HEICO Corp (HEI.A) 2004 Q2 法說會逐字稿

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

Thank you and good morning to everybody on this call. We welcome you to the HEICO second quarter fiscal 2004 earnings announcement teleconference. I am Larry Mendelson, CEO of HEICO Corporation, and I am joined here this morning by Eric Mendelson, who is President of HEICO's Flight Support Group; Victor Mendelson, President of HEICO Electronic Technologies Group and HEICO's General Counsel; and Tom Irwin, HEICO's Executive Vice President and CFO. Before we begin, Victor Mendelson will read a statement.

Thank you. Certain statements in this conference call will constitute forward-looking statements which are subject to risks and uncertainties and assumptions. HEICO's actual results could differ materially from those discussed or implied by those forward-looking statements as a result of factors including, but not limited to, lower demand for commercial air travel or airline fleet changes which could cause lower demand for our goods and services; product specification costs or requirements which could cause an increase to our costs to complete contracts; governmental and regulatory demands; export policies and restrictions; reductions in defense or space spending by U.S. and/or foreign customers; or competition from existing and new competitors which could reduce our sales; HEICO's ability to introduce new products and product pricing levels, which could reduce our sales or sales growth; HEICO's ability to make acquisitions and achieve operating synergies from acquired businesses; customer credit risk; interest rates; and economic conditions within and outside of the aerospace, defense, and electronics industries, which could negatively impact our costs and revenues.

Parties 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, 10-Q, and 8-K. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise. Thank you.

Thank you, Victor. Now, before reviewing our second quarter operating results in detail, I would like to take a few minutes to summarize the highlights of the second quarter. Both our Flight Support Group and our Electronic Technologies Group reported higher sales and operating margins in the second quarter of '04 compared to the same period of '03. Consolidated sales increased by 27 percent and consolidated operating margins grew from 12 percent to 16 percent in the second quarter of '04 versus the second quarter of '03. Next, the higher sales and margins contributed to a quarter-over-quarter increase of 66 percent in operating income and 58 percent in net income.

Cash flow generated by operating activities continues to be very strong and allowed us to pay down our revolving credit facility by $10 million in the second quarter and $5 million in the first quarter of fiscal '04, and that totaled $15 million in the first half of fiscal '04.

Our Flight Support Group entered into a strategic relationship with Japan Airlines to accelerate the development of a very broad range of new FAA-approved replacement parts. This is HEICO's first strategic relationship in Asia, and marks the sixth such unique partner position we have with some of the world's leading airlines, including of course Lufthansa, American, United, Delta, and Air Canada.

Our Flight Support Group's component repair group was awarded a five-year contract to supply repair and overhaul services for the thrust reverser actuation system on American Airlines' fleet of Boeing 777 aircraft. We believe that these results are a further indication of the progress that HEICO has made towards a return to long-term, sustainable growth.

Now focusing in on the specifics, consolidated sales in the second quarter of '04 increased by $11.2 million, or 27 percent, up from the second quarter of fiscal '03. This reflects substantial increases within both the Flight Support Group and the Electronic Technologies Group. Revenues of Flight Support increased 24 percent to $37.7 million in Q2 of '04, up from $30.4 million in Q2 of '03. The increase in Flight Support's revenue resulted from improved demand for the Company's aftermarket replacement parts, as well as repair and overhaul services, reflecting the continuing recovery within the commercial airline industry, as well as increased sales of new products and services. Sales of our non-JT8D PMA parts showed double-digit growth in the first half of '04 versus '03. Keep in mind that substantially all of the Flight Support's year-over-year growth results from organic growth.

Revenues of Electronic Technologies Group increased 34 percent to $15.1 million in the second quarter of '04, up from $11.3 million in the second quarter '03, reflecting our entry into the microwave components field through an acquisition in December of '03.

Our revenues for the first six months of fiscal '04 by market were comprised of approximately 65 percent from commercial aviation, 23 percent from defense and space, and 12 percent from other markets, including industrial, medical, electronics, as well as telecommunications.

Moving over to operating income, the consolidated operating income in the second quarter of '04 increased a strong 66 percent to $8.2 million, up from $4.9 million in the second quarter of '03. The increase in operating income reflects strong earnings both in Flight Support and in Electronic Technologies. Operating income of Flight Support in the second quarter of '04 increased 44 percent to $6 million from $4.2 million in the second quarter of '03. This is based on higher sales and operating margins I previously mentioned.

Operating income of Electronic Technologies increased a whopping 94 percent to $3.7 million in the second quarter of '04, up from $1.9 million in the second quarter '03, based upon the aforementioned acquisition, as well as increased sales of higher margin products.

Consolidated operating income in the first half of '04 increased 41 percent to $14.7 million, up from $10.5 million in the first half of fiscal '03, also reflecting strong earnings increases in both of our business segments.

Operating margins. The consolidated operating margins totaled 16 percent in the second quarter of '04, compared to 12 percent in the second quarter of '03. This reflects a 2 percent margin improvement in Flight Support and an 8 percent improvement in Electronic Technologies. Operating margins of Flight Support were 16 percent in the second quarter of '04, up from 14 percent in the second quarter of '03, and this was due primarily to higher sales volumes. The operating margins of Electronic Technologies was very strong at 25 percent in the second quarter of '04, versus 17 percent in the second quarter '03, resulting from the addition of the microwave components products, as well as increased sales of higher margin products.

Diluted earnings per share increased 45 percent to 16 cents per share in the second quarter of '04, up from 11 cents per share in the second quarter '03, reflecting the 58 percent increase in net income, partially reduced by the impact of an increase in the weighted average diluted shares outstanding. This is mainly due to the increase in the HEICO stock price, together with some other smaller items.

Depreciation and amortization expenses were $1.8 million in the second quarter of '04, up slightly from $1.6 million in the second quarter '03. Net research and development expense, which we consider fundamental to our mid- and long-term growth, increased to $2.4 million in the second quarter '04, compared to $2.1 million in second quarter '03.

The addition of new FAA PMA approvals, particularly for non-JT8D aircraft, continues to be critical to our mid- and long-term growth in light of the retirements in the JT8D standard fleet in the aftermath of 9/11. We currently have approximately 400 parts in our development pipeline, 99 percent of which are for non-JT8D engines, and we have over 3200 parts approved by the FAA. Over 70 percent of these parts are non-JT8D.

New parts released by our R&D groups in the second quarter of fiscal '04 continued at a strong level and pretty much as budgeted for the period. We are budgeting approximately 300 new PMA parts in fiscal '04, equivalent to the new PMA certification levels of fiscal '02 and '03. We also have a number of new products under development in Electronic Technologies.

On the SG&A side, expense as a percentage of sales dropped to 20 percent for the quarter from 22 percent in the second quarter of '03, and this was as a result of higher sales volume. The dollar increase in SG&A spending to $10.5 million for the second quarter of '04, up from $9 million in the second quarter '03, was due principally to higher Flight Support Group expenses due to increased sales; two, the microwave component products acquisition in December '03; and a $400,000 increase in corporate expenses, reflecting increases in a variety of general items.

Interest expense in the second quarter of '04 and '03 were comparable because average borrowings outstanding and the average interest rates remained at approximately the same levels in both years. During the first half of fiscal '04, we incurred net borrowings of $12 million under our revolving credit facility, reflecting $27 million used to fund the aforementioned acquisition, net of repayments of $15 million, including the $10 million repaid in the second quarter of '04. Interest and other income in the second quarter of '04 and '03 were minimal.

Our effective tax rate decreased to 34.3 percent in Q2 of '04, down from 35.3 percent in the second quarter of '03. This was because a portion of the minority interest share of the income is excluded from our consolidated income, which is subject to federal income tax, plus higher foreign sales subject to benefits under federal tax provisions.

The minority interest share of income of our consolidated subsidiaries was $1.1 million in the second quarter of '04, and principally represents the minority interest held by Lufthansa and American Airlines in our Flight Support Group, plus the 20 percent minority interest held in our microwave products subsidiary. The increase over the prior year is due to the microwave components products acquisition.

Our financial position remains extremely strong. Cash flow from operating activities remain strong and totaled $16.7 million in the first half of '04, including $9 million in the second quarter of '04. This compared to $6.8 million in the second quarter of '03, or a 32 percent increase in cash flow in the second quarter of this year. Cash flow from operating activities totaled 219 percent of net income in the second quarter of fiscal '04, and 228 percent of net income in the first half of fiscal '04. Very strong cash flow.

Our working capital ratio decreased slightly from 4.2 as of October 31, '03 to 4.0 as of April 30, '04, principally reflecting a $1,100,000 increase in income taxes payable. I guess if you make it, you have to pay it to Uncle Sam.

DSOs of accounts receivable as of April 30 improved by two days to 54 days, compared to 56 days as of October 31, '03. We continue to closely manage receivable collection efforts and maximize cash flow from operations in the current business environment. And I assure you we continue to work diligently to manage our credit exposure in light of the continued financial challenges facing some of our customers in the airline industry.

No customer represented more than 10 percent of consolidated sales in the first half of '04. Inventories are down nearly four percent since October 31, '03, and inventory turnover has improved to 130 days as of April 30, '04 versus 146 days as of October 31, '03. We continue to review these inventory levels to ensure our capital allocation to inventory is adequate to meet our customers' needs but is not excessive.

Long-term debt to capitalization is very low; however, it did increase to 16 percent as of April 30, versus 13 percent as of October 31, '03. This reflects the net increase in borrowings of $12 million under our revolving credit facility. The leverage, as I mentioned, is extremely low. The banks are constantly asking us to borrow more money. Capital expenditures in the first half of '04 were $2.2 million, somewhat below our full-year budget of $7 million to $8 million for fiscal '04.

Looking towards the future, we are pleased to report year-over-year sales and operating margin improvements in our two business segments, reflecting both strong organic growth and growth through acquiring profitable, well-managed businesses. Both of these are fundamental to our medium- and long-term growth strategies. Our Flight Support Group continued to show an increase in sales during the second quarter of fiscal '04 as compared to the second quarter of '03 and the first quarter of '04 because we continue to add new products and further penetrate our existing markets. Demand from our commercial airline customers continues to show some recovery, and we expect Flight Support's operating margins to continue to improve during the balance of fiscal '04. As I mentioned earlier, substantially all of this growth is organic.

Positive trends that we see within the commercial airline industry include April '04 U.S. airline traffic is up 19 percent and capacity is up 10 percent year-over-year. The forecast for 2004 full-year capacity growth is generally between 5 and 7 percent over the '03 levels. The FAA prediction that U.S. passenger traffic will reach pre 9/11 levels this summer.

We also expect to maintain our strong operating margins in Electronic Technologies on higher sales during the balance of fiscal '04. This is based upon our current backlogs. We believe our ongoing new product development efforts, combined with our strategic relationships with some of the world's major airlines, have and will continue to have a significant positive impact on our mid- and long-term growth.

Based on current market conditions, we continue to target fiscal '04 sales and earnings growth of at least 15 and 30 percent respectively over fiscal '03 without further acquisitions. I remind you that the Company does not give guidance on quarterly sales and earnings.

In closing, we continue to adhere to our long-term strategy of developing and marketing new products and services which provide our existing customers with substantial cost savings and allows us to expand our markets. We continue to believe that this strategy has resulted in strong financial position for the Company and positions us with the opportunity for substantial growth going forward. This has been our strategy for the past 10 to 14 years. It has resulted in significant growth until 9/11. We see that growth beginning to resume.

And that is the end of my formal comments. I would like to open the floor and wires for any questions that the audience may have. Thank you.

(OPERATOR INSTRUCTIONS) Chris Quilty.

This is actually Greg Lee filling in for Chris. He's traveling today. I had a question about inventory levels. You said you're going to continue to work inventory levels down. Just curious if the inventory turns that you saw this quarter, which appear to be pretty solid, whether that is sustainable or not?

This is Tom Irwin, Greg. I think the answer is we will continue to look at inventory levels. We are constantly trying to improve turnovers. However, our strategy is such that we must maintain the inventory necessary to meet our customer needs because of the high margin products. I would not expect them to deteriorate, but how much more improvement in terms of turnover may be a longer range objective.

Okay. Also, I guess you kind of reiterated your CAPEX expectations for the full year, so I guess we should be seeing a pretty big pickup in the second half in CAPEX?

I don't think that we can count on it. Some of the CAPEX that we had anticipated might be deferred. So at this point, it is not -- the answer to your question is a definite maybe, because at this point, the CAPEX is kind of contingent and we're just not sure.

What kind of factors is that contingent on?

We said 6 to 7. I think if we use 6, at this point, I think 6 is a safe number. It is conservative. It is possible that some of the things that we may want to do we might accelerate. But at this point, 6 looks probably on the high side.

On the last call, you got into a little bit, I think, during the Q&A, about the impact of low-fare airlines. I think the questioning there was targeted more towards the near-term impact -- are you seeing any impact now. But I was just curious if there is a longer-term impact that we should be aware of? What kind of trends do you see over a multi-year time period?

I'll make one comment and then I'm going to pass it over to Eric. The strategies of the low-cost airlines are running the planes full out. And when you run an engine constantly -- they take off and land and take off and land and they go on shorter hops -- generally results in more maintenance costs for the engine. So that, looking out over a period, presumably the maintenance costs will, on an industry basis, if the low-costs continue to increase their market share, will probably be greater over the longer-term. So we think that that ultimately would be a positive for the MRO industry. I will pass it to Eric now and he can be more specific.

As you know, our strategy is to provide cost savings to our customers through our parts and repair services. And of course, the low-cost carriers need to watch their costs even perhaps more so than some of the legacy carriers, so we see a tremendous market there for us. They are already customers and we see that continuing to grow. So to answer your question, I don't see a significant change in our business.

Okay. And then final question, you I think made brief mention of new products in the Electronic Technologies Group. Any color on what those might be and potential contribution?

This is Victor Mendelson. The products are really a continuation of the ones that we have already been producing in our electro-optical business, as well as our microwave components business, and really inertial navigation business as well -- just a continuation of what we've been doing.

Okay. Well, that does it for me. Thanks.

Jim Larkin (ph).

Good morning. I wondered if you could give me a little bit of color if there was any one-time catch-ups this quarter that drew down the inventory. It's sort of piggybacking on the last question.

The answer is no.

And so really what we saw -- the strength of the business right now really reflects an ongoing strength?

It does.

Okay, great. What would be your tax rate for this year? What are you expecting that to come in at?

For the six months, our effective tax rate is estimated at the 34.4 percent. That is our current estimate for the full year based on what we see at this moment.

Okay, great. And can you talk a little bit about the trouble we're having closing the gap on A shares, and if you've taken any -- considering any type of corporate action to rectify that? It seems like you tried to be a little more vocal about on your press releases, but for those of us who own the A shares and have little voting power, it's becoming really frustrating to see a 25 percent spread in the difference between the two classes of shares.

Jim, it is frustrating to us too. We constantly consult with various investment bankers and they show us other companies that have two classes, a lower voting and a higher voting share. And these, generally speaking, the differential is perhaps less than 5 percent, and we feel that clearly that is what it should be. The investment bankers tell us that the liquidity, strangely enough, there are more A shares, but they are held by more institutions, and the institutions that hold them fortunately like HEICO and they are not selling them. So therefore, the investment bankers tell us that in order to increase liquidity we should have more A shares.

One of the strategies that we have used is by paying 10 percent dividends to increase the number of A shares. That has been an attempt to increase that and to improve liquidity there. Also, in some acquisitions, we have given out A shares to improve the liquidity again. So again, the experts in Wall Street, a number of firms have told us that the problem is liquidity. Also, we are constantly on top of the specialists. We probably ask for more investigations than most companies. Why is the A trade that way and so forth? And it's just that it does and the liquidity issue. So other than that, I can't provide any more insight.

All right, well --

Incidentally, we think, and based upon the fact that institutional ownership of A percentagewise is much greater than that of common and the comments that I get from institutional portfolio managers is, why would I ever buy the common? I would only buy the A because it's 20 percent discount. So we think that certainly the A is a much better dollar-for-dollar investment at this point at that discount.

Okay. I would encourage you to keep trying to resolve that, if you can.

We are.

Thank you very much.

I have no further questions.

In that case, I again want to thank you all for your interest in HEICO. We are available, any one of the four of us, available if you have specific questions that we are able to field, and we would be happy to try to answer your questions. Give us a call at HEICO or e-mail us and we can do that. We look forward to speaking to you at the third quarter earnings conference. Thank you all.