Reverse engineering: Hollywood manufacturing heavyweight Heico is one of the country's top suppliers of aircraft parts. Its secret? Copying engine components. Its biggest partner? Germany's Lufthansa - Manufacturing

South Florida CEO, Oct, 2002 by Scott Singer

Unlike the parts of an automobile, which typically get replaced only when they break down, airlines replace jet engine components on a preventive maintenance basis. As Heico Chairman and CEO Laurans A. Mendelson says, There's no tow: truck at 37,000 feet."

Mendelson estimates that the annual global market for commercial jet replacement parts is at least $4 billion -- and that his NYSE-traded company owns some 4 percent of that market. Heico's aerospace division reverse-engineers identical copies of GE and Pratt & Whitney parts, and sells them at discounts of 25 percent to 30 percent.

While the original equipment manufacturers may not like Heico's business, there's not much they can do to stop it. Pratt & Whitney sued Heico in 1989, alleging various patent infringement and business violations. Ten years later, Heico won the case. Unlike pharmaceutical companies, which spend heavily on research and development and must recoup those costs through exclusive sales, jet engine development is largely subsidized by the US government, which stipulates, for the most part, that engine components cannot be patented.

According to Mendelson, replacement parts account for 75 percent of engine overhaul costs, the rest going to labor. The parts business generated $171.3 million of Heico's $200 million in revenue in 2001. Over the past four quarters, the company has averaged $43.15 million in revenues per quarter, with a net profit margin of 7.35 percent. Now, with a tight economy forcing airlines to examine all of their costs, Heico's parts are more in demand than ever. The company in July signed a seven-year replacement-parts deal with United Airlines that's estimated to be worth $100 million to $150 million.

"I think it's one of the great industries," says Mendelson of his business. "Most people are not even aware that the industry exists. I know of nothing that will make the airline industry obsolete. I know of no other way to travel from New York to LA or from New York to Miami in a reasonable time."

Industry cutbacks aren't entirely good news for Heico, though. "The secondary parts industry is not a desirable place be," says Paul Nisbet, analyst with JSA Research, Inc., which monitors the aerospace industry for institutional investors. The 10 percent to 15 percent reduction in airline flights following last year's terrorist attacks has taken its toll. "There is a huge supply of older planes which are being cannibalized for parts... None of the secondary producers are doing well [right now]."

Fortunately, Heico doesn't have all its eggs in the secondary-parts basket. Some 25 percent of its business comes from electronics technologies, primarily supplying the US and friendly governments with laser and infrared equipment.

The company has come a long way since its beginnings in the 1950s as Heineke Instrument, which specialized in cleaning laboratory equipment with pressurized water. The company applied its technology toward the development of a car wash, but the system removed dirt so well it took paint with it, resulting in customer lawsuits. After several re-toolings, in 1974 the company purchased Jet Avion, which had plans to manufacture a Pratt & Whitney-compatible engine combustor.

The market for engine parts picked up in 1985, when an aircraft accident in England prompted the FAA to require US carriers to replace certain parts on regular basis. Pratt & Whitney, caught short of parts, left a void which Jet Avion rushed to fill. The following year the company changed its name to Heico.

In 1988, Mendelson and his sons took advantage of a sales slump to become the largest shareholders of Heico. By 1990, following a proxy contest that let them name the board of directors, they had taken control of the company. Next came Lufthansa, which bought into Heico to ensure a steady supply of low-priced parts. The German carrier took an initial $24 million stake in Heico's aerospace division in 1997; to date, it has invested more than $50 million in the company, and now controls 20 percent of the aerospace division.

Today, with the family's 20-percent ownership of Heico, Mendelson's sons are in key management positions. Almost 600 of the company's 1,000 employees are based in its Hollywood design, engineering, and manufacturing center, the remainder scattered throughout the country.