HEICO CORPORATION Overview
Our business is comprised of two operating segments, the
The
• Designs, Manufactures, Repairs, Overhauls and Distributes Jet Engine and
Aircraft Component Replacement Parts. The
manufactures, repairs, overhauls and distributes jet engine and aircraft
component replacement parts. The parts and services are approved by the
manufactures and sells specialty parts as a subcontractor for aerospace and
industrial original equipment manufacturers and
government. Additionally, the
distributor, and integrator of military aircraft parts and support services
primarily to foreign military organizations allied with the
leading manufacturer of advanced niche components and complex composite
assemblies for commercial aviation, defense and space applications. Further,
the
insulation blankets and parts as well as removable/reusable insulation
systems for aerospace, defense, commercial and industrial applications,
manufactures expanded foil mesh for lightning strike protection in fixed and
rotary wing aircraft and is a distributor of aviation electrical
interconnect products and electromechanical parts.
• Designs and Manufactures Electronic, Microwave and Electro-Optical
Equipment, High-Speed Interface Products, High Voltage Interconnection
Devices and
types of electronic, data and microwave, and electro-optical products,
including power supplies, laser rangefinder receivers, infrared simulation,
calibration and testing equipment; power conversion products serving the
high-reliability military, space and commercial avionics end-markets;
underwater locator beacons used to locate data and voice recorders utilized
on aircraft and marine vessels; emergency locator beacons utilized on
commercial and military aircraft; electromagnetic interference shielding for
commercial and military aircraft operators, electronics companies and
telecommunication equipment suppliers; traveling wave tube amplifiers and
microwave power modules used in radar, electronic warfare and on-board
jamming and countermeasure systems; advanced high-technology interfaceproducts that link devices such as telemetry receivers, digital cameras,
high resolution scanners, simulation systems
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and test systems to computers; high voltage energy generators, high voltage
interconnection devices, cable assemblies and wire for the medical equipment,
defense and other industrial markets; high voltage power supplies found in
satellite communications, CT scanners and in medical and industrial x-ray
systems; three-dimensional microelectronic and stacked memory products that are
principally integrated into larger subsystems equipping satellites and
spacecraft; harsh environment connectivity products and custom molded cable
assemblies; radio frequency ("RF") and microwave amplifiers, transmitters and
receivers used to support military communications on unmanned aerial systems,
other aircraft, helicopters and ground-based data/communications systems;
communications and electronic intercept receivers and tuners for military and
intelligence applications; wireless cabin control systems, solid state power
distribution and management systems and fuel level sensing systems for business
jets and for general aviation, as well as for the military/defense market;
microwave modules, units and integrated sub-systems for commercial and military
satellites; crashworthy and ballistically self-sealing auxiliary fuel systems
for military rotorcraft; nuclear radiation detectors for law enforcement,
homeland security and military applications; high performance active antenna
systems for commercial aircraft, precision guided munitions, other defense
applications and commercial uses; silicone material for a variety of demanding
applications; precision power analog monolithic, hybrid and open frame
components for a certain wide range of defense, industrial and medical
applications; high-reliability ceramic-to-metal feedthroughs and connectors used
in the industrial and medical markets; technical surveillance countermeasures
equipment to detect devices used for espionage and information theft; and RF
sources, detectors, and controllers for a certain wide range of aerospace and
defense applications.
Our results of operations have been affected by recent acquisitions as further detailed in Note 2, Acquisitions, of the Notes to Consolidated Financial Statements.
Presentation of Results of Operations and Liquidity and Capital Resources
The following discussion and analysis of our Results of Operations and Liquidity and Capital Resources includes a comparison of fiscal 2019 to fiscal 2018. A similar discussion and analysis that compares fiscal 2018 to fiscal 2017 may be found in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of our Form 10-K for the fiscal year endedOctober 31, 2018 . 32
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Results of Operations
The following table sets forth the results of our operations, net sales and
operating income by segment and the percentage of net sales represented by the
respective items in our Consolidated Statements of Operations (in thousands):
Year ended October 31,
2019 2018
Net sales $2,055,647 $1,777,721
Cost of sales 1,241,807 1,087,006
Selling, general and administrative expenses 356,743 314,470
Total operating costs and expenses 1,598,550 1,401,476 Operating income$457,097 $376,245 Net sales by segment: Flight Support Group$1,240,183 $1,097,937 Electronic Technologies Group 834,522 701,827 Intersegment sales (19,058 ) (22,043 )$2,055,647 $1,777,721 Operating income by segment: Flight Support Group$242,029 $206,623 Electronic Technologies Group 245,743 204,508 Other, primarily corporate (30,675 ) (34,886 )$457,097 $376,245 Net sales 100.0 % 100.0 % Gross profit 39.6 % 38.9 % Selling, general and administrative expenses 17.4 % 17.7 % Operating income 22.2 % 21.2 % Interest expense 1.1 % 1.1 % Other income (expense) .1 % - % Income tax expense 3.8 % 4.0 % Net income attributable to noncontrolling interests 1.5 % 1.5 % Net income attributable to HEICO 16.0 % 14.6 % 33
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Comparison of Fiscal 2019 to Fiscal 2018
Our consolidated net sales in fiscal 2019 increased by 16% to a record$2,055.6 million , up from net sales of$1,777.7 million in fiscal 2018. The increase in consolidated net sales principally reflects an increase of$132.7 million (a 19% increase) to a record$834.5 million in net sales within the ETG and an increase of$142.2 million (a 13% increase) to a record$1,240.2 million in net sales within the FSG. The net sales increase in the ETG reflects organic growth of 10% and net sales of$66.1 million contributed by fiscal 2019 and 2018 acquisitions. The ETG's organic growth is mainly attributable to increased demand for our defense and aerospace products resulting in net sales increases of$60.6 million and$14.0 million , respectively. The net sales increase in the FSG principally reflects organic growth of 13%. The FSG's organic growth is mainly attributable to increased demand and new product offerings within our aftermarket replacement parts, specialty products and repair and overhaul services product lines resulting in net sales increases of$95.4 million ,$31.5 million and$10.8 million , respectively. Sales price changes were not a significant contributing factor to the ETG and FSG net sales growth in fiscal 2019.
Our net sales in fiscal 2019 and 2018 by market consisted of approximately 52% and 53% from the commercial aviation industry, respectively, 35% from the defense and space industries in both periods and and 13% and 12% from other industrial markets including electronics, medical and telecommunications, respectively.
Gross Profit and Operating Expenses
Our consolidated gross profit margin increased to 39.6% in fiscal 2019, up from 38.9% in fiscal 2018, principally reflecting an increase of .9% and .4% in the ETG's and FSG's gross profit margins, respectively. The increase in the ETG's gross profit margin is principally attributable to increased net sales and a more favorable product mix for certain defense products. The increase in the FSG's gross profit margin is principally attributable to the previously mentioned higher net sales within our aftermarket replacement parts product line. Total new product research and development expenses included within our consolidated cost of sales were$66.6 million in fiscal 2019 compared to$57.5 million in fiscal 2018. Our consolidated selling, general and administrative ("SG&A") expenses were$356.7 million and$314.5 million in fiscal 2019 and 2018, respectively. The increase in consolidated SG&A expenses principally reflects$21.6 million attributable to the fiscal 2019 and 2018 acquisitions,$9.1 million of higher performance-based compensation expense and$3.8 million attributable to changes in the estimated fair value of accrued contingent consideration. 34
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Our consolidated SG&A expenses as a percentage of net sales decreased to 17.4% in fiscal 2019, down from 17.7% in fiscal 2018. The decrease in consolidated SG&A expenses as a percentage of net sales principally reflects efficiencies realized from the net sales growth.
Operating Income
Our consolidated operating income increased by 21% to a record$457.1 million in fiscal 2019, up from$376.2 million in fiscal 2018. The increase in consolidated operating income principally reflects a$41.2 million increase (a 20% increase) to a record$245.7 million in operating income of the ETG and a$35.4 million increase (a 17% increase) to a record$242.0 million in operating income of the FSG. The increase in operating income of the ETG and FSG is principally attributable to the previously mentioned net sales growth and improved gross profit margins. Further, the operating income of the ETG in fiscal 2019 reflects$5.4 million of higher performance-based compensation expense and$2.7 million of higher acquisition-related costs. Our consolidated operating income as a percentage of net sales improved to 22.2% in fiscal 2019, up from 21.2% in fiscal 2018. The increase principally reflects an increase in the FSG's operating income as a percentage of net sales to 19.5% in fiscal 2019, up from 18.8% in fiscal 2018 and an increase in the ETG's operating income as a percentage of net sales to 29.4% in fiscal 2019, up from 29.1% in fiscal 2018. The increase in the FSG's and ETG's operating income as a percentage of net sales principally reflects the previously mentioned improved gross profit margins and efficiencies realized from the net sales growth. Further, the ETG's operating income as a percentage of net sales in fiscal 2019 reflects a .6% increase in SG&A expenses as a percentage of net sales mainly from the previously mentioned higher performance-based compensation expense and higher acquisition-related costs.
Interest Expense
Interest expense increased to
Other Income (Expense)
Other income (expense) in fiscal 2019 and 2018 was not material.
Income Tax Expense
InDecember 2017 ,the United States ("U.S.") government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act contains significant changes to previous tax law, some of which became immediately effective in fiscal 2018 including, among other things, a reduction in theU.S. federal statutory tax rate from 35% to 21% effectiveJanuary 1, 2018 resulting in a blended rate of 23.3% for fiscal 2018 and the implementation of a territorial tax system resulting in a one-time transition tax on the unremitted earnings of our foreign subsidiaries. Certain other provisions of the Tax Act became 35
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effective for HEICO in fiscal 2019 including a new tax on Global Intangible
Low-Taxed Income ("GILTI"), a new deduction for Foreign-Derived Intangible
Income ("FDII"), the repeal of the domestic production activity deduction and
increased limitations on the deductibility of certain executive compensation. As
a result of the Tax Act, we remeasured our U.S. federal net deferred tax
liabilities and recorded a discrete tax benefit of $16.5 million in fiscal 2018.
Further, we recorded a provisional discrete tax expense of $4.4 million in
fiscal 2018 related to a one-time transition tax on the unremitted earnings of
our foreign subsidiaries, which we intend to pay over the eight-year period
allowed for in the Tax Act.
Our effective tax rate in fiscal 2019 decreased to 17.8% from 19.8% in fiscal
2018. The decrease in our effective tax rate in fiscal 2019 is mainly
attributable to a $14.3 million larger tax benefit in fiscal 2019 from stock
option exercises compared to fiscal 2018 and the reduction in the federal tax
rate from a blended rate of 23.3% in fiscal 2018 to 21% in fiscal 2019,
partially offset by the net impact of the previously mentioned discrete tax
amounts recorded in fiscal 2018. The provisions of the Tax Act that became
effective for us in fiscal 2019 did not have a material net effect on our
effective tax rate.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests relates to the 20%
noncontrolling interest held by Lufthansa Technik AG in HEICO Aerospace Holdings
Corp. and the noncontrolling interests held by others in certain subsidiaries of
the FSG and ETG. Net income attributable to noncontrolling interests was $31.8
million in fiscal 2019 as compared to $26.5 million in fiscal 2018. The increase
in net income attributable to noncontrolling interests in fiscal 2019
principally reflects improved operating results of certain subsidiaries of the
FSG and ETG in which noncontrolling interests are held.
Net Income Attributable to HEICO
Net income attributable to HEICO increased to a record$327.9 million , or$2.39 per diluted share, in fiscal 2019, up from$259.2 million , or$1.90 per diluted share, in fiscal 2018 principally reflecting the previously mentioned increased net sales and operating income.
Outlook
As we look ahead to fiscal 2020, we anticipate net sales growth within the FSG's
commercial aviation and defense product lines. We also expect growth within the
ETG, principally driven by demand for the majority of our products. During
fiscal 2020, we plan to continue our commitments to developing new products and
services, further market penetration, and an aggressive acquisition strategy
while maintaining our financial strength and flexibility. Overall, we are
targeting growth in fiscal 2020 full year net sales and net income over fiscal
2019 levels. This outlook excludes the impact of additional acquired businesses,
if any.
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Inflation
We have generally experienced increases in our costs of labor, materials and services consistent with overall rates of inflation. The impact of such increases on net income attributable to HEICO has been generally minimized by efforts to lower costs through manufacturing efficiencies and cost reductions.
Liquidity and Capital Resources
The following table summarizes our capitalization (in thousands):
As of October 31,
2019 2018
Cash and cash equivalents $57,001 $59,599 Total debt (including current portion) 561,955 532,470 Shareholders' equity
1,694,660 1,503,008
Total capitalization (debt plus equity) 2,256,615 2,035,478 Total debt to total capitalization
25% 26%
Our principal uses of cash include acquisitions, capital expenditures, cash
dividends, distributions to noncontrolling interests and working capital needs.
Capital expenditures in fiscal 2020 are anticipated to approximate $42 million .
We finance our activities primarily from our operating and financing activities,
including borrowings under our revolving credit facility.
As of December 17, 2019 , we had approximately $741 million of unused committed
availability under the terms of our revolving credit facility. Based on our
current outlook, we believe that net cash provided by operating activities and
available borrowings under our revolving credit facility will be sufficient to
fund our cash requirements for at least the next twelve months.
Operating Activities
Net cash provided by operating activities was$437.4 million in fiscal 2019 and consisted primarily of net income from consolidated operations of$359.7 million , depreciation and amortization expense of$83.5 million (a non-cash item), net changes in other long-term liabilities and assets related to the HEICO Leadership Compensation Plan ("LCP") of$12.9 million (principally participant deferrals and employer contributions) and$10.3 million in share-based compensation expense (a non-cash item), partially offset by a$32.3 million increase in working capital. Net cash provided by operating activities increased by$108.9 million in fiscal 2019 from$328.5 million in fiscal 2018. The increase is principally attributable to a$74.1 million increase in net income from consolidated operations, an$18.4 million decrease in net working capital, a$6.6 million decrease in deferred income tax benefits, and a$6.3 million increase in depreciation and amortization expense. The decrease in net working capital mainly 37
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resulted from decreases in inventories and contract assets and an increase in income taxes payable, partially offset by a decrease in trade accounts payable.
Net cash provided by operating activities was$328.5 million in fiscal 2018 and consisted primarily of net income from consolidated operations of$285.7 million , depreciation and amortization expense of$77.2 million (a non-cash item) and net changes in other long-term liabilities and assets related to the HEICO LCP of$11.6 million (principally participant deferrals and employer contributions), partially offset by a$50.6 million increase in working capital mainly reflecting an increase in inventories to support the growth of our businesses and anticipated higher demand during fiscal 2019.
Investing Activities
Net cash used in investing activities totaled$280.6 million in fiscal 2019 and related primarily to acquisitions of$240.8 million (net of cash acquired), capital expenditures of$28.9 million and investments related to the HEICO LCP of$13.7 million . Further details on acquisitions may be found in Note 2, Acquisitions, of the Notes to Consolidated Financial Statement. Net cash used in investing activities totaled$113.5 million in fiscal 2018 and related primarily to acquisitions of$59.8 million (net of cash acquired), capital expenditures of$41.9 million and investments related to the HEICO LCP of$11.5 million . Further details on acquisitions may be found in Note 2, Acquisitions, of the Notes to Consolidated Financial Statement.
Financing Activities
Net cash used in financing activities in fiscal 2019 totaled$159.7 million . During fiscal 2019, we made$283.0 million in payments on our revolving credit facility, paid$110.9 million in distributions to noncontrolling interests, redeemed common stock related to stock option exercises aggregating$64.0 million and paid$18.7 million in cash dividends on our common stock. Additionally, we borrowed$313.0 million under our revolving credit facility to fund certain of our fiscal 2019 acquisitions and a certain distribution to a noncontrolling interest holder. Net cash used in financing activities in fiscal 2018 totaled$207.5 million . During fiscal 2018, we made payments on our revolving credit facility aggregating$204.0 million , redeemed common stock related to stock option exercises aggregating$25.0 million , paid$15.4 million in cash dividends on our common stock and made distributions to noncontrolling interests aggregating$13.1 million . Additionally, we borrowed$56.0 million on our revolving credit facility principally for tax payments, to fund a fiscal 2018 acquisition and for capital expenditures. 38
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InNovember 2017 , we entered into a$1.3 billion Revolving Credit Facility Agreement ("Credit Facility") with a bank syndicate, which matures inNovember 2022 . Under certain circumstances, the maturity of the Credit Facility may be extended for two one-year periods. The Credit Facility also includes a feature that will allow us to increase the capacity by$350 million to become a$1.65 billion facility through increased commitments from existing lenders or the addition of new lenders. Borrowings under the Credit Facility may be used to finance acquisitions and for working capital and other general corporate purposes, including capital expenditures. Borrowings under the Credit Facility accrue interest at our election of the Base Rate or the Eurocurrency Rate, plus in each case, the Applicable Rate (based on our Total Leverage Ratio). The Base Rate for any day is a fluctuating rate per annum equal to the highest of (i) the Prime Rate; (ii) the Federal Funds Rate plus .50%; and (iii) the Eurocurrency Rate for an Interest Period of one month plus 100 basis points. The Eurocurrency Rate is the rate per annum obtained by dividing LIBOR for the applicable Interest Period by a percentage equal to 1.00 minus the daily average Eurocurrency Reserve Rate for such Interest Period, as such capitalized terms are defined in the Credit Facility. The Applicable Rate for Eurocurrency Rate Loans ranges from 1.00% to 2.00%. The Applicable Rate for Base Rate Loans ranges from 0% to 1.00%. A fee is charged on the amount of the unused commitment ranging from .125% to .30% (depending on our Total Leverage Ratio). The Credit Facility also includes$100 million sublimits for borrowings made in foreign currencies and for swingline borrowings, and a$50 million sublimit for letters of credit. Outstanding principal, accrued and unpaid interest and other amounts payable under the Credit Facility may be accelerated upon an event of default, as such events are described in the Credit Facility. The Credit Facility is unsecured and contains covenants that require, among other things, the maintenance of a Total Leverage Ratio and an Interest Coverage Ratio, as such capitalized terms are defined in the Credit Facility. We were in compliance with all financial and nonfinancial covenants of the Credit Facility as ofOctober 31, 2019 . 39
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Contractual Obligations
The following table summarizes our contractual obligations as ofOctober 31, 2019 (in thousands): Payments due by fiscal period Total 2020 2021 - 2022 2023 - 2024 Thereafter Long-term debt obligations (1)$553,320 $62 $129 $553,106 $23 Estimated interest payments (1) 50,310 16,724 33,358 228 - Capital lease obligations (2) 10,962 1,213 2,415 1,738 5,596 Operating lease obligations (3) 76,947 15,508 29,371 13,256 18,812 Purchase obligations (4) (5) (6) 21,666 2,711 2,253 16,702 - Other long-term liabilities (7) 8,052 1,976 2,448 1,756 1,872 Total contractual obligations$721,257 $38,194 $69,974 $586,786 $26,303 __________________
(1) Estimated interest payments assumes the
under our revolving credit facility and related interest rate of 3.0% as of
date in fiscal 2023. Actual interest payments may vary significantly based on
future borrowings, repayments and interest rate fluctuations. See Note 5,
Long-Term Debt, of the Notes to Consolidated Financial Statements and
"Liquidity and Capital Resources," above for additional information regarding
our long-term debt obligations.
(2) Inclusive of
the Notes to Consolidated Financial Statements for additional information
regarding our capital lease obligations.
(3) See Note 16, Commitments and Contingencies - Lease Commitments, of the Notes
to Consolidated Financial Statements for additional information regarding our
operating lease obligations.
(4) Includes contingent consideration aggregating
fiscal 2016, 2017 and 2019 acquisition. See Note 8, Fair Value Measurements,
of the Notes to Consolidated Financial Statements for additional information.
(5) Also includes an aggregate
capital expenditures and inventory. All purchase obligations of inventory and
supplies in the ordinary course of business (i.e., with deliveries scheduled
within the next year) are excluded from the table.
(6) The holders of equity interests in certain of our subsidiaries have rights
("Put Rights") that may be exercised on varying dates causing us to purchase
their equity interests through fiscal 2029. The Put Rights provide that cash
consideration be paid for their equity interests (the "Redemption Amount").
As of
Amount of all Put Rights that we could be required to pay is approximately
in our Consolidated Balance Sheet. The amounts in the table do not include
Put Right obligations as none of the noncontrolling interest holders have
exercised their Put Rights as of
Noncontrolling Interests, of the Notes to Consolidated Financial Statements
for further information.
(7) The amounts in the table do not include liabilities related to the HEICO LCP
as they are fully supported by assets held within irrevocable trusts. See
Note 3, Selected Financial Statement Information - Other Long-Term Assets and
Liabilities, of the Notes to Consolidated Financial Statements for further
information about this deferred compensation plan.
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Off-Balance Sheet Arrangements
Guarantees
As ofOctober 31, 2019 , we have arranged for standby letters of credit aggregating$4.1 million , which are supported by our revolving credit facility and pertain to payment guarantees related to potential workers' compensation claims and a facility lease as well as performance guarantees related to customer contracts entered into by certain of our subsidiaries.
Critical Accounting Policies
We believe that the following are our most critical accounting policies, which require management to make judgments about matters that are inherently uncertain.
Assumptions utilized to determine fair value in connection with business combinations, contingent consideration arrangements and in goodwill and intangible assets impairment tests are highly judgmental. If there is a material change in such assumptions or if there is a material change in the conditions or circumstances influencing fair value, we could be required to recognize a material impairment charge. See Item 1A., Risk Factors, for a list of factors which may cause our actual results to differ materially from anticipated results.
Revenue Recognition
During fiscal 2019, we adopted Accounting Standards Update 2014-09, which, as
amended, was codified as Accounting Standard Codification ("ASC") Topic 606,
"Revenue from Contracts with Customers" ("ASC 606"). Pursuant to ASC 606, HEICO
recognizes revenue when it transfers control of a promised good or service to a
customer in an amount that reflects the consideration it expects to receive in
exchange for the good or service. Our performance obligations are satisfied and
control is transferred either at a point-in-time or over-time. The majority of
our revenue is recognized at a point-in-time when control is transferred, which
is generally evidenced by the shipment or delivery of the product to the
customer, a transfer of title, a transfer of the significant risks and rewards
of ownership, and customer acceptance. For certain contracts under which we
produce products with no alternative use and for which we have an enforceable
right to recover costs incurred plus a reasonable profit margin for work
completed to date and for certain other contracts under which we create or
enhance a customer-owned asset while performing repair and overhaul services,
control is transferred to the customer over-time. HEICO recognizes revenue using
an over-time recognition model for these types of contracts.
We utilize the cost-to-cost method as a measure of progress for performance
obligations that are satisfied over-time as we believe this input method best
represents the transfer of control to the customer. Under this method, revenue
for the current period is recorded at an amount equal to the ratio of costs
incurred to date divided by total estimated contract costs multiplied by (i) the
transaction price, less (ii) cumulative revenue recognized in prior periods.
Contract costs
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include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation.
Under the cost-to-cost method, the extent of progress toward completion is measured based on the proportion of costs incurred to date to the total estimated costs at completion of the performance obligation. These projections require management to make numerous assumptions and estimates relating to items such as the complexity of design and related development costs, performance of subcontractors, availability and cost of materials, labor productivity and cost, overhead, capital costs, and manufacturing efficiency. We review our cost estimates on a periodic basis, or when circumstances change and warrant a modification to a previous estimate. Cost estimates are largely based on negotiated or estimated purchase contract terms, historical performance trends and other economic projections. For certain contracts with similar characteristics and for which revenue is recognized using an over-time model, we use a portfolio approach to estimate the amount of revenue to recognize. For each portfolio of contracts, the respective work in process and/or finished goods inventory balances are identified and the portfolio-specific margin is applied to estimate the pro rata portion of the transaction price to recognize in relation to the costs incurred. This approach is utilized only when the resulting revenue recognition is not expected to be materially different than if the accounting was applied to the individual contracts. Certain of our contracts give rise to variable consideration when they contain items such as customer rebates, credits, volume purchase discounts, penalties and other provisions that may impact the total consideration we will receive. We include variable consideration in the transaction price generally by applying the most likely amount method of the consideration that we expect to be entitled to receive based on an assessment of all available information (i.e., historical experience, current and forecasted performance) and only to the extent it is probable that a significant reversal of revenue recognized will not occur when the uncertainty is resolved. We estimate variable consideration by applying the most likely amount method when there are a limited number of outcomes related to the resolution of the variable consideration.
Changes in estimates that result in adjustments to net sales and cost of sales are recognized as necessary in the period they become known on a cumulative catch-up basis. Changes in estimates did not have a material effect on net income from consolidated operations in fiscal 2019, 2018 and 2017.
Valuation of Inventory
Inventory is stated at the lower of cost or net realizable value, with cost being determined on the first-in, first-out or the average cost basis. Losses, if any, are recognized fully in the period when identified.
We periodically evaluate the carrying value of inventory, giving consideration
to factors such as its physical condition, sales patterns and expected future
demand in order to estimate the amount necessary to write down any slow moving,
obsolete or damaged inventory. These
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estimates could vary significantly from actual amounts based upon future economic conditions, customer inventory levels, or competitive factors that were not foreseen or did not exist when the estimated write-downs were made.
In accordance with industry practice, all inventories are classified as a current asset including portions with long production cycles, some of which may not be realized within one year.
Business Combinations
We allocate the purchase price of acquired entities to the underlying tangible and identifiable intangible assets acquired and liabilities and any noncontrolling interests assumed based on their estimated fair values, with any excess recorded as goodwill. Determining the fair value of assets acquired and liabilities and noncontrolling interests assumed requires management's judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives and market multiples, among other items. We determine the fair values of intangible assets acquired generally in consultation with third-party valuation advisors. As part of the agreement to acquire certain subsidiaries, we may be obligated to pay contingent consideration should the acquired entity meet certain earnings objectives subsequent to the date of acquisition. As of the acquisition date, contingent consideration is recorded at fair value as determined through the use of a probability-based scenario analysis approach. Under this method, a set of discrete potential future subsidiary earnings is determined using internal estimates based on various revenue growth rate assumptions for each scenario. A probability of likelihood is then assigned to each discrete potential future earnings estimate and the resultant contingent consideration is calculated and discounted using a weighted average discount rate reflecting the credit risk of HEICO. Subsequent to the acquisition date, the fair value of such contingent consideration is measured each reporting period and any changes are recorded to SG&A expenses within our Consolidated Statements of Operations. Changes in either the revenue growth rates, related earnings or the discount rate could result in a material change to the amount of contingent consideration accrued. As ofOctober 31, 2019 , 2018 and 2017,$18.3 million ,$20.9 million and$27.6 million of contingent consideration was accrued within our Consolidated Balance Sheets, respectively. During fiscal 2019, 2018 and 2017, such fair value measurement adjustments resulted in net increases (decreases) to SG&A expenses of$2.6 million ,($1.4) million and$1.1 million , respectively. For further information regarding our contingent consideration arrangements, see Note 8, Fair Value Measurements, of the Notes to Consolidated Financial Statements.
Valuation of
We test goodwill for impairment annually as ofOctober 31 , or more frequently if events or changes in circumstances indicate that the carrying amount of goodwill may not be fully recoverable. In evaluating the recoverability of goodwill, we compare the fair value of each of our reporting units to its carrying value to determine potential impairment. If the carrying value 43
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of a reporting unit exceeds its fair value, the implied fair value of that reporting unit's goodwill is to be calculated and an impairment loss is recognized in the amount by which the carrying value of the reporting unit's goodwill exceeds its implied fair value, if any. The fair values of our reporting units were determined using a weighted average of a market approach and an income approach. Under the market approach, fair values are estimated using published market multiples for comparable companies. We calculate fair values under the income approach by taking estimated future cash flows that are based on internal projections and other assumptions deemed reasonable by management and discounting them using an estimated weighted average cost of capital. Based on the annual goodwill impairment test as ofOctober 31, 2019 , 2018 and 2017, we determined there was no impairment of our goodwill. The fair value of each of our reporting units as ofOctober 31, 2019 significantly exceeded its carrying value. We test each non-amortizing intangible asset (principally trade names) for impairment annually as ofOctober 31 , or more frequently if events or changes in circumstances indicate that the asset might be impaired. To derive the fair value of our trade names, we utilize an income approach, which relies upon management's assumptions of royalty rates, projected revenues and discount rates. We also test each amortizing intangible asset for impairment if events or circumstances indicate that the asset might be impaired. The test consists of determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the undiscounted future cash flows is less than the carrying amount of those assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. The determination of fair value requires us to make a number of estimates, assumptions and judgments of underlying factors such as projected revenues and related earnings as well as discount rates. Based on the intangible asset impairment tests conducted, we did not recognize any impairment losses in fiscal 2019, 2018 and 2017. New Accounting Pronouncements
See Note 1, Summary of Significant Accounting Policies - New Accounting Pronouncements, of the Notes to Consolidated Financial Statements for additional information.
Forward-Looking Statements Certain statements in this report constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained herein that are not clearly historical in nature may be forward-looking and the words "anticipate," "believe," "expect," "estimate" and similar expressions are generally intended to identify forward-looking statements. Any forward-looking statement contained herein, in press releases, written statements or other documents filed with theSecurities and Exchange Commission or in communications and discussions with investors and analysts in the normal course of business through meetings, phone calls and conference calls, concerning our operations, economic performance and financial condition are subject to risks, uncertainties and contingencies. We have based these forward-looking statements on our current expectations and projections about future events. All forward-looking statements involve risks and uncertainties, many of which are beyond our control, which may cause actual results, performance or 44
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achievements to differ materially from anticipated results, performance or achievements. Also, forward-looking statements are based upon management's estimates of fair values and of future costs, using currently available information. Therefore, actual results may differ materially from those expressed in or implied by those forward-looking statements. Factors that could cause such differences include:
• Lower demand for commercial air travel or airline fleet changes or airline
purchasing decisions, which could cause lower demand for our goods and
services;
• Product specification 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
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 or sales growth;
• Product development or manufacturing difficulties, which could increase
our product development costs and delay sales;
• Our ability to make acquisitions and achieve operating synergies fromacquired 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 costs and revenues; and
• Defense spending or budget cuts, which could reduce our defense-related
revenue.
For further information on these and other factors that potentially could
materially affect our financial results, see Item 1A, Risk Factors. We undertake
no obligation to publicly update or revise any forward-looking statement,
whether as a result of new information, future events or otherwise, except to
the extent required by applicable law.
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Index
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