To the HEICO Corporation Fiscal 20 12 Second Quarter Earnings Conference Call. Certain statements in this conference 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, which could cause lower demand for our goods and services product specification costs and requirements, which could cause an increase to our cost to complete contracts governmental and regulatory demand export policies and restrictions reductions in defense, base or homeland security spending by U. S. And or foreign customers or competition from existing and new competitors, which could reduce our sales HEICO's ability to introduce new products and product pricing levels, which could reduce our sales or sales growth HEICO's 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, space, medical, telecommunication and electronic industries, which could negatively impact our costs and revenues.
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, the filings on Forms 10 ks, 10 Q and 8 ks. We undertake no obligation to publicly update or revise any forward looking statement whether as a result of new information, future events or otherwise. The moderator for today's call is Lorenz A. Mendelson, Chairman and Chief Executive Officer of HEICO Corporation. Please go ahead, sir.
Thank you and good morning to everyone on the call. We thank you for joining us and we welcome you to this HEICO 2nd quarter fiscal 2012 earnings announcement teleconference. I'm Larry Mendelson. I'm the CEO of HEICO Corporation and I'm joined here this morning by Eric Mendelson, who is HEICO's Co President and President of HEICO's Flight Support Group Victor Mendelson, HEICO's Co President and President of HEICO's Electronic Technologies Group and Tom Irwin, HEICO's Executive Vice President and CFO. Before reviewing
our second quarter operating
results in detail, I would like to take a few moments to just summarize the highlights of another record setting quarter. Our consolidated 2nd quarter net sales represent record quarterly results for HEICO, driven principally by all time record net sales within our Electronic Technologies Group and continued strong net sales within our Flight Support Group. Additionally, our 2nd quarter results marked the 9th consecutive quarter of sequential net sales growth. Our consolidated year to date net sales and operating income represent all time record results for HEICO and this has been driven principally by all time record net sales and operating income within both of our segments, the Flight Support Group and our Electronic Technologies Group. Consolidated 2nd quarter net income and operating income are up 13% 14% respectively on a 17% increase in net sales over the Q2 of 2011.
Consolidated net income and operating income for the 1st 6 months of 2012 are up 13% 15% respectively on a 20% increase in net sales over the 1st 6 months of 2011. Electronic Technologies set a quarterly net sales record in the Q2 of 2012, improving 48% over the Q2 of 2011. The increase in net sales reflects organic growth approximating 5% and additional net sales contributed by 4 acquisitions since the Q2 of fiscal 2011. Flight Support set a quarterly operating income record in the Q2 of 2012 by improving 14% over the Q2 of 2011. The increase in operating income is principally the result of both higher sales volumes as well as improved operating margins.
Consolidated net income per diluted share increased 13% to $0.36 a share for the Q2 of 'twelve, up from $0.32 for the Q2 of 2011 and this is based upon the strong performance again of both operating segments.
In March 2012,
we acquired the business and substantially all of the assets of Ramona Research, which designs and manufactures RF and microwave amplifiers, transmitters and receivers primarily used to support military communications on unmanned aerial systems, other aircraft, helicopters and ground based data communication systems. Incidentally, those ground based are used obviously to connect up to the communications that are flying principally the unmanned vehicles up in the air. We believe the acquisition of Ramona continues our practice of adding top quality niche businesses that solve customer problems with very unique designs and technology. In April 20 12, we acquired certain aerospace assets of Moritz Aerospace in an aerospace production line acquisition. The Moritz Aerospace product line designs and manufacturers next generation wireless cabin control systems, solid state power distribution and management systems and fuel level sensing systems for business jets and for general aviation as well as for the military defense market segments.
We believe that the acquisition of Morris continues HEICO's expansion into adjacent markets and products and is another example of HEICO providing complete product and service solutions throughout the aircraft life cycle. We do expect both of these acquisitions to be accretive to our earnings per share within the first anniversary of the acquisition. In March 2012, we declared a 5 for-four stock split reflecting the Board of Directors continued confidence in the growth of the business. The additional shares were distributed in April 2012. All applicable share and per share information has been retroactively adjusted to reflect this split.
This marks HEICO's 13th stock dividend or stock split since 1995. Our Board of Directors also reported in March that absent changes in the company's business outlook, the Board intends to continue the company's regular semiannual cash dividend at $0.06 per share and this would represent a 25% increase over the prior semiannual per share amount of $0.048 and this is adjusted for the 5 foot-four stock split. Cash flow was very strong in the Q2 of 2012 with cash flow provided by operating activities totaling 47,600,000 dollars This was up from 27.5 in the Q2 of 2011. And in the 1st 6 months of 12, cash flow provided by operating activities was $45,300,000 compared to 51.1 in the 1st 6 months of 2011. Now we do expect fiscal 2012 cash flow provided by operating activities to remain strong in the second half of twenty twelve and approximate $85,000,000 to $90,000,000 in the second half.
And that would total $130,000,000 to $135,000,000 for the full fiscal year. As a result of our strong cash flow, our net debt to shareholders' equity ratio was a very low 22.7 percent as of April 30 with net debt and that is total debt less cash and cash equivalents. So net debt of $152,500,000 reflecting borrowings under our revolving credit facility for the 3 acquisitions completed during the 1st 6 months of fiscal 2012. We have no significant debt maturities until fiscal 2017 and significant borrowing capacity is under our $670,000,000 revolving line of credit and this can be used for basically any purpose. We use it for additional acquisition opportunities.
We have plenty of firepower. We remain very active on the acquisition front. We are looking at a number of opportunities at this moment and those opportunities fall in both electronic technologies and flight support. Drilling down into the detail, our consolidated net sales for the Q2 of 'twelve increased 17% to a record $216,300,000 and that's up from $184,500,000 in the Q2 of 2011. In the 1st 6 months of 2012, consolidated net sales increased 20% to a record 429,000,000 and that was up from 358.7 in the 1st 6 months of 2011.
Flight Support's net sales increased 5 percent to $141,000,000 that was up from $133,800,000 in the Q2 of 2011 and that represents organic growth. The organic growth in Flight Support in the 2nd quarter reflects increased market penetration from both new and existing product offerings within certain of our industrial product lines and within certain of our aerospace aftermarket parts product lines. Flight Support net sales increased 10% to a record $279,900,000 in the first 6 months of 2012 that was up from 254.4 in the 1st 6 months of 2011, again principally reflecting organic growth approximating 7% as well as additional net sales contributed by a full 6 months of operating results from an acquisition which we made in the Q1 of 2011. The organic growth in Flight Support in the 1st 6 months of 2012 principally reflects increased market penetration from both new and existing product offerings within certain of our industrial product lines and within certain of our aerospace aftermarket replacement parts product lines as well as our repair and overhaul service. Electronic Technology 2nd quarter net sales increased 48% to a record 76,300,000 and that was up from $51,400,000 in the Q2 of 2011.
Net sales of ETG increased to a record 150 point $7,000,000 in the 1st 6 months of 2012, up 43% from 105.3 in the 1st 6 months of 2011. The increase in net sales in the 2nd quarter and the 1st 6 months of 2012 is principally attributed to additional net sales of approximately $22,000,000 $39,000,000 respectively contributed from the acquisitions of 3d Plus which we did September 2011 Switchcraft November 2011 Ramona Research March 2012 and Moritz Aerospace April 2012. Additionally, the increase in net sales for the Q2 and the 1st 6 months of 2012 reflects organic growth approximating 5% 6% respectively. The organic growth in the ETG group for both the Q2 and the 1st 6 months of 2012 principally reflects continued strength in demand for certain of our defense products. Our net sales by market in the 1st 6 months of 2012 were composed approximately 55% commercial aviation versus 62% in the 1st 6 months of 2011, 19% from defense in both 2012 20115% in space compared to 3% in the same period of 2011 and 21% from other markets including medical telecommunications and electronics versus 16% in 2011.
Our consolidated operating income in the Q2 of 'twelve increased 14 percent to $37,600,000 that was up from $32,900,000 in the Q2 of 'eleven and increased 15% to a record $75,200,000 in the 1st 6 months of 2012 that was up from $65,300,000 in the 1st 6 months of 2011. Flight Support's operating income increased 14% to a record $26,600,000 up from $23,400,000 in the Q2 of 2011 and increased 19% to a record $52,100,000 for the 1st 6 months of 2012, up from $43,800,000 in the 1st 6 months of 2011. The increase in operating income in the 2nd quarter and 1st 6 months of 2012 principally reflect both higher sales volume as well as improved operating margins. ETG operating income increased 12% to $15,300,000 in the Q2 of 20 12, up from $13,600,000 in the Q2 of 2011 and increased 8% to 31.5 percent for the 1st 6 months of 2012, up from 29.2 percent in the 1st 6 months of 2011. The increase in operating income is principally attributed to operating income contributed by the acquired businesses.
Although corporate expenses increased slightly to $4,400,000 and $8,400,000 in the 2nd quarter and 1st 6 months of 2012 respectively, as compared to $4,100,000 $7,700,000 in the 2nd quarter and 1st 6 months of 2011, they declined as a percentage of net sales to 2% for both the 2nd quarter and the 1st 6 months of 2012 down from 2.2% for both the 2nd quarter and first 6 months of 2011. The decrease in both periods is due to us being able to control corporate spending relative to our net sales growth. As a percentage, that corporate expense was down 10%. Operating margins consolidated were 17.4% 17.5% in the 2nd quarter and 1st 6 months of 2012 as compared to 17.8% 18.2% in the 2nd quarter and 1st 6 months of 2011. Flight Support's operating margins improved to 18.9% in the Q2 of 2012, up from 17.5% in the Q2 of 2011 and improved to 18.6 percent in the 1st 6 months of 2012 and that was up from 17.2 percent in the 1st 6 months of 2011.
Those improved operating margins in the Q2 and the 1st 6 months of 2012 principally reflect higher margins within our specialty products lines resulting from what I mentioned earlier sales growth and a reduction in selling SG and A as a percentage of net sales. ETG operating margins were 20.1% in the Q2 of 2020 compared to 26.6% in the Q2 of 'eleven and 20.9% in the 1st 6 months of 'twelve compared to 27.7% in the 1st 6 months of 2011. As anticipated, operating margins decreased for the Q2 and 1st 6 months of 2012 principally as a result of the dilutive impact of approximately 5% in both periods from lower operating margins realized by 3 d Plus and Switchcraft, which includes the impact of non cash acquisition related amortization of intangible assets as well as inventory purchase accounting adjustments. Just a comment, if you have questions on the detail of those accounting adjustments, Tom Irwin will be happy to explain if somebody wants to ask that question. Additionally, the decrease in operating margins is attributed to a more favorable product mix in the 2nd quarter and 1st 6 months of fiscal 2011.
As we discussed last quarter, the lower operating margin realized by 3 d plus is principally attributed to softer demand for certain products resulting from continued economic uncertainty throughout Europe as well as amortization of intangible assets and again inventory purchase accounting adjustments which aggregated approximately $1,000,000 per quarter. The lower operating margin realized by Switchcraft is principally attributed to amortization of intangibles and inventory purchase accounting adjustments aggregating 2,000,000 emphasize that we do expect these margins to improve during the second half of the year as a result of stronger revenue at 3d plus and the end of the acquisition related inventory purchase accounting adjustments. As we previously reported, variations in product mix and timing of customer delivery requirements do cause operating margins of ETG to vary fluctuate from quarter to quarter. Excluding 3 d plus and Switchcraft, Electronic Technologies operating margins in the 2nd quarter and 1st 6 months of 2012 would have been 25% and 26% respectively, which is comparable to ETG's full year operating margins, which normally approximate 25% to 26%. Diluted earnings per share increased 13% to $0.36 in the Q2 of 'twelve, up from $0.32 in the Q2 of 'eleven and they increased 13% to $0.72 in the 1st 6 months of 2012 up from 0.64 in the 1st 6 months of 'eleven.
As previously reported, the 1st 6 months of 'eleven includes a $0.02 per share per diluted share benefit from the retroactive extension of the R and D income tax credit. All fiscal 2011 and 2012 diluted earnings per share amounts have been retrospectively adjusted for our 5 for-four stock split, which we talked about earlier. Depreciation and amortization expense increased by 2 point $9,000,000 to $7,500,000 in the Q2 of 'twelve, up from $4,600,000 in the Q2 of 'eleven and increased by $5,500,000 in the 1st 6 months of 2012, up from $8,900,000 in the 1st 6 months of 2011. That increase in both periods reflects higher amortization and depreciation expenses related to the previously mentioned acquisitions. R and D expense increased 37 percent to $8,400,000 in the Q2 of 2012, up from $6,100,000 in the Q2 of 'eleven and increased 27% to $14,900,000 in the 1st 6 months of 2012 and that was up from 11.7 in the 1st 6 months of 2011.
Significant new ongoing new product development efforts are continuing at both Flight Support and ETG and we invest 3% to 4% of each sales dollar in the R and D programs. Our effective strategy for the last 20 plus years has been to increase such expenditures and develop new products and services for our customers and this in turn facilitates market share growth which contributes to us being able to meet growth goals. SG and A increased 12% to $37,600,000 in the Q2 of 2012, up from $33,500,000 in the Q2 of 'eleven and they increased 20% to $78,200,000 in 1st 6 months of 2012, up from 65,000,000 in the 1st 6 months of 2011. That increase in SG and A for the 2nd quarter and 1st 6 months of 2012 principally reflects an increase of about $4,000,000 $11,000,000 respectively, attributable to newly acquired businesses. SG and A expenses as a percentage of net sales decreased to 17.4 percent for the Q2 of 2020 from 18.1% in the Q2 of 2011, principally reflecting a reduction in certain personnel related expenses as a percentage of net sales in both Flight Support and Electronic Technologies Groups.
SG and A as a percentage of net sales remained comparable at 18.2 percent in the 1st 6 months of 201218.1 percent in the 1st 6 months of 2011. Interest expense of course increased about $600,000 to $700,000 in the Q2 of 2012 and increased $1,200,000 to $1,300,000 in the 1st 6 months of 2012. The increase of course is due to higher weighted net average balance outstanding under our credit facilities during the 6 months and that was all associated with the acquisition program. Other income in 2011 and 2012 was not significant and I won't comment on it. HEICO's effective tax rate in the Q2 of 2012 increased to 34.7%, up from 33% in the Q2 of 2011 and that principally reflects a higher effective state income tax rate attributable to acquisitions as well as changes in certain state tax laws which impacted certain state apportionment factors.
Additionally, our purchases of certain non controlling interest in the Q2 of both 201112 contributed to the increase in our effective tax rate. The effective tax rate in the 1st 6 months of 2012 increased again to 34.5 percent from 31.7% in 6 months of 2011. Increase was principally reflecting higher income tax credit for qualified research and development activities recognized in the 1st 6 months of 2011 as well as the previously mentioned higher effective state income tax rate and income and impact from our purchases of certain non controlling interest. Net income attributable to non controlling interests was $5,200,000 in the Q2 of 2012 compared to 5.3 $1,000,000 in 2011 and 10.5 $1,000,000 in the 1st 6 months of 2012 compared to 10.7 $1,000,000 in 1st 6 months of 2011. That small decrease in both periods reflects previously mentioned purchase of certain non controlling interest by HEICO during fiscal 2011 and 2012 partially offset by higher earnings and flight support in which a 20% non controlling interest is held by Lufthansa.
Moving on to the balance sheet and cash flow. I previously mentioned that our financial position
and forecasted cash flow
remained very strong. Cash flow was strong in the Q2 of 'twelve with cash flow provided by operating activities $47,600,000 up from $27,500,000 in the Q2 of 2011. In the 1st 6 months of 2012, cash flow provided by operating activities was 45.3% versus 51.1% in the 1st 6 months of 2011. The working capital ratio is a strong 2.8% as of April 30 and that was up from 2.6% in October 31, 2011. DSOs of receivables was 48 days on April 30, 2012 compared to 47 days October 31, 2011.
And as usual, we continue to closely monitor all receivable collection efforts in order to limit our credit exposure. No one customer accounted for more than 5% of net sales and our top five customers represented about 16% of consolidated net sales in the Q2 of 2012, down from 17% in the Q2 of 2011. The inventory turnover rate on April as of April 30, 2012 was 124 days, up slightly from 100 and 16 as of October 31, 2011 that reflects higher inventory levels for certain product lines necessary for us to meet customer demands. CapEx in the 1st 6 months of 2012 were 8,100,000 dollars and we continue to budget CapEx for the full year 12 to be in the range of $20,000,000 to 22,000,000 Now the outlook. In our Flight Support Group markets, continued global economic uncertainty could moderate our net sales growth for the remainder of fiscal 2012.
In electronic technologies markets, we generally anticipate stable demand for most of our products, but we acknowledge that government deficits and spending reduction plans could moderate demand for certain of our defense products. You are all aware of the ongoing discussions in Washington and elsewhere around the world in terms of defense spending. And the answer is that nobody knows the real answer to what the final result will be. We prefer to be cautious and if we're going to we'd rather on the side of being conservative. Based on current market conditions, we are increasing our estimates for the full fiscal 2012 year over year growth in net sales to 17% to 20% and the growth in net income to 12% to 14% and this is up from our prior year growth estimates in net sales of 15% to 18% and net income of 10% to 12%.
We now estimate full fiscal 2012 operating income to approximate $160,000,000 and depreciation and amortization expense to approximate $30,000,000 These estimates do include the fiscal 2012 acquisitions of Switchcraft, Ramona, Moritz, but exclude any additional acquisitions that we might make. In closing, we will continue to focus on intermediate and long term growth strategies with emphasis on the development of new products and services to meet the needs of our customers. And we will focus on strategic acquisition opportunities that complement our existing operations. And I may add at prices that we have paid historically. That is the extent of my planned remarks And I would like to open the floor for any questions.
So if the operator would help us and go into the queue, please.
Thank you. And your first question comes from Julie Yates of Credit Suisse. Good morning, guys.
Good morning, Julie.
A few questions on margins, one for Victor and one for Eric. Victor, on ETG margins with the improvement at 3 d Plus and then the end of some of the accounting adjustments, do you think that the segment can return to that targeted 25% to 26% level by the end of the year?
Yes, absolutely.
Okay. Okay. And then Eric on FSG, what is driving the record margins at 18.9%? Is it mix? And then what are your expectations around the sustainability of that in the second half of the year?
Well, in terms of what's driving it, our we've got a number of business units that were all run by very talented people. And the metric that we primarily focus on is operating income. And sales is just not I mean, it's something obviously we have to accomplish, but the thing that they're all evaluated on is the operating income. So that really is just a byproduct of all their efforts and we think represents a greater is of greater importance than the sales. So that's really the number that we are looking at.
And insofar as how it relates to sales and we derive the margin, they frankly are not compensated on nor evaluated on the percentage margin. It's really the total dollars of operating income based on their invested capital that they've got. So it's not something that we really can evaluate. It moves around. It could go higher.
It could go lower. Frankly, I don't know. It really just depends on product mix and what we're able to accomplish. So I wish I could provide greater clarity on that, but I really can't.
Good. This is Tom Irwin. I think exactly what Eric mentioned. That's one of the reasons we don't give guidance, particularly in the FSG segment. We made a big reference that we do see improvement in each gs.
But to the lack of a backlog visibility, you may recall, 16% or more of our orders each month are booked and shipped. So it's not like we have a larger backlog that we can see with projected margins on as opposed to ETG. So for that reason, we don't give guidance, if you will, on margins. The fluctuations may happen as Eric reported. And based on mix, we do target overall growth, but not specific margins and targets.
Okay, great. And then can you guys break out the growth in flight support in the quarter between parts and services?
In the FSG group by the quarter, the organic growth was just recalling exclusively in parts. The service business Q2 to Q2 was didn't have any substantial organic growth. It's the service business 2nd quarter to 2nd quarter. So the first half of the year, they all had growth, but quarter over quarter, it's basically not any organic growth in repair services versus parts in specialty products.
Okay, great. Thank you.
Thank you, Julie.
Thank you. Your next question comes from Arne Ursiner of CJS Securities.
Good morning. This is actually Lee Jagoda for Arne.
Okay. Good morning.
Good morning. So following up on the previous question, how much amortization and inventory accounting from the acquisitions remains in Q3 and or Q4?
It's difficult to give an exact number, but put a little more color on it. As Larry mentioned, it runs in the aggregate for Switchcraft and 3 d roughly $3,000,000 a quarter. Roughly a third of that is purchase accounting short term, which typically rolls out in 6 to 9 months in those businesses. It may vary a little bit depending on what's actually shipped versus the inventory we acquire at the acquisition date. The remaining roughly 2 thirds is amortization, which is a longer period and wouldn't roll out within a year or so.
Although we do use accelerated amortization methods for a number of our intangibles. So it's a decreasing amount, but it wouldn't typically go away immediately.
Okay, great. And then just switching gears a little to the Flight Support Group. You highlighted industrial as well as aerospace aftermarket for the 5% organic growth. Can you break that up between the industrial and the aerospace pieces?
For competitive reasons, we don't disclose specific within product lines. They both were up. As we've mentioned in the last few quarters, the industrial product is a small product line and so a relatively small aggregate dollar amount has a higher percentage growth if you will, but it wasn't both of them.
Okay. But both of those were up in the quarter?
Both the industrial product and the aftermarket parts, yes.
Okay, great. Thanks very much.
Thank you.
Thank you. Your next question comes from JB Growe of D. A. Davidson.
Good morning, guys.
Good morning, JB.
The increase in the guidance, I mean, I'm guessing that's driven largely by the acquisitions that you've made.
J. B, this is Tom Irwin. I would say it's a combination obviously of what Victor spoke about in terms of the opportunity to improve margins in ETG, a level of growth in FSG that we're comfortable with given overall market. Again, we don't have the detailed visibility, so there is a level of caution, if you will. But it's a combination of all those things that leads to our
full year forecast. JB, a little more color. Continuing with exactly what Tom has said, we have mentioned in last quarter and again now about 3 d and the order flows and so forth. And we definitely do see a pickup in the order flows and it gives us more confidence. We are pretty confident that well, very confident in what we told everyone last quarter with the order flows and the earnings flowing through from 3d.
3d is a very good company. It started off the first half of this year weak, but we knew that and we are seeing very strong water flows. So that gives us additional confidence.
Okay. And Eric, is there a way within Flight Support to kind of gauge sort of the current demand or changes in customer order pattern ordering patterns? I know you don't have really a backlog so to speak of in FSG.
No, correct. Like you said, we don't have backlog. As Tom mentioned, most our sales get booked and shipped in the same month. I mean, I can tell you on a qualitative basis, the interest in our products, the airlines that want us to develop more parts, the enthusiasm for it, I'd say is at a record high. I've been with HEICO now for 23 years and I've never seen so much enthusiasm in the customer area about what we're working on and what we're doing and the capabilities.
So I think that, that will continue. But insofar as specific quarter patterns, that's very difficult to say.
And then when we kind of when we think historically, I mean, if we get a case where capacity were to actually contract a little bit, I mean historically have you been able to kind of grow through that with a combination of increased penetration, expansion of the catalog, pricing?
Yes. I would say that, what's interesting this time and
of course over the last couple
of years there were a lot of questions about restocking. And we repeatedly said that we did not see restocking, which we define as basically putting more parts on the shelf waiting to go into airplanes. In hindsight, what we did see was returning some aircraft into service that basically there have been some deferred maintenance through the recession and basically there was a catch up roughly in 2011. In speaking with our folks, they still do not see any evidence of restocking. So if there were to answer your question, if there were a slowdown, I don't think that we're going to see the burn off of inventory
to the levels that we saw at the
last time. I mean, obviously, the macroeconomic picture is what drives their travel. So we all know the impact of that. But you don't have those inventories that were out there in 2,008, where people could basically live off a lot of inventories for a long period of time. The inventories we still maintain are very lame.
The airlines are not putting a lot of parts on the shelf and they're really watching the working capital very closely.
Good. Okay. Thanks a lot. Appreciate your time.
Thank you.
Thank you. Your next question comes from Tyler Hajde of Sidoti and Company.
Yeah. Hi, good morning, everyone.
Good morning, Tyler.
Thanks. So just to kind of speak a little bit more on the commercial aftermarket. Could you maybe talk a little bit about how things tracked in April? Was April stronger than March? And then maybe if you could talk a little bit about how things have tracked so far in May?
Well, we can't speak about May because first of all, it's not done yet. And frankly, I wouldn't know and our people really don't know how we're going to do in the month until the month completes, because again, they're not evaluated based on I mean, obviously, they want to
ship it as early as possible, but
they're really evaluated on what the total month is. And so it's also outside of our reporting period we can't comment. But with regard to April, I don't think we provide specific guidance month to month. But yes, Tom? Yes, I
was saying Tom, I think particularly the commercial aviation business, I don't know that 1 month being up or down versus the previous month is a meaningful measurement. We track it obviously, but I think in terms of trying to forecast something going forward based on whether April was up or down from March or February. That's why we report obviously on a quarterly basis and measure the organic growth and the acquisition growth etcetera, etcetera on a quarterly basis because we don't want to sort of try to read too much into the tea leaves.
If you're looking, which I think you are, not so much from HEICO specific, but the trend of what's happening in the aftermarket. I think at this point, it's really a little cloudy out there. It's not terrible. It's not fantastic. It's okay.
It's not booming. We have tough comps compared to last year when people I think there was a catch up period. And at this point, we're not sure exactly until we get a real hard reading when all the hard numbers come in. So we're unsure right now.
Okay. But Tyler, I think I can tell you if you're trying to get to a trend that April was not materially different from the other month.
Yes. That's what I was trying to get at. And when I look at kind of your forecast for the second half of the year, are you basically expecting that growth kind of tracks in that 5% range that we saw in the Q2?
Again, Tyler, this is Tom Sommer. We don't again give revenue targets by segment or margin targets by segment. I would say what we do look at as most forecast in terms of capacity growth, which is obviously the biggest organic driver that we not impacted by the number of new product we bring to market. I think most forecasts look for fiscal 2012 capacity growth industry wide since being somewhere in the 3% to 5%. So I mean I think that's the capacity or industry growth that we envision into our market.
Again, historically, we outperform or capture market share. And so we hope to do that as well. But I think that's the kind of industry expectations that are driving our planning if you will.
Okay. And I know last quarter you talked about kind of deemphasizing some of the lower margin PMA products. Did that theme kind of recur here in the Q2?
Tyler, it's Tyler again. I would say it's an ongoing thing, but I think as a result of the number of questions that we had on the call, probably the magnitude was overstated in terms of perception. It's something that had a little impact in the Q1, had a little impact in the Q2, It's an ongoing process. We're always looking to maximize as Eric mentioned, we're always looking to maximize operating income, not sales. So yes, it had a little impact, but not even it's not a meaningful impact and no meaningful change in the trend and no meaningful impact to our business model within FSG.
Yes. I would say that's correct. Yes. There were some products that were deemphasized, but it really got much more attention than we thought it really warranted.
Right. But I mean if capacity if your expectation is that capacity grows 3% to 5% this year and you did 5% or so organic growth this quarter, I mean, wouldn't that imply that you expect some sort of strengthening in the back half?
Again, I think historically we and we would expect going forward to outperform the market and capture market share. So but again specific growth targets by segments and by quarter
we don't issue those. Truthfully, it's so difficult that we never try to guess. We have a strategy. We have a projection over, for example, a 3 year period. And we estimate what sales would normally be in that 3 year period and we stock the shelves.
So we have to have inventory available to support our customers in the middle of the night should they have an order. But aside from that, we really don't try to predict what the aftermarket will demand of us because it's impossible. We have asked airlines and MRO facilities to tell us what their schedules are. And they themselves either don't know or have significant changes throughout the month. So for us to speculate on it, it's really it's impossible for us to speculate.
We know when there are major downturns and they put major aircraft back in service, we then feel highly confident that within a period of 3 to 6 months, we're going to see a big order inflow. Similarly, if we see lots of planes coming out of service, the opposite is true. But in between what they schedule and how they do it and switch engines and all these things, we cannot figure it out. So we don't want to mislead anybody or guess. We feel confident that it's a great industry that the sales will come through.
We can't just figure in what quarter, what month. We don't know. And Tyler, this is Eric.
Just to add and emphasize on what Tom said, we do believe that we're going to grow in excess of the capacity growth like we have in the past, which means we are going to capture market share. So we do feel confident about that. But again, with our people focused frankly on operating income and not sales, it's just not we try to keep them laser focused on the important things. There are 20 metrics they could report on like many big companies, but we try not to tie them up in that kind of stuff. And we seem to pull out the numbers quarter after quarter I think because of frankly the quality of our people and the focus their focus on their business.
Right. Got it. Okay. Thanks very much for all the color.
Your next question comes from Rama Bhandari of Royal Bank of Canada.
Good morning.
Good morning.
I'm going to start off on the ETG side. I just want to make sure I understood this correctly. Victor, you had said that you expected margins to get back to 25% to 26% on the back half of the year. But I think you is that including the potential 3,000,000 dollars per quarter charges from 3 d Plus and Switchback?
I'm going to let Tom answer the question as to the amortization impact and the inventory accounting acquisition accounting. Yes, Ram. I think the short answer is the operating margins that we're referring to are as reported. So it would be after that. A clarification though, given the fact that we're obviously well below those ranges for the first half of the year.
I think by again by the Q4, we're targeting to get back to that range. But for the full year, it may not average that. But again, I think we're talking about getting back to a normalized rate on a quarterly basis as reported, which would be after amortization. And again, we would expect certainly by the Q4 for the purchase accounting adjustments to roll out or finish, if you will.
Okay. And then I went back and I looked at following some of your acquisitions and I couldn't find more than once or twice that you had these separate charges following an acquisition. But to have 2 of them at the same time, I don't think that's happened at least in the last 4, 5 years that I went back and looked. Has there been any changes to the way the metrics that you're using when you make acquisitions or the process or procedure that you guys are doing?
No, no. I don't think we change at all. We have a kind of a proven methodology. So we are not changing. No, the answer is no.
It's just it's opportunity and we can never predict when that opportunity. We're not going to reach outside of our area of confidence. We're not going to reach outside of our price ranges. So when these transactions come up, that's when we work on it.
Rama, this is Victor. Also to add a little bit of background on that. The amount of inventory essentially that sort of disappears. The amount of profit that disappears because of the acquisition accounting varies by acquisition depending upon the level of of the types of inventory and the level of that type of inventory. So a company with more inventory and especially more inventory of finished goods time, let's say, will suffer that diminution in margin more than one that keeps less finished goods inventory on hand or has less inventory.
And so essentially under the rules, we wind up having to give up to eliminate profit that in my opinion shouldn't be eliminated, but it's for accounting reasons only and not for cash reasons, of course. The cash is the same. And that can last for a longer period of time depending upon the inventory level and so on and so forth. So it will just vary by acquisition. And in the case of these two acquisitions, we had more of that kind of inventory on the shelf at the close of the acquisition.
In terms of intangibles accounting and write offs, which is just pure intangibles, that's a headwind that we've been experiencing on our acquisitions since these rules really started to come into play somewhere around 2,005 or 2,006.
Okay. All right. And then switching gears over to FSG. In the past, you guys have looked at bringing into the market 500 to 700 new parts and services. It looks like R and D is up about 27% this quarter.
Is that number moving up in the 500 to 700 new parts per year?
I think we have 300 that we might get out of 500. It all depends on the part selection. So I would say that the projection is similar to prior years where we projected internally where we wanted the growth to be from the new part development.
Okay. All right. Great. Thanks. That's it.
Your next question comes from Michael Ciarmoli of KeyBanc Capital Markets.
Hey, good morning, guys. Thanks for taking my questions.
Good morning.
Just to maybe follow-up here on FSG and looking at the trends. I mean the revenues from I guess the Q3 2011 to present are basically sequentially flat. And I
guess you mentioned, can you give us sort of some
of the underlying trends? The services appear to not grow, I guess, at all this quarter. Are you seeing pressure on one side of the business over the other, given kind of the presence of the airline bankruptcies and other kind of weakening industry metrics out there? Is there any color or read throughs you can give us on the sequentially flat nature of those FSG revenues?
This is Tom. I would say there has been some growth excluding the 4th quarter, which was an unusually strong quarter, I think, in FSG. And I think as Eric mentioned, we definitely at this point realize that we benefited from some catch up or some deferred maintenance that the airlines apparently took opportunity to spend the money if you will in 2011.
So there has been some sequential growth. But again, the challenge for FSG in terms of the
pure numbers is that organic growth was 20% or more in each of the quarters last year. So we do have the challenging comps to deal with. And again, as Larry mentioned, I think overall economic uncertainty has caused us to be cautious. And I think particular to the airline industry, the economics and uncertainty in oil costs, oil fuel costs has caused them to at least potentially decelerate capacity growth.
Yes. Michael, this is Eric. In looking at last year's 3rd and 4th quarters, there were some pretty big jumps sequentially there from the Q1, the second, third, 4th. And looking back, we now see that in probably last year's 3rd Q4 that there was a catch up in deferred maintenance. Again, not restocking, but in deferred maintenance.
Okay.
And that did not continue into this year into 2012. So I think you are seeing growth in there and you really look at the Q3 or second half of this year compared to what we did last year, last year's numbers were helped tremendously by this deferred maintenance. So I think qualitatively our businesses are doing better. We're getting more parts approved. We're getting
more parts developed, installed. But it's just the
comps are being very difficult because we had this, if you will, one time bump in the second half of last year, which we didn't notice at the time. I mean, you don't as you receive the orders, you just show the parts and you only find out really after the fact if there's been some fluctuation. I know. Yes. I don't want you to think at all that the business is flatlining or anything like that.
I mean, we continue to grow. We continue to ship more parts, develop more parts. But unfortunately, we just got some deferred maintenance pickup last year, which we didn't fully understand at the time.
No, that's extremely helpful. And then just the last one, Eric. You mentioned a lot of interest and enthusiasm in new products from customers. Can you give us sort of a sense of what types of products? I mean, are those engine specific?
Are they more around other parts of the airframe?
Yes. I would say that they're around everything. As you know for competitive reasons, we're reluctant to go into too much details. But I can tell you in all the areas in which we operate engines, components, there's tremendous excitement. Airframe, repair services, there's a lot of excitement in what we are doing.
It's important to note that the way the OEMs maximize their profitability is by jacking up prices year over year. They've got this incredible monopoly, this incredible pricing power and where we're not present in the market, they've got 100% of the market share, maybe where we're present, they've got 70% or 80% of the market share. So still great numbers. In the way fundamentally that these folks can maximize their profitability and the best business model for them is to continue to jack up prices. And by definition that really sets the customer.
And so they typically are really at a they have a distressed relationship with their customers because of their ability to maximize profit through pricing. And that's the way unfortunately they have to do it. We on the other hand build up a lot of customer goodwill and we view it as an investment by keeping our prices reasonable. And the airlines see great opportunity in working with us. And it's really across the broad spectrum of everything we offer, including distribution services as well.
I mean, we're offering products, competitive products, which can save these folks a lot of money. And I would say the enthusiasm is around really everything that we're doing. It's not centered in any one area.
Okay, perfect. That's helpful. Thanks a lot guys.
Thank you.
Thank you. Your next question comes from Ken Herbert of Wedbush.
Yeah. Hi, good morning everybody. Good morning, Ken. Eric, just a first question on FSG.
I just wanted to follow-up on that. I mean, it looks like again you had another quarter where you likely took some nice share, especially on the engine side within the parts market considering some of the growth rates from the OEMs. Can you just 2 questions. 1, did you see any particular growth or better growth than you expected in any particular region? And then second, is there anything you'd comment on?
Or are you seeing anything different in reaction or response from the OEMs in the last few months above and beyond obviously the normal issues and the normal competitive threats?
Yes. I would say with regard to the first part of your question on region, definitely Europe has been weak. I think not only for us, but for the entire industry and we're all very familiar with what's going on there. But Europe is definitely, I think, pulling everybody down. We're doing very well in Asia, but compensating for the weakness in Europe is a tough thing to do.
With regard to the competitive dynamic, I would say that the OEMs when they came out with the new equipment, particular on the 787 and the airlines got a sneak peek at what that stuff is going to cost, they are really scared because of the lack of competition on this stuff. And I would have to say frankly that the OEM arrogance is at an all time high. And that really is a very good dynamic for us, because I mean just don't get me wrong, I mean the airlines don't necessarily make this entirely easy on us and we're still a supplier and they want to get the best price possible. But I think the OEMs are really setting up a good a very good opportunity for us to continue to develop parts and grow and that's why this enthusiasm exists.
Okay. That's helpful. Having said that, as you look then for the corporation, do you see potential opportunities organically product line development? Or obviously, I know the hurdle continues to be a product line development? Or obviously, I know the hurdle continues to be approval at the airlines and you face significant bottlenecks.
But are you seeing any desire there to maybe significantly step up efforts from that front?
No. I think we remain comfortable with the level that we're working at. We increase R and D annually by similar percentages and or similar amounts. And I think that we're at a good level right now. Some of the airlines have reduced their personnel and staff.
So even though they want to buy more parts, sometimes cycle time to get stuff approved takes longer. And
I think we're at
a good level right now. I don't see yes, we could go out and increase our expenditures and develop a lot more products and stick this stuff on the shelf. But unless we're able to sell it and get it out there, it really would make sense. So I think we'll sort
of stay where we are.
Okay, great. Thank you. And just one final question, Victor. When you look at the recent acquisitions, specifically Switchcraft and 3 d Plus, it sounds good that you're comfortable with getting margins back up to sort of the normal rate. As you look at these businesses, do you see opportunities longer term to maybe get are these businesses that will be accretive to the traditional ETG margins when we go out a year or 2?
Or how do you think the upside plays out for the recent acquisitions in particular?
I want to be careful on that because I don't want to commit to something that you'd later be disappointed on. I think there's a possibility for it and we're hoping to see that on these acquisitions. But time will tell and I'm more comfortable right now telling you to look more to the historical range.
Great. Fair enough. Hey, well, thank you very much.
You're welcome.
Thank you. Your next question comes from Steve Levinson of Stifel Nicolaus.
Thanks. Good morning, everybody.
Good morning.
Just in relation to the acquisitions recently, it seems like there's been more in electronic technologies rather than flight systems. Is that by design? Or is it just that's where the more attractive opportunities are right?
I think the latter clearly. As I mentioned earlier, the transactions we're looking at right now are in both fields. So and we're really opportunistic buyers. So that's where the opportunity was.
Okey doke. Thanks. With the most fragmented portion of the supply chain in aerostructures, do you feel that that's outside your wheelhouse? Or is that something you'd look more into in the future?
When you say aero, we really are not in the we don't do anything in aero structures and we Acquisitions. Are you talking about acquisitions in the Aerostructures area? Yes. I don't think we're really focused on aerostructures for a whole bunch of reasons, but it's not a focus of our business, aerostructure.
Wouldn't rule it out though.
No, I wouldn't rule it out. It's possible. But at this point, we have no Aero Structures activity. There are issues that that really is not as we look at that particular part of the industry, it's not something that we are too focused. Quite honestly, we don't favor that type of business.
Okay. Good enough. Thanks. As more of the deliveries skew away from North America and Europe over to Asia and I guess Latin America as well, are you making any additional investments to get into those markets even more than now?
Steve, this is Eric. Yes, we are. I mean, we're very focused on South and Central America as well as Asia. I'd say we're doing quite nicely. And we see those as very good opportunities for us.
Okay. And last, there's some stories out yesterday and today. I don't think it really affects commercial right now, but stories about some counterfeit parts popping up again from sources outside the U. S. Are you lobbying for regulations or restrictions that would help your business and help to defeat that sort of activity?
At this moment this is Victor. At this moment, we're not involved with those activities. We're aware of them and maybe in the future. And probably some of the trade groups we belong to are active in that, but it's not a major focus for us.
And Steve, this is Eric. To be clear, I'm not aware of that kind of behavior in the commercial aviation market. I think you may be referring to defense?
Right now that's where it seems to be. Okay.
Got it.
Okay. Thanks very much.
Thank you.
Our next question comes from Eric Huggl of Stephens Inc.
Hey, good morning guys.
Good morning, Eric.
Hey, Eric, the margins in the FSG Group, 18.9 were really solid this quarter. Where was the business in terms of sort of the mix and sort of how sustainable are those margins? Should we be thinking about something in the mid to high 18% is sustainable ongoing?
Again, specific to segments, we don't give operating margin guidance. I think on a historical basis, it was up and it was up based on principally favorable product mix, product mixes that have higher margins in the industrial and the commercial aftermarket parts as I made reference earlier. The service business which is a lower margin business for as an industry and lower for HEICO relative to our parts businesses. But again, typically we do have higher margins in our service business than sort of industry wide. But that being said, the MRO services were relatively flat quarter over quarter.
So the growth in organic growth was principally in the higher margin product lines. And that could switch, may not switch. And that's one of the reasons again that we don't give margin guidance by segment.
Sure. Larry, in terms of M and A, obviously, you continue to do more. I don't know if this sort of an issue per se, but you've got good cash flow, but you do more acquisitions, your debt to cap is probably going to go up. Where would you feel comfortable? Or is that really an issue because of your strong cash flow?
I mean, where do you feel comfortable taking
the balance?
Well, I have said at this point, our cash flow our debt is give or take one times EBITDA or less than one time EBITDA. So we really don't have any pressure. Our interest rates are extremely comfortable if we were at 2 maybe 2.5 times EBITDA. Not to say that that's we're going to push to make that happen because we're not going to force anything. We're just going to do it.
When we have opportunistic acquisitions, we're going to make them. We're not going to force the issue by paying up prices. That's not been our strategy and we don't believe in that. But I personally would like to put out a lot more money on our line because interest rates are so low and with our strong cash flow, we pay that back very quickly. And we look at HEICO as a mechanism to generate cash.
It's true we generate earnings per share, but we want real earnings and real cash. And we don't want to be a company that reports earnings per share, but no cash coming out of it because we're building receivables inventory plants and all kinds of stuff. So there's nothing left. We want the cash to come out of the operation. That's why we run the company to create an entity that generates a lot of cash.
So we want to put money out and we're trying very hard And we would put out a lot more money if we had the right opportunity. And again, we are looking at a number of transactions. As usual, I cannot predict which ones we will make, which ones we won't make. You don't know, so you kick the tires. I've never seen a seller tell us that our company is not too good and earnings are going to fall off.
We only discover that when we kick the tires and we find out that it very often it's not what it was presented to begin with. So we walk away.
And I guess lastly, Victor, with regards to the 3 d plus business, what is it exactly can you remind us what exactly in that business is so economically sensitive that sort of last fall it sort of dropped off with the European sort of economy? And maybe sort of if potentially we're on the verge of sort of all this news in Europe is that taking another step down, what would stop it from dropping off again?
Well, I think it probably had more to do with satellite production, procurement cycle than it had to do with anything else now that we've had some time to really look at it and understand it a little bit better. It was really a matter of much lower orders and there's a lead time on those 5, 6 months, let's say. And then as I said on our last conference call, we started to see that improve in December and that has continued and continues through now. So I think at this point that hopefully that trend will continue. I suppose it is possible that the same thing will happen again.
But at this point, I'm not seeing that.
Great. Thanks a lot, Gus.
Thank you.
Your next question comes from Jim Larkins of Wasatch.
Good morning. Tom, a question for you. Can you give me what the amortization was for the quarter? I see D and A, but could you break out the amortization and help me understand where that drops off? I think it sounds like it's maybe 2 or 3 quarters out the inventory adjustments will drop out of that number?
Yes, you are correct. The inventory adjustments will roll out in the second half of this year. In terms of the total D and A, we're forecasting somewhere approximating $30,000,000 and the amortization portion of that in the current year will be roughly 16,000,000 dollars The how quickly that will roll out? Well, I think the answer is with additional acquisitions that number could actually go up the
amortization numbers. But if we did no acquisition, I'd have
to check, we'd roll out slowly over 3 to 7 year period. Some of it
is longer life, some of it
is shorter life. But again, some of it is on a accelerated basis. But the actual roll forward is an item that now under the SEC rules is in our 10 Q. So there will be a forecast. There is a forecast in each Q as to what the amortization is by year for I think it's 5 years.
Okay. So not necessarily a big bolus that's rolling off next year then?
No, exactly. Again, the $16,000,000 is still going to be a big number next year. And again, as we would expect to continue acquisitions, it could actually grow.
Okay. And then on your acquisitions in ETG, I haven't been keeping track of these real well, but $22,000,000 of acquired growth this quarter, does that level of acquisition contribution sort of stay with us for a couple, I guess, 2 more quarters before it starts to roll off assuming there's no new acquisitions?
Let's see. Well, the biggest acquisition of the ones completed this year, of course, is Switchcraft, which was completed in November. So yes, that would roll off. Obviously, the big comp impact would roll off the Q1 of next year.
Okay. All right. So we pretty much have this level of acquisition revenue embedded for the next two quarters then?
Yes.
Okay. Great. All right. I think that's it. Thanks guys.
Thank you, Jim.
Your next question comes from Ron Epstein of Bank of America Merrill Lynch. Hi, good morning. It's actually Elizabeth in for Ron.
Good morning, Elizabeth.
Good morning. I know you've touched a bit on M and A opportunities, but how are you seeing that pipeline from a multiple
perspective? Probably the same as we have historically. There's a little bit more pressure to the pricing upside. People are asking a little bit more, but it's not a significant thing. So we are seeing opportunities within our normal 5 to 7 time EBIT price range.
Once deals go at 10 times, 12 times, we kind of step out anyway. So they're not potential deals for us.
Great. Thanks so much.
Thank you.
Your next question comes from Chris Quilty of Raymond James.
Thanks. Yes, I actually still do have a question. This one for Victor. You mentioned the pickup in certain defense products. And I was wondering how sustainable you think that is over the sort of near to mid term?
And second of all, can you just tell us given the overall mix of the ETG business, are there any areas where you are particularly concerned or excited by opportunities?
Well, I think taking sort of in reverse order, you're talking about when you say opportunities, you mean acquisition opportunities?
Either acquisition or generically what business or product areas in terms of vertical markets you're serving?
Yes. Well, I think we are probably most excited by the space end of our business. That seems to be we do some unique things there as you know And that seems to be I think a growing business internationally. And we're growing internationally as well outside the U. S.
Which is important. So I think we're excited about that business. We are excited about in the defense realm businesses that are more tied to the obviously the UAS or the UAV market and standoff activities like that. We are less excited of course by things that are tied to the operations tempo. So less excited by, let's say, things related to ground equipment, ground related equipment that's not linking up to something that flies.
And I think that has been softer for us and will continue to be softer things that like say some electro optical devices that are used on handheld or on tanks or army vehicles things of that sort. So kind of in the general mix that's where we see things. And the defense business has overall been pretty good, pretty strong. We don't know of course what's going to happen with all the sequestration and talk about the overall budget. But overall it's been pretty good except for things that are weighted to the ground side.
Got it. Great. Thanks and
keep up the good work.
Thanks very much, Bruce. Thank you.
Thank you. Your next question comes from Jim Fowling of Gabelli and Company.
Hi, good morning everyone.
Good morning, Jim.
So I just got two brief questions here. Larry, I guess now that you have kind of 3 d more in place, are you going to step up your acquisition activities? Or you want to just wait to see how 3 d pans out in the second half of this year?
No, the answer is whatever happens to 3 d 1st of all, we're highly confident that 3 d will pan out the way we thought because of the order flow, which I mentioned earlier. And that order flow is very strong and that's one of the reasons we feel confident to up the guidance. So that's number 1. Number 2, our acquisition program has very little to do with 3 d. We are aggressively looking to acquire other good companies in our area of expertise and we're trying to do it.
So no, we have plenty of firepower. I think as you well know on our credit facility, interest rates are very tempting. So we would like to make any acquisitions that fall within our area.
I know you said in the past it's very opportunistic, but you did 4 acquisitions in just the last 12 months. And are you looking to kind of match that type of number in terms of acquisitions?
Well, the answer is no, not necessarily because some of the acquisitions that we made were really tiny. One of the Moritz was a product line in fact acquisition. For us, think it will be a great acquisition because we tuck it in and it just works the product and it's very synergistic. It's a great thing. But this is really a small thing.
3 d was larger. But it's not the number of acquisitions. It's really the size.
Okay. Very good. And then just a question on Victor. As you come out of the Q4 with a 25% margin in the ETG segment, should we look at fiscal 2013 with a higher margin as the 4 acquisitions you have on your operations thus improve there?
Well, for 2013, I really prefer to wait until we've done our budgets and gone through our internal process. But I'll get back to you at that time.
Okay. Good. Thank you, guys.
Jim, thank you.
And at this time, there are no further questions.
Okay. Well, I want to thank all of you for your interest in HEICO Corporation. We remain available by phone or personal visit to answer your questions or show you what we are doing. And if we hear from you, we'll be happy to be very responsive. And if not, we look forward to speaking to you in another 3 months for the Q3 update.
So with that, this call is ended. And I wish you all a good day.