HEICO Corp (HEI) 2002 Q4 法說會逐字稿

Welcome to the HEICO corporation fiscal fourth quarter 2002 and fourth quarter conference call. We now turn it over to Laurance Mendelson, chairman, president and CEO of HEICO.

Thank you and good morning to everyone on this call. We welcome you to the HEICO fourth quarter fiscal 2002 earnings announcement teleconference. I'm Larry Mendelson, CEO of HEICO corporation and I'm joined here this morning by Eric Mendelson who is president of HEICO Flight Support Group, Victor Mendelson, president of HEICO's electronics technology group as well as HEICO's general counsel and Tom Irwin, HEICO's Executive Vice President and CFO. Before we begin, I would like Victor Mendelson to read a statement.

Thank you. Certain matters that will be discussed in this conference call 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, demand for commercial air travel, product specification costs and requirements, governmental and regulatory demands, competition on military programs, HEICO's ability to introduce new products, product pricing levels, commercial airline passenger travel, airline fleet changes, customer credit risks, U.S. government export policies and restrictions, military program funding by U.S. and nonU.S. government agencies, HEICO's ability to make acquisitions and achieve operating synergies from such acquisitions, interest rates and economic, conditions within and outside of the aerospace defense and electronics industries. Parties listening to this conference call are encouraged to review all of HEICO's filings with the Securities Exchange Commission including but not limited to filings on forms 10-K, forms 10-Q and forms 8-K. Thank you.

Thank you, Victor. Now, before reviewing the fourth quarter operating results in detail, I'd like to take a few minutes to summarize the highlights. While sales and earnings were negatively impacted by the reduction in airline travel, and in particular by the erosion in our JT8D part sales following September 11th, we are very encouraged by the progress we have made towards returning HEICO to future growth. Examples of this are our non-JT8D part sales are up significantly, and our ability to replace JT8D part sales is being demonstrated by, one, a 19 percent increase in the sales of non-JT8D FAA-approved replacement parts in 2002 versus 2001. Next, new product approvals, mainly for non-JT8D FAA-approved replacement parts were at an all-time, record-level for fiscal 2002. Total parts approved exceeded 300. And our successful diversification into non-commercial aerospace markets as demonstrated by the growth in our non-commercial aerospace related sales, which equaled one-third of our total fiscal year 2002 sales, and our contributing satisfactory operating margins.

Also, our fiscal 2002 and fourth quarter 2002 results were highlighted by continued, very strong cash flow, which demonstrates the high quality of our earnings. This allowed us to reduce our debt from 67 million to 56 million, a 16 percent decrease during the fiscal year. Also, more airlines have begun discussions regarding some form of strategic alliance with HEICO. Since the dramatic decline in aviation part sales immediately following 9/11, we have experienced a growth in sales and now expect to be back to the pre-9/11 monthly PMA part sales levels by the end of fiscal 2003. Now, digging down and becoming very specific, we'll first talk about revenue and consolidated revenue in the fourth quarter of '02 decreased by about $500,000 or 1 percent from the fourth quarter of '01. The decrease in sales primarily reflects lower commercial after-market parts and services sales in the Flight Support Group, as a result of 9/11 events as well as continuing weakness within the commercial aviation industry. Partially offset by newly acquired businesses and increased defense related sales. The fourth quarter of '02 sales are up seven percent from the sales in the third quarter of '02. And we think that this is a significant trend. We do expect an increasing trend.

I can't predict the percentage. But we definitely see our part sales trending upward. Anyway, they are up seven percent from third quarter '02, driven primarily by higher sales in earnings in flight support and from new products in the company's Electronic Technologies Group, reflecting a growth in the company's defense-related activities. Electronic technology group sales increased 549 thousand dollars or four percent, to 13.8 million in the fourth quarter of '02, versus 13.2 million in the fourth quarter of '01. This increase also reflects higher revenues from defense-related contracts. Compared to the third quarter of '02, electronic technologies fourth quarter fiscal '02 sales increased 806 thousand dollars or six percent, due mainly to shipments of foreign military sales that had been delayed in the third quarter of fiscal '02, pending the approval by government agencies, which of course was received.

Flight support sales in the fourth quarter of '02 decreased three percent from the fourth quarter of '01 to 31.8 million, down from 32.8 in the fourth quarter of '01, reflecting the full impact of September 11th on the commercial airline customers. And this was partially offset by sales of newly acquired businesses. As we had expected, sales of FAA replacement parts were off about five percent in the fourth quarter of '02, compared to the prior fiscal fourth quarter. After increasing in double digit rates throughout fiscal '01 up to September 11th, reflecting the well-publicized capacity reductions made by airlines particularly in the older JT8D-powered aircraft in the aftermath of 9/11. JT8D part sales are off approximately 45 percent year to year. However, as I mentioned, non-JT8D part sales are running about 19 percent ahead of last year. And please keep in mind that our own internal projections assumed that JT8D sales would probably decrease about 10 to 14 percent annually.

So even though the part sales were down 45 percent, we had always assumed they would be down somewheres between 10 to 14 percent. So the incremental drop from 9/11 is in the area of 30 to 32 percent. The fourth quarter of '02, flight support sales increased seven percent to 31.8 million, from 29.7 mill in the third quarter of '02 reflecting sales of new products. Again, I'm pointing -- we believe that this trend is becoming pretty clear. And we think it's the most -- to management it's the most important indicator of where the company and in particular flight support sales are going. Again, fourth quarter '02 versus third quarter '02 up seven percent in flight support. Moving along to operating income, the consolidated operating income in fourth quarter '02 was 5.7 million, versus 6.7 in the fourth quarter of '01. The operating income in two four of '02 reflects lower sales and earnings primarily in the flight support group. A good trend is that operating income again in the fourth quarter increased 727,000 from the third quarter of '02, mainly due to higher sales which I discussed previously, partially offset by higher reserve or uncollectible receivables.

Operating income of flight support was 4.2 million in the fourth quarter of '02, versus five million in the fourth quarter of '01. Primarily reflecting an unfavorable product mix and cost increases, higher sales and marketing expenses and higher reserves for uncollectible receivables, partially offset by the elimination of goodwill amortization. And again, an improving trend shows that Flight Support Group's operating income in fourth quarter of '02 increased 586,000 from 3.6 million in the third quarter of '02 due to the higher sales discussed earlier. Operating income of electronic technologies increased 572,000 to 3.1 million in the fourth quarter of '02 versus the fourth quarter of '01. And this increase reflects the elimination of goodwill amortization, as well as higher sales.

Another improving trend is that electronic technologies operating income in the fourth quarter of '02 increased by 386,000 from 2.7 million in the third quarter of '02. Again, this is due to higher sales and a lower level of new product development costs. Operating margins on a consolidated basis totaled 12 percent in the fourth quarter of '02, unchanged from the third quarter of '02 and down from 14 percent in the fourth quarter of '01. The decrease in the operating margins compared to '01 reflects lower margins within flight support, primarily attributable to lower sales of PMA parts, and unfavorable product mix and some cost increases, including increased marketing efforts which were partially offset by the elimination of goodwill amortization. Operating margins within flight support reflects the items I mentioned earlier and primarily lower sales of PMA, product mix and increased marketing, offset by elimination of goodwill amortization. Operating margins within the electronic technologies group were 22 percent in the fourth quarter of '02 versus 21 percent in the third quarter of '02.

And 19 percent in the fourth quarter of '01. There's a very strong trend developing. The increase relative to the fourth quarter of '01 is due to the elimination of goodwill amortization and the increase versus the third quarter of '02 reflects a somewhat lower level of R&D expenditure. Our EBITDA margins of the consolidated company and flight support were both 15 percent in the fourth quarter of '02 and are up from 14 percent in the third quarter of '02, but down from the 20 percent in the fourth quarter of '01. The EBITDA margins of electronic technology was 25 percent in the fourth quarter of '02, up from 23 percent in the third quarter of '02 and down slightly from 26 percent in the fourth quarter of '01. The slight changes in EBITDA margins reflect changes in operating margins which I mentioned earlier. Moving on to earnings per share.

The diluted earnings per share was 25 cents in the fourth quarter of '02 versus 14 cents in the fourth quarter of '01. And 13 cents in the third quarter of '02. Net income in the fourth quarter reflects the recovery of a portion of taxes paid in prior years resulting from a recently completed income tax audit which increased net income by 2.1 million dollars, or nine cents a share, net of related expenses. As previously reported, the company adopted SFAS 142 beginning in the first quarter of '02. And this eliminated the periodic amortization of goodwill. Our higher earnings per share in the fourth quarter of '02 versus the third quarter of '02 reflects higher net income in the fourth quarter of '02 of five million 599 thousand dollars which includes 2.1 million dollars related to the tax recovery compared to two million eight 29 in the third quarter of '02 and the increase in net income in the fourth quarter of '02 compared to the third quarter '02 reflects higher sales and earnings which are I discussed previously as well as the tax recovery. Moving on to research and development, our total R&D expense was 1.6 million in the fourth quarter of '02, compared to 2.3 million in the fourth quarter '01.

The fourth quarter year-over-year decrease in R&D expense of 700,000 was due primarily to a reclassification of certain new product costs previously included in R&D cost has now been reclassified to cost of sales. For the fiscal year ending October 31 '02, R&D expense totaled about 9.7 million versus 7.7 million in fiscal '01. The fiscal year increase year-over-year in R&D of about two million, which we consider fundamental to our long-term growth, reduced earnings per share, diluted earnings by about four cents in fiscal '02 compared to '01. The addition of new FAA PMA approvals, particularly for non-JT8D aircraft continues to be critical to our long-term growth in light of the apparent acceleration in retirements (ph) of the JT8 Standard fleet in the aftermath of 9/11.

We still see a pretty decent future for the JT8D 200 series and those aircraft are still flying and I want to emphasize that the big drop in JT8D volume was in what we call the baby 8, the non-2 hundred series. We now have approximately 900 parts in the development process, over 95 percent of which are for non-JT8D engines. And we have approximately 27 hundred parts approved by the FAA, two-thirds of which are nonJT8D parts. We are very pleased to note that this past fiscal year approximately 300 new PMA parts were approved by the FAA and that is the strongest, largest number of parts that we've ever had in the history of the company. New parts released by our R&D groups in the fourth quarter of fiscal '02 continue at a very strong level, pretty much as budgeted.

And we are budgeting approximately the same number of new PMAs for fiscal '03 as we had in '02. At this point we don't see any significant change between 2002 and '03 in budgeted R&D spending. SG&A expenses as a percentage of sales for the fourth quarter of '02 remained approximately level, compared to the third quarter of '02. And about the same as the fourth quarter of '01. However, SG&A expenses, as a percentage of sales for the fourth quarter of '02, is three percent higher than in the fourth quarter of '01, adjusted to exclude goodwill amortization. The increase is primarily due to professional fees associated with the recently completed income tax audit previously discussed and some increased and accelerated sales and marketing efforts as well as higher reserves for uncollectible receivables. Interest expense in the fourth quarter of '02 was about 513,000, 37 percent lower than in the fourth quarter of '01 and in line with third quarter of '02, the decline in interest expense is mainly due to lower interest rates. Other income in the fourth quarter '02 is immaterial.

It didn't change significantly from fourth quarter '01 or third quarter '02. Overall, other income for the full year '02 versus '01 remained approximately the same. Other income for '02 includes a one million 230,000 dollar pretax gain, about three cents a share net of tax on the sales for Trielectron Product line which we recognized in the second quarter. Other income for '01 includes a gain on the sale of property retained in the sale of Trielectron and some other investments, all aggregating about 800,000 or two cents a share net of tax. Income taxes reflect the recovery of a portion of taxes paid in the prior year resulting from our recently completed income tax audit discussed earlier and was the principal driver behind the reduction in the company's effective tax rate from 37.6 percent in the fourth quarter '01 to a net recovery in the fourth quarter '02. The company's effective tax rate in the fourth quarter '02 and the full year fiscal '02 excluding the tax recovery was about 35 percent.

And the elimination of goodwill amortization also contributed to a year-over-year decline in the effective tax rate of 38.1 to 23 percent. Actually, adjusted to exclude goodwill in the fourth quarter of '01, the effective tax rate would have been 34.8. The minority interests of 304 thousand in fourth quarter '02 represents principally the minority interest of Lufthansa and American in our flight support and decreased primarily due to lower earnings of the Flight Support Group. That are the prepared comments for the income statement. Now we'll talk about balance sheet and cash flow. As you can all see, our financial position remains extremely strong. Cash flow from operations totaled 8.7 million in the fourth quarter of '02 and 23.3 million in fiscal '02. And that exceeded net income in each period by more than 50 percent. The fiscal '02 cash flow represents a 41 percent increase over the cash flow from operations of 16.5 million in fiscal '01.

Our working capital ratio was 3.4 as of October 31, '02, versus 3.9 as of a year before that. The decrease is primarily related to a 6.8 million dollar current portion of long-term debt, included in current liabilities as of October 31, '02, assuming borrowings outstanding under our revolving credit facilities are converted to a term loan next July when the revolver period ends. We do intend to renew or replace this facility prior to its expiration date and our working capital ratio excluding this debt amount is 4.4 times as of October 31 and it's very strong, as you can see. The DSOs accounts receivable October 31 '02 improved to 57 days compared to 63 days a year ago and the improvement reflects our continuing efforts to closely manage receivable collections and maximize cash flow from operations in the current business environment. We have set up a very active credit review committee and process and in light of current conditions in the industry we feel this is quite critical to managing the business.

And that process is going very well bill. No customer represented more than 10 percent of consolidated sales in the fourth quarter of '02. Inventories increased by two and a half million, since October '01, and the inventory turnover rate is up about three days as we discussed in our third quarter conference and as expected this increase is mainly associated with higher inventory balances in flight support associated with new products. The inventory turnover rate has, however, improved by 13 days since July '02 and we expect further improvements as we sell more and more of these new products. Again, we have implemented and installed some fairly sophisticated monitoring systems with the help of some new IT software. We are now able to monitor parts turnover on an individual basis as opposed to looking at it in buckets. And again there's a very strong emphasis on this management control technique. And it seems to be working quite well. As you all know, as we increase parts, new PMA parts available for sale, we have to stock, for example, 300 new parts on the shelf. And that is going to point to an increase in inventory, investment in inventory.

Those parts on day one do not turn over. They don't sell. So naturally the natural tendency will be to increase the parts on the shelf and the days inventory will increase in and the turnover rate will increase. That's an expected result of our long-term strategy. It's nothing to be concerned about. Long term debt decapitalization (ph) decreased Five points to 21 percent which is quite low as of October 31 '02 versus 26 percent in '01. We've reduced the revolver loan balance by 11 million dollars and it was 54 million as of October 31st '02 compared to 65 million a year before that. Cap ex in '02 was 5.9 million, slightly below our original budget of 6.5 million. Cap ex for the next year is projected to be about five and a half to six million. Looking forward, just some comments on what we see coming up in the future. We are pleased to note that our 2002 results, although negatively impacted by 9/11, as well as the airline industry as a whole, continues to struggle to return to profitability.

We're pleased to note that we continue to operate quite profitably. We have very strong cash flow and we continue to pay dividends which we have done for the past 20 years. Furthermore, we've successfully diversified our operations beyond the commercial markets we historically serve. And this cushioned the impact of 9/11. Revenues from the defense industry and other markets including industrial, medical, electronics and telecommunications represented approximately one-third of our revenues in '02. And defense customers actually represented about 25 percent of revenues. We previously noted that we could have abandoned our medium and long-term growth strategies by reducing new product development spending and cutting back on marketing efforts to benefit short-term results. We could have reduced expenses and shown higher earnings per share.

We do not choose to do that. We don't follow that process. We have stayed the course and in fact we have increased our new product development and marketing efforts. And we've spent more money. That did affect the short-term results. And we do this with the expectation that the product development, combined with the strategic relationships with some of the world's major airlines, while having a negative impact on near term earnings will provide significant benefit in future periods. I remind you that this is the strategy that we adopted when we took over management of the company 12 or 13 years ago. It has been a strategy that's resulted in great growth. We are not afraid to invest in our future and we see the future as really quite bright. In spite of the terrible problems that the airline industry is facing at the current time. In some ways those problems indirectly benefit companies like HEICO who save airlines money. In '03, we expect considerable improvement in sales and earnings and in fact in the fourth quarter and the early results of '02 point in that depreciation.

Based on recent announcement of additional planned flight reductions by some of the major domestic airlines, we are targeting fiscal '03 earnings in the range of 68 to 75 cents a share. And this earnings estimate equates to a sales growth target within a range of 12 to 15 percent. Now, remember, that's all internal. That's assuming no acquisitions. So a range of 12 to 15 percent over our fiscal 2002 sales and represents an earnings per share growth of between 15 and 25 percent over fiscal 2002 earnings, adjusted to exclude the tax recovery of nine cents, which we talked about. Again, these estimates are before new acquisitions, if any. In closing, I'd like to say that while the weakness in the airline industry may continue into the foreseeable future, that our products do offer our customers substantial opportunities to reduce operating costs and we continue to have meaningful discussions with customers to reduce their costs through increased use of our products and services.

And we are confident that with these efforts, coupled with our strong balance sheet and the ability to continue developing new revenue sources through internal growth and some selected acquisitions, if we find them worthy ones at fair prices, we'll provide an opportunity for continued substantial growth for HEICO. And with that I would -- that's the end of my prepared comments and I would like to open the floor for any questions which you might have. And I remind you that Eric Mendelson, Victor Mendelson, Tom Irwin are here to help in the response and drill down deeper if you'd like it. So operator, would you please open the floor for questions.

Sure. Just a reminder, if at this time you do have a question press star 1 on your telephone keypad. Our first question is from Tom Louis.

Good morning.

Good morning.

Tom Louis here, CL Ping and associates. Just a couple things would I be correct in understanding when you talk about bringing on 300 new approved PMA parts, does that tend to have, when you bring a lot of new parts on, does that tend to have a depressing effect on your margins? Is there a certain amount of learning curve that you have to deal with there?

Generally speaking, the answer is no. In the initial stages, perhaps the production, depending upon if we manufacture the parts or if it's done outside, the learning curve might be a little bit more expansive. So it might have some small negative impact. But generally speaking the 300 -- the development costs of the 300 are the major impact. And that's reflected in R&D.

Okay. My other question would be, within the -- looking at this 19 percent increase in non-JT8D revenue you're getting, I would imagine you're getting most of that from a broader range of offerings and increased penetration, but is there anything in there for either pricing or from an actual improvement in the demand on programs like, say, the CFM56 supposed the other ones that are still in the tank?

I think we intentionally avoid commenting on which engine types the sales are coming from, except to say JT8D and non-JT8D. But I can tell you that the sales increase, the revenue increase is generally across the board and is focused on all non-JT8D engine types. Does that answer your question? If you want further clarification, just say so.

Just partly. Is there any indication in that improvement that the underlying demand for newer generation engines has picked up over the last 12 months..

I think the answer is yes. Incidentally, the airlines, to elaborate on that, as a result of the problems that the airlines are having worldwide, although the U.S. operators are having the greatest problems, probably due to their capacity and all the things that you people know, the result is that the airlines are much more concerned with every nickel and dime in cost that they have. So whereas when they were rolling in money a few years ago, we made pretty good inroads. We are having discussions with many more airlines about various types of strategic alliances, buying arrangements and so forth. These airlines are much more interested in working closely with us today. So we have a policy of not announcing any alliances until they're signed and done. And I can't predict on this call for all the reasons that you know when we might do it, because we might never do it. But based upon our discussions, there is an increased level of interest, very serious interest on the part of many additional airlines in our products.

Okay. Great. I'll let somebody else jump in. Thank you.

Thank you.

The next question is from Keith Hughes.

Good morning. It's Scott Phillips on Keith's behalf. We were just looking for some more detail on your revenue guidance. You put out a 12 to 15 percent organic number. We're just looking to get some kind of feel what you're looking for in the segments throughout the year. Are you looking for a bigger push from your ETG group or just a little bit, any detail you could provide there.

I'm going to turn that over to Tom Irwin, our CFO.

By segment, we're really looking for an overall approximate growth percentages, comparable in both segments. We see both growing in '03.

That's steadily ramping throughout the year or do you see it back half witted or --

By support group. That is for quarterly improvement. Within Electronic Technologies Group, we do see on occasion lumpy increases but we may have some, as an example, large governmental contract that may be as we've experienced in the third quarter to the fourth quarter some delays with foreign military approvals or export licenses or government funding budgetary considerations. So it's difficult to predict quarter over quarter. Generally in the FFC we see sequential growth by quarter there.

Okay. And then finally, on the JT8D, do you know what percentage of '02 revenue that was on those parts?

As a percentage of PMA sales, just PMA sales, it was approximately 38 percent for the full '02 year, which of course is down considerably.

Sure. Thank you that's it for me.

Incidentally, the reason it was down is that over the past five and six years we have consistently been building up the non-PMA part sales and revenue developing nonJT8D PMA part sales. So there's been a focus -- the change in the industry is something that we have expected for many years. And as I earlier indicated, we had always assumed a 10 to 15 percent drop in JT8D revenue over, going out and we have assumed this four or five years ago. We just assumed it would be dropping. The big drop came when they retired so many of the baby 8 D.

That actually only accounted for eight percent of our PMA sales, the baby 8s or standard 8s.

So it's a result of our own strategic planning, the only difference is that we had never planned for such a large retirement after 9/11. And to make up for it again we accelerated development of many non-JT8D parts. And you're seeing that reflected in the R&D costs as well as some of the marketing expenses. Are there other questions?

Yes, the next question is from Steve Wartman.

Good morning. Just first off a couple of modeling questions. How much R&D was reclassified as cost of goods in the quarter?

In the fourth quarter, it would have been probably somewhere half a million or so, approximately. Half a million to three-quarters of a million.

And that's going to go forward into next year as well?

No, that should be a one-time thing. When Larry mentioned approximate level R&D spending in '03 versus '02, that doesn't consider any additional reclassifications, that's net.

Okay. And also the tax rate guidance along with the EPS guidance for F '03.

For '03 as Larry mentioned '02 when you adjust for the tax recovery is about 35 percent in the normal course, with sales growth, are modeling would raise that a point to maybe a point and a half, so 36 to 36 and a half, within that range is what we're modeling at this point.

Okay. Just a couple general questions. On ETG for next year, I guess what type of offset do you expect commercial businesses from the defense growth and within defense growth what will drive it, are there any particular programs out there or platforms?

Steve, I'm not sure if I understood the first question about the offset of commercial.

Well, I guess, in your model, do you expect I guess the telecom, that part of the business to continue to come down? Are you seeing any flatness there and how much defense growth are you expecting for F '03?

I think we're probably seeing -- no, because there isn't that much telecom built into it to begin with. It's running at a pretty low level. We think we're flat out on that. Maybe a slight increase, because we're bumping along the bottom. So I don't think -- I don't think the mix in electronic technologies is assumed to have any significant shift. One of the problems, as Tom alluded, in the defense business, as opposed to the flight support, which is primarily commercial, in defense you have a lot of government rules, regulations, delays, approvals and things like that, that as Tom said, make it a little bumpy and lumpy and it's hard to predict. In ETG, in preparing our budgets and our estimates, we think that we have been rather conservative and we've left some room on the upside. Now, the reason we've been conservative is because we can't be absolutely sure that that stuff -- we may hit a bump and a lump and therefore to come out and predict, oh, everything is going to go great, would be a little bit too aggressive. It's possible that some of these programs could click in. I remind you of a program that requires governmental approval. We mentioned, I'm sure you remember about the power pack for the cockpit voice recorder and although the FAA has indicated that they're going to have a requirement with all the problems that are going organization this is a governmental regulation thing and we've been waiting and so forth and we can't predict when, if that may happen. So we exclude any upside that we might have for those kind of items.

Can what percentage of your defense revenue is international versus domestic?

Tom, do you have that?

It would be approximately 25 percent. That's a rough guess. I'd have to get back with you, of course, with specifics. But that's the ballpark.

The last question, just for a general question, going out to F '04, F 2005 with flight support if you annualize demand where do you see the operating margin recovering to. Right now it's running at the lowest rate it's run in years what's the leverage that you see on the upside over the long-term on that front?

I think there is leverage. We continue to believe that both of our segments and on a long-term basis provide for operating revenues, operating margin revenues of at least 20 percent, as you're pointing out, FSG is below that, EPG is at that now, I think we're expecting the leverage. It will probably take two years to get to that 20 percent operating margin. We do not expect it in '03, but I think by '04 if we're not there we'll be very close. Again leveraging off the higher sales relatively fixed R&D, greater absorption of our expanded marketing and new product efforts that are semi fixed if not totally fixed at this point.

Steve, we've noted with dismay the drop in FSG operating margins. And we've set up a group within the company to focus on this specifically. Part of it has to do with drop in volume and throughput and some of it has to do with marketing, additional marketing expense as the number of products increase that market expense and revenue increases. Hopefully that market expense will be spread over a broader base and will pick up some percentage points there. We should pick up some percentage points in manufacturing, also in some outsourcing and some other product profit improvement. So we've defined a number of metrics that we have to focus on and we have a group doing just that. So as Tom says, I think in '04, 2005 we should climb back up there.

Thanks a lot, guys.

The next question comes from --

Steve, Eric has another comment.

This is Eric. One other thing to mention, unlike many other companies that took one time impairment charges following 9/11 to take care of obsolete inventory, HEICO did not do that. So as a result we have had to work with our obsolete inventory and take inventory reserves throughout the year and that has been incorporated into the operating margin. So that has also impacted the situation.

But that should burn, as we said that should burn off by 4 and 5. Are there some more questions.

Yes. The next question is from Sue Kesmer (ph).

Sue Kesmer from Merrill Lynch. Just want to go through the earnings guidance, you've lowered earnings estimates a number much times over the past several months. I'm just kind of wondering what makes you confident in your latest estimate revision?

Well, I think one of the problems, the reasons that lower guidance is the atmosphere that we're operating in, and airlines and so forth and we try to be as realistic as we can as companies start to cut back and they reduce capacity, the big driver here, as you know, Sue, is the reduction in capacity that airlines are facing. I mean united is an example. There's no question in my mind they're going to be reducing capacity. And as they reduce capacity, how do you make that prediction? If united reduces capacity more, it might impact us. So we kind of have to roll with the punches. At this point our best guesstimate is the guidance that we've given today. We have gone to what Eric believes and I believe is a very sophisticated method of trying to predict revenue, but that method is based upon the number of aircraft that are flying and the input we get from the airlines. If they change their assumptions and they change their capacity and they take planes out of service and so forth, that could impact us. And we've tried to have some cushion in our estimate for that, but that is what forces us to change estimates.

Is your current guidance assume any further impact at United?

Our current guidance does include what the United has stated so far. But if they come out with further fleet plan announcements, then, no, it does not include it. However, that would be really towards the lower end of our range. United has announced of their 44 seven 47400s 10 are on the ground another 34 will go on the ground. If that happens, that has been concluded in our numbers. If it goes beyond what they've stated for other aircraft type, then we'll move towards the lower end of our range.

Eric, can you speak a little bit to the other exclusivity agreements you have and how they're running with Lufthansa and America.

We're very happy with them. Our customers are happy, we're happy. The revenue is on target. The product development has been very strong, coming out of our R&D centers. The airlines have been approving these parts that at a better rate than ever and I'm very optimistic with how things are going. And they realize now more than ever they really have to cut these long-term costs. They've been particularly dismayed at the OEM profit levels at times when the airlines have been suffering so badly and the airlines realize they need to have leverage and have a second source for these products and I anticipate that they are going to continue to work with us at an ever increasingly higher level.

Sue, there's one other thing. What we have not factored into our outlook is the possibility which we think is very great that other airlines will enter into alliances with us and as a result increase the volume. So if you get, just say united, for example, if they take some other aircraft out of service and put them in the desert, the offset to that kind of the ace in the hole that we have is the additional demand that we think might be likely from some other airlines at the moment don't have agreements but would have them. So it's kind of an offset. So how do we figure it out? We don't put it in there. In our projections we're not assuming we're going to get those agreements as soon as we get them, if we get them, of course they'll be announced. So there is sort of a reserve and an offset in there.

Okay. I guess I'm just not understanding -- I mean your prior guidance was for EPS of 90 to 95 cents and where is, if your committed revenues are kind of running along the same path, then what's really changed over the past 90 days in your view.

I think in those last three to four months we've seen further capacity reductions, we've seen obviously the bankruptcy of united which obviously, as the fact that we didn't have to take a big write off, we contemplated that potential, but still the capacity reductions, the further concerns that the airlines are expressing regarding their '03 revenue passenger miles, all of them are being tempered down, I think probably more a reflection of general economy as to any particular financial problems the airlines individually may be facing. So I think that that has tempered us to try to bring down our expectations so that we can have a reasonable expectation of meeting or exceeding them.

Okay. Thanks a lot.

Sue, there's one other thing, too, in electronic technologies, certain orders that we thought that we might receive have been pushed out and we're not sure whether we're going to receive those orders and if we do in what quarter and what fiscal year and so forth. So it's a little bit hard to predict where that will fall. And we have also taken a much more conservative look at that. Although we might get the orders in the current year and we're optimistic, hope that we will. We don't want to put it in expectations, because if it doesn't come in and a lot of it is very, very difficult to control and to predict. And we've been disappointed in that particular area before and we want to try to take the most conservative approach that we can. If it does come in, it's not in our estimates right now. Are there other questions?

Yes, the next question is from Chris Kolti (ph).

Most of my questions have been answered but if you could highlight for us on the defense side of the business what areas you have particular exposure to, what events or funding events might favor your positioning, and also if you can touch back on where you stand in the regional jet market. I know that was an effort you guys were looking at pretty seriously about a year, year and a half ago.

Chris, this is Victor. In answer to your question on our concentrations on defense. It's fairly broadly based, where we get our revenue. A big part of our revenue is really any system that uses a laser designate tore or laser range finder so there are a host of targeting systems and missile products that use our system in varying quantities, as well as hand-held ocular devices like binoculars, gun sights, tanks, so on. In addition, on the IR side of the electro-optical business we have similar broad exposure on a bunch of test systems for a variety of programs that use IR.

It's sort of wherever IR or laser is found you have a pretty good chance of finding us somewhere in there for varying quantities. For next year, I guess the largest single item that I can think of where we have exposure if we were to quantify it would be in some development work we're doing for ballistic missile defense. And that's really at this point generally lower margin work, it's more R&D oriented. And then last but not least we have our Inertial navigation business where we see a chunk of our revenue, defense revenue. And most of that is foreign military. So it's pretty broadly based.

Okay. And on all of the optical infrared type who are you generally competing and supplying there?

Generally our competition is very diffused. It's small companies, very small companies. Sometimes we're actually competing with the customer we're selling to, because they'll have an internal department that does similar work and we'll outsource it to. Most of our large customers are the large primes (ph) on those programs and to a lesser degree the U.S. government directly. And I would say in half of the instances we are designated by the U.S. government to the prime, as the supplier to be used.

Okay. On the regional side of the market. I'll let Eric answer that.

On the regional side of the market we have a very strong position with our future aviation subsidiary, which has been well connected in that industry for about 15 years. Futures business in the past was primarily turbo prop, however it's transitioned quite nicely over to the regional jet side. So they built up their reputation servicing these customers, not when it was fashionable to serve them but when people really weren't focused on it. So as a result they're very well entrenched, they have great customer satisfaction level and we've made a great transition over into the regional jet side. And we think that there's tremendous opportunity for HEICO all over the regional jets. We're already doing a lot of business on the RJs and I think that's going to continue to grow substantially for us.

Very good. Thank you.

The last question is from Sim Wooten (ph).

I've got a couple of questions. One, on the overall pricing environment for the business, can you just comment on that currently?

Are you talking commercial or --

PMA. I'm sorry. PMA pricing. I think that that's important to understand where that's going in the next 18 months.

This is Eric. The pricing is holding level. We are not seeing substantial price increases or decreases. The airlines are very focused on saving as much money as they can, but overall the pricing is fairly consistent with how it's been.

And given the downturn in the volume, is there any new competitive responses, that GE or Pratt and Whitney are incorporating in trying to garner more business?

Actually, as you know, the OEMs enjoy a monopoly on most of their products and as a result they've increased the prices quite substantially in this most recent quarter for '04. I don't have the exact numbers in front of me, but I think GE is up somewhere around six or seven percent and Pratt and Whitney is up in the same ballpark. So they've taken the opportunity to try to get pricing out of their customers in this environment.

Great. So given your discount to them, are you able to get some of that pricing increase going forward for next year or what?

We do get some, most of our business is under long-term agreement where we've locked in either a fixed price or a somewhat variable price with the customer. So I would say that the OEM increase doesn't immediately benefit us with the exception of just driving more business our way.

Sure. And in terms of the forecast next year, you've basically indicated eight percent of your PMA parts were the baby JT8Ds, what percent sort of next year do you anticipate that going to?

About six percent. Right now, what Tom mentioned, that about 38 percent of our sales in '02 for the PMA business was JT8D, and of the JT8D the parts that are only eligible for the baby 8s was eight percent. In our '03 numbers, we're anticipating about six percent for only baby 8 parts. MA business was JT8D, and of the JT8D the parts that are only eligible for the baby 8s was eight percent. In our '03 numbers, we're anticipating about six percent for only baby 8 parts. So it's only to the baby 8. And of course the balance are eligible on the MD 80s. And while those are not in production any longer, those are fairly consistent.

Then you indicated there were some obsolete inventory charges, did that occur this year and how much were they?

It's not that -- they have not been dramatic or material. Just in the ordinary course we review our inventory and set up appropriate charges, appropriate reserves for that inventory. So my point was that also had an impact on the margins whereas other companies pulled them out as a one-time event and put them into last year. We did not do that. So that has been impacting the margins. But it's not in a super significant way.

Okay. Great. Thank you.

You're welcome.

There are no further questions at this time.

Okay. Well, we want to thank you all for participating in this earnings call. We remind you that we are available to answer certain questions or clarifications, as long as we're not in violation of any SEC rules and so forth. And I'm available, Tom Irwin, Eric, Victor Mendelson, we're all available to try to respond to any questions and information that we are permitted to give you. And we'd like to wish you all a very happy holiday, a healthy new year and we look forward to our relationships continuing strong in the new year. So with that, again, thank you and have a good day.