Woodward, Inc. 10-Q Summary: Period Ended June 30, 2006
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2006, and the nine-month period ended June 30, 2006, for Woodward, Inc. (Woodward Governor Company). The company designs, manufactures, and services energy control systems for aircraft and industrial engines. Operations are divided into two segments: Industrial Controls and Aircraft Engine Systems. Financial statements reflect a three-for-one stock split effective February 1, 2006.
Key Financial Metrics
| Metric (Nine Months Ended June 30) | 2006 ($000s) | 2005 ($000s) |
|---|---|---|
| Net Sales | $621,604 | $610,196 |
| Net Earnings | $52,811 | $44,720 |
| Diluted EPS | $1.50 | $1.28 |
| Operating Cash Flow | $43,065 | $45,613 |
| Cash and Equivalents (End of Period) | $66,938 | $74,671 |
| Total Debt (Current + Long-term) | $73,992 | $95,787 |
| Working Capital | $254,912 | $241,066 |
Note: Total debt calculated as Current portion of long-term debt ($14,590) plus Long-term debt ($59,402). 2005 debt includes short-term borrowings of $8,419.
Material Changes vs. Prior Period
- Profitability: Net earnings increased 18% year-over-year for the nine-month period, driven by a significant reduction in the effective tax rate (8.7% in 2006 vs. 29.2% in 2005) due to a $13.7 million reduction in valuation allowances for deferred tax assets.
- Segment Performance: Industrial Controls segment earnings rose significantly (66% increase for nine months) due to productivity improvements and the consolidation of European operations. Aircraft Engine Systems earnings decreased slightly year-over-year, primarily because the prior year included a $3.8 million gain on the sale of product rights.
- Expenses: Selling, general, and administrative (SG&A) expenses increased due to $8.5 million in accruals for pending legal matters and the adoption of new stock-based compensation accounting (FAS 123R). Research and development costs also increased to support new engine programs.
- Debt Reduction: Total debt decreased by approximately $21.8 million as the company made payments on senior notes and reduced borrowings under revolving lines.
Guidance, Outlook, and Risks
- Outlook: Management forecasts full-year sales growth of 3% to 6% and diluted earnings per share of $1.67 to $1.75. This outlook excludes the effects of pending legal accruals and tax valuation allowance changes.
- Segment Outlook: Aircraft Engine Systems sales are expected to grow 7% to 9%, while Industrial Controls sales are expected to remain flat compared to the prior year. Industrial Controls segment earnings are targeted at approximately 10% of sales.
- Legal Contingencies: The company is a defendant in a class action lawsuit alleging discrimination and has accrued $8.5 million for pending legal matters. Management believes additional losses, if any, are unlikely to exceed $10 million in the aggregate.
- Accounting Changes: The adoption of FAS 123R reduced net earnings by $1.4 million for the nine-month period. The company is also evaluating the impact of FASB Interpretation No. 48 regarding uncertainty in income taxes.
Investor Verification Checklist
- Tax Rate Volatility: Verify the sustainability of the 8.7% effective tax rate, which was heavily influenced by a one-time $13.7 million reduction in valuation allowances.
- Legal Accruals: Monitor the status of the $8.5 million accrued for legal matters and the potential for additional costs related to the employment discrimination lawsuit.
- Stock Compensation Impact: Assess the ongoing impact of FAS 123R adoption, with $5.4 million of unrecognized compensation cost remaining to be expensed over future periods.
- Industrial Controls Margins: Confirm that the improved margins in the Industrial Controls segment (10.4% of sales) are sustainable following the completion of European operational consolidations.
- Debt Covenants: Review compliance with debt covenants, specifically the maximum debt-to-EBITDA and debt-to-operating cash flow ratios, given the company's active debt repayment schedule.