Woodward, Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended December 31, 2015. Unaudited interim results; amounts below are in millions of dollars unless noted. Woodward serves aerospace and industrial markets; the former Energy segment was renamed Industrial.
Financial results and liquidity
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net sales | $445.1 | $487.6 | Down 8.7% |
| Gross margin | 25.1% | 29.5% | Down 4.4 percentage points |
| Operating earnings before tax | $28.0 | $57.1 | Down 51.0% |
| Net earnings | $25.6 | $43.8 | Down 41.5% |
| Diluted EPS | $0.40 | $0.66 | Down 39.4% |
| Effective tax rate | 8.4% | 23.3% | Down 14.9 percentage points |
| Operating cash flow | $37.1 | $37.9 | Down $0.7 |
| Capital expenditures | $33.1 | $46.6 | Down $13.5 |
| Free cash flow | $4.0 | $(8.8) | Improved $12.7 |
EBIT was $34.4 million, down 45.3%; EBITDA was $51.5 million, down 36.8%. Management’s non-GAAP free cash flow is operating cash flow less property, plant and equipment purchases.
- Segment performance: Aerospace sales rose 5.0% to $268.6 million and segment earnings increased 21.5% to $43.5 million; segment margin improved to 16.2% from 14.0%. Industrial sales fell 23.9% to $176.5 million and earnings declined 45.1% to $21.6 million; segment margin fell to 12.2% from 16.9%.
- Balance sheet at December 31, 2015: Cash and equivalents were $84.4 million; working capital was $526.6 million, down from $609.3 million at September 30, 2015. Total debt was $887.0 million, versus $852.4 million at September 30, 2015. Revolver availability was $553.9 million, net of letters of credit, plus $40.8 million under foreign facilities. The company reported compliance with debt covenants.
- Capital returns: The company paid $6.3 million in dividends and repurchased $30.7 million of stock during the quarter. The quarterly dividend was $0.10 per share paid; a subsequent $0.11 dividend was approved for payment in March 2016.
Material changes and management commentary
- Consolidated sales declined mainly because Industrial volume fell $42.2 million and foreign exchange reduced sales by $12.9 million, partly offset by $9.8 million of higher Aerospace volume and $2.8 million from price and mix.
- Industrial weakness reflected a soft natural-gas truck market in Asia, weaker Chinese industrial output, depressed oil and gas markets, and unfavorable currency effects. Aerospace gains came from defense and commercial aftermarket sales; commercial OEM sales were relatively flat, while lower rotorcraft demand was a headwind.
- Results included approximately $16.1 million of special charges related to facility consolidation, cost reduction and market conditions: $13.3 million in cost of goods sold, $1.7 million in SG&A and $1.1 million in R&D. The filing also identifies an $8.2 million non-cash charge for a lease-loss reserve after vacating a Skokie facility.
- Gross margin was pressured by the special charges and start-up costs at the new Rockford-area facility. Higher debt levels contributed to increased interest expense.
- The 8.4% effective tax rate reflected reinstatement of the U.S. research and experimentation credit, including a $5.2 million retroactive benefit for the prior nine months, and favorable resolutions of foreign tax matters. Management cautions that interim tax rates can be volatile.
Outlook, transactions and risks
- Management expected fiscal 2016 capital spending of approximately $100 million for new Illinois and Colorado facilities and related investments. It stated that operating cash flow and borrowing capacity should fund operations and anticipated capital spending for the foreseeable future. The filing provides no specific full-year sales or EPS guidance.
- Revised useful-life estimates were expected to reduce depreciation on existing assets by approximately $12 million in FY2016; added depreciation from new facilities was expected to largely offset this, leaving full-year depreciation approximately in line with FY2015.
- GE joint venture, completed January 4, 2016: GE paid Woodward $250 million for a 50% interest in a venture covering specified existing and future GE commercial aircraft engine fuel systems. Woodward recorded the proceeds as deferred income, to be recognized as sales over the applicable program lives, rather than as immediate earnings. GE also agreed to 15 annual contingent payments of $4.894 million beginning in 2017, subject to claw-back conditions. Woodward expects to use equity-method accounting. The cash receipt is taxable upon receipt; approximately $95.8 million of related taxes was expected to be paid during 2016.
- Other identified risks include customer and market weakness, foreign currency movements, oil and gas conditions, customer and supplier performance, product liability, execution of facility plans, debt service and covenant requirements, tax exposures, and legal or regulatory matters. Management said pending legal matters were not expected to materially affect liquidity, financial condition or results.
Important facts for investors to verify
- Whether Industrial demand and margins stabilize, particularly in Asia, China, and oil- and gas-related markets.
- Whether the $16.1 million of special charges and facility start-up costs are non-recurring, and whether expected cost savings materialize.
- Progress on the GE venture, including deferred-income recognition, contingent-payment conditions, and the tax and cash implications.
- Execution of planned facility spending and whether depreciation, utilization and returns on the new campuses align with management’s expectations.
- Debt levels, revolver availability, covenant compliance, and the sustainability of cash generation alongside repurchases and dividends.
- Whether the unusually low quarterly tax rate is repeatable; the filing attributes much of the reduction to tax-credit reinstatement and favorable tax resolutions.