HEICO Corp (HEI) 2005 Q2 法說會逐字稿

Good morning and welcome to the HEICO Corporation fiscal 2005 second quarter earnings conference call. I will now turn the call over to your host, Mr. Laurans A. Mendelson, the Chairman, President, and CEO of HEICO Corporation.

Thank you very much. And good morning to everyone on this call. And we welcome to you the HEICO second quarter fiscal 2005 earnings announcement teleconference. This is Larry Mendelson, I am the CEO of HEICO. And I am joined here this morning, by Eric Mendelson, President of HEICO's Flight Support Group, Victor Mendelson, President of HEICO's Electronic Technologies Group and HEICO's General Counsel, And Tom Irwin, HEICO's Executive Vice President and CFO. Before we begin, Victor Mendelson will read a statement.

Thank you. Certain statements made in this 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 these forward-looking statements as a result of factors including but not limited to: Lower demand for commercial air travel or airline fleet changes, which could cause lower demand for our goods and services. Product specification costs and requirements, which could cause an increase to our cost to complete contracts. Governmental and regulatory demands, export policies and restrictions, reductions in defense or space spending by U.S. and or foreign customers. Or competition from existing and new competitors, which could reduce our sales. HEICO's ability to introduce new products and product pricing levels, which could produce 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, and electronics industries that could negatively impact our costs and revenues. And HEICO's ability to maintain effective internal controls, which could adversely affect our business and the market price of our common stock.

Parties listening to this conference call are encouraged to review all of HEICO's filings with the Securities and Exchange Commission, including but not limited to filings on forms 10-K, 10-Q and 8-K. We undertake no obligation to publicly update or revise any forward-looking statement, whether it is a result of new information, future events, or otherwise. Thank you.

Thank you, Victor. Now before reviewing our second quarter operating results in detail, I would like to take a few moments to summarize the highlights of what we consider a very strong quarter. Second quarter sales and operating income represent record quarterly results for HEICO. Next, both the Flight Support and Electronic Technologies groups reported higher sales and earnings in the second quarter of '05. Combining for an overall 27% improvement in consolidated sales and a 40% increase in operating income over the second quarter of last year. Consolidated operating margins increased by well more than 1% in the second quarter of '05 over the second quarter of '04. And higher sales and operating margins contributed to a 39% increase in consolidated net income over the prior year.

We also completed our 24th acquisition since 1990, with the addition of Lumina, a designer and manufacturer of power supplies for the laser industry. Our acquisition of Connectronics in the first quarter of '05 contributed nicely to our second quarter financial results. We believe that these results are a further indication of the progress that HEICO has made towards long term sustainable growth. As we have said many times before, we consider HEICO a growth Company. And we believe that this year's performance is clearly proving that.

Now, we'll talk about the specific items and start with net sales. Our consolidated sales in the second quarter of '05 increased by $14 million, up 27% from the second quarter of '04. Reflecting revenue growth of 22% within Flight Support and 39% within Electronic Technologies. Net sales of Flight Support increased 22% to 46.1 million in the second quarter of '05, up from 37.7 million in the second quarter of '04. And the increase in Flight Support's revenue represents all organic growth and reflects the continued strength in the after-market demand within commercial airline industry. And our success in developing and bringing to market new products and services. You can all see the results of our R&D expenditure when you look at these sales numbers. Net sales of Electronic Technologies increased 39% to 21 million in the second quarter of '05, up from 15.1 million in the second quarter of '04. This increase primarily reflects the acquisition of Connectronics in December '04 and Lumina in February '05. As well as organic growth of approximately 9%. The first half of fiscal '05 consolidated sales, increased 25% to 124 million, up from 98.9 million in the prior year. Our net sales for the first half of fiscal '05, by market, were: comprised approximately 67% from the Commercial aviation industries, 21% from the defense and space industries, and 12% from other markets, including industrial, medical, electronics, and telecommunications.

Moving on to talk about operating income. Our consolidated operating income in the second quarter of '05 increased 40% to 11.4 million, which was up from 8.2 in the second quarter of '04. Consolidated operating income in the first half of '05 increased 36% to 20.1 million, up from 14.7 in the first half of fiscal '04. Operating income of Flight Support in the second quarter of '05 increased a whopping 48% to 8.9 million, up from 6 million in the second quarter of '04. And this reflects both higher sales from organic growth, as well as higher margins reflecting operational efficiencies realized on the higher sales volumes. If you recall, we sort of predicted this on our earlier conference call for the first quarter. Operating income of Electronic Technologies in the second quarter of '05 increased 14% to 4.2 million, which was up from 3.7 in the second quarter of '04. And this reflects higher sales from the aforementioned acquisitions and a 9% organic sales growth, partially offset by a slightly less favorable product mix.

Moving on to operating margins. Consolidated operating margins increased 7 - - to 17% in the second quarter and 16% in the first half of fiscal '05. Up from approximately 15% for both the second quarter and the first half of fiscal '04. These increases are in line with the margin improvements that we have targeted for fiscal '05. Operating margins of Flight Support were 19% in the second quarter of '05, up - - and this is up considerably, 16% in the second quarter of '04 and again, due to operating efficiencies realized on higher sales volumes. Operating margins of Electronic Technologies were 20% in the second quarter of '05, down from 24% in the year-ago quarter. This, however, is a strong improvement over the operating margin of 17% in the first quarter of '05. And based on current backlogs, we do expect operating margins for the second half of fiscal '05 to return to a level approximating the operating margins we experienced in fiscal '04.

Diluted earnings per share improved to $0.22 in the second quarter of '05, up a very strong 38% from the $0.16 reported in the second quarter of '04. Depreciation and amortization expenses were about 1.8 million in both of the second quarters of '05 and '04. Moving on to research and development. Our total R&D expense was 2.9 million in the second quarter of '05 versus 2.4 million in the second quarter of '04. We continue to have great success in the addition of new FAA-PMA approvals. We are currently have approximately 400 parts in our development pipeline. Substantially all of which are for new generation engines. And we now have approximately 2700 parts approved by the FAA that are actively being marketed. Over 70% of these parts are non-JT8D.

New parts released by our R&D group in the second quarter of fiscal '05 continued at a very strong level and pretty much as budgeted for the period. We are budgeting approximately 300 new PMA's in fiscal '05. And that is comparable to the new PMA certification levels that we have done in each of the last three years. We also have a number of new products under development in Electronic Technologies. SG&A expenses represented 20% of net sales in both the second quarter of fiscal '05 and '04. And they were 13.6 million and 10.5 million in the respective periods. The dollar increase in SG&A expense is mainly due to increased operating costs, principally personnel related, associated with higher sales previously discussed; as well as increased regulatory costs, and by that I mean Sarbanes-Oxley.

Interest expense of about $300,000 in the second quarter of '05 was essentially the same as in the second quarter of '04. And during the first half of '05, we borrowed $22 million under our revolving credit facility, principally to fund the aforementioned acquisitions. And we did make repayments of 13 million, including 7 million in the second quarter of '05. So, our cash flow is very strong. Borrowing, again, 22 million and making repayments of 13 million. Interest and other income in the second quarters of fiscal '05 and '04 were really not material.

The Company's effective tax rate for the first half of fiscal '05, which reflects our latest full year estimates, was 36.3% compared to 34.4 for the first half of fiscal '04. The increase is due to a lower amount of the minority interest share of income excluded from our consolidated income, which is subject to federal income taxes. And a reduction in the tax benefit on foreign sales under the federal EIT, extraterritorial income provisions, that began phasing out in fiscal '05. And also higher state taxes, principally related to some recent acquisitions. The minority interest of 1.3 million in the second quarter of '05 and 1.1 in the second quarter of '04 represent principally the minority interest of Lufthansa and American Airlines in our Flight Support Group and Sierra in our Electronic Technologies group. The increase from the second quarter of '04 is principally attributable to higher earnings of our Flight Support Group.

Moving on to the balance sheet and cash flow. As you can see our financial condition remains extremely strong. Cash flow from operating activities was 11.5 million in the first six months of '05, versus 16.7 in the first six months of '04. And this was due to a higher investment required in inventories required to meet the strong sales demand and increased accounts receivable due to higher sales levels. Those numbers are not at all surprising, because the DSO's of accounts receivable as of April 30 '05 was 57 days. And was consistent with the 57 days as of January 31, '05 and 56 days as of October 31, '04. We continue to closely monitor receivable collection efforts in orderer to manage our credit exposure very carefully in light of the continued financial challenges facing some of our clients. The inventory turnover rate as of April 30, '05 improved to 116 days from 131 days as of January 31, '05 and approximately 113 days as of October 31, '04.

Working capital strengthened slightly to 3.2 as of April 30, '05 versus 2.9 as of October 31, '04. No one customer accounted for more than 10% of net sales. And our top five customers represented approximately 27% of consolidated sales in the first half of '05. Long term debt-to-capitalization increased slightly to 9%, but still very, very low and very conservative. 9% as of April 30, '05. It was 7% on October 31, '04. And this increase - - this slight increase reflects the net borrowing of 9 million under the revolving credit facility. Plus as you can see our leverage remains relatively low. CapEx in the first half of '05 was $3 million. Our net capital budget - - expenditure budget for the full year remains at about 6 million to 8 million. And that's net of 3.5 million proceeds we received on the sale of an excess facility.

Looking towards the future, we are pleased to report very strong year-over-year sales increases in both of our business segments, reflecting both the organic growth and the growth through acquiring profitable, well managed businesses. Both of these are fundamental to our long term growth strategies. Flight Support continued to show strong increases in sales and earnings during the second quarter of '05, compared to the second quarter of '04, as we continued to add new products and to further penetrate our market. Incidentally, a comment that the men at the - - the team at Flight Support is doing an extraordinary job and you can see that from the results. Demand from commercial airline customers continues to increase. And we expect the Flight Support operating margins to continue to show year-over-year improvements during the balance of fiscal '05.

Electronic Technologies, also showed sales and earnings growth in the second quarter of '05 versus the second-quarter of '04. And previously mentioning, we are expecting operating margins to improve in the balance of fiscal '05. The operating margins, incidentally, are still quite good. But we hope to see continued improvement. Based on our strong operating results year-to-date and the current market conditions; we are raising our target fiscal '05 net sales growth to a range of 250 to 260 million, and fiscal 2005 diluted net income per share to a range of $0.84 to $0.86. It was previously $0.83 to $0.85. The net sales and earnings targets exclude the impact of additional acquisitions if any. The earnings target compares very favorably, we believe, to the $0.80 per diluted share reported in fiscal '04 since the '04 results include the net impact of $0.13 per diluted share of life insurance proceeds, reduced by restructuring expenses and litigation related expenses. And please note that the Company does not give guidance on our quarterly sales or earnings. We continue to target cash flow from operating activities in the range of $40 million, with a net CapEx budget of approximately 6 to 8 million for fiscal '05.

In closing, I would like to say that we continue to adhere to our long-term strategy of developing and marketing new products and services, which provide our existing customers with improved technology and substantial cost savings, and allows us to expand our markets. And we believe that this strategy has resulted in our strong financial position and also, positions us with the opportunity for substantial forward growth. That is the extent of my prepared comments. And I would like to ask the operator, to open the floor for any questions which you may have. Thank you.

[OPERATOR INSTRUCTIONS] Our first question comes from Arnold Ursaner from CJS Securities.

Good morning. Hi, this is Bob Labick for Arnie Ursaner.

Good morning.

Congratulations on a nice quarter.

Thank you.

First question, and I know you mentioned this, you are expecting a return to second half of last year's margin in the Electronics group. I was just wondering if you could just elaborate on the conference? What you see in the backlog? And also tell us if the acquisitions you have recently made are at core levels or if they are below or above and if there is an opportunity to improve them?

I am going to ask Tom Irwin, our CFO to respond to that.

Yes, I think we are confident that we can reach those operating margins in the second half of the - - of this year. Last year, you may recall, our operating margins in the ET group averaged for the full year around 24%. So, obviously for the first half while we are short of that, the second quarter was around 20%. So I think getting to an average of 24% in the second half of the year for the last - - for the third and the fourth quarter is reasonable. And we base that on two things. One, the backlog; that is the existing orders that we have firm and we expect to ship over the next six months. We have projected margins on those. And as you are pointing out, the recent acquisitions have all been companies that are positive to the overall average of operating margins. And as they become a bigger part of our sales in the second half of the year, there will be some favorable impact of newly acquired businesses as well.

Great. And just one other question, if I could. Your free cash flow guidance appears very strong. And I was wondering if you could just elaborate on the uses of free cash flow and update us on the acquisitions front? What you are seeing out there? If there's any opportunities for you.

I will respond to that Bob. The uses - - generally what we do with our cash is we use our revolving lines for acquisitions. And we reduce that line by our significant cash flow, and that is really what we do. So we keep our - - our line can be drawn upon at will, and we can bring it up and down. It is very flexible. It is an excellent financing tool. So, that's what we do with the cash flow. And in terms of acquisitions, we are looking at a significant number of acquisitions. And there are a number of in the pipeline at various stages of negotiation. As you all know, with acquisitions, they are not done until they are signed and closed. So at this point, we are reluctant to predict that any one would definitely be closed. We think historically based on past experience, we know that a number have been closed in the past. We are an inquisitive Company. And we would expect some of these to be closed. If they are closed, they would all be accretive to the earnings. And our earnings projections for the year do not include any earnings from potential acquisitions.

Great. Thank you very much. I will get back in queue.

Thank you.

Our next question is from J.B. Groh with D.A. Davidson.

Hi, guys.

Good morning.

My forecast is a little off on the ETG. Can you - - is that - - is that a lot of that acquisitions? Or is that just a seasonally weak first quarter? What kind of accounts for the big jump sequentially on the ETG revenue line? And how should we think about that for the balance of the year in terms of run rate?

I am going to ask Victor Mendelson who is the President of the ETG group to respond to your question.

JB, this is Victor. The answer is we had what I would consider seasonably weak first quarter for sure. One thing you will notice about the Electronic Technologies Group is that our margins tend to vary considerably from quarter to quarter. And it can be the result usually of technical issues on programs, something slipping from one quarter into the next. Or slipping really from the end of one month into the beginning often of the next month. So that I believe we had some slower technical issues on some programs in the first quarter of the year. Which are - - which got resolved and are continuing to be resolved on other programs. I think we also saw some weakness in the space side of our business in the first quarter, maybe a little more. And we've seen that picking up. So, those will probably be the primary reasons for some of the slower revenue and margins.

In the first quarter?

In the first quarter, correct.

So it's safe to say that the second quarter is more representative of the year than the first quarter?

Yes, exactly, we believe so.

Great. And then just kind of a philosophical question. What are your current thoughts on the two-class system? And any thought on collapsing the two or finding some way to kind of resolve the valuation discrepancy between the two classes?

I think that when you did a piece on HEICO, you made a prediction, or you indicated that the gap between the "A" and the common was too great and you expected it to close. Another firm, CJS put out a piece saying basically the same thing. We have asked investment bankers. We have asked our specialists on the New York Stock Exchange, and all of these people seem to agree with your original conclusion that the "A" and the Common are just out of whack and the gap is too big. If you noticed that for a while, there was a about a - - almost 30% gap between the two. That gap is closed now in to about 20%. About a month ago it was 23%. So the prediction of the traders and the experts seem to be, we think, seems to be accurate.

We do believe that that gap is an unreasonable one. We think there is no reason that that gap exists. If anything, it should - - it might be a small gap, you know, as 5%, and that's based upon what the experts, investment bankers and so forth tell us. So, we believe that the aberration is due to a - - there's a matched trade, which perhaps is being put on by hedge funds. It has nothing to do with the value of HEICO and its shares, and this information. I am really parroting, again, what the experts and the traders in this market tell me. So at this - - because of that, at this point, we have no plans to interfere or change the capital structure of HEICO with regard to the two classes.

The reason I asked is because I had just seen another Company that had a dual class kind of collapsing together. So, I was just wondering if that had come across your plate. Okay, thanks a lot. Great job.

Thank you very much. Hello?

Our next question is from Terry Ledbetter with Freeberg Investments.

Good morning.

Good morning.

I was delighted to see how well the Flight Support Group is doing. And revenues were up 22% Over a period that ASM's were up only 2%. And - - but I am a little confused as to where that - - how it can be so much stronger as it - - because, there - - you just have so many more parts available or because you have better penetration into existing customers? Because new airlines that hadn't adopted PMA previously are starting to? Were there any JT8D sales? You've mentioned before sometimes there will be a little bulge in the FSG sales of that every now and then. What made it so strong this quarter? And it was on strong comps too, that's part of why I was surprised.

Well, I think that you apparently has studied HEICO very well, because you have answered your own question. I think all of the above, but I am going to ask Eric Mendelson to fill in, but I think you have a pretty good handle on what's happening, but Eric, would you please respond?

This is Eric. I would agree with all of your comments. We have had an increase far in excess of ASM's out there because of: Number one, our products. Number two, selling more product to old customers. Number three, adding new customers. Number four, JT8D has experienced a small increase. I would say that JT8D is probably the smallest of the four items. But they are tremendous - - there continues to be tremendous interest in our products. The worldwide airline community is very excited about them. They see the level of investment. They continue to encourage us to develop more parts, and - - with them. And significant cost-cutting modes, they need to figure out whether they can squeeze costs and not impact safety reliability. And they figured out that HEICO's parts are one of the best places to do it. So I think that's a trend that you've seen and you are going to continue to see.

Okay. Well, on that last point, I've heard - - you all do best whenever your customers are moderately uncomfortable. That whenever they are doing terrible profitability-wise, that they kind of can reach kind of a panic level and whenever they are comfortable, there is no impetus to change. It seemed to me that they are really being squeezed right now. So, you know, is my perception correct? Are they still kind of in a steady - - looking for new ways to save money or things like that?

I would like Eric - - I would like to respond and then Eric to add. One of the things that I can tell you that we have noted, that in the MRO industry, to a great extent, there has been a change in the leadership at most airlines. Some of the older people in the industry have retired and some of the younger people have taken over. Those younger people who have come up through the ranks and have learned a different tune recognize that they must consistently create cost saving opportunities for their airline if they wanted a) the airline to stay in business and b) if they want to have a job. And, so, part of what you - - it's - - they are very concerned with cost. But if they begin to do well as - - take an example, Lufthansa. Lufthansa is doing very well and it is very profitable. And yet it is buying more and more parts from us, for HEICO certified parts. So it is not just when business - - it used to be when business was bad for the airline, then they would scramble, and then they would coast. No longer are they coasting. They are looking for every dollar cost saving, and every airline - - I would say virtually every airline in the industry is aware of the opportunity to save considerable costs through HEICO certified parts. Now - - but Eric, I would like to you embellish that a little bit more

I agree with you completely. I think there has been a significant change in leadership at the airlines. And as you pointed out, there are many more younger people involved today. Those younger people were the ones who in the prior cycles were approving our parts and who championing HEICO's causes and HEICO products within the airlines. So they understand that HEICO products provides the same if not improved safety reliability. Obviously, significantly improved cost savings. And cost savings has become a way of life in this industry in good times and bad times. I agree that in bad times obviously airlines cut back. They try to defer as much maintenance as possible.

I would say our market share actually increases in bad times. But the total number of parts that they buy falls in that short period of time until they milk as much out of the existing product as possible without reinvesting. Then, of course, when they have to go back and fix and repair the aircraft and engines, then they end up pays a large bill at that time. But even in good times, I do not see our customers moving away from HEICO parts. It's become part of the culture. They have got to continue to get their costs down, and furthermore, as some of the newer aircraft age, they end up eating a lot of parts. And those parts are very, very expensive. So, if anything, in the good times, if the good times coincide with the maturity in the engine and aircraft cycle, you could end up seeing demand for even greater parts.

Okay.

There's one other thing I would like to point out to everyone on this call that recent articles in the - - I think it was the "The Wall Street Journal," the "new York Times" indicate that the FAA is predicting that this summer will be the greatest ASM in the history of the world. And - they are predicting greater than pre-9/11 volumes, more passengers flying. That means more airplanes and so forth. And obviously we think that that's - - if the FAA is correct, and they are probably the best ones to tell us. We would think that that bodes very well for our business.

All right, well, it is exciting to see the vision being fulfilled. So keep up the good work, guys. Thanks.

Thank you very much.

I have no further questions at this time.

Well, if there are no further questions, I want to thank everyone for being interested in HEICO. And to tell you that we are available if you do have questions. Call one of the four of us and we will try to respond to your questions. And otherwise, have a great day. And we look forward to speaking to you on our third-quarter conference - - earnings conference call, which will be later in the year. Thanks very much. And have a great day.