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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL QUARTER ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27559
------------------------
TEXTRON FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<Table>
DELAWARE 05-6008768
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</Table>
40 WESTMINSTER STREET, P.O. BOX 6687, PROVIDENCE, R.I. 02940-6687
(401) 621-4200
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
All of the shares of common stock of the registrant are owned by Textron
Inc.
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TEXTRON FINANCIAL CORPORATION
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Income for the three
and six months ended June 30, 2003 and 2002
(unaudited)............................................ 2
Condensed Consolidated Balance Sheets at June 30, 2003 and
December 28, 2002 (unaudited).......................... 3
Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2003 and 2002 (unaudited).... 4
Condensed Consolidated Statements of Changes in
Shareholder's Equity through June 30, 2003
(unaudited)............................................ 5
Notes to Condensed Consolidated Financial Statements
(unaudited)............................................ 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................. 15
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK......................................... 23
Item 4. CONTROLS AND PROCEDURES............................. 23
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.................... 24
</Table>
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TEXTRON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2003 2002 2003 2002
-------- -------- -------- --------
(IN THOUSANDS)
REVENUES
Finance charges and discounts.................... $116,851 $105,488 $228,167 $210,633
Rental revenues on operating leases.............. 6,306 7,141 14,019 14,205
Other income..................................... 31,976 36,393 63,675 68,260
-------- -------- -------- --------
155,133 149,022 305,861 293,098
EXPENSES
Interest......................................... 47,205 48,858 92,499 95,156
Selling and administrative....................... 46,472 42,549 93,756 83,525
Provision for losses............................. 31,184 25,011 60,921 55,386
Depreciation of equipment on operating leases.... 3,757 3,419 8,295 6,964
-------- -------- -------- --------
128,618 119,837 255,471 241,031
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES, DISTRIBUTIONS ON
PREFERRED SECURITIES AND CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE................... 26,515 29,185 50,390 52,067
Income taxes....................................... 9,082 10,281 17,046 18,630
Distributions on preferred securities (net of tax
benefits of $184, $190, $368 and $391,
respectively).................................... 384 368 748 725
-------- -------- -------- --------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE............................. 17,049 18,536 32,596 32,712
Cumulative effect of change in accounting principle
(net of tax benefit of $8,278)................... -- -- -- 15,372
-------- -------- -------- --------
NET INCOME......................................... $ 17,049 $ 18,536 $ 32,596 $ 17,340
======== ======== ======== ========
</Table>
See notes to condensed consolidated financial statements (unaudited).
2
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<Table>
<Caption>
JUNE 30, DECEMBER 28,
2003 2002
---------- ------------
(DOLLARS IN THOUSANDS)
ASSETS
Cash and equivalents........................................ $ 45,635 $ 21,287
Finance receivables, net of unearned income:
Installment contracts..................................... 1,745,573 1,827,797
Revolving loans........................................... 1,700,865 1,366,064
Golf course and resort mortgages.......................... 951,552 962,459
Distribution finance receivables.......................... 843,757 792,323
Leveraged leases.......................................... 463,234 460,163
Finance leases............................................ 314,102 346,844
---------- ----------
Total finance receivables......................... 6,019,083 5,755,650
Allowance for losses on receivables....................... (165,072) (166,510)
---------- ----------
Finance receivables -- net........................ 5,854,011 5,589,140
Equipment on operating leases -- net........................ 221,862 255,055
Goodwill.................................................... 180,843 180,843
Other assets................................................ 698,204 608,003
---------- ----------
Total assets...................................... $7,000,555 $6,654,328
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
LIABILITIES
Accrued interest and other liabilities...................... $ 478,731 $ 345,270
Amounts due to Textron Inc.................................. 22,793 23,471
Deferred income taxes....................................... 434,298 398,199
Debt........................................................ 4,994,446 4,839,621
---------- ----------
Total liabilities................................. 5,930,268 5,606,561
Textron Financial and Litchfield obligated mandatory
redeemable preferred securities of trust subsidiary
holding solely Litchfield junior subordinated
debentures................................................ 26,685 26,950
SHAREHOLDER'S EQUITY
Common stock ($100 par value, 4,000 shares authorized; 2,500
shares issued and outstanding)............................ 250 250
Capital surplus............................................. 573,676 573,676
Investment in parent company preferred stock................ (25,000) (25,000)
Accumulated other comprehensive income (loss)............... 10,552 (14,637)
Retained earnings........................................... 484,124 486,528
---------- ----------
Total shareholder's equity........................ 1,043,602 1,020,817
---------- ----------
Total liabilities and shareholder's equity........ $7,000,555 $6,654,328
========== ==========
</Table>
See notes to condensed consolidated financial statements (unaudited).
3
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(UNAUDITED)
<Table>
<Caption>
2003 2002
----------- -----------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income before cumulative effect of change in accounting
principle................................................. $ 32,596 $ 32,712
Adjustments to reconcile income to net cash provided by
operating activities:
Provision for losses...................................... 60,921 55,386
Deferred income tax provision............................. 22,232 25,765
Depreciation.............................................. 16,436 14,338
Increase (decrease) in accrued interest and other
liabilities............................................ 6,053 (44,431)
Amortization.............................................. 5,190 4,942
Noncash gains on securitizations.......................... (5,381) (19,238)
Other..................................................... (3,811) 5,324
----------- -----------
Net cash provided by operating activities......... 134,236 74,798
CASH FLOWS FROM INVESTING ACTIVITIES:
Finance receivables originated or purchased................. (4,614,766) (4,300,740)
Finance receivables repaid.................................. 4,002,420 3,632,522
Proceeds from receivable sales, including securitizations... 449,788 355,633
Proceeds from disposition of operating leases and other
assets.................................................... 48,605 32,677
Purchase of assets for operating leases..................... (28,324) (31,294)
Proceeds from sale of repossessed assets and real estate
owned..................................................... 21,788 3,594
Other capital expenditures.................................. (9,259) (12,616)
Other investments........................................... 50,561 20,727
----------- -----------
Net cash used in investing activities............. (79,187) (299,497)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt.................... 814,393 1,294,829
Principal payments on long-term debt........................ (460,180) (737,900)
Net (decrease) increase in commercial paper................. (320,253) 319,863
Net increase (decrease) in other short-term debt............ 14,826 (546,841)
Principal payments on nonrecourse debt...................... (44,481) (43,624)
Net decrease in amounts due to Textron Inc.................. (66) (5,065)
Capital contributions from Textron Inc...................... 4,505 4,505
Dividends paid to Textron Inc. ............................. (39,505) (57,505)
----------- -----------
Net cash (used in) provided by financing
activities...................................... (30,761) 228,262
Effect of exchange rate changes on cash..................... 60 (1,477)
----------- -----------
NET INCREASE IN CASH........................................ 24,348 2,086
Cash and equivalents at beginning of period................. 21,287 18,489
----------- -----------
Cash and equivalents at end of period....................... $ 45,635 $ 20,575
=========== ===========
</Table>
See notes to condensed consolidated financial statements (unaudited).
4
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
(UNAUDITED)
<Table>
<Caption>
INVESTMENT ACCUMULATED
IN PARENT OTHER
COMMON CAPITAL COMPANY COMPREHENSIVE RETAINED
STOCK SURPLUS PREF. STOCK INCOME (LOSS) EARNINGS TOTAL
------ -------- ----------- ------------- -------- ----------
BALANCE DECEMBER 29,
2001.................... $250 $573,676 $(25,000) $(18,793) $479,222 $1,009,355
Comprehensive income:
Net income.............. -- -- -- -- 60,306 60,306
Other comprehensive
income, net of income
taxes:
Unrealized net gains
on interest-only
securities......... -- -- -- 9,601 -- 9,601
Unrealized net losses
on hedge
contracts.......... -- -- -- (1,893) -- (1,893)
Foreign currency
translation
adjustments........ -- -- -- (3,552) -- (3,552)
-------- ----------
Other comprehensive
income............... -- -- -- 4,156 -- 4,156
----------
Comprehensive income...... -- -- -- -- -- 64,462
Capital contributions from
Textron Inc............. -- 9,010 -- -- -- 9,010
Dividends to Textron
Inc. ................... -- (9,010) -- -- (53,000) (62,010)
---- -------- -------- -------- -------- ----------
BALANCE DECEMBER 28,
2002.................... 250 573,676 (25,000) (14,637) 486,528 1,020,817
Comprehensive income:
Net income.............. -- -- -- -- 32,596 32,596
Other comprehensive
income, net of income
taxes:
Unrealized net gains
on interest-only
securities......... -- -- -- 13,357 -- 13,357
Unrealized net gains
on hedge
contracts.......... -- -- -- 11,166 -- 11,166
Foreign currency
translation
adjustments........ -- -- -- 666 -- 666
-------- ----------
Other comprehensive
income............... -- -- -- 25,189 -- 25,189
----------
Comprehensive income...... -- -- -- -- -- 57,785
Capital contributions from
Textron Inc............. -- 4,505 -- -- -- 4,505
Dividends to Textron
Inc. ................... -- (4,505) -- -- (35,000) (39,505)
---- -------- -------- -------- -------- ----------
BALANCE JUNE 30, 2003..... $250 $573,676 $(25,000) $ 10,552 $484,124 $1,043,602
==== ======== ======== ======== ======== ==========
</Table>
See notes to condensed consolidated financial statements (unaudited).
5
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The financial statements should be read in conjunction with the financial
statements included in Textron Financial Corporation's Annual Report on Form
10-K for the year ended December 28, 2002. The accompanying unaudited
consolidated financial statements include the accounts of Textron Financial
Corporation (Textron Financial or the Company) and its subsidiaries. All
significant intercompany transactions are eliminated. The consolidated financial
statements are unaudited and reflect all adjustments (consisting only of normal
recurring adjustments) which are, in the opinion of management, necessary for a
fair presentation of Textron Financial's consolidated financial position at June
30, 2003 and December 28, 2002, and its consolidated results of operations and
cash flows for each of the respective three- and six-month periods ended June
30, 2003 and 2002. The results of operations for the interim periods are not
necessarily indicative of the results to be expected for the full year. Certain
prior balances have been reclassified to conform to the current presentation.
NOTE 2. OTHER INCOME
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------- -------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2003 2002 2003 2002
-------- -------- -------- --------
(IN THOUSANDS)
Securitization gains................... $11,122 $11,643 $15,868 $19,238
Servicing fees......................... 8,047 6,982 15,471 12,498
Investment income...................... 1,957 5,920 6,695 10,385
Prepayment gains....................... 3,312 3,157 6,025 4,868
Late charges........................... 2,231 2,743 4,483 5,018
Syndication gains...................... 1,217 2,423 2,137 3,918
Other.................................. 4,090 3,525 12,996 12,335
------- ------- ------- -------
Total other income........... $31,976 $36,393 $63,675 $68,260
======= ======= ======= =======
</Table>
The Other component of Other income includes custodial fees, commitment
fees, residual gains, insurance fees and other miscellaneous fees, which are
primarily recognized as income when received.
NOTE 3. ALLOWANCE FOR LOSSES ON RECEIVABLES
<Table>
<Caption>
SIX MONTHS TWELVE MONTHS
ENDED ENDED
JUNE 30, DECEMBER 28,
2003 2002
---------- -------------
(IN THOUSANDS)
Balance at beginning of period...................... $166,510 $143,756
Provision for losses................................ 60,921 138,542
Receivable charge-offs.............................. (68,662) (138,862)
Recoveries.......................................... 6,303 10,971
Acquisitions and other.............................. -- 12,103
-------- --------
Balance at end of period............................ $165,072 $166,510
======== ========
</Table>
NOTE 4. MANAGED AND SERVICED FINANCE RECEIVABLES
Textron Financial manages finance receivables for a variety of investors,
participants and third-party portfolio owners.
6
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
<Table>
<Caption>
JUNE 30, DECEMBER 28,
2003 2002
----------- ------------
(IN THOUSANDS)
Total managed and serviced finance receivables..... $ 9,851,838 $ 9,395,778
Third-party portfolio servicing.................... (711,520) (515,546)
Nonrecourse participations......................... (582,425) (435,393)
SBA sales agreements............................... (51,961) (55,913)
----------- -----------
Total managed finance receivables.................. 8,505,932 8,388,926
Securitized receivables............................ (2,486,849) (2,633,276)
----------- -----------
Owned finance receivables........................ $ 6,019,083 $ 5,755,650
=========== ===========
</Table>
Nonrecourse participations consist of undivided interests in loans
originated by Textron Financial, primarily in vacation interval resorts and golf
finance, which are sold to independent investors.
Third-party portfolio servicing largely relates to finance receivable
portfolios of resort developers, third-party securitization servicing, as well
as private label bank and leasing company portfolio servicing.
Owned receivables include approximately $85 million of finance receivables
that were unfunded at June 30, 2003, primarily as a result of holdback
arrangements. The corresponding liability is included in Accrued interest and
other liabilities on Textron Financial's Condensed Consolidated Balance Sheets.
NOTE 5. LOAN IMPAIRMENT
Textron Financial periodically evaluates finance receivables, excluding
homogeneous loan portfolios and finance leases, for impairment. A loan is
considered impaired when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement. Impairment is measured by comparing the fair value of a loan to its
carrying cost. Fair value is based on the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's observable
market price or, if the loan is collaterally dependent, at the fair value of the
collateral. If the fair value of the loan is less than its carrying amount, the
Company establishes a reserve based on this difference. This evaluation is
inherently subjective, as it requires estimates, including the amount and timing
of future cash flows expected to be received on impaired loans, that may differ
from actual results.
The Company suspends the accrual of interest income for accounts that are
contractually delinquent by more than three months, unless collection is not
doubtful. In addition, detailed reviews of loans may result in earlier
suspension if collection is doubtful. Cash payments on nonaccrual accounts,
including finance charges, generally are applied to reduce principal. The
Company had $199.3 million of nonaccrual finance receivables at June 30, 2003,
compared to $181.6 million at December 28, 2002. Nonaccrual finance receivables
resulted in Textron Financial's revenues being reduced by approximately $8.9
million and $7.4 million for the first six months of 2003 and 2002,
respectively. No interest income was recognized using the cash basis method.
Excluding homogeneous loan portfolios and finance leases, the Company had
impaired loans of $145.1 million and $122.1 million at June 30, 2003 and
December 28, 2002, respectively. Impaired loans with identified reserve
requirements were $89.8 million and $109.9 million at June 30, 2003 and December
28, 2002, respectively. The allowance for losses on receivables related to
impaired loans with identified reserve requirements was $39.8 million and $32.7
million at June 30, 2003 and December 28, 2002, respectively. The average
recorded investment in impaired loans during the first six months of 2003 was
$130.6 million, compared to $84.2 million in the corresponding period in 2002.
7
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 6. GOODWILL
On December 30, 2001, Textron Financial adopted SFAS No. 142, "Goodwill and
Other Intangible Assets," which requires companies to stop amortizing goodwill
and certain intangible assets with indefinite useful lives and requires an
annual review for impairment. All existing goodwill as of December 30, 2001 was
required to be tested for impairment on a reporting unit basis with the adoption
of this standard. Goodwill is considered to be impaired when the net book value
of a reporting unit exceeds its estimated fair value. Fair values were
established using a discounted cash flow methodology.
Upon adoption, Textron Financial recorded an after-tax transitional
impairment charge of $15.4 million ($23.7 million, pre-tax) in the second
quarter of 2002, which was retroactively recorded in the first quarter of 2002.
This charge is included in the caption "Cumulative effect of change in
accounting principle, net of income taxes" in Textron Financial's Condensed
Consolidated Statements of Income. This after-tax charge related to the
Franchise Finance division within the Other segment and was primarily the result
of decreasing loan volumes and an unfavorable securitization market.
NOTE 7. OTHER ASSETS
<Table>
<Caption>
JUNE 30, DECEMBER 28,
2003 2002
-------- ------------
(IN THOUSANDS)
Retained interests in securitizations................. $257,636 $257,147
Investment in equipment residuals..................... 115,778 115,394
Interest-only securities.............................. 79,042 92,798
Fixed assets -- net................................... 49,041 50,196
Other long-term investments........................... 41,092 24,104
Repossessed assets and properties..................... 17,329 36,234
Other................................................. 138,286 32,130
-------- --------
Total other assets.......................... $698,204 $608,003
======== ========
</Table>
The Investment in equipment residuals represents the remaining equipment
residual values associated principally with Textron golf and turf equipment
lease payments that were securitized in years 2000 through 2003.
The cost of fixed assets is being depreciated using the straight-line
method based on the estimated useful lives of the assets.
8
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 8. DEBT AND CREDIT FACILITIES
<Table>
<Caption>
JUNE 30, DECEMBER 28,
2003 2002
---------- ------------
(IN THOUSANDS)
Short-term debt:
Commercial paper.................................. $ 552,144 $ 872,397
Other short-term debt............................. 58,781 43,955
---------- ----------
Total short-term debt..................... 610,925 916,352
Long-term debt:
2.75% -- 5.95% notes; due 2004 to 2007............ 1,464,801 1,152,682
6.00% -- 6.84% notes; due 2003 to 2009............ 630,214 595,836
7.13% note; due 2004.............................. 599,130 598,827
7.25% note; due 2007.............................. 29,685 25,718
7.37% notes; due 2003............................. 213,000 213,000
Variable rate notes; due 2003 to 2007............. 1,446,691 1,337,206
---------- ----------
Total long-term debt...................... 4,383,521 3,923,269
---------- ----------
Total debt................................ $4,994,446 $4,839,621
========== ==========
</Table>
The weighted average interest rates on short-term borrowings have been
determined by relating the annualized interest cost to the daily average dollar
amounts outstanding. The combined weighted average interest rate was 1.56%
during the six months ended June 30, 2003, and 1.55% at June 30, 2003.
Interest on Textron Financial's variable rate notes is predominately tied
to the three-month LIBOR for U.S. dollar deposits. The weighted average interest
rate on these notes, before consideration of the effect of interest rate
exchange agreements, was 2.30% at June 30, 2003.
The fair value adjustment to designated fixed rate debt in accordance with
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
was $86 million and $67 million at June 30, 2003 and December 28, 2002,
respectively.
Effective July 28, 2003, Textron Financial renewed and extended its bank
lines of credit. The Company has bank lines of credit of $1.5 billion, of which
$500 million expires in 2004 and $1.0 billion expires in 2008. Textron
Financial's lines of credit not reserved as support for commercial paper or
utilized for letters of credit at June 30, 2003, were $925 million. The Company
also maintains a CAD 50 million committed facility under which it can borrow an
additional CAD 50 million on an uncommitted basis. At June 30, 2003, the Company
has fully used the committed portion of the facility in addition to borrowing
CAD 13 million under the uncommitted portion of the facility. Textron Financial
also has a $25 million multi-currency facility, of which $13 million remains
unused at June 30, 2003. Both the Canadian and multi-currency facilities expire
in the third quarter of 2003. Textron Financial generally pays fees in support
of these lines.
Through its subsidiary, Textron Financial Canada Funding Corp. (Textron
Canada Funding), the Company may periodically issue debt securities. Textron
Financial owns 100% of the common stock of Textron Canada Funding. Textron
Canada Funding is a financing subsidiary of Textron Financial with no
operations, revenues or cash flows other than those related to the issuance,
administration and repayment of debt securities that are fully and
unconditionally guaranteed by Textron Financial.
9
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Securitizations are an important source of liquidity for Textron Financial
and involve the periodic transfer of finance receivables to qualified special
purpose trusts. At June 30, 2003 and December 28, 2002, the outstanding amount
of debt issued by these qualified special purpose trusts was $2.2 billion and
$2.3 billion, respectively.
The terms of certain of the Company's loan agreements and credit
facilities, under the most restrictive covenant, limit the payment of dividends
to $442 million at June 30, 2003. In the first six months of 2003, Textron
Financial declared and paid dividends of $39.5 million.
NOTE 9. TEXTRON FINANCIAL AND LITCHFIELD OBLIGATED MANDATORY REDEEMABLE
PREFERRED SECURITIES OF TRUST SUBSIDIARY HOLDING SOLELY LITCHFIELD
JUNIOR SUBORDINATED DEBENTURES
Prior to Textron Financial's acquisition of Litchfield on November 3, 1999,
a trust, sponsored and wholly-owned by Litchfield, issued to the public $26.2
million of mandatory redeemable preferred securities (Preferred Securities). The
trust subsequently invested in $26.2 million aggregate principal amount of
Litchfield 10% Series A Junior Subordinated Debentures (Series A Debentures),
due 2029. The Series A Debentures are the sole asset of the trust. The amounts
due to the trust under the Series A Debentures and the related income statement
amounts have been eliminated in Textron Financial's consolidated financial
statements.
The Preferred Securities were recorded by Textron Financial at the fair
value of $28.6 million as of the acquisition date and the fair value adjustment
is being amortized through June 2004.
The Preferred Securities accrue and pay cash distributions quarterly at a
rate of 10% per annum. The trust's obligations under the Preferred Securities
are fully and unconditionally guaranteed by Litchfield, including, without
limitation, all obligations arising under the Declaration Trust, the Trust
Preferred Securities, the Indenture, the Debentures and the ancillary agreements
entered into in connection with the foregoing. The trust will redeem all of the
outstanding Preferred Securities when the Series A Debentures are paid at
maturity on June 30, 2029, or otherwise become due. Litchfield will have the
right to redeem 100% of the principal plus accrued and unpaid interest on or
after June 30, 2004.
As a result of the acquisition, Textron Financial has agreed to make
payments to the holders of the Preferred Securities, when due, to the extent not
paid by or on behalf of the trust or the subsidiary.
10
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
NOTE 10. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) AND COMPREHENSIVE INCOME
Accumulated other comprehensive income (loss) is as follows:
<Table>
<Caption>
SIX MONTHS ENDED
-------------------
JUNE 30, JUNE 30,
2003 2002
-------- --------
(IN THOUSANDS)
Beginning of period..................................... $(14,637) $(18,793)
Net deferred gain (loss) on interest-only securities,
net of income taxes of $8,014 and income tax benefit
of $1,042, respectively............................... 13,357 (1,736)
Net deferred gain on hedge contracts, net of income
taxes of $6,043 and $647, respectively................ 10,071 1,079
Amortization of deferred loss on terminated hedge
contracts, net of income taxes of $657 and $824,
respectively.......................................... 1,095 1,373
Foreign currency translation adjustments................ 666 (3,375)
-------- --------
End of period........................................... $ 10,552 $(21,452)
======== ========
</Table>
Comprehensive income is summarized below:
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------- -------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2003 2002 2003 2002
-------- -------- -------- --------
(IN THOUSANDS)
Net income............................. $17,049 $18,536 $32,596 $17,340
Other comprehensive income (loss)...... 20,334 (4,188) 25,189 (2,659)
------- ------- ------- -------
Comprehensive income................... $37,383 $14,348 $57,785 $14,681
======= ======= ======= =======
</Table>
NOTE 11. CONTINGENCIES
In March 2003, the United States Department of Justice (DOJ) authorized the
filing of a civil action against Textron Financial and its Litchfield Financial
Corporation (Litchfield), and other third parties, arising from the financing of
certain land purchases by consumers through a third-party land developer. While
the Company believes that it has good defenses to any Government or potential
consumer litigation, it entered into settlement discussions with the DOJ during
the second quarter of 2003 to resolve the entire matter. While the outcome of
the settlement discussions with the DOJ is uncertain at this time, the Company
believes that it is reasonably possible that this matter will be resolved for
less than $5 million.
Textron Financial and Litchfield, together with other third parties, are
currently defending a class action arising from Litchfield's extension of credit
facilities to a third party. The plaintiffs in the class action are seeking
compensatory and punitive damages in excess of $20 million from all the
defendants. On July 16, 2003, the Company's motion to dismiss certain counts
within the class action was denied and the judge entered a preliminary ruling
against the Company. The Company is aggressively defending this litigation and
believes that a substantial part of any settlement or judgment would be covered
by insurance. The Company is not able to predict the outcome of this action at
this time.
There are other pending or threatened lawsuits and other proceedings
against Textron Financial and its subsidiaries. Some of these suits and
proceedings seek compensatory, treble or punitive damages in substantial
amounts. These suits and proceedings are being defended by, or contested on
behalf of, Textron
11
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Financial and its subsidiaries. On the basis of information presently available,
Textron Financial believes any such liability would not have a material effect
on Textron Financial's financial position or results of operations.
NOTE 12. NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51" (FIN 46). FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after June 15, 2003. Management is currently evaluating the impact of
the adoption of FIN 46 and does not anticipate that it will have a material
effect on Textron Financial's results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," which amended SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies the accounting and reporting for derivative instruments,
including embedded derivatives, and for hedging activities. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003, and for
hedging relationships designated after June 30, 2003. Management is currently
evaluating the impact of the adoption of SFAS No. 149 and does not anticipate
that it will have a material effect on Textron Financial's results of operations
or financial position.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
150 requires that an issuer classify certain financial instruments as
liabilities. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. Upon implementation, Textron
Financial will report its obligated mandatory redeemable preferred securities as
a liability and all related expenses as a component of income before income
taxes. See Note 9 for further discussion.
NOTE 13. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
During the third quarter of 2002, the Company made a strategic decision to
realign its business units into seven operating segments based on the markets
serviced and the products offered: Aircraft Finance, Asset-Based Lending,
Distribution Finance, Golf Finance, Resort Finance, and Structured Capital. In
addition, the Company maintains an Other segment that includes franchise
finance, media finance and small business finance in addition to liquidating
portfolios related to a strategic realignment of the Company's business and
product lines in 2001. As a result of these segment changes, the financial
information for June 30, 2002, has been recast reflecting the realignment of the
segments.
12
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2003 2002 2003 2002
--------- --------- --------- ---------
(IN THOUSANDS)
Revenues
Distribution Finance..................... $ 38,248 $ 24,349 $ 75,648 $ 43,810
Golf Finance............................. 21,716 17,495 41,304 33,423
Resort Finance........................... 21,270 21,936 40,224 44,318
Aircraft Finance......................... 19,051 20,078 37,802 43,286
Asset-Based Lending...................... 14,937 16,367 29,307 31,291
Structured Capital....................... 8,363 8,397 17,177 16,909
Other.................................... 31,548 40,400 64,399 80,061
-------- -------- -------- --------
Total revenues............................. $155,133 $149,022 $305,861 $293,098
======== ======== ======== ========
Income (loss) before income taxes,
distributions on preferred securities and
cumulative effect of change in accounting
principle (1) (2)
Distribution Finance..................... $ 15,694 $ 8,637 $ 28,953 $ 15,285
Golf Finance............................. 8,115 4,197 14,164 8,279
Resort Finance........................... 5,230 8,968 11,431 19,351
Aircraft Finance......................... 2,471 361 973 2,745
Asset-Based Lending...................... 5,141 5,099 8,746 5,993
Structured Capital....................... 3,016 3,338 6,872 8,967
Other.................................... (13,152) (1,415) (20,749) (8,553)
-------- -------- -------- --------
Total income before income taxes,
distributions on preferred securities and
cumulative effect of change in accounting
principle................................ $ 26,515 $ 29,185 $ 50,390 $ 52,067
======== ======== ======== ========
</Table>
<Table>
<Caption>
JUNE 30, DECEMBER 28,
2003 2002
---------- ------------
(IN THOUSANDS)
Finance assets (3)
Aircraft Finance.......................................... $1,299,740 $1,216,144
Resort Finance............................................ 1,135,704 1,052,734
Golf Finance.............................................. 942,416 964,271
Distribution Finance...................................... 851,131 841,118
Structured Capital........................................ 583,574 581,207
Asset-Based Lending....................................... 484,699 521,067
Other..................................................... 1,454,558 1,359,841
---------- ----------
Total finance assets........................................ $6,751,822 $6,536,382
========== ==========
</Table>
- ---------------
(1) Interest expense is allocated to each segment in proportion to its net
investment in finance assets. Net investment in finance assets includes
deferred income taxes, security deposits and other specifically
13
ITEM 1. FINANCIAL STATEMENTS (CONTINUED)
TEXTRON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
identified liabilities. The interest allocated matches, to the extent
possible, variable rate debt with variable rate finance assets and fixed
rate debt with fixed rate finance assets.
(2) Indirect expenses are allocated to each segment based on the use of such
resources. Most allocations are based on the segment's proportion of net
investment in finance assets, headcount, number of transactions, computer
resources and senior management time.
(3) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets and properties; retained
interests in securitizations; interest-only securities; investment in
equipment residuals; ADC arrangements; and other long-term investments (some
of which are classified in Other assets on Textron Financial's Condensed
Consolidated Balance Sheets).
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
TEXTROM FINANCIAL CORPORATION
FINANCIAL CONDITION
Liquidity and Capital Resources
Textron Financial Corporation (Textron Financial or the Company) uses a
broad base of financial resources for its liquidity and capital needs. Cash is
provided from operations and several sources of borrowings, including the
issuance of commercial paper and other short-term debt, and sales of medium and
long-term debt in the U.S. and foreign public and private markets. For liquidity
purposes, Textron Financial has a policy of maintaining sufficient unused lines
of credit to support its outstanding commercial paper. Textron Financial has
bank lines of credit of $1.5 billion, of which $500 million expires in 2004 and
$1.0 billion expires in 2008. The $500 million facility includes a one-year term
out option, effectively extending its expiration into 2005. In addition, on July
28, 2003, Textron Inc. (Textron) amended its credit facilities to permit Textron
Financial to borrow under the facilities. None of these lines of credit were
used at June 30, 2003, or December 28, 2002. Textron Financial also maintains a
CAD 50 million committed facility, under which it can borrow an additional CAD
50 million on an uncommitted basis. At June 30, 2003, Textron Financial had
fully used the committed portion of the facility in addition to borrowing CAD 13
million under the uncommitted portion of the facility. Textron Financial also
has a $25 million multi-currency facility, of which $13 million remains unused
at June 30, 2003. Both the Canadian and multi-currency facilities expire in the
third quarter of 2003. The Company expects to renew these facilities prior to
expiration. Lines of credit not reserved as support for commercial paper or
utilized for letters of credit were $925 million at June 30, 2003, compared to
$716 million at December 28, 2002. Further, Textron had unused and unreserved
primary lines of credit of $1.5 billion at June 30, 2003. The increase in the
unreserved portion of Textron Financial's lines of credit is principally
attributable to the securitization of golf equipment receivables, the sale of
franchise finance receivables and issuance of term notes, partially offset by
the voluntary termination and liquidation of a revolving securitization conduit
through a receivable repurchase and finance receivable growth.
Under a shelf registration statement filed with the Securities and Exchange
Commission, Textron Financial may issue public debt securities in one or more
offerings up to a total maximum offering of $3.0 billion. Under this facility,
Textron Financial issued $816 million of term notes during the first six months
of 2003 that mature in 2005 and 2006. The proceeds from these issuances were
used to refinance maturing commercial paper and long-term debt at par. At June
30, 2003, Textron Financial had $329 million available under this facility.
Securitizations are an important source of funding for the Company. During
the first six months of 2003, Textron Financial received net proceeds of $225
million, $79 million, $38 million and $9 million from the securitizations of
Distribution Finance receivables (on a revolving basis), golf equipment
receivables, Aircraft Finance receivables and Resort Finance receivables,
respectively. These securitizations provided Textron Financial with an alternate
source of liquidity. Textron used the proceeds from the securitizations to
retire commercial paper. Cash collections on current and prior period
securitization gains were $22.2 million and $26.0 million, for the six-month
periods ended June 30, 2003 and June 30, 2002, respectively. Textron Financial
anticipates that it will enter into additional securitization transactions
during the remainder of 2003.
During the first quarter of 2003, Textron Financial's short and long-term
debt credit ratings were downgraded from F1 to F2 and from A to A-,
respectively, by Fitch and the Company's long-term debt was placed on
CreditWatch with negative implications by Standard & Poor's. The economic
environment and its potential impact on the financial performance of the
Company's finance receivable portfolios were listed as contributing factors.
While the actions of the rating agencies caused the Company's cost of capital to
increase, it did not result in any loss of access to capital. In the second
quarter of 2003, Standard & Poor's affirmed the Company's short and long-term
debt ratings at A2 and A-, respectively, with a stable outlook. Further
downgrades in Textron Financial's ratings could increase borrowing spreads or
limit its access to the commercial paper, securitization and long-term debt
markets. In addition, Textron Financial's $1.5 billion
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
revolving bank line of credit agreements contain certain financial covenants
that Textron Financial needs to comply with to maintain its ability to borrow
under the facilities. Textron Financial was in full compliance with such
covenants at June 30, 2003.
Textron Financial believes that it has adequate credit facilities and
access to credit markets to meet its long-term financing needs.
Cash flows provided by operations were $134 million during the first six
months of 2003, compared to $75 million in the corresponding period last year.
The increase was principally due to the timing of payments of accrued interest
and other liabilities.
Cash flows used in investing activities were funded primarily from the
collection of receivables and through the issuance of debt. The increase in
proceeds from receivable sales primarily reflects the sale of a franchise
portfolio ($95 million).
Textron Financial declared and paid dividends to Textron of $39.5 million
during the first six months of 2003, compared to $57.5 million of dividends
declared and paid during the corresponding period of 2002. The decrease in 2003
was due to the retention of capital to support finance receivable growth.
Because the finance business involves the purchase and carrying of
receivables, a relatively high ratio of borrowings to net worth is customary.
Debt as a percentage of total capitalization was 83% at June 30, 2003 and
December 28, 2002. Textron Financial's ratio of earnings to fixed charges was
1.54x for both the six months ended June 30, 2003 and the corresponding period
in 2002. Commercial paper and Other short-term debt as a percentage of total
debt was 12% at June 30, 2003, compared to 19% at December 28, 2002. Textron
Financial has a policy of matching the duration of its assets with its debt.
Changes in short and long-term debt are directly related to the duration of
Textron Financial's assets and liabilities.
Finance Assets
Textron Financial's financing activities are confined almost exclusively to
secured lending and leasing to commercial markets. Management believes that the
portfolio avoids excessive concentration of risk through diversification across
geographic regions, industries and types of collateral, and among borrowers.
Total finance assets, which includes finance receivables, equipment on
operating leases -- net of accumulated depreciation, repossessed assets and
properties, retained interests in securitizations, interest-only securities,
investment in equipment residuals, ADC arrangements and other long-term
investments (some of which are classified in Other assets on Textron Financial's
Condensed Consolidated Balance Sheets), were $6.8 billion at June 30, 2003, up
3% from $6.5 billion at December 28, 2002. The increase in finance assets was
mostly due to small business finance within the Other segment ($172 million),
which was primarily the result of the liquidation of a revolving securitization
conduit, Aircraft Finance ($84 million) and Resort Finance ($83 million).
Finance receivable additions for the first six months of 2003 were $4.6
billion, compared to $4.3 billion in the corresponding period last year. The
majority of the growth in finance receivable additions was from Distribution
Finance ($419 million).
Nonperforming Assets
Nonperforming assets, which includes independent and nonrecourse captive
finance assets, as a percentage of finance assets decreased to 3.21% ($217
million) at June 30, 2003, compared to 3.33% ($218 million) at December 28,
2002. The $1 million decrease in nonperforming assets at June 30, 2003, compared
to December 28, 2002, was due to decreases in Aircraft Finance ($9 million),
Asset-Based Lending ($8 million) and Distribution Finance ($5 million) segments,
mostly offset by an increase in the Other segment ($12 million), Resort Finance
($8 million) and Golf Finance ($1 million) segments. The increases in the Other
segment primarily include franchise finance ($6 million) and small business
finance ($6 million).
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The Other segment represents 24% of owned receivables and 47% of nonperforming
assets at June 30, 2003. The Company believes that nonperforming assets will
generally be in the range of 2% to 4% of finance assets depending on economic
conditions.
The allowance for losses on receivables was $165.1 million at June 30,
2003, as compared to $166.5 million at December 28, 2002. The allowance for
losses on receivables as a percentage of total finance receivables was 2.7% at
June 30, 2003, compared to 2.9% at December 28, 2002 (3.0% and 3.1%,
respectively, excluding captive receivables with recourse to Textron). The
allowance for losses on receivables as a percentage of nonaccrual finance
receivables was 83% at June 30, 2003, as compared to 92% at December 28, 2002.
The decrease in the percentage represents an increase in nonaccrual loans ($199
million at June 30, 2003, as compared to $182 million at December 28, 2002) that
are supported by strong collateral values.
Interest Rate Sensitivity
Textron Financial's mix of fixed and floating rate debt is continuously
monitored by management and is adjusted, as necessary, based on evaluations of
internal and external factors.
Management's strategy of matching interest-sensitive assets with
interest-sensitive liabilities limits Textron Financial's risk to changes in
interest rates, and includes entering into interest rate exchange agreements. At
June 30, 2003, interest-sensitive assets in excess of interest-sensitive
liabilities were $1.2 billion, net of $1.6 billion of interest rate exchange
agreements on long-term debt and $265 million of interest rate exchange
agreements on finance receivables. However, classified within interest-sensitive
assets are approximately $850 million of floating rate loans with rate floors
that are generally 173 basis points above the rate that would otherwise be
applicable with reference to the benchmark index (predominately the prime rate).
As a consequence, these assets have become interest-insensitive, and will remain
so until the prime rate increases by more than 173 basis points.
Management believes that its asset/liability management policy provides
adequate protection against interest rate risks. Increases in interest rates,
however, could have an adverse effect on interest margin. Variable rate
receivables are generally tied to changes in the prime rate offered by major
U.S. banks or LIBOR. Changes in short-term borrowing costs generally precede
changes in variable rate receivable yields. Textron Financial assesses its
exposure to interest rate changes using an analysis that measures the potential
loss in net income, over a twelve-month period, resulting from a hypothetical
change in interest rates of 100 basis points across all maturities occurring at
the outset of the measurement period (sometimes referred to as a "shock test").
Textron Financial also assumes in its analysis that prospective receivable
additions will be match funded, existing portfolios will not prepay and all
other relevant factors will remain constant. This shock test model, when applied
to Textron Financial's asset and liability position at June 30, 2003, indicates
that an increase in interest rates of 100 basis points would have a beneficial
impact on Textron Financial's net income and cash flows for the following
twelve-month period, whereas, a decrease in interest rates of 100 basis points
reduces Textron Financial's net income and cash flow by $0.5 million for the
following twelve-month period, including the effects of the rate floors.
Financial Risk Management
Textron Financial's results are affected by changes in U.S. and, to a
lesser extent, foreign interest rates. As part of managing this risk, Textron
Financial enters into interest rate exchange agreements. Textron Financial's
objective of entering into such agreements is not to speculate for profit, but
generally to convert variable rate debt into fixed rate debt and vice versa. The
overall objective of Textron Financial's interest rate risk management is to
achieve a prudent balance between floating and fixed rate debt. These agreements
do not involve a high degree of complexity or risk. Textron Financial does not
trade in interest rate exchange agreements or enter into leveraged interest rate
exchange agreements.
Textron Financial manages its foreign currency exposure by funding most
foreign currency denominated assets with liabilities in the same currency. The
Company may enter into foreign currency exchange
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
agreements to convert foreign currency denominated assets and liabilities into
functional currency denominated assets and liabilities. In addition, as part of
managing its foreign currency exposure, Textron Financial may enter into foreign
currency forward exchange contracts. The objective of such agreements is to
manage any remaining exposure to changes in currency rates. The notional amounts
of outstanding foreign currency forward exchange contracts were nominal.
RESULTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 VS. JUNE 30, 2002
REVENUES
Three months ended June 30, 2003 vs. June 30, 2002
Second quarter 2003 revenues increased by $6.1 million, or 4.1%, compared
to the corresponding period in 2002. The increase in revenues principally
reflects higher finance charges and discounts ($11.4 million) due to a higher
level of average finance receivables ($9.4 million) and higher receivable
pricing ($2.0 million). The higher level of average finance receivables ($532
million) was primarily due to growth in the Distribution Finance segment. This
increase was partially offset by lower Other income ($4.4 million), primarily
due to lower investment income ($4.0 million).
Six months ended June 30, 2003 vs. June 30, 2002
Revenues for the first six months of 2003 increased by $12.8 million, or
4.4%, compared to the corresponding period in 2002. The increase in revenues
principally reflects higher finance charges and discounts ($17.5 million)
largely due to a higher level of average finance receivables ($13.4 million) and
higher receivable pricing ($4.1 million). The higher level of average finance
receivables ($397 million) was primarily due to growth in the Distribution
Finance segment. This increase was partially offset by lower Other income ($4.6
million), primarily due to lower investment income ($3.7 million),
securitization gains ($3.4 million) and syndication income ($1.8 million),
offset by higher servicing fees ($3.0 million) and prepayment gains ($1.2
million).
INTEREST EXPENSE
Three months ended June 30, 2003 vs. June 30, 2002
Second quarter 2003 interest expense decreased by $1.7 million, or 3.4%, on
6.7% higher average debt outstanding. The lower interest expense reflects a
decrease in the average borrowing rate to 3.51% from 3.88%, primarily
attributable to a lower interest rate environment and the maturity of higher
cost debt.
Six months ended June 30, 2003 vs. June 30, 2002
Interest expense for the first six months of 2003 decreased by $2.7
million, or 2.8%, on 4.2% higher average debt outstanding. The lower interest
expense reflects a decrease in the average borrowing rate to 3.58% from 3.83%,
primarily attributable to a lower interest rate environment and the maturity of
higher cost debt.
INTEREST MARGIN
Textron Financial's earnings are influenced by the interest margin earned
on finance receivables (i.e., revenues earned less interest expense on
borrowings and operating lease depreciation).
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Three months ended June 30, 2003 vs. June 30, 2002
Interest margin increased $7.4 million, and decreased 8 basis points (6.65%
versus 6.73%) for the second quarter of 2003 compared to the corresponding
period in 2002. The contraction in the interest margin percentage was primarily
due to lower other income.
Six months ended June 30, 2003 vs. June 30, 2002
Interest margin increased $14.1 million, or 5 basis points (6.76% versus
6.71%) for the first six months of 2003 compared to the corresponding period in
2002. The increase in interest margin was primarily due to higher finance
charges and discounts from higher average finance receivables, higher receivable
pricing and a lower borrowing cost, partially offset by lower other income.
SELLING AND ADMINISTRATIVE EXPENSES
Three months ended June 30, 2003 vs. June 30, 2002
Selling and administrative expenses of $46.5 million increased $3.9 million
in the second quarter of 2003 compared to the corresponding period in 2002. The
increase in 2003 principally reflects costs related to growth in managed and
serviced finance receivables ($1.5 million), and higher data processing ($1.5
million), legal and collection ($0.9 million) and telecommunication ($0.7
million) expenses. Selling and administrative expenses as a percentage of
average managed and serviced finance receivables were 1.91% (on an annualized
basis) in the second quarter of 2003, compared to 1.81% in 2002.
Six months ended June 30, 2003 vs. June 30, 2002
Selling and administrative expenses of $93.8 million increased $10.2
million in the first six months of 2003 compared to the corresponding period in
2002. The increase in 2003 principally reflects higher legal and collection
($3.5 million), data processing ($1.9 million) and telecommunication ($1.4
million) expenses as well as costs related to growth in managed and serviced
finance receivables ($2.4 million). Selling and administrative expenses as a
percentage of average managed and serviced finance receivables were 1.96% (on an
annualized basis) in the first six months of 2003, compared to 1.79% in 2002.
PROVISION FOR LOSSES
Three months ended June 30, 2003 vs. June 30, 2002
The provision for losses of $31.2 million for the second quarter of 2003
increased from $25.0 million for the corresponding period in 2002. The increase
reflects higher net charge-offs ($12.9 million), partially offset by a reduction
in the allowance for losses on receivables as a result of charge-offs related to
previously reserved accounts. The increase in net charge-offs was primarily
related to the Other segment ($4.5 million), Aircraft Finance ($3.1 million),
Distribution Finance ($2.4 million) and Resort Finance ($2.2 million) segments.
Six months ended June 30, 2003 vs. June 30, 2002
The provision for losses of $60.9 million for the first six months of 2003
increased from $55.4 million for the corresponding period in 2002. The increase
reflects higher net charge-offs ($12.6 million), partially offset by a reduction
in the allowance for losses on receivables as a result of charge-offs related to
previously reserved accounts. The increase in net charge-offs was primarily
related to Distribution Finance ($5.1 million), Aircraft Finance ($4.3 million),
Resort Finance ($2.1 million) and Golf Finance ($2.0 million) segments.
Although management believes it has made adequate provision for anticipated
losses, realization of these assets remains subject to uncertainties. Subsequent
evaluations of nonperforming assets, in light of factors then prevailing,
including economic conditions, may require additional increases in the allowance
for losses for such assets.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
OPERATING RESULTS BY SEGMENT
Six months ended June 30, 2003 vs. June 30, 2002
Segment income below represents income before special charges, income
taxes, distributions on preferred securities and cumulative effect of change in
accounting principle.
Distribution Finance income increased $13.7 million reflecting higher
interest margin ($27.2 million), offset by higher operating expenses ($8.7
million) and higher provision for losses ($4.8 million) largely related to
growth in finance receivables. The higher interest margin was principally due to
higher average finance assets ($419 million), higher receivable pricing and
higher other income.
Golf Finance income increased $5.9 million reflecting higher interest
margin ($7.4 million) primarily due to higher other income ($5.1 million) and
higher average finance assets ($46 million). This increase in interest margin
was partially offset by higher operating expenses ($1.6 million).
Resort Finance income decreased $7.9 million reflecting lower interest
margin ($4.3 million), higher operating expenses ($2.1 million) and higher loss
provision ($1.5 million). The decrease in interest margin largely reflects lower
pricing despite higher average finance assets ($118 million).
Aircraft Finance income decreased by $1.8 million reflecting lower interest
margin ($2.4 million) and higher operating expenses ($1.7 million), partially
offset by a lower provision for losses ($2.3 million). The decrease in interest
margin is primarily due to lower other income ($1.1 million).
Asset-Based Lending income increased $2.7 million primarily reflecting
lower provision for loan losses ($4.6 million), partially offset by lower
interest margin ($1.5 million).
Structured Capital income decreased $2.1 million primarily reflecting
higher provision for loan losses ($2.2 million).
Other segment income decreased $12.2 million reflecting lower interest
margin ($12.5 million) and a higher provision for losses ($4.0 million),
partially offset by lower operating expenses ($4.3 million). The lower interest
margin largely reflects lower other income ($12.9 million).
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Three months ended June 30, 2003 vs. June 30, 2002
Income before cumulative effect of change in accounting principle for the
second quarter was $17.0 million, $1.5 million or 8.0% lower than the
corresponding period in 2002. The decrease reflects a higher provision for
losses ($6.2 million) and higher selling and administrative expenses ($3.9
million), partially offset by a higher interest margin ($7.4 million) and a
lower effective tax rate.
Six months ended June 30, 2003 vs. June 30, 2002
Income before cumulative effect of change in accounting principle for the
first six months of 2003 was $32.6 million, $0.1 million lower than the
corresponding period in 2002. The decrease reflects higher selling and
administrative expenses ($10.2 million) and a higher provision for losses ($5.5
million), mostly offset by a higher interest margin ($14.1 million) and a lower
effective tax rate.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
CONTINGENCIES
In March 2003, the United States Department of Justice (DOJ) authorized the
filing of a civil action against Textron Financial and its Litchfield Financial
Corporation (Litchfield), and other third parties, arising from the financing of
certain land purchases by consumers through a third-party land developer. While
the Company believes that it has good defenses to any Government or potential
consumer litigation, it entered into settlement discussions with the DOJ during
the second quarter of 2003 to resolve the entire matter. While the outcome of
the settlement discussions with the DOJ is uncertain at this time, the Company
believes that it is reasonably possible that this matter will be resolved for
less than $5 million.
Textron Financial and Litchfield, together with other third parties, are
currently defending a class action arising from Litchfield's extension of credit
facilities to a third party. The plaintiffs in the class action are seeking
compensatory and punitive damages in excess of $20 million from all the
defendants. On July 16, 2003, the Company's motion to dismiss certain counts
within the class action was denied and the judge entered a preliminary ruling
against the Company. The Company is aggressively defending this litigation and
believes that a substantial part of any settlement or judgment would be covered
by insurance. The Company is not able to predict the outcome of this action at
this time.
There are other pending or threatened lawsuits and other proceedings
against Textron Financial and its subsidiaries. Some of these suits and
proceedings seek compensatory, treble or punitive damages in substantial
amounts. These suits and proceedings are being defended by, or contested on
behalf of, Textron Financial and its subsidiaries. On the basis of information
presently available, Textron Financial believes any such liability would not
have a material effect on Textron Financial's financial position or results of
operations.
SELECTED FINANCIAL RATIOS
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------- -------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2003 2002 2003 2002
-------- -------- -------- --------
Net interest margin as a percentage of average net
investment (1).................................. 6.65% 6.73% 6.76% 6.71%
Return on average equity (2)...................... 6.68% 7.55% 6.44% 6.63%
Return on average assets (3)...................... 0.94% 1.10% 0.93% 0.98%
Ratio of earnings to fixed charges................ 1.55x 1.59x 1.54x 1.54x
Selling and administrative expenses as a
percentage of average managed and serviced
finance receivables (4)......................... 1.91% 1.81% 1.96% 1.79%
Operating efficiency ratio (5).................... 44.6% 44.0% 45.7% 43.7%
Net charge-offs as a percentage of average finance
receivables..................................... 2.20% 1.51% 2.03% 1.73%
</Table>
<Table>
<Caption>
JUNE 30, DECEMBER 28,
2003 2002
-------- ------------
60+ days contractual delinquency as a percentage of finance
receivables (6)........................................... 3.23% 2.88%
Nonperforming assets as a percentage of finance assets
(7)....................................................... 3.21% 3.33%
Allowance for losses on receivables as a percentage of
finance receivables....................................... 2.74% 2.89%
Allowance for losses on receivables as a percentage of
nonaccrual finance receivables............................ 82.8% 91.7%
Total debt to tangible shareholder's equity (8)............. 5.9x 5.7x
</Table>
- ---------------
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
(1) Represents revenues earned less interest expense on borrowings and operating
lease depreciation as a percentage of average net investment. Average net
investment includes finance receivables plus operating leases, less deferred
taxes on leveraged leases.
(2) Return on average equity excludes the cumulative effect of change in
accounting principle.
(3) Return on average assets excludes the cumulative effect of change in
accounting principle.
(4) Average managed and serviced finance receivables include owned receivables,
receivables serviced under securitizations, participations and third-party
portfolio servicing agreements.
(5) Operating efficiency ratio is selling and administrative expenses divided by
net interest margin.
(6) Delinquency excludes captive receivables with recourse to Textron. Captive
receivables represent third-party finance receivables originated in
connection with the sale or lease of Textron manufactured products.
Percentages are expressed as a function of total Textron Financial
independent and nonrecourse captive receivables.
(7) Finance assets include: finance receivables; equipment on operating leases,
net of accumulated depreciation; repossessed assets and properties; retained
interests in securitizations; interest-only securities; investment in
equipment residuals; ADC arrangements; and long-term investments (some of
which are classified in Other assets on Textron Financial's Condensed
Consolidated Balance Sheets). Nonperforming assets include independent and
nonrecourse captive finance assets.
(8) Tangible shareholder's equity equals Shareholder's equity, excluding
Accumulated other comprehensive income or loss, less Goodwill.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51" (FIN 46). FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after June 15, 2003. Management is currently evaluating the impact of
the adoption of FIN 46 and does not anticipate that it will have a material
effect on Textron Financial's results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," which amended SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies the accounting and reporting for derivative instruments,
including embedded derivatives, and for hedging activities. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003, and for
hedging relationships designated after June 30, 2003. Management is currently
evaluating the impact of the adoption of SFAS No. 149 and does not anticipate
that it will have a material effect on Textron Financial's results of operations
or financial position.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
150 requires that an issuer classify certain financial instruments as
liabilities. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. Upon implementation, Textron
Financial will report its obligated mandatory redeemable preferred securities as
a liability and all related expenses as a component of income before income
taxes. See Note 9 for further discussion.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
FORWARD-LOOKING INFORMATION
Certain statements in this Form 10-Q and other oral and written statements
made by Textron Financial from time to time are forward-looking statements,
including those that discuss strategies, goals, outlook or other nonhistorical
matters; or project revenues, income, returns or other financial measures. These
forward-looking statements are subject to risks and uncertainties that may cause
actual results to differ materially from those contained in the statements,
including the following: (a) changes in worldwide economic and political
conditions that impact interest and foreign exchange rates; (b) the occurrence
of further downturns in customer markets to which Textron products are sold or
supplied and financed or where Textron Financial offers financing; (c) the
ability to control costs and successful implementation of various cost reduction
programs; (d) the ability to maintain portfolio credit quality; (e) Textron
Financial's access to debt financing at competitive rates; (f) access to equity
in the form of retained earnings and capital contributions from Textron; and (g)
uncertainty in estimating contingent liabilities and establishing reserves
tailored to address such contingencies.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding Textron Financial's Quantitative and Qualitative
Disclosure About Market Risk, see "Interest Rate Sensitivity" and "Financial
Risk Management" in Item 2 of this Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We have carried out an evaluation, under the supervision and with the
participation of our management, including our Chairman and Chief Executive
Officer (the "CEO") and our Executive Vice President and Chief Financial Officer
(the "CFO"), of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the "Act")) as of the end of the
fiscal quarter covered by this report. Based upon that evaluation, our CEO and
CFO concluded that our disclosure controls and procedures are effective in
providing reasonable assurance that (a) the information required to be disclosed
by us in the reports that we file or submit under the Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms, and (b) such information
is accumulated and communicated to our management, including our CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure.
There has been no change in our internal control over financial reporting
during the fiscal quarter covered by this report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
23
PART II. OTHER INFORMATION
TEXTRON FINANCIAL CORPORATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
<Table>
4.1 Indenture dated as of December 9, 1999, between Textron
Financial Corporation and SunTrust Bank (formerly known as
Sun Trust Bank, Atlanta), (including form of debt
securities). Incorporated by reference to Exhibit 4.1 to
Amendment No. 2 to Textron Financial Corporation's
Registration Statement on Form S-3 (No. 333-88509).
4.2 Indenture dated as of November 30, 2001, between Textron
Financial Canada Funding Corp. and SunTrust Bank, guaranteed
by Textron Financial Corporation. Incorporated by reference
to Exhibit 4.2 to amendment No. 1 to Textron Financial
Corporation's Registration Statement on Form S-3 (No.
333-72676).
12 Computation of Ratios of Earnings to Fixed Charges
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a)
32.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(b) and 18 U.S.C. Section 1350
32.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(b) and 18 U.S.C. Section 1350
</Table>
NOTE: Instruments defining the rights of holders of certain issues of long-term
debt of Textron Financial Corporation have not been filed as exhibits to
this Report because the authorized principal amount of any one such issues
does not exceed 10% of the total assets of Textron Financial Corporation
and its subsidiaries on a consolidated basis. Textron Financial
Corporation agrees to furnish a copy of each such instrument to Commission
upon request.
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended June 30, 2003.
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 5, 2003 TEXTRON FINANCIAL CORPORATION
/s/ THOMAS J. CULLEN
--------------------------------------
Thomas J. Cullen
Executive Vice President and Chief
Financial Officer
(Principal Financial Officer)
25