HEICO Corp (HEI.A) 2002 Q3 法說會逐字稿

Good morning. My name is [Tashila] and I will be your conference facilitator. At this time I would like to welcome everyone to the HEICO 2002 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. If you would like to ask a question during this time, press star and the number one on your telephone keypad. If you would like to withdraw your question, press the star and the number two on your telephone key pad.

Thank you. Mr. Mendelson, you may begin your conference.

Thank you very much. Good morning to everyone on this call. Welcome to the HEICO third quarter fiscal 2002 earnings announcement teleconference. This is Larry Mendelson. I am CEO of HEICO corporation. I'm joined here this morning by Eric Mendelson, president of HEICO's Flight Support Group; Victor Mendelson, president of the Electronic Technologies Group and general counsel; and Thomas Irwin, V.P. and CFO.

Before we begin, Victor Mendelson will read a statement.

Thank you. Certain matters discussed in this conference call include forward-looking statements which involve risks and uncertainties. HEICO's actual experience may differ materially from that discussed as a result of factors including but not limited to demand for commercial air travel, product specification costs and requirements, governmental and regulatory demands, competition on military programs, HEICO's ability to introduce new products, product pricing levels, commercial airline travel, airline fleet changes, U.S. government airport policy and restrictions, funding by U.S. and non-U.S. agencies, HEICO's ability to make acquisitions and achieve operating synergies from such acquisitions, and other factors within and without the aerospace industries. Parties listening are encouraged to review the company's filings, especially those on 10-K, 10-Q and form 8-K, filed with the SEC.

Thank you, Victor. Ladies and gentlemen, before reviewing our third quarter operating results in detail, I will take a few moments to summarize the highlights. While sales and earnings were negatively impacted by the reduction in airline travel, and in particular by the erosion in our [JT8D] part sales following September 11, our non-[JT8D] part sales are up significantly. Our ability to replace [JT8D] part sales is being demonstrated by, one, a 13 percent increase in sales of non-[JT8D] FAA-approved replacement parts in 2002 versus 2001.

Next, our new product approvals, mainly for non-[JT8D] FAA-approved replacement parts were at a record level for the first half of fiscal '02. Third, our latest partnership with United Airlines which does not operate a [JT8D] fleet. While United faces some short-term uncertainties which you are all aware of, we believe that long-term they will remain one of the major domestic airlines.

And four, our successful diversification non-commercial aerospace markets as reflected by the growth in our sales which account for 25 percent of consolidated sales and are contributing high margins.

In addition, our third quarter '02 results were highlighted by continued strong cash flow, which I believe demonstrates the high quality of HEICO's earnings.

We have had a 50 percent budgeted increase in R and D expenditures in fiscal '02 versus '01. This, of course, negatively impacts '02, but we are completely confident that it will benefit the future.

Next, more airlines have begun discussions with us regarding some form of strategic alliance. And lastly, after seeing improvement in the commercial aviation parts market in our second quarter, that was the April 30 quarter, demand weakened from our commercial airline customers in the third quarter before beginning to strengthen again in July, '02. We are seeing a continuation of that strengthening.

That is the summary. Now I will get into some of the more detailed explanations of changes in our P and L.

In revenues, consolidated sales in the third quarter decreased by $1.3 million or about 3 percent from the third quarter of '01. The decrease in sales primarily reflects the lower commercial after market parts and sales of services in our flight support group as a result of September 11 events, as well as a weak economy.

Partially offset by some newly acquired businesses, as well as increase in defense related sales.

The third quarter '02 sales represented a slight decrease from sales in the second quarter '02, about 1 percent, primarily driven by a slowing of the post nine-eleven recovery within the airline industry, as well as some delays in the shipments of foreign military sales resulting from delays in approval by government agencies.

These shipments are expected to be made in the fourth quarter of fiscal '02 and the first quarter of fiscal '03.

Electronic Technologies Group sales increased $4 million or 45 percent to 13 million in the third quarter of fiscal '02 versus 9 million in the third quarter of '01. The increase reflects the acquisition of Inertial airline services which was acquired in August '01. As we expanded our aircraft accessory component repair and overhaul operations, as well as increased revenues from defense customers.

Compared to the second quarter '02, Electronic Technologies Group sales decreased slightly, about 5 percent from the second quarter of '02 to mainly, due mainly to the delayed foreign military shipments previously mentioned. Flight support sales in the third quarter of '02 decreased 15 percent from the third quarter of '01. Down to 29.7 million from 34.9 in the third quarter of '01, reflecting the continued impact of September 11 on commercial airline customers, partially offset by sales of newly acquired businesses.

At this point, I just want to interject that it's our best guesstimate that within the year, we will be back at revenue levels for Flight Support Group that we were at at 9-11. The meaning of this is that at, as a result of 9-11 and the downturn in commercial airline business, as a result of [JT8D] - that's the main culprit, so to speak, our revenue line shifted down and that revenue, we feel, will never be recovered. That is [JT8D].

However, we feel very confident that within twelve months we will be at or above the revenue levels. That will be as a result of new product and non-[JT8D] product.

Continuing, as expected, the sales of FAA-approved replacement parts were off over 25 percent in the third quarter of '02, compared to the prior year fiscal third quarter, after having increased to double digit rates throughout fiscal '01, up to September 11.

And this reflected the capacity reductions made by airlines and particularly the older [JT8D] powered aircraft.

[JT8D] part sales are off approximately 50 percent. However, as I mentioned, non-[JT8D] part sales are running about 13 percent ahead of last year. The third quarter '02 Flight Support Group sales increased slightly to 29.7 million from 29.5 in the second quarter of fiscal '02.

You see, there's a slight increase, and sales were negatively impacted by a general softness in demand for our products and services by again the commercial airline customers following the strengthening in the second quarter of '02.

This reflects a slower recovery within the commercial airline industry than previously anticipated.

We are pleased to note, however, that demand strengthened since June of '02, and we currently anticipate some strengthening to continue for the balance of the year. This prediction is based upon quotes, levels of interest and indications from our commercial airline customers.

Moving on to operating income, the consolidated operating income in the third quarter '02 was 5 million versus 8.1 in the third quarter of '01. Operating income in the third quarter '02 reflects the lower sales and earnings within the Flight Support Group, as well as a planned increase budgeted of about half a million dollars for new product research and development expenses.

Operating income in the third quarter decreased about a million dollars from the second quarter '02, mainly due to a softness in demand for the products and services by our commercial airline customers, reflecting a slower evidence recovery within the commercial airline sector than had previously been anticipated, as well as higher new product research and development expenses.

The operating income of Flight Support Group was 3.6 million in the third quarter '02, versus 7.8 in the third quarter of '01, again as a result of lower sales post nine-eleven, new product development expenses, and partially offset by the elimination of good will amortization.

Flight Support Group's operating income in the third quarter of '02 decreased by about 265,000 from 3.8 million in the second quarter '02, primarily due to the slowing of sales growth and some higher marketing expenses.

Believe it or not, as sales drop, we are required - good business sense tells us to beef up our market penetration and, as a result of it, it is necessary to expand market share to make investment up front. We are doing that.

Operating income of Electronic Technologies increased 1.3 million to 2.7 million in the third quarter of '02 versus the third quarter of '01. This reflects the higher defense related sales that I discussed previously, as well as the elimination of some good will amortization, plus the - less the additional earnings from some acquisitions.

Compared to the second quarter of '02, Electronic Technologies Group operating income in the third quarter of '02 decreased by about .7 million, from 3.4 million in the second quarter. That decrease reflects increased R and D spending, as well as the delayed foreign military shipments discussed earlier.

While we could have abandoned our long-term growth strategies by reducing new product development spending and cutting back on our marketing efforts in order to benefit the short-term operating results, we've stayed the course. In fact, we have increased new product and marketing efforts in the light of our continued success in this area. And we did this with the expectation that those efforts, while having a negative impact on near term earnings, will provide significant benefit in the future.

The operating margins consolidated total 12 percent in the third quarter '02, down from 14 percent in the second quarter '02 and 18 in the third quarter of '01.

The decrease in margins compared to the third quarter of '01 reflects lower margins within Flight Support Group, primarily attributable to lower sales of alternative parts, coupled with increased marketing efforts and lower margins on other Flight Support Group business such as repair and overhaul and other products, as well as higher research and development and partially offset by elimination of good will amortization.

Operating margins within Flight Support Group reflect the items discussed above and lower sales of PMA parts with increased marketing and higher R and D expenses.

We do expect operating margins to improve in the fourth quarter '02, due to increased volumes and product mix. The operating margins within Electronic Technologies Group were 21 percent in the third quarter '02 versus 25 in the second quarter '02 and 15 in the third quarter '01.

The increase relative to third quarter '01 is due to the elimination of good will. The decrease versus the second quarter of '02 reflects some increased R and D spending and the delayed shipments of foreign military sales.

Talking about EBITDA margins, they were 14 percent in the third quarter of '02 and down from 19 percent in the third quarter - I'm sorry, in the second quarter of '02. As well as being down from 25 percent in the third quarter of '01. The EBITDA margin of Flight Support Group was 14 percent in the third quarter of '02, down slightly from 16 in the second quarter of '02 and 29 in the third quarter of '01.

The EBITDA margins of Electronic Technologies Group were 23 percent in Q3 of '02, down from 26 percent in Q2 of '02, but up slightly from 22 percent in Q3 of '01.

The movement in EBITDA margins reflects the changes in the operating margins which is I discussed before.

Diluted earnings per share was 13 cents in the third quarter '02 versus 18 in the third quarter '01 and 18 in the second quarter '02.

As reported previously, the company adopted SFAS 142 beginning in the first quarter '02. And that eliminated the periodic amortization of good will. Lower earnings per share in the third quarter of '02 versus second quarter '02 reflects lower net income in Q3 of '02. Net income in the second quarter reflects income of 3 cents per share related to the additional gain on the sale of the Trielectron product line sold in September 2000.

In addition, R and D expenses in Q3 of '02 were 375,000 or 1 cent per share higher than in the Q2 of '02.

Moving on to R and D spending, total R and D expense in the third quarter was 3 million, compared to two and a half million in the third quarter of '01. The incremental expense which we consider fundamental to long-term growth, reduced earnings per share by about 1 cent in the third quarter '02 versus the prior year.

The addition of new FAA-approved parts, particularly for non-[JT8D] aircraft, continues to be critical to our long-term growth in light of the apparent acceleration of the retirements of the [JT8D] standard fleet in the aftermath of 9-11.

Currently we have approximately 900 parts in development, over 95 percent of which are for non-[JT8D] engines. We now have approximately 2700 parts approved by the FAA and two thirds of them are non-[JT8D].

The new parts released by our R and D groups in the third quarter of '02, and by released I mean available for sale to our customers, continued at a very strong level and were pretty much as we had budgeted for the period.

We estimate - we don't want to give an exact number - the new part approval for fiscal 2000 will be over 250. I don't want to give you an exact number for competitive reasons, but 250 new parts is quite a lot.

Moving on to SG and A as a percentage of sales for Q3 '02 remained approximately level at 23 percent compared to second quarter '02 and to the third quarter of '01.

However, SG and A expenses as a percentage of sales for the third quarter of '02 is four points higher than the third quarter of '01, adjusted to exclude good will. That increase is due to accelerated marketing efforts, which I discussed a little earlier.

Interest expense is kind of approximately level with the second quarter, but lower than the third quarter of '01. And that decline in interest expense is due mainly to lower interest rates, partially offset by higher borrowings under our credit facility to partially fund acquisitions.

Other income did not change significantly from the third quarter of '01. And for the nine months ended July 31, '02, it includes $1,230,000 pre-tax gain. About 3 cents a share on the sale of the Trielectron product line, which we recognized in the second quarter.

Other income for the first nine months includes a gain on the sale of property and so forth, aggregating about 800,000 or 2 cents a share net of tax.

The company's effective tax rate decreased to 32.8 percent in the third quarter of '02, down from 37 in the third quarter '01. And this is primarily as a result of the elimination of good will amortization and a higher tax benefit on export sales.

Adjusted to include good will amortization in the third quarter of '01, the effective rate would have been 34.7.

Minority interest represents the minority interest of Lufthansa and American airlines in our Flight Support Group. And it decreased primarily due to the lower earnings of the Flight Support Group.

I'll now talk about the balance sheet and cash flow. As an overall comment, our financial position remains extremely strong. Cash flow from operations totalled 4.3 million in the third quarter '02, and 14.6 million in the first nine months of '02, exceeding net income by more than 50 percent in each respective period.

Cash flow to date represents a significant increase over cash flow from operations in the first nine months of '01. Our working capital ratio further improved to 4.8 as of July 31, versus 3.9 at October 31, '01.

The DSOs of accounts receivable as of July 31 improved by eight days to 55 days, compared to 63 days at October 31, '01. This improvement reflects our continuing efforts to manage receivable collection efforts and maximize cash flow from operations in the current business environment.

Just an additional comment about that. We have set up credit committees throughout the company and we are monitoring the receivables from all airlines. I can tell you that in all cases, we have put very, very tight controls, collection terms on those receivables. At this point we don't believe that we're there to be any airline customer of ours to go out of business. It would not have any significant impact upon our results.

As a result of the receive receivables, of course. That's what I'm talking about.

No customer represented more than 10 percent of consolidated sales in '02. And the top five customers represented less than 22 percent.

Inventories increased by 3.6 million since October 31, '01, and represents an increase in inventory turn over rate of about 16 days. As I discussed in our second quarter conference call, and as we expected, this increase is mainly associated with higher inventory balances in Flight Support Group associated with new products. The inventory turn over rate is up slightly, about two days from April.

As you know, and as I have discussed on prior conference calls, theed addition of new parts to our product line requires an increase in our base stock inventory in order to be in a position to supply these parts. So the more parts we receive FAA approval on, the more parts we must stock. Naturally, our inventories are going to increase.

Keep in mind that initially those inventories don't turn because they hit the shelves and they may be there 30, 60, 90 days before they start to move and show up in sales.

Inventory turns, as expected, will be a little bit slower. But saying that, we have programs in effect to cut down and monitor the size of these inventory stocks and we are, through management programs, trying to control it. That's why the inventory rate is up only slightly from April.

Long-term debt to capitalization decreased two percentage points to 24 percent, July 31, '02, versus 26 percent as of October 31, '01. And we reduced the revolver balance by about $3 million, to 62 million from 65 million at October 31.

Our credit line is 120 million. We have slightly more than 50 percent drawn down. We think it's quite conservative.

CAPEX in the first nine months of '02 was 5 million, within our annual budget of 7 million.

In terms of our outlook, we are pleased to note that while our 2002 results have been negatively impacted by events of September 11, and the airline industry as a whole continues to struggle to return to profitability, we have been able to cushion the impact by diversifying our operations. Revenues from defense customers represented about 25 percent of total revenues in the first nine months of '02. And defense revenues in the first nine months of '02 increased over 50 percent compared to the first nine months of '01. Including sales from newly acquired businesses. We do expect continuing strength in this market.

Approximately 10 percent of our year-to-date fiscal '02 sales were from customers other than aviation and defense, including industrial, medical, electronics and telecommunications.

So if you want to look at the breakdown, 65 percent were aviation related; 25 percent defense; and 10 percent from other, including industrial, medical, electronics and telecommunications.

Further, as we mentioned before, cash flow from operating activities remains extremely strong. We think this shows the quality of HEICO's earnings. As we noted before, we could have abandoned the medium and long-term growth strategies by reducing new product development spending and cutting back on marketing efforts. That would have benefited short-term operating results.

But we have stayed the course. In fact, we have increased our new product and marketing efforts. We did this with the expectation that such product development, together with strategic relationships, with some of the world's major airlines, while having a negative impact on near term, will provide significant benefit in future periods.

We look forward to the balance of '02, expecting some improvement within commercial aviation markets, and continued strengthening within defense related products and services. We recently completed a tax audit that will result in recovery of a portion of taxes paid in prior years and is expected to increase fourth quarter earnings by about $2 million. Despite the softness in the commercial airline industry we continue to believe that earnings per share for '02 will be within the range of 65 to 70 cents, including the tax recovery.

At this time we expect considerable improvement in '03 over '02, as we target earnings levels within current analyst expectations, or in a range of 90 to 95 cents for fiscal '03.

In closing, let me say that while the weakness in the airline industry may continue into the foreseeable future, our product offers substantial opportunities for the airlines to reduce operating costs. We continue to have discussions with customers to reduce their cost through the increased use of our products and services.

We are confident that these efforts, coupled with our strong balance sheet and ability to continue developing new revenue sources through internal growth, as well as a selected acquisitions, will provide opportunity for sustainable growth.

Keep in mind that the new product development is the source of our internal growth and those new products are coming on stream and being approved by the FAA in record numbers. Therefore, we are very optimistic about the outlook for the future.

Those are my prepared comments and explanations. I would like to open the floor for Q and A. We can direct questions to any of the four of us who are seated around the table.

So operator, if you would like to open the floor for Q and A, please.

At this time I would like to remind everyone, if you would like to ask a question, press star, then the number one on your telephone key pad. We will pause for just a moment to compile the Q and A roster.

Your first question comes from Sam [Walstein] from Wachovia.

Good morning.

Good morning, Sam.

Could you talk about the geographic nature of the airline demand? You said it strengthened over the summer. Where is that strengthening coming from?

I will let Eric answer that. He is our in-house expert on that.

Sam, in the beginning of the summer we started to see some weakness in the May and June period, primarily from Europe. And then in July we saw significant strengthening from all over the world, including Europe.

So I would say that the strengthening that we are seeing now is worldwide. It is not concentrated in any geographic area. Of course, the United States airlines are having their own financial difficulties and they are trying to reduce maintenance costs and operating expenses as much as possible. We think that's what caused the drop in the May and June time period.

But now that they have to go ahead and perform this maintenance, we are seeing reassuming of normal activity. We see the strengthening across the board.

What I'm trying to understand, how you can still have the same outlook into fiscal '03 given some of the capacity reductions we are seeing at American, Continental, U.S. Air and presumably UAL will be not too far behind.

We have not factored in capacity reductions at UAL. At this point they have not stated that they are going to pull out capacity. UAL was aggressive in pulling out capacity post September 11. Of course, that's what helped to contribute to our decline in sales as a result of the [JT8D] aircraft that they withdrew from service in September and October.

Fortunately, American Airlines is withdrawing aircraft for which we do not supply any parts. The same is true for Continental and U.S. Air.

So we don't believe that we have, I would say any exposure whatsoever to those carriers. And we still think that our '03 numbers are very realistic. They were built on committed customers for whom we had a high degree of confidence that they were going to use the parts. They have not announced any fleet plan changes for the fleets which utilize those parts.

So that's why we have been able to stand firm with this.

At this point have you seen any cannibalization to any great extent of the parts fleet in terms of what you are competing against in the marketplace?

In the [JT8D], while our sales are down about 50 percent, I think yes, that a portion of that drop is due to cannibalization. And as that cannibalization slows down over the next few years, possibly there could be a minor increase in sales.

But we are not forecasting that. [JT8D] now as a percentage of our sales, all the [JT8D] product as a percentage of our sales is around 8 percent.

So even if that were to increase, you know, the cannibalization were to slow down, maybe we would see a couple point pickup. We are not forecasting anything there.

We have not seen cannibalization or significant cannibalization in the non-[JT8D] portion of our business.

Sam, this is Larry. I would like to add one other thing. In our business model, which for competitive reasons we can't get into, you know, dig down and give you the details, it is based upon the new product development going into the market at a certain rate. And it is - the new product development, we talk about parts, but we don't talk about revenue streams.

As you know, one part can produce small or very large revenue stream. Part of our estimate of '03 and 04 is based upon our analysis and belief in the market for those new parts. So again, even though airlines would be cutting back - and they have been cutting back. The fact is that our non-[JT8D] part sales to date have increased. So we believe that as these new parts come on they will provide the strength in '03 and '04. That's really the main driver.

Okay, thank you very much.

Your next question comes from Steve [Workman] of Sidoti and Company.

Going to FSG for a moment, pretty much all year the sales were running flat sequentially, yet the margins continue to erode a little bit. Have you seen any change in terms of pricing? Is it mixed more towards MRO versus the new replacement parts?

Eric will answer that.

Steve, we do an analysis where we look at revenue change due to pricing and revenue change due to volume. And we have not seen any significant drop in pricing.

Yes, there have been certain competitive issues where we may have to compete against a little bit of surplus or a little bit of competition. But that has not been the significant driver there.

The reason the margins are down is because the [JT8D] business is down some 50 percent. That business was really on automatic. It was a mature business that was highly profitable. It didn't require much R and D or SG and A in order to manage. It had high incremental and conversely de incremental margins.

If you look at the non-[JT8D] business, the margins have not fallen in that area. The [JT8D], when you pull the [JT8D] out, of course, it creates overhead increases on a fully allocated basis in the manufacturing environments. Of course, the SG and A and R and D has to be allocated over fewer sales dollars. That's what's causing it.

Steve, that is really the main driver. Tom Irwin can get into that in a little more detail. As we cut down on the volume - I mean, the option is close a factory or lay off people and so forth. That would in the short-term increase the margins, in the real short-term.

But as a result of our production, the new parts approval production, we realize that we need those people and we need that equipment. So to lay them off in April, May, and June to try to find them back in October or November would be again a very short-term solution. It might have added a few cents to earnings, but in the long run would have hurt the company, would have hurt the morale and that's something that we don't want to do.

You know, we saw the drop in margins. We knew that this would happen. But we do expect that to, those margins to fill back up.

Okay. Can you also quantify to the bottom line the delayed shipments to those four military customers you alluded to during the quarter?

I think we would rather not for competitive reasons. At this point, anyway.

Okay. I'll move on, I guess.

Steve? Tom was going to comment.

Just to put numbers on what Larry was mentions. As he commented earlier we do expect to be back to pre-9-11 volumes next year. It costs us about a million dollars per quarter to avoid the lay off, severances, plant shut downs to keep what is today excess capacity that we believe we will need in terms of people, facilities, et cetera, et cetera, in '03. That's sort of a quantification, the million dollars per quarter is what it's costing us.

Okay.

That's what it is costing now. We expect that to be absorbed as - it will be spread over the new product as we move forward. And it won't, you know, it's going to shrink from the million dollars.

Gotcha.

Steve, this is Victor Mendelson speaking. I can give you maybe a little idea on some of those delayed shipments. They are a higher margin product. And it's somewhere in the neighborhood of $2 million.

In revenue.

I didn't feel comfortable giving the margins on it.

Nor do I. We don't want to let people know our pricing.

Sure, okay. Going out to FY '03 a little bit, can you tell us about the tax rate, R and D assumptions, and can you tell us about any acquisitions included in that forecast?

There are no acquisitions included in the forecast. Tom can get into some of the details.

Steve, as you know we continue to look at acquisitions. We think at some point we would make - none of the projections include those, because at this point it's too speculative. But Tom can answer the rest of your question.

In terms of the R and D presumption at this point, and we are just now reviewing our budgets in detail, but the overall presumption in our models are that R and D will be flat next year on a consolidated basis. That it wouldn't increase again as it did this year.

Relative to the tax rate, I think on an ongoing basis we feel like incremental rates would be somewhere between 35 and 36 percent, somewhere in that range. I think somewhere close to 35 and a half is what we used in our models.

Okay. I guess in your mind, how much of the recovery next year is based on the new products? And how much of it is based on improvement in air traffic?

I would say that mostly all of it is based on new product. Certainly over 80 percent is based on new products.

I think Eric is being very conservative at 80 percent. I would say it's closer to 100. You know, let's stick with his number. Maybe the guys have something in there. But it's virtually all new product.

Thanks a lot, guys.

Thank you, Steve.

Your next question comes from Sue [Kegmar] of Merrill Lynch.

Good morning, guys. Could we lay this out a little bit with more detail, just more simply? Can you just comment today on FSG sales, what percentage is [JT8D], what percentage is non-[JT8D], what percentage is components?

Looking to FY '03, what is that mix? If you can lay out what your after market growth assumptions are, either for each of those segments or just in total, however best?

Sue, I'm going to give that detail question to Eric. I'm sure he can help you with that.

Sue, we stated that going back to 1998, about 83 percent of our parts sales were [JT8D]. In 2002, it's running a little below 40 percent. A little below 39 percent is [JT8D].

So that can give you some idea of that.

In the Flight Support Group business, parts sales, total parts sales is about 68 percent of sales and overhaul and repair - component overhaul and repair is around 32 percent approximately.

So about two thirds-one-third.

Excuse me, one thing. Eric, to make it clear, some portion of overhaul includes sale of our parts.

That's correct. The consolidated - when we perform an overhaul and we use a HEICO part in that overhaul, say an air frame origin component, we are picking up that revenue in overhaul sales, not in part sales. So that is correct, a certain portion of the overhaul sales is parts sales - sales of HEICO parts, that's correct.

But of our PMA parts business, about a little less than 39 percent is [JT8D]. So the balance, a little over 61 percent, would be non-[JT8D]. That's up from about 17 percent was non-[JT8D] four years ago.

Does that answer your question about the break out between -

Right. And what are you guys seeing or expecting for FY '03?

For '03, we are expecting an increase, a fairly significant increase in our parts sales. So we expect that parts as a percentage of the Flight Support Group will increase by perhaps four or five percentage points. We have been rather conservative in the forecast of overhaul and repair sales, which we do expect to grow as well. But again, that increase in parts sales is, I would say, almost exclusively non-[JT8D] parts.

There are a few [JT8D] 200 parts that should contribute to a little bit of an increase, but the majority is going to be non-[JT8D].

Okay. Eric, are the components included in non-[JT8D]?

That is correct. All air frame related components and all engine related components are included in the non-[JT8D] category. That would include fuel, hydraulic, electric, mechanical component parts.

Just underline your forecast. What are you guys assuming for after market growth from, I guess let's just say last quarter and the fourth quarter and from year end to '03?

I'm sorry, can you repeat that? I'm a little bit confused.

Underline your forecast. What are you guys using for after market growth? What are you expecting in the fourth quarter and from FY '02 to FY '03?

Overall industry? When you say after market growth? Industry? Our sales?

Yeah, the industry.

Well, industry growth I would say is going to be fairly small. Our increase is going to come from a market share increases and new product penetration.

We think the industry will basically remain flat.

There may be a little bit above, but we are not for casting that into our model due to the uncertainty.

Just switching gears, the unit contract that you guys have, does that survive Chapter 11? Or do they have an out clause?

We do not believe they would reject our contract following a potential Chapter 11 filing. We hope that United is able to get the concessions from their employee groups that they need, as well as certain large vendors. But they say the significant amount of money as a result of working with us. We believe that will continue if there were a filing.

If all parties involved were to adjust prices the way we have with United, United wouldn't even be talking about Chapter 11. So we feel quite confident in our relationship surviving if they were to have Chapter 11.

Okay. Last question. What is your exact exposure to the 9 percent in general? The capacity cuts that were announced with the airline restructuring this couple weeks ago?

Most of the capacity reductions fortunately were in the [Fulker] 100 aircraft. American is taking out about 70 of them and U.S. Air is taking out some 30 or 35 aircraft. We have zero content on the [Fulker] aircraft. There will be zero impact on HEICO as a result of the American reduction as well as the U.S. Air reduction.

At American, they also announced they were going to pull out 9767s, which were powered by P W-4 thousands.

To date we have not had that business. We were forecasted actually to pick it up. But of course, we probably won't get that if they take those aircraft out of the fleet unless one of our other customers picks them up.

So we, in summary we don't think we have any exposure at American or U.S. Air because, in addition to U.S. airways pulling out the [Fulker] aircraft they are pulling out other Rolls Royce poured aircraft for which we don't have any content.

I think we are fortunate in that regard.

Continental is also pulling out some aircraft, but we don't enjoy that business currently. So we don't an physician don't anticipate any reduction in sales as a result of that.

If you look around the rest of the places in the world, the programs which they are keeping are the programs where we are heavy and the stuff they are pulling out we have minimal exposure to.

As a matter of fact, Lufthansa has announced they will be increasing their service and putting more aircraft in. So, of course, we are exclusively on the Lufthansa aircraft. So that offsets whatever small potential weakness there cobbles where.

That's interesting, they are one customer and they don't represent the major portion of our business, although they are a wonderful customer, but Lufthansa is doing quite well, as you know. We have a very close relationship with them.

Okay, thanks a lot.

Thank you.

Thank you, Sue.

Your next question comes from Chris [Quillty] of Raymond James.

I want to follow up on the gross margin question. Tom, you said a million dollars a quarter in say excess labor and overhead that you are maintaining in the near term because you think the sales are coming back.

If I scratch that out, your gross margins are around about 500 basis points where they have been historically the million dollars would translate into 200 basis points. So is it fair to assume you think there is around about 300 basis points of improvement based upon new product introductions, you know, new parts in the mix with better margins, supplanting the old [JT8D] stuff that was lost? How quickly can that transition take place?

I think the answer is, we continue to believe on a consolidated basis that operating margins for our business is in excess of 20 percent. That's obtainable, within FSG we are below that. There is one number that will impact those margins, but not to the magnitude of million dollars a quarter, but that's R and D. The answer is yes, we think it will be attainable to improve those margins back to those levels. We see it happening beginning in '03. Marginally beginning in the fourth quarter, but apparent in '03 and then by '04 we will be at a sustainable level. Again, that's given the impact of volume and R and D.

As we mentioned, this typically takes several years, maybe two to three years before we get significant volumes on newly introduced parts.

Okay. And speaking of parts, I just didn't jot down quick enough, I think it's when Larry went through the discussion of new PMAs and said 95 percent are non-[JT8D].

If you could go back quickly through the numbers of parts submitted to the FAA - I can't even read my handwriting now. I would like to get those numbers down once more.

Basically we now have about 2700 parts that are approved. I said that I don't want to give you an exact number for competitive reasons, but in fiscal '02 we expect to have in excess of 250 new parts approved. That doesn't give you a revenue number, but it, you know, it kind of gives you a number of parts.

And we think that those new parts, we estimate, go into the market over a three-year period in some fashion.

I also said that based upon our estimates of the market and the new product that we are introducing, our volumes say a year from now we would estimate that our parts volumes would be back to the levels that they were pre-9-11. That's our present guesstimate on that. We might be off a month or two either way, a couple months in the quarter. But the point is by the accelerated R and D activity, we are quickly replacing the [JT8D] and not only replacing it on the shelves, but it is selling.

Okay.

Does that answer your question, Chris?

I think that gets me the numbers. Quite honestly I expected you guys to have to guide down next year, just based upon the number of fleet reductions we have seen in the news. And you obviously seem to have dodged a bullet in terms of where they are pulling out capacity and remaining in the right places.

If there, if we are continuing to watch head lines, what areas either geographically or certain carriers would you be concerned or do you think would have an impact on the business if further cut backs continued?

That's a very general question, but since we sell the world's fleet virtually every airline that operates, with the exception of a few - and you are completely aware of this - I guess any time they begin to pull aircraft out of service, if there's a significant reduction, we will be impacted.

But what we see and what we have seen since 9-11 is an impact on [JT8D]. We have seen everything else improve. So again, you know, we have accepted the fact that [JT8D] is out. It's never coming back. And you know, forget about it. We have forgotten about it. We are producing parts. There is still a number of [JT8D] flying, but they are the newer ones.

All of our results since September 11 have non-[JT8D] has been on the up side. So you know, if they start pulling planes out, you know, it conceivably will impact us. But we think the new product will make it up. That's our best guesstimate at the moment.

Chris, one other comment in terms of our estimates for '03 on the ETG side, there's going to be some benefit from previous estimates by virtue of some of these items being pushed out, out of '02, which is hurting '02. Again if you look at our model, there's a slightly higher expectation on an ETG consolidate group also.

We are also, on the ETG side, we are also taxing '02 revenue with R and D expenditures. We have some very sophisticated, hopeful programs that are in the process that the one in particular that we are probably spending close to a million dollars a year on, one particular product item. It's being written off. As you know, we don't capitalize anything.

We would hope that that will come in. We haven't put the revenue estimate in there because, again, we can't be certain of it. But we are working on that product. And I know you always used to ask about the cockpit voice recorder.

Oh, you beat me to the point!

And the reason you ask about it is the same reason I ask about it. Let's ask Victor about it right now. It's a slow process. But it ain't dead yet.

I actually pulled some information on that from my file back when this whole issue first resolved. I have it from March of 1999 listed on the, you know, the request for top priorities. And I guess it's still pushing through the paperwork.

Victor can give you, he had some meetings within the last week or so. He can give you some color.

Chris, I don't know if you are aware, I don't remember whether it happened before or after our last conference call, but the FAA issued the technical standard order for the product, for that particular item. The technical standard order is the draft specification for it.

So they issued the draft technical standard or T S.O., it's called. Comments were due August 22. We provided the comments on our behalf plus two or three recorder manufacturers, basically the whole market for it. We are awaiting to see where that goes.

That generally goes in tandem with the proposed rule coming out. I can't tell you when the proposed rule is going to come out because we just don't know.

It was a very good sign and it caught everyone by surprise. But we still feel that the market is there for it and our relationships where we have exclusive relationships with the recorder manufacturers are very long-term. So

That's '03 and - the recorder manufacturers?

Recorder manufacturers, the market is dominated by L three communications and the 2nd largest producer is hone well and the next largest producer is Smiths industries. And fourth I think is spy Rones.

Chris, saying all this, we don't have anything in the '03 or '04 in terms of revenue for this product. So we are not assuming it is going to happen. If it does, we have kind of an up side potential there.

We think - incidentally, we still think that if it happens or when it happens, it will be a very strong blockbuster product.

I think the numbers I ran years ago were something like 40 or $50 million opportunity or, you know, cost to the industry to upgrade, just in terms of hardware, the existing commercial fleet.

It's absolutely broader than that. It's not just going to be our product. It involves upgrades to the recorders themselves or replacements of the recorders themselves. That's why it's a very important thing for the recorder manufacturers because for them, it means it's not just the revenue coming through us but it's the revenue for - which is much bigger. It kind of dwarfs, our revenue portion will be dwarfed by what they pick up. It's a huge thing and they are interested in it, too.

Final question from me just on the low cost airlines and where you are standing with most of those fleets. Is that an area of opportunity? Or threat as they eat into the established players?

We think it's an opportunity for us. There are obviously a number of the low cost carriers that have newer aircraft and they are on maintenance holidays right now and still have their warranties and the burn rate on the equipment hasn't kicked in. We think that's an opportunity for us to increase revenue as they continue to need new parts.

Of course, being low cost operators, they understand what it is to compete and the need to have competition and really cut their costs. We think it will be a great market for us.

Thanks a lot, guys.

Thank you, Chris.

Your next question comes from Sam woo ton of I C M.

Hi. Most of my questions have been answered. One question that I had was, I think was asked, in terms of the '03 and perhaps the third quarter, what was the [JT8D] percentage as well as the non-[JT8D] percentage? Where do you expect that to go next year? Where was it as of this quarter? You gave us the yearly run rate?

Eric will respond. Obviously it will go down in '03. It will continue to go down forever. But Eric will give you those numbers.

Sam, I have in front of me a schedule. I don't have it broken out by year, but in '02 it was - let me back up. In '01 it was 56 percent was [JT8D]. In '02, it's 39 percent. And we believe that that is going to continue to go down until '06 where it should reach around 17 percent. So I would say probably around a 5 percent drop roughly per year, until it gets down to the 17 percent area.

That's through a combination - that's primarily due to the growing of the non-[JT8D] part of the business, combined with continuing weakening in the [JT8D]. But I should point out that of the 39 percent of our sales which is [JT8D], only 9 percent of our sales are products which are eligible only on the baby [JT8D], or the [JT8D] standard engine which goes on the 727, the 737, 10200, and the D.C.-nines. The 30 percent of our [JT8D] are sales that are [JT8D] are eligible for installation on the dash 200, which powers the M.D.-80s.

We believe that the M.D.-80s are not going to be retired for a number of years and that we are in pretty good shape on that part of our business.

Okay, great. Thank you.

Thank you.

At this time there are no further questions. Mr. Mendelson, are there any closing remarks?

My only closing remarks are thank you all for participating in this conference call. And having confidence that you have had in HEICO. It has been a bumpy ride since September 11, not only for HEICO but for the economy and many industries, the airline industry in particular. And we think as in the past HEICO certainly will come out of it and so will the U.S. economy.

So again, we thank you. We are available if you have other questions. I'm available, Tom Irwin, Victor or Eric Mendelson. And we would be happy to take any calls or questions you may have. Thank you and have a good Labor Day holiday.

Thank you for participating in today's teleconference. You may now all disconnect.