Woodward, Inc. — Form 10-Q Summary
Business context and reporting period
Woodward designs and manufactures energy-control products for aerospace and industrial markets. This unaudited Form 10-Q covers the first quarter of fiscal 2023, the three months ended December 31, 2022; comparisons are with the three months ended December 31, 2021. Financial amounts below are in U.S. dollars and generally shown in millions.
Financial results and liquidity
| Metric | Q1 FY2023 | Q1 FY2022 |
|---|---|---|
| Net sales | $618.6 million | $541.6 million |
| Gross margin | 20.4% | 22.6% |
| Earnings before taxes | $31.7 million | $37.7 million |
| Net earnings | $29.6 million | $30.3 million |
| Diluted EPS | $0.49 | $0.47 |
| Operating cash flow | $5.4 million | $39.3 million |
| Capital expenditures | $24.4 million | $13.1 million |
| Free cash flow (non-GAAP) | $(19.0) million | $26.2 million |
Sales rose 14.2%, but net earnings fell 2.3%. Diluted EPS increased as weighted-average diluted shares declined to 60.9 million from 65.1 million. Gross margin contracted 2.2 percentage points; net margin was 4.8%, versus 5.6%. The effective tax rate fell to 6.7% from 19.7%, mainly reflecting releases of uncertain tax positions and increased tax benefits and credits.
Aerospace sales increased 17.6% to $395.7 million, with segment earnings of $55.4 million and a 14.0% margin (15.2% prior year). Industrial sales increased 8.7% to $222.9 million, but segment earnings fell 51.9% to $11.4 million and margin declined to 5.1% from 11.5%.
At December 31, 2022, cash and cash equivalents were $99.3 million, total debt was $834.4 million, and working capital was $726.3 million. The company reported $881.7 million of available revolving-credit capacity, net of letters of credit, and $27.5 million of additional foreign borrowing capacity. Total assets were $3.895 billion and stockholders’ equity was $1.939 billion. The company reported compliance with debt covenants.
Material changes versus the prior comparable period
- Revenue growth reflected higher sales volume, price increases and favorable mix, partly offset by unfavorable foreign exchange. Commercial aerospace OEM and aftermarket activity benefited from passenger-traffic recovery and greater aircraft utilization; industrial sales benefited from marine activity and demand in power generation and process industries.
- Cost of goods sold rose faster than sales, increasing from 77.4% to 79.6% of revenue. Management attributed margin pressure to material and labor inflation, supply-chain disruption, and higher manufacturing costs.
- Supply-chain and labor disruptions were estimated to have reduced quarterly Aerospace sales by approximately $35 million and Industrial sales by approximately $60 million.
- Operating cash flow decreased by $33.9 million year over year, primarily due to inventory accumulation amid production delays and timing of tax payments. Capital spending also increased, driving free cash flow negative.
- Interest expense rose 34.1% to $11.1 million, primarily due to higher revolving-credit borrowings. Total debt increased from $777.4 million at September 30, 2022 to $834.4 million.
- Industrial segment earnings were pressured by inflation, supply-chain-related manufacturing costs, foreign exchange, and incentive compensation. Aerospace earnings increased, but its segment margin also declined.
Outlook, commentary, risks and unusual items
- Management described demand as strong across most end markets, while noting that supply-chain and labor disruption, rising labor costs, and material inflation continued to adversely affect operations and financial performance. The filing provides no quantified earnings or revenue guidance.
- Woodward is pursuing supply-chain risk mitigation, reduced complexity, operational improvements, and pricing actions. Management cautioned that contractual arrangements can delay realization of price increases and that the duration and full effects of industry disruptions remain uncertain.
- Remaining performance obligations from firm orders were $1.644 billion at quarter-end, mostly in Aerospace; the company expects to recognize almost all within two years. Material-right obligations were $475.8 million, expected to be recognized over underlying program lives, potentially as long as 40 years.
- Risks cited include global supply-chain and labor pressures, inflation, geopolitical developments including the Russia-Ukraine conflict, foreign exchange and interest-rate movements, customer and market demand, and the ability to generate cash and service debt. Sales in Russia were less than 1% of total sales in each comparable quarter.
- Ordinary-course legal claims and proceedings include product liability, warranty, employment, contractual, and regulatory matters. Management believes resulting liabilities will not materially affect liquidity, financial condition, or results, but outcomes cannot be predicted with certainty.
- Accrued product warranties and related liabilities increased to $49.5 million from $40.0 million at September 30, 2022; the quarter included $17.0 million of net additions and $7.7 million of settlements. The filing notes that these accruals include estimated product liabilities expected to be fully recoverable from insurance.
- The October 2022 revolving-credit amendment extended the commitment termination date to October 21, 2027 and removed certain restrictive covenants, subject to specified conditions. The board approved a $0.22-per-share dividend payable March 7, 2023.
- Prior-year adjusted net earnings were $36.3 million, versus reported net earnings of $30.3 million, after $6.0 million of net-of-tax adjustments for a non-recurring matter and business-development costs. No such adjustments were reported for Q1 FY2023; accordingly, adjusted and reported earnings were the same in the current quarter.
Important facts for investors to verify
- Whether supply-chain recovery, production efficiency, and pricing actions improve gross margin and segment profitability, particularly in Industrial.
- Whether inventory levels convert into shipments and cash; quarterly operating cash flow was only $5.4 million and free cash flow was negative $19.0 million.
- Debt repayment plans, interest-rate exposure, and the company’s ability to maintain covenant compliance while funding capital expenditures, dividends, and share repurchases.
- The development of warranty claims and the extent and timing of any insurance recoveries.
- How customer demand, especially commercial aerospace recovery and defense demand, and the $1.644 billion firm-order backlog translate into revenue.
- The sustainability of the unusually low 6.7% effective tax rate; management notes interim tax provisions can be volatile.