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Executives

Lewis Campbell - Chairman & Chief Executive Officer

Scott Donnelly - President & Chief Operating Officer

Doug Wilburne - Vice President of Investor Relations

Analysts

Steve Tusa - JP Morgan

David Strauss - UBS

Jeff Sprague - Citigroup

[Scott Brugle] - Davidson Kempner

Cai von Rumohr - Cowen & Co.

Noah Poponak - Goldman Sachs

Shannon O’Callaghan - Barclays

Ron Epstein - BOA

Robert Stallard - Macquarie

Textron Inc. (TXT) Q2 2009 Earnings Call July 28, 2009 9:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Textron second quarter earnings conference call. At this time all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session. (Operator Instructions) As a reminder this conference is being recorded.

I would now like to turn the conference over to our host, Doug Wilburne, Vice President of Investor Relations, please go ahead.

Doug Wilburne

Thanks Teddy and good morning everyone. Before we begin I’d like to mention our discussion today will include remarks about future estimates and expectations. These forward-looking statements are subject to various risk factors, which are detailed in our filings and also into today’s press release.

You can also find an earnings call presentation slide deck containing key data items from today’s call in the Investor Relations section of our website. We will be referring to those slides during the process of the call so be sure to pull those down. On the call today we have Lewis Campbell, Textron’s Chairman and CEO and Scott Donnelly, Textron’s, President and Chief Operating Officer.

Moving now to second quarter results, revenues in the quarter were $2.6 billion, down 29% from a year ago, which yield-to-date GAAP loss of $0.22 per share. Adjusted earnings from continuing operations excluding restructuring charges were $0.08 per share, down $0.90 from a year ago.

Textron recorded second quarter pre-tax special charges of $129 million associated with the company’s restructuring program. This included $43 million in non-cash impairment related to the cancellation of the Citation Columbus development program, and $25 million of non-cash charges associated with recognition of pension related prior service cost triggered by headcount reduction.

Manufacturing operations provided $27 million of positive cash flow during the second quarter. This positive cash flow was achieved despite incurring cash payments of $77 million in return customer deposit at Cessna and $39 million for enterprise restructuring. Now let’s examine the major drivers that drove over the $0.90 year-over-year reduction in adjust EPS, which are outlined on slide four of the earnings call presentation.

As you would expect, the largest driver was lower manufacturing volume which drove $0.86 of the reduction. TFCs lower earnings contributed $0.29 to the decline in EPS and used aircraft valuation adjustments at Cessna cost $0.10.

We achieved positive pricing of 1.4%, which added $0.09 per share. This is partially offset by $0.06 of inflation, reflecting an inflation rate of .8%. Overall cost performance including selling, general and administrative benefited the quarter by $0.29. Tax rate changes contributed $0.02 and miscellaneous items provided a penny.

With that I’ll turn the call over to Lewis.

Lewis Campbell

Thanks Doug and good morning everyone. Once again this quarter we had real solid performances that balance systems. On the other side of the coin so to speak, we continued to experience market challenges at Cessna, industrial and finance.

Looking on the positive side though we generate manufacturing cash flow, that was positive this quarter which reflected our efforts to improve working capital productivity and lower cost. This is a specially noteworthy considering the significant volume decline experienced at Cessna and industrial. So, I think it’s a job well done on the second quarter on cash.

Finally, we made a significant progress liquidating non-GAAP refinance receivables at TFC once again. We had a gross reduction of about $1.3 billion during the second quarter and cash conversion even better than what we expected.

So, this brings us to a year-to-date reduction of $2.2 billion, which is nearly half of our original two year target of $4.5 billion. So, as you might expect with that success that we just demonstrated in Q2 we now increased our two year reduction target from $4.5 billion all the way up to $5.2 billion.

With this in mind, let’s take a look at our updated 2010 liquidity plan. I’ll take a minute here to gets you turning over to slide five and that’s our cash summary slide. If you then start on the second line labeled TFC receivable liquidation, there you see that we’ve recorded the actual second quarter amount of $1.28 billion and reflected our higher two year goal in the full year 2009 and 2010 calls.

On the next line, we’ve reduced the ‘09 manufacturing cash flow projection by $50 million to $350 million reflecting lower expected jet deliveries, which we’ll discuss later. We’ve added the $775 million in proceeds from the equity and convert offerings we completed in May and moving down to the term debt payments line, the annual amounts are higher than in previous version as we’ve been opportunistically retiring debt that is coming due in the next three years at meaningful discounts.

So far we’ve actually repurchased $393 million of face value debt at an average discount of almost 8%, and earlier this month, we consummated a $500 million facility with Ex-Im Bank for funding Cessna’s and Bell’s International customer purchases.

Expected proceeds from the Ex-Im facility, we actually spread across two years and the spread between 2009 and 2010 as we show on the chart. Next, the second quarter $648 million securitization payment actually includes a $150 million early payoff, again economically motivated on our part.

Finally, we paid off a $410 million advance we took against our company-owned life insurance program COLI, obviously we can re-borrow that at any time, but we don’t see the need to have that borrowing at the present time, so we paid it back. In total then this result in a projected 2010 cash balance of just under $1.5 billion which is $1.3 billion better than our original plan.

Now once you heard the cash story, let’s go to slide six and this will then summarize our liquidity position. Our total liquidity improvement consists of the higher cash, plus $111 million in a lower 2010 debt balance, which represents that portion of the $393 million in repurchased debt.

That would have matured after 2010, and the retirement of the $410 million insurance advanced I just mentioned. So we’ve improved our 2010 liquidity position by almost $1.8 billion from our original plan which I believe is very good progress.

Moving to operations, we continue to focus on managing our commercial businesses for the slower economy. Our efforts are clearly evident in the fact that industrial generated positive profits and cash in the quarter in the face of volumes being down to 36%.

At Cessna, market weakness continued with net cancellations consisting of 74 Columbus orders, 59 from large fleet operators, 58 from our authorized sales reps and finally 52 from across the remainder of the order book.

If you look at the balance of the year, we now have a 124 sold positions remaining for delivery during the second half. So, including the 84 deliveries made in the second quarter and 69 deliveries made in the first that bring us to 277 sold aircrafts for 2009.

So, we are now basing our ‘09 operating forecast on a delivery expectation of about 275 units, and as we look at the quality of the remaining ‘09 backlog, we believe we should be able to offset any further cancellations or deferrals with new ‘09 orders. With respect to order flow, we saw ‘09 cancellations stabilize somewhat in June, that's good news.

We also saw a modest improvement in new orders in June and let me give you the figures. During the first five months of the year, we averaged about three new gross orders per month. However, in June we booked seven all for delivery in 2009.

Now, seven gross orders remains low obviously, and one months experience is not establish a trend, but there were other data points from the marketplace that were carefully tracking that also look a bit positive. For example the number of used citation transactions also picked up in June and we saw stabilization in used pricing.

Correspondingly, the availability of used citations dropped slightly to 17.3% from 17.6% in May, which is actually the first time this measure has dropped in over a year. The daily usage declined within the fleet also leveled-off in June. In fact ADUs were up slightly in Europe. One final point on-demand, our Ex-Im financing facility while improving liquidity will also support international purchases.

So, we are not quite ready to call the bottom yet, but based on that data we are sure hoping that a period of stability is just around the corner, which should lead to further improved visibility at Cessna.

As I’ve said, when I began the call fortunately Bell and Textron Systems which are heavily defense and civil service oriented have been largely unaffected by the economy. They continue to perform well and are very well-positioned for solid growth.

We’re executing the ramp up of the V-22, the H-1 and the unmanned aircraft systems and a host of other programs. For example, the Bell Commercial model 429, has just received Canadian and FAA-Certification earlier this month.

We believe that with 30% greater cabin volume in any other model in its class, the 429 should be well received in the EMS and other utility markets and should contribute to Bell’s future growth over long period of years.

My final topic today concerns two important executive announcements we’re making this morning actually, they were made with releases that came out at the same time that our earnings were released.

First, I am very pleased to announce that Frank Connor would be coming on board as Executive Vice President and Chief Financial Officer, effective August 1. Frank is a 22 year veteran of Goldman Sachs and Company, where most recently he was Managing Director and Head of Telecom Investment Banking there.

He has advised many companies, across a wide range of industries and executed numerous public and private financings and strategic transactions. Frank will be based right here in Providence. He will also receive all the company’s financial activities and including the business units CFOs and their respective organizations. One final note, TFC will continue to report to Scott Donnelly.

I believe Frank will be a great addition to the Textron team as we focus on improving operating efficiency, enhancing cash flow and preparing the company for our future growth over the long term.

I would be remiss if I didn’t take a minute to thank Dick Yates for his great work he’s done, not only as our Senior Vice President and Controller, but he also stepped in as our Acting CFO for the past six months, and I think we’ve done a magnificent job there on liquidity, cash flow in just playing around the operations.

Today we also announced John Garrison, who was previously heading our Industrial segment as the new President and CEO of Bell helicopter effective August, 1. He’s replacing Dick Millman, who is retiring after 43 years with the company.

Scott will have more to say about this later, but I want to take the opportunity also to acknowledge Dick. He’s been with us for 43 years. He is certainly accomplished a great deal and he is provided excellent leadership during his long career at Textron especially while he’s been at Bell.

Let me wrap up. Our liquidity plan is clearly working and we demonstrated meaningful progress once again in the second quarter. Even though we expect and incurred $150 million of pre-tax cash restructuring charges, we’re forecasting 2009 manufacturing cash flow in the range of $300 million to 400 million.

As we offset a portion of lower expected cash at Cessna, with higher expected cash from the rest of our manufacturing unit. We’re maintaining our EPS outlook from continuing ops before special charges between $0.33 and $0.36 for the year.

I’ll close with the following point. We obviously are focused on cash generation and we’ve remain committed to improving our core manufacturing capabilities and efficiencies. In combination with our continued investment in new products, we should position ourselves to generate significant shareholder value when we emerged from this downturn.

With that I’ll turn it over to, Scott. Scott.

Scott Donnelly

Thanks, Lewis. Good morning, I’d like to start talking about our manufacturing businesses as Lewis referenced, we did generate $27 million in free cash flow in the quarter, again ahead of our plan. I think this reflects the improvements we continue to make in working capital and overall operational efficiencies. In fact our inventory programs in particular are getting traction as we’ve reduced inventory in the quarter by about $300 million.

If you look at Cessna; Cessna revenue was down 42% driven by lower volumes. Profits down also, again primarily driven by lower volume, but also we incurred $38 million charge for lower our used aircraft values. These were partially offset by $38 million benefit from forfeited customer deposits.

I believe that used valuations appear to be stabilizing in June, so we would expect that number in terms of lost to moderate through the balance of the year. Similarly, we would expect a fewer benefits forfeited customer deposits again through the balance of this year.

As we discussed in the first quarter call, Cessna consumed a considerable amount of cash in both the first and second quarter, as we continued at an accelerated production rate. We now expect Cessna will generate a significant amount of cash in the third and fourth quarter as we burn off that inventory particularly through finished goods.

Later cash flow obviously will depend on the actual number of new and used aircrafts that are delivered. Again we expect a significant improvement over the first couple of quarters.

We did take two major actions in the quarter at Cessna. As previously announced, we have elected to cancel the Columbus program. This is very unfortunate, but the realities of the marketplace create an uncertainty around that aircraft, we felt it this time in this market. We were better to spend our R&D to really defend our core in the small to mid size business jet market.

Second, we have continued our further production rates and layoffs at Cessna to make sure we align our capacity with the demand in the marketplace. Our team has just returned last week and we now have what we believe is a workforce and a production rate that will maintain through the balance of 2009 and 2010, consistent with what we believe our deliveries will be.

We have a lot more work to do obviously, but I think the fact that we now appear to be a stable point in the market and have a good feel for the actual production demand. We can continue to make operational efficiencies and the right moves in that business.

Industrial segment revenues were down 40%, primarily driven by volume with some unfavorable foreign exchange. Despite this we were able to drive $12 million in profit, in solid cash flow. This is reflection of the team’s work and restructuring in cost at last year’s commodity action prices.

Kautex in particular, returned to profitability in the quarter and we believe that we’ve seen some stabilization and actually a potential for some increasing volume, reflecting the bottoming of the global automotive market. So industrial margins, we believe as a result of the restructuring activities, when the volume return would be good performing businesses, not just at Kautex, but also E-Z-GO, Jacobsen and Greenlee.

The Textron business revenues were up 2% in the quarter, primarily driven by higher defense volumes, offset somewhat by lower Lycoming volumes reflecting the slowdown of the general aviation market. Even in the general aviation market, we feel pretty good about where we are positioned right now with Lycoming. If fact this week at the Oshkosh Air Show, we’re introducing the new innovated electronic engine, which really gives us some terrific breakthrough technology and differentiation in that market going forward.

The defense business continues to grow. We see strong demand for both ASVs and our Shadow Unmanned Air Vehicles from U.S. government, as well as the increasing opportunities in the international marketplace, and we have a couple of [Inaudible] products named as Scorpion and Spider in the Ground Weapons Systems area that we think will continue to generate good growth into the future.

Clearly, I think we’re all expecting to see top line acquisition budgets decline in the coming years, but we believe that our products and the nature of how our products are used in the sort of complex that we’ll continue to see growth in these businesses despite an overall top line decline.

Bell had very solid results in the quarter despite a slight revenue decline. Our military revenue was down primarily as a result of the cancellation of ARH development program, and some lower support for the H-1 program, offset by V-22 higher volumes.

Commercially, while revenues were down slightly, the number of deliveries was up, 35 aircrafts versus 31 a year ago. The slight decline of revenue was just a mix shift away from 412 Aircraft, 407’s and 206’s. The margins were strong, solid improved performance in the business. We’re actually generating significant solid cash generation out of Bell, despite the fact that we continue to ramp V-22, the VH-1 and now the commercial 429 program.

We also reserved certification from the Defense Contract Management agency for our Earned Value Management System. This is a significant milestone for the business as it demonstrates the right management program control systems are in place at Bell, which supports our ongoing program, as well as credibility for future program opportunities.

We also reached agreement with our unionized employees, who have been out on strike for about six weeks and UAW 218, that team returned to work yesterday. We’re glad to have them back. We can now focus on the competitiveness and capable in that business.

As Lewis mentioned, we also made an announcement this morning with the change of leadership. Dick Millman, will be retiring after 43 years. He’s done a great job at Bell for the last couple of years. I think he leaves that business very well position in terms of our execution on military programs, the new certification of the 429 and obviously the important milestone of getting our union contracts negotiated.

John has been with us for a number of years, most recently running the industrial segment, he had great leadership skills and I think he’ll be a great long term leader for the Bell business.

Let’s talk about TFC. As Lewis mentioned, our liquidation plan is continue to make meaningful progresses. The receivables now at $8.6 billion versus $10.8 billion at the beginning of the year, so we remain ahead of plan in terms of the runoff rate of liquidation.

As expected we are seeing continuing challenges in the credit markets, as a result of our liquidation and ongoing softening of the economy. 60 day plus delinquencies were up 6.2%, compared to 4.9% in the first quarter. Non-accruals rose to 10.04%, up from 6.11% in the first quarter, and this increase is primarily driven by a $149 million of increased non-accruals in our result portfolio, $95 million of which came from one single account and also a $32 million non-accrual out of our structured finance.

I assure you it’s important to mention that non-accruals don’t typically have full value losses, generally these are accounts that are supported by substantial collateral values. We try to maintain a very conservative policy with respect to non-accruals, so we don’t just have accounts that have gone delinquent, but in fact accounts that we believe have a probability of not returning their footprints upon interest. In fact just as a note, of the $683 million that we have non-accruals in the second quarter, $400 million of those accounts are actually not delinquent.

The good news on the credit front was that our actual charge-offs were only $23 million versus $47 million in the first quarter. In the second quarter there is a loss of $99 million which reflected several things higher loss provisions, higher portfolio losses and securitization impairments. These were partially offset by $37 million gain on the early debt retirements.

Loss provisions were $87 million. We increased our reserves by $64 million including one large $32 million structured finance account. Our portfolio losses were $50 million, this included $22 million in discount and pay offs from redistribution program. I think it’s important to note, as we’ve been going through these reductions, we are tackling some of the tougher assets to make sure that we do the right things here in terms of timing of these liquidations.

The marine distribution program is a good example of that. Those $22 million in pay offs were incurred as we made a special program to clear out ‘07 and ‘08 boat inventory, on our basic belief that it’s better to remove these older boats from the inventory now rather than wait for another season, were likely the assets will achieve even lower values. So in the marine portfolio, we started the year with $585 million. We finished the quarter at $300 million and these liquidations continue fairly strong into July as well.

So our success is not just been in boats, but across all of our distribution finance assets. In fact if we look at repossessed assets, they were actually reduced by $19 million in the quarter. This reflects our ability to take those repossessed assets and mark them accordingly and actually move those into the marketplace.

Slide seven, I think is very important. If you look at our largest liquidations continue to be out of distribution of $800 million and our asset baseline business of $230 million. In the quarter, we did reach agreement with two of our private brand customers to move those relationships to other financial institutions. At the time we negotiated those arrangements, we have $320 million of receivables.

These instruments allow us to forward funding to the new financial institution, and then we run off the balance of the receivables. Just to give you an idea, we signed those agreements in the beginning of June and have since been able to reduce that to $320 million by $50 million in June alone.

We also had one portfolio sale in our ABL business, $109 million sale at a value that was consistent with the mark-to-market, when we put those assets into our held for sale account. In the golf business, we had 12 mortgage payoffs and then one of our owned golf courses sold in the quarter for a total value of about $50 million.

Slide eight, as you look at all these liquidations receivables, you can see that our cash conversion rate in the quarter was 94% even with the discount programs, this is ahead of our expectations. We still expect the conversion rate will decline overtime, but we are certainly very encouraged by the results in the quarter.

So, in summary, I’d say that we continue to make excellent progress in terms of the rate of our liquidation and it demonstrates substantial collateral, liquidation value that we have in the portfolio and we believe strong cash conversion rates, for such aggressive liquidation.

In summary, I want to talk about our restructuring program. We have announced that we are increasing the program charges in 2009 to $200 million from $75 million. This reflects some non-cash items, such as the Columbus and the pension curtailment programs, but also more aggressive reductions in terms of employees across the company and primarily incurring employee severance expenses. So, we will have a total headcount reduction associated program now through the balance of the year of about 10,000 people.

So in summary, I think if you look at our businesses balance systems, continue to have a very strong performance. The TFC liquidations were ahead of schedule with strong cash conversion. Industrial business returning to profitability is a great sign of the strength that we have today in that business and the potential going forward, and also late in the quarter we did see early signs of stabilization in the business jet market.

So I don’t think any of us are bullish at this stage of the game. I think the fact that it appears to be stabilizing boards well for the start of the beginning for the recovery. So, I think Q2 demonstrate we have the right programs to maximize both our operational efficiencies and cash generation and clearly we will continue to take those actions to improve the business going forward.

Doug Wilburne

Thanks Scott. We’ll wrap up today. I just want to point out that everybody that we have three additional slides. Slide number nine is the chart that lays out segment revenue and profitability forecast associated with our EPS guidance.

Slide 10 contains our forecast for corporate items and then finally on slide 11 we have our quarter organic sales growth breakdown. So, Teddy with that, we’re pleased to take calls at this time.

Question-and-Answer-Session

Operator

Your first question comes from Steve Tusa - JP Morgan.

Steve Tusa - JP Morgan

Just a quick question; on the longer term Cessna outlook, what would you expect under the assumption of a very muted recovery. I guess I’m wonder what your longer term margin target would be for Cessna. Where would you be under a reasonable volume scenario? Where would you be kind of happy with the normalized type of margin number at Cessna?

Lewis Campbell

Steve, I think the recovery question is a tough one. We’re still predicting that we’ll have lover deliveries next year than we had this year, and that would be the bottom of the cycle and then you will start to see a recovery which obviously is going to be very hardly dependent on what the economy recovery look like.

We think the margin rate for the total of this year is going to be somewhere in that 5% kind of range. Obviously our expectations are to try to sustain that or even grow that as we go into 2010 given somewhat lower volumes and then continue to see that growth and we get better leverage as volumes return to business going forward.

Steve Tusa - JP Morgan

I guess my question, you’re making these cost reductions, you must have some sort of view on even at lower volume levels what you want to do. I’m trying to get a sense. Is it modestly above where it is today, is it double-digit. How should we think about a longer term? You guys must have that at the top of your mind, as you are making all theses moves on the cost side.

Scott Donnelly

Longer term, obviously we would expect this business to get back up into the mid teens where we’ve seen it before where we had higher volumes. I think our expectations here in the next couple of years, again obviously this is highly volume dependent as things start to turn, but I have to say that we want to achieve better margins, but we are making substantial investment in the R&D of this business over the next couple of years.

So, we have a lot of work yet to do frankly in terms of how we make sure that leveraging the base cost, the fix cost that we have in this business in terms of our manufacturing footprint and we’ll need to continue to take more action there I believe, but we’ll also have to be sensitive to the fact that we are at a unusually low volumes. We can’t let that influence our R&D investment or we won’t have the right products in the right places when the thing covers.

So I would expect Steve, you’d see this thing come from the 5% and slowly grow back up towards those mid teens are we’ve been in the past.

Steve Tusa - JP Morgan

How many jets in the backlog now and what is the pricing like in that backlog? Is there any movement on the price of those jets?

Scott Donnelly

We haven’t moved anything on the pricing, obviously as customers have come up with their deliveries. There’s been discussion and we’ve been trying to help some folks in terms of service something like that. We are trying to stay away from, much in the way of pricing. Obviously the Aircraft in the backlog were priced at the time the deals were done. So, we have contracts for that. Pricing is still up somewhat this year and we are going to try to hold that.

I don’t think this is a market where this is all about pricing. This is really more about, where is the demand in the economic recovery and I think as we look at June, we actually saw some customers come in at reasonable price points even for 2009 deliveries for guys that went even in the backlog.

Lewis Campbell

Hi Steve its Lewis. Let me add just one more point to Scott’s points. Out strategy at Cessna is rock solid and I think its very sound.

Remember it’s under core or underpinning in two areas. One, to keep the Mustang selling at above 100 if you can, because what that does, is brings people into the fleet and our customer’s fab numbers have never been better. So we know that once we get someone into Cessna, they’re probably going to buy another one. Remember, our numbers used to be seven out of ten or repeat customers. So we’ve got a flock of people now getting into the Cessna family, that’s number one.

As Scott said, we’re continuing to invest in new products and improved products so when this market comes back, I think we’re going to be particularly well positioned to ride it up at a pretty good rate. So, I’m not happy with the volume and where it is, but it is where it is and we just have to manage it carefully till the starts come back.

Operator

Your next question comes from David Strauss - UBS.

David Strauss - UBS

Based on your manufacturing free cash flow forecast, it looks like you’re expecting the second half to generate about $600 million. How does that break out between Q3 and Q4?

Scott Donnelly

Yes, it’s always a little bit back-end loaded, but you’re probably somewhere in the one-third, two-thirds or 40/60 kind of range, David.

David Strauss - UBS

Could you give us an update of exactly what you’re expecting in terms of debt pay down and the securitization in Q3 and Q4?

Scott Donnelly

David, I’ll follow-up with you if you want to breakdown on the quarterly. I mean, we’ll give you what’s coming due contractually, but in terms of what we might do opportunistically, of course we’re not going to discuss that publicly.

David Strauss - UBS

Then any additional color as far as you said the production rate, you’re looking at lower deliveries in 2010, any additional color. It looks like on the ex Mustang, you’re going to be down like the 150 range for 2009; is that going much lower in 2010 or just a little lower? Could you just help a little bit there?

Scott Donnelly

No Dave, I think it’s probably too early to start calling the numbers on 2010. We’ll know an awful lot more here in the next four, five months as this goes through what appears to be at least here in June and continues in July. Sort of stabilizing and seeing some customers coming back into the market, more customers taking delivery of their aircrafts. So I think we’re seeing some positive trends, but I think we can be a lot more accurate in terms of our views of what’s going in the market here in the coming few months.

David Strauss - UBS

Last one, on the used aircraft side, could you just tell us what you’re holding in terms of inventory on the used aircraft side?

Scott Donnelly

In terms of numbers?

David Strauss - UBS

Yes, numbers and value or whatever detail you can give us?

Scott Donnelly

Right now we’ve got about 48 aircrafts. We have about 38 that are Cessna inventory and about 10 that are citation share used aircraft inventory and that actually in terms of units went down a few in the second quarter as we were able to sell more used aircraft than we took in trade and so again, hopefully that’s a trend that we’ll see continue through the balance of the year.

Lewis Campbell

Dave, we’re carrying them at just a little over $200 million, which represents a net of about $100 million in write-offs that we’ve taken so far this cycle, so that’s one of the reasons that we’re expecting less of an impact from used in the second half of the year.

Operator

Your next question comes from Jeff Sprague - Citigroup.

Jeff Sprague - Citigroup

Scott, understanding that the non-accruals don’t necessarily come through the charge-offs, would you expect charge-offs to be moving up in the back half of the year regardless and into next year?

Scott Donnelly

Yes, I think there’s going to be a general trend Jeff, as we work our way through this, that we’ll see increased charge-offs and I think what we’re doing right now is appropriate. We take the loss provisions and reserve is up consistent with our expectation, we still will start to see higher charge-offs somewhere in the third and fourth quarter and frankly going forward.

Jeff Sprague - Citigroup

You’d also had indicated on the run-off you’re actually trying to focus on some of the tougher stuff first, but the cash conversion actually looks pretty decent. What is it about what you see in the pipeline that might make you a little more cautious on the cash conversion looking out say six or 12 months?

Scott Donnelly

Well, I think we get into some of the asset classes, which when you look at resort, when you look at golf, again, I think not so much in the next quarter or two, but as you get further out, these are some of the larger accounts. There’s not as much liquidity, let’s say in some of those industries.

So, I think a lot what we’ll do in distribution finance and ABL as capital is returning to the market. We see other financial institutions that are willing to take some of those accounts and we saw that for instance in a couple of those private brand accounts. So this is generally relatively good business and so I just think it’s the first place that capital is returning.

Now, we don’t know yet exactly what’s going to happen with some of these longer tail resorts. Obviously, the economy continues to strengthen, money keeps coming back into the market. We are hopeful that more capital will returns into some of those markets. If they do, then obviously we’ll incur lower losses.

As we go through this and have to release some of those assets, if we don’t have as much liquidity for instance, securitization and the timeshare resort kind of businesses, then we’ll expect to see higher losses and therefore lower cash conversion rates than we’ve seen on the shorter cycle, shorter tail receivables that we’ve been running off so far.

Jeff Sprague - Citigroup

Understanding you don’t want to go out on a lim on 2010 yet, I just wonder what the complexion of the conversations are maybe as you reach out to customers and it’s time to start paying progress payment on 2010 perhaps. Are you seeing some slippage out there as people reconsider?

Scott Donnelly

The trend has been positive. Again, I try to couch this in saying this is a sort of a June and now into July phenomena that we are seeing more customers that are making their payment, that are taking their delivery of their aircraft as opposed to canceling it the last minute, but again it’s a full month of June. The trend, it says continuing in July, but I think we still have some time here to play out to see whether truly it has stabilized and we’ll start to see that kind of a trend going forward.

Lewis Campbell

But we are taking orders for delivery in 2010.

Scott Donnelly

Absolutely. The good news of what we’ve seen is sort of interesting Jeff. It’s almost like a spot market has sort of started. Actually, we have customers that were not in the backlog. These are guys that have sort of been on the sidelines that are now looking and saying, “Okay, is this time the time to make the move.”

So as Lewis mentioned, we’ve got orders in June; seven that were for 2009 deliveries and we continue to get a few more in July. So these are actually customers not in the backlog that are kind of stepping in and taking 2009 and I think we are starting to see also interest in taking some slots in 2010 as well.

Operator

Your next question comes from Scott Kincaid - Davidson Kempner.

Scott Brugle - Davidson Kempner

Hi, it’s actually [Scott Brugle]. Can you guys just help me reconcile slide number five, the $1.282 billion of receivable liquidations? With the cash flow statement in the 8-K that was filed, it looks like you generated about $500 million in cash.

Lewis Campbell

Can you do that one again, Scott?

Scott Brugle - Davidson Kempner

Sure, the $1.3 billion of managed receivables decreasing with the cash flow statement for the second quarter that was filed in the 8-K, that showed 1.1 of receivables repaid, 745 of receivables originated.

Scott Donnelly

The primary difference is the difference between managed receivables and owned receivables. We present the managed receivables number here because we have to look at this from a total liquidity point of view, whereas the Q presents it on an owned basis. So those numbers will not match, but they do reconcile.

Scott Brugle - Davidson Kempner

So is the right way to think about that, you had about $700 million or so of receivables that were managed but not owned?

Scott Donnelly

Yes, 648 is the right number. We paid down $648 million of securitization debt in the quarter that came out of that $1.282 billion.

Scott Brugle - Davidson Kempner

Then my second question is, if you look at the golf balances, it looks like that decreased pretty significantly in the quarter.

Scott Donnelly

Golf, did you say?

Scott Brugle - Davidson Kempner

Golf, yes.

Scott Donnelly

We did have 12 payoffs and we did sell one, well, it’s in other assets, because it was a known golf course. I’d say we are seeing a fairly positive trend in the golf portfolio and I’d say there’s a number of customers out there.

People are interested in picking up golf courses, in the case those that we own and a positive trend I would say in folks that we talked to and said “Look, when you come due or even as a prepayment, we’d like to discount you to redo your mortgage somewhere else” and people are doing it, at reasonable discounts.

Operator

Your next question comes from Cai von Rumohr - Cowen & Co.

Cai von Rumohr - Cowen & Co.

So the pre-owned losses equaled to the forfeitures in the second quarter, what was that number in the first quarter and can you also comment on the trend in R&D in the second quarter? Where was it relative to the first and where do you expect it to be for the year?

Scott Donnelly

Give us the first question again.

Cai von Rumohr - Cowen & Co.

The first question is I guess you indicated that pre-owned losses were $38 million and that was the same as forfeiture gains in the second quarter. Where was the net of those two numbers in the first quarter, that’s the first part of that question?

Scott Donnelly

The pre-owned was about $13 million in the first quarter and the forfeitures I think was around the same number; I’m looking that up. What was your second half of your question as we’re looking at it?

Cai von Rumohr - Cowen & Co.

The second half is R&D; where was it in the first and second quarter and where do you expect it to be for the year?

Lewis Campbell

We’d really rather not talk about specific R&D at Cessna that’s competitively sensitive, but that’s through the year.

Scott Donnelly

Let me trace the year out for you Cai. R&D last year was 553; this is total company. Cessna is always as a percentage of sales higher than anybody else, but that’s just another point.

In January we thought that number should be a little bit south of 500 and we’ve now firmed up everything, which take a lot of work actually to know where to invest to get the most bang for the buck and so we basically let Cessna kind of free flow back to us on where they thought they ought to invest in order to keep our products, not only new ones coming but also fresh in the fleet.

We’ve now settled on total company R&D of 450. So, if you compare about 550 to 450 it’s down about 20% which I think is about right, but keep in mind, don’t under estimate my point, we didn’t say “Okay Cessna, instead of $10 you get $5.” We said “Free flow back to us. What do you need to freshen the fleet to make sure that we’re as competitive as we need to be when the market comes back” and we put that number in. Bell is the same way, Bell has got a good future there too from a competitive standpoint.

Cai von Rumohr - Cowen And Company

You mentioned the other seven orders in June went into the deliveries in 2009. If we get orders in July and August, presumably we will, will they go into 2009 or will they go into 2010?

Scott Donnelly

There’s a mix. So we already have some that we are talking in July that would be 2009 aircraft and we have a number that want to slot 2010 deliveries. So really, the mix here is if you have a customer that really wants to take a 2009 delivery, they are willing to take the aircraft as configured or with minor modifications which is what’s happening, we’ll do that, but there are some customers that want to do a full custom configuration to their exact requirements and specifications and those are largely folks that will take a 2010 delivery.

Cai von Rumohr - Cowen And Company

So if some are going into 2009, should we take the 275 as the number that has upside?

Lewis Campbell

If you want to Cai, that’s up to you. It’s going to go up and down Cai. I mean we really choose our words, I did, choose my words on how to talk about this and I know Scott did too.

Look, for the first month in I don’t know how long, nine months or thereabout, we’re seeing a positive sign. They are not flashing green lights, but they are certainly a lot better than they’ve been in months and months and we are basically sold out to deliver a little more than 275. We can get some more cancellations which would take the 275 down, but we could have net plus orders going forward and if we do that we would do more than 275, which we would love to do.

Cai von Rumohr - Cowen And Company

Last one, you hired an investment banker as a CFO as opposed to kind of a financial operating guy. Why did you make that decision?

Scott Donnelly

I’m sitting across the table from a great financial operating guy. That’s I think if you look at what’s going on in the last six or nine months. Dick has done a phenomenal job and always has. He has a control over the company and really running the finance and working the numbers and working with the business CFO on a day-in day-out basis. So I think we have an outstanding talent in the company to run that day-in day-out finance operation.

We came across Frank and here’s a guy that’s got a lot of expertise and experience in both capital market kind of work and also in M&A kind of work. So I look at a guy like Frank and say “This is having the complimentary talents of what both already have and a very solid great operating financial arm in being able to bring in a talent,” because obviously we still have work to do going forward in terms of the capital structure of the company.

Ultimately, once we get all the stuff behind us and markets kind of get back to normal and the world moves on, having a Chief Financial Officer that’s experienced and a savvy M&A kind of guy I think is the right talent to have in the company. So really that was an opportunity to bring somebody in that had very complimentary skills with the skills we already had in the company.

Operator

Your next question comes from Noah Poponak - Goldman Sachs.

Noah Poponak - Goldman Sachs

Was the cancellation number in the second quarter excluding Columbus, if we add up everything you gave us, was it 169?

Lewis Campbell

We got the exact number, 243 minus 76.

Scott Donnelly

Yes, it’s 243 minus 76 where the number is, that’s what it was.

Noah Poponak - Goldman Sachs

So I guess I’m kind of struggling; if there was over 150 legacy cancellations in the quarter, I’m kind of struggling with how the ‘09 number is only coming down by 20 aircrafts. If that kind of implies that they’re not coming out of ‘09, you said you had order activity, but it’s pretty modest. So, I know you guys are kind of reluctant to talk about ten, but does that imply that 2010 is at least what a bit worse than you had previously talked about with the down kind of 15%?

Scott Donnelly

No. I don’t think so. I think what you’re getting at is absolutely right. If you look at the cancellations that came out, again forget Columbus, which is obviously out in the 14, 15, 16 kind of timeframe, but the bulk of the other cancellations that we brought out in the quarter was really kind of going through and looking at large fleet/fractional customers.

So when you look at the nature of those kinds of orders that we took out in the order book, they do spread out in 10, 11, 12 and beyond. So we had one case with one large fraction guy, which actually normally wouldn’t have been cancellation, but it’s a model aircraft that we’re just not going to be building in that timeframe, so we obviously took those out.

Then we had a couple of other fractional customers that we just don’t believe they’re going to be taking aircraft in the near future and we didn’t think it was appropriate to have those orders sitting in the book. When we don’t think there is a probability, we’re going to realize them, so we worked with those customers and took them out of the book.

Noah Poponak - Goldman Sachs

So, either cancellations coming out of the next three or four years?

Scott Donnelly

Exactly, but there’s a lot that are 11, 12 and beyond.

Lewis Campbell

Noah, if we’re going to plan on getting our margins up, you have to have some kind of stability in predictable orders. So for example, if we’re having a discussion with a large guy, who’s got 24 jets on order, which was the one we did and we basically say “Hey guy, if you’ve got a big doubt right now, we’ll just soon pull you out. So we can plan on making whatever volume of that plane we want to plan on making.” If he wants to comeback in later, great, but we’re trying to get the book as predictable as possible.

Whenever the market comes back, the orders will come back and they’ll comeback to us. So, it’s not to our benefit to have a big order number that is not strong. So I think orders are less orders than we had, but I believe they are more certain than they were before so.

Noah Poponak - Goldman Sachs

How many Mustangs in the 275 number?

Lewis Campbell

125. That spreads over the long period of time.

Noah Poponak - Goldman Sachs

One more question on systems. The full year guidance implies that the second half growth really takes off, but the margin guidance kind of also implies that the second half margin is a lot weaker than the first half. Can you guys just walk through the puts and takes on that business for the rest of the year?

Lewis Campbell

We had kind of a big first quarter, but the third and the fourth quarters are pretty consistent with the second quarter Noah, nothing remarkable going on there.

Scott Donnelly

I don’t see a lot of movement in terms of the margin ratio in the balance of the year.

Lewis Campbell

They vary between 10 and a little over 12 depending on the quarter, which ebbs and flows depending on what we’re delivering as far as ASVs and what contracts expiring and VACs you book and which ones you don’t.

Systems are hard to call quarter-after-quarter, because you’re using contract or a lot of accounting in the sense that you have EACs which are based on how you price to the government and once you price it fixed price and the thing on how well you do against that fixed price, you make more money or less money and that accumulates until you know that you can book a higher profit rate and then that all flows in on a given month.

So the margins vary slightly, because of that fact, but I believe you’ll see systems, probably at the end of the year end up in a very good place margin wise. Not quite as strong as last year, but pretty darn good.

Operator

Your next question comes from Shannon O’Callaghan - Barclays.

Shannon O’Callaghan - Barclays

Can you give us a feel for what do you think has enabled you to really track so far ahead on the liquidation plan and where are people finding alternative financing? Give us a little color on that.

Scott Donnelly

I think that the nature of the assets that we’re talking about, specifically in the distribution finance business; in fact the matter is people are actually buying boats and RVs and stuff like that. So that business is obviously as well collateralized, so we have the collateral of that asset that’s been financed with the deal and dealer who sells it, and we get our money back.

We put a lot of feet on the street in terms of people checking accounts and make sure that when an asset is sold, that we do get our money back. Again, I think the fact that other folks have been stepping into that and picking up some of these accounts and financing these dealers, by and large has allowed them to stay whole.

Obviously, some dealers have gone bankrupt. When they do that, we’re frequently debt re-possessing those assets, but again, I think we saw that re-possessing kick-in in the first quarter and it continues in the second quarter, but we’ve actually been able to take those assets and mark them, turnaround and sell through alternative distribution channels and actually get them sold off. So we actually saw a net reduction in that class in the quarter.

So, I don’t think there’s anything pretty good magic about it. It’s just blocking and tackling and out there letting dealers know that we’re not financing any more and in the case of the private brand’s customers, we’ve been working with those customers to jointly go help find them; someone to take over that relationship and we’ve been successful in a number of cases of doing that.

Shannon O’Callaghan - Barclays

Obviously, I don’t think RV sales or boat sales were probably better than your internal plan, so if maybe, were you pleasantly surprised that all by your ability that find other people to lend to these customers?

Lewis Campbell

Not really. I mean actually if you look at classes like boats and RV, it actually has been ahead of our plan. So I mean though the number of turns in these deals of inventories, is lower than it has historically been, but they are still moving assets.

Again, in terms of these private brand relationships, these typically are relationships where not only do you have the collateral of the value of the asset, but in many occasions you have manufacturing take-back provisions and these are good manufacturers, they’re creditable companies. So they are historically accounts that do pretty well. So even in distressed time, as people are looking to put capital to work, we see people coming into this space.

Shannon O’Callaghan - Barclays

Then on the jumps in the non-accruals, can you flush that out a little bit more about the recovery dynamics and what you’re expecting to happen there?

Scott Donnelly

Well, the class of asset that exists the most and again these judgments in terms of non-accrual, where we have a belief that we may not get our full principal interest back as we look at the resort class, that’s the one that added the most to the non-accrual, because it’s the one that for us is most uncertain in terms of how that industry plays out.

Again I would say, that’s reflective of the fact that unlike some of these other assets where we do see our capital coming back into these areas, we remain concern on areas like time shares that have historically been dependent on doing a lot of securitization to finance their operations. Until that securitization market comes back, we’re going to need to hold and manage our way through some of these customers.

So I think that’s where we’re seeing the biggest add in the quarter in terms of non-accruals and frankly that’s where I would expect to see. Going forward, most of our increases in non-accrual will come from that portfolio.

Operator

Your next question comes from Ron Epstein - BOA.

Ron Epstein - BOA

Just a couple of quick ones; one for Scott, you mentioned that you guys have laid-off about 10,000 employees. How far do you think that deep enough is? I just what I’m trying to say is, when the economy does turn, how can you be prepared that you maybe didn’t let too many people go or you’re not prepared when things turn?

Scott Donnelly

That is something we try to be very helpful about as we look at all the businesses. We have tried where possible and a number of our industrial businesses, Cessna is another good example and we’ve done some with Bell. When we reach that point, where we worry that if went leaner than that, we would have a hard time responding as the market starts to come back.

In a number of those businesses we’ve actually used furloughs. So instead of taking a further reduction in the permanent number of employees, we actually shut Cessna for instance for a month. Furloughed all of our workforce and basically shut the factory. Obviously we’re doing customer deliveries and support, but we basically shut the production lines down for a month, because we felt like that was a more prudent thing to do to protect our capability as things start to come back.

We’ve done similar things in Bell and across and virtually all of our industrial businesses and we’ll continue to try to do that frankly to modulate demand going forward with furloughs to the extent that we can, but I think we had to be realistic about some of the businesses like Cessna, in terms of what’s the relate of recovery and when you think it’s going to be a longer, flatter recovery, then we’ve had to take those permanent actions in terms of [Inaudible].

Ron Epstein - BOA

Then I guess another one on Cessna, if I can. I don’t think anybody asked this one yet. When we look at whitetails, what’s the outlook on whitetails for this year going into next; how’s that gone? You had some I think last quarter and how does it look now?

Scott Donnelly

Well we have been accumulating. As we said before, the first quarter and second quarter we did build at let’s say an accelerated pace, because we had all the material coming in. We had the workforce in place and the most optimal thing in our view is to go ahead and build the aircraft. So we’ve been doing that.

So, I think if you look at classification, of inventory, even though Cessna has been going up, we actually moved that inventory. We went from rolling and process to work to now moving into finished goods and that manifest itself as these whitetails, which now we expect start to believe that number back over the third quarter and the fourth quarter.

How far that goes, it kind of goes back to our earlier discussions we had around how many customers do step-up to place 2009 orders and how many people stay in the backlog that are current in 2009 deliveries. When we get do that, the 275 kind of number, that’s the base plan that we are working around and that assumes obviously that we are working down the number of whitetails that came out of the second quarter versus what we have at the end of the year.

Doug Wilburne

The way to think about it is not so much where we are now, where are we at the end of ’09, but where are we at the end of 2010? And our plan is to have none by the end of 2010. We are basically managing a two year demand window here as well.

Scott Donnelly

Right, absolutely. To Doug’s point, when I say we stabilized our production rate for ‘09 and ’10, when we look at deliveries in ’09 and ’10, we take into consideration those whitetails that we would assume we have at the end of ‘09. Those all sell off.

Ron Epstein - BOA

How many do you have today?

Scott Donnelly

I don’t think we want to put that information out there, just from a competitive standpoint.

Ron Epstein - BOA

Then I have a question for Lewis. Having lived through this horrible economy, and you look at how you’ve been leading Textron, what have you learned? When you kind of look forward, what have you learned on how you would run the company different, having lived through this?

Lewis Campbell

That’s a tough question. When we went through 2001, 2002 and 2003, remember our stock went down to 26 and if you do a [Inaudible] which was just a very dramatic thing for the company, we launched a very significant transformation effort which was uncertain as to whether or not it was going to work, but we felt it was the only thing that we could do and a chance of working it and it really did work.

Now, so we have the benefits of that. We are network enterprise. We do so many things better than we did. So one thing we’ve learned is that what we’ve put in place in the one, two, three, that first part of this decade, is really saving our bacon, even though when you look at our EPS and cash flow you say “Gosh, you could be doing better.” You take a little cash flow for example and I think we’ve demonstrated that we are now doing a much better job of turning in manufacturing free cash flow; thanks to Scott and Dick and all the guys working on that.

I wish we made the cut sooner. It’s so tricky based on the question that just got asked, how do you know you’re not cutting too far? We should have done these cuts six months ago, but in hindsight that’s crystal clear and I guess everybody that’s ever had to make cut out, we cut over 8,000 people this year already. I wish we would have done it sooner, but we just did it in chunks.

So, I learned that the hard way again. I don’t know whether I’ll ever learn it permanently, maybe Scott will learn it from me and the next time it happens he’ll move more quickly than we both did.

On the positive side I’ve learned that people will do unbelievably heroic things that are very contrary to what you think they’d do. You take TFC, they’re making money for decades and decades and then grow, grow, grow, grow and basically have the same outlet for the same people primarily inline, are now totally focused on running off the very businesses they put in place and what motivated people to do that is just amazing.

So, I think the fact that people are aligned to drive Textron profitability ahead of their own unique side of the businesses is quite testimony. I wish we’ve been smart enough not to have such a big TFC, I sure learned that, but that’s something you can’t really know until you get into this financial crisis.

Operator

Your last question comes from Robert Stallard – Macquarie

Robert Stallard – Macquarie

I was wondering if you could just comment quickly on what this co-line is all about, $410 million seems like a significant amount of money.

Lewis Campbell

What was your question about it?

Robert Stallard – Macquarie

What is it all about; it seems like a very large amount of money.

Scott Donnelly

In the fourth quarter we borrowed against insurance policies, corporate owned life insurance policies that we had in place, which are available and I say borrowed it. It’s technically an advance on an asset and you have to pay an interest on the advance, and so given that we’ve improved our liquidity so significantly we were able to pay that down and as Lewis mentioned, that’s still available to us where we had to get into a situation where we need to tap back into it.

Robert Stallard – Macquarie

What was the interest rate on that?

Scott Donnelly

Like around 7%, 6% or so. It was 6% non-tax deductible.

Robert Stallard – Macquarie

Right. And that’s now caved down to zero?

Scott Donnelly

I believe so.

Okay, thank you very much ladies and gentlemen.

Lewis Campbell

Thank you everyone. Have a good day.

Operator

Thank you. Ladies and gentlemen, this conference will be made available for replay starting today after 11:00 am Eastern Time, until October 26 at midnight. You may access the AT&T executive playback service at anytime by dialing 1320-365-3844 and entering access code 991793. Again those numbers are 1320-365-3844 and the access code 991793.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Textron Inc. Q2 2009 Earnings Call Transcript
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