Woodward, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended September 30, 2018; the filing also reports fourth-quarter results. Financial amounts below are in U.S. dollars, generally millions unless stated otherwise.
Business context and reporting period
Woodward designs, manufactures and services energy-control systems for aerospace and industrial markets. It reports Aerospace and Industrial segments. On June 1, 2018, it acquired L’Orange, a fuel-injection systems supplier, for total consideration of approximately $811 million, including assumed liabilities. L’Orange contributed $102.9 million of sales for the four months included in FY2018 and a pretax loss of $9.3 million. The acquisition makes year-over-year comparisons less directly comparable.
Key financial results and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $2,325.9 | $2,098.7 |
| Net earnings | $180.4 | $200.5 |
| Diluted earnings per share | $2.82 | $3.16 |
| Gross margin | 26.1% | 27.3% |
| Net margin | 7.8% | 9.6% |
| Operating cash flow | $299.3 | $307.5 |
| Free cash flow (non-GAAP) | $172.2 | $215.2 |
| Capital expenditures | $127.1 | $92.3 |
| Total debt | $1,246.0 | $612.9 |
- Sales rose 10.8%; excluding L’Orange, organic sales increased 5.9%. Aerospace sales grew 16.1% to $1,558.0 million. Industrial sales rose 1.5% to $767.9 million, but organic Industrial sales declined 12.1%.
- GAAP earnings declined despite higher sales. The effective tax rate fell to 17.9% from 20.7%, primarily reflecting U.S. tax-law changes.
- Management reported adjusted net earnings of $245.9 million and adjusted diluted EPS of $3.85, excluding specified acquisition, restructuring, relocation and tax-related items; these are non-GAAP measures.
- Cash and cash equivalents, including restricted cash, were $83.6 million; working capital was $523.6 million. Revolver availability was approximately $722.0 million, net of letters of credit, with another $7.4 million available under foreign facilities.
- Cash used in investing was $896.6 million, including $771.1 million for the L’Orange acquisition. Debt increased to finance the deal; the company issued $400 million of senior notes and borrowed under its revolver.
- FY2018 dividends were $0.5525 per share. No common shares were repurchased during the year.
Material changes versus the prior comparable period
- Aerospace segment earnings increased 17.1% to $301.8 million, with segment margin improving to 19.4% from 19.2%, driven by commercial and defense OEM demand and commercial aftermarket activity.
- Industrial segment earnings fell 39.3% to $47.9 million, with margin down to 6.2% from 10.4%. Excluding $34.4 million of L’Orange purchase-accounting charges, adjusted Industrial earnings were $82.3 million and adjusted margin was 10.7%.
- Gross margin contracted, reflecting L’Orange inventory fair-value and backlog amortization charges, capacity-expansion costs and unfavorable mix. Cost of goods sold rose to 73.9% of sales from 72.7%.
- Nonsegment expenses increased to $100.1 million from $58.4 million, including $17.0 million of restructuring charges, $6.2 million of Duarte relocation costs and acquisition-related expenses. The Forward Option used to manage euro exposure expired unexercised, resulting in a $5.5 million loss.
- Operating cash flow decreased modestly, while free cash flow fell as capital spending increased, largely for campus renovations and aerospace production equipment.
- Unshipped-order backlog was $1,648.5 million at October 31, 2018, versus $1,015.4 million a year earlier; 80% was expected to be filled by September 30, 2019. The company cautions that backlog is not necessarily a reliable indicator of future sales.
Outlook, management commentary, risks and unusual items
- The filing provides qualitative expectations, not numeric FY2019 financial guidance. Management expected strong commercial aircraft production and solid order backlogs to support Aerospace; it also anticipated improvement in business jets, turboprops and helicopters and modest increases in certain weapons programs.
- Management expected industrial gas turbine demand to remain weak, with recovery potentially not beginning until 2020. It anticipated recovery in Chinese natural-gas truck systems and continued demand for large engines serving oil and gas and distributed power applications. New wind platforms were expected to support improved renewables sales, though customer transitions had reduced Woodward’s content in FY2018.
- Acquisition accounting remained preliminary at year-end. The purchase-price allocation included $257.4 million of goodwill and $573.4 million of acquired intangible assets, subject to potential measurement-period adjustments.
- Debt and financing risks include covenant restrictions, refinancing needs and exposure to interest rates and currency movements. The company reported compliance with debt covenants at September 30, 2018. A $100 million note maturity was paid October 1, 2018 using revolver borrowings; additional principal payments were scheduled, including $43 million due in April 2019.
- Key business risks include customer concentration (five largest customers represented 42% of sales; GE alone 16%), commercial aerospace cyclicality, U.S. defense spending, industrial-market weakness, tariffs and input costs, supplier disruptions, acquisition integration, product liability, and foreign-exchange and regulatory exposures.
- The company reported ongoing ordinary-course legal, regulatory and product-related matters and stated that expected liabilities were not believed to have a material effect on liquidity, financial condition or results. It reported no material off-balance-sheet arrangements.
- Management and the auditor concluded internal controls were effective as of September 30, 2018, but L’Orange was excluded from the internal-control assessment; it represented 50% of net assets, 27% of total assets and 4% of FY2018 sales.
Most important facts for investors to verify
- How the final L’Orange purchase-price allocation, integration and performance compare with the preliminary accounting and management’s expected synergies.
- Whether reported earnings and margins improve after the unusual acquisition, relocation, restructuring and purchase-accounting charges; review the non-GAAP reconciliations alongside GAAP results.
- Debt levels, covenant headroom, upcoming maturities and liquidity after the October 2018 refinancing and acquisition-related borrowing.
- Whether the Industrial segment recovers as management anticipated, particularly in gas turbines, renewables and Chinese natural-gas applications.
- Whether the elevated backlog converts to shipments and revenue on schedule, given the filing’s warning that backlog may not predict future sales.
- Progress integrating L’Orange’s financial controls and the potential effects of adopting the new revenue-recognition standard in FY2019.
- Exposure to major customers, tariffs, foreign exchange, pension obligations and other contingencies as described in the filing.