Victor Mendelson: Yes, we’re very happy we own it. It’s doing essentially as we expected and a lot of good potential ahead. Also, they’re looking at a number of acquisitions we’ve been able to bring to them, they bring up some. We’ll see whether they transpire. But a lot of good things happening there and so far, so good.
Peter Arment: Great. And a quick one for Carlos. Carlos, just rough expectations on how you’re thinking about interest expense for the year. I know the goal is obviously to continue to delever.
Carlos Macau: Yes. I mean — so right now, if everything plays out, I’m expecting our interest expense quarterly to run $35 million to $37 million. That’s pretty much what — we booked this quarter about $38 million. So I think as we pay some debt down, if we catch a break on a few rate cuts, you never know. I have a sort of tailing off a little bit at — that also is a function, Peter of how quickly I can pay the debt down depending on how many businesses Eric, Victor and Larry want to buy will certainly influence that during the year.
Peter Arment: Got it. I appreciate all the details and Larry, congrats on the award.
Victor Mendelson: I just might add something to — this is Victor, what Carlos had to say. We continue to look at acquisitions. Most are in our historical — overwhelmingly in our historical size. And we have an excellent acquisition pipeline, very strong. Again, whether we do that remains to be seen. But we will continue to those acquisitions that would fit the right way while being mindful of the importance of reducing debt and capital structure.
Laurans Mendelson: Just to further expand on what Victor said, it’s completely correct. It’s a balancing act. We are in the business of expanding, creating cash flow and bottom line income. And if we see an outstanding acquisition, we will make it. At the same time, we have to watch our debt level and we’re trying to reduce it. So as you saw, we made a Honeywell acquisition recently because we believe it will be very accretive and very positive cash flow. So we made the decision to acquire it by using debt which reduced our ability to reduce our debt to overall debt. But on the bottom line, it was helpful to HEICO and actually where you get more income and debt. So the balance actually benefits the ratio of debt to EBITDA. But anyway, this is all a balancing act and we watch it very, very carefully because, as you know, we are focused on bottom line cash flow.
So we will make these acquisitions when they are very, very desirable and we might have to use some debt but we’ll take each one as it comes. We are here to grow HEICO bottom line cash flow. Again, it’s a balancing act and we’re very careful with it.
Operator: We’ll take our next question from Sheila Kahyaoglu with Jefferies.
Sheila Kahyaoglu: Victor, I’m going to start with you if it’s okay, given the ETG margins spotlight. You gave us some color on R&D up 20%, so it implies about 100 basis points of margin pressure. Can you maybe talk about the less favorable sales mix, how much it was maybe even pricing into the mix as well just on the bridge and how we think about that improvement, as you said, Q3 and Q4 are headed to be better and should we expect a similar sub-20% rate in Q2?
Victor Mendelson: Sure. Sheila, a couple of things. One, I would be surprised to see a sub-20% rate in Q2. Number two, the sales difference was not based on pricing, it was based on the shipment schedule. So we — I would call it a fairly normal pricing environment which means in some instances, the customers can accept the prices that recognize our cost that maybe higher and other instances we have longer term contracts where pricing is a lot thin. So it’s kind of a normal scenario on the pricing side. Really, on the revenue side, it was all about the shipment schedule and when things were supposed to ship. It’s not necessarily, by the way, the production rate. So we try to keep the facilities level loaded. Our businesses try to stay level loaded in production.
But it depends upon when the order is due for delivery or acceptance and test by the customer, that dictates a lot of how it works for us. So again, just to emphasize, I would expect north of 20% GAAP margin — operating margin on the quarter which, of course, would be north of 24% the true margin, excluding intangibles amortization.
Sheila Kahyaoglu: Got it. Any sort of color on the mix impact in the quarter in terms of margin headwind?
Victor Mendelson: Not really other than the shipment schedules in our higher-margin businesses were lower than they had been in the prior period and that brings down the margin. But I don’t want to break out which business is what margins but I think our business…
Sheila Kahyaoglu: Well, hopefully not. Eric, one for you if it’s okay. Wencor, how do we think about this revenue synergy is the best? Is the best way to look at it based on a number of PMA parts? And the sales per part is about 4x greater at HEICO than it is at Wencor. So if you have that marketing channel, is that a potential way to think about the sales opportunity? Or how are you thinking about it?
Eric Mendelson: That is — that’s one way to think about it. I’m also really looking at it as how the product sets are very complementary, number one. Number two, without getting into specific customers, I would say there are a number of extremely strong relationships, sales relationships on the Wencor side as well as the HEICO side. And I think that we can help each other. The businesses can help each other with sharing those relationships and just basically one hand, helping the other. If you look historically, we’ve taken up our margins over the last decade that you covered us quite significantly and frankly, an even beat where I thought they would be. And I think that there is more potential in that regard. There’s some — there’s a lot of sharing that also can occur over on the repair side in terms of DER repairs as well as they’re already using the PMA parts.
So I think that, that’s an advantage. In the defense side, we’re already cooperating and working together, whereas orders used to go out to third-party companies that are now being placed internally and that’s very strong likewise over in our specialty manufacturing. There’s a lot of product that our specialty manufacturing group can build for our other businesses including Wencor and we’re really pushing that as well. So I think it’s just a very broad-based level of cooperation, as I said, without integration. When you’ve got really talented people who are running these businesses, who have really mastered their businesses, we find that by getting them autonomy, that’s very intrinsically motivating feature. And that’s not something that exists in many companies.
If you look at HEICO overall across all of HEICO, we’ve got roughly 100 business heads and for a company of our size to have 100 people of this talent and skill set where they performed so well and they really enjoy what they do because of way that they’re treated, I think that’s the real synergy here. It’s not going to be from knocking out little costs here and there. I mean, yes, there’s an opportunity to do that. And for example, in trade shows, in a number of the trade shows, Paris, Farmborough and others will have booths together. So HEICO and Wencor will be together. There’ll be certain other trade shows where they can be separate. And we want the businesses to each have their own strategy and to really take responsibility for the results.
So I think that’s why we’re getting these benefits.
Operator: I’ll take our next question from Mariana Perez Mora with Bank of America.
Mariana Perez Mora: So first of all, congratulations, Larry, on the award. My first question is about R&D, follow-up on ETG R&D. What are the main trends? Because you said like it’s pretty much across the board increase. But what are the main trends that are driving this increase in R&D? What are the opportunities that you guys are seeing that actually are calling for this increase R&D? Is this the particular technology, is it the trend, is it the — I don’t know, an end market? Could you please discuss that.
Victor Mendelson: Sure, this is Victor. It is a very good question. And by the way, when I say across the board, it doesn’t mean in every business but it’s kind of — I should clarify what I mean by that is the majority of the business or sort of the super majority of the businesses. It is what I could call, the trend; there is a tremendous amount of opportunity for our businesses or newer and evolved products. Sometimes it’s not just what you would consider revolutionary change, right? It’s not necessarily developing something that is wholly new. In our case, it is more typically evolutionary and it is an improvement on an earlier version or iteration of a product. And so what we’re seeing in a high number of our customers is demand for what you would consider our next generation of products.
So it’s not just technology based. It’s not for example as though there is a new design that has been developed. Like Bluetooth came up many years and everybody was implementing Bluetooth. It’s not like that. It’s more responsive to the individual needs of our customers.
Mariana Perez Mora: And are usually customers calling for this improvement? How this like R&D, how you pay, what arenas, what specific products are still are on the option?
Victor Mendelson: So we leave it to each one of our businesses to make those choices. In some cases, it’s customer-initiated. In other cases, it’s initiated by our subsidiaries or somewhere in between. I mean our businesses had regular meetings and visits and calls with customers. And so they’re aware of new programs, the customer may be on. New designs that they might need. And that’s probably the most typical but it runs the gamut, depending on the architecture of the particular business as well as the products. But the key to it is, one, a willingness to always invest and respond to the customer needs depending upon the history and relationship with the customer, the likelihood that they will, in fact, turn into orders. I mean let’s be honest, there are companies who will always ask their suppliers, their vendors, partners to develop something on their dime.
And then they may not buy it. So that is a factor that we consider is what is the history with the customer? Are they likely to, in fact, convert to orders? Is there a PO standing behind it? Are they on a program of record, for example, if it’s defense and where do they stand with that program? What Intel are we getting in the broader community? What do we hear from our other partners, customers, even trade shows, government people, things like that. So each business, though, is responsible for that. And that, to be honest, the beauty, I think, of our company is that it’s not from on high, it is experts talking with experts. We believe in devolving those decisions down at the lowest level to be able to understand the customer best.
Mariana Perez Mora: And my last one is on M&A. Could you please discuss when you do acquisitions like the recent Honeywell licenses [indiscernible], they are adjacent opportunities for you. But I could imagine that a company like this or a license could be able to unlock more upside opportunity in terms of revenues under the HEICO ecosystem compared to if this license ends up in another third-party MRO shop. Like can you please discuss how you think about those outside opportunities and how long it could take to actually see them?
Eric Mendelson: Sure. Mariana, this is Eric. I’d be happy to answer about that. So HEICO has done a number of licensing deals over the last decade. So we’re very well experienced on doing those licensing deals. And in particular, when you look at the component repair footprint, HEICO has got 19 individual MRO businesses just within Flight Support. And then over in ETG, there are another number of them there as well. So we’ve been able to buy these licenses and basically take the technology and put it into a business that’s already incredibly experienced in that market niche and really understands the technology. So when we buy a license, we’re able then to go out to the customer with people who can hit the ground running in many cases, are already working with the customer on other items and it’s really a seamless experience.
So I think that there is plenty of opportunity for HEICO in this area to continue to grow in adjacent white spaces. I can tell you that our reception at the customers for the Honeywell product has been extremely strong. They’ve been very happy about that. They’re used to our experience with regard to quality, turn time and price. So the reception has been very strong. So I think that it was a great move for both Honeywell as well as for HEICO as well as for our customers. There’s just a net benefit increase to the industry here. So I think that there is additional opportunity for us.
Operator: And we’ll take our next question from Gautam Khanna with TD Cowen.
Gautam Khanna: Congrats on the award. A lot of questions have been asked and answered. I was wondering if you guys are seeing any difference in activity level in the direct channel versus the indirect and maybe you could just talk by market, whether it be aftermarket, whether it be OE, if you’re seeing anything discernibly different — restocking, destocking in the distributor channel and the like.
Eric Mendelson: Yes. We’re — Gautam, this is Eric. So you want to know how we’re doing with regard to aftermarket and OE on order pattern or what you like me to comment on?
Gautam Khanna: Maybe just distributors, defense and aero, like is there — are you seeing any differences in those order patterns versus selling direct outside of the distribution channel.
Eric Mendelson: Well, so our distribution businesses are doing extremely well. They’re continuing to gain market share. They have the right inventories. I think our customers are very happy as a result of working with them. Likewise over in the PMA area where we — and the repair area where we sell direct, it’s likewise — it’s the same thing. So I would say a very good strength in both. With regard to product availability on the flight support side, things are tough where, frankly, our vendors are quite behind. And I think our results could be even better if they were able to shift the overdue backlog. And this is really across the board in the parts area. I would say both the PMA as well as the distribution. I think there have been some raw material challenges as a result of the sanctions.
And then, of course, as Victor alluded to with regard to labor, that continues to be a challenge. But definitely, the supply chain is tight. There really isn’t — there’s no excess capacity. Things are very tight. And we’re hoping that by the end of ’24, things normalize, Frankly, I would have thought by now things would have normalized more. But unfortunately, our vendors are — they’re really struggling. Things will get better after November in a lot of ways.
Gautam Khanna: Yes. And Carlos, you mentioned — you talked about the 21% to 22% Flight Support margins is sort of the right ballpark and I think previously, you said the cycle would be somewhere in that range as well. I mean, is there any — like what is the — it sounds like Wencor is going better. There is some pricing opportunity, as you’ve mentioned in response to Noah’s question, I’m just curious, like what is your confidence longer term of maybe doing better than that, forget fiscal ’24 but just looking at…
Carlos Macau: Highly confident. I mean I think if you look back over the last decade, just if you want to do a history lesson, go back from pre-COVID and just look back 10 years and you’ll see a pattern of where the FSG continually ekes out 20, 30, 40 basis points a year. I mean, sometimes it’s a little flatter. But if you look at that trend, I think we’re returning to that. I think we — that’s on an annual basis, by the way. I think we’re heading in that direction. We can’t continue to grow at a breakneck pace. I think we’re at a pretty high growth level right now. And at some point, we get back to what I’ll call a normal business cycle and that’s when you’ll see our margin take those nice incremental jumps up. Until then, with our end markets being as hard as they are, the margin could fluctuate a little bit based on volumes, what we’re selling.
But I do think at some point when this hyper growth scenario we’re in softens and gets back to, I don’t want to say business as usual but a more customary demand in the market, I would say that, that incremental eke out of growth north, small increments is what we would expect to see. By the way, as far as the 21% to 22% I mean I feel very confident that we’re going to wind up in there. We always could do better. But for modeling and thinking about the business, that’s why I keep your focus in that area.
Operator: [Operator Instructions] And we’ll take our next question from Bert Subin with Stifel.
Bert Subin: Maybe, Eric, first question for you. You talked about pricing being a primary growth driver when it comes to new customers just relative to existing customers where it’s more a function of inflation pass-through. Can you just talk about what your new customer strategy is and maybe what percent of sales come from new customers in a given year? And just also, is this a new customer increasingly an internationally based customer?
