ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

All references to years in this Management's Discussion and Analysis of Financial Condition and Results of Operations are to fiscal years.

Overview

Moog is a leading worldwide designer and manufacturer of a broad range of high performance precision motion and fluid controls and control systems for a broad range of applications in aerospace and industrial markets. In 2002, approximately 42% of the Company's sales were related to military defense or government funded programs. The Company has three operating segments.

Aircraft Controls designs and manufactures technologically advanced flight and engine controls for manufacturers of military and commercial aircraft. Moog supplies flight controls for major, in-production military aircraft, including the U.S. Navy's F/A-18E/F Super Hornet fighter aircraft, the V-22 Osprey tiltrotor aircraft and the F-15 Eagle. The Company is the contract lead for developing flight controls for the System Development and Demonstration phase of the F-35 Joint Strike Fighter program, teaming with Parker Hannifin, Hamilton Sundstrand and Curtiss-Wright. The F-35 is the next generation fighter aircraft to be used by all three branches of the U.S. military and several foreign governments. The Company is a supplier to both commercial large body aircraft manufacturers, The Boeing Company and EADS, and business aircraft manufacturers including Raytheon Company and Bombardier Inc. Aftermarket sales, including repairs and spare parts, represented 39% of Aircraft Controls revenues in 2002.

Space Controls designs and manufactures controls and systems that control the flight, positioning or thrust of tactical and strategic missiles, launch vehicles, satellites and NASA's Space Shuttle. Customers include Alliant Techsystems Inc., Lockheed Martin, Astrium Ltd., Raytheon and Boeing. Moog participates on tactical missile programs such as AGM-142 Popeye, VT-1, Hellfire and TOW, missile defense programs such as the Ground-Based Midcourse Defense program, or GMD, the Space Station Crew Return Vehicle and the Atlas and Delta Evolved Expendable Launch Vehicles.

Industrial Controls designs and manufactures hydraulic and electric controls used in a variety of industrial applications. Product applications include plastic injection and blow molding machines, steam and gas turbines, steel rolling mills, fatigue testing machines, motion simulators and gun and turret positioning and ammunition-loading systems on combat vehicles.

On November 20, 2001, the Company completed the sale of 1,980,000 Class A common shares at $21.00 per share. The net proceeds to the Company of $39 million were used to repay outstanding debt. On September 21, 2001, the Company distributed Class A and B common stock in a three-for-two stock split effected in the form of a 50% stock distribution. Share and per share amounts included herein have been restated where applicable to show the effects of the stock split.

2002 Acquisitions

On March 29, 2002, the Company acquired 81% of the stock of Tokyo Precision Instruments Co. Ltd. (TSS) from Mitsubishi Electric Corporation and other shareholders for $0.6 million in cash. TSS's balance sheet, which is consolidated in the Company's financial statements, included $4 million of net funded debt and $2 million of cash as of March 29, 2002. As of September 28, 2002, the Company had acquired 98.8% of TSS for $0.8 million. TSS manufactures high-performance servovalves, hydraulic systems and pneumatic components for a variety of industrial applications.

On October 25, 2001, the Company purchased the net assets of the satellite and space vehicle business of the Electro Systems Division of Tecstar, Inc. for $8 million in cash. The acquired business of Tecstar's Electro Systems Division manufactures electromechanical equipment for spacecraft.

Critical Accounting Policies - Estimates or Judgments

The Company's financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires management to make estimates, assumptions and judgments that affect the amounts reported. These estimates, assumptions and judgments are affected by management's application of accounting policies, which are discussed in Note 1 to the Consolidated Financial Statements. The Company's critical accounting policies relate to revenue recognition on long-term contracts, contract loss reserves, reserves for inventory valuation, review for impairment of goodwill, pension assumptions and deferred tax asset valuation allowances. These critical accounting policies were reviewed with the Audit Committee of the Company's Board of Directors.

Revenue Recognition on Long-Term Contracts. In 2002, 43% of the Company's sales were accounted for using the percentage of completion (cost-to-cost) method of accounting for long-term contracts which recognizes sales and costs as work is performed in advance of the delivery of the product. The percentage of completion (cost-to-cost) method of accounting is used primarily on the Company's aircraft and space contracts, which typically have longer performance cycles, resulting in the matching of sales with costs as they are incurred throughout the duration of the contract. The remaining 2002 sales were recognized when the risks and rewards of ownership and title to the product transferred to the customer, principally as units were shipped.

Percentage of completion (cost-to-cost) accounting for long-term contracts requires a disciplined cost estimating system in which all functions of the business are integrally involved. The Company believes it has adequate systems and procedures that result in complete and accurate cost estimates by contract. These cost estimates rely on engineering and manufacturing assessments of progress achieved against technical or performance milestones, and are validated using applicable product or project cost history.

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Contract prices, or contract values, are generally based on the terms and conditions specified in the contract or in the related customer purchase orders. However, the effort required under a contract can change during the performance period. These changes are typically in the form of a directed scope change from the customer, or a claim by the Company for an adjustment to the contract value based upon requirements that are different from the contract's baseline requirements. The Company includes an estimate of scope changes or claims in the contract value for purposes of revenue recognition only when that amount can be reliably estimated and when realization is considered probable. At September 28, 2002, approximately $5.7 million of unnegotiated scope changes or claims were included in contract values used in the determination of 2002 sales and operating profit.

The Company reviews contract cost estimates and contract values, including unnegotiated claims and scope changes, on a quarterly basis. As a result of these reviews, sales and costs of sales are appropriately recorded in the statement of earnings to reflect the most current assessment of each contract's percentage of completion.

Contract Loss Reserves. For contracts in which the estimated costs at completion, exclusive of allocated general and administrative period costs, exceed the estimated contract value, a loss reserve for the entire remaining loss is recorded when the loss becomes known. 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 customers' specifications. The determination of contract loss reserves is made on a specific contract basis and, therefore, no general reserves are maintained.

Once established, the amount of the loss reserve is reviewed at least quarterly and adjusted, if necessary, based on progress made and on updated cost estimates including a current assessment of any remaining risks.

Provisions for losses on contracts are reflected in the statement of earnings as additional cost of sales. As costs are incurred, the previously established contract loss reserve included in current liabilities is reduced. As of September 28, 2002, contract loss reserves were $13.9 million.

Reserves for Inventory Valuation. As of September 28, 2002, inventories represent approximately 18% of total assets and 35% of current assets. Inventories are stated at lower-of-cost-or-market with cost determined primarily on the first-in, first-out method of valuation and exclude amounts allocated to long-term contracts in progress.

The Company records valuation reserves to provide for slow-moving or obsolete inventory or to reduce inventory to net realizable value.

For slow-moving or obsolete inventory, the Company uses both a formula-based method that increases the valuation reserve as the inventory ages and, supplementally, a specific identification method. Determining the appropriate reserve for inventory valuation requires significant knowledge of the business. Management considers overall inventory levels in relation to firm customer backlog as well as forecasted demand including consideration of aftermarket sales. Inventory obsolescence reserves also consider issues such as low demand or technological obsolescence. The Company's inventory valuation reserve represents a reduction in inventory cost which creates a new cost basis of accounting. The reserve amount is maintained in a general ledger account separate from the gross inventory cost. Once a reserve is established for an inventory item, it is removed upon the subsequent use or disposition of the item. As of September 28, 2002, the reserve for inventory valuation was $27.5 million, or 14% of gross inventories.

Reviews for Impairment of Goodwill. The Company adopted the provisions of Statement of Financial Accounting Standards Board (SFAS) No. 142, "Goodwill and Other Intangible Assets," on October 1, 2001. Under SFAS No. 142, goodwill is no longer amortized, but is reviewed for impairment at least annually at the reporting unit level. As of September 28, 2002, the Company had $192.9 million of goodwill.

In testing for impairment of goodwill, companies are required to allocate goodwill among reporting units, estimate fair values of those reporting units and determine their carrying values. The Company's reporting units are the operating segments used for segment reporting: Aircraft Controls, Space Controls and Industrial Controls. This determination was made based on the similarities of the components of these groups as well as the components not qualifying as businesses themselves.

The process of evaluating the Company's goodwill for potential impairment is subjective and requires significant estimates. These estimates include judgments about future cash flows of the reporting units and allocations of commonly shared assets to the reporting units, as well as the estimates of the Company's cost of capital that was used to discount projected future cash flows.

Based on the discounted present values of the projected cash flows, management concluded that there is no impairment of the Company's goodwill.

Pension Assumptions. The Company maintains defined benefit plans covering substantially all employees in six countries. The U.S. plans represent 83% of the consolidated projected benefit obligation as of September 28, 2002. The accounting for these plans is based in part on certain assumptions that may be highly uncertain and may have a material impact on the financial statements if different reasonable assumptions had been used.

The assumption for return on assets 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. The assumed return on assets of 9.5% used in 2002 for the U.S. plans was determined with reference to the fund's investment mix as of September 29, 2001 of 75% equities and 25% fixed income securities, along with forecasted rates of return on these types of securities. Had the Company selected a return on assets that was 100 basis points lower, pension expense for U.S. plans for 2002 would have been $2 million higher than the amount recorded. The return on assets that will be used in 2003 is 8.5% for U.S. plans.

In addition to the return on assets assumption, assumptions for the rate of compensation increase and discount rate were made. The rate of compensation increase used in determining the 2002 pension cost was 3.7% for the U.S. plans and was determined using

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a long-term projection for inflation in addition to real wage increase assumptions. The discount rate used in determining the 2002 pension cost was 7.0% for U.S. plans. Consistent with prior years, the Company used the AA corporate bond rate as the discount rate for U.S. plans. At September 28, 2002, the discount rate used to value the projected benefit obligation was 6.9%.

Deferred Tax Asset Valuation Allowances. As of September 28, 2002, the Company had total gross deferred tax assets of $61.4 million. These assets relate principally to domestic liabilities or asset valuation reserves including pension and vacation accruals, inventory obsolescence, bad debt reserves and contract loss reserves. The Company believes that based on recent historical earnings performance and current projections, a valuation allowance is not required against the domestic portion of these deferred tax assets, which totaled $49.7 million as of September 28, 2002.

Deferred tax assets recorded as of September 28, 2002 by the Company's foreign subsidiaries totaled $11.7 million, of which $5.5 million relates to net operating losses. The Company has a $2.4 million valuation allowance recorded against this asset as of September 28, 2002 representing 44% of the gross asset related to net operating losses. Management believes this reserve is adequate after considering recent operating performance, future financial projections, tax planning strategies and the allowable tax carryforward period.

Notes: Certain amounts may not add to the total due to rounding.

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References to cost of sales as a percentage of sales, net earnings, diluted EPS and operating margins in the following discussion of results of operations for 2002 compared with 2001 and 2001 compared with 2000 reflect the exclusion of goodwill amortization for all periods. Goodwill amortization expense was $7 million and $6 million in 2001 and 2000, respectively. Goodwill amortization expense, net of taxes, was $5 million and $4 million in 2001 and 2000, respectively.

2002 Compared with 2001

Consolidated. Net sales for 2002 increased 2% to $719 million from $704 million in 2001. Sales increased by $19 million in Aircraft Controls and $4 million in Space Controls, while sales decreased by $8 million in Industrial Controls. Net sales for 2002 included incremental sales of $14 million from industrial and space-related acquisitions.

Cost of sales as a percentage of net sales decreased to 67.9% in 2002 from 69.1% in 2001. The decrease in cost of sales as a percentage of net sales is primarily due to a favorable change in product mix towards more profitable military aircraft sales, in particular aftermarket sales. In 2002, sales of controls for military aircraft represented 28% of net sales compared to 22% of net sales in 2001. In addition, operating losses narrowed on business jets, in part due to a favorable $2 million adjustment in the third quarter of 2002 related to progress made on certain scope change negotiations. These improvements were partially offset by weak margins for industrial products due primarily to lower sales.

Estimated costs to complete are reviewed quarterly for contracts accounted for under the percentage of completion (cost-to-cost) method of accounting. For those contracts with anticipated losses at completion, a contract loss reserve is recorded when the loss becomes known. Additions to contract loss reserves are reflected in the statement of earnings in cost of sales. Additions were $11 million in 2002, mostly related to unforeseen expanded work requirements on certain firm fixed price commercial business jet development contracts. The Company also recorded $1 million of contract loss reserves related to acquisitions as part of purchase accounting. During 2002, $13 million of contract loss reserves, primarily related to business jet development contracts, were utilized as costs were incurred and were reflected as reductions to the previously established contract loss reserve included in current liabilities. Contract loss reserves were also reduced by $2 million related to progress made on certain scope change negotiations for business jet development contracts. The net decrease in contract loss reserves was $3 million in 2002, compared to a net decrease of $4 million in 2001.

Reserves for inventory valuation are recorded for obsolete or slow-moving inventory as well as for reductions of inventory to net realizable value. The net increase in reserves for inventory valuation was $7 million in 2002, compared to a net increase of $2 million in 2001. Additions to the reserve in 2002 were $2 million higher as compared to 2001. The increase is primarily within the Aircraft Controls segment, and to a lesser extent, the Industrial Controls segment where product specifications or projected future demand have changed during the year resulting in inventory levels that, in management's estimation, are in excess of amounts needed to fulfill existing and future sales requirements. Reductions to the reserve resulting from inventory being disposed of were $2 million less in 2002 as compared to 2001, primarily in the Space Controls segment. Most of this inventory had been previously reserved and the reserve balance was relieved when the inventory was disposed.

Research and development expenses increased to $33 million in 2002 from $26 million in 2001. The higher levels of research and development related primarily to a variety of Aircraft Controls initiatives, including a new flap actuation system for the business jet market, a new pump and motor design for military aircraft applications, controls for unmanned combat aircraft and active vibration controls for helicopters.

As a percentage of net sales, selling, general and administrative expenses increased to 16.3% in 2002 from 15.7% in 2001. The increase is primarily attributable to higher personnel-related costs, including wage and salary increases and costs related to a stock-based deferred compensation plan for certain officers and directors, and higher professional fees.

Interest expense decreased to $26 million in 2002 from $32 million in 2001. The decrease in interest expense is due to lower interest rates and reduced debt levels, each contributing approximately equally to the decrease. The reduced debt levels are primarily related to $39 million of net proceeds from the November 2001 equity offering in addition to $30 million of reduced net debt levels related to cash flow from operations.

Other expense was $1 million in 2002 compared to zero in 2001. The increase is primarily due to higher foreign currency exchange impacts in 2002.

The Company's effective tax rate was 29.0% in 2002 compared to 33.5% in 2001. The decrease in the effective tax rate relates to additional export tax benefits that the Company claimed in 2002 on amended 1997, 1998 and 2000 U.S. tax returns and a reorganization of the Company's European operations. This decrease was partially offset by a first quarter charge related to decreasing a deferred tax asset in Europe for a change in a statutory tax rate enacted in 2002. During the fourth quarter, additional tax benefits related to the distribution of foreign earnings were offset by a valuation allowance adjustment related to deferred tax assets associated with net operating losses.

In 2002, net earnings increased 16% to $38 million from $32 million in 2001. Diluted EPS increased 2% to $2.50 in 2002 from $2.45 in 2001.

Aircraft Controls. Net sales in Aircraft Controls increased 6% to $359 million in 2002 from $340 million in 2001. The increase is primarily due to a $20 million increase in sales on fighter aircraft programs, an $18 million increase in military aftermarket sales, related primarily to the F-18 fighter aircraft and the Black Hawk helicopter, and a $4 million increase in sales to OEMs for the Black Hawk and Sea Hawk helicopter programs. The $20 million increase in sales on fighter aircraft programs is primarily comprised of $10 million on the F-35 Joint Strike Fighter, $5 million on the F-15 and $3 million on the F/A-18E/F programs. These increases were partially offset by decreases of $12 million in Boeing OEM sales resulting from lower build rates, $7 million, or 12%, in commercial aftermarket sales related to the reduced number of commercial airplane flights, $2 million in flight controls for Airbus and $2 million related to business jets.

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Operating margins for Aircraft Controls increased to 18.2% in 2002 from 15.6% in 2001. The increase is primarily a result of the higher levels of military aftermarket sales, narrowed operating losses on business jets, including a favorable $2 million adjustment in the third quarter of 2002 related to progress on certain scope change negotiations, and better margins on certain fighter aircraft as production rates increase.

Twelve-month backlog for Aircraft Controls was $239 million at September 28, 2002 compared to $223 million at September 29, 2001. The increase is due to an increase on the F-35 Joint Strike Fighter, partially offset by a decrease for commercial aircraft.

Space Controls. Net sales in Space Controls increased 4% to $107 million in 2002 from $103 million in 2001. An $8 million increase during the first nine months of 2002 was partially offset by a decrease of $4 million in the fourth quarter of 2002 resulting from lower sales of controls for tactical missiles and, to a lesser extent, satellites. The increase in sales for the year is primarily due to increases of $5 million for satellite controls, all related to acquisitions, $3 million on the Space Shuttle refurbishment effort and $3 million on the Hellfire tactical missile program. These increases were partially offset by a $7 million decrease in sales of controls for launch vehicles related to the wind down on the Titan IV program and lower development activity on Evolved Expendable Launch Vehicle programs.

Operating margins for Space Controls decreased to 11.5% in 2002 from 12.9% in 2001. The decrease in margins is primarily related to poor operating performance on contracts associated with the PerkinElmer acquisition in 2001 and lower sales in the fourth quarter of 2002 that resulted in fourth quarter operating margins of 5.6%. These decreases were partially offset by increases due to higher volume and better cost experience on the Space Shuttle refurbishment effort and favorable cost performance on the Crew Return Vehicle, which is nearing completion, and tactical missile programs such as Hellfire, TOW and AGM-142 Popeye.

Twelve-month backlog for Space Controls was $59 million at September 28, 2002 compared to $72 million at September 29, 2001. The decrease primarily relates to programs that are near completion such as the Crew Return Vehicle and reduced orders for satellites and tactical missiles such as the AGM-142 Popeye, which was completed, and the Hellfire missile program that has entered a production break.

Industrial Controls. Net sales in Industrial Controls decreased 3% to $253 million in 2002 from $261 million in 2001. The decrease in sales associated with the global industrial economic slowdown included a $9 million decrease for controls for motion simulators, a $6 million decrease for controls for plastic injection molding machinery, a $5 million decrease for electric drives and a $5 million decrease for turbine controls. These decreases were partially offset by an $11 million increase in sales for combat controls and $9 million of incremental sales from acquisitions.

Operating margins for Industrial Controls decreased to 5.5% in 2002 from 9.1% in 2001. The decrease in margins resulted from low volume in industrial markets and an unfavorable product mix weighted more towards lower margin standard products.

Twelve-month backlog for Industrial Controls was $67 million at September 28, 2002 compared to $69 million at September 29, 2001. Excluding the impact of the acquisition of TSS and foreign currency exchange, backlog decreased by $5 million primarily due to generally soft industrial markets.

2001 Compared with 2000

Consolidated. Net sales for 2001 increased 9% to $704 million from $644 million in 2000. Sales in Industrial Controls increased by $41 million and sales in Aircraft Controls increased by $28 million, while sales in Space Controls decreased by $9 million. Excluding the impact of a stronger U.S. dollar in 2001 compared to foreign currencies, primarily the Euro, British Pound, and the Yen, sales would have increased by an additional $16 million over 2000. During 2001, the Company acquired the space valve business of PerkinElmer, the industrial radial piston pump business of Bosch, Whitton Technology, which designs and manufactures pumps and specialty products for producers of industrial power generating equipment, and Vickers Electrics, which manufactures high-performance industrial electric drives. These acquisitions generated $38 million of sales in 2001.

Cost of sales as a percentage of sales was 69.1% in 2001 compared with 68.7% in 2000. The increase is primarily due to lower margins in Industrial Controls.

In 2001, $7 million of contract loss reserves were recorded, compared to $8 million in 2000. Inventory valuation provisions were $6 million in both 2001 and 2000.

Research and development expense increased by $4 million in 2001 to $26 million, or 3.8% of sales. The increase is attributable to a variety of aircraft initiatives.

Interest expense decreased $1 million to $32 million in 2001 due to a decline in interest rates, partially offset by the impact of the acquisitions.

The Company's effective tax rate for 2001 was 33.5% compared to 34.2% in 2000. The decrease resulted from higher U.S. tax incentives on export sales in 2001.

In 2001, net earnings increased 10% to $32 million compared to $30 million in 2000. Diluted EPS increased 11% to $2.45 in 2001 from $2.21 in 2000.

Aircraft Controls. Net sales in Aircraft Controls increased 9% to $340 million in 2001 compared to $312 million in 2000. Boeing commercial sales increased $12 million due to higher production rates in 2001. Sales of controls increased $12 million for fighter aircraft, primarily the F/A-18E/F for which production levels continued to increase. Sales also increased $3 million for engine controls, $3 million for aftermarket sales, and $1 million for controls on business aircraft. These increases were partially offset by a $3 million decrease in sales on the B-2 bomber program which has been completed.

Operating margins for Aircraft Controls were 15.6% in 2001 compared to 15.1% in 2000. The improvement in margins primarily resulted from favorable product mix and cost performance on production programs. Additions to contract loss reserves were

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$6 million in both 2001 and 2000, primarily related to business jet development contracts.

Twelve-month backlog for Aircraft Controls was $223 million at September 29, 2001 compared to $215 million at September 30, 2000. The increase was due to increases in backlog for military programs including the Black Hawk and Sea Hawk helicopters and F/A-18E/F that outweighs decreases in backlog for commercial aircraft.

Space Controls. Net sales in Space Controls decreased 8% to $103 million in 2001 from $112 million in 2000. A $23 million decrease in sales for launch vehicles, primarily the Titan IV program which was completed in 2001, was partially offset by an increase of $13 million for satellite controls.

Operating margins for Space Controls increased to 12.9% in 2001 from 11.6% in 2000. The improvement in margins is primarily due to cost improvement on newer programs, including the Crew Return Vehicle and various tactical missile programs, as well as increased volume for satellite controls.

Twelve-month backlog for Space Controls increased to $72 million at September 29, 2001 from $65 million at September 30, 2000 primarily related to refurbishments on the Space Shuttle.

Industrial Controls. Net sales in Industrial Controls increased 19% to $261 million in 2001 from $220 million in 2000. Excluding the impact of a strong U.S. dollar relative to foreign currencies, primarily the Euro and the Yen, sales would have increased an additional $13 million. The increase in net sales is primarily related to the acquisitions of the radial piston pump product line, Whitton and Vickers Electrics that generated $37 million of incremental sales in 2001. Excluding the effects of the acquisitions, sales increased $5 million for turbine controls, $2 million for motion simulator controls, $2 million within heavy industry and $6 million for various other industrial applications, while sales to the plastics market decreased $11 million due to softness in the injection molding machinery market, particularly in the Asian-Pacific region.

Operating margins for Industrial Controls decreased to 9.1% in 2001 from 12.0% in 2000. The decline in the margins is primarily attributable to lower volume in the plastics markets and, to a lesser extent, pricing pressures in the turbines business.

Twelve-month backlog for Industrial Controls increased to $69 million at September 29, 2001 from $65 million at September 30, 2000 primarily due to the acquisitions.

Financial Condition and Liquidity

The Company's Credit Facility consists of a term loan payable quarterly through 2005, which had a balance of $45 million at September 28, 2002, and a $265 million revolver of which $133 million was outstanding at September 28, 2002.

The Credit Facility expires in December 2005. Interest on the Credit Facility continues at LIBOR plus a spread that was 175 basis points on September 28, 2002. The Credit Facility is secured by substantially all of the Company's U.S. assets. The Credit Facility contains various covenants that adjust over the term of the facility. As of September 28, 2002, the covenant for minimum Consolidated Net Worth, defined as the sum of capital stock and additional paid-in capital plus retained earnings (or minus accumulated deficits), was $210 million; the covenent for the minimum Interest Coverage Ratio, defined as the ratio of adjusted EBITDA to total interest expense was 2.8; the covenant for the minimum Fixed Charge Coverage Ratio, defined as the ratio of (i) adjusted EBITDA minus capital expenditures to (ii) the sum of interest expense, provision for taxes and regularly scheduled principal payments on debt was 1.15; and the covenant for the maximum Leverage Ratio, defined as the ratio of total debt (including letters of credit) less aggregate cash balances to adjusted EBITDA was 4.0. Adjusted EBITDA is defined as (i) the sum of net income, interest expense, provisions for taxes based on income, total depreciation expense, total amortization expense and other non-cash items reducing net income minus (ii) other non-cash items increasing net income. Additionally, the Credit Facility limited capital expenditures to $28 million in 2002 and restricts the payment of cash dividends to common stockholders. As of September 28, 2002, the Company was in compliance with all covenants.

At September 28, 2002, the Company had $143 million of unused borrowing capacity under short and long-term lines of credit, including $128 million from the Credit Facility. Total debt decreased to $316 million at September 28, 2002 from $373 million at September 29, 2001. The reduction in debt primarily resulted from the application of $39 million from the November 2001 equity offering in addition to $30 million of cash flows from operations, partially offset by the $8 million purchase price for Tecstar and $4 million related to the TSS acquisition. Long-term debt to capitalization decreased to 49% at September 28, 2002 from 59% at September 29, 2001.

Cash provided by operating activities was $59 million in 2002 compared to $53 million in 2001. The increase in cash from operations was primarily due to the increase in earnings adjusted for non-cash charges.

Net property, plant and equipment was $203 million at September 28, 2002 compared to $199 million at September 29, 2001. Capital expenditures in 2002 were $27 million compared with depreciation and amortization of $26 million in 2002. Capital expenditures in 2001 were $27 million compared with depreciation and amortization of $32 million. Capital expenditures in 2003 are expected not to exceed $27 million. The Company leases certain facilities and equipment under operating lease arrangements. At September 28, 2002, future minimum rental payments required under noncancelable operating leases was $63 million.

The Company believes its 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 its operating needs.

Recent Accounting Pronouncements

In July 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146, "Accounting for Costs Associated with Exit and Disposal Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities. SFAS No. 146 requires that a liability for costs associated with an exit or

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disposal activity be recognized when the liability is incurred and that an entity's commitment to a plan, by itself, does not create a present obligation to others that meets the definition of a liability. The Company must adopt this standard for exit or disposal activities that are initiated after December 31, 2002.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145 updates, clarifies and simplifies existing accounting pronouncements. It rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related taxes, and requires that they be reported as part of earnings from operations. SFAS No. 145 also amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. The Company will adopt this standard on October 1, 2002 and believes it will not have a material impact on its results of operations or financial condition.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," but retains its fundamental provisions for recognition and measurement of the impairment of long-lived assets to be held and used and those to be disposed of by sale. The Company will adopt this standard on October 1, 2002 and believes it will not have a material impact on its results of operations or financial condition.

In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." Under SFAS No. 143, the fair value of a liability for an asset retirement obligation will be recorded in the period in which it is incurred, and the carrying amount of the related long-lived asset will be increased. Over time, the liability will be adjusted for revisions to either the timing or the amount of the original estimate of cash flows and the passage of time. The capitalized cost will be depreciated over the asset's useful life. A gain or loss will be recorded if necessary upon settlement of the liability. The Company will adopt this standard on October 1, 2002 and believes it will not have a material impact on its results of operations or financial condition.

Outlook

The Company has updated its outlook for 2003 from the discussion in its Form 10-Q for the quarter ended June 30, 2002 filed August 7, 2002. Net sales are expected to approximate $760 million compared to $764 million previously expected. This $4 million decrease consists of an $8 million upward adjustment in Aircraft Controls, a $6 million downward adjustment in Space Controls related to orders for controls on satellites and space vehicles and a $6 million downward adjustment in Industrial Controls related primarily to turbine controls. The upward adjustment in Aircraft Controls reflects a $22 million increase in military sales, primarily in aftermarket and on the F-15 fighter program and, to a lesser extent, on the F-35 Joint Strike Fighter and V-22 Osprey, and a $14 million decrease in commercial aircraft sales due to lower Boeing build rates and lower expected aftermarket sales. Operating margins for 2003 are expected to be 12.1%, unchanged from the previous outlook. However, the updated outlook reflects higher margins for Aircraft Controls than previously forecasted, offset by lower margins for Space Controls on reduced volume. The outlook for net earnings and earnings per share has not changed from the previous outlook.

The forecasted 2003 net sales of $760 million represents a 6% increase over 2002. Sales are expected to increase in Aircraft Controls and Industrial Controls and decrease in Space Controls. Aircraft Controls sales are expected to increase 10% to $394 million in 2003, with a $46 million increase in the military aircraft business, offset by a $12 million decrease in the commercial aircraft business. The increase in the military aircraft business primarily relates to the ramp up on the F-35 Joint Strike Fighter aircraft program, for which sales are expected to increase by $29 million to $40 million in 2003. Also, V-22 tiltrotor sales are expected to increase by $10 million primarily related to supplying redesigned swashplate actuators in conformity with the latest customer specifications. Military aftermarket sales are expected to increase by $9 million related to the F-18 fighter aircraft, for updating hydraulic drive units on the leading edge flaps and for overhauling wingfold actuators. Sales on the F-15 are also expected to increase due to increased production as a result of the recently announced Korean government buy as well as for subassemblies and parts to support the Japanese production at Mitsubishi. The decrease in the commercial aircraft business is primarily related to Boeing OEM sales, partially offset by increased sales on business jets. Aftermarket sales are forecasted to remain flat with the 2002 level of $50 million. Space Controls sales are expected to decrease 8% to $98 million in 2003. The decrease reflects a $4 million decrease in satellites reflecting a slow down in the GEO satellite market and a $4 million decrease in space vehicles related to the completion of work on the Crew Return Vehicle. Sales on tactical missiles are also expected to decrease, reflecting the completion of the AGM-142 program and a production break on Hellfire. These decreases are expected to be partially offset by increases for development work on the second generation reusable launch vehicles and missile defense. Industrial Controls sales are expected to increase 6% to $268 million in 2003, primarily due to a stronger Euro and a $4 million increase in combat controls. These increases, along with increases for controls for plastic injection molding machinery, motion simulators and a full year of sales from TSS, are expected to be offset by a $13 million decrease in sales for turbines related to the soft power generation market combined with intense competitive pressures.

Consolidated operating margins for 2003 are expected be 12.1%, compared to 12.8% in 2002. Aircraft Controls operating margins are expected to decrease to 16.4% in 2003 from 18.2% in 2002, reflecting higher volume on the cost-plus F-35 Joint Strike Fighter aircraft development program that carries lower margins. Space Controls operating margins are expected to decrease to 7.5% in 2003 from 11.5% in 2002 as a result of lower volume and the completion of certain programs whose contribution margins were relatively strong in 2002 including the Crew Return Vehicle. Industrial Controls operating margins are expected to increase to 7.5% in 2003 from 5.5% in 2002 as a result of cost reduction initiatives implemented in 2002 and higher volume.

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An increase in 2003 consolidated sales and lower non-operating expenses, which include interest and corporate expense, are expected to offset lower operating margins in 2003. This is expected to result in a 13% increase in net earnings to $42.4 million in 2003 and a 10% increase in diluted earnings per share to $2.75 in 2003. The Company expects that earnings per share for each of the quarters in 2003 will also increase by approximately 10% over the prior year quarters.

Regarding cash flow, the Company plans to increase funding on pension plans by approximately $10 million over the $7 million paid during 2002. In addition, the Company plans to reduce debt by approximately $20 million in 2003, primarily over the last three quarters of the year.