Welcome to the Bucyrus International Inc. second quarter 2009 earnings conference call. (Operator Instructions). At this time I will turn the call over to the Director of Global Communications, Shelley Hickman. You may proceed.
Good morning and thank you for joining us for Bucyrus International Incorporated second quarter 2009 earnings release teleconference. In a few moments I'll turn the teleconference to Mr. Tim Sullivan, President and Chief Executive Officer of Bucyrus, and Mr. Craig Mackus, Bucyrus' Chief Financial Officer. As is our practice, I will 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 terminologies such as believes, anticipates, expects, estimates, intends, may, will or similar terms.
You're cautioned that any such forward-looking statements are not guarantees of future performance and involves significant risks and uncertainties, and 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' policy on forward-looking statements including a list of factors that could cause actual results to differ materially from those anticipated in forward-looking statements, as well as risk factors related to Bucyrus, are included in Bucyrus' 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 with 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 conference over to Tim.
I'd like to start by welcoming Shelley in her new role as Global Communications Director here at Bucyrus. I'd also like to formally welcome both Michelle Collins and Deepak Kapur who recently joined our board. And you would have seen those press releases here in the last 30 to 45 days. And they recently completed their first board meeting with Bucyrus. We're very pleased to have them on our board.
One other thing I'd like to mention, I guess, before I turn it over to Craig. We were flying back from Germany last night and we never look back. We always like to look forward, but yesterday marked our fifth anniversary from the date of our IPO in 2004 of July 23.
And just for fun we decided to kind of look at some of the numbers and what's transpired in the last five years and it was interesting. Revenue has grown 450%, adjusted EBITDA has grown 675% and EBITDA margins have increased by approximately 50%. So we think that's a pretty good record of the initial five years here since our IPO, as of yesterday, five years.
With that I'll turn it over to Craig to give you some highlights here on the second quarter.
Sales for the second quarter of 2009 were $724.4 million, an increase of $103.4 million or 16.7% from $621 million for the second quarter of 2008. Original equipment sales were $366.8 million, an increase of $42.3 million or 13% from $324.5 million for the second quarter of 2008. And aftermarket parts and service sales were $357.6 million, an increase of $61.1 million or 20.6% from $296.5 million for the second quarter of 2008.
For the first six months of 2009, sales were $1.3 billion, an increase of $192.2 million or 16.9% from $1.1 billion for the first six months of 2008. Original equipment sales were $694.9 million, an increase of $86.2 million or 14.2%, from $608.7 million for the first six months of 2008. And aftermarket parts and service sales were $635.3 million, an increase of $106 million or 20% from $529.3 million for the first six months of 2008.
Surface mining sales for the second quarter 2009 increased 18% from the second quarter of 2008, and for the first six months of 2009 increased 13.9% from the first six months of 2008. The increases were primarily in aftermarket parts and services and were primarily in the Chilean, Australian and United States markets with a moderate increase in the Chinese markets and for the second quarter the Canadian markets.
Year-to-date 2009 surface mining sales were negatively impacted by approximately $29 million due to the effect of the stronger U.S. dollar on sales denominated on foreign currencies compared to the first six months of 2008.
Underground mining sales for the second quarter of 2009 increased 15.4% from the second quarter of 2009 [sic] and for the first six months of 2009 increased 20.1% from the first six months of 2008. The increase for the second quarter and first six months of 2009 was in both original equipment and aftermarket parts and services.
The increase in original equipment sales for the second quarter and first six months of 2009 was in longwall, room and pillar and belt systems product lines. The increase in aftermarket parts and service sales for the second quarter and first six months of 2009 was primarily due to increased longwall projects in the United States offset by a decline in the Australian market resulting from reduced mining activities as a result of lower coal prices.
Year-to-date 2009 underground mining sales were negatively impacted by approximately $54 million due to the effect of the stronger U.S. dollar on sales denominated in foreign currencies compared to the first six months of 2008.
Gross profit for the second quarter of 2009 was $205.3 million or 28.3% of sales, compared to $174.1 million or 28% of sales for the second quarter of 2008. Gross profit for the second quarter of 2009 was increased by $0.5 million, a purchase accounting adjustment related to the acquisition of DBT, compared to a $3.1 million reduction for the second quarter of 2008.
This had no effect on gross margin for the second quarter of 2009, but increased gross margin for the second quarter of 2008 by 0.5 percentage points. Gross profit for the first six months of 2009 were $375.4 million or 28.2% of sales, compared to $315.7 million or 27.7% of sales for the first six months of 2008.
Gross profit for the first six months of 2009 was increased by $0.9 million, a purchase accounting adjustments related to the acquisition of DBT compared to an $11.9 million reduction for the first six months of 2008.
This had no effect on gross margin for the first six months of 2009, but decreased gross margins for the first six months last year by 1.1 percentage points. Increase in gross profit for the second quarter and first six months of 2009 was primarily due to the increase in sales volume in both segments.
Excluding the effect of the DBT purchase accounting adjustments, gross profit was 28.3% of sales for the second quarter of 2009 compared to 28.5% of sales for the second quarter of 2008 and was 28.2% of sales for the first six months of 2009, compared to 28.8% of sales for the first six months of 2008. The decreases were due primarily to the mix of original equipment orders in our underground mining segment.
Surface mining original equipment sales which have lower gross margins were 42% of total surface mining sales for the second quarter of 2009 compared to 46% for the second quarter of 2008 and were 45% of total surface mining sales for the first six months of 2009 compared to 48% for the first six months of 2008.
Underground mining original equipment sales, which also have lower gross margins, were 59% of total underground mining sales for the second quarter of 2009 compared to 58% for the second quarter of 2008, and were 60% of total underground mining sales for the first six months of 2009, compared to 59% for the first six months of 2008.
Selling general and administrative expenses were 8.7% and 9.3% of sales for the second quarter in the first six months of 2009 respectively, compared to 9.6% and 10.4% of sales for the same periods last year.
Operating earnings for the second quarter of 2009 were $128.6 million, compared to $99.7 million for the second quarter of 2008. And were $223.2 million for the first six months of 2009, compared to $167.3 million for the first six months of 2008.
Operating earnings for our underground mining segment were reduced by amortization of purchase accounting adjustments related to the acquisition of DBT of $3.4 million and $7.5 million for the second quarter and first six months of 2009, respectively, compared to $7.4 million and $21.7 million for the second quarter and first six months of 2008 respectively.
Other expenses for the second quarter in the first six months of 2009 were $0.6 million and $5.6 million respectively, compared to $0.8 million and $1.5 million for the second quarter and first six months of 2008, respectively.
Decrease for the first six months of 2009 was primarily due to $3.8 million of losses that were reclassified from accumulated other comprehensive income into earnings due to a discontinuance of cash flow hedges. The cash flow hedges were concurrently settled and extended because original forecasted transactions did not occur within the original specified time period as a result of a customer requested delays of two orders in our underground mining segment. We anticipate that the losses will be recovered in 2010 when the hedges come due.
The effective tax rate for the first six months of 2009 was 32.6, which is similar to the first six months of 2008 and approximates our projected rate for 2009.
Net earnings for the second quarter of 2009 were $82.3 million or $1.08 per share on a fully diluted basis, compared to $62.3 million or $0.83 per share on a fully diluted basis for the second quarter of 2008.
Net earnings for the first six months of 2009 were $139.2 million or $1.84 per share on a fully diluted basis, compared to $103.4 million or $1.37 per share on a fully diluted basis for the first six months of 2008.
Net earnings were reduced by net of tax, depreciation and amortization of purchase accounting adjustments related to the 2007 acquisition of DBT of $2.3 million and $5 million for the second quarter and first six months of 2009 respectively, compared to $5.1 million and $14.6 million for the second quarter and first six months of 2008 respectively.
EBITDA for the second quarter of 2009 was $143 million, an increase of 25.4% from $114 million for the second quarter of 2008. And for the first six months of 2009 were $248.2 million, an increase of 26% from $197 million for the first six months of 2008. EBITDA was 19.7% of sales for the second quarter of 2009, compared to 18.4% for the second quarter of 2008, and was 18.7% of sales for the first six months of 2009, compared to 17.3% for the first six months of 2008.
EBITDA includes the impact of reductions for non-cash stock compensation expense, severance expenses, and a loss on sale of fixed assets and the inventory fair value of purchase accounting adjustment charged across the products sold. These reductions are itemized in the EBITDA reconciliation in our press release.
At June 30, 2009, our total backlog was $2 billion, $1.2 billion of which is expected to be recognized within the next 12 months. This represents a 20.7% and 28.3% decrease from the December 31, 2008 total backlog of $2.5 billion and 12-month backlog of $1.7 billion, respectively.
The weakening of the U.S. dollar for the first six months of 2009 has increased our June 30, 2009 backlog by approximately $50 million, when compared to our backlog calculated using the December 31, 2008 exchange rates.
New orders for the second quarter and the first six months of 2009 were $367.6 million and $812.6 million, respectively, compared to $776.5 million and $1.9 billion for the second quarter and the first six months of 2008, respectively.
Surface mining original equipment new orders for the second quarter and the first six months of 2009 declined for the same periods of last year and was due to fewer electric mining and blast tools, drills, new orders, which is attributable to the reduced demand for the commodities mined by our equipment as a result of the current global economic conditions.
Our surface mining aftermarket parts and service orders for the second quarter and first six months of 2009 have declined in most markets from the same period last year as a result of the current global economic conditions, but increased to $171.6 million for the second quarter of 2009 from $146.6 million for the first quarter of 2008.
Included in surface mining aftermarket parts and service new orders for the first six months of 2009 was $15.5 million related to multi-year contracts that will generate revenue in future years, compared to $278.7 million for the first six months of 2008.
Total surface mining new orders for the first six months of 2009 were negatively impacted by approximately $24 million, due to the effect of the stronger U.S. dollar on orders denominated in foreign currencies, compared to the first six months of 2008.
Underground mining original equipment new orders for the second quarter of 2009 declined from the second quarter of 2008, due to larger longwall new orders with customers in the United States and Russia during the second quarter of last year, and reduced longwall and room and pillar new orders in 2009 as a result of the current global economic conditions.
Underground mining original equipment new orders for the first six months of 2009 declined from the first six months of 2008, primarily due to an order in the Czech Republic for five longwall systems in the first quarter of 2008. Longwall and room and pillar new orders have been negatively impacted in 2009 as a result of the current economic conditions.
Our underground mining aftermarket parts and service new orders for the second quarter and first six months of 2009 have declined from the second quarter and first six months of 2008, primarily in Australia and South Africa, due to high order levels related to longwall equipment in 2008.
Current global economic conditions have resulted in moderate declines in all markets for our underground mining aftermarket new orders. However, underground mining aftermarket new orders did increase $139.9 million for the second quarter of 2009 from $104.8 million. That was an increase to $139.9 million for the second quarter of 2009 from $104.8 million for the first quarter of 2009.
Approximately $28 million of orders in our underground mining original equipment backlog at December 31st were cancelled during the first six months of 2009, $12 million of which occurred during the second quarter. Total underground mining new orders for the first six months of 2009 were negatively impacted by approximately $36 million due to the stronger U.S. dollar on orders denominated in foreign currencies, compared to the first six months of 2008.
At June 30, 2009, our total debt was $596.5 million, compared to $571 million at December 31, 2008. Our cash balance was $104.6 million at June 30, 2009, compared to $102.4 million at December 31, 2008. Receivables have increased to $670 million at June 30, 2009 from $636.5 million at December 31, 2008, primarily due to the recognition of sales on long-term contracts in excess of advanced payments from customers.
Cash collections of trade receivables were strong during the first six month of 2009. Inventory increased to $689.7 million at June 30, 2009, from $616.7 million at December 31, 2008. The increase was primarily in our underground mining segment and was due to the buildup of work in progress on orders that have been delayed per our customers' request, and on unsold orders that are expected in the near term. Consolidated inventory turns remain at 3.1.
Capital expenditures for the first 6sixmonths of 2009 were $24.3 million, which includes $8.6 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 million and $70 million. However, we are closely monitoring our capital spending in relation to current economic conditions and business levels. We believe that cash generated from our operations in existing credit facilities will be sufficient to fund our cash requirements during the remainder of 2009.
I'll now turn it back to Tim who will discuss our market conditions.
Okay, I just want to highlight a few things that Craig did give you in his report, though. One thing that is very critical and important to us is that the plan that we laid out early in the year, it seems to be playing out very well for us. And that is the fact that we are moving OE orders to 2010 as much as possible and basically hoping that we can book enough aftermarket to bridge that gap.
As of the end of June, we have moved approximately $200 million worth of OE business from our 2009 shipping schedule into 2010. I think as you saw, the booking levels on OE in the second quarter were low and some of that's a little bit of a timing issue, but the market is fairly soft out there now. CapEx for the big multinationals is down. There are pockets of opportunities, but certainly not at the robust levels that we've enjoyed the last 2.5 years.
Having said that, the strong aftermarket is really playing well into the plan for 2009 and allowing us to move additional OE business into 2010 as we look at that, and as we look at our financials as we go through the year, you'll see that inventory will move up somewhat, accounts receivable will as well. Working capital will be a little bit higher than normal for us. We're all okay with that. We would rather retain good solid contracts and work with our customers to the best of our ability to move those shipments out.
Craig did mention that we had $12 million worth of cancellations in the quarter. Obviously that was disappointing. That was primarily in Central Appalachia. That takes our total now for the year to $27 million. I think the good news about that, I think most of the backlog that we had for Central App has been dealt with. We'll see how we go through the third quarter, but obviously that is a fairly miniscule number compared to what it could have been with the current market. So we're very pleased by our efforts to continue to work with our customers and work to retain that backlog.
I also need to reconfirm that our backlog which is approximately $2 billion which is still a nice, solid number, a healthy number, is a quality backlog. Those were all non-cancelled contracts and as you can see our EBITDA margins are moving up. We're starting to achieve some of the efficiencies and some of the lean initiatives in our manufacturing facilities and we're starting to get the benefit of the CapEx that we've spent in the last two to three years on primarily equipment in these plants. So we hope that with the mix of aftermarket as we go through the year, and as we continue to improve our efficiencies, that those numbers will also hold up.
Craig also mentioned that there are some severance provisions in our numbers this quarter. That's disappointing to me personally. We don't like to have to do those types of things, especially as we have moved our company to, I think, a position where we can produce and engineer products at a very good level. We will continue to monitor our headcount and our expenses as we move through the latter half of this year.
Craig did mention our SG&A now is 8.7% – or it's 9.3% for the year, 8.7% for the quarter and we will continue to monitor and adjust expenses in advance of requirements that we may have. I do need to highlight, we will not be cutting Research and Development. As a matter of fact, that is something that we may enhance as we move through towards the end of the year and into 2010.
I mentioned that the market is soft. There is no question about that. The CapEx requirements of the big multinationals are down. Having said that, it's not completely dead and there are pockets of opportunity out there. And we think that if the market does continue internationally that way it has here the last few months, we're cautious that we might see more activity as well. By that I mean we tend to be domestic-centric when we say the United States and look at our own markets, which quite frankly, are in a difficult position, and that is probably an understatement.
But internationally things are not that bad. Copper, as we know, has been moving between $2.00 and $2.50 a pound. One thing that is not well known I don't think in the marketplace is that a lot of the leaching production that was pulled off the market in the fourth quarter last year is just having an effect on the market today.
With yields going down, leaching production being pulled off the market, which is being manifested in the market today, basically, in mid-summer, we believe, and I think the reports that are coming out of South America in particular right now, believe that copper prices will hold up pretty well as we move through 2009 and into 2010. With the yields going down and with pricing holding up, we should see some activity in the copper mines in South America in particular.
The steel market seems to have bottomed internationally. Met spot prices are creeping up. Iron ore prices are stabilizing. It's going to be curious to see how that all plays out with some of the new strategies on quarterly pricing versus annual pricing versus spot pricing. But I think the important thing is, our customers are as resilient as anyone. What they really need is certainty. The more certainty they have with pricing, the more they can plan for their production requirements.
Some production that was taken off the market in Brazil is coming back on stream. We think we may see some activity there. That's a result of, I think, the increased demand out of China, but also unfortunately, as a result of the unfortunate situation with the Rio Tinto executives in China at this point in time and the rift between the Chinese and that company.
And in June, if you look at the June numbers, steel was up 10% in China and it was up 8% globally; again, the U.S. market lagging significantly behind the world right now in steel production. China's GDP has been confirmed at around 7.9% or 8%. Coal consumption is up 16% year-over-year in China with all projections pointing to that to continue to increase. I think everyone's read it, everyone has heard about it, but the stimulus package in China has worked out very, very well and that economy is stable and appears to be moving forward unlike, again, the domestic U.S. economy.
The IEA has predicted an oil demand will be up again in 2010 and publications now are predicting that the oil price over the next couple of years, and maybe beyond, will be probably maintained within this $60 to $80 level of pricing per barrel. That's a positive for us, and it's a positive for potential oil sands opportunities. We also are seeing some activity now in potash and phosphate, which has been very poor over the last recent past year, but there seems to be quite a bit of activity in those areas as well.
I guess in general, if you look at the market, we're pleased that very rapidly after the production pull-backs in the fourth quarter of 2008, we've seen a pretty substantial and well established pricing floor for most commodities. Most producers are still producing their products well above cash costs, with exception of some of the domestic producers in Central Appalachia.
And in general, in talking with our customers the overall mining costs have gone down an average of 20% this year, which is positive. In other words, the market correction has done a lot to help reduce the costs in the mines that were running at a very, very high level, and this market correction is certainly helping those situations out a lot as well. I think I will leave it at that, just a couple of comments.
We will maintain capital spending, as Craig mentioned, between $60 and $, which was our guidance for the year. Our guidance as far as revenue and EBITDA, I want to update that. You will recall that our guidance for revenue was approximately $2.5 billion. That was our guidance given in the first part of February with adjusted EBITDA to be between $460 million and $475 million.
We are now advising that revenue will be maintained at the $2.5 billion level. Again, we believe our plan is working. We believe that moving some of our OE backlog into '10 is being replaced by some good old aftermarket business. With that in mind and with the mix changing for the second half of the year, we're increasing our guidance and adjusted EBITDA for $485 million to $500 million. So we are increasing EBITDA guidance, adjusted EBITDA guidance. We are not increasing revenue.
With that [Josh], I think we'll go ahead with questions and answers.
Thank you, sir. (Operator Instructions). Our first question comes from Charles Brady – BMO Capital.
Charles Brady – BMO Capital Markets
And with respect to moving OE orders into 2010, am I correct in assuming that there could still be more of that happening or have you kind of moved what you're going to move into 2010?
I think the bulk of its done. We picked up around $25 million to $30 million here in the quarter that we shifted into '10. So it's pretty well, I think, played out. I think pretty much of what we've got now in '09 we will keep in '09.
Charles Brady – BMO Capital Markets
In terms of production slots, looking out into 2010, can you gives us a sense of I guess how many openings on the production schedule are there now with respect to what's been moved into 2010?
Well we haven't really published that. I think that's still kind of a work in process right now. It's going to depend a lot on what happens here in Q3 and Q4. I think suffice it to say, we're probably about half of what we want to be right now for '10 and that's on OE only, not on aftermarket. And aftermarket continues to be quite strong with the larger install base that we have out there now. But we're about half booked I think on the OE side for both service and underground right now.
Charles Brady – BMO Capital Markets
Okay, and then one final one and I'll get back in queue. On the new order, in terms of a dollar number on new orders, do you think at the current Q2 rate, $367 or so million that we've kind of found a bottom on order rate in dollar terms or would you expect on a dollar terms does that kind of keep pulling down?
I don't think it's going to pull down. I think that's probably a pretty good level of, I don't want to call it worst case but that's certainly the low end of where we think we can book. I think we tend to underestimate at times the strength of that $28 billion install base out there, which in five years is three times what it was in 2004.
And there's some tremendous strength out there with that install base. And we still are seeing a lot of aftermarket activity. So it was a good quarter, don't get me wrong, in aftermarket, but with some of these other lingering opportunities on OE, potential business out there, if the commodity prices hold up and if aftermarket continues at the pace it is now and we think possibly even higher, I would say that Q2 is certainly on the low end of what we should be booking.
Our next question comes from Steve Barger – KeyBanc Capital Markets.
Steve Barger – KeyBanc Capital Markets
Just the sequential increase in the aftermarket, are you seeing continued pull through as you go into this quarter on that trend? And can you talk about whether you're seeing any change to that install base utilization rate across the board?
Well I guess we'll find out in the quarter. It's been – the inquiry levels have been high, the activity's been high. So far it looks like it's rolling into the same type of performance if not better hopefully in the third quarter.
Steve Barger – KeyBanc Capital Markets
One of your customers was out a few days ago saying that China's inventory build is essentially complete but they're seeing evidence of restocking going on in the developed world. Are you seeing that in some of your commodity exposures? Is there any evidence that North America and Europe need to start restocking at this point and that's actually taking place?
I think that will happen. To be perfectly honest with you, we've concentrated most of our efforts in this quarter, and where I've been spending most of my time is in the developing world, and I haven't really spent a whole lot of time, Steve, on what's happening in the developed world.
But it stands to reason you can only run down inventory so low and then you've got to start rebuilding. The domestic coal market in particular is really one that's struggling right now but that's – something's got to give there here in the near term.
Steve Barger – KeyBanc Capital Markets
One more and I'll get back in line. At the Longwall USA show a few weeks ago, two Chinese manufacturers had brought over roof supports to the show. Can you talk a little bit about what you're seeing in terms of competitive pressure for some of the less technology heavy parts of the product line? Are they really stepping up those efforts to penetrate those markets?
I think they're trying with no success at this point. I think there's probably a chance that they could get success in some of the other developing markets, for instance Russia and India. They might get some traction in those markets. We certainly are bumping into them in those markets and it's a potential threat for the future. But so far we've been able to get our share of those developing markets. I don't see that those products will find their way into the developed world any time soon.
Our next question comes from Robert Wertheimer – Morgan Stanley.
Robert Wertheimer – Morgan Stanley
I'm actually going to cover a couple of the same points. Can you explain the dynamic as you're pushing back orders into 2010, is that initiated by you or is that initiated by the customer? And would there be a risk of cancellation if it wasn't pushed back? I know they're cancelled, but still.
Well, it's both. I think some we've orchestrated; some have evolved out of necessity. I'll give you an example, just to give you a flavor for it. We had a customer in Russia that was struggling to come up with local financing or enough hard currency to keep the order in place.
We went to Hermes and got support. It was for a longwall system. And the financing got put in place very quickly and we were able to save that order and move it out further when they will have more ability to pay for – make those payments for that equipment.
But I think the point is is cancellations are still something that we don't think are going to happen for us. We've got significant down payments and progress billings, which means that it's very hard for customers to walk away from orders, and/or we have LCs. We have gotten a little aggressive with some of these customers to let them do – open an account but then we've got financing packages in place with [EFG] banker Hermes guarantees.
So the backlog's solid. I think whatever we have in there now with maybe a few minor exceptions that we don't have planned right now because I think most of the Central App has been where the issues have been. We think the backlog's solid.
Robert Wertheimer – Morgan Stanley
Okay, thanks. And then in China, specifically with Chinese competition, I know there's a big push to try and get more productivity out of the existing sophisticated mines that are there. Are you seeing local Chinese firms win more orders on the equipment side in China or is there more penetration by you and your competitors as China really needs the coal?
Well China's fairly complex. I don't think we're seeing any more success than what they've had over the last year or two. The Chinese will still buy equipment from ourselves and our competitor that they don't think is up to the technical standards that they require.
I'll give you an example of something like that. We sell plow systems. We're the only company in the world that sells automated plow systems. Now the Chinese, as they move into lower seam applications, that's an opportunity for us. It's not an opportunity for our competitors. It's not an opportunity for the local producers of equipment.
So where technology has not been copied in the China market and/or if they're looking for superior productivity in high production mines, they will still buy from Western companies like ourselves and our competitor.
Robert Wertheimer – Morgan Stanley
And you're saying it hasn't effectively shifted over the last year or so? You haven't seen an increase in sophistication or order winning among the Chinese?
No, no, I think it's fairly stabilized. In some respects I think we had a bit of a knee-jerk reaction last year. And it was a very low booking month or booking year for us for the China market. We're seeing a lot more activity for our products right now in China.
And again, it's kind of the horses for courses phenomena. If we've got a product that they need, that need and they have not found a local alternative for, or if they're looking for the high productivity they'll go with us. So I think it's actually just the reverse. I think we're going to see a little more activity than we have over the last two years in China as we move through 2009 and into 2010.
Robert Wertheimer – Morgan Stanley
And you mentioned the plow system is working. Are you selling roof supports or is it mostly plows and you're doing shears?
No, it's mostly plows and AFCs. The roof supports pretty much are all going to the Chinese manufacturers now. There are several companies that produce them. They are producing a low tech product. It's not automated. They still use a lot of manual valving and that type of thing, but they are more willing to support that low tech roof support product from the local suppliers. So we'll get the high tech portion of the longwall. We'll get the plow and we'll get the AFCs and we'll get the automation package.
(Operator Instructions). Our next question comes from Joel Tiss – Buckingham Research.
Joel Tiss – Buckingham Research
Just two fast ones for Craig and then a bigger picture one. Can you give us, Craig, the free cash flow year-to-date versus a year ago? And also I noticed the interest expense is down in the quarter even thought your debt is kind of flat to up a little bit. I just wondered if you could tell us what's behind that?
Well, the interest expense is a function of the lower interest rates. We do have some interest rate swaps out there on our long-term debt that are showing lower interest rates than we've had in the past, so that's a reflection of basically lower interest rates and not necessarily less borrowings than we've had. So it's just a reflection of that.
From the free cash flow, as you probably saw from our press release, we do have a significant amount of increase in working capital since the end of the year. Inventories are up, receivables are up and our liabilities and done completed contracts is down which means that's a cash use there.
So if you look at the changes in assets and liabilities for the quarter it's almost $135 million negative and year-to-date it's $167 million negative. But with the low interest rates and our determination to maintain our current production flow, we felt that was a prudent thing to do for us, so we are still positive on the cash flow but not as much because of the working capital increases.
Joel Tiss – Buckingham Research
Okay, and then, Tim, it just seems at the margin like the backlog is not really dropping as quickly as it was a couple of quarters ago, and I guess some projects are being delayed. Should we be thinking in the back of our minds that maybe the run-off that people have in their estimates for 2010 and 2011 is not as dramatic as what people have been just thinking in the back of their mind?
Yes, I think what everyone talks to me about, everyone uses the term trough. I kind of resist that a little bit because I think there's been somewhat of a market correction, but again, I'm going to repeat myself. With the strength of that backlog and the leverage of that – the strength of the install base and the leverage of that install base, I think you're seeing it quarter-over-quarter.
We still $2 billion worth of backlog there and you're basically knocking that backlog down a couple hundred million dollars a quarter right now, or $250 million a quarter and we're loading it in with more aftermarket. So I think the real aggressive modeling of dramatic drops in backlog, we just don t see it for us. It's, again, the leverage of that install base is tremendous.
Our next question is from Barry Bannister – Stifel Nicolaus.
Barry Bannister – Stifel Nicolaus
If two-thirds of backlog realizable within 12 months is normal and you have about $1.3 billion of backlog that you expect to realize in the next 12 months, that's about $2 billion of revenues, and if I look at your book-to-bill right now it's about half of revenues this quarter. And historically it's been closer to one, a little over one.
So I'm trying to get a flavor based on your nearest competitor saying that 2010 might be down around 20% year-over-year on the revenue side. What normalized levels of revenues are if something in the $2 billion range versus 259 is normalized? And then also this margin, which is obviously exceptional. It's approaching your 20% goal and ex-items it is there, what kind of decremental margin on any revenue contraction would likely occur and where would the margin settle in on the EBITDA side?
Yes, I think it's really the next two quarters are going to be absolutely critical to answer that question obviously, and that's really what the mix is going to look like, what level of activity we can actually see in the OE side in Q3, Q4, which is really anybody's guess right now. We're not as pessimistic as most but we're certainly not optimistic.
Could our revenue drop down as low as two? It might. Obviously we're trying to do everything we can to try to hold as much as we can flat. With a little bit of help and a little bit of activity, and we are seeing some out there, that we can protect some of that revenue drop with some OE business.
The interesting thing about that, as you know, is that if the mix for '10 shifts more toward aftermarket, these EBITDA margins are just going to continue to go up. So you're going to get kind of a mix of the two and I think if – you know, we want the OE business obviously to drive as much revenue as we can in '10, but if the OE is not as strong as we want then we can still leverage off of that large install base.
And I think what's going to happen is if people can't buy new machines in the second half of this year, I think the aftermarket spend will continue to go up, which means that we'll fall somewhere, hopefully above two, and the margins are probably going to be higher than where we're at right now.
Our next question comes from the line of Andrew Kaplowitz – Barclays Capital.
Andy Kaplowitz – Barclays Capital
Tim, can you talk about the dragline opportunities that are out there? I mean you've obviously talked about the Indian draglines before, any update on those, and anything going on in Australia over the next 6 to 12 months?
The draglines are out there. I think it's complicated out there right now for the multinationals in the developed world to commit. Some of the prospects that we thought would happen this year could be drifting – probably will be drifting into the first half of '10. And hopefully if we get a little bit of stabilization as we think we're getting right now in the commodity pricing internationally, those will occur around that timeframe.
We're still swinging away on India, and we think that there could be some action there this quarter, but I said that last quarter. The Chinese are really trying to determine what to do right now. They are seeing the full benefits of the dragline that's been running for quite some time. They need draglines. I think they're struggling a little bit with the capital required to buy the draglines, and I think they're also exploring other options.
But that, if you look at the Australian market, the Canadian market, those draglines I can almost guarantee you will go into '10 as far as prospects, but they're solid prospects. They're required. They're primary for power plants and/or for cost reductions in coking coal operations in Queensland. The Chinese just need more coal, the Indians need more coal and draglines are required. It's just a matter of them getting their hands around the capital required.
So we tend to internally discount dragline prospects somewhat because the fact that they are fairly large bookings when we do get them. There's activity. I guess – sorry, I'm repeating myself here, but in summary I think we've got some near term activity, although it's in the developing world and that's hard to predict. We have solid prospects in the developed world, but those will stretch now I think into 2010.
Andy Kaplowitz – Barclays Capital
Tim, your competitor has recently mentioned that they expect the U.S. aftermarket to weaken a little bit before strengthening again. I'm just curious what you guys are seeing if you break your aftermarket down into regions? What's going on in the U.S. versus the developing world? Any more color you could give us would be great.
The aftermarket is steady in the U.S. Most of the increases that we are getting is in the developing world on some of the new install base of shovels that are out there, primarily in copper and iron ore, but the U.S. is okay. I mean it's holding in there okay. I think what we're going to have to see though is some rebound obviously in the price of coal, but more importantly the production.
The production is going to drive the machines to run to their maximum which then creates parts opportunities, but we model it out and right now we've got the aftermarket as flat over where we are at right now as we move through 2009. We haven't looked beyond the end of 2009 yet for parts booking opportunities in the aftermarket region of the U.S.
Andy Kaplowitz – Barclays Capital
One more quick, if I could, on oil sands? You kind of alluded to oil prices in the range that they're in you might see some more activity. We've seen more project activity and maybe in the very early going. Have you seen anymore inquiries in the oil sands?
Yes, inquiries are up quite a bit in the oil sands for the brownfield sites, and I think there's a few of the customers up there that are feeling pretty strong about the price of oil and now is the time to move. So that could be an opportunity for us between now and the end of the year, and I feel pretty confident there will be some activity up in the oil sands.
The new projects, though, that were tabled, with the exception of the Kearl project by Imperial Oil, which is Exxon, with the exception of that one being announced as going ahead, nothing else has been announced for release. So I think the brownfields will continue to expand. We will get the Kearl opportunity here I think within the next six months and we'll see how the new projects go. If the oil price holds up, which it's predicted to do, I think some of those – two of those other projects could come on – could be announced to come back towards the end of the year.
Our next question comes from Jerry Revich – Goldman Sachs.
Jerry Revich – Goldman Sachs
Tim, can you please talk about the outlook for new equipment orders by commodity, where you see the most promise? It sounds like oil sands are at the top of the list. I'm wondering if you could just step us through the rest of the commodities and as you think about potential for new equipment orders?
Well, it's really across the board. We're seeing activity in Eastern Europe and Russia for coal. We're seeing potential opportunities in Chile in copper, and if copper prices hold up, and it could, I mean obviously those prospects could become a lot more solid.
India, China, I mentioned earlier China and India; there's activity in coal in those areas. And we are getting a little bit of activity in iron ore believe it or not, and that's probably a function of the fact that some of the companies are trying to position themselves for the rebound in the steel market.
So with very few exceptions, met coal is still very soft. Iron ore is not strong, but there are a few activities, a few opportunities out there. Steam coal U.S. is absolutely dead, but there's pockets of opportunity out there.
Jerry Revich – Goldman Sachs
Tim, I'm wondering if you could talk about, just based on the inquiry levels that you're seeing, where you expect orders to be directionally in the third quarter versus second quarter? Your book-to-bill on new equipment was 0.2 in the second, 0.6 in the first. In the third do you expect it to be somewhere in between or is it too early to tell?
A little too early to tell, but there are – I can say that there are a few things that did happen in Q2 that did not get booked just because of timing. So I can almost tell you that we're going to get a little bit more activity in Q3 than we had in Q2 just for that reason.
Jerry Revich – Goldman Sachs
And Tim, in the quarter you highlighted a decline in underground aftermarket orders in Australia and Africa in the quarter. Have you seen a pickup in activity since July? I'm wondering if you can talk about the outlook for the underground aftermarket business for other regions as well?
Nothing so far, but we don't think that will sustain itself. We think that those aftermarket opportunities will rebound. We're looking at some of the fairly recent installations that we put in here in the underground region, the underground segment, in the last two years that are going to start generating some parts business in particular in Eastern Europe and some of the installations in the U.S. So we think that's just sort of a temporary situation in Australia and South Africa and we feel that the rest of the markets will continue to grow.
Our next question comes from Paul Bodnar – Longbow Research.
Paul Bodnar – Longbow Research
Just kind of a follow-up on the aftermarket, how much of that has been kind of market share gain from you guys and how much of that has been kind of overall increases in the end market? I don't know if you can quantify that or perhaps have some idea on that?
I really don't think we've had much aftermarket share gain. It's just the sheer volume. If you go back like I said five years ago our install base was bouncing around 10 billion. We're approaching 30 billion now, so it's just the sheer size of the install base I think that we're reaping the benefits of.
Paul Bodnar – Longbow Research
Can you give some more details on just on what you see the opportunity in India over the next call it two or three years.
We're cautiously optimistic on India with the new government in place. The old government was really slowed down by the Communist Party that had a fairly significant percentage of the coalition. They are no longer in that coalition and we're already starting to see things move in that country. It's a great opportunity and I think I've had to bite my tongue here for the last three or four years because of the fact that the need is there, the demand is there, but the government couldn't get off the schnide because of political issues. That's changed and we're cautiously optimistic that that market could be good for us here in the next three or four years.
Our next question comes from Ann Duignan – JP Morgan.
Ann Duignan – JP Morgan
Hi guys good morning. I just wanted to follow up on Barry's question on margins just looking at 2010. I know you haven't given guidance for 2010, but can you talk a little bit about you know if your OE business were to fall dramatically, yes, the aftermarket would represent a much greater percent of the total volume, but at some point the aftermarket business would have to absorb a lot of the overhead that's currently being absorbed by the OE business.
Can you just talk about how that would shake out? It's hard for me, I mean, I'm kind of scratching my head going how could margins expand if revenues go down, because there is going to have to be some fixed overhead absorption by the aftermarket business. What am I missing?
Well, a couple things. First of all margins will go up with just the mix. Secondarily, we potentially, – not potentially – we do bring in the subcontract that's been out there the last couple of years, and that includes on the spare parts side. So the real key is to move as much volume as you can and to make sure you're absorbing your direct cost and that's in place. And our margins continue to move in that direction.
I think we are still seeing improvements based on efficiencies and we haven't even gotten all the machine tools in place yet that we purchased two years ago. So efficiencies, bringing subcontract back in, mix to higher margin products going through the plant, all those things combined tend to lead for an increase in margin opportunity.
Ann Duignan – JP Morgan
Yes, I understand the mix issue. It's the absorption that I was trying to get a handle on. So you're bringing outsourced volume back internally, which would help the overhead absorption and that was the component that I probably was missing.
Right, and I think – don't underestimate also the efficiencies that we're starting to get with less – I guess proportionately direct cost related to those efficiencies with the bigger faster machine tools that we have.
Ann Duignan – JP Morgan
Okay, and then could you address the severance cost? Could you tell us what percent of employees have been impacted to date and what you think the ultimate number might be? I know that's probably a touchy question to ask, but at least what you've done to date?
Yes, I think – well, we've done some trimming here in the south Milwaukee operations and from a production floor standpoint, it's around a 7%, 7% to 8% level. One of the things that we are doing is well is we are closing our U.K. operations. That market showed signs of recovery and we don't see it now. And we have two locations there, one service and one underground, so those are being shut. And we're also looking at some other plant rationalization just to make sure we're trying to create as much as we can from an efficiency standpoint and for proper sizing based on what we're seeing in the marketplace.
Ann Duignan – JP Morgan
So would you anticipate further costs in Q3 and Q4?
Ann Duignan – JP Morgan
And then one final one, since we are probably towards the end of questions, can you talk a little bit about the cash burn rate that you would expect to see in the back half , just given the increase in inventories? And where would you expect your net debt-to-total capital to end at the end of the year, given the buildup of inventory and receivables?
I would expect that the inventory will not increase as much have. We may even see some decreases in inventory in the last six months of the year. We've had some buildup in inventory on some of these delayed orders, almost $40 million worth in the first six months. And as we utilize some of that inventory that was for some unfilled orders that will cause inventory to come down, so I'm expecting inventory to actually be a cash plus for us in the last six months.
On the receivable side that could go up depending on what happens here in the third and fourth quarters, but I don't want to predict right now, but it could be maybe, if we did around $35 million for the first six months, it could be that much again in the last two quarters of the year depending on what the mix of the orders are. So it won't be real significant, but it probably will be an increase in receivables, probably a decrease in inventory, as we see it right now.
At this time we are showing no further questions. Tim Sullivan, you may proceed.
Well, thanks again for joining us today. Obviously we're reasonably pleased by where we sit from a financial standpoint for Q2. We have challenges ahead, but quite frankly I think in the grand scheme of things, and the fact that we are so internationally dependant, which is not a bad thing in this day and age, we're cautiously optimistic that we will continue to move forward as we roll through the remainder of this fiscal year and into 2010.
I think the most gratifying thing and the thing that we cannot lose sight of is the fact that the plan that we did put in place is playing out as we hoped it would, and we think that that plan will continue as we move through this fiscal year. Again, thanks for joining us. As always, if you have any additional questions feel free to contact us and we'll talk to you again in a quarter.
Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.
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