Woodward - 10-Q quarterly report FY

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 0-8408

Woodward Governor Company

(815) 877-7441

          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 þ          No o

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes þ          No o

          As of April 23, 2004, 11,298,576 shares of common stock with a par value of $.00875 cents per share were outstanding.

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PART I — FINANCIAL INFORMATION

Statements of Consolidated Earnings

See accompanying Notes to Consolidated Financial Statements.

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Statements of Consolidated Earnings

     Woodward Governor Company and Subsidiaries

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Balance Sheets

See accompanying Notes to Consolidated Financial Statements.

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Statements of Consolidated Cash Flows

See accompanying Notes to Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     The consolidated balance sheet as of March 31, 2004, the statements of consolidated earnings for the three and six-month periods ended March 31, 2004 and 2003, and the statements of consolidated cash flows for the six-month periods ended March 31, 2004 and 2003, were prepared by the company without audit. The September 30, 2003, 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 March 31, 2004, the results of its operations for the three and six-month periods ended March 31, 2004 and 2003, and its cash flows for the six-month periods ended March 31, 2004 and 2003. All such adjustments were of a normal and recurring nature. The statements were prepared following the accounting policies described in the company’s 2003 annual report on Form 10-K and should be read with the Notes to Consolidated Financial Statements on pages 34-46 of the 2003 annual report to shareholders. The statements of consolidated earnings for the three and six-month period ended March 31, 2004, is not necessarily indicative of the results to be expected for other interim periods or for the full year.

     We use the intrinsic value method to account for stock-based employee compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and therefore we do not recognize compensation expense in association with options granted at or above the market price of our common stock at the date of grant. The following table presents a reconciliation of reported net earnings and per share information to pro forma net earnings and per share information that would have been reported if the fair value method had been used to account for stock-based employee compensation:

     In December 2003, the Financial Accounting Standards Board issued a revised Statement of Financial Accounting Standards No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” The revised Statement requires additional disclosures to those in the original Statement No. 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The interim-period disclosure requirements of the revised Statement were effective during our first quarter this year, and our disclosures may be found in note 10 to the consolidated

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financial statements. The remaining disclosure requirements of the revised Statement are effective for our year ending September 30, 2004.

     The following stock options were outstanding during the three and six months ended March 31, 2004 and 2003, 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:

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     In August 2003, we acquired assets and assumed certain liabilities of Barber-Colman Dyna Products, a division of Invensys Building Systems, Inc. At September 30, 2003, both the cost for the acquisition and the related allocation of the acquisition cost were subject to change, including $3,491,000 that was recognized as goodwill. We finalized the acquisition cost and allocation of the acquisition cost in 2004. As finalized, our cost for this acquisition totaled $7,684,000, of which $3,776,000 was recognized as customer relationships and $100,000 was recognized as other intangibles in the Industrial Controls segment. No value was recognized as goodwill and, as a result, the preceding table reports a reduction in the amount of goodwill acquired. For this acquisition, we are using weighted-average amortization periods of eleven years for customer relationships, two years for other intangibles, and eleven years in the aggregate.

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(8)     Other intangibles — net:

     Amortization expense associated with current intangibles is expected to be approximately $6,800,000 for each year 2004-2005, approximately $6,750,000 for 2006, approximately $6,350,000 in 2007, and approximately $5,750,000 in 2008.

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     Salaries and other member benefits include accrued termination benefits totaling $1,145,000 at March 31, 2004 and $2,199,000 at September 30, 2003. Changes in accrued termination benefits for the six months ended March 31, 2004 were as follows:

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     Termination benefits accrued by Industrial Controls impacted manufacturing, selling, and administrative expenses and reflect adjustments to stay bonuses to be paid out in future periods. Accrual adjustments in Industrial Controls reflect retention of certain members due to increased production levels. We expect all terminations to be completed by the end of June 2004 and all associated payments to be completed by the end of September 2004.

     Provisions of our sales agreements include product warranties customary to such agreements. We establish accruals for specifically identified warranty issues that are probable to result in future costs. We also accrue for warranty costs on a non-specific basis whenever past experience indicates a normal and predictable pattern exists. A reconciliation of accrued product warranties from September 30, 2003, to March 31, 2004, follows:

     We provide various benefits to eligible members of our company, including pension benefits associated with defined benefit plans and retirement healthcare benefits. Components of net periodic benefit cost and company contributions for these plans were as follows:

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     Accumulated other comprehensive earnings, which totaled $12,880,000 at March 31, 2004, consisted of the following items:

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     We are currently involved in pending or threatened litigation regarding employment, environmental, and product liability matters, and arbitration proceedings regarding contractual matters arising from the normal course of business. We have accrued approximately $700,000 at March 31, 2004 in accrued expenses for these matters, which represent our estimate of the most likely amount of losses that we believe will be incurred.

     We also file income tax returns in various jurisdictions worldwide, which are subject to audit. Our income taxes receivable/payable include our estimate of the most likely amount of expenses that we believe will result from income tax audit adjustments.

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

     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.

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     The difference between the total of segment earnings and the statements of consolidated earnings follows:

     Segment assets were as follows:

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     We prepared the following discussion and analysis to help you better understand factors that may affect our future results, our critical accounting policies and market risks, our results of operations and financial condition, and the effects of recent accounting pronouncements. This discussion should be read with the consolidated financial statements.

Factors That May Affect Future Results

     This Form 10-Q contains forward-looking statements, including:

     Forward-looking statements do not reflect historical facts. Rather, they are statements about future events and conditions and often include words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” or similar expressions. Such statements reflect our expectations about the future only as of the date they are made. We are not obligated to, and we might not, update our forward-looking statements to reflect changes that occur after the date they are made. Furthermore, actual results could differ materially from projections or any other forward-looking statement regardless of when they are made.

     Important factors that could individually, or together with one or more other factors, affect our business, results of operations and/or financial condition are discussed more fully in the Management Discussion and Analysis on page 16 of our 2003 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2003.

Critical Accounting Policies

     We consider the accounting policies used in preparing our financial statements to be critical accounting policies when they are both important to the portrayal of our financial condition and results of operation, and require us to make difficult, subjective, or complex judgments. Critical accounting policies normally result from the need to make estimates about the effect of matters that are inherently uncertain. Management has discussed the development and selection of our critical accounting policies with the audit committee of the company’s Board of Directors. In each of the areas that were identified as critical accounting policies, our judgments, estimates, and assumptions are impacted by conditions that change over time. As a result, in the future there could be changes in our assets and liabilities, increases or decreases in our expenses, and additional losses or gains that are material to our financial condition and results of operations. Our critical accounting policies are discussed more fully in the Management Discussion and Analysis on pages 17-18 of our 2003 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2003.

Market Risks

     Our long-term debt and interest rate swap agreements are sensitive to changes in interest rates. Also, assets, liabilities, and commitments that are to be settled in cash and are denominated in foreign currencies for transaction purposes are sensitive to changes in currency exchange rates. These market risks are discussed more fully in the Management Discussion and Analysis on page 19 of our 2003 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2003.

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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 turbines.

     We use segment earnings internally to assess the performance of each segment and to make decisions on the allocation of resources. Total segment earnings do not reflect all expenses of the company. Nonsegment expenses, including income taxes, are separately discussed and analyzed.

     External net sales of Industrial Controls increased in both the three months and six months ended March 31, 2004, as compared to the same periods last year. Businesses acquired in the third and fourth fiscal quarters last year accounted for $13.5 million of the year-over-year increase for the three-month period and $25.7 million for the six-month period. The effect of changes in foreign currency exchange rates accounted for $4.8 million of the increase for the three-month period and $9.6 million for the six-month period. The remaining increases reflected firmer demand in many product lines, particularly from Asian and North American markets.

     Industrial Controls generated segment earnings in both the three months and six months ended March 31, 2004, as compared to segment losses for the same periods last year. These improvements were the result of higher sales and improved segment earnings margins. Also, last year, we incurred approximately $2.5 million in charges for workforce management and lease termination expenses during the three-month period and $3.0 million for the six-month period. The improvement in the segment earnings margin was driven by cost reduction efforts in fiscal year 2003, including reductions in our workforce, and the positive operating leverage associated with higher sales.

     Our accrual for workforce management activities at September 30, 2003, was $2.1 million. In this year’s first six months, we incurred an additional $0.2 million of expense associated with stay bonuses, made payments totaling $0.8 million and adjusted our accrual by $0.4 million. The accrual adjustment, which was a reduction, reflected retention of certain members due to increased production levels. At March 31, 2004, our remaining accrual was $1.1 million, including the effects of foreign currency rate fluctuations. We expect all member terminations to be completed by the end of June 2004 and all associated payments to be completed by the end of September 2004.

     External net sales of Aircraft Engine Systems increased in the three months ended March 31, 2004, over the same three-month period last year. For the six months ended March 31, 2004, sales were about the same as last year’s six-month period. Both comparisons reflected continued weakness in the commercial aviation industry generally, with improved military and commercial aftermarket sales in the last quarter.

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     Aircraft Engine Systems’ segment earnings increased in the three months ended March 31, 2004, as compared to the same three-month period last year. For the six months ended March 31, 2004, earnings were approximately the same as last year’s six-month period. Last year’s results included $1.0 million for workforce management and facility consolidation expenses in the three-month period and $3.3 million in the six-month period.

     Our six-month results were affected by lower sales and a less favorable sales mix in our first quarter as compared to the first quarter a year ago, reflecting normal variability in sales. The resulting decrease in first quarter margins was partially offset by cost reductions associated with the facility consolidation of Aircraft Engine Systems’ servovalve operations.

     Interest expense increased in both the three months and six months ended March 31, 2004, as compared to the same periods last year because of higher levels of outstanding debt.

     Certain key management members may elect to defer the payment of a portion of their compensation to future periods. These deferrals are recorded as deferred compensation, and individual member balances are increased or decreased as if they were held in specified investments, principally common stock of the company. The primary reason nonsegment expenses were lower in the three months and six months ended March 31, 2003, as compared to this year is related to deferred compensation. Last year, the value of deferred compensation balances decreased, which resulted in cumulative expense reductions.

     In February 2003, we contributed common stock of the company to a trust established specifically for the future settlement of certain deferred compensation obligations that are payable in actual shares of our common stock. To the extent that shares are held in this trust, it is not necessary to record deferred compensation expenses for changes in the fair value of the underlying common stock. As a result, we expect the volatility in our deferred compensation expense to be reduced in subsequent periods.