Woodward, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended September 30, 2019. The filing is an annual report, not a standalone “2019 Q4” report; quarterly figures are included but are unaudited. Woodward designs and services energy-control systems for aerospace and industrial markets. Unless stated otherwise, amounts below are in millions of U.S. dollars.
Financial performance and liquidity
| Metric | FY2019 | FY2018 |
|---|---|---|
| Net sales | $2,900.2 | $2,325.9 |
| Gross margin | 24.4% | 25.9% |
| Operating earnings before interest and taxes (EBIT) | $363.2 | $258.4 |
| Net earnings | $259.6 | $180.4 |
| Diluted earnings per share | $4.02 | $2.82 |
| Operating cash flow | $390.6 | $299.3 |
| Capital expenditures | $99.1 | $127.1 |
| Free cash flow (non-GAAP) | $291.5 | $172.2 |
| Cash and cash equivalents at year-end | $99.1 | $83.6 |
| Total debt at year-end | $1,084.9 | $1,246.0 |
| Working capital at year-end | $563.8 | $523.6 |
Net margin was 9.0%, up from 7.8%; cost of goods sold rose to 75.6% of sales from 74.1%. Interest expense was $44.0 million, versus $40.5 million, and the effective tax rate was 19.0%, versus 17.9%. The company reported adjusted net earnings of $314.5 million, or $4.88 per diluted share, as non-GAAP measures; these exclude specified acquisition, relocation, Senvion, and tax items.
Year-end debt included $262.3 million outstanding under the revolving facility, of which $220.0 million was classified as short-term, and $726.7 million of additional availability under that facility. The facility’s $1.0 billion commitment was extended to June 2024. Management said operating cash flow and borrowing capacity should fund foreseeable operating and capital needs; the company reported covenant compliance at year-end.
Material changes versus the prior year
- Sales increased 24.7%. Organic sales, excluding Woodward L’Orange, rose 15.5%; the comparison reflects a full year of L’Orange sales in FY2019 versus four months in FY2018. L’Orange contributed $332.0 million of FY2019 sales.
- Aerospace sales rose 20.7% to $1,880.5 million, with segment earnings of $389.1 million and a 20.7% segment margin, up from 19.8%.
- Industrial sales rose 32.8% to $1,019.7 million, substantially reflecting L’Orange. Organic Industrial sales increased 3.4%; reported segment earnings were $93.5 million and margin was 9.2%, versus $49.9 million and 6.5% in FY2018. Adjusted Industrial earnings were $114.6 million, a non-GAAP measure.
- Gross margin declined 1.5 percentage points, primarily due to capacity expansion and relocation costs, lower-margin Industrial mix, and ASC 606 noncash consideration. Operating cash flow increased, while investing cash outflow fell sharply because FY2018 included the L’Orange acquisition.
- The company repurchased $110.3 million of stock and paid $39.1 million in dividends during FY2019. FY2018 included $17.0 million of restructuring charges; no restructuring charges were recorded in FY2019.
Outlook, commentary, risks, and unusual items
- Management outlook: For FY2020, Woodward expected modest industrial gas-turbine growth, some softening in large reciprocating engines, and variability in China natural-gas truck demand during the China 6 transition. Management described commercial aerospace order backlogs and defense demand as supportive, while noting the 737 MAX grounding and expected a return to service in FY2020’s second quarter, with recovery of affected OEM and initial-provisioning sales thereafter. These are expectations stated in the filing, not guarantees.
- 737 MAX exposure: The grounding modestly affected FY2019 OEM sales and more significantly affected initial provisioning for the aircraft and CFM LEAP engine. A prolonged grounding could further pressure sales and cash flow.
- Senvion insolvency: The wind-turbine customer’s insolvency led to $12.6 million of FY2019 charges for impaired receivables, inventory, and other assets, including $8.2 million of inventory impairment. Woodward also reported $12.9 million of Industrial renewable-power-system losses. The renewable reporting unit had an estimated fair-value premium of about 20% over carrying value at the July 2019 goodwill test; no impairment was recorded.
- Revenue accounting: Woodward adopted ASC 606 in FY2019. Adoption increased reported sales by $109.6 million and net earnings by $5.6 million versus the prior accounting method, while having no effect on operating cash flow. It also increased opening retained earnings by $38.7 million. FY2018 was not restated, limiting direct comparability.
- Control issue: Management identified a material weakness in controls related to ASC 606 revenue reporting during FY2019 and reported that it was remediated by September 30, 2019. Auditors gave unqualified opinions on the financial statements and internal controls. Quarterly ASC 606 calculation errors were corrected out of period in Q3, increasing that quarter’s sales by $13.6 million and diluted EPS by $0.09.
- Concentration and other risks: The five largest customers accounted for 47% of sales; Boeing was 15% and GE 14%. Other key exposures include commercial aviation cycles, government spending and contract termination, acquisition integration, supplier and tariff risks, foreign exchange, pensions, cybersecurity, and environmental or product-liability claims. Management said ordinary-course legal matters were not expected to materially affect liquidity, financial condition, or results.
- Other items: A $10.6 million tax expense arose from final IRS regulations affecting the transition tax. The company completed the Duarte, California relocation and expected to sell the vacated property by March 31, 2020, anticipating a gain. No goodwill or tradename impairment was recorded.
Important facts for investors to verify
- How much FY2019 growth and earnings improvement is sustainable after separating L’Orange acquisition effects, ASC 606 timing/noncash consideration, and other adjustments.
- The pace and financial impact of the 737 MAX return to service, including recovery of OEM and initial-provisioning sales.
- Further losses, collections, or customer replacement effects related to Senvion and the renewable-power business.
- Debt covenant headroom, refinancing and repayment needs, and the availability and cost of revolving-credit borrowing.
- Whether the remediated revenue-recognition controls remain effective and whether subsequent ASC 606 estimates or reporting changes affect comparability.
- Progress on the Duarte property sale and any change in the expected gain, alongside the company’s FY2020 market assumptions.