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HEICO Corporation [HEI] Conference call transcript for 2022 q3

2022-12-20 16:18:02

Fiscal: 2022 q4

Operator: Welcome to the Heico Corporation fourth quarter and full year fiscal 2022 financial results call. My name is Samara and I’ll be today’s operator. Certain statements in today’s call will constitute forward-looking statements which are subject to risks, uncertainties and contingencies. Heico’s actual results may differ materially from those expressed in or implied by those forward-looking statements as a result of factors including but not limited to the COVID-19 pandemic, Heico’s liquidity and the amount of 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, export policies and restrictions, reductions in defense, space or Homeland Security spending by U.S. and/or foreign customers, or competition from existing and new competitors which could reduce our sales, our ability to introduce new products and services at profitable pricing levels which could reduce our sales or sales growth, product development or manufacturing difficulties which could increase our product development and manufacturing costs and delay sales, our ability to make acquisitions and achieve operating synergies from acquired businesses, customer credit risk, interest, foreign currency exchange and income tax rates, economic conditions including the effects of inflation within and outside of the aviation, defense, space, medical, telecommunications, and electronics industries which could negatively impact our cost and revenues, and defense spending or budget cuts which could reduce our defense-related revenue. Parties listening to this call are encouraged to review all of Heico’s filings with the Securities and Exchange Commission, including but not limited to filings on Form 10-K, Form 10-Q and Form 8-K. We undertake no obligation to publicly update or revise any forward-looking 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 Laurans Mendelson, Heico’s Chairman and Chief Executive Officer. Please go ahead.

Laurans Mendelson: Thank you and good morning to everyone on the call. We thank you for joining us and we welcome you to the Heico fourth quarter fiscal 2022 earnings announcement teleconference. I’m Larry Mendelson, Chairman and CEO of Heico Corporation, and I am joined here this morning by Eric Mendelson, Heico’s co-President and President of Heico’s flight support group; Victor Mendelson, Heico’s co-President and President of Heico’s electronic technologies group; and Carlos Macau, our Executive Vice President and CFO. Today my comments will address our consolidated fiscal 2022 fourth quarter results, acquisitions and accomplishments, followed by a presentation for the segment results from Eric and Victor Mendelson, Heico’s co-Presidents. Now before reviewing our record operating results, I would like to take a moment to thank all of Heico’s exceptional team members for delivering another strong quarter. Your continued focus on exceeding customer expectations and operational excellence has translated into outstanding results for our shareholders. I’m encouraged by the steady improvement in our businesses during fiscal ’22 and I am very optimistic that this trend will continue into fiscal ’23. Summarizing the highlights of our fourth quarter fiscal ’22 results, consolidated fourth quarter fiscal year ’22 net sales and operating income represents record results for Heico, and that was driven principally by record results within the flight support group mainly arising from the continued rebound in demand for our commercial aerospace products and services. In addition, this marks the ninth consecutive quarter of sequential growth in net sales and operating income for the flight support group. Consolidated operating income and net sales in the fourth quarter of fiscal ’22 improved 27% and 20% respectively as compared to the fourth quarter of fiscal ’21. These results mainly reflect 11% quarterly consolidated organic net sales growth and the favorable impact from our fiscal ’22 and ’21 acquisitions. Consolidated operating margin improved to 24% in the fourth quarter of fiscal ’22, and that was up from 22.6% in the fourth quarter of fiscal ’21. Consolidated net income increased 13% to $97.2 million or $0.70 per diluted share in the fourth quarter of fiscal ’22, and that was up from $86.1 million or $0.62 per diluted share in the fourth quarter of fiscal ’21. Heico’s effective tax rate was 23% in the fourth quarter of fiscal ’22 as compared to 18.3% in the fourth quarter of fiscal ’21. The increase in the effective tax rate for the fourth quarter of fiscal ’22 principally reflects a 7.6% unfavorable impact from tax exempt unrealized losses in the cash surrender values of life insurance policies related to the Heico leadership compensation plan, and that was recognized in the fourth quarter of fiscal ’22 as compared to the tax exempt unrealized gains recognized in the fourth quarter of ’21. Later on in this call, if anyone has questions about the detail, this is a complicated matter, Carlos Macau is here and he will be able to explain that to you. Truthfully, it has no impact on our real operations. Our recent activity in acquisitions, in September ’22 our ETG group completed the acquisition of Trad Test and Radiation located in Labege, France. Trad is a leader in the highly specialized field of radiation engineering, and their services and products are used primarily in space, nuclear and medical fields. In September ’22, our ETG group completed the acquisition of Ironwood Electronics located in Eagan, Minnesota. Ironwood is a leading designer and manufacturer of high performance test sockets and adaptors for both engineering and production use of semiconductor devices. As previously reported, our ETG group entered into a purchase agreement to acquire approximately 95% of Exxelia International, which is headquartered in Paris, France. Exxelia is a global leader in the design, manufacture and sale of high reliability, complex passive electronic components and rotary joint assemblies for mostly aerospace and defense applications. The transaction’s closing, which remains subject to government approval and customary closing conditions, is still expected to occur in the first quarter of fiscal ’23 and would be Heico’s largest ever acquisition in terms of purchase price and revenues. These acquisitions, all of them are expected to be accretive to Heico’s earnings per share within a year of the transactions’ closings. At this time, I would like to introduce Eric Mendelson, co-President of Heico and President of Heico’s flight support group, and he will discuss the fourth quarter results of the flight support group. Eric?

Eric Mendelson: Thank you very much. The flight support group’s net sales increased 33% to a record $346 million in the fourth quarter of fiscal ’22, up from $260.4 million in the fourth quarter of fiscal ’21. The net sales increase in the fourth quarter of fiscal ’22 reflects strong 22% organic growth as well as the impact from our profitable fiscal ’22 and ’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 fourth quarter of fiscal ’21. The flight support group’s operating income increased 60% to a record $77.8 million in the fourth quarter of fiscal ’22, up from $48.6 million in the fourth quarter of fiscal ’21. The operating income increase in the fourth quarter of fiscal ’22 principally reflects the previously mentioned net sales growth, an improved gross profit margin mainly from increased sales within our specialty products and aftermarket replacement parts product lines, as well as efficiencies realized from the higher net sales volume. The flight support group’s operating margin improved to a record 22.5% in the fourth quarter of fiscal ’22, up from 18.7% in the fourth quarter of fiscal ’21. The operating margin increase in the fourth quarter of fiscal ’22 principally reflects decreased SG&A expenses as a percentage of net sales, mainly reflecting the previously mentioned efficiencies as well as the previously mentioned improved gross profit margin. Now I would like to introduce Victor Mendelson, co-President of Heico and President of Heico’s electronic technologies group, to discuss the fourth quarter results of the electronics technologies group.

Victor Mendelson: Thank you Eric. The electronic technologies group’s net sales increased 6% to a record $268.5 million in the fourth quarter of fiscal ’22, up from $253 million in the fourth quarter of fiscal ’21. The net sales increase is mainly attributable to the impact from our profitable fiscal ’22 and ’21 acquisitions partially offset by a slight decrease in organic net sales. The organic net sales decline is mainly attributable to decreased defense and space products net sales partially offset by increased other electronics, medical and commercial aerospace products net sales. I’d like to point out that the electronic technologies group’s backlog remained elevated, reflecting strong orders and increasing delays in receiving components and raw materials from some suppliers. These delays have adversely impacted our planned production and shipment of some products during fiscal ’22, but we expect that they should benefit us in fiscal ’23 as these products ship. The electronic technologies group’s operating income increased 4% to a record $79.9 million in the fourth quarter of fiscal ’22, up from $76.9 million in the fourth quarter of fiscal ’21. The increase in operating income principally reflects the previously mentioned higher net sales volume, a favorable impact from changes in the estimated fair value of accrued contingent consideration and decreased performance-based compensation expense, partially offset by a lower gross profit margin mainly from decreased defense and space net sales. The electronic technology group’s operating margin was 29.7% in the fourth quarter of fiscal ’22 as compared to 30.4% in the fourth quarter of fiscal ’21. The lower operating margin principally reflects the previously mentioned lower gross margin partially offset by the previously mentioned changes in the estimated fair value of accrued contingent consideration and a decrease in performance-based compensation expense. I turn the call back over to Larry Mendelson.

Laurans Mendelson: Thank you Victor. As for the outlook, as we look ahead to fiscal ’23, we anticipate net sales growth in both FSG and ETG principally driven by demand for the majority of our products. Our largest end market is commercial aerospace, which continued to grow during fiscal ’22, and we expect the strong growth trends to continue into fiscal ’23. Our second largest end market is defense. The defense markets were essentially flat for Heico in fiscal ’22. Though we would all prefer peace, global disputes and unrest means more defense equipment is required, providing a favorable environment for defense suppliers. We were negatively impacted by supply chain matters principally for electronic components in fiscal ’22, and that delayed certain delivery schedules. We expect these external factors to mitigate in fiscal ’23 but we can’t predict when; however, we remain very optimistic on the defense industry’s future and have seen growth in our orders and our backlog, and that supports our optimism. We will not be providing detailed fiscal ’23 net sales and earnings guidance at this time. We believe that our ongoing conservative policies, strong balance sheet and high degree of liquidity all enable us to continuously invest in new research and development and execute on our successful acquisition program, which collectively positions Heico for continued growth and market share gains. In closing, I would again like to thank our incredible team members for their continued support and commitment to Heico. Fiscal ’23 looks very promising, and I believe that our culture of ownership and entrepreneurial excellence will provide excellent career growth and opportunities for all your success in fiscal ’23 and beyond. Thank you for all that you do to make Heico a great company. That is the extent of our prepared remarks, and I would now like to open the line for comments and questions from people who are listening.

Operator: We’ll take the first question from Rob Spingarn with Melius Research. Please go ahead.

Rob Spingarn: Hi everybody, good morning.

Laurans Mendelson: Good morning Rob.

Rob Spingarn: Nice finish to the year, very nice numbers today. You know, Larry just mentioned culture, and so I think this warrants a high level question, for any of you. With all of the acquisitions over time for Heico, I think many investors would have expected the company to inevitably change over time, so can you talk about how you’ve been able to maintain the culture and the operational excellence, and essentially, what drives the consistency in the outperformance?

Laurans Mendelson: Well, Eric is dying to answer that question, but since you posed it to me, I will respond. I don’t want to duck anybody’s question, Rob. The basic culture of Heico is one of a decentralized organization where we give tremendous authority to the operating level. As you know, we have no mid-level vice presidents that filter everything that comes from the operating group up to corporate and to myself, Eric, Victor and Carlos. The first thing we do in acquisition, the most important is really scrutinize, analyze, get to know the person who is selling the company to us and how he manages. If he treats his people well - this is very important - as an example, if he goes through the factory and he sees somebody and he tell us, oh, that’s a machine operator, that’s a this and that, that’s not very impressive, but some of these people go through the factory and they say--they stop at a machine and say, Charlie here, these are the Mendelsons, how is Anne, meaning his wife, family okay, everything good, Charlie, how long have you been working for, 22 years. This means an awful lot, Rob. We understand the relationship between the owner of the company and his workforce, his team members. That goes a long way and we understand how that all works, and that’s the Heico culture. The other thing is we give tremendous authority and responsibility to the operating person. We believe that the person running his organization knows more about his team members, his labor force, his customers, his manufacturers, everything else, than somebody in a corporate office a thousand or two thousand miles away. Again, it’s the authority that we give them, and people who are very talented respect the fact that we give them that authority. Talented people normally do not like somebody breathing down their neck and over-supervising them - what are you doing, what are you doing, so I think that has worked very well. Also, we have a very exceptional 401-K plan where we give employees, if they put in 6%, we match it normally with 5% in Heico stock. Many, many of our working people - I’m talking about factory workers, shipping clerks, secretarial help are millionaires, some multi-millionaires all as a result of the stock that’s Heico’s given them. They take a personal pride in being a Heico team member. It’s not as though, hey, I’m working and I hate my job. They understand that they are being compensated and rewarded by having shares of Heico stock given to them by the company, they didn’t pay for it, so that brings their interest aligned with all shareholders. We think that most of our people are focused on building Heico and being part of a team. There’s a psychological benefit to call somebody a team member as opposed to an employee. If you’re my employee, you work for me; if you are a team member, we all work together, so all of these things are what we call part of the Heico culture, and I think a lot of that is responsible for our success. Eric, do you want to add?

Eric Mendelson: Yes, I mean, I think that’s a good explanation of our acquisitions and our culture, but I think Rob, as I was thinking about this, I think it’s even more basic than that. It’s that when we came to this company 33 years ago, we decided we wanted to build something for the long term, and it wasn’t going to be built for years or a single decade, it was going to be built for multiple decades. Frankly, every single thing that we’ve done and every decision that we take has been designed to drive sustained, long term growth of the business as opposed to any short term focus. When we’ve got to make decisions on everything from inventory, capital expenditures, people, customer relationships, everything is focused on cash generation as a result of also maintaining low debt and being able to create a culture which drives long term performance. As a matter of fact, last night I was reviewing some of our capital expenditure plans and I saw some of our subsidiaries were buying equipment that, frankly, wasn’t going to impact ’23 or fiscal ’24 earnings, but was going to impact it in ’25, ’26, ’27 and after, and I realized that the results that we are showing today, which are frankly, I think, so far above what’s normal for the industry, are as a result of that long term focus, and we’re really benefiting as a result of decisions that were made 10 years ago, 20 years ago, 30 years ago, that you can’t make happen short term. People ask me all the time, why is it Heico performs? If you look at over the length of the economic cycle, we don’t have one-time write-offs, we don’t do things that, if you will, goose the earnings in the short term, and I think our culture, which has been designed for a long term approach, is very, very different than typical corporate culture or private equity, which obviously has--you know, which drives short term results as a result of their compensation structure and everything that they’re set out to be. I really want to call out the people at Heico because, frankly, the ones who get ahead and the ones who are in positions running our businesses today, are in positions of importance, are frankly the steady Eddies. They’re not the ones who came in and all of a sudden had a quick turnaround and a great success, a flash in the pan. Our people have worked hard year in, year out, most over decades, and it’s a result of that performance and that discipline and that rigor over decades which has driven the results that we have today. I just want to call out, frankly, all of our incredible people, our steady Eddies who just continue to work hard year after year and really make this happen. I think that’s really what makes us unique.

Rob Spingarn: Thanks very much for the comprehensive answer, appreciate that.

Eric Mendelson: You’re welcome.

Operator: We’ll take our next question from Larry Solow at CJS Securities. Please go ahead.

Larry Solow: Great, good morning. Thanks guys. Larry, I can totally appreciate on the guidance. You guys have a long successful history, don’t necessarily need to provide guidance anyhow, so, but I do appreciate the sort of qualitative outlook. Just maybe a couple questions for Eric and Victor. Eric, obviously it feels like your aftermarket is strong, parts are strong I’m sure, specialty I think also had a good quarter this quarter, but I’m just trying to figure out, you had a little bit of an above-average margin year this year. Some of those drivers, has that sort of settled back into more of a historical range as we look out to the coming year?

Carlos Macau: Hey Larry, this is Carlos. Let me jump in there. I think what we’re seeing in the flight support group, and it’s been amplified, let’s say starting in Q2 and running through the end of the year, is some disproportionate growth in specialty products, which has change the mix a little bit in FSG for the back half of this year, which normally isn’t the case. Normally, all aspects of the flight support group grow in tandem, and usually our story is a margin that’s based off volume growth. I think what we continue to see is our parts and specialty products outperforming some of the businesses within the flight support group, which has--because of mix has had an impact on--pulling the margin up a little bit. We’re happy to see that. As Eric mentioned earlier, it’s a 22.5% margin for the quarter, all-time record. We’re very happy to see that, but I think once the mix settles back into its footprint, once we get completely out of COVID, we’ll see that margin moderate a little bit, would be my expectation.

Larry Solow: Okay, yes, that makes sense. I just--yes?

Eric Mendelson: And Larry, also just to add, I think we did--you know, we have seen market share increases and, frankly, tremendous efficiency as a result of the effort of our people, but I also want to add that the margin that we have was--you know, we were still able to drive that margin, even having proper reserves, paying people frankly generous bonuses, and we did everything for the long term and still came out with those margins. We made all of our investments and did everything the right way, and I just couldn’t be more pleased with those margins.

Larry Solow: Absolutely, and from a high level, Eric, obviously, it feels like commercial aviation seems to be in a good place right now. The economy may be slowing a little bit, or for sure it’s slowing. I just assume it feels like you’re going to have a good growth year again, but obviously you can’t continue to grow like you did the last couple years, but just any color on how you feel that the industry is today?

Eric Mendelson: Yes, I feel very, very good about Heico’s position in the industry. There’s no question that a rising tide lifts all boats, but I think that Heico is in, frankly, a unique position because we’ve positioned ourselves in our various businesses and I’ve seen in all of those businesses substantial margin increase, as well as market share increase. We’re doing really well. I mean, as a matter of fact, and normally I wouldn’t call it out but just so you’re getting to this, what’s interesting is that our PMA sales are at an all-time record, and if you look, flights across the world are still down whatever - 20%, and we still haven’t seen full recovery in Asia and somewhat in Europe and Middle East and South America, and even in the U.S. to a lesser extent, North America. But Heico PMA sales are at an all-time record, so I think that we’ve got plenty of power behind us and I think that’s as a result of picking up market share and, frankly, treating the customers right. They know that we’ve treated them right for 30 years and we don’t take advantage of them, and we’re very fair, we’re very reasonable, and they’ve rewarded us with that market share. It wasn’t stuff that we did short term that made it happen, it was stuff that we did long term and they trust us. I think we’re really very much in a virtuous cycle which is permitting this.

Larry Solow: Absolutely, great. Then if I can maybe just switch gears real quick, one more quickie for Victor - I know you’ve been quiet back there. Just quickly, obviously it sounds like your largest market, defense, the macro is very favorable and maybe this year was impacted by some worse supply chain issues than anything else. How about some of your other larger markets - space, medical? It feels like the outlook there, industrial, all consistently good. Is that sort of a fair assessment?

Victor Mendelson: Yes, I mean, good questions Larry. Those other markets have been very strong for us this year, and in fact I think really toward the end of last year as well. They’ve really been star performers, all the ones you mentioned - medical, high end electronics in particular, space a little--commercial space a little--you know, certainly less so and actually a little softer in some instances. I would expect, by the way, going forward, you’ve heard me say this before that at some point, we see those other markets flatten out somewhat, and--still I think excellent markets for us, but I would expect them to flatten out or even soften up a little bit as the year wears on and as supply chains get worked out and customers deal with their own channels.

Larry Solow: Got it, great. I appreciate that color. Thanks guys.

Victor Mendelson: Thank you.

Operator: We’ll take our next question from Pete Skibitski with Alembic Global. Please go ahead.

Pete Skibitski: Hey, good morning everyone.

Laurans Mendelson: Good morning Pete.

Pete Skibitski: I guess Victor, maybe just to continue that discussion a little bit, it looks like we might get sort of high single digit budget growth this year in the base DoD budgets, and a lot of Ukraine-related spending as well. Can you give us some puts and takes in terms of, you know, if we look at that budget growth but also consider--you know, you’ve talked about the supply chain issues and some people talk about defense contracting officer kind of delays, what’s the right way to think about all those puts and takes and the expectation I think we would all have, that you could at least grow at least in line with DoD budget growth, at least averaging it over time?

Victor Mendelson: Yes, I certainly think over time we should exceed DoD budget growth, just knowing our businesses and what we’re working on and the things that we do. But of course, in any given period, we may be tied to the defense budget directly or it could be negative, right--our correlation would be a negative one to the defense budget. I would think that you’re absolutely right on some of the procurement specialists at the DoD being, let’s say, overwhelmed in their workloads and dealing with work-from-home conditions and things like that, which have definitely in our view delayed deferred items from getting put under contract. The supply chain issues, I think have been bigger for us, and I think they were kind of record level for us in the fourth quarter. I was hoping that they would come off in the fourth quarter, maybe we’re starting to see a little bit--seeing some green shoots in the supply chain, but I think it’s too early to call victory there. Then of course, you mentioned the foreign engagements, which I think benefit us. I don’t think that they are going to cause--you know, be major needle movers necessarily in the next quarter or two. I think actually if you look at what we make and how those things are getting inserted over there, I think they’re a little longer burn in terms of just the order cycle and production cycle, but I think as we said in the comments that the dynamic is positive for us.

Pete Skibitski: Okay, appreciate it. Maybe last one from me, for Carlos maybe. Carlos, I think this year was a year of building some safety stocks, and if we expect revenue up next year, how do you think working capital trends--does the safety stock issue kind of reverse itself or do we continue to build because of these supply chain issues and higher growth? Just was wondering if you could provide some color there. Thanks guys.

Carlos Macau: Sure, so we invested--I mean, Heico, we invested in inventory this year. If you look at our balance sheet, you’ll notice that we have a pretty big investment in working capital, particularly for inventory, so I suspect that, as you’re pointing out, a lot of companies around the world have done that also. The impact to us going into next year, I don’t think there is a ton of impact on the flight support side because most of the business that we do in the flight support group is ordered and shipped in the same month, there’s not a ton of backlog. Within our defense business on specialty products, there’s backlog, but most of the aftermarket is really built and shipped in the same month, which implies that most of our customers aren’t stocking our product. We have a model with our customers where the parts come when they need it, and they don’t have to stock our stuff if they don’t want to; in fact, if they do want that, we usually put consignment cages in their buildings and we handle all that for them, so not too much on the flight support side. In ETG, I do think that it has been in vogue, particularly with electronic parts, to go heavy on inventory - we’ve done that, and yes, I think in ’23, could there be some sort of inflection where people hit the pause button? That’s possible I think for our businesses, because we’re not stuffing channels and over-supplying our customers, I don’t believe it’s going to be a major impact to Heico, but I think globally there’s something out there that we’ll reckon with probably in ’23 or early ’24.

Pete Skibitski: Okay, thanks guys.

Carlos Macau: Does that answer your question? All right, Pete, thanks.

Operator: Our next question comes from Peter Arnett with Baird. Please go ahead.

Peter Arnett: Yes, good morning Larry, Victor, Eric, Carlos. Happy holidays.

Laurans Mendelson: Good morning Peter.

Peter Arnett: Hey Victor, last quarter you kind of quantified the supply chain push-out - I think it was around $25 million of sales. You just mentioned it was kind of at record levels, so exceeding that number, or maybe if you could just give us a little--if you can quantify it, that’d be helpful.

Victor Mendelson: Yes, sure. We estimate that in the fourth quarter, that number actually rose by a little more than $20 million to around $47 million. Now, I won’t identify which subsidiary. About half of it actually came in one subsidiary, and so--which had not been experiencing, actually had avoided the supply chain issues for quite a long time. They’re estimating they will ship that in fiscal ’23. In some ways, there was some improvement over the prior period because a number of other companies saw their numbers shrink, but we had one in particular that was high and then a couple of others that were on the higher side, too, whereas in the past it’d been a little more broadly distributed.

Peter Arnett: Okay, that’s helpful. Then Carlos, maybe you could just talk to us a little bit about tax rate expectations when we’re thinking about fiscal ’23.

Carlos Macau: I think for Heico, we typically run 20%, 21%, sometimes better than that. This year, our tax rate was amplified for pretty much most of the year except Q1 due to losses in the market, and as Larry mentioned earlier in the call, we have investments in life insurance policies which back what’s called our leadership compensation plan, which is a deferred comp plan for our employees, our team members. When the losses on cash surrender value occur, which is impacted by general market trends, we don’t recognize a loss on the P&L but what we do recognize is either gains or losses in our tax rate, as a result movement in those permanently deferred items, and so that can have a material impact on our tax rate. This year, it had about a $25 million impact on our tax rate and so that is not insignificant. That is the driver of what could move our rate off that 20% bogey that I would normally target, so if the markets grow, our tax rate will be a little lower. If the markets stay stable, you’ll see our tax rate similar to what we had this year, and if we have big losses next year in the market overall, it could amplify our tax rate a point or two.

Peter Arnett: Okay, that’s super helpful. Just lastly from me, Eric, you mentioned you’ve got record levels of PMA, but we still have a lot of traffic down in Asia. I was just wondering how you quantify when we see--you know, if China reopens fully, what the impact could be on FSG. I know you’re kind of already a global player in terms of your customer base.

Eric Mendelson: Yes, I mean, we’re already doing very well in China, and if china presumably--I mean, my expectation, speaking with various experts, is that China is going to experience hundreds of millions of cases of COVID. Whether they get reported or not is another thing. That should have a chilling effect on their domestic travel. The real question is whether that spreads. Based on the vaccination rates and therapeutics that are available around the world and our natural immunities as a result of everybody else getting infected, hopefully it doesn’t impact the rest of the world, but I think China, we’re going to see fits and starts. The air travel went up a lot a couple days ago and now it’s come down. They’re going to be in for a tough 12 months, I think, as a result of where they are with the virus. But we feel very strongly, and that’s why we’re wired to continue to take market share, and I think we’re in a very strong position to do well regardless of how China does, but we are doing very well in China currently.

Peter Arnett: Appreciate all the details. Thanks guys.

Eric Mendelson: Thank you.

Operator: We’ll take our next question from Scott Deuschle with Credit Suisse. Please go ahead.

Scott Deuschle: Hey, good morning everyone.

Laurans Mendelson: Good morning Scott.

Scott Deuschle: Victor, just following up on Pete’s question, could you talk a bit more about supply chain trends at ETG? I know you mentioned that some things have gotten worse this quarter, but you also talked about seeing some green shoots, so maybe just spend a minute talking about some of the details behind that, so what got worse and what the green shoots have been. Thank you.

Victor Mendelson: This is Victor. The answer is it’s particularly on the components side. I mean, we’re finding and a lot of our companies have been finding that FPGAs, for example - field programmable gate arrays are slow to come in, they’re behind in delivery schedules. We have some other very complex microwave components that are designed specifically for some of the products we make, and there are only a few vendors for those in the world and they are well behind schedule. We’ve also seen some lead times pull out--push out for, I won’t go into which subsidiaries, but some polymer-related products that are used in some of the things that we make, so that has been--I guess that’s been where it’s extended out. Where it’s been better has been on some of the lower cost and more common electronic components that are used in circuit boards and other things that we make, as well as for some silicones and products, interestingly enough some polymer-related products, so it’s kind of a mixed bag.

Scott Deuschle: Okay, that’s super helpful, thank you. Carlos, is 1.5% of sales still the right way to think about capex for next year?

Carlos Macau: I think so. We’re probably targeting somewhere around $40 million next year in capex roughly, so that’s about what your math should produce.

Scott Deuschle: Okay, and then last question for you, just as we incorporate Exxelia into the models, anything important to reflect on in terms of cadence there? Is there seasonality to that business, more Q4-weighted, anything like that that we should be mindful of? Thank you.

Carlos Macau: Sure. I mean, look - Exxelia, I’ve often said that it almost mirrors--it’s like a mini ETG. It’s got very similar business strategy and markets, so I think as the electronic technology group flexes throughout the year, I think you’ll see Exxelia perform the same way. The only caveat to that is they are a European-based company, so there can be external factors in Europe that would impact them that wouldn’t impact us here in the States, but those macro things we can’t control, so that will be well known as you read the paper. But no, I don’t think there’s any--there’s nothing on the table that would cause that business to perform much differently than the overall ETG.

Operator: We’ll take our next question from Ken Herbert with RBC. Please go ahead.

Ken Herbert: Hi, good morning. Thank you, and nice quarter.

Laurans Mendelson: Thank you.

Ken Herbert: Maybe Eric, I wanted to start off--I wanted to see within FSG, if you’re seeing anything yet that may lead you to believe that there is some potential slowdown or recession risk amongst your airline customers. I’m curious if you’re seeing anything yet in terms of delayed maintenance spending, downward revisions on work scopes, inventory adjustments, anything like that, and if you think about a potential recession risk, for instance here in the United States, how would that flow through your business? Which parts would be initially hit, and how should we think about the impact or potential impact of that on the segment?

Eric Mendelson: Yes, good question Ken. To start out, no, we have not seen any change in order patterns from our customers as a result of the most recent economic data. Things are continuing to be extremely strong, and as a matter of fact, we just keep on hitting new highs. However, we all know that if a recession comes and air travel is curtailed, there will ultimately be an impact. Now, I think the impact on air travel could be a little less perhaps than it’s been in other periods, only because we were sort of starved for air travel for about two years, so that may mitigate a little bit of it. But certainly the industry will be impacted, and clearly you could see it in cargo load factors and dedicated cargo aircraft flying, that those would definitely be curtailed. But I would anticipate that as far as Heico goes, we’re in a unique position, I believe because of the products that we’ve developed. Although I don’t want to cite on this call what they are, I can tell you that a large part of our rebound has been new products that, frankly, hadn’t been sold pre-COVID, and a large part of that is new products that we didn’t even offer pre-COVID. I think that we’re in a unique position to be able to mitigate that, and that is why our PMA results are at a record whereas the industry is--you know, the number of flights is still down 20%, so that would imply upside to us. I think one of the things, though, that you also have to consider is--and historically you’ve asked the question about destocking and restocking and all that, there’s no question it would be normal behavior in a time of shortage to over-buy, and I think that all recoveries do hit a period of over-buying, the question is when that occurs. Nobody tells you, hey, I’ve ordered 100 parts but I really only need 80 of them right now, and the extra 20 are for the shelf, because they want to get those 20 on the shelf because they’re afraid they can’t get them. I think that’s a natural risk for the industry, but I think Heico’s got the ability to mitigate. Clearly parts and repair would be impacted first and then ultimately new aircraft build rates would be impacted second, if that answers your question.

Ken Herbert: That’s very helpful. Thank you very much. Just as a follow-up, maybe for Eric or for Carlos, the incremental margins in the fourth quarter of ’22 were sequentially the strongest we’ve seen all this year within the FSG segment - you know, mid 40s. How should we think about--it sounded like maybe some moderation on margins from mix in ’23 could potentially be a scenario, but how should we think about incremental margins as we think about ’23, based on the comments you just had and what you’re seeing today?

Carlos Macau: Hey Ken, I would--you know, in a normal run for Heico, as I’ve talked about in the past, you should expect the fixed cost at around 15% plus our normal margin, so that would put us around 35% or 36%. That would be a normal run on growth. That can vacillate depending on events in a quarter and what’s happening, but once we settle into our footprint, once all the businesses have kind of settled down and they’re growing in tandem again, I think that that’s what you should expect. Hopefully as we get into ’23, that will be what I would expect to see.

Ken Herbert: Great, all right, well I’ll stop there. Thank you very much.

Carlos Macau: Thanks Ken.

Operator: Your next question comes from Sheila Kahyaoglu from Jefferies. Please go ahead.

Sheila Kahyaoglu: Good morning guys, thank you for the time. I wanted to start off, I think it was Peter’s question, Eric, that question to you on FSG and your thoughts on the recovery in China. You said you were doing really well in China. How much of your FSG business has recovered in China, and of your 35% of sales of international, how do we think about that split between FSG and ETG, and geographically?

Eric Mendelson: Yes, good questions. Our sales into China in the flight support group are at an all-time record. We’re frankly well ahead of our 2019 numbers, so we’re doing very well there. I think there is obviously upside from here. I remember--I think it was about a year ago or so, and you asked me did I think by the end of ’22, narrow body in the U.S., would it be recovered, and I said I didn’t know and I thought it would be hard. But in fact, not only did narrow body U.S. recover but, frankly, the whole world overall recovered for us. I think we’re in a very good position in all of our markets. It’s hard to say exactly what’s going to happen, to sort of lay out the next 12 months over in China. I think it’s going to be fits and starts. I like reading your weekly report on number of flights, and that’s got a lot of great data in it, but I think we’re well positioned there to grow our market share and we’re gaining market share all the time in China.

Sheila Kahyaoglu: Sure, and thank you so much for that shout-out. In terms of--Victor, you’ve been very busy yourself, and I know people have skirted around margins at ETG a little bit, but they were very strong to end the year. How do we think about that going forward, and I think Exxelia is 150 basis points dilutive to 2023 margins, how do we think about that long term opportunity?

Victor Mendelson: Well, a couple things. Exxelia does carry a lower margin than the ETG average. We haven’t said what that is, so I can’t comment on what it might be, but without Exxelia, excluding Exxelia when I look at--and I think you’ve heard me say this before, that I think we’re within a couple of points on what I call the real operating margin, right, which is--you can sort of think of as a cash flow margin before intangibles amortization but after depreciation. I think that somewhere within a point or two of 30%, either up or down on that, is the right level - I think I’ve been pretty consistent on it, and Exxelia of course will change that somewhat. I continue to believe that’s the case. There are always headwinds and tailwinds, and as you’ve heard me say before, I don’t really come down with a club on people, the people running our businesses, if they’re giving us a 31% margin instead of 32% or a 28% instead of 30%, or a 29%, et cetera. I look at it on a gross basis, an overall basis, so I think our margins should remain healthy and we’ll continue to be pretty proud of them.

Sheila Kahyaoglu: Great, thank you so much.

Victor Mendelson: You’re welcome.

Operator: Our next question comes from Michael Ciarmoli with Truist Securities. Please go ahead.

Michael Ciarmoli: Hey, good morning guys. Nice results. Thanks for taking the question here. I guess Carlos, maybe to dig in, I know you’re not giving the detailed guidance, but you do have that one liner in the press release where you called out potentially higher material and labor costs, so how should we think about that into ’23? Obviously we already covered the FSG margins, they may normalize. It sounds like ETG - you know, pre-Exxelia could pick up. Then I guess just on the revenue side as well, do we expect the normal FSG seasonality, or are we still in the recovery mode here from COVID?

Carlos Macau: I think the way to answer that question is we aren’t giving guidance, but we do expect the company to perform, let’s say better than the industry, just like our history has been. We do expect growth in our sales. I think the stated goal of the company every year when we come out of the box is to grow the bottom line 15% to 20%, and that will be our management team’s goal for the year. We’ve done it pretty consistently for 33 years, and you can see this year we grew 16% on the bottom line, so I think you could reverse engineer it. If you’re thinking about how to get the pieces of that pie, just reverse engineer up from that 15% to 20% bottom line expectation and come up with your numbers, but we’re not going to give detailed guidance at this time.

Michael Ciarmoli: That’s fair. The only other one I had, it kind of relates to guidance, but if we look at ETG, should we expect a pick-up of that $47 million - I mean, that would give you almost five points of growth there, and then think about just kind of a normal potential organic recovery, supply chain easing, because it seems like you’re going to have--you’re going to be off to a good start in ETG if you pick up the lost sales from ’22 here.

Carlos Macau: Well, we don’t know, Michael, when the disruptions from the supply chain fully bleed out, right, so we could have more pushes. But what I will say is that we did have a down year in defense which was in total greater than that $47 million you’re referring to, so I think what our expectations are is that as we get into ’23, we do expect the overall defense market to improve, at least as it relates to Heico, and that should be a nice little tailwind for ETG going into ’23.

Michael Ciarmoli: Got it, perfect. Thanks a lot, guys.

Carlos Macau: All right, thank you Michael.

Operator: The next question comes from Josh Sullivan with The Benchmark Company. Please go ahead

Josh Sullivan: Hey, good morning.

Laurans Mendelson: Good morning Josh.

Josh Sullivan: Just as demand grows for Heico’s PMAs, and I think you’re developing around 400 parts per year, one, what is the duration of the PMA approval process with the FAA look like at this point? Is it getting better? I know you’ve talked a little bit about the work-from-home dynamic. But then two, how are you looking at the PMA opportunity set? Are you looking to move up the value chain at all?

Eric Mendelson: Hi Josh, this is Eric. With regard to the FAA, our cycle time is great, it’s outstanding, so that doesn’t hold us up at all. With regard to the value set, we continue to go after parts similar to what we’ve done in the past, as well as what I’ll call adjacent white spaces, so we continue to really grow the product portfolio. We’ve got the largest portfolio in the industry by far, and we’re very well diversified across a very, very wide group, so I think we’re going to continue to grow. Our customers are asking us to go into more spaces, so we’re continuing to do that. You know, we’ve treated them very well over the decades and we’ve been very reasonable with regards to pricing, and they greatly appreciate that, so they’ve been encouraging us and rewarding us with, frankly, much more business, so I think we’re in a unique position there to continue to grow market share.

Josh Sullivan: Got it. Then maybe just moving over to the space exposure, there’s been a number of M&A transactions in the market on new programs evolving. How are you looking at the space market and that balance between legacy programs versus gaining some exposure to these growth programs that are ramping up in areas like LEO and the lunar markets?

Victor Mendelson: Thanks, this is Victor. We’re looking at that very carefully, as always. There is opportunity in the LEO market for us. We’ve been doing business in the LEO market very strongly and successfully for a long time, and of course we still think there’s some good opportunity in the GEO market and even smaller satellites now in the GEO market. But we are very careful to avoid some of the more experimental, if you will, parts of the satellite business where we would be more of a financial risk partner, where we’re concerned about margins, pricing, stability, reliability and so on. We haven’t taken the bait to go out and buy--I can’t count the number of exciting space companies that we hear about, we get a deal book or a teaser on, and it’s just, pun intended, straight to the moon. We’ve really been resistant to those opportunities because we also know that they’re highly speculative, so we’re going to proceed but proceed carefully. We want to be of very good value to our customers and the ones we have been serving historically, as well as a number of the new ones who we think are serious about buying our products long term.

Josh Sullivan: Great, thank you for the time.

Victor Mendelson: You’re welcome.

Operator: Our next question comes from Gautam Khanna with Cowen. Please go ahead.

Gautam Khanna : Hey, good morning. Happy holidays guys.

Laurans Mendelson: Thank you Gautam.

Gautam Khanna: Sorry, I joined a little late, so I was wondering at ETG, did you guys describe the changes in the estimated fair value of accrued contingent consideration? I was just curious how big that was and what that related to.

Carlos Macau: Sure. This is Carlos. We use contingent earn-outs to bridge deal value gaps when we’re dealing with sellers. Right now on the balance sheet, we have roughly $85 million in contingent earn-out obligations, fair value of $85 million. What winds up happening, Gautam, is a couple things: one, you have to evaluate performance of each of the units and re-compute, if you would, what that earn-out may be; but what really impacted us this fiscal year, fourth quarter end throughout the year, was the interest rates going up, because you have to fair value those liabilities, and as the rates go up, those liabilities shrink, right, so we did have some noise throughout the year for these earn-outs. In particular, we had maybe $2 million or something run through the numbers for the fourth quarter as credits to expense to reduce that liability as a result of the Fed’s moving the interest rate, and ultimately what that does to longer term or intermediate term risk-free rates.

Gautam Khanna: Got it, okay. That’s very helpful. I was curious, you know, a couple quarters ago I think specialized products started to come back within flight support, and if you could just talk a little bit about how that’s trending and if there’s any discernible difference on the defense piece of that, versus the defense piece of ETG in terms of supply chain or just demand trends.

Eric Mendelson: This is Eric. With regard to specialty products, we’re doing very well. In particular, we also have a lot of exposure to, frankly, to missile defense, and we’re doing particularly well in that area, but as well as commercial aviation. Again, we’ve got a unique value proposition in those businesses and I think they’re going to continue to grow and gain market share over time, especially as the aircraft--the commercial aircraft build rates increase.

Gautam Khanna: Okay, and just one last one for me, maybe Victor on ETG, broadly speaking what is your visibility on the defense and space side? I’m just curious, like how far out do you have orders through, and how has that changed maybe over the last year?

Victor Mendelson: Sure. Right now, the backlog for ETG is fairly typical. It’s a record backlog, by the way, and we’ve had record backlog throughout the year, in fact I was looking at every month through the year with the exception of one, we had record backlog, so as a percent of revenue, it seems to be very strong. We have some additional visibility into future shipments, in part because of those supply chain issues, right - that’s a little bit of it, although that is a pretty small fraction, actually, overall, the slippage of our backlog. In terms of defense outlook, I would generally say we are not short lead time on our products, and so it’s at least a good flavor for the next six months at any given moment, typically, and then sort of it starts to deteriorate from there, which is our typical situation. I would say we’re probably in a fairly typical situation now.

Gautam Khanna: Great, thanks a lot, guys.

Carlos Macau: Thank you.

Operator: The next question comes from Louis Raffetto with Wolfe Research. Please go ahead.

Louis Raffetto: Good morning guys.

Laurans Mendelson: Good morning Louis.

Louis Raffetto: Larry, I think you haven’t had the opportunity, so I guess let’s get your take on the M&A marketplace right now. I’ve kind of heard some mixed things recently. Obviously you guys have been busy this past year, but what are you seeing out there right now?

Laurans Mendelson: I think I would say it’s normal. We’re spending a lot of time trying to work with the Exxelia closing, but we are looking for--at a number of acquisitions in both areas, in ETG and in flight support. The market is a little strange now because sellers want high prices that they saw with low interest rates, and buyers, particularly private equity, is having more of a struggle raising money, so I think I would expect to see prices coming down as long as interest rates are up. We are very disciplined buyers, as you know, and I think--I’m hopeful that we will see some good opportunities. We’re looking at many now. Some of the things that we’re rejected, honestly, recently we’ve seen some companies and they were overpriced, well overpriced, and we made offers and those offers were not accepted, but the deals didn’t go either, so the people didn’t sell the company. We have to see what’s going to happen. We’re not going to change our discipline, and as you know, we look for strong cash flow and we want to see our money back, our investment in somewhere between 7 to 11 years, and when you pay 16 times EBITDA, you can’t do it, so we’re not playing in that market - we never did, we never will. I think overall I’m optimistic that we will make our fair share of investments. This past year, we concluded how many, Carlos - six?

Carlos Macau: It was eight deals.

Laurans Mendelson: Eight deals, you know, so that’s enough in a year, eight transactions. Deals, we are opportunistic, we don’t force deals. When deals are priced properly, when we have the right type of company, that’s what we will move on it. I hope that answers your question.

Louis Raffetto: No, that’s great color, thank you. Carlos, maybe just one, I understand no guidance, but what is the acquired sales growth based on deals that closed so far look like for FY23? Is it $150 million, or whereabouts?

Carlos Macau: Are you talking about acquired for next year?

Louis Raffetto: Yes, exactly.

Carlos Macau: Yes, I think it will be between 100 and 150. I know that’s a wide range, but that’s about what it’s going to look like.

Louis Raffetto: Okay, great. Thank you very much.

Carlos Macau: Sure.

Laurans Mendelson: Thank you.

Operator: As a reminder, it’s star, one to ask a question. We’ll take our next question from Colin Ducharme with Sterling Capital. Please go ahead.

Colin Ducharme: Hi, good morning. Thank you very much for the question and the time. I had a couple, maybe I’ll just throw them out in the table all at once here. Carlos, wondered if you could just speak briefly to--just comment on wage pressure and inflation, what you’re feeling now and what you’re hearing from the subsidiaries particularly as you roll forward into 2023, and also talk about the capex, a little muted actually from what I may have expected this past year. You mentioned the step-up as we look forward 12 months. Can you just talk a little bit more about where that money is going? Then maybe for Eric, you addressed the how in terms of margin expansion with FSG. You talked about specialty strength. Can you talk a little bit about the why - you know, not in tandem demand in terms of the different components moving together, but why are customers in particular kind of pulling through specialty here? Then maybe I’ll pause there, and I’ve got one or two follow-ups for Larry, thanks.

Carlos Macau: Colin, I’ll hit your first two questions and then hand it to Eric. On the wage and labor front, we’re highly sensitive to that. We watch it very closely. Because we are spread out, really, all over the country and all over the world, there are different dynamics in each market. The best way that we have found to deal with those dynamics is to allow our folks in the field, the general managers running our businesses to deal with their local marketplace, to deal with the wage pressures and material pressures on the raw material side. We’ve also told them that as it relates to pricing, to try to work with our customers to protect our margins. Our objective is to not be those guys - you know, we don’t want to be the guys that are known as jacking prices indiscriminately. We want to get paid fairly for what we do, and of course if our input costs do go up, we are asking our customers to help us out in that regard to protect our margins and so far, knock on wood, that strategy has worked very well for us. On the capex side, I did discuss around a $40 million number for next year. This year was a little light in aggregate dollars. It wasn’t because we didn’t buy what we needed. I feel like it’s a broken record, but it’s because our folks are frugal, and if they need a million dollar brand-new machine, our guys will put that in as a capex request and then they’ll go out and spend $80,000 on a used piece of equipment, drop another $10,000 into it to refurbish it and use that machine for the next decade. That’s generally what I’m dealing with. Our capex budgets, while I’d give you that $40 million number for next year, not including Exxelia by the way, that’s just our core businesses of today, there is a high probability, like in the past, that we under-spend that, but it will not be because our folks didn’t get exactly what they need to conduct business and plan for the future. Does that answer your question, Colin?

Colin Ducharme: Helpful, thank you. Yes.

Eric Mendelson: And Colin, you asked why - you know, why we have these results in terms of the sales and the earnings, and I really do believe it starts with our low debt decentralized culture. That permits us to make decisions well in advance and always keep our eye on the long term. When you do that, people are then able to spend their energy on creating true economic value. When you look at the crisis that we just went through, we had plenty of inventory, we continued to develop parts, we continued to treat our customers extremely well as a result of that and, frankly, treat our team members very well because they were critical to our business. I think that is the reason why Heico continues to outperform, and it’s not just in parts and repair but it’s also in the specialty products business. There are all sorts of cases that I can give you where we can significantly jack price on customers and we don’t do it. We don’t do it because we want to make sure that we retain that business for the long haul. In the short term, people can play all sorts of games with regard to pricing, inventory, all sorts of metrics that you see in the short term; but in the long term, you can’t get away with that, and if we want to build this market share like we’re doing, the only way to do it is to build the long term and to really have that level of trust, and frankly that’s how we incentivize our people. Victor and I each have a whole bunch of businesses that we go and we visit, we know the people not only running them but we know the people in charge of the different departments, all the way down very often to people on the shop floor. We understand who has a long term culture and who fits with the way we do things and who just plays games, so that’s honestly the why in why this happens. This management team has been here for 33 years - I can’t think of many management teams, and I certainly can’t think of any off the tip of my tongue, that have been there for 33 years and plan on being there decades longer, so.

Colin Ducharme: Okay, helpful. I appreciate the comments. Maybe just a quick follow-up for you, Eric there, just in terms of maybe digging into the why. The role of value-added distribution, I mean, you’ve got smaller private peers that have made distribution in particular central to their business strategy, and you guys yourselves did several quarters ago a string of deals which added--bolstered your muscle, as it were, in this particular area. Typically you’ve got some quasi-exclusive relationships that go along with those types of segments and businesses, and I’m trying to link back to your comments on today’s call on wallet share expansion, and I’m wondering what, if any, critical role value-added distribution in the deals you’ve done in prior quarters are playing today with the wallet share gains that we’re now seeing from you guys, versus other factors like the price umbrella with OEMs, et cetera. Maybe to round out, a final question for Larry, is just Exxelia has a--you know, great deal here, largest ever, has the potential to be a buy-and-build on that continent for you all. Can you just speak to your--the relative maturity of your deal flow model on that continent, meaning are you satisfied with the width of your M&A funnel there? Is it as wide and mature as we perceive the U.S. and North American M&A funnel to be for you all? Thank you very much.

Eric Mendelson: Colin, this is Eric. I’ll take the first part of your question that you asked me - you know, the why on the distribution. Our distribution companies are, in my opinion, the single most successful distribution companies in the industry. They started out as small entrepreneurial companies and they continue to run that way. They’ve got the financial muscle of Heico behind them so we’re able to buy inventory that makes sense, but we also are very, very realistic on the value of the inventory and the value that we bring to the table. You know, you mentioned other companies that are getting into this space and it’s becoming an interesting space for others, and I would throw out that you’ve got to be very, very careful in the distribution business because what we see very often, and if you look into a number of companies you’ll understand what I’m saying, is they have big one-time write-offs. They report whatever it is their margin is throughout the economic cycle and then they wait until there is a 9/11, a global financial crisis, a COVID in order to write off the inventory. If you look at Heico, there’s not a single time that we’ve done that, and the reason is because all of the people in those businesses are geared to make the correct economic decisions to drive cash flow and long term value and not create short term earnings. We start with, number one, low debt which permits us to hold the correct inventory, not the wrong inventory; and number two, we are incredibly rigorous, and I’m not aware of anybody else in t his industry that is as rigorous as Heico when it comes to inventory. We make sure that if we’ve got a problem, we take it off the books and we don’t spend management time or people’s time focusing on that. The final thing that we’ve got in the distribution business, which frankly differentiates us and permits us to do things that nobody else can do, is our PMA reach. We’re the largest in PMA, we’re in at all the airlines, and we have a very, very broad group of products, so if somebody, for example, is distributing a widget on a 737 but they’re not on the A320, Heico is in a unique position to be able to get them in that market. There is nobody else in this industry who can do that, so when you combine all the things that I said - the low leverage, the correct inventory, and the PMA combined with an entrepreneurial approach that is second to none, and these folks are into the details unlike anything that you’ve ever seen, and so I think it’s a remarkable business and I want to call it out, because Heico distribution and our companies in there, in particular led by Seal Dynamics, Blue Aerospace, Air Cost Control are really just absolutely phenomenal and unbeatable in the stuff that they do.

Laurans Mendelson: Hello, are you still there?

Colin Ducharme: Yes, thank you.

Laurans Mendelson: Okay, so you asked me about our reach in Europe. We’re an opportunistic buyer. We have reach throughout the U.S., we have reach in Europe. We have a number of operations, very successful operations in France and we’ve been operating in France for a number of years. When we started, we put our toe in the water and we were very successful, and our companies in France have expanded multiple times. We’ve increased employment, and actually the economic development people in France visit us often throughout the year and they want us to invest in France. They like what they’ve seen and they like how we’ve performed. We’re a big taxpayer over there and we’re a big employer, so yes, we have reach. The Exxelia transaction, we had been looking at that, we knew that company for four or five years. We looked at it, discussed it, and so forth. Yes, we do have reach in Europe, and when we see a good opportunity there, we will take it; but it’s not just Europe, it’s Europe, the U.S., the U.K. too. Does that answer your question?

Colin Ducharme: Yes, thank you. Happy holidays.

Laurans Mendelson: Thank you.

Operator: Our next question comes from Kristine Liwag with Morgan Stanley. Please go ahead.

Kristine Liwag: Hey, good morning everyone.

Laurans Mendelson: Good morning Kristine.

Kristine Liwag: You know, guys, the attractiveness of the PMA market is clear. You guys have made that industry very lucrative. Now we’re seeing another company expand PMA into the hot section of the jet engine, like high pressure turbine blades. How do you think of that market - is that ripe for PMA to enter, and would you consider going into that part of the aircraft?

Eric Mendelson: Hey Kristine, this is Eric. You know, we’re very familiar with everybody in the PMA market, and I know exactly what you’re speaking about. That has been a market that Heico has decided to not enter and to not participate in. It is a potential high reward but it is also a potential very high risk market as well, and we’re very happy in the spaces in which we operate and we think that that really makes a lot of sense from certification, manufacturing, customer acceptance, so we’ve decided really to focus in this market and we’re very happy with that decision. We get along with all of the companies that provide complementary products and we hope that they succeed, but it just--you know, we’ve picked our spots, I would say, very carefully.

Kristine Liwag: Thanks Eric. If that company were to be successful and actually get these parts certified, would that change how you evaluate that industry?

Eric Mendelson: No, it would not.

Laurans Mendelson: Kristine, can I just add a little color on how we look at the world and what our strategy is? Our strategy, as I think you know, is controlled growth. We focus on 15, 20% bottom line growth. We don’t want to hit home runs. We want to control our cash flow, which is very strong, and everything we do is really focused on cash flow, not so much earnings per share. As long as we get strong cash flow from our businesses, including PMA, that is what we’re looking for. We don’t have to have one spectacular thing in the hot section or that type of thing, but we want a broad offering of parts, highly diversified, and the company Heico in general is very highly diversified. I don’t know how many parts we make altogether, but I’m going to guess it’s going to be at 50,000, 100,000--I mean, and it’s highly diversified and that’s intentional. We don’t want to get into one particular product that stands out; in other words, if any one product that we make failed to sell or was discontinued, nobody would even notice it. It wouldn’t affect the bottom line at all, and that’s our strategy. That goes to the idea of making these hot section parts and so, but remember we do have some hot section parts. We used to make blades and so forth, and we have of course combustors, but we want to spread it across a wide number of parts and we don’t have to have one spectacular part to accomplish our objectives.

Eric Mendelson: Dad, I’m glad you mentioned that. One of the other things that’s very, very important to us is, as you can gather from our comments on the call and knowing us for so many years, is our reputation. We don’t want to--you know, when you offer lots of parts, you better be very, very careful that the performance of one part doesn’t impact the rest of the portfolio. We have a unique relationship with our customers, I believe with the FAA, and even our competitors, and therefore we’ve made the decisions that we’ve made which are right for Heico and right for our risk profile and for the benefits that we want to bring to our customers.

Kristine Liwag: Great, thanks Larry, thanks Eric. Really appreciate the color, that’s very helpful.

Laurans Mendelson: Thank you Kristine.

Operator: We’ll take our next question from Mike Hanson , private investor. Please go ahead.

Mike Hanson: I’m one of the minorities, thank you. A question for Victor. According to ETG, when you have sort of marginal sales increase and a 1% decrease in margin, are there parts of the company that maybe you should de-emphasize or spin off and that maybe at the end of the day really wasn’t worth your investment and your time?

Victor Mendelson: It’s a very good question and it’s something that our subsidiaries look at all the time, which is to say the appropriateness of making a part or not making a part, and there are a lot of decisions that go into that. It’s not always purely economic, although the economics obviously are the overwhelming majority of it. There are times when there’s a part that we will make or there’s something we’ll make because we’re selling something related to that. What we don’t do is get into loss making or low margin positions, but if something is lower than the rest of the margin and we feel, or the business feels they need to continue to offer it or it’s still very profitable, i.e. if maybe a contribution margin of 35% and the business is running at 36%, so you wouldn’t turn away 35% business because it’s not 36%. You wouldn’t make in a sense phenomenal the enemy of excellence, so that’s how we do it. It’s a good question, and that’s a part of the business all the time.

Laurans Mendelson: I’d like to add one other thing. If we’re running an operating margin of 28%, 30% in ETG, and we discover a company that has a 24% operating margin, we’ll buy that company and it will lower the overall operating margin of the ETG group. Why would we buy it? Because a 24% or 25% operating margin is a hell of a good margin, and we want that company, so you can’t--we don’t get that focused on absolute margin because there are reasons that we might have reduced margin, increased margin, and we have to be very careful. We’re talking, if you heard me earlier, about overall cash profitability, cash flow, and at 24%, even though it’s not our 30%, we get a hell of a good cash flow, so. You have to take all that--when you think about margin, you have to understand cash flow is more important than margin, but high margin brings cash flow. Does that help a little bit?

Mike Hanson: Okay, that’s perfect. But at the same time, are there times that you really look at an acquisition and say, maybe we made a mistake? Over the dozen years I’ve been with you, you’ve always bought-bought-bought, and I can probably count the two or three companies that I’ve read that you’ve spun off.

Victor Mendelson: Yes, so we buy to own forever, we try to make the right decisions. We’ve never had any disasters, blowouts in acquisitions. We’ve had ones that don’t perform as well as others for some period of time and then our jobs are to improve those, and they do eventually - we get them to where they want to be. We do ask ourselves this question, Mike, all the time - are we better off with an acquisition than without it? We do that, we look back, we analyze it historically, and we view is as our jobs to make sure that what we buy performs, even if it’s not as good of a performance as something else.

Laurans Mendelson: By the way, you mentioned that we spin off companies. We have only sold two companies in the entire 30-some years that we’ve run the business. One was a medical company which we wanted to be out of that industry - it was profitable--

Victor Mendelson: Services business.

Laurans Mendelson: It was a services business, it was highly related to labor and so forth, and we sold that business, I believe in 1996, or ’95--

Victor Mendelson: Yes, ’96.

Laurans Mendelson: The other one was a business that, honestly, we bought for $7 million and we sold it for something like $72 million in about, how many years, Victor?

Victor Mendelson: Four.

Laurans Mendelson: About four years, and the reason we sold it is that the operating margin was low. It was an interesting business, we sold it to a company that liked that--wanted to be in that business and wasn’t focused on operating margin. That business had about a 10% operating margin and it was sucking up cash, it was using so much cash that it didn’t make sense to own the business. But we paid 7 and we sold it for 72, so it wasn’t a bad day. Aside from that, we have not sold any or eliminated any other businesses, and as Victor pointed out, thank God we’ve never had a bust. Some businesses have performed better, some have been not so good, but if you take the overall package, again we’re talking about diversification at Heico, which is a critical strategy for us, putting all those businesses together, as you see, they generated fabulous cash flow and I think that our acquisition performance has been pretty good - you know, close to 100 acquisitions, not having a bust. I think we’ve done pretty well.

Eric Mendelson: Mike, I’ve got a note from the Operator, we’ve actually gone over time, but I’ll just--I will comment, we have not sold a business in 22 years, so that part I can tell you. But unfortunately, I’m getting this note from the Operator that we are over our time by five minutes now, but thank you for the questions.

Operator: I’ll turn the conference back to the speakers for any additional or closing remarks.

Laurans Mendelson: This is Larry Mendelson. I want to thank you all for participating in this call and for your interest in Heico. We remain available to you if you want to call Eric, Victor, myself, Carlos if you have any questions or you want clarification on anything. Otherwise, I want to wish everybody a happy holiday season, a healthy one. If you’re driving or traveling, be safe, and we look forward to speaking to you sometime in mid to late February with our first quarter ’23 results. This is the end of our teleconference. Thank you all.

Operator: This concludes today’s call. Thank you for your participation. You may now disconnect.