Earnings Call Transcript - HEI Q3 2023

Operator, Operator

Welcome to the HEICO Corporation Third Quarter Fiscal 2023 Financial Results Call. My name is Samia, and I'll be today's operator. Certain statements in this conference call will constitute forward-looking statements, which are subject to risks, uncertainties and contingencies. HEICO's actual results may differ materially from those expressed in or implied by those forward-looking statements as a result of factors including, but not limited to, the severity of magnitude and such as the COVID-19 pandemic or health emergencies; HEICO's liquidity and the amount and timing of cash generation; lower commercial air travel caused by health emergencies and their aftermath, airline fleet changes or airline purchasing decisions, which could cause lower demand for our goods and services; product specification costs and requirements, which could cause an increase to our cost to complete contracts; supplemental and regulatory demands, export policies and restrictions; reductions in defense, space or homeland security spending by U.S. and/or foreign customers or competition from existing and new competitors, which could reduce our sales; our ability to introduce new products and services at profitable pricing levels, which could reduce our sales or sales growth; product development or manufacturing difficulties, which could increase our product development and manufacturing costs and delay sales; our ability to make acquisitions, including obtaining any applicable domestic and/or foreign governmental approvals and achieve operating synergies from acquired businesses; customer credit risk, interest, foreign currency exchange and income tax rates; economic conditions, including the effects of inflation within and outside of the aviation, defense space, medical, telecommunications and electronics industries, which could negatively impact our cost and revenues; and defense spending or budget cuts, which could reduce our defense-related revenue. Parties listening to this call are encouraged to review all of HEICO's filings with the Securities and Exchange Commission, including, but not limited to, filings on Form 10-K, Form 10-Q and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except to the extent required by applicable law. I now turn the call over to Lawrence Mendelson, HEICO's Chairman and Chief Executive Officer.

Larry Mendelson, Chairman and CEO

Thank you very much, and good morning to everyone on the call. We thank you for joining us, and we welcome you to this HEICO third quarter fiscal '23 earnings announcement teleconference. I'm Larry Mendelson, Chairman and CEO of HEICO Corporation, and I'm joined here this morning by Eric Mendelson, HEICO's Co-President and President of HEICO's Flight Support Group; Victor Mendelson, HEICO's Co-President and President of HEICO's Electronic Technologies Group; and Carlos Macau, our Executive Vice President and CFO. Before reviewing our operating results in detail, I'd like to take a moment to thank all of HEICO's dedicated and talented team members who are responsible for another strong quarter of excellent results. They continue to produce the highest quality products and services for our customers while maintaining our unique entrepreneurial corporate culture that has delivered excellent returns to shareholders. I'd like to extend a warm welcome to the approximate 1,000 HEICO-Wencor Group team members who recently joined the HEICO family. We look forward to our collective journey of exceeding customer expectations and winning in the marketplace. I personally have never been more optimistic about the future for HEICO. I'd like to now summarize the highlights of our third quarter fiscal record results. Consolidated third quarter fiscal '23 net sales represent record results for HEICO, driven principally by record net sales within Flight Support Group, mainly arising from continued strong demand for our commercial aerospace products and services and the contributions from our fiscal '23 and '22 acquisitions. Consolidated operating income and net sales in the third quarter of fiscal '23 improved by 16% and 27%, respectively, as compared to the third quarter of fiscal '22. These results mainly reflect a 12% quarterly consolidated organic net sales growth and the impact from acquisitions. I’d like to note an important item. HEICO incurred acquisition costs from the Wencor acquisition during the third quarter of fiscal '23. This decreased our net income by approximately $3.5 million or $0.03 per diluted share. The way management looks at our operations, we were able to report $0.74 a share earnings in the third quarter after deducting this unusual $0.03 per share. So management considers our earnings in the third quarter as actually $0.77. Recognizing this, our operating margins, especially before Wencor-related non-recurring deal expenses, remained strong and are consistent with the expectations we previously communicated in investor calls and events. These margins are very healthy even though our product mix this year has meant lower overall margins than in prior years. Consolidated net income attributable to HEICO increased 24% to $102 million or $0.74 per diluted share, again after deducting $0.03 of those special Wencor expenses in the third quarter of fiscal '23, and that was up from $82.5 million or $0.60 per diluted share in the third quarter of fiscal '22. In connection with the Wencor acquisition, our net debt-to-EBITDA ratio was 0.75x as of July 31, '23, compared to 0.25x as of October 31, '22. Our net debt-to-EBITDA ratio increased in the first nine months of fiscal '23 due to our successful offering of $600 million of 5.5% senior unsecured notes due August 1, '28 and $600 million of 5.35% senior unsecured notes due August 1, '33. We used the net proceeds from the sale of these notes to repay the outstanding borrowings under our revolving credit facility and to fund a portion of the Wencor acquisition purchase price. Cash flow provided by operating activities was very strong at $145.9 million in the third quarter of fiscal '23 compared to $149.2 million in the third quarter of fiscal '22. Cash flow provided by operating activities in the third quarter of fiscal '23 reflects an increase in working capital, principally driven by an increase in inventories to support increased consolidated backlog. We continue to forecast strong cash flow from operations for fiscal '23. In June, we were honored to announce that I will receive the prestigious 44th Annual Howard Hughes Memorial Award from the Aero Club of Southern California on Wednesday, September 6. The Howard Hughes Memorial Award honors exceptional leaders who have advanced the field of aviation or aerospace technology. Upon receipt of the award, I will join 43 aviation and aerospace pioneers, including last year's honoree, Harrison Ford, as well as prior honorees, General Chuck Yeager, Bob Hoover, Neil Armstrong, General Jimmy Doolittle, Elon Musk, Jim Lovell, Maryland, Houston, and Captain Sully Sullenberger, and many others. I am profoundly honored to receive such a prestigious award from such a prestigious organization, though I believe it really belongs to all of HEICO's team members because it results from all of their remarkable work and success over several decades. Last week, we announced that our 3D PLUS and Exxelia subsidiaries supplied mission-critical electronic components on India's Chandrayaan-3 spacecraft, which successfully executed a soft landing on the Moon's South Pole. We offer our congratulations to the Indian Space Research Organization, and we are honored to be a trusted supplier on this remarkable and historic mission. The level of sophisticated engineering, quality, and precision demonstrated by our subsidiaries on this project was outstanding and commendable. I'd like to now discuss our recent acquisition activity. Earlier this month, we completed the acquisition of Wencor for $1.9 billion in cash and approximately 1.1 million shares of HEICO Class A common stock with an assigned value of $150 million in the merger agreement, for a total of $2.05 billion in the aggregate. The transaction was HEICO's largest ever in terms of purchase price as well as revenue and income acquired. We believe Wencor is a perfect and highly complementary fit with HEICO. And we expect the combination will be transformative, providing a unique and growing portfolio of proprietary cost-saving solutions for our airline and OEM customers. We continue to anticipate this highly synergistic acquisition to be accretive to our earnings within the year following closing. In addition, HEICO anticipates that it will continue to achieve its often articulated growth objective in the years subsequent to the closing. Immediately following the closing, we forecast pro forma net debt-to-EBITDA leverage ratio will be approximately 3:1, and will return to historically low levels within roughly one year to 18 months after acquisition, excluding the impact of future acquisition or possible capital deployment activities. At this time, I would like to now introduce Eric Mendelson, Co-President of HEICO and President of HEICO's Flight Support Group, and he will discuss the third quarter results of the Flight Support Group.

Eric Mendelson, Co-President and President of Flight Support Group

Thank you very much. First of all, I would like to welcome our new 1,000 Wencor team members into the new HEICO and Wencor family. This combination has been something that we've dreamed of doing for literally the past 20 years. And we could not be more excited and more overjoyed that this finally has come to fruition. Over the last number of weeks, I've been visiting Wencor facilities around the United States and have a very busy schedule planned for the next couple of months as I go out and meet all of the Wencor team members. I've been particularly impressed with the quality, the outstanding character, ability, and DNA of the Wencor team members. You can never know what is going to happen down the road. And you never know exactly what it's like to work with people who have been in the same space, but you haven't gotten to know very well over many years. And I can tell you that our hopes and dreams have been completely fulfilled. As I've gotten to know the Wencor team members and their DNA, it is remarkably similar to HEICO's style and DNA. And it is something that I think is going to yield tremendous results for many, many years to come. So again, welcome to all of our new team members from Wencor. Going into the results, the Flight Support Group's net sales increased 23% to a record $405 million in the third quarter of fiscal '23, up from $330.3 million in the third quarter of fiscal '22. The net sales increase in the third quarter of fiscal '23 reflects robust 19% organic growth as well as the impact from our profitable fiscal '22 acquisition. The organic growth mainly reflects increased demand for the majority of our commercial aerospace products and services, resulting from continued global commercial air travel growth as compared to the third quarter of fiscal '22. The Flight Support Group has now achieved 12 consecutive quarters of growth in net sales, and these numbers don't yet include the positive impact we expect from the Wencor acquisition, which will further transform our business as the world's leading independent aftermarket supplier. The Flight Support Group's operating income increased 26% to $89.2 million in the third quarter of fiscal '23, up from $70.8 million in the third quarter of fiscal '22. The operating income increase in the third quarter of fiscal '23 principally reflects the previously mentioned net sales growth and an improved gross profit margin, partially offset by an increase in the previously mentioned acquisition costs related to the Wencor acquisition. The improved gross profit margin in the third quarter of fiscal '23 principally reflects higher net sales and a favorable product mix across all of our product lines. The Flight Support Group's operating margin improved to 22.0% in the third quarter of fiscal '23, up from 21.4% in the third quarter of fiscal '22. The operating margin increase in the third quarter of fiscal '23 principally reflects the previously mentioned improved gross profit margin, partially offset by the previously mentioned acquisition costs, which reduced our operating margin by approximately 81 basis points. Our second quarter of fiscal '23 margin of 25.5% included a one-time benefit of 2.3%, yielding a 23.2% net operating margin on a continuing basis. Our third quarter of fiscal '23 margin was 22.8% before the unique costs related to the Wencor acquisition. We're very proud of these excellent operating margins, which have increased approximately 300 basis points from our then-record 2019 and increased 400 basis points from our then-record 2018. Now, I would like to introduce Victor Mendelson, Co-President of HEICO and President of HEICO's Electronic Technologies Group, to discuss the third quarter results of the Electronic Technologies Group.

Victor Mendelson, Co-President and President of Electronic Technologies Group

Thank you, Eric. The Electronic Technologies Group's net sales increased 33% to a record $325.9 million in the third quarter of fiscal '23, up from $244.2 million in the third quarter of fiscal '22. The net sales increase principally reflects the impact from our fiscal '23 and '22 acquisitions as well as increased commercial aviation and other electronics products net sales, partially offset by lower year-over-year defense product net sales. We were pleased to see 10% sequential growth over the second quarter of fiscal '23 in defense product net sales, and we're equally pleased that quarterly organic commercial aerospace and other electronic products, net sales growth contributed 2% overall organic net sales growth in the third quarter of fiscal '23. The Electronic Technologies Group's operating income increased 9% to $74.2 million in the third quarter of fiscal '23, up from $68 million in the third quarter of fiscal '22. The increase in operating income principally reflects the previously mentioned higher net sales volume, partially offset by a lower gross profit margin and higher costs from our January '23 acquisition. The lower gross profit margin in the third quarter of fiscal '23 principally reflects decreased defense products net sales, partially offset by increased commercial aviation and other electronics products net sales. In line with our expectations, the Electronic Technologies Group's operating income was 22.8% in the third quarter of fiscal '23 as compared to 27.9% in the third quarter of fiscal '22. This margin is after roughly 500 basis points of amortization. So, the EBITA margin from what our businesses sell was really close to around 28%, which I and we consider to be excellent and is consistent with the margin range that I've talked about on other earnings calls and in other venues that we should expect for this business before taking account into future acquisitions. The lower operating margin principally reflects the previously mentioned lower gross profit margin and increased SG&A expenses as a percentage of net sales. I turn the call back over to Larry Mendelson.

Larry Mendelson, Chairman and CEO

Thank you, Victor. As for the outlook of HEICO in our opinion, as we look ahead to the remainder of fiscal '23, we continue to anticipate net sales growth in both the FSG and ETG divisions, principally driven by demand for the majority of our products. Additionally, continued inflationary pressures may lead to higher material and labor costs. In addition, we've begun sharing the best practices and getting to know the Wencor businesses, which share a very similar entrepreneurial culture and customer focus as HEICO's businesses. We believe the Wencor acquisition provides HEICO with additional scale to continue broadening our aerospace products and services while maintaining our special culture of treating customers with respect and integrity. Our operating margins especially before non-recurring acquisition expenses remain very healthy and reflect our strong business operations. We believe our ongoing conservative policies and strong cash flows enable us to continuously invest in new research and development and take advantage of strategic acquisition opportunities, which collectively position HEICO for future market gains. In closing, I would like to again thank our incredible team members for their continued support and commitment to HEICO. I humbly welcome all of the Wencor team members to our family and look forward to winning new business together as one team. Thanks to all the HEICO team members for everything you do today to make HEICO an excellent company. I would now like to open the floor for questions. Thank you.

Operator, Operator

And we'll start with our first question from Peter Arment with Baird. Please go ahead.

Peter Arment, Analyst

Larry, Eric, Victor, and Carlos, congratulations on the Wencor deal. That’s fantastic. Eric, I wanted to start there. When you closed the Exxelia deal, it clearly affected the reported operating margins of the ETG Group. Could you help us understand the potential impact, considering it might result in a lower margin profile? Additionally, what opportunities do you see in terms of synergies?

Larry Mendelson, Chairman and CEO

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

Eric Mendelson, Co-President and President of Flight Support Group

Yes. This is Eric. We are very excited about the Wencor acquisition for several reasons I mentioned earlier on the call. We believe it significantly broadens our product line. It's remarkable that two companies in different sectors can come together, allowing us to offer much more to our customers. Major customers have shown strong support for this business combination and are eagerly anticipating the benefits it will bring, which contributed to our swift antitrust approval. In terms of margins, Wencor's EBITA margins are quite similar to those of the flight support margins. Carlos can provide further details, but they are essentially in the same range. There will be some intangible amortization due to the acquisition, but overall, the EBITA earnings of the business will be similar to those of HEICO. We foresee considerable synergies moving forward. Currently, we are in a learning phase and want to ensure we maximize the benefits of this combination. Unlike many companies, we don’t set specific operating margin targets; we simply aim for each business to perform to its fullest potential and achieve margins that support long-term success. For instance, I'm pleased to note that our Flight Support Group margins have improved greatly. Back in 2018, people thought we had reached peak margins, yet we are now up 400 basis points from that time. In 2019, similar expectations were set, and we increased by 300 basis points. We don't have a fixed target number; we just make logical decisions for our operating businesses, leading margins to where they should be. I am optimistic that with the addition of the Wencor product line, we will continue to enhance margins. Generally, the EBITA margins align closely with the flight support margins. Does that answer your question?

Peter Arment, Analyst

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

Carlos Macau, CFO

We completed the acquisition of Wencor on August 4, so it won't be reflected in our third-quarter figures, although we did incur acquisition expenses up until July 31. We paid just over $2 billion for Wencor, and I anticipate that the expenses associated with the deal will be less than 1% of the purchase price. We haven't received all the invoices yet, but there will be certain deal costs recorded in the fourth quarter that will not be capitalized and will be expensed. There is more information to come on that as we receive those invoices. Regarding purchase accounting, I do not foresee significant inventory write-ups that are typically seen in other acquisitions. Due to the nature of their products, which include repair, parts, and distribution, some of these segments, particularly parts and distribution, do not usually result in the same inventory write-ups as we've experienced elsewhere. We will monitor how this develops, and I will provide further updates in the fourth quarter.

Peter Arment, Analyst

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

Victor Mendelson, Co-President and President of Electronic Technologies Group

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

Operator, Operator

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

Peter Skibitski, Analyst

Maybe I want to start with Eric. Eric, as we wrap up the summer travel season, I'm curious about your thoughts on the potential for economic weakness in Europe and China. Given your conversations with the airlines, do you think they might approach their aftermarket spending with more caution in the upcoming year? Additionally, could you provide insight into Wencor and whether the opportunity for gaining market share could outweigh any increased costs associated with airlines' spending?

Eric Mendelson, Co-President and President of Flight Support Group

Yes. Pete, I want to start by emphasizing that the market is remarkably strong. Currently, we do not anticipate any slowdown. However, we recognize that recoveries often experience a slight overshoot before trending down a bit, after which they resume their upward trajectory. One interesting aspect at this moment is the presence of older equipment that requires significant maintenance, compounded by a parts shortage, as airlines still lack sufficient parts. Thus, we observe robust support in the market, and I don't foresee a slowdown on the horizon. Regarding China and Asia, those regions were the last to recover, so I believe we haven't witnessed their full recovery yet. Overall, the situation remains very strong. We are committed to this for the long term, and when a slowdown does occur, I believe there will be numerous synergy opportunities between HEICO and Wencor, allowing us to expand our product lines. I am confident that we will continue to gain market share and navigate through any such period successfully. I am not worried about it at all.

Peter Skibitski, Analyst

Thank you, that was very helpful. My last question is about your pricing strategy. I understand you're not taking an aggressive approach, but should we anticipate that you will continue your current strategy to offset inflation and gradually regain some pricing power after inflation? Is that how we should view the outlook moving forward?

Eric Mendelson, Co-President and President of Flight Support Group

Yes, I think that's fair. I mean, our business is always about gaining market share. We always believe in an expansionary opportunity. We don't work out of scarcity, and we think that tomorrow always has greater opportunity than today. Having said that, we've got to make sure that we recapture our costs, and we maintain and grow our margins a bit. So I think due to the efficiency that we've got in the businesses, the operating leverage, I would anticipate that we're going to continue to move in a positive direction while continuing to generate huge value for our customers. I mean, we save our customers a lot of money. We treat them very, very well. They know that. And I think that's why, frankly, they were so supportive of the Wencor combination; these two companies coming together is something that is really going to be very helpful to our customers.

Operator, Operator

Our next question comes from Larry Solow with CJS Securities. Please go ahead.

Lawrence Scott, Analyst

Great. I want to congratulate you on a successful quarter and the largest acquisition in your history. Staying on the Wencor topic for a couple of questions, Eric, I understand you don't provide specific details, but it seems like the synergies and immediate benefits were goals. This acquisition feels different; it really seems like one plus one equals three in many areas, more so than your typical acquisition. I would like to discuss some of the complementary aspects and how these combinations could particularly benefit HEICO.

Eric Mendelson, Co-President and President of Flight Support Group

Thanks. I agree with you. I think this acquisition is uniquely synergistic. It's something we needed to do, making us a stronger competitor and more efficient while offering more products to our customers. Additionally, as we share best practices, which we have already begun, each company focuses on different areas. There's a significant amount we can learn from each other, aiming for the highest common standard. If we achieve operating efficiencies, it would be excellent not only because our costs would decrease but also because the combined teams of HEICO and Wencor have over 100 unfilled job openings. We've discovered that our most productive team members typically come from within the organization, as they understand the culture. We believe there will be great opportunities for HEICO and Wencor employees to step into expanded roles moving forward. When we combine all of this, ideally, we won't need to hire as many externally, allowing us to promote from within. We're in a very unique position here. I want to be cautious and not get ahead of ourselves before we dive into the details, as everything depends on the specifics. We don't make blanket decisions from the corporate office to cut costs or raise prices. Some companies might find that effective, but in our competitive landscape, the best approach is to make sound long-term operational choices. By doing so, we plant seeds for future benefits. You've been with HEICO for a long time, and I don't think any of us in 2018 or 2019 anticipated increasing our operating margins by 300 basis points from 2019 and 400 basis points from 2018 just through our regular procedures. I believe we have that potential. Wencor is exceptionally well managed with a culture very similar to HEICO. They prioritize customer focus and operational efficiency, always striving to meet customer needs. This partnership is a perfect match, and I couldn't be more optimistic. Everything we hoped for in this acquisition is becoming a reality, and we are well on our way.

Lawrence Scott, Analyst

Great, I appreciate the details you've provided. Switching topics briefly, Victor, you've mentioned that defense has been somewhat slow this year mainly in terms of delivery rather than bookings. Could you discuss some of your other markets along with the outlook for defense bookings going forward and where we stand? Also, regarding the segment margin, I understand that Exxelia has affected margins to some extent. As defense recovers, can we anticipate a rebound from the 22% to 23% margins we've observed in the last two quarters?

Victor Mendelson, Co-President and President of Electronic Technologies Group

So, yes, a couple of things. I mean the defense businesses that we're seeing orders increase in those particular businesses tend to be our higher-margin businesses. So what I would expect is that this kind of 28% EBITA margin, probably at some point over the next six months starts to tick higher, though I want to see that and we're doing budgets now and we're going through our budget cycle. So I want to really see that for sure. But that's kind of how it feels now. Commercial Aviation, I would expect to remain strong. A variety of space businesses for us, I think will remain strong from what I see orders being healthy. I think the other electronics, the other high-end electronics, as I said, in the last two calls, those, I would expect to be softer and they're more tied to, let's say, the general economy and their own different cycles than the other businesses. And I think that will take a little bit of time to cycle through more than six months.

Operator, Operator

We'll take our next question from Michael Ciarmoli with Truist Securities. Please go ahead.

Michael Ciarmoli, Analyst

Congratulations on completing the deal. The results are impressive, as always. Eric or Carlos, you mentioned the historical FSG margins several times and how you've surpassed them. While you won't provide specific numbers, can we consider the previous peaks as a baseline? With Wencor and the potential synergies, do you believe there is potential to increase these FSG margins even further as you fully leverage the synergies and possibly enhance both revenue and cost efficiencies?

Eric Mendelson, Co-President and President of Flight Support Group

Good morning, Michael. Thank you for your comments. This is Eric. First of all, the short answer is yes. I want to be cautious about setting expectations too high as we are currently in the process of both HEICO and Wencor understanding how each other's businesses operate. It's very important to note that when we increased margins over the last five years by 400 basis points, we didn't simply set a goal and aim for it. Instead, we focused on having capable, dedicated, talented, hardworking, and honest people managing their respective businesses to perform at their best. This is exactly how Wencor operates, and it's how HEICO continues to function. Personally, I am hopeful that we will continue to see margin increases over time. However, I want to avoid predicting specific numbers too early. It's not about under-promising and over-delivering; it's about acknowledging the uncertainty. We make informed decisions and do what is right, which lays the groundwork for substantial opportunities. Therefore, I believe it is important to maintain that approach. Yes, I think the margins will increase. We do need to consider the amortization arising from the Wencor acquisition, and Carlos can elaborate on that. It's crucial for everyone to factor that into their models, even though it is a non-cash charge and not related to the operating income of the business. In fact, it provides us with a tax benefit. So, I do believe our margins will continue to perform well. Carlos, do you want to discuss some specifics?

Carlos Macau, CFO

Yes. I would just say, Michael, as I've said over the past several quarters, the FSG continues to grow at a fast pace. All verticals within the Flight Support Group are growing at a fast pace. And we still haven't settled into what I'll call our footprint where the mix sort of normalizes. So until that happens, we're going to have movement in the margin, plus and minus. This quarter, it was 22%. I think I've been pretty clear that I think that on a long-term basis, we might settle in around that point and then grow gradually from there. I don't know if we're at that point yet because I do think there's some more growth to come that may have the verticals growing at different rates that messes with mix a little bit. But I do think if you look at the last decade, the FSG, the one thing that's been pretty consistent is the EBITA margin gains is just about every year. And it's not large gains. It's just steps, right? Leveraging our fixed costs, it's new products and things like that. I expect that pattern to continue once we settle into our, what I'll call a normal footprint or mix for the segment.

Michael Ciarmoli, Analyst

Okay. Perfect. And just one more on housekeeping to help us align for modeling. Considering the fiscal fourth quarter and the two months contribution from Wencor, can you provide an idea of whether it's around a $200 million quarterly revenue run rate? What should we anticipate from the Wencor contribution in this fourth quarter?

Carlos Macau, CFO

I think that's a good question. What I’ll give you is this guidance. We expected when we did the deal that Wencor would do pro forma sales around $724 million in '23, and we still expect that. So I mean, I guess you could divide that number by four and come up with a quarterly run rate. But that's what we continue to expect. And the truth is they've done a little better since we've acquired them. But I think for modeling purposes, if you take what we already published, the $724 million divided by four, that will give you a quarterly run rate for now. And once we get through Q4, and we have our sea legs under us on the acquisition, we'll give some better thoughts at that point.

Operator, Operator

Our next question comes from Ken Herbert with RBC Capital Markets. Please go ahead.

Ken Herbert, Analyst

Maybe, Eric, if I could start with you with another question on Wencor. Can you talk a little bit about how that business has grown organically over the last couple of years coming out of the pandemic? And how should we think about with the Wencor business, the sort of the organic growth profile of that business over the next few years, maybe either relative to FSG at large or relative to some of the specific product lines within your business?

Eric Mendelson, Co-President and President of Flight Support Group

Ken, I'd be happy to answer that. I would say that one quarter's growth rate has been very similar to HEICO's, very comparable. They've done a great job in growing the PMA business, the repair, the distribution, the defense. So it's been very, very similar to HEICO. And their operating philosophies are so similar to HEICO. That's why I think that there's going to be immediate opportunities to start working together. As a matter of fact, one of our businesses just sent me an e-mail on Friday; he placed a $400,000 order with Wencor on a bunch of stuff they didn't even know Wencor supplied before we started introducing some of the various folks. So I think there's going to be a lot of opportunity there. And, but the growth rates, I would say, are really quite similar. Wencor has been extraordinarily aggressive in its markets. And it's sort of interesting that HEICO, Wencor sort of didn't bump up against each other very much. There's been relatively little overlap, and it's been in different areas. So, I think it is sustainable.

Ken Herbert, Analyst

That's great. And as you look at the Encore business and you look out over the next few years and obviously, the distribution, the repair and the PMA lines within Wencor. Are there any particular parts of the business that you're maybe more bullish about? Or where you see some really unique opportunity to take share? How should we think about the various pieces of Wencor and the outlook over the next couple of years?

Eric Mendelson, Co-President and President of Flight Support Group

Yes. I think they're very well positioned in each of the businesses. PMA is very strong and in areas complementary to HEICO in a lot of products that HEICO is not in. So, I think that by having a bigger supply basket that we can offer to our customers, we're going to generate a lot of value. Likewise, on the repair side, Wencor operates in a very decentralized autonomous entrepreneurial fashion, and they have focused in areas where HEICO wasn't by and large. So, I think that that's going to be very strong. Distribution has been phenomenal. They've captured a lot of lines, and they have a great relationship with their distribution partners, and they've got a very robust pipeline. So, I think that's going to be good. And then in the defense market, they're relatively new to that, and they found some defense areas where we haven't been planning. So it's really adding to the product line. So I don't mean to not answer the question, but I would say I'm very optimistic on all four of Wencor's. And then really, HEICO's vertical, which I'm very also optimistic on, is our specialty products because Wencor doesn't manufacture things themselves, and they buy a lot of stuff. And the HEICO Specialty Products group manufactured; I mean that's our specialty to manufacture these basically, source-approved products. And I think that we're going to be able to make a lot of stuff for Wencor. Not necessarily that they're going to resource existing suppliers. They're very loyal to their existing suppliers. But I think on a go-forward basis, in the time when capacity is very tight, they're already asking our businesses to make product for them. So, I think our Specialty Products business is also going to be a beneficiary. But that's going to be over like a five-year period because it takes a while to get all that manufacturing product digested. But I think it's going to be all across the Flight Support Group's five operating verticals.

Operator, Operator

I'll take our next question from Sheila Kahyaoglu with Jefferies. Please go ahead.

Sheila Kahyaoglu, Analyst

So, I wanted to go back to the same line of questioning you've had over the last few questions. Maybe on Wencor, just maybe touch upon the opportunity, Eric. You've been talking about a lot of the revenue synergies and what portion of their business is distribution for their own PMA parts versus third parties? And the same thing for HEICO, and how that kind of results in the delta revenue per employee, which is almost double HEICO's?

Eric Mendelson, Co-President and President of Flight Support Group

Yes. As you know, we break down revenue into three categories: parts, repair, and specialty products. Wencor's business will fall under the parts and repair section of our flight support numbers. I estimate that it's likely to be about one-third repair and two-thirds parts, with a possible slight increase on the parts side. The parts category includes both distribution and PMA, and both are experiencing strong growth alongside significant synergy opportunities between these businesses. I believe they will continue to perform exceptionally well. There is also a strong connection between these areas, as the repair businesses need parts to fulfill their services, which are supplied as distributed and PMA products. Overall, I would suggest a rough breakdown of around 70% parts and 30% repair in this sector.

Sheila Kahyaoglu, Analyst

Okay. And Eric, another one for you, sorry, I'm just keeping it to you for today. There's this thesis out there that aftermarket is softening and decelerating for whatever reason. How do you guys model the trajectory of FSG in the long term? Is it just that of warranty aircraft? Or is it individual sales? Can you give us your thoughts on how you think the overall aftermarket business is going to grow from here?

Eric Mendelson, Co-President and President of Flight Support Group

Well, for us, the aftermarket business is extremely strong. Back in last December, I thought that even though we weren't seeing any softening, that a softening would be inevitable and would come, and I was wrong. Things remain extremely strong. And I think that is a result of us capturing share, more people wanting to do more things with us. And I think, frankly, the future for us is very good. We don't see a softening as of now. And our backlog is tremendous. Some of our backlogs in some of the businesses are 2x the historical rate. So things are really strong. You've got an older fleet, which requires a lot of very expensive parts. And a lot of these, you can't MEL a lot of these components, and you've got to get them fixed. And I think things are continuing to remain strong. Yes, the day will come when we come off the top of it and the whole industry comes off the top a little bit and does a little bit of a dip. But I think, frankly, the industry is very, very well positioned and is going to go from strength to strength here.

Operator, Operator

And the next question will come from Josh Sullivan with the Benchmark Company. Please go ahead.

Josh Sullivan, Analyst

Just the comments around using strong cash flow to invest in R&D. As you integrate Wencor and explore new value parts or PMA opportunities, should we expect a development cycle from the time you increase that investment in PMA development to the time of FA approvals, any R&D cycle to think about as you integrate here?

Eric Mendelson, Co-President and President of Flight Support Group

I don’t think so. I believe the cycles at both HEICO and Wencor are fairly short. In fact, that may be one area where we can assist Wencor in shortening those cycles. Overall, the cycles are quite similar, and I don’t foresee any significant shifts in our spending on new product development. We will continue our current practices, which I expect will remain consistent. By grouping these product offerings, we're providing significant value to our customers. They have expressed considerable frustration when they are unable to obtain a part or component. Despite the many shortages, both HEICO and Wencor, in light of our substantial backlogs, have done commendably in maintaining on-time delivery compared to the industry. That’s why I believe our customers are inclined to reward us with additional business.

Josh Sullivan, Analyst

Got it. And regarding your comments about the majority of products driving growth, I'm curious about the types of products in the minority that didn't drive growth and if there are any common themes.

Eric Mendelson, Co-President and President of Flight Support Group

Yes. There have been a few businesses, particularly in the specialty products area, related to commercial OEM products. The commercial build market has its ups and downs; certain products are in demand while others aren't. As a result, there has been a slight slowdown in some of these areas, which I would consider the slowest. However, our backlogs remain very strong. On the defense side of our Specialty Products business, backlogs are substantial, and we are very optimistic about future sales. We are extremely well positioned. In fact, if we had the necessary capacity right now, our specialty products in various sectors could ship significantly more than they currently do. We are extremely busy, and we continue to expand our space, invest in real estate, add machines, and hire more people. Nonetheless, keeping up with the demand is quite challenging, and the cycles tend to be a bit longer. Both Wencor and the HEICO businesses would be eager to take on significantly more in our specialty products if we had the capacity currently.

Operator, Operator

We'll take our next question from Jack Ayers with TD Cohen. Please go ahead.

Jack Ayers, Analyst

This is Jack on for Gautam today. Eric, just going back to Wencor here. I think you talked about the margin profile, EBITA roughly similar to FSG? And I know, Larry, you kind of mentioned about net leverage at 3x and sort of quickly deleveraging kind of historical levels over time. I just kind of wanted to dig on that a little bit more because it seems pretty robust. And if we're kind of looking at this correctly, I mean it does seem like quite an inflection in cash and EBITDA. So I just kind of wanted to dig on sort of the cash profile of Wencor, maybe working capital dynamics, things like that. Just any color.

Eric Mendelson, Co-President and President of Flight Support Group

Yes, I believe Wencor's cash profile closely resembles HEICO's. Their approach to receivables and inventory shows a similar policy regarding cash generation, making it very comparable to HEICO. We will, however, have to deal with intangible amortization, but since that is a non-cash expense, it won’t affect our cash flow. Additionally, we receive a tax benefit from a portion of it, which actually supports cash. Overall, I would say they are quite similar. We have been fortunate to acquire a business that feels like a sibling; the operations are just very much alike.

Operator, Operator

And our next question comes from Louis Raffetto with Wolfe Research. Please go ahead.

Louis Raffetto, Analyst

Maybe just a follow-up on Jack's question there. When you guys talked about the historical leverage within 12 to 18 months, I guess, what are we looking at? Like are we looking at the 2019 to 2022 where you were sort of 0 to 0.5 turn levered? Are you talking sort of further back where you're one to two turns levered? Just trying to get a sense.

Carlos Macau, CFO

Louis, this is Carlos. When we talk about historical levels, we're talking something below two. That's how we think about it.

Louis Raffetto, Analyst

Okay. Great. And then maybe, Carlos, just the corporate expense seemed to step up in the quarter. Was there anything else related to the deal or anything else just to be mindful of?

Carlos Macau, CFO

No, there was some intersegment activity, which might have been around $1 million higher on a comparable basis. That's not unusual timing. There were some increases in costs, particularly in IT and professional services, travel, and similar areas. However, I would say that in proportion to the growth in the business, those costs did not increase at a significant rate. It was mostly consistent with the overall business growth.

Louis Raffetto, Analyst

Okay. That's great. And then, I mean, I guess, Larry, maybe one for you, just additional M&A from here. Obviously, you've done your two largest deals back to back now. I guess, how do we think about you absorbing Wencor and sort of moving on with your historical strategy from here?

Larry Mendelson, Chairman and CEO

I believe we might need to take a short break. Our goal is to reduce our debt below three and aim for around 2x EBITDA. However, I do think there may be opportunities for some acquisitions. We are evaluating several transactions and will not abandon our M&A strategy due to the two large acquisitions we just completed. We believe we can find ways to finance these options while still working to get our debt below 2x EBITDA. Essentially, I think we can manage both at the same time. We're committed to maintaining our current credit rating, which we take pride in because it helps us save on interest costs. So, we will continue to push for reductions below or at 2x EBITDA. It’s worth noting that before acquiring Wencor, we had never reached even 2x EBITDA. We are not fond of excessive leverage, so we will strive to achieve this target while still being able to make acquisitions.

Louis Raffetto, Analyst

Great. Victor, just a quick one for you. I think, obviously, the defense growth was nice sequentially up 10%. I think you said it was still down maybe year-over-year. Do you have that number? I know last quarter, you said it was down 14%, but just curious this quarter.

Carlos Macau, CFO

Louis, this is Carlos. I actually have that number ready. Organically, defense was down in the high single digits, which is an improvement compared to the last several quarters. That's why we found it important to highlight the sequential growth in defense, as we've been anticipating it. We have known it was going to happen; we just weren't sure when. One quarter doesn't establish a trend, but we're hopeful, not just because of this change but also due to some forecasts from our subsidiaries that suggest we might be seeing a turnaround in our defense electronics business.

Operator, Operator

There are no additional questions at this time.

Larry Mendelson, Chairman and CEO

Okay. This is Larry Mendelson, and we have no more questions. If any of you do have questions, you know that Eric, Victor, Carlos and I are available, give us a call. We'll try to help you out. And we thank you for participating in this call, and we look forward to speaking to you in the fourth quarter earnings call, which will be sometime towards the middle or end of December. So, thank you all, and this is the end of the call.

Operator, Operator

Thank you. And this concludes today's call. Thank you for your participation. You may now disconnect.