Woodward, Inc. — Q3 FY2018 Form 10-Q
Reporting period: Three and nine months ended June 30, 2018. The interim financial statements are unaudited. Unless stated otherwise, amounts below are in millions of U.S. dollars.
Business context and results
Woodward supplies systems and components to aerospace and industrial markets. Its reportable segments are Aerospace and Industrial. The quarter includes one month of results from Woodward L’Orange, acquired June 1, 2018.
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $588.1 | $548.6 | $1,606.5 | $1,491.9 |
| Net earnings | $49.1 | $53.6 | $105.9 | $138.3 |
| Diluted EPS | $0.77 | $0.85 | $1.66 | $2.18 |
| Gross margin | 27.2% | 28.0% | 26.8% | 26.9% |
| Net margin | 8.4% | 9.8% | 6.6% | 9.3% |
| Operating cash flow | — | — | $162.1 | $183.8 |
| Free cash flow (non-GAAP) | — | — | $72.5 | $118.7 |
Q3 reported sales rose 7.2%; excluding L’Orange, organic sales increased 2.7%. Nine-month reported sales rose 7.7%, and organic sales increased 6.0%. Q3 earnings before income taxes were $54.4 million versus $68.7 million; reported EBIT was $62.0 million versus $75.1 million.
Segments and material changes
- Aerospace: Q3 sales increased 13.7% to $404.6 million and segment earnings rose 22.4% to $82.2 million; segment margin improved to 20.3% from 18.9%. Growth reflected commercial OEM and aftermarket demand and defense OEM sales, partly offset by lower defense aftermarket sales.
- Industrial: Q3 sales decreased 4.7% to $183.5 million, while organic sales fell 17.7% to $158.6 million. Segment earnings declined 49.9% to $10.5 million and margin fell to 5.7% from 10.8%. Lower volumes, especially in industrial gas turbines and renewables, were partly offset by L’Orange and favorable mix.
- For the first nine months, Aerospace sales increased 16.3% and Industrial sales declined 7.1% year over year. Lower Industrial volume also weighed on segment earnings and margins.
- Gross margin declined in Q3, reflecting capacity-expansion costs, unfavorable mix, and $8.3 million of noncash L’Orange inventory fair-value and backlog amortization charges.
Cash, debt, and liquidity
At June 30, 2018, cash and cash equivalents, including restricted cash, were $114.4 million; working capital was $597.1 million. Total debt was $1,355.4 million, up from $612.9 million at September 30, 2017. The company reported $613.9 million of additional availability under its revolving credit facility, net of letters of credit, and $7.5 million under foreign facilities. Management said it expected operating cash flow and borrowing capacity to fund operations and planned capital needs for the foreseeable future.
Nine-month investing cash outflow was $851.3 million, including $771.1 million for the L’Orange acquisition and $89.6 million in capital expenditures. Financing cash inflow was $721.2 million, principally reflecting $400.0 million of new notes and revolving-credit borrowing. The company paid $25.2 million in dividends and made no company share repurchases during the period.
Outlook, unusual items, and risks
- L’Orange acquisition: Total consideration, including assumed liabilities, was approximately €700 million (about $811 million); net cash purchase price was $771.1 million. The preliminary allocation included $269.4 million of goodwill and $556.0 million of acquired intangible assets and remained subject to valuation adjustments. L’Orange generated $24.9 million of sales and a $1.2 million net loss in the reported period. A supply agreement with MTU and affiliates runs initially through December 31, 2032.
- Costs and adjustments: Nine-month restructuring charges were $17.0 million, primarily for the Duarte, California relocation and industrial turbomachinery realignment. Management anticipated approximately $12 million of additional Duarte move-related costs over the coming year. Acquisition-related costs included a $5.5 million loss on an unexercised currency option.
- Tax: The nine-month effective tax rate was 24.7%, including an $18.4 million net discrete unfavorable impact from the U.S. Tax Act; Q3’s rate was 9.7%. The company expected to complete its Tax Act assessment in Q4 FY2018 and anticipated a 21% U.S. federal statutory rate for fiscal years beginning after September 30, 2018.
- Market outlook: Management said the industrial gas turbine business might not begin to recover until 2020. It cited near-term weakness in Industrial markets and continuing variability in R&D spending. No consolidated earnings or sales guidance is stated in the provided filing text.
- Other considerations: Woodward identified acquisition integration, customer and supplier performance, market and foreign-exchange conditions, debt covenants, taxes, and legal or product-liability matters as risks. It said pending legal matters were not expected to materially affect results or liquidity. Disclosure controls were assessed as effective; L’Orange was expected to be excluded from the September 30, 2018 internal-control assessment while integration work continued.
Important facts for investors to verify
- How L’Orange performs after integration, and whether final purchase-accounting valuations materially change reported goodwill, intangibles, or future expenses.
- Whether Industrial organic sales and margins stabilize, including the timing of any industrial gas turbine recovery and renewables demand improvement.
- Whether operating cash generation and free cash flow can support capital spending, dividends, and debt service after the acquisition-related increase in leverage.
- How much of the reported earnings decline reflects ongoing operations versus acquisition, restructuring, purchase-accounting, currency-option, and Tax Act items; review the company’s non-GAAP reconciliations.
- The final Tax Act accounting and the effects of adopting ASC 606 in FY2019; Woodward expected some revenue and funded engineering-development activity to shift in timing and affect balance-sheet line items.