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Dresser-Rand Group Inc. (NYSE:DRC)

Q4 2013 Earnings Conference Call

March 12, 2014, 09:00 AM ET

Executives

Blaise Derrico - Vice President, Investor Relations

Vincent Volpe - President and Chief Executive Officer

Jan Kees van Gaalen - Executive Vice President and Chief Financial Officer

Analysts

David Feaster - Raymond James

Robin Shoemaker - Citi

David Anderson - JPMorgan

Martin Malloy - Johnson Rice

George O'Leary - Tudor, Pickering, Holt & Company

Jeff Spittel - Clarkson Capital Markets

Jon Donnel - Howard Weil

Chuck Minervino - Susquehanna

Operator

Good day, ladies and gentlemen, and welcome to the Dresser-Rand's fourth quarter 2013 earnings conference call. (Operator Instructions) I would now like to introduce your host for today's conference, Blaise Derrico. Please proceed, sir.

Blaise Derrico

Thank you, Charlotte. Good morning all. The call is open to the public. It's being webcast simultaneously at www.dresser-rand.com and will be temporarily archived for replay. A copy of the news release we issued last evening is available on our website, as are the slides we will use today during our presentation. We will let you know when to advance the slides as we deliver our prepared remarks.

Please turn to Slide number 2. The statements made during this conference call that are not historical facts may be forward-looking statements. Forward-looking statements involve risks and uncertainties that may cause actual results or events to differ materially from those expressed or implied in such statements. In addition, this conference call contains time-sensitive information that reflects management's best judgment only as of the date of the live call.

Management statements include non-GAAP financial measures. For reconciliation of these measures, refer to our earnings news release or the conference slides available on our website.

Dresser-Rand does not undertake any ongoing obligation other than that imposed by law to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after this call. Further information concerning issues that could materially affect the financial performance related to forward-looking statements can be found in Dresser-Rand's periodic filings with the SEC.

Today's discussion is based on unaudited financial data for 2013. While we believe the numbers are final, in our discussion today, you should consider them as expected results, as we have not filed our 10-K just yet. We expect to file the 10-K on March 14.

Now I'll turn the call over to Vince Volpe, our President and CEO.

Vincent Volpe

Thank you, Blaise. This morning I will take a different approach than which we normally follow, because we're just updating the numbers already provided in our earnings pre-release.

Over the past eight years since going public, our road to progress in terms of revenue and earnings growth has been good at 12% and 16% respectively. We're proud of this result as well as the improvements made in operational excellence, which is mirrored by our progression in safety from a total recordable incident rate of 2.2 in 2005 to 0.38 in 2013. This is not only critical to our employees, but is also a proxy for strong commitment to process discipline and operational excellence.

Over the past two years, however, while the year-over-year progress has been positive, it has not been consistent with our internal expectations nor the guidance that we provided to the investment community. As a result, our stock price is languished in a period that is generally seeing reasonable relative growth in the oil services and equipment sector. This is not acceptable to any of us. And I take responsibility for both the guidance that we disclosed as well as our actual results.

You can imagine, we have spend considerable time investigating what has changed over the past couple of years and what we can do to improve the accuracy of our forecasting process. This morning's discussion is centered on a high-level analysis and what needs to be changed in the process.

Please turn to Slide 3. On February 17, we issued a pre-release of earnings for 2013. On this chart, we are showing a table comparing what was in the pre-release and today's expected results. And you can see our reported operating income of $321 million, slightly above the range in the pre-release, principally due to the impact of the draft Spanish regulation coming in lower than previously assumed. On a pro forma basis, our operating income was $383 million, which is consistent with the disclosure in the earnings pre-release.

Please turn to Slide 4. As you can see on this chart, we have a history of good performance. As previously mentioned, revenue and earnings growth has been good over the past eight years, achieving a compound annual growth rate 12% and 16% respectively, before the impact of the draft Spanish regulation on the 2013 results.

Please turn to Slide 5. While our year-over-year progress has been positive, it has not been consistent with the guidance that we have provided to the investment community. Here we're showing a table comparing our results for 2013 for the guidance we've provided at the time of the third quarter 2012 earnings call that we held in November 2012.

Let me draw your attention to the revenue and operating margin data highlighted in yellow. This clearly shows the volume shortfall, but it also reinforces that we did a reasonably good job with our segment operating margins versus guidance.

Please turn to Slide 6. Guidance across that caused us to miss our guidance, include the following. First, we did not sell the three photovoltaic power plants or Kaggio and we were unable to recognize revenue on the shipment of equipment for a pipeline project in Central Asia that had been delivered due to pending contractual and administrative matters. The impact of these two items is approximately $83 million of revenues and $19 million of operating income.

Second, technical issues delayed delivery of three major projects totaling $135 million. All of these technical issues have now been resolved. Two of these units shipped in the first quarter and the third is scheduled to go in the second quarter of 2014. Third, we estimate new unit booking delays from fourth quarter 2012, reduced 2013 revenues by approximately $200 million and assuming an incremental margin of approximately 20% reduced operating income by approximately $40 million.

Fourth, the impact of the draft Spanish regulation reduced revenues and operating income approximately $22 million and the impairment charge further reduced the operating income by some $40 million. Finally, the adverse translational impact of a stronger U.S. dollar reduced revenues and operating income by $29 million and $21 million respectively.

Please turn to Slide 7. I want to take you back to the Investor Day, we held in November 2010. At that time, we shared our thoughts on a path forward to accelerate profitable growth. This slide shows what we were expecting based on the then 2015 plan, accelerated by a year after the Guascor acquisition. As a baseline, we felt that we could grow the underlying business over time at a compound annual growth rate of 10%, as we kept doing what we were doing in terms of the level investment and infrastructure and technology.

We said that if we continued to invest nominally about 1% of sales in R&D and between 1.5% and 2% of sales in CapEx, the business would grow 10% a year for the foreseeable future. We remarked at a time that we had strong opportunities and we had the ability to make incremental investments over the next couple of years, would change the slope of that growth curve, so that rather than ending up as a $3 billion company in 2015, we would be at approximately $4 billion.

With the acquisition of Guascor in May 2011, we said that we believe we could accelerate that growth aspiration by one year. It's now clear we will not achieve $4 billion in sales, $700 million in operating income and an operating margin at 17.5% in 2014, which was the aspiration we set at the time of our Investor Day in late 2010.

Please turn to Slide 8. The principal reason for the shortfall is that we did not tip the volume that we had anticipated in order to be on track for 2014. On this chart, we summarize the major reasons for the revenue shortfall versus our earlier expectations.

First, new unit project delays, especially offshore production projects, where we are especially well-positioned to push the significant amount of expected revenues to the right; second, impact of low gas prices on biomass, waste energy and other alternative fuel markets affected both engine and steam turbine sales, which are largely what we refer to as book-and-ship business.

Third, penetration of gas turbine repair market has been delayed beyond our original expectation as a result of softness in the market following the recession and the associated delays in overhaul smart traditional client base; fourth, the suspension of energy assets in Spain; and five, the stronger U.S. dollar.

Please turn to Slide 9. Let me shift gears and talk about the margins. This chart shows what the fourth quarter pro-forma sales and operating income numbers would have been achieved, had we completed the sale of the Kaggio solar park, recognized revenue for the West-to-East pipeline and not have the potential tariff change impact on the Spanish energy assets. Pro forma sales of $934 million, operating income of $168 million and operating margins of 18%, all represent record levels on a pro forma basis.

Please turn to Slide 10. If we were to annualize the pro forma revenues for the fourth quarter, we believe it shows that the soon we could secure the volume of bookings necessary, we have the capacity to achieve the $4 billion in sales without the need for any major investment in infrastructure. I might add, that at the time we set the $4 billion revenue target, the U.S. dollars have been weaker compared to today's exchange rates. On a currency adjusted basis, the revenue target is closer to $3.8 billion.

Furthermore, the margins at those volumes come up significantly due to the operating leverage from increased volumes against modest increases in fixed spending. Thus, when we get to approximately $4 billion, the data suggest that we should be able to also being in reasonable proximity to the operating income or EPS projections made back in 2010.

Please turn to Slide 11. In summary, we're pleased with our progress around operational excellence and demonstrated ability to expand margins, but recognized the need to improve forecasting. In this regard, we have made a fundamental change in our process around external guidance.

This slide outlines the process changes we have made to drive improvements in our forecast accuracy. We believe these changes should allow us to have more accurate bookings in sales data on which to base the forecast. The most significant change has to do with the timing of when we prepare the forecast.

Traditionally, the process began in the summer of the previous year. Bookings were assumed for the August to December period to drive a yearend backlog. We then developed a view of bookings that would book and ship in the forecast period. External guidance for full year was communicated in late October of the year, proceeding the forecast period.

In previous years, when the order sizes were smaller and project timing was less complex, this forecasting process was sufficient to get us, close enough, on an assumed basis, such the revenue guidance was reliable. With the increase complexity size and timing of projects, the old process no longer delivers reliable results.

Under the new process, we begin with the actual beginning of year backlog for the forecast period. No longer are we trying to project bookings and shipments for the final four to five months of the preceding year to derive a beginning New Year backlog. We expect that bookings that will ship in the forecast period and margins are set based on previous year actuals.

External guidance is now expected to be provided in late February at the time of our first quarter earnings call. As I mentioned earlier, the issue with our forecasting accuracy is one of volume rather than margins, and we believe this process change in the forecasting will go a long way in correcting the issue.

I'll now turn the call over to Jan Kees for a closer look at our fourth quarter financial results.

Jan Kees van Gaalen

Thank you, Vince, and good morning, everyone. Please turn to Slide 12. New unit bookings of approximately $1.3 billion were 18% lower than 2012 and reflect the often talked about the delays in clients placing orders, especially for large upstream projects.

In the New unit segment, fourth quarter bookings were $365 million. In the fourth quarter, we reduced new unit bookings by approximately $85 million, because we de-booked the Kaggio solar park transaction, as we have reclassified the value to PPE and expect to run the plant as a distributed power facility, and we recorded a scope adjustment on the Apex CAES projects.

Before these adjustments, new unit bookings in the fourth quarter totaled approximately $450 million, which would have been an increase of 24% over the corresponding period in 2012.

Please turn to Slide 13. We currently believe new unit bookings in 2014 will be approximately 5% to 10% higher than last year. While we had a strong level of bookings in the fourth quarter, we continue to expect delays in clients placing orders for major upstream projects. This is particularly challenging for us, as we are well-positioned in the upstream part of energy infrastructure, given our technology and ability to meet the most demanding applications.

The good news is that fundamentals are solid, and given with the steady decline in production at existing fields and with demand for oil and gas products continuing to increase, we believe continued investment in upstream assets is absolutely necessary and that major projects that have shifted to the right will go forward, but the timing remains less clear.

We continue to see considerable activity in both the mid and downstream sectors of energy infrastructure. In the midstream, our strength is in the large transmission lines, which move gas along great distances, such as the West-to-East pipeline traversing China.

In the downstream, the opportunities lie within refining, principally in developing world, including China, India, the Middle East and South America. Population growth and rising middle class are driving increasing demand for transportation fuels and other refined products. Opportunity for job creation is also a powerful incentive for these economies to build out their downstream industries.

On the petrochem side, there has been a lot of activity, especially in North America, due to the low natural gas prices. This market has been intensely competitive, especially in terms of price competition, and we are firm in holding to our philosophy of not accepting orders that have sub-parameters.

Please turn to Slide 14. Aftermarket Parts and Services bookings of $1.6 billion this past year is a record level and was approximately 5% higher compared to 2012. Activity levels and our performance were especially good in Europe and in the Middle East. Aftermarket bookings of $369 million for the fourth quarter of 2013 were 2% higher than the corresponding period in 2012.

We currently believe aftermarket bookings in 2014 will be 5% to 10% higher than last year's record level. The aftermarket is subject to geopolitical risk, as the install base of equipment is working in many parts over the world, and in come cases countries that are known for their sometimes unstable conditions.

Please turn to Slide 15. Our backlog at the end of December was approximately $2.9 billion, was 3% lower compared to the end of 2012. The new unit backlog of $2.2 billion was down 8% versus a year ago and the aftermarket backlog of $661 million was up about 15%. At the start of the year approximately $1.5 billion of the new unit backlog was scheduled for delivery in 2014.

Please turn to Slide 16. Total revenues for the fourth quarter of 2013 of $827 million decreased approximately $17 million or 2% compared to the $844 million for the fourth quarter of 2012. Revenues in the fourth quarter of 2013 would have been approximately $16 million higher by applying exchange rates from the corresponding period in 2012.

New unit revenues for the fourth quarter of 2013 of $388 million decreased $11 million or 3% compared with $399 million for the fourth quarter of 2012. Revenues in the fourth quarter 2013 would have been approximately $9 million higher by applying exchange rates from the corresponding period in 2012.

Aftermarket Parts and Services revenues for the fourth quarter of 2013 of $439 million decreased $6 million or 1.4% compared with $445 million for the fourth quarter 2012. The retroactive reduction of the tariffs in the draft Spanish regulation reduced revenues by approximately $24 million. Excluding this impact, revenues increased principally due to growth in most geographic regions, partially offset by an estimated $7 million adverse translational impact of a stronger U.S. dollar on full year revenues.

Turn to Slide 17, please. As I previously mentioned, revenues for the fourth quarter were approximately $827 million. Cost of sales was relatively flat at $595 million compared to the corresponding period in 2012. As a percentage of revenue, cost of sales was 71.9% for the fourth quarter of 2013 compared to 70.5% for the fourth quarter of 2012. The increase in cost of sales as a percentage of revenues was principally from the retroactive reduction of the tariffs in the draft Spanish regulation.

Operating income for the fourth quarter 2013 was $87 million. Before the asset impairment charge resulting from the draft Spanish regulation, operating income was $127 million. This compares to operating income of $138 million for the fourth quarter of 2012. Fourth quarter 2013 operating income decreased from the same period in 2012, as a result of the impact of the draft Spanish regulation on revenues and operating income. The effect of the proposed tariff reduction was partially mitigated by higher volume.

As a percentage of revenues, operating income for the fourth quarter of 2013 was 10.5%. As Vince mentioned earlier, operating income as a percentage of revenues in the fourth quarter would have been approximately 17.5% before the impact of the Spanish regulation.

Other expense net was approximately $10 million for the fourth quarter 2013 compared to other expense net of $800,000 for the corresponding period in 2012. This line item consist principally of net currency gains and losses, gains and losses on tradable commission allowances and income and losses from our equity investments.

The effective tax rate for the fourth quarter of 2013 was 53.8% compared to 34.5% for the fourth quarter 2012. The revenue and impairment impact of the draft Spanish regulation negatively affected the effective tax rate for the fourth quarter 2013 by approximately 19.7 percentage points, as we do not expect to realize tax benefit from the losses associated within energy assets.

As you can see, at the bottom of the slide, net income for the fourth quarter 2013 was approximately $33 million. Before the asset impairment, net income was $73 million compared to $80 million for the corresponding period in 2012. The decrease is principally due to the impact of the draft Spanish regulation and foreign exchange, partially offset by lower interest and income tax expenses in 2013.

Next slide, please. New unit operating income for the fourth quarter 2013 of $52 million compares with operating income of $49 million in the fourth quarter of 2012. The increase in the segment operating results was primarily attributable to higher volumes. This segment's operating margin was 13.5% compared to 12.4% for the fourth quarter of 2012. The increase in operating margin from the corresponding period in 2012 was principally attributable to a more favorable mix within this segment.

Next slide, please. The impact of the draft Spanish regulation, apologies, solidly affected the Aftermarket Parts and Services segment. Aftermarket operating income before the impact of the draft Spanish regulation for the fourth quarter 2013 of approximately $102 million compares with $124 million for the fourth quarter 2012. This segment operating margin before the impairment charge for the fourth quarter 2013 of 26.7% compares with 27.8% for the fourth quarter of 2012.

The decrease in operating margin was principally due to the retroactive reduction affairs in the draft Spanish regulation, which reduced revenues by $23.7 million and operating income by approximately $22 million, and a further reduction in operating income of approximately $40 million due to the asset impairment.

Next slide, please. Turning to cash flow. Net cash used in operating activities for the year ended December 31, 2013, was $67 million compared to net cash provided by operating activities of $93 million for the year ended December 31, 2012. The increase in cash use in operations in year ended December 31, 2013, is principally the result of an increase in working capital.

Net working capital at the end of the fourth quarter was $619 million before adjustment for foreign exchange, which was approximately $360 million higher than where we were and we ended last year. We continue to believe that net working capital will come down gradually over the course of 2014, due to the following.

During February, we collected approximately $25 million of pass-through receivables from PDVSA, net of which was significantly overdue. We are monitoring our total exposure carefully and working with the client to bring to receivable balance down through collections.

Working capital associated with the PEMEX Littoral project is expected to be collected during the second quarter of 2014. Third, we made a conscious business decision to build inventory to stimulate launch of our new LNGo product line. Over the course of this year, we expect a conversion of this inventory to cash, which will help in reducing net working capital.

Next slide, please. Net cash used in investing activities was $84 million for 2013 compared to $124 million for 2012. Capital expenditures increased to $83 in 2013 from $73 million for 2012. Cash used in investing activities for the year ended December 31, 2012, includes approximately $49 million related to the acquisition of Synchrony. Financing activities provided cash of $232 million in 2013. This compares to 2012 from financing activities provided cash of $27 million.

We have provided a schedule of the Extended Scope Contracts on Page 29 of the presentation. For more information about our results of 2013, please refer to the 10-K, which we expect to file on March 14 to the SEC.

With that, I turn the call back to Vince for closing comments and to moderate our Q&A session.

Vincent Volpe

Thank you, Jan Kees. Turn to Slide 22, please. As we enter 2014, we expect bookings in both new unit and aftermarket segments to increase approximately 5% to 10% over last year. The key risks to our 2014 bookings outlook include further delays in clients placing major new unit orders and for the aftermarket, the ever-present geopolitical risk in certain regions of the world, where we have an install base of equipment.

Turning to the profit and loss. As a result of the suspension of the energy assets in Spain due to the draft regulation, we have reduced our previously disclosed revenues and operating income guidance for 2014 by $125 million and $15 million respectively. We expect total 2014 revenues to be in the range of $2.9 billion to $3.1 billion and operating income of $377 million to $396 million.

Please note that this range is consistent with the pre-release disclosure of operating income in the range of $392 million to $411 million, where we identified the risk of not having the previous tariffs reinstated at $15 million. What we have now done is actually deducted the $15 million from the forecast results and eliminated the associated risk.

Clearly, if the old tariffs are reinstated, there will be an upside to these numbers based on the tariffs actually applied. Under this scenario, 2014 results could be positively impacted by reinstated operations, the possible recovery of part or all of the approximately $22 million for the proposed retroactive reduction of the tariffs and a lower cost base.

For modeling purposes we're showing on this slide other key financial metrics to get you to net income and EPS numbers for 2014. We expect our full year diluted earnings per share for 2014 to be in the range of $2.60 to $2.80 based on fully diluted share outstanding of approximately 77.5 million.

Before moving on, I understand that many of us have questions about our revenue guidance of approximately $3 billion for 2014, in light of the company's comments at the time of our third quarter earnings call. At that time, I said that, well, I did not know the exact number, we thought the new unit sales would be flattish.

To put that into context, we said that the fourth quarter sales were expected to be approximately $1.2 billion, which imply full year sales of approximately $3.4 billion for 2013. As previously mentioned, we felt short of that forecast by approximately $300 million.

About three quarters of shortfall is associated with the following issues. We did not complete the expected sale of the Kaggio solar parks and we were not able to recognize revenue on a major pipeline project for a client in central Asia. These two projects had associated revenues of approximately $84 million. Technical issues delayed delivery of three major projects totaling $135 million. These issues have now been resolved. And finally, the draft Spanish regulation reduced 2013 revenues approximately $24 million for the proposed retroactive reduction of the tariffs.

The question that remains is why aren't 2014 revenues forecasted to be much higher than the present guidance assuming the above mention revenues have now moved into 2014. The answer is, simply, that we based our earlier comments on preliminary data. This is the very reason we changed our process and timing of when we provide initial guidance for the coming year.

Turn to the next slide, please. I realize this slide is busy, but we thought it best to provide this level of detail to help explain the major changes from our initial revenue projections for 2014 communicated at the time of our third quarter earnings call to our present projections.

Let's start at the top and work down. The top portion of the slide begins with the new unit segment. Our initial projection for new unit revenues was a range of approximately $1.6 billion to $1.8 billion. Included in this range, we have assumed fourth quarter booking of approximately $550 million, which would ship in 2014. The actual bookings in the quarter were $365 million and contained in the numbers are major project booking late in the quarter for $67 million, which will not ship until 2015.

Additionally, our present view is that based on the most recent forecast, we believe there maybe as much as a $50 million difference in that, which we book-and-ship this year versus 2013. Recently, we have also learned of a delay in a major project, where the client is requesting us to hold off shipment previously planned in 2014, until 2015.

Next, we added to 2014 sales of projects that slipped out of 2013 that we previously discussed, such as the pipeline projects. This brings us to the present new unit sales projection for 2014 or approximately $1.5 billion to $1.6 billion.

In the aftermarket, our projections assume approximately of 5% to 10% increase in sales over 2013, which already includes some geopolitical based headwind and now further adjusted downward by a $132 million to include the impacts of the draft Spanish regulations. As mentioned previously, the final regulations are more favorable than the draft, some of the $132 million in revenue may not be lost.

Turn to Slide number 26 please. I want to share with you some insights into our first quarter outlook. Let me start by pointing out that our business has a seasonal pattern that continues. For example, our first quarter operating income for the last nine years was only 15% for the full year. And if we were to exclude 2010, which because of the recession was a bit of an outlier, the average is 13% and is ranged between 8% and 20%.

We expect first quarter operating income to be in the range of 8% to 10% for the full year. If we exclude the impacts of Spanish energy assets, operating income is actually expected to be in the range of 11% to 15% for the full year, which as a percentage for the full year results would be in line with prior year percentages.

As you can see the fundamentals of this business remains strong and while revenue should be flat year-over-year, we expect an overall expansion in operating margins due to our continued focus in areas of operational excellence, such as cycle time reduction, cost of quality and safety, with the understanding that as volumes do improve in the future in the form of increased bookings, our margins should continue to expand.

Thank you for your attention. At this point, we'll open the line for questions. Operator, please begin the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will be coming from the line of David Feaster from Raymond James.

David Feaster - Raymond James

I'd like to ask on LNG LNGo. This is one of the more exciting opportunities for you guys. And during your presentation at our conference, it appears that the opportunity is even larger than you guys had expected. Could you just give us an update on your outlook for this technology and when you expect to start seeing discussion start turning into actual bookings?

Vincent Volpe

We do see that the opportunity continues to grow. I think one of the things that we did that was wise was we agreed on a 6,000 gallon a day footprint with four basic modules and these are standard modules. And what we have discovered here as time has gone by is that by mixing and matching different amounts of modules, we actually have the ability as the plant sizes go up to increase capacity with less than the same pro rata incremental capital investment.

And so while our base plant is 6,000 gallons a day, we think as we move up in size, actually we become, we get closer and closer to what the larger plants would be on an installed basis, with the advantage that we can do this in matter of months rather than years, because of the standardization of the module. So that has really opened up more opportunities for us than some of the applications that we thought we might be limited to, to beginning with.

And so I'm not going to go through all those different applications, but there is flare gas, there is mining, there is thick and pipeline quality gas frankly converting into the power generation. So there is a variety of applications that have opened up. And as we look at the market, again when we started we were really focused and are principally focused being with North America, but we see opportunities arising in places like China and South America, where distributed LNG plants make a lot of sense because of lack of gas infrastructure. So that what you said makes sense.

Where are we in the process? With all the other stuff I had to cover in this presentation, I just didn't cover it in my formal remarks, but were pretty darn close I believe to be getting our first one or two orders here in. So I don't want to kind of jinx it with timing predictions, but I would say we're as close to imminent as you can get without it being an order, excited about that. We've got the architecture. It continues to expand in terms of the numbers of opportunities.

And I think our biggest, if I will issue right now is to make sure we stay focused on the opportunities that are the most qualified and the most mature and that we actually get those converted, so that we can turn these bookings into actual cash and worked out some of that net working capital Jan Kees has referred to, in terms of the inventory that we built. So we're quite close.

David Feaster - Raymond James

So you expect your level of inventory that you currently have to decrease over time as in it should actually improve working capital as demands starts coming -- as they start coming in?

Vincent Volpe

Yes, because what we did was we've built the first unit, the demonstration unit. We ran it, tested it, proved it that it would work. And then we also put inventory for 20 units in the pipeline and on order, so that once we got the demonstration model to work, we'd be able to start to fill orders quickly. Because our belief was that if you're pure demonstration and then somebody says I'll take one and then you have to build one from scratch, you're going to loose valuable time in terms of being first move over to market.

As we go forward, we're not going to replace the inventory per se, what we will do is we'll work with our suppliers and we're already doing it, working with our supply chain, so that we can have either raw materials or they will hold work in process for us, so that we can still be fast in terms of cycle times, as we said, months rather than years. But we don't need to hold all of finished goods in our inventory or very little of the inventory at all, in fact.

So that's our strategy going forward. What that means is what we have in inventory now is probably close to the apex of what we'll have and it should come down over time and not be replaced. So there is a one-time increase in networking capital that we planned on last year. Jan Kees has addressed it and that should roll down over the course of this year, as this inventory turns into bookings and these bookings turn into actual orders.

David Feaster - Raymond James

Can you talk a little bit about the project delays that you guys have seen? We've seen cost overruns for many offshore and FPSO projects, which has led some customers to go back to the drawing board and push projects that are right. Could you talk a bit more specifically about where you're seeing delays and your outlook for the FPSO market in 2014?

Vincent Volpe

Well, I am reticent to make a prediction for 2014, but we think it will be slightly better than 2013 in terms of the amount of vessels that actually get ordered. The delays really have been in the upstream and they've been in worldwide, in every region of the world, so we can't pick on Western Africa versus Brazil or anywhere else. It's really been spread out pretty much worldwide David. But I do think there will be a pick up. And when we talk about 5% or 10% increase year-over-year, it's basically of the upstream.

David Feaster - Raymond James

Last question from me. Could you talk a little bit about the competitive landscape? We have seen some consolidation in the industry recently, whether they were acquisitions or JVs. Do you see the market getting more competitive and consolidation continue? And specifically, I guess, in talking with Blaise, it's mostly on the downstream, is where you are seeing the most competition right now?

Vincent Volpe

I think the nature, first of all consolidation I don't think leads to necessarily lower prices. I'm not sure what it does, to be honest with you. So I'm not sure the consolidation -- when you talk about competitive, I'm translating that's a pricing. So I'm not sure the consolidation at this juncture does all that much one way or another. So let's leave that off to the side for a sec. In terms of the pricing, the nature of the downstream equipment is less technologically advanced in terms of what clients really require, in terms of weight, space and efficiency.

If you're working in a refinery and you have a 5% advantage and efficiency, but you're only compressing hydrogen and you can have a really big machine with a lot of capital expense, but it's only saving you couple of hundred kilowatts in power, because hydrogen is such a lightweight gas, there is no real gas density there. And so your horsepower gain in actual horsepower is not that great. So you can't really sell the advantage of efficiency compared to capital size of the capital investment.

On the opposite side of the equation, if you're in the upstream, you're building high density gas machines, natural gas, including up to CO2, which is quite heavy, and so 5% savings for the same capital expense, okay, 5% savings maybe instead of a couple of hundred kilowatts, maybe 2 megawatts. And so now you're looking at the advantage of efficiency, which translate in the upstream application, if you're saving all that power, it means that you can actually run the machines at a higher capacity and make more oil with the same horsepower than your competitors.

And so the value preposition of efficiency as well as the weight and size of the design is much more pronounced in the upstream that is in the downstream. That combined with the fact that there is only a couple of us that really have a strong position in the upstream because of our designs makes that a little bit more lucrative market for us. In the downstream more people can compete and so there is just more general price pressure around that.

Now, when I look at 2013 bookings, we did get some benefit from the lower gas price in terms of more downstream activity. But again there was more competition and that increase in bookings in the downstream was more or less offset by the fact that the low gas prices also put a damper on alternative energy applications like biomass and waste-to-energy, where we are traditionally supplying steam turbines in our engines. So I think that the low gas prices not really help us in the downstream, because that's been offset by the biomass business, but the downstream is more competitive.

And frankly, we're looking right now, because we think that this is going to stay for a while. We're looking at doing some things with some of our designs to I'm not going to say reduced the technological benefit that we offer to client but there are some things we can do in some special features that we might eliminate that will really have a negative impact on the value proposition, but could make fairly significant cost reductions.

And as Jan Kees said, we're not going to take bad business, but there is plenty of business out there and we think that if we focus on the core, and we work at some of the cost, the designs in some of these costs -- if you see the costs of some of these designs, then we maybe able to pick up a little bit of share. And so we're doing that in the course of 2014. These aren't long-term projects. So we're after that also.

Operator

Our next question will be coming from the line of Robin Shoemaker from Citi.

Robin Shoemaker - Citi

Just going back to the new unit ordering kind of shortfall versus expectations. I'm just wondering, if you have any experience in which a significant order that you though you would win maybe went to a competitor or if there is instances in which these project delays that we keep hearing about actually result in just like cancellation. In other words, they've just done the math and decided this project doesn't work. We keep hearing about delays, but I wonder if you actually see projects that are just not going forward that company has following a major review of that project?

Vincent Volpe

Well, there are a couple of different ways, because the answer for the fourth quarter, it maybe a proxy for the year. But if I just look at the fourth quarter, what we've seen is these jobs have been delayed, and so they moved out of the period. In Q4, I am not looking at any major orders that were cancelled. During the course of the year, if we talk to our new unit folks, there may have been one or two that have either been canceled or significantly re-scoped, like orders of magnitude change and what they thought they were going to build to what they're going to actually build.

As far as the share goes, from one month to the next, you win when you thought you were going to lose and you lose when you though you were going to win. So I don't see any upstream space. I don't see a lot of movement there. But again, I think it's mostly movement outward to the right, not actual destruction of the demand per se. And I think in terms of the competitive nature of the upstream business, that's fairly stable.

Robin Shoemaker - Citi

So let me ask about the Apex project, I think that was $200 million booking. And if I'm doing my math right, you took off $48 million or you de-booked $48 million of that project. So what's going on there in terms of the scope of work?

Vincent Volpe

We think it's fundamentally a client and a cash flow issue. And so they've looked at the -- as we feel, we've got two different types of equipment, trains being sold there. There is a compression frame, where you're putting the air into the ground and then there is a power generation frame.

So they ordered a certain combination of compressors and expanders to do all of this work. And as they've looked at it, and they've looked at the cash flow of the project and the economics, what they're really saying is, we can delay some of the compression on and still manage the whole project. So we've agreed that the best thing for them to do is to take that, reduce the scope by that amount.

And we believe, and nobody is sure, but we believe some of that compression probably comes back, don't know when, maybe a year, maybe two years, they decide they want to add it. There is no specific date, so we treat it as a cancellation. But the project is actually going forward, it's just a modification to the scope.

Have this happened in 2014 rather than 2013, we would not have de-booked that portion of the project, we would have just adjusted our backlog. But our internal accounting is that, if you book something in the year and then part of it is canceled in the year, it's considered a de-booking or as if you book it in the year and its canceled or a part of it is canceled the following year, it's an adjustment in backlog. So it's sort of an accounting thing, but it's not a statement about the overall project per se, Robin.

Robin Shoemaker - Citi

So with your joint venture that you've got here with Gaelectric on this CAES. Just give us kind of where you think the CAES opportunity is in energy storage generally?

Vincent Volpe

Well, I think Gaelectric is -- we're in process of doing feed space for them. It's possible that in 2014 that could move to an equipment order or it maybe '15. I think that's sort of what we're talking about. There is at least one other significant project, which I don't know that we believe we'll close in '14, it maybe '15 also, and there are variety of projects beyond that. So I think that Gaelectric is probably the next one to go.

And when you look at the overall market, there is 20, 30, 40 projects being looked at, at one degree or another. And what I like about this is, I don't think 20 or 30 or 40 of these are going to be ordered in a year. I think that they take time to develop. Each one of the field applications is different. We see, we know the tariffs, the energy rates are different. The storage, the cabin configurations are different. The available wind that's on that grade is different. All of these things are factors.

And so each one of these requires its own study. This isn't a cookie-cutter from an investment standpoint, it is a little bit in terms of the equipment standpoint, we standardized on our offerings. So my view and my hope is sort of one year for the next X amount of years will be terrific. This is definitely a business not just a project.

Operator

Our next question will be coming from the line of David Anderson from JPMorgan.

David Anderson - JPMorgan

I just wanted to ask about the aftermarket side. In your guidance, when you look at it, if you kind of pull out the stuff going on in Spain, it looks like aftermarket is going to be relatively flat, like for like with 2013. Can you talk about that a bit? I mean this is a business we have been kind of counting on to be in the double-digit growth, the last three years, just if you go back to '06 it's typically been kind of 10%-plus growth. So can you talk about what's happening kind of more fundamentally in that business? And how do expect that to trend say over the next 12 to 18?

Vincent Volpe

I think what we have in there is about a 5% to 10% increase in both bookings and sales when you adjust for the $132 million in Spain. So I'm not sure it's flat, I think it's up a little bit, but your point still is right and that is we normally expect 10%-plus or on the order of magnitude to 10%. Dave, what's going on is we have a very large receivables in a Latin American country that needs to be worked down. And until we work that down and we've started to make progress, we put the breaks on, little bit in terms of our aspiration or expectations.

Now, we should hope that we can get it to a level that we think is acceptable and manageable. But we're not going to let this thing overtake us. And so Jan Kees and I have thought hard about this and made the decision that we're going to factor some of that out. So in other words, instead of me saying to you, we're good to go for another 10% a year. And then halfway through the year, having to get on the phone and say, you know what, these guys aren't paying their bills and so we're going to have to shut down some of this business until they do. And so you know what this is a significant part of our aftermarket, its material. We disclosed it in the 10-K and we're really sorry we're not going to make our aftermarket number.

What we decided to do is try and get out in front of it and say, look we're going to try like crazy to work with these folks, they're really good customers and find a way to make sure that the receivables should doesn't get out of control, but if it does, if that is not the case, we want to have the lever here at management level to be able to say, you know what, we are not going to ship this stuff until you get this sorted out. And I don't want to do that without having put the investment community sort of built that into what I provided to the investment community.

So the difference, Dave, really very clearly is that it's a big opportunity. Its material to our numbers and it is principally one customer. You could look and say, well, there's Iraq and there is Syria and there is Libya and other stuffs, but that stuff we live with that from one day to the next. This is a bit special, so we're baking in a pretty small year with that one specific customer in that one country. And that's really the difference between sort of what we've said, which is kind of the 5% to 10% to what we normally say, which is more robust around, we think we can count on steady 10% compounded annual growth rate, that's what it is.

David Anderson - JPMorgan

So that one country is sort of the swing factor between the 5% to 10%, basically is what you're saying?

Vincent Volpe

Yes, it is, Dave. And if you look at my comments, sorry to prolong this, but if you look at the comments, Jan Kees has identified that there is always geopolitical risk in our numbers. But I also said that there is geopolitical risk, but part of that's been factored in and that's what I've just described.

David Anderson - JPMorgan

Now, I didn't see a break out kind of talking about the mix between that kind of the upstream, downstream, and midstream and new units. Now, looking back on 2013, can you kind of let us know, how did the mix look in 2013? What was different from prior years? And typically, it's been sort of a third from upstream, a third from downstream, and the rest has been kind of midstream environmental solutions. Can you talk about that a little bit?

Vincent Volpe

2013 was less than 30% upstream in sales.

David Anderson - JPMorgan

I mean that's either way its fine?

Vincent Volpe

No, we haven't had, since the recession in 2009, which really killed, right, killed the off services and the oil production, we booked 26% of our upstream business -- excuse me, 26% of our bookings in 2009 were upstream. 26% of our bookings in 2013 were upstream. In the intermediate years, 2010, 2011 to 2012, the number was of 44%, 41% and 34% respectively. So we had seen a significant drop versus the previous three years, call it 10% of the total swing.

The midstream has stayed fairly flat at about 15%, downstream at a third is about where it was, and the environmental has picked up 26% and now it's principally CAES in 2013. So there has been a flip-flop between the upstream and the environmental space this year-to-date. And I think 2014 we'll see a little bit more in the upstream than what we saw in '13.

David Anderson - JPMorgan

So Vince, you're talking about the 2010 Analyst Day and some of the projections of how you haven't quite made those kind of numbers. It seems to me, kind of it's a couple of different categories. Obviously, you talked about these some of these upstream delays, but also seems like the refining, maybe side hasn't picked up quite as much as you thought. I am just kind of curious how those two factor in, along with environmental solutions?

And also, there was a lot of R&D spend I think you were counting on to turn more into revenue. ICS is kind of one, which you have talked about quite a bit. Can you talk about maybe kind of that shortfall of between that projections in 2010 versus what you're looking at today? And kind of how would you rank what the cause of that shortfall is? Maybe I missed something, which you just described, but it seems to me that those are the key issues with that shortfall.

Vincent Volpe

I think the biggest one by a mile is the upstream. And you've got, if you look at the slide there, there is $800 million in delays. And then the low gas price has cost us about $100 million. And of course, if you add all these odd numbers, you get to a bigger shortfall than what we actually saw. We had an overall shortfall of about $1 billion yet, vis-à-vis you had $900 million, you get $1.1 billion -- you get about $1.4 billion. So the biggest single thing is project delays and the low gas price, quietly offset by petrochemical. I don't think that we're all that short on what we were expecting with petrochemical.

And then if we get into the aftermarket, the single biggest thing was the delay in gas turbine repair, because what I explained, which was basically, we had a recession and we knew we had recession at the time, but what we didn't really understand was how long it was going to take to this repair market to pick back up.

With really big customers, like Calpine and others just moved overhauls out. So we suffered from that. So I am going to say, now I am kind of making this up, Dave. I mean, nobody asked me the question the way you did, I must say three quarters of this volume, what's called $1 billion, we're off by three quarters of it is driven by the market or some high percentage.

And another part of it is us. And I am talking about volume now. I am actually satisfied with the way that the margins and the way company has developed in terms of the operational excellence initiatives. So the, us, part is sort of what you're refer to. So by now, I would have expected that we would have had more ICS business than what we have. So that's a shortfall.

I don't remember, it's Dave, but maybe it's another biggest $50 million or I don't know, some number. Maybe it's a $100 million. I don't know that it's more than that. I don't think it would have been in terms of what we were expecting in revenues. And the other is supersonic compressor. And the supersonic Ramgen, and so on the ICS, I think we underestimated the amount of time it was going to get for the people that needed to change their designs to change their designs.

So let me to be more specific. You've got a device and you go out and say this thing is have to wait and have the footprints of what it is that you normally have to put on a platform. Remember, we weren't really counting on a subsequent business in this period. This is really top side stuff. And so he said, that's right. And so we said, so you should buy it, right.

And we're going to -- by the way, we built one of those really small for Petrobras and that's run for a while and now Petrobras got it shutdown or doing something else on it. That will run again. And we are doing this development and we are building a unit with Statoil, that's says 10, 12 megawatt unit, which is right in the middle of the sweet spot. And so we say to people you have to buy this thing.

And so what they're focused on is it doesn't do me any good to buy something that's small and light, if I can't change my vessel design. And I am not going to change my vessel design, if I am building a same vessel, I'll built two pilots ago, and I am going to duplicate everything on there. So they will change their vessel design going forward.

And I know, specifically a one client, one vessel manufacturer or a vessel supplier, if you will, that is very focused on this and understands if there is a huge competitive advantage out there for them to do it. So I believe going forward, at least with that, and it's one of the major three that are in this business, I believe that we're going to start to see some business coming from them.

The good news -- so that's the bad news. It's just slower to market than we thought. It is not a product issue. We've got our mag bearings in there. We've got what we think is a good motor solution. The separator works great, compressor and so forth. So the issue really is market adoption and it's not the end users either. The end user is very interested in having this. It's really the people that are where there is so much CapEx involved, the people that are designing the vessels are taking the advantage of the ship. So we will get there.

We have had some success on the Littoral project. We design the quote unquote vessel. It wasn't a ship by the way. There were 2,000 ton modules that I am happy to report that's have a ship on time, their complete modules. And may have data mines on there and this is the value proposition and because we decided what went inside of these modules, we've got to put what we wanted and PEMEX was very supportive. The units ran just great on test. And so they've been toed out there now and are in the process of being installed and this is for Littoral and [ph] El Tabasco.

And so we do have I think end user client acceptance. We've got a couple of data mines that have gone out into the field now, which were the critical pieces of the ICS. And they're going to be running and they're sort of, I am not sure exactly what size they are, but they're somewhere between 10 and 20 megawatts. So there are not there in the sweet spot and we'll get more operating time, and then I think we'll just continue to work with boat maker. So that's the ICS side.

The other piece is the RAM presser. And you're talking about making a whole scale change in technology here, and you are going from subsonic to supersonic compression and all the advantages of that, in terms of huge cost reduction in the equipment cost and the footprint and the ability to maintain new unit and so forth. And what we got, to be very direct with you, was pretty good design, but not a design from an efficiency standpoint that we are satisfied with or operating range.

And so we've said look instead of pushing forward with that configuration, we've made a design change and it's more than just on the board now, Dave. We're going to build that unit this year. So I would have like to, and tested, and I think once we do there is a great deal of market interest in that. And that's not going to have the same gestation period for adoption.

We build out then, we tested, we show everybody it works, and starting the next day we've got a unit that can be substituted for not just CO2 sequestration and storage, but also on air separation and some of these other markets that have traditionally been served by integrally geared machines that we don't even build. So I believe that we're going to penetrate a new market space with this pretty quickly.

But again, I would say we're 18 months behind, where we thought we would have been in 2010. And I think those are the two biggies. Dave, I mean I could scrape around out for other stuff, we don't do every time right, but we do other things better than we thought also, right. We didn't know about LNGo in 2010.

So if I kind of summarize this, I'm going to say about three quarters for this, and don't hold me to that percentage, probably three quarters of the volume that we're not getting is based on external market. About a quarter of it is of our own doing, and those two misses in terms of where we thought we'd be from a development standpoint.

But the underlying theme here is, again, there is nobody that's more sensitive about the fact that we're up by $1 billion. But the data suggest that what we have done and what we are considering to do in terms of operational excellence is such that, as that volume comes and as we launch these new projects that have better margins than traditional market, and the LNGo was one of those, I believe that the operating income or the EPS projections wrapped around that $4 billion are still retainable.

Operator

Our next question will come from the line of Martin Malloy from Johnson Rice.

Martin Malloy - Johnson Rice

On the aftermarket side, can you talk about what percent of your aftermarket revenue and operating income are derived from the energy assets? What's the risk of care of changes in countries other than Spain? And does it make sense for you to continue to own these assets or would they perhaps be worth more to someone else?

Vincent Volpe

Well, I'm going to answer a part of it and then I'm going to let Jan Kees [indiscernible] to answer the rest of it. In terms of feed-in tariffs, I think the worst of it is now behind us. Nobody likes to talk about feed-in and that's what it is, right. And so there is feed in tariffs associated with that on government subsidies, if you will.

I don't believe it would feel as much of a risk on the other energy assets in terms of that. But Jan Kees, I don't have a same view, and then would you discuss sort of the rest of the question, which is what percentage of your aftermarket is the energy assets. I know we've thought about divesting them, could you perhaps shed a little light on why we don't think at this point it's a great idea?

Jan Kees van Gaalen

I think typically the energy assets run around 18%, 19%, 17% of the aftermarket. And that includes the Spanish aftermarket assets energy asset, I beg your pardon, the beautiful, the bad and the average. So effectively the pig manure is not so good in terms of feed-in tariffs, and how you say, operating income that these assets were generating.

In terms of the solar plants that we have in Italy, those are reasonable, but you know we have decided to dispose off those. And we will continue to look and in the meantime we're operating them as long as we don't have a viable, how do you say, transaction ahead of us. In terms of the Brazilian energy assets, the Brazilian energy assets run at reasonably good aftermarket margins, slightly less than what we would historically have for the aftermarket, but that's still a lot better than just our cost of capital and they are accretive.

Vincent Volpe

And I think the issue around the disposal, Jan Kees, is we thought about it and --

Jan Kees van Gaalen

We basically thought about disposing all of these energy generating assets. We've looked at certain number of times at propositions on the pig manure, but never really were able to take those anywhere further. In terms of Kaggio we've mentioned a couple of times and we still hope to close something there. And then the Brazil assets, we are renewing a certain number of the contracts for areas, as we're going along over the last year and there is still some renewals coming this year. And that basically puts some of these contracts on three to five-year time horizons.

A couple of big RFPs out there that we are participating in, and subject to winning one of those RFPs, we basically could structure the business either to hold on to it if we like the margins and the overall business or if we feel that we need to do something different in Brazil, perhaps missed it, perhaps sell it to a partner, perhaps find private equity partner, there are various options one can look at.

Vincent Volpe

But the default is we have these assets in Brazil. They are numerous, they are generating good returns. The contracts in some cases are getting extended. The amount of extension that you get wouldn't be enough to make it attractive for somebody else to step in and buy it. But of course, if you get an extension and your assets been depreciated and you just need to do a little bit of maintenance on them, the ROI on those assets incrementally going forward gets to be very, very attractive.

So we're fine with what we've got. We do not have a strategy to continue to grow assets and put them on our balance sheet, we don't like that model and that's not. So our default is go ahead and take more of these orders, but make sure that you're not going to carry them on your books. In other words, build it, own it, for the time that you're building inventory, transfer it, and then do all the operations and maintenance on it now.

So Jan Kees has talked about a variety of different alternatives that he is looking at. But the reality is, I want to be clear, we do not have a strategy to expand our energy asset business in terms of what we put on the balance sheet.

Martin Malloy - Johnson Rice

And could you comment on the potential Kaggio sale and what are the issues for the delay?

Vincent Volpe

Well, I can't comment on the issues for the delay, because that's something between us and our perspective buyer, which is NBB, that's already been disclosed, okay. That was disclosed last year. What I would say is that things that there have been a variety of delays and things have dragged on, and so we basically made the decision to reclassify as an asset at this point. And if the sale goes through and it's a good sale, that make sense, great, terrific. If not, what we have built into our plan right now is to run and operate that asset from now until the time that there is no asset to run and operate. So built into our plan this year would be our energy sales from the asset.

And so obviously, if there is a purchase out there that has a better return in doing that on an NPB basis, we'll do it. And so everything is not shutdown, in terms of the discussions with our perspective purchaser. But we've made the decision internally that it would be most prudent, given some of the delays that we've had and it would be most prudent not to assume that that sale is going forward. And so we've decided to reclassify and put it into our asset base.

Operator

Our next question will be coming from the line of George O'Leary from Tudor, Pickering, Holt & Company.

George O'Leary - Tudor, Pickering, Holt & Company

Maybe touching on one of the prior questions, could you talk about what normalized margins for that aftermarket business would look like, a, just excluding the pig manure treatment business, and b, x the energy assets?

Vincent Volpe

Well, x the pig manure business, what was the impact of pig manure business, do we know. It's not enough to move the needle, let me just say that. I think the overall energy asset business, we felt it had about a 300 basis points, does that replaces?

Jan Kees van Gaalen

We made the Guascor acquisition at time we indicated because of the change in mix. The increase in services, including the energy assets, would tap down aftermarket margins 200 basis points, 300 basis points. We went further to say that the energy asset margins overall are consistent with services.

Vincent Volpe

On a standard variable margin basis. And I think what we're seeing is, you might have, and I think Jan Kees said it also, so probably a 200 basis points, so when you're at 22% or 23%, had you not had those energy assets you might have been at 25%. However, that being said, it's still accretive to the overall company, because you knew your margins are at 10%. And so in terms of return on capital and in terms of return on sales, this is an accretive business for us and we like it. It's just not as lucrative as the traditional segment was, if you will If I could further just mentioned, as Jan Kees commented, the Brazilian energy assets are generating better returns than the Spanish assets.

George O'Leary - Tudor, Pickering, Holt & Company

And then you guys have been working to reduce cycle times just in general on your new units business. Could you just provide an update of kind of where you are on average from the cycle time perspective? And what level you have come down from, just to frame that?

Vincent Volpe

Well, it varies by product offering. We're really focused on our turbo products business to begin with. And the best way to measure this is what we quote, in other words, if you look at the deliveries one year to next, you could have quoted something and had a real long cycle time two years prior to that. So now in terms of delivered cycle times we're not all that focused on that number. The number we're really focused on is what we quote for a given piece of equipment today versus what we were quoting in 2011.

And our goal was really by next year, this year 2014, to be in a position where we are quoting about 50% cycle time versus what we were quoting back in 2011, and we're getting close to that. Now we're 70%, 80% of the way there and we continue to work on this. So something that we were quoting in 60 weeks, three years ago, we maybe now in the 40 week, 35 to 40 week range. And that is part of how you get the $4 billion in sales without making a big change to year-over-year footprint, the manufacturing footprint.

Jan Kees van Gaalen

And the improving the asset turns, the cycle time allows us and helps us to improve the asset turns that we do in our manufacturing facilities. And so it will work towards the improvement of the ROI.

Operator

Our next question will be coming from the line of Jeff Spittel from Clarkson Capital Markets.

Jeff Spittel - Clarkson Capital Markets

Maybe if we could hone in on the working capital. I understand that there are a lot of moving parts there. But perhaps could you just lay out maybe some preliminary expectations for, given all the moving parts throughout the year, what are reasonable expectation in terms of order of magnitude would be for the reduction in working capital in 2014?

Jan Kees van Gaalen

Look, we would hope towards a working capital target of approximately 15% towards yearend. Obviously, we have a couple of extraordinary element in there, which I have listed as part of my spoken comments. Then we have obviously the ongoing aftermarket business, which has its typical 20% around that right of LTM sales, working capital profile. And then the new unit business depends a little bit on the customer base. But the typical turns that we have for example, in the Littoral job, even PEMEX doesn't want to repeat in. And so we are working very hard with our perspective customers to make sure that the terms for the new bookings reflect good advantage and payments for progress.

Vincent Volpe

Jeff, just to pipe-in for a second. I mean I think as you think about the ability to generate free cash flow, first of all, there is a reduction from end of the third quarter at the end of the fourth quarter and net working capital actually came down a little bit. And then, we think that it will come down again by the end of the year. It's hard to get to the exact number.

But I think if you're modeling this, do not count on net working capital as being a use of cash. In 2014, it should be either neutral or a slight source of cash. And when we talk about percentages, we think a 12 point average. We've got to measure every month, right. You have to make payroll. So what you see at quarter ends and there is quite a bit of movement in intra-quarter activity also, which I think Jan Kees addressed with the percentage he gave.

Jeff Spittel - Clarkson Capital Markets

And I'll be the guy to ask this question, I guess, The ValueAct filing relatively recently, I guess just curious in terms of your impressions with the initial conversations of what the tone has been? And then I guess if you could provide any color and lighten us about what their articulated agenda is?

Vincent Volpe

Well, all I can do is tell you -- I'd tell you a couple of things. One, they've been in and out of our stock several times already. They have been fairly short-term investors, so I don't know, I would call that good or bad. But I guess we like long-term investors. They haven't been in for a long time. But they did decide to come in a big way here.

And the feedback that I've got directly, which is why I'm the one answering the question, was we like the company. We think now is a good entry point. We like the fact that you've got a very strong aftermarket that we can depend on. And the comment that was made was we think we're going to be in the stock for a while, and looking forward to meeting with you, and we're going to meet with them in the not too distant future. So that's some exceptions of what we've gotten from, so it's quite cordial and positive, right.

Operator

Our next question will come from the line of Jon Donnel from Howard Weil.

Jon Donnel - Howard Weil

I appreciate all the details on the guidance. I was just wondering a little bit on maybe the risk to the numbers and specifically to the range that you've got at the topline. I think in light of just kind of what we saw from fourth quarter and even just compared to the $219 million that slipped from '13 into '14. I wonder if you could just maybe describe to us whether there's still a lot of backend weighting that's going on, I would imagine there is, given that the first quarter outlook. But is there a big percentage of larger projects that are still to be shipped in fourth quarter again, as we think about the 2014 numbers? And it just seem like that was a really narrow range compared to what we've seen come through on the actuals from the topline.

Vincent Volpe

Well, John, the last thing you said is absolutely right. In fact, as recently at 6:30 in the morning I was saying, are you sure we don't want to have $200 million range on this, and you secondly answered itself. But let's go back to what we've discovered here, and it's been, look, I mean its been very painful John.

First this is you ask yourself, why did we miss the last couple of years, and you start with operating income or EPS, because that's where our memory goes, right. And we keep looking for this project slipped, that project slipped, and then what finally dawned on us that the issue is not the margins, it's the volume. And so that's what sort of brought us back to forecasting process.

So while we mentioned on the call, but I can tell you here is around and the formal remarks was, it wasn't just that we had a timing change, it's also that we have been through this now. Jan Kees, at least three iterations since the end of the year, and said, basically if we can get our volume right or close to be in right, we're going to be close to be and right on our earnings, because we're pretty good at predicting the margins. A lot of the stuff is in the backlog and so forth.

So we worked really hard at that. We've had probably three iterations since the beginning of this year and gone through with each of the facilities and said, what have you got, what could move. And we specifically ask the question you did, John, which is what you got in the fourth quarter, what could move out, and the result of that was what you saw on the slide.

Now that we're in the beginning of the year and you see something called, reschedule for Q '13 backlog to 2015, that's $90 million books right there. Basically, job that's schedule now, in this case it's the client, that we think is not going to want it and we actually think we could be done with it. But we went through and said, look, what have you got in the fourth quarter that you could lose or that you could slip, because again our assumption was let's work really hard at the revenue side of this equation now to get that right or close to right, and then the earnings will follow.

So we've done three extra iterations that we would not normally have done, had we given you the guidance in November of last year like we normally did in October, November timeframe. And yes there is some of the fourth quarter schedule that now we're looking at it slipping out. And so I don't think that we see right now the fourth quarter necessarily is having to be as huge on a percentage basis, as it has traditionally been in previous years.

Jon Donnel - Howard Weil

And then I guess kind of similarly on the margin side of that question there. It looks like if we just kind of look at the range.

Vincent Volpe

Sorry, John, before you go there, but let me say, it's still going to be the biggest quarter. So I don't want to leave you the impression that we've completely the risk adjusted new forms just like any other report. We're still seasonal. There is still a lot of stuff to close at the end and a lot of that is the aftermarket, where the customer compresses the cycle time on us.

We quote three months delivery or four months delivery on a part, they don't buy it. They get to October and say, I need the part, I've got my budget, but now I need it in two months. So we're still going to have -- the biggest quarter will still be Q4. So sorry to interrupt you, go ahead and talk about your next.

Jon Donnel - Howard Weil

On the margin side of that and maybe this kind of circles back to what is embedded in the backlog here. But it seems like the margins, if we just kind of look at the range versus the range, the incremental margins for the potential differences are smaller than the total average margins. So I mean does that suggest that it's a certain subset that's really at risk here maybe the upstream side, is that right to think that that's got lower kind of embedded margins in the backlog currently, right now? I mean, certainly, you've had better on the new unit side kind of gross margins in the last couple of quarters, as we have more of the upstream stuff slipping. Am I thinking about that correctly? How can you help us think about what's actually going to be moving through that backlog, as we get to the end of the year?

Vincent Volpe

Well, I think it's really hard. I wouldn't make the assumption that the upstream has got lower margins, okay. That's not the case. And so there is a lot of moving parts, including the switch in allocations between units and aftermarket. So I think the guidance that I would give you is, this year recognizing that we're talking about pretty similar sales to what we had in 2013.

I think that the segment margins are going to be pretty consistent with what you saw this year, all right. And we haven't given you detailed guidance on it, is it 9, 10, 8, 12, whatever on units, but I think I'd look for similar margins year-over-year. And if you look at the business, what are we really doing, we're on the same sales. If you were to take the impact of both years, you would have about $380 million something in operating income in 2013on a little. more in $3 billion in sales, going to a midpoint of about $400 million in operating income in 2014 on the same sales.

So what you're in '14 is you're getting call it 3%, 4% productivity improvement on more margin expansion if you will and the overall business, due to operational excellence issues, cycle time, cost quality and so forth. And so again I think you will see for that differential, that pretty small differential 3%, that's not 3 percentage points, right, it's 3% operating income improvement. You should expect fairly similar margins in both units and aftermarket.

Operator

Our next question will be coming from the line of Chuck Minervino from Susquehanna.

Chuck Minervino - Susquehanna

Just wanted to ask some details about the revenue guidance for 2014. You have about $219 million there from the pipeline and the solar park, and you mentioned some technical issues there too. And I guess, my question is, these are kind of projects that have had delays or unintended consequences along the way? Just wanted to know how your comfort level that you will see those types of revenues from those particular projects in 2014? Is that kind of a risk-adjusted number or is it a pretty high confidence level number?

Vincent Volpe

They are fine. The pipeline project was delivered at the end of the third quarter, more officially, I guess, delivered in the fourth quarter last year. So the equipment is already delivered. This was really around, frankly, a discussion about what documentation is required in order to achieve revenue recognition. And so we're still kind of working on that. We'll either book that in the first quarter or the second quarter of this year. But there's no physical work to be done on that, Chuck. That's done.

The second one is Kaggio, and we have de-booked that now, right. That's the solar parks. So we've actually taken that out of the number, right. When you look at our new unit bookings of 365, we de-booked it and as I mentioned earlier on previous comment, we've taken the incremental earnings associated with that out of the plan.

So that's out. So there is no risk there and then the technical issues, those were basically three different jobs and all of those technical problems have been solved now. Two of the three jobs have already been delivered and that was a $135 million of this, right those three jobs. Two of the three have already been delivered and second and the third one is schedule for Q2 delivery. So I think that's 19 discovered.

Chuck Minervino - Susque4hanna

So I guess I was just a little confused on maybe the solar park. If I heard you correctly earlier, are you going to run that now as an asset?

Vincent Volpe

Yes.

Chuck Minervino - Susquehanna

And so you are going -- are you going to be generating revenue?

Vincent Volpe

We're going to continue to operate it as a revenue producing, profit producing asset.

Chuck Minervino - Susquehanna

And can you give us a sense of the size of the revenues on that? So that's going to be a recurring revenue stream then beyond 2014 at least that's how it's contemplated right now, unless something changes on the sale of that?

Vincent Volpe

Chuck, we don't really break that stuff out for a variety of reasons as you can probably imagine. So the trick here is you look at the net present value of the future cash flow stream and then you evaluate that with what somebody repay you right now for it. And so we think that the deal that we almost had done made financial economic sense, not hugely positive, but positive.

And so we were willing to go through with the sale and in terms and it still looks like a positive and there is an opportunity to do, we'll do it. But if not, we'll reevaluate as time goes by and figure out whether or not we should do it. So we've disclosed that it was on a sale basis about $30 million in revenue. And that's really as far as we got on that one.

Jan Kees van Gaalen

That's from the divestiture perspective.

Chuck Minervino - Susquehanna

And then its just one question on the new unit margins. And you kind of look at 3Q and 4Q, and you were up into those double-digits both of those quarters, and the most recent quarters. And even your 4Q this year was higher than it was in prior years. Just wondering if you are seeing something there where you have maybe entered a higher level here on the new unit side? Maybe that's not a run rate for a full year, but have you seen some better efficiencies on the new unit side?

Jan Kees van Gaalen

I think that, yes, they are double-digits. Now the 10.6% is an impossible number to understand, because it's got Spain in it. So if you factor out Spain and this in fact -- if you just factor out Spain, it is between 17% and 18% operating income margin. And that it would be on just shy of a $1 billion in revenue.

Vincent Volpe

So what that says to you is, number one, the business can produce between $3.5 billion and $4 billion a year, right. That's a capacity to get to that elusive $4 billion target that we've been talking about. And because of the impact of the volume, it says that, 17% operating margin is getting into the zip code of which we're looking for from the overall business. So it's encouraging from a pro forma basis and that it says that if you get the volume, you are going to get mid double-digit, we talked double-digit means 10% to 20%, somewhere mid double-digit to above mid double-digit operating returns in the overall business.

Then what I've also said is things that are in front of us like new product launches should also help us improve the variable margin line through the cost on a variable margin line basis. So in other words, the volume you saw there was an improvement not because of standard variable margins it was because of the overall volume.

If you got a layer on top of that, it's not factored into any forecast, but if you layer on top of that, the fact that supersonic compressor, ICS, LNGo, [ph] Hayes are all fundamentally better-margin businesses on a variable margin basis, that should mean some margins will expand yet again.

Chuck Minervino - Susquehanna

Just given that probably a lot of people on the call aren't really following how the movement of the draft regulation in Spain is going on the pig manure farms? And I know you've taken this now out of your guidance, which maybe makes us assume that you have a greater than 50% probability that, that regulation could pass. Can you give us your sense of the latest update or when we will hear news on that? Or even your kind of probability that maybe that draft regulation doesn't pass?

Jan Kees Van Gaalen

First of all, in 2008, not dissimilar issue arose when the Spanish government started the discussion about the tariffs. And it took about two months to sort the tariffs out to the level that we've enjoyed until the end of June last year. We are the moment discussing with the Ministry of Industry and the Ministry of Agriculture.

A report has been prepared by the Industry Association of the 29 generation facilities. That report is going to be discussed for about a month between the two ministries. And they will provide us then with their answers. And we will have a certain time for concentration with the ministries.

So I suspect that the earliest an answer that will come back is going to be May and that is also the time of the elections in Europe. So that may condition some of the timing as well a little bit. But I would imagine for the moment it's in the middle of the second quarter.

Operator

Thank you. And at this time, I am not showing any further questions. I would now like to turn the call back over to management for any closing remarks.

Vincent Volpe

Thank you, Charlotte. I want to thank everybody for joining the call today. If you have further questions, this is Blaise Derrico, I'm available. My number can be found at the bottom of the news release. Everybody have a great day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone, have a great day.

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