Teleflex Incorporated (TFX) Q3 2008 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Third Quarter 2008 Teleflex Incorporated Earnings Conference Call. My name is Erika and I will be your coordinator for today. At this time, all participants are in listen-only mode. We'll be facilitating a question-and-answer session towards the end of this conference. [Operator Instructions]. As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Jake Elguicze, Senior Director of Investor Relations. You may proceed, sir.

Good morning everyone. The press release and slides to accompany this call are available on our website at www.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 25612541. Participating on today's call are Jeff Black, Teleflex's Chairman and Chief Executive Officer; and Kevin Gordon, Teleflex's 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 2. We wish to caution you that such statements are in fact forward-looking in nature and are subject to risk 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 will 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 over the call to Jeff Black. Jeff?

Good morning everyone, thanks, Jake. Results for the third quarter and the first nine months were strong for Teleflex. Our operations continued to deliver solid results. We've made good progress on our strategic initiatives and we are clearly benefiting from the portfolio changes we made last year. October 1st was the anniversary of the Arrow acquisition and the expansion of our Medical segment as well as the launch of SAP in North America. And we just passed the anniversary a line out so that we would divest the automotive and industrial businesses. Those actions and our focus on aftermarket service businesses in the Commercial and Aerospace has provided us with the diverse global base and a portfolio that although not immune to economic conditions is less cyclical and better positioned for this economic environment. Through the first nine months we performed well against the objectives that we set out on our outlook at the beginning of the year. Overall segment margins are in the mid teens, cash flow is strong and we are achieving synergies from our acquisitions. We have improved Commercial and Aerospace margins year-over-year despite very tough market conditions in Marine and Power and an increased engineering investment in our Aerospace businesses. And Medical has delivered segment operating margins of 20%; quite an accomplishment particularly given the spending on the FDA compliance program and the significant resources that we have dedicated to it. On the revenue side, our Medical segment is reaching our mid single digit core growth goals in Europe and Asia, Latin America and in the OEM business, but has been challenged in North America. As we progress through remediation efforts and integration, we intend to show up our competitiveness here. Cash flow from operations has been strong up 23% excluding the $90 million tax payment we made earlier in the year related to the automotive and industrial divestiture and importantly we have continued to bring down our debt paying down more than $100 million so far this year. Let me move on to some of the highlights. Highlights for the third quarter would sound a lot like the second quarter. A sign that we are making steady progress in line with our plans. Revenues grew 30% on acquisitions. Medical segment core growth was 1%. Again, international markets had solid core growth. But we had a tough comp with last year when we had higher sales to distributors in North America prior to our October 2007 launch of SAP. In aerospace, a favorable mix in both cargo systems and engine repairs resulted in lower core revenues but higher operating margins. Commercial core revenues declined 13% on significantly lower volumes in marine and for auxiliary powers but margins held. As a result core growth of the company overall declined to 4%. Overall operating margins before special charges in the quarter were 16.2%, nice margins in all three segments. And EPS excluding special charges was $1.11 up 41%. And cash flow from operations was up 65% over the prior year quarter and $76 million for the quarter. Let me just bring you up to date on some of our strategic initiatives. In the Medical segment, we've advanced our compliance programs and are now working extensively with outside consultants and third parties as we enter the latter stages of the program. This has been and continues to be a demand on our resources. The integration of Arrow continues in line with our plans for the full year and total synergies. We've focused on the corporate administrative and front end functional integrations and are now moving into the facility consolidation phase as we enter the 2009. The first two facility consolidations are well under way in Europe but most of our product moves are in the planning stages for executions in 2009 and 2010. We've just adjusted schedules for some of the moves to assure that we are ready and have the resources available for this transition. Overall, we expect to achieve roughly $40 million pretax synergies in 2008. And we continue to see ourselves at $70 million to $75 million by 2010. On the R&D front, as we move resources from the compliance program we will add research and development professionals and work to accelerate progress on our identified R&D projects. As I mentioned earlier, we are achieving solid core growth outside of the U.S. and in our OEM business. New product initiatives will enable us to maintain this growth and should help us to improve competitiveness in North America. We've also made some changes in the sales force of North America to focus on certain product areas creating a dedicated team in anesthesia. You may have also seen our press release in September when we announced moving Matt Jennings into the new position as President of North America. Matt, brings great industry experience with customers and with the sales and marketing organization and will be much valuable to the organization going forward. To strengthen our global operations we've moved Vince Northfield from President of the Commercial segment into a new position as Executive Vice President in the Medical business running the back end operations worldwide. In Aerospace, we are benefiting from the investments we have been making new technologies for engine repairs and we continue to invest in engineering and capacity for new cargo systems platforms. The focus in our commercial segments in managing through fluctuating market conditions, controlling cost and creating opportunities. We have been pleased to see the rigging services hold up well and a strong backlog of APU orders for the fourth quarter and for the first quarter of 2009. Today, given the results of our operations in the third quarter and the first nine months of our current and in line with our current order trends, we see ourselves at the top of the EPS range we provided to you on just our last call. We're forecasting an EPS in the $4 range for the year excluding special charges. Overall, for the year, operations should deliver results that are better than we forecasted last January and special charges will be slightly lower by approximately $0.50 per diluted share. And we continue to see very strong cash flow generation; typically a hallmark of Teleflex. Obviously, we have our challenges. Market conditions can change, we're keeping an eye on currency fluctuation and we have work to do to continue improving operational effectiveness while we move forward with integration activities. That said, I'm pleased with the progress that we've made in our position in this economic environment. We have solid fundamentals and improving balance sheet, strong cash flow and the ability to return capital to shareholders in the form of our dividends. Kevin, will go into more detail on the financial results for the quarter. And then I'll come back and provide some additional commentary on our outlook. Kevin?

Thank you, Jeff. Good morning everyone, pleased to have you join us this morning. Slide 9, provides the summary of results from continuing operations noting the adjustments related to special charges in the quarter. Revenues for the third quarter were $596 million, up 30% over the third quarter last year. Adjusted gross profit for the quarter increased to 40.3%, a 670 basis point improvement over 33.6% in the third quarter of 2007, reflecting the benefits of the portfolio changes we made last year and the growth of our Medical segment. Adjusted operating expenses of $143.6 million represented 24.1% of sales reflecting the expansion of our medical business and investment and compliance with the R&D programs. Operating income before special charges was $96.5 million, up 65% from $58.4 million in 2007, more than double the percentage growth in revenues. Adjusted operating margins of 60.2% reflected increase of 350 basis points compared to last year. Special charges in the quarter totaled $2.5 million related primarily to the Arrow integration program. And finally operating income was $94 million, up 75%. Slide 10, provides a reconciliation to the EPS number for income from continuing operations before special charges. Restructuring cost in the quarter totaled $1.9 million net of tax. Excluding these charges, income from continuing operations was $44.3 million or $1.11 per diluted share compared to $31.4 million or $0.79 per diluted share in the third quarter last year. You will note that tax adjustment in the third quarter of 2007 that related to 2007 and planned future tax repatriations of foreign earnings. It is also important to note the impact of stronger international sales of profitability on the third quarter of 2008 results. We continue to see greater improvement in our businesses outside of North America resulting in earnings and jurisdictions with lower income tax rates. As a result principally of this our adjustments in the affective income tax rates added approximately $0.8 in the third quarter of 2008. The overall effective income tax rate for the full year is now expected to be in a range of 24%. Moving to the year-to-date results, revenues for the first nine months exceeded $1.8 billion, growing 35% compared to the prior year. Adjusted gross profit for the period increased 510 basis points to 40.5%. Adjusted operating expenses of $454.9 million or 24.9% sales increased over the first nine months last year primarily as a result of our portfolio additions. Operating income before special charges was $284.1 million up 57% from $181.3 million in 2007. Adjusted operating margins of 15.6% represented an increase of 220 basis points compared to last year and included Medical segment adjusted operating margins over 20%. Special charges before taxes for the first nine months of 2008 totaled $24.7 million and relate entirely to integration programs within the Medical segment. And operating income was $259.3 million, an increase of 49%. For the first nine months of 2008 income in EPS excluding special charges was up $119.8 million or $3.01 per diluted share compared to $100.4 million or $2.53 per diluted share for the corresponding period in 2007. The 2008 special charges as outlined on this slide $0.42 per share aggregate impact on diluted EPS. Summarizing the first nine months, as Jeff, mentioned in his remarks we had a very strong showing. We have consistently improved performance on the bottom line and are executing well against our financial objectives overall for the year. Let's turn now to specifics on the quarter for each segment. Starting with medical, Medical segment revenues for the third quarter increased 61% to $367.3 million driven by acquisition. Core revenues grew 1%, currency added 3%. Third quarter of 2007 included orders placed in the event of the October 2007 SAP launch in North America. We estimated the full forward to be about $5 million. Adjusting for the full forward, we had core revenue growth of 3% in Medical in line with this year's second quarter. Our strongest sales growth continues to be in Europe and Asia. We also had nice pick up in sales to medical device manufacturers, our OEM business in the past two quarters. Sales in North America were weaker, last year's increase in orders prior to the SAP launch primarily impacted North America creating a tougher comp. In addition, we had declines in unit volumes for respiratory care products, primarily due to the loss of a full source contract through the large GPO early in the quarter. We are diligently working with that GPO, to recover some of that business and are making good progress but there was an impact in the third quarter. Globally, the Arrow acquisition contributed total of a $129.6 million to the third quarter growth, primarily adding to our critical care product line. Operating profits for this segment excluding acquisition related charges was $73.4 million, compared to $50.1 million in last year's third quarter. Adjusted segment operating margins were 20% a sequential improvement over the 19.3% in the second quarter of this year. Spending on our regulatory compliance program had a negative impact on margins in that quarter. Spending was slightly less than what we incurred in the second quarter, we expect spending to continue trending down in the fourth quarter. For the full year we expect to see spending on compliance programs specific to the remediation in the $20 million range. We are on track to achieve $40 million in pre-tax synergies from the Arrow acquisition in 2008 and our spending to achieve the synergies today has been slightly less than originally planned. On a year-to-date basis, revenues increased to $1.1 billion and Medical segment adjusted operating margins slightly exceeded 20%. Solid progress on the goals that we set out earlier this year. In our critical care product lines, Arrow vascular access and regional Anesthesia products added $113.6 million in the quarter and vascular access once again we had solid growth in North America and Asia and Latin America. Consistent with our strategic direction we are maintaining our high PICC market share, we are seeing strength in sales of tips and specialty catheters. For example hemodialysis [indiscernible], renal access and micro introducers. Anesthesia and airway management products has strong percentage growth in Europe and in Asia. In North America we increased sales of regional anesthesia products in the quarter and we are building out a dedicated sales team for a combined regional anesthesia airway management sales to better serve our customers. And we continue to see modest volume growth in Europe, Asia and Latin America for our urology product line. Respiratory care products has a strong year-over-year growth in Asia, Latin America across a number of products and our surgical products sales grew 5% largely on favorable currency and core growth in sales to customers in Europe, Asia and Latin America with modest year-over-year declines in North America. Both Europe and Asia have continued to be areas of strength for us while some of our niche products have some more competitive pressure. Sales to medical device OEM stood 3% compared to third quarter last year as we saw higher volumes for our specialty devices and specialty suture products. The Arrow cardiac care product added $16 million to revenue in the quarter. We saw a modest decline in cardiac sales when compared to Arrow sales in the prior year period. We have made progress but continue to work through some production issues on certain product lines in this product area. Overall the product line strengths are similar to what we have seen all year. Moving to aerospace, in this segment third quarter revenues were $126.9 million up 12% principally as a result of a $14 million contribution from the Nordisk acquisition which expanded our cargo containers business. Operating profit rose to $16.8 million, a significant increase compared to the $7.5 million in last year's third quarter. Segment operating margins rose to 13.2% in the quarter, the highest segment operating margins we have seen in some time. Our margin favorable mix of sales and with the cargo systems in the engineer repairs businesses resulted in a 2% decline in core revenue but much higher operating margins. Let me explain the dynamics displayed here during the quarter. In the engine repair business, the favorable mix is really the result of the investments we have made in new technologies. Very similar to last quarter we saw a higher mix of repairable engine components generating value added margin compared with replacement products. We expect to continue to invest in new technologies for the newer more fuel-efficient engines to further advance and enhance our strong position in the engine repairs market. The cargo systems business, we once again had near record sales of narrow body cargo loading systems. We had another year-over-year increase in higher margin cargo active market spares. Our narrow body cargo loading systems unit volume more than doubled in the quarter when compared to the third quarter of last year. Also it was another record quarter for cargo aftermarket spares and repairs, a reflection of our growing installed base. At the same time when compared with prior year we had fewer deliveries of new wide body systems scheduled for the quarter and a higher number of schedule for the fourth quarter, so the timing and mix had a positively impact on margins. On a year-to-date basis, revenues were $385.8 million reflecting a 16% increase over the first nine months of 2007. The growth is principally from the Nordisk acquisition and 1% core growth resulting from the growth in the cargo systems business offset by the mix related revenue decline in the engine repairs business. Segment operating profit increased to $45.9 million compared to $32.2 million in 2007. And segment operating margins were 11.9% on a year-to-date basis, a 220 basis point improvement over 2007. Turning to the Commercial segment, as expected third quarter revenues declined on lower volumes in both Marine and Power compared to prior year. Revenues in the quarter were $101.6 million compared to $117 million in the prior year. Marine sales declined significantly compared to prior year as OEM customers extended shut downs and cut back production levels during the summer months. Marine OEM and engine sales were down as they have been all year. We saw somewhat less of an impact in aftermarket and international sales but declined here as well. During the quarter our marine group responded with shutdowns and reduced production schedules. We do not see a turnaround in this market in the near term. However, we will continue to adjust the market conditions and at the same time work to position ourselves to continue new product development and maintain market share for the future. Power systems had another difficult comp as revenues decreased most notably for the truck APUs. On a more positive note as we said last quarter, order transfer truck APUs rebounded and we have a nice increase in scheduled deliveries for Q4 2008 and Q1 2009 compared to the prior year. During the third quarter we also continue shipments alternative fuel conversion hits to South America under $5 million contract with additional systems to be shipped over the remainder of the year. Once again the rigging services business had another great quarter. Core revenues increased on stronger sales for wholesale customers and a range of industrial and marine transportation markets. Storms in the Gulf region during September, closed some of our sites or prevented shipping but did not cause a significant interruption. We also did not see a level of damage and need for future repair work for oil rigs that we have seen in some previous storms. Overall, Commercial segment operating profit rose in part due to favorable mix and cost containment but also as a result of cost from warranty and engineering expense in the third quarter 2007 that did not recur in 2008. Operating profit increased to $7.1 million from $2.3 million for the prior year quarter. Segment operating margins were 7% considering the overall market conditions and good performance by the group. On a year-to-date basis revenues $330 million compared $338.7 million in 2007. Operating profit of $19.4 million in 2008 increased compared with $18 million in 2007. Moving to cash flow, as we previously discussed, we made income tax payments in the first two quarters of 2008 and were approximately $90 million related to the December of 2007 gain on sale that resulted from the divesture of our automotive and industrial businesses. Excluding the impact of these tax payments cash flow from operations was $188 million for the first nine months of 2008 up 23% over the same period in 2007. Free cash flow was $121 million, an increase of 39% over the comparable period in '07. On a working capital front we are seeing customers particularly in the Aerospace and Commercial businesses looking to stretch terms on receivables balances. However, we are monitoring our credit risk closely in the current economic environment and have done a nice job on our accounts receivable. On slide 18, you'll note that we had made progress in reducing our debt and improving our capital structure in 2008. Strong cash flow has enabled us to reduce outstanding debt by over $100 million this year. Net debt to capital has declined to 51.7% and as we continue to improve the structure it provides additional opportunities to invest in growth initiatives. In light of the current status of the capital markets, like many others, we have been asked questions about our structure and availability of capital. When we acquired Arrow last year we entered into a five-year borrowing arrangement that expires in 2012. The required payments under this agreement approximate $100 million in each of the next two years. Given the strong cash flow of our businesses and the availability provided under our revolving credit agreement, we believe we are well positioned and have an appropriate structure to allow us to execute our plans. As Jeff discussed, we now see ourselves at the top of the guidance range we provided last quarter. As a result of the strong performance in the first nine months and the current trends we see in our businesses. Special charges which principally relate to charges from the Arrow integration at fair market value adjustments the inventory are currently forecasted at a range of $0.49 to $0.52 per share. On a GAAP basis, our EPS is expected to be $3.38 to $3.51. Results from our operations are ahead of our earlier expectations. We expect special charges to be slightly lower this year than we had planned. Overall fourth quarter earnings should look alike the third quarter exclusive of the tax patch up that we saw in Q3. We expect cash flow from operations of approximately $250 million for the full year excluding the tax payments. And with that let me turn it back to Jeff with more on the outlook.

Thanks, Kevin. In summary, strong results to date. We are executing consistently and moving forward with our strategic initiatives. Looking ahead let me just make a few comments on expectations given the current market and the businesses that we have to manage. In Medical, we expect continued international sales growth particularly in Asia. In North America, we are instituting sales programs and continuing to expand our sales initiatives with GPOs and IBMs. The CMS reimbursement changes for hospital acquired infections went into effect October 1. We are continuing to work on awareness and support campaigns for customers particularly related to Arrow products and catheter related bloodstream infections. And on the OEM side, we continue to see positive order trends Our compliance initiatives will be ongoing. We're spending on these initiatives and the Arrow integration activities on track to achieve pre-tax synergies for 2008. We continue to expect medical operating margins of 20% for the year. In Aerospace, we expect strong sales of narrow body systems and cargo aftermarket components to continue. In addition, we should see revenue growth based on the ramp up of scheduled deliveries for wide body systems and we're pleased to see that Boeing and in the union have come to a tentative agreement. Engine repair trends to haves some of the seasonality with fewer engines for the repairs during the peak flight time around the holidays. At the same time this business has been a consistent performer executing well, expanding margins through the use of more efficient repair technologies. We continue to invest here for new engines and technologies. We remain cautious on Commercial with the down cycle in marine and we'll continue to adjust our plans going forward to address market conditions. But that business has managed fairly well in tough markets and we continue to win new business in future platforms. In the power systems, business should start to move out of its down cycle in the fourth quarter. We've already seen an improvement in the oil rates for auxiliary power units for both truck and rail. We continue to emphasize cash for our priorities in our businesses and are focused on the reduction in our borrowings. Overall, we are pleased with our progress for the first nine months. Although we are understandably cautious with the current financial and economic climate, we are executing well against our plans for the year and continue to position the company for the long-term. With that we'll take some questions. Question And Answer

[Operator Instructions]. Your first question comes from the line of Deane Dray [Goldman Sachs]. You may proceed.

Thank you. Good morning every one.

Good morning, Deane.

My question first in the Medical side on the R&D spending in the quarter and the outlook and specifically, Jeff, it sounded like that you had done some diverting of... would it been R&D funds that had to go into the FDA compliance program and did I understand that correctly and just want to understand your thinking here because if you are looking at a 18 to 24 month payback why would you not want to still fund that R&D spending now in order to start getting the results from that sooner and what's the outlook on the ramp down on that FDA compliance program?

Yes, Dean let me just touch on that. One, we are not diverting funds away from R&D, part of it is just using our resources to get through some of the technical issues on the remediation. But I will tell you that we are actively increasing our R&D spend. A part of that is getting the people on board and getting them up to speed. But I think we've committed to that. I wanted to say, Kevin, after the first quarter of increasing our R&D. So, if I gave the impression that we're making judgment between investing in R&D and working on remediation that is not the case. We are working on both of them. But there is some overlap on those resources but we do appreciate that if we take away from R&D now, it's only going to impact our future growth rates.

Sure, what was it on a percent of sales basis and what is the target rate?

The target over the long term deal is to get ourselves up to 5% to 6% range. That's going to take us a bit of time to get there. In the quarter, we're still at about the 4% or just under the 4% range on spending. But again a chunk of that is related to the remediation efforts in the R&D and the compliance efforts.

Okay. And then, broadly, could you give us an update of what you're seeing on a spending pattern across North American hospitals. Lot of focus on what would be the big ticket items, CapEx squeezes, that doesn't seem to be in your particular product line but what are you seeing in terms of the changing and spending patterns?

That's clear, I think you identified a right on a big ticket things, I think there's going to, there has been and will continue to be in this environment pressure on capital equipment suppliers that we've seen. From a disposable medical product, where isn't such an elective procedure which is the markets that we tend to participate we haven't seen any significant impact. A couple of areas of our business maybe more susceptible to some of that for instance the orthopedic OEM side from the instrumentation standpoint. But to date that has not had a major impact on us.

That's very helpful Kevin, what about the idea is I know about 80% of the products are considered disposable, but across the portfolio how much might be considered more discretionary within medical spending? What we're trying to do is figure out how susceptible or resilient is the portfolio in a deeper recession?

I guess that's for us trying to get out with that last one more thing is on the OEM side of our business we have orthopedic instrumentation that maybe considered more of an elective procedure type thing to support that. Our OEM business today as you see in the disclosures is about 10% or 11% of the overall business and maybe a third of that relates to the orthopedics side of the business. So, for the most part, we are looking at the disposables are around urology, anesthesia, respiratory even CDC, they don't typically tend to be an elective procedure they tend to feel more of a required.

Great. And then, just clarification, did you take advantage of the R&D tax credit this quarter?

We did not, we are very aware of the bail out program that the government put in and renewing that R&D proposal. But that will actually be a fourth quarter event for us.

Can you quantify that at this stage?

I don't know that I want to give also specific number. We're still through our analysis on that. But it could be I'd rather just not do at this point.

Okay. But that will be a fourth quarter event for you?

Yes it will.

Great, thank you.

Your next question comes from the line of Jim Lucas [Janney Montgomery Scott]. You may proceed.

All right, thanks, good morning guys.

Good morning, Jim.

First question, wanted to focus on the non-medical side. Within aerospace on the cargo, where do you stand currently in terms of OE versus aftermarket today?

From a spares basis.

Yes.

Jim, the revenue that's driven by our spares business is just under 30% of the total overall cargo business revenue.

Okay.

And just to clarify, OEM versus aftermarket, when you look at the cargo business you also have to consider the retrofit is a convergent in the market and OE or an aftermarket and I think we look at that much more as an aftermarket opportunity.

Okay. Some semantics there. Embedded in your guidance what assumption are you making with the Euro? Had to put you on the spot.

Well I would tell you that we're somewhere in the 130 to 135 range with our guidance at the moment.

Okay.

As you know there is some fluctuation there and there is some hedge between our businesses that help offset some, so we kind of balance some of that risk out.

With regards to the Arrow integration, you talked about the back end side making good progress; starting down the facility side you eluded in your prepared remarks about the new anesthesia dedicated sales force. Can you give a little more color from an update perspective of the sales integration as well as the R&D side and if we could look at both North America and Europe on the sales side of how the integration is going?

Yeah, Jim, I'll talk on the sales, Kevin can talk on the other end. I think we continue to make progress year later. I'd be remise if I say that some of our decisions when we did the deal and some of our initial thoughts haven't changed because they absolutely have changed. But overall I think we still feel good about the sales force integration, I think Matt Jennings, for those of you who didn't know, Matt's been with Teleflex for four years in a variety of different positions. Matt, came out of the cardinal organization again. He has got the skills, he knows our portfolio and so we feel pretty good about having him and in the past when we used to have Matt, in that North American job was you had front end and back end. Jim, you know Vince, Vince is probably one of the best operating guys that I have ever come across. So we felt that what we really wanted to is put our people back onto the growth and Matt really can go out and grow the business while, Vince, can support him on the back end. So our structural change really comes back to dealing with our growth issue of both we are having to invest in R&D, but we are having to look at how are we going to the market a little differently as we see some of these opportunities arise. Kevin, you want to touch on that.

Yes, from an R&D perspective, Jim, we are... I think we talked a lot about making the Redding facility our global R&D headquarters which we are continuing to invest there and kind of put the right people in place. But we've also moved forward with the strategy of having the right R&D or development folk at large local facilities, for instance, in our Malaysian facilities and the Czech Republic facility. So while we have a centralized place for R&D, we're putting it a very local as well and all that structure is going in place. And just to touch a little bit on the distributor conversion; I think that was part of your question as well. We are making good progress on that particularly in the European markets and the Central European markets, to do some of those conversions. So we're doing those at a tempered pace to make sure that there is no individual significant impact on anyone particular region.

Okay, great, thanks a lot.

Your next question comes from the line of Dan Ruder [ph], you may proceed.

Good morning.

Good morning, Dan.

Good morning, Dan.

Great looking quarter. Just a follow just on Jim's question, just to clarify. Did you say that you considered 30% of dispersed to be aftermarket this quarter?

No, what I was Dan, was that of the total cargo business revenues, 30% of those revenues are spare sales. The other component that would make an additional aftermarket sale would be a conversion of an existing aircraft from a passenger aircraft to a freighter.

Okay, thanks for the clarification on this. What is amount of APU that seems to be turning around so quickly. And I didn't perceive any truck engine or the locomotive business necessarily beginning at a much better all of the sudden?

I think some of its distribution channel, Dan, we had very strong sales at the end of last year. We so some softness in the market you do know that we exclusively distribute through carrier I think they had some inventory levels that may be we're a bit higher. And we are now refilling that distribution channel and with fuel prices jumping up the way we did over the course of the summer and it created some pretty significant demand for the product.

Okay great. And can you quantify the year-over-year delta on the warranty expense this quarter/

I think if you recall it maybe even right on directly on the slide as we took about a $4 million one time charge on a catch up basis in the third quarter of last year related in the power business.

Great, thank you very much.

Okay.

[Operator Instructions] Your next question comes from the line of Tom Mayer [ph]. You may proceed.

Hello.

Good morning Tom.

Hi, how are you guys, actually that was my question on the APU. But just a follow up in terms of the Arrow integration savings I think you said you're slightly behind the pace that you would expected. Could you just sort of clarify those comments?

No, I think we're actually on the synergies we're getting. We're still at that $40 million for this year. I think we will returned at the investors now they we're just moving it out on the in terms of some of these product moves. And so, therefore the spending was slightly less than we would have anticipated had we made some of the moves.

Alright, okay. So, we're still on drag just the matter of the timing of those.

Absolutely.

Great. And thank you.

This concludes our question-and-answer portion of the call. Everyone have a wonderful day. And thank you for your participation.

Thanks, everybody.

Thank you. .