HEICO Corp (HEI) 2016 Q3 法說會逐字稿

Good morning. My name is Melissa, and I will be your conference operator today. At this time, I'd like to welcome everyone to the FY16 third-quarter earnings results conference call.

(Operator Instructions)

Certain statements made in this call will constitute forward-looking statements, which are subject to risks, uncertainties and contingencies. HEICO actual results may differ materially from those expressed in accordance like by those forward-looking statements, as a result of factors including but not limited to: lower demand for commercial air travel or airline flight; changes or airline purchasing decisions, which could cause lower demand for our goods and services; product development or 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, space or Homeland Securities spending by US and foreign customers; and competition for existing and new competitors, which could reduce our sales, our ability to introduce new products and product pricing levels, which could reduce our sales or sales growth; product development difficulties which could increase our product development costs and delay sales; our ability to --acquisitions and achieve operating synergies from acquired businesses; customer credit risk; interest and income tax rates; economic contract additions within outside of the aviation defense, based medical, telecommunication and electronic industries, which could negatively impact our costs, revenues and defense budget costs, which could cause -- reduce our defense-related revenues.

Those listening to this call are encouraged to review all HEICO filings with the Securities and Exchange Commission, including but not limited to filings on Form 10-K, Form 10-Q, and Form 8-K. We are undertaking no obligation to publicly update and revise any forward-looking statement, whether as a result of new information, future events or otherwise, except to attendant required applicable law. I would now like to turn the call over to Mr. Mendelson.

Good morning, everyone, and we thank you for joining us and welcome you to the HEICO third quarter FY16 earnings announcement telecom. I'm Larry Mendelson, Chairman and CEO of HEICO Corporation, and I'm joined here this morning by Eric Mendelson, 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; Tom Irwin, HEICO's Senior Vice President and Executive Vice President, I'm sorry; and Carlos Macau, our Executive Vice President and CFO.

Now before reviewing our record third-quarter operating results in detail, I would like to take a few moments to summarize the quarterly highlights. Our third-quarter consolidated net sales, operating income, net income represents record quarterly results, and that was driven principally by record net sales at both of our operating segments.

Our consolidated net income in the third quarter of FY16 increased 22%, and both net sales and operating income increased 19% over third quarter of FY15. Consolidated net income per diluted share increased 22% to $0.62 in the third quarter of FY16, up from $0.51 in the third quarter of FY15.

The Electronic Technologies Group set a quarterly net sales record in the third quarter of FY16, improving 40% over the third quarter of FY15, and that increase principally reflects net sales contributed by our FY16 and FY15 acquisitions, as well as increased demand for certain of our products.

The Flight Support Group set a quarterly net sales record in the third quarter of FY16, improving 8% over the third quarter of FY15. That increase reflects net sales contributed by our FY15 acquisitions, as well as organic growth of about 4%.

Cash flow provided by operating activities was extremely strong, increasing 42% to $172.4 million in the first nine months of FY16, and that was up from $121.3 million in the first nine months of FY15. As of July 31, 2016, the Company's net debt to shareholders equity ratio was 47.7%, with net debt of $482.7 million.

Our net debt to EBITDA ratio was a very low 1.53 times as of July 31, 2016 and that compared favorably to the 1.97 times, shortly after the acquisition of Robertson Fuel Systems in January of this year. That of course was HEICO's largest acquisition in HEICO's history.

I am very pleased with HEICO's laser focus on strong cash flow generation, and the consistency of our growth in net income. As shareholders of HEICO, I'm sure you are all aware of the focus that HEICO places on cash flow generation. We actually consider it more important to the operations than the results of earnings per share. Fortunately, both have been very strong.

Our strong cash flow in the third quarter of FY16 allowed us to reduce borrowings under our line of credit by $52 million. In July 2016, we paid a semiannual cash dividend of $0.08 per share. This dividend was our 76th consecutive semiannual dividend in cash since 1979, and represents a 14% increase over the semiannual per-share amount of $0.07 per share, which we paid in 2015.

In July 2016 we reported that our 3D Plus and Sierra Microwave Technology subsidiaries supplied mission critical components for NASA's Juno spacecraft, which is the first spacecraft in history to enter Jupiter's orbit. We are consistently amazed by the engineering talent and the forward thinking of our team members, who supported NASA in this remarkable achievement.

In July 2016, we reported that our Inertial Aerospace Services subsidiary expanded their overhaul capabilities, by entering into a license agreement with Northrop Grumman Corporation. Under this agreement, Inertial will perform the overhaul and repair of select Inertial reference units and associated accessories, and will receive Northrop's parts inventory and test equipment for all Northrop licensed products. We are very pleased that Inertial can enter into a mutually beneficial arrangement with Northrop, and that ensures excellent service will continue for all of these licensed products.

In June 2016, we were very pleased to report that Forbes Magazine had named HEICO as one of the 100 most trustworthy companies in America, based upon accounting and governance practices. We are very honored that HEICO has once again been recognized by Forbes for outstanding achievement. We have also been ranked in the past by Forbes as one of the Top 100 best small companies, and one of the Top 100 most innovative growth companies.

This award recognizes the integrity and values of our corporate culture, and the nearly 5,000 team members that call HEICO home. We're very proud to lead one of the hardest working and most successful teams in our history, a team which consistently surpasses our targets and milestones, without compromising our transparency, our values, and our trust.

I would now like to introduce Eric Mendelson, co-President of HEICO, and President of HEICO's Flight Support Group, and he will discuss the results of the Flight Support Group.

Thank you. The Flight Support Group's net sales increased 8% to a record $222.6 million in the third quarter of FY16, up from $206.6 million in the third quarter of FY15. The Flight Support Group's net sales increased 9% to a record $647.4 million in the first nine months of FY16, up from $591.4 million in the first nine months of FY15. The increase in the third quarter and first nine months of FY16 reflects net sales contributed by our FY15 acquisitions, as well as organic growth of 4% and 3% respectively.

The organic growth in the third quarter and first nine months of FY16 is principally attributed to increased demand in new product offerings, within our after-market replacement parts and specialty products product lines. The increase in the first nine months of FY16 was partially offset by lower organic net sales from our repair and overhaul parts and service product lines, principally resulting from the mix of products repaired, which required less extensive repair and overhaul services, in addition to softer demand from our South American market.

The Flight Support Group experienced organic revenue growth of 5% and 6% in the third quarter and first nine months of FY16, excluding our repair and overhaul parts and services product line. The Flight Support Group's operating income increased 7% to $42 million in the third quarter of FY16, up from $39.3 million in the third quarter of FY15. The Flight Support Group's operating income increased 10% to a record $118.8 million in the first nine months of FY16, up from $107.5 million in the first nine months of FY15.

The increase in the Flight Support Group's operating income in the third quarter and first nine months of FY16 is mainly attributed to the previously-mentioned net sales growth, and a gross profit margin impact from favorable net sales volumes and product mix within our after-market replacement parts, and specialty products product lines. These increases were partially offset by a less favorable product mix within our repair and overhaul parts and services product line, higher performance-based compensation expense and changes in the estimated fair value of accrued contingent consideration, associated with the prior-year acquisition. Additionally, the first nine months of FY16 reflects an increase in amortization expense of intangible assets.

The Flight Support Group's operating margin was 18.9% and 19% in the third quarter of FY16 and FY15 respectively, and was 18.3% and 18.2% in the first nine months of FY16 and FY15. With respect to the remainder of FY16, we continue to estimate Flight Support Group's full year net sales growth to be between 8% and 10%, and the full-year Flight Support Group operating margin to approximate that of FY15.

Now, I would like to introduce Victor Mendelson, co-President of HEICO and President of HEICO's Electronic Technologies Group, to discuss the results of the Electronic Technologies Group.

Thank you, Eric. The Electronic Technologies Group's net sales increased 40% to a record $136.2 million in the third quarter of FY16, up from $97.2 million in the third quarter of FY15. The Electronic Technologies Group's net sales increased 34% to a record $372.9 million in the first nine months of FY16, up from $277.4 million in the first nine months of FY15.

The increase in the third quarter and first nine months of FY16 reflects net sales contributed by our FY16 and FY15 acquisitions, as well as organic growth of 1% and 6% respectively. The organic growth in the third quarter and first nine months of FY16 resulted mainly from higher sales of certain space and medical products, with organic growth in the third quarter of FY16 moderated by lower net sales of certain defense products. As we have commented many times before, the net sales within our Electronic Technologies Group are often lumpy on a quarter-to-quarter comparison.

The Electronic Technologies Group's operating income increased 38% to a record $33.6 million in the third quarter of FY16, up from $24.4 million in the third quarter of FY15. The Electronic Technologies Group's operating income increased 35% to a record $89.3 million in the first nine months of FY16, up from $66 million in the first nine months of FY15.

The increase in the Electronic Technologies Group's operating income in the third quarter and first nine months of FY16 is mainly attributed to the previously mentioned net sales growth, partially offset by an increase in amortization expense of intangible assets, and higher performance-based compensation expense. The Electronic Technologies Group's operating margin was 24.7% and 25.1% in the third quarter of FY16 and FY15 respectively, and was 23.9% and 23.8% in the first nine months of FY16 and FY15.

With respect to the remainder of FY16, we continue to estimate the Electronic Technologies Group's full year net sales growth to be between 29% and 32%, and the full year Electronic Technologies Group's operating margin to approximate 24%. I'll turn the call back over to Larry Mendelson.

Thank you, both Eric and Victor. We're going to talk about diluted earnings per share.

Consolidated net income per diluted share increased 22% to $0.62 in the third quarter of FY16. That was up from $0.51 in the third quarter of FY15, and increased 17% to $1.64 in the first nine months of FY16, again up from $1.40 in the first nine months of FY15.

As previously mentioned, on last quarter's call, one-time non-recurring acquisition costs totaling $3.1 million were incurred in the first quarter, in connection with a FY16 acquisition. These acquisition costs reduced our consolidated net income per diluted share by $0.03 in the first nine months of FY16.

Depreciation and amortization expense totaled $15.4 million and $11.9 million in the third quarter of FY16 and FY15 respectively and totaled $44.6 million, $35.1 million in the first nine months of FY16 and FY15. The increase in third quarter and first nine months of FY16 principally reflects the incremental impact of higher amortization expense of intangible assets attributable to our FY15 and FY16 acquisitions.

R&D expense increased 35% to $12.7 million in the third quarter of FY16. That was up from $9.4 million in the third quarter of FY15, and increased 13% to $32.7 million in the first nine months of FY16, up from $28.9 million in the first nine months of FY15.

Significant ongoing new product development efforts are continuing at both Flight Support and ETG, as we continued to invest approximately 3% to 4% of each sales dollar into new product development. We believe that our commitment to invest in new product development has proven very effective, and continues to be a significant part of our long-term growth strategy in both of our operating segments.

SG&A expense totaled $63.7 million in the third quarter of FY16, and that was up from $49.6 million in the third quarter of FY15, and totaled $190.5 million in the first nine months of FY16, again up from $146.7 million in the first nine months of FY15. The increase in third quarter and first nine months of FY16 principally reflects the impact from the FY16 and FY15 acquisitions, higher performance-based compensation expense, changes in the estimated fair value of contingent consideration associated with a prior-year acquisition, and additionally the first nine months of FY16 reflects a $3.2 million impact from foreign currency transaction adjustments on borrowings denominated in Euros under our credit facility, and a $3.1 million impact from acquisition costs associated with the FY16 acquisition.

SG&A expenses as a percentage of net sales were 17.9% in the third quarter of FY16, and that was up from 16.5% in the third quarter of FY15, and they were 18.8% in the first nine months of FY16, and that was up from 17.1% in the first nine months of FY15. The increase in the SG&A expense as a percentage of net sales during the third quarter and the first nine months of FY16 principally reflects the previously-mentioned higher performance-based compensation expense. Additionally, the increase in the first nine months of FY16 reflects the impact from the previously mentioned changes in the estimated fair value of contingent consideration, foreign currency transaction adjustments, and the acquisition costs.

Interest expense increased to $2.3 million in the third quarter of FY16, and that was up from $1.1 million in the third quarter of FY15, and it increased $6.2 million in the first nine months of FY16, up from $3.3 million in the first nine months of FY15. The increase in the third quarter and first nine months of FY16 was due to a higher weighted average balance outstanding under our revolving credit facility, associated with our FY15 and FY16 acquisition, as well as slightly higher interest rates. Other income and expense in the third quarter and first nine months of FY16, FY15 not significant.

Income taxes. Our effective tax rate in the third quarter of FY16 decreased to 30.5%, down from 32% in the third quarter of FY15, and increased 30.9% in the first nine months of FY16, from 30.6% in the first nine months of FY15.

The change in our effective tax rate in the third quarter and nine months of FY16 reflects the benefits recognized in FY15 from a prior-year tax return amendment for additional foreign tax credits, related to R&D activities at one of our foreign subsidiaries, as well as higher net income attributable to non-controlling interest in subsidiaries structured as partnerships, which were partially offset by a larger income tax credit recognized in FY16 from the permanent extension of the US Federal R&D tax credit earlier this year, and a higher deduction from manufacturing activities, mainly resulting from a FY16 acquisition. The decrease in our third-quarter effective tax rate also reflects the benefit of higher tax exempt unrealized gains in the cash surrender value of life insurance policies related to the HEICO leadership compensation plan.

Net income attributable to non-controlling interest was $5 million in the third quarter and $14.7 million in the first nine months of FY16, respectively. That's comparable to $4.6 million and $14.4 million reported in the third quarter and first nine months of FY15. For the full FY16 year, we continue to estimate a combined effective tax rate and non-controlling interest rate of 39% to 40% of pre-tax income.

Moving on to our balance sheet and cash flow, as you all know, our financial position and forecasted cash flow remain very strong. As we discussed previously, cash flow provided by operating activities was extremely strong, and it increased 42% to $172.4 million in the first nine months of FY16. That represented 154% of net income, and that compared to $121.3 million cash flow in the first nine months of FY15. Our working capital ratio is a strong 3 times as of July 31, 2016 about the same as October 31, 2015.

DSO, days sales outstanding of accounts receivable improved to 49 days at July 31, 2016 and that was down from 51 days as of October 31, 2015. Of course, we continue to closely monitor all receivable collection efforts, in order to limit our credit exposure. HEICO has very, very few receivable losses as uncollectible.

No one customer accounted for more than 10% of net sales. Our top five customers represented approximately 24% and 18% of consolidated sales, net sales in the third quarter of FY16 and FY15.

As expected, our inventory turnover rate increased, principally due to the impact of the January 2016 acquisition, and it increased to 124 days for the period ending July 31, 2016. That was up slightly from 117 days for the period ending July 31, 2015. And if we exclude the impact of this acquisition, the inventory turnover rate was 120 days in the first nine months of FY16.

Our net debt to shareholders equity ratio was 47.7% as of July 31, 2016, with net debt of about $482.7 million, principally incurred to fund acquisitions in FY16 and FY15. We have no significant debt maturities until FY19, and we plan to utilize our financial flexibility to aggressively pursue high-quality acquisition opportunities, and that will accelerate growth and maximize shareholder returns.

I would like to congratulate all of HEICO team members, and especially the leaders of our business units, for delivering an exceptional quarter of high cash flow generation. It's a testament to their business savvy and daily focus on delivering high-quality products that exceeds our customers' expectation. It's their hard work that allows HEICO to consistently deliver world-class cash generation for its shareholders.

As we look ahead to the remainder of FY16, we anticipate organic growth within our commercial aviation, after market replacement parts and specialty product lines, moderated by softer demand for certain component repair and overhaul parts and services. We also foresee modest full-year organic growth within ETG, based upon current forecasted product demand.

During the remainder of FY16, we plan to continue our focus on again new product development, further market penetration, executing our acquisition strategy, and maintaining our financial strength. These are the key items we have focused on for the past 25 years, and have made HEICO a very successful Company.

Based upon our current economic visibility, we are increasing our estimated consolidated FY16 year-over-year growth in net income to 13% to 15%, and this is up from our prior growth estimate of 12% to 14%. In addition, we continue to estimate consolidated FY16 year-over-year growth in net sales to approximate 15% to 17%, consolidated operating margin to approximate 18.5% to 19%, depreciation and amortization expense of about $62 million, CapEx about $32 million, cash flow from operations approximately $220 million.

In closing, we will continue to focus again, on intermediate long-term growth strategies with an emphasis on acquiring profitable businesses at fair prices, at the same time, expanding our own product lines and internal operations. That's the extent of my prepared, our prepared remarks. I would like to open the lines now for questions from all of the listeners. Thank you very much.

(Operator Instructions)

Your first question comes from the line of Larry Solow, CJS Securities.

Wondering, just on Flight Support, just on the after market specifically, seems like trends pretty steady, is that a good way to characterize it, maybe the industry is flat to slightly growing, and you are taking your usual 3 or 4 points better than that? Has there been any change in the after market the last few months?

Larry, this is Eric. I'd be happy to answer that. Yes, we have seen a little bit of a pick up in the market. Again for us, our sales, our organic growth is driven primarily or nearly exclusively from volume increases, as opposed to price increases, whereas certain other suppliers have price embedded in there. So yes, I think that particularly on a volume and overall basis, that we're outgrowing the market.

We had seen some firming in demand. If we go back, we like to talk about the timeline of the after market sales development in the industry, and if you look back, you'll see there was very high organic growth in the mid 2000s, and then of course with the high oil prices and the recession of 2008, 2009, and 2010 the industry was down. 2011, the industry started coming back, HEICO was up about 20%, a low 20% organic growth around the 2011 time, and then it flattened out in 2012 and 2013. And then in 2014 again, we saw midteen or high teen organic growth, and then its been flat, now it is coming back.

I feel that very strongly that HEICO can continue to outgrow the industry. We will do that at different paces. In other words, at times when a lot of new equipment is coming into the market, our organic growth, out growth, if you will, will be lower than at times when the products are more mature. And I can tell you, we've got a lot of new products in development and our business units are taking advantage of the opportunities that are out there.

We had a worldwide sales meeting last week, and we've got a lot of new opportunities in both the parts and the repair side that I think are going to be very good revenue and profit generators over the next number of years. So to answer your question, in summary yes, we do see a bit of a firming. I don't see it going back to, if you will, to the 22% growth, 21% growth that we saw in 2011 or even the high teens that we saw in 2014, but I do see us continuing to outgrow the industry, and it still is a very good business.

Appreciate that answer. Just real quick, on the repair and overhaul side. Obviously, South America, that is probably not going to change any time soon, but just in terms of the mix issue, is that something that will continue, do you think, or do you think as you look out to next year, that should at least firm up, and maybe start growing again?

We actually thought in the third quarter the South American market starting to firm, and we do anticipate continued improvement in the South American market. So I think if you will, some of that weakness is behind us, but we're being very careful and very aggressive in all our markets.

Got it, great. Okay, great, thanks.

Your next question comes from the line of Kevin Ciabattoni, KeyBanc Capital.

Nice quarter. Starting on ETG, we saw a meaningful deceleration in organic growth in Q3, relative to what was a very strong second quarter. Talk a little bit about what drove this slower growth there.

I know you had mentioned it tends to be a lumpy business, and it sounds like some of it was defense related. And just wonder if there's any more specific color or programs that you can point to in the quarter?

Kevin, this is Victor. It a good question, and as you noted, and if you look back at our conference calls and our earnings in the ETG over the years, it is lumpy like this. We'll have quarters that have low organic growth or negative organic growth, and so it isn't unusual, it isn't the thing we don't expect it to happen, and I think it will continue to be the case, going forward.

Specifically in the quarter, where we had the negative organic growth in some of the defense businesses, it was really more related to what would be the movements in shipments between quarters. It was across a few of the businesses. I would note that the businesses we acquired last year and earlier this year, had very nice organic growth, but of course that's not included in the organic growth figures the way we compute it.

But those had organic growth and it would have changed the organic growth picture obviously. They grew organically nicely over the time from when we acquired them, and the prior-year period and from the point at which we acquired them. So we continue to like those businesses, and feel pretty good about them.

On that note, maybe you could give an update on how the Robertson acquisition is tracking? Obviously that's been a big one, and what you're seeing in the broader helicopter market from your end?

Sure. A couple of things. Robertson has been a great acquisition for us, it's performed as we had expected, and we continue to be very pleased with the entire team there, and what they're doing.

In terms of the broader helicopter market, Robertson is really a defense business, and serves defense rotorcraft as opposed to being a primarily a commercial rotorcraft business, so we don't pay a lot of attention to what's happening in commercial rotorcraft. We know it's going through a tough time.

As we talked about though, we think there's opportunity for us in a segment, in a slice of commercial rotorcraft. We don't think that will be the dominant factor in Robertson for us, but it will be a nice adjunct for us, and that's continuing to proceed as we expected, and according to our own internal plans.

So that part really doesn't track with overall helicopter deliveries. That would be a little bit more of a retrofit opportunity, and then with helicopter commercial deliveries, later, but again, it is more defense business.

Any update maybe I should have been more specific but any update you can provide on what you're seeing in military rotorcraft business programmatically?

I don't think we've seen any material changes programmatically, and of course, we're now in the period where we do our budgets for the upcoming year, so we start to really dive deeply into that as this quarter wears on, toward the end of the quarter, and we get into the beginning of the first quarter. So I'll have a better sense of that in December.

Thanks, Victor. And one last one for you, Eric. Just big picture. Any changes you're seeing out there in terms of general airline purchasing behavior, inventory levels, that type of thing?

No, I wouldn't say we're seeing any changes. I think it's pretty much consistent to the way that it's been.

We see a tremendous, frankly a tremendous enthusiasm for our products, whether it's on the new parts side, or the repair side, distribution, there is significant focus at the airlines, and I think what we've been doing with them has really caught on. And the pipeline is, I must say, quite robust for us, in terms of new product development both on the parts as well as the repair side. So I'd say just a greater acceptance across the board.

We've seen some examples of new generation parts prices, and they are just out of sight. It makes -- some of this stuff makes the prior generation look like they were giving it away, and the airlines, what I'm very happy to see so early in the cycle, are the airlines coming to us as they see unfairness in the pricing practices of a number of OEMs, having them come to us with those projects.

And so I can tell you our people are very excited and motivated to bring this on. So I would say that in terms of airline purchasing behavior, probably a shorter cycle time now in the development of newer products than we've seen in the past. We try to say it's to be expected, as the Company continues to grow, and gains acceptance and market share throughout the world.

That's good color. Thank you.

Your next question comes from the line of Ken Herbert, Canaccord.

I first wanted to ask a question of Eric, if I could. You've highlighted several times new product opportunities, specifically within the after market replacement parts, as well as specialty products, and even repair. But within after market replacement parts, can you provide anymore details on where you're investing for the new products, where you're seeing the most demand from your airline customers, and what you see as the priorities here, or where we should be looking specifics around the new product introductions?

Yes, Ken, thank you for your question. I wish that I could talk about that, but we need to be very careful with regard to speaking about a particular customers or product types.

So I'm not able to provide specifics around it, but I can tell you that I think the new OEM build cycle was rather rapid, and perhaps airlines didn't ask a lot of questions up front about how much stuff was going to cost to be maintained. So the airlines are coming to us with these opportunities, so I would say it's somewhat across the board, in the products that we offer.

Did you see growth, if you think about your legacy or older portfolio, within after market replacement parts, was that growing in the third quarter?

Yes, I would say that yes it did grow. I mean, one of the phenomena in the history of our business is we get on a platform a number of years into the program, and then we ride it until the sunset.

So there is always aircraft that are coming out of the fleet. So we do see on certain products reduction in demand, but of course we've got the majority of aircraft are just continuing to age and stay in the fleet, so we see an increase there. So yes, we are seeing an increase, combined with our new part sales.

Okay that's helpful. And then just finally, obviously you are not giving 2017 guidance yet, but you've alluded to the surge in organic growth in 2011 and then again in 2014. As we sit here today, obviously probably not at the same levels as those two prior peaks, but do you currently now think 2017, you could see double digit organic growth within the FSG segment?

Yes, I think that it's too early to predict that. Right now, we are doing our budgets, and we do a bottoms-up budget by subsidiary, where they go by customer, by part number, by month. So that's an extremely comprehensive exercise, as you can imagine, and I don't yet have those budgets from the businesses.

So I honestly can't give you an answer on that; however, I certainly would not anticipate 22% organic growth like we had in 2011, nor would I anticipate high teens that we had, I mean mid 20% growth we had in 2011, nor high teens that we had in 2014. But I do see continued firmness and continued growth in the market.

Okay so fair to say you'd expect to see some acceleration of the growth over the mid single digit organic growth this year in 2017?

Again, we're pulling the budgets together right now so once we see that, I'll have greater granularity, and be able to give a closer indication. But I think, consistent with what we've been doing in past and continued firming, I would prefer to term it at this point, until I have greater data.

Okay, fair enough. I'll let that line of questioning go.

If I could, just one final question for Carlos, maybe. You had obviously pretty significant debt reduction in quarter. Should we assume similar reductions in the fourth quarter

And then maybe just as part of that, any commentary you can provide on what you're seeing in the M&A pipeline? Thank you very much.

Sure, Ken, this is Carlos. We plan to generate a significant amount of cash in Q4, and of course, after investing in our businesses, and new product development, et cetera, we take that money and pay down debt to open up opportunities to do more acquisitions. So you should expect to see a continuation of that trend.

Okay, great. Thank you very much. Nice quarter.

Your next question comes from the line of Sheila Kahyaoglu of Jefferies.

Good quarter. Eric, just a follow-up on the after market activity. I was just wondering if there's any way you're seeing any change in confidence, some retirements of aircraft, like the MD-80. Are you seeing any notable movement in your after market with regards to aircraft retirement?

Well, Sheila, thank you for your question. When we look back at the growth, the organic growth of high teens that we had in basically the end of 2013, the beginning of 2014, I think a lot of that was due to unexpected maintenance that ended up occurring on aircraft, that airlines thought was going to come out of the fleet, but didn't come out of the fleet because of basically OEM production delays. So we have seen some signs that some airlines are going to continue flying certain aircraft that had been predicted to come out of the fleet.

There was an article that I just read this morning, and we've had this information now for, I don't know, a number of weeks, that American Airlines had planned on pulling all of their MD-80s out of service by the end of 2018, and now an article that I just read this morning confirms that they plan on keeping them another I don't know, seven years or so beyond that. So that is the plan, they've got significant maintenance, I think, that probably will have to be performed.

And other airlines, I don't want to just highlight American but just because that was the news article of the day, if you will, but other airlines are able to continue tying these aircraft as well. And I'd like to point out that airlines like American are able to renovate the interiors of the aircraft, and give a passenger experience on an older aircraft that's just as good as the passenger experience on a newer aircraft, and you've seen Delta do this in other airlines as well.

So with a very sensitive customer that's looking for the best price, they're able to provide, I think, a very good product using already paid for fully depreciated equipment. So if they do that, if they continue to do that, there will be an increase in demand for parts, the parts and repairs associated with those aircraft. I think that we're starting to see a little bit of this, but I would prefer to a wait and see it from other airlines as well, before if you will, predicting that it's a trend.

I think it makes smart business. There's no reason why as long as revenue passenger miles stays where it is, and fuel stays in the area that it is, I think this makes complete sense, especially if interest rates start to tick up a little bit. But until we see the demand for the parts, I'd rather hold off on it, because it's a little speculative to guess as to when, if and when it will come through. But fortunately we are seeing some opportunities there.

I've asked this before but is there any way you could quantify what portion of your after market parts go in aircraft that are 5 years or younger, 5 to 10, or 10 years and older? Is there any break out that you guys look at?

No, we do look at various metrics but they don't fall out exactly that way, so I'm reluctant, and I don't have them in front of me. But we do look at them.

I would say that for the first five years that an aircraft comes out, there's very little demand. Normally for us, the demand would kick in years, if you will 10 through 15.

I think maybe we're seeing that a little bit sooner now, because of the pricing, and frankly HEICO's reputation in the marketplace. So I think there's opportunity there, notwithstanding some of the engine headwinds as a result of some of the power by the hour contracts.

But we feel very confident we can make that up in other areas, as well as continuing to develop more engine parts. So I would say we're probably going to develop parts and sell them sooner than we have in the past, but our business is definitely, I would say the majority of our business is in the years roughly 15 to 25, since that new aircraft was delivered.

Got it. Thank you for the color, and then I guess maybe this one is for Carlos. Is there any way you could talk about the first nine months of the year, how do you think about the guidance? Just the moving parts in terms of higher compensation and amortization expense, the contingent considerations, and any FX adjustments -- how you could, maybe, if you could quantify them, or if they're net neutral thus far, or a net positive to operating earnings?

Well, as far as the forecast if you would, for the year, I'm pleased that we're on forecast, and in the bottom line we're exceeding, as indicated by our jump in the guidance. Obviously, with the seven acquisitions we've done over the last 15 months, we're going to have a lot more amortization expense, and of course, these are not things we plan for, right? So that's incremental to decreasing margins. Frankly with the accounting rules that can be quite dramatic.

So those are things that pop up through the acquisition process, and I always tell you that when we buy a new Company, you've asked me many times about margin expansion and what winds up happening is our existing companies expand margins, and the companies we acquire perform more often than not, as we expected, if not better and then we get this drag of amortization, which can be anywhere from, in the FSG maybe 2 percentage points, and ETG, it's historically around 4 percentage points. So it's a substantial number.

That drags -- that increases our SG&A if you would, as a percentage of sales. Performance based comp is triggered pretty much across the Company based on growth and operating income, cash flows. So as we continue to report extremely strong cash flows, we will have some additional performance-based compensation expense for the HEICO leaders in the subsidiaries and abroad.

So those are things that for the quarter that are what I would call expected. We do have some FX adjustments, like you mentioned, related to our Euro borrowings, when we acquired Aeroworks, we did take out some Euro debt, and we've had -- last year we had some favorable outcomes from transaction or translation adjustments on that debt, because the dollar got strong against the Euro. And its gotten a little weaker this year, although we'll see how the year plays out.

Depending on how the Fed reacts with interest rates and how the dollar trends, it could be a net positive or negative. So those address the variables you asked about, Sheila.

Okay, thank you.

Sheila, this is Larry. Just want to add one thing which I think you and most of the people on this call are aware of. Because of the accounting rules and so forth, as Carlos was describing, we have this amortization expense. From an operating point of view, we ignore amortization of intangibles, because it becomes confusing, it's in a sense, arbitrary, you really don't know, we have rules to say you have to write it off.

And quite honestly, I always question when a Company is growing, doing well and better, why are we writing off in the intangibles, customer lists, and things like that. But those are the accounting rules, and we abide by the accounting rules. But in my opinion, to truly understand the business as the management does we focus very, very hard on cash flow because that's where the rubber meets the road.

And as a brilliant friend of mine one time said, earnings per share is opinion, and cash flow is fact. We can't fudge the cash flow. Nobody can. So that to us is the most critical, and it shows me as the CEO where we're really going.

If one of our subsidiaries tells me they're making all this money and I say well where is the cash, and it winds up in inventory receivables and fixed assets and everything else, we are not getting anywhere. So in my opinion, the key to our business is watching net cash flow, and as you know, we had a very, very strong cash flow year, and we expect it to continue, and that's just my color on how our business operates.

Sure, thank you. Appreciate it.

Your next question comes from the line of Eduardo Finkler, FK Capital Management.

Nice quarter. Regarding the return overhaul of parts and services, I just wanted to ask if you're able to identify if the main reason for the decrease comes from softer demand, or is it more from product mix? And also if you are maybe seeing some any trends in some OEM security maintenance over the life of the product?

Yes, Eduardo, most of the weakness has come from the South American market. I think that its been fairly across the board as a result of some of the turmoil and prices that have fallen, and a drop in demand. I don't think it has been in any particular area. I think that it's been pretty broad based in terms of customers, as well as product types.

OEMs continue to be very aggressive, that's nothing new for us. And as a result, we respond in a very aggressive way, and we believe we are continuing to grow our market share around the world, and specifically in South America as well. We also had a phenomenon where the average, if you will, the average ticket price, average invoice price was a little lower, because of some of the components needed slightly less comprehensive overhauls in parts than they needed, but again we're seeing that this is turning around now.

Okay, great, thank you.

Your next question comes from the line of Jim Foung, Gabelli & Company.

So I wanted to first ask about Inertial Aerospace. It sounds like Northrop Grumman is a new customer for you, and maybe you could address that?

And just wondering how big could this potential sales be? It seems like it's a new platform for you.

Jim, thank you for your question. This is a very good point that we haven't covered before, and one thing that I'm very excited about.

Actually, Inertial Airline Services was in the market, competing with Northrop Grumman, and what happened was over time we developed the relationship with Northrop Grumman, where Northrop Grumman sold us their equipment and their inventory and has licensed us, and has gotten out of the overhaul of their own components. So they in fact have notified their customers to send their parts to HEICO, and we will perform the overhaul on their parts, on the components using Northrop Grumman parts when we can get them, as well as our own proprietary repairs, and will pay Northrop Grumman various fees along the way.

So I think the model is very exciting, because it shows that where we were in a competitive situation with somebody, we were able to, if you will, put that behind us, and work together to satisfy the market as the exclusive supplier of these products. And I think, frankly, the opportunity to do this with other OEMs exists.

And I wouldn't want to make any prediction as to what we may be able to do, but I'm very excited as HEICO's reputation has grown, we've seen the ability to partner with OEMs, both on the commercial as well as on the military side. And actually, I'd point out that on the military side we only partner with the OEMs, we don't compete with them, or very, very little competition, I should say.

So I think that there's opportunity here for HEICO and OEMs, where applicable, to work together and provide a solution. That doesn't mean we're going to stop doing our standard business.

We're going to continue to do that, but I think it shows, if you will, a mutual understanding that HEICO and the OEMs can also work together to support the airlines, and reduce the airline operational costs. And in terms of size, we are not able to give specifics on that, but again, we're very excited about the business.

Yes, sounds like a great relationship here, and your partnership could open up additional OEM business.

Thank you, yes. We agree, and we're very, very excited about this.

And then I guess secondly, there's been a lot of deferrals of wide body aircraft. You have new deliveries of wide body aircrafts from various airlines, because of the overcapacity there.

And I guess that presumes they are just going to keep the existing wide body airplanes longer. And just curious, how big of revenue streams are wide body for you, and what potential upside could you see, as airlines keep the existing wide body airplanes longer?

Actually, I don't have in front of me the statistics, but we have a mix of the two, and I would say it's probably somewhat related to overall seat count in the industry. So I'm guessing that maybe our business is in the area of two-thirds narrow body one-third wide body, but that's just strictly a guess, because again I don't have the data in front of me.

However, I do agree with you, that if you look at the cost of operating these wide bodies, and the cost of buying the new equipment, and maintaining the new equipment, airlines are able to put in beautiful new interiors, provided by companies like B/E and Zodiac and are able to offer an incredible customer experience. So I think that there is good opportunity to extend the lives of some of these aircraft.

We have seen American Airlines that can push out some A350 deliveries, and of course there's general, I would say a little bit of weakness in the new wide body market, but it's hard to justify those --some of those new aircraft at very high prices. So I would assume that we'll see some opportunities there.

Are the dollar figures with wide body components greater than narrow body?

I would say on probably on an airplane basis, I would say probably in general, when you look at systems that are based on the ratio of seats obviously, there would be an upgrade or opportunity on a wide body than on a narrow body, for example, a four engine airplane versus a two engine airplane, so I think that there's good opportunity there.

Great, okay, great.

Jim, this is Larry. I just want to make one comment. I thought your question, the first question that you asked, was very incisive, and when you started to probe into the opportunities of working with the OEMs, similar to the Northrop transaction.

And I think that this is a very fertile area for us. I think we would like to proceed, and I think it's very likely that other OEMs will look at this Northrop deal. It's a win-win for Northrop and for HEICO, and it makes a lot of economic sense for both of us. I think other major OEMs will realize the value of the structured deal like that, and I would not be surprised to see HEICO enter into similar arrangements with other companies.

I think it's a great market opportunity there, and I sensed that when I read that in the press release. So good luck with that. It's a good platform. And thanks for taking the call and I look forward to seeing you guys in a couple of weeks.

Yes, we will. Thanks, Jim.

Your next question comes from the line of Robert Spingarn, Credit Suisse.

This is Joe on for Rob. I wanted to ask you about your organic growth expectations at ETG, following up from Kevin's question. I believe previously, you were looking for mid single digit organic growth, and today you characterized that as modest organic growth for the full year.

So just wondering is that a slight change perhaps a little bit weaker than before? And Victor, to the extent there was movement in shipments between quarters, maybe you don't expect to fully recover in last quarter, how should we think about that?

This is Victor. So I think we're still looking for mid to low single digits organic growth out of the ETG, in the range we have historically, and we'll see how it falls out.

On the second part of your question, I think that's probably the case, although we don't really know what we will see in the fourth quarter for sure, and we want to be careful and conservative. I've got guys who are absolutely convinced that we'll see it in the fourth quarter, and some who aren't, so I'm going to be a little more conservative on it. And that would of course obviously benefit 2017, and so on, but we'll have to wait and see how that plays out.

But I wouldn't call it earth shattering in either case. I don't think it's a case where the ETG is going to collapse or reach astronomic proportions as a result of these.

Right, understood, and just on the margins there as well, you're still expecting approximately 24% margin for the full year. So the implication is that the fourth-quarter margin is coming down a good bit sequentially and year-over-year, so I'm just wondering what's driving that pressure.

That would be more mix, that would be the biggest factor, there. By the way, just as aside, we talk about obviously the GAAP margin, and the way we look at that, and if you look at the business, how it's actually performing on a trading level, there's about 400 basis points of amortization, so it comes to an average all-in of around 28 basis points for the total, and the year, excuse me -- 28% for the total year. And that's very strong, so we're pretty happy with that.

Carlos I don't know if you have something to add to that.

To amplify what you said, prior-year Q4 the ETG really knocked it out of the park at almost 29% OI margins, and that was the unique things and some fantastic business opportunities we took advantage of last year. When we gave guidance this year, and have continued to give the same guidance throughout the year, we basically said that the full year would approximate really what the margins that ETG has experienced in the prior two years before last year.

So we continue to expect that, and as Victor said, we are cautiously optimistic the fourth quarter will be fantastic for us. But at the moment, we're going to stick with our guidance.

Great, thanks for the color, appreciate it.

(Operator Instructions)

Your next question comes from the line of George Godfrey, CL King.

Two questions. The first one is, on the -- Victor as you think about the budgeting and setting the targets for next year, can you share with us what inputs you look at to think about specifically how you come up with your organic growth estimate on what you think it's going to be for 2017?

Yes, that's a good question. Each subsidiary, just like with the Flight Support Group, each subsidiary in HEICO prepares a bottoms-up budget for the operation for the year. And we look at sales estimates, again it varies by company as to what goes into those sales estimates, so companies that are less parts-oriented don't do a month-by-month, part number by part number, and they will estimate on programs and things like that instead. But some do go into the level of detail on part by part.

In any event, they will prepare their sales estimates, and then cost estimates throughout the year, and margin throughout the year, and including details on headcount month by month and payroll changes, and literally person by person, because they are not gigantic operations, right? They are typically average size, somewhere around 75 people or something like that, some are bigger, some smaller. But they will go down person by person and estimate the month and when any payroll adjustments would occur.

And we go through and layer on of course, they layer on all of the SG&A expenses and other estimates, and submit that budget to us. And then we sit down with the companies and review the budgets and talk through various changes, and decide if we think that's fair and reasonable, and if not, we ask the companies to take a further look at their assumptions, and consider adjusting those assumptions. It's an integrated process, and eventually we come up with an estimate that we think is reasonable for the year.

And then on a top level here at HEICO, we look at that, and we know our people, we know who tends to be very conservative and blow through their budget every year, and we know who tends not to. So we'll make some kind of top level assumptions here.

Generally we'll build in some level of cushion to account for that, and we put that in, and then we have our budgets, once they are all aggregated. And that totals up the organic growth. And of course, the acquisitions are not, as we talked about, are not included in the organic growth.

Understood, that's helpful, thank you. And just one question for Eric. Could you just comment on where we are today, versus say six months or a year ago on M&A activity, and how active you are in talking with potential targets? It seems like it's pretty quiet, and the net debt leverage ratio just at 1.5 times seems toward the low-ish end of what I'd think you'd be comfortable running with.

Sure, George. It's a good question. Last year in the Flight Support Group, we did about 5 acquisitions, or I'd say 4 1/2, because one was a rather small bolt-on. So we were extremely busy, and we've had to digest those, and they are performing overall quite well, and we're very happy with the performance, they are outperforming our expectation.

We have been very busy, I would say, recently. Certainly over the last half year or so, looking at a number of acquisitions.

But again, we need to find the companies that are the correct fit for HEICO, that really fit with our culture, fit with our strategy, and our business operating model. And I think we've got a number that we are looking at now, that do fit within that criteria, and we're very careful, we need to make sure if you will trust but verify, and confirm through the due diligence process that the companies are as they had anticipated to be, sometimes.

And I would say today's robust M&A environment, advisors can be overly optimistic, if you will, on forward projections, and sometimes sellers realize that they can't achieve those projections. So we're very thorough on our due diligence there, but we do have a, as you point out, tremendous firepower to be able to make acquisitions. I think we have always been the acquirer of choice that continues to be, and I'm hopeful that we're able to get some deals done within the next six months. But we are very, very busy in that area now.

George this is Victor. I would just add, the same applies for the ETG. I would also add that we are, we like to get deals done, but we aren't afraid to not do deals. We are doing the right thing for the Company long term, and that's our attitude.

But right now, I have to say we're looking at a fair number of companies, and it's a pretty robust pipeline in both sides of the business. Where those go, only time will tell.

Got it. Thank you very much, gentlemen.

There's no further questions at this time. I'd like to turn it back to HEICO for any closing remarks.

This is Larry Mendelson again. I want to thank all of you on this call for your interest in HEICO. We remain available by phone, if you have any other questions, we'll be happy to try to respond to them, and otherwise we look forward to speaking with you either at one of the conferences in early September, we're going to be in New York. There are three conferences in early September, and we're going to be on the call in December for Q4, and the final year wrap up.

So again, thank you all very much. Happy Labor Day to you, and we'll speak soon. That's the end of our call.

Thank you for joining today's conference call. You may now disconnect your lines.