HEICO - Earnings Call - Q1 2012
February 23, 2012
Transcript
Speaker 2
Good morning to everyone, and we thank you for joining us. We welcome you to HEICO's first quarter fiscal 2012 earnings announcement telecon. I'm Laurans Mendelson, I'm the 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 Thomas Irwin, HEICO's Executive Vice President and CFO. Before we begin, Christy, our operator this morning, will read a statement. Christy?
Speaker 5
Welcome to the HEICO Corporation fiscal 2012 first quarter earnings conference call. Certain statements in this conference call will constitute forward-looking statements, which are subject to risks, uncertainties, and contingencies. HEICO's actual results may differ materially from those expressed in or implied by those forward-looking statements as a result of factors including, but not limited to, lower demand for commercial air travel or airline fleet changes, which could cause lower demand for our goods and services, product specification costs and requirements, which could cause an increase to our cost to complete contracts, governmental and regulatory demands, export policies and restrictions, reductions in defense, base, or homeland security spending by U.S.
and/or foreign customers or competition from existing and new competitors, which could reduce our sales, HEICO's ability to introduce new products and product pricing levels, which could reduce our sales or sales growth, HEICO's ability to make acquisitions and achieve operating synergies from acquired businesses, customer credit risk, interest and income tax rates, and economic conditions within and outside of the aviation, defense, space, medical, telecommunication, and electronic industries, which could negatively impact our costs and revenues. Those listening to this call are encouraged to review all of HEICO's filings with the Securities and Exchange Commission, including, but not limited to, filings on Form 10-K, 10-Q, and 8-K. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise. The moderator for today's call is Laurans Mendelson, Chairman and Chief Executive Officer of HEICO Corporation.
Please go ahead, sir.
Speaker 2
Christy, thank you very much. Before reviewing the first quarter operating results in detail, I'd like to take a few moments to summarize the highlights of what we consider another record-setting quarter. Consolidated net sales and operating income represent all-time record quarterly highs for HEICO, driven principally by all-time record net sales and operating income within our Electronic Technologies Group and record first quarter net sales and operating income within our Flight Support Group. Consolidated net income and operating income for the first quarter of 2012 are up 12% and 16%, respectively, on a 22% increase in net sales over the first quarter of 2011. The Flight Support Group set a first quarter net sales and operating income record, improving 15%, respectively, over the first quarter of 2011.
The increase in net sales reflects organic growth, approximating 10%, as well as additional net sales contributed by an acquisition in the first quarter of fiscal 2011, while the increase in operating income is principally the result of increased sales volumes and improved operating margins. Electronic Technologies set all-time quarterly net sales and operating income records in the first quarter of 2012, improving 38% and 4%, respectively, over the first quarter of 2011. The increase in net sales and operating income principally reflects additional net sales contributed by the acquisitions of 3D Plus in September 2011 and Switchcraft in November 2011, as well as organic growth approximating 7%. Net income per diluted share increased 13% to $0.45 for the first quarter, and that was up from $0.40 in the first quarter of 2011.
Net income per diluted share in the first quarter of 2011 included a $0.02 per diluted share benefit from the retroactive extension of R&D income tax credit. Internally, we adjust the first quarter of 2011 to $0.38 on a more normalized basis. In the way we look at it from a management perspective, net income was really up a little bit over 18% for the first quarter of 2012. In November 2011, as you know, we acquired Switchcraft through the purchase of all of the stock of Switchcraft's parent company, and that was for the price of about $142 million. Switchcraft is a leading designer and manufacturer of high-performance, high-reliability, and harsh environment electronic connectors and other interconnect products.
The acquisition is very consistent with our practice of acquiring outstanding niche designers, manufacturers, and marketers of critical components in aerospace and electronics with strong management teams and enables us to broaden our product offerings, technologies, and customer base. A little more color on that. Switchcraft is an old line company with what we consider an outstanding management team, extremely experienced. We have the highest regard for that management team. As a matter of fact, some people have asked us how it's tracking, how it's doing, and it's doing exactly what we thought it would do. In December 2011, we completed a new $670 million revolving credit. Excellent flexibility to continue to aggressively pursue quality acquisition opportunities, albeit perhaps larger than we have looked at in the past.
We're grateful that HEICO's excellent performance and credit characteristics have enabled us to more than double the size of the prior $300 million facility. In January 2012, we paid our 67th consecutive semiannual cash dividend since 1979, and this was at a rate of $0.06 per share. As of January 31, the company's net debt to shareholders' equity was a low 25.9%, with net debt, which is total debt less cash and cash equivalents, of about $167.7 million. That reflects the acquisition of 3D Plus and Switchcraft. You'll note that we have no significant debt maturities until fiscal 2017 and a net debt to EBITDA leverage ratio of less than 1 time. Moving on to net sales, consolidated net sales in the first quarter of 2012 increased 22% to a record $212.7 million, up from $174.2 million in the first quarter of 2011.
Flight Support net sales increased 15% to a first quarter record of $138.9 million, up from $120.6 million in the first quarter of 2011. The increase in net sales for the first quarter of 2012 reflects organic growth approximating 10%, as well as additional net sales contributed by a full three months of operating results from an acquisition in the first quarter of 2011. The organic growth principally reflects increased market penetration within certain of our industrial product lines, and these were primarily products used in heavy-duty and off-road vehicles, and also within certain of our aerospace repair and overhaul services. This compared favorably to the 2011 first quarter. Aftermarket part sales were also up in the first quarter of 2012 over the first quarter of 2011, but at a slower pace.
We attribute the slower growth percentage primarily to, excuse me, extraordinary growth in the first quarter of last year when organic growth approximated 24%. That was despite November and December being typically Flight Support Group's weakest months. That was then followed by a typically strong January. Last year most likely was impacted by some level of pent-up maintenance demand following cutbacks by the airlines in 2009 and 2010. In addition, the slower sales growth in the first quarter of 2012 reflects our reduced sales emphasis on certain lower margin PMA products. Electronic Technologies net sales increased 38% to an all-time record of $74.5 million, up from $53.9 million in the first quarter of 2011.
That increase in net sales in the first quarter of 2012 reflects additional net sales of approximately $17 million contributed by the previously mentioned acquisitions, with Switchcraft and 3D Plus, as well as organic growth of about 1%. Let me just mention that we always talk about ETG growing at an organic of about mid to upper single digits. It was right on target. The organic growth in Electronic Technologies principally reflects continued strength in demand for certain of our medical and defense products. Net sales for the first quarter of 2012 by market were composed approximately 55% commercial aviation versus 60% in the full fiscal 2011, 24% from defense and space, both in the first quarter of 2012 and the full fiscal 2011, and about 21% from other markets, which includes medical, communication, electronics. This was 16% in the full fiscal 2011.
Operating income consolidated for the first quarter of 2012 increased 16% to a record $37.6 million, up from $32.5 million in the first quarter of 2011. Flight Support's operating income increased 25%, a very healthy 25%, to a first quarter record of $25.5 million. That was up from $20.4 million in the first quarter of 2011. This principally reflects increased sales volumes as well as improved operating margins. ETG operating income increased 4% to a record $16.2 million, up from $15.5 million in the first quarter of 2011. This represents operating income contributed by the recently acquired businesses. The operating margins consolidated for the first quarter of 2012 was 17.7% compared to 18.6% in the first quarter of 2011. Flight Support operating margins were 18.4% in the first quarter of 2012. That was up significantly from $16.9 million in the first quarter of 2011.
That reflects a favorable product mix and favorable impact on operating margins that higher sales has on the fixed portion of our operating expenses. ETG operating margins were 21.8% in the first quarter of 2012 compared to 28.8% in the first quarter of 2011. That decrease in operating margin for the first quarter of 2012 principally reflects the impact from lower operating margin realized by our French subsidiary, newly acquired 3D Plus, and a more favorable product mix in the first quarter of 2011. The lower operating margin from 3D Plus is principally attributed to softer orders in certain of its products in the first quarter of 2012, resulting primarily from the economic uncertainty throughout Europe and approximately $1.2 million associated with non-cash charges for amortization of intangible assets and inventory purchase accounting adjustment.
Just to add a little bit of color, I guess most of you understand this, but that is where certain inventories that are required, principally finished goods under the accounting rules, must be written up from their historical cost as of the acquisition date. The increase in that value or cost is charged to cost of sales as the items are shipped. That has the result of reducing the operating income because that higher cost inventory is costed out in cost of sales. Although margins were lower than were expected at 3D, there were no asset write-downs. Just a little bit of color on that. We purchased 3D because we felt it was an unusual opportunity to gain access to European and foreign markets. Often it's difficult for U.S. companies to access particularly European markets, because they're very pro-European producers and European companies.
This gave us a foothold in a very, what we believe is an expanding and very strong market, world market, Europe and Far East and so forth, for the products that 3D makes. If you want to know what they are, later on, Victor can respond to that and give you more detail. As we discussed before, variations in product mix and the timing of customer delivery requirements may cause operating income and operating margins of Electronic Technologies Group to vary from quarter to quarter. This is true for 3D Plus as well. I think there's a very good example. We do believe at this point, based upon 3D management, to see stronger performance, particularly in the second half of the year as orders have been picking up and are expected to pick up. We think 3D was the right decision.
You know, the actual operations will prove, should prove, that out. Excluding 3D, Electronic Technologies' operating margin in the first quarter of 2011 would have been 25%, approximately 25%, which is comparable to the Electronic Technologies' full-year operating margins. They normally approximate 25% to 26%. Diluted earnings per share increased 13% to $0.45 in the first quarter of 2012, up from $0.40 in the first quarter of 2011. As I mentioned earlier, the first quarter of 2011 includes $0.02 benefit from retroactive extension of the R&D tax credit. I told you internally, for operating purposes, we look at 2011 as really $0.38. The growth in our mind is about 18.4% on a diluted earnings per share basis. Fiscal 2011 diluted earnings per share has, of course, been retrospectively adjusted to reflect the 5-for-4 stock split that was effected in April 2011.
Depreciation and amortization expense increased by $2.7 million to $7 million total in the first quarter of 2012, up from $4.3 million in the first quarter of 2011. This reflects higher amortization and depreciation expense related to the acquisitions, which I mentioned earlier. Research and development expense increased 15% to $6.5 million in the first quarter of 2012, up from $5.6 million in the first quarter of 2011. This is principally due to further enhanced growth opportunities and market penetration. We always believe that our commitment to invest in new product development has proven very effective over the years. It continues to be a significant part of our long-term growth strategy in both of our operating segments. SG&A expenses were $40.6 million in the first quarter of 2012, versus $31.6 million in the first quarter of 2011.
The $9 million increase in SG&A principally reflects an increase of $7 million attributable to the newly acquired businesses. SG&A spending as a percentage of net sales increased to 19.1% in the first quarter of 2012 from 18.1% in the first quarter of 2011. This principally reflects the impact of higher SG&A expenses as a percentage of net sales at the acquired businesses. Interest expense still is pretty low. It increased to $0.6 million in the first quarter of 2012 from $0.1 million in the first quarter of 2011. The increase was principally due to higher weighted average balance outstanding under the revolving credit facility. That was associated with the previously mentioned acquisitions, of course. Other income in both years was not significant. Our effective tax rate increased to 34.2% in the first quarter of 2012, up from 30.4% in the first quarter of 2011.
The increase in the rate is principally due to the income tax credit for qualified R&D for the last 10 months of fiscal 2010. That was recognized in the first quarter of fiscal 2011 because of the retroactive extension of the tax credits to cover the period from January 2010 to December 31, 2011. The increase in the first quarter of fiscal 2012 was attributed to the expiration of the R&D tax credits as of December 31, 2011, and also our purchase of certain non-controlling interest at the end of the first quarter of fiscal 2011. The net income attributable to non-controlling interest was $5.3 million in the first quarter of 2012 compared to $5.4 million in the first quarter of 2011. The decrease in the first quarter of 2012 principally reflects the previously mentioned purchase of certain non-controlling interests by HEICO.
We acquired a percentage of some of the non-controlling interest during fiscal 2011. That was partially offset by higher earnings in Flight Support, in which a 20% non-controlling interest is held by Lufthansa. Moving over to the balance sheet and cash flow, our financial position and forecasted cash flow remain extremely strong. Working capital ratio is strong at 3.5, that's current assets divided by current liabilities as of January 31, 2012, and that's up from 2.6 at October 31, 2011. DSOs of accounts receivable were 47 days in both January 31, 2012, and October 31, 2011. We continue to closely monitor all receivable collection efforts to limit credit exposure. No one customer accounted for more than 10% of net sales. Top five customers represented approximately 15% of consolidated net sales in the first quarter of 2012 compared to 18% in the first quarter of 2011.
We like that because we're diversifying, and we think that's good for the overall financial health of our business. The inventory turnover rate as of January 31, 2012, was about 126 days. That was up from 113 as of October 31, 2011. That reflects the impact of the previously discussed acquisitions on that computation, and so forth. If you exclude the recent acquisitions, the turnover rate would be 121 versus the actual of 126. Cash flow used in operating activities in the first quarter of 2012 was $2.3 million, primarily driven by the timing of certain payments pertaining to fiscal 2011 year-end and fiscal 2012 payables. We continue to expect fiscal 2012 cash flow provided by operating activities to remain strong and to be in the range of $120 to $130 million. The fact that the first quarter was negative really bears no impact.
We expected that, and that's nothing to be concerned about. Capital expenditure in the first quarter of 2012 was $3.8 million, and we budget CapEx for the full 2012 to be in the range of $20 to $22 million. Now, looking ahead, the outlook, improved economic conditions and increased capacity in the airline industry resulted in higher demand for Flight Support Group's products and services and strong sales growth for each of our reporting periods during 2011. Based on overall economic uncertainty, the commercial airline industry expects continued year-over-year capacity growth, but perhaps at a slower rate than experienced during 2011. In our Electronic Technologies Group markets, we generally anticipate stable demand for our products, but recognize that government deficits and spending reduction plans may moderate demand for certain of our defense products.
Based on current market conditions, we continue to estimate fiscal 2012 growth in the area of 15% to 18% in net sales and 10% to 12% in net income over fiscal 2011 levels, with consolidated operating income approximating $155 million and depreciation and amortization about $30 million. These estimates include the recent acquisitions of 3D Plus and Switchcraft, but exclude additional acquisitions, if any. Consistent with our long-term growth goals, management continues to target net income growth of 20% for the full fiscal 2012 year, but it remains too early in the year for us to make that prediction. We do continue to pursue a number of attractive acquisition opportunities. Some of the opportunities we put on hold because of pricing. We don't know if those opportunities will come back, if the sellers will lower the pricing.
There's a possibility, and maybe they won't, but certainly the pipeline is pretty good for the acquisitions over the year. Historically, we've made two to three acquisitions during the year. I think that's reasonable to the outlook at this time. In closing, we will continue to focus on intermediate and long-term growth strategies with an emphasis on the development of new products, new services to meet the needs of our customers, and strategic acquisition opportunities that complement our existing operations. That's the extent of my prepared comments. I would like Christy, our operator, to open the floor to questions. Of course, Tom, Eric, Victor, all here, to be responsive to your questions. Christy, let's open the floor.
Speaker 5
Thank you. At this time, if you would like to ask a question, press star then the number one on your telephone keypad. Your first question comes from Tyler Hojo of Sadodian Company.
Speaker 3
Yeah, hi. Good morning, everyone.
Speaker 2
Good morning, Tyler.
Speaker 3
Yeah, first question, I just wanted to go back to the growth rate in the Flight Support Group. I guess you mentioned in your prepared remarks that you were de-emphasizing certain lower margin products. Just kind of wondering if you could maybe quantify that a little bit or just, you know, that trend.
Speaker 2
Eric is going to respond to that.
Speaker 0
Hi, Tyler. As you know, the team members at HEICO and the leadership are incentivized on operating income. That's really the performance that our leadership looks at, and we think the metric that our shareholders want us to focus on. As a result, they really don't—I mean, sales is just not something that is really important to them because it's somewhat irrelevant to the total earnings. As a result, there were certain lower margin products which consume a certain amount of time to develop, support, and all, you know, just generally consume leadership and management time. In certain businesses, we made certain decisions to de-emphasize certain lower margin areas and focus on higher margin areas. I think that's why you've seen the margin, one of the reasons why you've seen the margin pick up in the Flight Support Group. We can't get into the details for competitive purposes.
Perhaps some of these lower margin areas will end up coming back in terms of demand, perhaps at price levels that are more attractive to our business unit. They've made the decision at this point just to de-emphasize certain products.
Speaker 3
Okay.
Speaker 0
That's all part of the natural running of the business. I would not say it's really material to the trend or where the company is going.
Speaker 3
Were the lower margins more attributable to volume or price?
Speaker 0
It could be both. It could be both a volume as well as price. Sometimes, frankly, with customers, you got to push back a little bit. When margins in certain areas need to be picked up, you know, we have to take certain positions. We continue to be very customer-friendly, and we want to obviously sell as much as we possibly can, but we've got just a certain amount of bandwidth. We really want our sales and product support people to focus in areas that are most accretive to HEICO and its shareholders.
Speaker 3
No, it totally makes sense. Just kind of a follow-up to that, just kind of wondering, you know, how you're looking at maybe enacting further price increases when you look at your PMA catalog as it sits today. I mean, what have you enacted and kind of just how are you thinking about that?
Speaker 0
We don't publish a, you know, we don't announce really an average price increase. There are all sorts of ways to calculate it. It can be weighted by volume, unit volume, which, of course, nobody knows about us, and it can be calculated just as a straight average of all the parts, you know, the thousands of parts that we provide. We continue to be extremely customer-friendly to those customers who want to provide long-term commitments to us, and that is a vast majority of our business. OEMs have taken the, our competitors have taken the opportunity to jack up prices significantly. As a matter of fact, there tends to be a tremendous amount of that in the industry.
I was just over in Singapore last week, and many people were commenting that on the newer platforms, they sense that the OEM prices are going to be even more egregious than they've seen in the past. I think that there's opportunity for us. We get pricing, you know, a little bit of pricing in our existing parts, but of course, we basically get pricing as the successive generation of parts are more expensive, significantly more expensive than the ones that they replaced. We sort of get, you know, a secular pricing usually with each new generation of product. We continue to look at that, and where we can get pricing, you know, we certainly do.
Speaker 3
Great, thanks for all the color. I'll hop back in the queue.
Speaker 0
You're welcome. Thank you.
Speaker 5
Thank you. Your next question comes from Arne Ersher of CJS Securities.
Speaker 1
Hi, to follow up on Tyler's question, what is it, what's exactly involved when you de-emphasize a product? Do you discourage your sales force, or do you, how do you de-emphasize a product?
Speaker 0
Yeah. Arne, this is Eric. We have a limited number of salespeople. I'm guessing we've got roughly 100 salespeople in the organization. They only have a certain amount of time with customers to be able to focus on a certain number of products. There are some products that are just, frankly, less profitable than others. Some of those products may be less important to our customers as well. We just don't spend the time on them that we spend in other areas. Don't get me wrong. We're not going out there saying to customers, "Please don't order these parts," but we may not be following up. We may be raising the price somewhat. We may not care if the volume falls off. We may have our people focused in other areas. When you sit down with the customer, you can go over X number of items per time.
Maybe those items are not on the list. That's what we mean in terms of de-emphasizing the product. Just to be clear, we are not discontinuing the sale of those products. We still continue to offer those products. Sometimes we just need a higher pricing to make them more attractive or higher volume. It's just in the natural flow of business.
Speaker 1
You had very good margin this quarter in Flight Support, and I assume part of it relates to the strategy. Should we, on a go-forward basis, assume you can maintain, you know, 50, 100 basis points higher margin in Flight Support if this trend continues?
Speaker 0
Arne, this is Thomas Irwin. As we went into the year, our comment was in terms of margins that we saw some opportunity for modest margin improvement. We continue to think that's the case for Flight Support Group, and it'll partly depend on mix going forward. I think we do expect some strengthening, whether they'll be at that high level throughout. It's kind of hard to tell pre-determining by quarter in particular. I think we continue to expect modest improvement for the full year.
Speaker 1
Tom, as long as I have you, long-term debt jumped to $190 million. Should we assume that Switchcraft was roughly $150 million and your availability currently is about $500 million?
Speaker 0
Yeah. Actually, the purchase price, as Larry mentioned earlier, for Switchcraft was $142 million. Prior to the close of last fiscal year, of course, we borrowed for 3D Plus, and there was some outstanding there as well. Typically, and obviously, with the cash flow from operations forecasted $120 million, $130 million, we'll pay that down throughout the, not totally pay it down over the year, but there'll be a pro rata reduction the remainder of the year.
Speaker 1
My final question is on 3D Plus, where you mentioned, you specifically highlighted softer orders for certain of its products. Do you believe it's timing, or is there a fundamental change in those specific products? Also, remind us if 3D Plus has an earnout.
Speaker 0
Arne, this is Victor. The answer is, we don't think it's a fundamental shift in the products. We think it's timing. In fact, we've seen the orders improve substantially of late. I think as that continues and those things get shipped, you deal with lead times and so forth. I think we would look for improvement in the sales line in the third quarter of our fiscal year. There is no earnout for that transaction.
Speaker 1
Thank you very much.
Speaker 0
You're welcome.
Speaker 2
Arne, there's just one comment, picking up on your question about the debt. I think that we have plenty of debt capacity for any acquisition plan that we might have. The $190 million that we show on the balance sheet, and there's $27 million in cash, so the net is $160 million, $170 million, whatever the number is. With cash flow of, give or take, $120 million, $130 million, that's going to be way, way down. We have more than enough debt capacity for anything we're even thinking about.
Speaker 1
Oh, plus you have an accordion feature on the debt you have.
Speaker 2
Exactly. Exactly.
Speaker 1
I'm not going to remind you of the math we've talked about. If you are successful in these acquisitions, I assume it sounds like you're remaining quite price disciplined.
Speaker 2
Yeah. I think that's been the, you know, part of our success that, you know, maybe in some cases we should have paid more, but, you know, we can't argue with success. The process has worked well. You can, as you well know, overpay and then you can see markets drop. I have said publicly that one of the acquisitions we were looking at was in the defense area. It was a very good acquisition. It still is a potentially very good acquisition. What is the future of defense? You can pay one price today and then wind up seeing the defense budget cut and seeing the sales and earnings of that acquisition fall. That's going to impact the growth going forward. All these things we try to balance, you know, purchase price, growth, everything else. We would rather, you know, the money's not burning a hole in our pocket.
We can grow very, very nicely, and we can look elsewhere. There's plenty of fish in the sea. That's how we operate the business. As you well know, we're very conservative in the way we spend the bank lines and shareholders' money. I think, I'm confident that the acquisition program will work out fine.
Speaker 1
Larry, you sound like you own a few shares and maybe not driven by size and ego.
Speaker 2
For sure.
Speaker 5
Thank you. Your next question comes from Julie Yates of Credit Suisse.
Speaker 4
Good morning.
Speaker 2
Good morning, Julie.
Speaker 4
Victor, this one's for you. Just in ETG, can you help us understand the weakness in the margins a little bit more in terms of how they should trend the rest of the year if sales on 3D Plus aren't going to come back until maybe the third quarter? Could you see this weakness persist into next quarter?
Speaker 0
I think it vacillates. You know, it moves up and down and sort of oscillates, as it has historically. It's not unusual for us to see lower margins in the business. I think it will be in the second quarter. It's just too early to tell where we're going to be in the second quarter alone. I think for the full year, we're still thinking that we should get to that sort of mid-20% margin that we've talked about historically.
Speaker 4
Okay.
Speaker 0
As I said earlier in response to Arne Ersender's question, we're seeing order improvement, significant order improvement in the one place where it particularly dragged us down.
Speaker 4
Okay. Did Switchcraft have any impact on the margins in the quarter?
Speaker 0
No. I think it was pretty much, yeah, it was that Switchcraft, number one, did perform as expected. Number two, even with the purchase accounting adjustments, the amortization and inventory adjustments are the type of things that we expected. It didn't have a significant change on the reported margins, you know, plus or minus. It's in line. That was a higher margin visit that met our norm, if you will.
Speaker 4
Okay. Then.
Speaker 0
We think 3D Plus on the long-term basis will hit our norm as well. The near term, in fact, has been a shortfall.
Speaker 4
Okay. Great. Tom, just on SG&A, at 19% of sales, how do we think about that in the rest of the year? I think you mentioned $7 million of the increase was from acquisitions. Does that continue in the year, or is that more one time in the quarter?
Speaker 0
I think the answer is those businesses have a slightly higher mix of SG&A versus margin. Again, we focus on the operating income margin line, and they're at our expectations or they will hit our targeted operating margins. They do, being the types of businesses, have a little bit more of a sales effort. As an example, in smaller businesses, often the two or three key executives are SG&A classified, but they're also, you know, the number one salesmen, the number one technical guy. That tends on these smaller electronic businesses to weight the SG&A above sort of industry averages of bigger companies. Similarly, the direct manufacturing costs or gross margins tend to be higher than overall larger industry costs.
Speaker 4
Okay. On a full-year basis for FY 2012, as a percentage of total sales, would we expect it to increase over the 17.8% in FY 2011?
Speaker 0
Yeah, I would say so. I would say it'd be more norm. I think a run rate is a bit more typical than what it may be last year before we bought these businesses.
Speaker 4
Okay, thank you.
Speaker 0
Both of the businesses that, in effect, we're saying have higher SG&A percentages than the 17.8%, so they would drive them up.
Speaker 4
Okay. Is it as high as the 19% or somewhere in between there?
Speaker 0
It would be in the higher range.
Speaker 4
Okay, thank you.
Speaker 5
Thank you. Your next question comes from Kenneth George Herbert of Wedbush.
Speaker 1
Hi. Good morning, everybody.
Speaker 2
Good morning, Ken.
Speaker 1
just wanted to, first, one final question from my end on 3D Plus. When you think about this business, it sounds like there's some timing on the top line, which should benefit later in the year. How much of the recovery in the margin of this business through the rest of this year is from potential changes to the cost structure? Is that something that you've got in the plans or much flexibility on?
Speaker 0
Ken, this is Victor. The answer is there is some improvement in the cost structure that's going on there now, but the improvement in the bottom line will come mostly from the top line growth.
Speaker 1
Okay.
Speaker 0
From resumption to kind of getting back to where they should be.
Speaker 1
If Switchcraft performed as planned, is it safe to say that the top line shortfall from 3D Plus in the quarter was, well, seemed like it was much more significant than you were expecting maybe, you know, one or two quarters ago when you announced the acquisition? Is that a fair statement?
Speaker 0
Yes, that's correct.
Speaker 1
All right. I think.
Speaker 0
Yeah.
Speaker 1
No, go ahead. I'm sorry.
Speaker 0
No, I think that summarized it well.
Speaker 1
Okay. Just to jump over, within Flight Support, you mentioned, or you highlighted specifically better growth on the repair and overhaul side of the business. Eric, can you provide any more details on that in terms of specific parts or specific areas that you're seeing? I tend to think of that as, and I think over the last few quarters, you've seen better growth on the parts side than on the repair side. It seems like this quarter was the inverse. Can you provide any more details specifically on the repair side and what you're seeing there? Maybe through the rest of 2012, do we see growth on that repair side, maybe outstripping the parts growth?
Speaker 0
Ken, yeah, this is Eric. As you know, we can't, we have a hard time getting into details of specific types of products or customers, because our competitors are on the call. As you know, we do all sorts of component overhaul. We're one of the largest non-OEM, non-airline affiliated component overhaul businesses in the United States. We do fuel, hydraulic, pneumatic, electromechanical, avionics, wheels and brakes, structures, all sorts of components basically throughout the aircraft. We're seeing a lot of interest in those products. As you know, our business is, you know, nothing normally goes up in a straight line. Things bounce around a little bit. We'll capture a bunch of market share in a particular area, and then we'll consolidate it.
It will go flat for a little bit of time, and then it jumps back up as we lay the groundwork for more business and as we add more capabilities. I think what you're seeing is just really the natural cycling of the business. I wouldn't draw any conclusions that we're focusing on one part of the business over the other. It's just sometimes there's particular strength in one area, and sometimes we don't exactly know why until many quarters after the fact, and we finally figure it out. Maybe a customer loves us with a particular new type of product in the beginning, after that they've got stocked up waiting for us to go into a certain area, and then it levels out at a different rate. All sorts of things invariably happen.
We are seeing significant opportunity in the component overhaul side using our parts as well as using OEM parts. I wouldn't say that it's in any one particular area. It's just the really strength throughout the entire area. Over on the parts side, we continue to develop all the same type of parts that we've developed now for the last, you know, 5 or 10 years. We're just continuing to do that as well.
Speaker 1
Okay. That's helpful, Eric. Just one final question. When you look at the overhaul and the repair business, it looked like it was a really very strong quarter for that side of the business. Is there any reason for you to think that strength won't continue through the rest of this fiscal year?
Speaker 0
No, I wouldn't say that. I wouldn't expect the strength to continue. The businesses, as I said, move around and we see strengths in different areas at different times. I wouldn't want to call it a trend or anything like that. We typically don't understand it until well after the fact. I expect to see continued growth, frankly, in all of the products and services that we offer within FSG. I wouldn't say that the growth is going to come from one particular area or another. I think it's going to be pretty broad-based.
Speaker 1
Thank you very much. Good quarter. Thank you.
Speaker 0
Thank you, Ken.
Speaker 1
Thank you.
Speaker 5
Thank you. Your next question comes from Steve Levinson of Stifel Nicolaus.
Speaker 1
Thanks. Good morning, everybody.
Speaker 2
Good morning, Steve.
Speaker 1
I know you don't like to talk specifically about parts, but I'm sorry, I've got to ask this one. It looks like there's going to be some pretty good growth in engine maintenance events, particularly this year and continued strength into next year. It looks like it's skewed more to narrow bodies and even within narrow bodies, more towards, you know, A320 family and the V2500 engine. Are you all satisfied with your content on V2500? Would you like to have more, in both parts and services? Do you think that'll be helpful this year?
Speaker 0
Yeah. I think, you know, we continue to develop products in all platforms. I would say that if there is a resurgence in narrow body engine demand, that will definitely benefit us. You know, we continue to develop new products. We've already got a large portfolio in narrow body engine parts, and I would expect to see continued growth in that area if that, in fact, comes to fruition.
Speaker 1
Great. Thanks a lot. Thanks for all the detail in the call.
Speaker 0
Thank you.
Speaker 2
Thank you.
Speaker 5
Thank you. Your next question comes from JB Groh of D.A. Davidson.
Speaker 3
Hey, morning, guys. Thanks for taking my call.
Speaker 2
Good morning.
Speaker 3
Larry gave us some details on ETG sort of business mix. Victor, I was wondering if you could sort of give us a kind of a pro forma look with Switchcraft and 3D Plus, what that business mix is like when you include those two, trailing basis or something.
Speaker 0
You mean like end markets?
Speaker 3
Yeah, yeah.
Speaker 0
Like the end markets. Okay. I think what the business looks like, with 3D Plus and with Switchcraft.
Speaker 3
Switchcraft.
Speaker 0
We probably are somewhere in the neighborhood, in terms of defense, it's probably somewhere in the neighborhood of about 30% or so straight defense, on a kind of a, I think, a go-forward basis, somewhere in that range. Space is probably something more like, going forward, probably somewhere in the neighborhood of 15%. In the other markets, it's probably somewhere in the neighborhood of 40% to 45%, somewhere in that range of the business. Of course, commercial aviation is probably somewhere in the upper single digits, somewhere around there. Mm-hmm. Within the other markets, medical would be a significant portion, maybe, I don't know, somewhere a third to a half, something like that, of the remainder. Mm-hmm.
Speaker 3
Okay. You lessen the dependence on space and defense with the deal.
Speaker 0
In the case of Switchcraft, yes.
Speaker 3
Yeah.
Speaker 0
Now, in the case of 3D Plus, that's almost all space.
Speaker 3
Right. Okay. That makes sense. Good. One for Eric, what's your sense of sort of customer inventory levels? It seemed like some other guys that are sort of aftermarket levered had these blowout quarters in terms of numbers, and capacity didn't change that much. I was just kind of curious as to what your feel is for inventory levels. What are your sales guys saying on that front?
Speaker 0
Actually, there was, I think, a focus by a number of customers in November and December to bring down their inventory level. I think that, you know, they continue to bring it down as they report their year-end numbers. We see things running at a pretty stabilized rate right now. We have not seen, if you will, the traditional restocking where customers want to keep more months on the shelf. I think customer inventories remain very, very lean. If there is a pickup in demand in any of these areas, I would expect that we would be selling parts very quickly for it because the airlines really just don't have, they don't have much inventory on the shelves right now.
Speaker 3
In the past, you've said you get these surges in fuel prices, the phone starts to ring a little bit more because they're looking for ways to save. How do you kind of balance that with the probability that capacity gets reined in a little bit? What are your thoughts there relative to last cycles where we had big moves in fuel?
Speaker 0
Yeah, there's no question that whenever fuel prices go up, the airlines get more serious about cutting their costs, and they become much less complacent and much more aggressive. I think that is a good, you know, medium and long-term driver for our business. As far as the short term, if they remove any capacity, then obviously that would hurt. However, if you look at it, the airlines have been able to pass through a significant amount of the fuel cost increases over the last, you know, six months or so. You know, we see continued strength by the customers. I think we're fortunate in that some of the fleets that are being impacted don't impact us as much, but we anticipate continued strength, really, in the markets that we serve. You know, as airlines come under pressure, I think it provides great opportunity for us.
Speaker 3
Great. Just a quickie for Tom. Tom, what's the, you mentioned this, but what's the tax rate embedded in your guidance?
Speaker 0
For the full year, it's basically based on the first quarter, you know, running around 34%. That does assume that, you know, there's no extension of the now expired R&D tax credit. There's some discussions, but at this point, we have not factored that in there. Again, that would be an outside if it is extended or it's certainly that it's extended before the end of the year. At this point, it looks like the current first quarter rate continued throughout the year, with no additional R&D extension.
Speaker 3
Great. Thanks for your help. See you guys in a few weeks.
Speaker 0
Thank you.
Speaker 2
Thank you.
Speaker 5
Thank you. As a reminder, for questions, press star then the number one on your telephone keypad. Your next question comes from Eric Mendelson of Stephens.
Speaker 1
Hey, good morning, guys.
Speaker 2
Good morning, Eric.
Speaker 1
Can you maybe give a little more clarity on the PMA products that you talked about you were de-emphasizing? Is there maybe some common theme as to why you can't get the pricing that you want? Is there competition, alternatives, or the OEM sort of lowering price? Can you sort of talk about, are they certain types of products, maybe older engines or non-engine parts?
Speaker 0
Yeah. I think it really is due to all of the above. I would not say, though, that it is due to an increased amount of competition in those areas. I think that that's not the case. It would really just be, you know, we have a natural distribution of profitability by part, and sometimes it depends on the amount of volume that we've got on a particular part. Sometimes we've got to increase our market share on something for it to be more competitive, or maybe it's an older product where the price was set a long time ago, and as a result, the OEM price is not as high as it is on a similar part on a newer platform. It really covers a whole bunch of different products. I would not say it's due to increased competition for those parts.
It really is, I mean, we offer tremendous value on what we provide, and sometimes the value is, frankly, just too good. You know, we decide that if the value is too good in some areas, we have to focus on more profitable areas. We just stop talking about it as much, and we stop going after it. We're not so aggressive. Sometimes you have to stop providing a part for a certain period of time until the customer is willing to accept that the current price level has increased, and then they come back at a significantly higher price. I would just say it's just part of the general flow of the business. This is no change. We've been doing this for 22 years, and I'd say that this has happened for the whole time that this leadership team has been out there.
Speaker 1
Are there any sort of differences here that you're seeing in terms of engine versus non-engine parts? Are there any differences in terms of your ability to get the pricing that you want, or is that just not an issue?
Speaker 0
No, I would say that's not an issue. That's really not an issue for us.
Speaker 1
Okay. In terms of 3D Plus, can you talk about, you know, is it basically, was it across their whole product base that you saw sort of the drop-off in demand, or were there really certain products that were more impacted and why?
Speaker 0
It was probably more on their main product line. They have a few product lines there, and I think it was more in particular markets and market segments, particular customers who were expected to place orders at the time. We were told that they were pushed out.
Speaker 1
Okay, I guess lastly, with regards to the FSG business, you talked about most of the growth was related to the industrial products. I guess that 10% organic growth in the FSG business. Can you give us a ballpark figure as to what kind of growth you saw on a year-over-year basis organically for the aerospace aftermarket business? Would a mid-single-digit 5% kind of number be a reasonable ballpark?
Speaker 0
You're speaking about all commercial aviation?
Speaker 1
For the FSG segment, because you said that a lot of the growth in that was driven by the industrial business.
Speaker 0
Yeah. I mean, it's pretty overall, the commercial aftermarket would be pretty close to the full 10% organic growth. It's partly because, remember, the industrial product, which again was growth above 10%, it's a small product line.
Speaker 1
Right. Okay. It was around, it was around a little, maybe a point or two below the 10%, but not too far different.
Speaker 0
Exactly. Yeah.
Speaker 1
Okay. Great. Thanks a lot, guys. Good quarter.
Speaker 2
Thank you.
Speaker 5
Thank you. Your next question comes from Michael Frank Ciarmoli of KeyBanc Capital Markets.
Speaker 1
Hey, good morning, guys. Thanks for taking my questions.
Speaker 2
Good morning, Mike.
Speaker 1
How are you? Just a couple of housekeeping questions. I may have missed this. Did you guys give, within the Flight Support Group, did you give the mix between product and services for the quarter?
Speaker 0
I've.
Speaker 1
Would you be willing to?
Speaker 0
I would say, you know, I'm not sure we did, but it's probably running, and I'll have to check the exact number. It's probably running pretty close to what it's normally running in terms of, say, 65%, 35%, something like that.
Speaker 1
Okay.
Speaker 0
I don't think it'd be too far off that.
Speaker 1
Okay. Just a point of clarity. On the ETG margin, you talked about, you know, kind of excluding 3D Plus, you'd be at a 25% margin. Was that also excluding the amortization or, you know, excluding that additional, you know, I guess, charge for amortization, you know, of $1.2 million puts you back up at a higher level over the 25%?
Speaker 0
The answer is the 25% computation basically takes reported to start and just excludes all of the 3D Plus. It would be the sales, the cost of sales, the SG&A, which would include the amortization and the purchase accounting exception. It is totally excluding 3D Plus. It is sort of a normalized or if 3D Plus were to hit the rest, and then it would be in the 25% range.
Speaker 1
Okay. Perfect. And then just within ETG, are you guys seeing any pricing pressure from some of your defense customers, given kind of what's been happening with the budget, with the cuts? Is that starting? Are you starting to get pushback on pricing for, you know, just better terms from some of your customers?
Speaker 0
I don't think it's any different than it's been over the past several years, you know, five years or more. We're not seeing anything more pronounced at this point.
Speaker 1
Okay, and then last one for me, just on Switchcraft. Can you give us sort of, you talked about, you know, obviously the order flow with 3D Plus. Any kind of order patterns or trends that you're seeing in Europe from some of the Switchcraft product lines? Nothing.
Speaker 2
That's notable on the Switchcraft launch that we're seeing out of Europe. I think, you know, that's not a huge part of their business. They're more North American and some Asian, but they do business in Europe, but nothing that jumps out.
Speaker 5
Okay, perfect. All right, thanks a lot, guys.
Speaker 2
Thank you.
Speaker 3
Thank you. At this time, there are no further questions. Are there any closing remarks?
Speaker 2
The only closing remarks that we thank everybody on the call for their interest in HEICO. We are available if you have additional questions. Tom, Eric, Victor, and I are available. Give us a call. If we don't hear from you, we'll either see you at an AeroConference over the next couple of months, or we'll be on the second quarter call sometime near the end of May. We thank you, and that's the end of the first quarter call. Thank you.
Speaker 3
Thank you. This does conclude today's call.