HEICO Corp (HEI.A) 2010 Q2 法說會逐字稿

Good morning, my name is Lynn and I will be your conference operator. At this time, I would like to welcome everyone to the HEICO Corporation, second quarter fiscal 2010, 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 session. (Operator Instructions). I will turn the conference over to Larry Mendelson, CEO and Chairman of the Board.

Good morning to everyone on the call. We thank you again for joining us and we welcome you to the HEICO second quarter fiscal 2010 earnings announcement teleconference. I'm Larry Mendelson. I'm the CEO of HEICO Corporation and I'm joined here this morning from New York with Victor Mendelson, HEICO's Co-President and President of HEICO's Electronic Technologies Group as well as Tom Irwin, HEICO's Executive Vice President and CFO and tuning in from Florida is Eric Mendelson, HEICO's Co-President and also President of HEICO's Flight Support Group. Before we begin, Victor Mendelson will read a statement.

Thank you. Certain statements in today's conference call will constitute forward-looking statements which are subject to risks uncertainties and contingencies. HEICO's actual results may differ materially from those expressed in or implied by those forward-looking statements as a result of factors including to but not limited to, lower demand for commercial air travel or airline fleet changes, which could cause lower demand for our goods and services, product specification costs and requirements which could cause an increase to our costs to complete contracts. Governmental and regulatory demands, export policies and restrictions, reductions in defense, space or Homeland Security spending by US and our 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 risks, interest rates and economic conditions within and outside of the aviation, defense, space, medical, telecommunications and electronics industries which could generally negatively impact our costs and revenues. Those listening to today's 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 statements whether as a result of new information, future events or otherwise. Thank you.

Thank you, Victor. And now before reviewing our second quarter operating results in detail, I would like to take a few moments to summarize the highlights of a strong quarter. Net sales and earnings within Electronic Technologies for the second quarter of 2010 represent all-time quarterly records and were up 73% and 69% respectively due to additional net sales from a previously-announced acquisition completed in February, as well as two acquisitions completed in the second half of fiscal 2009, plus organic growth of approximately 12%. The second quarter sales and earnings increase within flight support marks the first quarter of improvement within the group since we began experiencing the effects of reduced airline capacity and weakness in our commercial aviation markets back in 2009. Net income per diluted share increased by 19% to $0.37 per diluted share in the second quarter of 2010, up from $0.31 per diluted share in the second quarter of 2009.

In March 2010, we declared a five for four stock split reflecting the Board of Directors continued confidence in growth of the business. The additional shares were distributed in April of 2010. All applicable share and per-share information has been retroactively adjusted to reflect that five for four stock split. This marks HEICO's 11th stock dividend or stock split since 1995.

Our cash flow and balance sheet remain extremely strong. Cash flow from operating activities was $40.3 million in the first six months of 2010, representing 165% of reported net income, up from $26.6 million in the prior year. As of April 30, the Company's net debt to shareholders' equity ratio was a very low 10.3%. With net debt meaning total debt less cash of $53.8 million. We have no significant debt maturities until 2013. We also completed our 38th acquisition since 1990 with the February acquisition of DB Control. DB Control produces high-powered devices used in high-power radar, and other applications, for both defense and commercial applications. We believe that DB Control is a unique company offering us more participation in a growing part of defense budgets as reliance on high-power radar and electronic warfare systems increase.

Now, moving down to the detail items in our report, we talk about net sales. Consolidated net sales in the second quarter of 2010 increased 18% to $153.8 million, up from $130.2 million in the second quarter of 2009. Overall, our consolidated net sales increased to $289.4 million in the first half of 2010, up from $260.6 million in the prior year. Flight support reported net sales of $103 million for the second quarter of 2010, up 2%, from the $100.7 million in the second quarter of 2009. Flight support net sales for the first half of 2010, were $196.8 million, compared to $200.3 million in the first half of 2009. The second quarter net sales increase within flight support is entirely organic growth and reflects higher net sales of certain industrial products as reduced airline capacity continued to impact demand for many of our other flight support products and services. With respect to our commercial after markets, we are seeing early signs of recovery, and consistent with the consensus opinion within the industry, we continue to expect increased demand in the latter half of calendar 2010.

Electronic Technologies reported record net sales of $51.1 million for the second quarter of 2010, up 73% from $29.5 million in the same period in 2009. Net sales of Electronic Technologies in the first half of 2010, were $93.1 million, up 54% from the $60.5 million in the first half of 2009. The second quarter net sales increase within Electronic Technologies represents strong organic growth of approximately 12% as well as net sales totaling approximately $16 million contributed by three acquisitions completed during the preceding 12 months. The organic growth in Electronic Technologies reflects strengthening demand for certain of our satellite, defense and medical equipment products, and a favorable variation in customer shipping schedules which accelerated some sales into the second quarter of 2010. Our net sales for the first half of 2010 by market was comprised approximately of 64% from commercial aviation, versus 71% in 2009, 22% from defense and space, versus 16% in 2009, and 14% from other markets including medical, communications and electronics, versus 13% in 2009.

Moving down to our operating income, consolidated operating income in the second quarter of 2010 increased 22% to $26 million, up from $21.3 million in the second quarter of 2009, and increased 18% to $50.5 million in the first half of 2010, up from $42.8 million in the first half of 2009 and this reflects higher operating income primarily from our ETG Group. Operating income of flight support in the second quarter of 2010, improved slightly to $16.1 million, up from $15.9 million, in the second quarter of 2009. Flight support's operating income in the first half of 2010, increased 4% to $32.8 million, compared to $31.5 million in the first half of 2009, and this was as a result of more favorable product sales mix, including the favorable impact from the sale in the first quarter of 2010 of some products previously written down as slow-moving. Operating income of ETG in the second quarter of 2010 increased a whopping 69% to a record $13.6 million, up from only $8 million in the second quarter of 2009, reflecting the impact of the fiscal 2010 and 2009 acquisitions, and the 12% organic sales growth. Electronic Technologies operating income in the first half of 2010 increased 49% to $24.8 million, up from $16.6 in the first half of 2009 also reflecting the impact of acquisitions as well as a 9% organic sales growth.

Corporate expenses in the second quarter of 2010 increased to $3.7 million from $2.6 million in the second quarter of 2009, and increased to $7 million in the first half of fiscal 2010, compared to $5.3 million in the first half of fiscal 2009, but remained under 2.5% of net sales. These increases are primarily due to the higher level of accrued performance awards based upon improved consolidated operating results.

The operating margins of flight support remain relatively unchanged at 15.6% in the second quarter of 2010, compared to 15.8% in the second quarter of 2009. Operating margins of flight support improved to 16.7% for the full first half of 2010, up from 15.7% in the first half of 2009. And this increase reflects the more favorable product sales mix I mentioned earlier. Operating margins of Electronic Technologies remains strong at 26.6% for both the second quarter of 2010 and the first half of 2010. And they compared to 27.2% and 27.4% respectively, for the second quarter and first half of 2009. In the second quarter of 2010, the lowered margins of some newly acquired businesses slightly impacted the overall margin of the group. As we have mentioned in the past, sales and operating margins of Electronic Technologies can vary quarter to quarter depending on the timing of customer delivery requirements, variations in product mix, and possible technical issues. The second quarter accelerated customer shipping schedules within Electronic Technologies could have a minor negative impact on the group's results in the second half of 2010.

Our consolidated operating margin in the second quarter of 2010 improved to 16.9% compared to 16.4% in the second quarter of 2009 despite the slight decreases in operating margins experienced by both of our operating segments. The increased proportion of ETG net sales to our consolidated net sales, for the second quarter of 2010, compared to the second quarter of 2009, and Electronic Technologies' higher operating margin relative to that of flight support resulted in overall improvement in consolidated operating margin in the second quarter of 2010. Our consolidated operating margin for the first half of 2010, improved to 17.5% compared to 16.4% in the first half of 2009, principally as a result of higher margins within flight support. Diluted earnings per share increased 19% to $0.37 to the second quarter of 2010, up from $0.31 in the second quarter of 2009. Diluted earnings per share increased 13% to $0.72 in the first half of 2010, up from $0.64 in the first half of 2009, and we point out and think it's very important for you to note and do the arithmetic, that in the first half of 2009 earnings per share included -- that was $0.64 -- included a $0.04 benefit related to the settlement of an income tax audit making the fiscal 2010 increase even larger when you exclude the one-time benefits. So if you do the arithmetic, you can figure out what that is. These earnings per share results have been retrospectively adjusted for the five for four stock split which we distributed in April.

Depreciation and amortization was $4.6 million in the second quarter of 2010, compared to $3.4 million in second quarter of 2009. And the increase primarily reflects higher amortization expense related to the intangible assets acquired as part of the three acquisitions completed by ETG during the past year. Research and development, which is very critical to our long-term strategy, the R&D expense increased 10% to $5.4 million in the second quarter of 2010, up from $4.9 million in the second quarter of 2009. Our investment in new products and services grew to $10.5 million in the first half of 2009 -- I'm sorry, in the first half of 2010, which was an increase of 9% from the same period in 2009. We remain confident that these increased expenditures will allow us to expand our lower-cost product offerings, helping to lower the costs of our airline partners -- to our airline partners, and other customers, while allowing us to gain market share. And I want to remind you all that R&D at HEICO is treated as a period cost, it is 100% written off as incurred and none of it is capitalized. For the full-year 2010 we expect and continue to target 600 to 700 new PMAs and DER repairs. Significant ongoing new product development efforts continue within Electronic Technologies as well as flight support. And we believe that our focus on continuing new product development is fundamental to our long-term growth strategy.

Selling, SG&A expense was $27.7 million in the second quarter of 2010, compared to $21.2 million in the second quarter of 2009. They were $53.2 million in the first half of 2010, compared to $43.7 million in the first half of 2009. These increases are due principally to the additional operating costs associated with the recent Electronic Technologies acquisitions, as well as higher operating costs associated with the growth in consolidated net sales and earnings, and these are primarily personnel-related. SG&A spending as a percentage of net sales was 18% for the second quarter of 2010, compared to 16.3% in the second quarter of 2009, and 18.4% in the first half of 2010, compared to 16.7% in the first half of 2009. The increases reflect an increase in amortization expense of intangible assets associated with recent ETG acquisitions, as well as a higher level of accrued performance awards based upon improved consolidated operating results.

Interest expense in the second quarter and the first half of 2009 and 2010 was not significant as a result of our low -- relatively low debt levels, and very low variable interest rates under our revolving credit facility. As I referenced earlier, our net debt is only $53.8 million as of April 30, 2010. Other net income in all periods was not significant and I won't go into detail. HEICO's effective tax rate increased to a more normal 35.1%, and 35% for the second quarter of 2010 and the first half of 2010 respectively versus 32.7% and 30.2% for the second quarter of 2009 and the first half of 2009 respectively. The increase in the second quarter of 2010 is principally due to a higher effective state income tax rate reflecting the impact of recent acquisitions and the impact of the audit settlement reached with the IRS in fiscal 2009, relating to our qualified R&D tax credits. The year-to-date increase in tax rate principally reflects the benefit of the audit settlement in the prior year. Our net income attributable to non-controlling interest was $4.3 million in the second quarter of 2010, compared to $3.8 million in the second quarter of 2009. And it was $8.6 million in the first half of 2010, compared to $7.8 million in the first half of 2009. These increases are attributable to the 2009 acquisition of an Electronic Technologies subsidiary in which a non-controlling interest exists, as well as higher earnings of certain other ETG subsidiaries in which non-controlling interests also exist.

Moving now to the balance sheet, I referenced earlier that our financial position and cash flow remains strong. Cash flow from operating activities in the first half of 2010 totalled $40.3 million, including $20 million generated in the second quarter of 2010, and this was up from $26.6 million in the first half of 2009. So we moved to -- from $26.6 million to $40.3 million in the first half. Our working capital ratio, as you know, current assets divided by current liabilities, strengthened further to 3.9 as of April 30, 2010. It was 3.7 as of October 31, 2009. DSOs of accounts receivable improved slightly to 46 days as of April 30, down from 51 days as of January 31, 2010, and 50 days in October 31, 2009. We manage our credit exposure by closely monitoring all receivable collection efforts. Inventory turnover rate as of April 30, 2010, was 128 days down slightly from 133 days, as of October 31, 2009, and this reflects our efforts to prudently manage our inventory levels. No one customer accounted for more than 10% of sales. Our top five customers represented approximately 18% of consolidated net sales in the second quarter of 2010, compared to 22% in 2009, and to us this indicates greater successful diversification. Capital expenditures in the first half of 2010 were $4.6 million, which is at a run rate slightly below our current estimate of $12 million to $15 million for the full-year fiscal 2010.

Moving on to our outlook, we do continue to expect to see strengthening in commercial aviation markets during the second half of calendar 2010, which in our -- HEICO's case aligns with the latter half of our third quarter and our full fourth quarter of fiscal 2010. The outlook is consistent with the consensus opinion within the airline industry. However, the strength and exact timing of the recovery and the resulting benefit to HEICO remains uncertain at this time. Commercial aviation represents approximately 65% of our sales over the last 12 months. Based upon the aviation market outlook, and the conditions within our other major markets, we are raising our fiscal 2010 net sales targets to a range of $585 million to $595 million, representing a growth of 9% to 11% over fiscal 2009, and we are raising our net income per diluted share target to a range of $1.44 to $1.48, representing growth of 9% to 12% over fiscal 2009. We do continue to expect consolidated operating margins for the full fiscal year 2010 to approximate 17%, and, of course, these targets exclude the impact of any potential acquisition opportunities. Cash flow provided by operating activities is expected to remain very strong and to approximate $75 million to $80 million for fiscal 2010. We also expect to continue our successful strategy of identifying acquisition opportunities that will continue to strengthen our existing business platform.

In closing, we want to point out that we believe that our continued focus on developing new products and services increasing market penetration, maintaining our strong financial position and disciplined acquisition strategy, will provide opportunity for continued substantial growth and profitability. This is the same strategy that we have employed for 20 years, very successfully. Nothing has changed and we expect that hopefully we'll have another 20 years of successful operations, at least. So those are the extent of my prepared comments and I would like to open the call to questions from the listeners.

(Operator Instructions). We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Arnold Ursaner with CJS Securities.

Good morning and congratulations on the results.

Thank you, Arnie. Good morning.

I want to get a better feel for your guidance and how DB impacts the view for the second half of the year. I know when we had written at the end of last quarter we thought you were probably including about $10 million or so of revenue for the seven months that would have it. You also indicated that you had about $16 million revenue from the three acquisitions in the quarter. Perhaps the way to try to answer it is embedded in your $585 million to $595 million, how much is the contributions from the three acquisitions you've completed so far in that total?

I'm going to ask -- Arnie, I'm going to ask Tom to respond.

Yes, Arnie, this is Tom Irwin. Yes, you're correct, with respect to the acquired businesses they added about $16 million in the second quarter for the full six months they added about $24 million and inherent in our revenue outlook for the full-year, about 40 -- just under $40 million of that revenue would be contributed by acquired businesses.

Okay. My second question, obviously, you went out of your way to try to highlight, you had some shipments in ETG that were ahead of schedule or a shift within timing and in looking at the $50 million or so of revenue of ETG that is well above virtually any quarterly period and I appreciate you have had some acquisitions and I think you cautioned a little bit about the back half. Are you hinting or suggesting Q3 and 4 will be down sequentially from the Q2 levels?

Arnie, this is Tom Irwin again, I think you're correct in terms of we have some level of caution with respect to some customers accelerating some shipping requirements that landed in the second quarter that probably ordinarily would have come in the third quarter. It's difficult to quantify exactly what that number is, because customers always move things forward and back. But the way we looked at it was it -- the organic growth in Electronic Technologies in the second quarter by itself was about 12%. That is probably 5% to 6% higher than we have consistently said is sort of a normal reasonably projected organic growth. So that is the quantification in terms of potential dollars that may, again, an estimate that may have been accelerated in the second quarter. And when you do the math, that would equate to between $2 million and $3 million worth of revenue, may have been be a shortfall later on.

I have a question for you, Larry, is you -- your business model is 65% to 70% of what you ship in your flight safety group typically arrives in -- You ship within the month that you get the order. Can you give us any feel, perhaps, for the order trends and shipping trends by quarter, meaning have you begun to see some really meaningful acceleration month over month, and the broader question also is we're all trying to get a feel for airline maintenance plans, and are they in fact slowing some maintenance as best they can until after the summer season? Maybe you can help us give your perspective of trends by the month during the quarter and what you see going forward.

Arnie, I can answer that as I see it. I don't see a big upswing, yet. We've been very conservative or cautious and trying to say that we see it coming more in the latter part of this year, and we consistently said that. We don't see the big boom, yet. We do see the bottoming has occurred. It is bouncing along the bottom, popping up. But I think Eric is really in the best position to give you more color because he's closer to the ground, and that's my view of it. But Eric, would you like to elaborate a little on Arnie's question?

Sure, Arnie, you can see that in the second quarter our sales were higher than at any point than the first quarter of 2010 or any quarter that we had in 2009. So we definitely have seen a recovery, and of course a very strong recovery from our first quarter of 2010, which was pretty much everybody else's fourth quarter of 2009, due to us being a 10/31 year-end. So we have seen a nice recovery, and a bounce-back in sales there. Going forward from here, the situation is a little bit unclear. In general I can tell you that a lot of maintenance has been deferred at the airlines in general. The talk that I'm hearing is that they're anticipating in the second half more stacked towards the end of the year. But in the second half some amount of recovery, that they're just not going to be able to continue running at the rates they have been continue running at. But in terms of seeing order s you're right, we get a large percentage of our orders in the month of shipment, so we're not going to have a really a lot of tremendous amount of visibility for this. I mean, people say we expect that we're going to need more, but we don't have by part number by month, unfortunately a real indication of when it is going to occur.

Thank you very much.

But you can see, you know, we have a -- jumped up nicely from our first quarter on a consecutive basis way ahead, and again since it is ahead of every point in 2009, and we've had no acquisitions, so it is all internal growth, we're fairly optimistic about it.

Thank you very much.

Thank you.

Your next question comes from the line of Mickey Schleien from Ladenburg Thalmann.

Several of my questions have been answered but I do have a couple more. With respect to flight support in the press release you discussed certain demand improving for some of the industrial parts that you sell outside of the airlines. Can you tell us a little bit more about which particular segments are showing increased demand for those parts?

I'm going to ask Eric to respond to your question.

Yes, a small percentage of the flight support sales go to non-aviation markets. And those markets have seen nice pickup. Most of this would be non-aero-derivative products. So these are not engines that have an aero application, these are strictly industrial gas-powered units and that's where we have seen the recovery there, as well as in general in the automotive, construction, mining, those markets, as well.

Okay. So in your guidance, because I do agree with Arnie, it looks somewhat cautious. Are you assuming that this sort of incremental demand from the non-aero industries remains robust or are you also cautious on that front, as well?

There we're pretty optimistic on that front. At this point it remains robust. Of course, there was a big drop in demand in 2009, and that is now coming back pretty strong, with the new EPA emissions regulations with the amount of unburned hydrocarbons that are permitted to be dumped into the atmosphere reduced the amount of unburnt hydrocarbons that is increasing the exhaust temperatures, and that as a result torches all of the material around it and we are very active in that market, helping those manufacturers reduce the collateral damage to other -- other equipment that goes nearby the exhaust. So we anticipate continued improvement in that area.

Okay. And sticking with flight support, any concerns about the proposed merger between United and Continental on demand for your products from those two companies?

I would say no. Of course, it's -- it's very early for us to know what is going to happen there and I think even the folks out at United and Continental don't exactly know. But in general I think we're going to be in a good position there, because as United and Continental now have an increased amount of maintenance, I think they're going to be able to put more efficiently some of their shops greater volume. Of course, in order to get labor to go along with the proposed merger, I think they're going to have to be sensitive to the needs and the interests of the folks who work there. So both United and Continental are very good customers of ours. We saved them a lot of money. So I would anticipate that trend to continue, and frankly as you start putting these volume together the amount of savings that HEICO can deliver increases, and I think in general we should be in a pretty good position there. But, again, it's so early to tell that it's hard to get specific on exactly what products.

Yes, I appreciate that. Just a couple of quick financial questions, and then I'll turn over the call to someone else. How much liquidity do you have at the moment and do you expect your tax rate to remain near this 35% level?

I'm going to--this is Larry Mendelson. We have liquidity of technically roughly $250 million on our bank lines. These are senior unsecured facilities. I'm sure if we wanted more, banks have indicated that we have the ability to go significantly higher than that. We just don't choose to do it because we're at the moment our bank terms are very favorable rates. We're paying, I don't know, something like 85 basis points, and we don't need the money. And so we're very conservative, as you know. So the other question I think that we're probably -- the 35% rate sounds about right for the foreseeable future.

Thank you for your time.

Thank you.

Your next question comes from the line of Tyler Hojo with Sidoti & Company.

Good morning, guys.

Good morning, Tyler.

Just going back to the flight support group a little bit, so I'm just trying to get my head around this. The industrial products were strong and I get that. But if you could kind of back that out and maybe talk about how MRO, and how the core PMA business did in the quarter. I know you have kind of indicated you continued to see some destocking in the quarter, but, I mean, have -- would -- would we have seen organic growth if it wasn't for the strength on the industrial side?

This is Tom. I'll just give a brief color and then turn it over to Eric. But relative to the second quarter, you are correct that the industrial products of about 2% represented the organic growth in the quarter. Absent that, the commercial aviation market sales were relatively flat with the second quarter of last year. But I remind you that when you compare quarter-over-quarter year-to-year, the first and second quarters of last year in the flight support group, were stronger than the third and fourth quarters. That is, as the year went by, and airlines continued to take capacity out during the calendar of 2009, we were hurt, such that our third and fourth quarters were our weakest quarters. So we had some negative comps in the first and second quarter as it relates to commercial aviation business. As it relates to near-term MRO service outlook, I'll let Eric refer to that.

Tyler, I agree with what Tom said, and if you look at these numbers, the commercial MRO has come back substantially from the low points of the third and the fourth quarter. So the rebound is not just the industrial market. I mean, the rebound is also, whenever had organic growth within the commercial markets, as well.

Okay. Great.

And actually I would say most -- I mean, if you look at the increase from first quarter to second quarter, in sales, most of the increase was in the commercial markets.

Okay. All right. That makes a lot of sense. All right. Great. And maybe we could continue the dialog just in regards to PMA. A couple of questions on that front. First, of this 600 to 700 PMA and DERs that you're anticipating this year, where do we kind of stand in terms of developing those? And as well, just wondering if you've had any recent successes on the new customer front as it relates to PMA that you talked about?

Eric, do you want to respond, please?

Sure. In terms of development of new parts, typically most of our certifications are more heavily stacked in the second half of the year. We've done quite well this year, and we've gotten a higher percentage of them in the first half of the year than we have over the last five or so years. So, I'm very optimistic on that and so I would say that in general the new certifications are running at levels ahead of prior years, but we expect the full-year number to be consistent with prior years. As far as success with additional customers, yes, we have had success with additional customers. Some of it has been quite substantial. But we have not come out and done any press releases or talked publicly about it, because we would just rather ultimately let the numbers show up in our sales. And we don't want to give our competitors a heads-up of where we are and what's going on out there in the world. But, yes, there has been a -- some significant success that we've had, I would say, over the last six to 12 months, I'm bringing new customers on board as well as expanding existing customers into new product areas and new product families, that in the past they had not considered us for. So I would say we're doing quite well in that area.

Okay. Great. And just one pick follow -on to that. You guys have always stuck with your story that in these times of the kind of downturns in the market you really kind of ratchet up your share, and you spoke to that. But I'm just trying to get a sense of, if the share you've gained has been kind of as expected or better or worse than you were kind of thinking about it going into this downturn year?

Well, I would say that of course when we're in a downturn, volumes are depressed and airlines have inventory on the shelf. So it's sort of difficult as we enter the downturn for it to have a meaningful impact on our sales initially. I do feel very confident that they are approving our parts and getting them and intend to go buy greater quantity of them when we come out of the downturn, and as they burn out their inventory, and they need additional products. But I would, in terms of comparing it to earlier cycles, I would say it's consistent with earlier cycles where we really gained market share in the downturn, and then we produce sales as we come out of it.

Great. Appreciate all the color.

You're welcome.

Thank you.

Your next question comes from the line of Ken Herbert with Wedbush.

Good morning, thank you.

Good morning.

I just wanted to ask a first question on margins within flight support. I mean, it looks like when you exclude the slow-moving impact of those parts in the first quarter, you sequentially were at about a 15.6% margin give or take in each quarter, and based on your comments it sounds like, it is safe to say that you're starting to see some improvement in the second quarter could be the bottom, so to speak for margins in the flight support group. Considering your overall guidance, what should we be thinking about the potential for margin improvement as volumes increase with the industry turn in flight support here through the remainder of fiscal 2010 and into fiscal 2011?

Tom Irwin will respond to you.

Yes, as you point out, the first quarter we made reference to in the conference call in our disclosures, that there were some unusual benefits. About 200 basis points higher than sort of status -- or normal, relative to the revenue volumes in the first quarter was slow-moving inventory and some reserves that weren't required. So the second quarter is sort of a more normal in the mid-15% range for that current level of sales. As -- if sales do meet our guidance, and we do see some strengthening in the second half of our flight support group, as we have previously referenced, with those additional sales volume, we would expect that there would be some potential upside in terms of the operating margins. We don't guide or give guidance on specific operating margins by segment. We do on an overall basis, and that's indicated in the press release, and Larry's earlier comments, around 17%. So to get to a consolidated 17%, we would probably need to move the flight support group up maybe 50 to 100 basis points over segment margins last year which were down about 15%. So some margin improvement to the 16%, 16.5%. But again, not to the higher level that we attained at the peak of the market demand before the fall-off in 2009, which would be the 2008 margins which would 17% to 18% in that segment

Okay. No, that's very helpful. Similarly when you look at the ETG Group, I think you indicated with the -- the pull forward in the shipment of some products that may have been equivalent maybe $3 million or so in the quarter in sales, maybe $0.01 to $0.02 in terms of EPS. Is there any way you can quantify some of the lumpiness you alluded to, and I know it is hard to predict, but lumpiness that you on the top line and the margin line for ETG over the next couple of quarters here through the rest of 2010?

Well, again, it is lumpy because it is difficult to forecast customer requirements, technical delays and so on and so forth. Based on the current scheduled shipments in the third quarter, we indicated that there may be potential issue of some of the sales falling into the second versus the third. As we go beyond that, overall we manage that business segment for overall profitability on an annual basis and a multi-annual basis and really don't manage it on a quarter by quarter basis, so it is difficult to -- since we don't manage it on a quarterly basis it is difficult to give guidance specifically on a quarterly basis. What we said generally, that's a segment margins, operating margins, will range quarter by quarter from the low 20s to the high 20s, it's been running 26, 26.5 in these first two quarters. It could dip down into the lower 20s. It could range up to the higher 20s. But I think overall we've pretty consistently said on the current mix of product and businesses in that segment, 25%, 26%, 27% operating margins are probably reasonable ranges for a longer 12 to 24-month period.

Okay. Good, but it sounds like there isn't anything specific you would point to in ETG right now which just the history of the business, obviously, is going to warrant some caution because it can be lumpy.

On a quarterly basis, yes. Again, on an annual basis it has been pretty predictable but quarter by quarter it has been both negative lumpy and in the second quarter this year a positive lumpiness.

Great. And if I could just one final question for Eric on flight support. There has been a lot of talk about sort of a reversal of destocking at the airlines and maybe some buying greater than underlying demand as that destocking reverses. Are you seeing any of that in the next sort of the next three to six months, Eric, and to what extent do you think that might happen relative to a lot of the comments recently out of of airlines that they hope to get a lot more disciplined in inventory management relative to prior cycles?

Well, as I said, we haven't -- it's very difficult to pinpoint it on a part-specific, part by customer basis, on where we're going to see the recovery. As I mentioned, we have heard from our customers that they anticipate in general a greater level of demand, that they've depleted their inventories. But in terms of knowing exactly when and what percentage, it's very difficult at this point to very difficult at this point to see. One of the things typically that happens, of course, now, as the summer hits and the exhaust gas temperature margins of the aircraft go down, they're required to do additional maintenance, and I don't think they fully understand what the impact is going to be. But, of course, we've all seen the numbers, and the traffic numbers are pointing up, so, they're flying the aircraft. So sooner or later they have to buy the parts. So I'm sorry I can't give you greater detail than that. But, we definitely think that there will be some amount of recovery. In terms of now buying in advance of needing it, no, I don't think we've seen that, yet.

Okay. Thank you very much for the color, and excellent quarter.

You're welcome. Thank you.

Next question from Chris Quilty with Raymond James & Associates.

Yes, there are still a couple more questions, but not many. Excuse me if you've heard these already, I got called away for a moment. Did you comment at all on the volcanic clouds and what sort of impact, if any, you have seen or might see?

Is the question have we seen any volcanic clouds?

Yes, I don't think they made it to Florida.

Chris, the answer is, no, we have not been asked that question, and we're surprised because we were waiting for it. We have been asked by many people at various conferences recently about it. Clearly whenever you have some situation like that, it results in some fewer flights and those fewer flights are going to result in some fewer utilization of parts and so forth. We are unable to quantify it, we've talked about it. Eric can give you more color but it is really impossible to quantify it. Because, fortunately, it was a short-term period. It was probably four or five days. It was a lot of it was north Atlantic. In the long run, we don't expect to see a -- unless the volcanic activity continues and gets more serious, we would expect that it wouldn't be long-range a significant problem. But clearly it had to have taken some toll. So I think probably the month of April was impacted to some extent but it's hard to -- I've heard talk maybe 1%, 2%, but it's very hard to quantify it. Eric might have some further color.

Yeah, I would agree with that, Chris, that unfortunately for us it really came at the last 10 days of our second quarter. So some of our European customers were shut down, and getting parts over there was difficult, and they weren't inducting work engines, components. So, there was definitely some impact. The question is that exactly how much we're not entirely sure. We do have some consignment inventories that were impacted but maybe in that 1% to 2% area.

It is in the rear-view mirror, right?

Exactly.

So what do we care. BA having some problems, labor problems? I'm assuming that what BA doesn't play, somebody else does and it just shifts to the other hand for you?

I would say pretty much so. I mean, we hope that they get their situation all resolved, but I would say that that's not a meaningful impact -- not a meaningful impact for us. As a matter of fact, it just shows that they've got to cut costs wherever they possibly can, and if labor costs are going to ultimately go up or there are going to be a settlement or some concessions, presumably BA has to find the savings elsewhere. So I think that just puts us in a decent position to continue to help them.

Final question, when you gave the end market business mix, there was a fairly substantial pickup in space and defense. Were there specific programs or deliveries during the quarter that, you know, impacted the mix, or is that a sort of a longer-term trend?

Chris, I'm going to ask Victor to respond to that from ETG.

Hi, Chris. The answer is, it's -- I don't know that I would call it so much program-specific. Although at the end of the day everything is obviously tied to an end product or to an end program. Across the board this year, in 2010, and in the quarter, we had strong orders generally speaking. So things seemed -- the improvements for the group seemed to be pretty broadly based. Of course it is always mixed sensitive so there are always products that are contributing much more than others. But so far it has been broadly based. I think we have to see how it goes on the back end of the year and how long that continues or whether economic conditions cause a change.

Well congratulations on the good results again, and keep it up.

Chris, thank you very much.

Your next question comes from the line of JB Groh with DA Davidson.

Good morning, guys.

JB , good

I'll be scraping the bottom of the barrel for questions here so forgive me if you already answered these. Eric, I know there is a service component in flight support group and in this industrial comment caught me off guard. I wonder if can you refresh us in the breakdown between as granular as you're willing to get on flight support in terms of what service, what's parts, and then of that parts, how much is industrial, if you have covered that before I apologize. I jumped on a little late.

Eric?

Okay. I think Tom has got the -- I don't have the numbers in front of me for the quarter on the split-out between parts and service, and I don't know what we disclosed there. But Tom can add on that. But I would say that in the second quarter the service area was down a little bit.

Yes.

From where we would have liked it to be. But, Tom, do you want to -- would you like to comment on that?

Sure, Eric. Again, this is Tom Irwin . Over the last 12 months, it's still been running about 60-40 within flight support group, at about 60% parts sales and 40% repair services. The reference to the incremental revenue within industrial products, that is in the parts sales that is not service revenue. If that clarifies

I assume it was parts. I'm just curious, I'm guessing it is not more than 10% of that 60%, if that's safe assumption.

Yes, it's an -- our industrial products revenue within flight support is not a significant (inaudible).

Right. Okay. That's helpful. Tom, I think you mentioned, and Victor can comment, I think you covered this a little bit, but you're about five points better than, you know, sort of a normalized organic growth rate there in ETG and I think you mentioned satellite, medical and one other sub-segment there that was pretty strong?

I think we referenced defense, satellite and medical as being the areas that we've had some strength in fiscal 2009 versus comparable periods of last year.

You mean 2010 -- 2010 versus 2009.

You're right.

So that's pretty much everything within ETG, isn't it?

Well, we have some -- within the other category we still have the general electronics and some industrial products, some telecommunications, things like that.

Okay. And then, Tom, on your EPS number, what have you assumed on the R&D tax credit, and what would the impacts there be?

Yes, relative to the R&D tax credit, as a reminder the tax credit has expired now as of December 31, so our guidance assumes that there is no extension of it. There is great discussion and certainly a lot of support for extending the tax credit. But the timing of it, the couple years ago it didn't happen until after our fiscal year. So at this point we've let the -- we've assumed the tax credit benefit for the months of November, December, in accordance with the law. If that credit were extended in its old form, maybe rewritten, so on and so forth, but it would probably be a couple pennies, maybe $0.02, if you look at the tax credit historically versus what it is this year with just the two months. It is probably a potential upside of $0.02. If Congress were to act, before the end of our fiscal year.

But not a huge -- so that would be -- okay, okay, I got you.

But that would be upside. It is not contemplated our guidance.

All right. Good. Congratulations on the nice quarter.

Thank you.

Your next question comes from the line of Eric Hugel with Stephens.

Good morning, guys.

Eric, good morning.

Nice quarter.

Thank you.

Just wanted to -- Eric, maybe you can give us a little more visibility. If I look back at Q1 and the FSG sales there was a decent drop-off in the run rate versus if I look at 2009. My understanding was that that was really a drop-off on the services side of the business, and part of the reason why the margins were up in Q1, while you had the reserve reversal, was that those services businesses have somewhat lower margins. So from a mix issue that was a positive. Can you sort of talk sequentially sort of Q1 to Q2 now sort of how sort of things moved between the parts business and the services business, in terms of demand?

Tom, actually Tom and I are not in the same office right now so we don't have the sheets in front of us. Tom, do you want to--

Eric, if you like, in terms of comparing flight support group's revenue, in the second quarter of fiscal 2010 versus the first quarter, the PMA part sales were relatively flat. We mentioned the industrial products were up year-over-year $2 million to $3 million, and that's probably what it was up over in the quarter. There was some pickup in terms of service revenues in the second quarter versus the first quarter, and some pickup in some distribution sales. So the market for the PMA sales, as we would expect, it was flat relative to capacity. The service revenue grew with some market penetration as well as the distribution. I think Eric can add more color. But I think in the distribution area we picked up a couple of OEM lines this year versus last year.

Yes, that's correct. And we have been successful in the distribution area, as well. I mean, I would say that overall, I mean, the recovery is coming from all areas. And, we anticipate that as the airlines need more parts, they're going to need more service, and we're going to really see the benefit on both. I don't think that the future is going to impact us that differently on the parts versus the service revenue.

Okay. Fair enough. When I think about commercial the parts business flat, but pickup on the services side, that makes sense.

Well, when you say the parts business -- I mean--

The PMA business, if you look at sequentially was relatively flat and most of the increase. Again, related to commercial is really on the services side (inaudible).

Well, no, I think the increase over last year, quarter-over-quarter--

Yes, I'm talking sequentially.

Oh, Tom, is that--

First quarter this year versus second quarter this year, most of the increase is in service, that's correct.

Okay.

Okay. Fair enough. Tom, I'm looking at the cash flow statement, looks like there was $34 million in acquisition spending. Was all that DB or did you buy people's -- maybe some people's non-controlling interests, or something like that?

The answer is all of the above. That included the February acquisition, included some acquisition installments or payments that were made on prior year's acquisitions including contingent earn-out payments that matured or accrued, if you will, based on performance. So it is a combination of all of the acquired businesses.

Fair enough. So sort of looking at your guidance, I just wanted to sort of make sure, it doesn't look -- I mean it looks like Q2 was a very solid quarter, didn't look like there was sort of anything sort of strange. I know you had some push-forward on ETG, but if I just look at the top end of your guidance range, the $1.48 would imply doing about $0.38 each in the third and fourth quarter. And if you're talking about likely seeing at least in the fourth quarter a nice pickup beginning with pickup in the commercial parts business, I just want to make sure I'm not missing any potential headwinds we should be thinking about too.

Eric, this is Tom. I think in terms of, again, we don't give quarterly earnings guidance, so I can't comment specifically on how you would break down remaining second half of the year. But in terms of macro and market parameters, I think, yes, we see the fourth quarter is strengthening in the commercial aviation business, the potential, and of course that is 65% of our revenue, so that would have the most significant impact. You have the potential headwind of the second quarter extra sales in the electronic throughput if they're not replaced in the third quarter or fourth quarter. But I think overall, yeah, we see the potential that our fourth quarter would be our strongest.

Great. Thanks a lot, guys.

Thank you, Eric.

Your next question comes from the line of Jim Foung with Gabelli & Co.

Good morning, Jim.

Let me ask you big-picture questions and that will be it for me. Everyone is worried about the crisis in Europe and I see about a third of your sales are from -- third of your PMA sales from Europe, mainly from Africa. Can you just talk about what might -- what could happen in Europe and its kind of impact what happened in your business as opposed to what countries you're strong in Europe?

I can give you my 30,000-foot opinion. Couple things happening. Number one, the fact that Europe is having its problems initial reports and the press show that tourism to Europe is probably going to be up because the Euro is down. If that is the case, you're going to see more flights heading over to Europe. So that would be a little bit of a tailwind and a plus for us. On the other hand, if conditions in Europe are weaker, it's possible that you'll see the activity intra-Europe weaken a little bit. As to the push and the pull on that thing, where it takes us, we really don't know at this point. I do think the Europe -- personally I think the European economy is in for some tough sledding and maybe growth and maybe even a slight double-dip type of recession. So I think Europe is weak. But obviously Lufthansa is a major customer for us. We have a number of other strong customers in Europe. But as to where it's all going to fall out, it's very, very hard to really predict at this time. I -- I don't think we see a major problem ahead. Could we see a little bit of European weakness? Probably yes. But I'd like Eric to give you his thoughts on some more color on that. Eric?

Yes, Jim, I was over in Europe last week and I can tell you that as far as the market shift, the HEICO parts goes, the more trouble that in general the more trouble that airlines have, the more serious they become about needing to save money. So, whether it's fuel being up, or whether its labor issues, or whether it's potential revenue issues, I think that that gets them more serious about saving money and working with firms like HEICO, not only on the parts, but also on the repairs, as well as the distribution services. Because on the -- on the repair and the distribution services, we compete with others, and we generate very big savings for these customers and services, as well. So, yes, there is general apprehension but it hasn't translated into any change in the maintenance schedules for the airlines. So I would say at this point, unfortunately, it is really, as my dad said, it is just too early to tell. I think three months from now we'll have a greater idea, but if in general, again, as they need to reduce their costs, they can buy a lot more stuff from us that they're not buying. So I think we can turn it into a good opportunity.

Okay. And I presume you're two largest customers there are Lufthansa and British Airways.

Lufthansa is certainly a very large one. We don't for competitive purposes and regulatory purposes disclose that. But certainly British Airways is a very large customer as well.

Okay. All right. Great, so it's just kind of continuing to monitor the situation.

Yes.

Let me just ask you a second question. Boeing is talking about redesigning the 737 and it looks like the most likely option is to do a new engine to replace the existing engine. If they were to take that route, how would that affect your engine business of prevailing customers? Would they defer spending money your own engine in looking at a new replacement? I am just trying to understand the dynamics of how that would affect you?

A couple of things. First of all, the new engine is highly dependent upon some technology which has not been fully resolved, yet. So, the new engine is a bit off, and there is some question as to when the manufacturers are going to be able to get that to work. Number one. Number two, there is a tremendous installed base that already exists out there. And much of that base is already depreciated. When you look at the savings from a new engine compared to what exists out there, and the amount of time that it would take even if people wanted to buy new aircraft, I mean, we assume a natural attrition of our existing business, and I don't think that this is going to have a meaningful impact an our projections. We would certainly continue to develop parts, whether they go on new aircraft, existing aircraft, I mean the concept is that once a manufacturer gets in there and they -- things are very expensive to maintain, and HEICO is a relief valve that is really unique in the industry. So we'll continue to work with the airlines no matter what they fly.

Okay. So you don't -- so I'm just worried that customers might forego repairing their existing engines, they're going to opt for a newer engine in the future. But--

But it would take so long for them to phase out of the existing equipment. I mean, you're talking a very, very long period of time that I don't see that as really creating an impact for us.

Jim, I agree with that completely. I mean, we've got 18,000 or more CFM-56 engines out there and they're still building them and they're going to be doing it for the next few years. So all of the new aircraft, the narrow bodies, are going to have that engine. So I mean this re-engining, if it were to ever occur, is so far down the road, that it wouldn't have impact on HEICO for many, many years.

Okay. Great. Thanks for the color. Good quarter, guys.

Thank you.

You have a follow-up question from Tyler Hojo with Sidoti & Company.

Okay. Really quickly just on the R&D front. By my calculation you've done about $10.5 million in the first half of the year. Still on track for that $20 million to $22 million range in the back half, or given that you're ahead of schedule on some of the development efforts on CMA, and DERs does that go down?

Tyler, this is Tom Irwin, I think as it relates to the spending dollars, it's pretty much stable throughout the year. That is, the second half should look pretty similar to the first half of the year. In terms of the actual unit approvals, Eric commented on that earlier. But in terms of, yes, I think the bottom line the spending is going to be somewhere around the $20 million come the end of the year.

Great. Thanks a lot.

Thank you.

There are no further questions at this time.

Okay. Well, I want to thank you all for your interest in HEICO. You know that Tom, Eric, Victor and I are available for questions. You know where to reach us at HEICO. And we would be very happy to speak with you and try to respond to any questions that you may have. We will be talking to you at the end of our third quarter which will be the conference call will be sometimes toward the latter part of August. Our third quarter ends July 31, and we look forward to speaking to you at that time, if not before. Have a good summer all of you on the call. Thank you.

Thank you. That does conclude today's conference call. You may now disconnect.