Note 4. Business acquisition

On April 8, 2018, the Company, and its wholly-owned subsidiary, Woodward Aken GmbH (collectively, the “Purchasers”), entered into a Share Purchase Agreement (the “L’Orange Agreement”) with MTU Friedrichshafen GmbH (“MTU”) and MTU America Inc. (together with MTU, the “Sellers”), both of which were subsidiaries of Rolls-Royce PLC (“Rolls-Royce”). Pursuant to the L’Orange Agreement, the Purchasers agreed to acquire all of the outstanding shares of stock of L’Orange GmbH, together with its wholly-owned subsidiaries in China and Germany, as well as all of the outstanding equity interests of its affiliate, Fluid Mechanics LLC, and their related operations (collectively, “L’Orange”), for total consideration (including cash consideration and the assumption of certain liabilities) of €700,000, or approximately $811,000 based on the foreign currency exchange rate as of the date Woodward executed cross currency swaps in connection with the financing of the transaction as described in Note 7, Derivative instruments and hedging activities. The total consideration to be paid is subject to customary post-closing adjustments. The transactions contemplated by the L’Orange Agreement were completed on June 1, 2018 (the “Closing”) and L’Orange became a subsidiary of the Company.

L’Orange is a supplier of fuel injection systems for industrial diesel, heavy fuel oil and dual-fuel engines. L’Orange supplies fuel injection technology for engines that power a wide range of industrial applications including marine power and propulsion systems, special-application vehicles, locomotives, oil and gas processing, and power generation. L’Orange serves many large specialist diesel engine manufacturers, including Rolls-Royce Power Systems’ subsidiaries, MTU and Bergen Engines, and other low to high speed engine builders. Following the Closing, L’Orange was renamed Woodward L’Orange and has been integrated into the Company’s Industrial segment.

In connection with the Closing, MTU and a subsidiary of Rolls-Royce, and L’Orange, entered into a long-term supply agreement, dated June 1, 2018 (the “LTSA”). Pursuant to the terms of the LTSA, L’Orange will continue to supply to MTU and its affiliates within Rolls-Royce certain liquid fuel injection systems, injectors, pumps and other associated parts and components for industrial diesel, heavy fuel oil and dual-fuel engines in a manner consistent with the supply of such products prior to the transaction. The LTSA has an initial term that extends through December 31, 2032. During the term of the LTSA, MTU is required to continue to purchase certain of these products exclusively from L’Orange, subject to certain limitations specified therein, at pricing negotiated at arms-length.

ASC Topic 805, “Business Combinations” (“ASC 805”), provides a framework to account for acquisition transactions under US GAAP. The preliminary purchase price of L’Orange, prepared consistent with the required ASC 805 framework, is allocated as follows:



Cash paid to Sellers	$	780,355
Less acquired cash and restricted cash		(9,286)
Total purchase price	$	771,069

The cash consideration was financed through the use of cash on hand, the issuance of an aggregate principal amount of $400,000 of senior unsecured notes in a series of private placement transactions and $167,420 borrowed under Woodward’s existing revolving credit agreement (see Note 14, Credit Facilities, short-term borrowings and long-term debt). In connection with these borrowings, the Company entered into cross currency swap transactions, which effectively lowered the interest rate on each tranche of the senior unsecured notes and the borrowings under the existing revolving credit agreement (see Note 7, Derivative instruments and hedging activities).

The allocation of the purchase price to the assets acquired and liabilities assumed was accounted for under the purchase method of accounting in accordance with ASC 805. Assets acquired and liabilities assumed in the transaction were recorded at their estimated acquisition date fair values, while transaction costs associated with the acquisition were expensed as incurred. Woodward’s preliminary allocation was based on an evaluation of the appropriate fair values and represents management’s best estimate based on available data.

Due to the timing of the transaction, Woodward is in the process of finalizing valuations of current assets, property, plant and equipment (including estimated useful lives), goodwill, intangible assets (including estimated useful lives), and all current and noncurrent liabilities other than the valuation of the pension obligation, the valuation of which is complete. Additionally, Woodward is finalizing the projected combined future tax rate to be applied to the valuation of assets, which could impact the valuation of goodwill and intangible assets. The final determination of the fair value of assets and liabilities will be completed within the one year measurement period as allowed by ASC 805.

The following table, which is preliminary and subject to change, summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition of L’Orange. Any potential adjustments will be made retroactively and could be material to the preliminary values presented below.



Accounts receivable	$	26,538
Inventories (1)		72,674
Other current assets		1,385
Property, plant, and equipment		90,589
Goodwill		269,433
Intangible assets		556,023
Total assets acquired		1,016,642
Other current liabilities		40,362
Deferred income tax liabilities		164,791
Other noncurrent liabilities		40,420
Total liabilities assumed		245,573
Net assets acquired	$	771,069

(1)

Inventories include a $15,107 adjustment to state work in progress and finished goods inventories at their fair value as of the acquisition date. The inventory fair value adjustment is being recognized as a non-cash increase to cost of goods sold ratably over the estimated inventory turnover period, with the entire $15,107 fair value adjustment expected to be recognized in cost of goods sold during the year ending September 30, 2018.

In connection with the acquisition of L’Orange, Woodward assumed the defined benefit pension obligations of the L’Orange defined benefit pension plans (see Note 19, Retirement benefits). As of June 1, 2018, the total liability recognized by the Company associated with the L’Orange defined benefit pension plans was $38,998, of which $1,143 was considered current.

As summary of the intangible assets acquired, weighted-average useful lives, and amortization methods follows:



	Estimated Amounts		Weighted-Average Useful Life		Amortization Method
Intangible assets with finite lives:
Customer relationships and contracts	$	379,423	20	years	Straight-line
Process technology		71,940	21	years	Straight-line
Backlog		40,611	1	year	Accelerated
Other		232	3	years	Straight-line
Intangible asset with indefinite life:
Trade name		63,817	Indefinite		Not amortized
Total	$	556,023

Future amortization expense associated with the acquired intangibles as of June 1, 2018 is expected to be:



Year Ending September 30:
2018 (remaining)	$	18,832
2019		34,884
2020		19,701
2021		21,458
2022		21,745
Thereafter		375,586
	$	492,206

The preliminary purchase price allocation resulted in the recognition of $269,433 of goodwill. Only the portion of goodwill which relates to the U.S. operations of L’Orange is expected to be deductible for tax purposes. The Company has included all of the goodwill in its Industrial segment. The goodwill represents the estimated value of potential expansion with new customers, the opportunity to further develop sales opportunities with new customers, other synergies including supply chain savings expected to be achieved through the integration of L’Orange with Woodward’s Industrial segment, and intangible assets that do not qualify for separate recognition, such as value of the assembled L’Orange workforce that is not included within the estimated value of the acquired backlog and customer relationship intangible assets.

Pro forma results for Woodward giving effect to the L’Orange acquisition

The following unaudited pro forma financial information presents the combined results of operations of Woodward and L’Orange as if the acquisition had been completed as of the beginning of the prior fiscal year, or October 1, 2016. The unaudited pro forma financial information is presented for informational purposes and is not indicative of the results of operations that would have been achieved if the acquisition and related borrowings had taken place on October 1, 2016, nor are they indicative of future results.

The unaudited pro forma financial information for the three and nine-months ended June 30, 2018 includes Woodward’s results, including the post-acquisition results of L’Orange, since June 1, 2018, and the pre-acquisition results of L’Orange for those periods. The unaudited pro forma financial information for the three and nine-months ended June 30, 2017 combines Woodward’s results with the pre-acquisition results of L’Orange for those periods.

Prior to the L’Orange acquisition by Woodward, L’Orange was a wholly owned subsidiary of Rolls-Royce and as such was not a standalone entity for financial reporting purposes. Accordingly, the historical operating results of L’Orange may not be indicative of the results that might have been achieved, historically or in the future, if L’Orange had been a standalone entity.

The unaudited pro forma results for the three and nine-months ended June 30, 2018 and the three and nine-months ended June 30, 2017 follow:



	Three-Months Ended				Three-Months Ended
	June 30, 2018				June 30, 2017
	As reported		Pro forma		As reported		Pro forma
Net sales	$	588,117	$	639,665	$	548,622	$	619,485
Net earnings		49,117		60,488		53,626		53,071
Earnings per share:
Basic earnings per share	$	0.80	$	0.98	$	0.87	$	0.87
Diluted earnings per share		0.77		0.95		0.85		0.84



	Nine-Months Ended				Nine-Months Ended
	June 30, 2018				June 30, 2017
	As reported		Pro forma		As reported		Pro forma
Net sales	$	1,606,514	$	1,830,515	$	1,491,897	$	1,684,071
Net earnings		105,866		129,191		138,279		108,190
Earnings per share:
Basic earnings per share	$	1.72	$	2.10	$	2.25	$	1.76
Diluted earnings per share		1.66		2.03		2.18		1.70

The unaudited pro forma results for all periods presented include adjustments made to account for certain costs and transactions that would have been incurred had the acquisition been completed as of October 1, 2016, including amortization charges for acquired intangible assets, eliminations of intercompany transactions, adjustments for acquisition transaction costs, adjustments for depreciation expense for property, plant, and equipment, and adjustments to interest expense. These adjustments are net of any applicable tax impact and were included to arrive at the pro forma results above.

L’Orange’s operating results have been included in the Company’s operating results for the periods subsequent to the completion of the acquisition on June 1, 2018. L’Orange contributed net sales of $24,878 for both the three and nine-months ended June 30, 2018 and a net loss of $1,215 for both the three and nine-months ended June 30, 2018.

Woodward incurred transaction-related costs of $10,755 for the three-months ended June 30, 2018 and $12,036 for the nine-months ended June 30, 2018, which are included in “Selling, general and administrative expenses” in the Condensed Consolidated Statements of Earnings. These transaction-related costs consisted of the L’Orange Acquisition transaction and integration costs, warranty and indemnity insurance costs, and German real estate transfer tax costs. Woodward incurred acquisition financing related costs of $1,154 for the three and nine-months ended June 30, 2018, which are included in “Interest expense” in the Condensed Consolidated Statements of Earnings. Included in other expense (income), net for the three and nine-months ended June 30, 2018 was the cost of $5,543 related to an at-the-money-forward option (the “Forward Option”) entered into by the Company on April 18, 2018. The Forward Option, which was entered into to manage the Company’s exposure to fluctuations in the Euro prior to the anticipated close of the L’Orange Agreement, was not exercised by the Company and expired on June 1, 2018.