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Wesco Aircraft Holdings (NYSE:WAIR)

Q4 2013 Earnings Call

November 21, 2013 5:00 pm ET

Executives

Mark Davidson

Randy J. Snyder - Chairman of the Board, Chief Executive Officer, President and Member of Nominating & Corporate Governance Committee

Hal Weinstein - Executive Vice President of Sales and Marketing

Gregory A. Hann - Chief Financial Officer and Executive Vice President

Analysts

Carter Copeland - Barclays Capital, Research Division

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Jonathan Raviv

Sheila Kahyaoglu - Jefferies LLC, Research Division

John D. Godyn - Morgan Stanley, Research Division

Edward Marshall - Sidoti & Company, LLC

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

Darryl Genovesi - UBS Investment Bank, Research Division

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Wesco Aircraft's Fourth Quarter and Fiscal Year End 2013 Earnings Conference Call and Webcast. [Operator Instructions] Please note that this conference is being recorded. At this time, I will turn the call over to Mark Davidson, Head of Wesco Aircraft Investor Relations.

Mark Davidson

Thank you, Leslie. Good afternoon, and thank you for participating in Wesco Aircraft's Fourth Quarter and Fiscal Year End 2013 Earnings Call and Webcast.

Presenting today will be Randy Snyder, Chairman and CEO; Hal Weinstein, Executive Vice President of Sales and Marketing; and Greg Hann, Executive Vice President and CFO. Following our prepared remarks, we will open the line for questions, at which time we will be joined by Alex Murray, Vice President of Global Operations.

As a reminder, today's conference call includes forward-looking statements within the meaning of federal securities regulations. Although the company believes that such forward-looking statements are reasonable, we cannot assure you that any forward-looking statements will prove to be correct. Forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and other factors, which may cause the actual results to differ materially from those anticipated at the time of the forward-looking statements are made. Additional information relating to factors that may cause actual results to differ from our forward-looking statements can be found in the company's filings with the Securities and Exchange Commission, including the company's annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Wesco Aircraft undertakes no obligation to update or revise forward-looking statements except as required by law.

Now to begin the call, I would like to introduce Randy Snyder, who will deliver the opening remarks. Randy?

Randy J. Snyder

Thank you, Mark. Good afternoon. Please turn to Slide 4. I'm proud to announce Wesco Aircraft's fourth quarter and 2013 fiscal year end results. Our record fourth quarter revenue was $234 million, up 10.5% from a year ago, with all this growth being organic. Adjusted diluted EPS for the quarter was $0.33. Overall for the year, revenue came in at a record $902 million, an increase of 16% over our fiscal year 2012 results. Adjusted diluted EPS for the fiscal year 2013 was $1.22. We attribute approximately 13.7% of our revenue growth to organic activities for the fiscal year. Our business mix for the year saw a significant increase in commercial sales coming in at 64% as our military sales remained relatively flat, coming in at 36% of total sales.

Our 2013 performance proved that our value proposition to our customers and vendors is far more desirable and competitive than any other solution in the marketplace today. While the commercial aerospace market is flourishing, the defense market has its challenges. But Wesco still has the opportunity to grow in both segments over the next several years. Hal will touch on some of those opportunities during his presentation.

Over the year, we have invested in technology, while at the same time, devoting ourselves to continuously improving our processes to gain productivity. Today, out of our 1,300 employees, 1,086 have earned some level of Six Sigma accreditation. Today, we have many continuous improvement projects going on throughout the Wesco organization, which will bear fruit during the year and will add value to our suppliers and customers, as well as our shareholders. These same principles that Wesco demands of itself are the same that we offer our customers and supply base. We are designing innovative methods on how to deliver our customers' entire product needs through their production lines so they can improve their productivity, lower their need to carry inventory and increase their bottom line.

For our suppliers, we have the global infrastructure and channels to distribute their products more efficiently than they can do themselves. When you put all this together, the Wesco value proposition is far superior to any other in the market, and that is the main reason for our persistent double-digit organic growth over the years.

Wesco Aircraft has again proven its ability to perform and grow, as shown in our 2013 fiscal year performance. We have continued to focus on expanding our relationships and market share through our focus on customer service, quality and continuous process improvement. I am confident we will continue to add value to our customers and shareholders as we move ahead into our 2014 fiscal year.

Now I'd like to turn the call over to Hal.

Hal Weinstein

Thanks, Randy. Good afternoon, everyone. As Randy spoke about, our performance shows that our global sales team continues our very effective campaign, targeting new customers, new product opportunities at existing customers, as well as a very focused controlled expansion, both geographically and in specific market segments, most notably MRO and electronics. As Randy also mentioned, Q4 was yet another record quarter for revenue with long-term contracts awarded over past quarters beginning to grow as anticipated as our customers learn more about our value-added services and product offerings, which can enhance their efficiencies, provide much-needed cost savings, thus leading to even more contract business for Wesco.

Our MRO team continues to perform exceptionally well. The business is growing at a rate that is surpassing where we expected to be at this stage of our plan. We have also opened an office in Singapore to facilitate growth in that region, as well as enhanced sales and marketing efforts in both India and China. As you've heard, our military business has remained relatively flat during this challenging time. As Randy discussed, providing our customers the ability to do more with less, as Wesco does within its own organization, is resonating well and should continue to provide opportunities to grow within this segment of the market. We know that sounds counterintuitive in a market that appears to be contracting. However, within each of these customers is the ability to provide more products, more services and ultimately, much-needed cost savings that are critical to our customers' long-term well being. We remain optimistic about the opportunity for revenue gains in this market going forward.

As you've also heard, our commercial business has risen significantly as a percentage of total sales, thus validating our premise that we will continue to expand greater than market. We have long believed that our plan of global program diversification, coupled with a wide product range and an exceptional service offering, would lead to double-digit growth in this market segment.

As always, contract signings during the quarter help us gauge future growth. This quarter was yet another strong one in terms of contracts signed, contracts extended, and finally, new line items added to existing agreements. The last 2 also provide great indicators for us to judge customer satisfaction. A few recent examples of new contract wins during the quarter were Bombardier on the Learjet 85 program in Wichita; United Launch Alliance, which includes a wide range of products and services; Spirit AeroSystems for a variety of programs; as well as Kaman Aerospace and the Sikorsky program.

Internationally, our offices continue to perform very well and we have been awarded additional items for our Aer Lingus 787 contract, as well as a new contract with GE Aviation for a variety of programs. As always, all of these contracts are for a wide range of Wesco products and services, and these agreements tend to continually grow over time as our customers learn more about what we can do to help them gain efficiencies and trim costs.

So to summarize, our growth trajectory is exceeding our expectations and we don't see anything in the future that will hinder our business plan to gain more share and continue to grow our business.

Now let me turn the call over to Greg for a detailed discussion of our financial results. Greg?

Gregory A. Hann

Thanks, Hal, and good afternoon, everyone. If you'll please turn to Slide 5. As Randy noted, our sales during the quarter were very strong as the company had record sales of $234.3 million. This is up 10.5% year-over-year for the quarter. For the year, sales were $901.6 million as compared to $776.2 million in fiscal 2012, which is a 16.2% increase. As you'll recall from our Q1 call, we had a large one-time sale, which was military, in Q1 2012. Without that, our organic growth for the full year was 13.7%, which clearly exceeds the growth of the market. For the year, we continue to see increases in all channels to market in each of our major product lines and in all regions.

During the quarter, our North America segment grew by 9.8%, driven primarily from increases on our contract business. Our Rest of World segment continued to perform very well during the quarter with sales growing by 22.7% year-over-year, primarily due to growth across most of our largest customers, as well as new contract wins.

As we've mentioned previously, this year, we made a strategic decision to penetrate the MRO market. As we've stated before, we knew that this year would be one of transition. Our goal was to get our customers to begin to consider Wesco as an alternate source for their product. This is starting to happen. We exceeded our expectations this year as we worked to grow from this -- grow this business from a low base. We also saw growth in our electrical components, machine parts and bearings product lines. Our goal has continued to be to have sustained above-market growth, and we are clearly continuing to demonstrate this.

For the quarter, Ad hoc sales made up 39% of our total sales, JIT sales were 28% and LTA sales were 33%. The mix has been relatively consistent between Ad hoc and contract business over the last year, and from a dollar perspective, all channels to market continue to grow. For the year, 64% of our sales were commercial and 36% were military. This compares to 56% commercial and 44% military in 2012, and continues our trend over the last few years of a greater shift of our business to the commercial markets. From a dollar perspective, our military sales were relatively flat in 2013 as compared to 2012, if we normalize for the large one-time military sale I've mentioned earlier.

The gross profit percentage for the quarter was 36.3%. Over the last year, our gross margin has been in the range of 35.1% to 36.3%. As we've said before, our gross profit percentage can fluctuate quarter-to-quarter due to our sales mix of the more than 525,000 SKUs we sell.

Next, I'd like to discuss our SG&A expenses. For the quarter, we have a year-over-year decrease of approximately $400,000. This decrease was primarily due to the costs we incurred during Q4 2012 related to becoming Sarbanes-Oxley compliant. As a percentage of sales, consolidated SG&A expenses were 15.4% in the fourth quarter as compared to 15.5% in Q3, 15.5% in Q2, 16.4% in Q1 and 17.2% in Q4 2012, which was the first quarter of our Interfast acquisition. We continue to see SG&A as a percentage of sales improve as our sales increase.

Now if you'd please turn to Slide 6. Adjusted EBITDA as a percentage of sales was 22.6%. This compares to 21.6% in Q4 2012. This improvement was due to operating leverage we've seen over the last year. Adjusted net income for the fourth quarter was $31.7 million, an increase of 16%, resulting in adjusted diluted EPS of $0.33. This compares to adjusted net income of $27.4 million and adjusted diluted EPS of $0.29 in Q4 2012. For the year, adjusted net income was $116.5 million and adjusted diluted EPS was $1.22. Our effective tax rate for the quarter was 33.8%, which resulted in the rate for the year to be 33.5%.

Moving on to cash flow, we generated $21.9 million of free cash flow during the quarter. For the year, free cash flow was $76.9 million. The company also paid down $10 million in debt during the fourth quarter and has paid down a total of $57 million during the year. Our balance sheet continues to be strong with ample flexibilities to support our business growth.

Now if you'd please turn to Slide 7. Now let's take a look -- for our outlook for fiscal 2014. As we've discussed, our performance in the fourth quarter and in 2013 was strong, both in terms of revenue and earnings. Based on our results and the activity levels we are seeing worldwide, we expect revenues to be in the range of $975 million to $1,010,000,000, an increase of 8.1% to 12% as compared to 2013. We also expect to see continued growth and profitability with adjusted diluted EPS in the range of $1.31 to $1.37 per share, or an increase of 7.4% to 12.3% as compared to fiscal 2013.

We will continue to see growth in our commercial markets. And although our military market is forecasted to remain relatively flat, as we have discussed, we continue to see opportunities for growth in this market as well. In addition, our weighted average diluted shares outstanding are expected to be approximately 97.2 million in 2014 as compared to 95.8 million in 2013.

For some closing comments, I'd like to hand the call back over to Randy. Randy?

Randy J. Snyder

Thank you, Greg. As you can tell, we are very pleased with our fourth quarter and year-end results. We are optimistic about where our business is headed. We have the processes and breadth of product to support our employees as they lead us on the path to sustained performance and continued growth for the company and our shareholders.

We will now open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Carter Copeland.

Carter Copeland - Barclays Capital, Research Division

Just one for you, Greg, quickly on the SG&A. Can you help us -- give us some color around the path for the absolute SG&A dollars given the 10% increase in revenues? How should we envision that, that tracks year-over-year? And productivity benefits that were called out, is there any quantifiable impact on the margin that we should consider?

Gregory A. Hann

Well, clearly, as we go forward and as we saw through the course of this year, you can see that our growth rate on the SG&A is growing at a rate slower than sales. So that's what we would see going forward. From a productivity standpoint, I'm -- there's 1,000 projects that we're working on. It really gets down to headcount, quite honestly. Everything that we do from a productivity standpoint is driven towards having our headcount grow at a slower rate than sales, so.

Carter Copeland - Barclays Capital, Research Division

Okay. And as a follow-up, just -- I noticed that the inventory build in the quarter was prior to the previous 3 quarters. Is that just to support next year's growth or is there any, I guess, you'd call it strategic buying in there? And if so, what's your view on the benefits of that materializing? Can you help us think through that a little bit?

Gregory A. Hann

Yes. I mean, the -- we are buying to support next year's growth. That's -- we're making sure that we're well positioned to support not only the current contracts that are in place, but the new contracts as well that we've won over the past 6, 8 months. So what you're seeing now is the inventory to help ramp up, to support those identified sales.

Operator

Our next question comes from Joe Nadol.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

My first question is just on the sales outlook for next year, around 10% middle of the -- of your range. If defense is flat, that implies, I think, that the rest -- everything else is going to be up roughly 16%, again, middle of the range. So I was wondering if you could just talk about some of the major customers. I'm sure Airbus is one of them, but who are the major customers you see driving this? And then based on that, or once you answer that, what do you see as an impact potentially on gross margins and the mix? And how confident are you in -- what kind of handle do you have on the existing inventory?

Hal Weinstein

Okay. Joe, it's Hal. Yes, from a -- I'd rather kind of talk program than customer, if I may. We're looking obviously, like everyone else, pretty bullish on most of the Boeing programs. And as you know, we're positioned pretty well at the various subcontractors, the Triumphs and Aer Lingus and et cetera. So when we're looking at where the business is going, we're looking at a combination of build rate and share, if you will. And then where we are in terms of where the build rate's going and then from a Wesco perspective, the share we have on, as best we can, certainly, on the various subcontractors in the programs. So we're feeling -- we're very well positioned with all the good ones. From the other side, which is kind of more the helicopter, the Bells, et cetera, their commercial business, as you know, is doing also very well and, again, as you know, we're very well positioned there. So we feel very confident with the commercial end of the market. Sorry, do you want to talk?

Gregory A. Hann

Yes, from a -- you're asking about gross margin -- gross profit going forward. Obviously, we are more focused on operating income or EBITDA. But from a margin perspective, the fact that we do continue to anticipate that we'll have stronger growth with our electrical components, our machine parts, our bearings, there may be some downward pressure on gross profit as we go forward. Like I said, we prefer to look at EBITDA margins going forward as well. And we feel like the operating income -- excuse me, the operating income will be at least flat because of the leverage we're going to get on the cost side.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Okay. Okay. And then just the last part of that question was just, a couple of years ago, you had some of the issues with new customers and not necessarily anticipating -- or they had more inventory than you thought they did. I'm sure you guys are paying a lot of attention to that topic, but just wanted to gauge your confidence there and the customers you're ramping up on 2014.

Randy J. Snyder

The inventory is starting to get lower in the market, especially from those particular customers because we're eating through their inventories. But so -- and a lot of the new customers that we have, we -- again, they take up some of the -- burn down of their inventory as well. But I think the major customers that we have that we had that problem with, especially on the JSF, we're really starting to see larger numbers come in as their build rates go up.

Hal Weinstein

And we're not seeing, as you pointed out, Joe, we're pretty diligent. We were diligent before, frankly. It really just depends how close a look we get at the inventory levels for each of these customers. But specific to the contracts that we've taken, we feel pretty confident we're not going to run into the same issue we did before. So we feel pretty good about that this time.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Okay. And then just, Greg, just one little one. Just on capital deployment. You spent some capital in the quarter. I was wondering if you could talk a little bit about that? And then early in the year, you guys bought back a little bit of stock. You haven't done so since. And just wondering how you're thinking about that going forward.

Gregory A. Hann

Yes, I mean, there was nothing really unusual. We did a lot on the IT side. We had some building improvements as well. I think going forward, I think you'll probably continue to see somewhere in the neighborhood of 1% of sales for capital expansion of whatever. But I would think, generally, it's going to be the -- the primary use of capital will typically be in the IT area ongoing.

Randy J. Snyder

Joe, we just moved into a new corporate office, a 70,000 square foot corporate office we were moving about 160 people into. And that was -- most of the expense was at the end of the construction, which would have come last quarter.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Okay. And just that buyback part of the question. Any thoughts on -- you might do that again, what you did in the first quarter, going into next year?

Gregory A. Hann

The buyback? I'm sorry, I kind of lost you there.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Sorry, stock buyback, share repurchase.

Gregory A. Hann

Stock buyback and share repurchase?

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Yes.

Gregory A. Hann

I mean, it's something that we'll continue to revisit. Right now, from my perspective, we're focused on paying down our debt. So we'll continue to do that. Obviously, at some point in time, it's something that we will discuss with our board as well. But right now, we're not quite there.

Operator

Next question comes from Jason Gursky.

Jonathan Raviv

It's John Raviv here. Jason might be having some phone troubles so I'll just step in with a question. I wonder if you guys could talk about sort of it in -- I'm thinking to put some more detail to the gross margin issues and the way that moves with the various buckets that we're looking at. Is there a chance for EPG or machine or especially MRO to move up in the margin stack? Or are those businesses always going to be dilutive as they grow going forward?

Randy J. Snyder

Because we have such a big mix, it depends on the commodities. And like for -- you're talking about electronics, usually the lead times are very short and we have tremendous -- we have a lot more turns on our inventory. So because of that, your gross margins will be smaller. And the same thing with bearings as well.

Hal Weinstein

We don't see -- frankly, there's nothing in the history that we've seen to indicate that there would be any big way to increase margins. It will be a dilutive effect. We believe that; overall, good news for the company, frankly.

Gregory A. Hann

Yes, that's right. It's absolutely great news for the company. Once again, I mean, it adds to our bottom line. It's such a key part of our strategy, and we deal with our customers for us to become more linked in with our customers. So it's a perfect strategy for us to be able to present this basket of products to help grow our overall presence with our customers, so.

Randy J. Snyder

And that's our strategy. And it's not saying we're not grow all the segments, but it's saying that our strategy is, is to be able to offer our customers more products and more services. So that's our strategy. And how the mix comes out, we can't -- we don't know. It's just going to happen. We hope that everything grows -- expands tremendously. And that's what our job is to do.

Jonathan Raviv

Makes sense, guys. And then just a quick follow-up. How are you thinking about contract mix going into next year? Can you update us on the train coming to the station? Can you hear it, see it, anything like that?

Randy J. Snyder

Well, if I have that -- if I was able to predict that to the day or the quarter, it just -- it's everything -- the only thing we can do, Jason, is prepare ourselves for it. And the longer it takes, the more prepared we are. So it will come one day, the signals are there. But when it's going to come, I don't know. But there's just too much activity. Too many new planes being built, too many new engineering, a lot of pressure on manufacturing. But when it does happen, it's going to happen fast and furious. It's not much like the last -- this cycle is not much like the last one.

Gregory A. Hann

Yes, much different, much different, yes.

Randy J. Snyder

Yes.

Operator

Next question comes from Sheila Kahyaoglu.

Sheila Kahyaoglu - Jefferies LLC, Research Division

So just a quick question on market share and how you're thinking about market share gains within aerospace, and maybe the potential to even move into adjacent markets that would broaden your addressable market size?

Hal Weinstein

Well, okay. In terms of market share gains, we look at it twofold. Obviously, any win we get from either a customer that is -- doesn't currently have any contractual business or is doing something with other than Wesco, we view as, obviously, a market share gain, needless to say. Beyond that, however, there's kind of a deeper way we look at market share. And that's once we get integrated within a customer, we start looking at different commodities, different products. And the point Randy made earlier, we are really delving into different, new, more, broader product to give our customers more of what, frankly, we do very well, which is cutting their costs and making them leaner. So that's the 2 areas of market share gain. And as -- if you look historically, we've done pretty darn well. A lot of the -- a lot of our additional business certainly has been for market share gains in both categories. In terms of other markets, potentially, right now, we are remaining focused on aerospace. But again, as we move forward, there could be other opportunities. We do a bit right now in energy. We do a bit in industrial. And will that expand, knowing us? Yes, it probably will. Again, our major focus right now is still the aerospace. We still see a lot of runway there.

Randy J. Snyder

And plus -- the one thing leads into the other. So we have electrical, which led on into the industrial items because there's a lot of -- the electrical goes into a lot of black boxes, which also needs special fasteners to deal with the casings of those black boxes. So we just follow it. We try to get our heads into as many pots as we possibly can. And then, again, whatever shakes out at the end of the year, that's what happens.

Sheila Kahyaoglu - Jefferies LLC, Research Division

That makes sense. And is there an SKU count that you target? You've been growing it quite nicely. It's currently at 525,000. Is there a goal for next year's contracts requiring new products and new add-ons that you think you'll hit?

Randy J. Snyder

We'll definitely add to that next year.

Sheila Kahyaoglu - Jefferies LLC, Research Division

Makes sense. And just a quick follow-up on the overall pricing environment, if you could expand on that at all.

Randy J. Snyder

It's pretty neutral still.

Operator

Next question comes from John Godyn.

John D. Godyn - Morgan Stanley, Research Division

This is John. I was hoping -- I heard the commentary sort of adding some good detail as to the thought process driving the midpoint of the revenue guidance range. But I was hoping that the team could speak to what's driving the low end versus the high end. Is there sort of a view on Ad hoc in there? Is there just military uncertainty? Are there key contracts that you're not sure if they're going to opt? I was hoping that you could just elaborate on that, please.

Gregory A. Hann

Really, I think the low end's driven by the fact that 40% of our business is unknown. So that's really what drives the low end anytime, quite honestly. That we're talking about any kind of guidance is the fact that, as I said, year after year, at least somewhere around 40% of our business, we don't know what kind of phone calls we're getting tomorrow.

John D. Godyn - Morgan Stanley, Research Division

And the high end, what are the kind of -- what's the thought process that it went into the high end of the guidance range? Kind of what would drive that scenario?

Gregory A. Hann

How quickly new contract wins ramp up. What happens with some of -- how quickly some of the inventory burns down with some of the customers that we have.

John D. Godyn - Morgan Stanley, Research Division

Okay, that's really helpful. And I wanted to also follow up a little bit around the military flat revenue guidance for next year. We've heard a lot of good qualitative commentary about how this idea of sort of a cost proposition is resonating with customers. I'm not sure that, that guidance reflects a lot of momentum there. I was hoping that you could just kind of bridge the gap there. How do I kind of think about what I'm hearing on the qualitative side versus the flat military revenue guidance?

Randy J. Snyder

It's a -- that kind of sell, it's a long sell because what we're actually doing is getting into our customer and looking at best practices to improve their productivity. At the same time, looking at their supply base and getting rid of the stock, see what they have until we can replace it with stock that we own and sell. So the premise is with the -- a lot of the military is that they have to lower the internal costs and their inventory so that they use Wesco. And we don't really know how much inventory they have or what they're doing. But -- and also, if we're going to go into special, like machine parts, we have to be able to see -- go out and bid and also see what kind of engineering requirements are there. So it's really a slow sell, but it's moving forward. And that's the good part about it.

John D. Godyn - Morgan Stanley, Research Division

And I wonder, does that suggest that as we think about next year's military year-over-year growth guidance, that might be the low point in year-over-year growth? As we look at the multiyear trend, what are the chances of that? Or are you still uncomfortable kind of offering that sort of guidance?

Randy J. Snyder

I wouldn't say uncomfortable. We're kind of excited in some respects because of F-35.

Hal Weinstein

It's just hard to quantify.

Randy J. Snyder

It's just hard to quantify. Again, we're in a show-me kind of business. And until we start feeling real comfortable about it, they got to start showing it to us. But I'll tell you, we're in a good position because the -- when you get sequestration or military slowdown, it forces the customer to look at better ways to do things, and Wesco has shown them on the products that we have, which is probably 75% of the products they buy, that they don't have to pay attention to it. But at the other 25% they buy is probably 75% of the money, and that gives us opportunity.

Hal Weinstein

And I can tell you, we're receiving a lot of communication from levels of customers that, frankly, we would never have heard from, executive management and people that, frankly, wouldn't have a lot to do with a distributor necessarily. But because the need is so imminent and the value proposition we bring is so important to them, it's a paradigm shift. Randy's called it a slow sale. That's exactly what it is because it's a complete shift in the way they've done business. I got to tell you, they know they need to head that direction and it's just -- it takes some time. These companies are pretty bureaucratic, needless to say. So we're getting traction.

Operator

Next question comes from Karl Oelschlager [ph].

Unknown Analyst

You had some success that you talked about, quarter after quarter, winning a lot of new contracts and new business. And maybe, can you kind of talk sort of big picture about the trajectory of that sort of win rate and the size of the contracts? And is it exceeding your expectations quite a bit? And how are you thinking about that going into next year? Do you think there's a fairly -- you just issued guidance, is there a fairly low bogey you need to meet in terms of like the new win rates and the contracts or -- because that's going to be out in 2015? But maybe just talk about that a little bit.

Hal Weinstein

Yes. The contracts wins -- we're always excited about a contract win. And if you look quarter-to-quarter, if you look again back historically, the amount of contracts we won is -- impresses me and I'm hard to impress, I got to tell you. So we've done some great things. And relative to expectations or trajectory, I got to tell you,, we kind of do things maybe a little differently. We establish targets for our teams every year and it changes constantly. And our guys are doing just an amazing job of pursuing and winning this business. In terms of what that means and in terms of our expectations, I'd say we're right about where we expect to be.

Gregory A. Hann

I think I would add that we have some pretty high expectations that we continue to meet.

Hal Weinstein

Yes.

Randy J. Snyder

We've tried -- we go -- our expectations is to be able to satisfy the customer and grow our business as much as we possibly can each year.

Hal Weinstein

It's funny, too. The contract wins -- I mentioned it in the statement, the contract wins are not just a static win. The contract wins continue to accelerate and grow every single time. So it's not just this one win that you win a $1 million contract. That's just the beginning. And we have, over the years, tremendous examples of that. And that's really what we focus on. Getting in the door, showing what we can do, bringing new products to the table. And I think we've done incredibly well.

Operator

Next question is from Edward Marshall.

Edward Marshall - Sidoti & Company, LLC

So if I look at the 4 contracts that were announced that were won in the quarter, how do I look at that from a revenue contribution maybe for 2014? Are these sizable wins or what can you tell me about these 4 contracts?

Gregory A. Hann

Well, we're not going to get into the size of contracts. I think to Hal's point, each contract is varying degree on the amount and how quickly we'll see it. As Hal pointed out, some contracts, not necessarily these 4, but some contracts may start out relatively small, but they're very, very significant because maybe we haven't had a major foothold in the location or with that customer yet. So -- but I don't think -- we're not going to get into the size of contracts.

Randy J. Snyder

Yes, and also it's -- the size of contracts are going to range. We're happy about it, but the idea is that we have to -- when we go do a contract, the key thing for us is to go in there and find out what kind of assets the customer has or that they have in their inventory. And then get it -- and then get the supply chain flow in a matter that can be worked, that we can actually measure what they're using so we don't buy too much or we don't buy too little. So that takes time. So we're going by their record of saying, "I only have 4 months of it, oh I have 6 months of them, I got 2 months." And I'll tell you, the accuracy level of what they tell us is probably around 5% accurate. So for us just to make a commitment what we think we're going to do on 2014 on our new contracts, it would just be a total guess that it's going to be probably 3% or 5% right. So we got to stay away from that. It is what it's going to be.

Edward Marshall - Sidoti & Company, LLC

Sure. I guess the reason why I bring it up is because we discussed kind of the margin compression on the gross margin side and you've well defined as to why. But you've also mentioned that the op margins would be somewhat stable year-over-year or kind of flattish, I think, is the term used. But yet if I look at the fourth quarter and I just annualize the revenue for the fourth quarter, you're looking at, next year, you're coming out at about $940 million on an annualized basis. The guidance is implying $35 million to $70 million more in revenue. And if I do the same to EPS, you're coming out of the midpoint of the range. So I'm just kind of curious as to how we're working towards those numbers, or maybe you've just learned your lesson as you kind of moved into fiscal '13, I don't know. But I'm just kind of wondering how you get to those numbers if they -- looking at a kind of a flattish operating margin environment with significant revenue increase for fiscal '14.

Gregory A. Hann

Well, I mean, I think that we will continue to see revenue grow throughout the year. So I think just looking at where we are today and annualizing it, the fact that, once again, we would expect to grow the business. Our Q1 is typically a little bit lower, but the other 3 quarters, higher. So it certainly is not flatlined. It grows throughout the year. I think we will continue to see that.

Edward Marshall - Sidoti & Company, LLC

I guess my questions are centered around the EPS guidance for next year. If you annualize the 2 numbers, I mean, you're coming up pretty much at the midpoint of the range on EPS. And I'm saying, it seems a little bit light considering the fact that you're seeing a significant ramp in the revenue, and margins should be somewhat stable. And I'm just kind of -- see how you're working down to that number that doesn't show much growth off an annualized basis.

Gregory A. Hann

Yes, I think there was -- the one thing, obviously, that we have a higher tax rate that brings that down a little bit. I think the guidance that we get -- that we've given, given what we're seeing, I think, is appropriate.

Operator

Next question comes from Kevin Ciabattoni.

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

Looking at defense, you guys talked a little bit about the F-35. I was wondering if you could maybe give us some color around your expectations on any other platforms, military platforms, sort of in the way you looked at the commercial side earlier.

Hal Weinstein

Yes, the -- so the F-35, and again, 2014, we're feeling very confident. Funding, I believe, is in tact for [indiscernible] 6 and 7, 71 planes total, if I recall correctly. Yes, I got it right. I think F-18 is also stable for this year as well, 40-some-odd aircraft, I believe. Yes. So yes, I mean, when we look at the major programs we're on, we are feeling -- and again, we're on the Raytheon Missile Systems as well. We're feeling pretty comfortable with, we'll call it -- as we called relative stability for this year in terms of revenue. So we're not really seeing a heck of a lot in terms of downside on the programs that we are so heavily involved in. And we do have that potential upside of, as we talked about earlier, of getting kind of more indifferent as they look for cost savings. But as we also said, that takes a lot.

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

Anything on the helicopter side that you could discuss?

Hal Weinstein

Yes, I think -- I mean, I think we're relatively good. The Apache is -- and Chinook -- yes, I think -- just trying to go through my head, the programs on the helicopter side and I...

Randy J. Snyder

The commercial helicopters for Bell are...

Hal Weinstein

Commercial, but on the military side. Yes, commercial's going way up. Yes. I think overall, pretty stable for all the programs we're on.

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

Okay. And then maybe just looking at the contract mix question asked earlier from kind of the other direction. It's down -- if you look at Ad hoc, it's down a couple of hundred basis points as a percent of total sales over the last couple of quarters. Just wondering if you could give us some idea of what was kind of driving that mix shift.

Gregory A. Hann

Ad hoc as a percentage of total sales has been relatively stable. I mean, if you've gone over the last kind of 4 quarters, I think it's balanced between 39% and 41% of total sales. So for that piece of kind of unknown business, it's been relatively stable.

Kevin Ciabattoni - KeyBanc Capital Markets Inc., Research Division

Okay, yes. I guess I'm just looking at it from the 41% in 2Q, turned it down to 40% in 3Q and then down to 39% in the current quarter. I mean, is that...

Gregory A. Hann

Yes, it's a little bit of a roller coaster. I mean, we'll get calls every once in a while for $1 million order or something like that, or large orders that may happen in one quarter and then they don't buy again, or in that kind of range for another quarter or 2. So it kind of bounces around a little bit. I think the key is that we're not seeing any large shift with lead times starting to stretch out that's starting to drive additional Ad hoc demand.

Operator

The next question is from Darryl Genovesi.

Darryl Genovesi - UBS Investment Bank, Research Division

So maybe just a quick one for Greg. On the guidance, did you give any -- I didn't hear you give any free cash flow guidance. Are we going to see another kind of 60% to 70% kind of free cash conversion here in '14?

Gregory A. Hann

Yes, and no, we didn't. But I would think that, that's probably pretty accurate. As I've said before, that as long as the market is kind of a growing market like that, not huge, huge shifts in the market, that we would expect to see between 60% and 70% in net income.

Darryl Genovesi - UBS Investment Bank, Research Division

Okay. And then also, I think on the defense mix, you say it was 36% for this year?

Gregory A. Hann

That's correct.

Darryl Genovesi - UBS Investment Bank, Research Division

I guess just working through the numbers, I mean -- this is just my little back of the envelope here, but it looks like defense was actually down kind of mid-single-digits on the year on an absolute basis. Is that correct?

Gregory A. Hann

Mid-single-digits. We went from 44% down to 36%. And from a dollar standpoint, once again, if we kind of normalize for this one large sale we had in 2012 that was military, on a dollar perspective, it was flat.

Operator

We have no further questions at this time. I'd like to turn the call back over to Greg Hann for closing remarks.

Gregory A. Hann

I want to thank everybody for participating on the call, and we look forward to a really good 2014, and we'll talk to you next quarter. Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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