泰利福醫療 (TFX) 2008 Q2 法說會逐字稿

Good day ladies and gentleman and welcome to the second quarter 2008 Teleflex Incorporated earnings conference call. My name is Nikita and it will be my pleasure to assist you today. At this time all participants are in listen only mode. We will be facilitating a question and answer session towards the end of today's conference at which time you may press star one to participate. (OPERATOR INSTRUCTIONS).

As a reminder this conference is being recorded for replay purposes. I would now like to introduce your host for today's call, Ms. Julie McDowell, Senior Vice President of Corporate Communications. Please proceed, ma'am.

Good morning. The press release and slides to accompany this call are available on our website at Teleflex.com and as a reminder this call will be available on our website and a replay will be available by dialing 888 286 8010 or for international calls 617 801 6888, pass code 19203250.

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.

Before we begin, I'd like to remind you that some of the matters discussed in this conference call will contain forward looking statements regarding future events as outlined on slide two. We wish to caution you that such statements are in fact forward looking in nature and are subject to risks and uncertainties 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 factors as made in our press release today as well as our filing with the SEC including our Form 10 K which can be accessed on our website.

Throughout our presentation and conference call today we'll be using non GAAP financial measures and the reconciliation of these non GAAP measures is included in the appendices of the presentation. Now, I will turn the call over to Jeff Black.

Good morning, everyone. Thanks for joining us. Before I begin the call I'd like to introduce you to Jake Elgiocze. Jake was recently named Senior Director of Investor Relations reporting directly to Kevin Gordon. For the past two years he's managed our financial planning and analysis function and has done an outstanding job. He's a great addition and we look forward to having him in this role.

Julie, on the other hand, is also going to be expanding her role as Senior Vice President of Corporate Communications. She'll be responsible for our Global Communications Program and developing our new market initiatives for our operations. Julie will be working closely with Jake on the transition, but she has been a trooper for the last five plus years working through our transition. So, again, Julie thanks for all of your help.

Let me get on to the quarter. Another good quarter for Teleflex. Operations delivered strong performances and we executed well in our strategic initiatives really across the board in a somewhat difficult environment. Revenues for the quarter were up on acquisitions and strong international sales. Medical delivered nice core growth at 3%, aerospace came in with a 5% core growth and this offset the expected decline in commercial core revenues. EPS excluding special charges was $1.05, up 18% over prior year.

Overall, operating margins before special charges were in line with the goal we set at the beginning of the year for mid teens adjusted operating margins. Cash flow from operations was ahead of last year when adjusted for the income tax payments we made on the divestiture of the automotive and industrial business in December of 2007. So, overall, great progress. We're executing well and continuing to see the benefits of the portfolio changes that we've made over the last several years. Turning to slide six.

Our medical segment delivered nice core revenue growth this quarter. Core growth was driven by strong critical care and surgical sales in European markets. And we also had double digit growth in sales to medical device manufacturers primarily based on a significant increase in sales in our orthopedic product lines. It's really nice to see the progress in this business after some challenging quarters.

In North America, core revenues were down modestly with lower volume and price pressure impacting several product lines in both critical care and surgery. Arrow product sales grew at about 6% compared with prior year. We were especially pleased to see the significant up tick in vascular access sale in our Asia/ Latin America regions. Kevin will provide more detail on the specific product lines and the ups and downs, but overall a good quarter.

Our regulatory compliance program and the Arrow integration program are top priorities for the medical segment and we made good progress here as well. Regulatory remediation programs efforts continued on schedule and we are executing well against our plan and budget expectations. During the quarter we made the decision to dedicate additional resources and dollars to expedite our training and documentation effort. This meant a significant increase in spending in Q2 compared to Q1, but it should also enable us to reallocate committed resources to R&D projects sooner then we would have otherwise been able to do. As we have said previously we are working to ramp up our R&D program. As we progress with our compliance program our plan is to allocate some of the spending to new product development efforts. Today, we are actively working to increase our resources in R&D.

On the Arrow integration, we remain on track to achieve our pretax synergy target for 2008 of between $35 million and $40 million. In addition, we remain on track to achieve the annual pretax synergies of $70 million to $75 million by 2010.

Slide eight gives you a little more detail on the integration activity. To date, most of benefits are resulted from eliminating administrative and corporate costs. We've realigned the functional organizations, created a dedicated anesthesia and airway management sales team, begun streamlining processes and prepared to consolidate manufacturing.

We've announced manufacturing product transfers from three Teleflex facilities in Europe and one in the US and from one former Arrow facility. The first product line moves were complete, but we are still early in the process and expect most of the product line moves and facility consolidation to occur over the next 18 to 24 months or so. You should note that we will make product line moves gradually. We will take the same approach to any changes in the distribution channel. This takes more time, but in our experience it also limits risk and the potential for disruption in service to our customers.

You'll also note that we will be creating a new European distribution center that is expected to open in the third quarter. So far we have a great start, but still relatively earlier in the integration process with much of the benefit still to come over the next few years.

Taking a look at the medical revenue by region and product groups. To remind you, nearly 90% of our revenues come from critical care, surgical and cardiac products sold to hospitals and healthcare providers. We enjoyed broad geographical distribution with approximately 50% of our revenues outside of North America. We've seen strength in foreign markets and look to continue to expand our presence and sales activities in places like Asia, Latin America and Eastern Europe.

11% of our revenues come from sales of products sold to medical device manufacturers as components of products sold worldwide. These are reflected on the slide as OEM. Critical care products are the largest product group representing 63% of sales. And again, well over 80% of our total revenues come from disposable or single use products. Let me move on to aerospace.

It was a strong quarter for the aerospace segment. On the revenue side we continue to see strong growth in cargo systems. We added to our installed base of wide body cargo handling systems delivering about the same number of main and lower decks systems as in 2Q '07. The 5% core growth resulted largely from higher unit volume per narrow body cargo loading systems and a record quarter for cargo after market spares and repairs. We previously announced our selection as a preferred supplier on the A330 and 340 Airbus platforms and the Boeing 747 8 platform. Deliveries of the A330 and 340 platforms have begun and we expect strong growth heading into 2009. The first 747 8 systems are expected to ship in the fourth quarter of this year.

The engine repair business held revenue in line with last year despite the impact of exiting lower margin product lines in 2007 and improved its margin with a more favorable mix of repair services in contrast to replacement parts.

In commercial, power systems sales of auxiliary power units for Class A trucks was the weak spot again with a significant decline in unit volume compared to the strong second quarter last year.

Our marine business saw a seasonal pickup for the second quarter compared to Q1, but weaker markets over all, particularly when compared to prior years. The marine team has done a good job in cost containment and adjusting operations for market conditions, but with fuel prices where they are we expect this will continue to be a tough market.

On a more positive note, oil drilling activity in the Gulf region and expansion into other markets through the wholesale business shows strong growth and margin improvement in the rigging services.

In summary, a strong first half and given the market trends, order rates and our operational plans today we are raising our full year EPS and cash flow from continuing operation expectations. We'll talk about this in a few more minutes after Kevin walks you through the financials. Kevin?

Thanks, Jeff. Let's begin with the operating results for the quarter. Slide 12 provides a summary of results from continuing operations noting the adjustments related to special charges in the quarter.

Revenues for the second quarter were $624 million, up 38% over the second quarter of 2007. Gross profit for the quarter increased 540 basis points over the second quarter of 2007 to 41.5%. This was up sequentially as well reflecting the benefits of the portfolio changes we made last year and the growth of our medical segment. Operating expenses of $159.7 million represented 25.6% of sales reflecting the expansion of our medical business and investment in compliance and R&D programs.

Operating income before special charges was $99.3 million, up 66% from $59.8 million in 2007. Adjusted operating margins of 15.9% reflect an increase of 270 basis points compared to last year. Special charges in the quarter totaled $6.1 million and related primarily to the Arrow integration program. We continue on track with the integration programs and Jeff previously provided some insight into the future activities. And finally, operating income was $93.2 million, up 65%.

Slide 13 provides reconciliation to the $1.05 EPS number for income from continuing operations before special charges. Restructuring costs in the quarter totaled $2.6 million or $1.7 million net of tax. We also had additional costs recorded in operating expenses related largely to the Arrow integration of $3.5 million or $2.4 million net of tax. Classification of these charges are provided in the appendix to the slides.

Excluding these charges income from continuing operations was $41.9 million or $1.05 per diluted share, compared to $35.4 million or $0.89 per diluted share in 2007, a healthy 18% increase. The amounts recorded in discontinued operations in the quarter related to charges in connection with the fourth quarter 2007 divestiture of the automotive and industrial businesses and the second quarter of 2007 included a significant gain on the sale of the precision machine components business.

Moving to the year to date results revenues for the first six months exceeded $1.2 billion, growing 38% compared to the prior year. Core revenue growth included 1% in medical and 4% in aerospace. Gross profit for the period increased 420 basis points to 40.6%. Operating expenses of $311.3 million or 25.3% of sales increased over the first six months last year primarily as a result of our portfolio additions.

Operating income before special charges was $187.5 million, up 53% from $122.9 million in 2007. Adjusted operating margins of 15.3% represented an increase of 150 basis points compared to last year and include medical segment adjusted operating margins over 20%. Special charges before taxes for the first six months of 2008 totaled $22.2 million and relate to integration programs within the medical segment. And operating income was $165.3 million. Again, an increase of 38%.

For the first six months of 2008 income and EPS excluding special charges was $75.5 million or $1.90 per diluted share, compared to $68.9 million or $1.74 per diluted share for the corresponding period in 2007, a 9% increase. A strong showing from continuing operations in the first half. The aforementioned 2008 special charges as outlined on this slide had a $0.37 per share impact on diluted EPS.

Let's now look at the second quarter results for the operating segment. Medical segment revenues increased 70% to $384.3 million in the second quarter of 2008 from $226.4 million in the second quarter of '07. Core revenues still a respectable 3%, currency added 6% and acquisitions net of dispositions added 61%. The Arrow acquisition contributed a total of $139 million to second quarter growth primarily adding to our critical care product line. Arrow product lines overall grew 6% compared with the prior year period.

In our critical care product lines Arrow vascular access and regional anesthesia products added $120 million. Growth in these lines was led by our Asia/Latin America regions. Going into the second half we should benefit from new GPO agreements in the US and growth of new products, the pressure injectable picks. Pressure injectable CBC picked up nicely in the second quarter and we are introducing a new 5cc pick.

Respiratory care products had strong year over year growth in both Europe and Asia with double digit growth in Europe more than offsetting a modest decline in North America. Regional anesthesia products sales were especially strong. We expect this product line to continue to grow into the second half of 2008 and 2009 as we build out a dedicated anesthesia airway management sales force for us in North America and long term market trends for the use of peripherals, nerve blocks should also benefit this product line.

We continue to see nice volume growth in Europe and Asia for our urology product lines partially offset by continued price pressure on basic Foley catheters. Our surgical product sales grew 8% largely unfavorable currency and core growth in European sales and modest year over year declines in North America and Asia/Latin America. Sales to medical device OEMs grew 14% driven by a significant improvement in our orthopedics business. Given current order trends we expect that momentum to continue with particular strength in the fourth quarter.

The Arrow cardiac care product contributed $19.1 million to revenue in the second quarter. We saw a modest decline in cardiac care sales when compared to Arrow sales in the prior year period as we are working through some production issues. Operating profit for the segment excluded acquisition related charges was $74.2 million compared to $43.2 million in last year's second quarter. Adjusted segment operating margins were 19.3%, a 20 basis point improvement over the prior year comparable period, but down sequentially. The accelerated investment in our regulatory compliance program had a negative impact on margins in the quarter.

On a year to date basis revenues increased 67%, principally from the Arrow acquisition. Medical segment adjusted operating margins exceeded 20% in line with prior year.

Moving to aerospace. Aerospace had a particular strong quarter. Revenues increased 21% to $130.1 million principally as a result of a $13 million contribution from the Nordisk acquisition, which expanded our cargo containers business. Core growth in the quarter was 5%. The most significant drivers for core growth were narrow body cargo loading systems and cargo after market spares. With the narrow body product lines we saw unit volume double in the quarter compared to the second quarter last year with deliveries to 13 different airlines, the majority of them in Europe and Asia.

Also, there was a record quarter for cargo after market spares and repairs, a continuation of the growth trend we have seen over the last few quarters as our installed base grows and ages. Engine repair sales were up slightly compared to second quarter last year despite the impact of exiting lower margin product lines. The investments we are making in repair technologies are showing returns through a higher mix of repairable components generating value added margin compared with replacement components. We expect to continue to invest in new technologies for the newer more fuel efficient engines to further enhance our strong position in the after market.

Operating profit was $16.8 million compared to $12 million in last year's second quarter. Segment operating margins rose to 12.9% in the quarter, a 170 basis point improvement over the prior year's second quarter. On a year to date basis, revenues were $258.8 million reflecting a 19% increase over the first six months of 2007. The growth is principally from the Nordisk acquisition and 4% core growth generated entirely by the cargo systems business.

Segment operating profit increased 18% to $29.1 million compared to $24.6 million in 2007 and segment operating margins were 11.3% on a year to date basis in both 2008 and 2007. Commercial segment revenues in the quarter were $109.6 million compared to $118.5 million in the prior year, an 8% decline. Second quarter 2007 included strong sales of auxiliary power units for the North American truck market.

As we noted earlier marine sales declined with challenging market conditions. As expected, marine OEM and engine sales were down as they have been all year. We saw the seasonal increase in after market and international sales early in the quarter and then as fuel prices spiked into the early summer months we saw a softening in these markets as well.

Power systems had another difficult comp as revenues decreased 26%, most notably truck auxiliary power units. We are pleased to see a turnaround in the order transfer of the truck APUs with orders for delivery in fourth quarter 2008 and the first quarter of 2009. With the rising fuel costs and emission standards we expect to see improved demand for these products in 2009.

During the second quarter, we also began shipments of alternative fuel conversion kits to South America under a $5 million contract. The full contract is expected to be shipped over the remainder of the year. The rigging services business had another great quarter. Core revenues increased 12% on strong sales in the oil and drilling market in the Gulf region and in sales to wholesale customers and we saw a favorable product mix.

Overall, commercial segment operating profit declined to $9.5 million from $10.2 million for the quarter. Segment operating margins held steady with last year at 8.6% as cost containment initiatives in marine and the increased volume and favorable product mix in rigging services contributed positively to segment operating margins helping to offset an unfavorable currency impact related to the Canadian dollar. Considering the overall market conditions, strong performance by the commercial group.

On a year to date basis revenues were $211.4 million compared to $221.7 million in 2007, a 5% decline. Operating profit of $12.3 million in 2008 declined 22% from $15.7 million in 2007 principally from losses incurred in the power systems business in the first half of 2008.

Moving to cash flow. As we previously discussed, we made income tax payments in the first two quarters of 2008 of approximately $90 million relating to the December 2007 gain on sale that resulted from the divestiture of our automotive industrial businesses. Excluding the impact of these payments cash flow from operations was $112 million in the first six months of 2008, up 5% over the first half of 2007. Free cash flow was $68 million, an increase of 9% over the comparable period in 2007 and we increase our dividend by over 6% in the second quarter of 2008.

On the working capital front we made nice progress in the quarter. We made improvements in inventory management and accounts receivable compared to last quarter in both the medical and commercial segments. However, as we ramp up for cargo system shipments and facility relocations in connection with the Arrow integration we expect to see increased working level capital levels to support the future backlog in cargo systems and in preparation for the product line transfers in the medical segment.

The strong cash flow in the second quarter reduced outstanding debt by approximately $36 million and net debt to cap total capital to 52.5%. With all this we are raising our guidance to reflect the strong results in the first half and the current trends we see in our business. Before special charges we are forecasting an EPS range of $3.90 to $4.00 per diluted share for 2008, a 20% to 23% increase over the prior year. We do expect a seasonally slower third quarter as usual for some of our operations and these positive trends could be tempered by increasing commodity costs and fuel surcharges. At the same time what we see today is operations that are executing well and making good progress in an uncertain US economy.

Special charges which principally relate to charges from the Arrow integration and fair market value adjustment to inventory are currently forecasted at $0.55 to $0.62 per share, a slight reduction from our original estimate as we continue to refine the integration programs and appropriately time the implementation plans.

Earnings per share from continuing operations including special charges are expected to be in the range of $3.28 to $3.45 per diluted share in 2008. Operating cash flow for the full year 2008 will be impacted by integration and restructuring costs, but with a strong first half and our view of the second half of the year we are increasing our guidance of cash flow from operations to approximately $260 million excluding the tax payments.

I know housekeeping is always important, so let me close with a few items for you. CapEx is expected to come in at about $50 million to $55 million for the year. This is a bit lower than originally expected as operations have been prudent with spending and we are reviewing alternative methods of investment in certain capacity expansion projects. Our annual effective tax rate is likely to be at the lower end of our originally provided range or roughly 27%.

Depreciation and amortization expense is expected to be in the $120 million range. And we have seen favorable interest rates on our floating rate borrowings which represent approximately 30% of our total outstanding borrowings at the end of the second quarter.

With that, let me turn it back to Jeff with more on the outlook for the year.

Thanks, Kevin. In summary, strong first half results and we're executing well against our plans for the year, but let's look ahead. In medical, continued international sales growth, new product gains particularly for the Arrow vascular access products, new sales programs for surgical products are all positive. Recent CPO contract additions create some good opportunities in North America for both Arrow and Teleflex core products.

CMS reimbursement changes for hospital acquired infections go into effect October 1st and we are working on awareness and support campaigns for customers particularly related to the Arrow products and catheter related bloodstream infection. We'll see how quickly customers react; however, this certainly could drive changes in buying patterns over time.

And on the OEM side we continue to see positive order trends across all product lines. With the Arrow integration activity on track we see medical operating margins over 20% for the year.

In aerospace, this was a particularly strong quarter with significant increases in narrow body system sales and cargo after market spares. And on the revenue side the current delivery schedule for cargo handling systems and narrow body cargo loading system ramps up in the later part of the year.

Engine repairs has been a consistent performer executing well and expanding margins through the use of more efficient repair technologies. We continue to invest here for new engines and technologies. We do remain cautious on commercial with a down cycle in marine and plans for tough second half comps with third quarter shutdowns at some of the marine OEMs. But that business has managed fairly well in tough markets and we continue to win new business in future platforms that indicate customers are moving towards our electronic controls.

On a positive side rigging services should continue to benefit from the strong oil drilling markets and the expansion of our wholesale operations. And the power systems business should start to move out of its down cycle in the second half. We've already seen an improvement in the order rate for auxiliary power units for both the truck and rail with delivery scheduled for the fourth quarter and 2009. So, we're pleased with the results in the first half of the year and the progress we're making on the Arrow integration.

We really do appreciate the efforts of our employees who are focused on the execution and the investment and core growth as we enter into the second half of the year, which should position us well for future growth in 2009 and beyond.

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

Nikita, we're ready to take questions now.

(OPERATOR INSTRUCTIONS). Please stand by for your first question. Our first question comes from the line of Jim Lucas of Janney Montgomery Scott. Please proceed.

Thanks. Good morning and appreciate all the color on the call today. Continuous improvement. First, on the OEM business could you give a little bit more color of what you're seeing there? Is that more company specific where you're seeing the pickup or is there something indicative of what's happening in the market there on the orthopedic side?

I think it's a return of some of the business. We said we had a few challenging quarters. So, I think we picked some business back up in there and we're seeing order trends. It is in some cases dedicated to specific customers. But Jim, as we look to the second half I think the first half was particularly strong in orthopedics. I think you may have heard we said in the second half of the year it's really across the board. It's the specialty side. It's our sutures business with there and it's orthopedics. So, I wouldn't necessarily say that it's totally customer specific. I think it's just the capabilities that we provide our customers, I think, are paying dividends and we're seeing some return to the upside there.

Okay. And in your comments on the medical segment, Kevin, you had eluded to some margin pressure from production issues. Can you expand on that comment?

Yes, that was in relation to our cardiac care business. That was a business that came along with the Arrow acquisition. The main product line there are the balloon pumps and the balloons. So, we are having a few issues there from a quality perspective, but we're working to overcome those.

Okay. Would you expect that how many quarters would you expect that to linger?

We certainly would hope that we'd get it corrected in the third quarter.

Okay. And sticking within medical, you made a lot of comments about the strength you're seeing internationally. Within North America, could you kind of give us a glimpse of what you're seeing within each of the medical segments that you're how you're breaking it out now and categorizing it?

Sure. Critical care, I think, breaks down into a number of areas, but on the critical care side we see again, I think as we said in the remarks vascular access and the Arrow products are very strong. You're seeing year over year there. Where we have seen a bit of pressure in the US and product line is more on the respiratory side of our business. So, I think we've had a few challenges there.

There's a number of, I think, contracts that are up for renewal. We're seeing more multi source on GPO contracts and so forth. So, it's not necessarily that the business is going away. I think you have maybe potentially a bit more competitive nature on each of those contracts. So, in the short term there's some renewals.

On OEM I think we commented it's been very strong in that segment. Surgical we continue to see positive trends. You saw an 8% growth there. Some of that was currency, but there was certainly core growth within that segment as well. So, cardiac care we just referred to in terms of some of the issues there, so that is having a top line impact.

Okay. Great. And then on the aerospace side, you touched on it briefly in the prepared remarks, but very surprised to see after many years growth actually in the narrow body cargo systems. Can you talk about geographically where you're seeing that from a customer basis and why you think now you're seeing such strong demand on the narrow body side?

Yes. You're right, Jim. It has been a good business for us for many years. The growth slowed there a bit, but I think really what you're seeing right now is turnaround time is as important as the weight and the fuel cost. So, the faster they can get these planes up in the air given that there may be fewer planes flying they're putting these systems in place.

Geographically, it has been more Europe and Asia, so the opportunity that may exist within North America is likely yet to be fully tapped as we've seen strong growth in Europe and Asia.

The other market segment that has been very positive for us are the lower cost carriers. Again, their mission is to turn planes around quickly on the ground and this system provides them the opportunity to do that.

Okay. And finally on the engine repair side you alluded to some new technologies that are benefiting you there. Any additional color you can provide?

Yes. As you know, our primary facility for that business is in Singapore and we continue to automate that the processes there further and look at repair technologies that give us the capability to actually make more a higher quantity of the blades that are coming in repairable. So, we're continuing to do that. That's one side of the investment.

The other side of the investment is looking at the newer engine types that are coming on the GE 90s, for example, the Gen X for another example. As those newer engines begin to [come of wing] with more frequency we are investing in the technologies to repair blades for those engines as well. So, it's a two pronged investment approach.

Okay. Great. Thank you.

Our next question comes from the line of Deane Dray of Goldman Sachs. Please proceed.

Good morning. This is Mark Zepf calling on behalf of Deane. Jeff, I was wondering if you could expand a bit on the new product initiatives as that becomes a bigger part of the medical growth story. What percentage of sales today come from new products? How should we think about that going into the second half and then into 2009 in terms of a vitality index? Is it 30% of sales, 40%, et cetera?

Yes, Mark, I think we've been down this road and I would say the way we're looking at it today is what's our spend in R&D in that segment and I think it was about 4, 4.5. Again, some of that has got some of the remediation and that, but I think what we're seeing is the pipeline now that we're getting the moving the R&D guys back to R&D we would expect to see that kind of start to increase and expect to see some products coming out of there.

We have continued to not be willing to put out a vitality index because I think we're still struggling with definition. Yet we truly do understand that from a medical device company that's an area that we have to do better in. But I think what we're doing for the time being is we're making the investment in the resources. We see enough market opportunities, not just on the vascular access, but across our company and our product lines.

So, I think we're going to continue to see as we move off of remediation continue to invest in that R&D area to start to get the top line moving to a much higher organic growth rate.

In terms of timing of the shift from remediation to R&D was the ramp up 2Q investment something that is going to pay dividends immediately in 3Q in terms of the R&D spend or is that maybe something we will see in 4Q or early '09?

I think it's an '09 event and I would tell you it's probably on the back half of '09 just not to set expectations to early.

Okay. Thank you. And then on the commodity cost side there was a comment in the outlook about potential pressure there. Where do you stand versus commodity costs now in terms of pricing? What are the biggest headwinds and in which businesses do have the strongest pricing power?

In terms of where it can have the more significant impact I would tell you it's in the medical side of the business from a resin standpoint. So, we're happy to see fuel prices dropping a little bit in the last couple of weeks, but certainly there is some work to be done there. I think that could have the most impact, but certainly we've consider that and baked it into what we talked about today.

Okay. And in the first half on the medical side has the raw material headwind been negative to margins, or are you fully offsetting with price? Where does that stand?

On the first half it had a lesser of an impact, Mark. You'll probably see a little bit more in the fourth quarter. And the reason it had impact is we had purchasing contracts that had price associated with them that have certainly impacted the first half favorably. As we're building inventory now with our inventory turns the higher price materials may turn more fourth quarter into '09.

At the same time, Mark, I mean besides productivity gains we are actively talking with customers regarding pricing and as contracts come up it gives you the opportunity. I don't think we're in any different position than any of our other competitors in the disposable medical field.

Okay. Of the 3% medical core growth in the quarter how much was price?

Very little.

Okay. Thank you.

(OPERATOR INSTRUCTIONS). Our next question comes from the line of the [Levon Ronredden of Hickey Capital]. Please proceed.

I have three questions. If you take a look at the OEM within the medical division could you just kind of give me a little bit of a sense of what types of products are being sold into that market?

Sure. There's three major product areas within our OEM business. One is orthopedic, primarily spinal instrumentation and fixation devices. The second is specialty sutures typically geared very much toward cardiovascular procedures. And then the third would be a much broader area of specialty primarily single use devices that we would produce on behalf of the OEMs.

Okay. Is it weighted more to one of those groups or the other?

I would say that the specialty side is the larger group within there followed by orthopedic and then suture.

Okay. And if you take a look at the discontinued ops could you kind of let me know, I guess, what we have still left there and the timing for the final disposition there.

There's actually nothing remaining in there to be disposed as classified there, Levon. What you saw go through there in the second quarter were some adjustments related to the disposition that occurred in December.

Perfect.

There's no operating units in there.

Okay. Great. And the final question as it relates to the commercial segment between marine and the rigging services and power systems. Could you give us a relative, I guess, weighting in terms of where the sales are within that division?

Yes, I think we've done that before. I think medical represents I'm sorry, marine represents over half of the revenues. Rigging services would be and power would be relatively close in size with maybe rigging services being slightly larger.

Perfect. Thank you.

Okay.

Our next question comes from the line of Gregory Macosko of Lord Abbett. Please proceed.

Yes, thank you. Very nice quarter. Could you speak a little bit about the Arrow integration process? It sounds like things are moving along nicely there. Talk about the headcount and kind of redeployments or whatever hirings that you're expecting there. I see the sales force and your discussion on the sales team for anesthesia airway. What should we kind of expect there in terms of how things are structured, particularly with regard to the sales force?

I think in terms of structuring the sales force, I think, it's primarily complete at this point. We are adding a dedicated regional anesthesia airway management sales force and looking to add to resources there for the North American market. So, that's a North America focus on adding those resources.

The other area, I think, you heard Jeff comment on of adding resources in R&D. So, as far as structure, the remainder of the sales force, that is set. I think we're comfortable with resources. We'll build regional anesthesia and airway and we continue to look at adding resources to R&D to bolster the efforts of primarily related to some of the codings issues to help us with the hospital acquired infection.

I think, Greg, what you also see is in the last probably 18 months we've made significant investment in the sales force in both Asia and Latin America. And again, we're starting to see some of the benefits of doing that. So, I think again we're comfortable on the anesthesia making investment there, but no question. We've got to make the investment in R&D to get the new product pipeline to a more robust state.

And just overall in terms of headcount with regard to Arrow and the medical side, has there been any reduction? Has there been a lot of turnover?

Certainly with the integration programs there's been reductions, but I wouldn't limit it to the Arrow side of the house. As we've said in the past, when we do integration we're really looking at how do we integrate these business in the most efficient manner with the best player. So, when we look at headcount changes that affected both sides of the business?

Okay. And then moving over to the commercial side cost containment was really quite impressive. I guess you focused on marine. Is this a new lower level or is this flexibility that at some point we would expect that business to grow and other businesses there, that you flex up and flex down? Is that part of the structure there?

I think, Greg, I mean we've been in the marine business for 40 plus years. We've seen these cycles come. We've seen them go. I actually give credit to the leadership of the commercial. I think it was probably a year ago where we really started to see some of the signs both from the economy and from our customers. I think we started to take action then. We continue to look at it and quite frankly I think we are in a pretty good flex position both from a direct and indirect standpoint, but I think it's something we're monitoring fairly closely.

Again, you've got to remember part of it is mix. We have an aftermarket piece which is at least doing better than the OEM piece, but again with fuel prices where they are I'm not sure that the after markets are not going to have some challenges going forward. But overall, again, I think it comes back to being proactive and kind of seeing it coming and dealing with it then as opposed to waiting.

Thank you.

(OPERATOR INSTRUCTIONS). At this time there are no additional questions. I will turn the call back to Ms. Julie McDowell for closing remarks.

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