HEICO Corp

NYSE:HEI

Earnings Call Transcript 2018-Q3

[Operator]

Good morning. I would like to welcome everyone to the Heico’s Fiscal Year 2018 Third Quarter Earnings Results. Now we’re going to a moment to share the forward-looking statement disclaimer for earnings conference calls.

Certain statements in this conference call will constitute forward-looking statements which are subject to risks, uncertainties and contingencies. Heico’s actual results may differ materially from those expressed in or implied by those forward-looking statements. As a result, such factors, including lower demand for commercial air travel, airline fee changes or airline purchasing decisions which could cause lower demand for our goods and services, product specifications, costs and requirements which could cause an increase to our costs to complete contracts, governmental and regulatory demands, export policies and restrictions, reductions in defense, space or homeland security spending by the 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 services at profitable pricing levels, which could reduce our sales and sales growth, product development or manufacturing 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, foreign currency exchange and income tax rates, economic conditions within and outside of the aviation, defense, space, medical, telecommunications and electronics industries which could negatively impact our cost and revenues, the defense spending or budget cuts which could reduce our defense-related revenue.

Parties listening to or reading a transcript of this call are encouraged to review our latest filings with the Securities and Exchange Commission, including but not limited to filings on Form 10-K, 10-Q, and 8-K. We undertake no obligation to publicly update information, future events and otherwise except to the extent required by applicable law.

Now I would like to introduce our host for today, Mr. Laurans Mendelson, Chairman and Chief Executive Officer of Heico Corporation. The call is yours.

[Laurans Mendelson, Chairman, Chief Executive Officer]

Thank you and good morning to everyone on the call. We thank you for joining us and we welcome you to this Heico third quarter fiscal ’18 earnings announcement teleconference. I’m Larry Mendelson, Chairman and CEO of Heico Corporation. 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 third quarter operating results, I’d like to take a moment to thank all of Heico’s talented, dedicated, and loyal team members who again were responsible for the outstanding results. Our team members and a strong corporate culture of entrepreneurial excellence has allowed us to grow and to win in the markets we serve. Their commitment to customers and producing high quality products coupled with the enthusiasm they bring to work every day makes Heico the great company that it is.

I’d like to take a few moments to summarize the highlights of our third quarter. Consolidated third quarter net sales, operating income, net income represent record quarterly results, and they were driven principally by record net sales fueled by double-digit organic growth at both Flight Support and ETG. Consolidated net income in the third quarter of fiscal ’18 increased 47% on operating income and net sales increases of 33% and 19% respectively over third quarter of fiscal ’17. Consolidated net income in the first nine months of fiscal ’18 increased 45% on operating income and net sales increases of 25% and 18% respectively over the first nine months of fiscal ’17.

Consolidated net income per diluted share increased 44% to $0.49 in the third quarter of fiscal ’18, and that was up from $0.34 in the third quarter of fiscal ’17. It was an increase of 43% to $1.40 in the first nine months of fiscal ’18, and again up from $0.98 in the first nine months of fiscal ’17. Consolidated operating margin improved to 21.8% in the third quarter of fiscal ’18, and that was up from 19.4% in the third quarter of fiscal ’17 and improved to 21% in the first nine months of fiscal ’18, again up from 19.7% in the first nine months of fiscal ’17.

As we have mentioned on previous calls, a contributing factor to the outstanding growth in net income has been the impact of the U.S. Tax Cuts and Jobs Act of ’17. This pro-business cut enjoyed by many companies has unleashed additional cash to invest in plant and equipment, in team members, and profitable acquisitions. Our effective tax rate for the first nine months of fiscal ’18 was 17.9%, which was down from 29.8% in the first nine months of fiscal ’17. We intend to utilize these tax savings to grow Heico and create additional shareholder value.

The ETG group set a quarterly net sales record in the third quarter of fiscal ’18 by improving 35% over the third quarter of fiscal ’17. This increase in the third quarter of fiscal ’18 reflects organic growth of 16% as well as the favorable impact from our fiscal ’17 and ’18 acquisitions. The Flight Support Group set a quarterly net sales record in the third quarter of fiscal ’18, improving 11% over the third quarter of fiscal ’17. The increase in the third quarter of fiscal ’18 reflects organic growth of 10% as well as the impact from a fiscal ’17 acquisition.

Cash flow, which as you all know I believe is the most important indicator of success, cash flow provided by operating activities increased 14% to $204.7 million in the first nine months of fiscal ’18, and that was up from $179.3 million in the first nine months of fiscal ’17. Cash flow provided by operating activities increased 34% to $109.7 million in the third quarter of fiscal ’18, and that was up from $81.6 million in the third quarter of fiscal ’17. We continue to forecast record cash flows from operations in fiscal ’18.

Our total debt to shareholders equity decreased to 43.6% as of July 31, 2018, and that was down from 54% as of October 31, 2017. Our net debt, which we define as total debt less cash and cash equivalents, total debt was $556.8 million to shareholders equity ratio decreased to 38.9% as of July 31, 2018, down from 49.8% as of October 31, 2017. Our net debt to EBITDA ratio improved to 1.27 times as of July 31, and that compared to 1.67 times as of October 31, 2017. During fiscal ’18, we have successfully completed three acquisitions and we have completed four acquisitions over the past year. We have no significant debt maturities until fiscal 2023, and we plan to utilize our financial flexibility to aggressively pursue high quality acquisitions and to accelerate growth, which we believe will maximize shareholder returns.

In June 2018, we declared a five-for-four stock split reflecting the Board of Directors’ continued confidence in the strategic trajectory and the growth of our businesses. These additional shares were distributed in June 2018. This marks Heico’s second five-for-four stock split made this year, and the 17th stock split or stock dividend since 1995. All applicable share and per-share information has been retroactively adjusted to reflect the five-for-four stock splits distributed in both January 2018 and June 2018.

In July 2018, we paid an increased regular semi-annual cash dividend of $0.06 per share. This represented our 80th consecutive semi-annual cash dividend and was a 7% increase over the prior semi-annual per-share amount, and a cumulative increase of 17% in dividends since July 2017.

In August 2018, we reported that our 3D Plus subsidiary supplied mission critical equipment for NASA’s Parker solar probe. The Parker solar probe will travel closer to the sun’s corona than any other human space mission before it and has mission goals of understanding coronal heat patterns, particle acceleration dynamics, magnetic field changes, space weather movements, and stars’ general behavior and characteristics. We congratulate the entire NASA team and could not be more proud that 3D Plus helped to make their mission possible. We thank the entire 3D Plus team for their continued hard work and commitment to unparalleled excellence.

At this time, I would like to introduce Eric Mendelson, co-President of Heico and President of Heico’s Flight Support Group. He will discuss the results of the Flight Support Group.

[Eric Mendelson, President, Flight Support Group]

Thank you. The Flight Support Group’s net sales increased 11% to a record $285.1 million in the third quarter of fiscal ’18, up from $258 million in the third quarter of fiscal ’17. The Flight Support Group’s net sales increased 14% to a record $807.7 million in the first nine months of fiscal ’18, up from $710.7 million in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 is attributable to organic growth of 10% and 6% respectively as well as the impact from our profitable fiscal ’17 acquisitions. The organic growth in the third quarter and first nine months of fiscal ’18 reflects increased demand in new product offerings within our aftermarket replacement parts, specialty products, and repair and overhaul parts and services product lines.

The Flight Support Group’s operating income increased 17% to a record $54.7 million in the third quarter of fiscal ’18, up from $46.7 million in the third quarter of fiscal ’17. The Flight Support Group’s operating income increased 15% to a record $152.1 million in the first nine months of fiscal ’18, up from $132.8 million in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 is mainly attributable to the previously mentioned net sales growth. The operating income increase in the third quarter of fiscal ’18 also reflects the favorable impact from efficiencies realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expenses and changes in the estimated fair value of accrued contingent consideration associated with the prior year acquisition, partially offset by a slightly lower gross profit margin mainly due to a less favorable product mix within our aftermarket replacement parts product line.

The Flight Support Group’s operating margin increased to 19.2% in the third quarter of fiscal ’18, up from 18.1% in the third quarter of fiscal ’17. The Flight Support Group’s operating margin increased to 18.8% in the first nine months of fiscal ’18, up slightly from 18.7% in the first nine months of fiscal ’17. The increase in the Flight Support Group’s operating income as a percentage of net sales in the third quarter of fiscal ’18 principally reflects the previously mentioned SG&A efficiencies and changes in the estimated fair value of accrued contingent consideration, partially offset by the previously mentioned lower gross profit margin.

With respect to the remainder of fiscal ’18, we now estimate full year net sales growth of approximately 11% to 12% over the prior year, up from the prior estimate of 10%, and the full year Flight Support Group’s operating margin to approximate 19.0%, up from the prior estimate of 18.5% to 19%. Further, we now estimate the Flight Support Group’s full year organic net sales growth rate to be in the mid to high single digits. 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.

[Victor Mendelson, President, Electronic Technologies Group]

Thank you, Eric. The Electronic Technologies Group’s net sales increased 35% to a record $186.4 million in the third quarter of fiscal ’18, up from $137.9 million in the third quarter of fiscal ’17. The Electronic Technologies Group’s net sales increased 26% to a record $510.8 million in the first nine months of fiscal ’18, up from $405.2 million in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 reflects organic growth of 16% and 8% respectively as well as favorable impact from our fiscal ’17 and ’18 acquisitions. The organic growth in the third quarter and first nine months of fiscal ’18 principally reflects increased demand for certain defense products. Further, the organic growth in the third quarter was partially moderated by lower demand for certain space products.

The Electronic Technologies Group’s operating income increased 45% to a record $56 million in the third quarter of fiscal ’18, up from $38.5 million in the third quarter of fiscal ’17. The Electronic Technologies Group’s operating income increased 38% to a record $147.4 million in the first nine months of fiscal ’18, up from $106.5 million in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 is principally attributable to the previously mentioned net sales growth and an improved gross profit margin, mainly reflecting increased net sales and a more favorable product mix for certain defense products, partially offset by a less favorable product mix for certain space and other electronics products. Further, the increase in the third quarter and first nine months of fiscal ’18 reflects efficiencies realized from the benefit of our growth in net sales on relatively consistent period-over-period SG&A expenses.

The Electronic Technologies Group’s operating margin improved to 30.1% in the third quarter of fiscal ’18, up from 28% in the third quarter of fiscal ’17. The Electronic Technologies Group’s operating margin improved to 28.9% in the first nine months of fiscal ’18, up from 26.3% in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 principally reflects the previously mentioned improved gross profit margin and SG&A efficiencies.

With respect to the remainder of fiscal ’18, we now estimate full year net sales growth of approximately 20% to 21% over the prior year, up from the prior estimate of 18% to 20%, and the full year Electronic Technologies Group’s operating margin to approximate 28.5% to 29%, up from the prior estimate of 28% to 29%. Further, we continue to estimate the Electronic Technologies Group’s organic net sales growth rate to be in the mid single digits. These estimates exclude additional acquired businesses, if any.

I turn the call back over to Larry Mendelson.

[Laurans Mendelson, Chairman, Chief Executive Officer]

Thank you, Victor and Eric. Now moving on diluted earnings per share, our consolidated net income per diluted share increased 44% to $0.49 in the third quarter of fiscal ’18, and that was up from $0.34 in the third quarter of fiscal ’17. It was increased to 43% to $1.40 in the first nine months of fiscal ’18, and that was up from $0.98 in the first nine months of fiscal ’17. As we said before, all fiscal ’17 - ’18 diluted earnings per share amounts have been adjusted retrospectively for our five-for-four stock splits, which we did in January and June 2018.

Depreciation and amortization expense totaled $19.4 million in the third quarter of fiscal’ 18. That was up from $16.4 million in the third quarter of fiscal ’17. It totaled $57.5 million in the first nine months of fiscal ’18, up from $46.9 million in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 principally reflects the incremental impact of higher amortization expense of intangible assets from our fiscal ’17 acquisitions.

Research and development expense increased 23% to $14 million in the third quarter of fiscal ’18. That was up from $11.4 million in the third quarter of fiscal ’17 and increased 20% to $40.7 million in the first nine months of fiscal ’18, up from $33.9 million in the first nine months of fiscal ’17. Significant ongoing new product development efforts are continuing as usual at both Flight Support and ETG, and we continue to invest approximately 3% of each consolidated net sales dollar into new product development.

SG&A expenses on a consolidated basis increased to $80.2 million in the third quarter of fiscal ’18. That was up from $72.8 million in the third quarter of fiscal ’17 and increased to $231.7 million in the first nine months of fiscal ’18. That was up from $197.5 million in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 mainly reflects the impact from our fiscal ’18 and ’17 acquisitions and higher performance based compensation expense. Furthermore, the increase in the third quarter of fiscal ’18 was partially mitigated by changes in the estimate fair value of accrued contingent consideration associated with a prior year acquisition.

Our consolidated SG&A expense as a percent of net sales decreased to 17.2% in the third quarter of fiscal ’18, and that was down from 18.6% in the third quarter of fiscal ’17, and it decreased slightly to 17.8% in the first nine months of fiscal ’18, down slightly from 17.9% in the first nine months of fiscal ’17. The decrease in consolidated SG&A as a percentage of net sales in the third quarter of fiscal ’18 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 favorable impact from the previously mentioned changes in accrued contingent consideration.

Interest expense increased to $5.2 million in the third quarter of fiscal ’18, and that was up from $2.4 million in the third quarter of fiscal ’17. It was $14.8 million in the first nine months of fiscal ’18 as compared to $6.4 million in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 was principally due to, one, higher interest rates due to increases in the LIBOR rate as well as a higher weighted average balance outstanding under our revolving credit facility, and that was associated with our fiscal ’17 acquisitions.

Other income and expense in the third quarter was not significant, so I won’t comment on it.

Our effective tax rate in the third quarter of fiscal ’18 decreased to 23.1%, down from 30.3% in the third quarter of fiscal ’17. Our effective tax rate in the first nine months of fiscal ’18 decreased to 17.9%, down from 29.8% in the first nine months of fiscal ’17. As mentioned on our previous calls, the decrease in the effective rate for the third quarter and first nine months of fiscal ’18 is directly related to the Tax Cuts and Jobs Act, or the Tax Act, under which the U.S. federal tax rate was reduced from 35% to 21% effective January 1, 2018, and that resulted in a blended federal rate of 23.3% for Heico in fiscal ’18. Of course, the months of November and December, the first two months of our fiscal year, were taxed at the old tax rate of 35%.

In addition, the decrease in the first nine months of fiscal ’18 reflects the $16.6 million discrete tax benefit we recognized in the first quarter of fiscal ’18 from the re-measurement of our U.S. federal net deferred tax liabilities using the lower federal tax rate that was partially offset by a $4.7 million discrete tax expense we recorded in the first quarter of fiscal ’18, and that was related to a one-time transition tax on unremitted earnings of foreign subsidiaries, again as a result of the Tax Act.

Net income attributable to non-controlling interest increased to $6.8 million in the third quarter of fiscal ’18. That was up from $5.8 million in the third quarter of fiscal ’17, and increased to $19.7 million in the first nine months of fiscal ’18, again up from $16.3 million in the first nine months of fiscal ’17. The increase in the third quarter and first nine months of fiscal ’18 principally reflects the impact of the Tax Act as well as improved operating earnings of certain subsidiaries of the Flight Support and ETG groups in which non-controlling interests are held. For the full fiscal ’18, we estimate a combined effective tax rate in non-controlling interest rate of between 27% and 28% of pre-tax income.

Moving on to the balance sheet and cash flow, I’m happy to note that our financial position and forecasted cash flow remain very strong. As previously discussed, cash flow provided by operating activities increased 14% to $204.7 million in the first nine months of fiscal ’18. That was up from $179.3 million in the first nine months of fiscal ’17. Cash flow provided by operating activities increased 34% to $109.7 million in the third quarter of fiscal ’18, up from $81.6 million in the third quarter of fiscal ’17. We continue to forecast record cash flows from operations in fiscal 2018.

Our working capital ratio, that’s current assets divided by current liabilities, improved to 2.9 times as of July 31, 2018, and that was up from 2.5 times as of October 31, 2017. DSOs of accounts receivable days sales outstanding was 49 days in both July 31, 2018 and July 31, 2017. We continue to closely monitor all receivable collection efforts in order to limit credit exposure. As you know as shareholders that have been around for a long time, we have very few receivable losses. No one customer accounted for more than 10% of net sales. Our top five customers represented about 21% and 18% of consolidated net sales in the third quarters of fiscal ’18 and ’17 respectively. Our inventory turnover rate was 134 days for the period ended July 31, 2018, which is consistent with 135 days for the period ended July 31, 2017.

As previously mentioned, our total debt to shareholder equity ratio decreased to 43.6% as of July 31, 2018. That was down from 54% as of October 31, 2017. In addition, our net debt of $556.8 million to shareholders equity ratio decreased to 38.9% as of July 31, 2018, and that was down from 49.8% as of October 31, 2017.

Our net debt to EBITDA ratio improved to 1.27 times as of July 31, 2018, and that compared to 1.67 times as of October 31, 2017. I’d just point this really signifies very strong cash flow and earnings growth relative to Heico’s consolidated debt. We are not a debt constrained company, and I would pre-empt the question that probably will come up - we have plenty of firepower left for acquisition activity. We have no significant debt maturities until fiscal ’23, and we plan to utilize financial flexibility to continue to aggressively pursue high quality acquisition opportunities and to accelerate the growth and again maximize shareholder returns.

The outlook as we look ahead for the remainder of fiscal ’18, we anticipate net sales growth within Flight Support and ETG resulting from increased demand across the majority of product lines. We will also continue our commitment to developing new products and services, further market penetration, and an aggressive acquisition strategy while maintaining our financial strength and flexibility. Again, we are not a capital constrained company and have access to a $1.3 billion unsecured revolving credit facility to accomplish our controlled growth strategy. As a practical matter, we can increase that probably to $1.6 billion or $1.65 billion if we need the additional availability. At this moment, we don’t foresee that we would need that, but you never can tell.

Our acquisition pipeline remains very robust, and we continue to actively work on a number of potential acquisitions. Of course, as is always the case, we do not know when or if an acquisition were working on will be consummated, but we’re excited about all of them at this point.

Based on current economic visibility, we now estimate consolidated fiscal ’18 year-over-year growth in net sales to be 15% to 16%, in net income to be 35% to 37%, up from our prior growth estimates of net sales of 13 to 14, so we went from 13-14 now to 15-16, and in net income of 33 to 35%, so from net income we are now forecasting 35 to 37% increase, up from our prior estimate of 3%3 to 35%.

We continue to anticipate our consolidated operating margin to approximate 21%, cash flow from operations to approximate $310 million, depreciation and amortization expense to approximate $77 million, and capex about $45 million. These estimates exclude additional acquired businesses, if any.

In closing, I’d like to end where I began. Heico’s team members have delivered these outstanding results and deserve the credit for hard work and discipline it took to successfully navigate another record-setting quarter. Heico’s executive management team has the utmost respect for everything our team leaders do to make their company successful. For my contribution, I intend to continue leading these talented team members with a focus on intermediate and long-term growth strategies, a laser focus on cash generation, and the acquisition of profitable businesses at fair prices.

That is the extent of our prepared remarks, and I would like to open the floor for any questions which may be out there. Thank you.

[Operator]

[Operator instructions]

Your first question comes from the line of Rob Spingarn from Credit Suisse. Your line is open.

[Rob Spingarn, Credit Suisse]

Well, good morning.

[Laurans Mendelson, Chairman, Chief Executive Officer]

Good morning, Rob.

[Rob Spingarn, Credit Suisse]

Congratulations on an excellent quarter all around. You continue to deliver outstanding performance, and even in the spots where there are some pressures such as the product mix that Victor mentioned in space, and Eric talked about gross margins. In each of these cases, you’ve offset that pressure elsewhere very successfully, so I wanted to--you know, given here we are in August, another good quarter, I wanted to go a little less conventionally here and ask each of the four of you if you could talk about just briefly your greatest individual unrealized opportunity at Heico, and at the same time what your greatest challenge might be in the business. I was hoping that Eric might be able to factor in this recent CFM news to see if maybe that’s an opportunity.

[Eric Mendelson, President, Flight Support Group]

Rob, over the last 28.5 years, we’ve gotten a lot of questions, and I would have to say that that’s definitely the first time that I’ve gotten this question, but I think it’s really a terrific one. Of course, I’ve only had 30 seconds to think about it, but we had great opportunities within all of the businesses within Flight Support. We speak a lot about the structure of the business, and I think our greatest competitive advantage is the way that we’re structured. And instead of having one single enterprise where all the decisions end up on one desk, my desk, the decisions are made within Flight Support by roughly 25 really talented people who frankly know more about their spaces than I will ever know. We are really grateful to have them, their dedication. They treat those businesses like they own 100% of them. They get very emotional about their businesses, and they each have got incredible growth opportunities going forward in many, many different segments.

But since you asked the question, I haven’t had very long to think about it, I do think that one of our largest unrecognized opportunities would be, frankly, the engine PMA business. This is from where we came. The company started out in this area, and we did very well. We saved a lot of airlines and customers a lot of money, and that of course has led to competitive dynamic and competition in the non-engine space, and that’s what our customers wanted us to get into 20 years ago, and we branched out from airlines I mean from engines into non-engines, so we’re doing very well in all of those areas.

But the engine space over the last 10 years has become very difficult, and from our perspective and from what the airlines have told us, some manufacturers have been extremely anti-competitive and have basically threatened their customers and told them that if they use alternative parts, they’re not going to support it, and they’re going to play all sorts of games. It would be like if you bought a car and you decided that you wanted to change the tires on the car, and the original manufacturer said no, if you change from, whatever, Michelin tires to some other tires, I’m not going to support it and next time you have a problem, I’m not going to support you.

That’s been a real headwind for our business, and as you know the airlines got very upset about this. They went to their trade association, IATA, and complained to the European Commission on this point because they really couldn’t take it any longer, and there ultimately was a settlement. The European Commission had to make a decision whether they were going to take on a formal investigation. They encouraged the parties, from what I hear, to settle that, and they decided to basically agree to a set of conduct policies which would promote competition.

If those conduct policies are stuck to and are adhered to by all parties, I think that it will be very pro-competitive. I think that the engine manufacturers will continue to do extraordinarily well - they’ve got incredible backlogs, they’ve got great engineering. I really admire those organizations, their technical, their manufacturing ability, and frankly I think their future is phenomenal and they’re going to make a lot of money for themselves and their shareholders.

But at the same time, the airlines want a choice, just like when you bring your car in for service, you want a choice on tires, what you’re going to use. And so, if the manufacturers heed this warning and basically cut out these, what I would term--you know, I’m not a lawyer, but anti-competitive monopolistic trade practices, then I think that that is probably the Flight Support Group’s greatest opportunity. However, I have to caveat this with I don’t know if in fact that that’s definitely going to happen. I feel confident that if it doesn’t happen, the airlines still can complain to the European Commission and to the DOJ, and we’ve spoken to a number of airlines and we are certain that they will. However, frankly, Heico is not a complainant into that matter and we really don’t have a front row seat to it.

I think it is a good opportunity, but I’d just caution you to not get overly excited about it until we see some of the results. So, sorry for this longwinded explanation, but it’s--

[Laurans Mendelson, Chairman, Chief Executive Officer]

Rob, this is Larry. I have a little bit different take on this from Eric. I agree with everything he said, but I have always viewed Heico as a company that must get it done. It’s by basic nature. I was in the army, and there was no such thing as--if you’ve been in the army, there’s no such thing as I can’t do it. My whole nature in business and my life is do it, so Heico, we’re not going to live or die on PMA parts. The PMA business is very good, it’s wonderful business, but we have expanded far beyond PMA, and Heico has become a great company not only because of PMA. PMA is part of the team.

Heico is a big team with--I can’t tell you, we probably have, how many, 50 different operating--say, 50 different? I would say 90% of those 50 groups have incredibly outstanding management. That is what makes Heico grow. It’s not me and it’s not Victor and it’s not Eric, it’s not Carlos. I’m giving all the credit, 95% of the credit goes to those team members, some of which make more money than I do, or Eric or Victor or Carlos, and God bless them because they’re so outstanding. I don’t want to mention names here. The guys on the phone, some of them are on the phone, they know who I’m talking about, but these are incredibly talented, loyal, hardworking individuals, and in my opinion shareholders of Heico, they look at the numbers and so forth, and I’m not sure if they truly understand the depth of the management, and that is in my opinion the key.

If we had not another PMA, I guarantee you Heico will be an unbelievably successful company, and it’s because it really is our ability to pick these fantastic individuals. That’s my two cents on it.

[Victor Mendelson, President, Electronic Technologies Group]

Rob, this is Victor. It’s good that Eric and my father went first and gave me time to think about some answers to your question. It’s a very good question. When I think about for the ETG, because I think you were kind of looking for me to distill down at that level, is that right?

[Rob Spingarn, Credit Suisse]

Yes, and then Carlos on the financial side.

[Victor Mendelson, President, Electronic Technologies Group]

Yes. On the ETG level, our focus is more on components, sub-components and that part of the world, and we’ve done very well doing the things that Eric talked about and my father talked about, serving the customers through our team members and just the basic blocking and tackling and expanding the product mix and developing product. There continues to be opportunity to do that and grow that as larger companies consolidated. As we see consolidation, invariably what happens is customers are increasingly mistreated, product lines fall out, the large companies tend to lose focus. Our structure doesn’t allow for that because in small business units, there’s nowhere to hide, and if you’re losing customers or you’re losing product focus, it gets noticed really quickly. You know, if somebody doesn’t show up in a 70 person business, the president of the business knows about it, so that gives us opportunity.

Another area we’re starting to flesh out more is on smaller acquisitions, ones that we wouldn’t have made as standalone businesses but businesses that earn maybe $1 million or $2 million of operating income, and operating income to us is earnings before interest, taxes and amortization. We don’t do EBITDA, where we add back the depreciation because that’s not really to us a true cash flow numbers, because you have some capex. But businesses that are kind of smaller in size, where it’s a product line, they may actually be lower margin products, it’s a product line or there’s an owner who is retiring and doesn’t have a successor, and it’s time for the business to close or be consolidated into something else. We’ve had some opportunities where we’ve bought those and we’re buying them, and we’ll see how that continues and how that plays out. It certainly has its own risks, but we’ve been successful so far with a number of those. If we’re able to do more of those, and I’m looking at ETG and they’re roughly 19 companies that sort of roll up at a top level and then a number of companies have subsidiaries, but if it’s just at the top level, 19 companies, we did--if all 19 companies made an acquisition of a million or $2 million of EBITA a year, that would be very promising for us. So those are a couple examples of potential for us.

Now, that’s not likely to happen at every single one of 19, but if we got halfway there, it would certainly be very exciting, so that offers some potential and we’ll see how that goes. That’s a good possibility.

You asked for some of the challenges. I think we’re always mindful of what can happen with the economy, with the U.S. government budget. There’s not a lot we can do about that. We’re not going to influence, frankly, what the U.S. budget is going to be beyond voting, and we don’t really have a lot of influence on that, and we’re not going to influence the broader economy all too much, so the best thing we can do there is what we’ve always done historically, which is keep our eyes on cost for our businesses. Not us, not at the corporate level--as my father said, we’re not there running the businesses, but our businesses to just be really tight on costs and really cautious, and don’t run out and expand too much in the expansionary economy economic times.

Lately one of the things that I think companies are seeing, the economy is extremely strong, is that--it’s something that companies, not just us but everybody is kind of dealing with, is lead time increase, material shortages, labor shortages, things like that. We’re managing it fine, it’s working out fine, but that’s a challenge that we’re going to have to continue to make sure works okay. Increasingly we see things slip out to the right here and there because of material shortages and labor shortages.

I’ll let Carlos in. I don’t know, did that answer your question, Rob?

[Rob Spingarn, Credit Suisse]

Yes, that was great. I appreciate that.

[Victor Mendelson, President, Electronic Technologies Group]

You’re welcome.

[Carlos Macau]

So you saved the best for last - finance, accounting? Look, I feel very fortunate to lead the finance and accounting function at Heico. As you know, we’ve got a very diversified structure and we utilize principally the same management style as Eric, Victor and Larry do for the operating units, is to empower the employees and the team members on my team to both make mistakes and do good things, and then not beat them over the head whenever something bad happens but to encourage them to continue to learn and to do good things. When I think of opportunities and untapped potential, I think growing that team and continuing to allow them to grow in their careers is something that’s very important to me, and that’s an opportunity and a challenge, frankly, in a diversified environment.

I do think on the challenge side, the one thing that concerns me personally is some of the changes to generally accepted accounting principles that keep getting, I’ll say, jammed down our throats. Some of the changes, I think, when it comes to revenue and leases and some of the things coming down the pipeline, I’m not so sure that that helps our shareholders or investors fully understand our financial statements. I think it’s confusing, sometimes I think it’s a full employment act for auditors, but nonetheless when it comes to challenges, our group is quite talented and able to effect these changes, but I sometimes question the need for them.

I hope that answers your question, Rob.

[Victor Mendelson, President, Electronic Technologies Group]

Rob, this is Victor. Just one thing I wanted to add. My comment on some smaller opportunities doesn’t mean that we’re abandoning our typical acquisitions, so the typical kind of company we buy, the standalone business, I think will remain our bread and butter where we are a great home for the acquirer, where we leave the business alone to do what it did pre-closing. We will continue to do that, and in fact most of the acquisitions we’re working on now, the majority of them fit in exactly that mode where the management team, the people will stay, the company will be where it was pre-closing under the same name, same operations and so forth.

[Laurans Mendelson, Chairman, Chief Executive Officer]

Rob, there’s one other thing I’d like to add a little bit of color that after running this company for about 28 years, I have finally realized--or I realized it a while ago, and that is the culture of the company, and I’ve said this at some of the conferences that we’ve attended, the culture of the company, I think, becomes very, very important. I think it’s the tone from the top, it’s the honesty, the integrity and so forth, but it’s also how you treat the team members, the employees. I think you know this - a number of years ago, we sold a block of stock to the 401(k), people defer 6%--they can defer 6% in their 401(k), they have a whole menu of mutual funds that they invest in, and we match that annually with 5% in Heico stock. The reason I’m bringing--you’ll hear in a minute why I’m bringing this out and why it’s so important.

We have 4,000 U.S.--approximately 4,000 U.S. employees. Most of them are in the 401(k). Ten percent or a little more have between $750,000 and a $1.5 million in their 401(k) principally as a result of their gift of Heico stock to the 401(k). Another 40 or 50 of them have between $1.5 million and $6.5 million in their 401(k) principally Heico stock. I am not talking about senior executives, I’m talking about shipping clerks, factory workers, secretaries, and people who work hard, manual labor for a living.

Now, what has happened is that we now have a good majority of those 4,000 people think of Heico as their company. It’s no longer we’re working for some rich guys on Wall Street and mutual funds and the CEO, he’s getting all this money, we’re getting nothing, when I retire I have Social Security, I can’t even make ends meet and so forth. The last thing I want to tell you is about six months ago when I sent out the quarterly reports, I received an email back from one of our secretaries, and the comment - I’ll paraphrase, dear Larry, thank you so much for sending the report. We are doing so well. We meant she - it wasn’t Heico. She didn’t write Heico is doing so well, we are doing so well, and she further went on to say, and it’s wonderful to know that some day when I retire, I will retire as a millionaire. This is a secretary.

When you put that in perspective and understand that the people who are building this company and supporting it and doing the great things that we can do, they look at it as their company. They are working for themselves. I feel very strongly that that strategy that we have used has been extremely, extremely effective, and I hear it all the time. People say to me, God, the stock is doing so well. They have access through Fidelity and they see their 401(k) values and so forth, and they feel part of it. If somebody is out of line, believe me - the people themselves, the team members will go and say, hey, you better get on the ball. They’re not going to let people goof off.

That is why I think we have--a great reason for the great success that we’ve had, and it’s in the execution and the performance of the people in the field. I just wanted to add that.

[Rob Spingarn, Credit Suisse]

Thank you all very much. That was well more than I could have hoped for.

[Victor Mendelson, President, Electronic Technologies Group]

Thank you, Rob.

[Operator]

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

[Sheila Kahyaoglu, Jefferies]

Hi, good morning everyone. I think that question covered about everything, so I don’t know if I have anything more to ask; but maybe we could just start off with ETG. Victor, superb organic growth. How do we think about how sustainable that is and what a more normalized growth outlook for the business would look like and some of the drivers?

[Victor Mendelson, President, Electronic Technologies Group]

Sheila, that’s a good question. I wouldn’t expect organic growth of that level every quarter. I think what we’ve guided historically is what we’ll continue to tell people to expect of ETG over time, and we do look at it over long term, is a mid to low single digit organic growth kind of business. We have quarters where it’s much higher and then there are quarters where it’s lower, and if you look at it that way, I think you’re safe.

I know we’ve done more historically and people always say to me, well, you’re sandbagging because the business seems to grow faster than that, and if it does, great, and then we can all be very happy. But in the meantime, I think we’re much safer expecting the mid to low single digit growth because, as I said, we can’t predict a lot of things like defense budgets and the economy overall.

[Sheila Kahyaoglu, Jefferies]

Got it. Were there specific drivers this quarter that shouldn’t repeat, like a pull forward, or is it just robust defense spending?

[Victor Mendelson, President, Electronic Technologies Group]

In robust economic times, what I’ve noticed is there always seems to be in every corner some amount of what I would consider pull forward. The guys tell me--we get to the end of the month or the end of a quarter and they say, we shipped more than we expected to ship, we got more out the door, the customers were pulling things in, and I tend to notice that there’s a few million dollars every quarter, and I wouldn’t say this quarter was any exception, where it seemed that there were orders that shipped in the quarter that I thought would ship in the next quarter, and originally our budget or our plan was to see it ship in the next quarter. This wasn’t an exception. When economic times are weaker, it seems to shift the other way more frequently.

I wouldn’t call it anything major this quarter, and we’ll see if they give me the same surprise in the fourth quarter.

[Sheila Kahyaoglu, Jefferies]

Sure. Thank you, Victor. Eric. I just wanted to ask about the IATA and CFM ruling, just following up on that a little bit more. How do we think about next steps? Are there other rulings that we should expect from the other engine OEMs, and what should we be looking out for?

[Eric Mendelson, President, Flight Support Group]

That’s a good question, Sheila. As I mentioned in my earlier answer, we were not a complainant in the matter, so it was the airlines who went to the European Commission, and IATA with their concerns. I think that the--I know from what I’ve been told that the European Commission wants to send a message to all the manufacturers that they can’t take advantage of the customers and squash competition, so I’m not aware, I don’t have specific information on what they’re looking at. I do know, and it was reported in the press that they did look and they were looking into other manufacturers. I know that IATA wants this to be a precedent for the whole industry, but I’m not aware of exactly where this stands at the moment.

[Sheila Kahyaoglu, Jefferies]

Okay, thank you.

[Operator]

Your next question comes from the line of Larry Solow from CJS Securities. You line is open.

[Larry Solow, CJS Securities]

Great guys, thanks, and thanks for a lot of great color this morning. Just taking a look at a bit more of the minutia on the quarterly performance, perhaps a question for Eric first, just on the aftermarket growth - it looks like it accelerated a little bit, close to 9 or 10% in the quarter. Was there anything particular in that? I know you did mention a little bit of some mix issues on the negative side, but on the positive side, anything that had a bump-up, maybe just a little bit of timing? Was that the main driver for the increase in your organic expectations? I know you had specialty products to rebound, which they obviously did, so just a little more color on that would be great.

[Eric Mendelson, President, Flight Support Group]

Right, thanks Larry. Again, those are very good questions. With regard to specialty products, we did forecast that in the second half of 2018, we would see a rebound, and in fact we’re very pleased that we did see that rebound in specialty products and expect that it will continue. You’re right that aftermarket was up about 9%, and remember that with Heico is pretty much all volume related, it’s not pricing. When we compare that to other companies that are reporting who get pricing and will also get initial provisioning for new fleets, ours is 9% on the core business, so I’m really proud of the team for hitting those numbers.

Nine percent is a heck of a number, so I would never want to predict that number in perpetuity going forward; but there is definitely a lot of strength in all of the areas that we’re looking at. Also, I’m particularly happy that the 10% organic growth follows roughly 6% organic growth a year ago, in the year ago quarter, so when looking at that, when viewed in that light, the team really outperformed.

Again, I think that there is a lot of interest in what we do, so I’m very encouraged by it; but as I always say, I like to be very vocal about this, our competitors are very, very tough and they don’t give up any ground easily or willingly. We’ve got to fight for every inch of ground that we have and to keep it, and I think what the European--this resolution with the European Commission and IATA and engine manufacturers, I think that that is a very good sign for us. But I don’t want to get carried away and start predicting something different going forward because of it. I think it’s a great opportunity, but we’ve got to go see what happens.

[Larry Solow, CJS Securities]

Okay, and then switching, a question for Victor, obviously another great performance for ETG. A couple questions - obviously you left the organic growth number the same, still mid single digits, an impressive number; but I guess I assumed growth at AeroAntenna, which is the primary acquisition over the last year, is sort of driving that upside, which is I guess to acquire growth but it’s growing since you acquired it. Is that fair to say?

[Victor Mendelson, President, Electronic Technologies Group]

That’s correct. Aero is a very successful company, and in fact as you know, we are conservative the way we measure organic growth. We measure organic growth starting one year after the acquisition, on the anniversary of the acquisition. Only then does it count as organic growth in our computations, so we so to speak lose the organic growth for the period in the first year of the acquisition. In their case, it would have driven our organic growth nicely higher - I can’t say exactly what it is, but it would have driven it nicely higher, so it’s been a great acquisition. Great company.

[Larry Solow, CJS Securities]

And the 30% or over 30% segment operating margin, anything in there unusual? Obviously you had great top line growth, which I guess always helps the economies of scale and whatnot; but anything that would sort of prevent you from not reaching this number as we look out?

[Victor Mendelson, President, Electronic Technologies Group]

I would say we’re--

[Carlos Macau]

Larry, this is Carlos. I don’t want Victor to get ahead of my projections. I think we’re looking for 28 to 29% OI margins, and I think--first of all, I’m not embarrassed of that. I think the 30% that we posted this quarter was the combination of really all of our businesses hitting on all cylinders. We had really nice growth in the defense area, and areas that we’ve now got a fair amount of certainty with budgets and we’ve got our [indiscernible] contract [indiscernible] acting much more predictably, rationally, and so that contributed quite a bit to the quarter. I think on an ongoing basis if we had the same dynamics, the same circumstances, God bless us all, we would be able to post an OI margin like that, but I’m not counting on it for the full year.

[Larry Solow, CJS Securities]

Got it. Carlos, while I’ve got your attention, just last question - any particular reason why you didn’t raise the cash flow from operations guidance despite the increase in net income outlook?

[Carlos Macau]

Yes, there’s two reasons, Larry. One, we’ve had to invest in our growth, and that requires a little bit of working capital. By example, we’ve had investments in inventories to support not only Q4 growth but the first half of fiscal ’19; and as Victor, I think, mentioned earlier, we are seeing in the supply chain scarcity of resources, and so our guys are making sure that we have what we need on hand to support our customers. That’s one aspect of it.

The other aspect of it is we’ve got--with this Tax Act change, we’ve got a lot of moving parts, and that is working with our deferred tax liability change, it goes through our operating cash flow statement. It’s a non-cash item, but nonetheless it’s not something that’s easy to nail down. I think it’s growing, and so I’ve been a little conservative, if you would, on some of those estimates. We think the $310 million that we’re projecting for cash flow from operations is achievable, though of course we always hope to do better.

[Larry Solow, CJS Securities]

Got it. Okay, great guys. Thanks again.

[Operator]

Your next question comes from the line of Michael Ciarmoli from SunTrust. Your line is open.

[Michael Ciarmoli, SunTrust]

Hey, good morning guys. Thanks for taking the question, real nice quarter here. Maybe--you know, I guess whoever wants to chime in on this one, but it’s been touched upon a couple times regarding the supply chain. Carlos, you just mentioned some scarcity of resources, Victor mentioned it. Can you guys just elaborate on that? Certainly we’re hearing about a lot of tightness in the commercial aerospace world, not only on OE production but also in the aftermarket, especially as it relates to labor. Can you guys just maybe elaborate on where specifically you’re seeing the tightness? Are these creating any headwinds, are they manageable for you right now, and just maybe a little bit more color in general on supply chain.

[Victor Mendelson, President, Electronic Technologies Group]

This is Victor. I was referring to in the Electronic Technologies Group more particularly, not so much commercial aviation, commercial aviation aftermarket, component shortages and delays, lead times stretching out, things like that. In a number of instances, our companies have been great about getting out ahead of that, anticipating it, building up buffer stock and inventory for the most part. That’s not always the case, but sometimes we’ve got vendors who just are very far behind the tower curve on that, so we’ll have a delay here and there. It hasn’t been too bad.

Finding good, qualified people is becoming an increasing challenge. I think we can always find bodies, but finding the right people, and that’s a big part of what we do. It hasn’t been a big problem for us, but here and there sporadically, it is, and of course the issue for a public company is always when does that rear its head and do you have it around the end of a quarter, and does that push something-- a shipment or a group of shipments out a week or something like that, from one quarter into the next. That’s something we’re vigilant about and we try to watch closely, and so far we’ve been able t handle it pretty well.

[Eric Mendelson, President, Flight Support Group]

Over on the Flight Support side, I think we’ve been able to handle it. Yes, there are particular areas where there have been some shortages, and we’ve been able to handle it. There are a couple of areas where some pricing is going up, so we are going to have to look at that. While we are very good to our customers, if our costs go up, then we do have to pass that along, so we’ve got that opportunity to do that, and I think the customers are very realistic and understanding of that. But so far, I think we’re handling it just fine.

[Michael Ciarmoli, SunTrust]

Got it. Would you be able to elaborate on those areas where you’re seeing the pricing going up, Eric?

[Eric Mendelson, President, Flight Support Group]

No, I would just say in certain materials. It’s nothing that’s having a major impact on us.

[Michael Ciarmoli, SunTrust]

Got it. Just last one from me, and maybe I’m getting a little bit too enthusiastic here and putting the cart before the horse, but on this IATA CFM, Eric, one of the biggest, I feel negatives around the Heico story, if there has ever really been a negative, has been the opportunities in engines, and you guys being boxed out. Doesn’t this ruling potentially change the total market opportunity for you guys on a go-forward basis, and seemingly allow you to start PMA-ing parts with materially higher price points than air frame components? I mean, I’m just--I know it’s early and I know this just happened, but it seems like this has been a major, major obstacle, and this would seemingly knock down the wall to reopen a very sizeable market for you.

[Eric Mendelson, President, Flight Support Group]

Well, I agree that it’s probably been our greatest headwind. I mean, it’s been a massive disappointment that we haven’t been able to make more progress in this area because the customers really want this, but frankly they’ve been boxed out by all of this behavior which hopefully is going to stop going forward. I think that there is very good opportunity, but we need to be very cautious about it. We’re not going to go spend a whole bunch of money and go develop a whole bunch of parts without commitments and knowing in fact that there’s going to be a home for those parts. It’s a very expensive process to be able to develop these parts, and again we also--you know, our philosophy has never been to take too much of the pie. We want to make sure that we share with the original manufacturers and that they have the opportunity to continue to do very well. They’ve got huge backlogs, they’re going to make a fortune. They’ve got incredible business models, and frankly we can get a small amount of business and not do any damage to them.

So yes, I think the opportunity is there, and really stay tuned. We’re going to be continuing to talk to the customers. Again, this news just broke within the last 30 days, a lot of people are on vacation right now, so we’re seeing where everybody stands on this, but I do think it’s good opportunity. I don’t believe it’s going to show up in our numbers over the next year or two. It would be a longer story, but clearly it does put the legs back on in terms of opportunity in that space. Also, hopefully as Sheila had alluded to, or somebody in another question, hopefully the other manufacturers see the same thing and they recognize, you know what? It’s not really so bad to have a little bit of competition nibbling around the edges on some of this stuff. They’re able to, frankly, mint money on the new production as well as the majority market share that they’ve got, so I do think there is good opportunity for us.

[Michael Ciarmoli, SunTrust]

Got it, that’s helpful. Thanks a lot, guys. Good quarter.

[Operator]

Your next question comes from the line of Peter Arment from Baird. Your line is open.

[Peter Arment, Baird]

Yes, good morning. Terrific results. A lot’s been discussed here. Victor, maybe if I could just touch upon--maybe to get a little more color on the ongoing weakness, I guess, in the space market. You’ve kind of talked about it in the past, but just maybe what’s the visibility you’re seeing there and how we should think about that going forward.

[Victor Mendelson, President, Electronic Technologies Group]

Peter, it’s really in the geosat market, that’s something I think that’s well covered in the trade press and in other press, and right now visibility isn’t great. I think I would not expect geosat orders to pick up anytime soon - I don’t think I’m in the minority in that view. The rest of our space business is strong and is doing very well, but--and continues to grow, actually, so that’s positive for us.

[Peter Arment, Baird]

Okay, and then Eric, just quickly on the consolidation on the distribution side in the commercial space, does this create some additional opportunities for you longer term, or how should we be thinking about that? Thanks.

[Eric Mendelson, President, Flight Support Group]

I think so. Frankly, over on the distribution side, whether it is commercial through our Steel Dynamics subsidiary or over on the military side through Blue Aerospace and ECT, I think that we provide a very, very unique value to manufacturers. Those companies started out very, very small, they're focused on the detail, they don’t take tons of different lines, they focus on their lines, and frankly they knock the ball out of the park and they do an amazing job. I was over in Farmborough with these guys a month ago and the way our principals feel about us due to the performance--it’s not BS, it’s actual performance, our people know how to sell their product, so I think that there is a lot of opportunity for those companies to continue to grow in both the commercial as well as the military markets. I’m pretty optimistic.

We’re not a catalog house where we cover everything. There are firms that do that and they do a great job, and that’s tremendously needed; but there are certain areas where we can really differentiate and make a lot of money for the companies for whom we distribute, the manufacturers for whom we distribute, and we’re really good at it. So yes, I expect this to continue to be an increasing part of the Heico story, and I expect that we’re going to do really well in those areas, and frankly we’ve done just amazingly in those spaces.

[Peter Arment, Baird]

Great, thanks for the color. Nice quarter.

[Operator]

Your next question comes from the line of Jennifer Oppold from Alpine Peaks Capital. Your line is open.

[Jennifer Oppold, Alpine Peaks Capital]

Thank you, guys. A quick accounting question for either Carlos or Eric. Wondering about the approximate impact of the reduced contingent consideration in Flight Support. Then secondly it was great to hear that specialty products had good demand this quarter, and I was wondering if you could provide a little bit more color whether that was due to new customers or if you’re just seeing a step-up in demand from your existing customers. Thanks.

[Carlos Macau]

Jennifer, this is Carlos. The accrued contingent consideration change is a few million dollars, and primarily that impact was from mostly FX last year. We had some losses last year due to the euro, and then this year we had some strength in the dollar which sort of reverses that, so we had that change on a change going through there. That was, if you would, the accrued contingent consideration impact.

I think on the mix issue that we mentioned, our volume, as Eric mentioned, was up and there’s no trend there, it was just a product mix thing in our aftermarket parts that was a little different than what we had in Q3 last year. But nothing unusual, no trends, and nothing that we’re worried about.

Does that answer your question, Jennifer?

[Jennifer Oppold, Alpine Peaks Capital]

Yes. To follow up slightly on the specialty product lines, that was an area that had been struggling a little bit in the last year or two. Just wondering if you had any color about what is helping that business - it sounds like it’s on better footing now.

[Eric Mendelson, President, Flight Support Group]

Hi Jennifer, it’s Eric. Yes, that business is doing better in a number of areas: one, in some OE equipment that we manufacture, there was a little bit of a slowdown roughly in the last year or so, that is picking up, number one. By the way, in no particular order, just as it’s coming into my mind, number one. Number two, we do a lot of defense and space products, and we’re very strong in that area. That business is doing well with the increased spending that everybody is aware of, and we’re benefiting from that. I would say that is number two. Then number three, in some other general specialty product areas, we continue to do really well. We’ve got great management teams that are really focused in their businesses. I went out and visited all the specialty products companies within the last couple of weeks, and they’re doing very well and, frankly, they’ve got great growth prospects. We saw that we were--you know, there was a little period of softness there - we’re past it, and we believe that it’s going to continue to do well.

[Jennifer Oppold, Alpine Peaks Capital]

Thanks so much, that’s great.

[Operator]

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

[Ken Herbert, Canaccord Genuity]

Hi, good morning. Just if I could, I guess either Carlos or Larry, perhaps, you’ve had really good improvement over time on the gross margin, and the last two recent--you know, this quarter and the last quarter had very good levels. Can you just talk about either initiatives you’re doing across the company that may be benefiting and where we could see incremental opportunity on the gross margin, or is this--because obviously volume, I’m sure, is a part of it recently, but what are the other opportunities on the gross margin, or maybe if you could talk about what you’ve been doing across the organization to really specifically focus on this?

[Laurans Mendelson, Chairman, Chief Executive Officer]

This is Larry. One of the areas that we have been very successful in is something that Victor mentioned earlier before, and that is where we take a company which is not doing very well, that’s up for sale, might be breakeven, maybe have a low gross margin, or even they may be negative, and what we do, you will purchase that company, relocate them, merge them into one of our existing operations, and all of a sudden drop out all of the excess cost and overhead, and add the profitability to an already existing operation without much overhead attached to it. That has been a very, very powerful driver for increased profit and increased margin, and that’s been very successful and we’ve done that about three, four, five times, and the results are really amazing.

The other thing of course, which we mentioned, as the volume goes up and SG&A kind of remains constant or goes up, but we eke out a bigger spread between the increased revenue and the existing SG&A, so that helps margins a little bit. I guess somebody mentioned the defense industry, and of course as you increase throughput, you’re going to see margin increase for a whole bunch of reasons. You’re going to see again the relationship SG&A and fixed costs - as your revenues go up, those spreads will start to expand, so all of those things are very critical.

I don’t know, Carlos, do you have some other thoughts on that too?

[Carlos Macau]

I would agree with everything Larry just said, and I would further emphasize that we don’t have--frankly, we don’t need to have corporate initiatives, if you would, to mitigate our spending. Our culture and our general managers or CEOs of our subsidiaries are already very frugal, they’re very cost conscious, and they watch every nickel like it’s their own, and we’re in a very fortunate position because of that. So no big corporate initiatives on improving margin from a cost cutting perspective, it is all what Larry said - leverage on our SG&A costs and really doing a good job with integrating some product line and smaller acquisitions in, and then giving them the opportunity to grow their top line so that they can capitalize on their own profitability.

[Ken Herbert, Canaccord Genuity]

Okay, that’s helpful, thank you. Just finally on the leverage, you had a very nice quarter with again paying down debt, and leverage is--you know, obviously you’ve got plenty of capacity. The question more is about what’s the lower range of where you’d like to see the leverage get to, and moving forward, how should we think about acquisitions relative to a potential special dividend or some other use of capital, depending upon that pipeline moving forward?

[Laurans Mendelson, Chairman, Chief Executive Officer]

I think, as you know, our policy is to grow the company because we feel that the growth of the company is the best place that we can add capital. Barring a market collapse or something, we don’t foresee stock repurchases. We’re not in the business to shrink Heico, so we’re in the business to grow Heico. It’s been a very successful endeavor, and that’s our focus to move forward.

As to where the debt levels go, it’s opportunistic, so we don’t say we must--we don’t feel pressure to hurry up, we’ve got to make an acquisition because we have to make Wall Street happy and all that kind of stuff. We are strictly opportunistic and we are going to buy companies that will add to our cash flow and so forth. People have asked me in the past, where would I feel comfortable in terms of leverage? The real question is how quickly we could reduce the leverage, so I would be content, I could sleep at night if we had six times--our debt was six times EBITA or more, as long as I knew that within a year or two, that six would be three. In fact, we have looked on many occasions at very big acquisitions that would increase leverage. They didn’t work out, they weren’t interesting to us when we did the due diligence and kicked the tires, we said no, this won’t work. But we have considered much higher levels of debt initially, but not for a prolonged time. It all depends on the availability of acquisition opportunity, how we think it’s going to fit in, does it meet our criteria as far as strong margins, ability to generate cash and to pay down the debt.

[Ken Herbert, Canaccord Genuity]

Great, thank you very much.

[Operator]

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

[George Godfrey, CL King]

Thank you. Very nice quarter, gentlemen. Just one question as it relates to the margins within the different segments. If I go back to 2013, the margin differential between Flight Support and ETG, 540 basis points for the full year, and in the quarter just reported, now that differential is over 1,000 basis points. My question is, one, what specifically within the product mix for ETG makes it such a more profitable business; and then B, is there an opportunity in the Flight Support to bring those margins up and close that gap to be tighter, perhaps, with having more markets and engine part PMA, or some other product line? Again, very nice quarter, well done.

[Laurans Mendelson, Chairman, Chief Executive Officer]

This is Larry. I really don’t think that there is much of an opportunity to close that gap because of the product mix and so forth. I think Flight Support--on its own, Flight Support has a margin of 20%, give or take, operating margin of 20--

[Carlos Macau]

Nineteen is what I guided to, Larry!

[Laurans Mendelson, Chairman, Chief Executive Officer]

Okay, 19, 20 - whatever it is. That’s a very impressive margin. If you look at aerospace companies across the board, we are way, way up there. In Electronic Technologies, it’s a different industry. It’s a niche industry, smaller products and so forth, and in those areas by the nature of the business, it’s just higher margin. The margin that I use actually is 25% - Heico is a 25% margin company in operating margin because I ignore amortization, which is a GAAP kind of thing, and from an operating point of view it’s nothing. We ignore that, and I’m sure you do when you analyze Heico’s numbers.

All in, we’re 25 - one is 30, one is 20, so we’re 25, but I really don’t think those two are going--I can’t see that--and I don’t suggest you expect much higher. I think we’re doing extremely well compared to all the other aerospace companies. I think we’re an outlier. The only one that has higher margin is TransDigm, and they have a whole different business and they’re a terrific company, but I think after TransDigm, Heico is at the top of the list. I think we’re doing very well, and I wouldn’t expect more, George.

[George Godfrey, CL King]

Okay, agreed - definitely doing well. Thank you for taking the question, Larry.

[Operator]

Your next question comes from the line of Colin Ducharme from Sterling Capital. Your line is open.

[Colin Ducharme, Sterling Capital]

Hi, good morning folks. Thanks for the question. Just a quick housekeeping question for Carlos, because Eric and Victor already hit my earlier question on margins that I had. Just on cash, for housekeeping, Carlos, could you just add a little bit more color on the year-on-year difference in the inventory line, the receivables line - A/R, and then the capex line? I’m assuming inventories and capex are just due to above guidance growth that you’re experiencing, but that A/R balance, just trying to understand that year-on-year. Thank you.

[Carlos Macau]

Yes, sure. You’re right on capex and inventories. As I kind of mentioned earlier, we are--our guys are investing in some inventory. They did in third quarter to support some growth that we expect in Q4 and first half of ’19, and so that doesn’t bother me. Our days in inventory, our turns are pretty consistent as we’ve grown our revenue, so that growth, while nobody likes to invest in working capital unless you’re going to quickly turn it into a dollar, our guys do quickly turn it into a dollar so I don’t worry about that so much.

On the receivables side, our DSOs have remained consistent around 49 days, so what’s happening is our business is growing and our receivables are growing with it. There is a phenomenon going on where you have some large companies that try and drag turns out to 90 days from what might typically be 30 days. We have seen some of that. That hasn’t necessarily contributed to extraordinary growth in our receivable balance relative to our sales growth, but that is one thing that we’re seeing in the industry that has been going on for a year, year and a half, and it’s getting a little more prevalent. That’s one aspect, I guess, in the receivable world that we’re dealing with.

I’d say the quality of our receivables and the turns are fantastic. We have no worries about credit run-offs or anything like that. We are high quality, if you would, on the receivable side.

[Colin Ducharme, Sterling Capital]

Okay, great. Thanks. Just a quick follow-up, I guess for Larry, Victor and Eric, we’re seeing the shift from the two big OEMs certainly making an increased presence on the one hand from Boeing in the services space, and on the other hand from both of them in the mid-tier business and regional jet space. Kind of a two-pronged question: number one, the enlarged service presence from Boeing, is that affecting any of the market dynamics from demand at all, is that affecting your business; and then on the other hand, I know you do business with all of the above - Bombardier and Embraer, but now that we’ve got some consolidation there, incremental risk or incremental opportunity? Just trying to understand if that dynamic is changing and how it might affect your business. Thanks - great quarter, folks.

[Eric Mendelson, President, Flight Support Group]

Thanks Colin. We do a tremendous amount of business with all of the OEMs. People, very often when they think of Heico, they think of us with our original legacy business, which was the PMA business; but that is just one piece of Heico today. Heico is frankly so much larger in all these other areas, it’s larger than our PMA business, so we have a very good relationship with all of these different manufacturers. As I alluded to earlier, the order books are so tremendous and the products that these guys are developing are so outstanding, that they are going to do very, very well for the next many, many years. They’re going to make a lot of money and they’re going to really make their customers very happy.

Having said that, the customers want choice, and while they can be very happy with a particular supplier--I mean, you may buy, as I said in the example, a particular car, you want service options. I think the manufacturers are coming to grips with this and, frankly, the volumes are going up so much, and I think that the service opportunities for non-OE providers in certain spaces are also going to go up, and that is not going to be overall to the detriment to these manufacturers. They’re going to continue to do extremely well.

So I think there are certain customers who are going to want, if you will, one-stop shopping and the benefits that that brings to them, and there are going to be other customers who want alternatives and options. It’s like what do you want for dinner tonight - French, Chinese or Italian food? There is no one right answer, so Heico endeavors to have very good relationships with all of the market participants. We’re now--after seeing our stock this morning, we have north of a $10 billion market cap, so we’re a legitimate, credible company. We work with all of the participants in the industry, and I think that specifically Boeing and Airbus are going to do very well on their initiatives and we’re also going to do very well. There are certain products that manufacturers are going to want to put through them, and there are other products that they’re going to want to put through us, and there’s no one right package. I think Heico can work with all of the market participants to make sure that there’s a very good, dynamic, growing, competitive yet healthy industry.

I don’t know if that answers both parts of your question, Colin?

[Colin Ducharme, Sterling Capital]

Yes, that’s helpful, and thank you very much, Eric. I guess I was just curious on whether you’ve seen any of the demand dynamics change, and my takeaway is it doesn’t sound like it is. You guys are still able to forge ahead with your existing model. Thank you.

[Eric Mendelson, President, Flight Support Group]

You’re welcome, and your takeaway is 100% correct. That’s how I feel and am thinking.

[Operator]

Again if you have a question, simply press star then the number one on your telephone keypad.

There are no further questions at the moment. Presenters, please continue.

[Laurans Mendelson, Chairman, Chief Executive Officer]

This is Larry Mendelson. Again, we want to thank you for your interest in Heico. We thank you for participating, asking questions, and digging into it. We are available, as you know - Eric, Victor, me, Carlos if you have further questions. Please give us a call, you know where to reach us. Otherwise, we wish you a very good Labor Day weekend, drive safely if you’re traveling, and we look forward to speaking to you at the next quarterly conference, which will be--when, Carlos?

[Carlos Macau]

In December.

[Laurans Mendelson, Chairman, Chief Executive Officer]

In December, so there we are. Again, thank you all, and have a wonderful weekend.

[Operator]

Thank you for joining. This concludes today’s conference call. You may now disconnect.