At the end of each quarter, Woodward estimates the tax that will be provided for the current fiscal year stated as a percentage of estimated “ordinary income.” The term ordinary income refers to earnings from continuing operations before income taxes, excluding significant unusual or infrequently occurring items.

The estimated annual effective rate is applied to the year-to-date ordinary income at the end of each quarter to compute the estimated year-to-date tax applicable to ordinary income. The tax expense or benefit related to ordinary income in each quarter is equal to the difference between the most recent year-to-date and the prior quarter year-to-date computations.

The tax effects of significant unusual or infrequently occurring items are recognized as discrete items in the interim period in which the events occur. The impact of changes in tax laws or rates on deferred tax amounts, the effects of changes in judgment about beginning of the year valuation allowances, and changes in tax reserves resulting from the finalization of tax audits or reviews are examples of significant unusual or infrequently occurring items that are recognized as discrete items in the interim period in which the events occur.

The determination of the annual effective tax rate is based upon a number of significant estimates and judgments. In addition, as a global commercial enterprise, Woodward’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, changes in the estimate of the amount of undistributed foreign earnings that Woodward considers indefinitely reinvested, and other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.

On December 22, 2017, the U.S. enacted significant changes to the U.S. tax law following the passage and signing of the Tax Act. The Tax Act included significant changes to existing tax law, including a permanent reduction to the U.S. federal corporate income tax rate from 35% to 21%, a one-time repatriation tax on deferred foreign income (“Transition Tax”), deductions, credits and business-related exclusions.

Enactment of the Tax Act during December 2017 resulted in a discrete net charge to Woodward’s income tax expense in the amount of $14,778, which was recorded in the three-months ended December 31, 2018. After adjustments to amounts made throughout fiscal year 2018, the net impact of the enactment of the Tax Act was $10,860. Woodward finalized its assessment of the income tax effects of the Tax Act in the first quarter of fiscal year 2019.

On June 14, 2019, the Internal Revenue Service (“IRS”) issued final regulations that modified the Transition Tax computation required by the Tax Act. As a result, in the three-months ended June 30, 2019, Woodward recognized additional income tax expense related to the Transition Tax of $10,588.

Within the calculation of Woodward’s annual effective tax rate, Woodward has used assumptions and estimates that may change as a result of future guidance, interpretation, and rule-making from the IRS, the SEC, and the FASB and/or various other tax jurisdictions. Changes in corporate tax rates, the net deferred tax assets and/or liabilities relating to Woodward’s U.S. operations, the taxation of foreign earnings, and the deductibility of expenses contained in the Tax Act or other future tax reform legislation could have a material impact on Woodward’s future income tax expense. Additionally, Woodward anticipates the IRS will issue additional regulations related to the Tax Act which may have an impact on Woodward’s future income tax expense.

The following table sets forth the tax expense and the effective tax rate for Woodward’s earnings before income taxes:



	Three-Months Ended				Nine-Months Ended
	June 30,				June 30,
	2019		2018		2019		2018
Earnings before income taxes	$	92,314	$	54,417	$	243,997	$	140,551
Income tax expense		26,207		5,300		51,191		34,685
Effective tax rate		28.4%		9.7%		21.0%		24.7%

The increase in the effective tax rate for the three-months ended June 30, 2019 compared to the three-months ended June 30, 2018 is primarily attributable to favorable resolutions of tax matters in the prior fiscal year quarter that did not repeat in the current quarter and the additional income tax expense related to the Transition Tax resulting from final regulations issued by the IRS on June 14, 2019 that modified the Transition Tax computation required by the Tax Act. Also contributing to the increase in the three-months ended June 30, 2019 was the loss of the domestic production activities deduction in the current quarter and the U.S. federal corporate income tax on estimated current year foreign earnings. Partially offsetting these increases were the impacts of the Tax Act on the resolution of the fiscal year 2014, 2015, and 2016 IRS audits recorded in the prior fiscal year quarter that did not repeat in the current quarter and a reduction in the U.S. federal corporate income tax rate provided by the Tax Act.

The decrease in the effective tax rate for the nine-months ended June 30, 2019, compared to the nine-months ended June 30, 2018 is primarily attributable to higher income tax expense related to the Tax Act recognized in the prior fiscal year compared to the amount recognized in the current fiscal year, the reduction in the U.S. federal corporate income tax rate provided by the Tax Act in the first nine months of fiscal year 2019, and an increase in the net excess income tax benefits from stock-based compensation in the first nine months of fiscal year 2019. Partially offsetting this decrease were favorable resolutions of tax matters in the first nine months of the prior fiscal year that did not repeat in the first nine months of the current fiscal year, an increase in the U.S. federal corporate income tax on estimated current year foreign earnings in the first nine months of fiscal year 2019, and the loss of the domestic production activities deduction in the first nine months of fiscal year 2019.

Gross unrecognized tax benefits were $10,143 as of June 30, 2019, and $8,364 as of September 30, 2018. Included in the balance of unrecognized tax benefits were $4,012 in tax benefits as of June 30, 2019 and $3,288 as of September 30, 2018 that, if recognized, would affect the effective tax rate. At this time, Woodward does not believe it is reasonably possible that the liability for unrecognized tax benefits will decrease in the next twelve months. Woodward accrues for potential interest and penalties related to unrecognized tax benefits and all other interest and penalties related to tax payments in tax expense. Woodward had accrued gross interest and penalties of $393 as of June 30, 2019 and $279 as of September 30, 2018.