Moog Inc (MOG.A) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Moog FY '10 third quarter earnings conference call. At this time, all lines are in a listen-only mode. Later, there will be a question and answer session, and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's call is being recorded. At this time, then, I'd like to turn the conference over to Ann Luhr of Moog Incorporated. Please go ahead.

Good morning.

Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. These forward-looking statements are not guarantees of our future performance, and are subject to risks, uncertainties, and other factors that could cause actual performance to differ materially from such statements. A description of these risks, uncertainties, and other factors is contained in our news release of July 30, 2010, and our most recent form 8-K filed on July 30, 2010, and in certain of our other public filings with the SEC.

We've provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today's financial presentation is available on our Investor Relations home page and our webcast page at www.moog.com.

Bob?

Good morning. Thanks for joining us. This morning we'll review the results of the third quarter, we'll update our guidance for the balance of 2010, and we'll provide our initial outlook for 2011.

This is a good news conference call. We had a very good third quarter. But we believe that 2010 will finish up in line with our guidance, and we're looking for an earnings per share increase in 2011 of 15%. We'll talk more about 2011 in a few minutes.

Back to this quarter. Sales in the quarter, $537 million, up 21% from a year ago. Incidentally, the comparisons with the third quarter of '09 are actually pretty easy comparisons. That quarter was our weakest sales quarter in '09. The recession was really having its effect on us then, particularly in our industrial business, and we expensed in that quarter almost $10 million worth of restructuring charges.

Nevertheless, there are some comparisons that I think are worth making. Compared to the same quarter a year ago, our gross margin this quarter was up by almost a percentage point. R&D, at $25.8 million, was 4.8% of sales this quarter, a slightly lower percentage than last year. Similarly, SG&A, at $79.3 million, was 14.8% of sales, and that was down as a percent from last year.

We did incur, in this quarter, restructuring expense of $1.7 million, but nothing like last year's $9.9 million. Interest this year, $9.4 million, about the same as last year. The result was net earnings of $29.2 million, 5.4% of sales, up 84% from last year's third quarter.

Earnings per share, $0.64, were up 73%. You'll recall that we issued additional shares last September, and so our share count this year is higher than last.

Now, I'll go to the segments. Let me make a quick summary. Aircraft is on track, in spite of an occasional boulder in the road. Space and defense had a good quarter; but the future of our NASA business is somewhat confused. Our industrial systems business is recovering at a pace that I'd describe as a little better than we had expected. The components group had an amazing quarter, but the demand for overall of military vehicles is slowing down. Our medical business is doing better on sales, but still struggling with excess costs. So, now to the segments.

Aircraft, Q3-- Total aircraft sales-- $191.2 million, up 18%, or $29.6 million, from a year ago. Of the increase, $24.6 million came from our recent acquisition of the GE actuation business in Wolverhampton in the UK. Military aircraft sales, $115.7 million, were up 12%. Commercial aircraft sales, $66.1 million, up 39%. Our Navaids equipment, at $9.3 million, was actually down 14% from a year ago.

As you know, our military aircraft revenues are influenced every quarter by the changing pattern of sales on the F-35. The development program is nearing completion, and the production program is beginning to ramp up. This quarter, including Wolverhampton, F-35 development revenue was $10.6 million, down from the comparable quarter a year ago.

On the other hand, revenue from the production program was up by $8.7 million. The swing on F-35 was only a negative $2.9 million. Revenue on the V-22, $18.7 million, was up $7.4 million from a year ago. Sales on Blackhawk at $7.5 million was up a $1.5 million. The military after market, at $37.3 million, was up $4.9 million, or 15%, and about half of that increase in the aftermarket was generated at Wolverhampton.

On the commercial side, sales of $66.1 million, up 39%. Sales were up in every OEM category. Sales to Boeing were more than double last year. Airbus sales up 56%. Even our business jet product line was up by 6%, and the increase was in the Challenger 300 program at Bombardier, and the G-250 for Gulf Stream. The commercial aftermarket, at $19.6 million, was down 2% from last year, and that includes $2.6 million revenue generated at Wolverhampton. Excluding that revenue, aftermarket sales were down 3.1 million, or 15%, in the quarter.

We said many times that our commercial aircraft revenue-- aftermarket revenue is fairly volatile. In the last four quarters, it swung between $18 million and $22 million. So, that's kind of a range of plus or minus 10%, around a $20 million average. In this quarter we're pretty close to the average. Aircraft for the balance of 2010-- we're expecting a strong fourth quarter. We've adjusted our forecast for the year upwards to a total of $753.1 million. The increase in forecast is on the military side. We're now expecting slightly increased revenue from the F-35 development program and from the production program. We're now anticipating a total of $79.1 million for F-35.

In other OEM product lines, we're increasing our forecast on F-15 equipment we sell to the Japanese and on the V-22, and we're increasing our aftermarket forecast by $2 million to $152 million. On the commercial side, we've actually reduced the forecast for 2010 to $256.6 million. Moderating our business jet forecast by $1 million, but the big change, $5 million, is in our forecast for the aftermarket. We're reflecting on our experience in the third quarter, in which we saw lower returns than we expected on both the 747 and the 777, and particularly returns coming from Singapore and Cafe Pacific. We've revised our forecast for Navaids from $46.1 million to $40.6 million. The change doesn't reflect the loss of opportunities for business, but we have seen some delays in major program awards.

Aircraft for 2011-- We're forecasting a 6% increase in aircraft sales to a total of $797 million, and the big increase next year will be in the commercial business. Military aircraft business will be up only slightly. F-35 will generate about the same revenue, but there will be a swing between development and production. Development program will be down $19.2 million; the production program up $20.2 million. We'll see a slight reduction in some other OEM programs; F-18 will be down a little. F-18 sales in Japan will be down a little. Most other production programs will be stable. We're looking for a $19.9 million increase in the military aftermarket.

Of this increase, about $10 million will come as a result of a recent acquisition of a third party repair establishment called Mid-America. This is a small company in Fargo, North Dakota, which we acquired just this last quarter. We paid $9 million for the company. Mid-America a provider of MRO and aftermarket engineering services, primarily focused on the DOD . They have product expertise in mechanical systems, including constant speed drives, gear boxes, ball screw actuators, and they also do hydraulic components. The company has a history of demonstrated performance with Air Force bases, has extensive platform expertise on the CH-47, F-16, B-52, and the KC-135.

So, this is kind of an increased emphasis in our business on the aftermarket, and we're feeling pretty comfortable with our military aftermarket forecast. We're projecting the increase in commercial aircraft to a total of $285.4 million, an increase in almost every product line. Boeing, we're projecting an $8.4 million increase to $95.1 million, and it's all a buildup of the 8-7.

At air brush, we'd projecting a $5 million increase, business jets up $5.8 million, all based on the production rate of the Challenger 300.

In the commercial aftermarket, we're projecting a modest $9.5 million increase to a total of $89.5 million. This is a 12% increase over what we're expecting in 2010, but half of the increase is expected initial spares provisioning on the 787. Our forecast for Navaids is a total of $50.5 million, up 24%, all based on military aircraft systems that we've recently won, or expect to win in the very near future. So, in summary, that gets us to an aircraft total very close to $800 million for 2011.

Aircraft margins-- Margins in the quarter, after a small restructuring charge, were 9%. Last year, after a bigger restructuring charge, margins were 8%. If we factor out the restructuring charges this year, operating margins were 9.1%, compared to 9.4% last year.

However, this year's third quarter had an unusual expense, which I'll explain in a minute. It was $3 million. Were it not for that charge, margins would have been 10.6%, and we're optimistic about margins in the fourth quarter in this business. So, we're still projecting margins for the year will come in at 10.5% before restructuring, 10.2% after. The 10.5% before restructuring compares to 8.6% last year.

I mentioned the $3 million charge in the quarter, and it's an unusual situation that's related to Airbus. At the same time we were negotiating the award of the primary flight controls of the 350, the folks at Airbus responsible for production programs were involved in their so-called "PowerAid Cost Reduction" program.

You may remember PowerAid. What this came down to in our case was a simple request that we send $3 million in cash, which would reduce their apparent cost. In response, we agreed in principal that we would provide a $3 million benefit, and we thought what we'd do is set up a sort of credit, such that when we were changes of scope on the primary flight control contract, we'd refrain from asserting nonrecurring claims until the $3 million credit was used up. In this most recent quarter, we were notified that Airbus wanted to separate the two transactions, and they wanted their $3 million for PowerAid now, and they wanted it in cash. So, we paid up and sent the cash, and the scope changes developed on the A-350; we're now free to assert our claims.

Those of you who followed our company know that we've been moving through a period of very heavy investment in the aircraft business. Last year R&D in aircraft was 9.5% percent of sales. We've projected that as the years go by, our R&D expense will come down as a percent of sales; margins will improve. The shift will be slow for the next couple of years because of the investment we're making on the A-350 . However, the Wolverhampton acquisition actually helps, so that our R&D for this year, at $61.2 million, will be 8.1% of sales, compared to the 9.5% last year, and, excluding restructuring margins, will be 10.5% of sales, compared to 8.6% last year. So, the pattern has already begun to take shape. Recognizing that we'll be continuing to invest in the A-350 next year, and our R&D expenditures will be comparable to this year, we're forecasting operating margins for aircraft in 2011 at 10.6%, without any restructuring charge.

Before I leave the aircraft business, I want to take a minute and make one brief report from the Farnborough Airshow. As you know, the 8-7 was there, and although we've been advised that suppliers wouldn't be invited to tour, an exception was made in our case, I think because we had three members of our board of directors at the show. Our tour guide was a well respected member of the Boeing engineering fraternity, and as we climbed the ramp to the cabin door, our host paused, pointed at the wing and made this comment, and I quote-- "The design of the high lift actuation system on this aircraft is so compact that we have the cleanest wing in the history of the commercial aircraft industry." The organization that designed that actuation system, of course, is the company that we bought in Wolverhampton. They were ably assisted by our folks in Torrance, and that we had arranged with what was then the Smith's company, a team partnership. I'm sure that our friend's comment was spontaneous, but it's reassuring for us to know that the work done by the company we just acquired is that well appreciated in the technical community of Boeing.

Space and defense, Q3-- another very strong quarter. Sales, $87.5 million, up 35% from a year ago; the increase nearly all organic. Major sales increases in almost all product lines. Sales were what I refer to as the legacy product line, which includes controls for steering; satellite launch vehicles; controls that position satellites on orbit; steering controls for strategic and tactical missiles. That legacy product line was up in the quarter by $14.3 million, or 48%. Sales on satellites of almost $20 million were up 45% from a year ago, reflecting the fact that this was an unusually big year for commercial satellites.

We're delivering on orders for 32 GO satellites this year, compared to a more typical year of 20 or 25. We've also had a number of large, one-off government-funded satellite jobs, some of which are classified. One that isn't, as an example, is a gimble for an instrument package called CERES that goes on the NPOESS weather measuring satellite, and I'm sure that you all know that NPOESS is the National Polar Orbiting Environmental Satellite System. So, what we're talking about are some one-off government sponsored jobs that won't repeat.

Launch vehicle sales $749 million, double last year; the increase mostly on the Taurus II launch vehicle at Orbital Sciences. Taurus II is one of the launch vehicles that's described as commercial, and, therefore, favored by the current administration. Sales of tactical missile fin controls, $12.8 million, were up over 50% from last year, and the increase is primarily Hellfire and TOW, the replenishment for the missiles that have been used in the Mideast. Strategic missile defense came in about the same as last year. The defense controls product line at $28.8 million, had the benefit of a huge increase in Driver's Vision Enhancer systems. Sales in the quarter of that product $10.6 million, compared with less than $100,000 in the same quarter last year. The rest of our defense controls product line was down somewhat, because last year in the third quarter, we had sales of future combat systems, a program which you know has been canceled, and sales on the gator program, which was not active in this quarter.

Our situation on NASA programs is somewhat confused at the moment. Total sales in the quarter, $5.6 million, were actually up $700,000. But the increase was all in activity on the solid rocket booster actuators for space shuttle. Our cost-plus development work on the constellation program, $4.5 million in sales in the quarter, almost exactly the same as last year. There was a shift of more work on the crew launch vehicle, the Ares I, and less work on the exploration vehicle. So, that's the result in the third quarter, and I'll talk more about NASA in a minute.

In our other space and defense product lines, including security and surveillance, navy applications, vibration controls, the aftermarket, revenue in the quarter about the same as last year.

Incidentally, we need to change the name of our homeland security category to Security and Surveillance, recognizing that in this most recent quarter, we acquired a company in this business in Germany with the name Pieper. Given the fact that it's in the surveillance business, I prefer to call it Piper. We announced the acquisition in May. The company is a German manufacturer of vision systems for security applications and hardened video products that are used in extreme industrial environments.

Space and defense, 2010-- We're anticipating slightly lower fourth quarter sales in space and defense. Our order book for controls on satellite is not as robust as it has been. Sales of the Driver's Vision Enhancer systems in the fourth quarter will be down by about $4 million compared to the third quarter, and we're expecting that our NASA programs in the fourth quarter will be $2.3 million lower than the third. This forecast will bring the year to $313.4 million, $7 million less than we were forecasting 90 days ago.

Space and defense, 2011-- In 2011, we're forecasting a $24.6 million increase, to a total of $338 million. Much of the increase will result from the acquisition of Pieper. We expect that acquisition will generate sales close to $14 million. What I've described as the legacy business-- the controls, steer rockets, launch vehicles, position satellites, controls, strategic tactical missiles-- is forecasted slightly lower in 2011 than 2010, to a total of $150.7 million, and the decrease reflects a lower volume of orders for both military and commercial satellites and somewhat-reduced activity on launch vehicles.

Also in strategic missiles, we've completed the Minuteman refurbishment program, and our activity in missile defense is down slightly. The one area of increase is tactical missiles. We'll see increased activity on Hellfire, TOW, the MALD program, and we have an FMS order for Maverick. Defense controls were forecasting that driver vision enhancer sales were $16.4 million compared to $24.1 million this year. Other than that, we expect defense controls to be up only slightly.

I mentioned before, the NASA business is slightly confused at the moment. As you know, our company has been extremely active over the last couple of years in cost-plus development programs on Constellation. We began this year with a forecast of $35 million in revenue on that program. As you may be aware, the current administration has announced in its 2011 budget proposal the intention to terminate Constellation at the end of 2010. The Congress, in the 2010 legislation, directed the administration to continue Constellation, in line with the funding that had been authorized and appropriated. There is a mechanism, however, wherein NASA can restrict funding on contracts that have not been terminated, and that seems to be what's going on.

We have many different contracts on Constellation, and the situation seems to be different with each of them. We've received notice of funding limitations in June on contracts that we were awarded as recently as April. So, we've tried to estimate where we're going to finish up this year. The result is a total of $19.3 million for NASA. Of that, $2.5 million is continuing work on Space Shuttle, and $16.8 million is Constellation, and that compares to our original forecast of $35 million. For 2011, we're forecasting a total of $15.2 million for NASA, and in addition to that, $0.5 million to complete the Space Shuttle program.

So, of the NASA work, contemplates continue to work on Orion crew exploration vehicle, the Congress it seems to be trying to salvage, and some parts of the work being done on the Ares I, particularly on the J2X engine. In addition, we believe there are a number of NASA development programs in which we can be successful, as they shift their emphasis to R&D. As you may know, there is a bill in the house this week, which actually directs NASA to continue the Constellation program as it was; but, as it turns out, that bill, I guess, won't be considered again until the fall, and so as I say, the whole situation is still pretty unclear. As I mentioned, though, the big increase in our forecast for 2011 is in security and surveillance, largely on the basis of the Pieper acquisition and the slight recovery in the sale of commercial security systems.

Space and defense margins-- Operating margins in the quarter 10.8% before restructuring, compared to 11.1% last year, the difference being a slight shift in product mix. However, in quarter three in the space and defense segment, we did book a $1 million restructuring charge. We had to reduce our staffing in the satellite business in anticipation of the lower volume that we'll experience in both the fourth quarter and in fiscal 2011. On an after-restructuring basis, margins in the quarter were 9.6%. We're expecting the product mix of the fourth quarter will yield margins of 11.1%, which will bring us to 10.9% for the year before restructuring, and 10.6% after.

For 2011, although we're forecasting a sales increase, we expect to see a reduction in margins to 10%. In 2011, we'll see a reduction in sales of satellite controls, as I mentioned. There will be no Minuteman refurbishment program, and the volume of Driver Vision Enhancer systems will be lower. The loss of those sales will be offset by slightly less profitable business in tactical missiles, and increased sales in security and surveillance. Much of that from the revenue of the new acquisition, which in the first year will produce very modest operating profit.

Now, from space to industrial, industrial Q-3-- I think there are two major questions in our industrial systems segment-- is the core business continuing to recover from the recession that we experienced in '09? And the answer to that question is yes. The second question is whether the wind energy business is developing as fast as we planned? And the answer to that question is, sort of. The wind energy business is developing a little more slowly than we'd planned, but it is a growing business, and it's profitable.

All in all, our industrial segment had a strong quarter. Sales $129 million, up 26% from last year, and up 7% from the most recent quarter. 90 days ago I talked about the sales pattern in the core business, that is, the set of product lines that existed in '08 before we made the most recent wind energy acquisitions. In '08, this business averaged quarterly sales of $133 million. In the third quarter of '09-- the low point-- sales of these same product lines were down to $84 million. The fourth quarter of last year was $88 million, then $91 million in the first quarter, $94 million in the second quarter, and this quarter $100 million. So, clearly we're in the midst of a recovery.

Sales in the quarter of controls for plastics machinery were $14.3 million, up 81% from a year ago. In this business, the strength is in Europe, and it's primarily the packaging industry that's driving the recovery. In addition, in this industry, some of our major customers are introducing new products, wherein we have increased participation. That is to say, we have more products and more content on their machines. In metal forming, sales, $7.5 million, were up 44% from last year. Once again, the growth primarily in Europe, in controls for metal forming presses.

A strong quarter in specialized test equipment; sales $11.1 million, up 45% from last year. Very strong sales in the Pacific. We delivered a test rig in India for a railroad train bogey test system, and we delivered a system in China to the aircraft strength research institute. The Chinese system included 192 control channels and sold for over $2 million-- one piece of equipment. Sales also up in the oil and gas industry, and in products we sold through distribution and in the aftermarket.

In steel mill equipment and in motion simulators, sales were about the same as a year ago, but up slightly from the most recent quarter. So, in this core product line, we're forecasting sales in the fourth quarter of about $99 million, almost the same level as this quarter.

And now, to the story of wind energy. You may recall that we shipped $44.9 million in wind energy products in the first quarter of this year, and then only $26 million in the second. We explained that our largest customer, the Chinese company that we call United Power, delivers most of their turbines to the northern part of China near the Manchurian border. They don't build wind farms, nor do they accept hardware in the winter. So, our sales in Asia, which were $29 million in the first quarter, were only $11 million in the second quarter. In the third quarter, Asian sales improved to $16.9 million. However, in that quarter, sales in Europe were down. So, the total was only $29 million.

We are forecasting, though, a real acceleration in the fourth quarter. Sales of over $53 million, about $16 million in Europe, and $37 million in Asia, and we have the orders in hand.

That will get us to a wind energy sales total for the year of about $153 million. This is about $12 million less than our most recent forecast. Part of that difference is our sales of low measurement sensors through on the Insensys company, one of our recent acquisitions. Those sales will be reduced from our last forecast by about $3 million, for this reason-- Mitsubishi heavy industry is a major customer for that product line, and their sales in the US have been severely limited by a patent infringement case brought by GE. The result is that Mitsubishi is building fewer turbines and they've put us on hold for shipments.

The major problem, though, in this area-- in production of wind energy pitch control systems, is that we've begun to experience shortages in electronics components. Sales in this most recent quarter would have been higher, if we were able to simply produce the systems we had on order. We believe that the component availability problem is likely to persist. As a result we're forecasting sales in the fourth quarter even at the $53 million level that are less than the backlog we have available for delivery.

Some of you will remember that earlier this year we had forecasted much higher sales for our wind energy products, and as the year has progressed, we've adjusted every quarter. Some of the change from the early forecast was exchange rates. Some, this current difficultly in component availability. Some, the shipment hold to MHI. But much is disappointing sales in the European market, and particularly in Spain. Nevertheless, we regard sales of $153 million in this product area as a remarkable achievement, particularly since nearly $100 million of that revenue is in pitch control systems that have been built in a factory in Shanghai, which last year produced less than half that volume.

So, how about 2011? In 2011 we're forecasting a 9% increase in the core business, to $420 million. So, if you think about our current $100 million quarter run rate the last two quarters of 2010, that would be an increase of only 5%. We're looking for modest increases in metal forming and specialized test equipment, in the non-wind power generation business, in simulators, in sales through distribution, and in the aftermarket. In heavy industry, we're looking for a repeat of this year's level, and we're anticipating a slowdown in plastics, particularly in the sales of blow molding equipment in Asia. We're forecasting a 10% increase in the wind energy business. Sales will probably follow the same seasonality pattern that occurred this year. The total, then, of core business and wind energy will bring us to $589 million, a 10% increase over 2010.

Industrial margins-- We've been projecting industrial margins for the year, after restructuring, at only 7.7%. Margins were lower than that in the second quarter, at 6.8%, and in this quarter, rebounded to 9.5%. Based on the performance in the third quarter and the surge of wind energy that we expect in the fourth quarter, we're anticipating margins in the fourth quarter of 10.6%, which will bring us for the year to total margins of 8.9%, versus our original forecast of 7.7%. And in fiscal 2011, we're anticipating a further improvement in industrial margins. We expect to generate 10.4% on the sales of $589 million.

Components group-- Components group had and exceptionally strong third quarter. Sales, $95.6 million, were up 6% from the same quarter a year ago, and you'll hear in a minute that margins were at record levels. The 6% sales increase was achieved in spite of a $2.6 million decline in aftermarket revenue, all of which relates to reduced repair and overall activity of the military vehicles used in the Mideast.

The strength in the quarter was in the aircraft business and in the industrial markets. In aircraft sales, $41.2 million, up 16%. We had the ongoing Guardian program at $5.8 million, Blackhawk at $3.2 million, the multi-spectral targeting system at $2.1 million, [a tercum] and the V-22 both at just over $1 million.

Components used by a variety of customers in commercial avionics systems totaled $6.6 million in the quarter, up $1.2 million. Also in the quarter, we had an unusual $7.9 million in sales on the Euro Fighter contract, primarily the result of a catchup in the delivery of fiber optic controls, which had been held up for some months by the availability of a particular component, which finally came through.

In the space and defense component product, sales, $20.4 million, were up only 1%. The CROWS program-- Common Remotely Operated Weapons System, wherein we deliver a slip ring assembly to Kongsberg, and we're currently delivering at the rate of 70 a week-- that program produced sales of $3 million in the quarter, up $2.7 million from last year, when it was just getting started. And these increases offset a slight decline in OEM revenue for military vehicle products and a very sizable decline in the aftermarket.

If I take our sales on Bradley, the Abrams tank, and the Stryker Mobile Gun System, OEM sales for the quarter at $6.5 million were down $1.6 million from a year ago, primarily reflecting a decline in upgrade programs on the Bradley. In addition, as I mentioned, the aftermarket and the defense portion of our business declined from $3.5 million a year ago to $700,000 this year, and we believe this reflects the reduced requirement for repair and overhaul of the equipment that was being used in the Mideast. Iraq, as we know, is winding down, and these heavy ground vehicles aren't very useful in the terrain in Afghanistan.

In marine product, sales in the quarter, $7.7 million, were down 37% from a year ago, but up $1.4 million from the most recent quarter. We said in the second quarter, we thought we'd hit the bottom in sales of marine products. Incoming orders in that quarter were much higher than shipments, and it's also true in this quarter. Incoming orders have been running at a $9 million per quarter rate. And so, we're optimistic.

Part of the improved picture is a recovery in the so-called FPSO swivel market. These are the huge slip rings used on floating production and storage vessels that are, in turn, used in off-shore drilling. We've been without orders for a couple of quarters for FPSOs, and now those orders have started to come again. We're still unclear as to what impact, if any, the situation in the Gulf will have on the market for remote operating vehicles on which we supply slip rings. If the drilling rigs in the Gulf move to Brazil and Africa because of the prospect of a moratorium, there may be an increased need for ROVs in these new locations. Time will tell.

Sales in products in the medical market, $12.3 million, up 5% from a year ago. Sales to Respironics, about even. A slight increase in sales of slip rings for CAT scan machines, and for motors used in laboratory centrifuge equipment. The other good news in the components group is the industrial market; sales $14 million, up 30% from a year ago. Half of the $3.3 million dollar increase was sales of slip rings to Sinovel, the very large Chinese manufacturer of wind turbines; but sales were also up sharply in closed circuit TV, and in motors and controls used in general automation. Components Group industrial products hit their bottom in the third quarter of last year and have been recovering slowly but steadily since then.

So, the rest of 2010, we believe the Components Group sales will moderate some in the fourth quarter, because we won't have the sales benefit of the catch-up on deliveries on the Euro Fighter, and we expect that we're going to have to adjust to lower sales levels in military vehicles in the defense segment. As a result, we're projecting sales in the fourth quarter at about $85 million, which will bring us to a total for the year of $355.7 million.

In 2011, we think we have a conservative forecast. We're predicting sales at $361 million, only slightly higher than 2010. We're anticipating continued growth in the industrial market, in medical, and in marine sales; but the aircraft will be without this big slug of Euro Fighter controls, and the space and defense part of the business will be adjusting to lower OEM and aftermarket revenues on military vehicles.

Margins-- Component group margins in the third quarter, at 19.1% were up from 16.2% a year ago. They had the benefit in this quarter of a very favorable product mix, influenced by those sales on the Euro Fighter. As I mentioned a year ago, they won't be repeated in the fourth quarter, so we're projecting somewhat lower margins at 14.8%. We're expecting margins for the year at 16.2% for 2010, and we're projecting 15.7% for all of fiscal 2011.

And now medical devices, Q3-- We were hoping that this quarter would bring marked improvements in medical devices in both sales and earnings. And what we got was half of the result that we wanted. Sales of $33.5 million were up 29% from the same quarter last year, sales of pumps up 53%, and up slightly from the most recent quarter, sales of admin sets up 40% from last year, and up $0.5 million from the most recent quarter. Sensors and hand pieces generated $4.6 million sales in this quarter, up 47% from a year ago. Only in sales of other OEM equipment, including contract manufacturing and some other accessories, only those sales were down from the year previous. So, all these sales increases I've described, they're all organic, and I think underscore the point that last year, there really was a recession in this business.

Even on the cost side, compared to the same quarter last year, we're making tremendous progress, but from a low base. In the last quarter-- in the third quarter of last year, we lost $4.4 million. But our gross profit this year of $27.6 is up 12 percentage points from last year. R&D is only slightly higher percentage of sales than last year, and that increase has all to do with our extensive effort to achieve FDA approval on our new products. Our real problem at the moment in the medical business is the start-up of our production plant in Costa Rica. We made a decision a couple of years ago to consolidate all of our production of administration sets in one big production plant in Costa Rica. We still believe that in the long-term this decision will benefit both our cost structure and our quality performance.

But the startup of this plant has been a much more extensive effort, and much more expensive than we anticipated. The cost we incurred in terms of excess labor, both direct and overhead, and excess operating expenses in this quarter, were $1.2 million more than we'd planned. But we are making progress, and we are in production. We produced, in the quarter, over 0.5 million administration sets in this plan, and the costs are coming down, and they will come under control.

For the fourth quarter of 2010, we're anticipating sales at about the same level as quarter three. The small mix shift, slightly fewer pumps, higher admin sets, sensors and hand pieces and other OEM products at about the same level as quarter three. We're anticipating total sales in the quarter of $33.7 million, which will get us to $129 million for the year. Then we're expecting a considerably better cost picture in quarter four.

That leads me to the discussion of margins. In quarter three, given the excess cost that I described in the startup of Costa Rica and the increased R&D expense, we actually incurred an operating loss of about $700,000, or 2%. On about the same sales level in quarter four, we're forecasting an improved cost picture, and we're expecting to be positive in quarter four by about $1 million, or 3% of sales, and for the year, that would bring margins just north of break even for medical devices.

In 2011, we're forecasting a 16% sales increase in medical devices to a total of $150 million, with a $21 million sales increase. We expect that in 2011, we will have FDA approval of our new large-volume pump, so we'll have that new product introduction. We've been expanding our distribution network, strengthening our direct sales force, and we think, in 2011, we'll be operating in a still better economy. As a result, we're forecasting a $13.2 million increase in pump sales, and a 12% increase in admin sets. Sensors and hand pieces, about the same as this year. Other OEM products, forecasted to increase by just over $2 million. All of that brings us to sales of $150 million, and on that sales level, and based on the much improved cost structure in Costa Rica, we're anticipating operating profits in 2011 of $8 million, or 5.3% of sales.

Our longer-term objective, as I've discussed with some of you, is to get to operating profit margins of 15%. Clearly achieving those margins has turned out to be more of a challenge than we anticipated, and we've made the current situation more difficult by taking on the big Costa Rican project.

This is a big facility. It's close to 80,000 square feet, has a class 100,000 clean room, and it currently employs over 300 people who have been only recently hired and have to be trained. But by the end of this year, they'll be producing 40 different products with an annual volume of 12 million sets. Certainly, we underestimated the expense involved in developing this facility, but we believe the investment we're now making will pay off downstream, and we think we have a plan that gets us to 15% operating profit by fiscal 2013, if not before.

There are some dynamics in the infusion pump market that could accelerate our progress over the next couple of years. As you may know, one of the major incumbents in the market, Baxter, is involved in a major recall of large volume pumps. We're told that there are 200,000 infusion pumps in the hospital market that have to be recalled over the next couple of years. This will certainly provide an opportunity for other suppliers, which is why it's so crucial for us to get FDA approval of our large volume pump. So, that could be a positive influence.

On the other hand, everyone in the business has now come to understand that FDA approval has become a more arduous and time-consuming effort than it had been in the past. We're hoping that we're very close on our large-volume pump. In the near-term, the stiffening up at the FDA has certainly slowed our progress. In the longer term, we see it as a barrier to entry for prospective competitors. So, as I said, we think we have a plan that gets us to where we hope to be in the medical devices business. In the next couple of years, we'll tell the story.

So, now let me summarize. For 2010, we're now projecting sales of $2.089 billion, operating profit after restructuring of $215.7 million, that will be 10.3% of sales. Together with the rest of our cost structure and our current estimate of 29.2% in taxes, these operating profits should generate net earnings of $107.4 million, $2.35 a share, a 19% increase over '09.

For 2011, we're projecting sales of $2.235 billion, a 7% sales increase. We're anticipating operating profit of $243.6 million, up 13%, a tax rate of 31%, net earnings of $124.2 million, 5.6% of sales. Based on a share count of 46 million, that would provide earnings per share of $2.70, a 15% increase over 2010.

We expect that the year will start slowly. For the first couple of quarters, $0.60, then $0.62 cents. Then, in the second half, accelerate to $0.73 and $0.75. And so, fiscal 2011 should be another step on what we hope will be a new trajectory of annual increases in sales, earnings, and earnings per share.

With that, I'll turn you over to John. We'll talk about cash flow, taxes, and our balance sheet.

Thanks, Bob. Good morning.

Q3 continued our trend of strong cash flow. Every quarter, we revise our estimate for free cash flow upwards, and we're continuing that positive story this quarter. In addition, as our earnings continue to improve, our leverage ratio continues to come down, back to the more normal levels we enjoyed before the 2009 recession. Now, let me provide you with some more details.

Cash flow-- Over the last 90 days, our free cash flow was positive $34 million. Through the first nine months of our fiscal year, we're running a conversion ratio of 120%. Similar to our first quarter, however, we enjoyed some positive timing impacts in quarter three, which will not repeat in quarter four.

Working capital was down $3 million over the last 90 days, despite the growth in sales. Net debt remained constant, as we used our free cash flow for the acquisitions Bob has described. Capital expenditures in the quarter were $17 million, while depreciation and amortization was $23 million. Interest payments were $10 million, and we paid $9 million in cash in taxes.

Some other items-- Our effective tax rate in the quarter was 26.9%, in line with our historical averages. Last year, our tax rate was only 3%, but you'll remember that this was the result of several one-time effects, as well as a cumulative adjustment for the anticipated lower earnings for all of fiscal '09. Contributions to our US defined-benefit pension plan in the quarter were $9 million. Given our strong cash flow, we're increasing our planned contributions to our US plan for 2010 by $6 million, to a total of $30 million.

Our leverage ratio, defined as our net debt divided by an adjusted EBITDA, ended the quarter at 2.57, down from 2.67 at the end of the last quarter. And at the end of June, our net debt to total capitalization stood at 38.2%.

So, for fiscal '10, we're now, last quarter we forecasted $90 million of free cash flow for this year. We continue to do better than planned, so we're updating our guidance for the last time this quarter, to $100 million. We're moderating our capital expenditures by $5 million, to $70 million. The A350 capital run has been slower coming than we had anticipated, but we think Q4 will start to see this effect. Our forecast for depreciation and amortization is unchanged at $91 million, and our estimate of interest expense remains at $38 million. Finally, we're edging up our effective tax rate for the full year to 29.2%.

Forecast for fiscal '11-- For next year, we're projecting free cash flow of $90 million, close to a 75% conversion ratio. Capital expenditures will increase to $90 million, driven by the A350 program run. This level of capital investment is in line with our historical average of about 4% of sales. Depreciation and amortization will be $95 million. And we are anticipating an increase in our average tax rate, to 31%. Finally, we estimate interest expense next year will be $39 million.

Now, let me pass you back to Bob to lead the Q&A discussion.

Okay. Can we go to questions, please?

(Operator Instructions) And our first question comes from the line of Cai von Rumohr with Cowen. Please go ahead.

Yes. Good quarter, good review. Could you give us some color on the R&D split? How much was in aircraft in the 787 and A350, and kind of what we expect there for the year and next year?

So, the current quarter in aircraft, $14.5 million. The 87 in the quarter was down to $2.1 million, the 350 up to $7.8 million. Let's see, so I guess we're now forecasting that we'll wind up the year at $61.2 million, $10.3 million on the 87, and about $35 million on the 350.

Okay.

And for 2010 -- for 2011, we're forecasting the 350 at about the same level, $35.7 million. The 87 coming down to $5.9 million. And the total for aircraft of $63.6 million. We've -- in the numbers that we've projected, Cai, we have, for the total Company, incorporated projection for R&D of $110 million up from $102 million this year.

Got it. Thank you very much. That's terrific. And John, you mentioned that the tax rate kind of edged up. You're basically up from what? I thought you were looking for 27%, and now it's 29%. So, really, it's a lot higher in the final quarter, and it's somewhat higher than I would have guessed for next year. What are you assuming about the R&D tax credit and why is that tax rate up?

Well, we're not assuming that the R& -- well, there's an extenders bill, Cai, that has two effects. It has an extension of the R&D tax credit. But also the effect that it takes away a foreign tax credit that we've enjoyed. So there is a slightly net negative to that. So we're assuming that that bill may get passed in the fourth quarter, and that will edge up the tax rate, and that, then -- for next year we see that slightly higher tax rate because of that effect of the last of the foreign tax credits.

Okay. That's very useful. And what are you assuming next year regarding the pension expense?

The pension expense, Cai, if you take all of our -- both the defined benefits and the defined contributions worldwide, the total expense would be about a $40 million expense, and that's up from about $35 million this year. That really has to do with the discount rate, we're assuming about a 5.5% discount rate, and we know that, of course, at the end of September, but that's what we're assuming.

And what's your return year-to-date in your plan?

Year-to-date we're about flat. On the assets.

Okay, so that's also something of an issue. And then, I'm jumping around here a little bit, but, Bob, you mentioned the opportunity, because of the colleague problems, where are you in terms of FDA approval? What do you still have to do to get that pump approved, and when do you think that might occur?

What we think is going on is this, that the FDA, sometime back, adopted a new set of criteria for approval and didn't publish them, and so, what's been going on is that we submit to the FDA a package that we think is approvable, and it doesn't measure up to this new set of criteria, and they respond with questions. They've recently, I'm told, now disclosed the new criteria. We have -- I think we've had three or four rounds of questions, and in every round, we respond, and they have another -- a minimum of 30 days to come back to us. So I think we have another submission going in shortly. I guess I think of it this way. I'm hopeful that we'll have FDA approval sometime, hopefully early, in the last calendar quarter of this year. But I think -- I've talked to people involved in other medical devices companies, and I think, although there may be a specific focus on infusion pumps, I think it's understood that, in general, the FDA has stiffened up with respect to 510K approval for these kinds of devices.

Okay. And then, just one last one, because I've used a lot. As you look at next year, maybe tell us the two or three areas where you have the opportunity to do better than your plan, and maybe a couple of areas where you might be a little bit nervous that you might have a little trouble getting to the numbers.

I think the opportunities we could -- I'll run through them, not necessarily in order of priority, but kind of in order of the business. I think the aircraft business is pretty solid. I think it is conceivable that we could do better in business jets if there was a little revival there, and in the commercial aftermarket. I think we've been conservative in the commercial after market.

In space and defense, if the House had its way and prevailed over the administration and, in effect, resumed the Constellation program, that would be -- that would have a very salubrious effect on our Company. I think that's probably unlikely. I think there will be some compromise in the middle so that the administration can save face. But I also think that, although I say that the recession is over, I think that investment in security systems is still quite a bit slower than it was a couple of years ago, and I think there's a potential upside in the security business, and industrial, it's -- there's both sides of it, the industrial capital equipment market could come back stronger than we forecasted, and we could do better in wind energy.

In the components group, I think the positives are the potential in wind energy -- or excuse me, not wind energy, in marine products, and in the industrial business, and part of that is, in the components group, are slip rings used in wind energy. So I think there are real opportunities there. I mean, if you look at our forecast, we're projecting hardly any sales increase there. And the reason is that we're anticipating that the revenue that we've enjoyed in the overhaul and repair and upgrade of the Bradley, the Abrams, and the Stryker, that's really going to slow down as Iraq winds up. Maybe it won't slow down as fast as we think it's going to, but we're very concerned about that. And I think medical, the cost structure could improve a little faster than we projected. I think in terms of sales, the upside is we get FDA approval and sell a lot more pumps. The downside is that the FDA approval continues to drag on and we're late in that market. So I think, on balance, I consider the forecast we've just described as biased slightly on the conservative side.

Thank you very much.

Great. Thanks. And our next question then comes from the line of Michael Ciarmoli with Boenning. Please go ahead.

Hey, Mike.

Sir, your line is muted on your end. We're unable to hear you.

Can you hear me?

Sure can.

Now we do.

This is Kevin Ciabattoni on for Mike. Starting with wind energy, can you give us some color on what you're seeing in Europe, I know that was kind of the new point of contention last quarter? Are you seeing any improvement there? What are you seeing through next year?

We don't have a lot of -- in Europe, we don't have a lot of visibility into next year, and what we've seen recently is mostly it's -- some of the projects -- and I think particularly in Spain -- seem to be influenced by the availability of financing, I guess you could say the general economic circumstance in that part of Europe. So it's -- compared to -- when we came into this year, we had a much more robust forecast for wind energy business in Europe, and it's moderated all the way through. But I think the drivers are still in place. I think the Europeans have in place the government stimulus for increased wind energy. I think the problem is that they've kind of built out much of the on-shore wind pattern. So what's left to do is off-shore wind farms and what they call repowering, which is dismantling small turbines in the wind corridors and replacing them with bigger turbines.

Is there any chance that you guys would have to take an impairment charge on that business? I mean, it's down significantly compared to your forecast at the beginning of the year.

No, no. On the contrary, the company that we bought, LTi REEnergy, maybe you've heard this story. I'll try to tell it quickly. This was an acquisition that was the result of discussions that began, you know, when the business was much smaller and then developed over a couple of years, and our acquisition price for LTI, all told, we paid $72 million for a business that this year, I think the LTI portion of our total is somewhere in the neighborhood of $140 million. As opposed to taking an impairment charge, this acquisition will go down in the history of our Company as one of the most fortunate and successful, from an economic point of view, ever.

Okay. That answers that. Switching gears here to space and defense, can you just give us an idea of what the opportunities out there are related to NASA that aren't -- you haven't currently outlined specifically, and then also talk a little bit about what more commercial-related opportunities there are?

Well, with NASA, I think that if they -- in the best of circumstances, somebody in the administration would wake up and say, "Oh, no This was all a big mistake. We don't really want to cancel the cancellation program. Let's go back to the program of record and keep doing what we're doing." Now that's not going to happen, but if it did happen, our forecast for next year would probably not be $15 million or $16 million; it would be $35 million. So that's not going to happen, and it will be somewhere in the middle, we think.

With respect to the commercial business, what we're seeing is that there were very strong commercial satellite orders, both in calendar '08 and calendar '09. As I said, I think in '08, the total was, like, 28 orders, and in '09, like, 32, against a more typical 20 to 25, and so we've been delivering for the last year, I guess I would say, controls to commercial customers at the rate of, like, 30 satellites a year, and the future is probably more in the 20 to 25 range. In addition, as I mentioned in the prepared remarks, we've had the benefit over the last year of a couple or three, one-off, large military jobs that won't be repeated. So, that's a fairly long lead time business, and I think our projection of what we're going to do in the satellite business in 2011 is probably a reasonably accurate projection, and there probably isn't a lot of upside .

Okay. And just one last one on medical. So we're looking at a 3% operating margin in 4Q to get to your just above break even for the year. What's the risk in that in terms of additional startup costs in Costa Rica? Are there -- is it likely that there are going to be additional costs? Have you guys factored those in?

We think the estimate we've made is reasonable. I mean, it is a situation that's changing rapidly. As I mentioned, in Q3, we produced 521,000, I think, administration sets out of that factory. I think the factory is currently running at close to rate, which would be about 1 million sets a month. So we expect that it will be better. I think if we miss, we're going to miss by a couple hundred thousand dollars. We're not going to miss by a million.

Okay. Great. Thanks, guys.

Thank you. And we do have a question from the line of Tyler Hojo with Sidoti. Please go ahead.

Hello, Tyler.

Hello. Good morning. Just a follow-on in the wind conversation for a second here. A lot of the OEMs have been talking about pricing pressure in that market, and some of the other wind component manufacturers that I follow have been talking about some opportunities just in terms of additional outsourcing. Just curious to hear your thoughts there.

That the components -- oh, component suppliers have opportunities -- outsourcing opportunities.

From the OEMs, right.

I think, in our case, it's -- I think it's -- I would describe it differently.

Okay.

I don't think we would benefit from a turbine manufacturer's decision to simply outsource. I think we will benefit from a decision on the part of turbine manufacturers, first of all, to place more emphasis on reliability than first cost. I think the products we have -- the pitch control system we have, the company we acquired has delivered a lot of pitch control systems, and I think we have an excellent reliability record. Also with respect to slip rings, I think we have a product that is, in our opinion, anyway, a more reliable product than has been used by a number of turbine manufacturers. We know of one turbine manufacturer, for instance, who selected what we think is kind of an inferior product to save $200 on a $3,000 slip ring. If you have to change a slip ring in the cell of a turbine, it's a pretty clumsy thing to have to do. So I think reliability is an issue.

The other is the shift in technology. There are companies who use hydraulic pitch control systems, who are considering, not immediately, but, in the longer term, a shift to electric pitch control systems, which would provide an opportunity for -- a better opportunity for a number of our products. Also, I think, in terms of technology, there is a trend towards independent blade control, and the sensors that we build in the company Insensys that we acquired are a key element, if you want to go to independent pitch control, and so that trend will work for us. So, I think those are the things that could benefit our Company. I don't think it's because somebody will decide to outsource to save money.

Okay. That's definitely helpful. And then just lastly, just wondering if you could perhaps comment in terms of the acquisition strategy and how that piece of the business looks, or that piece of the growth strategy, and where you think you're going to be kind of focused on that inorganic growth. Thanks a lot.

On the acquisition strategy or did you say a de-acquisition strategy.

"The."

Oh, because we don't really have a de-acquisition strategy.

Yes, that would be odd.

We, we -- As I think you heard, our acquisition targets are developed in the groups as part of our strategic planning. We typically approach companies that we think would be a good fit because of products and technologies. Most often they're not for sale. Oftentimes it takes a long time to persuade to sell, and sometimes they won't. So, we're continuing that campaign, and the result and reality is largely happenstance, what becomes available, and whether the owners are willing to sell, so we intend to continue that campaign. We don't see -- I guess I would say, I don't see a major acquisition on the horizon; but if I did, I probably wouldn't say so.

Okay. But the pipeline seems like it's pretty robust? Is that a fair characterization?

I wouldn't say robust. I would say it's average.

Having said that, I think it's important to understand, all of our forecasts are organic growth only. So, the 7% sales increase next year is just organic. We never include future acquisitions in any forecasts.

Completely understood.

Just as a reminder, (Operator Instructions) And at this time we're showing no further questions in queue.

I think we've run everybody out of time. Thank you all for staying with us, and we'll see you next time.

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