<Page>
EXHIBIT 13
Business Description
Woodward designs, manufactures, and services energy control systems and
components for aircraft and industrial engines, turbines, and other power
equipment. Leading OEMs (original equipment manufacturers) throughout the world
use our products and services in the power generation, process industries,
transportation, and aerospace markets.
Contents
<Table>
Financial Highlights 1
To Our Shareholders 2
Board of Directors 5
Market Drivers Shape Our Strategy 6
Financial Review 17
Officers and Investor Information 47
</Table>
<Page>
Financial Highlights
<Table>
<Caption>
Fiscal year ended September 30, 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS AND OTHER YEAR-END DATA)
Operating Results
Net sales $ 679,991 $ 678,791 $ 597,385
Adjusted earnings before cumulative effect of accounting change* 45,170 55,943 49,636**
Basic per share amount* 3.99 4.94 4.41**
Diluted per share amount* 3.90 4.84 4.39**
Cash dividends per share .93 .93 .93
Year-end Financial Position
Working capital 152,312 123,744 100,836
Total assets 582,395 584,628 533,723
Long-term debt, less current portion 78,192 77,000 74,500
Shareholders' equity 354,901 318,862 275,624
Other Year-end Data
Shareholders' equity per diluted share 30.66 27.58 24.35
Worker members 3,337 3,709 3,302
Registered shareholder members 1,592 1,652 1,742
================================================================================================================
</Table>
* Adjusted earnings before cumulative effect of accounting change reflects the
elimination of goodwill-related amortization and associated income taxes from
amounts reported in the financial statements.
** In 2000, adjusted earnings includes a gain from the sale of business, net of
tax, of $17,082 or $1.52 per basic share and $1.51 per diluted share. Without
this item, adjusted earnings would have been $32,554 or $2.89 per basic share
and $2.88 per diluted share.
<Page>
To Our Shareholders
Tough years can provide an opportunity for those who have the insight and
resilience to advance with thoughtful strategies. The game of chess is an
appropriate symbol of Woodward's ability to respond to challenges and achieve
its long-term goals.
In 2002, two of our largest markets, power generation and aerospace, faced major
slowdowns and the industrial markets generally were impacted by a weakened
economy. Despite these adverse conditions, we remained committed to our
underlying strategy of making solid moves to build profitable market share. The
strength of these moves will be evident when the growth of the economy resumes.
Increasing market share
Woodward continues to increase its market share by developing new products,
acquiring complementary technologies, and building customer loyalty. We debuted
70 new products in Industrial Controls in fiscal year 2002 that expand our core
technology platforms into new applications and systems, and we intend to
maintain that development pace.
Our engineering capabilities have provided our customers with innovative,
practical, and cost-effective systems solutions and have resulted in a full
pipeline of projects for new products and applications, many of which are direct
requests from our customers. No other supplier of energy control components can
provide the complete range of technologies that Woodward offers.
We are working toward balance in three primary global markets--the United
States, Europe, and Asia. Over the past year, we increased our global
presence with an acquisition of a company in Europe that provides us with
power management control system capability. We are also initiating a presence
in China to repair and overhaul aircraft engine components.
In March, we acquired Nolff's Carburetion and formed a joint venture with
MotoTron to become a major supplier of energy control technology products to
engine manufacturers for small mobile industrial equipment. The true driver for
our success in this $300 million market is our ability to help our customers
cost effectively meet anticipated emissions standards while maintaining high
standards of system performance.
Customer satisfaction builds loyalty and is a key measurement of our success. In
June, our Rockton, Illinois, facility became the 24th out of more than 3,000
suppliers to achieve Platinumsm supplier status with American Airlines. The
Department of Defense recognized Aircraft Engine Systems with a Quality and
Delivery Performance Award. In addition, Pratt & Whitney Canada presented
Woodward with their Externals, Controls, and Nacelles Supplier of the Year
Award. Because we provide them with the cost-effective quality products they
need, delivered on time, our customers increasingly turn to Woodward as a single
source for energy control solutions.
<Page>
Strategic wins
While the sales volume in our industrial markets declined in 2002, Woodward
gained share in a number of areas.
Content we provide on large industrial gas turbines has increased over the past
few years from nothing to an array of fuel nozzles, valves, and actuators that
are placed on almost every new turbine developed, from the 5 megawatt GE-5 to
the 150 megawatt GE Frame 9. The value of our products on these large turbines
today ranges from $500,000 to over $1 million.
On smaller gas engines for power generation, we now provide the throttle body,
bypass and waste gate valves (including actuators), gas-metering valves, and
ignition systems.
In our aircraft engine markets, we executed multi-year extensions on contracts
with most of our key original equipment manufacturer customers, including GE
Aircraft Engines, and in several instances, expanded the content we provide on
each engine with manifolds and actuators. These agreements enable Woodward to
team with our customers at the planning stage of new engines and proactively
offer customized solutions for fuel-efficient, cost-effective, and reliable
engine systems.
The aftermarket, repair, and overhaul portion of our aircraft engine business
has been stronger than anticipated, as Woodward has more engine content on the
newer aircraft that remain flying even with decreased commercial activity. On
the military side, we have been included on both the F135 and F136 engines for
the Joint Strike Fighter program, and military repair, overhaul, and spare parts
sales have been strong this year.
Board and Senior Management
Woodward pursues excellence in its evolving board and management teams. Three
new members have joined the board in 2002 to build the skills and strength
required in today's business environment. John Cohn, Mary Petrovich, and James
Rulseh have outstanding experience in industrial manufacturing and exemplify the
qualities of integrity and commitment we seek in our board members.
Vern Cassens and Tom Heenan retired from the Board of Directors on September 30,
2002, and we appreciate their many years of diligent service.
In September, Tom Gendron, who has served 12 years with Woodward in both
Industrial Controls and Aircraft Engine Systems, was promoted to president and
chief operating officer. This change was part of our shift to integrate all our
technologies across the organization to ensure a more global approach to the
range of markets we serve.
Phil Turner, a key player on my management team with more than four decades of
service, will help integrate Aircraft Engine Systems into the global business
<Page>
structure and plans to retire as the process nears completion. I would like to
thank Phil for his countless contributions, including his effective management
of the aircraft engine business in the months following September 11, 2001.
Ron Fulkrod, a vice president who served in many valuable roles since 1961, will
retire at the end of calendar 2002. I want to thank him for his tireless efforts
and sincere commitment to the company.
All public companies were challenged to demonstrate their standards of corporate
governance in the wake of malfeasance by a few high-profile companies. The
Sarbanes-Oxley Act of 2002 imposed a number of regulations designed to protect
shareholders through improved governance, accountability, and disclosure.
Woodward has always fostered a culture of integrity and has conducted its
financial business in an open and understandable manner. We are easily
reaching compliance with all the new standards, many of which were already
our typical practices. It is our longstanding belief that our shareholders,
customers, and members deserve honesty and respect, along with excellent
performance.
Financial performance
Our total company sales for fiscal 2002 rose slightly to $679,991,000. Earnings
fell, however, to $45,170,000 or $3.90 per diluted share, before the cumulative
effect of accounting change, from $53,943,000, or $4.84 per share in fiscal year
2001, as adjusted to eliminate goodwill-related amortization.
Adverse external events impacted almost all businesses this year. The effects of
the attacks of September 2001 sent an already weakened commercial aircraft
industry into severe decline. We reacted swiftly by accelerating planned
cost-cutting measures early in the year and maintained strong earnings despite
the drop in sales.
Turbulence in the domestic wholesale electricity market slowed spending for new
power generation equipment, including a notable increase in project
cancellations as the year progressed. In addition, macroeconomic uncertainties
and a subdued outlook contributed to a decline in orders across all our
industrial markets.
In late fiscal year 2002, we implemented cost-cutting measures designed to
stabilize margins, while preserving an infrastructure that will allow us to
continue to serve customers well, even in tough times, and resume growth quickly
as conditions improve.
Executing the strategy
Market conditions will remain challenging through 2003. We are confident in our
ability to face those challenges head-on and succeed. We will stay focused on
building the long-term value of our business through winning an increased share
of a growing number of profitable niche markets.
<Page>
Our plans call for careful cost management and continuous improvement
initiatives that should allow fiscal year 2003 earnings to approximate those of
fiscal 2002, despite lower sales.
Industrial Controls is improving its cost base through productivity gains and
global purchasing initiatives that allow us to consolidate our supplier base.
While sales will likely be down from fiscal year 2002, we believe these
activities, as well as more favorable product mix, should help improve earnings
in 2003.
Aircraft Engine Systems achieved a number of long-term contract wins that allow
us to supply additional content on multiple engine platforms for a number of
years to come.
We believe sales for this segment in fiscal year 2003 will be below 2002 levels.
But, our proven ability to manage costs and increase productivity should
partially offset the effect of lower sales and will also be beneficial when the
aerospace markets begin to normalize and our growth resumes.
We will continue to make the right moves to ensure our success. We have a very
talented and highly motivated workforce, advanced technologies, and the
financial resources to effectively execute our strategy, capture market share,
and position ourselves well for the future.
John A. Halbrook
Chairman of the Board
and Chief Executive Officer
December 6, 2002
<Page>
Implementing customer-focused plans for strategic growth
Chess is the ultimate competition between two minds. To skillfully use the
sixteen chessmen to win the game, players must execute their moves with planning
and foresight. In business, leaders of companies must demonstrate the same
skills applied by tournament-level chess players.
As in chess, Woodward never underestimates its rivals. Our goal is to always be
several moves ahead of the competition. To do this, we rely on our thorough
understanding of the aircraft engine and industrial power equipment markets. We
develop and use strategies that are focused and aligned to meet the needs of our
customers. Moreover, we adapt our plans, when necessary, to fit the
ever-changing market environment.
Our market drivers
Our customers are faced with meeting new, stringent air quality standards to
reduce air pollution. Internationally, the Kyoto Protocol mandates that
industrialized countries reduce their emissions of greenhouse gasses, while
clean air acts adopted in North America, Europe, and Asia direct other emissions
reductions over the next five years. These air quality standards will drive the
increased use of natural gas and high-efficiency engines and turbines.
<Page>
Meanwhile, pressures have increased on engine and turbine manufacturers to lower
their cost structures. Additionally, customers are demanding continuous quality
and reliability improvements for their power equipment.
Finally, global sourcing influences how Woodward works with its original
equipment manufacturer (OEM) customers, who produce products in multiple
manufacturing facilities around the world. These customers need their supply
chain to be located near their plants to help reduce costs, achieve faster
turn-around times, and access product support locally.
Meeting market demands with systems and components
Woodward uses its sophisticated technologies to develop and produce an extensive
line of components. Often, we integrate the components into complete engine fuel
control and combustion systems.
The systems approach simplifies our customers' supply chain and system testing
activities, decreases development engineering resource requirements, and
consolidates component testing. Our customized solutions address the critical
needs of our customers--emissions, reliability, cost, and global sourcing.
The Pratt & Whitney PW600 engine family program represents the most
comprehensive aircraft engine application of Woodward's Energy Control
Technologies strategy. While maintaining system level responsibility, Woodward
teamed with Hispano-Suiza to develop and integrate the electronic engine
control. Additionally, Woodward is combining other electrical products with its
core fuel system products to provide a fully integrated engine control system.
The systems approach, demonstrated in the PW600 program, applies throughout our
business. We had great success this year with sales of our OH1 comprehensive
engine control system for on-highway vehicles powered by compressed natural gas.
Similar Woodward solutions are being designed into our customers' newest and
most advanced engines and turbines.
Emissions regulations make an engine or turbine control system more complicated
by necessity. Woodward's smart network approach enables its customers to meet
these tough standards in the simplest and most cost-effective way possible, with
the reliability and durability required in today's marketplace.
Woodward's strategies at the component level correspond with our systems
approach. The GS16 valve demonstrates our networked control strategies in
action. The valve is designed to precisely control gas fuel flow on
aeroderivative and industrial gas turbines for GE, Rolls-Royce, Pratt & Whitney,
and other OEMs.
The electrically actuated valve with integral driver electronics reduces our
customers' total installed costs by eliminating the need for separate hydraulic
or electrical driver systems. The GS16 networks easily with the turbine control
system to minimize installation and start-up costs.
<Page>
Another of our all-electric solutions for turbine control, the EML100 linear
actuator, provides accurate, closed-loop position control of steam and fuel
valves. When paired with Woodward's 3151A water valve, the unit meters water
flow into the turbine combustion chamber to reduce emissions and increase power
output.
Our low-cost ProAct(TM) ITB throttle valve is simple for OEM customers to
install and set up. It is a key element in a total controls solution for two
of the most advanced natural gas engines under development in Europe and the
United States. With only one moving part, it provides the dependability and
durability demanded in today's marketplace.
In fiscal year 2002, Woodward signed a developmental agreement with GE Aircraft
Engines (GEAE) to design, engineer, and manufacture the fuel manifold ring for
the LV100 gas turbine, which will power the U.S. Army's M2 Abrams main battle
tank. Developing and acquiring key technologies over the past five years has
been instrumental in giving Woodward the flexibility to offer a variety of
products that meet the fuel delivery system needs of our customers.
To increase our aerospace aftermarket offerings and engine content, Woodward
expanded its scope beyond those products normally provided to the OEM market.
For example, we won a competitive bid in fiscal year 2002 to provide the F100
flameholder for the U.S. Air Force.
The flameholder controls air flow through an augmentor to ensure proper
afterburner combustion. Although we do not provide the original equipment, the
manufacturing and quality requirements are well within the core competencies of
our combustion product activities. The flameholder adds to the products and
services Woodward provides to support F-15 and F-16 fighter aircraft.
Meeting market demands with exceptional performance
Growth is directly tied to customer satisfaction. We know that through
continuous improvements, we will retain our existing customers, attract new
ones, and increase market share.
By emphasizing lean manufacturing principles and practicing Six Sigma
methodologies, we have laid the foundation to consistently improve and
aggressively manage costs. Within the confines of a data-driven Six Sigma
environment, we view our business and our suppliers' businesses as a system of
processes that must first be understood then controlled.
Our metrics demonstrate positive results: dramatic on-time delivery
improvements, reduced quality defects from suppliers, significant productivity
improvements, shortened lead times, and improvements in our quality.
Woodward is committed to providing a level of quality, delivery, cost, and
responsiveness that is unsurpassed in our industries, and we are being
recognized for achieving these goals. In fiscal year 2002, Woodward achieved
<Page>
Platinumsm supplier status from American Airlines as a top performing supplier.
Only 24 of their 3,000 suppliers have achieved this status.
Additionally, this year the U.S. Government honored Woodward with a quality and
delivery performance award. Woodward supplies various products and services to
the Department of Defense and other government agencies, including the repair
and overhaul of fuel flow governors, main engine controls, and fuel injectors.
Meeting market demands through business development activities
Acquisitions, alliances, and partnerships remain vital strategies to help
Woodward meet its growth objectives. We use these strategic business development
activities to acquire key technologies and to enter new, growing markets.
After working together for a year with great success under a product sales
agreement, Woodward acquired Leonhard-Reglerbau in fiscal year 2002. It is
operating as Woodward's center for power management control systems. Now, we are
positioned to pursue a much wider cross-section of the power management controls
market. The integrated generator set controls, generator voltage regulators, and
protective relay technologies are critical to the expansion of the distributed
generation market.
In March 2002, Woodward acquired Nolff's Carburetion, Inc. and formed a joint
venture with MotoTron Corporation, a subsidiary of Brunswick Corp. These
transactions were key to accelerating Woodward's strategy to develop and provide
integrated control systems for an almost $300 million mobile industrial
equipment market. With this capability, Woodward is strongly positioned as a
major supplier to small gas and diesel engine manufacturers and packagers for
lift trucks, aerial lift platforms, aircraft cargo tractors, and other mobile
equipment.
While focusing on market drivers, Woodward concentrates on developing strong
relationships with its foundation OEM customers. This fiscal year, Woodward
signed a long-term agreement with GE Aircraft Engines, its largest aerospace
customer, for all non-combustion products we supply to them. The agreement was
expanded to include fuel metering units on the GP7200 engine, which will power
the newly developed Airbus A380. GEAE and Pratt & Whitney are jointly producing
the engine for this superjumbo jet.
A key Woodward strategy is to align its technology plans with those of its
customers. We are developing control and combustion system technologies to
support the special reliability and performance requirements of the single
engine F-35 Joint Strike Fighter (JSF) aircraft. The U.S. Navy, Air Force, and
Marines, the United Kingdom Royal Air Force and Royal Navy, and U.S. allies will
use the JSF, the next generation strike fighter.
Woodward will be the supplier of the augmentor spray bar manifold assembly, the
fuel nozzle assemblies, and the pilot burner fuel nozzle for Pratt & Whitney's
F135 engine for the JSF. Deliveries to support the engine development program
are slated for 2003. Woodward will supply Rolls-Royce Corporation with fuel
<Page>
injectors for the GE/Rolls-Royce F136 engine, the alternate engine that will
power the JSF.
Sustaining our growth
Expanding our focus from prime mover controls and governors to energy control
technologies is the key to our increased market share. As we continue to develop
closer relationships with our foundation customers earlier in the product
development cycle, we can offer better, more cost-effective networked solutions
that increase our content on engines and turbines.
Woodward will keep executing its strategies by offering systems solutions to
aircraft and industrial engine, turbine and power equipment manufacturers. We
will gain new technologies and expand into new markets through our development
activities and through acquisitions, alliances, and partnerships. Also, we will
continue to introduce upgrades and new services for our aftermarket customers.
Most importantly, we will not relent in our vision to improve customer
satisfaction levels in all aspects of our business.
Like a well-played game of chess, winning at business depends on successful
plans. Strategies must be executed with great precision. Woodward will set
itself apart from its competitors by developing and delivering integrated
systems and components that meet our customers' demands and anticipate their
future needs.
<Page>
Contents
<Table>
Management's Discussion and Analysis 18
Consolidated Financial Statements 28
Report of Independent Accountants 43
Selected Financial Data 44
Selected Quarterly Financial Data 46
Cautionary Statement 46
</Table>
Management's Responsibility for Financial Statements
Management is responsible for the accompanying financial statements and believes
that the financial statements accurately and consistently present the financial
position, results of operations, and cash flows of the company in accordance
with accounting principles generally accepted in the United States.
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 accountants, audit the
company's financial statements in accordance with generally accepted auditing
standards. Their report on these financial statements follows the notes to
consolidated financial statements.
The audit committee of the company's Board of Directors, which consists of
directors who are not officers or employees of the company, meets with
management and PricewaterhouseCoopers LLP to review and discuss the audited
financial statements, along with other matters.
John A. Halbrook
Chairman and
Chief Executive Officer
Stephen P. Carter
Vice President,
Chief Financial Officer and Treasurer
<Page>
Management's Discussion and Analysis
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 and cautionary statement.
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
to make decisions on the allocation of resources. Total segment earnings do not
reflect all expenses and gains of the company, and are before the cumulative
effect of an accounting change. Nonsegment expenses and gains, 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
<Table>
<Caption>
IN THOUSANDS FOR THE YEAR
ENDED SEPTEMBER 30, 2002 2001 2000
- ---------------------------------------------------------------------
External net sales $ 408,665 $ 384,145 $ 330,962
Adjusted segment earnings 33,294 59,601 42,983
=====================================================================
</Table>
2002 Compared to 2001 and Outlook
External net sales of Industrial Controls increased 6% in 2002 over 2001.
Businesses acquired in 2001 and 2002 accounted for about $24 million of the
increase. Without these acquisitions, our external net sales in 2002 would have
been about the same as in 2001.
- - Virtually all of our OEM customers had lower shipment volumes in 2002 as
compared to 2001. These decreases were most evident among customers shipping
large gas turbines, particularly aeroderivative turbines, which are used in
power generation. As a result, despite increases in market share across most
of our product lines, sales of our core manufactured products decreased.
- - Decreases in sales among our core manufactured products were largely offset
by a series of shipments that included lower-profit purchased components.
These shipments were completed substantially in our second and third
quarters.
- - Price changes from 2001 levels reduced sales in 2002 by approximately 1%.
Changes in foreign currency exchange rates did not have a significant impact
on sales.
In 2002, we acquired the capital stock of Leonhard-Reglerbau Dr.-Ing. Adolf
Leonhard GmbH and certain net assets of Nolff's Carburetion, Inc. These
acquisitions enhanced our capabilities using technologies that can be leveraged
to existing systems, power equipment, and market applications.
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.
<Page>
Industrial Controls' segment earnings, as adjusted to eliminate goodwill-related
amortization, decreased 44% in 2002 from 2001. This earnings decrease was the
result of reduced segment earnings margins, which more than offset the effect of
higher sales.
- - Changes in our sales mix reduced our average gross margins (which we measure
as net sales less cost of goods sold as a percent of net sales) in 2002 as
compared to 2001. Reduced sales of our core manufactured products, the series
of shipments that included lower- profit purchased components, and the lower
average margins from the businesses we acquired in 2002 and 2001 all
contributed to this decline.
- - Reductions in our workforce in 2002, resulting in total expense of $4.0
million, were made to align staffing levels with expected demand. These
reductions occurred throughout the year, but slightly more than half of them
occurred toward the end of the fourth quarter.
- - Product development activities increased in 2002 over 2001. We continued to
actively pursue opportunities to gain market share, often working in
conjunction with our customers' own development programs.
- - A charge of $3.0 million was recognized in the fourth quarter of 2002 to
reduce the carrying value of certain manufacturing equipment to its estimated
fair value. This equipment is no longer in service and is to be disposed of.
- - Amortization expense, as adjusted to eliminate goodwill-related amortization
from 2001, increased from $1.0 million to $2.2 million. This increase is
directly related to the business acquisitions that were completed in 2001 and
2002. Among the assets acquired were intangible assets other than goodwill
that are being amortized over periods ranging from five to eight years.
OUTLOOK: While it remains difficult to project the timing of economic recovery,
we believe Industrial Controls' net sales will decrease in 2003 as compared to
2002, with growing volume in the second half of the year. Despite this decrease,
we believe the actions we have taken to reduce our costs and increase
productivity, along with a more favorable sales mix, should result in improved
Industrial Controls segment earnings in 2003.
2001 Compared to 2000
External net sales of Industrial Controls increased 16% in 2001 over 2000.
Increases in sales volumes more than offset the impact of the sale of our
turbine control retrofit business and negative foreign currency translation
effects.
- - Strong demand for turbine and engine control products throughout the world,
as well as new product introductions and market share gains, accounted for
most of our volume increase. We benefited from continued strength in key
end-markets, particularly power generation. Prices averaged about 1% higher.
- - Businesses acquired in November 2000 and June 2001 accounted for
approximately $9 million of our volume increase.
- - The sale of our turbine control retrofit business four months prior to our
fiscal year-end in 2000 reduced our sales by an undetermined amount. We
believe this business had annual sales approaching $50 million.
- - The strengthening of the dollar against most foreign currencies reduced our
sales by 3%.
Several key actions in 2001 broadened the functionality and scope of our
integrated energy control systems.
- - We acquired the Bryce diesel fuel injection business of Delphi Automotive
Systems, which extended and complemented our existing products for the
important medium-speed diesel market.
- - We acquired Hoeflich Controls, Inc. and entered into a licensing agreement
with Adrenaline Research to add to our ignition systems technology for gas
engines.
- - We formed an alliance with Leonhard-Reglerbau for networked system solutions
targeting distributed power and centrally generated power applications,
ranging from a few kilowatts to 300 megawatts.
<Page>
- - We formed an alliance with Edward King AG of Switzerland, to design, develop,
supply, and service integrated fuel skids for gas turbines.
Industrial Controls' segment earnings, as adjusted to eliminate goodwill-related
amortization, increased 39% in 2001 from 2000. In 2000, expenses of
approximately $4.2 million that we associate with the decision to sell our
turbine control retrofit business reduced segment earnings. These expenses
primarily involved the relocation of certain ongoing business activities.
Without these expenses, our segment earnings would have been $47.2 million in
2000, and our increase in 2001 over 2000 would have been 26%. This earnings
increase was the result of higher sales and improved segment earnings margins.
- - Exclusive of the impact of the sale of our turbine control retrofit business,
our selling, general, and administrative expenses are relatively independent
of changes in sales volumes.
- - The sale of our turbine control retrofit business four months prior to our
fiscal year-end in 2000 impacted our segment earnings margin by an
undetermined amount. While the retrofit business generated higher gross
margins than our remaining business, it also incurred more selling, general,
and administrative expenses as a percent of sales.
Aircraft Engine Systems
<Table>
<Caption>
IN THOUSANDS FOR THE YEAR
ENDED SEPTEMBER 30, 2002 2001 2000
- ---------------------------------------------------------------------
External net sales $ 271,326 $ 294,646 $ 266,423
Adjusted segment earnings 57,226 56,172 40,662
=====================================================================
</Table>
2002 Compared to 2001 and Outlook
External net sales of Aircraft Engine Systems decreased 8% in 2002 from 2001.
The decrease in sales is attributed to the effects of reduced commercial airline
traffic since September 2001 on both OEM and aftermarket sales, although demand
for our aftermarket services has been better than we expected. Also, increased
military sales have partially offset sales declines in our commercial markets.
While most of our sales are to OEMs, we estimate that about 36% of our sales
resulted from the aftermarket in 2002 compared to 39% in 2001. The impact of
changes in selling prices and changes in foreign currency exchange rates was
insignificant.
Aircraft Engine Systems' segment earnings, as adjusted to eliminate
goodwill-related amortization, increased 2% in 2002 over 2001. This earnings
increase was the result of improved segment earnings margins.
- - Aggressive productivity enhancements and cost-control measures were initiated
in our first quarter in response to decreased sales volumes, benefiting both
cost of goods sold and selling, general, and administrative expenses.
- - Reductions in our workforce in 2002, resulting in total expense of $4.0
million, were made to align staffing levels with expected demand. These
reductions occurred predominantly in the first quarter.
- - Expenses for accounts receivable collection losses decreased in 2002. In
2001, we recognized additional expense due to increased uncertainty about
receivable collections following the September 2001 terrorist attacks. While
we are continuing to maintain allowances for losses higher than we would have
immediately preceding those events, our allowances at September 30, 2002, are
below those of September 30, 2001.
OUTLOOK: With continued weakness in commercial markets due to reduced airline
traffic, we believe Aircraft Engine Systems' net sales will remain at volumes
that are relatively consistent with the second half of 2002, resulting in a
full-year decrease in 2003 as compared to 2002. Proportionately, Aircraft Engine
Systems' segment earnings are likely to decrease slightly more than sales due to
a less favorable sales mix. However, we are continuing to pursue greater
efficiencies and productivity improvements to minimize the impact on margins.
<Page>
2001 Compared to 2000
External net sales of Aircraft Engine Systems increased 11% in 2001 over 2000.
In addition to solid orders for products used in regional and narrow-body
commercial jets, sales growth was driven by increased demand for some OEM
products, aeroderivative engine nozzles and controls for power generation
applications, military spare parts, and commercial aftermarket sales. While most
of our sales are to OEMs, we estimate that about 39% of our sales resulted from
the aftermarket in 2001 compared to 42% in 2000. The impact of changes in
selling prices and changes in foreign currency exchange rates was insignificant.
Aircraft Engine Systems' segment earnings, as adjusted to eliminate
goodwill-related amortization, increased 38% in 2001 over 2000. In 2000, segment
earnings were impacted by expenses totaling $5.1 million associated with a
workforce management program to align staffing levels with expected demand.
Without these expenses, adjusted segment earnings would have been $45.8 million
in 2000, and our increase in 2001 over 2000 would have been 23%. This earnings
increase was the result of higher sales and improved segment earnings margins.
- - Cost of goods sold was relatively high in the first half of 2000. Near the
end of the second quarter, we implemented our workforce management program to
align staffing levels with expected demand. Our cost of goods sold in 2001,
as a percent of sales, was relatively close to the comparable percent in the
last half of 2000.
- - Selling, general, and administrative activities are relatively independent of
changes in sales volumes and did not increase proportionally with sales.
- - Partially offsetting the items above, in 2001, we recognized additional
expense due to increased uncertainty about receivable collections following
the September 2001 terrorist attacks, and we had higher losses on disposals
of equipment. In 2000, we reduced certain acquisition-related accruals and
recognized insurance proceeds that settled certain matters from previous
years as a reduction in expense.
Nonsegment Expenses and Gain
<Table>
<Caption>
IN THOUSANDS FOR THE YEAR
ENDED SEPTEMBER 30, 2002 2001 2000
- ----------------------------------------------------------------------
Interest expense $ 5,109 $ 7,554 $ 10,897
Interest income (635) (967) (770)
Corporate expenses 15,366 18,753 20,689
Gain on sale of business -- -- (25,500)
======================================================================
</Table>
2002 Compared to 2001
Interest expense decreased in 2002 from 2001 primarily because average interest
rates were lower in 2002 as compared to 2001. Our average outstanding debt was
also lower.
Corporate expenses decreased in 2002 from 2001 primarily because of reductions
in variable compensation expense, due to a decline in overall financial
performance of the company.
2001 Compared to 2000
Interest expense decreased in 2001 from 2000 primarily because we had lower
levels of average outstanding debt in 2001 as compared to 2000. Average interest
rates were also lower.
Corporate expenses were 3% of consolidated net sales in both 2001 and 2000.
The gain on the sale of business in 2000 relates to a sale on May 31, 2000, of
certain assets associated with our turbine control retrofit business for cash,
with the buyer assuming certain liabilities. The resulting gain was reported
separately in the statements of consolidated earnings.
<Page>
The net sales and earnings of the turbine control retrofit business were
included as part of Industrial Controls and could not be separately identified.
However, we believe annual sales of this business were approaching $50 million
at the time of the sale.
Consolidated Earnings
<Table>
<Caption>
IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS, FOR THE YEAR
ENDED SEPTEMBER 30, 2002 2001 2000
- ---------------------------------------------------------------------------------
Adjusted earnings before
income taxes and cumulative
effect of accounting change $ 70,680 $ 90,433 $ 78,329
Adjusted income taxes 25,510 34,490 28,693
- ---------------------------------------------------------------------------------
Adjusted earnings before
cumulative effect of
accounting change 45,170 55,943 49,636
Cumulative effect of
accounting change,
net of income taxes (2,489) -- --
- ---------------------------------------------------------------------------------
Adjusted net earnings $ 42,681 $ 55,943 $ 49,636
=================================================================================
Basic earnings per share amounts:
Adjusted earnings before
cumulative effect of
accounting change $ 3.99 $ 4.94 $ 4.41
Adjusted net earnings 3.77 4.94 4.41
=================================================================================
Diluted earnings per share amounts:
Adjusted earnings before
cumulative effect of
accounting change $ 3.90 $ 4.84 $ 4.39
Adjusted net earnings 3.69 4.84 4.39
=================================================================================
</Table>
2002 Compared to 2001 and Outlook
Earnings before the cumulative effect of accounting change and net earnings, as
adjusted to eliminate goodwill-related amortization and associated income taxes,
decreased in 2002 from 2001. Income taxes were provided at an effective rate on
adjusted earnings before income taxes of 36.1% in 2002 compared to 38.1% in
2001. The most significant reason for the lower rate in 2002 was related to a
transfer of our interest in a joint venture, which allowed us to reduce
valuation allowances provided on deferred tax assets associated with a capital
loss carryback.
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 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.
OUTLOOK: We believe our sales volume will begin to recover from the relatively
low level we experienced in our fourth quarter 2002, but we expect consolidated
net sales for the full year will be lower in 2003 as compared to 2002. Benefits
from actions taken in late 2002 to reduce costs, as well as continued
productivity gains and an improved sales mix, should improve margins. As a
result, we believe that consolidated earnings in 2003 will approximate earnings
of 2002, as measured before the cumulative effect of the accounting change made
in 2002.
<Page>
2001 Compared to 2000
Earnings before the cumulative effect of accounting change and net earnings, as
adjusted to eliminate goodwill-related amortization and associated income taxes,
increased in 2001 over 2000. Income taxes were provided at an effective rate on
adjusted earnings before income taxes of 38.1% in 2001 compared to 36.6% in
2000. The most significant reason for the lower rate in 2000 was related to the
sale of our turbine control retrofit business, which allowed us to use capital
loss carryforwards for which we previously provided valuation allowances. The
spread between basic and diluted earnings per share increased in 2001 as
compared to 2000, primarily because of increases in the price for our common
stock during 2001.
Results for 2000 included a gain on sale of the turbine control retrofit
business, net of tax, of $17.1 million or $1.52 per basic share and $1.51 per
diluted share. Without this gain, adjusted net earnings would have been $32.6
million or $2.89 per basic share and $2.88 per diluted share for 2000. Our
results in 2000 also included costs to streamline operations after the sale,
costs associated with reductions in our workforce, and certain other costs not
indicative of normal operations which totaled, net of tax, $6.7 million or $0.60
per basic share and $0.59 per diluted share.
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
<Table>
<Caption>
IN THOUSANDS AT SEPTEMBER 30, 2002 2001 2000
- -----------------------------------------------------------------------
Segment assets:
Industrial Controls $ 286,302 $ 283,072 $ 214,935
Aircraft Engine Systems 219,480 241,002 260,712
Nonsegment assets 76,613 60,554 58,076
- -----------------------------------------------------------------------
Total assets $ 582,395 $ 584,628 $ 533,723
=======================================================================
</Table>
2002 Compared to 2001
Industrial Controls' segment assets at September 30, 2002, were near last year's
levels. Increases in goodwill and other intangibles, attributable to business
acquisitions, were largely offset by reductions in accounts receivable. The
reductions in accounts receivable were primarily related to changes in the level
of sales activity immediately prior to the end of the year. Industrial Controls'
sales were 11% lower in the fourth quarter 2002 than in the fourth quarter 2001.
Aircraft Engine Systems' segment assets at September 30, 2002, were 9% lower
than a year earlier. Reductions in accounts receivable and inventories, both
attributable to changes in the level of business activity, account for most of
the decrease. Aircraft Engine Systems' sales were 16% lower in the fourth
quarter 2002 than in the fourth quarter 2001.
Nonsegment assets at September 30, 2002, increased over the prior year primarily
because of higher cash balances.
2001 Compared to 2000
Industrial Controls' segment assets at September 30, 2001, were 32% higher than
a year earlier. Business acquisitions accounted for about half of the increase.
The remaining increase resulted from changes in accounts receivable,
inventories, and property, plant, and equipment associated with the level of
business activity. Industrial Controls' sales were 23% higher in the fourth
quarter 2001 than in the fourth quarter 2000 and we anticipated higher sales
volumes in following quarters. Goodwill and other intangibles decreased by the
amount of amortization for the year.
<Page>
Aircraft Engine Systems' segment assets at September 30, 2001, were 8% lower
than a year earlier. This decrease primarily resulted from negotiating
accelerated pay agreements with several of our customers and better collection
experience generally, reducing accounts receivable. Also affecting receivables,
Aircraft Engine Systems' sales were 3% lower in the fourth quarter 2001 than in
the fourth quarter 2000 and we increased our allowance for losses by $1.5
million following the terrorist attacks in September 2001. Other contributing
factors to the decrease in segment assets are that goodwill and other
intangibles decreased by the amount of amortization for the year and capital
expenditures were below depreciation levels. Increases in inventories made in
anticipation of first quarter 2002 sales partially offset these decreases.
Other Balance Sheet Measures
<Table>
<Caption>
IN THOUSANDS AT SEPTEMBER 30, 2002 2001 2000
- -------------------------------------------------------------------------
Working capital $ 152,312 $ 123,744 $ 100,836
Long-term debt, less
current portion 78,192 77,000 74,500
Other liabilities 52,928 51,042 50,142
Commitments and contingencies -- -- --
Shareholders' equity 354,901 318,862 275,624
=========================================================================
</Table>
2002 Compared to 2001
Working capital (current assets less current liabilities) at September 30, 2002,
increased over the prior year primarily as a result of financing activities that
provided $75 million of new long-term debt in 2002, none of which is current.
Principal of this new debt is payable in seven equal annual installments
beginning in 2006. As a result, our cash and cash equivalents exceeded our
current debt by $11.6 million at September 30, 2002, whereas last year our
current debt exceeded our cash and cash equivalents by $17.5 million.
At September 30, 2002, required future principal payments of long-term debt and
commitments under operating leases were as follows:
<Table>
<Caption>
IN THOUSANDS FOR THE YEAR(S) 2004/ 2006/
ENDING SEPTEMBER 30, 2003 2005 2007 Thereafter
- ------------------------------------------------------------------------------------
Long-term debt $ 2,000 $ -- $ 21,428 $ 53,572
Operating leases 3,235 4,037 2,721 2,348
====================================================================================
</Table>
We currently have a revolving line of credit facility with a syndicate of U.S.
banks totaling $150 million that expires on June 15, 2003. In addition, we have
other lines of credit facilities, which totaled $56.4 million at September 30,
2002, 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, 2002, we had
the ability to pay dividends and purchase the company's common stock up to
$109.2 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 Q in the notes to
consolidated financial statements.
Shareholders' equity increased 11%, resulting primarily from 2002 net earnings
in excess of cash dividend payments.
<Page>
2001 Compared to 2000
Increases in working capital were most significantly attributed to increases in
Industrial Controls' inventories in anticipation of higher sales volumes in
upcoming quarters and to reductions in short-term borrowings made possible by
the excess of operating cash flows over our investing cash flows. Shareholders'
equity increased 16%, resulting primarily from 2001 net earnings in excess of
cash dividend payments.
Cash Flows
<Table>
<Caption>
IN THOUSANDS FOR THE YEAR
ENDED SEPTEMBER 30, 2002 2001 2000
- -----------------------------------------------------------------------------
Net cash provided by
operating activities $ 91,394 $ 87,293 $ 55,717
Net cash provided by (used in)
investing activities (48,211) (61,699) 15,736
Net cash used in
financing activities (24,514) (23,521) (71,299)
=============================================================================
</Table>
2002 Compared to 2001 and Outlook
Net cash flows provided by operations increased by 5% in 2002 over 2001. This
improvement is predominantly due to relative changes in cash flows associated
with accounts receivable and inventories, which more than offset relative
changes in cash flows associated with income tax payments and other accruals.
While net earnings for 2002 were lower than 2001, the 2002 measure included
additional non-cash charges for the cumulative effect of an accounting change
and an equipment impairment loss, reducing the cash flow impact of the decline.
Net cash flows used for investing activities decreased by $13.5 million in 2002
as compared to 2001. This change primarily resulted from business acquisition
and divestiture activities of Industrial Controls. We made payments associated
with Industrial Controls' acquisitions and divestitures totaling $25.8 million
in 2002 compared to $35.2 million in 2001. We also reduced Aircraft Engine
Systems' capital expenditures by $2.7 million.
Net cash flows used in financing activities were approximately the same in 2002
as in 2001. As previously indicated, we received proceeds from long-term debt
totaling $75 million in 2002, which we principally used to repay debt that was
due in 2002 and 2003. Under the terms of the new senior notes, the new debt is
payable in seven equal annual installments beginning in 2006.
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 financing activities in 2002 have enhanced our liquidity for
several years by delaying principal payment requirements for $60 million of debt
from the 2002-2003 timeframe to the 2006-2012 timeframe, and by adding an
additional $15 million of debt to the extended timeframe. We also expect to
replace the current $150 million revolving line of credit facility, none of
which was outstanding at September 30, 2002, with a new facility prior to its
expiration on June 15, 2003. Despite these factors, it is possible business
acquisitions could be made in the future that would require amendments to
existing debt agreements and the need to obtain additional financing.
2001 Compared to 2000
Net cash flows provided by operations increased by 58% in 2001 over 2000. This
improvement is predominantly due to increased net earnings, exclusive of the
pretax gain from the sale of our turbine control retrofit business in 2000. For
purposes of preparing the statement of consolidated cash flows, the proceeds
from the sale of the retrofit business were not considered an operating
activity, but the associated income tax payments were.
Net cash flows for investing activities changed by $77.4 million in 2001 as
compared to 2000. This change resulted from Industrial Controls' business
acquisition and divestiture
<Page>
activities. In 2001, we made payments associated with two acquisitions totaling
$31.2 million and made payments associated with the prior year's sale of our
turbine control retrofit business of $4.0 million. In 2000, we received proceeds
from the sale of our retrofit business of $41.7 million.
Net cash flows used in financing activities decreased by $47.8 million in 2001
from 2000. This decrease is primarily associated with lower levels of debt
reductions due to two business acquisitions, despite higher levels of operating
cash flows. In 2000, we also used proceeds received from the sale of the turbine
control retrofit business to reduce debt.
Other Matters
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, other long-lived assets, deferred tax asset
valuation allowances, and retirement healthcare benefits.
We test goodwill for impairment on an annual basis and more often if
circumstances require. Estimates and assumptions, the most important of which
are used to estimate the fair value of reporting units within the company,
impact our test results. 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 other long-lived assets, including property, plant, and equipment and
other intangibles, for recoverability whenever events or changes in
circumstances indicate that the carrying values may not be recoverable. The
carrying value of a long-lived asset is reduced to its fair value whenever
estimates of future cash flows are insufficient to indicate the carrying value
is recoverable. To account for long-lived assets, we form judgments as to
whether recoverability should be assessed, we estimate future cash flows, and we
estimate fair value. Fair value estimates are most often based on estimated
future cash flows and assumed 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 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.
We recognize the cost of retirement healthcare benefits over employee service
periods using an actuarial-based attribution approach. To determine our net
periodic benefit cost and net accrued benefit, we form judgments about the best
estimate for each assumption used in the actuarial computation. The two most
important assumptions that impact the computation are the healthcare cost trend
rate and the discount rate.
Our judgments, estimates, and assumptions for goodwill, other long-lived assets,
deferred tax asset valuation allowances, and retirement healthcare benefits are
impacted by conditions that change over time. As a result, in the future we
could incur impairment charges, changes to our deferred tax asset valuation
allowances, or changes in our retirement healthcare benefit costs and accruals
that are material to our financial condition and results of operations.
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, 2002, all
long-term debt was denominated in United States dollars and consisted of fixed
rate agreements. However, to effectively offset our exposure to
<Page>
changes in the fair value of a portion of our long-term debt, we have entered
into interest rate swap agreements. Under these agreements, we are swapping
fixed rate interest payments for interest payments at rates that vary with
LIBOR. As measured at September 30, 2002, a hypothetical 1% immediate increase
in interest rates would adversely affect our 2003 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 $4.2 million. Last year,
a hypothetical 1% immediate increase in interest rates would have adversely
affected our 2002 net earnings and cash flows by approximately $0.4 million and
reduced the fair value of our long-term debt by approximately $0.5 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, 2002, balances, would adversely
affect our expected 2003 net earnings and cash flows by approximately $1.1
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 expected 2002 net earnings and cash flows by $1.9 million.
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 impacts
accounting for acquisitions 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 began applying the provisions of Statement No. 142 and the
transition provisions of Statement No. 141 on October 1, 2001. Had we not
elected early adoption of these standards at that date, we would have been
required to adopt these standards on October 1, 2002. Adoption of these new
accounting standards had the following effects on our consolidated financial
statements:
- - We recognized an increase in goodwill and a 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 decreased
by $4.9 million in 2002, which increased 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 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 $2.7 million higher
in 2000.
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which established a single accounting model to
be used to account for the impairment of long-lived assets to be disposed of by
sale and which broadened the presentation of discontinued operations to include
more disposal transactions. The standard also resolved various implementation
issues related to Statement No. 121, which it superseded. We began applying the
provisions of Statement No. 144 in 2002, and it had no impact on our financial
statements. Had we not elected early adoption, we would have been required to
adopt the standard at the beginning of 2003.
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal
<Page>
Activities." Under this new standard, a liability for a cost associated with an
exit or disposal activity is to be recognized at its fair value when the
liability is incurred. We began applying the provisions of Statement No. 146 in
2002, and it had no material impact on our financial statements. Had we not
elected early adoption, we would have been required to adopt the standard for
exit or disposal activities initiated after December 31, 2002.
<Page>
Statements of Consolidated Earnings
Woodward Governor Company and Subsidiaries
<Table>
<Caption>
Year Ended September 30,
- ----------------------------------------------------------------------------------------------------------
(In thousands except per share amounts) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------
Net sales $ 679,991 $ 678,791 $ 597,385
- -----------------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of goods sold 539,130 511,027 453,538
Selling, general, and administrative expenses 58,765 67,437 77,463
Amortization of intangible assets 3,748 7,055 6,418
Interest expense 5,109 7,554 10,897
Interest income (635) (967) (770)
Other expense--net 3,194 730 1,247
Gain on sale of business -- -- (25,500)
- -----------------------------------------------------------------------------------------------------------
Total costs and expenses, net of gain 609,311 592,836 523,293
- -----------------------------------------------------------------------------------------------------------
Earnings before income taxes and
cumulative effect of accounting change 70,680 85,955 74,092
Income taxes 25,510 32,887 27,116
- -----------------------------------------------------------------------------------------------------------
Earnings before cumulative effect of accounting change 45,170 53,068 46,976
Cumulative effect of accounting change, net of income taxes (2,489) -- --
- -----------------------------------------------------------------------------------------------------------
Net earnings $ 42,681 $ 53,068 $ 46,976
===========================================================================================================
Reconciliation of reported to adjusted earnings:
Reported earnings before cumulative effect of accounting change $ 45,170 $ 53,068 $ 46,976
Goodwill-related amortization, net of income taxes -- 2,875 2,660
- -----------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative effect of accounting change $ 45,170 $ 55,943 $ 49,636
===========================================================================================================
Reported net earnings $ 42,681 $ 53,068 $ 46,976
Goodwill-related amortization, net of income taxes -- 2,875 2,660
- -----------------------------------------------------------------------------------------------------------
Adjusted net earnings $ 42,681 $ 55,943 $ 49,636
===========================================================================================================
<Caption>
Year Ended September 30,
- -----------------------------------------------------------------------------------------------------------
(In thousands except per share amounts) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
BASIC PER SHARE AMOUNTS:
Reported earnings before cumulative effect of accounting change $ 3.99 $ 4.69 $ 4.17
</Table>
<Page>
<Table>
Goodwill-related amortization, net of income taxes -- .25 .24
- -----------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative effect of accounting change $ 3.99 $ 4.94 $ 4.41
===========================================================================================================
Reported earnings before cumulative effect of accounting change $ 3.99 $ 4.69 $ 4.17
Cumulative effect of accounting change, net of income taxes (.22) -- --
- -----------------------------------------------------------------------------------------------------------
Reported net earnings 3.77 4.69 4.17
Goodwill-related amortization, net of income taxes -- .25 .24
- -----------------------------------------------------------------------------------------------------------
Adjusted net earnings $ 3.77 $ 4.94 $ 4.41
===========================================================================================================
DILUTED PER SHARE AMOUNTS:
Reported earnings before cumulative effect of accounting change $ 3.90 $ 4.59 $ 4.15
Goodwill-related amortization, net of income taxes -- .25 .24
- -----------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative effect of accounting change $ 3.90 $ 4.84 $ 4.39
===========================================================================================================
Reported earnings before cumulative effect of accounting change $ 3.90 $ 4.59 $ 4.15
Cumulative effect of accounting change, net of income taxes (.21) -- --
- -----------------------------------------------------------------------------------------------------------
Reported net earnings 3.69 4.59 4.15
Goodwill-related amortization, net of income taxes -- .25 .24
- -----------------------------------------------------------------------------------------------------------
Adjusted net earnings $ 3.69 $ 4.84 $ 4.39
===========================================================================================================
Weighted-average number of basic shares outstanding 11,325 11,318 11,263
Weighted-average number of diluted shares outstanding 11,577 11,561 11,318
</Table>
See accompanying Notes to Consolidated Financial Statements.
<Page>
Consolidated Balance Sheets
Woodward Governor Company and Subsidiaries
<Table>
<Caption>
At September 30,
- ---------------------------------------------------------------------------------------------
(In thousands except per share amounts) 2002 2001
- ---------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 29,828 $ 10,542
Accounts receivable, less allowance for losses
of $2,717 for 2002 and $4,720 for 2001 76,406 102,008
Inventories 127,112 131,160
Deferred income taxes 15,340 17,758
- ---------------------------------------------------------------------------------------------
Total current assets 248,686 261,468
- ---------------------------------------------------------------------------------------------
Property, plant, and equipment, at cost:
Land 8,046 7,966
Buildings and improvements 136,771 131,761
Machinery and equipment 242,487 242,266
Construction in progress 3,312 4,762
- ---------------------------------------------------------------------------------------------
390,616 386,755
Less accumulated depreciation 266,994 256,179
- ---------------------------------------------------------------------------------------------
Property, plant, and equipment--net 123,622 130,576
Goodwill 115,265 95,704
Other intangibles--net 66,762 69,131
Other assets 10,175 11,571
Deferred income taxes 17,885 16,178
- ---------------------------------------------------------------------------------------------
TOTAL ASSETS $ 582,395 $ 584,628
=============================================================================================
Liabilities and shareholders' equity
Current liabilities:
Short-term borrowings $ 16,185 $ 5,561
Current portion of long-term debt 2,000 22,500
Accounts payable and accrued expenses 74,995 91,180
Income taxes payable 3,194 18,483
- ---------------------------------------------------------------------------------------------
Total current liabilities 96,374 137,724
- ---------------------------------------------------------------------------------------------
Long-term debt, less current portion 78,192 77,000
Other liabilities 52,928 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 13,542 13,440
Unearned ESOP compensation (1,418) (3,297)
</Table>
<Page>
<Table>
Accumulated other comprehensive earnings 2,823 1,046
Retained earnings 359,556 327,276
- ---------------------------------------------------------------------------------------------
374,609 338,571
Less treasury stock, at cost 19,708 19,709
- ---------------------------------------------------------------------------------------------
Total shareholders' equity 354,901 318,862
- ---------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 582,395 $ 584,628
=============================================================================================
</Table>
See accompanying Notes to Consolidated Financial Statements.
<Page>
Statements of Consolidated Shareholders' Equity
Woodward Governor Company and Subsidiaries
<Table>
<Caption>
Additional Unearned Accumulated Other
Common Paid-in ESOP Comprehensive
(In thousands except per share amounts) Stock Capital Compensation Earnings
- --------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1999 $ 106 $ 13,300 $ (7,450) $ 9,351
Net earnings -- -- -- --
Other comprehensive earnings--
Foreign currency translation adjustments -- -- -- (6,306)
- ------------------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings
Purchases of treasury stock -- -- -- --
Sales of treasury stock -- (12) -- --
Issuance of stock to ESOP -- 7 -- --
ESOP compensation expense -- -- 2,142 --
Cash dividends--$.93 per common share -- -- -- --
Tax benefit applicable to ESOP dividend and stock options -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2000 106 13,295 (5,308) 3,045
Net earnings -- -- -- --
Other comprehensive earnings:
Foreign currency translation adjustments,
net of reclassification to earnings -- -- -- (625)
Unrealized losses on derivatives -- -- -- (1,374)
- ------------------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings
Sales of treasury stock -- 145 -- --
ESOP compensation expense -- -- 2,011 --
Cash dividends--$.93 per common share -- -- -- --
Tax benefit applicable to ESOP dividend and stock options -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2001 106 13,440 (3,297) 1,046
Net earnings -- -- -- --
Other comprehensive earnings:
Foreign currency translation adjustments -- -- -- 2,823
Reclassification of unrealized losses on
derivatives to earnings -- -- -- 154
Minimum pension liability adjustment -- -- -- (1,200)
- ------------------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings
Purchases of treasury stock -- -- -- --
Sales of treasury stock -- 102 -- --
ESOP compensation expense -- -- 1,879 --
Cash dividends--$.93 per common share -- -- -- --
Cash dividend paid by subsidiary to minority shareholder -- -- -- --
Tax benefit applicable to ESOP dividend and stock options -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2002 $ 106 $ 13,542 $ (1,418) $ 2,823
==============================================================================================================================
<Caption>
Retained Total
(In thousands except per share amounts) Earnings Shares Amount Amount
- -------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1999 $ 247,420 890 $ (20,735) $ 241,992
Net earnings 46,976 -- -- 46,976
Other comprehensive earnings--
Foreign currency translation adjustments -- -- -- (6,306)
- -------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings 40,670
Purchases of treasury stock -- 64 (1,762) (1,762)
Sales of treasury stock -- (101) 2,423 2,411
Issuance of stock to ESOP -- (5) 129 136
ESOP compensation expense -- -- -- 2,142
Cash dividends--$.93 per common share (10,472) -- -- (10,472)
Tax benefit applicable to ESOP dividend and stock options 507 -- -- 507
- -------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2000 284,431 848 (19,945) 275,624
Net earnings 53,068 -- -- 53,068
Other comprehensive earnings:
Foreign currency translation adjustments,
net of reclassification to earnings -- -- -- (625)
Unrealized losses on derivatives -- -- -- (1,374)
- -------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings 51,069
Sales of treasury stock -- (10) 236 381
ESOP compensation expense -- -- -- 2,011
Cash dividends--$.93 per common share (10,526) -- -- (10,526)
Tax benefit applicable to ESOP dividend and stock options 303 -- -- 303
- -------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2001 327,276 838 (19,709) 318,862
Net earnings 42,681 -- -- 42,681
Other comprehensive earnings:
Foreign currency translation adjustments -- -- -- 2,823
Reclassification of unrealized losses on
derivatives to earnings -- -- -- 154
Minimum pension liability adjustment -- -- -- (1,200)
- -------------------------------------------------------------------------------------------------------------------
Total comprehensive earnings 44,458
Purchases of treasury stock -- 4 (286) (286)
Sales of treasury stock -- (10) 287 389
ESOP compensation expense -- -- -- 1,879
Cash dividends--$.93 per common share (10,533) -- -- (10,533)
Cash dividend paid by subsidiary to minority shareholder (198) -- -- (198)
Tax benefit applicable to ESOP dividend and stock options 330 -- -- 330
- --------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2002 $ 359,556 832 $ (19,708) $ 354,901
====================================================================================================================
</Table>
See accompanying Notes to Consolidated Financial Statements.
<Page>
Statements of Consolidated Cash Flows
Woodward Governor Company and Subsidiaries
<Table>
<Caption>
Year Ended September 30,
- ----------------------------------------------------------------------------------------------------------------------
(In thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 42,681 $ 53,068 $ 46,976
- ----------------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Cumulative effect of accounting change, net of income taxes 2,489 -- --
Depreciation and amortization 32,088 32,732 30,419
Impairment loss on equipment 3,000 -- --
Net loss on sale of property, plant, and equipment 354 1,445 411
ESOP compensation expense 1,879 2,011 2,142
Deferred income taxes 1,243 1,303 (9)
Unrealized losses on derivatives -- (1,374) --
Reclassification of unrealized losses on derivatives to earnings 154 -- --
Equity in loss of unconsolidated affiliate -- -- 271
Gain on sale of business -- -- (25,500)
Changes in operating assets and liabilities,
net of business acquisitions and sale:
Accounts receivable 29,287 3,096 (3,997)
Inventories 9,028 (25,126) (3,746)
Accounts payable and accrued expenses (20,635) 12,219 3,994
Income taxes payable (14,563) 10,271 4,305
Other--net 4,389 (2,352) 451
- ----------------------------------------------------------------------------------------------------------------------
Total adjustments 48,713 34,225 8,741
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 91,394 87,293 55,717
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchase of property, plant, and equipment (22,898) (26,903) (27,416)
Proceeds from sale of property, plant, and equipment 439 404 1,700
Proceeds from sale of business--net of direct costs -- -- 41,742
Payments associated with sale of business -- (3,985) --
Investment in unconsolidated affiliate -- -- (290)
Business acquisitions, net of cash acquired (25,752) (31,215) --
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (48,211) (61,699) 15,736
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid (10,731) (10,526) (10,472)
Proceeds from sales of treasury stock 389 381 2,411
Purchases of treasury stock (286) -- (1,762)
Net proceeds (payments) from borrowings under revolving lines (25,149) 9,124 (39,826)
Proceeds from long-term debt 75,000 -- --
Payments of long-term debt (63,737) (22,500) (21,650)
- ----------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (24,514) (23,521) (71,299)
- ----------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 617 (846) (1,288)
- ----------------------------------------------------------------------------------------------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 19,286 1,227 (1,134)
</Table>
<Page>
<Table>
Cash and cash equivalents, beginning of year 10,542 9,315 10,449
- ----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 29,828 $ 10,542 $ 9,315
======================================================================================================================
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest expense paid $ 2,982 $ 8,058 $ 11,854
Income taxes paid 38,140 19,769 22,656
NONCASH INVESTING:
Liabilities assumed in business acquisitions (sale)--net 5,040 501 (1,430)
======================================================================================================================
</Table>
See accompanying Notes to Consolidated Financial Statements.
<Page>
Notes to Consolidated Financial Statements
(In thousands of dollars except per share amounts)
A. Significant accounting policies:
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 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 earnings as a separate component of shareholders' equity and
are presented net of tax in the statements of consolidated shareholders' equity.
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.
RESEARCH AND DEVELOPMENT COSTS: Expenditures related to new product development
are charged to expense when incurred and totaled approximately $36,700 in 2002,
$30,400 in 2001, and $29,100 in 2000.
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 if undistributed
earnings of overseas subsidiaries were to be remitted to the United States,
except for those earnings that we consider to be permanently reinvested.
CASH EQUIVALENTS: Highly liquid investments purchased with an original maturity
of three months or less are considered to be cash equivalents.
INVENTORIES: Inventories are valued at the lower of cost or market, with cost
being determined on a first-in, first-out basis.
PROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment are recorded at
cost and are depreciated over the estimated useful lives of the assets, ranging
from 5 to 45 years for buildings and improvements and 3 to 15 years for
machinery and equipment. Assets placed in service after September 30, 1998, are
depreciated using the straight-line method and assets placed in service as of
and prior to September 30, 1998, are depreciated principally using accelerated
methods. Assets are tested for recoverability whenever events or circumstances
occur that indicate the carrying value is not recoverable.
GOODWILL: Goodwill represents the excess of the cost of an acquired entity over
the net amount assigned to assets acquired and liabilities assumed. Goodwill is
tested for impairment on an annual basis and more often if circumstances
require. 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
not amortized.
OTHER INTANGIBLES: Other intangibles are recognized apart from goodwill whenever
an acquired intangible 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. 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.
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 effective portion of a
<Page>
gain or loss in the value of a derivative designated as a cash flow hedge is
initially reported as a component of other comprehensive earnings and is
subsequently reclassified into earnings when the future interest payments affect
earnings. The ineffective portion of the gain or loss in the value of a
derivative designated as a cash flow hedge is reported in earnings immediately.
RECLASSIFICATIONS: Certain reclassifications were made to the 2000 and 2001
financial statements to conform to the 2002 presentation.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE: We adopted Statement No. 142, "Goodwill
and Other Intangible Assets," and the transition provisions of Statement No.
141, "Business Combinations," 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 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 resulting loss, which
was related to an Industrial Controls' reporting unit, was incurred to reduce
goodwill to its implied fair value.
Adoption of these new 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 new standards reduced amortization expense in 2002 by approximately
$4,900.
NEW ACCOUNTING STANDARDS: In August 2001, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which established a single
accounting model to be used to account for the impairment of long-lived assets
to be disposed of by sale and which broadened the presentation of discontinued
operations to include more disposal transactions. The standard also resolved
various implementation issues related to Statement No. 121, which it superseded.
We began applying the provisions of Statement No. 144 in 2002, and it had no
impact on our financial statements. Had we not elected early adoption, we would
have been required to adopt the standard at the beginning of 2003.
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities." Under this new standard, a liability for a cost
associated with an exit or disposal activity is to be recognized at its fair
value when the liability is incurred. We began applying the provisions of
Statement No. 146 in 2002, and it had no material impact on our financial
statements. Had we not elected early adoption, we would have been required to
adopt the standard for exit or disposal activities initiated after December 31,
2002.
B. Business acquisitions and sale:
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 industrial engines. Our cost for these
acquisitions totaled $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.
In November 2000, we acquired the stock of Hoeflich Controls, Inc., a
manufacturer of ignition systems, and certain related assets, and in June 2001,
we acquired certain assets and assumed certain liabilities of the Bryce diesel
fuel injection business of Delphi Automotive Systems. These acquisitions, which
cost a total of $31,844, were accounted for using the purchase method of
accounting. In 2001, acquired goodwill was amortized based on an amortization
period of 15 years. Beginning October 1, 2001, goodwill is no longer amortized.
Under terms of the Hoeflich purchase agreement, we could be required to make an
additional payment of up to $1,200 in fiscal year 2004, contingent upon
attaining certain investment and sales volumes, as defined by the agreement. If
we had completed the acquisitions on October 1, 1999, net sales and net earnings
for 2001 and 2000 would not have been materially different from amounts reported
in the statements of consolidated earnings.
<Page>
At the time of our acquisition from Delphi, one of our directors was an
executive vice president with Delphi Automotive Systems and served as president
in a sector other than the one containing diesel fuel injection businesses.
C. Impairment loss on equipment:
In 2002, we reduced the carrying value of certain Industrial Controls
manufacturing equipment to its estimated fair value. This equipment is no longer
in service and is to be disposed of. The resulting loss, which totaled $3,000,
was recognized as other expense in the statement of consolidated earnings. A
present value technique involving multiple cash flow scenarios was used to
estimate the fair value of the equipment.
D. Income taxes:
Income taxes consisted of the following:
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- ----------------------------------------------------------------
Current:
Federal $ 16,784 $ 23,884 $ 17,947
State 2,288 3,064 2,202
Foreign 5,125 6,603 5,456
Deferred 1,313 (664) 1,511
- ----------------------------------------------------------------
$ 25,510 $ 32,887 $ 27,116
================================================================
</Table>
Deferred income taxes presented in the consolidated balance sheets are related
to the following:
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001
- ----------------------------------------------------------------
Deferred tax assets:
Postretirement and
early retirement benefits $ 17,933 $ 17,853
Foreign net operating loss
and state tax credits 11,943 9,796
Inventory 7,219 6,105
Other 26,899 24,961
Valuation allowance (12,033) (10,936)
- ----------------------------------------------------------------
Total deferred tax assets,
net of valuation allowance 51,961 47,779
- ----------------------------------------------------------------
Deferred tax liabilities:
Intangibles--net (11,401) (8,084)
Other (7,335) (5,759)
- ----------------------------------------------------------------
Total deferred tax liabilities (18,736) (13,843)
- ----------------------------------------------------------------
Net deferred tax assets $ 33,225 $ 33,936
================================================================
</Table>
We have not provided for taxes on $11,595 of undistributed foreign earnings that
we consider permanently reinvested. These earnings could become subject to
income taxes if they are remitted as dividends, are loaned to the company, or if
we sell our stock in the subsidiaries. However, we believe that foreign tax
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 primarily due to foreign net operating loss
carryforward limitations. Remaining deferred tax assets are expected to be
realized through future earnings. The changes in the valuation allowance were as
follows:
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30, 2002 2001
- ------------------------------------------------------------------------------
Beginning balance $ (10,936) $ (11,168)
Foreign net operating loss carryforward (2,137) 25
State net operating loss carryforward (10) 177
Capital loss carryback utilization 1,050 30
- ------------------------------------------------------------------------------
Ending balance $ (12,033) $ (10,936)
==============================================================================
</Table>
<Page>
The reasons for the differences between our effective income tax rate and the
United States statutory federal income tax rate were as follows:
<Table>
<Caption>
PERCENT OF PRETAX EARNINGS,
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- -----------------------------------------------------------------------
Statutory rate 35.0 35.0 35.0
State income taxes, net
of federal tax benefit 2.6 2.2 2.1
Foreign loss effect 2.2 1.5 2.4
Foreign tax rate differences (1.1) 0.1 0.1
Foreign sales benefits (1.6) (1.1) (1.6)
Other items, net 0.5 0.6 0.2
Capital loss utilization (1.5) -- (1.6)
- -----------------------------------------------------------------------
Effective rate 36.1 38.3 36.6
=======================================================================
</Table>
E. Earnings per share:
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- --------------------------------------------------------------------------------
Earnings before cumulative
effect of accounting
change(A) $ 45,170 $ 53,068 $ 46,976
- --------------------------------------------------------------------------------
Determination of shares,
in thousands:
Weighted-average shares
of common stock
outstanding(B) 11,325 11,318 11,263
Assumed exercise of
stock options 252 243 55
- --------------------------------------------------------------------------------
Weighted-average shares of
common stock outstanding
assuming dilution,
in thousands(C) 11,577 11,561 11,318
- --------------------------------------------------------------------------------
Earnings before cumulative
effect of accounting change:
Basic per share amount(A/B) $ 3.99 $ 4.69 $ 4.17
Diluted per share amount(A/C) 3.90 4.59 4.15
================================================================================
</Table>
The following stock options were outstanding during 2002, 2001, and 2000 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:
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- -------------------------------------------------------------------------------
Options 12,543 4,884 203,429
Weighted-average exercise price $ 70.28 $ 69.73 $ 32.22
================================================================================
</Table>
F. Inventories:
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001
- -------------------------------------------
Raw materials $ 5,499 $ 4,638
Component parts 77,004 74,595
Work in process 27,095 33,472
Finished goods 17,514 18,455
- -------------------------------------------
$ 127,112 $ 131,160
===========================================
</Table>
<Page>
G. Goodwill:
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001
- ----------------------------------------------------------------------------
INDUSTRIAL CONTROLS:
Beginning balance $ 37,849 $ 31,008
Goodwill acquired 17,784 8,382
Reclassification of assembled workforce 159 --
Cumulative effect of accounting change (4,015) --
Foreign currency exchange rate changes 1,366 343
Amortization expense -- (1,884)
- ----------------------------------------------------------------------------
Ending balance $ 53,143 $ 37,849
============================================================================
AIRCRAFT ENGINE SYSTEMS:
Beginning balance $ 57,855 $ 60,245
Reclassification of assembled workforce 4,267 --
Amortization expense -- (2,390)
- ----------------------------------------------------------------------------
Ending balance $ 62,122 $ 57,855
============================================================================
CONSOLIDATED:
Beginning balance $ 95,704 $ 91,253
Goodwill acquired 17,784 8,382
Reclassification of assembled workforce 4,426 --
Cumulative effect of accounting change (4,015) --
Foreign currency exchange rate changes 1,366 343
Amortization expense -- (4,274)
- ----------------------------------------------------------------------------
Ending balance $ 115,265 $ 95,704
============================================================================
</Table>
Consolidated amortization expense associated with assembled workforce totaled
$204 in 2001, consisting of $7 for Industrial Controls and $197 for Aircraft
Engine Systems.
H. Other intangibles--net:
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001
- --------------------------------------------------------
INDUSTRIAL CONTROLS:
Customer relationships:
Amount acquired $ 16,780 $ 15,780
Accumulated amortization (2,379) (1,753)
- --------------------------------------------------------
14,401 14,027
- --------------------------------------------------------
Other:
Amount acquired 20,487 16,444
Accumulated amortization (1,749) (778)
- --------------------------------------------------------
18,738 15,666
- --------------------------------------------------------
Total $ 33,139 $ 29,693
========================================================
AIRCRAFT ENGINE SYSTEMS:
Customer relationships:
Amount acquired $ 28,547 $ 28,547
Accumulated amortization (4,124) (3,172)
- --------------------------------------------------------
24,423 25,375
- --------------------------------------------------------
Other:
Amount acquired 11,785 16,708
Accumulated amortization (2,585) (2,645)
- --------------------------------------------------------
9,200 14,063
- --------------------------------------------------------
Total $ 33,623 $ 39,438
========================================================
CONSOLIDATED:
Customer relationships:
Amount acquired $ 45,327 $ 44,327
</Table>
<Page>
<Table>
Accumulated amortization (6,503) (4,925)
- --------------------------------------------------------
38,824 39,402
- --------------------------------------------------------
Other:
Amount acquired 32,272 33,152
Accumulated amortization (4,334) (3,423)
- --------------------------------------------------------
27,938 29,729
- --------------------------------------------------------
Total $ 66,762 $ 69,131
========================================================
</Table>
Amortization expense associated with current intangibles is expected to be
approximately $4,100 for each year 2003-2006 and approximately $3,900 in 2007.
I. Short-term borrowings:
Short-term borrowings reflect borrowings under certain bank lines of credit. The
total amount available under these lines of credit, including outstanding
borrowings, totaled $56,432 at September 30, 2002, and $43,483 at September 30,
2001. Interest on borrowings under the lines of credit is based on various
short-term rates. Several of the lines require compensating balances or
commitment fees. The lines, generally reviewed annually for renewal, are subject
to the usual terms and conditions applied by the banks. The weighted-average
interest rate for outstanding borrowings was 4.1% at September 30, 2002, 4.8% at
September 30, 2001, and 6.5% at September 30, 2000.
J. Long-term debt:
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001
- --------------------------------------------------------------------
Senior notes--6.39% $ 75,000 $ --
ESOP debt guarantee--8.01% 2,000 4,500
Term note -- 60,000
Revolving line of credit facility -- 35,000
Fair value hedge adjustments:
Interest rate swap agreements 1,334 --
Unrecognized discontinued hedge gains 1,858 --
- --------------------------------------------------------------------
80,192 99,500
Less current portion 2,000 22,500
- --------------------------------------------------------------------
$ 78,192 $ 77,000
====================================================================
</Table>
The senior notes, which are held by multiple institutions, are uncollateralized.
In June 1992, the company's Member Investment and Stock Ownership Plan (a
qualified employee stock ownership plan) borrowed $25,000 for a term of eleven
years and used the proceeds to buy 1,027,224 shares of common stock from the
company. We guaranteed the payment of the loan and agreed to make future
contributions to the plan sufficient to repay the loan. Accordingly, the
original amount of the loan was recorded as long-term debt and unearned ESOP
compensation. The consolidated balance sheets reflect the outstanding balance of
the loan in long-term debt and the remaining unearned ESOP compensation as a
component of shareholders' equity. Unearned ESOP compensation has been reduced
using the shares allocated method for shares allocated to plan participants. The
unallocated shares were 58,276 at September 30, 2002; 135,472 at September 30,
2001; and 218,076 at September 30, 2000.
Required future principal payments of the senior notes and ESOP debt guarantee
at September 30, 2002, are $2,000 in 2003, $10,714 in 2006, $10,714 in 2007, and
$53,572 thereafter.
We have effectively offset our exposure to changes in the fair value of a
portion of the senior notes by entering into interest rate swap agreements.
Under these agreements, we are swapping interest payments related to a notional
amount of $50,000 at a fixed rate of 6.39% for rates that vary with LIBOR. The
timing of these payments corresponds directly with interest payments due under
the senior notes and we have assessed the swaps as having no hedge
ineffectiveness. As a result, the fair value of these swap agreements is shown
as an adjustment of long-term debt.
<Page>
We also discontinued certain interest rate swaps that were previously designated
as fair value hedges of long-term debt. This action resulted in a gain that will
be recognized as a reduction of interest expense over the term of the associated
hedged debt using the interest rate method of amortization. The unrecognized
portion of the gain is presented as an adjustment to long-term debt.
The revolving line of credit facility involves uncollateralized financing
arrangements with a syndicate of U.S. banks. A maximum amount of $150,000 is
available under the revolving line of credit facility, which expires June 15,
2003. Interest rates on borrowings under the line vary with LIBOR, the money
market rate, or the prime rate. Similar financing arrangements were associated
with the term note, which was repaid in 2002.
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 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 ratio, as defined in the agreements. At September 30, 2002,
we had the ability to pay dividends and purchase the company's common stock up
to $109,220.
K. Accounts payable and accrued expenses:
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001
- --------------------------------------------------------------
Accounts payable $ 22,739 $ 27,613
Salaries and other member benefits 19,846 31,872
Deferred compensation 7,701 7,481
Taxes, other than on income 4,058 4,586
Other items--net 20,651 19,628
- --------------------------------------------------------------
$ 74,995 $ 91,180
==============================================================
</Table>
Included in salaries and other member benefits are accrued termination benefits
for 36 members totaling $1,389 at September 30, 2002. Termination benefits were
provided in connection with workforce management programs to better align our
workforce with expected demand. Expenses for these termination benefits totaled
$8,045 in 2002, of which Industrial Controls incurred $4,032 for 233 members and
Aircraft Engine Systems incurred $4,013 for 202 members. Both cost of goods sold
and selling, general, and administrative expense were affected. We paid $6,656
of these expenses in 2002, and the remaining accrual is expected to be paid
predominantly in the first quarter of 2003.
Certain key management members may elect to defer the payment of a portion of
their compensation to future periods. These deferrals are recorded as deferred
compensation, and individual member balances are increased or decreased as if
they were held in specified investments, including common stock of the company.
Deferred compensation balances are payable upon the retirement or other
termination of a participating member, or as otherwise specified by plan
documents.
L. 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. The amount of
expense associated with defined contribution plans totaled $11,927 in 2002,
$11,239 in 2001, and $11,062 in 2000. Information regarding our retirement
pension benefits and retirement healthcare benefits are provided in the tables
that follow.
Among the changes in the retirement pension benefit obligation and plan assets
are increases due to a business acquisition that occurred in 2001. In the table
that follows, these increases are reflected in 2002, which is the year the
amounts were determined. Plan amendments to retirement healthcare benefits in
2002 relate to changes in cost-sharing provisions.
For retirement healthcare benefits, we assumed net healthcare cost trend rates
of 10.00% in 2003, decreasing gradually to 4.50% in 2008, and remaining at 4.50%
thereafter. A 1.00% increase in assumed healthcare cost trend rates would have
increased the total of the service and interest cost components by $1,137 and
increased the benefit obligation at the end of the year by $9,862 in 2002.
Likewise, a 1.00% decrease in the assumed rates would have decreased the total
of service and interest cost components by $863 and decreased the benefit
obligation by $8,522 in 2002.
<Page>
<Table>
<Caption>
Retirement Pension Benefits Retirement
United States Other Countries Healthcare Benefits
AT OR FOR THE YEAR ENDED SEPTEMBER 30, 2002 2001 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
Changes in benefit obligation:
Benefit obligation at beginning of year $ 14,369 $ 12,907 $ 15,424 $ 16,386 $ 49,996 $ 39,631
Service cost -- -- 1,301 698 1,208 894
Interest cost 1,035 995 1,378 370 3,443 3,019
Contribution by plan participants -- -- 172 -- 3,150 3,082
Net actuarial losses (gains) 2,117 724 2,990 (353) 17,458 9,931
Foreign currency exchange rate changes -- -- 1,323 (1,568) 117 --
Benefits paid (315) (257) (2,371) (109) (7,122) (6,561)
Plan amendments 9 -- -- -- (9,396) --
Business acquisition -- -- 14,971 -- -- --
Curtailment loss -- -- 357 -- -- --
Settlement gains -- -- -- -- (304) --
- ------------------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year 17,215 14,369 35,545 15,424 58,550 49,996
- ------------------------------------------------------------------------------------------------------------------------------
Changes in plan assets:
Fair value of plan assets at beginning of year 9,839 11,488 12,372 16,114 -- --
Actual return on plan assets (872) (1,392) (4,304) (2,721) -- --
Foreign currency exchange rate changes -- -- 1,305 (1,525) -- --
Contributions by the company 400 -- 1,339 613 3,972 3,479
Contributions by plan participants -- -- 172 -- 3,150 3,082
Benefits paid (315) (257) (2,371) (109) (6,818) (6,561)
Business acquisition -- -- 14,971 -- -- --
Settlements -- -- -- -- (304) --
- ------------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year defined 9,052 9,839 23,484 12,372 -- --
- ------------------------------------------------------------------------------------------------------------------------------
Funded status (8,163) (4,530) (12,061) (3,052) (58,550) (49,996)
Unamortized prior service cost 8 -- (92) (103) -- --
Unrecognized net losses 5,211 1,421 10,965 2,305 10,802 2,769
Unamortized transition obligation -- -- 691 798 -- --
Accumulated other comprehensive income (1,088) -- (848) -- -- --
- ------------------------------------------------------------------------------------------------------------------------------
Net accrued benefit $ (4,032) $ (3,109) $ (1,345) $ (52) $ (47,748) $ (47,227)
==============================================================================================================================
</Table>
<Page>
<Table>
<Caption>
Retirement Pension Benefits
United States Other Countries
YEAR ENDED SEPTEMBER 30, 2002 2001 2000 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------------
Components of net periodic benefit cost:
Service cost $ -- $ -- $ -- $ 1,301 $ 698 $ 781
Interest cost 1,035 995 956 1,378 370 396
Expected return on plan assets (801) (943) (893) (1,318) (363) (337)
Amortization of unrecognized transition obligation -- -- -- 85 89 100
Recognized losses (gains) 1 (23) -- -- -- 9
Recognized prior service costs -- -- -- (8) (8) (9)
Settlement or curtailment losses (gains) -- -- -- 357 -- --
- --------------------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 235 $ 29 $ 63 $ 1,795 $ 786 $ 940
================================================================================================================================
<Caption>
Retirement
Healthcare Benefits
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- -----------------------------------------------------------------------------------------
Components of net periodic benefit cost:
Service cost $ 1,208 $ 894 $ 1,051
Interest cost 3,443 3,019 2,758
Expected return on plan assets -- -- --
Amortization of unrecognized transition obligation -- -- --
Recognized losses (gains) 22 (69) (142)
Recognized prior service costs -- -- --
Settlement or curtailment losses (gains) (304) -- (964)
- -----------------------------------------------------------------------------------------
Net periodic benefit cost $ 4,369 $ 3,844 $ 2,703
=========================================================================================
</Table>
<Page>
<Table>
Increase in minimum pension liability adjustment
included in other comprehensive earnings $ 1,088 $ -- $ -- $ 848 $ -- $ --
=================================================================================================================================
Applicable weighted-average assumptions:
Discount rate 6.50% 7.25% 7.75% 4.29% 2.50% 2.50%
Rate compensation 5.00% 5.00% 5.00% 5.98% 3.50% 3.50%
Expected long-term rate of return on plan assets 8.25% 8.25% 8.25% 3.22% 2.50% 2.50%
=================================================================================================================================
<Caption>
Increase in minimum pension liability adjustment
included in other comprehensive earnings $ -- $ -- $ --
==========================================================================================
Applicable weighted-average assumptions:
Discount rate 6.75% 7.25% 7.75%
Rate compensation
Expected long-term rate of return on plan assets
===========================================================================================
</Table>
M. Stock option plan:
We have a stock option plan covering key management members and directors of the
company. Options granted under the plan generally have a term of 10 years and
vest evenly at the end of each year over four years from the date of grant.
There were 2,100,000 shares of common stock authorized for issuance under the
plan at September 30, 2002. We account for options in accordance with 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.
As required by Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation," the following table presents pro forma net
earnings and per share information that has been prepared as if compensation for
these options was recognized:
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- --------------------------------------------------------------------
Net earnings $ 41,771 $ 52,420 $ 46,850
Basic earnings per share 3.69 4.63 4.16
Diluted earnings per share 3.61 4.53 4.14
====================================================================
</Table>
The determination of compensation expense for this pro forma information was
based upon the estimated fair value of the options granted on the date of their
grant. The weighted-average estimated fair value of options granted was $16.03
in 2002, $16.05 in 2001, and $6.82 in 2000. These estimates were determined
using the Black-Scholes option pricing model and the following weighted-average
assumptions by grant year:
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- ---------------------------------------------------------
Risk-free interest rate 4.5% 5.8% 6.9%
Expected life 7 years 7 years 7 years
Expected volatility 35.0% 30.0% 26.4%
Expected dividend yield 2.8% 1.7% 3.7%
=========================================================
</Table>
Changes in outstanding stock options were as follows:
<Table>
<Caption>
Weighted-
Average
Exercise
Number Price
- ---------------------------------------------------------
Balance at September 30, 1999 641,415 $ 25.33
Options granted 145,100 24.75
Options exercised (100,990) 23.38
Options canceled (55,353) 30.46
- --------------------------------------------------------
Balance at September 30, 2000 630,172 25.06
Options granted 162,979 44.08
Options exercised (5,533) 28.68
Options canceled (6,800) 29.77
- --------------------------------------------------------
Balance at September 30, 2001 780,818 28.96
Options granted 178,500 49.42
Options exercised (9,100) 29.50
</Table>
<Page>
<Table>
Options canceled (14,000) 43.38
- --------------------------------------------------------
Balance at September 30, 2002 936,218 $ 32.64
========================================================
</Table>
Stock options outstanding at September 30, 2002, consisted of the following:
<Table>
<Caption>
Options Outstanding Options Exercisable
Weighted- Weighted- Weighted-
Exercise Average Average Average
Price Exercise Remaining Exercise
Range Number Price Life In Years Number Price
- --------------------------------------------------------------------------------------------
$ 16.625 - $ 24.750 446,600 $ 22.41 5.3 390,200 $ 22.06
$ 30.594 - $ 41.813 304,139 $ 36.63 6.5 199,889 $ 33.92
$ 49.000 - $ 73.700 185,479 $ 50.75 8.9 13,979 $ 67.28
- --------------------------------------------------------------------------------------------
936,218 $ 32.64 6.4 604,068 $ 27.08
============================================================================================
</Table>
There were 541,043 stock options exercisable at
September 30, 2001, and 501,972 at September 30, 2000.
N. Shareholder rights plan:
We have a shareholder rights plan to protect shareholders against unsolicited
attempts to acquire control of the company that do not offer what the Board of
Directors believes to be an adequate price to all shareholders. In connection
with this plan, a dividend of one preferred stock purchase right for each
outstanding share of common stock was paid to shareholders in February 1996.
Each right entitles its holder to purchase from the company 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 in whole (but not in part) at a redemption price of $.003 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.
O. Accumulated other comprehensive earnings:
Accumulated other comprehensive earnings, which totaled $2,823 at September 30,
2002, and $1,046 at September 30, 2001, consisted of the following items:
<Table>
<Caption>
AT OR FOR THE YEAR ENDED SEPTEMBER 30, 2002 2001
- ----------------------------------------------------------------------------------
Accumulated foreign currency translation adjustments:
Balance at beginning of year $ 2,420 $ 3,045
Translation adjustments 4,553 358
Reclassification adjustment for
substantial liquidation of subsidiary -- 500
Taxes associated with translation
adjustments (1,730) (1,483)
- ----------------------------------------------------------------------------------
Balance at end of year $ 5,243 $ 2,420
==================================================================================
Accumulated unrealized derivative losses:
Balance at beginning of year $ (1,374) $ --
Unrealized losses on derivatives -- (2,217)
Taxes associated with unrealized losses -- 843
Reclassification to interest expense 248 --
</Table>
<Page>
<Table>
Taxes associated with interest reclassification (94) --
- -------------------------------------------------------------------------------
Balance at end of year $ (1,220) $ (1,374)
===============================================================================
Accumulated minimum pension liability adjustments:
Balance at beginning of year $ -- $ --
Minimum pension liability adjustment (1,936) --
Taxes associated with minimum
pension liability adjustments 736 --
- -------------------------------------------------------------------------------
Balance at end of year $ (1,200) $ --
===============================================================================
</Table>
P. 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: $3,235 in 2003, $2,242 in 2004, $1,795 in 2005, $1,489 in 2006,
$1,232 in 2007, and $2,348 thereafter. Rent expense for all operating leases
totaled $4,507 in 2002, $4,430 in 2001, and $4,845 in 2000.
Q. Contingencies:
We are currently involved in matters of litigation arising from the normal
course of business, including certain environmental and product liability
matters. We have accruals of approximately $1,000 at September 30, 2002 and
2001, 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.
R. Financial instruments:
The estimated fair values of our financial instruments were as follows:
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001
- ----------------------------------------------------------------------
Cash and cash equivalents $ 29,828 $ 10,542
Interest rate swap agreements 1,334 --
Short-term borrowings (16,185) (5,561)
Long-term debt, including current portion (83,897) (99,637)
======================================================================
</Table>
The fair value 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. 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 interest rates is repriced frequently at market rates
of interest. Interest rate swap agreements are carried at their fair value,
which is estimated based on proprietary models used by financial institutions
that rely on assumptions regarding past, present, and future market conditions.
The fair value of long-term debt at fixed interest rates was estimated based on
a model that discounted future principal and interest payments at interest rates
available to the company at the end of the year for similar debt of the same
maturity.
S. Segment information:
<Page>
Our operations are organized based on the nature of products and related
services provided and consist of 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 engines.
The accounting policies of the segments are the same as those described in Note
A. Intersegment sales and transfers are made at established intersegment selling
prices generally intended to approximate selling prices to unrelated parties.
Our determination of segment earnings does not reflect gain on sale of business
and allocations of corporate expenses, and is before interest expense, interest
income, income taxes, and the cumulative effect of accounting change. Segment
assets consist of accounts receivable, inventories, property, plant, and
equipment--net, goodwill, and other intangibles--net. Summarized financial
information for our segments follows:
<Table>
<Caption>
AT OR FOR THE
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- -------------------------------------------------------------------------
INDUSTRIAL CONTROLS:
External net sales $ 408,665 $ 384,145 $ 330,962
Intersegment sales 842 808 700
Segment earnings 33,294 57,710 41,258
Goodwill-related amortization -- 1,891 1,725
- -------------------------------------------------------------------------
Adjusted segment earnings 33,294 59,601 42,983
- -------------------------------------------------------------------------
Segment assets 286,302 283,072 214,935
Depreciation and amortization 16,657 14,850 13,322
Capital expenditures 15,536 15,582 14,631
- -------------------------------------------------------------------------
AIRCRAFT ENGINE SYSTEMS:
External net sales $ 271,326 $ 294,646 $ 266,423
Intersegment sales 2,752 2,919 2,010
Segment earnings 57,226 53,585 38,150
Goodwill-related amortization -- 2,587 2,512
- -------------------------------------------------------------------------
Adjusted segment earnings 57,226 56,172 40,662
- -------------------------------------------------------------------------
Segment assets 219,480 241,002 260,712
Depreciation and amortization 13,076 15,704 15,318
Capital expenditures 7,038 9,711 10,071
=========================================================================
</Table>
The differences between the total of segment amounts and the consolidated
financial statements were as follows:
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- --------------------------------------------------------------------------
Total segment net sales
and intersegment sales $ 683,585 $ 682,518 $ 600,095
Elimination of
intersegment sales (3,594) (3,727) (2,710)
- --------------------------------------------------------------------------
Consolidated net sales $ 679,991 $ 678,791 $ 597,385
==========================================================================
Total segment earnings $ 90,520 $ 111,295 $ 79,408
Unallocated corporate expenses (15,366) (18,753) (20,689)
Gain on sale of business -- -- 25,500
Interest expense and income (4,474) (6,587) (10,127)
- --------------------------------------------------------------------------
Consolidated earnings
before income taxes and
cumulative effect of
accounting change $ 70,680 $ 85,955 $ 74,092
==========================================================================
</Table>
<Page>
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001 2000
- ---------------------------------------------------------------------------
Total segment assets $ 505,782 $ 524,074 $ 475,647
Unallocated corporate property,
plant, and equipment--net 3,385 4,505 5,072
Other unallocated assets 73,228 56,049 53,004
- ---------------------------------------------------------------------------
Consolidated total assets $ 582,395 $ 584,628 $ 533,723
===========================================================================
</Table>
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 accounted for more than 10% of consolidated net sales, impacting
both the Industrial Controls and Aircraft Engine Systems segments totaling
approximately $212,000 in 2002, $219,000 in 2001, and $147,000 in 2000.
External net sales by geographical area, as determined by the location of the
customer invoiced, were as follows:
<Table>
<Caption>
YEAR ENDED SEPTEMBER 30, 2002 2001 2000
- -----------------------------------------------------------------
United States $ 403,864 $ 429,020 $ 372,773
Other countries 276,127 249,771 224,612
- -----------------------------------------------------------------
$ 679,991 $ 678,791 $ 597,385
=================================================================
</Table>
Property, plant, and equipment--net by geographical area, as determined by the
physical location of the assets, were as follows:
<Table>
<Caption>
AT SEPTEMBER 30, 2002 2001
- ---------------------------------------------------
United States $ 97,137 $ 105,945
Other countries 26,485 24,631
- ---------------------------------------------------
$ 123,622 $ 130,576
===================================================
</Table>
<Page>
REPORT OF INDEPENDENT ACCOUNTANTS
To 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, 2002 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 2002, 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 auditing standards
generally accepted in the United States of America, which 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 A 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
Chicago, Illinois
October 31, 2002
<Page>
Selected Financial Data
(In thousands of dollars except per share amounts)
<Table>
<Caption>
FOR THE YEAR ENDED SEPTEMBER 30, 2002 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------------
Net sales $ 679,991 $ 678,791 $ 597,385 596,904
Earnings (loss) before cumulative effect of accounting change 45,170 53,068 46,976* 30,829
Goodwill-related amortization, net of income taxes -- 2,875 2,660 2,770
- -------------------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 45,170 55,943 49,636 33,599
- -------------------------------------------------------------------------------------------------------------------------
Basic per share amounts:
Earnings (loss) before cumulative effect of accounting change 3.99 4.69 4.17* 2.74
Goodwill-related amortization, net of income taxes -- 0.25 0.24 0.24
- -------------------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 3.99 4.94 4.41 2.98
- -------------------------------------------------------------------------------------------------------------------------
Diluted per share amounts:
Earnings (loss) before cumulative effect of accounting change 3.90 4.59 4.15* 2.73
Goodwill-related amortization, net of income taxes -- 0.25 0.24 0.25
- -------------------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 3.90 4.84 4.39 2.98
- -------------------------------------------------------------------------------------------------------------------------
Cash dividends per share 0.93 0.93 0.93 0.93
Depreciation expense 28,340 25,677 24,001 25,267
Amortization expense 3,748 7,055 6,418 6,769
EBITDA** 107,242 125,274 114,638* 95,174
Capital expenditures 22,898 26,903 27,416 22,789
Effective income tax rate 36.1% 38.3% 36.6% 39.8%
Adjusted earnings (loss) as percent of sales 6.6% 8.2% 8.3% 5.6%
Adjusted earnings (loss) as percent of beginning shareholders' equity 14.2% 20.3% 20.5% 15.3
Weighted-average basic shares outstanding in thousands 11,325 11,318 11,263 11,272
Weighted-average diluted shares outstanding in thousands 11,577 11,561 11,318 11,292
AT SEPTEMBER 30,
- -------------------------------------------------------------------------------------------------------------------------
Working capital $ 152,312 $ 123,744 $ 100,836 $124,392
Total assets 582,395 584,628 533,723 550,664
Long-term debt, less current portion 78,192 77,000 74,500 139,000
Total debt 96,377 105,061 118,284 180,953
Shareholders' equity 354,901 318,862 275,624 241,992
Shareholders' equity per diluted share 30.66 27.58 24.35 21.43
Percent of debt to debt-equity 21.4% 24.8% 30.0% 42.8%
Worker members 3,337 3,709 3,302 3,791
Registered shareholder members 1,592 1,652 1,742 1,866
=========================================================================================================================
</Table>
<Table>
<Caption>
FOR THE YEAR ENDED SEPTEMBER 30, 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------
Net sales $ 490,476 $ 442,216 $ 417,290
Earnings (loss) before cumulative effect of accounting change 21,592 18,140 22,178
Goodwill-related amortization, net of income taxes 1,293 578 346
- ---------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 22,885 18,718 22,524
- ---------------------------------------------------------------------------------------------------------------
Basic per share amounts:
Earnings (loss) before cumulative effect of accounting change 1.90 1.58 1.92
Goodwill-related amortization, net of income taxes 0.12 0.05 0.03
- ---------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 2.02 1.63 1.95
- ---------------------------------------------------------------------------------------------------------------
Diluted per share amounts:
Earnings (loss) before cumulative effect of accounting change 1.90 1.57 1.92
Goodwill-related amortization, net of income taxes 0.11 0.05 0.03
- ---------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 2.01 1.62 1.95
- ---------------------------------------------------------------------------------------------------------------
Cash dividends per share 0.93 0.93 0.93
Depreciation expense 23,715 21,854 22,786
Amortization expense 2,927 983 608
EBITDA** 67,699 55,884 61,075
Capital expenditures 20,862 21,152 21,163
Effective income tax rate 40.5% 38.6% 37.0%
Adjusted earnings (loss) as percent of sales 4.7% 4.2% 5.4%
Adjusted earnings (loss) as percent of beginning shareholders' equity 10.9% 9.0% 11.4%
Weighted-average basic shares outstanding in thousands 11,340 11,482 11,570
Weighted-average diluted shares outstanding in thousands 11,379 11,525 11,570
AT SEPTEMBER 30,
- ---------------------------------------------------------------------------------------------------------------
Working capital $ 119,506 $ 124,827 $ 121,103
Total assets 563,435 348,110 348,798
Long-term debt, less current portion 175,685 17,717 22,696
Total debt 213,645 30,604 42,868
Shareholders' equity 220,102 210,614 207,995
Shareholders' equity per diluted share 19.34 18.27 18.01
Percent of debt to debt-equity 49.3% 12.7% 17.1%
Worker members 3,994 3,246 3,211
Registered shareholder members 1,907 1,994 2,029
===============================================================================================================
</Table>
<Table>
<Caption>
FOR THE YEAR ENDED SEPTEMBER 30, 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------------------
Net sales $ 379,376 $ 333,207 $ 331,156 $ 374,173
Earnings (loss) before cumulative effect of accounting change 11,936 (3,273) 13,389 20,212
Goodwill-related amortization, net of income taxes 245 307 204 216
- ------------------------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 12,181 (2,966) 13,593 20,428
- ------------------------------------------------------------------------------------------------------------------------------
Basic per share amounts:
Earnings (loss) before cumulative effect of accounting change 1.03 (0.28) (0.28) 1.81
Goodwill-related amortization, net of income taxes 0.02 0.03 0.03 0.02
- ------------------------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 1.05 (0.25) (0.25) 1.83
- ------------------------------------------------------------------------------------------------------------------------------
Diluted per share amounts:
Earnings (loss) before cumulative effect of accounting change 1.03 (0.28) 1.13 1.81
Goodwill-related amortization, net of income taxes 0.02 0.03 0.01 0.02
- ------------------------------------------------------------------------------------------------------------------------------
Adjusted earnings (loss) before cumulative effect of accounting change 1.05 (0.25) 1.14 1.83
- ------------------------------------------------------------------------------------------------------------------------------
Cash dividends per share 0.93 0.93 0.93 0.92
Depreciation expense 23,334 26,114 24,837 22,241
Amortization expense 452 500 419 392
EBITDA** 47,239 24,652 50,314 57,652
Capital expenditures 18,988 16,515 18,335 52,684
Effective income tax rate 40.9% 37.0% 42.0% 38.7%
Adjusted earnings (loss) as percent of sales 3.2% (0.9)% 4.1% 5.5%
Adjusted earnings (loss) as percent of beginning shareholders' equity 6.3% (1.4)% 6.2% 9.8%
Weighted-average basic shares outstanding in thousands 11,623 11,765 11,889 11,179
Weighted-average diluted shares outstanding in thousands 11,623 11,765 11,889 11,179
AT SEPTEMBER 30,
- -------------------------------------------------------------------------------------------------------------------------------
Working capital $ 116,364 $ 113,751 $ 107,809 $ 103,818
Total assets 349,599 323,318 332,461 331,653
Long-term debt, less current portion 27,796 32,665 36,246 40,135
Total debt 62,960 61,591 58,258 64,375
Shareholders' equity 197,903 193,846 206,222 219,690
Shareholders' equity per diluted share 17.05 16.57 17.36 18.48
Percent of debt to debt-equity 24.1% 24.1% 22.0% 22.7%
Worker members 3,071 3,439 3,264 3,632
Registered shareholder members 2,179 2,256 2,301 2,301
===============================================================================================================================
</Table>
* Earnings before cumulative effect of accounting change and EBITDA 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.
** EBITDA represents earnings before interest (expense and income), income
taxes, depreciation, and amortization, and before cumulative effect of
accounting change. Although EBITDA is a common financial measure, it is not a
measure that is reported in financial statements prepared in accordance with
accounting principles generally accepted in the United States.
<Page>
Selected Quarterly Financial Data
(Unaudited)
<Table>
<Caption>
2002 FISCAL QUARTERS
(In thousands except per share data) FIRST SECOND THIRD FOURTH
- -------------------------------------------------------------------------------------------------------
Net sales $ 180,653 $ 174,864 $ 171,888 $ 152,586
Gross profit* 39,285 38,570 38,246 24,760
Reported earnings before cumulative
effect of accounting change 13,719 13,623 14,611 3,217
Goodwill-related amortization,
net of income taxes -- -- -- --
- -------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative
effect of accounting change $ 13,719 $ 13,623 $ 14,611 $ 3,217
=======================================================================================================
BASIC PER SHARE AMOUNTS:
Reported earnings before cumulative
effect of accounting change $ 1.21 $ 1.20 $ 1.29 $ 0.28
Goodwill-related amortization,
net of income taxes -- -- -- --
- -------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative
effect of accounting change $ 1.21 $ 1.20 $ 1.29 $ 0.28
=======================================================================================================
DILUTED PER SHARE AMOUNTS:
Reported earnings before cumulative
effect of accounting change $ 1.19 $ 1.18 $ 1.26 $ 0.28
Goodwill-related amortization,
net of income taxes -- -- -- --
- -------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative
effect of accounting change $ 1.19 $ 1.18 $ 1.26 $ 0.28
=======================================================================================================
Cash dividends per share $ 0.2325 $ 0.2325 $ 0.2325 $ 0.2325
Common stock price per share
High 60.10 72.77 74.65 60.22
Low 46.50 53.50 54.40 44.85
Close 58.25 68.80 59.12 47.40
=======================================================================================================
<Caption>
2001 FISCAL QUARTERS
FIRST SECOND THIRD FOURTH
- -------------------------------------------------------------------------------------------------------
Net sales $ 150,730 $ 170,176 $ 182,508 $ 175,377
Gross profit* 37,329 41,591 44,806 44,038
Reported earnings before cumulative
effect of accounting change 10,908 12,672 13,728 15,760
Goodwill-related amortization,
net of income taxes 681 694 698 802
- -------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative
effect of accounting change $ 11,589 $ 13,366 $ 14,426 $ 16,562
=======================================================================================================
BASIC PER SHARE AMOUNTS:
Reported earnings before cumulative
effect of accounting change $ 0.96 $ 1.12 $ 1.21 $ 1.39
Goodwill-related amortization,
net of income taxes 0.06 0.06 0.06 0.07
- -------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative
effect of accounting change $ 1.02 $ 1.18 $ 1.27 $ 1.46
=======================================================================================================
DILUTED PER SHARE AMOUNTS:
Reported earnings before cumulative
effect of accounting change $ 0.95 $ 1.10 $ 1.18 $ 1.36
Goodwill-related amortization,
net of income taxes 0.06 0.06 0.06 0.07
- -------------------------------------------------------------------------------------------------------
Adjusted earnings before cumulative
effect of accounting change $ 1.01 $ 1.16 $ 1.24 $ 1.43
=======================================================================================================
Cash dividends per share $ 0.2325 $ 0.2325 $ 0.2325 $ 0.2325
Common stock price per share
High 49.00 57.73 91.00 86.85
Low 35.75 40.00 49.00 42.06
Close 44.75 51.38 84.35 48.45
=======================================================================================================
</Table>
* Gross profit represents net sales less cost of goods sold as reported in our
statements of consolidated earnings.
Cautionary Statement
This annual report contains forward-looking statements, including financial
projections, our plans and objectives for future operations, expectations of
future economic performance, and various other assumptions relating to the
future. While such statements reflect our current expectations, all such
statements 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. Important
factors that could cause results to differ materially from those projected or
otherwise stated include the following: unanticipated global or regional
economic developments, particularly in, but not limited to, Asia, Europe, and
the United States; political risks, military actions, or trade embargoes
affecting customers' markets, including the possibility of a war in Iraq;
other changes in business cycles of particular industries served by our
company, primarily OEMs of aircraft engines, both commercial and military,
and industrial engines, turbines, and other power equipment, particularly in
power generation, transportation, and process industries markets;
fluctuations in currency exchange rates of U.S. and foreign countries,
primarily those located in Europe and Asia; fluctuations in interest rates,
primarily LIBOR, which affect the cost of borrowings; timing and acceptance
of new products and product enhancements, including, but not limited to,
products that integrate energy control technologies of recently-acquired
companies; competitor actions that adversely impact our orders or pricing,
including, but not limited to, aftermarket sales; reliability of customer
forecasts of their sales volumes and purchase requirements; adverse changes
in the business acquisition climate; effects of any business acquisitions or
divestitures; changes in U.S. and other country laws and regulations
involving acquisitions, the environment, and taxes; relative success of
quality and productivity initiatives, such as the Six Sigma initiative and
supplier designation levels with key customers; and unusual or extraordinary
events or developments involving litigation or other potential liabilities.