Woodward - 10-Q quarterly report FY

 

 

 

 

 

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

 

 

Woodward Governor Company’s (“Woodward”) Condensed Consolidated Financial Statements as of March 31, 2008 and for the three and six months ended March 31, 2008 and 2007, included herein, have not been audited by an independent registered public accounting firm. These Condensed Consolidated Financial Statements reflect all normal recurring adjustments which are, in the opinion of management, necessary to present fairly Woodward’s financial position as of March 31, 2008, and the results of operations and cash flows for the periods presented herein. The Condensed Consolidated Balance Sheet as of September 30, 2007 was derived from Woodward’s annual report onForm 10-Kfor the fiscal year ended September 30, 2007. The results of operations for the three and six month periods ended March 31, 2008 are not necessarily indicative of the operating results to be expected for other interim periods or for the full fiscal year.

 

The Condensed Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto included in Woodward’s Annual Report onForm 10-Kfor the fiscal year ended September 30, 2007 and other financial information filed with the SEC.

 

The preparation of the Condensed Consolidated Financial Statements requires management to make use of estimates and assumptions that affect the reported amount of assets and liabilities, revenues and expenses and certain financial statement disclosures. Significant estimates in these Condensed Consolidated Financial Statements include allowances for losses, net realizable value of inventories and related purchase commitments, the cost of sales incentives, useful lives of property and identifiable intangible assets, the evaluation of impairments of property, identifiable intangible assets and goodwill, income tax and valuation reserves, the valuation of assets and liabilities acquired in business combinations, assumptions used in the determination of the funded status and annual expense of pension and postretirement employee benefit plans and the valuation of stock compensation instruments granted to employees, including estimates of the related volatility and expected lives for the instruments. Ultimately realized values could differ from these estimates.

 

At the 2007 annual meeting of shareholders on January 23, 2008, shareholders approved a two-for-one stock split. The stock split became effective for shareholders at the close of business on February 1, 2008. The number of shares and per share amounts reported in these Condensed Consolidated Financial Statements have been updated from amounts reported prior to February 1, 2008, to reflect the effects of the split. In addition, the shareholders, at the same meeting, approved an amendment to Woodward’s Certificate of Incorporation increasing the number of authorized shares of common stock from 100,000 to 150,000.

 

 

Woodward operates through three business segments:

 

 

 

 

 

 

 

 

During fiscal 2008, Woodward fully funded its deferred compensation program totaling $4,292 at March 31, 2008. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and based on Woodward’s intentions regarding these instruments, marketable equity securities are classified as trading securities. The trading securities are reported at fair value, with unrealized gains and losses recognized in earnings. The trading securities are included in “Other current assets”.

 

 

SFAS 157:  In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. As a result, SFAS 157 is effective for Woodward in the first quarter of fiscal 2009. Woodward is currently assessing the impact that SFAS 157 may have on its results of operations and financial position.

 

SFAS 159:  In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 is expected to expand the use of fair value accounting but does not affect existing standards which require certain assets or liabilities to be carried at fair value. The objective of SFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under SFAS 159, a company may choose, at specified election dates, to measure eligible items at fair value and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. As a result, SFAS 159 is effective for Woodward in the first quarter of fiscal 2009. Woodward is currently assessing the impact that SFAS 159 may have on its results of operations and financial position.

 

EITF 07-3:  In June 2007, the Emerging Issues Task Force (“EITF”) issuedEITF 07-3,“Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities”(“EITF 07-3”).EITF 07-3addresses the diversity that exists with respect to the accounting for the non-refundable portion of a payment made by a research and development entity for future research and development activities. The EITF concluded that an entity must defer and capitalize non-refundable advance payments made for research and development activities, and expense these amounts as the related goods are delivered or the related services are performed.EITF 07-3is effective for interim or annual reporting periods in fiscal years beginning after December 15, 2007 (fiscal 2009 for Woodward). Woodward does not expect the adoption ofEITF 07-03to have a material impact on its results of operations and financial position.

 

SFAS 141(R):  In December 2007, the FASB issued SFAS No. 141 (Revised) “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) is intended to improve, simplify, and converge internationally the accounting for business combinations. Under SFAS 141(R), an acquiring entity in a business combination must recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquired entity at the acquisition date fair values, with limited exceptions. In addition, SFAS 141(R) requires the acquirer to disclose all information that investors and other users need to evaluate and understand the nature and financial impact of the business combination. SFAS 141(R) applies prospectively to business combinations for which the

 

 

 

acquisition date is on or after the beginning of the first annual reporting period on or after December 15, 2008. Earlier adoption is prohibited. Accordingly, Woodward will record and disclose business combinations under the revised standard beginning October 1, 2009.

 

SFAS 160:  In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an Amendment of Accounting Research Bulletin (“ARB”) 51”, (“SFAS 160”). This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest (minority interest) in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 establishes accounting and reporting standards that require (i) noncontrolling interests to be reported as a component of equity, (ii) changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions, and (iii) any retained noncontrolling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value. SFAS 160 is to be applied prospectively to business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008. SFAS 160 is effective for fiscal years beginning after December 15, 2008. As a result, SFAS 160 is effective for Woodward in the first quarter of fiscal 2010. Woodward is currently evaluating the impact SFAS 160 may have on its results of operations and financial position.

 

SFAS 161:  In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. The new standard is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 (fiscal 2010 for Woodward). Woodward is currently assessing the impact that SFAS 161 may have on its results of operations and financial position.

 

 

Net earnings per share — basic is computed by dividing net earnings available to common shareholders by the weighted average number of shares of common stock outstanding for the period. Net earnings per share — diluted reflects the potential dilution that could occur if options were exercised.

 

The average shares outstanding decreased in the second quarter of fiscal 2008 as a result of shares repurchased under Woodward’s ongoing share repurchase program. Woodward repurchases common stock at times management deems appropriate, given current market valuations. During the first quarter of fiscal 2008, Woodward completed its accelerated stock repurchase agreement through J.P. Morgan Chase Bank. Woodward purchased a total of 989 common shares in exchange for $31,114 through this program at an average price of $31.48 per common share.

 

The following is a reconciliation of net earnings to net earnings per share — basic and net earnings per share — diluted for the three and six month periods ended March 31, 2008 and 2007:

 

 

 

 

 

The following weighted average stock options were outstanding during the three and six months ended March 31, 2008 and 2007, but were not included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive:

 

 

 

Effective Annual Tax Rate for Interim Reporting — GAAP requires that the interim period tax provision be determined as follows:

 

 

The estimated annual effective rate is applied to the year-to-date “ordinary” income at the end of each quarter to compute the year-to-date tax applicable to ordinary income. The tax expense or benefit related to ordinary income in each quarter is the difference between the most recent year-to-date and the prior quarter year-to-date computations.

 

 

The determination of the annual effective tax rate is based upon a number of significant estimates and judgments, including the estimated annual pretax income of Woodward in each tax jurisdiction in which it operates and the development of tax planning strategies during the year. In addition, as a global commercial enterprise, Woodward’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, as well as other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.

 

The following table sets out the tax expense and the effective tax rate for Woodward’s continuing operations:

 

 

 

 

Income taxes for the six months ended March 31, 2007 included an expense reduction of $1,177 related to the retroactive extension of the U.S. research and experimentation tax credit. This expense reduction related to the estimated amount of the credit applicable to the period January 1, 2006 through September 30, 2006.

 

In June 2006, the FASB issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement 109” (“FIN 48”), which provides guidance on the financial statement recognition, measurement, reporting and disclosure of uncertain tax positions taken or expected to be taken in a tax return. FIN 48 addresses the determination of whether tax benefits, either permanent or temporary, should be recorded in the financial statements. For those tax benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.

 

Woodward adopted the provisions of FIN 48 on October 1, 2007, as required. The change in measurement criteria caused Woodward to recognize a decrease in the retained earnings component of shareholders’ equity of $7,702.

 

The total amount of the gross liability for worldwide unrecognized tax benefits reported in other liabilities in the Condensed Consolidated Balance Sheet was $19,393 at March 31, 2008, and $20,509 at October 1, 2007, after the adjustment to the beginning balance of retained earnings. The net decrease in the liability of $1,116 since the date of adoption resulted from a $3,494 decrease due to the resolution of a review by a tax authority. This decrease was partially offset by an additional provision for unrecognized tax benefits and related interest for the first six months of fiscal 2008. At March 31, 2008, the amount of unrecognized tax benefits that would impact Woodward’s effective tax rate, if recognized, was $15,832. At this time, Woodward estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease by up to $7,632 in the next twelve months through completion of reviews by various worldwide tax authorities.

 

Woodward recognizes interest and penalties related to unrecognized tax benefits in tax expense. Woodward had accrued interest and penalties of $4,931 and $4,396 as of March 31, 2008, and October 1, 2007, respectively.

 

Woodward’s tax returns are audited by U.S., state, and foreign tax authorities and these audits are at various stages of completion at any given time. Fiscal years remaining open to examination in significant foreign jurisdictions include 2002 and forward. Woodward is subject to U.S. and state income tax examinations for fiscal years 2003 and forward.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization expense associated with current intangibles is expected to be:

 

 

 

On October 25, 2007, Woodward entered into a Second Amended and Restated Credit Agreement with J.P. Morgan Chase Bank, National Association, Wachovia Bank, N.A., Wells Fargo Bank, N.A. and Deutsche Bank Securities. This agreement increased the initial commitment from $100,000 to $225,000 and also increased the option to expand the commitment from $75,000 to $125,000, for a total of $350,000. The agreement generally bears interest at LIBOR plus 41 basis points to 80 basis points and expires in October 2012. At March 31, 2008, there were $25,000 of borrowings outstanding under the agreement (none at September 30, 2007).

 

 

 

Provisions of the sales agreements include product warranties customary to such agreements. Accruals are established for specifically identified warranty issues that are probable to result in future costs. Warranty costs are accrued on a non-specific basis whenever past experience indicates a normal and predictable pattern exists. Changes in accrued product warranties were as follows:

 

 

 

 

 

 

 

The components of the net periodic pension cost related to continuing operations are as follows:

 

 

 

 

The components of the net periodic retirement healthcare benefits related to continuing operations are as follows:

 

 

Woodward expects its contributions for retirement pension benefits will be $0 in the United States and $2,913 in other countries in 2008. Woodward also expects its contributions for retirement healthcare benefits will be $3,276 in 2008, less amounts received as U.S. subsidies. The exact amount of cash contributions made to these plans in any year is dependent upon a number of factors including minimum funding requirements in the jurisdictions in which Woodward operates and arrangements made with trustees of certain foreign plans. As a result, the actual funding in fiscal 2008 may differ from the current estimate.

 

Woodward is entitled to a federal subsidy under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Woodward received no subsidy for the three and six months ended March 31, 2008. Woodward received $130 for the three months and $563 for the six months ended March 31, 2007. Woodward currently expects to receive an additional $542 during the year ending September 30, 2008.

 

Woodward paid prescription drug benefits of $662 and $506 during the three months ended March 31, 2008 and 2007, respectively, and $1,476 and $1,184 during the six months ended March 31, 2008 and 2007, respectively. Woodward expects to pay additional prescription drug benefits of approximately $1,400 for the year ending September 30, 2008.

 

 

 

 

Woodward uses the Black-Scholes-Merton pricing model to value its stock options. Expected volatilities are based on historical volatility using daily stock price observations. Woodward uses an expected life equal to the midpoint between the vesting date and the date of contractual expiration of the options, as permitted by the SEC’s Staff Accounting Bulletin 107 “Share-Based Payment”. Dividend yields are based on historical dividends. The risk-free interest rate is based on the U.S. Treasury yield curve at the time of grant. The estimated fair value of the Options is amortized to expense using the straight-line method over the vesting period.

 

 

 

Stock options are granted to Woodward’s key management members. The grant date for these awards is used for the measurement date. These awards are valued as of the measurement date and are amortized over the requisite vesting period. A summary for the activity for stock option awards in the three and six months ended March 31, 2008 is as follows:

 

 

 

 

 

Accumulated other comprehensive earnings, which totaled $36,554 at March 31, 2008, consisted of the following items:

 

 

 

 

 

Woodward is currently involved in pending or threatened litigation or other legal proceedings regarding employment, product liability, intellectual propertyand/orcommercial matters arising from the normal course of business. Woodward has accrued for individual matters that it believes are likely to result in a loss when ultimately resolved using estimates of the most likely amount of loss. There are also individual matters that it believes the likelihood of a loss when ultimately resolved is less than likely but more than remote, which were not accrued. While it is possible that there could be additional losses that have not been accrued, Woodward currently believes the possible additional loss in the event of an unfavorable resolution of each matter is less than $10,000 in the aggregate.

 

Woodward does not recognize contingencies that might result in a gain until such contingencies are resolved and the related amounts are realized.

 

 

 

In the event of a change in control of the company, Woodward may be required to pay termination benefits to certain executive officers.

 

 

 

The differences between the total of segment amounts and the Condensed Consolidated Financial Statements were as follows:

 

 

The summary of consolidated total assets is as follows:

 

 

 

 

 

 

 

We design, manufacture, and service energy control systems and components for aircraft and industrial engines and turbines and electrical power equipment. Leading original equipment manufacturers (“OEMs”) throughout the world use our products and services in the aerospace, power and process industries, and transportation markets.

 

Our strategic focus is Energy Control and Optimization Solutions. The control of energy — fluid energy, combustion, electrical energy, and motion — is a growing requirement in the markets we serve. Our customers look to us to optimize the efficiency, emissions, and operations of power equipment. Our core technologies leverage well across our markets and customer applications, enabling us to develop and integrate cost effective and state-of-the-art fuel, combustion, fluid, actuation, and electronic systems. We focus primarily on OEMs and equipment packagers, partnering with them to bring superior component and system solutions to their demanding applications.

 

We have three operating segments — Turbine Systems, Engine Systems, and Electrical Power Systems.

 

 

We use segment information internally to assess the performance of each segment and to make decisions on the allocation of resources.

 

At the 2007 annual meeting of shareholders on January 23, 2008, shareholders approved a two-for-one stock split. The stock split became effective for shareholders at the close of business on February 1, 2008. The number of shares and per share amounts reported in our Condensed Consolidated Financial Statements have been updated from amounts reported prior to February 1, 2008, to reflect the effects of the split. In addition, the shareholders, at the same meeting, approved an amendment to Woodward’s Certificate of Incorporation increasing the number of authorized shares of common stock from 100,000 to 150,000.

 

Net sales for the second quarter were $305,753, an increase of 19.3%, from $256,298 for the second quarter of the prior year. Net earnings for the second quarter were $29,714, or $0.43 per diluted share, compared to $20,262, or $0.29 per diluted share, in the three month period ended March 31, 2007.

 

Net sales for the six month period were $577,816, an increase of 19.7%, from $482,546 for the six month period of the prior year, with organic growth of 17.9%. Net earnings for the six month period were $55,039, or $0.79 per diluted share, compared to $38,149, or $0.54 per diluted share, in the previous year’s six month period.

 

Turbine Systems’ net sales for the second quarter were $147,454, an increase of 12.8% from $130,772 for last year’s second quarter. Turbine Systems’ net sales for the six month period were $278,247, an increase of 12.3% from $247,777 for the six month period ended March 31, 2007. Turbine Systems’ segment earnings for the second quarter increased 29.9% to $30,951 from $23,830 for the same quarter a year ago. Turbine Systems’ segment earnings as a percentage of sales for the second quarter increased to 21.0% from 18.2% for the second quarter a year ago. Turbine Systems’ segment earnings as a percentage of sales for the six month period increased to 20.9% from 17.4% from the six month period ended March 31, 2007. As in recent quarters, our sales performance reflected generally strong demand for both our OEM and aftermarket offerings in the industrial and aerospace turbine markets. The earnings increase in Turbine Systems was principally the result of leverage on the increased volume.

Engine Systems’ net sales for the second quarter were $125,828, an increase of 14.4% from $110,024 for last year’s second quarter. Engine Systems’ net sales for the six month period were $239,862, an increase of 12.6% from $212,945 for the six month period ended March 31, 2007. Sales continued to be robust in all of our markets. Engine Systems’ segment earnings for the second quarter increased 10.4% to $13,005 from $11,785 for the same quarter a year ago. Engine Systems’ second quarter earnings as a percentage of sales decreased to 10.3% from 10.7% from the second quarter a year ago. Engine Systems’ six month period earnings as a percentage of sales decreased to 10.5% from 11.4% from the six month period ended March 31, 2007 reflecting higher than expected operating costs.

 

Electrical Power Systems’ net sales for the second quarter were $64,891, an increase of 43.5% from $45,223 for last year’s second quarter. Electrical Power Systems’ net sales for the six month period were $122,365, an increase of 57.8% from $77,525 for the six month period ended March 31, 2007. Sales growth in the second quarter was entirely organic. Electrical Power Systems’ segment earnings for the quarter increased 48.9% to $9,546 from $6,409 for the same quarter a year ago. Electrical Power Systems’ second quarter earnings as a percentage of sales increased to 14.7% from 14.2% from the second quarter ended March 31, 2007. Electrical Power Systems’ six month period earnings as a percentage of sales increased to 13.7% from 12.9% from the six month period ended March 31, 2007. Again this quarter, growth occurred in both our power generation and distribution and wind turbine inverter markets with growth in wind continuing at an exceptional pace. Earnings for Electrical Power Systems increased primarily because of the increase in volume as well as favorable currency translation and improved operating processes.

 

Nonsegment expenses for the quarter declined to $9,288 from $9,918 last year. The income tax provision this quarter was more favorable than anticipated as a result of the favorable resolution of outstanding tax issues.

 

Our six month period results for this year also included the effect of the implementation of Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (“FIN 48”), which decreased the retained earnings component of shareholders’ equity by $7,702.

 

At March 31, 2008, our total assets were $863,830, including $60,242 in cash and cash equivalents, and our total debt was $73,795. We continue to be well positioned to fund expanded research and development projects and to explore other investment opportunities consistent with our focused strategies.

 

 

 

The following table presents the breakdown of consolidated net external sales by segment:

 

 

Turbine Systems’ net external sales increased 14.2% and 13.6% in the three and six month periods ended March 31, 2008, respectively, compared to the same periods a year ago, reflecting the strength of the aerospace and power generation business. This has driven higher demand for aviation and power generation OEM, military, and commercial aftermarket products.

 

Engine Systems’ net external sales increased 14.3% and 12.5% in the three and six month periods ended March 31, 2008, respectively, compared to the same periods a year ago. The primary drivers of this growth are increased production in the marine and alternative fuel markets.

 

Electrical Power Systems’ net external salesincreased 55.6% and 75.6% in the three and six month periods ended March 31, 2008, respectively, compared to the same periods a year ago. Demand in both the

power generation and distribution and wind inverter turbine markets drove the increase in sales. The growth in wind turbine inverter demand has been exceptional.

 

 

The following table presents costs and expenses: