased $11 million, 8%, in 2020, compared with 2019, primarily due to favorable product mix. Performance and other includes the impact of an $18 million gain recognized in the second quarter of 2019 related to our contribution of assets to a training business formed with FlightSafety International, Inc.

Textron Systems Backlog

Backlog at Textron Systems’ increased $1.3 billion in 2020, primarily due to new contracts received in excess of revenues recognized across all product lines.

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Industrial

												% Change
(Dollars in millions)			2020			2019			2018			2020			2019
Revenues:
Fuel Systems and Functional Components			$	1,751		$	2,237		$	2,352		(22)%			(5)%
Specialized Vehicles			1,249			1,561			1,691			(20)%			(8)%
Tools and Test Equipment			—			—			248			—%			(100)%
Total revenues			3,000			3,798			4,291			(21)%			(11)%
Operating expenses			2,889			3,581			4,073			(19)%			(12)%
Segment profit			111			217			218			(49)%			—%
Profit margin			3.7%			5.7%			5.1%

Industrial Revenues and Operating Expenses

Factors contributing to the 2020 year-over-year revenue change are provided below:

(In millions)			2020 versus 2019
Volume and mix			$	(817)
Foreign exchange			7
Other			12
Total change			$	(798)

Industrial segment revenues decreased $798 million, 21%, in 2020, compared with 2019, largely due to lower volume and mix, in both product lines. Lower volume in the Fuel Systems and Functional Components product line was primarily related to manufacturing facility closures in the first half of 2020 as a result of the pandemic. As our OEM customers reopened and resumed production, all of our manufacturing facilities had reopened by the end of the second quarter. In the Specialized Vehicles product line, lower volume and mix was primarily related to reduced demand in the ground support equipment business, which has been impacted by the reduction in global air travel, as well as reduced demand in certain consumer and commercial markets that have been impacted by the pandemic.

Operating expenses for the Industrial segment decreased $692 million, 19%, in 2020 compared with 2019, primarily due to lower volume and mix described above.

Industrial Segment Profit

Factors contributing to 2020 year-over-year segment profit change are provided below:

(In millions)			2020 versus 2019
Volume and mix			$	(195)
Performance			61
Pricing and inflation			26
Foreign exchange			2
Total change			$	(106)

Segment profit for the Industrial segment decreased $106 million in 2020, compared with 2019, largely resulting from lower volume and mix described above, partially offset by favorable performance of $61 million. Performance includes the impact from cost reduction activities, partially offset by idle facility costs of $27 million recognized in 2020, reflecting unfavorable absorption of manufacturing costs attributable to abnormally low production levels resulting from the pandemic and temporary manufacturing facility closures.

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Finance

(In millions)			2020			2019			2018
Revenues			$	55		$	66		$	66
Segment profit			10			28			23

Finance segment revenues decreased $11 million in 2020, compared with 2019, and segment profit decreased $18 million in 2020, compared with 2019, primarily due to higher provision for loan losses. The following table reflects information about the Finance segment’s credit performance related to finance receivables.

(Dollars in millions)			January 2, 2021			January 4, 2020
Finance receivables			$	779		$	707
Allowance for credit losses			35			25
Ratio of allowance for credit losses to finance receivables			4.49%			3.54%
Nonaccrual finance receivables			93			39
Ratio of nonaccrual finance receivables to finance receivables			11.94%			5.52%
60+ days contractual delinquency			29			17
60+ days contractual delinquency as a percentage of finance receivables			3.72%			2.40%

The Finance segment has provided temporary payment relief through loan modifications at the request of certain customers and continues to work with certain customers to provide extended payment relief as needed. If the current economic conditions continue to persist or worsen, we may experience increased customer delinquencies, however, we believe our allowance for credit losses adequately covers our exposure on these loans as our estimated collateral values largely exceed the outstanding loan amounts. Loan modifications and key portfolio quality indicators are discussed in Note 4 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.

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, 2021			January 4, 2020
Manufacturing group
Cash and equivalents			$	2,146		$	1,181
Debt			3,707			3,124
Shareholders’ equity			5,845			5,518
Capital (debt plus shareholders’ equity)			9,552			8,642
Net debt (net of cash and equivalents) to capital			21%			26%
Debt to capital			39%			36%
Finance group
Cash and equivalents			$	108		$	176
Debt			662			686

The unprecedented conditions surrounding the COVID-19 pandemic led to volatility in the capital markets and uncertainty in the economic outlook, in addition to causing various degrees of disruption in our operations. In light of these conditions, we have strengthened our cash position since the onset of the pandemic by taking various measures to reduce costs and conserve cash, and by increasing our borrowings as discussed below. Given our strengthened liquidity position and stabilization of the capital markets in the second half of 2020, we reactivated our share repurchase plan in the fourth quarter. We believe that we will have

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sufficient cash to meet our needs based on our existing cash balances, the cash we expect to generate from our manufacturing operations and the availability of our existing credit facility.

Credit Facilities and Other Sources of Capital

Textron has a senior unsecured revolving credit facility for an aggregate principal amount of Textron has a senior unsecured revolving credit facility for an aggregate principal amount of $1.0 billion, of which up to $100 million is available for the issuance of letters of credit. We may elect to increase the aggregate amount of commitments under the facility to up to $1.3 billion by designating an additional lender or by an existing lender agreeing to increase its commitment. The facility expires in October 2024, subject to up to two one-year extensions at our option with the consent of lenders representing a majority of the commitments under the facility. At January 2, 2021 and January 4, 2020, there were no amounts borrowed against the facility and there were $9 million and $10 million, respectively, of outstanding letters of credit issued under the facility.

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 2020, we issued $650 million in SEC-registered fixed-rate notes due June 2030, with an annual interest rate of 3.00%. In August 2020, we issued $500 million of SEC-registered fixed-rate notes due March 2031 with an annual interest rate of 2.45%, the proceeds of which were used to repay $500 million of outstanding borrowings under a new 364-Day Term Loan Credit Agreement entered into in April 2020.

In September 2020, the Finance Group’s $150 million variable-rate loan due December 2020 was amended to extend its maturity date to September 2021, with an option to extend for an additional year. The annual interest rate was modified from the London interbank offered rate (LIBOR) plus 1.125% to LIBOR plus 1.55%, which is an annual interest rate of 1.70% at January 2, 2021.

Manufacturing Group Cash Flows

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

(In millions)			2020			2019			2018
Operating activities			$	833		$	960		$	1,127
Investing activities			(277)			(329)			539
Financing activities			393			(439)			(1,738)

Cash flows from operating activities were $833 million in 2020 compared with $960 million in 2019, a decrease of $127 million. The change in cash flows primarily reflected an $893 million year over year increase in cash used to settle accounts payable, principally at the Textron Aviation segment, and lower earnings, partially offset by a $753 million reduction in cash used for inventories, primarily at the Textron Aviation segment, a $299 million increase in cash flows from contract assets/liabilities, primarily at the Bell segment, and other favorable improvements in working capital accounts.

Net tax payments were $34 million and $120 million in 2020 and 2019, respectively. Pension contributions were $47 million and $51 million in 2020 and 2019, respectively.

In 2020 and 2019, investing cash flows included capital expenditures of $317 million and $339 million, respectively. Cash flows provided by financing activities in 2020 primarily included $1.1 billion of net proceeds from the issuance of long-term debt and $377 million of proceeds from borrowings against corporate-owned life insurance policies. These cash inflows were partially offset by $548 million of payments on long-term debt, $377 million of payments on borrowings against corporate-owned life insurance policies, and $183 million of cash paid to repurchase an aggregate of 4.1 million shares of our common stock under both a prior 2018 share repurchase plan and a 2020 share repurchase plan described below. In 2019, cash flows used in financing activities primarily included $503 million of cash paid to repurchase an aggregate of 10.0 million shares of our outstanding common stock under a 2018 share repurchase authorization and $252 million of payments on long-term debt, partially offset by net proceeds of $301 million from the issuance of long-term debt.

On February 25, 2020, our Board of Directors authorized the repurchase of up to 25 million shares of our common stock. This plan allows us to opportunistically repurchase shares and to continue our practice of repurchasing shares to offset the impact of dilution from shares issued under compensation and benefit plans. The 2020 plan has no expiration date and replaced the prior 2018 share repurchase authorization.

Dividend payments to shareholders totaled $18 million in both 2020 and 2019. In 2019, dividends of $50 million received from the Finance group are included within cash flows from operating activities for the Manufacturing group as they represent a return on investment.

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Finance Group Cash Flows

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

(In millions)			2020			2019			2018
Operating activities			$	13		$	34		$	14
Investing activities			(48)			135			99
Financing activities			(33)			(113)			(176)

The Finance group’s cash flows from operating activities were $13 million in 2020, compared with $34 million in 2019, a decrease of $21 million, primarily reflecting higher net tax payments and lower earnings. Cash flows from investing activities primarily included collections on finance receivables totaling $128 million and $277 million in 2020 and 2019, respectively, partially offset by finance receivable originations of $195 million and $184 million, respectively.

Cash flows used in financing activities included payments on long-term and nonrecourse debt of $45 million and $51 million in 2020 and 2019, respectively. Dividend payments to the Manufacturing group totaled $50 million in 2019.

Consolidated Cash Flows

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

(In millions)			2020			2019			2018
Operating activities			$	769		$	1,016		$	1,109
Investing activities			(248)			(266)			620
Financing activities			360			(502)			(1,864)

Consolidated cash flows from operating activities were $769 million in 2020, compared with $1.0 billion in 2019, a decrease of $247 million. The change in cash flows primarily reflected an $893 million year over year increase in cash used to settle accounts payable, principally at the Textron Aviation segment, lower earnings, and a $134 million net cash outflow from captive finance receivables, partially offset by a $726 million reduction in cash used for inventories, primarily at the Textron Aviation segment, a $299 million increase in cash flows from contract assets/liabilities, primarily at the Bell segment, and other favorable improvements in working capital accounts.

Net tax payments were $42 million and $121 million in 2020 and 2019, respectively. Pension contributions were $47 million and $51 million in 2020 and 2019, respectively.

In 2020 and 2019, investing cash flows included capital expenditures of $317 million and $339 million, respectively. Cash flows provided by financing activities in 2020 primarily included $1.1 billion of net proceeds from the issuance of long-term debt and $377 million from borrowings against corporate-owned life insurance policies. These cash inflows were partially offset by $593 million of payments on outstanding debt, $377 million of payments on borrowings against corporate-owned life insurance policies, and $183 million of share repurchases. In 2019, cash flows used in financing activities primarily included $503 million of share repurchases and $303 million of payments on outstanding debt, partially offset by $301 million of proceeds from the issuance of long-term debt.

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.

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

(In millions)			2020			2019			2018
Reclassification adjustments from investing activities:
Finance receivable originations for Manufacturing group inventory sales			$	(195)		$	(184)		$	(177)
Cash received from customers			106			229			199
Other			12			27			(4)
Total reclassification adjustments from investing activities			(77)			72			18
Reclassification adjustments from financing activities:
Dividends received by Manufacturing group from Finance group			—			(50)			(50)
Total reclassification adjustments to cash flow from operating activities			$	(77)		$	22		$	(32)

Under a Support Agreement between Textron and TFC, Textron is required to maintain a controlling interest in TFC. The agreement, as amended in December 2015, also requires Textron to ensure that TFC maintains fixed charge coverage of no less than 125% and consolidated shareholders' equity of no less than $125 million. There were no cash contributions required to be paid to TFC in 2020 and 2019 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, 2021:

						Payments Due by Period
(In millions)			Total			Year 1			Years 2-3			Years 4-5			More Than 5 Years
Debt			$	3,731		$	509		$	16		$	718		$	2,488
Purchase obligations not reflected in balance sheet			3,103			2,284			774			45			—
Interest on borrowings			819			134			225			194			266
Operating leases			456			59			97			68			232
Pension benefits for unfunded plans			440			28			54			50			308
Postretirement benefits other than pensions			230			23			42			36			129
Other long-term liabilities			293			63			104			30			96
Total Manufacturing group			$	9,072		$	3,100		$	1,312		$	1,141		$	3,519

Pension and Postretirement Benefits

We maintain defined benefit pension plans and postretirement benefit plans other than pensions as described in Note 16 to the Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. 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 2021, we expect to make approximately $22 million of contributions to our funded pension plans. Based on our current assumptions, which may vary with changes in market conditions, our current contribution for each of the years from 2022 through 2025 is estimated to be approximately $51 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 reserves for product liability, warranty, product maintenance and litigation, 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 42% of the purchase obligations we

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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, 2021:

						Payments Due by Period
(In millions)			Total			Year 1			Years 2-3			Years 4-5			More Than 5 Years
Term debt			$	368		$	13		$	332		$	20		$	3
Subordinated debt			294			—			—			—			294
Interest on borrowings			140			15			19			12			94
Total Finance group			$	802		$	28		$	351		$	32		$	391

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 in Item 8. Financial Statements and Supplementary Data, which includes other significant accounting policies.

Revenue Recognition

A substantial portion of our revenues is related to long-term contracts with the U.S. Government, including those under the U.S. Government-sponsored foreign military sales program, for the design, development, manufacture or modification of aerospace and defense products as well as related parts and services. We generally use the cost-to-cost method to measure progress for these contracts because it best depicts the transfer of control to the customer that occurs as we incur costs on our contracts. Under this measure, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the estimated costs at completion of the performance obligation, and revenue is recorded proportionally as costs are incurred.

Approximately 75% of our 2020 revenues with the U.S. Government were under fixed-price and fixed-price incentive contracts. To the extent our actual costs vary from the estimates upon which the price was negotiated, we will generate more or less profit and could potentially incur a loss.

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

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

At the outset of each contract, we estimate an initial profit booking rate considering the risks surrounding our ability to achieve the technical requirements (e.g., a newly-developed product versus a mature product), schedule (e.g., the number and type of milestone events), and costs by contract requirements in the initial estimated costs at completion. Profit booking rates may

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increase during the performance of the contract if we successfully retire risks surrounding the technical, schedule, and cost aspects of the contract. Conversely, the profit booking rate may decrease if we are not successful in retiring the risks; and, as a result, our estimated costs at completion increase. All estimates are subject to change during the performance of the contract and, therefore, may affect the profit booking rate.

Changes in our estimate of the total expected cost or in the transaction price for a contract typically impact our profit booking rate. We utilize the cumulative catch-up method of accounting to recognize the impact of these changes on our profit booking rate for a contract. Under this method, the inception-to-date impact of a profit adjustment on a contract is recognized in the period the adjustment is identified. The impact of our cumulative catch-up adjustments on segment profit recognized in prior periods is presented below:

(In millions)			2020			2019			2018
Gross favorable			$	148		$	173		$	249
Gross unfavorable			(76)			(82)			(53)
Net adjustments			$	72		$	91		$	196

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

Goodwill

We evaluate the recoverability of goodwill annually in the fourth quarter or more frequently if events or changes in circumstances, such as declines in sales, earnings or cash flows, or material adverse changes in the business climate, indicate a potential impairment of a reporting unit. A 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 using discounted cash flows. These cash flows incorporate assumptions for 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 characteristics to the reporting unit being assessed. The revenue growth rates and operating margins are based on our strategic plans and long-range planning forecasts. The long-term revenue 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. The discount rates utilized in this analysis are based on each reporting unit’s weighted average cost of capital, which takes into account the relative weights of each component of capital structure (equity and debt) and represents the expected cost of new capital, adjusted as appropriate to consider the risk inherent in future cash flows of the respective 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, an impairment loss is recognized in an amount equal to that excess carrying value over the estimated fair value amount. Based on our annual impairment review, the fair value of all of our reporting units exceeded their carrying values, and we do not believe that there is a reasonable possibility that any units might fail the impairment test in the foreseeable future.

Retirement Benefits

We sponsor funded and unfunded domestic and international pension and postretirement plans for certain of our employees. Beginning on January 1, 2010, we initiated actions to commence the closure of the pension plans to new entrants. We provide employees hired subsequent to these closures with defined contribution benefits. Our pension and postretirement benefit obligations are calculated based on actuarial valuations. Key assumptions used in determining these obligations and related expenses or benefits include the 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.

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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 2020 and 2019, the assumed expected long-term rate of return on plan assets used in calculating pension expense was 7.55%. For 2020, the assumed rate of return for our domestic plans, which represent approximately 90% of our total pension assets, was 7.75%. For 2021, to reflect the impact of current expectations of long-term market conditions on certain investment returns, we have assumed a long-term rate of return for our domestic plans of 7.25%. The change in this assumption will increase pension cost for our domestic plans by approximately $35 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 2020, the weighted-average discount rate used in calculating pension expense was 3.36%, compared with 4.24% in 2019. For our domestic plans, the assumed discount rate was 3.45% in 2020, compared with 4.35% in 2019. A decrease of 50 basis-points in this weighted-average discount rate in 2020 would have increased pension cost for our domestic plans by approximately $64 million.

Actuarial gains and losses, representing differences between the assumptions utilized to develop estimated obligations and actual results or experience, that exceed 10% of the higher of the market related value of assets or the benefit obligation in a year, are initially recognized as a component of accumulated other comprehensive income (loss) and amortized over future years as a component of our annual benefit cost. We amortize actuarial differences over the average remaining service period of eligible employees. If all or almost all of a plan’s participants are inactive or are not accruing additional benefits, we amortize these differences over the average remaining life expectancy of the plan participants. As of the end of 2020, almost all of the participants in one of our domestic plans, the Textron Master Retirement Plan (TMRP), are no longer active. Beginning in 2021, actuarial gains and losses for this plan will be amortized over the remaining life expectancy of the participants. A change in the TMRP amortization period in 2021 from 7 years to 20 years will reduce pension cost by approximately $85 million. The deferral of these differences reduces the volatility of our annual benefit cost that can result either from year-to-year changes in the assumptions or from actual results that are not necessarily representative of the long-term financial position of these plans.

The trend in healthcare costs is difficult to estimate and has an important effect on postretirement liabilities. The 2020 medical and prescription drug cost trend rates represent the weighted-average annual projected rate of increase in the per capita cost of covered benefits. In 2020, we assumed a trend rate of 7% for both medical and prescription drug cost and assumed this rate would gradually decline to 5% by 2024 and then remain at that level.