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.
Questions. Certain statements made on this call will constitute forward looking statements, which are subject to risks, uncertainties and contingencies. Micron'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 and 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 rate and economic conditions within and outside the aviation, defense, space, medical, health communications and electronics industries, which negatively impacts our costs and revenues.
Defense budget cuts would reduce our defense related revenue. Those listening to this call are encouraged to review all of Hyten's filings with the Securities and Exchange Commission, including the not limited to filings on Form 10 ks, Form 10 Q and Form 8 ks. 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 Mr. Hans Mendelsohn.
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 2nd quarter fiscal '17 Earnings Announcement Telecom. 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 2nd quarter operating results in detail, I would like to take a few minutes to summarize the quarterly highlights. Consolidated second quarter and 1st 6 months of fiscal 2017 net income, operating income and net sales represent record results for HEICO, driven principally by record net sales operating income within both operating segments.
Consolidated net income increased 18% to a record $45,700,000 or $0.53 per diluted share in the Q2 of fiscal 'seventeen, and that was up from $38,700,000 or $0.45 per diluted share in the Q2 of fiscal 'sixteen. Consolidated net income increased 24 percent to a record 86,600,000 dollars or $1 per diluted share in the 1st 6 months of fiscal 'seventeen. And again, that was up from $69,900,000 or $0.82 per diluted share in the 1st 6 months of fiscal 'sixteen. Our net debt, which is total debt less cash and cash equivalents, so net debt to EBITDA ratio was a low 1.2x as of April 30, and that compared to 1.8x shortly after the acquisition of Robertson Fuel Systems in January 2016. Robertson, of course, was our largest acquisition in HEICO history.
So, I'm continuing 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 Q2 of fiscal Those increases principally reflect increased demand within the Flight Support Group aftermarket replacement parts and repair and overhaul parts and 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 Q2 of fiscal 2017 by improving 6% 16% respectively over the Q2 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 97,700,000 dollars or about 113 percent of net income for the 1st 6 months of fiscal 'seventeen.
Keep in mind that we are projecting that for the full fiscal year 'seventeen, we expect cash flow provided by operating activities to approximate 150 percent of reported income. As of April 30, 17, 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, 17. With net debt, again, total debt less cash and cash equivalents, total debt of $424,100,000 and that was principally incurred to fund acquisitions in fiscal 'seventeen and '16. In April 'seventeen, 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 of 'seventeen, we increased the aggregate principal amount of our revolving credit facilities by 200,000,000 dollars or 25 percent reaching a total of $1,000,000,000 and that was through increased commitments from existing lenders. We are very pleased to have such strong support and confidence from our lenders and our 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 17, 2017, we declared a 5 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 5% -four stock split. And for your interest, the 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, and he will discuss the results of the Flight Support Group.
Thank you. The Flight Support Group net sales increased 5% to a record $231,800,000 in the Q2 of fiscal 'seventeen, up from $220,300,000 in the Q2 of fiscal 'sixteen an increase 7% to a record $452,700,000 in the 1st 6 months of fiscal 'seventeen, up from $424,900,000 in the 1st 6 months of fiscal 'sixteen. The increase in the 2nd quarter and 1st 6 months fiscal 'seventeen mainly reflects organic growth of 5% and 6%, respectively. The organic growth in the Q2 and 1st 6 months of fiscal 'seventeen is principally attributed to increased demand in new product offerings within our aftermarket replacement parts and repair and overhaul parts and services product lines, partially offset by lower sales within our specialty products product line. The Flight Support Group's operating income increased 8% to a record $44,700,000 in the Q2 of fiscal 'seventeen, up from $41,300,000 in the Q2 of fiscal 'sixteen and increased 12% to a record $86,100,000 in the 1st 6 months of fiscal 'seventeen, up from $76,800,000 in the 1st 6 months of fiscal 'sixteen.
The increase in the Q2 and 1st 6 months of fiscal 'seventeen is mainly attributed to the previously mentioned net sales growth inefficiencies realized from the benefit of our growth in net sales on a relatively consistent period over period SG and A expense. The Flight Support Group's operating margin increased to 19.3% in the Q2 of fiscal 'seventeen, up from 18.8% in the Q2 of fiscal 'sixteen and increased 19% in the 1st 6 months of fiscal 'seventeen, up 18.1% in the 1st 6 months of fiscal 'sixteen. The increase in the 2nd quarter and 1st 6 months of fiscal 'seventeen principally reflects the previously mentioned net sales growth and efficiencies realized within SG and A expenses. With respect to the remainder of fiscal 'seventeen, we now estimate mid- to high single digit growth in the Flight Support Group's net sales over fiscal 16 levels and the full year Flight Support Group operating margin to approximate 19.0% to 19.5%. We continue to estimate mid single digit organic growth in full fiscal 'seventeen net sales over fiscal 'sixteen levels.
These estimates include our recent acquisition of Air Cost Control to 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.
And 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. And I'd like to acknowledge our team and thank them for their outstanding service. Now 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. So, I thank you all for your hard work. In sales, the Electronic Technologies Group's net sales increased 6% to a record $141,200,000 in the Q2 of fiscal 2017, up from $132,600,000 in the Q2 of fiscal 2016 and increased 13% to a record $267,300,000 in the 1st 6 months of fiscal 'seventeen, up from $236,700,000 in the 1st 6 months of fiscal 'sixteen.
The increase in the second quarter and 1st 6 months of 4th 6 months of fiscal 2017 reflects organic growth of 5% 6% respectively. The organic growth in the 2nd quarter and 1st 6 months of fiscal 2017 resulted from increased demand in certain aerospace, other electronics and medical products. Additionally, the increase in the 1st 6 months of fiscal 'seventeen reflects the contribution from our profitable fiscal 'sixteen acquisition. The Electronic Technologies Group's operating income increased 16% to a record $38,800,000 in the Q2 of fiscal 2017, up from 33,400,000 dollars in the Q2 of fiscal 'sixteen and increased 22% to a record $67,900,000 in the 1st 6 months of fiscal 'seventeen, up from $55,700,000 in the 1st 6 months of fiscal 'sixteen. The increase in the Q2 and 1st 6 months of fiscal 'seventeen came primarily from the previously mentioned net sales growth and efficiency realized from the benefit of our growth in net sales and relatively consistent period over period SG and A expenses.
Further, the increase in the 1st 6 months of fiscal 2017 reflects a decrease in acquisition costs due to the Q1 of fiscal 2016 reflecting $3,100,000 in acquisition costs associated with prior year acquisition, partially offset by higher performance based compensation expense. The Electronic Technology Group's operating margin improved to 27.5% in the Q2 of fiscal 2017, up from 25.2% in the Q2 of fiscal 'sixteen and improved to 25.4% in the 1st 6 months of fiscal 'seventeen, up from 23.5% in the 1st 6 months of fiscal 2016. The increase in the 2nd quarter and first 6 months of fiscal 2017 principally reflects the previously mentioned net sales growth and efficiencies realized within SG and A expenses. Respect to the remainder of fiscal 'seventeen, 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 they anticipate the full year Electronic Technology Group's operating margin to approximate 25%. Of course, these estimates exclude additional acquired businesses, if any.
I turn the conversation back over to Larry 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 Q2 of fiscal 'seventeen and that was up from $0.45 in the Q2 of fiscal 'sixteen and it increased 22% to $1 in the 1st 6 months of fiscal 'seventeen, again up from $0.82 in the 1st 6 months of fiscal 2016. All fiscal 2016 diluted EPS amounts have been adjusted retrospectively for the LIBOR for core stock split, which was distributed April 7, 2017.
Looking at R and D, the expense increased 2% to $11,200,000 in the Q2 of fiscal 'seventeen, and that was up from $11,000,000 in the Q2 of fiscal 'sixteen. It was an increase of 12% to $22,500,000 in the first 6 months of fiscal 'seventeen, again up from $20,000,000 in the 1st 6 months of fiscal 'sixteen. Significant ongoing new product development efforts are continuing in both Flight Support and ETG as we continue to invest approximately 3% to 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.
And that's a basic strategy that we will never give up. SG and A expense decreased to $63,800,000 in the Q2 of fiscal 'seventeen. That was down from $67,200,000 in the second quarter of fiscal 'sixteen and decreased to $124,700,000 in the 1st 6 months of fiscal 'seventeen, down from $126,800,000 in the 1st 6 months of fiscal 'sixteen. The decrease in the Q2 of fiscal 'seventeen principally reflects a $1,500,000 impact from foreign currency transaction adjustments on borrowings denominated in euros under our revolving credit facility and a $1,200,000 impact from changes in the estimated fair value of accrued contingent consideration associated with prior year acquisitions. The decrease in the 1st 6 months of fiscal 'seventeen principally reflects $3,100,000 of acquisition costs recorded in the 1st 6 months of fiscal 2016 associated with the fiscal 2016 acquisition and a $1,600,000 impact from current foreign currency transaction adjustments on borrowings denominated in euros under our revolving credit facility and partially offset by a $2,800,000 increase in performance based compensation expense.
Consolidated SG and A expenses as a percentage of net sales decreased to 17.3% in the second quarter of fiscal 'seventeen, and that was down significantly from the 19.2% in the Q2 of fiscal 'sixteen and decreased to 17.5% in the 1st 6 months of fiscal 'seventeen, down again significantly from 19.3% in the 1st 6 months of fiscal 2016. That decrease in consolidated SG and A expense as a percentage of net sales in the Q2 of fiscal 'seventeen principally reflects efficiencies realized from the benefit of our growth in net sales on relatively consistent period over period SG and 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 and A expense as a percentage of net sales in the 1st 6 months of fiscal 'seventeen principally reflects efficiencies realized from the benefit of our growth in net sales on relatively consistent period over period SG and A expenses, as well as the impact from the previously mentioned decrease in acquisition costs. Interest expense was $2,000,000 in the Q2 of fiscal 2017 and that compared to $2,300,000 in the second quarter of fiscal 'sixteen, and it was about $3,900,000 in both the 1st 6 months of fiscal 'seventeen 'sixteen.
Other income was insignificant. I won't comment on it. Income taxes, our effective tax rate in the Q2 of fiscal 2017 decreased to 32% from 32.8% in the Q2 of fiscal 'sixteen 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 1st 6 months of fiscal 2017 decreased to 29.5% from 31.1% in the 1st 6 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 Q1 of 2017 and the favorable impact of higher tax exempt unrealized gains and cash earned 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 Q1 of fiscal 'sixteen from the retroactive and permanent extension of the U. S. Federal R and D tax credit, and that resulted in recognition of additional income tax credit for qualified R and D activities related to the last 10 months of fiscal 'fifteen. Net income attributable to non controlling interest was $5,100,000 in both the Q2 of fiscal 'seventeen and 'sixteen and $10,500,000 in the 1st 6 months of fiscal 'seventeen compared to $9,700,000 in the 1st 6 months of 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 pretax income and that assumes that U.
S. Corporate tax reform does not become effective during this fiscal year. Now 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 $97,700,000 in the 1st 6 months of fiscal 2017, representing 113 percent of net income. And for the full fiscal year 'seventeen, we anticipate cash flow provided by operating activities to approximate 150% of net income.
And 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 were that came in the 1st 6 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 3 times as of April 30, 'seventeen. That was up from 2.7 as of October 31, 'sixteen. DSOs, days sales outstanding of receivables increased to 52 days as of April 30, 'seventeen, and that was up from 46 days a year prior, April 30, 'sixteen.
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, 'seventeen. 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. Number 1 customer accounted for more than 10% of net sales. The top 5 customers represent approximately 19% 21% of consolidated net sales in the Q2 of fiscal 2017 2016 respectively.
Our inventory turnover rate increased to 133 days for the period ended April 30, 'seventeen as compared to 125 days for the period April 30, 2016. And that was due to the quarter end acquisition again of Air Cross Control.
And if we exclude
the impact of this acquisition, the inventory turnover rate actually decreased to 123 days versus 125 for the 1st 6 months of fiscal 2017. As previously mentioned, our total debt to shareholders' equity was 40.5% as of April 30, 17 and our net debt to shareholder equity was 37.3% on April 30, 17 with net debt, again debt less cash and cash equivalents of 424,100,000 dollars and that was principally incurred to fund acquisitions in fiscal 2016 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. So, the pipeline for acquisition is very strong.
We can hardly keep up with it, but 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. But we have a very, very full acquisition pipeline and all priced within our normal guidelines for acquisition. As we look ahead, the outlook for the remainder of fiscal 'seventeen, 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 '17, 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 'seventeen year over year growth in net sales to 8% to 10% and in net income to 12% to 14%.
And both of those are up from prior growth estimates and net sales of 6% to 8% and net income of 9% to 11%. In addition, we now anticipate our consolidated operating margin to approximate 20%, depreciation and amortization expense to approximate $65,000,000 CapEx expenditures about $35,000,000 cash flow from operations to approximate $270,000,000 and that's up from the previous estimate of $260,000,000 in cash flow from operations. Of course, these estimates include our recent acquisition of Add 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.
And as always, we'll continue to focus on intermediate and long term growth strategy with an emphasis on acquiring profitable businesses. And just one personal comment, what doesn't appear in 10 ks's, 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. So, thank you all. That's the extent of our prepared comments and the floor is open for questions.
Our first question comes from George Crabtree with CL
Thank you. Good morning, gentlemen.
Good morning.
Just wanted to ask 2 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?
Yes. If memory serves, they were both 8% organic growth last quarter, but I could be wrong on that.
I can tell you that if you look at the comps, the comps got tougher in the second, third, 4th quarters of 2016. So I would say that that's probably the biggest reason why it was a lower number. I mean, 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. So I think we're we believe that we're outgrowing the industry, and we continue to do very well.
But we did have an uptick in the organic sales in the final 9 months of 2016, which I think is driving this.
Thank you. And then just
a follow-up, the operating margin, specifically in Electronic Technologies Group 20%, I mean that's just outstanding. Is that a high watermark or is there even an opportunity to continue to march that up? And then as a follow on, is Roberson 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.
And there are a lot of factors that can contribute to it. You remember, over time, and we 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 through the year and not so much to the quarter. We're very focused on maximizing profitability and margins And that just means we have lumpiness in the quarters over the course of
the year, and we really try to get people
to look to the full year. So we're if we do better, that's great, but we don't encourage people to look for more than our guidance on that. In terms of Robertson, Robertson is a 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 Scialla with CJS.
For those questions, Eric, on the FSJ side, I know you mentioned and you've continually mentioned a lot of 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 it still basically essentially barely flat? What's your feel?
Are you seeing growth improve at all, obviously excluding the
easier year over year comp?
Yes. That's a good question, Larry. Since we don't get very much price, maybe we get 1% a year, most of our growth I mean, basically, all of our growth, the 5% was due to unit volume growth. And I think that unit volume growth of 5% is far in excess of what the industry is seeing, number 1. So 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 0 to 5 year range where they don't need much maintenance. And I think that, that's having that's holding down the industry aftermarket growth. And but 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 2 points of growth from the FSG segment.
So when you look at it, I mean, the organic unit growth was even higher. And we feel very strongly about the new products, the customer relationship. You can see with the recognition by Alta. And I think that while that's just one region of the world, I think that simplifies how our customers view us. And I think we're setting up very good in a very good way for a nice upcycle as some of these newer as some of the newer equipment needs maintenance because the OE prices on this newer equipment, I mean, some of it
is just crazy.
And yes, of course, we've got to develop the parts, we've got to get them approved at the airlines. We have to get installed, etcetera. But I feel very strongly that our strategy of maintaining basically a very low price increases and building a lot of customer goodwill is putting us in a very positive position with our customers. Okay, great.
And maybe a question for Victor on just I know in terms of new defense budget, so what's going to happen, that's going to it's still several quarters, if not a year plus a web. I know on the last call, you had mentioned I mean, 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. And I don't think we've seen things shake out palpably except I have noticed, and I think I mentioned this on the last call, we have noticed in our businesses, there is less reticence to spend and to commit dollars where in the past, in the prior administration, there were, I'll call them, quasi obstructionist efforts geared at finding ways to not spend the allocated money and thereby let it get redirected to something else. And we're not seeing that or not seeing it as much.
And the usual amount of confusion in the defense budget that exists over the years decades is always there for us in terms of spending and why isn't this contract coming through or that contract, why is it delayed and they have 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's only a proposal at this point as we all know. Our general view is it's a net positive going forward, but not to really expect it in a material way this year. And of course, as that gets delayed, if it gets delayed, then that would delay the benefit to us.
Got it. And just last question, if I may.
Just on the Air Force Control, it looks like you've just
finished your cash flow statement, you guys
spent about $80,000,000 on that and it sounds like it's in your usual acquisition criteria, immediately accretive. Is it 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, this is Carlos. Some of it is related to that. The increase in guidance went from mid single digits to mid to upper single digits, some of that was our cost control, some of that is higher expectations in some of our operating units. So it's a combination of both.
Our next question comes from Luis Repatto with Deutsche Bank.
Good morning, gentlemen. Stick with ETG. Just you
mentioned this is the 2nd quarter, I guess, with Aerospace. Is that just linked to sort of higher overall production rates? Or is there anything else there?
No. Louis, this is Victor. It's some of it is aftermarket, some of it's production. I'd probably say maybe a little more aftermarket than production improvement, but it's a nice mix.
And then just sorry, Sandy check my numbers here. I think the you called out 6% growth in ETG or yes, 6% growth, but only organic was 5%. I thought we were sort of at a clean year over year now, but
I wasn't sure what that discrepancy was.
Louis, this is Carlos. I think the 5% is quarter 6% is a 6 month period. So
that's helpful. Okay.
All right. And then just last one on the cash flow. I guess it was just a bit below what I expected. Obviously, you've raised the guidance. Was there and I
think Larry may have touched on
this a bit. I may have missed it. Anything timing in the first half versus second half within
the second quarter, I guess?
No, I think, Louis, I think, generally speaking, if you look back on history of HEICO and our cash generative operations, traditionally, I mean, and it could change, but traditionally, the first half of the year from a cash flow generation standpoint is generally a little less than the latter half. And so 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 do have some we had a little bit of an inventory build, which if you look across all our subsidiaries, it's 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 is a little higher as a result of 'sixteen operations versus the prior 'fifteen operations, which would have been accrued in that cash flow statement. So I wouldn't say there's any trend or any unusual items in it. It was principally based on time.
No purchase consideration or meaningful in the quarter,
I guess? I know that you're probably just $7,000,000 next year.
No. Okay. $7,000,000 What was this? I'm sorry.
The purchase consideration, I guess. I think there's $7,000,000 that's going to be paid out this year.
We've already paid that out. It doesn't come out of operations.
Our next question comes from Ken Stewart 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 deliveries 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 'seventeen or calendar 'seventeen?
Yes. It's a good question, Ken. We've seen some increase in spending on some of the older equipment. I think one of the 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. So I think that last year's numbers in hindsight were probably helped by that, which is making the comps a little bit tougher.
But yes, we are seeing some increase in spending on the older equipment. As you point out, the dollar rate coming down on some of the wide body equipment. And 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. But clearly, with wide body build rates being down and fuel being down, I mean that should bode well for extending some of the time on some of the older equipment. But again, we don't have that baked into our projections at this point.
Okay. That's helpful. And now that you've completed
the A2C acquisition and obviously you've been able to build a very nice
organic growth maybe for specifically A2C or maybe distribution at large within the segment, not just in 'seventeen, but over the next few years?
Yes. I'm very positive in that area. Actually, a week after roughly a week after the MRO show, I went and visited ATC in Hamburg in Toulouse. And while I have been there in the past, I can tell you that 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.
And we are immediately finding opportunities for our distribution companies to work together. There really is no product overlap. So we don't have a situation where we would have multiple subsidiaries trying to sell the same product. It truly is complementary. And the relationships that our existing distribution business has with Steel Dynamics And with the new distribution business with our cost control or HCC, I think it's extremely complementary.
And the people are on both in both businesses are very excited to help open doors for the others. And I've got, significant expectations for great opportunities down the road. We met with some of the larger customers and ATC is really viewed in an extremely unique way due to their business model, their customer attentiveness. I mean, this is a company that 17 years ago didn't even exist. And it started with 1 person and then 2 people in a little office, and they learned how to, again, as the other HEICO businesses do, listen to their customers, understand what they want, proactively deliver high quality product, find alternatives at a lower price.
And in meeting with some of ATC's customers, ATC's growth was not by accident. I mean, it was by targeting these opportunities and making sure that the customers were very happy. So I do see a great opportunity and synergy with the with our distribution business. And then, of course, with distribution and PMA, I mean, there's the synergy that we've spoken about for a while. And I would say I'm very bullish on that.
Well, thank you very much for that color.
If I could just one final question for Victor. Just a follow-up again on the margins of the quarter, very impressive. And I just want to make sure I heard you correctly, really know those sort of one time items you'd specifically point to either from a mix standpoint or timing, just good performance? Or is there anything in particular you
would highlight as maybe something that doesn't repeat with the statement moving forward? 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're able to execute on were good. I think we always have a business here or there where something goes forward a quarter or slips a quarter and maybe we had a little bit better in that regard. But I don't see anything outside of the noise level that we typically see on that. So, overall, I would say
it was just kind of all
the factors each adding up incrementally delivered it for us.
Thank you very much.
And Carlos has something to add.
Yes. I might just want to add, Victor's point is absolutely correct. We have the scenario this quarter in the ETG where really all of our subs and industry participants are firing on all cylinders. Occasionally, that happens. And we had a similar situation in Q4 last year where we sort of had broad growth across all the subsidiaries.
And when that happens, and given the fact that most of the folks running these business units are very entrepreneurial and today at this point cost conscious, we get some nice leverage in SG and A spend and we get some nice product mix and growth. And so I wouldn't over read that. To Victor's point, we plan for diversification, we plan for ups and downs within the same by subsidiary. And so the guidance we've given of 25 percent on the year, we hope to do better, but that's kind of how we see things on a go forward basis, based on backlog and what we can see at this point.
Great. Thank you very much.
Our next question comes from Rob Brinkman with Credit Suisse.
Hi, guys. Good morning. Good morning. I missed any of your calls because I was on another one. So I'm not sure whether or
not you talked about this.
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 or any opportunities there?
No. We haven't covered that yet on the call. I mean, we continue to think and 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. And I think that that's an area for growth and opportunity for us as time goes on.
Yes. Sorry, Eric.
Well, I was going to ask you from a process perspective, how might a cooperative effort to develop 2nd Source Corp differ from a traditional PMA process from 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 and we love them. Understood. Unfortunately, I can't go into the details on that, but suffice it to say that the airframers and some of the larger OEMs don't necessarily have the same interest as some of the smaller OEMs. And 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. And I think that that's really where HEICO would fit in.
Okay. Excellent.
Peter, I wanted to ask you about margins
that just got asked.
And so it sounds like we suggest, 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've got that exactly right. And again, with the emphasis on expect what more of what we are telling you for the year, that 25% number and not margins higher. But if we do better, great. The objective is great. It's higher, of course, but let's keep where
we are. And 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, right. Well, I guess as a follow-up to that and somewhat related maybe Carlos this is for you. As a percentage of sales and again this might have come up earlier SG and 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. And what we've seen over the last couple of quarters is some leverage on that SG and A spend. And I would anticipate, barring any one timers or anything like that, I would anticipate to continue to catch some of that leverage on SG and A spend, which is really a contributor, frankly, to our move up, if you would, on the consolidated margin to approximate 20% from a range of 19% to 20%.
Right.
I guess when I look at it, this makes 2017 look a little more like 2015 in terms of SG and A performance versus where 'sixteen was relatively a little higher?
Yes. You have to remember in 'sixteen, it was littered with we had a one time charge
of about
$3,100,000 for an acquisition and we had some FX impacts during 'sixteen that we hadn't experienced this year. So if you look back historically, 'fifteen, maybe 'fourteen and prior, our SG and A extends 17.5% to 18% or so. It's kind of been the range. And as we grow the business, the top line at a greater rate than that sort of range of done SG and A spends, we are catching leverage. I'm quite proud of the guys for that.
Okay. All right. Well, thank you. Larry, sorry I didn't have one for you.
That's fine. They answered it, but that is not good. There you go.
Thanks, guys.
Our next question comes from Drew Lemski with Stephens.
Good morning, guys. Thanks for taking the time.
Good morning.
It's 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? 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 our 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 products area. So if you look at it, we're probably looking at roughly 6% unit growth. And 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 having or 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 it is going to need maintenance and the price points are higher on the newer equipment. So I think there is 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. And 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 of ease. But 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. So 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 were really putting us in position to be able to further increase our unit volumes and supply more parts.
I mean I've heard examples. There are some OEMs out there that have raised prices 10%, 11% per year for the last number of years. And we've been clearly, we could have done the same and we didn't. And they recognize that. And 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 is looking.
And 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. And we think that our shareholders are going to be better rewarded by taking the long deal. And that's also, frankly, it 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. So I think it really sets Haikol up very well for this pull through that you're referencing.
And I anticipate we're going to see a lot more of that over the next couple of years.
Yes. That absolutely makes sense. And then your ability to increase your annual parts approval from kind of $500,000,000 to maybe something greater if we start to
see this greater pull through,
What are the leading 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. So 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, very confident.
I mean, 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 stocking horse. So 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 are going to be increased 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. And last one for 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 the supply chain and greater use of e commerce solutions, is there a silver lining for you guys and that allows you to highlight your lower price position and provide more transparent pricing for you to capture more share?
Yes. I mean, in general, as 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. But we clearly, with the airlines, we're able to point out the areas of savings, the areas of opportunity.
There have been many newspaper or many media reports on the increases coming on particularly the cost of engine parts. There's been 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. And airlines see that, they're not happy about it. And I think that there's continued opportunity throughout the industry.
Our next question comes from Jim Fong with Cowen and Company.
Hi, guys. Good quarter there.
Thanks, Jim.
I want to just ask about the specialty products. I guess you still see us a little disappointing. Maybe just talk a little bit what happened there and you see catch up in the second half of sales in that unit?
Sure. So 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. And there were 2 areas. 1, 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 Q3. But I think we are seeing a pickup in the industrial side. So I'm fairly confident that we've bottomed in that area. And then 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 a foreign military sales order and one country can finish taking delivery of its product and then maybe there's a break until the next country sort of gets in line.
So that's fairly common in the defense area. So we've seen that, 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 an impact, 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. So but it's also important to point out that I don't want to overstate the industrial side for us.
And this is only about 4% of FSG. So it's not a very big part, but that's why I'm sort of confident that we've hit the bottom there. Could you think that could
kind of be a potential upside as you work through the second half maybe some catch up in the weaker first half then?
Yes. I think there could be. And of course, we need to see what happens with the wide body and the narrow body production rates. But yes, I do think that there is a lot of catch up opportunity for the second half and, frankly, 2018 in a big way.
And then just on the industrial on the O and D expense area, Mary, if you can chime in on this. If you typically, just kind of a year end budget spending, you have to make sure that you get all the money spent so that you can request more money with the upcoming budget. And do you think you get kind of a year end surge in buying in debt over fiscal year to budget ending? And 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 is 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. So, there are times when we actually see the inverse where things get quiet in the back end of the year, get a little bit quieter in the back end of the year because they just run out of money to spend and then all of a sudden it comes flying through in November. And 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.
So, it's really difficult to see. We're not counting on any surge, if you will, in our defense revenue in the back half of the year. And if that happens, that's great. I guess that would be upside, but we're not counting on any of that right now.
Yes. I would think if you're talking about the increase in the defense measure, everyone wants to make sure to give their last
dollar. Right.
Yes. All right. But either it comes in October or November, you still feel a little bit of the same thing, okay?
Yes. I mean, that's I could the more reliable sort of pattern. But there's no again, there's no great discernible pattern as far as we're concerned that we noticed on our business. Now, 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.
And we plan kind of according to the orders that we have and level loading our shops. And if more comes, that's great. But we're not going to
in all likelihood gear up for
that and increase our spending.
Okay. And then last one for me, maybe for Carlos, if you just stock options. So a lot of companies are getting some lower tax rate from the exercise of options. You had some of that in your second quarter. You expect more in the second half of the year with the tax rate to be lower than you expect?
Jim, so actually, that particular phenomenon or new accounting guidance you're talking about, we implemented in Q1. And so 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'll see that diminish down over the years. So I don't expect that on an aggregate annual basis to have a significant impact on our overall rate.
Okay. And then were you guiding for your tax rate to still kind of 30% for the year?
Well, what we're guiding to is between our income tax rate and our non controlling interest rate as a percent of pretax income, roughly 39% to 40% for those 2 components.
Okay, great. All right. Thank you, guys.
Thank you, Jim. Thank you, Jim.
Ladies and gentlemen, that does conclude today's Q and A session. It's now my pleasure to hand the program back over to Laurence Mendelson for any additional or closing remarks.
Thank you. And 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 Tom Irwin and Eric and Victor throughout the year, so we're happy to chat with you and give you answers that we can provide. And we look forward to speaking to you at the end of our Q3 and that conference call will be sometime towards the end of August of this year.
So, we wish you a good summer, a safe summer, and look forward to speaking to you real soon. Thank you. And that's the end of this call.