WWD

Woodward, Inc. 10-Q Summary: Period Ended June 30, 2002

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2002, and the nine-month period ended June 30, 2002, for Woodward Governor Company (Woodward). The company operates in two primary segments: Industrial Controls (energy control systems for industrial engines and turbines) and Aircraft Engine Systems (energy control systems for aircraft engines). The financial statements are unaudited.

Key Financial Metrics

Margin Analysis: For the nine months ended June 30, 2002, the effective income tax rate was 36.4%, compared to 38.9% in the prior year, due to a reduction in valuation allowances on deferred tax assets. Gross margins were impacted by lower sales volumes of core manufactured products and the inclusion of lower-profit purchased components in the Industrial Controls segment.

Material Changes vs. Prior Period

• Revenue: Net sales increased 4.8% year-over-year for the nine-month period, driven by acquisitions (Leonhard-Reglerbau and Nolff's Carburetion) and market share gains, partially offset by declining demand for large gas turbines and reduced commercial airline traffic.
• Profitability: Reported net earnings increased 5.8%. Adjusted net earnings (excluding goodwill amortization from the prior year) increased slightly. Segment earnings for Industrial Controls decreased due to lower volumes and margins, while Aircraft Engine Systems earnings increased due to cost-control measures and favorable sales mix.
• Accounting Change: The company adopted FAS 142 (Goodwill and Other Intangible Assets) effective October 1, 2001. This resulted in a one-time cumulative effect charge of $2,489,000 (net of tax) in the first quarter of 2002 due to a goodwill impairment in the Industrial Controls segment. Goodwill is no longer amortized.
• Restructuring: The company incurred $5.3 million in termination costs (accrued and expensed) to align capacity with business prospects, involving 202 employees across both segments.

Guidance, Outlook, and Risks

• Outlook: Management reaffirms that consolidated earnings for fiscal 2002 are expected to approximate 2001 levels, within a range of plus or minus 5%. However, management expects earnings to likely fall in the lower part of this range due to the economic downturn's impact on customer engine shipments.
• Market Conditions: Demand for civil aircraft products is expected to remain soft. Resistance to capital spending on power generation projects is expected to continue impacting turbine sales temporarily.
• Liquidity: The company maintains a $150 million revolving credit facility expiring June 15, 2003. Future cash flows from operations and available credit lines are deemed adequate for the next 12 months.
• Risks: Key risks include the potential for further goodwill impairment charges, environmental and product liability litigation (with $1 million currently accrued), and the impact of foreign currency exchange rates on assets and liabilities.

Investor Verification Checklist

• Verify the sustainability of the $2.5 million goodwill impairment charge and the methodology used for fair value estimation of reporting units.
• Monitor the progress of the $5.3 million restructuring plan and the associated cost savings realization.
• Assess the impact of the "lower-profit purchased components" on future gross margins in the Industrial Controls segment.
• Review the status of the $150 million revolving credit facility renewal prior to its June 2003 expiration.
• Track the recovery of commercial airline traffic and its correlation to Aircraft Engine Systems sales volume.