Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

I've been following HEICO and TransDigm for years, but I haven't delved into Proponent in great detail due to its reorganizations and private status. It would be great to know how and when you joined AAXICO.

To give you a bit of my background, I worked for Embraer and then moved to McDonell Douglas during a time when they laid off 55,000 employees. Eventually, I ended up in Miami, working for a Brazilian airline for almost three years. I then had the opportunity to join AAXICO, starting as a Vice President of Sales and eventually becoming the company's president. We were acquired by Kapco on Leap Day 2012, which is now 12 years ago.

Like any acquisition, there were pros and cons. The good part was that we were being bought by a larger company. Our owners needed a liquidity event because the Korth family, who owned the company, had lost their father. The son, who was the CEO and Chairman of the Board, had been part of the organization for 30 years. His seven siblings were pressuring him to sell, and eventually, he agreed.

I mentioned in our email exchange that there's a significant difference between HEICO and Proponent. Proponent acquires companies and merges them together. They did this with four small acquisitions, each less than half a million dollars. These were primarily electrical interconnect companies, distributors selling either broken down connectors or assembled connectors. They wanted to expand into this space, so they bought these companies. Three of them were English companies, and one was based in Florida.

So, they merged the warehousing and technology side of these companies?

Yes, that's correct. They acquired these companies and integrated them into their system, including all the employees and the entire warehouse. They didn't dissect the good and bad parts of these companies; they just brought them in as they were. They repeated this process with their second, third, and fourth acquisitions.

When they acquired us, AAXICO, as their fifth acquisition, they realized we were twice as large as all their previous acquisitions combined. We had close to 80 employees and generated about 1.2 million in sales per employee. They kept our warehouse but decided to find a location in the middle of our West Palm Beach and Miami offices for the warehouse and office. I disagreed with this decision, given that we were generating most of the revenue, but when you're acquired, you have to follow the new management's decisions.

What was their core business?

Their core business was aftermarket distribution.

Were they focused on electrical components?

No, there were no electrical or hardware components. The majority were from companies like Collins Aerospace and W.L. Gore, primarily sensors.

And these were non-exclusive contracts?

No, the majority were exclusive.

So they were all exclusive?


You mentioned that Proponent's philosophy was to integrate. Could you explain their rationale?

Their rationale was to control everything and avoid having disparate pieces. What they didn't realize was that when you acquire a company, you're not just buying their sales. There's more to a company than just the sales figures. There's the know-how, market knowledge, customer base, and so on. They were adamant about integrating the organization into their system, despite any arguments against it. There are pros and cons when a small company integrates into a much larger one.

How does that work, though? For instance, if you're exclusively distributing a Collins product, and Kapco has a competing product they're distributing exclusively, and you're looking to merge, how does that work?

For every distribution agreement, you have to go back to the principal and inform them about the impending merger. If there's a competing product, they will tell you whether you can continue distributing their product or not. If there's a conflict, they might ask you to stop distributing the competing product.

What happened during that time?

We didn't have any issues.

All the original equipment manufacturers (OEMs) were fine with it?

Yes, we went back to all the OEMs, and none of them had an issue because we didn't have competing lines.

But consider Wencor and HEICO now, and their distribution businesses that they've acquired. If they have competing lines, which I believe they do, how do you think that will work?

They keep Wencor completely separate from HEICO. That's HEICO's model. When HEICO acquires a company, they don't integrate anything. The company continues to operate exactly as it did before.

So, it's effectively a Chinese wall, right? They're still within the group, but they operate as standalone entities.

They operate as a standalone entity and continue to use their own systems. If the original owner is still running the company after selling it to HEICO, they can continue as long as they meet their profit objectives. With the resources of HEICO behind them, they can now pursue larger projects or opportunities that were previously out of reach.

HEICO maintains an active dialogue with 30 to 40 companies at any given time. These companies may be looking to sell in a year or five years, but the relationship is always kept alive. When they're ready to sell, it's as simple as flipping a switch. The fact that HEICO doesn't integrate the companies they acquire is preferred by many. When companies are integrated, a lot of the know-how disappears as people leave or long-established relationships are discarded.

For instance, after the acquisition in 2012, we ran the company until 2014 when it was integrated. I changed roles and became a VP. We had the know-how of dealing with Collins Aerospace and purchasing stock products. Proponent had an automated system with a minimum and a maximum. When it hit the minimum, they would reorder. However, we argued that a machine couldn't make these decisions due to the many external variables. For example, changes in fleets, retrofit programs, an AD, all impact how parts are acquired. These variables need to be considered individually, as they are so different that only a human can make the decision.

When you say one by one, do you mean by OEM?

No, I mean part number, by partner. For example, if you have a family of parts used on the 757, 767 and the triple seven, and the 757 is being phased out while the 767 is dwindling, you have to consider this when ordering parts. You're not going to order more based on your history; you're going to order less. You have to look at what the fleet is doing. We had the know-how, but they didn't respect that. As a result, the inventory ballooned by $40 million because they weren't listening to the people with the know-how. This happens all the time.

Is that a Collins-specific issue, or is it about optimizing the buying of parts? You mentioned how it's focused on the partner because that's based on the fleets and the demand of the fleet and the retrofit and all that. But you also mentioned how you know how to buy from Collins. So, is there a specific insight into how you buy specifically from Collins? Or is that the same across all OEMs?

Every supplier's purchase is nuanced. Sometimes, you may have advantages if you buy more or less, or depending on the timing, like at the end of a quarter, you might get a better price. However, an automated process doesn't consider these factors. It simply follows a schedule, and the purchase is made without any strategic thought.

How was your team organized? In terms of dealing with OEMs like Collins Aerospace, were you organized by account manager? Did one person manage one OEM?

From a sales perspective, we were organized geographically. For purchasing, certain buyers had specific accounts. In addition, we had business development and supplier development teams working with the OEMs to ensure smooth operations. These teams didn't handle day-to-day tasks but maintained relationships, provided reports, and understood the OEMs' issues. For instance, if an OEM needed to sell more product due to an event, they might offer us an extra 5% if we could take another million dollars' worth of product. It was our job to decide whether or not to take up such offers based on our projections.

How did Collins Aerospace and other OEMs react when AAXICO was merged into Kapco?

It was fairly smooth. The merger was quite a headache internally. Getting the team to understand how the OEMs operate without dedicating the time was challenging. They just wanted to resolve the issue and move on. From senior management's perspective, there wasn't much focus on the details of what was happening.

It's interesting that you mention inventory, which is one of the most important variables for a distributor. You said that Proponent didn't optimize for that, or at least they thought they were optimizing for that through automation, but it didn't work. How did that change over time?

Some still use automation, but most now have product managers who review the inventory every two or three months to ensure it aligns with sales. For instance, when there's excess stock, they don't rush to sell it off. They don't incentivize their salespeople to move the inventory. In contrast, during the AAXICO days, we would incentivize our salespeople to sell old inventory. After two years, we would start writing the inventory down. Once it's written down, there's an incentive to sell it before it gets too old and is written off. We would offer a financial bonus to salespeople who could move this inventory. This strategy helped us move about 60% of our stagnant inventory within a couple of years. Proponent, however, doesn't have this approach.

What is your opinion on how the major OEMs will perceive the HEICO-Wencor deal in terms of distribution?

As long as Wencor continues to perform, I don't foresee any issues.

Suppose I'm an OEM with an exclusive agreement with Wencor, and they're producing private label PMAs to target my competitor who is being distributed by Seal Dynamics. Although they can operate separately, they are still part of the same group. Is there an inherent trust that the two businesses are separate? How do you think OEMs will react to this?

Let's say, for instance, if Seal Dynamics is selling a product that is privately labeled as built by another company, and Wencor has a competing product with an exclusive distribution agreement. The owner of that distribution agreement, the OEM, will likely identify this as a conflict if they're diligent. They may decide to give the distribution to another company or they may require proof of a clear separation between the two businesses. In many cases, this is what has been done.

You're saying it's possible to prove this separation and OEMs would be satisfied with that?

I'm not sure how they would do it, as I've never been in that situation, but it is possible. For example, when we were dealing with Proponent and Collins Aerospace, there was a company, the name escapes me, that had several part numbers Proponent was selling. These parts accidentally appeared on the Collins report because Collins had interchangeable parts. When parts are interchangeable, they often show up on the Collins report as they are linked to the Collins part number, even though they are not Collins parts.

They were selling them?

Yes, exactly. So, that happened, and I had to explain to them that it was a mistake. We brokered this part, and there was no relationship with the OEM. It was a minor issue, maybe $50,000, so it was not significant. Interestingly, about six months ago, they established a relationship with this OEM and are now distributing their product. Collins has not pursued their original part and have moved on, so there's no conflict. However, managing these conflicts can be stressful because the people on the OEM side are primarily focused on their numbers. They don't care about the relationship. They want to meet their targets. Any disruption to that flow quickly grabs their attention, and you have to explain your position thoroughly to ensure you don't lose the product line.

But their numbers are based on the competitiveness of their product and how well you sell that versus other products. How much do they care about intellectual property and competitors seeing that? Especially now that Wencor and Seal Dynamics are producing PMAs.

How do you think this would affect, for instance, if Wencor Seal Dynamics has a 10% overlap in principles, not just Seal Dynamics, but the entirety of HEICO distribution. Out of that 10% overlap with competitors, how many do you think they'll retain versus how many do you think will switch out of that relationship? Could they potentially lose a significant amount of business?

I don't believe it will be significant. Honestly, I don't think it will be. Now, the thing with Wencor, and this isn't confirmed, it's just what I've heard from various people. Historically, whenever Wencor lost a distribution line, they would start getting PMAs on the parts from that OEM. This left a bad taste in many people's mouths.

But aren't they still infringing on their IP?

It's reverse engineering. That's the thing many people don't realize when they enter the aviation industry. There are no patents in aviation, if you really think about it, because anything can be reverse engineered. The only item that may be more challenging is a seatbelt. But even a seatbelt, if you look at all the traditional ones, like on American Airlines, they're all AmSafe.

Why is that?

That's because it's like an American logo. It's their standard. We actually tried to PMA those. The PMA wasn't difficult. The problem is, how do you manufacture at a competitive rate? That was the issue. Nobody can compete with them because of the volume they produce.

We could discuss PMAs in a moment. Let's walk through how you onboard OEMs. Say you're a Proponent, you're out in the field. What is your pitch to an OEM principal about why they should choose Proponent over other distributors?

There are various types of sales pitches. The first one is that you have one entity that does annual buys and moves your product. Essentially, you have a standard price list. For instance, the majority of the OEMs produce an annual price list that they put out in the market. Then certain airlines, which we'll call house accounts, negotiate based on that and get a 40% discount off the prices because they're American Airlines or United. Typically, the distributor deals with what you would call the second and third tier airlines, MROs, and brokers. That's the majority of it.

The large airlines are going direct, is that what you mean?

Indeed, they are going direct. The complexity arises when, for instance, you consider the aftermath of 9/11. Numerous airlines were either filing for Chapter 11 or attempting to recover money they had paid. They argued that the risk was high because companies like American were spending millions of dollars, and then suddenly they would file for Chapter 11. This would create a significant gap in your cash flow. Managing this as an OEM or distributor can be challenging. We focus on timely delivery, ensuring we have the high movers in stock and make annual purchases. Each transaction with an OEM incurs a certain cost. For instance, Collins discovered that each transaction was costing them more than the process itself.

Are you referring to selling parts to you as a distributor?

No, I'm referring to selling parts to the airlines.

This includes man hours and administration costs?

Yes, and also the cost of collecting money. However, the most important aspect from an OEM's perspective is not having to deal with accounts receivable. As a distributor, if you can offer to pay net 15 in exchange for a 25% discount on their prices, while maintaining the price integrity and exclusivity for certain customers, it's a compelling proposition. For example, if you have exclusivity in Brazil and Gol, a Brazilian airline, goes directly to the OEM, the OEM would direct them to you, the distributor. In this case, Proponent would handle it. This is particularly important for US OEMs, who are much more stringent about collecting money due to the quarterly-driven nature of their operations. No CFO or OEM wants to have airlines paying them in net 45 or net 60.

What are the average payment terms?

More than that. For the Chinese, it's net 180.

What about American and Delta?

Depending on the volume of the transaction, they're always aiming for net 60. So they might pay you in 75 days.

It's at a 30% to 40% discount to the catalog price because they're buying in such volume. If you come in as Proponent and offer to pay net 50 in exchange for exclusivity with all their airline customers, promising to set the price as close to the catalog price as possible, how do Seal Dynamics and Wencor fit into this? What differentiates Proponent if you're competing against HEICO and Wencor?

We're not competing with the same product lines. Proponent has a certain portfolio of products, and Wencor has a different portfolio. They may compete against each other, but not with the same products.

But if you, Wencor, and HEICO approach Collins for a certain product, how would they decide who's more effective?

The decision usually involves assessing the overall benefits of each option. It's a pay-to-play scenario. Assuming everyone is on the same level, with a set discount and purchase volume, and a defined territory, the differentiating factor becomes how much you're willing to invest to enter this space. It's essentially a form of bribe to secure a spot. We've been in several bids with Collins Aerospace where we concluded that it wasn't worth investing five or six million dollars, as it would take us 20 years to recoup this investment.

So it's not worth it if other distributors offer to do it at a lower price?

Or if they're willing to invest more to enter the space. We're not prepared to do that.

How does Proponent's portfolio differentiate from HEICO and Wencor?

Wencor's products don't overlap with ours, or if they do, they're simply competitors. So, if you compare Proponent's portfolio with Wencor's, they're vastly different. You could almost merge both companies into one, with very few redundancies.

What's the mix of Proponent's products?

From what I recall, our most significant products were from Collins and Meggitt. We also carried Boeing's line.

Boeing licenses you to carry all their lines from Collins?

Yes, but only certain categories, like what used to be Rosemount Aerospace, which includes all the sensors. They also produced heated floor panels, which are from Ohio and West Virginia. They also had some sensors from Vermont.

Looking at Wencor, they deal with bearings, tooling, interiors, electrical filters, hardware safety, and seals.

Correct. Do they list the OEMs?

Yes, they do. For bearings, they have Rexnord. For interiors, they have Adams Rite, Collins, Safran, NORDAM. So, would an OEM, like Safran, have multiple different lines and distributors across those lines?

Yes, they would. Another aspect to consider is what they're distributing for Safran, and in which territory.

The broader question is, all these distributors, Wencor, HEICO, you all carry different lines. You all run very similar businesses. What differentiates them?

They're all doing the same thing, except they carry different distribution lines.

Does it matter though? Are there synergies? If you specialize in interiors, do you carry more interior items? Because it seems they carry somewhat similar things.

For instance, Wencor excels at PMAs. They carry a lot of PMAs, reverse engineering many items. However, when it comes to their PMAs, if they were to try to secure a distribution for Honeywell products, Honeywell would reject them because they PMA a lot of Honeywell items. They would never be able to negotiate with Honeywell because Honeywell would insist they get rid of all the PMAs or pay them a fee.

Would the same situation apply to Seal Dynamics and HEICO?

No, Seal Dynamics handles all of their own PMAs. For example, HEICO owns Seal Dynamics. I'm trying to remember which HEICO company distributes Greene Tweed. Greene Tweed and Seal Dynamics both deal with seals, but there's no competition between the two. They maintain separation, and if there's ever any competition, Greene Tweed would confront them, threatening to terminate the distribution agreement or take some other action.

You're suggesting that because there are so many different products on an airplane across the fleets, these companies, Proponent, HEICO, and Wencor, have enough room to operate without truly competing with each other?

Yes, absolutely.

Were you concerned about competition then? What were your worries if you weren't concerned about HEICO?

The only issue that concerned us was the potential for OEMs to shift to certain distributors. For instance, if it's the end of the quarter and the OEM wants us to buy half a million dollars of a product because they need it, and we refuse because there's no demand, they could find someone else in the market willing to pay. That's a possibility, but it was rare. The other concern was airlines buying parts in excess. They could buy at a discount and then compete against us by selling to our customers at a lower price. That could be a problem. We had this situation with a company in Ireland, either Irish Aerospace or Dublin Aerospace. For years, they would buy in large volumes and then sell to the market to recoup some of their investment.

So they acted like a distributor?

Correct, but they were an airline. This does happen occasionally.

As a representative of Proponent, what was the biggest competitive risk you were concerned about?

As a distributor, the greatest risk is losing the distribution line and ending up with obsolete inventory. Essentially, it's the OEM deciding to part ways with you. For instance, if Proponent were to lose Collins, that's over $100 million, which is more than 25% of their business. Imagine the impact of losing 25% of your sales dollars. It's significant.

How does one lose the line? How would you lose Collins, for example?

It could happen if a new CEO or a new head of aftermarket decides they don't want to deal with distribution and opts for direct sales. If Proponent is doing $100 million and their discount is 15%, that's $15 million that could be reclaimed. However, this is short-sighted as it doesn't take into account the accounts payable issue and the extra labor. There's a significant trade-off. But often, CFOs aren't willing to go into the granular details and account for these costs. They're just looking at the big numbers.

What was the biggest challenge for you when onboarding new OEMs?

The biggest challenge is differentiating yourself, ensuring that your value proposition is better than the competitors'.

How do you achieve that? You mentioned it was essentially buying and paying them, right?

If you can purchase a large inventory at the outset, maintain a high level of service, and ensure your on-time deliveries are above 95%, you're doing well. Another key aspect is the courtship. These processes can take two or three years. It's a long process.

How would you compare HEICO's distribution philosophy to Proponent's?

HEICO differs in that their distribution is primarily Seal Dynamics and Air Cost Control. I'm not sure if they have any other distributors. When we were in the process of selling, AAXICO, HEICO did approach us.

Why didn't they make the purchase?

The individuals who visited us were the Mendelson brothers, who are the sons of the owners, and a man named David Susser. David is the son of the owner of Seal Dynamics. HEICO had bought Seal Dynamics and was the only distributor. David wanted to know about our interest in selling, so he came to visit us. However, the Mendelson brothers let David speak as if he represented HEICO. David suggested getting rid of certain product lines, to which Bill Korth, our CEO, responded that he was out of his mind.

Why was he planning to get rid of them?

He simply didn't believe it was a suitable match. That was his perspective on our product. I'm not sure if he had any competing interests at that time, but he didn't believe it was a suitable match. We had spent many years trying to make it work. You wouldn't discard a $5 million product line just because you don't like it. To put it mildly, this did not sit well with the CEO. The CEO was not interested in selling to them, especially when dealing with private equity. If you want 100, private equity will offer you 35. They're always looking for a bargain.

I thought HEICO kept everything the same and didn't make many changes. But you're saying they were suggesting they were going to make changes.

Yes, but they're not purchasing a manufacturer, they're buying a distributor. It's very different. I believe that because HEICO's first venture into distribution, they didn't quite get it right. David was the one steering the ship as they ventured into this. Their next acquisition, I believe, was Air Cost Control. Both Seal Dynamics and Air Cost Control are run by David, who is the CEO of both.

If you think about HEICO's merger and acquisition strategy, they could acquire Proponent or another similar distributor that doesn't overlap with Seal Dynamics or Air Cost Control.

For HEICO to acquire Proponent, they would have to pay a significant premium, and here's why. Proponent is an Employee Stock Ownership company, meaning the employees own the stock.

But who is the largest shareholder?

The employees are.

Is it a former CEO?

No, it's the employees. The CEO, upon joining, receives a certain amount of shares. For instance, as an employee, I received a certain amount of shares during my tenure. When I retired, they cashed out my shares. Depending on the amount, they'll pay everything at once, or they'll pay you in three, five, or 10 years.

But who is the largest shareholder?

There is no largest shareholder.

So everyone has an equal amount? So it's more of a profit share rather than equity ownership?

Correct. It's not profit. You receive shares when you join the company. You don't buy shares, they are given to you. These shares vest over time. The CEO probably has the most shares, but once he leaves the company, he has to sell all those shares back to the company. Then, he gets paid over time.

So, a buyer would have to pay a premium to satisfy all the employees.

Each year, a stock valuation is conducted. For instance, the fiscal year runs from April 1 to March 31. The process begins on April 1, and by August or September, the stock's value is determined. Your payout is based on this value. For instance, if I had a five-year payout plan and owned 10,000 shares priced at $100 each in December, I would receive $100,000. If the stock's value increases the following year, I earn more. If it decreases, I earn less. That's the basic principle.

However, I want to clarify a point about Proponent. In order for Proponent to sell, they would only do so at a premium. I liken it to a communist company because they allegedly prioritize the employees' best interests. If an outside company purchases Proponent, all shares must be paid out to the employees. For instance, if the shares are worth half a billion dollars, the buyer must have the liquidity to purchase them all. Some employees may choose to leave, while others might convert their shares into those of the purchasing company, like HEICO, for example. But, as I've heard from Proponent's CEO, they would only sell at a significant premium because they prioritize the employees.

How appealing would Proponent be as an asset for HEICO, in your opinion?

Not at all. HEICO could simply establish another company and target Proponent's suppliers. There's no need for them to purchase Proponent.

So, you don't think it's worth buying a distributor like Proponent?

For HEICO? No. They have the capacity to do so, unless they don't want to invest the time. I'm certain they wouldn't opt for that route.

When would it make sense for a company like HEICO to purchase a distributor? They've bought Air Cost Control and Blue Aerospace, for instance.

Everyone was pursuing Air Cost Control. They have a unique niche that no one else could match. The founders, a husband and wife, started at Airbus and established excellent relationships with all the electrical interconnect suppliers. After several years, they created a distribution company and transferred all their Airbus relationships to their new venture.

So, they both worked at Airbus before starting their own company?

Yes, that's correct. That's essentially how it happened. I recall, about 20 years ago, everyone was eager to purchase Air Cost Control due to their impressive margins. They offered exceptional customer service and were highly competent. Eventually, HEICO acquired them. I believe there was some personal conflict between the husband and wife owners, possibly infidelity, leading to a divorce. HEICO stepped in and agreed to buy, perhaps, 49% of the company initially, with plans to acquire the rest over time.

Why are their margins significantly higher than Proponent's?

Their margins are higher primarily because electrical interconnect has better margins. It's a smaller value item, hence the margins are higher. If you have significant volume, you'll make more profit.

Is it because it's not a large sub-assembly or a big part?

Correct, it's not a high-dollar value item. For instance, a seal has a gross profit margin of 50%. That's substantial, but it's 50% of $3, not 50% of $6,000. The volume they generate is the key.

What's the average sales value per product for Proponent? What type of products are they selling?

I believe it's less than $200.

That's relatively low, isn't it? Why aren't the margins high?

The margins aren't high because the more transactions you have, the more transaction costs you incur. Each transaction requires packing, inspection, and other costs. In Proponent's case, it's about $40 per transaction. We've argued that they need to focus on larger items because they complain to AAXICO about our small margins. We respond by pointing out that while our margins are 15%, we're selling a single $10,000 product. To match the $1,500 we make, they would need to conduct about 1,000 transactions.

But what about the connectors? If the sales are so small, say $3 or $4 for a seal or a connector, they also have to pay the transaction fee. How do they maintain 50% margins?

The key for Air Cost Control is their deep product knowledge and exclusive lines. Customers have to buy from them; there's no alternative.

But surely there must be competing electrical interconnect product companies. Do they all go through Air Cost Control?

There are competing products, but often there's a significant lead time, possibly 120 days. Airlines can't wait that long for a part. They need it immediately, and they're willing to pay a premium to get it.

They've established a niche in a low-priced, yet important product category. They've effectively built a brand and a wide range around connectors only, which obviously drives people towards their exclusive products.

It certainly attracts everyone.

So you're suggesting that Proponent is more like a traditional distributor with much higher-priced items and doesn't really have a brand centered around any specific product category?

Proponent does offer a variety of things, but they're not specialized. They attempted to become a specialist in electrical interconnect, but the market is too competitive. So, there's a conflict between wanting to be in this space but not wanting to settle for a 15% gross margin when they desire a 60% gross margin.

Are you familiar with Blue Aerospace as well? HEICO acquired them.

I was under the impression that Blue Aerospace was a repair facility.

They provide parts and services, I believe.

Let me check. Blue Aerospace. Yes, from what I can see, they're entirely military-focused. So HEICO has one division that is military or defense, and another that is commercial. Blue Aerospace appears to be their military division.

Can we discuss how Proponent approaches PMA suppliers?

Proponent acquired a company in Connecticut, the name escapes me, that specialized in reverse engineering engine seals. When they acquired us, we had a PMA group. The majority of AAXICO's PMAs were identicality. We partnered with a Japanese company that didn't have any PMAs. Boeing was selling their product for six times the purchase price. This company, Koito, wanted to bridge that gap. We proposed that we could get their PMAs if they gave us a 25% discount. We would sell the parts below Boeing's price and become their exclusive distributor. We simply bought and sold the parts, and they made up the difference.

So you weren't manufacturing anything?

No, we had all of the Boeing drawings and everything. It was essentially a paper exercise.

The supplier provided you with the Boeing drawings?

They were actually Koito drawings, but they had a Boeing stamp on them.

So you went to the FAA and said, 'I want to get PMA by identicality. I have the original drawings.' You bought them from Koito and then sold them in the US?

Yes, that's exactly what happened.

But why doesn't Proponent have any PMA capabilities like Wencor?

The main issue with Proponent is that they've always had a negative perception of PMAs. However, that has changed over time. Currently, they still have the Koito. They have a series of PMAs that are seals.

What percentage of their revenue comes from these foreign PMAs?

The percentage is very small.

So, it's roughly 5%?

No, it's probably 1%, if that.

I noticed on their website that they mention PMA capabilities.

Yes, what they've done is they've approached several of the OEMs and asked if they want to get a PMA on their competitors' product? The OEMs agree but they don't want their names associated with it. Proponent then gets the PMA for them, they build the part, sell it to Proponent, who then puts their own PMA on it and sells it as a Proponent PMA.

I see here that they mention manufacturing legacy parts and small runs. I'm not sure if that implies sophisticated in-house manufacturing.

Proponent has a very good machine shop and they used to do a lot of work for Boeing on the McDonell Douglas projects. This was their major project and it started when they were Kapco, manufacturing for McDonell Douglas under a licensing agreement. This relationship dates back to the early 70s.

How would you compare Seal Dynamics's PMA strategy and Wencor's to Proponent's?

Proponent doesn't really have a strategy. They're trying to target everything they can, but not very successfully. Seal Dynamics and Wencor work with a series of customers who ask them to reverse engineer and improve specific parts. The key to PMAs is having a launch customer or a series of them to justify the upfront investment in engineering.

So, they outsource the manufacturing to a contract manufacturer then?

Yes, they can do that. I'm not sure if they do anything in-house.

How important is the capability to do private PMAs in winning the OEM relationship?

You don't need that if you're a distributor. If you're a distributor with PMA capability, you can add that as a value-add to your capabilities, but it's not crucial. If you were to rank it, it would be at the bottom.

What are the top two or three points?

The first one is on-time delivery and the second is shielding them from bad accounts receivable.

So, it's really about paying quickly, buying at scale, and delivering.

Indeed, having a network of people in your organization to sell the product is crucial. For instance, when you consider a product like Collins or Meggitt, you don't really sell it. You advertise it and the customer comes to buy it from you. Essentially, it's more like order fulfillment.

Considering the categories of products distributed by companies like Air Cost Control and Seal Dynamics, compared to Collins and what you're accustomed to at Proponent, what's the best type of distribution business to have in aerospace?

Personally, I would prefer not to deal with high volume, low dollar items.

That's Air Cost Control.

Correct. I wouldn't want to deal with that. It's like being at the supermarket where you have to keep turning over stock. Ideally, I would prefer high dollar value items that are non-repairable or have limited repair. Items that you could sell outright with a 20% to 25% margin, anything that has a value of $5,000 or more. So, we're talking about companies like Collins and Woodward.

And HEICO seems to be at the opposite end of the spectrum.

Yes, HEICO is not into that. They have many companies that do repairs. They're heavily into the repair side of the business, and many of those repairs use PMA parts.

But their seals and connectors are not repairable, right?

They're not repairable, but they're feeding into the repair process. So, if you were to look at a repair, depending on the part, you could have 50% of repair costs going to labor and 50% to parts. If you have PMA parts, you could increase your margin by 20 points because you're using PMAs, but you're guaranteeing that the part is not going to fail because you have experience with those PMAs.

How important is MRO to Proponent?

There's a lot of MRO activity, but it's very specific. Every MRO has multiple suppliers depending on what airplane is in the hangar, what kind of check they're doing. A lot of MROs are classified, but they're really repair facilities or repair stations. They're doing repairs on fuel pumps, electronics.

What's the mix in Proponent's revenue between third-party MRO shops or repair shops and direct-to-airline customers?

I'm not sure. I used to know that, but it's been a while.

Is it around 50-50?

No, I would say airlines probably account for 30% to 40%.

Typically, the margin is lower when selling directly to airlines.

No. Unless the airline has a contract, they typically don't buy as promised. Most of the time, these contracts aren't very beneficial as airlines tend to take advantage of them.

So, is the margin the same or different between airlines and third parties?

If there's a contract, the margin tends to be a bit lower.

How much MRO does Proponent handle in-house? Do they have any MRO shops?

No, they don't. It's simply because it's not very profitable.

But HEICO has MRO.

Yes, that's correct. But HEICO's business model is different. Proponent doesn't do that.

Wencor had it as well.

Yes, but Proponent isn't equipped to do that. They have no interest in it due to the liability. If you repair a product, you have to take on the liability. For instance, if you're supporting United Airlines with a repair station, you must have a $100 million insurance policy. If there's any issue, such as a plane going down, your company is liable.

What advantage do HEICO and Wencor gain by owning MRO in terms of the distribution side of the business?

There's no advantage, except for PMA parts if they're used in repairs. The only synergy is the cost of parts if they use them. But as a distributor, you wouldn't buy a repair facility just to use your parts. You'd buy a repair facility because it has a specific, profitable niche. That's what HEICO has done. They've acquired most of their repair stations because they're all military and have specific niches. This allows them to command a great price.

One is in avionics repair, right?

The majority of them, I believe, are in avionics.

FSC, specialties components.

But you would have thought that they would have merged some of those together. However, they haven't done that. Everyone is still operating independently.

You're saying that there's no real advantage to having these repair shops in-house to win OEM distribution agreements?

In some cases, there might be an advantage.

Like if the OEM wanted to understand their product more, where it's potentially faulty, or to provide them with information. Or is that marginally important in your opinion?

Yes, because depending on the OEM, if you look at the market trend, no one wants to be involved in the low dollar business of turning wrenches. The labor tends to absorb all the margin. There are some distributors in Asia with repair capabilities, but they are very few. It's not like it's a perfect match.

I'm currently looking at HEICO. They appear to have various repair units, some of which are in the flight support group.


Why do you think they own repair shops?

That's part of their core business; repairing parts and developing repair solutions for customers. They're not mutually exclusive, but you don't have to have one to have the other.

It seems like Wencor replicated HEICO's strategy by adding distribution, PMAs, and MRO shops. Proponent, on the other hand, seems to be more of a pure distributor. Why is that?

That shift occurred about 15 or 20 years ago. Wencor was owned by a man named Brent Wood, who was heavily invested in PMAs and distribution. He mixed PMAs with distribution, which led to a bad reputation for Wencor. After losing distribution for certain parts, he would pursue PMAs on those parts. Eventually, he sold the company to either Primco or Prime America, making a significant profit. The investment company that took over then started adding different elements to the company. The original focus was on distribution and PMAs.

How difficult would it be for Proponent to replicate HEICO's strategy?

It's quite easy. They could simply purchase a few repair shops and implement it. However, they would need to be focused on growing the business. Proponent is primarily focused on distribution. They're not even really focused on PMAs because if you look at the growth rate of the PMAs, it's almost stagnant, They haven't done anything.

What do you think sets HEICO apart from other distributors?

HEICO has a much broader perspective. They're not just focused on distribution, but also on military repairs, commercial repairs, seals, and distribution. They're open to any opportunity that can generate profit. Proponent, on the other hand, is only looking at distribution. They're not interested in adding other elements as they believe it would be a distraction. The group managing Proponent is the same group running it, whereas the group buying companies for HEICO are not the ones managing them. It's a very different proposition.

After Wencor, who do you think is the most attractive acquisition target for HEICO?

I'm surprised they would consider purchasing Wencor, given its size. It's too large, and it will always be an entity on the side since they won't integrate it. Air Cost Control and Seal will continue to operate independently. Wencor will be their largest organization, but it won't be able to leverage any synergy because it will always be seen as a competitor by the OEMs. There's certainly value in it, but unless they plan to buy Wencor and then another large distributor, it doesn't make much sense. The largest other distributor is Proponent. If Wencor or HEICO were to buy Proponent, I don't think they would integrate them either. So, you'd still have the same issue. Wencor and Proponent would continue to operate independently. I don't see the point if they're not going to merge them.

With Wencor, they would acquire the PMA business, right? They could sell more PMAs and distribute more PMAs to their customers. I believe the HEICO repair group sells PMAs to airlines.

I'm not sure if there's a specific number assigned to that. I have no idea. Is it 5%? Is it 10%? I really don't know.