泰利福醫療 (TFX) 2007 Q3 法說會逐字稿

Welcome to the Teleflex third quarter 2007 results conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's conference, Ms. Julie McDowell, Vice President of Corporate Communications at Teleflex.

Good morning. Teleflex issued a press release last evening that is available on our Web site. This call will be available on our Web site and the replay will be available by dialing 888-286-8010, or for international callers 617-801-6888, and the passcode is 55450271.

Participating on today's call are Jeff Black, Teleflex Chairman and Chief Executive Officer, and Kevin Gordon, Teleflex Executive Vice President and Chief Financial Officer. Jeff and Kevin will make brief prepared remarks, and then we will open up the call to questions. As is our usual practice, please keep your questions to one and a follow-up. You will find a set of slides accompanying our remarks on our Web site, at www.Teleflex.com.

Before we begin I would like to remind you that some of the matters discussed in this teleconference could contain forward-looking statements regarding future events. We wish to caution you that such statements are in fact forward-looking in nature and are subject to risks and uncertainty, and actual events or results may differ materially. The factors that could cause actual results or events to differ materially include, but are not limited to, economic conditions and conditions in our markets, delays in the closing of transactions, failure to successfully integrate assets, employees and processes of the two companies, the actual amounts of the transaction expenses associated with acquisitions, inability to realize expected synergies, and other benefits. Additional factors that can cause actual results to differ materially from those in the forward-looking statements we make today are included in our press release today regarding (inaudible) today, as well as our filings with the SEC, which can be accessed at www.SEC.gov.

Throughout our presentation and the conference call today, we will be using non-GAAP financial measures, including adjusted operating income, adjusted net income, adjusted EPS. These non-GAAP measures are adjusted to exclude the impact of restructuring costs, any gain or loss on the sale of assets, and any tax adjustments. A reconciliation of these non-GAAP measures is included in the appendices to the presentation on the investor relations portion of our Web site. I'll now turn the call over to Jeff Black.

Good morning, everyone. Those of you who have followed Teleflex for some time know that over the past few years we've made significant changes in our business with the goal of creating a portfolio that can deliver better long-term value for our shareholders and customers. The most dramatic changes to date were made in just the last few months with the announcement of two transactions that redefine Teleflex.

On October 1st we completed the acquisition of Arrow International, expanding our medical technology segment to more than 1.4 billion in revenues.

Just two weeks later, we announced the signing of an agreement to sell our automotive and industrial businesses to Kongsberg Automotive for $560 million. The automotive and industrial businesses have annual revenues of approximately $855 million.

Two large, portfolio-changing transactions, followed by a small acquisition in our aerospace segment, which is expected to close later this week. Short-term, these actions create a lot of moving parts. But over time, they clearly create a portfolio that can deliver better operating margins, reduce cyclicality, and opportunities for future growth.

Just to give you some more perspective on the transition, slide number 6 approximates the composition of the Teleflex portfolio before and after the transactions. Teleflex is becoming a diversified company, defined by its medical business. Medical technology will represent roughly 60% of Teleflex's revenues and 75% of segment operating profits. In 2002, medical represented just 22% of revenues and 35% of our operating profits.

When I assumed the role of President and CEO of Teleflex, I saw that we could significantly invest and grow our medical business. It generated margins and returns in excess of the corporate average, provided significant growth opportunities worldwide, and was less cyclical and less influenced by economic conditions. This quarter's strategic actions bring that goal to fruition in a big way.

The commercial segment has historically been about 50% of our revenues and had 2006 operating margin of 6%. With the divestiture, the commercial segment will represent less than 20% of the overall revenues for the Corporation. We've gradually moved away from dependence on OEM customers to become a portfolio of businesses with strong brand and market positions, established customer base, and more focused development efforts. Needless to say, we are excited about the potential created by the actions and the opportunities which lie ahead.

Turning to the quarter, we had a good third quarter overall, with solid financial results and good progress on some of our initiatives. We generated solid growth on both the top-line and bottom-line, all three segments posted positive core growth, and our cash flow remains strong.

Kevin will go into the financing for the aero transaction in some detail, but I want to also note that in a tough financing market, we were able to secure the financing in line with our original expectations. As you would expect, we will look to utilize the net proceeds of the auto and industrial divestiture to pay down our debt.

Also of note is the successful launch of a new IT system in the North American medical business. We started the cut over in late September, went live a few weeks ago, and the transition to date has gone pretty much as planned. At this point I'd like to recognize the tireless efforts of the team of people who made this happen over the last 18 months, yet there is still more work to be done.

In the aerospace segment we added to the order book and win record of our cargo systems business with the first orders for cargo systems designed for the 747-8 freighter. And we also completed the closure of a US facility and [consolidated] operations for our repairs business.

Slide number 8 summarizes the business dynamics that we saw this quarter. In general, we saw continued strength in international markets. The marine aftermarket and international sales were up again, despite continued softness in the overall marine market. Sales were strong again for driver controls for the truck and bus markets in Europe and Asia, and we weathered the short strikes and slow summer season in automotive. The only significant change in market conditions came at the end of the quarter as the continued downturn in the North American truck markets hit our forecast for auxiliary power units.

In medical, European sales increased double-digits, and we had a very good year-over-year growth in other international markets as well. North American sales were up nicely on both disposable products and surgical products, regaining some momentum from the past.

Our other international markets for medical continued to make inroads across our product lines, and aerospace revenue growth tapered off slightly compared to last year's quarter, but the market remains very strong. We're investing in new technology for repairs on new engine types, and we maintain a strong position and order book on 747s as well as on Airbus planes.

In the fourth quarter, we focused our resources on execution. In commercial, we will look to complete the divestiture of our automotive and industrial businesses by year-end, and to provide a smooth transition for our customers and employees. In addition, we have responded to reduced projections for the auxiliary power units with consolidation and closure of a facility, and we expect to continue with cost controls.

In medical, the top two objectives are executing the Arrow integration plans and accelerating the review and improvement of Arrow's quality systems. At the time of the acquisition, we conducted due diligence with our regulatory team and set aside significant resources as part of the integration plan to deal with outstanding issues. We will be working closely with the FDA to respond to their findings and address outstanding issues, and expect to be actively engaged in this program for some time.

On the integration front, we have been moving rapidly through Phase I, organizational changes, corporate and public company expense reductions, and such. And in aerospace, we expect to realize the benefits of our facility closure and consolidation repairs, and to capitalize on productivity initiatives in cargo, as well as to quickly integrate our bolt-on acquisition of Nordisk Aviation Products.

In summary, the third and fourth quarters have been quite a time of dramatic and positive change here at Teleflex. We will be spending the next few months completing the transactions, implementing processes and changes to address the new portfolio structure, and laying the groundwork for 2008 and beyond.

With that I'll turn it over to Kevin for more detailed financial results.

Thanks, Jeff. Good morning, everyone. Obviously, a very busy quarter for us here at Teleflex, with a number of moving parts. Let's start with a quick summary of third-quarter and nine-month results.

On slide 11, we provide a snapshot of our operating results from continuing operations for the third quarter and nine months. All told it was a good quarter for Teleflex, with good revenue growth, including positive core growth across all three business segments. Some operational issues and related adjustments for estimated warranty and production inefficiencies in commercial and aerospace, respectively, caused margin compression during the quarter, but we did see growth on the bottom-line as the medical segment had a great quarter.

The trends certainly validate the strategic direction that we are taking for the Company as a whole. For the quarter, revenues were up 8% to $656 million, with approximately 3% of the growth coming from core growth. For the nine-month period, revenues were also up 8% to just over $2 billion, with core growth accounting for 3% of the improvement.

Gross margins were down 30 basis points during the quarter, but up 70 basis points in the nine-month period, and I'll address this further in the segment reviews.

In the third quarter, a $90 million tax adjustment related to repatriation of cash in connection with the Arrow acquisition caused us to post a $57 million loss on a GAAP basis, or $1.44 per share. For the nine months, GAAP net income from continuing operations was $29 million, or $0.74 per share after the tax adjustment.

Adjusted operating income was $67 million, down slightly from last year's third quarter. For the nine-month period, adjusted operating income was up 13.2% to $221.3 million. A reconciliation of the adjustments is found in the appendices to the presentation as posted on our investor relations page.

Adjusting operating margins were down 100 basis points to 10.2% in the quarter, but were up 50 basis points to 11% year-to-date. Compared to last year, adjusted earnings were up approximately 5% for the quarter. Adjusted net income was $38 million, or $0.96 per diluted share, compared to $36 million, or $0.92 per share last year. For the nine-month period, adjusted net income from continuing operations rose 22%, from $103.3 million, or $2.57 per share, to 126.1 million, or $3.18 per share. All things considered, we have delivered good financial results thus far in 2007.

Slide 12 provides some additional details on the cash repatriation. I will go into the details of the financing a bit later in the presentation. Teleflex has generated and expects to generate significant cash flows in its foreign operations. In connection with the funding of the Arrow acquisition, we repatriated approximately $197 million of cash from foreign subsidiaries during the third quarter. In order to free up earnings to be repatriated, we changed our position on previously untaxed foreign earnings so that they are no longer deemed permanently reinvested. This enabled us to repatriate cash in the third quarter and in the future as a means to pay down debt from US sources, but it also necessitated the tax charge of approximately $90 million. The repatriation of 197 million in cash in the quarter required an associated cash tax cost of approximately $6 million and a reversal of a deferred tax asset of $26 million. In addition, we recorded a deferred tax liability of $58 million related to future repatriation of funds to service our debt. To summarize this, this predominantly non-cash income tax charge anticipates our need to access foreign cash to both invest in the acquisitions and to pay debt over the next few years using cash generated in certain foreign operations.

Our cash flow remains strong, with $73.7 million of operating cash flow in the third quarter and $208 million in the year-to-date period. Trailing 12 months operating cash flow was a healthy $330 million, which demonstrates our ongoing cash generation ability, which we expect will effectively fund the debt repayment requirements associated with the Arrow acquisition.

Let's now take a look at the results from the operating segment. Obviously, the big news in this segment happened after the close of the quarter, with the signing of an agreement to divest the automotive and industrial businesses. These businesses will be classified as discontinued operations beginning in the fourth quarter. We expect to post unaudited historical financial statements on the discontinued operations to our Web site sometime later this quarter.

Turning to the results, overall the commercial segment had a healthy 8% growth in the quarter, of which 2% was core growth. However, operating profit in the quarter was down 38%, from 14.8 million to $9.2 million. The negative news here was the need for an adjustment to and a catch-up accrual for warranty in the power systems business, as well as a call down in the forecast for that business from our largest distributor. The warranty reserve impacted commercial's operating profit by about $4 million for this quarter, and was the biggest driver for the year-over-year delta in performance. An additional $0.8 million inventory step-up charge related to acquisitions was also recorded in the quarter and will not repeat in Q4.

In the businesses to be divested, strong truck markets in Europe and Asia and the ramp-up of a new product launch helped to increase sales for industrial driver controls and fluid systems in the quarter, a trend we have seen all year. Automotive sales increased on currency in what is a seasonally slow quarter. Operating profit for these businesses was impacted by customer price reductions in automotive, and the impact of increased engineering spend related to new platforms that will launch in 2008 and beyond. Additionally, we had a negative impact as the Slovakian currency continues to strengthen against the euro, putting pressure on margins.

Some insight into the composition of our commercial segment on a go-forward basis, subsequent to the proposed divestiture. Products for the recreational marine market make up just over half of the revenue. Auxiliary power and alternative fuel systems for industrial vehicles, truck and rail markets, and rigging services for oil and gas marine transportation and a range of industrial markets represent approximately 30% and 20%, respectively.

To give you some color on the tone of the business, the marine aftermarket and international sales continued to be strong, and an acquisition that expands the rigging service business into new markets contributed 3% to overall commercial revenue growth in the quarter. Each of these businesses has aftermarket or service components, brand recognition, and is positioned with a strong market niche. Product lines serving the marine market and rigging products and services for industrial markets tend to contribute higher operating margins than the segment average, in the high single to low double-digits. The auxiliary power and alternative fuel system product lines are in changing markets, and have been lower than the segment average. There is definitely some seasonality in these businesses, particularly with the marine product sales, generally highest in the second and third quarter boating season.

Moving to aerospace, in aerospace we see revenues increased 6% from $107.4 million to $113.7 million for the quarter. Operating profit was $7.5 million, compared to $9.8 million in last year's third quarter. For the nine months, revenues were up 12% from $294.9 million to $331.4 million, and operating profit was up 19% from $27 million to $32.2 million. Core growth in the quarter was 4%, with sales increases in both repair services and cargo systems. In cargo systems, revenues were up on a different mix of wide-body systems. Aftermarket spares, while still a relatively small percentage of total revenues, were again up.

Operating profit in the quarter was impacted by an approximate $2 million charge related to production inefficiencies in the cargo container product lines. Additionally, we had a mix impact in both businesses. Repair services had a higher percentage of replacement versus repair than we have seen recently, as well as in the prior-year quarter. In cargo systems, we delivered more production and special freighter systems and fewer large cargo freighter systems than in the prior-year quarter. Looking ahead, we expect to benefit in the fourth quarter and next year from the cost savings achieved from the closure of a US facility and repairs and further production efficiencies that are strengthening the cargo systems business.

Moving to medical, medical had a very strong quarter. Revenues increased 10% from $207.7 million to $227.8 million. Core growth was 3% for the quarter and 3% for the year-to-date period. Operating profit was $50.4 million, up 14% compared to $44.2 million in last year's third quarter. Operating margins increased to 22.1%, the highest we have ever recorded. For the nine months, revenues were up 8% from $628.6 million to $681.1 million, and operating profit was up approximately 27% from $111.8 million to $142.3 million.

Revenue drivers this period include an increase in disposable product sales and airway management and urology in Europe, where we generally saw improvement across major markets compared with the same time last year. In North America, respiratory care and anesthesia sales were up nicely in the quarter. We also saw recovery in North America surgical product sales for products like instruments and light sources that were down somewhat in the second quarter. In addition, nice growth from our acquisition last year of a minimally invasive instrument line helped to offset the declines from smaller product lines that we are phasing out.

Our acquisition of an orthopedic fixation device line for medical device manufacturers also contributed both growth and profits. Overall our business serving medical device manufacturers continued the pattern we have seen all year, with increased sales in sutures and specialty devices. As noted earlier, the new IT system launch has been successful and costs are in line with our expectations -- no small accomplishment by the medical and IT teams. We're a month into our system launch, and we've had only minor issues to work our way through. Fourth-quarter revenues in North America may be tempered slightly, based on distributors building inventory prior to launch. We do, however, expect core Teleflex medical businesses to maintain their 20% margins going forward.

We also wanted to give you some perspective on the Arrow business (inaudible) and provide you an opportunity to scale it for financial modeling purposes. As shown on slide 17, Arrow delivered $512 million of revenues in the trailing 12 months ended August 2007, which was Arrow's fiscal year-end. Revenues ramped up throughout the fiscal year, and in the August quarter were $133 million. Excluding special charges and restructuring, principally related to the transaction, Arrow delivered $91.1 million of operating profit for the year and a 17.8% operating margin. We believe that synergies will enable us to drive these margins closer to the Teleflex 20% [bogey] over time.

Slide 18 provides you with the post-closing debt structure for Teleflex. The Arrow acquisition was financed with cash, both from Teleflex and Arrow, a senior secured syndicated bank loan, and issuance of private placement notes. Total outstanding debt was $2.25 billion with a blended interest rate of 6.85%. Approximately $992 million of the debt, or 44%, is floating, with most of that pegged to LIBOR with a spread of 150 basis points.

Let's discuss our outlook for the fourth quarter and beyond. We're looking for another strong quarter from our existing medical business in Q4. We're also expecting aerospace to return to the double-digit margin range, benefiting from cost savings and improved production efficiency. In commercial, we will have a tough comp as we pare back to address the change in forecast for power systems. All told, we think the performance of medical and aerospace will balance out the tough comp in commercial. We're planning to provide 2008 guidance in January once we are through our normal profit planning cycle, purchase accounting, and have completed the analysis of costs related to the integration of Arrow.

Slide 19 also reiterates the expectations for the Arrow acquisition, which were articulated in July. We expect Arrow to contribute revenues in line with its fiscal fourth quarter, although the transaction will be dilutive to GAAP EPS in Q4, including transaction-related and purchase accounting adjustments. We will provide more details as soon as we can.

We've acquired Arrow, agreed to sell the automotive industrial businesses with revenues of approximately $855 million, and expect to complete the Nordisk acquisition this week, though from a financial standpoint, there are a number of pieces to come together over the coming weeks. We believe that by the end 2008, we could see an earnings per share accretion from Arrow on a pro forma basis, but that it will be dilutive to GAAP EPS. We also are shooting for 20% combined medical margins by the end of the year. We think $30 million of synergies are achievable in 2008, and we continue to believe that Arrow will be solidly accretive to EPS in 2009. We are targeting 50 to $60 million of synergies in 2009, and we expect to meet our 70 to $75 million target for synergies by the end of 2010. 80% of such synergies are expected to result from cost savings, and approximately 20% from revenue synergies.

With that, let me turn it back to Jeff for closing comments before we take your questions.

Thanks, Kevin. I think the actions we've taken in the past few months will go a long way to recasting Teleflex's business portfolio, and no doubt make us a stronger, more balanced, less cyclical company going forward. In essence, we swapped out our automotive and industrial business, plus cash, for a medical business with recurring revenues, strong branded products, distinct competitive points of differentiation, world-class research and development capabilities, and a significant percentage of recurring revenues.

At the same time, we will soon complete the bolt-on acquisition of Nordisk, an aerospace business that complements our leadership position in the global cargo equipment market. The result is that Teleflex will be a stronger company with expanded margins, distinct growth drivers, including demographic trends, and less exposure to market cycles and risk.

Our challenge now is to smoothly complete the auto and industrial divestiture and aggressively pursue our integration activities in the medical segment to unlock synergies. We're off to a running start from this standpoint, and we believe the expected synergies are very achievable. We believe our recent strategic actions have positioned Teleflex for future growth with continued expansion in new products and markets.

With that I'll turn it back over to Julie for questions.

Operator, we're ready to take questions.

(OPERATOR INSTRUCTIONS). Deane Dray, Goldman Sachs.

Just for starters, it's more of a statement than a question. You really have taken on an extraordinary amount of projects here in a very compressed timeframe. And to your credit, you've stayed right on track. No small feat with credit market pressures as well. So, I'm not inclined to throw accolades out like that freely, but it really has been a tough process, and you've executed well so far. Don't get complacent here, I'm sure.

We knew that was coming, Deane. That's great. Thanks.

Just for starters, that 22% margin in medical, that's a record. And I just want to make sure that there is nothing in there that would be more non-recurring. Or just is there anything that really was the factor that drove the margins this quarter?

I would put it more on the volume. I think we had a good quarter, and the mix of the product was attractive. We had growth in all segments, whether it be Europe or Asian markets, or even here in North America. So the biggest part of it would be volume. There's nothing significant in there that I would consider to be any type of onetime adjustment.

That's helpful. How about just to make sure you can put this warning letter in context. We've seen this in companies that have medical lines before with companies that we follow, and it didn't sound as though there had ever been an issue of any product, affected product being shipped; it's more in your testing procedures. I've seen this before. Just kind of walk us through what the context of the issue is, and what would be the optimistic timeframe.

I think we identified this, obviously, as we were doing our due diligence. And I think there was probably three areas that the FDA picked out. One was training. The other was following processes. I'm sorry; I forgot the third off the top of my head -- and the quality systems, again, being up to snuff. I think we saw it. We did put aside a fair amount in the integration to deal with these. Again, while I think the timing is unfortunate that it comes 10 days after we have acquired the business, I think we were prepared for it. And I will tell you that Ernest Waaser and our head of [our QA] has been through this process before. We are fairly confident that we will work closely with the FDA, but there is no question it will require some resources and some investment to get us to the point where we need to be.

That's very helpful. And again, that's within the framework of what we've seen happen before. I'm inclined to call that benign, in terms of you're going to get one of these warning letters; it is much better to get them on that side of the business and something that can be addressed quickly and resolved. So that's fine there.

I would just be very curious if you've heard feedback from customers regarding the Arrow acquisition. You've now had it under the belt for a bit here. Have there been any surprises in terms of the integration? It didn't sound like it. Because, Kevin, when you clicked through the synergies, everything was spot on with what you said before in terms of the timing and the size.

I think the integration started off pretty well. I think as we said on previous calls, before we even closed the deal, we had folks from both sides of the Arrow companies, the Teleflex companies working together to plan integration and develop the processes. So the up-front planning, I think, is paying off. And we're in execution phase, and everything seems to be on track.

I think the other thing, Deane, was literally, I think, the week after we closed, they had their national sales meeting, which myself, Ernest, Rich Kindberg all attended. The excitement within their sales group was unbelievable. They've had a fairly narrow product line. I think, again, with the antimicrobial coatings that they have putting them across some of our product lines, we feel like that's a real opportunity for growth and margin expansion in the future. Salespeople are always very reluctant. But I would say that by the time we finished, they were as fired up, I think, as we were.

And quite frankly, I think the other positives that we've seen -- the cultures of the two companies, while I think you always get a view of that during due diligence, we really have found the cultures to be somewhat aligned. And I think, again, we really take an industrial mentality. We're pretty much into lean manufacturing. So there are areas of opportunity for us to work together. But they also do some things very well, especially in the R&D area, that we hope to continue to take advantage of.

Last question and I'll hand it off. What have the lessons from Hudson taught you about these larger-scale integrations?

I think that the one is your planning has to be very detailed. You have to have the accountability. But more importantly, you've got to step in and you have to act upon change fairly quickly. Organizations are receptive to it early, and I think we've said best-of-breed. I think when you take a look at our senior management team, which I think we will be rolling out when we do our analyst day in January, you will find that several of the senior managers from Arrow have filled senior positions within our organization. We truly have believed best-of-breed, but we've also believed that you have to act quickly and set the tone, that change is going to be there. And quite frankly, we found the Arrow organization to be quite receptive.

Ryan MacLean, Janney Montgomery Scott.

I know it's only been a month, but I was wondering if, with Arrow, if you have identified anymore opportunities, or has it pretty much just been what you've expected with the integration so far?

The teams have been working pretty well. I think, as we said earlier, we certainly expect to achieve the synergies that we articulated earlier. As you get into these things into more detail, I think, you find pluses and minuses. So, where you may have seen things that you thought were a larger opportunity before, perhaps maybe it wasn't as large as you thought. I think the good news is I think we're finding many more pluses than minuses. So execution on those are going to be critical. But all told, I think, we're very much in line with what our first impressions were.

Also, from an overall portfolio standpoint, are you happy with the remaining businesses that you do have, or do you see additional pruning down the road?

I think, as we've demonstrated over the last few years. we're going to continue to be active portfolio managers. Where we find opportunities either on the buy side or on the sell side to create shareholder value, we'll do so. I will tell you at this time, I think, our capacity, both from a leverage standpoint and from a resource standpoint, is fairly limited. So I think we know what we have on our plate, and we see just execution as the key over the next at least six months. But no doubt, if we find opportunities to continue to look at the portfolio, both on the plus and minus side, we'll act upon those.

Thank you. A couple of other short questions. In aerospace, the container demand issue, is that pretty much just short-lived, or is there anything longer-term about that?

I think the good news there is the acquisition that we're completing has an extremely strong backlog as we look at it going into the acquisition. I think some of the production inefficiencies that we've seen in that particular facility are somewhat short-lived, and we'll be sharing capacity as we integrate that business.

That's good. Your fourth-quarter tax rate assumption -- what are you assuming that?

I'm sure as you can imagine, with the $90 million charge and the cash repatriation, and the acquisition coming in, it's going to be a bit moving. In the third quarter it was in the 25% range. So from our core operations, we would expect it to be in a very similar range to that. However, when you start taking the magnitude of a business such as the industrial and auto businesses out, we're talking about operations that represent 14 or 15 countries. So it's going to move around a bit. I can't give you a specific number today. But certainly the steps that we've taken with the repatriation and the charge have put us in a position to kind of minimize the tax expense line as we go forward, consistent with what we've done in the past.

That's fair enough. Finally, the commercial businesses divestiture. Do you expect that to happen first quarter of '08?

No. We expect that to happen by the end of this year.

[Alex Jachnic], [Janon Partners].

I guess just a couple of quick questions. On the FDA side, I guess you sort of anticipated that letter from the FDA that related to the Arrow facilities.

It's almost like anticipating a root canal. I don't think it's something -- I think we saw some of the signs, but I don't think we anticipated it by any stretch.

Just to clarify, Alex, we were certainly aware, as part of our due diligence, that there were previous letters that were issued by the FDA. I think as Jeff said earlier, as part of our modeling of the acquisition going forward, we anticipated the need and the requirement for us to invest in those areas to improve the quality systems. So I can't say that we anticipated getting the letter that we got, but we certainly are taking it seriously, and we'll work closely with the FDA to make sure that we address all their issues.

Okay. And then, as far as -- I know you've, obviously, gone through, as you mentioned before about the Q4 tax rate. But going forward, the business mix should raise your overall tax rate, right? If I'm starting to model out to '08, '09, I (multiple speakers)

Certainly, the Arrow businesses had a tax rate that was significantly higher than the Teleflex tax rate, as you can see from their financial results. However, we will employ integration strategies and so forth and tax planning for their international operations the way we have in the past. So there may be an expectation. As we change the portfolio, again, there's a large part going out and a large part going in that's spread across many taxing jurisdictions. We can't tell you precisely, but there may be the opportunity or the potential that it may rise a bit. But I can't precisely -- I wish I could tell you exactly what it was, but I can't.

(OPERATOR INSTRUCTIONS). Dan Rutter, WHV.

Thanks for the opportunity. Can you talk a little bit about the IT transition in the medical division? Specifically, I guess, are there duplicate costs? And what is the risk and expense profile, maybe, for the fourth quarter? I'll come back after that.

I would tell you, as Jeff mentioned in his remarks, that we're extremely pleased with the launch and the way (inaudible) unveiled since we went live on the first part of October. As with any systems launch, you have some minor -- some hiccups. Fortunately for us, I think, the amount of planning and investment that went into this process before we went live put us in a position to be quite successful here. Certainly our next hurdle is to close the books for October, which will put us through our first closing. But right now, all signs are very positive.

In terms of spending, as we mentioned in our remarks, we are certainly in line with what our original expectations were. The launch has been focused on our North American medical business. So as we look to the fourth quarter, our spending in the fourth quarter may actually be a bit lower than I think the previous estimate that we've given. So we expect that spend to be in the 2.5 to $3 million range as we transition and get everybody up, appropriately finish the training and so forth.

That's great. That's very helpful. Would you talk a little bit about the warranty expense? Is that all APUs? And I'm curious, it doesn't seem intuitively to me that a slowdown in the heavy truck market would necessarily create a need for more warranty expense. Could you talk about returns, and if there's been any kind of actual quality issues with those?

I think you're correct in that there's two unrelated issues. One is we launched a new version of the APU, an upgraded version, more than a year ago, that we've been selling. The warranty issues that are existing are actually on the previous model to that -- to the new. So the newer version we launched, I think, had some increased HVAC components in it and so forth, and the warranty there has been nowhere near what it was.

Unfortunately, with respect to the older version, as we've gotten into our relationship here, particularly with Carrier and having them process claims, the number of claims that have come in with respect to those older versions were higher than we had originally estimated, which required us to book this reserve. So that's the warranty side of things.

On the outlook side, with respect to the North American truck market, and the transportation market in general, we have seen sales of our AP units this year be approximately equivalent with what they were for the first three quarters of last year. However, the outlook as we look into the fourth quarter, and then potentially into the early part of next year, we see a significant drop-off in demand through our distribution channel at the moment. So they are unrelated issues. As Jeff mentioned, we've addressed some of that with cost controls. We've actually taken steps to consolidate a facility in that product line. So we're addressing the issue on the cost side with respect to that outlook.

Just to be clear, from a market standpoint, we see this as a lot of a market issue and not reflective on our quality issue. So to me, that's why, I think, some of this is -- we've got to, obviously, have this accrual.

Are the APUs going on mostly on new engines, or is there a high degree of retrofit here?

What we've seen historically is it's been an aftermarket product. However, what we've seen is that an individual who may buy a new truck would typically put this product on, and they would make the investment within the first six to 12 months of ownership of a new vehicle. So it's not going in on the OEM, and it's not sold through an OEM; it's sold through an aftermarket channel. But it typically is associated very clearly with the purchase of a new vehicle.

[Steve Rom], [TCW]

Could you talk a little bit about the $4 million warranty charge in commercial, what particular line that was, and whether it's in one of the lines which are to be sold or to be retained?

We just went through -- I think that was the previous question in terms of APUs. It's related to the power business, which is the APU business. That is a business that is not part of the portfolio of businesses that we are divesting. So it is a continuing product line.

You have no further questions. I would now like to turn the call back over to management for closing remarks.

Thank you all for joining all of us. This call will be available on the Web site, and a replay will be available by dialing 888-286-8010, or for international callers, 617-801-6888, passcode again, 55450271. Thank you.

Thank you, everybody.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.