HEICO Corp (HEI) 2012 Q2 法說會逐字稿

Welcome to the HEICO Corporation fiscal 2012 second-quarter earnings conference call. Certain statements 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 those forward-looking statements as a result of factors including, but not limited to, lower demand for commercial air travel or airline fleet changes, which could cause lower demand for our goods and services; product specification costs and requirements, which could cause an increase to our costs to complete contracts; governmental and regulatory demand; export policies and restrictions; reductions in defense-based or homeland security spending by US and/or foreign customers, or competition from existing and new competitors which could reduce our sales.

HEICO's ability to introduce new products and product pricing levels, which could reduce our sales or sales growth; HEICO's ability to make acquisitions and achieve operating synergies from acquired businesses; customer credit risks; interest and income tax rates; and economic conditions within and outside of the aviation, defense, space, medical, telecommunication and electronic industries, which could negatively impact our costs and revenues. Those listening to this call are encouraged to review all of HEICO's filings with the Securities and Exchange Commission, including but not limited to, the 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.

The moderator for today's call is Laurans A. Mendelson, Chairman and Chief Executive Officer of HEICO Corporation. Please go ahead, sir.

Thank you, and good morning to everyone on the call. We thank you for joining us. We welcome you to this HEICO second-quarter fiscal 2012 earnings announcement teleconference. I'm Larry Mendelson. I'm the CEO of HEICO Corporation. I'm joined here this morning by Eric Mendelson who is HEICO's Co-President and President of HEICO's Flight Support Group. Victor Mendelson, HEICO's Co-President and President of HEICO's Electronic Technologies Group. And Tom Irwin, HEICO's Executive Vice President and CFO.

Before reviewing our second-quarter operating results in detail, I would like to take a few moments to just summarize the highlights of another record-setting quarter. Our consolidated second-quarter net sales represent record quarterly results for HEICO, driven principally by all-time record net sales within our Electronic Technologies Group. Continued net strong net sales within our Flight Support Group. Additionally, our second-quarter results marked the ninth consecutive quarter of sequential net sales growth.

Our consolidated year-to-date net sales and operating income represent all-time record results for HEICO. This has been driven principally by all-time record net sales and operating income within both of our segments, the Flight Support Group and our Electronic Technologies Group. Consolidated second-quarter net income and operating income are up 13% and 14%, respectively, on a 17% increase in net sales over the second quarter of 2011. Consolidated net income and operating income for the first six months of 2012 are up 13% and 15%, respectively, on a 20% increase in net sales over the first six months of 2011.

Electronic Technologies set a quarterly net sales record in the second quarter of '12, improving 48% over the second quarter of '11. The increase in net sales reflects organic growth approximating 5%, and additional net sales contributed by four acquisitions since the second quarter of fiscal '11. Flight Support set a quarterly operating income record in the second quarter of 2012 by improving 14% over the second quarter of 2011. The increase in operating income is principally the result of both higher sales volumes, as well as improved operating margins. Consolidated net income per diluted share increased 13% to $0.36 a share for the second quarter of '12, up from $0.32 for the second quarter of '11. This is based upon the strong performance again of both operating segments.

In March 2012 we acquired the business and substantially all of the assets of Ramona Research, which designs and manufactures RF and microwave amplifiers, transmitters and receivers. Primarily used to support military communications on unmanned aerial systems, other aircraft, helicopters and ground-based data communications systems. Incidentally, those ground-based are used, obviously, to connect up to the communications that are flying the -- principally the unmanned vehicles up in the air. We believe the acquisition of Ramona continues our practice of adding top-quality niche businesses that solve customer problems with very unique designs and technology.

In April 2012 we acquired certain aerospace assets of Moritz Aerospace, in an aerospace production line acquisition. The Moritz Aerospace product line designs and manufactures next-generation wireless cabin control systems, solid-state power distribution and management systems, and fuel level sensing systems for business jets and for general aviation, as well as for the military defense market segments. We believe that the acquisition of Moritz continues HEICO's expansion into adjacent markets and products. Is another example of HEICO providing complete product and service solutions throughout the aircraft life cycle. We do expect both of these acquisitions to be accretive to our earnings per share within the first anniversary of the acquisition.

In March 2012 we declared a 5-for-4 stock split, reflecting the Board of Directors' continued confidence in the growth of the business. The additional shares were distributed in April 2012. All applicable share and per share information has been retroactively adjusted to reflect the split. This marks HEICO's 13th stock dividend or stock split since 1995. Our Board of Directors also reported in March that absent changes in the Company's business outlook, the board intends to continue the Company's regular semi-annual cash dividend at $0.06 per share. This would represent a 25% increase over the prior semi-annual per share amount of $0.048. This is adjusted for the 5-for-4 stock split.

Cash flow was very strong in the second quarter of '12, with cash flow provided by operating activities totaling $47.6 million. This was up from $27.5 million in the second quarter of '11. In the first six months of '12, cash flow provided by operating activities was $45.3 million compared to $51.1 million in the first six months of '11. Now, we do expect fiscal 2012 cash flow provided by operating activities to remain strong in the second half of 2012. Approximate $85 million to $90 million in the second half. That would total $130 million to $135 million for the full fiscal year.

As a result of our strong cash flow, our net debt to shareholders equity ratio was a very low 22.7% as of April 30. With net debt -- and that is total debt less cash and cash equivalents -- net debt of $152.5 million, reflecting borrowings under our revolving credit facility for the three acquisitions completed during the first six months of fiscal '12. We have no significant debt maturities until fiscal 2017. Significant borrowing capacity is under our $670 million revolving line of credit. This can be used for basically any purpose. We use it for additional acquisition opportunities. We have plenty of firepower. We remain very active on the acquisition front where we are looking at a number of opportunities at this moment. Those opportunities fall in both Electronic Technologies and Flight Support.

Drilling down into the detail, our consolidated net sales for the second quarter of '12 increased 17% to a record $216.3 million. That is up from $184.5 million in the second quarter of '11. In the first six months of '12, consolidated net sales increased 20% to a record $429 million. That was up from $358.7 million in the first six months of '11. Flight Support net sales increased 5% to $141 million. That was up from $133.8 million in the second quarter of '11. That represents organic growth. The organic growth in Flight Support in the second quarter reflects increased market penetration from both new and existing product offerings within certain of our industrial product lines, and within certain of our aerospace aftermarket parts product lines.

Flight Support net sales increased 10% to a record $279.9 million in the first six months of '12. That was up from $254.4 million in the first six months of '11. Again principally reflecting organic growth approximating 7%, as well as additional net sales contributed by a full six months of operating results from an acquisition which we made in the first quarter of '11. The organic growth in Flight Support in the first six months of '12 principally reflects increased market penetration from both new and existing product offerings within certain of our industrial product lines. And within certain of our aerospace aftermarket replacement parts product lines. As well as our repair and overhaul services.

Electronic Technologies' second-quarter net sales increased 48% to a record $76.3 million. That was up from $51.4 million in the second quarter of '11. Net sales of ETG increased to a record $150.7 million in the first six months of '12, up 43% from $105.3 million in the first six months of '11. The increase in net sales in the second quarter and the first six months of '12 is principally attributed to additional net sales of approximately $22 million and $39 million, respectively. Contributed from the acquisitions of 3D Plus, which we did September 2011; Switchcraft, November 2011; Ramona Research, March 2012; and Moritz Aerospace, April 2012.

Additionally the increase in net sales for the second quarter and the first six months of '12 reflects organic growth approximating 5% and 6%, respectively. The organic growth in the ETG group for both the second quarter and the first six months of '12 principally reflects continued strength in demand for certain of our defense products. Our net sales by market in the first six months of '12 were composed approximately 55% commercial aviation versus 62% in the first six months of '11. 19% from defense in both 2012 and 2011. 5% in space compared to 3% in the same period of '11. 21% from other markets, including medical, telecommunications and electronics, versus 16% in 2011.

Our consolidated operating income in the second quarter of '12 increased 14% to $37.6 million. That was up from $32.9 million in the second quarter of '11. Increased 15% to a record $75.2 million in the first six months of '12. That was up from $65.3 million in the first six months of '11. Flight Support's operating income increased 14% to a record $26.6 million, up from $23.4 million in the second quarter of '11. Increased 19% to a record $52.1 million for the first six months of '12, up from $43.8 million in the first six months of '11. The increase in operating income in the second quarter and first six months of '12 principally reflects both higher sales volume as well as improved operating margins.

ETG operating income increased 12% to $15.3 million in the second quarter of '12, up from $13.6 million in the second quarter of '11. Increased 8% to $31.5 million for the first six months of '12, up from $29.2 million in the first six months of '11. The increase in operating income is principally attributed to operating income contributed by the acquired businesses.

Although corporate expenses increased slightly to $4.4 million and $8.4 million in the second quarter and first six months of '12, respectively, as compared to $4.1 million and $7.7 million in the second quarter and first six months of '11, they declined as a percentage of net sales to 2% for both the second quarter and the first six months of '12. Down from 2.2% for both the second quarter and first six months of '11. The decrease in both periods is due to us being able to control corporate spending relative to our net sales growth. As a percentage, that corporate expense was down 10%.

Operating margins consolidated were at 17.4% and 17.5% in the second quarter and first six months of '12. As compared to 17.8% and 18.2% in the second quarter and first six months of '11. Flight Support's operating margins improved to 18.9% in the second quarter of '12, up from 17.5% in the second quarter of '11. Improved to 18.6% in the first six months of '12. That was up from 17.2% in the first six months of '11. Those improved operating margins in the second quarter and the first six months of '12 principally reflects higher margins within our specialty products line resulting from what I mentioned earlier, sales growth and a reduction in selling SG&A as a percentage of net sales.

ETG operating margins were 20.1% in the second quarter of '12 compared to 26.6% in the second quarter of '11. 20.9% in the first six months of '12 compared to 27.7% in the first six months of '11. As anticipated, operating margins decreased for the second quarter and first six months of '12, principally as a result of the dilutive impact of approximately 5% in both periods from lower operating margins realized by 3D Plus and Switchcraft. Which includes the impact of non cash acquisition-related amortization of intangible assets, as well as inventory purchase accounting adjustments. Just a comment, if you have questions on the detail of those accounting adjustments, Tom Irwin will be happy to explain them if somebody wants to ask the question.

Additionally the decrease in operating margins is attributed to a more favorable product mix in the second quarter and first six months of fiscal '11. As we discussed last quarter, the lower operating margin realized by 3D Plus is principally attributed to softer demand for certain products resulting from continued economic uncertainty throughout Europe. As well as amortization of intangible assets. Again inventory purchase accounting adjustments, which aggregates approximately $1 million per quarter.

The lower operating margin realized by Switchcraft is principally attributable to amortization of intangibles and inventory purchase accounting adjustments aggregating $2 million per quarter. I want to emphasize that we do expect these margins to improve during the second half of the year as a result of stronger revenue at 3D Plus and the end of the acquisition-related inventory purchase accounting adjustments.

As we've previously reported, variations in product mix and timing of customer delivery requirements do cause operating margins of ETG to vary and fluctuate from quarter to quarter. Excluding 3D Plus and Switchcraft, Electronic Technologies' operating margins in the second quarter and first six months of '12 would have been 25% and 26%, respectively. Which is comparable to ETG's full-year operating margins, which normally approximate 25% to 26%.

Diluted earnings per share increased 13% to $0.36 in the second quarter of '12. Up from $0.32 in the second quarter of '11. They increased 13% to $0.72 in the first six months of '12, up from $0.64 in the first six months of '11. As previously reported, the first six months of '11 includes a $0.02 per diluted share benefit from the retroactive extension of the R&D income tax credit. All fiscal '11 and '12 diluted earnings per share amounts have been retrospectively adjusted for our 5-for-4 stock split, which we talked about earlier.

Depreciation and amortization expense increased by $2.9 million to $7.5 million in the second quarter of '12, up from $4.6 million in the second quarter of '11. Increased by $5.5 million in the first six months of '12, up from $8.9 million in the first six months of '11. That increase in both periods reflects higher amortization and depreciation expenses related to the previously-mentioned acquisitions.

R&D expense increased 37% to $8.4 million in the second quarter of '12, up from $6.1 million in the second quarter of '11. Increased 27% to $14.9 million in the first six months of '12. That was up from $11.7 million in the first six months of '11. Significant ongoing new product development efforts are continuing at both Flight Support and ETG. We invest 3% to 4% of each sales dollar in the R&D program. Our effective strategy for the last 20-plus years has been to increase such expenditures and develop new products and services for our customers. This in turn facilitates market share growth, which contributes to us being able to meet growth goals.

SG&A increased 12% to $37.6 million in the second quarter of '12, up from $33.5 million in the second quarter of '11. They increased 20% to $78.2 million in the first six months of '12, up from $65 million in the first six months of '11. That increase in SG&A for the second quarter and first six months of '12 principally reflects an increase of about $4 million and $11 million, respectively, attributable to newly-acquired businesses.

SG&A expenses as a percentage of net sales decreased to 17.4% for the second quarter of '12, from 18.1% in the second quarter of '11. Principally reflecting a reduction in certain personnel-related expenses as a percentage of net sales in both Flight Support and Electronic Technologies Groups. SG&A as a percentage of net sales remained comparable at 18.2% in the first six months of '12, and 18.1% in the first six months of '11.

Interest expense, of course, increased about $600,000 to $700,000 in the second quarter of '12. Increased $1.2 million to $1.3 million in the first six months of '12. The increase, of course, is due to higher weighted net average balance outstanding under our credit facilities during the six months. That was all associated with the acquisition program. Other income in '11 and '12 was not significant and I won't comment on it.

HEICO's effective tax rate the second quarter of '12 increased to 34.7%, up from 33% in the second quarter of '11. That principally reflects a higher effective state income tax rate attributable to acquisitions. As well as changes in certain state tax laws which impacted certain state apportionment factors. Additionally, our purchases of certain non-controlling interest in the second quarter of both '11 and '12 contributed to the increase in our effective tax rate.

The effective tax rate in the first six months of '12 increased again to 34.5% from 31.7% in six months of '11. The increase was principally reflecting higher income tax credit for qualified research and development activities recognized in the first six months of '11. As well as the previously-mentioned higher effective state income tax rate and impact from our purchases of certain non-controlling interest.

Net income attributable to non controlling interests was $5.2 million in the second quarter of '12 compared to $5.3 million in '11. $10.5 million in the first six months of '12 compared to $10.7 million in the first six months of '11. That small decrease in both periods reflects previously-mentioned purchase of certain non controlling interest by HEICO during fiscal '11 and '12. Partially offset by higher earnings in Flight Support in which a 20% non controlling interest is held by Lufthansa.

Moving onto the balance sheet and cash flow. I previously mentioned that our financial position and forecasted cash flow remain very strong. Cash flow was strong in the second quarter of '12 with cash flow provided by operating activities, $47.6 million, up from $27.5 million in the second quarter of '11. In the first six months of '12, cash flow provided by operating activities was $45.3 million versus $51.1 million in the first six months of '11. The working capital ratio is a strong 2.8% as of April 30. That was up from 2.6% in October 31, 2011.

DSOs of receivables was 48 days on April 30, 2012 compared to 47 days October 31, 2011. As usual, we continue to closely monitor all receivable collection efforts in order to limit our current exposures. No one customer accounted for more than 5% of net sales. Our top five customers represented about 16% of consolidated net sales in the second quarter of '12, down from 17% in the second quarter of '11. The inventory turnover rate as of April 30, 2012 was 124 days, up slightly from 116 as of October 31, 2011. That reflects higher inventory levels for certain product lines necessary for us to meet customer demands. CapEx in the first six months of '12 were $8.1 million. We continue to budget CapEx for the full year of '12 to be in the range of $20 million to $22 million.

Now the Outlook. In our Flight Support Group markets, continued global economic uncertainty could moderate our net sales growth for the remainder of fiscal '12. In Electronic Technologies markets, we generally anticipate stable demand for most of our products. But we acknowledge that government deficits and spending reduction plans could moderate demand for certain of our defense products. You are all aware of the ongoing discussions in Washington and elsewhere around the world in terms of defense spending. The answer is that nobody knows the real answer to what the final result will be. We would prefer to be cautious and err, if we're going to err we would rather err on the side of being conservative.

Based on current market conditions, we are increasing our estimates for the full fiscal 2012 year-over-year growth in net sales to 17% to 20%. The growth in net income to 12% to 14%. This is up from our prior-year growth estimates in net sales of 15% to 18%, and net income of 10% to 12%. We now estimate full fiscal 2012 operating income to approximate $160 million. Depreciation amortization expense to approximate $30 million. These estimates do include the fiscal 2012 acquisitions of Switchcraft, Ramona, Moritz, but exclude any additional acquisitions that we might make.

In closing, we will continue to focus on intermediate and long-term growth strategies, with emphasis on the development of new products and services to meet the needs of our customers. We will focus on strategic acquisition opportunities that complement our existing operations -- I may add, at prices that we have paid historically. That is the extent of my planned remarks. I would like to open the floor for any questions. So if the Operator would help us to go into the queue please.

(Operator Instructions) Julia Yates, Credit Suisse

A few questions on margins, one for Victor and one for Eric. Victor, on ETG margins, with the improvement at 3D Plus, and then the end of some of the accounting adjustments, do you think that this segment can return to that targeted 25% to 26% level by the end of the year?

Yes, absolutely.

Okay. And then, Eric, on FSG, what is driving the record margins at 18.9%? Is it mix? And then what are your expectations around the sustainability of that in the second half of the year?

In terms of what is driving it, we've got a number of business units that are all run by very talented people. And the metric that we primarily focus on is operating income. And sales is just, it is something, obviously, that we have to accomplish, but the thing that they are all evaluated on is the operating income. So that really is just a byproduct of all their efforts. And we think is of greater importance than sales. So that is really the number that we are looking at.

Insofar as how it relates to sales, and we derive the margin, they frankly are not compensated nor evaluated on the percentage margins. Really the total dollars of operating income based on their invested capital that they have got. So it is not something that we really can evaluate. It moves around. It could go higher. It could go lower. Frankly, I don't know. It really just depends on product mix and what we are able to accomplish. So I wish I could provide greater clarity on that. But I really can't.

Julie, this is Tom Irwin. I think exactly what Eric mentioned. That's one of the reasons we don't give guidance, particularly in the FSG segment. We made reference that we do see improvement in ETG. But the lack of backlog visibility, you may recall, 60% or more of our orders each month are booked and shipped. So it's not like we have a large backlog that we can see, and check the margins on, as opposed to ETG. So for that reason we don't give guidance, if you will, on margins. Fluctuations may happen, as Eric reported, based on mix. We do target overall growth, but not specific margin targets.

Okay great. And then can you guys break out the growth in Flight Support in the quarter between parts and services?

In the FSG group, by the quarter, the organic growth was -- I'm just recalling -- exclusively in parts. The service business second quarter to second quarter didn't have any substantial organic growth. The service business, second quarter to second quarter. For the first half of the year, they all had growth, but quarter-over-quarter it was basically not any organic growth in repair services versus parts and specialty products.

Okay great. Thank you.

Arnie Ursaner, CJS Securities

This is actually Lee Jagoda for Arnie. Following up on the previous question, how much amortization and inventory accounting from the acquisitions remains in Q3 and/or Q4?

It's difficult to give an exact number but to put a little more color on it, as Larry mentioned it runs in the aggregate for Switchcraft and 3D roughly $3 million a quarter. Roughly one-third of that is purchase accounting, short-term, which typically rolls out in six to nine months in those businesses. It may vary a little bit depending on what is actually shipped versus the inventory we acquire at the acquisition date. The remaining roughly two-thirds is amortization, which is a longer period and wouldn't roll off within a year or so, although we do use accelerated amortization methods for a number of our intangibles. So it's a decreasing amount but it wouldn't typically go away immediately.

Okay great. And then just switching gears a little to the Flight Support Group, you highlighted industrial as well as aerospace aftermarket for the 5% organic growth. Can you break that up between the industrial and aerospace pieces?

For competitive reasons, we don't disclose specifics within product lines. They both were up. As we've have mentioned in the last few quarters, the industrial product is a small product line and so a relatively small aggregate dollar amount has a higher percentage growth, if you will. But it was in both of them.

Okay. But both of those were up in the quarter?

Both the industrial products and the aftermarket parts, yes.

Okay great. Thanks very much.

J.B. Groh, DA Davidson

The increase in the guidance, I'm guessing that is driven largely by the acquisitions that you made?

J.B., this is Tom Irwin. I would say it is a combination, obviously, of what Victor spoke about in terms of the opportunity to improve margins in ETG. A level of growth in FSG that we are comfortable with, given overall market. Again, we don't have the detail visibility so there is a level of caution, if you will. But it is a combination of all those things that leads to our full-year forecast.

J.B., a little more color. Continuing with exactly what Tom has said, we have mentioned in last quarter and again now about 3D. And the order flows and so forth. And we definitely do see a pickup in the order flows and it gives us more confidence. We are pretty confident -- very confident -- in what we told everyone last quarter with the order flows and the earnings flowing through from 3D. 3D is a very good company. It started off the first half of this year weak but we knew that, and we are seeing very strong order flows. So that gives us additional confidence.

Okay. And, Eric, is there a way within Flight Support to gauge the current demand or changes in customer ordering patterns? I know you don't have really a backlog so to speak of in FSG.

Correct. Like you said we don't have a backlog. And, as Tom mentioned, most of our sales get booked and shipped in the same month. I can tell you on a qualitative basis, the interest in our products, the airlines that want us to develop more parts, the enthusiasm for it, I'd say is at a record high. I have been with HEICO now for 23 years and I've never seen so much enthusiasm in the customer area about what we are working on and what we are doing and the capabilities. So I think that that will continue. But insofar as specific order patterns, that's very difficult to say.

And then when we think historically, if we get a case where capacity were to actually contract a little bit, historically have you been able to grow through that with a combination of increased penetration, expansion of the catalog, pricing?

Yes. What is interesting this time, and of course over the last couple of years there were a lot of questions about restocking. And we repeatedly said that we did not see restocking, which we define as basically putting more parts of the shelves waiting to go into airplanes. In hindsight, what we did see was returning some aircraft into service. That basically there had been some deferred maintenance through the recession and basically there was a catch up roughly in 2011. In speaking with our folks, they still do not see any evidence of restocking. So if there were -- to answer your question -- if there were a slowdown, I don't think that we're going to see the burn off of inventory to the levels that we saw the last time. Obviously the macroeconomic picture is what drives air travel, so we all know the impact of that. But you don't have those inventories that were out there in 2008 where people could basically live off a lot of inventories for a long period of time. The inventories, we still maintain, are very lean. The airlines are not putting a lot of parts of the shelf and they're really watching their working capital very closely.

Good. Okay, thanks a lot. Appreciate your time.

Tyler Hojo, Sidoti & Company.

Just to speak a little bit more on the commercial aftermarket, could you maybe talk a little bit about how things tracked in April? Was April stronger than March? And then maybe if you could talk a little bit about how things have tracked so far in May.

We can't speak about May because, first of all, it is not done yet. And frankly, I wouldn't know and our people really don't know how we are going to do in the month until the month completes because, again, they are not evaluated based on -- I mean obviously they want to ship it as early as possible -- but they're really evaluated on what the total month is. And so this is also outside of our reporting period so we can't comment. But with regard to April, I don't think we provide specific guidance from month-to-month.

Yes, I was going to say, I think, particularly in the commercial aviation business, I don't know that one month being up or down versus the previous month is a meaningful measurement. We track it, obviously. But I think in terms of trying to forecast something going forward based on whether April was up or down from March or February, that is why we report obviously on a quarterly basis and measure the organic growth and the acquisition growth, et cetera, on a quarterly basis. Because we don't want to try to read too much into the tea leaves.

If you're looking -- which I think you are -- not so much from HEICO specific but the trend of what is happening in the aftermarket, I think at this point it is really a little cloudy out there. It is not terrible, it is not fantastic. It's okay. It's not booming. We have tough comps compared to last year. I think there was a catch-up period and at this point, we are not sure exactly until we get a real hard reading when all the hard numbers come in. So we are unsure right now.

But I think I can tell you, if you are trying to get to a trend, that April was not materially different from the other months.

That's what I was trying to get at. When I look at your forecast for the second half of the year, are you basically expecting that growth tracks in that 5% range that we saw in the second quarter?

Again, Tyler, this is Tom Irwin. We don't, again, give revenue targets by segment or margin targets by segment. I would say what we do look at is, most forecasts in terms of capacity growth, which is obviously the biggest organic driver not impacted by the number of new product we bring to market, I think most forecasts look for fiscal '12 capacity growth industry-wide should be somewhere in the 3% to 5%. I think that the capacity or industry growth that we envision into our market, again, historically we outperform or capture market share. And so we hope to do that, as well. But I think that is the kind of industry expectations that are driving our planning, if you will.

Okay. And I know last quarter you talked about de-emphasizing some of the lower margin PMA products. Did that theme recur here in the second quarter?

Tyler, this is Tom Irwin again. I would say it is an ongoing thing. But I think as a result of the number of questions that we had on the call, probably the magnitude was overstated in terms of perception. It's something that had a little impact in the first quarter, had a little impact in the second quarter. It was an ongoing process. As Eric mentioned, we are always looking to maximize operating income, not sales. So yes, it had a little impact but not a meaningful impact and no meaningful change in the trends. And no meaningful impact to our business model within FSG. I don't know if Eric wants to say anything.

I would say that is correct. Yes. There were some products that were de-emphasized, but it really got much more attention than we thought it really warranted.

Right. But if capacity -- if your expectation is that capacity grows 3% to 5% this year, and you did 5% or so organic growth this quarter, wouldn't that imply that you expect some strengthening in the back half?

Again, I think historically, and we would expect going forward, to outperform the market and capture market share, but again specific growth targets by segment and by quarter, we don't issue those.

Truthfully, it is so difficult that we never try to guess. We have a strategy. We have a projection over, for example, a three-year period. And we estimate what sales would normally be in that three-year period and we stock the shelves. So we have to have inventory available to support our customers in the middle of the night, should they have an order. But aside from that, we really don't try to predict what the aftermarket will demand of us because it is impossible. We have asked airlines and MRO facilities to tell us what their schedules are, and they themselves either don't know or have significant changes throughout the month. So for us to speculate on it, it's impossible for us to speculate. We know when there are major downturns and they put major aircraft back in service. We then feel highly confident that within a period of three to six months we're going to see a big order inflow. Similarly, if we see lots of planes coming out of service, the opposite is true. But in between, what they schedule and how they do it and switch engines and all these things, we cannot figure it out. So we don't want to mislead anybody or guess. We feel confident that it is a great industry, that the sales will come through. We can't just figure in what quarter or what month. We don't know.

And Tyler, this is Eric. Just to add and emphasize on what Tom said, we do believe that we are going to grow in excess of the capacity growth, like we have in the past, which means we are going to capture market share. So we do feel confident about that. But again, with our people focused, frankly, on operating income and not sales, we try to keep the laser-focused on the important things. There are 20 metrics they could report on, like many big companies but we try not to tie them up in that kind of stuff. We seem to pull out the numbers quarter after quarter, I think because of, frankly, the quality of our people and their focus on their business.

Right, got it. Thanks very much for all the color.

Rama Bondada, Royal Bank of Canada.

I figured I'd just start off on the ETG side. I just want to make sure I understood this correctly. Victor, you had said that you expected margins to get back to 25% to 26% on the back half of the year. Is that including the potential $3 million per quarter charges from 3D Plus and Switchcraft?

I'm going to let Tom answer the question as to the amortization impact and the acquisition accounting.

Yes, Rama. I think the short answer is the operating margins that we are referring to are as reported, so it would be after deducting the things. As clarification, though, given the fact that we are obviously well below those ranges for the first half of the year, I think again by the fourth quarter we are targeting to get back to that range, but for the full year, it may not average that. But again I think we're talking about getting back to a normalized rate on a quarterly basis as reported, which would be after amortization. And again, we would expect certainly by the fourth quarter for the purchase accounting adjustments to roll out or finish, if you will.

Okay. And then I went back and looked at, following some of your acquisitions, and I couldn't find more than once or twice that you had these type of charges following an acquisition. But to have two of them at the same time, I don't think that has happened, at least in the last four or five years that I went back and looked. Has there been any changes to the way, the metrics that you are using when you make acquisitions, or the process or procedure that you guys are doing?

No, I don't think we changed at all. We have a proven methodology so we are not changing. No. The answer is no. It's just opportunity and we can never predict when that opportunity -- we're not going to reach outside of our area of competence. We're not going to reach outside of our price ranges. So when these transactions come up, that's when we work on them.

Rama, this is Victor. Also, to add a little bit of background on that, the amount of inventory, essentially, that disappears, the amount of profit that disappears because of acquisition accounting varies by acquisition depending upon the types of inventory and the level of that type of inventory. So a company with more inventory, and especially more inventory of finished goods, let's say, will suffer that diminution in margin more than one that keeps less finished goods inventory on hand, or has less inventory. So essentially, under the rules, we wind up having to give up, to eliminate profit that, in my opinion, shouldn't be eliminated, but it is for accounting reasons only and not for cash reasons, of course. And cash is the same. That can last for a longer period of time depending upon the inventory level and so on and so forth. So it will just vary by acquisition. And in the case of these two acquisitions we had more of that kind of inventory on the shelf at the close of the acquisition. In terms of intangibles accounting and write-offs of just pure intangibles, that is a headwind that we have been experiencing on our acquisitions since these rules really started to come into play around 2005 or 2006.

Okay. All right. And then switching gears over to FSG. In the past you guys have looked at bringing into the market 500 to 700 new parts and services. It looks like R&D is up about 27% this quarter. Is that number moving up into the 500 to 700 new parts per year?

We have stopped quoting 500 to 700 in numbers because it can be a little confusing. We can get the revenue out of 300 that we might get out of 500. It all depends on the part selection. So I would say that the projection is similar to prior years where we projected internally where we wanted the growth to be from the new part development.

Okay. Great. Thanks, that's it.

Michael Ciarmoli, KeyBanc Capital Markets.

Just maybe a follow-up here on FSG and looking at the trends. The revenues from the third quarter of '11 to present are basically sequentially flat. And I guess you mentioned, can you give us some of the underlying trends? The services appeared to not grow at all this quarter. Are you seeing pressure on one side of the business over the other, given the presence of the airline bankruptcies and other weakening industry metrics out there? Is there any color or read-throughs you can give us on the sequentially flat nature of those FSG revenues?

This is Tom. I would say there has been some growth, excluding the fourth quarter which was an unusually strong quarter, I think, in FSG. And I think, as Eric mentioned, we definitely at this point realize that we benefited from some catch-up or some deferred maintenance that the airlines apparently took the opportunity to spend the money, if you will, in 2011. So there has been some sequential growth. But again, the challenge for FSG in terms of pure numbers is that organic growth was 20% or more in each of the quarters last year. So we do have the challenging comps to deal with. And again, as Larry mentioned, I think the overall economic uncertainty has caused us to be cautious. And I think, particular to the airline industry, the economics and uncertainty in oil fuel costs has caused them to at least potentially decelerate capacity growth.

Michael, this is Eric. In looking at last year's third and fourth quarters, there were some pretty big jumps sequentially there, from the first quarter to the second, third, fourth. In looking back, we now see that in probably last year's third and fourth quarter that there was a catch-up in deferred maintenance. Again, not restocking but in deferred maintenance. And that did not continue into this year, into 2012 so I think you are seeing growth in there. And really, if you look at the third quarter or the second half of this year compared to what we did last year, last year's numbers were helped tremendously by this deferred maintenance. So I think qualitatively our businesses are doing better. We're getting more parts approved. We're getting more parts developed and sold. But it is just the comps are being very difficult because we had this, if you will, one-time bump in the second half of last year, which we didn't notice at the time. As you receive the orders, you just ship the parts, and you only find out really after the fact if there has been some fluctuation.

I don't want you to think at all that the business is flatlining or anything like that. We continue to grow, we continue to ship more parts, develop more parts. But unfortunately, we just got some deferred maintenance pickup last year, which we didn't fully understand at the time.

That's extremely helpful. And then just the last one, Eric. You mentioned a lot of interest and enthusiasm in new products from customers. Can you give us a sense of what types of products? Are those engine specific? Are they more around other parts of the airframe?

I would say that they're around everything. As you know, for competitive reasons we're reluctant to go into too much detail. But I can tell you, in all the areas in which we operate -- engines, components -- there is tremendous excitement. Airframe, repair services -- there is a lot of excitement in what we are doing. It is important to know that the way the OEMs maximize their profitability is by jacking up prices year-over-year. They've got this incredible monopoly, this incredible pricing power, and where we are not present in the market they've got 100% of the market share; maybe where we are present they've got 70% or 80% of the market share. So it is still great numbers. And the way fundamentally that these folks can maximize their profitability, the best business model for them is to continue to jack up prices.

And, by definition, that really upsets the customer. So they typically are really -- they have a distressed relationship with their customers because of their ability to maximize profit through pricing. And that is the way, unfortunately, they have to do it. We, on the other hand, develop a lot of customer goodwill -- and we view it as an investment -- by keeping our prices reasonable. And the airlines, the great opportunity in working with us. And it is really across the broad spectrum of everything we offer including distribution services, as well. We are offering products, competitive products, which can save these folks a lot of money, and I would say the enthusiasm is around really everything that we are doing. It is not centered in any one area.

Okay, perfect. That's helpful. Thanks a lot, guys.

Ken Herbert, Wedbush

Eric, just a first question on FSG. I just wanted to follow-up on that. It looks like, again, you had another quarter where you likely took some nice share, especially on the engine side within the parts market, considering some of the growth rates from the OEMs. Two questions. One, did you see any particular growth, or better growth that you expected in any particular region? And then, second, is there anything you would comment on, or are you seeing anything different in reaction or response from the OEMs in the last few months above and beyond, obviously, the normal issues and the normal competitive threats?

I would say with regard to the first part of your question on region, definitely Europe has been weak, I think not only for us but for the entire industry. And we are all very familiar with what is going on there. But Europe is definitely, I think, pulling everybody down. We are doing very well in Asia, but compensating for the weakness in Europe is a tough thing to do. With regard to the competitive dynamics, I would say that the OEMs, when they came out with the new equipment, in particular on the 787, and the airlines got a sneak peek at what that stuff is going to cost, they are really scared because of the lack of competition on this stuff. And I would have to say, frankly, that the OEM arrogance is at an all-time high and that really is a very good dynamic for us because, don't get me wrong, the airlines don't necessarily make this entirely easy on us and we're still a supplier and they want to get the best price possible. But I think the OEMs are really setting up a very good opportunity for us to continue to develop parts and grow. So that is why this enthusiasm exists.

Okay, that's hopeful. Having said that, as you look then for the Corporation, do you see potential opportunities organically that would justify within FSG maybe some more capital being deployed or put to work to further accelerate product line development? Obviously I know the hurdle continues to be approval at the airlines and you face significant bottlenecks, but are you seeing any desire there to maybe significantly step up efforts from that front?

No. I think we remain comfortable with the level that we are working at. We increase R&D annually by similar percentages, or similar amounts and I think that we are at a good level right now. Some of the airlines have reduced their personnel and staff so even though they want to buy more parts sometimes the cycle time to get stuff approved takes longer. I think we are at a good level right now. Yes, we could go out and increase our expenditures and develop a lot more product and stick this stuff on the shelf, but unless we are able to sell it and get it out there, it really wouldn't make sense. So I think we will stay where we are.

Okay, great, thank you. And just one final question. Victor, when you look at the recent acquisitions, specifically Switchcraft and 3D Plus, it sounds good that you're comfortable with getting margins back up to the normal rate. As you look at these businesses, do you see opportunities longer-term to maybe get -- are these businesses that will be accretive to the traditional ETG margins when we go out a year or two? Or how do you think the upside plays out for the recent acquisitions in particular?

I want to be careful on that because I don't want to commit to something that you would later be disappointed on. I think there's a possibility for it and we're hoping to see that on these acquisitions. But time will tell and I'm more comfortable right now telling you to look more to the historical range.

Great, fair enough. Thank you very much.

Steve Levenson, Stifel Nicolaus

Just in relation to the acquisitions recently, it seems like there has been more in Electronic Technologies rather than Flight Systems. Is that by design or is it just that is where the more attractive opportunities are right now?

I think the latter, clearly. As I mentioned earlier, the transactions we're looking at right now are in both fields. And we are really opportunistic buyers. So that is where the opportunity was.

Okay, thanks. With the most fragmented portion of the supply chain in aerostructures, do you feel that that is outside your wheelhouse? Or is that something you'd look more into in the future?

When you say -- we don't do anything in aerostructures. Are you talking about acquisitions in the aerostructures area?

Yes.

I don't think we're really focused on aerostructures for a whole bunch of reasons. It is not a focus of our business, aerostructures.

We would not rule it out, though.

No, I wouldn't rule it out. It's possible but at this point we have no aerostructures activity. There are issues

Okay. Good enough. Thanks. As more of the deliveries skew away from North America and Europe over to Asia, and Latin America, as well, are you making any additional investments to get into those markets even more than now?

Steve, this is Eric. Yes, we are. We're very focused on South and Central America, as well as Asia. We're doing quick nicely and we see those as very good opportunities for us.

Okay. And last, there's some stories out yesterday and today. I don't think it really affects commercial right now, but stories about some counterfeit parts popping up again from sources outside the US. Are you lobbying for regulations or restrictions that would help your business and help to defeat that activity?

This is Victor. At this moment we are not involved with those activities. We are aware of them. And maybe in the future. And probably some of the trade groups we belong to are active in that, but it is not a major focus for us.

And Steve, this is Eric. To be clear, I'm not aware of the kind of behavior in the commercial aviation market. I think you may be referring to defense?

Right now that is where it seems to be, yes.

Okay, got it.

Okay, thanks very much.

Eric Hugel, Stephens Inc.

Eric, the margins in the FSG group of 18.9% were really solid this quarter. Where was the business in terms of the mix? And how sustainable are those margins? Should we be thinking about something in the mid to high 18% is sustainable ongoing?

This is Tom. Again, specific to segments, we don't give operating margin guidance. I think an a historical basis it was up, and it was up based upon principally favorable product mix. Product mixes that have higher margins in the industrial and the commercial aftermarket parts, as I made reference earlier, the service business, which is a lower margin business as an industry and lower for HEICO relative to our parts businesses. But again, typically we do have higher margins in our services business then industry-wide. But that being said, the MRO services were relatively flat quarter over quarter. So the growth in organic growth was principally in the higher-margin product lines. That could switch. It may not switch. That is one of the reasons, again, that we don't give margin guidance by segment.

Sure. Larry, in terms of M&A, obviously you continue to do more. I don't know if this is an issue per se, but you've got good cash flow. But you do more acquisitions, your debt to cap is probably going to go up. Where would you feel comfortable? Or is that really an issue because of your strong cash flow? Where do you feel comfortable taking the balance?

I have said, at this point, our debt is, give or take, 1 times EBITDA, or less than 1 times EBITDA, so we really don't have any pressure. Our interest rates are extremely low, maybe a little over 1%. So I would feel extremely comfortable if we were at 2, maybe 2.5 times EBITDA. Not to say that we're going to push to make that happen because we're not going to force anything. We're just going to do it -- when we have opportunistic acquisitions, we're going to make them. We're not going to force the issue by paying up prices. That has not been our strategy, and we don't believe in it. But I personally would like to put out a lot more money on our line because interest rates are so low and with our strong cash flow, we pay that back very quickly.

We look at HEICO as a mechanism to generate cash. It is true we generate earnings per share but we want real earnings and real cash. And we don't want to be a company that reports earnings per share but no cash coming out of it because we're building receivables, inventory, plants and all kinds of stuff so there's nothing left. We want the cash to come out of the operation. That is why we run the Company, to create an entity that generates a lot of cash. So we want to put money out and we are trying very hard. And we would put out a lot more money if we had the right opportunity. And again, we are looking at a number of transactions. As usual, I cannot predict which ones we will make, which ones we won't make. You don't know until you kick the tires. I've never seen a seller tell us -- our company is not too good and earnings are going to fall off. We only discover that when we kick the tires and we find out that very often it is not what it was presented to begin with, so we walk away.

Lastly, Victor, with regards to the 3D Plus business, what is it exactly? Can you remind us what exactly in that business is so economically sensitive that last fall it dropped off, but with the European economy? And maybe if potentially we're on the verge of all this news in Europe is that taking another step down? What would stop it from dropping off again?

I think it probably had more to do with satellite production procurement cycle than it had to do with anything else, now that we have had some time to really look at it and understand it a little bit better. It was really a matter of much lower order, and there is a lead time on those; five, six months, let's say. And then, as I said on our last conference call, we started to see that improve in December and that has continued and it continues through now. So I think at this point, hopefully that trend will continue. I suppose it is possible that the same thing will happen again but at this point I am not seeing that.

Okay, great. Thanks a lot, guys.

Jim Larkins, Wasatch.

Tom, a question for you. Can you give me what the amortization was for the quarter? I see D&A, but could you break out the amortization and help me understand where that drops off? I think it sounds like maybe two or three quarters out the inventory adjustments will drop out of that number?

Yes, you are correct. The inventory adjustments will roll out in the second half of this year. In terms of the total D&A, we are forecasting somewhere approximating $30 million, and the amortization portion of that in the current year will be roughly $16 million. How quickly that will roll out, I think the answer is with additional acquisitions that number could actually go up; the amortization numbers. But if we did no acquisitions, I'd have to check, it would roll out slowly over a three to seven year period. Some of it's longer-lived, some of it's shorter-lived but, again, some of it is on an accelerated basis. But the actual roll forward an item that now under the SEC rules is in our 10-Q. So there will be a forecast, there is a forecast in each Q as to what the amortization is by year for, I think it's five years.

Okay. So not necessarily a big bolus that is rolling off next year then.

No. Exactly. Again, the $16 million is still going to be a big number next year, and again as we would expect to continue acquisitions it could actually grow.

Okay. And then on your acquisitions in ETG, I haven't been keeping track of these real well, but $22 million of acquired growth this quarter, does that level of acquisition contribution stay with us for two more quarters before it starts to roll off, assuming there is no new acquisitions?

The biggest acquisition of the ones completed this year, of course was Switchcraft which was completed in November. So, yes, that would roll off. Obviously the big comp impact would roll off the first quarter of next year.

Okay, all right. So we pretty much have this level of acquisition revenue embedded for the next two quarters then?

Yes.

Okay, great. All right. I think that's it. Thanks, guys.

Ron Epstein, Bank of America Merrill Lynch.

It's actually Elizabeth in for Ron. I know you have touched a bit on M&A opportunities. But how are you seeing that pipeline from a multiple perspective?

Probably the same as we have historically. There's a little bit more pressure to the pricing upside. People are asking a little bit more. But it is not a significant thing. So we are seeing opportunities within our normal 5 to 7 times EBIT price range. Once deals go at 10 or 12 times we step out anyway so they are not potential deals for us.

Great. Thanks so much.

Chris Quilty, Raymond James.

Yes, I actually still do have a question. This one for Victor. You mentioned the pickup in certain defense products. I was wondering how sustainable you think that is over the near to mid term. And second of all, can you just tell us, given the overall mix of the ETG business, are there any areas where you are particularly concerned or excited by opportunities?

Thinking in reverse order, when you say opportunities, you mean acquisition opportunities?

Either acquisition or generically what business or product areas in terms of vertical markets you are serving.

I think that we're probably most excited by the space end of our business. We do some unique things there, as you know and that seems to be, I think, a growing business internationally. And we are growing internationally as well outside the US, which is important. So I think we are excited about that business. We are excited about, in the defense realm, businesses that are more tied to obviously the UAS or UAV market and standoff activities like that. We're less excited, of course, by things that are tied to the operations tempo. So less excited by, let's say, things related to ground equipment, ground-related equipment that is not linking up to something that's live. And I think that has been softer for us and will continue to be softer at things like, say, electro-optical devices that are used on handheld or on tanks or armored vehicles and things of that sort. So in the general mix, that is where we see things. And the defense business has overall been pretty good, pretty strong. We don't know, of course, what is going to happen with all the sequestration and the talk about the overall budget. But overall it has been pretty good except for things that are weighted to the ground side.

Got it. Great, thanks, and keep up the great work.

Jim Foung, Gabelli & Company.

I've just got two brief questions here. Larry, now that you have 3D more in place, are you going to step up your acquisition activities? Or do you just want to wait and see how 3D pans out in the second half of this year?

No, the answer is, whatever happens -- first of all, we are highly confident that 3D will pan out the way we thought because of the order flow which I mentioned earlier. That order flow is very strong and that is one of the reasons that we feel confident to up the guidance. So that is number one. Number two, our acquisition program has very little to do with 3D. We are aggressively looking to acquire other good companies in our area of expertise and we're trying to do it. So, no, we have plenty of firepower, I think as you well know, on our credit facility. Interest rates are very tempting. So we would like to make any acquisitions that fall within our area.

I know you've said in the past it's very opportunistic, but you did four acquisitions in just the last 12 months. Are you looking to match that type of number in terms of acquisitions?

The answer is no, not necessarily. Because some of the acquisitions that we made were really tiny. Moritz was a product line, in fact, acquisition. For us, we think it will be a great acquisition because we tuck it in and it just works, the product. It is very synergistic. It is a great thing. But this is really a small thing. 3D was larger. But it's not the number of acquisitions, it's really the size.

Okay, very good. And then just a question for Victor. As you come out of the fourth quarter with a 25% margin in the ETG segment, should we look at fiscal 2013 with a higher margin as the four acquisitions that you have under your belt, operations thus improve there?

For 2013, I really prefer to wait until we have done our budgets and gone through our internal process. But I will get back to you at that time.

Okay. Good enough. Thank you, guys.

And at this time there are no further questions.

Okay. I want to thank all of you for your interest in HEICO Corporation. We remain available by phone or personal visit to answer your questions or show you what we are doing and if we hear from you, we will be happy to be very responsive. And if not, we look forward to speaking to you in another three months for the third quarter update. So with that, this call is ended and I wish you all a good day.

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