1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of HEICO Corporation and its subsidiaries (collectively, “HEICO,” or the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. Therefore, the condensed consolidated financial statements do not include all information and footnotes normally included in annual consolidated financial statements and should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended October 31, 2021. The October 31, 2021 Condensed Consolidated Balance Sheet has been derived from the Company’s audited consolidated financial statements. In the opinion of management, the unaudited condensed consolidated financial statements contain all adjustments (consisting principally of normal recurring accruals) necessary for a fair presentation of the condensed consolidated balance sheets, statements of operations, statements of comprehensive income, statements of shareholders' equity and statements of cash flows for such interim periods presented. The results of operations for the nine months ended July 31, 2022 are not necessarily indicative of the results which may be expected for the entire fiscal year.
The Company has two operating segments: the Flight Support Group (“FSG”), consisting of HEICO Aerospace Holdings Corp. and HEICO Flight Support Corp. ("HFSC") and their respective subsidiaries; and the Electronic Technologies Group (“ETG”), consisting of HEICO Electronic Technologies Corp. (“HEICO Electronic”) and its subsidiaries.
The Company's results of operations in fiscal 2022 continue to reflect the adverse impact from the COVID-19 global pandemic (the “Pandemic”), including its impact on the Company’s supply chain. Despite the aforementioned, the Company experienced continued improvement in operating results in the first nine months and third quarter of fiscal 2022 as compared to the first nine months and third quarter of fiscal 2021 principally reflecting improved demand for its commercial aerospace products. The Flight Support Group has reported eight consecutive quarters of improvement in net sales and operating income resulting from signs of commercial air travel recovery in certain domestic travel markets, moderated by a slower recovery in international travel markets.
New Accounting Pronouncement
In October 2021, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") 2021-08, "Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers," which requires contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, "Revenue from Contracts with Customers," as if the acquirer had originated the contracts. ASU 2021-08 is effective for fiscal years and interim reporting periods within those fiscal years beginning after December 15, 2022, or in fiscal 2024 for HEICO. Early adoption is permitted and ASU 2021-08 shall be applied on a prospective basis to business combinations that occur on or after the adoption date. The Company is currently evaluating the effect, if any, the adoption of this guidance will have on its consolidated results of operations, financial position and cash flows.
2. ACQUISITIONS
In July 2022, the Company, through a subsidiary of HFSC, acquired 96% of the stock of Accurate Metal Machining, Inc. ("Accurate"). Accurate is a manufacturer of high-reliability components and assemblies. The remaining 4% interest continues to be owned by certain members of Accurate’s management team (see Note 3, Selected Financial Statement Information - Redeemable Noncontrolling Interests, for additional information). The total consideration includes an accrual of $13.1 million as of the acquisition date representing the estimated fair value of contingent consideration the Company may be obligated to pay should Accurate meet certain earnings objectives following the acquisition. See Note 8, Fair Value Measurements, for additional information regarding the Company’s contingent consideration obligation. The purchase price of this acquisition was paid in cash, principally using proceeds from the Company's revolving credit facility.
In March 2022, the Company, through a subsidiary of HFSC, acquired 74% of the membership interests of Pioneer Industries, LLC ("Pioneer"). Pioneer is a specialty distributor of spares for military aviation, marine, and ground platforms. The remaining 26% interest continues to be owned by certain members of Pioneer's management team (see Note 3, Selected Financial Statement Information - Redeemable Noncontrolling Interests, for additional information). The total consideration includes an accrual of $9.8 million as of the acquisition date representing the estimated fair value of contingent consideration the Company may be obligated to pay should Pioneer meet a certain earnings objective following the acquisition. See Note 8, Fair Value Measurements, for additional information regarding the Company’s contingent consideration obligation. The purchase price of this acquisition was paid in cash, principally using proceeds from the Company's revolving credit facility.
In March 2022, the Company, through a subsidiary of HEICO Electronic, acquired 100% of the stock of Flight Microwave Corporation ("Flight Microwave"). Flight Microwave is a designer and manufacturer of custom high power filters and filter assemblies used in space and
defense applications. The purchase price of this acquisition was paid in cash using cash provided by operating activities.
The individual purchase price of Accurate, Pioneer and Flight Microwave is not material or significant to the Company's condensed consolidated financial statements. The allocation of the total consideration for the fiscal 2022 acquisitions to the tangible and identifiable intangible assets acquired and liabilities and noncontrolling interests assumed is preliminary until the Company obtains final information regarding their fair values. However, the Company does not expect any adjustment to such allocations to be material to the Company's consolidated financial statements. The operating results of the fiscal 2022 acquisitions were included in the Company’s results of operations as of each effective acquisition date. The amount of net sales and earnings of the fiscal 2022 acquisitions included in the Condensed Consolidated Statements of Operations for the nine and three months ended July 31, 2022 is not material.
Had the fiscal 2022 acquisitions occurred as of November 1, 2020, net sales and net income from consolidated operations on a pro forma basis for the nine and three months ended July 31, 2022 would not have been materially different than the reported amounts, and net sales on a pro forma basis for the nine and three months ended July 31, 2021 would have been $1,448.0 million and $504.1 million, respectively, and net income from consolidated operations on a pro forma basis for the nine and three months ended July 31, 2021 would have been $248.5 million and $88.1 million, respectively. Had the fiscal 2022 acquisitions occurred as of November 1, 2020, net income attributable to HEICO, and basic and diluted net income per share attributable to HEICO shareholders on a pro forma basis for the nine and three months ended July 31, 2022 and 2021 would not have been materially different than the reported amounts. The pro forma financial information is presented for comparative purposes only and is not necessarily indicative of the results of operations that actually would have been achieved if the acquisitions had taken place as of November 1, 2020. The unaudited pro forma financial information includes adjustments to historical amounts such as additional amortization expense related to the intangible assets acquired and increased interest expense associated with borrowings to finance the acquisitions.
On July 26, 2022, the Company, through HEICO Electronic, entered into a Put Option Agreement with IK Partners and certain other parties thereto (collectively, the “Sellers”). Pursuant to the Put Option Agreement and a Stock Purchase Agreement attached to the Put Option Agreement (the “Purchase Agreement” and, together with the Put Option Agreement, the “Acquisition Agreements”), the Company has committed to acquire Exxelia International (“Exxelia”) from an affiliate of IK Partners and the Sellers for €453 million, or approximately $463.1 million as of July 31, 2022, in cash to be paid at closing plus the assumption of approximately €14 million, or approximately $14.3 million as of July 31, 2022, of liabilities pursuant to the terms, and subject to the conditions, set forth in the Acquisition Agreements. On August 5, 2022, pursuant to the exercise of the Put Option Agreement, the Company entered into the Purchase Agreement to purchase Exxelia. Exxelia designs, manufactures and sells high-reliability (“Hi-Rel”), complex, passive electronic components and rotary joint assemblies for mostly aerospace and defense applications, in addition to other high-end applications, such as medical and energy uses, including emerging “clean energy” and electrification applications.
Exxelia's management and team members are expected to continue to own a minority interest of around 5% of the business. The purchase price of this acquisition is expected to be paid in cash, principally using proceeds from the Company's revolving credit facility. The closing of the transaction, which is expected to occur in the first quarter of fiscal 2023, is subject to customary closing conditions, including, among others, obtaining a required foreign antitrust clearance and foreign investment authorizations.
3. SELECTED FINANCIAL STATEMENT INFORMATION
Accounts Receivable
| | | | | | | | | | | | | | |
(in thousands) | | July 31, 2022 | | October 31, 2021 |
Accounts receivable | | $282,693 | | | $255,793 | |
Less: Allowance for doubtful accounts | | (9,542) | | | (10,874) | |
Accounts receivable, net | | $273,151 | | | $244,919 | |
Inventories
| | | | | | | | | | | | | | |
(in thousands) | | July 31, 2022 | | October 31, 2021 |
Finished products | | $267,839 | | | $238,867 | |
Work in process | | 58,738 | | | 44,887 | |
Materials, parts, assemblies and supplies | | 219,366 | | | 194,296 | |
Inventories, net of valuation reserves | | $545,943 | | | $478,050 | |
Property, Plant and Equipment
| | | | | | | | | | | | | | |
(in thousands) | | July 31, 2022 | | October 31, 2021 |
Land | | $11,200 | | | $11,363 | |
Buildings and improvements | | 139,777 | | | 134,150 | |
Machinery, equipment and tooling | | 311,102 | | | 297,297 | |
Construction in progress | | 13,320 | | | 7,784 | |
| | 475,399 | | | 450,594 | |
Less: Accumulated depreciation and amortization | | (272,555) | | | (256,956) | |
Property, plant and equipment, net | | $202,844 | | | $193,638 | |
Accrued Customer Rebates and Credits
The aggregate amount of accrued customer rebates and credits included within accrued expenses and other current liabilities in the accompanying Condensed Consolidated Balance Sheets was $17.5 million as of July 31, 2022 and $13.2 million as of October 31, 2021. The total customer rebates and credits deducted within net sales for the nine months ended July 31, 2022 and 2021 was $5.9 million and $2.5 million, respectively. The total customer rebates and credits deducted within net sales for the three months ended July 31, 2022 and 2021 was $2.2 million and $.7 million, respectively.
Research and Development Expenses
The amount of new product research and development ("R&D") expenses included in cost of sales for the nine and three months ended July 31, 2022 and 2021 is as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine months ended July 31, | | Three months ended July 31, |
| 2022 | | 2021 | | 2022 | | 2021 |
R&D expenses | $55,804 | | | $52,179 | | | $18,657 | | | $17,976 | |
Redeemable Noncontrolling Interests
The holders of equity interests in certain of the Company's subsidiaries have rights ("Put Rights") that may be exercised on varying dates causing the Company to purchase their equity interests through fiscal 2032. The Put Rights, all of which relate either to common shares or membership interests in limited liability companies, provide that the cash consideration to be paid for their equity interests (the "Redemption Amount") be at fair value or a formula that management intended to reasonably approximate fair value based solely on a multiple of future earnings over a measurement period. Management's estimate of the aggregate Redemption Amount of all Put Rights that the Company could be required to pay is as follows (in thousands):
| | | | | | | | | | | |
| July 31, 2022 | | October 31, 2021 |
Redeemable at fair value | $274,854 | | | $217,416 | |
Redeemable based on a multiple of future earnings | 22,140 | | | 35,171 | |
Redeemable noncontrolling interests | $296,994 | | | $252,587 | |
As discussed in Note 2, Acquisitions, the Company, through a subsidiary of HFSC, acquired 96% of the stock of Accurate in July 2022. As part of the operating agreement, the noncontrolling interest holders have the right to cause the Company to purchase their membership interest over a four-year period beginning in fiscal 2029, or sooner under certain conditions, and the Company has the right to purchase the same membership interest over the same period.
As discussed in Note 2, Acquisitions, the Company, through a subsidiary of HFSC, acquired 74% of the membership interests of Pioneer in March 2022. As part of the operating agreement, the noncontrolling interest holders have the right to cause the Company to purchase their membership interest over a four-year period beginning in fiscal 2029, or sooner under certain conditions, and the Company has the right to purchase the same membership interest over the same period.
During fiscal 2022, the holder of a 19.9% noncontrolling equity interest in a subsidiary of the FSG that was acquired in fiscal 2017 exercised its option to cause the Company to purchase one-half of the noncontrolling interest in fiscal 2022 and the remaining one-half in fiscal 2024. Accordingly, the Company acquired an additional 9.95% equity interest in May 2022, which increased the Company's ownership interest in the subsidiary to 90.05%.
During fiscal 2022, the Company sold a 3% equity interest in a subsidiary of the FSG that was acquired in fiscal 2015, which decreased the Company's ownership interest in the subsidiary to 82%. As part of the operating agreement, the noncontrolling interest holder has the right to cause the Company to purchase one-fifth of its equity interest beginning in fiscal 2028, or sooner under certain conditions, and each remaining one-fifth equity interest following the first anniversary of the most recent put option exercise. The Company has the right to purchase the same equity interest over the same period.
During fiscal 2022, the Company sold 10% of the membership interests of a subsidiary of the FSG that was acquired in fiscal 2018, which decreased the Company's ownership interest in the subsidiary to 90%. As part of the operating agreement, the noncontrolling interest holder has the right to cause the Company to purchase its membership interest over a four-year period beginning in fiscal 2027, or sooner under certain conditions, and the Company has the right to purchase the same membership interest over the same period.
Accumulated Other Comprehensive Loss
Changes in the components of accumulated other comprehensive loss for the nine months ended July 31, 2022 are as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| Foreign Currency Translation | | Defined Benefit Pension Plan | | Accumulated Other Comprehensive Loss |
Balances as of October 31, 2021 | ($6,989) | | | ($1,563) | | | ($8,552) | |
Unrealized loss | (29,424) | | | — | | | (29,424) | |
Amortization of unrealized loss | — | | | 49 | | | 49 | |
Balances as of July 31, 2022 | ($36,413) | | | ($1,514) | | | ($37,927) | |
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill by operating segment for the nine months ended July 31, 2022 are as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| Segment | | Consolidated Totals |
| FSG | | ETG | |
Balances as of October 31, 2021 | $468,288 | | | $982,107 | | | $1,450,395 | |
Goodwill acquired | 107,265 | | | 2,652 | | | 109,917 | |
Foreign currency translation adjustments | (5,288) | | | (6,527) | | | (11,815) | |
Adjustments to goodwill | (6,911) | | | (109) | | | (7,020) | |
Balances as of July 31, 2022 | $563,354 | | | $978,123 | | | $1,541,477 | |
The goodwill acquired pertains to the fiscal 2022 acquisitions described in Note 2, Acquisitions, and represents the residual value after the allocation of the total consideration to the tangible and identifiable intangible assets acquired and liabilities and noncontrolling interests
assumed. Foreign currency translation adjustments are included in other comprehensive income (loss) in the Company's Condensed Consolidated Statements of Comprehensive Income. The adjustments to goodwill principally reflect a measurement period adjustment of the write-up to fair value of property, plant and equipment associated with a fiscal 2021 acquisition. The Company estimates that $108 million of the goodwill acquired in fiscal 2022 will be deductible for income tax purposes.
Identifiable intangible assets consist of the following (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | As of July 31, 2022 | | As of October 31, 2021 |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
Amortizing Assets: | | | | | | | | | | | | |
Customer relationships | | $480,195 | | | ($197,070) | | | $283,125 | | | $464,506 | | | ($221,098) | | | $243,408 | |
Intellectual property | | 263,382 | | | (106,013) | | | 157,369 | | | 255,011 | | | (94,313) | | | 160,698 | |
Licenses | | 6,559 | | | (5,344) | | | 1,215 | | | 6,559 | | | (5,072) | | | 1,487 | |
Patents | | 1,109 | | | (801) | | | 308 | | | 1,110 | | | (793) | | | 317 | |
Non-compete agreements | | 641 | | | (641) | | | — | | | 722 | | | (722) | | | — | |
Trade names | | 300 | | | (133) | | | 167 | | | 450 | | | (257) | | | 193 | |
| | 752,186 | | | (310,002) | | | 442,184 | | | 728,358 | | | (322,255) | | | 406,103 | |
Non-Amortizing Assets: | | | | | | | | | | | | |
Trade names | | 196,366 | | | — | | | 196,366 | | | 176,204 | | | — | | | 176,204 | |
| | $948,552 | | | ($310,002) | | | $638,550 | | | $904,562 | | | ($322,255) | | | $582,307 | |
Amortization expense related to intangible assets for the nine months ended July 31, 2022 and 2021 was $45.4 million and $45.5 million, respectively. Amortization expense related to intangible assets for the three months ended July 31, 2022 and 2021 was $15.2 million. Amortization expense related to intangible assets for the remainder of fiscal 2022 is estimated to be $15.5 million. Amortization expense for each of the next five fiscal years and thereafter is estimated to be $58.3 million in fiscal 2023, $53.3 million in fiscal 2024, $48.9 million in fiscal 2025, $44.4 million in fiscal 2026, $41.5 million in fiscal 2027, and $180.3 million thereafter.
5. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
| | | | | | | | | | | |
| July 31, 2022 | | October 31, 2021 |
Borrowings under revolving credit facility | $230,000 | | | $225,000 | |
Finance leases and notes payable | 15,757 | | | 11,498 | |
| 245,757 | | | 236,498 | |
Less: Current maturities of long-term debt | (1,734) | | | (1,515) | |
| $244,023 | | | $234,983 | |
The Company's borrowings under its revolving credit facility mature in fiscal 2025 as discussed further below. As of July 31, 2022 and October 31, 2021, the weighted average interest rate on borrowings under the Company's revolving credit facility was 3.3% and 1.1%, respectively. The revolving credit facility contains both financial and non-financial covenants. As of July 31, 2022, the Company was in compliance with all such covenants.
On April 7, 2022, the Company entered into an amendment to extend the maturity date of its Revolving Credit Facility Agreement ("Credit Facility") by one year to November 2024 and to replace the Eurocurrency Rate with Adjusted Term SOFR as an election in which borrowings under the Credit Facility accrue interest, as such capitalized terms are defined in the Credit Facility.
6. REVENUE
Contract Balances
Contract assets (unbilled receivables) represent revenue recognized on contracts using an over-time recognition model in excess of amounts invoiced to the customer. Contract liabilities (deferred revenue) represent customer advances and billings in excess of revenue recognized and are included within accrued expenses and other current liabilities in the Company’s Condensed Consolidated Balance Sheets.
Changes in the Company’s contract assets and liabilities for the nine months ended July 31, 2022 are as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| July 31, 2022 | | October 31, 2021 | | Change |
Contract assets | $86,534 | | | $80,073 | | | $6,461 | |
Contract liabilities | 58,366 | | 32,738 | | | 25,628 | |
Net contract assets | $28,168 | | | $47,335 | | | ($19,167) | |
The increase in the Company's contract liabilities during the first nine months of fiscal 2022 principally reflects the receipt of advance deposits on certain customer contracts at both the ETG and FSG.
The amount of revenue that the Company recognized during the nine and three months ended July 31, 2022 that was included in contract liabilities as of the beginning of fiscal 2022 was $22.7 million and $3.1 million, respectively.
Remaining Performance Obligations
As of July 31, 2022, the Company had $451.3 million of remaining performance obligations associated with contracts with an original duration of greater than one year pertaining to the majority of the products offered by the ETG as well as certain products of the FSG's specialty products product line. The Company will recognize net sales as these obligations are
satisfied. The Company expects to recognize $123.8 million of this amount during the remainder of fiscal 2022 and $327.5 million thereafter, of which the majority is expected to occur in fiscal 2023.
Disaggregation of Revenue
The following table summarizes the Company’s net sales by product line for each operating segment (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine months ended July 31, | | Three months ended July 31, |
| 2022 | | 2021 | | 2022 | | 2021 |
Flight Support Group: | | | | | | | |
Aftermarket replacement parts (1) | $512,335 | | | $390,685 | | | $187,453 | | | $136,357 | |
Repair and overhaul parts and services (2) | 193,973 | | | 147,709 | | | 66,440 | | | 54,591 | |
Specialty products (3) | 202,945 | | | 128,338 | | | 76,366 | | | 46,170 | |
Total net sales | 909,253 | | | 666,732 | | | 330,259 | | | 237,118 | |
| | | | | | | |
Electronic Technologies Group: | | | | | | | |
Electronic component parts primarily for defense, space and aerospace equipment (4) | 485,780 | | | 521,586 | | | 165,871 | | | 176,238 | |
Electronic component parts for equipment in various other industries (5) | 218,152 | | | 184,596 | | | 78,332 | | | 63,305 | |
Total net sales | 703,932 | | | 706,182 | | | 244,203 | | | 239,543 | |
| | | | | | | |
Intersegment sales | (14,501) | | | (16,654) | | | (4,934) | | | (4,954) | |
| | | | | | | |
Total consolidated net sales | $1,598,684 | | | $1,356,260 | | | $569,528 | | | $471,707 | |
| | | | | | | |
(1) Includes primarily various jet engine and aircraft component replacement parts.
(2) Includes primarily the sale of parts consumed in various repair and overhaul services on selected jet engine and aircraft components, avionics, instruments, composites and flight surfaces of commercial and military aircraft.
(3) Includes primarily the sale of specialty components such as thermal insulation blankets, renewable/reusable insulation systems, advanced niche components, complex composite assemblies, and expanded foil mesh as well as machining, brazing, fabricating and welding services generally to original equipment manufacturers.
(4) Includes various component parts such as electro-optical infrared simulation and test equipment, electro-optical laser products, electro-optical, microwave and other power equipment, high-speed interface products, power conversion products, underwater locator beacons, emergency locator transmission beacons, traveling wave tube amplifiers, microwave power modules, a wide variety of memory products and radio frequency (RF) and microwave products, crashworthy and ballistically self-sealing auxiliary fuel systems, high performance communications and electronic intercept receivers and tuners, high performance active antenna systems and technical surveillance countermeasures (TSCM) equipment.
(5) Includes various component parts such as electromagnetic and radio frequency interference shielding, high voltage interconnection devices, high voltage advanced power electronics, harsh environment connectivity products, custom molded cable assemblies, silicone material for a variety of demanding applications and rugged small form-factor embedded computing solutions.
The following table summarizes the Company’s net sales by industry for each operating segment (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine months ended July 31, | | Three months ended July 31, |
| 2022 | | 2021 | | 2022 | | 2021 |
Flight Support Group: | | | | | | | |
Aerospace | $637,282 | | | $473,470 | | | $219,558 | | | $175,388 | |
Defense and Space | 231,014 | | | 162,196 | | | 94,756 | | | 51,898 | |
Other (1) | 40,957 | | | 31,066 | | | 15,945 | | | 9,832 | |
Total net sales | 909,253 | | | 666,732 | | | 330,259 | | | 237,118 | |
| | | | | | | |
Electronic Technologies Group: | | | | | | | |
Defense and Space | 402,639 | | | 439,488 | | | 136,778 | | | 148,035 | |
Other (2) | 243,238 | | | 210,114 | | | 87,103 | | | 72,203 | |
Aerospace | 58,055 | | | 56,580 | | | 20,322 | | | 19,305 | |
Total net sales | 703,932 | | | 706,182 | | | 244,203 | | | 239,543 | |
| | | | | | | |
Intersegment sales | (14,501) | | | (16,654) | | | (4,934) | | | (4,954) | |
| | | | | | | |
Total consolidated net sales | $1,598,684 | | | $1,356,260 | | | $569,528 | | | $471,707 | |
| | | | | | | |
(1) Principally industrial products.
(2) Principally other electronics and medical products.
7. INCOME TAXES
The Company's effective tax rate was 19.4% in the first nine months of fiscal 2022, as compared to 13.3% in the first nine months of fiscal 2021. The increase in the Company's effective tax rate principally reflects a 4.9% unfavorable impact from tax-exempt unrealized losses in the cash surrender values of life insurance policies related to the HEICO Leadership Compensation Plan ("the LCP") recognized in the first nine months of fiscal 2022 as compared to the tax-exempt unrealized gains recognized on such policies in the first nine months of fiscal 2021.
The Company's effective tax rate was 27.0% in the third quarter of fiscal 2022, as compared to 15.7% in the third quarter of fiscal 2021. The increase in the Company's effective tax rate principally reflects a 5.3% unfavorable impact from tax-exempt unrealized losses in the
cash surrender values of life insurance policies related to the LCP recognized in the third quarter of fiscal 2022 as compared to the tax-exempt unrealized gains recognized on such policies in the third quarter of fiscal 2021. The increase also reflects a 2.6% unfavorable impact as the third quarter of fiscal 2021 benefited from a larger income tax credit due to higher qualifying R&D expenditures.
8. FAIR VALUE MEASUREMENTS
The Company's assets and liabilities that were measured at fair value on a recurring basis are set forth by level within the fair value hierarchy in the following tables (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | As of July 31, 2022 |
| | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total |
Assets: | | | | | | | | |
Deferred compensation plan: | | | | | | | | |
Corporate-owned life insurance | | $— | | | $210,995 | | | $— | | | $210,995 | |
Money market fund | | 8,484 | | | — | | | — | | | 8,484 | |
Total assets | | $8,484 | | | $210,995 | | | $— | | | $219,479 | |
| | | | | | | | |
Liabilities: | | | | | | | | |
Contingent consideration | | $— | | | $— | | | $80,632 | | | $80,632 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | As of October 31, 2021 |
| | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total |
Assets: | | | | | | | | |
Deferred compensation plan: | | | | | | | | |
Corporate-owned life insurance | | $— | | | $245,580 | | | $— | | | $245,580 | |
Money market fund | | 4 | | | — | | | — | | | 4 | |
Total assets | | $4 | | | $245,580 | | | $— | | | $245,584 | |
| | | | | | | | |
Liabilities: | | | | | | | | |
Contingent consideration | | $— | | | $— | | | $62,286 | | | $62,286 | |
The Company maintains the HEICO Corporation Leadership Compensation Plan (the "LCP"), which is a non-qualified deferred compensation plan. The assets of the LCP principally represent cash surrender values of life insurance policies, which derive their fair values from investments in mutual funds that are managed by an insurance company, and are classified within Level 2 and valued using a market approach. Certain other assets of the LCP represent investments in money market funds that are classified within Level 1. The assets of the LCP are
held within an irrevocable trust and classified within other assets in the Company’s Condensed Consolidated Balance Sheets. The related liabilities of the LCP are included within other long-term liabilities and accrued expenses and other current liabilities in the Company’s Condensed Consolidated Balance Sheets and have an aggregate value of $218.2 million as of July 31, 2022 and $244.3 million as of October 31, 2021.
As part of the agreement to acquire 96% of the stock of a subsidiary by the FSG in fiscal 2022, the Company may be obligated to pay contingent consideration of up to $27.4 million in fiscal 2027 based on the earnings of the acquired entity during fiscal years 2025 and 2026 provided the entity meets certain earnings objectives during each of fiscal years 2022 to 2024. As of July 31, 2022, the estimated fair value of the contingent consideration was $13.1 million.
As part of the agreement to acquire 74% of the membership interests of a subsidiary by the FSG in fiscal 2022, the Company may be obligated to pay contingent consideration of $14.1 million in fiscal 2027 should the acquired entity meet a certain earnings objective during the five-year period following the acquisition. As of July 31, 2022, the estimated fair value of the contingent consideration was $9.7 million.
As part of the agreement to acquire 89% of the membership interests of a subsidiary by the FSG in fiscal 2021, the Company may be obligated to pay contingent consideration of $8.9 million as early as in fiscal 2024 should the acquired entity meet a certain earnings objective during the three-year period following the acquisition. Additionally, the Company may be obligated to pay contingent consideration of up to $17.8 million as early as in fiscal 2026 should the acquired entity meet a certain earnings objective during the three-year period following the second anniversary of the acquisition. As of July 31, 2022, the estimated fair value of the contingent consideration was $17.4 million.
As part of the agreement to acquire 89.99% of the equity interests of a subsidiary by the ETG in fiscal 2020, the Company may be obligated to pay contingent consideration of up to CAD $27.0 million, or $21.1 million, in fiscal 2025 should the acquired entity meet certain earnings objectives during fiscal 2023 and 2024. However, should the acquired entity achieve a certain earnings objective over any two consecutive fiscal years beginning in fiscal 2021 and ending in fiscal 2023, half of the contingent consideration obligation, or CAD $13.5 million, would be payable in the following year. As of July 31, 2022, the estimated fair value of the contingent consideration was CAD $18.5 million, or $14.4 million, of which $10.4 million was included in accrued expenses and other current liabilities in the Company's Condensed Consolidated Balance Sheet.
As part of the agreement to acquire a subsidiary by the ETG in fiscal 2020, the Company may be obligated to pay contingent consideration of up to $35.0 million in fiscal 2025 based on the earnings of the acquired entity during calendar years 2023 and 2024 provided the entity meets certain earnings objectives during each of calendar years 2021 to 2024. As of July 31, 2022, the estimated fair value of the contingent consideration was $7.4 million as compared to $13.3 million as of October 31, 2021. The decrease in the fair value of the contingent consideration is principally attributable to an increased probability that the required earnings
objective for each of calendar years 2022 to 2024 is not met as forecasted sales and earnings growth is delayed reflecting the lower demand that the subsidiary is currently experiencing for its defense products. The obligation to pay any contingent consideration would be payable by a consolidated subsidiary of HEICO that is 75% owned by HEICO Electronic.
As part of the agreement to acquire a subsidiary by the ETG in fiscal 2017, the Company may be obligated to pay contingent consideration of $20.0 million in fiscal 2023 should the acquired entity meet a certain earnings objective during the first six years following the acquisition. As of July 31, 2022, the estimated fair value of the contingent consideration was $18.6 million.
The following unobservable inputs were used to derive the estimated fair value of the Company's Level 3 contingent consideration liabilities as of July 31, 2022 ($ in thousands):
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| | | | Unobservable | | | | Weighted |
Acquisition Date | | Fair Value | | Input | | Range | | Average (1) |
7-18-2022 | | $13,145 | | Compound annual revenue growth rate | | 0% - 5% | | 3% |
| | | | Discount rate | | 7.2% - 7.2% | | 7.2% |
| | | | | | | | |
3-17-2022 | | 9,653 | | Compound annual revenue growth rate | | (3%) - 8% | | 3% |
| | | | Discount rate | | 5.8% - 5.8% | | 5.8% |
| | | | | | | | |
8-4-2021 | | 17,394 | | Compound annual revenue growth rate | | (1%) - 9% | | 7% |
| | | | Discount rate | | 6.9% - 7.3% | | 7.0% |
| | | | | | | | |
8-18-2020 | | 14,450 | | Compound annual revenue growth rate | | 12% - 21% | | 15% |
| | | | Discount rate | | 3.7% - 7.3% | | 4.7% |
| | | | | | | | |
8-11-2020 | | 7,386 | | Compound annual revenue growth rate | | (2%) - 13% | | 6% |
| | | | Discount rate | | 7.0% - 7.0% | | 7.0% |
| | | | | | | | |
9-15-2017 | | 18,604 | | Compound annual revenue growth rate | | (1%) - 5% | | 3% |
| | | | Discount rate | | 6.2% - 6.2% | | 6.2% |
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(1) Unobservable inputs were weighted by the relative fair value of the contingent consideration liability.
Changes in the Company’s contingent consideration liabilities measured at fair value on a recurring basis using unobservable inputs (Level 3) for the nine months ended July 31, 2022 are as follows (in thousands):
| | | | | | | | |
| | Liabilities |
Balance as of October 31, 2021 | | $62,286 | |
Contingent consideration related to acquisitions | | 22,980 | |
Decrease in accrued contingent consideration, net | | (4,253) | |
Foreign currency transaction adjustments | | (381) | |
Balance as of July 31, 2022 | | $80,632 | |
| | |
Included in the accompanying Condensed Consolidated Balance Sheet under the following captions: | | |
Accrued expenses and other current liabilities | | $10,421 | |
Other long-term liabilities | | 70,211 | |
| | $80,632 | |
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The Company records changes in accrued contingent consideration and foreign currency transaction adjustments within selling, general and administrative expenses in its Condensed Consolidated Statement of Operations.
The carrying amounts of the Company’s cash and cash equivalents, accounts receivable, trade accounts payable and accrued expenses and other current liabilities approximate fair value as of July 31, 2022 due to the relatively short maturity of the respective instruments. The carrying amount of long-term debt approximates fair value due to its variable interest rates.
9. NET INCOME PER SHARE ATTRIBUTABLE TO HEICO SHAREHOLDERS
The computation of basic and diluted net income per share attributable to HEICO shareholders is as follows (in thousands, except per share data):
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine months ended July 31, | | Three months ended July 31, |
| 2022 | | 2021 | | 2022 | | 2021 |
Numerator: | | | | | | | |
Net income attributable to HEICO | $254,471 | | | $218,158 | | | $82,540 | | | $76,889 | |
| | | | | | | |
Denominator: | | | | | | | |
Weighted average common shares outstanding - basic | 135,835 | | | 135,291 | | | 135,978 | | | 135,370 | |
Effect of dilutive stock options | 2,055 | | | 2,546 | | | 1,859 | | | 2,587 | |
Weighted average common shares outstanding - diluted | 137,890 | | | 137,837 | | | 137,837 | | | 137,957 | |
| | | | | | | |
Net income per share attributable to HEICO shareholders: | | | | | | | |
Basic | $1.87 | | | $1.61 | | | $.61 | | | $.57 | |
Diluted | $1.85 | | | $1.58 | | | $.60 | | | $.56 | |
| | | | | | | |
Anti-dilutive stock options excluded | 748 | | | 13 | | | 767 | | | — | |
10. OPERATING SEGMENTS
Information on the Company’s two operating segments, the FSG and the ETG, for the nine and three months ended July 31, 2022 and 2021, respectively, is as follows (in thousands):
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| | | | | | Other, Primarily Corporate and Intersegment (1) | | Consolidated Totals |
| | Segment | | |
| | FSG | | ETG | | |
Nine months ended July 31, 2022: | | | | | | | | |
Net sales | | $909,253 | | | $703,932 | | | ($14,501) | | | $1,598,684 | |
Depreciation | | 11,493 | | | 10,153 | | | 743 | | | 22,389 | |
Amortization | | 17,543 | | | 29,750 | | | 844 | | | 48,137 | |
Operating income | | 189,329 | | | 189,605 | | | (28,588) | | | 350,346 | |
Capital expenditures | | 12,084 | | | 11,874 | | | 399 | | | 24,357 | |
| | | | | | | | |
Nine months ended July 31, 2021: | | | | | | | | |
Net sales | | $666,732 | | | $706,182 | | | ($16,654) | | | $1,356,260 | |
Depreciation | | 10,159 | | | 9,457 | | | 728 | | | 20,344 | |
Amortization | | 15,036 | | | 32,588 | | | 848 | | | 48,472 | |
Operating income | | 103,357 | | | 200,419 | | | (25,905) | | | 277,871 | |
Capital expenditures | | 5,885 | | | 23,749 | | | 490 | | | 30,124 | |
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Three months ended July 31, 2022: | | | | | | | | |
Net sales | | $330,259 | | | $244,203 | | | ($4,934) | | | $569,528 | |
Depreciation | | 4,082 | | | 3,361 | | | 250 | | | 7,693 | |
Amortization | | 6,281 | | | 9,571 | | | 274 | | | 16,126 | |
Operating income | | 70,756 | | | 68,029 | | | (10,038) | | | 128,747 | |
Capital expenditures | | 3,971 | | | 3,879 | | | 296 | | | 8,146 | |
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Three months ended July 31, 2021: | | | | | | | | |
Net sales | | $237,118 | | | $239,543 | | | ($4,954) | | | $471,707 | |
Depreciation | | 3,330 | | | 3,238 | | | 242 | | | 6,810 | |
Amortization | | 4,929 | | | 10,871 | | | 287 | | | 16,087 | |
Operating income | | 42,059 | | | 68,997 | | | (10,218) | | | 100,838 | |
Capital expenditures | | 1,792 | | | 5,921 | | | 473 | | | 8,186 | |
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(1) Intersegment activity principally consists of net sales from the ETG to the FSG.
Total assets by operating segment are as follows (in thousands):
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| | | | | | Other, Primarily Corporate | | Consolidated Totals |
| | Segment | | |
| | FSG | | ETG | | |
Total assets as of July 31, 2022 | | $1,595,356 | | | $1,938,593 | | | $253,402 | | | $3,787,351 | |
Total assets as of October 31, 2021 | | 1,274,462 | | | 1,952,413 | | | 271,532 | | | 3,498,407 | |
11. COMMITMENTS AND CONTINGENCIES
Guarantees
As of July 31, 2022, the Company has arranged for standby letters of credit aggregating $21.3 million, which are supported by its revolving credit facility and principally pertain to performance guarantees related to customer contracts entered into by certain of the Company's subsidiaries as well as payment guarantees related to potential workers' compensation claims and a facility lease.
Product Warranty
Changes in the Company’s product warranty liability for the nine months ended July 31, 2022 and 2021, respectively, are as follows (in thousands):
| | | | | | | | | | | | | | |
| | Nine months ended July 31, |
| | 2022 | | 2021 |
Balances as of beginning of fiscal year | | $3,379 | | | $3,015 | |
Accruals for warranties | | 1,352 | | | 1,486 | |
Acquired warranty liabilities | | — | | | 33 | |
Warranty claims settled | | (1,719) | | | (1,209) | |
Balances as of July 31 | | $3,012 | | | $3,325 | |
Litigation
On April 20, 2021, an indirect subsidiary of HFSC, which was acquired in June 2020, received a grand jury subpoena from the United States District Court for the Southern District of California requiring the production of documents for the time period December 1, 2017 through February 4, 2019 related to the subsidiary's employment of a certain individual and its performance of work on certain Navy vessels during that time period. The Company is cooperating with the investigation. The Company has completed its production of documents responsive to the subpoena, although the Company has a continuing obligation to produce such documents should any be located. At this early stage in the investigation, the Company cannot predict the outcome of the investigation or when the investigation will ultimately be resolved; nor can the Company reasonably estimate the possible range of loss or impact to its business, if any, that may result from this matter.
With the exception of the matter noted above, the Company is involved in various legal actions arising in the normal course of business. Based upon the Company’s and its legal counsel’s evaluations of any claims or assessments, management is of the opinion that the outcome of these matters will not have a material adverse effect on the Company’s results of operations, financial position or cash flows.
12. SUBSEQUENT EVENTS
In August 2022, the Company, through a subsidiary of HEICO Electronic, acquired 100% of the stock of Charter Engineering, Inc. ("Charter"). Charter designs and manufactures a complete line of RF and Microwave coaxial switches for the aerospace, defense, commercial, Automated Test Equipment ("ATE"), and instrumentation markets. The purchase price of this acquisition was paid in cash using cash provided by operating activities and is not material or significant to the Company's condensed consolidated financial statements.
In August 2022, the Company acquired 100% of the stock of Sensor Systems, Inc. ("Sensor"). Sensor designs and manufactures airborne antennas for commercial and military applications. The purchase price of this acquisition was paid for with a proportional combination of cash using proceeds from the Company's revolving credit facility and 576,338 shares of HEICO Class A Common Stock. The purchase price is not material or significant to the Company's condensed consolidated financial statements.