Heico Corporation

Certain statements in this conference call will constitute forward-looking statements which are subject to risks, uncertainties, and contingencies. HICO's actual results may differ materially from those expressed in or implied by those forward-looking statements as a result of factors including lower demand for commercial air travel or 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 in our costs to complete contracts. Governmental and regulatory demands, export policies and restrictions, reductions in defense, space or homeland security, spending by U.S. and or foreign customers or competition from existing and new competitors, which could reduce our sales, our ability to introduce new products and services at profitable pricing levels, which could reduce our sales or sales growth, product development or manufacturing difficulties, which could increase our product development costs and delay sales, our ability to make acquisitions and achieve operating synergies from acquired businesses, customer credit risk, interest, foreign currency, exchange, and income tax rates, economic conditions within and outside of the aviation, defense, space, medical, telecommunications, and electronics industries, which could negatively impact our costs and revenues, and defense spending or budget cuts. which could reduce our defense-related revenue. Parties listening to or reading a transcript of this call are encouraged to review all of HICO'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, further events, or otherwise, except to the extent required by applicable law. Ladies and gentlemen, thank you for standing by and welcome to the Physical Year 2020 First Quarter Earnings Results Conference Call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press Star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press Star 0. I will now turn the conference over to your speaker today, Lawrence Mendelsohn.

Thank you very much. Good morning to everyone on the call. We thank you for joining us and welcome you to the HICO first quarter fiscal 20 earnings teleconference. I'm Larry Mendelsohn. I'm chairman and CEO of HICO Corporation, and I'm joined here this morning by Eric Mendelsohn, HICO's co-president and president of HICO's Flight Support Group, Victor Mendelsohn, HICO's co-president and president of HICO'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 HICO's talented team members who, again, were responsible for our strong results. I am truly proud of this dedicated and loyal group, and they are the ones that continue to produce the highest quality products and services for our customers while maintaining our unique entrepreneurial culture and delivering outstanding returns to shareholders. I'd like to summarize the highlights of our first quarter results. Consolidated net income increased 54 percent to $121.9 million, or 89 cents per diluted share, in the first quarter of fiscal 20, and that was up from $79.3 million or 58 cents per diluted share in the first quarter of fiscal 19. The net income attributable to HICO in the first quarter of fiscal 20 and 19 were both favorably impacted by a discrete income tax benefit from stock option exercises. The benefit in the first quarter of fiscal 20 and fiscal 19 was approximately 46.3 million and 15.1 million respectively. These tax benefits were mainly driven by more stock options being exercised as they approached expiration, as well as the strong appreciation in HICO stock price during the optionese holding period. And the next comment I think is very critical because the tax benefit and the increase in taxes can be a little bit confusing to normal operating earnings. I want to point out that excluding the impact of tax benefit in both periods, 19 and 20, net income and diluted earnings per share increased 18% and 17% respectively in the first quarter of fiscal 20. And I think that's an amazing accomplishment that I credit our great team members with producing those results. And to me, that should be the clearest message that we send in this entire report. Consolidated operating income increased 13 percent to $111 million in the first quarter of fiscal 20, and that was up from $97.9 million in the first quarter of fiscal 19. Consolidated operating margin improved to 21.9 percent in the first quarter of fiscal 20, and that was up from 21% in the first quarter of fiscal 19. Consolidated net sales increased 9% to $506.3 million in the first quarter of fiscal 20, up from $466.1 million in the first quarter of fiscal 19. In summary, Our consolidated first quarter 2020 net sales increased 9%. Our operating income increased 13%. And our net income, excluding the stock option impact, increased 18%. And we are all very pleased with these results, and we hope all of our shareholders are, too. Our ETG Group's net sales and operating income in the first quarter of fiscal 20 are up 13 and 11% respectively over the first quarter of fiscal 19. Those increases reflect the impact from our very well managed and profitable fiscal 19 and 20 acquisitions, as well as strong double-digit organic growth for our defense product. Our flight support group net sales and operating income in the first quarter of fiscal 20 are up 5% and 17%, respectively, over the first quarter of fiscal 19. Reflect organic growth within all of our product lines, as well as improved gross profit margins. Cash flow. provided by operating activities increased 64 percent to a strong $81.1 million in the first quarter of fiscal 20, and that was up from $49.6 million in the first quarter of fiscal 19. We continue to forecast very strong cash flow from operations for the balance of fiscal 20. We also continue to generate significant cash flow for our shareholders by remaining focused on developing niche products and our strategic commitment to an entrepreneurial structure that minimizes bureaucracy and focuses team members on serving our customers. Our total debt to shareholders' equity decreased to 31.4% as of January 31, 2020, down from 33.2% as of October 31, 2019. Our net debt, which we define as total debt less cash and cash equivalents of $504.8 million as of January 31, 2020, to shareholders' equity ratio decreased to 27.9% as of January 31, 20, and that was down from 29.8% as of October 31, 19. Net debt to EBITDA ratio improved to 0.9 times as of January 31, 20, and that was down from 0.93 times as of October 31, 19. We are not a financially challenged company. We have major firepower behind the lines to do really anything that we want to do, and we are aggressively pursuing acquisitions and, of course, our standard R&D development. We have no significant debt maturities until fiscal 2023, and we plan to utilize our financial flexibility again to pursue those high-quality acquisitions and maximize shareholder returns. In January 2020, we paid an increased regular semiannual cash dividend of $0.08 per share, which represented our 83rd consecutive semiannual cash dividend since 1979, and it was a 14% increase over the prior semiannual per share amount. In December 2019, our Radiant Power subsidiary acquired 100% of the business and assets of the human-machine interface or product line of Spectralux. HMI designs, manufactures, repairs flight deck annunciators, panels, indicators, and illuminated keyboards, as well as lighting controls and flight deck lighting. Radiant Power is part of our ETG group, and we expect the acquisition to be accretive to earnings within the first 12 months following closing. In December 19, 2019, we acquired 80.1% of the stock of Quell Corporation, which designs and manufactures EMI, RFI, and transient protection solutions for a very wide variety of connector products in aerospace and defense. The acquisition successfully closed during the first quarter of fiscal 20 and has integrated well into our ETG group. And we expect that acquisition to be accretive to earnings within the first 12 months following closing. In January 2020, we reported that our 3D plus subsidiary supplied numerous mission critical and highly reliability components on the solar orbiter space mission. That mission will provide the first views of the sun's uncharted polar regions and investigate how intense radiation and energetic particles being blasted out from the sun and carried by the solar wind through the solar system will impact our home planet Earth. We congratulate the European Space Agency on leading this project, along with its partners at NASA, Airbus, 3D Plus, and the numerous other contributors to this effort. HEICO takes great pride in 3D Plus's involvement in this historic mission. Now, at this time, I'd like to introduce Eric Mendelson, co-president of HICO and president of HICO's Flight Support Group, and he will discuss the results of the Flight Support Group.

Good morning and thank you. The Flight Support Group's net sales increased 5% to $301.1 million in the first quarter of fiscal 20, up from $287.2 million in the first quarter of fiscal 19. The increase is attributable to 4% organic growth, mainly due to increased demand and new product offerings across all of our product lines. The flight support group's operating income increased 17% to $62 million in the first quarter of fiscal 20, up from $52.9 million in the first quarter of fiscal 19. I'd like to point out that our team members are incentivized and focused on operating income, not sales, and I consider a near 17% organic increase in operating income to be a phenomenal achievement, especially since it was accomplished while maintaining our long-term minimal price increase model and keeping the loyalty and appreciation of our customers. The increase principally reflects an improved gross profit margin, mainly attributable to a more favorable product mix within all of our product lines. The previously mentioned net sales growth and a favorable impact from lower expenses related to changes in the estimated fair value of accrued contingent consideration. The flight support group's operating margin increased to 20.6% in the first quarter of fiscal 20, up from 18.4% in the first quarter of fiscal 19. Again, this was accomplished by maintaining our low-price increase model. The increase principally reflects the previously mentioned improved post-profit market and the decrease in SGA expenses as a percentage in the sales, mainly from the policies realized from the net sales growth as well as the previously mentioned lower expenses related to changes in the estimated fair value of accrued contingency consideration. With respect to the remainder of fiscal 2020, we continue to estimate 7% to 8% net sales growth over the prior year, and now estimate the 5% to 11%. up from the prior operating margin estimate of 19.5 to 20%. Further, we continue to estimate mid to high single-digit organic growth in fiscal 20. These estimates exclude additional acquired businesses and the impact from the recent coronavirus outbreak, if any. Now I would like to introduce Victor Mendelson, President of HEICO and President of HEICO's Electronic Technologies Group to discuss the results of the Electronic Technologies Group.

Thank you, Eric. The Electronic Technologies Group's net sales increased 13% to $208.4 million in the first quarter of fiscal 20, up from $184.4 million in the first quarter of fiscal 19. The increase is attributable to the favorable impact from our fiscal 19 and 20 acquisitions, as well as 6% organic growth, mainly due to increased demand for our defense products, partially offset by lower sales for some of our space products, which was within our planning and expectations in the first quarter, and which we expect to level up during the balance of the year. The electronic technologies group's operating income increased 11%, to $57.5 million in the first quarter of fiscal 20, up from $51.6 million in the first quarter of fiscal 19. The increase principally reflects the previously mentioned net sales growth partially offset by a lower gross profit margin, mainly due to a decrease in the previously mentioned net sales of our space products, partially offset by the increased net sales of our defense products. The electronic technologies group's operating margin was 27.6% in the first quarter of fiscal 20 as compared to 28% in the first quarter of fiscal 19. The decrease is mainly due to the previously mentioned lower gross profit margin partially offset by the decrease in SG&A expenses as a percentage of net sales mainly due to a decrease and performance-based compensation expense, as well as efficiencies realized from the net sales growth. With respect to the remainder of fiscal 20, we now estimate approximately 6% to 7% net sales growth over the prior year, up from our prior estimate of 5% to 6%, and continue to anticipate the full-year electronic technologies group's operating margin to approximate 28% to 29%. Further, we continue to estimate mid to low single-digit organic growth in fiscal 20. These estimates exclude additional acquired businesses and the impact from the coronavirus outbreak, if any. I'll turn the call back over to Larry Mendelson. Thank you, Victor.

Moving on to diluted earnings per share. Consolidated net income per diluted share increased 53% to 89 cents in the first quarter of fiscal 20, and that was up from 58 cents in the first quarter of fiscal 19. As previously mentioned, the increase in diluted earnings per share reflects the discrete tax benefit net of non-controlling interest from stock option exercises recognized in the first quarter of fiscal 20 and fiscal 19. Excluding, again, I repeat, excluding the impact of tax benefits in both areas, the 18% increase in diluted things per share reflects the strong performance within the both flight support and electronics technologies group. Somehow or other, I think a number of analysts kind of missed that, and I would like to point that out to them because some analysts didn't mention this in their report, and I think It's a very important item for shareholders to focus on. Appreciation and amortization expense totaled 21.6 million in the first quarter of fiscal 20. That was up from 20 million in the first quarter of fiscal 19. And the increase in the first quarter of fiscal 20 principally reflects the incremental impact from our fiscal 19 and 20 acquisitions. Research and development expense increased 13 percent to $17.1 million in the first quarter of fiscal 20, and that was up from $15.2 million in the first quarter of fiscal 19. Significant ongoing product development efforts are continuing at both flight support and ETG as we continue to invest approximately 3 percent of each sales dollar in new product development. SG&A consolidated expenses increased and principally reflects the impact of our fiscal 19 and 20 acquisitions, partially offset by lower expenses related to changes in the estimated fair value of accrued contingent consideration. Carlos can explain the details to you later on if you want to know that. Consolidated SG&A expense. as a percentage of net sales, decreased to 17.2% in the first quarter, and that was down, quarter of 20, down from 18.1 in the first quarter of fiscal 19. That, of course, is a very positive change. And that decrease in consolidated SG&A expense as a percentage of net sales is mainly due to efficiencies, which we realized from net sales growth, the previously mentioned lower expenses related to changes in the estimated fair value of a crude contingent consideration, and a decrease in performance-based compensation as a percentage of net sales. Interest expense decreased to $4.3 million in the first quarter of fiscal 20, down from $5.5 million in the first quarter of fiscal 19. And that decrease was due mainly to a lower weighted average interest rate on borrowings outstanding under our revolving credit agreements. Other income and expense in both years was not significant. HICO incurred an income tax benefit of $22.9 million in the first quarter of fiscal 20. compared to an income tax expense of $4.1 million in the first quarter of fiscal 19. We recognized the discrete tax benefits from stock option exercises in both the first quarter of fiscal 20 and 19 of $47.6 million and $16.6 million, respectively. The larger benefit from stock option exercises recognized in the first quarter of fiscal 20 was the result of more stock options being exercised, as well as the strong appreciation in HICO stock price during the optionese holding period. The majority of the options exercised which generated this cash windfall for HICO were approaching their 10-year expiration date. I have a personal comment which I'll mention. According to the accounting rules, we are not permitted to accrue those increases over the approximately 10 years that those options were vesting. Had we accrued them year by year, we wouldn't have had this big windfall all in one year. In my personal opinion, and I don't run the accounting board, they should make a change and permit companies to adjust those items to fair market on an annual basis, and that would eliminate a little bit of the confusion that folks seem to have with this, all of a sudden, this one windfall all at one moment. Net income attributable to non-controlling interest was $7.9 million in the first quarter of fiscal 20, down from $8.7 million in the first quarter of fiscal 19. And that decrease principally reflects the impact of a dividend paid by Heiko Aerospace in June 19 that effectively resulted in the transfer of the 20% non-controlling interest held by Lufthansa Technik in eight of our existing subsidiaries and back to the Heiko Flight Support Group. And that was partially offset by improved operating results of certain subsidiaries of flight support and ETG in which non-controlling interests are held. For the full fiscal year 20, we continue to estimate a combined effective tax rate and non-controlling interest rate of approximately 19 to 20% of pre-tax income. Moving on to balance sheet and cash flow, Cash flow provided by operating activities was very, very strong, increasing 64% to $81.1 million in the first quarter of fiscal 20, up from $49.6 million in the first quarter of fiscal 19. Our working capital ratio improved to 3.4 times as of January 31, 20, compared to 2.8 as of October 31, 20. Our day DSOs or day sales outstanding of receivables improved to 46 days as of January 31, 20, and that compared to 47 days as of January 31, 19. We continue to closely monitor all receivable collection efforts in order to limit credit exposure. We have very little loss in accounts receivable. No one counted for more than a number of net sales. Customers represented approximately 22% of consolidated net sales in the first quarter of fiscal 2019, respectively. Inventory turnover rate of 132 days as of January 31 was the same as the rate for the period January 31, 19. Now for the outlook. As we look ahead to the remainder of fiscal 20, we anticipate continued net sales growth within flight support, commercial aviation, and defense product lines. We also anticipate growth within ETG, principally driven by demand for the majority of our products. During fiscal 20, we plan to continue our commitments to developing new products and services, further market penetration, and aggressive acquisition strategy, while at the same time maintaining our financial strength and flexibility. Based upon our current economic visibility, we now estimate 14% to 15% growth in full-year net income, and that was up from our prior growth estimate of 13% to 14%. And we continue to estimate approximately 6% to 8% growth in full-year net sales over fiscal 19. In addition, we continue to anticipate our fiscal 20 consolidated operating margin to approximate 21.5% to 22%. Depreciation and amortization expense of about $89 million. approximate $42 million, and cash flow from operations to approximate $475 million. These estimates exclude additional acquired businesses, if any. They also exclude any potential impact from the recent coronavirus outbreak as the impact to our business is uncertain and difficult to predict. In closing, we intend to continue to focus on intermediate and long-term growth strategies with a laser focus on growing our earnings and cash flow while executing our discipline acquisition strategy of acquiring profitable businesses at fair prices. All of this is made possible by the dedication and hard work of our approximately 6,500 team members worldwide that continue to exceed customer expectations and deliver these outstanding results. Again, Heiko's management team thanks them for making their company a success. And I want to emphasize their company because we consider the team members as the ones who really make it happen, and they look upon Heiko as their company, and we believe that is the culture that makes our success possible. With that, those are the extent of our prepared remarks, and we'd like to open the floor for questions.

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from the line of Robert Springer with Credit Suisse.

Hi, good morning. Good morning. You know, I think I'll start, Eric, on your side and talk about these margins, the margin strength you talked about earlier. I mean, I think the incremental margin, 66%, if I'm doing the math right, And you did raise the guide and talked about the mix. Could you give us a little more color on what is happening with the mix there?

Yeah, I would be happy to, Rob. Good morning. As you know, and I think most of our shareholders know, our team members and our leadership are incentivized and focused on operating income. We try to keep things very simple. And they're not focused on revenue. You know, they don't get compensated on revenue. They get compensated on earnings. So I think what we continue to see is a shift where we de-emphasize lower margin products and we focus more on higher margin products. And I think that really is the driver of the improvement in the operating income that we've seen. And I'm particularly happy, as I mentioned in my comments, that we were able to drive this increase in margin without alienating our customers. You know, we continue to maintain a very low price increase model so we make sure that our customers appreciate us and that they want to come back and want, you know, we're the vendor of choice and they want to develop more items with us. So I'm very happy that we were able to accomplish that by focusing on these new products and increasing the margin. The margin increase wasn't in any One particular area, I would say that it was very broad-based and consistent with basically how we operate the company.

Okay. And then just switching to the topic that was brought up earlier, I know coronavirus is tough to – we don't know how this is going to play out. You don't have it in the guide. But have you seen any evidence yet of a slowdown in your spare parts demand, either in the late part of the first quarter or even early – here in the beginning of the second quarter?

No. Actually, so far, and I've gotten reports as late as this morning, we have not seen any material change in our orders or deliveries. We are watching a few customers, and I don't want to mention which customer names, but a few customers that have been reported in the press as having some financial challenges. So, we just want to make sure that we do the intelligent thing. We'll make sure that we take care of them and continue to support them. But in a sense, I think the timing. For Heiko is fairly good because, as, you know, February 1st was the start of our 2nd quarter. So we're now going to be able to have another two months before we report to be able to see what the impact is. But we're watching this very closely. There has not been a change to date. I mean, clearly, in my opinion, this will impact the industry. There's no question that this will impact demand. But it is so difficult to estimate at this point, especially given the strong order pattern that we've seen to date, that we just think that it would be irresponsible for us to, if you will, take a flag at what it could be. You know, it really depends on what happens with the virus and, you know, what continues to happen with air travel. But meanwhile, our people are very much focused on their supply chains as well as their customers, and we're, of course, keeping our ear to the ground on that.

And just on that, I think your 10K says that outside of the U.S., no country, no single country accounts for more than 10% of total company sales. But is there any way to calibrate how much FSG sells into the Asia Pacific region?

Hey, Rob, this is Carlos. You're right. We don't disclose that specifically. I will tell you that consolidated because something like this, doesn't just affect the flight support group. It can have impacts on the ETG also. So when you think about it on a consolidated basis, our sales into Asia, and particularly the Chinese areas, are in the low single digits. We're not dependent on that market. In fact, we've stated before that, you know, that's a growth opportunity for us in the future. And I just want to emphasize another thing, because it may be the next question you pose on the supply chain side of things. One of the benefits that I guess Heiko is enjoying right now is that when Trump, President Trump put his tariffs on China, a lot of our guys that were sourcing product from that region had to find alternatives. And so, or at least look for second sources. And so right now, as product is not moving out of China as quickly, we do have backup plans and our guys are actually executing on that so that it's not as dramatic of an impact to the company.

Okay, thank you. And then just quickly, Victor, on your side, I was wondering if you just elaborate a little bit more on the extra strength and defense and then some of the headwinds in space, which I think you said will reverse over time. And it looks like this might have had a slight impact on the margin.

Yeah, that definitely did. We were expecting that in our budgets and in our planning with orders picking up as the year Whereas on, it was just programmatic and timing of when programs are hitting and when orders are shipping. And we're still expecting that more in the back half of the year. I would say still back half, not first half, but back half. Okay, great. Thank you all.

By the way, Rob, this is Eric. Just to finish up on one thing, just to add on what Carlos was saying. I met with our heads of sales last week to do an in-depth review on any potential impact as a result of the coronavirus. And I can tell you, and while I don't want to go into information on specific regions, countries, airlines, or products, I can tell you that there is a significant increase in our cost-saving solutions at a number of customers. Our sales VPs have speculated that part of this may be due to the coronavirus and that they're getting very serious. You know, we've seen historically whenever there is a supply or demand imbalance that our customers become a lot more focused on cost-saving opportunities. So, we have definitely seen that. Again, I don't want Due to competitive reasons, I welcome our competitors on the call. I can't get into, you know, what regions, what customers, what type of products, but there has been a definite increase in interest and, you know, where I would say we're hopeful that it will turn into something good for HICO. Okay.

Thanks for the extra call around market share.

This is Victor. I just made one other comment on COVID-19. which is, you know, I think people are expecting this to spread beyond Asia and beyond China, and nobody knows where and how that will play out. Ultimately, it gets under control, and it'll over some period of time affect different places and different companies in different ways, but eventually it gets under control, and it becomes what's effectively, we believe, a short-term effect, and that's the way we look at it. Sure. Thank you. You're welcome.

Your next question comes from the line of Sheila Kahailu with Jefferies. Hi.

Good morning, everyone. Thank you for the time.

Good morning, Sheila.

Eric, I wanted to ask you to expand on a few comments you made just now with Rob. One, I guess, can you talk about your lead time on your order book and, you know, what sort of visibility you have just given corona and then How do you think airlines are going to react, you know, given the capacity has been tight in the market? Do they take this time to do maintenance work? If you could talk a little bit about that. And then you also mentioned de-emphasizing low margin products and YFSG incrementals for through the roof. So, you know, how do you think about how that impacts sales growth for the year or is it de minimis? Thank you.

Okay, I'd be happy, Sheila. So, with regard to the order patterns, I would say that in our parts business, both PMA and distribution, we receive most of the orders in the time of shipment. I'm sorry, in the month of shipment. So, the visibility there is probably 30 to 60 days out. Within repair, it's probably another 30 days on top of that. And in specialty products, it's probably, say, another 60 days on top of that. So, you know, I think that when there is an impact on the order demand, we will see it rather quickly. And so, it's somewhat interesting that we haven't seen it to date. Going to your other question with regard to maintenance, yes, I think that they're taking this opportunity now to perform additional maintenance. A number of airlines have come out with that position, so we think that that is going to happen. So perhaps that's one of the reasons why we haven't seen an impact. With regard to the margin improvement, I think this is just the continuing ongoing focus at HICO. You know, as I mentioned, our team members are focused on margin. When we do business reviews, we're talking about profitability. We try to keep people focused on the single most important thing rather than 20 metrics. And, of course, we go over all those metrics. We talk about them and make sure that the companies are developing in the right way. But this focus on margin is pervasive. So I'm really very happy about the performance. If you notice, we estimated 20% for the year, whereas in the quarter, I think we were 20.6%. So I'm not saying that we're going to maintain sort of this incredible level that we're at right now, but I do think that it's just a continuing focus and, you know, trickle up. in the margin activity while making sure that we keep our customers happy and not doing this on the backs of our customers in terms of price increases.

Great. Okay. I'll jump back in the queue. Thank you very much.

Thank you, Sheila.

Your next question comes from the line of Robert Stallard with Vertical Research.

Thanks so much. Good morning. Good morning. Not to belabor this whole virus thing, I was wondering if you could remind us what the company went through in the SARS period and how you saw customers respond then and how it might be different.

That's a very good question, Robert. This is Eric. I would say that in the SARS period, we saw more of an immediate impact, which we haven't seen to date. And perhaps the SARS Pattern is giving people confidence that they need to maintain an orderly flow of business, number one. Number two, the airlines are in significantly better financial shape today than they were then. Of course, they were at that time coming off of the bottom. I mean, just as we were really in the bottom. after the 9-11 events and the economic shock that followed in 2002, SARS happened in 2003. So the airlines were very ill-prepared to be able to, if you will, hold inventory and sort of take the long view. So, you know, thus far, I think we've seen a lot more maturity and stability in the market. Again, we do believe there will be an impact, but we're just sort of trying to figure out where that impact is. One of the other unique things going on now, of course, is that the MAX fleet is out of service, so they perhaps don't have that, if you will, that added capacity that they've got to think about. So I think all of those things put together are keeping the airlines pretty confident right now. Also, I'd have to say that economic activity is strong. I think confidence in the United States is strong. So I think overall things are moving in the right direction.

Robert, there's one other. This is Larry. I'd like to add one other thing. Back in SARS time in 2003, we were highly concentrated in essentially one product, and that was JT8D engine. Since then, as a result of that, we have diversified both through aerospace and through ETG. So we have a much broader footprint, and the impact, individual impact, I think will be much less than it was for us than it was during the SARS problems.

That's very helpful. And just a quick follow-up on that. If you look across me, I know you have hundreds and hundreds of different products, but if you were to look at your products and say how much of this is, say, discretionary versus non-discretionary, is it fair to say that most of this is required by the airlines to continue their operations? There's not a huge element of, say, retrofits and upgrades in here.

Yes, I would definitely say that, that you're correct.

Also, we're also talking about the defense component. So As you know, our company in total defense is like 25%. I don't see any change really coming from that. And so that absorbs 25% of our revenue. And then the other parts, as Eric pointed out, I really so far, again, in SARS, we saw it, as Eric said, very immediate. Now it's not so immediate. We haven't seen it or else we would tell you.

Robert, this is Carlos. I just want to add one other final point. Eric made this point earlier, but I don't want it to get lost in the discussion. HACO is a value proposition to our customers. We, as Eric pointed out, provide a service whereby airlines save money. Hence, if this coronavirus does actually impact the financial health of the industry, I do believe that that would cycle in a unique position to serve our customers and allow them to save money on their spend, to which you point out is really non-discretionary.

That's great. Thank you very much. Thank you.

Your next question comes from the line of Peter Armit with Bayard.

Yeah, thanks. Good morning, Larry, Eric, Victor, Carlos. Hey, so, Eric, I feel like we give you this question every quarter for the last year about regarding the max. You just mentioned it, you know, the grounding persisting, and it sounds like it's going to persist a lot longer than anticipated this year. Are you seeing or have you been able to see any kind of net benefit that you've been able to quantify or any color around that?

Yeah, we, you know, with regard to the aftermarket, there definitely has been some sort of benefit. It's very hard. to be able to put a number with that. Clearly we've been helped, but I've tried to get some definition around it and really can't. However, I do have to mention that while our aftermarket has been helped with that, our specialty products business has been hurt because we do have content on new aircraft and that has definitely been impacted in the first quarter and is continued to estimate to be impacted throughout the balance of this year. So, you know, overall for Hyco, while it's a net positive, it definitely did suppress our organic growth in the first quarter of this year.

Okay, and then I could just follow up, Larry, on the M&A pipeline, and obviously the HMI product line sounds like it's a very good fit for Radiant. Just in general, have there's been a few private equity kind of deals that didn't get done in press regarding because of the max? Are you seeing any change in kind of the pricing or anything regarding deals that you're looking at?

No, not yet. We really have not seen it. We're looking at lots of deals. We're looking, as you know, we're looking at big ones. We're looking at smaller ones. We're looking a lot. And the We're spending a lot of time doing the due diligence, but we really haven't seen much change in pricing, not yet. Appreciate the call, and thanks.

Your next question comes from the line of Larry Solo with CJS Security.

Hi, good morning. It's Peter Lucas for Larry. You guys covered most everything. Just had one quick question. ETG was strong this quarter, driven by prior acquisitions and defense, but you mentioned space was down and expect that to level off. Just wondering if you could give us any more color on visibility for the space segment going forward.

Yeah, hi, this is Victor. You know, we've seen orders picking up for Some of the GeoSat market, we've seen an increase in quoting activity and indications from customers that lead us to believe those will turn into orders, those quotations will turn into order. Also, the timing indications from customers as to when they would be placing orders have led us to believe that we would start to see those things materialize as the year went on. And that was the case. We were putting our budgets together last year. So that's why we think it's a back half of the year event for us. We can't be certain of that, but that's what it's looking like, and indications remain the same.

Very helpful. Thank you.

You're welcome. Thank you.

Your next question comes from the line of Ken Herbert with Canaccord.

Hi, good morning.

Good morning, Ken.

Eric, I just wanted to first start with you. You've obviously maintained the mid to high single-digit organic growth outlook for the FSG segment. You know, comps are still very tough in the second quarter, maybe get a little easier in the back half of the year. Is there anything you'd call out or point to that maybe gives you we should watch out for as an inflection or confidence that you'll, you know, the driving, you know, the implied step up in organic growth in the segment for the remainder of the year?

Good morning, Ken. That's a good point. I'm glad you mentioned this. I mentioned on our fourth quarter call that in the fourth quarter of 2019, flight support had organic growth of 12%. which followed the year prior, 2018, organic growth of 13%. And I commented that 25% organic growth over a two-year period is really incredible and probably unsustainable at that point. Once the first quarter numbers came in, we realized that perhaps some of and I think I may have mentioned this on the fourth quarter call, that the fourth quarter was so strong that we wondered if a little bit of business was pulled in by our customers, not by us, from the first quarter into the fourth quarter of last year. And I think in hindsight, perhaps, I speculate that some of that has happened. So as a result, we think that perhaps the fourth quarter was a little bit larger in terms of organic growth than perhaps it otherwise would have been. And as a result, the first quarter was a little bit smaller. So I think that gives me some, if you will, confidence and visibility into the balance of the year and why we think that organic growth is going to be at the numbers that we projected.

Okay, that's helpful. So if you normalize it, you know, there's no specific one thing you'd point to, but sort of a normalization as you go through the year, it sounds like. That is correct. Yeah, and I just wanted to follow up. Obviously, we'll get the details in the queue, but you called out maybe some weakness in specialty products. I know repair was very strong in the fourth quarter for you, partially, you know, max related, but other trends. Is there anything else? you'd call out specifically in the first quarter up 4% organic growth, any of the puts and takes there?

Yeah, I think what I was referring to in the specialty products in the first quarter of this year was not weakness, but instead, while it still grew and it did nicely, it would have grown more had it not been for the max grounding and the curtailment of production. So we got hurt by those activities, but we still posted good numbers there. But what I meant was, absent the max problem, we would have been even higher in that area. I wouldn't say that there's really any particular area of strength. We're really seeing good strength, very, very much broad-based across the entire flight support product line. So I'm really quite encouraged with everything that we're doing there. Very strong support from our customers in every area, whether it's in parts, repair, specialty products. You know, just speaking with our team, we seem to be winning more business and increasing market penetration. as a result, frankly, of the way we treat our customers.

That's great. And if I could, just one final question for Carlos. Really good, obviously, cash generation in the quarter. I know, obviously, it's a high focus for the company. You kept the full year guidance intact. Is there anything you'd highlight specifically, Carlos, in the first quarter or anything else operationally maybe that you're doing a little different which is contributing to the better cash profile as we think about things moving forward?

Okay, Mr. Carlos, I think we're not doing anything unique or special here at Heiko. The fact that we maintain high-margin businesses and we're expanding ever so slightly those margins as we continue to grow our sales and catch efficiencies and leverage on our SD&A, and then also gross margin improvement, that does drop to the bottom line and ultimately turns into cash. So that's been helpful. You know, to be candid with you, you know, it wouldn't be for the uncertainty of the outlook for this coronavirus. We might have a different view on our outlook and our cash generation for the year, but right now I chose to keep things relatively stagnant, if you would, with the December guidance until we get a little more visibility into how this is going to impact the airline industry.

That sounds reasonable. Thank you very much.

Thanks, Ken.

Your next question comes from the line of Guatam Kahana with Cowan.

I have a couple questions. First, I was wondering, could you quantify the accrued contingent consideration benefit year over year? Was it $1.4 million? I'm just looking at the cash flow, but.

That's a pretty damn good guess. Yeah, that's about right. We had in Q1 of 19, we had about a million, it was close to a million four of contingent earn out expense that we had to take on one of the FSG companies. And in fact, that was the last earn out payment we made on that particular subsidiary. And this year, we didn't have any of that. So ultimately, what you wind up having is no expense issues. Some last year, hence the less expense. Your guess at 1.4 is pretty close to what it was.

Okay. And maybe could you talk a little bit about how things are going on the CFM parts rollout, where you are in that process, and if we're actually starting to see some parts get approved in the system, if you will?

Yeah. As I mentioned, when that settlement came out, we said that directionally it was good for us and that we felt that it could only help that business. I would say that while we are very careful for competitive reasons, as you can imagine, not to comment on particular products, customers, regions, anything like that, I would say that I'm encouraged with what I've seen so far, and I do think that there is opportunity for us in that space.

Okay. And last one, I mean, you did mention the valuations are a little rich in the M&A pipeline, but can you characterize the pipeline for us? I mean, does this look like a more promising – last year was a big year, but can you characterize maybe – A lot of mid-sized targets, big targets, fewer, more, what have you.

This is Eric. I would be happy to tell you about what we're seeing over in the flight support side. There's a tremendous amount of interest in businesses that we're in, in particular the aftermarket and the new build markets. While we've seen prices, I would say, at an elevated level, we are also seeing that many deals are not printing. And there are, I would say, a host of lesser quality businesses. I think that, frankly, some of the buyers out there have gotten a little bit confused and are not, or in the past, hadn't differentiated. And I think perhaps since certain businesses have not traded, that that's a sign that either pricing is starting to come down or that, you know, people are no longer able to pass off lower quality businesses as higher quality businesses. So I would say that I'm encouraged. Heiko remains the, in our opinion, the buyer of choice. You know, we hear this from entrepreneurs all the time and we work very hard to have a buyer-friendly entrepreneurial culture whereby those folks really want to be part of HICO for the long term. And, you know, it's not, if you will, a quick private equity, you know, ring the business dry, jack up the prices, and run out the door. And for people who appreciate our model, I think we remain a great home for those businesses.

And Victor, do you have a... Anything to say on that?

Well, I think that applies across the board to all of HICO equally.

Okay. And one last one for Carlos, just tax rate. Any update to that in the guidance update today?

Yeah, certainly. So we still estimate for the full year, we kind of give a non-controlling interest and tax rate of somewhere between 19% and 20%. I think When we gave guidance in December, that same statement I made just now was the statement I made in December. You should assume for the remainder of the year that our tax rate will normalize. My guess is somewhere in the neighborhood, at least the way we modeled it out, of 22.5% to 23% for the next three quarters. And that will bring us in line with that 19% to 20% overall tax and NCI rate.

Perfect. Thank you, guys. Appreciate it. You're welcome.

As a reminder, to ask a question, you will need to press star 1 on your telephone. Your next question comes from the line of Louis Fraffetto with UBS.

Good morning, gentlemen. Good morning. Good morning. So I just want to follow up on the M&A given the sort of the current environment that we are in. The aerospace side, obviously the OEM, there's a lot of sort of uncertainty over the next several years there. Aftermarket, maybe in the near term, some uncertainty. And then if you switch over to defense, depending on what happens with the election, a lot of the Democrats are talking about cutting defense spending. So just how are you taking that sort of environment with maybe prices that aren't really changing right now? and sort of roll that up into potential M&A.

Lewis, this is Victor. It's something that we've been used to doing and dealing with uncertainty now in our acquisition program since we started doing acquisitions in 96, and we've had elections every four years since then. And we've had changes in the defense budget during those times, and we've had changes in commercial aviation spending, and we adjust the strategy. As we go and we look at the transactions, we look at the companies and we buy companies that we think are appropriate for us and for both the long term and the short term. And it's worked out very well. So we're very confident in our ability to continue to do that. And we're going to manage the business in the same way that we've always done it.

And I would also add that Heiko is a very educated buyer. You know, when we go in and do due diligence, we understand these businesses. We understand their supply chains, their customers, the products that they're on, whereas I think other buyers may not be as sophisticated and knowledgeable and, frankly, can be fooled, and we see this all the time. HICO is, you know, we're in this for the long haul. We're not in it for a get-rich-quick scheme or to hurry up and flip something. And when we find the right type of seller and they're in the right type of business, then we act. We don't feel like we're under any pressure to meet a specific number of acquisitions. And I think it's proven to be true with nearly 80 acquisitions over a 23-year period.

Look, this is Larry. If you're in the business that we're in for the long run and not from just day to day, we believe that the commercial aerospace industry is is a wonderful industry to be in. So if we buy something today, we don't expect, and do the due diligence that we normally do in our understanding, we understand what's going to be around for now and for the next 10 years. So I think we're pretty sophisticated buyers. When you talk about defense, you've got a similar situation. No matter who's elected, the defense budget is not going to go away. It may shrink. But when you focus, I hope you're aware of the kind of products that we make and supply to the defense industry. We don't supply tanks, bombs, guns, and we supply very high tech electronic type of components and things like that, which they need whether we're at war or at peace, just listening to every enemy that's out there on the field. So if you really delve into the kind of defense business that we're in, you will see that we're not something that is going to be buffeted by whether the Democrats get in there or the Republicans. It may be a little stronger, a little weaker, but it's not something that we believe that affects us. You have to look at our growth pattern in the last 30 years. We've grown it bottom line at 19%. I don't know many companies that have done that. And I think we continue to focus on being able to grow it somewhere, you know, 15 to 20%. So I'm not worried about that.

All right, that's great. I appreciate the color. And just one quick one for Carlos. I noticed the other non-current assets and liabilities jumped up. Anything specific or just curious what that was?

No, we had to implement the new accounting standard on leases. So basically, and every other company, most of December 31s, you've probably seen that also, we had to put about $64 million worth of leases up on our books, both as liabilities and assets. It's just a gross up to the balance sheet.

All right, so just the lease stuff. All right, perfect. Thank you, Carlos.

You're welcome.

Your next question comes from the line of Colin B. Charm with Sterling Capital.

Good morning. Thanks for taking the question. Most of my others have been answered already, but just maybe a quick, easy one for both Eric and Victor. Can you remind us what, if any, are the most important macro indicators that you deem relevant to our being linked to your order patterns over time. I'm just asking in the context of as we all try to assess and monitor the potential impact of outbreak of coronavirus, things that you perhaps have on your dashboard and are looking at next.

Yeah, this is Victor. You know, when it comes to the coronavirus, we're of course watching it closely. And as you know, it is very difficult to anticipate where it's going. I mean, personally, I believe that it'll spread further and it'll be in this country deeper in the not-too-distant future. But that's just my opinion. We all read the press and read the same sorts of things. So the question becomes, how do you deal with it? How does it affect your business? How do you prepare for it? We've surveyed our companies this week and asked them how they're what they're seeing, and so far the effect has really been immaterial or de minimis, in fact, almost across the board. We've had a few cases, a couple of companies where they've said they've had maybe one company, in fact, where they've said it's had some more material effect, but basically it's been fairly immaterial so far. And they talk about what they're trying to do to diversify their supply chains. and to stock up on extra material, things like that, what they might do if they have people out of the plant, if they have people who are sick. And I think it's going to be that kind of flexibility, which HICO is really good at. We're kind of known for being flexible and bobbing and weaving when we're running on an ordinary basis anyway, and that's how we're going to have to deal with it. Anybody in any industry.

So flexibility is going to be the key. And this is Eric. I think Victor brings up a great point in flexibility and, you know, making sure that we figure out how to get the job done regardless of the market condition. Specifically with device support, clearly in the aftermarket space, available seat miles, ASMs. is the, I would say, the closest correlation. Now, the only thing that you've got to be a little bit careful on is there's been, in general, a shortage of a certain maintenance capacity as the economy has been pretty strong and travel has increased. So, as some of the other analysts mentioned, airlines are taking the opportunity, if you will, in this lower period to perform some needed maintenance. So I think that will mitigate, at least in the short term, any potential impact of the virus. But long-term, ASMs are really the driver for the aftermarket. With regard to our specialty product, it is both defense spending and new build. However, we are on, I would say, very good programs that are very much needed in the missile defense area. as well as various narrow body new build programs. So I think that we should be pretty well in that area as well. Any further questions?

At this time, there are no further questions. I would now like to turn the call back over to management for any closing remarks.

Thank you all very much for participating and listening and for your interest in HICO, and we look forward to speaking to you at our second quarter conference call, which will be a little bit later this year. Thank you all, and that is the extent of the conference call.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.