Earnings Call Transcript - HEI Q4 2023

Operator, Operator

Welcome to the HEICO Corporation Fourth Quarter Year End 2023 Financial Results Call. My name is Samara, 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. Factors that could cause such differences include the severity, magnitude, and duration of public health threats, 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; governmental and regulatory demands, export policies, and restrictions; reductions in defense, space, or homeland security spending by U.S. and/or foreign customers or competition from existing and new competitors, which could reduce our sales; our ability to introduce new products and services at profitable pricing levels, which could reduce our sales or sales growth; 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 achieving operating synergies from acquired businesses; customer credit risk, interest, foreign currency exchange, and income tax rates; and 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 costs and revenues. Parties listening to this call are encouraged to review all of HEICO’s filings with the Securities and Exchange Commission, including, but not limited to, filings on Form 10-K, Form 10-Q, and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise, except to the extent required by applicable law. I now turn the call over to Laurans Mendelson, HEICO’s Chairman and Chief Executive Officer.

Laurans Mendelson, Chairman and CEO

Thank you, Samara. Good morning to everyone on this call, and we thank you very much for joining us, and we welcome you to the HEICO fourth quarter fiscal ‘23 earnings announcement teleconference. I am 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 would like to take a moment to thank all of HEICO’s talented team members for delivering another strong quarter and strong year. Your continued focus on exceeding customer expectations and operational excellence has translated into superb results for the shareholders. I would also like to congratulate and thank the Wencor team for a terrific quarter within the HEICO family. We could not be more pleased with their performance and their results. I personally continue to be very optimistic about the future for HEICO. And as a matter of fact, I have never been more optimistic about HEICO’s future than I am today. I will now summarize the highlights of our fourth quarter fiscal ‘23 record results. Consolidated fourth quarter fiscal ‘23 operating income and net sales represent record results for HEICO, driven principally by record net sales within the Flight Support Group and Electronic Technologies 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 fourth quarter of fiscal ‘23 improved by 29% and 54% respectively as compared to the fourth quarter of fiscal ‘22. These results mainly reflect 14% quarterly consolidated organic net sales growth as well as the impact from the acquisitions. Consolidated net income increased 6% to $103.4 million or $0.74 per diluted share in the fourth quarter of fiscal ‘23 and that was up from $97.2 million or $0.70 per diluted share in the fourth quarter of fiscal ‘22. In connection with the Wencor acquisition, HEICO incurred acquisition costs during the fourth quarter of fiscal ‘23, which decreased net income attributable to HEICO by approximately $13.6 million or $0.10 per diluted share. Our consolidated operating margins before the Wencor-related non-recurring deal expenses remain strong and are consistent with the expectations we have previously communicated. These margins are extremely healthy, even though our product mix this year has meant lower overall margins than in the prior year. In the fourth quarter of fiscal ‘23, excluding the Wencor acquisition cost, consolidated net income increased 20% to $117 million or $0.84 per diluted share. Our net debt to EBITDA ratio was 3.04x as of October 31, ‘23, and that compares to 0.25x as of October 31, ‘22. The net debt to EBITDA ratio increased in the fiscal year ending October 31, ‘23 principally reflects our successful offering of $1.2 billion in senior unsecured notes and increased borrowings on our revolving credit facility. We used the net proceeds from the sale of the notes and additional borrowings on our revolving credit facility to fund the acquisition of Wencor. Cash flow provided by operating activities improved to $148.4 million in the fourth quarter of fiscal ‘23 and that was up from $143.9 million in the fourth quarter of fiscal ‘22. Cash flow provided by operating activities in the fourth quarter of fiscal ‘23 reflects an increase in working capital, principally driven by an increase in inventories to support our increased consolidated backlog. The continued excellent cash flow generation by HEICO permitted our Board of Directors to recently declare a $0.10 per share semiannual dividend, which represents our 91st consecutive dividend payment. At this time, I would like to introduce Eric Mendelson, Co-President of HEICO and President of HEICO’s Flight Support Group, and he will discuss the fourth quarter results of the Flight Support Group.

Eric Mendelson, Co-President, Flight Support Group

Thank you very much. I would like to take a moment to recognize and welcome the Wencor team members to the HEICO family. The Wencor team is a perfect and highly complementary fit with the HEICO culture and I am extremely optimistic about the future of Wencor’s contributions to the Flight Support Group’s future. I must say that over the last number of months, I have gotten the chance to visit most of the Wencor facilities. And I’ve been incredibly impressed with the caliber of team members that Wencor has. We had very high expectations for them prior to closing the acquisition, but they continue to amaze everyone and really perform outstandingly well. It really is a privilege and an honor to have gotten to know these people. And also I’d like to thank the HEICO team members for being so welcoming to their new Wencor brothers and sisters and bringing them into the board, because as a team, we can accomplish so much more than we can individually. The HEICO team members have been phenomenally excited about the Wencor acquisitions. We have done about 100 acquisitions, but I can say that this one really has generated incredible enthusiasm and excitement. And I am just absolutely honored to work with both the HEICO and the Wencor team members. We have got a phenomenal group. And I think the results really speak for themselves with a lot more to come. So, again, thank you very much to all of our HEICO Flight Support team members for an incredible performance in the fourth quarter and full 2023. On to the results. The Flight Support Group’s net sales increased 74% to a record $601.7 million in the fourth quarter of fiscal ‘23, up from $346 million in the fourth quarter of fiscal ‘22. The net sales increase in the fourth quarter of fiscal ‘23 reflects $185.7 million from Wencor and strong organic growth of 20%. The Flight Support Group’s operating income increased 47% to a record $114.6 million in the fourth quarter of fiscal ‘23, up from $77.8 million in the fourth quarter of fiscal ‘22. Wencor’s operating income in the fourth quarter of fiscal ‘23 was $29.3 million. The operating income increase principally reflects the previously mentioned net sales growth and an improved gross profit margin, partially offset by $12.7 million of Wencor acquisition costs and $11.8 million of Wencor’s intangible asset amortization expense and higher performance-based compensation expense. The improved gross profit margin principally reflects higher net sales within our aftermarket replacement parts and repair and overhaul parts and services product lines. The Flight Support Group’s operating margin was 19% in the fourth quarter of fiscal ‘23 as compared to 22.5% in the fourth quarter of fiscal ‘22. The operating margin decrease in the fourth quarter of fiscal ‘23 principally reflects the previously mentioned Wencor acquisition costs and intangible asset amortization expense. Excluding the Wencor acquisition costs and intangible asset amortization expense, the Flight Support Group’s operating income increased 79% to $139.1 million in the fourth quarter of fiscal ‘23 and the operating margin was 23.1%. Now I would like to introduce Victor Mendelson, Co-President of HEICO and President of HEICO’s Electronic Technologies Group, to discuss the fourth quarter results of the Electronic Technologies Group.

Victor Mendelson, Co-President, Electronic Technologies Group

Thank you, Eric. The Electronic Technologies Group’s net sales increased 28% to a record $342.5 million in the fourth quarter of fiscal ‘23, up from $268.5 million in the fourth quarter of fiscal ‘22. The net sales increase principally reflects the impact from our fiscal ‘23 and ‘22 acquisitions as well as 6% organic growth. The organic net sales increase in the fourth quarter of fiscal ‘23 mainly resulted from increased net sales of defense, space, and commercial aviation products, partially offset by lower net sales of other electronics products. We are pleased to see 26% sequential growth in defense product net sales in the fourth quarter of fiscal ‘23 over the prior quarter, which now marks our third consecutive quarter of defense-related net sales growth. The Electronic Technologies Group’s operating income increased 8% to a record $86.4 million in the fourth quarter of fiscal ‘23, up from $79.9 million in the fourth quarter of fiscal ‘22. The operating income increase in the fourth quarter of fiscal ‘23 principally reflects the previously mentioned higher net sales volume, partially offset by higher costs from the Exxelia acquisition, higher performance-based compensation expense, and unfavorable changes in the estimated fair value of accrued contingent compensation. The Electronic Technologies Group’s operating margin was 25.2% in the fourth quarter of fiscal ‘23 as compared to 29.7% in the fourth quarter of fiscal ‘22. As acquisitions' intangible amortization is equal to approximately 400 basis points from our sales, we view that our ETG businesses achieved a roughly 29% margin from their, what we consider to be their true operational activities, which is excellent by any measure. And we are very happy with it even if it is not as high as it was before. I also note that in last year’s fourth quarter, we recorded a $3 million gain from contingent consideration reversal. So last year’s fourth quarter operating income included that gain, while this year, we had the opposite effect, which reduced the operating margin in total between the two years by around 140 basis points from last year’s fourth quarter. All of this is why I look at what we consider to be the businesses’ actual performance before non-cash acquisition accounting. And that, as I said before, is excellent in absolute terms. The lower operating margin in the fourth quarter of fiscal ‘23, as we said, principally reflects the previously mentioned higher costs from the Exxelia acquisition, the unfavorable changes in the estimated fair value of contingent compensation, and higher performance-based compensation. I turn the call back over to Larry Mendelson.

Laurans Mendelson, Chairman and CEO

Thank you, Victor. Now for the outlook. As we look ahead to fiscal ‘24, we anticipate net sales growth in both the Flight Support Group and the Electronic Technologies Group and that will be driven by contributions from our fiscal ‘23 acquisitions as well as the demand for the majority of our products. Additionally, continued inflationary pressures may lead to higher material and labor costs. We plan to actively work on Wencor’s ongoing integration into our business and operations, continue our commitment to developing new products and services and further market penetration while maintaining our financial strength and flexibility. Our operating margins, especially before non-recurring acquisition expenses remain extremely healthy and reflect our strong business operations. We believe that our ongoing conservative policies and strong cash flow enable us to continuously invest in new research and development and to take advantage of strategic acquisition opportunities, which collectively position HEICO for success in the markets that we serve. In closing, I would like to again thank our incredible team members for their continued support and commitment to HEICO. Their persistent drive and determination to win in the marketplace has resulted in another quarter of outstanding results. Thank you all team members for everything you do to make HEICO a great company. And now, Samantha, I’d like to open the floor for questions.

Operator, Operator

Thank you. And we’ll take our first question from Robert Spingarn with Melius Research. Please go ahead.

Robert Spingarn, Analyst

Hi, good morning everybody.

Laurans Mendelson, Chairman and CEO

Good morning, Rob.

Robert Spingarn, Analyst

You put up a terrific quarter. You’re so far ahead of 2019 where everybody else is trying to get even on an organic basis. I’d like to start there with Victor and just talk about this 26% sequential growth, Victor, if you could and characterize what’s behind that? Is that across defense? Is it a few specific programs that have started to move forward?

Victor Mendelson, Co-President, Electronic Technologies Group

Yes, hey, Rob, it’s good to talk with you. And it’s a good question as always. So I think our strongest market right now and what’s the biggest driver has been commercial aviation. And we have a few businesses in the ETG that have been particularly strong as a result of multiple factors. Some of it is the recovery in air travel. Some of it is new products that we have introduced. Some of it is also some efficiency initiatives and some of it is acquisition-related. So it’s a broad mix there. Defense is definitely moving in the right direction for us as well. The – and commercial space is holding in pretty nicely overall for us. There are pockets of weakness here and there. But overall, it’s pretty good for us. I would say the headwind for us and I mentioned this before, I think over the last year, I signaled this probably a year or more ago that I thought some of our high-end non-aerospace and defense markets would start to turn down this year. And those have been more difficult. So, those markets that serve some high-end electronics, medical, and markets like those are definitely trending in the opposite direction. And I would expect that will continue for some time. And I think we will see the effects of that over the next few quarters, actually, first quarter in particular and as we go on into the year before that starts to reverse. And that’s principally a result of probably overly aggressive ordering by customers during the supply chain crunch dealing with the same kinds of things that we were dealing with. They wanted to get out ahead of it. And now the deliveries are coming in, and some of their orders may be slower, so they have to correct their inventory levels.

Robert Spingarn, Analyst

Okay. Understood. And then the next one moves over to FSG. So Eric, this is either for you, it could be for Carlos. But if we look at the 8-K that you filed back in mid-October, it looks like Wencor sales outgrew overall organic sales for FSG. I mean the numbers look like they could be 40% or more. It’s not an exact comparison because it’s an October quarter versus the December quarter. But I wanted to ask if that math is correct. And if so, what’s driving that strong performance and can it continue for Wencor?

Eric Mendelson, Co-President, Flight Support Group

Hi, good morning, Rob. This is Eric. So I’ll start out answering that question, and then Carlos will fill in with some of the details. Wencor has performed exceptionally well, as have, frankly, all of the HEICO Flight Support businesses. They are ahead of plan. They are doing very well, working incredibly hard, and very similar in culture to the HEICO Group in terms of being conservative in what they predict and frankly, outperforming. I am not sure that the numbers that you state are… let’s see what Carlos has to say about it. My sense is Wencor is growing at a similar rate to the HEICO Flight Support aftermarket businesses, but I’ll let Carlos fill in on that.

Carlos Macau, Executive Vice President and CFO

Yes, Rob, this is Carlos. I would say that you have to remember that when we put the 8-K out, we had pro forma sales in there, which, as you know, Wencor has some acquisitions early in ‘23 and so that’s probably why you are seeing sort of exponential growth. I really, to be honest, haven’t gone back and calculated the organic as we just bought them. I will tell you that we were counting on about $724 million in pro forma sales. I mean if you just divide that before, we would expect at $181 million, they delivered almost $186 million. So we are pleased with the sales growth. I would say that Q4 is typically a little bit more richer than some of the other quarters when it comes to aerospace sales. So, none of this is unexpected. But no, they had a great year. And to Eric’s point, they are performing at the same rate that the overall FSG is, particularly in the parts business.

Robert Spingarn, Analyst

Okay. That’s super helpful. And just on all of this growth and on the complementary nature of the two groups, Eric, how are you doing with the cross-selling effort? Has that started to get traction and what might we expect from that?

Eric Mendelson, Co-President, Flight Support Group

Yes, I would say that we have started the effort, and its borne fruit. There are a number of projects that the companies are cooperating on. The HEICO style is very much to let our new acquisitions to continue to run as they have. So we can really make sure that we fully understand. I can tell you that a lot of the businesses are cooperating, figuring out product rationalization, how to maximize sales opportunities. There are number of projects that are moving forward. But I would say that, that’s something that we are going to be getting into more heavily in 2024.

Pete Skibitski, Analyst

Good morning, everyone. Happy holidays.

Eric Mendelson, Co-President, Flight Support Group

Good morning.

Pete Skibitski, Analyst

Maybe another one for Eric or Carlos. But Eric, I think what you called out for kind of the adjusted FSG margin was over 23%, which is really strong. And I don’t know how much seasonality factored in there, but I would also think you’d have some pricing power in ‘24 because some of the bigger suppliers, I think have called out high single-digit pricing increases for ‘24. So it seems like you have got some bigger room there or even though I know you guys don’t want to be too aggressive, but – so is something approaching 23% reasonable all-in for 2024 at FSG or are there other factors that we should – I know Laurans called out inflation and that sort of thing. So how do you think it nets out next year?

Carlos Macau, Executive Vice President and CFO

Let me take that one, Eric. So hey, Pete, this is Carlos. You have to remember that we have a pretty big amortization flow coming in from the Wencor acquisition. So that’s going to temper some of the, just going to temper the GAAP margin a little bit. I think that it’s going to be a little lumpy throughout the quarters, but I wouldn’t get too proud over your skis. I’ve been talking about the segment doing around 21% margins when things settle when we sort of settle into our footprint. And I think as we are looking forward, that might be a good barometer. We haven’t given guidance, but that’s kind of what I am thinking that the ‘24 is going to look like right now.

Pete Skibitski, Analyst

Okay and just curious. Go ahead...

Eric Mendelson, Co-President, Flight Support Group

I am sorry. And Pete, this is Eric to add, you had asked about pricing. Yes, there is no question that we’ve got pricing upside potential. However, it’s really been our philosophy to pass along our cost increases. And so that’s what we’ve been focused on doing to be able to maintain our margins and to continue to provide a lot of opportunities for our customers. So I think that there is a very large potential there. One of the things is as – if someone’s not buying a part and the OEM has raised the price on the part, then as new customers come in and start buying that part, they pay higher prices. So in a sense, we do get some pricing that way, but we are being very good to our existing customers, and we’re looking very much at our cost increases and cost increases have been significant in a number of areas. I don’t need to tell you about labor and material. And we have been successful in passing along those cost increases because it’s something that we’ve got to do in order to maintain our margins. As far as the overall operating margin before intangible amortization, I think that we will continue to perform as we have in the past that I’m quite pleased with our performance in the past. And we’ve got a lot of very, very good things in the hopper, a lot of projects where HEICO and Wencor can work together on a number of things. So I’m very optimistic about the future.

Larry Solow, Analyst

Great. Thanks.

Carlos Macau, Executive Vice President and CFO

So, I think that on the – as you mentioned, the inventories side, we did have a significant investment in ‘23 in inventory. And I suspect that for a few quarters into ‘24, we might have a little bit more inventory build. Part of that is due to firm commitment orders we place, sometimes as much as 2 years ago, to deal with the supply chain challenges to make sure we had product on the shelf for our customers. But I do think that carrying costs and inventory isn’t free anymore, right. Rates are up, so we are very cognizant of that. And I do think as we get into ‘24, my hope is, is that towards the back half of the year, we get a little bit more rationalization on the working capital usage. That’s my expectation. As far as free cash flow, I expect the company to continue to have strong free cash flows. And I do think you have hit the nail on the head. Once the working capital investment to support the growth and some of these firm commitment orders has tempered, I think our conversion will be slightly… Does that answer your question, Larry?

Larry Solow, Analyst

Yes. Absolutely. And I guess just priority. Debt pay down, is that probably the priority or…?

Carlos Macau, Executive Vice President and CFO

Yes. Look, I mean our objective right now as we stated before is to try and de-lever as quick as possible. Our plan after completing the Wencor acquisition within 12 months to 18 months, we set out on a plan to get our debt leverage ratio to something close to normal, around the 2% range, roughly. That’s the goal of the 12 months to 18 months, I would say that, that is not a goal that prohibits us from doing acquisitions. I would say that for smaller acquisitions we will draw on our line to do what we need to do to complete those if they are good for our shareholders. I think if they are larger deals, we might have to get creative, but I don’t expect that over the next 12 months to 18 months, something as large as Wencor probably would be very unique. I don’t know that we have got something on the horizon right now. And I do think, to your point, that deleveraging is sort of our highest and best use of free cash right now.

Laurans Mendelson, Chairman and CEO

Thank you very much. I want to thank everybody who has been listening to this call. I hope we have satisfied you and give you information that you would like, if not, we are available, as you know, give us a call, Eric, Victor, Carlos, myself. And we look forward to speaking to you in the first quarter call, which will be in a few months from now. And we wish all of you a very happy, healthy holiday season, and New Year. And that’s the end of this call.