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 June 30, 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 July 23, 2004, 11,302,387 shares of common stock with a par value of $.00875 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		16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		21
Item 4.	Controls and Procedures		22

PART II — OTHER INFORMATION
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities		23
Item 6.	Exhibits and Reports on Form 8-K		23
Signatures			24
Certification
Certification
Certification

PART I — FINANCIAL INFORMATION


Item 1.	*Financial Statements*

Statements of Consolidated Earnings


	*Woodward Governor Company and Subsidiaries*



			Three Months Ended
			June 30,

			2004			2003


			(Unaudited)

			(In thousands except
			per share amounts)
Net Sales			$	180,496		$	141,637

Costs and expenses:
	Cost of goods sold			145,947			121,343
	Selling, general, and administrative expenses			18,303			16,958
	Amortization of intangible assets			1,713			1,043
	Interest expense			1,372			1,349
	Interest income			(135	)		(135	)
	Other expense — net			78			1,487

		Total costs and expenses		167,278			142,045

Earnings (loss) before income taxes				13,218			(408	)
Income taxes				5,005			(243	)

Net earnings (loss)			$	8,213		$	(165	)

Earnings (loss) per share:
Basic			$	0.73		$	(0.01	)
Diluted				0.71			(0.01	)

Weighted-average number of shares outstanding:
Basic				11,299			11,112
Diluted				11,608			11,112

Cash dividends per share			$	0.24		$	0.24

See accompanying Notes to Consolidated Financial Statements.

Statements of Consolidated Earnings

Woodward Governor Company and Subsidiaries



			Nine Months Ended
			June 30,

			2004			2003


			(Unaudited)

			(In thousands except
			per share amounts)
Net Sales			$	512,420		$	432,621

Costs and expenses:
	Cost of goods sold			412,494			361,723
	Selling, general, and administrative Expenses			52,308			47,044
	Amortization of intangible assets			5,143			3,089
	Interest expense			4,067			3,494
	Interest income			(921	)		(627	)
	Other expense (income) — net			(499	)		784

		Total costs and expenses		472,592			415,507

Earnings before income taxes				39,828			17,114
Income taxes				15,117			6,503

Net earnings			$	24,711		$	10,611

Earnings per share:
Basic			$	2.19		$	0.95
Diluted				2.14			0.94

Weighted-average number of shares outstanding:
Basic				11,279			11,190
Diluted				11,543			11,325

Cash dividends per share			$	0.72		$	0.7125

See accompanying Notes to Consolidated Financial Statements.

Consolidated Balance Sheets


	*Woodward Governor Company and Subsidiaries*


			At		At
			June 30,		September 30,
			2004		2003

			(Unaudited)

			(In thousands except
			per share amounts)
ASSETS
Current assets:
	Cash and cash equivalents		$	27,861	$	24,058
	Accounts receivable, less allowance for losses of $2,016 for June and $2,601 for September			92,553		87,807
	Inventories			141,636		126,289
	Income taxes receivable			—		1,782
	Deferred income taxes			16,136		14,179
	Other current assets			3,582		5,157

		Total current assets		281,768		259,272

Property, plant, and equipment — net				118,779		124,144
Goodwill				131,398		133,620
Other intangibles — net				87,381		85,291
Deferred income taxes				2,174		6,429
Other assets				6,214		7,243

Total assets			$	627,714	$	615,999

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Short-term borrowings		$	5,413	$	5,774
	Current portion of long-term debt			—		30,000
	Accounts payable			36,824		26,703
	Accrued liabilities			46,822		45,533
	Income taxes payable			6,380		—

		Total current liabilities		95,439		108,010

Long-term debt, less current portion				88,495		89,970
Other liabilities				62,569		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			14,390		13,760
	Accumulated other comprehensive earnings			12,068		9,625
	Deferred compensation			4,438		4,377
	Retained earnings			378,668		361,382

				409,670		389,250
Less: Treasury stock, at cost, 858 shares for June and 901 shares for September				24,021		24,069
Treasury stock held for deferred compensation				4,438		4,377

		Total shareholders’ equity		381,211		360,804

Total liabilities and shareholders’ equity			$	627,714	$	615,999

See accompanying Notes to Consolidated Financial Statements.

Statements of Consolidated Cash Flows


	*Woodward Governor Company and Subsidiaries*



			Nine
			Months Ended
			June 30,

			2004			2003


			(Unaudited)

			(In thousands)
Cash flows from operating activities:
Net earnings			$	24,711		$	10,611

Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization				24,923			23,986
Net loss on sale of property, plant, and equipment				97			191
ESOP compensation expense				—			(436	)
Deferred income taxes				150			4,276
Reclassification of unrealized losses on derivatives to earnings				223			129
Changes in operating assets and liabilities:
	Accounts receivable			(3,020	)		5,325
	Inventories			(13,576	)		5,044
	Accounts payable and accrued liabilities			9,910			(11,331	)
	Income taxes payable			8,890			(588	)
	Other — net			5,719			4,127

		Total adjustments		33,316			30,723

Net cash provided by operating activities				58,027			41,334

Cash flows from investing activities:
Payments for purchase of property, plant, and equipment				(14,015	)		(12,149	)
Proceeds from sale of property, plant, and equipment				253			218
Business acquisitions, net of cash acquired				(2,310	)		(49,472	)
Receipts associated with business acquisitions				389			—

Net cash used in investing activities				(15,683	)		(61,403	)

Cash flows from financing activities:
Cash dividends paid				(8,120	)		(8,006	)
Proceeds from sales of treasury stock				2,225			697
Purchases of treasury stock				(1,547	)		(9,503	)
Net proceeds (payments) from borrowings under revolving lines				(30,640	)		31,513

Net cash provided by (used in) financing activities				(38,082	)		14,701

Effect of exchange rate changes on cash				(459	)		1,555

Net change in cash and cash equivalents				3,803			(3,813	)
Cash and cash equivalents, beginning of year				24,058			29,828

Cash and cash equivalents, end of period			$	27,861		$	26,015

Supplemental cash flow information:
Interest expense paid			$	5,639		$	4,303
Income taxes paid				10,761			2,369
Noncash investing:
Liabilities assumed in business acquisition				338			4,431

See accompanying Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Overview:

The consolidated balance sheet as of June 30, 2004, the statements of consolidated earnings for the three and nine-month periods ended June 30, 2004 and 2003, and the statements of consolidated cash flows for the nine-month periods ended June 30, 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 June 30, 2004, the results of its operations for the three and nine-month periods ended June 30, 2004 and 2003, and its cash flows for the nine-month periods ended June 30, 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 nine-month periods ended June 30, 2004, are 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						Nine Months
		Ended						Ended
		June 30,						June 30,

		2004			2003			2004			2003


		(In thousands except per share amounts)
Reported net earnings (loss)		$	8,213		$	(165	)	$	24,711		$	10,611
Stock-based compensation expense using the fair value method, net of income tax			(355	)		(272	)		(1,044	)		(795	)

Pro forma net earnings (loss)		$	7,858		$	(437	)	$	23,667		$	9,816

Reported net earnings (loss) per share amounts:
	Basic	$	0.73		$	(0.01	)	$	2.19		$	0.95
	Diluted		0.71			(0.01	)		2.14			0.94

Pro forma net earnings (loss) per share amounts:
	Basic	$	0.70		$	(0.04	)	$	2.10		$	0.88
	Diluted		0.68			(0.04	)		2.06			0.87

(3) Business Acquisitions:

In June 2004, we acquired assets and assumed certain liabilities of Adrenaline Research, Inc., specialists in advanced combustion electronics. On a preliminary basis, our cost for this acquisition totaled $2,870,000, and the amount allocated to other intangibles, which were recorded in the Industrial Controls segment and are currently expected to be amortized over 17 years, was $3,113,000. The cost of the acquisition, and the related allocation of the acquisition costs, are subject to change. The purchase price for the assets acquired may increase or decrease based on a purchase price adjustment procedure customary to asset purchase agreements. Also, we are in the process of finalizing valuations of other intangibles. We expect settlement of the purchase

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

price adjustment, if any, and the final purchase price allocation will be completed before the end of December 2004.

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. 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. 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.

(4) 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 11. The remaining disclosure requirements of the revised Statement are effective for our year ending September 30, 2004.

In May 2004, the Financial Accounting Standards Board issued FASB Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” The Staff Position provides guidance on accounting for the effects of the Act, which introduced a federal subsidy to sponsors of retiree healthcare benefit plans that provide a prescription drug benefit that is at least actuarially equivalent to Medicare Part D, among other provisions. For all public companies, the guidance of the Staff Position is effective for the first interim or annual period beginning after June 15, 2004, with earlier adoption encouraged. We adopted the guidance of the Staff Position in our quarter ended June 30, 2004. Disclosures about the effects of the subsidy on our benefit obligation and net periodic benefit cost are included in note 11.

(5) Earnings per share:



		Three Months Ended					Nine Months Ended
		June 30,					June 30,

		2004		2003			2004		2003


		(In thousands, except per share amounts)
Net earnings (loss)(A)		$	8,213	$	(165	)	$	24,711	$	10,611

Determination of shares:
	Weighted-average shares of common stock outstanding(B)		11,299		11,112			11,279		11,190
	Assumed exercise of stock options		309		—			264		135

	Weighted-average shares of common stock outstanding assuming dilution(C)		11,608		11,112			11,543		11,325

Earnings (loss) before cumulative effect of accounting change:
	Basic per share amount(A/B)	$	0.73	$	(0.01	)	$	2.19	$	0.95
	Diluted per share amount(A/C)	$	0.71	$	(0.01	)	$	2.14	$	0.94

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following stock options were outstanding during the three and nine months ended June 30, 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				Nine Months Ended
	June 30,				June 30,

	2004		2003		2004		2003

Options		11,660		1,050,537		15,391		438,908
Weighted-average exercise price	$	70.37	$	34.42	$	67.75	$	47.10

(6) Inventories:


	At		At
	June 30,		September 30,
	2004		2003


	(In thousands)
Raw materials	$	3,431	$	6,017
Component parts		87,594		76,151
Work in process		30,994		27,237
Finished goods		19,617		16,884

	$	141,636	$	126,289

(7) Property, plant, and equipment:


	At		At
	June 30,		September 30,
	2004		2003


	(In thousands)
Land	$	10,503	$	10,049
Buildings and equipment		147,604		145,779
Machinery and equipment		249,758		247,767
Construction in progress		5,751		2,239

		413,616		405,834
Less accumulated depreciation		294,837		281,690

Property, plant, and equipment — net	$	118,779	$	124,144

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(8) Goodwill:


		(In thousands)

Industrial Controls:
	Balance at September 30, 2003	$	71,498
	Goodwill acquired		(3,491	)
	Foreign currency exchange rate changes		1,269

	Balance at June 30, 2004	$	69,276

Aircraft Engine Systems:
	Balance at September 30, 2003 and June 30, 2004	$	62,122

Consolidated:
	Balance at September 30, 2003	$	133,620
	Goodwill acquired		(3,491	)
	Foreign currency exchange rate changes		1,269

	Balance at June 30, 2004	$	131,398

We finalized accounting for an August 2003 business acquisition in 2004, which reduced goodwill acquired by $3,491,000.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(9) Other intangibles — net:


			At			At
			June 30,			September 30,
			2004			2003


			(In thousands)
Industrial Controls:
	Customer relationships:
		Amount acquired	$	37,387		$	33,610
		Accumulated amortization		(5,565	)		(3,615	)

				31,822			29,995

	Other:
		Amount acquired		31,359			27,815
		Accumulated amortization		(6,714	)		(4,594	)

				24,645			23,221

	Total		$	56,467		$	53,216

Aircraft Engine Systems:
	Customer relationships:
		Amount acquired	$	28,547		$	28,547
		Accumulated amortization		(5,789	)		(5,075	)

				22,758			23,472

	Other:
		Amount acquired		11,785			11,785
		Accumulated amortization		(3,629	)		(3,182	)

				8,156			8,603

	Total		$	30,914		$	32,075

Consolidated:
	Customer relationships:
		Amount acquired	$	65,934		$	62,157
		Accumulated amortization		(11,354	)		(8,690	)

				31,822			53,467

	Other:
		Amount acquired		43,144			39,600
		Accumulated amortization		(10,343	)		(7,776	)

				32,801			31,824

	Total		$	87,381		$	85,291

Amortization expense associated with current intangibles is expected to be approximately $6,850,000 in 2004, $7,000,000 in 2005, $6,900,000 in 2006, 6,600,000 in 2007, and $5,900,000 in 2008.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(10)	Accrued liabilities:


	At		At
	June 30,		September 30,
	2004		2003


	(In thousands)
Salaries and other member benefits	$	25,414	$	17,005
Warranties		6,312		6,113
Taxes, other than on income		2,814		3,591
Deferred compensation		2,392		2,328
Other items — net		9,890		16,496

	$	46,822	$	45,533

Salaries and other member benefits include accrued termination benefits totaling $677,000 at June 30, 2004 and $2,199,000 at September 30, 2003. Changes in accrued termination benefits for the nine months ended June 30, 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			(1,257	)
	Accrual adjustments			(431	)
	Foreign currency exchange rate changes			177

	Balance at June 30, 2004		$	677

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

	Balance at June 30, 2004		$	—

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

	Balance at June 30, 2004		$	—

Consolidated:
	Balance at September 30, 2003		$	2,199
	Expense:
		Cost of goods sold		126
		Selling, general, and administrative expenses		25
	Payments			(1,419	)
	Accrual adjustments			(431	)
	Foreign currency exchange rate changes			177

	Balance at June 30, 2004		$	677

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Accrual adjustments in Industrial Controls reflected retention of certain members due to increased production levels. We expect all terminations 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 June 30, 2004, follows:


	(In thousands)

Balance at September 30, 2003	$	6,113
Accruals related to warranties issued during the period		5,274
Accruals related to pre-existing warranties		(1,850	)
Settlements of amounts accrued		(3,393	)
Foreign currency exchange rate changes		168

Balance at June 30, 2004	$	6,312


(11)	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						Nine Months
		Ended						Ended
		June 30,						June 30,

		2004			2003			2004			2003


		(In thousands)
Retirement pension benefits — United States:
Components of net periodic benefit cost:
	Interest cost	$	220		$	224		$	802		$	724
	Expected return on plan assets		(407	)		(149	)		(707	)		(549	)
	Recognized losses		10			117			128			117

Net periodic benefit cost		$	(177	)	$	192		$	223		$	292

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

Retirement pension benefits — other countries:
Components of net periodic benefit cost:
	Service cost	$	427		$	501		$	1,264		$	1,186
	Interest cost		464			455			1,367			1,196
	Expected return on plan assets		(415	)		(365	)		(1,222	)		(967	)
	Amortization of unrecognized transition obligation		24			22			73			66
	Recognized losses		136			149			397			443
	Recognized prior service costs		(2	)		(2	)		(7	)		(6	)

Net periodic benefit cost		$	634		$	760		$	1,872		$	1,918

Cash contributions by the company		$	312		$	301		$	874		$	738

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



		Three Months						Nine Months
		Ended						Ended
		June 30,						June 30,

		2004			2003			2004			2003


		(In thousands)
Retirement healthcare benefits:
Components of net periodic benefit cost:
	Service cost	$	472		$	429		$	1,670		$	1,287
	Interest cost		901			966			3,179			2,898
	Recognized losses		222			192			1,022			576
	Recognized prior service costs		(127	)		(127	)		(381	)		(381	)

Net periodic benefit cost		$	1,468		$	1,460		$	5,490		$	4,380

Cash contributions by the company		$	666		$	685		$	1,820		$	3,060

As part of our retirement healthcare benefits, we provide a prescription drug benefit that is at least actuarially equivalent to Medicare Part D. As a result, we are entitled to a federal subsidy that was introduced by the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The effect of the subsidy reduced our accumulated postretirement benefit obligation by $7,934,000. It also reduced our net periodic postretirement benefit cost for the three and nine months ended June 30, 2004, by $562,000, which consisted of $126,000 for service cost, $237,000 for interest cost, and $199,000 for recognized actuarial gains.


(12)	Accumulated other comprehensive earnings:

Accumulated other comprehensive earnings, which totaled $12,068,000 at June 30, 2004, consisted of the following items:


		At or For the Nine
		Months Ended
		June 30, 2004

		(In thousands)
Accumulated foreign currency translation adjustments:
	Balance at beginning of year	$	11,611
	Translation adjustments		3,717
	Taxes associated with translation adjustments		(1,413	)

	Balance at end of period	$	13,915

Accumulated unrealized derivative losses:
	Balance at beginning of year	$	(1,047	)
	Reclassification to interest expense		223
	Taxes associated with interest reclassification		(84	)

	Balance at end of period	$	(908	)

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(13)	Total comprehensive earnings:



		Three Months						Nine Months
		Ended June 30,						Ended June 30,

		2004			2003			2004		2003


		(In thousands)
Net earnings (loss)		$	8,213		$	(165	)	$	24,711	$	10,611
Other comprehensive earnings (loss):
	Foreign currency translation adjustments		(860	)		3,897			2,304		5,644
	Reclassification of unrealized losses on derivatives to earnings		48			44			139		129

Total comprehensive earnings		$	7,401		$	3,776		$	27,154	$	16,384


(14)	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.


(15)	Segment information:



		Three Months Ended					Nine Months Ended
		June 30,					June 30,

		2004		2003			2004		2003


		(In thousands)
Industrial Controls:
	External net sales	$	113,130	$	83,122		$	314,781	$	243,962
	Intersegment sales		273		132			585		559
	Segment earnings (loss)		2,692		(4,479	)		12,657		(4,657	)

Aircraft Engine Systems:
	External net sales	$	67,366	$	58,515		$	197,639	$	188,659
	Intersegment sales		1,102		705			1,711		1,546
	Segment earnings		15,162		8,824			40,262		33,822

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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



	Three Months						Nine Months
	Ended						Ended
	June 30,						June 30,

	2004			2003			2004			2003


	(In thousands)
Total segment earnings	$	17,854		$	4,345		$	52,919		$	29,165
Unallocated corporate expenses		(3,399	)		(3,539	)		(9,945	)		(9,184	)
Interest expense and income		(1,237	)		(1,214	)		(3,146	)		(2,867	)

Consolidated earnings (loss) before income taxes	$	13,218		$	(408	)	$	39,828		$	17,114

Segment assets were as follows:


	At		At
	June 30,		September 30,
	2004		2003


	(In thousands)
Industrial Controls	$	366,341	$	336,654
Aircraft Engine Systems		203,223		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					Nine Months Ended
	June 30,					June 30,

	2004		2003			2004		2003


	(In thousands)
Industrial Controls
External net sales	$	113,130	$	83,122		$	314,781	$	243,962
Segment earnings (loss)		2,692		(4,479	)		12,657		(4,657	)

External net sales of Industrial Controls increased in both the three months and nine months ended June 30, 2004, as compared to the same periods last year. Businesses acquired in the third and fourth fiscal quarters last year accounted for $12.1 million of the year-over-year increase for the three-month period and $37.9 million for the nine-month period. The effect of changes in foreign currency exchange rates accounted for $2.9 million of the increase for the three-month period and $12.9 million for the nine-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 nine months ended June 30, 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. Last year, we expensed $1.5 million in the three-month period and $3.1 million in the nine-month period for workforce management activities, $1.1 million in the three-month and nine-month periods for the write-off of certain advance license fees, $1.0 million in the nine-month period for lease termination expenses, and $0.7 million in the three-month and nine-month periods for the transfer of an overseas pension to a different plan. The remaining 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 nine months, we incurred an additional $0.2 million of expense associated with stay bonuses, made payments totaling $1.3 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 June 30, 2004, our remaining accrual was $0.7 million, including the effects of foreign currency rate fluctuations. We expect all member terminations and all associated payments to be completed by the end of September 2004.



	Three Months Ended				Nine Months Ended
	June 30,				June 30,

	2004		2003		2004		2003


	(In thousands)
Aircraft Engine Systems
External net sales	$	67,366	$	58,515	$	197,639	$	188,659
Segment earnings		15,162		8,824		40,262		33,822

External net sales of Aircraft Engine Systems increased in both the three months and nine months ended June 30, 2004, as compared to the same periods last year. Sales in the third quarter last year were influenced

by the war in Iraq and concerns about SARS, as well as ongoing aircraft production and air travel considerations.

Aircraft Engine Systems’ segment earnings increased in both the three months and nine months ended June 30, 2004, as compared to the same periods last year. These improvements were the result of higher sales and improved segment earnings margins.

Last year, we expensed $0.7 million in the three-month period and $3.5 million in the nine-month period for workforce management activities, primarily associated with the facility consolidation of our servovalve operations. We also incurred other expenses related to this consolidation last year, totaling $1.5 million in the three-month period and $2.0 million in the nine-month period.

In addition to the items noted above, our segment earnings margin improved due to cost reductions associated with the servovalve facility consolidation and the positive operating leverage associated with higher sales. For the nine-month period, these improvements were partially offset by a less favorable sales mix in our first quarter as compared to the first quarter a year ago, which reflected normal variability in sales.



	Three Months						Nine Months
	Ended						Ended
	June 30,						June 30,

	2004			2003			2004			2003


	(In thousands)
Nonsegment Expenses
Interest expense	$	1,372		$	1,349		$	4,067		$	3,494
Interest income		(135	)		(135	)		(921	)		(627	)
Nonsegment expenses		3,399			3,539			9,945			9,184

Interest expense increased in the nine months ended June 30, 2004, as compared to the same period last year because of higher levels of average 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 nine months ended June 30, 2003, as compared to this year is that the value of deferred compensation balances decreased last year, 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, deferred compensation did not have a significant effect on the comparison for the three months ended June 30.



	Three Months					Nine Months
	Ended					Ended
	June 30,					June 30,

	2004		2003			2004		2003


	(In thousands)
Consolidated Earnings
Earnings (loss) before income taxes	$	13,218	$	(408	)	$	39,828	$	17,114
Income taxes		5,005		(243	)		15,117		6,503

Net earnings (loss)	$	8,213	$	(165	)	$	24,711	$	10,611

Earnings before income taxes and net earnings improved in the three months and nine months ended June 30, 2004, as compared to the same periods last year. Income taxes were provided at an effective rate on earnings before income taxes of 38.0% for both the three-month and nine-month periods this year. Last year’s

effective rate was 38.0% for the nine-month period, down from 38.5% in the six-month period ended March 31, 2003. Our effective income tax rate for the full fiscal year 2003 was 38.1%.

Outlook: Our financial performance in the third quarter benefited from improved markets and market share gains. Our customers are still optimistic about the next six months — some of them more so than last quarter — but only a few are sufficiently confident in their outlook to express views about 2005. As we enter the fourth quarter, our outlook for fiscal year 2004 earnings has not changed from the one expressed last quarter — we still expect second half earnings to approximate the quarterly average for the first half of the fiscal year. Actual results will be influenced by many internal and external variables, including the sustainability and slope of the recoveries in our power generation, 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
		June 30,		September 30,
		2004		2003


		(In thousands)
Assets
Segment assets:
	Industrial Controls	$	366,341	$	336,654
	Aircraft Engine Systems		203,223		217,685
Nonsegment assets			58,150		61,660

Total assets		$	627,714	$	615,999

Industrial Controls’ segment assets increased in the nine months ended June 30, 2004, reflecting increases in inventories and accounts receivable primarily due to higher levels of sales and related production activity.

Aircraft Engine Systems’ segment assets decreased in the nine months ended June 30, 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.


	At		At
	June 30,		September 30,
	2004		2003


	(In thousands)
Other Balance Sheet Measures
Working capital	$	186,329	$	151,262
Long-term debt, less current portion		88,495		89,970
Other liabilities		62,569		57,215
Commitments and contingencies Shareholders’ equity		381,211		360,804

Working capital increased in the nine months ended June 30, 2004, as cash provided by operating activities exceeded capital expenditures and the payment of dividends by $35.9 million. Most of this net cash flow was used to repay current debt obligations that are components of working capital.

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 June 30, 2004.

Other liabilities increased in the nine months ended June 30, 2004, primarily as a result of changes in accruals for retirement healthcare benefits and retirement pension benefits. These changes represent the excess of actuarially determined periodic benefit costs over cash contributions by the company.

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 June 30, 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 nine months ended June 30, 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 June 30, 2004, we purchased $11.0 million of our common stock.



	Nine Months Ended
	June 30,

	2004			2003


	(In thousands)
Cash Flows
Net cash provided by operating activities	$	58,027		$	41,334
Net cash used in investing activities		(15,683	)		(61,403	)
Net cash provided by (used in) financing activities		(38,082	)		14,701

Net cash flows provided by operations increased in the first nine months this year as compared to the first nine 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 increased earnings and normal variations in collection and payment patterns. Other factors contributing to the change include higher income tax payments this year as compared to last year, which were partially offset by receipts of income tax refunds.

Net cash flows used for investing activities decreased in the first nine months this year as compared to the first nine months last year. Most of this difference is related to our acquisition of Synchro-Start Products, Inc. last year.

Cash flows from financing activities reflected net payments in the first nine months this year compared to net receipts in the first nine months last year. This change was primarily caused by two offsetting factors: First, we reduced our borrowings by $30.6 million in the nine-month period this year compared to net increases in borrowings — largely a result of the acquisition of Synchro-Start Products, Inc. — of $31.5 million in the nine-month period last year. Second, purchases of treasury stock were $8.0 million lower in the nine-month period this year than they were a year ago. Stock purchases in both years 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 $0.7200 this year and $0.7125 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.


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 except per share amounts)

April 1, 2004 through April 30, 2004

—

10,500

May 1, 2004 through May 31, 2004

14,186

62.47

14,186

9,600

June 1, 2004 through June 30, 2004

10,453

66.06

10,000

8,950

On November 26, 2002, we announced in a news release a plan to purchase up to $20 million of our outstanding shares of common stock over a two-year period. There have been no terminations or expirations of stock purchase plans or programs since the announcement date.


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 Third Quarter of the Fiscal Year Ending September 30, 2004.

We did not file any reports on Form 8-K during the quarter ended June 30, 2004. However, we furnished the news release announcing our financial results for the fiscal quarter ended March 31, 2004, to the Securities and Exchange Commission in a report on Form 8-K dated April 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: July 30, 2004		/s/ JOHN A. HALBROOK

		John A. Halbrook, Chairman and Chief Executive Officer

Date: July 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.