Certain statements in today’s 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 the severity, magnitude and duration of the COVID-19 pandemic; HEICO’s liquidity and the amount and timing of cash generation; lower commercial air travel caused by the COVID-19 pandemic and its 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 costs to complete contracts, governmental 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; development or manufacturing difficulties, which could reduce our sales growth, product development or manufacturing difficulties which could increase our product development and manufacturing costs and delay sales; our ability to make acquisitions and achieve operating synergies from acquired 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. 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 statement, whether as a result of new information, future events or otherwise, except to the extent required by applicable law.

Okay. Well, thank you and good morning to everyone on the call. We thank you for joining us. We welcome you to the HEICO second quarter fiscal ’21 earnings announcement teleconference. I am Larry Mendelson, Chairman and CEO of HEICO Corporation. And I am 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 beginning my review of the operating results, I would like to take a moment and thank all of HEICO’s talented team members for their loyalty and high performance during the continuing challenges brought on by COVID-19. The dedication to HEICO’s customers and to the safety of their fellow team members has been commendable. I want to thank every member of HEICO’s worldwide team. Be proud of what we accomplished during these unusual circumstances and recognize that our future is very bright and we will exit this COVID-19 period a stronger and more competitive company. I would now like to take a few moments to address the impact of COVID-19 on HEICO’s recent operating results. Results of operation in the first six months and the second quarter of fiscal ’21 continued to reflect the adverse impact from COVID-19. Most notably, demand for our commercial aviation products and services continues to be moderated by the ongoing depressed commercial aerospace market, which we know is beginning to rebound and return to normal. Looking ahead to the remainder of fiscal ’21, we are cautiously optimistic that the ongoing worldwide rollout of COVID-19 vaccines will have, and in fact is having, a positive influence on commercial air travel and will generate more favorable economic environments in the markets that we serve. Summarizing the highlights of the first six months and second quarter of fiscal ’21, we are pleased to report record quarterly net sales within the ETG Group and our third consecutive sequential increase in quarterly net sales and operating income of the Flight Support Group. The ETG Group set a quarterly net sales and operating income record in the second quarter of fiscal ’21, improving 11% and 9% respectively. These increases principally reflect the impact from our profitable fiscal ’20 and ’21 acquisitions as well as very strong organic growth of 19% for our other electronic products. The Flight Support Group reported sequential growth in operating income and net sales in the second quarter of fiscal ’21; they improved 37% and 16% respectively as compared to the first quarter of fiscal ’21. Our total debt to shareholders’ equity reduced and improved to 27.1% as of April 30, ’21, compared to 36.8% as of October 31, ’20. Our net debt, which is total debt less cash and cash equivalents, was $199 million as of April 30, ’21. The net debt-to-shareholders’ equity ratio improved to 9.2% as of April 30, ’21, down from 16.6% as of October 31, ’20. This provides HEICO with substantial acquisition capital within the balance of our $1.5 billion unsecured revolving credit facility as well as other available capital. We are not a capital constrained company. Our net debt-to-EBITDA ratio improved to 0.47x as of April 30, ’21, down from 0.71x as of October 31, ’20. During fiscal ’21, we successfully completed one acquisition and we have completed five acquisitions over the past year. We have no significant debt maturities until fiscal ’24 and we plan to utilize our financial strength and flexibility to aggressively pursue high-quality acquisitions of various sizes, which will accelerate growth and maximize shareholder returns. Cash flow provided by operating activities remains strong, increasing 2% to $210.1 million in the first six months of fiscal ’21, up from $205.9 million in the first six months of fiscal ’20. In March ’21, we acquired all of the business assets and certain liabilities of Pyramid Semiconductor. Pyramid is a specialty semiconductor designer and manufacturer, which offers a well-developed line of processors, static random access memory, electronically erasable programmable read-only memory and logic products on a diverse array of military, space and medical platforms. We do expect this acquisition to be accretive to earnings within the first 12 months following the closing. At this time, I would like to introduce Eric Mendelson, Co-President of HEICO and President of HEICO’s Flight Support Group, and he will discuss the results of the Flight Support Group.

Thank you. The Flight Support Group’s net sales were $429.6 million in the first six months of fiscal ’21 as compared to $553 million in the first six months of fiscal ’20. The Flight Support Group’s net sales were $230.3 million in the second quarter of fiscal ’21 as compared to $252 million in the second quarter of fiscal ’20. The net sales decrease in the first six months and second quarter of fiscal ’21 is principally organic and reflects lower demand for the majority of our commercial aerospace products and services resulting from the significant decline in global commercial air travel attributable to the pandemic. The Flight Support Group’s operating income was $61.3 million in the first six months of fiscal ’21 as compared to $109.6 million in the first six months of fiscal ’20. The operating income decrease in the first six months of fiscal ’21 principally reflects the previously mentioned lower net sales as well as a lower gross profit margin, higher performance-based compensation expense, and the impact from lost fixed cost efficiencies stemming from the pandemic. The Flight Support Group’s operating income was $35.5 million in the second quarter of fiscal ’21 as compared to $47.5 million in the second quarter of fiscal ’20. The operating income decrease in the second quarter of fiscal ’21 principally reflects higher performance-based compensation expense, directly resulting from the strong improvement in operations during the past three consecutive quarters. The Flight Support Group’s operating margin was 14.3% in the first six months of fiscal ’21 as compared to 19.8% in the first six months of fiscal ’20. The operating margin decrease in the first six months of fiscal ’21 principally reflects an increase in SG&A expenses as a percentage of net sales, mainly from the previously mentioned higher performance-based compensation expense and lost fixed cost efficiencies and the lower gross profit margin. The Flight Support Group’s operating margin was 15.4% in the second quarter of fiscal ’21 as compared to 18.9% in the second quarter of fiscal ’20. The operating margin decrease in the second quarter of fiscal ’21 principally reflects the previously mentioned higher performance-based compensation expense. Now, I would like to introduce Victor Mendelson, Co-President of HEICO and President of HEICO’s Electronic Technologies Group, to discuss the results of the Electronic Technologies Group.

Thank you, Eric. The Electronic Technologies Group’s net sales increased 9% to a record $466.6 million in the first six months of fiscal ’21, up from $427.4 million in the first six months of fiscal ’20. The net sales increase in the first six months of fiscal ’21 principally reflects our fiscal ’20 and ’21 acquisitions as well as organic growth of 1%. The organic growth principally reflects increased demand for other electronic and space products, partially offset by demand for commercial aerospace products. The Electronic Technologies Group’s net sales increased 11% to a record $243.1 million in the fiscal second quarter of ’21, up from $219 million in the second quarter of fiscal ’20. The net sales increase in the second quarter of fiscal ’21 principally resulted from our fiscal ’20 and ’21 acquisitions as well as organic growth of 3%. The organic growth principally reflects increased demand for our other electronic and defense products, partially offset by decreased demand for commercial aerospace products. The Electronic Technologies Group’s operating income increased 7% to a record $131.4 million in the first six months of fiscal ’21, up from $123 million in the first six months of fiscal ’20. The operating income increase in the first six months of fiscal ’21 principally reflects the previously mentioned net sales growth partially offset by a lower gross profit margin, mainly from lower net sales of defense and commercial aerospace products that were partially offset by an increase in net sales of certain other electronic products. The Electronic Technologies Group’s operating income increased 9% to $71.3 million in the second quarter of fiscal ’21 as compared to $65.5 million in the second quarter of fiscal ’20. The operating income increase in the second quarter of fiscal ’21 principally reflects the previously mentioned net sales growth partially offset by a lower gross profit margin, mainly from a less favorable product mix for our defense products as well as a decrease in net sales of commercial aerospace products that were partially offset by a net increase in sales of certain other electronic products. The Electronic Technologies Group’s operating margin was 28.2% in the first six months of fiscal ’21 as compared to 28.8% in the first six months of fiscal ’20. The Electronic Technologies Group’s operating margin was 29.3% in the second quarter of fiscal ’21 as compared to 29.9% in the second quarter of fiscal ’20. The operating margin decrease in the first six months and second quarter of fiscal ’21 principally reflects the previously mentioned gross profit margin, partially offset by a decrease in SG&A expenses as a percentage of net sales, mainly from efficiencies gained from the previously mentioned net sales growth. I would turn the call back over to Larry Mendelson.

Thank you, Victor and Eric. Moving on to details, consolidated net income per diluted share was $1.03 in the first six months of fiscal ’21 as compared to $1.44 in the first six months of fiscal ’20. The decrease in the first six months of fiscal ’21 principally reflects the previously mentioned lower operating income of Flight Support and higher income tax expense and that was partially offset by the previously mentioned higher operating income of the ETG group and lower interest expense. Consolidated net income per diluted share was $0.51 in the second quarter of fiscal ’21 as compared to $0.55 in the second quarter of fiscal ’20. The decrease in second quarter fiscal ’21 principally reflects the previously mentioned lower operating income of Flight Support, partially offset by lower income tax expense as well as higher operating income of the ETG Group and lower interest expense. Depreciation and amortization expense totaled $22.9 million in the second quarter of fiscal ’21, up from $21.7 million in the second quarter of fiscal ’20, and totaled $45.9 million in the first six months of fiscal ’21, up from $43.3 million in the first six months of fiscal ’20. The increase in depreciation and amortization in the second quarter and first six months of fiscal ’21 principally reflects incremental impact from the fiscal ’20 and ’21 acquisitions. R&D expense increased to $34.2 million, or 3.9% of net sales in the first six months of fiscal ’21, up from $33.9 million, or 3.5% of net sales in the first six months of fiscal ’20. R&D expense increased to $18 million, or 3.9% of net sales in the second quarter of fiscal ’21, up from $16.8 million, or 3.6% of net sales in the second quarter of fiscal ’20. We know that significant ongoing new product development efforts are continuing at both ETG and Flight Support. Our consolidated SG&A expenses were $161.2 million in the first six months of fiscal ’21 as compared to $157.8 million in the first six months of fiscal ’20. Consolidated SG&A expenses were $83 million in the second quarter of fiscal ’21 as compared to $70.7 million in the second quarter of fiscal ’20. The increase in consolidated SG&A expense in the first six months and second quarter of fiscal ’21 principally reflects higher performance-based compensation expense and the impact from our fiscal ’20 and ’21 acquisitions, partially offset by reductions in other G&A and selling expenses. Consolidated SG&A expense as a percentage of net sales increased to 18.2% in the first six months of ’21, up from 16.2% in the first six months of fiscal ’20. Consolidated SG&A expense as a percentage of net sales increased to 17.8% in the second quarter of fiscal ’21, up from 15.1% in the second quarter of ’20. The increase in consolidated SG&A expense as a percentage of net sales in the first six months and second quarter of fiscal ’21 principally reflects higher performance-based compensation expense. Interest expense decreased to $4.5 million in the first six months of fiscal ’21, down from $8 million in the first six months of fiscal ’20. Interest expense decreased to $2.1 million in the second quarter of fiscal ’21, down from $3.8 million in the second quarter of fiscal ’20. The decrease in the first six months and second quarter of fiscal ’21 was principally due to a lower weighted average interest rate on borrowings outstanding under our revolving credit facility. Other income in the first six months and second quarter was not significant. Talking about income taxes. Our effective rate in the first six months of fiscal ’21 was 12% as compared to 0.3% in the first six months of fiscal ’20. As previously mentioned, HEICO recognized a discrete tax benefit from stock option exercises in both the first quarter of fiscal ’21 and ’20, and that accounted for the majority of the decrease in the year-to-date effective tax rate. The tax benefit from stock option exercises in both periods was the result of strong appreciation in HEICO’s stock price during the option-holding period, and the larger benefit recognized in the first quarter of fiscal ’20 was the result of more stock options exercised in that period. Our effective tax rate decreased to 19.5% in the second quarter of fiscal ’21, down from 22.6% in the second quarter of fiscal ’20. The decrease principally reflects the favorable impact of higher tax-exempt unrealized gains in the cash surrender values of life insurance policies related to the HEICO leadership compensation plan. Net income attributable to non-controlling interest was $11.5 million in the first six months of fiscal ’21, compared to $13.4 million in the first six months of fiscal ’20. The decrease in net income attributable to non-controlling interest in the first six months of fiscal ’21 principally reflects a decrease in the operating results of certain subsidiaries of the Flight Support Group in which non-controlling interests are held, partially offset by higher allocations of net income to non-controlling interest as a result of certain fiscal ’20 acquisitions and an increase in the operating results of certain subsidiaries of the ETG Group in which non-controlling interests are held. Net income to non-controlling interest was $5.8 million in the second quarter of fiscal ’21 as compared to $5.5 million in the second quarter of fiscal ’20. For the full fiscal ’21 year, we continue to estimate a combined effective tax rate and non-controlling interest rate of between 24% and 26% of pre-tax income. Now, let’s talk about the balance sheet and cash flow. One thing I want to mention is that in the second quarter of fiscal ’21, cash flow from operations was 146% of reported net income. Net income was $70.7 million and the cash flow was almost $103 million. Our financial position and forecasted cash flow remain very strong. As we discussed earlier, cash flow provided by operating activities increased 2% to $210.1 million in the first six months of fiscal ’21, up slightly from $205.9 million in the first six months of fiscal ’20. Our working capital ratio was 4.5 to 1 as of April 30 compared to 4.8 as of October 31, ’20. Our day sales outstanding of receivables improved to 41 days as of April 30, ’21, down slightly from 44 days as of April 30, ’20. We continue to closely monitor receivable collection in order to limit our credit exposure. No one customer accounted for more than 10% of net sales. Our top five customers represented approximately 23% and 24% of consolidated net sales in the second quarter of fiscal ’21 and ’20 respectively. Inventory turnover rate was 153 days for the period ending April 30, ’21 compared to 139 days for the period ended April 30, ’20. The increased turnover rate principally reflects lower sales volume from the pandemic’s impact on demand for certain of our commercial aerospace products and services. Despite the increased turnover rate, our subsidiaries have done an excellent job controlling inventory levels in the first six months of fiscal ’21 and we believe that is appropriate to support expected future net sales as well as our increased backlog as of April 30, ’21, which increased by $51 million to $895 million. Looking ahead, as we look ahead to the remainder of fiscal ’21, we are cautiously optimistic that the ongoing worldwide rollout of COVID-19 vaccines will have a positive influence, and in fact is having a positive influence, on commercial air travel and will generate favorable economic environments in the markets that we serve. The pace of recovery in global travel remains difficult to predict and can be negatively influenced by new COVID variants and varying vaccine adoption rates. Given those uncertainties, we cannot provide fiscal ’21 net sales and earnings guidance at this time. We continue to estimate capital expenditures of approximately $40 million for fiscal ’21. We believe that our ongoing conservative fiscal policies, strong balance sheet, and high degree of liquidity enable us to invest in new R&D, execute on a successful acquisition program, and position HEICO for market share gains as the industry recovers. Again, in closing, I would like to again thank our incredible team members for their continued support and commitment to HEICO. During these professionally and personally challenging times, that strength will manifest in our culture of ownership, mutual respect for each other and the unwavering pursuit of exceeding our customers’ expectations. We thank you all for everything you do to make HEICO an exceptional company. I want to remind listeners that a very high percentage of HEICO team members are HEICO shareowners through their 401(k) plans. We have many millionaires, multimillionaires and wealthy team members who all support the operation of HEICO. That’s the extent of my planned remarks. I would like to open the floor for any questions. Thank you. Operator?

Thank you. We have our first question from Robert Spingarn of Credit Suisse. Your line is now open.

Hi, good morning everybody. I have a few different questions across for all of you, but I am going to start with Victor and the organic growth in the quarter. I’m wondering if you could talk a little bit about the markets where you did see positive growth and if you could size for us or quantify perhaps the negative growth in commercial?

Good morning, Robert.

Yes, Rob, thank you. Those are good questions. In the quarter, our strongest growth came out of what I would call our other electronic markets. We saw a strong rebound year-over-year and continuing sequentially there and that’s in line with what we expected. That was number one for us, followed by medical, which was our second strongest for obvious reasons; a year ago things were shutting down in both of those markets. Then third strongest was defense for us in terms of growth. In commercial space, we gave up a little bit of ground, but that’s really a result of two things. One, tough comparables, and two, we had some things shifting out of the quarter into the later part of the year due to delivery schedules we’re expecting later. So I would say commercial space should be decent overall on the year. Commercial aviation was really the weakest for us, and that’s down in the neighborhood comparable to what we’re seeing in the Flight Support Group. So no surprise there.

Okay. And then just on your margins. You mentioned earlier there is a little bit of gross margin pressure. I assume that’s the volume shortfalls in the end markets you just cited. But at the same time you’re not far off your high margins; you’re in that low-30% neighborhood. How might we think about margins once volumes recover in commercial? Or is margin spread across the other business lines so that it doesn’t necessarily matter how much commercial comes back?

Well, commercial is important to us, and that’s a good margin business for us. So I think that will help us. But margins are broadly spread across the portfolio and, as you’ve heard me say before, it is mix sensitive. Where some of our higher-margin defense products sell will influence that in the future. So while small quarterly swings of 50 to 200 basis points are within the range we have experienced historically, the key is product mix. Commercial aviation coming back will be a benefit, but the question is what might be offset by higher-margin defense sales.

One thing to keep in mind, Rob, is that the way I think about ETG margins on normal years, not focusing on quarters, is we should run anywhere from 20% to 30% on GAAP margin. That is what I would expect as a business. It’s going to fluctuate on a quarterly basis, but it’s a healthy segment with a good mix of companies. When commercial comes back, we should see that benefit.

Okay, alright. Thanks for that, Carlos. Eric, just switching over to an FSG question that we all ask each quarter: how did the quarter trend month by month? How are things shaping up in May? And can you speak to your expectations of how airlines and customers will behave ahead of a strong summer domestic travel season? Will they want parts beforehand or after? How should we think about that?

Good morning, Rob. Those are really good questions. As you can imagine, the quarter trended up as we went along. With U.S. carriers adding back capacity, we anticipate that trend to continue. Europe is very slow and Asia is mixed right now, but as airlines start operating more aircraft they will need more parts. In the new-build area, our specialty products area, that is still more challenged and will take longer to recover than the aftermarket did.

Okay. And then just a final question, Larry. You talked about M&A earlier and transactions you’ve done. How does the pipeline look today and to what extent is the potential capital gains tax increase influencing sellers?

I thought there might be a bigger impact, but we don’t really see a panic. The number of opportunities is about normal. The ability to do due diligence is getting a little better because we’re able to access targets. I don’t see people rushing to sell. Many sellers are discounting the notion of a 40% capital gains rate and are talking more about 25% or 28%. At those rates, there doesn’t seem to be a panic. With Congress closely divided, my personal view is that I don’t think 40% will happen, and I’m not even sure 25% or 28% will pass without pushback. So at this point it’s pretty normal.

Okay, thank you everyone.

Thank you, Rob.

Thank you. The next question is from the line of Peter Arment from Baird. Please go ahead.

Hi, good morning. Maybe following up on the order environment at FSG, Eric: regarding airline inventory levels, last quarter we were talking about inventory destocking having ended, and you were pretty vocal in predicting that. You mentioned schedules expand and you expect more parts. Are you seeing any restocking yet, or is it still just-in-time order activity?

Hi, Eric. Good morning and thanks for the question. We called the end of destocking correctly in December, and in our last call in February. Right now, we see accelerated sales—you can see the 16% increase Q1 to Q2, a consecutive increase—so the airlines are buying more and much of that is being used. We haven’t seen serious restocking yet; most is consumption as aircraft come back into service. Restocking should occur more meaningfully once a greater percentage of the fleet gets put back into service. European airlines are struggling and are not restocking yet; that will come later in the cycle. My guess is we will see more restocking in HEICO’s fiscal 2022, maybe a little in our fourth quarter, but it’s hard to be precise. Due to our relationships with customers, we will be well positioned to understand and support restocking when it begins. Airline executives are focused on ensuring they can complete planned flights and making sure they have the parts on the shelf.

Okay. That’s a good segue into my next question on market share gains at FSG. After previous downturns HEICO has materially increased its revenue share of flight activity. Through COVID so far, there’s been a dramatic increase already. Are you seeing increased content with your customers already given that destocking has ended and they are placing orders? Can you provide an update on conversations with your sales team?

Yes, I’d be happy to. The answer is yes. HEICO is picking up market share. We see it in product-level visibility and across parts, repair and distribution. We expect the market share shift to continue. When comparing to prior downturns, this downturn was so precipitous that we expect a quicker bounce back because carriers could not operate at prior levels for long. HEICO’s strong customer relationships and how we behaved during the pandemic position us to capture additional share versus other suppliers. We expect to continue picking up share in the marketplace.

Okay, thanks. I appreciate your comments. I will leave it there.

Thank you.

Thank you. The next question is from Larry Solow from CJS Securities. Please go ahead.

Great, thanks. Good morning, guys. A couple follow-ups on FSG, Eric: you guys are continuing to rebound and are down about 25% relative to pre-pandemic fiscal ’19. Do you still think you can get back to fiscal ’19 levels sometime in fiscal ’22, perhaps even before the market or passenger demand fully recovers? And do you expect the cadence of recovery, given this quarter’s pretty strong sequential improvement, to continue, or might it slow down over the next few quarters?

Those are good questions, Larry. I don’t have a crystal ball. With the 16% growth we saw in Q2, it’s a strong consecutive increase and a high bar to beat quarter-over-quarter. HEICO is cautious—we want parts on the shelf but won’t get over our skis. I’d be surprised to see that kind of quarter-over-quarter improvement every quarter. The 16% was better than expected and likely reflects market share gains due to how we behaved during the pandemic. IATA’s projections this morning predict global passenger numbers recovering to 52% of pre-COVID levels in 2021, 88% in 2022 and 105% in 2023. For HEICO, reaching 2019 levels is more likely a 2023 story given our fiscal year end in October. Leisure travel is driving the recovery so far; business travel and international travel remain depressed. Government actions to open travel corridors and allow vaccination or testing as acceptable for travel will be important for restoring long-haul and business traffic. We will continue to monitor the situation, and the recovery will depend heavily on those policy and travel developments.

Right. Okay. Great. I appreciate that color. Second question: you mentioned several times the increase in incentive comp. Is that a signal you expect business to continue to improve? Was there catch-up in incentive comp this quarter relative to prior quarters, and might it trend back toward a normalized level going forward?

Larry, relative to 2020, in the second quarter last year we actually had reversals of Q1 bonus, so comparisons are tricky. Are levels normalizing? I’d say we’re still below 2019 levels on performance-based compensation. I would expect that to be the case throughout ’21. We’re not going to get up to those 2019 payout levels this fiscal year given volumes, so the increase you see is not out of line. The unique element this quarter was that 2020 had reversals which amplify the impact of performance-based comp in our comparisons. The expectation for the rest of the year is constructive, which is why we have conservative comp assumptions in our numbers.

Fair enough. I appreciate that. Thanks, Carlos.

Sure.

Thank you. The next question is from Josh Sullivan from The Benchmark Company. Please go ahead.

Hey, good morning. Curious on overall trends of PMA adoption and interest: are you seeing more demand from existing traditional PMA customers as you gain share, or is COVID inducing any new or previously underrepresented categories of customers for PMA parts?

I would say both. The bigger area is increased penetration with existing customers, but we are also making progress with underrepresented customers. Those adjacent white-space opportunities are where we see good upside.

Got it. And how about the leasing customer base—has their acceptance increased?

We’re making progress with lessors. There are number of lessors that use our parts. It’s not an immediate switch for everyone—some prefer OEM parts for commercial reasons—but the trend is in our favor and there is upside for us in the lessor channel.

Got it. And one last question on semiconductors—Apex and Pyramid—how do you see HEICO fitting into the overall semiconductor supply chain conversation?

Josh, we participate in more specialized segments of semiconductors—higher-reliability, low-volume markets like defense, aerospace, space, medical. We focus on niche, high value-add areas rather than mass-market segments. We see lengthening supply chains in those markets and expect to grow through both market penetration and new product development, plus acquisitions. We’re unlikely to participate broadly in automotive mass-market semiconductors, except for unique high-end applications. We’ll continue to participate in defense, aviation, high-end clean energy, power systems, rail electrification—areas where our capabilities and acquisitions like Connect Tech are relevant.

Okay, thank you. Appreciate the time.

Thank you.

Thank you. The next question is from Robert Stallard from Vertical Research. Your line is now open.

Thanks so much. Good morning. There has been talk that Rolls-Royce might be close to a deal with IATA to sort out its MRO chain. Does this present an opportunity for you to gain share on the Rolls-Royce fleet or is this not aligned with what you’re focused on?

Hi, Rob. We’ve read the same trade press. Rolls-Royce had a fairly closed and smaller network than other manufacturers, so it was never a primary focus for HEICO. Given the engine quantities, the fact many are wide-body engines, and the service model through JV shops, I wouldn’t see this as a major opportunity for us. If a customer wants us to participate, we’d be happy to talk, but it’s not an area of focus.

And secondly, there’s a lot of talk about inflation—have you seen any signs of input cost pressure over the last quarter? What’s your ability to pass on inflated costs up the line?

With aftermarket business we have the ability to pass along cost increases. We offer value to customers and would explain increases if needed. OEM list prices will likely reflect inflation pressure and we will work with customers on necessary price adjustments. Labor and standard material availability are challenging right now. We are watching inflation closely and believe we can adjust prices as necessary. As a shareholder, I feel confident HEICO can offset inflation-related valuation risks by increasing prices where appropriate.

Yes, that makes sense. Thank you very much.

Thanks.

Thank you. Next is Ken Herbert from Canaccord.

Yes. Hi, good morning everybody. Eric, I wanted one final question on FSG. You were up 16% sequentially. Can you break that down or provide color on how the respective businesses—repair, distribution and replacement parts—fit into that in terms of where you saw more growth versus less growth?

Yes, I can. The area down the most year-over-year was commercial aviation. Defense wasn’t down as much. Specialty products, which are more new-build/OEM-focused, were down the most. Parts, distribution and component repair were not down nearly as much as specialty products. We anticipate specialty products will recover as Airbus and Boeing increase build rates.

So it’s fair to say the pure aerospace aftermarket businesses—distribution, repair and replacement parts—were up greater than the 16% segment increase?

That’s correct, Ken. If you look at those three lines of business, the organic decline was mid-single digits on parts and repair, so they are coming back. Specialty products was the bigger drag on the segment, so you can back into the numbers with that information.

Perfect. Thanks, Carlos. Victor or Larry, a number of recent acquisitions have been on the defense side. Can you comment on what you’re seeing in terms of multiples? Are you being more patient on defense deals because multiples might get more attractive as budgets and the cycle evolve?

We’ve been careful about multiples for defense deals because defense budgets don’t grow forever. It’s an excellent place to compete, but we have been cautious. Over the last nine months, there was a bit of a feeding frenzy for A&D targets as buyers funneled into defense; we passed on many potential deals that were overvalued. We expect some stabilization and perhaps new opportunities where valuation is more attractive. We remain extremely selective—selectivity is key. For context, we probably review something like 100 potential acquisitions for every one we complete.

Great. Thanks for the detail, Victor.

Thank you.

Thank you. The next is Noah Poponak from Goldman Sachs. Please go ahead.

Hey, good morning everybody. Trying to pull apart FSG margins: the sequential incremental margin was about 30% and the two-year decremental is about 30% as well. But year-over-year decremental is much higher at about 55%. If I strip out abnormal expenses you had in the back half of last year, you were maybe already near the 15% margin. Is that all explained by the incentive comp you discussed? Or is there another way to reconcile those changes in FSG margin?

Noah, this is Carlos. It is completely explained by the performance-based compensation.

Okay, got it. And Eric, you mentioned share gain a few times and you attributed the sequential improvement partly to share gain. Can you give specific examples of where you’re picking up share in the early parts of recovery so we can better understand?

In particular, it’s in the PMA area. We’re expanding into adjacent white spaces and increasing penetration with customers. That’s where we see the share gains.

Can you tell us what some of those are?

I’d rather not provide specific product or customer details for competitive reasons. We don’t want to give a roadmap to competitors.

Fair enough. Last one quickly: Carlos, on free cash flow—should we expect free cash flow to be higher in the back half of fiscal ’21 versus the first half?

I expect that. As volumes increase we will build working capital—receivables and inventories will grow—but historically our free cash flow is stronger in the back half of the fiscal year and I expect that pattern to continue, absent new disruptions.

Okay. Thanks very much.

Sure.

Thank you. Next is Sheila from Jefferies. Your line is open.

Thank you. Good morning. Eric, on share gains: where are you gaining share from? Is it other PMA manufacturers, USM, OEMs? What makes an airline choose a used serviceable part versus a PMA? Does it differ with lessors versus operators?

Sheila, we’re gaining share from both other PMA companies and OEMs. We don’t see significant exposure to the USM market—less than 10% of our parts sales are units greater than $5,000 on the PMA side. We do have a subsidiary that participates in the USM market and it provides visibility into that space, but it isn’t a major impact for our other businesses. Airlines choose USM when it makes financial sense; we see both channels in the market but USM is not a principal focus for HEICO’s PMA strategy.

Okay, that’s helpful. Can you talk about where within commercial aero you see recovery—engine parts, airframe, interiors—and how you expect different parts of the market to recover?

The engine market fell more precipitously and is coming back more slowly, as airlines prioritize cash. A majority of our PMA business is in non-engine markets, which recovered faster than engine-heavy segments. We do have engine exposure and it remains important, but most of our business is non-engine and that’s supported the recovery.

Last question for Carlos: can you define your split of labor versus commodities within COGS? How should we think about major commodity cost exposure?

Sheila, a lot of HEICO’s input costs are labor, IP, engineering and R&D. Actual material costs as a percentage of COGS are relatively lower across both segments. I’m less concerned about raw materials inflation compared to labor. OEMs will likely reflect inflation pressure in list prices and we would follow. The labor side could have more impact as we expand and hire more skilled workers, but I don’t expect HEICO to be uniquely disadvantaged relative to other companies.

Sure. Thank you, guys, very much for the call.

Sure. Thank you.

Thank you. Next we have Louis Raffetto from UBS. Please go ahead.

Thank you. Good morning. A follow-up: Eric, I think you guys reduced headcount in certain areas last year. Are you rehiring as volumes return, or do you expect to be leaner going forward?

Louis, we did have limited layoffs and some furloughs last year, some voluntary. HEICO retained a much larger percentage of the workforce than many peers. We did take voluntary pay cuts across the company. We retained new product development skills and are in a good position to support customers and capture market share as demand returns.

I’ll follow up with Carlos on the numbers in the 10-K. Victor, I think the budget comes out later this week; any specific areas you’re watching? You mentioned high-margin defense areas—any more color?

Louis, we should wait and see the budget release. We’ve biased toward intelligence, surveillance, reconnaissance and higher-technology segments within defense, which is consistent with our strategy. Items like missile defense remain important and align with what we do. Friday will provide a first look and then negotiations will play out; we’ll have a better sense of priorities after that.

Louis, the larger workforce reductions occurred in specialty products—non-aftermarket businesses—predominantly at a facility in Asia due to lack of work. Those operations can be spooled up as demand returns; they have well-defined manufacturing processes. Our aftermarket workforce reductions were much smaller compared to some peers.

That’s another good point, Louis.

One thing to recall: we did take a 20% pay cut across executives since last year. Perhaps that’s what you remember. It may show up in the headcount or compensation comparisons.

Okay. I was looking at reported headcounts from the 10-Ks; maybe furloughs affect those numbers. One more on guidance—still no guidance for fiscal ’21. Is there a reason you don’t give piecemeal guidance for ETG versus FSG?

In ETG, commercial aerospace can be 10% to 15% of segment run rate, so visibility is still limited. We prefer not to give piecemeal segment guidance because HEICO is one company and giving guidance for one division and not the other could be confusing. Historically we provide annual guidance when we feel we have sufficient visibility.

Louis, our 16% sequential increase was far beyond expectations and surprised many. If we had given guidance three months ago, we would have missed it. Given the pace and uncertainty, we don’t think it’s responsible to give guidance now.

I agree with Eric and Carlos. HEICO is one company; we won’t give guidance for one division but not the other. That would be improper and potentially misleading.

Fair enough. Thank you.

Thanks.

Our next question is from the line of Gautam Khanna from Cowen. Please go ahead.

Good morning. This is Scott on for Gautam. Given your comments on defense M&A last year, are you seeing any difference in end markets for M&A this year? Are opportunities more in commercial versus defense or still limited?

This is Victor. We’re still seeing a heavier bias toward defense M&A. Some commercial activity is starting to awaken, consistent with expectations, but much of the opportunity flow remains weighted toward defense, space and related markets.

Okay, great. Thank you.

We have our next question from Colin Ducharme from Sterling Capital. Please go ahead.

Hi, good morning. A couple for Carlos: you opportunistically paid down the revolver a couple of quarters ago—anything to read into that? Also, any color on M&A pipeline top-of-funnel trends—LOIs, etc.? And on incremental free cash flow margins and facility footprint: you previously mentioned some CapEx to upgrade equipment—where does that stand as volumes recover? Any out-of-ordinary CapEx coming?

Colin, on M&A pipeline: we don’t speculate on LOIs publicly because due diligence can change outcomes and we don’t want to mislead. Our comment that the pipeline is normal stands: we’re considering many opportunities but can’t predict which will close.

Colin, we expanded the credit facility last year to ensure we have dry powder for acquisitions. The paydown on the credit facility was driven by strong cash generation last quarter. Our average borrowing cost is low—around 1.2%—so it’s an efficient, flexible source of capital. Regarding CapEx, we still expect roughly $40 million for fiscal ’21. Through the first six months we spent about $22 million, including expansion capital for key businesses and maintenance. Historically our free cash flow is stronger in the back half of the fiscal year and I expect that pattern to continue.

That’s helpful color. Thank you.

Okay.

Thank you. We don’t have any further questions at this time. Presenters, please continue.

This is Larry Mendelson. I want to thank everybody on the call for your interest and your input. We look forward to improving conditions; we believe conditions will improve in the second half of our fiscal year and running into ’22, barring any resumption of COVID issues or other problems. We look forward to speaking to you at the third quarter call, which should be toward the middle-to-end of August. In the meantime, if anybody has any questions or comments, please call us. Eric, Victor, Carlos and I are all available and we will be happy to speak with you and respond to your questions. Thank you all very much. This concludes our Q2 conference call.

This concludes today’s conference call. Thank you for participating. You may now disconnect. Have a great day.