Business context and reporting period
Woodward, Inc. designs, manufactures and services energy-control products for aerospace and industrial markets. This unaudited Form 10-Q covers the fiscal third quarter and first nine months ended June 30, 2019. Results include Woodward L’Orange, acquired June 1, 2018, in the Industrial segment; its contribution complicates comparisons with the prior year.
Financial performance and liquidity
Amounts below are in millions of dollars, except per-share data. Year-to-date means the nine months ended June 30.
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $752.0 | $588.1 | $2,163.7 | $1,606.5 |
| Net earnings | $66.1 | $49.1 | $192.8 | $105.9 |
| Diluted EPS | $1.02 | $0.77 | $2.99 | $1.66 |
| Operating cash flow | Not provided separately for the quarter | $219.2 | $162.1 | |
| Capital expenditures | Not provided separately for the quarter | $77.9 | $89.6 | |
| Free cash flow (non-GAAP) | Not provided separately for the quarter | $141.3 | $72.5 |
Q3 gross margin was 25.2%, down from 27.1%; year-to-date gross margin was 25.1%, down from 26.6%. Q3 net margin was 8.8%, versus 8.4%. Sales growth, higher capacity-expansion costs, an unfavorable Industrial product mix and ASC 606 noncash customer-supplied inventory affected margins. That inventory is recognized in both sales and cost of goods sold at equal amounts.
Reported Q3 sales rose 27.9%. Excluding L’Orange, company-reported organic sales increased 19.6%; this comparison still reflects the new revenue standard. The filing attributes growth chiefly to Aerospace commercial and defense OEM activity and defense aftermarket demand, and to Industrial reciprocating-engine sales. L’Orange contributed $78.5 million of Q3 and $254.2 million of year-to-date sales.
Cash and cash equivalents were $63.3 million at June 30, 2019, compared with $83.6 million at September 30, 2018. Working capital was $655.4 million. Total debt was $1,191.1 million, down from $1,246.0 million at September 30; short-term borrowings were $180.0 million. The company reported $627.2 million of availability under its revolving facility, net of letters of credit, and said it was in compliance with debt covenants. The facility was amended in June, extending maturity to June 2024 and retaining $1.0 billion of commitments, with an option to increase capacity to $1.5 billion subject to lender participation.
Material changes versus the prior comparable period
- Reported Q3 sales rose $163.9 million and net earnings rose $17.0 million year over year. Comparisons reflect the L’Orange acquisition, the adoption of ASC 606 and a $7.2 million unfavorable foreign-exchange impact on Q3 sales.
- Aerospace Q3 sales grew 23.3%; segment earnings increased 23.1% to $103.2 million, with segment margin unchanged at 20.7%. Industrial sales grew 38.0%, including L’Orange; segment earnings rose to $26.2 million from $10.9 million, and segment margin increased to 10.4% from 6.0%. Industrial results also reflect acquisition-related purchase-accounting amortization.
- Year-to-date operating cash flow increased $57.1 million, while capital spending declined $11.7 million. Management cited higher earnings and payment timing as cash-flow benefits, partly offset by collection timing and increased inventory investment.
- Financing cash outflow was $159.0 million year to date, including $110.3 million of share repurchases, $29.0 million of dividends and net debt payments. The prior-year period included substantial acquisition-related borrowings and debt issuance.
Outlook, management commentary and risks
- No specific consolidated full-year earnings or sales guidance is stated in the supplied filing text. Management expected modest year-over-year and sequential industrial-gas-turbine sales growth to continue into fiscal Q4.
- Management cautioned that Chinese natural-gas truck demand may fluctuate as the market absorbs pre-buying ahead of China 6 standards and transitions to compliant products. Renewables remained challenged by lower Woodward content on some turbine platforms, reduced subsidies, auction-based pricing and competition.
- Senvion, a significant renewables customer, entered insolvency proceedings. It secured interim financing and continued operating; on July 30, 2019, it announced lender support through the end of August, potentially longer if discussions succeeded. Management said the impact of losing the customer could be significant to renewables, though it did not expect a material effect on Woodward overall.
- Q3 income tax expense included an additional $10.6 million related to IRS regulations changing the Transition Tax calculation. The effective tax rate was 28.4%, compared with 9.7% in the prior-year quarter; year-to-date it was 21.0%, versus 24.7%.
- ASC 606 adoption and an out-of-period correction increased Q3 reported sales by $50.6 million versus the previous accounting standard, including a $13.6 million correction for earlier quarters. The correction added $8.0 million to Q3 pretax earnings, $6.0 million to net earnings and $0.09 to diluted EPS. Management deemed the prior-period errors individually immaterial and did not amend prior filings.
- Management identified a material weakness in internal controls over revenue accounting under ASC 606 and concluded disclosure controls were not effective as of June 30. Remediation efforts include enhanced data review, communication and monitoring; the filing says effectiveness must be validated through subsequent testing.
- Ordinary-course legal claims and proceedings were not expected by management to materially affect liquidity, financial condition or results. Woodward also expected to adopt lease accounting guidance in fiscal 2020; the most significant anticipated effect was recognition of operating-lease assets and liabilities.
Most important facts for investors to verify
- How ASC 606 timing effects and the out-of-period correction affect reported growth, segment earnings and future-period comparability, and whether remediation resolves the material weakness.
- Whether underlying margins improve as capacity-expansion costs and acquisition-related purchase-accounting charges evolve, and how much reported growth depends on L’Orange and noncash customer-supplied inventory.
- Any deterioration in Senvion-related orders, receivables or renewables exposure, alongside demand changes tied to the Boeing 737 MAX grounding and China’s truck-standard transition.
- Cash conversion, inventory and receivables trends, debt repayment and covenant headroom, and the company’s ability to fund capital spending, dividends and repurchases.
- Further tax adjustments arising from Transition Tax rules, tax audits or foreign earnings.