E-Z-GO 2006 Annual Report Download - page 48

27
Textron Inc.
Software Indemnifications
With the acquisition of Overwatch Systems in 2006, we now are a party to software license agreements with customers. These software license
agreements generally include certain provisions for indemnifying customers against liabilities if our software products infringe a third party’s
intellectual property rights. To date, we have not incurred any material costs as a result of such indemnifications and have not accrued any liabili-
ties related to such obligations in our consolidated financial statements.
Forward Contract
We enter into a forward contract in our common stock on an annual basis. The contract is intended to hedge the earnings and cash volatility of
stock-based incentive compensation indexed to our stock. The forward contract requires annual cash settlement between the counterparties based
upon a number of shares multiplied by the difference between the strike price and the prevailing common stock price. As of December 30, 2006,
the contract was for approximately 1.5 million shares with a strike price of $77.62. The market price of the stock was $93.77 at December 30,
2006, resulting in a receivable of $24 million, compared with a receivable of $10 million at December 31, 2005.
Finance Receivable Securitizations and Sales
We sell finance receivables utilizing both securitizations and whole-loan sales. As a result of these transactions, finance receivables are removed
from the balance sheet, and the proceeds received are used to reduce the recorded debt levels. Despite the reduction in the recorded balance sheet
position, we generally retain a subordinated interest in the finance receivables sold through securitizations, which may affect operating results
through periodic fair value adjustments. These retained interests are more fully discussed in the Securitizations section of Note 5 to the consoli-
dated financial statements. We utilize these off-balance sheet financing arrangements (primarily asset-backed securitizations) to further diversify
funding alternatives. These arrangements provided net proceeds from operations of $50 million and $361 million in 2006 and 2005, respectively.
Proceeds from securitizations include amounts received related to incremental increases in the level of distribution finance receivables sold and
exclude amounts received related to the ongoing replenishment of the outstanding sold balance of these short-duration receivables. We have
used the proceeds from these arrangements to fund the origination of new finance receivables and to retire commercial paper.
Whole-loan finance receivable sales in which we maintain a continuing interest differ from securitizations as loans are sold directly to investors
and no portion of the sale proceeds is deferred. Limited credit enhancement occasionally is provided for these transactions in the form of a con-
tingent liability related to finance receivable credit losses and, to a lesser extent, prepayment risk. At December 30, 2006, we had no remaining
contingent liabilities related to credit losses or prepayment risk associated with whole-loan sales. Termination of our off-balance sheet financing
arrangements would reduce our short-term funding alternatives. While these arrangements do not contain provisions that require us to repur-
chase significant amounts of receivables previously sold, there are risks that could reduce the availability of these funding alternatives in the
future. Potential barriers to the continued use of these arrangements include deterioration in finance receivable portfolio quality, downgrades in
our Finance group’s debt credit ratings and a reduction of new finance receivable originations in the businesses that utilize these funding arrange-
ments. We do not expect any of these factors to have a material impact on our liquidity or income from operations.
Critical Accounting Policies
To prepare our consolidated financial statements to be in conformity with generally accepted accounting principles, we must make complex and
subjective judgments in the selection and application of accounting policies. The accounting policies that we believe are most critical to the por-
trayal of our financial condition and results of operations are listed below. We believe these policies require our most difficult, subjective and
complex judgments in estimating the effect of inherent uncertainties. This section should be read in conjunction with Note 1 to the consolidated
financial statements, which includes other significant accounting policies.
Allowance for Losses on Finance Receivables
Our allowance for losses on finance receivables is intended to provide for losses inherent in the portfolio, which requires the application of esti-
mates and significant judgment as to the ultimate outcome of collection efforts and realization of collateral values, among other factors. Therefore,
changes in economic conditions or credit metrics, including past due and nonperforming accounts, or other events affecting specific obligors or
industries may require additions or reductions to our reserves.
We evaluate the collectibility of our finance receivables based on a combination of factors. For homogeneous loan pools, we examine current
delinquencies, characteristics of the existing accounts, historical loss experience, underlying collateral value, and general economic conditions
and trends. We estimate losses will range from 0.3% to 6.0% of finance receivables depending on the specific homogeneous loan pool. For larger
balance commercial loans, we also consider borrower specific information, industry trends and estimated discounted cash flows. Our process
involves the use of estimates and a high degree of management judgment. While we believe that our consideration of the factors and assumptions