Woodward, Inc. — Q3 FY2011 Form 10-Q
Reporting period: Quarter and nine months ended June 30, 2011; comparative periods ended June 30, 2010. Financial statements are unaudited. Dollar amounts below are in millions unless noted.
Business context and financial performance
Woodward supplies control systems and components through four segments: Turbine Systems, Airframe Systems, Electrical Power Systems, and Engine Systems. Management attributed broad-based sales growth to the global recovery, higher volumes, favorable foreign exchange, and, in some areas, pricing and mix.
| Metric | Q3 FY2011 | Q3 FY2010 | Nine months FY2011 | Nine months FY2010 |
|---|---|---|---|---|
| Net sales | $438.5 | $356.4 | $1,222.4 | $1,045.0 |
| Gross margin | 30.6% | 29.9% | 29.8% | 29.8% |
| Earnings before income taxes | $50.9 | $38.1 | $128.8 | $105.4 |
| Net earnings attributable to Woodward | $36.1 | $31.7 | $90.5 | $78.2 |
| Diluted EPS | $0.51 | $0.45 | $1.29 | $1.12 |
| EBIT (non-GAAP) | $57.1 | $44.9 | $147.7 | $127.6 |
| Effective tax rate | 29.1% | 16.3% | 29.7% | 25.5% |
Sales increased 23.0% in Q3 and 17.0% year to date. Net earnings attributable to Woodward rose 13.6% in Q3 and 15.9% year to date. Higher volumes supported earnings; increased R&D and variable compensation partly offset the gains. R&D was $29.3 million in Q3 and $80.1 million year to date, up 36.7% and 34.7%, respectively.
Segments and material changes
- Turbine Systems: Q3 segment sales were $191.0 million and earnings $46.1 million; nine-month sales were $514.5 million and earnings $123.2 million. Growth reflected stronger industrial turbine and aerospace demand, including aftermarket activity.
- Airframe Systems: Q3 segment sales were $103.0 million and earnings $5.5 million; nine-month sales were $284.1 million and earnings $4.5 million. Nine-month earnings declined from $10.2 million, primarily due to lower customer-funded development revenue, variable compensation, and a workers’ compensation estimate change.
- Electrical Power Systems: Q3 segment sales were $71.9 million and earnings $3.2 million; nine-month sales were $206.4 million and earnings $13.4 million. Wind converter and other power equipment volumes grew, but price reductions, expansion costs, and compensation costs weighed on earnings.
- Engine Systems: Q3 segment sales were $104.1 million and earnings $9.8 million; nine-month sales were $304.3 million and earnings $28.1 million. Higher demand across engine markets drove growth.
Woodward acquired Integral Drive Systems (IDS) in Q3 for approximately $48.4 million, including marketable securities acquired. IDS develops power electronics for wind and solar applications, among other markets, and is being integrated into Electrical Power Systems. Preliminary purchase accounting included $24.2 million of goodwill; valuation work was not complete at June 30.
Cash flow, debt, and liquidity
- Nine-month operating cash flow was $46.8 million, down from $161.6 million; free cash flow (operating cash flow less capital expenditures, a non-GAAP measure) was $14.2 million versus $142.8 million.
- Management attributed the cash-flow decline principally to working-capital use, including a $77.4 million inventory cash use and increased accounts receivable. Inventory stood at $387.8 million at June 30, versus $295.0 million at September 30, 2010.
- Capital expenditures were $32.6 million for the nine months, versus $18.8 million a year earlier. Investing cash use was $71.6 million, including the IDS acquisition.
- Cash and equivalents were $72.6 million; total debt was $468.8 million, compared with $465.8 million at September 30, 2010. Working capital was $523.6 million. The current ratio was approximately 2.9.
- Woodward reported $179.3 million of additional availability under its $225 million revolving facility, net of letters of credit, plus $29.1 million under foreign facilities. It said it complied with debt covenants. Of cash on hand, $64.9 million was held in foreign subsidiaries; repatriation could result in additional taxes.
Outlook, commentary, and risks
The filing provides no specific financial guidance. Management said it expects operating cash generation to fund continuing operating needs and considered available credit adequate. It described demand improvement across segments, while noting that wind converter demand remains affected by tight project-financing requirements and uncertainty over government stimulus programs. Forward-looking statements are subject to risks including economic and industry conditions, customer demand, input costs and supply, acquisition integration, debt covenants and financing access, foreign exchange, government contracting, and legal, tax, and pension matters.
Unusual items include a $2.3 million, approximately $0.03 per-share, nine-month charge from a revised estimate of future workers’ compensation costs; a $3.1 million tax benefit from retroactive extension of the U.S. research credit; and a $6.4 million favorable tax adjustment in the comparable 2010 period, which contributed to the lower prior-year tax rate. The filing also reports $1.6 million of nine-month expense related to foreign currency derivatives. No goodwill impairment was identified in the annual test, but Airframe Systems had the narrowest valuation cushion; specified adverse assumption changes could have triggered impairment.
Woodward said ordinary-course legal claims and proceedings were not expected to materially adversely affect liquidity, financial condition, or results. Disclosure controls were deemed effective. IDS was excluded from the planned September 2011 internal-control assessment and was expected to be included in the September 2012 assessment.
Important facts for investors to verify
- Whether working-capital investment, especially inventory growth, converts into shipments and operating cash flow in subsequent quarters.
- Whether revenue and margin growth persists, particularly in Airframe Systems and Electrical Power Systems.
- Final IDS purchase-price allocation, integration progress, and the acquisition’s contribution to earnings and cash generation.
- Debt repayment, revolver use, covenant headroom, and potential tax costs associated with foreign cash repatriation.
- Workers’ compensation estimates, tax reserves and effective tax-rate normalization, and Airframe Systems goodwill impairment assumptions.