UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

Commission file number 0-8408

 

WOODWARD GOVERNOR COMPANY

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

 

(970) 482-5811

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

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 þ     No o

 

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 o     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

                                          (Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o     No þ

 

As of July 20, 2009, 67,926,896 shares of the common stock with a par value of $0.001455 per share were outstanding.

 

 

TABLE OF CONTENTS

 

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts)

 

 

 

The Condensed Consolidated Financial Statements of Woodward Governor Company (“Woodward” or the “Company”) as of June 30, 2009 and for the three and nine months ended June 30, 2009 and 2008, included herein, have not been audited by an independent registered public accounting firm. These Condensed Consolidated Financial Statements reflect all normal recurring adjustments which are, in the opinion of management, necessary to present fairly Woodward’s financial position as of June 30, 2009, and the results of operations and cash flows for the periods presented herein. The Condensed Consolidated Balance Sheet as of September 30, 2008 was derived from Woodward’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008. The results of operations for the three and nine month periods ended June 30, 2009 are not necessarily indicative of the operating results to be expected for other interim periods or for the full fiscal year. Dollar 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”). 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 Annual Report on Form 10-K for the fiscal year ended September 30, 2008 and other financial information filed with the SEC.

 

The preparation of the Condensed Consolidated Financial Statements requires management to make use of estimates and assumptions that affect the reported amount of assets and liabilities, at the date of the financial statements and the reported revenues and expenses recognized during the reporting period and certain financial statement disclosures. Significant estimates in these Condensed Consolidated Financial Statements include allowances for losses, net realizable value of inventories, percent complete on long-term fully-funded contracts, cost of sales incentives, useful lives of property and identifiable intangible assets, the evaluation of impairments of property, identifiable intangible assets and goodwill, income tax and valuation reserves, the valuation of assets and liabilities acquired in business combinations, assumptions used in the determination of the funded status and annual expense of pension and postretirement employee benefit plans, and the valuation of stock compensation instruments granted to employees. Actual results could vary materially from Woodward’s estimates.

 

 

Woodward is an independent designer, manufacturer, and service provider of energy control and optimization solutions for commercial and military aircraft and ground vehicles, turbines, reciprocating engines, and electrical power system equipment. Woodward’s innovative fluid energy, combustion control, electrical energy, and motion control systems help customers offer cleaner, more reliable and more cost-effective equipment. Leading original equipment manufacturers use Woodward’s products and services in aerospace, power and process industries, and transportation.

 

Woodward operates in the following four business segments:

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

 

 

On October 1, 2008, Woodward completed the acquisition of MPC Products Corporation (“MPC Products”), and Techni-Core, Inc. (“Techni-Core” and, together with MPC Products, “MPC”), which formed the basis for the Airframe Systems business segment.

 

On April 3, 2009, Woodward acquired all of the outstanding capital stock of HR Textron Inc. from Textron Inc., its parent company, and the United Kingdom assets and certain liabilities related to HR Textron Inc.’s business (collectively “HRT”). HR Textron Inc. became a wholly owned subsidiary of Woodward and was renamed Woodward HRT, Inc. following the consummation of the acquisition. HRT is being integrated into Woodward’s Airframe Systems business segment.

 

Additional information about Airframe Systems and the MPC and HRT acquisitions is included in Note 3, “Business acquisitions.”

 

 

Revenue Recognition — Woodward generally recognizes revenue upon shipment or delivery for the sale of products that are not under long-term contracts. Delivery is upon completion of manufacturing, customer acceptance, and the transfer of the risks and rewards of ownership. In countries whose laws provide for retention of some form of title by sellers, enabling recovery of goods in the event of customer default on payment, product delivery is considered to have occurred when the customer has assumed the risks and rewards of ownership of the products.

 

Revenue from cost-reimbursable type contracts is recognized on the basis of reimbursable contract costs incurred during the period, including applicable fringe, overhead expenses, and general administrative expenses, as permitted by the specific contracts. For most cost reimbursable contracts, sales are calculated based on the percentage that total costs incurred bear to total estimated costs at completion. For certain contracts with large upfront purchases of material, sales are calculated based on the percentage that incurred direct labor costs bear to total estimated direct labor costs. Airframe Systems does not progress bill for any services where the contract has not been completed or where the contract does not have specified milestones, unless specifically permitted by the contract.

 

Long-Term Development Contracts — Airframe Systems provides development services under long-term development contracts. Development services may be fully-funded or partially-funded by the customer based on the terms of the contract.

 

Revenues under long-term fully-funded contracts and fixed price contracts are accounted for under the percentage-of-completion method of accounting in accordance with American Institute of Certified Public Accountants Statement of Position No. 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”. Under the percentage-of-completion method, Woodward estimates profit as the difference between the total estimated revenue and the cost of a contract. Woodward then recognizes this estimated profit over the contract term based on either the costs incurred (under the cost-to-cost method, which is typically used for development effort) or the units delivered (under the units-of-delivery method, which is used for production effort), as appropriate under the circumstances. Revenues under all cost-reimbursement contracts are recorded

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

using the cost-to-cost method. Revenues under fixed-price contracts generally are recorded using the units-of-delivery method; however, when the contracts provide for periodic delivery after a lengthy period of time over which significant costs are incurred or when they require a significant amount of development effort in relation to total contract volume, revenues are recorded using the cost-to-cost method.

 

Profits from long-term fully-funded development contracts are based on estimates of total contract cost and revenue utilizing current contract specifications, expected engineering requirements and the achievement of contract milestones, including product deliveries. Certain contracts are awarded with price redetermination or for cost and/or performance incentives. Such redetermined amounts or incentives are included in sales when the amounts can reasonably be determined and estimated. Amounts representing contract change orders, claims requests for equitable adjustment, or limitations in funding are included in sales only when they can be reliably estimated and realization is probable. Contract costs typically are incurred over a period of several years, and the estimation of these costs requires substantial judgment. Woodward reviews and revises these estimates periodically throughout the contract term. Revisions to contract profits are recorded when the revisions to estimated revenues or costs are made. Anticipated losses on contracts are recognized in full during the period in which the losses become probable and estimable. In the period in which it is determined that a loss will result from the performance of a contract, the entire amount of the estimated ultimate loss is charged against income. Loss provisions are first offset against costs that are included in inventories, with any remaining amount reflected in liabilities. Changes in estimates of contract sales, costs, and profits are recognized using the cumulative catch-up method of accounting. This method recognizes in the current period the cumulative effect of the changes on current and prior periods. As a result, the effect of the changes on future periods of contract performance is recognized as if the revised estimate had been the original estimate. A significant change in an estimate on one or more contracts could have a material adverse effect on the Company’s consolidated financial position or results of operations.

 

Costs related to partially funded contracts are accounted for using the guidance provided in Emerging Issues Task Force (“EITF”) Issue 99-5, “Accounting for Pre-Production Costs Related to Long-Term Supply Arrangements” (“EITF 99-5”). EITF 99-5 addresses whether design and development costs related to long-term supply arrangements should be expensed or capitalized. Airframe Systems also produces goods to customers’ specifications. All pre-production costs to design, develop, and test prototypes, in excess of a buyer’s funding, are expensed as incurred. In the event costs are equal to or less than a buyer’s funding levels, the costs are capitalized. Costs incurred to produce deliverable hardware are inventoried. On customer programs where such costs exceed market value, inventory is written down to reflect market value. In addition, losses are recorded for outstanding purchase orders for materials procured specifically for such programs. Revenue and capitalized costs are recognized in earnings as milestones are achieved.

 

Certain of Airframe Systems’ contracts are with the U.S. government and commercial customers who supply the U.S. government, and are subject to audit and adjustment. For all such contracts, revenues have been recorded based upon those amounts expected to be realized upon final settlement. The Federal Acquisition Regulations provide guidance on the types of costs that will be reimbursed in establishing contract price.

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

 

 

 

 

SFAS 157: In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and requires additional disclosures about a company’s financial assets and liabilities that are measured at fair value. SFAS 157 does not change existing guidance on whether or not an instrument is carried at fair value. In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13” (“FSP FAS 157-1”) which excludes SFAS No. 13, “Accounting for Leases” and certain other accounting pronouncements that address fair value measurements, from the scope of SFAS 157. In February 2008, the FASB issued FSP No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), which delays the effective date for SFAS 157 for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. In October 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active” (“FSP FAS 157-3”), which clarifies the application of SFAS 157 when the market for a financial asset is inactive. Specifically, FSP FAS 157-3 clarifies how (1) management’s internal assumptions should be considered in measuring fair value when observable data are not present, (2) observable market information from an inactive market should be taken into account, and (3) the use of broker quotes or pricing services should be considered in assessing the relevance of observable and unobservable data to measure fair value.

 

On October 1, 2008, Woodward adopted the measurement and disclosure impact of SFAS 157 as amended by FSP FAS 157-1 and FSP FAS 157-3 only with respect to financial assets and liabilities. The adoption did not have a material impact on its Condensed Consolidated Financial Statements. Woodward expects to adopt the nonfinancial assets and liabilities portion of SFAS 157 in the first quarter of fiscal 2010 and is currently evaluating the impact the adoption may have on its Condensed Consolidated Financial Statements.

 

Financial assets and liabilities recorded at fair value in the Condensed Consolidated Balance Sheet are categorized based upon the fair value hierarchy established by SFAS 157, 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.

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

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 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.

 

The following table presents information about Woodward’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2009, and indicate the fair value hierarchy of the valuation techniques Woodward utilized to determine such fair value:

 

 

Investments in money market funds:  Woodward sometimes invests excess cash in money market funds not insured by the Federal Deposit Insurance Corporation (“FDIC”). The investments in money market funds are reported at fair value, with realized gains or, potentially, losses, realized in earnings and are included in “Cash and cash equivalents.” 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.

 

Trading securities:  Woodward holds marketable equity securities, through investment in various mutual funds, related to its deferred compensation program. In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and 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 earnings. The trading securities are included in “Other current 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.

 

SFAS 159: In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 expands the use of fair value accounting but does not affect existing standards that require certain assets or liabilities to be carried at fair value. The objective of SFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under SFAS 159, a company may choose, at specified election dates, to measure eligible items at fair value and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 became effective for Woodward on October 1, 2008. Woodward has not elected to apply SFAS 159 to any eligible items as of June 30, 2009.

 

SFAS 161: In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. The new standard is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. SFAS 161 became effective for Woodward on January 1, 2009. Woodward adopted the provisions of SFAS 161 effective January 1, 2009. See Note 11 for Woodward’s disclosures about its derivative instruments.

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

FAS 140-4 and FIN 46(R)-8: In December 2008, the FASB issued FSP No. FAS 140-4 and Financial Interpretations No. (“FIN”) 46(R)-8 (“FIN 46(R)-8”), “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP FAS 140-4”). The document increases disclosure requirements for public companies and is effective for reporting periods (interim and annual) that end after December 15, 2008. FSP FAS 140-4 and FIN 46(R)-8 became effective for Woodward on October 1, 2008. The adoption of FSP FAS 140-4 and FIN 46(R)-8 had no impact on Woodward’s Condensed Consolidated Financial Statements.

 

FSP FAS 107-1 and APB 28-1: On April 9, 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” (“FSP FAS 107-1”). FSP FAS 107-1 relates to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet at fair value. Prior to issuing FSP FAS 107-1, fair values for these assets and liabilities were only disclosed once per year. FSP FAS 107-1 requires these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. The Company has provided these disclosures in Note 19 to these Condensed Consolidated Financial Statements.

 

SFAS 165: In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date and alerts all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. The new standard is effective for financial statements issued for fiscal years and interim periods ending after June 15, 2009. SFAS 165 became effective for Woodward on April 1, 2009. The adoption of SFAS 165 had no impact on Woodward’s Condensed Consolidated Financial Statements. In regards to the issuance of these Condensed Consolidated Financial Statements, management evaluated subsequent events through July 22, 2009.

 

 

EITF 07-1: In November 2007, the EITF issued EITF 07-1, “Accounting for Collaborative Arrangements” (“EITF 07-1”). EITF 07-1, which will be applied retrospectively, requires expanded disclosures for contractual arrangements with third parties that involve joint operating activities and may require reclassifications to previously issued financial statements. EITF 07-1 is effective for fiscal years beginning after December 15, 2008 (fiscal year 2010 for Woodward). Woodward is currently evaluating the impact EITF 07-1 may have on its Condensed Consolidated Financial Statements.

 

SFAS 141(R): In December 2007, the FASB issued SFAS No. 141 (Revised) “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) is intended to improve, simplify, and converge internationally the accounting for business combinations. Under SFAS 141(R), an acquiring entity in a business combination must recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquired entity at the acquisition date fair values, with limited exceptions. In addition, SFAS 141(R) requires the acquiror to disclose all information that investors and other users need to evaluate and understand the nature and financial impact of the business combination. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period on or after December 15, 2008. Earlier adoption is prohibited. Accordingly, Woodward will record and disclose business combinations under the revised standard beginning October 1, 2009.

 

FSP FAS 141(R)-1: In April 2009, the FASB issued FSP SFAS No. 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (“FSP SFAS 141(R)-1”). This FSP amends and clarifies SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”), to require that an acquirer recognize at fair value, at the acquisition date, an asset acquired or a liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

determined during the measurement period. If the acquisition-date fair value of such an asset acquired or liability assumed cannot be determined, the acquiror should apply the provisions of SFAS No. 5, “Accounting for Contingencies” (“SFAS 5”), to determine whether the contingency should be recognized at the acquisition date or after it. FSP SFAS 141(R)-1 is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is after the beginning of the first annual reporting period beginning after December 15, 2008. Accordingly, Woodward will adopt FSP SFAS 141(R)-1 prospectively in fiscal year 2010.

 

SFAS 160: In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an Amendment of Accounting Research Bulletin (“ARB”) 51” (“SFAS 160”). This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest (minority interest) in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 establishes accounting and reporting standards that require (i) noncontrolling interests to be reported as a component of equity, (ii) changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions, and (iii) any retained noncontrolling equity investment upon the deconsolidation of a subsidiary be initially measured at fair value. SFAS 160 is to be applied prospectively to business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008. SFAS 160 is effective for fiscal years beginning after December 15, 2008. As a result, SFAS 160 is effective for Woodward in the first quarter of fiscal year 2010. Woodward anticipates that, upon the adoption of SFAS 160, approximately $3,000 will be reclassified within its Condensed Consolidated Balance Sheet from other liabilities to stockholders’ equity.

 

FSP FAS 142-3: In April 2008, the FASB issued FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”), which improve the consistency of the useful life of a recognized intangible asset among various pronouncements. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008 (fiscal year 2010 for Woodward). Woodward is currently assessing the impact that FSP FAS 142-3 may have on its Condensed Consolidated Financial Statements.

 

FSP EITF 03-6-1: In June 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities” (“FSP EITF 03-6-1”). The FSP addresses whether instruments granted in stock-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in computing earnings per share under the two-class method described in paragraphs 60 and 61 of SFAS No. 128, “Earnings Per Share.” The new FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years (fiscal year 2010 for Woodward). Early application is not permitted. Woodward anticipates that, upon the adoption of FSP EITF 03-6-1, outstanding restricted stock will be included in the denominator of both the basic and fully diluted earnings per share calculations in the Condensed Consolidated Financial Statements.

 

FSP 132(R)-1: In December 2008, the FASB issued FSP No. FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP FAS 132(R)-1”). The guidance requires employers to disclose factors that help investors understand a plan’s investment policies and strategies, the nature of each asset category in the plan and the risks associated with the categories, information that helps investors assess the data and valuation methods used to develop fair value measurements for plan assets, particularly for instruments that are not actively trading in open markets, and concentrations of risk in the plan. FSP FAS 132(R)-1 will be effective for fiscal years ending after December 15, 2009 (fiscal year 2010 for Woodward). Woodward is currently assessing the impact that FSP FAS 132(R)-1 may have on its Condensed Consolidated Financial Statements.

 

SFAS 166: In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets” (“SFAS 166”). SFAS 166 removes the concept of a qualifying special-purpose entity (“QSPE”) from SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS 140”) and removes the exception from applying FIN 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46(R)”). This statement also clarifies the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. SFAS 166 will be effective for fiscal years beginning after

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

November 15, 2009 (fiscal year 2011 for Woodward). Woodward is currently assessing the impact that SFAS 166 may have on its Condensed Consolidated Financial Statements.

 

SFAS 167: In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”). SFAS 167 amends FIN 46(R) to require an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. This statement requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. SFAS 167 will be effective for fiscal years beginning after November 15, 2009 (fiscal year 2011 for Woodward). Woodward is currently assessing the impact that SFAS 167 may have on its Condensed Consolidated Financial Statements.

 

SFAS 162 and SFAS 168: In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 is technically effective for periods ending after September 15, 2009 (fiscal year 2009 for Woodward). In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification^tm and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”). SFAS 168 is also effective for periods ending after September 15, 2009 and effectively supersedes SFAS 162; therefore, Woodward does not anticipate that it will ever adopt SFAS 162. SFAS 168 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative U.S. GAAP for nongovernmental entities, in combination with rules and interpretive releases of the SEC under authority of U.S. federal securities laws for SEC registrants. The Codification organizes and simplifies all authoritative U.S. GAAP literature, and establishes that all authoritative U.S. GAAP in the Codification carries an equal level of authority. SFAS 168 will be effective for financial statements issued for interim and annual periods ending after September 15, 2009 (fourth quarter of fiscal year 2009 for Woodward). Woodward does not anticipate that the adoption of SFAS 168 will have any impact on its Condensed Consolidated Financial Statements.

 

 

Woodward has recorded the recent acquisitions described in this Note 3 using the purchase method of accounting and, accordingly, has included the results of operations of the acquired businesses in its consolidated results as of the date of each acquisition. In accordance with SFAS No. 141, “Business Combinations,” the respective purchase prices for these acquisitions are allocated to the tangible assets, liabilities and intangible assets acquired based on their estimated fair values. The excess purchase price over the respective fair values of assets is recorded as goodwill. Goodwill is not amortized for book purposes in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” The goodwill resulting from the MPC and MotoTron Corporation (“MotoTron”) acquisitions is not tax deductible while the goodwill resulting from the HRT acquisition will be tax deductible.

 

Woodward has evaluated and continues to evaluate pre-acquisition contingencies related to its recent acquisitions that may have existed as of the acquisition dates. If these pre-acquisition contingencies become probable in nature and estimable during the remainder of the purchase price allocation period, amounts will be recorded to goodwill for such matters. If these pre-acquisition contingencies become probable in nature and estimable after the end of the purchase price allocation period, amounts will be recorded for such matters in Woodward’s results of operations.

 

MPC acquisition

 

On October 1, 2008, Woodward acquired all of the outstanding stock of Techni-Core and all of the outstanding stock of MPC Products not owned by Techni-Core for approximately $370,435. The estimated purchase price, less approximately $18,610 of assumed outstanding debt, is included in “Cash flows from investing activities” in the Condensed Consolidated Statement of Cash Flows. Woodward paid cash at closing of approximately $334,702, a portion of which was used by the Company to repay the outstanding debt of MPC in an aggregate amount equal to

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

approximately $18,610. In addition, contractual change of control payments totaling $32,175 were made to certain MPC employees during October 2008 as a result of employment agreements in place prior to the acquisition. Direct transaction costs include investment banking, legal, and accounting fees and other external costs directly related to the acquisition.

 

MPC is an industry leader in the manufacture of high-performance electromechanical motion control systems, primarily for aerospace applications. MPC’s main product lines include high performance electric motors and sensors, analog and digital control electronics, rotary and linear actuation systems, and flight deck and fly-by-wire systems for commercial and military aerospace programs. Through an improved focus on aerospace energy control solutions, MPC complements Woodward’s energy and motion control technologies and is expected to enhance Woodward’s system offerings. MPC formed the basis of the fourth Woodward business segment, Airframe Systems.

 

The preliminary purchase price of the MPC acquisition is as follows:

 

 

MPC Products is subject to an investigation by the U.S. Department of Justice (the “DOJ”) regarding certain of its government contract pricing practices prior to 2005 and a related temporary suspension from participation in federal procurements and grants (See Note 18. Contingencies). Payments associated with this pre-acquisition contingency will be incremental to the estimated purchase price above. The purchase price paid by Woodward in connection with the MPC acquisition, as shown above, was reduced by this contingency totaling $25,000 at closing.

 

The following table summarizes preliminary estimated fair values of the assets acquired and liabilities assumed at the date of the MPC acquisition, including accrued restructuring charges:

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

A summary of the intangible assets acquired, amortization methods, and estimated useful lives follows:

 

 

Accelerated amortization is calculated based on the pattern of estimated future economic benefits of the related intangible asset.

 

Woodward is in the process of finalizing valuations of intangible assets, estimates of liabilities, including restructuring reserves, and related income tax adjustments associated with the MPC acquisition.

 

The results of MPC’s operations are included in Woodward’s Condensed Consolidated Statements of Earnings beginning October 1, 2008.

 

MotoTron acquisition

 

On October 6, 2008, Woodward acquired MotoTron and the intellectual property assets owned by its parent company, Brunswick Corporation, which were used in connection with the MotoTron business for approximately $17,237. The estimated purchase price is included in “Cash flows from investing activities” in the Condensed Consolidated Statement of Cash Flows. The Company paid cash at closing of $17,000. In January 2009, Woodward received $29 based on the outcome of working capital adjustment procedures.

 

MotoTron specializes in software tools and processes used to rapidly develop control systems for marine, power generation, industrial and other engine equipment applications. MotoTron was integrated into Woodward’s Engine Systems business segment.

 

MotoTron has been an important supplier and partner to Woodward since 2002 and has helped Woodward to better position itself in electronic control technologies for the alternative-fueled bus and mobile equipment markets. The acquisition of MotoTron further strengthens Woodward’s ability to serve the transportation and power generation markets.

 

The preliminary purchase price of the MotoTron acquisition is as follows:

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

A summary of the preliminary estimated fair values of assets acquired and liabilities assumed at the date of the MotoTron acquisitions, including accrued restructuring charges, follows:

 

 

A summary of the intangible assets acquired, amortization methods, and estimated lives follows:

 

 

Accelerated amortization is calculated based on the pattern of estimated future economic benefits of the related intangible asset.

 

Woodward is in the process of finalizing valuations of estimates of liabilities, including restructuring reserves, and related income tax adjustments associated with the MotoTron acquisition.

 

The results of MotoTron’s operations are included in Woodward’s Condensed Consolidated Statements of Earnings as of October 6, 2008. If the MotoTron acquisition had been completed on October 1, 2008, Woodward’s net sales and net earnings for the three and nine months ended June 30, 2009 would not have been materially different from amounts reported in the Condensed Consolidated Statements of Earnings.

 

HRT acquisition

 

On April 3, 2009, Woodward acquired all of the outstanding stock of HR Textron Inc. from Textron Inc., its parent company, and the United Kingdom assets and certain liabilities related to HR Textron Inc.’s business for approximately $380,749. The estimated purchase price is included in “Cash flows from investing activities” in the Condensed Consolidated Statement of Cash Flows. Woodward paid cash at closing of approximately $377,660.

 

HRT is an industry leader in the advanced technology, engineering development, and manufacturing of mission-critical actuation systems and controls for weapons, aircraft, turbine engines and combat vehicles. It is recognized for hydraulic and electric primary flight control actuation products, including electro-mechanical

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

actuation systems for unmanned combat air vehicles and weapons, such as the Joint Direct Attack Munitions (JDAM) and the AIM-9X Sidewinder; hydraulic and electric flight controls for fixed and rotor wing aircraft; servovalves for global aerospace; turret controls and stabilization systems for the U.S. M1 Abrams Main Battle Tank and other armored vehicles worldwide; and fuel and pneumatics valves for aircraft and helicopters. HRT is expected to complement the MPC business and is being integrated into Woodward’s Airframe Systems business segment.

 

The preliminary purchase price of the HRT acquisition is as follows:

 

 

The following table summarizes preliminary estimated fair values of the assets acquired and liabilities assumed at the date of the HRT acquisition, including accrued restructuring charges:

 

 

A summary of the intangible assets acquired, amortization methods, and estimated useful lives follows:

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

Accelerated amortization is calculated based on the pattern of estimated future economic benefits of the related intangible asset.

 

Woodward made a 338(h)(10) election with the U.S. Internal Revenue Service, which allows the HRT acquisition to be treated as an asset purchase for income tax purposes. Accordingly, any deferred tax assets and liabilities recorded by Textron Inc. at the acquisition date are not available to Woodward because the election causes the HRT acquisition to be treated, for income tax purposes, as though Woodward did not purchase an ongoing business.

 

In connection with the HRT acquisition, Woodward assumed certain defined benefit pension obligations contingent upon transfer of related pension plan assets (See Note 14. Retirement benefits). If for any reason the pension plan assets are not transferred, Woodward is not contractually obligated to assume the related pension benefit obligation, which would reduce both the assumed postretirement benefits liabilities and goodwill by approximately $10,000.

 

Woodward is in the process of finalizing valuations of property, plant, and equipment, other intangibles, defined benefit plan assets and liabilities, estimates of other liabilities, including restructuring reserves, and related income tax adjustments associated with the HRT acquisition.

 

The results of HRT’s operations are included in Woodward’s Condensed Consolidated Statements of Earnings as of April 3, 2009.

 

Pro forma results for MPC and HRT acquisitions

 

The following unaudited pro forma financial information presents the combined results of operations of Woodward, MPC, and HRT as if the acquisitions had occurred as of the beginning of each of the fiscal years presented. The pro forma financial information is presented for informational purposes and is not indicative of the results of operations that would have been achieved if the acquisitions and related borrowings had taken place at the beginning of each of the fiscal years presented. The unaudited pro forma financial information for the three and nine months ended June 30, 2009 includes the historical results of Woodward, including the post-acquisition results of MPC since October 1, 2008 and HRT since April 3, 2009. The unaudited pro forma financial information for the three and nine months ended June 30, 2008 combines the historical results of Woodward with the historical results of MPC and HRT for those periods. The unaudited pro forma financial information for the nine months ended June 30, 2009 combines the historical results of Woodward with the historical results of HRT for the approximately six months ended April 2, 2009. Prior to the HRT acquisition by Woodward, HRT was a wholly owned subsidiary of Textron Inc. and as such was not a stand-alone entity. Accordingly, the historical operating results of HRT may not be indicative of the results that might have been achieved, historically or in the future, if HRT had been a stand-alone entity. The unaudited pro forma results for all periods presented include amortization charges for acquired intangible assets, eliminations of intercompany transactions, adjustments for stock options and restricted stock issued, adjustments for depreciation expense for property, plant, and equipment, adjustments to interest expense, adjustments for estimated general and administrative costs for HRT’s historical management and administrative structure and functions, and related tax effects. The unaudited pro forma results follow:

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

 

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 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, as well as other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.

 

The following table sets out the tax expense and the effective tax rate for Woodward’s income from operations:

 

 

Income taxes for the nine months ended June 30, 2009 included expense reductions of $1,637 related to the retroactive extension of the U.S. research and experimentation tax credit. This expense reduction related to the estimated amount of the credit applicable to the period from January 1 through September 30, 2008. There was no similar benefit in the three or nine months ended June 30, 2008.

 

The total amount of the gross liability for worldwide unrecognized tax benefits reported in other liabilities in the Condensed Consolidated Balance Sheet was $17,142 at June 30, 2009 and $22,576 at September 30, 2008. During the three months ended June 30, 2009, Woodward reached a favorable resolution of an international tax matter, causing its liability for worldwide unrecognized tax benefits to decline by $4,992. At June 30, 2009, the amount of unrecognized tax benefits that would impact Woodward’s effective tax rate, if recognized, was $12,529. At this time, Woodward estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease by as much as $3,794 in the next twelve months through completion of reviews by various worldwide tax authorities.

 

Woodward recognizes interest and penalties related to unrecognized tax benefits in tax expense. Woodward had accrued interest and penalties of $3,321 and $5,956 as of June 30, 2009 and September 30, 2008, respectively.

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

Woodward’s tax returns are audited by U.S., state, and foreign tax authorities and these audits are at various stages of completion at any given time. Fiscal years remaining open to examination in significant foreign jurisdictions include 2002 and forward. Woodward is subject to U.S. Federal income tax examinations for fiscal years 2006 and forward and is subject to U.S. state income tax examinations for fiscal years 2005 and forward.

 

 

Net earnings per share — basic is computed by dividing net earnings available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Net earnings per share — diluted 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 net earnings per share — basic and net earnings per share — diluted:

 

 

The following stock option grants were outstanding during the three and nine month periods ended June 30, 2009 and 2008, but were excluded from the computation of diluted earnings per share because their inclusion would have been anti-dilutive:

 

 

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

 

 

 

 

 

Woodward tests goodwill on the reporting unit level on an annual basis as of March 31 each year and more often if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The impairment test consists of comparing the fair value of the reporting unit, determined using discounted cash flows, with its carrying amount including goodwill. If the carrying amount of the reporting unit exceeds its fair value, Woodward compares the implied value of goodwill with its carrying amount. If the carrying amount of goodwill exceeds the implied fair value of goodwill, an impairment loss would be recognized to reduce the carrying amount to its implied fair value. Woodward considers all operating segments to be reporting units for purposes of testing for goodwill impairment.

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

 

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

 

Amortization expense associated with current intangibles is expected to be:

 

 

 

2008 Term Loan Credit Agreement

 

On October 1, 2008, Woodward entered into a Term Loan Credit Agreement (the “2008 Term Loan Credit Agreement”), which provides for a $150,000 unsecured term loan facility, and may, from time to time, be expanded by up to $50,000 of additional indebtedness, subject to the Company’s compliance with certain conditions and the lenders’ participation. The 2008 Term Loan Credit Agreement bears interest at LIBOR plus 1.00% to 2.25%, requires quarterly principal payments of $1,875 beginning in March 2009, and matures in October 2013.

 

The 2008 Term Loan Credit Agreement contains customary terms and conditions, including, among others, covenants that place limits on the Company’s ability to incur liens on assets, incur additional debt (including a leverage or coverage based maintenance test), transfer or sell the Company’s assets, merge or consolidate with other persons, make capital expenditures, make certain investments, make certain restricted payments, make dividend payments, and enter into material transactions with affiliates. The 2008 Term Loan Credit Agreement contains financial covenants requiring that (a) the Company’s ratio of consolidated net debt to consolidated earnings before interest, taxes, depreciation, and amortization, plus any unusual non-cash charges to the extent deducted in computing net income minus any unusual non-cash gains to the extent added in computing net income (“EBITDA”), not exceed 3.5 to 1.0 and (b) the Company have a minimum consolidated net worth of $400,000 plus 50% of net income for any fiscal year and 50% of the net proceeds of certain issuances of capital stock, in each case on a rolling four quarter basis. The 2008 Term Loan Credit Agreement also contains customary events of default, including certain cross default provisions related to Woodward’s other outstanding debt arrangements in excess of $15,000, the occurrence of which would permit the lenders to accelerate the amounts due.

 

Woodward’s obligations under the 2008 Term Loan Credit Agreement are guaranteed by Woodward FST, Inc., MPC Products and Woodward HRT, Inc., each of which is a wholly owned subsidiary of Woodward.

 

2009 Term Loan Credit Agreement

 

On April 3, 2009, Woodward entered into a Term Loan Credit Agreement (the “2009 Term Loan Credit Agreement”), by and among Woodward, the institutions from time to time parties thereto, as lenders, and JPMorgan Chase Bank, National Association, as administrative agent. The 2009 Term Loan Credit Agreement provides for a $120,000 unsecured term loan facility, and may be expanded by up to $50,000 of additional indebtedness from time to time, subject to the Company’s compliance with certain conditions and the lenders’ participation. The 2009 Term Loan Credit Agreement generally bears interest at LIBOR plus 2.50% to 3.50% and matures on April 3, 2012.

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

Quarterly principal payments of $6,000 are due beginning September 30, 2009 through June 30, 2010. Quarterly principal payments of $9,000 are due beginning September 30, 2010 until maturity. The 2009 Term Loan Credit Agreement can be prepaid without penalty.

 

The 2009 Term Loan Credit Agreement contains customary terms and conditions, including, among others, covenants that place limits on the Company’s ability to incur liens on assets, incur additional debt (including a leverage or coverage based maintenance test), transfer or sell the Company’s assets, merge or consolidate with other persons, make certain investments, make certain restricted payments, and enter into material transactions with affiliates. The 2009 Term Loan Credit Agreement contains financial covenants requiring that (a) the Company’s ratio of consolidated net debt to consolidated EBITDA not exceed 3.5 to 1.0 and (b) the Company have a minimum consolidated net worth of $510,000 plus 50% of net income for any fiscal year and 50% of the net proceeds of certain issuances of capital stock, in each case on a rolling four quarter basis. The 2009 Term Loan Credit Agreement also contains customary events of default, including certain cross default provisions related to Woodward’s other outstanding debt arrangements in excess of $15,000, the occurrence of which would permit the lenders to accelerate the amounts due thereunder.

 

Woodward’s obligations under the 2009 Term Loan Credit Agreement are guaranteed by Woodward FST, Inc., MPC Products and Woodward HRT, Inc., each of which is a wholly owned subsidiary of Woodward.

 

2008 Note Purchase Agreement

 

On October 1, 2008, Woodward entered into a Note Purchase Agreement (the “2008 Note Purchase Agreement”) relating to the sale by Woodward of an aggregate principal amount of $250,000 comprised of (a) $100,000 aggregate principal amount of Series B Senior Notes due October 1, 2013 (the “Series B Notes”), (b) $50,000 aggregate principal amount of Series C Senior Notes due October 1, 2015 (the “Series C Notes”) and (c) $100,000 aggregate principal amount of Series D Senior Notes due October 1, 2018 (the “Series D Notes” and, together with the Series B Notes and Series C Notes, the “2008 Notes”) in a series of private placement transactions which were consummated on October 1, 2008 and October 30, 2008.

 

The 2008 Notes issued in the private placement have not been registered under the Securities Act of 1933 and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. Holders of the 2008 Notes do not have any registration rights.

 

The Series B Notes have a maturity date of October 1, 2013 and generally bear interest at a rate of 5.63% per annum. The Series C Notes have a maturity date of October 1, 2015 and generally bear interest at a rate of 5.92% per annum. The Series D Notes have a maturity date of October 1, 2018 and generally bear interest at a rate of 6.39% per annum. Under certain circumstances, the interest rate on each series of 2008 Notes is subject to increase if Woodward’s leverage ratio of consolidated net debt to consolidated EBITDA increases beyond 3.5 to 1.0. Interest on the 2008 Notes is payable semi-annually on April 1 and October 1 of each year until all principal is paid. Interest payments commenced on April 1, 2009.

 

Woodward’s obligations under the 2008 Note Purchase Agreement and the 2008 Notes rank equal in right of payment with all of Woodward’s other unsecured unsubordinated debt, including its outstanding debt under Woodward’s existing term loan facilities, existing revolving credit facility and existing note purchase agreements.

 

The 2008 Note Purchase Agreement contains customary restrictive covenants, including, among other things, covenants that place limits on Woodward’s ability to incur liens on assets, incur additional debt (including a leverage or coverage based maintenance test), transfer or sell its assets, merge or consolidate with other persons, and enter into material transactions with affiliates. The 2008 Note Purchase Agreement also contains customary events of default, including certain cross default provisions related to Woodward’s other outstanding debt arrangements in excess of $25,000, the occurrence of which would permit the holders of the 2008 Notes to accelerate the amounts due.

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

The 2008 Note Purchase Agreement contains financial covenants requiring that Woodward’s (a) ratio of consolidated net debt to consolidated EBITDA not exceed 4.0 to 1.0 during any material acquisition period, or 3.5 to 1.0 at any other time on a rolling four quarter basis, and (b) consolidated net worth at any time equal or exceed $425,000 plus 50% of consolidated net earnings for each fiscal year beginning with the fiscal year ended September 30, 2008. Additionally, under the 2008 Note Purchase Agreement, Woodward may not permit the aggregate amount of priority debt to at any time exceed 20% of its consolidated net worth at the end of the then most recently ended fiscal quarter. Priority debt generally refers to certain unsecured debt of Woodward’s subsidiaries and all debt of Woodward and its subsidiaries secured by liens other than certain permitted liens.

 

Woodward is permitted at any time, at its option, to prepay all, or from time to time prepay any part of, the then outstanding principal amount of any series of the 2008 Notes at 100% of the principal amount of the series of 2008 Notes to be prepaid (but, in the case of partial prepayment, not less than $1,000), together with interest accrued on such amount to be prepaid to the date of payment, plus any applicable make-whole amount. The make-whole amount is computed by discounting the remaining scheduled payments of interest and principal of the 2008 Notes being prepaid at a discount rate equal to the sum of 50 basis points and the yield to maturity of U.S. Treasury securities having a maturity equal to the remaining average life of the 2008 Notes being prepaid.

 

Woodward’s obligations under the 2008 Note Purchase Agreement and the 2008 Notes are guaranteed by Woodward FST, Inc., MPC Products and Woodward HRT, Inc., each of which is a wholly owned subsidiary of Woodward.

 

2009 Note Purchase Agreement

 

On April 3, 2009, Woodward entered into a Note Purchase Agreement (the “2009 Note Purchase Agreement”) relating to the sale by Woodward of an aggregate principal amount of $100,000 of senior unsecured notes comprised of (a) $57,000 aggregate principal amount of Series E Senior Notes due April 3, 2016 (the “Series E Notes”) and (b) $43,000 aggregate principal amount of Series F Senior Notes due April 3, 2019 (the “Series F Notes” and together with the Series E Notes, the “2009 Notes”) in a private placement transaction consummated on April 3, 2009.

 

The 2009 Notes issued in the private placement have not been registered under the Securities Act of 1933 and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. Holders of the 2009 Notes do not have any registration rights.

 

The Series E Notes have a maturity date of April 3, 2016 and bear interest at a rate of 7.81% per annum. The Series F Notes have a maturity date of April 3, 2019 and bear interest at a rate of 8.24% per annum. Interest on the 2009 Notes is payable semi-annually on April 15 and October 15 of each year until the principal is paid. Interest payments commence on October 15, 2009.

 

Woodward’s obligations under the 2009 Note Purchase Agreement and the 2009 Notes rank equal in right of payment with all of Woodward’s other unsecured unsubordinated debt, including outstanding debt under Woodward’s existing term loan facilities, existing revolving credit facility and existing note purchase agreements.

 

The 2009 Note Purchase Agreement contains customary restrictive covenants, including, among other things, covenants that place limits on Woodward’s ability to incur liens on assets, incur additional debt (including a leverage or coverage based maintenance test), transfer or sell Woodward’s assets, merge or consolidate with other persons, and enter into material transactions with affiliates. The 2009 Note Purchase Agreement also contains customary events of default, including certain cross default provisions related to Woodward’s other outstanding debt arrangements in excess of $30,000, the occurrence of which would permit the holders of the 2009 Notes to accelerate the amounts due.

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

The 2009 Note Purchase Agreement contains financial covenants requiring that Woodward’s (a) ratio of consolidated net debt to consolidated EBITDA not exceed 3.5 to 1.0 at any time on a rolling four quarter basis, and (b) consolidated net worth at any time equal or exceed $485,940 plus 50% of consolidated net earnings for each fiscal year beginning with the fiscal year ending September 30, 2009. Additionally, under the 2009 Note Purchase Agreement, Woodward may not permit the aggregate amount of priority debt to at any time exceed 20% of its consolidated net worth at the end of the then most recently ended fiscal quarter. Priority debt generally refers to certain unsecured debt of Woodward’s subsidiaries and all debt of the Woodward and its subsidiaries secured by liens other than certain permitted liens.

 

Woodward is permitted at any time, at its option, to prepay all, or from time to time prepay any part of, the then outstanding principal amount of any series of the 2009 Notes at 100% of the principal amount of the series of 2009 Notes to be prepaid (but, in the case of partial prepayment, not less than $1,000), together with interest accrued on such amount to be prepaid to the date of payment, plus any applicable make-whole amount. The make-whole amount is computed by discounting the remaining scheduled payments of interest and principal of the 2009 Notes being prepaid at a discount rate equal to the sum of 50 basis points and the yield to maturity of U.S. treasury securities having a maturity equal to the remaining average life of the 2009 Notes being prepaid.

 

Woodward’s obligations under the 2009 Note Purchase Agreement and the 2009 Notes are guaranteed by Woodward FST, Inc., MPC Products and Woodward HRT, Inc., each of which is a wholly owned subsidiary of Woodward.

 

The proceeds from the 2008 Term Loan Credit Agreement and the issuance of the 2008 Notes were used primarily to finance the MPC and MotoTron acquisitions. The proceeds from the 2009 Term Loan Credit Agreement and the issuance of the 2009 Notes were used primarily to finance the HRT acquisition.

 

Woodward was in compliance with its financial debt covenants at June 30, 2009.

 

Outstanding long-term debt

 

Long-term debt consisted of the following:

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

The senior notes, 2008 and 2009 term loans, and Series B, C, D, E and F Notes are held by multiple institutions. The term notes are held by banks in Germany.

 

The senior notes, 2008 and 2009 term loans, and Series B, C, D, E and F Notes are guaranteed by Woodward FST, Inc., MPC Products and Woodward HRT, Inc., each of which is a wholly owned subsidiary of Woodward.

 

The current portion of long-term debt includes $142 and $183 at June 30, 2009 and September 30, 2008, respectively, related to the fair value hedge adjustment for unrecognized discontinued hedge gains.

 

Required future principal payments of outstanding long-term debt are as follows:

 

 

Debt Issuance Costs

 

During 2009, Woodward incurred $5,602 of debt issuance costs, which are being amortized using the effective interest method or patterns that approximate the effective interest method, over the term of the debt to which the costs relate. The related amortization is recognized as interest expense. As of June 30, 2009, Woodward had $4,995 of unamortized debt issuance costs related to the 2009 debt issuances.

 

Lines of Credit

 

Woodward has a $225,000 revolving credit facility related to unsecured financing arrangements with a syndicate of U.S. banks. The agreement provides for an option to increase the amount to $350,000, subject to the lenders’ participation, and has an expiration date of October 2012. The interest rate on borrowings under the agreement, which varies with LIBOR, the federal funds rate, or the prime rate, was 0.91% as of June 30, 2009. Borrowings under the revolving credit facility were $43,000 and $0 as of June 30, 2009 and September 30, 2008, respectively.

 

Woodward also has various foreign lines of credit. The lines are generally reviewed annually for renewal and are subject to the usual terms and conditions applied by the banks. Aggregate borrowings under such foreign lines of credit were $0 and $4,031 as of June 30, 2009 and September 30, 2008, respectively.

 

 

Woodward enters into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), and those utilized as economic hedges. Woodward uses interest rate related derivative instruments to manage its exposure to fluctuations of interest rates. By using these instruments, Woodward is exposed, from time to time, to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes Woodward, which creates credit risk for Woodward. Woodward minimizes this credit risk by entering into

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

transactions with high quality counterparties. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates, commodity prices, currency exchange rates, or the market price of Woodward’s common stock. Woodward minimizes this market risk by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. As of June 30, 2009 and September 30, 2008, all derivative instruments into which Woodward had entered were terminated.

 

In 2001, Woodward entered into treasury lock agreements that were designated as cash flow hedges of its long-term debt. The discontinuance of these treasury lock agreements resulted in losses that are recognized as an increase of interest expense over the term of the associated debt (10 years) using the effective interest method. The unrecognized portion of the loss is recorded in accumulated other comprehensive income.

 

In 2002, Woodward entered into certain interest rate swaps that were designated as fair value hedges of its long-term debt. The discontinuance of these interest rate swaps resulted in gains that are recognized as a reduction of interest expense over the term of the associated debt (10 years) using the effective interest method. The unrecognized portion of the gain is presented as an adjustment to long-term debt based on the accounting guidance in effect at the time the interest rate swaps were terminated.

 

In September 2008, the Company entered into treasury lock agreements with a notional amount totaling $100,000 that qualified as cash flow hedges under SFAS 133. The objective of this derivative instrument was to hedge the risk of variability in cash flows related to future interest payments of a portion of the anticipated future debt issuances attributable to changes in the designated benchmark interest rate associated with the expected issuance of long-term debt to acquire MPC. The hedges were terminated prior to September 30, 2008 resulting in a gain of approximately $108 and the gain was recorded in accumulated other comprehensive income as of September 30, 2008, net of tax. The realized gain on the termination of the treasury lock agreements will be recognized as a reduction of interest expense over a seven-year period on the hedged debt issued on October 1, 2008 using the effective interest method.

 

In March 2009, Woodward entered into LIBOR lock agreements with a total notional amount of $50,000 that qualified as cash flow hedges under SFAS 133. The objective of this derivative instrument was to hedge the risk of variability in cash flows over a seven-year period related to future interest payments of a portion of anticipated future debt issuances attributable to changes in the designated benchmark interest rate associated with the expected issuance of long-term debt to acquire HRT. The hedges were terminated prior to June 30, 2009, resulting in a loss of $1,308. The realized loss was recorded in accumulated other comprehensive income as of June 30, 2009, net of tax. The realized loss on the terminated LIBOR lock agreements will be recognized as an increase of interest expense over a seven-year period on the hedged debt issued on April 3, 2009 using the effective interest method.

 

The following table discloses the remaining unrecognized gains and losses associated with the terminated derivative instruments on Woodward’s Condensed Consolidated Balance Sheet as of June 30, 2009:

 

 

 

 

Woodward Governor Company

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in thousands, except per share amounts) — (Continued)

 

 

The following tables disclose the impact of terminated derivative instruments on Woodward’s Condensed Consolidated Statements of Earnings for the three months ended June 30, 2009: