Heico Corporation

Ladies and gentlemen, thank you for standing by and welcome to the fiscal year 2020 fourth quarter and end of the year earnings results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, follow your question and answer session. To ask a question during the 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 zero. Certain statements in today's call will constitute forward-looking statements, which are subject to risk, uncertainties, and contingencies. HICO's actual results may differ materially from those expressed and or implied by those forward-looking statements as a result of factors including the severity, magnitude, and duration of the COVID-19 pandemic. high cost liquidity and the amount and timing of a cash generation, lower commercial air travel cost by the COVID-19 pandemic and its aftermath, airline fleet changes or airline purchasing decisions, which could cost lower demand for our goods and services, products specification cost and requirements, which could cost an increased or cost to complete contracts, governmental and regulatory demands, export policies and restrictions, reduction 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 as profitable pricing levels, which could reduce our sales or sales crop, product development or manufacturing difficulties, which could increase our product development and manufacturing cost and delay sales. Our ability to make acquisition and achieve operating synergies from acquired businesses, customer credit risk, interest, foreign currency exchange and income tax rates, economic condition within and outside of the aviation, defense, space, medical, telecommunications, and electronics industries. which could negatively impact our cost and revenues, and defense spending or budget cuts, which could reduce our defense-related revenue. Parties receiving listening to this call or reading a transcript of this call are encouraged to review all of HICO's filing with the Securities and Exchange Commission, including but not limited to filings on Form 10-K, Form 10-Q, and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except to the extent required by applicable law. I now turn the call over to Lawrence A. Mendelson, High Coast Chairman and Chief Executive Officer. Thank you. Please go ahead.

Thank you very much, and good morning to everyone on the call. We thank you for joining us, and we welcome you to this HICO fourth quarter and full 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 Vice President and CFO. Now, before reviewing our fourth quarter and full fiscal year results, I'd like to take a few moments to discuss the impact on HICO's operating results from the COVID-19 global pandemic. The results of operations in fiscal 20 were significantly affected by COVID-19 global pandemic. The effects of the pandemic and related actions by governments around the world to mitigate its spread have impacted our employees, customers, suppliers, and manufacturers. Since the beginning of the pandemic in March 2020, we have implemented health and safety measures at our facilities in accordance with the CDC guidelines to protect team members and mitigate the spread of COVID-19. Most of our facilities are considered essential businesses and have remained operational during the pandemic. We are thankful for the outstanding commitment of our team members towards our customers, shareholders, and each other during these very challenging times. The Board of Directors and management of Heiko are truly humbled by the dedication of our team members to their company during these unprecedented times. Currently, we believe the recent vaccine progress will most notably result in a gradual recovery in demand for our commercial aerospace parts and services commencing in fiscal 21. As demand for air travel slowly recovers, we remain very confident in our ability to offer cost-saving solutions and robust product development programs that we expect to increase our market share and allow us to have even a stronger presence within the commercial aviation market. I'd like to take a few moments to summarize the highlights of our full fiscal 2020 and fourth quarter results. Despite the many challenges faced in fiscal 2020, HICO has continued to generate excellent cash flow. Our cash flow provided by operating activities was very strong at $409 million and $437.4 million in fiscal 2019, respectively. Cash flow provided by operating activities totaled $110.2 billion, or 177% of reported net income in the fourth quarter of fiscal 20, as compared to $124 million in the fourth quarter of fiscal 19. As all of you know, HICO's most important metric is cash flow. And I think that the results of 2020 operations, particularly the fourth quarter, are clearly indicative of the success. We are encouraged by the sequential improvements in our fiscal 20 consolidated fourth quarter operating results over the third quarter of fiscal 20. And during the fourth quarter, we experienced increases in consolidated operating income, net income, and net sales of 30 percent, 15 percent, and 10 percent, respectively. In fact, despite the continued impact for the pandemic on demand for our commercial aerospace parts and services, The flight support groups operating income and net sales in the fourth quarter of fiscal 20 improved sequentially by 78% and 9% respectively as compared to the third quarter of fiscal 20, a significant improvement. The electronic technologies group, and from now on I'll call it ETG, set all-time quarterly net sales and operating income records in the fourth quarter of fiscal 20, improving 8% and 14% respectively over the fourth quarter of fiscal 19. These increases principally reflect the excellent operating performance of our fiscal 20 acquisitions, as well as continued disciplined cost management on the part of our operating teams. We recently entered into an amendment to extend the maturity date of our revolving credit agreement by one year to November 23, and to increase the committed capital to $1.5 billion. In addition, our credit facility continues to include a feature that will allow the company to increase the capacity by $350 million or become a $1.85 billion facility through increased commitments from existing lenders or the addition of new lenders and can be extended for an additional one-year period. We are very thankful for the continued support of our existing bank group. Their loyalty to HICO as demonstrated by this credit facility amendment further offers us the financial flexibility to pursue our disciplined strategy of acquiring high-quality businesses at fair prices. Our net debt, which we define as total debt less cash and cash equivalents, of $333 million, compared to shareholders' equity ratio, improved to 16.6% as of October 31, 2020, and this was down from 29.8% as of October 31, 2019. Our net debt to EBITDA ratio improved to 0.71 times as of October 31, 2020, down from 0.93 times as of October 31, 19. Keep in mind, this is after making six acquisitions during the year. During fiscal 20, we successfully completed six acquisitions, four of which were completed since the pandemic start. We have no significant debt maturities until fiscal 24, and we plan to utilize our financial strength and flexibility to aggressively pursue high-quality acquisitions of various sizes and accelerate growth to maximize shareholder returns. As we reported yesterday, we declared an 8-cent-per-share regular semiannual cash dividend on both classes of common stock payable January 21, 2021, to shareholders of record as of January 7, 2021. This cash dividend will be our 85th consecutive semiannual cash dividend since 1979. Heiko's strength in the face of challenging business conditions, coupled with our optimism of the future, gave our board of directors the confidence to continue paying our normal cash dividend. While this is very important to all of our shareholders, it is especially important to our team members, the vast majority of whom are fellow HICO shareholders through the personal holdings in their 401k plan. Let's talk about some of the new fourth quarter acquisitions. As I discussed during the third quarter teleconference, we completed three acquisitions in August through our ETG group. First, we acquired a 75 percent of the equity interest in transformational security and intelligent devices. These two companies design and develop and manufacture state-of-the-art technical surveillance countermeasures equipment. Next, we acquired approximately 90% of the equity interest of Connect Tech. Connect Tech designs and manufactures rugged small form factor embedded computing solutions used in rugged commercial and industrial aerospace and defense, transportation, and smart energy applications. These acquisitions are expected to be accretive to earnings within the first 12 months following closing. At this time, I would like to introduce Eric Mendelsohn, co-president of HEICO and president of HEICO's Flight Support Group, and he will discuss the results of the Flight Support Group.

Eric Mendelsohn, Thank you. The Flight Support Group's net sales were $924.8 million in fiscal year 20, as compared to $1,240.2 million in fiscal year 19. The flight support group's net sales were $193.6 million in the fourth quarter of fiscal 20, as compared to $324.7 million in the fourth quarter of fiscal 19. The net sales decreases are principally organic and reflect 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 pandemic. Net sales in fiscal 20 follows the 13% and 12% organic growth reported in the year and fourth quarter of fiscal 19, respectively. The flight support group's operating income was $143.1 million in fiscal 20, as compared to 242 million in the fiscal year 19. The flight support group's operating income was 21.5 million in the fourth quarter of fiscal 20, as compared to 62.2 million in the fourth quarter of fiscal 19. The operating income decreases principally reflect the previously mentioned decrease in net sales, a lower gross profit margin, and an increase in bad debt expense due to potential collection difficulties from certain commercial aviation customers that filed for bankruptcy protection during fiscal 20 as a result of the pandemic's financial impact, partially offset by a decrease in performance-based compensation expense. The lower gross profit margin principally reflects an increase in inventory obsolescence expense mainly resulting from the announced retirement of certain aircraft types and engine platforms by our commercial aerospace customers due to the pandemic's financial impact. Additionally, the lower gross profit margin reflects the impact from lower net sales within our repair and overhaul parts and services and aftermarket replacement parts product lines. The place of work group's operating margin was 15.5% in fiscal 20 as compared to 19.5% in fiscal 19. The flight support group's operating margin was 11.1% in the fourth quarter of fiscal 20 as compared to 19.2% in the fourth quarter of fiscal 19. The operating margin decreases principally reflect the previously mentioned lower gross profit margin and an increase in SG&A expenses as a percentage of net sales, mainly from the previously mentioned higher bad debt expense and fixed cost efficiencies loss resulting from the pandemic's impact, partially offset by lower performance-based compensation expense. Now, I would like to introduce Victor Mendelson, co-president of HICO, and President of Heiko's Electronic Technologies Group to discuss the results of the Electronic Technologies Group.

Thank you, Eric. The Electronic Technologies Group's net sales increased 5% to a record $875 million in fiscal 20, up from $834.5 million in fiscal 19. The increase in fiscal 20 is attributable to the favorable impact from our fiscal 20 and 19 acquisitions, partially offset by an organic net sales decrease of 1%. The organic net sales decrease is principally due to lower sales of commercial aerospace and medical products, largely attributable to the pandemic, partially offset by increased sales of defense and space products. The ETG's net sales increased 8% to a record $236.7 million in the fourth quarter of fiscal 20, up from $219.5 million in the fourth quarter of fiscal 19. The increase in the fourth quarter of fiscal 20 is attributable to the favorable impact from our fiscal 20 acquisitions and the anticipated increase in commercial space revenues. The Electronic Technologies Group's operating income increased 5 percent to a record $258.8 million in fiscal 20, up from $245.7 million in fiscal 19. The increase in fiscal 20 principally reflects the previously mentioned net sales growth, lower performance-based compensation expense, and a decrease in acquisition-related expenses, partially offset by a lower gross profit margin. The lower gross profit margin is mainly due to a decrease in net sales and less favorable product mix of certain commercial aerospace and medical products, partially offset by increased net sales of certain defense products. The ETG's operating income increased 14 percent to a record $73.9 million in the fourth quarter of fiscal 20, up from $64.6 million in the fourth quarter of fiscal 19. The increase in the fourth quarter of fiscal 20 principally reflects the previously mentioned net sales growth and improved gross profit margin. The improved gross profit margin principally reflects a more favorable product mix and increased net sales of certain space and defense products partially offset by a decrease in net sales of certain commercial aerospace products. The Electronic Technologies Group's operating margin improved to 29.6% in fiscal 20, up from 29.4% in fiscal 19. The ETG's operating margin improved to 31.2% in the fourth quarter of fiscal 20, up from 29.4% in the fourth quarter of fiscal 19. The increase in the fourth quarter fiscal 20 mainly reflects efficiencies gained from the previously mentioned net sales growth and the improved gross profit margin. I turn the call back over to Larry Mendelson.

Thank you, Victor. Moving on to diluted earnings per share, consolidated net income per diluted share decreased 4% to $2.29 in fiscal 20. as compared to $2.39 in fiscal 19. Consolidated net income per diluted share decreased 27 percent to 45 cents in the fourth quarter of fiscal 20, as compared to 62 cents in the fourth quarter of fiscal 19. Those decreases principally reflect the previously mentioned lower operating income of flight support partially offset by lower income tax expense, less net income attributable to non-controlling interest, as well as lower interest expense. Depreciation and amortization expense totaled $88.6 million in fiscal 20, up from $83.5 million in fiscal 19, and totaled $23.3 million in the fourth quarter of fiscal 20, up from 21.8 million in the fourth quarter of fiscal 19. The increase in the fiscal year and fourth quarter of fiscal 20 principally reflect the incremental impact from our fiscal 20 and 19 acquisitions. Research and development. significant ongoing new product development efforts are continuing at both ETG and flight support. R&D expense was $65.6 million in fiscal 20, or about 3.7% of net sales, and that compared to $66.6 million in fiscal 19, or 3.2% of net sales. R&D expense was $16.6 million in the fourth quarter of fiscal 20, or 3.9 percent of net sales. And that compared to $17.9 million in the fourth quarter of fiscal 19, and that was 3.3 percent of net sales. SG&A expenses consolidated, decreased by 14 percent, to $305.5 million in fiscal 20, and that was down from $356.7 in fiscal 19. The decrease in consolidated SG&A expense in fiscal 20 reflects a decrease in performance-based compensation expense, a reduction in other G&A expenses, and a reduction in other selling expenses, including outside sales commissions, marketing, and travel. These decreases were partially offset by the impact of our fiscal 19 and 20 acquisitions, as well as the previously mentioned increase in bad debt expense, and that was due to collection difficulties from certain commercial aviation customers that filed for bankruptcy protection during fiscal 20 as a result of the financial impact of the pandemic. Consolidated SG&A expense decreased by 18% to $72.6 million in the fourth quarter of fiscal 20, down from $88.8 million in the fourth quarter of fiscal 19. The decrease in consolidated SG&A expense in the fourth quarter of fiscal in other general administrative expense, decrease in performance-based compensation expense, and a reduction in other selling expenses, including outside sales commission, marketing, and travel. The decreases were partially offset by the impact of our fiscal 2019 acquisitions, as well as the increase in bad debt expense. Consolidated SG&A expense as a percentage of net sales dropped to 17.1 percent in fiscal 20, and that was down slightly from 17.4 percent in fiscal 19. The decrease in consolidated SG&A expense as percentage of net sales in fiscal 20, again, is due to lower performance-based compensation expense and a decrease in other selling expenses, partially offset by the impact of higher other G&A expense as a percentage of net sales and an increase in bad debt expense. Consolidated SG&A expense as a percentage of net sales increased to 17% in the fourth quarter of fiscal 20, and that was up slightly from 16.4% in the fourth quarter of fiscal 19. The increase in consolidated SG&A expense as a percentage of net sales of a fourth quarter of fiscal 20 reflects higher other general administrative expense as a percentage of net sales due to the decreased sales volume and the aforementioned increase in their debt expense partially offset by a decrease in lower performance-based compensation expense and a decrease in other selling expenses. Interest expense decreased to $13.2 million in fiscal 20, and that was down significantly from $21.7 million in fiscal 19, and it decreased to $2.5 million in the fourth quarter of fiscal 20, down from $5.2 million in the fourth quarter of fiscal 19. Decreases were principally due to a lower weighted average interest rate on borrowings outstanding under our credit facility. Our effective tax rate in fiscal 20 was 7.9 percent as compared to 17.8 percent in fiscal 19. The decrease in fiscal 20 is mainly attributable to a larger tax benefit recognized in fiscal 20 from stock option exercises compared to fiscal 19, and that resulted from more stock options being exercised as well as the strong appreciation in HICO stock price during the optionee's holding period. Our effective tax rate in the fourth quarter of fiscal 20 was 22.3 percent, and that compared to 19.8 percent in the fourth quarter of fiscal 19. Net income attributable to non-controlling interests was 21.9 million in fiscal 20, and that compared to 31.8 million in fiscal 19. The decrease in fiscal 20 principally reflect a decrease in operating results of certain subsidiaries of flight support in which non-controlling interests are held, as well as the impact of a dividend paid by Heiko Aerospace in June 2019, that effectively resulted in the transfer of 20% non-controlling interest held by Lufthansa Technik in eight of our existing subsidiaries, and that was transferred back to our flight support group. Net income attributable to non-controlling interest was $5.3 million in the fourth quarter of fiscal 20, and that compared to $6.9 million in the fourth quarter of fiscal 19. The decrease in the fourth quarter of fiscal 20 principally reflects a decrease the operating results of certain subsidiaries of the flight support group in which non-controlling interests are held. For the full fiscal year 21, at the present time, we anticipate a combined tax and non-controlling interest rate of approximately 23 to 24 percent. Moving on to the balance sheet and cash flow, as you all know, our financial position and forecasted cash flow remain very strong. Previously, I mentioned cash flow provided by operating activities was consistently strong at $409.1 million and $437.4 million in fiscal 2019, respectively. Cash flow provided by operating activities totaled 110.2 million, or 177% of net income in the fourth quarter of fiscal 20, and that compared to 124 million in the fourth quarter of fiscal 19. We currently anticipate capital expenditures of approximately $40 million in fiscal 21, and that would be up from the $22.9 million spent in fiscal 20. Our working capital ratio, which is, of course, current assets divided by current liabilities, improved to 4.8 as of October 31, 20, as compared to 2.8 as of October 31, 19. Day sales outstanding, DSOs of accounts receivable improved to 45 days as of October 31, 20, and that compared favorably to the 47 days as of October 31, 19. We continue to closely monitor all receivable collection efforts in order to limit our credit exposure. No one customer accounted for more than 10 percent of sales. and our top five customers represented approximately 24 and 20 percent of consolidated net sales in fiscal 20 and 19, respectively. Our inventory turnover rate increased to 153 days for the year ended October 31, 20, as compared to 124 days for the year ended October 31, 19. That increase in turnover rate principally reflects certain long-term and non-cancellable inventory purchase commitments, which were based on pre-pandemic net sales expectations and also to support the backlog of certain of our businesses. Now, the outlook. As we look ahead to fiscal 21, The pandemic will likely continue to negatively impact commercial aerospace industry as well as HICO. Given this uncertainty, HICO cannot provide fiscal 21 net sales and earning guidance at this time. However, we do believe our ongoing fiscal conservative policies, healthy balance sheet, increased liquidity, will permit us to invest in new research and development and gain market share as the industry recovers. In addition, our time-tested strategy of maintaining low debt and acquiring operating high cash-generating businesses across a diverse base of industry, besides commercial aerospace, and these industries are defense space, and other high-end markets, including electronics and medical, puts us in good financial position to weather this uncertain economic period. We are cautiously optimistic that the recent vaccine progress should generate increased commercial air travel and will result in a gradual recovery in demand for our commercial aerospace parts and services commencing in fiscal 21. I'd like to conclude my remarks by again thanking all of HICO's talented team members who have worked very hard to exceed our customers' expectations during these difficult times, which were brought on by the COVID-19 pandemic. Their dedication to HICO's customers and to the safety of their fellow team members has been exemplary. And I want to thank each and every member of HICO's global team to understand that the Board of Directors and I value your commitment to our collective safety and success 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. Those are the extent of my prepared remarks, and I would now like to open the floor for questions.

Ladies and gentlemen, as a reminder, if you would like to ask a question, please press park. then the number one on your telephone keypad. Again, if you would like to ask a question, please press par, then the number one on your telephone keypad. Your first question comes from Peter Arment with Baird. He may now ask a question.

Hi, yes. Good morning, Larry, Eric, Victor, Carlos. Eric, I guess I'd just start with you on FSG. The 9% sequential improvement, maybe you could just provide an A little color of what you're seeing. I mean, we saw, I guess, a modest pickup in flight activity quarter over quarter compared to the Q3. But what are you hearing from or seeing from your customers in terms of their behavior?

Yeah, I would say we're – well, first of all, good morning, Peter, and thanks for your question. We are, I would say, very encouraged by seeing the pickups. Conversations with our customers remain very strong. They're very interested and excited about our product. We believe that we're going to come out of the pandemic with greater market share. In conversations with our sales VPs, I really question them on the particular products that we're coming out with, as well as why specifically each one of them felt that we would be growing market share. and they claim that the conversations with the customers are causing them to understand that HICO is viewed as a very significant part of the supply chain. We've matured into a nice-sized company, and there's no reason why they shouldn't be buying a greater number of our products. So I think we were correct when we called the bottom in May, expecting that May was going to be the bottom and that things were going to trend up. I can tell you that November was a very good month. and things were looking very good, I would say, you know, for the last couple of, probably the last week or so, things have gotten a little quieter, but that's not necessarily atypical, because normally around the holiday season, things start to slow down, but I think given the news that we see with the pandemic, it's sort of logical that the second half of December and January may be a bit quieter. But having said that, the vaccine news, of course, was very good. And in looking and speaking with our customers about the flight schedules that they're operating and the inventory that they have, as I pointed out in our August call, the flight schedules were really far in excess of the spare parts purchases. And in discussions with a number of airlines, you know, they recognize that they can't continue to operate the schedules that they're operating based on the purchases that they're making. So we anticipate an improvement in particular in the second half of our fiscal year. And obviously, the timing is going to be very dependent on the vaccine news and what we see in terms of the infection rates.

Well, that's really helpful. And you mentioned the bad debt expense. Can you quantify what the margin would have been without that additional expense in FSG?

Hey, Peter, this is Carlos. So the additional bad debt wasn't that significant in the quarter, maybe a million and a half, something like that. Remember, we took about $7.5 million in Q3 to deal with some bankruptcies. And in Q4, it was kind of the normal noise. So you'd have to add about, I guess, $9 million back to the annual margin to see what that would be.

Okay. And then, Carlos, just one question. Quick one, and then I'll jump back in queue. Larry mentioned SG&A was down 14% year over year, and I think over 30 million of it is tied to kind of performance comp. How do we think about that as we're thinking about fiscal 21?

I think that performance-based comp is going to flux with sales, Peter. So I'm not anticipating getting back to 19 performance-based comp levels in 21. but they will flux with our sales and profitability. So as things pick up during 21, we'll probably see some increase in the bonus and performance-based comp expenses, but it will be commensurate with our profitability growth.

Thanks very much. Thank you.

Your next question comes from Scott McKiss with CreditSmith. Can we now ask your question?

Good morning. Um, Eric with where aerospace names are currently trading, have you considered increasing the multiple you would be willing to pay for a high quality commercial arrow company? Um, maybe a multiple that's higher than your historic norms. And then as a followup, given the current valuation of Heiko stock, would you consider doing an all stock or combination of cash and stock for a larger acquisition?

So. Good morning, Scott. So with regard to the pricing, you know, I think that we're definitely flexible on pricing. I think that a lot of people, you know, frankly, there's a lot of private equity in the space right now. And they look at the results. You know, we've had this long cycle where commercial and defense have done very well. And we're, I think, very good at operating in this space. And we understand where the landmines are. And I think that there are a number of companies out there which are being bid up at really, you know, prices that don't make sense. And so to answer your question, if it's a high-quality company and we think that we can accelerate the growth, would we be more aggressive on it? Sure. However, if, you know, a lot of these businesses don't meet that criteria, and, you know, frankly, people look at Heiko. And they say, well, you know, these guys didn't know what they were doing, and they entered this business 31 years ago. Look at how well Heiko has performed with the stock, I don't know, 20-something percent CAGR over 31 years without any leverage. You know, how hard can this be? And, you know, they get into this space, and they realize, in fact, it's pretty hard. And we've got people who really know what they're doing, and we've got this unique product offering where they're we're able to combine PMA repair and distribution into the aftermarket and have, you know, outside of a couple of, you know, the airframe engine or a couple of the large component OEMs, we've got the largest aftermarket sales force. And it's extremely synergistic where these businesses are able to feed business to each other. And we've learned a tremendous amount along the way. So, and then, The other thing I would say, we're also fairly conservative when we look at them in terms of inventory reserves and in terms of not pressing the pricing envelope. We want to make sure that we've got a very good business for generations to come. And we're not trying to, if you will, burn the furniture, take everything out of the fields in order to hit our numbers. And that is the culture that we've created, and our people understand that. And so I think that when you look at some companies that may really be doing things in the short term in order to get a high price and then they want to get a high multiple off that, honestly, that's somewhat of a fool's errand and not something that we want to do. So sorry for the long answer, but if it truly is a Heiko-run company, yes. You know, Heiko-style run company, yes, we would pay a higher price for it. But frankly, we haven't, you know, you don't see that very often. So, and then with regard to larger transactions, as our dad says, we, you know, Hygo is very open to all sorts of different transactions. We believe that we've got a differentiated model in terms of how we run the business and how we treat our people. And so, yes, if we found a a larger deal, we would, you know, definitely want to go ahead and act on it. But, you know, of course, there can be no assurance. And my comment should not be interpreted as there's one on the horizon. But we're always focused on where we can grow. And, you know, frankly, by having this culture, we really, you know, in a sense, it's like planting, you know, a lot of seeds in the ground to make sure that the future is going to be very good. And we've got that. And we're very confident on the future because of that. And even when a crisis happens like this, we treat our people very nicely because, you know, as we say, they're our greatest asset. And if you don't treat, other people may say their people are the greatest asset and then they go and cut them. and do all sorts of things, whereas Heiko has been willing to suffer the financial consequences of treating our people right. We're not afraid to go ahead and have reduced earnings so we can come out of this thing very strong. So acquisitions really need to line up like that, and we've made a number of them where typically the founder entrepreneurs share that same vision. where they really put the people ahead of short term profits, because they know that that leads to long term, you know, superiority. So I hope that answers your question. But if not, I'd be happy to expand on it in any way.

I guess just kind of on the follow up, if it were to be a larger acquisition, say, in the north of a few billion dollars, would you consider doing all stock or a combination of cash and stock to finance the acquisition?

I think all things would be on the table. Frankly, it's our preference to use cash because we're believers in the stock. The stock has performed extremely well. And if you look at the 82 acquisitions we've made to date, I don't think that we've given out more than a million dollars of stock and billions of dollars of acquisitions. So now with the added a flexibility that we've got with our new line of credit that Carlos worked so hard to arrange. We've got a lot of flexibility there. But yes, I mean, we would be open. I mean, one of the things that we need to be open to is some people may be concerned at selling at, if you will, a lower point in the cycle. So therefore, they may request our stock as a way to be able to play the upcycle. So I think in that case, we would be sensitive to it. But cash is definitely our preference.

Let me just add to that. I think the bottom line to the whole thing is it depends on the deal. It depends on how much we want it. It depends on what the seller is looking for and so forth. And we would consider giving stock under the right circumstances. As Eric says, we always prefer cash. And the reason we prefer cash is because when we make accretive acquisitions, the value of the whole company goes up. So whatever stock we give really is we've given out too much stock because the stock price goes up. So it's better for all existing shareholders for us to use cash. But if there is a real juicy, desirable acquisition, we're going to make that acquisition, and we're going to do it in the best way we can. So we definitely would consider cash, stock, or a combination.

Thank you, and happy holidays, guys. Thank you. Thanks, Scott.

Your next question comes from Josh Sullivan with Benchmark. He's going to ask your question.

Hey, good morning. Good morning, Josh. Just on the other robust product development programs you highlighted there in the opening remarks, can you just give us some color on the current pace of development? I know you outlined some R&D figures there, but have you increased the pace of PMA submissions? Do you think aircraft-type retirements makes you think differently about your PMA portfolio at this point?

Hi, I would say that we maintained, this is Eric, we maintained our pace of PMA. We could have increased it. I think one of the things which is, and while we've got plenty of opportunity, one of the things that we also have to be a little sensitive to is a lot of people, including ourselves, took pay reductions this year. Some people were furloughed. There were some layoffs. And we wanted to be sensitive to make sure that, if you will, the pain was, you know, the sacrifice was throughout the company. So while we could have increased new product development, you know, we kept it consistent, thinking that that was really the right thing in order to show that everybody in the company was in this together. Having said that, I'm very proud that we've come out with you know, the similar number of PMAs that we've done. I can tell you that we're very aggressively developing new product. Our subsidiaries really have a very good grasp on the products that they're going after, and we continue to grow into adjacent white spaces. Our airline customers and defense customers are very confident about the use of these products, so I'm, you know, it gives me great optimism for the future, especially when talking to our sales executives and going through the details with them and seeing why they, too, are very optimistic.

Got it. And then just, you know, as you look for that eventual rebound in commercial in the second half that you're expecting, you know, outside of just the traffic recovery, you know, what kind of activity or class of products would you expect to see from the airlines picking up in the first half that would really give you confidence that the second half is going to work out as you're thinking it's going to?

Well, I think the first half is going to sort of be a continuation of what we've seen, you know, frankly, since May, where we've been coming out of the bottom. You know, it sort of comes out and fits and starts at You know, it moves ahead, then it sort of settles in, then it moves ahead, and then it settles in. And I really would anticipate more of that type of progress, I would say, probably through, you know, or until perhaps the beginning or through our second quarter. Then what we've seen is, you know, when you talk to the airlines, they're operating the equipment in excess of what, you know, the spare parts that they are purchasing, right? Early in the crisis, there was a destocking phenomenon. I don't really see that anymore. I think the airlines are now very much living hand to mouth. And I think that destocking has occurred already. So in terms of products going forward, I think it's going to be our standard mix of products. I think airlines will continue to try to defer expensive maintenance as much as possible. However, not in a way that would impact their, you know, the return to service of the equipment. So, I would say, in general, heavy maintenance and engine visits will be, if you will, the last to recover. And then, you know, with everything improving along the way, sort of linear with of flight demand. You know, some of the line maintenance stuff needs to be replaced, even if they're not flying that much, then the components. But again, the expensive stuff we expect would be definitely stacked to the later part of the recovery.

Got it. Appreciate the time. Thank you. Thank you.

Your next question comes from Greg Conrad with Jefferies. He went to ask a question.

Good morning. Just to follow up on, you know, one of your last points, I mean, you mentioned declines across product lines. I mean, any noticeable difference in the quarter between aftermarket replacement and repair and overall in what you're seeing in terms of recovery given the sequential improvement in the quarter?

No, I would say it's similar. Oh, good morning, Greg. This is Eric, I should say. I would say that it is similar. between the replacement parts and the repair. You know, it's all in the same ballpark. One could be ahead or behind in a particular month or quarter, but it's all in a similar zip code, I would say.

And then maybe just one on ETG. Can you maybe talk about the bridge for ETG margins, given some of the fiscal year 20 drivers around lower performance-based compensation? and net sales growth, which was somewhat offset by, you know, the gross margin pressures, which seemed to reverse in Q4. How are you thinking about the trajectory there, just given some of those moving pieces outside of volume?

Great. Greg, this is Victor. I'm not sure I'm following the question. The trajectory for margins or

Yeah, you had a really strong Q4 where some of the gross margin pressures seemed to reverse, and you did over 31% margins, which were impressive. I mean, how do you think about mix and maybe lower performance-based compensation expense as kind of headwinds, tailwinds to fiscal year 21?

Yeah, I mean, I don't think of it very much in terms of performance-based compensation so much as the mix. and the businesses doing well first on their own independently and good margin performance at the operating level, the individual businesses. And if you look in the mix, as we had told you earlier in the year, we expected that our space revenues, commercial space revenues, would be healthy, which they were. Would it be strong, which they were. That's a decent margin. Some of those operations are good margin operations for us. So I wouldn't say this was a surprise to us. And keep in mind, Greg, that our margins, and we guide to this frequently in the ETG, our margins fluctuate over the course of the year. That is a typical year for us. This is nothing unusual for us. And I would anticipate that's The past is prelude, and we don't really do anything to try to manage the margins or manage the earnings into a particular quarter or period. We really manage to maximize profitability. So this is a reflection of that.

Thank you.

You're welcome.

Your next question comes from Gautam Khanna with Cohen. You may ask your question.

Hey, good morning, guys. Happy holidays. Good morning. Hey, I just wanted to ask a couple questions. First, on ETG, I was curious. I think it was last quarter where you guys cited some order delays, some shipment delays, some lumpiness, if you will, that kind of dampened down the Q3 number. Has that all been caught up now? As of Q4, are you still seeing kind of a backlog build in that business?

Yeah, I mean, disruptions, this is Victor, by the way. Good morning. Look, that is continuing, that kind of thing. And it just, it's sort of, I would say it ebbs and flows a little bit. I would expect that with the pandemics numbers, the COVID cases numbers rising, we may see more of that in the few months ahead. I don't know. But it comes through, you know, it's in supply chain. It can be on the customer side where the customer doesn't show up to do an acceptance and test procedure or their transportation doesn't show up and can be a week or two late. It's nothing that fundamentally shifts the business and it eventually catches up. And it seems to come and go with this pandemic. I think it was better through much of the fourth quarter. started to reappear again as the pandemic numbers began to increase later in October. And I would expect that to be the case until this thing gets under control. And so I'm optimistic that as it gets more under control with the vaccine, we'll see less of it.

Okay. And a follow-up, Victor, on that. You know, Lockheed and Some of the defense primes have largely guided for next year. And I just wanted to understand again, in years past you've talked about kind of the relationship between ETG's sales growth and that of the defense large cap primes. Could you update us on sort of what that relationship is in terms of the lag? Because they're guiding low to mid single digits, basically. I'm just wondering, when does ETG start to see that glide path you know, in that ballpark?

And it's a good question. Of course, keeping in mind that defense is about usually around half of the ETGs business that can fluctuate up and down a bit, but it's somewhere in that ballpark. And then you've got the other markets that we serve, which are, of course, significant, which is a little different than the large defense primes, which are much more heavily defense, although you do see some commercial space in the defense primes as well in their numbers. So I think it's difficult to find a one-to-one correlation between the defense primes and RETG businesses. And really what we do is we look down and we drill down into the individual businesses we have and, in turn, the individual programs that they're on and the products that they're on. And to be honest with you, we don't always know. As you're aware, the products we make respond to a specification to a customer need, a specific customer need, as opposed to their design or blueprint, let's say. So they'll tell us, as an example, they need something that does a very specific function and performs in very specific ways. area and will produce that. And they may not tell us what is going on. Very often we figure it out. We usually can figure it out, but they may not share with us exactly what is going on. So that's why there's not a one-to-one correlation to it. As a rule of thumb, as we've said before, we don't think defense budgets grow to the sky and that at some point we see defense as a rule of thumb. flatter than it was over the past, let's say, four years or so. We'll just have to see how that all plays out.

Okay. And may I ask Eric just a couple questions? First, I was curious, there's been this argument floated that less ores may become a bigger part of the market, just given the airline financial challenges. And I wondered, has there been any change afoot in terms of lessors' willingness to utilize PMA parts? Do they today, and are you seeing any change in behavior where they're more open to utilizing more PMA?

That's a very good question. The answer is yes. We are making progress on lessors using Heiko parts. We're very careful that when we go out, we don't promote PMA parts. We promote Heiko parts to the lessors, given Heiko's market cap and technical capabilities, technical history, product success. So we're very careful to promote HICO in that way. And we've had a number of very good successes. Number one, if airlines negotiate in and request the right to be able to use HICO parts or PMA parts, DER parts, up front in the lease, very often they're able to get that concession because The airlines know that the vast majority of airlines out there operate using these parts. So there really is not a reduced marketability on the product, number one. Number two, there are a number of lessors that are coming out and offering really like power by the hour, thrust by the hour, aircraft by the hour, where they take responsibility for the overhaul and maintenance. of the particular product. And those lessors are using our parts very aggressively. So we see, you know, so the answer is yes, we've seen progress. However, there is a lot of opportunity out there because there's been a fair number of leases that have been signed in the past whereby airlines, or some airlines were, if you will, fooled into giving away that right, and now certain lessors want to try to extract value in order to, you know, in order to, frankly, make more money. So the airlines need to be very vigilant and request this up front, and then they're able to get that concession.

Okay. And maybe just given the commentary around, you know, the amended credit agreement and Some of the questions on M&A, I am curious if you think there's actually some opportunity for more transformational acquisitions. I mean, in other words, different profile than what you've done over the past couple of years where it's more tuck-ins that were plug and play. Do you see any big swing opportunities, you know, multi-billion dollar assets that are available for sale and that you'd actually care to I'm just curious, does this shake out with COVID and everything else, shake loose some attractive assets that you could utilize your valuation to pounce upon? It's more likely now.

We spend a fair amount of time studying the market, and we're aware of our peers. And I think if an opportunity ever presented itself, you know, we would certainly act on it. I think that we've got a very differentiated model where we treat our people extraordinarily well. And I think for a seller, you know, whether it's a larger public company or a private company, I think that is a point of value and something which differentiates us. So, yes, we could use, you know, our balance sheet to go ahead and do that. And I can tell you that we're always out looking and reviewing, you know, the market out there for these kind of opportunities.

Okay. I apologize for asking. Go ahead.

Sorry. Let me add one thing. We have a few hundred people on the line right now. So let me give everybody on the line an open invitation. If they have a wonderful acquisition for us to make, if they want cash, if they want stock, whatever the notes, whatever you want, if you've got a great company and you want a wonderful home, give us a call and we're going to talk to you. So, you know, we'll use whatever medium of exchange. is necessary to make a great acquisition.

And that's regardless of size.

Right. It can be. In the past, we've looked at some very large transactions, and we've been priced out of the market. Some of them were good. Some of them were, you know, not so good. But we don't pay 14 to 12 times EBITDA. It's just, you know, that's not in our strategy. So, you know, and in spite of it, We've been able to grow compounded at the bottom line at 19% of stock price, 24%. So we have a model which is somewhat unique, and I think Eric described it very aptly. We really believe in the culture of HICO. What the analysts can't relate in their reports is the quality of the management. I must say, and I'm not talking about myself or even Eric or Victor, but the people who are team members of Heiko, in my opinion, are truly extraordinary individuals. They're entrepreneurial. They're smart. They watch every dollar. They work 24-7. And this is an asset that doesn't appear on the balance sheet. And I think the great strength of Heiko lies in its ability very, very capable array of team members. And again, if any of them are on the phone, I want to thank them personally. But I do want the investing public to understand that this is a great, great asset that doesn't appear in a 10K or Q or analyst reports. But to me, it's the culture that drives the bottom line and the success of Heiko.

I appreciate that answer. One last one for me. and I apologize for taking so much time, is, Eric, have you seen any competitive changes in the industry, you know, just given that there is more interest in the Heiko part portfolio? What are the OEMs doing to push back against that and that potential share loss, if anything?

You know, the OEMs, our competitors are doing what they've always done. And we have to fight very hard for each piece of business that we have. I would say nothing really has changed in the playbook. Hyco has become a very well-respected, distinguished competitor out there. And I think we're continuing to gain share and we're doing very well. So there's really no change in that regard. Having said that, our strategy within the parts business is to take a minority market share. We only go for a 30% market share. As long as we're able to pick up that market share at terms which make sense for our customers as well as for ourselves, we cap that market share around that level because we want to make sure that our competitors also have a very good, you know, business strategy for their market share. So, you know, I think that our competitors have got very good, you know, our OEM competitors have very good business plans. I think they're going to continue to do very well. And I think there's plenty of opportunity for Heiko in there as well.

Thank you very much, guys.

Thank you.

Here's the next question. This is from Ken Herbert with Canaccord. Can you ask your question?

Hi, good morning and happy holidays, everybody.

Good morning, Ken. Happy holiday to you.

Thank you. First, Eric, if I could, I just wanted to see if we could unpack the comments that I think both you and Larry have made around expectations to be able to sort of take share coming out of this. I'm just curious if you can provide any specifics on what you're seeing today, either in terms of maybe RFPs or quote activity or maybe, you know, issues with availability of OEM parts or other things that give you increased confidence just beyond the environment that should obviously favor, you know, favor price and other aspects coming out of this. But is there anything more specific you would point to around the share gain confidence?

I would say it's really, Ken, the same things that you pointed out. It's price. It's having a competitor. It's having somebody else, you know, large and respected out in the field. And that's really, I think, what's driving it. You know, the airlines entered this, you know, recession or this crisis very strong. And then, of course, as time has gone on, you know, their business models have really been challenged. And when I speak with our sales folks, They explained to me that, frankly, fear, uncertainty, and doubt, what our OEM competitors try to push as reasons why not to buy our product, really doesn't hold up. They believe that we're going to be able to develop additional products because that's what the customers are asking for. They want us to go into these other products. They want us to broaden our product line. and they're willing to buy it. So as a result, we go ahead and continue to develop it. It's not only in the parts area, but it's also in the repair area as well. So I think it will continue to be a very competitive market, but that's what really gives me the confidence that we're going to do quite well.

Okay, and as we think about the organic opportunities from an investment standpoint in FSG, it sounds like across the organization you've obviously got the ability to step up investments. Are there any particular areas, Eric, you'd identify where you're seeing maybe greater spending? And when I say areas, either expanding your distribution capabilities, expanding maybe the repair capabilities or the PMA portfolio areas, Are there areas that are maybe getting a little more investment from you or you're looking at as perhaps a little more attractive coming out of this?

No, I would say it's all of our areas are where we're continuing to invest. I mean, you hit on all of them, PMA, repair and distribution. We see very good opportunities in all of those. I think that we provide a unique balance in all of those businesses. You know, there's obviously the nexus and how they connect across the top, which nobody else can bring. And then in addition, you know, we operate them as small businesses where we're very knowledgeable about the details, and that really helps our customers as well as, you know, our manufacturers, our principals. And then we've got the balance sheet of a larger organization, so we're able to compete like a larger company would. So I think we're in a very unique space.

That's great. And if I could, just one final one for Victor. It sounds like space, you continue to be pretty optimistic on your space market. Is it possible for you to sort of break out the government versus commercial space as their sort of relative contribution within the segment, and maybe just provide a little bit more color on what you're seeing on the commercial side in terms of opportunities or how you expect this to grow in 21 for you.

Sure, Ken. And by the way, I don't want to overstate space. It's been good for us this year. I think it's looking promising going into next year, but I don't want to overstate it to lead you to believe that it's You know, it's going to be stratospheric, no pun intended. But, you know, it is moving in the right direction for us, and we have some good opportunities, and we are pursuing them. And when I refer to space, by the way, we're referring to commercial space, in fact. And defense space is encompassed within the defense number that we report, so we don't actually break it out separately. And that's why you hear us refer to that. And I would expect that the opportunities for us in the space markets are more in what I would consider some of the larger satellite markets or satellite opportunities, some of the constellations, actually, but some of the larger constellations and less in the very new space, very, very small sat market. I don't think that's going to be the big market for us. But there certainly is an increased interest in both satellite opportunities as well as Earth observation and space exploration that's benefited us, and I think it will continue to benefit us. That doesn't mean, by the way, that we won't have periods where space, you know, we won't have quarters where space is lower for us. It is still a somewhat volatile realm, but overall, we like it and think it's moving in the right direction.

Great. Thank you very much, and congratulations on the strong year of the cash generation.

Thank you.

Thank you very much.

Your next question comes from Michael Fermoli with Truist. He's going to ask your question.

Hey, good morning, guys. Thanks for taking the question, and happy holidays. Good morning. Victor, maybe just to stay on ETG, what was the organic growth? I know it was negative in the quarter. Do you actually have the organic growth number? And I know you're not going to give much detail on 21, but do you think ETG can grow organically in 21?

Let me take it in reverse order there. I think we can have organic growth in 21, but It's early in the year. There are a lot of things that will dictate what happens there, which is why we didn't issue guidance on the year. But our companies are certainly working toward that, and I have optimism that we can accomplish that at this point. But I want to let the year get further in. But right now, I would be surprised if we don't get organic growth in fiscal 21. But let's see how the year wears on and what happens. And in terms of 20, Carlos?

Yeah, that'd be great. How you doing, Michael? For the year, organic growth in the ETG was roughly flat. I said down a percent. And that was principally driven by aerospace. Remember that roughly 10% or so of the segment is commercial airspace and it's going to follow the same trends as our FSG segment. So that was down. Other businesses did about what we expect them to do this year, absent logistical challenges of COVID and some of the disruptions that Victor mentioned earlier. So I share Victor's optimism for next year. I think that the businesses can grow. I think that the commercial aerospace portion of ETG will mimic the recovery pattern in the FSG, and that will be a bit of an anchor probably in the early part of the year and then pick up towards the end of 21.

And let me add, I mean, I can say that internally our businesses are budgeting for organic growth, but you know us. We're always, me in particular, very cautious, very conservative, and I don't You know, we like to over-deliver, to be honest with you, outperform. And so, you know, I'd rather comment further on that as we get a little deeper into the year. But that's certainly what we're planning for internally.

Got it. Got it. And then I don't know if this is Carlos or Eric. On the FSG margin, I guess, taking out that bad debt expense, 11% or so last quarter, looks like close to 12% this quarter. I know the first quarter is usually seasonally weaker, but should we expect kind of this continued margin progression as the market recovers? And if you do get that second half 21 strength, I mean, can we expect you guys to get into the teams? I don't expect you to get all the way back up to the upper teams 20% or maybe a total recovery, but is that the right way to think about the margin progression for FSG?

I think, Michael, this is Carlos. I think you're on the right path. So as Eric mentioned earlier, we are thinking about next year in terms of a bit of a continuation of what we saw in Q4 into the early part of 21 with a gradual progression upwards towards the back end of 21. And I think during that back end period, you'll see our margins improve. And I think in the early part of the year, you should see them slightly improve. So could we get to the low teens? Yes. I mean, I think that's definitely in the cards for us. And obviously, we hope to do better. When we have more visibility, Michael, on next year, I'm hopeful we can restore guidance at some point, but when we do at that point, I'll give you all the details you need. But for right now, what I've told you is about all I can prepare to talk about at the moment.

And, Mike, this is Eric. Just also to add some color, picking up on what I answered in one of the questions earlier, we could have generated higher operating margins. but we felt it was really important to take care of our people. And I think a lot of other companies are very sort of aggressive with their people. Other people say, other companies say their people are the most important, but then they don't act that way. And we really tried to act that way. And as a result, the margins had taken a hit. And we have been fully prepared you know, recognizing that we've got to invest in our people. Now, that's not to say that our team members haven't, you know, shared in the sacrifice because they have tremendously. But we've done everything we possibly could to, you know, hang on to them and to have them sacrifice less than other organizations. And we think that HICO will be rewarded, you know, with their loyalty and dedication coming out of the crisis. So, we're very cognizant of the margins and why we think that we can get them to increase moving forward.

Got it. Helpful. And then just one last one on performance comp into next year. Is that, I mean, any color around, should we think of that as being a slight headwind just given what took place in 20 or kind of a net neutral to margins? Or just how do we think about the mechanics there?

You know, I'll let Carlos explain on the specifics. But in general, incentive comp is based on performance. So first, the performance has to be there. Then the incentive comp will kick in. But Carlos can then explain the details.

Well, hell, I couldn't have said it any better, Eric. I mean, I think as the operations improve and our profitability goes up, there will be incentive comp that's commensurate with that growth. But I don't expect it to be at 19 levels next year. But I do, hopefully, knock on wood, as things progress into 21 and our profits increase, I would expect our performance-based comp to increase also. But, you know, if you're modeling and thinking about it on the numbers side, whatever your estimates are for growth and profitability, we're going to have some growth in our performance comp that's commensurate with that move.

Got it. All right. Very good. Thanks, guys. Thanks, Mike. Thank you.

Your next question comes from Noah Poponik with Goldman Sachs. He's going to ask their questions.

Hey, good morning, everyone. Good morning, Noah. Hey, just staying on that FSG margin, actually. The sequential incremental, so just the drop through of the EBIT on the higher revenue sequentially, using the adjusted number, is 22%. And you've talked about the 30% decremental and then a higher than 30% incremental on the way back up, recognizing everything you just said on the different cost components. But you've taken out some cost, and you'll have costs coming back, like you just said, when you have good incrementals. Should I care about that number at all, or is it just kind of irrelevant because it's one quarter and everything is still sort of funky?

No, I would say this, Carlos. I would say that in the quarter, we had some headwinds in Q3 and Q4 relative on the margin side to inventory reserves, which I don't think will repeat itself going forward. So that had a bit of a drag on our incrementals. So I think you've probably captured it correctly. I wouldn't focus so much on just one quarter. But I do think the incrementals will be better on a go-forward basis than our decrementals have been going down.

That's the inventory obsolescence expense that's in the gross margin separate from the bad debt expense that's in the segment margin?

That's correct.

Can you quantify how much that's been in excess of normal the last two quarters?

Yeah, I think in the last couple quarters we've probably had evenly between the two quarters about $14 million worth of incremental increases in our inventory reserves. And most of that, Noah, has been a result of us recognizing that many airlines over the last six months have come out publicly and discussed some of their fleet reduction plans and retirement of certain types of planes. And so what we did, rather than try and fool ourselves and keep that product at full value on the shelves, we took a very conservative approach. and said if the airline is going to put down, let's say, an A300, then we probably need to reserve for some of that inventory we might have sitting around to support that portion of the fleet. So we did take those charges, and before I flood, we've got that kind of out of our way now. And that would be one aspect, if you will, of the margin that I don't anticipate repeating going forward.

Sorry, that's $14 million in both 3Q and 4Q individually above and beyond.

Seven and a quarter.

Seven and a quarter.

Fourteen total in the back half of the year.

Okay. I mean, even seven and a quarter would take, you know, if I adjusted for the bad debt, then I adjusted for that. It would put your margins more in the mid-teens in the back half of 20 already. Right. And then should I be working in back half of 21 a better than 30% incremental off of that?

At this point, no, I don't know that I would go that high. As we get into 21, I'm happy to help you with that math, but I don't know that I would guide you to that right now.

Okay. Last quarter you said incremental is better than 30. Was that correct?

Last quarter I said our incrementals should rise faster than our decrements.

Right.

It went down, but I don't think I gave any numbers. Okay. Because incrementals are dependent on mix, which part of each segment grows faster. So, you know, it's not like Hypo has one product and it's very easy to just do the math. We've got such a diverse product base. Sure. It does make it a little more difficult to pinpoint incrementals. you know, without guidance out there where that, you know, what those incrementals are going to look like.

I appreciate that. I guess I'm just trying to get at whatever the incrementals are going to be or whatever you sort of think of the incrementals as being in a framework, right? It's a company with a 30% incremental. It's going to vary quarter to quarter. That calculation can get wonky. Was that a statement working off of the lower margins knowing that the lower margins had the inventory obsolescence? Or was that a statement last quarter that's just sort of the broad, long-term framework of the company's incremental-decremental?

It's a broader, long-term framework. I don't think we were looking at any specific quarterly adjustments in making that statement. I do think it's more of a broader, long-term view.

Got it. Okay. The company has always maintained, as you've alluded to, a reasonably conservative balance sheet, a degree of leverage relative to the consistency of the margins and cash flows. You've just been handed what will be hard to, knock on wood, hard to ever repeat in terms of severity of downturn, yet you didn't have a negative cash flow quarter. Does that have you rethinking the optimal balance sheet leverage going forward to continue to do deals and enhance the equity returns?

This is Larry. What we do is we model in a controlled growth pattern, and that's our strategy. So we have said publicly that we aim for a bottom-line growth of 15 to 20 percent annually. And that's accurate. We think in the relative near future, we can continue that growth. I mean, historically, over 31 years, we've done 19 percent. So, in order to accomplish that growth, the controlled growth, we can do it very well using the debt strategy that we have implemented. There is no need for us to go out and do anything greater. Now, saying that, people have asked, would you do a transformational transaction, a major acquisition or something else? And the answer is yes, if it is really going to benefit the bottom line. Too often, we see and we're approached by investment bankers with ideas that we can make HICO bigger. We can double HICO or increase it 60%. But they're talking about the top line. And we're focused on increasing the bottom line in cash flow. And so if the opportunity presented itself to increase the bottom line, we would do that, and we would probably take on more debt. The key to taking on the debt is how quickly it would be repaid Because we don't want to be up at six or seven times like some other companies. We don't feel comfortable there. Nor do we need to do that to grow at the 15% to 20% target. And I think speaking to shareholders, which we do a lot, as you know, they like the idea of the steady growth. And we do, too. And we're the largest shareholders. So it's a strong, steady growth. when the market collapsed in March, the banks weren't calling on us. We didn't sell debt at 8%, 10%. And we slept well every night. So I don't know if that answers your question. It does. Yeah. So that's really the way we look at it. I guess you could say it's conservative. And in the past, we've been criticized by some

people who said oh why don't you put on more debt and you can do all this stuff and it's just that is hypo strategy and that's what we're known for so got it yeah that's really the question is any rethinking of that so that helps me and then last one related to that controlled growth is the pace of new product intro which if I understand correctly you know in given periods of time could be faster but There's a controlled growth element. How will you think through that, Larry or Eric, if there's an opportunity to take market share because the industry has situation presents it, but you normally have that controlled growth? How above and beyond will you go with pace of new product intro 2021, 2022 with those sort of competing interests?

I think what we will do, we will reach for the sky as long as it will benefit the cash flow and the bottom line, and that we see it's going to be strong, real growth. You know, we're not into financial engineering, and you can see in the last quarter we had 177% of reported income was cash. So that's our whole problem. game, if you will. It's the cash flow. It's the bottom line. And anything we can do, Noah, to accomplish that, we are going to do it for sure.

And having said that, I agree completely. I think that our current level of new product development is a good level. It's a level at which we Make sure that we've got, you know, a lot of customers and they're excited about the different products that we're coming out with. So I really expect that we will continue to stay the course. Now, if we see, you know, a significant change in the approval rate at our customers, then we could revisit it. But I would say right now, we're very comfortable with what we've got going right now. It was also very encouraging to find out that a lot of our customers were working on approving the use of our parts from their homes. And they were continuing to focus in this area because it continues to be a major cost driver for the airlines. I mean, the airlines know very clearly that if Heiko doesn't exist, their prices go way up. And so we're a significant part of their strategy. Okay. Excellent. Thanks so much. Thanks, Noah. Thank you, Noah.

Your next question comes from Colin Deshawn with Sterling Capital. You know, ask your question.

Hi, good morning. Thanks for the opportunity to ask a question. First question really in the theme of just visibility, maybe best for Victor and then for Carlos. Victor, you've given us some good comments on where you're seeing opportunity, particularly outside of the commercial aero realm within ETG. I'm just trying to kind of roll up some of the detail that you offered. If you could help us just characterize, you know, within ETG, apart from commercial, from the, you know, portion of that segment that does have commercial aero leverage. Can you characterize the visibility you today see and compare it perhaps where that visibility for that portion of the business was pre-pandemic? I'm just trying to kind of understand, you know, your confidence there. And then linking that to the overall business, maybe best for Carlos would be, you know, still with suspended guidance, can you help us think through what framework or preconditions you need to see before you get incremental confidence to reestablish that guidance? And then I had a follow-up for Larry next.

So Colin, hi, this is Victor. It's a good question. It's an interesting mix of what's going on now. Visibility is certainly less than it was pre-pandemic. And what we're seeing, though, and what we've found in the businesses that are serving the high-end electronics market, things that I would consider more connected to the general economy, the broader economy, that of late, there has been, over the past few months, a a marked increase in demands, a marked increase in orders, a marked increase in inquiries, quoting activity, and things of that sort. And the level of activity is markedly better than it was earlier in the year. And so that leads me to be generally optimistic. It seems that people are asking to pull in orders. They're asking for faster deliveries. They're more concerned with that than they were in the very early days of the pandemic. We had an interesting phenomenon where customers were actually looking to accelerate orders because they were worried about the supply chain and things getting delayed. There were stories, of course, of a product not making it from the Far East, particularly China. where the virus originated. And so they were worried about that. And so there was an acceleration. And then all of a sudden that stopped and it flipped around and it was going the other way for a while. And now that's reverted. And so that seems to be very positive. And the visibility question is, well, how does that hold up? How long does that hold up? How does that work? Where does it stabilize? And so on. One of the key things I think about is we're about to, within a few months, we'll anniversary out of the start of the pandemic. So everything will feel much more positive and be much more positive as a result of that. By the way, on commercial aviation, the 10% or so of ETG that is usually commercial aviation, you know, that's been improving as well. We've seen some nice signs of improvement there in the future order outlook. I think as the year wears on, that will do better. Also on the medical side, I think that offers us some upside potential because things had slowed down there. If you recall, there were fewer medical procedures and people just not going to the doctor, et cetera, during the pandemic, I think that will start to switch around. So that impacted some of our businesses and the components that we sell. The question is one of timing, so that's why I say it's less visibility as a rule of thumb. So generally speaking, I believe it turns in the right way, and it is turning in the right way. The question is when and exactly how, keeping in mind we're already halfway through, a little more actually, halfway through, then halfway through our first fiscal quarter. So our year is a little bit different than most people's year, and as that starts to filter through, it becomes a question of does that push through in the third quarter, does it push through in the fourth, or does it wind up being at the end of 2020, but our fiscal, excuse me, at the end of 2021, but our fiscal 22, and we'll just have to see how that falls out. Is that helpful?

Thank you.

You're welcome.

Colin, I would just add that once we see the cadence of orders from the airlines being a little bit more stable, if you would, and the flights and the number of aircraft in the air are a little more predictable and more flying, that would probably give us the confidence as an organization to reinstate our guidance and think a little bit more broadly about doing that. But right now, there is so much – each of our customers are acting so differently as far as how they spend or maintain their fleet that it's just not in our best interest to try and outthink them at this moment. But I do anticipate during fiscal 21 that that – That fog, if you would, will lift. I do believe we'll have a little better visibility as the year progresses. And at that point, we'll discuss. And as a management team, we're in state and guidance. And if we can, we will do so.

Okay, understood. I appreciate that. And then just a couple of follow-ups. Quick one for Eric and then maybe a longer, more thoughtful one for Larry. Eric, I heard you say earlier within FSG PMA, you, I think, characterize competitive conditions as having not changed significantly. Just wanted to link that back to that regulatory announcement. I guess it was now a little over a year ago with CFM and potentially loosening some soil for you guys to plant some seeds there within PMA. I know we've had a pandemic since that announcement that has kind of upended that end market, but just wanted to verify whether you've seen any tangible evidence of any competitive movement, whether it's tangible or anecdotal there. That would be great. And then for Larry, from an M&A standpoint and potential currency used for deals, there's been some conversation on this call of potential for transformational deals, much larger in quantum than what you've done in the past. I remember, I guess it was 20 some odd years ago where we created the A shares and that was in anticipation of, at the time, what could have been a transformational deal. So there is some history with the willingness to pay stock, but I just wanted to ask you, has the currency been a sticking point to get folks kind of over the hump? I've always thought that that 80-20 equity share ownership with the put calls that you typically have kind of takes care of that participation and upside for sellers. And so is that structure, has that been a sticking point? And then relatedly, if you were to consider a use of stock for a more transformational deal, do the criteria, the financial and accretion criteria, change at all? I.e., do you pull your horns in and perhaps become a little more conservative because you're using stock for a larger purchase? Because since you've been such good stewards of the stock over the longer haul, perhaps you'd have a little more caution when doing thinking of a move like that. Thank you very much.

So that's a great question and the way you structured it really shows your understanding of HICO and you go all the way back to the 1999 and the transaction that we were considering. Most people have forgotten about that and how the A stock came into being, but you have a great long history and a good memory. So to answer your question, we will make any accretive acquisition using any medium of exchange that we can. We'll use wampum. We'll use gold bullion. We'll use stock. We'll use cash. We'll use bonds. We'll use notes. As long as it meets the criteria that we have set forth, which I think I've explained, and that is Cash flow, bottom line. Now, keep in mind the difficulty in which we operate. Most industrial companies, or even aerospace companies, operate at margins which are 50 percent or less than our margin. The trick and the reason we use strong margins is because strong margins generate strong cash flow. It's not rocket science. It's very good. Number two, this management is really compensated because of our stock ownership, just like every shareholder out there. And we are completely aligned with every shareholder. If we selfishly make a good acquisition or we generate cash and it goes to the bottom line, the stock price goes up, Yes, we benefit because we're the largest group of shareholders. However, every shareholder benefits pari possu with what we have. In other companies, many companies, I believe that the motivation is bifurcated. The management generally owns little equity. And therefore, the management wants to grow the company because the top line, even if the operating margins are 8% or 10%, the top line can double. That requires the use of a lot of cash. It sucks up cash. But the management, who is generally there for three to seven years, sees his or her compensation double. If they grow the top line from $2 billion to $5 billion, 5 billion, the compensation, the manager's compensation goes from 3 million to 6 million, whatever the number is. In our case, we own a large number of shares. So if the stock goes up 10 points, and I'll define it for you, it's public. If we own 12 or 14 million, and I don't know the exact number, but if you include the 401k because we're very concerned about the success and the financial stability of our people, our team members, if that goes up 10 points, we make $140 million or $200 million in equity value. Now, do I care if my salary goes up $3 million? Of course not. So to answer your question, we will make transactions that generate cash flow, accretion, and stock value. And however, again, whatever currency we must use, we will do it. I can tell you as an example, we're negotiating, we're talking to somebody now, and they came to us and they said, we only want to sell for stock. And I said, well, normally, you know, we prefer to give cash. We normally give cash. But for you, because we want this acquisition, whatever you want, we'll give you. You want cash, you want stock, whatever you want, we will give you. So I don't – does that kind of answer your question?

It does. I'll have to work wampum into my model, but thank you.

What – We're not sure about Bitcoin. I've got to ask Carlos if we can use Bitcoin.

Like he said, we'll use whatever we have to.

Whatever we have to do, we'll use it.

Hello? Your next question comes from the line of Ruiz Rofeto with UBS. He's going to ask a question.

Hey, good morning, guys. Good morning. I was hoping you mentioned Bitcoin. I was, I was, I was the one missing thing in there, but Wampum's interesting as well. Um, Victor, I just want to go back to you. Just make sure I have this for, for the fourth quarter. What was the organic growth for ETG? Was it, was it flat down a little up a little, and then, you know, either you or Carlos, can you help us baseline what the acquired sales will look like, you know, based on deals so far into 21?

It was, uh, uh, Louis, it was flat. Uh, ETG, this is Victor, it was flat organic growth in the fourth quarter.

That's correct. That's correct. Lewis, roughly in the fourth quarter, we probably had an ETG around $16 million worth of acquired sales in the numbers. Okay. So, you know, that will, we have no reason to think that that won't continue going forward. And most of the acquisitions, you know, occurred in August in Q4. So we got the benefit of most of that in the quarter. So that's probably a decent run right now, I guess.

Okay. That's perfect. And Eric, just one for you, one to follow up. I know you've mentioned before that between parts and MRO is kind of same ballpark, but if I go back to last quarter, it was kind of, you know, down 40 in parts, down 60 in MRO. So, you know, business down 40%. So are we looking for, was there a kind of an improvement in MRO and parts was flattish or any additional color you can give there?

So let me take a look at some of my numbers here. I mean, it was all really in the same, as I said, the same ballpark there. So I wouldn't say that there was, much of a difference. You know, in any one quarter, one can be, you know, based on the prior comp, one can be ahead, you know, versus the other. You know, if you look at 2019 in the fourth quarter, we had 12% organic growth in plate support and on against the comp in 2018, 13% growth. So it's 25% growth over you know, to annual quarters there. So things can move around, you know, based on this. You know, in general, I would say that the parts and the parts business would be down less than the component repair. The way that that normally works is in component repair, you can end up having some in the pipeline, which has been approved by the customers, so there can be a little bit of a lag there. And as a result, it could lag where the component repair comes back a little after the parts come back because first they have to procure the parts in order to be able to do the component repair. But I would say that it was all, you know, in a similar ballpark. Component repair was down more than parts, but I wouldn't get too wrapped around that because it can vary a little bit, as I said, quarter by quarter.

I know. That's perfect. Thank you.

You're welcome. It's similar to Q3, I would say.

Once again, participants, if you would like to ask a question, please press star, then the number one on your telephone keypad. To ask a question, please press star, then the number one on your telephone keypad. We have a follow-up question from Colleen DeCarm with Sterling Capital. You may now ask your question.

Yeah, sorry for the follow-up, Eric. I did just want to get a color on that comment with the European Regulatory Action a little over a year ago, linking to your comments, FSC, PMA, that competitive conditions haven't changed. Thanks.

Thank you, Colin. I'm glad you asked that because we went on to the next question before we had opportunity. I had opportunity to answer on that. Yes, I would say that we continue to be encouraged based upon the conversations that we've heard. We don't like to speak about particular product lines or customers, but we do believe that there's been good progress in that area. It has sent a very clear message regarding engine, you know, alternative parts for engines, whether it's PMA or DER repair. So, again, I think that there have been, you know, nice conversations and some good, you know, good results coming out of that enforcement action. Thanks. Thank you.

Again, if you would like to ask a question, please press park. Tender number one on your telephone keypad. Presenters, there are no further questions.

If there are no further questions, I want to thank everybody on this call for participating and for their interest in HICO. As you know, we remain available to you by phone. If you have any other further questions or information that you'd like, you can call Carlos, Eric, Victor, myself. We'll be happy to respond. And I want to wish you all a very happy, healthy holiday season. Hopefully, when we next speak, which will be the report of our Q1 sometime in late February, most of you will have received your... COVID vaccine and we'll be on the way to continued good health. So happy holidays to everyone. And again, thank you very much.

Thank you for centers. And thank you ladies and gentlemen for joining fiscal year, 2024 quarter and end of the year earnings results call. You may now disconnect.