Earnings Call Transcript
Heico Corp (HEI)
Earnings Call Transcript - HEI Q3 2020
Operator, Operator
Welcome to the HEICO Corporation Fiscal 2020 Nine Months and Third Quarter Earnings Conference Call. We thank you for joining us today. My name is Vincent, and I'll be your conference operator. As we begin the call, we remind you that 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 the severity, magnitude, and duration of the COVID-19 outbreak. HEICO's liquidity and the amount and timing of cash generation; the continued decline in commercial air travel caused by the outbreak; 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; 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 and profitability. Our ability to introduce new products and services at profitable pricing levels, which could reduce our sales, sales growth, our profitability; 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 electronic industries, which could negatively impact our costs and revenues; and defense spending or budget cuts, which could reduce our defense-related revenue and profitability. Parties listening to or reading a transcript of 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. I'd now turn the call over to Laurans A. Mendelson, HEICO's Chairman and Chief Executive Officer. Thank you.
Laurans Mendelson, Chairman and CEO
Thank you very much, and thank you and good morning to everyone on this call. We thank you for joining us, and welcome you to the HEICO Third Quarter Fiscal 2020 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 VP and CFO. Before reviewing our operating results in detail, I would like to take a moment to thank all of HEICO's talented team members who have performed admirably during the challenges brought on by the COVID-19 outbreak. Their dedication to HEICO's customers and the safety of their fellow team members has been exemplary. I want each and every member of HEICO's global team to understand that the Board of Directors and I are humbled by your dedication and continued focus on safety and wellbeing during these challenging times. I am confident that our future is bright and we will exit this COVID-19 period as a stronger and more competitive company. At this time, I will take a few minutes to discuss the impact on HEICO's operating results from the outbreak for the three and nine months ended July 31, 2020. The effects of the outbreak and the related actions by governments around the world to mitigate its spread have impacted our employees, customers, suppliers, and manufacturers. In response to the economic impact from the outbreak, we at HEICO have implemented certain cost reduction efforts, including layoffs, temporary reduced work hours, temporary pay reductions within various departments of our business, including within our entire executive management team as well as our Board of Directors. Our response to the outbreak included implementing varying health and safety measures at our facilities, including supplying and requiring the use of personal protective equipment, staggering work shifts, body temperature taking, increasing work-from-home capabilities, consistent and ongoing cleaning of workspaces and high-touch areas, and establishing processes aligned with the Centers for Disease and Control guidelines to work with any individual exposed to COVID-19 on their necessary quarantine period, and the process for the individual to return to work. With respect to the results of operations, approximately half of our net sales are derived from defense, space, and other industrial markets, including electronics, medical, and telecommunications. Demand for products in that half of our business has not been fundamentally impacted and its operational results remain materially consistent with the financial expectations prior to the outbreak. We have experienced and expect to continue experiencing periodic operational disruptions resulting from supply chain disturbances, staffing challenges, including at some of our customers, temporary facility closures, transportation interruptions, and other conditions, which could result in increased costs. While these issues have not yet been material overall, we have experienced disruption in some orders and some shipments during the third quarter. The remaining portion of our net sales is derived from commercial aviation products and services. The outbreak has caused significant volatility and a substantial decline in the value across global markets. Most notably, the commercial aerospace industry experienced an ongoing substantial decline in demand resulting from a significant number of aircraft in the global fleet being grounded during our third quarter. Our businesses that operate within the commercial aerospace industry have been materially impacted by the significant decline in global commercial air travel that began in March of this year. Consolidated net sales for our businesses that operate within the commercial aerospace industry decreased by approximately 54% during the third quarter of fiscal 2020. As I previously mentioned, we have taken responsible measures to address these reductions in net sales at our affected businesses. Once commercial air travel resumes, cost savings most likely will be a priority for commercial aviation customers, and we anticipate recovery in demand for our commercial aviation products, which frequently provides aircraft operators with significant cost savings. One item that I'd like to point out that we have been asked on calls between last night and this morning, a number of people asked for the dollar amount of account receivable reserves that we set up for the bankruptcy of some small airlines, and that number, the absolute number was $7.5 million. Later on in this call, Carlos can give you more details on how it affects the operating margins and so forth, but the absolute number was $7.5 million. Keep in mind that historically we have been able to make up and possibly collect some of that $7.5 million. At this point, we don't know how much that might be, if any. So we have, as we normally do, taken the most conservative approach and reserved the whole amount that could go bad. We believe that our cost savings solutions and robust product development programs will enable us to potentially increase market share and emerge with a stronger presence within the commercial aviation market. Summarizing the highlights of the third quarter, consolidated net income increased 4% to a record $251.7 million or $1.83 per diluted share in the first nine months of fiscal 2020, and that was up from $242.2 million or $1.76 per diluted share in the first nine months of fiscal 2019. We continue to forecast positive cash flow from operations for the remainder of fiscal 2020. Cash flow provided by operating activities was consistently strong at $299 million and $313.4 million in the first nine months of fiscal 2020 and 2019, respectively. Cash flow provided by operating activities totaled $93.1 million or 171% of net income in the third quarter of fiscal 2020 as compared to $135.1 million in the third quarter of fiscal 2019. Our net debt, which is total debt less cash and equivalents, of $344.8 million compared to shareholders' equity improved to 17.7% as of July 30, down from 29.8% as of October 31, 2019. Our net debt-to-EBITDA ratio improved to 0.7x, less than 1x as of July 31, 2020, and that was down from 0.93x as of October 31, 2019. During fiscal 2020, we have successfully completed six acquisitions, four of which were completed since the outbreak started. We have no significant debt maturities until fiscal 2023, and we plan to utilize our financial flexibility to aggressively pursue high-quality acquisitions to accelerate growth and maximize shareholder returns. I do want to point out that unlike some companies in the aerospace industry, HEICO did not have to go to the market to raise money at what I consider exorbitant rates of 8% or more. So we just went through this financially sound and I think that has really helped us and has proven to be an excellent strategy. In July 2020, we paid the regular semiannual cash dividend of $0.08 per share, and that represented our 84th consecutive semiannual cash dividend. We did not have to cut the dividend and we were very proud of that. Some companies did cut dividend significantly because of cash flow pressures, we did not. In July 2020, we reported that our Sierra Microwave, VPT, 3D-Plus subsidiaries supplied mission-critical hardware for the Mars 2020/Perseverance mission. The Mars mission is designed to better understand the geology of Mars and seek signs of ancient life by collecting and storing rocks, soil samples for a future return to Earth, while also testing new technology for robotic and human space exploration. We congratulate the many remarkable people who accomplished this first step in this incredible mission, and we are proud of the HEICO companies and team members who contributed to the effort, and we are excited about the mission's next stage. Talking about acquisitions, in June 2020, we acquired 70% of the membership interest of Rocky Mountain Hydrostatics, which overhauls industrial pumps, motors, and other hydraulic units, with a focus on the support of legacy systems for the U.S. Navy. The remaining 30% continues to be owned by certain members of Rocky Mountain's management team. And Rocky Mountain is part of our Flight Support Group, and we expect the acquisition to be accretive to earnings within the first 12 months following closing. In August 2020, we acquired 75% of the equity interest of Intelligent Devices and Transformational Security. These two companies design, develop, and manufacture state-of-the-art technical surveillance countermeasures equipment used to protect critical spaces from exploitation via wireless transmissions, technical surveillance, and listening devices. In summary, I'll say basically spying by unwanted people. These acquisitions are part of Electronic Technologies, and we expect them to be accretive to earnings within the first 12 months following closing. The remaining 25% interest was acquired by the non-controlling interest holders of a subsidiary in HEICO Electronic that is also a designer and manufacturer of the same type of equipment used basically for different applications. In August 2020, we acquired 90% of the equity interest of Connect Tech. Connect Tech designs, manufactures rugged, small form factor embedded computing solutions. Its components are designed for very harsh environments and primarily used in rugged commercial and industrial, aerospace and defense, transportation, and smart energy applications. The remaining 10% interest continues to be owned by a member of Connect Tech's management team. This acquisition is part of the Electronic Technologies Group, and we expect it to be accretive to earnings within the first 12 months following closing. At this time, I'd 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.
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Thank you. The Flight Support Group's net sales were $731.2 million in the first nine months of fiscal 2020 as compared to $915.5 million in the first nine months of fiscal 2019. The Flight Support Group's net sales were $178.2 million in the third quarter of fiscal 2020 as compared to $320 million in the third quarter of fiscal 2019. The net sales decrease in the first nine months in the third quarter of fiscal 2020 is principally organic and reflects lower demand across all of our product lines, resulting from the significant decline in global commercial air travel beginning in March 2020 due to the outbreak. Net sales in fiscal 2020 follows a very strong 12% and 13% organic growth reported in the third quarter and full fiscal 2019 year respectively. The Flight Support Group's operating income was $121.6 million in the first nine months of fiscal 2020 as compared to $179.8 million in the first nine months of fiscal 2019. The Flight Support Group's operating income was $12 million in the third quarter of fiscal 2020 as compared to $64.8 million in the third quarter of fiscal 2019. The operating income decreased in the first nine months and third quarter of fiscal 2020, principally reflects the previously mentioned decrease in net sales, a lower gross profit margin, mainly within our aftermarket replacement parts and repair and overhaul parts and services product lines, and an increase in bad debt expense, principally due to potential collection difficulties from certain commercial aviation customers that filed for bankruptcy protection during the third quarter of fiscal 2020, as a result of the financial impact of the outbreak. These decreases were partially offset by lower performance-based compensation expense. The Flight Support Group's operating margin was 16.6% in the first nine months of fiscal 2020 as compared to 19.6% in the first nine months of fiscal 2019. The Flight Support Group's operating margin was 6.7% in the third quarter of fiscal 2020 as compared to 20.2% in the third quarter of fiscal 2019. The decrease in the first nine months and third quarter of fiscal 2020 principally reflects the previously mentioned lower gross profit margin and an increase in SG&A expenses as a percentage of net sales mainly reflecting the impact of the outbreak and previously mentioned higher bad debt 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.
Victor Mendelson, Co-President & President of HEICO's Electronic Technologies Group
Thank you, Eric. The Electronic Technologies Group's net sales increased 4% to a record $638.3 million in the first nine months of fiscal 2020, up from $615 million in the first nine months of fiscal 2019. This increase is attributable to the favorable impact from our fiscal 2019 and fiscal 2020 acquisitions partially offset by an organic net sales decrease of 1%. The organic net sales decrease is principally due to lower sales of our space, commercial aerospace, and other electronics products, largely attributable to the outbreak, partially offset by increased sales of our defense products. The Electronic Technologies Group's net sales decreased 2% to $210 million in the third quarter of fiscal 2020, from $216.1 million in the third quarter of fiscal 2019. This decrease is attributable to an organic net sales decrease of 6% partially offset by the favorable impact from our fiscal 2019 and fiscal 2020 acquisitions. The organic net sales decrease is principally due to lower shipments of our defense and commercial aerospace products, mainly attributable to the outbreak, partially offset by increased sales of our space products in the third quarter. The Electronic Technologies Group's operating income increased 2% to a record $184.9 million in the first nine months of fiscal 2020, up from $181.2 million in the first nine months of fiscal 2019. The Electronic Technologies Group's operating income was $61.9 million and $62.2 million in the third quarter of fiscal 2020 and fiscal 2019, respectively. The increase in the first nine months of fiscal 2020 principally reflects the previously mentioned net sales growth, lower performance-based compensation expense, and a decrease in acquisition-related expenses, partially offset by a lower gross profit margin. The lower gross profit margin is mainly due to a decrease in net sales of certain space products and a less favorable product mix of certain aerospace products, partially offset by increased net sales of certain defense products. The Electronic Technologies Group's operating margin was 29% in the first nine months of fiscal 2020, as compared to 29.5% in the first nine months of fiscal 2019. The decrease principally reflects the previously mentioned lower gross profit margin partially offset by a decrease in SG&A expenses as a percent of net sales mainly from lower performance-based compensation expense and lower acquisition-related expenses. The Electronic Technologies Group's operating margin improved to 29.4% in the third quarter of fiscal 2020, up from 28.8% in the third quarter of fiscal 2019. The increase principally reflects a decrease in SG&A expenses as a percent of net sales mainly from lower performance-based compensation expense and a decrease in acquisition-related expenses partially offset by a lower gross profit margin. The lower gross profit margin is mainly due to a decrease in net sales and less favorable product mix of certain commercial aerospace and defense products partially offset by increased net sales and a more favorable product mix of certain space products in the quarter. Now I would like to turn the call back to our Chairman, Larry Mendelson.
Laurans Mendelson, Chairman and CEO
Thank you, Victor and Eric. Consolidated net income per diluted share decreased 32% to $0.40 in the third quarter of fiscal 2020, and that was down from $0.59 in the third quarter of fiscal 2019. The decrease principally reflects the previously mentioned lower operating income of the Flight Support Group, partially offset by lower income tax expense, less net income attributable to non-controlling interest, and lower interest expense. Consolidated net income per diluted share increased 4% to $1.83 in the first nine months of fiscal 2020, and that was up from $1.76 in the first nine months of fiscal 2019. And that increase principally reflects an incremental discrete tax benefit from stock option exercises, which we recognized in the first quarter of fiscal 2020, less net income attributable to non-controlling interest and lower interest expense, partially offset by the previously mentioned lower operating income of Flight Support. Depreciation and amortization expenses totaled $21.9 million in the third quarter of fiscal 2020, that was up slightly from $21.1 million in the third quarter of fiscal 2019 and totaled $65.2 million in the first nine months of fiscal 2020, up from $61.7 million in the first nine months of fiscal 2019. The increase in the third quarter and first nine months of fiscal 2020 principally reflects the incremental impact from our fiscal 2019 and 2020 acquisitions. R&D expense was $15.1 million in the third quarter of fiscal 2020 compared to $16.6 million in the third quarter of fiscal 2019, and it increased 1% to $49 million in the first nine months of fiscal 2020, and that was up from $48.7 million in the first nine months of fiscal 2019. Significant new product development efforts are continuing at both Electronic Technologies and Flight Support, and we continue to invest more than 3% of each sales dollar into new product development. Consolidated SG&A expense decreased by 20% to $75 million in the third quarter of fiscal 2020, down from $93.4 million in the third quarter of fiscal 2019. Consolidated SG&A expense decreased by 13% to $232.8 million in the first nine months of fiscal 2020, and that was down from $267.9 million in the first nine months of fiscal 2019. The decrease in consolidated SG&A expense in the third quarter and first nine months of fiscal 2020 principally reflects a concerted effort by both Flight Support and Electronic Technologies to control their SG&A spending. And these efforts resulted in lower G&A expenses such as a decrease in performance-based compensation expense and a reduction in various selling expenses, including outside sales commissions, marketing, and travel. These decreases were partially offset by an increase in bad debt expense at Flight Support, which I previously mentioned was $7.5 million, due to potential collection difficulties from certain commercial aviation customers that filed for bankruptcy protection during the third quarter of fiscal 2020 as a result of the financial impact of the outbreak, as well as the increase from fiscal 2019 and 2020 acquisitions. Consolidated SG&A expense as a percentage of net sales increased to 19.4% in the third quarter of fiscal 2020, and that was up from 17.5% in the third quarter of fiscal 2019. The increase in consolidated SG&A expense as a percent of net sales in the third quarter of fiscal 2020 principally reflects the aforementioned increase in bad debt expenses due to bankruptcy filings made by certain commercial aviation customers and higher other SG&A expenses as a percentage of net sales due to decreased sales volumes. These increases were partially offset by lower performance-based compensation expense. Consolidated SG&A expense as a percent of net sales decreased to 17.1% in the first nine months of fiscal 2020, down from 17.7% in the first nine months of fiscal 2019. The decrease in consolidated SG&A expense as a percentage of net sales is mainly due to, again, lower performance-based compensation expenses, partially offset by an increase in other SG&A expenses as a percentage of net sales and an increase in the bad debt expense, reflecting the previously mentioned bankruptcy filings. Interest expense decreased to $2.6 million in the third quarter of fiscal 2020 down from $5.5 million in the third quarter of fiscal 2019 and decreased to $10.6 million in the first nine months of fiscal 2020, and that was down from $16.5 million in the first nine months of fiscal 2019. The decrease in the third quarter and first nine months of fiscal 2020 was principally due to a lower weighted-average interest rate on borrowings outstanding under our revolving credit facility. Our effective tax rate in the third quarter of fiscal 2020 was 13.4% compared to 22% in the third quarter of fiscal 2019. The decrease principally reflects a larger deduction related to foreign-derived intangible income, principally resulting from final tax regulations that were issued in the third quarter of fiscal 2020 as part of the Tax Cuts and Jobs Act that was enacted in December 2017 as well as a larger income tax credit for qualified R&D activities. Our effective tax rate in the first nine months of fiscal 2020 was 3.5% compared to 17.1% in the first nine months of 2019. As previously mentioned, HEICO recognized a discrete tax benefit from stock option exercises in both the first quarter of fiscal 2020 and 2019, which accounted for a majority of the decrease in our year-to-date effective rate. The decrease in the effective rate in the first nine months of fiscal 2020 also reflects a larger deduction related to the previously mentioned foreign-derived intangible income deduction as well as larger income tax credits for qualified R&D activities. Net income attributable to non-controlling interest was $3.2 million in the third quarter of fiscal 2020 and that compared to $8 million in the third quarter of fiscal 2019. Net income attributable to non-controlling interest was $16.6 million in the first nine months of fiscal 2020 compared to $25 million in the first nine months of fiscal 2019. The decrease in the third quarter and first nine months of fiscal 2020 principally reflects the impact of the dividend paid by HEICO Aerospace on June 19, 2019, that effectively resulted in the transfer of the 20% non-controlling interest held by Lufthansa Technik in eight of our existing subsidiaries back to the Flight Support Group and a decrease in operating results of certain subsidiaries of the Flight Support Group in which non-controlling interests are held. Moving on to the balance sheet and cash flow. Our financial position and forecasted cash flow remain extremely strong. As we mentioned earlier, cash flow provided by operating activities was consistently strong at $299 million and $313.4 million in the first nine months of fiscal 2020 and 2019, respectively. Cash flow provided by operating activities totaled $93.1 million or 171% of net income in the third quarter of fiscal 2020 as compared to $135.1 million in the third quarter of fiscal 2019. Our working capital ratio improved to 5x as of July 31, 2020 compared to 2.8x as of October 31, 2019. Our day sales outstanding, DSOs, of receivables improved to 43 days as of July 31, 2020 and that compared to 45 days as of July 31, 2019. We monitor all receivable collection efforts and try to limit our credit exposure. No one customer accounted for more than 10% of net sales, and our top-five customers represented 25% and 21% of consolidated net sales in the third quarter of fiscal 2020 and 2019, respectively. Inventory turnover increased to 154 days for the period ended July 31, 2020 and that compared to 125 days for the period ended July 31, 2019. The increase in the turnover rate principally reflects certain long-term and non-cancelable inventory purchase commitments based on pre-outbreak net sales expectations and also the necessity to support the backlog of certain of our businesses. Now looking forward, the outlook. We cannot estimate the outbreak's duration and magnitude, and we cannot confidently predict when demand for commercial aerospace products will return to pre-outbreak levels. However, we do continue to forecast positive cash flow from operations for the remainder of fiscal 2020. We entered the outbreak with a healthy balance sheet that included a strong cash position and nominal debt. We believe HEICO is favorably positioned for long-term success despite the short-term challenges created by the outbreak in the global economy. This COVID pandemic will not last forever. Our time-tested strategy of maintaining low debt and acquiring and operating high cash-generating businesses across a diverse base of industries beyond commercial aviation such as defense, space and other high-end markets, including electronics and medicals puts us in a good financial position to weather this uncertain economic period. I would like to end my remarks by again thanking our team members for their continued support and commitment to HEICO during these professionally and personally challenging times. Our executive team is focused on your safety and professional success. We will exit this outbreak stronger than before, and that strength will manifest from our culture of ownership, mutual respect for one another, and the unwavering pursuit of exceeding customers’ expectations. And we thank you all for all that you do to make HEICO an exceptional company. And I would like to add, I also thank our loyal shareholders who have stuck by HEICO and sent us many, many positive comments and thanks, and we truly appreciate your interest and support. And now I would like to open the floor for questions. Thank you.
Operator, Operator
The first question comes from Robert Spingarn. Your line is now open. Please ask your question.
Robert Spingarn, Analyst
Good morning.
Laurans Mendelson, Chairman and CEO
Good morning, Rob.
Robert Spingarn, Analyst
Thank you for all of the detail. I just wanted to perhaps dig in a little bit. Eric, maybe we could start with FSG and just talk about the different businesses within FSG and their varying performances, if you will, the parts overhaul distribution. And then if you could talk a little about the trend between the months. In other words, did May mark bottom? And how did June and July look? And then I have a couple of other things after that.
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Sure, Rob. Let me start with the trend. We were – back in May, when we said we were hopeful that May would mark the bottom, in fact, May was the bottom, and we were able to bounce nicely off of the May numbers into June and July. And I would say they were sort of consistent at that level. In terms of reviewing the businesses within the parts side, of course, we've got the PMA and we've got the distribution, and I would say that they were down sort of in the similar area. Repair was down a little bit more and that was to be expected as airlines we anticipated would reduce whatever expenditures that they saw. Specialty products, I would say, was down a little less in the beginning of the pandemic, but I think now as people recognize that the build rate is going to be reduced, I think the suppliers to the OEMs, including the HEICO businesses that do that, are going to be impacted sort of longer than the aftermarket is going to be impacted. I reviewed with our sales executives the customer sales and how we're doing by product lines and by customers and it's sort of interesting to note that while the business is down, the percentage that we reported, there are certain airlines that are down very significantly, I would say, 96%, 90%, 88%, 87%, and these are major customers. I don't want to mention their names and I don't want to mention their geographies, but I can tell you that these are major airlines that are not going to be able to operate. I mean, they're operating 30% to 50% of their flights and yet their purchases are down in the 90s. And obviously, that is not a sustainable model. I think that they – our people believe that they entered the crisis with lean inventories and my sense is that they are – they've used up or they're using up whatever they've got. And this is not going to last indefinitely. So to answer your question, I think that the OEM market will be down longer for the new build and for the reasons that airlines don't need the aircraft, but I do believe that the aftermarket will start to snap back.
Robert Spingarn, Analyst
And did you see – did July improve from June?
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
July did improve from June, but I would be careful to sort of extrapolate that improvement going forward because as we've seen with the sort of the late July increase in infection rate, of course, that's now come down, I mean, that would, obviously, sort of put a damper on the increases going forward. So I think very much it's going to be related to the infection rates into the progress on a therapeutic as well as a vaccine. But the one thing which I am extraordinarily hopeful of and very, very positive on is, when I met with our salespeople, who are probably on this call, and we reviewed the customers in detail, I gave them every opportunity to tell me why the future would be tough and why I should – why things may be difficult coming out and sort of for them to set expectations low. And I can tell you that to a person they were extraordinarily optimistic. They think that – and they gave me specifics as to why HEICO has increased its credibility with the customers and they believe that we're going to come out of this significantly stronger than we've come out of any of the other prior crises, and they gave me the specifics, which I don't want to mention for competitive reasons on this call, but I believe that we're going to be in a very strong shape to come out. So I guess, what you're getting to is, when do we think things will get better? Of course, we don't know, but the one thing we are 100% certain of is they will get better and we will emerge definitely stronger than we've ever been.
Robert Spingarn, Analyst
And just on that, Eric, while some airlines are underperforming the traffic numbers, as you just mentioned, are others starting to recognize your value proposition? Are you gaining any market share here? And I wanted to call out China, specifically, since it sounds like PMA has not yet really penetrated that one region.
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Yes. I mean, as you know, we are hesitant to talk about specific regions or customers. We pretty much deal with everybody. So it's not so much getting new customers for us as it is selling customers more of our product line. And I'm very optimistic that we are going to be selling. I've seen a lot of specifics on customers interested in and working on improving product that they had not in the past. Our time has come. There is no reason that if somebody is buying X percent of our product line, they shouldn't be buying the entire product line. And we've got, I believe, the best people in the field. One of the reasons why our results and margins were better than expected but lower than we would have liked is because while there was a lot of shared sacrifice in terms of furloughs and reduced hours and reduced pay, we've done everything we could and we can to keep our people, whether it's the new product development folks or the sales folks, quality, purchasing, everything to keep our people on our payroll because we believe that we're going to come out this extremely strong, and we don't want to be caught flatfooted. We've got a number of peers in the industry, who I believe were very aggressive with their reductions, and I think that is going to hamper them coming out, whereas HEICO has continued to maintain that infrastructure.
Robert Spingarn, Analyst
Okay. I'll leave margins for the next person, but, Victor, just quickly on your side, I just was going to ask if you could talk a little bit more about the decline in sales in the quarter and the impact of COVID, and how you think that sets up here for the fourth quarter in terms of organic growth?
Victor Mendelson, Co-President & President of HEICO's Electronic Technologies Group
Thanks Rob. This is Victor. Maybe taking it a little bit in reverse order and thinking about the fourth quarter, which, of course, we're in right now, I'm not sure where things will wind up exactly within the fourth quarter. I could see us being up 5% or 10% just as easily as I could see us being down 5% or 10% in the fourth quarter, and that sort of gets into then the first part of your question and the kind of things that we're dealing with. And so, of course, commercial aviation that part of ETG is down, and it's comparable to what we're seeing within the Flight Support Group – in the commercial aviation businesses within the Flight Support Group. And I expect that to have a trajectory that will be comparable to what we experienced in the Flight Support Group. So the other part that has impacted some of the markets, the more general markets that we've talked about that are serving the broader economy, some of the harsh environment markets have been slower and – or have slower demand, not dramatically, but you'll see 5% to 20% down in some product lines and things like that. So that's kind of the part of the business that's just a little bit slower. And then you get to the part that isn't slower, right, that has strong orders that remains healthy, which is the bulk of the business and that's in the defense and space side. And what we continue to see are disruptions that we talked about in the early part of the call that comes from – generally, it's supply chain side of it, but sometimes the customer side where, let's say, on the supply chain, it's deliveries, we’ll have a supplier, which is experiencing their own outbreak issues in their plant, and they will have a line go down or something in their two weeks or four weeks later, something like that. We have it – and then they're late delivering to us, and then in turn that slows us down. And so you see things just kind of moving out nothing dramatic, but things can move out for a month or two weeks or something like that, and it shifts it from one quarter to the next. And then on the customer side, we will see the same kind of effect, where they will be closed or they will be at half staffing or something like that for two weeks or four weeks, and PO doesn't get out and the order doesn't get placed, and then we have decisions to make. Well, we know it's coming. Do we go ahead? Do we build ahead? And we generally don't take a lot of risk on building ahead and committing capital far in advance ourselves. We grapple with those decisions. We've got actually some government customers. I won't obviously name who they are, but you've got government customers who can't work online. They can't have their people working from home for security reasons, and they are at 30% or 50% staffing levels, and so they are delayed simply because they have people on these rotating shifts, and they're like one month on and one month off, it's just stuff like that. So no fundamental change. The demand is there, and it eventually gets placed. So we're very optimistic about those, and that's why I say it could just as easily be up 5% or 10% as down 5% or 10%. I don't think anything dramatic fortunately, and overall pretty, pretty healthy, but it makes it difficult to forecast, if you will, at the margins. Keep in mind one other thing when you look at the business, you look at the ETG for example, and you're talking about a business that's couple hundred million-ish in a quarter, 1% is about $2 million, a little bit more, but that 1% is about $2 million. And you have a few businesses that shift by just a few hundred thousand dollars, and it moves from one quarter to the next, then you have a small number of businesses where that happens. It can have an effect where you have 1% or 2% or 3% of organic growth all of a sudden disappears and moves.
Robert Spingarn, Analyst
Just a final detailed point. Would you call any difference or major difference out between space and defense in terms of either supply issues or demand issues?
Victor Mendelson, Co-President & President of HEICO's Electronic Technologies Group
Well, in space – when I talk about space, I'm really referring to the commercial space part of it. On the supply chain side, no, not so much because the issues that face people and companies are similar, and so if you have a space supplier who is delayed, and he can just easily the defense guy who is delayed. I mean, we all saw this on the F-35, right, that they're going to have a delay in testing them and simulation, right, last week. So on the supply side, it can be the same. It's just sort of a luck of the draw, and commercial space, of course, as we've talked about in the prior calls that the shipments now are picking up to match the orders that we talked about, which had been accelerating and there has been an improvement on our commercial space side as we expected.
Robert Spingarn, Analyst
Okay. Thank you very much.
Laurans Mendelson, Chairman and CEO
Thank you, Rob. Thank you for the questions.
Operator, Operator
Next question comes from the line of Peter Arment. Your line is now open. Please ask your question.
Peter Arment, Analyst
Yes. Good morning, Larry, Victor, and Eric.
Laurans Mendelson, Chairman and CEO
Good morning, Peter.
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Good morning.
Victor Mendelson, Co-President & President of HEICO's Electronic Technologies Group
Good morning.
Peter Arment, Analyst
Eric, just to follow up on Rob's – left me the margin question, so I'll ask it. Just how you're thinking about the kind of the decrementals were, I guess, in kind of looking at high 30s. How you think about margins kind of trending from here, if clearly this 3Q was kind of the trough from an overall topline perspective?
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Good morning, Peter, and thanks for your question. So if you add back the bad debt reserves that we had in the third quarter, the Flight Support Group's operating margin was around 11%, the adjusted operating margin. And of course, we had no way of knowing the impact of what these bad debt charges would be when we originally said at the end of our second quarter call that the Flight Support Group would operate in the breakeven area with sales down 50% to 60%. So I think we did, sales-wise, much better than we expected as well as margins much better than we expected. And going forward, it really depends on the slope of the recovery. We're very optimistic that we will recover and we're going to come back much stronger than when we went in. But the period of time that it's going to take for that recovery is difficult at this point. But I would say probably somewhat comparable, if I were to guess, to the third quarter.
Peter Arment, Analyst
On an adjusted basis, right?
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Correct. And Carlos, I think has something to add here.
Carlos Macau, Executive VP & CFO
Yes. Hi, Peter. Good morning. I would say that the bad debt expense, even though it was kind of this one-time period-type cost that we don't like to see. It is something that's hard to control when airlines have bankruptcies. We probably had 20 airlines during the quarter declared reorganizations or Chapter 11. So our policies are to just basically write that stuff off, put a reserve up against it when we see that occurring. And if we get paid great, we hope to get paid, but nonetheless be conservative about it. Now as a result of that, and I talked about at the end of Q2, we have continued to really scrub our receivables and our customer base and make sure that credit that we're granting to our customers aligns with their financial strength in hopes that we – and continue to not extend ourselves in any one particular customer. So I think we've got – well, I can't predict whether there'll be more bankruptcies, I do believe that we have very conservative and very practical policies around receivables. And hopefully, outside of these Chapter 11s, we won't see this type of charge in the future.
Peter Arment, Analyst
Okay. That's helpful. And just as a follow-up question on just M&A. You’ve six deals this year, I think four since the pandemic in terms of – so clearly, your ability to execute deals remains on a good pace. What are you seeing in the M&A environment? Do you see that – are there more deals that you think now that are coming available? Or how are you approaching it, I guess, particularly if you're looking at anything on the FSG line?
Laurans Mendelson, Chairman and CEO
Pete, this is Larry. We see a lot of books coming across our desk. We think the motivation are probably twofold. One, some companies feel under pressure. They've seen their markets shrink and so forth, and they would like to have a strong financial partner. So that's one thing. The other thing is that the talk of a Biden win, increasing capital gain tax to 43.5% or something like that is really scaring a lot of people, including me. And I must tell you that we are seeing more books than we can handle. And also, because of the logistics of doing due diligence and you know, we do very thorough due diligence in-house, it takes longer because you can't go out, you can't access the facilities and so forth, but I would say that the M&A pipeline is really very, very strong. And I also think that we're seeing much more reasonable pricing. And I think that we will over the next six, 12 months have some very excellent opportunities.
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
And Peter, this is Eric. Also, I want to add that due to our capital structure and the culture at HEICO of valuing our team members because, frankly, they're the ones who make the company. When times are tough like this, we stick by our people, we stick by our programs. We're not highly levered. We don't swing around and cut very deeply. So as a result, I think when sellers look at HEICO, our businesses go through various cycles, but they want to be connected with somebody who is going to be patient and work with them, and frankly, not kill them and run them out the door the first time there's a downturn. And I think when you look at HEICO, you see that that's the case and that's something that we try to articulate. And I think is one of the reasons why we continue to be the acquirer of choice. We're very busy flying around, meeting with management teams with entrepreneurs and very, very much focused on continuing to make acquisitions and use our way under-levered balance sheet.
Peter Arment, Analyst
Appreciate all the details. Thanks.
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Thanks.
Operator, Operator
Next question comes from the line of Gautam Khanna. Your line is now open. Please ask your question.
Gautam Khanna, Analyst
Yes. Thank you. Good morning, guys.
Laurans Mendelson, Chairman and CEO
Good morning.
Gautam Khanna, Analyst
I wanted to follow-up on a couple of questions. First, any commentary on August trends at FSG? Has that sort of continued the linearity of improvement that you talked about during the July quarter?
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
This is Eric, Gautam. No, I would say since it's really outside of our – it's not included in our third quarter, we'd rather not comment on it. However, I think it's reasonable to expect – if you look at the general – as I mentioned before, if you look at the general sort of infection rate trend, what's going on in the economy. I think it's logical to assume that things are a little flattish right now, but I think people are optimistic that it will recover. So the only question is exactly when that recovery occurs.
Gautam Khanna, Analyst
Got it. And just on that point, have you seen customers that have not been as aggressive in using PMA starting to inquire more about it so that will actually – maybe you'll see greater customer adoption of the overall Americas?
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Yes. Unequivocally, yes. There has been a lot more interest, definitely. With airlines under the gun, having to show reduced cost for the same, if not improved performance, absolutely. And that's what gives me so much confidence for the future.
Gautam Khanna, Analyst
Okay. That's helpful. At ETG, Victor, could you – maybe you said it, but I just wanted to make it clear for myself. In terms of underlying demand, so there's this timing on shipments which a customer may or may not be onsite to accept delivery and that can swing the organic growth rate around. But can you – what do you think the underlying demand growth is right now? Do you think it is kind of low-single digits? And so we do see a catch up to 5% to 10%. Maybe it's not in Q4, but at some point, this draws in later? How do you – if you put it all together, how would you aggregate underlying demand at this point?
Victor Mendelson, Co-President & President of HEICO's Electronic Technologies Group
It's a good question, and I'm not trying to be cute or evasive. It's difficult to assess that now because of some of those disruptions I was talking about, where we have customers who are not there, sort of missing in action. And all of a sudden, they're there and placing big orders and hurrying up or asking us to rush because they were out for two weeks or a week or a month or something like that. So it's difficult to assess. On the defense demand and space, it feels robust. And when they show up – if they're not there, all of a sudden it's slow and then it picks up, it seems to make up very nicely, where it does seem to be lagging, as I said, are in some of those other markets that we serve. But then again, we'll see something – it'll have a feel of lagging, and then the customer shows up and says, okay, look, we really need to hurry up. Can you ship faster? And we have a bunch of orders. Is there anything you can do to trim the lead times? So I really hate to be evasive on this or to seem evasive, but I would prefer not to give you any percentage field at this point until we've got some better clarity, which I'm hoping maybe in three or six months, we will and have a better sense.
Eric Mendelson, Co-President & President of HEICO's Flight Support Group
Remember one thing, Gautam, and we said this historically quite often, we are very customer-focused. And if our customers are struggling, not there or whatever, we're not going to put something in the mail and send it to them and say tough. We want to make sure that we're easy to do business with, and then our customers respect our flexibility. And our structure is uniquely done in a way that it can handle that ad hoc. We're not one big monolithic organization. We have multiple subsidiaries all over the place, and they're close with their customers and they monitor and deal with this. And I think what that will do for us going forward and into the future is that we’ll endure even more to our customer base and will allow us to move forward with an even stronger position with all of these customers. So I agree with Victor. We can't really give a percentage because we're not so focused on that. But what I do know is that our customers appreciate the way we're handling this right now. And I think that's going to pay dividends for us in the future.
Gautam Khanna, Analyst
I appreciate that. And if I may, just on FSG, on the repair side of the business, are you seeing customers in-source more of that stuff? Or is there – do you think there's been no change to how the customers are actually looking to sell? I'm just wondering how much is like underlying demand versus in-house.
Victor Mendelson, Co-President & President of HEICO's Electronic Technologies Group
Got it. No, I don't think they've in-sourced. I think that there hasn't been much change. If anything, it’s probably going to be greater outsourcing due to the people cuts that they've been forced to make. So I think our component repair people are very wired in and are very optimistic about a number of really good opportunities.
Laurans Mendelson, Chairman and CEO
Okay. Thank you, gentlemen. We appreciate your time and your contribution. As usual, the team is around to take calls. And we welcome your follow-up questions and we look forward to speaking to you again on our next quarterly report. Thank you all.
Operator, Operator
This concludes our teleconference for the third quarter. Thank you.