WOODWARD GOVERNOR CO - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

		For the quarterly period ended March 31, 2004

or

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

		For the transition period from to

Commission file number 0-8408

Woodward Governor Company

(Exact name of registrant as specified in its charter)


Delaware		36-1984010
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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

(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 þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

As of April 23, 2004, 11,298,576 shares of common stock with a par value of $.00875 cents per share were outstanding.

TABLE OF CONTENTS


		Page

PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements		2
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		20
Item 4.	Controls and Procedures		20

PART II — OTHER INFORMATION
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities		22
Item 4.	Submission of Matters to a Vote of Security Holders		22
Item 6.	Exhibits and Reports on Form 8-K		22
Signatures			23
Certification
Certification
Certification

PART I — FINANCIAL INFORMATION


Item 1.	*Financial Statements*

Statements of Consolidated Earnings


	*Woodward Governor Company and Subsidiaries*



			Three Months Ended
			March 31,

			2004			2003


			(Unaudited)

			(In thousands except
			per share amounts)
Net Sales			$	172,951		$	146,159

Costs and expenses:
	Cost of goods sold			139,232			122,114
	Selling, general, and administrative expenses			16,827			15,289
	Amortization of intangible assets			1,820			1,029
	Interest expense			1,451			951
	Interest income			(213	)		(383	)
	Other income — net			(755	)		(259	)

		Total costs and expenses		158,362			138,741

Earnings before income taxes				14,589			7,418
Income taxes				5,484			2,907

Net earnings			$	9,105		$	4,511

Earnings per share:
Basic			$	0.81		$	0.40
Diluted				0.79			0.40

Weighted-average number of shares outstanding:
Basic				11,276			11,151
Diluted				11,557			11,270

Cash dividends per share			$	0.24		$	0.24

See accompanying Notes to Consolidated Financial Statements.

Statements of Consolidated Earnings

Woodward Governor Company and Subsidiaries



			Six Months Ended
			March 31,

			2004			2003


			(Unaudited)

			(In thousands except
			per share amounts)
Net Sales			$	331,924		$	290,984

Costs and expenses:
	Cost of goods sold			266,547			240,380
	Selling, general, and administrative Expenses			34,005			30,086
	Amortization of intangible assets			3,430			2,046
	Interest expense			2,695			2,145
	Interest income			(786	)		(492	)
	Other income — net			(577	)		(703	)

		Total costs and expenses		305,314			273,462

Earnings before income taxes				26,610			17,522
Income taxes				10,112			6,746

Net earnings			$	16,498		$	10,776

Per share amounts:
Basic			$	1.46		$	0.96
Diluted				1.43			0.95

Weighted-average number of shares outstanding:
Basic				11,269			11,229
Diluted				11,507			11,366

Cash dividends per share			$	0.48		$	0.4725

See accompanying Notes to Consolidated Financial Statements.

Consolidated Balance Sheets


	*Woodward Governor Company and Subsidiaries*


			At		At
			March 31,		September 30,
			2004		2003

			(Unaudited)

			(In thousands except
			per share amounts)
ASSETS
Current assets:
	Cash and cash equivalents		$	36,969	$	24,058
	Accounts receivable, less allowance for losses of $1,926 for March and $2,601 for September			84,100		87,807
	Inventories			136,442		126,289
	Income taxes receivable			—		1,782
	Deferred income taxes			14,922		14,179
	Other current assets			3,392		5,157

		Total current assets		275,825		259,272

Property, plant, and equipment — net				120,574		124,144
Goodwill				131,505		133,620
Other intangibles — net				86,002		85,291
Deferred income taxes				3,450		6,429
Other assets				6,669		7,243

Total assets			$	624,025	$	615,999

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Short-term borrowings		$	9,248	$	5,774
	Current portion of long-term debt			—		30,000
	Accounts payable			36,654		26,703
	Accrued liabilities			43,722		45,533
	Income taxes payable			7,313		—

		Total current liabilities		96,937		108,010

Long-term debt, less current portion				90,064		89,970
Other liabilities				60,331		57,215
Commitments and contingencies				—		—
Shareholders’ equity represented by:
	Preferred stock, par value $.003 per share, authorized 10,000 shares, no shares issued			—		—
	Common stock, par value $.00875 per share, authorized 50,000 shares, issued 12,160 shares			106		106
	Additional paid-in capital			14,145		13,760
	Accumulated other comprehensive earnings			12,880		9,625
	Deferred compensation			4,415		4,377
	Retained earnings			372,818		361,382

				404,364		389,250
Less: Treasury stock, at cost, 864 shares for March and 901 shares for September				23,256		24,069
Treasury stock held for deferred compensation				4,415		4,377

		Total shareholders’ equity		376,693		360,804

Total liabilities and shareholders’ equity			$	624,025	$	615,999

See accompanying Notes to Consolidated Financial Statements.

Statements of Consolidated Cash Flows


	*Woodward Governor Company and Subsidiaries*



			Six Months Ended
			March 31,

			2004			2003


			(Unaudited)

			(In thousands)
Cash flows from operating activities:
Net earnings			$	16,498		$	10,776

Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization				17,014			15,652
Net loss on sale of property, plant, and equipment				143			76
ESOP compensation expense				—			(291	)
Deferred income taxes				297			4,023
Reclassification of unrealized losses on derivatives to earnings				147			85
Changes in operating assets and liabilities:
	Accounts receivable			5,550			3,085
	Inventories			(8,311	)		3,295
	Accounts payable and accrued liabilities			6,996			(9,303	)
	Income taxes payable			9,386			(390	)
	Other — net			5,120			(18	)

		Total adjustments		36,342			16,214

Net cash provided by operating activities				52,840			26,990

Cash flows from investing activities:
Payments for purchase of property, plant, and equipment				(9,361	)		(6,881	)
Proceeds from sale of property, plant, and equipment				124			98
Business acquisitions, net of cash acquired				389			—

Net cash used in investing activities				(8,848	)		(6,783	)

Cash flows from financing activities:
Cash dividends paid				(5,408	)		(5,310	)
Proceeds from sales of treasury stock				1,198			307
Purchases of treasury stock				—			(9,503	)
Net payments from borrowings under revolving lines				(26,837	)		(4,961	)

Net cash used in financing activities				(31,047	)		(19,467	)

Effect of exchange rate changes on cash				(34	)		284

Net change in cash and cash equivalents				12,911			1,024
Cash and cash equivalents, beginning of year				24,058			29,828

Cash and cash equivalents, end of period			$	36,969		$	30,852

Supplemental cash flow information:
Interest expense paid			$	3,036		$	658
Income taxes paid				4,498			2,623

See accompanying Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(1)	Overview:

The consolidated balance sheet as of March 31, 2004, the statements of consolidated earnings for the three and six-month periods ended March 31, 2004 and 2003, and the statements of consolidated cash flows for the six-month periods ended March 31, 2004 and 2003, were prepared by the company without audit. The September 30, 2003, 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 March 31, 2004, the results of its operations for the three and six-month periods ended March 31, 2004 and 2003, and its cash flows for the six-month periods ended March 31, 2004 and 2003. All such adjustments were of a normal and recurring nature. The statements were prepared following the accounting policies described in the company’s 2003 annual report on Form 10-K and should be read with the Notes to Consolidated Financial Statements on pages 34-46 of the 2003 annual report to shareholders. The statements of consolidated earnings for the three and six-month period ended March 31, 2004, is not necessarily indicative of the results to be expected for other interim periods or for the full year.


(2)	Stock-based compensation policy:

We use the intrinsic value method to account for stock-based employee compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and therefore we do not recognize compensation expense in association with options granted at or above the market price of our common stock at the date of grant. The following table presents a reconciliation of reported net earnings and per share information to pro forma net earnings and per share information that would have been reported if the fair value method had been used to account for stock-based employee compensation:



		Three Months						Six Months
		Ended						Ended
		March 31,						March 31,

		2004			2003			2004			2003


		(In thousands except per share amounts)
Reported net earnings		$	9,105		$	4,511		$	16,498		$	10,776
Stock-based compensation expense using the fair value method, net of income tax			(452	)		(257	)		(689	)		(512	)

Pro forma net earnings		$	8,653		$	4,254		$	15,809		$	10,264

Reported net earnings per share amounts:
	Basic	$	0.81		$	0.40		$	1.46		$	0.96
	Diluted		0.79			0.40			1.43			0.95

Pro forma net earnings per share amounts:
	Basic	$	0.77		$	0.38		$	1.40		$	0.91
	Diluted		0.75			0.38			1.38			0.91


(3)	New Accounting Standards:

In December 2003, the Financial Accounting Standards Board issued a revised Statement of Financial Accounting Standards No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” The revised Statement requires additional disclosures to those in the original Statement No. 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The interim-period disclosure requirements of the revised Statement were effective during our first quarter this year, and our disclosures may be found in note 10 to the consolidated

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

financial statements. The remaining disclosure requirements of the revised Statement are effective for our year ending September 30, 2004.


(4)	Earnings per share:



		Three Months Ended				Six Months Ended
		March 31,				March 31,

		2004		2003		2004		2003


		(In thousands, except per share amounts)
Net earnings(A)		$	9,105	$	4,511	$	16,498	$	10,776

Determination of shares:
	Weighted-average shares of common stock outstanding(B)		11,276		11,151		11,269		11,229
	Assumed exercise of stock options		281		119		238		137

	Weighted-average shares of common stock outstanding assuming dilution(C)		11,557		11,270		11,507		11,366

Earnings before cumulative effect of accounting change:
	Basic per share amount (A/B)	$	0.81	$	0.40	$	1.46	$	0.96
	Diluted per share amount (A/C)	$	0.79	$	0.40	$	1.43	$	0.95

The following stock options were outstanding during the three and six months ended March 31, 2004 and 2003, 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:



	Three Months Ended				Six Months Ended
	March 31,				March 31,

	2004		2003		2004		2003

Options		11,979		449,146		25,763		437,688
Weighted-average exercise price	$	70.33	$	46.93	$	62.49	$	47.10


(5)	Inventories:


	At		At
	March 31,		September 30,
	2004		2003


	(In thousands)
Raw materials	$	3,596	$	6,017
Component parts		86,796		76,151
Work in process		30,433		27,237
Finished goods		15,617		16,884

	$	136,442	$	126,289

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(6)	Property, plant, and equipment:


	At		At
	March 31,		September 30,
	2004		2003


	(In thousands)
Land	$	10,555	$	10,049
Buildings and equipment		147,817		145,779
Machinery and equipment		247,220		247,767
Construction in progress		4,717		2,239

		410,309		405,834
Less accumulated depreciation		289,735		281,690

Property, plant, and equipment — net	$	120,574	$	124,144


(7)	Goodwill:


		(In thousands)

Industrial Controls:
	Balance at September 30, 2003	$	71,498
	Goodwill acquired		(3,491	)
	Foreign currency exchange rate changes		1,376

	Balance at March 31, 2004	$	69,383

Aircraft Engine Systems:
	Balance at September 30, 2003 and March 31, 2004	$	62,122
Consolidated:
	Balance at September 30, 2003	$	133,620
	Goodwill acquired		(3,491	)
	Foreign currency exchange rate changes		1,376

	Balance at March 31, 2004	$	131,505

In August 2003, we acquired assets and assumed certain liabilities of Barber-Colman Dyna Products, a division of Invensys Building Systems, Inc. At September 30, 2003, both the cost for the acquisition and the related allocation of the acquisition cost were subject to change, including $3,491,000 that was recognized as goodwill. We finalized the acquisition cost and allocation of the acquisition cost in 2004. As finalized, our cost for this acquisition totaled $7,684,000, of which $3,776,000 was recognized as customer relationships and $100,000 was recognized as other intangibles in the Industrial Controls segment. No value was recognized as goodwill and, as a result, the preceding table reports a reduction in the amount of goodwill acquired. For this acquisition, we are using weighted-average amortization periods of eleven years for customer relationships, two years for other intangibles, and eleven years in the aggregate.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(8) Other intangibles — net:


			At			At
			March 31,			September 30,
			2004			2003


			(In thousands)
Industrial Controls:
	Customer relationships:
		Amount acquired	$	37,386		$	33,610
		Accumulated amortization		(4,915	)		(3,615	)

				32,471			29,995

	Other:
		Amount acquired		28,272			27,815
		Accumulated amortization		(6,042	)		(4,594	)

				22,230			23,221

	Total		$	54,701		$	53,216

Aircraft Engine Systems:
	Customer relationships:
		Amount acquired	$	28,547		$	28,547
		Accumulated amortization		(5,551	)		(5,075	)

				22,996			23,472

	Other:
		Amount acquired		11,785			11,785
		Accumulated amortization		(3,480	)		(3,182	)

				8,305			8,603

	Total		$	31,301		$	32,075

Consolidated:
	Customer relationships:
		Amount acquired	$	65,933		$	62,157
		Accumulated amortization		(10,466	)		(8,690	)

				55,467			53,467

	Other:
		Amount acquired		40,057			39,600
		Accumulated amortization		(9,522	)		(7,776	)

				30,535			31,824

	Total		$	86,002		$	85,291

Amortization expense associated with current intangibles is expected to be approximately $6,800,000 for each year 2004-2005, approximately $6,750,000 for 2006, approximately $6,350,000 in 2007, and approximately $5,750,000 in 2008.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(9)	Accrued liabilities:


	At		At
	March 31,		September 30,
	2004		2003


	(In thousands)
Salaries and other member benefits	$	19,875	$	17,005
Warranties		6,975		6,113
Taxes, other than on income		2,702		3,591
Deferred compensation		2,390		2,328
Other items — net		11,780		16,496

	$	43,722	$	45,533

Salaries and other member benefits include accrued termination benefits totaling $1,145,000 at March 31, 2004 and $2,199,000 at September 30, 2003. Changes in accrued termination benefits for the six months ended March 31, 2004 were as follows:


			(In thousands)

Industrial Controls:
	Balance at September 30, 2003		$	2,037
	Expense:
		Cost of goods sold		126
		Selling, general, and administrative expenses		25
	Payments			(787	)
	Accrual adjustments			(431	)
	Foreign currency exchange rate changes			175

	Balance at March 31, 2004		$	1,145

Aircraft Engine Systems:
	Balance at September 30, 2003		$	104
	Payments			(104	)

	Balance at March 31, 2004		$	—

Nonsegment:
	Balance at September 30, 2003		$	58
	Payments			(58	)

	Balance at March 31, 2004		$	—

Consolidated:
	Balance at September 30, 2003		$	2,199
	Expense:
		Cost of goods sold		126
		Selling, general, and administrative expenses		25
	Payments			(949	)
	Accrual adjustments			(431	)
	Foreign currency exchange rate changes			175

	Balance at March 31, 2004		$	1,145

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Termination benefits accrued by Industrial Controls impacted manufacturing, selling, and administrative expenses and reflect adjustments to stay bonuses to be paid out in future periods. Accrual adjustments in Industrial Controls reflect retention of certain members due to increased production levels. We expect all terminations to be completed by the end of June 2004 and all associated payments to be completed by the end of September 2004.

Provisions of our sales agreements include product warranties customary to such agreements. We establish accruals for specifically identified warranty issues that are probable to result in future costs. We also accrue for warranty costs on a non-specific basis whenever past experience indicates a normal and predictable pattern exists. A reconciliation of accrued product warranties from September 30, 2003, to March 31, 2004, follows:


	(In thousands)

Balance at September 30, 2003	$	6,113
Accruals related to warranties issued during the period		2,806
Accruals related to pre-existing warranties		(330	)
Settlements of amounts accrued		(1,679	)
Foreign currency exchange rate changes		65

Balance at March 31, 2004	$	6,975


(10)	Retirement benefits:

We provide various benefits to eligible members of our company, including pension benefits associated with defined benefit plans and retirement healthcare benefits. Components of net periodic benefit cost and company contributions for these plans were as follows:



		Three Months						Six Months
		Ended						Ended
		March 31,						March 31,

		2004			2003			2004			2003


		(In thousands)
Retirement pension benefits — United States:
Components of net periodic benefit cost:
	Interest cost	$	291		$	250		$	582		$	500
	Expected return on plan assets		(150	)		(200	)		(300	)		(400	)
	Recognized losses		59			—			118			—

Net periodic benefit cost		$	200		$	50		$	400		$	100

Cash contributions by the company		$	—		$	—		$	—		$	—

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



		Three Months						Six Months
		Ended						Ended
		March 31,						March 31,

		2004			2003			2004			2003


		(In thousands)
Retirement pension benefits — other countries:
Components of net periodic benefit cost:
	Service cost	$	421		$	398		$	837		$	685
	Interest cost		455			400			903			741
	Expected return on plan assets		(407	)		(323	)		(807	)		(602	)
	Amortization of unrecognized transition obligation		25			22			49			44
	Recognized losses		132			148			261			294
	Recognized prior service costs		(3	)		(2	)		(5	)		(4	)

Net periodic benefit cost		$	623		$	643		$	1,238		$	1,158

Cash contributions by the company		$	229		$	278		$	562		$	437

Retirement healthcare benefits:
Components of net periodic benefit cost:
	Service cost	$	599		$	429		$	1,198		$	858
	Interest cost		1,140			966			2,278			1,932
	Recognized losses		390			192			800			384
	Recognized prior service costs		(127	)		(127	)		(254	)		(254	)

Net periodic benefit cost		$	2,002		$	1,460		$	4,022		$	2,920

Cash contributions by the company		$	449		$	1,241		$	1,154		$	2,375


(11)	Accumulated other comprehensive earnings:

Accumulated other comprehensive earnings, which totaled $12,880,000 at March 31, 2004, consisted of the following items:


		At or For the Six
		Months Ended
		March 31, 2004

		(In thousands)
Accumulated foreign currency translation adjustments:
	Balance at beginning of year	$	11,611
	Translation adjustments		5,104
	Taxes associated with translation adjustments		(1,940	)

	Balance at end of period	$	14,775

Accumulated unrealized derivative losses:
	Balance at beginning of year	$	(1,047	)
	Reclassification to interest expense		147
	Taxes associated with interest reclassification		(56	)

	Balance at end of period	$	(956	)

Accumulated minimum pension liability adjustments:
	Balance at beginning of year and end of period	$	(939	)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(12)	Total comprehensive earnings:



		Three Months				Six Months
		Ended March 31,				Ended March 31,

		2004		2003		2004		2003


		(In thousands)
Net earnings		$	9,105	$	4,511	$	16,498	$	10,776
Other comprehensive earnings:
	Foreign currency translation adjustments		305		405		3,164		1,747
	Reclassification of unrealized losses on derivatives to earnings		45		42		91		85

Total comprehensive earnings		$	9,455	$	4,958	$	19,753	$	12,608


(13)	Contingencies:

We also file income tax returns in various jurisdictions worldwide, which are subject to audit. Our income taxes receivable/payable include our estimate of the most likely amount of expenses that we believe will result from income tax audit adjustments.

In the event of a change in control of the company, we may be required to pay termination benefits to certain executive officers.

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.


(14)	Segment information:



		Three Months Ended					Six Months Ended
		March 31,					March 31,

		2004		2003			2004		2003


		(In thousands)
Industrial Controls:
	External net sales	$	104,832	$	82,311		$	201,651	$	160,840
	Intersegment sales		162		249			312		427
	Segment earnings (losses)		5,374		(1,848	)		9,965		(178	)

Aircraft Engine Systems:
	External net sales	$	68,119	$	63,848		$	130,273	$	130,144
	Intersegment sales		270		167			609		841
	Segment earnings		13,679		12,167			25,100		24,998

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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



	Three Months						Six Months
	Ended						Ended
	March 31,						March 31,

	2004			2003			2004			2003


	(In thousands)
Total segment earnings	$	19,053		$	10,319		$	35,065		$	24,820
Unallocated corporate expenses		(3,226	)		(2,333	)		(6,546	)		(5,645	)
Interest expense and income		(1,238	)		(568	)		(1,909	)		(1,653	)

Consolidated earnings before income taxes	$	14,589		$	7,418		$	26,610		$	17,522

Segment assets were as follows:


	At		At
	March 31,		September 30,
	2004		2003


	(In thousands)
Industrial Controls	$	348,708	$	336,654
Aircraft Engine Systems		207,754		217,685


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 factors that may affect our future results, our critical accounting policies and market risks, our results of operations and financial condition, and the effects of recent accounting pronouncements. This discussion should be read with the consolidated financial statements.

Factors That May Affect Future Results

This Form 10-Q contains forward-looking statements, including:

• Projections of sales, earnings, cash flows, or other financial items;

• Descriptions of our plans and objectives for future operations;

• Forecasts of future economic performance; and

• Descriptions of assumptions underlying the above items.

Forward-looking statements do not reflect historical facts. Rather, they are statements about future events and conditions and often include words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” or similar expressions. Such statements reflect our expectations about the future only as of the date they are made. We are not obligated to, and we might not, update our forward-looking statements to reflect changes that occur after the date they are made. Furthermore, actual results could differ materially from projections or any other forward-looking statement regardless of when they are made.

Important factors that could individually, or together with one or more other factors, affect our business, results of operations and/or financial condition are discussed more fully in the Management Discussion and Analysis on page 16 of our 2003 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2003.

Critical Accounting Policies

We consider the accounting policies used in preparing our financial statements to be critical accounting policies when they are both important to the portrayal of our financial condition and results of operation, and require us to make difficult, subjective, or complex judgments. Critical accounting policies normally result from the need to make estimates about the effect of matters that are inherently uncertain. Management has discussed the development and selection of our critical accounting policies with the audit committee of the company’s Board of Directors. In each of the areas that were identified as critical accounting policies, our judgments, estimates, and assumptions are impacted by conditions that change over time. As a result, in the future there could be changes in our assets and liabilities, increases or decreases in our expenses, and additional losses or gains that are material to our financial condition and results of operations. Our critical accounting policies are discussed more fully in the Management Discussion and Analysis on pages 17-18 of our 2003 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2003.

Market Risks

Our long-term debt and interest rate swap agreements are sensitive to changes in interest rates. Also, assets, liabilities, and commitments that are to be settled in cash and are denominated in foreign currencies for transaction purposes are sensitive to changes in currency exchange rates. These market risks are discussed more fully in the Management Discussion and Analysis on page 19 of our 2003 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2003.

Results of Operations

Our results of operations are discussed and analyzed by segment. We have two operating 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 turbines.

We use segment earnings internally to assess the performance of each segment and to make decisions on the allocation of resources. Total segment earnings do not reflect all expenses of the company. Nonsegment expenses, including income taxes, are separately discussed and analyzed.



	Three Months Ended					Six Months Ended
	March 31,					March 31,

	2004		2003			2004		2003


			(In thousands)
Industrial Controls
External net sales	$	104,832	$	82,311		$	201,651	$	160,840
Segment earnings (losses)		5,374		(1,848	)		9,965		(178	)

External net sales of Industrial Controls increased in both the three months and six months ended March 31, 2004, as compared to the same periods last year. Businesses acquired in the third and fourth fiscal quarters last year accounted for $13.5 million of the year-over-year increase for the three-month period and $25.7 million for the six-month period. The effect of changes in foreign currency exchange rates accounted for $4.8 million of the increase for the three-month period and $9.6 million for the six-month period. The remaining increases reflected firmer demand in many product lines, particularly from Asian and North American markets.

Industrial Controls generated segment earnings in both the three months and six months ended March 31, 2004, as compared to segment losses for the same periods last year. These improvements were the result of higher sales and improved segment earnings margins. Also, last year, we incurred approximately $2.5 million in charges for workforce management and lease termination expenses during the three-month period and $3.0 million for the six-month period. The improvement in the segment earnings margin was driven by cost reduction efforts in fiscal year 2003, including reductions in our workforce, and the positive operating leverage associated with higher sales.

Our accrual for workforce management activities at September 30, 2003, was $2.1 million. In this year’s first six months, we incurred an additional $0.2 million of expense associated with stay bonuses, made payments totaling $0.8 million and adjusted our accrual by $0.4 million. The accrual adjustment, which was a reduction, reflected retention of certain members due to increased production levels. At March 31, 2004, our remaining accrual was $1.1 million, including the effects of foreign currency rate fluctuations. We expect all member terminations to be completed by the end of June 2004 and all associated payments to be completed by the end of September 2004.



	Three Months Ended				Six Months Ended
	March 31,				March 31,

	2004		2003		2004		2003


	(In thousands)
Aircraft Engine Systems
External net sales	$	68,119	$	63,848	$	130,273	$	130,144
Segment earnings		13,679		12,167		25,100		24,998

External net sales of Aircraft Engine Systems increased in the three months ended March 31, 2004, over the same three-month period last year. For the six months ended March 31, 2004, sales were about the same as last year’s six-month period. Both comparisons reflected continued weakness in the commercial aviation industry generally, with improved military and commercial aftermarket sales in the last quarter.

Aircraft Engine Systems’ segment earnings increased in the three months ended March 31, 2004, as compared to the same three-month period last year. For the six months ended March 31, 2004, earnings were approximately the same as last year’s six-month period. Last year’s results included $1.0 million for workforce management and facility consolidation expenses in the three-month period and $3.3 million in the six-month period.

Our six-month results were affected by lower sales and a less favorable sales mix in our first quarter as compared to the first quarter a year ago, reflecting normal variability in sales. The resulting decrease in first quarter margins was partially offset by cost reductions associated with the facility consolidation of Aircraft Engine Systems’ servovalve operations.



	Three Months						Six Months
	Ended						Ended
	March 31,						March 31,

	2004			2003			2004			2003


	(In thousands)
Nonsegment Expenses
Interest expense	$	1,451		$	951		$	2,695		$	2,145
Interest income		(213	)		(383	)		(786	)		(492	)
Nonsegment expenses		3,226			2,333			6,546			5,645

Interest expense increased in both the three months and six months ended March 31, 2004, as compared to the same periods last year because of higher levels of outstanding debt.

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, principally common stock of the company. The primary reason nonsegment expenses were lower in the three months and six months ended March 31, 2003, as compared to this year is related to deferred compensation. Last year, the value of deferred compensation balances decreased, which resulted in cumulative expense reductions.

In February 2003, we contributed common stock of the company to a trust established specifically for the future settlement of certain deferred compensation obligations that are payable in actual shares of our common stock. To the extent that shares are held in this trust, it is not necessary to record deferred compensation expenses for changes in the fair value of the underlying common stock. As a result, we expect the volatility in our deferred compensation expense to be reduced in subsequent periods.



	Three Months				Six Months
	Ended				Ended
	March 31,				March 31,

	2004		2003		2004		2003


	(In thousands)
Consolidated Earnings
Earnings before income taxes	$	14,589	$	7,418	$	26,610	$	17,522
Income taxes		5,484		2,907		10,112		6,746

Net earnings	$	9,105	$	4,511	$	16,498	$	10,776

Earnings before income taxes and net earnings increased in both the three months and six months ended March 31, 2004, as compared to the same periods last year. For the six-month periods, income taxes were provided at an effective rate on earnings before income taxes of 38.0% this year compared to 38.5% last year. Our effective income tax rate for the full fiscal year 2003 was 38.1%.

Outlook: The broad-based improvement in demand for industrial products in the second quarter this year is consistent with the indications from many of our customers that industrial markets bottomed last fall and are beginning to recover. Tempered by the past few years, we do not yet have sufficient visibility to characterize the recovery in our industrial markets as a sustainable trend. However, we currently expect sales

in the second half of the fiscal year to approximate the run rate of the second quarter. At this sales level, combined with anticipated increased product development activities and other initiatives, we expect net earnings in the second half of the year will be approximately the same as generated in the first half. Actual results will be influenced by many internal and external variables including the timing and slope of the recoveries in our power generation, commercial aviation, and other global markets.

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.


		At		At
		March 31,		September 30,
		2004		2003


		(In thousands)
Assets
Segment assets:
	Industrial Controls	$	348,708	$	336,654
	Aircraft Engine Systems		207,754		217,685
Nonsegment assets			67,563		61,660

Total assets		$	624,025	$	615,999

Industrial Controls’ segment assets increased in the six months ended March 31, 2004, reflecting increases in inventories, due to normal variability in production schedules, and the effects of fluctuations in foreign currency exchange rates. These increases were partially offset by amortization of intangibles and lower accounts receivable attributed to normal variability of collections.

Aircraft Engine Systems’ segment assets decreased in the six months ended March 31, 2004, primarily as a result of a decrease in accounts receivable, attributed to normal variability of collections from customers, and depreciation of property, plant, and equipment at a rate that exceeded capital expenditures.

Nonsegment assets increased in the six months ended March 31, 2004. Increases in cash and cash equivalents, totaling $12.9 million, were partially offset by reductions in deferred income taxes, income taxes receivable, and other assets.


	At		At
	March 31,		September 30,
	2004		2003


	(In thousands)
Other Balance Sheet Measures
Working capital	$	178,888	$	151,262
Long-term debt, less current portion		90,064		89,970
Other liabilities		60,331		57,215
Commitments and contingencies
Shareholders’ equity		376,693		360,804

Working capital increased in the six months ended March 31, 2004, due primarily to two offsetting factors: 1) cash provided by operating activities exceeded capital expenditures and the payment of dividends by $37.9 million; and 2) accounts payable increased by $10.0 million.

Required future principal payments of long-term debt and commitments under operating leases were as follows:


			2005/		2007/
In thousands for the year(s) ended September 30,	2004		2006		2008		Thereafter

Long-term debt	$	—	$	15,197	$	28,600	$	42,858
Operating leases		3,194		4,171		2,769		4,189

We currently have a revolving line of credit facility with a syndicate of U.S. banks totaling $100 million, with an option to increase the amount of the line to $175 million if we desire. The line of credit facility expires on March 14, 2006. In addition, we have other lines of credit facilities, which totaled $30.6 million at September 30, 2003, that are generally reviewed annually for renewal.

Provisions of debt agreements include covenants customary to such agreements that require us to maintain specified minimum or maximum financial measures and place limitations on various investing and financing activities. The agreements also permit the lenders to accelerate repayment requirements in the event of a material adverse event. Our most restrictive covenants require us to maintain a minimum consolidated net worth, a maximum consolidated debt to consolidated operating cash flow, a maximum consolidated debt to EBITDA, and a minimum EBIT to consolidated interest expense ratio, as defined in the agreements. We were in compliance with all covenants at March 31, 2004.

Other liabilities increased in the six months ended March 31, 2004, primarily as a result of changes in net accrued retirement healthcare benefits and retirement pension benefits. Our expenses associated with these plans totaled $9.0 million and our contributions totaled $6.5 million in 2003.

We are currently involved in pending or threatened litigation regarding employment, environmental, and product liability matters, and arbitration proceedings regarding contractual matters arising from the normal course of business. We have accrued approximately $700,000 at March 31, 2004, in accrued expenses for these matters, which represent our estimate of the most likely amount of losses that we believe will be incurred. We also file income tax returns in various jurisdictions worldwide, which are subject to audit. Our income taxes receivable/payable include our estimate of the most likely amount of expenses that we believe will result from income tax audit adjustments. In the event of a change in control of the company, we may be required to pay termination benefits to certain executive officers. 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.

Shareholders’ equity increased in the six months ended March 31, 2004. Increases due to net earnings and favorable foreign currency translation adjustments were partially offset by cash dividend payments.

On November 9, 2002, our Board of Directors authorized the repurchase of up to $20 million of our common stock from time to time in open market and private transactions over the two years following the authorization. Through March 31, 2004, we purchased $9.5 million of our common stock.



	Six Months Ended
	March 31,

	2004			2003


	(In thousands)
Cash Flows
Net cash provided by operating activities	$	52,840		$	26,990
Net cash used in investing activities		(8,848	)		(6,783	)
Net cash used in financing activities		(31,047	)		(19,467	)

Net cash flows provided by operations increased in the first six months this year as compared to the first six months last year. Both operating cash receipts and disbursements increased over the prior year’s first quarter due to higher sales volume. However, cash collected from customers increased at a greater rate than

cash paid to employees and other suppliers, reflecting normal variations in collection and payment patterns, as well as increased earnings. Other factors contributing to the change include higher cash receipts of income tax refunds, which were partially offset by higher cash payments for interest expense and income taxes.

Net cash flows used for investing activities increased in the first six months this year as compared to the first six months last year primarily because of higher levels of capital expenditures. For the full fiscal year last year, capital expenditures were $18.8 million.

Net cash flows used for financing activities increased in the first six months this year compared to the first six months last year primarily because of two offsetting factors: First, we reduced our borrowings by $26.8 million in the six-month period this year compared to $5.0 million in the same period last year. Second, we purchased $9.5 million of treasury stock in the six-month period last year. These stock purchases were made in connection with a November 19, 2002, authorization by the Board of Directors to repurchase up to $20 million of our common stock from time to time in open market and private transactions over the two years following the authorization.

Cash dividends paid reflect cumulative year-to-date per share payment rates of $0.4800 this year and $0.4725 last year.

Outlook: Future cash flows from operations and available revolving lines of credit are expected to be adequate to meet our cash requirements over the next twelve months. Payments of our $75 million of senior notes are not due until the 2006-2012 timeframe. Also, we have a $100 million line of credit facility that includes an option to increase the amount of the line up to $175 million that does not expire until March 14, 2006. Despite these factors, it is possible business acquisitions could be made in the future that would require amendments to existing debt agreements and the need to obtain additional financing.

Recent Accounting Pronouncements

In December 2003, the Financial Accounting Standards Board issued a revised Statement of Financial Accounting Standards No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” The revised Statement requires additional disclosures to those in the original Statement No. 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The interim-period disclosure requirements of the revised Statement were effective beginning with our first quarter report this fiscal year, and our disclosures may be found in the notes to the consolidated financial statements. The remaining disclosure requirements of the revised Statement are effective for our year ending September 30, 2004.

In January 2004, the Financial Accounting Standards Board issued FASB Staff Position 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2004.” The Act introduced a prescription drug benefit and federal subsidy to sponsors of retiree healthcare benefit plans. The Staff Position permits a plan sponsor to make a one-time election to defer recognition of the effects of the Act in accounting for its retiree healthcare benefit plans until authoritative guidance on accounting for subsidies provided by the Act is issued. The next expected measurement date for our retirement healthcare benefits plan is September 30, 2004.


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk*

Our long-term debt is sensitive to changes in interest rates. Also, assets, liabilities and commitments that are to be settled in cash and are denominated in foreign currencies for transactional purposes are sensitive to changes in currency exchange rates. These market risks are discussed more fully in the Management Discussion and Analysis on pages 19 of our 2003 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2003.


Item 4.	*Controls and Procedures*

We have established disclosure controls and procedures, which are designed to ensure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 are recorded,

processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

John A. Halbrook, our chairman of the board and chief executive officer, and Stephen P. Carter, our executive vice president, chief financial officer and treasurer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Form 10-Q. Based on their evaluation, they concluded that our disclosure controls and procedures were effective in achieving the objectives for which they were designed.

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

PART II — OTHER INFORMATION


Item 2.	*Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities*

(c)

(d)

Total Number

Approximate

of Shares

Dollar Value

Purchased

of Shares that

(a)

(b)

as Part of

May Yet be

Total Number

Average

Publicly

Purchased

of Shares

Price Paid

Announced

Under the

Period

Purchased

per Share

Plans or Programs

(In thousands)

January 1, 2004 through January 31, 2004

—

10,500

February 1, 2004 through February 29, 2004

—

10,500

March 1, 2004 through March 31, 2004

—

10,500

On November 19, 2002, our Board of Directors approved a plan to purchase $20 million of treasury shares over a two-year period. There have been no terminations or expirations since the approval date. During this quarter, we purchased no treasury shares.


Item 4.	*Submission of Matters to a Vote of Security Holders*

One matter was submitted to a vote of shareholders at the January 28, 2004 Annual Meeting of Shareholders which regarded the election of Class II directors. Three directors were elected. The results of the voting were as follows:


	Number of		Number of Shares
Director	Shares For		Against/Withheld

John D. Cohn		9,982,819		317,623
Michael H. Joyce		10,008,795		291,646
James R. Rulseh		9,992,410		308,032

Directors whose terms continued after the shareholders annual meeting were John A. Halbrook, Rodney O’Neal, Mary L. Petrovich, Michael T. Yonker, and Paul Donovan.


Item 6.	*Exhibits and Reports on Form 8-K*

(a) Exhibits Filed as Part of this Report:

      (31) (i) Certification of John A. Halbrook pursuant to Section 302 of the Sarbanes-Oxley Act of 2003.

            (ii) Certification of Stephen P. Carter, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

      (32) (i) Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K During the Second Quarter of the Fiscal Year Ending September 30, 2004.

We did not file any reports on Form 8-K during the quarter ended March 31, 2004. However, we furnished the news release announcing our financial results for the fiscal quarter ended December 31, 2003, to the Securities and Exchange Commission in a report on Form 8-K dated January 26, 2004.

SIGNATURES

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


		WOODWARD GOVERNOR COMPANY

Date: April 30, 2004		/s/ JOHN A. HALBROOK

		John A. Halbrook, Chairman and Chief Executive Officer

Date: April 30, 2004		/s/ STEPHEN P. CARTER

		Stephen P. Carter, Executive Vice President, Chief Financial Officer and Treasurer

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	•	Projections of sales, earnings, cash flows, or other financial items;

	•	Descriptions of our plans and objectives for future operations;

	•	Forecasts of future economic performance; and

	•	Descriptions of assumptions underlying the above items.


	(31) (i) Certification of John A. Halbrook pursuant to Section 302 of the Sarbanes-Oxley Act of 2003.

	(ii) Certification of Stephen P. Carter, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	(32) (i) Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.