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May 28, 2020, 4:32 p.m. EDT

10-Q: HEICO CORP

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(EDGAR Online via COMTEX) -- Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

This discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and notes thereto included herein. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates if different assumptions were used or different events ultimately transpire.

Our critical accounting policies, which require management to make judgments about matters that are inherently uncertain, are described in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," under the heading "Critical Accounting Policies" in our Annual Report on Form 10-K for the year ended October 31, 2019. There have been no material changes to our critical accounting policies during the six months ended April 30, 2020.

Our business is comprised of two operating segments: the Flight Support Group ("FSG"), consisting of HEICO Aerospace Holdings Corp. and HEICO Flight Support Corp. and their respective subsidiaries; and the Electronic Technologies Group ("ETG"), consisting of HEICO Electronic Technologies Corp. and its subsidiaries.

Our results of operations for the six and three months ended April 30, 2020 have been significantly affected by the COVID-19 outbreak, classified by the World Health Organization as a global pandemic in March 2020 (the "Outbreak"). The effects of the Outbreak and related actions by governments around the world to mitigate its spread have impacted our employees, customers, suppliers and manufacturers. In response to the economic impact from the Outbreak, we have implemented certain cost reduction efforts, including layoffs, temporary reduced work hours and temporary pay reductions within various departments of our business, including within our executive management team. Additionally, our response to the Outbreak has included the implementation of varying health and safety measures at our facilities, including: supplying and requiring the use of personal protective equipment; body temperature taking; staggering work shifts; increasing work-from-home capabilities; consistent and ongoing cleaning of work spaces and high-touch areas; and establishing processes aligned with the Centers for Disease and Control guidelines to work with any individual exposed to COVID-19 on their necessary quarantine period and the process for the individual to return to work.







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fundamentally impacted and its operational results remain materially consistent with financial expectations prior to the commencement of the Outbreak. However, we have experienced, and expect to continue experiencing, periodic operational disruptions resulting from supply chain disturbances, staffing challenges, temporary facility closures, transportation interruptions and other conditions which slow production or increase costs. While these issues have not yet been material, it is impossible to predict their future impact and our current experience indicates that the likely effect will be to delay orders and shipments measured in weeks and months, and to temporarily increase some costs, as opposed to profoundly changing our business overall. Fortunately, many of our defense and medical component design, manufacturing and supply operations are believed to be crucial suppliers to markets with continuing strong needs. While it has not had a material impact on our consolidated net sales, demand for our components used in medical equipment, such as ventilators, x-ray systems, sterilization equipment and personal protective equipment, has increased as a result of the Outbreak.

The remaining portion of our net sales is derived from commercial aviation products and services. The Outbreak has caused significant volatility and a substantial decline in value across global economic markets. Most notably, the commercial aerospace industry has experienced an ongoing substantial decline in demand. As such, our businesses that operate within the commercial aerospace industry have been materially impacted by the significant decline in global commercial air travel that began in March 2020. Once commercial air travel resumes, cost savings will most likely be a priority for our commercial aviation customers and we anticipate recovery in demand for our commercial aviation products, which frequently provide aircraft operators with significant savings. Furthermore, we believe our cost-saving solutions and robust product development programs will enable us to potentially increase market share and emerge with a stronger presence within this market.

Additionally, our results of operations for the six and three months ended April 30, 2020 have been affected by the fiscal 2019 acquisitions as further detailed in Note 2, Acquisitions, of the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended October 31, 2019.







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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 Condensed Consolidated Statements of Operations (in
        thousands):
                                                                                                                                  Three months ended April
                                                        Six months ended April 30,                                                           30,
                                                     2020                        2019                        2020                        2019
        Net sales                                      $974,421                    $981,794                    $468,146                    $515,648
        Cost of sales                                   597,484                     590,170                     289,256                     306,261
        Selling, general and administrative
        expenses                                        157,786                     174,494                      70,729                      90,204
        Total operating costs and expenses              755,270                     764,664                     359,985                     396,465
        Operating income                               $219,151                    $217,130                    $108,161                    $119,183
        Net sales by segment:
        Flight Support Group                           $553,031                    $595,464                    $251,964                    $308,251
        Electronic Technologies Group                   427,366                     398,880                     218,955                     214,451
        Intersegment sales                               (5,976)                    (12,550)                     (2,773)                     (7,054)
                                                       $974,421                    $981,794                    $468,146                    $515,648
        Operating income by segment:
        Flight Support Group                           $109,576                    $115,046                     $47,531                     $62,166
        Electronic Technologies Group                   123,017                     118,954                      65,526                      67,352
        Other, primarily corporate                      (13,442)                    (16,870)                     (4,896)                    (10,335)
                                                       $219,151                    $217,130                    $108,161                    $119,183
        Net sales                                         100.0  %                    100.0  %                    100.0  %                    100.0  %
        Gross profit                                       38.7  %                     39.9  %                     38.2  %                     40.6  %
        Selling, general and administrative
        expenses                                           16.2  %                     17.8  %                     15.1  %                     17.5  %
        Operating income                                   22.5  %                     22.1  %                     23.1  %                     23.1  %
        Interest expense                                     .8  %                      1.1  %                       .8  %                      1.1  %
        Other income                                          -  %                       .2  %                        -  %                       .5  %
        Income tax expense                                   .1  %                      3.1  %                      5.0  %                      5.1  %
        Net income attributable to
        noncontrolling interests                            1.4  %                      1.7  %                      1.2  %                      1.6  %
        Net income attributable to HEICO                   20.3  %                     16.4  %                     16.1  %                     15.9  %
        


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Comparison of First Six Months of Fiscal 2020 to First Six Months of Fiscal 2019

Net Sales

Our consolidated net sales in the first six months of fiscal 2020 decreased by 1% to $974.4 million, as compared to net sales of $981.8 million in the first six months of fiscal 2019. The decrease in consolidated net sales principally reflects a decrease of $42.4 million (a 7% decrease) to $553.0 million in net sales within the FSG partially offset by an increase of $28.5 million (a 7% increase) to a record $427.4 million in net sales within the ETG. The net sales decrease in the FSG is principally organic and reflects lower demand for the majority of our products and services resulting from the significant decline in global commercial air travel beginning in March 2020 due to the Outbreak. As a result, net sales of our repair and overhaul parts and services, aftermarket replacement parts, and specialty products product lines decreased by $18.7 million, $17.2 million, and $6.5 million, respectively. The net sales increase in the ETG reflects net sales of $28.2 million contributed by our fiscal 2019 and 2020 acquisitions as well as organic growth of 2%. The ETG's organic growth is mainly attributable to increased demand for our defense products resulting in a net sales increase of $22.0 million partially offset by lower demand for our space products resulting in a net sales decrease of $14.8 million. Sales price changes were not a significant contributing factor to the change in net sales of the FSG and ETG in the first six months of fiscal 2020.

Gross Profit and Operating Expenses

Our consolidated gross profit margin decreased to 38.7% in the first six months of fiscal 2020, as compared to 39.9% in the first six months of fiscal 2019, principally reflecting a decrease of 2.2% and 1.1% in the ETG's and FSG's gross profit margin, respectively. The decrease in the ETG's gross profit margin principally reflects a decrease in net sales of certain space products and a less favorable product mix of certain aerospace products, partially offset by increased net sales of certain defense products. The decrease in the FSG's gross profit margin principally reflects a decrease in net sales and less favorable product mix within our repair and overhaul parts and services product line as well as a less favorable product mix within our aftermarket replacement parts product line. Total new product research and development expenses included within our consolidated cost of sales were $33.9 million in the first six months of fiscal 2020, up from $32.0 million in the first six months of fiscal 2019.

Our consolidated selling, general and administrative ("SG&A") expenses decreased by 10% to $157.8 million in the first six months of fiscal 2020, as compared to $174.5 million in the first six months of fiscal 2019. The decrease in consolidated SG&A expenses principally reflects an $18.6 million decrease in performance-based compensation expense and a $4.3 million reduction in other selling expenses including outside sales commissions, marketing and travel, partially offset by $7.5 million attributable to the fiscal 2019 and 2020 acquisitions.

Our consolidated SG&A expenses as a percentage of net sales decreased to 16.2% in the first six months of fiscal 2020, down from 17.8% in the first six months of fiscal 2019. The







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decrease in consolidated SG&A expenses as a percentage of net sales is mainly due to a 1.9% impact from the previously mentioned lower performance-based compensation expense.

Operating Income

Our consolidated operating income increased by 1% to a record $219.2 million in the first six months of fiscal 2020, up from $217.1 million in the first six months of fiscal 2019. The increase in consolidated operating income principally reflects a $4.1 million increase (a 3% increase) to a record $123.0 million in operating income of the ETG partially offset by a $5.5 million decrease (a 5% decrease) to $109.6 million in operating income of the FSG. The increase in operating income of the ETG principally reflects the previously mentioned net sales growth and a $4.3 million decrease in performance-based compensation expense, partially offset by the previously mentioned lower gross profit margin. The decrease in operating income of the FSG principally reflects the previously mentioned decrease in net sales and lower gross profit margin, partially offset by an $11.8 million decrease in performance-based compensation expense. Further, the increase in consolidated operating income reflects $2.1 million of lower corporate expenses mainly attributable to a decrease in performance-based compensation expense.

Our consolidated operating income as a percentage of net sales improved to 22.5% in the first six months of fiscal 2020, up from 22.1% in the first six months of fiscal 2019. The increase principally reflects an increase in the FSG's operating income as a percentage of net sales to 19.8% in the first six months of fiscal 2020, up from 19.3% in the first six months of fiscal 2019 and the previously mentioned lower corporate expenses, partially offset by a decrease in the ETG's operating income as a percentage of net sales to 28.8% in the first six months of fiscal 2020 as compared to 29.8% in the first six months of fiscal 2019. The increase in the FSG's operating income as a percentage of net sales principally reflects a 1.6% decrease in SG&A expenses as a percentage of net sales mainly from lower performance-based compensation expense, partially offset by the previously mentioned lower gross profit margin. The decrease in the ETG's operating income as a percentage of net sales principally reflects the previously mentioned lower gross profit margin partially offset by a 1.1% decrease in SG&A expenses as a percentage of net sales mainly from lower performance-based compensation expense.

Interest Expense

Interest expense decreased to $8.0 million in the first six months of fiscal 2020, down from $11.0 million in the first six months of fiscal 2019. The decrease was principally due to a lower weighted average interest rate on borrowings outstanding under our revolving credit facility.

Other Income

Other income in the first six months of fiscal 2020 and 2019 was not material.







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Income Tax Expense

Our effective tax rate in the first six months of fiscal 2020 was .3%, as compared to 14.5% in the first six months of fiscal 2019. HEICO recognized a discrete tax benefit from stock option exercises in both the first quarter of fiscal 2020 and 2019 of $47.6 million and $16.6 million, respectively. The $31.0 million larger benefit from stock option exercises recognized in the first quarter of fiscal 2020 was the result of more stock options exercised and the strong appreciation in HEICO's stock price during the optionees' holding periods.

Net Income Attributable to Noncontrolling Interests Net income attributable to noncontrolling interests relates to the 20% noncontrolling interest held by Lufthansa Technik AG ("LHT") in HEICO Aerospace Holdings Corp. ("HEICO Aerospace") and the noncontrolling interests held by others in certain subsidiaries of the FSG and ETG. Net income attributable to noncontrolling interests was $13.4 million in the first six months of fiscal 2020, as compared to $17.0 million in the first six months of fiscal 2019. The decrease in net income attributable to noncontrolling interests in the first six months of fiscal 2020 principally reflects the impact of a dividend paid by HEICO Aerospace in June 2019 that effectively resulted in the transfer of the 20% noncontrolling interest held by LHT in eight of our existing subsidiaries within HEICO Aerospace that are principally part of the FSG's repair and overhaul parts and services product line to HEICO Flight Support Corp., a wholly owned subsidiary of HEICO.

Net Income Attributable to HEICO

Net income attributable to HEICO increased to a record $197.3 million, or $1.44 per diluted share, in the first six months of fiscal 2020, up from $161.1 million, or $1.18 per diluted share, in the first six months of fiscal 2019 principally reflecting the previously mentioned income tax benefit, increased operating income and lower interest expense.

Comparison of Second Quarter of Fiscal 2020 to Second Quarter of Fiscal 2019

Net Sales

Our consolidated net sales in the second quarter of fiscal 2020 decreased by 9% to $468.1 million, as compared to net sales of $515.6 million in the second quarter of fiscal 2019. The decrease in consolidated net sales principally reflects a decrease of $56.3 million (an 18% decrease) to $252.0 million in net sales within the FSG partially offset by an increase of $4.5 million (a 2% increase) to $219.0 million in net sales within the ETG. The net sales decrease in the FSG is principally organic and reflects lower demand for the majority of our products and services resulting from the significant decline in global commercial air travel beginning in March 2020 due to the Outbreak. As a result, net sales of our aftermarket replacement parts, repair and overhaul parts and services, and specialty products product lines decreased by $26.0 million, $20.8 million, and $9.5 million, respectively. The net sales increase in the ETG reflects net sales of $13.3 million contributed by our fiscal 2019 and 2020 acquisitions, partially offset by an







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organic net sales decrease of 2%. The ETG's decrease in organic net sales is mainly attributable to lower shipments of our space products resulting in a net sales decrease of $7.3 million partially offset by increased demand for our defense products resulting in a net sales increase of $2.7 million. Sales price changes were not a significant contributing factor to the change in net sales of the FSG and ETG in the second quarter of fiscal 2020.

Gross Profit and Operating Expenses

Our consolidated gross profit margin decreased to 38.2% in the second quarter of fiscal 2020, as compared to 40.6% in the second quarter of fiscal 2019, principally reflecting a decrease of 3.5% and 2.7% in the FSG's and ETG's gross profit margin, respectively. The decrease in the FSG's gross profit margin principally reflects a decrease in net sales and a less favorable product mix within our repair and overhaul parts and services and aftermarket replacement parts product lines. The decrease in the ETG's gross profit margin principally reflects a decrease in net sales and less favorable product mix of certain space and commercial aerospace products partially offset by increased net sales of certain defense products. Total new product research and development expenses included within our consolidated cost of sales were $16.8 million in both the second quarter of fiscal 2020 and 2019.

Our consolidated SG&A expenses decreased by 22% to $70.7 million in the second quarter of fiscal 2020, as compared to $90.2 million in the second quarter of fiscal 2019. The decrease in consolidated SG&A expenses principally reflects an $18.2 million decrease in performance-based compensation expense and a $3.7 million reduction in other selling expenses including outside sales commissions, marketing and travel, partially offset by $3.3 million attributable to the fiscal 2019 and 2020 acquisitions.

Our consolidated SG&A expenses as a percentage of net sales decreased to 15.1% in the second quarter of fiscal 2020, down from 17.5% in the second quarter of fiscal 2019. The decrease in consolidated SG&A expenses as a percentage of net sales is mainly due to a 3.5% impact from the previously mentioned lower performance-based compensation expense partially offset by some inefficiencies resulting from the overall impacts of the Outbreak.

Operating Income

Our consolidated operating income decreased by 9% to $108.2 million in the second quarter of fiscal 2020, as compared to operating income of $119.2 million in the second quarter of fiscal 2019. The decrease in consolidated operating income principally reflects a $14.6 million decrease (a 24% decrease) to $47.5 million in operating income of the FSG and a $1.8 million decrease (a 3% decrease) to $65.5 million in operating income of the ETG. The decrease in operating income of the FSG principally reflects the previously mentioned decrease in net sales and lower gross profit margin, partially offset by an $11.5 million decrease in performance-based compensation expense. The decrease in operating income of the ETG principally reflects the previously mentioned lower gross profit margin partially offset by a $4.0 million decrease in performance-based compensation expense and the previously mentioned increase in net sales.

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Further, the decreases in operating income of the FSG and ETG were partially moderated by lower corporate expenses of $4.1 million mainly attributable to a decrease in performance-based compensation expense.

Our consolidated operating income as a percentage of net sales was 23.1% in both the second quarter of fiscal 2020 and 2019 principally reflecting a 1.5% and 1.3% decrease in the ETG's and FSG's operating income as a percentage of net sales, respectively, offset by the previously mentioned lower corporate expenses. The decrease in the ETG's operating income as a percentage of net sales to 29.9% in the second quarter of fiscal 2020 from 31.4% in the second quarter of fiscal 2019 principally reflects the previously mentioned lower gross profit margin partially offset by a 1.2% decrease in SG&A expenses as a percentage of net sales mainly reflecting lower performance-based compensation expense. The decrease in the FSG's operating income as a percentage of net sales to 18.9% in the second quarter of fiscal 2020 from 20.2% in the second quarter of fiscal 2019 principally reflects the previously mentioned lower gross profit margin partially offset by a 2.2% decrease in SG&A expenses as a percentage of net sales mainly from lower performance-based compensation expense partially offset by some inefficiencies resulting from the overall impacts of the Outbreak.

Interest Expense

Interest expense decreased to $3.8 million in the second quarter of fiscal 2020, down from $5.5 million in the second quarter of fiscal 2019. The decrease was principally due to a lower weighted average interest rate on borrowings outstanding under our revolving credit facility.

Other Income

Other income in the second quarter of fiscal 2020 and 2019 was not material.

Income Tax Expense

Our effective tax rate in the second quarter of fiscal 2020 was 22.6%, as compared to 22.5% in the second quarter of fiscal 2019.

Net Income Attributable to Noncontrolling Interests

Net income attributable to noncontrolling interests relates to the 20% noncontrolling interest held by LHT in HEICO Aerospace and the noncontrolling interests held by others in certain subsidiaries of the FSG and ETG. Net income attributable to noncontrolling interests was $5.5 million in the second quarter of fiscal 2020, as compared to $8.3 million in the second quarter of fiscal 2019. The decrease in net income attributable to noncontrolling interests in the second quarter of fiscal 2020 principally reflects the impact of a dividend paid by HEICO Aerospace in June 2019 that effectively resulted in the transfer of the 20% noncontrolling interest held by LHT in eight of our existing subsidiaries within HEICO Aerospace that are

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principally part of the FSG's repair and overhaul parts and services product line to HEICO Flight Support Corp., a wholly owned subsidiary of HEICO.

Net Income Attributable to HEICO

Net income attributable to HEICO was $75.5 million, or $.55 per diluted share, in the second quarter of fiscal 2020, as compared to $81.8 million, or $.60 per diluted share, in the second quarter of fiscal 2019 principally reflecting the previously mentioned lower operating income, partially offset by less net income attributable to noncontrolling interests and lower interest expense.

Outlook

In our Quarterly Report on Form 10-Q for the three months ended January 31, 2020, we provided net sales and net income estimates for fiscal 2020, but noted that it excluded any impact from the coronavirus outbreak as it was at such an early stage. As noted within our Form 8-K, filed on April 15, 2020, we withdrew our fiscal 2020 financial guidance due to the COVID-19 outbreak, classified by the World Health Organization as a global pandemic in March 2020 (the "Outbreak"). The Outbreak has resulted in a significant reduction in global demand for commercial air travel beginning in March 2020. As such, the results of operations for the six and three months ended April 30, 2020 are not indicative of the results to be expected for the full fiscal 2020 year.

We entered the Outbreak with a healthy balance sheet that included a strong cash position and nominal debt. We cannot estimate the duration and magnitude of the Outbreak and cannot confidently predict when demand for our commercial aerospace products will return to pre-Outbreak levels. However, we believe HEICO is favorably positioned for long-term success despite the short-term challenges created by the Outbreak in the global economy.

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Liquidity and Capital Resources

Our principal uses of cash include acquisitions, capital expenditures, cash dividends, distributions to noncontrolling interests and working capital needs. At the onset of the Outbreak, we borrowed $200.0 million on our revolving credit . . .

May 28, 2020

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