Joy Global Earnings Call Nuggets: Aftermarket Business and Restructuring

Joy Global (NASDAQ:JOY) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Aftermarket Business

Andy Kaplowitz – Barclays Capital: Mike Olsen, congrats on your retirement again. Mike Sutherlin, if I could ask you about aftermarket, the aftermarket business was down 5% in terms of orders in the quarter and it was flat for the year. Can you sort of reconcile for us what’s in your guidance for ’13 in terms of aftermarket? Is it still sort of that flattish growth that you expect and what’s the visibility like to flattish for 2013 in aftermarket?

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Michael W. Sutherlin – CEO and President: Let me just touch on 2012 for just a second, because I think it relates to what we see for 2013. The flattish aftermarket that we had was largely the international markets growing year-over-year and offsetting the decline we’ve seen in the U.S. coal markets. So, we’ve seen a pretty significant decline in the U.S. coal market, not unlike that which we saw in 2009. Due to different reasons, but the magnitudes are not all that dissimilar. So, fairly significant decline in a large sector for us and we saw the aftermarket in other regions around the world capable of offsetting that. We do have a pretty consistent aftermarket on an annual basis. On a quarterly basis, we do get some lumpiness for example from China. We’ll get large aftermarket orders three or four times a year rather than monthly. So, the fact we got a large order in our third quarter from China that became aftermarket revenue in our fourth quarter as we delivered that order. So, I think you got to look at the year-over-year more so than the fourth quarter just because the predictability on aftermarket even on a quarterly basis particularly with large parts orders is not absolutely crystal clear and it’s not always consistent. As we look at 2013, we’ve gone back and looked at our aftermarket business over long periods of time and aftermarket has historically in worse conditions has flattened. In 2009, we saw aftermarket flat now and I think it demonstrates the stability there. We’re looking today — aftermarket is generally aligned to production rate, so we’re looking at some decline in production rates, but not massive declines globally in production rates. U.S. is going to seem a little bit more severe because the structural changes to – the coal volume in the U.S. is not down all that much. It’s like 5% or 8% or something in production, but much more in Central Appalachia. We’re seeing increases in Illinois basin. So, that structural dislocation is having a bigger impact on aftermarket in the U.S. and yet there through 2012 we were able to offset that albeit in national markets. Generally those adjustments are more severe at the early stages as people destock inventories at mine sites and part equipment and things like that and then they begin to move back up to a little bit higher level where we see stabilization. So, in that regard 2012, would represent what we would expect to be possibly the worst year for our U.S. underground coal aftermarket, so you put all those things together and I think we still believe that the aftermarket is going to be able to stabilize over 2013 given what we see new machines coming into the fleet, machines moving into their first rebuild cycle, production levels internationally coming off a bit but not dramatically, and you put all that into the equation and we expect our aftermarket to hold its own in 2013.

Andy Kaplowitz – Barclays Capital: Let me take a short at a slightly longer-term question. You had relatively good awards in the quarter and you guided to 2012 order rates carrying forward into ’13. I know it’s early, but one of the big questions that I think we have is whether earnings should stabilize at your ’13 rate as you go into ’14. I mean, I think you’re kind of hinting that at least at this point you think that’s possible given the stabilization of the markets, but I don’t want to put words in your mouth. How do you look at sort of ’14 and beyond versus ’13? Is this going to be sort of the bottom in earnings and what confidence level do you have around that?

Michael W. Sutherlin – CEO and President: Well, I think two sides of that, one side is the market side and we certainly have seen our customers adjust CapEx to cash flow, and cash flow dropped pretty dramatically in 2012 as commodity pricing came down. And we’ve seen commodity prices in the second half stabilize. In the fourth quarter, we saw it’s starting to move up in commodity price and certainly iron ore has regained a lot of its loss. So, we’re starting to see some – we’re seeing a roll over in met coal, but we expect the first quarter to be better as the steel mills go back to restocking of iron ore and met coal. With those pricing level, we will some improved cash flow and I think that our expectation from that and talking to customers is that we’ll see a stabilization of cash flow. We don’t expect to see multiyear significant declines in customer cash flow. Our customers generally believe that when they stopped projects in 2008, restarted them in 2010, that process was very inefficient. The push to catch up in 2011 created a lot of inefficiency and gave them projects that had higher cost than they had planned for. So this idea of starting and stopping big projects had some negative impacts on cost efficiencies and so at this point I don’t see multiyear significant declines in CapEx. We really do believe CapEx is going to stabilize and what we see is at 2013 level that our customer is looking for the opportunity to bring new capacity back online. First that will be their bets projects with – they will come in low on the marginal cost curve, but they certainly don’t want to be in a position where we massively undersupply the market and when we start moving, the difference between supply and demand, even though there is excess supply today, the difference is not a large magnitude difference. It’s a relatively small magnitude of difference. So that’s why we talked about CapEx in 2013 when we start to see improvement, it will be back-end loaded. And on our own earnings we have been taking cost out to restructure our business. Some of this is to reflect current market conditions, some of it is in line with our strategic plans. This is for us an opportunity to move forward on some plans that might have taken longer had we done them by the original plan timeline. So this will allow us to accelerate what we plan to do anyhow. But those costs that we incurred in 2012 are helping us to take cost out in 2013. The (restructuring) we’ll be doing in 2013 will help us take more cost out in 2013. So, under level revenue conditions, we would expect 2014 to be a better year than 2013, just as those cost improvements flow through. But we do believe that the market is on a cusp of starting to see some improvement and we think that that will make a bigger impact on our 2014. Long answer to your short question.

Restructuring

Jerry Revich – Goldman Sachs: I’m wondering if you gentlemen can talk about the restructuring that you’re planning for the back half of ’13, just give whatever level of color you’re comfortable giving us on the major efforts or businesses and if you could just help us understand the timing in the back half of the year versus earlier considering the dynamics might be, you just mentioned in response to the last question?

Michael W. Sutherlin – CEO and President: I’m going to push this over to Mike to answer, but we’re not going to be able to give you a lot of specifics because this involves facilities, people and we’ll give you some general directions and sort of where we see that in broad terms. But we just – it’s not good for our business to go down into specifics on some of those plans.

Michael S. Olsen – EVP, CFO and Treasurer: Jerry, what you need to think about is as we go into 2013 there will be two sorts of restructuring activities that will in fact take place. Earlier in the year, there will be restructuring activities that will be a continuation of some of the activities that took place in the fourth quarter of 2012. These will be the more traditional cost reduction activities where as we went through the fourth quarter and identified opportunities we also identified some additional opportunities that would allow us to position ourselves to establish a low overall cost structure. These actions will take place probably either at the very end of the first quarter or most likely in the second quarter and these as I said would be the more traditional cost restructuring, the reduction of headcount. Then in the latter part of 2013 as a result of the timing that will be required, we would in fact look to accelerate the strategic actions that Mike had identified. If you recall, part of our strategy is to move our manufacturing capacity closer to those locations where the opportunities for growth exists. So, we’ll take advantage of the opportunity with some softness in the market to downsize and possibly close those higher cost facilities, and migrate manufacturing footprint to the lower cost locations. Those activities would take place in the latter part of 2013 primarily because of the timing and planning that would be necessary to successfully execute those. So, you would be looking at two phases and two different types of cost reduction activities in 2013. We still anticipate that the costs of those activities will be in that $25 million ballpark and would still be looking at paybacks in that nine-month period. Most of the facility restructuring would be realized in 2014. Some of the more traditional restructuring activity would in fact benefit the second half of 2013.

Jerry Revich – Goldman Sachs: I appreciate the context. And then as a follow-up, I’m wondering if you could touch on where do you expect your proportion of outsourcing activities to stack up exiting 2013 versus where we’re at in the fourth quarter, and if you could just update us in your low-cost facilities roughly what proportion material costs are sourced from low-cost areas versus the higher-cost areas that we have seen historically?

Michael S. Olsen – EVP, CFO and Treasurer: I guess there is a number of questions there. As far as the outsourcing is concerned, as we’ve indicated in the past, we typically have our outsourcing range from 15% to 35% of our direct labor hours. We’ll never get to a situation where we bring all of those outsourced labor hours in house because then that would, in most instances, put those outsourcing partners out of business, and it takes years to in fact develop them. So, over the last quarter or so, we have in fact begun to bring some of that outsourced work back into our facilities and would anticipate by the end of the 2013 fiscal year, we would be at the lower end of that outsourcing range. As we look at the low-cost manufacturing facilities that’s really an evolving process. As we look at those facilities, we initially start with utilizing material that we import into those facilities in order to maintain product quality and then we have the supply chain organization developing the supply chain network that allows us to gradually increase the amount of local content that we incorporate into those products. So there really isn’t anyone percentage that I could actually give you only to say that as we move forward the benefits from moving to those low-cost manufacturing facilities will continue to increase as we source more of the material from those local supply chains.

Michael W. Sutherlin – CEO and President: Just a couple of probably amplifying comments. One is that the sourcing ratio, even in China for us the sourcing ratio today is probably less than half of our total supply is sourced locally, so we still are relatively low on that curve with a lot of opportunity. Some of the restructuring that we’re going to do in 2013 I’ll give you just an example, we have in our Australia operations we have increasing aftermarket requirements based on equipment we’ve been delivering over the last couple of years. It’s not a low-cost country for production, so we’ll start moving the manufacture of original equipment out of China to free up capacity to increase our capability to rebuild and so that out of Australia we’ll probably move that to China and be building those machines in China for delivery to Australia and then focusing our Australia capacity on aftermarket repairs and rebuilds. There’s a number of other projects that we have that are sort of similar nature, but it sort of gives you a flavor of when we talk about optimizing our manufacturing facility, that’s not what we’re talking about doing and that is one example of (indiscernible) but they are all fairly consistent in style and the overall impact.

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