HEI - NYSE

Welcome to the HEICO Corporation Second Quarter Fiscal 2023 Financial Results Call. My name is Tamara, 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 severity, magnitude and duration of public health threats such as the COVID-19 pandemic or health emergencies; HEICO's liquidity and the amount and timing of cash generation; lower commercial air travel caused by health emergencies and their 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 will now turn the call over to Laurans Mendelson, HEICO's Chairman and Chief Executive Officer.

Thank you very much, and good morning to everyone on this call. We thank you for joining us, and we welcome you to the HEICO Second Quarter Fiscal '23 Earnings Announcement Teleconference. I'm Larry Mendelson, Chairman and CEO of HEICO Corporation; and I'm 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. Before reviewing our operating results in detail, I'd like to take a moment to thank all of HEICO's talented team members for delivering another strong quarter. As I have said many times before, HEICO's strength comes from its people, our team members. Their commitment to our customers and the consistent delivery of high-quality products and services is what drives our excellent financial results for shareholders. I continue to be very optimistic about the future for HEICO and our over 9,000 team members. I'd like to summarize the highlights of the second quarter fiscal '23 results. They are record results. Consolidated second quarter fiscal '23 net sales represent record results for HEICO, driven principally by record net sales within the Flight Support Group. This arose mainly from continued rebound in demand for commercial aerospace products and services and the contributions from our fiscal '23 and '22 acquisitions. Consolidated operating income and net sales in the second quarter of fiscal '23 each improved by 28% as compared to the second quarter of fiscal '22. These results mainly reflect 10% quarterly consolidated organic net sales growth as well as the impact from some acquisitions. Consolidated net income increased 24% to $105.1 million or $0.76 per diluted share in the second quarter of fiscal '23, and that was up from $85 million or $0.62 per diluted share in the second quarter of fiscal '22. Our total debt to shareholders' equity was 26.4% as of April 30, '23, and this compared to 11% as of October 31, '22. Our net debt, which is total debt less cash and cash equivalents of $627.5 million as of April 30, '23 compared to shareholders' equity ratios was 21.9% as of April 30, '23, and this compared to 5.7% as of October 31, '22. Our net debt-to-EBITDA ratio was 0.4x, less than 1x, as of April 30, '23, and that compared to 0.25x as of -- October 31, '22. Both times were less than 1x EBITDA. The increase in our debt ratio in the first 6 months of fiscal '23 principally reflects the impact from financing the purchase of Exxelia in January '23. Cash flow provided by operating activities was $77.8 million in the second quarter of fiscal '23, and that compared to $96.8 million in the second quarter of fiscal '22. The cash flow provided by operating activities in the second quarter of fiscal '23 reflects an increase in working capital principally driven by an increase in inventory to support our increased consolidated backlog. We continue to forecast strong cash flow from operations for fiscal '23. As a personal comment, I always consider increase in inventories an indication of future growth in sales, so the increase in the inventory does not concern me. I will now discuss our recent acquisition activity. In March 23, we entered into an exclusive license and acquired certain key assets for the aircraft emergency locator transmitter, or as we call it in the industry, the ELT product line from Honeywell International, and this will fit nicely with the business operations of a subsidiary of the ETG Group. ELTs provide critical emergency transition signals in the event of aircraft impact on land or water to enable first responders to aircraft. We expect this license and asset acquisition to be accretive to our earnings in the year following closing. Earlier this month, we announced that we entered into an agreement to acquire Wencor Group for $1.9 billion in cash and $150 million in HEICO Class A common stock, all to be paid at closing for a total of $2.050 billion in the aggregate. Upon closing, which is expected to occur by the end of calendar '23, Wencor would be HEICO's largest ever acquisition in purchase price as well as in revenue and income acquired. Wencor will become part of HEICO's Flight Support Group. Wencor is a large commercial and military aircraft aftermarket company, offering factory new FAA-approved aircraft replacement parts and value-added distribution of high use commercial and military aftermarket parts and aircraft and engine accessory component repair and overhaul services. Wencor is based in Peachtree, Georgia, and provides its parts and services internationally, employing approximately 1,000 team members in 19 facilities around the United States. HEICO recently entered into the financing arrangements to secure adequate funding for the Wencor acquisition. This acquisition is subject to government approval and customary closing conditions. The highly-synergistic acquisition is expected to be accretive to HEICO's earnings within the following year after closing. This acquisition materially expands HEICO's aftermarket product offerings and will enable the combined company to offer even greater savings and greater capabilities to customers while expanding our new products and services development capacity. Wencor is an ideal and perfect highly-complementary fit with HEICO. 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 second quarter results of the Flight Support Group.

Thank you. The Flight Support Group's net sales increased 28% to a record $392.2 million in the second quarter of fiscal '23, up from $306.3 million in the second quarter of fiscal '22. The net sales increase in the second quarter of fiscal '23 reflects robust 20% organic growth as well as the impact from our profitable fiscal 2022 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 second quarter of fiscal '22. The Flight Support Group's operating income increased 51% to a record $99.9 million in the second quarter of fiscal '23, up from $66.2 million in the second quarter of fiscal '22. The operating income increase in the second quarter of fiscal '23 principally reflects the previously mentioned net sales growth and improved gross profit margin and the impact the amendment and termination of a contingent consideration agreement, partially offset by an increase in performance-based compensation expense. The improved gross margin in the second quarter of fiscal '23 principally reflects higher net sales within our Aftermarket Replacement Parts and Specialty Products product lines. The Flight Support Group's operating margin improved to 25.5% in the second quarter of fiscal '23, up from 21.6% in the second quarter of fiscal '22. The operating margin increase in the second quarter of fiscal '23 principally reflects the previously mentioned improved gross profit margin and decreased SG&A expense as a percentage of net sales, mainly reflecting the previously mentioned amendment and termination of a contingent consideration agreement, partially offset by higher performance-based compensation expense. Now, I would like to introduce Victor Mendelson, Co-President of HEICO and President of HEICO's Electronic Technologies Group, to discuss the second quarter results of the Electronic Technologies Group.

Thank you, Eric. The Electronic Technologies Group's net sales increased 27% to a record $301.8 million in the second quarter of fiscal '23, up from $237.4 million in the second quarter of fiscal '22. The net sales increase principally reflects the impact from our fiscal '23 and '22 acquisitions as well as increased net sales of our other electronics, aerospace and space products, offset by decreased defense products' net sales. The Electronic Technologies Group's operating income increased 3% to $68 million in the second quarter of fiscal '23, up from $66 million in the second quarter of fiscal '22. The increase in operating income principally reflects the previously mentioned high net sales volume partially offset by a lower gross profit margin and lower efficiency levels, mainly resulting from the impact of our January '23 acquisition. The lower gross profit margin in the second quarter of fiscal '23 principally reflects decreased net sales of defense products, partially offset by net sales increases of our other electronics and aerospace products. The Electronic Technologies Group's operating margin was 22.5% in the second quarter of fiscal '23 as compared to 27.8% in the second quarter of fiscal '22. Keeping in mind that the ETG's noncash amortization is about 5 percentage points, this performance equates to what we consider to be the real operating margin metrics by which to measure a business of around 27.5%, which is a strong performance at the operating level and consistent with my prior comments about the rough range where I expected our margins to be. The lower yet strong operating margin principally reflects the previously-mentioned lower gross profit margin and increased SG&A expenses as a percentage of net sales, mainly from the previously-mentioned lower efficiencies. Our Defense sales remained lower than the prior year, as anticipated and as I discussed on our last earnings call. This overall reduced operating margin, despite the strong sales increases of our other electronics and aerospace products. In a little more detail on those sales, our Commercial Aviation sales and backlog have been particularly strong, and I would expect that to continue for some time. Sales of our other high-end electronic components have been healthy, though I still expect some softening in those markets overall as the year wears on. Our Commercial Space sales grew, and overall, we have a good products backlog, though deliveries are not linear over the course of the year. Exxelia, our largest ETG acquisition, has performed in line with our expectations so we are very happy with this acquisition. But as we've often explained, Exxelia's operating margins are lower than the average ETG segment margin -- operating margin. And consistent with our prior comments, we expect -- we continue to anticipate that Exxelia will reduce the consolidated average ETG operating margin by approximately 2 percentage points going forward. On supply chain, we continue to make progress in reducing our sales that have been delayed due to supply issues, with our subsidiaries now estimating that amount fell below $30 million, even into the mid- to low $20 million out Exxelia. The majority of our businesses tell us that overall supply conditions are either the same as or better than they were, and they anticipate continued, though uneven improvement throughout the year. Of course, we remain very confident in the ETG's outlook, both long and short term, as our ETG companies are a remarkable and irreplaceable set of businesses that are managed by gifted leaders and filled with talented team members. Further, given the combination of the ETG's record backlog, the overall expected delivery timing for that backlog and anticipated orders, we expect our Defense Product net sales to start to increase within the next year. Though, of course, we can never be certain of the timing and exact sales levels. I'll turn the call back to Larry Mendelson.

Thank you, Victor. As we look ahead to the remainder of fiscal '23, we continue to anticipate net sales growth in both the FSG and ETG groups, principally driven by demand for the majority of our products. Additionally, continued inflationary pressures and lingering supply chain disruptions stemming from the COVID-19 pandemic may lead to higher material and labor costs. During fiscal '23, we plan to continue our commitments to developing new products and services, further market penetration and an aggressive acquisition strategy while maintaining our financial strength and flexibility. We believe that our ongoing conservative policies, a strong balance sheet and a high degree of liquidity enables us to continuously invest in new research and development and to take advantage of periodic strategic inventory purchasing opportunity, as well as executing on our successful acquisition program. All these collectively position 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. Their persistent drive and determination to win in the marketplace has resulted in another quarter of outstanding results, and we thank you for all that you do to make HEICO a great company. I would now like to open the floor for questions.

[Operator Instructions]. And we'll take our first question from Rob Spingarn with Melius Research.

First, congratulations on the Wencor deal. I have a couple of questions on that. So Eric, if it's okay, if I could just start with you. I wanted to ask if you could perhaps offer some color on the differences between the 2 companies' PMA, distribution and component repair businesses, and how those complement one another?

Great. Rob. I would be happy to. We're very, very excited about the Wencor deal because of the complementary nature of the transaction. If you look at their various businesses, their product lines really complement HEICO's very well. HEICO started out over in the PMA area focused on engine parts, Wencor has focused on non-engine parts. HEICO also does non engine parts, but there actually is very little similarity in the product that we do. And as a matter of fact, the HEICO component repair stations purchased all of the Wencor PMAs because HEICO doesn't offer those PMAs. So we're very excited about the complementary nature there. With regard to component repair, Wencor overhauls a lot of components and is in a lot of market niches where HEICO is not in, so we think that that's going to broaden us. And then likewise, in distribution, we focus in different areas. Wencor is, for example, has a very large position over in the bearings area whereas HEICO basically doesn't -- isn't involved in the bearings business. So we think that overall, this is going to permit HEICO to become a more efficient and stronger competitor by giving more products to our customers at lower prices, so we're very excited about it.

And so Eric, this isn't -- based on what you just said, this isn't just additive putting the 2 together, but it sounds like there's a pretty decent cross-selling opportunity where Wencor's customers can buy some more HEICO parts and the opposite.

Absolutely. We feel very, very strongly about that. There's a whole product line that HEICO doesn't offer that we're going to now be able to offer to the airlines, and frankly, give them more choice, greater opportunity, greater savings, and it's really going to work out very well. Also, Wencor's got a whole set of manufacturers that makes product for them, and frankly, a lot of those manufacturers, I think can also make product for HEICO as well and vice versa. So we think it's really going to create a tremendous amount of efficiencies. And sort of lastly, HEICO has focused over the years more on, I would say, the airline market. Yes, we serve independent repair stations and brokers and smaller customers. But Wencor really has a world-class e-commerce system, e-commerce platform, which I think is going to be a really great value to our customers. So I mean, I know that our component repair stations' like buying parts from Wencor, so I think that as we bring the best that both companies have to offer, I think it's really going to be good for our customers.

Okay. And just to close the loop on this, Eric. I think normally, HEICO or FSG does about 300 to 500 new PMAs annually, get added to the catalog. I'm not sure what that equivalent number would be for Wencor. But should we assume that the pace of product development in addition to the catalog won't change for either company? Or is there a different answer there?

Correct. I would say that it would definitely not go down, and it would probably go up as our -- as we offer -- as we've got a more fulsome product line to offer to our customers. I think that there's going to be additional development opportunities, yes, so we view it very much as additive. And in today's market, obviously, labor is very tight. We've got a great workforce. Wencor has got a great workforce. We share -- our DNA is very, very similar. Companies that view themselves as small compared to the very large companies in the industry, and we're really very much focused on product quality, turn time, service and pricing. And I think that there's -- it's really a great, great marriage. And frankly, something that we've all wanted to do for quite a long time, and I'm just happy that we are able to get it done.

Rob, this is Larry. As a comment to summarize, we really believe that this combination is a great win for our customers because with expanded capacity and we believe that we'll be able to offer customers better pricing, lower pricing, more products and more efficiency. So we look at it not so much as a win for HEICO and Wencor, which I think it will be, but really a big win for the customers and the industry. As you know, HEICO exists because its pricing is below the OEM, and that's the reason that they buy our products, we're 30%, 40% below. And this will give us the capacity to give even more value.

Larry, Eric, thank you very much. Victor, Carlos, I had a couple for you, but I'll step aside.

Thank you, Rob.

We'll take our next question from Peter Arment with Baird.

Larry, Eric, Victor, Carlos. Victor, maybe I can just start with you. ETG margins are now kind of fully reflecting the inclusion of Exxelia. How should we think about the progression from margins to go back towards kind of the 27%, you mentioned the 200 basis points or the 2% kind of impact, but how are you thinking about that progression back?

Yes. Peter, this is Victor. It's a good question. Right now, I'm keeping our assumptions within close distance of where we are. I think you probably know, we're always fairly consistent -- excuse me, conservative when it comes to this. I do believe that as some of our defense products pick up later this year, first part of next year, which tend to be higher margin, that it should bring the margins north of where we are. But I'm more comfortable right now saying that we'll stick where we are. But you've always kind of heard me say that I think within more or less 10% of where we are is a healthy zone. Now of course, that excludes acquisitions, right? So acquisitions could change that materially, depending on what [indiscernible].

Yes, that's helpful. And then, Eric, just another one on margins. Just -- it seems like the March performance here continues to be incredibly impressive at FSG, but you mentioned the elimination of contingent agreements. Maybe just a clarification that -- how big was that? You said it was partially offset by stock comp. And just how do we think about kind of FSG margins here going forward? I know excluding Wencor, but just you've had really strong performance post-COVID. Just any clarification there would be helpful.

Peter, this is Carlos. I'll take that one. The earnout on the 2021 acquisition, that was basically 2 tranches of earnout that we were going to pay, subject to operating performance levels. The company that has those earnouts with the prior owners, we believe more than likely would have made that earnout. We have probability weighted, the likelihood of that outcome to be a success for them. The seller requested a mechanism to get him his earnout sooner, and what we want up doing was renegotiating the earnout structure and paying them the $9 million of earnout basically this quarter versus paying it to them over the next -- I think the first tranche would have been done at the end of next year and the second tranche at the end of '26. So they basically monetized the earnout today and gave up the upside on the back end. I think the earnout would have been -- the first tranche, $9 million, second tranche $18 million, so he took $9 million or basically $27 million in possible earnings. And we thought that was a good deal for our shareholders, a good deal for the -- our partner, the owners of the company we bought, and that's how it all came about.

And also just to add, the proposal to do this was from the -- from our partners, so this wasn't that HEICO initiated for both. So our partner came to us with the suggestion. We said, sure. If that's what you want to do, we're happy to go ahead and do it. Company is performing extremely well, and we couldn't be happier with it and with our partners over there. So it's I think, as Carlos said, a win-win. And then you also asked with regard to the margin. So post-COVID, HEICO has done very well. I think that we have shown to our customers that we started out as a very small company, and everybody's heard me say this 100 times. When you start out very small, you've got to make sure that you keep your customers happy. It's sort of obvious because if you don't do that, you're out of business. And we -- due to our approach of having inventory, we had inventory on the shelf and when, frankly, others ran out of inventory. And we continue to keep our people. We continue to work with the customers, and we added product lines, we added new parts. And as a result, we're doing really, really well. We also shrunk our footprint a little bit as a result of COVID due to some changes in the market, and I think we've become a lot more efficient. So all of this coming through, I mean, obviously, the $9 million isn't going to repeat. But even if you pull that out, the operating margin was above 23%, which is really very, very good. And again, that's in a period of time where we're making our customers happy and supplying parts to them and expanded product line at very, very competitive prices. So I really have to hand it to our team because frankly, in the corporate office, we just sort of make the acquisitions. But the folks in the field were the ones who figured out how to do this, and the numbers just roll up where they do. We don't tell them where to be. It's just that's what comes out of the machine at the end of the day. So I really have to commend them for this.

Appreciate all the color, and congrats on Wencor.

Our next question comes from Larry Solow with CJS Securities.

Great. Congrats on a really strong quarter. Maybe, Eric, we'll stick with you and just maybe some -- a little more color just on -- just on the Commercial Aviation. Just your markets, obviously, you grew 20% this quarter, and I think that was on top of like close to 25% organic growth in Q2 last year at 23%. We've recovered pretty much from COVID, I guess, or at least a narrow body, right, has recovered. Maybe you can give us a little color, narrow-body versus wide-body? And just recovery from COVID? Where we're going from here? Have you seen any change in order patterns or airlines holding more or less inventory? Any color there too would be great.

Larry, thanks. I'd be happy to answer that. The sales -- the organic sales growth has really been, frankly, amazing. In Flight Support, we just had our eighth quarter of organic growth over 20%. So the one thing to have 4 quarters where you bounce back, but it's . And the numbers are, frankly, surprised me to the upside every single quarter, and there's a lot of strength out there. I think that the airlines are getting ready for summer season. They know that it's going to be really tough this summer. Everybody wants to fly, whether it's for leisure or business. And they are very, very conscientious and very focused to make sure that they complete those that fly. And so as a result, they make sure that they've got the inventory. I keep on asking our people, I meet quarterly with our sales leaders and I want to understand where we are. And they just see, frankly, continued strength. So Asia was -- it is the last region, if you will, to recover. A widebody is also the last of the fleet type to recover. But we see added interest in the stuff that we're doing, so we're able to bring on additional principles and develop additional parts and repairs. And I think it just in general, speaks to the market. I mean, ultimately, there will be a slowdown. We can't continue at this pace forever, and -- but I'm still very, very bullish that even when that slowdown or a little [indiscernible], which again, we don't see on the horizon right now. Even after that occurs, we're going to continue to ride right through this just as we had in the past. It's like impossible at a time -- impossible to time these things, and that's why we're so committed to the market.

Got it. And I have just a follow-up just on the margin question, and Carlos can chime in. I think your margins ex the onetime benefit, like, for the segment year-to-date or in the first 2 quarters, close to 23%. Carlos, just how should we look at that going forward? Feel like you're operating close to -- all cylinders are close to it. Is this a high watermark? Should we tail back a little bit as you look out over the next couple of quarters and even now? Just your feeling on that.

I mean, look, it's -- intention not giving guidance, so be careful about what I say. But I do think that we are in a circumstance right now in the business environment where the segment is performing extraordinarily well. You've got high growth, you've got good product mix, so we would love this to continue. And I think that if we're -- I think where we fall out candidly is between maybe '22 and '23 as a run rate type segment margin. But I don't want to make too many promises right now because we still have to settle into our footprint from the disruptions that were caused by COVID.

Got it. Great. I appreciate that color. .

We'll take our next question from Pete Skibitski with Alembic Global.

I guess maybe for Victor, ETG. Victor, just within Defense, obviously, there's been some supply chain issues. But kind of beyond supply chain, are you seeing areas where your Defense sales are strong, some areas where it's weak? Is it just kind of a timing mismatch right now in terms of what the Pentagon is prioritizing for purchases?

Yes, this is Victor. So the answer is yes, and it's not unusual for us to have a variety of results in different businesses. It's maybe a little more pronounced between some of our higher and lower margin products and businesses now than it has been at other times. In some cases, we have backlog, but delivery is not due yet. In some cases, we're expecting some large orders, some of whom -- some of which have been delayed. Others are for foreign military use to maybe U.S. customers, or they may even go through the DoD, like FMS or things of that nature. So that's why we tend to have that optimism as we get a little bit further out. But it is, as you pointed out, this is a little bit of a mixed bag, which is not terribly unusual for us.

You don't feel like you've lost any market share? Or the competition has gotten particularly intense amongst suppliers?

Yes, definitely not. We feel strongly we haven't ceded market share on any products or programs. It's more, in a sense, what they're buying at the particular moment. But we feel pretty good about the backlog and the orders and the order estimates going forward. But again, I'm not anticipating it as a next quarter change or even necessarily the quarter after that. I think it goes a little further and deeper into time based on when I look at our backlogs, our delivery schedules and some of the orders that we're anticipating.

Okay. So am I right, when you guys talk about Exxelia being 2 points of headwind, I think from a core perspective and some modest increase in amortization. So it still seems maybe you're down a couple of points year-over-year in underlying core margin at ETG, and so is that basically all mix essentially? So you really need defense mix to recovering ETG to get back to kind of the core level of margin that you did in the past year or 2? Is that the right way to think about it?

That's a good way to think about it. I think that's right. Or mix on some of the other higher-margin products that we have.

Okay. Thanks, guys.

It doesn't have to be defense. Well, I think it's defense weighted.

We'll take our next question from Kristine Liwag with Morgan Stanley.

With the recent acquisition, once you complete this, I think Laurans, you mentioned that you expect net debt to EBITDA to be below 3x. But this leverage is still higher than where you've historically operated. How do you think about the debt load for the business going forward? I mean, when you look at the other main after -- commercial since aftermarket player, I mean, they could lever up as much as 7x net debt to EBITDA. So one, is this kind of the 3x as the new normal? Or do you anticipate to go where you've historically operated at below 1x? Or does this give you appetite for even further leverage, maybe not as much as 7x but maybe higher than 3x?

So to answer that question, first of all, I want to emphasize that according to our projections, when we closed this transaction, Wencor, our debt-to-EBITDA will be under 3x. I think the number is 2.8x or 2.7x, Carlos?

Yes. Net-net.

Net-net will be under 3x. The reason that we insisted upon giving HEICO A shares in the transaction was the purpose to keep the leverage under 3x. HEICO has never been a highly -- as you mentioned, never been a highly leveraged company. Until now, we've never been above 2x. We've been below. Our projections show that within a year, we expect to be slightly below 2x again. So to answer your question, at this point, we are not thinking about becoming a highly leveraged company at 6x or 7x. We felt that taking leverage on at under 3x and being able to reduce it within approximately 1 year below 2x is consistent with our past practices of being very conservative on the leverage side. So the other thing that I want to point out that we don't give guidance, but we do tell the that we project. We try to grow 15% to 20% bottom line on an annual basis in this compound. We have done that pretty consistently for the past 30 years, and according again to our projections, we believe that we will be able to, in '24, grow within that 15% to 20% increase. Now of course, everything is dependent upon market conditions and everything else. But based on everything we know today, this acquisition will permit us to continue to compound at least in '24, and our leverage will be below 2x when we get to the end of '24. So I presume that we will continue to make smaller acquisitions as long as the leverage does not go up. So I don't know, does that answer your question?

Yes, it does.

Our next question from Pete Osterland with Truist Securities.

I'm on for Mike Ciarmoli this morning. First, I just wanted to ask one on the Wencor acquisition. Given that historically you've operated acquired companies on more of a stand-alone basis, how are you thinking about the integration of Wencor into HEICO? Are there any preparations you're making that you can talk about that are perhaps different than for some of the acquisitions you've made in the past?

Yes. It's a great question, and something we've been thinking about quite a bit. Wencor is a very, very well-run company, and they've got tremendous asset in their people. So frankly, our plan at the moment is just to acquire it and believe it as a separate stand-alone company for the near term. Let's see what benefits could exist between the 2 companies over time, we'll share best practices and we'll figure out how to serve our customers even better. So I think there's obvious areas where we can help each other continue to grow and improve, but the plan is to believe it is a separate stand-alone company for the moment.

All right. That's helpful. And then just kind of a follow-up on some of those synergies that you might expect from the Wencor acquisition. Do you expect that as a combined company, it might give you an opportunity to speed up development of new PMA parts? Or do you anticipate there might be any benefits related to scale in terms of working to get PMA parts approved?

Yes, that's also a great question. In terms of scale and getting PMA parts approved, we've got a great track record with the FAA to be able to get parts approved so I feel pretty confident that we'll be able to continue to add to that. Wencor has, as I mentioned earlier, a product line that HEICO doesn't offer so I think that this is going to add to the portfolio. And yes, it will speed up the development because right now, for example, HEICO wants to develop the type of part that we haven't done in the past, whereas Wencor has done that type of part in the past then we would be able, yes, to develop it more quickly. So I think that that's going to be a benefit. Also, when we go to customers, very often, customers ask for a broader product line. And by adding the 2 product lines together, we're going to be able to cover a lot more of the waterfront. And so we're very excited about all the benefits that that's going to bring.

Great. Well, congrats on the acquisition.

We'll take our next question from Sheila Kahyaoglu with Jefferies.

Congratulations. Larry, I want to ask you a question first. You mentioned inventory and supply chain a few times in your prepared remarks, and you guys have typically done very well with cash conversion. So maybe can you talk about that? And Eric, you also referred to inventory and having supply ready for customers. Is this something new? Is it specific to a certain business? And maybe -- if you could talk about that.

No, I think two things were happening. Number one, our backlog is larger, and to fill that backlog to supply the customers on time, we have to have inventory. So that went up. Number two, because of supply chain issues, our subsidiaries want to make sure they have inventory on the shelf to meet the customers' demand. So those 2 things increased the inventory. And that was the main increase, I think, in inventory.

And then also, Sheila, to add to that. We are anticipating additional growth in the businesses and in particular, over in the distribution side. Picking up additional principles, additional territories, so we had to grow inventory for that. And then also, I think everybody is pretty aware of the extended lead times in the industry. Product that used to have 4-week, 8-week lead times now can have anywhere from 26 to 52 week lead times. And we want to make sure that we are able to service our customer and we've got the parts on the shelf. And as a matter of fact, the head of our distribution business told me this morning that a very major, major industry player out there who is a very big customer, we've got 98% on-time delivery in a market where we are having the place of the 52-week lead times for the products to which we are distributing to that. So in the -- the way we're able to get 98% of this particular business on time delivery when others are dozens of points below that, is by holding the inventory. So we want to be there for our customers. We've never been cash constrained. We want to make sure that we invest in the right inventory. It doesn't do any good to have the wrong inventory, obviously. But we got the right inventory, we make our principals happy, and we're able to service our customers. So I think that's really why inventory has increased and we think it's the right thing to do.

Okay. That's helpful. And then, Victor, maybe for you with Exxelia. I mean, obviously, we all understand that it's lower margin, but is it lower margins now? Is there something structural in the business? Or is it just a factor of its footprint?

Look, it's a good margin business in absolute terms. It's just not as high margin as the rest of the business. Their margins have been increasing over the last several years. I think that I would expect that to continue, but I don't anticipate it's going to get to the same margin as the rest of the ETG in the near term at least or in the next couple of years, absent some acquisition or acquisitions which would change that story. So we're very happy with the margins. They're very good, but just not as high as the rest. And that went into our acquisition decision.

By the way, Sheila, in past conferences, we have stated that the ETG Group would acquire a strong company that had a lower margin than -- I mean, when ETG was 28% or 33%. We always said, if we bought a company that had close to 20%, it's going to lower the average margin. But the cash and profit generation and the size of the acquisition of Exxelia warranted us saying, fine, we'll lower -- we'll take a lower operating margin because this is a very fine company. And by the way, it has great management, and we believe it has the ability to grow. So those things overrode the desire. It would have been great to have higher margin. We do believe that as we build in some efficiencies, that margin can creep up.

Our next question comes from Josh Sullivan with The Benchmark Company.

I'm going to comment of doing PMA parts you haven't maybe done in the past using possibly some of Wencor's expertise, what is your appetite to expand the PMA waterfront? Where might you go with PMA you haven't gone in the past?

Yes, it's a great question and it's something that we thought quite a bit about. We think that there's a whole set of parts that we just haven't been able to tap as efficiently. And if you look at HEICO's sort of developed a certain skill, engineering skill set to go after the types of parts that HEICO does and Wencor has done the same for the parts that they have done. And by being able to focus in each of those areas, I think there's going to be a lot more that we can do together. A lot of these parts made up, so you can have a complex part next to it. That's a complex part, but the 2, there's certain interaction between them. And so this is really going to help us develop a much fuller product set because we're going to be able. But basically, we'll be able to expand into areas that we haven't done in the past.

And then just on the growth of PMA in general, there's some thought PMAs have benefited from some of the struggling OEM supply chain issues. How should we think about that dynamic? If and when OEM supply chains recover, do you still think PMA growth will be strong in the years?

Well, I sure hope so. We think that there's really been a permanent shift and change in the industry. So we've been out there, both HEICO and Wencor have been out there preaching to the customers for whatever, 50 years about PMA, and it's taking in a certain period of time. But you know the old saying, what is it, that necessity is the motherhood of invention? And so we've been out there with, frankly, as good technical product, if not better. And don't get me wrong, our -- the OEM companies out there supplying the market, they supply very, very fine products. So to supply products that are the same as the OEM is quite a technical challenge. And then frankly, in order to have the products on the shelf, that really takes a tremendous amount of effort. So I think we are in a very, very good position to continue to grow our sales. And we compete with the OEMs, and they are really high-quality, excellent companies and they're really, really tough to compete with because they offer a very broad product set at -- with an outstanding quality. So we think that this is the opportunity to obviously bring multiple products together and be able to compete with the OEMs on a better basis. Also, I have to say, I don't want to mention which ones, but even OEMs have now moved to buying both HEICO and Wencor PMA product because if they don't have the parts on the shelf and they've got to shift even their own repaired units. And again, I don't want to go into which ones or what they are, but they purchase our parts to go ahead and do that, saying we're happy to sell it to them. So I think it's really coming together, and there is what I believe is a permanent market shift in how HEICO and Wencor products are viewed in the marketplace.

Our next question comes from Tony Bancroft with Gabelli Funds.

Well done on the quarter, very nice. Just -- maybe could you just frame -- could you frame maybe what else is out there in the PMA market? Who else participates there besides the Wencor's? It sounds like they're one of -- I mean, small relative to you, but larger ones out there. Is that where you want to focus going forward? And maybe -- just maybe talk about that.

Yes. Tony, this is Eric. I'd be happy to go ahead and go over that. There's a long list of competitors who supply PMA parts there. And I don't want to call them out by name, but they exist and our customers know who they are and they work with them, and so I think that will continue. Our area really for future acquisitions, I wouldn't say is in the PMA area. Our area for future acquisitions would be -- I want to be careful not to because we welcome our competitors to this call, but we don't want to exactly tell them what we're going to be going out after. But we think that there are a lot of adjacent white spaces in which HEICO does not participate. Many, many. And HEICO is still, even though we've done quite nicely, we're still a very small company and there's so much more to do out there. So I think we're going to grow, we're going to focus in areas that are additive and really broaden our product set so we can bring more -- we can become a more efficient and stronger competitor and be able to bring more products to the marketplace.

Our next question comes from Colin Ducharme with Sterling Capital.

Quick housekeeping for Victor, Carlos on ETG. Did you give the organic sales number for that segment for the quarter as though I missed it? And then a follow-up, I'll just ask them all at the same time here. A follow-up on just pulling the thread for the Wencor deal for Eric and/or Larry. I wanted to maybe pull that thread with -- using kind of 2 lenses, the strategic and financial. So strategic, you talked about the marriage of both PMA franchises. But can you talk about perhaps marriage of distribution and PMA? And what I mean by that is it sure looks like Wencor has put more muscle in recent periods into signing exclusive distribution agreements, and I'm wondering if you can now bring to bear your larger PMA catalog and marry them with some of those distribution agreements? That seems like a logical strategic synergy there. And then from a financial lens, in your previous responses, you talked about not doing anything different or special with integrating this culture and then having the same DNA as you all. We kind of view the real asset of HEICO is your culture. And one differentiator, if you look at this asset now, Wencor in prior years, you're talking about a business that has borne the load of a debt load 6x, 7x, 8x EBITDA, and that burden is significant. It does inhibit some reinvestment. And now, they're going to be able to benefit from a much stronger financial model. So can you just talk a little bit about that? That DNA looks and smells a little different in terms of opportunity and the capacity to reinvest, and so I would just love to hear you tee off with some opportunities there.

Yes. Let me make one comment. Wencor was owned by private equity, and their model is heavy leverage. HEICO, when it closes, will own Wencor and our model is low leverage. So that leverage situation will totally disappear. Yes Eric wants to.

Yes. And Colin, I mean these are really great questions, and I'm glad you're hitting on them. Both HEICO and Wencor are in the distribution market, and the unique benefits that we bring to our distribution partners is that we're able to -- first of all, we both very much focus on the details. Starting out as small companies, we really focused to make sure that we get maximum benefits to the customers, making sure that they know what's available for [indiscernible] that we get the products sold. But the other area of similarity is both HEICO and Wencor have been able to bring 2 distribution partners the ability to develop additional parts that they don't already offer in their catalog. And I'm glad you're mentioning this, because this is something that we've been thinking about. HEICO, to date, we have distribution partners and we've got the ability to develop certain PMAs and we're known at the airlines for developing those PMAs. But for the existing distribution partners that we've got, there's a whole set of additional parts that Wencor can bring to the HEICO distribution partners and really help them, and likewise, HEICO can bring to the Wencor distribution partners. So I think that this is going to increased competition in the distribution aftermarket and make the products that go into the airlines just being that much bigger, so they're going to be able to save a lot more money on it. So that was on the strategic side. You asked also about financial and the culture side. The businesses, the people are really, really similar. Again, as I said, focused on the detail, focused on quality, making sure that we're out there with the customers, whatever they need, when they need it, we move heavy on earth for them, and that is identical in both HEICO and Wencor. And you're right that the people are the real assets, I mean, that's the most important part of the business by far. And Wencor has been constrained as a result of having -- being private equity owned, and they have been constrained. And I think frankly, HEICO's lower leverage is going to free the Wencor people to be able to go out and sell additional product, take additional inventory positions, call it additional inventory, if that's what makes sense, broadly what they do. And again, that's going to help our customers because the more we sell them by definition, the more they make. I mean we've got, by definition, competition on pretty much every single thing that we offer. And our competitors are these big, huge companies that do a phenomenal job and are really, really hard to compete with. So Wencor, in a sense, has had one hand tied behind its back for the last number of years. And now, we're going to be able to go out and free that hand. And I think it's going to work out really, really well for our customers. And then I think you had some ETG. Carlos or.

I got to follow that. All right, so you asked about the ETG. For the quarter, it was down 3% organically, most of that driven by Defense. The other slips within the ETG organically were all up. They were either flat compared to the prior quarter or were all up, so that's the quarter. And I think for the year, it's similar. It was some around, year-to-date, around 2% down for the segment on organic growth.

[Operator Instructions]. We'll take our next question from Noah Poponak with Goldman Sachs.

Can you frame your market share now in PMA and then where Wencor sits in that respect? And it sounds like you do not foresee any issue in terms of closing with that combined size in PMA. Is that because the combined PMA there would still be small as a percentage of total PMA? Or because it would still be small as a percentage of total aerospace broad aftermarket?

Yes. We don't know specific shares because it's impossible to get that information. But our competitors, as we've always said, are the OEMs. And when you look at the OEM aftermarket sales, I mean, we are -- we've always said that we are absolutely tiny, tiny compared to them. So this is going to give us the ability to compete better with the OEMs. So we still view our market share as very small. We think the product into which we can grow is very, very considerable, so that's why we're very optimistic for the future and why we think that there is really a lot of opportunity here.

Were you able to, in the diligence process, look into whether or not market share and just PMA would be a factor?

No. I mean, look, we study everything, but the -- as I've always said, and I've been asked on these calls for 20 years about what are the factors in the marketplace that affect us the most, and it's always been the OEMs. It's always been. I mean the OEMs, they have the home field advantage, they're selling the original product. They're in there. They got point of sale ability. When they sell the asset, they're able to tie up the maintenance long term. They offer a full product set. That's always been our competition. So my -- I mean, if you had to pin me down and get what our market share, the combined market share against aftermarket parts, I guess it's in the 2% area. I mean, it's very, very small, and that's what I think there is a lot of opportunity to really grow. And frankly, look, it's 2%. We're never going to be -- we're never going to have the sales of some of these very large companies. But I think we can continue to grow our product line and be able to offer more product at very good prices to our customers and save them a lot of money. I mean, the airlines are saving a fortunate as the result of our products. And if they're able to do that and we're at 2%, I think they'll be able to save even more as we move forward here.

No. As -- this is Larry. As you know, the OE generally has a monopoly position in replacement parts. He starts off with offering the only available parts. If they want to replace parts, they have to go to the OE. HEICO has a tiny share because of its PMA, but PMA has succeeded because of its price benefit to the airlines. So we offer a much greater value to the airlines, and that's where our competitive advantage exists. So that -- you know what the marketplace looks like, but we are very small compared to what the market is. And we only -- essentially, we said we only compete with ourselves. So we try to grow the bottom line 15%, 20%, but that's a tiny share of the overall market.

Okay. I appreciate all that. I just had 2 more. One, was the accelerated earnout or the contingent consideration, was that in the FSG segment EBIT and EBIT margin in the quarter?

It was, Noah. The $9 million was a liability on our balance sheet up through the middle of Q2, and then we reversed it when we renegotiated the transaction. It went through EBIT in the segment. So there was about 2.3% worth of benefit to the OEM margin related to this matter.

So Carlos, I guess that's a pretty sporty margin if I adjust that.

Yes.

Should I work from there going forward? Or does that have some other favorable timing that doesn't repeat in the near term? Or how should I think about the next steps there?

So look, I'm always conservative when we talk about margins because really, who knows, right? But I would say and what I've told people pretty consistently is that we're in an extraordinary time right now where the business is growing and growing. We have product and our sales, as Eric pointed out, was it 8 quarters of 20% or higher growth? So when you're in an environment like that, you get tremendous leverage on your fixed costs, you get favorable product mix, et cetera. I am cautiously optimistic that the margins will remain high. Today, I'm more optimistic they would be higher than it was yesterday. What's that number? If I'm modeling I'm thinking 22% to 23% might be the norm for the segment, but I can't tell you that with great specificity because we need the business to calm down, if you would. The industry came down, take a pause, et cetera. And once we see what the footprint looks like, it will be an easier question to answer. But right now, all businesses within the Flight Support Group are firing on all cylinders. So this -- this is what you get in a period like this, and we'll see where it shakes out once the industry growth came down a little bit.

Interesting. Okay. And then what was the organic growth or decline in just Defense within ETG revenue?

So it was double digits. It was in the low teens, and that's been a little better than it had been in prior quarters. And I think that Victor pointed out, I think the trend is that we're starting to see a little bit of life in the Defense segment. And hopefully, for the ETG hopefully, that plays itself out towards the back half of the year.

Defense was down double digits in the quarter?

Yes. In ETG. It was up quite nicely in the FSG, by the way, but it was down in the ETG. Defense Electronics, in particular, has been soft for about the last 4 quarters.

And it sounds like you expect that to maybe be a little better in the back half, but probably still down year-over-year? Is that what you're looking for?

That's what we're hoping for, yes. If you look at the backlog and the timing of deliveries, as Victor talked about earlier, that's what we think is going to play out.

Yes. I appreciate it.

We'll take our next question from Louis Raffetto with Wolfe Research.

Eric, you've provided some really good thoughts on the FSG business in Wencor. I guess as we think about product development, you kind of mentioned you guys did some parts, Wencor did other parts, but you guys could maybe leverage each other. I guess how do you think about HEICO wanting to do a part that maybe Wencor would have done in the past? How do you manage that going forward?

In general, I would say that in the past, if Wencor already had a part, HEICO would not develop the part. So they really sort of play, if you will, very much in 2 sandboxes. So we think that we're really going to be able to get best of breed here, whereby each business can focus on what it does exceptionally well. And also, there's a lot of engineering and technical tools that each company uses, frankly, that can improve the process of the other company as well. And I think all of this put together is just going to benefit the customer with a broader product set in going into areas where we -- where we haven't gone into in the past. I'm reluctant, as you can imagine, Louis, to get into specificity because we don't want to tip people off as to where we're going. But we think that there's a lot of stuff to be developed where no alternative exists now, and we're going to be able to go that stuff.

Right. I guess, Victor, one for you. In the press release and on the call, you kind of mentioned these lower efficiencies or lower level of efficiencies due to Exxelia. I guess I'm just trying to understand exactly what that means. Is that just sort of the drop-through of the dilution? Or was there some other level of lower efficiencies as a result of the deal? Did something else happen?

Yes, I think it's just the drop-through of the dilution.

Okay. Just wanted to make sure that was it. And then just one last one for Carlos. The 2.7x to 2.8x leverage multiple you kind of mentioned and Larry mentioned, to be clear, that's not pro forma, that's just kind of adding the $1.9 billion? I guess, technically, if you kind of give yourself credit for that EBITDA, I think it should be lower, probably under 2.5x. Is that correct?

We'll see. I mean I think the net leverage in our model is supposed to be around $2.8 million. We'll see how much is outstanding on our line. When we [indiscernible], it will all be dependent on how much debt we pay down between now and closing, so -- but that's where our best forecast is right now.

Sorry, but is that including any EBITDA from Wencor? Or is that just sort of the HEICO EBITDA and then the Wencor ?

It would be the pro forma earnings for both companies.

We'll take our next question from Gautam Khanna with TD Cowen.

I wanted to ask a couple of questions. First, on the Wencor multiple, you guys are paying for it. Maybe just a little bit of background on the sale process? Like it seems like a fairly low multiple, all things considering. Was it an auction? If you could just describe some of the background to how this acquisition came about?

First of all, it's a good question. We have known about Wencor for many years. We were aware of it. In previous times, we try to buy it at much lower prices. There was an auction. We were competing with some -- what we consider pretty well-financed private equity groups. We don't feel that we paid a low price. We feel that we -- actually, I feel that I pay a high price, and much higher than we had really wanted to pay. So the auction pushed us up, and we paid what I consider and we consider a market price.

Yes. So I mean look, obviously, we always try to do right by HEICO shareholders so we want to pay a most reasonable price possible. It was very competitive. There was a lot of interest in the company, and we think that it was a fair price for this business. I mean, it's a large business. It's a large asset. It's much bigger than anything we bought in terms of earnings or people, revenue. So I think overall, it's a fair price for -- it's a very fair price for the business, and we're really excited going forward. There is, as we said, great opportunities for our customers. So overall, we think it's going to work out very well.

And perhaps could you just frame -- on paper, looks very accretive, but then there's amortization and other deal-related costs. What is your expectation for earnings accretion in '24 and then perhaps in '25? Just to help frame it.

Well, I'll tell you what, I'd be happy to answer that question for you when we close. At the moment, we've signed a deal but we haven't closed it. So I rather not get into forecasting that stuff until we've actually closed on the deal.

Fair enough. Curious, Eric, if you can talk about mix within the quarter? Specialized products versus the other 2 subsegments at FSG, if that helps kind of the margins in the quarter?

Yes, they -- look, all the businesses had very similar organic growth between parts and distribution, specialty products and the repair. So I mean, they were all in sort of similar areas. Some parts of the business have higher margins than other parts of the business, but overall, we're pleased with the development in each. We think that specialty products, there's still plenty of tailwind to cover because the OE cycle has not fully recovered. And we think that we are, frankly, best of breed in what we do over in the specialty products area. And I think that there is a lot of opportunity, a lot of opportunity for us here to continue to grow and do well and as the business -- as the industry recovers. And also, when you specifically talk about specialty products, Wencor doesn't have a manufacturing capability, or relatively minimal. And this is one of the other very complementary features of the deal because we've got some really outstanding, truly, truly best-in-class manufacturing capabilities within our Specialty Products group. So while Wencor will continue to be loyal to its existing suppliers as we develop additional product going forward, I think that there's going to be a very, very good capability for Wencor to use some of the HEICO Specialty Products businesses as manufacturers. And also, we'll be able to create some redundancy so we don't just have single sources for some of these products. We're really good at this machining, sheet metal fabrication and composites, various stuff that we do. And I think that that's going to provide opportunities for Wencor to grow their product set to get into areas where perhaps traditionally, they have gotten into because they didn't have a supplier to be able to make something which is somewhat similar to what they've done, but different. So I think Specialty Products is going to be a great asset for the combined company going forward.

And just one last one. I was wondering if you could comment on whether there are any, maybe regions, that are still lagging with respect to demand that has -- still have a big catch-up opportunity? If there's anything you can say by customer set or region or some other way?

Yes. We look at the sales. And I mean, obviously, in Asia, things have not fully recovered, and likewise in South America. I think that there continues to be opportunity, if you will, recovery coming out of COVID. Frankly, in our other markets, we're way ahead of where we used to be where we were pre-COVID, and we're doing extraordinarily well. And I think, again, that's a result of just being able to sell more stuff. So I think that there's added recovery opportunity. In particular -- and I think everybody is aware of the widebody in Asia. I mean, that's the last thing to come back, and so there's a very good opportunity there.

And there are no additional questions at this time.

Thank you very much. I want to thank everybody who participated on this call, people who asked questions and those who were just listening. I want to remind you that if you do have questions, give us a call. We'll try to respond to them. And unless you have any other comments or questions, I want to again thank the HEICO team members. They are the guys who make it happen and they do a phenomenal job. And we will -- in another 3 months, we will have another third quarter earnings call. Thank you all, and this is the end of our prepared remarks.