Business context and reporting period
Textron Inc. filed this unaudited Form 10-Q for the quarter ended September 29, 2018, with nine-month results also compared with the prior-year periods. The filing period is 2018 Q3, notwithstanding the request metadata specifying 2017 Q3. Textron reports Textron Aviation, Bell, Textron Systems, Industrial and Finance segments.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $3.200B | $3.484B | $10.222B | $10.181B |
| Income from continuing operations | $563M | $159M | $976M | $412M |
| Diluted EPS, continuing operations | $2.26 | $0.60 | $3.80 | $1.53 |
| Manufacturing gross margin | 15.6% | 16.8% | 16.6% | 16.3% |
| Operating cash flow, continuing operations | Not stated for quarter | Not stated for quarter | $697M | $365M |
Third-quarter revenue declined 8%; nine-month revenue was essentially flat, up $41M. The reported profit increase includes a $444M pretax ($410M after-tax) gain from selling Tools and Test Equipment. Q3 segment profit was $99M at Textron Aviation, $113M at Bell, $29M at Textron Systems, $1M at Industrial and $3M at Finance. Industrial’s Q3 margin fell to 0.1% from 4.7%; other reported Q3 margins were Aviation 8.7%, Bell 14.7% and Systems 8.2%.
At September 29, 2018, cash and equivalents totaled $1.293B ($1.150B Manufacturing and $143M Finance). Manufacturing debt was $3.078B and Finance debt $788M; Manufacturing net-debt-to-capital was 26%. Total assets were $14.669B and shareholders’ equity $5.543B. The company had no borrowings under its $1.0B revolving credit facility, which expires in September 2021.
Nine-month investing cash flow was $734M, including $807M net proceeds from the divestiture and $233M of capital expenditures. Financing cash flow was negative $1.390B, chiefly reflecting $1.383B of share repurchases. Operating cash flow improved in part because pension contributions fell to $37M from $338M.
Material changes versus prior comparable periods
- Q3 revenue declined across all segments. The divested product line reduced Industrial revenue; lower Systems volume and Bell commercial mix also weighed on sales.
- Nine-month revenue growth at Aviation, Bell and Industrial was largely offset by lower Systems revenue. Systems’ decline included the discontinuance of its sensor-fuzed weapon product.
- Q3 manufacturing gross margin declined 120 basis points, mainly from weaker Industrial margins; Aviation pricing and Bell performance partly offset the pressure.
- ASC 606 adoption changed revenue timing, particularly for certain U.S. Government contracts now recognized using cost-to-cost progress. Comparatives were not restated. The company reported nine-month revenue $225M higher and net income $35M higher than under prior accounting; reported operating cash flow was unchanged.
- Backlog/remaining performance obligations increased to $8.653B from $7.184B at year-end 2017, led by Bell. Bell’s backlog includes its share of a multiyear V-22 contract for 58 aircraft and related support through 2024.
Outlook, commentary, risks and unusual items
- The filing provides no specific full-year earnings or revenue guidance. Management said it expects sufficient cash for future needs from existing balances, operating cash generation and other funding alternatives.
- Of $8.7B in remaining performance obligations, Textron expects to recognize about 62% through 2019, a further 22% through 2021, and the balance thereafter.
- Management said Arctic Cat/Specialized Vehicles results were significantly below expectations in Q3, including because dealer sell-through lagged. It was assessing its go-to-market strategy, dealer network and cost reductions; an impairment of certain long-lived assets was reasonably possible in Q4.
- Contract estimates are judgment-sensitive. Cumulative catch-up adjustments increased segment profit by $63M in Q3 and $167M in the first nine months of 2018; management cautioned that cost overruns, inflation, engineering changes or missed milestones could materially reduce earnings.
- The 2018 effective tax rates were 10.4% for Q3 and 11.8% year to date, reflecting primarily the disposition’s tax treatment; the year-to-date rate also included a $25M benefit from reassessing uncertain tax reserves.
- Risks include U.S. Government funding and contract performance, defense budget changes, supplier and subcontractor issues, demand and foreign-exchange volatility, Finance portfolio credit quality, and integration or performance of acquisitions. Textron said existing legal proceedings were not expected to materially affect its financial position or results; a substantial Fair Finance-related claim remained pending in part.
Important facts for investors to verify
- How much of reported earnings growth is attributable to the $410M after-tax divestiture gain, and what are the post-closing adjustments?
- How ASC 606 contract timing and the favorable catch-up adjustments affect sustainable revenue, margins and earnings.
- Whether Industrial/Specialized Vehicles performance improves and whether a Q4 impairment is recorded.
- Execution and profitability of the V-22 backlog, other major contracts, and the $8.7B remaining performance obligations.
- Capital allocation after $1.383B of repurchases, liquidity and debt levels, and the Finance segment’s delinquency trends.