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Dec. 19, 2019, 4:39 p.m. EST

10-K: HEICO CORP

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(EDGAR Online via COMTEX) -- Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Our business is comprised of two operating segments, the Flight Support Group ("FSG") and the Electronic Technologies Group ("ETG").

The Flight Support Group consists of HEICO Aerospace Holdings Corp. ("HEICO Aerospace"), which is 80% owned, and HEICO Flight Support Corp., which is wholly owned, and their collective subsidiaries, which primarily:

Designs, Manufactures, Repairs, Overhauls and Distributes Jet Engine and Aircraft Component Replacement Parts. The Flight Support Group designs, manufactures, repairs, overhauls and distributes jet engine and aircraft component replacement parts. The parts and services are approved by the Federal Aviation Administration ("FAA"). The Flight Support Group also manufactures and sells specialty parts as a subcontractor for aerospace and industrial original equipment manufacturers and the United States ("U.S.") government. Additionally, the Flight Support Group is a leading supplier, distributor, and integrator of military aircraft parts and support services primarily to foreign military organizations allied with the U.S. and a leading manufacturer of advanced niche components and complex composite assemblies for commercial aviation, defense and space applications. Further, the Flight Support Group engineers, designs and manufactures thermal insulation blankets and parts as well as removable/reusable insulation systems for aerospace, defense, commercial and industrial applications, manufactures expanded foil mesh for lightning strike protection in fixed and rotary wing aircraft and is a distributor of aviation electrical interconnect products and electromechanical parts.

The Electronic Technologies Group consists of HEICO Electronic Technologies Corp. ("HEICO Electronic") and its subsidiaries, which primarily:

Designs and Manufactures Electronic, Microwave and Electro-Optical Equipment, High-Speed Interface Products, High Voltage Interconnection Devices and High Voltage Advanced Power Electronics. The Electronic Technologies Group collectively designs, manufactures and sells various types of electronic, data and microwave, and electro-optical products, including power supplies, laser rangefinder receivers, infrared simulation, calibration and testing equipment; power conversion products serving the high-reliability military, space and commercial avionics end-markets; underwater locator beacons used to locate data and voice recorders utilized on aircraft and marine vessels; emergency locator beacons utilized on commercial and military aircraft; electromagnetic interference shielding for commercial and military aircraft operators, electronics companies and telecommunication equipment suppliers; traveling wave tube amplifiers and microwave power modules used in radar, electronic warfare and on-board jamming and countermeasure systems; advanced high-technology interface products that link devices such as telemetry receivers, digital cameras, high resolution scanners, simulation systems

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and test systems to computers; high voltage energy generators, high voltage interconnection devices, cable assemblies and wire for the medical equipment, defense and other industrial markets; high voltage power supplies found in satellite communications, CT scanners and in medical and industrial x-ray systems; three-dimensional microelectronic and stacked memory products that are principally integrated into larger subsystems equipping satellites and spacecraft; harsh environment connectivity products and custom molded cable assemblies; radio frequency ("RF") and microwave amplifiers, transmitters and receivers used to support military communications on unmanned aerial systems, other aircraft, helicopters and ground-based data/communications systems; communications and electronic intercept receivers and tuners for military and intelligence applications; wireless cabin control systems, solid state power distribution and management systems and fuel level sensing systems for business jets and for general aviation, as well as for the military/defense market; microwave modules, units and integrated sub-systems for commercial and military satellites; crashworthy and ballistically self-sealing auxiliary fuel systems for military rotorcraft; nuclear radiation detectors for law enforcement, homeland security and military applications; high performance active antenna systems for commercial aircraft, precision guided munitions, other defense applications and commercial uses; silicone material for a variety of demanding applications; precision power analog monolithic, hybrid and open frame components for a certain wide range of defense, industrial and medical applications; high-reliability ceramic-to-metal feedthroughs and connectors used in the industrial and medical markets; technical surveillance countermeasures equipment to detect devices used for espionage and information theft; and RF sources, detectors, and controllers for a certain wide range of aerospace and defense applications.

Our results of operations have been affected by recent acquisitions as further detailed in Note 2, Acquisitions, of the Notes to Consolidated Financial Statements.

Presentation of Results of Operations and Liquidity and Capital Resources

The following discussion and analysis of our Results of Operations and Liquidity and Capital Resources includes a comparison of fiscal 2019 to fiscal 2018. A similar discussion and analysis that compares fiscal 2018 to fiscal 2017 may be found in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of our Form 10-K for the fiscal year ended October 31, 2018.

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Results of Operations

The following table sets forth the results of our operations, net sales and operating income by segment and the percentage of net sales represented by the respective items in our Consolidated Statements of Operations (in thousands):







                                                               Year ended October 31,
                                                                2019            2018
        Net sales                                            $2,055,647      $1,777,721
        Cost of sales                                         1,241,807       1,087,006
        Selling, general and administrative expenses            356,743         314,470
        Total operating costs and expenses                    1,598,550       1,401,476
        Operating income                                       $457,097        $376,245
        Net sales by segment:
        Flight Support Group                                 $1,240,183      $1,097,937
        Electronic Technologies Group                           834,522         701,827
        Intersegment sales                                      (19,058 )       (22,043 )
                                                             $2,055,647      $1,777,721
        Operating income by segment:
        Flight Support Group                                   $242,029        $206,623
        Electronic Technologies Group                           245,743         204,508
        Other, primarily corporate                              (30,675 )       (34,886 )
                                                               $457,097        $376,245
        Net sales                                                 100.0 %         100.0 %
        Gross profit                                               39.6 %          38.9 %
        Selling, general and administrative expenses               17.4 %          17.7 %
        Operating income                                           22.2 %          21.2 %
        Interest expense                                            1.1 %           1.1 %
        Other income (expense)                                       .1 %             - %
        Income tax expense                                          3.8 %           4.0 %
        Net income attributable to noncontrolling interests         1.5 %           1.5 %
        Net income attributable to HEICO                           16.0 %          14.6 %
        


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Comparison of Fiscal 2019 to Fiscal 2018

Net Sales

Our consolidated net sales in fiscal 2019 increased by 16% to a record $2,055.6 million, up from net sales of $1,777.7 million in fiscal 2018. The increase in consolidated net sales principally reflects an increase of $132.7 million (a 19% increase) to a record $834.5 million in net sales within the ETG and an increase of $142.2 million (a 13% increase) to a record $1,240.2 million in net sales within the FSG. The net sales increase in the ETG reflects organic growth of 10% and net sales of $66.1 million contributed by fiscal 2019 and 2018 acquisitions. The ETG's organic growth is mainly attributable to increased demand for our defense and aerospace products resulting in net sales increases of $60.6 million and $14.0 million, respectively. The net sales increase in the FSG principally reflects organic growth of 13%. The FSG's organic growth is mainly attributable to increased demand and new product offerings within our aftermarket replacement parts, specialty products and repair and overhaul services product lines resulting in net sales increases of $95.4 million, $31.5 million and $10.8 million, respectively. Sales price changes were not a significant contributing factor to the ETG and FSG net sales growth in fiscal 2019.

Our net sales in fiscal 2019 and 2018 by market consisted of approximately 52% and 53% from the commercial aviation industry, respectively, 35% from the defense and space industries in both periods and and 13% and 12% from other industrial markets including electronics, medical and telecommunications, respectively.

Gross Profit and Operating Expenses

Our consolidated gross profit margin increased to 39.6% in fiscal 2019, up from 38.9% in fiscal 2018, principally reflecting an increase of .9% and .4% in the ETG's and FSG's gross profit margins, respectively. The increase in the ETG's gross profit margin is principally attributable to increased net sales and a more favorable product mix for certain defense products. The increase in the FSG's gross profit margin is principally attributable to the previously mentioned higher net sales within our aftermarket replacement parts product line. Total new product research and development expenses included within our consolidated cost of sales were $66.6 million in fiscal 2019 compared to $57.5 million in fiscal 2018.

Our consolidated selling, general and administrative ("SG&A") expenses were $356.7 million and $314.5 million in fiscal 2019 and 2018, respectively. The increase in consolidated SG&A expenses principally reflects $21.6 million attributable to the fiscal 2019 and 2018 acquisitions, $9.1 million of higher performance-based compensation expense and $3.8 million attributable to changes in the estimated fair value of accrued contingent consideration.

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Our consolidated SG&A expenses as a percentage of net sales decreased to 17.4% in fiscal 2019, down from 17.7% in fiscal 2018. The decrease in consolidated SG&A expenses as a percentage of net sales principally reflects efficiencies realized from the net sales growth.

Operating Income

Our consolidated operating income increased by 21% to a record $457.1 million in fiscal 2019, up from $376.2 million in fiscal 2018. The increase in consolidated operating income principally reflects a $41.2 million increase (a 20% increase) to a record $245.7 million in operating income of the ETG and a $35.4 million increase (a 17% increase) to a record $242.0 million in operating income of the FSG. The increase in operating income of the ETG and FSG is principally attributable to the previously mentioned net sales growth and improved gross profit margins. Further, the operating income of the ETG in fiscal 2019 reflects $5.4 million of higher performance-based compensation expense and $2.7 million of higher acquisition-related costs.

Our consolidated operating income as a percentage of net sales improved to 22.2% in fiscal 2019, up from 21.2% in fiscal 2018. The increase principally reflects an increase in the FSG's operating income as a percentage of net sales to 19.5% in fiscal 2019, up from 18.8% in fiscal 2018 and an increase in the ETG's operating income as a percentage of net sales to 29.4% in fiscal 2019, up from 29.1% in fiscal 2018. The increase in the FSG's and ETG's operating income as a percentage of net sales principally reflects the previously mentioned improved gross profit margins and efficiencies realized from the net sales growth. Further, the ETG's operating income as a percentage of net sales in fiscal 2019 reflects a .6% increase in SG&A expenses as a percentage of net sales mainly from the previously mentioned higher performance-based compensation expense and higher acquisition-related costs.

Interest Expense

Interest expense increased to $21.7 million in fiscal 2019, up from $19.9 million in fiscal 2018. The increase was principally due to higher interest rates partially offset by a lower weighted average balance outstanding under our revolving credit facility.

Other Income (Expense)

Other income (expense) in fiscal 2019 and 2018 was not material.

Income Tax Expense

In December 2017, the United States ("U.S.") government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act contains significant changes to previous tax law, some of which became immediately effective in fiscal 2018 including, among other things, a reduction in the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018 resulting in a blended rate of 23.3% for fiscal 2018 and the implementation of a territorial tax system resulting in a one-time transition tax on the unremitted earnings of our foreign subsidiaries. Certain other provisions of the Tax Act became

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effective for HEICO in fiscal 2019 including a new tax on Global Intangible Low-Taxed Income ("GILTI"), a new deduction for Foreign-Derived Intangible Income ("FDII"), the repeal of the domestic production activity deduction and increased limitations on the deductibility of certain executive compensation. As a result of the Tax Act, we remeasured our U.S. federal net deferred tax liabilities and recorded a discrete tax benefit of $16.5 million in fiscal 2018. Further, we recorded a provisional discrete tax expense of $4.4 million in fiscal 2018 related to a one-time transition tax on the unremitted earnings of our foreign subsidiaries, which we intend to pay over the eight-year period allowed for in the Tax Act.

Our effective tax rate in fiscal 2019 decreased to 17.8% from 19.8% in fiscal 2018. The decrease in our effective tax rate in fiscal 2019 is mainly attributable to a $14.3 million larger tax benefit in fiscal 2019 from stock option exercises compared to fiscal 2018 and the reduction in the federal tax rate from a blended rate of 23.3% in fiscal 2018 to 21% in fiscal 2019, partially offset by the net impact of the previously mentioned discrete tax amounts recorded in fiscal 2018. The provisions of the Tax Act that became effective for us in fiscal 2019 did not have a material net effect on our effective tax rate.

Net Income Attributable to Noncontrolling Interests Net income attributable to noncontrolling interests relates to the 20% noncontrolling interest held by Lufthansa Technik AG in HEICO Aerospace Holdings Corp. and the noncontrolling interests held by others in certain subsidiaries of the FSG and ETG. Net income attributable to noncontrolling interests was $31.8 million in fiscal 2019 as compared to $26.5 million in fiscal 2018. The increase in net income attributable to noncontrolling interests in fiscal 2019 principally reflects improved operating results of certain subsidiaries of the FSG and ETG in which noncontrolling interests are held.

Net Income Attributable to HEICO

Net income attributable to HEICO increased to a record $327.9 million, or $2.39 per diluted share, in fiscal 2019, up from $259.2 million, or $1.90 per diluted share, in fiscal 2018 principally reflecting the previously mentioned increased net sales and operating income.

Outlook

As we look ahead to fiscal 2020, we anticipate net sales growth within the FSG's commercial aviation and defense product lines. We also expect growth within the ETG, principally driven by demand for the majority of our products. During fiscal 2020, 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. Overall, we are targeting growth in fiscal 2020 full year net sales and net income over fiscal 2019 levels. This outlook excludes the impact of additional acquired businesses, if any.

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Inflation

We have generally experienced increases in our costs of labor, materials and services consistent with overall rates of inflation. The impact of such increases on net income attributable to HEICO has been generally minimized by efforts to lower costs through manufacturing efficiencies and cost reductions.







        Liquidity and Capital Resources
        The following table summarizes our capitalization (in thousands):
                                                    As of October 31,
                                                   2019          2018
        Cash and cash equivalents                  $57,001       $59,599
        Total debt (including current portion)     561,955       532,470
        Shareholders' equity                     1,694,660     1,503,008
        Total capitalization (debt plus equity)  2,256,615     2,035,478
        Total debt to total capitalization             25%           26%
        


Our principal uses of cash include acquisitions, capital expenditures, cash dividends, distributions to noncontrolling interests and working capital needs. Capital expenditures in fiscal 2020 are anticipated to approximate $42 million. We finance our activities primarily from our operating and financing activities, including borrowings under our revolving credit facility.

As of December 17, 2019, we had approximately $741 million of unused committed availability under the terms of our revolving credit facility. Based on our current outlook, we believe that net cash provided by operating activities and available borrowings under our revolving credit facility will be sufficient to fund our cash requirements for at least the next twelve months.

Operating Activities

Net cash provided by operating activities was $437.4 million in fiscal 2019 and consisted primarily of net income from consolidated operations of $359.7 million, depreciation and amortization expense of $83.5 million (a non-cash item), net changes in other long-term liabilities and assets related to the HEICO Leadership Compensation Plan ("LCP") of $12.9 million (principally participant deferrals and employer contributions) and $10.3 million in share-based compensation expense (a non-cash item), partially offset by a $32.3 million increase in working capital. Net cash provided by operating activities increased by $108.9 million in fiscal 2019 from $328.5 million in fiscal 2018. The increase is principally attributable to a $74.1 million increase in net income from consolidated operations, an $18.4 million decrease in net working capital, a $6.6 million decrease in deferred income tax benefits, and a $6.3 million increase in depreciation and amortization expense. The decrease in net working capital mainly

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resulted from decreases in inventories and contract assets and an increase in income taxes payable, partially offset by a decrease in trade accounts payable.

Net cash provided by operating activities was $328.5 million in fiscal 2018 and consisted primarily of net income from consolidated operations of $285.7 million, depreciation and amortization expense of $77.2 million (a non-cash item) and net changes in other long-term liabilities and assets related to the HEICO LCP of $11.6 million (principally participant deferrals and employer contributions), partially offset by a $50.6 million increase in working capital mainly reflecting an increase in inventories to support the growth of our businesses and anticipated higher demand during fiscal 2019.

Investing Activities

Net cash used in investing activities totaled $280.6 million in fiscal 2019 and related primarily to acquisitions of $240.8 million (net of cash acquired), capital expenditures of $28.9 million and investments related to the HEICO LCP of $13.7 million. Further details on acquisitions may be found in Note 2, Acquisitions, of the Notes to Consolidated Financial Statement.

Net cash used in investing activities totaled $113.5 million in fiscal 2018 and related primarily to acquisitions of $59.8 million (net of cash acquired), capital expenditures of $41.9 million and investments related to the HEICO LCP of $11.5 million. Further details on acquisitions may be found in Note 2, Acquisitions, of the Notes to Consolidated Financial Statement.

Financing Activities

Net cash used in financing activities in fiscal 2019 totaled $159.7 million. During fiscal 2019, we made $283.0 million in payments on our revolving credit facility, paid $110.9 million in distributions to noncontrolling interests, redeemed common stock related to stock option exercises aggregating $64.0 million and paid $18.7 million in cash dividends on our common stock. Additionally, we borrowed $313.0 million under our revolving credit facility to fund certain of our fiscal 2019 acquisitions and a certain distribution to a noncontrolling interest holder.

Net cash used in financing activities in fiscal 2018 totaled $207.5 million. During fiscal 2018, we made payments on our revolving credit facility aggregating $204.0 million, redeemed common stock related to stock option exercises aggregating $25.0 million, paid $15.4 million in cash dividends on our common stock and made distributions to noncontrolling interests aggregating $13.1 million. Additionally, we borrowed $56.0 million on our revolving credit facility principally for tax payments, to fund a fiscal 2018 acquisition and for capital expenditures.

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In November 2017, we entered into a $1.3 billion Revolving Credit Facility Agreement ("Credit Facility") with a bank syndicate, which matures in November 2022. Under certain circumstances, the maturity of the Credit Facility may be extended for two one-year periods. The Credit Facility also includes a feature that will allow us to increase the capacity by $350 million to become a $1.65 billion facility through increased commitments from existing lenders or the addition of new lenders. Borrowings under the Credit Facility may be used to finance acquisitions and for working capital and other general corporate purposes, including capital expenditures.

Borrowings under the Credit Facility accrue interest at our election of the Base Rate or the Eurocurrency Rate, plus in each case, the Applicable Rate (based on our Total Leverage Ratio). The Base Rate for any day is a fluctuating rate per annum equal to the highest of (i) the Prime Rate; (ii) the Federal Funds Rate plus .50%; and (iii) the Eurocurrency Rate for an Interest Period of one month plus 100 basis points. The Eurocurrency Rate is the rate per annum obtained by dividing LIBOR for the applicable Interest Period by a percentage equal to 1.00 minus the daily average Eurocurrency Reserve Rate for such Interest Period, as such capitalized terms are defined in the Credit Facility. The Applicable Rate for Eurocurrency Rate Loans ranges from 1.00% to 2.00%. The Applicable Rate for Base Rate Loans ranges from 0% to 1.00%. A fee is charged on the amount of the unused commitment ranging from .125% to .30% (depending on our Total Leverage Ratio). The Credit Facility also includes $100 million sublimits for borrowings made in foreign currencies and for swingline borrowings, and a $50 million sublimit for letters of credit. Outstanding principal, accrued and unpaid interest and other amounts payable under the Credit Facility may be accelerated upon an event of default, as such events are described in the Credit Facility. The Credit Facility is unsecured and contains covenants that require, among other things, the maintenance of a Total Leverage Ratio and an Interest Coverage Ratio, as such capitalized terms are defined in the Credit Facility. We were in compliance with all financial and nonfinancial covenants of the Credit Facility as of October 31, 2019.

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        Contractual Obligations
        The following table summarizes our contractual obligations as of October 31,
        2019
        (in thousands):
                                                                 Payments due by fiscal period
                                    Total           2020         2021 - 2022      2023 - 2024       Thereafter
        Long-term debt
        obligations (1)
                                   $553,320            $62              $129         $553,106              $23
        Estimated interest
        payments (1)                 50,310         16,724            33,358              228                -
        Capital lease
        obligations (2)              10,962          1,213             2,415            1,738            5,596
        Operating lease
        obligations (3)              76,947         15,508            29,371           13,256           18,812
        Purchase obligations (4)
        (5) (6)                      21,666          2,711             2,253           16,702                -
        Other long-term
        liabilities (7)               8,052          1,976             2,448            1,756            1,872
        Total contractual
        obligations                $721,257        $38,194           $69,974         $586,786          $26,303
        __________________
        


(1) Estimated interest payments assumes the $553.0 million outstanding balance under our revolving credit facility and related interest rate of 3.0% as of October 31, 2019, will remain constant through the credit facility's maturity date in fiscal 2023. Actual interest payments may vary significantly based on future borrowings, repayments and interest rate fluctuations. See Note 5, Long-Term Debt, of the Notes to Consolidated Financial Statements and "Liquidity and Capital Resources," above for additional information regarding our long-term debt obligations.

(2) Inclusive of $2.3 million in interest charges. See Note 5, Long-Term Debt, of the Notes to Consolidated Financial Statements for additional information regarding our capital lease obligations.

(3) See Note 16, Commitments and Contingencies - Lease Commitments, of the Notes to Consolidated Financial Statements for additional information regarding our operating lease obligations.

(4) Includes contingent consideration aggregating $18.3 million related to a fiscal 2016, 2017 and 2019 acquisition. See Note 8, Fair Value Measurements, of the Notes to Consolidated Financial Statements for additional information.

(5) Also includes an aggregate $3.3 million of commitments principally for . . .

Dec 19, 2019

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