Woodward, Inc. - Quarter Report: 2017 June (Form 10-Q)



UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2017

or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 

Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company.  See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☒    Accelerated filer ☐    Non-accelerated filer ☐    Smaller reporting company ☐

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

As of July 20,  2017, 61,316,556 shares of the registrant’s common stock with a par value of $0.001455 per share were outstanding.

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PART I – FINANCIAL INFORMATION

Item 1.Financial Statements



WOODWARD, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands, except per share amounts)

(Unaudited)















See accompanying Notes to Condensed Consolidated Financial Statements

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WOODWARD, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(In thousands)

(Unaudited)



































See accompanying Notes to Condensed Consolidated Financial Statements



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WOODWARD, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

(Unaudited)







See accompanying Notes to Condensed Consolidated Financial Statements.





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WOODWARD, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)







See accompanying Notes to Condensed Consolidated Financial Statements



 

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WOODWARD, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

(Unaudited)







See accompanying Notes to Condensed Consolidated Financial Statements

 

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WOODWARD, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)



Note 1.  Basis of presentation

The Condensed Consolidated Financial Statements of Woodward, Inc. (“Woodward” or the “Company”) as of June 30, 2017 and for the three and nine-months ended June 30, 2017 and June 30, 2016, included herein, have not been audited by an independent registered public accounting firm.  These Condensed Consolidated Financial Statements reflect all normal recurring adjustments that, in the opinion of management, are necessary to present fairly Woodward’s financial position as of June 30, 2017, and the statements of earnings, comprehensive earnings, cash flows, and changes in stockholders’ equity for the periods presented herein.  The results of operations for the three and nine-months ended June 30, 2017 are not necessarily indicative of the operating results to be expected for other interim periods or for the full fiscal year.  Dollar and share amounts contained in these Condensed Consolidated Financial Statements are in thousands, except per share amounts.

The Condensed Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim reporting.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations.

These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto included in Woodward’s most recent Annual Report on Form 10-K filed with the SEC and other financial information filed with the SEC.

Management is required to use estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported revenues and expenses recognized during the reporting period, and certain financial statement disclosures, in the preparation of the Condensed Consolidated Financial Statements included herein.  Significant estimates in these Condensed Consolidated Financial Statements include allowances for uncollectible amounts, net realizable value of inventories, customer rebates earned and payable, warranty reserves, useful lives of property and identifiable intangible assets, the evaluation of impairments of property, the provision for income tax and related valuation reserves, assumptions used in the determination of the funded status and annual expense of pension and postretirement employee benefit plans, the valuation of stock compensation instruments granted to employees and board members, and contingencies.  Actual results could vary from Woodward’s estimates.





Note 2.  New accounting standards

From time to time, the Financial Accounting Standards Board (“FASB”) or other standards setting bodies issue new accounting pronouncements.  Updates to the FASB Accounting Standards Codification (“ASC”) are communicated through issuance of an Accounting Standards Update (“ASU”).

In May 2017, the FASB issued ASU 2017-09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.”  ASU 2017-09 was issued to provide clarity and reduce both 1) diversity in practice and 2) cost and complexity when applying the guidance in Topic 718 to a change in the terms or conditions of a share-based payment award.  ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under Topic 718.  The amendments in ASU 2017-09 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 (fiscal year 2019 for Woodward).  Early adoption is permitted, including adoption in any interim period.  The amendments in ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date.  Woodward adopted the new guidance in its third quarter of fiscal year 2017 and will apply the guidance to any future changes to the terms or conditions of its share-based payment awards.

In March 2017, the FASB issued ASU 2017-07, “Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.”  ASU 2017-07 requires that the service cost component of net periodic benefit costs from defined benefit and other postretirement benefit plans be included in the same Statement of Earnings captions as other compensation costs arising from services rendered by the covered employees during the period.  The other components of net benefit cost will be presented in the Statement of Earnings separately from service costs.  ASU 2017-07 is effective for fiscal years beginning after December 31, 2017 (fiscal year 2019 for Woodward).  Following adoption, only service costs will be eligible for capitalization into manufactured inventories, which should reduce diversity in practice. The amendments of ASU 2017-07 should be applied retrospectively for the presentation of the service cost component and the other components of net periodic benefit costs from defined benefit and

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other postretirement benefit plans in the earnings statement and prospectively, on and after the effective date, for the capitalization of the service cost component into manufactured inventories.  Early adoption is permitted as of the beginning of Woodward’s fiscal year 2018.  Woodward has not determined whether it will adopt the new guidance in fiscal year 2018 or fiscal year 2019, and expects changes to earnings before income taxes to be insignificant in the year of adoption.

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350):  Simplifying the Accounting for Goodwill Impairment,” to simplify financial reporting by eliminating the need to determine the fair value of individual assets and liabilities of a reporting unit to measure goodwill impairment.  Under ASU 2017-04, an entity should perform its goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, up to the amount of goodwill allocated to that reporting unit.  The new guidance effectively eliminates “Step 2” from the previous goodwill impairment test.  ASU 2017-04 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019 (fiscal year 2021 for Woodward).  Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017.  Woodward plans to adopt the new guidance in its fourth quarter of fiscal year 2017 when it performs its annual goodwill impairment test as of July 31, 2017.  Woodward does not expect the adoption of ASU 2017-04 to have a significant impact on the results of its goodwill impairment testing.

In October 2016, the FASB issued ASU 2016-16, “Accounting for Income Taxes: Intra-Entity Asset Transfers of Assets Other than Inventory.”  ASU 2016-16 eliminates the current U.S. GAAP exception deferring the tax effects of intercompany asset transfers (other than inventory) until the transferred asset is sold to a third party or otherwise recovered through use.  After adoption of ASU 2016-16, Woodward will recognize the tax consequences of intercompany asset transfers in the buyer’s and seller’s tax jurisdictions when the transfer occurs, even though the pre-tax effects of these transactions are eliminated in consolidation.  ASU 2016-16 is effective for fiscal years beginning after December 15, 2017 (fiscal year 2019 for Woodward), including interim periods within the year of adoption.  Early adoption is allowed only in the first quarter of fiscal year 2017 or the first quarter of fiscal year 2018.  Modified retrospective adoption is required with any cumulative-effect adjustment recorded to retained earnings as of the beginning of the period of adoption.  Woodward has not determined in which period it will adopt the new guidance.  Woodward currently anticipates the adoption of ASU 2016-16 will result in balance sheet reclassifications, but based on Woodward’s current transactional activity, such adjustments are not expected to be significant.

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments.”  ASU 2016-13 adds a current expected credit loss (“CECL”) impairment model to U.S. GAAP that is based on expected losses rather than incurred losses.  Modified retrospective adoption is required with any cumulative-effect adjustment recorded to retained earnings as of the beginning of the period of adoption.  ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 (fiscal year 2021 for Woodward), including interim periods within the year of adoption.  Early adoption is permitted for fiscal years beginning after December 15, 2018 (fiscal year 2020 for Woodward), including interim periods within those fiscal years.  Woodward has not determined in which period it will adopt the new guidance but does not expect the application of the CECL impairment model to have a significant impact on Woodward’s allowance for uncollectible amounts for accounts receivable and notes receivable from municipalities.

 

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).”  The purpose of ASU 2016-02 is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.  In addition, ASU 2016-02 modifies the definition of a lease to clarify that an arrangement contains a lease when such arrangement conveys the right to control the use of an identified asset. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 (fiscal year 2020 for Woodward), including interim periods within the year of adoption.  In transition, Woodward will be required to recognize and measure leases beginning in the earliest period presented using a modified retrospective approach; therefore, Woodward anticipates restating its Consolidated Financial Statements for the two fiscal years prior to the year of adoption.  Early adoption is permitted.  Woodward has not determined in which period it will adopt the new guidance.  Woodward is currently assessing the impact this guidance may have on its Consolidated Financial Statements, including which of its existing lease arrangements will be impacted by the new guidance and whether other arrangements not currently classified as leases may become subject to the guidance of ASU 2016-02.  Rent expense for all operating leases in fiscal year 2016, none of which was recognized on the balance sheet, was $7,359.  As of September 30, 2016, future minimum rental payments required under operating leases, none of which were recognized on the balance sheet, were $15,612.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” and has subsequently issued several supplemental and/or clarifying ASUs (collectively “ASC 606”). ASC 606 prescribes a single common revenue standard that replaces most existing U.S. GAAP revenue recognition guidance.  ASC 606 outlines a five-step model, under which Woodward will recognize revenue as performance obligations within a customer contract are satisfied. ASC 606 is intended to provide more consistent interpretation and application of the principles outlined in the standard across filers in multiple industries and within the same industries compared to current practices, which should improve comparability.  

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Adoption of ASC 606 is required for annual reporting periods beginning after December 15, 2017 (fiscal year 2019 for Woodward), including interim periods within the reporting period.  While Woodward may elect to adopt ASC 606 in fiscal year 2018, it does not expect to do so. Upon adoption, Woodward must elect to adopt either retrospectively to each prior reporting period presented or using the cumulative effect transition method with the cumulative effect of initial adoption recognized at the date of initial application. Woodward has not determined what transition method it will use.  

Woodward is currently assessing the impact that the future adoption of ASC 606 may have on its Consolidated Financial Statements by analyzing its current portfolio of customer contracts, including a review of historical accounting policies and practices to identify potential differences in applying the guidance of ASC 606.  Woodward is also performing a comprehensive review of its current processes and systems to determine and implement changes required to support the adoption of ASC 606 on October 1, 2018, the first day of Woodward’s fiscal year 2019.

Based on Woodward’s review of its customer contracts, Woodward has determined that revenue on the majority of its customer contracts will continue to be recognized at a point in time, generally upon shipment of products, consistent with Woodward’s current revenue recognition model.  Upon adoption of ASC 606, however, Woodward also believes some of its revenues from sales of products and services to customers will be recognized over time, rather than at a point in time, due primarily to the terms of certain customer contracts.  As a result of recognizing some revenue over time, various balance sheet line items will be impacted.  As such, Woodward believes the adoption of ASC 606 will have an impact on both the timing of revenue recognition and various line items within the Consolidated Balance Sheet.

Woodward generally expenses costs as incurred for the engineering and development of new products.  Customer funding received for such engineering and development efforts is currently recognized as revenue when earned, with the corresponding costs recognized as cost of sales. ASC 606 requires customer funding of product engineering and development to be deferred and recognized as revenue as the related products are delivered to the customer.  ASC 606 also requires product engineering and development costs to be capitalized as contract fulfillment costs, to the extent recoverable from the deferred customer funding, and subsequently amortized as the related products are delivered to the customer.  Therefore, under ASC 606, Woodward expects to record both contract assets and contract liabilities related to such funded engineering and development efforts, which are expected to become material over time.  Recognized revenues and research and development costs are both expected to decrease in the year of adoption and for at least several years thereafter, due to the recognition of these contract assets and liabilities.  However, recognition of these contract assets and liabilities are expected to have an immaterial impact on pre-tax earnings in future periods.

In addition, ASC 606 will require more comprehensive disclosures about revenue streams and contracts with customers, including significant judgments required.  Woodward is currently evaluating potential changes to its processes for preparing required disclosures and to information systems that support the financial reporting process. 

In addition, Woodward is evaluating implications to the Company’s system of internal controls, relative to revenue recognition and the related revenue disclosures, which are based on the criteria outlined in the Committee of Sponsoring Organizations of the Treadway Commission’s 2013 Internal Control – Integrated Framework.



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Note 3.  Earnings per share

Basic earnings per share is computed by dividing net earnings available to common stockholders by the weighted-average number of shares of common stock outstanding for the period.

Diluted earnings per share reflects the weighted-average number of shares outstanding after consideration of the dilutive effect of stock options and restricted stock. 

The following is a reconciliation of net earnings to basic earnings per share and diluted earnings per share:





The following stock option grants were outstanding during the three and nine-months ended June 30, 2017 and 2016, but were excluded from the computation of diluted earnings per share because their inclusion would have been anti-dilutive.











The weighted-average shares of common stock outstanding for basic and diluted earnings per share included the weighted-average treasury stock shares held for deferred compensation obligations of the following:

 

Note 4. Joint venture

On January 4, 2016, Woodward and General Electric Company (“GE”), acting through its GE Aviation business unit, consummated the formation of a strategic joint venture between Woodward and GE (the “JV”) to design, develop and source fuel systems for specified existing and all future GE commercial aircraft engines that produce thrust in excess of fifty thousand pounds.

As part of the JV formation, Woodward contributed to the JV certain contractual rights and intellectual property applicable to the existing GE commercial aircraft engine programs within the scope of the JV.  Woodward had no initial cost basis in the JV because Woodward had no cost basis in the contractual rights and intellectual property contributed to the JV.  GE purchased from Woodward a 50% ownership interest in the JV for a $250,000 cash payment to Woodward.  In addition, GE will pay contingent consideration to Woodward consisting of fifteen annual payments of $4,894 per year which began on January 4, 2017 subject to certain claw-back conditions.  Woodward received its first annual payment of $4,894 during the three-months ended March 31, 2017, which was recorded as deferred income and is included in Net cash provided by operating activities under the caption “Other” on the Condensed Consolidated Statement of Cash Flows, for the nine-months ended June 30, 2017.  Neither Woodward nor GE contributed any tangible assets to the JV.

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Woodward determined that the JV formation was not the culmination of an earnings event because Woodward has significant performance obligations to support the future operations of the JV.  Therefore, Woodward recorded the $250,000 consideration received from GE, in January of 2016, for its purchase of a 50% equity interest in the JV as deferred income.  The $250,000 deferred income will be recognized as an increase to net sales in proportion to revenue realized on sales of applicable fuel systems within the scope of the JV in a particular period as a percentage of total revenue expected to be realized by Woodward over the estimated remaining lives of the underlying commercial aircraft engine programs assigned to the JV.  Unamortized deferred income recorded in connection with the JV formation included accrued liabilities of $6,252 as of June 30, 2017 and $6,552 as of September 30, 2016, and other liabilities of $238,866 as of June 30, 2017 and $238,187 as of September 30, 2016.  Amortization of the deferred income recognized as an increase to sales was $1,387 for the three months and $4,515 for the nine-months ended June 30, 2017, and $1,733 for the three months and $3,695 for the nine-months ended June 30, 2016. 

Woodward and GE jointly manage the JV and any significant decisions and/or actions of the JV require the mutual consent of both parties.  Neither Woodward nor GE has a controlling financial interest in the JV, but both Woodward and GE do have the ability to significantly influence the operating and financial decisions of the JV.  Therefore, Woodward is accounting for its 50% ownership interest in the JV using the equity method of accounting.  The JV is a related party to Woodward.  Other income includes a loss of $432 for the three months and income of $634 for the nine-months ended June 30, 2017, and income of $2,728 for the three months and $4,886 for the nine-months ended June 30, 2016 related to Woodward’s equity interest in the earnings of the JV.  During the nine-months ended June 30, 2017, Woodward received a $2,500 cash distribution from the JV which is included in Net cash provided by operating activities under the caption “Other” on the Condensed Consolidated Statement of Cash Flows. Woodward received no cash distributions from the JV in the nine-months ended June 30, 2016.  Woodward’s net investment in the JV, which is included in other assets, was $4,338 as of June 30, 2017 and $6,204 as of September 30, 2016.  

Woodward’s  net sales include $18,645 for the three months and $52,362 for the nine-months ended June 30, 2017 of sales to the JV, compared to $15,136 for the three months and $30,151 for the nine-months ended June 30, 2016.  Woodward recorded a reduction to sales of $6,163 for the three months and $17,240 for the nine-months ended June 30, 2017 related to royalties paid to the JV by Woodward on sales by Woodward directly to third party aftermarket customers, compared to $7,643 for the three months and $14,659 for the nine-months ended June 30, 2016.  The Condensed Consolidated Balance Sheets include “Accounts receivable” of $9,554 at  June 30, 2017, and $5,326 at September 30, 2016 related to amounts the JV owed Woodward, and include “Accounts payable” of $2,740 at June 30, 2017, and $3,926 at September 30, 2016 related to amounts Woodward owed the JV.



Note 5.  Financial instruments and fair value measurements

Financial assets and liabilities recorded at fair value in the Condensed Consolidated Balance Sheets are categorized based upon a fair value hierarchy established by U.S. GAAP, which prioritizes the inputs used to measure fair value into the following levels:

Level 1: Inputs based on quoted market prices in active markets for identical assets or liabilities at the measurement date.

Level 2: Quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable and can be corroborated by observable market data.

Level 3: Inputs that reflect management’s best estimates and assumptions of what market participants would use in pricing the asset or liability at the measurement date.  The inputs are unobservable in the market and significant to the valuation of the instruments.

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The table below presents information about Woodward’s financial assets that are measured at fair value on a recurring basis and indicates the fair value hierarchy of the valuation techniques Woodward utilized to determine such fair value.  Woodward had no financial liabilities required to be measured at fair value on a recurring basis as of June 30, 2017 or September 30, 2016.





Investments in money market funds: Woodward sometimes invests excess cash in money market funds not insured by the Federal Depository Insurance Corporation (“FDIC”).  Woodward believes that the investments in money market funds are on deposit with creditworthy financial institutions and that the funds are highly liquid.  The investments in money market funds are reported in “Cash and cash equivalents” at fair value, with realized gains from interest income recognized in earnings.  The fair values of Woodward’s investments in money market funds are based on the quoted market prices for the net asset value of the various money market funds.

Investments in reverse repurchase agreements:  Woodward sometimes invests excess cash in reverse repurchase agreements.  Under the terms of Woodward’s reverse repurchase agreements, Woodward purchases an interest in a pool of securities and is granted a security interest in those securities by the counterparty to the reverse repurchase agreement.  At an agreed upon date, generally the next business day, the counterparty repurchases Woodward’s interest in the pool of securities at a price equal to what Woodward paid to the counterparty plus a rate of return determined daily per the terms of the reverse repurchase agreement.  Woodward believes that the investments in these reverse repurchase agreements are with creditworthy financial institutions and that the funds invested are highly liquid.  The investments in reverse repurchase agreements are reported at fair value, with realized gains from interest income recognized in earnings, and are included in “Cash and cash equivalents.”  Since the investments are generally overnight, the carrying value is considered to be equal to the fair value as the amount is deemed to be a cash deposit with no risk of change in value as of the end of each fiscal quarter.

Investments in term deposits with foreign banks: Woodward’s foreign subsidiaries sometimes invest excess cash in various highly liquid financial instruments that Woodward believes are with creditworthy financial institutions.  Such investments are reported in “Cash and cash equivalents” at fair value, with realized gains from interest income recognized in earnings.  The carrying value of Woodward’s investments in term deposits with foreign banks are considered equal to the fair value given the highly liquid nature of the investments.

Equity securities: Woodward holds marketable equity securities, through investments in various mutual funds, related to its deferred compensation program.  Based on Woodward’s intentions regarding these instruments, marketable equity securities are classified as trading securities.  The trading securities are reported at fair value, with realized gains and losses recognized in “Other (income) expense, net.”  The trading securities are included in “Other assets.”  The fair values of Woodward’s trading securities are based on the quoted market prices for the net asset value of the various mutual funds.

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Accounts receivable, accounts payable, the current portion of long-term debt, and short-term borrowings are not remeasured to fair value, as the carrying cost of each approximates its respective fair value.  The estimated fair values and carrying costs of other financial instruments that are not required to be remeasured at fair value in the Condensed Consolidated Balance Sheets were as follows:







In fiscal years 2014 and 2013, Woodward received long-term notes from municipalities within the states of Illinois and Colorado in connection with certain economic incentives related to Woodward’s development of a second campus in the greater-Rockford, Illinois area for its Aerospace segment and Woodward’s development of a new campus at its corporate headquarters in Fort Collins, Colorado.  The fair value of the long-term notes was estimated based on a model that discounted future principal and interest payments received at an interest rate available to the Company at the end of the period for similarly rated municipal notes of similar maturity, which is a level 2 input as defined by the U.S. GAAP fair value hierarchy.  The interest rates used to estimate the fair value of the long-term notes were 2.7% at June 30, 2017 and 2.2% at September 30, 2016.

From time to time, certain of Woodward’s foreign subsidiaries will invest excess cash in short-term time deposits with a fixed maturity date of longer than three months but less than one year from the date of the deposit.  Woodward believes that the investments are with creditworthy financial institutions. The fair value of the investments in short-term time deposits was estimated based on a model that discounted future principal and interest payments to be received at an interest rate available to the foreign subsidiary entering into the investment for similar short-term time deposits of similar maturity.  This was determined to be a level 2 input as defined by the U.S. GAAP fair value hierarchy.  The interest rate used to estimate the fair value of the short-term time deposits was 5.1% at June 30, 2017 and 6.9% at September 30, 2016. 

The fair value of long-term debt was estimated based on a model that discounted future principal and interest payments at interest rates available to the Company at the end of the period for similar debt of the same maturity, which is a level 2 input as defined by the U.S. GAAP fair value hierarchy.  The weighted-average interest rates used to estimate the fair value of long-term debt were 2.8% at June 30, 2017 and 1.9% at September 30, 2016.

 

Note 6.  Derivative instruments and hedging activities

Woodward has exposures related to global market risks, including the effect of changes in interest rates, foreign currency exchange rates, changes in certain commodity prices and fluctuations in various producer indices.  From time to time, Woodward enters into derivative instruments for risk management purposes only, including derivatives designated as accounting hedges and/or those utilized as economic hedges.  Woodward uses interest rate related derivative instruments to manage its exposure to fluctuations of interest rates.  Woodward does not enter into or issue derivatives for trading or speculative purposes.

By using derivative and/or hedging instruments to manage its risk exposure, Woodward is subject, from time to time, to credit risk and market risk on those derivative instruments.  Credit risk arises from the potential failure of the counterparty to perform under the terms of the derivative and/or hedging instrument.  When the fair value of a derivative contract is positive, the counterparty owes Woodward, which creates credit risk for Woodward.  Woodward mitigates this credit risk by entering into transactions with only counterparties that are believed to be creditworthy.  Market risk arises from the potential adverse effects on the value of derivative and/or hedging instruments that result from a change in interest rates, commodity prices, or foreign currency exchange rates.  Woodward minimizes this market risk by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.

Woodward did not enter into any derivatives or hedging transactions during any of the three or nine-months ended June 30, 2017 or June 30, 2016.

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The remaining unrecognized gains and losses in Woodward’s Condensed Consolidated Balance Sheets associated with derivative instruments that were previously entered into by Woodward, which are classified in accumulated other comprehensive (losses) earnings (“accumulated OCI”), were net gains of $236 as of June 30, 2017 and $290 as of September 30, 2016.

The following table discloses the impact of derivative instruments in cash flow hedging relationships on Woodward’s Condensed Consolidated Statements of Earnings, recognized in interest expense:









Based on the carrying value of the realized but unrecognized gains on terminated derivative instruments designated as cash flow hedges as of June 30, 2017, Woodward expects to reclassify $72 of net unrecognized gains on terminated derivative instruments from accumulated other comprehensive (losses) earnings to earnings during the next twelve months.

On September 23, 2016, Woodward and Woodward International Holding B.V., a wholly owned subsidiary of Woodward organized under the laws of The Netherlands (the “BV Subsidiary”), each entered into a note purchase agreement (the “2016 Note Purchase Agreement”) relating to the sale by Woodward and the BV Subsidiary of an aggregate principal amount of €160,000 of senior unsecured notes in a series of private placement transactions.  Woodward issued €40,000 aggregate principal amount of Woodward’s Series M Senior Notes due September 23, 2026.  Woodward designated the €40,000 Series M Notes as a hedge of a foreign currency exposure of Woodward’s net investment in its Euro denominated functional currency subsidiaries.  A foreign exchange loss on the Series M Notes of $880 for the three months and a foreign exchange loss of $3,030 for the nine-months ended June 30, 2017 is included in foreign currency translation adjustments within total comprehensive (losses) earnings. 

In June 2015, Woodward designated an intercompany loan of 160,000 Renminbi (“RMB”) between two wholly owned subsidiaries as a hedge of a foreign currency exposure of the net investment of the borrower in the lender.  Foreign exchange gains on the loan of $395 for the three months and $912 for the nine-months ended June 30, 2016 are included in foreign currency translation adjustments within total comprehensive (losses) earnings.  In June 2016, the intercompany loan was repaid, resulting in a realized gain of $1,484 that was recognized within total comprehensive earnings, of which $912 was recognized in fiscal year 2016.

In July 2016, Woodward designated a new intercompany loan of 160,000 RMB between two wholly owned subsidiaries as a hedge of a foreign currency exposure of the net investment of the borrower in the lender.  Net unrealized foreign exchange losses on the loan of $283 for the three months and net unrealized foreign exchange gains on the loan of $452 for the nine-months ended June 30, 2017 are included in foreign currency translation adjustments within total comprehensive (losses) earnings.  The intercompany loan was repaid in July 2017, and Woodward is currently negotiating a new intercompany loan between the two wholly owned subsidiaries.

 

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Note 7.  Supplemental statement of cash flows information















 

Note 8.  Accounts receivable

Almost all of Woodward’s sales are made on credit and result in accounts receivable that are recorded at the amount invoiced.  In the normal course of business, not all accounts receivable are collected.  Therefore, an allowance for losses of accounts receivable is provided equal to the amount that Woodward believes ultimately will not be collected.  In establishing the amount of the allowance, Woodward considers customer-specific information related to delinquent accounts, past loss experience, bankruptcy filings, deterioration in the customer’s operating results or financial position, and current economic conditions.  Accounts receivable losses are deducted from the allowance, and the related accounts receivable balances are written off when the receivables are deemed uncollectible.  Recoveries of accounts receivable previously written off are recognized when received.



Consistent with business practice common in China, Woodward’s Chinese subsidiary accepts from Chinese customers, in settlement of certain customer accounts receivable, bankers’ acceptance notes issued by Chinese banks that are believed to be creditworthy.  Bankers’ acceptance notes are financial instruments issued by Chinese financial institutions as part of financing arrangements between the financial institution and a customer of the financial institution.  Bankers’ acceptance notes represent a commitment by the issuing financial institution to pay a certain amount of money at a specified future maturity date to the legal owner of the bankers’ acceptance note as of the maturity date.  The maturity date of bankers’ acceptance notes varies, but it is Woodward’s policy to only accept bankers’ acceptance notes with maturity dates no more than 180 days from the date of Woodward’s receipt of such draft.  The issuing financial institution is the obligor, not Woodward’s customers.  Upon Woodward’s acceptance of a banker’s acceptance note from a customer, such customer has no further obligation to pay Woodward for the related accounts receivable balance.  Woodward only accepts bankers’ acceptance notes issued by banks that are believed to be creditworthy as to which the credit risk associated with the bankers’ acceptance notes is believed to be minimal.



The composition of Woodward’s accounts receivable at June 30, 2017 and September 30, 2016 follows:









 



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Note 9.  Inventories





 

Note 10.  Property, plant, and equipment







Included in “Office furniture and equipment” and “Other” is $1,653 at each of June 30, 2017 and September 30, 2016, of gross assets acquired on capital leases, and accumulated depreciation included $635 at June 30, 2017 and $322 at September 30, 2016 of amortization associated with the capital lease assets.

In fiscal year 2015, Woodward completed and placed into service a manufacturing and office building on a second campus in the greater-Rockford, Illinois area and has occupied the new facility for its Aerospace segment.  This campus is intended to support Woodward’s expected growth in its Aerospace segment over the next ten years and beyond, required as a result of Woodward being awarded a substantial number of new system platforms, particularly on narrow-body aircraft.  Included in “Construction in progress” are costs of $43,582 at June  30, 2017 and $26,741 at September 30, 2016 associated with new equipment purchases for the second campus. 

For the three and nine-months ended June 30, 2017 and 2016, Woodward had depreciation expense as follows:





For the three and nine-months ended June 30, 2017  and 2016, Woodward capitalized interest that would have otherwise been included in interest expense of the following:

 

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Note 11.  Goodwill







Woodward tests goodwill for impairment during the fourth quarter of each fiscal year, or at any time there is an indication goodwill is more-likely-than-not impaired, commonly referred to as triggering events.  There have been no such triggering events during any of the periods presented and Woodward’s fourth quarter of fiscal year 2016 impairment test resulted in no impairment.

 

Note 12.  Intangible assets, net



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For the three and nine-months ended June 30, 2017 and 2016, Woodward recorded amortization expense associated with intangibles of the following:



Future amortization expense associated with intangibles is expected to be:





 



Note 13.  Credit facilities, short-term borrowings and long-term debt

Revolving credit facility

Woodward maintains a $1,000,000 revolving credit facility established under a revolving credit agreement among Woodward, a syndicate of lenders and Wells Fargo Bank, National Association, as administrative agent (the “Revolving Credit Agreement”).  The Revolving Credit Agreement provides for the option to increase available borrowings to up to $1,200,000, subject to lenders’ participation.  Borrowings under the Revolving Credit Agreement generally bear interest at LIBOR plus 0.85% to 1.65%.  The Revolving Credit Agreement matures in April 2020.  Under the Revolving Credit Agreement, there were $116,900 in principal amount of borrowings outstanding as of June 30, 2017, at an effective interest rate of 2.28% and $156,700 in principal amount of borrowings outstanding as of September 30, 2016, at an effective interest rate of 1.77%.   As of June 30, 2017,  all of the borrowings under the Revolving Credit Agreement were classified as short-term based on Woodward’s intent and ability to pay this amount in the next twelve months. 

Short-term borrowings

During the three-months ended March 31, 2017, a Chinese subsidiary of Woodward amended its local uncommitted credit facility with the Hong Kong and Shanghai Banking Company (“HSBC”) under which it had the ability to borrow up to either $22,700, or the local currency equivalent of $22,700, up to the amount of a parent guarantee from Woodward.  Under the amended agreement, the Chinese subsidiary has the ability to borrow up to either $4,550, or the local currency equivalent of $4,550, up to the amount of a parent guarantee from Woodward.   The Chinese subsidiary may utilize the local facility for cash borrowings to support its operating cash needs.  Local currency borrowings on the Chinese credit facility are charged interest at the prevailing interest rate offered by the People’s Bank of China on the date of borrowing, plus a margin equal to 15% of that prevailing rate.  U.S. dollar borrowings on the credit facility are charged interest at the lender’s cost of borrowing rate at the date of borrowing, plus 3%.  The Chinese subsidiary had no outstanding cash borrowings against the local credit facility at June 30, 2017 and September 30, 2016.

On January 5, 2017, the Brazilian subsidiary of Woodward amended its local uncommitted credit facility with the Banco J.P. Morgan S.A., under which it had the ability to borrow up to 52,000 Brazilian Real, to extend the maturity date until July 14, 2017 and decrease the maximum borrowing capacity to 1,000 Brazilian Real. In July 2017, the Brazilian subsidiary entered into another amendment to the credit facility to extend the maturity date until March 15, 2018.  Any cash borrowings under the local Brazilian credit facility are secured by a parent guarantee from Woodward.  The Brazilian subsidiary may utilize the local facility to support its operating cash needs.  Local currency borrowings on the Brazilian credit facility are charged interest at the lender’s cost of borrowing rate at the date of borrowing, plus 1.75%.  The Brazilian subsidiary had no outstanding cash borrowings against the local credit facility at June 30, 2017 and September 30, 2016.

Woodward also has other foreign lines of credit and foreign overdraft facilities at various financial institutions, which are generally reviewed annually for renewal and are subject to the usual terms and conditions applied by the financial institutions.  Pursuant to the terms of the related facility agreements, Woodward’s foreign performance guarantee facilities are limited in use to providing performance guarantees to third parties.  There were no borrowings outstanding as of June 30, 2017 and September 30, 2016 on Woodward’s other foreign lines of credit and foreign overdraft facilities.

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Long-term debt

The Notes

In October 2008, Woodward entered into a note purchase agreement relating to the Series D Notes (the “2008 Notes”).  In April 2009, Woodward entered into a note purchase agreement relating to the Series F Notes (the “2009 Notes”).

On October 1, 2013, Woodward entered into a note purchase agreement relating to the sale by Woodward of an aggregate principal amount of $250,000 of its senior unsecured notes in a series of private placement transactions.  Woodward issued the Series G, H and I Notes (the “First Closing Notes”) on October 1, 2013.  Woodward issued the Series J, K and L Notes (the “Second Closing Notes”, and together with the 2008 Notes, 2009 Notes and the First Closing Notes, the “USD Notes”) on November 15, 2013. 

On September 23, 2016, Woodward and the BV Subsidiary each entered into note purchase agreements relating to the sale by Woodward and the BV Subsidiary of an aggregate principal amount of €160,000 of senior unsecured notes in a series of private placement transactions.  Woodward issued €40,000 aggregate principal amount of Woodward’s Series M Senior Notes (the “Series M Notes”).  The BV Subsidiary issued (a) €77,000 aggregate principal amount of the BV Subsidiary’s Series N Senior Notes (the “Series N Notes”) and (b) €43,000 aggregate principal amount of the BV Subsidiary’s Series O Senior Notes (the “Series O Notes” and together with the Series M Notes and the Series N Notes, the “2016 Notes”, and together with the USD Notes, collectively, the “Notes”). 

Interest on the 2008 Notes, the First Closing Notes, and the Series K and L Notes is payable semi-annually on April 1 and October 1 of each year until all principal is paid.  Interest on the 2009 Notes is payable semi-annually on April 15 and October 15 of each year until all principal is paid.  Interest on the 2016 Notes is payable semi-annually on March 23 and September 23 of each year, until all principal is paid.  Interest on the Series J Notes is payable quarterly on January 1, April 1, July 1 and October 1 of each year until all principal is paid.  As of June 30, 2017, the Series J Notes bore interest at an effective rate of 2.4%.

Debt Issuance Costs

Unamortized debt issuance costs associated with the Notes of $1,856 as of June 30, 2017 and $2,091 as of September 30, 2016 were recorded as a reduction in “Long-term debt, less current portion” in the Condensed Consolidated Balance Sheets.  Unamortized debt issuance costs of $2,478 associated with the Revolving Credit Agreement as of June 30, 2017 and $3,134 as of September 30, 2016 were recorded as “Other assets” in the Condensed Consolidated Balance Sheets.  Amortization of debt issuance costs is included in operating activities in the Condensed Consolidated Statements of Cash Flows.

 

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Note 14.  Accrued liabilities







Warranties

Provisions of Woodward’s sales agreements include product warranties customary to these types of agreements.  Accruals are established for specifically identified warranty issues that are probable to result in future costs.  Warranty costs are accrued on a non-specific basis whenever past experience indicates a normal and predictable pattern exists.  Changes in accrued product warranties were as follows:









Loss reserve on contractual lease commitments

In connection with the construction of a new production facility in Niles, Illinois, Woodward vacated a leased facility in Skokie, Illinois.  During the first quarter of fiscal year 2016 Woodward fully vacated the Skokie facility and therefore recorded a charge of $8,165 to recognize a loss reserve against the estimated remaining contractual lease commitments, less anticipated sublease income.  During the third quarter of fiscal year 2017, Woodward entered into an additional sublease agreement with a third party related to a portion of the vacated Skokie facility.  Woodward recorded a reduction in the loss reserve associated with the vacated Skokie facility of $2,322 related to the anticipated sublease income it will receive.

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The summary for the activity in the loss reserve during the three and nine-months ended June 30, 2017 and June 30, 2016 is as follows:







Other liabilities included $3,851 of accrued loss reserve on contractual lease commitments that are not expected to be settled or paid within twelve months as of June 30, 2017.

 

Note 15.  Other liabilities









 

Note 16.  Other (income) expense, net 



















 

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Note 17.  Income taxes

U.S. GAAP requires that the interim period tax provision be determined as follows:  



The estimated annual effective rate is applied to the year-to-date ordinary income at the end of each quarter to compute the estimated year-to-date tax applicable to ordinary income.  The tax expense or benefit related to ordinary income in each quarter is the difference between the most recent year-to-date and the prior quarter year-to-date computations.



The determination of the annual effective tax rate is based upon a number of significant estimates and judgments, including the estimated annual pretax income of Woodward in each tax jurisdiction in which it operates, and the development of tax planning strategies during the year.  In addition, as a global commercial enterprise, Woodward’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, changes in the estimate of the amount of undistributed foreign earnings that Woodward considers indefinitely reinvested, and other factors that cannot be predicted with certainty.  As such, there can be significant volatility in interim tax provisions.

On December 7, 2016, the U.S. Treasury Department issued regulations under Internal Revenue Code Section 987 (“Section 987 Regulations”) which clarify how companies calculate foreign currency translation gains and losses for income tax purposes for branches whose accounting records are kept in a currency other than the currency of the company.  The issuance of these Section 987 Regulations had no significant impact on Woodward’s Condensed Consolidated Financial Statements for the nine-months ended June 30, 2017.

The following table sets forth the tax expense and the effective tax rate for Woodward’s earnings before income taxes:



The increase in the year-over-year effective tax rate for the third quarter of fiscal year 2017 is primarily attributable to a smaller favorable adjustment for the net excess income tax benefits from stock-based compensation in the current quarter.  This increase in the year-over-year effective tax rate was partially offset by larger net favorable resolutions of tax matters in the current quarter compared to the prior year quarter.   

The decrease in the year-over-year effective tax rate for the nine-months ended June 30, 2017 is primarily attributable to the impact of the repatriation to the U.S. of certain net foreign profits and losses in the first quarter of fiscal year 2017.  The U.S. foreign tax credits available as a result of the repatriation of the foreign net earnings were greater than the U.S. taxes payable on these net foreign earnings.  The excess U.S. foreign tax credits are expected to be used to offset U.S. taxes on other foreign source income.  The decrease in the year-over-year effective tax rate for the nine-month period was also attributable to larger favorable resolutions of tax matters in the current fiscal year compared to the prior fiscal year.  This combined decrease was partially offset by a smaller favorable adjustment for the net excess income tax benefit from stock-based compensation in the current fiscal year and the retroactive benefit of the U.S. research and experimentation credit pursuant to the December 18, 2015 enactment of the Protecting Americans from Tax Hikes Act of 2015, which was included in the effective tax rate for the first quarter of fiscal year 2016 but did not repeat in the first quarter of fiscal year 2017. 

Gross unrecognized tax benefits were $18,058 as of June 30, 2017, and $23,526 as of September 30, 2016.  Included in the balance of unrecognized tax benefits were $8,422 as of June 30, 2017 and $11,426 as of September 30, 2016 of tax benefits that, if recognized, would affect the effective tax rate.  At this time, Woodward estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease by as much as $7,657 in the next twelve months due to the completion of reviews by tax authorities, lapses of statutes, and the settlement of tax positions.  Woodward accrues for

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potential interest and penalties related to unrecognized tax benefits and all other interest and penalties related to tax payments in tax expense.  Woodward had accrued gross interest and penalties of $1,005 as of June 30, 2017 and $1,273 as of September 30, 2016.

Woodward’s tax returns are subject to audits by U.S. federal, state, and foreign tax authorities, and these audits are at various stages of completion at any given time.  Reviews of tax matters by authorities and lapses of the applicable statutes of limitations may result in changes to tax expense.  Fiscal years remaining open to examination in significant foreign jurisdictions include 2008 and thereafter.  Woodward’s fiscal years remaining open to examination in the United States include fiscal years 2014 and thereafter.  Woodward is currently under examination by the Internal Revenue Service for fiscal year 2014.  Woodward has concluded U.S. federal income tax examinations through fiscal year 2012.  Woodward is generally subject to U.S. state income tax examinations for fiscal years 2012 and the periods thereafter.

 

Note 18.  Retirement benefits

Woodward provides various retirement benefits to eligible members of the Company, including contributions to various defined contribution plans, pension benefits associated with defined benefit plans, postretirement medical benefits and postretirement life insurance benefits.  Eligibility requirements and benefit levels vary depending on employee location.

Defined contribution plans

Most of the Company’s U.S. employees are eligible to participate in the U.S. defined contribution plan.  The U.S. defined contribution plan allows employees to defer part of their annual income for income tax purposes into their personal 401(k) accounts.  The Company makes matching contributions to eligible employee accounts, which are also deferred for employee personal income tax purposes.  Certain foreign employees are also eligible to participate in similar foreign plans.

Most of Woodward’s U.S. employees with at least two years of service receive an annual contribution of Woodward stock, equal to 5% of their eligible prior year wages, to their personal Woodward Retirement Savings Plan accounts.  In the second quarter of fiscal years 2017 and 2016, Woodward fulfilled its annual Woodward stock contribution obligation using shares held in treasury stock by issuing a total of 199 shares of common stock for a value of $14,014 in fiscal year 2017, and 317 total shares of common stock for a value of $13,999 in fiscal year 2016. 

The amount of expense associated with defined contribution plans was as follows:





Defined benefit plans

Woodward has defined benefit plans that provide pension benefits for certain retired employees in the United States, the United Kingdom, and Japan.  Woodward also provides other postretirement benefits to its employees including postretirement medical benefits and life insurance benefits.  Postretirement medical benefits are provided to certain current and retired employees and their covered dependents and beneficiaries in the United States and the United Kingdom.  Life insurance benefits are provided to certain retirees in the United States under frozen plans, which are no longer available to current employees.  A September 30 measurement date is utilized to value plan assets and obligations for all of Woodward’s defined benefit pension and other postretirement benefit plans.

U.S. GAAP requires that, for obligations outstanding as of September 30, 2016, the funded status reported in interim periods shall be the same asset or liability recognized in the previous year end statement of financial position adjusted for (a) subsequent accruals of net periodic benefit cost that exclude the amortization of amounts previously recognized in other comprehensive income (for example, subsequent accruals of service cost, interest cost, and return on plan assets) and (b) contributions to a funded plan or benefit payments.

During the third quarter of fiscal year 2016, Woodward opened a lump-sum buy-out window, which closed in the fourth quarter of fiscal year 2016 and was fully settled during the first quarter of fiscal year 2017, for certain former U.S. employees and/or their dependents eligible to receive postretirement defined benefit pension payments for past employment services to the Company.  Eligible pension plan participants elected to receive a one-time lump-sum payment or an immediate annuity in lieu of future pension benefit payments.  Pension benefit payments paid from available pension plan assets under the lump-sum buy-out options were $670 during the first nine-months of fiscal year 2017.  Woodward expects to make no further pension benefit payments under the lump-sum buy-out options.

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The components of the net periodic retirement pension costs recognized are as follows:







The components of the net periodic other postretirement benefit costs recognized are as follows:







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The amount of cash contributions made to these plans in any year is dependent upon a number of factors, including minimum funding requirements in the jurisdictions in which Woodward operates and arrangements made with trustees of certain foreign plans.  As a result, the actual funding in fiscal year 2017 may differ from the current estimate.  Woodward estimates its remaining cash contributions in fiscal year 2017 will be as follows:









Multiemployer defined benefit plans

Woodward operates multiemployer defined benefit plans for certain employees in both the Netherlands and Japan.  The amounts of contributions associated with the multiemployer plans were as follows:



 

Note 19.  Stockholders’ equity

Stock repurchase program

In the first quarter of fiscal year 2017, Woodward’s Board of Directors terminated the Company’s prior stock repurchase program (the “Prior Repurchase Program”) and replaced it with a new program for the repurchase of up to $500,000 of Woodward’s outstanding shares of common stock on the open market or in privately negotiated transactions over a three-year period that will end in 2019 (the “2016 Authorization”).  Under the 2016 Authorization, in the first nine-months of fiscal year 2017, Woodward purchased 886 shares of its common stock for $61,229, of which 350 shares were purchased pursuant to a 10b5-1 plan and 536 shares were purchased pursuant to a 10b-18 plan.

Under the Prior Repurchase Program, in the first quarter of fiscal year 2016, Woodward executed a 10b5-1 plan to repurchase up to $125,000 of its common stock for a period that ended on April 20, 2016.  During the first nine-months of fiscal year 2016, Woodward purchased 2,635 shares of its common stock for $125,000.

Stock-based compensation

Provisions governing outstanding stock option awards are included in the 2006 Omnibus Incentive Plan (the “2006 Plan”) and the 2002 Stock Option Plan (the “2002 Plan”).  The 2002 Plan provided that no further grants would be made after December 31, 2006.  The 2006 Plan, which was approved by Woodward’s stockholders and became effective January 25, 2006, expired in fiscal year 2016, therefore, no further grants will be made under the 2006 Plan. 

Woodward has reserved a total of 2,000 shares of Woodward’s common stock for issuance under the 2017 Omnibus Incentive Plan (the “2017 Plan”), which was approved by Woodward’s stockholders in January 2017 and is a successor plan to the 2006 Plan.  As of September 14, 2016, the effective date of the 2017 Plan, Woodward’s Board of Directors delegated authority to administer the 2017 Plan to the compensation committee of the board (the “Committee”), including, but not limited to, the power to determine the recipients of awards and the terms of those awards.  The Committee approved issuance of options under the 2017 Plan, with an award date of October 3, 2016 conditional and subject to approval of the 2017 Plan by the stockholders.  The stock options conditionally awarded under the 2017 Plan were not granted or outstanding for accounting purposes prior to stockholder approval of the 2017 Plan, and as such no stock-based compensation expense was recognized on these stock options during the three-months ended December 31, 2016.  Stock-based compensation expense recognized on these stock options for the six-months ended June 30, 2017 includes recognition of the elapsed service period of these stock options from October 3, 2016 through June 30, 2017.

Stock options

To date equity awards under the 2017 Plan have consisted of grants of stock options to Woodward’s employees and directors.  Woodward believes that these stock options align the interests of its employees and directors with the interests of its stockholders.  Stock option awards are granted with an exercise price equal to the market price of Woodward’s stock at the date the grants are awarded, a ten-year term, and generally a four-year vesting schedule at a rate of 25% per year.

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The date of grant for stock options is the date when the grants become unconditionally awarded and an employer and grantee reach a mutual understanding of the key terms and conditions of the grant.  Stock options awarded as of October 3, 2016 were conditional and subject to the approval of the 2017 Plan by the stockholders.  As such, those awards have a date of grant for accounting purposes of January 25, 2017, the date the 2017 Plan was approved by stockholders.  The fair value of options granted is estimated as of that same date using the Black-Scholes-Merton option-valuation model using the assumptions in the following table.  Woodward calculates the expected term, which represents the average period of time that stock options granted are expected to be outstanding, based upon historical experience of plan participants.  Expected volatility is based on historical volatility using daily stock price observations.  The estimated dividend yield is based upon Woodward’s historical dividend practice and the market value of its common stock.  The risk-free rate is based on the U.S. treasury yield curve, for periods within the contractual life of the stock option, at the time of grant.









The following is a summary of the activity for stock option awards during the three and nine-months ended June 30, 2017:







Changes in non-vested stock options during the three and nine-months ended June 30, 2017 were as follows:





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Information about stock options that have vested, or are expected to vest, and are exercisable at June 30, 2017 was as follows: 



Restricted Stock

In the first quarter of fiscal year 2014, Woodward granted an award of 24 shares of restricted stock under the 2006 Plan to its Chief Executive Officer and President, Thomas A. Gendron, pursuant to a form restricted stock agreement approved by Woodward’s Compensation Committee of the Board of Directors.  Subject to Mr. Gendron’s continued employment by the Company, 100% of these shares of restricted stock would vest following the end of the Company’s fiscal year 2017 if a specified cumulative earnings per share (“EPS”) target is met or exceeded for fiscal years 2014 through 2017.  If this EPS target is not met for that period, all shares of restricted stock will be forfeited by Mr. Gendron.  During the second quarter of fiscal year 2017, Woodward determined it is not probable that the restricted shares will vest. 

A summary of the activity for restricted stock awards in the three and nine-months ended June 30, 2017 follows:



Stock-based compensation cost

Woodward recognizes stock-based compensation expense on a straight-line basis over the requisite service period.  Pursuant to form stock option agreements used by the Company, with terms approved by the administrator of the applicable plan, the requisite service period can be less than the four-year vesting period based on grantee’s retirement eligibility.  As such, the recognition of stock-based compensation expense associated with some stock option grants can be accelerated to a period of less than four years, including immediate recognition of stock-based compensation expense on the date of grant.

At June 30, 2017, there was approximately $11,047 of total unrecognized compensation expense related to non-vested stock-based compensation arrangements, both stock options and restricted stock awards, granted under the 2006 Plan (for which no further grants will be made) and stock options granted under the 2017 Plan.  The pre-vesting forfeiture rates for purposes of determining stock-based compensation expense recognized were estimated to be 0% for members of Woodward’s board of directors and 9% for all others.  The remaining unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately 2.1 years.

 

Note 20.  Commitments and contingencies

Woodward is currently involved in claims, pending or threatened litigation or other legal proceedings, investigations and/or regulatory proceedings arising in the normal course of business, including, among others, those relating to product liability claims, employment matters, worker’s compensation claims, contractual disputes, product warranty claims and alleged violations of various laws and regulations.  Woodward accrues for known individual matters where it believes that it is probable the matter will result in a loss when ultimately resolved using estimates of the most likely amount of loss.  

Legal costs are expensed as incurred and are classified in “Selling, general and administrative expenses” on the Condensed Consolidated Statements of Earnings.

Woodward is partially self-insured in the United States for healthcare and worker’s compensation up to predetermined amounts, above which third party insurance applies.  Management regularly reviews the probable outcome of these claims and proceedings, the expenses expected to be incurred, the availability and limits of the insurance coverage, and the established accruals for liabilities.

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While the outcome of pending claims, legal and regulatory proceedings, and investigations cannot be predicted with certainty, management believes that any liabilities that may result from these claims, proceedings and investigations will not have a material effect on Woodward's liquidity, financial condition, or results of operations.

In the event of a change in control of Woodward, as defined in change-in-control agreements with its current corporate officers, Woodward may be required to pay termination benefits to such officers.

 

Note 21.  Segment information

Woodward serves the aerospace, industrial and energy markets through its two reportable segments - Aerospace and Industrial.  When appropriate, Woodward’s reportable segments are aggregations of Woodward’s operating segments.  Woodward uses operating segment information internally to manage its business, including the assessment of operating segment performance and decisions for the allocation of resources between operating segments.

The accounting policies of the reportable segments are the same as those of the Company.  Woodward evaluates segment profit or loss based on internal performance measures for each segment in a given period.  In connection with that assessment, Woodward generally excludes matters such as certain charges for restructuring costs, interest income and expense, certain gains and losses from asset dispositions, or other non-recurring and/or non-operationally related expenses. 

A summary of consolidated net sales and earnings by segment follows:





Segment assets consist of accounts receivable, inventories, property, plant, and equipment, net, goodwill, and other intangibles, net.  A summary of consolidated total assets by segment follows:





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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations (Amounts in thousands, except per share amounts)



Forward Looking Statements

This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results within the meaning of the Private Securities Litigation Reform Act of 1995.  All statements other than statements of historical fact are statements that are deemed forward-looking statements.  These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of management.  Words such as “anticipate,” “believe,” “estimate,” “seek,” “goal,” “expect,” “forecast,” “intend,” “continue,” “outlook,” “plan,” “project,” “target,” “strive,” “can,” “could,” “may,” “should,” “will,” “would,” variations of such words, and similar expressions are intended to identify such forward-looking statements.  In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characteristics of future events or circumstances are forward-looking statements.  Forward-looking statements may include, among others, statements relating to:

Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including:

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These factors are representative of the risks, uncertainties, and assumptions that could cause actual outcomes and results to differ materially from what is expressed or forecast in our forward-looking statements.  Other factors are discussed under the caption “Risk Factors” in Part I, Item 1A in our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) (our “Form 10-K”), as updated from time to time in our subsequent SEC filings.  We undertake no obligation to revise or update any forward-looking statements for any reason.

Unless we have indicated otherwise or the context otherwise requires, references in this Quarterly Report on Form 10-Q (this “Form 10-Q”) to “Woodward,” “the Company,” “we,” “us,” and “our” refer to Woodward, Inc. and its consolidated subsidiaries. 

Except where we have otherwise indicated or the context otherwise requires, amounts presented in this Form 10-Q are in thousands, except per share amounts.

This discussion should be read together with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our most recent Form 10-K and the Condensed Consolidated Financial Statements and Notes included therein and in this report.

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OVERVIEW

Operational Highlights

Third Quarter Highlights

Net sales for the third quarter of fiscal year 2017 were $548,622, an increase of $40,958, or 8.1% from $507,664 for the third quarter of the prior year.  Aerospace segment sales for the third quarter of fiscal year 2017 were up $47,410, or 15.4% to $355,992, compared to $308,582 for the third quarter of the prior fiscal year.  Industrial segment sales for the third quarter of fiscal year 2017 were down $6,452, or 3.2% to $192,630, compared to $199,082 for the third quarter of the prior fiscal year. 

Net earnings for the third quarter of fiscal year 2017 were $53,626, or $0.85 per diluted share, an increase of $2,579, compared to $51,047, or $0.81 per diluted share, for the third quarter of fiscal year 2016. 

The effective tax rate in the third quarter of fiscal year 2017 was 21.9%, compared to 19.5% for the third quarter of the prior fiscal year.

Earnings before interest and taxes (“EBIT”) for the third quarter of fiscal year 2017 were $75,098, up 8.3% from $69,320 in the third quarter of fiscal year 2016.  Earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the third quarter of fiscal year 2017 were  $95,678, up 10.5% from $86,620 for the third quarter of fiscal year 2016. 

Aerospace segment earnings as a percent of segment net sales increased to 18.9% in the third quarter of fiscal year 2017 from 18.7% in the third quarter of the prior fiscal year.  Industrial segment earnings as a percent of segment net sales decreased to 10.8% in the third quarter of fiscal year 2017 from 11.0% in the third quarter of the prior fiscal year.

Year to Date Highlights

Net sales for the first nine months of fiscal year 2017 were $1,491,897, an increase of 4.2% from $1,432,156 for the first nine months of the prior fiscal year.  Aerospace segment sales for the first nine months of fiscal year 2017 were up 8.7% to $943,198, compared to $867,871 for the first nine months of the prior fiscal year.  Industrial segment sales for the first nine months of fiscal year 2017 were down 2.8% to $548,699 compared to $564,285 for the first nine months of the prior fiscal year.

Net earnings for the first nine months of fiscal year 2017 were $138,279, or $2.18 per diluted share, an increase of $20,588, or 17.5% compared to $117,691, or $1.85 per diluted share, for the first nine months of fiscal year 2016.  Net earnings for the first nine months of fiscal year 2016 included approximately $9,900 ($16,100 pre-tax), or $0.16 per diluted share, of special charges related to our initiatives to consolidate facilities, reduce costs and address market conditions.

The effective tax rate in the first nine months of fiscal year 2017 was 16.7%, compared to 19.2% for the first nine months of the prior fiscal year.

EBIT for the first nine months of fiscal year 2017 was $185,144, up 13.0% from $163,896 in the same period of fiscal year 2016.  EBITDA for the first nine months of fiscal year 2017 was $244,731, up 14.5% from $213,817 for the same period of fiscal year 2016.  EBIT and EBITDA for the first nine months of fiscal year 2016 include the special charges of approximately $16,100 discussed above.

Aerospace segment earnings as a percent of segment net sales increased to 18.3% in the first nine months of fiscal year 2017 from 17.5% in the prior fiscal year.  Industrial segment earnings as a percent of segment net sales decreased to 10.2% in the first nine months of fiscal year 2017 from 11.2% in the prior fiscal year.

Liquidity Highlights

Net cash provided by operating activities for the first nine months of fiscal year 2017 was $183,798, compared to $362,481 for the first nine months of fiscal year 2016.  Net cash provided by operating activities for the first nine months of fiscal year 2016 included $202,395 of after-tax proceeds related to the formation of a strategic joint venture (the “JV”) between Woodward and General Electric Company (the “JV Proceeds”).  For further discussion of the JV, see Note 4, Joint venture in the Notes to the Condensed Consolidated Financial Statements in Part I, Item I of this Form 10-Q.

For the first nine months of fiscal year 2017, adjusted free cash flow, which we define as net cash flows provided by operating activities less payments for property, plant and equipment and less the net after-tax JV Proceeds, was $118,723, compared to $31,458 for the first nine months of fiscal year 2016.  The increase is primarily attributable to lower payments for property, plant and equipment and higher net earnings in the first nine months of fiscal year 2017 as compared to the first nine months of fiscal year 2016.

At June 30, 2017, we held $89,002 in cash and cash equivalents, and had total outstanding debt of $691,078 with additional borrowing availability of $873,189, net of outstanding letters of credit, under our revolving credit agreement.  At

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June 30, 2017, we had additional borrowing capacity of $7,529 under various foreign lines of credit and foreign overdraft facilities. 



RESULTS OF OPERATIONS

The following table sets forth selected consolidated statements of earnings data as a percentage of net sales for each period indicated:



Other select financial data:













Net Sales

Consolidated net sales for the third quarter of fiscal year 2017 increased by $40,958, or 8.1%, compared to the same period of fiscal year 2016.  Consolidated net sales for the first nine months of fiscal year 2017 increased by $59,741, or 4.2%, compared to the same period of fiscal year 2016.  Details of the changes in consolidated net sales are as follows:



The increase in net sales for the third quarter and first nine months of fiscal year 2017 was primarily attributable to increased defense original equipment manufacturer (“OEM”) sales and increased commercial aftermarket and OEM sales in the Aerospace segment,  partially offset by decreased industrial gas turbine aftermarket and OEM sales and wind turbine converter sales in our Industrial segment.

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Costs and Expenses

Costs and expenses for the first nine months of fiscal year 2016 included special charges totaling approximately $16,100 ($13,300 included in cost of goods sold, $1,700 included in selling, general and administrative expenses, and $1,100 included in research and development costs) related to our efforts to consolidate facilities, reduce costs and address current market conditions in fiscal year 2016.  There were no comparable costs and expenses recorded in the first nine months of fiscal year 2017.

Cost of goods sold increased by $22,080 to $392,802, or 71.6% of net sales, for the third quarter of fiscal year 2017 from $370,722, or 73.0% of net sales, for the third quarter of fiscal year 2016.  Cost of goods sold increased by  $34,914 to $1,085,152 or 72.7% of net sales, for the first nine months of fiscal year 2017 from $1,050,238, or 73.3% of net sales, for the first nine months of fiscal year 2016.  The increase in cost of goods sold for the third quarter and first nine months of fiscal year 2017 as compared to the same periods of fiscal year 2016 is primarily attributable to higher sales volume and planned facility ramp-up costs in our Aerospace segment.  The increase for the first nine months of fiscal year 2017 also included planned new facility expenses for our new Colorado facilities.  The increase for the nine months year-over-year was partially offset by the inclusion of special charges in the first nine months of fiscal year 2016 of approximately $13,300, as described above, for which no such similar charge was recorded in fiscal year 2017.

Gross margin (as measured by net sales less cost of goods sold, divided by net sales) was 28.4% for the third quarter of fiscal year 2017, compared to 27.0% for the third quarter of fiscal year 2016.  Gross margin for the third quarter of fiscal year 2017 was higher as compared to the third quarter of fiscal year 2016 due to fixed cost leverage on higher sales volume in our Aerospace segment partially offset by planned facility ramp-up costs in our Aerospace segment.

Gross margin was 27.3% for the first nine months of fiscal year 2017, compared to 26.7% for the first nine months of fiscal year 2016.  The increase in gross margin for the first nine months of fiscal year 2017 as compared to the first nine months of fiscal year 2016, was due to the inclusion in cost of goods sold of approximately $13,300 of special charges in the first nine months of fiscal year 2016 and fixed cost leverage on higher sales volume in our Aerospace segment, partially offset by planned facility ramp-up costs for the current year period in both our Aerospace and Industrial segments.

Selling, general, and administrative expenses increased by $3,655, or 10.0%, to $40,070 for the third quarter of fiscal year 2017 as compared to $36,415 for the third quarter of fiscal year 2016.  Selling, general, and administrative expenses as a percentage of net sales was 7.3% for the third quarter of fiscal year 2017 as compared to 7.2% for the third quarter of fiscal year 2016.  Selling, general, and administrative expenses increased by $3,018, or 2.6%, to $117,038 for the first nine months of fiscal year 2017 as compared to $114,020 for the first nine months of fiscal year 2016.  Selling, general, and administrative expenses as a percentage of net sales was 7.8% for the first nine months of fiscal year 2017, as compared to 8.0% for the first nine months of fiscal year 2016.  The increase in selling, general and administrative expenses for the third quarter and first nine months of fiscal year 2017 compared to the same periods of the prior fiscal year was primarily due to timing differences in the recognition of various expenses, partially offset by savings associated with cost reduction initiatives previously implemented.  In addition, the first nine months of fiscal year 2016 included special charges of approximately $1,700, described above, recorded in the first quarter of fiscal year 2016.    

Research and development costs increased by $4,735, or 15.8%, to $34,663 for the third quarter of fiscal year 2017, as compared to $29,928 for the third quarter of fiscal year 2016.  Research and development costs increased as a percentage of net sales to 6.3% for the third quarter of fiscal year 2017, as compared to 5.9% for the third quarter of fiscal year 2016.  Research and development costs decreased by $1,699, or 1.8%, to $91,588 for the first nine months of fiscal year 2017, as compared to $93,287 for the first nine months of fiscal year 2016.  Research and development costs decreased as a percentage of net sales to 6.1% for the first nine months of fiscal year 2017, as compared to 6.5% for the first nine months of fiscal year 2016.  Research and development costs in the third quarter of fiscal year 2017 were higher due to variability in the timing of projects and expenses.  Research and development costs in the first nine months of fiscal year 2017 were lower due primarily to the inclusion in the first quarter of fiscal year 2016 of the special charges of approximately $1,100 described above.  Our research and development activities extend across almost all of our customer base, and we anticipate ongoing variability in research and development due to the timing of customer business needs on current and future programs.

Amortization of intangible assets decreased to $6,439 for the third quarter and $19,328 for the first nine months of fiscal year 2017, compared to $6,887 for the third quarter and $20,759 for the first nine months of fiscal year 2016.  As a percentage of net sales, amortization of intangible assets was 1.2% for the third quarter and 1.3% for the first nine months of fiscal year 2017, as compared to 1.4% for both the third quarter and first nine months of fiscal year 2016.  The decrease in amortization expense was primarily related to certain intangible assets becoming fully amortized during fiscal year 2016.

Interest expense was $6,769, or 1.2% of net sales, for the third quarter and $20,399, or 1.4% of net sales for the first nine months of fiscal year 2017, compared to $6,522, or 1.3% of net sales, for the third quarter and $19,664, or 1.4% for the first nine months of fiscal year 2016.  The slight increase in interest expense is primarily attributable to lower amounts of capitalized interest in the third quarter and first nine months of fiscal year 2017 as compared to the third quarter and first nine

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months of fiscal year 2016, as capital projects have been completed, partially offset by a decrease in higher interest debt due to the retirement of $57,000 of 7.81% Series E notes in fiscal year 2016. 

Income taxes were provided at an effective rate on earnings before income taxes of 21.9% for the third quarter and 16.7% for the first nine months of fiscal year 2017, compared to 19.5% for the third quarter and 19.2% for the first nine months of fiscal year 2016.  The changes in components of our effective tax rate (as a percentage of earnings before income taxes) were attributable to the following:

The increase in the year-over-year effective tax rate for the third quarter of fiscal year 2017 is primarily attributable to a smaller favorable adjustment for the net excess income tax benefits from stock-based compensation in the current quarter.  This increase in the year-over-year effective tax rate was partially offset by larger net favorable resolutions of tax matters in the current quarter compared to the prior year quarter. 

The decrease in the year-over-year effective tax rate for the nine-months ended June 30, 2017 is primarily attributable to the impact of the repatriation to the U.S. of certain net foreign profits and losses in the first quarter of fiscal year 2017.  The U.S. foreign tax credits available as a result of the repatriation of the foreign net earnings were greater than the U.S. taxes payable on these net foreign earnings.  The excess U.S. foreign tax credits are expected to be used to offset U.S. taxes on other foreign source income.  The decrease in the year-over-year effective tax rate for the nine-month period was also attributable to larger favorable resolutions of tax matters in the current fiscal year compared to the prior fiscal year.  This combined decrease was partially offset by a smaller favorable adjustment for the net excess income tax benefit from stock-based compensation in the current fiscal year and the retroactive benefit of the U.S. research and experimentation credit pursuant to the December 18, 2015 enactment of the Protecting Americans from Tax Hikes Act of 2015, which was included in the effective tax rate for the first quarter of fiscal year 2016, but did not repeat in fiscal year 2017.

Segment Results

The following table presents sales by segment:



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The following table presents earnings by segment:





The following table presents earnings by segment as a percent of segment net sales:



Aerospace

Aerospace segment net sales were $355,922 for the third quarter of fiscal year 2017, up 15.4% compared to $308,582 for the same period of fiscal year 2016.  Aerospace segment net sales were $943,198 for the first nine months of fiscal year 2017, up 8.7% compared to $867,871 for the same period of fiscal year 2016.  The increase in segment net sales for the third quarter and first nine months of fiscal year 2017 as compared to the same period of fiscal year 2016 was driven primarily by increased defense OEM sales and increased commercial aftermarket and OEM sales in fiscal year 2017.  Defense aftermarket sales were flat year over year for the quarter, but up on a year-to-date basis as compared to the prior year. 

U.S. government funds continue to be prioritized for defense platforms on which we have content.  Defense OEM sales continued to increase in the third quarter and first nine months of fiscal year 2017, driven by sales of smart weapons, as demand has remained strong.  Defense aftermarket sales were flat in the third quarter of fiscal year 2017 and increased on a year-to-date basis as compared to the same periods of the prior fiscal year, reflecting variability in the timing of continued maintenance needs and upgrade programs.  

Commercial aftermarket sales increased significantly in the third quarter and first nine months of fiscal year 2017 as compared to the same periods of the prior fiscal year, benefitting from both the initial provisioning for new platforms and increased utilization of existing fleets. 

Commercial OEM sales were up for the third quarter and first nine months of fiscal year 2017 as compared to the third quarter and first nine months of fiscal year 2016 due to next generation aircraft programs driving strong commercial OEM sales, reflecting the increased production of certain next generation aircraft on which Woodward has increased content, partially offset by continuing weakness in business jets and rotorcraft. 

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Aerospace segment earnings increased by $9,447, or 16.4%, to $67,173 for the third quarter of fiscal year 2017, compared to $57,726 for the third quarter of fiscal year 2016.  Aerospace segment earnings increased by $20,487, or 13.5%, to $172,277 for the first nine months of fiscal year 2017, compared to $151,790 for the first nine months of fiscal year 2016.  The change in Aerospace segment earnings for the third quarter and first nine months of fiscal year 2017 were due to the following:





Aerospace segment earnings as a percentage of segment net sales were 18.9% for the third quarter and 18.3% for the first nine months of fiscal year 2017, compared to 18.7% for the third quarter and 17.5% for the first nine months of fiscal year 2016.  The increase in aerospace segment earnings was primarily attributable to higher sales volume, partially offset by new facility costs, lower JV earnings and the timing of various other costs.



Industrial

Industrial segment net sales decreased by 3.2% to $192,630 for the third quarter of fiscal year 2017, compared to $199,082 for the third quarter of fiscal year 2016.  Segment net sales were $548,699 for the first nine months of fiscal year 2017, down 2.8% compared to $564,285 for the same period of fiscal year 2016.  Industrial gas turbine aftermarket and OEM sales and wind turbine converter sales declined in both the third quarter and first nine months of fiscal year 2017 as compared to the same periods of the prior fiscal year due to macroeconomic activity tempering demand for industrial gas turbines and unfavorable regional dynamics in the wind turbine market.  Sales of fuel systems for Compressed Natural Gas (“CNG”) trucks in Asia increased in both the third quarter and first nine months of fiscal year 2017 as compared to the same periods of fiscal year 2016 as the Chinese government continues to encourage natural gas usage.  In addition, reciprocating engine power generation applications were up in both the third quarter and first nine months of fiscal year 2017 as compared to the same periods of the prior year.

Industrial segment earnings  decreased by $1,093, or 5.0%, to $20,870 for the third quarter of fiscal year 2017, compared to $21,963 for the third quarter of fiscal year 2016. Segment earnings decreased by $7,026, or 11.2% to $55,957 for the first nine months of fiscal year 2017 compared to $62,983 for the same period of 2016.  The net decrease in Industrial segment earnings for the third quarter and first nine months of fiscal year 2017 was due to the following:





Industrial segment earnings as a percentage of sales were 10.8% for the third quarter and 10.2% for the first nine months of fiscal year 2017, compared to 11.0% for the third quarter and 11.2% for the first nine months of fiscal year 2016.  The decrease in segment earnings for the third quarter of fiscal year 2017 as compared to the same period of fiscal year 2016 was driven by the impact of lower sales volume.    The decrease in segment earnings for the first nine months of fiscal year 2017 as compared to the same period of fiscal year 2016 was driven by the impact of lower sales volume, unfavorable sales mix, the

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planned increase in new facility costs, and unfavorable changes in exchange rates, which were partially offset by the savings associated with significant cost reduction initiatives previously implemented.

Nonsegment expenses

Nonsegment expenses increased to $12,945 for the third quarter of fiscal year 2017, compared to $10,369 for the third quarter of fiscal year 2016.  As a percent of consolidated net sales, nonsegment expenses increased to 2.4% of consolidated net sales for the third quarter of fiscal year 2017, compared to 2.0% of consolidated net sales for the third quarter of fiscal year 2016.  The increase in nonsegment expenses in the third quarter of fiscal year 2017 is primarily due to timing differences in the recognition of various expenses.     

Nonsegment expenses decreased to $43,090 for the first nine months of fiscal year 2017, compared to $50,877 for the first nine months of fiscal year 2016.  As a percent of consolidated net sales, nonsegment expenses were 2.9% of consolidated net sales for the first nine months of fiscal year 2017, compared to 3.6% of consolidated net sales for the first nine months of fiscal year 2016.  The decrease in nonsegment expenses in the first nine months of fiscal year 2017 as compared to the first nine months of fiscal year 2016 is due to special charges taken in the first quarter  of fiscal year 2016 totaling approximately $16,100 related to our efforts to consolidate facilities, reduce costs and address market conditions, which did not recur in the first nine months of fiscal year 2017, partially offset by timing differences in the recognition of various expenses. 





LIQUIDITY AND CAPITAL RESOURCES

Historically, we have satisfied our working capital needs, as well as capital expenditures, product development and other liquidity requirements associated with our operations, with cash flow provided by operating activities and borrowings under our credit facilities.  Historically, we have also issued debt to supplement our cash needs or repay our other indebtedness.  We expect that cash generated from our operating activities, together with borrowings under our revolving credit facility, will be sufficient to fund our continuing operating needs, including capital expansion funding for the foreseeable future.

Our aggregate cash and cash equivalents were $89,002 at June 30, 2017 and $81,090 at September 30, 2016, and our working capital was $528,297 at June 30,  2017 and $463,811 at September 30, 2016.  Of the $89,002 of cash and cash equivalents held at June 30, 2017, $86,576 was held by our foreign locations.  We are not presently aware of any significant restrictions on the repatriation of these funds, although a portion is considered indefinitely reinvested in these foreign subsidiaries.  If these funds were needed to fund our operations or satisfy obligations in the United States, then they could be repatriated and their repatriation into the United States may cause us to incur additional U.S. income taxes or foreign withholding taxes.  Any additional U.S. taxes could be offset, in part or in whole, by foreign tax credits.  The amount of such taxes and application of tax credits would be dependent on the income tax laws and other circumstances at the time these amounts are repatriated.  Based on these variables, it is impractical to determine the income tax liability that might be incurred if these funds were to be repatriated.

Consistent with business practice common in China, our Chinese subsidiary accepts bankers’ acceptance notes from Chinese customers, in settlement of certain customer accounts receivable.  Bankers’ acceptance notes are financial instruments issued by Chinese financial institutions as part of financing arrangements between the financial institution and a customer of the financial institution.  Bankers’ acceptance notes represent a commitment by the issuing financial institution to pay a certain amount of money at a specified future maturity date to the legal owner of the bankers’ acceptance note as of the maturity date.  The maturity date of bankers’ acceptance notes varies, but it is our policy to only accept bankers’ acceptance notes with maturity dates no more than 180 days from the date of our receipt of such draft.  The issuing financial institution is the obligor, not our customers.  Upon our acceptance of a bankers’ acceptance note from a customer, such customer has no further obligation to pay us for the related accounts receivable balance.  We had bankers’ acceptance notes of $21,119 at June 30, 2017 and $5,093 at September 30, 2016 recorded as non-customer accounts receivable on our consolidated balance sheets.  The increase in the amount of bankers’ acceptance notes is due to the higher sales of natural gas truck systems in China.  We only accept bankers’ acceptance notes issued by banks that are believed to be creditworthy as to which the credit risk associated with the bankers’ acceptance note is believed to be low.

Our revolving credit facility matures in April 2020 and provides a borrowing capacity of up to $1,000,000 with the option to increase total available borrowings to up to $1,200,000, subject to lenders’ participation.  We can borrow against our $1,000,000 revolving credit facility as long as we are in compliance with all of our debt covenants.  Historically, we have used borrowings under our revolving credit facilities to meet certain short-term working capital needs, as well as for strategic uses, including repurchases of our common stock, payments of dividends, acquisitions, and facilities expansions.  In addition, we have various foreign credit facilities, some of which are tied to net amounts on deposit at certain foreign financial institutions.  These foreign credit facilities are reviewed annually for renewal.  We use borrowings under these foreign credit facilities to finance certain local operations on a periodic basis.  For further discussion of our $1,000,000 revolving credit facility and our other credit facilities, see Note 13, Credit facilities, short-term borrowings and long-term debt in the Notes to the Condensed Consolidated Financial Statements in Part I, Item I of this Form 10-Q.

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At June 30, 2017, we had total outstanding debt of $691,078 consisting of amounts borrowed under our revolving credit facility and various series of unsecured notes due between 2018 and 2031, with additional borrowing availability of $873,189 under our revolving credit facility, net of outstanding letters of credit, and additional borrowing availability of $7,529 under various foreign credit facilities.  For further discussion of our notes, see Note 13, Credit facilities, short-term borrowings and long-term debt in the Notes to the Condensed Consolidated Financial Statements in Part I, Item I of this Form 10-Q. 

At June 30, 2017, we had $116,900 of borrowings outstanding under our revolving credit facility, all of which was classified as short-term.    Revolving credit facility and short-term borrowing activity during the nine-months ended June 30, 2017 were as follows:



We believe we were in compliance with all our debt covenants as of June 30, 2017.  See Note 13, Credit facilities, short-term borrowings and long-term debt in the Notes to the Consolidated Financial Statements in Part II, Item 8 of our most recent 10-K, for more information about our covenants.

In addition to utilizing our cash resources to fund the working capital needs of our business, we evaluate additional strategic uses of our funds, including the repurchase of our common stock, payment of dividends, significant capital expenditures, consideration of strategic acquisitions and other potential uses of cash.

Our ability to service our long-term debt, to remain in compliance with the various restrictions and covenants contained in our debt agreements, and to fund working capital, capital expenditures and product development efforts will depend on our ability to generate cash from operating activities, which in turn is subject to, among other things, future operating performance as well as general economic, financial, competitive, legislative, regulatory, and other conditions, some of which may be beyond our control.

In the first quarter of fiscal year 2017, our Board of Directors terminated the Company’s prior stock repurchase program and replaced it with a new program for the repurchase of up to $500,000 of Woodward’s outstanding shares of common stock on the open market or in privately negotiated transactions over a three-year period that will end in 2019 (the “2016 Authorization”).  In the first nine months of fiscal year 2017, we purchased 886 shares of our common stock for $61,229, of which 350 shares were purchased pursuant to a 10b5-1 plan and 536 were purchased pursuant to a 10b-18 plan.

For our Aerospace segment, in fiscal year 2015 we completed construction of a manufacturing and office building on a second campus in the greater-Rockford, Illinois area.  This campus is intended to support the expected growth in our Aerospace segment over the next ten years and beyond, as a result of our being awarded a substantial number of new system platforms, particularly on narrow-body aircraft.  We have been purchasing production equipment for the second campus and anticipate continuing such purchases as new aircraft platforms ramp up to full production volumes.  

We believe that cash flows from operations, along with our contractually committed borrowings and other borrowing capability, will continue to be sufficient to fund anticipated capital spending requirements and our operations for the foreseeable future.  However, we could be adversely affected if the financial institutions providing our capital requirements refuse to honor their contractual commitments, cease lending, or declare bankruptcy.  We believe the lending institutions participating in our credit arrangements are financially stable.

Cash Flows

Net cash flows provided by operating activities for the first nine months of fiscal year 2017 was $183,798, compared to $362,481 for the same period of fiscal year 2016.  Net cash provided by operating activities for the first nine months of fiscal

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year 2016 included net after-tax JV Proceeds of $202,395.  Excluding the net after-tax JV Proceeds, the remaining increase in net cash provided by operating activities is primarily attributable to increased net earnings.

Net cash flows used in investing activities for the first nine months of fiscal year 2017 was $63,720, compared to $122,881 in the first nine months of fiscal year 2016.  The decrease in cash used in investing activities compared to the same period of the prior fiscal year is due primarily to decreased payments for capital expenditures.  Payments for property, plant and equipment decreased by $63,553 to $65,075 in the first nine months of fiscal year 2017 as compared to $128,628 in the first nine months of fiscal year 2016 related mainly to lower equipment purchases associated with the our aerospace segment facility in the greater-Rockford, Illinois area and completion of our Industrial segment facility in Fort Collins, Colorado.

Net cash flows used in financing activities for the first nine months of fiscal year 2017 was $111,411, compared to $200,635 in the first nine months of fiscal year 2016.  During the first nine months of fiscal year 2017, we had net debt payments of $39,800 compared to net debt payments of $67,784 in the first nine months of fiscal year 2016.  We utilized $61,229 to repurchase 886 shares of our common stock in the first nine months of fiscal year 2017 under the 2016 Authorization, compared to $125,000 to repurchase 2,635 shares of our common stock, under the then existing stock repurchase program, in the first nine months of fiscal year 2016.

Contractual Obligations

We have various contractual obligations, including obligations related to long-term debt, operating and capital leases, purchases, retirement pension benefit plans, and other postretirement benefit plans.  These contractual obligations are summarized and discussed more fully in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our most recent Form 10-K.  There have been no material changes to our various contractual obligations during the first nine months of fiscal year 2017.



NON-GAAP MEASURES

EBIT,  EBITDA, free cash flow, and adjusted free cash flow are financial measures not prepared and presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  However, we believe these non-U.S. GAAP financial measures provide additional information that enables readers to evaluate our business from the perspective of management.

Earnings based non-U.S. GAAP financial measures

Management uses EBIT to evaluate Woodward’s performance without financing and tax related considerations, as these elements may not fluctuate with operating results.  Management uses EBITDA in evaluating Woodward’s operating performance, making business decisions, including developing budgets, managing expenditures, forecasting future periods, and evaluating capital structure impacts of various strategic scenarios.  Securities analysts, investors and others frequently use EBIT and EBITDA in their evaluation of companies, particularly those with significant property, plant, and equipment, and intangible assets subject to amortization.

EBIT and EBITDA for the three and nine-months ended June 30, 2017 and June 30, 2016 were as follows:



The use of these non-U.S. GAAP financial measures is not intended to be considered in isolation of, or as a substitute for, the financial information prepared and presented in accordance with U.S. GAAP.  As EBIT and EBITDA exclude certain financial information compared with net earnings, the most comparable U.S. GAAP financial measure, users of this financial information should consider the information that is excluded.  Our calculations of EBIT and EBITDA may differ from similarly titled measures used by other companies, limiting their usefulness as comparative measures.

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Cash flow-based non-U.S. GAAP financial measures    

Management uses free cash flow, which is defined by the Company as net cash flows provided by operating activities less payments for property, plant and equipment, as well as adjusted free cash flow, which is defined by the Company as free cash flow less the net after-tax JV Proceeds, in reviewing the financial performance of Woodward’s various business groups and evaluating cash levels.  We believe free cash flow and adjusted free cash flow are useful measures for investors because they portray our ability to generate cash from our businesses for purposes such as paying interest on our indebtedness, repaying maturing debt, funding business acquisitions, purchasing our common stock, and paying dividends.  In addition, securities analysts, investors, and others frequently use free cash flow in their evaluation of companies.  The use of these non-U.S. GAAP financial measures is not intended to be considered in isolation of, or as substitutes for, the financial information prepared and presented in accordance with U.S. GAAP.  Neither free cash flow nor adjusted free cash flow necessarily represent funds available for discretionary use, and neither is necessarily a measure of our ability to fund our cash needs.  In particular, the gross proceeds received in connection with the formation of the JV was a discrete positive cash flow event not expected to recur.  Our calculations of free cash flow and adjusted free cash flow may differ from similarly titled measures used by other companies, limiting its usefulness as a comparative measure.

Free cash flow and adjusted free cash flow for the nine-months ended June 30, 2017  and June 30, 2016 were as follows:



 



CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires us to make judgments, assumptions, and estimates that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying notes.  Note 1, Operations and summary of significant accounting policies, to the Consolidated Financial Statements in our most recent Form 10-K, describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements.  Our critical accounting estimates, identified in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our most recent Form 10-K, include the discussion of estimates used for revenue recognition, inventory valuation, depreciation and amortization, reviews for impairment of goodwill, postretirement benefit obligations, and our provision for income taxes.  Such accounting policies and estimates require significant judgments and assumptions to be used in the preparation of the Condensed Consolidated Financial Statements included in this Form 10-Q, and actual results could differ materially from the amounts reported. 

New Accounting Standards

From time to time, the Financial Accounting Standards Board (“FASB”) or other standards-setting bodies issue new accounting pronouncements.  Updates to the FASB Accounting Standards Codification are communicated through issuance of an Accounting Standards Update.  Unless otherwise discussed, we believe that the impact of recently issued guidance, whether adopted or to be adopted in the future, is not expected to have a material impact on our Condensed Consolidated Financial Statements upon adoption.

To understand the impact of recently issued guidance, whether adopted or to be adopted, please review the information provided in Note 2, New accounting standards, in the Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q.



Off-Balance Sheet Arrangements

As of June 30, 2017, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by the SEC, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues, or expenses, results of operations, liquidity, capital expenditures, or capital resources, that are material to investors.

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Item 3.Quantitative and Qualitative Disclosures About Market Risk

In the normal course of business, we have exposures to interest rate risk from our long-term and short-term debt and our postretirement benefit plans, and foreign currency exchange rate risk related to our foreign operations and foreign currency transactions.  We are also exposed to various market risks that arise from transactions entered into in the normal course of business related to items such as the cost of raw materials and changes in inflation.  Certain contractual relationships with customers and vendors mitigate risks from changes in raw material costs and foreign currency exchange rate changes that arise from normal purchasing and normal sales activities.

These market risks are discussed more fully in “Quantitative and Qualitative Disclosures About Market Risk” in Part II, Item 7A of our most recent Form 10-K.  These market risks have not materially changed since the date our most recent Form 10-K was filed with the SEC.







Item 4.Controls and Procedures

We have established disclosure controls and procedures, which are designed to ensure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Act”) is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.  These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Act is accumulated and communicated to management, including our Principal Executive Officer (Thomas A. Gendron, Chairman of the Board, Chief Executive Officer and President) and Principal Financial and Accounting Officer (Robert F. Weber, Jr., Vice Chairman, Chief Financial Officer and Treasurer), as appropriate, to allow timely decisions regarding required disclosures.

Thomas A. Gendron and Robert F. Weber, Jr., evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Form 10-Q.  Based on their evaluations, they concluded that our disclosure controls and procedures were effective as of June 30, 2017.

Furthermore, there have been no changes in our internal control over financial reporting during the fiscal quarter covered by this Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



PART II – OTHER INFORMATION

Item 1.Legal Proceedings

Woodward is currently involved in claims, pending or threatened litigation or other legal proceedings, investigations and/or regulatory proceedings arising in the normal course of business, including, among others, those relating to product liability claims, employment matters, worker’s compensation claims, contractual disputes, product warranty claims and alleged violations of various laws and regulations.  We accrue for known individual matters where we believe that it is probable the matter will result in a loss when ultimately resolved using estimates of the most likely amount of loss. 

While the outcome of pending claims, legal and regulatory proceedings, and investigations cannot be predicted with certainty, management believes that any liabilities that may result from these claims, proceedings and investigations will not have a material effect on Woodward's liquidity, financial condition, or results of operations.

Item 1A.Risk Factors

Investment in our securities involves risk.  An investor or potential investor should consider the risks summarized under the caption “Risk Factors” in Part I, Item 1A of our most recent Form 10-K when making investment decisions regarding our securities.  The risk factors that were disclosed in our most recent Form 10-K have not materially changed since the date our most recent Form 10-K was filed with the SEC.

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Item 2.Unregistered Sales of Equity Securities and Use of Proceeds



Sales of Unregistered Securities

None.











Item 6.Exhibits

Exhibits filed as part of this Report are listed in the Exhibit Index.



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.





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WOODWARD, INC.

EXHIBIT INDEX



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