HEICO Corp (HEI) 2016 Q4 法說會逐字稿

Good morning. My name is Jody, and I will be your conference operator today. At this time, I would like to welcome everyone to the FY16 full-year and fourth-quarter earnings conference call.

(Operator Instructions)

Certain statements made in this 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 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 cost to complete contracts; governmental and regulatory demands; export policies and restrictions; reductions in defense, space or homeland security spending by US and/or foreign customer or competition from 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 make acquisitions and achieve operating synergies from acquired businesses; customer credit risk, interest, and income tax rates; and economic conditions within and outside of the aviation, defense, space, medical, telecommunications and electronics industries, which could negatively impact our costs and revenues; and defense budget cuts, which could reduce our defense-related revenue.

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, filings on Form 10-K, Form 10-Q, and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except to the extent required by the applicable law. I would now like to turn the call over to Laurans Mendelson. Thank you. You may begin.

Thank you very much, and good morning to everyone on the call. We thank you for joining us and welcome you to this HEICO fourth-quarter and full-year FY16 earnings announcement teleconference.

I am Larry Mendelson, Chairman and CEO of HEICO Corporation. And I am 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 Executive Vice President; and Carlos Macau, our Executive VP and CFO.

Before reviewing our operating results in detail, I'd like to take a few moments to summarize the highlights of our record full-fiscal-year and fourth-quarter results. Consolidated FY16 net sales of $1.3763 billion was up 16%. Operating income of $265.3 million, also up 16%, and net income of $156.2 million was up actually 17%. These numbers represent record results, driven principally by the impact of our FY16 and FY15 acquisitions, as well as organic growth within both operating segments.

Our consolidated fourth-quarter FY16 net sales of $363.3 million was up 11%. Operating income of $76.1 million up 10%, and net income of $44.3 million was up 16%. And they, too, represent record results, driven principally by the impact of the FY16 and FY15 acquisitions, as well as organic growth within Flight Support and increased demand from majority of Electronic Technology Group's products.

Consolidated net income and operating income in FY16 are up 17% and 16%, respectively, on a 16% increase in net sales. Additionally, consolidated net income and operating income in the fourth quarter of FY16 are up 16% and 10%, respectively, on an 11% increase in net sales.

Consolidated net income per diluted share increased 16% to $2.29 in FY16, up from $1.97 in FY15. Consolidated net income per diluted share increased 16% to $0.65 in the fourth quarter of FY16, and that was up from $0.56 in the fourth quarter of FY15.

Cash flow provided by operating activities was very strong, and increased 44% to a record $249.2 million in FY16, and that was up from $172.9 million in FY15. As of October 31, 2016, the Company's net-debt-to-shareholders'-equity ratio was 39.6%, with net debt, which we define as total debt less cash, of $415.3 million.

Our net-debt-to-EBITDA ratio was a very low 1.28 times as of October 31, 2016, and that compared favorably to the 1.97 times shortly after the acquisition of Robertson Fuel Systems in January of this year. I remind you that Robertson was the largest acquisition in HEICO's history.

The strong cash flow generated by HEICO during FY16 allowed us to internally fund the growth of our existing businesses while reducing borrowings under our line of credit by $170 million. And I continue to be very pleased with HEICO's laser focus on strong cash flow generation, which is a core strategy for HEICO, and in my opinion, the most important aspect of building a successful business.

I have said many times at conferences that HEICO is focused on cash flow, and earnings per share will then take care of themselves. We could focus on earnings per share and, as many companies do, would have no cash flow or very low cash flow. And to us at HEICO, that is not the formula for a successful business.

I remind you that I think, and upper Management feels, that HEICO is really a vehicle for generating strong cash flow. The methodology that we use are in two groups: Aviation and Electronic Technologies, where we get very, very strong margins on products which are protected mainly from excessive competition.

As I previously mentioned, both the Flight Support Group and Electronic Technologies reported across-the-board record results in FY16. And I'm very pleased with the leadership team's constant focus on serving needs of customers, introducing new products and services, and developing talented team members to continue our collective success in the new FY17.

During September 2016 we had a notable and very unique success story in the space market. As you may recall, in September we reported that our VPT and 3D Plus subsidiaries supplied mission-critical components for NASA's OSIRIS-REx program, which featured the first US mission in history to carry samples back from an asteroid back to earth, and the largest sample return from space since the Apollo era. We are constantly amazed by the engineering talent and forward thinking of our team members who have supported NASA in this endeavor.

In November 2016 we regretfully reported that Samuel Higginbottom, a 26-year member of our Board of Directors, passed away at age 95. Sam served on HEICO's Board since December 1989, and he chaired significant committees such as Compensation Stock Option, served on the Executive and Finance and Audit Committee for many years. Sam was a great friend to me, and to HEICO and many others. His insight into business, world affairs, education and people were legendary, and we all counted on him for his wise counsel over the course of several decades. We will deeply miss having his advice and his participation in HEICO.

As reported earlier this week, we declared an increased regular semiannual cash dividend of $0.09 per share, which is payable on January 18. This represents our 77th consecutive semiannual cash dividend, and is a 13% increase over the prior semiannual amount of $0.08 per share. By declaring and raising the semiannual cash dividend, our Board of Directors' goal is to confirm its continued confidence in HEICO's consistent growth strategies, and continue to reward shareholders, while retaining sufficient capital to fund our internal growth objectives and acquisition strategies.

In addition, given the strength in HEICO's share price, and the Company's history of stock splits and dividends, the Board of Directors intends to consider a stock split or a stock dividend at its next regular meeting, which will be held on March 17, 2017. I remind you that historically we have declared 14 stock splits or stock dividends since 1995.

Now I would 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. Eric?

Thank you. The Flight Support Group's net sales increased 5% to a record $228.5 million in the fourth quarter of FY16, up from $218.3 million in the fourth quarter of FY15. The Flight Support Group's net sales increased 8% to a record $875.9 million in the FY16, up from $809.7 million in FY15. The increase in fourth quarter and FY16 reflects net sales contributed by our FY15 acquisitions, as well as organic growth of 4% and 3%, respectively.

The organic growth in the fourth quarter and FY16 is principally attributed to increased demand and new product offerings within our aftermarket replacement parts and specialty products product lines. The aforementioned increases were partially offset by lower organic net sales from our repair and overhaul parts and services product line, principally resulting from the mix of products repaired, which required less extensive repair and overhaul services, as well as softer demand from our South American market. The Flight Support Group experienced organic revenue growth of 6% in both the fourth quarter and FY16, excluding our repair and overhaul parts and services product line.

The Flight Support Group's operating income increased 6% to a record $44.7 million in the fourth quarter of FY16, up from $42.3 million in the fourth quarter of FY15. The increase principally reflects the previously mentioned net sales growth.

The Flight Support Group's operating income increased 9% to a record $163.4 million in FY16, up from $149.8 million in FY15. The increase principally reflects the previously mentioned net sales growth, and a profit margin impact mainly from favorable net sales volumes and product mix within our aftermarket replacement parts and specialty products product lines. These increases were partially offset by higher performance-based compensation expense, changes in the estimated fair value of accrued contingent consideration associated with a prior-year acquisition, and an increase in amortization expense of intangible assets.

The Flight Support Group's operating margin increased to 19.6% in the fourth quarter of FY16, up from 19.4% in the fourth quarter of FY15. The increased principally reflects a decrease in certain selling, general, and administrative expenses as a percentage of net sales, partially offset by a gross profit margin impact, mainly from the previously mentioned decrease in net sales within our repair and overhaul services product line.

The Flight Support Group's operating margin improved to 18.7% in FY16, up from 18.5% in FY15. The increase principally reflects the previously mentioned gross profit margin impact, partially offset by higher performance-based compensation expense, changes in the estimated fair value of accrued contingent consideration associated with a prior-year acquisition, and an increase in amortization expense of intangible assets.

With respect to FY17, we are estimating mid-single-digit growth in the Flight Support Group's net sales over FY16 levels and the full-year Flight Support Group operating margin to approximate 19% to 19.5%. These estimates exclude additional acquired businesses, if any. 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 22% to a record $138.3 million in the fourth quarter of FY16, up from $113.5 million in the fourth quarter of FY15. The Electronic Technologies Group's net sales increased 31% to a record $511.3 million in FY16, up from $391 million in FY15. The increase in the fourth quarter and FY16 is principally attributed to the net sales contributed by our FY16 and FY15 acquisitions.

Further, the increase in net sales in FY16 reflects organic growth of 4%, mainly resulting from higher net sales of certain space and medical products. Additionally, our fourth quarter of FY16 results were moderated by a decrease in customer demand for certain defense products.

The Electronic Technologies Group's operating income increased 12% to a record $36.8 million in the fourth quarter of FY16, up from $32.8 million in the fourth quarter of FY15. The increase principally reflects the previously mentioned net sales growth, partially offset by a gross margin impact, mainly driven by a less favorable product mix for certain of our space products and an increase in amortization expense of intangible assets.

The Electronic Technologies Group's operating income increased 28% to a record $126 million in FY16, up from $98.8 million in FY15. The increase principally reflects the previously mentioned net sales growth, partially offset by an increase in amortization expense of intangibles.

The Electronic Technologies Group's operating margin was 26.6% and 28.9% in the fourth-quarter FY16 and FY15, respectively. The decrease principally reflects the previously mentioned decrease in gross profit margin and the increase in intangible assets amortization expense.

The Electronic Technologies Group's operating margin was 24.7% and 25.3% in FY16 and FY15, respectively. The decrease principally reflects the previously mentioned increase in amortization expense for intangible assets.

With respect to FY17, we are estimating mid- to high-single-digit growth in the Electronic Technologies Group net sales over FY16 levels, and the full-year Electronic Technologies Group's operating margin to approximate 24%. These estimates exclude additional acquisitions, if any. I'll turn the call back over to Larry Mendelson. Thank you.

Thank you, Victor. Moving on now to some of the details, talk about diluted earnings per share. Consolidated net income per diluted share increased 16% to $0.65 in the fourth quarter of FY16. That was up from $0.56 in the fourth quarter FY15, and increased by 16% to $2.29 in the FY16, and again, that was up from $1.97 in FY15.

As I have mentioned before, one-time non-recurring acquisition costs of $3.1 million were incurred in the first quarter in connection with a FY16 acquisition. These costs reduced our consolidated net income per diluted share by $0.03 in FY16. Of course, if you add it back, it would've been $3.32.

Depreciation and amortization expense totaled $15.7 million and $12.8 million in the fourth quarters of FY16 and FY15, respectively, and totaled $60.3 million and $47.9 million in FY16 and FY15. The increase in fourth quarter and FY16 principally reflects the incremental impact of higher amortization expense of intangible assets attributable to FY16 and FY15 acquisitions.

R&D expense increased 22% to $12.1 million in the fourth quarter of FY16, and that was up from $9.9 million in the fourth-quarter FY15, and increased 15% to $44.7 million in FY16 for the full year, and that was up from $38.7 million in FY15. As you can imagine, significant ongoing new product development efforts are continuing at both Flight Support and Electronic Technologies as we continue to invest approximately 3% to 4% of each sales dollar into new product development.

SG&A expenses totaled $59.6 million in the fourth quarter of FY16, and that was up from $57.8 million fourth quarter of FY15. That increase mainly reflects the impact from our FY16 and FY15 acquisitions, partially offset by changes in foreign currency transaction adjustments, principally from borrowings in euros under our revolving credit facility.

SG&A expense as a percent of net sales were 16.4% and 17.6% in the fourth quarter of FY16 and FY15, respectively. The decrease principally reflects the efficiencies and favorable leverage on SG&A expenses attributable to FY16 and FY15 acquisitions, and in addition the previously mentioned change in foreign currency transaction adjustments.

SG&A expenses were $250.1 million and $204.5 million in FY16 and FY15, respectively. The increase principally reflects the impact from FY16 and FY15 acquisitions, inclusive of previously mentioned acquisition costs associated with a FY16 acquisition -- that was the $0.03 per share that I mentioned earlier -- higher performance-based compensation expense, change in estimated fair value of accrued contingent consideration, and changes in foreign currency transaction adjustments on borrowings denominated in euros under our revolving credit facility.

SG&A expenses as a percentage of net sales were 18.2% and 17.2% in FY16 and FY15, respectively. The increase principally reflecting higher performance-based compensation, the previously mentioned change in estimated fair value of accrued contingent consideration, foreign currency transaction adjustments, and acquisition costs associated with FY16 acquisition.

Interest expense increased to $2.1 million in the fourth quarter of FY16, and that was up from $1.3 million in the fourth quarter of FY15, and increased to $8.3 million in FY16, up from $4.6 million in FY15. And that increase in the fourth quarter and FY16 was due to a higher weighted average balance under our revolving credit facility associated with the FY16 and FY15 acquisitions, as well as slightly higher interest rates. Other expense in the fourth quarter and FY16 was not significant, so, no comment.

Taxes: Our effective tax rate in the fourth quarter of FY16 decreased to 32.9% from 34.5% in the fourth quarter of FY15. That decrease principally reflects the lower effective state tax rate driven by certain apportionment updates recognized upon the amendment of certain prior-year tax returns in FY16.

Our effective tax rate in FY16 decreased to 31.5% from 31.7% in FY15, the decrease, again, principally reflecting larger income tax credit for qualified R&D activities, and lower effective state tax driven by certain apportionment updates in FY16. The decreases were partially offset by 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 which are structured as partnerships.

Net income attributable to non-controlling interest was $5.3 million in the fourth quarter of FY16 and $20 million for the full FY16, and that's comparable to the $5.8 million and $20.2 million reported in the fourth quarter and FY15, respectively. For full FY17, we do estimate a combined effective tax rate and non-controlling interest rate of between 39% and 40% of pre-tax income.

Now moving on to the balance sheet and cash flow, our financial position and cash flow remain very strong. As previously discussed, cash flow provided by operating activities was extremely strong, and increased 44% to a record $249.2 million in FY16. That represents 160% of net income as compared to the $172.9 million in FY15. Our working capital ratio -- of course, current assets divided by current liabilities -- is strong at 2.7 times as of October 31, 2016, and this compared to 3 times as of October 31, 2015.

DSOs, days sales outstanding, of receivable was 51 days as of October 31, 2016, same as October 31, 2015. Of course, we continue to monitor very carefully all receivable collection efforts to limit our credit exposure. Traditionally, HEICO has very, very little accounts receivable write-offs.

No one customer accounted for more than 10% of sales. Top five customers represented approximately 21% and 17% of consolidated sales in FY16 and FY15. As a comment, the Robertson acquisition, Robertson is principally a US government defense-related business, and that increased the customer exposure to the US government. Of course, it's a pretty good credit.

As expected, our inventory turn-over rate increased, principally due to the impact of a January 2016 acquisition. And that went to 122 days for the period ending October 31, 2016, up a little bit from 118 days from the period October 31, 2015. If you exclude the impact of the acquisition, the inventory turn-over rate was 120 days in FY16 and pretty comparable to the 118 days in the year before.

Our net-debt-to-shareholders'-equity ratio was 39.6% as of October 31, 2016, with net debt of $415.3 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 to accelerate growth and maximize shareholder returns. The EBITDA-to-debt ratio was 1.28, I mentioned that earlier, as of October 31, a very, very low ratio for a Company that does as many acquisitions as we do.

And I want to answer in advance questions which I expect will come, that the acquisition pipeline is very, very full. As a matter of fact, it's hard to keep up with it.

Prices a little bit higher, but certainly nothing that will really -- the pricing is nothing that's really preclude us from doing acquisitions. It is the due diligence and great in-depth detail of due diligence that we do that really makes the difference.

And at this point, I can't project which acquisitions, if any, we will make. But I can assure you that we are working on a very, very large number.

Looking forward to FY17, we do anticipate net sales growth within Flight Support's commercial aviation and defense product lines. We expect growth within ETG, principally driven by demand for the majority of our products. During FY17, we will continue our commitments to developing new products and services -- this is, of course, critical to our strategy -- and further market penetration and aggressive acquisition strategy. And we will continue to maintain financial strength and flexibility. And we avoid getting over-leverage, as you all know. But we still will be able to grow because of our enormous cash flow strength.

Based on current economic visibility, we are estimating 5% to 7% growth in the full-year net sales, and a 7% to 10% growth in full-year net income over FY16 levels. In addition, we anticipate FY17 consolidated operating margin to approximate 19% to 20%; depreciation/amortization of approximately $63 million; CapEx approximately $38 million; and cash flow from operations approximately $255 million. These estimates exclude additional acquired businesses, if any.

Some analysts have written that our projected guidance for 2017 is slightly below our guidance for 2016. That is true. And I just want to remind you that, as another analyst wrote, since 2005 HEICO has underpromised and overdelivered, so some of the analysts tend to get a little bit ahead of us in their estimates. We like to come out of the box in December with the annual guidance on the conservative side. We do not want to overpromise and underperform. So we are a little bit conservative.

And it's based on a bottoms-up budget that we get from all of the team members and the subsidiaries. And we give our guidance based upon that. Historically, these people are very conservative. They don't want to get ahead of the curve. They don't want senior management coming in and saying: Why didn't you make your budget? So they tend to shoot low. And we understand that.

But we don't want to push them. We accept their budgets. And as the year progresses, we get more color and visibility on their operations. And historically we have moved our estimates and guidance up.

I don't want to predict we're going to do the same thing this year. I hope we will, and truthfully I think we will, but there is no assurance that will happen, but we certainly are going to try to do it.

One other thing I'd like to mention, you all are aware of the new administration coming in, in January, and their focus on reducing the corporate income tax rate, and perhaps individual, too. But as it impacts HEICO, if they should reduce it from 35%, of course, we pay about 31%, and if they reduce it to 15%, the impact on HEICO, you can do the calculations yourself, but would be very, very significant and would add a big number to cash flow and would also add a big number to earnings per share.

I don't want to jump ahead of the analysts who might want to make those calculations, and I guess the SEC says I shouldn't do it either. But you can do it yourself. And I don't know if there will be a reduction in taxes, but we've got our fingers crossed, and it would be very, very healthy for HEICO's earnings per share and also HEICO's cash flow -- big, big effect.

In closing, I would like to thank HEICO team members. We are very proud to lead one of the hardest working and most successful teams in our history. This team consistently surpasses our targets, as I mentioned before, and milestones without compromising transparency, values, and trust. It is through their dedication and efforts that we have achieved our significant 26-year compound annual growth rate of 16% in net sales, 18% in net income, and 22% in stock price.

That is the extent of my prepared comments, and I would like to open the floor for any questions which might be asked. Thank you.

(Operator Instructions)

Robert Spingarn, Credit Suisse.

Good morning.

Good morning Rob.

Nice quarter. Nice end of the year. So with that, I want to talk about next year a little bit.

And first on the top line, the 5% to 7% target, I guess I ask you this question all the time and if you mentioned it earlier I apologize. But what's the organic component there within that 5% to 7% sales growth for 2017? And then I wanted to ask Victor and Eric about their respective margin targets for 2017.

It looks like FSG is going up a little bit, but Victor your target, is that a little conservative? Is that -- how should we think about that?

Okay. So the first question I'm going to give to our CFO, Carlos Macau.

If I could remember it. Rob, on the FSG, we are expecting mid-single digits. That, by definition, is 5%. That is what we are looking for as organic growth in that division.

We have no acquisitions that roll. So at the moment that's what our team members, when they are doing their budgets, are rolling everything up to us at, at present time.

On the ETG, we are expecting mid- to high-single digit growth in that division. Half of that is going to be organic after we burn off some of the effect of some of the acquisitions in 2015 and 2016.

Okay. Yes, that's what I was looking for. The next question was on margins.

Eric will talk about margins for FSG.

FSG margins are anticipated between 19% and 19.5%, which is an increase from this past year. I think that it's important to point out that when we prepare the budget, obviously the budgets are prepared starting in the middle of the summer, finishing up late summer. And typically we have a very good fourth quarter that later comes.

But the focus is on earnings. And yes, they have to project revenue, and that's obviously important in the calculation. But the thing that everybody is measured on is earnings. So I think that typically that's one of the reasons we why out-perform in revenue a little bit.

But also with regard to earnings, I think our people are very much focused on eliminating, if you will, lower margin sales and trading them in for higher margin sales. So I think that we could have, if the focus at HEICO were revenue and not earnings, we probably could have much higher revenue growth. But since it's earnings growth, the -- that's why the margins are going up and why the operating income we anticipate will increase at a faster clip than the revenue growth.

So Eric, before we go over to Victor. With the higher margin focus driving earnings, how do we think about that qualitatively in terms of the product-mix shift?

I think more aftermarket parts, less lower margin activities, just more spare parts being sold. We do anticipate a recovery in the repair and overhaul product line, so that will help a little bit. But it's primarily just a greater focus on parts that save our customers a lot of money.

We've got a lot of very good parts in the hopper right now, a lot of parts that our customers are committed to purchasing as soon as we deliver them. Our new product development output was very strong this year, as it's been roughly the last five years. And we're pretty optimistic on good sales growth and penetration of those products.

Just quickly, Eric, on the new product generation, is there a way to quantify what you got through in 2016 versus 2015 in terms of new parts?

It's hard to quantify because it depends what you look at. I can tell you in terms of numbers of approvals, it is similar to -- I think a little bit ahead of where we have been in the past, but the value of those parts is very strong.

The commitment from the customers is very strong. I think our reputation and credibility out there in the industry is very strong. So for that reason we're pretty optimistic on it.

Okay. Great color. Thanks.

Thank you, Rob.

Rob, this is Victor. So in answer to your question. The margin for ETG, of course the GAAP margin for ETG of about 24%, the 24% that we are forecasting for next year, of course is after intangibles amortization. Which is about 400 basis points which puts what I consider the true margin when you look at the business and their trading margin, what they are doing, it's about 28%, somewhere in that range, which to us is pretty high and is very good.

So it's hard for me to beat down on business is if they are 50 basis points lower on average or something like that, or maybe even a little more year over year. They tend to be conservative in their budgeting, but I wouldn't plan that they are being conservative. It really is what we believe is going to happen.

And that predominantly is a result, I would say, of product mix, not necessarily at a high level. For example, not necessarily saying we're going to have more defense product then space product, or more commercial aviation then defense or space or something like that. It's just when you drill down in the individual line items and the estimated shipments what they think they're going to do over the course of FY17, it winds up at around what I consider 28% true margin, or 24% when you look at it in our financial statement.

Okay.

Does that help?

Yes, So it's really the intangibles and it's acquisition driven.

That's a big part of it.

That hurts the GAAP margin. To Victor's point, I don't know if you could hear me, Rob. To Victor's point, it doesn't hurt the cash margin.

But as you know, we had some good acquisition, good-sized acquisitions last year in ETG. And of course we're buying businesses that are not capital intensive. So really all we are paying for is intellectual capital and a lot of IP, a lot of things that have to amortize off the books.

So it does put a bit of a damper on the GAAP margin. As you recall last year we came out of the box also. We estimated 24% for the ETG margin. They did about 24.7% this year, which is great; we're very proud of that.

We hope to do better. But at the moment, as Victor said, when you look at the backlog and when you think about it very tactically and you look back over history, that 24% margin is a good barometer. And that's one for us to beat.

Okay.

Rob, this is Larry. I mentioned earlier, and you know about this, our focus is really cash flow. So if you add the amortization, which truthfully to me doesn't make a whole heck of a lot of sense because these companies are growing and they are telling us to write off customer lists and all this kind of stuff as though it were decreasing in value when in fact it's increasing in value. But we have to follow GAAP.

But the key margin to us as operators of the Company is the pre-amortization margin. We understand depreciation, but amortization of these intangibles, it provides cash. So our actual, if you add it back, if you add the amortization back, what is our -- so in ETG we are between 28% and 30% and in Flight Support we are probably in the low 20%s, 22%.

And to us, that is really the key because that's where the money comes from to generate R&D, to generate expansion, acquisition and so forth. We key on that, and I think you know that.

Great. Thank you all for the help.

Thanks Rob.

Larry Solow, CJS Securities.

Great, thanks. Good morning guys, and thanks for the color you have provided so far. It's very enlightening.

I was wondering if you could just help us a little bit, just give us your read on the aftermarket. It seems obviously from your performance quite steady.

Perhaps you could just help us, you guys generally outperform the market. Has there been any trend different divergence in the market, any -- with the price of oils coming up a little bit, but still sort of hanging pretty low and other variables out there, anything noteworthy?

Larry, this is Eric. Thank you for your question. With regard to our growth rate, the organic growth rate in the fourth quarter for FSG was 4%. However, if you exclude the repair and overhaul businesses it was 6%, and I think that 6% is outperforming the market.

We feel confident of our ability to outperform the market. There has been a fair amount of new product delivered in the recent past which hasn't needed maintenance. And I think that's in general had an impact on the industry.

It's important to note, though, that our organic growth is primarily volume related and it's not price related. This is not coming because we don't gouge our customers, we don't jack up prices. We have very mild, very nominal price increases and we treat our customers extremely well.

So it's really volume related. And I think if you look at just the pure volume, we're way outperforming our competitors because most of our competitors increases has been coming from pricing.

And that's probably a difficult thing to sustain in the long term. And we feel that our focus on keeping costs low, generating value, I think will permit us to continue to outperform the industry.

Okay. Any thoughts on the aftermarket in 2017? Do you see a similar market that you have seen the last few quarters, a little firming up, I guess?

It looks like there is a little bit of firming, I would say similar to firming. We certainly don't see deterioration.

I met with our heads of our various sales regions last week to review some of the details. And they all tell me that our customers are not holding much inventory. Some customers are holding very, very little inventory.

So I would not anticipate, certainly with our products, a destocking. If anything, I think they're going to have to buy more products. So I would say consistent to where it is, firming, improving a little bit.

And have the inventories change at all, or they've been pretty low for quite some time now, right?

I'd say they've been low since the financial crisis. But they continue to remain low. They continue to remain low, and to the point where there's not much excess supply in the chain.

Got it. And perhaps a question for Victor. Independent of what might happen under Trump, and I think you mentioned some of the defense contracts were pushed a little bit to the right. I think you mentioned that on last quarterly call, and it looks like organic growth in ETG has been flat the last couple of quarters. Any thoughts on that, and do you see some of those contracts moving forward? And then maybe you got a little bonus under the new President?

A couple things. That's a good question, Larry. With respect to the lumpiness of the quarters, it's something we have had historically. If you go back and look at 10 years, 15 years you will see the same thing, and I would expect past to be prelude in that regard, and that will continue to be the case.

I think some of the things that were, if you call it delayed, have shaken loose, if you will, more recently, which is kind of what we expect. We expect things to delay from time to time and then accelerate and so forth. I wouldn't say there's anything extraordinary in the mix. I think it's going to be fairly typical that way.

In terms of the new administration, right now we're operating under a continuing resolution, although a plussed-up one, as an aside. It's kind of an odd continuing resolution, but it's a positive, I think, net positive for the industry. We all know what the President-elect has said about buying more defense goods. We will see what he does in terms of pressuring the industry and other things, like we've seen some of the headlines later.

I don't want to get out ahead of ourselves and make predictions at this point. I do think it's a net positive, and I think everybody in industry is very excited about it. We all have to be careful not to get too excited and keep in mind that these things don't happen overnight.

The new administration takes office on, what is it, January 20, and it will take some time for these things to get reflected, orders to be made and things to be built and shipped. I wouldn't be looking for anything out of it until somewhere toward later in calendar 2017, maybe in our fiscal year, maybe not. That is where I would start to feel. So to me, I think the effects are felt in a big way a little further out.

Got it.

That is just my view, and you find different people with different views in the industry, for sure.

Absolutely. I think better to err on the side of conservatism, and if it happens, great.

And just lastly, and believe me, not to split hairs. I think your cash flow generation in 2016 was phenomenal. Any reason why the year-over-year increase is pretty muted?

Is there any working capital issue or anything there, or is it just it was a great year last year and perhaps you match and modestly even beat that. But the growth is not quite as high as maybe I would thought with 10% net income growth?

Larry, this is Carlos. I was very pleased, frankly, with our cash flow from operations. In fact that put a big smile on Larry's face, because every morning that's the first call I get is how is our cash situation, do we have more than yesterday, and et cetera?

But I think from a cash flow generation, the increased net income helped. I think our working capital management was phenomenal.

We did have a little bit of a benefit in the fourth quarter with some deposits coming in for customers for work to be performed in the first half of 2017. We had increased some of our current liabilities, which obviously is a source of cash.

So if your real question is, was there a surprise there? I wouldn't call that a surprise. I would call that something that is very unpredictable.

Particularly in the ETG group when we get those contracts and we do get those upfront fundings to begin the work and do the research and development, it's very hard to predict. So that was the one part of working capital.

I'm always pleased to get the cash ahead of time to start the work. That contributed to it.

160% to cash flow from operations, [again a] certain income number tells me that the quality of earnings are very strong. And I couldn't be happier, and I feel very fortunate to be the CFO of a Company generating this kind of cash flow.

Absolutely. Couldn't agree more. Okay, great. Thanks guys, appreciate it.

Thank you, Larry.

Sheila Kahyaoglu, Jefferies.

Hi. Good morning, team. Thank you for taking my question.

Good morning, Sheila.

Maybe one for Victor, if that's okay. I thought Robertson trended a little lightly versus my expectations (technical difficulties). Can you talk about it trended in general?

Yes.

Go ahead. I am sorry, Sheila, I didn't mean to cut you off.

No, it's okay. Just a quick follow up with regards to that. I think the organic growth was about -- was really good in the first half, was about flattish in the second half. So the mid- to high-single digits is forecasting a reacceleration. And so what's driving that, if it's not the defense budget?

Okay. So the first question, how is Robertson doing? It is doing pretty much exactly as we expected and we forecasted when we bought it. So we're very happy with the business, with the operation.

Now, this will be the first year that they will operate for the full, pretty much the full year under the budget they have submitted to us for the year going forward. And we're pretty happy with what they have submitted.

I think they are probably, in their own internal forecasting, they are cautious as we are. But I'm going to rely on those numbers and see how that goes as the year pans out. But with respect to the company overall, so far so good.

And we are very pleased, especially with the team there. We think we've got a great team which has done some really terrific things.

With respect to organic growth, just a reminder. One of the things that we exclude over the course of the year is the growth of the companies that we acquired over the period before we owned them, and so we don't -- our organic growth numbers don't pick that kind of thing up. So just keep that in mind, generally we are buying growing businesses and we in fact have an internal discussion, debate about it, whether we should -- because to me that's really organic growth. We may see organic growth out of businesses that we acquire.

In terms of where we expect things to grow, it's pretty much across the board. As I said earlier in my comments to Rob Spingarn's question, we really go through business by business and then in turn they go product by product. And so we are expecting from the vast majority of the ETG businesses to see growth, some more than others, over the prior year. Some will go backward over the prior year, which is always the case. So it's kind of evenly spread out amongst the businesses for the forecast for 2017 and across the business lines.

By the way, Sheila, I believe, Victor you can correct me if I'm wrong. I believe that a number of other companies that make acquisitions reflect the organic growth in a different way, which shows up much higher than what we do. Am I correct, Victor?

Yes, that's right. There are different ways of counting. A number of companies include it.

So we err on the conservative side, but other companies show organic growth from prior to the day they acquired it. So it's a little bit different. Carlos can comment a little more.

Hi Sheila, It's Carlos. I will just make a quick comment on that. To what the guys mentioned, we do a straight organic growth calculation. We exclude inorganic growth and call it acquired.

There's all kinds of different ways to skin a cat. That is how HEICO chooses to do it. I will tell you this. Since you asked about the ETG, both acquisitions that were done in the ETG grew nicely under our leadership, particularly under Victor's leadership in the ETG.

And we were pleased when we modeled those acquisitions out and looked at them, they performed as Victor said, as expected, maybe even slightly ahead of what we expected. And so we're very proud of that. Our acquired growth in the ETG, roughly 85% to 87% of the total growth of the segment when you look on a year-over-year comparison basis. Does that answer your question?

Yes. Thank you. And then I just one for Eric. In terms of aftermarket, you sort of alluded to more spare parts [versus] maybe overhaul and repair activity. Is there any distinction between the two of them in terms of a CRD check might be more spare parts, or any sort of color you can provide there?

I think, Sheila, what I was referring to was this past year we had more aftermarket part sales because that business was up whereas the repair and overhaul was down just a little bit. And we are anticipating next year a recovery in the overhaul and repair business, but continued good growth over in the spare parts area.

With regard to the ultimate application of the parts, most of our -- we say well over half of our business is non-engine parts. So it's both component as well as airframe. And the component parts are not heavily dependent on the heavy checks. So I don't anticipate tremendous correlation there.

We do sell some airframe parts, thrust reverser and various other structural parts as well. And some of those may have more of a heavy check component. But I think our business is pretty well diversified so we are not focused in any one area.

Okay, thanks. And then just a clarification question as well on FSG margin. What was the -- was there a total earn-out associated with the five deals that were done for 2016? And is there anything for 2017 that we should be thinking about?

I will let Carlos answer that.

If you recall, when we acquired Aeroworks in the Netherlands January 2015, as part of that deal we had an earn-out with our partner over there. And that earn-out was basically a four-year earn-out, four tranches, if you would, based upon him or the company hitting certain operation metrics. So it's a good and a bad thing.

When you hear us say that we are increasing our contingent earn-out, that means that the business subsidiary performed much greater than our expectations, okay? Now, at the moment in time that we have to make that adjustment to increase that liability, yes, it hits our P&L, it's an unfortunate thing in some regards.

But the story behind that adjustment is that the subsidiary itself performed much more profitably and much more better than what we expected. So that's the only earn-out we have in the FSG right now.

Okay. The level is similar year over year since it's a four-year earn-out, or does it decline over time?

We do a probability weighted analysis. If the client, his payments are made and if we have to adjust it based on probable outcomes, we do so. And that's where the adjustments come from.

Okay. Thanks. Thank you.

You're welcome.

(Operator Instructions)

Eduardo Finkler, FK Capital Management.

Hello, good morning.

Good morning.

Can you please provide an update on how the license agreement negotiated with Northrop Grumman Corporation is doing, and if you have any similar deals with other OEMs in the pipeline?

Hi, Eduardo. This is Eric. I will answer the question. We have to be careful about giving specific information with regard to specific product lines, customers, partners for obvious competitive reasons.

But I can tell you that in general it is going very well. We have become their license source for the repair and overhaul of certain inertial navigation units and inertial reference unit systems, and we've got a very good relationship with them.

We are always in constant discussion with various manufacturers about ways that we can continue to support them and support our joint customers in the marketplace. So I can tell you we do have various conversations ongoing. But unfortunately I am not able to provide any more detailed information than that.

Okay. Thank you very much.

Thank you.

Jim Foung, Gabelli & Company.

Hi. Good morning, guys. Good quarter.

Good morning, Jim.

I just wonder if you could talk a little bit about your acquisition pipeline. You seem pretty positive about more acquisitions going forward in 2017. And with the emphasis that it's been pretty busy. So maybe you could give us a little bit of a idea the range and size and type of acquisitions you are looking at?

Jim, we are, as I mentioned, we're looking at a large number of acquisitions. Some of them are quite large for us, Everything is relative, but for us they would be large acquisition. We're looking --

You mean like the Robertson type acquisition?

I would say that there are some like the Robertson type acquisition. There are some which are smaller than the Robertson.

But all following the same guidelines, being accretive, being a reasonable multiple that we are used to paying, having good forward opportunity. But I always caution people, and there are many of them. I caution people that although there are many in the pipeline, and that normally results in a number of good acquisitions, you never know with an acquisition if it's going to close until it closes, or at the closing table and we wire the money and so forth.

So I feel optimistic about the number we will get but I don't want to promise. And of course we never build into our projections and our guidance acquisitions that we might make, because I really don't know.

Some of these things are very fluid and we go in and they give us a book and they tell us what they are doing and the financials, and you go in there and you discover that is not exactly the way it was, or sometimes the guy in the middle of the deal raises the price. All kinds of things happen where the deal doesn't happen.

Again, I am optimistic because the more in the pipeline, the more likely I believe that we will find some that close. They are not all going to close.

But I think we're seeing there is enough opportunity for me to be very optimistic. But to make a promise or to build those expectations into our guidance, we never do that.

The Robertson acquisition was a little more towards the defense market. And I was just curious, are you looking more with defense companies, try to increase that exposure as the macros for the defense spending increase looks more positive?

Well, Jim, the way we look at acquisitions and the way we look at our business is, number one, I told you we are focused on cash flow. And so there are lots of opportunities within industry for us to acquire companies that are either defense-related or non-defense-related.

So some of the companies we are looking at our defense-related, others are not defense-related. But the key is always the bottom line, the cash flow, the opportunity, the accretion and so forth. So -- and we are an opportunistic buyer.

We don't go out and say, we want to acquire X dollars of defense business. We look at all these businesses and whichever meets our bottom-line needs, and meaning by that earnings per share and cash flow, we really don't have a focus.

In my personal opinion, it might be a good time to acquire defense assets because of what we've been told about the Trump, the new administration, is looking to build the military and so forth. So clearly when we do the due diligence we would review their projections and expectations with a positive bias as to it probably is going to get better as opposed to saying, under the Obama administration it's probably going to get worse. So we would have that positive bias.

But in either case we're not going to make an acquisition until we are very confident that we're going to get a minimum result and we're going to get the bang for the buck in the accretion and the cash flow, even if things don't go soaring up in space, that all of a sudden this company doubles its sales and all that. Every acquisition we look at, they predict this hockey stick projection, next year we're going to do 20%, all this kind of stuff.

We ignore it and we basically buy based upon past history. So in the area of defense specifically to answer your question, there would be a positive bias looking forward. But we're not going to pay today for what he thinks a seller is going to do in two years from now.

Jim, this is Victor. I'll just add to that. We tend to be cautious about what we buy and when we buy it. So we were buying defense in the sequester because we thought that various factors, the business we were buying were the right businesses we were paying the right prices, it was the right point in the cycle of earnings and so on. So we take that into our account.

We tend to go where other people aren't going, And that's what we will look for as well in continuing defense. We're probably -- you're not going to find us following the herd, just for a short-term period.

That puts you in a very good position for growth as you look forward with these defense companies that you acquired during the downturn.

That's absolutely -- by the way, we put that bias into our acquisition this year when we saw the two acquisitions, MMS and Robertson, that was early in the year. We said that defense probably would be a good thing because whoever won, Trump or Hillary, both of them had indicated an increase in the defense budget over the Obama Administration.

So we had a positive bias and more confidence in making those defense acquisitions than we would've had at the beginning of the Obama Administration where his philosophy was completely opposite. So -- and I think that served us well.

And we made those acquisitions, and we will continue to try to find assets that meet -- again, to us it's the bottom line cash flow. I said earlier, HEICO is a cash flow -- it's a vehicle to generate strong cash flow. And then after that, earnings per share. And that's just what we do.

If we don't think it's going to be strong cash flow, we're not interested. And it could be defense or it could be widgets or it could be anything within those two spheres, Aerospace and Electronic Technologies.

And of course all the other things have to fit in. We have to have great managements, we have to have consistency and honest people, hard-working smart people, all those things go into the formula.

We've been very successful, as you know. We've done 62 acquisitions and we have never had a bust. We have some do better, we have some do a little worse. But we've never had a disaster scenario as, oh my God, this thing blew up on us and so forth.

And we are very picky. We do a lot of due diligence, and we reject a lot of things that we see.

I guess the last question is, would you consider buying something outside your traditional areas, like in energy where the assets are going still very cheap?

The answer is, we would consider it. It has to meet all of the items; number one, cash flow; number two, management; three, earnings per share; fourth, with cash flow is basically low CapEx, and so forth. And then we'd have to study the industry.

I have said many times that we buy an ice cream cone company if it had all those benefits and [hike]. And the problem is that most companies don't have that. And you know as a very successful analyst that if you go down the aerospace group, you will see how many companies operate at 4% operating margin. Some operate at 7% and 9%.

We wouldn't get up in the morning for that. We wouldn't even think about going into a business just to keep busy and do that. So that's why we're all in; we're somewheres around 19%, 20% and Electronic Technologies is closer to 30% and Flight Support is 22% without amortization.

So it would have to have all the elements, that business have all the elements. The other thing is, the energy business is something we don't know. And we, to go into something that we really don't know and understand where it can be extremely cyclical, it's probably not likely, I would say.

I don't want to preclude any kind of business. But we like stable businesses, we like slow -- we are very happy if a acquisition grows at 5% a year, 7% a year. And the reason is that our strategy is to use the tremendous cash flow to acquire other business.

You can grow a business by investing in increasing your market or you can grow a company by making acquisitions with the cash flow that comes out of that business. And to us, if we grow cash flow and bottom line, that's what we're here for, that's what were trying to accomplish.

And so if we buy a very strong company that grows slowly, that's great. I'm very, very happy. If we can get the returns that we get and the cash flow, strong cash flow. Remember, if it's strong cash flow by the second or third year, our investment has been paid back, a big chunk of the investment is back and we have much less, and on a going-forward basis the price that we paid to EBIT drops considerably.

If you have a company that has very low cash flow, your investment stays the same, you never get your money back. So this is very important to us, to see the return cash flow return that we get.

Right, that's great. Thank you

Jim, I was just going to add, this is Victor. I was going to add to that. With respect to energy specifically, we look at our different product lines that we have in our businesses. And we have some businesses that are aerospace or electronics or defense that also sell into the energy markets.

It's not a huge part of what we do, it's pretty small. It's not the focus. But when you get into some of the harsh environment or the high reliability environments, they have the same characteristics for down-hole drilling, deep drilling they do in space background, but maybe for heat instead of coal. Anyway, so we do look at that and we do included in what we (technical difficulties).

Great. Thank you so much for all the color and the details.

Thanks, Jim.

Thank you.

George Godfrey, CL King.

Good morning, gentlemen.

Good morning, George.

Larry, I share your passion with free cash flow. And I just want to ask two questions. First, a housekeeping question. I wasn't -- ETG organic revenue growth, 4% for the year. Was that the same in quarter as well?

Carlos will respond to that.

No, the ETG organic growth in the fourth quarter was down a tick.

Down a tick, okay.

Yes, it was just down a tick. And that was principally some movements, as Victor mentioned early, and some vacillation of defense. Again, we don't give quarterly guidance, George, for that reason because, particularly in the ETG, we do have that up-and-down trend of orders coming in and fulfillment back and forth.

Got it. And then the free cash flow question. If I look at CapEx, in 2015 it was $18 million and then here in 2017 you're guiding to $38 million. So about a $20 million increase, or on a incremental basis about 7% of the incremental net revenue.

Can you at somewhat granular level, can you tell me where that $20 million in incremental CapEx is going as a percentage of revenue it's going up from 1.5% to 2.5%. I just want to get an idea of what's the incremental spending on.

I can give you -- the best granular level to keep it simple is roughly half to 60%-some, low 60% was expansion, expanding some of our existing locations for growth. And the rest was normal course of business replacement type stuff.

Okay. Business expansion, Carlos, in both FSG and ETG?

Both segments, correct.

Okay.

And to be honest with you, George, we get a capital budget every year from our guys. And it's got several cuts. There is a wish list, there is a like to have, and then there is a must have. And so we have to make a judgment as to what to put out there.

This year we are shooting for $38 million. Do I think they will spend that money? Probably not.

But right now that would be their wish list, and we will see what happens. Historically I think we have under spent our capital budgets quite a bit. But in reference to your specific question, the majority, 60%-some was expansion, which is a good spend of capital. And the rest of it was replacement over that time period.

Understood. Thank you very much.

Thanks, George.

There are no further questions at this time. I will turn the call back over to the presenters for closing remarks.

Thank you all very much for your interest in HEICO. We all remain available to you by phone or email if you have additional questions. Also we wish you, HEICO and its Board and top management wishes everybody on the call a very happy holiday and wonderful new year with health and good fortune.

And we look forward to speaking to you, I guess the next call will be the first quarter of FY17, which will be around mid to late February. So again, thank you all. And we are signing off.

This concludes today's conference call. You may now disconnect.