Woodward
Annual Report 2004

Plain-text annual report

STRONG AND FOCUSED Our strengths lie within our people, our technologies, and our customer relationships. We apply our broad portfolio of technologies to solve complex fuel and combustion control applications. Engine and turbine original equipment manufacturers (OEMs) depend on Woodward to address their market needs for lower emissions, higher reliability, and lower costs. Today and in the future, Woodward will continue to develop and deliver systems, 30 0 20 40 15 10 35 25 5 Woodward Governor Company 5001 North Second Street, P.O. Box 7001 Rockford, Illinois 61125-7001 USA 815-877-7441 www.woodward.com components, and services to meet unique aerospace, power generation, process industries, and transportation needs. Power Generation Transportation Process Industries Aerospace (Military) Aerospace (Commercial) Market Segment Sales 32% 33% 37% 21% 2004 — FY2004 Sales $709,805 (in thousands) 2003 — FY2003 Sales $586,682 (in thousands) 2002 — FY2002 Sales $679,991 (in thousands) 13% 13% 9% 11% 10% 12% 11% 10% 26% 32% 30% Business Description Woodward designs, manufactures, and services energy control systems and components for aircraft and industrial engines and turbines. Leading OEMs throughout the world use our products and services in the power generation, Contents 1 Financial Highlights 2–5 Dear Shareholders 6–12 Strong and Focused 13–55 Financial Review process industries, transportation, and aerospace markets. 56 Officer and Investor Information IBC Board of Directors W O O D W A R D G O V E R N O R C O M P A N Y 2 0 0 4 A n n u a l R e p o r t STRONG AND FOCUSED Our strengths lie within our people, our technologies, and our customer relationships. We apply our broad portfolio of technologies to solve complex fuel and combustion control applications. Engine and turbine original equipment manufacturers (OEMs) depend on Woodward to address their market needs for lower emissions, higher reliability, and lower costs. Today and in the future, Woodward will continue to develop and deliver systems, 30 0 10 20 40 25 15 35 5 Woodward Governor Company 5001 North Second Street, P.O. Box 7001 Rockford, Illinois 61125-7001 USA 815-877-7441 www.woodward.com components, and services to meet unique aerospace, power generation, process industries, and transportation needs. Power Generation Transportation Process Industries Aerospace (Military) Aerospace (Commercial) Market Segment Sales 32% 33% 37% 21% 2004 — FY2004 Sales $709,805 (in thousands) 2003 — FY2003 Sales $586,682 (in thousands) 2002 — FY2002 Sales $679,991 (in thousands) 13% 13% 9% 11% 10% 12% 11% 10% 26% 32% 30% Business Description Woodward designs, manufactures, and services energy control systems and components for aircraft and industrial engines and turbines. Leading OEMs throughout the world use our products and services in the power generation, Contents 1 Financial Highlights 2–5 Dear Shareholders 6–12 Strong and Focused 13–55 Financial Review process industries, transportation, and aerospace markets. 56 Officer and Investor Information IBC Board of Directors W O O D W A R D G O V E R N O R C O M P A N Y 2 0 0 4 A n n u a l R e p o r t ■ We use our energy control technologies to develop and produce components that we integrate into systems. Our systems and components help our customers satisfy their needs for reliable and cost effective power equipment that meets strict air quality standards. MARKET STRATEGY T E C H N O L O G I E S : WHAT DRIVES OUR BUSINESS ■ Technologies and components are integrated into energy control systems specifically designed for power equipment, focusing on emissions, reliability, cost, and service. ■ Woodward systems and components are used in equipment that powers the world’s infrastructure. Original equipment manufacturers rely on Woodward as a single-source supplier for their critical fuel and combustion control needs. ■ By delivering integrated control solutions, Woodward is a global leader in the aerospace, process industries, transportation, and power generation markets. EMISSIONS Achieving environmental standards. Global emissions regulations demand cleaner air now and in the future, while world economic factors necessitate improved fuel economy and use of alternative fuel sources. Woodward’s systems and component solutions help our power equipment customers meet environmental standards with improved reliability and efficiency. GLOBALIZATION Conducting global business locally. Business is changing as economies around the world become more connected. Woodward knows that doing business in a customer’s language and time zone enables us to better understand and serve them. With locations in China, India, and around the world, we are positioned to serve rapidly growing markets as well as other established economies. SYSTEM SOLUTIONS Solving challenges with innovation and integration. Customers demand technical solutions that meet their needs for efficiency, reliability, and cost. Our market strategy helps us deliver integrated systems and advanced components that meet stringent aerospace and industrial requirements. With experience in fuel and combustion control systems for engines and turbines of every size and application, Woodward is ready to solve tomorrow’s challenges. FUEL SYSTEMS COMBUSTION CONTROL SYSTEMS ELECTRONIC CONTROLS AND SOFTWARE SYSTEMS INTEGRATION SERVICES C O M P O N E N T S : TURBINE VALVES AND ACTUATORS ENGINE VALVES AND ACTUATORS DIESEL FUEL INJECTION EQUIPMENT FUEL METERING UNITS ENGINE AND TURBINE ELECTRONIC CONTROLS GENSET AND SWITCHGEAR CONTROLS GAS TURBINE FUEL NOZZLES IGNITION SYSTEMS FUEL PUMPS SERVOVALVES GOVERNORS I N T E G R AT E D S Y S T E M S : TOTAL SYSTEM SOLUTIONS FOR POWER EQUIPMENT APPLICATIONS P O W E R E Q U I P M E N T: INDUSTRIAL DIESEL AND GAS ENGINES INDUSTRIAL GAS TURBINES STEAM TURBINES COMPRESSORS GENSETS AND SWITCHGEAR AIRCRAFT GAS TURBINES FUEL CELLS O U R C U S T O M E R S I N C L U D E : CATERPILLAR CUMMINS KUBOTA YANMAR MITSUBISHI MAN GE SIEMENS DRESSER-RAND INGERSOLL-RAND DAEWOO HYUNDAI ROLLS-ROYCE PRATT & WHITNEY US GOVERNMENT MAJOR AIRLINES WORLDWIDE WÄRTSILÄ DAIMLERCHRYSLER M A R K E T A P P L I C AT I O N S : POWER GENERATION TRANSPORTATION PROCESS INDUSTRIES AEROSPACE Paul Donovan Larry E. Rittenberg John D. Cohn James R. Rulseh Michael T. Yonker Michael H. Joyce Mary L. Petrovich John A. Halbrook DIRECTORS John A. Halbrook Chairman and Chief Executive Officer, Woodward Governor Company Mary L. Petrovich Chief Executive Officer, AxelTech International John D. Cohn Senior Vice President, Strategic Development and Communications, Rockwell Automation, Inc. Larry E. Rittenberg Ernst & Young Professor of Accounting & Information Systems, University of Wisconsin Paul Donovan Retired Executive Vice President and Chief Financial Officer, Wisconsin Energy Corporation Michael H. Joyce President and Chief Operating Officer, Twin Disc, Incorporated James R. Rulseh Group Vice President, Modine Manufacturing Company Michael T. Yonker Retired President and Chief Executive Officer, Portec, Inc. FINANCIAL HIGHLIGHTS (In thousands except per share amounts and other year-end data) Operating Results Net sales Earnings before cumulative effect of accounting change Basic per share amount Diluted per share amount Cash Dividends per Share Year-end Financial Position Working capital Total assets Long-term debt, less current portion Shareholders’ equity Other Year-end Data Shareholders’ equity per diluted share Worker members Registered shareholder members W O O D WA R D Fiscal year ended September 30, 2004 2003 2002 $709,805 31,382 2.78 2.71 0.96 $586,682 12,346 1.10 1.08 0.9525 $679,991 45,170 3.99 3.90 0.93 197,524 654,294 88,452 385,861 151,262 615,999 89,970 360,804 155,440 582,395 78,192 354,901 33.36 3,287 1,529 31.68 3,273 1,576 30.66 3,337 1,592 Net Sales (Dollars in Millions) Earnings Before Cumulative Effect of Accounting Change* (Dollars in Millions) Earnings Before Cumulative Effect of Accounting Change and Cash Dividends Per Share* (In Dollars) 800 600 400 200 0 $800 60 $600 45 $400 30 $200 15 0 0 $60 5.00 $45 3.75 $30 2.50 $15 1.25 0 0.00 $5.00 $3.75 $2.50 $1.25 0 ’00 ’01 ’02 ’03 ’04 ’00 ’01 ’02 ’03 ’04 ’00 ’01 ’02 ’03 ’04 Earnings before cumulative effect of accounting change per diluted share Cash dividends per share * Earnings before cumulative effect of accounting change for 2000 and 2001 includes goodwill-related amortization, net of income taxes, of $2.7 million or $0.24 per diluted share in 2000 and $2.9 million or $0.25 per diluted share in 2001. Beginning in 2002, goodwill was no longer amortized. In addition, earnings before cumulative effect of accounting change for 2000 included a gain from the sale of business, net of income taxes, of $17.1 million or $1.51 per diluted share. 1 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T DEAR SHAREHOLDERS 2004 was a turnaround year for Woodward. We experienced solid growth in most of our markets, after two consecutive years of decline. However, the strength of the markets has not returned to the vigorous levels of 2000. The prospects of demand returning to 2000 levels within the next two years, assuming the economy cooperates, are reasonably good with the exception of large industrial gas turbines, which we believe will continue to strengthen, but most likely not return to the boom years of 2000 and 2001. We converted this market growth into much improved operating margins for 2004. Our aircraft segment showed significant improvement year-over-year as a result of a higher mix of aftermarket business as well as efficiency John A. Halbrook Chairman and Chief Executive Officer Thomas A. Gendron President and Chief Operating Officer Stephen P. Carter Executive Vice President, Chief Financial Officer and Treasurer 2 W O O D WA R D W O O D WA R D improvements from the 2003 closure and integration of We believe these actions and locations will best serve our our Buffalo, New York servovalve operation into our customers and investors as we continue to integrate our Rockford, Illinois plant. recent acquisitions and expand our global presence for end While we made improvements in our industrial business, we were not able to convert the additional sales into targeted operating margins. Supply chain problems, acquisition integration issues, and inefficiencies caused by the fast ramp-up in orders prevented the expected operating leverage from flowing through to the bottom line. Correcting these problems has been and will continue to be a primary focus in 2005. markets and sourcing of components. Our Strategy Reducing emissions, improving operating efficiencies, and lowering costs remain the dominant drivers in our markets. To that end, through acquisitions, our own product development, and licensing agreements, we have put together a technology portfolio that gives us critical mass to meet these market challenges. Most recently, through the acquisition of Adrenaline In addition to these efforts, we recently announced our Research, which had developed proprietary combustion intention to consolidate our European businesses to eliminate sensing expertise, we added crucial technology to remain two manufacturing operations and to integrate the work into a leader in energy control solutions. other Woodward facilities. To leverage this knowledge, we have also committed to We will also reduce our sales and service resources investing in a new combustion test facility at our Zeeland, in Europe. This will improve our margins and allow Michigan location. We believe combustion control is key to us to reallocate our resources from Europe, where achieving emission regulations in 2010 and beyond. Coupled engine manufacturing is declining, so we can focus with our existing strengths, the world-class test facility will more resources in Asia, where engine manufacturers support future systems development that focuses on the are moving and markets are growing. components necessary for aircraft and industrial combustion control. Building construction has begun, and we expect the facility to be completed by April 2005. Along with our facility in Tomisato, Japan and sales offices located throughout Asia, we have two wholly-owned operations in China, located in Tianjin and Suzhou. Through these facilities, we support our western original equipment manufacturers (OEM) activities in China, develop relationships with Chinese OEMs, and establish sourcing in the region. 3 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T “ We have strong, solid relationships with our foundation customers, who are the world’s major engine and turbine manufacturers.” 4 Helping Customers Meet Demands We have strong, solid relationships with our foundation customers, who are the world’s major engine and turbine manufacturers. Our customers face many issues—emissions regulations, the need for high fuel efficiency, the drive for lower cost products, and the ability to respond quickly to the global market. We work closely with our customers early in the development and design stages, which enables us to anticipate their needs and deliver products to meet their specifications. In fiscal year 2004, we invested approximately $40 million, or about 6 percent of sales, in developing systems and products that will secure our future. For example, we recently announced our role as fuel systems integrator with GE Transportation–Aircraft Engines for the new GEnx turbofan engine for the Boeing 7E7 Dreamliner. The Boeing 7E7, scheduled for entry into service in 2008, is expected to revolutionize widebody aircraft travel. The GEnx contract win solidifies our role as a systems integrator, demonstrates the value of our new product development efforts, and continues our strong position with GE on their aircraft engine product lines. Industry analysts estimate the potential for our total fuel system program will exceed $400 million over the life of the program. We engineer systems that enhance the competitiveness of our customers’ products by meeting stringent emissions regulations. For instance, we are developing the next generation of an engine control system for compressed natural gas (CNG) vehicles, the OH-2. Primarily for Asian markets, this system reduces emissions and increases fuel efficiency on urban bus and commercial truck engines without sacrificing driveability. W O O D WA R D W O O D WA R D Similarly, we developed the MI-04 engine control system to Second, Larry E. Rittenberg, Ph.D., CIA, CPA, was elected meet 2004 emissions requirements for the mobile industrial as a director of the company, effective September 1, 2004. engine market, and we are currently developing the MI-07 Professor Rittenberg is recognized for his knowledge and to meet more stringent 2007 emission standards. These insight regarding corporate governance and internal auditing, systems use proven products that reduce emissions, increase areas that are a major focus in today’s business environment. engine performance, and offer ease of maintainability. By investing in the small engine market, we now can offer our customers total system solutions for their engines that power forklifts and other off-road vehicles. Looking at 2004 and Beyond Total company sales for 2004 were $709,805,000 and earnings were $31,382,000 or $2.71 per diluted share. The 2004 results included pretax workforce management costs of $12,868,000 related primarily to the consolidation of two manufacturing operations in Europe into existing operations. On November 18, 2004, Woodward announced plans for the transition of our chief financial officer role. Executive Vice President, CFO and Treasurer Stephen P. Carter has decided to retire from Woodward following the appointment and transition of his successor. During his 18-year tenure, Steve’s achievements and contributions were exemplary, including helping to manage our transformation to full public company status. Steve has been an outstanding colleague and advisor, and we will miss his strategic vision, broad range of capabilities, and professionalism. From our current vantage point, we believe our markets will I want to thank our Board of Directors for their guidance continue to show growth over the next year and into 2006, and our leaders and members for their hard work this year. and we are dedicated and positioned to capture the revenue They are the reason we had a successful year in building on and earnings growth opportunities. our strengths and strategies for growth. The Sarbanes-Oxley Act has raised the visibility of corporate Woodward sets the standard for energy control system governance, which holds a place of high importance to our solutions for aerospace, industrial power systems, power shareholders and has always been an area of focus for generation, transportation, and process industries. We will Woodward. We are actively working on requirements continue to work within our strategies and structure to build related to internal controls over financial reporting for a strong future. Section 404 of the Act, and we are on target to meet the 2005 deadline. This year brought a couple of changes to our Board of Directors. First, Rodney O’Neal resigned from our Board in March 2004 because he was unable to commit the time he felt was appropriate. We will miss his valuable participation John A. Halbrook Chairman of the Board and Chief Executive Officer in our strategic and operational deliberations. December 8, 2004 5 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T STRONG IN OUR TECHNOLOGIES Our core technologies focus on fuel delivery and combustion control for aircraft and industrial engines and turbines. Our engineers translate their knowledge and expertise into systems and components that help our customers provide reliable, low-cost, and low-emission energy control equipment. We leveraged technologies from our small industrial turbine and engine applications and extended those technologies into aircraft engine control. Ultimately, we simplified the control system, which reduced component count, weight, and cost while enhancing engine performance. In cooperation with Pratt & Whitney Canada (P&WC), an aircraft turbine manufacturer, Woodward evaluated and developed a technology concept for an engine fuel delivery system for the general aviation market. As the engine went from thought to creation, it became the P&WC PW600 engine family program. As the system integrator, Woodward is responsible to provide the fuel pump, metering unit, sensors, harness, actuator, and ignition system for the PW610F, which will power the twin-engine Eclipse 500 business jet. Eclipse Aviation Corporation has experienced a strong demand for the entry-level jet for the general aviation and new “air taxi” marketplaces. Page 6 (left–right): Woodward technicians Jason Jerome, Terry Roby, and Ronda Hermann study results of a development test for fuel control system components for the Pratt & Whitney Canada PW610F engine. Page 7 (left–right): At a f low test stand, Woodward technician Tom Collard and engineer George Sanchez examine a 6 prototype gas valve assembly for GE’s new LMS100™ gas turbine. As engines and aircraft become more sophisticated, their systems require more information sharing and greater heat management capability. By developing, acquiring, and applying our technologies, we are finding solutions and contributing to the industry’s efforts to offer aircraft that are safer, easier, and less expensive to operate. As the first new power generation concept in more than a decade, GE’s 100-megawatt LMS100 is a simple-cycle, high efficiency gas turbine. It is designed to provide fast starts, high availability and reliability, and low emissions. The LMS100 represents a significant change in power generation technology. When developing the turbine, GE used technologies from its aeroderivative and industrial gas turbine experience. W O O D WA R D W O O D WA R D Likewise, Woodward drew upon technologies from its aircraft and industrial business segments to provide the gas and liquid fuel metering system, water metering valves, liquid fuel pumps, variable-geometry servovalve actuators, and fuel nozzle premixers. GE required a supplier with systems engineering expertise, the ability to meet its technical requirements, and the talent to design and manufacture reliable systems and components. To meet GE’s requirements, Woodward tapped into expertise from operations that spanned the company, including technologies associated with pumps, pre-mixers, and valves. We also developed new digital driver and electric actuation technologies that are leveraged across the fuel metering system on the LMS100. Through our advanced technologies, Woodward is able to meet GE’s fuel and actuation system needs for the world’s most efficient simple-cycle gas turbine. FOCUSED on SYSTEM SOLUTIONS Woodward offers single-source system solutions to original equipment manufacturers for their fuel and combustion control needs, increasing our content per engine while lowering their costs. 7 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T STRONG IN OUR MARKETS Serving leading engine and turbine original equipment manufacturers, Woodward solves key issues that drive their businesses—emissions, globalization, reliability, and cost. In the last decade, Woodward developed and successfully marketed three generations of the OH-1 engine control system for heavy-duty CNG engines. The need for clean air and energy independence has resulted in new government requirements worldwide that expand the use of low-emission natural gas vehicles. Particularly in China and other parts of Asia, governments are requiring urban bus and vehicle fleets to use compressed natural gas (CNG) or propane-fueled engines to increase reliance on locally available energy supplies and to reduce emissions. To meet the next round of engine emissions requirements and to serve the escalating Asian market, Woodward is introducing the next generation control system, the OH-2. With upgraded features, it will provide improved fuel, air, and combustion control for lower emissions, better fuel efficiency, and enhanced system performance. Page 8: The OH-2 engine control system, being tested in Woodward’s dynamometer lab, will help customers meet upcoming emissions requirements. Inset: We will provide a suite of components for the GP7200 engine for the Airbus A380 jet, part of the widebody commercial aircraft market. Page 9: The commercial and military aircraft aftermarkets remained strong for Woodward in 2004. Test Stand Operator Pam Lindsey inspects a 8 combustion control component for the US Air Force. LEADER in VITAL GLOBAL MARKETS Woodward’s advanced systems and component solutions address key drivers in the aerospace, power generation, transportation, and process industries markets. We continue to gain market share by providing solutions for our customers. W O O D WA R D W O O D WA R D In the aerospace market, Woodward is represented on military engines that will power the frontline fighters of the future. We supply an augmentor spraybar for the F119 engine on the F/A-22 Raptor, and we are developing combustion components for the main and augmentor portions of the Pratt & Whitney F135 engine for the F-35 Joint Strike Fighter. In recent years, we have been expanding our presence in the widebody aircraft market. We produce a hydromechanical unit for the GE90-115B, the exclusive engine on the Boeing 777-300ER and -200LR, and we developed a suite of components for the GP7200 engine for the Airbus A380 superjumbo jet. We manufacture fuel nozzles, fuel metering units, and air modulating valves for the IAE V2500 engine used on the popular narrow body Airbus A319/320/321 family of aircraft. We are gaining market share in the commercial and military aftermarkets by focusing on repair, overhaul, and replacement of both Woodward and non-Woodward components. For example, we are repairing Woodward components and replacing competitors’ components for the IAE V2500 engine. Also, the US Air Force is updating the engine configurations for F15 and F16 fighter jets, and we are supplying combustion control components. Additionally, we developed a repair and overhaul process for an engine combustion system component for the KC-135 fuel delivery tanker and B52 long-range bomber. Our strength in vital global markets positions us to offer solutions to issues that drive our customers’ businesses. LEADER in VITAL GLOBAL MARKETS Woodward’s advanced systems and component solutions address key drivers in the aerospace, power generation, transportation, and process industries markets. We continue to gain market share by providing solutions for our customers. 9 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T STRONG IN OUR RELATIONSHIPS Strong customer relationships are a Woodward hallmark. As a supplier, we cultivate our relationships by listening to the needs of our engine and turbine customers and by offering solutions that benefit them and their end users. For decades, Woodward and our customers have worked together to provide fuel control system solutions for the industrial and aircraft markets. We support GE with on-site representatives at their aircraft engine facility, and our industrial combustion system operation is located near one of their plants. Woodward’s on-site representatives focus on current and future development efforts, ensuring the voice of the customer is heard. Our engineers have earned increasing levels of responsibility in the joint development of Woodward components for both GE Transportation and GE Energy. Our relationship with GE Transportation–Aircraft Engines contributed to our successful bid to be the fuel system integrator for the new GEnx turbofan engine for the widebody Boeing 7E7 Dreamliner. DEDICATED to our CUSTOMER BASE Our customer relationships are built on trust because we first listen, then analyze, suggest, develop, and manufacture advanced engine fuel control systems and components. 10 As system integrator, Woodward is responsible for the specifications, development, certification, production and support of the fuel system, which manages fuel pumping and metering, engine actuation and control, heat management, and fuel filtration. In building strong relationships, we have worked with Daewoo Heavy Industries and Machinery and NGVI, an engine packager, for almost a decade. By coupling technical expertise with our team approach, we have helped Daewoo and NGVI solve many complex challenges in the heavy-duty industrial engine market. Woodward teamed with Daewoo and NGVI to develop the MI-04 engine control system for the small mobile industrial engine market. The system helps engine and equipment manufacturers reduce emissions and increase engine performance. W O O D WA R D W O O D WA R D With the MI-04 system, Woodward extended the relationship beyond our system and component development scope to support Daewoo and NGVI in the field. Before production release of the system, we worked together to develop a training program for Daewoo’s distributors and sales and service managers. The training program also educates service managers on use and maintenance of the advanced MI-04 system. With a thorough knowledge of Woodward’s engine control features and benefits, Daewoo’s sales and service organization can address questions about the mobile equipment more effectively. Currently, we are developing the MI-07 engine control system to meet more stringent 2007 emission standards. The close relationship forged between Woodward, Daewoo, and NGVI has been instrumental to our mutual success. Page 10 and center: Every action we take is customer-focused, from Page 10 and center: Our customer-focused activities range from Page 10 and center: Every action we take is customer-focused, from concurrent design engineering to proactive production meetings. concurrent design engineering to proactive production meetings. Page 11: concurrent design engineering to proactive production meetings. Building on our close relationship with Daewoo, we solve many complex This page: Building on our close relationship with Daewoo, we solve many This page: Building on our close relationship with Daewoo, we solve many challenges in the small mobile industrial engine market. complex challenges in the heavy-duty industrial engine market. complex challenges in the heavy-duty industrial engine market. 11 2 0 0 4 A N N U A L R E P O R T STRONG FINANCIALLY A strong financial base affords a company the resources to invest in its future. At Woodward, it allows us the flexibility to fund new product development, to execute our acquisition strategy, and to attract and retain talented employees who are recognized as a competitive advantage in the industry. As a financially secure company, we can concentrate on key initiatives that will help us continue to address our customers’ needs now and in the future. One of many plans in progress is establishing a common set of product design tools and processes that incorporate Six Sigma and lean approaches across our aircraft and industrial businesses. This type of standardization and discipline leads to ongoing improvements in our product development efforts, which enables us to offer our customers market-leading solutions. Sound investments lay the groundwork for future opportunities with our customers. To support the growth of our systems capabilities, test facilities are under construction for both combustion and fuel systems. When completed in fiscal year 2005, we will use these facilities to test innovative products and control solutions that will lead to improved efficiencies and reduced emissions. With a strategic partner mindset and continued investments in technologies, products, and people, we set the global standard for energy control system solutions. FOCUSED on the FUTURE As we successfully leverage our investments across our core markets, we bring added value to our customers and shareholders. 12 W O O D WA R D FINANCIAL REVIEW 14 – Management’s Discussion and Analysis 31 – Consolidated Financial Statements 52 – Report of Independent Registered Public Accounting Firm 53 – Selected Quarterly Financial Data 54 – Selected Financial Data Management’s Responsibility for Financial Statements Management is responsible for the accompanying The audit committee of the company’s Board of financial statements and believes that the financial Directors, which consists of directors who are not statements accurately and consistently present the officers or employees of the company, meets with financial position, results of operations, and cash management and PricewaterhouseCoopers LLP to flows of the company in accordance with accounting review and discuss the audited financial statements, principles generally accepted in the United States. along with other matters. Management makes what it believes to be reasonable and prudent judgments and estimates where necessary, and has a system of internal accounting controls designed to provide reasonable assurance that its financial records are accurate, assets are safeguarded, and transactions are executed in accordance with management’s authorizations. Self-monitoring of the internal accounting control system, along with selective testing, is a part of our control environment. Corrective actions are taken whenever deficiencies in our internal accounting control system are identified. PricewaterhouseCoopers LLP, the company’s independent registered public accounting firm, audit the company’s financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Their report on these financial statements follows the notes to consolidated financial statements. John A. Halbrook Chairman and Chief Executive Officer Stephen P. Carter Executive Vice President, Chief Financial Officer and Treasurer 13 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis We prepared the following discussion and analysis to help While we saw improved market conditions in 2004, you better understand our financial condition, changes they were still not at the levels they were before the in our financial condition, and results of operations. declines began. This discussion should be read with the consolidated financial statements. Overview Our business is focused on the design, manufacture, and servicing of energy control systems and components for aircraft and industrial engines, turbines, and other power equipment. We use technologies in the areas of fuel With our fixed cost base and our decision to maintain our research and development activities at similar levels, the effect of sales changes on our earnings in 2004 and 2003 was significant. As sales decreased in 2003, the ratio of fixed costs to variable costs increased and reduced earnings. As sales returned in 2004, the ratio of fixed costs to variable costs decreased, increasing earnings. systems, combustion control, electronic controls and The changes in our markets have also affected our software, and systems integration to develop components decisions in managing our workforce. Over the last and integrated systems that we sell to OEMs (original three years, we have taken actions to better align equipment manufacturers) for use in power equipment staffing levels with expected demand and to consolidate for the power generation, process industries, transportation, manufacturing operations to streamline our organization and aerospace markets. We have two operating segments—Industrial Controls and Aircraft Engine Systems. Industrial Controls provides energy control systems and components primarily to OEMs 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 information internally to assess the performance of each segment and to make decisions on the allocation of resources. There has been a lot of volatility in the markets we serve in recent years, and our sales and earnings reflect the results of that volatility. Virtually all of our OEM customers had lower shipment volumes in 2003 as compared to 2002. These decreases were most evident among customers shipping large gas turbines used in power generation, which experienced decreases of over 40%. Our markets were affected by bankruptcies and financial difficulties of certain large utility companies, the aftermath of the events of September 2001, and uncertainty about the economy in general. As a result, and gain production cost efficiencies. The most recent actions will be implemented in 2005 and the first half of 2006, and primarily involve the consolidation of certain manufacturing operations in The Netherlands, United Kingdom, and Japan with existing operations in the United States, Germany, and China. Once fully implemented, we expect the most recent actions will generate annual savings of $9 million to $11 million on a pretax basis. The related cost for the actions is estimated at $17 million, of which $14 million was recognized in 2004. In the sections that follow, we are providing information 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. Factors That May Affect Future Results This annual report contains forward-looking statements, including: • Projections of sales, earnings, cash flows, or other financial items; purchases of discretionary capital equipment decreased. • Descriptions of our plans and objectives for future operations; 14 W O O D WA R D W O O D WA R D • 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 • Changes in the legal environment of the United States and other countries in which we operate, including changes in the areas of taxation, business acquisitions, and environmental matters; • Changes in competitive conditions, including the availability of new products and services, the introduction of new channels of distribution, and changes in OEM and aftermarket pricing; • Reliability of customer and third-party forecasts of sales volumes and purchase requirements in our markets, including aircraft engines (OEM and aftermarket), power generation, transportation, and process industries markets; materially from projections or any other forward-looking • Our ability to continue to develop innovative new 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 include, but are not limited to, the following: • General business and economic conditions, including the strength of the global economy (particularly the economies of the United States, Europe, and Asia), fluctuations in exchange rates of foreign currencies against the United States dollar (primarily currencies of European and Asian countries), and fluctuations in interest rates (primarily LIBOR), which affect our cost of borrowings; • Industry-specific business and economic conditions, including the strength of manufacturers of industrial engines, turbines and other power equipment for power generation, transportation, and process industries markets, manufacturers of aircraft turbines for commercial and military markets, commercial airlines, and generators of electric power; • Significant geopolitical events and actions that impact business and economic conditions, including acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism, and trade embargoes; products and product enhancements that are accepted by our customers and markets in accordance with our project schedules and resource plans; • Our ability to consolidate manufacturing operations in The Netherlands, United Kingdom, and Japan with existing operations in the United States, Germany, and China in accordance with the timeframes, cost estimates, and annual savings estimates anticipated; • Effects of business acquisitions and/or divestitures, including the incremental effects of the business acquired or divested, the completion of integration activities within planned timeframes and at planned cost levels, and the achievement of planned operating efficiencies; • Effects of quality and productivity initiatives, including achievement of expected results from Six Sigma and other ongoing improvement programs and maintenance of supplier designation levels with key customers; • Effects of changes in accounting policies resulting from new accounting pronouncements and/or changes in the selection and application of accounting methods necessary to implement accounting policies; • Effects of unusual or extraordinary events, or of other events and unforeseen developments involving litigation or other contingencies. 15 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis (continued) Critical Accounting Policies We consider the accounting policies used in preparing To assess the effect on our annual impairment tests in 2004 if different assumptions had been used, we our financial statements to be critical accounting policies separately measured the effects of a hypothetical 20% when they are both important to the portrayal of our reduction in estimated cash flows, a 20% increase in financial condition and results of operations, and require the discount rates used, and a 20% reduction in the us to make difficult, subjective, or complex judgments. transaction multiples used. While each of these changes Critical accounting policies normally result from the need would have reduced the estimated fair value of reporting to make estimates about the effect of matters that are units within the company, none of them individually inherently uncertain. Management has discussed the would have resulted in an impairment loss in 2004. development and selection of our critical accounting policies with the audit committee of the company’s Board of Directors, and the audit committee has reviewed the disclosures that follow. Other long-lived assets As discussed here, our other long-lived assets consist of property, plant, and equipment, and other intangibles, which are included in the segment assets of both Industrial In each of the following areas, our judgments, estimates, Controls and Aircraft Engine Systems. Long-lived assets and assumptions are impacted by conditions that change totaled $203.0 million at September 30, 2004, and over time. As a result, in the future there could be changes represented 31% of total assets. To the extent a long-lived in our assets and liabilities, increases or decreases in our asset was acquired in a business acquisition, its initial expenses, and additional losses or gains that are material cost is equal to its estimated fair value. In 2004, the to our financial condition and results of operations. Goodwill Goodwill, which is included in the segment assets of both Industrial Controls and Aircraft Engine Systems, totaled $131.6 million at September 30, 2004, representing 20% of total assets. We began testing goodwill for impairment on an annual basis in 2002 and we test goodwill for impairment more often if circumstances require. As a result of adopting new accounting standards on October 1, 2001, we recognized a pretax impairment loss of $4.0 total amount of long-lived assets acquired in business acquisitions totaled $6.0 million. We depreciate or amortize long-lived assets over their estimated useful lives. Depreciation expense and amortization expense associated with these assets totaled $32.8 million in 2004, $32.4 million in 2003, and $32.1 million in 2002. We also test long-lived assets for recoverability whenever events or changes in circumstances indicate that the carrying values may not be recoverable. We recognized an impairment loss of $3.0 million in 2002. million to reduce goodwill of an Industrial Controls Judgment is required to determine the fair value of reporting unit to its implied fair value. Subsequent annual long-lived assets acquired in business acquisitions. The impairment tests in 2002, 2003, and 2004 did not result valuation of land and buildings and improvements in any impairment losses. Estimates and assumptions, the most important of which are used to estimate the fair value of reporting units within the company, impact the results of our goodwill impairment tests. To estimate the fair value of reporting units, we estimate future cash flows, discount rates, and transaction multiples that we believe a marketplace participant would use in an arm’s length transaction. 16 considers factors such as the size, condition, and utility of the property and sales prices of similar property in the approximate vicinity of the acquired property. The valuation of machinery and equipment considers factors such as the estimated replacement cost of the equipment less deductions for loss of value arising from condition, utility, and age of the equipment. W O O D WA R D W O O D WA R D The valuation of identifiable intangible assets is based on Deferred income tax asset valuation allowances techniques that are dependent upon factors such as Valuation allowances for deferred income tax assets expected future cash flows, estimated fair value royalty totaled $18.6 million at September 30, 2004, representing rates, and discount rates. For our 2004 acquisition, we 26% of deferred income tax assets before the allowances. determined the fair value of tangible and identifiable The net changes in the valuation allowances increased intangible assets acquired were approximately equal to income tax expense by $2.1 million in 2004 and $4.5 our cost of the acquisition and we did not record any million in 2003. goodwill. While we believe our valuations of long-lived assets is appropriate, we also believe the valuations of long-lived assets acquired in our 2004 business acquisition could reasonably have been up to 20% higher or lower— or $1.2 million—than the actual amounts determined. If our fair value determinations had been lower, we would have recorded goodwill. However, there would not have been a significant change had our fair value determinations been higher. We establish valuation allowances to reflect the estimated amount of deferred tax assets that might not be realized. Both positive and negative evidence are considered in forming our judgment as to whether a valuation allowance is appropriate. Our current valuation allowances are primarily for deferred tax assets associated with foreign net operating loss carryforwards. Remaining deferred tax assets are expected to be realized through future earnings. If we had made different judgments The selection of useful lives for depreciation and regarding the realizability of deferred tax assets associated amortization purposes requires judgment. If we had with foreign net operating loss carryforwards, our increased the remaining useful life of all assets being valuation allowance and income tax expense would have depreciated and amortized by one year, depreciation and decreased. If we had made different judgments regarding amortization expense would have decreased, and the the realizability of other deferred tax assets, our valuation year-end carrying value of long-lived assets would have allowance and income tax expense would have increased. increased, by approximately $4.2 million in 2004. Similarly, if we had decreased the remaining useful lives by one year, depreciation and amortization expense would have increased, and the year-end carrying value of long-lived assets would have decreased, by approximately $5.7 million in 2004. (The results of this sensitivity analysis ignore the impact of individual assets that might have become fully depreciated or amortized during 2004 had these hypothetical changes been made.) The carrying value of a long-lived asset, or related group of assets, is reduced to its fair value whenever estimates of future cash flows are insufficient to indicate the carrying value is recoverable. We form judgments as to whether recoverability should be assessed, we estimate future cash flows and, if necessary, we estimate fair value. Fair value estimates are most often based on estimated future cash flows and assumed discount rates. Retirement healthcare benefits The cost of retirement healthcare benefits is recognized over employee service periods using an actuarial-based attribution approach. Our liability at September 30, 2004, consisted of a benefit obligation of $82.7 million, unamortized prior service cost of $8.4 million, and unrecognized net losses of $36.3 million, resulting in a recorded net accrued benefit of $54.8 million, representing 20% of total liabilities. Our expense in 2004 consisted of service and interest costs totaling $6.4 million and other costs netting to an increase of $0.8 million, resulting in a net periodic benefit cost of $7.2 million. To determine our net accrued benefit and net periodic benefit cost, we form judgments about the best estimate for each assumption used in the actuarial computation. 17 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis (continued) The two most important assumptions that impact the Under these agreements, we are swapping fixed rate computation are the healthcare cost trend rate and interest payments for interest payments at rates that vary the discount rate. We assumed net healthcare cost trend rates of 10.00% in 2005, decreasing gradually to 5.00% in 2010, and remaining at 5.00% thereafter. A 1.00% increase in assumed healthcare cost trend rates would have increased the benefit obligation at the end of 2004 by $15.7 million and the total of the service and interest costs by $1.3 million in 2004. Likewise, a 1.00% decrease in the assumed healthcare cost trend rates would have decreased the benefit obligation by $12.1 million and the total of service and interest costs by $1.0 million in 2004. We assumed discount rates of 5.79% to determine our benefit obligation at September 30, 2004, and 6.00% to determine our service and interest costs in 2004. A 1.00% increase in these discount rates would have decreased the benefit obligation at the end of 2004 by $12.8 million and the total of service and interest costs by $0.7 million in 2004. Likewise, a 1.00% decrease in these discount rates would have increased the benefit obligation by $16.9 million and the total of service and interest costs by $0.8 million in 2004. Market Risks Our long-term debt and interest rate swap agreements are sensitive to changes in interest rates. We monitor trends in interest rates as a basis for determining whether to enter into fixed rate or variable rate debt agreements, the duration of such agreements, and whether to use hedging strategies. Our primary objective is to minimize our long-term costs of borrowing. At September 30, 2004, our long-term debt was denominated principally with LIBOR. As measured at September 30, 2004, a hypothetical 1% immediate increase in interest rates would adversely affect our 2005 net earnings and cash flows by approximately $0.3 million and reduce the combined fair value of our long-term debt and interest rate swap agreements by approximately $1.8 million. Last year, a hypothetical 1% immediate increase in interest rates would have adversely affected our 2004 net earnings and cash flows by approximately $0.4 million and reduced the fair value of our long-term debt and interest rate swap agreements by approximately $2.8 million. 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. We monitor trends in foreign currency exchange rates and our exposure to changes in those rates as a basis for determining whether to use hedging strategies. Our primary exposures are to the European Monetary Union euro and the Japanese yen. We do not have any derivative instruments associated with foreign currency exchange rates. A hypothetical 10% immediate increase in the value of the United States dollar relative to all other currencies, when applied to September 30, 2004, balances, would adversely affect our 2005 net earnings and cash flows by approximately $0.7 million. Last year, a hypothetical 10% immediate increase in the value of the United States dollar relative to all other currencies would have adversely affected our 2004 net earnings and cash flows by $0.5 million. Results of Operations in United States dollars and consisted of fixed rate Sales agreements. However, to effectively offset our exposure to changes in the fair value of a portion of our long-term debt, we have entered into interest rate swap agreements. In thousands for the year ended September 30, External net sales: Industrial Controls Aircraft Engine Systems 2004 2003 2002 $439,801 $408,665 $332,755 270,004 253,927 271,326 Consolidated net sales $709,805 $586,682 $ 679,991 18 W O O D WA R D W O O D WA R D 2004 Compared to 2003 acquisition into existing operations and did not separately Consolidated net sales increased 21% in 2004 compared measure the effect on sales, although we considered the to 2003, attributable to the following (in millions): effect insignificant. • Industrial Controls’ sales volume changes $53 • Incremental sales from business acquisitions • Foreign currency translation rate changes • Aircraft Engine Systems’ sales volume changes • Price changes 41 16 14 (1) Industrial Controls’ sales volume changes: Incremental sales associated with the manufacture of diesel fuel injectors and pumps for one of our major customers accounted for approximately $42 million of the increase in Industrial Controls’ sales volume. We believe our acquisition of the Bryce diesel fuel injection business of Delphi Automotive Systems in June 2001 provided us with the capabilities that ultimately allowed us to pursue this opportunity. Sales of the injectors and pumps began in late 2003. The remaining $11 million increase in Industrial Controls’ sales volume, as measured before the effects of business acquisitions, resulted from increased demand across many product lines in Asia and North America. Incremental sales from business acquisitions: We Aircraft Engine Systems’ sales volume changes: External net sales of Aircraft Engine Systems increased 6% in 2004 from 2003. We attribute most of the increase to higher revenue passenger miles experienced by airlines, which has driven greater utilization of aircraft and higher aftermarket sales for us. Even at the increased levels, however, we believe commercial aircraft production and commercial airline traffic were both low in 2004 relative to recent periods—in particular, periods immediately preceding the events of September 2001. We estimate approximately half of our total sales were aftermarket sales in 2004 and 2003. 2003 Compared to 2002 Consolidated net sales decreased 14% in 2003 compared to 2002, attributable to the following (in millions): • Industrial Controls’ sales volume changes $(104) • Incremental sales from business acquisitions • Aircraft Engine Systems’ sales volume changes • Foreign currency translation rate changes 19 (18) 15 (5) completed two acquisitions in 2003 that, on an incremental • Price changes basis, increased sales by approximately $41 million in 2004 over 2003. Both acquisitions were accounted for in Industrial Controls. Industrial Controls’ sales volume changes: Virtually all of our OEM customers had lower shipment volumes in 2003 as compared to 2002. These decreases were most Our acquisitions in 2003 expanded our position in the evident among customers shipping large gas turbines small, high-speed diesel engine market. Synchro-Start used in power generation. The decrease in our large gas Products, Inc., acquired in May 2003, designed and turbine combustion product sales was in excess of 40%. manufactured actuators, solenoids, and controls for Utility companies in the United States were investing in industrial engines and equipment. Barber-Colman new power generation equipment at increasing levels in Dyna Products, acquired in August 2003, manufactured the few years preceding 2002 and began decreasing their and distributed controls for off-highway diesel and gas investments in 2002. Our largest customer referred to engines and mobile industrial equipment. this dynamic as the “U.S. power bubble,” which peaked We also completed an acquisition of Adrenaline Research, Inc. in June 2004 to enhance our capabilities in advanced combustion electronics. We immediately integrated this in 2002. They also reported that their sales of large gas turbines were 43% lower in calendar year 2003 than in 2002. We believe the rapid decrease in demand from the 19 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis (continued) peak sales was influenced by bankruptcies and financial manufactured and sold natural gas and propane fuel difficulties of certain large utility companies, which systems for small industrial engines. impacted the investment plans of many utility companies. Not only were utility companies placing orders for power equipment at lower rates, but they were canceling orders already placed and paying cancellation fees to power equipment manufacturers. Aircraft Engine Systems’ sales volume changes: External net sales of Aircraft Engine Systems decreased 6% in 2003 from 2002. The low levels of commercial aircraft production and low levels of commercial airline traffic relative to recent periods—in particular, periods Industrial Controls’ sales of products other than large gas immediately preceding the events of September 2001— turbine combustion products decreased an average of affected the demand for our products, reducing our sales 20%. Companies have considerable discretion over the volume. The most notable decrease in sales volumes timing of capital equipment purchases and, as a result began in the second fiscal quarter of 2002. Generally, of general economic conditions and uncertainty about commercial aftermarket sales held up better than OEM the future, were making fewer investments in 2003 than sales in 2003. We estimate about 51% of our total sales in 2002. Decreased demand for capital equipment in were aftermarket sales in 2003, compared to 46% in 2002. numerous areas—such as marine, locomotive, off-highway equipment, alternative-fuel trucks and buses, oil and gas processing, petrochemical processing, paper processing, and sugar processing—all affected our sales. Incremental sales from business acquisitions: We completed four acquisitions in 2003 and 2002 that increased sales by $19 million in 2003 over 2002. All four acquisitions were made by Industrial Controls. Our acquisitions in 2003 expanded our position in the Costs and Expenses In thousands for the year ended September 30, 2004 2003 2002 Cost of goods sold $542,240 $450,676 $502,396 Selling, general, and administrative expenses Research and 70,949 67,310 61,857 development costs All other expense items 40,057 12,942 Interest and other income (5,675) 41,565 13,536 (6,344) 36,734 12,582 (4,258) small, high-speed diesel engine market. Synchro-Start Consolidated costs Products, Inc., acquired in May 2003, designed and manufactured actuators, solenoids, and controls for industrial engines and equipment. Barber-Colman Dyna Products, acquired in August 2003, manufactured and distributed controls for off-highway diesel and gas engines and mobile industrial equipment. Our acquisitions in 2002 enhanced our capabilities using technologies that can be leveraged to existing systems, power equipment, and market applications. Leonhard-Reglerbau Dr.-Ing. Adolf Leonhard GmbH, acquired in January 2002, specialized in the design, manufacture, and sales of control, protection, and monitoring devices for power generation equipment. Nolff ’s Carburetion, Inc., acquired in March 2002, 20 and expenses $660,513 $566,743 $609,311 2004 Compared to 2003 Cost of goods sold increased 20% in 2004 as compared to 2003, attributable to the following (in millions): • Increase in net sales • Cost effects associated primarily with the lower ratio of fixed costs to variable costs • Changes in segment sales mix • Higher performance-based variable compensation • Other factors, net $ 95 (15) 4 6 2 W O O D WA R D W O O D WA R D Cost of goods sold would have increased $95 million in 2003 Compared to 2002 2004 over 2003 had the increase been proportional to the 21% increase in net sales. However, cost of sales includes both variable and fixed cost components. The most significant reason cost of goods sold did not increase by $95 million was due to the operating leverage effect of the increased sales versus fixed costs. The percent increase in Industrial Controls sales was greater than the percent increase in Aircraft Engine Systems sales. However, Industrial Controls’ average margins are not as high as those of Aircraft Engine Cost of goods sold decreased 10% in 2003 as compared to 2002, attributable to the following (in millions): • Reduction in net sales • Cost effects associated primarily with the higher ratio of fixed costs to variable costs • Other factors, net $(69) 18 (1) Cost of goods sold would have decreased $69 million in 2003 from 2002 had the decrease been proportional to the 14% decrease in net sales. However, cost of sales Systems. As a result, the relative change in the sales mix includes both variable and fixed cost components. The from one segment to the other increased our cost of goods sold by approximately $4 million in 2004 as compared to 2003. most significant reason cost of goods sold did not decrease by $69 million was due to the reverse operating leverage effect of the reduced sales versus fixed costs. Among the other factors affecting cost of goods sold Among the other factors affecting cost of goods sold were workforce management costs totaling $12.4 million were workforce management costs and related facility in 2004 and workforce management costs and related consolidation costs totaling $10.1 million in 2003 and facility consolidation costs totaling $10.1 million in 2003. workforce management costs totaling $6.9 million Selling, general, and administrative expenses increased in 2002. 5% in 2004 as compared to 2003, attributable to the Selling, general, and administrative expenses increased following (in millions): 9% in 2003 as compared to 2002, attributable to the • Incremental expenses of businesses acquired $ 3.7 following (in millions): • Higher performance-based variable compensation • Other factors, net 3.5 (3.6) Among the other factors affecting selling, general, and administrative expenses were workforce management costs totaling $0.5 million in 2004 and $1.8 million in 2003. Research and development costs decreased 4% in 2004 from 2003 due to normal variations in the timing of project expenditures. • Incremental expenses of businesses acquired • Other factors, net $3.6 1.9 Among the other factors affecting selling, general, and administrative expenses were workforce management costs totaling $1.8 million in 2003 and $1.2 million in 2002. Research and development costs increased 13% in 2003 over 2002 primarily due to increased expenditure levels for the further development of combustion control technologies and electronic controls and software technologies, including activities related to businesses acquired in 2001 and 2002. 21 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis (continued) Interest and other income increased by $2.1 million in The total expense for the 2004 actions is estimated to be 2003 over 2002 primarily due to gains realized in 2003 approximately $17.0 million, of which $13.8 million was on the sale of certain product line rights ($1.2 million) recognized in 2004. In addition, we reduced accrued and on the sale of marketable securities ($0.8 million). member termination benefits from the previous year’s Workforce Management Actions actions by $0.7 million as a direct result of decisions to discontinue the remaining actions from the previous year In thousands for the year ended September 30, Member termination benefits: 2004 2003 2002 given the newly-formed consolidation plans in 2004. The termination benefits that have been expensed in 2004 Industrial Controls $12,151 $ 5,092 $4,032 are related to ongoing termination benefit plans that Aircraft Engine Systems Nonsegment — — 3,956 343 4,013 — 12,151 9,391 8,045 Contractual pension termination benefits— Industrial Controls 1,800 — Related costs of facility consolidation— Aircraft Engine Systems — 2,560 Member termination benefits adjustments— — — we provide to our members and reflect expense for member service through September 30, 2004. The contractual pension termination benefits in 2004 are related to provisions of one of our retirement pension benefit plans that provide for early retirement benefits for certain plan participants in the event of a workforce management action. The remaining estimated amount of $3.2 million is for termination benefits that will be earned by members over their remaining service period and for Industrial Controls (1,083) — — other costs primarily associated with moving equipment Total costs of workforce and inventory to other locations. We expect to expense management actions $12,868 $11,951 $8,045 the $3.2 million in 2005 and 2006. 2004 Actions The actions in 2004 are primarily related to the consolidation of manufacturing operations in The Netherlands and United Kingdom with existing Our cash expenses for the 2004 actions are expected to total $15.2 million, and will be paid from available cash balances in 2005 and 2006 without the need for additional borrowings. The contractual pension operations in the United States and Germany. We are termination benefits are non-cash expenses. also consolidating a small manufacturing operation in Japan with an existing operation in China and are making sales force reductions in The Netherlands. These actions are being taken to streamline the organization by eliminating redundant manufacturing operations and to adjust the sales force in response to recent market shifts from Europe to Asia and North America. In total, approximately 250 positions will be eliminated from the three locations. We expect to substantially complete these actions by March 31, 2006. Once fully implemented, annual savings are expected to range from $9.0 million to $11.0 million. These savings are primarily related to reduced personnel costs, although we anticipate some savings in travel and other costs due to the reduced headcount. Of the total savings, approximately 90% is expected to affect cost of goods sold and 10% selling, general, and administrative expenses. We currently expect to realize about half of the estimated savings level in the third quarter of 2005, increasing gradually thereafter through the second quarter of 2006 when virtually all of the savings is expected to be realized. 22 W O O D WA R D W O O D WA R D We currently plan to continue to use the facilities and totaled $3.9 million in 2003 and $0.1 million in 2004. equipment located in The Netherlands, United Kingdom, Other costs directly associated with the consolidation and Japan after the actions are completed. We own all of our servovalve operations totaled $2.6 million and three facilities, and each of them will have ongoing sales were expensed and paid in 2003. and service activities. In addition, the facility in the United Kingdom will remain a key development site for diesel fuel injection products. We expect to move manufacturing The benefits of the 2003 actions have been reflected in our 2004 results. equipment used by the three locations to other facilities. 2002 Actions 2003 Actions Industrial Controls’ actions in 2003 were made to align staffing levels with expected demand and involved plans to eliminate 172 positions in various manufacturing, selling, and administrative functions worldwide. Payments associated with these actions totaled $3.1 million in 2003 and $1.1 million in 2004. In addition, the ending accrual for 2003 was reduced in 2004 by $1.1 million. We attributed $0.4 million of the accrual reduction to increased production levels and the decision to retain Actions taken in 2002 were made to align staffing levels with expected demand and involved the elimination of 233 positions in Industrial Controls and 202 positions in Aircraft Engine Systems. The eliminated positions were predominately involved with direct and indirect manufacturing functions, although some selling and administrative functions were affected as well. Payments associated with these actions totaled $6.6 million in 2002 and $1.4 million in 2003. The benefits of these actions have been reflected in our 2004 results. certain members to meet the increased demand. The Earnings remaining accrual adjustment of $0.7 million was related to members of the European operations affected by the 2004 actions and reflects the decision to discontinue the remaining 2003 actions given the newly-formed consolidation plans. Aircraft Engine Systems’ actions in 2003 were primarily associated with the consolidation of our servovalve operations into our Rockford, Illinois, manufacturing facility to achieve production cost efficiencies. In total, 165 positions were eliminated, predominately involving direct and indirect manufacturing positions in Buffalo, New York. Payments associated with these actions In thousands for the year ended September 30, Segment earnings (loss): 2004 2003 2002 Industrial Controls $ 6,437 $(11,588) $ 33,294 Aircraft Engine Systems 59,192 47,615 57,226 Total segment earnings 65,629 36,027 90,520 Nonsegment expenses (12,100) (12,323) (15,366) Interest expense and income (4,237) (3,765) (4,474) Consolidated earnings before income taxes and cumulative effect of accounting change Income taxes Cumulative effect of accounting change 49,292 17,910 19,939 7,593 70,680 25,510 — — (2,489) Consolidated net earnings $ 31,382 $ 12,346 $ 42,681 23 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis (continued) 2004 Compared to 2003 Industrial Controls’ segment earnings were $6.4 million in 2004 compared to a segment loss of $11.6 million in 2003. The change was attributable to the following (in millions): • Increase in net sales • Cost effects associated primarily with the lower ratio of fixed costs to variable costs • Workforce management actions, net • Incremental expenses of businesses acquired • Lower research and development costs • Higher performance-based variable compensation • Other factors, net $20 8 (8) (6) 5 (4) 3 Industrial Controls’ segment earnings would have increased by approximately $20 million in 2004 over 2003 if the change in gross margin (measured as external net sales less external cost of goods sold) had been proportional to the 32% increase in net sales. However, cost of goods sold includes both variable and fixed cost components and timing of project expenditures, particularly for combustion control technologies that had relatively high expenditure levels in 2003. Variable compensation was primarily driven by consolidated results in 2004 and 2003. Among the other factors affecting the comparison of Industrial Controls’ segment earnings between 2004 and 2003 were the following items recognized in 2003: $1.1 million for the write-off of certain advance license fees, $1.0 million for lease termination expenses, and $0.7 million of expense for the transfer of an overseas pension to a different plan. Aircraft Engine Systems’ segment earnings increased 24% in 2004 as compared to 2003, attributable to the following (in millions): • Increase in net sales • Cost effects associated primarily with the lower ratio of fixed costs to variable costs • Workforce management actions, net • Higher performance-based variable $ 4.7 4.8 6.5 (4.4) other expenses affecting segment earnings are relatively compensation fixed. As a result, segment earnings benefited from the operating leverage effect of the increased sales versus fixed costs. Industrial Controls’ workforce management actions resulted in the recognition of $12.9 million of expense in 2004 and $5.1 million in 2003, netting to a $7.8 million increase in 2004 over 2003. Our business acquisitions in 2003 and 2004 resulted in increases in selling, general, and administrative expenses of approximately $3.7 million and in amortization expense of approximately $2.0 million in 2004 over 2003. Aircraft Engine Systems’ segment earnings would have increased by approximately $4.7 million in 2004 over 2003 if the change in gross margin had been proportional to the 6% increase in net sales. However, cost of goods sold includes both variable and fixed cost components and other expenses affecting segment earnings are relatively fixed. As a result, segment earnings benefited from the operating leverage effect of the increased sales versus fixed costs. Aircraft Engine Systems’ workforce management actions resulted in the recognition of $6.5 million of expense in 2003. There were no actions or expense in 2004. Industrial Controls’ research and development costs decreased in 2004 from 2003 due to variations in the Variable compensation was primarily driven by consolidated results in 2004 and 2003. 24 W O O D WA R D W O O D WA R D Income taxes were provided at an effective rate on Among the other factors affecting the comparison of earnings before income taxes of 36.3% in 2004 compared Industrial Controls’ segment earnings between 2003 to 38.1% in 2003. The effective rate change is primarily and 2002 were the following: $5.1 million for workforce due to changes in the distribution of taxable earnings and management actions, $1.1 million for the write-off of losses by country. 2003 Compared to 2002 Industrial Controls’ segment loss was $11.6 million in 2003 compared to segment earnings of $33.3 million in 2002. This change was attributable to the following (in millions): • Decrease in net sales $(17) • Effects associated primarily with the higher ratio of fixed costs to variable costs (11) • Changes in selling prices • Increases in research and development costs • Incremental expenses of businesses acquired • Other factors, net (5) (5) (5) (2) Industrial Controls’ segment earnings would have decreased by approximately $17 million in 2003 from 2002 if the change in gross margin had been proportional to the 19% decrease in net sales. However, cost of goods sold includes both variable and fixed cost components and other expenses affecting segment earnings are relatively fixed. As a result, the reverse operating leverage effect of the decreased sales versus fixed costs negatively affected segment earnings. Industrial Controls’ research and development costs increased in 2003 over 2002 primarily due to increased expenditure levels for the further development of combustion control technologies and electronic controls and software technologies. Our business acquisitions in 2002 and 2003 resulted in increases in selling, general, and administrative expenses of approximately $3.6 million and in amortization expense of approximately $1.1 million in 2003 over 2002. certain advance license fees, $1.0 million for lease termination expenses, and $0.7 million for the transfer of an overseas pension to a different plan in 2003; and $4.0 million for workforce management actions and $3.0 million for an impairment loss on equipment in 2002. Aircraft Engine Systems’ segment earnings decreased 17% in 2003 from 2002 attributable to the following (in millions): • Decrease in net sales $(5.4) • Effects associated primarily with the higher ratio of fixed costs to variable costs (4.6) • Lower performance-based variable compensation • Workforce management actions, net 2.9 (2.5) Aircraft Engine Systems’ segment earnings would have decreased by approximately $5.4 million in 2003 from 2002 if the change in gross margin had been proportional to the 6% decrease in net sales. However, cost of goods sold includes both variable and fixed cost components and other expenses affecting segment earnings are relatively fixed. As a result, the reverse operating leverage effect of the decreased sales versus fixed costs negatively affected segment earnings. Aircraft Engine Systems’ variable compensation was primarily driven by consolidated results in 2003 and segment results in 2002. Aircraft Engine Systems’ workforce management actions and related costs of facility consolidation resulted in the recognition of $6.5 million of expense in 2003 and $4.0 million in 2002, netting to a $2.5 million increase in 2003 over 2002. 25 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis (continued) Nonsegment expenses decreased in 2003 from 2002 period to offset the realized capital loss, we reversed the primarily due to changes in deferred compensation valuation allowance that same quarter. expense. Certain key management members have elected to defer the payment of a portion of their compensation to future periods. Individual unfunded deferred compensation obligations that are payable in cash have been accounted for on an accrual basis by increasing or decreasing the amount of the obligation, as necessary, to reflect our actual obligation at each balance sheet date in accordance with the terms of the underlying contract. The decrease in deferred compensation expense was related to changes in these obligations, which were reflected as accrued liabilities in our consolidated balance sheets. The cumulative effect of accounting change is related to our October 1, 2001, adoption of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” We completed the transitional goodwill impairment reviews required by the new standard and determined that one of our Industrial Controls reporting units had a goodwill carrying value that exceeded its estimated implied fair value. The cumulative effect of accounting change reflects the write-down of the goodwill, net of income taxes, to its implied fair value. In performing our impairment reviews, we estimated the fair value of the various reporting units using a present value method that Income taxes were provided at an effective rate on discounted future cash flows as we expect marketplace earnings before income taxes of 38.1% in 2003 compared participants would, and we further assessed the to 36.1% in 2002. The most significant reason for the reasonableness of the estimates by using valuation lower rate in 2002 was related to a sale of our interest in methods based on market multiples. a joint venture, which allowed us to reduce valuation allowances provided on deferred tax assets associated Outlook with a capital loss carryback. The tax basis of the joint venture investment that was sold in 2002 exceeded its carrying value for financial reporting purposes by $3 million. Prior to the quarter of the sale, we recognized a deferred tax asset for this basis difference and, at the same time, reduced the deferred tax asset by a valuation allowance because it was more likely than not that the deferred tax asset would not be realized. The sale of our investment in the second quarter of 2002 resulted in a slight gain for financial reporting purposes and a taxable loss of approximately $3 million. Given that we had sufficient capital gain income in the carryback Sales and earnings are expected to increase in 2005 as compared to 2004. In particular, we anticipate higher sales volume as a result of improved market conditions for capital equipment purchases in power generation, transportation, and process industries. These higher sales are expected to result in improved segment earnings for Industrial Controls and improved consolidated earnings. For Aircraft Engine Systems, we currently anticipate sales volume to be approximately the same in 2005 as compared to 2004. At this level, our earnings could be lower in 2005 than in 2004 as a result of changes in sales mix and development expenditures for future OEM programs. However, any decrease in earnings is expected to be more than offset by increased earnings in Industrial Controls. 26 W O O D WA R D W O O D WA R D While the consolidation of manufacturing operations in 2003 Compared to 2002 Europe and Asia will result in additional costs in 2005, we expect these costs will be offset by savings related to the consolidations and have minimal impact on 2005 earnings. Financial Condition Assets In thousands at September 30, 2004 2003 2002 Industrial Controls Aircraft Engine Systems $364,584 205,580 $336,654 $286,302 217,685 219,480 Nonsegment assets 84,130 61,660 76,613 Consolidated total assets $654,294 $615,999 $582,395 2004 Compared to 2003 Industrial Controls’ segment assets at September 30, 2004, increased over the prior year, driven by higher levels of business activity near the end of 2004 as compared to 2003, which resulted in higher accounts receivable and inventories. Aircraft Engine Systems’ segment assets at September 30, 2004, decreased from the prior year. Accounts receivable and inventories both decreased, despite higher levels of business activity in 2004 as compared to 2003, which we attribute to normal variability in the timing of customer payments and to actions taken to improve Industrial Controls’ segment assets at September 30, 2003, increased from the prior year due to assets acquired in business acquisitions. The resulting increases, which totaled $63.1 million in 2003, were partially offset by decreases among other assets. Lower levels of business activity near the end of 2003 as compared to 2002 resulted in lower accounts receivable and inventories. Also, depreciation of property, plant, and equipment exceeded the level of capital expenditures in 2003. Aircraft Engine Systems’ segment assets at September 30, 2003, were near the prior year’s levels. Higher accounts receivable, attributed to higher sales near the end of 2003 as compared to 2002, were offset by reductions in inventories, and property, plant, and equipment. Normal variability of inventory balances accounted for the reductions in inventories and depreciation of property, plant, and equipment exceeded the level of capital expenditures in 2003. Nonsegment assets at September 30, 2003, decreased from the prior year primarily because of reductions in net deferred income tax assets. Other Balance Sheet Measures In thousands at September 30, 2004 2003 Working capital $197,524 $151,262 88,452 68,709 89,970 57,215 inventory turnover. In addition, depreciation of property, Long-term debt, less current portion plant, and equipment exceeded the level of capital Other liabilities expenditures in 2004. Nonsegment assets at September 30, 2004, increased from the prior year primarily because of increases in cash and cash equivalents. Net cash flows provided by operating activities exceeded net cash flows used in investing and financing activities in 2004. Commitments and contingencies Shareholders’ equity 385,861 360,804 Working capital (total current assets less total current liabilities) at September 30, 2004, increased over the previous year primarily as a result of increases in cash and cash equivalents and reductions in the current portion of long-term debt. Our cash and debt positions at September 30, 2004, reflect the results of cash flows during the year and the fact that most of our debt is represented by senior notes payable in 2006 through 2012. 27 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis (continued) Long-term debt at September 30, 2004, was near the Commitments and contingencies at September 30, 2004, prior year’s level. Required future payments for long-term include various matters arising from the normal course debt principal and operating lease commitments at of business. We are currently involved in pending or September 30, 2004, were as follows: threatened litigation or other legal proceedings In thousands for the year(s) ended September 30, 2006/ 2005 2007 2008/ 2009 Thereafter Long-term debt $ 956 $29,072 $25,251 Operating leases 3,600 6,000 3,400 $32,143 6,900 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 line of credit facilities, which totaled $26.4 million at September 30, 2004, that are generally reviewed annually for renewal. The total amount of borrowing under all facilities was $5.8 million at September 30, 2004. 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 regarding employment, product liability, and contractual matters. We accrued for individual matters that we believe are likely to result in a loss when ultimately resolved using estimates of the most likely amount of loss. There are also individual matters that we believe the likelihood of a loss when ultimately resolved is less than likely but more than remote, which were not accrued. While it is possible that there could be additional losses that have not been accrued, we currently believe the possible additional loss in the event of an unfavorable resolution of each matter is less than $5 million in the aggregate. We file income tax returns in various jurisdictions worldwide, which are subject to audit. We have accrued for our estimate of the most likely amount of expenses that we believe will result from income tax audit adjustments. financing activities. The agreements also permit the In the event of a change in control of the company, we lenders to accelerate repayment requirements in the event may be required to pay termination benefits to certain of a material adverse event. Our most restrictive covenants executive officers. 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 September 30, 2004. Shareholders’ equity at September 30, 2004, increased 7% over the previous year. Increases due to net earnings, sales of treasury stock, and favorable foreign currency translation adjustments were partially offset by cash dividend payments and purchases of treasury stock. We purchased $1.5 million of our common stock in 2004 and Other liabilities at September 30, 2004, increased over $9.5 million in 2003 under a November 20, 2002, Board the previous year primarily as a result of changes in net of Directors’ authorization to repurchase up to $20 accrued retirement healthcare benefits and retirement million of our common stock in open market and pension benefits. Our expenses associated with these private transactions. The authorization period ended plans totaled $11.9 million and our contributions totaled November 20, 2004. $5.6 million in 2004. In addition, changes in foreign currency translation rates increased these liabilities by $1.1 million. 28 W O O D WA R D W O O D WA R D Cash Flows In thousands for the year ended September 30, Net cash provided by 2004 2003 2002 operating activities $ 85,215 $ 60,775 $ 91,394 Net cash used in 2003 Compared to 2002 Net cash flows provided by operating activities decreased by 34% in 2003 from 2002. Both operating cash receipts and disbursements decreased in 2003 from 2002 due to lower sales volume. However, cash investing activities (20,272) (75,701) (48,211) collections from customers decreased at a greater Net cash provided by (used in) financing activities (39,895) 8,325 (24,514) 2004 Compared to 2003 Net cash flows provided by operating activities increased 40% in 2004 over 2003. Both operating cash receipts and disbursements increased in 2004 over 2003 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. rate than cash paid to employees and other suppliers, reflecting decreased earnings and normal variations in collection and payment patterns. Lower income tax payments in 2003 as compared to 2002 offset approximately half of the decrease. Net cash flows used in investing activities increased by $27.5 million in 2003 as compared to 2002. This change primarily resulted from Industrial Controls’ business acquisitions, for which payments totaling $57.7 million were made in 2003 compared to $25.8 million in 2002. We also reduced our capital expenditures in Industrial Controls by $3.0 million and in Aircraft Net cash flows used in investing activities decreased Engine Systems by $1.3 million. by $55.4 million in 2004 as compared to 2003. This change primarily resulted from Industrial Controls’ business acquisitions, for which payments totaling $2.3 million were made in 2004 compared to $57.7 million in 2003. Net cash flows for financing activities changed by $32.8 million between 2002 and 2003. Our net borrowings increased in 2003 by $27.5 million, compared to a reduction of $13.9 million in 2002. The higher borrowings are primarily related to the increase in cash used for Net cash flows for financing activities changed by business acquisitions in 2003 as compared to 2002. In $48.2 million between 2003 and 2004. Our net repayment of borrowings totaled $30.4 million in addition, we acquired $9.5 million of treasury stock in 2003. These stock purchases were made in connection 2004 compared to increased net borrowings totaling with a November 20, 2002, authorization by the Board $27.5 million in 2003. The higher borrowings in 2003 of Directors to repurchase up to $20 million of our were primarily related to the use of cash for business common stock from time to time in open market and acquisitions in 2003. In addition, we used $1.5 million of private transactions over the two years following the cash to acquire treasury stock in 2004, down from $9.5 authorization. Dividends were approximately the same million in 2003. These stock purchases were made in in both years. connection with a November 20, 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. Dividends were approximately the same in both years. 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. 29 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Management’s Discussion and Analysis (continued) Payments of our $75 million of senior notes are not due In May 2004, the Financial Accounting Standards Board until the 2006–2012 timeframe. Also, we have a $100 issued FASB Staff Position 106-2, “Accounting and million line of credit facility that includes an option to Disclosure Requirements Related to the Medicare increase the amount of the line up to $175 million that Prescription Drug, Improvement and Modernization does not expire until March 14, 2006. Despite these Act of 2003.” The Staff Position provides guidance on factors, it is possible business acquisitions could be accounting for the effects of the Act, which introduced a made in the future that would require amendments federal subsidy to sponsors of retiree healthcare benefit to existing debt agreements and the need to obtain plans that provide a prescription drug benefit that is at additional financing. Recent Accounting Pronouncements In December 2003, the Financial Accounting Standards least actuarially equivalent to Medicare Part D, among other provisions. For all public companies, the guidance of the Staff Position became effective for the first interim or annual period beginning after June 15, 2004, with Board issued a revised Statement of Financial Accounting earlier adoption encouraged. We adopted the guidance Standards No. 132, “Employers’ Disclosures about of the Staff Position in our quarter ended June 30, 2004. Pensions and Other Postretirement Benefits.” The Disclosures about the effects of the subsidy on our benefit revised Statement requires additional disclosures about obligation and net periodic benefit cost are included in the assets, obligations, cash flows, and net periodic Note 13 to the consolidated financial statements. benefit cost of defined benefit pension plans and other defined benefit postretirement plans that were not required by the original Statement. The revised Statement became effective in our first quarter 2004. Our disclosures may be found in Note 13 to the consolidated financial statements. 30 Statements of Consolidated Earnings (In thousands except per share amounts) Net sales Costs and expenses: Cost of goods sold Selling, general, and administrative expenses Research and development costs Amortization of intangible assets Interest expense Interest income Other income Other expense Total costs and expenses Earnings before income taxes and cumulative effect of accounting change Income taxes Earnings before cumulative effect of accounting change Cumulative effect of accounting change, net of income taxes Net earnings Basic per share amounts: Earnings before cumulative effect of accounting change Cumulative effect of accounting change, net of income taxes Net earnings Diluted per share amounts: Earnings before cumulative effect of accounting change Cumulative effect of accounting change, net of income taxes Net earnings Weighted-average number of basic shares outstanding Weighted-average number of diluted shares outstanding See accompanying Notes to Consolidated Financial Statements. W O O D WA R D W O O D WA R D Year Ended September 30, 2004 2003 2002 $ 709,805 $ 586,682 $ 679,991 542,240 450,676 502,396 70,949 40,057 6,905 5,332 (1,095) (4,580) 705 67,310 41,565 4,870 4,635 (870) (5,474) 4,031 61,857 36,734 3,748 5,109 (635) (3,623) 3,725 660,513 566,743 609,311 49,292 17,910 19,939 7,593 31,382 12,346 — — 70,680 25,510 45,170 (2,489) $ 31,382 $ 12,346 $ 42,681 $ 2.78 $ 1.10 $ 3.99 — — (0.22) $ 2.78 $ 1.10 $ 3.77 $ 2.71 $ 1.08 $ 3.90 — — (0.21) $ 2.71 $ 1.08 $ 3.69 11,286 11,565 11,246 11,389 11,325 11,577 31 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Consolidated Balance Sheets (In thousands except per share amounts) Assets Current assets: Cash and cash equivalents Accounts receivable, less allowance for losses of $2,836 for 2004 and $2,601 for 2003 Inventories Income taxes receivable Deferred income taxes Other current assets Total current assets Property, plant, and equipment—net Goodwill Other intangibles—net Deferred income taxes Other assets Total assets Liabilities and shareholders’ equity Current liabilities: Short-term borrowings Current portion of long-term debt Accounts payable Accrued liabilities Income taxes payable Total current liabilities Long-term debt, less current portion Other liabilities 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 Additional paid-in capital Accumulated other comprehensive earnings Deferred compensation Retained earnings Less: Treasury stock, at cost Treasury stock held for deferred compensation Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying Notes to Consolidated Financial Statements. 32 At September 30, 2004 2003 $ 48,895 99,277 138,708 — 16,852 5,064 $ 24,058 87,807 126,289 1,782 14,179 5,157 308,796 259,272 117,310 131,542 85,711 4,318 6,617 124,144 133,620 85,291 6,429 7,243 $ 654,294 $ 615,999 $ 5,833 956 35,207 65,573 3,703 $ 5,774 30,000 26,703 45,533 — 111,272 108,010 88,452 68,709 89,970 57,215 — 106 15,878 12,038 4,461 — 106 14,234 9,625 4,377 381,458 360,908 413,941 23,619 4,461 389,250 24,069 4,377 385,861 360,804 $ 654,294 $ 615,999 Statements of Consolidated Cash Flows (In thousands) Cash flows from operating activities: Net earnings Adjustments to reconcile net earnings to net cash provided by operating activities: Cumulative effect of accounting change, net of income taxes Depreciation and amortization Contractual pension termination benefits Impairment loss on equipment Net loss on sale of property, plant, and equipment ESOP compensation expense Deferred income taxes Reclassification of unrealized losses on derivatives to earnings Changes in operating assets and liabilities, net of business acquisitions: Accounts receivable Inventories Accounts payable and accrued liabilities Income taxes payable Other—net Total adjustments Net cash provided by operating activities Cash flows from investing activities: Payments for purchase of property, plant, and equipment Proceeds from sale of property, plant, and equipment Receipts associated with business acquisition Business acquisitions, net of cash acquired Net cash used in investing activities Cash flows from financing activities: Cash dividends paid Proceeds from sales of treasury stock Purchases of treasury stock Net proceeds (payments) from borrowings under revolving lines Proceeds from long-term debt Payments of long-term debt Net cash provided by (used in) financing activities Effect of exchange rate changes on cash Net change in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental cash flow information: Interest expense paid Income taxes paid Noncash investing activities: Liabilities assumed in business acquisitions W O O D WA R D W O O D WA R D W O O D WA R D Year Ended September 30, 2004 2003 2002 $ 31,382 $ 12,346 $ 42,681 — 32,761 1,800 — 319 — (1,988) 300 (9,639) (10,592) 26,751 6,298 7,823 — 32,418 — — 1,613 1,418 8,540 279 (1,759) 13,725 (6,031) (4,695) 2,921 2,489 32,088 — 3,000 354 1,879 1,243 154 29,287 9,028 (20,635) (14,563) 4,389 53,833 48,429 48,713 85,215 60,775 91,394 (18,698) 367 395 (2,336) (18,802 ) 770 — (57,669) (22,898) 439 — (25,752) (20,272) (75,701) (48,211) (10,832) 2,875 (1,547) (30,391) — — (39,895) (10,707) 1,043 (9,503) 24,393 5,099 (2,000) (10,731) 389 (286) (25,149) 75,000 (63,737) 8,325 (24,514) (211) 831 617 24,837 24,058 (5,770) 29,828 19,286 10,542 $ 48,895 $ 24,058 $ 29,828 $ 5,696 9,919 $ 4,884 3,399 $ 2,982 38,140 505 5,832 5,040 See accompanying Notes to Consolidated Financial Statements. 33 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Statements of Consolidated Shareholders’ Equity (In thousands except per share amounts) Common stock Beginning and ending balance Additional paid-in capital Beginning balance Sales of treasury stock Deferred compensation transfer Tax benefit applicable to stock options Ending balance Unearned ESOP compensation Beginning balance ESOP compensation expense Ending balance Accumulated other comprehensive earnings Beginning balance Foreign currency translation adjustments, net of reclassification to earnings Reclassification of unrealized losses on derivatives to earnings Minimum pension liability adjustment Ending balance Deferred compensation Beginning balance Deferred compensation invested in the company‘s common stock Deferred compensation settled with the company‘s common stock Ending balance Retained earnings Beginning balance Net earnings Cash dividends—$.96 per common share in 2004, $.9525 per common share in 2003, and $.93 in 2002 Cash dividend paid by subsidiary to minority shareholder Tax benefit applicable to ESOP dividend Ending balance Treasury stock, at cost Beginning balance Purchases of treasury stock Sales of treasury stock Deferred compensation transfer Ending balance Statements of Consolidated Shareholders’ Equity continued on next page 34 Year Ended September 30, 2004 2003 2002 $ 106 $ 106 $ 106 $ 14,234 878 — 766 $ 13,850 (117) 335 166 $ 13,586 102 — 162 $ 15,878 $ 14,234 $ 13,850 $ $ — $ 1,418 — (1,418) $ 3,297 (1,879) — $ — $ 1,418 $ 9,625 2,628 186 (401) $ 2,823 6,368 173 261 $ 1,046 2,823 154 (1,200) $ 12,038 $ 9,625 $ 2,823 $ 4,377 120 (36) $ — $ 4,377 — $ 4,461 $ 4,377 $ — — — — $ 360,908 31,382 $ 359,248 12,346 $ 327,130 42,681 (10,832) — — (10,707) — 21 (10,533) (198) 168 $ 381,458 $ 360,908 $ 359,248 $ 24,069 1,547 (1,997) — $ 19,708 9,503 (1,160) (3,982) $ 19,709 286 (287) — $ 23,619 $ 24,069 $ 19,708 (In thousands except per share amounts) Treasury stock held for deferred compensation Beginning balance Deferred compensation transfer Share distributions Automatic dividend reinvestment Ending balance Total shareholders’ equity Beginning balance Effect of changes among components of shareholders’ equity: Additional paid-in capital Unearned ESOP compensation Accumulated other comprehensive earnings Deferred compensation Retained earnings Treasury stock, at cost Treasury stock held for deferred compensation Total effect of changes among components of shareholders’ equity Ending balance Total comprehensive earnings Net earnings Other comprehensive earnings: Foreign currency translation adjustments, net of reclassification to earnings Reclassification of unrealized losses on derivatives to earnings Minimum pension liability adjustment Total other comprehensive earnings Total comprehensive earnings Common stock, number of shares Beginning and ending balance Treasury stock, number of shares Beginning balance Purchases of treasury stock Sales of treasury stock Deferred compensation transfer Ending balance Treasury stock held for deferred compensation, number of shares Beginning balance Deferred compensation transfer Share distributions Automatic dividend reinvestment Ending balance See accompanying Notes to Consolidated Financial Statements. W O O D WA R D W O O D WA R D W O O D WA R D Year Ended September 30, 2004 2003 2002 $ $ 4,377 — (36) 120 $ — 4,317 — 60 $ 4,461 $ 4,377 $ — — — — — $ 360,804 $ 354,901 $ 318,862 1,644 — 2,413 84 20,550 450 (84) 25,057 384 1,418 6,802 4,377 1,660 (4,361) (4,377) 264 1,879 1,777 — 32,118 1 — 5,903 36,039 $ 385,861 $ 360,804 $ 354,901 $ 31,382 $ 12,346 $ 42,681 2,628 186 (401) 2,413 6,368 173 261 6,802 2,823 154 (1,200) 1,777 $ 33,795 $ 19,148 $ 44,458 12,160 12,160 12,160 901 24 (81) — 844 124 — (1) 2 125 832 229 (37) (123) 901 — 123 — 1 124 838 4 (10) — 832 — — — — — 35 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Notes to Consolidated Financial Statements (In thousands of dollars except per share amounts) Note 1. Significant accounting policies: service facilities. Sales terms for distributors, dealers, and Principles of consolidation: The consolidated financial statements include the accounts of the company and its majority-owned subsidiaries. Transactions within and between these companies are eliminated. Results of joint ventures in which the company does not have a controlling financial interest are included in the financial statements using the equity method of accounting. Use of estimates: Financial statements prepared in conformity with accounting principles generally accepted in the United States require the use of estimates and assumptions that affect amounts reported. Actual results could differ materially from our estimates. Foreign currency translation: The assets and liabilities of substantially all subsidiaries outside the United States are generally translated at year-end rates of exchange, and earnings and cash flow statements are translated at weighted-average rates of exchange. Translation adjustments are accumulated with other comprehensive independent service facilities are identical to our sales terms for direct customers. Stock-based compensation: 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: Year ended September 30, 2004 2003 2002 Reported net earnings $ 31,382 $ 12,346 $ 42,681 Compensation expense using the fair value method, net earnings as a separate component of shareholders’ equity of income tax benefits 1,400 1,025 910 and are presented net of tax effects in the statements Pro forma net earnings $ 29,982 $ 11,321 $ 41,771 of consolidated shareholders’ equity. The effect of changes in exchange rates on loans between consolidated Reported net earnings per share amounts: subsidiaries that are not expected to be repaid in the foreseeable future are also accumulated with other comprehensive earnings. Revenue recognition: We recognize sales when delivery of product has occurred or services have been rendered and there is persuasive evidence of a sales arrangement, selling prices are fixed or determinable, and collectibility from the customer is reasonably assured. We consider product delivery to have occurred when the customer has taken title and assumed the risks and rewards of ownership of the products. Most of our sales are made directly to customers that use our products, although we also sell products to distributors, dealers, and independent Basic Diluted $ 2.78 $ 1.10 $ 3.77 2.71 1.08 3.69 Pro forma net earnings per share amounts: Basic Diluted $ 2.66 $ 1.01 $ 3.69 2.60 0.99 3.61 Research and development costs: Expenditures related to new product development activities are expensed when incurred and are separately reported in the statements of consolidated earnings. Income taxes: Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the company’s assets and liabilities. We provide for taxes that may be payable 36 W O O D WA R D W O O D WA R D W O O D WA R D if undistributed earnings of overseas subsidiaries were acquired and liabilities assumed. Goodwill is tested for to be remitted to the United States, except for those impairment on an annual basis (as of April 1) and more earnings that we consider to be permanently reinvested. often if an event occurs or circumstances change that Cash equivalents: Highly liquid investments purchased with an original maturity of three months or less are would more likely than not reduce the fair value of a reporting unit below its carrying amount. considered to be cash equivalents. The goodwill impairment test is a two-step process. Accounts receivable: Virtually all our sales are made on credit and result in accounts receivable, which are recorded at the amount invoiced. In the normal course of business, not all accounts receivable are collected and, therefore, we provide an allowance for losses of accounts receivable equal to the amount that we believe ultimately will not be collected. We consider customer-specific information related to delinquent accounts, past loss experience, and current economic conditions in establishing the amount of our allowance. Accounts receivable losses are deducted from the allowance and the related accounts receivable balances are written off when the receivables are deemed uncollectible. Recoveries of accounts receivable previously written off are recognized when received. Inventories: Inventories are valued at the lower of cost or market, with cost being determined on a first-in, first-out basis. The first step compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount exceeds the fair value, the goodwill of the reporting unit is considered potentially impaired and the second step of the impairment test must be performed. The second step of the goodwill impairment test compares the implied fair value of the goodwill of the reporting unit to the carrying amount of that goodwill. If the carrying amount of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized to reduce the carrying amount to its implied fair value. In performing this step, the implied fair value is determined in the same manner as the amount of goodwill recognized when a business combination is determined. A reporting unit is the level at which goodwill is tested for impairment. A reporting unit is an operating segment or a component one level below an operating segment if the component constitutes a business for which Property, plant, and equipment: Property, plant, and discrete financial information is available and segment equipment are recorded at cost and are depreciated over management regularly reviews the operating results of the estimated useful lives of the assets, ranging from that component. Furthermore, two or more components 5 to 45 years for buildings and improvements and 3 to would be aggregated and considered a single reporting 15 years for machinery and equipment. Assets placed in unit if the components have similar economic conditions. service after September 30, 1998, are depreciated using In our most recent impairment test, we determined our the straight-line method and assets placed in service as operating segments were our reporting units for purposes of and prior to September 30, 1998, are depreciated of our impairment tests. principally using accelerated methods. Assets are tested for recoverability whenever events or circumstances occur that indicate the carrying value is not recoverable. Other intangibles: Other intangibles are recognized apart from goodwill whenever an acquired intangible asset arises from contractual or other legal rights, Goodwill: Goodwill represents the excess of the cost of or whenever it is capable of being separated or an acquired entity over the net amount assigned to assets divided from the acquired entity and sold, transferred, 37 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) (In thousands of dollars except per share amounts) licensed, rented, or exchanged, either individually effective portion of a gain or loss in the value of a derivative or in combination with a related contract, asset, or designated as a cash flow hedge is initially reported as liability. An intangible other than goodwill is amortized a component of other comprehensive earnings and is over its estimated useful life unless that life is determined subsequently reclassified into earnings when the future to be indefinite. Currently, all of our intangibles have an interest payments affect earnings. The ineffective portion estimated useful life and are being amortized. Impairment of the gain or loss in the value of a derivative designated losses are recognized if the carrying amount of an as a cash flow hedge is reported in earnings immediately. intangible subject to amortization exceeds its fair value. ESOP debt guarantee: We guaranteed the payment of Deferred compensation: Deferred compensation obligations a loan obtained by the company’s Member Investment will be settled either by delivery of a fixed number of and Stock Ownership Plan, a qualified employee stock shares of the company’s common stock (in accordance ownership plan (ESOP), in June 1992. The proceeds with certain eligible members’ irrevocable elections) or of the loan were used by the plan to buy 1,027,224 in cash. We have contributed shares of common stock shares of the company’s common stock. The original of the company into a trust established for the future amount of the ESOP debt was included in the company’s settlement of deferred compensation obligations that consolidated balance sheet as long-term debt and unearned are payable in shares of the company’s common stock. ESOP compensation, a component of shareholders’ equity. Common stock held by the trust is reflected in the Long-term debt was reduced as loan payments were consolidated balance sheet as treasury stock held for made. Unearned ESOP compensation was reduced as deferred compensation, and the related deferred shares were allocated to plan participants using the compensation obligation is reflected as a separate shares-allocated method. At September 30, 2003, all component of equity in amounts equal to the fair value debt had been repaid and all shares had been allocated. of the common stock at the dates of contribution. These accounts are not adjusted for subsequent changes in fair value of the common stock. Deferred compensation obligations that will be settled in cash are accounted for on an accrual basis in accordance with the terms of the underlying contract and are reflected in the consolidated Reclassifications: Certain reclassifications have been made in the 2003 and 2002 consolidated financial statements to conform to the 2004 presentation. Most significantly, research and development costs are now presented separately from cost of goods sold. balance sheet as an accrued expense. Cumulative effect of accounting change: We adopted Derivatives: We recognize derivatives, which are used to hedge risks associated with interest rates, as assets or liabilities at fair value. These derivatives are designated as hedges of our exposure to changes in the fair value of long-term debt or as hedges of our exposure to variable cash flows of future interest payments. The gain or loss in the value of a derivative designated as a fair value hedge is recognized in earnings in the period of change together with an offsetting loss or gain on long-term debt. The Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” and the transition provisions of Statement No. 141, “Business Combinations,” both issued by the Financial Accounting Standards Board, on October 1, 2001. As a result of adopting these new standards, we completed the transitional goodwill impairment reviews required by the new standards and recognized an aftertax loss of $2,489 as a cumulative effect of an accounting change in 2002. In performing our impairment reviews, we estimated the fair values 38 W O O D WA R D W O O D WA R D W O O D WA R D of the various reporting units using a present value or annual period beginning after June 15, 2004, with method that discounted future cash flows as we expect earlier adoption encouraged. We adopted the guidance marketplace participants would, and we further assessed of the Staff Position in our quarter ended June 30, 2004. the reasonableness of the estimates by using valuation Disclosures about the effects of the subsidy on our methods based on market multiples. The resulting loss, benefit obligation and net periodic benefit cost are which was related to an Industrial Controls reporting included in Note 13. unit, was incurred to reduce goodwill to its implied fair value. Adoption of these standards also resulted in the reclassification of $4,426 from other intangibles to goodwill on October 1, 2001. This amount was related to an assembled workforce. Based on goodwill that existed at September 30, 2001, these standards reduced amortization expense in 2002, 2003, and 2004 by approximately $4,900 per year. Note 2. Business acquisitions: In June 2004, we acquired assets and assumed certain liabilities of Adrenaline Research, Inc., specialists in advanced combustion electronics. Our cost for this acquisition totaled $2,896, and we recognized $3,139 as other intangibles in the Industrial Controls segment. We are using an amortization period of seventeen years for these intangibles. If we had completed this acquisition on October 1, 2001, net sales and net earnings for New accounting standards: In December 2003, the 2004, 2003, and 2002 would not have been materially Financial Accounting Standards Board issued a revised different from amounts reported in the statements Statement of Financial Accounting Standards No. 132, of consolidated earnings. “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” The revised Statement requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans that were not required by the original statement. The revised Statement became effective in our first quarter 2004. Our disclosures may be found in Note 13. In May 2003, we acquired 100 percent of the common stock of Synchro-Start Products, Inc., and in August 2003, we acquired assets and assumed certain liabilities of Barber-Colman Dyna Products, a division of Invensys Building Systems, Inc. Synchro-Start Products, Inc. specializes in the design and manufacture of actuators, solenoids, and controls for industrial engines and equipment. Barber-Colman Dyna Products manufactures In May 2004, the Financial Accounting Standards Board and distributes controls for off-highway diesel and gas issued FASB Staff Position 106-2, “Accounting and engines and mobile industrial equipment. Our cost for Disclosure Requirements Related to the Medicare these acquisitions totaled $58,084, of which $12,329 Prescription Drug, Improvement and Modernization was recognized as goodwill, $20,607 was recognized as Act of 2003.” The Staff Position provides guidance on customer relationships, and $5,940 was recognized as accounting for the effects of the Act, which introduced a other intangibles, all in the Industrial Controls segment. federal subsidy to sponsors of retiree healthcare benefit We are using weighted-average amortization periods of plans that provide a prescription drug benefit that is at eleven years for customer relationships, nine years for least actuarially equivalent to Medicare Part D, among other intangibles, and eleven years in the aggregate. The other provisions. For all public companies, the guidance total amount of goodwill is expected to be fully deductible of the Staff Position became effective for the first interim for income tax purposes. If we had completed these 39 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) (In thousands of dollars except per share amounts) acquisitions on October 1, 2001, net sales and net earnings for 2003 and 2002 would not have been materially different from amounts reported in the statements of consolidated earnings. In January 2002, we acquired the capital stock of Leonhard-Reglerbau Dr.-Ing. Adolf Leonhard GmbH, and in March 2002, we acquired certain assets and assumed certain liabilities of Nolff’s Carburetion, Inc. Leonhard-Reglerbau specializes in the design, manufacture, and sale of control, protection, and monitoring devices for power generation equipment. Nolff’s manufactures and sells natural gas and propane fuel systems for small Note 4. Income taxes: Income taxes consisted of the following: Year ended September 30, 2004 2003 2002 Current: Federal State Foreign Deferred $12,400 $ 2,481 6,148 (3,119) 606 292 2,294 4,401 $16,784 2,288 5,125 1,313 $17,910 $ 7,593 $25,510 Earnings before income taxes and cumulative effect of accounting change by geographical area consisted of the following: industrial engines. Our cost for these acquisitions totaled Year ended September 30, 2004 2003 2002 $25,313, of which $17,484 was recognized as goodwill, $1,000 was recognized as customer relationships, and $4,227 was recognized as other intangibles, all in the Industrial Controls segment. We are using weighted-average amortization periods of five years for customer relationships, six years for other intangibles, and six years in the aggregate. The amount of goodwill expected to be fully deductible for income tax purposes is $11,391. If we had completed the acquisitions on October 1, 2001, net sales and net earnings for 2002 would not have been materially different from amounts reported in the statements of consolidated earnings. Note 3. Impairment loss on equipment: In 2002, we reduced the carrying value of certain Industrial Controls manufacturing equipment to its estimated fair value, which was based on a present value technique involving multiple cash flow scenarios. The United States Other countries $39,054 10,238 $22,279 $65,463 (2,340) 5,217 $49,292 $19,939 $70,680 Deferred income taxes presented in the consolidated balance sheets are related to the following: At September 30, 2004 2003 Deferred tax assets: Postretirement and early retirement benefits $ 20,304 $ 18,579 Foreign net operating loss carryforward Inventory Other 18,629 8,531 23,623 16,528 7,490 20,077 Valuation allowance (18,629) (16,528) Total deferred tax assets, net of valuation allowance 52,458 46,146 Deferred tax liabilities: Intangibles—net Other (19,190) (12,098) (15,185) (10,353) resulting loss totaled $3,000 and was recognized as other Total deferred tax liabilities (31,288) (25,538) expense in the statement of consolidated earnings. We Net deferred tax assets $ 21,170 $ 20,608 sold this manufacturing equipment in 2003. We are currently studying the impact of the one-time favorable foreign dividend provisions recently enacted as part of the American Jobs Creation Act of 2004. However, at September 30, 2004, based on the tax laws 40 W O O D WA R D W O O D WA R D W O O D WA R D in effect at that time, it was our intention to continue to Note 5. Earnings per share: indefinitely reinvest $20,503 of our undistributed foreign earnings. We have not provided for taxes on these undistributed foreign earnings, which could become Year ended September 30, 2004 2003 2002 Earnings before cumulative effect of accounting subject to income taxes if they are remitted as dividends, change (A) $31,382 $ 12,346 $45,170 are loaned to the company, or if we sell our stock in Determination of shares, the subsidiaries. However, we believe that foreign tax in thousands: credits would largely offset any income tax that might otherwise be due. We recorded a valuation allowance to reflect the estimated amount of deferred tax assets that may not be realized due to foreign net operating loss carryforwards. Under existing laws, these net operating losses may be Weighted-average shares of common stock outstanding (B) 11,286 11,246 11,325 Assumed exercise of stock options 279 143 252 Weighted-average shares of common stock outstanding carried forward indefinitely. However, we are uncertain assuming dilution (C) 11,565 11,389 11,577 whether we will generate taxable earnings in the particular tax jurisdictions necessary to benefit from these carryforwards. All other deferred tax assets are expected to be realized through future earnings. The changes in the valuation allowance were as follows: Year ended September 30, 2004 2003 Beginning balance $(16,528) $(12,033) Foreign net operating loss carryforward (2,101) (4,999) State net operating loss carryforward State capital loss utilization — — 414 90 Ending balance $(18,629) $(16,528) Earnings before cumulative effect of accounting change: Basic per share amount (A/B) Diluted per share amount (A/C) $ 2.78 2.71 $ 1.10 $ 3.99 1.08 3.90 In 2004, the weighted-average shares of common stock outstanding includes 124,965 shares for deferred compensation obligations that are payable in actual shares of our common stock. The following stock options were outstanding during 2004, 2003, and 2002 but were not included in the computation of diluted earnings per share because The reasons for the differences between our effective the options’ exercise prices were greater than the income tax rate and the United States statutory federal average market price of the common shares during the income tax rate were as follows: respective periods: Percent of pretax earnings, year ended September 30, Statutory rate State income taxes, net of federal tax benefit Foreign loss effect Foreign tax rate differences Foreign sales benefits ESOP dividends on allocated shares Capital loss utilization Other items, net 2004 2003 2002 35.0 35.0 35.0 3.6 2.1 — (3.4) (1.1) — 0.1 3.0 9.7 (3.3) (3.9) (2.7) — 0.3 2.6 2.2 (1.1) (1.6) — (1.5) 0.5 Effective rate 36.3 38.1 36.1 Year ended September 30, 2004 2003 2002 Options Weighted-average exercise price 11,648 $70.37 435,230 $47.12 12,543 $70.28 Note 6. Inventories: At September 30, Raw materials Component parts Work in process Finished goods 2004 2003 $ 3,304 $ 6,017 88,760 30,237 16,407 76,151 27,237 16,884 $138,708 $126,289 41 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) (In thousands of dollars except per share amounts) Note 7. Property, plant, and equipment: Note 9. Other intangibles—net: At September 30, Land Buildings and improvements Machinery and equipment Construction in progress Less accumulated depreciation 149,361 237,677 2,044 399,462 282,152 145,779 247,767 2,239 405,834 281,690 2004 2003 At September 30, 2004 2003 $ 10,380 $ 10,049 Industrial Controls: Customer relationships: Amount acquired $ 37,387 $33,610 Accumulated amortization (6,215) (3,615) Other: Property, plant, and equipment—net $117,310 $124,144 Amount acquired Depreciation expense totaled $25,856 in 2004, $27,548 in 2003, and $28,340 in 2002. Note 8. Goodwill: Year ended September 30, Industrial Controls: Beginning balance Goodwill acquired Reclassification Foreign currency exchange rate changes Ending balance Aircraft Engine Systems: 2004 2003 $ 71,498 — (3,491) $ 53,143 16,496 — 1,413 1,859 $ 69,420 $ 71,498 Beginning and ending balance $ 62,122 $ 62,122 Consolidated: Beginning balance Goodwill acquired Reclassification Foreign currency exchange rate changes Ending balance $133,620 $115,265 — 16,496 (3,491) — 1,413 1,859 $131,542 $133,620 Accumulated amortization Total Aircraft Engine Systems: Customer relationships: Amount acquired Accumulated amortization Other: Amount acquired Accumulated amortization Total Consolidated: Customer relationships: Amount acquired Accumulated amortization Other: Amount acquired Accumulated amortization We finalized accounting for an August 2003 business Total 31,172 29,995 31,502 (7,490) 27,815 (4,594) 24,012 23,221 $ 55,184 $53,216 $ 28,547 (6,027) $28,547 (5,075 ) 22,520 23,472 11,785 (3,778) 11,785 (3,182) 8,007 8,603 $ 30,527 $32,075 $ 65,934 $62,157 (12,242) (8,690) 53,692 53,467 43,287 (11,268) 39,600 (7,776) 32,019 31,824 $ 85,711 $85,291 acquisition in 2004, which resulted in a reclassification of amounts from goodwill primarily to other intangibles. Amortization expense associated with current intangibles is expected to be approximately $7,100 for 2005, $7,000 for 2006, $6,600 for 2007, $5,900 for 2008, and $5,500 for 2009. 42 W O O D WA R D W O O D WA R D W O O D WA R D Note 10. Short-term borrowings: Short-term borrowings reflect borrowings under certain We have effectively offset our exposure to changes in the fair value of a portion of the senior notes by entering bank lines of credit. The total amount available under into interest rate swap agreements. Under these these lines of credit, including outstanding borrowings, agreements, we are swapping interest payments related totaled $26,426 at September 30, 2004, and $30,608 to a notional amount of $40,000 at a fixed rate of 6.39% at September 30, 2003. Interest on borrowings under for rates that vary with LIBOR. The timing of these the lines of credit is based on various short-term rates. payments corresponds directly with interest payments Several of the lines assess commitment fees. The lines, due under the senior notes and we have assessed the generally reviewed annually for renewal, are subject to swaps as having no hedge ineffectiveness. As a result, the usual terms and conditions applied by the banks. the fair value of these swap agreements is shown as an The weighted-average interest rate for outstanding adjustment of long-term debt. borrowings was 2.8% at September 30, 2004, 3.2% at September 30, 2003, and 4.1% at September 30, 2002. Note 11. Long-term debt: At September 30, Senior notes—6.39% Term note—5.75% Revolving line of credit facility Fair value hedge adjustments: Interest rate swap agreements Unrecognized discontinued hedge gains Less current portion We also discontinued certain interest rate swaps that were previously designated as fair value hedges of long-term debt. These actions resulted in gains that are recognized as a reduction of interest expense over the 2004 2003 term of the associated hedged debt using the effective $75,000 12,422 — $ 75,000 11,655 30,000 (895) 2,881 (256) 3,571 89,408 119,970 956 30,000 $88,452 $ 89,970 interest method. The unrecognized portion of the gain is presented as an adjustment to long-term debt. Provisions of the 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 The senior notes, which are held by multiple institutions, event of a material adverse event. Our most restrictive and the term note, which is held by a bank in Germany, covenants require us to maintain a minimum consolidated are uncollateralized. Required future principal payments net worth, a maximum consolidated debt to consolidated of the senior notes and the term note at September 30, operating cash flow, a maximum consolidated debt to 2004, are $956 in 2005, $14,536 in 2006, $14,536 in 2007, EBITDA, and a minimum EBIT to consolidated interest $14,537 in 2008, $10,714 in 2009, and $32,143 thereafter. expense ratio, as defined in the agreements. The revolving line of credit facility involves uncollateralized financing arrangements with a syndicate of U.S. banks. Note 12. Accrued liabilities: We have $100,000 available under the revolving line of At September 30, credit facility and an option to increase the amount of the line to $175,000. This line of credit expires March 14, 2006. Interest rates on borrowings under the line vary with LIBOR, the money market rate, or the prime rate. At September 30, 2004, there were no outstanding borrowings against the line. Salaries and other member benefits Warranties Taxes, other than on income Deferred compensation Other items—net 2004 2003 $41,236 6,401 4,214 2,278 11,444 $19,066 6,113 3,591 2,328 14,435 $65,573 $45,533 43 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) (In thousands of dollars except per share amounts) Salaries and other member benefits include accrued two European manufacturing operations with existing termination benefits totaling $12,000 at September 30, operations. This action is being taken to streamline the 2004, and $2,199 at September 30, 2003. Changes in organization by eliminating redundant manufacturing accrued termination benefits were as follows: operations and is expected to be substantially complete Year ended September 30, Industrial Controls: Beginning balance Expense: Cost of goods sold Selling, general, and administrative expenses Accrual adjustments Foreign currency exchange rate changes Payments Ending balance Aircraft Engine Systems: Beginning balance Expense: Cost of goods sold Selling, general, and administrative expenses Payments Ending balance Nonsegment: Beginning balance Expense: Selling, general, and administrative expenses Payments Ending balance Consolidated: Beginning balance Expense: Cost of goods sold Selling, general, and administrative expenses Accrual adjustments Foreign currency exchange rate changes Payments Ending balance 2004 2003 by March 31, 2006. The total expense for this action is estimated to be approximately $17,000, of which $ 2,037 $ 1,349 $13,800 was recognized in 2004. In addition to the 11,611 3,832 540 (1,083) 1,260 — 170 (1,275) — (4,404) $12,000 $ 2,037 $12,000 reflected in the preceding table, we recognized contractual pension termination benefits of $1,800 in 2004. The remaining estimated amount of $3,200 is for termination benefits that will be earned by members over their remaining service period and for other costs primarily associated with moving equipment and inventory to other locations. $ 104 $ 40 Accrued termination benefits that were expensed in — 3,682 — (104) 274 (3,892) $ — $ 104 $ 58 $ — — (58) 343 (285) $ — $ 58 2003 were related to actions to better align staffing levels with expected demand in Industrial Controls and to consolidate our servovalve manufacturing operations in Buffalo, New York, with existing manufacturing operations in Rockford, Illinois, to achieve cost efficiencies. The accrual for the actions in Industrial Controls was adjusted in 2004 by $1,083 and both actions are now complete. We attributed $431 of the accrual reduction to increased production levels and the decision to retain certain members to meet the increased demand. The remaining accrual adjustment of $652 was related $ 2,199 $ 1,389 to members of the European operations now being 11,611 7,514 540 (1,083) 1,877 — 170 (1,437) — (8,581) $12,000 $ 2,199 consolidated and reflects the decision to discontinue the remaining 2003 actions given the newly-formed consolidation plans. 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 Accrued termination benefits that were expensed in for warranty costs on a non-specific basis whenever 2004 were primarily related to the consolidation of past experience indicates a normal and predictable 44 W O O D WA R D W O O D WA R D W O O D WA R D pattern exists. Changes in accrued product warranties percentage of the fair value of total plan assets for were as follows: Year ended September 30, Beginning balance retirement pension benefits were as follows: 2004 2003 United States Other Countries $ 6,113 $ 6,356 At September 30, 2004 2003 2004 2003 Accruals related to warranties issued during the period 6,913 5,747 Accruals related to pre-existing warranties Settlements of amounts accrued Foreign currency exchange rate changes Ending balance (1,998) (4,798) 171 (949) (5,315) 274 $ 6,401 $ 6,113 Note 13. Retirement benefits: We provide various benefits to eligible members of our company, including contributions to various defined contribution plans, pension benefits associated with defined benefit plans, and retirement healthcare benefits. Equity securities Fixed income securities Insurance contracts Other Total 60.1% 58.8% 39.4% 39.7% — 0.5% 1.5% — 71.6% 67.8% 12.0% 13.6% 12.7% 15.4% 3.7% 3.2% 100.0% 100.0% 100.0% 100.0% Estimated benefit payments to be made over the next ten years, with retirement healthcare benefit payments presented net of estimated participant contributions, are as follows: Retirement Pension Benefits Retirement United Other Healthcare The amount of expense associated with defined Year ending September 30, States Countries Benefits contribution plans totaled $11,623 in 2004, $11,010 in 2003, and $11,927 in 2002. Information regarding our retirement pension benefits and retirement healthcare benefits, using a September 30 measurement date, is 2005 2006 2007 2008 2009 $ 400 $ 818 $ 3,329 420 451 487 519 889 1,120 1,220 1,291 3,564 3,286 3,412 3,583 provided in the tables that follow. 2010–2014 3,805 9,260 24,251 Policies have been established for the investment of We expect contributions by the company for retirement plan assets for retirement pension benefits. In the United pension benefits will be $0 in the United States and $1,909 States, our strategy is to balance the rewards of long-term in other countries in 2005. We also expect contributions growth with the risks of adverse, short-term market by the company for retirement healthcare benefits will behavior. Our investments are broadly diversified so be $2,594 in 2005. as to limit the impact on the total portfolio of losses in individual securities. Target ranges for our assets are 40% –50% for United States equity investments, 12%–18% for foreign equity investments, and 35%–45% We recognized contractual pension termination benefits of $1,800 in 2004 as a result of workforce reductions that are probable during 2005 and 2006. for fixed income investments. In other countries, we As part of our retirement healthcare benefits, we provide adhere to investment strategies which are consistent a prescription drug benefit that is at least actuarially with the practices of similar pension plans. Formal equivalent to Medicare Part D. As a result, we are investment policies in other countries are being considered. entitled to a federal subsidy that was introduced by The assumptions we used for the expected long-term the Medicare Prescription Drug, Improvement and rate of return on plan assets was based on historical Modernization Act of 2003. The effect of the subsidy performance and adjusted to estimate the potential range reduced our accumulated postretirement benefit of returns for the current asset allocations. The actual obligation by $7,934 at January 1, 2004, the date the 45 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) (In thousands of dollars except per share amounts) Act became effective. It also reduced our net periodic thereafter. A 1.00% increase in assumed healthcare cost postretirement benefit cost for 2004 by $843, which trend rates would have increased the total of the service consisted of $189 for service cost, $356 for interest cost, and interest cost components by $1,262 and increased and $298 for recognized actuarial gains. the benefit obligation at the end of the year by $15,726 in For retirement healthcare benefits, we assumed net healthcare cost trend rates of 10.00% in 2005, decreasing gradually to 5.00% in 2010, and remaining at 5.00% 2004. Likewise, a 1.00% decrease in the assumed rates would have decreased the total of service and interest cost components by $973 and decreased the benefit obligation by $12,149 in 2004. At or for the year ended September 30, Changes in benefit obligation: Retirement Pension Benefits United States Other Countries Retirement Healthcare Benefits 2004 2003 2004 2003 2004 2003 Benefit obligation at beginning of year $ 17,994 $ 17,215 $ 39,787 $ 35,545 $ 70,349 $ 58,550 Service cost Interest cost Contribution by plan participants Net actuarial losses (gains) Foreign currency exchange rate changes Benefits paid Contractual termination benefits — 1,070 — 180 — (389) — — 1,110 — 39 — (370) — 1,694 1,835 251 2,312 2,487 (1,199) 1,800 1,590 1,600 223 (40) 2,638 (1,769) — 2,206 4,204 2,937 8,326 208 1,717 3,863 2,833 9,796 111 (5,505) (6,521) — — Benefit obligation at end of year 18,855 17,994 48,967 39,787 82,725 70,349 Changes in plan assets: Fair value of plan assets at beginning of year Actual return on plan assets Foreign currency exchange rate changes Contributions by the company Contributions by plan participants Benefits paid 11,587 1,228 — 1,400 — (389) 9,052 1,439 — 1,466 — (370) 27,689 23,484 2,780 1,614 1,681 251 (1,199) 2,525 1,868 1,358 223 (1,769) — — — 2,568 2,937 (5,505) — — — 3,688 2,833 (6,521) Fair value of plan assets at end of year 13,826 11,587 32,816 27,689 — — Funded status Unamortized prior service cost Unrecognized net losses Unamortized transition obligation Intangible asset (5,029) (6,407) (16,151) (12,098) (82,725) (70,349) 7 7 4,040 4,317 — — — — (84) 11,124 572 (488) (682) (93) 9,701 666 — (292) (8,380) 36,286 (8,888) 29,247 — — — — — — Accumulated other comprehensive income (1,513) (1,273) Net accrued benefit $ (2,495) $ (3,356) $ (5,709) $ (2,116) $ (54,819) $ (49,990) Accumulated benefit obligation $ 16,321 $ 14,943 $ 36,309 $ 29,267 46 W O O D WA R D W O O D WA R D W O O D WA R D Year ended September 30, 2004 2003 2002 2004 2003 2002 2004 2003 2002 Retirement Pension Benefits United States Other Countries Retirement Healthcare Benefits Components of net periodic benefit cost: Service cost Interest cost $ — $ — $ — 1,035 1,110 1,070 $ 1,694 $ 1,590 $ 1,301 $2,206 $1,717 $1,208 1,835 1,600 1,378 4,204 3,863 3,443 Expected return on plan assets (942) (741) (801) (1,641) (1,293) (1,318) Amortization of unrecognized transition obligation Recognized losses Recognized prior service costs Contractual termination benefits Settlement or curtailment — 170 1 — — 235 1 — — 1 — — 98 533 (9) 1,800 losses (gains) — — — — 89 593 (8) — — — — 1,343 (508) — — — 767 (508) — — — 22 — — 85 — (8) — 357 — — (304) Net periodic benefit cost $ 299 $ 605 $ 235 $ 4,310 $ 2,571 $ 1,795 $7,245 $5,839 $4,369 Increase (decrease) in minimum pension liability adjustment included in other comprehensive earnings $ 240 $ 185 $1,088 $ 390 $ (556) $ 848 $ — $ — $ — Weighted-average assumptions used to determine benefit obligation at September 30: Discount rate Rate of compensation increase Weighted-average assumptions used to determine net periodic benefit cost for years ended September 30: Discount rate Rate of compensation increase Expected long-term rate of 5.80% 6.00% 6.50% 5.00% 5.00% 5.00% 4.36% 3.02% 4.06% 4.29% 2.91% 3.65% 6.00% 6.50% 7.25% 5.00% 5.00% 5.00% 4.06% 2.91% 4.29% 2.50% 3.65% 3.50% 5.79% 6.00% 6.75% — — — 6.00% 6.75% 7.25% — — — return on plan assets 8.25% 8.25% 8.25 % 5.44% 5.36% 2.50% — — — 47 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) (In thousands of dollars except per share amounts) Note 14. Stock option plan: We have a stock option plan covering key management The weighted-average estimated fair value of options granted during the year, as measured at their grant date, members and directors of the company. Options granted was $15.68 in 2004, $14.85 in 2003, and $16.03 in 2002. under the plan generally have a term of 10 years and These estimates were determined using the Black-Scholes vest evenly at the end of each year over four years from option-pricing model and the following weighted-average the date of grant. There were 2,100,000 shares of assumptions by grant year: Year ended September 30, 2004 2003 Risk-free interest rate 3.7% 3.4% 2002 4.5% Expected life Expected volatility Expected dividend yield 7 years 7 years 7 years 37.0% 2.6% 35.0% 2.5% 35.0% 2.8% Information about outstanding stock options at September 30, 2004 is provided in the table below. There were 681,937 stock options exercisable at September 30, 2003, with a weighted-average exercise price of $29.36, and 604,068 at September 30, 2002, with a weighted-average exercise price of $27.08. common stock authorized for issuance under the plan at September 30, 2004. Changes in outstanding stock options were as follows: Weighted-Average Number Exercise Price Balance at September 30, 2001 Options granted Options exercised Options forfeited Options expired Balance at September 30, 2002 Options granted Options exercised Options forfeited 780,818 178,500 (9,100) (13,000) (1,000) 936,218 125,000 (34,706) (21,750) Balance at September 30, 2003 1,004,762 Options granted Options exercised Options forfeited Options expired 169,000 (81,248) (5,250) (3,000) $28.96 49.42 29.50 41.40 69.00 32.64 46.86 27.31 44.96 34.33 46.94 35.01 49.25 55.74 Balance at September 30, 2004 1,084,264 $36.11 Options Outstanding at September 30, 2004 Options Exercisable at September 30, 2004 Weighted-Average Weighted-Average Remaining Life Weighted-Average Exercise Price in Years Number Exercise Price $22.34 $36.28 $48.01 $70.44 $36.11 3.3 4.6 8.1 6.6 5.5 393,850 231,935 110,249 10,979 747,013 $22.34 $35.64 $49.22 $70.44 $31.14 Number 393,850 258,810 420,625 10,979 1,084,264 Exercise Price Range $16.625– $24.750 $30.594– $41.813 $46.420– $59.000 $69.220– $73.700 48 W O O D WA R D W O O D WA R D W O O D WA R D Note 15. Shareholder rights plan: We have a shareholder rights plan to protect shareholders against unsolicited attempts to acquire control of the Note 16. Accumulated other comprehensive earnings: Accumulated other comprehensive earnings, which company that do not offer what the Board of Directors totaled $12,038 at September 30, 2004, and $9,625 at believes to be an adequate price to all shareholders. In September 30, 2003, consisted of the following items: connection with this plan, a dividend of one preferred stock purchase right for each outstanding share of Year ended September 30, 2004 2003 Accumulated foreign currency translation common stock was paid to shareholders in February 1996. Each right entitles its holder to purchase from the company adjustments: Beginning balance one-four hundredth of a share of Series A Preferred Stock, par value $.003 per share, at a price of $75.00 (subject to adjustment, and restated for the January 1997 stock split). The rights may not be exercised or transferred apart from the company’s common stock until 10 days after it is announced that a person or group has acquired 15% or more of the outstanding common stock or 15 business days after it is announced that there is an offer (or an intent to make an offer) by a person or group to acquire 15% or more of the outstanding common stock. The Board of Directors may extend the 15 business day period referred to above and may redeem the rights Translation adjustments Taxes associated with translation adjustments Ending balance Accumulated unrealized derivative losses: Beginning balance Reclassification to interest expense Taxes associated with interest reclassification Ending balance Accumulated minimum pension liability adjustments: Beginning balance in whole (but not in part) at a redemption price of $.003 Minimum pension liability $11,611 $ 5,243 4,237 10,271 (1,609) (3,903) $14,239 $11,611 $ (1,047) 300 $ (1,220) 279 (114) (106) $ (861) $ (1,047) $ (939) $ (1,200) per right at any time prior to an acquisition of 15% or more of the outstanding common stock by a person or group. The rights expire on January 17, 2006. adjustment (680) 421 Taxes associated with minimum pension liability adjustments 279 (160) Ending balance $ (1,340) $ (939) Note 17. Leases: We have entered into operating leases for certain facilities and equipment with terms in excess of one year. Future minimum rental payments required under these leases are approximately $3,600 in 2005, $3,300 in 2006, $2,700 in 2007, $1,800 in 2008, $1,600 in 2009, and $6,900 thereafter. Rent expense for all operating leases totaled $4,239 in 2004, $4,125 in 2003, and $4,507 in 2002. 49 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Notes to Consolidated Financial Statements (continued) (In thousands of dollars except per share amounts) Note 18. Contingencies: We are currently involved in pending or threatened litigation or other legal proceedings regarding Cash and cash equivalents have short-term maturities, short-term borrowings have short-term maturities and market interest rates, and long-term debt at variable employment, product liability, and contractual matters interest rates is repriced frequently at market rates of arising from the normal course of business. We accrued interest. Interest rate swap agreements are carried at their for individual matters that we believe are likely to result fair value, which is estimated based on proprietary models in a loss when ultimately resolved using estimates of the used by financial institutions that rely on assumptions most likely amount of loss. There are also individual regarding past, present, and future market conditions. matters that we believe the likelihood of a loss when The fair value of long-term debt at fixed interest rates ultimately resolved is less than likely but more than was estimated based on a model that discounted future remote, which were not accrued. While it is possible principal and interest payments at interest rates available that there could be additional losses that have not been to the company at the end of the year for similar debt accrued, we currently believe the possible additional loss of the same maturity. The weighted-average interest in the event of an unfavorable resolution of each matter rates used to estimate the fair value of long-term debt is less than $5,000 in the aggregate. We file income tax returns in various jurisdictions worldwide, which are subject to audit. We have accrued for our estimate of the most likely amount of expenses that we believe will result from income tax audit adjustments. at fixed interest rates were 4.28% at September 30, 2004, and 4.62% at September 30, 2003. Note 20. Segment information: Our operations are organized based on the nature of products and related services provided and consist of two operating segments—Industrial Controls and Aircraft In the event of a change in control of the company, we Engine Systems. Industrial Controls provides energy may be required to pay termination benefits to certain control systems and components primarily to OEMs of executive officers. Note 19. Financial instruments: The estimated fair values of our financial instruments were as follows: At September 30, industrial engines, turbines, and other power equipment. Aircraft Engine Systems provides energy control systems and components primarily to OEMs of aircraft engines. The accounting policies of the segments are the same as those described in Note 1. Intersegment sales and 2004 2003 transfers are made at established intersegment selling Cash and cash equivalents $ 48,895 $ 24,058 prices generally intended to approximate selling prices to Interest rate swap agreements Short-term borrowings Long-term debt, including (895) (5,833) (256) (5,774) current portion (93,947) (123,521) The fair values of cash and cash equivalents, short-term borrowings, and long-term debt at variable interest rates were assumed to be equal to their carrying amounts. unrelated parties. Our determination of segment earnings does not reflect allocations of certain corporate expenses, which we designate as nonsegment expenses, and is before interest expense, interest income, income taxes, and the cumulative effect of accounting change. 50 W O O D WA R D W O O D WA R D W O O D WA R D Segment assets consist of accounts receivable, inventories, property, plant, and equipment—net, goodwill, and other intangibles—net. Summarized financial information for our segments follows: At or for the year ended September 30, Industrial Controls: 2004 2003 2002 External net sales $ 439,801 $ 332,755 $ 408,665 Intersegment sales 849 697 842 Segment earnings (loss) Segment assets Depreciation and amortization Capital expenditures Aircraft Engine Systems: External net sales Intersegment sales Segment earnings Segment assets Depreciation and amortization Capital expenditures 6,437 364,584 (11,588) 33,294 336,654 286,302 21,341 13,564 18,914 11,601 16,657 14,585 $ 270,004 2,193 59,192 205,580 $ 253,927 $ 271,326 2,016 47,615 2,752 57,226 217,685 219,480 10,276 4,281 11,464 5,775 13,076 7,038 At September 30, 2004 2003 2002 Total segment assets $ 570,164 $ 554,339 $ 505,782 Unallocated corporate property, plant, and equipment—net Other unallocated assets 2,384 81,746 2,812 58,848 3,385 73,228 Consolidated total assets $ 654,294 $ 615,999 $ 582,395 Differences between total depreciation and amortization and capital expenditures of our segments and the corresponding consolidated amounts reported in the statements of consolidated cash flows are due to unallocated corporate amounts. One customer individually accounted for more than 10% of consolidated net sales in each of the years 2002 through 2004. These sales were made by both of our segments and totaled approximately $156,000 in 2004, $151,000 in 2003, and $212,000 in 2002. In addition, a second customer individually accounted for more than 10% of consolidated net sales in 2004. These sales were made by Industrial Controls and totaled $83,000 In addition, Industrial Controls recognized contractual in 2004. pension termination benefits of $1,800 in 2004, which External net sales by geographical area, as determined by reduced segment earnings. the location of the customer invoiced, were as follows: The differences between the total of segment amounts and the consolidated financial statements were as follows: Year ended September 30, 2004 2003 2002 Total segment net sales and intersegment sales $ 712,847 $ 589,395 $ 683,585 Elimination of intersegment sales (3,042) (2,713) (3,594) Year ended September 30, 2004 2003 2002 United States Other countries $ 413,901 $ 332,986 $ 403,864 295,904 253,696 276,127 $ 709,805 $ 586,682 $ 679,991 Property, plant, and equipment—net by geographical area, as determined by the physical location of the assets, were as follows: Consolidated net sales $ 709,805 $ 586,682 $ 679,991 At September 30, Total segment earnings $ 65,629 $ 36,027 $ 90,520 Nonsegment expenses Interest expense and (12,100) (12,323) (15,366) income (4,237) (3,765) (4,474) United States Other countries 2004 2003 $ 84,091 $ 92,326 33,219 31,818 $ 117,310 $ 124,144 Consolidated earnings before income taxes and cumulative effect of accounting change $ 49,292 $ 19,939 $ 70,680 51 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Woodward Governor Company In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings, cash flows and shareholders’ equity present fairly, in all material respects, the financial position of Woodward Governor Company and its subsidiaries at September 30, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1 to the consolidated financial statements, effective October 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142). PricewaterhouseCoopers LLP November 1, 2004 52 Selected Quarterly Financial Data (Unaudited) W O O D WA R D W O O D WA R D (In thousands except per share amounts) Net sales Gross profit Earnings (loss) before income tax Net earnings (loss) Net earnings (loss): Per basic share Per diluted share Cash dividends per share Common stock price per share: High Low Close Notes: 2004 Fiscal Quarters 2003 Fiscal Quarters First Second Third Fourth First Second Third Fourth $158,973 $172,951 $180,496 $197,385 $144,825 $146,159 $141,637 $154,061 41,284 42,888 45,064 38,329 35,881 34,929 30,845 34,351 12,021 7,393 14,589 9,105 13,218 8,213 0.66 0.65 0.81 0.79 0.73 0.71 9,464 6,671 0.59 0.57 10,104 6,265 0.55 0.55 7,418 4,511 0.40 0.40 (408) (165) (0.01) (0.01) 2,825 1,735 0.15 0.15 0.24 0.24 0.24 0.24 0.2325 0.24 0.24 0.24 57.65 43.02 56.83 65.00 54.26 63.74 73.72 59.04 72.11 72.69 54.75 67.49 49.45 35.00 43.50 44.68 32.81 34.83 44.43 34.04 43.01 50.30 40.19 43.39 1. Gross profit represents net sales less cost of goods sold. Certain reclassifications have been made to cost of goods sold on a quarterly basis to conform to the presentation in our statements of consolidated earnings for the year ended September 30, 2004. 2. Earnings (loss) before income taxes included the effects of workforce management actions in 2003 and 2004 to consolidate certain facilities and better align staffing levels with expected demand. Our workforce management costs consisted of the following: 2004 Fiscal Quarters 2003 Fiscal Quarters (In thousands) First Second Third Fourth First Second Third Fourth Member termination benefits $ 151 $ — $ — $12,000 $2,854 $2,200 $1,841 $2,496 Contractual pension termination benefits Related costs of facility consolidation Member termination benefits adjustments — — (83) — — (348) — — — 1,800 — (652) — — — 500 — 1,500 — — — — 560 — Total workforce management costs $ 68 $(348) $ — $13,148 $2,854 $2,700 $3,341 $3,056 Amount of workforce management costs affecting gross profit $ 50 $(288) $ — $12,612 $2,742 $1,750 $2,905 $2,677 53 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T 2 0 0 4 A N N U A L R E P O R T Selected Financial Data (In thousands of dollars except per share amounts) 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 Net sales Earnings (loss) before cumulative effect of accounting change Goodwill-related amortization, net of income taxes $709,805 $ 586,682 31,382 12,346 — — $ 679,991 $ 678,791 $ 597,385 $ 596,904 $ 490,476 $ 442,216 $ 417,290 $ 379,736 $ 333,207 45,170 — 53,068 2,875 46,976 * 2,660 30,829 2,770 21,592 1,293 18,140 22,178 11,936 (3,273) 578 346 245 307 Adjusted earnings (loss) before cumulative effect of accounting change 31,382 12,346 45,170 55,943 49,636 33,599 22,885 18,718 22,524 12,181 (2,966) For the Year Ended September 30, Basic per share amounts: Earnings (loss) before cumulative effect of accounting change Goodwill-related amortization, net of income taxes Adjusted earnings (loss) before cumulative effect of accounting change Diluted per share amounts: Earnings (loss) before cumulative effect of accounting change Goodwill-related amortization, net of income taxes Adjusted earnings (loss) before cumulative effect of accounting change Cash dividends per share Income taxes Interest expense, net of interest income Depreciation expense Amortization expense Capital expenditures Effective income tax rate Adjusted earnings (loss) as percent of sales Adjusted earnings (loss) as percent of beginning shareholders’ equity Weighted-average basic shares outstanding in thousands Weighted-average diluted shares outstanding in thousands Working capital Total assets Long-term debt, less current portion Total debt Shareholders’ equity Shareholders’ equity per diluted share Percent of debt to debt–equity Worker members Registered shareholder members 2.78 — 2.78 2.71 — 2.71 0.96 17,910 4,237 25,856 6,905 18,698 36.3% 4.4% 8.7% 1.10 — 1.10 1.08 — 1.08 0.9525 7,593 3,765 27,548 4,870 18,802 38.1% 2.1% 3.5% 3.99 — 3.99 3.90 — 3.90 0.93 25,510 4,474 28,340 3,748 22,898 36.1% 6.6% 14.2% 4.69 0.25 4.94 4.59 0.25 4.84 0.93 32,887 6,587 25,677 7,055 26,903 38.3% 8.2% 20.3% 4.17* 0.24 4.41 4.15* 0.24 4.39 0.93 27,116 10,127 24,001 6,418 27,416 36.6% 8.3% 20.5% 2.74 0.24 2.98 2.73 0.25 2.98 0.93 20,390 11,919 25,267 6,769 22,789 39.8% 5.6% 15.3% 1.90 0.12 2.02 1.90 0.11 2.01 0.93 14,946 4,519 23,715 2,927 20,862 40.5% 4.7% 10.9% 1.58 0.05 1.63 1.57 0.05 1.62 0.93 13,305 1,602 21,854 983 1.92 0.03 1.95 1.92 0.03 1.95 0.93 13,003 2,500 22,786 608 1.03 0.02 1.05 1.03 0.02 1.05 0.93 8,247 3,270 23,334 452 (0.28) 0.03 (0.25) (0.28) 0.03 (0.25) 0.93 (1,922) 3,233 26,114 500 21,152 21,163 18,988 16,515 38.6% 4.2% 9.0% 37.0% 5.4% 11.4% 40.9% 3.2% 6.3% 37.0% (0.9)% (1.4)% 11,286 11,565 11,246 11,389 11,325 11,577 11,318 11,561 11,263 11,318 11,272 11,292 11,340 11,379 11,482 11,525 11,570 11,570 11,623 11,623 11,765 11,765 At September 30, 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 $197,524 $ 151,262 654,294 615,999 88,452 95,241 385,861 33.36 89,970 125,744 360,804 31.68 19.8% 25.8% 3,287 1,529 3,273 1,576 $ 155,440 $ 123,744 $ 100,836 $ 124,392 $ 119,506 $ 124,827 $ 121,103 $ 116,364 $ 113,751 582,395 584,628 533,723 550,664 563,435 348,110 348,798 349,599 323,318 78,192 96,377 77,000 74,500 139,000 175,685 105,061 118,284 180,953 213,645 17,717 30,604 22,696 42,868 27,796 62,960 32,665 61,591 354,901 318,862 275,624 241,992 220,102 210,614 207,995 197,903 193,846 30.66 27.58 24.35 21.43 19.34 18.27 18.01 17.05 16.57 21.4% 24.8% 30.0% 42.8% 49.3% 12.7% 17.1% 24.1% 24.1% 3,337 1,592 3,709 1,652 3,302 1,742 3,791 1,866 3,994 1,907 3,246 1,994 3,211 2,029 3,071 2,179 3,439 2,256 * Earnings before cumulative effect of accounting change for 2000 include a gain from the sale of business of $25,500 before income taxes and $17,082 after income taxes, or $1.52 per basic share and $1.51 per diluted share. 54 W O O D WA R D W O O D WA R D W O O D WA R D (In thousands of dollars except per share amounts) 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 Net sales Earnings (loss) before cumulative effect of accounting change Goodwill-related amortization, net of income taxes $709,805 $ 586,682 31,382 12,346 — — $ 679,991 $ 678,791 $ 597,385 $ 596,904 $ 490,476 $ 442,216 $ 417,290 $ 379,736 $ 333,207 45,170 — 53,068 2,875 46,976 * 2,660 30,829 2,770 21,592 1,293 18,140 22,178 11,936 (3,273) 578 346 245 307 Adjusted earnings (loss) before cumulative effect of accounting change 31,382 12,346 45,170 55,943 49,636 33,599 22,885 18,718 22,524 12,181 (2,966) For the Year Ended September 30, Basic per share amounts: Earnings (loss) before cumulative effect of accounting change Goodwill-related amortization, net of income taxes Adjusted earnings (loss) before cumulative effect of accounting change Diluted per share amounts: Earnings (loss) before cumulative effect of accounting change Goodwill-related amortization, net of income taxes Adjusted earnings (loss) before cumulative effect of accounting change Interest expense, net of interest income Cash dividends per share Income taxes Depreciation expense Amortization expense Capital expenditures Effective income tax rate Adjusted earnings (loss) as percent of sales Adjusted earnings (loss) as percent of beginning shareholders’ equity Weighted-average basic shares outstanding in thousands Weighted-average diluted shares outstanding in thousands Working capital Total assets Total debt Shareholders’ equity Long-term debt, less current portion Shareholders’ equity per diluted share Percent of debt to debt–equity Worker members Registered shareholder members 2.78 — 2.78 2.71 — 2.71 0.96 17,910 4,237 25,856 6,905 18,698 36.3% 4.4% 8.7% 1.10 — 1.10 1.08 — 1.08 0.9525 7,593 3,765 27,548 4,870 18,802 38.1% 2.1% 3.5% $197,524 $ 151,262 654,294 615,999 88,452 95,241 385,861 33.36 89,970 125,744 360,804 31.68 19.8% 25.8% 3,287 1,529 3,273 1,576 3.99 — 3.99 3.90 — 3.90 0.93 25,510 4,474 28,340 3,748 22,898 36.1% 6.6% 14.2% 4.69 0.25 4.94 4.59 0.25 4.84 0.93 32,887 6,587 25,677 7,055 26,903 38.3% 8.2% 20.3% 4.17* 0.24 4.41 4.15* 0.24 4.39 0.93 27,116 10,127 24,001 6,418 27,416 36.6% 8.3% 20.5% 2.74 0.24 2.98 2.73 0.25 2.98 0.93 20,390 11,919 25,267 6,769 22,789 39.8% 5.6% 15.3% 1.90 0.12 2.02 1.90 0.11 2.01 0.93 14,946 4,519 23,715 2,927 20,862 40.5% 4.7% 10.9% 1.58 0.05 1.63 1.57 0.05 1.62 0.93 13,305 1,602 21,854 983 1.92 0.03 1.95 1.92 0.03 1.95 0.93 13,003 2,500 22,786 608 1.03 0.02 1.05 1.03 0.02 1.05 0.93 8,247 3,270 23,334 452 (0.28) 0.03 (0.25) (0.28) 0.03 (0.25) 0.93 (1,922) 3,233 26,114 500 21,152 21,163 18,988 16,515 38.6% 4.2% 9.0% 37.0% 5.4% 11.4% 40.9% 3.2% 6.3% 37.0% (0.9)% (1.4)% 11,286 11,565 11,246 11,389 11,325 11,577 11,318 11,561 11,263 11,318 11,272 11,292 11,340 11,379 11,482 11,525 11,570 11,570 11,623 11,623 11,765 11,765 At September 30, 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 $ 155,440 $ 123,744 $ 100,836 $ 124,392 $ 119,506 $ 124,827 $ 121,103 $ 116,364 $ 113,751 582,395 584,628 533,723 550,664 563,435 348,110 348,798 349,599 323,318 78,192 96,377 77,000 74,500 139,000 175,685 105,061 118,284 180,953 213,645 17,717 30,604 22,696 42,868 27,796 62,960 32,665 61,591 354,901 318,862 275,624 241,992 220,102 210,614 207,995 197,903 193,846 30.66 27.58 24.35 21.43 19.34 18.27 18.01 17.05 16.57 21.4% 24.8% 30.0% 42.8% 49.3% 12.7% 17.1% 24.1% 24.1% 3,337 1,592 3,709 1,652 3,302 1,742 3,791 1,866 3,994 1,907 3,246 1,994 3,211 2,029 3,071 2,179 3,439 2,256 * Earnings before cumulative effect of accounting change for 2000 include a gain from the sale of business of $25,500 before income taxes and $17,082 after income taxes, or $1.52 per basic share and $1.51 per diluted share. 55 2 0 0 4 A N N U A L R E P O R T OFFICER AND INVESTOR INFORMATION Officers John A. Halbrook Chairman and Chief Executive Officer Thomas A. Gendron President and Chief Operating Officer Stephen P. Carter Executive Vice President, Chief Financial Officer and Treasurer Dennis M. Benning Vice President, General Manager Fluid Systems and Controls Donald J. Bergholz Vice President, General Manager Turbine Combustion Systems Martin V. Glass Vice President, General Manager Aircraft Engine Systems Gerhard Lauffer Vice President, General Manager Electronic Controls Timothy Loyd Vice President Chad R. Preiss Vice President, General Manager Industrial Controls Gerard Willemsen Vice President, General Manager Diesel Fuel Systems and European Operations Carol J. Manning Corporate Secretary Investor Information Woodward Governor Company Corporate Headquarters 5001 North Second Street P.O. Box 7001 Rockford, IL 61125-7001 1-815-877-7441 www.woodward.com Transfer Agent and Registrar American Stock Transfer & Trust Company New York, NY 1-800-937-5449 Correspondence and transfer requests should be sent to the following: American Stock Transfer & Trust Company Shareholder Services 59 Maiden Lane New York, NY 10038 Shareholder Account Assistance Shareholders who wish to change the address or ownership of stock, report lost certificates, eliminate duplicate mailings or for other account registration procedures and assistance should contact the Transfer Agent at the address or phone number above. Dividend Reinvestment Plan and Direct Deposit of Dividends Woodward offers shareholders of record a convenient Dividend Reinvestment and Direct Stock Purchase and Sale Plan. Through this Plan, shareholders have options to purchase or sell shares of Woodward stock, have their dividends automatically reinvested in Woodward common stock, and to make periodic supplemental cash payments to purchase additional shares. For further information and an authorization form, contact the Transfer Agent at the address or phone number on this page. Annual Meeting January 26, 2005, at 10:00 a.m. NIU-Rockford 8500 E. State Street Rockford, IL 61108 Annual Report on Form 10-K Shareholders may obtain, without charge, a single copy of Woodward’s 2004 annual report on Securities and Exchange Commission Form 10-K upon written request to the Corporate Secretary, Woodward Governor Company, Rockford, Illinois. Stock Exchange Nasdaq National Market Ticker Symbol: WGOV SEC filings are available on our website at www.woodward.com An Equal Opportunity Employer It is Woodward’s policy to provide equal employment opportunity for all qualified members and applicants without regard to race, color, religion, age, sex, national origin, disability, veteran’s or marital status, and to base all employment decisions so as to further this principle of equal employment opportunity. 56 ■ We use our energy control technologies to develop and produce components that we integrate into systems. Our systems and components help our customers satisfy their needs for reliable and cost effective power equipment that meets strict air quality standards. MARKET STRATEGY T E C H N O L O G I E S : WHAT DRIVES OUR BUSINESS ■ Technologies and components are integrated into energy control systems specifically designed for power equipment, focusing on emissions, reliability, cost, and service. ■ Woodward systems and components are used in equipment that powers the world’s infrastructure. Original equipment manufacturers rely on Woodward as a single-source supplier for their critical fuel and combustion control needs. ■ By delivering integrated control solutions, Woodward is a global leader in the aerospace, process industries, transportation, and power generation markets. EMISSIONS Achieving environmental standards. Global emissions regulations demand cleaner air now and in the future, while world economic factors necessitate improved fuel economy and use of alternative fuel sources. Woodward’s systems and component solutions help our power equipment customers meet environmental standards with improved reliability and efficiency. GLOBALIZATION Conducting global business locally. Business is changing as economies around the world become more connected. Woodward knows that doing business in a customer’s language and time zone enables us to better understand and serve them. With locations in China, India, and around the world, we are positioned to serve rapidly growing markets as well as other established economies. SYSTEM SOLUTIONS Solving challenges with innovation and integration. Customers demand technical solutions that meet their needs for efficiency, reliability, and cost. Our market strategy helps us deliver integrated systems and advanced components that meet stringent aerospace and industrial requirements. With experience in fuel and combustion control systems for engines and turbines of every size and application, Woodward is ready to solve tomorrow’s challenges. FUEL SYSTEMS COMBUSTION CONTROL SYSTEMS ELECTRONIC CONTROLS AND SOFTWARE SYSTEMS INTEGRATION SERVICES C O M P O N E N T S : TURBINE VALVES AND ACTUATORS ENGINE VALVES AND ACTUATORS DIESEL FUEL INJECTION EQUIPMENT FUEL METERING UNITS ENGINE AND TURBINE ELECTRONIC CONTROLS GENSET AND SWITCHGEAR CONTROLS GAS TURBINE FUEL NOZZLES IGNITION SYSTEMS FUEL PUMPS SERVOVALVES GOVERNORS I N T E G R AT E D S Y S T E M S : TOTAL SYSTEM SOLUTIONS FOR POWER EQUIPMENT APPLICATIONS P O W E R E Q U I P M E N T: INDUSTRIAL DIESEL AND GAS ENGINES INDUSTRIAL GAS TURBINES STEAM TURBINES COMPRESSORS GENSETS AND SWITCHGEAR AIRCRAFT GAS TURBINES FUEL CELLS O U R C U S T O M E R S I N C L U D E : CATERPILLAR CUMMINS KUBOTA YANMAR MITSUBISHI MAN GE SIEMENS DRESSER-RAND INGERSOLL-RAND DAEWOO HYUNDAI ROLLS-ROYCE PRATT & WHITNEY US GOVERNMENT MAJOR AIRLINES WORLDWIDE WÄRTSILÄ DAIMLERCHRYSLER M A R K E T A P P L I C AT I O N S : POWER GENERATION TRANSPORTATION PROCESS INDUSTRIES AEROSPACE Paul Donovan Larry E. Rittenberg John D. Cohn James R. Rulseh Michael T. Yonker Michael H. Joyce Mary L. Petrovich John A. Halbrook DIRECTORS John A. Halbrook Chairman and Chief Executive Officer, Woodward Governor Company Mary L. Petrovich Chief Executive Officer, AxelTech International John D. Cohn Senior Vice President, Strategic Development and Communications, Rockwell Automation, Inc. Larry E. Rittenberg Ernst & Young Professor of Accounting & Information Systems, University of Wisconsin Paul Donovan Retired Executive Vice President and Chief Financial Officer, Wisconsin Energy Corporation Michael H. Joyce President and Chief Operating Officer, Twin Disc, Incorporated James R. Rulseh Group Vice President, Modine Manufacturing Company Michael T. Yonker Retired President and Chief Executive Officer, Portec, Inc. STRONG AND FOCUSED Our strengths lie within our people, our technologies, and our customer relationships. We apply our broad portfolio of technologies to solve complex fuel and combustion control applications. Engine and turbine original equipment manufacturers (OEMs) depend on Woodward to address their market needs for lower emissions, higher reliability, and lower costs. Today and in the future, Woodward will continue to develop and deliver systems, 30 0 35 15 25 10 40 20 5 Woodward Governor Company 5001 North Second Street, P.O. Box 7001 Rockford, Illinois 61125-7001 USA 815-877-7441 www.woodward.com components, and services to meet unique aerospace, power generation, process industries, and transportation needs. Power Generation Transportation Process Industries Aerospace (Military) Aerospace (Commercial) Market Segment Sales 32% 33% 37% 21% 2004 — FY2004 Sales $709,805 (in thousands) 2003 — FY2003 Sales $586,682 (in thousands) 2002 — FY2002 Sales $679,991 (in thousands) 13% 13% 9% 11% 10% 12% 11% 10% 26% 32% 30% Business Description Woodward designs, manufactures, and services energy control systems and components for aircraft and industrial engines and turbines. Leading OEMs throughout the world use our products and services in the power generation, Contents 1 Financial Highlights 2–5 Dear Shareholders 6–12 Strong and Focused 13–55 Financial Review process industries, transportation, and aerospace markets. 56 Officer and Investor Information IBC Board of Directors W O O D W A R D G O V E R N O R C O M P A N Y 2 0 0 4 A n n u a l R e p o r t 

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