HEICO Corporation — Q2 Fiscal 2017 10-Q
Business context and period: HEICO operates through its Flight Support Group (FSG) and Electronic Technologies Group (ETG). This unaudited filing covers the quarter and six months ended April 30, 2017; comparisons are with the corresponding 2016 periods. Share and per-share figures reflect the April 2017 five-for-four stock split.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $368.7 million | $350.6 million | $712.1 million | $656.9 million |
| Gross margin | 38.1% | 38.2% | 37.3% | 37.5% |
| Operating income | $76.5 million | $66.8 million | $141.1 million | $119.4 million |
| Operating margin | 20.8% | 19.0% | 19.8% | 18.2% |
| Net income attributable to HEICO | $45.7 million | $38.7 million | $86.6 million | $69.9 million |
| Diluted EPS attributable to HEICO | $0.53 | $0.45 | $1.00 | $0.82 |
- Q2 sales increased 5%; operating income rose 15%. Six-month sales increased 8%; operating income rose 18%. Management attributed growth to organic demand and, for the six-month ETG comparison, sales from a fiscal 2016 acquisition.
- For the six months, FSG sales were $452.7 million, up 7%, and ETG sales were $267.3 million, up 13%. Both groups reported higher operating income and margins.
- SG&A declined to $63.8 million in Q2 and $124.7 million for six months; SG&A as a share of sales fell to 17.3% and 17.5%, respectively. Gross margin was broadly stable. Six-month R&D expense was $22.5 million, versus $20.0 million.
- Six-month effective tax rate fell to 29.5% from 31.1%, partly due to a $3.1 million discrete tax benefit from adopting share-based payment accounting guidance. This benefit increased HEICO-attributable net income by $2.6 million, net of noncontrolling interests.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was $97.7 million, compared with $102.7 million. Capital expenditures were $13.5 million, implying operating cash flow less capital expenditures of approximately $84.2 million. Investing activities used $95.3 million, primarily for acquisitions ($80.8 million net of cash acquired); financing activities used $9.1 million.
- Cash was $36.7 million at April 30, 2017, down from $43.0 million at October 31, 2016. Inventory rose to $325.7 million from $286.3 million; management said the increase supported anticipated higher demand.
- Total debt was $460.9 million, including $457.9 million under the revolving credit facility, versus total debt of $458.2 million at fiscal year-end. The facility was increased by $200 million to $1.0 billion in April; borrowings matured in fiscal 2019, and the weighted-average facility rate was 2.0%. HEICO reported compliance with all covenants and a total-debt-to-shareholders’-equity ratio of 40.5%.
- Management said operating cash flow and available revolver borrowings should fund requirements for at least the next 12 months. Fiscal 2017 capital expenditures were expected to approximate $35 million.
Material changes, outlook and risks
- HEICO acquired an 80.1% interest in Air Cost Control (A2C), an aviation electrical-interconnect products distributor, on April 24, 2017. The purchase price was funded principally with revolver proceeds; the acquisition’s reported-period sales and earnings were not material. Purchase accounting remained preliminary.
- Management raised fiscal 2017 growth estimates to 8%–10% for consolidated net sales and 12%–14% for net income, from prior estimates of 6%–8% and 9%–11%. It anticipated sales growth in both segments, citing demand across most product lines, and reiterated focus on product development, market penetration, acquisitions and financial strength.
- Redeemable noncontrolling interests, reflecting put rights exercisable through fiscal 2025, were estimated at $125.1 million, up from $99.5 million. Contingent consideration liabilities were $19.7 million; their valuation depends on projected acquired-business earnings and other assumptions. A $6.7 million payment related to a prior acquisition was made in May 2017.
- Management identified risks including weaker commercial aviation demand or airline purchasing, defense and regulatory changes, competition, product-development or manufacturing difficulties, acquisition execution, customer credit, and interest, foreign-exchange and tax-rate changes. It expected ordinary-course litigation not to materially adversely affect results, financial position or cash flows. The filing reported no material change in market-risk assessment and no material change in internal controls.
- New revenue-recognition guidance was expected to apply to HEICO in fiscal 2019; the company was evaluating its impact and transition method. Other upcoming accounting changes, including inventory, leases and goodwill impairment guidance, were also under evaluation.
Important facts for investors to verify
- Whether the raised fiscal 2017 sales and net-income growth outlook is achieved, and how organic growth compares with acquisition contributions.
- Whether higher inventory converts to sales and cash, given the decline in operating cash flow and management’s explanation of working-capital movements.
- The final purchase-price allocation and subsequent performance of A2C, along with acquisition funding and integration needs.
- The timing and potential cash cost of subsidiary put rights and contingent consideration, including the assumptions used to estimate future earnings.
- How the $3.1 million discrete tax benefit and increased diluted share count affect comparability of reported earnings and EPS.