HEICO Corporation
Q1 2021 Earnings Call Transcript

Published: 24 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the HEICO's Fiscal Year 2021 First Quarter Earnings Results Call. 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

[Laurans Mendelson:]

Thank you very much, and good morning to everyone on the call. We thank you for joining us, and we welcome you to HEICO's First Quarter Fiscal '21 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 I get into some of the detail, I would like to thank all of HEICO's extraordinary team members who have really performed in the most admirable way during this pandemic, which is now into about a year. As management looks at the company, we really believe that our success and the ability to keep our head well above water, not to get into any financial binds, not to struggle to sell debt at 8% or 10% and so forth and to be fiscally sound is all attributed to the unbelievable talent and brilliance of the team members. And I can tell you, senior management hold -- and the Board holds these people in the highest regard. So I thank them, and our hats are off to the entire team. Before reviewing our operating results in detail, I'd like to take a few minutes to discuss the impact on HEICO's operating results from the COVID pandemic. Results of operations in the first quarter of fiscal '21 continue to reflect adverse impact from COVID-19. Most notably, demand for commercial aviation products and services continues to be moderated and impacted negatively by ongoing depressed commercial aerospace markets. We continue to focus on health and safety measures at our facilities in accordance with the CDC guidelines in order to protect the global team members and mitigate the spread of COVID-19 while serving our customers' needs. Keep in mind that almost all of our facilities were open continually since the start of the COVID pandemic. And very, very few members of our teams came down with this miserable disease. That was because of the safety measures and health measures that we employ throughout the company.

[Eric Mendelson:]

Thank you. The Flight Support Group's net sales were $199.3 million in the first quarter of fiscal '21 as compared to $301.1 million in the first quarter of fiscal '20. The net sales decrease is principally organic and reflects lower demand for the majority of our commercial aerospace products and services resulting from the significant decline in global commercial air travel attributable to the pandemic. The Flight Support Group's operating income was $25.8 million in the first quarter of fiscal '21 as compared to $62 million in the first quarter of fiscal '20. The operating income decrease principally reflects the previously mentioned decrease in net sales as well as a lower gross profit margin and the impact from lost fixed cost efficiencies stemming from the pandemic. The lower gross profit margin principally reflects the impact from lower net sales of commercial aerospace products and services across all of its product lines. The Flight Support Group's operating margin was 13.0% in the first quarter of fiscal '21 as compared to 20.6% in the first quarter of fiscal '20. The operating margin decrease principally reflects the previously mentioned lower gross profit margin and an increase in SG&A expenses as a percentage of net sales mainly from the previously mentioned lost fixed cost efficiencies and the effect of higher intangible asset amortization expense.

[Victor Mendelson:]

Eric, thank you. And I would also like to echo my gratitude to all of HEICO's team members, including those at the Electronic Technologies Group, for their remarkable efforts during this difficult time. About 90% of our people cannot work from home and have to come in. And our businesses have been operating as essential businesses throughout this pandemic very carefully and very safely and taking care of each other. And I'm very proud of the job that our people have done throughout this entire difficult period as well as the many years before, and I know that they'll continue to do the excellent work that they've carried out.

[Laurans Mendelson:]

Thank you, Victor. Moving on to earnings per share. Consolidated net income per diluted share was $0.51 in the first quarter of fiscal '21 and that compared to $0.89 in the first quarter of fiscal '20. The decrease principally reflects the previously mentioned lower operating income of the Flight Support Group and higher income tax expense, partially offset by less net income attributable to noncontrolling interest as well as lower interest expense. Depreciation and amortization expense totaled $23 million in the first quarter of '21. That was up from $21.6 million in the first quarter of fiscal '20. The increase in the first quarter of fiscal '21 principally reflects the incremental impact of higher intangible asset amortization expense from our fiscal '20 acquisitions. Significant new product development efforts are continuing at both ETG and flight support. R&D expense was $16.2 million in the first quarter of fiscal '21 or about 3.9% of sales, and that compared to $17.1 million in the first quarter of fiscal '20 or 3.4% of sales. Consolidated SG&A expense decreased by 10% to $78.1 million in the first quarter of fiscal '21 as compared to $87.1 million in the first quarter of fiscal '20. The decrease in consolidated SG&A expense reflects

[Operator:]

. We have your first question from the line of Robert Spingarn from Credit Suisse.

[Robert Spingarn:]

Good set of numbers today. Larry, could I start with you on M&A? I think you said earlier that the company will continue to pursue a strong M&A policy. What are you seeing trend-wise in the market as the pandemic has evolved? Are sellers more or less willing to sell at this point?

[Laurans Mendelson:]

Well, we see a lot of product coming out of -- some of it coming out of private equity. So sellers are willing to sell. In the Flight Support Group, it's a little tougher because their profits have gone down, and a lot of them are pulling their sales activity hoping for recovery, which I know will be coming. However, in looking at our backlog of potential M&A possibilities, it's probably business as usual. And probably the difficulty hereof is the logistics of getting out, kicking the tires, checking and doing all these things. And that really has slowed us down a little bit, particularly when you're dealing with private equity guys. They have the information and they're more up to speed. But when you're dealing with private sellers who have never sold a company before, it becomes much more difficult. But the bottom line is we are seeing many opportunities, some at very reasonable prices. And we're kicking the tires. Others are at the 14, 16x EBITDA multiples, which price us out of the gate. And we are also looking at small companies that we traditionally buy size-wise, and we're looking at larger companies. So -- and of course, as you know, we are not physically constrained. We've been asked many times, would you use your currency, which is selling at a high multiple, for acquisition? And the answer is yes. We -- as a matter of fact, there's one transaction, I don't know if it'll ever close but -- where the seller wants HEICO shares. So our currency, we have cash. I said this on the last call, we have cash. We have stock and we have won them. So we're ready to give you -- give the sellers whatever they would like. I guess we'd give them bitcoin, too.

[Robert Spingarn:]

That was my next question. But in terms of the end markets, historically, you've been a little more active, on Victor's side of the business, with the defense and the space types of acquisitions. Are we seeing any more opportunity or less opportunity in commercial aero M&A?

[Eric Mendelson:]

Rob, this is Eric. What -- we are seeing opportunity in commercial. But as my dad pointed out, the current level of earnings are depressed. So it's a little difficult to narrow down prices there, but we are still seeing plenty of opportunity.

[Robert Spingarn:]

Okay. Okay. Just a couple of other ones. Victor, I wanted to just ask you a couple of things about ETG. You have this very strong 19% and 14% growth in space and other electronics. Could you talk a little bit about what's driving that, and then separately, how defense did? And clearly, I guess, commercial aero was a factor as it's been across the industry.

[Victor Mendelson:]

Yes. Thank you, Rob. Those are good questions. On space, I think you heard us talk about throughout last year that we felt it would strengthen and will continue to strengthen into this year for us that we saw our backlogs building and orders increasing. And so that was really the follow-through on that. And I would expect that to continue for some period of time and then flatten out at some point. And -- but that really has been fairly broad-based for us on the space side, which has been very nice. And in terms of the other electronics markets, we started to see those firm up really in the fourth quarter a bit, and that followed through in the first quarter. We did see weakness, as I've talked about before, as the pandemic wore on. And I think perhaps inventories, there was a, call it, a destocking effect or inventories weren't built at all. And that's reversed, and I think we're seeing much more order inquiry out of our customers as well. So at the moment, that feels like it's continuing to move in the right direction. Commercial aero, still down but looking better, kind of bit by bit. I think the same general tone as you see with our Flight Support Group, I would say, should follow that same trajectory. And defense. Defense, at this point, we had some things that wound up getting delayed and moving out into the second quarter, not as a result really so much of our actions but supply chain as well as actually on the customer side with inspection and delivery on their end, things that have been built and were waiting for delivery. So we saw a little bit of that. And I would say I would expect as a rule of thumb, as we've talked about, to see defense generally flatten out as we move forward. I don't think that's any surprise to anybody. And I would expect us to see medical markets firm up as we move out. I think we all know they were tended to be softer last year because of the cessation of elective procedures and doctor visits and things like that. And I think that's beginning to reverse as people feel more comfortable returning to doctors' offices and so on.

[Robert Spingarn:]

Right. And just quickly on your margins. Your margins are always up there in the, call it, mid- to high 20s, but they dipped a little bit here in the quarter. I assume that's mix. And does that reflect commercial being down? Is there anything different this quarter about the level or magnitude of commercial? Or maybe it's something else? I just wanted to ask you about that.

[Victor Mendelson:]

Yes. Our commercial business is a very strong kind of business. So therefore, it's a high-margin business. So when that trails off, it tends to hit our margins. It was also mix on the defense side, definitely mix on the defense side. And I'll point out that the margins, I mean, we've talked about this before, we don't really go too hard after people. If we're running, let's say, 32% what I call cash margin, right, the real margin, and we have amortization in there, which is the -- obviously, the number, the operating margin that we report. But there's about 4 to 5 points of amortization, and there's probably this period an additional beyond that 0.5 point or so beyond what we saw last year, which was a further headwind. So if you take that out, it was actually much more comparable to where we were last year. But even so, I mean, if I look at it and I say -- I look at how we're doing, you've heard us say this before on many calls and in conferences and so on. I don't really -- we don't rack people on the knuckles if they're 100 basis points or 200 basis points lower and they're giving us 32% as opposed to 33% or 34%. And people ask, "Where do you think your margins are going to be?" I generally say, look, I think we're comfortable within this range, up or down 10%, although I think the up part is always hard. So that's consistent with what, I think, to be honest, what we are expecting.

[Robert Spingarn:]

Okay. Okay. Eric, just quickly. On order flow and air customer behavior, are you starting to see any signals of restocking of airlines trying to get set up for potential recovery here in the summer?

[Eric Mendelson:]

Yes. I'll answer that by saying I think we correctly called the bottom of the market in May as this was happening. And we also, in our fourth quarter, correctly called that destocking was over. And then other companies have since come out and said the same thing, but I think we were the first to talk about it. With regard to restocking, I wouldn't say that we've seen restocking so much as we've seen really depletion of inventory. And when customers order items, they need it right away. So we -- now that doesn't mean they're out of all inventory, but they're out of all parts. But the parts that they need, they really don't have on the shelf and there's not a lot of safety stock. So no, I don't think that we've seen restocking yet. I think they're being very careful. If you look, in particular, what's going on in Europe right now, with the passenger miles just cratered and really at the bottom, somewhat similar to what we saw in the spring, those airlines are not in a position right now to restock. And also, we're seeing it in a whole bunch of other markets as well. So no, I think that benefit is yet to come. And I would -- it's very hard to predict, obviously, with these variants and what's going to happen with the virus. But I don't think you're going to see a restocking until the airlines really start seeing that surge in travel, which we all know is going to come. But I think that they're going to really hold off on spending the cash until the last possible moment.

[Operator:]

Your next question comes from the line of Peter Arment from Baird.

[Peter Arment:]

I just wanted to follow up on just what Rob just asked about, Eric. Just I guess, maybe just to ask it a different way, less about the restock, but more about just qualitatively maybe some of the conversations you're having about potential pickup in share. I know you've talked about that in the past that coming out of downturns, you've been able to increase share. Maybe any color you could give us there would be helpful.

[Eric Mendelson:]

Yes. We're very optimistic. Yes, I've spoken with all of our sales heads to understand where the opportunities are and the color of those discussions. And I can tell you that they are extremely optimistic as well as our business heads are very optimistic in terms of the recovery and in terms of our position with respect to those customers. HEICO is no longer a small company. We're diversified. We're in many different areas. I think our customers trust us. They're relying on us to deliver cost savings, and I think that we're going to be in a very unique position going forward. If you look at most of our colleagues or competitors in the industry, I think that their cuts were far more aggressive. I know that their cuts were far more aggressive than ours. I alluded to in my comments that we held on to a much higher percentage of our workforce and protected a much higher percentage of our workforce than both our smaller and larger competitors. So I think we are in position. We don't have to rebuild a workforce. We don't have to remotivate a workforce. And I think we're going to be very strong in mining those opportunities. I can tell you that at the moment, things are difficult. There are some airlines that are working partial days, where they've decided to also try to hang on to their workforce and they're rotating them where people work a couple of days every other week. So it's more complicated, getting in touch with people. But I think where we've got those relationships and our people are very excited about both the new product that is coming out as well as the comments that we're getting from our customers. I think after going through a pandemic like this, buying the type of products that HEICO offers is a no-brainer because we generate savings without technical risk. So I think people understand that, and that's what specifically gives me the optimism.

[Peter Arment:]

Would you characterize that as just that you expect that your -- maybe your existing customers, you would expand kind of the reach there? And then maybe also, you're seeing some new customers show interest in your products?

[Eric Mendelson:]

Yes. I would say that is correct. I mean there's not a lot of new customer opportunity because we pretty much deal with everybody. However, you're correct in that the existing, I would say, more penetrated customers are wanting to do more with us as well as customers where we are less penetrated, they're very focused on a whole variety of products that we offer that we haven't sold them in the past. And I think that we will continue to do very well. And also, I want to point out that even though we will take market share, in no means should this be interpreted that OEM businesses will not do well because we take a minority of the market share, we believe the majority for the OEM. The OEMs have been pretty aggressive with price increases, and we're just trying to take our little piece, and I think their business models are very much intact.

[Peter Arment:]

Right. Right. And then just two quick ones, Carlos. Just CapEx was up quite a bit year-over-year. And just wondering what the kind of the trend is there. Anything to call out? And then also just a clarification on what you expect the tax rate to be for the balance of the year.

[Carlos Macau:]

Sure, sure, sure. So CapEx was up. We had plans in our budgets to have some capital expansion in two of our facilities. Actually, they're both in the ETG group, where we are expanding their footprint with some new equipment and some more floor space for them to support their growth. And so that was -- about half that spend, if you would, was that type of growth expansion for the quarter, which we didn't see last year in the numbers. So that's why it's accelerated a bit.

[Peter Arment:]

And then on the tax rate?

[Carlos Macau:]

Yes. So the tax rate, I think what we're going to wind up seeing this year for HEICO is, Larry mentioned earlier that we expect 24% to 26% rate. I think that breaks down somewhere, 18% to 19% on the tax rate for the year, the effective tax rate. And then NCI could be 6% to 7%. Both those percentages are of pretax income. So that's kind of where my head is on those rates.

[Peter Arment:]

Nice results, guys.

[Eric Mendelson:]

Thank you.

[Operator:]

Your next question comes from the line of Gautam Khanna from Cowen.

[Gautam Khanna:]

First, for Carlos, was there any bad debt expense at FSG or elsewhere this quarter?

[Carlos Macau:]

I mean we always have a little bit of pluses and minuses on our normal cadence for HEICO. I think that's what we experienced in Q1. There were no bankruptcies, there weren't any large buckets or receivable days or anything like that. So it was -- on the bad debt side, it's pretty much business as usual under normal times in that regard. So no one-timers there or any amplified charges.

[Gautam Khanna:]

Okay. Because it was interesting, if you were to strip out the $1.5 million of bad debt in Q4, the incremental margin sequentially was like 49% in FSG. I just want to -- is that right? I mean that's what it is, right? I mean it's fairly high incremental margin.

[Carlos Macau:]

Yes. The incremental margins are high on the rebound, absolutely. We've seen that two consecutive quarters in a row now. If you look at it sequentially, that's correct.

[Gautam Khanna:]

And maybe, Eric, if you could talk about FSG, if you're seeing any differing trends by the submarkets there? So the PMA products versus the repair and obviously, specialized products. But just if you could disaggregate what you're seeing in the various submarkets.

[Eric Mendelson:]

Sure, Gautam. The -- obviously, the commercial aviation market continues to be down the most. And that would be in our parts business, which includes PMA and distribution as well as component overhaul as well as the specialty products that go to commercial applications and primarily new builds. The specialty products area has been down significantly in the commercial area. Not in the defense, but in the commercial area because as you see, the build rates have gone down. So the -- you'll see our aftermarket replacement parts was down actually a little less than repair and overhaul and specialty products. However, a lot of our military business also goes through there. So that's one of the reasons why. But I would say, in general, commercial is what was hit. Defense and space, still relatively strong, in particular, on the products that we provide. So if that gives you an indication.

[Gautam Khanna:]

Yes. That's helpful. And is there any discernible difference between what you're seeing demand-wise in the distribution channel that you guys control versus the direct sales?

[Eric Mendelson:]

No. I would say it's all in the similar area.

[Gautam Khanna:]

Okay. And then one for Victor, if you wouldn't mind, your comment, defense eventually flattens out. I'm just curious, what do you think the time frame is when that happens? We see the primes guiding kind of low single-digit growth for sales in 2021, I mean, do you think that's sort of where we end up tracking on the defense side of ETG and it declines from there? Or how should we frame it?

[Victor Mendelson:]

It's difficult to know, of course, in these early days of the administration, but it sort of feels like that to me. And I think they probably have as good a handle on it as anybody. And of course, budgets for -- the budget or budgets for '21 are really pretty set, and the direction is fairly well known. Although there can be variations for sure in the current government fiscal year. So I think they've got, like I said, a reasonable handle on the situation, as reasonable as anyone has. And I think we're all just waiting to see where it shakes out. And we're all watching certainly like, for example, daily comments now coming out of DC and the struggles in between various democrats, for example, I'll call them the hawks and the doves. And so we'll just kind of wait and see where it pans out. But I think in the very least, one thing it does seem is that there does not appear to be this movement toward the Budget Control Act that we saw in the Obama administration. And so I think that's a positive.

[Gautam Khanna:]

That's helpful. And one for you, Larry. I was intrigued by your remark about one of the targets you're looking at would actually prefer stock. Is that -- anything you can say about that type of target? Is it -- would that be reserved for a large acquisition? Or in other words, you're not inclined to use stock on some of these $100 million deals, but it would have to be kind of one that moves the needle where you'd actually contemplate stock as the currency for M&A?

[Laurans Mendelson:]

As you know, our preference has always been to pay cash. Occasionally, we will get -- and it's very rare. We'll get somebody who prefers stock for -- probably for tax reasons, number one. And number two, because these people, well, certain ones, are really long-term believers in HEICO. So it doesn't really matter to us. If we want that acquisition and the only way we can make it is by giving stock, we would do it. And if -- as you know, we would still want to have it accretive as to earnings and cash. And it will have the same impact. I mean the alternative is we could sell stock and give them cash, but they don't want cash in this case. So again, if we want the deal badly enough, we would give them stock. But this is really an unusual case.

[Gautam Khanna:]

Got it. And I should not infer that it's a big deal because of...

[Laurans Mendelson:]

No. No, you can't make any inferences from that at all. No.

[Operator:]

The next question is from the line of Larry Solow from CJS Securities.

[Peter Lukas:]

It's Pete Lukas for Larry. You guys have covered most everything. Just one question, kind of a random one. Any thoughts on the price disparity or lack thereof between the common and the A shares. Discounts waned from over 20% 6 months ago to close to 5% today, which we think makes sense, but would love to hear your thoughts.

[Laurans Mendelson:]

We agree with you. We think it makes a lot of sense. We have no idea -- over the years, we've been asked this question many times, and we never really have the answer. I think -- we think now, and I think I'm speaking for everybody in the corporate office, we think it makes a whole hell of a lot of sense that the difference has shrunk so much. So -- but as to what the reason is, I guess, a lot of investors realize that they're better off buying the A shares at a discount and -- than the HEI shares. But that's all I can venture. It's just a guess.

[Carlos Macau:]

And maybe I'll add to that, we believe they should be a pari. I mean there should not even be a 5% discount at all when there had been times originally when the shares were issued, in fact, that they traded at par with HEI.

[Laurans Mendelson:]

Well, actually, they traded originally at a premium to HEI.

[Carlos Macau:]

There was a time, yes.

[Operator:]

Our next question is from the line of Ken Herbert from Canaccord.

[Kenneth Herbert:]

First, Victor, over the last couple of years, you've seen a really nice sequential step-up in margins within the ETG segment from the first to the second quarter. Can you -- sorry if I missed it earlier, but should we expect a similar step-up here in '21? Or how are you thinking about the margin progression off the first quarter?

[Victor Mendelson:]

I think we've got to be careful. At this point, there's still a little too much uncertainty. So -- and I think I'll stick with what I said before, which is pretty much within 10% or so of where we are feels pretty safe to me and a one way, up or down, in our margins, and we'll see where it comes out. Not trying to be evasive, but I just don't really know yet. We're still too early into the quarter.

[Kenneth Herbert:]

Okay. Fair enough. What was the amortization headwind in the quarter?

[Carlos Macau:]

Can I take it?

[Victor Mendelson:]

Sure.

[Carlos Macau:]

Ken, this is Carlos. There was about -- related to the acquisitions we did in the prior year, there was about $1.1 million roughly and an additional amortization expense that we absorbed for those acquisitions that was done around in Q1 of '20. So that would be the incremental uptick in amortization expense that went through the ETG's OI margin.

[Kenneth Herbert:]

Perfect. And if I could, Eric, just one for you. We're starting to hear about some delays on OEM material, and perhaps that risk is getting a little greater just because of all the restructuring and cost cutting we've seen in the industry. As you look at your portfolio, I think clearly, that benefits the PMA product line, and that's always been an opportunity for you. Could perhaps be a risk on the distribution side, if you're seeing delays in some -- from some suppliers? Are you seeing any opportunities emerge potentially yet from the risk of delays from OEM material? And how do you think about that as it emerges, potentially presenting opportunities or risks to your segment?

[Eric Mendelson:]

Yes. That's a good question, Ken. We are seeing some opportunities as a result of OEMs cutting back inventory. We were pretty careful to maintain in all of our businesses sufficient inventory because we're not capital constrained. And we need happy customers because we have an expansionary view of the market and our position in the market. So we want people to be very happy. And we don't deal from a view of perspective of scarcity. And we are seeing opportunities that you alluded to. I think that there are going to be pockets of opportunities. Having said that, I think the -- our competitors are -- our OEM competitors are well run, and they will be able to flex up and build the inventory that is required in order to satisfy the demand. So yes, I think it could help us get if you will, specked out on some products. So that is a potential area of opportunity for us.

[Kenneth Herbert:]

Okay. And just finally, Eric, there's been, obviously, unfortunately, some tragedies around the PW4000. I know you typically don't talk about types of engines, but I can imagine that's been a significant market for you over time. Are you seeing any potential incremental risk to the PW4000, if there's any sort of accelerated retirement or discontinuance of some of those engines?

[Eric Mendelson:]

I don't think that, that's going to be a major impact to us. I will come out because of the unique extenuating circumstances of this and mention, of course, we do have HEICO parts on the PW4000 engine. We, of course, did not have anything on that engine which could have contributed to this kind of fan blade release. We're very knowledgeable about the incident. And it's for that reason that HEICO does not produce parts that are susceptible to this kind of issue. I think the FAA AD that they've come out with to mandate the thermal imaging of the hollow composite fan blade is sufficient and is appropriate. I would feel entirely comfortable flying on a PW4000-powered 777. I think that they're going to get this under control quickly. If you look, none of the incidents caused a crash. And so I think it shows that Pratt & Whitney did a great job and really designed a very high-quality product to be able to withstand such an event. So I do think that there will be opportunity for us to sell our parts as those engines do come in for service. As you know, roughly half of them have been grounded due to the pandemic. But I think that those are perfectly good aircraft, and Pratt is more than capable of resolving this issue.

[Operator:]

Your next question comes from the line of Noah Poponak from Goldman Sachs.

[Noah Poponak:]

Carlos, the -- back to that discussion of the FSG margin and some of the moving pieces in there. I mean last quarter, you had quantified the bad debt expense, even though it was only $1.5 million. So the lack of quantification this quarter, can I interpret that to assume that, that is now pretty close to 0?

[Carlos Macau:]

No. Well, I wouldn't say it's zero. It's just more in the normal run rate. It's certainly less than the $1.5 million we had in Q1. It's not something, Noah, that sticks out or there was a flux in any of the numbers this quarter. It wasn't zero, but it certainly wasn't $1 million.

[Noah Poponak:]

Okay. Got it. And then you had also, over the last few quarters, spoke to the inventory obsolescence reserves in addition to that bad debt expense. And it was a somewhat sizable number in the back half of last year. Did you have that again in the fiscal first quarter?

[Carlos Macau:]

No. We have -- I guess, the answer to that question is we have a little bit of that right now. The bigger hits were taken last year because if you recall, last year, we had some specific reserves that we took for fleet retirements and aircraft that were being put down. So we took 100% reserve and some of that stuff that we had in stock. And then with the lower sales volumes that we're experiencing in FSG, you do get into this situation when you project demand over the near term, you do wind up a little bit of a kick to your slow-moving reserve. And so we have a little bit of that, but nothing that, Noah, is noteworthy to call out as being any different than it maybe would have been, let's say, in Q1 of '20. It is about the same pace.

[Noah Poponak:]

Okay. So those items are now kind of getting pretty close to normal or at normal. But your 1Q is usually seasonally the lower margin of the year. And then presumably, there's some volume pickup in the back half of the year. I guess how much of a margin lift through the year at FSG should we be looking at with what we know today?

[Carlos Macau:]

Well, I would say this, we've demonstrated the ability or the market has allowed us to participate in having sequential growth in the margin. And I don't foresee, even though we're not giving guidance or we're real careful, I don't see a scenario right now where we wouldn't continue that cadence. I don't think it's going to be a cliff up, if you would. I think it's going to be a steady progression back towards normal at some point. We're not going to get there in '21 in my judgment. But I do think we'll see marginal improvements as we play out the year and as our volumes pick up and that it's logical. If you think about the cost structure of the FSG, it is highly variable. We have very little fixed cost components. So as the volumes kick up, we do get cliffed in our margins. So you'll see that throughout '21.

[Noah Poponak:]

Got it. And then on the ETG margin, Carlos or Victor, you guys have spoken in the past to the lumpiness quarter-to-quarter from mix or other items. But you have specified that, that segment's margin should be in the 28% to 30% range over time. Just want to make sure that still holds and nothing has changed there.

[Carlos Macau:]

I mean -- this is Carlos, Noah. I think on an annual basis, because as we've talked about in the past, and you're aware of -- the quarter-by-quarter margins are real tough because you have push and pulls and it's a lumpy business. But I think on a normal year, and I'm not so sure I would call '21 a normal year yet, you know what I mean? In a normal year, I do see that segment in the 28% to 30% range. Could it be a tick lower? Are we going to tick higher? Of course, it could. But I think expectation-wise, if you're thinking about a normal year, that's the range, and we'll see how '21 plays out. I wouldn't necessarily call '21 a normal year yet, you know what I mean?

[Noah Poponak:]

Sure. Hopefully getting there. Okay. And then on the ETG organic revenue growth rate, that's been chopping around a bit in recent quarters with some of the -- with the nondefense pieces in there going against you. Looking at the model, starting next quarter, in your fiscal second quarter, you will be annualizing the start of the decline. Can that give us reason to expect the organic growth rate of the segment to start to consistently get back to a definitively positive territory?

[Carlos Macau:]

The answer to that question is I think our second quarter is straddled to this pandemic, right? So we kind of have half the quarter is good, half the quarter is shell-shocked. That was the initial byways that came in from this whole pandemic. So we got still kind of a lumpy Q2 to deal with. But yes, to answer your question, as we get into the back half of the year, the comps get easier. And as the business and the vaccine kicks in and people start traveling, we expect that the ETG's commercial aerospace business will pick up, and that will be helpful to the margin because that was the one area that drug us down this quarter compared to Q1 of '20.

[Noah Poponak:]

Okay. And then just lastly, I wanted to dig a little further into free cash flow. Carlos, your fiscal '20 free cash flow is only down 5% despite all of the challenges. Your 1Q free cash is up again year-over-year despite comparing to a normal period of time. I guess where does that go from here? Is there anything that was abnormally helping fiscal '20 that reverses on you? Or should we be thinking that, that just grows '21 versus '20? I know you have the higher CapEx, but you still have it up in 1Q versus last year. Just any further thoughts on where you go from here with free cash flow of the business.

[Carlos Macau:]

No. Look, I think our free cash flow, if I think in terms of operating cash flow, I do think that as the year plays out, we should run on a conversion rate of, let's say, around 130% of net income. So that's traditionally about where we're granted. I believe we'll convert at that rate, which will help our free cash flow numbers that you're talking about. The problem is with -- and I want to be very careful because it is an uncertain time for us, predicting our net income number right now is hard to do. And so until we get to a point where -- I know when the numbers flush out, we'll probably see it converted 130-plus percent. I just -- I don't want -- I want to be careful not to give you some kind of guidance here that we have certainty on net income because right now, it's still in flux. As we get more -- I was just going to say, as our subsidiaries get more confident in their end markets, we'll start talking a little bit more about guidance and things like that. But right now, that's not on the table.

[Noah Poponak:]

That's helpful. And the capital expenditure piece, I think last quarter, you had discussed approximately $40 million for the year, which that would put the expansion effort pretty loaded into the number you just had for 1Q. Is that the case?

[Carlos Macau:]

That's correct. Yes, that's exactly the case. We had -- this is no surprise. We planned on this, and it was part of the $40 million.

[Noah Poponak:]

So that was back kind of sub-$10 million a quarter. And then '22 -- or beyond '21, it was a sort of a onetime thing. Beyond '21, goes back up?

[Carlos Macau:]

Yes. I mean look, every year, we have the potential for one of our facilities graduating and having needs for bigger facilities or expansion. We always have growth capital that's planned. This year, to your point, in Q1, it's a little bit more amplified. But I think that if you're thinking about modeling or you're thinking about '22 and things like that, I think if you think along terms of our CapEx being somewhere between -- somewhere around 1.5% of sales, that's generally where we've trended. And that's kind of a conservative way to think about it and put your model together.

[Operator:]

Your next question comes from the line of Michael Ciarmoli from Truist Securities.

[Michael Ciarmoli:]

Nice results, as always. Maybe -- I don't know who wants to field this one, if it's Victor, Eric Carlos. But maybe just if you could touch on the backlog. I think you called it out as $906 million. So a nice little sequential uptick. Can you give us any more color there in terms of the breakout by segment? Were you seeing disproportionately more strength in ETG or FSG? And maybe some color on product lines there?

[Carlos Macau:]

I'll take a stab, and I'm sure the guys may want to follow up. The -- as you know, Michael, the FSG, for the most part, not everything, because we do have defense and that has backlog. But for the most part, the FSG, you kind of eat what you kill in the month, you get the order. It's a business that doesn't have a ton of backlog by its nature. So a lot of the expansion that we're seeing in backlog has come in through FSG defense and through the ETG. And to parse that out within the ETG, we're seeing -- as Victor mentioned, we're seeing strength in some of our space backlog in this first half of the year and general electronics and things like that. I think defense and -- is pretty stable. It's lumpy, but the backlog is there right now. And commercial aero in ETG is down. So we're not seeing expansion of that backlog at the moment. So that's kind of the breakout of it.

[Michael Ciarmoli:]

Okay. No, that's helpful. And then just maybe a little bit more on, Eric, on some of the, call it, bookings trends you're seeing from some of the airlines. I mean obviously, there's still pretty significant reduced utilization of older planes. Can you help us or quantify? Are you seeing a significant amount of pickup on the parts side in support of the newer, younger fleet? I know you've been pretty guarded in the past on what kind of content you've got on the 87 and the 350, but are you guys positioned, do you think, to support a younger fleet as this kind of -- we emerge through this pandemic and presumably the fleet age tilts lower given the older retirements?

[Eric Mendelson:]

Yes. That's a great question, Mike. Yes, I think the short answer is we are well positioned on the newer equipment. I think that we're going to do very well on that. A lot of customer interest and customer approvals in those areas. In addition, also to point that, we took the position early in the pandemic that a lot of these aircraft would not be retired as some have -- as some thought for the simple reason that they already exist and the lessors and the banks that would end up having to replace them, finds a new home for them, would have two options

[Michael Ciarmoli:]

Got it. Got it. That's helpful. And I mean, you're close enough to the customers. Presumably, I think everybody in this industry is watching oil prices, which keep climbing. That could kind of throw a wrench into keeping some of that older equipment, for sure, with these cash-strapped airlines. So I'm sure you guys are watching that indicator as well.

[Eric Mendelson:]

We are. And I think a lot of the recent climb was due to the cold snap that we've had here in the United States. And that should pass, so I still think that the older equipment with its lower acquisition cost makes a lot of sense for the airlines. So I don't see them -- at this point, who wants to commit to newer equipment where you increase your cost base in the face of what we've just gone through? So I think the older equipment is going to hang in there and do well. And actually, the number of aircraft retired was even below what we thought it was going to be. And we were on the low side of the spectrum and the estimates on the retirement. I mean a lot of people spoke of big retirements, and we didn't share that view. But we're positioned well, I think, in both sides.

[Michael Ciarmoli:]

Got it. Last one I had, just Carlos, I think you guys called out this quarter all of commercial aerospace across the entity was down 43%. Did you have that number in the fourth quarter? Just trying to get a sense of the rate of decline there. I think you called it out for 2020 or fiscal '20 in total, but did you have what all of aero did in fiscal fourth quarter?

[Carlos Macau:]

I don't recall what it was in the fourth quarter off of that. You're right. We did disclose it for the year. It was like in the mid-30s or something like that for the year. I don't recall that -- what the fourth quarter was.

[Operator:]

Your next question comes from the line of Colin Ducharme from Sterling Capital.

[Colin Ducharme:]

Most of my questions were answered, but just a quick one for Carlos. Perhaps just trying to take a look at the incremental margin progression from a different angle. You guys have kept human resources and capacity, given the culture, through the pandemic, totally understandable. But clearly, it seems to me like the business is built and can sustain, and with the current expense structure, a higher revenue level. And that's my question for Carlos. I mean if you had to back into how much incremental revenue, perhaps on a percentage basis, your current expense base from a human resourcing capacity could sustain, what your best guess might be?

[Carlos Macau:]

Well, I think that our businesses right now are positioned to handle quite a bit of sales growth in the FSG, which I think is what you're focusing on. Naturally, as that business picks up, we will have some hires to get back up to levels we saw in '19, but that's going to be a slow tick upward. And I think what we'll -- what you'll see happen is that as the sales grow, you will see us catching some more leverage in our fixed costs as that expands. But we will have some expenditures. I don't have a percentage for you because the problem, Colin is that we don't have total clarity on what those sales are going to be. We have a sense that they're going to rise, but we don't know the magnitude or the steepness of that rise. So we're very nimble, and we will flex as necessary. But as we're sitting here today, the current business can handle a pretty sizable jump in sales before we got to go out and make meaningful hires.

[Colin Ducharme:]

Okay. And then just as a quick follow-up, maybe 1 for Carlos and 1 for Eric. Carlos, you talked a little bit about OEMs continuing to push price, somewhat surprising given the health of the customer base through the pandemic. HEICO's franchise poised to take share. Can you talk about the price disparity, i.e., the umbrella? Is that widening over time, and therefore, better positioning you not just with the recovery, which would normally be a time for you to take share, but is that price umbrella making that opportunity even more positioning HEICO to be an even more attractive option as the economy recovers here? And then just quickly for Victor, congrats again on the Perseverance landing, very exciting for the company and for the country. You guys are putting a variety of parts, sensors, memory, et cetera, on electronic vehicles on Mars. Wondering if there's any crossover opportunity to participate in what is still an early but large and growing market for electronic vehicles here on Earth, where share positions are still fluid, if that's even on your radar?

[Eric Mendelson:]

So this is Eric. I'll go ahead and start first. With respect to the pricing umbrella, we treat our committed customers extremely well. And so we moderate price increases for them if they commit to us for a long period of time. So yes, you're absolutely right that pricing umbrella does widen over time. And we can get to a point where, if somebody has been buying a part from us for 15 to 20 years, our price could end up being 70%, 80% below the OEM price and we're still able to earn a fair margin on it and we're able to give a very good value, and then we add more products as a result of that. There's no question that we've got the opportunity if we wanted to push pricing that we could. But we've decided that the future is much greater to us and we would rather continue on our growth path and sort of limit -- voluntarily limit those opportunities in order to capture more market share. The OEMs, I would say, this year, in general, their price increase -- I mean, they've been across the board. Some have decided to raise price substantially in order to make up all of the lost margin that they've surrendered due to the pandemic. Others have been slightly more moderate in their price increases. But I would say it's pretty much across the board of business as usual. So the HEICO value has even been enhanced during the pandemic. And then for Victor?

[Victor Mendelson:]

It's a very good question, and I appreciate you're asking it actually. It's insightful. And thank you, by the way, for the complement to our people and to our company on Perseverance. The answer is yes, some of our businesses are working on autonomous vehicles, cars, automobiles. And it's not -- I wouldn't call it a big part of our business. I think it has some potential for us. We'll see how it develops. Part of the question is we tend to be a high-end, higher-margin producer, as you know, and we tend not to be in the extreme high-volume, low-margin end, which is often where automotive lies. And so we'll have to see how it develops for us. Is it something that turns into an opportunity longer term? Or are we really more on the development end? So right now, what we're doing there tends to be more in the development end. Unfortunately, I can't tell specifically or disclose specifically the companies we're working with, the programs were on because we're subject to some confidentiality agreements on those, and they want it kept secret. But if -- by the way, I can say it's not just the automotive companies, but it's the tech companies as well who are involved with automotive applications. And Carlos, do you have...

[Carlos Macau:]

I couldn't have said it better, Victor. I couldn't have said it better.

[Victor Mendelson:]

Was there one that you were going to answer?

[Carlos Macau:]

I think Eric took care of it actually.

[Operator:]

Your next question is from the line of Greg Konrad from Jefferies.

[Gregory Konrad:]

Just quick -- two quick follow-ups. One on ETG. I think last year, defense and space was about 2/3 of the segment. Any granularity around the breakout? And then you mentioned space was broad-based in terms of opportunities. Any color around drivers? I mean you mentioned Mars Rover, but how much is government versus maybe some of these new commercial space opportunities we hear about?

[Victor Mendelson:]

Yes. So just in terms of giving you a sense of the breakdown sales, it's comparable to where it's been. I mean it's a little better than half is defense. And commercial space is around the 10% range. And then other markets, other electronics and government markets, kind of about 1/4; and our medical bounces around 5% to 10%; and commercial aviation is sub-10% now, between 5% and 10%, running between 5% and 10%. And I would expect commercial aviation to get back up more toward 10% as the year wears on or as we get into next year, certainly, based on what we know today and how things are doing. And on the space side, you're right, of course, Perseverance, there was no revenue in the quarter from that as that launched, of course, in July of last year. But it's broad-based. It tends to be more satellites. It's most heavily satellites and most heavily communication satellites. The space exploration part of the business is nice. And it is a profitable business for us, but it is not the bread-and-butter part, if you will. It tends to be the branding rights, if you will, for us, and it tends to be the more noteworthy. But obviously, there are not a lot of Rovers built each year and launched each year. But when you get into Earth observation, there are a number of growth observation satellites that we're on, that we're getting on, that our companies are supplying components on and as well as some launch vehicles. So that's broadly where we mine.

[Gregory Konrad:]

And then just a quick question on FSG. I mean you mentioned you're up earlier in the call. When we think about the eventual improvement of the aftermarket, should that kind of follow the capacity trends that we're seeing in the regions with recovering ahead of others? And is that kind of what we should be looking at in terms of regional trends?

[Eric Mendelson:]

Yes. Absolutely. I think you nailed it. There may be a little bit of a recovery slightly before that as airlines get prepared, if they start to see bookings, I think that could drive it, drive an early recovery. They got to make sure that they've got the aircraft ready for, I believe, what's going to be a surge down the road.

[Operator:]

. We have another question from Louis Raffetto from UBS.

[Louis Raffetto:]

Just take one from me. Carlos, the SG&A trended up a bit in the quarter. Is that some of the performance comp coming back in? Is that also maybe what weighed a little bit on the FSG margins? Because I think if you add back the bad debt expense and the inventory reserves, sort of the clean margins did tick down, but is that just maybe some of that SG&A coming back?

[Carlos Macau:]

The performance-based comp in the first quarter of 2020 and 2021 were fairly comparable. So -- because remember, last year, we had very low bonuses. So this year, we're wanting to take care of our folks as we do see some green shoots in the process going forward. So I think what we're seeing, to be candid with you, Lou, is that as the sales have started to tick up a little bit, we're still not catching the leverage in our SG&A that we experienced in Q1 of '20. We had a great quarter in '20. And comparatively speaking, it's some of the fixed cost inefficiencies, is the only way I could think to put it, that we're experiencing when compared to Q1 '20. I don't think it has anything to do with performance-based comp.

[Louis Raffetto:]

Okay. And then, Eric, the talk of the share taking, I guess, is that -- do you see that more on the parts side or the MRO side? I just -- obviously, the parts, to your point, you have 70% to 80% lower prices in some cases. That's extremely competitive. Are you as competitive on the MRO side? Just trying to get a sense of where you think that share taking could take place?

[Eric Mendelson:]

Yes. I think it's really across the board in all of our businesses. Yes, you're right that the -- first of all, the 70% to 80% price benefit would be for, as I mentioned, for a customer who's committed to us and who's been buying something for, say, 15 to 20 years. So -- and that would be the maximum. I mean that's not where we come out of the box. So if you look at repair, typically, parts as a percentage of repairs, just say, roughly 40% of the cost. So you're right that the extreme cost benefit would be more on the -- in particular, on the PMA side. But I think we're very competitive across the board in everything that we do.

[Louis Raffetto:]

Okay. Great. And Victor, just for you, to your earlier point, aviation is now 5% to 10% of ETG. And correct me if I'm wrong, but I think it's primarily OEM. So where is the uncertainty in ETG? I mean defense, all defense primes have guidance, just what else is it that you guys are particularly so uncertain about in that business?

[Victor Mendelson:]

So Lou, this is Victor. The business is roughly split between OEM and aftermarket in ETG for commercial aviation. So that pretty much explains what we're looking at, right? I mean if you've got the uncertainty in aftermarket, which is improving and the uncertainty in new production, which I think is also probably moving in the right direction. I mean there was a lot of disruption in new aircraft production rates and shifting, which seems to be moving again in the right direction. And we've got the MAX, which is now resuming production that had stopped. And so that's why generally optimistic about the direction that we're moving in commercial aviation. I just don't know the exact timing.

[Louis Raffetto:]

Okay. And I think that earlier number someone asked about, I think it was minus 49.5% for the fourth quarter. So just so it's there.

[Operator:]

There are no further questions at this time. Mr. Mendelson, please continue.

[Laurans Mendelson:]

Thank you very much. I want to thank everybody on the call for your interest in HEICO. As you know, we remain available, if you have questions, give us a call. Eric, Victor, Carlos or I will be happy to speak with you. And if not, we look forward to speaking to you at the Q2 conference, which will be in about 3 months. So stay well, stay healthy. Hopefully, get vaccines. And we'll speak to you real soon. Thank you all.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Have a great day.