Woodward - 10-Q quarterly report FY

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

          As of April 22, 2005, 11,412,628 shares of common stock with a par value of $.00875 cents per share were outstanding.

See accompanying Notes to Consolidated Financial Statements.

See accompanying Notes to Consolidated Financial Statements.

See accompanying Notes to Consolidated Financial Statements.

See accompanying Notes to Consolidated Financial Statements.

      The consolidated balance sheet as of March 31, 2005, the statements of consolidated earnings for the three and six-month periods ended March 31, 2005 and 2004, and the statements of consolidated cash flows for the six-month periods ended March 31, 2005 and 2004, were prepared by the company without audit. The September 30, 2004, 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, 2005, the results of its operations for the three and six-month periods ended March 31, 2005 and 2004, and its cash flows for the six-month periods ended March 31, 2005 and 2004. All such adjustments were of a normal and recurring nature. The statements were prepared following the accounting policies described in the company’s 2004 annual report onForm 10-K/ A Amendment No. 1 and should be read with the Notes to Consolidated Financial Statements on pages 38-58 of the 2004 annual report to shareholders. The statements of consolidated earnings for the three and six-month periods ended March 31, 2005, are 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:

      We recognize sales when delivery of product has occurred or services have been rendered and there is persuasive evidence of a sales arrangement, selling prices are fixed or determinable, and collectibility from the customer is reasonably assured. We consider product delivery to have occurred when the customer has taken title and assumed the risks and rewards of ownership of the products. Most of our sales are made directly to customers that use our products, although we also sell products to distributors, dealers, and independent service facilities. Sales terms for distributors, dealers, and independent service facilities are identical to our sales terms for direct customers. We account for payments made to customers as a reduction of revenue unless

they are made in exchange for identifiable goods or services with fair values that can be reasonably estimated. These reductions in revenues are recognized immediately to the extent that the payments cannot be attributed to expected future sales, and are recognized in future periods to the extent that the payments relate to future sales, based on the specific facts and circumstances underlying each payment.

      In November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs.” The Statement clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current-period charges. This Statement also requires that allocations of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Statement becomes effective for our fiscal year beginning October 1, 2005. We currently do not expect that application of this Statement will have any material effect on our financial statements.

      In December 2004, the Financial Accounting Standards Board issued a revised Statement of Financial Accounting Standards No. 123, “Share-Based Payment.” Among its provisions, the revised Statement will require us to measure the cost of employee services in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize the cost over the requisite service period. In accordance with a Securities and Exchange Commission rule issued in April 2005, this revised statement becomes effective for our fiscal year beginning October 1, 2005, although early adoption is allowed. As described in Note 2 to these financial statements, we currently use the intrinsic value method to account for stock-based employee compensation. As a result, adoption of this revised Statement is expected to reduce our net earnings in interim and annual periods after adoption. We believe the best indication of the approximate immediate net earnings effect of adopting the provisions of this revised Statement may be determined by reviewing Note 2 to these financial statements and Note 1 to Consolidated Financial Statements on page 39 of the 2004 annual report to shareholders, which was filed with ourForm 10-K/ A Amendment No. 1 for the year ended September 30, 2004. These notes show that net earnings would have decreased by $0.03 per diluted share for the quarter ended March 31, 2005, $0.05 per diluted share for the six months ended March 31, 2005, and $0.11 per diluted share for the year ended September 30, 2004. Also, upon adoption we will be allowed to, but not required to, restate prior years in accordance with a prescribed modified retrospective method or, in the event of early adoption of the revised statement this fiscal year, restate prior interim periods in accordance with a prescribed modified retrospective method. We have not yet determined whether we will adopt the revised statement this fiscal year or wait until the required effective date of next fiscal year and we have not yet determined whether we will restate prior periods.

      The following stock options were outstanding during the three and six months ended March 31, 2005 and 2004, 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:

      Amortization expense associated with current intangibles is expected to be approximately $7,100,000 for 2005, $7,000,000 for 2006, $6,600,000 in 2007, $5,900,000 for 2008, and $5,500,000 for 2009.

      Salaries and other member benefits include accrued termination benefits totaling $10,005,000 at March 31, 2005 and $12,000,000 at September 30, 2004. These accrued termination benefits were in Industrial Controls. Changes in accrued termination benefits for the six months ended March 31, 2005 were as follows:

      The amounts expensed during the six-month period were for termination benefits earned by members over the period and are primarily related to the consolidation of two European manufacturing operations with existing operations. This action is being taken to streamline the organization by eliminating redundant manufacturing operations and is expected to be substantially complete by March 31, 2006. The total expense for this action is currently estimated to be approximately $15,400,000, of which $12,557,000 was recognized through March 31, 2005. The remaining estimated amount of $2,843,000 is for termination benefits that will be earned by members over their remaining service period and for other costs primarily associated with moving equipment and inventory to other locations. The accrual adjustments reflected in the preceding table were made as a result of changes in estimates for termination benefits payable. These estimates changed because of voluntary member resignations, the currently expected transfer of members to a third-party distributor, and more members electing early retirement options at a lower cost.

      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, 2004, to March 31, 2005, 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:

      On May 3, 2005, we announced amendments to one of our retirement healthcare benefit plans that will result in the recognition of a curtailment gain in the third quarter of fiscal year 2005 and will reduce our future net periodic benefit cost. We currently expect the curtailment gain to be in the range of $7,000,000 to $8,000,000. The future reduction in net periodic benefit cost resulting from the plan amendment has not yet been determined. Our future net periodic benefit cost will be affected by the measurement of plan benefit obligations as of May 3, 2005, which we expect to complete in our third quarter.

      Accumulated other comprehensive earnings, which totaled $14,183,000 at March 31, 2005, consisted of the following items:

      We are currently involved in pending or threatened litigation or other legal proceedings regarding employment, product liability, and contractual matters arising from the normal course of business. We accrued for individual matters that we believe 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 we believe 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, we currently believe the possible additional loss in the event of an unfavorable resolution of each matter is less than $5,000,000 in the aggregate.

      We also file income tax returns in various jurisdictions worldwide, which are subject to audit. We have accrued for 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.

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

      Segment assets were as follows:

      We prepared the following discussion and analysis to help you better understand our financial condition, changes in our financial condition, and results of operations. This discussion should be read with the consolidated financial statements.

      Our business is focused on the design, manufacture, and servicing of energy control systems and components for aircraft and industrial engines, turbines, and other power equipment. We use technologies in the areas of fuel systems, combustion control, electronic controls and software, and systems integration to develop components and integrated systems that we sell to OEMs (original equipment manufacturers) for use in power equipment for the power generation, process industries, transportation, and aerospace markets.

      We have two operating segments — Industrial Controls and Aircraft Engine Systems. Industrial Controls provides energy control systems and components primarily to OEMs 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 information internally to assess the performance of each segment and to make decisions on the allocation of resources.

      There has been a lot of volatility in the markets we serve in recent years, and our sales and earnings reflect the results of that volatility. While we saw improved market conditions in 2004, they were still not at the levels they were before the declines that began in 2002. Our second quarter and first half of 2005 reflected improved market conditions over the corresponding periods a year ago, approximately in line with the fourth quarter of last year.

      The changes in our markets have affected our decisions in managing our workforce. We will be implementing actions in 2005 and the first half of 2006 to consolidate certain manufacturing operations in The Netherlands, United Kingdom, and Japan with existing operations in the United States, Germany, and China. Once fully implemented, we expect these actions will generate annual savings of $9 million to $11 million on a pretax basis. The related cost for the actions is currently estimated at $15.4 million. We recognized approximately $12.6 million of this cost through the second fiscal quarter of 2005.

      In the sections that follow, we are providing information 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 Form 10-Qcontains 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 pages 15-16 of our 2004 annual report to shareholders, which was filed with ourForm 10-K/ A Amendment No. 1 for the year ended September 30, 2004.

      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 16-19 of our 2004 annual report to shareholders, which was filed with ourForm 10-K/ A Amendment No. 1 for the year ended September 30, 2004.

      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 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 2004 annual report to shareholders, which was filed with ourForm 10-K/ A Amendment No. 1 for the year ended September 30, 2004. However, we currently do not have any existing interest rate swap agreements.

      Consolidated net sales increased in both the three months and six months ended March 31, 2005, as compared to the same periods a year ago. Industrial Controls benefited from a broad industrial recovery that encompassed power generation, transportation, and process industries, including the mobile industrial and marine markets. In particular, we have experienced higher demand for large gas turbine combustion products — the area affected most by the severe market declines of 2002 and 2003 — and diesel fuel injection products in the first six months this year as compared to last year.

      Aircraft Engine Systems’ improvements reflect the favorable trends in commercial aviation. We experienced modest growth in commercial OEM sales, as Boeing and Airbus ramped up their production levels for narrow and widebody aircraft. Also, there has been increased demand for commercial aftermarket spare parts and repair and overhaul services.

      Cost of goods sold increased in both the three months and six months ended March 31, 2005, compared to the same periods last year, primarily as a result of increased sales. For the quarter, cost of goods sold represented 74.8% of sales this year and 75.2% last year. For the six months, cost of goods sold represented 75.2% of sales this year and 74.6% last year.

      Research and development increased in both the three months and six months ended March 31, 2005, as compared to the same periods last year. Research and development activities have continued at a pace similar to the last half of fiscal 2004, which totaled $21.3 million.

      Interest and other income increased in both the three months and six months ended March 31, 2005, compared to the same periods last year. Net gains on the sale of equipment were approximately $0.6 million in the most recent quarter, compared to net losses of $0.1 million in the same quarter a year ago. In addition, this year’s six month period was affected by the sale of rights to our aircraft propeller synchronizer product line to an unrelated third party, which resulted in a pre-tax gain of $3.8 million. Prior to the sale, the product line generated annual sales of approximately $2.0 million.

      Workforce management costs in the three months and six months ended March 31, 2005, are primarily related to the consolidation of manufacturing operations in The Netherlands and United Kingdom with existing operations in the United States and Germany. We are also consolidating a small manufacturing operation in Japan with an existing operation in China and are making sales force reductions in The Netherlands. These actions are discussed more fully in the Management Discussion and Analysis on pages 24-25 of our 2004 annual report to shareholders, which was filed with our Form 10-K/ A Amendment No. 1 for the year ended September 30, 2004.

      The amounts reflected in the preceding table for fiscal 2005 consist of costs for termination benefits earned by members during the three and six-month service periods ended March 31, 2005, and for adjustments of amounts previously accrued for these actions. The accrual adjustments were made as a result of changes in estimates for termination benefits payable. These estimates changed because of voluntary member resignations, the currently expected transfer of members to a third-party distributor, and more members electing early retirement options at a lower cost.

      The total expense for these current actions is currently estimated to be approximately $15.4 million, of which $12.6 million has been recognized through March 31, 2005. By fiscal year, we recognized $13.8 million

of expense in 2004 and a net expense reduction of $1.2 million in the first six months of 2005. The remaining estimated amount of $2.8 million is for termination benefits that will be earned by members over their remaining service period and for other costs primarily associated with moving equipment and inventory to other locations. We expect to expense the $2.8 million over the next four quarters.

      Our cash expenses for the 2004 actions are expected to total $13.6 million, and will be paid from available cash balances in 2005 and 2006 without the need for additional borrowings. The remaining $1.8 million was for non-cash contractual pension termination benefits, which were recognized in last fiscal year’s fourth quarter.

      Once fully implemented, our annual savings are expected to range from $9.0 million to $11.0 million. These savings are primarily related to reduced personnel costs, although we anticipate some savings in travel and other costs due to the reduced headcount. Of the total savings, approximately 90% is expected to affect cost of goods sold and 10% selling, general, and administrative expenses. We currently expect to begin realizing savings in the third and fourth quarters of 2005, increasing gradually through the end of the second quarter of 2006 when we expect to begin realizing the full savings level.

      We currently plan to continue to use the facilities and equipment located in The Netherlands, United Kingdom, and Japan after the actions are completed. We own all three facilities, and each of them will have ongoing sales and service activities. In addition, the facility in the United Kingdom will remain a key development site for diesel fuel injection products. We expect to move manufacturing equipment used by the three locations to other facilities.

      The amounts reflected in the preceding table for the three and six months ended March 31, 2004, were related to actions initiated in fiscal 2003, discussed more fully in the Management Discussion and Analysis on pages 24-25 of our 2004 annual report to shareholders, which was filed with ourForm 10-K/ A Amendment No. 1 for the year ended September 30, 2004. We attributed last year’s accrual reduction to increased production levels and the decision to retain certain members to meet the increased demand.

      Industrial Controls’ segment earnings increased in both the three months and six months ended March 31, 2005, as compared to the same periods last year. The effects of higher sales were partially offset by changes in our sales mix for the six-month period, and higher development and general and administrative expenses for both the three-month and six-month periods this year as compared to last year. In addition, net reductions in accruals for workforce management activities benefited earnings for both periods this year.

      Industrial Controls’ gross margin (external net sales less external cost of goods sold) increased by approximately $7.5 million in this year’s second quarter as compared to the same quarter last year. For the first six months, the increase was $9.1 million over last year. For both periods, the year-over-year increase in sales resulted in higher gross margins. For the six-month period, this year’s sales mix included a higher percentage

of diesel fuel injection products and turbine combustion products. While most of the products we sell have been designed by us, both of these product lines include the manufacture of certain customer-designed products, which have lower-than-average margins. In addition, there are certain other diesel fuel injection products that had higher sales and generated lower margins; the sales of these other products are being phased out through the end of October 2005.

      Industrial Controls’ research and development costs increased approximately $2.0 million in this year’s second quarter and $2.7 million in this year’s first half as compared to the same periods a year ago, reflecting higher development activity and normal variations in the timing of project expenditures.

      Industrial Controls’ selling, general, and administrative expenses increased approximately $1.4 million in this year’s second quarter and $1.7 million in this year’s first half as compared to the same periods a year ago. This increase is primarily attributable to normal variations in legal and other professional services. As a percent of sales, these expenses were 8.6% in this year’s second quarter, down from 9.9% from the second quarter last year, and 9.3% in this year’s first half, down from 11.0% in last year’s first half.

      Industrial Controls’ workforce management actions resulted in the net reductions of $1.7 million of expense in this year’s second quarter and $1.2 million of expense in the six months ended March 31, 2005. Last year, there were net reductions in expenses related to workforce management actions totaling approximately $0.3 million for both the second quarter and six months ended March 31, 2004. These actions are discussed more fully in a separate section of this management’s discussion and analysis.

      Aircraft Engine Systems’ segment earnings increased in both the three months and six months ended March 31, 2005, as compared to the same periods last year. The increases were due to a gain on the sale of certain product line rights in the six-month period, and higher sales and the cost effects associated with the lower ratio of fixed costs to variable costs in both the three-month and six-month periods.

      Aircraft Engine Systems sold the rights to its propeller synchronizer product line in the first quarter this year, generating a gain of $3.8 million. Prior to the sale, the product line generated annual sales of approximately $2.0 million.

      Higher sales generated additional gross margin dollars in Aircraft Engine Systems’ second fiscal quarter and first half this year as compared to the same periods a year ago. In addition, we benefited from the operating leverage effect of the increasing sales versus fixed costs.

      Nonsegment expenses increased in both the three months and six months ended March 31, 2005, as compared to the same periods a year ago primarily because of increases in professional services associated with the assessment and audit of internal controls over financial reporting, which is required by the Sarbanes-Oxley Act of 2002, and current recruiting activities.

      Income taxes were provided at an effective rate on earnings before taxes of 36.5% in the six months ended March 31, 2005, compared to a 36.3% effective rate for fiscal year 2004. The change in the rate from the first quarter, which was 37.0%, was made to reflect our current full year outlook on the mix of foreign and domestic earnings.

     Outlook: Our markets are strong and indications suggest that the strength will continue. While our sales are dependent on how vigorous our markets remain, we anticipate higher sales for the second half of this fiscal year as compared to the first half. Our earnings will continue to be affected by the costs associated with the consolidation of our European operations. However, we expect these additional costs to be partially offset by saving from these actions. As a result of these items and the gain on the product line sale in the first quarter, we now anticipate our full-year earnings to be in the range of $3.85 to $4.15 per share.

      On May 3, 2005, we announced amendments to one of our retirement healthcare benefit plans that will result in the recognition of a curtailment gain in the third quarter of fiscal year 2005 and will reduce our future net periodic benefit cost. We currently expect the curtailment gain to be in the range of $7 million to $8 million. The future reduction in net periodic benefit cost resulting from the plan amendment has not yet been determined. Our future net periodic benefit cost will be affected by the measurement of plan benefit

obligations as of May 3, 2005, which we expect to complete in our third quarter. The effects of these changes are not reflected in the range of earnings provided in the preceding paragraph.

      Industrial Controls’ segment assets increased in the six months ended March 31, 2005, primarily as a result of higher inventories for future sales and changes in foreign currency exchange rates.

      Aircraft Engine Systems’ segment assets decreased in the six months ended March 31, 2005, primarily as a result of a decrease in accounts receivable, which reflected normal variations in the timing of billing and collections.

      Nonsegment assets increased in the six months ended March 31, 2005, primarily because of an increase in cash and cash equivalents. Net cash flows provided by operations during the period exceeded net cash used in investing and financing activities.

      Working capital (current assets less current liabilities) increased in the six months ended March 31, 2005, primarily as a result of increases in cash and cash equivalents and inventories, which were partially offset by increases in the current portion of long-term debt. Changes in cash and cash equivalents and inventories are directly observable in our statements of consolidated cash flows and are discussed in other sections of this management’s discussion and analysis. The increase in the current portion of long-term debt reflects changes due to the timing of the future payments. The first payments of the senior notes payable are due in October 2005. The related liability for these payments was classified as noncurrent at September 30, 2004, and as current at March 31, 2005.

      Long-term debt decreased in the six months ended March 31, 2005, as a result of the timing of future payments, as noted in the preceding paragraph. Required future principal payments of long-term debt and commitments under operating leases were as follows:

      We currently have a revolving line of credit facility with a syndicate of U.S. banks totaling $100 million, with an option to increase the amount of the line to $175 million if we desire. The line of credit facility is set to

expire on March 11, 2010. In addition, we have other lines of credit facilities, which totaled $26.4 million at September 30, 2004, that are generally reviewed annually for renewal.

      Provisions of debt agreements include covenants customary to such agreements that require us to maintain specified minimum or maximum financial measures and place limitations on various investing and financing activities. The agreements also permit the lenders to accelerate repayment requirements in the event of a material adverse event. Our most restrictive covenants require us to maintain a minimum consolidated net worth, a maximum consolidated debt to consolidated operating cash flow, and a maximum consolidated debt to EBITDA, as defined in the agreements. We were in compliance with all covenants at March 31, 2005.

      Other liabilities increased in the six months ended March 31, 2005, primarily as a result of changes in accruals for retirement healthcare benefits and retirement pension benefits. These changes represent the excess of actuarially determined periodic benefit costs over cash contributions by the company.

      On May 3, 2005, we announced amendments to one of our retirement healthcare benefit plans that will result in the recognition of a curtailment gain in the third quarter of fiscal year 2005, which will reduce other liabilities. We currently expect the curtailment gain to be in the range of $7 million to $8 million.

      Commitments and contingencies at March 31, 2005, include various matters arising from the normal course of business. We are currently involved in pending or threatened litigation or other legal proceedings regarding employment, product liability and contractual matters. We accrued for individual matters that we believe 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 we believe 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, we currently believe the possible additional loss in the event of an unfavorable resolution of each matter is less than $5 million in the aggregate.

      We file income tax returns in various jurisdictions worldwide, which are subject to audit. We have accrued for 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.

      Shareholders’ equity increased in the six months ended March 31, 2005, primarily as a result of net earnings for the first six months. Dividend payments were more than offset by sales of treasury stock, foreign currency translation adjustments, and the tax benefit applicable to stock options.

      On January 26, 2005, the Board of Directors authorized the repurchase of up to $30 million of our outstanding shares of common stock on the open market and private transactions over a three-year period. We did not repurchase any shares in the three months ended March 31, 2005, under this authorization.

      Also, on January 26, 2005, the Board of Directors declared a cash dividend of $0.25 per share payable March 1, 2005, to shareholders of record at February 15, 2005. Cash dividends were $0.24 per share in each of the previous eight quarters. This change raises the indicated annual dividend rate to $1.00 from $0.96, an increase of 4.2%. The Board of Directors declared a second consecutive quarterly cash dividend of $0.25 per share on April 27, 2005.

      Net cash flows provided by operating activities decreased in the first six months this year as compared to the first six months last year. Both operating cash receipts and disbursements increased in the six-month period this year compared to last year due to higher sales volume. However, cash paid to employees and suppliers increased at a greater rate than cash collected from customers, reflecting normal variations in payment and collection patterns and payments of variable compensation that was earned during fiscal year 2004 and paid in fiscal year 2005. In addition, our income tax payments were higher in the six-month period this year as compared to the same period last year.

      Net cash flows used in investing activities were about the same in the first six months this year as compared to the first six months last year, consisting primarily of capital expenditures.

      Net cash flows used in financing activities decreased in the first six months this year compared to the first six months last year. Our borrowings remained relatively stable in this year’s six-month period compared to a reduction of $26.8 million in last year’s six-month period. Also, proceeds from the sale of treasury stock increased by $2.0 million in the first six months this year as compared to the same period last year, attributable to the exercise of member stock options.

     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. Payments of $64.3 million of senior notes are not due until the 2007-2012 timeframe. Also, we have a $100 million line of credit facility that includes an option to increase the amount of the line up to $175 million that does not expire until March 11, 2010. Despite these factors, 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.