Moog Inc (MOG.B) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Moog's first quarter 2007 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 during that time. [OPERATOR INSTRUCTIONS] As a reminder, today's conference is being recorded.

At this time, then, I'd like to turn the call over to Ann Luhr of Moog Inc. Please go ahead.

Good morning. Before we begin, we call your attention to the fact that we 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 today's date, our most recent Form 10-K filed on November 29, 2006, and in certain other of our public filings with the SEC. Bob?

Good morning. Thanks for joining us. This morning, we'll report on the first quarter of fiscal '07 and we'll update our guidance for the year. The results I'm about to describe are the strongest first quarter that I can ever remember. Sales of $350 million were up 15%, net earnings $24.1 million, up 3% from the year previous and earnings per share at $0.56 were up 30%. We're $0.05 ahead of our most recent guidance for this quarter.

Looking at the consolidated P&L, the $46 million sales increase produced a $20 million increase in gross margin. Our R&D was way up in the quarter. An increase of almost $9 million took R&D to 6.2% of sales. On the other hand, SG&A expense was down to 15.9% of sales, interest was about the same. Net earnings of $24.1 million were 6.8% of sales, and, as I said, up 43%.

You will recall that we issued shares in the early part of '06, so our average share count has increased, with an earnings per share at $0.56 we're up 30%. A great start for the year. In three of our segments, product mix was very favorable and operating profits were unusually strong. We do think that the next three quarters are likely to track more closely to our original plan.

We expect there will be some small changes in our sales forecast, but in total we're forecasting an upward shift in the midpoint of our sales range by only $2 million. So our sales guidance is now $1.44 billion, plus or minus $10 million. We expect that margins will return to more normal levels and the next three quarters will be $0.55, $0.58 and $0.61bringing us to a total of $2.30 for the year, a 17% EPS increase.

Now let me go to the segments. Aircraft. As you know, our aircraft business is in the midst of a period of intense product and program development. For the year, we've predicted modest sales growth of about 4% and slightly reduced margins and that was the pattern in the first quarter. Overall, aircraft sales grew by 3% to $131 million, and the growth was all on the commercial side. OEM sales to Boeing Commercial were up 16% to just under $13 million. Sales on business jets up slightly to just over $8 million. Commercial after market revenue up 7% to $21.2 million. Total commercial aircraft sales of $51.2 million were up 8% from last year.

On the other hand, military aircraft sales of $79.6 million were very slightly below last year's first quarter. Sales on our major production programs were pretty close to last year. But revenue on the F-35 development programs of $18 million was down $800,000 from last year. As you all know, the F-35 made its first flight in December, all our equipment performed flawlessly.

We're now entering a phase in which the level of effort on the development programs will trend down over the course of the year. We're forecasting the next three quarters we'll average about $16 million a quarter.

Military after market at $24.3 million was down $2 million from last year. We're expecting that it'll strengthen as the year progresses, and we're now forecasting $114 million for the year, a reduction of about $7 million from our previous forecast. However, it does appear that our previous forecast for OEM equipment on the V-22 and the Blackhawk was a little conservative, so we're maintaining our military aircraft forecast at $321 million as we previously projected, and we're still comfortable with our commercial forecast of $227 million so in total we're still projecting aircraft for '07 at $548 million.

Aircraft margins. In this quarter, margins on our aircraft business were down to an unusually low 10.2%. We've been expecting that aircraft R&D would remain high influenced primarily by the 787. First quarter R&D expense on that program was $10.4 million, down only slightly from the fourth quarter of '06 and double what it was in the first quarter of a year ago.

Over the last year, our Company has made unbelievable progress on this program. A year ago, design requirements were still changing. Today all the designs are complete and all the hardware is in "qual-test" or about to start "qual-test." Completing [southern accentuator] designs with associated electronics, getting all the hardware built and into test in less than a year, it's a tremendous accomplishment, and we're very proud of the team that achieved it.

In addition to high R&D expense, which we expected ,we have in the quarter recognized some cost problems which we didn't anticipate. First of these is on the Airbus military cargo aircraft, the A400M. Our responsibility on this program is the design and manufacture of four actuator applications. Originally two of these designs were going to be minor modifications of actuators we have in production for the A330, however, as the develop program has progressed, requirements have shifted and now all four actuators are new designs.

As you can imagine, this turn of events has increased design costs, cost to build development and qualification hardware as well as the expense of development and "qual-test" required. During the quarter, we revised our estimate at completion and a booked an additional $2.6 million in program costs.

Our other major cost problem, in the neighborhood of $2 million, is the result of a collection of problems in our business jet product line. In deference to our customers, we won't be describing specific problems on specific programs. I'll describe in general terms three of these problems. First is the cost to retrofit some equipment that's on airplanes, equipment that incorporates material not correctly specified.

Second, is the cost to improve and validate new acceptance test procedures on a number of our products.

And, thirdly, our costs incurred in the redesign and reqaul of electronics as a result of component obsolescence. We've reported some of these kinds of problems in our business jet product line in the past. I won't say that this will never happen again, but I can say that our design production processes in this product area continue to improve and these kind of costs should be much reduced in the future.

In our original guidance for '07 aircraft margins, we projected 11.9%. We do anticipate fewer cost problems in future quarters, so we should see aircraft margins improve from the first quarter level and, therefore, we're still projecting 11.9% for the year.

Space and defense. Space and defense had another very solid quarter. Sales up 18%, $43.7 million, a big increase in defense controls. The Marines light armored vehicle program, which hadn't started in the first quarter of last year, generated sales of $5 million. Another new program, future combat system, was over $1 million and sales of nearly $2 million in our naval systems product line, the product that came to us in the Flow Torque acquisition, were up over a million from the first quarter of last year. Our [Merrily Equipment] delivered free use on Virginia class submarines.

We're nearing completion on our refurbishment program for orbiter actuators on the Shuttle. This was a big quarter. Sales were over $2.5 million. In previous quarters, we discussed the growth in our satellite space vehicle products to over $10 million a quarter, the growth was initially driven by a couple of large classified military programs. Those programs are almost complete, but revenues in this category have continued at over $10 million a quarter as a result of renewed activity on commercial satellites.

Our other major product lines and launch vehicles and missiles were pretty stable in the quarter. Even the tactical missile business got off to a good start. Our forecast for the year in tactical missiles was just under $14 million, in the first quarter we shipped $6.7 million. Given the strength in tactical missiles in the first quarter and the emergence of some new programs in that category, we're now increasing that forecast for the year by $5 million. There's some small puts and takes in some of our other space and defense product line that all net out, so we're increasing our sales forecast for the year from $170 million to $175 million which will represent a 18% increase over sales in fiscal '06.

Space and defense margins in the quarter were an unusually strong 12.3%. This is a reflection of strong sales volume and a very favorable product and program mix in the quarter. We predicted margins for the year of around 9% and we expect the balance of the year will tend more toward that number. As a result, we're forecasting margins for the year at 9.5%, up from 9% in our initial guidance.

Our industrial segment got off to a great start in '07. Sales were up 13% to $102 million. Our largest market, controls for plastic machinery, was up 7% to almost $16 million, largely the reflection of increased activity in Europe. Test equipment is now our second largest market, about $12 million a quarter. It was up only slightly in this quarter. The motion simulator business was up 13% to $11 million. Metal forming continues to be a very fast-moving market this quarter. The increase was 45% to over $8 million, but in the quarter the largest gross percentage was generated in gauge control equipment for steel mills, an increase of 48% to almost $9 million. We had expected the demand in steel mills as well as turbine controls would be fairly stable over the course of this year. That is the case of turbine controls, but the steel mill business is remarkably strong. The emphasis continues to be in the Pacific, and more particularly in China.

We had forecasted industrial sales for the year in a range from $412 million to $432 million, midpoint of $422 million. Looking at shipments and incoming orders in the first quarter, most of our product line seemed to be tracking. There are two changes, though, that suggest that we need to adjust the range. In the test equipment business, we have learned of some delays and one cancellation of major test equipment orders. Also based on the order rate for the last couple of quarters, we're lowering our forecast of aftermarket sales by about $4 million. The result is that we're revising our total industrial forecast to a range $401 million to $421 million, the midpoint of $411 million is down $11 million, but still $411 million will be a 8% increase over fiscal '06.

Industrial margins of 13.2% were up nicely from last year's 12.8%. Industrial margins fluctuate somewhat quarter-to-quarter depending on product mix. But over the long-term, margins are improving as we move more towards supplying systems as opposed to selling components. The result of the strong first quarter, we're increasing our margin forecast for the year to 12.8%, which will be a nice increase over last year's 11.8%.

Components Group. Our Components Group continues its outstanding performance. Sales up 22% to $68.3 million in the quarter. Controls for the aircraft continue to be the largest product line, continues to be a surprisingly strong market. Sales were up 39% to almost $24 million in the quarter. Our single largest fighter was the Eurofighter, on which we supply a number of fiber optic transmitters and receivers to a consortium of European customers. Sales on this program in the quarter were $2.3 million.

Blackhawk continues as a major program. Total sales in the quarter were $1.8 million, over 75% after market. The products you will recall are slip rings used in the deicing system. It's ironic that the [spares] requirement is so high for a deicing system on helicopters flown in the deserts.

Another of our major programs is the [Fleer] System in the F-18. We deliver about $1 million worth of slip rings a quarter. Space and defense sales in the Components Group, up 37% to $14.6 million. Biggest program in the quarter, another fiber optic product, a fiber optic modem used for battlefield communication. In this quarter our customer was the Egyptian Army. Sales were $2.6 million.

The other big program in the quarter was the commander's independent viewer for Bradley. We supply a number of components and sales in the quarter were $2.4 million.

In a quarter-over-quarter comparison sales in the marine market were up 29% to $6.5 million, but they were about the same level as the previous two quarters, so it does appear that this market has leveled off. As we've said in the past, our marine market is greatly influenced by oil prospecting and ultimately the price of oil which also seems to have leveled off.

Compared to a year ago, sales of components used in medical applications were down $800,000 to about $11.2 million. The swing has all to do with sales of motors to Respironics. We actually sold more motors in the quarter than we did a year ago, but last year we made a major effort to reduce both our costs and our selling price and, as a result, we're selling more motors at a lower price. Sales of slip rings for CAT scan machines were fairly stable, as were the rest of the products in medical equipment.

On the other hand, industrial sales for Components were up 12% to $12.4 million. Industrial component sales include a wide variety of products used in a broad range of applications including wind power, oil pumps for diesel engines, packaging machinery. One of the most important is commercial slip rings used in closed-circuit TV. Sales in this product line were up 6% from a year. For the year, we had forecasted a 9% increase for Components to $258 million. Given the performance of the first quarter that does seem overly conservative and it now appears aircraft, space defense and the marine market will be stronger than our original forecast, so now we're projecting $266 million, a 12% increase over '06.

Components' margins. Last year the Components Group started with a very strong first quarter, margins of 18.2% and then settled down for the rest of the year and finished up at 15.5%. We had forecasted 15.6% for the whole of fiscal '07, and once again we're off to a very strong start. Margins for the quarter were 19.2%. This extraordinary margin performance reflects the rapid growth in both aircraft and defense controls product lines and particularly the substantial growth in the aircraft after market.

We'd love to predict a continuation of 19% margins, but we do expect some moderation throughout the year and we now expect to finish the year at 16.7%, still a nice improvement from last year's 15.5%.

Medical Devices. There's a lot of interesting news in our new Medical Devices segment. I'm sure you know about two weeks ago we announced the proposed acquisition of Zevex International, but before I get into that subject let me report on the results achieved in the quarter of the Curlin and McKinley products. You may recall that we forecasted for the year sales of $40 million and operating profit of about 20% or $8 million. Sales in the first quarter were actually $11 million, so in sales were slightly ahead of plan. Operating profit of $2.1 million was 19.5% of sales, which could be rounded to 20%, so at least for the first quarter we're on track.

The December ending quarter is reputed to be a strong sales period for pumps and that worked out that way for us. We had pump sales of $6.7 million, up from $4.1 million in the prior quarter, and sales of administration sets at $3.1 million, rebounded nicely from the weak performance of the previous quarter. Strength in administration sets is directly related to the marked improvement in profitability.

The $2.1 million in operating profit that I already mentioned was achieved after over $1 million in amortization of intangibles. So in this quarter, the Medical segment delivered exactly the kind of performance we'd hoped for when we entered the medical market. Those of you who followed our Medical Devices initiative know that our first acquisition, Curlin Medical, is a product line of electric ambulatory infusion pumps. Next, we acquired McKinley Medical, a disposable infusion pump product line.

The Zevex acquisition relates directly to our strategy of becoming a specialist in infusion pumps. Two-thirds of Zevex revenues are related to infusion therapy. The primary products are infusion pumps used in enteral nutritional therapy, and also sensors used in infusion pumps.

But in addition, the Company has established technology in hand pieces used in cataract removal and in systems used for transporting organs. The Zevex acquisition, of course, has to be approved by the Zevex shareholders and the appropriate regulatory agencies. We're hoping for a closing by the end of March and if that occurs we expect that Zevex will add $25 million in sales to our Medical segment for '07. We also expect that because of the typical purchase accounting adjustments required in our first year of ownership there will be little or no impact on our fiscal '07 earnings per share projection.

So let me summarize the revisions that we're may go to our prior guidance for '07. In terms of sales, we think Aircraft will still come in at $548 million. Space and Defense will be up $5 million to $175 million. Industrial will be in a range centered around $411 million, down $11 million from before. Components will be up $8 million to $266 million. We'll leave Medical Devices at $40 million until we close the Zevex deal, and so our new projection totals $1.44 billion, plus or minus $10 million. This would be a 10% increase over last year's $1.3 billion.

In terms of margins, we expect Aircraft will come in at the previously projected 11.9%, Space and Defense up to 9.5%, Industrial 12.8%, Components up to 16.7%, and we'll leave Medical Devices at 20%. That will generate total operating margins of 13%, which we believe will produce earnings in a range around $99.3 million, and earnings per share between $2.26 and $2.34. The midpoint at $2.30 a share will be a 17% increase from last year's $1.97. And now, Bob Banta.

All right, Bob, everyone, thank you. Just a few tidbits on balance sheet type of items before we get to what I expect will be your interesting questions on all the good news that Bob has just gone over. Our cash flow from operations was $23 million this quarter. Receivables increased by $5.8 million and inventories by $22.6 million. Included in both of these numbers is an $8 million increase which is simply the foreign currency translation effect resulting from the weak dollar at the end of December. Excluding the effect of foreign currencies, receivables and inventories combined increased 3.6%, while our sales, if you exclude the effect of foreign currencies, increased by 3.8%, when comparing these Q1 results to our fourth-quarter results of last year.

So our use of cash to increase our working capital was to support our top-line growth. Our forecasted sales for the next three quarters suggest that growth and working capital should slow down. And we believe that cash flow will improve in the quarters ahead. We now estimate cash flow from operations for all of '07 will total $126 million. That's up from our previous estimate last fall of $119 million. In addition to the leveling off in the growth of working capital, capital we've lowered our estimates of our U.S. pension contributions from $30 million to only $15 million. That's because we're pretty much matched now with the assets that are actually greater than our accumulated benefit obligation.

After considering the tax effects of the lower pension contributions, cash flow will improve by $10 million from our previous estimates as a result of these pension contribution estimates. During Q1, we contributed $3 million to this U.S. plan.

Capital expenditures for the year need to be adjusted upward from our last estimates to a new total of $75 million, in light of sizable outlays in Q1. Capital expenditures at $24.9 million in the first quarter included $7.8 million for test rigs for our 787 hardware developments. We also used $5.5 million to purchase a small ball screw manufacturer in Italy. Funding these cash uses was, of course, profits as well as an increase in advances from customers. Such customer advances increased by $10 million in the quarter.

Several programs, actually many, saw up front payments from customers that were providing new purchase orders to us. All in all, our debt net of cash balances increased by $6.9 million in the quarter, or by just under $1 million, $900,000, if the effects of that acquisition were excluded. Depreciation and amortization in the quarter was $12 million, and cash tax payments amounted to $6.8 million. And now to your questions and answers.

Great. Thank you very much. [OPERATOR INSTRUCTIONS] And our first question this morning comes from the line of Cai Von Rumohr from Cowen & Co. Please go ahead.

Nice quarter.

Morning, Cai.

R&D was considerably higher, you're going at a $88 million run rate. I forgot, did you give us revised guidance for R&D for the year and could you comment a little bit about how it might pattern and some color on why the non-787 continues to rise?

We didn't provide updated guidance, but we will. We've jacked up our estimate for the year from $75.6 million to $78.6 million. The 787 continued high. As I mentioned, this last quarter there was a flurry of activity. We're racing to build of the qualification hardware, the first aircraft hardware has been delivered, a lot of action on testing of software, and I think we've mentioned in the past that we have R&D increases in other parts of our business. We have some increased activity in Space and Defense, and a major project in our Industrial business. So we expect that R&D expense will stay up, well, as I said, the new number is $78.6 million, but it still works.

On the other hand, that number is about $10 million below what you mentioned $88 million which is just annualizing the first quarter run rate so there's some slight fall-off as the quarters go on.

We do expect the R&D expense on the 787 will trend down as the year goes by.

I believe your expectation was that it would be relatively flat at about $31 million. Is that the case? Where does the full-year increase come?

Partly, it's on the 787 and partly on a couple of the other programs that I mentioned.

So that we still should see a pretty good decline on the 787, it's essentially on track?

It is declining, I mean, last quarter it was 10.6, this quarter it was to 10.4.

Okay. Okay.

It's coming down, seriously, it's just coming down a little more slowly than what we had expected.

And why in the Medical area, if we're over 11, in a business where seasonally, I guess, you know, fall is better, but winter is usually not too bad either, it's usually a fourth quarter where we have a seasonal downtick. These humongous numbers given, the supposed continuing increase in population of pumps why are we only looking at $40 million in sales at Zevex?

Let me say first of all, that this will be our first full year in this business, and as you notice in the last -- in our previous quarter, the fourth quarter of last year, we're still learning about the seasonality of the business and what can happen with the ups-and-downs of the sales of administration sets. So -- but the folks -- the sales and marketing folks that we have and those folks that are working with B. Braun, do expect that this was a relatively strong quarter. They're expecting a slightly lower quarter next quarter. And then as we get towards the end of the year, they are expecting a relatively weak quarter in the summer quarter.

So we're not expecting that all four quarters are going to come in at $11 million. On the other hand, these numbers will get slightly confused if we succeed in closing Zevex, let's say at the end of March. Then we'll be talking about a $65 million forecast for the year. But for the time being, we'll leave the Curlin and McKinley forecast at $40 million.

Okay, excellent. Let me turn it over to someone else. Great quarter.

Thanks, Cai.

Thank you, and we do have a question now from the line of Robert Stallard with Banc of America. Please go ahead.

Good morning, guys. Just thirsty, Bob, I was wondering if you could comment on how you're dealing with the extra acquisitions you've made over the last, say, 12 months, just how logistically you keep a track now that you've moved into the medical area as well as the other different companies you control?

How logistically we keep track. I'm not sure where you're headed. In Medical, as you know, we've established a new segment. We have a small, I'll call it, corporate overhead or oversight structure. Marty Berardi is responsible for that show and he's staffed with a very strong marketing strategy, planning fellow, and a very strong technical person, and we intend -- well, initially, Curlin was going to be the primary location, and when we acquired the McKinley products, we literally moved the production and assembly of the McKinley products to the Curlin location in Huntington Beach.

If we succeed in putting the Zevex deal together, we're going to maintain -- Zevex has about 178 or thereabouts staff in Salt Lake. So we'll continue to work the two locations. But we're expecting considerable collaboration between the two locations and particularly the sharing of both technology and market management, if I can use that term.

The other acquisitions we made recently, I mean, this little ball screw company is really just a bolt-on deal. So we still are operating within now the five segments and the leadership of each of the segments is quite comfortable, you know, managing the acquisitions that we've made in recent years. I guess I could say that the assimilation of the Kaydon companies and the components group went particularly smoothly, particularly putting the two companies together in Blacksburg, Virginia.

What we did there was literally, we had two companies that had been competing for 50 years that were a quarter of a mile away, and by -- for the most part what we did was specialize one of the companies in the slip ring business and the other in customized electric motors, for the most part used in the aerospace business, and that specialization seems to have been very beneficial for both product lines. I don't know, Rob, if I'm answering your question but --

Yes, it's just looking at this as sort of a big picture perspective. MOGA over the last couple of years, that should become more diversified and it's whether you're feeling you're spreading yourself a bit thin. That's all.

I would put it this way. You know, certainly in the Medical Devices business, we're in this circumstance. The technology compared to what we do in our other businesses is hardly challenging. But it is for us a new market. And we have to be cautious and careful and attentive and learn the new market.

On the other hand, Rob, if you went back through the history of our Company, our Company started as a missile-age supplier of servovalves and for fin controls on missiles. We didn't start off knowing all about the injection molding business, for instance, in either Europe or Asia. So I think over the history of our Company, we've demonstrated an ability to take proven technology into new markets, and so, no, we don't think we're spreading ourselves too thin.

On the contrary, we think that the four segments that we had before we got into medical were really good shape, and the medical market we think offers potentially higher organic, typical organic growth rates and perhaps higher profitability and given the technology and production capabilities we have, I mean, you're led to the answer why not?

I see. Okay. Just switching over to the other, Bob, have you changed any of your assumptions for the effect of foreign exchange this year and any change to your pension assumptions beyond the contributions?

No, Rob. The assumptions are all the same. We'll -- we'll deal with them in reverse. Pension we'll deal with as we get near the end of the current fiscal year, see where discount rates are. They're probably not too dissimilar from where we ended up last year. And foreign exchange, no, we haven't changed. Our plans are, particularly with all the important Euro, still using a number that's below today's current level which is 129.5, give or take. So we've got a little built-in cushion there.

Okay. Thank you very much.

Thank you, we have a question now from the line of Eric Hugel with Stephens. Please go ahead.

Good morning, guys, great quarter.

Hi, Eric.

To start out, I guess the way you describe the cost problems in the aircraft business, at least on some of the things, the A400M, you talked about some kind of spec. change, as well as I guess one of the three issues in regards to the "biz" jet product line that the customer incorrectly specified, I guess, some equipment. Do you have any recourse there as you deliver product?

Let me clarify that last statement. As I mentioned, in my prepared remarks, we're replacing material that was incorrectly specified. I did not intend to suggest that that was a customer error. The incorrect specification was our error. In fact, we had incorporated incorrectly the use of two alternate materials. The plan was to start with two and get down to one, and we didn't make that shift before we started producing hardware. So there is no recourse.

I think in the aircraft business, not that I want to make excuses for these kinds of cost problems, but there are going to be, on occasion, these kind of problems. I mean, it is the nature of this business. When you start out with multiyear, multimillion dollar development programs, as time goes on, there are new things learned, problems develop, and there are problems that you can't anticipate perfectly when you set up the accounting for the program. And it's not considered appropriate these days to just set up large reserves for the unexpected. And so this sort of thing happens.

Now, on the A400, I mean, that really is a case where we made a bet that when we got into that program that two of the applications, elevator and aileron, looked -- the initial specification was such that we were going to be able to use hardware that was almost identical to what was in production for the A330. And we believed that was a sensible basis on which to bid the program and price the program and estimate its cost. And it was in both our interests and the Airbus interest to have it come out that way.

Now, as it turns out, that as the requirements on the airplane, the aerodynamics developed, that's simply not practical and so the hardware, you know, that is going to be, that is going to be, has been designed and developed is not going to be identical to what's on the A330. So we made a bet that it would work out that way and it hasn't worked out that way so we've got to face the music.

Great. With regards to -- can you shed a little more light. You talked about in the Industrial Group, I believe, some cancellations or delays of some -- I forget which aircraft it was.

I can do that one for you. You may recall that last year we acquired a company in -- based in Amsterdam called FCS Controls. And there is a product line in this company building specialized test equipment for both the aerospace and the automotive test business. And it is the nature of this business that there are you know -- this is the company that we bought was $35 million, $40 million company, and test equipment orders can range in value from $2 million to $4 million for a particular piece of test equipment.

And what I'm describing is that as we developed our initial forecast for this year, which you'll recall was done a couple of quarters ago, we had a forecast that included three particular pieces of equipment for specific customers each of which valued in the neighborhoods of a couple million bucks. One of those, the customer requirements have changed. They're not going to do it. They're going to take a much simpler approach. That one's gone. The other two are -- appear to be delayed out of this fiscal year. So --

But it was nothing on your end? It was just the customer changed?

Right, so we adjusted our forecast.

Okay. Fair enough. Can we address, when you gave your '07 forecast previous quarter, you talked about the possibility of bid and proposal costs surrounding A350 that was sort of in your expectations. Can you sort of update us as to sort of where things stand sort of on a timeline basis? Is that still your expectation for this year that you're going to incur some of those costs?

I think we will. The thing that's not so clear to me is which of them will appear in sales support and which in R&D, all of which hinges on where along the line we get a contract. The, Airbus is going to select suppliers, more than one to work for some period of time in developing specification requirements. And during that period, we'll probably -- I shouldn't say probably. During that period, our efforts will show up as sales support.

Somewhere between -- somewhere in the summer or early fall we expect that they'll select a supplier to go to work on the real design, and at that point the expense maybe -- may turn into R&D. But we -- it appears to us that there is a program. They are going to proceed. It's not going to be a derivative for our kind of hardware. A derivative of either the A380 or A400 directly, and there will be plenty of design work to do, so that's what we expect to happen.

Okay. Great. I'll get back into line. Thank you very much, guys. And good quarter, again.

Okay.

Thanks, and we have a question then from the line of Ron Epstein with Merrill Lynch. Please go ahead.

Hi, Ron.

Hi, this is actually Stephanie. Good quarter, guys. I'm was wondering if you can refresh kind of on your strategy on Medical Devices and what you're seeing long-term it would comprise as percentage of sales?

Well, our strategy is not complex. We, after looking at a wide variety of potential product positions in the medical devices market, we decided to focus on infusion therapy. And basically these are small electrically -- for the most part electrically-operated pumps. So a fluid metering device, that's parts of our skill set run by electric motors, we make electric motors controlled by electronic controls incorporating software, those are all things we do in other part of our business.

Our observation of the current market is that most of the installed base has been supplied by large companies Abbott, Cardinal Health, companies that have other interests. They're more interested in supplying the medication that flows through the pump than they are in the pumps, and as a result, it seems to us anyway, that the technology is not particularly advanced. And so we believe that there's an opportunity for new entrants to come in and accelerate the advance of technology.

And as it turns out, in the case of Curlin, Curlin is, we think, the most capable infusion pump in its size category on the market. So it's not that we have to, you know, do a lot of work to catch up with the market. We already have a leading product. And I think in enteral nutritional infusion therapies, Zevex is in similar circumstance.

But the idea is to become a specialist in this kind of device and to continue to accelerate the advancement of technology. It doesn't have to move very fast to be accelerated. Most of the pumps that are in use today are designs that are 15 years old. So this is not a rapidly advancing market. So we think there's that opportunity for us.

And in these businesses, there is the aspect that in the administration sets are an important part of the product offering, and at least the companies that we've acquired so far have been nicely profitable companies. As I mentioned, in the quarter, we're talking about 20% operating profit. We think that's pretty handsome number. So that's what we're doing.

How big is it going to be? I think if we complete Zevex, we'll probably focus our attention on developing the capabilities of the companies we've acquired. I was asked not too long ago, are we only going to make acquisitions in the medical arena? The answer to that is no. It just happens that the first three have come along pretty, you know, pretty quickly. But I don't expect that it will be anywheres near the largest of our segments for a very long time.

Okay, thank you.

Thank you. And we have a question now from the line of Alex Hamilton with the Benchmark Group. Please go ahead.

Hi, good morning, gentlemen.

Hi, Alex.

Hi. Quick question on the margins. Usually, and maybe I am looking at it improperly. I usually tend to look at the Industrials business as a business that's a little more short term, and also the components business. We're talking about some healthy margins, according to your guidance this year. Where do you see these margins sort of peaking out or how do you look at this business kind of on a macro perspective beyond '07? Does it become cost savings within the businesses? Does it become growing out the product lines, can we talk to that a little bit?

I think Industrial margins, 13.2% this quarter, we are now up to 12.8% for the year, I think that's a pretty respectable margin performance for that business. If you look over our history, that's doing pretty well in the industrial business. Long-term, we're hopeful that our margins will continue to improve slowly, but, you know, we're not without competition in the Industrial business. And, you know, so I don't think that anyone should be thinking that our Industrial business is going to be a 17% or 18% margin business. I think it's -- I think 12%, 13%, you know, if we can get if over the years to 14% or 15%, I'd be happy.

The Component segment, really -- first of all, I think it's important to keep in mind that the Components Group we did $68 million this year. If you listened to our prepared remarks, there are relatively few programs wherein sales in the quarter are over a million bucks. This is a very large number of small orders, and the profitability on them, the range of products is not completely uniform.

So our experience has been since we've owned this business that profitability quarter-by-quarter does seem to be influenced considerably by the particular product mix in the quarter. If you look at this quarter, it looks like very strong growth in what I'll call the aircraft business aftermarket was very helpful, and -- but we aren't willing to predict 19% margins continuing forever. So, you know, we think we've taken a sensible approach, and we're now, you know, -- we're preparing, let's say, that the balance of the quarters would be down at the 15.6% that we projected for the year in which case we'd average 16.7%. Maybe that will turn out to be a conservative forecast, but it's awfully hard to project it more precisely than that.

Great, thank you very much.

Thanks, and we're showing a follow-up question from the line of Cai von Rumohr with Cowen & Co. Please go ahead.

Yes. Bob, you mentioned that you had the pickup in R&D in Space and Defense, as well as Industrial. Could you give us a little more color, I assume Space and Defense we're talking about FCS, is that true or not, and what's it in the Industrial, what sort of products and when might we see these come out and impact sales?

In Space, it's really not FCS. FCS we're under contract. But we do have some internal product development efforts underway. Let me put it this way. In an attempt to advance the fundamental technology in some of our businesses, I don't really want to be any more specific than that.

In the Industrial arena, we have a major effort underway to develop a multiaxis, digital controller that will be applicable over a broad range of product lines, a kind of electronic device that we'll be able to use in plastics controls machinery, ejection moldings, [flow] molding in material handling applications, in the test equipment business. So this is -- one of the challenges in the Industrial arena is the inexorable advancement of digital controls technology.

And you know -- this is -- I mean, this is not personal computer type of technology advance rate. But there is the opportunity every couple of three years to update the technology of industrial controllers. So we have a rarely -- fairly substantial activity underway involving technical folks in a variety of our industrial companies. And so our R&D expense is up.

Okay. And help me understand. If I look at the margins, R&D was 6.2% of sales based on, you know, your guidance for the rest of the year. It looks like it is going to be, you know, averaging 5.2%. So we should pick up like a hundred basis points just if we look at total margins, jumps from that factor. And we should have the benefit of, hopefully, no more contract reserves, so --

Well, I wouldn't -- I think it would be unrealistic to project a future that did not incorporate any more contract problems on any other programs.

Okay.

In addition, I'm not ready yet to project continuation of the kind of margins that we experience in this quarter in either Space and Defense or in the Components Group. I think these really are unusually high margins. I mean, we haven't seen 12.3% in Space and Defense in years.

I know, that's true, that's true.

So I think, yes, R&D is going to come down, but on the other hand, I think we could see a mix in the next few quarters where we'll be seeing 9%, 9.5% Space and Defense margins and Components down in the 15% or 16% range. Maybe I'd be wrong and wouldn't that be great.

Eric's issue about, you know, the recoverability, I mean, if, in fact, it was a change in the design on the A400M, does your contract provide that you can go back to the customer and claim that it was their change in design?

No, no, it doesn't.

It does not, okay.

We -- that's why I put it the way I put it a few minutes ago. We made a bet that it would come out that way, and, as a result, the whole program will be a little will be -- it didn't and, as a result, the whole program will be a little less profitable for us. I mean $2.6 million looks like a big deal in the quarter, but over the long haul, I think the A400M is going to be a successful airplane. I think they're going to sell more than 180 of them and when it's all said and done, I think it will turn out to have been a worthwhile effort and, as I mentioned, way back when we got into this, the A400M is really the first time the Airbus flight controls community has selected our Company to do flight control actuation. Historically, we've been a supplier of servovalves to the companies now owned by Goodrich. It's worth doing, but it kind of messed up aircraft margins in this quarter a little bit.

Normally when you look at your contract issues, the issues tend to be kind of program-specific. We went through the Raytheon programs.

Right.

We've been kind of dealing with the A400M. You mentioned that there may be more issues on a go-forward basis. Where should we look for the areas where you might have exposure on terms of further --

All I'm trying to suggest is that, I think in this business, I don't think it's realistic that the future is going to be without any development problems. You know, we continue to propose on new programs in the business jet field. There will be, as we've talked, derivatives on the 787. Somebody mentioned the A350. There will be other opportunities to have these kinds of experiences. But overall, you know, the aircraft business has been good to us. We intend to stick with it.

We've booked all the costs on the episodes Bob talked about that we know of and allowed for them adequately. All he's saying is this is not an ice cream type of a manufacturing business. There are ups-and-downs, and unexpected things doesn't mean it'll happen next quarter, but you never know where it's going -- where the next speed bump is going to be.

Right. Housekeeping issue. Corporate expense looked a little high at $4.8 million in the quarter. Where do you expect it for the year? Were there any abnormal things and [INAUDIBLE]

I think for the year we haven't changed it much. I think our projection is $17.5 million for the year.

In the quarter -- I was just going to say in the quarter, Cai, the big expense was the stock option expense, 123, it was about $1.6 million, and we just had it front loaded just the way the options were granted.

No, I meant, actually if the 17.5 includes that but you're 4.8 excluding that and if you're 17.5, so basically it's still what, 3+ for stock options and 14 excluding that, that would assume the rest of it went down, is that correct?

Our stock option for the year, we're forecasting it's a $14.2 million.

And then the rest of corporate expense for the year would be --

It's going to be 14.3, I guess. Just do the math.

Okay. Yes, correct. So what's causing that to be -- that would be coming down quite significantly. So seems that that was quite a bit higher in this first quarter? 4.8?

For the year, it's starting to come down a little because we're, one, having less Sar-Ox costs and two, last year we had actually a higher stock option thing. So we're getting a little benefit there. And if you look from a year ago, our stock option expense was down $410,000 and Sar-Ox was down another $411,000. So year-over-year we're down, but compared to the fourth quarter because of the way we grant options, mostly in the first quarter of any year, it's up from the fourth quarter level.

Okay, great. Thanks so much.

Thank you. And we're showing a follow-up question also from the line of Eric Hugel with Stephens. Please go ahead.

Hey, guys. I guess maybe just a follow-up question to potential new programs, last quarter I guess somebody threw out there your desire, you guys being the incumbent on some of the 747 actuators. I guess, the question was asked would you be interested in designing some new actuators that would go on to the Dash 8. Has the success in Boeing in selling some programs, some of those aircraft more to Boeing and some interest on the freighter side change your minds on that program any?

I think we're in this circumstance. I think the industry has a pretty good idea of how the 747-8 is going to shake out, but we're not under contract, and, so we're not in a position to describe how that's all going to shake out.

Okay

So -- let's talk about that next quarter.

Okay. With regards to the 787, you said all your equipment's either in qual testing or ready to go in. So that would put you on track and all that stuff to support Boeing's timeline?

Yes.

And my final question with regards to the medical. The after market, the margins on the aftermarket, the admin sets are incredibly high. You know, is there an equivalent, sort of like from an aerospace, like a PMA side where somebody else could sort of walk in and start making your admin sets and sell them to people who own the pump set for half the cost?

Yes. It could happen. They are -- each of the pumps has an admin -- they're all different. So each pump has its own admin set design. And -- but there -- you know, these are pretty simple devices. I mean, mostly this is plumbing and plastic. So, you know, one could imagine doing that. Apparently, what the obstacle is, the marketing and sales contact, and it just doesn't seem to happen.

And I think what it comes down -- I mean, when we got into this business or started thinking about getting into this business, we had exactly the same question, coming back -- coming out of the PMA experience. And the behavior in the market seems to be this, that there isn't an outfit that is in a position to copy, replicate, administration sets for the major suppliers that also has the marketing and sales connections to actually deliver. And so it doesn't happen.

There are a number of aspects of the healthcare and medical devices market, in my opinion, that would suggest it's a much less mature market in terms of the practices term with respect to sales, pricing, competition. It doesn't seem that, for instance, the purchasing offices are all peopled by folks who used to work in the auto industry and think there ought to be a 3% price reduction every year. Those folks out of the auto industry and GE haven't yet -- it seems haven't yet permeated the healthcare and medical devices market.

Great. Thanks a lot, guys.

Thank you. And we're showing a question also from the line of Chris McDonald with Kennedy Capital. Please go ahead.

Good morning.

Hi.

Just a question on Joint Strike Fighter. When might you expect to see revenue on that program reaccelerate?

It's going to be awhile. I think, I'm trying to decide whether it's -- probably 2010, 2009. I think next year we'll be down some because we'll be in a period where the development program is winding down. I mean, there still will be development work underway for the B and C variance and the production program will be just starting. But it's going to be a couple years.

Okay.

Keep in mind that the revenues we have now include that of our partners as well as it's a cost plus job, which is nominal margins, compared to when we do get to production out there, it's a slow buildup there and hopefully a lot of birds being built so there is hardware for the planes. That's where the margin should expand, so it may have a dampening effect on total sales, but out -- a handful of years or part of a handful, it should be a positive in terms of margins.

Great, thank you.

Thanks. And at this time then I'm showing no further questions in queue.

Okay. Thank you, all very much for listening, and we'll see you next time.

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