Woodward, Inc. 10-Q Summary: Period Ended March 31, 2010
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended March 31, 2010 (the second quarter of fiscal year 2010) and the six months ended March 31, 2010. Woodward, Inc. is an independent designer, manufacturer, and service provider of energy control and optimization solutions for aerospace, power generation, and transportation markets. The company operates through four segments: Turbine Systems, Airframe Systems, Electrical Power Systems, and Engine Systems. Financial results for the prior year periods have been recast to reflect the adoption of new accounting standards regarding noncontrolling interests and the realignment of business segments.
Key Financial Metrics
| Metric | Three Months Ended Mar 31, 2010 | Three Months Ended Mar 31, 2009 | Six Months Ended Mar 31, 2010 | Six Months Ended Mar 31, 2009 |
|---|---|---|---|---|
| Net Sales | $349,352 | $334,661 | $688,660 | $679,405 |
| Net Earnings (Attributable to Woodward) | $24,068 | $18,474 | $46,424 | $45,538 |
| Diluted EPS | $0.34 | $0.27 | $0.66 | $0.66 |
| Gross Margin | 30.1% | 29.6% | 29.7% | 29.4% |
| Operating Cash Flow (6 Months) | $125,981 (vs. $51,826 prior year) | |||
| Free Cash Flow (6 Months) | $111,845 (vs. $36,472 prior year) | |||
| Total Debt | $463,659 (as of Mar 31, 2010) | |||
| Cash and Equivalents | $72,560 (as of Mar 31, 2010) |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated net sales increased 4.4% quarter-over-quarter and 1.4% year-to-date. This growth was driven primarily by the acquisition of HR Textron Inc. (HRT) in April 2009, which contributed $59.1 million in sales for the quarter. Excluding HRT, organic net sales declined 13.3% for the quarter and 15.9% year-to-date due to volume decreases across all segments.
- Profitability: Net earnings increased 30.3% for the quarter and 2.0% year-to-date. The prior year quarter included $15.159 million in restructuring charges, whereas no such charges were recorded in the current period. Organic EBIT increased 10.8% for the quarter despite volume declines, aided by cost reduction initiatives.
- Segment Performance:
- Airframe Systems: Sales increased significantly due to the HRT acquisition, though organic sales declined 38.8% due to softness in regional and business jet markets.
- Electrical Power Systems: Sales declined due to reduced demand for wind turbine converters, partially offset by growth in non-wind power generation equipment.
- Turbine & Engine Systems: Both segments experienced volume declines in industrial and aerospace markets.
- Debt Reduction: The company prepaid $82 million of long-term debt during the six-month period, reducing total debt from $651.9 million (post-acquisition peak) to $463.7 million.
Guidance, Outlook, and Risks
- Outlook: Management expects continued focus on generating cash from operations to fund ongoing needs and debt reduction. The company anticipates that restructuring actions implemented in fiscal 2009 will continue to generate improved cash flows.
- Goodwill Impairment: The company completed its annual goodwill impairment test as of March 31, 2010. No impairment was recorded; however, the Airframe Systems reporting unit (impacted by the depressed business jet market) had the closest ratio of fair value to carrying value (a premium of over 30%). Management notes that future impairment charges are possible if economic assumptions are not realized.
- Tax Matters: The effective tax rate increased to 32.5% for the quarter (from 25.5% prior year) due to the expiration of the U.S. research tax credit and changes in foreign earnings mix. The company estimates a potential decrease of up to $3.46 million in unrecognized tax benefits in the next twelve months.
- Legal Contingencies: A subsidiary, MPC Products, settled DOJ investigations regarding pre-2005 pricing practices. A $25 million liability was assumed at acquisition and paid during the period. The company is under a three-year administrative agreement with the Department of Defense.
- Subsequent Events: On April 21, 2010, the Board approved the purchase of the remaining 26% noncontrolling interest in Woodward Governor India Limited for approximately $8 million and declared a quarterly dividend of $0.06 per share.
Investor Verification Checklist
- Organic Sales Trends: Verify the sustainability of the 13.3% organic sales decline and the specific impact of the global economic downturn on the business jet and wind energy markets.
- Debt Covenants: Confirm continued compliance with debt covenants, specifically the leverage ratio (consolidated net debt to Debt Covenant EBITDA) which must not exceed 3.5 to 1.0.
- Goodwill Valuation: Monitor the Airframe Systems segment closely, as it carries the highest risk for future goodwill impairment given its exposure to depressed market segments.
- Tax Rate Volatility: Assess the impact of the expired U.S. research tax credit on future effective tax rates and the potential for resolution of unrecognized tax benefits.
- Cash Flow Utilization: Track the company's strategy of using strong operating cash flows ($125.9 million for six months) to aggressively pay down debt rather than for expansion or dividends.