UNITED STATESSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended December 31, 2001
OR
For the transition period from to
Commission file number 0-8408
WOODWARD GOVERNOR COMPANY (Exact name of registrant as specified in its charter)
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 /x/ No / /
As of January 31, 2002, 11,324,150 shares of common stock with a par value of $.00875 cents per share were outstanding.
TABLE OF CONTENTS
Part I
Item 1. Financial Statements
Statements of Consolidated Earnings Woodward Governor Company and Subsidiaries
See accompanying Notes to Consolidated Financial Statements.
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Consolidated Balance Sheets Woodward Governor Company and Subsidiaries
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Statements of Consolidated Cash Flows Woodward Governor Company and Subsidiaries
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Notes to Consolidated Financial Statements
(1) The consolidated balance sheet as of December 31, 2001, the statements of consolidated earnings for the three-month periods ended December 31, 2001 and 2000, and the statements of consolidated cash flows for the three-month periods ended December 31, 2001 and 2000, were prepared by the company without audit. The September 30, 2001, consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. Information in this 10-Q report is based in part on estimates and is subject to year-end adjustments and audit. In our opinion, the figures reflect all adjustments necessary to present fairly the company's financial position as of December 31, 2001, the results of its operations for the three-month periods ended December 31, 2001 and 2000, and its cash flows for the three-month periods ended December 31, 2001 and 2000. All such adjustments were of a normal and recurring nature. The statements were prepared following the accounting policies described in the company's 2001 annual report on Form 10-K and should be read with the Notes to Consolidated Financial Statements on pages 26-33 of the 2001 annual report to shareholders. The statement of consolidated earnings for the three-month periods ended December 31, 2001, is not necessarily indicative of the results to be expected for other interim periods or for the full year.
Certain reclassifications were made to the statement of consolidated cash flows for the three months ended December 31, 2001, to conform to the current presentation.
(2) In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets." Statement No. 141 primarily impacts accounting for transactions initiated or completed after June 30, 2001. However, Statement No. 141 also contains transition provisions that may result in the reclassification of carrying values among existing goodwill and other intangibles. We were required to adopt Statement No. 142 and the transition provisions of Statement No. 141 on October 1, 2002, or on October 1, 2001, and we elected the 2001 date.
As a result of adopting these new standards, our accounting policies for goodwill and other intangibles changed on October 1, 2001, as described below:
Goodwill: We recognize the excess of the cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed as goodwill. Goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances. Impairment losses are recognized whenever the implied fair value of goodwill is less than its carrying value. Prior to October 1, 2001, goodwill was amortized over periods of up to 30 years. Beginning October 1, 2001, goodwill is no longer amortized.
Other Intangibles: We recognize an acquired intangible apart from goodwill whenever the asset arises from contractual or other legal rights, or whenever it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged, either individually or in combination with a related contract, asset, or liability. However, we would not recognize an assembled workforce as an intangible apart from goodwill. An intangible other than goodwill is amortized over its estimated useful life unless that life is determined to be indefinite. Currently, all of our intangibles have an estimated useful life and are being amortized. Impairment losses are recognized if the carrying amount of an intangible subject to amortization is not recoverable from expected future cash flows and its carrying amount exceeds its fair value.
Also as a result of adopting these new standards, we completed the transitional goodwill impairment reviews required by the new standards and recognized an aftertax loss of $2,489,000 as a cumulative effect of an accounting change. In performing our impairment reviews, we estimated the fair values of the various reporting units using a present value method that discounted future cash flows as we expect marketplace participants would, and we further assessed the reasonableness of the estimates by using valuation methods based on market multiples. The impairment loss related to an Industrial Controls reporting unit.
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Other than the cumulative effect of the accounting change, adoption of the new accounting standards resulted in an increase in goodwill and a decrease in other intangibles of $4,425,000 on October 1, 2001, and, based on goodwill existing at October 1, 2001, is expected to result in a decrease in amortization expense of $4,874,000 for 2002.
(3) Earnings per share:
The following stock options were outstanding during the three months ended December 31, 2001, but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares during the respective periods: options, 1,031,744; weighted-average exercise price, $68.33. All outstanding stock options during the three months ended December 31, 2000, were included in the above computation.
(4) Inventories:
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(5) Goodwill:
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(6) Other intangibles—net:
Amortization expense associated with current intangibles is expected to be approximately $3,070,000 for each year 2002-2007.
(7) In October 2001, we entered into interest rate swap agreements with notional amounts totaling $25,000,000 to hedge against changes in the fair market value of a portion of our long-term debt. The debt we hedged has a fixed interest rate of 6.39% and principal payments through fiscal 2012. Under the agreements, we will pay interest at floating rates based on LIBOR. We have designated the swap agreements as fair value hedges and have assessed the hedges as having no ineffectiveness. The fair value of the interest rate swaps are included in other liabilities with a balance of $1,111,000 and the carrying value of the related long-term debt has been reduced by a similar amount.
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In January 2002, we entered into additional interest rate swap agreements with notional amounts totaling $25,000,000 that have also been designated as fair value hedges and have been assessed as having no ineffectiveness.
(8) Accounts payable and other accrued expenses:
Included in salaries and other member benefits are termination benefits and other termination related costs of $3,484,000. During the first quarter ended December 31, 2001, we expensed and accrued $767,000 for 32 members as a result of consolidating manufacturing activities performed in two Industrial Control locations into a single location. We also accrued and expensed $3,422,000 for 141 members in Aircraft Engine Systems, predominantly involved in manufacturing activities, to better align both capacity and cost structure with current business prospects. By December 31, 2001, 58 members had been terminated and payments totaling $705,000 had been paid.
(9) Accumulated other comprehensive earnings:
(10) Total comprehensive earnings:
(11) We are currently involved in matters of litigation arising from the normal course of business, including certain environmental and product liability matters. We have accruals of approximately $1,000,000 at December 31, 2001, related to such matters. These accruals are based on our current
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estimate of the most likely amount of losses that we believe will be incurred. These amounts have been included in accounts payable and accrued expenses.
We have been designated a "de minimis potentially responsible party" with respect to the cost of investigation and environmental cleanup of certain third-party sites. Our current accrual for these matters is based on costs incurred to date that we have been allocated and our estimate of the most likely future investigation and cleanup costs. There is, as in the case of most environmental litigation, the possibility that under joint and several liability we could be required to pay more than our allocated share of costs.
It is our opinion, after consultation with legal counsel, that additional liabilities, if any, resulting from these matters are not expected to have a material adverse effect on our financial condition, although such matters could have a material effect on our quarterly or annual operating results and cash flows when resolved in a future period.
(12) Segment information:
The difference between the total of segment earnings and the statements of consolidated earnings follows:
Segment assets were as follows:
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Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations
We prepared the following discussion and analysis to help you better understand our results of operations and financial condition. This discussion should be read with the consolidated financial statements.
This discussion and analysis should also be read with the cautionary statement of our 2001 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2001. This discussion and analysis contains forward-looking statements, including financial projections, our plans and objectives for the future, expectations for future economic performance, and various other assumptions relating to the future. While such statements reflect our current expectations, all such statements involve risks and uncertainties. Actual results could differ materially from projections or any other forward-looking statement, and we have no obligation to update our forward-looking statements. Important factors that could cause results to differ materially from those projected or otherwise stated are identified in the cautionary statement of our 2001 annual report to shareholders.
Results of Operations
Our results of operations are discussed and analyzed by segment. We have two operating segments—Industrial Controls and Aircraft Engine Systems. Industrial Controls provides energy control systems and components primarily to OEMs (original equipment manufacturers) of industrial engines, turbines, and other power equipment. Aircraft Engine Systems provides energy control systems and components primarily to OEMs of aircraft engines.
We use segment earnings internally to assess the performance of each segment and for making decisions on the allocation of resources. Total segment earnings do not reflect all expenses of the company and are before the cumulative effect of an accounting change. Nonsegment expenses, including income taxes, and the accounting change are separately discussed and analyzed.
Among the effects of the accounting change is that goodwill is no longer amortized after September 30, 2001. Therefore, to provide the most meaningful comparison of earnings and income tax expense between periods, various earnings measures and income tax expense are analyzed and discussed on an adjusted basis. Any amount in this discussion and analysis labeled "adjusted" reflects the elimination of goodwill-related amortization and associated income taxes from amounts reported in the financial statements.
Industrial Controls
External net sales for Industrial Controls increased in this year's first quarter over the same quarter last year. Continued strength in the power generation market, market share gains, new product introductions, and growth from the third quarter, fiscal 2001 acquisition of the Bryce diesel fuel injection business of Delphi Automotive Systems drove revenues, despite a softening of several industrial markets.
Industrial Controls' segment earnings, as adjusted to eliminate goodwill-related amortization of $0.4 million from last year's reported earnings, increased only slightly in this year's first quarter as compared to the first quarter last year. Sales mix was an important influence on changes in our margins. For example, we sold a significant quantity of alternative fuel systems in the transportation
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market in the first quarter this year that included components we purchased complete. Consequently, our margins on those sales were lower than our average margins. We also continued to invest in new product development at levels higher than in the first quarter last year. We intend to introduce nearly 70 new products this year, as compared to more than 30 in fiscal year 2001.
We expensed and accrued $0.8 million for the planned termination of 32 members involved in manufacturing activities in this year's first quarter. The terminations are the result of consolidating certain manufacturing activities performed in two locations into a single location. We expect to complete the terminations and make the related payments in the second and third quarters of the current fiscal year.
Outlook: We currently expect Industrial Controls' sales to increase between 10% and 15% in 2002 over 2001. We also expect improved earnings performance during the next three quarters as compared to the quarter most recently ended.
Aircraft Engine Systems
External net sales for Aircraft Engine Systems increased in this year's first quarter over the same quarter last year. While general demand for original equipment components and systems weakened towards the end of the first quarter as the impact of September 11 began to take hold, orders from manufacturers of regional and business jet engines remained reasonably firm, and military orders increased.
Aircraft Engine Systems' segment earnings, as adjusted to eliminate goodwill-related amortization of $0.6 million from last year's reported earnings, increased in this year's first quarter as compared to the first quarter last year. Strong sales in the quarter, a favorable product sales mix, and continuous improvement initiatives offset workforce realignment costs accrued in this year's first quarter.
We expensed and accrued $3.4 million for the planned termination of 141 members involved predominantly in manufacturing activities in this year's first quarter, which represents approximately 9% of Aircraft Engine Systems' workforce. The terminations are to better align both capacity and cost structure with current business prospects. In the first quarter, 58 members were terminated and payments totaling $0.7 million were made. We expect to complete the terminations and make all remaining payments in the second and third quarters of the current fiscal year.
Outlook: As indicated earlier, we began to see a decline in year-over-year Aircraft Engine Systems sales toward the end of the most current quarter. We expect this decline to continue into the second quarter and over the remainder of the year. For the full year, we currently expect Aircraft Engine Systems sales to decrease about 15% from fiscal 2001. We also expect segment earnings to be lower in each of the next three quarters as compared to the quarter most recently ended.
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Nonsegment Expenses
Interest expense decreased in the first quarter this year because we had lower levels of average outstanding debt and lower average interest rates as compared to the same quarter last year.
Earnings
Earnings before the cumulative effect of accounting change, as adjusted to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings, increased in the first quarter this year over the same quarter last year. Income taxes were provided at an effective tax rate of 38.0% this year compared to 39.1% in the first quarter last year and 38.3% for the full fiscal year 2001. Among other factors, the mix of taxable earnings among various tax jurisdictions worldwide impacts our effective rate.
Net earnings, as adjusted to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings, decreased in the first quarter this year over the same quarter last year. In this year's first quarter, we reported a cumulative effect of accounting change related to our October 1, 2001, adoption of Financial Accounting Standards No. 142, "Goodwill and Other Intangibles." We completed the transitional goodwill impairment reviews required by the new standards and determined that one of our Industrial Controls' reporting units had a goodwill carrying value that exceeded its estimated implied fair value. The cumulative effect of accounting change reflects the write-down of the goodwill, net of income taxes, to its implied fair value. In performing our impairment reviews, we estimated the fair value of the various reporting units using a present value method that discounted future cash flows as we expect marketplace participants would, and we further assessed the reasonableness of the estimates by using valuation methods based on market multiples.
The adjustment to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings increased both earnings before the cumulative effect of accounting change and
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net earnings by $0.7 million, or $0.06 per share on both a basic and diluted share basis. Goodwill-related amortization includes amortization expense associated with all intangibles currently classified as goodwill.
Outlook: Based on an updated review of our outlook, we reaffirm our previous belief that consolidated earnings in 2002 are expected to approximate those of 2001, within a range of plus or minus 5%. For this outlook, we are using an earnings measurement before the cumulative effect of the accounting change and after adjustments to eliminate goodwill-related amortization from last year's reported amounts. Goodwill-related amortization, net of income taxes, totaled $2.9 million in fiscal 2001.
Financial Condition
Our discussion and analysis of financial condition is presented by segment for assets. We also separately discuss and analyze other balance sheet measures and cash flows. Together, this discussion and analysis will help you assess our liquidity and capital resources, as well as understand changes in our financial condition.
Assets
Decreases in segment assets were due primarily to reductions in accounts receivable in the first quarter, due to the timing of shipments and collections.
Other Balance Sheet Measures
Increases in working capital (current assets less current liabilities) were most significantly attributable to reductions in accounts payable and accrued expenses that included the impact of making annual payments associated with variable compensation plans and defined contribution plans. The increase in shareholders' equity resulted primarily from first quarter net earnings in excess of cash dividend payments.
We rent certain facilities using operating leases. Future minimum rental commitments under these operating leases as of September 30, 2001, are disclosed in Note O in the notes to the consolidated financial statements in our 2001 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2001.
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We are currently involved in matters of litigation arising from the normal course of business, including certain environmental and product liability matters. Further discussion of these matters is in Note 11 in the notes to the consolidated financial statements.
Cash Flows
Net cash provided by operations decreased in this year's first quarter compared to the first quarter last year. Although we generated more earnings, annual cash payments associated with variable compensation plans and defined contribution benefit plans that are paid out in the first quarter each year were higher this year than last year. Other factors impacting operating cash flows are less significant.
Net cash used in investing activities included payments associated with the acquisition of Hoeflich Controls, Inc. and related assets in last year's first quarter.
Among the cash provided by financing activities in this year's first quarter were the proceeds from new debt totaling $75 million. These new senior notes have a ten-year term, and the principal is payable in seven equal annual installments beginning in 2006. A portion of the proceeds from the new borrowings was used to pay $60 million of term notes that were due in 2002 and 2003.
Outlook: Future cash flows from operations and available revolving lines of credit are expected to be adequate to meet our cash requirements over the next twelve months. Our first quarter financing activities this year have enhanced our liquidity for several years by delaying principal payment requirements for $60 million of debt from the fiscal 2002-2003 timeframe to the fiscal 2006-2012 timeframe. However, it is possible business acquisitions could be made in the future that would require amendments to existing debt agreements and the need to obtain additional financing.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets." Statement No. 141 primarily impacted accounting for transactions initiated or completed after June 30, 2001. However, Statement No. 141 also contains transition provisions that may result in the reclassification of carrying values among existing goodwill and other intangibles. We were required to adopt Statement No. 142 and the transition provisions of Statement No. 141 on October 1, 2002, or on October 1, 2001, and we elected the 2001 date. Adoption of these new accounting standards had the following effects on our consolidated financial statements:
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Goodwill-related amortization and associated income taxes for each quarter in the year ended September 30, 2001, were as follows:
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations." This statement provides guidance on retirements of tangible long-lived assets and the associated asset retirement costs. The statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred, if a reasonable estimate can be made. The effective date of this standard is for fiscal years beginning after June 15, 2002. We considered whether we have asset retirement obligations as described by the statement and have determined that there are none. Consequently, adoption of this statement is not expected to have a material impact on our consolidated financial statements.
In August 2001, the Financial Accounting Standards board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement establishes a single impairment accounting model to be used for all long-lived assets, including those disposed of in a business sale. The effective date of this statement is for fiscal years beginning after December 15, 2001. We currently do not have any long-lived assets associated with the sale of a business as described in the statement. Consequently, adoption of this statement is not expected to have a material impact on our consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our long-term debt is sensitive to changes in interest rates. Also, assets, liabilities and commitments that are to be settled in cash and are denominated in foreign currencies are sensitive to changes in currency exchange rates. These market risks are discussed more fully in the Management Discussion and Analysis on page 21 of our 2001 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2001.
Part II
Item 6 Exhibits and Reports on Form 8-K
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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.
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