HEICO Corp (HEI.A) 2003 Q2 法說會逐字稿

Good morning and welcome to the HEICO Corporation second quarter results conference call. I will now turn the call over to your host, Mr. Laurans Mendelson.

Thank you. And good morning to everyone on this call and we welcome you to the HEICO second quarter fiscal 2003 earnings announcement teleconference.

I'm Larry Mendelson, CEO of HEICO Corporation and I'm joined here this morning by Eric Mendelson, President of HEICO's Flight Support Group, Victor Mendelson, President of HEICO's Electronic Technologies Group and HEICO's General Counsel and Tom Irwin, HEICO's Executive Vice President and CFO. Before we begin, Victor Mendelson would like to read a statement. Thank you. Good morning.

Certain matters discussed in this conference call will include forward-looking statements which involve risks and uncertainties.

HEICO's actual experience may differ materially from those discussed as a result of factors including but not limited to, the 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, airline fleet changes, customer credit risk, U.S. Government export policies and restrictions, military program funding by U.S. and non-U.S. government agencies, HEICO's ability to make acquisitions and achieve operating synergies from acquired businesses, interest rates and economic conditions within and outside of the aerospace, defense and electronics industries.

Parties receiving, listening to this conference call are encouraged to review all of HEICO's filings with the Securities and Exchange Commission including but not limited to filings on forms 10-K, forms 10-Q and forms 8-K.

Thank you. Victor, thank you. And now before reviewing our second quarter operating results in detail, I would like to take a few moments to summarize the highlights.

Our Flight Support Group reported higher sales and operating margins in the second quarter of '03 despite the continued weakness in the commercial aerospace industry, which was further impacted by the war in Iraq, and the outbreak of SARS. Next, we continue to generate very strong cash flow and that's facilitated our successful refinancing of our $120 million revolving credit facility earlier this month.

Positive cash flow from operations has allowed us to reduce the amount outstanding on the facility, by $8 million in fiscal '03 through April 30. Next, we expanded our services to regional airlines through a small acquisition which was completed after the close of the second quarter.

In addition, HEICO's Flight Support Group entered into a strategic relationship with Air Canada, to accelerate the development of new FAA approved replacement parts. This strategic relationship marks the fifth such unique partner position that we have with some of the world's leading airlines. including Lufthansa, American Airlines, United and Delta.

At HEICO, we believe that these successes are a direct result of our known strategy of remaining focused on medium to long-term growth opportunities. I'd like to point out that sales of non-JT8D FAA approved replacement parts were up 21% in the first half of '03 versus '02.

New product approvals almost all of which were for non-JT8D powered aircraft in the first half of fiscal '03, approximated our planned results and we are on target to meet our goal of approximately 300 new part approvals in fiscal '03. At this point, we now have approvals for almost 3,000 parts from the FAA.

Moving into the specific areas on the P&L, we'd like to tell you that consolidated revenues in the second quarter of '03 decreased by $1.4 million, or about 3% versus the second quarter of '02. The decrease in sales primarily reflects a decline in the Electronic Technologies Group, not the Flight Support Group, partially offset by improved sales within Flight Support.

Sales of the Flight Support Group actually increased 3% to $30.4 million in the second quarter of '03, from $29.5 million in the second quarter of '02. This reflects an increase in parts sales and repair services.

Note that the sales of the Flight Support Group in the second quarter of '03 started out much stronger until about mid-March, when they began to turn down. And that reflected the war in Iraq, and the impact of SARS on our commercial airline customers.

Moving over to the Electronic Technology Group. Their sales decreased 17% to $11.3 million, in the second quarter of '03 versus 13.6 in the second quarter '02. The decrease primarily reflects lower foreign military sales, and to a lesser extent, shipments that were deferred due to production delays in certain products as well as some delays pursuant to customers' requirements.

Sales of the Electronic Technologies Group were actually up $1.3 million over the first quarter of '03. And that reflects the shipment of some previously delayed deliveries which we have discussed with you in the Q1 telephone call.

Moving on to operating income, the consolidated operating income in Q2 of '03 was $4.9 million, versus $6 million in the second quarter of '02. Operating income in the second quarter of '03 primarily reflects lower earnings in Electronic Technologies, partially offset by improved sales and earnings within Flight Support and lower corporate expenses.

Operating income of Flight Support actually increased 8% to $4.2 million in Q2 of '03, versus $3.8 million in the second quarter of '02. This reflects primarily lower new product development expenses as well as the impact of improved sales from new products and services.

Operating income of Electronic Technologies was $1.9 million in the second quarter of '03, versus $3.4 million in the second quarter of '02. And the decrease primarily reflects lower foreign military sales, and the deferred shipments that I spoke of a moment ago. Electronic Technology operating income rose $1.1 million from the first quarter of '03 reflecting higher revenues.

In terms of operating margins, the consolidated operating margins were 12% in the second quarter of '03, down slightly from 14% in the second quarter of '02, and this was due primarily to lower Electronic Technologies Group margins. The operating margins within Flight Support are principally due to lower new product development expenses and higher sales volume.

The lower operating margins within Electronic Technologies that were 17% in Q2 of '03, versus 25% in the second quarter of '02, reflect the lower foreign military sales and a less favorable product mix, plus the deferred shipments.

Electronic Technologies operating margins for the second quarter of '03 increased significantly from reported margins from the first quarter of '03. And that is 17% versus 8%, and that was due to higher sales volumes previously discussed.

In terms of earnings per share, our diluted earnings per share was 12 cents in the second quarter of '03, versus 18 cents in the second quarter of '02. I want to point out that in '02, 3 cents of the 18 cents was as a result of the sale of a product line.

The lower earnings per share in the second quarter of '03, which was 12 cents versus '02, 18 cents, reflects the lower net income in the second quarter of '03, which was $2.6 million, compared to $4 million in '02.

Moving on to depreciation and amortization, they were $1.2 million in the second quarter of '03, up slightly from $1.1 million in the second quarter of '02.

Research and development, total expense was $2.1 million, in the second quarter of '03, compared to $2.6 million in the second quarter of '02. The second quarter year-over-year decrease in R&D expense of approximately $600,000 is in line with the small budgeted decrease within our Flight Support Group for 2003.

Flight Support's budget for '03 is about $6.8 million, and in '02, the actual was about $7.8 million. And we do not expect this budgeted decrease to negatively affect our new product development results. As a result, -- because of our development group's have become more efficient and have reduced costs consistent with our expectations.

The addition of new FAA PMA approvals particularly for non-JT8D aircraft continue to be critical to our long-term growth in light of the retirements in the JT8D standard fleet after 9/11. We currently have approximately 800 parts in development over 95% of which are for non-JT8D powered aircraft, and we now have approximately 3,000 parts approved by the FAA. Over 70% of those are non-JT8D powered aircraft.

The new parts released by our R&D group in the first half of '03 continued at a strong level and pretty much as budgeted for that period.

SG&A expense in the second quarter of '03 decreased approximately $400,000 from the second quarter of '02 on lower sales levels, and remained approximately level at 22% of sales in the second quarter of '03 pretty much the same as the second quarter of '02.

Interest expense in the second quarter of '03 decreased by $189,000 compared to the second quarter of '02. The decrease was principally due to a lower weighted average balance outstanding under the credit facility in the second quarter of '03, as well as lower interest rates.

I want to point out again that our strong cash flow from operations has allowed us to pay down the outstanding balance on our credit facility by about $20 million over the last 12 months. Interest and other income in '02 and '03 were both minimal.

The company's effective tax rate decreased slightly from the 35.8% in the second quarter of '02 to 35.3% in the second quarter of '03. Minority interests of $405,000 in the second quarter of '03 represent principally the minority interest of Lufthansa and American Airlines in our Flight Support Group.

Moving onto the balance sheet and cash flow, I want to point out that our financial position remains extremely strong.

Cash flow from operating activities improved and totaled $6.8 million in the second quarter of '03, versus $6.3 million in the second quarter of '02. And it was $13.5 million dollars in the first half of '03 compared to $10.3 million in the first half of '02.

The year to date cash flow of about $13 million approximated 250% of the net income in the first half of 2003. And I'm going to stop to mention that we believe that cash flow is the name of the game. We think it's, you know, crucial, particularly in these difficult times.

We are a company that is financially conservative, as all of you know, and we watch the cash flow very carefully. The banks appreciate it and I think our creditors appreciate it, and to have 250% of net income as cash flow shows the, I think, very high quality of HEICO's earnings.

The strong working capital ratio that we have increased to 4.7 times as of April 30, '03 versus 3.4 as of October 31, '02. And this reflects the new revolving credit facility.

The DSOs, days sales outstanding of accounts receivable at April 30, '03 improved by three days to 54 days, compared to 57 days at October 31, '02. The improvement reflects our continuing efforts to closely manage receivable collection, and maximize cash flow from operations in this current business environment.

We work continually to diligently manage these credit exposures in light of financial challenges facing some of our customers. I'd like to point out that no customer represented more than 10% of consolidated sales in the second quarter of '03, and the top five customers represent about 30%.

Inventories decreased slightly since October 31, '02, and the inventory turnover rate is up about three days, 175 days as of April 30, '03 versus 172 days as of October 31, '02. The increase is mainly the result of decreased foreign military sales within the Electronic Technologies Group, as I previously discussed.

Our low total debt to capital ratio decreased actually further to -- by three points to 18% as of April 30, '03 versus 21% at October 31, '02, as we used our positive cash flow to reduce the revolver loan balance by about $8 million during the first half of '03. As of October 31, '02 the revolver was $54 million, as of April 30, '03 it was $46 million.

CAPEX in the first half of '03 was $2.3 million, pretty much in line with our annual budget of 5 to $6 million for fiscal '03.

That is the historical and now a few comments on the outlook, what we see. We are pleased to report improved results in Flight Support, which not only have been affected by the weak economy, but were further impacted by the recent military conflict in Iraq, as well as the outbreak of SARS. As I mentioned before, sales were stronger until mid-March and then softened somewhat due to the Iraqi war as well as SARS and the general conditions in the commercial airline industry.

We believe that our continuing new product development efforts combined with the strategic relationships that we have with some of the world's major airlines contributed to the improved earnings in Flight Support.

Although sales and earnings of our Electronic Technology Group increased significantly compared to the first quarter of '03, the decline in sales to foreign military customers and some continuing production and delivery delays contributed to Electronic Technology sales and earnings in the second quarter of '03 falling short of our expectations.

We do continue to work diligently to overcome these issues, although the timing of certain foreign military sales remains uncertain.

We remain confident of our long-term opportunities for growth, although we have revised our targeted fiscal '03 earnings to a range a 50 to 55 cents a share on sales growth of 1 to 2% over fiscal '02, due to the current uncertainty in the commercial aviation industry.

I don't have to point out to all of you that we try to look at this thing on a conservative basis, we're not forecasting an upturn. We're optimistic that we might have one, but we would rather forecast continuation of the current trends and at this point we do not assume any upturn in the current year.

In closing, in light of the challenges facing the aviation industry today, we are continuing to adhere to our long-term strategy of developing and marketing new products and repair services which provides our customers with substantial cost-reduction opportunities. We believe that the strategy coupled with our strong balance sheet, as well as the ability to develop new revenue sources through internal growth, as well as selected acquisitions, positions us with the opportunity for substantial forward growth.

One other comment about acquisitions. We continue to look at a fairly large number of acquisitions. Our acquisition criteria is very, very tough, and there is nothing that I can tell you that is imminent, that we're going to announce immediately, but I can tell you that we are busy looking at a large number and we will continue to be very selective.

And that ends my formal prepared comments, and I would like to open the floor up for questions for our listeners.

If you would like to ask a question at this time, you can do so by pressing star 1 on your telephone keypad. And if you wish to no longer ask your question or your question has been asked or answered, then you can press the pound sign and it will take you out of the question queue. Again, to ask a question, you can press star 1 on your telephone keypad. We do have a couple of questions on the board, our first question is from Tom Lewis.

Good morning. Hello?

Hi, Tom, good morning. How are you?

Great, great. First question, can you tell us a little bit about what you're getting in this acquisition that you've made? Should we understand this as a product line, a development effort, can you put a little quantification on it?

Yes. I'm going to ask Eric to comment on it because he has been in the forefront of that, so he'll tell you about it. Tom, this is Eric Mendelson. We acquired a repair station in California which focuses on the regional aircraft products, and the component repair, and it's consistent with our plans to continue growing our already significant business in the regional aircraft component repair market and component parts market.

Okay.

Just a little bit more color. The motivation for it was that we think that this particular facility can increase our market share and reach out to other customers that we would -- well, didn't have presently, and some other customers that we would be able to increase our market share with those other customers, broaden our line and our capability. It was really -- we now have two facilities out there, of similar nature in California, and we have two in Florida. So it was kind of a geographic move as well as one to increase market share.

Okay. Are regional aircraft meaningfully represented in your array of PMA qualification?

Not so much in PMA, but in the repair and overhaul part of our business.

As you know, approximately 30% of the Flight Support Group revenue comes from repair and overhaul, and certain key niche relatively higher margin there. We don't do, you know, low margin overall, we don't do C checks, D checks and so forth, but we will do various types of component repair, hydraulic, pneumatic, and some structural repair. It's in that segment that -- not in the PMA and parts as much. Although, I must add, there are opportunities that we do develop occasionally in that regional area with PMA. Tom, this is Eric. Now as the regional jets continue to mature, there is great opportunity for us in that market and we are developing products for that market.

Well, I absolutely agree with the opportunity to service that fast growing base of assets. Okay, the other question I have being relatively new to your particular situation, the apparent unpredictability of foreign sales in the ETG part of your business, is that kind of the way it's always been? Was it unusually strong a year ago or normal a year ago? Can you put a little bit of that kind of perspective on it for me?

I'm going to answer part of it and turn it over to Victor. It has always been that way and we've always recognized -- it's a very good business because of foreign governments and all the other approvals that are necessary. It is not a -- as predictable a business as we might like. It can be a very good -- excellent business, in this particular case some of these shipments, I don't want to go into the governments and so forth, but they have been delayed longer than we had expected. But Victor can give you a little bit more color on that, Tom. Tom, this is Victor Mendelson. That business -- when we acquired our commercial airline services business almost two years ago, we started cautioning at that time that one of the potential rifts we could see from quarter-to-quarter would be foreign military sales as a result of governmental and political issues that pop up. And it's also possible that from time to time we would see, although we haven't seen it happen yet, but it's possible that orders could get cancelled after they get stretched out for long periods of time. So I would expect that there will be some lumpiness to it, although the stretch-out that we've seen there over the last six, eight months or so, I believe should be atypical, but I guess we'll just have to wait and see as more time passes.

Okay. Should we understand a level that this kind of business in the year ago period as being, if there is such a thing, relatively normal, on the high side of normal, on the low side of normal?

That, in the year ago period, that should have been roughly, you know, fairly normal, maybe a little bit on the high side. But we would have -- you know, that was probably a level that we would have expected to see maybe a little bit higher than we would typically expect. But, you know, somewhere close. Tom, one other thing I'd like to point out with that IAS business, the inertial business. We're doing a lot of interesting kind of analysis and work up there in that facility, and we would expect in the future to see -- just like in every business that we have, we would assume that new products and other things would become available. We do that in all businesses. But when the sales are pushed out, you don't see the revenue benefits. And you only see the expense side. So, you know, we're optimistic that the future is going to be bright, although, you know, you can't be positive.

Okay. Last question, would have to do with the -- you know, your assessment of the level of uncertainty in FSG's markets. I think that, you know, compared with 90 days ago when we didn't know how the Iraq situation was going to turn out, except for SARS arguably, I would think the level of uncertainty would be lower now than it was 90 days ago. Can you talk based on what you're hearing from your customers in addition to SARS what might be the basis of increased rather than decreased level of uncertainty in protecting demand?

Tom I'm going to ask Eric to respond to that because he's very close to it. Tom, you're absolutely right. With regard to everything other than SARS, things are turning up. The, you know, American Airlines, United Airlines have received concessions from their vendors and their labor groups and they're starting to fly more. The U.S. industry is getting stronger in that regard. And people are feeling better about the future.

The big problem is SARS. And the carriers that have large exposure to the Far East which includes some of the U.S. carriers as well as the European, of course the Far East carriers are experiencing significant problems. A number of them have upwards of a third of their fleet on the ground. And of course when the fleet is on the ground, they don't need the parts. To make the problem worse, in the engine world, when they have engines on the ground on parked aircraft rather than in duct, engines which need to be overhauled, on the still-flying aircraft, they pull them off of the parked aircraft and that further suppresses demand. That's really what we've seen over the last couple of months.

Now, that will ultimately snap back when the airlines need to return the grounded aircraft into the air, they won't have engines available for service, and they will continue to have demand to service the engines that were flying. So there will be a snap back in demand for a period of time to approximate what happened by taking the good engines off the grounded aircraft.

But until that happens, and until the engines that are on the ground are used up, we are experiencing some weakness. And I could say that almost all of this is attributable to SARS and as soon as the world gets a handle on this thing, things should turn around rather rapidly.

Okay. Well, thanks, I had a hunch that the physical redeployment of physical assets was an exacerbating factor there in addition to the reduced cycles and just one last little thing. Am I correct in assuming that your top customer, Lufthansa had a meaningful Europe-to-Asia business going there?

By the way, Lufthansa is not -- I don't think we've stated that they are necessarily our top customer, but specifically with regard to them, yes, they did have and they do continue to have a number of flights to Asia and of course those flights are flying much emptier than they were four months ago. So but it's not only affecting Lufthansa, it's affecting I would say every carrier in the world that has exposure to the Far East. Thanks a lot, keep up the good work. Thank you, Tom.

Our next question is from Sam Yake.

Yes, hello. I've been a long time shareholder, I think you've done very well in a tough environment. But could you address an issue that I still don't understand? And that is the gap between the price of your common stock and your Class A stock? Because from my study, there is no difference, except for the vote, one vote on the one hand, one-tenth of a vote on the other. Can you fill me in on why you think that gap exists?

Well first of all, I can tell you that we all agree with your conclusion. And we also agree with your analysis as to the only difference being the vote. We don't understand it ourselves. We can tell you that we had a study commissioned by Merrill Lynch and one of the other firms, and I don't remember if it was Morgan Stanley or somebody else, but there should not, in our opinion, there should not be a gap at all.

And if there is a gap, it should be no more than, say, 3 to 5% maximum. We do not understand why there is this gap and we cannot account for it. Because under any circumstance, in every single respect, dividends, opportunity, earnings per share, whatever it is, the two classes are equal except for the voting difference. And so we don't understand it either.

Okay. And as a follow-up on that, I know you authorized another buyback. Are you considering buying back -- the A stock looks particularly cheap. Could you comment on that?

Personally, I agree with you. I think the A stock is cheap in this current environment. I think that the -- you know, there are some people that are concerned that, you know, the aircraft industry, and they don't want to be participants in this, I think from our perspective that's a relatively short-term view. We have never been a short-term player, as you know, we're a medium and longer term player.

And I think that as Eric mentioned earlier, when the airlines start flying, they're going to have to get parts and we believe that this is a situation similar to what happened in the early '90s, mid-'90s at a certain point they're going to have to pull those engines and repair them and overhaul them. And they're going to need parts.

So I think the shares are very attractive price. We have purchased some shares over the past six months as part of that buyback announcement. We actually did. Other times, truthfully, we went into the market and couldn't even buy the shares.

My observation is that if somebody wants to buy 50 or 100,000 shares, and they try to buy it when the A stock is six, they're going to have a hell of a time doing it. I don't think it can be done. But, you know, sometimes on an intra-day basis if people are not active in the market and the specialist is the only one there, the buyer of last resort, he may buy it at 6 or buy $5.80 or $5.90, and bang it jumps right back up. I'm talking from actual experience. I think HEICO is a very strong company and I think at these prices it's a very good value.

Thank you so much.

Thank you.

Our next question is from Jim Friendly.

Good morning.

Good morning, Jim.

I'm calling in for Chris Quilty this morning. Would you guys consider a dividend increase at this point or probably not?

We always consider those things, Jim. You know, we -- the board meets and we regularly, you know, probably at least once or twice a year, we discuss dividends. We discuss cash dividends and stock dividends and that's a board policy decision. I don't want to make any advance predictions, but the answer is yes, we do consider it.

The other question I had was with regard to some of your recent partnerships. And I was wondering at what point do you expect those agreements to translate into higher sales growth? And what kind of indicators would you be looking for from an outside perspective to keep tabs on that?

I'm going to ask Eric to respond. I can tell you, overall, [INAUDIBLE] those relationships are extremely valuable and our relationships with the airlines are really outstanding. It's a pleasure to deal with those people. They have resulted in increased revenues. But Eric can comment a little more on that. Jim, this is Eric Mendelson. I can tell you that our partner airlines and our customer airlines are very happy with our new product development approach. They're happy with the number of products we're bringing to the market. They have internally projected the savings as part of their very important cost cuts.

One of the ways that some of the airlines that have been able to achieve labor concessions were able to do so was by showing the rank and file employees that they were doing more than just asking for givebacks that they were, in fact, cutting costs. And we've been a rather high profile part of a number of those discussions. So they are forecasting and counting on those earnings.

Unfortunately, as you know, the demand has just dropped in the last couple of months. So while we signed up Delta and Air Canada, I'm sure you're aware of some of the financial problems that not only they have had but all of the carriers have had. And I would say that airlines today are trying to conserve cash to the highest degree that we have ever seen. They've got these various cash requirements in their loan agreements. And they are holding back on purchases as much as they can, drawing down on inventory, making sure we can support them on 24 hours notice.

And so while we have not seen the increase in sales that we would have liked associated with the business partnerships, I feel extremely confident that it is coming. These airlines are committed to us to purchase these products as we develop them and as they need them. They are all requirements contracts. So we can't make them buy something if they don't need it.

We are sure that we will pick up the sales as soon as they need the parts, and it's not a matter of losing market share or anything like that, it's just a matter of them conserving cash, using engines that are on parked aircraft, in order to try to save as much money as possible. And there will be a snap back here that I think you'll see just as soon as these engines on the ground are used up. And I think we're probably getting, you know, we're at least midway through that cycle. If not further along.

If there were a snap back, do you think that your prior guidance would have been attainable? In other words, if let's just say tomorrow we get this snap back for whatever reason, do you think the impact, the positive impact would get you back to where you might have been otherwise? Or is there just enough continued weakness in the industry that guidance would have come down in any event?

With regard to the Flight Support Group, the answer is definitely. We definitely would have achieved -- we would achieve those numbers if there were a snap back. We could actually even go above the numbers if there were, depending on the degree of the snap back in the industry.

And what about ETG?

ETG is not as affected by the commercial aircraft, so I will let Victor answer that. I think that -- this is Victor, Jim. I think that it will benefit us because we do have commercial customers and we do have commercial initiatives that we work on from time to time there. So I think it would certainly.

And --

But just so you understand and Tom Irwin, I think, I'm going to ask -- if I'm speaking out of turn, Tom, correct me. I think that if the flight support business were to snap back, that we probably would have been, even with ETG, probably would have been pretty close to our original earnings projection. You know, reasonably close to it. Is that correct, Tom?

Yes, this is Tom Irwin and I would say yes. And again, that's the significant benefit of the in fact that within the Flight Support Group we have some very high incremental margin products that would -- a big portion of the sales dollar would go to the bottom line.

Okay. You mentioned some production delays and shortfalls in ETG and I was wondering if you could provide any more delineation with regard to that as far as by product line or customer or country customers?

Jim, this is Victor. We really can't break out the product line or the customers too much other than I would say the biggest part of the shortfall came out of our inertial, navigation and repair businesses.

At what point would you essentially write off those sales as far as saying okay these production delays have really become cancellations?

I guess we wait and see at which point, you know, we don't include those in backlog figures and we don't include those in our outlook at this point. We've actually taken them out of our internal outlook and our planning for the current year. That's right, for the current year. And we haven't done the budgeting, completed our budgeting process of course for 2004. So we run the business assuming that it won't be there, but we believe that it will be there because our customer is telling us that they're just dealing with internal political and funding delays, and they're governmental issues that we've been apprised of. So that's how we do it. I want to clarify this or make it pretty clear that the customer is telling us that the order is coming and that we should plan on doing it and so forth. We have, because of the delays and trying to err on the conservative side, we have excluded it from our future outlook. The customer is still saying it is coming. So hopefully the customer will be right, but we don't want to make predictions that we're beginning to lose confidence.

I must tell you that this has happened in the past, and in most cases the customer was right. So -- but I can't tell you that this time because we really have no control over it. But the customer tells us it is coming.

Jim, this is Tom Irwin. Just one other point. There were some production delays within some of the infrared product lines and, in fact, those production delays were fixed, if you will, in the second quarter. Some of those products went out in the second quarter, some of them are now being projected to go out in the third and fourth quarter. So from that respect, the items have been worked out, there were some vendor delays I think we spoke about on our first quarter conference call in particular, in fact those products did ship in the second quarter.

Final question from me is sort of a two-part question. With regard to your current guidance, how much of -- if any, of the current guidance assumes the snap back that we've talked about? And if so, how soon? And part two of that question is, how much of current guidance assumes a strong repair and overhaul business? And if you could just shed some color on your assumptions in the repair side of the business, just in terms of pricing and demand, what have you.

To answer -- I'm going to turn that over to Tom Irwin, but I can tell you that the repair and overhaul business is quite strong. It's actually slightly ahead of what we had even anticipated. We think that's due to just a lot of hard work on our people's part, in addition to market share. And we think that those people are really doing an extraordinarily good job, particularly in this environment.

On the parts side, it is very hard to gain market -- we do gain market share by the addition of new parts. And that's part of our overall strategy. However, when the total parts market is down, even though we add new parts, the pickup -- we have seen a revenue pickup, as I pointed out in my comments. So that group is, from the marketing side, is doing a very, very good job. It's just the demand side that has hurt us. But as to what has been projected, I'm going to ask -- and when that clicks in, I'm going to ask Tom Irwin to try to respond to your question. Tom?

Yes. Specifically, our targeted earnings for the full year and in particular, the rest of this year, do not presume anything that you would describe as a snap back, that is, no dramatic recovery or dramatic catch-up. The earnings estimates as targeted do include some strengthening in the fourth quarter for our parts, PMA parts sales relative to what we saw in the second quarter as Larry mentioned, particularly with the Iraqi and SARS impact beginning in March and April, and to date in May.

And as Larry mentioned, the repair and overhaul revenue has been strong throughout this year, and at this point, we don't expect any significant positive or negative change in repair and overhaul revenue. And again, in our outlook at this moment, we've taken out a piece of that significant foreign military sales shortfall that was originally in our outlook and have in effect taken it out of our '03 numbers.

Okay. That will do it for me. Thank you very much.

Thank you.

Our next question is from John Walthoffen.

Yes, good morning. This is a follow-up question on the guidance, and this is maybe a picky point, but I'm intrigued by your guiding to 1 to 2% revenue growth, which is incredibly tight given the uncertainties you have there, but then you bracket the earnings by a nickel which suggests that there's more uncertainty about earnings than revenues. And I was wondering whether there's some uncertainties in your cost structure that we haven't talked about that we should talk about?

I don't think so at all. No. I don't think there are any questions about the cost structure. I think our cost structures are very good. As revenue come down, our operating margins going to come down. But the cost structure, I don't think there's weakness in that. If anything, I think the cost structure is really improving. It's getting better than it was last year, it's strengthening. But it's the revenue side.

I think that this whole issue that we are facing is a revenue issue. That's, you know, I don't think there's really any more to it than that. They're flying less airplanes, we are adding products to our product line, as we always do, but as Eric amply commented, it's a revenue question. I think that's it.

This is Eric. I can tell you that with regard to cost, we are getting our parts costs and our component repair costs below our budgeted numbers. We've set up significant cost reduction targets. We are meeting those.

And further, on the pricing side, we are not seeing pricing pressure on any of our product. So as a matter of fact, the gross margins are doing quite well. What we've set up is a fairly large new product development, and SG&A pipeline in order to handle the increased volume. And since we've seen this drop, temporarily, in the revenues, we still have all of the fixed costs associated with the larger projected revenues. And we do not feel that we should take out the NPD or the SG&A infrastructure because when the revenue does return, it will prove to be a very good investment. So we're not seeing cost problems at all. We were, this is Larry Mendelson. To further elaborate on that, we have been at two industry conferences in the past few weeks where the major aerospace industry companies have CEOs have been in attendance. And the general commentary that's back and forth is that most people in that group feel that when the turn comes, and they all do believe it will come, that probably HEICO, because of its aftermarket concentration, will be one of the first companies to see the benefits of it.

But again, they recognize and some of these are very large companies where the aerospace groups are buried underneath and you don't see as clearly as HEICO is more of a pure player, it's more out front. Their parts business and actually the OEMs are significantly down more than HEICO.

Sure, absolutely. Okay. That makes sense. The other question I had was, as the model evolves, what do you think the correct inventory turnover should be for the company?

We have a -- an inventory turnover goal significantly better than the current inventory turns. We have a high percentage of our existing product in new product coming out every year. And one of the paradox's that we have is we try to put enough new product on the shelf so when the customer needs it, it's available. So that basically reduces our inventory turns compared to other aerospace companies due to the high percentage, the continual high percentage of new product development. But I can tell you that our internal goals are significantly better than where we are operating today, and I expect this trend to continue to improve over the next 12 and 24 months.

Okay. That makes sense. With business tough as it is, but more new products coming out, I would take from that that we shouldn't expect significant improvement in the turnover through the balance of the year and then maybe next year we should see some? Is that correct?

I think we might see some slight improvement. In our business, the important thing -- inventory turns is important, and as I pointed out, we do watch our capital and our financial ratios. But putting new product on the shelf, on day one if we develop a part, we have to have anywhere from 90 to 180 days of available product on the shelf.

First of all, if you do a smaller run than that, your costs will be much higher so you -- if we manufacture it or we go outside to have it manufactured, we couldn't have a one-month supply, it would be too costly. So we start day one with, say, 90 to 180 days supply but not a dollar worth of sales.

If you add a minimum of 300 new parts onto the shelves every year, and on day one have zero revenue, to support that, you can see why the inventory turns will be pushed down. And that is just a decision that we have made in-house that we have to accept that as a cost of doing business. And so to a certain extent, the inventory turns are not as crucial as they might be in some other business that doesn't have that particular situation.

Good, that's a very helpful explanation. Thanks a lot guys, you're doing a good job.

Thank you very much.

Our next question is from Keith Hughes.

Good morning, it's Scott Phillips sitting in for Keith. I just wanted to just summarize, on those production delays, I get the impression that first quarter and second quarter, those are buy and large different issues, right? Like the first quarter was more the vendor delays and the second quarter is more the customer delays. Is that a fair way to look at it? Or was there a little bit in both?

This is Victor speaking. The answer is, there's a little bit in both. In the first quarter, it was more from the vendor delays, the customer delays, and in the second quarter, it was all pretty much all from the customer delays and not from the vendor delays

Got you. Okay. Thanks for clearing that up. And then -- now, you talked about pursuing some business with the regionals. How important is it to get traction in the repair side to win business on the parts side? Do those two work together in that dynamic, are they completely separate?

I'm going to ask Eric to respond to you, Scott. That's a good question. Yes, they are-related. We offer our customers the choice of either having OEM replacement parts or putting in HEICO replacement parts. And we also sell the HEICO replacement parts to competitors of our repair shops. Because we don't want to.

Sure.

Subsidize the profitability of our repair shops, they need to be able to stand on their own. So it is a choice. And yes, we do think that we will make our repair stations more competitive by being able to reduce the cost of material on the product. So it's definitely helpful, it's been a big success. But it is not a required in all cases that we have a HEICO replacement part. We do plenty of work where the OEM has a replacement part if HEICO hasn't developed one yet, or if in the alternative, the customer wants us to use an OEM part.

Right. Is it safe to assume that you would continue to pursue acquisitions on that repair side as you did in the last quarter?

Absolutely. We've been very successful in the component overhaul business. I think we've got a very good approach to the market. We've got very competitive pricing, very good turn time, an extremely good reputation in the industry. And we, I think, acquisitions make a lot of sense there for us. I do want to point out though that this acquisition that we did make following the close of the second quarter was a very small acquisition. Both purchase price and revenue. So it's just important to understand that that acquisition is not going to have major immediate impact on the numbers.

Right. Right. That's the impression I got. Okay. Thanks a lot.

I'd just like to add one other thing, which Eric didn't mention, and I think that in that group, we also have some very good managers that run those businesses, and I give a lot of credit to Eric, he's on top of them, but these fellows do an outstanding job. So I think that's probably true of all of our people, our operating people. I think they really -- and in these times, I want to make a general for a comment to everybody listening, in these very difficult times, work is very hard. Every dollar you earn you work for it. Nothing comes easy. And I can tell you that we have about a thousand team members who are all out there and they are working hard. I have a very, very high opinion of this group of people. They're making it happen.

All right. Thanks for your help.

I have no other questions at this time.

If there are no other questions, I want to thank everyone who is on this call for their time and interest in HEICO. I want to remind you that if you do have questions that the four of us are available to try to respond to your questions when we can. And you all know where to reach us at HEICO. So give us a call or e-mail us and we'll try to be responsive. Again, thank you all and we look forward to the third quarter conference call. Thank you.