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Wesco Aircraft Holdings, Inc. (NYSE:WAIR)

Q3 2014 Earnings Conference Call

August 4, 2014 5:00 PM ET

Executives

Mark Davidson - Corporate Treasurer and Head, IR

Randy Snyder - CEO and Chairman

Thad Fortin - EVP and CSO

Greg Hann - EVP and CFO

Alex Murray - President

Analysts

Carter Copeland - Barclays Capital

Joe Nadol - JPMorgan

Jason Gursky - Citigroup

Steve Kohl - Royal Bank of Canada

Michael Ciarmoli - KeyBanc Capital Markets

Sheila Kahyaoglu - Jefferies

Kristine Liwag - Bank of America

Myles Walton - Deutsche Bank

John Godyn - Morgan Stanley

Luke Junk - Robert W. Baird

Gautam Khanna - Cowen and Company

Operator

Good afternoon, ladies and gentlemen and thank you for standing-by. Welcome to the Wesco Aircraft 2014 Third Quarter Earnings Conference Call and Webcast. At this time, all participants are in a listen only-mode. Later, we will conduct the question-and-answer session. Please note, that this conference is being recorded.

At this time, I will turn the call over to Mark Davidson, Corporate Treasurer and Head of Investor Relations for Wesco Aircraft.

Mark Davidson

Thank you, Jeannette. Good afternoon and thank you for participating in Wesco Aircraft 2014 third quarter earnings call and webcast. Presenting today would be Randy Snyder, CEO and Chairman; Thad Fortin, Executive Vice President and Chief Strategy Officer; and Greg Hann, Executive Vice President and CFO.

Following our preparatory remarks, we will open the lines for question where we will be joined by Alex Murray. During today’s call, management will review and discuss Wesco Aircraft’s third quarter fiscal 2014 results.

As a reminder, today’s conference call includes forwarding-looking statements within the meaning of Federal Security Regulations. Also, 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 on involve known and unknown risks and certainties of other factors, which may cause the actual results to differ materially from those anticipated at the time the forward-looking statements are made.

Additional information relating to the 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 Snyder

Thank you, Mark. Good afternoon everyone. I am pleased to announce Wesco Aircraft’s third quarter results for 2014. Thad will be giving update on our business activities and our gong integration of Haas with Wesco. Greg will discuss the details of our financial results for the quarter and provide an update to our performance.

Now please turn to Slide 4. Wesco Aircraft’s third quarter revenue was $396 million, up 72% from a year ago. This includes approximately 6% organic growth for the quarter bringing us to approximately 11% organic growth for the first nine months of our fiscal year. Adjusted diluted EPS for the quarter was $0.34. While we’re disappointed that EPS was short of our expectations, we did have a number of positive developments continue to shape our business for the future. We signed a number of add-ons and new significant contracts, a prime example is with Bell a large add-on to our scope, which includes new product lines that we do not have a good position with Bell before.

We also won a new contract with a major aerostructures company in our rest of the world segment, which positions us for future growth in that segment. As Thad will discuss further, the integration of Haas is off to a strong start. As we have said before, this was a merger driven primarily by joint customer pursuits with significant potential for revenue synergies. This allows to us become an even more important player to our customer supply chain. We have already seen some of these opportunities materialize through a number of joint proposals in progress and even a larger recent win at a legacy Wesco customer for the Haas team.

Don’t forget as we have said before, our sales cycle can be long and implementation take time as well, though we are currently progressing well and have already identified over 150 sales opportunities. I am also happy to report that the joint teams are identifying additional cost synergies beyond what we expected initially. The team is attacking the basic function of support areas, indirect spending, facilities and other costs areas. We expect to identify additional opportunities as the team collaborates further and the integration activities progress.

As for our electronic products, the new managing director has been on the job for four months is off to a great start with a big win. We have secured a global distribution agreement with one of the world’s largest electronic manufacturers for all their lines, which will allow us to significantly increase the products we offer our customer.

Now let me tell you about our performance at a major military OEM, which is similar to our performance with our customers. In 2013, we shipped 21.4 million pieces of 23,293 different part numbers to five locations in three countries. Our on-time delivery was 99.9%, Wesco’s quality rating was 99.9%, and we performed over 2 million transactions for this customer in 2013, saving the millions of dollars in cost. This is just one example of many Wesco value propositions we provide to our customers around the world.

We continue to grow our business nicely with the mix of newly awarded contracts along with more new contract opportunities in the pipeline. Our efforts to provide our industry-leading surfaces to our OEM and MRO markets continue to grow in the rest of the world segment along with our focus on gating market share in our North American segment. These coordinated efforts are providing results.

Our one Wesco sales focus is bringing our Wesco and Haas products and services to more customers on a global scale. I believe these efforts may drive significant growth over the next several quarters.

Now before I turn it over to Thad, I just want to reiterate that while we had expected production rates to drive higher volume and sales than we saw this quarter we have not been sitting by just waiting for this to happen. We continue to pursue new opportunities, expand our existing contracts and position ourselves well for the future. We take our guidance and commitment to our shareholders seriously and no one is more disappointed than I am that we have fallen short this quarter. As I said last quarter Wesco cannot control cycle change in the market, but we can control growing our revenue and profitability through contract wins, aggressively pursuing new opportunities and managing our cost.

Now I would like to turn the call over to Thad, Thad?

Thad Fortin

Thanks Randy and good afternoon everyone. In my new role as the Chief Strategy Officer at Wesco Aircraft one of the tasks Randy has given me is leading our integration of Haas.

First, let me say how excited Haas is to be part of Wesco Aircraft. From the Haas perspective the reasons for choosing to combine with Wesco were reinforced this past quarter. It really was the perfect fit of shared values, cultures and entrepreneurial spirit that we believe will allow us to accelerate the growth of Haas and deliver results to our customers and shareholders.

Before I discuss our integration process, let me give you a one Wesco business update for the quarter. From a sales perspective, our focus continues to be on market share gains. Importantly and very exciting for us, our new opportunities pipeline has never been larger with all areas of our business both product and geography related contributing to the mix. The commercial market continues to build at a robust pace and we’re making tremendous strides in market development within that segment to assure strong growth for the future.

The military market although challenging for the entire industry still provides Wesco with upside potential. Most notably, our Haas unit has had continued success in this end of the market which we believe will facilitate movement for the bigger Wesco entity. Our MRO and international businesses are firing on all cylinders and we are making significant progress as we win new business and demonstrate our exceptional performance leading to additional growth opportunities and again, increases in market share.

Wesco had yet another great quarter in terms of new contracts signed, contracts extended and new line items added to existing agreements. A few examples of contract wins for Wesco in North America for the last quarter were Bombardier with more items added to our existing agreement, Cadence Aerospace another new contract for all sites and all programs, Flightstar Aircraft Services yet another new contract win for our MRO team, Bell Helicopter who continues to expand our agreement with more products and services. Spirit AeroSystems which are additions to our existing agreement following which is an extension of an existing agreement for all products as well as SpaceX, which is a renewal of our existing agreement.

We also had great success in our Rest of World segment inclusive of a new contract with TAI in Turkey for the 787 program, Dynamax for the Boeing Chinook program and Alenia for their F-35 subcontract work. Haas had a large award within the aerostructures industry in our North America segment. The sales process was underway prior to the acquisition, but what brought it home was the strong relationship and significant assist from Wesco salesforce. In addition, Haas also has had a large number of contract extensions and additions with aerospace and non-aerospace customers in both the North America and Rest of World segments.

Next for Haas was a significant win putting us into an adjacency where we are the first mover and provider of chemical supply chain management services. This award has a large information management system play which reinforces our custom-based IT system known as total chemical management information system or tcmIS this link starts in one key location and we look to expand across the customer’s enterprise overtime. The customer will use tcmIS to manage all aspects of their complex chemicals inventory through a licensing arrangement. We are excited about this win as it penetrates a new industry vertical and allows us to further monetize tcmIS with minimal capital investments. The win shows the utility of tcmIS and the value our customers’ place in our industry-leading cloud-based tcmIS solutions.

This win does not materially change Haas’ mix of aerospace and other industrial businesses. We do continue to see value in our current balance of aerospace and other industrial revenue at Haas and we’ll pursue opportunities in other industrial as they come our way. For those of you who visited us at Farnborough Airshow we just laid a combined booth Wesco and Haas which was our first public presentation of one Wesco. The event led to numerous cross-selling meetings, collaborations and opportunities.

I’d also like to mention GKN Aerospace Premier Supplier Award given to Wesco at the Airshow. Another highlight is being selected at Bell Helicopter’s 2013 premier supplier. We at Wesco are proud of both of these awards from two of our valued customers. In short, our sales, marketing and business development teams have commercialized numerous wins during their first quarter together. We have many more opportunities teed up and have confidence in announcing even more awards in the quarters to come.

Now, turning to integration, I am pleased to report that the progress is going very well. We anticipate a steady cadence of integration activity through the remainder of this fiscal year and at the fiscal year 2015. As we said previously, our primary focus on generating value from the acquisition is via revenue synergies through our one Wesco sales effort. Suffice to say, we are often running at a great pace. Our intent is to take a few minutes to layout our integration path with the goal of creating a one Wesco face to the customer and investment communities.

Before I describe the processes and methods of the integration, I want to reiterate our strategic objective. Our goal is to as I said earlier go to the customer with one voice. Wesco sees continued growth in value by gaining more content in the aerosystem by continuing to grow and diversify our SKUs from the service we provide to the global aerospace industry. In short, we want to supply the parts, tooling, chemicals and services to the companies that design and build aerosystems. We want to provide more of the parts and services for the industry and are working to have a great presence on the manufacturing floors.

To this end, we’re keenly focused across all functional areas of the enterprise in our effort to integrate Haas. During our first quarter, we have aligned our basic IT functions to ensure seamless and common communication across the company. Our IT team is working to further integrate Haas’ legacy SAP-based system into Wesco’s Oracle system. As an example, look for chemicals to appear on our MRO eCommerce secured site in a compliment to our existing hardware and electrical inventory available for purchase by our MRO customers.

Our HR team has aligned and is making great progress in many areas. Examples are the coming implementation of a one Wesco HR system, employee benefit alignment, and common HR policies and tools set for our employees and management. In the area of finance, great strides have been made to align and put processes in place to ensure our compliance. Greater progress has been made in aligning the general ledger and our planning function has incorporated Haas into our fiscal year 2015 forecasting and budgeting process.

Another function where we know we can gain efficiencies is in facilities and operations. We are conducting an in-depth analysis each and every time a building lease has entered into or renewed where we have a legacy and Haas facility in near proximity, we will look to merge into one facility. This will enhance our services to customers, reduce our footprint, and ensure the safe handling in storage of chemicals as well as maintaining our high quality standard for the mechanical, electrical and chemical product we provide to our customers in North America and rest of world segments.

Lastly, we continue to see growing demand from our legacy customers to discuss in “Our One Wesco Solution”. This demand is not only coming from our traditional OEM and growing set of MRO customers, but from our suppliers too. I look forward to providing another update next quarter to include details on a combined organization structure, progress in our functions and hopefully many more One Wesco contract wins.

In conclusion, we’re on the right path to bring about our vision of a One Wesco to the industry. Our focus is to protect the business, gaining a seamless transition with our customers, suppliers, employees, and investors through the integration and to capitalize on the significant growth opportunities that this combination will bring to the market.

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

Greg Hann

Thanks, Thad, and good afternoon, everyone. Now if you please turn to Slide 5. As Randy noted our sales during the quarter were 395.6 million, this was up 72% year-over-year for the quarter of which approximately 6% is organic. We will continue to see growth in Q4 and beyond as new contracts that have been signed and current customer implementations gain more traction. On the chemicals side alone, we currently have nine customer implantations in progress. We continue to move methodically through our identified list of opportunities as we integrate the business.

Also, we saw growth in both of our segments. North America and rest of the world both continued to perform very well and grew by 72% this quarter if compared to a year ago. The growth we saw on both segments was primarily driven by sales associated with the Haas acquisition as well as new contract wins and increases in existing contract business. For the quarter Ad Hoc sales made up 25% of our total sales and contract sales made up 75% of our total sales. This reflects a full quarter of a Haas acquisition. As a reminder, Haas sales are heavily weighted to contract versus the Ad Hoc.

SG&A costs were 68.9 million and included approximately 2 million in Haas integration cost along with costs primarily associated with our secondary offering in May. Without these costs our SG&A as a percentage of sales would have been 16.9% as compared to 15.5% in Q3 2013. Haas’ SG&A cost structure as a percent of sales is approximately 2% higher than the Wesco Aircraft legacy cost structure at this time, primarily due to scale. We would expect for SG&A as a percentage of sales to continue to improve overtime as we further leverage our cost structure which is what we’ve demonstrated in the past.

As Thad mentioned, we have aggressively moved to realize the cost synergies we have indentified and we expect that we will start to see those results as we move into fiscal 2015. Adjusted EBITDA as a percentage of sales was 15% this compares to 21.6% in Q3 2013. The decline in margin was primarily due to the impact of the Haas acquisition as operating margins are lower than the legacy Wesco results. Adjusted EBITDA margins for legacy Wesco operations was 19.7% in Q3. The reason for this decline in the legacy Wesco operations as compared to the prior year was primarily the result of a lower gross profit percentage, specifically as we discussed last quarter, we had declined in certain contract margins where we chose to offer discounts in exchange for signing longer term agreements and receiving significant sales opportunities going forward. This does come at a short-term cost however as lower priced inventory that has been negotiated with our supplier base isn’t recognized until the product is received as fully reflected in our weighted average inventory cost and cost-of-goods sold. We are only now just beginning to see the lower cost benefits and this should continue over the next few quarters.

Adjusted net income for the fourth quarter is 33 million resulting in adjusted diluted EPS of $0.34. This compares to adjusted net income of 29.5 million and adjusted diluted EPS of $0.31 in Q3 2013. While our effective tax rate for the quarter was 35.9% which was slightly higher than expected due primarily to movements in foreign income taxes. We would anticipate that the effective tax rate for the year would end up at between 34.5% to 35%, which is consistent with the effective tax rate year-to-date.

Moving on to cash flow, year-to-date we have used 5.5 million of free cash flow including almost 9 million associated with the Haas acquisition and integration. In Q3 we generated 31.4 million of free cash flow and we would expect to generate additional cash flows in Q4. Our balance sheet continues to be strong with the flexibility we need to support our business growth.

Now please turn to Slide 6. As Randy indicated based on our latest view of our markets and customers we service, we are revising our guidance for revenues to be in the range of 1.350 billion to 1.380 billion and we are revising our adjusted diluted EPS guidance to be in the range of $1.30 to $1.33 per share reflecting the Q3 results. We are also revising our diluted EPS guidance to $1.12 to $1.15 reflecting primarily the Haas acquisition and integration cost. We continue to be extremely excited about our opportunities going forward as we integrate Haas and leverage the capabilities of both companies.

Randy and Thad touched on only a few of the options in sales opportunities we are working on as a combined entity. Given the current market condition although we are disappointed that our results are not what we had expected, we know we are very well positioned with our supplier and very well aligned with our customers which will allow us to continue to grow. For some closing comments I’d like to hand the call back over to Randy. Randy?

Randy Snyder

Thank you, Greg. As you can see our activity levels are very high and our integration of Haas is proceeding as planned. During the last quarter of this fiscal year and we’ll continue growing our customer contracts penetrating the MRO market and aggressively moving forward with our one Wesco value proposition. I am excited about our future and believe with confidence that we will deliver results to our customers and shareholders. We will now open the line for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) We ask that each participant limit themselves to one question in the interest of time. (Operator Instructions) And we have a question from Carter Copeland of Barclays. Please go ahead.

Carter Copeland - Barclays Capital

Hey, good evening guys.

Randy Snyder

Hey Carter.

Carter Copeland - Barclays Capital

Hey, good evening guys. Can you hear me? Yes, just kind of a big picture question here. You guys have a lot of irons in the fire, in terms of the integration of Haas, the MRO initiative, you have been taking a lot of customer contracts, but just with respect to the change in the outlook which went up last quarter and now back down to a lower level this quarter. Does this speak to a kind of, I don't want to say trend, but when you take on some of this new business, is it just a little bit more unpredictable on how you think about profitability levels, the cadence of when sales come in, is part of this related to just, Wesco changing a bit in its business composition, and then making the predictability tougher from a guidance standpoint?

Greg Hann

Carter this is Greg. And clearly yes, we came up shorter than what we expected. I think there were a couple of things here. One, the overall margins we were seeing as we got into and into or near the end of Q3, we are slower to a cover than what we anticipated. I think this was due to a couple of things one was, as we discussed the this disconnect between the discounts that we gave on some of our contracts that we spoke about and then the recognition of the lower inventory costs that come in from our suppliers. That didn’t rebound, I mean we began to see some benefit but we didn’t see it to the extent that we were anticipating which caused us impart to be a little bit lower than expectation.

Also to the point you just raised, the pace of new contract wins has been robust it is probably the right word used. We do have to add infrastructure and in some of the cases the sales that we’re seeing aren’t ramping up on those contracts as quickly as expected. So we incur those costs. So we are extending in China and Singapore and Mexico and it’s just taking time for some of that revenue to match the infrastructure that we have to build.

Carter Copeland - Barclays Capital

A follow-up to Thad's comments on the integration of the ERP system, the SAP and Oracle. After seeing a lot of these over the years, how are you thinking the execution risks associated with that, and is the cost of that integration part of the original plan, or is that in any way incremental? Thanks guys.

Randy Snyder

Yes Carter I think we’re seeing very smart and methodical about integration. We are starting with the financial systems because quite honestly we need to make sure we do that to be SaaS compliant. So that’s really the immediate need I will tell you that we have a very detailed well thought out and well staffed group -- plan in place to execute on that. So I don’t -- it was all planned. I don’t think there is anything that I see that is of surprise to us at this point. Thad you have any additional comments on that?

Thad Fortin

The only comment that I would make regarding the IT systems is this is a core competency of legacy Haas. There are probably anywhere from a 65 to 75 people in our IT department. We made approximately probably seven or eight acquisitions prior to Wesco where we did on-board their legacy IT systems on a Haas IT system. So I am confident that we have a battle-tested group at Haas and have lived through various conversions and so we know what we’re doing and we believe because of the SaaS compliance that started with the accounting systems, is the best place to start.

Randy Snyder

And Carter, this is Randy. It also is that when we do the financials, it allows us to bring part masters over to the Oracle system, so all of a sudden Haas has 20 people or 20 offices around the world that could move their products, now they have visibility to their product. So I think we’re doing the integration based on one, what we need to do for regulations and also what we’re going to do so that we can get recouped on as much as sales we possibly can during this integration.

Operator

And our next question comes from Joe Nadol of JPMorgan. Please go ahead.

Joe Nadol - JPMorgan

Hi. I was wondering if you could give us a sense of the legacy Wesco business gross margin in the quarter, and maybe just speak to the industry dynamics? We have seen for your guys in over at BE Aerospace this quarter some similar things, which are the sales popping up but the margins weakening. So I guess the question is two parts, one just quantitative, what was the gross margin, and then secondly, more qualitatively, do you think this is a healthy, unhealthy environment in the industry, and most importantly, where is it going from here?

Randy Snyder

Well I’ll start with the gross margin. On the legacy, Wesco site, Joe, the gross margin year-over-year was down 1.3%. The majority of that was related to what we discussed earlier on the disconnect on the contract between the timing of when we give the discount and when we get the benefit on the lower inventory cost. Ad Hoc margins were down a little bit but essentially flat a little bit half but it was the contract piece that drove it.

Thad Fortin

Joe on the other side of that, everyone is anticipating in that the rates are going to go up tremendously all over the place and it is just not happening most of our suppliers and competitors as you can see are saying that things are pretty flat and not moving as quickly as we want to, it will happen but at this particular moment it’s pretty flat.

Joe Nadol - JPMorgan

Okay. I was just getting more into that, I was asking more around the pricing situation, because we're seeing the same things now from both you and from BE, and that's really what I'm getting at, is are you stealing each other's customers, and are we circling down here in terms of margin, or do you think this is just temporary and that the industry is healthy? This is an industry that's been consolidating, and typically we think of industries that consolidate as having better pricing power. It almost seems like the opposite is happening here.

Thad Fortin

Well it’s not us competing with BE or us taking contracts based on price. It’s really that the industry is healthy it just has not gone to the point where we know it is going to go to when the build rates will expect to pop and there is a differentiation between supply and demand. So right now we feel very good at where we’re going it’s just waiting to be in the right position at the right when it gets popped and that’s where we think we’re strong enough.

Joe Nadol - JPMorgan

Okay, alright. Thank you.

Operator

And our next question comes from Jason Gursky of Citi. Please go ahead.

Jason Gursky - Citigroup

Good afternoon everyone. Just a quick follow-up to that question. And then one on the balance sheet. A quick follow-up, I just want to make sure that these new contracts and these new deals that you're bringing in, can you kind of break out whether this is incremental outsourcing. These are new opportunities, that the distribution industry was not addressing before. What percentage of these deals is that? And what percentage is, they were using a different distributor and you now want to get the share gain. Can you split the two? Is that possible?

Alex Murray

Hi Jason it is Alex. I think we can go further than fifty-fifty in terms of incremental outsourcing and taking it from another distributor much of what Thad spoke about in terms of when he was naming the new contract wins for the most part that’s predominately incremental outsourcing in terms of the ones that were called out there. And that’s a big part of where Wesco’s growth comes from as was spoken about before taking a piece of our customer and continuing to grow and expand into other commodities and other parts of that customer’s network.

Jason Gursky - Citigroup

Okay. Where are you seeing the pricing pressure? Is it recompeting existing business, or it in the competition to garner these new outsourcing deals?

Alex Murray

I think the pricing pressure for the most part doesn’t come to a straight forward competition in terms of vendor A to B it is more about the pricing pressure that’s coming through the supply chain the pricing pressure that is coming all the way from the major OEMs and flowing its way down, which has something new in the business, so it’s a pressure has been applied over way through the supply chain and it just haven’t passed Wesco our point so as the pricing pressure from Boeing from Airbus, from Gulfstream from any of the end OEMs and that touches Wesco the same as it touches everybody else.

Jason Gursky - Citigroup

Okay. That’s helpful I’ll hop back in the queue for my other question. Thanks guys.

Operator

And our next question comes from Steve Kohl of Royal Bank of Canada. Please go ahead.

Steve Kohl - Royal Bank of Canada

Yes, maybe just a couple of follow-ups on the Haas integration, maybe first, a big picture one. I think early on in the transaction, most of the focus was on the revenue synergy, and while I know that continues to be a focus. I think there's a bit more emphasis now than earlier on the cost side. Is that because you just didn't want to talk about the cost, as you closed the deal. Is that because you found things as you have gone through the integration that were not there before? Maybe you can speak to what I pick up as sort of a change in tone on the cost side of things?

Greg Hann

It is Greg no, that’s not really true I mean we identify cost opportunities very early on that we thought were achievable. We have been working on those since day one, so there is really no change in focus. This was primarily as we stated at the very beginning that the reason we did this was for the revenue synergies that we were seeing. The cost opportunities that we identify, we are going after them, we’ve indentified, we feel very comfortable with what we’ve indentified, we think there is opportunities for more and we should begin to start seeing those early in 2015.

Steve Kohl - Royal Bank of Canada

Okay. And then maybe just related, it looks like the gap between diluted and adjusted EPS has increased a little bit. Is this because we are starting to see more integration costs flow through in the SG&A line, and that will come down into the reconciliation between GAAP and adjusted? And I think what you said is we will see that through the rest of 2014, and then maybe it tails off in early 2015, but maybe you can give us some directional bits there?

Greg Hann

Yes I mean it really is -- there is a couple of major things there is mostly related to the Haas acquisition and integration, but it’s the amortization of intangible assets, the deferred financing costs associated when we did some of the refinancing and then there are the Haas primarily acquisition related cost as well as the integration cost as well. Those are really the items that drive the difference.

Steve Kohl - Royal Bank of Canada

And then just a last quick one --?

Thad Fortin

And also don’t forget, we’ve gotten a lot of contracts and we have the infrastructure first on that as well.

Steve Kohl - Royal Bank of Canada

Okay. Thank you. Just one last follow-on, and then I will get back in the queue. Any meaningful change in the legacy business percentage of ad hoc contracts sequentially in the quarter?

Thad Fortin

No.

Operator

And our next question comes from Michael Ciarmoli of KeyBanc Capital Markets. Please go ahead.

Michael Ciarmoli - KeyBanc Capital Markets

Hi guys. Thank you for taking my questions. Maybe a follow-up on Joe's line of questioning. What, talking about the build rates, I guess, haven't popped yet, what exactly are you guys looking for? I mean, it seems like the 87 has a little bit more to go. We've got the 350, but there's also probably equal concerns about the 777 and the A330. Maybe if you can expand on that? We have come a long way in terms of total aircraft off of the assembly lines over the past couple of years. Outside of the 350, what else is really going to drive the business or volumes?

Thad Fortin

I think very specifically the Bell grade, we now see in terms of when these Bell grades are discussed an OEM platform label when they actually reach our part of the supply chain. So, I mean I would agree with your comment in the sense that we still see more problems on the 87. And then in terms of A350, we’ve probably only seen one quarter of relevant A350 sales. And it’s only just started to show itself on Wesco supply chain as a consumer of product. 737 and 320 I guess are single aisle is a little bit more about market shares as about just actually taking benefit from any increases in Bell grade although I think there is still certainly discussion point in our commentary around with the potential for further increases in those platforms.

And then across that is also for Wesco anyway, an awful lot of interest in Bombardier and Gulfstream, and looking for further increases especially around Gulfstream and to take in part for Wesco. And not so much above the actual Bell grade itself, it is about the fact that we are continuing to add more and more and more with those customers and we start off with their inventory possession and then we’ll believe it down. So we’re not seeing the full impact of their Bell grades because they are still running some of the inventory. So it’s not as pure as a statement as we’re feeling the full effect of the market in terms of Bell grade as adopter in part in Wesco.

Michael Ciarmoli - KeyBanc Capital Markets

Okay. That's helpful. And then one last one on the pricing or the competitive environment. After the Farnborough Air Show, we heard some commentary from New Breed, the logistics manager that runs Boeing's basin initiative. It sounded like they were getting ready to expand their content beyond Boeing proprietary fasteners? Is that having any impact out there, it seems like you guys are still expanding customer relationships and gaining share, but I mean, can you kind of speak to what New Breed is trying to do? I know they just got acquired by XPO. I have know that might muddy the waters. Anything you can say on their initiative and what's happening there?

Thad Fortin

No, nothing to comment there in terms of New Breed does and potentially in part Wesco, we still see that tied to BAC product line and we haven’t failed to understand they’re being communicated on that front.

Operator

And our next question comes from Sheila Kahyaoglu of Jefferies. Please go ahead.

Sheila Kahyaoglu - Jefferies

Hi, good afternoon, thanks for taking my question. Can you discuss about inventories, the chain outside of your Company, maybe what is going on with Churche suppliers, and also on the defense side, is there any change in buying behavior from your customers maybe versus six months ago?

Alex Murray

Hi it’s Alex, Sheila. There is no further change in terms of our understanding inventory and the Tier 2 suppliers. As we have mentioned before that in that territory that's where a lot of LPAs are. It's more difficult for us to understand the inventory position with our customers and what’s in the chain. These people could be buying one year, what’s EPO and what’s three weeks, what is just difficult to handle this, so we certainly haven’t changed our understood the shelf in terms of inventory position without the supply chain. Sorry, you may take the second part. I think Thad called out a couple of our military customers in terms of ones we still see that impacts of sequestration in terms of that has put some pressure on our military customers in terms of their administrative headcounts and the people that they need to manage their supply chains, if that pressure increases their likelihood to outsource increases and some of the ones that Thad pointed out are directly related to that. So we still see the potential offsite for Wesco as a result of what’s happening with our military customers.

Sheila Kahyaoglu - Jefferies

Okay. And then maybe I missed this, but just on Haas, it was slightly lower than expectations in terms of the top line. Was that just timing, or was it lower margin business that Wesco decided not to participate in?

Alex Murray

No, I mean sales were pretty much on target, slightly down but it was, we’re more concerned on a Haas side with the gross profit not the sales necessarily and the gross profit was on target.

Sheila Kahyaoglu - Jefferies

Okay. Yes, no, it seems like you have a robust pipeline. And then I guess just on the gross profit, or on the profitability, SG&A, I know you called out the secondary costs. It was still a tad higher. Is that just the nature of the business, more marketing efforts, or is it more transportation and logistics that are affecting it? So on a go forward should we think about like 16.5%-plus, SG&A to sales?

Alex Murray

Yes, I mean we would see the SG&A once we continue to go down as we have scaled, we’ve talked about it before where the largest percentage of our SG&A related costs are payroll and we should as we grow and as we have the people in place and the revenue starts to come in from new contract that we’ve taken that we will see the SG&A go down as a percentage of sale. So I mean like I said it was 16.9% this quarter as I have said we should see the trend on quarter-to-quarter some things can move around but generally speaking we should see that trend go down.

Sheila Kahyaoglu - Jefferies

Okay. Thank you.

Operator

And our next question comes from Kristine Liwag of Bank of America. Please go ahead.

Kristine Liwag - Bank of America

Hi, good afternoon. Just a follow-up on the pricing pressure question. Alex, you mentioned that the cost pressure is coming from everywhere in the supply chain from OEMs to the suppliers. So if pressure isn't coming from competition, should we think about this as pressure from threats of possible disintermediation in the industry?

Alex Murray

No, no, disintermediation we just recognize as a threat for Wesco not in a way that it’s been certainly discussed over the course of the last year in terms of an industry that can survive with our distribution we just don’t see that whatsoever there are so many other services that distribution offer so many ways that distribution facilitate the total sense of a lean supply chain and the spread of commodities that we have as well that we just don’t see them. And we also spoke about all the way through Wesco’s history in many other cycles that the pricing pressure these things are appear as a point in every cycle, every five or six years or so there is more pricing pressure than before as OEMs look to dive a lower cost of operation or they look to find a different breakeven point for a new platform or whatever the pressure is. Certainly Wesco has always been open to trade in terms of growth that a sometime for some short-term margin and because that is something that we believe that we can recover through our negotiations with our vendor base and we just ourselves right in the middle of that scenario at a moment that something that we’re comfortable in dealing with.

Kristine Liwag - Bank of America

Great. Thank you.

Operator

And our next question comes from Myles Walton of Deutsche Bank. Please go ahead.

Myles Walton - Deutsche Bank

Thanks. Good evening guys. First of all, maybe is on cash flow, and Greg, I know you mentioned you will have, I think, additional cash flow in 4Q, but looking at cash flow for the year, I think last quarter, we talked about 50% conversion. I mean, are we now down to 15% to 20% conversion?

Greg Hann

No, I think at the end of the year given what we saw in Q3 what we expected to see and what we delivered I think we’ll probably be closer to 40% something like that, we’ll end the year somewhere around 40 million in free cash flow for the year. Once again we expected the first part of the year not to generate cash, we expect that the second half of the year to generate quite a bit of cash maybe a little short of what we thought in two quarters ago but I think we’ll probably in a year end up somewhere around 40.

Myles Walton - Deutsche Bank

So as we look out, I know you are not giving, it but as we look out to 2015, is the 60%, any reason to think you can't get to that target, that's usually your--?

Greg Hann

No, I mean this was the special set of circumstances when we made a decision last year to build inventory in a number of part numbers that we felt we had gaps in our portfolio to be able to service the customer. So we went into at knowing that this was a unique situation. I would expect normally as we have demonstrated in last four, five, six years at 60% probably a pretty good number.

Myles Walton - Deutsche Bank

Okay. And then I think the EPS contribution, or let's talk about it in terms of the EPS change in guidance, how much, if any of the change in guidance was due to Haas versus the legacy Wesco?

Greg Hann

I would say that the change in guidance was due to legacy Wesco I think Haas is delivering right now exactly what we anticipated.

Myles Walton - Deutsche Bank

So Haas is still $0.05 in the back half?

Greg Hann

Haas did about 3.9 million of net income this past quarter.

Operator

And our next question comes from John Godyn of Morgan Stanley. Please go ahead.

John Godyn - Morgan Stanley

Thanks for taking my question. I was just hoping to follow-up on some of the commentary that we heard about momentum with Haas and sales opportunities, but within the context of the 8% to 10% accretion math that you guys put out. I mean is the right interpretation that there's now upside to that run rate, or has something been pushed to the left? I'm just trying to kind of, think about the numbers behind the commentary that we have heard?

Greg Hann

No, I mean, we’re not ready to talk about next year. I think 8% to 10% that we said in the first year, we feel is achievable. Like I said, Haas and what we’re doing with integration from sales standpoint right now is meeting our expectations. And I think I would leave it like that right now.

John Godyn - Morgan Stanley

Okay. Okay. Fair enough. And just one more follow-up on B Aerospace. I'm just curious if you noticed any change in behavior since they put themselves up for sale?

Greg Hann

We usually don’t pay that much attention to and don’t know -- I know there isn’t lot of management change almost for the year, but we’re just concentrating on what we can do in the market not what they’re doing in the market.

Randy Snyder

Yes, I don’t think that we’re seeing any change in the way that they market, they way they compete anything like that.

Greg Hann

I don’t think there is anything back on the table in terms of major recomplete of GIT type contract or anything that’s passed in the time either. So there is been nothing of any significance.

Operator

And our next question comes from Luke Junk of Robert W. Baird. Please go ahead.

Luke Junk - Robert W. Baird

Good afternoon guys. Switching to the MRO business, I know maybe six months or so ago, before the Haas acquisition came onto your plate, you mentioned that you were readying a Phase II development for the eCommerce platform there. Has that been implemented, and if so, how it's going and just more broadly speaking, whether there's been any impact from Haas, as it relates to your ability to invest in the MRO business and the IT side?

Randy Snyder

We are not completely finished with the Phase II. The Phase II, there is more detail that you probably want, but Phase II involved 18 different enhancements, which allowed us to one it leads directly into Haas to offer a broader production offering on our MRO eCommerce platform. And that’s an area that Haas will stepping straight into so because of the Phase II work is probably shortened, our times scales and our lead time to be in a position where we can sell chemical products on the eCommerce platform, so that’s been very complementary. I don’t think Haas has done anything advanced for position in MRO. Haas came with some customers we were already in a long-term agreements scenario with the chemical product line that Wesco certainly didn’t have significant share in the hardware or the electrical product line and equally in geographies that are best suited in terms of rest of the world segment Hass brought some business that Wesco had not enjoyed in terms of customer demand. We are already seeing that we are very successful in terms of one part of the business using its relationship power to help or improve understanding of the other. So we’re very comfortable with the Haas position on MRO.

Luke Junk - Robert W. Baird

And then a quick follow-up, Greg, if you don't mind, of the overall 6% organic growth, is there a significant difference between North America and Rest of World?

Greg Hann

North America is a little bit higher than the rest of the world. That was primarily because at a customer request that was just a shift in a contract that was being supplied out of the rest of world as now at North America. Otherwise, that they were essentially they grew it about same rate.

Operator

And our next question comes from Gautam Khanna of Cowen and Co. Please go ahead.

Gautam Khanna - Cowen and Company

I was wondering if any of the sales guidance change related to some of your customers moving over to the Boeing basin program. We had heard that Alenia might be doing so, and if you could just comment on that, and if you could just comment on the maturity of that program? Do you think that we have seen all of the adaptation that we are going to see, or do you think that there is more pressure from the OEMs for some of these contract manufacturers to join? Thank you.

Greg Hann

We have raised the guidance because our sales are coming in stronger then we anticipate. So really had nothing to do with Basin, so I’ll leave that, any other comments?

Thad Fortin

I think the constant pressure on the supply chain to adopt Basin. It’s not something that Boeing, are entering into half hearted sense. We recognized it something that they very much want it to be successful and they constantly supplying pressure for it to be adopted I think the one notable change and it is something that we’ve been talking about over the course of the last six months, nine months, is the subject was first if you discussed talked about or understood or believe to be a disintermediation project where the project would exclude distribution from participating we very much feel the project is inclusive of Wesco. So Wesco participate in any discussions, Wesco are part of the solution and we’re comfortable again where the possession and actually as an opportunity to bring more business for Wesco as it applies to some of the subcontractors. I think that’s the one change for us and it was something exclusive distribution and we think it to be something that inclusive of distribution.

Operator

And our next question comes from Joe Nadol of JPMorgan. Please go ahead.

Joe Nadol - JPMorgan

Hi, I wanted to follow-up on the Haas revenue. I understand it came in line with your expectations. As far as I can tell, it's not really growing much year on year, and it didn't in the first half, and Greg, I think we had talked earlier in the year, or last year, I guess it was earlier this year about the composition of Haas, and that there's non-A&D in there. I'm wondering if you can give an update on what's happening there, is aerospace going up and something else going down. What is happening?

Greg Hann

No, I mean the split between aerospace and aerospace is relatively flat. So I wouldn’t say that I think the Haas right now has the opportunity to get into some other industries but the focus I think the split is still going to be relatively consistent going forward between aerospace, defense and other industry.

Thad Fortin

This is Thad. What I’d also like to say is that as lifelong sales question, a question saying this, but in our business sale is an important driver but it is not the only driver. When we look at business level of effort and cost to serve is probably as significant in our business as revenue. And so to Greg’s point earlier we look at gross margin or contribution margin based on the business, because in our non-aerospace business our cost to serve particularly for the commodities that we’re purchasing are significantly rough and therefore it really depends on the cost of serve as really how we look at the business and what the parameter should be for success.

Greg Hann

Okay. I mean, I guess it's been, the acquisition has been characterized in a couple of different ways the last six months. My initial impression was there was a significant top line growth opportunity and that was the key driver. I understand there are cost synergies and you are pursuing those in different facilities. But I guess as we think about next year and going forward, do you expect the sales growth to pick up, or is this really kind of a margin story?

Randy Snyder

We were talking one the reason is why Wesco purchased Haas it was basically because of our logistic solution which saves the company so much money by adding product line and having chemicals and hardware or mechanical and electrical turnover had a sense grows our business significantly. So our goal is always been to have the customer to be a once stop shop for our customers and that’s where the growth is going to come long-term.

Greg Hann

I mean I guess to add to Randy’s comments yes, we will see sales grown here absolutely I mean we thought this obviously for specific reason as we discussed and we would certainly expect to show that kind of growth going forward into 2015 beyond.

Thad Fortin

And we’ve been getting a lot really good reaction from our already contract customers, that’s why we have 150 opportunities to combine our strength and add more SKUs to our contract, which just saves the customers so much more money.

Greg Hann

And one of the questions that came earlier was, how we’re winning market share and from a legacy Haas perspective a very, very small piece is taking share from a competitor, the significant piece is from the customer in sourcing to now Wesco an outsourcing play on the legacy Haas side. So we’re seeing probably greater than 75% to 80% win rate of new business and not taking share.

Joe Nadol - JPMorgan

Okay. Thank you.

Operator

And our next question comes from Jason Gursky of Citi. Please go ahead.

Jason Gursky - Citigroup

Yes, one quick follow-up. You mentioned in response to my question earlier that this pricing pressure is perhaps being less driven by the competitive environment and more by the OEMs, and this is kind of a top down pressure is being applied to the entire supply chain, and you also mentioned there was either this call or a different caller or maybe both, that one of the ways that you have reacted to that is to go back to your suppliers in search of better pricing, and that your cost of inventory will come down over time. That all makes perfect sense. Is there anything else that you can or should be doing at this point to bring down your own cost structure, to get yourselves in line with what is now expected from the OEMs? We are hearing from your customers, Tier 1 and Tier 2 suppliers of the litany of things they are doing to reduce their cost structures so that they can maintain or expand margin in the face of all of this pressure. Can you talk about what other things you might be doing other than seeking a lower inventory cost basis?

Randy Snyder

From a facility standpoint, already we’re in the mix of consolidating a Haas facility and a Wesco facility in the north. And the same time, we’re going to our customer and offering our logistic solutions to them, so they can lower their costs beside piece price. And helping them reduce a lot of their supply chain cost internally, so we can be able to more competitive. It’s just not about these prices but about the ability to do so and when we do that, it brings us so much more opportunities for Wesco to bid on that we were not having the chance to bid on before, and that was the example of the from Bell that I’ve mentioned in my -- that opportunities when I was giving my part of the script. So by doing all this together and leaning out the supply chain only helps Wesco with our logistic solution and our ability to support them as a distributor as well.

Greg Hann

I think what Randy is talking about is Wesco helps to reduce the total acquisition cost for our customers and that’s one of the ways that we try to keep the subject off of price as much as we possibly can. But as far as Wesco's own cost of operation, yes, I mean we’ve got again a very robust pipeline of projects which are constantly being developed in advance within the business, and so we’re very-very keen on we’re reducing our own administrative efforts, and then in terms of how we use our ERP system and use the automated features of that system, so that we rely less on people and headcount as we grow our business and take an every opportunity to reduce the cycle times that it takes to mange Wesco’s transaction. And we’ve got plenty of examples of retaining credit and go into detail as to where we shop the Tanker is bunch is that and we shorten the Tanker as sales although we time inspect an item. We improve the time that it takes to pack mark and ship our items, and we are constantly looking as to where we can make improvements on those operational efficiencies, so as a constant part of our business for sure.

Randy Snyder

And we can take that those principles as what we’re doing internally and bring that our customer it just makes Wesco so much of a valuable vendor to our customers and allows us to increase our business.

Jason Gursky - Citigroup

So is it fair to say that operating margins, adjusted operating margins were, we have reached the trough then given all of your talking about here, or do we still have more to do in front of us, and how do we get this turned around other than waiting for this higher cost inventory to flush its way through the system?

Greg Hann

A lot of that cost is people setting up these new programs that we have, that we haven’t generated income because part of what we do, is to take that the inventory that our customer has and then filter though that before we utilize our own product line. So that one of the constant right now we’re spending up quite a few of these contracts. So where that comes together, you’d see SG&A drop significantly.

Jason Gursky - Citigroup

When does that come together? What is the timing of that?

Greg Hann

As far as the inventory part of it, you have got a business with a stop tunnel on about 1/10 about that we’re certainly not going to change over the short terms although that lower cost of goods sold in terms of the ultimate benefit except that going take a few quarters for that flush through just like we can tell you to make incremental benefit on the other parts in terms of cost to serve in terms of the actual operation.

Jason Gursky - Citigroup

Right. And is the exact timing, or the turning point on the SG&A, when do you get these contracts up and running, and you can begin lining that down?

Greg Hann

We should begin now that we’ve had a full quarter of Haas and we’re growing the business, we should begin to see that relatively quickly.

Thad Fortin

And as we consolidate warehousing.

Greg Hann

Exactly.

Thad Fortin

And so on so forth, it’s a little journey, but we’re working on it. And as the market and production rates go up on the lines just not the Boeing or Airbus line that is what you’re going to start seeing the SG&A go down as well.

Operator

We have no further questions at this time. Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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Source: Wesco Aircraft Holdings' (WAIR) CEO Randy Snyder on Q3 2014 Results - Earnings Call Transcript
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