Moog Inc (MOG.B) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Moog Second Quarter Full Year 2008 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 conference is being recorded. At this time then, I'd like to introduce Miss 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 today's date, our most recent Form 10-Q filed on February 5, 2008; 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 webcast page at www.moog.com. Here's Bob.

Good morning. Thanks for joining us. This morning we will review the results of our second quarter and of course we'll update our guidance for the year.

On the face of it, this quarter would appear to be just another steady-as-she-goes quarter; sales up 22% to $469 million, net earnings $28.6 million, earnings per share $0.66; an increase of 16%.

But as we go through the segments, you'll notice that there were some unusual (peaks) and tanks in the quarter; often good news, some not so good news. The quick summary goes like this.

Aircraft had higher sales. The sales increase was mostly the F-35 development program, a cost-plus program with very low margins. So the higher Aircraft sales generated about the same operating profit as the similar quarter last year.

Space and Defense had the benefit of the recent QuickSet acquisition. QuickSet sales were outstanding and provided enough profit to overcome a reserve that we set up in the Satellite business.

Our Industrial segment and our Components Group both had very strong margins on higher sales; then on the other hand, our new Medical Devices segment had a disappointing quarter both in sales and in profits.

If you look at our consolidated P&L, gross profit is up $21 million, in spite of an increase in cost of sales percentage; R&D at $26 million, up less than 2% from a year ago; SG&A down as a percentage of sales; interest expense up to $9 million, reflecting our additional borrowings to support working capital, CapEx and our recent acquisitions; the result, a net earnings increase of 17%.

Now I'll go over the segments. Aircraft; Aircraft Q2 total Aircraft sales up 11% to $162 million, increase all on the military side and primarily on the F-35 development program. F-35 sales in this quarter were $26.6 million, almost double last year's $13.8 million.

Every quarter I remind you that on the F-35 development program, we're the lead contractor and work done by our partners- Parker Hannifin, Hamilton Sundstrand and Curtiss-Wright, becomes cost to us which we then pass on to Lockheed. However, in this quarter $17 million of the $26.6 in sales was work done in our Company, an increase of over $9 million from a year ago.

Over the last couple of quarters there has been a sizeable increase in the staff devoted to this program. We're finishing up qual testing on the conventional take-off aircraft, the CTOL. We're building and delivering the hardware for the short take-off aircraft, the STOVL, and we're progressing with design work for flight controls on the carrier version.

The effect of this increased revenue on a cost-plus program is much higher sales, but not much benefit on the profit line. There were small increases in sales on a number of other programs including F-18, V-22 and Black Hawk; and on the military side a nice 13% increase in aftermarket to a total of $30.2 million. So in total, Military sales increased 28% in the quarter, to $98 million.

Commercial aircraft sales, on the other hand, were down from the second quarter of last year; sales $63.8 million, down 8%. The reduction is primarily related to Boeing commercial.

Last year in our second quarter, we received our initial contract for the 787, resulting in a very strong quarter with over $8 million in sales. This year, given what's going on in the 787, our revenues were $5.1 million. In addition, OEM revenues on the Boeing production airplanes were also down a couple million dollars; $13.3 million.

Our sales to Boeing for their production aircraft are triggered by specific orders for equipment on specific airplanes and they vary somewhat with the Boeing build schedule on those airplanes and the Boeing inventory position on each.

Sales on our Business Jet product line were up 7% to nearly $15 million. Increases on the Premiere and revenue generated via an as-yet unannounced platform offset reduced sales on the Hawker 4000.

The other Biz Jet news was Gulfstream's announcement of the G650. I'm happy to announce our participation. We're doing the flap actuation system on that airplane. And as you probably know, the aircraft's reception in the market has been outstanding.

Historically, our Commercial aircraft aftermarket revenues have been relatively low in the first quarter of our fiscal year and then built as the year progressed. In this year's second quarter, those revenues were $22.4 million, up from the previous quarter but down 3% from a year ago. In last year's second quarter we had more spare sales on Business Jets. Other than that, the quarters were quite comparable.

Based on our experience in the first half of '08, we've made some adjustments to our overall Aircraft forecast for the year. Clearly, activity in the F-35 will be sustained. We had thought that the work on the CTOL aircraft would be pretty much done by now and that we'd be close to finished on the STOVL. As it turns out, we're continuing support of the CTOL aircraft, continuing work on the STOVL and the carrier version will carry on through this year. We're now forecasting $95 million in revenue for the year, up from $75 million.

We've increased our forecast for Military aftermarket to $123 million, made some other small changes, with the result that our Military aircraft forecast is now $380 million, up $25 million from our last estimate.

On the other hand, the reschedule of the 787 will reduce our revenues on that program by $7 million. Lower sales on Boeing production aircraft, we'll reduce that forecast by $3 million. And we're reducing our forecast on Business Jets by a little less than $3 million.

Given the slow pace of activity in the Commercial aftermarket and the delay in 787's initial spares provisioning, we've reduced forecasts for Commercial aftermarket now to-- so that the total Commercial aircraft forecast is now $277 million, down $20 million from our previous guidance. So in total, Aircraft goes from $651 million, up to $657; with the most significant adjustment being an increase in the cost-plus F-35.

Margins; Aircraft margins, given the product mix for this year and the continued investment in R&D, we've been looking for Aircraft margins in the neighborhood of 10%. This quarter, margins were actually down to 8.8%, compared to the 10% we achieved last year at this time.

Margins in the quarter, as I've said, were not helped by the strong F-35 sales. If F-35 sales were at the same level as last year, margins in the quarter would have been close to 10%.

On the last few quarters, we've been talking about R&D spending in Aircraft. Our Aircraft R&D expense in the quarter was just under $15 million; was just about the same as last quarter, even though we're spending more on 787 than we had planned. R&D on the 787 in this quarter was $7.3 million, down from $9.4 in the previous quarter.

We had hoped to get through this year with only $19 million in R&D in the 787, but the stretch-out program has resulted in a higher level of continued engineering activity that otherwise might have occurred. We're in qual test on our equipment. We've had the typical qual test anomalies and they have to be addressed. We do expect that as the year goes by spending in the 787 will decline. On the other hand, we have started work on the A350, spent almost $2 million in this quarter, and we expect that expense level will grow as the year continues.

Given the increased expense on the 787, we're increasing our R&D forecast for Aircraft from $55 to $61 million. However, we do have reductions in other segments that will offset this increase, and our total Company R&D forecast remains at the $103 million that we forecasted last time.

We expect that over the last two quarters Aircraft margins will improve slightly. We'll end the year at 9.9% on increased Aircraft sales. So in terms of operating profit, we're expecting Aircraft will come in very close to our most-recent guidance.

We ask you to remember that in our Aircraft business we now find ourselves in the midst of a period of unprecedented opportunity. We've positioned ourselves on key programs, both Military and Commercial-- F-35, 787, A350. These programs we think will ensure our long-term growth in profitability. Our heavy investment in R&D over the last few years will continue in the near term; however, in the longer term, margins will strengthen as these new platforms go into production.

Space and Defense Q2; quarter 2 had a big positive and a big negative. Sales of $70 million, up a remarkable 48%; the huge increase was all the result of the acquisition of QuickSet International. In the quarter, QuickSet added $17.6 million of sales in our Defense Controls product area, and that offset a $6 million reduction rising from the completion of the LAV-25 program and a lull in sales on future combat systems.

The main positive was the sales increase at QuickSet, the result of the driver vision enhancer system. QuickSet is delivering this system to [BRS] for use on the MRAP vehicles. We had a huge deliver quarter. We delivered 5,000 units. So far this year, we've delivered over 6,700 of the 7,600 that were ordered; there are 840 left to ship.

In addition to the DVE program, QuickSet contributed another $5.4 million in sales of surveillance systems; what we are now calling our Homeland Security product line.

There were some other increases in Space and Defense. Sales of $6.7 million on consolation program, more than offset a $2.3 million reduction in Space Shuttle; tactical missile business, up $2 million, reflecting increased shipment of hellfire and tone missiles; satellite business up slightly at $14.3 million; total of launch vehicles, strategic missiles and missile defense was down slightly.

So the overall strength of the Space and Defense business, including QuickSet, was the good news. Now here is the other side to the coin.

Every once in a while we have a manufacturing problem on controls we deliver to the satellite industry. And when that happens, it's generally expensive. In this quarter, we uncovered a problem with a thruster valve used on satellites. Our production valve failed in tests, failure analysis discovered that in this particular design, there is a potential problem in the press fitting in the steel stop pin into the valve body. This design has been in production for many, many years and we have never experienced this problem.

We've been able, using CAT scan techniques to evaluate the valves we have in house. And based on our findings, we've developed a model to estimate cost of recalling equipment that's in the field. We've set up a reserve of $3.6 million in the quarter to cover this anticipated expense.

So the Lord giveth and the Lord taketh away.

For the year '08, we have the benefit of strong orders at QuickSet, and that phenomenon has offset some downward adjustments in other defense controls. The result is an increase in our Space and Defense forecast by $3 million, to a new total of $246 million.

Space-Defense margins; given the extraordinary sales level with QuickSet and the profit contribution that generated, if we had not had this recall reserve, margins in Space and Defense would have been an extraordinary 18.1%. After providing for the reserve, margins in the quarter were a respectable 13%, a level that compares favorably with margins in this segment for most quarters, but not the unusually high 15% margins in the second quarter of last year which were driven by strong space shuttle sales.

For all of last year, we averaged 13%. We did 11.7% in the first quarter of this year. We're projecting more moderate margins as the year progresses. We're now projecting 11.2% for the year.

Industrial systems Q2; sales for the quarter $130.2 million, up 17%; as you know the majority of our Industrial revenues are generated outside the U.S.; so strong foreign currency translate into increased sales. That effect came into play this quarter, but setting that aside, our organic sales increased by 8%; excellent organic growth in the industries in which we're operating.

Our largest dollar increase was in the motion simulator business. Sales of $17.2 were up 31%; very strong deliveries to CAE and Flight Safety. Motion simulators is now our second-largest Industrial product line.

The most dramatic percentage growth in the quarter was in metal-forming presses; sales of $13.7 million were up 36% from a year ago. Most of our customers in this product category are in Europe and that's where most of the growth occurred. Increasing metal prices seems to stimulate the demand for presses with more accurate controls, and that's where our Company comes in.

Sales in power generation increased by 17% to almost $12 million; sales particularly strong in Asia, and most particularly in Japan where we're selling the control for Mitsubishi for gas turbines, Toshiba for steam turbines, and [Fujiami] for wind turbines.

Last quarter, our sales on equipment used in steel mills grew by 52%. This quarter the year-over-year growth rate moderated to 18%; sales in the quarter (inaudible) million. The steel mill business sales have been robust in China where we're delivering equipment for new mills and spare equipment for mills that are currently running flat out. Business is also strong in Europe where mill operators are upgrading their capabilities.

Sales for controls of plastics machinery, our largest industrial market, increased only slightly to almost $20 million.

As we went through our review of our Industrial Systems for this quarter, there was no mention of recession. In the market areas that are important for us; flight-training simulators, metal forming presses, power gen, (inaudible) control for steel mills, plastics machinery; we have not seen any signs of weakness.

So far, these markets are vibrant. Incoming orders have been strong. We're forecasting a second half for '08 that will be $10 million higher than the first half, and $10 million higher than our previous guidance. So we're now projecting Industrial sales for '08 in the range centered around $516 million.

Margins; Industrial margins 14%, up nicely from 13.3% a year ago. Last quarter we were projecting 13.7% for the year. We're well ahead of that for the first six months and we now expect that the product mix in the back half of the year will support a repeat of the first half, so we're currently projecting 14.3% for the year.

The Components Group Q2; last quarter I described our Components Group as a juggernaut that continues to steam ahead, and it hasn't slowed down. Sales of $84.2 million are up 21% from a year ago. Of the $14.8 million of increase, $3.3 million was generated by recent acquisition, Thermal Control Products, Techtron and Prizm.

Nevertheless, organic growth is still at an impressive 17%; sales up in every market area. Sales of Aircraft products, $26.6 million, up 13%; the increase is primarily the Guardian program at Northrop. The program was not in production a year ago and in this most recent quarter, sales were $3.8 million. Guardian, as you may know, is the system designed to protect military and commercial aircraft from shoulder-fired missiles.

Sales in the Black Hawk helicopter continued strong at $2 million. We sold well over a million worth of avionics and equipment to Rockwell Collins, the Arrowhead Target acquisition system for Lockheed increased by over a third to $1.2 million.

Sales of component products used in Space and Defense at $16.8 million were up 29% for the quarter. The commander's independent viewer on the Bradley continues to be the largest program. Sales in the quarter were $3.8 million, up 35% from a year ago.

Sales of (inaudible) slip rings used on both the Bradley and the Abrams continued strong in the quarter. Aftermarket sales in the Defense market increased by a third to $2 million.

In '07, our sales in the marine market grew by 32%. We were inclined to simply extrapolate this growth rate when we put together the '08 plan, so we projected flat sales. Sales in this quarter of $11.4 million were up 73%. On a year-to-date basis, we're up 58%. So clearly the growth continues, stimulated by the continually increasing price of oil.

Sales in the Medical market; $14.9 million, up only 4% from a year ago; the increase driven by higher slip ring sales to customers for CT scanners, primarily Phillips Medical and Hitachi.

Industrial component sales of $14.5 million, up 22%; the increase in this area was primarily revenues from the TCP and Techtron acquisitions. Incoming orders remain strong. We do know however, that two of our slip ring customers in the closed-circuit TV over-ordered in the first quarters as they began new projects, and future sales may be somewhat lower.

As I've said in the past, forecasting the Components group is more art than science with relatively few large, long-running orders. So we begin each year with a relatively conservative forecast and adjust as we go along. Our guidance 90 days ago was that we finish the year at $326 million, we're now inching that forecast up to $330 million, driven primarily by the continued growth in the marine market.

Aircraft and Space business are also off slightly, so we're moderating our forecast in Medical and Industrial.

Components margins; the quarter at 17.3%, up nicely from last year's 14.2%. We're currently running ahead of our margin prediction for the year. Margins in this business are very much affected by the product mix, so we're projecting hopefully conservatively a moderation of the last two quarters, and a year-end average of 16.8%.

Medical devices Q2; the performance of our fledgling Medical devices segment in the first quarter of '08-- the first quarter was very close to our plan and left us optimistic about the rest of the year. Sales in that quarter were just over $27 million, operating profit just over 13%. We were projecting subsequent quarters averaging $24.8 million in sales and $3.5 million in operating profit or about 14%. The results in the second quarter did not come close to that forecast. Sales were a disappointing $22.7 million; operating profit was $350,000 or just 1.5%.

Here's what happened. [Pump] sales at $8.2 million were $1.8 million off plan on sales of the more profitable intravenous pumps, were $3.6 million off plan. A number of reasons-- being one our sales agency had very strong hospital sales in quarter one, which didn't repeat. We theorize that some hospital administrators had held onto their pump budget and released it at the end of their calendar year, which is the end of our quarter one.

In addition, we had some key part shortages which held up shipments of pumps in Europe. Also sales of disposable pain pumps softened in the quarter, since we're in the process of changing distributor organizations.

Sales of admin sets at $7.8 million were a half a million off plan, but once again, the shortfall was that administration sets for IV pumps, which are more profitable.

During the quarter, we introduced a new offshore supplier and got hung up with B. Braun on approval of this new source. So although the overall sales on this, was only $2.1 million, the dramatic product mix shift resulted in a $2.3 million shortfall in gross profit. And that accounts for most of the problem.

The other part is in higher SG&A. It turns out that the ZEVEX organization has a sales commission plan such that if certain sales goals are met, it triggers higher payouts. The very high ZEVEX product sales in our first half actually hit this trigger and the result was an unusual payment.

In addition, we had some unanticipated legal fees and we're investing more in R&D than we'd planned. The result was increased expense of about $800,000, and a very modest operating profit.

So where does that leave us for the year? We had targeted for the year, sales of $102 million, operating profit of 14% or $14.2 million. Based on our analysis of the first half, we now believe that a reasonable sales forecast for each of the next two quarters is about $24 million. We think that because it appears that sales of IV pumps will recover in the second half. Sales of the IV administration sets have already resumed with the approval of the new supplier.

So it seems reasonable to believe that the normal run rate in this business will not be $22.7 million as in the second quarter, but more like $24 million. In addition, the commission payments will moderate, so we believe operating profit of $2 million a quarter or about 8% should be achievable. The result would be year-end sales of $97.9 million, operating profit of $8 million, or about 8.2%.

I'm sure that many of you remember that we began our initiative in the medical market, hoping to develop a product line with the potential for double-digit sales growth and 20% operating margins. In our acquisition pattern, we're achieving the sales growth; thus far, we haven't achieved the 20% margins. But we still believe that that potential really does exist.

We think that this year '08, will be a year of rearranging and in some cases re-staffing our organization, a year of investing in the improvement of some of our production planning and quality assurance systems, and a year of learning to work with the channels of distribution in what is a new market for us.

But we continue to believe that our initial assessment was correct. We have very strong products and there is the potential in this business for (inaudible) growth and strong margin performance.

So a summary of '08 guidance; let me summarize where we think we are for the fiscal year. The bottom line is that although we're rising our segment sales forecast mostly upward, and margin forecast some up some down; the bottom line comes out the same.

We're now projecting sales in a range around $1.846 billion, a net earnings midpoint of $117.3 million or $2.71 a share; which I hasten to point out is a 16% increase from last year.

Looking at the segments, we've increased Aircraft sales to $657 million, changed our margin projection from 10 to 9.9%. Space and Defense increase sales forecast to $246 million, change margins from 12% to 11.2%. In Industrial, we're increasing sales projection to a range of around $516 million, and increasing margins from 13.7 to 14.3%. And in Components we're increasing sales to $330 million and margins to 16.8%. In Medical Devices, sales now forecast at $97.9 million, margins of 8.2%.

We're anticipating $0.69 earnings per share in the third quarter and $0.72 in the fourth; a slight change in those two quarters from our recent guidance.

So that's my story. I'll now turn you over to John Scannell. John's going to talk about cash flow and our balance sheet.

Thanks Bob. Good morning. I would like to follow the same format as last quarter. First I'll discuss cash flow in the quarter and provide an update for the year. Then I'll speak to our recent financing activities and talk about our tax rate, and finish with some other items from the balance sheet.

Q2 cash flow; our free cash flow in this quarter was break even, an improvement of $29 million over the first quarter. Net debt decreased by $4 million in the quarter. The reduction was the result of the translation effect on our overseas cash deposits.

Cash flow from operations was positive at $21 million, $25 million higher than in Q1. The improvement was a result of slower growth in working capital. Capital expenditures were down from $25 million in Q1 to $21 million in Q2. The depreciation and amortization in the quarter was $15 million. Interest payments totaled $13 million, but our cash tax payments were $12 million.

We're maintaining our forecast for free cash flow for the year at positive $5 million. We anticipate that our cash flow from operations will come in at $95 million and our capital expenditures will be about $90 million.

As we said last quarter, this forecast assumes we will receive $20 million from Boeing for work performed on the 787. Our discussions with Boeing on this subject continue, and we are encouraged by the recent news that Spirit Aerosystems has received a cash payment from Boeing.

Financing; we closed an expansion to our senior resolving credit facility in March. This increased our capacity from $600 million to $750 million and reset the terms at five years. The additional funds will support our continued growth, both organic and through acquisitions.

Given the tough credit market conditions, we were very pleased that each of the banks in our credit facility supported our expansion and we were able to complete this transaction with an over-subscribed offering.

Taxes; our effective tax rate in the quarter was 32.7%. For the year, we're forecasting an average tax rate of 31.6%. The reduction for the second half will come from some tax benefits associated with foreign taxes and R&D tax credits.

Other items; our non-cash stock compensation expense in the quarter was $700,000. Contract loss reserves increased by $4 million over the prior quarter, driven by our satellite valve recall.

Finally, at the end of March our net debt to total capitalization stood at 38.1%.

Thank you, John. Now, we'll go to questions. Ken--?

Thank you very much. (Operator Instructions). And our first question does come from the line of Ron Epstein with Merrill Lynch. Please go ahead.

Hey Bob, how are you doing?

Good, how are you?

Good. So when we think about Medical going forward-- I mean we were kind of hoping that things would have been kind of stabilized at this point. Can you give us any more color on how we should think about it and how we should model it and that kind of thing?

Yes, well I think your model for this year ought to be what we just described because that's what we think is most likely to happen; $24 million in the quarter, in the next couple of quarters; and then a couple of million in operating profit.

We think that next year will be stronger in operating profit. I guess I think this. When we began this initiative, as I said, we believed that this would be a market that would provide faster than average sales growth and nice profitability.

Now, I think what we've learned is that in the acquisitions that we've made, we have acquired some very strong products. We are however getting acquainted with the channels of distribution in the clinic market for intravenous pumps, and in pain management pumps, which was the McKinley product line and in the (inaudible) pumps.

And we have some things to learn. It's a new market for us. And as I mentioned in the prepared remarks, in this particular quarter we had some unusual expenses which we don't think will recur. I'm still optimistic that this is going to turn out to be a strong product line for us and I think we just have to be patient.

We bought the ZEVEX halfway through last year. We're in the process of combining the ZEVEX-- what was the ZEVEX and the Curlin organizations into a say coordinated unit with one engineering organization, one sales management outfit, one operations organization, and we're making real progress.

I can tell you I spent last week in Europe and visited a couple prospective customers, companies that are not yet customers for the products that we're talking about. And they have a very high regard for the products that we have. So, what I say; these are strong products-- it's not just my opinion, it's the opinion of people who've actually been in the market.

Okay, great. And then just maybe a follow-on question; something a little bit different-- with the award of the multi-year on the V-22 to Techtron and Boeing; how big of an opportunity is it for Moog as we walk out over the next year or so?

V-22 will be a -- will be, has been a strong program for us. We're optimistic that production rate will increase over the next couple of years. We're forecasting 36 aircraft a year and it's a good business for us. So we think it's an indicator of strong support for the program.

Okay, and then just one last question; in -- it's kind of the second half of the year here. You might have mentioned this but I guess I didn't get it. The R&D spend; do you it expect it to just be kind of flat in the second half or where do you expect it to go?

Year-to-date we're just over $50 million and we're expecting to end the year at about $103 million. So we're actually expecting it to be up somewhat over the balance of the year. The Aircraft portion; everybody seems to be focusing on, we expect will be about the same in the back half, a slow decline of the 787 and a offsetting increase in A350 and a couple of other programs. So there will be an increase in R&D spending in some of our other segments. So we, as I say, we expect to wind up the year at about just under $103 million, which was the same guidance we provided last quarter.

Okay, great. And then I guess, just one last question; in the Industrial business, Bob; have you seen any signs of a slowdown, given what's going on economically, particularly in the U.S.? Has that filtered out to any of your Industrial businesses?

Our Industrial segment-- I think you'll remember our sales-- over three quarters of our sales are generated outside the U.S. Customers are in the businesses of building power-generation facilities all over the world, steel mills in China and in Europe, flight-training simulators is an important business for us, the plastics business; plastics controls all of our customers are exporters and in the market areas that we're in, and as you can imagine we listen very carefully and we went through the review of all of those businesses to prepare for this quarter's report; there was not one mention of the term recession.

Also in the Industrial portion of our Components business, as yet we haven't seen any signs. So that's not to say that-- that there is a recession, but as you know, we don't have products that are related to home construction. We don't have any investments in CDOs or sub-prime mortgages, so we're not having those kinds of problems. So we'll see.

I mean, we just-- it's not to say ultimately a slowdown in sales of autos might ultimately have some effect on metal forming presses, but we haven't seen any signs of it yet. (Inaudible) is quite strong.

Super. Thanks.

Thank you. And our next question then comes from the line of Cai von Rumohr with Cowen. Please go ahead.

Thanks so much. You'd mentioned in talking about Medical if I recall, or maybe I got this wrong; that you changed distributors. Who is your new distributor? What was that change?

I did mention that Cai, and that was related to our disposable pump product line; we're not changing from--B. Braun is still handling the Curlin electric ambulatory pumps, but we did have a distributor-- an important distributor in the pain pump business as you may remember is the McKinley product line. And the focus of that distributor was on the orthopedic business and for a variety of reasons, that outfit has withdrawn from that business and we're now kind of in the awkward position of changing-- we're actually interviewing, if I can use that term, evaluating alternative distribution. And the result of that was a very weak sales quarter in the disposable pump business.

Got it. And then you mentioned being $800,000 above on expenses included legal and R&D. Why was the legal over and kind of-- did the R&D-- how much was it over about? And is that going to be higher for the year?

R&D wasn't the biggest part of it. The R&D over budget was about $100,000, so legal expenses were between $100,000 and $200,000 and there were a couple of activities that will not continue. I don't know that we're getting into, but we had some legal issues that had to be resolved, let me leave it there.

Most of the increase was in commission sales. The ZEVEX organization had some arrangements with some distributors that they really hit the jackpot if sales achieved some particular levels, which no one ever anticipated to have. You may remember that we had very strong ZEVEX sales in the first quarter, marginally an order from Abbott. And that taken together with strong sales in the second quarter, actually we kept those triggers and wound up with some distributors that had a real pay day. So that was the biggest part of that increase. And that's won't continue. We hadn't anticipated it, it was budgeted; but it did happen and it won't continue.

If we look at the second half, it looks you've brought your expectations down and I assume the mix should improve; what should we think about? Is it just that you've missed an off year that you really want to be cautious that you're planning to spend a little bit more to really get it sorted out? How should we think about how you're approaching that in Medical and the potential variability around the number? Is that number kind of on map to be below number or a conservative guess or the midpoint of a range? How should I think about it?

I think for the balance of this year, these look like achievable numbers. I don't know that I'd be willing to say not to be below, but I think it's likely that we will make those numbers- the $24 million in sales, the operating profit; maybe do a little bit better.

Part of this picture that I guess we don't describe in the presentation that we just went through; we're looking at sales numbers, earnings numbers in the current quarter; the thing that we don't describe is that there is in the market a lot of interest in the products that we have. And I'm optimistic-- I'm not suggesting that the interest in these products is going to have a big impact on sales in the next three to six months, but I continue to be impressed that perspective major customers have a lot of respect for the quality and the capability of these products. And we're hopeful that as a result, this business will build nicely in '09 and the years beyond. And I think with a little more volume, particularly in the intravenous pumps, that the financials will swing around.

Okay, great. On the Spirit call, in addition to kind of mentioning the revised payment schedule, they mentioned that they're looking at lower gross margins on the 787 because of the disruption of the delayed schedule. What's the impact on you? How much is the R&D expected to be for the year on the 787?

As I mentioned, we have been talking about getting through this year with an R&D spend on the 787 of about $19 million. We revised that estimate up to over $29 million-- $29.7 million. On the other hand, we have some offsets in the Aircraft business, so as I mentioned in my text, we're taking Aircraft R&D from $55 to $61 million, but we're under-spending our original budget in some of our other segments and so the total R&D spend for the year we expect will still come in at about $103 million.

So the 787 is-- there will be more expense in terms of R&D that we anticipated. In terms of the ongoing production profitability, that's still work in progress. We're still negotiating changes with Boeing. But I'm still comfortable that the production pricing is going to be just fine, so long term I think we will have invested more in R&D to get the program launched. On the other hand, we're able to afford doing what we're doing and we're still generating 16% increases in EPS quarter after quarter.

So I think the whole picture fits together okay. We're still-- there's still the issue of the cash impact on our Company. As John mentioned, we're happy to know that Boeing has decided to pay somebody some cash. And we'll continue our discussions about what the cash payment ought to be. There isn't any question of production. Let me put it this way. It won't surprise you, I don't think, if I tell you that the change that they've made in their recently announced reschedule, would have been really helpful for companies like ours if they had come to that schedule a year or a year and a half ago.

We have capacity in-- we've been investing in CapEx and developing capacity for '09 and 2010 that it now appears we didn't need to. But I'm sure we're not alone in that sentiment.

Last question; given all these disruptions that Boeing has imposed on your from let's be fair, their own bad planning; what are your opportunities to get request for equitable adjustment actually addressed?

We'll see. We continue in those discussions, as I'm sure you can appreciate. The folks that we're trying to have those discussions with have been very busy and so our ability to conduct that dialog is intermittent or shortened. But we think they'll be reasonable. We think that-- I'm hopeful that now that they have a sensible schedule that the folks will be able to devote [our] attention to the circumstances of suppliers like ourselves.

Excellent; thanks so much.

Okay.

Thanks. And we have a question in from the line of Eric Hugel with Stephens. Please go ahead.

Hey guys; how're you doing?

Good.

Can you talk about and give us an update as to sort of where things stand right now with your relationship with B. Braun. I know it's been sort of on again, off again.

I would say overall it's positive or potentially positive. There have been some hitches. We're still getting adjusted, I think, to their forecasting process. I mentioned that in this quarter we encountered a delay in our ability to deliver admin sets because of an approval process of a new offshore source. One might have hoped for a more supportive posture on their part, but I think overall the relationship can be a positive one.

It just so happens that I visited B. Braun headquarters last week and had a very positive and productive conversation with the man who was ultimately responsible for sales of our kind of products. He's one of the people that are quite enthusiastic about the capability of the product that we have. So I think long term it can be a positive and supportive relationship.

In terms of the product-line financials, we need a little more volume and we're working on that.

Just with regards to the Medical business in general I guess Bob and the senior management team; I mean do you find yourselves sort of spending an inordinate-- I mean there just seems to be every quarter, these things come out of left field. Do you find yourselves spending an inordinate amount of time dealing with these issues relative to the size of the business?

Well, I don't regard it as inordinate and it may seem that way. We're talking about a Company that's going to $1.8 billion in sales and we have a segment reporting because of the SEC requirements for segment reporting; a segment that's going to do $100 million out of $1.8 billion. So in a way, if it were in a fashion, it's the segment reporting that sort of pumps this particular product out of proportion in terms of the apparent attention.

It is a new business for us and so we're all in the senior management group, interested in getting educated, better acquainted in this market. But this is something we've been through in the past. I hasten to point out that our Company-- when I joined the Company it was primarily a Space and Defense company that delivered [several] valves and [several] actuators and little else. We had to learn the industrial market. We learned the international market. We learned the Commercial airplane business. Our Company was not a participant in the Commercial airplane business until almost 19680.

So I don't think it's unusual or inappropriate for the senior management to pay attention to new opportunities for the Company and we'll learn our way around this business.

You know, we talk about it because it's different and it's interesting and there's a lot interest in it. But you shouldn't walk away with the impression that the management of our Company spends all our time on the Medical business; quite the contrary.

No, I mean it just seems to me from a technology standpoint, where you guys sort of excel, everything looks great. It's really the distribution business where you guys-- it's the distribution end of it where you guys are just sort of relying on other people where you sort of have the issues.

Yes. (Inaudible) with that characterization that we need to learn effective distribution in this market--

Is there a case to be made for bringing distribution in house or just doing it internally with a sales force or is that just more cost than it's worth?

That's the question. I think that case could be made, depending on the volume potential of the product. But I don't think there's an obvious answer. And I think in part it will depend on the interest in this product line on the part of organizations like B. Braun. And if that company-- that is a very sizeable and very capable company. And if their interest in our products continues to grow, it could be a great relationship.

I don't think we should-- I think we need to be patient and shouldn't overreact to the particular results quarter to quarter, in this business. We've got to give ourselves some time to get the business organized and get acquainted with the market. And I think the results of this year; going from $14 million in operating profit to $8 million is hardly going to slow our train down.

Fair enough. The Components business; looking at the Medical sales up 4%, I mean I remember-- if I remember correctly, your main customer there is Respironics. They were acquired or in the process of being acquired by Phillips.

They are acquired by Phillips.

They have been acquired? Has there been any sort of change in the relationship or anything that's sort of going on there?

No. The thing that's going on there is a very sizeable automation project to automate the production of I was going to say motors-- it's now a motor-blower assembly that we're building so Respironics has actually made an investment in automated equipment which is installed in our factory which reduces the cost of the product and also the price of the product.

And as a result, sales in total are not growing at the rate that they have been in recent years, recent quarters. But as far as the relationship is concerned, we're still dealing with the same people and as yet we don't see any impact of the acquisition by Phillips.

Great. Can you update us on the Filipino peso headwinds?

Let me turn you over to one of my Filipino peso experts. John-?

The last quarter we reported that the Philippine peso had strengthened by about 20% over the previous 18 months and we had seen, we had about $30 million in peso-denominated accounts filtered through to a $4 or $5 million additional cost in this fiscal year.

The peso-- actually the spot rate at the moment, the peso has come down- has weakened relative to the dollar over the last quarter or so. So in Q1, the average rate was about 33, Q2 the average rate was 41. But we're now back up at about 42 to a dollar. So the situation seems to have stabilized. The peso, you would say, is trending weaker against the dollar but we are also in the process of reviewing our hedging strategies and do plan to insulate ourselves more proactively as we move forward.

And lastly; can you give us an update as to how many sort of 787 production ship sets that you've already shipped-- so what's in the pipeline?

Well, we've shipped about six ship sets. These are primarily for the flight test aircraft. So we're just beginning, we're just getting close to the delivery of production aircraft. We certainly have delivered as much hardware as Boeing is able to use at the moment.

And so it not like you're in a situation where you've sort shipped a heck of a lot more and they're going to tell you stop until they catch up. You're still sort of in line with their actual production rates?

Yes. Actually we had slowed our production and our production deliveries in anticipation of something like their current reschedule. That was a-- we explained some weeks back that we were taking that action and had put some of the procurement folks at sort of an awkward spot. Off the record, we got kind of a wink and a nod that what we were planning to do was about right, and that's the way it came out.

Alright. Great; thanks a lot guys.

Thank you. And we have no further questions in queue.

Okay folks, thanks very much for coming and listening and we'll see you next time.

Thank you very much. Ladies and gentlemen, replay of this conference will be available starting today, Tuesday, April 29, 2008 at 1 P.M. That replay will run through Thursday, May 9th at midnight. You may access the AT&T Executive Teleconference replay service at any time by dialing 1-800-475-6701 and entering the access code 920521. International participants will dial 320-365-3844. Those numbers once again 1-800-475-6701 and 320-365-3844 with an access code of 920521.

That concludes our conference today. We appreciate your participation as well as you're using AT&T Executive Teleconference. And you may now disconnect.