HEICO Corporation (HEI) Earnings Call Transcript & Summary

Okay. Moving along, our next guest is Victor Mendelson, the Co-President and [ CO ] of HEICO's Electronic Technologies Group. HEICO is the world's largest manufacturer of FAA-approved jet engine aircraft component related parts other than OEMs and their subcontractors as well as a leading producer of various types of electronic equipment for aviation, defense, medical, telecom and electronic industries. HEICO has 83 million A shares and 55 million common. The common trade around 252 or $30 billion market cap, $2 billion of net debt for a $33 billion total enterprise value. We are honored and delighted to have with us today HEICO and Victor. Victor, thank you for being here.

Well, thank you very much, and thank you for having me here today. It's always a pleasure. It's a great conference every year look forward to...

Thank you for coming in and making the effort. I appreciate it. I don't think I should have to say this, but I'm still going to. Maybe for those less familiar, maybe you can talk a little bit more about what HEICO does. But I think most of us all know what you guys do and the performance you guys have had.

Sure. So we're really -- what we're about is generating cash. I think that fundamentally that's what it's about. I'll tell you more -- in a little more detail. But my brother and my father and I took control of the company in 1990. It was a small business with about $25 million in revenue and about $25 million market cap. And we actually -- I won't bore you with the entire story, but we actually had a proxy contest for control, which interestingly enough we lost and had to sue the company over, but very long story. But the bottom line is we got control. And we were always committed to building the equity value of the company. And our view was to build the company's equity value. We had to generate cash. We had to do it increasingly, reliably, very consistently and sort of, as I say, no games. So we have an opportunistic business. And in having an opportunistic business, we started with and we're most known for the part of our business, which I think is probably the most exciting. And that is what they call PMA parts. So in order to put a part on a plane, any part on a commercial aircraft has to have FAA approval. The original manufacturers, of course, get that approval when they design the plane new. And the planes need to be rebuilt more or less every 6, 7 years, on average, more or less. And so a lot of parts have to be replaced, and if you don't replace the parts, you don't fly the plane. It's that simple. And so the original manufacturers are the only approved source usually. So what you do if you're the only approved source, of course, rational people raise prices, and they raise prices 6% to 13% a year regardless of the economic conditions. We -- when we took over the company, that one part under this PMA Authority, and PMA Authority basically allows a producer to reverse engineer the parts on the plane, show through testing computations that it is identical and sell those in competition with the OEMs. It's sort of like generic drugs are to the pharmaceuticals. And it applies to every part of the plane. So armrest to the most complicated part, hot section in the engine. It doesn't matter where you got to get FAA approval all the same. So we started that one part and people looked at it as sort of gray market, and what are you doing? Is this really reliable? It's not an easy business. We're the alternative source. So we've started with one part, and that's really what we're most known for. Today, we have about 20,000 parts. It took us 2 years to get our second approval to make a part. And I have some parts here. If it's okay with Mr. Gabelli to illustrate the point, and if you've seen this before, "Oh, thank you." Thank you. Thank you very much.

I'll start on this side here.

So there are 3 bags there. It's a bag with some metallic parts. You'll notice little rings. There are bushings that go in the CFM56 engine. There are 1,000 of those in the bag made of -- I mean, the parts are made of ordinary cobalt steel, and no special process. There's nothing really unique or phenomenal about them. Again, there are 1,000 of those in the bag. There will be a quiz. And if you've heard this before, please don't answer the quiz because that would be -- yes, exactly. And then there's a bag of 78 drain plugs that will be obvious what those are. They go on the threshold of a 737 when you walk in the door because fluids can get in, rain or whatever. And it's just a drain cover, right? And then the other is, I think, 392 Teflon washers, which I think go in an actuator in hydraulic system somewhere in the plane, I forget exactly where and which plane. So I will ask you a question about those in a moment, but that's what we're most known for. And we kind of created that market. It didn't exist. It's been a long, tough slog. In my opinion, we should be doing multiples of what we sell in those parts. But it's very hard. It's very hard to convince people to buy an alternative on an airplane. I think obviously, we've done very well with it, but there's just a lot left for us to do. There is so much penetration remaining, and it's been a great business. My brother, Eric, is really the one who built that and sort of created that value within. And so along the way, customers asked us, "Well, gee, can you do accessory component repair and overhaul." So we don't run hangers. You got to fly a plane into us. We're not doing whole engines. We go where there's a lot of value added with some engineering in parts as opposed to just selling labor. So we have accessory component repair business. We believe it's the largest non-OEM and non-airline accessory component repair business in the U.S. also with some operations outside the U.S. and sales outside the U.S. for that business. But that's grown, right? Customers liked us selling the replacement parts, so we got deeper into that, which led us, in turn, as I said, we're an opportunistic. Let us then turn into distribution. And we have specialty distribution businesses, which are extremely successful within our business -- within our company. And they are not just stock distributors, where there's a catalog and somebody pulls off the catalog, they actually engage in sales and development for really sort of very often the second source of supply for a particular part that may have 2 approvals on the airplane and they are, again, very successful. All of these businesses, by the way, we started out with acquisitions. We've made about 100 acquisitions since 1996 when we started making acquisitions, most typically from the entrepreneur, founder manager, so it's entrepreneurs like we are, right? Like people who are really concerned with the bottom line and the business is performance. They stay close to the customer. We don't believe in a structure where there are vice presidents and group vice presidents and assistant vice presidents. We don't want anybody too far from the customer for the engineering. And that's panned out well. We've noticed that in a small business, if you look at HEICO, we've got about 10,000 people, but it's not 10,000 people in some one location. It's about a 100-person operations, that kind of thing. And if you've got 75 or 100 people in a business, there's nowhere to hide. If somebody doesn't show up today, the boss knows. And so that's a big part of our thought process. And then we make specialty components. So for example, we make the entire, or not the entire, but most of the body of the Patriot 2 missile, the Arrow 3 missile. Mostly, it's for missile defense. So we make some serious components in those. We don't make, obviously, the whole missile. And there are a number of others, Hellfire, exhaust nozzles, things like that. So we have a lot of specialty components we do, and that includes the machining and milling. But again, in niches, we're not looking to do it on a broad basis. And then we have an electronics business, which I oversee. And that is we call our Electronic Technologies Group. And there are niche subcomponents found in -- they're basically mission-critical, high-reliability parts that are required for something else to work. I brought a few of them here today, by the way. I'll pass these around as well. I got to get them all back. But this is a communications antenna we make. I believe we are the largest maker in the U.S. of maybe the world of commercial aircraft antennas. Communications and navigation and things like that. But the range is pretty broad. We make, for example, again, we stay in the niches. So we are the leading maker of laser rangefinder receivers. So we don't make a rangefinder, we don't make a laser system for military purposes. We just make the receiver chip that picks up the reflected light in the atmosphere and then helps the system calibrate where the weapon needs to go. I'm also handing around a point-of-load converter. It's a satellite product from our subsidiary near Paris, called 3D PLUS, a company we acquired back in 2011, a very successful company, which is probably on every satellite. That's made as well as -- that's right, some memory modules that are used in satellites. So again, the strategy has always been in a sense to go where others ain't. And to focus -- let the businesses operate themselves, those 100 acquisitions I mentioned from the -- 80% from the entrepreneur founder managers. They want to sell to somebody who will keep the business operating where it is under the same name with the same people. People often ask me, isn't that risky? You're going to have these businesses spread around, and I actually think it's less risk because if you buy right, we're not buying broken businesses or businesses with poor records and or even records. We're buying businesses that have stood the test of time. We don't buy new businesses. And they've been through every downturn in every problem there is. So kind of in a large nutshell, that is what we do. There are a lot of other components we make in the electronics business. We are the producer of the of the -- what they call pingers, people refer to as pingers, the underwater locator beacons that are used on cockpit voice data recorders, people call them black boxes. They're actually orange boxes, but -- and I'm going to hand around a memory module that we also make at that French subsidiary, and our operations are spread around the world.

Well, that's a wonderful overview, and it was such a nice pleasant surprise opening up 13Fs this past quarter and seeing the Berkshire of aerospace and defense industry meeting the actual Berkshire. So congratulations with that. We've always thought that. For the ETG business, the Electronic Technologies Group, how do you think about meaningful growth drivers and whether from a specific program or just specifically maybe in defense itself? Where are you seeing the growth drivers there?

Yes. So right now, in our Electronic Technologies Group, for those of you who know the company, we've always said that's a business that should grow low- to mid-single digits organically, and then we grow, obviously, more with acquisitions. Right now, and I would expect it to carry through, but we're doing our fiscal '25 budgets now, fiscal '25 for us on November 1st. I would expect defense to continue to propel us. I think, a recovery in our non-aerospace markets, non-aerospace and defense markets, which are about 30% typically of that business. I would expect to see that right now. It kind of feels like recoveries start sometime in the first 3 years, 6 months of calendar 2025. So I think we'll get a tailwind from that from those other markets. Commercial aviation has been extraordinary for us. in ETG as it's been in the rest of the business. And I would expect that to continue to be strong. It's a nice mix of new production as we call line fit and aftermarket.

If you could -- could you maybe break out the growth differential between the -- in ETG within space, aerial and ground programs?

Sure. Space, I would say space is going to be, if I were to guess for us, probably a lower single-digit growth rate for us. And again, I have to be careful because I don't have the budgets for next year, and I don't want to get out ahead of regulation FD. But I think that commercial aviation, I just would expect that to continue to be in the higher -- mid-to-higher single digits. And I would hope that space -- excuse me, defense would do that, too. But again, big caveat there is we haven't done our budgets yet, and they could be totally wrong.

Could you maybe talk a little bit more about an ETG portfolio, your split of OEM versus aftermarket. Is there a PMA -- how large is the PMA component, or is there in the ETG business?

We really only do PMA in the Flight Support Group, but we do have some of the ETG businesses work with our PMA companies and supply them and help them on engineering. What we want to, of course, is compete with the customer. I mean we're not going to sell to a customer in our electronic technologies group and then go compete in the Flight Support Group. So we are fastidious about that.

Why isn't the aftermarket opportunity not larger in this ETG business? It seems like there potentially could be lot of programs. What's the dynamic there?

For the most part, most of the products don't fail, right? And they're not wear parts. So the aftermarket portion is fairly small now. In commercial aviation, in that part of the business aftermarket is meaningful. But the other things we make tend to be electronic components, capacitors, power supplies, resistors, position sensors, laser range finder receivers, antennas that go on missiles or other munitions that maybe there's a test or something on the ground. They've got it to some sample testing, but by and large, those obviously don't come back.

We could talk maybe about defense budgets. What do you see -- obviously, elections coming up? What do you see as far as different scenarios and with the defense budget, and how it would impact the ETG business in the new administration?

Yes. It's a very good question. I really don't know. There are a lot of arguments to be made. I mean, certainly, President Trump, in his first term, believe strongly in recapitalizing the defense space. And if that's an indication of what he do in his second term, that's great. He seems to be concerned about our foreign commitment, so I am not sure if he would have the same commitment too. But my general sense is he gets it. He gets that a strong defense is a great way to avoid wars. Ronald Reagan said, "Of the 4 wars in my lifetime, none happened because America was too strong." And I think Trump buys into that. I'm not sure what Harris buys into. I don't think anybody really does, join my bias there. But I do know that she probably wants to get reelected, they -- Biden administration has been committed to places like Ukraine and Israel and others, too, along the way. So it's -- sorry to equivocate, but I really don't know what the answer is.

Could you maybe talk about -- maybe moving over to the other -- the FSG business...

And could I take a moment -- where are those parts? You have 3 bags back there and the others? That would be great if I could add them back. So here's the quiz, and we'll start as we talk about the flight support if it's okay with you, if we could start with the quiz. So again, for those who have not seen this before, and don't tell your neighbor, if you have, don't supply the answer. There's nothing to win here anyway. I'm not going to leave the parts behind as you can tell. Thank you so much, I appreciate it. They're all there. I've got to count though in any event. So these bags -- so let's start with this bag of bushings, the things the washers, the thousand bushings. How much do you think the OEM, they go into CFM56 engine, how much do you think the OEM charges for that bag of parts? Okay. I heard $2,000. Any other guesses? Okay. That's -- by the way, that is -- that would be expensive, right? I mean these are things you -- looks like you go into Home Depot, and you put them in a scoop, and they're $0.01 a piece, you walk out a few bucks later. And so the price of this bag is $50,000 at OEM pricing. By the way, the new version is almost $100,000. And the reason very simple. We weren't in the market for it. For that part, that bag is building up, we don't get approval on a part and start selling and until there's a large enough -- sufficiently large base, it doesn't make economic sense. So the 392 Teflon washers, $50,000. And finally, these phenomenal 78 drain plugs $50,000. So you get the idea. That's why we're critical to our customers. We help them control their costs and -- anyway. So I just -- I wanted to answer that as we started...

That was good of a segue you can get into. Switching to the FSG business. Given the leverage to older aircraft, how does organic growth over the next few years look like that is going to track out? What are you seeing there?

You're talking about for the parts business or flight support...

FSG. I'm sorry, the FSG.

FSG generally -- so our target for FSG generally is in the upper single digits. And we think that's achievable organically. I'm talking about the organic part of it. And that's a mix of the parts business, of course, and all the others that go into it. And again, we look to more or less double that or maybe a little less than double, but through acquisitions, sort of 50-50.

Given airlines are -- and again, part of the segue here is they're focused on cost savings. Has there been evidence of further interest in PMAs, obviously, costs have gone up for these airlines. Could you explain some of the dynamics going on there?

Yes. There's a lot of interest. We do notice that airlines become much more energetic and excited about buying from us when they have their own difficulties, and that's logical, no shock there. And they tend to approve parts faster -- to sell these, as I said in the beginning, it's difficult. Need engineering approval, you need purchasing approval. And purchasing is incented in a totally different way than engineering. Engineering is not incented to do that to approve any alternative. It's sort of a pain in the neck, right? They've got to worry about keeping the planes flying. They're not necessarily there to reduce cost. Also, they typically are populated by engineering departments by former OEM people. And so they believe buying the OEM product is the right way to do it. But we seem to get through increasingly, and it seems to be moving faster for us than it has historically.

I'll open the floor up to the audience. Any questions? If not, we'll continue.

Thought I was off the hook.

You talked about the amount of PMAs that you've done and you talked about 300 to 500 a year. Is there a natural ceiling to the amount of SKUs that you could do on an aircraft, or how far could this go?

I think there is -- I'm not sure exactly what that is. I mean it's a lot higher than where it is right now. And the limiting factors, one is throughput through the FAA is 1 limiting factor. The second is throughput through the airline's own engineering departments, and we've tried to help them with that, but not the easiest thing to do. But those would typically be the limiting factors in terms of our production. I don't think we're limited and in terms of our engineering talent, I don't think we're limited there either.

Maybe I should frame that. Could you say -- could you remind us again or talk about what percent of the fleet actually uses PMA parts.

PMA parts constitute somewhere around 1% to 2%, we believe, of the market. So it's tiny. And in fact, because of that 6% to 13% price increase each year, interestingly enough, Mr. Gabelli's heard this before from me, the market expands more than our size every year from price increases alone. And so it's like the expanding universe theory, right? We can never get to the edge of the universe because it just keeps growing. And it's a good problem to have, right?

What about -- obviously, the industry has shifted to sale leasebacks and leasing. How is that -- maybe how has that changed the relationship with you and -- versus directly airlines, or can you discuss that dynamic?

Yes. Usually, the operator is responsible for maintaining the plane. And so they've got to run it, they've got to operate it. I know there are some leasing companies historically banned the PMA parts. Like you said, if you sign a lease with us, you can't use PMA parts. I think you've got to be brain-dead to do that. I mean it really is a mistake because you put your customer to a serious disadvantage. Someone else is buying parts of roughly 30% less. And then your customer can't buy them. So that's really, really changed. And the theory was so -- the theory was that if you populate your plane with parts that cost 30% less, then the value of your plane is 30% less. So it's like if somebody's got a fancy car and they use some other air filter than the, I don't know, Rolls-Royce air filter then somehow your car is no longer worth $0.5 million or something like that. So -- and people are seeing through that logic and -- or lack of logic. And increasingly, that's not an issue for us.

Maybe before we go, we can talk a little bit about your capital allocation and your great use of your cash flow. What do the M&A market look like right now? Obviously, you're big acquirers and maybe you could sort of talk through that.

Yes, it's extremely strong for us, and it's in both parts of the business. It is mostly our typical sell or entrepreneurial founder manager looking for a good home for the business, but it includes some that we're looking at from private equity as well as carve-outs or product lines. We've bought those. As I said, we're opportunistic. So we bought from all of those kinds of people. Of course, we're strategic, and there are things we want to buy, but we're not going to buy if it's not right. So maybe a great product, but the price is too high, or it may be cheap, but quasi product, any of those variables in the mix just don't work, those permutations wouldn't work out. It's got to be right across the board. And we're looking at various sizes of businesses, anywhere from a few million dollars of EBITDA. We look at EBITDA because that's cash flow. I mean, the D is the same as CapEx more or less. It's a proxy. The A is amortization of intangibles, and that's a phony GAAP number. But -- and that's not cash, obviously. So look at EBITDA when we buy a business and anywhere from a few million dollars in sales -- excuse me, in EBITDA up to the $50 million or so range. And I heard somebody a couple of days ago and our company said, "Gee, if we buy everything we're looking at and history tells us, we won't." But everything we're looking at sort of seriously and we could spend $2 billion in fairly short order. That -- I can't imagine that will happen. I can't imagine that will happen because history is a guide, we get into diligence and things don't always pan out. But anyway, it's very active for us, a little too active right now.

A lot of opportunities and a lot of success. Congratulations. It's hard to keep up with you guys. Thank you for coming and making the time and hope to have you back next year. Well done.

Well, thank you. And it's always an honor to come here, and I can tell you when the news about [ Virtuous ] 13F came out, Mr. Gabelli made a very nice post on X about us, and I think that was even more thrilling to me.

Thank you so much. Thanks, Victor.