-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F6bWTspKQHWCI7l2Cff5wpioME6loT6P7gAYz7CiA+GelSD1FkbuXpFny0R1anSn muRcFuZpBEt4dWqxlE04nw== 0000950135-06-003189.txt : 20060505 0000950135-06-003189.hdr.sgml : 20060505 20060505135102 ACCESSION NUMBER: 0000950135-06-003189 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060505 DATE AS OF CHANGE: 20060505 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TEXTRON FINANCIAL CORP CENTRAL INDEX KEY: 0000709255 STANDARD INDUSTRIAL CLASSIFICATION: FINANCE LESSORS [6172] IRS NUMBER: 056008768 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15515 FILM NUMBER: 06812068 BUSINESS ADDRESS: STREET 1: 40 WESTMINSTER ST STREET 2: P O BOX 6687 CITY: PROVIDENCE STATE: RI ZIP: 02901 BUSINESS PHONE: 4016214200 MAIL ADDRESS: STREET 1: 40 WESTMINSTER ST STREET 2: P O BOX 6687 CITY: PROVIDENCE STATE: RI ZIP: 02901 10-Q 1 b60731tce10vq.htm TEXTRON FINANCIAL CORPORATION e10vq
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
FORM 10-Q
 
     
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal quarter ended March 31, 2006
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934          
 
Commission file number 001-15515
 
 
 
 
Textron Financial Corporation
(Exact name of registrant as specified in its charter)
 
 
 
 
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  05-6008768
(I.R.S. Employer
Identification No.)
 
40 Westminster Street, P.O. Box 6687, Providence, RI 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 þ     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o  Accelerated filer o  Non-accelerated filer þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
 
Yes o     No þ
 
All of the shares of common stock of the registrant are owned by Textron Inc.
 


 

 
TEXTRON FINANCIAL CORPORATION
 
TABLE OF CONTENTS
 
                 
        Page
 
   
  FINANCIAL STATEMENTS    
  2
  3
  4
  5
  6
  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   15
  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   25
  CONTROLS AND PROCEDURES   25
   
  EXHIBITS   26
 EX-12 Computation of Ratio of Earnings to Fix Charges.
 EX-31.1 Section 302 Certification of CEO
 EX-31.2 Section 302 Certification of CFO
 EX-32.1 Section 906 Certification of CEO
 EX-32.2 Section 902 Certification of CFO


1


Table of Contents

 
PART I.  FINANCIAL INFORMATION
 
Item 1.   Financial Statements
 
 
                 
    2006     2005  
    (In millions)  
 
Finance charges and discounts
     $ 145        $ 104  
Securitization gains
    11       10  
Rental revenues on operating leases
    7       7  
Other income
    19       20  
                 
Total revenues
    182       141  
Interest expense
    73       45  
Depreciation of equipment on operating leases
    4       4  
                 
Net interest margin
    105       92  
Selling and administrative expenses
    47       47  
Provision for losses
    9       12  
                 
Income before income taxes
    49       33  
Income taxes
    18       11  
                 
Net income
  $ 31     $ 22  
                 
 
See notes to consolidated financial statements.


2


Table of Contents

 
Item 1.  Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
                 
    March 31,
    December 31,
 
    2006     2005  
    (In millions)  
 
Assets
               
Cash and equivalents
  $ 10     $ 10  
Finance receivables, net of unearned income:
               
Distribution finance receivables
    1,974       1,654  
Revolving loans
    1,643       1,633  
Installment contracts
    1,424       1,374  
Golf course and resort mortgages
    1,083       1,020  
Leveraged leases
    553       569  
Finance leases
    528       513  
                 
Total finance receivables
    7,205       6,763  
Allowance for losses on finance receivables
    (100 )     (96 )
                 
Finance receivables — net
    7,105       6,667  
Equipment on operating leases — net
    228       231  
Goodwill
    169       169  
Other assets
    360       364  
                 
Total assets
  $ 7,872     $ 7,441  
                 
         
Liabilities and shareholder’s equity
               
         
Liabilities
               
Accrued interest and other liabilities
  $ 537     $ 499  
Amounts due to Textron Inc. 
    11       11  
Deferred income taxes
    460       461  
Debt
    5,842       5,420  
                 
Total liabilities
    6,850       6,391  
Shareholder’s equity
               
Capital surplus
    574       574  
Investment in parent company preferred stock
    (25 )     (25 )
Accumulated other comprehensive income
    8       5  
Retained earnings
    465       496  
                 
Total shareholder’s equity
    1,022       1,050  
                 
Total liabilities and shareholder’s equity
  $ 7,872     $ 7,441  
                 
 
See notes to consolidated financial statements.


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Table of Contents

 
Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2006 and 2005
(Unaudited)
 
                 
    2006     2005  
    (In millions)  
 
Cash flows from operating activities:
               
Net income
  $ 31     $ 22  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for losses
    9       12  
Increase in accrued interest and other liabilities
    50       25  
Depreciation
    7       8  
Amortization
    3       2  
Collections in excess of noncash gains on securitizations and syndications
    3       2  
Deferred income tax provision
    (1 )     (2 )
Other — net
    (2 )     6  
                 
Net cash provided by operating activities
    100       75  
Cash flows from investing activities:
               
Finance receivables originated or purchased
    (2,700 )     (2,456 )
Finance receivables repaid
    2,201       2,028  
Proceeds from receivable sales, including securitizations
          32  
Other investments
    (2 )     7  
Proceeds from disposition of operating lease and other assets
    34       8  
Other capital expenditures
    (3 )     (3 )
Purchase of assets for operating leases
    (18 )     (19 )
                 
Net cash used by investing activities
    (488 )     (403 )
Cash flows from financing activities:
               
Proceeds from issuance of long-term debt
    556       398  
Principal payments on long-term debt
    (50 )     (310 )
Net (decrease) increase in commercial paper
    (54 )     182  
Net (decrease) increase in other short-term debt
    (2 )     106  
Principal payments on nonrecourse debt
          (14 )
Capital contributions from Textron Inc. 
    2       2  
Dividends paid to Textron Inc. 
    (64 )     (99 )
                 
Net cash provided by financing activities
    388       265  
Effect of exchange rate changes on cash
           
                 
Net decrease in cash and equivalents
          (63 )
Cash and equivalents at beginning of year
    10       127  
                 
Cash and equivalents at end of period
  $ 10     $ 64  
                 
 
See notes to consolidated financial statements.


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Table of Contents

 
Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION
 
(Unaudited)
 
                                         
          Investment
    Accumulated
             
          in Parent
    Other
             
          Company
    Comprehensive
          Total
 
    Capital
    Preferred
    Income
    Retained
    Shareholder’s
 
    Surplus     Stock     (Loss)     Earnings     Equity  
    (In millions)  
 
Balance January 1, 2005
  $ 574     $ (25 )   $ 1     $ 485     $ 1,035  
Comprehensive income:
                                       
Net income
                      111       111  
Other comprehensive income:
                                       
Foreign currency translation
                (1 )           (1 )
Change in unrealized net losses on hedge contracts, net of income taxes
                             
Change in unrealized net gains on interest-only securities, net of income taxes
                5             5  
                                         
Other comprehensive income
                4             4  
                                         
Comprehensive income
                            115  
Capital contributions from Textron Inc. 
    9                         9  
Dividends to Textron Inc. 
    (9 )                 (100 )     (109 )
                                         
Balance December 31, 2005
    574       (25 )     5       496       1,050  
Comprehensive income:
                                       
Net income
                      31       31  
Other comprehensive income:
                                       
Foreign currency translation
                             
Change in unrealized net losses on hedge contracts, net of income taxes
                1             1  
Change in unrealized net gains on interest-only securities, net of income taxes
                2             2  
                                         
Other comprehensive income
                3             3  
                                         
Comprehensive income
                            34  
Capital contributions from Textron Inc. 
    2                         2  
Dividends to Textron Inc. 
    (2 )                 (62 )     (64 )
                                         
Balance March 31, 2006
  $ 574     $ (25 )   $ 8     $ 465     $ 1,022  
                                         
 
See notes to consolidated financial statements.


5


Table of Contents

 
Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1.   Basis of Presentation
 
The consolidated financial statements should be read in conjunction with the consolidated financial statements included in Textron Financial Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005. The accompanying 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 March 31, 2006, and its consolidated results of operations and cash flows for each of the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.
 
Note 2.   Recent Accounting Pronouncements
 
In the first quarter of 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155 “Accounting for Certain Hybrid Financial Instruments-An amendment of FASB Statements No. 133 and 140.” SFAS 155 requires evaluation of all interests in securitized financial assets to determine whether they represent either freestanding derivatives or contain embedded derivatives. These interests were previously exempted from such evaluation in SFAS 133. The statement permits any hybrid instrument, such as an interest in securitized financial assets containing an embedded derivative, to be accounted for at fair value as opposed to bifurcating and accounting for the embedded derivative separate from the host instrument. The statement also amends SFAS 140 by eliminating restrictions on a qualifying special purpose entity’s ability to hold passive derivative financial instruments pertaining to beneficial interests that are, or contain a derivative financial instrument. The Company will adopt SFAS 155 effective January 1, 2007. At March 31, 2006, the Company has not completed its evaluation of the impact of this statement on its interests in securitized financial assets.
 
The FASB also issued SFAS No. 156 “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140” in the first quarter of 2006. SFAS 156 requires all separately recognized servicing assets and liabilities to be initially measured at fair value and permits entities to choose to either subsequently measure servicing rights at fair value and report changes in fair value in earnings, or amortize servicing rights in proportion to, and over the estimated net servicing income or loss and assess the rights for impairment or the need for an increased obligation. The option to subsequently measure servicing rights at fair value will allow entities which utilize derivative instruments to hedge their servicing rights to account for such hedging relationships at fair value and avoid the complications of hedge accounting under SFAS 133. Textron Financial does not utilize derivative instruments to hedge its servicing rights as of March 31, 2006. The Company will adopt SFAS 156 effective January 1, 2007 and will likely utilize the amortization method to subsequently measure its servicing rights. The adoption of this statement is not expected to have a material impact on the Company’s financial position or results of operations as the Consolidated Balance Sheets do not contain a significant balance of servicing assets at March 31, 2006.


6


Table of Contents

 
Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

 
Note 3.   Other Income
 
                 
    Three Months Ended  
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Servicing income
  $ 7     $ 8  
Investment income
    4       3  
Prepayment gains
    2       2  
Late charges
    1       1  
Syndication income
          1  
Other
    5       5  
                 
Total other income
  $ 19     $ 20  
                 
 
The Other component of Other income includes commitment fees, residual gains, gains from asset sales, excluding syndications, insurance fees and other miscellaneous fees, which are primarily recognized as income when received. Impairment charges related to assets and investments acquired through repossession of collateral are also recorded in the Other component of Other income.
 
Note 4.   Managed and Serviced Finance Receivables
 
Textron Financial manages and services finance receivables for a variety of investors, participants and third-party portfolio owners. Managed and serviced finance receivables are summarized as follows:
 
                 
    March 31,
    December 31,
 
    2006     2005  
    (In millions)  
 
Total managed and serviced finance receivables
  $ 10,059     $ 9,915  
Nonrecourse participations
    (341 )     (383 )
Third-party portfolio servicing
    (333 )     (509 )
SBA sales agreements
    (25 )     (28 )
                 
Total managed finance receivables
    9,360       8,995  
Securitized receivables
    (2,070 )     (2,124 )
Other managed finance receivables
    (85 )     (108 )
                 
Owned finance receivables
  $ 7,205     $ 6,763  
                 
 
Third-party portfolio servicing largely relates to finance receivable portfolios of resort developers and loan portfolio servicing for third-party financial institutions.
 
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.
 
Other managed finance receivables represent the rental streams related to equipment lease portfolios sold to a third-party financial institution, which continue to be serviced and managed by Textron Financial.
 
Owned receivables include approximately $158 million of finance receivables that were unfunded at March 31, 2006, primarily as a result of holdback arrangements. The corresponding liability is included in Accrued interest and other liabilities on Textron Financial’s Consolidated Balance Sheet.


7


Table of Contents

 
Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

 
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. In addition, the Company identifies loans that are considered impaired due to the significant modification of the original loan terms to reflect deferred principal payments generally at market interest rates, but which continue to accrue finance charges since full collection of principal and interest is not doubtful. These loans are classified as impaired for the remainder of the calendar year during which they are modified. Impairment is measured by comparing the fair value of a loan to its carrying amount. 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 collateral dependent, at the fair value of the collateral, less selling costs. 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, which may differ from actual results.
 
                 
    March 31,
    December 31,
 
    2006     2005  
    (In millions)  
 
Nonaccrual finance receivables
  $ 98     $ 89  
Impaired nonaccrual finance receivables (included in nonaccrual finance receivables above)
  $ 80     $ 67  
Impaired accrual finance receivables
          36  
                 
Total impaired finance receivables
  $ 80     $ 103  
                 
Impaired finance receivables with identified reserve requirements
  $ 67     $ 53  
Allowance for losses on finance receivables related to impaired loans
  $ 19     $ 18  
 
The average recorded investment in impaired nonaccrual finance receivables during the first quarter of 2006 was $73 million compared to $81 million in the corresponding period in 2005. There was no average recorded investment in impaired accrual finance receivables for the first quarter of 2006. The average recorded investment in impaired accrual finance receivables was approximately $13 million for the first quarter of 2005.
 
Nonaccrual finance receivables resulted in Textron Financial’s finance charges being reduced by $3 million and $2 million in the first quarter of 2006 and 2005, respectively. No finance charges were recognized using the cash basis method.
 
Captive finance receivables with recourse that were delinquent 90 days or more amounted to $6 million at March 31, 2006 and $8 million at December 31, 2005, and were 2.7% and 3.3% of captive finance receivables with recourse, respectively. Revenues recognized on these accounts were $1 million in both the first quarter of 2006 and 2005.
 
Textron Financial has a performance guarantee from Textron for leases with the U.S. and Canadian subsidiaries of Collins & Aikman Corporation (“C&A”). At March 31, 2006, these leases had an outstanding balance of $68 million. During the second quarter of 2005, the U.S. subsidiary of C&A filed for Chapter 11 bankruptcy protection. The Company has not classified this lease as nonaccrual due to the performance guarantee from Textron.


8


Table of Contents

 
Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

 
Note 6.   Other Assets
 
                 
    March 31,
    December 31,
 
    2006     2005  
    (In millions)  
 
Retained interests in securitizations
  $ 202     $ 208  
Other long-term investments
    58       53  
Fixed assets — net
    33       33  
Repossessed assets and properties
    22       22  
Investment in equipment residuals
    9       10  
Other
    36       38  
                 
Total other assets
  $ 360     $ 364  
                 
 
Interest-only securities within retained interests in securitizations were $64 million and $66 million at March 31, 2006 and December 31, 2005, respectively.
 
Other long-term investments and Repossessed assets and properties include assets received in satisfaction of troubled loans. Declines in the value of these assets subsequent to receipt are recorded as impairment charges in the Other component of Other income.
 
The cost of fixed assets is being depreciated using the straight-line method based on the estimated useful lives of the assets.
 
The Investment in equipment residuals represents the remaining equipment residual values associated principally with Textron golf and turf equipment lease payments that were sold.
 
The Other category primarily represents the fair value of derivative instruments and debt acquisition costs.


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Table of Contents

 
Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

 
Note 7.   Debt and Credit Facilities
 
                 
    March 31,
    December 31,
 
    2006     2005  
    (In millions)  
 
Short-term debt:
               
Commercial paper
  $ 1,133     $ 1,187  
Other short-term debt
    11       13  
                 
Total short-term debt
    1,144       1,200  
Long-term debt:
               
Fixed rate notes
               
Due 2006 (weighted-average rates of 2.87% and 3.04%, respectively)
    494       519  
Due 2007 (weighted-average rates of 5.54% and 5.54%, respectively)
    813       813  
Due 2008 (weighted-average rates of 4.12% and 4.12%, respectively)
    603       603  
Due 2009 (weighted-average rates of 5.68% and 5.87%, respectively)
    648       542  
Due 2010 (weighted-average rates of 4.58% and 4.58%, respectively)
    557       557  
Due 2011 and thereafter (weighted-average rates of 4.98% and 4.71%, respectively)
    626       226  
Variable rate notes
               
Due 2006 (weighted-average rates of 5.23% and 4.78%, respectively)
    491       516  
Due 2007 (weighted-average rates of 5.33% and 4.93%, respectively)
    275       275  
Due 2008 (weighted-average rates of 4.80% and 4.38%, respectively)
    220       220  
Due 2009 (weighted-average rate of 4.67%)
    50        
                 
Long-term debt
    4,777       4,271  
Unamortized discount
    (4 )     (4 )
Fair value adjustments
    (75 )     (47 )
                 
Total long-term debt
    4,698       4,220  
                 
Total debt
  $ 5,842     $ 5,420  
                 


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Table of Contents

 
Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

 
The Company’s committed and uncommitted credit facilities at March 31, 2006 were as follows:
 
                         
    Facility Amount     Available Credit     Expiration  
    (In millions)  
 
Domestic Committed Lines of Credit:
                       
Textron Financial multi-year facility
  $ 1,000     $ 987       2010  
Textron Financial 364-day facility
  $ 500     $ 500       July 2006  
Textron multi-year facility
  $ 1,250     $ 1,224       2010  
Other Credit Facilities:
                       
Canadian dollar uncommitted credit facility
    CAD 50       CAD 45        
Australian dollar committed credit facility
    AUD 25       AUD 25       2007  
Multi-currency committed credit facility
  $ 25     $ 19       July 2006  
 
Textron Financial is permitted to borrow under Textron’s multi-year facility. Textron Financial’s available domestic lines of credit not reserved as support for outstanding commercial paper were $354 million at March 31, 2006, compared to $300 million at December 31, 2005. None of these lines of credit were drawn at March 31, 2006.
 
The weighted-average interest rates on short-term borrowings at March 31, 2006 and March 31, 2005 were as follows:
 
                 
    March 31,
    March 31,
 
    2006     2005  
 
Commercial paper
    4.81 %     2.83 %
Other short-term debt
    4.62 %     3.34 %
 
The combined weighted-average interest rates on these borrowings during the first quarters of 2006 and 2005 were 4.58% and 2.66%, respectively. 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 Company had interest rate exchange agreements related to the conversion of fixed rate debt to variable rate debt of $3.5 billion and $3.1 billion at March 31, 2006 and December 31, 2005, respectively, whereby the Company makes periodic floating rate payments in exchange for periodic fixed rate receipts. The weighted-average rate of these interest rate exchange agreements was 5.14% and 3.96% for the three months ended March 31, 2006 and March 31, 2005, respectively. The weighted-average rate on the remaining fixed rate notes was 5.52% and 5.62% during the three months ended March 31, 2006 and March 31, 2005, respectively.
 
Interest on Textron Financial’s variable rate notes is predominantly tied to the three-month LIBOR for U.S. dollar deposits. Textron Financial had $200 million of interest rate exchange agreements at both March 31, 2006 and December 31, 2005, related to the conversion of variable rate debt to fixed rate debt with a weighted-average fixed interest rate of 3.40%. The weighted-average interest rate on the remaining variable rate notes was 5.05% and 3.50% for the three months ended March 31, 2006 and March 31, 2005, respectively.
 
Securitizations are an important source of liquidity for Textron Financial and involve the periodic transfer of finance receivables to qualified special purpose trusts. The outstanding amount of debt issued by these qualified special purpose trusts was $1.9 billion and $2.0 billion for the periods ending March 31, 2006 and December 31, 2005, respectively.
 
Through its subsidiary, Textron Financial Canada Funding Corporation (“Textron Canada Funding”), the Company periodically issues 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 operations, revenues and cash flows related to the issuance, administration and repayment of debt securities that are fully and unconditionally guaranteed by Textron Financial.


11


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Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

 
The terms of certain of the Company’s loan agreements and credit facilities, under the most restrictive covenant, limit the payment of dividends to $302 million at March 31, 2006. In the first quarter of 2006, Textron Financial declared and paid dividends of $64 million.
 
Note 8.   Accumulated Other Comprehensive Income (Loss) and Comprehensive Income
 
Accumulated other comprehensive income (loss) is as follows:
 
                 
    Three Months Ended  
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Beginning of year
  $ 5     $ 1  
Foreign currency translation
          (5 )
Amortization of deferred loss on hedge contracts, net of income taxes of $0.3 million and $0.5 million, respectively
    1       1  
Net deferred loss on hedge contracts, net of income tax benefit of $2.1 million in 2005
          (5 )
Net deferred gain on interest-only securities, net of income taxes of $1.0 million and $0.9 million, respectively
    2       1  
                 
End of period
  $ 8     $ (7 )
                 
 
Comprehensive income is summarized below:
 
                 
    Three Months Ended  
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Net income
  $ 31     $ 22  
Other comprehensive income (loss)
    3       (8 )
                 
Comprehensive income
  $ 34     $ 14  
                 
 
Note 9.   Contingencies
 
On February 3, 2004, in the Court of Common Pleas for Knox County, Ohio, a purported class action lawsuit was commenced against the Company and Litchfield, certain of their current and former officers, and other third-parties, related to the financing of certain land purchases by consumers through a third-party land developer commonly known as “Buyer’s Source.” Among other claims, the purported class action alleges fraud and failure to disclose certain information in the financing of Buyer’s Source and seeks compensatory damages and punitive damages in excess of $10 million. The Company intends to aggressively defend this claim. The Company believes that the purported class action will not have a material effect on the Company’s financial position and results of operations.
 
Textron Financial is subject to challenges from tax authorities regarding amounts of tax due. These challenges may alter the timing or amount of taxable income or deductions, or the allocation of income among tax jurisdictions. Textron Financial is currently under examination by the Internal Revenue Service (“IRS”) for the years 1998 through 2003. The IRS has issued Notices of Proposed Adjustment that may affect certain leveraged lease transactions with a total initial net investment of approximately $94 million related to the 1998 through 2001 tax years. Resolution of these issues may result in an adjustment to the timing of taxable income and deductions that reduce the effective yield of the leveraged lease transactions and could result in a pre-tax adjustment to income.


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Item 1.   Financial Statements (Continued)

 
TEXTRON FINANCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

Management believes that the proposed IRS adjustments are inconsistent with then existing tax law and intends to vigorously defend the Company’s position. The resolution of these issues and the impact on the Company’s financial position and results of operations cannot be reasonably estimated 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.
 
Note 10.   Financial Information about Operating Segments
 
The Company aligns its business units into six 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 (non-core) that includes franchise finance, media finance, syndicated bank loans and other liquidating portfolios related to a strategic realignment of the Company’s business and product lines into core and non-core businesses.
 
                 
    Three Months Ended  
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Revenues:
               
Distribution Finance
  $ 59     $ 40  
Resort Finance
    30       21  
Golf Finance
    30       22  
Aircraft Finance
    28       22  
Asset-Based Lending
    21       16  
Structured Capital
    7       12  
Other
    7       8  
                 
Total revenues
  $ 182     $ 141  
                 
Income before income taxes: (1) (2)
               
Distribution Finance
  $ 22     $ 15  
Resort Finance
    13       2  
Golf Finance
    6       6  
Aircraft Finance
    7       6  
Asset-Based Lending
    1       6  
Structured Capital
    2       7  
Other
    (2 )     (9 )
                 
Income before income taxes
  $ 49     $ 33  
                 
 


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Item 1.   Financial Statements (Continued)

TEXTRON FINANCIAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) — (Continued)

                 
    March 31,
    December 31,
 
    2006     2005  
    (In millions)  
 
Finance assets: (3)
               
Distribution Finance
  $ 2,027     $ 1,710  
Golf Finance
    1,432       1,344  
Aircraft Finance
    1,342       1,278  
Resort Finance
    1,132       1,155  
Asset-Based Lending
    789       764  
Structured Capital
    699       704  
Other
    303       332  
                 
Total finance assets
  $ 7,724     $ 7,287  
                 

 
 
(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 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; investment in equipment residuals; Acquisition, Development and Construction arrangements; and other short- and long-term investments (some of which are classified in Other assets on Textron Financial’s Consolidated Balance Sheets).

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
TEXTRON FINANCIAL CORPORATION
 
Key Business Initiatives and Trends
 
Textron Financial Corporation (“Textron Financial” or the “Company”) is a diversified commercial finance company with operations in six segments: Aircraft Finance, Asset-Based Lending, Distribution Finance, Golf Finance, Resort Finance and Structured Capital. Textron Financial’s other financial services and products include transaction syndication, equipment appraisal and disposition, and portfolio servicing.
 
During the first quarter of 2006, we experienced significant growth in our managed finance receivable portfolio. Managed finance receivables grew by $365 million, or 4%, from year-end 2005, primarily in Distribution Finance, Golf Finance and Aircraft Finance. We expect continued growth in our core portfolios during 2006.
 
Portfolio quality statistics remained stable in the first quarter compared to year-end 2005. Nonperforming assets as a percentage of finance assets was 1.55% at March 31, 2006 compared to 1.53% at year-end 2005, and 60+ days contractual delinquency as a percentage of finance receivables improved to 0.67% at March 31, 2006 from 0.79% at year-end 2005. We expect relative stability in these statistics during 2006; however, we could experience an out-of-trend result in any one quarter.
 
Net interest margin as a percentage of average net investment (“net interest margin percentage”) decreased to 6.22% during the first quarter of 2006 as compared to 6.30% during the first quarter of 2005, primarily attributable to a lower proportion of other income and securitization gains to total revenue.
 
Operating efficiency (the ratio of selling and administrative expenses divided by net interest margin) improved during the first quarter of 2006 (44.8%) compared to the same period in 2005 (51.1%). The improvement is primarily the result of continued process improvement initiatives, which have enabled growth in the receivable portfolio without significant growth in staffing levels.
 
Financial Condition
 
Liquidity and Capital Resources
 
Textron Financial mitigates liquidity risk (i.e., the risk that we will be unable to fund maturing liabilities or the origination of new finance receivables) by developing and preserving reliable sources of capital. We use a variety of financial resources to meet these capital needs. Cash is provided from finance receivable collections, sales and securitizations as well as the issuance of commercial paper and term debt in the public and private markets. This diversity of capital resources enhances our funding flexibility, limits dependence on any one source of funds, and results in cost-effective funding. In making particular funding decisions, management considers market conditions, prevailing interest rates and credit spreads, and the maturity profile of its assets and liabilities.
 
As part of our commercial paper program, we have a policy of maintaining unused committed bank lines of credit in an amount not less than outstanding commercial paper balances. As of March 31, 2006, these lines of credit totaled $1.5 billion, of which $500 million was set to expire in July of 2006 and $1.0 billion in 2010. In April 2006, these facilities were combined into a single facility expiring in 2011, and the amount of available credit was increased to $1.75 billion. Lines of credit not reserved as support for outstanding commercial paper or letters of credit were $354 million at March 31, 2006, compared to $300 million at December 31, 2005. In addition, Textron Financial is permitted to borrow under Textron’s $1.3 billion revolving credit facility, which was set to expire in 2010. In April 2006, the Textron facility was amended to extend the expiration date to 2011. None of these lines of credit were drawn at March 31, 2006. At March 31, 2006, we had a CAD 50 million uncommitted credit facility, of which CAD 45 million remained unused. We also maintain an AUD committed credit facility, which was reduced to AUD 25 million and extended to January 2007 during the first quarter of 2006. At March 31, 2006, the entire facility remained unused. We also maintain a $25 million multi-currency committed credit facility, of which $19 million remained unused at March 31, 2006. This facility expires in July 2006 and we expect to renew it prior to expiration.
 
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 $4.0 billion. Under this


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
registration statement, Textron Financial issued $470 million of USD term debt and CAD 87 million of term debt during the first quarter of 2006. The proceeds from these issuances were used to fund receivable growth and repay short-term debt. At March 31, 2006, Textron Financial had $1.2 billion of capacity under this registration statement.
 
Cash flows provided by operating activities were $100 million during the first quarter of 2006, compared to $75 million in the corresponding period of 2005. The increase in cash flows was primarily due to the timing of payments of accrued interest and other liabilities.
 
Cash flows used by investing activities totaled $(488) million during the first quarter of 2006, compared to $(403) million in the corresponding period of 2005. The increase in cash flows used during the first quarter of 2006 was largely the result of a $71 million increase in finance receivable originations, net of cash collections and the absence of incremental sales of receivables, partially offset by increases in the sales of equipment on operating lease and other assets.
 
Cash flows provided by financing activities were $388 million during the first quarter of 2006, compared to $265 million in the corresponding period of 2005. The increase in cash flows during the first quarter of 2006 principally reflected a net increase in debt issued to fund asset growth, and a reduction in dividends paid.
 
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 85% at March 31, 2006, compared to 84% at December 31, 2005. Textron Financial’s ratio of earnings to fixed charges was 1.66x for the three months ended March 31, 2006, compared to 1.71x for the corresponding period in 2005. Commercial paper and Other short-term debt as a percentage of total debt was 20% at March 31, 2006, compared to 22% at the end of 2005.
 
During the first quarter of 2006, Textron Financial declared and paid dividends to Textron of $64 million, compared to dividends declared and paid of $99 million during the corresponding period of 2005. The decrease in 2006 was due to an increase in equity required to support our receivable portfolio growth. Textron contributed capital of $2 million to Textron Financial in both the first quarter of 2006 and 2005, which consisted of Textron’s dividend on the preferred stock of Textron Funding Corporation.
 
Off-Balance Sheet Arrangements
 
Textron Financial sells finance receivables utilizing both securitizations and whole-loan sales. As a result of these transactions, finance receivables are removed from the Company’s balance sheet and the proceeds received are used to reduce the Company’s recorded debt levels. Despite the reduction in the recorded balance sheet position, the Company generally retains a subordinated interest in the finance receivables sold through securitizations, which may affect operating results through periodic fair value adjustments. The Company also sells receivables in whole-loan sales in which it retains a continuing interest, through limited credit enhancement, in the form of a contingent liability related to finance receivable credit losses and, to a lesser extent, prepayment risk.
 
The Company utilizes off-balance sheet financing arrangements (primarily asset-backed securitizations) to further diversify the Company’s funding alternatives. These arrangements are an important source of funding. The Company did not utilize incremental off-balance sheet financing arrangements in the first quarter of 2006. Proceeds provided by these transactions generated $26 million in the first quarter of 2005. Proceeds from securitizations includes proceeds received related to incremental increases in the level of Distribution Finance receivables sold and excludes amounts received related to the ongoing replenishment of previously sold receivables with short durations. Gains related to these transactions amounted to $11 million in the first quarter of 2006 and $10 million in the first quarter of 2005. Securitization gains recognized in the first quarter of 2006 related to the recurring finance receivable sales into the Distribution Finance revolving securitization conduit. Cash collections on current and prior period securitization gains were $15 million and $14 million for the first quarter of 2006 and 2005, respectively.


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
 
Managed Finance Receivables
 
Managed finance receivables consist of owned finance receivables, and finance receivables that Textron Financial continues to service, but has sold in securitizations or similar structures in which substantial risks of ownership are retained. The managed finance receivables of our business segments are presented in the following table.
 
                                         
    March 31,
    December 31,
    Increase /
 
    2006     2005     (Decrease)  
    (Dollars in millions)  
 
Distribution Finance
  $ 3,310       36 %   $ 2,993       33 %   $ 317  
Aircraft Finance
    1,682       18 %     1,664       19 %     18  
Golf Finance
    1,503       16 %     1,435       16 %     68  
Resort Finance
    1,120       12 %     1,138       13 %     (18 )
Asset-Based Lending
    788       8 %     764       8 %     24  
Structured Capital
    675       7 %     689       8 %     (14 )
Other
    282       3 %     312       3 %     (30 )
                                         
Total managed finance receivables
  $ 9,360       100 %   $ 8,995       100 %   $ 365  
                                         
 
Managed finance receivables increased $365 million, primarily as a result of growth in the private brands and diversified products portfolios within Distribution Finance, the business credit portfolio within Asset-Based Lending, and the golf mortgage portfolio within Golf Finance. The increase was partially offset by higher collections, net of new finance receivable originations, in the Resort Finance portfolio and the maturity of a leveraged lease in the Structured Capital portfolio. The $30 million decrease in the Other segment represents the continued portfolio collections, prepayments and sales of the liquidating portfolios.
 
Nonperforming Assets
 
Nonperforming assets include nonaccrual finance receivables and repossessed assets. Textron Financial classifies receivables as nonaccrual and suspends the recognition of earnings when accounts are contractually delinquent by more than three months, unless collection of principal and interest is not doubtful. In addition, earlier suspension may occur if Textron Financial has significant doubt about the ability of the obligor to meet current contractual terms. Doubt may be created by payment delinquency, reduction in the obligor’s cash flows, deterioration in the loan to collateral value relationship or other relevant considerations.
 
The following table sets forth certain information about nonperforming assets and the related percentages of owned finance assets at March 31, 2006 and December 31, 2005, by business segment.
 
                                 
    March 31,
    December 31,
 
    2006     2005  
    (Dollars in millions)  
 
Resort Finance
  $ 28       2.52 %   $ 31       2.67 %
Asset-Based Lending
    23       2.87 %     6       0.81 %
Golf Finance
    13       0.93 %     13       0.99 %
Aircraft Finance
    11       0.79 %     14       1.07 %
Distribution Finance
    2       0.08 %     2       0.11 %
Other
    43       14.28 %     45       13.64 %
                                 
Total nonperforming assets
  $ 120       1.55 %   $ 111       1.53 %
                                 
 
The Company believes that nonperforming assets generally will be in the range of 1% to 4% of owned finance assets depending on economic conditions. Nonperforming assets increased $9 million in the first quarter of 2006 from year-end 2005. Improvements in Resort and Aircraft Finance were more than offset by a $17 million increase


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
in Asset-Based Lending. The increase in Asset-Based Lending was the result of two loans, which management does not believe represents a trend.
 
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 floating rate assets with floating rate liabilities limits Textron Financial’s risk to changes in interest rates. This strategy includes the use of interest rate exchange agreements. At March 31, 2006, floating rate liabilities in excess of floating rate assets were $144 million, net of $3.3 billion of interest rate exchange agreements on long-term debt and $103 million of interest rate exchange agreements on finance receivables.
 
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 finance receivables are generally tied to changes in the prime rate offered by major U.S. banks. As a consequence, 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”). The analysis also assumes that prospective receivable additions will be match funded, existing portfolios will not prepay and contractual maturities of both debt and assets will result in issuances or reductions of commercial paper. This shock test model, when applied to Textron Financial’s asset and liability position at March 31, 2006, indicates that an increase in interest rates of 100 basis points would have a negative impact on Textron Financial’s net income and cash flows of $0.2 million for the following twelve-month period.
 
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 match-funding objectives. The fair values of interest rate exchange agreements are recorded in either Other assets or Accrued interest and other liabilities on the Company’s Consolidated Balance Sheets. These agreements do not involve a high degree of complexity or risk.
 
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 agreements to convert foreign currency denominated assets, liabilities and cash flows into functional currency denominated assets, liabilities and cash flows. 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 foreign currency exposures to changes in currency rates. The notional amounts of outstanding foreign currency forward exchange contracts were $23 million and $39 million at March 31, 2006 and December 31, 2005, respectively. The fair values of foreign currency forward exchange contracts are recorded in either Other assets or Accrued interest and other liabilities on the Company’s Consolidated Balance Sheets. As the Company hedges all substantial foreign currency exposures which could impact net income, likely future changes in foreign currency rates would not have a significant impact on earnings.


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Table of Contents

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
 
RESULTS OF OPERATIONS
 
For the three months ended March 31, 2006 vs. March 31, 2005
 
Revenues and Net Interest Margin
 
A comparison of revenues and net interest margin is set forth in the following table.
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (Dollars in millions)  
 
Finance charges and discounts
  $ 145     $ 104  
Securitization gains
    11       10  
Rental revenues on operating leases
    7       7  
Other income
    19       20  
                 
Total revenues
    182       141  
Interest expense
    73       45  
Depreciation of equipment on operating leases
    4       4  
                 
Net interest margin
  $ 105     $ 92  
                 
Portfolio yield
    8.89 %     7.43 %
Net interest margin as a percentage of average net investment
    6.22 %     6.30 %
 
Finance charges and discounts increased during the first quarter of 2006, principally reflecting $948 million of higher average finance receivables ($17 million) and a higher interest rate environment ($24 million), partially offset by lower relative receivable pricing ($2 million). The increase in average finance receivables was primarily the result of growth in Distribution Finance, Asset-Based Lending, and Golf Finance. Receivable pricing remained fairly stable relative to the interest rate environment as the impact of competitive pressures in our markets was offset by the recognition of $4 million of loan discount in earnings, which resulted from the successful collection of loans purchased at a discount.
 
Net interest margin increased in the first quarter of 2006 despite a decrease in net interest margin percentage of 6.22% during the first quarter of 2006 compared to 6.30% in the corresponding period in 2005. The increase principally reflects growth in average finance receivables, partially offset by higher interest expense ($28 million) and a lower proportion of other income and securitization gains to total revenue. The reduced proportion of other income and securitization gains reflects a decrease in servicing income and securitization activity relative to portfolio growth. . The increase in interest expense reflects a higher interest rate environment ($27 million), and higher average debt levels to fund receivable growth ($6 million), partially offset by improved borrowing spreads ($5 million).
 
Selling and Administrative Expenses
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (Dollars in millions)  
 
Selling and administrative expenses
  $ 47     $ 47  
Selling and administrative expenses as a percentage of managed and serviced finance receivables
    1.91 %     2.03 %
Operating efficiency ratio
    44.8 %     51.1 %
 
Selling and administrative expenses were relatively unchanged during the first quarter of 2006 compared to the same period in 2005. Higher salaries and benefits expense ($4 million) were offset by process improvement initiatives, which have enabled growth in the receivable portfolio without significant growth in staffing levels, and


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
the recognition of an asset impairment charge ($2 million) in 2005 related to specialized computer software in the Other segment.
 
Provision for Losses
 
Allowance for losses on finance receivables is presented in the following table.
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Allowance for losses on finance receivables beginning of year
  $ 96     $ 99  
Provision for losses
    9       12  
Less net charge-offs:
               
Asset-Based Lending
    2        
Resort Finance
    1       4  
Distribution Finance
    1       2  
Golf Finance
          1  
Aircraft Finance
    1       1  
Other
          1  
                 
Total net charge-offs
    5       9  
                 
Allowance for losses on finance receivables end of period
  $ 100     $ 102  
                 
 
The decrease in the provision for losses during the first quarter of 2006 principally reflects sustained improvements in portfolio quality realized during 2005 as indicated by a stable nonperforming asset percentage (1.55% vs. 1.53%) and improvement in the 60+ days contractual delinquency percentage (0.67% vs. 0.79%). The decrease in net charge-offs reflects stabilization in portfolio quality primarily from improvements in overall general economic conditions, partially offset by an increase in net charge-offs in Asset-Based Lending.
 
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 or decreases in the allowance for losses for such assets.
 
Operating Results by Segment
 
Segment income presented in the tables below represents income before income taxes.
 
Distribution Finance
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Revenues
  $ 59     $ 40  
Net interest margin
  $ 43     $ 33  
Selling and administrative expenses
    19       16  
Provision for losses
    2       2  
                 
Segment income
  $ 22     $ 15  
                 
 
Distribution Finance segment income increased $7 million in the first quarter of 2006 due to an increase in net interest margin ($10 million), partially offset by higher selling and administrative expenses. The increase in net interest margin is the result of higher average finance receivables of $695 million ($10 million), improved


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
borrowing spreads ($5 million), partially offset by lower relative receivable pricing ($7 million). The increase in selling and administrative expenses ($3 million) was primarily a result of portfolio growth. Selling and administrative expenses as a percentage of average managed and serviced receivables improved to 2.38% as compared to 2.59% in the first quarter of 2005.
 
Resort Finance
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Revenues
  $ 30     $ 21  
Net interest margin
  $ 18     $ 13  
Selling and administrative expenses
    6       7  
Provision for losses
    (1 )     4  
                 
Segment income
  $ 13     $ 2  
                 
 
Resort Finance segment income increased $11 million during the first quarter of 2006 as compared to the corresponding period of 2005. The increase in segment income was primarily the result of higher net interest margin and lower provision for losses. The increase in net interest margin was largely the result of the recognition of a $4 million loan discount in earnings, which resulted from the successful collection of loans purchased at a discount. The lower provision for losses is principally the result of continued improvement in portfolio quality. Nonaccrual loans decreased by $12 million in the first quarter of 2006 compared to the same period in 2005.
 
Golf Finance
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Revenues
  $ 30     $ 22  
Net interest margin
  $ 13     $ 12  
Selling and administrative expenses
    5       5  
Provision for losses
    2       1  
                 
Segment income
  $ 6     $ 6  
                 
 
Golf Finance segment income was relatively unchanged in the first quarter of 2006 compared to the corresponding period in 2005. The increase in revenues is primarily due to a higher interest rate environment and $271 million of higher average finance receivables ($5 million). Net interest margin increased as higher revenues were partially offset by higher borrowing costs.
 
Aircraft Finance
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Revenues
  $ 28     $ 22  
Net interest margin
  $ 13     $ 11  
Selling and administrative expenses
    5       4  
Provision for losses
    1       1  
                 
Segment income
  $ 7     $ 6  
                 


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
 
Aircraft Finance segment income was relatively unchanged in the first quarter of 2006 compared to the corresponding period in 2005. The increase in revenues is the result of a higher interest rate environment and higher average finance receivables ($29 million). Net interest margin increased as higher revenues were partially offset by higher borrowing costs.
 
Asset-Based Lending
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Revenues
  $ 21     $ 16  
Net interest margin
  $ 12     $ 11  
Selling and administrative expenses
    6       5  
Provision for losses
    5        
                 
Segment income
  $ 1     $ 6  
                 
 
The decrease in Asset-Based Lending segment income in the first quarter of 2006 was primarily due to a $5 million increase in provision for losses, partially offset by higher net interest margin. The higher net interest margin is principally due to $157 million of higher average finance receivables ($2 million). The increase in provision for losses reflects specific reserving actions taken on two nonperforming accounts during the first quarter of 2006.
 
Structured Capital
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Revenues
  $ 7     $ 12  
Net interest margin
  $ 3     $ 8  
Selling and administrative expenses
    1       1  
                 
Segment income
  $ 2     $ 7  
                 
 
Structured Capital segment income decreased in the first quarter of 2006 reflecting a lower net interest margin, primarily due to lower average finance receivables and lower other income. The reduction in average finance receivables ($89 million) reflects the sale of a $78 million note receivable in the fourth quarter of 2005. The lower other income reflects a $2 million leveraged lease residual impairment charge recognized in the first quarter of 2006.
 
Other Segment
 
                 
    March 31,
    March 31,
 
    2006     2005  
    (In millions)  
 
Revenues
  $ 7     $ 8  
Net interest margin
  $ 3     $ 4  
Selling and administrative expenses
    5       9  
Provision for losses
          4  
                 
Segment loss
  $ (2 )   $ (9 )
                 
 
Other segment loss decreased during the first quarter of 2006 primarily reflecting lower provision for losses and lower selling and administrative expenses. The decrease in provision for losses primarily reflects the continued


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
liquidation of the portfolio and relative stability in portfolio quality. The decrease in selling and administrative expenses is primarily the result of an impairment charge ($2 million) recognized in 2005 related to specialized computer software, and an overall decrease in operating expenses as the portfolio continues to liquidate.
 
Net Income
 
Net income of $31 million for the first quarter of 2006 was $9 million (41%) higher than the corresponding period of 2005. The increase was primarily due to a $948 million increase in average finance receivables and a $3 million decrease in provision for losses resulting from stability in portfolio quality. Income taxes increased by $7 million due to higher operating income and a higher effective income tax rate. The increase in the effective income tax rate from 34.4% in the first quarter of 2005 to 36.1% in the first quarter of 2006 is primarily attributable to interest on tax contingencies, which is more fully discussed in Note 9 Contingencies, and to a reduction in tax exempt interest.
 
Selected Financial Ratios
 
                 
    Three Months Ended  
    March 31,
    March 31,
 
    2006     2005  
 
Net interest margin as a percentage of average net investment(1)
    6.22 %     6.30 %
Return on average equity
    12.10 %     8.85 %
Return on average assets
    1.65 %     1.26 %
Selling and administrative expenses as a percentage of average managed and serviced finance receivables(2)
    1.91 %     2.03 %
Operating efficiency ratio(3)
    44.8 %     51.1 %
Net charge-offs as a percentage of average finance receivables
    0.30 %     0.56 %
 
                 
    March 31,
    December 31,
 
    2006     2005  
 
60+ days contractual delinquency as a percentage of finance receivables(4)
    0.67 %     0.79 %
Nonperforming assets as a percentage of finance assets(5)
    1.55 %     1.53 %
Allowance for losses on finance receivables as a percentage of finance receivables
    1.39 %     1.43 %
Allowance for losses on finance receivables as a percentage of nonaccrual finance receivables
    102.1 %     108.6 %
Total debt to tangible shareholder’s equity(6)
    6.91 x     6.19 x
 
 
(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) Average managed and serviced finance receivables include owned receivables, receivables serviced under securitizations, participations and third-party portfolio servicing agreements.
 
(3) Operating efficiency ratio is selling and administrative expenses divided by net interest margin.
 
(4) Delinquency excludes any captive finance receivables with recourse to Textron. Captive finance 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.
 
(5) 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; Acquisition, Development and Construction arrangements; and short- and long-term


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
investments (some of which are classified in Other assets on Textron Financial’s Consolidated Balance Sheets). Nonperforming assets include independent and nonrecourse captive finance assets.
 
(6) Tangible shareholder’s equity equals Shareholder’s equity, excluding Accumulated other comprehensive income (loss), less Goodwill.
 
Recent Accounting Pronouncements
 
In the first quarter of 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155 “Accounting for Certain Hybrid Financial Instruments-An amendment of FASB Statements No. 133 and 140.” SFAS 155 requires evaluation of all interests in securitized financial assets to determine whether they represent either freestanding derivatives or contain embedded derivatives. These interests were previously exempted from such evaluation in SFAS 133. The statement permits any hybrid instrument, such as an interest in securitized financial assets containing an embedded derivative, to be accounted for at fair value as opposed to bifurcating and accounting for the embedded derivative separate from the host instrument. The statement also amends SFAS 140 by eliminating restrictions on a qualifying special purpose entity’s ability to hold passive derivative financial instruments pertaining to beneficial interests that are, or contain a derivative financial instrument. The Company will adopt SFAS 155 effective January 1, 2007. At March 31, 2006, the Company has not completed its evaluation of the impact of this statement on its interests in securitized financial assets.
 
The FASB also issued SFAS No. 156 “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140” in the first quarter of 2006. SFAS 156 requires all separately recognized servicing assets and liabilities to be initially measured at fair value and permits entities to choose to either subsequently measure servicing rights at fair value and report changes in fair value in earnings, or amortize servicing rights in proportion to, and over the estimated net servicing income or loss and assess the rights for impairment or the need for an increased obligation. The option to subsequently measure servicing rights at fair value will allow entities which utilize derivative instruments to hedge their servicing rights to account for such hedging relationships at fair value and avoid the complications of hedge accounting under SFAS 133. Textron Financial does not utilize derivative instruments to hedge its servicing rights as of March 31, 2006. The Company will adopt SFAS 156 effective January 1, 2007 and will likely utilize the amortization method to subsequently measure its servicing rights. The adoption of this statement is not expected to have a material impact on the Company’s financial position or results of operations as the Consolidated Balance Sheets do not contain a significant balance of servicing assets at March 31, 2006.
 
Forward-looking Information
 
Certain statements in this quarterly report on 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 speak only as of the date on which they are made, and we undertake no obligation to update or revise any forward-looking statements. 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 slowdowns or downturns in customer markets in which Textron products are sold or supplied and financed or where we offer financing; (c) the ability to realize full value of receivables and investments in securities; (d) the ability to control costs and successful implementation of various cost reduction programs; (e) increases in pension expenses related to lower than expected asset performance or changes in discount rates; (f) the impact of changes in tax legislation; (g) the ability to maintain portfolio credit quality; (h) access to debt financing at competitive rates; (i) access to equity in the form of retained earnings and capital contributions from


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Textron; (j) uncertainty in estimating contingent liabilities and establishing reserves tailored to address such contingencies and (k) performance of acquisitions.
 
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
 
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 were no changes in Textron Financial’s internal control over financial reporting during the quarter ended March 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION
 
TEXTRON FINANCIAL CORPORATION
 
Item 6.   Exhibits
 
         
  12     Computation of Ratio 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 18 U.S.C. Section 1350
  32 .2   Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350


26


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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.
 
Textron Financial Corporation
 
/s/  Thomas J. Cullen
Thomas J. Cullen
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Date: May 5, 2006


27

EX-12 2 b60731tcexv12.txt EX-12 COMPUTATION OF RATIO OF EARNINGS TO FIX CHARGES. EXHIBIT 12 TEXTRON FINANCIAL CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (DOLLARS IN MILLIONS)
THREE MONTHS ENDED MARCH 31, 2006 Income before income taxes............................... $ 49 -------- FIXED CHARGES: Interest on debt......................................... 73 Estimated interest portion of rents...................... 1 -------- Total fixed charges...................................... 74 -------- Adjusted income.......................................... 123 Ratio of earnings to fixed charges (1)................... 1.66x ========
(1) The ratio of earnings to fixed charges has been computed by dividing income before income taxes and fixed charges by fixed charges. Fixed charges consist of interest on debt and one-third rental expense as representative of interest portion of rentals.
EX-31.1 3 b60731tcexv31w1.txt EX-31.1 SECTION 302 CERTIFICATION OF CEO EXHIBIT 31.1 TEXTRON FINANCIAL CORPORATION CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO RULE 13a-14(a) I, Ted R. French, Chairman and Chief Executive Officer of Textron Financial Corporation certify that: 1. I have reviewed this quarterly report on Form 10-Q of Textron Financial Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 5, 2006 /s/ Ted R. French -------------------------- Ted R. French Chairman and Chief Executive Officer EX-31.2 4 b60731tcexv31w2.txt EX-31.2 SECTION 302 CERTIFICATION OF CFO EXHIBIT 31.2 TEXTRON FINANCIAL CORPORATION CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO RULE 13a-14(a) I, Thomas J. Cullen, Executive Vice President and Chief Financial Officer of Textron Financial Corporation certify that: 1. I have reviewed this quarterly report on Form 10-Q of Textron Financial Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 5, 2006 /s/ Thomas J. Cullen --------------------------------------- Thomas J. Cullen Executive Vice President and Chief Financial Officer EX-32.1 5 b60731tcexv32w1.txt EX-32.1 SECTION 906 CERTIFICATION OF CEO EXHIBIT 32.1 TEXTRON FINANCIAL CORPORATION CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Textron Financial Corporation (the "Company") on Form 10-Q for the period ended March 31, 2006 as filed with the Securities and Exchange Commission on the Date hereof (the "Report"), I, Ted R. French, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Textron Financial Corporation Date: May 5, 2006 /s/ Ted R. French --------------------------------------- Ted R. French Chairman and Chief Executive Officer EX-32.2 6 b60731tcexv32w2.txt EX-32.2 SECTION 902 CERTIFICATION OF CFO EXHIBIT 32.2 TEXTRON FINANCIAL CORPORATION CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Textron Financial Corporation (the "Company") on Form 10-Q for the period ended March 31, 2006 as filed with the Securities and Exchange Commission on the Date hereof (the "Report"), I, Thomas J. Cullen, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Textron Financial Corporation Date: May 5, 2006 /s/ Thomas J. Cullen --------------------------------------- Thomas J. Cullen Executive Vice President and Chief Financial Officer
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