Woodward, Inc. (then Woodward Governor Company) — FY2010 Form 10-K
Reporting period: Fiscal year ended September 30, 2010. Amounts are in thousands of dollars except per-share data. Woodward designs, manufactures, and services energy-control systems for aerospace and defense and energy markets through Turbine Systems, Airframe Systems, Electrical Power Systems, and Engine Systems.
Financial performance and liquidity
| Metric | FY2010 | FY2009 | Change or context |
|---|---|---|---|
| Net sales | $1,457,030 | $1,430,125 | Up 1.9%; included $117,329 of HRT sales for six months not included in FY2009 |
| Net earnings attributable to Woodward | $110,844 | $94,352 | Up 17.5% |
| Diluted EPS | $1.59 | $1.37 | Up 16.1% |
| Gross margin | 29.9% | 28.0% | FY2009 was 29.1% excluding its $12,500 HRT inventory step-up charge |
| EBIT (non-GAAP) | $183,751 | $154,974 | Up 18.6%; adjusted EBIT was $183,751 versus $184,079 |
| Operating cash flow | $184,572 | $219,227 | Down $34,655, mainly from higher year-end receivables |
| Capital expenditures | $28,104 | $28,947 | Free cash flow, as defined by Woodward, was $156,468 versus $190,280 |
| Cash and cash equivalents | $105,579 | $100,863 | Year-end balance |
| Total debt, including short-term borrowings | $465,842 | $572,340 | Down $106,498; debt-to-total-capitalization ratio fell to 36.7% from 44.6% |
| Working capital | $456,577 | $434,166 | Up $22,411 |
| Effective tax rate | 28.2% | 22.9% | FY2010 included a $6,416 benefit from prior-year tax resolutions and revaluation assessments |
Woodward reported gross margin improvement from cost reductions, pricing and mix, while noting the comparison benefited from the prior-year acquisition-related inventory charge. FY2010 earnings also included the tax benefit above; FY2009 included $15,159 of restructuring and other charges and the $12,500 HRT inventory step-up charge. These items make reported earnings comparisons less directly comparable.
Segment earnings were $142,993 for Turbine Systems, $11,578 for Airframe Systems, $24,268 for Electrical Power Systems, and $27,346 for Engine Systems. Turbine and Engine earnings increased; Electrical Power earnings fell 32.4%, primarily with lower wind-converter demand and pricing pressure. Airframe results were affected by acquisition timing, volume declines, integration savings, and elevated acquired-intangible amortization.
Changes versus prior period and operating context
- Sales increased modestly, but management attributed the increase primarily to the additional six months of HRT sales in FY2010. Excluding acquisition and disposal timing, volume declines across all segments were partly offset by price/mix and currency effects.
- Sales began stabilizing in the second half of FY2010 and returned to sequential growth overall. Fourth-quarter consolidated sales were $412,003, compared with $356,367 in the third quarter; fourth-quarter diluted EPS was $0.47.
- Management described recovering commercial aviation, defense stability, and improved late-year demand in turbine, engine, and electrical-power markets. Wind installations remained weak due to tight project financing and uncertainty about government support.
- HRT, acquired in April 2009, added to Airframe Systems results. Woodward sold the acquired Fuel and Pneumatics product line in August 2009. In April 2010, it bought the remaining 26% of Woodward Governor India Limited for $8,120.
- Research and development spending was $82,560, or 5.7% of sales, versus $78,536, or 5.5%, in FY2009. The company began constructing a 48,000-square-foot Rockford test facility, expected to enter service in FY2012.
Outlook, risks, contingencies, and unusual items
The filing gives no quantified company-wide revenue or earnings guidance. Management expected continued recovery but cautioned that market uncertainty and softness in some segments could cause volatility. It identified customer-demand recovery, cost control, supply-chain coordination, and liquidity as priorities. The filing said available cash, operating cash generation, and borrowing capacity were expected to support operations.
- Debt and liquidity: Woodward had $20,401 drawn on its $225,000 revolving facility, with $200,685 of remaining availability net of letters of credit; it reported compliance with debt covenants at year-end. Scheduled long-term debt principal was $18,425 in FY2011 and $149,375 in FY2014. Covenant restrictions and refinancing or credit-market risk remain relevant.
- Customer concentration: The five largest customers represented approximately 39% of sales; GE alone represented about 15%. Sales to U.S. government customers directly or through third parties were about 23% of sales. Government appropriations, contract termination, and compliance requirements can affect demand and execution.
- Market and execution risks: Risks include prolonged economic weakness, commercial-aircraft and business-jet demand, wind-market overcapacity and price pressure, supplier disruption, long sales cycles, acquisition integration, and ability to manage costs as volumes change.
- Goodwill and pensions: Goodwill was $438,594, or 26.4% of assets; no impairment was recorded. The annual test showed Airframe Systems fair value more than 30% above carrying value, but management warned that changed forecasts could lead to future impairment. Defined-benefit pension liabilities were $25,776 and other postretirement liabilities $37,222; expected FY2011 contributions were $6,629 and $2,770, respectively.
- Legal and unusual matters: MPC’s pre-2005 government-contract pricing matter was settled for $25,000; MPC pleaded guilty to one count of wire fraud and was placed on two years’ probation. Woodward and MPC also entered a three-year DOD administrative agreement requiring compliance enhancements and reporting. Management said required enhancements were substantially complete; failure to comply could result in suspension or debarment.
- Other items: Environmental remediation accruals were described as not significant, and management did not expect pending ordinary-course legal matters to materially affect liquidity, financial condition, or results. The company authorized a new $200,000 share-repurchase program through July 2013; $196,999 remained at year-end.
Most important facts for investors to verify
- How much of FY2010 earnings growth reflects sustainable operating improvement versus acquisition timing and the unusual FY2009 comparison items; compare reported and adjusted EBIT.
- Whether sequential sales recovery continued, particularly in Electrical Power Systems and commercial aerospace, and whether wind-converter demand and pricing improved.
- Receivables, working-capital conversion, and operating cash flow: FY2010 cash generation declined as year-end accounts receivable rose.
- Debt repayment schedule, covenant headroom, borrowing availability, and the impact of future interest rates on variable-rate debt.
- Progress on HRT integration and facility consolidation, future restructuring costs, and goodwill assumptions for Airframe Systems.
- Compliance with the DOD administrative agreement and probation terms, along with any developments in litigation, warranty, or other contingencies.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting as of September 30, 2010.