HEICO Corp (HEI) 2017 Q2 法說會逐字稿

Good morning. My name is Kristen, and I will be your conference operator today. At this time, I would like to welcome everyone to the HEICO Corporation Fiscal Year 2017 Second Quarter Earnings Results Conference Call. (Operator Instructions)

Certain statements made on this call will constitute forward-looking statements, which are subject to risk, 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; 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 U.S. and/or foreign customers 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 cost and delay sales; our ability to make acquisitions and achieve operating synergies from acquired businesses; customer credit risk; interest and income tax rate and economic conditions within and outside the aviation, defense, space, medical, telecommunications and electronics industries, which could negatively impact our costs and revenue; 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 statements, whether as a result of new information, future events or otherwise, except to the extent required by applicable law.

I would now like to turn the call over to Laurans Mendelson. Thank you. You may begin.

Well, thank you very much, and good morning to everyone on the call. We thank you for joining us and we welcome you to the HEICO Second Quarter Fiscal '17 Earnings Announcement Telecon. 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; and Carlos Macau, our Executive Vice President and CFO.

Before reviewing our record second quarter operating results in detail, I would like to take a few minutes to summarize the quarterly highlights.

Consolidated second quarter and first 6 months of fiscal '17 net income, operating income and net sales represent record results for HEICO, driven principally by record net sales and operating income within both operating segments.

Consolidated net income increased 18% to a record $45.7 million or $0.53 per diluted share in the second quarter of fiscal '17, and that was up from $38.7 million or $0.45 per diluted share in the second quarter of fiscal '16. Consolidated net income increased 24% to a record $86.6 million or $1 per diluted share in the first 6 months of fiscal '17. And again, that was up from $69.9 million or $0.82 per diluted share in the first 6 months of fiscal '16.

Our net debt, which is total debt less cash and cash equivalents, so net debt-to-EBITDA ratio, was a low 1.2x as of April 30, and that compared to 1.8x shortly after the acquisition of Robertson Fuel Systems in January 2016. Robertson, of course, was our largest acquisition in HEICO history.

So I continue to be very pleased with HEICO's laser focus on strong cash flow generation as well as the consistency of our growth in net income.

The Flight Support Group set an all-time quarterly net sales and operating income record in the second quarter of fiscal '17 by improving 5% and 8%, respectively, over the second quarter of fiscal '16. Those increases principally reflect increased demand within the Flight Support Group aftermarket replacement parts and repair and overhaul parts and services product lines as well as the benefit of operating efficiencies.

Our ETG group set an all-time quarterly net sales and operating income record in the second quarter of fiscal '17 by improving 6% and 16%, respectively, over the second quarter of fiscal '16. The increases principally reflect period-over-period net sales growth across the majority of ETG's product offerings as well as the benefit of some operating efficiencies.

Cash flow provided by operating activities remained strong, totaling $97.7 million or about 113% of net income for the first 6 months of fiscal '17. Keep in mind that we are projecting that for the full fiscal year '17, we expect cash flow provided by operating activities to approximate 150% of reported net income.

As of April 30, '17, the company's total debt-to-shareholder equity ratio was 40.5%. In addition, our net debt-to-shareholders' equity ratio was 37.3% as of April 30, '17, with net debt, again, total debt less cash and cash equivalents, total debt -- net debt of $424.1 million, and that was principally incurred to fund acquisitions in fiscal '17 and '16.

In April '17, our Flight Support Group acquired 80.1% of the equity interest in Air Cost Control, a leading aviation electrical interconnect product distributor of such items as connectors, wire, cable, protection and fastening systems, in addition to distributing a wide range of electromechanical parts. We expect the acquisition to be accretive to our earnings within the current fiscal year.

In April '17, we increased the aggregate principal amount of our revolving credit facilities by $200 million or 25%, reaching a total of $1 billion, and that was through increased commitments from existing lenders. We are very pleased to have such strong support and confidence from our lenders. And our HEICO's financial strength, coupled with our expanded funding capacity, should allow us to continue to execute our strategic acquisition strategies and our goals.

In March 17, 2017, we declared a 5-for-4 stock split, which reflects the Board of Directors' continued confidence in the strategic trajectory and growth of the business. The additional shares were distributed in April 2017. All applicable share and per-share information has been retroactively adjusted to reflect for this 5-for-4 stock split. And for your interest, this marks HEICO's 15th stock dividend or stock split since 1995.

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 5% to a record $231.8 million in the second quarter of fiscal '17, up from $220.3 million in the second quarter of fiscal '16, and increased 7% a record $452.7 million in the first 6 months of fiscal '17, up from $424.9 million in the first 6 months of fiscal '16.

The increase in the second quarter and first 6 months of fiscal '17 mainly reflects organic growth of 5% and 6%, respectively. The organic growth in the second quarter and first 6 months of fiscal '17 is principally attributed to increased demand and new product offerings within our aftermarket replacement parts and repair and overhaul parts and services product line, partially offset by lower sales within our specialty products product line.

The Flight Support Group's operating income increased 8% to a record $44.7 million in the second quarter of fiscal '17, up from $41.3 million in the second quarter of fiscal '16, and increased 12% to a record $86.1 million in the first 6 months of fiscal '17, up from $76.8 million in the first 6 months of fiscal '16. The increase in the second quarter and first 6 months of fiscal '17 is mainly attributed to the previously mentioned net sales growth and efficiencies realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expenses.

The Flight Support Group's operating margin increased to 19.3% in the second quarter of fiscal '17, up from 18.8% in the second quarter of fiscal '16, and increased 19% in the first 6 months of fiscal '17, up from 18.1% in the first 6 months of fiscal '16. The increase in the second quarter and first 6 months of fiscal '17 principally reflects the previously mentioned net sales growth and efficiencies realized within SG&A expenses.

With remain -- with respect to the remainder of fiscal '17, we now estimate mid- to high single-digit growth in the Flight Support Group's net sales over fiscal '16 levels, and the full year Flight Support Group operating margin to approximate 19.0% to 19.5%. We continue to estimate mid-single-digit organic growth in full fiscal '17 net sales over fiscal '16 levels. These estimates include our recent acquisition of Air Cost Control but exclude additional acquired businesses, if any.

Lastly, I'd like to acknowledge our team, which we consider to be the best in the industry, for being recognized as the top 2016-2017 supplier by ALTA's airlines. ALTA is the Latin American and Caribbean Air Transport Association and represents the airlines in that region. HEICO was ranked #1 out of over 200 suppliers evaluated. This recognition is presented industry suppliers that have demonstrated their dedication to the highest standards in categories such as customer support and documentation, turnaround times and quality service.

And I can tell you that this does not come by accident. Our team works extremely hard to make sure they satisfy our customers and keep them happy. And I'd like to acknowledge our team and thank them for their outstanding service.

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. As I start the review of the ETG businesses, I would like to thank and recognize the ETG team members who made our excellent results possible, not only this quarter, but over a long period of time, and have continued to endeavor mightily for us and for our customers and for each other every day. The results we achieved aren't the result of blueprints or equipment or buildings. They come from hard-working, dedicated team members who show up every day and do everything they can for our company. So I thank you all for your hard work.

In sales, the Electronic Technologies Group's net sales increased 6% to a record $141.2 million in the second quarter of fiscal '17, up from $132.6 million in the second quarter of fiscal '16, and increased 13% to a record $267.3 million in the first 6 months of fiscal '17, up from $236.7 million in the first 6 months of fiscal '16. The increase in the second quarter and first 6 months of fiscal '17 reflects organic growth of 5% and 6%, respectively.

The organic growth in the second quarter and first 6 months of fiscal '17 resulted from increased demand in certain aerospace, other electronics and medical products. Additionally, the increase in the first 6 months of fiscal '17 reflects the contribution from our profitable fiscal '16 acquisition.

The Electronic Technologies Group's operating income increased 16% to a record $38.8 million in the second quarter of fiscal '17, up from $33.4 million in the second quarter of fiscal '16, and increased 22% to a record $67.9 million in the first 6 months of fiscal '17, up from $55.7 million in the first 6 months of fiscal '16.

The increase in the second quarter and first 6 months of fiscal '17 came primarily from the previously mentioned net sales growth and efficiency realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expenses. Further, the increase in the first 6 months of fiscal '17 reflects a decrease in acquisition costs due to the first quarter of fiscal '16 reflecting $3.1 million in acquisition costs associated with prior year acquisition, partially offset by higher performance-based compensation expense.

The Electronic Technology Group's operating margin improved to 27.5% in the second quarter of fiscal '17, up from 25.2% in the second quarter of fiscal '16, and improved to 25.4% in the first 6 months of fiscal '17, up from 23.5% in the first 6 months of fiscal '16. The increase in the second quarter and first 6 months of fiscal '17 principally reflects the previously mentioned net sales growth and efficiencies realized within SG&A expenses.

With respect to the remainder of fiscal '17, we are continuing to estimate mid- to high single-digit growth in the Electronic Technologies Group's net sales over fiscal '16 levels, principally reflecting organic growth, and anticipate the full year Electronic Technologies Group's operating margin to approximate 25%. Of course, these estimates exclude additional acquired businesses, if any.

I turn the conversation back over to Larry Mendelson. Thank you.

Thank you, Victor. Looking at diluted earnings per share. Consolidated net income per diluted share increased 18% to $0.53 in the second quarter of fiscal '17, and that was up from $0.45 in the second quarter of fiscal '16. And it increased 22% to $1 in the first 6 months of fiscal '17, again, up from $0.82 in the first 6 months of fiscal '16. All fiscal '16 diluted EPS amounts have been adjusted retrospectively for the 5-for-4 stock split, which was distributed April 7, 2017.

Looking at R&D. The expense increased 2% to $11.2 million in the second quarter of fiscal '17, and that was up from $11 million in the second quarter of fiscal '16. It was an increase of 12% to $22.5 million in the first 6 months of fiscal '17, again, up from $20 million in the first 6 months of fiscal '16.

Significant ongoing new product development efforts are continuing at both Flight Support and ETG as we continue to invest approximately 3% to 4% of each sales dollar into new product development. As we've told you many times, this is a basic driver of HEICO. We constantly spend money on research and development to develop new products and improve the existing products that we sell. And that's a basic strategy that we will never give up.

SG&A expense decreased to $63.8 million in the second quarter of fiscal '17. That was down from $67.2 million in the second quarter of fiscal '16, and decreased to $124.7 million in the first 6 months of fiscal '17, down from $126.8 million in the first 6 months of fiscal '16. The decrease in the second quarter of fiscal '17 principally reflects a $1.5 million impact from foreign currency transaction adjustments on borrowings denominated in euros under our revolving credit facility and a $1.2 million impact from changes in the estimated fair value of accrued contingent consideration associated with prior year acquisitions.

The decrease in the first 6 months of fiscal '17 principally reflects $3.1 million of acquisition cost recorded in the first 6 months of fiscal '16 associated with the fiscal '16 acquisition and a $1.6 million impact from foreign currency transaction adjustments on borrowings denominated in euros under our revolving credit facility and partially offset by a $2.8 million increase in performance-based compensation expense.

Consolidated SG&A expenses as a percentage of net sales decreased to 17.3% in the second quarter of fiscal '17, and that was down significantly from the 19.2% in the second quarter of fiscal '16, and decreased to 17.5% in the first 6 months of fiscal '17, down again significantly from 19.3% in the first 6 months of fiscal '16.

That decrease in consolidated SG&A expense as a percentage of net sales in the second quarter of fiscal '17 principally reflects efficiencies realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expense as well as the impact from the previously mentioned foreign currency transaction adjustments and changes in the estimated fair value of accrued contingent consideration.

The decrease in SG&A expense as a percentage of net sales in the first 6 months of fiscal '17 principally reflects efficiencies realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expenses as well as the impact from the previously mentioned decrease in acquisition cost.

Interest expense was $2 million in the second quarter of fiscal '17 and that compared to $2.3 million in the second quarter of fiscal '16, and it was about $3.9 million in both the first 6 months of fiscal '17 and '16. Other income was insignificant and I won't comment on it.

Income taxes. Our effective tax rate in the second quarter of fiscal '17 decreased to 32% from 32.8% in the second quarter of fiscal '16, and that decrease principally reflects the favorable impact of higher tax-exempt unrealized gains in the cash surrender value of life insurance policies related to the HEICO Corporation leadership compensation plan.

Our effective tax rate in the first 6 months of fiscal '17 decreased to 29.5% from 31.1% in the first 6 months of fiscal '16. The decrease principally reflects a discrete income tax benefit related to stock option exercises resulting from the adoption of the new accounting standard on share-based payment transactions in the first quarter '17 and the favorable impact of higher tax-exempt unrealized gains in cash surrender value of life insurance policies, again, related to the HEICO Corporation leadership compensation plan.

The decreases were partially offset by the benefit recognized in the first quarter of fiscal '16 from the retroactive and permanent extension of the U.S. federal R&D tax credit, and that resulted in recognition of additional income tax credit for qualified R&D activities related to the last 10 months of fiscal '15.

Net income attributable to noncontrolling interest was $5.1 million in both the second quarter of fiscal '17 and '16, and $10.5 million in the first 6 months of fiscal '17 compared to $9.7 million in the first 6 months of fiscal '16.

For the full year -- fiscal year 2017, we continue to estimate a combined effective tax rate and noncontrolling interest rate of between 39% and 40% of pretax income, and that assumes that the U.S. corporate tax reform does not become effective during this fiscal year.

Now moving on to the balance sheet and cash flow. Our financial position and our forecasted cash flow remain extremely strong. As we previously discussed, cash flow provided by operating activities totaled $97.7 million in the first 6 months of fiscal '17, representing 113% of net income. And for the full fiscal year '17, we anticipate cash flow provided by operating activities to approximate 150% of net income.

And later on, if the people on the call want to ask Carlos for the details of why it was only 113% as opposed to 150%, it was because there were some payments that were -- that came in the first 6 months and will not repeat in the second. And we expect our cash flow, again, to be 150% of net income and very strong.

The working capital ratio improved to 3x as of April 30, '17. That was up from 2.7x as of October 31, '16. DSOs, days sales outstanding of receivables, increased to 52 days as of April 30, '17, and that was up from 46 days a year prior, April 30, '16. That was due to the quarter-end acquisition of Air Cost Control and the timing of receivable collections. Excluding the impact of this acquisition on DSOs, the DSOs would've been 49 days as of April 30, '17. We closely monitor receivable collection efforts to limit credit exposure. We have very little receivable write-off losses and we've never had big ones.

No one customer accounted for more than 10% of net sales. The top 5 customers represent approximately 19% and 21% of consolidated net sales in the second quarter of fiscal '17 and '16, respectively.

Our inventory turnover rate increased to 133 days for the period ended April 30, '17, as compared to 125 days for the period April 30, '16, and that was due to the quarter-end acquisition, again, of Air Cost Control. And if we exclude the impact of this acquisition, the inventory turnover rate actually decreased to 123 days versus 125 for the first 6 months of fiscal '17.

As previously mentioned, our total debt-to-shareholders' equity was 40.5% as of April 30, '17, and our net debt-to-shareholder equity was 37.3% on April 30, '17, with net debt, again, debt less cash and cash equivalents, of $424.1 million. And that was principally incurred to fund acquisitions in fiscal '16 and '17. We have no significant debt maturities until fiscal '19, and we plan to utilize our financial flexibility and strength to aggressively pursue high-quality acquisition opportunities to accelerate growth and maximize shareholder returns.

I know I'm going to be asked this question in a few minutes, so the pipeline for acquisition is very strong. We can hardly keep up with it, but we do such a thorough due diligence process that it really takes us a lot of time. And we try to turn over all the stones and do an extremely thorough, complete job. But we have a very, very full acquisition pipeline, and all priced within our normal guidelines for acquisition.

As we look ahead, the outlook for the remainder of fiscal '17, we do anticipate net sales growth in the Flight Support Group and ETG resulting from increased demand across the majority of our product lines. During the remainder of fiscal '17, we'll continue our commitments to developing new products and services, market penetration, aggressive acquisition strategy while maintaining financial strength and flexibility.

Based on our current economic visibility, we are increasing our estimated consolidated fiscal '17 year-over-year growth in net sales to 8% to 10% and in net income to 12% to 14%, and both of those are up from prior growth estimates in net sales of 6% to 8% and net income of 9% to 11%.

In addition, we now anticipate our consolidated operating margin to approximate 20%; depreciation and amortization expense to approximate $65 million; CapEx expenditures, about $35 million; cash flow from operations to approximate $270 million, and that's up from the previous estimate of $260 million in cash flow from operations. Of course, these estimates include our recent acquisition of Air Cost Control but exclude additional acquired businesses, if any.

In closing, I'd like to thank all of HEICO's team members for another outstanding quarter of excellence in execution and financial results. It's because of their dedication and hard work that we're able to deliver consistent high performance for our shareholders. And as always, we'll continue to focus on intermediate and long-term growth strategy with an emphasis on acquiring profitable businesses.

And just one personal comment. What doesn't appear in 10-Ks, 10-Qs, financial statements and presentation is the incredible capability of our team members. These are the people that make these results possible. These are the people that strive for growth. Of course, we incentivize them with what we believe our great incentive plans, but these are exceptionally talented people, and we are very pleased and proud to be working with them because these are the ones that produce the results.

So thank you all. Those are -- that's the extent of our prepared comments and the floor is open for questions.

(Operator Instructions) Our first question comes from George Godfrey from CLK.

Just wanted to ask 2 questions. The first one, organic growth this quarter, 5%, and mid-single digits for the full year, very solid but a little bit of a downtick from Q1. Can you just comment on what you're seeing on the organic growth trends going from 8% in Q1 down to 5% here in Q2?

You're speaking about the FSG segment?

Yes, if memory serves, they were both 8% organic growth last quarter, but I could be wrong on that.

I can tell you that if you look at the comps, the comp got tougher in the second, third, fourth quarters of 2016. So I would say that that's probably the biggest reason why the -- why it was the lower number. I mean, we still feel very good about the industry. There's still a lot of potential, a lot of opportunity, new products being discussed with our customers being contracted. So I think we're -- we believe that we're outgrowing the industry and we continue to do very well. But we did have an uptick in the organic sales in the final 9 months of 2016, which I think is driving that.

Got it. And then just a follow-up, the operating margin, specifically in Electronic Technologies Group, 27 -- I mean, that's just outstanding. Is that a high watermark? Or is there even an opportunity to continue to march that up? And then as a follow-on, is Robertson a material driver of that profitability there?

George, this is Victor. It's a very good question. Look, it's always our objective to see margins improve, but I wouldn't plan that in. I wouldn't model that in. I think the guidance that we gave you is the right place to look. Sometimes, we have great quarters in margin, other times, it's not as good. I don't know if it's a high watermark. I honestly don't remember, it towards the higher end, and there are a lot of factors that can contribute to it. If you remember, over time and you listened to our conference calls over the years and attended some conferences over the years, you've heard me say that we manage the business and we have our companies manage their business to the year and not so much to the quarters, that we're very focused on maximizing profitability and margins. And that just means we have lumpiness in the quarters over the course of the year and we really try to get people to look to the full year. So we're -- if we do better, that's great. But we don't encourage people to look for more than our guidance on that. In terms of Robertson, Robertson is a contributor to the margins. It is not the sole contributor to the margins. It's a very important business for us, but truthfully, the other businesses are very important, too, and pretty healthy. I would say overall, the company, the ETG across the board had a strong, strong quarter.

Our next question comes from Larry Solow with CJS.

To those questions, Eric, on the FSG side, I know you mentioned -- and you've continually mentioned a lot of the growth has been driven, your growth, at least, by new product offerings. How about just the underlying growth in the aftermarket? Is that basically -- or lack thereof. Is it still basically essentially nearly flat? What's your feel? Are you seeing that improve at all? Obviously, excluding the easier year-over-year comp.

That's a good question, Larry. Since we don't get very much price, maybe we get 1% a year, most of our growth -- I mean basically, all of our growth, the 5%, was due to unit volume growth. And I think that unit volume growth of 5% is far in excess of what the industry is seeing, number one. So I think that we're building up a tremendous amount of good will. There's been a lot of new aircraft delivered over the last couple of years and are in that sort of 0 to 5-year range where they don't need much maintenance or they don't need any maintenance. And I think that that's having -- that's holding down the industry aftermarket growth. And -- but I think our numbers are really quite good when you look at basically 5% organic growth. Also, it's important to point out, and it was referenced in there, that our specialty products business saw a little bit the weakness this quarter, and that probably trimmed off about 2 points of growth from the FSG segment. So when you look at it, I mean, the organic unit growth was even higher. And we feel very strongly about the new products, the customer relationships. You can see with the recognition by ALTA. And I think that while that's just one region of the world, I think that typifies how our customers view us. And I think we're setting up very good in a very good way for a nice upcycle as some of these newer -- some of the newer equipment needs maintenance because the OE prices on this newer equipment, I mean, some of it is just crazy. And yes, of course, we've got to develop the parts, we've got to get them approved at the airlines. We have to get them sold, et cetera. But I feel very strongly that our strategy of maintaining, basically, very low price increases and building a lot of customer good will is putting us in a very positive position with our customers.

Okay, great. And then maybe a question for Victor. Just I know in terms of new defense budget, (inaudible) that's going to -- it's still -- it's several quarters, if not a year or plus away. But I know on the last call, you had mentioned -- maybe in the last couple of calls, you guys have seen a little bit less reluctance to spend sort of budgeted dollars. Is that trend still -- anything shaking out on that side of things?

At this point, I think we should be careful to predict where things are going with the budget. It was sort of flattish for us in defense in the quarter, down slightly, but to me, within the noise level. I still think that we should look for the net benefit next year, not this year. And I don't think we've seen things shake out palpably, except I have noticed, and I think I mentioned this on the last call, we have noticed in our businesses, there is less reticence to spend and to commit dollars, where in the past, in the prior administration, there were, I'll call them, quasi-obstructionist efforts geared at finding ways to not spend the allocated money and thereby let it get redirected to something else. And we're not seeing that or not seeing it as much. And the usual amount of confusion in the defense budget that exists over the years and decades is always there for us in terms of spending, and why isn't this contract coming through? Or that contract, why is it delayed? And they have the agencies and departments have their own internal issues. And generally speaking, I think we all saw what was published yesterday on the budget proposal, and that's only a proposal at this point, as we all know. Our general view is it's a net positive going forward but not to really expect it in a material way this year. And of course, as that gets delayed -- if it gets delayed, then that would delay the benefit to us.

Got it. And just last question, if I may. Just on the Air Cost Control, it looks like, just from your cash flow statement, you guys spent about $80 million on that. And it sounds like it's in your usual acquisition criteria, immediately accretive. Is it fair to say that the impact from that or the effect from that is most of the reason behind the increase in guidance for the year?

I think -- Larry, this is Carlos. Some of it is related to that. The increase in guidance went from mid-single digits to mid- to upper single digits. Some of that was Air Cost Control. Some of that is higher expectation with some of our operating units. So it was a combination of both.

Our next question comes from Louis Raffetto with Deutsche Bank.

I'm going to stick with ETG. Just you mentioned this, the second quarter in a row, I guess, of good aerospace. Is that just linked to sort of higher overall production rates? Or is there anything else there?

No. Louis, this is Victor. It's -- some of it is aftermarket, some of it's production. I'd probably say maybe a little more aftermarket than production improvement, but it's a nice mix (inaudible).

Right. And then just, sorry, sanity check my numbers here. I think the -- you called out 6% growth in ETG -- or yes, 6% growth, but only organic was 5%. I thought we were sort of at a clean year-over-year now. But -- so I wasn't sure what that discrepancy was.

Louis, this is Carlos. I think the 5% was the quarter, 6% was the 6-month period. So that should help.

Okay, all right. And then just last one on the cash flow. I guess it was just a bit below what I expected. But obviously, you've raised the guidance. Was there -- and I think Larry may have touched on this a bit, I may have missed it. Anything timing in the first half versus second half? Or in the second quarter, I guess?

No, I think -- Louis, I think generally speaking, if you look back on history of HEICO and our cash generated by operations, traditionally, and I mean and it could change, but traditionally, the first half of the year from a cash flow generation standpoint is generally a little less than the latter half. And so that's part of it. I would say as it relates specifically to this fiscal year, there wasn't anything unusual. Most of it was timing related. We do have some -- we had a little bit of an inventory build, which, if you look across all our subsidiaries, is directed tied to backlog or orders in-house. We had some timing on some accrueds that were paid out. Some of that was performance-based comp related, which was a little higher as a result of '16 operations versus the prior '15 operations, which would have been accrued in that cash flow statement. So I wouldn't say there's any trend or any unusual items, and that it was principally based on timing.

No purchase consideration or meaningful in the quarter, I guess? I know that you plan to do $7 million, I think, this year.

No -- the $7 million, Louis? I'm sorry.

The purchase consideration, I guess. I thought -- I think there's $7 million that was going to be paid out this year.

Oh, we've already paid that out. That doesn't come out of operations. That's operating cash flow, that's below that.

Our next question comes from Kenneth Hubert (sic) [Herbert] with Canaccord.

I wanted to first ask a question for Eric. Just bigger picture, Eric, when you look at your conversations with your airline customers, fuel prices seem to have settled in here. As you look at your argument regarding delivery of aircraft, currently, we're starting to see a slowdown in deliveries of, certainly, wide-body aircraft. Have you seen any change? Or can you comment on any change you've seen from your airline customers, maybe in their desire to spend on some of the older aircraft, with a maybe more benign fuel environment and maybe a little bit more predictability on the cost from that standpoint as you look through the rest of either your fiscal '17 or calendar '17?

Yes, it's a good question, Ken. We've seen some increase in spending on some of the older equipment. I think one of the -- also one of the tougher comps that you've pointed out in some of your reports is that last year, there was a big PW4000 overhaul, a program, and a lot of money that needed to be spent to do some service bulletins. So I think that the last year's numbers, in hindsight, were probably helped by that, which is making the comps a little bit tougher. But yes, we are seeing some increase in spending on the older equipment. As you point out, the build rate coming down on some of the wide-body equipment. And we don't have that factored into our numbers right now because we don't know, really, what the future is going to bring on that. But clearly, with wide-body build rates being down and fuel being down, I mean, that should bode well for extending some of the time on some of the older equipment. But again, we don't have that baked into our projections at this point.

Okay, that's helpful. And now that you've completed the A2C acquisition, and obviously, you've been able to build a very nice distribution business within FSG, how do you think about organic growth maybe for specifically A2C or maybe distribution at large within the segment? Not just in '17 but over the next few years?

Yes, I'm very positive in that area. Actually, a week after -- roughly a week after the MRO show, I went and visited A2C in Hamburg and Toulouse. And while I have been there in the past, I can tell you that as I got to know the people better and we got into some of the details, I was really super impressed by the company's DNA, the people, the processes, the culture. And we are immediately finding opportunities for our distribution companies to work together. There really is no product overlap. So we don't have the situation where we have multiple subsidiaries trying to sell the same product. It truly is complementary. And the relationships that our existing distribution business has with Seal Dynamics and with the new distribution business with Air Cost Control, or A2C, I think it's extremely complementary. And the people are, on both -- in both businesses are very excited to help open doors for the others. And I got, I would say, some significant expectations for great opportunities down the road. We met with some of the larger customers and A2C is really viewed in an extremely unique light due to their business model, their customer attentiveness. I mean, this is a company that 17 years ago, didn't even exist. And it started with 1 person and then 2 people in a little office. And they learned how to, again, as the other HEICO businesses do, listen to their customers, understand what they want, proactively deliver high-quality product, find alternatives at a lower price. And in meeting with some of A2C's customers, A2C's growth was not by accident. I mean, it was by targeting these opportunities and making sure that the customers were very happy. So I do see a great opportunity and synergy with the -- with our distribution business. And then, of course, with distribution and PMA, I mean, there's the synergy that we've spoken about for a while. And I would say I'm very bullish on it.

If I could, just one final question for Victor. Just a follow-up again on the margins in the quarter, very impressive. And I just want to make sure I heard you correctly. Really no sort of onetime items you'd specifically point to, either from a mix standpoint or timing, just good performance? Or is there anything in particular you would highlight as maybe something that doesn't repeat within the segment moving forward?

Yes, overall, I wouldn't call out anything notable. I think there were elements of everything in the quarter, right? We -- the mix was favorable to us. The -- I think the cost control, if you will, the attention to cost detail, the opportunities that we were able to execute on were good. I think we always have a business here or there where something pulls forward a quarter or slips a quarter, and maybe we had a little bit better in that regard. But I don't think anything outside of the noise level that we typically see on that. So overall, I would say it was just kind of all the factors, each adding up incrementally, delivered it for us. And Carlos has something to add.

Yes. And I just want to add, Victor's point is absolutely correct. We had the scenario this quarter in ETG where really all of our subs and industry participants are firing on all cylinders. Occasionally, that happens. And we had a similar situation in Q4 last year, where we sort of had broad growth across all of the subsidiaries. And when that happens, and given the fact that most of the folks running these business units are very entrepreneurial, and to Victor's point, cost-conscious, we get some nice leverage on our SG&A spend, and we get some nice product mix and growth. And so I wouldn't over-read that. To Victor's point, we plan for diversification, we plan for ups and downs within the segment by subsidiary. And so the guidance we've given of 25% on the year, we hope to do better, but that's kind of how we see things on a go-forward basis based on backlog and what we can see at this point.

Our next question comes from Rob Spingarn with Crédit Suisse.

I missed the beginning of your call because I was on another one, so I'm not sure whether or not you talked about this or not. But Eric, this one's for you. Have you talked at all incrementally about your opportunity on OEM parts, second sourcing or whether it's military or commercial, any opportunities there?

No, we haven't covered that yet on the call. I mean, we continue to think -- and that's a very good question. We continue to think that there is opportunity as the air framers want to bring down the cost of operation of their equipment, that there is opportunity for HEICO in that. And I think that that's an area for growth and opportunity for us as time goes on. I mean...

Sorry, Eric, well, I was going to ask you from a process perspective, how might a cooperative effort to develop second-source parts differ from a traditional PMA process for an aftermarket part?

Well, I need to be a little careful on this call because we of course have a number of competitors listening in and we love them. Unfortunately, I can't go into the details on that. But suffice it to say that the air framers and some of the larger OEMs don't necessarily have the same interest as some of the smaller OEMs. And where you got situations when airlines are complaining to manufacturers about the cost to maintain their equipment, there may be opportunity for some of those larger OEMs to put some pressure to reduce those costs. And I think that that's really where HEICO would fit in.

Okay. Excellent. Victor, I wanted to ask you about margin. That just got asked. And so it sounds like we've just, both you and Carlos, had expected just a range of outcomes as we go, it just really depends on a mix of what's flowing through in the quarter. Did I get that right?

I think you got that exactly right. And again, with the emphasis on expect what -- more of what we are telling you for the year, that 25% number, not the margins higher. And if we do better, great. The objective is great, is higher, of course, but let's keep where we are. And by the way, even 25% is not guaranteed. None of this is easy. And we work very hard, but I can't be certain of where the margins will be either.

Right, right. Well, I guess as a follow-up to that and somewhat related, maybe Carlos, this is for you. But as a percentage of sales, and again, this might have come up earlier, SG&A looked pretty (inaudible) couple of quarters. How are you expecting that to trend for the rest of the year? Is this a sustainable level, under 18% of sales? Or how should we think about that?

I think that we've been blessed by the way that all our subsidiaries are entrepreneurial in nature, they're very cost-conscious. We have no corporate initiative on cost cutting. These guys drive their businesses. And what we've seen over the last couple of quarters is some leverage on that SG&A spend. And I would anticipate -- barring any onetimers or anything like that, I would anticipate to continue to catch some of that leverage on SG&A spend, which is really a contributor, frankly, to our move up, if you would, on the consolidated margin to approximately 20% from a range of 19% to 20%.

Right. I guess when I look at it, this makes 2017 look a little more like '15 in terms of SG&A performance, where '16 was relatively a little higher.

Yes, you have to remember in '16, it was littered with -- we had a onetime charge of about $3.1 million for an acquisition, and then we had some FX impacts during '16 that we haven't experienced this year. So if you look back historically in '15, even maybe '14 and prior, our SG&A expense, 17.5% to 18% or so is kind of in the range. And as we grow the business, the top line, at a greater rate than that sort of range-bound SG&A expense, we are catching leverage. I'm quite proud of the guys for that.

Larry, sorry I didn't have one for you.

That's fine. They answered them better than I could.

(Operator Instructions) Our next question comes from Drew Lipke with Stephens.

Just for Eric. You pointed out the good will with customers. And I'm curious, if you think about maybe aircraft coming off warranty, maybe that kind of aging of the fleet there, have you seen any kind of change in demand from your customers for replacement parts? Kind of meaning, have you hit a tipping point where the demand has turned from more of a push to a pull?

Well, if you take a look at our -- the organic growth, the FSG organic growth was about 5%, and of course, that was held down by a couple of points due to some slippage in the specialty products area. So if you look at it, we're probably looking at roughly 6% unit growth. And I think a lot of that is demand being, if you will, pulled by the customers. We don't really differentiate it when we do the sales reviews. We don't really differentiate it between sort of what we're pushing and what the customers are pulling. It's, I think, a group effort. The good will is palpable, and I think that, that is really having -- or permitting us to find more opportunities with the airlines and, I think, setting up for a very good increase in sales as some of this newer equipment matures and is going to need maintenance, and the price points are higher on the newer equipment. So I think there's general recognition by the customers that we're a very important part of their approach. In reviewing specific customers with our sales leadership, I can tell you that there is, really at a high level at the airlines, a desire to increase the amount of competitive procurement, and HEICO is really at the forefront of that. And I've heard a number of examples whereby, perhaps 10 years ago, some of the finance folks were more likely to sign, if you will, power-by-the-hour packages from the OEMs because of ease of -- ease. But now as those packages wear on in duration and the airlines see that they've got basically no operating leverage, and HEICO has developed this reputation of not taking advantage of the customers when we can take advantage of the customers, we've now seen a number of airlines tilt towards the competitive procurement side where they don't want to go with power by the hour. They don't want to go with the OEM because it ties their hands. So to your point in terms of pull-through, I think that that's an example of -- and we've seen this in a number of cases. That's an example where the airlines are really putting us in position to be able to further increase our unit volumes and supply more parts. I mean, I've heard examples. There are some OEMs out there that have raised prices 10%, 11% per year for the last number of years. And we've been -- clearly, we could have done the same, and we didn't, and they recognize that. And that's why HEICO, I believe, has built this good will and why ALTA and others hold us in very high regard, because our people do the right thing when nobody's looking. And we do that because we're very small, we're tiny compared to the industry, and we're here for the long haul. And we want to be able to position ourselves and supply more parts and services. And we think that our shareholders are going to be better rewarded by taking the long view. And that's also -- frankly, it fits in very well with our people because we want people who want to be here and we want team members who want to be here for the long haul and want to be with a company that is moving in the right direction, is in the forefront of serving its customers. So I think it really sets HEICO up very well for this pull-through that you're referencing. And I anticipate we're going to see a lot more of that over the next couple of years.

Yes, that absolutely makes sense. And then your ability to increase your annual parts approval from kind of 500 to maybe something greater if we start to see that greater pull-through, what are the gating factors there?

From a regulatory process, we're very confident that we can get them approved. We've got a great relationship and a great rapport and confidence from our regulators, so I feel very comfortable about that. It would require, obviously, increasing the engineering effort a little bit, also increasing the manufacturing effort. But we've got plenty of capacity. So I feel very, very confident. I mean, we've been careful. It's a little bit of a chicken-and-egg thing because if we come out with too many products, then the OEMs get very concerned and start cutting very good deals. So we need to be very careful. We know with whom we can develop products and we know that they're really going to buy them and they're not just going to use us a stalking horse. So we, again, want to be very careful on how we do this. But I feel very confident that as this new equipment burns in that we are going to be increasing -- be -- we will be able to increase our product offerings and our new product approval process commensurate with the increase in demand. I don't view that as a limiting factor whatsoever.

Okay, and last one for me, pooling has been referenced as a headwind for the industry. And if you also think about just the greater use of open-source IT platforms for the supply chain and greater use of e-commerce solutions, is there a silver lining for you guys and that allows you to highlight your lower price position and provide more transparent pricing for you to capture more share?

Yes. I mean, in general, as I think as information becomes more readily accessible, it definitely provides an opportunity for us. It also permits our competitors to see more quickly what we're doing, and obviously, that's not helpful to us. But we -- clearly with the airlines, we're able to point out the areas of savings, the areas of opportunity. There have been many newspaper, or many media reports on the increases coming on, particularly the cost of engine parts. There have been a number of articles and independent reports that have come out, particularly on the CFM56 and the CF6, showing price increases over a 10-year period roughly in the 8% per year area. And airlines see that. They're not happy about it. And I think that there's continued opportunity throughout the industry.

Our next question comes from Jim Foung from Gabelli & Company.

I want to just ask about the specialty products. I guess you said sales growth was a little disappointing. Maybe just talk a little bit about what happened there. And do you see a catch-up in the second half of sales in that unit?

So Jim, in the specialty products area, there's a higher proportion of -- basically that's where all of our industrial business is, and that's where some of our defense business is. And there were 2 areas. One, I would say I think the second quarter probably saw the bottom of the industrial market. We're starting to see a tick-up now. I don't want to get ahead of myself because we're only less than a month into our third quarter, but I think we are seeing a tick-up in the industrial side. So I'm fairly confident that we've bottomed in that area. And then with regard to defense, this can be a lumpy business because these are fairly large contracts. And sometimes, there are breaks in production because the government is working with a foreign military sales order and one country can finish taking delivery of its product and then maybe there's a break until the next country sort of gets in line. So that's fairly common in the defense area. So we've seen that, that was the other source of weakness. The other thing which we really need to take a look at is on the commercial aviation side. There's been a shift in some of the production from wide-body to narrow-body, and I think that that's having an impact, a little bit of an impact on us. And it's probably going to hit other suppliers as well because some of the wide-body production was requiring some additional products, and that, if you will, has ticked down. Whereas the narrow-body doesn't need as much of that on the OE side. So -- but it's also important to point out, I don't want to overstate the industrial side for us because it's only about 4% of FSG, so it's not a very big part. But that's why I'm sort of confident that we've hit the bottom there.

Okay, but that could kind of be a potential upside. As you work through the second half, maybe there will be some catch-up from the weaker first half then.

Yes, I think there could be. And of course, we need to see what happens with the wide-body and the narrow-body production rate. But yes, I do think that there's a lot of catch-up opportunity for the second half and frankly 2018 in a big way.

And then just on the industrial -- I mean, on the defense area, maybe Victor can chime in on this. Typically, there's kind of a year-end budget spending to make sure they get all the money spent so that they can request more money with the upcoming budget. And do you typically get kind of a year-end surge in buying, the October fiscal year with the budget ending? And I'm just wondering, are you expecting that this year, particularly if they're talking about an increase in the budget -- in the fiscal 2018 budget?

Jim, this is Victor. There is no reliable pattern or discernible pattern in that. There have been times in the past where it would happen in November that we would get a bump because the government would essentially have spent their money and sort of run out of money. So there are times when we actually see the inverse, where things get quiet in the back end of the year, get a little bit quieter in the back end of the year, and because they've just run out of money to spend. And then all of a sudden, it comes flying through in November. And we've seen the opposite effect, where money has been clogged up for allocation reasons earlier in the year and it comes out later on in the year. So it's really difficult to say. We're not counting on any surge, if you will, in our defense revenue in the back half of the year. And if that happens, that's great. I guess that, that would be upside. But we're not counting on any of that right now.

Yes, I was thinking if they're talking about an increase in the defense budget, everyone wants to make sure they get their last dollar spent.

Right.

Yes. All right. But it either comes in October or November, you should see a little bit of it then in that case.

Yes, I mean, that's -- I think that's the more reliable sort of pattern. But there's no -- again, there's no great, discernible pattern as far as we're concerned that we notice on our business. Now maybe other people notice different things, but in terms of what we've noticed in our business over the years, it -- essentially, government spending can lock up and unleash at any time during the year. And we plan kind of according to the orders that we have and level-loading our shops. And if more comes, that's great. But we're not going to, in all likelihood, gear up for that and increase our spending for that.

Okay. And then the last one for me would be, [I mean, you've called] (inaudible) just the stock options. So a lot of companies are getting some lower tax rate from the exercise of options. You had some of that in your second quarter. Do you expect more in the second half of the year, where your tax rate could be lower than you expect?

Jim, so actually, we -- that particular phenomena or new accounting guidance you're talking about, we implemented in Q1. And so we did have a discrete tax benefit in Q1. The impact cumulatively through 6 months is about a $0.02 bump, if you would, in our EPS. I do believe based on that standard, because it does force you to increase the denominator or the number of shares outstanding, that we'll see that diminish down over the year. So I don't expect that, on an aggregate annual basis, to have a significant impact on our overall rate.

Okay, and were you guiding for your tax rate to still look kind of 30% for the year?

Well, what we're guiding to is, between our income tax rate and our noncontrolling interest rate, as a percent of pretax income, roughly 39% to 40% for those 2 combined.

Ladies and gentlemen, that does conclude today's Q&A session. It's now my pleasure to hand our program back over to Laurans Mendelson for any additional or closing remarks.

Thank you. And to everyone on the call, we thank you for your interest in HEICO. We remain available to you by phone or personal visit to answer your questions. I know a lot of you speak to Carlos, and some -- Tom Irwin and Eric and Victor throughout the year, so we're happy to chat with you and give you answers that we can provide. And we look forward to speaking to you at the end of our third quarter, and that conference call with be sometime towards the end of August of this year.

So we wish you a good summer, a safe summer and look forward to speaking to you real soon. Thank you, and that's the end of this call.

Ladies and gentlemen, that does conclude today's conference call. You may now disconnect your lines, and have a great day.