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

FORM 10-Q

For the quarterly period ended June 30, 2002

OR

For the transition period from                              to                             

Commission file number 0-8408

WOODWARD GOVERNOR COMPANY
(Exact name of registrant as specified in its charter)

5001 North Second Street, Rockford, Illinois 61125-7001
(Address of principal executive offices)

(815) 877-7441
(Registrant's telephone number, including area code)

        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 ý    No o

        As of August 1, 2002, 11,328,146 shares of common stock with a par value of $.00875 cents per share were outstanding.

TABLE OF CONTENTS

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Part I

Item 1.    Financial Statements

Statements of Consolidated Earnings
Woodward Governor Company and Subsidiaries

See accompanying Notes to Consolidated Financial Statements.

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Statements of Consolidated Earnings
Woodward Governor Company and Subsidiaries

Statements of consolidated earnings continued on next page.

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Statements of Consolidated Earnings
Woodward Governor Company and Subsidiaries

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Balance Sheets
Woodward Governor Company and Subsidiaries

See accompanying Notes to Consolidated Financial Statements.

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Statements of Consolidated Cash Flows
Woodward Governor Company and Subsidiaries

See accompanying Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements

        (1)  The consolidated balance sheet as of June 30, 2002, the statements of consolidated earnings for the three and nine-month periods ended June 30, 2002 and 2001, and the statements of consolidated cash flows for the nine-month periods ended June 30, 2002 and 2001, were prepared by the company without audit. The September 30, 2001, consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. Information in this 10-Q report is based in part on estimates and is subject to year-end adjustments and audit. In our opinion, the figures reflect all adjustments necessary to present fairly the company's financial position as of June 30, 2002, the results of its operations for the three and nine-month periods ended June 30, 2002 and 2001, and its cash flows for the nine-month periods ended June 30, 2002 and 2001. All such adjustments were of a normal and recurring nature. The statements were prepared following the accounting policies described in the company's 2001 annual report on Form 10-K (except as noted below in Note 2) and should be read with the Notes to Consolidated Financial Statements on pages 26-33 of the 2001 annual report to shareholders. The statements of consolidated earnings for the three and nine-month periods ended June 30, 2002, are not necessarily indicative of the results to be expected for other interim periods or for the full year.

        Certain reclassifications were made to the statement of consolidated cash flows for the nine months ended June 30, 2001, to conform to the current presentation.

        (2)  In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets." Statement No. 141 primarily impacts accounting for transactions initiated or completed after June 30, 2001. However, Statement No. 141 also contains transition provisions that may result in the reclassification of carrying values among existing goodwill and other intangibles. We adopted Statement No. 142 and the transition provisions of Statement No. 141 on October 1, 2001.

        As a result of adopting these new standards, our accounting policies for goodwill and other intangibles changed on October 1, 2001, as described below:

        Goodwill:    We recognize the excess of the cost of an acquired entity over the net amount assigned to assets acquired and liabilities assumed as goodwill. Goodwill is tested for impairment on an annual basis and between annual tests in certain circumstances. Impairment losses are recognized whenever the implied fair value of goodwill is less than its carrying value. Prior to October 1, 2001, goodwill was amortized over periods of up to 30 years. Beginning October 1, 2001, goodwill is no longer amortized.

        Other Intangibles: We recognize an acquired intangible apart from goodwill whenever the asset arises from contractual or other legal rights, or whenever it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged, either individually or in combination with a related contract, asset, or liability. However, we would not recognize an assembled workforce as an intangible apart from goodwill. An intangible other than goodwill is amortized over its estimated useful life unless that life is determined to be indefinite. Currently, all of our intangibles have an estimated useful life and are being amortized. Impairment losses are recognized if the carrying amount of an intangible subject to amortization is not recoverable from expected future cash flows and its carrying amount exceeds its fair value.

        Also as a result of adopting these new standards, we completed the transitional goodwill impairment reviews required by the new standards and recognized an aftertax loss of $2,489,000 as a cumulative effect of an accounting change. In performing our impairment reviews, we estimated the fair values of the various reporting units using a present value method that discounted future cash flows as we expect marketplace participants would, and we further assessed the reasonableness of the estimates by using valuation methods based on market multiples. The impairment loss related to an Industrial Controls reporting unit.

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        Other than the cumulative effect of the accounting change, adoption of the new accounting standards resulted in an increase in goodwill and a decrease in other intangibles of $4,425,000 on October 1, 2001, and, based on goodwill existing at October 1, 2001, is expected to result in a decrease in amortization expense of $4,874,000 for 2002.

        (3)  We acquired the capital stock of Leonhard-Reglerbau Dr.-Ing. Adolf Leonhard GmbH and acquired certain assets and assumed certain liabilities of Nolff's Carburetion, Inc. in the second quarter of the year ending September 30, 2002. Leonhard-Reglerbau specializes in the design, manufacture, and sales of control, protection, and monitoring devices for power generation equipment. Nolff's Carburetion manufactures and sells natural gas and propane fuel systems for small industrial engines. Our cost for these acquisitions totaled $25,292,000.

        The current amount of goodwill recognized for the acquisitions totaled $22,843,000, of which $12,545,000 is expected to be fully deductible for income tax purposes. However, we have not yet completed a final allocation of the purchase price. As a result, the amounts recorded for the acquisitions are subject to adjustment, but we do not expect any adjustments to be significant. Goodwill for these acquisitions is accounted for in the Industrial Controls' segment.

        Pro forma information of our consolidated results of operations as if the acquisitions had been completed at the beginning of fiscal year 2002 are not included as the resulting pro forma data would not be materially different from the results reported.

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(4)

Earnings per share:

        The following stock options were outstanding during the three months and nine months ended June 30, 2002 and 2001, but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares during the respective periods.

(5)

Inventories:

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(6)

Goodwill:

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(7)

Other intangibles—net:

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(7)

Other intangibles—net (continued):

        Amortization expense associated with current intangibles is expected to be approximately $3,070,000 for each year 2002-2007.

        (8)  In October 2001 and January 2002, we entered into interest rate swap agreements with notional amounts totaling $50,000,000 to hedge against changes in the fair market value of a portion of our long-term debt. The debt we hedged has a fixed interest rate of 6.39% and principal payments through fiscal 2012. Under the agreements, we will pay interest at floating rates based on LIBOR. We have designated the swap agreements as fair value hedges and have assessed the hedges as having no ineffectiveness. The fair value of the interest rate swaps are included in other liabilities with a balance of $65,000 and the carrying value of the related long-term debt has been reduced by a similar amount.

(9)

Accounts payable and other accrued expenses:

        Included in salaries and other member benefits are termination benefits and other termination related costs of $424,000. In the first and second quarters of the fiscal year ending September 30, 2002, we accrued and expensed $5,312,000, of which payments totaling $4,888,000 involving 202 members have been made. Aircraft Engine Systems accounted for $3,422,000 of the total expense, which was incurred in the first quarter. These terminations were made to better align both capacity and cost structure with current business prospects and involved 141 members, predominantly in manufacturing functions. Industrial Controls accounted for $1,890,000 of the total expense, of which $767,000 was incurred in the first quarter and $1,123,000 was incurred in the second quarter. These terminations were made to consolidate certain manufacturing and administrative activities into fewer locations and involved 32 members in the first quarter and 41 members in the second quarter from both manufacturing and administrative functions.

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(10)

Accumulated other comprehensive earnings:

(11)

Total comprehensive earnings:

        (12) We are currently involved in matters of litigation arising from the normal course of business, including certain environmental and product liability matters. We have accruals of approximately $1,000,000 at June 30, 2002, related to such matters. These accruals are based on our current estimate of the most likely amount of losses that we believe will be incurred. These amounts have been included in accounts payable and accrued expenses.

        We have been designated a "de minimis potentially responsible party" with respect to the cost of investigation and environmental cleanup of certain third-party sites. Our current accrual for these matters is based on costs incurred to date that we have been allocated and our estimate of the most likely future investigation and cleanup costs. There is, as in the case of most environmental litigation, the possibility that under joint and several liability we could be required to pay more than our allocated share of costs.

        It is our opinion, after consultation with legal counsel, that additional liabilities, if any, resulting from these matters are not expected to have a material adverse effect on our financial condition, although such matters could have a material effect on our quarterly or annual operating results and cash flows when resolved in a future period.

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(13)

Segment information:

        The difference between the total of segment earnings and the statements of consolidated earnings follows:

        Segment assets were as follows:

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Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        We prepared the following discussion and analysis to help you better understand our results of operations and financial condition. This discussion should be read with the consolidated financial statements, including the notes, and the cautionary statement on page 35 of our 2001 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2001.

        Statements in this discussion and analysis concerning the company's future sales, earnings, business performance, prospects, and the economy in general reflect current expectations and are forward-looking statements that involve risks and uncertainties. Actual results could differ materially from projections or any other forward-looking statement and we have no obligation to update our forward-looking statements. Factors that could affect performance and could cause results to differ materially from projections and forward-looking statements are described in the cautionary statement referred to above.

Results of Operations

        Our results of operations are discussed and analyzed by segment. We have operating two segments—Industrial Controls and Aircraft Engine Systems. Industrial Controls provides energy control systems and components primarily to OEMs (original equipment manufacturers) of industrial engines, turbines, and other power equipment. Aircraft Engine Systems provides energy control systems and components primarily to OEMs of aircraft engines.

        We use segment earnings internally to assess the performance of each segment and for making decisions on the allocation of resources. Total segment earnings do not reflect all expenses of the company and are before the cumulative effect of an accounting change. Nonsegment expenses, including income taxes, and the accounting change are separately discussed and analyzed.

        Among the effects of the accounting change is that goodwill is no longer amortized after September 30, 2001. Therefore, to provide the most meaningful comparison of earnings and income tax expense between periods, various earnings measures and income tax expense are analyzed and discussed on an adjusted basis. Any amount in this discussion and analysis labeled "adjusted" reflects the elimination of goodwill-related amortization and associated income taxes from amounts reported in the financial statements.

Industrial Controls

        External net sales for Industrial Controls increased in both the three months and nine months ended June 30, 2002, as compared to the same periods last year. Sales growth primarily reflects market share gains across most product lines as a result of acquisitions and new product introductions over the last year. In addition, a series of shipments that included lower-profit purchased components increased revenues. That order was substantially completed in the third quarter. However, sales of our core manufactured products decreased due to continued lower shipment volumes at virtually all our OEM customers. Most significantly, we have seen a decrease in demand for large gas turbines, particularly aeroderivative turbines, used in power generation. Demand for these products, which have been strong over the last two years, began declining in this year's second quarter as investors and companies became more cautious in the energy sectors of the economy.

        The acquisition of the Bryce diesel fuel injection business of Delphi Automotive Systems in the third quarter of 2001 has had a positive impact on Industrial Controls' sales in 2002. To a lesser degree, our acquisition of the capital stock of Leonhard-Reglerbau Dr.-Ing. Adolf Leonhard GmbH and certain net assets of Nolff's Carburetion, Inc. in this year's second quarter positively impacted sales. Leonhard-Reglerbau specializes in the design, manufacture, and sales of control, protection, and monitoring devices for power generation equipment. Nolff's Carburetion manufactures and sells natural gas and propane fuel systems for small industrial engines. As a result of these three acquisitions, our sales

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increased by $8.7 million in the three-month period and $20.8 million in the nine-month period ended June 30, 2002.

        Industrial Controls' segment earnings, as adjusted to eliminate goodwill-related amortization from last year's reported earnings, decreased in both the three months and nine months ended June 30, 2002, as compared to the same periods last year. Reduced sales volumes of our core manufactured products, combined with lower profits that resulted from sales of purchased components used in alternative fuel systems in the transportation market, were the primary contributors to reduced margins. For the full nine-month period, we have also invested in new product development at levels higher than last year.

        We expensed and accrued $1.9 million for the planned termination of 73 members involved in manufacturing and administrative functions in the first six months of the current year. The terminations are the result of consolidating certain manufacturing and administrative activities into fewer locations. At the end of June 2002, 63 members had been terminated and paid and we expect to complete the remaining terminations and make related payments by the end of the second quarter of fiscal 2003.

        Outlook:    Our long-term growth strategies continue to serve us well. We are increasing our customer base and providing increased content per engine; unfortunately, those achievements are currently offset by a decline in orders overall. The current resistance to capital spending on power generation projects, while certainly temporary, may continue to impact our turbine product sales for some time. In addition, we do not anticipate resumed growth in our other market sectors until signs of economic recovery are more evident. Once that begins, however, we are well positioned to benefit.

Aircraft Engine Systems

        External net sales for Aircraft Engine Systems decreased in both the three months and nine months ended June 30, 2002, as compared to the same periods last year. The decrease in sales is attributed to the effects of reduced commercial airline traffic since September 2001 on both OEM and aftermarket sales, although demand for our aftermarket services have been better than we expected. Also, increased military sales have partially offset sales declines in our commercial markets.

        We recently renewed or expanded long term agreements with several of our larger customers, such as GE Aircraft Engines. We are also developing product improvement packages and expanding our aftermarket service capabilities to target high-growth markets such as China.

        Aircraft Engine Systems' segment earnings, as adjusted to eliminate goodwill-related amortization from last year's reported earnings, decreased slightly in the three months ended June 30, 2002 and increased in the nine months ended June 30, 2002, as compared to the same periods last year. Segment earnings reflect aggressive productivity enhancements and cost-control measures in response to the decreased sales volume, as well as a favorable sales mix.

        We expensed and accrued $3.4 million for the planned termination of 141 members involved predominantly in manufacturing activities in this year's first quarter, which represents approximately 9% of Aircraft Engine Systems' workforce. The terminations were to better align both capacity and cost structure with current business prospects. At the end of the nine months, all but two terminations and related payments had occurred.

        Outlook:    We believe demand for civil aircraft products will remain soft over the next several quarters. However, we believe the quality-enhancement and expense control strategies, particularly Six Sigma, which have helped manage costs during these difficult times will help improve operational performance in the future. We also maintain strong customer relationships, have long term agreements in place with several of our larger customers, and are developing product improvement packages and expanding our aftermarket service capabilities to target growing markets. We therefore expect proportionate sales increases when the industry improves.

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Nonsegment Expenses and Gain

        Interest expense decreased in both the three months and nine months ended June 30, 2002, as compared to the corresponding periods last year because we had lower levels of average outstanding debt and lower average interest rates.

        Corporate expenses decreased in both the three months and nine months ended June 30, 2002, as compared to the corresponding periods last year primarily due to changes in deferred compensation expense, which is dependent on the market price of the company's common stock. Certain key management members may elect to defer the payment of a portion of their compensation to future periods. These deferrals are recorded as deferred compensation, and individual member balances are increased or decreased as if they were held in specified investments, including common stock of the company. We have not set aside investments to offset these deferred compensation obligations.

Earnings

        Earnings before the cumulative effect of accounting change, as adjusted to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings, increased in both the three months and nine months ended June 30, 2002, as compared to the same periods last year. Income taxes for the nine months ended June 30, 2002, were impacted by a reduction in valuation allowances provided on deferred tax assets, reducing our overall effective income tax rate to 36.4% for the nine months ended June 30, 2002, as compared to 38.9% for the same period last year. The

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reduction in valuation allowances was associated with a transfer of our interest in a joint venture. We expect the rate for the remainder of the year to be about 38%.

        Net earnings, as adjusted to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings, increased slightly in both the three and nine months ended June 30, 2002, as compared to the same periods last year. In this year's first quarter, we reported a cumulative effect of accounting change related to our October 1, 2001, adoption of Financial Accounting Standards No. 142, "Goodwill and Other Intangibles." We completed the transitional goodwill impairment reviews required by the new standards and determined that one of our Industrial Controls' reporting units had a goodwill carrying value that exceeded its estimated implied fair value. The cumulative effect of accounting change reflects the write-down of the goodwill, net of income taxes, to its implied fair value. In performing our impairment reviews, we estimated the fair value of the various reporting units using a present value method that discounted future cash flows as we expect marketplace participants would, and we further assessed the reasonableness of the estimates by using valuation methods based on market multiples.

        The adjustment to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings increased both earnings before the cumulative effect of accounting change and net earnings by $0.7 million, or $0.06 per share on both a basic and diluted share basis, for the three-month period and $2.1 million, or $.18 per basic and diluted share for the nine-month period last year. Goodwill-related amortization includes amortization expense associated with all intangibles currently classified as goodwill.

        Outlook:    Based on an updated review of our outlook, we reaffirm our previous belief that consolidated earnings in 2002 are expected to approximate those of 2001, within a range of plus or minus 5%. However, as we communicated last quarter, we expect the earnings will more likely be in the lower part of that range because the current economic downturn has had a more significant impact on our customers' engine shipments than we had first anticipated. For this outlook, we are using an earnings measurement before the cumulative effect of the accounting change and after adjustments to eliminate goodwill-related amortization from last year's reported amounts. Goodwill-related amortization, net of income taxes, totaled $2.9 million in fiscal 2001.

Financial Condition

        Our discussion and analysis of financial condition is presented by segment for assets. We also separately discuss and analyze other balance sheet measures and cash flows. Together, this discussion and analysis will help you assess our liquidity and capital resources, as well as understand changes in our financial condition.

Assets