Woodward, Inc. (Woodward Governor Company) — Q1 FY2011 Form 10-Q
Reporting period: Three months ended December 31, 2010; comparative period is the three months ended December 31, 2009. Interim financial statements are unaudited. Dollar amounts below are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q1 FY2011 | Q1 FY2010 | Change |
|---|---|---|---|
| Net sales | $365.1 | $339.3 | +7.6% |
| Gross margin | 28.5% | 29.4% | Down 0.9 percentage points |
| Earnings before income taxes | $31.5 | $31.5 | Essentially flat |
| Net earnings attributable to Woodward | $22.4 | $22.4 | Essentially flat |
| Diluted earnings per share | $0.32 | $0.32 | Unchanged |
| EBIT (non-GAAP) | $37.9 | $39.6 | Down 4.5% |
| EBITDA (non-GAAP) | $56.8 | $58.6 | Down $1.8 |
| Operating cash flow | $7.2 | $61.3 | Down $54.1 |
| Capital expenditures | $10.2 | $9.0 | Up $1.2 |
| Free cash flow (non-GAAP) | $(3.0) | $52.3 | Lower by $55.3 |
Sales growth reflected higher volumes across most businesses, partly offset by a $4.1 million adverse foreign-exchange impact. Cost of goods sold rose faster than sales, while research and development expense increased to $23.7 million from $18.3 million. SG&A was broadly flat at $32.7 million. Interest expense declined $1.8 million to $6.5 million, attributed to debt reduction. The effective tax rate was 28.8%; Q1 FY2011 tax expense included a $1.9 million benefit from the retroactive extension of the U.S. research tax credit.
Cash and cash equivalents were $61.3 million at December 31, down from $105.6 million at September 30, 2010. Working capital was $475.1 million, versus $456.6 million. The balance sheet reports current and long-term debt totaling $431.1 million; the MD&A also cites total debt of $431.1 million, while a fair-value note gives carrying cost of $431.078 million. The company reported no revolving-facility or foreign short-term borrowings at quarter-end, $220.1 million of availability under its $225 million revolver (net of letters of credit), and $27.7 million under foreign credit facilities. It reported compliance with debt covenants.
Operating cash flow fell mainly because inventory increased to support expected deliveries and accounts payable and other current liabilities declined. Cash used in financing included $19.6 million of short-term borrowing repayments, $12.6 million of scheduled long-term debt payments, $6.8 million of share repurchases, and $4.1 million of dividends. Cash used in investing was $10.2 million, principally capital expenditures.
Material changes and segment results
- Turbine Systems: Segment sales rose to $153.7 million from $142.4 million; segment earnings increased to $36.5 million from $32.1 million. Management cited stronger aerospace aftermarket and industrial turbine demand, higher volume, and favorable mix.
- Airframe Systems: Segment sales declined to $83.6 million from $91.7 million, and segment results shifted to a $5.0 million loss from $2.4 million of earnings. Lower customer-funded development revenue, weaker military-related demand, unfavorable mix, and workers’ compensation costs were factors.
- Electrical Power Systems: Segment sales increased to $61.6 million from $56.8 million, primarily from intersegment activity; external sales were slightly lower. Segment earnings fell to $4.9 million from $7.3 million, reflecting infrastructure costs and strategic pricing reductions.
- Engine Systems: Segment sales rose to $92.1 million from $67.9 million, and earnings increased to $8.1 million from $3.2 million, driven mainly by stronger volumes in engine-control markets.
Despite higher consolidated sales, gross margin declined, consolidated pretax earnings remained flat, and EBIT fell. Management attributed the margin pressure in part to reduced customer-funded development in Airframe Systems. Sales gains in Turbine and Engine Systems were important offsets to the Airframe decline.
Outlook, commentary, risks, and unusual items
- No specific full-year revenue or earnings guidance is provided in the supplied filing text. Management said operating cash generation is expected to fund continuing operating needs and that the current level of R&D spending is consistent with expectations for the remainder of FY2011.
- Management described sales growth as reflecting the global economic recovery, while noting that first-quarter sales are typically seasonally lower due to holidays, plant maintenance shutdowns, and customer buying patterns.
- Woodward recorded a workers’ compensation estimate change: approximately $2.3 million of charge, or $0.03 per diluted share after an approximately $1.3 million tax benefit. Management separately described the related pretax impact as approximately $3.6 million in its EBIT discussion.
- A foreign-currency forward contract settled in December at a realized loss of $1.0 million. The income statement reported $1.1 million of net other expense, compared with $0.2 million of other income in the prior-year quarter.
- Inventory increased $31.5 million during the quarter. Management attributed the increase to anticipated next-quarter deliveries and some sourcing inefficiencies, making inventory conversion and operating cash flow important items to monitor.
- The company is building a 48,000-square-foot Rockford, Illinois, systems test facility, expected to enter service in early FY2012. Capital spending on the project was included in construction in progress.
- Goodwill was approximately $438.1 million. The last annual impairment test, as of March 31, 2010, found no impairment; management noted that future impairment remains possible if cash-flow forecasts or recovery assumptions are not realized.
- Routine litigation, investigations, warranty matters, and other claims are disclosed. Management said it believes any resulting liabilities will not materially adversely affect liquidity, financial condition, or results, but outcomes cannot be predicted with certainty. The filing also describes a government-contract guarantee with purchaser indemnification and potential executive termination benefits on a change in control.
- Key stated risks include customer and market weakness, economic and industry conditions, input costs and supply availability, competition, acquisition integration, debt and covenant requirements, U.S. government spending, foreign exchange, pension assumptions, product liability, regulatory and tax matters, and possible impairment charges. Management reported no material change in risk factors from its most recent Form 10-K.
Most important facts for investors to verify
- Whether the inventory build converts into sales as anticipated, and whether operating cash flow recovers from the quarter’s low level.
- Whether Airframe Systems’ customer-funded development revenue and segment profitability improve, and whether its workers’ compensation and launch-related costs persist.
- Whether sales growth in Turbine and Engine Systems continues and offsets weakness in other markets, including wind and military-related applications.
- The magnitude and timing of future debt repayments, capital spending, dividends, and share repurchases; also reconcile the filing’s slightly different reported debt carrying amounts.
- Whether goodwill assumptions remain supportable at the next annual impairment test and whether legal, warranty, tax, or other contingencies change materially.
- That non-GAAP EBIT, EBITDA, and free cash flow are company-defined measures and should be read alongside GAAP results.