Heico Corporation

Welcome to the HICO Corporation Fiscal 2029 Months and Third Quarter Earnings Conference Call. We thank you for joining us today. My name is Vincent, and I'll be your conference operator. As we begin the call, we remind you that certain statements in this conference call will constitute forward-looking statements, which are subject to risks, uncertainties, and contingencies. HICO's actual results may differ materially from those expressed in or implied by those forward-looking statements as a result of factors including the severity, magnitude, and duration of the COVID-19 outbreak. HICO's liquidity and the amount and timing of cash generation, the continued decline in commercial air travel caused by the outbreak, airline fleet changes or airline purchasing decisions, which could cause lower demand for our goods and services. Project specification costs and requirements, which could cause an increase to our costs to complete contracts. Governmental and regulatory demands, export policies and restrictions, reductions in defense, space or homeland security spending by U.S. and or foreign customers or competition from existing and new competitors which could reduce our sales and profitability. Our ability to introduce new products and services at profitable pricing levels which could reduce our sales, sales growth or profitability. Product development or manufacturing difficulties which could increase our product development and manufacturing costs and delay sales, our ability to make acquisitions and achieve operating synergies from acquired businesses, customer credit risk, interest, foreign currency exchange and income tax rates, economic conditions within and outside of the aviation, defense, space, medical, telecommunications, and electronics industries, which could negatively impact our costs and revenues, and defend spending or budget cuts, which could reduce our defense-related revenue and profitability. Partners listening to or reading a transcript of this call are encouraged to review all of HICO's pilings with 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 Lawrence A. Mendelsohn, HICO's chairman and chief executive officer. Thank you.

Thank you very much, and thank you and good morning to everyone on this call. We thank you for joining us and welcome you to the HICO third quarter fiscal 20 earnings announcement teleconference. I'm Larry Mendelsohn, 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 Mendelson, 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 have performed admirably during the challenges brought on by the COVID-19 outbreak. Their dedication to HICO's customers and the safety of their fellow team members has been exemplary. I want each and every member of HICO's global team to understand that the board of directors and I are humbled by your dedication and continued focus on safety and wellbeing during these challenging times. I am confident that our future is bright and we will exit this COVID-19 period as a stronger and more competitive company. At this time, I'll take a few minutes to discuss the impact on Heiko's operating results from the outbreak for the three and nine months ended July 31, 2020. The effects of the outbreak and the related actions by governments around the world to mitigate its spread have impacted our employees, customers, suppliers, and manufacturers. In response to the economic impact from the outbreak, we at Heiko have implemented certain cost reduction efforts, including layoffs, temporary reduced work hours, temporary pay reductions within various departments of our business, including within our entire executive management team, as well as our board of directors. Our response to the outbreak included implementing varying health and safety measures at our facilities, including supplying and requiring the use of personal protective equipment, staggering work shifts, body temperature taking, increasing work from home capabilities, consistent and ongoing cleaning of workspaces and high touch areas, and establishing processes aligned with the Centers for Disease and Control guidelines to work with any individual exposed to COVID-19 on their necessary quarantine period and the process for the individual to return to work. With respect to the results of operations, approximately half of our net sales are derived from defense, space, and other industrial markets, including electronics, medical, and telecommunications. Demand for products in that half of our business has not been fundamentally impacted, and its operational results remain materially consistent with the financial expectations prior to the outbreak. We have experienced and expect to continue experiencing periodic operational disruptions resulting from supply chain disturbances, staffing challenges, including at some of our customers, temporary facility closures, transportation interruptions, and other conditions which or increased costs. While these issues have not yet been material overall, we have experienced disruption in some orders and some shipments during the third quarter. The remaining portion of our net sales is derived from commercial aviation products and services. The outbreak has caused significant volatility and a substantial decline in the value across global markets. Most notably, the commercial aerospace industry experienced an ongoing substantial decline in demand resulting from a significant number of aircraft in the global fleet being grounded during our third quarter. Our businesses that operate within the commercial aerospace industry have been materially impacted by the significant decline in global commercial air travel that began in March of this year. Consolidated net sales for our businesses that operate within the commercial aerospace industry decreased by approximately 54% during the third quarter of fiscal 20. As I previously mentioned, we have taken responsible measures to address these reductions in net sales at our affected businesses. Once commercial air travel resumes, cost savings most likely will be a priority for commercial aviation customers, and we anticipate recovery in demand for our commercial aviation products, which frequently provides aircraft operators with significant cost savings. One item that I'd like to point out that we have been asked on calls over between last night and this morning, a number of people asked for the dollar amount of account receivable reserves that we set up for the bankruptcy of some small airlines. And that number, the absolute number, was $7.5 million. Later on in this call, Carlos can give you more details of how it affects the operating margins and so forth, but the absolute number was $7.5 million. Keep in mind that historically, we have been able to make up and possibly collect some of that $7.5 million. At this point, we don't know how much that might be, if any. So we have, as we normally do, taken the most conservative approach and reserved the whole amount that could go bad. We believe that our cost-saving solutions and robust product development programs will enable us to potentially increase market share. and emerged with a stronger presence within the commercial aviation market. Summarizing the highlights of the third quarter, consolidated net income increased 4% to a record $251.7 million, or $1.83 per diluted share, in the first nine months of fiscal 20, and that was up from 242.2 million or 176 per diluted share in the first nine months of fiscal 19. We continue to forecast positive cash flow from operations for the remainder of fiscal 20. Cash flow provided by operating activities was consistently strong at $299 million and $313.4 million in the first nine months of fiscal 20 and 19, respectively. Cash flow provided by operating activities totaled $93.1 million, or 171 percent of net income in the third quarter of fiscal 20, as compared to $135.1 million in the third quarter of fiscal 19. Our net debt, which is total debt less cash and equivalents, of $344.8 million compared to shareholders' equity, improved to 17.7% as of July 30, down from 29.8% as of October 31, 2019. Our net debt to EBITDA ratio improved 2.7 times, less than one, as of July 31, 2020. And that was down from 0.93 times as of October 31, 2019. During fiscal 20, we have successfully completed six acquisitions, four of which were completed since the outbreak started. We have no significant debt maturities until fiscal 23, and we plan to utilize our financial flexibility to aggressively pursue high-quality acquisitions to accelerate growth and maximize shareholder returns. I do want to point out that unlike some companies in the aerospace industry, HEICO did not have to go to the market. to raise money at what I consider exorbitant rates of 8% or more. So we just went through this financially sound, and I think that has really helped us and has proven to be an excellent strategy. In July 20, we paid the regular semiannual cash dividend of $0.08 per share. and that represented our 84th consecutive semi-annual cash dividend. We did not have to cut the dividend, and we were very proud of that. Some companies did cut dividends significantly because of cash flow pressures. We did not. In July 20, we reported that our Sierra Microwave, DPT, and 3D Plus subsidiaries supplied mission-critical hardware for the Mars 2020 Perseverance mission. The Mars mission is designed to better understand the geology of Mars and seek signs of ancient life by collecting and storing rocks, soil samples for a future return to Earth. while also testing new technology for robotic and human space exploration. We congratulate the many remarkable people who accomplished this first step in this incredible mission, and we're proud of the Heiko companies and team members who contributed to the effort, and we are excited for the mission's next stage. Talking about acquisitions, in June 2020, we acquired 70% of the membership interest of Rocky Mountain Hydrostatics, which overhauls industrial pumps, motors, and other hydraulic units with a focus on the support of legacy systems for the U.S. Navy. The remaining 30% continues to be owned by certain members of Rocky Mountain's management team. And Rocky Mountain is part of our flight support group, and we expect the acquisition to be accretive to earnings within the first 12 months following closing. In August 2020, we acquired 75% of the equity interest of Intelligent Devices and Transformational Security. These two companies design and develop and manufacture state-of-the-art technical surveillance countermeasures equipment used to protect critical spaces from exploitation via wireless transmission, technical surveillance, and listening devices. In summary, I'll say basically spying by unwanted people. These acquisitions are part of electronic technologies, and we expect them to be accretive to earnings within the first 12 months following closings. The remaining 25 percent interest was acquired by the non-controlling interest holders of a subsidiary in Heiko Electronic that is also a designer and manufacturer of the same type of equipment, used basically for different applications. In August 20, we acquired 90% of the equity interest of Connect Tech. Connect Tech designs, manufactures rugged, small-form factor-embedded computing solutions. Its components are designed for very harsh environments and primarily used in rugged commercial and industrial, aerospace and defense, transportation, and smart energy applications. The remaining 10% interest continues to be owned by a member of Connect Tech's management team. This acquisition is part of the electronic technologies group, and we expect it to be accretive to earnings within the first 12 months following closing. At this time, I'd like to introduce Eric Mendelsohn, co-president of Heiko and president of Heiko's flight support group, and he will discuss the results of the flight support group.

Thank you. The flight support group's net sales were $731.2 million in the first nine months of fiscal 20, as compared to $915.5 million in the first nine months of fiscal 19. The flight support group's net sales were $178.2 million in the third quarter of fiscal 20, as compared to $320 million in the third quarter of fiscal 19. The net sales decrease in the first nine months in the third quarter of fiscal 20 is principally organic and reflects lower demand across all of our product lines, resulting from the significant decline in global commercial air travel beginning in March 2020 due to the outbreak. Net sales in fiscal 20 follows a very strong 12 percent and 13 percent organic growth reported in the third quarter and full fiscal 2019 year, respectively. The Flight Support Group's operating income was $121.6 million in the first nine months of fiscal 20, as compared to $179.8 million in the first nine months of fiscal 19. the flight support group's operating income was $12 million in the third quarter of fiscal 20, as compared to $64.8 million in the third quarter of fiscal 19. The operating income decrease in the first nine months and third quarter of fiscal 20 principally reflects the previously mentioned decrease in net sales, a lower gross profit margin, mainly within our aftermarket replacement parts and repair and overhaul parts and services product lines, and an increase in bad debt expense principally due to potential collection difficulties from certain commercial aviation customers that filed for bankruptcy protection during the third quarter of fiscal 20 as a result of the financial impact of the outbreak. These decreases were partially offset by lower performance-based compensation expense. The flight support group's operating margin was 16.6% in the first nine months of fiscal 20, as compared to 19.6% in the first nine months of fiscal 19. The flight support group's operating margin was 6.7% in the third quarter of fiscal 20, as compared to 20.2% in the third quarter of fiscal 19. The decrease in the first nine months, and third quarter fiscal 20 principally reflects the previously mentioned lower gross profit margin and an increase in SG&A expenses as a percentage of net sales, mainly reflecting the impact of the outbreak and previously mentioned higher bad debt expense. Now I would like to introduce Victor Mendelson, co-president of HEICO and president of HEICO's Electronic Technologies Group, to discuss the results of the Electronic Technologies Group.