Welcome to HEICO Corporation's Fiscal 2015 third quarter earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue, press the pound key. Certain statements made in 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 those forward-looking statements as a result of factors including, but not limited to, lower demand for commercial air travel or 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, space 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, foreign currency exchange, and income tax rates, and economic conditions within and outside of the aviation, defense, space, medical, telecommunications, and electronics 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 statements, whether as a result of new information, future events, or otherwise, except to the extent required by applicable law. Thank you. I would now like to turn the call over to Laurans Mendelson , HEICO's Chairman and CEO.
Thank you. Good morning to everyone on the call. We thank you for joining us. We welcome you to this HEICO third quarter Fiscal 2015 earnings announcement teleconference. I'm Larry Mendelson, Chairman and CEO of HEICO Corporation. 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; Tom Irwin, HEICO's Senior Executive Vice President; and Carlos Macau, our Executive VP and CFO. Before reviewing our third quarter operating results in detail, I'd like to take a few moments to summarize the highlights of another record-setting quarter. I want to thank our HEICO team members for their collective efforts, outstanding execution during the third quarter, and by remaining focused on income generation, cash flow, and profit margin strength.
As I've said before, our mission is not just to grow sales to make a larger company, but to generate income and strong cash flow for all shareholders. The record third-quarter results I'll now discuss are a testament to that strategy. Our consolidated net sales, operating income, and net income in the third quarter of fiscal 2015 represent record quarterly results. They were driven principally by record quarterly net sales and operating income in Flight Support and increased profitability in ETG. Consolidated net sales, operating income, and net income in the first nine months of fiscal 2015 represent all-time record results for HEICO. They were driven principally by record net sales and operating income within both segments.
Consolidated operating income increased 17% to a record $58.5 million in the third quarter of fiscal 2015. That was up from $50.1 million in the third quarter of fiscal 2014. It increased 7% to a record $160.7 million in the first nine months of fiscal 2015. That was up from $149.7 million in the first nine months of fiscal 2014. Consolidated net income increased 3% to a record $34.4 million in the third quarter of fiscal 2015. That was up from $33.4 million in the third quarter of fiscal 2014. It also increased 7% to a record $95.1 million in the first nine months of fiscal 2015. That was up from $89.2 million in the first nine months of fiscal 2014.
Consolidated net income per diluted share increased 4% to $0.51 in the third quarter of fiscal 2015, up from $0.49 in the third quarter of fiscal 2014. Consolidated net income per diluted share in the third quarter of fiscal 2014 included a net $0.05 per diluted share benefit from a reduction in accrued contingent consideration related to a prior year acquisition. Consolidated net income per diluted share increased 6% to $1.40 in the first nine months of fiscal 2015. That was up from $1.32 in the first nine months of fiscal 2014. Consolidated net income per diluted share in the first nine months of fiscal 2014 included a net $0.10 per diluted share benefit from a reduction in accrued contingent consideration related to a prior year acquisition.
Just to comment, later on in the Q&A, I'm sure Carlos and Tom will be happy to discuss the impact of those reductions in accrued contingent consideration. Cash flow from operating activities remained strong in the third quarter of fiscal 2015, totaling $56.5 million or 164% of our consolidated net income. Very strong, I may add. Cash flow provided by operating activities in the first nine months of fiscal 2015 totaled $121.3 million or 128% of consolidated net income. In July 2015, we paid our 74th consecutive semiannual cash dividend since 1979. That was paid at a rate of $0.07 per share. As of July 31, 2015, we remain extremely well-positioned for growth as a result of our financial flexibility. The company's net debt to shareholders' equity ratio was only 31%, with net debt of $267.8 million.
In June 2015, we reported that our Dukane Seacom subsidiary had created the first FAA and EASA-certified 90-day underwater beacon. We're pleased to note that they have now established the new operational standard in underwater locator beacon technology. With over 40 years of industry experience, Dukane Seacom has the largest installed base of underwater locator beacons on commercial, military, and biz jets around the world. In July 2015, we reported that our 3D PLUS and VPT subsidiaries supplied mission-critical components for NASA's New Horizons spacecraft, which has traveled farther and faster than any prior space mission in history. We are consistently amazed by the engineering talent and forward-thinking of our team members who supported NASA in this historic flight past Pluto and beyond.
3D Plus, VPT, and certain other HEICO subsidiaries have routinely supplied critical components on NASA and the European Space Agency programs, and many of HEICO's subsidiaries are well-known leaders in complex, high-reliability, mission-critical engineering and manufacturing for spacecraft. We want to congratulate our teams at 3D Plus, VPT, and Dukane Seacom on these wonderful, tremendous accomplishments. As I reported in our last conference call, the acquisition pipeline has been very active. As you know, we're pleased to report that we closed four transactions since the second quarter. In May 2015, our Flight Support Group completed the acquisition of Thermal Energy Products, which engineers, designs, and manufactures removable and/or reusable insulation systems for industrial, commercial, aerospace, and defense applications. This is now part of HEICO's Specialty Products Group.
In August 2015, our Flight Support Group acquired 80.1% of the equity of Aerospace & Commercial Technologies, we call it ACT, a leading provider of products and services necessary to maintain up-to-date F-16 aircraft operational capabilities. Aerospace & Commercial Technologies, ACT, will work in coordination with our Blue Aerospace subsidiary to support the F-16 community worldwide. The acquisition expands our reach into defense aftermarket support and broadens our existing base of business in this very important sector. In August 2015, our Flight Support Group also acquired all of the outstanding stock of Astroseal Products Manufacturing Corp., a manufacturer of expanded foil mesh, which is integrated into composite aerospace structures for lightning strike protection in both fixed and rotary wing aircraft. This acquisition expands HEICO's capabilities and offerings of aerospace and composite parts.
Also in August 2015, our ETG Group acquired 80.1% of the equity in Midwest Microwave Solutions, we refer to it as MMS, a designer and manufacturer of unique size, weight, power, and cost-optimized communications and electronic intercept receivers and tuners for military and intelligence applications. This acquisition is a perfect fit for HEICO and expands our intelligence gathering equipment business. In June 2015, we were pleased to report that Forbes Magazine had again named HEICO as one of the world's 100 most innovative growth companies. This makes 10 awards in 10 years. The recognition is a true testament to the expertise and innovative spirit of our more than 4,500 team members worldwide. I express my deepest appreciation and admiration for their remarkable efforts and dedication to HEICO's success.
I would now like to introduce Eric Mendelson, Co-President of HEICO and President of HEICO's Flight Support Group, to discuss the results of Flight Support Group. Eric?
The Flight Support Group's net sales increased 8% to a record $206.6 million in the third quarter of fiscal 2015, up from $191.6 million in the third quarter of fiscal 2014, and increased 4% to a record $591.4 million in the first nine months of fiscal 2015, up from $568 million in the first nine months of fiscal 2014. The increase in the third quarter and first nine months of fiscal 2015 mainly reflects net sales contributed by the fiscal 2015 acquisitions, as well as additional net sales from new product offerings in our aftermarket replacement parts and repair and overhaul services product line. These increases were partially offset by lower net sales of certain industrial products that we have discussed in prior conference calls.
As a result of the lower net sales of certain industrial products, the Flight Support Group experienced a small 1% and 2% organic revenue decline in the third quarter and first nine months of fiscal 2015, respectively. Excluding the impact of declines in certain industrial net sales, the Flight Support Group experienced organic growth of 4% and 3% in the third quarter and first nine months of fiscal 2015, respectively. Consistent with most of our peers, we experienced somewhat lower aftermarket industry growth in our third quarter and first nine months of 2015 as compared to expectations for higher industry growth going into this year. Based on current available seat miles, or ASMs, we believe that in our third quarter, airlines avoided spending on maintenance costs where possible, and ultimately will have to increase such spending if they continue to fly the aircraft that they are currently operating.
The Flight Support Group's operating income increased 15% to a record $39.3 million in the third quarter of fiscal 2015, up from $34.2 million in the third quarter of fiscal 2014, and increased 4% to a record $107.5 million in the first nine months of fiscal 2015, up from $103.3 million in the first nine months of fiscal 2014. The increase in third quarter and first nine months of fiscal 2015 is principally attributed to the previously mentioned net sales growth. The increase in the third quarter of fiscal 2015 also reflects the impact of foreign currency gains related to a euro-denominated contingent earn out liability and lower accrued performance-based compensation expense, partially offset by a less favorable product mix from the previously mentioned decrease in net sales of certain industrial products.
The Flight Support Group's operating margin improved to 19.0% in the third quarter of fiscal 2015, up from 17.9% in the third quarter of fiscal 2014, and approximated 18.2% in both the first nine months of fiscal 2015 and 2014. The increase in operating income as a percentage of net sales in the third quarter of fiscal 2015 principally reflects the previously mentioned foreign currency gains in lower accrued performance-based compensation expense, partially offset by the less favorable product mix. 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.
Eric, thank you. The Electronic Technologies Group's net sales decreased 5% to $97.2 million in the third quarter of fiscal 2015 from $102.1 million in the third quarter of fiscal 2014. The decrease principally reflects foreign currency exchange rate changes, as well as slightly lower demand for certain space and medical products, partially offset by higher demand for certain defense and other electronic products. The Electronic Technologies Group's net sales decreased 1% to $277.4 million in the first nine months of fiscal 2015, from $279.3 million in the first nine months of fiscal 2014. The decrease is mostly from lower net sales of certain space and other electronics products, resulting mainly from foreign currency exchange rate changes, partially offset by higher demand for certain defense and aerospace products.
As for our principal markets, overall, our defense businesses have strengthened. As we discussed in last quarter's call, there is bipartisan support in Washington for increased defense spending in the next fiscal year. We're cautiously optimistic that U.S. defense budgets overall will grow. Our commercial space business has been a little bit softer, about half of which came from currency translation changes, and half of which resulted from some parts of our businesses coming off excellent performance last year, as well as earlier this year. Overall, we're very pleased with our space businesses. We'll wait to see if the industry is a little softer than it was. Notably, Lucix did well in the quarter and has continued to improve.
The other ETG markets that we serve are seeing a slightly positive overall mix of conditions. There are pockets of weakness in some of the electronics markets that we serve. The Electronic Technologies Group's operating income increased 14% to $24.4 million in the third quarter of fiscal 2015, up from $21.5 million in the third quarter of fiscal 2014. The increase principally reflects a more favorable product mix for certain space and defense products. The ETG Group's margins operating income increased 6% to a record $66 million in the first nine months of fiscal 2015, up from $62.5 million in the first nine months of fiscal 2014. The increase mainly reflects a more favorable product mix for certain space and defense products and lower amortization expense associated with intangible assets.
The ETG Group's operating margin improved to 25.1% in the third quarter of fiscal 2015, up from 21% in the third quarter of fiscal 2014. The increase mainly reflects a more favorable product mix for certain space and defense products. The Electronic Technologies Group's operating margin improved to 23.8% in the first nine months of fiscal 2015, up from 22.4% in the first nine months of fiscal 2014. The increase mainly reflects a more favorable product mix for certain space and defense products and lower amortization expense associated with intangible assets. At this point, I turn the call back over to Laurans Mendelson.
Thank you, Victor and Eric. Commenting now on diluted earnings per share. Consolidated net income per diluted share increased 4% to $0.51 in the third quarter of fiscal 2015. That was up from $0.49 in the third quarter of 2014. Third quarter of fiscal 2014 again included a net benefit of $0.05 per diluted share. That was mainly due to the reduction of accrued contingent earn-out liabilities associated with a prior year acquisition. Consolidated net income per diluted share increased 6% to $1.40 in the first nine months of fiscal 2015, and that was up from $1.32 in the first nine months of fiscal 2014. The first nine months of fiscal 2014, again, included a net $0.10 per diluted share benefit, mainly due to the reduction of accrued contingent earn-out liabilities associated with that prior year acquisition.
Depreciation and amortization expense was $11.9 million in the third quarter of 2015, comparable to the third quarter of 2014. Depreciation amortization expense decreased to $35.1 million in the first nine months of fiscal 2015, and that was down from $36.3 million in the first nine months of fiscal 2014. That decrease mainly reflects lower amortization expense of certain intangible assets resulting from impairment losses recorded in fiscal 2014, partially offset by a higher amortization expense of intangible assets recognized in connection with some of our fiscal 2015 acquisitions. Research and development expense totaled $9.4 million in the third quarter of fiscal 2015. That compared to $9.9 million in the third quarter of 2014. R&D expense totaled $28.9 million in the first nine months of fiscal 2015, compared to $28.3 million in the first nine months of fiscal 2014.
Significant ongoing new product development efforts are ongoing at both Flight Support and ETG as we continue to invest approximately 3%-4% of each sales dollar into new product development. Our effective strategy for the last 24 years has been to reinvest a portion of our earnings into the development of new products and services that can offer lower cost and higher value to our customers. That, in turn, facilitates market share growth sufficient to meet our growth goals. SG&A expense decreased to $49.6 million in the third quarter of fiscal 2015. That was down from $53.2 million in the third quarter of fiscal 2014. SG&A expense as a percentage of net sales decreased to 16.5% in the third quarter of fiscal 2015, and that was down from 18.3% in the third quarter of fiscal 2014.
The decrease in SG&A expense as a percentage and expenses as a percentage of net sales in the third quarter of fiscal 2015 mainly reflects the impact of foreign currency gains, and that was related to liabilities denominated in EUR as well as lower accrued performance-based compensation expense. SG&A expenses total $146.7 million in the first nine months of fiscal 2015, and that was comparable to the $145.7 million in the first nine months of fiscal 2014. SG&A expense as a percentage of net sales decreased to 17.1% in the first nine months of fiscal 2015. That was down from 17.3% in the first nine months of fiscal 2014. Interest expense decreased to $1.1 million in the third quarter of fiscal 2015, and that was down from $1.4 million in the third quarter of fiscal 2014.
Interest expenses decreased to $3.3 million in the first nine months of fiscal 2015, again down from $4.2 million in the first nine months of fiscal 2014. The decrease in interest expense during the third quarter and first nine months of fiscal 2015 principally reflects a higher weighted average balance outstanding under our revolving credit facilities in the prior periods, and that was associated with fiscal 2013 acquisitions and the acquisition of certain non-controlling interests in fiscal 2014. Other income and expense was not significant. I won't comment on it. Income tax. The effective tax rate in the third quarter of fiscal 2015 increased to 32% from 23.4% in the third quarter of fiscal 2014. The lower tax rate experienced in the third quarter of 2014 was mainly attributed to a reduction of contingent earn-out liabilities associated with a prior year non-taxable stock acquisition.
The reduction in contingent earn-out liabilities during the third quarter of fiscal 2014 was non-taxable and accounted for approximately 7% of the change in the effective tax between the two periods. The effective tax rate in the first nine months of fiscal 2015 was 30.6%, comparable to 29.7% effective rate in the first nine months of fiscal 2014. Net income attributable to non-controlling interests increased to $4.6 million in the third quarter of fiscal 2015. That was up from $4 million in the third quarter of fiscal 2014. The increase mainly reflects the impact of net income allocations to the fiscal 2015 acquisitions in which non-controlling interests are held. Net income attributable to non-controlling interests increased to $14.4 million in the first nine months of fiscal 2015. That was up from $13.5 million in the first nine months of fiscal 2014.
The increase in the first nine months of fiscal 2015, again, mainly reflects higher allocations of net income to certain subsidiaries of FSG and ETG in which non-controlling interests are held. On a combined basis, we estimate fiscal 2015 effective tax rate and non-controlling interest allocations will approximate 40% of consolidated pre-tax income in the full fiscal year. Now moving on to the balance sheet and cash flow. As you can see, our financial position and forecasted cash flow remain extremely strong. Cash flow was strong in the third quarter of fiscal 2015, and cash flow provided by operating activities totaled $56.5 million, and that was 164% of reported net income. Working capital ratio is a strong 3.2 as of July 31, and that was up from 2.8 as of October 31, 2014.
DSOs or receivables was 46 days in the third quarter of fiscal 2015. That was comparable to the 47 days in the third quarter of fiscal 2014. Of course, we continue to closely monitor all receivable collection efforts to limit our credit exposure. No one customer accounted for more than 10% of net sales. Our top five customers represented approximately 18% and 17% in the third quarter of fiscal 2015 and 2014, respectively. Inventory turnover rate in the first nine months of fiscal 2015 was 117 days compared to 111 in the first nine months of 2014. The increase in our inventory turnover rate principally attributed to slightly higher inventory balances at our subsidiaries, which we need to meet customer orders in the near term.
Net debt to shareholders' equity ratio was 31.3% as of July 31, 2015. Net debt of $267.8 million principally incurred to fund acquisitions and the payment of the special cash dividends in fiscal 2014 and 2013. We have no significant debt maturities until fiscal 2019. We plan to use our financial flexibility to aggressively pursue high-quality acquisition opportunities, which should accelerate growth and maximize shareholder returns. As for the outlook, we look ahead to the remainder of fiscal 2015. We anticipate organic growth within our product lines that serve commercial aviation markets, moderated by lower demand for certain industrial-related products within our Specialty Products Group lines. Despite the currency headwinds impacting our foreign subsidiaries within the ETG, we continue to forecast full-year organic growth within ETG.
During the remainder of fiscal 2015, we plan to continue to focus on new product development, further sales penetration into markets we serve, executing our acquisition strategies, continuing to maintain financial strength. Based upon current economic visibility, we estimate consolidated fiscal 2015 year-over-year growth in net sales to approximate 5%, versus our prior estimate of 8%-10%. Net income growth to approximate 8%, which is within our prior estimate of 8%-10%. We have raised our full-year fiscal consolidated operating margin estimate to approximate 18.5% versus our prior estimate of 18%. We also anticipate depreciation, amortization, CapEx, and cash flow from operations to approximate $48 million, $20 million, and $200 million, respectively.
While we have lowered our full-year revenue estimates in light of headwinds which we are experiencing as a result of slower industry growth in aerospace aftermarket, Eric talked about that earlier, as well as the impact of foreign currency exchange rates, which Victor spoke about, we are pleased to maintain our net income growth estimates at approximately 8% for the full fiscal year. We have benefited from our focus on profit margin strength. Our fiscal 2015 acquisition should position us for continued growth in fiscal 2016 and beyond. We expect those acquisitions to be accretive at least in the first year of the acquisition. In closing, we will continue to focus on creating shareholder value through remaining focused on customers, strong cash flow, generating growth in net income, and strong profit margins.
Those are the extent of our prepared comments, and we would like to open the floor for questions.
At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number 1 on your telephone keypad. Again, that is star 1 to ask a question. Your first question comes from the line of Larry Solow of CJS Securities.
Hi, this is actually Lee Jagoda for Larry. Good morning.
Good morning.
I know on the acquisition side, talking about individual acquisitions, purchase price, and revenue contribution is sometimes difficult, but given you've made three in the last few weeks, is there any way you can combine them and sort of give us a ballpark range for both purchase price and revenue as the combined group of them?
Actually, we didn't release that information, and we don't release it. At this point, we really cannot give you that information. It has not been released to the public. Carlos can comment a little more on it.
Yeah. Baked into our guidance that Larry just articulated, we knew about those acquisitions that were closing. They were factored into it. They're not material, otherwise we would've disclosed that information. They are acquisitions that are very complementary to our existing product lines and expand our business, and we think they're going to be very good for us, as Larry mentioned, going forward.
Okay.
Part of the answer, which you guys will figure out, is when you see the cash flow statement and so forth. You're going to get a kind of a guesstimate from the cash flow statement that we produce, I guess, in the fourth quarter. It'll give you a kind of figure. As Carlos says, overall it was not that material.
Assuming at the end of the year that the 5% top-line growth is achieved, what are the components of that 5%? Meaning, what's organic? What would acquisitions contribute? What's the negative from FX embedded in that 5%?
Right now, year-to-date, we have acquired growth on a consolidated basis of about $32 million. We expect similar run rate going through the end of the year from the acquired acquisitions that we've already purchased in the first quarter of maybe about $10 million a quarter. As we just previously mentioned, we're not going to talk specifically about the financial operations or contributions of the acquired acquisitions because they are insignificant to the overall consolidated operations.
What do you think the FX impact has been over the first three quarters, and how should we think about that for Q4?
It's interesting.
It's principally impacted the Electronic Technologies Group through some of our foreign subsidiaries that do business in euros and Canadian dollars. So in the Electronic Technologies Group in particular, they had about a 5% revenue headwind, comparatively between Q3 last year and this year. About half of that was related to FX impacts on our revenue line. I don't have a crystal ball as to what currencies are going to do right now, but we've sort of been conservative in the way we've thought about it going forward.
Okay. Then one more question and I'll hop back in the queue. In terms of the better margin forecast despite the lower sales, what are the key drivers of the 50 basis point increase?
The key drivers overall were, I think as both Eric and Victor mentioned in their presentation, we had some lower accrued performance-based compensation, and we have a euro-denominated loan, which we took out in Q1 to do the acquisition of Aeroworks, which had some positive FX benefits, which also contributed to it. Finally, some of the efficiencies that our subsidiary general managers have baked into their businesses through operating leaner over the past nine months has contributed principally to it.
Great. Thanks very much.
Your next question comes from the line of J.B. Groh of D.A. Davidson.
Hey, guys. Morning. Thanks for taking my call.
Good morning, J.B.
Hey, Eric. One of the other aftermarket levered players the other day talked a lot about retirements and how that's impacted growth in the aftermarket. Maybe you could give us your thoughts on that and how that's impacting your business. Obviously, you guys have multiple ways to grow, it seems like the organic growth has been a little slow, you think that's having an impact in terms of the total aftermarket demand?
Well, I think that's a very good question, we've been in a number of investor conferences over the last month or so and received a lot of these kinds of questions. I think in looking at it, as we entered the year, the investors, and I would say the analyst community, were a little more bullish on the aftermarket performance than what turned out for most of the suppliers. If you look at most of the suppliers, they've been reporting sort of comparable, a little bit disappointing numbers, with the exception of GE and Safran, which I think had some initial provisioning related to some new aircraft engine types in their numbers.
The way we look at it is, it's a fairly complex equation in that you've got the base fleet aging, obviously one year per year, and then the older aircraft dropping out at the back end and of course, the new aircraft coming in at the front end. The airlines have been flying the older aircraft beyond what everybody originally anticipated, I think that's one of the reasons why the ASMs are up. If the airlines continue to fly these older aircraft, they're going to have to put some dollars into it. We had baked into, when we build our budgets, we analyze the fleet plans of our customers, we have that all put in there in the, if you will, the complex equation. Yes, I think the retirements are impacting it.
What's going to be really a telling quarter will be in the fourth quarter, when we find out whether the airlines are in fact going to go ahead and fly some of these older assets longer or whether they're going to pull them out as originally planned. That's a little bit unclear as of now.
That probably wouldn't slow your pace of PMA development, which is, I'm-
That's correct.
Yeah.
Our pace of PMA development is not slowing whatsoever. As a matter of fact, the airlines are very focused on how we can help them with their current fleet, as well as with the fleet that they will be taking deliveries of. There's no change to our business model whatsoever. As a matter of fact, I've been getting a lot of questions recently. I don't want to go into specifically which aircraft type or which engines, but I've been getting a lot of questions from senior airline executives about what we're going to be doing on the newer platforms, because they very much want us to be there.
One more, Eric, and then I'll hop back in queue. Just speaking geographically, I guess the fleet age is going to vary by region depending on what markets are kind of replacement markets and what markets are growth markets, and specifically, everybody's worried about China. I'm guessing that geographically, that's not a huge PMA market for you quite yet.
Yeah. China, as we say, remains a very good opportunity for us. We do sell some parts into China, but I do not anticipate any significant impact on our business whatsoever as a result of specifically China. Now, to the extent China impacts the rest of the world, and the rest of the world gets impacted and reduces their flying, then obviously there could be some impact. With regards specifically to China, no, that's not going to be a major impact for us.
PMA is probably more highly levered to North America, Europe?
Yes. I would say the world, with the exception of China.
Okay. Hey, thanks a lot, guys.
You're welcome.
Thank you.
Thank you.
Your next question comes from the line of Robert Spingarn of Credit Suisse.
Good morning, everybody.
Good morning.
Eric, staying on the topic, is there a way to quantify the organic growth in same parts? You talked earlier in your monologue about the fact that your growth was derived from the introduction of the new parts. Larry, you talked about the R&D that gets you there, but if we looked at sort of a same store sales on particular parts, can you talk about what's happening?
Yeah. We analyze those numbers periodically, we don't disclose what they are, because we can't get into, obviously, trends on specific platforms or engines or product types. We do, we definitely look at that. Most of our growth, again, is through a volume change, as opposed to pricing. We're not one of those suppliers who ratchets up pricing and gets it that way. If we get 1%-2% on pricing, that's probably all we get, and the vast majority is on volume growth.
Is it fair to say, just given the softness the industry is seeing, that volumes are modestly down year-on-year?
I don't have that information in front of me. With us, we were up, for example, 4%. We're not getting 4% on pricing.
No, I know, you're getting this adoption of the new products, which is organic growth, but it's also really market share driven. As long as you continue to spend on that R&D, I would expect that that market share will continue to grow. I'm just trying to get a sense really about what you just talked about a moment ago, which is the behavior of the airlines. They've discovered, it seems recently, various means to put off maintenance, and trying to figure out how deep that goes, and if we're going to start to see some evidence that that's reversing. You talked about it a moment ago, is it possible that they're also sourcing from the surplus market, and we may not see that recovery so soon?
No, I don't think so. In the products that we provide, there's not a lot of surplus available. We tend to supply more of the expendable parts. I don't believe it's a surplus phenomenon. I think what's going on is that with lower fuel, the airlines are flying some of the older equipment, and that's increasing ASMs, but they're not putting money into fixing the older equipment. Really, the moment of truth will come out when we find out whether they're going to in fact retire or extend the lives of some of these aircraft. There are certain airlines with certain, what I would say, not competitive, non, if you will, current generation aircraft, and we anticipate those to go down. No matter what fuel does, we don't anticipate those non-competitive aircraft to be flown beyond their expected retirement dates.
There are other competitive aircraft, and with fuel down where it is, it makes sense to extend time on those. I don't believe the industry in general has seen the benefit, and that's HEICO included, has seen the benefit of extending the time on those older competitive aircraft. That's really what we're going to end up seeing, I think, as the airlines develop their budgets in the fourth quarter, we learn about it, of course, perhaps in the fourth and in the first quarter.
Okay.
Yeah.
Yeah, go ahead.
For us specifically, we're doing well with the new product introductions. Again, our business is one of, since we basically enter a product, let's just say, roughly, five to 10 years after the initial delivery of the first aircraft. By definition, we are in there on the back end as they retire the aircraft. We do always have, as part of our business model, it's always contemplated being on the sunset fleet. I don't anticipate any significant change to our business model or what we've seen over the last 20 years.
Okay, just a question really for all of you, which is, in your non-aerospace businesses, if you could just talk about some of the both positive and negative trends that might have been a bit of a surprise. I think there was some industrial pressure, Eric, in your business. Victor, you had medical and space, and then upside in defense. If you could just talk a little bit about that.
The largest non-aerospace business within the Flight Support Group is this ancillary industrial product line. Again, that was something basically where a customer had come to us a number of years ago, wanted to use an aerospace solution for an industrial product. We went ahead and we did this. We had the orders, they realized that their unit that they were shipping to customers was not running as hot as they anticipated it to run, and they were able just to basically remove the product from the bill of materials. It wasn't really a loss to a competitor, it was really a change in the design specifications. That's our only significant non-aerospace application. I can tell you that in terms of foreign military sales, we continue to do very well.
We have a little bit of defense exposure, we're doing very well in that area as well.
Rob, this is Victor. I would first tell you that the organic growth in ETG in the third quarter was around 9% in 2014. We're coming off a sort of heavy comp there. In terms of the overall markets that we're looking at, defense has been good for us, it's been good for us this year. I think it hasn't been on fire. We talked about, and you and I have talked about this, and talked about this on other calls, that we expected that at some point this year we'd see defense turning, I think that is happening. We'll have to see what happens, as I mentioned in the earlier comments, with the defense budgets. Right now, there appears to be support for that as well in Washington.
By the way, our defense business, I think, has been good in both domestic capacity and in foreign business, and that's a big chunk of it. As I've told you in the past, the foreign destined part of ETG's defense sales probably are average in excess of a third.
By the way, Victor, on that note, do you get any visibility into the behavior of those customers with all this emerging market pressure, et cetera? Do you get to see that, or is it too many degrees of separation for you?
I think that's probably too many degrees of separation for us, and we're generally not so much on the emerging market side, so we don't really see a lot of that. In terms, Rob, of the other markets that we're serving, space has been extremely strong for us and moderated a little bit in the period about somewhere in the neighborhood of half of that or somewhere around that. Is a result of the heavy foreign sales that we have in euro denomination changes internally, when we have to translate back into dollars from our foreign businesses. I wouldn't say those are weak, but they're just a little bit softer. In the other markets that we're serving, again, we've singled out medical, but again, a big chunk of that was related to foreign currency translation changes.
In terms of those businesses' local operations, they've been strong overall, and we're pretty happy with those. The other markets are just kind of the typical mix that we see out there.
Okay. Thank you.
Thank you.
Your next question comes from the line of Chris Quilty of Raymond James.
Thanks, gentlemen. I know you don't comment on specific acquisitions, but I think last quarter you did mention an unusually large one that was in the pipeline, and I didn't hear mention of that. Has that one slipped off the radar screen, or is it potentially still in the pipeline?
Chris, it's potentially still in the pipeline. The acquisitions, as you know, you never can know when they're going to come around. You do the due diligence. You have questions in them, and some of these things take a year and a half or more to incubate. The one that I was thinking about is still around. I don't know where it'll wind up. We never do until we get to the closing table.
Got you. Just to circle back on that industrial products, if I remember how long we've been talking about that, is it fair to assume we're about at the end of the negative comps in that, or when do we get some relief from that headwind?
Chris, this is Carlos. We'll get relief. That'll tail off in Q4. Our 2016 numbers will be comparatively clean when it comes to that. It tails off in Q4, and then we should be good. As Eric mentioned, that's tended to be between $7 million and $10 million a quarter in headwinds for us as a result of those customer orders not being necessary in the current year.
Got you. Eric, the better margins in the Flight Support Group, are those sustainable looking out into 2016, or were there some one-time benefits that we shouldn't expect to repeat?
I'm sorry, can you repeat your question?
The Flight Support Group margins, better than expected. Are those margins sustainable going into fiscal 2016, or were there one-time benefits that you derived in the current quarter?
We've always said that the operating margins in the Flight Support Group run around the 18% level, and they move around from sort of the low 17s or 17% up to 19% or sometimes a little bit higher. I wouldn't want to say that anything has changed. There was a greater focus on higher margin activities in the quarter. There was some lower sales of some lower margin. We do a little bit of parts trading, and there definitely was pressure, and we decided not to be active in that market where prices, I think, have been bid up by sort of financial buyers without a lot of experience in the sector. We decided to sit some of that out. Those tend to be lower margins. I think that weighed on our organic growth sales change, but also helped our operating margin.
I would say that if the surplus market continues to show the dynamics that we've seen over the last three and nine months, they would tend to the upper side. If that market becomes a little bit more reasonable where we think we've got some good entry points, it would drop back down a little bit.
Got you. All right. Thank you, gentlemen.
Thank you.
Thanks, Chris.
Your next question comes from the line of Michael Ciarmoli of KeyBanc Capital Markets.
Hey, good morning, guys. Thanks for taking my questions.
Good morning.
Eric or Carlos, back onto the FSG margins. Did you guys actually quantify? It looks like the 50 basis point increase for the year works out to about four and a half million. Was all that in the current quarter between the accrued comp and the euro-denominated earn out, or is that kind of split between this current quarter and next quarter?
A lot of that was in this quarter.
Okay.
As we mentioned before, some of that was FX related, and some of that was related to lower accrued performance-based comp.
Okay. Is that kind of the ballpark number, about four and a half million though?
That's very close. Yes.
Okay, perfect. Then just Victor, you mentioned commercial space moderating. Should we be concerned at all what we're seeing, Boeing citing the Export-Import Bank and potentially laying off workers and the domestic satellite market coming under pressure? Will that be an impact to you guys in that business line?
I think it's a little too early to tell. It doesn't help us, I don't think. Our sales in the business are spread in a few markets, right? We've got the U.S. businesses, but we also have our French business, 3D Plus, which offsets a certain degree when the U.S. satellite primes are softer. I think we'll have to see how it plays out, and give it a little bit of time.
Okay, fair enough. Just the last one on ETG again. Margins in the quarter I think the best they've been in quite some time, maybe since that fourth quarter of 2014. Should we expect this sort of 25-ish% level as we move into 2016? Is all the amortization headwind behind you guys? Should we be thinking about this as, again, a consistent mid-20% segment margin?
Yeah. Overall, whether it's the same as it was this quarter, remember, you have to keep in mind that we have somewhere around 403-400 basis points of amortization expense, which impacts us. When we look at these businesses, we're really looking at 25% is somewhere around, give or take 29%, what I consider to be the true margin of the business, what it derived from making and selling its products and services. That's a pretty good number to me, whether it becomes 28 or 27 or 30. I'll be honest with you, I don't get too worked up about it. To me, that's all pretty similar. I would hope and expect that somewhere in that range is where we'll continue to fall.
I think you'll see quarters where it's a little better, and I think you'll see quarters where it's a little bit off from there. This range is around the range that seems to make sense for us. Again, whether it's a point or two lower, a point or two higher, it's kind of hard to see.
Great. Thanks, guys. That's all I had.
Once again, if you'd like to ask a question, please press star one. Your next question comes from the line of James Hong of Gabelli & Company.
Hi, good morning, everyone.
Good morning.
I just want to see if you could just talk about the flow of new products coming in for the next 12 months. It seems like that kind of been a big contributor to your profit this quarter, and I was just wondering if, sequentially, you can see more of a new product introduction over the next 3 quarters.
James, Eric will answer that.
Hi, Jim. I anticipate the new product development over the next 3 quarters to be consistent with what we've done in the past. I don't think any tremendous changes there. We continue to develop the same kinds of parts we've done, as well as enter into other adjacent markets. I don't anticipate any significant change there.
Okay. They typically carry a higher margin, right? Because you get better pricing from the products than your existing components.
Not necessarily. Especially when a product is new, there may be some initial costs and first articles, and until we streamline the process. It's not necessarily higher margin.
Okay. Maybe just shifting gears a little bit on acquisitions, Larry. Could you just talk about your pipeline of acquisitions? You have been pretty active in the last quarter in August, making some of these acquisitions. How does it look for the rest of the year and going into 2016?
Well, I think the pipeline is good. One of the problems, as we've discussed before, is that we can have a strong pipeline and then we get in there and we do the due diligence, which we do very thoroughly, and we find problems
I can tell you we are looking I guess Chris Quilty asked me about one large acquisition. I can tell you we actually, when I say large, I mean larger than we normally do, but I can tell you that there's more than one, but you never know what you're going to find. For example, Eric and I are having dinner with people tonight on an acquisition, and God only knows what we're going to find out. It's just a question of due diligence, digging, and so forth. To predict we're going to do it is very difficult. I don't like to blow smoke, and I don't like to tell people, "Oh, we're going to do this." There is a good pipeline, but we never know when these things will close and what we're going to find when we look under the rocks.
That's the problem with the acquisitions. Unfortunately, many sellers, just to put it plain, misrepresent. They say that they're going to produce apples, and they produce oranges. When we get in there, and we start turning over the rocks, we don't like what we see. Even though we're optimistic because they give us a great picture, and they give us a book and show what a great company it is, and then we start to look, and we find out that it isn't. We are very active. To answer your question, we're very active, but to predict which one is going to stick, we really can't.
Right. I guess the involvement and activity has picked up more so than in the past, essentially.
Yes.
In terms of spending time in meeting with potential companies.
I think that's accurate. I think there are a lot of transactions. We have actually one and a half people working on. We used to have one person that's focused strictly on M&A, and recently we hired another individual, a younger person. The other person that used to do it kind of does it half-time now. He was tired, and he wanted to kind of retire half-time. We have one and a half people, and then in addition to that, we have Eric, myself, Victor, and others, Carlos. The pipeline is good. In theory, it's good. We're looking in Europe, we're looking in the U.S. To predict an acquisition is such a risky thing, and to give people false hope.
I do think the more that we have, the more likely we are to make more. Just the odds are that we will do more acquisitions. Some of the ones that we see are really terrific, and we have to nail them down. As to when and how, I don't know.
And Jim, this is Eric. If you look, we've done six acquisitions so far this year. I think what was unique in all of those cases is that HEICO was the preferred acquirer by far, by each of those sellers. Many of whom are partners with us, and we're very excited about where they can take their businesses and how we can continue to help them grow their businesses and induct them into the HEICO network. I think that there's a lot of very good opportunity. We are, as mentioned, working on a number of deals, and I think HEICO remains still the preferred acquirer in these transactions. We're relatively optimistic there.
You know, the acquisitions that Eric's referring to are companies where the seller wants to have a liquidity event, however, wants to remain active, is very knowledgeable about his industry. He winds up with a minority interest of roughly 20%, and it's a win-win for us. We're normally not an acquirer that wants to buy a company and then take that and shrink it down and get rid of personnel and fire people and so forth. That's normally not our model. In a few cases, we have purchased companies or product lines and put them in, but we prefer to keep the personnel, to keep the company, to keep the management, and to work cooperatively. It's just our style.
No, I think it's a great formula. It keeps the owner motivated in growing the business as part of the larger HEICO Corporation.
Exactly. We always have put calls, and we'll go over anywhere from 3 to 8 years or something. They can put the stock to us over a period of time, and we can call the stock for over a period of time. Interestingly enough, in some of these cases, in many of the cases, the people have cashed out completely, and they still continue to run the company, and they're compensated, incentivized, and so forth, and the relationship remains very strong.
As a matter of fact, probably our best sales tool is to give a potential acquiring company that we want to acquire a list of 10 or 15 names of people from whom we've acquired companies, and we say, "Just call them up and ask them." That's really the best sales tool because they do that, and they find out that HEICO does what it says it's going to do. If they promise you something, that's exactly what'll happen. That's our formula, and it works.
Okay, terrific. Thank you for the update, and look forward to seeing you at my conference on September 9th.
Right. Thanks, Jim.
The next question comes from the line of Steve Levenson of Stifel.
Thanks. Good morning, everybody.
Good morning.
Just wondering, there's a huge installed base of CFM56 engines of various types. Over the next few years, CFM will be winding down production of that engine and shifting over to the LEAP. Do you see HEICO's role changing on the CFM56? Do you see an additional investment required in parts development, or do you think it'll just go along as it is now?
Yeah, Steve, that's a good question. Unfortunately, we can't comment on specific engine platforms or customer relationships. We are watching all of the various developments out there and plan to remain active and do what our customers want us to do.
Okey-doke.
We anticipate the follow-on engine to be very successful, as well as the Pratt option as well.
Okay. Rather than ask on a specific engine, maybe we can look back on previous engines of any types. In general, has the role changed? Do you find yourself being asked to deliver additional parts or develop additional parts to supplant what the OEM had made?
I would rather not answer the question due to competitive dynamics. We're active across a wide array of engines as well as components to airframe parts, we're basically all over the aircraft. We're not going to want to necessarily develop a part at the end of its life because we're not going to be able to recover our investment. We are-
No, I just meant because the last engines will still be in service for 20 years.
Right. We're active, I would say, on anything that's flying, we want to be active on it.
Got it. Thanks very much.
Thank you.
At this time, there are no further questions. I'll now return the call to Laurans Mendelson for any additional or closing remarks.
I want to thank everybody on this call for their interest in HEICO. We remain available by phone or personal visit to answer questions which you may have. I'm sure we're going to get a bunch of calls. Carlos and Tom are going to get a bunch of calls this afternoon for further detail. We are open to your questions, and anything that we can do to help you, please let us know. Until then, we wish you a good balance of the summer, happy Labor Day, and we will speak to you with the fourth quarter conference call, which will be probably around the mid-December date. This is all that we have for the moment, and we will speak to you soon. Bye-bye.
Thank you for participating in HEICO Corporation's fiscal 2015 third quarter earnings results conference call. You may now disconnect your lines, have a wonderful day.
Thank you.