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Joy Global (NYSE:JOY)

Q3 2013 Earnings Call

August 28, 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 the Underground Mining Equipment Division and Chief Operating Officer of the Underground Mining Equipment Division

Analysts

Vlad Bystricky - Barclays Capital, Research Division

Stephen E. Volkmann - Jefferies LLC, Research Division

Jerry Revich - Goldman Sachs Group Inc., Research Division

Joel Gifford Tiss - BMO Capital Markets U.S.

Robert Wertheimer - Vertical Research Partners, LLC

Steven Fisher - UBS Investment Bank, Research Division

Eli S. Lustgarten - Longbow Research LLC

Adam William Uhlman - Cleveland Research Company

Operator

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

James M. Sullivan

Thank you, Melanie. Good morning, and welcome, 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 are Mike Sutherlin, President and Chief Executive Officer; Ted Doheny, CEO elect; Randy Baker, COO elect, and Sean Major, Executive Vice President and General Counsel.

This morning, I will begin with some brief comments on our results for the third quarter of fiscal year 2013. Mike Sutherlin will then provide an overview of our operations and our outlook. After Mike's comments, we will conduct a question-and-answer session. [Operator Instructions]

During the call today, we will be making forward-looking statements. These statements should be considered 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 our third quarter results. Bookings of $695 million in the current quarter were down 36% versus the prior year, with currency translation accounting for nearly 25% of the decline. Orders for original equipment were down 76%, while aftermarket orders were down 13%. Adjusting for currency translation, which is mostly due to a revaluation of our Australian and South African local currency backlog to U.S. dollars, orders in the quarter were down 28% in total, with aftermarket bookings down 7%.

Now compared to the fiscal second quarter, reported aftermarket orders were down 8%. On a currency adjusted basis, aftermarket bookings were down 2% sequentially. The decline in new order bookings was comprised of a 27% decrease for surface mining equipment and a 43% decrease for underground mining machinery. The 27% decrease in surface mining equipment bookings was comprised of an 87% decrease in original equipment orders, only partially offset by a 3% increase in aftermarket bookings.

OE orders were down in all regions. Aftermarket bookings in the third quarter of fiscal 2013 increased year-over-year in all regions, except Australia and South America. Adjusting for currency, aftermarket bookings increased 7% from the prior year period and continue to reflect a decline in order lead times, as our customers carefully manage operating costs, mine site inventories and capital spending. The 43% decrease in underground mining machinery bookings was comprised of a 68% decrease in original equipment orders, and a 27% decline in aftermarket bookings.

Original equipment bookings in the quarter were down in all regions except China, while the year-over-year reduction in aftermarket bookings occurred across all regions except North America, as our customers continue to defer rebuild activity, reduced parts inventories at mine sites, and in certain markets, idle equipment.

On a currency adjusted basis, aftermarket orders for the underground business were down 20%. Backlog fell to $1.6 billion from $2.2 billion at the beginning of the fiscal third quarter.

Turning to sales. Net sales of $1.3 billion in the third quarter decreased 5% versus the year ago period, with surface mining equipment revenue down 5%, and underground mining machinery shipments down 4%. Currency translation accounted for approximately 40% of the year-over-year decline in the company's sales revenue.

Original equipment sales for surface mining decreased 15%, while underground mining OE sales were flat. Aftermarket shipments of surface mining equipment increased 4%, and shipments of aftermarket underground mining equipment decreased 8% compared to last year. Surface aftermarket sales increased in all regions except Africa and Australia, while the underground aftermarket sales decrease was spread among all regions except China.

Taken together, consolidated aftermarket revenue in the third quarter totaled $720 million, which was a 2% year-over-year decline. Operating profit, excluding unusual items, totaled $278 million in the current quarter, reflecting a decrease from last year of $31 million. Currency translation reduced operating profit in the current period by $8 million.

Return on sales decreased to 21% from 22% in the prior year period. Year-over-year, the surface mining equipment operating profit improved from 23% to 25%, and was attributed to manufacturing operational efficiencies and reduced SG&A spending.

On the underground mining equipment side, the operating profit margin fell to 20%, from 23% in the prior year, due to unfavorable product mix and higher period cost.

Unusual items in the quarter included $3 million of restructuring cost as the company continues to rationalize its higher cost manufacturing operations in light of current and anticipated market conditions. We still expect restructuring cost for the year to approximate $25 million or about $0.15 per share, which is consistent with our previous guidance.

Now just a quick recap on our cost reduction programs. You will recall our Phase 1 restructuring, which was announced in the fourth quarter of fiscal 2012, was expected to deliver $40 million of savings in fiscal year 2013. We now expect these actions to deliver $47 million of savings for the year, with $40 million already reflected in our year-to-date results. Our Phase 2 restructuring effort, which began in earnest earlier this year, includes a combination of facility rationalizations and headcount reductions. And our initial expectation was that these actions will deliver approximately $40 million of cost reduction, mostly benefiting 2014. We now expect Phase 2 to deliver $65 million of savings, with $5 million expected this year, and another $60 million in fiscal 2014.

With the lower revenue profile, we are now looking at, in fiscal 2014, we have triggered our Phase 3 cost reduction plan, which is expected to result in additional savings in fiscal '14 of approximately $15 million. So in total, we expect incremental cost reduction in fiscal 2014 from our Phase 2 and Phase 3 programs to be $75 million.

As a reminder, these cost reductions, in combination with further in-sourcing of certain third-party manufacturing activity in fiscal 2014, will help position the company to deliver on its 34% decremental margin target.

Now let me turn back to the financials, talk about the tax rate. The effective income tax rate was 29.7% in the current quarter and that compares to 31.2% in the third quarter of 2012. The current period tax rate included $3.5 million of net discrete, return to provision benefits realized during the quarter. Excluding discrete items, the company continues to expect its effective tax rate in fiscal 2013 to be in the range of 30.5% to 31.5%.

Income from continuing operations totaled $183 million or $1.71 per fully diluted share. This compares to $194 million or $1.82 per fully diluted share in the prior-year quarter. Excluding unusual items in both periods, fully diluted earnings per share totaled $1.70 in the third quarter of 2013, and $1.87 in the third quarter of 2012. Cash from continuing operations in the quarter was very strong, totaling $350 million, with net trade working capital contributing about $100 million.

The company made good progress reducing inventory levels and improving collection rates in the quarter. The company's days sales outstanding metric was reduced by 7 days, and inventory days on hand was reduced by 24 days during the quarter.

In our second quarter call, you will recall we pointed to the structural opportunities we had for reducing inventory while being careful to maintain service levels for our customers. Our internal teams worked very hard to address those opportunities, which drove the significant reduction in days inventory on hand in the quarter.

These working capital improvements were partially offset by reduced advanced payments from the lower original equipment bookings level.

Fiscal year-to-date, cash from operations totaled $443 million, an increase of 75% compared to the prior year period. Capital expenditures for the quarter held steady at $31 million, with spending for the first 9 months of the fiscal year at $118 million, which was down $51 million versus last year. We continue to scrutinize and reprioritize our capital projects to align with anticipated market conditions.

For the year, we now expect cash from operations to be at the high end of our previous guidance range of $450 million to $500 million, and capital spending to be at the low end of the previous range of $150 million to $175 million.

With our global cash balance approaching $500 million, and our expectation for continued strong cash generation going forward, we have a solid position for executing the share repurchase authorization. Reduced pension funding next year, continued trade working capital monetization and lower CapEx levels should mitigate the impact from anticipated lower revenue and earnings in fiscal 2014.

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

Michael W. Sutherlin

Thanks, Jim, and welcome to everyone on the call today. I think it goes without saying that this quarter has added significant challenges to our business. Before turning to the markets, I wanted to reiterate that this quarter demonstrates that we are an operationally efficient and bottom line-focused business. You can see that in the results that Jim has just reviewed. This gives us a better ability to respond to changing conditions in our markets and translate those conditions into results for our shareholders. This quarter certainly demonstrates how important that's going to be.

We saw a significant order rate decline in this quarter, down 36% year-over-year and 38% sequentially. About 1/4 of the year-over-year decline came from the exchange rates and a similar portion of this sequential decline resulted from the longwall system result last quarter. However, that still leaves orders well below expectation and requiring explanation. For the first time in over a decade, global capacity has caught up with demand and most mine commodities are in surplus.

Starting last year, our customers reassessed CapEx projects on lower commodity prices and many projects were deleted. Those estate were more viable and led us to expect that about 1 project each quarter on average, to reach an equipment selection point. New projects were then added as customers reset their long-term priorities. These new projects were back-end loaded, but they indicated that the project phase would extent for longer. But our end markets shifted gears again this fiscal third quarter. China went into de-stocking and new production came online. Significant coal capacity has come online as Australian mines came back into production from previous flooding. And this has driven seaborne thermal and met coal prices down by double-digits this year, and down by 9% and 16%, respectively, in the 3 months ended in July. This leads between 30% and 50% of coal production uneconomic.

Copper prices were down 10% this year, but they're still at incentive levels. However, future output expansion is tempered by recent production increases, including the Escondida back in full production, and by new mines in final stages of completion that will add to supply. Iron ore prices have held out much better than expected despite a 30% de-stocking of China port inventories. But this is driven by the global cost curve rather than volume. In fact, there is almost no growth in global steel production outside of China, but there's a very material cost difference between the top 40% versus the bottom 40% of global iron ore production.

Although this has provided price support, a significant amount of new capacity will be coming online over the next year. There's still room for low-cost expansion, but it's just not going to be for everyone. And as a result of the increasing surplus and continued pricing pressures, our customers have slowed down many of their projects. This is leaving a timing GAAP as projects in later stages slide back and is moving some of the newer projects outside of our tracking scope. As a result, major project -- as a result, booking a major project per quarter is looking optimistic for a while, at least until the supply to demand GAAP closes.

Our updated prospect list has coal projects, particularly in Australia, China and Africa, but is more weighted to copper and iron ore. Aftermarket bookings were down 13% this quarter, but almost 1/2 of that was due to exchange rates. We have mostly gone through an aftermarket correction in the U.S. underground coal market and are now seeing an improving trend, albeit modest.

The experience in the U.S. is relevant as we move to similar corrections in Australia and China. The U.S. parts demand was reduced as our customers work down the parts stocks they carried at mine sites and rebuilds were deferred.

This was often compounded by parts redistributed from mines being close to other mines in the customers' fleet. Rebuilds temporarily approached 0 and parts fell below consumption levels. The correction bottom was significantly lower than the decline in the related coal production. For example, a 15% decline in U.S. Eastern underground coal production resulted in an aftermarket decline in a 20% to 25% range to reach bottom. It took 4 to 5 quarters for aftermarket orders to decline and stabilize. They have been on an improving trend for the last couple of quarters, but it will take several more quarters to normalize in line with production levels. Australia has been going through a similar process, and China is now entering that correction process. Australia has started to improve, aided by some of the recent production increases. We have seen China aftermarket bookings decline over the past 2 quarters, and more particularly this quarter, but we may still be several quarters from bottoming. This will create headwinds for the next few quarters, but the aftermarket will also start to be aided by the impact of machines delivered over the last few years that are beginning to see higher parts consumption and that are entering their rebuild cycle.

Overall, we do not believe that this quarter is representative of our order rate going forward. In fact, we are confident that our fourth quarter will report a meaningful sequential increase in original equipment bookings and a sequential improvement in aftermarket bookings. Although up from the third quarter, this will still be down from our previous order run rates.

Furthermore, based on the continuation of current market conditions, we do not expect the order run rate to support fiscal 2014 revenues above $4 billion.

As shipments have been higher than bookings as we continue to maintain our scheduled delivery dates and this has been depleting backlog. In fact, $1 billion of this year's shipments have come from backlog depletion. However, we have essentially exhausted shippable backlog and our fourth quarter will be a transition from a higher to lower shipping rates as we prepare to enter 2014. As a result, this year's fourth quarter will not be the typical strong finish for us. Even with fourth quarter deceleration, we expect to be comfortably within our previous guidance range for the year. And therefore, we continue to expect earnings per share of $5.60 to $5.80 on revenues of $4.9 billion to $5 billion. Excluding the restructuring charges and other call outs, EPS should be between $5.75 and $5.95.

I want to end on a positive note by confirming that we have board authorization to initiate a share buyback program. That authorization is for $1 billion over the next 36 months and we can be in the market as early as tomorrow. I have previously said that I wanted to position ourselves to make a meaningful start to the buybacks on announcement, and we've done that.

Last quarter, we had indicated the cash flow would be back-end loaded and the strong cash flow this quarter has put us back on track. Reductions in receivables and inventory were an important part of the cash flow as we align working capital to future production levels.

We are approaching fully funded pension plans in the U.S. and that will free up over $100 million in cash flow going forward. We are also completing our newest factory in China and several other growth projects and this will allow us to reduce CapEx to a sustainable level of around $125 million a year. Cash balances, plus solid cash generation, puts us in a very good position to start our share buyback program.

So with that, I'll turn the call over to Q&A. So Melanie, I'll give this back to you.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Andrew Kaplowitz with Barclays.

Vlad Bystricky - Barclays Capital, Research Division

This is Vlad Bystricky on for Andy. So first question, I guess, if I look at your bookings of $700 million this quarter, that obviously implies revenue well below the $4 billion level. So what gives you the confidence that orders will pick up here in the fourth quarter and will be sustainable at a higher run rate than what we saw this quarter?

Michael W. Sutherlin

Well, I think you better look at 2 pieces of that and maybe the smaller piece is the aftermarket. But we've seen in the U.S., the early stages of correction are fundamentally go into overcorrection to get parts inventories down and to stretch out some of the rebuilds. And then, as things settle in, those aftermarket order rates begin to move back up to a level that's in line with the production chain. So what we're seeing in the U.S. is the bottoming is starting to see modest quarter-over-quarter improvement. As we go through the corrections in Australia and China, we're seeing the drop at the front end. And so that's becoming a drag on our third quarter bookings for aftermarket. We'll start to see Australia improve. And I think that we may see some more headwinds out of China. But fundamentally, we think that the aftermarket is going to start to become incrementally better. But the big one is the original equipment. And original equipment for us has been notoriously lumpy. We've said that repeatedly over the last several years. And I think that's a fact that we have here today that -- in addition to slowing CapEx and some of the projects that have been -- slowed down in our project tracking list. At the same time, we ran into some timing issues on some projects that we're working on. We had the choice of trying to accelerate those to get them into the quarter. But in the process of doing that, we end up losing some negotiating position and that could affect margins, it could affect terms and conditions, and in the long-term, it's just not good for our business. So we always -- in those situations, we take a long-term view and we let the timing be what it may and continue to work to pricing levels in terms and conditions that we think are right for the business. So as a result of that, we have some stuff in process that we didn't get into the quarter. And it wasn't good for us to do that. So we have that to look forward to as we look at the fourth quarter. But down the road, we also see a number of other projects. And again, some of the timing is going to be a little bit iffy, but we do see the commitment on our customers to move some of the projects forward and we expect to see some projects over and above our base order rate bookings.

Vlad Bystricky - Barclays Capital, Research Division

Okay. That's very helpful. And then, just as a follow-up, can you talk about decremental margins in the quarter? And I think, it actually seemed a little higher in the quarter, I think, than we've come to expect. I think you mentioned as the cost savings flow through that, you expect them to get back to that low 30% range you've talked about, but can you talk about what impacted decrementals in the quarter and your expectations going forward?

James M. Sullivan

Sure. This is Jim Sullivan. 34% is our decremental target over the course of a year. Quarter-to-quarter, we will and have seen fluctuations against this target driven by one-off items and certain other factors. You may recall last quarter the decremental margin was a bit higher than target due to some transitory items in the underground business, specifically to facility rationalization initiative, the startup of our China facility, and the acceleration of IMM integration activities. This quarter, the actual decremental rate was just below 46% or about $8 million higher than the 34% target. And here again, the shortfall was mostly in the underground business and there were 2 primary factors. One, last year, the underground business adjusted their bonus accrual in the third quarter down. So if you look at the bonus accrual last year versus this year, it's about $5 million higher this year. Secondly, as I mentioned in our prepared comments, the OE mix of sales this quarter for the underground business was more weighted to longwall systems, with the structural steel content high on roof supports, the value added was a bit lower there. So really, this quarter was a combination of both those items. I think, looking forward, again, over the course of the year, adjusting for some noise, we do feel like with cost reduction actions that we've taken already and that we're prepared to take here over the next few quarters, that we can deliver on that target going forward.

Operator

We'll go next to Steve Volkmann with Jefferies.

Stephen E. Volkmann - Jefferies LLC, Research Division

Actually, a question along the same lines. I guess I'm just curious, on the other side of the equation, what type of costs you will incur while running to these programs?

James M. Sullivan

So we've incurred roughly $10 million of restructuring cost year-to-date. We expect the fourth quarter to be about that amount, maybe a little bit higher. For the full year, we could be as high as $25 million. So fourth quarter, we're going to see some actions. Most of those actions are going to be cash restructuring-related costs, severance and some other things. As we turn into next year and the incremental benefits that we talked about for next year, on that $15 million, you're probably looking at a payback that's pretty short. So it could be up to another $10 million of cash next year.

Stephen E. Volkmann - Jefferies LLC, Research Division

Okay. Great. That's helpful. And then, I guess, I'm curious, I don't know if you want to get into this yet, but maybe just if you could sketch out a little bit specifically of kind of what you're doing, plant closures or consolidations or in-sourcing, so forth. I guess what I'm trying to understand and think about is that usually when you have these types of reorganizations and so forth, there's learning curve issues so you can have a quarter or 2 or 3 where things are a little bit below whatever the final run rate is going to end up being from a margin perspective. I'm just curious if that's something I should be concerned about?

Michael W. Sutherlin

Yes, Steve, let me give you sort of an overview comment and Jim can talk about some of the cost issues because in -- we have been, and our strategy has been to outsource particularly structural fabrications in the up cycle. And we get to a point at the -- in 2012, where we were outsourcing about 35% of our production hours, and that number has been coming down and we have some more to take down, but we're probably in the low 20s, and we'll get that percentage down into the mid to upper teens kind of area. So that really does help buffer some of the volume adjustments we have to go through. The facility consolidations, we have some smaller satellites, special purpose facilities and as we go through operational excellence programs and lean out our main factories, we end up freeing up effectively realizable capacity within roof line. And we're now in a position we could begin to move production around in areas that allow us to be more cost-efficient in those production areas. So we get -- methodologies are the same, processes are the same, and we get to improve volumes by moving some production around. And that's going to help us quite a bit. We've also got the benefit, as we continue to move down the One Joy Global Program of looking at manufacturing processes rather than surface to underground equipment separately. And in fact, one of our recent moves has been to move some equipment that was in the underground category, we moved some of that production into another facility that's been primarily focused on surface equipment. So in making those kind of moves, we end up getting economy of scale and process efficiencies for the manufacturing process. So now, on the other hand, we can write off the cost of closing, our downsizing the facility. But we incurred costs and sometimes in the new facility to realign its production floor to be most efficient in bringing on the new production. And that was some of the cost we had in our last quarter that we -- Jim talked about, and we had $12 million or $15 million of extra cost. And a lot of that is in getting the new facility new prepared to handle the production that's not in the category of restructuring cost. So Jim, I don't know if you want to give a little bit more detail on the cost.

James M. Sullivan

Mike, I thought that was a terrific summary.

Stephen E. Volkmann - Jefferies LLC, Research Division

So I'll pass it on, but I guess you're just -- it sounds like you're fairly confident that you won't see a lot of sort of business interruption and inefficiencies in this process.

Michael W. Sutherlin

Well, we -- yes, as a business, we move people around a lot. So in some of these moves, we've got people from the facility that we're taking production out of, that move with the production in the early stages. So it's a pretty -- pretty much of a baton pass. It's not just over the wall, and so we do everything we can to try to smooth out that process and make it run as smooth and efficiently as possible.

James M. Sullivan

And as we said, there will be a little bit of noise because we call out the restructuring items and give you clear visibility of the charges. But we don't call out specifically in terms of our reported results, the kind of the transition costs where you're standing up a new facility and you're running both facilities kind of concurrently. So there will be a little bit of that going forward. I think the other impact you might see as we get further down the road with some of the facility rationalizations is -- are maybe some choppiness on our inventory levels just simply because we're just very focused on making sure that we can deliver on our commitments to our customers. We saw a little bit of that timing in the second quarter on inventory. It came back in the third quarter. We're certainly focused on trying to keep that in good shape. But there could be a little bit of lumpiness associated with inventories in our facility rationalization.

Operator

And we'll go next to Jerry Revich with Goldman Sachs.

Jerry Revich - Goldman Sachs Group Inc., Research Division

I'm wondering if you gentlemen can just talk about where do you see the bookings run rate on the new equipment side currently? And Mike, you mentioned that's above the $100 million or so we saw in the third quarter. I'm wondering if you can just give us some more context. Is it the year-to-date average that you're thinking about? And within that, can you just break that out for us in terms of what proportion of that run rate do you see coming from the greenfield projects that are yet to be finished versus the ordinary replacement of machines in service?

Michael W. Sutherlin

Yes, we -- to put this quarter in context from an original equipment booking standpoint, we did not book a shovel in the quarter and we did not book a longwall in the quarter. And you have to go back to 2009 to find a period where that happened previously. So 2009, in those early stages, it was pretty -- the lookdown was pretty steep and everyone was in a shutdown cash-conversation mode. So it is an unusual situation from the timing standpoint that we have in the -- in our third quarter. And from a lumpiness standpoint, it represents the bottom side of the lump, and we're very confident that that's unrepresentative. We are working prospects that have longwalls, we're working prospects that have shovels. We expect to continue booking those at some kind of rates. If you look at our previous bookings rates and you take out some of the bigger projects, you can get a base rate that it softened a little bit, but not all that much. Some of the softening is coming from the aftermarket, but we will expect to go through those corrections and begin to see the aftermarket stabilizing, begin to -- slowly begin to build back. But the original equipment, we do have things working. We feel confident that there are some stuff in the pipeline, like the longwall systems. Historically, if we go back a few years, we would be looking at booking longwalls of -- the longwall systems of 4 to 6 a year. And even under relatively soft market conditions where there's a lot of cost pressures, we would -- we'd still expect to be looking at 1 or 2 a year, something like that. So I don't have a dollar number that I can give you. But there are some numbers in there that would give us confidence that we're not going to see a continuation of our third quarter. We do, if you look at our -- how we've given some outlook for 2014, we're saying that the overall order rate numbers under current market conditions are going to probably be $1 billion on average at the top end of the range. Now it may be -- some quarters may be a little bit lower than that; some quarters may be a little above that. But they're not likely to average above $1 billion. And that you put the aftermarket in, and that pretty much is going to be -- our outlook for original equipment is going to be the difference.

Jerry Revich - Goldman Sachs Group Inc., Research Division

And Mike, can we go through the same exercise on the shovel side? 7 years ago, you're shipping roughly 15, 16 shovels a year. Where do you see that -- those demand levels in over -- of next 1 to 2 years?

Michael W. Sutherlin

Well, if you look at our bookings over the last several quarters, we have been in our level bookings. Level has been somewhere like 3 to 5, 6 shovels; somewhere like maybe in the 3 to 6 range depending upon the quarter. If you run that out on average, you're going to get a number that's in the upper teens, maybe touching 20-unit number. And that's probably what we believe is sort of a steady-state outlook for the shovel opportunities we -- that we see going forward. So that's a rough -- I think the last 3 or 4 quarters probably -- or the last 2 or 3 quarters probably represent a condition that we would expect to see going forward on a sustainable level.

Jerry Revich - Goldman Sachs Group Inc., Research Division

Okay. And lastly, you mentioned in an earlier comment, Mike, that there are some shifting in pricing or market conditions. Can you just say a bit more about whether you're seeing a more competitive marketplace, and what's the margin structure on orders that are going into backlog today at the gross margin level compared to what you're shipping?

Michael W. Sutherlin

Actually, I'll ask Ted to do -- he's closer to some of the activity. But certainly, I mean, we are a business that continually pushes and works very hard to maintain margins. I think we've done a really good job. But the market is always tough and we are constantly working every opportunity to book at that margins that we think are appropriate for our business. But Ted can give us more examples of what we see on the front lines in the marketplace.

Edward L. Doheny

Okay. Jerry, the answer would be yes, seeing pricing pressure breaking up in the 2 areas in the OE and then the aftermarket. On the OE, obviously, you've been reading about what's going on in the mining industry, a significant number of new CEOs out there with the edict to reduce CapEx, take cost out of the mines and focus on the productivity. And also, as Mike just shared in the last quarter, the amount of new OE activity is quite low. We are actually working on orders and that's a little bit of the confidence we have actually engineering in place for orders, and that's why we do see some confidence in the fourth quarter. The pricing, we're fortunate if we break it up on the OE, our competitor that you know well out there is pretty disciplined. And the 2 of us together are disciplined in a market, and both are pushing what we think are superior products. And so the pricing actually hasn't hit us yet on the OE. Though obviously, the customers are looking for everything. We're pushing our value propositions of safer solutions, higher productivity, lower cost pieces of equipment, so driving that quite hard. On the aftermarket side, the answer again is, yes. We're seeing pricing pressure on the aftermarket. And that pricing pressure hits from those third-party suppliers, where the customers are looking to take cost out of their maintenance budgets. And also, even looking at foreign suppliers, we have to watch that carefully. But again, we have to drive our strategy that we truly believe our superior equipment in driving our service, we have the lower Life Cycle costs. So actually, some of our increase in activity, even in a tough quarter, is selling higher productivity solutions to that installed base. So the pressure is out there. We're working hard to maintain, but we think it's in that maintain mode, not losing pricing pressure at the moment.

Operator

And we'll go next to Joel Tiss with BMO.

Joel Gifford Tiss - BMO Capital Markets U.S.

Just at the -- two things. One, in the fourth quarter, I'm really struggling to get to where your implied guidance is. Can you just help us on the margin side? It seems like there has to be a significant margin deterioration to get to that -- to those levels.

Michael W. Sutherlin

Yes, I'll make a quick comment and give it to Jim. But as we move our production levels down in the fourth quarter, not having shippable backlog like we had, we're going to have lower production volumes. Low production volumes translate into less overhead cost absorption. And so there are some things as we do go through that deceleration, there are some drags on the bottom line as a result of that. So Jim can give us more details.

James M. Sullivan

Joel, so I think you're right. I just want to make sure we are all on the same page in terms of the implied fourth quarter. If you take our guidance and prior year-to-date results, you get sales in the range of kind of $1.50 billion to kind of $1.150 billion, give or take. And you get EPS, excluding restructuring items around $1 to $1.20. Now if you look at that on a year-over-year basis, in the quarter, I think you're going to see a decremental margin, that's very much in line with what the target the company has established. And I think the reason why we had those decrementals is exactly what Mike said in terms of the manufacturing overhead. Now we are introducing new programs, as I talked earlier, to address that situation. But I think net-net for the quarter, kind of at the midpoint of the range, you're in that 16% to 17% operating profit margin, which is a step down from where we're at year-to-date.

Joel Gifford Tiss - BMO Capital Markets U.S.

And we shouldn't imply that that's the -- or infer that that's the new run rate going forward? There's just the one-off for the quarter to make the adjustment?

James M. Sullivan

Well, not really, because, I mean, if we're looking at lower revenue next year, you got to take the decremental revenue, whatever you put in your model. Based on our comments today, we're not giving guidance today. But you would have to take that revenue decrement and apply the mid-30 decremental margin to it. And I think the net effect of that is going to be you're going to see operating margins that are going to be lower than what we've experienced year-to-date. I'll let you do the math on what you think the sales revenue is going to be, or you can wait until the fourth quarter and we'll give you what we think.

Operator

We'll go next to Rob Wertheimer with Vertical Research Partners.

Robert Wertheimer - Vertical Research Partners, LLC

I wanted to follow up on the pricing question and just ask in a roundabout way, I guess, on Life Cycle Management. Are you able or willing to sort of talk about which -- what portion of your various product lines are on Life Cycle Management? And whether you're seeing a shift to it as mines are looking to cut costs in that value proposition, or shift away as you're looking to either lowball parts or pressure you guys to lower your price?

Michael W. Sutherlin

I actually don't have details by product. But our Life Cycle Management, the contractual program-based aftermarket, is about 1/3 of our aftermarket revenues come out of that. And so those are contractual and they give us some buffer against the pressures of the market in current kind of conditions. They, also, because of the way that those contracts are written, we have, in some cases, minimums in there. And they can also give us a higher activity level and equipment that our customers operate on those same programs. As we work with customers to help them, we've been doing more of this in a partnering relationship, work with customers to improve their -- help them improve their productivity of their mining operations. One of the key elements of that is to improve the productivity of mission-critical equipment, which is fundamentally our equipment. So by applying some of our Operational Excellence programs, we've been able to work with the customer to realize significant improvements in cutting availability on the longwall shearer, on the continuous miner. And those things translate into real unit cost reductions, sustainable unit cost reduction for the customer. We're seeing more and more interest in looking at those kind of programs, and those kind of programs give us the ability to apply Life Cycle Management programs, smart services and other elements and tie those in. We also have a number of customers. One of the main areas of cost reduction that our customers are going through is the elimination of contract minings. We've seen a lot of contract mining contracts terminated, and customers begin to operate their own mines. And in the case of 1 of our customers, they talk about rightsizing the equipment for their mining application. But those mines that were contract mining generally don't have a strong maintenance, equipment maintenance staff at the mine sites. So they become more dependent upon us to maintain the equipment and it, again, gives us the opportunity to begin to build in program-based aftermarket with those customers as they move from contract mining to their own -- operating their own equipment. So there are number of things we're working on that are most strategic in long term, but helpful under current market conditions. So I think a lot of those things are helping us to buffer the pressures of current market. I can tell you that our #1 concern when we deal with aftermarket, we're always concerned about that price. But really, delivery turnaround time, parts availability are really key. If we can turn a rebuild around quickly and if we can -- if we have parts on the shelf, we don't get those intense discussions around pricing. So we're doing a lot to improve those service levels as well. And I think that's helping us to maintain pricing and margins in the market.

Robert Wertheimer - Vertical Research Partners, LLC

That was great. Can I ask -- and Mike, we've written a lot about rope shovels and hydraulics. Some of the decisions the mines are making now seem to be a lot more short-term focused than maybe they used to be. Are you at all worried about a shift over whether or not it's purely economic, but a shift over to hydraulics for a year or 2, are you seeing that in the biz you're working on now?

Michael W. Sutherlin

We don't really see that -- well, actually, our customers tend to prefer the rope shovels because they are looking at 20-year mine life. And the unit cost reductions are just -- unit cost is just pretty significantly better with rope shovels. Where we get hydraulic excavators is in some areas of the mine that require more mobility. Contractors love them because they usually are doing their 5-year contracts and they have contract-life issues to deal with. So when -- we have some places where shovels are competing against hydraulic excavators. But it's probably 10% or 15% of the projects we work on. Usually, the decisions are made on operational issues or on unit cost issues, and only in a few cases do we compete directly with the hydraulic excavators.

Operator

We'll go next to Steven Fisher with UBS.

Steven Fisher - UBS Investment Bank, Research Division

I presume that the restructuring plans, prior to this quarter, were the right size, your business to a revenue base, north of $4 billion of revenues. And so, I guess, what level of revenues does the new restructuring size you to? I mean, it sounds like you're sizing towards that $4 billion level with a, kind of a mid- to upper-teens operating margin. Is that the way to think about it, or are you sizing to something below that on revenues?

Michael W. Sutherlin

I'm feeling entrapped here, Steve. It's a tricky question. We -- our outlook for next year, we've said that, at current order rates, that we do not -- is the -- I think it's likely that we're going to see 2014 revenues above $4 billion. So if you translate that, that says that $4 billion is more or less at the top of the range we're looking at, and as we move into Phase 3, we're obviously looking at that expectation for 2014, and as we look at the Phase 3 cost reduction side. If you put that together and triangulate that, you're going to sort of get to where we are.

Steven Fisher - UBS Investment Bank, Research Division

Okay. And then the aftermarket orders increased in North America. If you didn't discuss this, if I didn't miss it, can you just talk about what specifically drove that, how much of that was related to increased use of coal in power production in the last couple of quarters?

Michael W. Sutherlin

Yes, not much. We -- coal burn is up, for power generation, is up by 10% or something like that. But that's primarily coming from 2 places. One, there are some long-term contracts that are continuing to be delivered by our customers, but a lot of that is coming of stockpile depletion at the power plants. So we've not seen that much volume impact in the mines themselves, production impact in the mines. And in fact, the slowdown in some of the export demand has probably worked on a net-negative against some of those mines. So what we're seeing is as the aftermarket stabilizes and starts to improve, it's fundamentally at a steady-state condition. It's not based on an improving market, right now, it's based on just working the parts volumes back up to the consumption level. We've been selling parts at lower level that our customers have been consuming those parts. And we're now moving that back up and getting the parts demand that's equal to end-use consumption. So that's been pretty much the improvement, in fact. And that's why the improvement has been more modest over the last couple of quarters.

Operator

We'll go next to Eli Lustgarten with Longbow Securities.

Eli S. Lustgarten - Longbow Research LLC

Can we talk a little bit about the backlog at this point? You're $1.50 billion, with a $1 billion -- a little over $1 billion of OEM, and based on the fourth quarter, you're probably going to see the backlog go down to the $1.1 billion, somewhere between $1 billion and $1.2 billion, and the OEM backlog probably down in this -- mining a bit, but somewhere in the $700 million range, is that -- precision doesn't matter. My question is, do we -- does the backlog that you have at the end of the fourth quarter shift evenly throughout 2014? Or does it continue to be dug into the first couple of quarters?

Michael W. Sutherlin

Well, probably, that's probably the level of precision that we haven't really looked at. I can tell you that the backlog -- our backlog will typically have about a month's worth of aftermarket in it. Some of that is -- yes. So that's obviously shippable early. We do have some backlog that is shippable in the first half of the year. I think it's probably going to be -- the backlog is probably going to be a little bit more weighted to the first half of the year than the second half, but I don't think it's going to be heavily skewed to the first half versus second half. We have some first half deliveries and we have some second half deliveries that are in our backlog. But I just don't know what -- how that balances out.

James M. Sullivan

But is that -- what we pull on the backlog as we go into '14 will be in a much lower rate than what we've been pulling out of backlog in the first 3 quarters of this year.

Michael W. Sutherlin

Yes, the 2014 is going to be pretty much a book-to-bill of 1. I mean, we have a little bit of backlog that -- at depletion. But we -- the way our business works, we have 5 months of bill time on shovels. We have 5 or 6 months on longwall systems. So we're going to be pretty much at book-to-bill of 1 for 2014.

Eli S. Lustgarten - Longbow Research LLC

Okay. And are we seeing, in the activity, any differentiation between surface and underground? I mean, they're sort of an expectation that as coal normalizes and begins to improve in North America, at least because of the lower sulfur content and all the flak of the government on emissions, that the benefits would go more to surface mining than it would to underground coal as we pick up at least in the early stages of next year. Are you seeing any of that, or is that just economics of their take completely?

Michael W. Sutherlin

Yes, the -- there's some of that. I mean, what we -- in the U.S., I think our expectation is for CapEx to be basically equipment replacement, but not so much expansion. There maybe some expansion in the U.S, but we don't see it to be in the context of 2014, nothing material. The projects we're working on that have -- that are coal-based projects right now are primarily in China, Australia and some in South Africa. And Australia and South Africa, obviously, are focused on their export capacity. So more or less, that's how it gets back to China on coal. There is some upside in the U.S. but I think that the upside there -- our customers probably have enough capacity in their fleets even after taking out some of them -- the high-cost mines that are permanently taken out, I still think they have enough capacity. But they won't need any major amount of CapEx, as we get a good multi-year run of our improved power demand. On the other side, our backlog on our surface equipment, I think in the -- in my comments I said that their backlog was also weighted to copper and iron ore. And then copper and iron ore will be more surface than underground. So we've got those 2 commodities continue to hold up remarkably well, and they continue to have pricing at incentive levels. So we've got some surface opportunities and we've got some underground opportunities. The U.S. is not -- wouldn't be in the top 3 of our outlook list for our underground opportunities as we look, at least through 2014, we don't see the U.S. as being in the top 3 for underground.

Eli S. Lustgarten - Longbow Research LLC

And one final question on -- is the -- there was some fear about met coal and the drop in prices in closing of mines and being, in other words, down? Has that sort of dissipated with the stabilization of prices and the slight improvement in steel?

Michael W. Sutherlin

Yes, the prices are beginning to move back up in the right direction. And that's taken some pressure off. We saw some customers close a couple of mines in the U.S. I think Arch has announced that they're going to delay the startup of the Leer mine, wanted to bring it online when market conditions are a little bit stronger. But I think things are moving in the right direction. Certainly, we believe -- we continue to believe that met coal prices at the threshold level need to be probably 1 80. And so we think they're going to -- they'll move back in that direction and provide some relief. And I don't think anybody's going to take more production offline as long as the prices are moving up.

Operator

We'll take our last question from Adam Ulhman with Cleveland Research.

Adam William Uhlman - Cleveland Research Company

Jim, I was wondering if you could talk about the working capital target as we move into 2014. You guys have done some really hard work on the inventories and receivables. I'm just wondering how much is left to squeeze out of that on a days perspective?

James M. Sullivan

Yes, I think we've got a tale of 2 cities on receivables versus inventory. I think as our footprint continues to shift eastward, I think our DSO structurally will want to go up just because the terms in Asia tend to be longer than the terms in the other world areas. So I think that may be a bit of a drag in terms of the underlying DSO of the company. I think offsetting that is as we continue to shift our production into our lower-cost facilities as part of this facility rationalization plan, we would expect to see further structural declines in inventory. And we'll have -- we're in the process of building out the supply chain, for example, in Asia. And a lot of our inputs, if you will, into our China factory now come from other world areas. And as build out the supply chain, we'll be able to see a reduction in inventory more structurally. From a modeling perspective, I would tell you probably that we would kind of hold the line on working capital as a percent of sales. It might inch up a bit just because as we complete these facility rationalizations, we're going to need to make sure, to Mike's earlier comment, that we've got the inventory in the right place for our customers. So there could be a little bit of an uplift from that, net-net. I do think that the advance payment drop that we saw this year was pretty severe because our bookings were down severely. As Mike talked, we would expect next year to have a book-to-bill closer to 1. So I wouldn't anticipate next year to see as dramatic of a change in that area. But net-net, I think if you're kind of modeling the year, it looks to me like it's a kind of flat. Now, of course, we're going to be going after all the opportunities that we can.

Adam William Uhlman - Cleveland Research Company

Okay. I got it. And then Mike, just to circle back on the comments about the pending China correction, and in coal, I was wondering what you think the magnitude of that decline will be? And if it will be similar to what we've seen in the U.S. underground business?

Michael W. Sutherlin

So in the U.S. underground business, we saw -- in the U.S. coal markets, we saw a production decline of about 7% or 8%. In our underground business in the U.S. we saw -- we dealt with a production decline in its Eastern underground markets of about 15%. So the U.S. reduction was heavily skewed to the Eastern underground markets. We're looking at China right now with production that's 2% or 3% higher than demand, but demand is starting to improve. So the -- on a percentage basis, the correction cycle is going to be much smaller in China. It's a bigger market by far, but we don't serve all of that market. So from an impact on us, I think that the China impact is probably like when you average everything out, the China impact is probably going to feel somewhat like the U.S. impact, maybe not quite as much, but somewhat like that. One of the things we do have in China is our customers have historically carried a lot of parts inventories. So as they begin to deplete those inventories, we'll get that early inventory depletion impact. And so, first -- the next couple of quarters could look a bit rough, from a China standpoint, until they get their inventory levels down. Then it should normalize out. And it won't be a significant change from where we were on a run rate basis.

James M. Sullivan

Okay. Well, we are at the top of the hour. So I just want to close out by, I guess, acknowledging that we had a difficult quarter for us and we do have some challenges ahead in our business. But I just want to remind our investors that we, I think, continue to demonstrate that we are an operationally and financially efficient business and that we continue to be focused on managing the incrementals, and we do that very well. So I think these things will support our performance through these correction cycles and they're certainly going to enhance our leverage to the upside. So with that, I will end the call and begin to thank everyone for being on the call, and I look forward to talking to you at the end of our fourth quarter.

Operator

This does conclude today's conference call. At this time, we appreciate your patience. Have a good day.

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