HEICO Corporation (NYSE:HEI) Q3 2023 Earnings Call Transcript

HEICO Corporation (NYSE:HEI) Q3 2023 Earnings Call Transcript August 29, 2023

Operator: Welcome to the HEICO Corporation Third Quarter Fiscal 2023 Financial Results Call. My name is Samia, and I’ll be today’s operator. 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, the severity of magnitude and such as the COVID-19 pandemic or health emergencies; HEICO’s liquidity and the amount and timing of cash generation; lower commercial air travel caused by health emergencies and their aftermath, 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 cost to complete contracts; supplemental and regulatory demands, export policies and restrictions; reductions in defense, space or homeland security spending by U.S. and/or foreign customers or competition from existing and new competitors, which could reduce our sales; our ability to introduce new products and services at profitable pricing levels, which could reduce our sales or sales growth; product development or manufacturing difficulties, which could increase our product development and manufacturing costs and delay sales; our ability to make acquisitions, including obtaining any applicable domestic and/or foreign governmental approvals and achieve operating synergies from acquired businesses; customer credit risk, interest, foreign currency exchange and income tax rates; economic conditions, including the effects of inflation within and outside of the aviation, defense space, medical, telecommunications and electronics industries, which could negatively impact our cost and revenues; and defense spending or budget cuts, which could reduce our defense-related revenue.

Parties 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, Form 10-Q and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except to the extent required by applicable law. I now turn the call over to Lawrence Mendelson, HEICO’s Chairman and Chief Executive Officer.

Larry Mendelson: Thank you very much, and good morning to everyone on the call. We thank you for joining us, and we welcome you to this HEICO third quarter fiscal ’23 earnings announcement teleconference. I’m Larry Mendelson, Chairman and 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 Carlos Macau, our Executive Vice President and CFO. Before reviewing our operating results in detail, I’d like to take a moment to thank all of HEICO’s dedicated and talented team members who are responsible for another strong quarter of excellent results.

They continue to produce the highest quality products and services for our customers, while maintaining our unique entrepreneurial corporate culture that has delivered excellent returns to shareholders. I’d like to extend a warm welcome to the approximate 1,000 HEICO-Wencor Group team members who recently joined the HEICO family. We look forward to our collective journey of exceeding customer expectations and winning in the marketplace. I, personally, have never been more optimistic about the future for HEICO. I’d like to now summarize the highlights of our third quarter fiscal record results. Consolidated third quarter fiscal ’23 net sales represent record results for HEICO, driven principally by record net sales within Flight Support Group, mainly arising from continued strong demand for our commercial aerospace products and services and the contributions from our fiscal ’23 and ’22 acquisitions.

Consolidated operating income and net sales in the third quarter of fiscal ’23 improved by 16% and 27%, respectively, as compared to the third quarter of fiscal ’22. These results mainly reflect a 12% quarterly consolidated organic net sales growth and the impact from acquisitions. I’d like to note an important item. HEICO incurred acquisition costs from the Wencor acquisition during the third quarter of fiscal ’23. And this decreased our net income by approximately $3.5 million or $0.03 per diluted share. The way management looks at our operations, we were able to report $0.74 a share earnings in the third quarter, after deducting this unusual $0.03 per share. So management considers our earnings in the third quarter as actually $0.77. Recognizing this, our operating margins, especially before Wencor related non-recurring deal expenses, that’s what I was talking about, $3.5 million or $0.03, remained strong and are consistent with the expectations we previously communicated in investor calls and events.

These margins are very healthy margins even though our product mix this year has meant lower overall margins than in prior years. Consolidated net income attributable to HEICO increased 24% and to $102 million or $0.74 per diluted share, of course, again, after deducting $0.03 of those special Wencor expenses in the third quarter of fiscal ’23, and that was up from $82.5 million or $0.60 per diluted share in the third quarter of fiscal ’22. In connection with the Wencor acquisition, our net debt-to-EBITDA ratio was 0.75x as of July 31, ’23, and that compared to 0.25x as of October 31, ’22. Our net debt-to-EBITDA ratio increased in the first nine months of fiscal ’23, and due to our successful offering of $600 million of 5.5% senior unsecured notes due August 1, ’28 and $600 million of 5.35% senior unsecured notes due August 1, ’33.

We used the net proceeds from the sale of these notes to repay the outstanding borrowings under our revolving credit facility and to fund a portion of the Wencor acquisition purchase price. Cash flow provided by operating activities was very strong at $145.9 million in the third quarter of fiscal ’23, and that compared to $149.2 million in the third quarter of fiscal ’22. Cash flow provided by operating activities in the third quarter of fiscal ’23, reflects an increase in working capital, principally driven by an increase in inventories to support increased consolidated backlog. We continue to forecast strong cash flow from operations for fiscal ’23. In June, we were honored to announce that I will receive the prestigious 44th Annual Howard Hughes Memorial Award from the Aero Club of Southern California on Wednesday, September 6.

The Howard Hughes Memorial Award honors exceptional leaders who have advanced field of aviation or aerospace technology. Upon receipt of the award, I will join 43 aviation and aerospace pioneers, including last year’s honoree, Harrison Ford, as well as prior honorees, general Chuck Yeager, Bob Hoover, Neil Neil, general Jimmy Doolittle, Elon Musk, Jim Love, Maryland, Houston and captain Sully Sullenberger and many others. I’m profoundly honored to receive such a prestigious award from such a prestigious organization, though I believe it really belongs to all of HEICO’s team members because it results from all of their remarkable work and success over several decades. The Aero Club of Southern California is recognized as one of the leading aviation and aerospace organizations in the world.

And the idea that they would bestow this award upon me leaves me deeply humbled and very grateful. Last week, we announced that our 3D PLUS and Exxelia subsidiaries supplied mission-critical electronic components on India’s Chandrayaan-3 spacecraft, which successfully executed a soft landing on the Moon’s South Pole. We offer our congratulations to the Indian Space Research Organization, and we are honored to be a trusted supplier on this remarkable and historic mission. The level of sophisticated engineering, quality and precision demonstrated by our subsidiaries on this project was outstanding and commendable. I’d like to now discuss our recent acquisition activity. Earlier this month, we completed the acquisition of Wencor for $1.9 billion in cash and approximately 1.1 million shares of HEICO Class A common stock with an assigned value of $150 million in the merger agreement or a total of $2.05 billion in the aggregate.

The transaction was HEICO’s largest ever in terms of purchase price as well as revenue and income acquired. We believe Wencor is a perfect and highly complementary fit with HEICO. And we expect the combination will be transformative, providing a unique and growing portfolio of proprietary cost saving solutions for our airline and OEM customers. We continue to anticipate this highly synergistic acquisition to be accretive to our earnings within the year following closing. In addition, HEICO anticipates that it will continue to achieve its often articulated growth objective in the years subsequent to the closing. Immediately following the closing, we forecast pro forma net debt-to-EBITDA leverage ratio will be approximately 3:1, and will return to historically low levels within roughly one year to 18 months after acquisition, excluding the impact of future acquisition or possible capital deployment activities.

At this time, I would like to now introduce Eric Mendelson, Co-President of HEICO and President of HEICO’s Flight Support Group, and he will discuss the third quarter results of the Flight Support Group. Eric?

Eric Mendelson: Thank you very much. First of all, I would like to welcome our new 1,000 Wencor team members into the new HEICO and Wencor family. This combination has been something that we’ve dreamed of doing for literally the past 20 years. And we could not be more excited and more overjoyed that this finally has come to fruition. Over the last number of weeks, I’ve been visiting Wencor facilities around the United States and have a very busy schedule plan for the next couple of months as I go out and meet all of the Wencor team members. I’ve been particularly impressed with the quality and the outstanding character and ability and DNA of the Wencor team members. You can never know what is going to happen down the road. And you never know exactly what it’s like to work with people who have been in the same space, but you haven’t gotten to know very well over many years.

And I can tell you that our hopes and dreams have been completely fulfilled. As I’ve gotten to know the Wencor team members and their DNA, it is remarkably similar to HEICO’s style and DNA. And it is something that I think is going to yield tremendous results for many, many years to come. So again, welcome to all of our new team members from Wencor. Going into the results. The Flight Support Group’s net sales increased 23% to a record $405 million in the third quarter of fiscal ’23, up from $330.3 million in the third quarter of fiscal ’22. The net sales increase in the third quarter of fiscal ’23 reflects robust 19% organic growth as well as the impact from our profitable fiscal ’22 acquisition. The organic growth mainly reflects increased demand for the majority of our commercial aerospace products and services, resulting from continued global commercial air travel growth as compared to the third quarter of fiscal ’22.

The Flight Support Group has now achieved 12 consecutive quarters of growth in net sales, and these numbers don’t yet include the positive impact we expect from the Wencor acquisition, which will further transform our business as the world’s leading independent aftermarket supplier. The Flight Support Group’s operating income increased 26% to $89.2 million in the third quarter of fiscal ’23, up from $70.8 million in the third quarter of fiscal ’22. The operating income increase in the third quarter of fiscal ’23 principally reflects the previously mentioned net sales growth and an improved gross profit margin, partially offset by an increase in the previously mentioned acquisition costs related to the Wencor acquisition. The improved gross profit margin in the third quarter of fiscal ’23 principally reflects higher net sales and a favorable product mix across all of our product lines.

The Flight Support Group’s operating margin improved to 22.0% in the third quarter of fiscal ’23, up from 21.4% in the third quarter of fiscal ’22. The operating margin increase in the third quarter of fiscal ’23 principally reflects the previously mentioned improved gross profit margin, partially offset by the previously mentioned acquisition costs, which reduced our operating margin by approximately 81 basis points. Our second quarter of fiscal ’23 margin of 25.5% included a onetime benefit of 2.3%, yielding a 23.2% net operating margin on a continuing basis. Our third quarter of fiscal ’23 margin was 22.8% before the unique costs related to the Wencor acquisition. We’re very proud of these excellent operating margins, which have increased approximately 300 basis points from our then record 2019, and increased 400 basis points from our then record 2018.

Now, I would like to introduce Victor Mendelson, Co-President of HEICO and President of HEICO’s Electronic Technologies Group, to discuss the third quarter results of the Electronic Technologies Group.

Victor Mendelson: Thank you, Eric. The Electronic Technologies Group’s net sales increased 33% to a record $325.9 million in the third quarter of fiscal ’23, up from $244.2 million in the third quarter of fiscal ’22. The net sales increase principally reflects the impact from our fiscal ’23 and ’22 acquisitions as well as increased commercial aviation and other electronics products net sales, partially offset by lower year-over-year defense products net sales. We were pleased to see 10% sequential growth over the second quarter of fiscal ’23 in defense product net sales, and we’re equally pleased that quarterly organic commercial aerospace and other electronic products, net sales growth contributed 2% overall organic net sales growth in the third quarter of fiscal ’23.

The Electronic Technologies Group’s operating income increased 9% to $74.2 million in the third quarter of fiscal ’23, up from $68 million in the third quarter of fiscal ’22. The increase in operating income principally reflects the previously mentioned higher net sales volume, partially offset by a lower gross profit margin and higher costs from our January ’23 acquisition. The lower gross profit margin in the third quarter of fiscal ’23 principally reflects decreased defense products net sales, partially offset by increased commercial aviation and other electronics products net sales. In line with our expectations, the Electronic Technologies Group’s operating income was 22.8% in the third quarter of fiscal ’23 as compared to 27.9% in the third quarter of fiscal ’22.

This margin is after roughly 500 basis points of amortization. So, the EBITA margin from what our businesses sell was really close to around 28%, which I and we consider to be excellent and is consistent with the margin range that I’ve talked about on other earnings calls and in other venues that we should expect for this business before taking account into future acquisitions. The lower operating margin principally reflects the previously mentioned lower gross profit margin and increased SG&A expenses as a percentage of net sales. I turn the call back over to Larry Mendelson.

Larry Mendelson: Thank you, Victor. As for the outlook of HEICO in our opinion, as we look ahead to the remainder of fiscal ’23, we continue to anticipate net sales growth in both the FSG and ETG, divisions, principally driven by demand for the majority of our products. Additionally, continued inflationary pressures may lead to higher material and labor costs. In addition, we’ve begun sharing the best practices and getting to know the Wencor businesses, which share a very similar entrepreneurial culture and customer focus as HEICO’s businesses. We do believe the Wencor acquisition provides HEICO with additional scale to continue broadening our aerospace products and services, while maintaining our special culture of treating customers with respect and integrity.

Our operating margins especially before non-recurring acquisition expenses remain very healthy and reflect our strong business operations. We believe our ongoing conservative policies and strong cash flows enable us to continuously invest in new research and development and take advantage of strategic acquisition opportunities, which collectively position HEICO for future market gains. In closing, I would like to again thank our incredible team members for their continued support and commitment to HEICO. I humbly welcome all of the Wencor team members to our family and look forward to winning new business together as one team. Thanks to all the HEICO team members for everything you do today to make HEICO an excellent company. I would now like to open the floor for questions.

Thank you.

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Q&A Session

Operator: [Operator Instructions] And we’ll start with our first question from Peter Arment with Baird. Please go ahead.

Peter Arment: Larry, Eric, Victor and Carlos, congratulations on the Wencor deal. Really great stuff. Eric, I just wanted to start there. Just when you closed the Exxelia deal, there was — that obviously put some pressure on the reported operating margins of the ETG Group. And I just — maybe if you could just level set us how we’re thinking about the impact will be because of, one, of course, probably a little bit of a lower margin profile. How you think about what that kind of the impact will be? And then, what are some of the opportunities to think about just from a synergy perspective?

Larry Mendelson: Let me just kind of clarify one thing. The margins on Wencor and the margins on Exxelia are really different. And so Eric and Victor can speak to that. The margins on Wencor are pretty much in line with the margins of our Flight Support Group. But the margins on Exxelia are lower. But Eric and Victor can speak more detail to that.

Eric Mendelson: Yes. So we’re — this is Eric. We’re obviously very excited about the Wencor acquisition for some of the reasons that I mentioned earlier on the call. We think that it’s a tremendous broadening of our product line. It’s sort of amazing that you could have two companies sort of focused in different spaces. And now with the opportunity to bring them together, we’re able to offer significantly more to our customers. And I can tell you that major customers have been extremely supportive of this business combination and have really been looking forward to the benefits that it’s going to bring. And I think that’s one of the reasons why we were able to secure antitrust approval so quickly, and because, frankly, our customers are really pushing us and very excited about this.

So with regard to the margins, I would say that the Wencor EBITA margins are very similar to the flight support margins. Carlos can get into some of the specifics, but are basically within the same area. Obviously, there’s going to be some intangible amortization as a result of those — as a result of the acquisition. But as far as the EBITA earnings of the business, it’s going to be, in general, in the same area as the HEICO businesses. And we do anticipate tremendous synergies going forward. Right now, we’re all in a learning phase. We want to be very careful and make sure that we harness all of the benefits that this combination brings. Unlike many companies, we don’t sort of set out with an operating margin target. We just simply want each of the businesses to perform to the best of its ability and to generate the margins that are correct for its long-term success.

So if look at the Flight Support group, I’m really happy that our margins, people back in 2018 thought we were sort of at top margins, and now we’re up 400 basis points from there. In 2019, they thought we were at top margins we’re up 300 basis points. We did not set a target a specific target of a number where we want it to be. Instead, we just make the decisions that make sense, breach operating businesses and the margins end up where they are. So, I’m very encouraged that as a result of adding the Wencor product line that we’re going to continue on this journey to improve margins. But in general, there — the EBITA margins are in the same ZIP code as the flight support margins. Does that sort of answer your question?

Peter Arment: Yes. Yes, very helpful. Maybe Carlos could just clarify maybe on the purchase accounting adjustments.

Carlos Macau: So we closed on one core August 4. So it’s not in our third quarter numbers, although we did have acquisition expenses incurred through the end of 7/31 in there. We paid a little over $2 billion for Wencor. I would expect the expenses related to the deal will be south of 1% of the purchase price. We don’t have all of those bills in yet, if you would, but there will be some deal costs that flow in Q4 that are not capitalized and will be expensed. So more to come on that as we get those bills. The purchase accounting side of it, I don’t expect huge inventory write-ups like we normally have with some deals. Given the nature of their products, they have a lot of — they have repair, they have parts and they have distribution.

And so some of those businesses, particularly in the parts and distribution, they don’t lend themselves to inventory write-ups that we experienced in other businesses. So we’ll see how that plays out. And there’ll be more to come on that, Peter, in the fourth quarter.

Peter Arment: Okay. That’s helpful. And just, Victor, just to clarify, could you just quantify, if you can, the impact of the supply chain on ETG in the third quarter?

Victor Mendelson: Yes, Peter, this is Victor. Good question. It’s now running below or it ran below rather $20 million, probably a few million dollars below $20 million, somewhere in that range. And so definitely moving in the right direction, big improvement there, and from talking with our companies and surveying them, the vast majority feel, it’s moving in the right direction or at least stabilized. So we’re pretty happy with that.

Operator: We’ll take our next question from Pete Skibitski with Alembic Global. Please go ahead.

Peter Skibitski: Maybe I want to start with Eric. Eric, just kind of broadly, we’re kind of at the end of the summer travel season here for the most part, right? I was just wondering, as you look at the potential for kind of the reality maybe of economic weakness in Europe and China, we’ll see how long that lasts or not. But you talked to so many of the airlines. I was wondering if you could give us your perspective on — do you think these guys are going to get more cautious on their aftermarket spend kind of in the forward 12 months in this environment? And maybe you can give us a sense of with Wencor, is the opportunity for share gain maybe more than enough to offset any potential greater cost and by the airlines and their spend?

Eric Mendelson: Yes. So Pete, let me start out by saying the market is incredibly strong. And we — at the moment, we don’t see any slowdown in sight. We — having said that, we also understand that all recoveries are — tend to end with a little bit of an overshoot and then things trend down just a little bit and then they resume their upward climb. I think one of the interesting things that may be going on now is that there’s a lot of older equipment out there that really needs a lot of maintenance. And there has been a shortage of parts. The airlines still don’t have as much as many parts as they need. And so we really see a lot of support in the market. So I don’t see a slowdown in the cards right now. As far as China and Asia goes, those were the last to recover.

So I don’t think that we’ve even seen the full recovery there yet. So I think things are very strong in general. I mean, we’re in this for the long haul. And whenever a little slowdown comes, to your point, I think that there’s going to be a lot of synergy opportunities between HEICO and Wencor and being able to broaden our product lines. And I think we will continue to gain share and we’ll move through that period. very well. So, I’m not concerned about it at all.

Peter Skibitski: Okay. That’s very helpful. I appreciate that. Just last one for me is just I know you guys are not aggressive with pricing. But just should we expect the continued approach at FSG just to be — make sure you kind of — you claw back inflation, so you get some modest net pricing power post inflation. Is that kind of the general way to think about things going forward?