NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Note 1.  Basis of Presentation

The Condensed Consolidated Financial Statements of Woodward, Inc. (“Woodward” or the “Company”) as of December 31, 2015 and for the three-months ended December 31, 2015 and December 31, 2014, included herein, have not been audited by an independent registered public accounting firm.  These Condensed Consolidated Financial Statements reflect all normal recurring adjustments that, in the opinion of management, are necessary to present fairly Woodward’s financial position as of December 31, 2015, and the statements of earnings, comprehensive earnings, cash flows, and changes in stockholders’ equity for the periods presented herein.  The Condensed Consolidated Balance Sheet as of September 30, 2015 was derived from Woodward’s Annual Report on Form 10-K for the fiscal year then ended.  The results of operations for the three-months ended December 31, 2015 are not necessarily indicative of the operating results to be expected for other interim periods or for the full fiscal year.  Dollar and share amounts contained in these Condensed Consolidated Financial Statements are in thousands, except per share amounts.

The Condensed Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim reporting.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations.

These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto included in Woodward’s most recent Annual Report on Form 10-K filed with the SEC and other financial information filed with the SEC.

Management is required to use estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported revenues and expenses recognized during the reporting period, and certain financial statement disclosures, in the preparation of the Condensed Consolidated Financial Statements included herein.  Significant estimates in these Condensed Consolidated Financial Statements include allowances for uncollectible amounts, net realizable value of inventories, customer rebates earned, warranty reserves, useful lives of property and identifiable intangible assets, estimates to support unit-of-production depreciation, the evaluation of impairments of property, valuation of identifiable intangible assets and goodwill, the provision for income tax and related valuation reserves, the valuation of assets and liabilities acquired in business combinations, assumptions used in the determination of the funded status and annual expense of pension and postretirement employee benefit plans, the valuation of stock compensation instruments granted to employees and board members, and contingencies.  Actual results could vary materially from Woo dward’s estimates.

Woodward has changed the name of its Energy segment to Industrial.  The term   “energy” is largely viewed as “oil and gas” and therefore was not representative of the broader markets Woodward serv es in this segment.

Note 2.  Recent accounting pronouncements

From time to time, the Financial Accounting Standards Board (“FASB”) or other standards setting bodies issue new accounting pronouncements.  Updates to the FASB Accounting Standards Codification (“ASC”) are communicated through issuance of an Accounting Standards Update (“ASU”).

In November 2015, the FASB issued ASU 2 015-1 7, “Balance Sheet Classification of Deferred Taxes,” to simplify financial reporting and more closely conform U . S . GAAP with International Financial Reporting Standards (“ IFRS ”) .     Under ASU 2015- 1 7 , Woodward will classify all deferred tax asset s and liabilities by taxing jurisdiction, along with any related valuation allowances, as either a single non-current asset or liability on the balance sheet.   ASU 2015- 1 7 is effective for fiscal years beginning after December 15, 2017 (fiscal year 2018 for Woodward), and interim periods within fiscal years beginning after December 15, 2018 (fiscal year 2019 for Woodward).   Early adoption is al lowed.   Upon adoption, ASU 2015-1 7 may be applied prospectively, for all deferred tax assets and liabilities, or retrospectively.   Woodward has not determined in what period it will adopt or what adoption method it will use and is currently assessing the impact that this guidance may have on its Condensed Consolidated Financial Statements.

In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs.”  Under ASU 2015-03 , Woodward will present debt issuance costs in the balance sheet as a reduction from the related debt liability rather than as an asset.  Amortization of such costs will continue to be reported as interest expense.  ASU 2015-03 is effective for fiscal years − and interim periods within those fiscal years − beginning after December 15, 2015 (fiscal year 2017 for

Woodward), but early adoption is allowed.  In August 2015, the FASB issued ASU 2015-15,  “ Presentation and Subsequent Measurement of Debt Issuance Costs Associated wi th Line-of-Credit Arrangements.”  ASU 2015-15 supplements the requirements of ASU 2015-03 by allowing an entity to defer and present debt issuance costs related to a line of credit arrangement as an asset and subsequently amortize the deferred costs ratably over the term of the line of credit arrangement.     Woodward has not determined in which period it will adopt the new guidance. Retrospective adoption is required.  Woodward had una mortized debt issuance costs of $5,221 as of December 31 , 2015 and $5,521   as of September 30 , 2015.  Long-term debt issuance costs will be reclassified from other assets to long-term debt upon adoption.

In April 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis” in response to stakeholders’ concerns about current accounting for consolidation of certain legal entities and changes the analysis that a reporting entity must perform to determine whether it should consolidate such legal entities.   ASU 2015-02 is effective for public business entities for fiscal years − and interim periods within those fiscal years − beginning after December 15, 2015, but early adoption is allowed.  Woodward adopted ASU 2015-02 on January 1, 2016, concurrent with the consummation of the joint venture formation described in N ote 4, “ Joint v entures .”   The adoption of ASU 2015-02 had no impact on Woodward’s conclusion that the joint venture described in Note 4 should not be consolidated following the guidance of ASC 810, Consolidation .  

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.”  The purpose of ASU 2014-09 is to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards.  The amendments (i) remove inconsistencies and weaknesses in revenue requirements, (ii) provide a more robust framework for addressing revenue issues, (iii) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets, (iv) provide more useful information to users of financial statements through improved disclosure requirements, and (v) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.  In July 2015, the FASB delayed the effective date for the adoption of ASU 2014-09 by one year, and as a result, ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017 (fiscal year 2019 for Woodward), including interim periods within the repor ting period.  Early adoption in fiscal year 2018 is permitted for Woodward .  An entity should adopt the amendments using one of the following methods: retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application.  Woodward has not determined what transition method it will use and is currently assessing the impact that this guidance may have on its Condensed Consolidated Financial Statements. 

Note 3.  Earnings per share

Basic earnings per share is computed by dividing net earnings available to common stockholders by the weighted-average number of shares of common stock outstanding for the period.

Diluted earnings per share reflects the weighted-average number of shares outstanding after consideration of the dilutive effect of stock options and restricted stock.

The following is a reconciliation of net earnings to basic earnings per share and diluted earnings per share:

The following stock option grants were outstanding during the three-months ended December 31 , 2015 and 2014, but were excluded from the computation of diluted earnings per share because their inclusion would have been anti-dilutive:

T he weighted-average shares of common stock outstanding for basic and diluted earnings per share included the weighted-average treasury stock shares held for deferred compensation obligations of the following:

Note 4. Joint venture s  

On January 4, 2016, Woodward and General Electric Company (“GE”), acting through its GE Aviation business unit, consummated the formation of a strategic joint venture betw een Woodward and GE (the “JV”). The JV will design, develop, and source the fuel system for specified existing and all future GE commercial aircraft engines that produce thrust in excess of fifty thousand pounds.

As part of the JV formation , Woodward contributed to the JV certain contractual rights and intellectual property applicable to the existing GE commercial aircraft engin e programs within the scope of  the JV.   Woodward has no initial cost basis in the JV because Woodward had no cost basis in the contractual rights and intellectual property contributed to the JV.   GE purchased from Woodward a 50% ownership interest in the JV for a $250,000 cash payment to Woodward.   In addition, GE will pay contingent consideration to Woodward consisting of fifteen annual payments of $4,894 each per year beginning January 4, 2017 subject to certain claw-back conditions.   Neither Woodward nor GE contributed any tangible assets to the JV.

Woodward determined that the JV formation was not the culmination of an earnings event because Woodward has significant performance obligations to support the future operations of the JV.  T herefore , Woodward recorded the $250,000 consideration received from GE for its purchase of a 50% equity interest in the JV as deferred income.  The $250,000 deferred income will be recognized as an increase to   net sales   in proportion to revenue realized on sales of applicable fuel systems within the scope of the JV in a particular period as a percentage of total revenue expected to be realized by Woodward over the estimated remaining lives of the underlying commercial aircraft engine programs assigned to the JV.

The $250,000 cash consideration received from GE on January 4, 2016 is taxable upon receipt for income tax purposes but not for book purposes.  T herefore , on January 4, 2016, Woodward recorded incremental current income taxes payable of $95,750 and a noncurrent deferred tax asset of $95,750 related to this transaction .

The JV will be jointly managed by Woodward and GE , and any significant decisions and/or actions of the JV will require the mutual consent of both parties .     Neither Woodward nor GE has a controlling financial interest in the JV, but Woodward does have the ability to significantly influence the operating and financial decisions of the JV .    T herefore , Woodward will account for its 50% ownership interest in the JV using the equity method of accounting.

Note 5.  Financial instruments and fair value measurements

Financial assets and liabilities recorded at fair value in the Condensed Consolidated Balance Sheets are categorized based upon a fair value hie rarchy established by U.S. GAAP, which prioritizes the inputs used to measure fair value into the following levels:

Level 1: Inputs based on quoted market prices in active markets for identical assets or liabilities at the measurement date.

Level 2: Quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable and can be corroborated by observable market data.

Level 3: Inputs reflect management’s best estimates and assumptions of what market participants would use in pricing the asset or liability at the measurement date.  The inputs are unobservable in the market and significant to the valuation of the instruments.

The table below presents information about Woodward’s financial assets that are measured at fair value on a recurring basis and indicates the fair value hierarchy of the valuation techniques Woodward utilized to determine such fair value.  Woodward had no financial liabilities required to be measured at fair value on a recurring basis as of December 31 , 2015 or September 30, 201 5 .

Investments in money market funds: Woodward sometimes invests excess cash in money market funds not insured by the F ederal D epository I nsurance C orporation (“FDIC”) .  Woodward believes that the investments in money market funds are on deposit with creditworthy financial institutions and that the funds are highly liquid.  The investments in money market funds are reported at fair value, with realized gains from interest income realized in earnings and are included in “Cash and cash equivalents.”  The fair values of Woodward’s investments in money market funds are based on the quoted market prices for the net asset value of the various money market funds.

Investments in reverse repurchase agreements:  Woodward sometimes invests excess cash in reverse repurchase agreements.  Under the terms of Woodward’s reverse repurchase agreements, Woodward purchases an interest in a pool of securities and is granted a security interest in those securities by the counterparty to the reverse repurchase agreement.  At an agreed upon date, generally the next business day, the counterparty repurchases Woodward’s interest in the pool of securities at a price equal to what Woodward paid to the counterparty plus a rate of return determined daily per the terms of the reverse repurchase agreement.  Woodward believes that the investments in these reverse repurchase agreements are with creditworthy financial institutions and that the funds invested are highly liquid.  The investments in reverse repurchase agreements are reported at fair value, with realized gains from interest income realized in earnings, and are included in “Cash and cash equivalents.”  Since the investments are generally overnight, the carrying value is considered to be equal to the fair value as the amount is deemed to be a cash deposit with no risk of change in value as of the end of each fiscal quarter.

Equity securities: Woodward holds marketable equity securities, through investments in various mutual funds, related to its deferred compensation program.  Based on Woodward’s intentions regarding these instruments, marketable equity securities are classified as trading securities.  The trading securities are reported at fair value, with realized gains and losses recognized in “Other (income) expense, net.”  The trading securities are included in “Other assets.”  The fair values of Woodward’s trading securities are based on the quoted market prices for the net asset value of the various mutual funds.

Accounts receivable, accounts payable and short-term debt are not remeasured to fair value, as the carrying cost of each approximates its respective fair value.  The estimated fair values and carrying costs of other financial instruments that are not required to be remeasured at fair value in the Condensed C onsolidated Balance Sheets were as follows:

In fiscal years 2014 and 2013, Woodward received long-term notes from a municipality within the state of Illinois in connection with certain economic incentives related to Woodward’s development of a second campus in the greater-Rockford, Illinois area for its Aerospace segment.  The fair value of the long-term notes was estimated based on a model that discounted future principal and interest payments received at an interest rate available to the Company at the end of the period for similarly rated municipal notes of similar maturity, which is a level 2 input as defined by the U.S. GAAP fair value hierarchy.  The interest rates used to estimate the fair value of the long-term notes were 2.7 % at December 31 , 2015 and 3.0% at September 30, 2015 .  

In fiscal year 2013, Woodward received a long-term note from a municipality within the state of Colorado in connection with certain economic incentives related to Woodward’s development of a new campus at its corporate headquarters in Fort Collins, Colorado.  The fair value of the long-term note was estimated based on a model that discounted future principal and interest payments received at an interest rate available to the Company at the end of the period for similarly rated municipal notes of similar maturity, which is a level 2 input as defined by the U.S. GAAP fair value hierarchy.  The interest rates used to estimate the fair value of the long-term note were 2.7% at December 31, 2015 and 3.0% at September 30, 201 5 .  

The fair value of long-term debt 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 period for similar debt of the same maturity, which is a level 2 input as defined by the U.S. GAAP fair value hierarchy.  The weighted-average interest rates used to estimate the fair value of long-term debt were 2.9 % at December 31 , 2015 and 2.8 % at September 30, 201 5 .

Note 6.  Derivative instruments and hedging activities

Woodward has exposures related to global market risks, including the effect of changes in interest rates, foreign currency exchange rates, changes in certain commodity prices and fluctuations in various producer indices.  From time to time, Woodward enters into derivative instruments for risk management purposes only, including derivatives designated as accounting hedges and/or those utilized as economic hedges.  Woodward uses interest rate related derivative instruments to manage its exposure to fluctuations of interest rates.  Woodward does not enter into or issue derivatives for trading or speculative purposes.

By using derivative and/or hedging instruments to manage its risk exposure, Woodward is subject, from time to time, to credit risk and market risk on those derivative instruments.  Credit risk arises from the potential failure of the counterparty to perform under the terms of the derivative and/or hedging instrument.  When the fair value of a derivative contract is positive, the counterparty owes Woodward, which creates credit risk for Woodward.  Woodward mitigates this credit risk by entering into transactions with only creditworthy counterparties.  Market risk arises from the potential adverse effects on the value of derivative and/or hedging instruments that result from a change in interest rates, commodity prices, or foreign currency exchange rates.  Woodward minimizes this market risk by establishing and monitoring parameters that limit the types and degree of mark et risk that may be undertaken.

Woodward did not enter into any derivatives or hedging transactions during either of the three-months ended December 31, 2015 or December 31, 2014.

The remaining unrecognized gains and losses in Woodward’s Condensed Consolidated Balance Sheets associated with derivative instruments that were previously entered into by Woodward, which are classified in accumulated other

comprehensive losses (“accumulated OCI”), were net gains of $298 as of December 31 , 2015 and $ 269 as of September 30, 201 5 .

The following table discloses the impact of derivative instruments in cash flow hedging relat ionships on Woodward’s Consolidated Statements of Earnings, recognized in interest expense:

Based on the carrying value of the realized but unrecognized gains and losses on terminated derivative instruments designated as cash flow hedges as of December 31 , 2015, Woodward expects to reclassify $ 26 of net unrecognized gains on terminated derivative instruments from accumulated other comprehensive earnings to earnings during the next twelve months.

In June 2015, Woodward designated an intercompany loan of 160,000 RMB between two wholly owned subsidiaries as a hedge of a foreign currency exposure of the net investment of the borrower in the lender.  An unrealized foreign exchange gain on the loan of $ 862 is included in foreign currency translation adjustments within total comprehensive earnings for the three-months ended December 31, 2015 .

I ncluded in “Land and land improvements” and “Buildings and improvements” are assets held for sale of $662 at December 31 , 2015 and $681 at September 30, 201 5 related to Woodward’s Industrial segment .  The entire change in value is due to changes in foreign currency exchange rates between September 30, 2015 and December 31, 2015.    

In fiscal year 2015, Woodward completed and placed into service a manufacturing and office building on a second campus in the greater-Rockford, Illinois area and has begun occupying the new facility for its Aerospace segment .  This campus is intended to support Woodward’s expected growth in its Aerospace segment over the next ten years and beyond, required as a result of Woodward being awarded a substantial number of new system platforms, particularly on narrow-body aircraft.  Included in “Construction in progress” are costs of $55,716 at December 31 , 2015 and $47,629 at September 30, 201 5 , associated with the construction of the second cam pus and new equipment purchases including capitalized interest of $836 at December 31 , 2015 and $499 at September 30, 201 5 . 

Woodward is also developing a new campus at its corporate headquarters in Fort Collins, Colorado to support the continued growth of its Industrial segment by supplementing its existing Colorado manufacturing facilities and corporate headquarters.  Included in “Construction in progress” are $177,061 at December 31 , 2015 and $151,669 at September 30, 201 5 , associated with the construction of the new campus including capitalized interest of $6,669 at December 31 , 2015 and $5,205 at September 30, 201 5 .  Woodward will begin occupying the new campus starting in its second quarter of fiscal year 2016.

Concurrent with and in relation to Woodward’s significant investment in three new campuses and related equipment in the greater-Rockford, I llinois area, its corporate headquarters in Fort Collins , Colorado (discussed above), and a new campus in Niles, Illinois (that was completed in fiscal year 2015) , Woodward initiated a comprehensive review of its depreciation lives as required by US GAAP to evaluate the estimates of the useful lives of Woodward assets.  This review resulted in estimates of the useful lives of both existing and new assets generally in excess of those utilized prior to fiscal year 2016.  The revised estimates will be used in fiscal year 2016 a nd going forward and result in a downward adjustment of depreciation on existing assets of approximately $ 12 ,000 for fiscal year 2016.

For the three-months ended   December 31, 2015 and December 31, 2014 , Woodward had depreciation expense as follow s :

For the three-months ended   December 31, 2015 and December 31, 2014 , Woodward capitalized interest that would have otherwise been included in interest expense of the following:

Woodward tests goodwill for impairment at the reporting unit level on an annual basis and more often if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  Woodward completed its annual goodwill imp airment test as of July 31, 2015 during the quarter ended September 30, 2015 .  At that date, Woodward determined it was appropriate to aggregate certain components of the same operating segment into a single reporting unit.  The fair value of each of Woodward’s reporting units was determined using a discounted cash flow method.  This method represents a Level 3 input and incorporates various estimates and assumptions, the most significant being projected revenue growth rates, earnings margins, future tax rates, and the present value, based on an estimated weighted-average cost of capital (or the discount rate) and terminal growth rate, of forecasted cash flows.  Management projects revenue growth rates, earnings margins and cash flows based on each reporting unit’s current operational results, expected performance and operational strategies over a ten-year period.  These projections are adjusted to reflect current economic conditions and demand for certain products, and require considerable management judgment.

Forecasted cash flows used in the July 31, 2015 impairment test were discounted using weighted-average cost of capital assumptions ranging from 9.49% to 12.83% .  The terminal values of the forecasted cash flows were calculated using the Gordon Growth Model and assumed an annual compound growth rate after ten years of 4.03% .  These inputs, which are unobservable in the market, represent management’s best estimate of what market participants would use in determining the present value of the Company’s forecasted cash flows.  Changes in these estimates and assumptions can have a significant impact on the fair value of forecasted cash flows.  Woodward evaluated the reasonableness of the reporting units’ resulting fair values utilizing a market multiple method.

The results of Woodward’s goodwill impairment tests performed as of July 31, 2 015 did no t indicate impairment of any of Woodward’s reporting units .