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Joy Global Inc. (NYSE:JOY)

February 20, 2013 10:35 am ET

Executives

Michael W. Sutherlin - Chief Executive Officer, President, Executive Director, Member of Executive Committee and Chief Executive Officer of Joy Mining Machinery

Edward L. Doheny - Executive Vice President, President of Joy Mining Machinery and Chief Operating Officer of Joy Mining Machinery

James M. Sullivan - Chief Financial Officer and Executive Vice President

Analysts

Andy Kaplowitz - Barclays Capital, Research Division

Andy Kaplowitz - Barclays Capital, Research Division

Okay. We're going to get started again. We're very excited to have Joy Global with us. They've been a mainstay at our conference for probably 12, 13 years. Mike Sutherlin is with us today. He's the President and Chief Executive Officer. I've known Mike since he started at the company. He's done -- I think Joy has been consistently the best executor in the machinery space. Jim Sullivan just started as the EVP and CFO. And Ted Doheny is the President of the company's Underground Mining Operations.

What I think would be good to do first, Mike, is just sort of talk about the overall markets and sort of what you see in the overall commodity markets, how that's affecting your business. And maybe give us a couple-minute overview of what you see right now.

Michael W. Sutherlin

Thanks, Andy. It's always a pleasure to be in Florida in February, particularly if you're based in Milwaukee. So as we look at our markets, we see some encouraging signs in our markets. We've been working through headwinds. And we've seen weak commodity demand and that's translated into weak order rates for us for -- throughout 2012. As we look forward in 2013, we see some positive signs. We see in the U.S. market, signs of stabilization in our business. We think that after 4 quarters of ratcheting down and 4 quarters that our customers have used to close mines and reposition their volume into lower-cost operations, that most of that is behind us now. We're finding a position that's looking like it's starting to stabilize. That's encouraging for us.

In the process that we've gone through, we have seen inventories that our customers hold have been depleted. So the order rates we've seen have been less than the consumption rates and we've seen increased time between rebuilds. And those rebuilds that have been pushed out are starting to come back in scope now.

So we see the stability in the U.S. market, which is a key part of our business. And to get that stabilized allows us to focus on growth opportunities.

In the international markets, commodities are very, very dependent upon China. And China had its own headwinds through most of 2012. But in the latter half of the year, we started to see improvements in fundamentals. And we look at things that both are more discretely measurable and things that are more directly -- have more direct impact on our business. So we looked at electricity demand in China. We saw that turn in September and has been consistently improving month-over-month for the last 5 months.

Steel production has -- was flat for most of the year but started to improve in the last 2 or 3 months of the year.

Those improvements in power demand for -- which drives thermal coal demand for China and demand for steel, which drives the demand for metallurgical coal and iron ore, they happen at a time when the inventory levels for those commodities were significantly depleted. The inventories held by the power producers were down. The inventories of iron ore at the ports were down. The inventories of metallurgical coal that were held in the steel mills were down significantly. So on top of the outlook for improving demand out of China, we see the need to replenish stockpiles on top of that. So it's still, I think, early and the views are early right now, but we're starting to see encouraging signs and the start of improvement in China and definitely, it looks like the third quarter was a bottom for China and things are going to start trending up.

As we look at our customers, we've had a lot of change in our customers. They focus historically more on increasing volume. And today, the focus is more on returns on capital investment. A lot more scrutiny on projects, re-prioritizing projects. A lot of our customers have new management teams and new mandates and those things are creating time delays. So although we're seeing improvement in the fundamentals in China, we believe that's going to take some time before it works through our customers' decision-making process and translate into order rates for our business. So we continue to focus on ways we can streamline our business, take some cost out, improve the efficiency of our business. We are a business that's historically been able to respond very well to the upside. We know that, that is probably getting closer, but we also know that we have the capacity and the capability of responding when the time comes. And in the meantime, we're focused on efficiency and cost reduction.

Andy Kaplowitz - Barclays Capital, Research Division

So, Mike, given the fluctuations in the commodity markets, what's your best guess around sort of mining CapEx over the next couple of years? Like often, we hear one of the criticisms or the bearish cases that mining CapEx is going to be down 10%, 15% this year and then down again significantly in 2014. What do you think is the likelihood of that versus flat or up as we go into '14 and beyond?

Michael W. Sutherlin

The mining CapEx is going to be tied to 2 things. One is the demand profile for the commodities that they're producing and second is their cash flow. Our customers generally are reinvesting cash flow. And part of the mining CapEx that's been pushed back has been a high-risk CapEx, long lead times, greenfield projects in new areas requiring a lot of infrastructure investment. There's very little appetite for that kind of CapEx today. We have seen a lot of re-prioritizing of the projects and much more focus on brownfield expansion, much more focus on greenfield expansion but in adjacent properties so they can share infrastructure, known geologies, reduced risk. But ultimately, the growth in our customers' mining capacity has to keep pace with the growth in demand. And we still see the long-term story around the industrialization of the emerging markets is still very strong in our view. We still see very low per capita energy consumption, commodity consumption, minerals, metals in places like China and India, we still see a lot of growth out of those emerging markets. And then there's a whole list of other markets that are following, like Indonesia and Thailand and a number of other ones. So the growth for commodities in the long term continues to be very strong. Our customers will respond to that with sufficient capacity at pricing levels that give them a good return. So right now, there's not a great sense of urgency because there's excess supply. In most commodities, our supply demand is nearly in balance. So we -- our customers feel like they have more time to evaluate before they have to make those decisions. So I do think that's a near-term impact. I think the long term, prices will be sufficient to incentivize capacity expansion and our customers will respond to that.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. Great. There is an elephant in the room so I'm just going to sort of address it right now. I'd be shot if I weren't. Maybe like to the extent that you could talk about Joy as sort of the last pure play mining company, I mean, I think a lot of the times why the rumors come up is because Joy is sort of the last one standing when it comes down to it. How do you view the company over the next 3 to 5 years? Does it need to partner up? Are you going to be the consolidator? How do you look at that and how do you view all these rumors that are out there from time to time?

Michael W. Sutherlin

Well, I guess I'll start by saying that rumors have come and gone and rumors will come and go, and it doesn't change the way we look at our business. And we have a business that's focused on delivering value for our customers. And we think we do that very well. We've also delivered value for our shareholders. So if you look back at our track record, both in top line growth, bottom line growth, asset efficiency, I think we've demonstrated that we've done just an excellent job of delivering value. As we look at our business going forward, we're a business that is mining specific. And we're mining specific because we have a business model that is tailored to the mining industry and that business model is a direct-to-the-end-user model. We design, build, sell, service our equipment. We run the whole gamut. We have -- out of our workforce, we have a significant percentage, 25%, 30% of our people whose job every day it is to go to mine sites to support our equipment. The knowledge that gives them, the ability that gives us to keep that equipment running in high levels of reliability are really, really important to our customers. We think that filling out some gaps in our portfolio are really important. But top line growth is not our #1 driver, it's the strategic benefit that some additional products would have for our business. When we acquired LeTourneau, it fit into a business that serves the same customers, the same mines and the same regions. And the leverage on that business has been very good for us. And it just sort of demonstrates the value that can be obtained by putting the right products in your portfolio. We believe that our performance, we believe that our focus, we believe that the position we have on a direct model can -- is the basis for a larger business going forward, filling out the portfolio. If anybody should be consolidating this industry, I think we've demonstrated our ability to add value and we should be the guys doing that. But right now, we're just focused on integrating the acquisitions we've done and we're looking at the next steps. But we're not preoccupied with that. At the end of the day, we're always -- we work for our shareholders and we're going to do the right thing for our shareholders. So whatever third parties want to do, we'll do the proper evaluation to make the right decision. But right now, we're focused on leaning out our business, getting more efficient in the way we deliver products and services to the market and being prepared for the opportunities we see as the markets return and demand for commodities returns.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. So let me talk about a smaller elephant in the room and that is IMM. So look, again, I think you were sort of guilty by association to some extent. But maybe you could talk about what you saw in IMM, sort of when you saw it? What gives you confidence in sort of the business model of IMM? And what gives you confidence in your sort of stated goals that you were sort of bottoming out last quarter, more or less, in terms of execution and that you were going to get better over time?

Michael W. Sutherlin

Let me give you just a -- what we saw with IMM when we made the decision for that acquisition. Then I'll sort of pass it over to Ted and Jim, and they can talk a little bit about the -- some of the financial control issues and talk about the -- where we see the business today and where we see it going. We looked at the China market. And the China market is, in effect, 2 markets. It's a top-tier market that we serve with our globally produced product, global standard product and we sell to companies like Shenhua, China Coal and Tudong [ph] but a much bigger market exists in the provincially owned mining companies, smaller state-owned and provincially owned mining companies. And that's a market that's sized 2x to 3x the size of the top-tier market. To be a leader in the China market, we needed to be a leader in that mid-tier market. And that was sort of the genesis for the IMM acquisition. As we looked at the equipment suppliers in China, IMM had some very, very significant advantages. It was a -- it had been westernized. It had an established ownership that it was focused on delivering returns. It had gone through the IPO process and it met all those standards.

But more importantly for us, it was a machinery business. And machinery is the core of what we do. It generates the aftermarket that's so important to our business and it generates margin. So IMM had core machines that were leaders in their respective product ranges.

When we did the acquisition, it was by far a better business and had less complications, not just operational but ownership complications than anything else we looked at. As we did the evaluation, we realized that the roadheader had sort of -- the competition had caught up with the roadheader and we needed to extend the performance capability to get back into leadership position. We saw problems that they were having with the armored face conveyor product. And we saw our ability to bring technology that would solve those problems and put that into a strong position in the marketplace.

So some of the problems that we -- operational problems that we saw with IMM were opportunities to significantly improve that business and that was sort of the basis for that acquisition. Quality company, quality management team, well-established with great products and opportunities to push those products way into the lead in the market.

So if I'll turn this over to Ted, he'll give you a little bit of a view of where we are with IMM today. And then Jim can close out with the financial performance of the business.

Edward L. Doheny

Well, I'll leave it over to Jim but I'm sure the question Jim will tell, the inventory is real. The issue with IMM -- we're quite excited. As Mike described, what we have in China is we have 3 parts of our strategy. First is the high-performance equipment. For now almost 20 years, Joy has been working with the top customers, as they've been trying to modernize the mines in China. And just remember, 3.7 billion tonnes are mined in China, half the world's coal production. So if you're not -- in the future, if you're not in China, you're not in the business, the machinery business.

So we're doing well there at the top tier. But really the real play is can we consolidate those local manufacturers. And that was our play with IMM. Looking at 4 distinct businesses, 2 of them had been in business for a long time, the roadheader business, as Mike described, and the shearer business.

So what can we do with that next large segment, an $8 billion segment, that we believe to rapidly grow the share and change the game? So when we first bought the company, we did look at IMM for actually a few years. We looked at their management team, and as far as the financials, they were run by a private equity firm. So that part of the business, we felt pretty good about. The issue on the management team, they actually had Western managers in but it was still being run by private equity business. They did not invest in the product and the process. So our strategy at the first 2 quarters looking at the business was let them watch the business, see what they were running in the market but what we ran into is the headwinds in China. If you look at our #1 competitor, significant drop-off in the second half of the year. So we've now engaged our integration harder. So we actually put -- running the complete evaluation of the product lines, again, the roadheader, the shearer business and the armored face conveyors. What can we do to inject this technology quick and fast, differentiate the product in the marketplace?

The other piece that we think is unique about our strategy is can we lean out their footprint. And this is what we're doing with our company -- with our customers. We are now a Chinese company. We have 29% of our workforce now in China. 30% of our manufacturing footprint now is in China. Both of the Tier 1 products that we're exporting around the world, world-class manufacturing in China.

So the next step is can we lean out their facility? And as we inject the technology to create the real product differentiation in the market, to have the best roadheader, to have the best shearer, the best armored face conveyor but still be able to compete in the China market as we consolidate that market.

The third part of the strategy that we're moving quickly on is the service model. And that's really what defines Joy. We really are a service company and that's how we differentiate with our customers. With our life cycle management. Well, with IMM, with the roadheader business and the shearer business, it's more of a throwaway product. So we're doing some basic things. Getting the parts business, that's a key part of the aftermarket, number one. They were having some of their sub suppliers, after they would sell the machine, their suppliers would be selling parts to the customers. Cleaning up some of those processes, investing in service technicians, so we have great service around the equipment. And then even we're using our Smart Services center, we have the first Smart Service center now in Baotou, even showing them what this life cycle can be. So instead of a roadheader being a throwaway product, actually rebuild that a number of times. A shearer, instead of rebuilding it maybe once, like a Joy shearer that's rebuilt 6, 7, 8 times, putting that service model in place. So lots of work to do, we do see, as Mike described, we do see China rebounding. So we're -- the premise of what we bought, we're still excited. We do have a lot of work to do on the execution side.

James M. Sullivan

So obviously, we've received a lot of questions over the last month or so regarding IMM accounting irregularities and that sort of thing that may have happened with others in the industry dealing in China. As the new guy, I was able to kind of take a fresh look and really try to understand really what's going on there, while Jordan, who was a private equity company, didn't bring a lot of the operational synergies and opportunities that Joy will bring to bear on the asset going forward. What's clear to me in making that assessment is they put a really good governance structure in when they acquired the business back in 2006. They hired experienced U.S. multinational managers to run the business, to bring Western-style philosophy, governance into the business, made a lot of improvements in terms of the accounting, reporting and controls of the business. E&Y was hired from the very beginning when they took over in 2006 and has been the auditor there for quite some time. So good track record with that, leading up to the IPO. And I'm sure many of you are very familiar with the IPO process. Even in Hong Kong, it's pretty rigorous. So a lot of hoops were jumped through to demonstrate over a long period of time that these companies, which have been in business for quite some time, had very, very strong financial controls. And then of course, Joy came along and brought to bear resources above and beyond that after the acquisition. Of course, we've had valuation experts in there from PwC. We have our auditor E&Y in there. Lots of people have been looking at the practices that are going on there from an accounting perspective and feel very comfortable. We signed off on our financial statements at the end of 2012.

So not to say that we can't always improve, we're always looking to improve within Joy, but I feel very comfortable based on what I've seen even since I've been there in terms of testing we've done on inventory, sales recognition, et cetera, that the controls here are very solid.

Michael W. Sutherlin

I'll finish off on the outlook of the business. We feel really confident that the business has reached the point of -- the bottom in the fourth quarter and will start to improve in each quarter in 2013. Certainly, as trends and outlook improves, this sort of adds more confidence to that view. And I guess, one closing comment on IMM and the roadheaders. Ultimately, the roadheaders aren't the product for the market. Every other market that we serve has long ago transitioned from roadheaders to continuous miners because it's just a much more productive tool to do the same job. And ultimately, that's where we see with the kind of upside we see with IMM is not making it the definitive roadheader business but to transition from roadheaders to continuous miners, which we know how to do very well. We've done in other markets historically. So there's a lot of things that IMM brings to us, a lot of things we bring to IMM that together, I think, will add value to our business over the long term.

Andy Kaplowitz - Barclays Capital, Research Division

Great. Let me ask you one more question before I open it up to the audience for some questions. Global asset market business. You've got it flat, maybe down a little bit in the global asset market business. What kind of visibility do you have in that business right now? Can you talk to us a little bit about what production you've been doing? And how confident are you about sort of what you've guided to?

Michael W. Sutherlin

We're, again, a direct-to-the-end-user company so we have a lot of visibility in things like the aftermarket. We're the guys providing aftermarket service and support to customers. So as I said, the important thing was getting to stability in the U.S. market. In the process of ratcheting down the U.S. market during 2012, we were doing that at a time when we were able to maintain pretty steady aftermarket order rates. And we maintained those aftermarket order rates because of the upside we had in the international markets. The international markets were enough to offset the decline in the U.S. market. U.S. market stabilized so we don't expect more declines and that's a positive for us. As we look at the international markets, we expect those to continue to provide not only offset to the U.S., but growth through time. We see most of the growth coming out of the international markets. The aftermarket will grow along with that. In the near term, we could have some choppiness in the near term where we -- timing of Lunar New Year is really important because of the impact that China has on our business. And China is a big part of our aftermarket business as well. Orders come in lumpy. China New Year, the timing of that can have an effect. We have about 80 million tonnes of mine capacity in Australia. That's offline today because of the flooding conditions from the cyclone. So there's an aftermarket disruption effect there.

So as we focus on the aftermarket more intently, all of those little bumps that sort of get ignored historically become more focused and get highlighted. So you just have to expect a little bit of choppiness in the near term, I believe. But certainly, our outlook is for the growth in the international markets to continue to be strong. The U.S., to stabilize, has a little bit of upside in the U.S. And overall, we expect the aftermarket to continue to grow at rates that are consistent or higher than our overall growth rate.

Andy Kaplowitz - Barclays Capital, Research Division

Let me push you just a little bit more, and you can always push back. But like one of the prominent suppliers in the mining market talked about order rates being down over 10% for them. Do you think that they were too pessimistic in saying that or is that just near-term choppiness? Or what do you think that is?

Michael W. Sutherlin

Well, I think we have a number of factors going on. And I don't know how much of that is aftermarket versus original equipment driven. But we have a lot of changes in our customers and their management teams. Their priority for capital allocation and CapEx programs, expansion risks and all those things are changing. And there's no doubt that things are slowing down on the original equipment side as a result of that. We see that in the way we track our prospect list. We look at prospects and -- if we look at our prospect list at the start of 2012, the vast majority of the projects were on that list have been pushed far out to the right. But there's been a lot of new projects that have been added to the list, as well, to offset the pushouts. So we have a process of projects being pushed out over the horizon and new projects pulled in that have better predictability, quicker returns to first production and good ROIs. And those -- that's going on all the time. But all that is creating a delay in a lot of the projects as they go through this reevaluation phase. Certainly, we're seeing that in the original equipment side of our business, the project side of our business, we see that, and there's more things sliding today than they've ever been before. There's no real sense of urgency because of some excess capacity in most of the commodity supply chains, and getting the numbers right is more important than getting the CapEx deployed early for our customers today.

On the aftermarket, there's an interconnect there as well. I mean, some of the mining companies in Australia has put the edict out that they were going to reduce OpEx. And even though that operational cost was driven by taxes, it was driven by capital overruns, it was driven by exchange rates, when they go to reduce CapEx, they just -- everything's on the table and they do what it takes.

And so there's a lot of factors that are going on. But I look at all those factors being near-term choppiness rather than affecting the long-term demand profile that we see for the aftermarket. So the bumpiness we're going to see in the near term is -- we'll manage through that. It doesn't have any impact on where we see the long-term potential for the aftermarket.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. Great. Any questions from the audience? Don't be shy.

Unknown Analyst

Mike, I have a question with the success of the shale industry in the U.S., what's the likelihood that some of those mines in the East will just never be back in the money, and if you believe that, would you have to adjust the manufacturing footprint or your service center footprint in the U.S.?

Michael W. Sutherlin

We certainly see the -- in the U.S., a significant difference in the competitiveness of coal based upon the producing region and the cost of production. We believe that the Powder River Basin becomes competitive when prices for natural gas get above $2.50. We think that the Illinois Basin becomes competitive when prices get above like $3.25. But Central App, it's going to take prices that are $4 and above. And therefore, we believe that Central App is going to become a coproducing region that's going to be viable for metallurgical grades of coal only and that the thermal coal will continue to decline. A lot of the thermal coal production has been taken out already, a lot of the production cutbacks have come out of Central Appalachia. There may be more to come but right now, we see that stabilizing. The thermal coal that's still produced in Central Appalachia has viability in the export market. It may not have viability in the U.S. market but it has viability in the export markets. We -- as part of our facility rationalization program that we're working on now as part of the restructuring costs that we guided cost in 2013 that will translate to savings in 2014, a lot of that is focused on repositioning ourselves for the U.S. market where we see growth in the future coming out of Illinois Basin, Northern Appalachia a little bit, Powder River Basin but not out of Central Appalachia. So we are in the process of repositioning our footprint in the U.S. to accommodate those kind of changes.

As we look at -- the worst of the switching has occurred last April when gas prices were below $2. The dispatch of coal-fired units was down to 33% of the utility production of electricity in April. By November, the coal percentage of the power generation fuel supply in the U.S. had moved back up to 42%. So there is an economic switching that goes back and forth. But as gas moves back to its replacement cost, as economics bring more regions in, Central Appalachia will be the last one to come into play. And even then, I still think the Central Appalachia's long-term viability is around met coal and not around thermal coal.

Andy Kaplowitz - Barclays Capital, Research Division

Any other questions from the audience? All right. Can you guys talk about your Operational Excellence program? I mean, you've been very clear about what restructuring could bring in terms of savings from the one that you did last year to this year and the one you're doing this year to next year. But how far along are you in the sort of Operational Excellence process? What is there still left to do? And then maybe you could also talk about sort of the One Joy Global initiative and the opportunity there over time?

Michael W. Sutherlin

On the Operational Excellence, it's been really an important program for our business and has leaned out our manufacturing operations, streamlined our processes, taken cycle times down. I guess, for us, the best example has been the electric rope shovels on surface that in 2008, were taking us about 15 to 16 months to build an electric rope shovel. Today, we build them in something close to 5 months. So the cycle time has come down. That's driven a lot of efficiencies in our manufacturing operations but it's also made us a much more responsive business. We can respond to changes in the market a lot faster.

Operational Excellence is -- we're deploying Operational Excellence in Longview for the LeTourneau loader factory we're doing. As Ted said, we're beginning to deploy Operational Excellence in China. So we still have work to do on Operational Excellence. We have some of the old legacy service centers that we need to work through to bring those up to standard.

But the restructuring programs that we're going through is all about -- not all, but a lot of it is focused on optimizing the loading of our factories and what we make in the factory. We've got our factories efficient. Now, it's a matter of doing the loading in the most effective way possible. Part of that is enabled -- and I'll come back and talk about that for a second, part of that is enabled by One Joy Global. And we are taking our 2 businesses, our surface to underground business, we're consolidating that into one business under the Joy Global brand. That allows us to eliminate duplications in a lot of regions around the world. We have -- where we've had 2 managing directors, 2 finance directors, 2 methods of getting parts and equipment moved from source factory to the regions. And all those things are going to be combined. So we get the scale and efficiency and a more consistent focus on our customers mine by mine and less differentiation between surface to underground. And in fact, we have a lot of mines that have both surface to underground operations going on simultaneously at the same mine site.

But pulling the business together as one business under Joy Global. It gives us the opportunity to look at our manufacturing loading. And what we find is that we are making -- we were making things in 2 different factories that have similar manufacturing characteristics. So we've taken a factory in Tianjin that makes planetary transmissions for shovels. We've moved into that factory some of the AFC gear boxes that we use that use a similar technology. It gives us additional volume, economy of scale and it allows us to streamline that production process. Now we're making products that go to surface and underground but the manufacturing efficiency is significantly improved. We're going through all our facilities now and beginning to look at where we make things and using similar manufacturing processes to gain another level of manufacturing efficiency above and beyond what we've been doing with our Operational Excellence program. So all this is trying to drive us to be the most efficient, lowest-cost producer in everything we do so that we can continue to be competitive at the pricing levels that we need to make our bottom line look good.

Andy Kaplowitz - Barclays Capital, Research Division

I think the One Joy program you talked about being potentially $50 million incremental, positive to SG&A over time? Is that fair?

Michael W. Sutherlin

That's the number we're using, but I think the real payback on One Joy Global is leverage to the upside. And we can talk about the dollars we're going to take out of eliminating duplicate costs and parallel processes. And those are real tangible dollar reductions. But the other benefit is on the upside as we begin to ramp up the business, the leverage we get from not having to do everything twice is just a significantly improved leverage to the upside.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. Can we talk about the competitive landscape for a second? I don't see you get the question as often around your main competitor and what they're doing. And have they been sort of slowly, methodically moving their service business to their dealers? Have you felt any impact yet? Has it been better for you without Bucyrus out there? I mean, '10 [ph] was pretty crazy.

Michael W. Sutherlin

CAT is a very credible competitor. They obviously have a great brand reputation. No one's going to get fired for buying CAT equipment. We know that. And this causes us to have to work harder to deliver performance to convince the customer that we're their best option.

To the dealer transition process, obviously, that goes on. The dealers do a good job with the legacy CAT-branded equipment. They'll do a good job with the Bucyrus equipment, as well. So we're working hard to make sure that as they finish the transition process, we still are able to deliver better service, better products, better support to our customers. And I think that CAT, like we are, are very rational about the market. And that rationality, it provides some stability, as well. And we appreciate competing with a rational, stable customer. And even though they're bigger, we still appreciate the fact that they're rational and stable.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. Let me ask you guys about cash flow and the balance sheet. I think for Joy, you kind of had a substandard 2012 in terms of cash generation. But talk to me about the improvement that you could have in 2013 and in 2014 and what that would mean for the business? I don't really get the question much these days around restarting the share repurchase program or where you have talked about acquisitions in the past, but your balance sheet could look a whole lot different 2 years from now.

Michael W. Sutherlin

Well, I'll ask Jim to talk about the cash flow generation for the business. Then I'll come back and talk about priorities for the capital allocation.

James M. Sullivan

Yes. So, Andy, in 2012, the company's cash generation was impacted by working capital investment. There was an inventory increase and then receivables ran up pretty good as sales even at the end of the year were pretty high. At the same time, the original equipment orders were coming down, so advance payments were coming down. It was a combination of all that. With a high CapEx profile versus the depreciation rate, I think we had about $240 million of CapEx in 2012, yielded a net free cash flow number that maybe was a little below expectation. As we look at 2013, notwithstanding that we talked about earnings being down year-over-year, we do see an opportunity to improve cash generation largely as a result of working capital. We'll continue to see some level of advanced payments come down with OE falling off a bit. But we believe we're going to make good progress on receivables and inventory. And that's a real focus of this company. Another thing coming in new to the company is the focus that this company does have on the balance sheet is really good. And again, we talked about improvements, we can always improve, and we are working very hard to try to improve that.

So working capital, I think, will be a generator of cash for the company in 2013 where it was a use of cash in 2012. And then if you look at CapEx, CapEx will come down modestly versus what we spend in 2012, kind of in that $200 million range versus the $240 million. Still above depreciation because of the continued investment in our service infrastructure, as well as rounding out our investment in the Tianjin facility in China. But overall, really solid, kind of a countercyclical cash flow profile for the company.

Michael W. Sutherlin

As we extend that into 2014, cash flow gets better. We take another step down in completing some of the capital projects and not starting up the same level of new projects. But we also will reach funding -- full funding levels for our pension, U.S. pension plans at the end of this year. So we'll make a significant reduction in the pension funding that we've been going through the last couple of years. Intent was to get these plans up to be fully funded so we can begin to look at options that provide more cost stability around those pension plans. So 2014 looks even better than 2013.

Our capital allocation, we obviously -- our first priority is investment in our business. And investment has been high because of the growth prospects that we saw a few years ago. Growth prospects are down, we're doing the same thing our customers are. We have enough excess capacity, we can pull back CapEx for a while and get a better look at demand before we have to make those next decisions.

And then it gets down to what do you do with the cash, is it to acquisitions or share buybacks? And I still believe that there's certain products that would be strong, strategic fits into our business, give us really high levels of incremental leverage. Because of that, we can put them into an aftermarket infrastructure that's already in place. But the do-ability of that involves a lot of variables. And the predictability is quite low as a result of that. You've got to have 2 players, and they've got to agree on the premise and the valuation, and who knows when those things are going to happen. So share buybacks become an important part of the way we look at the future. We're in the process right now of accumulating cash. I'd like to retain enough cash that we have the capability of acting on the right acquisition if it comes along. And I want to have enough cash that when we start a share buyback program, we can execute that in a meaningful manner. We're not looking for announcement value. We're looking for long-term value.

Over the long term, because we're a mining equipment company and we're not have any -- we don't have interest in becoming diversified industrial or getting into the construction space, we believe that we're going to be generating more cash than we're going to consume in the business over the long run. So over the long run, we have a return to shareholder profile for our business.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. Great. I want to do some of the automated response questions, it would be good in the last couple of minutes. So can we do question one? You guys can vote, too, if you'd like. Do you currently own this stock? 1, yes, overweight; 2, yes, equal weight, 3, yes, underweight; 4, no.

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

A lot of "no"s. That's very interesting. [indiscernible] Okay. We do question 2. What is your general buy for the stock right now? 1, positive; 2, negative; 3, neutral.

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

All right. So pretty balanced, mostly neutral. Let's just move on to question 3, if we could. In your opinion, future EPS growth for Joy Global will be 1, above peers; 2, in line with peers; or 3, below peers.

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

It's interesting that nobody owns the stock, yet they think that your growth will be above peers.

Michael W. Sutherlin

Timing is everything.

Andy Kaplowitz - Barclays Capital, Research Division

Timing is everything. Okay, can we move to question 4, please? In your opinion, what should Joy Global do with excess cash? 1, bolt-on M&A; 2, larger M&A; 3, share repurchases; 4, dividends; 5, debt paydown; or 6, internal investments?

Michael W. Sutherlin

That's hardly fair for me to have -- to say beforehand, then ask their opinion afterwards.

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

So I mean, they think you should have a different -- you should be more focused on share repurchases. I mean, how do you sort of respond to that?

Michael W. Sutherlin

Well, share repurchase, like I said, are -- they have been historically, they will be over the future core to our business. Acquisition prospects that we see are not predictable. And so, share repurchases will definitely be a priority for us. Still want to accumulate enough cash so when we start those programs, we can execute them in a meaningful way.

Andy Kaplowitz - Barclays Capital, Research Division

Got you. Can we move on? In your opinion, on what multiple of 2013 earnings should Joy Global trade, 1, less than 10x; 2, 10 to 12; 3, 13 to 15; 4, 16 to 18; 5, 19 to 21; 6, higher than 21x?

[Voting]

Michael W. Sutherlin

Can I answer that one? Put my input in?

Andy Kaplowitz - Barclays Capital, Research Division

So it's interesting. I mean, I think people are pretty torn right now. Historically, you've been or at least since I've been covering you, you've been a higher multiple business. But before that, you weren't.

Michael W. Sutherlin

Right.

Andy Kaplowitz - Barclays Capital, Research Division

Now you're not again. And so, it's, I guess, all about timing again, but it's interesting in that sense. And we have one more question in here. What do you see as the most significant investment issue for Joy Global? 1, core growth; 2, margin performance; 3, capital deployment; or 4, execution through our strategy?

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

So I don't think anybody really debates your margin performance. It's been very good. It's all about core growth. And maybe I'll ask you one more quick question while we're at it. You focused on sort of -- you talked at MINExpo about new products and new product development. How is that going in general? You still going to spend what you wanted to spend even with the markets sort of being a little weaker than we thought they were?

Michael W. Sutherlin

When we -- as we exercised our cost-reduction and restructuring and ways to improve efficiency of the business, we have not taken down the costs on those R&D programs as our new programs will remain intact. For us, we have great products that have strong market positions. Our growth is going to come out of moving into adjacent spaces. So things like the hybrid shovel gives us the ability to do that, things like the -- that we're working on with the technology to cut the underground hardrock formations will give us the ability to move into that space. Those R&D programs have significant revenue and bottom line impact potential on the business for the next 5 years. And those are a high priority for us and we're going to stay with them.

Andy Kaplowitz - Barclays Capital, Research Division

Great. Thank you very much.

Michael W. Sutherlin

Thank you.

Andy Kaplowitz - Barclays Capital, Research Division

Thank you.

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Source: Joy Global, Inc. Presents at Barclays Industrial Select Conference, Feb-20-2013 10:35 AM
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