Ladies and gentlemen, thank you for standing by and welcome to the fiscal 2014 third quarter earnings results and first six months of fiscal 2014 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. To ask a question during this time, press star, then the number one on your telephone keypad. To withdraw your question, press the pound key. Your host today is Laurans A. Mendelson, Chairman and Chief Executive Officer of HEICO Corporation. 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 change, or airline purchasing decisions, which could cause lower demand for our goods and services. Product development or product specification cost 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 core customers or competition from existing and new competitors, which could reduce our sales. Our ability to introduce new products and product pricing levels, which could reduce our sales or sales growth. Product development difficulties, which could increase our product development costs and delay sales. Our ability to make acquisitions and achieve operating synergies from acquired businesses.
Customer credit risk, interest and income tax rates and economic conditions within and outside of the aviation, defense, base, medical, telecommunications, and electronic industries, which could negatively impact our cost and revenue. Defense budget cuts, which could reduce our defense-related revenue. Those listening to this call are encouraged to review all of HEICO's filings with the Securities and Exchange Commission, including, but not limited to, filings on Form 10-K, Form 10-Q, and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, further events or otherwise, except to the extent required by applicable law. Thank you. I will now turn the conference over to Mr. Mendelson. Please go ahead.
Thank you very much, and thank all of you on this call for joining us. We welcome you to the HEICO third quarter fiscal 2014 earnings announcement telecon. I'm Larry Mendelson. I'm Chairman and CEO of HEICO Corporation, and I am 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 Vice President and CFO. Before reviewing our third quarter operating results in detail, I would like to take a few minutes to summarize the highlights of another record-setting quarter. Our consolidated third quarter fiscal 2014 net sales and net income represent record quarterly results, driven principally by record sales within Electronic Technologies and continued year-over-year growth in net sales within our Flight Support Group.
Consolidated net sales, operating income, and net income in the first nine months of fiscal 2014 also represent record results, principally driven by record net sales and operating income within Flight Support Group and Electronic Technologies Group. I would like to point out that in spite of some people, investors believing that the bud is off the rose in terms of commercial aerospace, HEICO's annual sales to the commercial aerospace industry have increased by over $100 million in the last 12 months, and approximately 60% of that is from organic growth. Consolidated third quarter fiscal 2014 net income and operating income are up 15% and 4% respectively, on a 9% increase in net sales over third quarter of fiscal 2013.
Consolidated net income and operating income in the first nine months of fiscal 2014 are up 23% and 17% respectively, on a 16% increase in net sales over the first nine months of fiscal 2013. Consolidated net income per diluted share increased 14% to $0.49 per share in the third quarter of fiscal 2014, up from $0.43 in the third quarter of fiscal 2013. Our ETG Group set an all-time quarterly net sales record in the third quarter of fiscal 2014, improving 17% over the third quarter of fiscal 2013. That increase principally reflects organic growth of about 9% and additional net sales contributed by a fiscal 2013 acquisition. Cash flow provided by operating activities increased by 38% to $127.2 million in the first nine months of fiscal 2014, and that was up from $92.3 million in the first nine months of fiscal 2013.
As of July 31, 2014, the company's net debt to shareholders' equity ratio was 49%, with net debt, which we say is total debt less cash, of $365.4 million. In June 2014, a subsidiary of our Flight Support Group acquired certain assets and liabilities of Quest Aviation Supply, that is a niche supplier of parts, predominantly PMA parts, to repair thrust reversers on various aircraft engines. In July of 2014, we paid our 72nd consecutive semiannual cash dividend since 1979, and that dividend was at the rate of $0.06 per share. In July 2014, we were pleased to report that "Forbes" magazine had named HEICO as one of the world's 100 most innovative growth companies for 2014, making HEICO the only company listed in that category under aerospace and defense.
The recognition is a true testament to the expertise and innovative spirit of our more than 4,000 team members. I express my deepest appreciation for their remarkable efforts and their dedication. While this is the first time that HEICO has been included in the selection of the best-performing companies under $10 billion in market cap, it complements the seven years that HEICO has been included in either list of Forbes 200 Best Small Companies or Forbes 100 Best Small Companies. At this time, I would like to introduce Eric Mendelson, Co-President of HEICO and President of HEICO's Flight Support Group. He will discuss the results of that group.
Thank you. The Flight Support Group's net sales increased 6% to $191.6 million in the third quarter of fiscal 2014, up from $181.3 million in the third quarter of fiscal 2013. The increase in the third quarter of fiscal 2014 is attributed to additional net sales of $6.5 million from a fiscal 2013 acquisition, as well as organic growth of approximately 2%. The organic growth in the third quarter of fiscal 2014 principally reflects increased market penetration from new product offerings, further building upon our 17% organic growth posted in the third quarter of fiscal 2013. The organic growth in the third quarter of fiscal 2014 consists of strong net sales growth within our aftermarket replacement parts in repair and overhaul services product lines, partially offset by softer demand for certain defense-related products in our specialty products lines.
The Flight Support Group's net sales increased 19% to a record $568 million in the nine months of fiscal 2014, up from $475.6 million in the first nine months of fiscal 2013. The increase in the first nine months of fiscal 2014 resulted from organic growth of approximately 12%, as well as additional net sales of $37.7 million from a fiscal 2013 acquisition. The strong organic growth in the Flight Support Group principally reflects new product offerings in favorable market conditions in the commercial aerospace sector, resulting in net sales increases in our aftermarket replacement parts and repair and overhaul services product lines and our specialty product lines. Over the past 12 months, the Flight Support Group's organic growth has exceeded 10%, which we estimate to approximate one and a half to two times the market growth.
The Flight Support Group's operating income increased 5% to $34.2 million and 19% to a record $103.3 million in the third quarter and first nine months of fiscal 2014, respectively, up from $32.6 million and $87.2 million in the third quarter and first nine months of fiscal 2013, respectively. The increase in the third quarter and first nine months of fiscal 2014 principally reflects the aforementioned net sales growth. The Flight Support Group's operating margin was 17.9% and 18.2% in the third quarter and first nine months of fiscal 2014, respectively. It was comparable to the operating margins of 18% and 18.3% in the third quarter and first nine months of fiscal 2013. We 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. The Electronic Technologies Group's net sales increased 17% to a record $102.1 million and 12% to a record $279.3 million in the third quarter and first nine months of fiscal 2014, respectively.
Up from $87.4 million and $250.2 million in the third quarter and first nine months of fiscal 2013, respectively. The increase in both the third quarter and first nine months of fiscal 2014 reflects additional net sales of $6.8 million and $19 million, respectively, from a fiscal 2013 acquisition and organic growth of 9% and 4%, respectively. The Electronic Technologies Group's organic growth in both the third quarter and first nine months of fiscal 2014 reflects increased demand for their product offerings across substantially all of the markets that ETG serves. The Electronic Technologies Group's operating income was $21.5 million in both the third quarter of fiscal 2014 and 2013, increased 9% to $62.5 million in the first nine months of fiscal 2014, up from $57.3 million in the first nine months of fiscal 2013.
The increase in the first nine months of fiscal 2014 reflects the previously mentioned net sales growth, partially offset by a less favorable product mix. During the first nine months of fiscal 2014, we reduced the estimated contingent consideration and impaired certain intangible assets associated with the previously referenced fiscal 2013 acquisition. The impact of these adjustments, net of lower than expected operating income from the fiscal 2013 acquisition, resulted in a $0.05 and $0.10 benefit in the third quarter and first nine months of fiscal 2014. The reduction to contingent consideration effectively means that we no longer believe it is probable that a significant earn-out payment will be made to the previous owners of Lucix.
We believe the long-term outlook for Lucix, which is a strong and profitable business, remains attractive despite the short-term backlog hurdles and general lumpiness of demand seen from time to time in the commercial satellite industry. The ETG's operating margin was 21% and 22.4% in the third quarter and first nine months of fiscal 2014, respectively, as compared to 24.6% and 22.9% in the third quarter and first nine months of fiscal 2013, respectively. Operating margins remain strong, decreased in the third quarter of fiscal 2014 due to the previously mentioned less favorable product mix, including the overall impact of the fiscal 2013 acquired business. I turn the call back over to Larry Mendelson.
Thank you, Victor. Moving into some of the details. Diluted earnings per share. Consolidated net income per diluted share increased 14% to $0.49, and 21% to $1.32 in the third quarter and the first nine months of fiscal 2014, respectively. That was up from $0.43 and $1.09 in the third quarter and first nine months of fiscal 2013, respectively. The increase in the third quarter and the first nine months of fiscal 2014 principally reflects the previously mentioned consolidated sales growth, as well as the net benefits from the previously referenced ETG acquisition. Depreciation and amortization expense increased by $2.6 million and $10.4 million in the third quarter and first nine months of fiscal 2014, respectively, up from $9.5 million and $25.9 million in the third quarter and first nine months of 2013, respectively.
The increase in both periods principally reflects higher amortization expense of intangible assets recognized in connection with our fiscal 2013 acquisition. R&D expense increased 15% and 20% to $9.9 million and $28.3 million in the third quarter and first nine months of fiscal 2014, respectively, up from $8.5 million and $23.5 million in the third quarter and first nine months of fiscal 2013, respectively. Significant ongoing new product development efforts are continuing at both Flight Support and ETG, as we continue to invest between 3% and 4% of each sales dollar into new product development in order to support our future growth strategies. SG&A expenses increased 8% to $53.2 million and 7% to $145.7 million in the third quarter and first nine months of fiscal 2014, respectively, up from $49.1 million and $136.5 million in the third quarter and first nine months of fiscal 2013, respectively.
The aforementioned increases in the third quarter and first nine months of fiscal 2014 were principally due to additional costs incurred to support the higher net sales volumes. In addition, these increases were partially offset by the previously mentioned net impact of the adjustments to contingent consideration and impairment losses related to the write-down of certain intangible assets. SG&A expenses as a percentage of net sales were 18.3% and 17.3% in the third quarter and first nine months of fiscal 2014, as compared to 18.4% and 18.9% in the third quarter and first nine months of fiscal 2013. The decrease in the first nine months of fiscal 2014 principally reflects the previously mentioned net impact of adjustments to contingent consideration and impairment losses related to the write-down of those intangible assets.
Interest expense in the third quarter and first nine months of fiscal 2014 was $1.4 million and $4.2 million, and that was up from $1.1 million and $2.5 million in the third quarter and first nine months of fiscal 2013. The increases principally reflect a higher weighted average balance outstanding under our revolving credit facility, and this was associated with borrowings that we needed to fund recent acquisitions and payment of special cash dividends. Other income in the third quarter and nine months of fiscal 2014 was not significant. Our effective tax rate in the third quarter of fiscal 2014 decreased to 23.4%, down from 26.6% in the third quarter of fiscal 2013. The effective tax rate in the first nine months of fiscal 2014 increased slightly to 29.7% from 29.5% in the first nine months of fiscal 2013.
The decrease in the effective tax rate in the third quarter of 2014 is principally attributed to the impact of the previously mentioned reduction in accrued contingent consideration, and that is non-taxable. Our full-year combined tax rate and non-controlling interest rate, expressed as a percentage of pre-tax income, is now anticipated to be approximately 39%. Net income attributable to non-controlling interest was $4 million and $13.5 million in the third quarter and first nine months of fiscal 2014, and that was compared to $5.8 million and $16.2 million in the third quarter and first nine months of fiscal 2013. The decrease in net income attributable to non-controlling interest in the third quarter and first nine months of fiscal 2014 reflects the purchase of certain non-controlling interests during fiscal 2014, which resulted in lower allocations of net income to non-controlling interests. Now moving on to our balance sheet and cash flow.
Our financial position and cash flow remain extremely strong. Cash flow provided by operating activities increased by 38% to $127.2 million in the first nine months of fiscal 2014. That was up from $92.3 million in the first nine months of fiscal 2013. That reflected the impact of favorable changes in working capital, increase in earnings, and the impact of certain non-cash adjustments. We continue to expect cash flow provided by operating activities to approximate $160 million in fiscal 2014. As a comment, one of the analysts reported today that our actual cash earnings was 200% of reported operating income. We think that's a pretty good result. I can tell you that our banks and anybody who's looking at our balance sheet and our ability to generate quality earnings has been very impressed and happy with that.
The working capital ratio, that's current assets divided by current liabilities, was a strong 3.2 times as of July 31, 2014. That was up from 2.7 as of October 31, 2013. Days sales outstanding, DSOs, and receivables are down to 47 days on July 31. That's down from 50 days as of October 31, 2013. As you know, we continue to closely monitor all receivable collection efforts. We watch the granting of credit very carefully. No one customer accounted for more than 10% of net sales. Our top five customers represented about 16% of consolidated net sales. As you can see, not a concentration at all, in both the third quarter of fiscal 2014 and 2013. Inventory turnover rate improved to 108 days as of July 31, 2014. That's down three days from 111, which it was at October 31, 2013.
Net debt to shareholders' equity ratio was 49% as of July 31, 2014. As I said before, net debt of $365.4 million principally incurred to fund fiscal 2013 acquisitions and the purchase of certain non-controlling interest earlier this year. We have no significant debt maturities until fiscal 2019. We plan to utilize our financial flexibility to aggressively pursue high-quality acquisition opportunities. Now, the outlook. As we look ahead to the remainder of fiscal 2014, we continue to anticipate growth within Flight Support, commercial, aerospace, aftermarket replacement parts, and repair and overhaul services product lines partially offset by declines in some of our defense products within our specialty products lines. We anticipate softer demand in ETG's defense products during the fourth quarter, partially offset by a net increase in demand within the other markets served by ETG.
During the remainder of fiscal 2014, we plan to remain focused on new product development, further market penetration, executing acquisition strategies, and maintaining our financial strength. Based upon our current economic visibility, we are increasing our estimate of fiscal 2014 year-over-year growth in net income to 14%-16%, up from our prior growth estimate of 12%-14%. We estimate fiscal 2014 year-over-year growth in net sales at 12%-14%. Our full-year fiscal 2014 consolidated operating margin should approximate 18%, CapEx about $20 million, depreciation/amortization expense approximately $49 million, and cash flow from operations approximately $160 million. That is the extent of my prepared comments. At this time, I would like to open the floor for questions from our callers. Thank you.
At this time, I would like to remind everyone, if you would like to ask a question, please press *1 on your telephone keypad. Again, to ask a question, please press *1. Your first question comes from the line of J.B. Groh, D.A. Davidson.
Hear me okay?
I can hear you, yep.
Great. Hey, Larry.
J.B., yep.
Quick one for Eric. Eric, can you kind of remind us of what the military mix is in FSG? I think it sounds like what you said is that the commercial side was pretty strong still, I'm just trying to get a feel for what the drag was from the military markets.
Well, good morning, J.B. We don't break out by segment our quarterly results on product lines. However, the military is a minority of what we do. I can tell you that the shortfall in military sales was really as a result of certain, primarily foreign military contracts slipping to the right. We are in receipt of the purchase orders, we do have the business. As you know, sometimes with foreign military sales, there can be a little bit of a delay due to the bureaucracy and the number of people involved there. We do anticipate making those shipments, they just got delayed a little bit. We don't break out as a percentage of the overall-
Okay
Flight Support sales.
Can probably back into it. Then just had a sort of conceptual question, Eric. Given the fact that traffic's been really good and margins at airlines have been decent and profitability has been pretty strong for five years. I guess it would be normal when margins are pressured for the phone for PMA to ring pretty significantly. Do you notice when margins are higher and profitability is better at the airlines, that maybe they back off on using PMA? Give me your thoughts on that.
Yeah, I think normally, we always say that we gain market share in financial downturns. That's when airlines realize they've got to focus on cost. I think in general, what happens is, when markets turn down, we get more parts approved more quickly. Then as the markets recover, we benefit from that. I think that our issue this quarter was we had such strong organic growth last year in the third quarter of, I don't know, some 17%. I think, if you look at what we had, organic growth in our first and second quarters of this year, it was really off the charts at our first quarter organic growth was about 19% in Flight Support Group. Second quarter was 15%. Last year, third quarter was 17%, and fourth quarter was 14%. We've got such tough comps that we are up against.
Really, I think it's more just a matter of consolidating those sales. We come out with some new products. We get them sold. The customers need to burn off a little bit of inventory, then we're back selling some more stuff. I can tell you, I was very proud of being able to hold on to those big gains that we reported in, say, over the past year, in organic growth and being able to build on top of it. The airlines remain very focused on cost savings. We're doing very well in that area. I can also tell you, just as a little bit of color, last week I met with our aftermarket sales and operations teams for just about the entire week.
I can tell you that I've never been more impressed with those people and with the projects that we've got in process and their strategies. The fact that we have this team now that over the last 20 years has been integrated and is working incredibly well together and embracing this culture. I'm very optimistic going forward that they will continue to find opportunities, as are they.
That's helpful, Eric. Thanks. I'll hop back in the queue.
Thank you.
Your next question comes from the line of Tyler Hojo with Sidoti & Company.
Good morning, everyone. Just a follow-up to J.B.'s question on specialty products in the defense markets. Maybe you could talk about your expectations for that product line. Do you think that area has stabilized? I'm also kind of curious maybe as a follow-on is, if you were to back that out, what would the organic growth have looked like within the commercial aftermarket this quarter?
Hi, Tyler. This is Eric. As I think we put in the press release, the organic growth was strong and was higher in the commercial parts market as compared to the defense and industrial markets. We all know that the defense sales can be rather lumpy. This is a great business. We really like being in those businesses, and the returns are very good. We've got some incredible people and products. It does sometimes generate lumpiness, and the same in the industrial markets. We're still very optimistic. We're very committed to those markets. I don't think that's really a surprise to most people, given there's been some defense and industrial weakness in the economy lately. We're very optimistic that it is going to prove to be, and will continue to prove to be, a very strong business.
Again, we were stronger than over in the commercial markets as compared to the defense and industrial markets.
Interesting.
I'm sorry. Again, if we look at our numbers, we still think that our organic growth is somewhere, for the nine months, in the one and a half to two times the industry growth. We still feel confident of our ability to outgrow the industry.
Okay. Is it fair to say that you're kind of chalking up the weakness in specialty products more to lumpiness? I guess where I'm going with this is I know specialty products has been kind of a tailwind for you guys for at least the last couple of quarters. I guess maybe what my concern is that it's now on the downswing.
Well, no. I would not consider it to be on the downswing at all. Number one, it can be lumpy, and number two, when some contracts are pushed a little bit to the right, that impacts, obviously, when they're delivered. Again, we are in receipt of the POs, so it's not a matter of losing the business, if you will. The defense business can get pushed to the right, and industrial products, things are designed, they have some shorter lifespans. There's switchovers in products. As a result, those can be lumpy as well. I wouldn't say it's any significant change to the business. Yes, we had done very well in the past on that, and I anticipate we will continue to do well in the future on those programs as well.
Okay, great. Thanks for that color. Just lastly from me, was curious if you could maybe shed a little bit more light on the Quest acquisition. First, I'm wondering what the contribution from Quest is to the guidance. It just seems like a really good fit within your existing business. I'm also curious about kind of the acquisition pipeline within FSG.
Yeah. Again, Quest was not a large business. It was a product line. It was basically a bolt-on. It helps round out some of our products. Frankly, it was a make versus buy on some of that stuff. We could have just as easily developed it, but we had the opportunity to go ahead and buy it. We think that it fits very well. We're very optimistic on the product line and the capability. As far as acquisitions, I can tell you the pipeline is quite full. We're looking at a number of transactions at the moment. I can't go into what kind of businesses they are for competitive reasons, and our competitors, I'm sure, are listening on this call. We are looking at a number of companies out there.
This is Larry. I'd like to add a little bit of color to the acquisition questions, because I'm sure somebody on this call is going to ask it. We are, as Eric says, looking at a number of transactions. We are, as you know, as investors, very disciplined in the way we buy companies. We do not pay 14 times or 12 times EBITDA for companies. We believe that when interest rates rise a little bit and pricing becomes more reasonable, we'll be able to get more active. Saying that, we are still finding good companies at prices that we can afford and that can be accretive. We're spending a lot of time in the due diligence processes. We're not going to rush a closing of an acquisition in order to meet a Wall Street expectation or hope and try to financially engineer our results.
We're going to do due diligence in a very thorough manner, the way we always do it, and make sure that we're not buying a pig in the poke. We won't change that process and the strategy that we've used. The strategy has proven to be very good over the last 20 years. I think the acquisitions will come, but it's going to take a little bit longer to complete the due diligence.
Got it. That's a great color. That's all I had. Thanks a lot.
Thank you.
Your next question comes from the line of Ernie Yerksner with CJS Securities.
Hi, good morning.
Good morning, Ernie.
Could you discuss the actions you've took or have taken in Q3 to resolve the issues at Lucix, and do you anticipate these will continue to impact your Q4 results?
Yeah, Ernie, this is Victor. I'll answer the question. At this point, Lucix is profitable. It is a profitable business. It's a very good business. It's a strong business. I think that a lot of the issues we saw in the first half of the year were washing out in the third quarter, and we anticipate Lucix will be stronger as time wears on. That doesn't mean it won't be lumpy quarter by quarter. In fact, that's really what I would expect. These are a little longer cycle businesses. Companies like Lucix are a little longer cycle in nature than some of the other space work that we do in some of our other companies.
From what I see out there and the order flow that's been coming in, which has been pretty good of late, I would say that those extreme issues we saw in the first half of the year seem to be behind us at this point.
Great. My second question is just numerical. In your guidance for the upcoming year, if I took the low end of your revenue growth, you give us an operating margin assumption. There's an implied tax rate given in that 39% that you mentioned before. The problem I have with that math is it would lead to net income growth well above the targeted level you gave us. I don't know if you or Tom care to comment on it.
Ernie, this is Tom. Inherent in our guidance numbers, at the high-end range, I guess what you're looking at, as you're pointing out, roughly flattish with the fourth quarter last year. What we see in our near-term outlook is continued strength on the commercial aerospace side, and some continued uncertainty in the defense side, relative to the fourth quarter last year. That's going to have an impact on the reported margins because of the margin mix between FSG and ETG. Again, in our guidance numbers, we try to be highly confident in those numbers. We are always targeting to do better, and that will continue to be the effort.
Well, again, it's simple math. Again, if I put in around a 30% tax rate, even at the lower end, your net income growth would be between 19% and 20%, well above what you've given us in the way of guidance. I appreciate conservatism, but just the pure math doesn't work.
Might be something we follow up on offline.
Yeah, sure. I'm just saying, I'll have to check how the computations, but again, at the high end of the range, you're looking at roughly flattish with the fourth quarter net income last year. I'll have to check to see what your modeling numbers are.
Okay. Thank you very much.
Thanks, Ernie.
Your next question comes from the line of Julie Yates with Credit Suisse.
Just to continue on that, the margin guidance of 18% suggests margins will bounce back in the fourth quarter. What are the drivers there, and how should we think about the margin trajectory from the levels we saw in the third quarter in both segments?
Yeah. Julie, this is Tom Weber. Again, in terms of our guidance numbers, we use an approximate 18% number, and that's our best estimate. That would be a mix, again, of the Flight Support Group and the ETG group, with the ETG group margins running historically higher than FSG. At approximately 18%, I think in terms of the math numbers, it might be still comparable to what they've been running the nine-month numbers. Not a huge change. There might be some upside, but there might be a little bit of downside, too, again, depending on the uncertainty, primarily in some of the higher margin defense electronic work.
Okay. Are the specialty products margins higher margin than your commercial aftermarket products?
Within Flight Support Group, the specialty product margins are good, again, for competitive reasons. We don't want to try to get too granular, particularly with customers. Typically, the specialty products have been good margins, and as clarification, when we added to that specialty product group Reinhold last year, which began impacting the comps in this quarter, that's where the larger portion of defense component sales comes from. One of the earlier questions about the mix of specialty products, the defense component increased with the acquisition last May of Reinhold.
Okay. Just going back to the organic growth discussion. As organic growth is decelerating with the tough comps, can you help us calibrate expectations for FSG over the next several quarters? Should we kind of continue to expect a low single-digit organic growth rate?
Again, I think as Eric Mendelson mentioned, we typically target
Within our FSG group, and particularly the commercial aerospace, 1.5 to two times the industry growth. I guess it's therefore, that continues to be our target. If the industry's going to grow mid-single-digits, we don't know for sure. We don't have a crystal ball in terms of what the MRO spend and traffic, et cetera, et cetera, over the next 1 to 12 months are, but I think we're comfortable that we'll outperform the market.
Julie, this is Larry. Historically, when we go back over a period of time, we don't take it quarter by quarter, the FSG Group has organic growth somewhere in the area of 10%-14%. I just use a round number of 12%. As Eric pointed out, we've had 17%. I've said this to investors, 17% organic growth is not sustainable. Similarly, if we have 5%, that is probably too low. I think somewhere between 10% and 12% is a reasonable target for the organic growth. It's going to fluctuate, because when you're coming off of a low period, all of a sudden, we've had some times where it's 20-some% growth, and totally unsustainable. That's only comparing one period to another.
In my opinion, if you look at the FSG Group and HEICO as a long-term investment, I think the numbers I just gave you are a reasonable organic growth target.
Julie, this is Eric. Just to add, I went back and looked at some of the historical numbers. In fiscal 2011, our organic growth in Flight Support was about 22%. In fiscal 2012, it was 4%. Fiscal 2013 was above 9%. You can see that it fluctuates up and down. Typically, when you've got a very high organic growth rate, you can't continue to build upon that. Likewise, when it's lower, you've got the opportunity, obviously, on the upside. I can tell you, though, that as I mentioned in one of my other comments, that in meeting for four days last week with our parts and repair sales and operating teams, we have a tremendous number of products that are in the market in development right now, where we're working with customers. We're very optimistic on the future of those products.
When we've got a great team, I think they're able to execute. They understand the market very well. They understand the HEICO culture very well. I've never seen a group like this at HEICO before. We have, in my opinion, the best group that we have ever had, by far, in the history of the company, in this market sector. I can tell you, we're right now working on our budgets for fiscal 2015. Our fiscal 2015 year starts November one. I don't have those budgets. I don't have the numbers in front of me. I can tell you that based on the caliber of these people and the culture that we've got and how they work together, I'm very optimistic that they're going to do quite well and beat whatever is going on in the market.
Julie, one more comment from me. Historically, I have seen when the organic growth is low, it picks up, and when it's very high, it drops. It's a cyclical business, and I have often said, again, to investors at meetings, that there's a conflict between the aerospace cycle and the financial cycle, and the financial cycle is 12 months or three months, if you go by quarter. The MRO cycle is somewhere between, say, 30 and 36 months. So within one MRO cycle of 36 months, you're going to have three financial cycles of 12 months. I think the way I look at it is that we're going to have peaks and valleys, and we're comparing it to a financial cycle, to a natural business cycle. Investing under those circumstances takes an adjustment to convert the financial to the actual business cycle.
That's the result of my observation of running this company for the last 20-some years.
Thank you very much.
Thanks, Julie.
Your next question comes from the line of Kenneth Herbert with Canaccord Genuity.
Good morning.
Good morning.
Hi. First, Victor, I wanted to ask you a question. A couple years ago, you had a similar situation, not exactly the same as you're facing with Lucix, but you had 3D Plus and now you've got the Lucix, and it sounds like it's a timing issue. Have your experience with some of these deals on the space market, in particular, maybe changed what you're looking for from an acquisition standpoint, or maybe the attractiveness of some of these markets, or is it really timing and more of a short-term issue?
It's a good question. As a rule of thumb, no. I think, of course, as we gain more experience in space and understand the markets a little better, we fine-tune the strategy as we go. For example, in the case of 3D Plus
That was a rough first six months, that acquisition has turned into a home run. It is just a great business, I think we may even be able to drive more business to 3D Plus from some of our other space businesses, in fact, vice versa. I could see 3D Plus benefiting Lucix as we get out probably a year from now or so. It's still a great market, it is somewhat of a lumpy market. If I had the choice to do it all over again, to make these acquisitions, I'd make each one of them. They really are great businesses that can't be replicated. They are in very important niches.
One does have to look over kind of a longer period of time and sort of a longer cycle, which is a little more similar to the ETG as you used to know it a few years ago. I think we became a little more linear in our progression each year in terms of performance, as opposed to as variable as it had been in the past. I kind of look over the year, I think in some of the space businesses, maybe over a two-year period, to see how these perform.
Okay. No, that's helpful. The organic growth within ETG, I think, was a nice surprise in this quarter. Is that something as we think about it, I know your comps were obviously the inverse of what FSG was facing, as you go through the fourth quarter and into 2015, what do you think is a good sort of normalized organic growth rate in the near term for the ETG segment?
I would rather tell you to look at what I've always said historically out of ETG, that's organic growth in the mid to low single digits organically from ETG, and we're working to do higher. I know over the last few years we have done higher than that. I'd rather not go out there and tell you to look for the higher numbers and for us to be unable to deliver. I'm a little more comfortable sticking with that right now.
Okay. No, that's reasonable. Then, Larry, you had great, obviously, as you mentioned and you called out, great cash flow generation in the quarter. Looks like you paid down some of the debt, at least for some of the near term. As you think about cash flow for the rest of this year, any change in your priorities? I know in the last few years you've considered a special dividend. Anything you can comment as you continue to generate such strong cash in considering the acquisition pipeline and how we should think about it?
At this time, I really don't know. The question of dividends, we always bring up at the board meetings. Excuse me. That's a board decision. Of course, management will make recommendations. I did indicate earlier that we do have a few acquisition opportunities that we're in due diligence right now. That's going to use a little bit of that money. I think we'll just have to play it by ear and see what we do. The greatest concern that I have is cash flow, cash earnings, and the quality of earnings as opposed to earnings per share. As you know, we can show great earnings per share, but no cash. HEICO is a company that we historically have generated 140%-180% of our net income has been cash. In this quarter, it was 200 or something.
We don't know what we're going to do with that cash, but if we have excess cash, we will seriously consider additional dividends and acquisitions. The two uses of the cash will be acquisition and additional dividend. No change in the overall strategy.
Okay. That's helpful. Finally, Eric, I don't want to belabor this too much, any color you can provide, I know within FSG segment, specifically on the PMA side, whether it be engine versus non-engine, is the ramp of the non-engine business that you've talked about, whether it be interiors or maybe some of the more recent components and other systems you're looking at, is that ramp going according to plan, are you seeing maybe any push to the right of the adoption of some of the newer product line?
Ken, we're seeing, I would say, results consistent with our plans and consistent with what we have expected and what we've experienced in the past. We haven't seen a push to the right. We think that there's very good opportunity in the products that we've got coming out. We've been saying now for many years that our non-engine business is the majority, is over 50% of our total PMA business. It continues to be very strong. We have a tremendous focus in that area. 15 years ago, we weren't even in that space. Today, we're the largest player in that space, we're very optimistic on the future for it.
All right. I'll stop there. Thank you very much.
Thank you.
Thank you.
Your next question comes from the line of Herbert Wertheim with Horton Power Inc.
Good morning, Larry, and very young children who I remember when they were just walking around as teenagers. Thank you for all you've done at HEICO. As you know, I'm your single largest individual shareholder for the last 20 plus years. I thank the family for doing such a wonderful job and allowing us to be able to share the experience with you. I have a question that has to do with long-term objectives or whether you have had some bites at the apple. Have there been any inquiries about the purchase of HEICO to be bolted onto any of the other companies that might be interested in what you do each and every day?
Herb, first of all, this is Larry. I thank you, one, for your comments. Two, for your strong support over many years. That support, as you have mentioned many times, has been well rewarded and you have done extremely well as a long-term investor. Your mentality is a perfect HEICO investor because you happen to be a brilliant guy and a brilliant investor, not only in HEICO but many other securities where you have the vision for the long term. To answer your question specifically, we really don't comment on questions about has HEICO been approached or selling the company and so forth and so on. We really don't comment on that type of thing.
If there is a serious approach, HEICO management would recommend to the board, if there's a price at which somebody wants to purchase HEICO, and it's beneficial for all shareholders, we would certainly consider it. To make a comment about being approached, we really don't make those comments, unless something is truly on the table. I can't comment on that.
You would not be opposed at the right number to be able to-
Absolutely not. Remember that the benefit that the Mendelson family gets from this, and the same benefit that you get is in the ownership of equity shares. We're not in this for salary and benefits and so forth, but to build a strong company, which, as we all know, we've been able to do over the past 20 some years. If somebody comes with a generous offer, we are very happy to consider that offer. We would talk to them, no, we're not an entrenched management at all.
Well, thank you. Again, I want to thank you for allowing me to be one of your investors over the last 20-something years, where you take a few million dollars and turn it into hundreds of millions of dollars. Thank you very much from our family.
Again, Herb, the thanks goes back to you because, it's unique having a wonderful investor, a brilliant guy, and a good friend, in Herbert Wertheim. We appreciate your comments and your loyalty, and we'll stay in touch. Thanks so much.
Thank you very much.
Your next question comes from the line of Michael Ciarmoli with KeyBanc Capital Markets.
Hey, good morning, guys. Thanks for taking my questions.
Good morning.
Just a couple of housekeeping items. In terms of the earnings guidance or net income guidance for the remainder of the year, is there any additional earn-out reversal baked into that guidance or any other items, whether it's a buyback of more than non-controlling? Anything else out there that would sort of dilute the quality of earnings for the remainder of the year?
The answer is no.
Okay. Victor, on Lucix, you said the business is profitable. I'm assuming the margins are still a drag to ETG. It sounds like the incoming orders are picking up. Sounds like the backlog's growing. When do you expect that those margins would maybe get up to sort of in line or even possibly accretive to the ETG group?
It's difficult to say for sure. I could see that happening within the next year. I can't guarantee that, but I could see that happening within the next year. Also, by the way, keep in mind that amortization of intangibles, acquisition intangibles, is a drag on our margins. Of course, that accounts for some of the reason for the gap between net income and cash flow, and why you've got cash flow running so much greater than net income generally with us. That's a drag, and we make acquisitions, certainly the newer ones, it takes a number of years for that intangible amortization to run off, versus companies we've had for a longer period of time. As we make more acquisitions, one would generally expect the intangibles rate to take an increasing chunk, not huge, but increasing each year of the income.
When we evaluate the businesses internally, by the way, the way I look at it, I look at the businesses before amortization of intangibles. What are the true operating characteristics of the business? What is the cash that's coming out of each business, and what's the outlook for each business?
Got it. Then just I think last quarter on Lucix, you were saying, some of the satellite programs, you had customers coming in making changes to designs. You had rework. Is that all in the rear view mirror? I think you said some would slide into 4Q, I guess, restarting in 3Q and then in 4Q. Are those issues all in the rear view mirror now?
Yeah, you're referring to the rework issues and the change issues on existing programs. As far as I know, those are all in the rear view mirror, and have been now for some months.
Okay.
Yeah.
Perfect. Then just the last one. Eric, can you give us a sense FSG, on a sequential basis from the second quarter to third quarter, the revenues were down. It sounds like most of the peer companies are seeing aftermarket expansion. I know you've got the tough comps on a year-over-year basis, but can you give us any color, what you're seeing sequentially or month-by-month in terms of airline purchasing patterns, incoming orders or behavior there?
Yes, I'd be happy to. If you take a look at our sales, as you know, we had a tremendous jump in the third and the fourth quarters of fiscal 2013, and that strong sales continued into the first and second quarters of fiscal 2014. If you look, yes, our third quarter revenue in Flight Support Group is down about $3 million compared to the second quarter, but again, up very substantially from where we were in the early part of fiscal 2013. As my dad mentioned, our sales in Flight Support are up over $100 million over the last 12-month period. I think that we've got tremendous growth, but we've just got some very tough comps that we've got in there. As we mentioned before, we had some military contracts slip to the right.
Again, we're in receipt of the PO, so it's not a matter of losing the business. It's more just sometimes those contracts get a little lumpy, and that's why we caution and we don't give quarter-by-quarter guidance because we really don't know. Unlike some other companies, we don't game the system. When the sales come, that's when we ship them, when the customer wants the product, and our people are always focused on doing the right thing. As a result, sometimes we just have a blowout quarter, and I wish that it would be more linear, but it's just not, and that's really how it falls out. I wouldn't say that there's any material change in the outlook of the business or the products or anything.
As a matter of fact, I'm, again, much more optimistic in the quality of our people, the quality of the products, and as they put together the budget for 2015, I think they're going to do great things.
This is Larry. I'd like to just go back to the Lucix questions, point something out, that this whole accounting for Lucix contingent earn-out and reversal and everything is complicated accounting. However, I want to point out two things which are beneficial to us. Number one, the earn-out is cash. That means that we will not be paying, or we estimate we will not be paying approximately $50 million over a two-year period in an earn-out. That's number one. Number two, the reversal of the liability for the earn-out also reduces amortization of intangibles that would hit the P&L going forward.
At this moment, I can't predict what the net effect will be, but if Victor is correct, I do believe he is correct, that Lucix begins to pick up and do better in the future, the earnings should come through stronger than they would have come through because there is less amortization that will go against those earnings. It's a complicated calculation, but I am expecting that should be the result.
Okay. That's helpful. Thanks a lot, guys.
Thank you.
Your next question comes from the line of Greg Konrad with Jefferies.
Hi, it's actually Sheila. Sorry for the mix-up. I just actually had a follow-up on ETG margins medium term. Should we see that go back to the 22%-24% level as defense mix and Lucix rework works its way through, or is the medium-term margin for ETG closer to 20%-22%?
Sheila, I would say I'm looking in the midpoint of that entire range that you laid out there.
Okay
midpoint of the lower 20s.
Okay. The mix impact, should the anniversary itself through as we head into fiscal 2015?
The mix impact.
In terms of.
anniversary itself through
I feel like for the last few quarters, we've had mix impact hit profitability, and that's why we've seen the contraction year-over-year, in addition to what's been going on at Lucix.
Yeah.
That sort of works out, I guess.
Yeah, Sheila, it's difficult for me to really anticipate the mix, particularly as we get further out, at this point. Of course, we haven't completed the budgets for 2015 yet. I'm not certain as to that answer. I would expect over time, we probably get back more toward our historical mix. I can't be certain.
Okay.
I don't want to give you a definitive answer on that until I'm certain.
Yes. I guess, Victor, just one more follow-up. In terms of the organic growth you saw in the quarter sequentially, what markets improved the most?
It was pretty much across the board. I wouldn't highlight any one of them, I think, as a particularly strong versus another.
Okay. Eric, if you don't mind, just one last question for you. In terms of Seal Dynamics, I know the business has been progressing really well, but some of the competitors have seen some industry dynamics change. Could you comment on that at all and maybe who your big customers are and the success of that business?
Sheila, we have to be careful, obviously, for competitive reasons, we said about speaking about any business or particular product line. I can tell you Seal Dynamics is in the distribution business and is extremely successful, and has an incredible management team, a great list of principals, a great business strategy, which I believe is not able to be replicated by anybody else in the industry. This is a business that grew from a very small business by putting in the correct disciplines, and over the last 25 years has just done exceptionally well. I can tell you we're very optimistic on where the business is going. We think that there's a lot of fit with what HEICO does and the credibility that HEICO brings to the marketplace. I'm not familiar with any specific industry dynamics that would negatively impact us.
I think everything is very much going in our favor.
Okay. Thank you very much.
Thank you, Sheila.
Your next question comes from the line of Jim Song with Gabelli.
Hi, everyone. Got all my questions answered here, but I just have one question regarding just the growth rate for FSG. You say it was 1.5% to 2%, the industry growth over the longer-term period. What are the drivers that caused that to go higher than that or below that trend line?
Jim, that's a great question. When we look at our growth, it's primarily driven by the sales, the development of new products, which are sold to existing as well as new customers, as well as additional sales of existing product to existing customers who are not buying those particular parts. When we look at the number of aircraft that are being delivered, roughly half of them are for new growth, half of them are for replacement. On the other hand, we've got roughly 95% of the fleet is aging by one year every year, and the parts become even more expensive. I think that to answer your question, it's the aging of the existing fleet that gives us the opportunity, and that's why we're optimistic on the future of where we're headed.
Our sales growth, unlike other aftermarket firms, is not impacted by the delivery of new material or new stocking for new deliveries, for example, 787. Our sales are the support of existing products. If you look at the aftermarket of mature products, that's where we think that we're going to be able to grow 1.5 to two times the industry average. If you look historically, we've done that or better.
Great. Just lastly, how big is your specialty product line now in the FSG segment?
Yeah, we don't break out, again, due to competitive reasons, we don't break out the sales of the various business units within the reporting segments. We're not permitted to do that.
Right.
Also, we don't want to let our competitors know. Again, these businesses basically have grown out of what we're doing in the aftermarket side. There's some relationship there, and we're very optimistic on the future of these businesses.
Okay, great. That's all I have. See you in a couple of weeks.
Thank you. See you in a few weeks.
Thanks, Jim.
Your next question comes from the line of Steven Levinson with Stifel.
Hey, everybody.
Good morning.
Hi, Steve.
Just a question. With the increased role of leasing companies, I know that's not going to have an immediate effect, but do you see it as more of an opportunity in the future, or do you see potential restrictions that they would have on parts and repair services as a headwind? Thanks.
We see it as an opportunity. We've had to deal with this issue for over 10 years, and we see it as a big opportunity. There are some very progressive lessors out there that want to give their customers a competitive advantage to be able to use alternative material, and we see that as a very positive trend. Again, I think HEICO is unique in the space because people have faith in HEICO's product line due to our quality reputation that frankly nobody else has in the industry. We've seen very good success in that area. We're making sure that we educate the airlines around the world about the alternatives and the opportunity that they've got in leasing. I see it as a great opportunity for us.
Thanks very much.
Thank you.
Thank you.
Your next question comes from the line of Michael Derchin with CRT Capital Group.
Thanks for taking my question. Just two quick ones. One, we're seeing in the airline industry an increasing move to part out older aircraft, and Boeing is even talking about potentially going into that business. Is that something that competes with PMA parts more effectively than a new part, or are they dealing in areas that are not competitive with you?
Yeah. It's in areas that are primarily not competitive with us. Most of our PMA businesses are expendables, which are not typically recovered in a part-out. We also do some parting out and some asset management services, and we do that very successfully. We're very up-to-date on the market and the market trends that are out there. We don't believe that there's a significant impact on our parts business. As far as Boeing getting into the space, I don't know whether they will or they won't, but I don't think it's going to have really an impact on our business.
Just one more quick one. I saw that one of your competitors, Wencor, was sold to Warburg Pincus from Odyssey recently. I was just wondering whether or not you looked at that, and if you did, whether you rejected it because it was too expensive or there was a size issue in terms of you're really more focused on bolt-on acquisitions as opposed to something that was larger.
Right. That's a good question, and we've received that question from many investors. We're not permitted to comment on any specific acquisition, as you can imagine, due to possible confidentiality agreements. I can't say whether we did look at it or we didn't look at it. What I can tell you is various investors have mentioned to us that it went at a very high price, about 15 times earnings. If you look at their product line and their capability and their reputation in the marketplace, 15 times earnings was certainly a price that was very aggressive. Personally speaking, if Wencor is worth 15 times earnings, my guess is HEICO's probably worth 25 times earnings.
What we tend to do, is we tend to look for businesses where there's going to be a very good cultural fit with the company, where they want to join HEICO, they want to sell at a reasonable price. We all know that you can't get blood from a stone. If something is sold at a very high price, that means invariably there's probably gonna have to be adverse effects on employees, customers, suppliers. Typically, the people who sell businesses and work with HEICO are interested in continuing the growth of those companies and are very loyal to the people who remain behind and the customers. It's really a necessity for us to find those people who want to be part of the HEICO family. As we mentioned before, we've got a number of transactions that we're looking at that are very good cultural fits with HEICO.
I'm very optimistic that we can buy businesses below 15x earnings.
Thank you very much.
Thank you.
Thanks, Michael.
At this time, there are no questions in queue.
Okay. Well, I would like to thank everybody who's participated in this call, comments and listeners alike. We look forward to hearing from you and speaking with you on the fourth quarter earnings call, which should be sometime in December. In the meantime, if you do have any questions or comments, as you know, the management team here at HEICO is available by phone or email, and please stay in touch with us. Again, thank you, and have a good Labor Day weekend.
This concludes today's conference call. You may now disconnect.