Business context and reporting period
Woodward, Inc. filed this unaudited Form 10-Q for the second quarter and first six months of fiscal 2018, ended March 31, 2018. The company reports Aerospace and Industrial segments.
Financial results
| Metric | Q2 FY2018 | Q2 FY2017 | First half FY2018 | First half FY2017 |
|---|---|---|---|---|
| Net sales | $548.2m | $500.4m | $1,018.4m | $943.3m |
| Earnings before income taxes | $48.6m | $50.2m | $86.1m | $97.3m |
| Net earnings | $38.5m | $38.1m | $56.7m | $84.7m |
| Diluted EPS | $0.60 | $0.60 | $0.89 | $1.33 |
| Gross margin | 26.8% | 26.6% | 26.5% | 26.2% |
| Net margin | 7.0% | 7.6% | 5.6% | 9.0% |
| Operating cash flow | Not stated for quarter | $56.7m | $130.0m | |
| Free cash flow (non-GAAP) | Not stated for quarter | $(1.8)m | $86.9m |
Unless otherwise stated, financial amounts are in U.S. dollars. First-half cash flow from operations fell primarily because of working-capital use, including timing of payments for accounts payable and accrued liabilities. Capital expenditures were $58.5m, up from $43.1m, mainly for Fort Collins campus renovations and Rockford production equipment.
At March 31, cash and cash equivalents were $100.1m, working capital was $677.3m, and total debt was $630.4m, including $41.9m of short-term borrowings. Woodward reported $947.1m of availability under its revolving facility, net of letters of credit, and $7.7m under foreign facilities. The $1.0bn revolving facility matures in April 2020. The company said it was in compliance with debt covenants.
Material changes and segment performance
- Q2 sales rose 9.6%; first-half sales rose 8.0%. Foreign exchange contributed $11.0m and $16.6m, respectively. Aerospace growth more than offset Industrial declines.
- Aerospace sales increased 20.5% in Q2 and 17.9% in the first half. Segment earnings rose to $73.0m in Q2 and $116.5m in the first half. Q2 segment margin improved to 18.9% from 18.2%, while the first-half margin declined to 16.8% from 17.9%.
- Industrial sales declined 10.0% in Q2 and 8.4% in the first half; segment earnings fell 40.1% and 15.7%, respectively. Margins were 6.3% in Q2 and 9.1% in the first half, compared with 9.5% and 9.9% a year earlier.
- Q2 earnings included $17.0m of restructuring charges ($12.7m after tax), mainly for the Duarte, California relocation. Adjusted net earnings, a non-GAAP measure excluding restructuring, relocation, acquisition-related and, for the first half, Tax Act transition items, were $52.4m ($0.82 per diluted share) for Q2 and $85.4m ($1.34) for the first half.
- The first-half effective tax rate was 34.1%, versus 13.0% a year earlier, primarily reflecting a $14.8m discrete net tax charge from the Tax Act in Q1. Q2’s rate was 20.9%, versus 24.1%.
Outlook, commentary and risks
- Management said higher Aerospace OEM and aftermarket sales reflected defense demand, including smart weapons, and commercial platform production ramps and aftermarket activity. Higher capacity-expansion costs, learning-curve effects, unfavorable mix and increased R&D spending partly offset growth.
- Industrial weakness reflected lower industrial gas turbine and renewables sales. Management said the gas turbine business may not begin to recover until 2020; reciprocating-engine sales increased. The filing gives no consolidated earnings or sales guidance.
- Woodward expects approximately $12m of additional Duarte relocation-related costs over the coming year, including equipment relocation, training, accelerated depreciation and higher labor expense. It plans to sell the Duarte land and buildings and expects a gain, but timing and amount are not stated.
- On April 9, 2018, Woodward agreed to acquire L’Orange GmbH for total consideration of €700m, including assumed debt and other specified obligations. Subject to regulatory approval, closing was expected in Q3 FY2018. The company expected to finance it with revolving-credit borrowings, private-placement debt, or both, increasing debt and interest expense and reducing facility availability. Acquisition and integration risks are highlighted.
- On April 18, Woodward paid $5.5m for a euro forward option related to the acquisition. It may purchase €490m at a fixed rate; if unexercised, the option loss is limited to its cost.
- The estimated $26m U.S. transition-tax liability is provisional and expected to be paid over eight years beginning in FY2019. Management expects the lower U.S. corporate tax rate to benefit future tax expense and operating cash flows, but notes that tax estimates remain subject to change.
- Management said operating cash flow and available borrowing capacity should fund operations and planned capital spending. Risks include customer and market weakness, input costs and supply constraints, foreign-exchange exposure, debt and acquisition financing, tax uncertainty, and execution of restructuring and integration plans. Management did not expect pending legal matters to materially affect liquidity, financial condition or results.
Important facts for investors to verify
- Whether the L’Orange acquisition closed as expected, its final purchase accounting, financing mix, and resulting leverage and interest costs.
- Whether Aerospace growth and margins can offset Industrial weakness, capacity-expansion costs and R&D spending; monitor the projected timing of an industrial gas turbine recovery.
- Actual Duarte relocation costs, asset-sale proceeds and any expected gain, as well as the timing and realization of anticipated savings.
- Working-capital trends, capital spending and cash generation after first-half free cash flow turned negative.
- Final Tax Act adjustments, transition-tax payments and the effect of future tax guidance on Woodward’s effective tax rate.