Good morning. My name is Kristen, and I will be your conference operator today. At this time, I would like to welcome everyone to the HEICO Corporation Fiscal Year 2017 Second Quarter Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question at this time, simply press star and then number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Certain statements made on this call will constitute forward-looking statements, which are subject to risks, uncertainties, and contingencies.
HEICO's actual results may differ materially from those expressed in or implied by these forward-looking statements as a result of factors including, but not limited to, lower demand for commercial air travel, airline fleet changes, or airline purchasing decisions, which could cause lower demand for our goods and services, product development or product specification costs and requirements, which could cause an increase to our cost to complete contracts, governmental and regulatory demands, export policies and restrictions, reductions in defense, base, or homeland security spending by U.S. and/or foreign customers, or competition from existing and new competitors, which could reduce our sales, our ability to introduce new products and product pricing levels, which could reduce our sales or sales growth, product development difficulties, which could increase our product development costs and delay sales, our ability to make acquisitions and achieve operating synergies from acquired businesses, customer credit risk, interest and income tax rates, and economic conditions within and outside the aviation, defense, base, medical, telecommunications, and electronic industries, which can negatively impact our costs and revenues, and defense budget cuts, which could reduce our defense-related revenue.
Those listening to this call are encouraged to review all of HEICO's filings with the Securities and Exchange Commission, including but not limited to Filings on Form 10-K, Form 10-Q, and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events, or otherwise, except to the extent required by applicable law. I would now like to turn the call over to Laurans Mendelson . Thank you. You may begin.
Well, thank you very much, and good morning to everyone on the call. We thank you for joining us, and we welcome you to the HEICO Second Quarter Fiscal 2017 Earnings Announcement telecon. I'm Larry Mendelson, Chairman and CEO of HEICO Corporation, and I'm joined here this morning by Eric Mendelson, HEICO's Co-President and President of HEICO's Flight Support Group; Victor Mendelson, HEICO's Co-President and President of HEICO's Electronic Technologies Group; and Carlos Macau, our Executive Vice President and CFO. Before reviewing our record second quarter operating results in detail, I would like to take a few minutes to summarize the quarterly highlights. Consolidated second quarter and first six months of fiscal 2017 net income, operating income, and net sales represent record results for HEICO, driven principally by record net sales and operating income within both operating segments.
Consolidated net income increased 18% to a record $45.7 million, or $0.53 per diluted share in the second quarter of fiscal 2017, and that was up from $38.7 million, or $0.45 per diluted share in the second quarter of fiscal 2016. Consolidated net income increased 24% to a record $86.6 million, or $1.00 per diluted share in the first six months of fiscal 2017. That was up from $69.9 million, or $0.82 per diluted share in the first six months of fiscal 2016. Our net debt, which is total debt less cash and cash equivalents, so net debt to EBITDA ratio was a low 1.2 times as of April 30, and that compared to 1.8 times shortly after the acquisition of Robertson Fuel Systems in January 2016.
Robertson, of course, was our largest acquisition in HEICO history. I continue to be very pleased with HEICO's laser focus on strong cash flow generation, as well as the consistency of our growth in net income. The Flight Support Group set an all-time quarterly net sales and operating income record in the second quarter of fiscal 2017 by improving 5% and 8% respectively over the second quarter of fiscal 2016. Those increases principally reflect increased demand within the Flight Support Group after-market replacement parts and repair and overhaul parts in services product lines, as well as the benefit of operating efficiencies. Our ETG Group set an all-time quarterly net sales and operating income record in the second quarter of fiscal 2017 by improving 6% and 16% respectively over the second quarter of fiscal 2016.
The increases principally reflect period-over-period net sales growth across the majority of ETG's product offerings, as well as the benefit of some operating efficiencies. Cash flow provided by operating activities remained strong, totaling $97.7 million or about 113% of net income for the first six months of fiscal 2017. Keep in mind that we are projecting that for the full fiscal year 2017, we expect cash flow provided by operating activities to approximate 150% of reported net income. As of April 30, 2017, the company's total debt to shareholder equity ratio was 40.5%. In addition, our net debt to shareholders' equity ratio was 37.3% as of April 30, 2017, with net debt, again, total debt less cash and cash equivalents. Total debt, net debt of $424.1 million, and that was principally incurred to fund acquisitions in fiscal 2017 and 2016.
In April 2017, our Flight Support Group acquired 80.1% of the equity interest in Air Cost Control, a leading aviation electrical interconnect product distributor of such items as connectors, wire, cable, protection and fastening systems, in addition to distributing a wide range of electromechanical parts. We expect the acquisition to be accretive to our earnings within the current fiscal year. In April 2017, we increased the aggregate principal amount of our revolving credit facilities by $200 million or 25%, reaching a total of $1 billion, and that was through increased commitments from existing lenders. We are very pleased to have such strong support and confidence from our lenders, and HEICO's financial strength, coupled with our expanded funding capacity, should allow us to continue to execute our strategic acquisition strategies and our goals.
In March 2017, we declared a five-for-four stock split, which reflects the board of directors' continued confidence in the strategic trajectory and growth of the business. The additional shares were distributed in April 2017. All applicable share and per share information has been retroactively adjusted to reflect for this five-for-four stock split. For your interest, this marks HEICO's 15th stock dividend or stock split since 1995. I would now like to introduce Eric Mendelson, Co-President of HEICO and President of HEICO's Flight Support Group. He will discuss the results of the Flight Support Group.
Thank you. The Flight Support Group's net sales increased 5% to a record $231.8 million in the second quarter of fiscal 2017, up from $220.3 million in the second quarter of fiscal 2016. Increased 7% to a record $452.7 million in the first six months of fiscal 2017, up from $424.9 million in the first six months of fiscal 2016. The increase in the second quarter and first six months of fiscal 2017 mainly reflects organic growth of 5% and 6% respectively. The organic growth in the second quarter and first six months of fiscal 2017 is principally attributed to increased demand in new product offerings within our aftermarket replacement parts and repair and overhaul parts and services product line, partially offset by lower sales within our specialty products product line.
The Flight Support Group's operating income increased 8% to a record $44.7 million in the second quarter of fiscal 2017, up from $41.3 million in the second quarter of fiscal 2016. Increased 12% to a record $86.1 million in the first six months of fiscal 2017, up from $76.8 million in the first six months of fiscal 2016. The increase in the second quarter and first six months of fiscal 2017 is mainly attributed to the previously mentioned net sales growth and efficiencies realized from the benefit of our growth in net sales on a relatively consistent period-over-period SG&A expenses. The Flight Support Group's operating margin increased to 19.3% in the second quarter of fiscal 2017, up from 18.8% in the second quarter of fiscal 2016. Increased to 19% in the first six months of fiscal 2017, up from 18.1% in the first six months of fiscal 2016.
The increase in the second quarter and first six months of fiscal 2017 principally reflects the previously mentioned net sales growth and efficiencies realized within SG&A expenses. With respect to the remainder of fiscal 2017, we now estimate mid to high single-digit growth in the Flight Support Group's net sales over fiscal 2016 levels. In the full year Flight Support Group operating margin to approximate 19.0%-19.5%. We continue to estimate mid-single-digit organic growth in full fiscal 2017 net sales over fiscal 2016 levels. These estimates include our recent acquisition of Air Cost Control. Exclude additional acquired businesses, if any. Lastly, I'd like to acknowledge our team, which we consider to be the best in the industry, for being recognized as the top 2016-2017 supplier by ALTA's Airlines. ALTA is the Latin American and Caribbean Air Transport Association and represents the airlines in that region.
HEICO was ranked number 1 out of over 200 suppliers evaluated. This recognition is presented to industry suppliers that have demonstrated their dedication to the highest standards in categories such as customer support and documentation, turnaround times, and quality service. I can tell you that this does not come by accident. Our team works extremely hard to make sure they satisfy our customers and keep them happy. I'd like to acknowledge our team and thank them for their outstanding service. I would like to introduce Victor Mendelson, Co-President of HEICO and President of HEICO's Electronic Technologies Group, to discuss the results of the Electronic Technologies Group.
Thank you, Eric. As I start the review of the ETG businesses, I would like to thank and recognize the ETG team members who made our excellent results possible, not only this quarter, but over a long period of time, and have continued to endeavor mightily for us and for our customers and for each other every day. The results we achieve aren't the result of blueprints or equipment or buildings. They come from hardworking, dedicated team members who show up every day and do everything they can for our company. I thank you all for your hard work.
In sales, the Electronic Technologies Group's net sales increased 6% to a record $141.2 million in the second quarter of fiscal 2017, up from $132.6 million in the second quarter of fiscal 2016, and increased 13% to a record $267.3 million in the first six months of fiscal 2017, up from $236.7 million in the first six months of fiscal 2016. The increase in the second quarter and first six months of fiscal 2017 reflects organic growth of 5% and 6%, respectively. The organic growth in the second quarter and first six months of fiscal 2017 resulted from increased demand in certain aerospace, other electronics, and medical products. Additionally, the increase in the first six months of fiscal 2017 reflects the contribution from our profitable fiscal 2016 acquisition.
The Electronic Technologies Group's operating income increased 16% to a record $38.8 million in the second quarter of fiscal 2017, up from $33.4 million in the second quarter of fiscal 2016, and increased 22% to a record $67.9 million in the first six months of fiscal 2017, up from $55.7 million in the first six months of fiscal 2016. The increase in the second quarter and first six months of fiscal 2017 came primarily from the previously mentioned net sales growth and efficiency realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expenses. The increase in the first six months of fiscal 2017 reflects a decrease in acquisition costs due to the first quarter of fiscal 2016 reflecting $3.1 million in acquisition costs associated with prior year acquisition, partially offset by higher performance-based compensation expense.
The Electronic Technologies Group's operating margin improved to 27.5% in the second quarter of fiscal 2017, up from 25.2% in the second quarter of fiscal 2016, and improved to 25.4% in the first six months of fiscal 2017, up from 23.5% in the first six months of fiscal 2016. The increase in the second quarter and first six months of fiscal 2017 principally reflects the previously mentioned net sales growth and efficiencies realized within SG&A expenses. With respect to the remainder of fiscal 2017, we are continuing to estimate mid to high single-digit growth in the Electronic Technologies Group's net sales over fiscal 2016 levels, principally reflecting organic growth, and anticipate full year Electronic Technologies Group's operating margin to approximate 25%. Of course, these estimates exclude additional acquired businesses, if any. I turn the conversation back over to Laurans Mendelson. Thank you.
Thank you, Victor. Looking at diluted earnings per share, consolidated net income per diluted share increased 18% to $0.53 in the second quarter of fiscal 2017, that was up from $0.45 in the second quarter of fiscal 2016, it increased 22% to $1 in the first six months of fiscal 2017, again, up from $0.82 in the first six months of fiscal 2016.
All fiscal 2016 diluted EPS amounts have been adjusted retrospectively for the five-for-four stock split, which was distributed April 7, 2017. Looking at R&D, the expense increased 2% to $11.2 million in the second quarter of fiscal 2017, that was up from $11 million in the second quarter of fiscal 2016. It was an increase of 12% to $22.5 million in the first six months of fiscal 2017, again, up from $20 million in the first six months of fiscal 2016. Significant ongoing new product development efforts are continuing in both Flight Support and ETG, as we continue to invest approximately 3%-4% of each sales dollar into new product development. As we've told you many times, it is a basic driver of HEICO.
We constantly spend money on research and development to develop new products and improve the existing products that we sell, that's a basic strategy that we will never give up. SG&A expense decreased to $63.8 million in the second quarter of fiscal 2017. That was down from $67.2 million in the second quarter of fiscal 2016, decreased to $124.7 million in the first six months of fiscal 2017, down from $126.8 million in the first six months of fiscal 2016. The decrease in the second quarter of fiscal 2017 principally reflects a $1.5 million impact from foreign currency transaction adjustments on borrowings denominated in EUR under our revolving credit facility, a $1.2 million impact from changes in the estimated fair value of accrued contingent consideration associated with prior year acquisitions.
The decrease in the first six months of fiscal 2017 principally reflects $3.1 million of acquisition costs recorded in the first six months of fiscal 2016 associated with the fiscal 2016 acquisition, and a $1.6 million impact from foreign currency transaction adjustments on borrowings denominated in EUR under our revolving credit facility, and partially offset by a $2.8 million increase in performance-based compensation expense. Consolidated SG&A expenses as a percentage of net sales decreased to 17.3% in the second quarter of fiscal 2017, and that was down significantly from the 19.2% in the second quarter of fiscal 2016, and decreased to 17.5% in the first six months of fiscal 2017, down again significantly from 19.3% in the first six months of fiscal 2016.
That decrease in consolidated SG&A expense as a percentage of net sales in the second quarter of fiscal 2017 principally reflects efficiencies realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expense, as well as the impact from the previously mentioned foreign currency transaction adjustments and changes in the estimated fair value of approved contingent consideration. The decrease in SG&A expense as a percentage of net sales in the first six months of fiscal 2017 principally reflects efficiencies realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expenses, as well as the impact from the previously mentioned decrease in acquisition costs.
Interest expense was $2 million in the second quarter of fiscal 2017, and that compared to $2.3 million in the second quarter of fiscal 2016, and it was about $3.9 million in both the first six months of fiscal 2017 and 2016. Other income was insignificant, and I won't comment on it. Income taxes. Our effective tax rate in the second quarter of fiscal 2017 decreased to 32% from 32.8% in the second quarter of fiscal 2016, and that decrease principally reflects the favorable impact of higher tax-exempt unrealized gains in the cash surrender value of life insurance policies related to the HEICO Corporation Leadership Compensation Plan. Our effective tax rate in the first six months of fiscal 2017 decreased to 29.5% from 31.1% in the first six months of fiscal 2016.
The decrease principally reflects a discrete income tax benefit related to stock option exercises resulting from the adoption of the new accounting standard on share-based payment transactions in the first quarter 2017, and the favorable impact of higher tax-exempt unrealized gains in cash surrender value of life insurance policies, again related to the HEICO Corporation Leadership Compensation Plan. The decreases were partially offset by the benefit recognized in the first quarter of fiscal 2016 from the retroactive and permanent extension of the U.S. Federal R&D tax credit, and that resulted in recognition of additional income tax credit for qualified R&D activities related to the last 10 months of fiscal 2015.
Net income attributable to non-controlling interest was $5.1 million in both the second quarter of fiscal 2017 and 2016, and $10.5 million in the first six months of fiscal 2017, compared to $9.7 million in the first six months of fiscal 2016. For the full year, fiscal year 2017, we continue to estimate a combined effective tax rate and non-controlling interest rate of between 39%-40% of pre-tax income, and that assumes that the U.S. corporate tax reform does not become effective during this fiscal year. Moving on to the balance sheet and cash flow. Our financial position and our forecasted cash flow remain extremely strong. As we previously discussed, cash flow provided by operating activities totaled $97.7 million in the first six months of fiscal 2017, representing 113% of net income.
For the full fiscal year 2017, we anticipate cash flow provided by operating activities to approximate 150% of net income. Later on, if the people on the call want to ask Carlos for the details of why it was only 113% as opposed to 150%, it was because there were some payments that came in the first six months and will not repeat in the second. We expect our cash flow, again, to be 150% of net income, and very strong. The working capital ratio improved to three times as of April 30, 2017. That was up from 2.7 as of October 31, 2016. DSOs, Days Sales Outstanding of receivables, increased to 52 days as of April 30, 2017, and that was up from 46 days a year prior, April 30, 2016.
That was due to the quarter-end acquisition of Air Cost Control and the timing of receivable collections. Excluding the impact of this acquisition on DSOs, the DSOs would have been 49 days as of April 30, 2017. We closely monitor receivable collection efforts to limit credit exposure. We have very little receivable write-off losses, and we've never had big ones. No one customer accounted for more than 10% of net sales. The top five customers represent approximately 19% and 21% of consolidated net sales in the second quarter of fiscal 2017 and 2016, respectively. Our inventory turnover rate increased to 133 days for the period ended April 30, 2017, as compared to 125 days for the period April 30, 2016. That was due to the quarter-end acquisition, again, of Air Cost Control.
If we exclude the impact of this acquisition, the inventory turnover rate actually decreased to 123 days versus 125 for the first six months of fiscal 2017. As previously mentioned, our total debt to shareholders' equity was 40.5% as of April 30, 2017, and our net debt to shareholder equity was 37.3 on April 30, 2017, with net debt, again, debt less cash and cash equivalents, of $424.1 million. That was principally incurred to fund acquisitions in fiscal 2016 and 2017. We have no significant debt maturities until fiscal 2019, and we plan to utilize our financial flexibility and strength to aggressively pursue high-quality acquisition opportunities to accelerate growth and maximize shareholder returns. I know I'm going to be asked this question in a few minutes. The pipeline for acquisition is very strong. We can hardly keep up with it.
We do such a thorough due diligence process, that it really takes us a lot of time, and we try to turn over all the stones and do extremely thorough, complete job. We have a very full acquisition pipeline. All priced within our normal guidelines for acquisition. As we look ahead at the outlook for the remainder of fiscal 2017, we do anticipate net sales growth in the Flight Support Group and ETG, resulting from increased demand across the majority of our product lines. During the remainder of fiscal 2017, we'll continue our commitments to developing new products and services, market penetration, aggressive acquisition strategy, while maintaining financial strength and flexibility. Based on our current economic visibility, we are increasing our estimated consolidated fiscal 2017 year-over-year growth in net sales to 8%-10%, and in net income to 12%-14%.
Both of those are up from prior growth estimates in net sales of 6%-8% and net income of 9%-11%. In addition, we now anticipate our consolidated operating margin to approximate 20%, depreciation and amortization expense to approximate $65 million, CapEx expenditures about $35 million, cash flow from operations to approximate $270 million, and that's up from the previous estimate of $260 million in cash flow from operations. Of course, these estimates include our recent acquisition of Air Cost Control, but exclude additional acquired businesses, if any. In closing, I'd like to thank all of HEICO's team members for another outstanding quarter of excellence in execution and financial results. It's because of their dedication and hard work that we're able to deliver consistent high performance for our shareholders.
As always, we'll continue to focus on intermediate and long-term growth strategy with an emphasis on acquiring profitable businesses. Just one personal comment. What doesn't appear in 10-Ks, 10-Qs, financial statements, and presentation is the incredible capability of our team members. These are the people that make these results possible. These are the people that strive for growth. Of course, we incentivize them with what we believe are great incentive plans, but these are exceptionally talented people, and we are very pleased and proud to be working with them because these are the ones that produce the results. Thank you all. That's the extent of our prepared comments. The floor is open for questions.
Ladies and gentlemen, at this time, I would like to remind everyone, in order to ask a question, press star, then number one on your telephone keypad. If your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that while posing your question, you pick up your handset to allow optimum sound quality. Our first question comes from George Godfrey with CLSA.
Thank you. Good morning, gentlemen.
Good morning.
Just wanted to ask two questions. The first one, organic growth this quarter, 5% and mid-single digits for the full year. Very solid. A little bit of a downtick from Q1. Can you just comment on what you're seeing on the organic growth trends going from 8% in Q1 down to 5% here in Q2?
Victor, you're speaking about the FSG segment?
Yes. If memory serves, they were both 8% organic growth last quarter, but I could be wrong on that.
Oh, I see. Well, I can tell you that if you look at the comps, the comps got tougher in the second, third, fourth quarters of 2016. I would say that that's probably the biggest reason why it was a lower number. We still feel very good about the industry. There's still a lot of potential, a lot of opportunity, new products being discussed with our customers, being contracted. I think we believe that we're outgrowing the industry, and we continue to do very well. We did have a uptick in the organic sales in the final nine months of 2016, which I think is driving this.
Thank you. Just to follow up on the operating margin, specifically Electronic Technologies Group, 27%, that's just outstanding. Is that a high watermark, or is there even an opportunity to continue to march that up? As a follow-on, is Robertson a material driver of that profitability there?
George, this is Victor. It's a very good question. Look, it's always our objective to see margins improve, but I wouldn't plan that in. I wouldn't model that in. I think the guidance that we gave you is the right place to look. Sometimes we have great quarters in margin. Other times it's not as good. I don't know if it's a high watermark. I honestly don't remember. It's towards the higher end. There are a lot of factors that can contribute to it. You remember, over time, and you listen to our conference calls over the years and attended some conferences over the years, you've heard me say that we manage the business, and we have our companies manage their business to the year, and not so much to the quarter.
We're very focused on maximizing profitability and margins, that just means we have lumpiness in the quarters over the course of the year, we really try to get people to look to the full year. If we do better, that's great, we don't encourage people to look for more than our guidance on that. In terms of Robertson is a contributor to the margins. It is not the sole contributor to the margins. It's a very important business for us, but truthfully, the other businesses are very important too, and pretty healthy. I would say overall, the company, the ETG, across the board, had a strong quarter.
Understood. Thank you for taking my questions.
Thank you, George.
Our next question comes from Larry Solow with CJS.
those questions for Eric on the FSG side. I know you've continually mentioned a lot of the growth has been driven, your growth at least, by your new product offerings. How about just the underlying growth in the aftermarket? Is that basically or lack thereof? Is the growth basically, essentially barely flat? What's your feel? Are you seeing it improve at all? Obviously excluding the easier year-over-year comp.
Yeah. That's a good question, Larry. Since we don't get very much price, maybe we get 1% a year, most of our growth, basically all of our growth, the 5%, was due to unit volume growth. I think that unit volume growth of 5% is far in excess of what the industry is seeing, number one. I think that we're building up a tremendous amount of goodwill. There's been a lot of new aircraft delivered over the last couple of years and are in that sort of zero to 5-year range where they don't need much maintenance. I think that that's holding down the industry aftermarket growth. I think our numbers are really quite good when you look at basically 5% organic growth.
Also, it's important to point out, and it was referenced in there, that our specialty products business saw a little bit of weakness this quarter, and that probably trimmed off about two points of growth from the FSG segment. When you look at it, the organic unit growth was even higher. We feel very strongly about the new products, the customer relationships. You can see with the recognition by ALTA, I think that while that's just one region of the world, I think that signifies how our customers view us. I think we're setting up in a very good way for a nice up cycle as some of the newer equipment needs maintenance, because the OE prices on this newer equipment, some of it is just crazy.
Yes, of course, we've got to develop the parts, we've got to get them approved at the airlines, we have to get them sold, et cetera. I feel very strongly that our strategy of maintaining basically very low price increases and building a lot of customer goodwill is putting us in a very positive position with our customers.
Okay, great. Maybe a question for Victor on just, in terms of new defense budget, what is going to happen. That is still several quarters if not a year, plus or whatever. I know on the last call you had mentioned, maybe the last couple of calls, you guys have seen a little bit less reluctance to spend sort of budgeted dollars. Is that trend still, anything shaking out on that side of things?
At this point, I think we should be careful to predict where things are going with the budget. It was sort of flattish for us in defense in the quarter, down slightly. To me, within the noise level, I still think that we should look for the net benefit next year, not this year. I don't think we have seen things shake out palpably, except I have noticed, and I think I mentioned this on the last call, we have noticed in the businesses, there is less reticence to spend and to commit dollars. Where in the past, in the prior administration, there were, I will call them quasi-obstructionist efforts geared at finding ways to not spend the allocated money and thereby let it get redirected to something else. We are not seeing that, or not seeing it as much.
The usual amount of confusion in the defense budget that exists over the years and decades is always there for us in terms of spending and why is not this contract coming through or that contract, why is it delayed? The agencies and departments have their own internal issues. Generally speaking, I think we all saw what was published yesterday on the budget proposal, and that is only a proposal at this point, as we all know. Our general view is it is a net positive going forward, but not to really expect it in a material way this year. Of course, as that gets delayed, if it gets delayed, then that would delay the benefit to us.
Got it. Last question if I may, just on the Air Cost Control, it looks like just from your cash listed, you guys spent about $80 million on that. Sounds like it is in your usual acquisition criteria, immediately accretive. Is fair to say that the impact from that, or the effect from that is most of the reason behind the increase in guidance for the year?
I think, Larry Solow, this is Carlos Macau. Some of it was related to that. The increase in guidance, went from mid-single digits to mid to upper single digits. Some of that was Air Cost Control. Some of that is a higher expectation of some of our operating units. It was a combination of both.
Got it. Okay, great. Excellent. Thanks, guys.
Our next question comes from Louis Raffetto with Deutsche Bank.
Good morning, gentlemen.
Hello.
Stick with ETG. You mentioned this the second quarter in a row, I guess with aerospace. Is that just linked to sort of higher overall production rates, or is there anything else there?
Louis, this is Victor. Some of it is aftermarket, some of it's production. I'd probably say maybe a little more aftermarket than production improvement. It's a nice mix.
All right. Sorry, Sandy, check my numbers here. I think you called out 6% growth in ETG, or yeah, 6% growth, only organic was five. I thought we were at a clean year-over-year now, I wasn't sure what that discrepancy was.
Louis, this is Carlos. I think the five is quarter, six is a six-month period, that's.
Okay. All right. Just last one on the cash flow. I guess it was just a bit below what I expected. Obviously, you've raised the guidance reserve, and I think Larry may have touched on this a bit, I may have missed it. Anything timing in the first half versus the second half or in the second quarter, I guess?
No, Louis, I think generally speaking, if you look back on history of HEICO and our cash generative operations, traditionally, and it could change, but the first half of the year from a cash flow generation standpoint is generally a little less than the latter half. That's part of it. I would say, as it relates specifically to this fiscal year, there wasn't anything unusual. Most of it was timing related. We had a little bit of an inventory build, which, if you look across all our subsidiaries, is directly tied to backlog or orders in-house. We had some timing on some accrues that were paid out. Some of that was performance-based comp related, which was a little higher as a result of 16 operations versus the prior 15 operations, which would've been accrued in that cash flow statement.
I wouldn't say there's any trend or any unusual items in it. It was principally based on timing.
No purchase consideration or meaningful in the quarter, I guess? I know that you said you did $7 million, I think, this year.
No.
Okay.
$7 million what, Louis? I'm sorry.
The purchase consideration, I guess. I think there was $7 million that was going to be paid out this year.
Oh, we've already paid that out. That doesn't come out of operations.
Okay.
That's operating cash flows. That's below that.
Thank you.
Our next question comes from Kenneth Herbert with Canaccord.
Hi, good morning.
Good morning.
I wanted to first ask a question for Eric. Just bigger picture, Eric, when you look at your conversations with your airline customers, fuel prices seem to have settled in here. If you look at your argument regarding delivery of aircraft, clearly we're starting to see a slowdown in deliveries of certainly wide body aircraft. Have you seen any change, or can you comment on any change you've seen from your airline customers, maybe in their desire to spend on some of the older aircraft with a maybe more benign fuel environment and maybe a little bit more predictability on the cost from that standpoint, as you look through the rest of either your fiscal 2017 or calendar 2017?
Yeah, it's a good question, Ken. We've seen some increase in spending on some of the older equipment. I think also one of the tougher comps, as you pointed out in some of your reports, is that last year there was a big PW4000 overhaul program and a lot of money that needed to be spent due to some service bulletins. I think that last year's numbers in hindsight were probably helped by that, which is making the comps a little bit tougher. Yes, we are seeing some increase in spending on the older equipment. As you point out, the build rate is coming down on some of the wide body equipment. We don't have that factored into our numbers right now because we don't know really what the future is going to bring on that.
Clearly, with wide body build rates being down and fuel being down, that should bode well for extending some of the time on some of the older equipment. Again, we don't have that baked into our projections at this point.
Okay, that's helpful. Now that you've completed the A2C acquisition and obviously you've been able to build a very nice distribution business within FSG, how do you think about organic growth, maybe for specifically A2C or maybe distribution at large, within the segment? Not just in 2017, but over the next few years.
Yeah, I'm very positive in that area. Actually, roughly a week after the MRO show, I went and visited A2C in Hamburg and Toulouse. While I had been there in the past, I can tell you that as I got to know the people better and we got into some of the details, I was really super impressed by the company's DNA, the people, the processes, the culture. We are immediately finding opportunities for our distribution companies to work together. There really is no product overlap. We don't have a situation where we would have multiple subsidiaries trying to sell the same product. It truly is complementary. The relationships that our existing distribution business has with Seal Dynamics and with the new distribution business with Air Cost Control or A2C, I think it's extremely complementary.
The people in both businesses are very excited to help open doors for the others. I would say some significant expectations for great opportunities down the road. We met with some of the larger customers. A2C is really viewed in an extremely unique light due to their business model, their customer attentiveness. This is a company that 17 years ago didn't even exist. It started with one person and then two people in a little office. They learned how to, again, as the other HEICO businesses do, listen to their customers, understand what they want, proactively deliver a high-quality product, find alternatives at a lower price. In meeting with some of A2C's customers, A2C's growth was not by accident. It was by targeting these opportunities and making sure that the customers were very happy.
I do see a great opportunity and synergy with our distribution business. Then, of course, with distribution and PMA, there's the synergy that we've spoken about for a while, and I would say I'm very bullish on that.
Thank you very much for that color. Just one final question for Victor. Just to follow up again on the margins of the quarter, very impressive. I just want to make sure I heard you correctly. Really no sort of one-time items you'd specifically point to, either from a mix standpoint or timing, it's just good performance, or is there anything in particular you would highlight as maybe something that doesn't repeat with the segment moving forward?
Yeah. Overall, I wouldn't call out anything notable. I think there were elements of everything in the quarter, right? The mix was favorable to us. The cost control, if you will, the attention to cost detail, and the opportunities that we were able to execute on were good. I think we always have a business here or there where something pulls forward a quarter or slips a quarter, and maybe we had a little bit better in that regard, but I don't think anything outside of the noise level that we typically see on that. Overall, I would say it was just kind of all the factors, each adding up incrementally, delivered it for us.
Thank you very much. Really nice.
Thank you. Carlos has something to add.
Yeah, I might just want to add, Victor's point's absolutely correct. We have this rarest quarter in the ETG, where really all of our subs and industry participants are firing on all cylinders. Occasionally that happens. We had a similar situation in Q4 last year, where we sort of had broad growth across all the subsidiaries. When that happens, and given the fact that most of the folks running these business units are very entrepreneurial and, to Victor's point, cost-conscious, we get some nice leverage in R&D spend, and we get some nice product mix and growth. I wouldn't overread that. To Victor's point, we plan for diversification. We plan for ups and downs within the same by subsidiary.
The guidance we've given of 25% on the year, we'd hope to do better, but that's kind of how we see things on a going forward basis based on backlog and what we can see at this point.
Great. Thank you very much.
Our next question comes from Robert Spingarn with Credit Suisse.
Hi, guys.
Good morning.
Good morning. I missed the beginning of your call because I was on another one. I'm not sure whether or not you talked about this or not, but Eric, this one's for you. Have you talked at all incrementally about your opportunity on OEM parts, second sourcing or, whether it's military or commercial, any opportunities there?
No, we haven't covered that yet on the call. That's a very good question. We continue to think that there is opportunity as the airframers want to bring down the cost of operation of their equipment, that there is opportunity for HEICO in that. I think that that's an area for growth and opportunity for us as time goes on.
How-
Yeah. Go ahead.
Oh, I'm sorry, Eric. Well, I was going to ask you from a process perspective, how might a cooperative effort to develop second source parts differ from a traditional PMA process for an aftermarket part?
Well, I need to be a little careful on this call because we, of course, have a number of competitors listening in. We love them.
Understood.
Unfortunately, I can't go into the details on that. Suffice it to say that the airframers and some of the larger OEMs don't necessarily have the same interests as some of the smaller OEMs. Where you've got situations when airlines are complaining to manufacturers about the cost to maintain their equipment, there may be opportunity for some of those larger OEMs to put some pressure to reduce those costs. I think that that's really where HEICO would fit in.
Okay. Excellent. Victor, I wanted to ask you about margins. That just got asked. So it sounds like we have just, both you and Carlos said, expect a range of outcomes as we go. It just really depends on the mix of what's flowing through in the quarter. Did I get that right?
I think you got that exactly right. Again, with the emphasis on Expect more of what we're telling you for the year, that 25% number, and not margins higher. If we do better, great. The objective is great. It is higher, of course, but let's keep where we are. By the way, even 25% is not guaranteed. None of this is easy, and we work very hard, but I can't be certain of where the margins will be either.
Right. Well, I guess as a follow-up to that, and somewhat related, maybe Carlos, this is for you, but as a percentage of sales, and this might have come up earlier, SG&A looked pretty couple of quarters.
How are you expecting that to trend for the rest of the year? Is this a sustainable level, under 18% of sales, or how should we think about that?
I think that we've been blessed by the way that all our subsidiaries, their entrepreneurial nature, they're very cost conscious. We have no corporate initiative on cost cutting. These guys drive their businesses. What we've seen over the last couple quarters is some leverage on that SG&A spend. I would anticipate barring any one-timers or anything like that, I would anticipate to continue to catch some of that leverage on SG&A spend, which is really a contributor, frankly, to our move up, if you would, on the consolidated margin to approximately 20%, from a range of 19%-20%.
Right. I guess when I look at it, this makes 2017 look a little more like 2015, in terms of SG&A performance, where 2016 was relatively a little higher.
Yeah. You have to remember, in 2016, it was littered with, we had a one-time charge of about $3.1 million for an acquisition, then we had some FX impacts during 2016 that we haven't experienced this year. If you look back historically, 2015, even maybe 2014 and prior, SG&A extends 17.5%-18% or so, has kind of been the range.
Right.
As we grow the business, the top line, at a greater rate than that sort of range on SG&A spend, we are catching leverage, and I'm quite proud of the guys for that.
Okay. All right. Well, thank you. Hello, Larry. Sorry, I didn't have one for you.
That's fine. They answered it better than I could.
There you go. Thanks, guys.
Again, ladies and gentlemen, for audio questions, please press star followed by one on your touch-tone phones. Our next question comes from Drew Lipke with Stephens.
Yeah, good morning, guys. Thanks for taking the time.
Good morning.
This is for Eric. You pointed out the goodwill with customers, and I'm curious if you think about maybe aircraft coming off warranty, maybe that kind of aging of the fleet there, have you seen any kind of change in demand from your customers for replacement parts? Kind of meaning, have you hit a tipping point where the demand has turned from more of a push to a pull?
Well, if you take a look at the organic growth, the FSG organic growth was about 5%, and of course, that was held down by a couple of points due to some slippage in the specialty product area. If you look at it, we're probably looking at roughly 6% unit growth. I think a lot of that is demand being, if you will, pulled by the customers. We don't really differentiate it when we do the sales reviews. We don't really differentiate it between sort of what we're pushing and what the customers are pulling. It's, I think, a group effort.
The goodwill is palpable, and I think that that is really permitting us to find more opportunities with the airlines and I think setting up for a very good increase in sales as some of this newer equipment matures and is going to need maintenance, and the price points are higher on the newer equipment. I think there's general recognition by the customers that we're a very important part of their approach. In reviewing specific customers with our sales leadership, I can tell you that there's really, at a high level at the airlines, a desire to increase the amount of competitive procurement, and HEICO is really at the forefront of that. I've heard a number of examples whereby perhaps 10 years ago, some of the finance folks were more likely to sign, if you will, Power by the Hour packages from the OEMs because of ease.
Now, as those packages wear on in duration and the airlines see that they've got basically no operating leverage, and HEICO has developed this reputation of not taking advantage of the customers when we can take advantage of the customers, we've now seen a number of airlines tilt towards the competitive procurement side, where they don't want to go with Power by the Hour. They don't want to go with the OEM because it ties their hands. To your point, in terms of pull-through, I think that that's an example of, and we've seen this in a number of cases. That's an example where the airlines are really putting us in position to be able to further increase our unit volumes and supply more parts. I've heard examples. There are some OEMs out there that have raised prices 10%, 11% per year for the last number of years.
Clearly, we could have done the same, and we didn't. They recognize that. That's why HEICO, I believe, has built this goodwill, and why ALTA and others hold us in very high regard, because our people do the right thing when nobody's looking. We do that because we're very small, we're tiny compared to the industry, and we're here for the long haul, and we want to be able to position ourselves and supply more parts and services. We think that our shareholders are going to be better rewarded by taking the long view.
That also, frankly, fits in very well with our people, because we want people who want to be here, we want team members who want to be here for the long haul, and want to be with a company that is moving in the right direction and is in the forefront of serving its customers. I think it really sets HEICO up very well for this pull-through that you're referencing. I anticipate we're going to see a lot more of that over the next couple of years.
Yeah, that absolutely makes sense. Then your ability to increase your annual parts approval from 500 to maybe something greater if we start to see that greater pull-through, what are the limiting factors there?
From a regulatory process, we're very confident that we can get them approved. We've got a great relationship and a great rapport and confidence from our regulators. I feel very comfortable about that. It would require, obviously, increasing the engineering effort a little bit, also increasing the manufacturing effort, but we've got plenty of capacity, so I feel very confident. We've been careful. It's a little bit of a chicken and egg thing, because if we come out with too many products, then the OEMs get very concerned and start cutting very good deals, so we need to be very careful. We know with whom we can develop products, and we know that they're really going to buy them, and they're just not going to use us as a stalking horse.
We, again, want to be very careful on how we do this, but I feel very confident that as this new equipment burns in, that we will be able to increase our product offerings and our new product approval process commensurate with the increase in demand. I don't view that as a limiting factor whatsoever.
Okay. Last one from me. Pooling has been referenced as a headwind for the industry, and if you also think about just the greater use of open source IP platforms for the supply chain and greater use of e-commerce solutions, is there a silver lining for you guys in that it allows you to highlight your lower price position and provide more transparent pricing for you to capture more share?
Yes. In general, I think as information becomes more readily accessible, it definitely provides an opportunity for us. It also permits our competitors to see more quickly what we're doing, and obviously, that's not helpful to us. Clearly, with the airlines, we're able to point out the areas of savings, the areas of opportunity. There have been many media reports on the increases coming on, particularly the cost of engine parts. There's been a number of articles and independent reports that have come out, particularly on the CFM56 and the CF6, showing price increases over a 10-year period, roughly in the 8% per year area. Airlines see that. They're not happy about it. I think that there's continued opportunity throughout the industry.
All right, thanks guys. Best of luck.
Thank you.
Thank you.
Our next question comes from James Foung with Gabelli & Company.
Hi, guys. Good quarter there.
Thanks, Jim.
I want to just ask about the specialty products. I guess you said sales were a little disappointing. Maybe just talk a little bit about what happened there, and you see catch-up in the second half of sales in that unit?
Sure. Jim, in the specialty products area, there's a higher proportion of basically, that's where all of our industrial business is, and that's where some of our defense business is. There were two areas. One, I would say, I think the second quarter probably saw the bottom of the industrial market. We're starting to see a tick-up now. I don't want to get ahead of myself because we're only less than a month into our third quarter, but I think we are seeing a tick-up in the industrial side. I'm fairly confident that we've bottomed in that area.
With regard to defense, this can be a lumpy business because these are fairly large contracts, and sometimes there are breaks in production because the government is working with a foreign military sales order, and one country can finish taking delivery of its product, then maybe there's a break until the next country sort of gets in line. That's fairly common in the defense area. We've seen that was the other source of weakness.
The other thing which we really need to take a look at is on the commercial aviation side, there's been a shift in some of the production from wide body to narrow body, and I think that that's having a little bit of an impact on us, and it's probably going to hit other suppliers as well, because some of the wide body production was requiring some additional products, and that, if you will, has ticked down, whereas the narrow body doesn't need as much of that on the OE side. It's also important to point out that I don't want to overstate the industrial side for us, because it's only about 4% of FSG. It's not a very big part, but that's why I'm sort of confident that we've hit the bottom there.
That could kind of be a potential upside as you work through the second half, maybe it can catch up with the weaker first half then.
Yes, I think there could be. Of course, we need to see what happens with the wide body and the narrow body production rates. Yes, I do think that there's a lot of catch-up opportunity for the second half and frankly, 2018 in a big way.
Just on the industrial, on the defense area, maybe Victor can chime in on this. Is it typically just kind of a year-end budget spending to make sure they get all the money spent so that they can request more money with the upcoming budget? Do you think you get kind of a year-end surge in buying in the October fiscal year of the budget ending? I was just wondering, are you expecting that this year, particularly if they're talking about an increase in the budget in the fiscal 2018 budget?
Jim, this is Victor. There's no reliable pattern or discernible pattern in that. There have been times in the past where it would happen in November that we would get a bump because the government would essentially have spent their money and sort of run out of money. There are times when we actually see the inverse, where things get quiet in the back end of the year because they've just run out of money to spend, and then all of a sudden it comes flying through in November. We've seen the opposite effect where money has been clogged up for allocation reasons earlier in the year, and it comes out later on in the year. It's really difficult to say.
We're not counting on any surge, if you will, in our defense revenue in the back half of the year. If that happens, that's great. I guess that would be upside, but we're not counting on any of that right now.
Yeah, I would think if you're talking about an increase in the defense budget, everyone wants to make sure they get their last dollar spent.
Right.
Yeah.
Yeah.
Right, either it comes in October or November, you still feel a little bit of the same thing. Okay.
Yeah. I think the more reliable sort of pattern. Again, there's no great discernible pattern as far as we're concerned, that we noticed on our business. Maybe other people notice different things, but in terms of what we've noticed in our business over the years, essentially government spending can lock up and unleash at any time during the year, we plan kind of according to the orders that we have and level loading our shops. If more comes, that's great, but we're not going to, in all likelihood, gear up for that and increase our spending for that.
Okay. Last one from me, maybe for Carlos, just the stock options. A lot of companies are getting some lower tax rate from the exercise of options. You had some of that in your second quarter. Do you expect more in the second half of the year where your tax rate could be lower than you expect?
Jim, actually, that particular phenomena or new accounting guides you're talking about, we implemented in Q1.
Okay.
We did have a discrete tax benefit in Q1. The impact cumulatively through 6 months is about a $0.02 bump, if you would, in our EPS. I do believe based on that standard, because it does force you to increase the denominator or the number of shares outstanding, that we will see that diminish down over the year. I don't expect that on an aggregate annual basis to have a significant impact on our overall rate.
Oh, okay. Were you guiding for your tax rate to still a kind of 30% for the year?
What we're guiding to is between our income tax rate and our non-controlling interest rate as a percent of pre-tax income, roughly 39%-40% for those two combined.
Okay, great. All right. Thank you.
Yes, I am. Thank you, Jim.
Thank you, Jim.
Ladies and gentlemen, that does conclude today's Q&A session. It is now my pleasure to hand our program back over to Laurans Mendelson for any additional closing remarks.
Thank you. To everyone on the call, we thank you for your interest in HEICO. We remain available to you by phone or personal visit to answer your questions. I know a lot of you speak to Carlos and some Thomas Irwin and Eric and Victor throughout the year, so we are happy to chat with you and give you answers that we can provide. We look forward to speaking to you at the end of our third quarter, and that conference call will be sometime towards the end of August of this year. We wish you a good summer, a safe summer, and look forward to speaking to you real soon. Thank you. That's the end of this call.