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Joy Global (NYSE:JOY)

Q1 2013 Earnings Call

February 27, 2013 11:00 am ET

Executives

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

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

Analysts

Andy Kaplowitz - Barclays Capital, Research Division

Joseph O'Dea - Vertical Research Partners, LLC

Michael W. Gallo - CL King & Associates, Inc., Research Division

Seth Weber - RBC Capital Markets, LLC, Research Division

Damien Fortune - JP Morgan Chase & Co, Research Division

Jerry Revich - Goldman Sachs Group Inc., Research Division

Eli S. Lustgarten - Longbow Research LLC

Operator

Good day, and welcome to the Joy Global Inc. Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jim Sullivan, Chief Financial Officer. Please go ahead, sir.

James M. Sullivan

Thank you, and good morning. Welcome to everyone. Thank you for participating in today's conference call and for your continued interest in our company.

Joining me on the call this morning is Mike Sutherlin, President and Chief Executive Officer; Ted Doheny, President and Chief Operating Officer of the Underground Business; Randy Baker, President and Chief Operating Officer of our Surface Business; and, finally, Sean Major, General Counsel, Executive Vice President and General Counsel.

This morning, I will begin with some brief comments on our results for the first quarter of fiscal year 2013. Mike Sutherlin will then provide an overview of our operations and our market outlook. After Mike's comments, we will conduct a question-and-answer session. During this session, we ask that you limit yourself to one question and one follow-up before going back into the queue. This will allow us to accommodate as many questioners as possible.

During the call today, we will be making forward-looking statements. These statements should be considered, along with the various risk factors detailed in our press release and other SEC filings. We encourage you to read and become familiar with these risk factors.

We may also refer to a number of non-GAAP measures, which we believe are important to understanding our business. For a reconciliation of non-GAAP metrics to GAAP, as well as for other investor information, we refer you to our website at joyglobal.com.

Now let's spend a few minutes reviewing first quarter results. Bookings of $1 billion in the current quarter were down 29% versus the year-ago period. Orders for original equipment were down 36%, and aftermarket orders were down 22%.

The decline in new order bookings was comprised of a 25% decrease for our surface mining equipment and a 27% decrease for underground mining machinery, inclusive of the full quarter results of IMM.

The prior-year quarter contained only 1 month of IMM results. Excluding IMM, underground mining machinery orders were down 33%. The 25% decrease in surface mining equipment bookings reflects a drop from the record first quarter of 2012 and includes a 34% decrease in original equipment orders and an 18% decrease in aftermarket bookings.

Prior-year bookings reflected increases across all geographies on a more optimistic outlook for commodities and the economy. Surface mining, original equipment and aftermarket bookings in the first quarter of 2013 decreased year-over-year in all markets.

Current quarter aftermarket bookings reflect a lower order rate, typical of the seasonally slower first quarter, as well as the decrease in customer lead times on orders, as they continue to carefully manage operating costs and capital spending.

The 27% decrease in underground mining machinery bookings was comprised of a 30% decrease in original equipment orders and a 24% decline in aftermarket bookings. The original bookings decline, compared to the first quarter of 2012, was due to a structurally smaller U.S. coal market and orders for longwall systems in Australia and the U.S., which did not repeat in 2013. Excluding these longwall system orders in 2012, underground original equipment would have been flat.

Although the reduction in aftermarket bookings occurred across all regions, the majority of the decrease was in China, due to the early Lunar New Year holiday and lower production and rebuild activity in the Central Appalachian region of the U.S.

Backlog fell to $2.4 billion from $2.6 billion at the beginning of the fiscal year. Net sales increased by 1% in the first quarter, with surface mining equipment shipments up 14%, substantially offset by underground mining machinery revenue decreases of 8%.

As previously mentioned, our current results include a full quarter of IMM activity, while the prior-year quarter contained only 1 month. Original equipment shipments for surface mining increased 25%, while underground mining original equipment sales decreased 26%, excluding incremental sales from IMM of $47 million.

Aftermarket shipments of surface mining equipment increased 6%, while shipments of aftermarket underground mining equipment decreased 6% compared to last year.

Surface aftermarket sales increased in all regions, except the U.S. and China, while the underground aftermarket sales decrease was largely in the U.S. and was partially offset by increases realized in China, Australia and South Africa.

Operating profit, excluding unusual items, totaled $219 million in the current quarter, which exceeded last year by $5 million. Return on sales in both periods was approximately 19%, with year-over-year incremental profitability at 34%. The increase in operating profit was due to the inclusion of a full quarter of IMM results, as lower SG&A expenses were more than offset by higher period cost, primarily from lower overhead absorption in our U.S. manufacturing facilities.

Unusual items in the quarter included $1 million of restructuring costs, as we continue to rationalize our operations in light of current market conditions. In total, we expect restructuring costs for the year to approximate $25 million, which is consistent with the guidance coming out of our fourth quarter of 2012.

In addition, during the first quarter, we finalized our purchase accounting for IMM. This resulted in a one-time gain of $4 million for excess purchase accounting amortization, as our preliminary estimates in 2012 were more conservative than the amounts finalized this quarter.

With regard to IMM, as discussed in the fourth quarter, we have accelerated our technology, manufacturing and supply chain integration activities to address competitive pressures in China. The IMM team has made good progress this quarter on a number of fronts, and we have begun to see some underlying improvement in the business.

Similar to our LeTourneau business last year, the integrated Joy underground mining and IMM operations will be difficult to separate in future periods. And therefore, this will be the last quarter we will report the operating results of IMM.

It's time to put to rest the questions regarding the integrity of the financials reported by IMM. We believe the internal and external financial and operational audits and business reviews performed at IMM before, during and subsequent to our acquisition, provide a high level of comfort that the reported results for this business are accurate.

Returning back to the financials. The effective income tax rate was 31% in the current quarter compared to 27.9% in the first quarter of 2012. The prior-year quarter included $4 million of net favorable discrete tax benefits and $2 million of permanent tax differences, arising from the share gain and acquisition costs associated with the IMM transaction.

The effective income tax rate, excluding discrete items and the permanent tax differences, would have been 31% in the first quarter of 2012. Excluding the discrete items, the company currently expects its effective tax rate for 2013 to be in the range of 30.5% to 31.5%.

Income from continuing operations totaled $142 million or $1.33 per fully diluted share in both the current and prior-year quarter. Excluding unusual items, which resulted in net gains in both periods, fully diluted earnings per share increased $0.05 to $1.31 in the first quarter of 2013.

Cash from continuing operations in the quarter totaled $92 million, up $106 million compared to the first quarter of 2012. Trade-related working capital in the current quarter resulted in $58 million of cash generation, while working capital in the prior-year period was a usage of cash of a similar amount.

Capital expenditures in the current quarter totaled $55 million, up $6 million versus the prior-year quarter. Expenditures in the first quarter of 2013 were focused on completing the company's capacity expansion in China and the continued build-out of the company's aftermarket surface infrastructure. The company continues to expect full year capital expenditures of approximately $200 million.

Let me stop now and turn the discussion over to Mike Sutherlin. Mike?

Michael W. Sutherlin

Yes. Thank you, Jim, and let me just add my welcome to all of those on this call. It was another quarter defined by strong execution and continued market challenges. Our execution is important because it provides a solid foundation for implementing programs to streamline our business and reduce our cost base in addressing the more challenging market that we see.

So let me start with the market, since that's what drives our strategy and determines our operating decisions. We are seeing improvement in a number of tangible statistics that are key industry barometers. After declining for much of 2012, the year-over-year growth in China electricity production reached a turning point in September, and this has improved consistently for the last 4 months.

Similarly, year-over-year growth in China's steel production increased steadily during the last 5 months of the year after bottoming in August. And in addition, residential construction in the U.S. has been improving for the past several months, non-residential construction is pushing up equipment rental rates and industrial production finished the year at a 9-month high. These are admittedly early signs, but the increasing number of them adds to the confidence that the market is headed toward a turning point.

At the same time, there's been a significant destocking of commodities in key markets. The research in the steel production in China dropped iron ore inventories from over a 90 million tonne run rate to just 74 million tonnes by year end, while imports reached record levels.

In metallurgical, coal inventories at the mills dropped from 31 days to just 19 days over the same period. Finished steel inventories held by traders in China dropped to a 3-year low in December. And steel inventories in key consuming regions ended last year below their 2010 levels. And finally, the strong increase in electricity production in China dropped inventories at the generating plants from 31 to 18 days by December against record levels of imports. The restocking will add to demand pressures.

The U.S. coal market is another positive, at least on a relative basis. The 14% year-over-year decline in coal production in the first half of 2012 narrowed to 3% in the fourth quarter. U.S. coal generation actually increased year-over-year in the fourth quarter. Almost 70 million tonnes of annualized production cuts by the largest mining companies helped the market make significant progress towards stabilization. It's also a part of the structural change underway in the U.S. coal market. Some of the closed production is being displaced by increased production in the Illinois Basin with more to come. Part of the restructuring plans we previously announced will adjust our U.S. footprint to new market opportunities. The production cuts were primarily underground and, therefore, have reduced underground volumes by 16%.

The decline in the aftermarket from our U.S. Underground business has been even greater due to customer destocking of parts they hold at mine site and increasing the time between rebuilds. The good news is that the U.S. orders have bottomed and were up slightly this quarter.

Although we expect in our planning for the U.S. coal market to remain structurally smaller, we believe there are still some opportunities. U.S. power generators are expected to burn up to 50 million more tons of coal this year as natural gas prices continue to move toward supply replacement levels, which we believe reaches above the $4.50 to $5 range.

Touring rigs [ph] targeting natural gas were cut by almost half, as gas prices dropped to record lows last April. But more importantly, they did not budge, even as natural gas prices moved above $3.50 per million BTUs. Coal-fired generation operated at 55% capacity utilization in 2012, and coal burn could increase by 40 million to 60 million tons, if capacity utilization increased to 73%, which was the average for 2007.

There are new management teams with new mandates at many of our customers, but all customers are adjusting to new expectations. They are not only changing their decision criteria from volumes to returns, but they also prefer lower-risk projects. To make returns, projects that no longer assume rising commodity prices and new mines need to come online in the lower half of the global cost curve.

High-risk, high-return projects are out in favor of predictable returns. Customers now prefer brownfield expansions and new mines in proximity to current operations because these provide known geology and leverage from existing infrastructure. This process has slowed decisions across-the-board, and we have seen slippage of even top-priority projects. This has substantially slowed the deployment of capital on projects. A number of research reports are projecting minor CapEx down 10% to 20% over 2013 and 2014. And that may be the case on the basis of the announcement budgeted CapEx, but the rate of deployment is running substantially behind those numbers.

Based on capital allocated to the projects we track, deployment is down 40%, maybe more. And as a result, we're expecting the deployment of CapEx to improve just to get to the reduced budgeted levels. The reracking [ph] of the projects has resulted in significant change to our prospect list. This is a list of major projects that we expect to reach equipment selection in the next 12 months. And based upon the new criteria, many projects have been moved out beyond the tracking horizon. However, they're being replaced by new projects. To give some insight on how the list is changing, we have seen the peril of a copper project even though copper has the strongest fundamentals on our major commodities. And this is not a project subject to permitting delays.

Conversely, we have a number of new brownfield expansions that are looking for near-term deliveries, and the work we've done on reducing cycle time gives us an advantage on these opportunities. There are enough new projects being added to the list to offset the deferrals, and our list has stabilized this quarter after 4 quarters of sequential decline. As a result, the quality of the projects on our list has become significantly better. Although there is an increasing number of positive signs in the market, it's not all one-sided, and there are also troubled waters to navigate.

Commodity prices and supply surplus are issues, as our customers look for better returns. Copper has the best incentive level pricing of all the major commodities, and the deferral I just cited is an example that customers are being increasingly selective and patient. Increased steel production is raising prices for iron ore and metallurgical coal, but those prices do not keep all production in the money. Thermal coal has the greatest supply surplus, with pricing generally above cash cost, but not total cost. And in all cases, our customers need demand increases to work down supply surpluses and raise prices and, therefore, will wait before committing.

The relatively quick downturn in aftermarket orders that we saw this quarter was primarily due to timing, but it is still a strong reminder that it could be rough for a while longer before it starts to get better.

We have addressed the main issues affecting the aftermarket in the press release, and I will not recover that ground. However, it confirms how challenging it is to maintain traction in current market conditions. The aftermarket will improve from here, but possibly not fast enough to finish the year with year-over-year growth.

In the meantime, we're focused on restructuring to take cost out. I want to point out that these programs are not just focused on adjusting to current market conditions, but more importantly, on lowering our ongoing cost base and increasing our leverage to the upside. Some of the restructuring will downsize and reposition our U.S. Underground business.

We're also consolidating our manufacturing footprint to improve process flow and efficiencies. And our One Joy Global initiative will enable us to combine similar products and technologies into centers of excellence for components such as gearing and transmissions, for controls and automation and for structural fabrications. This focus on process improvement and cost reduction will not restrict our ability to respond to upside opportunities and, in fact, it will improve our response and our leverage.

So what does that mean for outlook? We do not expect market factors to materially impact our revenues for 2013 to the upside or the downside, and our restructuring programs remain on track. As a result, we are reconfirming our prior guidance for 2013 of earnings between $5.75 and $6.35 per share on revenues of $4.9 billion to $5.2 billion. This includes $25 million of planned restructuring costs this year with resulting savings not realized until 2014.

So with that overview, I'll turn the call back to Marquita [ph] for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Andy Kaplowitz with Barclays.

Andy Kaplowitz - Barclays Capital, Research Division

Mike, I just want to understand your base order comment in the release. You talked about it being flat from 1Q levels. Do you mean you think you could do about $1 billion in orders, and then you would add some improvement from the aftermarket or maybe $100 million-or-so each quarter, and then you could win a couple of larger awards on top of that? I just want to understand what you're thinking there.

Michael W. Sutherlin

Yes. I -- our base order rate, which we define as excluding major projects, have, since the second quarter of last year, sort of bumped around the $1.1 billion level. Sometimes it's a little bit below, sometimes it's a little bit above. We had a couple of projects in the first quarter of last year that moved that number up. We had a couple of projects we booked in the fourth quarter of last year that moved that number up. And so, if you look at the second quarter of last year, the third quarter of last year and then you look at the first quarter of this year, with a little bit of seasonal adjustment, you'll see those numbers to be relatively flat. So we look at that as indicative of what the base of the business is under current market conditions. And then, we look at the major projects, not every machine we sell, but we look at every major projects and the timing of those. And we see the base order rate under current market conditions continuing to be pretty flat, as we look out to 2013. But we do have a couple of projects that we feel very comfortable with. There could be a couple of more in the back half of the year based on timing. Some things are moving into the prospect list that are giving us some positive indicators. So we haven't vetted those enough to know how solid those are. Those are still back half of the year. It doesn't take a lot of time in the back half of the year to slip into next year. So if you put all that together, we feel pretty comfortable that we can -- that our order rates are going to be consistent with what we expected going into the year. We still believe that. We think the order rates are probably going to be pretty close to the revenue rates for the year, with those projects added in.

Andy Kaplowitz - Barclays Capital, Research Division

Okay, that's helpful, Mike. And then, last quarter, we asked you about '14 -- and I know it's early. It was even earlier last quarter. But you know we're going to ask you again. And so, given the sort of what you've seen this quarter and the aftermarket, especially, being a bit weak, do you still have confidence in a level revenue forecast for '14 versus '13? Is that still the best guess right now or -- because if your order rate would have to pick up pretty materially, you'd have to win a couple of the larger projects, it seems to me, to get there for '14.

Michael W. Sutherlin

Yes. A couple of, I think, comments. One, we don't -- or I don't, anyhow, put too much into the current dip we've seen in the aftermarket. It is a factor for the first quarter, but some of that stuff is just not sustainable. We have mission-critical equipment, and people can begin to squeeze down an operating budget by reducing their parts replenishment. But there's a very limited life in doing that -- rebuilds. We know that rebuilds can be stretched a bit, but we also know that there's a limit to how much they can be stretched, and we also know that the value of the cost to rebuild goes up at the same time. So there's no money to be saved. There's just money to be deferred. So we're not looking at 2013 and 2014 as being down because of a change in our outlook for the aftermarket. As we look at the projects, as I said, we feel more confident that the new projects on the list that are under new decision criteria are more likely to go forward. We have to get an increase in projects just to get to the bottom end of the CapEx range that our customers are working with. So with that, we do expect the markets to slowly start to improve as we go through 2013, which will help our booking rates, which we need to be able to maintain level revenues in 2014. If you look at what we've done in the last few quarters, our book-to-bill is up in 1, much less over 1. So we do need to have some of those projects come in, and we do need to see some improvement in the booking trades in the remainder of 2013 to be able to have level revenues in 2014.

Operator

We'll take our next question from Rob Wertheimer.

Joseph O'Dea - Vertical Research Partners, LLC

It's Joe O'Dea on for Rob. First question is just adding into the aftermarket weakness a little bit more. Can you describe to what extent it's a combination of machines not running or cannibalization? Or is it really just sort of destocked mines and major overhauls that are put off? And then, along with that, do you find that the installed base of the equipment out there now is just more updated and so versus normal?

Michael W. Sutherlin

Yes. And it's going to be in the answer to that will cover a couple of different areas to give you a comprehensive answer. One of those is in the U.S. We have seen our aftermarket order rates in the U.S. decline more than the volume decline, as our customers sort of take slack out of the system. They have mines that they've closed and redeployed some of those. They have parts in other mines. They've taken destocking levels down in the mines that they continue to operate. Again, as I said, there's a limited life for that. We've seen in the U.S. this quarter -- on a sequential basis, we've seen the order rates in the U.S. bottomed out. Actually, on a sequential basis, they're up slightly. So we are seeing that bottoming effect that all that stuff of cannibalization and all the things that you mentioned are in the decline phase of the U.S. market. And I think those are out of the system now and behind us. There's -- again, there's only so much of that, that you can do.

On the other end of the spectrum is the decline we've seen in the aftermarket from South America. And South America contains our strongest commodities, a lot of copper, iron ore in Brazil. And those are commodities that are strong, active. Production of copper is up, and we definitely are dealing with timing issues in that market. Some of that is the startup of LCM, life cycle management, contracts tagged onto shovels that have recently been delivered into the market are starting to go to work. And those contracts are -- we're working on those, and we'll finalize those contracts. But in the timing of the first quarter, they didn't get done, and we have a policy of not trying to rush contracting to get them into a quarter because we'll end up with the terms that we don't really like. So, yes, probably 2 extremes. One is the U.S. market has worked through those adjustments and is an example of what happens. The U.S. market is reduced out to the -- to a level below the rate of consumption. So there is some upside in the U.S. market just to get to normal consumption rates, not even counting any kind of increased production because increased coal burn or increased exports. So they're there. We have overcorrected. We've got a little bit of an adjustment back to the upside to come in the U.S. market. The markets in South America is strictly a timing issue. It's just sort of one of those things where everything happens at once. And under current conditions, our customers are just more cautious. And last year and the years before, the mine managers would continue on as normal, assuming that budgets would be set appropriately. In today's world, everybody is in wait, check and double check before you move forward just to be sure that you don't get yourself cross-wise [ph] with a -- with new management -- so -- new management or new directors. So there's just a lot more wait and check before you move forward. And I think, as we start the year, some of the dip we've seen in the first quarter is that to make sure the budgets are in place first before you start spending the money. There's a lot of variables going on. But I think, by and large, that those variables are timing issues in our Surface Equipment business and the U.S. market correction is mostly behind us in the Underground business, and we may have a little bit more of the correction to go through in Australia. But the volume declines there are nowhere close to what we've seen in the U.S. So maybe a modest impact, but nothing like we've seen in the U.S. market. It was a long answer to a quick question.

Operator

We'll take our next question from Michael Gallo with CL King.

Michael W. Gallo - CL King & Associates, Inc., Research Division

I just want to dig in the aftermarket a little bit further. I was wondering if you could update us on what you're seeing as you're trying to develop the aftermarket at IMM. And then, also, if you could just give us just a little better feel that some of the lack of parts and services you've seen in Australia and other markets wasn't a function of lost share or just the more competitive environment in the marketplace?

Michael W. Sutherlin

Yes. I'll speak to the issue of share loss, and then I'll turn it over to Ted, who's much, much closer to IMM and what we're doing at IMM. And there are plans on building that aftermarket around that business. So, share loss, we've -- that was -- our first concern was, are we losing market share? We've done just a lot of drill-down analysis on market share issues. And we are confident that we're not seeing any market share loss. There may be the normal things that go on, but nothing material on market share. We are just seeing a slowing down of decisions by customers in response to mandates to reduce operating costs. Some of those operating cost reductions are coming out of consulting agreements, in general contracting relationships. Some of our customers contract out their mining operations, some contract out longwall moves. A lot of those things are being looked at. Our aftermarket has limited ability to adjust because we deal with mission-critical equipment. All the checks we've seen -- and we continue to see more of an impact of the market on our -- the competitors who are selling knockoff parts for our equipment, we're seeing more of a dramatic impact on those suppliers than we are in our own business. So we're pretty confident we're not seeing market share erosion. We're pretty confident that there's a limited time that our customers can understand on parts and services without impacting the reliability of the equipment. So again, we believe that the aftermarket is going to come back. It's going to get back on track here pretty quickly, and we will finish the year close to year-over-year comparisons. I will say that, right now in Australia, we have 80 million tonnes of annual capacity in Australia that's offline because of flooding. It's at 80 million tonnes of capacity that's not using parts or services. And the past examples have indicated that it may take the rest of the year to bring some of that capacity back into production, as they have to dewater the mines. So we do have those unusual things going on. But by and large, we're not especially worried about a long-term decline in the aftermarket. And then, Ted, maybe you have -- you talked about the aftermarket opportunities at IMM and what we're doing to begin to capture those.

Edward L. Doheny

Sure. In recommitting to on the not share, actually, using this downturn is a chance to actually get even more aggressive with their service differentiating ourselves and from the previous ramp-up, really applying all our resources on the services. And so, we don't believe it's a share issue. Directly into the IMM, just reconfirming what we're doing, we bought the company -- is we're looking to really stand it up pretty strong. China is going through some tough headwinds, making sure we're focusing on the sales teams, getting -- making sure we're aligned to the markets and with our products. But the first step was injecting the Joy technology. We probably won't see that impact until the second half of 2013. The second piece is we've got our OpEx teams in there really leaning out what they have. And the third one is really growing that service business. And in China, with the business we bought, really nice margins on the OE. The roadheaders, the shares, we like that. But the aftermarket we saw is a real opportunity. They weren't aggressive about the parts business, even just simple things of how they label and attract some of the sub-suppliers who were going around and actually selling direct to the customers. So we're really bringing our team and really helping with the process, the products and even the people. They have their service engineers working on that. Actually, that's an area that we'll look to expand. So we -- the first step is get the parts business. The second step is really upgrading that service capability. We're even bringing in service programs to talk to them our life-cycle management, which is a different stage in the evolutionary model in China. But we really believe that that's a growth opportunity for us with the IMM business. But reconfirming the margins that they're selling at the OE is attractive, and we think the aftermarket is an upside for us.

Michael W. Gallo - CL King & Associates, Inc., Research Division

Okay. Great. And then, just a follow-up question on the capital allocation. You've been, obviously, deleveraging over the last year since the IMM acquisition. I was wondering at what point you feel comfortable that the debt levels are down where you want them to be, and we might look to see some of that free cash flow coming back to shareholders more aggressively again at some point?

Michael W. Sutherlin

Yes. We -- based upon our outlook for the markets that we serve, we do have -- in our manufacturing network, we do have ample capacity looking out. So we're not in a position where we need to be adding capacity in the near term. We've done a lot to build out our service center fleet, and we feel pretty good that we're, sort of, in the finishing stages of doing that. And so, our capital requirements are going to come down. Our pension funding requirements will come down at the end of this year. And so, we will -- and this will be a year where we'll monetize some of the working capital buildup we saw last year. So, yes, we will get more cash flow into this year as a result of that. We -- I want to do 2 things: I want to have some cash built up, so that if we see a strong strategic acquisition opportunity, we can act on that. I also want some cash built up so that when we get into share buybacks, we will be able to execute in a meaningful fashion. We don't want to get into announcing a value and then a quiet period after that to build up cash. So in all likelihood, we'll be at that kind of position in the second half of this year. So going into the second half of the year, we'll probably be in a position where we'll start to look at capital allocation which would -- as a default value, would be share buybacks. And more than likely, we'll start to see some of that -- our announcements around that in the second half of the year.

Operator

We'll take our next question from Seth Weber with RBC Capital Markets.

Seth Weber - RBC Capital Markets, LLC, Research Division

Mike, just given the kind of the moving parts around the customer orders and customer intentions, I'm wondering if you had a chance to sort of scrub your backlog recently. I know that's something you've done in the past and kind of gone through what the project-by-project basis for big contracts. Is there anything to that? Is that something you revisited recently?

Michael W. Sutherlin

Yes. We carefully look at the quality of our backlog. And if we went to 2008 -- the end of 2008, we ended the year with some backlog that was tied to letters of intent and not contract and not significant down payments. We have a much stronger policy around contracts and the down payments before we book the major contracts. So we feel really good about the quality of our backlog, discussions we've had with customers. In some cases, where we move machines from one mine to another for a customer, things like that. So that as they begin to relook at where they want to see production increases within their fleets. But we don't see any risk -- any meaningful risk in our backlog. We feel pretty confident in our backlog and the quality of our backlog. And the down payment or progress payments that we get on the backlog puts us in a strong position, if those kind of discussions would come up. But we haven't seen anything that gives us any worry about the backlog. We have taken out a reserve on the backlog based upon Central Appalachian coal producers. And we have not seen as much exposure to backlog cancellations from that category of customers as the reserve we've taken. So I don't remember the exact numbers. But I think we have about $120 million of reserve. About 1/3 of that was actually delivered to the customer, another 1/3 was canceled and the final 1/3 remains in backlog, I believe, right now. It's still yet to ship. So we're not -- we don't see any -- other than noise-level stuff that -- where people sort of switch out some equipment for configuration changes or model changes. We don't really see any significant issues around our backlog at this point.

Seth Weber - RBC Capital Markets, LLC, Research Division

Okay. That's helpful. And maybe just a follow-up for Jim. The $80 million cost save, can you just give us an idea how that's tracking and how we should think about the cadence of that fund [ph] through the model over the next -- I guess, next 4 quarters or so?

James M. Sullivan

Sure, Seth. So we took the actions in the fourth quarter of '12 on the first tranche, and that we expect to deliver $40 million savings for the full year, and that, kind of, will happen equally across quarters. So the benefits from those actions last year are in our first quarter and really helping us keep the margin profile that we showed in the quarter. As we walk forward, we did, as you know, take a little bit of restructuring in the first quarter. It's going to accelerate in the second and the third quarter. So we'll see some incremental benefits because we are moving forward a little faster on some of the headcount-related actions. But the facility moves that we're talking about will largely be announced in the third quarter and really won't provide a lot of benefits in terms of earnings stuff until 2014. So think about year-over-year savings in '13 versus '12 in that $40 million to $50 million range, and then have another $40 million coming in starting in the first quarter of '14. It won't all be there in the first quarter of '14, but it'll ramp up across the year.

Michael W. Sutherlin

Yes. And, Seth, just to add a few, first quarter, if you take out the SG&A cost that were added because of IMM, we've had a decrease in SG&A cost, which is one measure of the start of the cost savings rolling off of those restructuring programs.

Operator

We'll take our next question from Ann Duignan with JPMorgan.

Damien Fortune - JP Morgan Chase & Co, Research Division

It's Damien Fortune on for Ann. Could you guys just talk about the cadence of ordering and how it progressed through the quarter and whether or not activities picked up at all since the beginning of the year?

Michael W. Sutherlin

Well, the original equipment orders are always, always lumpy. So cadence isn't really a measurable item on original equipment orders. The aftermarket orders were soft as we guided into the end of the year. December, January, were particularly very weak on the aftermarkets. So it's sort of around year end and the start of 2013, where we've seen the weakness, which is sort of consistent with the view that some of this is driven by customers just managing their budgets going into year end and being careful before they start spending in 2013 to make sure that they've got a budget to cover those expenses. And that -- again, we look at South America, where we're seeing some weakness in the aftermarket. It's a -- there's a lot of that in there. Timing in South Africa, we have some good projects on the drawing board in South Africa, but there's quite a bit of labor on rest. The mines are finally going back to work. But it was late in the year before those mines went back to work. And South Africa takes up about 3 weeks over the year-end holiday. So we do get a significant disruption effect. So the cadence sort of indicates a weak finish to last year and a weak start to this year. But again, we -- those are inconsistent with production rates, and we believe that those really are not sustainable at those kind of order rates.

Damien Fortune - JP Morgan Chase & Co, Research Division

Got it. And then, just turning back to the OE business. Are there any of your product lines that are seeing higher demand than others?

Michael W. Sutherlin

Well, yes, I mean -- probably, if I could answer the question in the other way, and it will probably be helpful. We've -- we have 2 things that I think that are working. One is the -- on our underground equipment, as we see production declines coming out of Central Appalachia and we see more opportunities in places like the Illinois Basin in the U.S., but also more opportunities in Australia, those will be longwall production. And so, we're shifting our product base from room and pillar continuous miners and shuttle cars to longwall. There's still an entry development equipment we sell with those longwalls. But on a percentage of sales basis, the room and pillar equipment will -- a decline in the longwall equipment is increasing as a result of that. So our outlook sees -- reflects that shift and our plans reflect that shift. We also went through a period and particularly affecting our surface equipment in 2011 and probably up to the first half of 2012, where we had really extremely strong order booking rates for shovels, as projects that were put on hold in 2009 got restarted and they were in catch-up mode. And so, we've got a lot of that falls [ph] through the system, and we're getting down after order rates that, that are more reflective of sustainable growth rather than catch-up growth. And there's a little bit of a slowing in the order rates for shovels on a year-over-year comparison, as it gets down to normal run rates with normal growth expectations in the industry. So there are a couple of moving pieces around the products for sure.

Operator

We'll take our next question from Jerry Revich with Goldman Sachs.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Mike, can you please talk about how you see the seaborne coal CapEx cycle playing out? We've seen pretty sharp cuts to production in Asia this year. Is that enough in your mind to shake extra supply by the end of '13 and potentially drive some level of CapEx recovery next year? How do you see that playing out?

Michael W. Sutherlin

Yes. I'll give you a rundown by all the commodities, maybe, Jerry, rather than just the seaborne coal markets. But we -- we're going to see CapEx for copper slow down a little bit, not because copper has negatives, but because there's been lot of CapEx deployment in and around copper capacity production. And some of that production is coming to the market right now. There's expectations that we might be even be in supply surplus. But we've had those expectations for the last 7 years in a row, and we had never -- material production rates and never materialized. So we'll see some continued strong CapEx around copper, but again more measured, more selective. Seaborne markets and met coal, we think has got upside, particularly, as the steel mills go back to work, and we're seeing that in the China and in the U.S. There's some upside in the U.S. Auto production numbers are looking positive and steel demand as a result of that. We also don't believe we're going to see very much increase in met coal supply coming out of Mongolia or Mozambique and a limited amount out of Russia. So the market does begin to shift more toward Australia and the U.S. as a result of that. So there's some embedded pluses in that. The seaborne thermal coal markets still are in significant supply surplus. That number may be around 20 million or 30 million annual tonnes of supply surplus. So we still has some things to work down on that. And that's a bit of demand improvement. There's also some high grading [ph] where we've got to still do some higher [indiscernible as mines come off production. We don't believe that our customers in the U.S. and we don't believe our customers in Australia are getting the kind of margins that would justify mine expansion to seaborne and thermal coal. And so, we're going to have limited CapEx deployment in that area until we get demand improvements, supply shortage and more upside pressure on pricing. That probably -- we think, with the outlook -- particularly, if we start to see some economic recovery, we think that could start to happen in the second half of the year, but certainly, not before that and maybe not until the early part of 2014.

Jerry Revich - Goldman Sachs Group Inc., Research Division

That's helpful context. And Mike, can you just flesh out a comment you made in your prepared remarks. You mentioned that demand for your products can actually be up in 2014, even if global CapEx budgets are down 10%. Is that driven by your mix of commodities? Or can you just say more about the drivers behind your view?

Michael W. Sutherlin

Yes. The drivers behind our view are the difference between CapEx as budget and CapEx as spend. I mean, we -- this whole decision process has really ground down to a halt. I can tell you we have 1 project that is the top of our customers' list. It gets talked about on their earnings call. It gets talked about at their annual shareholders meetings. And yet, that project has slipped over several quarters, as they just are much more methodical before they release the CapEx on that project. And so, it probably exemplifies that things are -- there is no rush. Right now, I think what -- one of the issues that our customers have is that there is no penalty for being late. In the past, they believe there is a penalty for being late with new capacity coming online. Today, there's no penalty for being late. All you got to do is shorten supply, raise prices and you got to bring your capacity on under better pricing conditions. They don't have the sense of urgency they had before. And I think that the difference we see on the spend level is we're so far behind on CapEx spend compared to what's budgeted, we have to see improvement in spending levels even to meet the reduced budget expectations that we have right now, and the reduced budgets that we've seen set for 2013 and even if 2014 is down. The current spend levels are far below that. So we see things starting to change. I mean, we are seeing a lot of projects come back onto the horizon, have been scrubbed and evaluated under new criteria. We're starting to see those projects come back. The likelihood that they'll turn into CapEx deployment quickly is really high because they've gone through the scrubbing. They wouldn't put them on the list unless they saw those as close to ready to start moving. So there are number of things here. We're not just trying to run the numbers as stated. We've got to start spending sooner or later. We're also looking at the projects coming in the pipeline, the quality of those projects, the equipment that's tied to that. And we just see that those refreshed lists are going to be managed to get started here quicker. A year ago, we had a lot of rescrubbing and reracking [ph] to do on the -- in our prospect list. Today, we think a lot of that has been done -- maybe a little bit more to do, but a lot of that has been done, which then sort of shift, I mean, to start to move forward on those projects load.

Operator

We'll take our next question from Eli Lustgarten with Longbow Securities.

Eli S. Lustgarten - Longbow Research LLC

Most questions have been answered, but I do have a couple of lingering ones. Can you talk about what's going on in the political regulation arena, as we look out for the next 6 to 9 months? I'm not sure if there's anything coming down, but the U.S. and EPA are always a pain and can radically affect the way the year unfolds. I'm not sure what we should or should not expect. Or are you expecting anything to happen this year? And it's true is there any other parts of the global market that's also facing some of it? I know that there's a little bit -- some of it going on in China and something is going on in Brazil. So I just think if we can talk a little bit about, is there any regulation except to watch out for, I think, we have to worry about?

Michael W. Sutherlin

Yes. I'll touch on this, as -- but regulations is probably the least predictable of anything we work with. Yes, I think that there is some regulatory issues that are floating out in the U.S., but those regulatory issues will generally impact new capacity coming online rather than existing capacity. There's been some older plants that have been moved out of the fleet. But those are older inefficient power plants and were destined to come out of the fleet anyhow. So what we see right now in the regulatory front is -- still creates enough uncertainty that no one is really making very much investment decision. We're not seeing a lot of gas-fired capacity additions being announced either. In fact, we still see some of the utilities investing in coal -- clean coal technology because they're really concerned about the volatility around gas prices in the regulatory environment, where they have to go for regulatory rate approvals. You got to remember, we had a gas bubble for 20 years in the last half of the last century. And when the bubble broke, we've got gas prices that went up above $11. And so, that volatility in gas pricing is a concern that a lot of utilities have. I think we look at the market and look at how much -- if the fleet of power generation is going to be what it is today, there's not going to be very much additions over the next 3 to 5 years. Then the upside comes out of existing available capacity, and we have -- we believe that there's significant amount of existing available capacity in the coal-fired fleet, as that fleet is underutilized. Higher rates of utilization even getting up to the rates of utilization we've seen in recent years would increase the coal burn significantly. And we think that's more likely to happen. Now if we look at on sales over the next 2 to 3, 4 years, it's more likely to be utilization of existing capacity. At the peak, when we were in April of last year, we had single-cycle peaking plants dispatched onto the grid running 24 hours a day, and those plants are high-cost plants, very inefficient and designed only to run 6 to 8 hours a day during demand peak periods. So I don't have numbers on exactly how much capacity is available in the gas-fired fleet, but it is not unlimited. If you go back and say, "They didn't have enough capacity in base load plants to meet the requirements in April," which gives you some definition of what the limit is. As we look at Europe. Europe is switching rapidly from gas to coal because gas prices are -- outside the U.S., gas prices are high and utilities are losing money burning gas, and they're making money burning coal. And we'll continue to see them to do as much coal burn as they possibly can. On top of that, places like Germany are unlikely to build nuclear power plants, but don't want to utilize the ones they have. And so, they've got to look for alternative fuel sources, which is good for coal. And then -- and China has got some issues around regulations. But a lot of that is all from old coal-fired plants that have been around like -- around the city of Beijing, for example. There's a lot of old power plants that need to be replaced. I think there's a real likelihood you'll see new technology, supercritical coal-fired plants as part of that solution. There may be some wind that they use natural gas for the -- for China I think is going to be more difficult. The reservoirs for the shale gas formations are deeper in China. Water use is going to be a critical issue, where they have shale gas in areas where they don't have much water, and water is already an issue in the Western province. And so, there's a lot of complexity around the issues in China. I don't see that making a dash to gas. I think you'll still see a balanced approach, and you may see a little bit more build-out around gas, a little bit more around renewables, but I still think a significant amount of refleeting their power plants are still utilizing the best coal technology that's available today. So I don't know. There's probably no specific answer in there. I guess, in the of the question, it's a combination of risk and opportunities, and that sort of have been the definition of the market for the last 4 or 5 years, as we've gone through different phases of regulatory issues. I don't really see that to be too much of a change going forward.

Eli S. Lustgarten - Longbow Research LLC

And a quick follow-up. Last year, you had 2 projects you're monitoring that came through. You had 2 projects that you were monitoring for this year that you were hoping to come through. Are those still in the line? Or are those have been pushed out and replaced by other ones? I'm just trying to get some ideas...

Michael W. Sutherlin

Yes. One of those is the one I talked about earlier about being at the top of our customers' list. It gets talked about a lot. So -- and we are -- we're getting down to the final stages on that, making sure we get a contract that we can have confidence we can deliver on-spec, on-time and on-budget. And that clarity in today's environment is very, very important for us. So we're getting much closer on that. The second one is a project tied to a power plant that's behind schedule. So there's a little bit of time relief because it'll need coal before the power plant is ready to come online. So it's still a viable project. It's still a viable opportunity for us. But the timing of the power plant has pushed that back, and we're not -- that may still slip a quarter or 2 more or so, anyhow. But I think on the other side, we're going to see more projects come back into horizon, as the new qualification process delivers new projects into the list that when they get on the list that they'll move into startup a lot quicker than what we've seen over the last year. And I guess, with that, we're just on the top of the hour.

So I think probably the best thing here is to just wrap up here. And again, I just want to close and make a couple of closing comments. I think in summary, to sum up the -- what we talked about today. I think that we are seeing some encouraging but early signs of market improvement. However, the impact on us is more likely to be on the horizon than around the corner. So we don't expect it to have the near-term impact. And therefore, we're going to continue to focus on reducing our costs and streamlining our business. And that's going to allow us to respond better to those upside opportunities. And it's also going to give us more leverage in that response. So we think that's the right place to be positioning the company under current market conditions. Again, I want to thank everybody for being with us on this call, and thank you for your continued interest in Joy Global.

Operator

That does conclude today's conference. We appreciate your participation. You may now disconnect.

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