10-Q 1 a2079158z10-q.htm FORM 10-Q
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2002
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-8408

WOODWARD GOVERNOR COMPANY

(Exact name of registrant as specified in its charter)

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

As of April 30, 2002, 11,328,146 shares of common stock with a par value of $.00875 cents per share were outstanding.

TABLE OF CONTENTS

			Page
Part I.	Item 1.	Financial Statements	1
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	14
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21
	Item 4.	Submission of Matters to a Vote of Security Holders	21
Part II.	Item 6.	Exhibits and Reports on Form 8-K	22
Signatures			23

Part I

Item 1. Financial Statements

Statements of Consolidated Earnings
Woodward Governor Company and Subsidiaries

			Three months ended March 31,
(In thousands except per share amounts)			2002			2001
			(Unaudited)
Net Sales			$	174,864		$	170,176

Costs and expenses:
	Cost of goods sold			136,294			128,585
	Sales, general, and administrative expenses			15,800			17,007
	Amortization of intangible assets			766			1,722
	Interest expense			1,330			2,336
	Interest income			(245	)		(289	)
	Other (income) expense—net			642			(26	)

		Total costs and expenses		154,587			149,335

Earnings before income taxes				20,277			20,841
Income taxes				6,654			8,169

Net earnings			$	13,623		$	12,672

Reconciliation of reported to adjusted earnings:
Reported net earnings			$	13,623		$	12,672
Goodwill-related amortization, net of income taxes				—			694

Adjusted net earnings			$	13,623		$	13,366

Basic per share amounts:
Reported net earnings			$	1.20		$	1.12
Goodwill-related amortization, net of income taxes				—			.06

Adjusted net earnings			$	1.20		$	1.18

Diluted per share amounts:
Reported net earnings			$	1.18		$	1.10
Goodwill-related amortization, net of income taxes				—			.06

Adjusted net earnings			$	1.18		$	1.16

Weighted—average number of shares outstanding:
Basic				11,324			11,316

Diluted				11,591			11,524

Cash dividends per share			$	0.2325		$	0.2325

See accompanying Notes to Consolidated Financial Statements.

Statements of Consolidated Earnings
Woodward Governor Company and Subsidiaries

			Six months ended March 31,
(In thousands except per share amounts)			2002			2001
			(Unaudited)
Net Sales			$	355,517		$	320,906

Costs and expenses:
	Cost of goods sold			277,662			241,986
	Sales, general, and administrative expenses			30,728			32,293
	Amortization of intangible assets			1,534			3,367
	Interest expense			2,709			4,515
	Interest income			(358	)		(568	)
	Other expense—net			838			530

		Total costs and expenses		313,113			282,123

Earnings before income taxes and cumulative effect of accounting change				42,404			38,783
Income taxes				15,062			15,203

Earnings before cumulative effect of accounting change				27,342			23,580
Cumulative effect of accounting change, net of income taxes				(2,489	)		—

Net earnings			$	24,853		$	23,580

Reconciliation of reported to adjusted earnings:
Reported earnings before cumulative effect of accounting change			$	27,342		$	23,580
Goodwill-related amortization, net of income taxes				—			1,375

Adjusted earnings before cumulative effect of accounting change			$	27,342		$	24,955

Reported net earnings			$	24,853		$	23,580
Goodwill-related amortization, net of income taxes				—			1,375

Adjusted net earnings			$	24,853		$	24,955

Statements of consolidated earnings continued on next page.

Statements of Consolidated Earnings—Continued
Woodward Governor Company and Subsidiaries

	Six months ended March 31,
(In thousands except per share amounts)	2002			2001
	(Unaudited)
Basic per share amounts:
Reported earnings before cumulative effect of accounting change	$	2.41		$	2.08
Goodwill-related amortization, net of income taxes		—			.12

Adjusted earnings before cumulative effect of accounting change	$	2.41		$	2.20

Reported earnings before cumulative effect of accounting change	$	2.41		$	2.08
Cumulative effect of accounting change		(.22	)		—

Reported net earnings		2.19			2.08
Goodwill-related amortization, net of income taxes		—			.12

Adjusted net earnings	$	2.19		$	2.20

Diluted per share amounts:
Reported earnings before cumulative effect of accounting change	$	2.36		$	2.05
Goodwill-related amortization, net of income taxes		—			.12

Adjusted earnings before cumulative effect of accounting change	$	2.36		$	2.17

Reported earnings before cumulative effect of accounting change	$	2.36		$	2.05
Cumulative effect of accounting change		(.21	)		—

Reported net earnings		2.15			2.05
Goodwill-related amortization, net of income taxes		—			.12

Adjusted net earnings	$	2.15		$	2.17

Weighted—average number of shares outstanding:
Basic		11,323			11,316

Diluted		11,572			11,498

Cash dividends per share	$	0.4650		$	0.4650

See accompanying Notes to Consolidated Financial Statements.

Consolidated Balance Sheets
Woodward Governor Company and Subsidiaries

(In thousands except per share amounts)				At March 31, 2002		At September 30, 2001
				(Unaudited)
Assets
	Current assets:
		Cash and cash equivalents		$	13,042	$	10,542
		Accounts receivable, less allowance for losses of $3,948 for March and $4,720 for September			88,693		102,008
		Inventories			137,680		131,160
		Deferred income taxes			17,232		17,758

			Total current assets		256,647		261,468

	Property, plant, and equipment, at cost:
		Land			7,554		7,966
		Buildings and improvements			132,285		131,761
		Machinery and equipment			235,926		242,266
		Construction in progress			3,903		4,762

					379,668		386,755
		Accumulated depreciation			252,989		256,179

	Property, plant, and equipment—net				126,679		130,576
	Goodwill				118,988		95,704
	Other intangibles—net				63,149		69,131
	Other assets				11,888		11,571
	Deferred income taxes				16,967		16,178

Total assets				$	594,318	$	584,628

Consolidated balance sheets continued on next page.

Consolidated Balance Sheets—Continued
Woodward Governor Company and Subsidiaries

(In thousands except per share amounts)				At March 31, 2002			At September 30, 2001
				(Unaudited)
Liabilities and shareholders' equity
	Current liabilities:
		Short-term borrowings		$	14,809		$	5,561
		Current portion of long-term debt			12,567			22,500
		Accounts payable and accrued expenses			79,036			91,180
		Income taxes payable			6,794			18,483

			Total current liabilities		113,206			137,724

	Long-term debt, less current portion				90,722			77,000
	Other liabilities				54,089			51,042
	Commitments and contingencies				—			—

	Shareholders' equity represented by:
		Preferred stock, par value $.003 per share, authorized 10,000 shares, no shares issued			—			—
		Common stock, par value $.00875 per share, authorized 50,000 shares, issued 12,160 shares			106			106
		Additional paid-in capital			13,487			13,440
		Unearned ESOP compensation			(3,608	)		(3,297	)
		Accumulated other comprehensive Earnings (loss)			(728	)		1,046
		Retained earnings			346,854			327,276

					356,111			338,571
		Less treasury stock, at cost			19,810			19,709

			Total shareholders' equity		336,301			318,862

Total liabilities and shareholders' equity				$	594,318		$	584,628

See accompanying Notes to Consolidated Financial Statements.

Statements of Consolidated Cash Flows
Woodward Governor Company and Subsidiaries

			Six months ended March 31,
(In thousands)			2002			2001
			(Unaudited)
Cash flows from operating activities:
Net earnings			$	24,853		$	23,580

Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization				15,659			16,628
Net loss on sale of property, plant, and equipment				238			575
Cumulative effect of accounting change, net of tax				2,489			—
Deferred income taxes				1,263			125
ESOP compensation expense				(311	)		(244	)
Changes in operating assets and liabilities, net of business acquisitions and sale:
	Accounts receivable			14,988			(1,863	)
	Inventories			(3,724	)		(9,903	)
	Current liabilities, other than short-term borrowings and current portion of long-term debt			(26,875	)		(10,465	)
	Other—net			791			(199	)

		Total adjustments		4,518			(5,346	)

Net cash provided by operating activities				29,371			18,234

Cash flows from investing activities:
Payments for purchase of property, plant, and equipment				(10,737	)		(10,535	)
Proceeds from sale of property, plant, and equipment				108			291
Payments associated with sale of business				—			(2,821	)
Business acquisitions, net of cash acquired				(25,777	)		(4,556	)

Net cash used in investing activities				(36,406	)		(17,621	)

Cash flows from financing activities:
Cash dividends paid				(5,476	)		(5,262	)
Proceeds from sales of treasury stock				232			162
Purchases of treasury stock				(286	)		—
Net proceeds (payments) from borrowings under revolving lines				(539	)		14,767
Proceeds from long-term debt				75,000			—
Payments of long-term debt				(60,038	)		(10,000	)

Net cash provided by (used in) financing activities				8,893			(333	)

Effect of exchange rate changes on cash				642			(389	)

Net change in cash and cash equivalents				2,500			(109	)
Cash and cash equivalents, beginning of year				10,542			9,315

Cash and cash equivalents, end of period			$	13,042		$	9,206

Supplemental cash flow information:
Interest expense paid			$	835		$	4,640
Income taxes paid			$	22,720		$	15,186
Noncash investing:
Liabilities assumed in business acquisition (sale)—net			$	5,167		$	(81	)

See accompanying Notes to Consolidated Financial Statements.

Notes to Consolidated Financial Statements

(1) The consolidated balance sheet as of March 31, 2002, the statements of consolidated earnings for the three and six-month periods ended March 31, 2002 and 2001, and the statements of consolidated cash flows for the six-month periods ended March 31, 2002 and 2001, were prepared by the company without audit. The September 30, 2001, consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. Information in this 10-Q report is based in part on estimates and is subject to year-end adjustments and audit. In our opinion, the figures reflect all adjustments necessary to present fairly the company's financial position as of March 31, 2002, the results of its operations for the three and six-month periods ended March 31, 2002 and 2001, and its cash flows for the six-month periods ended March 31, 2002 and 2001. All such adjustments were of a normal and recurring nature. The statements were prepared following the accounting policies described in the company's 2001 annual report on Form 10-K and should be read with the Notes to Consolidated Financial Statements on pages 26-33 of the 2001 annual report to shareholders. The statements of consolidated earnings for the three and six-month periods ended March 31, 2002, are not necessarily indicative of the results to be expected for other interim periods or for the full year.

Certain reclassifications were made to the statement of consolidated cash flows for the six months ended March 31, 2001, to conform to the current presentation.

(2) In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets." Statement No. 141 primarily impacts accounting for transactions initiated or completed after June 30, 2001. However, Statement No. 141 also contains transition provisions that may result in the reclassification of carrying values among existing goodwill and other intangibles. We were required to adopt Statement No. 142 and the transition provisions of Statement No. 141 on October 1, 2002, or on October 1, 2001, and we elected the 2001 date.

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

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

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

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

by using valuation methods based on market multiples. The impairment loss related to an Industrial Controls reporting unit.

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

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

The current amount of goodwill recognized for the acquisitions totaled $22,795,000, of which $12,497,000 is expected to be fully deductible for income tax purposes. However, we have not yet completed final allocation of the purchase price. As a result, the amounts recorded for the acquisitions are subject to adjustment, but we do not expect any adjustments to be significant. Goodwill for these acquisitions is accounted for in the Industrial Controls' segment.

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

(4) Earnings per share:

		Three months ended March 31,				Six months ended March 31,
(In thousands, except per share amounts)		2002		2001		2002		2001
Earnings before cumulative effect of accounting change (A)		$	13,623	$	12,672	$	27,342	$	23,580

Determination of shares:
	Weighted-average shares of common stock outstanding (B)		11,324		11,316		11,323		11,316
	Assumed exercise of stock options		267		208		249		182

	Weighted-average shares of common stock outstanding assuming dilution (C)		11,591		11,524		11,572		11,498

Earnings before cumulative effect of accounting change per share:
Basic (A/B)		$	1.20	$	1.12	$	2.41	$	2.08
Diluted (A/C)		$	1.18	$	1.10	$	2.36	$	2.05

The following stock options were outstanding during the three months and six months ended March 31, 2002, but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares during the respective periods: 911,752 options at a weighted-average exercise price of $70.25 for the three-month period; and 1,042,385 options at a weighted-average exercise price of $68.19 for the six-month period. All outstanding stock options during the three months and six months ended March 31, 2001, were included in the above computation.

(5) Inventories:

(In thousands of dollars)	At March 31, 2002		At September 30, 2001
Raw materials	$	2,825	$	4,638
Component parts		71,481		74,595
Work in process		28,521		33,472
Finished goods		34,853		18,455

	$	137,680	$	131,160

(6) Goodwill:

(In thousands)		At or for the six months ended March 31, 2002
Industrial Controls:
	Beginning balance	$	37,849
	Reclassification of assembled workforce		159
	Cumulative effect of accounting change		(4,015	)
	Goodwill acquisition costs		23,095
	Foreign currency exchange rate changes		(221	)

	Ending Balance		56,867

Aircraft Engine Systems:
	Beginning balance		57,855
	Reclassification of assembled workforce		4,266

	Ending balance		62,121

Consolidated:
	Beginning balance		95,704
	Reclassification of assembled workforce		4,425
	Cumulative effect of accounting change		(4,015	)
	Goodwill acquisition costs		23,095
	Foreign currency exchange rate changes		(221	)

	Ending balance	$	118,988

(7) Other intangibles—net:

(In thousands)			At March 31, 2002			At September 30, 2001
Industrial Controls:
	Customer relationships:
		Amount acquired	$	15,780		$	15,780
		Accumulated amortization		(2,017	)		(1,753	)

				13,763			14,027

	Other:
		Amount acquired		16,259			16,444
		Accumulated amortization		(1,271	)		(778	)

				14,988			15,666

	Total		$	28,751		$	29,693

Aircraft Engine Systems:
	Customer relationships:
		Amount acquired	$	28,547		$	28,547
		Accumulated amortization		(3,648	)		(3,172	)

				24,899			25,375

	Other:
		Amount acquired		11,785			16,708
		Accumulated amortization		(2,286	)		(2,645	)

				9,499			14,063

Total			$	34,398		$	39,438

Consolidated:
	Customer relationships:
		Amount acquired	$	44,327		$	44,327
		Accumulated amortization		(5,665	)		(4,925	)

				38,662			39,402

	Other:
		Amount acquired		28,044			33,152
		Accumulated amortization		(3,557	)		(3,423	)

				24,487			29,729

	Total		$	63,149		$	69,131

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

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

of $2,343,000 and the carrying value of the related long-term debt has been reduced by a similar amount.

(9) Accounts payable and other accrued expenses:

(In thousands)	At March 31, 2002		At September 30, 2001
Accounts payable	$	24,616	$	27,613
Salaries and other member benefits		19,201		31,872
Deferred compensation		9,913		7,481
Other items—net		25,306		24,214

	$	79,036	$	91,180

Included in salaries and other member benefits are termination benefits and other termination related costs of $1,661,000. In the first and second quarters of the fiscal year ending September 30, 2002, we accrued and expensed $5,312,000, of which payments totaling $3,651,000 involving 148 members have been made. Aircraft Engine Systems accounted for $3,422,000 of the total expense, which was incurred in the first quarter. These terminations were made to better align both capacity and cost structure with current business prospects and involved 141 members, predominately in manufacturing functions. Industrial Controls accounted for $1,890,000 of the total expense, of which $767,000 was incurred in the first quarter and $1,123,000 was incurred in the second quarter. These terminations were made to consolidate certain manufacturing and administrative activities into fewer locations and involved 32 members in the first quarter and 41 members in the second quarter from both manufacturing and administrative functions.

(10) Accumulated other comprehensive earnings:

(In thousands)	At or for the six months ended March 31, 2002
Accumulated foreign currency translation adjustments:
Beginning balance	$	2,420
Translation adjustments		(2,979	)
Taxes associated with translation adjustments		1,132

Ending balance		573

Accumulated unrealized derivative losses:
Beginning balance		(1,374	)
Reclassification to interest expense, net of income taxes		73

Ending balance		(1,301	)

Accumulated other comprehensive earnings	$	(728	)

(11) Total comprehensive earnings:

	Three months ended March 31,					Six months ended March 31,
(In thousands)	2002			2001		2002			2001
Net earnings	$	13,623		$	12,672	$	24,853		$	23,580
Foreign currency translation adjustments, net of tax		(265	)		968		(1,847	)		(397	)
Reclassification of unrealized losses on derivatives to earnings		41			—		73			—

Total comprehensive earnings	$	13,399		$	13,640	$	23,079		$	23,183

(12) We are currently involved in matters of litigation arising from the normal course of business, including certain environmental and product liability matters. We have accruals of approximately $2,000,000 at March 31, 2002, related to such matters. These accruals are based on our current estimate of the most likely amount of losses that we believe will be incurred. These amounts have been included in accounts payable and accrued expenses.

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

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

(13) Segment information:

		Three months ended March 31,				Six months ended March 31,
(In thousands)		2002		2001		2002		2001
Industrial Controls:
	External net sales	$	106,418	$	95,180	$	212,151	$	178,225
	Intersegment sales		407		372		565		549

	Segment earnings		12,384		13,381		25,395		25,838
	Goodwill-related amortization		—		446		—		877

	Adjusted segment earnings	$	12,384	$	13,827	$	25,395	$	26,715

Aircraft Engine Systems:
	External net sales	$	68,446	$	74,996	$	143,366	$	142,681
	Intersegment sales		1,062		1,080		1,708		1,614

	Segment earnings		15,053		14,165		29,965		26,657
	Goodwill-related amortization		—		646		—		1,293

	Adjusted segment earnings	$	15,053	$	14,811	$	29,965	$	27,950

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

	Three months ended March 31,						Six months ended March 31,
(In thousands)	2002			2001			2002			2001
Total segment earnings	$	27,437		$	27,546		$	55,360		$	52,495
Unallocated corporate expenses		(6,075	)		(4,658	)		(10,605	)		(9,765	)
Interest expense and interest income		(1,085	)		(2,047	)		(2,351	)		(3,947	)

Consolidated earnings before income taxes	$	20,277		$	20,841		$	42,404		$	38,783

Segment assets were as follows:

(In thousands)	At March 31, 2002		At September 30, 2001
Industrial Controls	$	296,612	$	283,072
Aircraft Engine Systems		234,824		241,002

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

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

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

Results of Operations

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

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

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

Industrial Controls

	Three months ended March 31,				Six months ended March 31,
In thousands	2002		2001		2002		2001
External net sales	$	106,418	$	95,180	$	212,151	$	178,225
Adjusted segment earnings		12,384		13,827		25,395		26,715

External net sales for Industrial Controls increased in both the three months and six months ended March 31, 2002, as compared to the same periods last year. Sales growth primarily reflects market share gains across most product lines, particularly distributed power generation and gas pipeline markets, and growth from acquisitions. These factors have more than offset a decrease in demand for large gas turbines, particularly aeroderivative turbines, used in power generation. Demand for these products, which have been strong over the last two years, declined in this year's second quarter as investors and companies became more cautious in the energy sectors of the economy.

The acquisition of the Bryce diesel fuel injection business of Delphi Automotive Systems in the third quarter of 2001 has had a positive impact on Industrial Controls' sales in 2002. To a lesser degree, our acquisition of the capital stock of Leonhard-Reglerbau Dr.-Ing. Adolf Leonhard GmbH in this year's second quarter positively impacted sales. Leonhard-Reglerbau specializes in the design,

manufacture, and sales of control, protection, and monitoring devices for power generation equipment. As a result of these two acquisitions, our sales increased by $6.8 million in the three-month period and $9.8 million in the six-month period ended March 31, 2002. We also acquired certain net assets of Nolff's Carburetion, Inc. toward the end of this year's second quarter. Nolff's Carburetion manufactures and sells natural gas and propane fuel systems for small industrial engines.

Industrial Controls' segment earnings, as adjusted to eliminate goodwill-related amortization from last year's reported earnings, decreased in both the three months and six months ended March 31, 2002, as compared to the same periods last year. Sales mix continues to have an important influence on changes in our margins. Decreasing demand for large gas turbine equipment has resulted in lower than expected sales of turbine products. We also sold a significant quantity of alternative fuel systems in the transportation market during the first six months this year that included components we purchased complete. Consequently, our margins on those sales were lower than our average margins. Sales on the products that we purchased complete are expected to decline beginning in the third quarter and return to levels more comparable to previous years in our fourth quarter. Also, we continued to invest in new product development at levels higher than last year. We intend to introduce nearly 70 new products this year, of which 30 have already been introduced, as compared to more than 30 in the full fiscal year 2001.

We expensed and accrued $1.9 million for the planned termination of 73 members involved in manufacturing and administrative functions in the first six months of the current year. The terminations are the result of consolidating certain manufacturing and administrative activities into fewer locations. At the end of March 2002, 9 members had been terminated and paid and we expect to complete the remaining terminations and make related payments in the third quarter of the current fiscal year.

Outlook: We currently expect Industrial Controls' sales to increase between 10% and 15% in 2002 over 2001. We also expect improved earnings performance during the next six months as compared to the first six months most recently ended.

Aircraft Engine Systems

	Three months ended March 31,				Six months ended March 31,
In thousands	2002		2001		2002		2001
External net sales	$	68,446	$	74,996	$	143,366	$	142,681
Adjusted segment earnings		15,053		14,811		29,965		27,950

External net sales for Aircraft Engine Systems decreased in the three months ended March 31, 2002, and increased slightly in the six months ended March 31, 2002, as compared to the same periods last year. We continued to experience a softening in demand for most of our civil aircraft products following the events of September 11, although product sales for military and regional jets remain strong and demand for aftermarket services was better than we originally thought.

Aircraft Engine Systems' segment earnings, as adjusted to eliminate goodwill-related amortization from last year's reported earnings, increased in both the three months and six months ended March 31, 2002, as compared to the same periods last year. The increased earnings were the result of improvements gained from productivity enhancing measures and continuous improvement initiatives, plus a favorable sales product mix. Together these factors more than offset workforce realignment costs accrued in this year's first quarter.

We expensed and accrued $3.4 million for the planned termination of 141 members involved predominantly in manufacturing activities in this year's first quarter, which represents approximately 9% of Aircraft Engine Systems' workforce. The terminations were to better align both capacity and cost

structure with current business prospects. At the end of the first six months, all but two terminations and related payments had occurred.

Outlook: We currently expect Aircraft Engine Systems sales to decrease between 10% and 15% in 2002 from 2001. We also expect segment earnings to be lower in the next six months as compared to the six months most recently ended.

Nonsegment Expenses

	Three months ended March 31,						Six months ended March 31,
In thousands	2002			2001			2002			2001
Interest expense	$	1,330		$	2,336		$	2,709		$	4,515
Interest income		(245	)		(289	)		(358	)		(568	)
Unallocated corporate expenses		6,075			4,658			10,605			9,765

Interest expense decreased in both the three months and six months ended March 31, 2002, as compared to the same periods last year because we had lower levels of average outstanding debt and lower average interest rates. However, our debt increased toward the end of our second quarter this year because of our two Industrial Controls' acquisitions. At March 31, 2002, our total debt was at 96 percent of the comparable March 31, 2001 amount.

Unallocated corporate expenses increased in the three months and six months ended March 31, 2002, as compared to the same periods last year. This increase is due largely to an expense associated with a transfer of our interest in a joint venture that has had limited activity over the last several years.

Earnings

		Three months ended March 31,				Six months ended March 31,
In thousands except per share amounts		2002		2001		2002			2001
Adjusted earnings before income taxes and cumulative effect of accounting change		$	20,277	$	21,933	$	42,404		$	40,953
Adjusted income taxes			6,654		8,567		15,062			15,998

Adjusted earnings before cumulative effect of accounting change			13,623		13,366		27,342			24,955
Cumulative effect of accounting change, net of income taxes			—		—		(2,489	)		—
Adjusted net earnings		$	13,623	$	13,366	$	24,853		$	24,955

Basic per share amounts:
	Adjusted earnings before cumulative effect of accounting change	$	1.20	$	1.18	$	2.41		$	2.20
	Adjusted net earnings	$	1.20	$	1.18	$	2.19		$	2.20

Diluted per share amounts:
	Adjusted earnings before cumulative effect of accounting change	$	1.18	$	1.16	$	2.36		$	2.17
	Adjusted net earnings	$	1.18	$	1.16	$	2.15		$	2.17

Earnings before the cumulative effect of accounting change, as adjusted to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings, increased in both the three months and six months ended March 31, 2002, as compared to the same periods last year.

Income taxes for the three months ended March 31, 2002, were impacted by a reduction in valuation allowances provided on deferred tax assets, reducing our overall effective income tax rate to 35.5% for the six months ended March 31, 2002, as compared to 39.2% for the same period last year. The reduction in valuation allowances was associated with a transfer of our interest in a joint venture. We expect the rate for the remainder of the year to be about 38%.

Net earnings, as adjusted to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings, increased slightly in the three months ended March 31, 2002, and decreased slightly for the six months ended March 31, 2002, as compared to the same periods last year. In this year's first quarter, we reported a cumulative effect of accounting change related to our October 1, 2001, adoption of Financial Accounting Standards No. 142, "Goodwill and Other Intangibles." We completed the transitional goodwill impairment reviews required by the new standards and determined that one of our Industrial Controls' reporting units had a goodwill carrying value that exceeded its estimated implied fair value. The cumulative effect of accounting change reflects the write-down of the goodwill, net of income taxes, to its implied fair value. In performing our impairment reviews, we estimated the fair value of the various reporting units using a present value method that discounted future cash flows as we expect marketplace participants would, and we further assessed the reasonableness of the estimates by using valuation methods based on market multiples.

The adjustment to eliminate goodwill-related amortization and associated income taxes from last year's reported earnings increased both earnings before the cumulative effect of accounting change and net earnings by $0.7 million, or $0.06 per share on both a basic and diluted share basis, for the three-month period and $1.4 million, or $.12 per basic and diluted share for the six-month period last year. Goodwill- related amortization includes amortization expense associated with all intangibles currently classified as goodwill.

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

Financial Condition

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

Assets

(In thousands)		At March 31, 2002		At September 30, 2001
Segment assets:
	Industrial Controls	$	296,612	$	283,072
	Aircraft Engine Systems		234,824		241,002
Nonsegment assets			62,882		60,554

Total assets		$	594,318	$	584,628

Changes in segment assets were caused primarily by reductions in accounts receivable due to the normal variability in the timing of shipments and collections.

Other Balance Sheet Measures

(In thousands)	At March 31, 2002		At September 30, 2001
Working capital	$	143,441	$	123,744
Long-term debt, less current portion		90,722		77,000
Other liabilities		54,089		51,042
Commitments and contingencies		—		—
Shareholders' equity		336,301		318,862

Increases in working capital (current assets less current liabilities) were most significantly attributable to reductions in accounts payable and accrued expenses that included the impact of making annual payments associated with variable compensation plans and defined contribution plans. The increase in long-term debt is associated with the impact of acquisitions. The increase in shareholders' equity resulted primarily from net earnings in excess of cash dividend payments.

At March 31, 2002, required future principal payments of long-term debt total $2.6 million for the year ending March 31, 2003, $3.1 million for the two years ending March 31, 2005, $21.4 million for the two years ending March 31, 2007, and $53.5 million thereafter. In addition, long-term debt at March 31, 2002, includes borrowings under a revolving line of credit facility totaling $25.0 million, and a fair value hedge accounting adjustment that reduced long-term debt by $2.3 million.

We rent certain facilities using operating leases. Commitments under these operating leases are not reflected on our balance sheet. Future minimum rental commitments under the operating leases existing at September 30, 2001, total $1.5 million for the year ending September 30, 2002, $2.5 million for the two years ending September 30, 2004, and $1.7 million for the two years ending September 30, 2006.

We currently have a revolving line of credit facility with a syndicate of U.S. banks totaling $150.0 million that expires on June 15, 2003. In addition, we have other lines of credit facilities, which totaled $43.5 million at September 30, 2001, that are generally reviewed annually for renewal.

Provisions of debt agreements include covenants customary to such agreements that require us to maintain specified minimum or maximum financial measures and place limitations on various investing and financing activities. The agreements also permit the lenders to accelerate repayment requirements in the event of a material adverse event. Our most restrictive covenants require us to maintain a minimum consolidated net worth and a maximum consolidated debt to consolidated operating cash flow, as defined in the agreements. At September 30, 2001, we had the ability to pay dividends and purchase the company's common stock up to $87.8 million.

We are currently involved in matters of litigation arising from the normal course of business, including certain environmental and product liability matters. Further discussion of these matters is in Note 12 in the notes to the consolidated financial statements.

Cash Flows

	Six months ended March 31,
(In thousands)	2002			2001
Net cash provided by operating activities	$	29,371		$	18,234
Net cash used in investing activities		(36,406	)		(17,621	)
Net cash provided by (used in) financing activities		8,893			(333	)

Net cash provided by operations increased in this year's first six months compared to the first six months last year. Earnings before the cumulative effect of accounting change, which was a non-cash change, increased in this year's six-month period over last year. The remaining difference is accounted for by changes in operating assets and liabilities in this year's six-month period relative to the same period last year.

Net cash used in investing activities included the acquisitions of the capital stock of Leonhard-Reglerbau Dr.-Ing. Adolf Leonhard GmbH and certain net assets of Nolff's Carburetion, Inc. during the second quarter of fiscal 2002.

Among the cash provided by financing activities in this year's first six months were the proceeds from new debt totaling $75 million. These new senior notes have a ten-year term, and the principal is payable in seven equal annual installments beginning in 2006. A portion of the proceeds from the new borrowings was used to pay $60 million of term notes that were due in 2002 and 2003.

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. Our first six months financing activities this year have enhanced our liquidity for several years by delaying principal payment requirements for $60 million of debt from the fiscal 2002-2003 timeframe to the fiscal 2006-2012 timeframe. However, it is possible business acquisitions could be made in the future that would require amendments to existing debt agreements and the need to obtain additional financing.

Critical Accounting Policies

We consider the accounting policies used in preparing our financial statements to be critical accounting policies when they are both important to the portrayal of our financial condition and results of operation, and require us to make difficult, subjective or complex judgments. Critical accounting policies normally result from the need to make estimates about the effect of matters that are inherently uncertain. Our most critical accounting policies are related to our accounting for goodwill and other intangible assets and for deferred tax asset valuation allowances.

We test goodwill for impairment on an annual basis and between annual tests in certain circumstances. Estimates and assumptions impact our test results, the most important of which are used to estimate the fair value of reporting units within the company. 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.

We test an amortizable intangible asset for impairment whenever its carrying value is less than its expected future cash flows. Based on events or changes in circumstances, we form judgments as to whether recoverability should be assessed, we estimate future cash flows, and we make assumptions regarding discount rates.

We establish valuation allowances to reflect the estimated amount of deferred tax assets that might not be realized. Our current valuation allowances are generally for deferred tax assets associated with capital loss carryforwards and state and foreign net operating loss carryforward limitations. We consider both positive and negative evidence in forming our judgment as to whether a valuation allowance is appropriate.

Our judgments, estimates and assumptions for goodwill, other intangible assets, and deferred tax asset valuation allowances are impacted by conditions that change over time. As a result, we could incur impairment charges or changes to our deferred tax asset valuation allowances in the future that are material to our financial condition and results of operations.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible Assets." Statement No. 141 primarily impacted accounting for transactions initiated or completed after June 30, 2001. However, Statement No. 141 also contains transition provisions that may result in the reclassification of carrying values among existing goodwill and other intangibles. We were required to adopt Statement No. 142 and the transition provisions of Statement No. 141 on October 1, 2002, or on October 1, 2001, and we elected the 2001 date. Adoption of these new accounting standards had the following effects on our consolidated financial statements:

•: We recognized an increase in goodwill and decrease in other intangibles of $4.4 million on October 1, 2001. This reclassification resulted from the transition provisions of Statement No. 141, which, among its other provisions, prohibited the recognition of an assembled workforce as an intangible asset apart from goodwill.
•: Based on goodwill existing at October 1, 2001, amortization expense will decrease by $4.9 million in 2002, which is expected to increase net earnings in 2002 by approximately $3.1 million. Upon adoption, Statement No. 142 prohibits amortization of goodwill.
•: We recognized a cumulative effect of an accounting change, which reduced first quarter 2002 net earnings by $2.5 million. This item resulted from a goodwill impairment charge, net of income taxes, for an Industrial Controls' reporting unit.
•: Disclosures are made in the consolidated financial statements that adjust certain amounts reported in prior periods to eliminate goodwill-related amortization and associated income taxes. Had the new accounting standards for goodwill and other intangibles been adopted at the beginning of 2000, net earnings would have been $2.9 million higher in 2001 and $2.6 million higher in 2000.

Goodwill-related amortization and associated income taxes for each quarter in the year ended September 30, 2001, were as follows:

	2001 Fiscal Quarters
(in thousands)	First		Second		Third		Fourth
Industrial Controls	$	431	$	446	$	444	$	570
Aircraft Engine Systems		647		646		647		647

Consolidated		1,078		1,092		1,091		1,217
Income taxes		397		398		393		415

Goodwill-related amortization, net of income taxes	$	681	$	694	$	698	$	802

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our long-term debt is sensitive to changes in interest rates. Also, assets, liabilities and commitments that are to be settled in cash and are denominated in foreign currencies are sensitive to changes in currency exchange rates. These market risks are discussed more fully in the Management Discussion and Analysis on page 21 of our 2001 annual report to shareholders, which was filed with our Form 10-K for the year ended September 30, 2001.

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

Two matters were submitted to a vote of shareholders at the January 23, 2002 Annual Meeting of Shareholders. The first matter related to the election of Class II directors. Three directors were elected. The results of the voting were as follows:

Director	Number of Shares For	Number of Shares Against/Withheld
John A. Halbrook	7,971,488	2,037,988
Rodney O'Neal	7,595,786	2,413,690
Michael T. Yonker	9,510,234	499,242

The second matter related to the approval of The Woodward Governor Company 2002 Stock Option Plan. The plan was approved. Results of the voting were 7,614,469 shares for, 1,148,677 shares against, 114,072 shares abstained, and 1,132,257 shares of broker non-votes.

Part II

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits Filed as Part of this Report.

(10): (iii) Stock Option plan

(b): Reports Filed on Form 8-K During the Second Quarter of the Fiscal Year Ending September 30, 2002. None.

SIGNATURES

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

WOODWARD GOVERNOR COMPANY

May 6, 2002		/s/John A. Halbrook John A. Halbrook, President and Chief Executive Officer
May 6, 2002		/s/Stephen P. Carter Stephen P. Carter, Vice President, Chief Financial Officer and Treasurer

QuickLinks

TABLE OF CONTENTS
Part I
Item 1. Financial Statements

Statements of Consolidated Earnings Woodward Governor Company and Subsidiaries

Consolidated Balance Sheets Woodward Governor Company and Subsidiaries

Statements of Consolidated Cash Flows Woodward Governor Company and Subsidiaries

Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Nonsegment Expenses
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Submission of Matters to a Vote of Security Holders
Part II
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES