Heico Corporation

Welcome to HICO's Fiscal Year 2022 First Quarter Earnings Results Conference Call. My name is Polly and I will be the operator assisting today. Certain statements made during this 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 but not limited to the severity, magnitude, and duration of the pandemic, high cost liquidity and the amount and timing of cash generation, lower commercial air travel caused by the pandemic and its aftermath, airline fleet changes or airline purchasing decisions which could cause lower demand for our goods and services, product specification costs and requirements which could cause an increase to our cost to complete contracts, governmental and regulatory demands, expert policies and restrictions, reductions in defense, space or homeland security, spending by U.S. and or foreign customers, or competition from existing and new competitors which could reduce our sales, our ability to introduce new products, and services at profitable pricing levels, which could reduce our sales or sales growth, product development, or manufacturing difficulties, which could increase our product development and manufacturing costs and delay sales. Our ability to make acquisition and achieve operating synergies from acquired businesses, customer credit risk, interest, foreign and current exchange, and income tax rates. Economic conditions, including the effects of inflation within and outside of the aviation defense space, medical and telecommunications, and electronic industries, which could negatively impact our costs and revenues and defense spending or budget cuts, which could reduce our defense-related revenues. Parties listening to this call are encouraged to review all of HICO's filing with the Securities and Exchange Commissions, including, but not limited to, filing 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. As we begin the call, I turn the call over to Lawrence Mendelson, HICO's Chairman and Chief Executive Officer. You may begin, sir.

Polly, thank you, and good morning to everyone on this call. We thank you for joining us and welcome you to HICO's first quarter fiscal 22 earnings announcement teleconference. I'm Larry Mendelson, Chairman and CEO of Heiko Corporation, and I'm joined here this morning by Eric Mendelson, Heiko's Co-President and President of Heiko's Flight Support Group, Victor Mendelson, Heiko's Co-President and President of Heiko's Electronic Technologies Group, and Carlos Macau, our Executive Vice President and CFO. Before reviewing operating results in detail, I would like to take a moment to thank all of HEICO's talented team members for delivering another strong quarter. Your continued focus on exceeding customer expectations and operational excellence has translated into excellent results for shareholders, and I'm encouraged by the steady improvement in the operating results over the past 18 months. I'm also optimistic that this trend will continue during the remainder of fiscal year, this fiscal year. I will now summarize the highlights of the first quarter fiscal 22 results. Consolidated operating income and net sales in the first quarter of fiscal 22 improved 23% and 17 percent, respectively, as compared to the first quarter of fiscal 21, driven mainly by our 13 percent quarterly consolidated organic net sales growth, as well as the favorable impact from our fiscal 21 acquisitions. The Flight Support Group reported quarterly increases of 103 percent and 37 percent in operating income and net sales, respectively, as compared to the first quarter of fiscal 21. These results principally reflect strong 48 percent quarterly organic growth for commercial aerospace parts and services. Additionally, this marks the sixth consecutive quarter of sequential growth in net sales and operating income at flight support. Our total debt to shareholders' equity improved to 10.1 percent as of January 31-22, and that was down slightly from 10.3 percent as of October 31-21. Our net debt, which we define as total debt less cash and cash equivalents of $112.3 million, at January 31, 22, compared to shareholders' equity ratio improved to 4.8% as of January 31, 22, and that was down slightly from 5.6% as of October 31, 21. Our net debt to EBITDA ratio improved to 0.22 times as of January 31, 22, and that was down slightly again from 0.26 times as of October 31, 21. 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 to accelerate growth and maximize shareholder returns. Cash flow provided by operating activities was $78 million in the first quarter of fiscal 22, and that compared to $107.2 million in the first quarter of fiscal 21. The decrease is principally attributable to an investment $54.8 million in working capital, partially offset by $18 million increase in net income from consolidated operations. The investment in working capital includes $29.6 million increase in inventories, which reflect strategic buys within distribution businesses and to support an increase in the consolidated backlog as well as a decrease in accrued expenses resulting from the payment of fiscal 21 accrued performance-based compensation. A little bit of color. We added to inventory, as you know, to prevent inventory shortages so our companies would not be running out of stock and could complete their manufacturing and processes and ship. We think that that was a very wise decision. In January 22, we paid our regular semiannual cash dividend of nine cents per share. This represented our 87th consecutive semiannual cash dividend since 1979. In January 22, we reported that our Sierra Microwave subsidiary designed and manufactured flight critical components in the James Webb Space Telescope, which is considered to be the premier observatory of the next decade. As always, we thank Sierra Microwave for their outstanding accomplishments, great quality, and we take great pride in their involvement in this amazing feat. Moving over to recent acquisition activity, February 22, we announced Flight Support had entered into an agreement to acquire 74% of the membership interest of Pioneer Industries, LLC, a specialty distributor of spares for military, aviation, marine, and ground platforms. The remaining 26% will continue to be owned by certain members of Pioneer's management team, and closing is expected to occur in the second quarter of fiscal 22. We expect this acquisition to be accretive to earnings within the first 12 months following closing. My own comment, which was not prepared, is that in my own mind, this was a very timely acquisition because of the events taking place in Ukraine and possibly in the future in the Far East. We think our military budget clearly, I read this morning, that Congress is probably going to pass some additional measures military budgets, and I would not be surprised to see that. My comment is that's a good idea. We continue to vet excellent M&A opportunities, which meet our high standards for acquisition. Due diligence is ongoing on many of these opportunities, and I'm optimistic that we will be successful in closing additional transactions in fiscal 22, all of which I believe will be accretive to earnings. At this time, I'd like to introduce Eric Mendelsohn, co-president of HICO and president of HICO's Flight Support Group, and he will discuss the results of the Flight Support Group.

Eric Mendelsohn, Co-President, HICO Thank you. The flight support group's net sales increased 37% to $272.7 million in the first quarter of fiscal 22, up from $199.3 million in the first quarter of fiscal 21. The net sales increase reflects strong organic growth of 30%, as well as the impact from our profitable fiscal 21 acquisitions. The organic growth mainly reflects increased demand for the majority of our commercial aerospace products and services, resulting from continued recovery in global commercial air travel as compared to the first quarter of fiscal 21. The Flight Support Group's operating income increased 103% to $52.4 million in the first quarter of fiscal 22, up from $25.8 million in the first quarter of fiscal 21. The operating income increase principally reflects an improved gross profit margin, mainly from the previously mentioned net sales increase, which was across all of our product lines. Additionally, the operating income increase reflects the previously mentioned net sales growth and the benefit of SG&A efficiencies realized from higher net sales volume. The flight support group's operating margin increased to 19.2% in the first quarter of fiscal 22, up from 13% in the first quarter of fiscal 21. The operating margin increase principally reflects the previously mentioned improved gross profit margin, as well as a decrease in SG&A expenses as a percentage of sales as a percentage of net sales, mainly reflecting the previously mentioned efficiencies. 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.

Thank you, Eric. The Electronic Technologies Group's net sales were $222.3 million in the first quarter of fiscal 22, which was comparable to the $223.6 million in the first quarter of fiscal 21. The Electronic Technologies Group experienced continued growth in medical and other electronics products net sales, as well as from the impact from our fiscal 21 acquisitions, offset by a slight decrease in defense and space product net sales in the first quarter of fiscal 22. As has historically been the case, Electronic technologies group sales tend to be lumpy by quarter, and we expect that this year's three remaining quarters sales will each be greater than the first quarter sales, which were reduced as a result of many team members being out from work as the Omicron variant surged. We witnessed the same issue at both vendors and customers, particularly in January, which delayed production, deliveries, and orders at various subsidiaries. We expect these effects to be cured during the remainder of our year. The Electronic Technologies Group's operating income was $55.6 million in the first quarter of fiscal 22, as compared to $60.1 million in the first quarter of fiscal 21. The decrease principally reflects a lower gross profit margin, mainly from an increase in new product research and development expenses, as a percentage of net sales to support ongoing new product and development activities, as well as lower level of efficiencies on SG&A expenses during the quarter. The Electronic Technologies Group's operating margin was 25% in the first quarter of fiscal 22, as compared to 26.9% in the first quarter of fiscal 21. The lower operating income as a percent of net sales principally reflects an increase in SG&A expenses as a percentage of net sales, mainly from the previously mentioned reduced efficiencies, as well as the previously mentioned lower gross profit margin. I turn the discussion back over to Larry Mendelson.

Consolidated net income per diluted share increased 24 percent to 63 cents in the first quarter of fiscal 22, and that was up from 51 cents in the first quarter of fiscal 21. The increase principally reflects the previously mentioned higher consolidated operating income. Depreciation and amortization expense totaled 23.2 million in the first quarter of fiscal 22, and that was up very slightly from $23 million in the first quarter of fiscal 21. Research and development. Significant ongoing new product development efforts are continuing at both electronic technologies and flight support, and this is critical for the development of new products and technologies that fuel our growth. R&D expense increased to $18.4 million, or 3.8 percent of sales in the first quarter of fiscal 22, and that was up from 16.2 million, or 3.9 percent of sales, net sales in the first quarter of fiscal 21. Consolidated SG&A expenses. were $91.4 million in the first quarter of fiscal 22, as compared to $78.1 million in the first quarter of fiscal 21. And that's in line with our large net sales growth and is inclusive of a $3.8 million higher corporate expense, mainly attributable to increased performance-based compensation expense, as well as the suspension of corporate salary reductions as of the end of the first quarter of fiscal 21. Consolidated SG&A expense as a percentage of net sales was 18.6 percent in the first quarter of fiscal 22, and that compared to 18.7 percent in the first quarter of fiscal 21, a slight drop. Interest expense decreased to 0.8 million in the first quarter of fiscal 22, down from 2.4 million in the first quarter of fiscal 21, and that was due to lower weighted average borrowing balance outstanding under our revolving credit facility. Other income in the first quarter of fiscal 21 and 22 was not significant. ICO's effective tax rate was 4.1% in the first quarter of fiscal 22, and that compared to 2.9% in the first quarter of fiscal 21. The rate increase, slight rate increase, reflects an unfavorable impact from tax-exempt unrealized losses in the cash surrender value of life insurance policies relating to the HICO leadership compensation plan during the first quarter fiscal 22 as compared to tax exempt unrealized gains recognized on such policies in the first quarter fiscal 21. Partially offset by a larger tax benefit from stock option exercised recognized in the first quarter of fiscal 22. My comment on this, when we get into the details and the questions, some people have pointed out that the gain from year to year was a result of tax and so forth. And if you study, dig deep into it, you'll see that the two tax provisions are fairly similar. So we are really comparing apples and apples. So when you say to analyze it, certain people have pointed out that it's all due to tax benefit. And in my opinion, that is definitely not the case. And those people should clarify it with Carlos, who can explain it to them in more detail. ICO recognized a discrete tax benefit from stock option exercises. in both the first quarter of fiscal 22 and 21, and they were $17.8 million and $13.5 million, respectively. And that resulted from strong appreciation and high cost stock price during the optionese holding period. For those of you who are not familiar with the taxation of stock options, again, Carlos can get into the detail but essentially the recipient of the stock option, when he exercises, pays ordinary income tax on the gain, whether he sells the stock or not, and the company takes a tax deduction for the opposite side for the gain. So that's how the company picks up this tax benefit. Net income attributable to non-controlling interest was $7.3 million in the first quarter of fiscal 22. That compared to $5.7 million in the first quarter of fiscal 21, principally reflecting aggregate increase in the operating results of subsidiaries in which non-controlling interests are held. Bottom line, non-controlling interest-owned companies did very well. For the first full fiscal year 22, we continue to estimate a combined effective tax rate and non-controlling interest rate of between 25 and 27 percent of pre-tax income. Moving on to the balance sheet and cash flow, Our financial position and forecasted cash flow remain very strong. Working capital ratio improved to 3.6 times as of January 22, January 31, 22, and that was up from 3.2 times as of October 31, 21. Our accounts receivable, days outstanding, which we call the ESOs, improved to 43 days as of January 31, 22, and that was down from 45 days as of January 31, 21. 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 net sales, and our top five customers represented approximately 22 and 24 percent of consolidated net sales in the first quarter of fiscal 22 and 21. Inventory turnover rate decreased to 154 days for the period ended January 31, 22, and that was down nicely from 164 days for the period ended January 31, 21. I'd like to talk about the outlook as we see it. As we look ahead to the remainder of fiscal 22, we expect global commercial air travel to continue on a path to recovery despite the potential for additional pandemic variants. we remain cautiously optimistic that the ongoing worldwide COVID-19 vaccine rollout, including boosters, will continue to positively influence global commercial air travel and benefit the markets we serve. However, it remains very difficult to predict the pandemic's path and effect, including factors like new variants vaccination rates, potential supply chain disruption, and inflation, which can impact our key markets. Therefore, we feel it would not be responsible to provide fiscal 22 net sales and earnings guidance at this time. However, we believe that our ongoing conservative policies, very strong balance sheet, high degree of liquidity, enable us to continually invest in new research and development, take advantage of periodic strategic inventory purchasing opportunities, and execute on our successful acquisition program all which collectively position HICO for market share gains. In closing, I would like Again, to thank our incredible team members for their continued support and commitment to HICO. The remainder of fiscal 22 looks very promising, and I do believe that our culture of ownership and entrepreneurial excellence will provide the necessary foundation to win in the marketplace. We thank all of our team members for everything you do to make HICO a great company. We also thank our shareholders who have been extremely supportive during these difficult times, and we appreciate your interest and concern with HEICO. And now I would like to open the floor for questions.

As a reminder, in order to ask a question, you will need to press star, then the number one on your telephone keypad. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from the line of Robert Spinningard with Milius Research.

Hi. Good morning, everybody. Good morning. Larry, thank you for all of the color. I have a couple questions here for Victor and for Eric. Victor, I guess I'd start with the R&D, and you talked about the margin pressure there. Is that elevated R&D across all of your product lines, or is there a specific target market? And so where are you concentrating that spend? And is there a seasonality here? Because I see a similar margin here. decline last year in the first quarter, so would you expect margins to rise from here?

Rob, thank you. Good questions. The answer is that, of course, it's not every business and everywhere, but I would say it's fairly broad across our product lines where we're spending, but it varies, of course, by business. There can be a seasonality to it. I don't know, honestly, this year whether there is one but it can be there are times of the year in some of our businesses where they have to do more spending and then it tends to flatten out. Most of our R&D expense is people and that's followed by third-party vendor expenses, things like testing and parts where we have to buy parts and discard them and we do destructive testing and things like that. So I'd have to actually go in and look at case by case. In terms of our margins, I would say that, as you've heard me say in the past, that, by the way, these margins, if you add amortization of about 400 to 500 basis points to it, you get to about 30% on an operating basis. I consider an operating basis obviously a cash flow basis. So those are pretty high margins. And as I've said in the past, I think that we're going to stay in shooting distance of that, whether it's down below that a little or up above that. It's going to vary, I think, by quarter.

Okay. All right. That's very helpful. And then, Eric, I've got one for you, just really on the supply chain. And are you seeing concerns from the airlines about the ability to procure – enough spare parts from the OE component manufacturers that's maybe driving an accelerated interest in your products?

Good morning, Rob. That's a very good question. We made the conscious decision to, you know, if you recall when the pandemic started, to retain a higher percentage of our people and to make sure that we invested in inventory in order to be able to support the market when it recovered. So the short answer is yes. I think that we are picking up some market share due to competitors not being able to supply. But I think the majority of the market share, though, that we're picking up is because customers are approving parts that they hadn't purchased before from us. And in meeting with our sales heads last week in reviewing, going customer by customer and understanding what the situation is and what the customers are looking for, I can tell you that our people are more optimistic than I have ever seen them in terms of ICOs, market share capture, and what the future looks like for us. So yes, some of the short-term Lack of supply has helped, but I think it's more of really the long-term development positioning of the product line, which has helped us so much.

So it's really driven by the value opportunity that the customers are looking for. Correct. Correct. Okay. And that's really about existing parts in your catalog. Is there any evidence that this is also accelerating the pace of new part development, more airlines and customers coming to you and saying, can we develop these other parts that you don't currently have for the same reasons?

The answer is yes. I would say that the airlines have been fairly lean in terms of staff going through the crisis, and obviously they've had to focus on many things. So I think that the opportunities that we're seeing are more driven by us in the recent past as opposed to driven by the customers. But the customer support is just as strong, if not stronger, than it was in the past. And again, it's due to the competitive nature of our products and the desire for the airlines to have alternative sources at competitive prices.

Okay, just the last question on this. Would you say your new parts development activity this year is any different than prior years? Are you doing more or less, regardless of the reason?

Yeah, I would say it's consistent with prior years. We did not, as you probably remember, we did not take down new product development During the crisis, we continue to develop a similar number of products. So those products are getting sold, and our current inductions and our forecasted inductions, I would say, are consistent with those numbers. We do have the ability to flex it up if we want, and we'll have to see how market developments are. Okay. Thanks so much. Appreciate it. Thank you, Rob.

And your next question comes from the line of Peter Ahmed with Baird.

Yes, good morning, Larry, Victor, Carlos. Good morning. Eric, maybe just to come back to you, maybe just talking about the margins a little bit. Your margins have recovered all the way back, which is really great to see. And are you seeing any kind of structural gains coming out of the pandemic? I know you were focused on a lot of cost, but you're always kind of careful on pricing, too. So maybe you could talk a little bit about margins.

So you're talking structural gains in margins specifically as opposed to in customers. So the 19.2% honestly surprised me on the upside. We thought that we would get back to our historical level, but I thought that it was going to take a longer period of time. And I think that speaks to frankly, the strength of our people and the strength of the product offering. We'll have to see what develops going forward, but I don't see any reason why we shouldn't get back to our old margins fairly soon and possibly exceed them. I want to be careful and not get in front of myself and predict an increase in them, but I can tell you based on the confidence that I see coming out of the sales and marketing group as well as the businesses, I think that that's a real possibility.

That's really helpful. And then just on, Eric, just staying on kind of the demand environment, you know, how did you see the cadence of orders during the quarter? Because you obviously had to deal with Omicron. And are you seeing any changes now as we kind of prepare for what could be a busy, you know, spring and summer season?

Yes. As I mentioned in the fourth quarter call in December, we thought Omicron would be negative. And of course, in general, it was negative for the industry. However, there has been very strong strength. I would say the quarter was fairly consistent across it. And I can tell you that the forecast going forward is consistent as well and very strong. So, again, I think that's a combination of our market share gains as well as the market just being strong.

Appreciate all the callers.

Thanks, guys. Thank you.

And your next question comes from the line of Peter Skavinsky with Olympic Global.

Good morning, everyone. Just to follow up on Peter's question with regard to FSG margin rates, you know, I think We're really talking about a lot of positive volume impact. I'm interested in just the net inflationary impact to the business. Are you guys seeing gains, net of inflation, or is inflation kind of holding you back? I guess that kind of gets to pricing. Could you talk about all that?

Yes, absolutely. This is Eric. With regard to gains, I feel very confident of our ability to to maintain GAINS net of inflation, and we've been very cognizant to make sure that we pass those added costs on to our customers. We're not trying to take advantage of them, you know, to change the value proposition, but we do need to make sure that we get our costs covered. So I can tell you that our businesses, yes, they have seen costs increase in all the usual areas, and they've been extremely proactive in making sure that we get those price increases as well to maintain our margins and not give up ground because of inflation.

I appreciate that. Just one last one for me. maybe you guys were anticipating this a week or two ago, but certainly, you know, with the news this morning of this Russian invasion that, you know, do you guys foresee any, you know, near-term impact to your business? Do you, do you change how you manage the business and, you know, do you get concerned about supplies like titanium, that, that sort of a thing? I was just interested in your kind of top level thoughts.

Yeah. If, If you look at our businesses, I think one of the key strengths of Heiko is the decentralized nature. And we've got these basically 60 decentralized business units who are each very intimate and knowledgeable about the products that they use, and they work very closely with their suppliers to get what they need. And that's not to say that we don't have occasional shortages, as we do. However, I would not say that there's anything... There is no one input that is so predominant that would have a major impact across all of HICO. So, you know, specifically if you look at titanium coming out of Russia, yes, we are a user of titanium. But I think that we've got the ability to buy titanium in the quantities that we use it from a variety of sources. So, you know, we're typically able to mitigate that. And typically it's not going to be a major impact to us like it would other folks who require, you know, very, very large quantities of this. So we're still very bullish on our business, both on the commercial side as well as the military. You know, frankly, events of today prove the importance of having a strong defense. not only in the United States and in NATO, but around the world. And when the world goes through periods of time without conflict, I think events like today serve as very good reminders that there will always be somebody out there who wants to destabilize, and the best way to ensure peace is through strong defense. And that's why we continue to be very bullish on defense, as well as the commercial side, and we really like the nature of our businesses. That's great. Thanks, guys. Thank you.

And your next question comes from the line of Larry Solo with CJS Securities.

Hi, it's actually Elijah Goda for Larry this morning. Good morning. Good morning. So just going back to the inflation and pricing conversation, Given that both you and obviously the OEM parts producers are seeing inflation and are trying to price to at least capture the inflationary increases, how does that impact the spread between the OEM parts and the PMA parts, and does that make you more competitive in periods of rising material costs?

I would say that it does make us more competitive. The OEM responses tend to be very aggressive. and they tend to be in excess of their true cost changes. So we've got the ability to create additional value to make sure that we cover our costs and make sure our margins don't shrink as a result of it. And I think it does make our product offering even more compelling.

Okay, and then just looking at the FSG revenue in Q1, it looks like we're about 5% below where we were in Q1 of 2019, obviously not all organic because we have some M&A in there. But that was also despite the Omicron impact during Q1. So if we look forward and assume that the Omicron impact is less in the next few quarters than it was in Q1, Is it a reasonable assumption to think that FSG revenue looks closer to where it was in 2019 for the full year, just given the Q1 performance? And if for some reason that's not the case, what are the other factors we should be thinking about to make that not the case?

So this is Carlos. I think if you strip out the acquisitions that we've had since then, it's going to be a slow grind the rest of the year up to those levels. I hope we get there in total, but our expectation is that by the end of this fiscal year for HICO, we ought to be at a run rate that mirrors 2019. End of this year, maybe first quarter of 2020. That's been our goal since day one of this crisis and what we thought would happen, and I think that's playing out. I don't know. We're not giving guidance for the full year, but if that directionally gets you where your question is going, I hope it's helpful.

It is helpful. And was your commentary on FSG specifically or both segments?

FSG specifically.

Okay, great. Very helpful. Thank you.

And your next question comes from the line of Ken Herbert with RBC Capitals.

Yeah, hi, thanks. Carlos, maybe I could just follow up on that or Eric. It looks like organically the last three quarters FSG revenues have grown about, you know, call it five-ish percent, mid-single digits sequentially. Is there any reason that sort of sequential growth in the segment shouldn't change as we think about the next three quarters here or for the year?

Hi, Candace, Eric. You know, I think that we're going to continue, as I mentioned, continue to grab market share, and our sequential growth will continue. You know, if you look, our first quarter was, frankly, well ahead of what anybody expected. And I can tell you, in particular, over on the aftermarket side, you know, the quarter over quarter change was really quite strong. So I think, yes, as the year continues, we will, you know, we'll continue to post the increase. I don't know if Carlos has got added color.

Yeah, I think, I think, Ken, that's probably the right way to look at it, because what that does is it grinds us north as opposed to assuming that will have peaks and valleys throughout the year. We continue to believe that it's just gonna be more of a linear run back to the 19 levels. And whether it's 5%, you know, 4%, 10%, whatever it is, it's gonna get us back at a rate that is more linear than jumping, at least in the FSG. And to Eric's point, you know, One thing that's hard to predict is the strength that we're going to have in any one particular market segment. I think Eric's pointing out that our aftermarket was incredibly strong in Q1, which typically for Heiko, Q1 is probably our down quarter, right? It's been historically our softest quarter due to November and December, holiday seasons, travels, less days in the quarter, those kind of things, and less planes being worked on. They're all in the air flying. We were very pleased with the FSG's performance in Q1. It did exceed what we thought the company would do in Q1 this year.

No, that's great. Thanks. And if I run that out, it looks like, you know, you're obviously, you've got another, call it sort of quarter of easy comps this quarter, just considering the timing. And then the second half of fiscal 22, obviously you're up against much more challenging comps within FSG. But if I run that out, it looks like you should still be able to maintain performance pretty significant sort of growth relative to sort of historical averages and, and where traffic growth could be. And I'm guessing part of that is, is it sounds like we're maybe hearing some, some restocking efforts at some airlines and obviously a lot of pent up demand, but is there anything else you would call out, you know, Eric that could perhaps get, get to or, or maintain sort of above trend line growth in the back half of the year with, with what you're seeing in the marketplace today?

Yeah, I, I, um, you know going out on a limb here a little bit and of course you know we don't have the orders at the moment to support them because we get most of our orders in the month of shipment but i think we're going to be comfortably ahead uh in the uh the back half of the year as well you know given everything that we know today with regard to omicron ukraine uh i feel very confident uh in predicting you know continued growth um I had the luxury of being able to look at certain detail numbers, and I can tell you when you look at our commercial aftermarket, the quarter-over-quarter change has really been very, very good. And if you look at the growth that we've had over the years, prior year that's also extremely strong. So I feel our growth is going to continue. It's not going to be, you know, based on what we see here today, it's not going to be limited in our first and second quarter. We're going to grow substantially in the third and fourth quarter as well.

Great. No, that's excellent. And if I could, just one for Victor. You called out Victor in the quarter. Some supply chain and Omicron-related disruptions. Is it possible to size that a little bit or maybe think about within the defense portfolio, specifically within ETG, how that could have looked organically, you know, excluding some of these one-time disruptions?

Yeah, it's a good question. The answer is, and by the way, the disruptions that I was talking about, it's mostly actually people-related, I think, as I As I commented, I think at one point during January, a rough estimate is that we had close to 10%, maybe 8%, I'm not sure exactly the number, of our people in ETG out because of COVID. Either they had it or they were exposed to somebody who had it or they were caring for somebody. But there was a point in January when the country and the world was experiencing that surge. So I went into January believing our sales would be at least $10 million higher than where they wound up. And so the people issue existed within our company. We also had it, as I said, at some suppliers and even customers. And we had customers pushing out deliveries, delaying deliveries. You've got to cooperate with your customers. I mean, you could go, and in some instances, I think we had the ability to really push the customer based on a purchase order, a contract, but we don't believe in doing that. So, you know, these things should resolve themselves over the course of the year, and that, you know, I felt really good in December. Sales would be at least $10 million higher in the quarter, but They move out. And that's why we point out, you know, ETG is a great business. There are great margins over time, but it tends to be lumpy like that. And, you know, something else I should comment on, I think I've been saying it for over a year now, maybe a year and a half, that we thought defense budgets would moderate, drop, flatten out at the very least. And so this isn't inconsistent with our own internal policy. thoughts and planning. Now, what's transpired recently in Ukraine and elsewhere may change that calculus. Who knows? And we'll see. But this is not outside of our contemplation, certainly.

Great. Thank you very much, Victor.

Thank you.

And our next question comes from the line of Michael Siramoli with Chuis Securities.

Hey, good morning, guys. Thanks for taking the questions here. Morning. Maybe, Eric, just can you give a little bit more color on maybe what you're seeing from your customers regarding wide body ordering and parts procurement? It seems like, you know, the airline industry in general is getting ready for a pretty big uptick in international travel. Are you seeing that demand flow through yet?

Yeah, we are. We are starting to see wide-body recovery. If you look at the statistics, you know, obviously domestic is stronger and, you know, followed by Europe. Of course, Asia and South America are still depressed. But we do see continued recovery in those markets, including the wide body. So, yes, I think people are getting ready for a good wide body increase in demand here.

Back to Ken's line of questioning, I mean, as these carriers prep for the summer season, does that create a step function increase at all in your 2Q FSG revenues and maybe – bleed into early 3Q, or you think you've kind of got all that contemplated?

I think we, you know, our forecast takes that into account, and that's one of the reasons why, you know, I continue to be very bullish, in particular in our aftermarket areas, but also in our new OE equipment areas as well, seeing continued growth throughout the

uh fiscal 22 and 23 due to market share gains as well as recovery got it and then back to the fsg margins i mean you're still basically running you know i guess revenue maybe give or take 50 million below your quarterly run rate high you've been getting really good incrementals you talked about the efficiencies i mean you're in shooting distance already with the margins You know, assuming you've got, you know, some sustained efficiencies, better cost takeout, I mean, could we see these FSG margins get into that 22% to 23% range, you know, once we're kind of fully recovered and you guys are kind of humming at a quarterly run rate in excess of $320 million in revenue?

Mike, this is Carlos. Look, we do expect at some point – in the future here, in the near future, that we will get back to approximately 20% operating margins on a sustained basis. During COVID, just be mindful, we didn't structurally change business. We didn't, you know, tool plants. We didn't do things that would impact the way we operate. In fact, we kept that structure in place. And so I would be cautious to model in or think about expanded margins at higher increments. Now, I do think what you'll see in the FSG is once we level out and we get back to, you know, 19,000 rates and grow from there, you ought to witness what happened historically. If you look back, you know, over 15 years, you will see the FSG's margins just had these incremental tick-ups, and really that was a function of growth in the business and really efficiencies in our fixed costs and SG&A spend, and I think that would continue, but I wouldn't anticipate that for the near term. I think that's more of an intermediate play in thinking.

Got it. Got it. And then just last one, Eric, any thoughts and maybe even using history as a guideline here on airline consolidation? We've got Frontier and Spirit. What should we expect? I mean, if we see more consolidation globally, what typically happens to the the HICO catalog. Is that consolidation generally good for you, bad for you, based on historical trends?

Yeah, consolidation is typically very good for us because, you know, basically, you know, the more aircraft that a customer has got, the more savings potential they've got. So it tends to be very good for us. There are, you know, you point out Frontier and Spirit. There are also some other some other talk in Europe about some other consolidation. So I think, again, whenever that occurs, it's typically or always good news for us. Got it. Perfect. Thanks, guys. Thank you.

And your next question comes from the line of Christine Lewag with Morgan Stanley.

Hey, good morning, guys. Good morning. Good morning. When you start looking at the pipeline for potential acquisition targets, are you seeing more opportunities these days? I guess, you know, when we look at COVID, we've seen fewer bankruptcies in the supply chain. And as it seems, you know, the payment, the Paycheck Protection Program seemed to have worked. But as this kind of expires, or already expired, and then banks are now starting to collect on bad debt, does this open up opportunity there for targets?

I think, Christine, I think we have a pretty full pipeline. We're doing a lot of due diligence. I can tell you the big issue that we face is competition from, say, private equity or corporate buyers who will pay 17 times EBITDA. And we can't compete. Our model doesn't work at 17 times EBITDA. And we were with an investment banker recently. who you probably know fairly well or would know. And he came for a meeting to talk about an acquisition. And in the conversation, he said, you realize that 90% of all acquisitions are not successful. And the percent, you know, it's easy to make acquisitions, easy to buy, but it's not so easy to make them work out. And our model requires us to buy a company, continue it, and keep it in the portfolio virtually forever. The old expression, we don't buy a company, put lipstick on the pig and dump it in three years so we make a profit because we increase the multiple or cut expenses by a few bucks. That's not our model. So we're competing with people who have a different model than we do. Now saying all that, we are still able to find companies who are very anxious to join Heiko because of the Heiko culture. But when you're dealing with, say, another private equity company or a corporate, they really don't care about the culture. They just want to get the highest dollar. And if they want the highest dollar, we tell them at the get-go, we're not your buyer. So I would say this is the most difficult part that we're facing. However, there are many people, as I say, because, look, we've made 89 acquisitions and we give lists of people that sold companies to us. We give you a list to see if we've done what we said, how we've treated people, how we treated their team members and everything else. And that's very positive. So many private owners would rather sell to us at a slightly lower price than to sell to, say, one of the other companies, private equity guys, because they know that the culture, they will stay with the company. They will be able to share in the future profits. We let them keep 20%, 25%, whatever it might be, so they are really our partners, and they like that structure. So there are plenty of companies. We are doing the due diligence, and I can tell you the due diligence is, that we do. We do it all internally. We don't farm it out to other companies, except if there's a specific technical question that we need special expertise. So it takes our staff time to get in and do it, but we're spending an enormous amount of time on these acquisitions, and there are plenty of them in the pipeline.

Well, thank you very much, Earl. We appreciate it.

Thank you.

And your next question comes from the line of Colin Descharmes with Sterling Capital Management.

Hi, good morning. Just a couple for you. Look, you've got a heck of a franchise that's in no small part been built on long-term industry relationships, and you've historically not used price as a weapon or really a key piece of your growth algorithm. Now, given prior comments in today's call, that's been critical of the Heiko value prop. you know, long-term for customers, but inflation is forcing your hand a little bit here on pricing to protect your margins from inputs. So to kind of protect that historical value prop kind of reputation with customers, which has been a differentiator for you, do you now see an opportunity to embed any pricing models that perhaps share value with customers? And in particular, I'm thinking kind of like discrete, you know, COVID supply chain charges or something like that, akin to what we've seen from freight providers years ago embedding fuel surcharges when those inputs shot up or what we see from certain waste haulers today who have volatile recycling businesses and have kind of price share, cost share mechanisms with customers. You know, anything that could be perhaps kind of discreetly broken out for customers so they see that it's input driven for you all, not a hyco weapon, and that that pricing can kind of rise and fall with that volatility to share the value with customers.

idea here is you know further embedding your long-term relationships and gendering new ones and just making that customer base even stickier just wondering what you're doing from a pricing standpoint that's been quite different from your long-term history thanks and i got a phone colin thank you that's that's a very good question this is victor i think you've hit the nail on the head by the way uh and it's it's you know that heiko offers this value proposition across all of our product lines and all of our businesses and you know so pma what's most notable with that right is a cost-saving solution, but it's actually across the board that that what we do is a lower cost alternative to something else and consistent with that we've made and our businesses have made the decisions not to go if you will ripping off our customers and not to just use this as an excuse to gig prices and then get them angry with us, and then we lose that long-term loyalty, which we have, and it's very important and extremely valuable to us. At the same time, of course, we need to be compensated for the additional inflation. We need to maintain our margins, et cetera. So we do it. Each business does it case by case. They decide how they're going to address it. Many businesses use the methods that you've mentioned, that we're They're putting through something that is identified relative to inflation. The thing is, to be honest, we don't expect inflation to drop back. There may be lower costs here and there, but overall, we would expect that, and our businesses expect that their cost rates will be higher, and so the pricing that they've made will continue to stick. Case by case, they'll break it out. They'll show different categories, different reasons. Some customers, you've actually got to do that in the defense realm where you've got to actually break it out. And in other cases, you know.

Colin, I would just add one thing to that. Keep in mind that any price increases that we may be passing on to cover our costs tend to lag, right? You know, you don't often reprice backlog and things like that. So oftentimes when we're talking about, you know, getting a bit of price to cover the cost increases. It's a little more prospective than it is contemporaneous to this quarter. So just keep that in mind.

Okay, thanks. And then just a quick follow-up. You talked a little bit about just supply chain management bottleneck alleviation. Larry chatted about buying inventory ahead being a sage decision for you this quarter. What else, what other color can you provide about additional actions for I've just long heard Eric Victor talk about cost quality and turn time being, you know, keys for Heiko and the value prop. And we know crises are terrible things to waste and often can spark innovation here. So are there any new operating practices that are finding their way into kind of your go-forward Heiko standard operating procedure that are perhaps learned COVID behaviors but might stick longer term to either benefit operating practice, financial model, margins, et cetera? Thanks for the questions.

Another good question, Colin, and it varies, of course, case by case, but the answer to your question is yes, definitely. And it varies by subsidiary, as I said, but we look at things that we're doing, more things we're doing, and more aggressively in automation. In a number of our subsidiaries making decisions to insource some of the production of materials, even down in some cases on packaging materials and things like that. Now, we want to keep the right balance. We don't want to create too much of a heavy overhead, if you will, so we leave it up to each subsidiary. But those are some examples between automation and insourcing as well as training, and we rely to a certain degree on technology to advance the equipment that we have so that we can increase the throughput. And then there are other things. I mean, increasing the vendor base. We've done that in a number of subsidiaries where we've decided to decrease the risk. And that has been, I know of at least a few, that's been a crucial part of decision-making for us. Things like arranging transportation directly in some instances as opposed to going through brokers or through other transportation companies. are just some more examples of that.

Eric, I don't know if you've got any... Yeah, I agree with all of the points that Victor mentioned. And again, I would just point back to our corporate structure, which I think is a competitive advantage. You know, that rather than having a highly centralized organization where people are waiting on instructions from the corporate office on what to do, we've got 60 decentralized, entrepreneurial, hardworking, aggressive organizations business heads and their staff out in the field figuring out every day what they need to do. And the old adage, necessity is the motherhood of invention, I think is very much the case. I mean, when there are shortages, people figure out other ways to get stuff done. So I think that our corporate structure really lends itself very much to these kinds of dislocations. And if you look, we've emerged after every economic setback, we've emerged a much stronger company in terms of revenues, earnings, margin, cash flow, everything. And I fully anticipate that to happen again after this most recent situation. Operator, I think.

And your next question comes from the line of Gotham Calmer with Cowan.

Hi, good morning, guys. How are you doing? Good morning. I just wanted a lot of questions were already answered. So the one I wanted to make sure I had a better sense for was at ETG in the first quarter, you mentioned, you know, some of the outages related to staffing and COVID and the like. Do you have a sense for how much what the opportunity cost of sales were in the quarter related to, you know, if you had the personnel and everything you needed, sales would have been higher by how much?

Yeah, Gotham, it's a good question, and it's difficult to pinpoint, and that's why I said I believe that we were looking at, before the surge, we were looking at around $10 million more in revenue in the quarter, which moved off into later in the year. And that was principally driven by personnel issues within our company, but also actually at vendors and at customers. So it was kind of... roundly out there. But, you know, that's my best guess at this point is probably in the range of $10 million or so.

Okay. And, you know, you mentioned the conflict in Ukraine, you know, is potentially a stimulant for demand. I was curious maybe what products within ETG, you know, could actually see more up-tempo driven demand and, you know, what percentage, if there's a way to frame quantitatively, like how much of a ETG product portfolio is kind of very up-tempo sensitive.

Yeah, and I'll give you my opinion on this, of course. I don't know anything more than anybody else about what's happening over in Europe and Russia, Ukraine, et cetera. But our products that might see an impact is pretty clear. well across the board. And I don't think it's instantaneous, but I don't think tomorrow morning we're going to suddenly get an order and be able to ship double the product or something like that because of this. So we'll see what happens. None of us know what's going to happen, but it's very much across the board. I mean, we have things that are used, for example, electro-optical products, both in the infrared and the laser realm. We've got a lot of power products, power amplifiers, products like digitizers, tuners, things that help to pick up over-the-air signals, as well as items that are used on precision-guided munitions, as well as missiles and targeting systems, surveillance and reconnaissance as well. So it's kind of a broad range of what we do. I even see possibility in fuel systems on top of that, but it's hard to know exactly because it really depends on what's being supplied and to whom and what's needed. Is it to our country? Is it to our allies? And how does it make its way over there? And how does congressional approval work and state department? You get through all those things. So right now, our internal planning And our internal assumption is nothing additional from those. And the rest, if it comes, then we will obviously see that in our sales.

Thanks. That makes sense. One for Eric, just quickly on FSG. Could you talk a little bit about what you're seeing in the sub-market? So, you know, repair, component repair versus the PMA parts. If there's any... are the trends kind of the same? Are they, are you seeing any disconnects there? And so what might explain it?

Yeah, our, um, I would have to say that our aftermarket across, you know, our commercial aftermarket across PMA, uh, repair and distribution is all up, uh, similarly and, you know, operating in a similar area. Um, Yes, there's been particular strength over in the PMA area, but our aftermarket is really performing extremely well. You know, there are times when one business may be ahead of the other, but I would say they're all in a very similar number and frankly have surprised me in terms of the recovery, which has been very swift and meaningful.

Thanks, guys. I'd just further point out your knowledge that we talked in December on our call about specialty products being a laggard in 21 with the OEM products that they produce. And we started to see life out of that slip of the business during Q1. So that was very positive. And we think that'll be a tailwind force going into 22.

Thanks, Carlos. Appreciate it, guys. Thanks, guys.

And your next question comes from the line of Ron Epstein with Bank of America.

Hey, good morning, guys. Good morning, Ron. Yeah, one area I don't think you spoke to, but I was wondering how it's going. How are things on the labor front, right? I mean, labor's pretty tight. Have you been able to keep all of your employees and so on and so forth? And And what are you seeing in terms of labor inflation?

Well, you know, we've been very good at retention. Definitely there is inflation in payroll. And, you know, people are the most important part of our business. So we are making sure that we take care of our people. And that is definitely an inflation factor. again, generally winds up something that we can pass on to our customers. They understand and expect it because they're undergoing the same thing. It is challenging to get new people, right, for growth and retirements and things of that sort. And that's where I said that it's the kind of thing that... We just have to address on a case-by-case basis.

And, Ron, this is Eric. I would also add that, you know, due to our corporate structure and due to the competitive advantage we've got by operating these smaller businesses, I would have to say that overall our people, our legacy people, you know, the people who have been at the company a number of years, like us, very much the way that they are treated because they are able to do meaningful work. They're able to decide autonomously what they want to do. They're intrinsically motivated. And also, they feel good. The opportunity, if you look at large corporate employers, Typically, people are not able to decide and people are not able to make their own decisions on running their businesses, running their areas. They've got to go through five levels of sign-off. They've got to get other people involved. At Heiko, it's very entrepreneurial and decentralized, and that's very, very rewarding for people, number one. Number two, when you compare Heiko to a private equity shop, where everybody understands very clearly in private equity that the goal is to get a temporary rise, defer shipments, accelerate shipments, get it all into one period, try to price off an abnormally high moment in time, try to get the highest multiple as possible. They understand. that their labor is not really appreciated. And yeah, there could be a short-term financial benefit, but it's not a long-term benefit. And if you look at the performance of these companies, they're really substandard. So Victor mentioned that we tend to hang on to our people and do very well with that. Yes, it is harder to get new people. However, we've also been successful in being able to recruit new folks. As far as labor rate inflation, I would say that it's consistent with what you read in the newspaper about what's going on nationally. It depends very much in certain pockets. There are certain areas where they put in they've raised minimum wage rates, which have a knock-on effect. Not a lot of our people are at minimum wage, but there are others that are based off of that. So you've got certain labor markets which can be tighter than others. But across the board, I would say it's consistent with what you read nationally.

Ron, this is Carlos. I just want to put since you're a numbers guy like me, I'll put a finer point on it. The, uh, attrition rate at Heiko last I checked was in the mid single digit. And, um, you know, we're proud of that. We, we, it's Derek's point victors. We tend to keep our folks very happy, give them a good career path. So, you know, we're not losing people to others, but, but the cost of labor add ons to growth aspect of that is, is inflated from what we've seen in the past.

Great. Great. And then maybe if I can just change gears a little bit, um, Are you guys seeing any opportunities yet in kind of quote-unquote new space or in sort of new aerospace, electric propulsion, the eVTOL world, or either in launch or satellites in the commercial space?

Sure. Ron, this is Victor. We are seeing opportunities in all those categories, right? I mean, and we supply... components to a lot of manufacturers or a lot of companies in design stage and things of that sort in new space, in we'll call it clean aviation just broadly. And I don't think that's going to be immediately a huge part of our business, but we do have to be involved and play. In space, generally speaking, we're serving higher end And, you know, we've always been fairly focused on the value we add that gets recognized in our margins. And that's, I think that'll continue to be the case. We're not going to chase after the more commodity work, the more low margin work. So we'll try to stay in the upper end. And, you know, we're even looking at a few acquisitions, which would help us that way. You got it. Thank you. Thank you. Thank you.

And our final question comes from the line of Ellen Page with Jeffries.

Hi. Thanks for the question. Just looking at ETG, how do we think about the return to growth? And can you give us any sense of how sales trended through the quarter across the different pieces of defense? And anything you can give on the customer split across the Army, Navy, and Air Force?

Yeah, Ellen, we don't break out the sales split or the split by products, but what I can say about it, to try to put a little bit of color on it, is that generally speaking, our higher-end electronics are stronger than some of the electronics that were or the equipment that were and are forward deployed in what I'll call the operations tempo. And so that's within defense. You know, that's kind of how it broke out. And, of course, we're seeing the strength in our non-defense, non-space, the high-end electronics market outside of space defense, and that includes commercial aviation. has some nice growth prospects for us there.

Thank you. That's helpful.

That's it for me. You're welcome.

And excuse me, we do have a question from the line of Louis Raffetto with UBS.

Hi, thank you. Sorry about that. I thought I hit star one earlier. I guess, Victor, one for you, just to sort of follow up on some of the earlier questions. If we look at ETG year over year, margins were down 2%, sales were roughly flat, and obviously you guys called out defense being weak. So can you ballpark how much of that margin decline was actually just mixed? Because I know that defense and space tend to have higher versus any incremental investment or some of those inefficiencies you talked about. Yeah. Unfortunately, Lewis, I can't break that out. Okay. I figured I'd try again. I knew, I knew that those businesses tend to have a, yeah. Okay. And then Eric, just, just one for you. As I look at this new pioneer business, you know, once it closes, you know, it looks like another one of your typical, you know, solid singles or doubles you guys talk about, but I guess I think a little bit bigger. Is that something you guys are looking to maybe be able to leverage some of your, your, your other Heiko parts to sell more through that distribution business?

Lewis, I would say that's always a possibility. I think you're pretty familiar with how HEICO operates with our decentralized structure, and definitely Pioneer is going to bring into the HEICO family certain capabilities that aren't as developed or built out today. So I think that our businesses will definitely look to They're pioneer brethren about, you know, how to penetrate some additional markets. So, yes, I think that that will definitely be an opportunity for us. Pioneer is really very, very well skilled, very entrepreneurial, fits culturally very well with how Heiko does, performs well financially. So we're very excited about it.

And then just last one, how much of FSG is distribution, would you say, at this point, given Blue, Seal Dynamics, ACT, or all those different ones you've got there?

Yeah, we, Lewis, we, in our SEC filings, we disaggregate revenue into parts, repair, and specialty products. So the distribution business would be within the parts segment. would be reported within the segments, but we don't further disaggregate parts. We just leave it all. It's got very similar dynamics. And you have to remember, in particular over on the commercial side, we can either sell something as a PMA, we can work with a distributor. It really becomes very... discretionary, you know, which bucket it goes. So we think that it's most wise and provides the greatest investor disclosure and analysis by putting it all together in the part side because there are such similarities between the businesses.

Okay, great. Thank you very much.

Thanks, Louis.

And at this time, there are no further audio questions. Are there any closing remarks?

The only closing remarks are we thank everybody that's been on this call for their interest in HICO and for their questions. And we look forward to having our second quarter call in about three months from now. So we wish you all a very good day. And we look forward to speaking with you. If you have questions in the meantime about Heiko, Eric, Victor, Carlos, myself are available. Give us a call. Send us an email. And we'll set up an appointment to speak with you. So thank you. And that's the end of our comments for this morning.

And thank you. And thank you for your participation. This concludes today's conference. You may now disconnect.