UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended September 30, 2014

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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☒    No ◻

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ◻  No ☒

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ◻

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

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

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

Aggregate market value of registrant’s common stock held by non-affiliates of the registrant, based upon the closing price of a share of the registrant’s common stock on March 31, 2014 as reported on The NASDAQ Global Select Market on that date:  $1,829,752,615.  For purposes of this calculation, shares of common stock held by (i) persons holding more than 5% of the outstanding shares of stock, (ii) officers and directors of the registrant, and (iii) the Woodward Governor Company Profit Sharing Trust, Woodward Governor Company Deferred Shares Trust, or the Woodward Charitable Trust, as of March 31, 2014, are excluded in that such persons may be deemed to be affiliates.  This determination is not necessarily conclusive of affiliate status. 

Number of shares of the registrant’s common stock outstanding as of November 10, 2014:  65,587,860.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our proxy statement for the Annual Meeting of Stockholders to be held January 21, 2015, are incorporated by reference into Parts II and III of this Form 10-K, to the extent indicated.

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PART I

Forward Looking Statements

This Annual Report on Form 10-K, 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 this Annual Report on Form 10-K for the fiscal year ended September 30, 2014 (this “Form 10-K).  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 Form 10-K  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-K are in thousands, except per share amounts.

Item 1. Business

General

Woodward enhances the global quality of life and sustainability by optimizing energy use through improved efficiency and lower emissions.  We are an independent designer, manufacturer, and service provider of energy control and optimization solutions.  We design, produce and service reliable, efficient, low-emission, and high-performance energy control products for diverse applications in challenging environments.  We have significant production and assembly facilities in the United States, Europe and Asia, and promote our products and services through our worldwide locations. 

Our strategic focus is providing energy control and optimization solutions for the aerospace and energy markets.  The precise and efficient control of energy, including fluid and electrical energy, combustion, and motion, is a growing requirement in the markets we serve.  Our customers look to us to optimize the efficiency, emissions and operation of power equipment in both commercial and defense operations.  Our core technologies leverage well across our markets and customer applications, enabling us to develop and integrate cost-effective and state-of-the-art fuel, combustion, fluid, actuation and electronic systems.  We focus primarily on serving original equipment manufacturers (“OEMs”) and equipment packagers,

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partnering with them to bring superior component and system solutions to their demanding applications.  We also provide aftermarket repair, replacement and other service support for our installed products.

Our components and integrated systems optimize performance of commercial aircraft, defense aircraft, ground vehicles and other equipment, gas and steam turbines, wind turbines, including converters and power grid related equipment, industrial diesel, gas, alternative and dual fuel reciprocating engines, and electrical power systems.  Our innovative fluid energy, combustion control, electrical energy, and motion control systems help our customers offer more cost-effective, cleaner, and more reliable equipment. 

We were established in 1870, incorporated in 1902, and are headquartered in Fort Collins, Colorado.  The mailing address of our world headquarters is 1000 East Drake Road, Fort Collins, Colorado 80525.  Our telephone number at that location is (970) 482-5811, and our website is www.woodward.com.  None of the information contained on our website is incorporated into this document by reference.

Markets and Principal Lines of Business

We serve two primary markets – aerospace and energy – which comprise our two reportable segments.  Our customers require technological solutions to meet their needs for performance, efficiency, and reliability, and to reduce their costs of operation.

Within the aerospace market, we provide systems, components and solutions for both commercial and defense applications.  Our key focus areas within this market are:

Within the energy market, our key focus areas are:

Additional information about our operations in fiscal year 2014 and outlook for the future, including certain segment information, is included in “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Additional information about our business segments and certain geographical information is included in Note 20, Segment information and Note 21, Supplemental quarterly financial data (Unaudited), to the Consolidated Financial Statements in “Item 8 – Financial Statements and Supplementary Data.”

Products, Services and Applications

Aerospace

Our Aerospace segment designs, manufactures and services systems and products for the management of fuel, air, combustion and motion control.  These products include main fuel pumps, metering units, actuators, air valves, specialty valves, fuel nozzles, and thrust reverser actuation systems for turbine engines and nacelles; as well as flight deck controls, actuators, servocontrols, motors and sensors for aircraft.  These products are used on commercial and private aircrafts and helicopters, as well as in military fixed-wing aircraft and rotorcraft, weapons and defense systems. 

We have significant content on a wide variety of commercial aircraft, rotorcraft and business jet platforms, including the Airbus A320, Boeing 737 and 787, Bell 429 and Gulfstream G650.  We also have significant content on such defense applications as the Blackhawk and Apache helicopters, F-18 and F-35 fighter jets, M1A1 Abrams Tank and guided tactical weapons (for example, the Joint Direct Attack Munition (“JDAM”)).

Revenues from the Aerospace segment are generated by sales to OEMs, tier-one suppliers, and prime contractors, and through aftermarket sales of components, such as provisioning spares or replacements.  We also provide aftermarket repair, overhaul and other services to commercial airlines, turbine OEM repair facilities, military depots, third party repair shops, and other end users. 

Energy

Our Energy segment designs, produces and services systems and products for the management of fuel, air, fluids, gases, electricity, motion, and combustion.  These products include actuators, valves, pumps, injectors, solenoids, ignition systems, governors, electronics and software, power converters, and devices that measure, communicate and protect electrical distribution systems.  Our products are used on industrial gas turbines, including heavy frame and aeroderivative turbines,

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steam turbines, reciprocating engines, power generation and power distribution systems, wind turbines, and compressors.  The equipment on which our products are found is used to extract and distribute fossil and renewable fuels; generate and distribute power; and convert fuel to work in marine, mobile, and industrial equipment applications. 

Revenues from the Energy segment are generated primarily by sales to OEMs, tier-one suppliers, and prime contractors, and by providing other related services to our OEM customers. The Energy segment also sells products through an independent network of distributors, in some cases, directly to end users.

Sales Order Backlog

Our backlog of unshipped sales orders as of October 31, 2014 and 2013 by segment was as follows:

 

Our current estimate of the sales order backlog is based on unshipped sales orders that are open in our order entry systems.  Unshipped orders are not necessarily an indicator of future sales levels because of variations in lead times and customer production schedules.

Seasonality

We do not believe that our sales, in total or in either business segment, are subject to significant seasonal variation.  However, our sales have generally been lower in the first quarter of our fiscal year as compared to the immediately preceding quarter due to fewer working days resulting from the observance of various holidays and scheduled plant shutdowns for annual maintenance.

Customers

For the fiscal year ended September 30, 2014, approximately 39% of our consolidated net sales were made to our five largest customers.  Sales to our five largest customers represented approximately 39% of our consolidated net sales for the fiscal year ended September 30, 2013 and 36% for the fiscal year ended September 30, 2012.

Sales to our largest customer, General Electric, accounted for approximately 15% of our consolidated net sales in the fiscal years ended September 30, 2014 and September 30, 2013 and 14% of our consolidated net sales in the fiscal year ended September 30, 2012.  Our accounts receivable from General Electric represented approximately 12% of total accounts receivable as of September 30, 2014 and 11% as of September 30, 2013.  We believe General Electric and our other significant customers are creditworthy and will be able to satisfy their credit obligations to us.

The following customers account for approximately 10% or more of sales to each of our reporting segments for the fiscal year ended September 30, 2014.

Government Contracts and Regulation

Portions of our business, particularly in our Aerospace segment, are heavily regulated.  We contract with numerous U.S. Government agencies and entities, including all of the branches of the U.S. military, the National Aeronautics and Space Administration (“NASA”), and the Departments of Defense, Homeland Security, and Transportation.  We also contract with similar government authorities outside the United States.

The U.S. Government, and other governments, may terminate any of our government contracts, or any government contracts under which we are a subcontractor, at their convenience, as well as for default based on specified performance measurements.  If any of our government contracts were to be terminated for convenience, we generally would be entitled to receive payment for work completed and allowable termination or cancellation costs.  If any of our government contracts were to be terminated for our default, the U.S. Government generally would pay only for the work accepted, and could require us to pay the difference between the original contract price and the cost to re-procure the contract items, net of the

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work accepted from the original contract.  The U.S. Government could also hold us liable for damages resulting from the default.

We must comply with, and are affected by, laws and regulations relating to the formation, administration and performance of U.S. Government contracts.  These laws and regulations, among other things:

Sales made directly to U.S. Government agencies and entities, or indirectly through third party manufacturers utilizing Woodward parts and subassemblies, collectively represented 17% of our sales for fiscal year 2014, 21% of our sales for fiscal year 2013, and 18% of our sales for fiscal year 2012.  The level of U.S. spending for defense, alternative energy and other programs, and the mix of programs to which such funding is allocated, is subject to periodic congressional appropriation actions, and is subject to change at any time.

U.S. Government related sales from our reporting segments for fiscal years 2014, 2013 and 2012 were as follows:

 

 

Manufacturing

We operate manufacturing and assembly plants in the United States, Europe, and Asia.  Our products consist of mechanical, electronic and electromechanical systems and components.

Aluminum, iron and steel are primary raw materials used to produce our mechanical components.  Other commodities, such as gold, copper and nickel, are also used in the manufacture of our products, although in much smaller quantities.  We purchase various goods, including component parts and services used in production, logistics and product development processes from third parties.  Generally there are numerous sources for the raw materials and components used in our products, which we believe are sufficiently available to meet current requirements.

We maintain global strategic sourcing models to meet our global facilities' production needs while building long-term supplier relationships and efficiently managing our overall supply costs.  We expect our suppliers to maintain adequate levels of quality raw materials and component parts, and to deliver such parts on a timely basis to support production of our various products.  We use a variety of agreements with suppliers intended to protect our intellectual property and processes and to

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monitor and mitigate risks of disruption in our supply base that could cause a business disruption to our production schedules or to our customers.  The risks monitored include supplier financial viability, business continuity, quality, delivery and protection of our intellectual property and processes.

Our customers expect us to maintain adequate levels of certain finished goods and certain component parts to support our warranty commitments and sales to our aftermarket customers, and to deliver such parts on a timely basis to support our customers’ standard and customary needs.  We carry certain finished goods and component parts in inventory to meet these rapid delivery requirements of our customers.

The Securities and Exchange Commission (“SEC”) has adopted disclosure rules for companies that use tantalum, tin, tungsten, and gold or their derivatives (referred to as conflict minerals) in their products, with substantial supply chain verification requirements in the event the conflict minerals come or may come from the Democratic Republic of Congo or adjoining countries; our first related report was filed with the SEC on June 2, 2014.  Additional reporting obligations are being considered by the European Union.  Due to the complexity of our supply chain, we may face reputational challenges with our customers, stockholders and other stakeholders if we are unable to sufficiently verify the origins of the conflict minerals used in our products.  Further, the implementation of the existing U.S. requirements and any additional European requirements could affect the sourcing and availability of metals used in the manufacture of a number of parts contained in our products.  Regardless, we have and will continue to incur costs associated with compliance, including time-consuming and costly efforts to determine the source of minerals used in our products.

Research and Development

We finance our research and development activities with our own independent research and development funds.  Our research and development costs include basic research, applied research, component and systems development, and other concept formulation studies. 

Company funded expenditures related to new product development activities are expensed as incurred and are separately reported in the Company’s Consolidated Statements of Earnings.  Across both of our segments, research and development costs totaled $138,005 in fiscal year 2014, $130,250 in fiscal year 2013, and $143,274 in fiscal year 2012.  Research and development costs were 6.9% of consolidated net sales in fiscal year 2014 compared to 6.7% in fiscal year 2013 and 7.7% in fiscal year 2012.  See “Research and development costs” in Note 1, Operations and summary of significant accounting policies, to the Consolidated Financial Statements in “Item 8 – Financial Statements and Supplementary Data.”

Aerospace is focused on developing systems and components that we believe will be instrumental in helping our customers achieve their objectives of lower fuel consumption, lighter weight, more efficient performance, reduced emissions, and improved operating economics.  Our development efforts support technology for a wide range of:

The aerospace industry is moving toward more electric (“fly-by-wire”), lighter weight aircraft, while demanding increased reliability and redundancy.  In response, we are developing an expanded family of intelligent flight deck control products (including throttle and rudder controls) with both conventional and fly-by-wire technology, as well as motor driven actuation systems.

We collaborate closely with our customers as they develop their technology plans, which leads to new product concepts.  We believe this collaboration allows us to develop technology that is aligned with our customers’ needs and therefore, increases the likelihood that our systems and components will be selected for inclusion in the platforms developed by our customers.  Further, we believe our close collaboration with our customers during preliminary design stages allows us to provide products that deliver the component and system performance necessary for our customers’ products. 

Some technology development programs begin years before an expected entry to service, such as those for the next-generation of commercial aircraft engines.  Other development programs result in nearer-term product launches associated with new OEM offerings, product upgrades, or product replacements on existing programs.  Some of the major projects/programs we are developing are listed below.

We are currently developing the fuel system, air management, and actuation hardware for CFM International’s LEAP engine program, and actuation system, combustion system and oil system components for Pratt & Whitney’s PurePower engine program.  These programs target applications in the single aisle and regional aircraft markets with expected entry into service in the 2015 to 2018 timeframe.  Both the LEAP engine and the PurePower engine have been selected by Airbus as options to power its re-engined A320neo aircraft.  In addition, the LEAP engine has been selected exclusively by Boeing for its re-engined 737 MAX and by Comac for its C919 aircraft.  The PurePower engine has been selected exclusively by

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Bombardier for its CSeries aircraft, by Embraer for its EJets E2 aircraft family, and by Irkut for the MS-21 aircraft.  In addition, we are the selected supplier for the thrust reverser actuation system (“TRAS”) for the Boeing 737 MAX and the LEAP-engined Airbus A320neo.  We continue to pursue and win major programs in our TRAS and motion control product lines.   

We are also currently developing the fuel system, air management, and actuation hardware for the Passport engine program, as well as the thrust reverser actuation system for the integrated propulsion system.  Passport is the next generation GE Aviation engine for the large business aviation market, and has been selected by Bombardier to power its Global 7000 and 8000 long-range business aircraft, targeting entry into service in 2016 and 2017, respectively.

In addition, we are currently developing sensor solutions for the Airbus A350 high lift system, an actuation sub-system for the Boeing 787-9 that improves fuel burn, flight deck components for the Bombardier CSeries and Global 7000 and 8000 aircraft, and control and sensing solutions for the KC-46A refueling tanker boom subsystem.

Energy is focused on developing improved technologies, including integrated control systems, and system components that we believe will allow our OEM customers to cost-effectively meet mandated emissions regulations and fuel efficiency demands, allow for usage of a wider range of fuel sources, increase reliability, reduce total cost of ownership, support global infrastructure requirements, and safely distribute power on the electrical grid. 

Our efforts include research and development of technologies and products that improve combustion processes and provide more precise flow of various fuels and gases in our customers’ gas turbines and industrial reciprocating engines.  We also develop electronic devices and software algorithms that provide improved control and protection of reciprocating engines, gas turbines, steam turbines, wind turbines, and engine- and turbine-powered equipment.  Major development projects include diesel common rail fuel injection systems, comprehensive gas engine control systems, fuel flow control valves and actuators, and various other technologies that will help our OEM customers meet future global emissions regulations expected to become effective in 2015 or thereafter. We believe our technologies also help our OEM customers’ engines, turbines, power generation, power distribution, compressor and other powered equipment operate more efficiently and more reliably. 

Competitive Environment

Our products and product support services are sold worldwide into a variety of competitive markets.  In all markets, we compete on the basis of differentiated technology and design, product performance and conformity with customer specifications.  Additional factors are customer service and support, including on-time delivery and customer partnering, product quality, price, reputation and local presence.  Both of our segments operate in uniquely competitive environments.

We believe that new competitors face significant barriers to entry into many of our markets, including various government mandated certification requirements to compete in the aerospace markets in which we participate.

Aerospace industry safety regulations and manufacturing standards demand significant product certification requirements, which form a basis for competition as well as a barrier to entry.  Technological innovation and design, product performance and conformity with customer specifications, and product quality and reliability are of utmost importance in the aerospace and defense industry.  In addition, on-time delivery, pricing, and joint development capabilities with customers are points of competition within this market.  Our customers include airframe and aircraft engine OEM manufacturers and suppliers to these manufacturers.  We supply these customers with technologically innovative system and component solutions and align our technology roadmaps with our customers.  We focus on responding to needs for reduced cost and weight, emission control and reliability improvements.  Our products achieve high levels of field reliability, which offers end users an advantage in life-cycle cost.  We compete with numerous companies around the world that specialize in fuel and air management, combustion, and electronic control products.  In addition, some of our OEM customers are capable of developing and manufacturing these same products internally. 

Our competitors in aerospace include divisions of United Technologies Corporation (“UTC”) Aerospace Systems, Honeywell, Moog, Parker Hannifin and Eaton.  We address competition in aftermarket service through responsiveness to our customers’ needs, providing short turnaround times and maintaining a global presence.

Several competitors are also customers for our products, such as UTC Aerospace Systems, Parker Hannifin, and Honeywell.  Some of our customers are affiliated with our competitors through ownership or joint venture agreements.  We compete in part by establishing relationships with our customers’ engineering organizations, and by offering innovative technical and commercial solutions to meet their market requirements.

Energy operates in the global markets for industrial turbines, industrial reciprocating engines, electric power generation systems, power distribution networks, and wind turbines.

We compete with numerous companies that specialize in various engine, turbine, and power management products, and our OEM customers are often capable of developing and manufacturing some of these same products internally.  Many of our

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OEM customers are large global OEMs that require suppliers to support them around the world and meet increasingly higher requirements in terms of quality, delivery, reliability and cost improvements.

Competitors include Heinzmann GmbH & Co., Robert Bosch AG, L’Orange GmbH, Hoerbiger, General Electric, ABB, Siemens, and Schweitzer Electric.  OEM customers with internal capabilities for similar products include General Electric, Caterpillar, Wartsila, Siemens, and Cummins.

We believe we are a market leader in providing our customers advanced technology and superior product performance at a competitive price.  We focus on developing and maintaining close relationships with our OEM customers’ engineering teams.  Competitive success is based on the development of innovative components and systems that are aligned with the OEMs’ technology roadmaps to achieve future emission, efficiency, and fuel flexibility targets.

Employees

As of October 31, 2014, we employed approximately 6,700 full-time employees of which approximately 1,750 were located outside of the United States.  We consider the relationships with our employees to be good.

Approximately 16% of our total full-time workforce were union employees as of October 31, 2014, all of whom work for our Aerospace segment.  The collective bargaining agreements with our union employees are generally renewed through contract renegotiation near the contract expiration dates.  The MPC Employees Representative Union contract, which covers 451 employees as of October 31, 2014, expires September 30, 2017.  The Local Lodge 727-N International Association of Machinists and Aerospace Workers agreement, which covers 423 employees as of October 31, 2014, expires April 21, 2017.  The International Union, United Automobile, Aerospace and Agricultural Implement Workers of America and Local No. 509 agreement, which covers 226 employees as of October 31, 2014, expires June 3, 2017.  We believe our relationships with our employees and the representative unions are good.

All of our other employees in the United States were at-will employees as of October 31, 2014, and therefore, not subject to any type of employment contract or agreement.  Our executive officers and our other corporate officers each have change-in-control agreements which have been filed with the SEC.

Outside of the United States, we enter into employment contracts and agreements in those countries in which such relationships are mandatory or customary.  The provisions of these agreements correspond in each case with the required or customary terms in the subject jurisdiction.

Patents, Intellectual Property, and Licensing

We own numerous patents and have licenses for the use of patents owned by others, which relate to our products and their manufacture.  In addition to owning a large portfolio of intellectual property, we also license intellectual property to and from third parties.  For example, the U.S. Government has certain rights in our patents and other intellectual property developed in performance of certain government contracts, and it may use or authorize others to use the inventions covered by such patents for government purposes as allowed by law. 

Some of our intellectual property is not covered by patents (or patent applications) and includes trade secrets and other know-how that is not patentable or for which we have elected not to seek patent protection, including intellectual property relating to our manufacturing processes and engineering designs.  Such unpatented technology, including research, development and engineering technical skills and know-how, as well as unpatented software, is important to our overall business and to the operations of each of our segments. 

While our intellectual property assets taken together are important, we do not believe our business or either of our segments would be materially affected by the expiration of any particular intellectual property right or termination of any particular intellectual property patent license agreement.

As of September 30, 2014, our Consolidated Balance Sheet includes $254,772 of net intangible assets.  This value represents the carrying values, net of amortization, of certain assets acquired in various business acquisitions and does not purport to represent the fair value of our intellectual property as of September 30, 2014.

U.S. GAAP requires that research and development costs be expensed as incurred; therefore, as we develop new intellectual property in the normal course of business, the costs of developing such assets are expensed as incurred, with no corresponding intangible asset recorded.

Environmental Matters and Climate Change

The Company is regulated by federal, state and international environmental laws governing our use, transport and disposal of substances and control of emissions.  Compliance with these existing laws has not had a material impact on our capital expenditures, earnings or global competitive position.

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We are engaged in environmental remedial activities, generally in coordination with other companies, pursuant to federal and state laws.  When it is reasonably probable we will pay remediation costs at a site, and those costs can be reasonably estimated, we accrue a liability for such future costs with a related charge against our earnings.  In formulating that estimate and recognizing those costs, we do not consider amounts expected to be recovered from insurance companies, or others, until such recovery is assured.  Our accrued liability for environmental remediation costs is not significant and is included in the line item “Accrued liabilities” in the Consolidated Balance Sheets in “Item 8 – Financial Statements and Supplementary Data.”

We generally cannot reasonably estimate costs at sites in the very early stages of remediation.  Currently, we have two sites undergoing remediation, and there is no more than a remote chance that remediation costs at any individual site, or at all sites in the aggregate, will be material.

Our manufacturing facilities generally do not produce significant volumes or quantities of byproducts, including greenhouse gases, that would be considered hazardous waste or otherwise harmful to the environment.  We do not expect legislation currently pending or expected in the next several years to have a significant negative impact on our operations in any of our segments.

Domestic and foreign legislative initiatives on emissions control, renewable energy, and climate change tend to favorably impact the sale of our energy control products.  For example, our Energy segment produces inverters for wind turbines and energy control products that help our customers maximize engine efficiency and minimize wasteful emissions, including greenhouse gases.

Executive Officers of the Registrant

Information about our executive officers is provided below.  There are no family relationships between any of the executive officers listed below.

Thomas A. Gendron, Age 53. Chairman of the Board since January 2008; Chief Executive Officer, President, and Director since July 2005; Chief Operating Officer and President September 2002 through June 2005; Vice President and General Manager of Industrial Controls June 2001 through September 2002; Vice President of Industrial Controls April 2000 through May 2001; Director of Global Marketing and Industrial Controls’ Business Development February 1999 through March 2000.

Robert F. Weber, Jr., Age 60.  Vice Chairman, Chief  Financial Officer and Treasurer since September 2011, and Chief Financial Officer and Treasurer since August 2005.  Prior to August 2005, Mr. Weber was employed at Motorola, Inc. for 17 years, where he held various positions, including Corporate Vice President and General Manager - EMEA Auto.  Prior to this role, Mr. Weber served in a variety of financial positions at both a corporate and operating unit level with Motorola.

Martin V. Glass, Age 57.  President, Airframe Systems since April 2011; President, Turbine Systems October 2009 through April 2011; Group Vice President, Turbine Systems September 2007 through September 2009; Vice President of the Aircraft Engine Systems Customer Business Segment December 2002 through August 2007; Director of Sales, Marketing, and Engineering February 2000 through December 2002.

Sagar Patel, Age 48.  President, Aircraft Turbine Systems since June 2011.  Prior to this role, Mr. Patel was employed at General Electric for 18 years, most recently serving as President, Mechanical Systems, GE Aviation, from March 2009 through June 2010.  He served as President, Aerostructures, GE Aviation from July 2008 through July 2009 and as President and General Manager, MRS Systems, Inc., GE Aircraft Engines, from October 2005 through June 2008. 

Chad R. Preiss, Age 49.  President, Engine Systems since October 2009; Group Vice President, Engine Systems October 2008 through September 2009; Vice President, Sales, Service, and Marketing, Engine Systems December 2007 through September 2008; and Vice President, Industrial Controls September 2004 through December 2007.  Prior to this role, Mr. Preiss served in a variety of engineering and marketing/sales management roles, including Director of Business Development, since joining Woodward in 1988. 

James D. Rudolph, Age 53.  President, Industrial Turbomachinery Systems since April 2011; Corporate Vice President, Global Sourcing October 2009 through April 2011; Vice President, Global Sourcing April 2009 through October 2009; Director of Global Sourcing April 2005 through April 2009; Director of Engineering for Industrial Controls March 2000 through April 2005.  Prior to March 2000, Mr. Rudolph served in a variety of engineering, operations and sales roles since joining Woodward in 1984.

A. Christopher Fawzy, Age 45.  Corporate Vice President, General Counsel, Corporate Secretary and Chief Compliance Officer since October 2009; Vice President, General Counsel, and Corporate Secretary June 2007 through September 2009.  Mr. Fawzy became the Company’s Chief Compliance Officer in August 2009.  Prior to joining Woodward, Mr. Fawzy was employed by Mentor Corporation, a global medical device company.  He joined Mentor in 2001 and served as Corporate Counsel, then General Counsel in 2003, and was appointed Vice President, General Counsel and Secretary in 2004.

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Other Corporate Officers of the Registrant

Information about our other corporate officers is provided below. There are no family relationships between any of the corporate officers listed below or between any of the corporate officers listed below and the aforementioned executive officers.

Steven J. Meyer, Age 54. Corporate Vice President, Human Resources since October 2009; Vice President, Human Resources November 2006 through September 2009;  Director, Global Human Resources November 2002 through October 2006;  Director, Human Resources for Industrial Controls July 1997 through October 2002.  Prior to joining Woodward, Mr. Meyer was employed by PG&E Corporation and Nortel in a variety of roles in human resources.

Matthew F. Taylor, Age 52. Corporate Vice President, Supply Chain since February 2011; Vice President, Engine Fluid Systems and Controls Center of Excellence (“CoE”) October 2009 through February 2011; General Manager, Fluid Systems and Controls CoE December 2006 through October 2009; Director of Operations, Fluid Systems and Controls June 2005 through December 2006.  Prior to joining Woodward in June 2005, Mr. Taylor was the Vice President and General Manager, Warner Electric and served in a variety of general management roles at Eaton Corporation from February 1998 through August 2003.

Matt R Cook, Age 43. Corporate Vice President, Information Technology since January 2014; Director, Global Business Systems July 2012 through January 2014.  Prior to joining Woodward, Mr. Cook was employed by Satcon Corporation as Vice President, Global Information Technology.  Prior to Satcon, Mr. Cook served in a variety of senior roles in information technology and business development.

Information available on Woodward’s Website

Through a link on the Investor Information section of our website, www.woodward.com, we make available the following filings as soon as reasonably practicable after they are electronically filed or furnished to the SEC: our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements on Schedule 14A, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934.  None of the information contained on our website is incorporated into this document by reference.

Stockholders may obtain, without charge, a single copy of Woodward’s 2014 Annual Report on Form 10-K upon written request to the Corporate Secretary, Woodward, Inc., 1000 East Drake Road, Fort Collins, Colorado 80525.

 

Item 1A.Risk Factors

Investment in our securities involves risk.  An investor or potential investor should consider the risks summarized in this section when making investment decisions regarding our securities.

Important factors that could individually, or together with one or more other factors, affect our business, results of operations, financial condition, and/or cash flows include, but are not limited to, the following:

Company Risks

A decline in business with, or financial distress of, our significant customers could decrease our consolidated net sales or impair our ability to collect amounts due and payable and have a material adverse effect on our business, financial condition, results of operations and cash flows. 

We have fewer customers than many companies with similar sales volumes.  For the fiscal year ended September 30, 2014, approximately 39% of our consolidated net sales were made to our five largest customers.  Sales to these same five largest customers represented approximately 39% of our consolidated net sales for the fiscal year ended September 30, 2013.  Sales to our largest customer, General Electric, accounted for approximately 15% of our consolidated net sales in the fiscal year ended September 30, 2014, 15% in the fiscal year ended September 30, 2013, and 14% in the fiscal year ended September 30, 2012.  Accounts receivable from General Electric represented approximately 12% of accounts receivable at September 30, 2014 and 11% at September 30, 2013.  Sales to our next largest customer accounted for approximately 7% of our consolidated net sales in the fiscal year ended September 30, 2014, 7% in the fiscal year ended September 30, 2013, and 6% in the fiscal year ended September 30, 2012.  If any of our significant customers were to change suppliers, in-source production, institute significant restructuring or cost-cutting measures, or experience financial distress, these significant customers may substantially reduce or otherwise be unable to pay for purchases from us.  Accordingly, our consolidated net sales could decrease significantly or we may experience difficulty collecting or be unable to collect amounts due and payable, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

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Instability in the financial markets and global economic uncertainty could have a material adverse effect on the ability of our customers to perform their obligations to us and on their demand for our products and services.

During the last several years, there has been widespread concern over the instability in the financial markets and their influence on the global economy.  As a result of the extreme volatility in the credit and capital markets, sovereign credit rating downgrades and uncertainty surrounding European sovereign and other debt defaults, and global economic uncertainty, our current or potential customers may experience cash flow problems and, as a result, may modify, delay or cancel plans to purchase our products.  Additionally, if customers are not successful in generating sufficient revenue or are precluded from securing necessary financing, they may not be able to pay, or may delay payment of, accounts receivable that are owed to us.  Any inability of current or potential customers to pay us for our products may adversely affect our earnings and cash flows. 

In addition, the general economic environment significantly affects demand for our products and services.  Periods of slowing economic activity may cause global or regional slowdowns in spending on infrastructure development in the markets in which we operate, and customers may reduce their purchases of our products and services. 

There can be no assurance that any market and economic uncertainty in the United States or internationally would not have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Our profitability may suffer if we are unable to manage our expenses or if we experience change in product mix as a result of sales increases or decreases.

Some of our expenses are relatively fixed in relation to changes in sales volume and are difficult to adjust in the short term.  Expenses driven by business activity other than sales level, such as fixed manufacturing overhead and research and development costs, may be difficult to reduce in a timely manner in response to a reduction in sales.  Expenses such as depreciation or amortization, which are the result of past capital expenditures or business acquisitions, are generally fixed regardless of sales levels.  Due to the nature of our sales cycle, in periods of sales increases it may be difficult to rapidly increase our production of finished goods, particularly if such sales increases are unanticipated.  An increase in the production of our finished goods requires increases in both the purchases of raw materials and components and in the size of our workforce.  If a sudden, unanticipated need for raw materials, components and labor should arise in order to meet unexpected sales demand, we could experience difficulties in sourcing raw materials, components and labor at a favorable cost or to meet our production needs.  These factors could result in delays in fulfilling customer sales contracts, damage to our reputation and relationships with our customers, an inability to meet the demands of the markets that we serve, which in turn could prevent us from taking advantage of business opportunities or responding to competitive pressures, and result in an increase in variable and fixed costs leading to a decrease in net earnings or even net losses.  In addition, we sell products that have varying profit margins, and increases or decreases in sales of our various products may change the mix of products that we sell during any period.  Any of these events could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

The long sales cycle, customer evaluation process and implementation period of our products and services may increase the costs of obtaining orders and reduce the predictability of sales cycles and our inventory requirements.

Our products and services are technologically complex.  Prospective customers generally must commit significant resources to test and evaluate our products and to install and integrate them into larger systems.  Orders expected in one quarter may shift to another quarter or be cancelled with little advance notice as a result of customers’ budgetary constraints, internal acceptance reviews and other factors affecting the timing of customers’ purchase decisions.  In addition, customers often require a significant number of product presentations and demonstrations before reaching a sufficient level of confidence in the product’s performance and compatibility with the approvals that typically accompany capital expenditure approval processes.  The difficulty in forecasting demand increases the challenge in anticipating sales cycles and our inventory requirements, which may cause us to over-produce finished goods and could result in inventory write-offs, or could cause us to under-produce finished goods.  Any such over-production or under-production could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Our product development activities may not be successful, may be more costly than currently anticipated, or we may not be able to produce newly developed products at a cost that meets the anticipated product cost structure.

Our business involves a significant level of product development activities, generally in connection with our customers’ development activities.  Industry standards, customer expectations, or other products may emerge that could render one or more of our products or services less desirable or obsolete.  Maintaining our market position requires continued investment in research and development.  During an economic downturn or a subsequent recovery, we may need to maintain our investment in research and development, which may limit our ability to reduce these expenses in proportion to a sales shortfall.  In addition, increased investments in research and development may divert resources from other potential investments in our business, such as acquisitions or investments in our facilities, processes and operations.  If these activities are not as successful as currently anticipated, are not completed on a timely basis, or are more costly than currently anticipated, or if we are not able to produce newly developed products at a cost that meets the anticipated product cost

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structure, then our future sales, margins and/or earnings could be lower than expected, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Our business may be affected by government contracting risks.

Sales made directly to U.S. Government agencies and entities were 4% of total net sales during fiscal year 2014, 6% during fiscal year 2013, and 4% during fiscal year 2012, primarily in the aerospace market.  Sales made directly to U.S. Government agencies and entities, or indirectly through third party manufacturers, such as tier-one prime contractors, utilizing Woodward parts and subassemblies, accounted for approximately 17% of total sales in fiscal year 2014, 21% in fiscal year 2013, and 18% in fiscal year 2012.  Our contracts with the U.S. Government are subject to the following unique risks, some of which are beyond our control, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows. 

Product liability claims, product recalls or other liabilities associated with the products and services we provide may force us to pay substantial damage awards and other expenses that could exceed our accruals and insurance coverage.

The manufacture and sale of our products and the services we provide expose us to risks of product liability and other tort claims.  We currently have and have had in the past product liability claims relating to our products, and we will likely be subject to additional product liability claims in the future for both past and current products.  Some of these claims may have a material adverse effect on our business, financial condition, results of operations and cash flows.  We also provide certain services to our customers and are subject to claims with respect to the services provided.  In providing such services, we may rely on subcontractors to perform all or a portion of the contracted services.  It is possible that we could be liable to our

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customers for work performed by a subcontractor.  Regardless of the outcome, product liability claims can be expensive to defend, can divert the attention of management and other personnel for significant periods of time, and can cause reputational damage.  While we believe that we have appropriate insurance coverage available to us related to any such claims, our insurance may not cover all liabilities or be available in the future at a cost acceptable to us.  An unsuccessful result in connection with a product liability claim, where the liabilities are not covered by insurance or for which indemnification or other recovery is not available, could have a material adverse effect on our business, financial condition, results of operations, and cash flows. 

Suppliers may be unable to provide us with materials of sufficient quality or quantity required to meet our production needs at favorable prices or at all.

We are dependent upon suppliers for parts and raw materials used in the manufacture of components that we sell to our customers, and our raw material costs are subject to commodity market fluctuations.  We may experience an increase in costs for parts or raw materials that we source from our suppliers, or we may experience a shortage of parts or raw materials for various reasons, such as the loss of a significant supplier, high overall demand creating shortages in parts and supplies we use, financial distress, work stoppages, natural disasters, fluctuations in commodity prices, or production difficulties that may affect one or more of our suppliers.  In particular, current or future global economic uncertainty may affect our key suppliers in terms of their operating cash flow and access to financing.  This may in turn affect their ability to perform their obligations to us.  Our customers rely on us to provide on-time delivery and have certain rights if our delivery standards are not maintained.  A significant increase in our supply costs, including for raw materials that are subject to commodity price fluctuations, or a protracted interruption of supplies for any reason, could result in the delay of one or more of our customer contracts or could damage our reputation and relationships with customers.  In addition, quality and sourcing issues that our suppliers may experience can also adversely affect the quality and effectiveness of our products and services and may result in liability or reputational harm to us.  Any of these events could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Subcontractors may fail to perform contractual obligations, which would adversely affect our ability to meet our obligations to our customers.    

We frequently subcontract portions of work due under contracts with our customers and are dependent on the continued availability and satisfactory performance by these subcontractors.  Nonperformance or underperformance by subcontractors could materially impact our ability to perform obligations to our customers.  A subcontractor’s failure to perform could result in a customer terminating our contract for default, expose us to liability, substantially impair our ability to compete for future contracts and orders, and limit our ability to enforce fully all of our rights under these agreements, including any rights to indemnification.  Any of these events could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

We have engaged in restructuring and alignment activities from time to time and may need to implement further restructurings or alignments in the future, and there can be no assurance that our restructuring or alignment efforts will have the intended effects.

From time to time, we have responded to changes in our industry and the markets we serve by restructuring or aligning our operations.  Our restructuring activities have included workforce management and other restructuring charges related to our recently acquired businesses, including, among others, changes associated with integrating similar operations, managing our workforce, vacating or consolidating certain facilities and cancelling certain contracts.  Based on cost reduction measures or changes in the industry and markets in which we compete, we may decide to implement restructuring or alignment activities in the future, such as closing plants, moving production lines, or making additions, reductions or other changes to our management or workforce.

Restructuring and/or alignment activities can create unanticipated consequences, such as instability or distraction among our workforce, and we cannot be sure that any restructuring or alignment efforts that we undertake will be successful.  A variety of risks could cause us not to realize an expected cost savings, including, among others, the following:

If we are unable to structure our operations in the light of evolving market conditions, it could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

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Activities necessary to integrate acquisitions may result in costs in excess of current expectations or be less successful than anticipated.

We completed an acquisition of a business from GE Aviation Systems LLC in fiscal year 2013 and we may acquire other businesses in the future.  The success of these transactions will depend on, among other things, our ability to integrate assets and personnel acquired in these transactions and to apply our internal controls process to these acquired businesses.  The integration of these acquisitions may require significant attention from our management, and the diversion of management’s attention and resources could have a material adverse effect on our ability to manage our business.  In addition, we may incur unanticipated costs or expenses following an acquisition, including post-closing asset impairment charges, expenses associated with eliminating duplicate facilities, and other liabilities.

The risks associated with our past or future acquisitions also include, among others, the following:

Many of these factors will be outside of our control and any one of them could result in increased costs, decreases in the amount of expected revenues and diversion of management’s time and attention. Furthermore, we may not realize the degree or timing of benefits we anticipate when we first enter into these transactions.  Failure to implement our acquisition strategy, including successfully integrating acquired businesses, could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

We may not be able to obtain financing, on acceptable terms or at all, to implement our business plans, complete acquisitions, or otherwise take advantage of business opportunities or respond to competitive pressures.

During the last several years, global financial markets, including the credit and debt and equity capital markets, and economic conditions have been volatile.  These issues, along with significant write-offs in the financial services sector, the re-pricing of credit risk, sovereign credit rating downgrades, and the global economic uncertainty, have in the past made, and may in the future make, it difficult to obtain financing.  In addition, as a result of concerns about the stability of financial markets generally and the solvency of counterparties specifically, the cost of obtaining money from the credit markets may increase as many lenders and institutional investors have or may increase interest rates, enact tighter lending standards, refuse to refinance existing debt at maturity either at all or on terms similar to existing debt, and reduce and, in some cases, cease to provide financing to borrowers.  Due to these factors, we cannot be certain that financing, to the extent needed, will be available on acceptable terms or at all.  If financing is not available when needed, or is available only on unacceptable terms, we may be unable to implement our business plans, complete acquisitions, fund significant capital expenditures, or otherwise take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Our debt obligations and the restrictive covenants in the agreements governing our debt could limit our ability to operate our business or pursue our business strategies, and could adversely affect our business, financial condition, results of operations, and cash flows.

As of September 30, 2014, our total long-term debt was $710,000, including $210,000 of borrowings on our revolving credit facility.  Our debt obligations could require us to dedicate a portion of our cash flow from operations to payments on our indebtedness, reducing the availability of our cash flow for other purposes, including business development efforts and mergers and acquisitions.  We are contractually obligated under the agreements governing our long-term debt to make principal payments of $0 in fiscal year 2015, $107,000 in fiscal year 2016, $0 in fiscal year 2017, $0 in fiscal year 2018, and $393,000 in fiscal year 2019 and thereafter.  Interest on the majority of our long-term notes is payable semi-annually, with the exception of the Series J Notes which is payable quarterly, each year until all principal is paid.  Our debt obligations could make us more vulnerable to general adverse economic and industry conditions and could limit our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate, thereby placing us at a disadvantage to our competitors that have less indebtedness.

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Our existing revolving credit facility and note purchase agreements impose financial covenants on us and our subsidiaries that require us to maintain certain leverage ratios and minimum levels of consolidated net worth.  Certain of these agreements require us to repay outstanding borrowings with portions of the proceeds we receive from certain sales of property or assets and specified future debt offerings.

These financial covenants place certain restrictions on our business that may affect our ability to execute our business strategy successfully or take other actions that we believe would be in the best interests of our Company.  These restrictions include limitations or restrictions, among other things, on our ability and the ability of our subsidiaries to:

These agreements contain certain customary events of default, including certain cross-default provisions related to other outstanding debt arrangements.  Any breach of the covenants under these agreements or other event of default could cause a default under these agreements and/or a cross-default under our other debt arrangements, which could restrict our ability to borrow under our revolving credit facility.  If there were an event of default under certain provisions of our debt arrangements that was not cured or waived, the holders of the defaulted debt may be able to cause all amounts outstanding with respect to the debt instrument to be due and payable immediately.  Our assets and cash flow may not be sufficient to fully repay borrowings under our outstanding debt instruments if accelerated upon an event of default.  If we are unable to repay, refinance, or restructure our indebtedness as required, or amend the covenants contained in these agreements, the lenders or note holders may be entitled to obtain a lien or institute foreclosure proceedings against our assets.  Any of these events could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Additional tax expense or additional tax exposures could affect our future profitability.

In fiscal year 2014, approximately 35% of our earnings before income taxes was earned in jurisdictions outside the United States.  Accordingly, we are subject to income taxes in both the United States and various non-U.S. jurisdictions.  Our tax liabilities are dependent upon the distribution mix of operating income among these different jurisdictions.  Our tax expense includes estimates of additional tax that may be incurred and reflects various estimates, projections, and assumptions that could impact the valuation of our deferred tax assets and liabilities.  Our future operating results could be adversely affected by changes in the effective tax rate, including:

We derive a significant portion of our revenues from non-U.S. sales and are subject to the risks inherent in doing business in other countries.

In 2014, approximately 49% of our total sales were made to customers in jurisdictions outside of the United States (including products manufactured in the United States and sold outside the United States as well as products manufactured in international locations).  Accordingly, our business and results of operations are subject to risks associated with doing business internationally, including:

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We are also subject to U.S. laws prohibiting companies from doing business in certain countries, or restricting the type of business that may be conducted in these countries.  The cost of compliance with increasingly complex and often conflicting regulations governing various matters worldwide, including foreign investment, employment, import, export, business acquisitions, environmental and taxation matters, land use rights, property, and other matters, can also impair our flexibility in modifying product, marketing, pricing or other strategies for growing our businesses, as well as our ability to improve productivity and maintain acceptable operating margins.  We must also comply with restrictions on exports imposed under the U.S. Export Control Laws and Sanctions Programs.  These laws and regulations change from time to time and may restrict foreign sales.

In 2014, approximately 7% of our total sales were recorded in the Peoples’ Republic of China and we have significant operations in the Peoples’ Republic of China.  Our independent registered public accounting firm’s audit documentation related to their audit report included in this annual report may be located in the Peoples’ Republic of China.  The Public Company Accounting Oversight Board (“PCAOB”) currently cannot inspect audit documentation located in China and, as such, prevents the PCAOB from regularly evaluating audit work of any auditors that was performed in China, including that performed by our independent auditors in China.  As a result, investors may be deprived of the full benefits of PCAOB oversight of our global audits via their inspections.  The inability of the PCAOB to conduct inspections of audit work performed in China makes it more difficult to evaluate the effectiveness of our Chinese independent auditor’s audit procedures as compared to auditors in other jurisdictions that are subject to PCAOB inspections on all of their work.

In addition, in January 2014, an SEC Administrative Law Judge (“ALJ”) issued an initial decision concluding that each of the firms in China that are members of four largest firms in the world, which includes our audit firm, violated the SEC’s Rules of Practice by failing to produce audit work papers directly to the SEC.  The ALJ further determined that each of the four largest firms in China should be censured and barred from practicing before the SEC for a period of six months.  The sanctions set forth in the initial decision could be very serious for the Chinese audit firms with U.S. listings and U.S. companies with Chinese subsidiaries audited in China.  The initial decision has no binding legal effect until it is reviewed and endorsed by the SEC.  The SEC is currently facilitating settlement discussions among all parties. 

Sales and purchases in currencies other than the U.S. dollar expose us to fluctuations in foreign currencies relative to the U.S. dollar.  These exposures may change over time as our business and business practices evolve, and they could have a material adverse effect on our financial results and cash flows.  An increase in the value of the U.S. dollar could increase the real cost to our customers of our products in those markets outside the United States where we sell in U.S. dollars, and a weakened U.S. dollar could increase the cost of local operating expenses and procurement of raw materials to the extent that we must purchase components in foreign currencies.  Foreign currency exchange rate risk is reduced through several means, including the maintenance of local production facilities in the markets served, invoicing of customers in the same currency as the source of the products, prompt settlement of inter-company balances utilizing a global netting system, and limited use of foreign currency denominated debt.   While we monitor our exchange rate exposures and seek to reduce the risk of volatility, our actions may not be successful in significantly mitigating such volatility.

In addition, uncertain global economic conditions arising from circumstances such as slowing growth in emerging regions and credit rating downgrades in certain European countries or speculation regarding changes to the composition or viability of the Euro zone could result in reduced customer confidence and decreased demand for our products and services, disruption in payment patterns and higher default rates, a tightening of credit markets, increased risk regarding supplier performance, increased counterparty risk with respect to the financial institutions with which we do business, and exchange rate fluctuations.  While we employ comprehensive controls regarding global cash management to guard against cash or investment loss and to ensure our ability to fund our operations and commitments, a material disruption to the financial institutions with whom we transact business could have a material adverse effect on our international operations or on our business, financial condition, results of operations, and cash flows.

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Changes in the estimates of fair value of reporting units or of long-lived assets, specifically goodwill, may result in future impairment charges, which could have a material adverse effect on our business, financial condition, results of operations and  cash flows.

Over time, the fair values of long-lived assets change.  At September 30, 2014, we had $559,724 of goodwill, representing 23% of our total assets.  We test goodwill for impairment at the reporting unit level on an annual basis 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.  Based on the relevant U.S. GAAP authoritative guidance, we aggregate components of a single operating segment into a reporting unit, if appropriate.   Future goodwill impairment charges may occur if estimates of fair values decrease, which would reduce future earnings.  We also test property, plant, and equipment and other intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  Future asset impairment charges may occur if asset utilization declines, if customer demand decreases, or for a number of other reasons, which would reduce future earnings.  Any such impairment charges could have a material adverse effect on our business, financial condition, results of operations, and cash flows.  Impairment charges would also reduce our consolidated stockholders’ equity and increase our debt-to-total-capitalization ratio, which could negatively impact our credit rating and access to the debt and equity markets.

We completed our annual goodwill impairment test during the quarter ended September 30, 2014.  In performing the annual goodwill impairment test, we determined it was appropriate to aggregate certain components of the same operating segment into a single aggregated reporting unit.  The identification of reporting units and consideration of aggregation criteria requires management’s judgment.  Further, we use the income approach based on a discounted cash flow method that incorporates various estimates and assumptions.  The results of our fiscal year 2014 annual goodwill impairment test performed as of July 31, 2014 indicated the estimated fair values of each of our reporting units were in excess of their carrying amounts, and accordingly, no impairment existed.  There can be no assurance that our estimates and assumptions of the fair value of our reporting units, the current economic environment, the level of U.S. defense spending, or the other inputs used in forecasting the present value of forecasted cash flows used to estimate the fair value of our reporting units will prove to be accurate projections of future performance.

As part of our ongoing monitoring efforts, we will continue to consider the global economic environment and its potential impact on our businesses, as well as other factors, in assessing goodwill and long-lived assets for possible indications of impairment.

Manufacturing activities may result in future environmental costs or liabilities.

We use hazardous materials and/or regulated materials in our manufacturing operations.  We also own, operate, and may acquire facilities that were formerly owned and operated by others that used such materials.  The risk that a significant release of regulated materials has occurred in the past or will occur in the future cannot be completely eliminated or prevented.  As a result, we are subject to a substantial number of costly regulations.  In particular, we are required to comply with increasingly stringent requirements of federal, state, and local environmental, occupational health and safety laws and regulations in the United States, the European Union, and other territories, including those governing emissions to air, discharges to water, noise and odor emissions, the generation, handling, storage, transportation, treatment and disposal of waste materials, and the cleanup of contaminated properties and human health and safety.  Compliance with these laws and regulations results in ongoing costs.  We cannot be certain that we have been, or will at all times be, in complete compliance with all environmental requirements, or that we will not incur additional material costs or liabilities in connection with these requirements.  As a result, we may incur material costs or liabilities or be required to undertake future environmental remediation activities that could damage our reputation and have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Our performance depends on continued access to a stable workforce and on favorable labor relations with our employees.

Certain of our operations in the United States and internationally involve different employee/employer relationships and the existence of works’ councils.  In addition, a portion of our workforce is unionized and is expected to remain unionized for the foreseeable future.  Competition for technical personnel in the industries in which we compete is intense.  Our future success depends in part on our continued ability to hire, train, assimilate, and retain qualified personnel.  There is no assurance that we will continue to be successful in recruiting qualified employees in the future.  Any significant increases in labor costs, deterioration of employee relations, including any conflicts with works’ councils or unions, or slowdowns or work stoppages at any of our locations, whether due to employee turnover, changes in availability of qualified technical personnel, or otherwise, could have a material adverse effect on our business, our relationships with customers, and our financial condition, results of operations, and cash flows.

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Operations and suppliers may be subject to physical and other risks, including natural disasters, that could disrupt production and have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our operations include principal facilities in the United States, China, Germany, and Poland. In addition, we operate sales and service facilities in Brazil, Bulgaria, India, Japan, the Netherlands, the Republic of Korea, Russia, Switzerland and the United Kingdom. We also have suppliers for materials and parts inside and outside the United States. Our operations and sources of supply could be disrupted by unforeseen events, including fires, tornadoes, tsunamis, hurricanes, earthquakes, floods and other forms of severe weather in the United States or in other countries in which we operate or in which our suppliers are located, any of which could adversely affect our operations and financial performance.  Natural disasters, public health concerns, war, political unrest, terrorist activity, equipment failures, power outages, or other unforeseen events could result in physical damage to, and complete or partial closure of, one or more of our manufacturing facilities, or could cause temporary or long-term disruption in the supply of component products from some local and international suppliers, disruption in the transport of our products and significant delays in the shipment of products and the provision of services, which could in turn cause the loss of sales and customers.  Existing insurance arrangements may not provide protection for all of the costs that may arise from such events.  Accordingly, disruption of our operations or the operations of a significant supplier could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Our intellectual property rights may not be sufficient to protect all our products or technologies.

Our success depends in part on our ability to obtain patents or rights to patents, protect trade secrets and know-how, and prevent others from infringing on our patents, trademarks, and other intellectual property rights.  Some of our intellectual property is not covered by patents (or patent applications) and includes trade secrets and other know-how that is not patentable or for which we have elected not to seek patent protection, including intellectual property relating to our manufacturing processes and engineering designs.  We will be able to protect our intellectual property from unauthorized use by third parties only to the extent that it is covered by valid and enforceable patents, trademarks, or licenses.  Patent protection generally involves complex legal and factual questions and, therefore, enforceability of patent rights cannot be predicted with certainty; thus, any patents that we own or license from others may not provide us with adequate protection against competitors.  Moreover, the laws of certain foreign countries do not recognize intellectual property rights or protect them to the same extent as do the laws of the United States.  Additionally, our commercial success depends significantly on our ability to operate without infringing upon the patent and other proprietary rights of others.  Our current or future technologies may, regardless of our intent, infringe upon the patents or violate other proprietary rights of third parties.  In the event of such infringement or violation, we may face expensive litigation or indemnification obligations and may be prevented from selling existing products and pursuing product development or commercialization.  If we are unable to sufficiently protect our patent and other proprietary rights or if we infringe on the patent or proprietary rights of others, our business, financial condition, results of operations, and cash flows could be materially adversely affected.

Amounts accrued for contingencies may be inadequate to cover the amount of loss when the matters are ultimately resolved.

In addition to intellectual property and product liability matters, we are currently involved or may become involved in claims, pending or threatened litigation or other legal proceedings, investigations or regulatory proceedings regarding employment or other regulatory, legal, or contractual matters arising in the ordinary course of business.  There is no certainty that the results of these matters will be favorable to the Company.  We accrue for known individual matters if we believe it is probable that the matter will result in a loss when ultimately resolved using estimates of the most likely amount of loss.  There may be additional losses that have not been accrued, or liabilities may exceed our estimates, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws and regulations.

The U.S. Foreign Corrupt Practices Act (“FCPA”) and similar anti-bribery laws and regulations in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to non-U.S. government officials for the purpose of obtaining or retaining business or securing an improper business advantage.  Our policies mandate compliance with these anti-bribery laws.  However, we operate in many parts of the world and sell to industries that have experienced corruption to some degree.  If we are found to be liable for FCPA or other similar anti-bribery law or regulatory violations, whether due to our or others’ actions or inadvertence, we could be subject to civil and criminal penalties or other sanctions that could have a material adverse impact on our business, financial condition, results of operations and cash flows.

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Our net postretirement benefit obligation liabilities may grow, and the fair value of our pension plan assets may decrease, which could require us to make additional and/or unexpected cash contributions to our pension plans, increase the amount of postretirement benefit expenses, affect our liquidity or affect our ability to comply with the terms of our outstanding debt arrangements.

Accounting for retirement, pension and postretirement benefit obligations and related expense requires the use of assumptions, including a weighted-average discount rate, an expected long-term rate of return on assets, and a net healthcare cost trend rate, among others.  Benefit obligations and benefit costs are sensitive to changes in these assumptions.  As a result, assumption changes could result in increases in our obligation amounts and expenses.  If interest rates decline, the present value of our postretirement benefit plan liabilities may increase faster than the value of plan assets, resulting in significantly higher unfunded positions in some of our pension plans.  As of September 30, 2014, we had $205,161 in invested pension plan assets.  Investment losses may result in decreases to our pension plan assets.

Funding estimates are based on certain assumptions, including discount rates, interest rates, mortality, fair value of assets and expected return on plan assets and are subject to changes in government regulations in the countries in which our employees work.  Volatility in the financial markets may impact future discount and interest rate assumptions.  Significant changes in investment performance or a change in the portfolio mix of invested assets can result in increases or decreases in the valuation of plan assets or in a change of the expected rate of return on plan assets.  Also, new accounting standards on fair value measurement may impact the calculation of future funding levels.  We periodically review our assumptions, and any such revision can significantly change the present value of future benefits, and in turn, the funded status of our pension plans and the resulting periodic pension expense.  Changes in our pension benefit obligations and the related net periodic costs or credits may occur as a result of variances of actual results from our assumptions, and we may be required to make additional cash contributions in the future beyond those which have been estimated.

In addition, our existing revolving credit facility and note purchase agreements contain continuing covenants and events of default regarding our pension plans, including provisions regarding the unfunded liabilities related to those pension plans.  See the discussion above concerning “Our debt obligations and the restrictive covenants in the agreements governing our debt could limit our ability to operate our business or pursue our business strategies, and could adversely affect our business, financial condition, results of operations, and cash flows.” 

To the extent that the present values of benefits incurred for pension obligations are greater than values of the assets supporting those obligations or if we are required to make additional or unexpected contributions to our pension plans for any reason, our ability to comply with the terms of our outstanding debt arrangements, and our business, financial condition, results of operations, and cash flows may be adversely affected.

Our business operations may be adversely affected by information systems interruptions or intrusion.

We are dependent on various information technologies throughout our company to administer, store and support multiple business activities.  If these systems are damaged, cease to function properly or are subject to cybersecurity attacks, such as unauthorized access, malicious software and other violations, we could experience production downtimes, operational delays, other detrimental impacts on our operations or ability to provide products and services to our customers, the compromising of confidential or otherwise protected information, destruction or corruption of data, security breaches, other manipulation or improper use of our systems or networks, financial losses from remedial actions, loss of business or potential liability, and/or damage to our reputation, any of which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.  While we attempt to mitigate these risks by employing a number of measures, including technical security controls, employee training, comprehensive monitoring of our networks and systems, and maintenance of backup and protective systems, our systems, networks, products, solutions and services remain potentially vulnerable to additional known or unknown threats. 

Industry Risks

Unforeseen events may occur that significantly reduce commercial aviation.

A significant portion of our business is related to commercial aviation.  Global economic downturn and uncertainty in the marketplace typically lead to a general reduction in demand for air transportation services, leading some airlines to withdraw aircraft from service, which negatively affects sales of our aerospace components and services.  These economic conditions can similarly affect our sales of systems and components for new business jet aircraft.  The commercial airline industry tends to be cyclical and capital spending by airlines and aircraft manufacturers may be influenced by a variety of factors, including current and future traffic levels, aircraft fuel pricing, labor issues, competition, the retirement of older aircraft, regulatory changes, terrorism and related safety concerns, general economic conditions, worldwide airline profits and backlog levels.  In the event these or other economic indicators stagnate or worsen, market demand for our components and systems could be negatively affected by renewed reductions in demand for air transportation services or commercial airlines’ financial difficulties, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

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The U.S. Government may change acquisition priorities and/or reduce spending.

The U.S. Government participates in a wide variety of operations, including homeland defense, counterinsurgency, counterterrorism, and other defense-related operations that employ our products and services.  U.S. defense spending has historically been cyclical in nature, and defense budgets tend to rise when perceived threats to national security increase the level of concern over the country’s safety.  The U.S. Government continues to adjust its funding priorities in response to changes in the perceived threat environment.  In addition, defense spending currently faces pressures due to the overall economic and political environment, budget deficits, and competing budget priorities.  A decrease in U.S. Government defense spending or changes in the spending allocation could result in one or more of our programs being reduced, delayed, or terminated. 

The Budget Act triggered automatic reductions, under sequestration, in both defense and discretionary spending in March 2013.  The resulting automatic across-the-board budget cuts in sequestration have had and will likely continue to have significant consequences for the aerospace and defense industries.  The effects of these actions on our fiscal year 2014 results were realized in our reduced defense sales, and the impact in future years, could continue to have an adverse effect on our business, financial condition, results of operations and cash flows.

Shifts in domestic and international spending and tax policy, changes in security, defense, and intelligence priorities, changes in government budget appropriations, general and political economic conditions and developments, and other factors may affect a decision to fund, or the level of funding for, existing or proposed programs.  If the priorities of the U.S. Government change and/or defense spending is reduced, this may adversely affect our business, financial condition, results of operations, and cash flows.

Increasing emission standards that drive certain product sales may be eased or delayed.

We sell components and systems that have been designed to meet strict emission standards, including standards that have not yet been implemented but are expected to be implemented soon.  If these emission standards are eased, developed products may become unnecessary and/or our future sales could be lower as potential customers select alternative products or delay adoption of our products, which would have a material adverse effect on our business, financial condition, results of operations, and cash flows. 

Natural gas prices may increase significantly and disproportionately to other sources of fuels used for power generation.

Commercial producers of electricity use many of our components and systems, most predominately in their power plants that use natural gas as their fuel source.  Commercial producers of electricity are often in a position to manage the use of different power plant facilities and make decisions based on operating costs.  Compared to other sources of fuels used for power generation, natural gas prices have increased slower than fuel oil, but about the same as coal.  This increase in natural gas prices and any future increases could decrease the use of our components and systems, which could have a material adverse affect on our business, financial condition, results of operations, and cash flows. 

Changes in government subsidy programs and regulatory requirements may result in decreased demand for our products.

The U.S. Government, as well as various foreign governments, provide for various stimulus programs or subsidies, such as grants, loan guarantees and tax incentives, relating to renewable energy, alternative energy, energy efficiency and electric power infrastructure. Some of these programs have expired, which may affect the economic feasibility or timing of future projects. Additionally, while a significant amount of stimulus funds and subsidies are available to support various projects, we cannot predict the timing and scope of any investments to be made by our customers under stimulus funding and subsidies or whether stimulus funding and subsidies will result in increased demand for our products. Investments for renewable energy, alternative energy and electric power infrastructure under stimulus programs and subsidies may not occur, may be less than anticipated or may be delayed, any of which would negatively impact demand for our products.

Other current and potential regulatory initiatives may not result in increased demand for our products.  It is not certain whether existing regulatory requirements will create sufficient incentives for new projects, when or if proposed regulatory requirements will be enacted, or whether any potentially beneficial provisions will be included in the regulatory requirement.

Uncertainty with respect to government subsidy programs and regulatory requirements could cause decreased demand for our products as investments are delayed or become economically unfeasible, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows. 

We operate in a highly competitive industry.

We face intense competition from a number of established competitors in the United States and abroad, some of which are larger in size or are divisions of large diversified companies with substantially greater financial resources.  In addition, global competition continues to increase.  Companies compete on the basis of providing products that meet the needs of

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customers, as well as on the basis of price, quality, and customer service.  Changes in competitive conditions, including the availability of new products and services, the introduction of new channels of distribution, and changes in OEM and aftermarket pricing, could impact our relationships with our customers and may adversely affect future sales, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Competitors may develop breakthrough technologies that are adopted by our customers.

The markets in which we operate experience rapidly changing technologies and frequent introductions of new products and services.  The technological expertise we have developed and maintained could become less valuable if a competitor were to develop a breakthrough technology that would allow it to match or exceed the performance of existing technologies at a lower cost.  If we are unable to develop competitive technologies, future sales or earnings could be lower than expected, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Industry consolidation trends could reduce our sales opportunities, decrease sales prices, and drive down demand for our products.

There has been consolidation and there may be further consolidation in the aerospace, power, and process industries.  The consolidation in these industries has resulted in customers with vertically integrated operations, including increased in-sourcing capabilities, which may result in economies of scale for those companies.  If our customers continue to seek to control more aspects of vertically integrated projects, cost pressures resulting in further integration or industry consolidation could reduce our sales opportunities, decrease sales prices, and drive down demand for our products, which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

Investment Risks

The historic market price of our common stock may not be indicative of future market prices.

The market price of our common stock has fluctuated over time.  Stock markets in general have experienced extreme price and volume volatility particularly over the past few years.  The trading price of our common stock ranged from a high of $55.76 per share to a low of $38.80 per share during the twelve months ended September 30, 2014.  The following factors, among others, could cause the price of our common stock in the public market to fluctuate significantly:

Fluctuations in our stock price often occur without regard to specific operating performance.  The price of our common stock could fluctuate based upon the above factors or other factors, including those that have little to do with our company, and these fluctuations could be material.

The typical trading volume of our common stock may affect an investor’s ability to sell significant stock holdings in the future without negatively affecting stock price.

As of September 30, 2014, we had 72,960 shares of common stock issued, of which 7,397 shares were held as treasury shares.  In addition, 4,525 shares were reserved for issuance upon exercise of outstanding stock-based compensation awards.  While the level of trading activity will vary each day, the typical trading level represents only a small percentage of total shares of stock outstanding.  As a result, a stockholder who sells a significant number of shares of stock in a short period of time could negatively affect our share price.

Certain anti-takeover provisions of our charter documents and under Delaware law could discourage or prevent others from acquiring our company.

Our certificate of incorporation and bylaws contain provisions that:

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In addition, Section 203 of the Delaware General Corporation Law limits business combinations with owners of more than 15% of our stock that have not been approved by the board of directors.  These provisions and other similar provisions make it more difficult for a third party to acquire us without negotiation.  Our board of directors could choose not to negotiate a potential acquisition that it does not believe to be in our best interest.  Accordingly, the potential acquirer could be discouraged from offering to acquire us, or could be prevented by the anti-takeover measures, from successfully completing a hostile acquisition.

Item 1B.Unresolved Staff Comments

None.

 

Item 2.Properties

Our principal plants are as follows:

United States 

Duarte, California – Aerospace segment manufacturing and engineering

Fort Collins, Colorado – Corporate headquarters and Energy segment manufacturing and engineering

Greenville, South Carolina (leased) – Energy segment manufacturing and Aerospace and Energy segments engineering

Loveland, Colorado – Energy segment manufacturing and engineering

Rockford, Illinois – Aerospace segment manufacturing and engineering

Santa Clarita, California – Aerospace segment manufacturing and engineering

Skokie, Illinois (leased) – Aerospace segment manufacturing and Aerospace and Energy segments engineering

Zeeland, Michigan – Aerospace segment manufacturing and engineering

Other Countries

Aken, Germany (leased) – Energy segment manufacturing and engineering

Kempen, Germany – Energy segment manufacturing and engineering

Krakow, Poland – Energy segment manufacturing and Aerospace and Energy segments engineering

Tianjin, Peoples’ Republic of China (leased) – Energy segment assembly

In addition to the principal plants listed above, we own or lease other facilities used primarily for sales and service activities in Brazil, Bulgaria, China, India, Japan, the Netherlands, the Republic of Korea, Russia, the United Kingdom, Germany, and the United States.

We are currently developing a second campus in the greater-Rockford, Illinois area for our Aerospace segment.  This campus is intended to support the growth expected over the next ten years and beyond stimulated by our being awarded a substantial number of new system platforms, particularly on narrow-body aircraft.  These investments are expected to result in future productivity gains for our existing and new business.  However, given the significance of the anticipated volumes associated with the new system platforms, we still expect our Rockford area workforce to increase substantially, by as much as 70%-90% from current levels, by the end of 2021.  In addition, in September 2013, we invested in a building site in Niles, Illinois.  We are building a new facility on this site for our Aerospace segment and will relocate some of our operations currently residing in nearby Skokie, Illinois, to this new facility.  We are also developing a new campus at our corporate headquarters in Fort Collins, Colorado to support the continued growth of our Energy segment by supplementing our existing Colorado manufacturing facilities and corporate headquarters.  We anticipate investing approximately $500,000 through fiscal year 2016 in land, buildings and equipment among our two Rockford, Illinois area campuses, the facility in Niles, Illinois, and a new campus at our corporate headquarters in Fort Collins, Colorado and to date have spent approximately $200,000 related to these investments. 

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Our remaining principal plants are suitable and adequate for the manufacturing and other activities performed at those plants, and we believe our utilization levels are generally high. 

Item 3.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 4.Mine Safety Disclosures

Not applicable.

PART II

Item 5.Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is listed on The NASDAQ Global Select Market and is traded under the symbol “WWD.”  At November 7,  2014, there were approximately 1,100 holders of record. 

The following table sets forth the high and low sales prices of our common stock and dividends paid for the periods indicated.

 

 

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Performance Graph

The following graph compares the cumulative 10-year total return to stockholders on our common stock relative to the cumulative total returns of the S&P Midcap 400 index and the S&P Industrial Machinery index.  The graph shows total stockholder return assuming an investment of $100 (with reinvestment of all dividends) was made on September 30, 2004 in our common stock and in each of the two indexes and tracks relative performance through September 30, 2014.  We have used a period of 10 years as we believe that our stock performance should be reviewed over a period that is reflective of our long-term business cycle. 

 

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

 

 

 

Item 6. Selected Financial Data

The following selected financial data should be read in conjunction with the Consolidated Financial Statements and related notes which appear in “Item 8 – Financial Statements and Supplementary Data” of this Form 10-K.

 

 

 

 

 

Notes:

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Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Woodward enhances the global quality of life and sustainability by optimizing energy use through improved efficiency and lower emissions.  We are an independent designer, manufacturer, and service provider of energy control and optimization solutions.  We design, produce and service reliable, efficient, low-emission, and high-performance energy control products for diverse applications in challenging environments.  We have significant production and assembly facilities in the United States, Europe and Asia, and promote our products and services through our worldwide locations. 

Our strategic focus is providing control solutions for the aerospace and energy markets.  The precise and efficient control of energy, including fluid and electrical energy, combustion, and motion, is a growing requirement in the markets we serve.  Our customers look to us to optimize the efficiency, emissions and operation of power equipment in both commercial and defense operations.  Our core technologies leverage well across our markets and customer applications, enabling us to develop and integrate cost-effective and state-of-the-art fuel, combustion, fluid, actuation and electronic systems.  We focus primarily on serving OEMs and equipment packagers, partnering with them to bring superior component and system solutions to their demanding applications.  We also provide aftermarket repair, replacement and other service support for our installed products.

Our components and integrated systems optimize performance of commercial aircraft, defense aircraft, ground vehicles and other equipment, gas and steam turbines, wind turbines, including converters and power grid related equipment, industrial diesel, gas, alternative and dual fuel reciprocating engines, and electrical power systems.  Our innovative fluid energy, combustion control, electrical energy, and motion control systems help our customers offer more cost-effective, cleaner, and more reliable equipment. 

Management’s discussion and analysis should be read together with the Consolidated Financial Statements and Notes included in this report.  Dollar and number of share amounts contained in this discussion and elsewhere in this Annual Report on Form 10-K are in thousands, except per share amounts.

 

BUSINESS ENVIRONMENT AND TRENDS

We serve the aerospace and energy markets. 

Aerospace Markets

Our aerospace products and systems are primarily used to provide propulsion, actuation and motion control in both commercial and defense fixed-wing aircraft and rotorcraft, as well as in other defense systems.

Commercial and Civil Aircraft – In the commercial aerospace markets, global air traffic continued to grow in fiscal year 2014.  Commercial aircraft production has increased as aircraft operators continue to take delivery of more fuel efficient aircraft and retire older, less efficient aircraft.  This trend toward more fuel efficient aircraft favors our product offerings because we have more content on the newer generation of aircraft that have recently entered service or are scheduled to go into production over the next several years.  We have been awarded content on the Airbus A320neo, Bell 429, Boeing 737 MAX, 787 and 747-8, Bombardier CSeries, Comac 919, Irkut MS-21 and a variety of business jet platforms, among others.  We continue to explore opportunities on new engine and aircraft programs that are under consideration or have been recently announced.

Defense – The defense industry has been negatively impacted by the sequestration of appropriations under the Budget Act, as well as threats of additional budget cuts and related program delays.  Our involvement with a wide variety of defense programs in fixed-wing aircraft, rotorcraft and weapons systems has provided relative stability for our defense market sales, although the levels of future defense spending remain uncertain.  Key programs on which our deliveries have been stable or growing include the F/A-18 E/F, the F-35 (Joint Strike Fighter), and the Black Hawk and Apache helicopter programs.  We have significant motion control system content for the refueling boom on the KC-46A refueling tanker program, which continues in development.  Weapons programs for which we have significant sales include the JDAM, SDB and AIM9X guided tactical weapon systems.

Aftermarket – Our commercial aftermarket business has increased as our products have been selected for new aerospace platforms and our content has increased across existing platforms.  We have experienced the strongest gains in commercial aftermarket sales related to programs like Airbus A320 and Boeing 777.  While some legacy programs have been negatively impacted by the availability of surplus hardware from aircraft retirements (and subsequent disassembly for parts re-use)

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combined with increasingly tight budget control by airline maintenance departments, growth at better-than-market levels returned in fiscal year 2014.  U.S. Government sustainment funds continue to be prioritized to defense aircraft platforms on which we have content and accordingly, our defense aftermarket has remained steady throughout this cycle.  While fiscal year 2014 sales were impacted by completion or peaking in fiscal year 2013 of some major upgrades/overhaul programs, we expect such programs to resume in 2015 and to contribute to an improved defense aftermarket performance.  

Energy Markets

Our energy products are used worldwide in various types of turbine- and engine-powered equipment, including electric power generation and distribution systems, ships, locomotives, compressors, pumps, and other mobile and industrial machines.

Industrial Turbines and Compressors – In fiscal year 2014, the industrial turbine and compressor market continued slow growth with some positive signs of acceleration.  Demand for rotating equipment is increasing in Asia and specifically China, while Europe remains slow and North America steady.   

We believe we are well positioned in the gas turbine market, supporting our customers with high reliability systems enabling efficiency gains and maintaining emissions compliance.  It is expected that demand for gas turbines will increase to meet long-term power needs and due to the inherent flexibility of gas turbines.  Start reliability, fuel flexibility, and part load efficiency are all key drivers, and we believe Woodward is well positioned to meet these demands on the next generation gas turbine.  Additionally, gas turbine aftermarket sales and services demonstrated significant growth in 2014 as owner/operators worked with the OEMs upgrading equipment to meet new demands, and this growth is expected to continue.

In the oil and gas process industry, demand for industrial gas, steam turbines and compressors is expected to grow, primarily due to increased supply of non-conventional natural gas and oil and increased global trade of natural gas.  Extraction, production, distribution and processing of oil and gas products utilize both gas and steam turbines, as well as compressors.  Most of the current growth is in upstream (extraction/production) applications, although downstream (petrochemical, refining) applications are also expected to increase in the coming period as the supporting infrastructure is built out.  Liquefied Natural Gas production, gas-to-liquids processing, gas processing, oil refining and other chemical refining processes drive demand for gas/steam turbines and compressor applications.  We believe we are well positioned to capture many of these opportunities with a renewed steam turbine portfolio and expanded focus on compressor controls.

Reciprocating Engines – While industrial production strengthened slowly in the United States during fiscal year 2014, there was slowing growth in the key China markets and a decline in much of Europe.

We experienced increased demand for control systems and components used on large industrial gas engines, which we believe was driven by increased market interest in using a relatively clean burning and low cost fuel, as well as increased use of low-heat-content gases recovered from coal mines and bio waste streams.  We also experienced increased demand for controls and systems used on large industrial diesel engines, which reflects strengthening in orders for ships and other large engine-powered equipment.

While demand for our control systems used on natural gas-fueled mobile and industrial equipment remained very strong, we believe short-term natural gas supply shortages and fuel price increases in some key international markets limited growth.  Demand for our controls used on small diesel engines in construction and other industrial equipment declined slightly this year.

Longer term, government emissions requirements across many regions and engine applications is driving demand for higher-technology control systems, as is customer demand for improved engine efficiencies.  Energy policies in some countries encourage the use of natural gas and other alternative fuels over carbon-rich petroleum fuels, which we expect will drive increased demand for our alternative fuel clean engine control technologies over the next five years.

Renewable Power – The renewable power industry, although strengthened in fiscal year 2014, remains challenged as a result of concerns regarding government support, competitive pricing, and capacity and credit availability in the credit markets for wind and solar projects.  We expect the uncertainty regarding government renewable mandates and subsidies will contribute to continued volatility in the renewable energy industry.  In the longer term, we anticipate improvement in the market as demand for low emission power sources increases and technology advancements allow renewable energy to be more competitive with conventional energy sources.

Electrical Power Generation and Distribution – While various OEM customers have indicated a weakness in the power generation markets during fiscal year 2014, demand for Woodward controls for power generation and power distribution applications has held fairly steady.  While slow economic growth has moderated the stress on utility generation capacity and electrical grid infrastructures, demand for power generation controls used on wind turbines and in critical power applications – such as back-up power supply at data centers – has remained strong.

Looking forward, we anticipate that integration of renewable energy sources into the grid and increased global energy demand will drive new opportunities for advanced control and protection solutions.

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RESULTS OF OPERATIONS

Non-U.S. GAAP Financial Measures

EBIT, EBITDA, and free cash flow

Earnings before interest and taxes (“EBIT”), earnings before interest, taxes, depreciation and amortization (“EBITDA”), Energy segment net sales without the renewable power business, Energy segment earnings without the renewable power business, and free cash flow are financial measures not prepared and presented in accordance with U.S. GAAP.

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 fiscal years ended September 30, 2014, September 30, 2013 and September 30, 2012  were as follows:

 

In addition to the above non-U.S. GAAP financial measures, in fiscal year 2013 we used the following financial measures: Energy segment net sales without the renewable power business and Energy segment earnings without the renewable power business, which are financial measures not prepared and presented in accordance with U.S. GAAP.  For further discussion of these non-U.S. GAAP measures, see the Energy discussion in “Segment Results” under the caption “2013 Segment Results Compared to 2012.” 

The use of any 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, EBITDA,  Energy segment net sales without the renewable power business, and Energy segment earnings without the renewable power business exclude certain financial information compared with net earnings, segment net sales and segment earnings, the most comparable U.S. GAAP financial measures, users of this financial information should consider the information that is excluded.  Our calculations of EBIT, EBITDA, Energy segment net sales without the renewable power business, and Energy segment earnings may differ from similarly titled measures used by other companies, limiting their usefulness as comparative measures. 

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

Management uses free cash flow, which is defined as net cash flows provided by operating activities less payments for property, plant and equipment, in reviewing the financial performance of Woodward’s various business groups and evaluating cash levels.  Securities analysts, investors, and others frequently use free cash flow in their evaluation of companies.  The use of this non-U.S. GAAP financial measure 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.  Free cash flow does not necessarily represent funds available for discretionary use and is not necessarily a measure of our ability to fund our cash needs.  Our calculation of free cash flow may differ from similarly titled measures used by other companies, limiting its usefulness as a comparative measure.

 

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Free cash flow for the fiscal years ended September 30, 2014, September 30, 2013 and September 30, 2012 were as follows:

 

 

Operational Highlights

Net sales for fiscal year 2014 increased 3.4% to $2,001,240 from $1,935,976 for fiscal year 2013.  Net sales for fiscal year 2014, excluding the Duarte Business (discussed below) for the first three months of fiscal year 2014, were $1,969,808, an increase of 1.7% from the prior fiscal year. 

Net earnings for fiscal year 2014 were $165,844, or $2.45 per diluted share, an increase in net earnings of 13.6% compared to $145,942, or $2.10 per diluted share, in fiscal year 2013.  During the third quarter of fiscal year 2013, net earnings included specific charges of $15,707, or $0.17 per diluted share, related to the realignment of our renewable power business.  The effective tax rate in fiscal year 2014 was 27.0%, compared to 26.9% for the prior fiscal year.

EBIT increased by $23,776, or 10.5%, to $249,777 in fiscal year 2014, compared to $226,001 for fiscal year 2013.  The prior year’s EBIT included the $15,707 of specific charges related to our renewable power business.  EBITDA for fiscal year 2014 was $327,130, an increase of 9.0% from $300,234 for the same period of fiscal year 2013.    

Duarte Business Acquisition

On December 27, 2012, Woodward entered into a definitive asset purchase agreement with GE Aviation Systems LLC (the “Seller”) and General Electric Company for the acquisition of substantially all of the assets and certain liabilities related to the Seller’s thrust reverser actuation systems business located in Duarte, California (the “Duarte Business”) for an aggregate purchase price of $200,000.  The sale was completed on December 28, 2012, and we paid cash at closing in the amount of $198,900.

The Duarte Business develops and manufactures motion control technologies and platforms, more specifically thrust reverser actuation systems.  The Duarte Business serves customers such as Airbus, Boeing, General Electric, Safran and the U.S. Government.  Its products are used primarily on commercial aircraft, such as the Boeing 737, 747 and 777, and the Airbus A320.  The Duarte Business has been integrated into Woodward’s Aerospace segment and included in our operating results since the acquisition. 

Due to the timing of the closing of the acquisition, for the first quarter of fiscal year 2013 the Duarte Business had no impact on net sales, and except for acquisition costs of $1,707, had no impact on EBIT or net earnings.  In comparison, fiscal year 2014 includes a full year of Duarte Business operating results.

Liquidity Highlights

Net cash provided by operating activities for fiscal year 2014 was $268,083, compared to $222,592 for fiscal year 2013. 

Free cash flow for fiscal year 2014 was $60,977, compared to $80,992 for fiscal year 2013, primarily attributable to higher cash flow from operations in the current year related mostly to improved earnings and working capital management, more than offset by higher levels of capital expenditures in the current year.

On October 1, 2013, we entered into a note purchase agreement (the “2013 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.  We issued the Series G, H and I Notes on October 1, 2013 in an aggregate principal amount of $100,000 and used the proceeds to repay all of the outstanding balance on the Series B Notes due October 1, 2013.  We issued the Series J, K and L Notes in an additional $150,000 aggregate principal amount on November 15, 2013 and used the proceeds to partially repay the uncommitted line of credit discussed below. 

In connection with the acquisition of the Duarte Business on December 21, 2012, we entered into a 364 day uncommitted line of credit with JPMorgan Chase Bank, N.A. (the “Line of Credit”), which provided for unsecured loans to the Company of up to $200,000 on a revolving basis.  The Line of Credit was repaid in full and terminated on December 20, 2013.

At September 30, 2014, we held $115,287 in cash and cash equivalents, and had total outstanding debt of $710,000 with additional borrowing availability of $384,592, net of outstanding letters of credit, under our $600,000 revolving credit

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facility.  There was additional borrowing capacity of $27,872 under various foreign lines of credit and foreign overdraft facilities.

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

 

 

Other select financial data:

 

2014 RESULTS OF OPERATIONS

2014 Sales Compared to 2013

Consolidated net sales in fiscal year 2014 increased 3.4% to $2,001,240 from $1,935,976 in fiscal year 2013.  Details of the changes in consolidated net sales are as follows:

 

 

Net sales in fiscal year 2014 include sales from the Duarte Business for the first quarter of fiscal year 2014 for which there were no comparable sales in the first quarter of fiscal year 2013 due to the timing of the acquisition.  The remaining increase in net sales for fiscal year 2014 was primarily attributable to improvements in a number of markets within both our Energy and Aerospace segments, mostly offset by decreased volumes in defense sales in our Aerospace segment and lower sales of natural gas bus and truck systems in our Energy segment.

Price changes:  Increases in selling prices were driven primarily by our Aerospace segment markets. 

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Foreign currency exchange rates:  During the fiscal year ended September 30, 2014, our net sales were positively impacted by $2,300 due to favorable fluctuations in foreign currency exchange rates compared to the same period of fiscal year 2013.

Our worldwide sales activities are primarily denominated in U.S. dollars (“USD”), European Monetary Units (“EUR”), Great Britain pounds (“GBP”), Japanese yen (“JPY”), and Chinese yuan (“CNY”).  As the USD, EUR, GBP, JPY, and CNY fluctuate against each other and other currencies, we are exposed to gains or losses on sales transactions.  If the CNY, which the Chinese government has not historically allowed to fluctuate significantly against USD, is allowed to fluctuate against USD in the future, we would be exposed to greater variability on sales transactions denominated in CNY.  For additional information on foreign currency exchange rate risk, please refer to the risk factor titled, “We derive a significant portion of our revenues from non-U.S. sales and are subject to the risks inherent in doing business in other countries” set forth under the caption “Risk Factors” in Part I, Item 1A of this Form 10-K.

2014 Costs and Expenses Compared to 2013

As previously reported, the third quarter of fiscal year 2013 included specific charges of $15,707 related to our renewable power business.  Uncertainty with respect to U.S. and other government renewable power incentives and economic factors associated with alternate energy sources resulted in significant overcapacity and financial distress in the renewable power industry, particularly in our fiscal year 2013.  As a result, we made a decision in fiscal year 2013 to align our renewable power business appropriately for the then current environment and foreseeable future, through revaluation of its assets and liabilities, including workforce management actions. 

Variable compensation expense, which is tied to relative financial and operating performance, can vary significantly from fiscal year to year.  During fiscal year 2014, variable compensation increased $29,667 as compared to fiscal year 2013 and impacted cost of goods sold, selling, general and administrative expenses, and research and development costs.

During the fourth quarter of fiscal year 2014, we recorded the following in costs and expenses: a curtailment gain of $6,624 that pertained to amendments made to one of our defined benefit pension plans that resulted in a freeze to the benefits of certain U.S. employees, an impairment charge of $3,138 related to the write down to fair market value of certain non-U.S. held for sale assets, and accelerated cost recognition on lease commitments and related assets for property no longer in use of $2,651.  The majority of these amounts were recorded in cost of goods sold.

Cost of goods sold increased by $49,568 to $1,425,839, or 71.2% of net sales, for fiscal year 2014 from $1,376,271, or 71.1% of net sales, for 2013.  The increase in costs of goods sold is primarily attributable to increased sales in our Energy segment and significant increases in variable compensation compared to the prior year periods.  Cost of goods sold for the fiscal year 2013 included $8,300 of the specific charges (discussed above) related to the realignment of the renewable power business within our Energy segment. 

Gross margins (as measured by net sales less cost of goods sold, divided by net sales) were 28.8% for fiscal year 2014 and 28.9% for fiscal year 2013.  Gross margins for the fiscal year 2014 were down slightly compared to fiscal year 2013, primarily related to significant increases in variable compensation in fiscal year 2014, partially offset by the $8,300 of specific charges included in gross margin in fiscal year 2013.

Selling, general, and administrative expenses decreased by $12,758 or 7.6%, to $155,339 for fiscal year 2014 as compared to $168,097 for fiscal year 2013.  Selling, general and administrative expenses decreased as a percentage of net sales to 7.8% for fiscal year 2014 as compared to 8.7% for fiscal year 2013.  The decrease in selling, general and administrative expenses in fiscal year 2014 is due to cost control initiatives as well as the $7,407 of specific charges (discussed above) that were included in selling, general and administrative expenses in fiscal year 2013 and that more than offset significantly higher levels of variable compensation in fiscal year 2014. 

Research and development costs increased by $7,755, or 6.0%, to $138,005 for fiscal year 2014 as compared to $130,250 for fiscal year 2013.  Research and development costs increased as a percentage of net sales to 6.9% for fiscal year 2014 as compared to 6.7% for fiscal year 2013.  Research and development costs for fiscal year 2014 reflected increased variable compensation when compared to the prior fiscal year and ongoing variability in spending.  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 $33,580 for fiscal year 2014, compared to $36,979 for fiscal year 2013.  As a percentage of net sales, amortization of intangible assets decreased to 1.7% for fiscal year 2014 as compared to 1.9% fiscal year 2013.  The decrease in amortization expense is primarily related to intangible assets becoming fully amortized in the current year.

Interest expense decreased to $22,804, or 1.1% of net sales, for fiscal year 2014, compared to $26,703, or 1.4% of net sales, for fiscal year 2013.  The decrease in interest expense is primarily attributable to an increase in the amount of interest capitalized on our current capital improvement projects partially offset by increased borrowing year over year.

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Income taxes were provided at an effective rate on earnings before income taxes of 27.0% for fiscal year 2014, compared to 26.9% for fiscal year 2013.  The changes in components of our effective tax rate (as a percentage of earnings before income taxes) were attributable to the following:

 

The year-over-year effective tax rate for fiscal year 2014 increased slightly due to the retroactive impact of the reinstatement of the U.S. research and experimentation credit in fiscal year 2013, which did not recur in fiscal year 2014.  This increase was offset by larger net favorable resolutions and reviews of tax matters and lapses of applicable statutes of limitations, higher earnings in jurisdictions with lower tax rates, and reduced taxes on current and anticipated future distributions of foreign earnings to the U.S in the current year.

The total amount of the gross liability for worldwide unrecognized tax benefits reported in other liabilities in the Consolidated Balance Sheet was $22,687 at September 30, 2014 and $22,694 at September 30, 2013.  At September 30, 2014, the amount of unrecognized tax benefits that would impact Woodward’s effective tax rate, if recognized, was $12,807.  At this time, we estimate it is reasonably possible that the liability for unrecognized tax benefits will decrease by as much as $114 in the next twelve months due primarily to the expiration of certain statutes of limitations.  We accrue for potential interest and penalties related to unrecognized tax benefits in tax expense.  Woodward had accrued interest and penalties of $1,158 as of September 30, 2014 and $2,066 as of September 30, 2013.

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.  Reviews of tax matters by authorities and lapses of the applicable statutes of limitations may result in changes to tax expense.  With a few exceptions, Woodward’s fiscal years remaining open to examination in the United States include fiscal years 2011 and thereafter, and fiscal years remaining open to examination in significant foreign jurisdictions include 2005 and thereafter.

SEGMENT RESULTS

Woodward serves the aerospace market and the energy market through its two reportable segments - Aerospace and Energy.  Woodward’s reportable segments are aggregations of Woodward’s operating segments.  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:

 

 

2014 Segment Results Compared to 2013

Aerospace

Aerospace segment net sales were $1,084,025 for fiscal year 2014, compared to $1,061,477 for fiscal year 2013.  Segment net sales for fiscal year 2014, excluding the sales from the acquired Duarte Business for the first quarter of fiscal year 2014, for which there were no comparable sales in the first quarter of fiscal year 2013 due to the timing of the acquisition, were $1,052,593, a decrease of $8,884, or 0.8%, compared to the prior fiscal year.  The decrease in segment net sales for fiscal year 2014 compared to fiscal year 2013 after excluding the net sales from the acquired Duarte Business for the first quarter of fiscal year 2014, was driven primarily by significantly lower defense sales in both aftermarket and OEM, partially offset by increases in commercial OEM and aftermarket sales. 

Defense sales continue to reflect the ongoing U.S. government budget constraints, which have impacted the timing of contracts and upgrade programs and resulted in variability during the current fiscal year, causing lower defense sales in fiscal year 2014 as compared to the prior fiscal year.  Defense aftermarket sales in fiscal year 2013 were strong compared to fiscal year 2012 levels.  Fiscal year 2014 defense sales decreased significantly from the prior year, particularly related to sales for rotorcraft programs, but were comparable to fiscal year 2012.  The majority of the decline in fiscal year 2014 related to defense aftermarket sales as defense OEM sales declined, but not as significantly. 

Commercial OEM aircraft deliveries of narrow-body and wide-body aircraft have continued to increase based on improved airline demand and new product introduction.  The commercial aftermarket showed improvement as global passenger traffic growth continues to drive aircraft utilization. 

Aerospace segment earnings decreased by $6,922, or 4.2%, to $159,200 for fiscal year 2014, compared to $166,122 for fiscal year 2013 due to the following:

 

 

Segment earnings as a percentage of sales were 14.7% for fiscal year 2014 compared to 15.7% for fiscal year 2013.  The decrease in Aerospace segment earnings in fiscal year 2014 compared to fiscal year 2013 was primarily attributable to the

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impact of reduced defense sales volumes and increases in variable compensation, partially offset by cost control initiatives and lower research and development expenses. 

Energy

Energy segment net sales were $917,215 for fiscal year 2014, compared to $874,499 for fiscal year 2013.  The increase in sales is primarily attributable to improvements in several markets, including the wind turbine converter, aero-derivative turbine, and large gas and diesel engine markets, partially offset by lower sales of natural gas bus and truck systems.

Energy segment earnings increased by $35,338, or 35.7%, to $134,278 for fiscal year 2014 as compared to $98,940 for fiscal year 2013 due to the following:

 

 

Segment earnings as a percentage of sales increased to 14.6%  in  fiscal year 2014 compared to 11.3% for fiscal year 2013.    

Uncertainty with respect to U.S. and other government renewable power incentives and economic factors associated with alternate energy sources resulted in significant overcapacity and financial distress in the renewable power industry, particularly in our fiscal year 2013.  As a result, we made a decision in fiscal year 2013 to align our renewable power business appropriately for the then current environment and foreseeable future, through revaluation of its assets and liabilities, including workforce management actions, which resulted in specific charges of $15,707 in the third quarter of fiscal year 2013.  The savings benefits of these realignment changes contributed to improved earnings results in fiscal year 2014. 

The remaining increase for fiscal year 2014 compared to the prior year in the Energy segment earnings, excluding the specific charges of $15,707 taken in fiscal year 2013, was driven primarily by increased sales volume and related fixed cost leverage, lean implementation and productivity improvements and realignment savings, partially offset by increases in variable compensation and research and development expenses.  Foreign currency exchange rates had a favorable impact of $1,187 in fiscal year 2014 compared to fiscal year 2013. 

Nonsegment expenses

Nonsegment expenses for fiscal year 2014 increased to $43,701, or 2.2% of net sales, compared to $39,061, or 2.0% of net sales, for fiscal year 2013.  The increase in nonsegment expense was primarily related to increases in variable compensation.

 

 

 

 

 

 

 

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2013 RESULTS OF OPERATIONS

2013 Sales Compared to 2012

Consolidated net sales increased 3.8% from $1,865,627 in fiscal year 2012 to $1,935,976 in fiscal year 2013.  Details of the changes in consolidated net sales are as follows:

 

 

 

The increase in net sales for fiscal year 2013 was primarily attributable to the Duarte Business acquisition, increased volumes in our Aerospace segment due to increased commercial OEM and defense aftermarket sales, partially offset by decreased volumes in our Energy segment attributable to significantly lower wind turbine converter sales.  Wind turbine converter sales through our renewable power business were higher in fiscal year 2012 compared to fiscal year 2013 due to accelerated ordering by our customers in an effort to take advantage of the then-expiring government incentives and to comply with various renewable energy mandates.  The balance of the decline in wind turbine converter sales in fiscal year 2013 reflected general uncertainty with respect to investments in large wind projects. 

Price changes:  Increases in selling prices were driven primarily by our Aerospace segment markets.  Selling prices in the Energy segment also increased due to standard business practice in response to inflationary increases in production and material costs.

Foreign currency exchange rates:  During the fiscal year ended September 30, 2013, our net sales were negatively impacted by $3,910 due to unfavorable fluctuations in foreign currency exchange rates, compared to the same period of fiscal year 2012.

 2013 Costs and Expenses Compared to 2012

Cost of goods sold increased by $72,927 to $1,376,271 or 71.1% of net sales, for fiscal year 2013 from $1,303,344, or 69.9% of net sales, for fiscal year 2012.    Gross margins (as measured by net sales less cost of goods sold, divided by net sales) were 28.9% for fiscal year 2013 and 30.1% for fiscal year 2012.  The decrease in gross margin in fiscal year 2013 as compared to fiscal year 2012 was attributable to the decreased volume in our Energy segment, mostly due to reduced wind turbine converter sales volumes and the loss of related fixed cost leverage, as well as charges of $8,300 associated with a portion of the specific charges in the third quarter of fiscal year 2013 related to the renewable power business within the Energy segment, partially offset by the effects of increased sales volume in our Aerospace segment, favorable product mix and improved operational performance.    

Selling, general, and administrative expenses increased by $3,585 or 2.2%, to $168,097 for fiscal year 2013 as compared to $164,512 for fiscal year 2012.  Selling, general and administrative expenses increased as a percentage of net sales to 8.7% for fiscal year 2013 as compared to 8.8% for fiscal year 2012.  The increase in expenses was primarily related to charges of $7,407 associated with a portion of the specific charges in the third quarter of fiscal year 2013 related to our renewable power business within the Energy segment.  In addition, fiscal year 2013 selling, general, and administrative expenses included approximately $1,944 of transaction costs related to the Duarte Acquisition as well as a general increase in expenses related to the Duarte Business.  These increases were partially offset by decreased bad debt expenses in fiscal year 2013 as compared to fiscal year 2012.  Fiscal year 2012 expense included charges related to the bankruptcies of several airlines and the credit issues of some of our renewable power customers that did not recur in fiscal year 2013. 

Research and development costs decreased by $13,024, or 9.1%, to $130,250 for fiscal year 2013 as compared to $143,274 for fiscal year 2012.  Research and development costs decreased as a percentage of net sales to 6.7% for fiscal year 2013 as compared to 7.7% for fiscal year 2012.  Research and development costs decreased primarily due to the completion of development of certain programs and related decreases of materials purchases. 

Amortization of intangible assets increased to $36,979 for fiscal year 2013 compared to $32,809 for fiscal year 2012.  As a percentage of net sales, amortization of intangible assets increased to 1.9% for fiscal year 2013 as compared to 1.8% fiscal year 2012.

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Interest expense increased to $26,703, or 1.4% of net sales, for fiscal year 2013 compared to $26,003, or 1.4% of net sales, for fiscal year 2012.

Income taxes were provided at an effective rate on earnings before income taxes of 26.9% for fiscal year 2013 compared to 28.4% for fiscal year 2012.  The change in the effective tax rate (as a percentage of earnings before income taxes) was attributable to the following:

 

On January 2, 2013, the Taxpayer Relief Act was enacted, which retroactively extended the U.S. research and experimentation tax credit through December 31, 2013.  As a result, income taxes for fiscal year 2013 included a net expense reduction related to the extension of the U.S. research and experimentation tax credit pursuant to the Taxpayer Relief Act, including the fiscal year 2012 retroactive portion of the extension.

During the second quarter of fiscal year 2012, we re-evaluated our strategic alternatives in various international markets and determined that a portion of the undistributed earnings of certain of our foreign subsidiaries that were previously expected to be repatriated to the United States within the foreseeable future will remain indefinitely invested outside the United States to support the growth of future foreign operations.  We accordingly reversed the deferred tax liability associated with repatriating those earnings, which resulted in a tax benefit of $3,326 for fiscal year 2012.  This item is included in the “Taxes on international activities” line in the rate reconciliation above.

2013 Segment Results Compared to 2012

Aerospace

Aerospace segment net sales increased $165,394, or 18.5%, to $1,061,477 for fiscal year 2013 from $896,083 for fiscal year 2012.  Segment net sales excluding the Duarte Business were $950,216 for fiscal year 2013.  Segment sales, excluding the Duarte Business sales, for fiscal year 2013 were higher compared to fiscal year 2012, driven primarily by defense aftermarket sales and commercial OEM sales.

Defense aftermarket spare parts and repair sales were up significantly, particularly due to increases related to sales for rotorcraft programs.  Commercial OEM aircraft deliveries of narrow-body and wide-body aircraft have continued to increase based on improved airline demand and new product introduction. 

During our second quarter of fiscal year 2013, the sequestration of U.S. federal government appropriations took effect under the Budget Act.  The effect on our fiscal year 2013 results was limited, as we saw strong defense aftermarket sales and slightly lower OEM defense sales. 

Aerospace segment earnings increased by $35,930, or 27.6%, to $166,122 for fiscal year 2013 compared to fiscal year 2012 due to the following:

 

Segment earnings as a percentage of sales increased to 15.7% in fiscal year 2013 compared to 14.5% for fiscal year 2012.  The increase in Aerospace segment earnings in fiscal year 2013 compared to fiscal year 2012 was primarily the result of sales volume increases, the effects of increased selling prices and favorable mix, and decreased investment in research and development. 

 

 

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Energy

The following table presents the Energy segment’s external net sales and earnings excluding the results of and charges related to the renewable power business.

 

 

Uncertainty with respect to U.S. and other government renewable power incentives and economic factors associated with alternate energy sources resulted in significant overcapacity and financial distress in the renewable power industry, particularly in our fiscal year 2013.  As a result, we made a decision in fiscal year 2013 to align our renewable power business appropriately for the then current environment and foreseeable future, through revaluation of its assets and liabilities, including workforce management actions.  

Energy segment net sales without the renewable power business and Energy segment earnings without the renewable power business are financial measures not prepared and presented in accordance with U.S. GAAP.  Management used these financial measures to compare the performance of its business with and without the effects of significant discrete economic events in order to analyze and understand Woodward’s Energy reportable segment results.  Management identified the changes in the market economics of its renewable power business as such a significant discrete economic event.  Management used this with and without the renewable power business segment net sales and segment net earnings information in its decision to align its renewable power business appropriately for the current environment and foreseeable future.  In addition, management used this with and without the renewable power business information for prior year comparative purposes for the Energy segment.  As management believes Energy segment net sales without the renewable power business and Energy segment earnings without the renewable power business provides more comparable year over year information, we have included this non-U.S. GAAP measure in this “Management’s Discussion and Analysis” to provide insight to securities analysts, investors, and others into how our management views our current financial condition and results of operations. 

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 Energy segment net sales without the renewable power business and Energy segment earnings without the renewable power business exclude certain financial information compared with segment net sales and segment earnings, respectively, the most comparable U.S. GAAP financial measures, users of this financial information should consider the information that is excluded.

Energy segment net sales decreased $95,045, or 9.8%, to $874,499 for fiscal year 2013 from $969,544 for fiscal year 2012.  Excluding the renewable power business sales for all periods, Energy segment net sales for fiscal year 2013 would have been comparable to fiscal year 2012.

Wind turbine converter sales for fiscal year 2013 declined approximately $95,000 as compared to fiscal year 2012.  Wind turbine converter sales were higher in fiscal year 2012 partially due to accelerated ordering by our customers in an effort to take advantage of the then expiring government incentives and to comply with various renewable energy mandates.  The balance of the decline in wind turbine converter sales in fiscal year 2013 was unanticipated and reflected general uncertainty with respect to investments in large wind projects due to the volatility of government incentives, economic uncertainty and overcapacity in the market.

The Taxpayer Relief Act extended the wind tax credit for projects that begin construction in calendar year 2013.  Due to the lengthy planning and ordering cycle involved in these wind turbine projects, the effect of this legislation on our sales in fiscal year 2013 was not material.

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Strong sales of compressed natural gas systems and aero-derivative gas turbine systems were offset by softness in other reciprocating engine and heavy-frame industrial turbine systems sales.  Other reciprocating engine and heavy-frame industrial turbine systems sales were negatively impacted by weaker economic conditions, outside of the United States, in the global economy.  Growth in shipbuilding, petrochemical plants and heavy frame turbines, where long lead times and significant investments are required, did not materialize as anticipated due to the continuing economic conditions.

Energy segment earnings increased by $27,501, or 21.8%, to $98,940 for fiscal year 2013 as compared to fiscal year 2012 due to the following:

 

Segment earnings as a percentage of sales decreased to 11.3% in fiscal year 2013 compared to 13.0% for fiscal year 2012.    The decrease in the Energy segment earnings for fiscal year 2013 as compared to fiscal year 2012 was driven primarily by $15,707 of specific charges, as well as decreased volumes and the loss of related fixed cost leverage, related to our renewable power business.  This was partially offset by the effects of selling prices and favorable product mix and reduced research and development expense.  Foreign currency exchange rates had an unfavorable impact of $3,099 for fiscal year 2013 compared to fiscal year 2012. 

Excluding the specific charges in fiscal year 2013 and the operations of the renewable power business for all periods, segment earnings were $120,167 for fiscal year 2013 compared to $112,540 for fiscal year 2012.  Excluding the specific charges in fiscal year 2013 and the operations of the renewable power business for all periods, earnings as a percentage of sales were 15.9% for fiscal year 2013 compared to 14.8% for fiscal year 2012.  The increase in segment earnings excluding the specific charges and operations of the renewable power business was due to the effects of selling prices and favorable product mix and reduced research and development expense. 

Non segment expenses

Nonsegment expenses for fiscal year 2013 increased to $39,061, or 2.0% of net sales, compared to $33,365, or 1.8% of net sales, for fiscal year 2012.  The increase in nonsegment expenses as a percent of net sales for fiscal year 2013 is primarily attributable to costs of $1,944 associated with the acquisition of the Duarte Business.

 

LIQUIDITY AND CAPITAL RESOURCES

Historically, we have been able to satisfy 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.  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.

Our aggregate cash and cash equivalents were $115,287 at September 30, 2014 and $48,556 at September 30, 2013, and our working capital was $668,628 at September 30, 2014 and $541,183 at September 30, 2013.  Of the $115,287 of cash and cash equivalents held at September 30, 2014, $95,264 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, 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, Woodward’s Chinese subsidiary accepts from Chinese customers, in settlement of certain customer accounts receivable, bankers acceptance notes issued by creditworthy Chinese banks.  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 

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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 bankers acceptance note from a customer, such customer has no further obligation to pay Woodward for the related accounts receivable balance.  Woodward had bankers acceptance notes of $62,352 at September 30, 2014 and $72,954 at September 30, 2013 recorded as non-customer accounts receivable on its consolidated balance sheets.  Woodward only accepts bankers acceptance notes issued by creditworthy banks as to which the credit risk associated with the bankers acceptance note is assessed to be minimal.

On October 1, 2013, we entered into the 2013 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.  We issued the Series G, H and I Notes on October 1, 2013 in an aggregate principal amount of $100,000 and used the proceeds to repay all of the outstanding balance on our Series B Notes due October 1, 2013.  We issued the Series J, K and L Notes in an additional $150,000 aggregate principal amount on November 15, 2013.  The notes issued under the 2013 Note Purchase Agreement have not been registered under the Securities Act of 1933 and they may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.  Holders of the notes under the 2013 Note Purchase Agreement are not entitled to any registration rights.  For further discussion of the 2013 Note Purchase Agreement, see Note 12, Credit facilities, short-term borrowings and long-term debt to the Consolidated Financial Statements in “Item 8 – Financial Statements and Supplementary Data.”

 Our revolving credit facility, which we entered into on July 10, 2013, matures in July 2018 and provides a borrowing capacity of up to $600,000 with the option to increase total available borrowings to up to $800,000, subject to lenders’ participation.  We can borrow against our $600,000 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 stock, payments of dividends, and acquisitions.  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 revolving and other credit facilities, see Note 12, Credit facilities, short-term borrowings and long-term debt, to the Consolidated Financial Statements in “Item 8 – Financial Statements and Supplementary Data.” 

At September 30, 2014, we had total outstanding debt of $710,000, with additional borrowing availability of $384,592 under our revolving credit facility, net of outstanding letters of credit, and additional borrowing availability of $27,872 under various foreign credit facilities. 

In connection with the acquisition of the Duarte Business on December 21, 2012, we entered into the Line of Credit.  The Line of Credit provided for unsecured loans to the Company of up to $200,000 on a revolving basis.  Loans made under the Line of Credit bore interest at a floating rate based, at the Company’s option, on either the prime rate or an adjusted LIBOR.  The Line of Credit was repaid in full and terminated on December 20, 2013.

 At September 30, 2014, we had  $210,000 of borrowings outstanding under our revolving credit facility, which was classified as long-term, and no borrowings outstanding under our foreign credit facilities.    Revolving credit facility and short-term borrowing activity during the fiscal year ended September 30, 2014 was as follows:

 

 

We were in compliance with all our debt covenants at September 30, 2014.  See Note 12, Credit facilities, short-term borrowings and long-term debt, to the Consolidated Financial Statements in “Item 8 – Financial Statements and Supplementary Data” 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 stock, payment of dividends, significant capital expenditures, consideration of strategic acquisitions and other potential uses of cash.

 We are currently developing a second campus in the greater-Rockford, Illinois area for our Aerospace segment.  This campus is intended to support the growth expected over the next ten years and beyond stimulated by our being awarded a substantial number of new system platforms, particularly on narrow-body aircraft.  These investments are expected to result in future productivity gains for our existing and new business.  However, given the significance of the anticipated volumes associated with the new system platforms, we still expect our Rockford area workforce to increase substantially, by as much as 70%-90% from current levels, by the end of 2021.  In addition, in September 2013, we invested in a building site in Niles,

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Illinois.  We are building a new facility on this site for our Aerospace segment and will relocate some of our operations currently residing in nearby Skokie, Illinois, to this new facility.  We are also developing a new campus at our corporate headquarters in Fort Collins, Colorado to support the continued growth of our Energy segment by supplementing our existing Colorado manufacturing facilities and corporate headquarters.  We anticipate investing approximately $500,000 through fiscal year 2016 in land, buildings and equipment among our two Rockford, Illinois area campuses, the facility in Niles, Illinois, and a new campus at our corporate headquarters in Fort Collins, Colorado and to date have spent approximately $200,000 related to these investments. 

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 banks supplying our borrowing requirements refuse to honor their contractual commitments, cease lending, or declare bankruptcy.  While we believe the lending institutions participating in our credit arrangements are financially stable, events in the global credit markets, including the failure, takeover or rescue by various government entities of major financial institutions, have created uncertainty with respect to credit availability.

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.

Cash Flows

 

2014 Cash Flows Compared to 2013

Net cash flows provided by operating activities for fiscal year 2014 was $268,083, compared to $222,592 in fiscal year 2013.  The increase of $45,491 is primarily attributable to improved working capital utilization and higher earnings in the current fiscal year.

Accounts receivable provided $30,880 of cash in fiscal year 2014 compared to $9,774 of cash utilized in fiscal year 2013, accounting for the majority of the increase in operating cash flows.  The amount of cash provided by accounts receivable in fiscal year 2014 reflects a decrease in accounts receivable in fiscal year 2014 as compared to fiscal year 2013 due to better collections in fiscal year 2014.  The increase in operating cash flows was also attributable to higher net earnings in fiscal year 2014 as compared to fiscal year 2013.  These increases in cash were partially offset by an increase in cash utilized for inventory in fiscal year 2014.  Inventory utilized $27,788 of cash in fiscal year 2014 compared to cash utilized of $1,485 in fiscal year 2013.  The increase in cash utilized is the result of inventory builds to meet the future demands of our customers.

Net cash flows used in investing activities for fiscal year 2014 was $205,829, compared to $340,042 in fiscal year 2013.  The decrease in cash used in investing activities compared to the same period of the last fiscal year is due primarily to the acquisition of the Duarte Business in the first quarter of fiscal year 2013, which utilized $198,860 of cash. This decrease was partially offset by increased payments for property, plant and equipment of $65,506 to $207,106 in fiscal year 2014 as compared to $141,600 in fiscal year 2013 related mainly to the development of a second campus in the greater-Rockford, Illinois area, a new facility in Niles, Illinois, and a new campus at our headquarters in Fort Collins, Colorado.

Net cash flows provided by financing activities for fiscal year 2014 was $9,477 compared to $102,473 for fiscal year 2013.  During fiscal year 2014, we had net short and long-term borrowings of $160,002 compared to net debt borrowings of $157,713 in the prior year.  Slightly higher borrowings in fiscal year 2014 were primarily attributable to increased payments for property, plant and equipment.  We utilized $141,488 to repurchase 3,272 shares of our common stock in fiscal year

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2014, compared to $45,754 to repurchase 1,233 shares of our common stock in fiscal year 2013.  The fiscal year 2014 repurchases were made under our existing stock repurchase program, which is described in greater detail under “Issuer Purchases of Equity Securities” in Part II, Item 5 of this Form 10-K.

2013 Cash Flows Compared to 2012

Net cash flows provided by operating activities for fiscal year 2013 was $222,592 compared to $144,113 in fiscal year 2012.  Accounts receivable utilized $9,774 of cash in fiscal year 2013 compared to $59,061 of cash utilized in fiscal year 2012, accounting for the majority of the change.  The amount of cash utilized for accounts receivable in fiscal year 2013 reflects a slight increase in accounts receivable in fiscal year 2013 as compared to fiscal year 2012.  The higher utilization in fiscal year 2012 reflects the significant increase in accounts receivable in fiscal year 2012 when compared to fiscal year 2011 due to higher sales in fiscal year 2012 as compared to fiscal year 2011.  The increase in operating cash flows was also attributable to operational improvements, which lowered inventory requirements in fiscal year 2013.  Inventory utilized $1,485 of cash in fiscal year 2013 compared to $18,702 of cash utilized in fiscal year 2012.

Net cash flows used in investing activities for fiscal year 2013 was $340,042 compared to $64,617 in fiscal year 2012.  The increase in cash used in fiscal year 2013 compared to fiscal year 2012 is due primarily to the acquisition of the Duarte Business in the first quarter of fiscal year 2013 which utilized $198,860 of cash.  In addition, payments for property, plant and equipment increased by $76,700 to $141,600 in fiscal year 2013 as compared to $64,900 in fiscal year 2012 related mainly to the development of a second campus in the greater-Rockford, Illinois area, a new campus at our headquarters in Fort Collins, Colorado and the purchase of a building site in Niles, Illinois.

Net cash flows provided by financing activities for fiscal year 2013 was $102,473 compared to net cash flows used for financing activities of $90,461 for fiscal year 2012.  During fiscal year 2013, we had net short and long-term borrowings of $157,713 compared to net debt repayments of $33,091 in fiscal year 2012.  The higher borrowings in fiscal year 2013 were primarily attributable to the acquisition of the Duarte Business.  We utilized $45,754 to repurchase 1,233 shares of our common stock in fiscal year 2013, compared to $44,110 to repurchase 1,132 shares of our common stock in fiscal year 2012, under our $200,000 stock repurchase program authorized by our Board of Directors in July 2010. 

Off-Balance Sheet Arrangements and Contractual Obligations

Off-Balance Sheet Arrangements

As of September 30, 2014, 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.

Contractual Obligations

A summary of our consolidated contractual obligations and commitments as of September 30, 2014 is as follows:

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The above table does not reflect the following items:

In connection with the sale of the F&P product line during fiscal year 2009, Woodward assigned to a subsidiary of the purchaser its rights and responsibilities related to certain contracts with the U.S. Government.  Woodward provided to the U.S. Government a customary guarantee of the purchaser’s subsidiary’s obligations under the contracts.  The purchaser and its affiliates have agreed to indemnify Woodward for any liability incurred with respect to the guarantee.

Guarantees and letters of credit totaling approximately $5,937 were outstanding as of September 30, 2014, some of which were secured by parent guarantees from Woodward or by Woodward line of credit facilities. 

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

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”).  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 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 our Note 2, New accounting standards, to the Consolidated Financial Statements in “Item 8 – Financial Statements and Supplementary Data.”

 

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 Consolidated Financial Statements and accompanying notes.  Note 1, Operations and summary of significant accounting policies, to the Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements.  The estimates and assumptions described below are those that we consider to be most critical to an understanding of our financial statements because they involve significant judgments and uncertainties.  All of these estimates reflect our best judgment about current, and for some estimates, future economic and market conditions and their effects based on information available as of the date of these financial statements.  As estimates are updated or actual amounts are known, our critical accounting estimates are revised, and operating results may be affected by the revised estimates.  Actual results may differ from these estimates under different assumptions or conditions. 

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Our management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our disclosures in this Management’s Discussion and Analysis.

Revenue recognition

Woodward recognizes revenue when the following criteria are met:

1) persuasive evidence of an arrangement exists,

2) delivery of the product has occurred or services have been rendered,

3) price is fixed or determinable, and

4) collectability is reasonably assured. 

In implementing the four criteria stated above, we have found that determining when the risks and rewards of ownership have passed to the customer, which determines whether persuasive evidence of an arrangement exists and if delivery has occurred, may require judgment.  The passage of title indicates transfer of the risks and rewards of ownership from Woodward to the customer; however, contract- and customer-specific circumstances are reviewed by management to ensure that transfer of title constitutes the transfer of the risks and rewards of ownership. 

Examples of situations requiring management review and judgment, with respect to the passage of the risks and rewards of ownership, include: interpretation of customer-specific contract terms, situations where substantive performance obligations exist, such as completion of product testing that remain after product delivery to the customer, situations that require customer acceptance (or in some instances regulatory acceptance) of the product, and situations in countries whose laws provide for retention of some form of title by sellers such that Woodward is able to recover goods in the event a customer defaults on payment. 

Based on management’s determination, if the risks and rewards of ownership have not passed to the customer, revenue is deferred until this requirement is met.

Purchase accounting

During the first quarter of fiscal year 2013, we completed the Duarte Acquisition for an aggregate purchase price of $200,000.  The acquisition was completed on December 28, 2012, and, based on preliminary purchase adjustments, we paid cash at closing in the amount of $198,900.  For more information on the Duarte Acquisition see Note 4, Business acquisitions, in the Notes to the Consolidated Financial Statements included in “Item 8 – Financial Statements and Supplementary Data.”

Assigning fair values to the assets acquired and liabilities assumed at the date of an acquisition requires knowledge of current market values, and the values of assets in use, and often requires the application of judgment regarding estimates and assumptions.  While the ultimate responsibility resides with management, for material acquisitions, we retain the services of certified valuation specialists to assist with assigning estimated values to certain acquired assets and assumed liabilities, including intangible assets and postretirement benefit plan assets and liabilities.

Acquired intangible assets, excluding goodwill, are valued using a discounted cash flow methodology based on future cash flows specific to the type of intangible asset purchased.  This methodology incorporates various estimates and assumptions, the most significant being projected revenue growth rates, earnings margins, and forecasted cash flows based on the discount rate and terminal growth rate.  Management projects revenue growth rates, earnings margins and cash flows based on the historical operating results of the acquired entity adjusted for synergies anticipated to be achieved through integration, expected future performance, operational strategies, and the general macroeconomic environment.  We review finite-lived intangible assets for triggering events such as significant changes in operations, customers or future revenue that might indicate the need to impair the assets acquired or change the useful lives of the assets acquired.  There was no impairment or change in useful lives recognized on other intangible assets acquired in fiscal years 2014, 2013 or 2012.  

Estimated values for acquired property, plant and equipment are based on current market values and replacement costs of similar assets.  Estimated values for inventory acquired is subject to reliable estimates, as of the acquisition date, of future sales volumes, replacement costs, costs of selling effort, anticipated selling prices, normal profit margins, the percent complete, and costs to complete work-in-process inventory.  Estimated values for accounts receivable are subject to reliable estimates of collectability.

Assumed liabilities are valued based on estimates of anticipated expenditures to be incurred to satisfy the assumed obligations, including estimation of any warranty or other contractual liabilities assumed, which require the exercise of professional judgment.  Valuation of postretirement benefit plan assets and liabilities is dependent on similar assumptions and estimates as those used to value our non-acquisition postretirement benefit plan assets and liabilities.

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Assumed contracts may have favorable or unfavorable terms that must be valued as of the acquisition date.  Such valuation is subject to management judgment regarding the evaluation and interpretation of contract terms in relation to other economic circumstances, such as the market rates for office space leases.

If we assume a performance obligation to customers as of the acquisition date, a deferred revenue obligation is recognized.  Judgment is required to evaluate whether a future performance obligation exists and to assign a value to the performance obligation.

Valuation of gain and loss contingencies, if not resolved during the purchase measurement period, requires exercise of management judgment.  We measure pre-acquisition contingencies at their acquisition date fair value if their fair value can be determined during the measurement period.  If we cannot determine the fair value of the pre-acquisition contingency during the measurement period, we recognize an acquired asset or assumed liability if it is probable that an asset existed or that a liability had been incurred at the acquisition date and the amount of the asset or liability can be reasonably estimated.

Assumed acquired tax liabilities for uncertain tax positions are dependent on assessing the past practices of the acquisition target based on review of actual tax filings and information obtained through due diligence procedures.  Evaluation of the validity of tax positions taken by the acquisition target are subject to management judgment.

Inventory

Inventories are valued at the lower of cost or market value.  Inventory cost is determined using methods that approximate the first-in, first-out basis.  We include product costs, labor and related fixed and variable overhead in the cost of inventories. 

Inventory market values are determined by giving substantial consideration to the expected product selling price.  We estimate expected selling prices based on our historical recovery rates, general economic and market conditions, the expected channel of disposition, and current customer contracts and preferences.  Actual results may differ from our estimates due to changes in resale or market value and the mix of these factors.  Management monitors inventory for events or circumstances, such as negative margins, recent sales history suggesting lower sales value, or changes in customer preferences, which would indicate the market value of inventory is less than the carrying value of inventory, and management records adjustments as necessary.  When inventory is written down below cost, such reduced amount is considered the cost for subsequent accounting purposes.  Our recording of inventory at the lower of cost or market value has not historically required material adjustments once initially established.

The carrying value of inventory was $451,944 at September 30, 2014 and $431,744 at September 30, 2013.  If economic conditions, customer product requirements, or other factors significantly reduce future customer demand for our products from forecast levels, then future adjustments to the carrying value of inventory may become necessary.  We attempt to maintain inventory quantities at levels considered necessary to fill expected orders in a reasonable time frame, which we believe mitigates our exposure to future inventory carrying cost adjustments.

Postretirement benefits

The Company provides various benefits to certain employees through defined benefit pension plans and other postretirement benefit plans.  A September 30 measurement date is used to value plan assets and obligations for all Woodward defined benefit pension and other postretirement benefit plans.  For financial reporting purposes, net periodic benefits expense and related obligations are calculated using a number of significant actuarial assumptions, including anticipated discount rates, rates of compensation increases, long-term return on defined benefit plan investments, and anticipated healthcare cost increases.  Based on these actuarial assumptions, at September 30, 2014, our recorded assets and liabilities included a net asset of $3,886 for our defined benefit pension plans and a liability of $29,225 for other postretirement benefit plans.  Changes in net periodic expense or the amounts of recorded assets and liabilities may occur in the future due to changes in these assumptions.  

Estimates of the value of postretirement benefit obligations, and related net periodic benefits expense, are dependent on actuarial assumptions, including future interest rates, compensation rates, mortality trends, healthcare cost trends, and returns on defined benefit plan investments.

It should be noted that economic factors and conditions often affect multiple assumptions simultaneously, and the effects of changes in assumptions are not necessarily linear due to factors such as the 10% corridor applied to the larger of the postretirement benefit obligation or the fair market value of plan assets used to determine the amortization of actuarial net gains or losses. 

Primary actuarial assumptions for our defined benefit pension plans were determined as follows:

 

 

 

 

 

 

Primary actuarial assumptions for our other postretirement benefit plans were determined as follows:

 

 

 

 

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Variances from our fiscal year end estimates for these variables could materially affect our recognized postretirement benefit obligation liabilities.  On a near-term basis, such changes are unlikely to have a material impact on reported earnings, since such adjustments are recorded to other comprehensive earnings and recognized into expense over a number of years.  Significant changes in estimates could, however, materially affect the carrying amounts of benefit obligation liabilities, including accumulated benefit obligations, which could affect compliance with the provisions of our debt arrangements and future borrowing capacity.

Reviews for impairment of goodwill

At September 30, 2014, we had $559,724 of goodwill, representing 23% of our total assets.  At September 30, 2013, we had $561,458 of goodwill, representing 25% of our total assets.  Goodwill is tested for impairment at the reporting unit level on an annual basis 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.  Based on the relevant U.S. GAAP authoritative guidance, we aggregate components of a single operating segment into a reporting unit, if appropriate.   For purposes of performing the impairment tests, we identify reporting units in accordance with U.S. GAAP.  The identification of reporting units and consideration of aggregation criteria requires management judgment.  The impairment tests consist of comparing the fair value of reporting units, determined using discounted cash flows, with their carrying amount including goodwill.  If the carrying amount of the reporting unit exceeds its fair value, we compare the implied fair 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.  There was no impairment charge recorded in fiscal years 2014, 2013, or 2012.

Woodward completed its annual goodwill impairment test as of July 31, 2014 for the fiscal year ended September 30, 2014 during the fourth quarter.  At that date, Woodward determined it was appropriate to aggregate certain components of the same operating segment into a single aggregated reporting unit.  The fair value of each of Woodward’s reporting units was determined using an income approach based on a discounted cash flow method.  This method represents a Level 3 input and incorporates various estimates and assumptions, the most significant being projected revenue growth rates, earnings margins, future tax rates and the present value, based on an estimated weighted-average cost of capital (or the discount rate) and terminal growth rate, of forecasted cash flows.  Management projects revenue growth rates, earnings margins and cash flows based on each reporting unit’s current operational results, expected performance and operational strategies over a five or ten-year period.  These projections are adjusted to reflect current economic conditions and demand for certain products, and require considerable management judgment.

Forecasted cash flows used in the July 31, 2014 impairment test were discounted using weighted-average cost of capital assumptions ranging from 8.93% to 11.04%.  The terminal values of the forecasted cash flows were calculated using the Gordon Growth Model and assumed an annual compound growth rate after five or ten years of 4.20%.  These inputs, which are unobservable in the market, represent management’s best estimate of what market participants would use in determining the present value of the Company’s forecasted cash flows.  Changes in these estimates and assumptions can have a significant impact on the fair value of forecasted cash flows.  Woodward evaluated the reasonableness of the reporting units resulting fair values utilizing a market multiple method.

The results of Woodward’s annual goodwill impairment test performed as of July 31, 2014, indicated the estimated fair value of each reporting unit was significantly in excess of its carrying value, and accordingly, no impairment existed.  Increasing the discount rate by 20%, decreasing the growth rate by 20%, or decreasing forecasted cash flow by 20%, would also not have resulted in an impairment charge at July 31, 2014.

As part of the Company’s ongoing monitoring efforts, Woodward will continue to consider the global economic environment and its potential impact on Woodward’s business in assessing goodwill for possible indications of impairment.  There can be no assurance that Woodward’s estimates and assumptions regarding forecasted cash flows of certain reporting units, the current economic environment, or the other inputs used in forecasting the present value of forecasted cash flows will prove to be accurate projections of future performance.

Income taxes

We are subject to income taxes in the United States and numerous foreign jurisdictions.  Significant judgment is required in evaluating our tax positions and determining our provision for income taxes.

During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain.  We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due.  The reserves are established when we believe that certain positions are likely to be challenged and may not be fully sustained on review by tax authorities.  We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or refinement of an estimate.  Although we believe our reserves are reasonable, no assurance can be given that the final outcome of these matters will be consistent with what is reflected in our historical income tax provisions and accruals.  To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will impact the current provision for income taxes.  The provision for income taxes

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includes the impact of reserve positions and changes to reserves that are considered appropriate.  As of September 30, 2014 and September 30, 2013, unrecognized gross tax benefits for which recognition has been deferred were $22,687 and $22,694, respectively.

Significant judgment is also required in determining any valuation allowance recorded against deferred tax assets.  The determination of the amount of valuation allowance to be provided on recorded deferred tax assets involves estimates regarding the timing and amount of the reversal of taxable temporary differences, expected future taxable income, and the impact of tax planning strategies.  A valuation allowance is established to offset any deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax asset will not be realized.  In assessing the need for a valuation allowance, we consider all available evidence including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies.  Changes in the relevant facts can significantly impact the judgment or need for valuation allowances.   In the event we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.  Our valuation allowance was $9,486 as of September 30, 2014 and $11,783 as of September 30, 2013.

Our effective tax rates differ from the U.S. statutory rate primarily due to the tax impact of foreign operations, adjustments of valuation allowances, research tax credits, state taxes, and tax audit settlements.  In addition to potential local country tax law and policy changes that could impact the provision for income taxes, management’s judgment about and intentions concerning the repatriation of foreign earnings could also significantly impact the provision for income taxes. Management reassesses its judgment regularly, taking into consideration the potential tax impacts of these judgments and intentions.

Our provision for income taxes is subject to volatility and could be affected by earnings that are different than those anticipated in countries which have lower or higher tax rates; by transfer pricing adjustments; by tax effects of share-based compensation; and/or changes in tax laws, regulations, and accounting principles, including accounting for uncertain tax positions, or interpretations thereof.  There can be no assurance that these items will remain stable over time. 

In addition, we are subject to examination of our income tax returns by the relevant tax authorities in the jurisdictions in which we are subject to taxes.  We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.  There can be no assurance that the outcomes from these examinations will not have a significant effect on our operating results, financial condition, and cash flows.

 

Item 7A.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.

Interest Rate Risk

We use derivative instruments as risk management tools that involve little complexity, and are not used for trading or speculative purposes.  In June 2013, in connection with Woodward’s expected refinancing of current maturities on its existing long-term debt, Woodward entered into a treasury lock agreement with a notional amount of $25,000 that qualified as a cash flow hedge under ASC Topic 815, “Derivatives and Hedging.”  The objective of this derivative instrument was to hedge the risk of variability in cash flows attributable to changes in the designated benchmark interest rate over a seven-year period related to the future interest payments on a portion of anticipated future debt issuances.   To manage interest rate risk related to the $400,000 of long-term debt issued in October 2008, we used a treasury lock, which locked in interest rates on the then future debt.  The treasury lock agreement was designated as a cash flow hedge against interest rate risk on a portion of the debt issued in October 2008.  Similarly, we used a LIBOR lock agreement with a notional amount of $50,000, which hedged the risk of variability in cash flows over a seven-year period related to future interest payments of a portion of the long-term debt issued in April of 2009 in connection with an acquisition.

A portion of our long and short-term debt is sensitive to changes in interest rates.  As of September 30, 2014 our Series J Notes of $50,000 and advances on our revolving credit facility are at interest rates that fluctuate with market rates.    A hypothetical 1% increase in the assumed effective interest rates that apply to the variable rate loan outstanding as of September 30, 2014 and the average borrowings on our revolving credit facility in fiscal year 2014  would cause our annual interest expense to increase approximately $1,981.  A hypothetical 0.2% decrease in interest rates that apply to the variable rate loan outstanding as of September 30, 2014 and the average borrowings on our revolving credit facility, which would effectively reduce the variable component of the applicable interest rates to 0%, would decrease our annual interest expense by approximately $403. 

The discount rate and future return on plan asset assumptions used to calculate the funding status of our retirement benefit plans are also sensitive to changes in interest rates.  The discount rate assumption used to value the defined benefit

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pension plans as of September 30, 2014 was 4.4% in the United States, 4.1% in the United Kingdom, and 1.1% in Japan.  The discount rate assumption used to value the other postretirement benefit plans was 4.4%.

The following information illustrates the sensitivity of the net periodic benefit cost and the projected accumulated benefit obligation to a change in the discount rate assumed.  Amounts relating to foreign plans are translated at the spot rate on September 30, 2014.  It should be noted that economic factors and conditions often affect multiple assumptions simultaneously and the effects of changes in assumptions are not necessarily linear due to factors such as the 10% corridor applied to the larger of the postretirement benefit obligation or the fair market value of plan assets when determining amortization of actuarial net gains or losses.

 

Foreign Currency Exchange Rate Risk

We are impacted by changes in foreign currency exchange rates when we sell product in currencies different from the currency in which product and manufacturing costs were incurred.  The functional currencies and our purchasing and sales activities primarily include USD, EUR, CNY, JPY and GBP.  We may also be impacted by changes in the relative buying power of our customers, which may impact sales volumes either positively or negatively.  As these currencies fluctuate against each other, and other currencies, we are exposed to foreign currency exchange rate risk on sales, purchasing transactions, and labor.  Foreign currency exchange rate risk is reduced through the maintenance of local production facilities in the markets we serve, which we believe creates a natural hedge to our foreign currency exchange rate exposure.  For the year ended September 30, 2014, the percentages of our net sales denominated in a currency other than the USD were as follows:

Currency exchange rates vary daily and often one currency strengthens against the USD while another currency weakens.  Because of the complex interrelationship of our worldwide supply chains and distribution channels, it is difficult to quantify the impact of a particular change in exchange rates.

From time to time, we will enter into a foreign currency exchange rate contract to hedge against changes in foreign currency exchange rates on liabilities expected to be settled at a future date.  Market risk arises from the potential adverse effects on the value of derivative instruments that result from a change in foreign currency exchange rates.  We minimize this market risk by establishing and monitoring parameters that limit the types of, and degree to which we enter into, derivative instruments.  We enter into derivative instruments for risk management purposes only.  We do not enter into or issue derivatives for trading or speculative purposes.  As of September 30, 2014 and 2013, we had no open foreign currency exchange rate contracts and all previous derivative instruments were settled or terminated.  For more information on derivative instruments, see Note 6, Derivative instruments and hedging activities,  to the Consolidated Financial Statements in “Item 8 – Financial Statements and Supplementary Data.”

Our reported financial results of operations, including the reported value of our assets and liabilities, are also impacted by changes in foreign currency exchange rates.  The assets and liabilities of substantially all of our subsidiaries outside the

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United States are translated at period end rates of exchange for each reporting period.  Earnings and cash flow statements are translated at weighted-average rates of exchange.  Although these translation changes have no immediate cash impact, the translation changes may impact future borrowing capacity, debt covenants, and the overall value of our net assets.  In addition, we also have assets and liabilities, specifically accounts receivable, accounts payable and current inter-company receivables and payables, whose carrying amounts approximate their fair value, which are denominated in currencies other than their relevant functional currencies.  Foreign currency exchange rate risk is reduced through several means, including the invoicing of customers in the same currency as the source of the products, the prompt settlement of inter-company balances utilizing a global netting system, and limited use of foreign currency denominated debt.  We recognized net foreign currency losses of $1,089 in fiscal year 2014, $2,738 in fiscal year 2013 and $480 in fiscal year 2012 in “Selling, general, and administrative expenses” of our Consolidated Statements of Earnings related to these assets and liabilities.

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Item 8.Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

Woodward, Inc.

Fort Collins, Colorado

We have audited the accompanying consolidated balance sheets of Woodward, Inc. and subsidiaries (the "Company") as of September 30, 2014 and 2013, and the related consolidated statements of earnings, comprehensive earnings, stockholders' equity, and cash flows for each of the three years in the period ended September 30, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15.  These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Woodward, Inc. and subsidiaries as of September 30, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2014, in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of September 30, 2014, based on the criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 12, 2014 expressed an unqualified opinion on the Company's internal control over financial reporting.

 

 

/s/ DELOITTE & TOUCHE LLP

Denver, Colorado

November 12, 2014

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WOODWARD, INC.

CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands, except per share amounts)

 

 

See accompanying Notes to Consolidated Financial Statements.

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WOODWARD, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to Consolidated Financial Statements.

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WOODWARD, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

See accompanying Notes to Consolidated Financial Statements.

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WOODWARD, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

See accompanying Notes to Consolidated Financial Statements.