E-Z-GO 2005 Annual Report Download - page 77

57
tax effect in Other Comprehensive Income (Loss). At December 31, 2005, these instruments had a fair value liability of $5 million, compared with
$8 million at January 1, 2005. Textron Finance expects approximately $0.2 million of net tax deferred gains to be reclassified to earnings related
to these hedge relationships in 2006.
At December 31, 2005, Textron Finance had $4 million of deferred losses, net of income taxes, recorded in Other Comprehensive Income (Loss)
related to terminated forward starting interest rate exchange agreements. These agreements were executed to hedge the exposure to the variability
in cash flows from anticipated future issuances of fixed-rate debt and were terminated upon issuance of the debt. Textron Finance is amortizing the
deferred losses into Interest Expense over the remaining life of the hedged debt of 26 months and expects approximately $2 million, in deferred
losses, net of income taxes, to be reclassified to earnings in 2006.
For cash flow hedges, Textron Finance recorded an after-tax loss of $5 million in 2005 and $7 million in 2004 and a gain of $12 million in 2003 to
Accumulated Other Comprehensive Loss with no impact to the Statements of Operations. Textron Finance has not incurred or recognized any sig-
nificant net gain or loss in earnings as the result of the ineffectiveness, or the exclusion of any component from its assessment of hedge effective-
ness, of its cash flow hedges in 2005 and 2004.
Textron had minimal exposure to loss from nonperformance by the counterparties to its interest rate exchange agreements at the end of 2005 and
does not anticipate nonperformance by counterparties in the periodic settlements of amounts due. Textron currently minimizes this potential for
risk by entering into contracts exclusively with major, financially sound counterparties having no less than a long-term bond rating of “A,” by con-
tinuously monitoring such credit ratings and by limiting exposure to any one financial institution. The credit risk generally is limited to the
amount by which the counterparties’ contractual obligations exceed Textron’s obligations to the counterparty.
Cash Flow Foreign Exchange Rate Hedges
Textron manufactures and sells its products in a number of countries throughout the world and, as a result, is exposed to movements in foreign
currency exchange rates. The primary purpose of Textron’s foreign currency hedging activities is to manage the volatility associated with foreign
currency purchases of materials, foreign currency sales of its products, and other assets and liabilities created in the normal course of business.
Textron primarily utilizes forward exchange contracts and purchased options with maturities of no more than 18 months that qualify as cash flow
hedges. These are intended to offset the effect of exchange rate fluctuations on forecasted sales, inventory purchases and overhead expenses. The
fair value of these instruments at December 31, 2005 was a $23 million receivable. At year-end 2005, a $21 million after-tax gain was reported in
Accumulated Other Comprehensive Loss from qualifying cash flow hedges. This gain is generally expected to be reclassified to earnings in the
next 12 months as the underlying transactions occur. Textron Manufacturing also enters into certain foreign currency derivative instruments that
do not meet hedge accounting criteria and are primarily intended to protect against exposure related to intercompany financing transactions and
income from international operations. The fair value of these instruments at the end of 2005 and the net impact of the related gains and losses on
selling and administrative expense in 2005 were not material.
Net Investment Hedging
Textron hedges its net investment position in major currencies and generates foreign currency interest payments that offset other transactional
exposures in these currencies. To accomplish this, Textron borrows directly in foreign currency and designates a portion of foreign currency debt
as a hedge of net investments. Textron may also utilize currency forwards as hedges of its related foreign net investments. Currency effects of
these hedges, which are reflected in the cumulative translation adjustment account within Other Comprehensive Income (Loss), produced a $49
million after-tax gain during 2005, leaving an accumulated net income balance of $30 million.
Stock-Based Compensation Hedging
Textron manages the expense related to stock-based compensation awards using cash settlement forward contracts on its common stock. The use
of these forward contracts modifies compensation expense exposure to changes in the stock price with the intent to reduce potential variability.
The fair value of these instruments at December 31, 2005 and January 1, 2005 was a receivable of $10 million and $31 million, respectively.
Gains and losses on these instruments are recorded as an adjustment to compensation expense when the award is charged to expense. These
contracts impacted net income by $8 million in 2005, $28 million in 2004 and $23 million in 2003. Cash received or paid on the contract settle-
ment is included in cash flows from operating activities, consistent with the classification of the cash flows on the underlying hedged compensa-
tion expense.
Notes to the Consolidated Financial Statements