WWD

Woodward, Inc. 10-Q Summary: Period Ended June 30, 2004

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2004, and the nine-month period ended June 30, 2004, for Woodward, Inc. (Woodward Governor Company). The company operates in two primary segments: Industrial Controls (energy control systems for industrial engines and turbines) and Aircraft Engine Systems (energy control systems for aircraft turbines). The financial statements are unaudited but reflect all normal recurring adjustments necessary for a fair presentation.

Key Financial Metrics

Note: Gross margin for the nine months ended June 30, 2004, was approximately 19.5% ($99,926 gross profit / $512,420 sales).

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 27.4% for the three months and 18.4% for the nine months compared to the prior year periods. This growth was driven by acquisitions ($12.1M and $37.9M impact respectively), favorable foreign currency exchange rates, and firmer demand in Asian and North American markets.
• Profitability Turnaround: The company reported a net loss of $165,000 for the three months ended June 30, 2003, compared to net earnings of $8,213,000 in the current period. For the nine months, net earnings rose from $10,611,000 to $24,711,000.
• Segment Performance:
  • Industrial Controls: Turned from a segment loss of $4,479,000 (3-month prior year) to earnings of $2,692,000. Improvements were due to higher sales, cost reduction efforts, and the absence of prior-year workforce management expenses ($1.5M) and license fee write-offs ($1.1M).
  • Aircraft Engine Systems: Segment earnings increased from $8,824,000 to $15,162,000 (3-month comparison), driven by higher sales and improved margins following the consolidation of servovalve operations.
• Cash Flow: Net cash provided by operating activities increased to $58,027,000 for the nine months ended June 30, 2004, from $41,334,000 in the prior year. Investing cash outflows decreased significantly due to the absence of the large Synchro-Start Products acquisition ($49.5M) that occurred in the prior year.

Guidance, Outlook, and Risks

• Outlook: Management expects second-half fiscal year 2004 earnings to approximate the quarterly average of the first half. Customers remain optimistic for the next six months, though confidence regarding 2005 is limited.
• Acquisitions: In June 2004, Woodward acquired assets of Adrenaline Research, Inc. for approximately $2.87 million. The purchase price is subject to adjustment, with final allocation expected by December 2004.
• Debt and Liquidity: The company maintains a $100 million revolving credit facility (expandable to $175 million) expiring in March 2006. It is in compliance with all debt covenants. Senior notes totaling $75 million are not due until 2006-2012.
• Risks and Contingencies:
  • Legal: Pending litigation regarding employment, environmental, and product liability matters. An accrual of approximately $700,000 has been recorded.
  • Market: Sensitivity to interest rate changes on long-term debt and foreign currency exchange rate fluctuations.
  • Workforce: Remaining accruals for workforce management activities ($677,000) are expected to be fully paid by September 2004.

Investor Verification Checklist

• Verify the final purchase price allocation for the Adrenaline Research, Inc. acquisition, as it is currently preliminary.
• Monitor the sustainability of the recovery in power generation and aviation markets, which are cited as key drivers for future results.
• Review the impact of foreign currency exchange rates on future earnings, given the significant contribution to recent sales growth.
• Confirm the timeline for the completion of workforce termination payments and associated accrual adjustments.
• Assess the company's ability to maintain debt covenant compliance as it manages debt levels and potential future acquisitions.