MOOG INC – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

  We are a worldwide designer, manufacturer and integrator of high performance precision motion and fluid controls and control systems for a broad range of applications in aerospace and defense, industrial and medical markets. Our aerospace and defense products and systems include military and commercial aircraft flight controls, satellite positioning controls, controls for steering tactical and strategic missiles, thrust vector controls for space launch vehicles, controls for gun aiming, stabilization and automatic ammunition loading for armored combat vehicles, and homeland security products. Our industrial products are used in a wide range of applications, including wind energy, pilot training simulators, injection molding machines, power generation, material and automotive testing, metal forming, heavy industry and oil exploration. Our medical products include infusion therapy pumps, enteral clinical nutrition pumps, slip rings used on CT scanners and motors used in sleep apnea devices. We operate under five segments, Aircraft Controls, Space and Defense Controls, Industrial Systems, Components and Medical Devices. Our principal manufacturing facilities are located in the United States, England, the Philippines, Germany, China, Italy, India, Costa Rica, The Netherlands, Luxembourg, Canada, Ireland and Japan.  We have long-term contracts with some of our customers. These contracts are predominantly within Aircraft Controls and Space and Defense Controls and represent 29% of our sales. We recognize revenue on these contracts using the percentage of completion, cost-to-cost method of accounting as work progresses toward completion. The remainder of our sales are recognized when the risks and rewards of ownership and title to the product are transferred to the customer, principally as units are delivered or as service obligations are satisfied. This method of revenue recognition is predominantly used within the Industrial Systems, Components and Medical Devices segments, as well as with aftermarket activity.  

We concentrate on providing our customers with products designed and manufactured to the highest quality standards. In achieving a leadership position in the high performance, precision controls market, we have capitalized on our strengths, which include:

• superior technical competence and customer intimacy that breed market

        leadership,     •   customer diversity and broad product portfolio,  

• well-established international presence serving customers worldwide, and

• proven ability to successfully integrate acquisitions.

   We intend to increase our revenue base and improve our profitability and cash flows from operations by building on our market leadership positions, by strengthening our niche market positions in the principal markets that we serve and by extending our participation on the platforms we supply by providing more systems solutions. We also expect to maintain a balanced, diversified portfolio in terms of markets served, product applications, customer base and geographic presence. Our strategy to achieve our objectives includes:    

• maintaining our technological excellence by building upon our systems

integration capabilities while solving our customers' most demanding

        technical problems,     •   taking advantage of our global capabilities,     •   growing our profitable aftermarket business,     •   capitalizing on strategic acquisitions and opportunities,     •   developing products for new and emerging markets, and     •   striving for continuing cost improvements.   We face numerous challenges to improve shareholder value. These include but are not limited to: adjusting to dynamic global economic conditions that are influenced by governmental, industrial and commercial factors, foreign currency fluctuations, pricing pressures from customers, strong competition and increases in costs such as health care benefits. We address these challenges by focusing on strategic revenue growth and by continuing to improve operating efficiencies through various process, manufacturing and restructuring initiatives and using low cost manufacturing facilities without compromising quality.                                          44  

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Acquisitions

  All of our acquisitions are accounted for under the purchase method and, accordingly, the operating results for the acquired companies are included in the consolidated statements of earnings from the respective dates of acquisition. Under purchase accounting, we record assets and liabilities at fair value and such amounts are reflected in the respective captions on the balance sheet. The purchase price described for each acquisition below is net of any cash acquired and includes debt issued or assumed.  In 2011, we completed three business combinations within two of our segments. We completed two business combinations within our Aircraft Controls segment, both of which are located in the U.S. We acquired Crossbow Technology Inc., based in California, for $32 million. Crossbow designs and manufacturers acceleration sensors that are integrated into inertial navigation and guidance systems used in a variety of aerospace, defense and transportation applications. We also acquired a business that complements our military aftermarket business for $2 million in cash. Combined sales of these acquisitions for the 2010 calendar year were approximately $19 million. We completed one business combination within our Components segment by acquiring Animatics Corporation, based in California. The purchase price was $24 million, which includes 467,749 shares of Moog Class A common stock valued at $19 million on the day of closing. Animatics supplies integrated servos, linear actuators and control electronics that are used in a variety of industrial, medical and defense applications and had approximately $15 million of sales for the twelve months preceding the acquisition.  In 2010, we completed four business combinations within three of our segments. We completed one acquisition in our Aircraft Controls segment for $11 million. This acquisition complements our military aftermarket business. We completed two acquisitions in our Space and Defense Controls segment for a total of $23 million. One business specializes in turret design, fire control systems and vehicle electronics and the other expands our capabilities in the security and surveillance market. We completed one acquisition in our Industrial Systems segment for $1 million.  

CRITICAL ACCOUNTING POLICIES

  Our financial statements and accompanying notes are prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates, assumptions and judgments that affect the amounts reported. These estimates, assumptions and judgments are affected by our application of accounting policies, which are discussed in Note 1 of Item 8, Financial Statements and Supplementary Data of this report. We believe the accounting policies discussed below are the most critical in understanding and evaluating our financial results. These critical accounting policies have been reviewed with the Audit Committee of our Board of Directors.  

Revenue Recognition on Long-Term Contracts

  Revenue representing 29% of 2011 sales was accounted for using the percentage of completion, cost-to-cost method of accounting. This method of revenue recognition is predominately used within the Aircraft Controls and Space and Defense Controls segments due to the contractual nature of the business activities, with the exception of their respective aftermarket activities. The contractual arrangements are either firm fixed-price or cost-plus contracts and are with the U.S. Government or its prime subcontractors, foreign governments or commercial aircraft manufacturers, including  and Airbus. The nature of the contractual arrangements includes customers' requirements for delivery of hardware as well as funded nonrecurring development work in anticipation of follow-on production orders.  We recognize revenue on contracts in the current period using the percentage of completion, cost-to-cost method of accounting as work progresses toward completion as determined by the ratio of cumulative costs incurred to date to estimated total contract costs at completion, multiplied by the total estimated contract revenue, less cumulative revenue recognized in prior periods. Changes in estimates affecting sales, costs and profits are recognized in the period in which the change becomes known using the cumulative catch-up method of accounting, resulting in the cumulative effect of changes reflected in the period. Estimates are reviewed and updated quarterly for substantially all contracts. A significant change in an estimate on one or more contracts could have a material effect on our results of operations.                                                45  

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  Occasionally, it is appropriate to combine or segment contracts. Contracts are combined in those limited circumstances when they are negotiated as a package in the same economic environment with an overall profit margin objective and constitute, in essence, an agreement to do a single project. In such cases, we recognize revenue and costs over the performance period of the combined contracts as if they were one. Contracts are segmented in limited circumstances if the customer had the right to accept separate elements of the contract and the total amount of the proposals on the separate components approximated the amount of the proposal on the entire project. For segmented contracts, we recognize revenue and costs as if they were separate contracts over the performance periods of the individual elements or phases.  Contract costs include only allocable, allowable and reasonable costs, as determined in accordance with the Federal Acquisition Regulations and the related Cost Accounting Standards for applicable U.S. Government contracts, and are included in cost of sales when incurred. The nature of these costs includes development engineering costs and product manufacturing costs such as direct material, direct labor, other direct costs and indirect overhead costs. Contract profit is recorded as a result of the revenue recognized less costs incurred in any reporting period. Amounts representing performance incentives, penalties, contract claims or change orders are considered in estimating revenues, costs and profits when they can be reliably estimated and realization is considered probable. Revenue recognized on contracts for unresolved claims or unapproved contract change orders was not material in 2011, 2010 or 2009.  

Contract Loss Reserves

  At October 1, 2011, we had contract loss reserves of $45 million. For contracts with anticipated losses at completion, a provision for the entire amount of the estimated remaining loss is charged against income in the period in which the loss becomes known. Contract losses are determined considering all direct and indirect contract costs, exclusive of any selling, general or administrative cost allocations that are treated as period expenses. Loss reserves are more common on firm fixed-price contracts that involve, to varying degrees, the design and development of new and unique controls or control systems to meet the customers' specifications.  

Reserves for Inventory Valuation

  At October 1, 2011, we had net inventories of $502 million, or 36% of current assets. Reserves for inventory were $94 million, or 16% of gross inventories. Inventories are stated at the lower-of-cost-or-market with cost determined primarily on the first-in, first-out method of valuation.  We record valuation reserves to provide for slow-moving or obsolete inventory by using both a formula-based method that increases the valuation reserve as the inventory ages and, additionally, a specific identification method. We consider overall inventory levels in relation to firm customer backlog in addition to forecasted demand including aftermarket sales. Changes in these and other factors such as low demand and technological obsolescence could cause us to increase our reserves for inventory valuation, which would negatively impact our gross margin. As we record provisions within cost of sales to increase inventory valuation reserves, we establish a new, lower cost basis for the inventory.  

Reviews for Impairment of Goodwill

  At October 1, 2011, we had $735 million of goodwill, or 26% of total assets. We test goodwill for impairment for each of our reporting units at least annually, during our fourth quarter, and whenever events occur or circumstances change in the business climate, poor indicators of operating performance or the sale or disposition of a significant portion of a reporting unit.  We identify our reporting units by assessing whether the components of our operating segments constitute businesses for which discrete financial information is available and segment management regularly reviews the operating results of those components. Certain of our reporting units are our operating segments while others are one level below our operating segments.  When we evaluate the potential for goodwill impairment, we assess a range of qualitative factors including, but not limited to, macroeconomic conditions, industry conditions, the competitive environment, changes in the market for our products and services, regulatory and political developments, entity specific factors such as strategy and changes in key personnel and overall financial performance. If, after completing this assessment, it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we proceed to a two-step impairment test.                                          46  

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  In order to perform the two-step impairment test, we use the discounted cash flow method to estimate the fair value of each of our reporting units. The discounted cash flow method incorporates various assumptions, the most significant being projected revenue growth rates, operating profit margins and cash flows, the terminal growth rate and the discount rate. Management projects revenue growth rates, operating margins and cash flows based on each reporting unit's current business, expected developments and operational strategies over a five-year period. In estimating the terminal growth rate, we consider our historical and projected results, as well as the economic environment in which our reporting units operate. The discount rates utilized for each reporting unit reflect management's assumptions of marketplace participants' cost of capital and risk assumptions, both specific to the reporting unit and overall in the economy.  We performed our qualitative assessment during the fourth quarter and determined that it was not more likely than not that the fair value of each of our reporting units was less than that its applicable carrying value. Accordingly, we did not perform the two-step goodwill impairment test for any of our reporting units.  

Purchase Price Allocations for Business Combinations

  During 2011, we completed three business combinations for a total purchase price of $58 million. Under purchase accounting, we recorded assets and liabilities at fair value as of the acquisition dates. We identified and ascribed value to programs, customer relationships, patents and technology, trade names, backlog and contracts and estimated the useful lives over which these intangible assets would be amortized. Valuations of these assets were performed largely using discounted cash flow models. These valuations support the conclusion that identifiable intangible assets had a value of $20 million. The resulting goodwill was $35 million.  

Ascribing value to intangible assets requires estimates used in projecting relevant future cash flows, in addition to estimating useful lives of such assets. Using different assumptions could have a material effect on our current and future amortization expense.

Pension Assumptions

  We maintain various defined benefit pension plans covering employees at certain locations. Pension expense for all defined benefit plans for 2011 was $32 million. Pension obligations and the related costs are determined using actuarial valuations that involve several assumptions. The most critical assumptions are the discount rate and the long-term expected return on assets. Other assumptions include mortality rates, salary increases and retirement age.  The discount rate is used to state expected future cash flows at present value. Using a higher discount rate decreases the present value of pension obligations and reduces pension expense. We used the Mercer Pension Discount Yield Curve to determine the discount rate for our U.S. plans. The discount rate is determined by discounting the plan's expected future benefit payments using a yield curve developed from high quality bonds that are rated Aa or better by Moody's as of the measurement date. The yield curve calculation matches the notional cash inflows of the hypothetical bond portfolio with the expected benefit payments to arrive at the discount rate. In determining expense for 2011 for our largest U.S. plan, we used a 5.3% discount rate, compared to 6.0% for 2010. We will use a 4.8% discount rate to determine our expense in 2012 for this plan. This 50 basis point decrease in the discount rate will increase our pension expense by $4 million in 2012.  The long-term expected return on assets assumption reflects the average rate of earnings expected on funds invested or to be invested to provide for the benefits included in the projected benefit obligation. In determining the long-term expected return on assets assumption, we consider our current and target asset allocations. We consider the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance. Asset management objectives include maintaining an adequate level of diversification to reduce interest rate and market risk and to provide adequate liquidity to meet immediate and future benefit payment requirements. In determining expense for 2011 for our largest plan, we used an 8.9% return on assets assumption, the same as we used in 2010. A 50 basis point decrease in the long-term expected return on assets assumption would increase our annual pension expense by $2 million.                                                47  

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Deferred Tax Asset Valuation Allowances

  At October 1, 2011, we had gross deferred tax assets of $257 million and a deferred tax asset valuation allowance of $4 million. The deferred tax assets principally relate to benefit accruals, inventory obsolescence and contract loss reserves. The deferred tax assets include $12 million related to tax benefit carry forwards for which $4 million of deferred tax asset valuation allowances are recorded.  We record a valuation allowance to reduce deferred tax assets to the amount of future tax benefit that we believe is more likely than not to be realized. We consider recent earnings projections, allowable tax carryforward periods, tax planning strategies and historical earnings performance to determine the amount of the valuation allowance. Changes in these factors could cause us to adjust our valuation allowance, which would impact our income tax expense when we determine that these factors have changed.                                          48  

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CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK

                                                                                             2011 vs. 2010                     2010 vs. 2009 (dollars in millions except per share data)                          2011            2010            2009         $ Variance       % Variance       $ Variance       % Variance  Net sales                         $     2,331     $     2,114     $     1,849     $       217              10%      $       265              14%  Gross margin                            29.2%           29.0%           29.1%  Research and development expenses                          $       106     $       103     $       100     $         3               3%      $         3               3%  Selling, general and administrative expenses as a percentage of sales                15.2%           14.8%           15.2%  Restructuring expense             $         1     $         5     $        15     $        (4 )           (80% )    $       (10 )           (67% )  Interest expense                  $        36     $        39     $        39     $        (3 )            (8% )    $         -               0%  Effective tax rate                      26.0%           27.7%           23.1%  Net earnings                      $       136     $       108     $        85     $        28              26%      $        23              27%  Diluted earnings per share        $      2.95            2.36            1.98     $      0.59              25%      $      0.38              19%   Our fiscal year ends on the Saturday that is closest to September 30. The consolidated financial statements include 52 weeks for the year ended October 1, 2011, 52 weeks for the year ended October 2, 2010 and 53 weeks for the year ended October 3, 2009. While management believes this affects the comparability of financial results presented, the impact has not been determined.  

Net sales increased in 2011 compared to 2010 with strong increases coming from all of our segments with the exception of Components.

The net sales increase in 2010 was predominantly a result of $200 million of incremental sales from acquisitions, primarily in Aircraft Controls and Industrial Systems.

  Our gross margin was relatively unchanged in 2011 compared to 2010, reflecting volume increases and a more favorable product mix, offset by more additions to contract loss reserves. The loss reserves are primarily related to our Aircraft Controls segment. Our gross margin in 2010 was comparable to 2009, reflecting the positive impact of the sales mix in our legacy product lines being offset by the impact of increased sales of lower gross margin products attributable to the recent acquisitions of wind energy and high lift actuation businesses.  Research and development increased modestly in 2011 compared to 2010 as increases on multiple programs, including the Airbus A350 program, were offset by $13 million of reimbursements for a commercial transport program. Research and development expenses increased modestly in 2010 compared to 2009. Increased expenditures for the Airbus A350 program and the impact from acquisitions were partially offset as development activity continued to decline on the Boeing 787.  Selling, general and administrative expenses as a percentage of sales increased in 2011 compared to 2010 as a result of increased marketing efforts and bid and proposal activity for aerospace programs, partially offset by the efficiencies gained from our higher sales volume. The decrease as a percentage of sales in 2010 compared to 2009 is primarily a result of the impact of acquisitions that had lower selling, general and administrative cost structures than most of our other product lines.  In 2009, we initiated the restructuring plans to better align our cost base with the lower level of sales and operating margins associated with the global economic recession. The restructuring actions taken resulted in workforce reductions, primarily in the U.S., the Philippines and Europe. During 2009, we incurred $15 million of severance costs, of which $10 million was in Industrial Systems and $5 million was in Aircraft Controls. We incurred an additional $5 million of restructuring charges for severance in 2010.  

Interest expense decreased in 2011 compared to 2010 as a result of lower average borrowings and lower interest rates.

  The effective tax rate for 2011 is lower than 2010 primarily from the recognition of current and future tax benefits associated with the net operating loss carryforward from one of our foreign operations. The effective tax rate for 2010 was higher than 2009, which had an unusually low tax rate. During 2009, we benefited from a $5 million foreign tax credit from the repatriation of $31 million of cash to the U.S. from our Japanese subsidiary, a benefit related to our 2008 tax year as a result of the reinstatement of the U.S. research and development tax credit under the TARP legislation and the benefit of the effect of our equity earnings in LTi REEnergy which were recognized in operating profit on an after-tax basis.                                                49  

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In 2010, the diluted earnings per share increase reflected the net earnings growth and the impact of the issuance of additional shares from a stock offering completed at the end of 2009.

  2012 Outlook - We expect sales in 2012 to increase $184 million, or 8%, to $2.52 billion reflecting increases in all of our segments. We expect operating margins to improve to 11.1% in 2012 compared to 10.6% in 2011. We expect operating margins to increase in all of our segments except for Space and Defense Controls. We expect net earnings to increase to $152 million and diluted earnings per share to increase by 12% to $3.31.                                          50  

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SEGMENT RESULTS OF OPERATIONS AND OUTLOOK

  Operating profit, as presented below, is net sales less cost of sales and other operating expenses, excluding interest expense, equity-based compensation expense and other corporate expenses. Cost of sales and other operating expenses are directly identifiable to the respective segment or allocated on the basis of sales, manpower or profit. Operating profit is reconciled to earnings before income taxes in Note17 of Item 8, Financial Statements and Supplementary Data of this report.  Aircraft Controls                                          000000        000000        000000         000000            000000             000000            000000                                                                                         2011 vs. 2010                        2010 vs. 2009  (dollars in millions)                2011          2010          2009      

$ Variance % Variance $ Variance % Variance

Net sales - military aircraft $ 498$ 458$ 419

   $         40                 9%      $         39                 9%   Net sales - commercial aircraft         314           262           214                52                20%                48                22%   Net sales - navigation aids              38            37            30                 1                 3%                 7                23%    Net sales                          $    850      $    757      $    663      $         93                12%      $         94                14%   Operating profit                   $     84      $     76      $     52      $          8                11%      $         24                46%   Operating margin                       9.9%         10.1%          7.9%   Backlog                            $    641      $    567      $    508      $         74                13%      $         59                12%    Military aircraft sales increased $49 million in aftermarket for 2011 compared to 2010, partially offset by a $15 million decrease in military fighter programs. The increase in military aftermarket reflects the benefit of some significant upgrade programs on several platforms. Commercial aircraft sales were strong as commercial aftermarket sales increased $17 million, returning to pre-recession levels. The Boeing 787 production ramp up increased sales $15 million, which includes the settlement of open scope changes. In addition, sales increased $7 million on Airbus programs and $6 million in business jets as that market recovers.  Net sales in Aircraft Controls increased in 2010 resulting from the acquisition of the high lift actuation business located in Wolverhampton, U.K. at the end of 2009 that contributed $94 million. Military aircraft sales increased with the Wolverhampton operation contributing $42 million of incremental sales. Sales increased $21 million on the V-22 Osprey as production levels continued to increase on that program. Sales increased $18 million in military aftermarket, due in part to the Wolverhampton acquisition. These increases were offset by a $23 million decrease on the F-35 program as it shifted from the development phase into the production phase. Commercial aircraft sales increased as $51 million of incremental sales from Wolverhampton more than offset the decrease of $12 million in business jets. Navigation aids increased $7 million as a result of the incremental sales from the 2009 Fernau acquisition offset by decreases due to delays in the award of certain military programs.  Our operating margin was comparable in 2011 and 2010. In 2011, we had lower research and development as a percentage of sales, primarily the result of reimbursements totaling $13 million on a commercial transport program in 2011, along with the benefits associated with higher volume and sales mix changes toward higher margin business such as military aftermarket. Partially offsetting those positive contributions were increased contract loss reserves of $20 million. The higher loss reserves are on various commercial programs, including the 787 related to higher cost estimates of early production units and the G280 as a result of changes coming out of flight certification efforts. Our operating margin was higher in 2010 compared to 2009 as a result of lower research and development spending as a percentage of sales in 2010. In addition, during 2009, we incurred $5 million of restructuring charges and recorded $4 million of inventory and other charges on certain business jet programs.  The higher level of twelve-month backlog for Aircraft Controls at October 1, 2011 compared to October 2, 2010 reflects strong commercial aircraft orders. The higher level of twelve-month backlog at October 2, 2010 compared to October 3, 2009 reflects strong military aircraft orders.  2012 Outlook for Aircraft Controls - We expect sales in Aircraft Controls to increase 11% to $944 million in 2012. Military aircraft sales are expected to increase 6% to $528 million, primarily from the ramp up of production on the F-35. Commercial aircraft sales are expected to increase 19% to $373 million with increases in all product lines, including Boeing 787, Airbus, business jets and aftermarket. Navigation aids are expected to increase to $44 million. We expect our operating margin to be 11.0% in 2012, an improvement from 2011 in which we recorded significant loss reserves.                                                51  

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  Table of Contents  Space and Defense Controls                                                                               2011 vs. 2010                    2010 vs. 2009 (dollars in millions)           2011        2010        2009        $ Variance       % Variance      $ Variance       % Variance  Net sales                      $   356     $   325     $   275     $         31              10%     $        50              18%  Operating profit               $    49     $    36     $    40     $         13              36%     $        (4 )           (10% )  Operating margin                 13.8%       11.0%       14.6%  Backlog                        $   223     $   213     $   202     $         10               5%     $        11               5%   Net sales in Space and Defense Controls increased in 2011, primarily in two areas, security and surveillance and tactical missiles. Sales increased $21 million in security and surveillance, a result of our Pieper acquisition and stronger demand in government and industrial markets. Tactical missiles increased $19 million as a result of a large order for an aircraft stores management system and the replenishment of TOW and Hellfire missile inventory. Partially offsetting those increases was a $11 million decline in the satellite market, which experienced a record year in 2010 due to an unusually high number of GEO satellite orders last year.  Net sales in Space and Defense Controls increased in 2010 compared to 2009 as sales of tactical missiles increased $16 million, primarily related to replenishment requirements for both the Hellfire and TOW. Sales of launch vehicles increased $14 million, principally from the Taurus program, which the Administration considers commercial. Activity on the Driver's Vision Enhancer (DVE) program increased sales by $14 million, offsetting declines in other defense controls programs. Our acquisitions of Pieper in 2010 and Videolarm midway through 2009 contributed $11 million of incremental sales in security and surveillance. Sales of satellite controls were also strong, increasing by $9 million. Sales in our NASA programs increased by $2 million, but were impacted by the uncertainty and delays by the Administration's re-definition of the Constellation program.  Our operating margin increased significantly in 2011 as a result of the higher sales volume, in particular from a profit rate adjustment on the aircraft stores management system. Export approval for the aircraft stores management system was granted in 2011 which eliminated a significant program risk, thereby allowing us to adjust the profit rate. Our operating margin decreased in 2010 primarily related to a larger proportion of sales coming from lower margin cost-plus development work and $1 million of restructuring charges.  

The higher level of twelve-month backlog for Space and Defense Controls at October 1, 2011 compared to October 2, 2010 reflects increased orders for satellites, launch vehicles and tactical missiles. The higher level of twelve-month backlog at October 2, 2010 compared to October 3, 2009 is primarily as a result of increased orders for the DVE program.

  2012 Outlook for Space and Defense Controls - We expect sales in Space and Defense Controls to increase $18 million, or 5%, to $374 million in 2012. We expect sales increases in tactical missiles and development work for NASA, which will offset a decline on the DVE program. We expect our operating margin in 2012 to decrease to a more normal 11.7% compared to 2011, which was influenced by certain favorable program adjustments.                                          52  

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   Table of Contents  Industrial Systems                              00000000       00000000       00000000        00000000        00000000        00000000        00000000                                                                             2011 vs. 2010                   2010 vs. 2009 (dollars in millions)      2011           2010           2009        $ Variance      % Variance      $ Variance      % Variance  Net sales               $      629     $      546     $      455     $        83             15%     $        91             20%  Operating profit        $       63     $       48     $       31     $        15             31%     $        17             55%  Operating margin             10.0%           8.8%           6.8%  Backlog                 $      284     $      233     $      196     $        51             22%     $        37             19%    Net sales in Industrial Systems for 2011 reflect increases in all of our major markets except for wind energy. The broad-based sales recovery reflects the strengthening of business in all of our geographic markets. Sales increased $21 million in motion simulation, $15 million in metal forming and presses and $9 million each in plastics making machinery and power generation and $7 million each in distribution and heavy industry. Offsetting those increases was a decrease in wind energy of $22 million, primarily due to the Chinese market, where large customers had built up inventory, allowing them to slow their orders.  Net sales in Industrial Systems increased in 2010, primarily a result of incremental sales from acquisitions, but we also began to see a recovery from the recession in our legacy markets in the latter half of the year. Acquisitions accounted for $82 million of increased sales, primarily in the wind energy market. Sales also increased $19 million in plastics making machinery. Those increases were offset by lower sales in other major markets such as motion simulation, which was down $12 million, and power generation, which was down $9 million.  Our operating margin for 2011 increased as a result of the higher sales volume in our legacy markets but was tempered by the decline in the wind energy market. Our operating margin for Industrial Systems increased in 2010 compared to 2009. This increase was the result of higher sales volume in 2010 and lower restructuring charges recorded in 2010 compared to 2009. Offsetting those increases was the impact of $7 million of equity earnings recorded in 2009 for LTi REEnergy before we acquired full ownership.  The higher level of twelve-month backlog for Industrial Systems at October 1, 2011 compared to October 2, 2010 is due primarily to increased demand in most of our major markets due to improving global economic conditions, especially in test equipment and power generation. The higher level of twelve-month backlog for Industrial Systems at October 2, 2010 compared to October 3, 2009 reflects the economic recovery in a variety of markets from the lower level as of October 3, 2009.  2012 Outlook for Industrial Systems - We expect sales in Industrial Systems to increase 8% to $680 million in 2012. We expect sales increases in our major markets, with the largest increases expected in the test equipment, motion simulators and power generation markets. We also expect sales to increase modestly in wind energy. We expect that our operating margin will increase to 10.5% in 2012 as a result of the higher sales volume.                                                53  

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   Table of Contents  Components                              00000000       00000000       00000000        00000000         00000000         00000000         00000000                                                                             2011 vs. 2010                     2010 vs. 2009 (dollars in millions)      2011           2010           2009        $ Variance       % Variance       $ Variance       % Variance  Net sales               $      353     $      360     $      346     $        (7 )            (2% )    $        14               4%  Operating profit        $       50     $       60     $       56     $       (10 )           (17% )    $         4               7%  Operating margin             14.3%          16.7%          16.1%  Backlog                 $      163     $      153     $      183     $        10               7%      $       (30 )           (16% )    Net sales in Components decreased in 2011 as sales shifted between markets. Sales increased $12 million in our industrial business with a recent acquisition contributing $6 million. Sales increased $11 million in the marine market, related to off shore oil exploration which is influenced by oil prices, and $9 million in medical equipment, primarily from sales to Respironics for sleep apnea equipment. Sales for space and defense controls declined $22 million, mostly a result of slowing demand for various military vehicles, including our completion of the upgrade program on the Bradley Fighting Vehicle, and a large fiber optic modem order on the Eurofighter we supplied in 2010 which did not repeat in 2011. Sales in the aircraft market declined $16 million, primarily in military aircraft, reflecting a general softness in 2011 and strong de-icing system sales on the Black Hawk helicopter program in 2010.  Net sales in Components increased in 2010 as aircraft sales increased $19 million, all on military programs. The largest increase within military aircraft was for de-icing systems on both the Black Hawk helicopter and V-22 tilt rotor aircraft. Industrial sales increased $9 million, primarily for slip rings for wind turbines. These increases were partially offset as marine sales decreased $12 million, mostly for equipment used on undersea robots.  Our operating margin decreased in 2011 compared to 2010 as a result of the sales volume decline, a less favorable product mix and a general shift to newer products with larger up-front costs. In addition, we recorded a $2 million write down in 2011 on a technology investment in data compression technology for use in CAT scan machines. Our operating margin increased in 2010 compared to 2009 as a result of the higher sales volume and the sales mix.  The higher level of twelve-month backlog at October 1, 2011 compared to October 2, 2010 relates to orders on the Guardian system. The lower level of twelve-month backlog at October 2, 2010 compared to October 3, 2009 primarily relates to slowing orders for space and defense controls and military aircraft programs.  2012 Outlook for Components - We expect sales in Components to increase by $19 million, or 5%, in 2012. We expect the sales growth will come in our industrial markets with half of that coming from our acquisition of Animatics, which we completed in the third quarter of 2011. We expect our operating margin in 2012 to be 15.0%, higher than in 2011 due to the technology investment write off in 2011.                                          54  

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  Table of Contents  Medical Devices                                                                                     2011 vs. 2010                      2010 vs. 2009 (dollars in millions)                2011        2010         2009        $ Variance       % Variance        $ Variance       % Variance  Net sales                           $   142     $   127      $   111      $        15              12%      $         16              14%  Operating profit (loss)                 -       $    (4 )    $    (7 )    $         4             100%      $          3              43%  Operating margin                       0.2%       (3.2% )      (6.7% )  Backlog                             $    13     $    15      $    11      $        (2 )           (13% )    $          4              36%   Net sales in Medical Devices for 2011 compared to 2010 increased primarily from our strong sales in both administration sets and sensors and hand pieces, which increased $7 million and $5 million, respectively. Our sensors, which are used to detect air bubbles in pumping applications, benefitted from higher demand for one of our customer's pumps due to a recall of certain large volume pumps in the hospital market. In addition, sales of our pumps increased $4 million. We introduced our new enteral pump in the international market, but that was partially offset by lower sales of our infusion pumps as we completed a voluntary software correction during 2011.  Net sales in Medical Devices increased in 2010 compared to 2009 from sales of administration sets which increased $7 million, or 17%, and acquisitions that contributed $4 million of incremental sales.  Our operating margin improved to break-even in 2011 as a result of several factors, including lower costs from having our Costa Rica facility fully operational, the higher sales volume and a more favorable product mix. Offsetting those improvements were warranty costs in 2011 in connection with the voluntary software correction. Our operating margin for Medical Devices was below break-even in 2010. We were negatively impacted by greater than expected start up costs for the production facility in Costa Rica, a high level of product development costs and the build-up of a direct sales force. Our operating margin was lower in 2009 compared to 2010 as a result of lower sales volume, excluding the impact of acquisitions, a shift in product mix and other costs incurred in 2010, which included $2 million of costs for a voluntary software modification for certain of our enteral feeding pumps and $1 million of first year purchase accounting adjustments for the Aitecs and Ethox acquisitions.  

Unlike our other segments, twelve-month backlog for Medical Devices is not substantial relative to sales reflecting the shorter order-to-shipment cycle for this line of business.

  2012 Outlook for Medical Devices - We expect sales in Medical Devices to increase $3 million, or 2%, to $145 million in 2012. We expect sales increases from new product offerings, including increases of $5 million in pumps, partially offset by a $2 million decline in administration sets to a more typical level. We expect our operating margin to improve to 3.4% in 2012 as a result a more favorable product mix and no longer having the costs from the 2011 voluntary infusion pump recall.                                                55  

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FINANCIAL CONDITION AND LIQUIDITY

                                              0000000000        0000000000        0000000000        0000000000      0000000000      0000000000      0000000000                                                                                                         2011 vs. 2010                   2010 vs. 2009  (dollars in millions)                       2011              2010              2009           $ Variance       % Variance     $ Variance       % 

Variance

Net cash provided (used) by:

 Operating activities                     $        196      $        195      $        118      $          1              1%    $         77             65%  Investing activities                             (121 )             (98 )            (325 )             (23 )          (23%)            227             70%  Financing activities                              (73 )             (66 )             201                (7 )          (11%)           (267 )         (133%)  

Our available borrowing capacity and our cash flow from operations provide us with the financial resources needed to run our operations, reinvest in our business and make strategic acquisitions.

Operating activities

  Net cash provided by operating activities was virtually unchanged in 2011 compared to 2010. Positive contributions in 2011 came from higher net earnings, increased customer advances and improved collections on receivables, most notably on Boeing 787. Offsetting those positive cash flows were greater use of cash for inventory requirements to fund the sales growth and a higher level of U.S. defined pension contributions. Net cash provided by operating activities increased in 2010, primarily due to increased earnings and non-cash expenses as well as a smaller increase in working capital requirements.  

Investing activities

  Net cash used by investing activities in 2011 includes $84 million for capital expenditures and $38 million for three acquisitions, two in Aircraft Controls and one in Components. Net cash used by investing activities in 2010 includes $66 million for capital expenditures and $30 million for four acquisitions, two in Space and Defense Controls and one each in Aircraft Controls and Industrial Systems. Net cash used by investing activities of $325 million in 2009 includes $261 million for the completion of eight acquisitions and $82 million for capital expenditures. Those amounts were partially offset by the redemption of $20 million of supplemental retirement plan investments that were used to purchase $21 million par value of our 6 1/4% and 7 1/4% senior subordinated notes.  

We expect our 2012 capital expenditures to increase to approximately $105 million. This increase is a result of investments in major program initiatives and facility expansions.

  Financing activities  Net cash used by financing activities in 2011 primarily reflects pay downs on our U.S. credit facility and $29 million used for our share repurchase program, under which we purchased the remaining 766,400 shares authorized by our Board of Directors in October 2008. Net cash used by financing activities in 2010 primarily reflects pay downs on our U.S. credit facility and the payment of a note issued for the LTi REEnergy acquisition. Net cash provided by financing activities in 2009 is primarily related to borrowings on our U.S. credit facility to fund most of the acquisitions and net proceeds of $75 million received from the sale of 2,675,000 shares of Class A common stock at $29.50 per share. Those amounts were partially offset by the redemption of $21 million par value of our senior subordinated notes, pay downs of $17 million on notes payable and $7 million used for our share repurchase program authorized in October 2008.                                          56  

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CAPITAL STRUCTURE AND RESOURCES

  We maintain bank credit facilities to fund our short and long-term capital requirements, including for acquisitions. From time to time, we also sell equity and debt securities to fund acquisitions or take advantage of favorable market conditions.  On March 18, 2011, we amended our U.S. credit facility. Our new revolving credit facility, which matures on March 18, 2016, increased our borrowing capacity to $900 million. Previously, our credit facility consisted of a $750 million revolver which was to mature on March 14, 2013. The new revolving credit facility had an outstanding balance of $333 million at October 1, 2011. Interest on the majority of the outstanding credit facility borrowings is based on LIBOR plus the applicable margin, which was 150 basis points at October 1, 2011. The credit facility is secured by substantially all of our U.S. assets.  The U.S. credit facility contains various covenants. The covenant for minimum interest coverage ratio, defined as the ratio of EBITDA to interest expense for the most recent four quarters, is 3.0. The covenant for the maximum leverage ratio, defined as the ratio of net debt, including letters of credit, to EBITDA for the most recent four quarters, is 3.5. The covenant for maximum capital expenditures is $135 million for 2011 and increases by $10 million each year thereafter. We are in compliance with all covenants. EBITDA is defined in the loan agreement as (i) the sum of net income, interest expense, income taxes, depreciation expense, amortization expense, other non-cash items reducing consolidated net income and non-cash equity-based compensation expenses minus (ii) other non-cash items increasing consolidated net income.  We are required to obtain the consent of lenders of the U.S. credit facility before raising significant additional debt financing. In recent years, we have demonstrated our ability to secure consents to access debt markets. We have also been successful in accessing equity markets, from time to time. We believe that we will be able to obtain additional debt or equity financing as needed.  At October 1, 2011, we had $571 million of unused borrowing capacity, including $555 million from the U.S. credit facility after considering standby letters of credit.  

Net debt to capitalization was 34% at October 1, 2011 and 37% at October 2, 2010. The decrease in net debt to capitalization is primarily due to debt reductions funded by our positive cash flow and net earnings.

We believe that our cash on hand, cash flows from operations and available borrowings under short and long-term lines of credit will continue to be sufficient to meet our operating needs.

Off Balance Sheet Arrangements

We do not have any material off balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.

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Contractual Obligations and Commercial Commitments

  Our significant contractual obligations and commercial commitments at October 1, 2011 are as follows:           (dollars in millions)                          Payments due by period                                                                2013-      2015-      After        Contractual Obligations          Total        2012       2014       2016       2016         Long-term debt                  $    716     $    1     $    3     $  520     $  192         Interest on long-term debt           133         26         52         31         24         Operating leases                      97         20         29         17         31         Purchase obligations                 653        436        189          6         22 

Total contractual obligations $ 1,599$ 483$ 273 $

574 $ 269

   In addition to the obligations in the table above, we have $8 million recorded for unrecognized tax benefits in current liabilities, which includes $1 million of related accrued interest. We are unable to determine if and when any of those amounts will be settled, nor can we estimate any potential changes to the unrecognized tax benefits.  

Interest on long-term debt consists of payments on fixed-rate debt, primarily our senior subordinated notes.

  Total contractual obligations exclude pension obligations. In 2012, we anticipate making contributions of $8 million to defined benefit pension plans.         (dollars in millions)                       Commitments expiring by period                                                               2013-       2015-       After

Other Commercial Commitments Total 2012 2014 2016 2016

      Standby letters of credit      $    13       $   8       $    1     $     2     $     2                                           58  

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ECONOMIC CONDITIONS AND MARKET TRENDS

  We operate within the aerospace and defense, industrial and medical markets. Our aerospace and defense markets are affected by market conditions and program funding levels, while our industrial markets are influenced by general capital investment trends. Our medical markets are influenced by economic conditions, population demographics, medical advances and patient demand. A common factor throughout our markets is the continuing demand for technologically advanced products.  

Aerospace and Defense

  Approximately 60% of our 2011 sales were generated in aerospace and defense markets. The military aircraft market is dependent on military spending for development and production programs. Production programs are typically long-term in nature, offering predictability as to capacity needs and future revenues. We maintain positions on numerous high priority programs, including the F-35 Joint Strike Fighter, F/A-18E/F Super Hornet and V-22 Osprey. The large installed base of our products leads to attractive aftermarket sales and service opportunities. Future defense spending may moderate in the coming years as the Administration balances U.S. military commitments and needs with domestic spending. We believe, however, that we're well positioned on key strategic platforms that will not be severely impacted by any U.S. defense budget reductions.  Global demand for air travel generally follows economic growth and, therefore, the commercial OEM market has historically exhibited cyclical swings. The aftermarket is driven by usage of the existing aircraft fleet, the age of the installed fleet and is currently being impacted by fleet re-sizing programs for passenger and cargo aircraft. Changes in aircraft utilization rates affect the need for maintenance and spare parts and impact aftermarket sales. Boeing and Airbus have historically adjusted production in line with air traffic volume. Demand for our commercial aerospace products is in large part dependent on new aircraft production, which is increasing as modest global economic growth continues.  The military and government space market is primarily dependent on the authorized levels of funding for satellite communications. Government spending on military satellites has increased along with the military's need for improved intelligence. The commercial space market is comprised of large satellite customers, traditionally telecommunications companies. Trends for this market, as well as for commercial launch vehicles, follow the telecommunications companies' need for increased capacity and the satellite replacement lifecycle of 7-10 years. Our position on NASA programs is impacted by the Administration's willingness to fund those programs. We believe that we're well positioned to benefit from the Administration's decision to replace the retired Space Shuttle.  The tactical missile, missile defense and defense controls markets are dependent on many of the same market conditions as military aircraft, including overall military spending and program funding levels. Our homeland security product line is dependent on government funding at federal and local levels, as well as private sector demand.  

Industrial

  Approximately 31% of our 2011 sales were generated in industrial markets. The industrial markets we serve are influenced by several factors, including capital investment, product innovation, economic growth, cost-reduction efforts and technology upgrades. As global economic conditions have modestly improved, we have seen a recovery in these markets. We experience challenges from the need to react to the demands of our customers, which are in large part sensitive to international and domestic economies. We currently see modest global growth across several of the markets in which we participate and are well positioned for increased demand in renewable energy markets.  

Medical

  Approximately 9% of our 2011 sales were generated in medical markets. The medical markets we serve are influenced by economic conditions, regulatory environments, hospital and outpatient clinic spending on equipment, population demographics, medical advances, patient demands and the need for precision control components and systems. Advances in medical technology and medical treatments have had the effect of extending the average life span, in turn resulting in greater need for medical services. These same technology and treatment advances also drive increased demand from the general population as a means to improve quality of life. Greater access to medical insurance, whether through government funded health care plans or private insurance, also increases the demand for medical services.                                                59  

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Foreign Currencies

  We are affected by the movement of foreign currencies compared to the U.S. dollar, particularly in Industrial Systems. About one-third of our 2011 sales were denominated in foreign currencies. During 2011, average foreign currency rates generally strengthened against the U.S. dollar compared to 2010. The translation of the results of our foreign subsidiaries into U.S. dollars increased sales by $32 million compared to the same period one year ago. During 2010, average foreign currency rates generally strengthened against the U.S. dollar compared to 2009. The translation of the results of our foreign subsidiaries into U.S. dollars increased 2010 sales by $11 million compared to 2009.  

RECENT ACCOUNTING PRONOUNCEMENTS

  In January 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-06, "Fair Value Measurements and Disclosures (ASC Topic 820) - Improving Disclosures About Fair Value Measurements." This amendment requires separate disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements. The new disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. This standard is effective for us beginning in the first quarter of 2012. Other than requiring additional disclosures, the adoption of this new guidance will not have a material impact on our consolidated financial statements.  In December 2010, the FASB issued ASU No. 2010-28, "Intangibles - Goodwill and Other (ASC Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." This amendment modifies the criteria for performing Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts, and it requires performing Step 2 if qualitative factors indicate that it is more likely than not that an impairment exists. The new standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Any goodwill impairment resulting from the initial adoption of the amendments should be recorded as a cumulative effect adjustment to beginning retained earnings. Any goodwill impairments occurring after the initial adoption of the amendments should be included in earnings. We will adopt this standard in the first quarter of 2012. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements.  In December 2010, the FASB issued ASU No. 2010-29, "Business Combinations (ASC Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations." This amendment expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This amendment is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. We will adopt this standard during the first quarter of 2012. Other than requiring additional disclosures, the adoption of this amendment will not have a material impact on our consolidated financial statements.  In June 2011, the FASB issued ASU No. 2011-04, "Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS." The amendments provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. The amendments also change certain fair value measurement principles and enhance the disclosure requirements, particularly for Level 3 fair value measurements. The amendments are effective during interim and annual periods beginning after December 15, 2011 and should be applied prospectively. Early adoption is not permitted. We will adopt this standard during the second quarter of 2012. Other than requiring additional disclosures, the adoption of this amendment will not have a material impact on our consolidated financial statements.  In July 2011, the FASB issued ASU No. 2011-05, "Comprehensive Income (Topic 220) - Presentation of Comprehensive Income." The amendment eliminates the option to present other comprehensive income and its components in the statement of stockholders' equity. The amendment requires all nonowner changes in stockholders' equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment, which must be applied retrospectively, is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. On October 21, 2011, the FASB Board decided that certain presentation requirements concerning reclassification adjustments will be deferred. While the Board is considering the operational concerns about presentation requirements for reclassification adjustments, it stated that the deferral did not affect the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Other than requiring a change in the format of our current financial statement presentation, the adoption of this amendment will not have a material impact on our consolidated financial statements.  

See also Note 1 of the Consolidated Financial Statements at Item 8, Financial Statements and Supplementary Data of this report.

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