WWD

Woodward, Inc. 10-Q Summary: Period Ended June 30, 2005

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2005, and the nine-month period ended June 30, 2005, for Woodward, Inc. (Woodward Governor Company). The company designs, manufactures, and services energy control systems and components for aircraft and industrial engines. Operations are divided into two segments: Industrial Controls and Aircraft Engine Systems. The financial statements are unaudited.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 16.5% for the quarter and 19.1% for the nine-month period compared to the prior year. Growth was driven by a broad industrial recovery (power generation, transportation) and favorable trends in commercial aviation.
• Profitability Surge: Net earnings for the quarter more than doubled to $19.7 million from $8.2 million. This was significantly aided by a $7.8 million curtailment gain related to amendments in a retirement healthcare plan.
• Segment Performance: Industrial Controls segment earnings rose to $9.5 million (quarter) and $24.6 million (nine months). Aircraft Engine Systems earnings were $14.3 million (quarter) and $48.6 million (nine months), boosted by a $3.8 million gain on the sale of product line rights.
• Cost Structure: Cost of goods sold increased in line with sales volume. Research and development costs increased due to higher development activity. Workforce management actions resulted in $1.3 million of expense in the quarter, though net expense for the nine months was minimal ($0.1 million) due to accrual adjustments.
• Tax Rate: The effective income tax rate for the quarter was 22.5% and 31.0% for the nine months, significantly lower than the prior year's 36.3% due to favorable changes in estimates for previous periods.

Guidance, Outlook, and Risks

• Earnings Guidance: Management estimates fiscal year 2005 earnings per share will be in the range of $4.70 to $4.85. This is an increase from the previous estimate, driven by the curtailment gain and tax estimate changes.
• Market Outlook: Demand in industrial and aircraft markets remains strong. However, supply constraints from other suppliers and production capacity limitations for some customers may moderate the rate of sales growth.
• Workforce Actions: The company is consolidating manufacturing operations in the Netherlands, UK, and Japan. Total estimated cost is $15.4 million, with $14.0 million recognized through June 30, 2005. Expected annual savings range from $9.0 million to $11.0 million.
• Accounting Changes: Adoption of revised FAS 123 (Share-Based Payment) effective October 1, 2005, is expected to reduce net earnings by approximately $0.08 per diluted share for the nine-month period if applied retrospectively.
• Liquidity: The company maintains a $100 million revolving credit facility (expandable to $175 million) expiring in 2010. Future cash flows are expected to be adequate for operations and debt service.
• Contingencies: Pending litigation regarding employment, product liability, and contractual matters exists. Management believes potential additional losses are less than $5 million in the aggregate.

Investor Verification Checklist

• Verify the sustainability of the $7.8 million curtailment gain and its impact on future benefit costs.
• Confirm the timeline and cost realization of the $15.4 million workforce consolidation initiative.
• Monitor the impact of the upcoming adoption of FAS 123(R) on reported net earnings starting October 1, 2005.
• Assess the extent of supply chain constraints mentioned in the outlook that could limit sales growth.
• Review the effective tax rate reconciliation to understand the volatility caused by changes in estimates for prior periods.