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Bucyrus International Inc. (NASDAQ:BUCY)

Q1 2009 Earnings Call

April 24, 2009 9:00 am ET

Executives

Timothy Sullivan - President & Chief Executive Officer

Craig Mackus - Chief Financial Officer & Secretary

Kent Henschen - Director, Corporate Communications

Analysts

Steve Barger - KeyBanc Capital Markets

Robert Wertheimer – Morgan Stanley

Andy Kaplowitz - Barclays Capital

Jerry Revich – Goldman Sachs

Joel Tiss – Buckingham Research

Ann Duignan - JP Morgan

Paul Bodnar –Longbow Research

Barry Bannister - Stifel Nicolaus

Operator

Welcome to the first quarter Bucyrus International earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Mr. Kent Henschen, Director Corporate Communications.

Kent Henschen

Welcome to Bucyrus's first quarter 2009 earnings release teleconference. As we normally do, in a few minutes I'll turn the teleconference over to Mr. Tim Sullivan our President and Chief Executive Officer, and Mr. Craig Mackus our Chief Financial Officer. As is our practice, too, I'll begin today's teleconference by reviewing the forward-looking statements and cautionary factors.

This call contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be identified by the use of predictive future tense or forward-looking terminology, such as beliefs, anticipates, expects, estimates, intends, may, will, or similar items.

You are cautioned that any such forward-looking statements are not guarantees of future performance and involve significant risk and uncertainties and that actual results may differ materially from those contained in the forward-looking statements, as a result of various factors some of which are unknown.

Bucyrus's policy on forward-looking statements including a list of factors that can cause actual results to differ materially from those anticipated in forward-looking statements, as well as risk factors relating to Bucyrus are included in Bucyrus's 2008 Form 10-K filed with the Securities and Exchange Commission on March 2, 2009, and any other cautionary statements described in other reports filed by Bucyrus with the Securities and Exchange Commission. All forward-looking statements attributable to Bucyrus are expressly qualified in their entirety by the foregoing cautionary statements. Bucyrus undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Now, I'll turn the call over to Tim.

Timothy Sullivan

I am actually joining from a very remote location, hopefully the technology will hold up and we won't have any issues. I'm going to turn the call over to Craig.

Craig Mackus

I'll go through the financial performance for the first quarter and then turn it over to Tim to give more color on the numbers and how the markets are doing. Sales for the first quarter of 2009 were $605.7 million, an increase of $88.8 million or 17.2% from $517 million for the first quarter of 2008. Original equipment sales were $328 million, an increase of $43.9 million or 15.5% and $284.1 million for the first quarter of 2008, and aftermarket parts and service sales were $277.7 million, an increase of $44.8 million or 19.3% from $232.9 million for the first quarter of 2008.

Surface mining sales for the first quarter of 2009 increased 9.5% from the first quarter of 2008. The increase was primarily in aftermarket parts and services and was primarily in the Chilean and Australian markets. There was also moderate increases in aftermarket sales to customers in Brazil and China, which were offset by a decline in Canada.

First quarter 2009 surface mining sales were negatively impacted by $16.8 million due to the affect of the stronger U.S. dollar on sales denominated in foreign currencies compared to the first quarter of 2008. Underground mining sales for the first quarter of 2009 increased 26.5% from the first quarter of 2008. The increase was in both original equipment and aftermarket parts and services.

Increase in original equipment sales was primarily results of strong longwall system sales related to a large order in the Czech Republic received in early 2008. Increase in aftermarket parts and service sales was primarily in the United States. First quarter 2009 underground mining sales were negatively impacted by $20.6 million due to the affect of the stronger U.S. dollar on sales denominated in foreign currencies compared to the first quarter of 2008.

Gross profit for the first quarter 2009 was $170.2 million or 28.1% of sales compared to $141.6 million or 27.4% of sales for the first quarter of 2008. Gross profit for the first quarter of 2009 was increased by $0.5 million of purchase accounting adjustments related to the acquisition of DBT compared to an $8.7 million reduction for the first quarter of 2008. This had the affect of increasing gross margin for the first quarter 2009 by 0.1 percentage points and decreasing gross margin for the first quarter last year by 1.7 percentage points.

The increase in gross profit for the first quarter 2009 was primarily due to increased sales volumes in both segments. Excluding the affect of purchased accounting adjustments, gross profit was 28% of sales for the first quarter of 2009 compared to 29.1% of sales for the first quarter of 2008, with the increase due primarily to the mix of original equipment orders and our underground mining segment.

Surface mining equipment sales, which have lower gross margins, were 47% of total mining sales for the first quarter of 2008 compared to 50% for the first quarter of 2008. Underground mining original equipment sales also have lower gross margins were 61% of total underground sales for the first quarter of 2009 and the first quarter of 2008.

Selling, general and administrative expenses were approximately 10% of sales for the first quarter of 2009. Operating earnings for the first quarter 2009 were $94.6 million compared to $67.5 million for the first quarter of 2008. Operating earnings for our underground mining segment were reduced by amortization of purchase accounting adjustments related to the acquisition of DBT of $4.1 million for the first quarter of 2009 compared to $14.3 million for the first quarter of 2008.

Other expense for the first quarter of 2009 was $5 million compared to $0.8 million for the first quarter of 2008. Increase in 2009 was primarily due to $4 million of losses that were reclassified from accumulated other comprehensive income into earnings due to the discontinuance of cash flow hedges. The cash flow hedges were discontinued and rolled forward as a result of customer requested delays of two orders in our underground mining segment and it is anticipated that the losses will be recovered in 2010 when the hedges come due.

Effective tax rate for the first quarter of 2009 was 32.5%, which is the same as the first quarter of 2008 and is currently our projected rate for 2009. Net earnings for the first quarter of 2009 were $56.9 million or $0.76 per share on a fully diluted basis compared to $41.1 million or $0.55 per share on a fully diluted basis for the first quarter of 2008. Net earnings were reduced by net of tax depreciation and amortization of purchase accounting adjustments related to the acquisition of DBT of $2.7 million for the first quarter of 2009 compared to $9.5 million for the first quarter of 2008.

EBITDA for the first quarter of 2009 was $105.2 million, an increase of 26.8% from $82.9 million for the first quarter of 2008. As a percent of sales, EBITDA for the first quarter of 2009 was 17.4% compared to 16% for the first quarter of 2008. EBITDA includes the impact of reductions of non-cash stock compensation expense, severance expenses, gain or loss on sale of fixed assets, and the inventory fair value purchase accounting adjustment charged to across the sales and sold. These reductions were itemized in the EBITDA reconciliation in our press release.

On March 31, 2009 our total backlog was $2.3 billion, $1.7 billion of which is expected to be recognized within the next 12 months. This represents a 6.4% and 3.1% decrease from the December 31, 2008 total backlog of $2.5 billion and 12-month backlog of $1.7 billion respectively. The strengthening of the U.S. dollar in the first quarter of 2009 has reduced our March 31, 2009 backlog by approximately $24 million when compared to our backlog calculated using December 31, 2008 exchange rates.

New orders for the first quarter of 2009 were $445 million compared to $1.1 billion for the first quarter of 2008. Surface mining original equipment new orders declined from the first quarter last year due to fewer electric mining shovel orders. Our surface mining aftermarket parts and service new orders for the first quarter of 2008 included $209.8 million related to multiyear contracts that will generate revenue in future years.

Underground mining equipment new orders for the first quarter of 2008 included an order in the Czech Republic for five longwall systems. Approximately 16 million of orders in our underground mining backlog at December 31, 2008 were canceled during the first quarter of 2009. New orders for the first quarter of 2009 were negatively impacted by approximately $25 million due to the strengthening of the U.S. dollar.

At March 31 our total debt was $510.6 million compared to $571 million at December 31, 2008. Our cash balance was $64.8 million at March 31, 2009 compared to $102.4 million at December 31, 2008. We made an additional $13.2 million payment to our hourly pension plan during the first quarter of 2009. Receivables have decreased to $584 million at March 31, 2009 from $636.5 million at December 31, primarily due to strong cash collections in the first quarter.

Inventory increased to $673.5 million at March 31, 2009 from $616.7 million at December 31, 2008. Increase was primarily due to the buildup of work in process on orders and potential orders in our underground segment that have been delayed per our customer's request. These orders are expected to ship later in the year. Consolidated inventory turns remains at 3.1.

Capital expenditures for the first quarter of 2009 were $11.2 million, which includes $4.1 million related to the expansion and additional renovation of our facilities in South Milwaukee. We still expect our capital expenditures for 2009 to be between $60 and $70 million, however, we are closely monitoring our capital spending in relation to current economic conditions in business levels. We believe that cash generated from operations in existing credit facilities will be sufficient to fund our cash requirements in 2009.

I'll now turn it back to Tim who will discuss the market conditions.

Timothy Sullivan

Obviously, we're very pleased by the quarterly results. Let me highlight and emphasize a couple things that Craig had mentioned. Obviously, sales increased in both segments compared to the first quarter of last year and new orders for the quarter $445 million was, we think, a pretty good performance in, obviously, what is a weakening market. I think when you do those comparisons, as Craig highlighted, our OE business tends to be a little bit lumpy.

So, if you're comparing to the fourth quarter of last year, we had a dragline in our backlog in our new bookings in the fourth quarter of 2008 and in the first quarter of 2008 we had that nice longwall order for the Czech Republic. So, it's always a little complicated to compare bookings quarter-over-quarter year-over-year, but all in all a nice quarter for us.

We're pleased by the backlog. The backlog's at $2.34 billion compared to $2.5 at the end of the year so we really only had a falloff of about $150 million out of our backlog. It's interesting to note, and Craig highlighted it, that our plan for the year is $2.5 billion in revenue, $1.7 billion of our current backlog will shift this year, which means that we really only have to make up new orders of about $800,000 over the year to reach our goal.

Now, one of the things I want to reemphasize is we are continuing to work with our customers restructuring some contracts and moving some of our backlog into 2010. As we sit here today, we have effectively moved approximately $170 million worth of our backlog into 2010. This is all OE business and we will continue to do that. We still have a couple more opportunities to move some OE backlog into 2010.

The strategy there is, as we approach some potentially soft booking quarters here in the middle part of this year, we want to make sure that we're backfilling OE business into 2010. The business that's being shifted will be replaced by what is continuing to be a pretty strong aftermarket market that we have for our machines our there. I think most of you know that if you go back to the IPO in 2004 our installed base machinery at that time was about $9.5 billion, as we sit here today it's about $28 billion.

So, almost three times about 2.5 to three times the installed base that we had just five years ago. Now, we've had during that period of time 32 draglines re-commissioned and we also had the shovel demand over the last three or four years effectively doubled, and in our aspect it effectively tripled. Basically, the shovel demand went to 55 to 60 shovels a year back in 2004, 2005 our maximum capacity in large electric mining shoves was eight. I think most of you know that we moved that up to 24.

So, we have been fueling the installed base at a very strong pace here over the last three to five years and I think that bodes well for us then to be able to rely on aftermarket to continue to build into our backlog and allowed to shift to the extent possible OE bookings currently in backlog into 2010. And, again, we're hedging the potential issue of softer demand as we move through the year for OE business.

As we sit here today, obviously, that hasn't been the case. We still think that we have opportunities out there in the marketplace and we will continue to pursue those. It is not all doom and gloom. There are opportunities out there in the OE market, and maybe I'll highlight that in just a few minutes from now. But let me talk maybe in general first about the market and where we see our customer base and how they're purchasing right now.

We have seen some good stability in the market. We think there's now a floor on the commodity pricing. I think there, as we talked about in our February call, there was a dramatic reaction to the drop-off in demand by the commodity producers by dropping off production very dramatically. That basically created a floor in commodity pricing that remains well above historical cash costs for those commodities. So, as we sit here today, all the cash costs are well below where the current sales prices are, whether it be on a spot basis or on a contract basis.

So, we feel pretty good about the fact that there has been some good stability that's been brought into the commodity market. When there is certainty people can start to plan around their fiscal years and what they plan to do with their spending and their production levels.

The recovery, and I think most of you have read about this, is really being led by China. Some of the statistics coming out of China are very encouraging. The stimulus package is having a dramatic affect on what we see as demand out of the China market.

Just infrastructure costs or infrastructure spending alone in 2009 is projecting to be 43% over 2008 or roughly an incremental increase of almost 1 billion [renminbi], which is a lot of money, and we believe that that just in the infrastructure, which is highways, bridges, railways, power grids, power plants, will increase the incremental steel demand in 2009 by 22 million metric tons. That is a bright spot in otherwise a pretty gloomy market that we do have out there.

If you look at the overall demand worldwide, China is the only market that's showing positive growth year-over-year on any of the commodities. Demand for copper this year is predicted to be about 8% over 2008, zinc 4%, crude steel, as I mentioned, 22 million metric tons, which is approximately 1.5% year-over-year. So, the numbers are positive they're moving in the right direction. The rest of the world is, obviously, fairly bleak.

Copper remains a bright spot for the marketplace. We're well above the average cash cost of copper now. Cash cost at $1 with recent pricing just slightly above $2 a pound really, obviously, bodes well for the copper companies. There's a lot of dynamics going on with that particular commodity. The cash costs have been dropping fairly significantly in the last quarter. Some of the copper companies estimated their cash costs have dropped as much as 20% to 25%.

Obviously, at lot of that is directly related to fuel costs that have dropped significantly and, as you know, these copper mines run a lot of off-the-highway trucks, which is a big part of their cost base. So as costs come down, as pricing firms, we see some positive effect in the copper market. The other thing that's been fairly dramatic, and we've talked about this in previous calls, the actual copper yields have been dropping fairly significantly and very significantly at some of the larger mines, like Escondida.

I think a press release came out the day before yesterday that Escondida's production is going to be significantly off this fiscal year. I think they were approximately 45% off year-over-year in the last quarter, and they're predicting an overall 30% reduction in copper production and part of that's process related. They've had some [Ord] rate issues, but also they've had some processing issue with their milling problems that they've had at the mine site.

That shows really that relates to almost 100,000 tons of production coming out of Escondida for the year and it's projected that copper production may be off as much as 1.5 million tons, metric tons this year, so that all bodes well for keeping that copper price firm and allowing the costs to continue to be reduced. And, again, it's just creating a much better situation to stabilize that commodity in the current marketplace and create some certainty around the future.

What's particularly of interest to us is, obviously, the copper yields dropping to the level that they are. Obviously, if copper yields are dropping, the grades are dropping. That means that more machinery is going to be required just to maintain existing production levels and/or in the case of mines like Escondida recover back to previous levels of production. So, that means more shovels, more drills, more trucks and those are all projected by virtually all the copper producers.

When that will start to move in to reflect possible bookings is yet to be determined. Part of that has to do with the fact that the credit markets are in difficult shape and the fact that there's been such a dramatic drop off in the copper price so quickly. There needs to be a little bit of recovery time before I think the copper companies start to look to rebuild their capability and get their production back to the levels that it had previously been at. But all in all, good signs, good news for the industry, and good news for us.

Iron ore steel has obviously been way off, with the exception of China is the odd man out increasing their steel production slightly. I guess you could consider it almost flat, but I'd rather have flat or slightly up than the negative numbers we're seeing in the developed world. Pricing is a little bit uncertain out there. There is no contract price this year.

Valley, the largest producer out of Brazil, has effectively tried to put a quasi, a contract price out there by establishing a benchmark of selling their iron ore at 20% below 2008 pricing. That seems to be getting some traction. The rest of the producers, primarily Rio, BHP Biliton, have been selling at spot prices, so there's still quite a bit of volatility in the iron market. There's still quite a bit of uncertainty on price in the iron market, and that will probably be slower to recover versus copper.

Coal has stabilized price-wise. We do have some new contract pricing out there. It's obviously less than 2008, but from our standpoint, it's still well above the last five year average. And the thermal coal international price now, contract price, has been set around $70 a ton, which is up from $57, $58 a ton between 2005 and 2008, when obviously it spiked well above that in 2008. Again, the cash costs will come back into line and are dropping and the floor on commodity pricing is well above five year averages, so we're encouraged by that.

Coking coal a little bit different, it peaked out at $300 a ton. It's at $129 a ton contract price, which is again up from what it was in 2006, 2007, which was less than, or right around $100 a ton. So we're cautious, obviously, about the immediate future, but I think there's stability in the commodity markets that we have not had now for a couple of quarters.

And I think the stimulus package in China is starting to help everyone out, and I think that we'll be very careful and watch our markets here as we go through the next two quarters. All indications are that, as the credit markets improve and fix themselves as we move through the next two quarters, that we'll start to see some reasonably good activity in the fourth quarter of 2009, if not before that, depending on how things evolve here over the next few months.

Craig mentioned, again, we've been very fortunate we have not had cancellations. We have restructured some contracts, as I said, and tried to move some of the OE business out into 2010. The total cancellations for the quarter, is now $16 million. I mentioned on our last call, that we had recorded $6 million in January. We've had an addition $10 million worth of cancellations and these have been contracts that we've just not been able to restructure.

They're for room and pillar equipment for small Central Appalachian coal companies. Central Appalachia's getting hit particularly hard, their cash costs are high and it's a very complicated market with many smaller players. As most of you know, we don't do a lot of business in Central Appalachia because room and pillar is not our strongest product offering, but we're pretty gratified by the fact that so far to date $16 million is our total dollar value of cancellations.

Draglines remain active and as most of you know I'm also reluctant to talk about draglines because they tend to be delayed and fairly volatile. The dragline order that we've been hoping to get out of the Indian market will now be delayed further with the elections happening. We hope that we will get something by mid-summer, a report of those are four medium sized draglines. We still have dragline activity in Australia.

We are talking to customers in South Africa and Canada, and the dragline in China has been doing exceptionally well, and we believe that we will have some dragline activity in China here over the next 12 to 18 months. So there is business out there. These are countries and localities that do need production and that do have a market for their production.

The Indian market, in particular, they're talking about doubling or tripling the amount of coal that they need to import, because they're struggling to make decisions on buying equipment to mine their own coal in their own country. So it's a frustrating for us, but hopefully we'll get the knock on effect if they start importing more and more coal that we might get some business out of some of the people that are supplying them that coal.

Our expansion of our South Milwaukee facilities is effectively finished. I think we will be looking maybe next year to make some improvements in maybe some of the amenities for our steel workers in the Milwaukee plant.

We're looking to improve some of our brick and mortar around the world in this market. And having said that, I want to re-confirm that we're looking at capital spending in the range of $60 to $70 million, which is approximately half of what we spent the last couple of years. We'll continue to look on, both on acquisitions as we move through this market. We have a strong balance sheet, we have excellent cash flow and, if there's an opportunity out there that presents itself, and there might be some here as we move through this market, we'll continue to look at those.

Let me close by restating our guidance for the year. We still are targeting $2.5 billion in revenue, which is even with what we achieved in 2008 and I explained already how we plan to achieve that. And we still will confirm adjusted EBITDA between $460 million and $475 million. And we will, as is customary, look at that at mid-year and if there's any adjustments to be made, we'll make them at that time.

With that, let's turn it over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steve Barger - KeyBanc Capital Markets.

Steve Barger – KeyBanc Capital Markets

Can you talk about your delivery and order expectations in the second quarter so far, maybe the expectations for specifically the aftermarket sales?

Timothy Sullivan

Well, aftermarket book has remained strong. I think the good news is that installed base is going to continue to drive good aftermarket opportunities for us. Even with commodity prices and some uncertainty in commodity prices in the marketplace, people are still operating our machinery on a daily basis, which means that they're still requiring spare parts. So we're very bullish about our aftermarket opportunities in the quarter, and we think that that will continue through the year.

Steve Barger – KeyBanc Capital Markets

And this is kind of region specific but so far in April domestically here coal car loadings are down. I think some of that's weather related, but I also think some utilities have decent stockpiles of coal. Are you seeing any impact on the aftermarket, specifically out of the PRB?

Timothy Sullivan

No, not really but it's quite frankly, it's a little bit more than weather related. We're looking at a power demand around the country off anywhere from 2.5% to 3% and I get the weekly reports on power demand and coal production and coal production's off 2.5% too. So domestically we're probably going to run through a year where production in coal mines is going to be down.

They typically don't shut machines down at least they certainly don't shut down their primary movers like their stripping machines that we produce. So we've not seen a falloff at this point at least and it's early in the year yet, but we haven't seen a falloff in the domestic aftermarket demand.

Steve Barger – KeyBanc Capital Markets

Okay. And shifting gears to the underground, you've been shipping those longwalls to Eastern Europe. Is most of that delivered or is there some left to go in 2Q?

Timothy Sullivan

No, there's a little bit left in Q2 and we should be cleaning up this quarter so it's pretty well done now, at least the first tranche of machines. We're expecting more demand out of that market as there gets a little more stability in the pricing out there.

Steve Barger – KeyBanc Capital Markets

Were there any other big specific orders that are going to ship in 2Q that you had talked about in past quarters?

Timothy Sullivan

Well, we have our dragline that we got in the fourth quarter that we're starting to get progress payments on that. We also have all the shovel business from last year that is shipping through this quarter. So we've got pretty good visibility on a fairly steady good shipping quarter. And we're looking to be on our plan for the quarter, so nothing unusual other than shipping our backlog that was booked in 2008.

Operator

Your next question comes from Robert Wertheimer - Morgan Stanley.

Robert Wertheimer – Morgan Stanley

I have a few questions on aftermarket and your summary was actually very, very helpful, but specifically on China there's always been a push to buy local and I wonder if that has changed or intensified with the stimulus. We've seen that in some other construction machinery. So that's one question, whether local players are getting more of an entree?

Timothy Sullivan

They're always going to have a preference for local. The good news about some of the things we do is they will buy local equipment for medium to low productivity mines. If they're into what I would call a high productivity mine and there's various tiers of coal mining companies in the country. In the high productivity mines where they need to have that coal come out of the ground, they will still buy western equipment and we have had some activity this year.

We had kind of ebbs and flows, but as the demand for coal increases and it's interesting they're projecting now that coal will probably peak above 3 billion tons next year in China. So you can see the rapid expansion of coal mining in the country. So they'll buy our equipment for the high production underground mines. The larger size shovels, and obviously the draglines they'll definitely buy our equipment.

And then we have, well we have an underground as well. They're moving into lower high production seams, which falls into the category of our automated plow systems, the longwall underground automated plow systems, and we're the only provider of those systems in the world. So although I think they'd probably like to have their local people produce those, they don't. So there's pockets of opportunities for us in that market.

Robert Wertheimer – Morgan Stanley

Okay. And then more generally in aftermarket I wonder if you can sort of split roughly or however you want to do it historically sort of split the aftermarket between majors for rebuild projects, proprietary parts and then just sort of flow through parts that you might buy from others and sell to your customers and compare what's been happening the last two or three years to what's happening now. You have a larger installed base but I wonder if you're getting fewer rebuilds and fewer big orders or maybe even more because there's machines that maybe can be taken offline and have major work done.

Timothy Sullivan

That's a good question. Obviously we've had a good strong rebuild surge in aftermarket over the last two or three years with, I should say really the last five years, with these 32 draglines going back to work. Those are major rebuild, refurbishment type orders. We're going to see less of that on the draglines as we move through the next year or two, but we have 32 more of those out there operating right now, which means that we're going to get more of the day-in day-out parts business at a higher volume. That's the draglines.

And shovels, shovels are a little bit more complicated. They really need overhauls every three to four years, and as you load those machines into the marketplace like we have the last three or four years, those overhauls are going to be rolling forward on a regular basis. So even though the dragline large refurbishment overhaul activity will probably diminish somewhat and shift into a more of a day-to-day type of phenomenon, especially in this market, I think people are going to try to not make the big spends on the draglines.

We will get to have a new shovel installed base that we've put into the marketplace here the last five years. So it shifts around a little bit, but the good news is with that large installed base we're going to get that day-in day-out parts business, which tends to be a lot more predictable and certainly easier to manage anyway.

Robert Wertheimer – Morgan Stanley

I'll get back in line after this, but the dragline is the increase sort of flow business enough to completely offset the decrease rebuild or is it sort of a net negative for now?

Timothy Sullivan

No. We'll have to run those models and really project that out. Right now we're seeing basically a net even. Our guys are showing us with, and we track this thing literally monthly to determine what the demand looks like out there, but we don't see any necessary falloff in actual volume of dragline parts business. So we'll keep you advised. I think that will mainstay or maintain kind of a steady state here as we move through certainly the next couple of quarters.

Operator

Your next question comes from Andrew Kaplowitz - Barclays Capital.

Andrew Kaplowitz – Barclays Capital

Tim, could you talk about pricing in the current environment? Any sense on what the competitors are doing, maybe some of the smaller guys out there? Could you just give us sort of lay of the land on how easy it is or how hard it is to maintain pricing?

Timothy Sullivan

Well, we only have one competitor and I think if you look at our current situation then it's not dissimilar to our other competitor. As we are in this environment then I think that as we move through and see some cost reductions in our supply chain, we will pass those on to our customers but there's no reason for us to drop margins. That's not what we do and there's no reason to do that. We will pass on cost savings as they become apparent.

But margins are being maintained as margin discipline in what we do. That's not the case with other associate suppliers in the industry. And I think we don't compete with them but there's, when you look at the hydraulic excavators, the trucks, some of the ancillary type equipment, those people have had a lot of cancellations and they've got a lot of inventory. And we are seeing some break in ranks on some of the pricing on some of that type of equipment, which I think in some respects is decisions that people have to make.

If they have some balance sheet issues or some issues on their lending side, they've got to make some decisions. But in what we do, and that's what we care about, what we do is we're fine. And I think that there's good discipline. Everyone is working very intelligently through what I would call a market correction, not a trough. Everyone keeps referring to this as a trough, it's not a trough it's a market correction, that I think we will continue to see those disciplines.

Andrew Kaplowitz - Barclays Capital

I remember a few years ago the goal was to capture more of your aftermarket work and you've done that over time. Is there a worry that some of the smaller guys who are hurting on the parts and service space would come and try and take back some work from you guys? And then, what do you see going forward?

Timothy Sullivan

I think we've been able to demonstrate to our customers over the recent past that that's a false economy. In the grand scheme of things, and we ran these sensitivities a couple of years ago as to what we were losing, and we have two different categories of spare parts.

We have manufactured spare parts and what we call vendor or purchase parts. People that buy manufactured parts from parts pirates eventually pay the price in a much larger way than the savings that they might get with pirate parts. And I think we've been able to demonstrate time and time again to our customers that that's a false economy, and I think to a great extent our customer base around the world understands that.

On the supply side for vendor parts and other manufactured parts, that's just basic blocking and tackling. And in our industry, and we believe this sincerely, in our industry, whether it's a manufactured part or a purchased part or vendor part, it's about availability. Our machines work very, very remotely. And even in a down market, our machines are turning. They're out there and they need spare parts. And people do not want to wait for spare parts.

If they're available, they will buy parts from us. I think we price our parts reasonably and I think we could demonstrate that to our customers. So we've got a very loyal base of customers out there that work with us on spare parts, and I think the whole pirate market that we always talk about, I think we've effectively managed through that to really work with our customers and educate our customers that working with non-OEM providers of spare parts, is a false economy.

Andrew Kaplowitz – Barclays Capital

One more I could and then I'll get back in queue. A few quarters ago you had good visibility from all of your LOIs and obviously it's a different market these days, and so I'm just wondering what kind of visibility do you have, Tim, over the next few quarters? And what does that LOI landscape look like, if anything? Maybe more detail around that and if there's any color you can give us by region?

Timothy Sullivan

The good news is we've not lost any backlog but we have lost some LOIs, and we don't move LOIs as we've always said into backlog until they are rock solid contracts. So we've lost some. And we've been able to move some of those into orders and restructure those to push them out into later delivery slots and work with our customers on terms accordingly.

I don't think there's any particular market that we've had some issues with. I think I stated on our last call that we have had in some of our, I'll call them non-traditional markets, places like Russia, some of the private companies we're working with in India that we require LCs, those LOIs were potentially not going to move into orders and we were able to work with [Epson] Bank and commercial lenders in the United States to put together financing packages that were able to get those LOIs into contracts.

So, those are the areas that probably have been a challenge but I think we've effectively managed through those challenges. I think there's a pent-up demand being built up in copper right now, and I think that that will eventually turn into some good business as well. We've had some LOIs in the copper area been delayed. They haven't cancelled them but they've pushed them off and I think that's just really a matter of getting more certainty on cash cost, pricing, financing and things like that.

So, no particular markets that we haven't been able to manage through some of the more periphery non-traditional markets were a challenge but we've been able to move through those.

Operator

Your next question comes from Jerry Revich – Goldman Sachs

Jerry Revich – Goldman Sachs

I'm wondering if you could talk about order outlook in the OEM piece of your underground mining business, were you seeing inquiry levels. Is it similar to the 0.5 book-to-bill that you saw in the first quarter?

Tim Sullivan

Well, I can tell you our prospect list, both service and underground, is down significantly but it's not disappeared. I'm not really sure if it's at that same level of opportunity but it definitely is probably slightly off than what we've had in the first quarter. And we have had some drop-off in prospects, but like I said, it's not disappeared.

Jerry Revich– Goldman Sachs

Can you discuss on the surface mining business of the prospect list, can you talk about for which commodities is that prospect list strongest and how does that compare to the commodity mix in your OEM orders in surface in the first quarter?

Timothy Sullivan

I think probably if you would rank them as far as prospects right now, copper and oil sands would be at the top of the list, coking coal, iron ore at the bottom of the list, and thermal coal kind of in the middle, obviously, very much in line with where the commodity markets are right now. And that's typical for OE business. OE business kind of runs up when there's certainty and good pricing on a particular commodity and we shift into aftermarket mode when the pricings down.

Jerry Revich – Goldman Sachs

And Tim, in the first quarter was most of your orders on surface OE copper and oil sands? Is that fair?

Timothy Sullivan

Yes. We had a couple in iron ore as well though, so we did get a bit of a tail on the iron ore.

Jerry Revich – Goldman Sachs

Tim, the really strong aftermarket sales growth you reported in both businesses was in contrast to the production cuts that we've seen from a lot of your customers, can you just talk about if there was any lumpiness in your results and they key drivers perhaps, if you can talk about, that for the two businesses separately

Timothy Sullivan

Yes, it's a different purchasing mentality. I think I mentioned already that our machines don't really get shut down even if production gets pulled of the market. It's very rare that a dragline is parked, for instance, or a fleet of shovels and trucks is parked, which means that you still get the consistent flow of spare parts from those types of businesses. It's pretty steady.

Jerry Revich – Goldman Sachs

Tim, have you seen any impact on the service side of the business as customers are looking to do more of the maintenance on their own now that they have spare capacity on the personnel side?

Timothy Sullivan

No, just the opposite, they don't have spare capacity on the personnel side. I think that was one of the things we've been talking to our customers about. If you look at a lot of the announcements that were made by the big multinationals and some of the domestic coal companies, they've had some fairly large layoffs of their personnel, which actually put a lot more burden on us to provide service. So the service bookings are actually up.

Operator

Your next question comes from Joel Tiss – Buckingham Research.

Joel Tiss – Buckingham Research

Tim, you talked a little bit about the quality of the mines deteriorating a little bit, which would mean more mining equipment intensity in copper. Can you just go through the other end markets and give us a sense of what the trends are there as well?

Timothy Sullivan

Well, the trends are all brown field. In other words, all the green field sites have literally been shelved, and I think that's across the board. I don't know of any green field project that hasn't been shelved. I mean there's been a dramatic drop-off on expiration and investment in green field sites, and that's going to create two things.

First of all, that's going to create more demand in the brown field sites that have the lower ore grades that need more machinery to move more rock to get the same output. So that's a positive. The other positive is that with the green field's coming off stream and being delayed that means, I think that when we get a recovery, and we're predicting it towards the end of this year into the first quarter of '10, it's going to be pretty dramatic. You are going to have a lot of demand come on the market fairly rapidly.

Joel Tiss – Buckingham Research

And then just based on everything you can see, do you think that demand in China for 2009 is enough to offset the weakness that we're seeing in the rest of the world? I didn't kind of get a clear signal from –

Timothy Sullivan

No, it's not. I mean if you add up all of the tonnages that are less around the world, there's no way that China by themselves can offset the other reductions in demand. The idea, I think, is that if China can get some traction and move forward, hopefully they'll start pulling the rest of the economies up as well. We concentrate on China and China is important, but India's driving some of this as well.

I mean their GDP has dropped somewhat, but it's still positive and they're moving forward. So it's ironic that you're going to see some of these emerging economies pull the rest of us along as we move through this demise that we find ourselves in. But it's not enough to balance out what else is out there, and that's why the production's been pulled off to the level's it has been.

Operator

Your next question comes from Ann Duignan – JP Morgan.

Ann Duignan - J.P. Morgan

Tim, could you talk a little bit about reconciling the fact that you have about an $800 million GAAP to make your goal for the year and yet inventories are rising. Should be concerned that inventories are rising at exactly the wrong point in the cycle?

Timothy Sullivan

No. The inventories that are rising are primarily on the underground side of our business and those are in anticipation of what we believe to be some pretty solid demand, and a couple things that I mentioned. I mentioned some of the China business that we think is imminent that is particularly special to us, things like plow systems.

We're building some inventory as well for LOIs that we feel pretty confident that they're going to turn into contracts over the next four to six months. So, obviously, inventory is one of those things that you want to make sure you keep on top of, but it's mostly work in process that we feel pretty confident about.

Ann Duignan - J.P. Morgan

And what happens in your industry as you've been through prior cycles? What happens if those orders don't materialize?

Timothy Sullivan

Well, in some respects you can move some of that material into finished goods inventory and mitigate some of that. If you got it wrong, you got it wrong and you're going to carry some inventory longer. So we're careful. We want to make sure our guys are pretty confident that the customers their dealing with that those things will materialize into contracts. But if you get it wrong, you get it wrong, and you're going to carry it.

Craig Mackus

Ann, this is Craig. Just one thing, our investment cost or borrowing costs, we're not borrowing now, but if we would is very low as you know LIBOR is very at about half a percent and with our spread the carrying cost from an interest standpoint is not very high. So we're kind of measuring the risk of having the inventory available when we need it and the customer wants it versus our carrying cost. And other than obsolescence, which is all brand new inventory, we have no real concern there. I think this is a decision we've looked at very closely and are comfortable with.

Ann Duignan - J.P. Morgan

Okay. The color is very helpful. I appreciate that. And then just on underground, margins came in a bit lower than we were expecting. Can you talk about, was that just mix or, can you give us some color in terms of as we've progressed through the year what you would expect to have in the margins, particularly in underground?

Timothy Sullivan

Yes, that's primarily a mix. Our underground margins, as you know, have been moving up and we continue to see that trend as we move through the year. So it was mixed.

Ann Duignan - J.P. Morgan

And you'd expect the mix to improve as you go through the year.

Timothy Sullivan

Yes, and it usually does and I think everything is trending in the right direction, and we think we'll achieve our goals.

Operator

Your next question comes from Paul Bodnar - Longbow Research.

Paul Bodnar - Longbow Research

Could one of you just talk a little bit about some of the orders that you delayed into 2010 or the customers did, and if the primary motivation there was credit issues or just some additional detail on that?

Timothy Sullivan

No credit issues, it was primarily demand. As they're pulling production down, they want to stretch those orders out which actually in many respects have played nicely into our strategy to build some backlog into '10. So we really don't have any credit issues out there. It's strictly pulling down demand, pulling down production, shifting it off to the inevitable. I think everyone is pretty fine with the projections that they're seeing for next year, and everyone's done their modeling and it's worked out well.

Paul Bodnar - Longbow Research

So you're pretty comfortable with those orders don't end up cancelled or they don't have to re-address this again in 2010?

Timothy Sullivan

No. Some of them are under LCs or some of them are with multinational companies that are quite strong financially themselves. So, no, we do a very good job, I think, as a company mitigating those types of risks and that's why we have very few cancellations and we have literally no bad debt.

Paul Bodnar - Longbow Research

And this is kind of a follow-up to that. If you take a look out in say the next three to five years and you look at where you think shovel demand can kind of bottom out at on an annual basis, and last year obviously was a very good year in terms of demand, where do you think that that new bottom is on that?

Timothy Sullivan

Hard to say, I think it's a little early for us to really determine that. Obviously, we're trying to determine that to project out our production needs and that sort of thing three to five years out. The convention of wisdom says that we probably are not going to see pricing like we had before, but also with the yields coming down the way we've been talking about in various ore bodies, and this is all ore bodies, coal keeps getting deeper, seams keep getting thinner, which just means that more and more equipment's required.

So we're very bullish. We think the type of production levels that we've seen over the last year that we finally got to with our expansions are definitely in the cards for three to five years out. So, we're in a bit of a market correction, although we're still trying to quantify that precisely, we're very bullish on that period of time.

Paul Bodnar - Longbow Research

How do you think of it in terms of what it would be due to in terms of future demand of declining ore bodies versus just incremental commodity demand?

Timothy Sullivan

It's both, and that's why we have to model that because you look at the commodity demand that's going to be driven by the emerging world that we haven't seen before and declining ore grades, it's a combination of the two, which that's why we're as bullish as we are about the whole situation.

Paul Bodnar - Longbow Research

There's no real way to know a percentage of each or a guesstimate?

Timothy Sullivan

No, we haven't done that yet. I mean we've been working on it. I think it's a thing where we haven't really come out to really define what that is yet. I think we have time for one more, Kent.

Kent Henschen

Right, one more question.

Operator

Your next question comes from Barry Bannister - Stifel Nicolaus.

Barry Bannister - Stifel Nicolaus

In the past, in the electric mining equipment industry the gross margin kind of falls out where it will based on OE aftermarket, and the industry can make it on aftermarket alone, if it has to, but where it typically blows it is in SG&A. You've done a great job in SG&A it did uptick, however, 3% to 4% year-over-year, quarter-on-quarter. Can you explain that? And then would you give me the change in the fixed versus variable cost of SG&A since the IPO since you've described your progress.

Timothy Sullivan

I'll answer the first half and then I'll let Craig answer the second half. Yes, you know, Barry that we will control SG&A, and actually I think you're going to see some movement in that over the next couple of quarters. One of the things that we aren't really pulling back on and we're actually expanding on that is some of our research and development.

We want to try to position ourselves for what we consider to be a very robust market with some good potential coming up, so we're working on some pretty unique things and I don't want to slow that down. So we may even subsidize some of that with other reductions, just to make sure that we don't fall off on those types of things because we've got great ideas and we want to make sure that we can move those forward.

And for the second half, Craig, why don't you, if you've got that information, pass it on.

Craig Mackus

Sure. I would say that, as you know, any cost is variable so there's no such thing as a total fixed cost, but in the realm of things, after the acquisition we thought there were some opportunity to enhance the EBITDA percent of the underground operation. We had stated they were around 10% EBITDA and we want to get them to 20%.

Part of that was in the margin improvement, a significant portion of that was going to be looking at the SG&A and consolidating some facilities around the world and doing some things on consolidation, in the IT area. And that was going to be an attempt to get their SG&A down to a number more in line with where the surface was.

The underground operation has done a great job the last couple of years, which is why the margins have been increasing in that area and so, to the extent that there were significantly more I'd call variableness to the numbers when we acquired them, the total consolidated number might have been say 70%, 80% fixed.

With reductions that they've made recently, it's probably more in the 90% range, with some discretion for certain corporate initiatives that are variable based on the economic conditions. So it's moving more towards a higher percent of fixed, but it's a result of some hard work by the underground guys the last couple of years. And there's been some work on the surface side by aligning the two segments together.

Barry Bannister – Stifel Nicolaus

And then lastly, I think of gross margin for OE versus aftermarket within the surface as being roughly a 2:1 ratio, is the ratio similar for underground where your margin progression has been a bit ahead of what I would've expected, even adjusting for purchase accounting?

Tim Sullivan

The strategy is both for both segments and it is approaching that, yes, and that will be our goal.

Barry Bannister – Stifel Nicolaus

And you've expanded the aftermarket portion of underground to what percent, given where it was when you bought it? It was only about 25% historically on their market share, what is it now?

Tim Sullivan

I think, Craig correct me, but I think we bounced just above 40% last year.

Craig Mackus

Yes.

Tim Sullivan

So we made some nice inroads into that whole initiative. Thanks, Barry.

I hate to cut it off, everyone, we might have more questions in queue but we do have a hard stop this morning. I would like to thank you all for joining us. Obviously, we're very pleased by the quarter but, quite frankly, I think we're more pleased by some stability and some certainty now that's coming out of the commodity market that will help us all plan as we move through the rest of this fiscal year.

We feel confident in our guidance and, as I mentioned, if that moves in a positive direction, and it could, we will readjust that at mid-year. Our next call will be in I guess it's July, and that will be coming to you from our operations in Germany. So thanks again for joining us today. As always, if you have any questions, feel free to contact us and we'll do the best we can to provide you that information. Talk to you again in a quarter. Thank you.

Operator

Thank you for your participation in today's conference as this concludes your presentation. You may now disconnect and have a wonderful day.

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Source: Bucyrus International Inc. Q1 2009 Earnings Call Transcript
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