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Executives

Michael W. Sutherlin - President, Chief Executive Officer, Director

Michael S. Olsen - Chief Financial Officer, Executive Vice President, Treasurer

Sean D. Major - Executive Vice President, General Counsel, Secretary

Analysts

Ann Duignan - JPMorgan

Michael W. Gallo - C.L. King

Charlie Brady – BMO Capital Markets

Jerry Revich - Goldman Sachs

Andy Kaplowitz - Barclays Capital

Robert F. McCarthy - Robert W. Baird

Barry Bannister – Stifel Nicolaus

Analyst for Steve Barger - Keybanc Capital

Mark Koznarek – Cleveland Research

Joy Global Inc. (JOYG) F3Q09 Earnings Call September 2, 2009 11:00 AM ET

Operator

Good morning. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Joy Global Inc. fiscal third quarter 2009 earnings conference call. (Operator instructions) I would now like to turn the conference over to Mike Olsen, Executive Vice President and Chief Financial Officer. Mr. Olsen, you may begin your conference.

Michael S. Olsen

Thank you, Stephanie. Good morning and welcome everyone. Thank you for participating in today’s conference call and for your continued interest in our company. Joining me on today’s call are Mike Sutherlin, President and Chief Executive Officer of Joy Global; and Sean Major, our General Counsel and Secretary.

This morning, I will begin with some brief comments which expand upon our press release and which provide the results of the fiscal third quarter. Mike Sutherlin will then provide his insights into our operations and our market outlook. We will then conduct a question-and-answer session and would appreciate it if you would limit yourself to one question and one follow up before going back into the queue. This will allow us to accommodate as many questioners as possible.

During the call today, our executives will be making forward-looking statements. These statements should be considered along with the various risk factors detailed in our press release and other SEC filings. We encourage you to read and become familiar with these risk factors. We may also be referring to a number of non-GAAP measures which we believe are important to understanding our business. For a reconciliation of non-GAAP metrics to GAAP, as well as for other investor information, we refer you to our website at www.joyglobal.com.

Now let’s turn to the results for the third quarter. During the current quarter, the company received $683 million of new orders and had $39 million of order cancellations. This compares to the record quarterly new orders of $1.5 billion received in the third quarter last year. This 54% decline before the effect of cancellations was made up of a 76% decline in new orders for original equipment and a 21% decline in after-market new orders. Each of the company’s three business segments reported lower new orders in the current quarter than they did a year ago. Underground mining equipment was down 49%, surface mining equipment was down 64%, and the crushing and conveying business was off 36%. The softness in original equipment bookings in the current quarter, despite improvement in commodity prices, continues to reflect the caution our customers are demonstrating in making capital investment decisions. The decrease in after-market bookings was led by the softness in demand from customers mining coal, copper, and iron ore in the United States. The decreases in these markets are consistent with the announced cut-backs in production for these commodities.

During the third quarter, the company made the decision to conform the original equipment backlog for the surface mining equipment business with the bookings policy put in place earlier in this fiscal year. This policy requires contracts and down payments before an order is placed in backlog. The effect of this decision was a $606 million adjustment, representing the removal of orders from backlog supported by letters of intent and deposits. Mike Sutherland will discuss this adjustment in more detail during his comments.

Total Joy Global backlog at the end of the third quarter after this $606 million adjustment was $1.8 billion, compared to $3.2 billion at the end of the 2008 fiscal year.

Net sales in the third quarter were $956 million, compared to $904 million a year ago. A 19% increase in net sales reported for the underground mining equipment business was offset by decreases of net sales of 8% and 10% for the surface mining equipment and crushing and conveying businesses respectively. In addition, a 19% increase in original equipment shipments were partially offset by a 4% decrease in after-market net sales.

The increase in original equipment sales was led by increased shipments of new machines in the underground equipment business as a result of good execution of the strong original equipment backlog, primarily in the United States and South Africa, more than offsetting soft market conditions in the European and Russian markets.

After-market sales were flat for the underground equipment business and slightly lower for the surface mining equipment and crushing and conveying businesses. For the underground equipment business, after-market sales were substantially flat and all geographic markets except for an 8% increase in the U.S. and a 9% decrease in South Africa, where about half of the decrease was due to foreign exchange rate fluctuations.

For the surface mining equipment business, after-market sales decreased in the copper and iron ore markets in North America and this decrease was partially offset by the increased sales in the Eurasia and Australasia markets.

Operating profit in the current quarter was $195 million, compared to $134 million in the third quarter of the 2008 fiscal year. Operating profit as a percentage of sales was 20% in the current quarter versus 15% a year ago. All three of the company’s businesses reported an increase in operating profit compared to a year ago. The improvement in operating profit was due to improved product price realization, compared to last year, which experienced unrecovered material cost increases, the increase in sales volume, manufacturing, and supply chain efficiencies and strict cost control measures. In addition, the third quarter last year was adversely impacted by a $5 million charge for the settlement of a union contract and an additional $5 million of purchase accounting amortization charges associated with the acquisition of the continental conveyor business.

Net income in the third quarter was $124 million, or $1.21 per fully diluted shares, compare to $113 million, or $1.03 per fully diluted share a year ago. Last year benefited from a discrete tax adjustment of $24 million, or $0.22 per share, associated with foreign tax credits recognized in the United States. The effective tax rate was 34% in the current quarter compared to 12% or 30% excluding the discrete tax adjustment last year.

Cash provided by operations was $187 million in the current quarter and was $142 million in the third quarter last year. The improvement in cash flow in the current quarter was primarily associated with a $95 million reduction in inventories, the improvement in profitability, and not repeating the $33 million pension contribution, which was made in the third quarter a year ago. These favorable items were partially offset by a $91 million reduction in advanced payment in the current quarter.

Now let me turn the call over to Mike Sutherlin.

Michael W. Sutherlin

Thank you, Mike, and I would like to add my welcome to those on the call. Let me start by congratulating the Joy Global team for the progress they are making on fundamental improvements in our business. They are driving programs that are leaning out our processes, controlling costs, and improving asset efficiency. These programs are the basis for current performance and the foundation for future performance.

I also want to comment on the backlog adjustment we made. There were too many factors that prompted us to take this step. First was concern to more effectively communicate the nature and degree of any backlog risk and the second was that those orders no longer met our current booking policy that we updated at the first of this year. This started with a surge of original equipment orders last year as the industry was scrambling to catch up supply with accelerating commodity demand and as our customers were rushing to get surety of equipment supply for their projects. The preference for P&H machines and our extended lead time caused those customers to book shovels for delivery in 2011 and beyond. At that time, our booking policy was letter of intent plus deposit, which enabled us to commit delivery slots while the contracts were being completed. However, the sudden and dramatic downturn in the commodity markets interrupted that process and many of the underlying projects were put on hold. This left us with backlog that did not have defined and certain delivery dates. And then at the beginning of this year, we tightened our policy to book only contracts with progress payments. This left us with reported backlog amounts that both were subject to investor interpretation and also no longer met our current booking policy. We are not comfortable with either and have taken all of the letters of intent out of our backlog.

This is positive for transparency. We will report bookings as these letters of intent are moved to contracts and this will give you more visibility of market activity. In fact, I think you will get the same insight into our customers’ view of the market when they make a decision to reactivate a project and let contracts for equipment as you do when they approve an entirely new project.

It also has broader positive implications. These letters of intent are mostly for multiple machine orders for major customers for projects that were previously approved. The letters of intent and deposits remain valid and the underlying projects will eventually be restarted. These factors, plus direct discussions with customers involved, cause us to believe that many of these will be the next machines that these customers order. These letters of intent can therefore give us an important advantage when the market recovers.

Our view of the market, especially the international market, has improved significantly since our last earnings call. China continues to import [mat] and thermal coal, iron ore, and copper at high record and sometimes unprecedented levels. Some of this importing has been strategic stocking. Although I previously thought we could see a drop in China’s imports as the stock building reached an end, there have been a number of positive changes in the meantime. China’s economic growth was up to almost an 8% rate in the second quarter after bottoming out at a 6% rate in the first quarter, and 2010 forecasts are now back to double-digit rates.

China’s steel production in July was up 13% year-over-year, which shows positive momentum from the 3% growth measured on a year-to-date basis. And as a result, year-over-year electricity demand finally turned to growth in June after declines every month since last October.

More importantly, China’s trading partners are reporting improved economic results. In the second quarter, the U.S. rate of decline slowed dramatically and Germany, France, and Japan surprisingly had positive growth. This is consistent with the China purchasing managers’ index for new export orders, which have been improving since bottoming last November.

There is enough momentum in the Chinese economy to allow the correction of large stockpiles of commodities to be achieved through moderating growth rates rather than import declines. And as a result, [sea-borne] traded commodities continue to be strong. Net coal production is increasing, new contracts are at higher prices, and next year’s benchmark is expected to increase 8% to $140.

China and India are setting the market for sea-borne thermal coal with China imports running double that of last year and its exports down to 2004 levels, and with India imports up 18% and expected to be at $40 million tons for the year. As a result, next year’s benchmark for thermal coal is now expected to rise 20% to $85.

Sea-borne iron ore that is selling at spot is more than 30% above the benchmark and this is becoming the expectation for next year’s price. And finally copper prices have doubled from their lows last December and should continue to rise above $3 next year.

Our international customers are starting to add back production and they are dusting off the plans and proposals for projects they put on hold late last year. At the same time, they do not want to be caught jumping the gun because they are still not sure if we are seeing the start of a V-curve recovery or if we will have to bump along the bottom for a while. Therefore we expect any projects they plan to restart to flow through their annual capital budgeting process at year-end.

The U.S. coal market is quite a contrast to the international markets. Electricity demand is down 5% from last year. More critically, low natural gas prices are reducing the dispatch from coal fuel plants. The result is thermal coal demand down 10% to 12%. At the second quarter run-rate, 100 million tons of coal production has been cut but to balance supply to demand, another 10 to 30 million tons may need to be idled. Although these cuts are dramatic, they were not taken soon enough to prevent stockpiles from doubling to their highest level in over 20 years and this will create a headwind for recovery in the U.S. coal market.

We therefore expect the recovery in U.S. coal to lag the international markets by 12 to 18 months. But there are some positive signs in the broader U.S. economy. Steel inventories have been cut to about half their level of last August and are now at their lowest level in 26 years, lower than the 10-year average at 2.3 months of supply.

With the effective end of inventory reductions, steel production in the U.S. has increased from its low of 40% back to 54% by July. This is helping demand for iron ore and met coal from our U.S. customers.

And similarly, industrial production in the U.S. has started to move up from its low of 65%. Although not close to the levels of the international market, it is still good to see commodity demand in the U.S. stabilize.

Although there are more and more positive signs from the global economy and from the commodity markets, we continue to be guided by our customers. We are being engaged in discussions about projects that could be restarted and even though our customers are making serious efforts to get these projects ready to go, our best intelligence is that any orders that result will not be placed until next year. With our normal manufacturing lead time, we would not expect new orders in 2010 to become shipments until 2011.

Since the current trajectory would have shipping levels converging to the current order rate some time in the second half of 2010, we continue to expect some gap before recovery of shipments. As a result, we expect our 2010 revenues to be lower than 2009 levels and continue to prepare our business to deliver strong performance in that environment by being sized right as we enter next year.

In the meantime, we expect revenues for 2009 to be within our previous guidance range of $3.5 billion to $3.6 billion. Our operational excellence and cost reduction initiatives continue to gain momentum and therefore we were able to increase our earnings guidance and now expect fully diluted earnings per share for 2009 to be between $4.00 and $4.20, including any restructuring costs that we incur in the fourth quarter.

So with that, I would like to finish my comments and turn the call over to the Q&A session. Stephanie.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ann Duignan with JPMorgan.

Ann Duignan - JPMorgan

My first question is just around Q4 -- can you talk a little bit about the restructuring costs that you are anticipating in Q4? Can you quantify how much you think you might be spending? And then do you expect restructuring costs to accelerate into 2010 in order to right-size the business?

Michael W. Sutherlin

I will give you some color comments and then Mike can give you some more detail on the numbers but we are trying to stay ahead of the curve. We have a pretty good model and the order rates today are in line with that model. We have seen in the first three quarters of this year, the incoming order rates at reasonably steady levels for those three quarters, so we feel pretty good about the predictability at this point. We are downsizing our business to prepare for 2010 and we are also at the same time making some strategic moves trying to reposition our business to be in a better position during the recovery, so part of this is to get our costs down to the levels we expect for 2010 and part of it is to accelerate some of the strategic items we had in progress but to get those accelerated so we can be better prepared for recovery when we get to that point.

The restructuring costs right now that we are looking at in the fourth quarter are a combination of the two and the strategic items are obviously a little bit more difficult to nail down at this time but I will have Mike give you some more information on some of the number ranges we are looking at.

Michael S. Olsen

Yes, at the end of the second quarter, we had indicated on our discussions with this group that we were looking at about $10 million over the remaining two quarters of the fiscal year. We had just over $4 million in the third quarter and we are looking probably to be a little bit higher than that overall $10 million amount for the final two quarters, so looking at probably slightly above $7 million for the fourth quarter and once again we’ll be monitoring the incoming order rate, be monitoring what is happening in the after market and would anticipate that there would be some additional restructuring costs that would flow over into the beginning of the 2010 fiscal year.

We had talked about our scenario planning being arranged in stages so that as we hit various points, there would be specific additional actions that would take place and depending on where those various stages are reached, that will be the determining factor as to additional restructuring activity.

Michael W. Sutherlin

And just one follow-up on that -- we continue to look at facility rationalization as part of the overall plans that we are looking at right now and obviously if that was included in some of the restructuring, those numbers could jump up pretty significantly if we decided to take on a facility rationalization step at this point.

Ann Duignan - JPMorgan

Okay, so right now you don’t have any facility rationalization in the numbers that you have shared with us?

Michael W. Sutherlin

No, we do not.

Ann Duignan - JPMorgan

Okay, that’s good color and helpful. Then my follow-up question is more around the balance between yes, we are seeing steel prices improve and increase. You know, what impact could this have on you in let’s say the next 12 months as input costs go up and yet even if new orders come in, you won't be delivering original equipment until 2011. Is there a risk that we also see a margin squeeze over the next 12 months, just from the higher input costs? And no ability to pass on pricing?

Michael W. Sutherlin

Obviously there is always some level of risk but I do not think it is a significant risk. I mean, we are seeing input costs beginning to move up, steel costs -- we’ve seen some increases in steel costs. They have been relatively modest and we interpret that to be more signaling to the customers that we -- that the steel companies are not going to continue to chase their prices down.

As we -- we have long discussions with customers about current prices and commodity movements and I think we have been pretty firm on dealing with the customers on the need to maintain pricing levels and we’ve done a good job of that in the current market.

With the commodity prices improving, I think we’ve laid the foundation to continue to have those discussions with customers about costs going up and our ability to recover those.

You know, within the scope of a year, we are in pretty good shape on I think risk mitigation on that. One of the reasons is that we buy steel early in the process so we’ll actually have steel on the ground as we start the manufacture of one of our machines and that gives us a hedge against inflation probably within the 12-month window. Beyond 12 months, we’ve done a lot of analysis and we feel pretty comfortable that contracts that require escalators, we’ve put escalators and sur-charges and other kind of formulaic additions in and we feel pretty good that that would protect us if the lead times run out more than one year. But you know, an increasing commodity price levels, you know we obviously have a learning off our past experience so we are trying to mitigate the chance that we get, fall behind, and have to go into catch-up mode again.

Ann Duignan - JPMorgan

Okay, that’s very good color. I’ll get back in line in the interest of time and everybody else. Thanks.

Operator

Your next question comes from the line of Michael Gallo with C.L. King. Mr. Gallo, your line is open.

Michael W. Gallo - C.L. King

Sorry, I had the mute on. My question is on the mix of business in the quarter -- it looked like North America was strong, as was OE, while after market was somewhat weak. I was wondering what drove that and when you would expect to see after-market starting to return based on customers starting to look at either restarting projects, et cetera. We would think they would look to try to put some idle equipment back to work or restart machines first. Thank you.

Michael W. Sutherlin

The mix -- on shipments, the mix can be a little bit deceptive because our underground business, for example, is shipping off machines that they booked last -- in 2008 with strong bookings in 2008, so shipments should only reflect the flow-through of 2008 bookings through our backlog and manufacturing process. So don’t read too much into the strong shipments in the U.S. from our underground business being indicative of a strong current market for sure.

On the after market, the declines in the after market came from fundamentally two areas -- one when we book a shovel order, we include with that a booking for the assembly of that shovel order on mine site. That assembly order is an after-market booking, so we have 90% of the value is booked as original equipment, 10% is after-market, so we are seeing some cancellations of some of those after-market bookings as we had cancellations of the original equipment bookings and that’s been part of the factor. But we have relatively weak conditions in the U.S. metals market -- copper and iron ore. Activity levels are down dramatically. After-market is down dramatically but we are starting to see the early signs of improvement, obviously with better copper prices and with steel industry becoming, you know, seeing production levels move up. We are starting to see customers increase their production in both copper and iron ore. We are starting to see them get ready, reactivating machines, so we feel pretty confident that the worst of the after-market decline in those two market areas is ending and we should start to see some improvement in after-market. It’s not going to go back to the robust levels that we saw last year but I think we’ll start to see some improvement. If we take those two negatives out and eliminate the issue of assembly orders associated with new original equipment bookings, the original equipment we have in backlog and I think you will see a dramatic change in the after-market booking ratio.

Michael W. Gallo - C.L. King

Okay, thanks.

Operator

Your next question comes from the line of Charlie Brady with BMO Capital Markets.

Charlie Brady – BMO Capital Markets

With respect to the backlog adjustments, you previously in the last quarter talked about the at-risk backlog of about $525 million and now you have an adjustment for just over 600, so I’m just trying to square that up -- where that incremental I guess at-risk backlogs and LOIs came from and has the backlog now been scrubbed of everything that’s on an LOI and deposit?

Michael W. Sutherlin

The answer to the second question is yes -- everything that is on an LOI is scrubbed out of backlog. As for your first question, is that we -- not all -- obviously not all of the LOIs that we had at the end of the second quarter were included in our backlog risk. We see -- again, we see those kinds of projects that are going to be reactivated at some point, some of those earlier and some of those later. We believe that the discussions we are having with customers doesn’t put all of those letters of intent at risk of cancellation or exploration and so there’s -- that fundamentally is the difference between the $606 million we took out of backlog today and the $525 million that we reported at risk at the end of the second quarter.

The reason we took the adjustment to the letters of intent is they still are highly uncertain as to timing. It requires the customers to bring projects back online and reactivate and turn those letters of intent into contracts. Although our discussions are moving forward and we get good indications that some of that stuff will get reactivated, we have yet to have one of those letters of intent converted into a contract and even though we get -- we think we are getting closer and even though we feel that the discussions are headed in that direction, the uncertainty around the timing we though was going to continue to be confusing and potentially misleading to the investors. They reviewed our backlog levels and so that’s really the reason we took them out but if you look at all those letters of intent, there’s some portion of those we feel pretty confident about and we are not in a risk category. There’s a lot of them we feel will eventually go forward as those projects get reactivated and towards the tail end of that, there is always some measure of risk. The further out you go, the more uncertainty there is about whether the project will go or not, so sort of gives you a flavor of how we looked at those LOIs.

Charlie Brady – BMO Capital Markets

And if you are looking at the existing backlog today in terms of the pricing in that, you know, you’ve been getting the benefit as you have been recapturing the material costs, have we now worked through that so that the -- I guess what I am trying to get to is, is there anymore benefit on the margin to come from better pricing as we move forward over the next couple of quarters, or have we kind of caught up to that?

Michael W. Sutherlin

I think we had some pretty aggressive price increases in 2008 as we were trying to catch up to the commodity cost increases that we had already received. We are in catch-up mode and as the market began to level out and the commodities market decline, you know we obviously lost credibility to continue to increase prices so our pricing level has stayed pretty consistent since late 2008 when we had our last price increases. Commodity prices went down. They are starting to stabilize. They sort of look like they may start to go back up but right now, if you measure it with today’s numbers, I think we would see stable margins going forward. Obviously as the commodity prices move up, if that happens, if commodity prices continued to increase, we would have to go back in and reassess what we do about pricing but right now we don’t have in backlog higher priced orders than we are shipping today. Those are about on the same level.

Charlie Brady – BMO Capital Markets

Thanks, I’ll hop back in the queue.

Operator

Your next question comes from the line of Jerry Revich with Goldman Sachs.

Jerry Revich - Goldman Sachs

I am wondering if you could talk about which markets you expect to drive new equipment orders over the next two or three quarters. You mentioned China coal this quarter. Are you seeing strong inquiry levels from Australia and Africa coal as well?

Michael W. Sutherlin

Well, I think that the market that has the greatest amount of upside potential is currently copper and copper, if we look at that, the demand is strong with very little demand coming from the developed countries but the economy seems to be closer to the point of recovery so we think that the copper markets probably have the greatest amount of upside.

Also the copper projects are bigger projects, longer lead time from start to first ore mined and I think that it is very likely that the copper markets will be supply constrained here as we see economic recovery. So you say what’s got the greatest amount of upside, both in terms of price demand and equipment requirements, I think you will see that at the top of the markets.

Second on the list would be the markets being into sea-borne coal markets, primarily Australia. We’re seeing a lot of activity around Australia, some mines coming back online, capital budgets getting worked pretty aggressively to get those tuned up for their year-end capital budgeting process but you also have to look at other markets like Colombia and South Africa that have a role in the sea-borne markets.

Jerry Revich - Goldman Sachs

Thank you, Mike, and we’re hearing that China is looking to ramp up coal production from previously shot small mines. Can you talk about whether you are seeing those plans going forward and what proportion of those mines are big enough to use the Joy light type products?

Michael W. Sutherlin

Yeah, there’s actually -- you know, part of the demand from China is being driven off of some shut-down of mines up in Ashanzi province, safety violations in cleaning those up. There’s been quite a bit of consolidation so a lot of the small mines have been consolidated into groupings that have larger operators. It’s not the [Shenwa] China coal level of operator but the level of sophistication the operators have moved up as they have consolidated some of those mines, but it’s been -- a lot of what they produce up there is met coal and one of the things that has caused some tightness in the met coal market but the Chinese steel companies have, as a result of all that, as a result of importing more met coal, there’s a growing delineation between the quality of met coal coming out of the domestic China market versus what they are able to get from the international sea-borne market, so I don’t think that all that production that is coming back online is going to compete with the imports. I think there’s been a quality price differentiation established in China. But certainly as those come back on, we will see some moderation in the growth of China imports. I think you will see more of that moderation in thermal coal than in met coal but there may be some in met coal as well.

I don’t think you are going to see a massive ramp up. The nature of that market is going to be slow or steady or trying to revamp those mines and clean up some of the safety issues. It’s not just a matter of having toolbox meetings with the workforce and restarting the same mining operations. It’s reengineering the mines, replacing the equipment, and yes I think that we have some good exposure for some of the -- both the Joy light product but also the product we are making with our [Shen Ga] acquisition in China that makes Chinese shearing machines and in fact, that is one of the strongest market potentials that the [Shen Ga] company sees at this point.

Jerry Revich - Goldman Sachs

Thank you.

Operator

Your next question comes from the line of Andy Kaplowitz with Barclays Capital.

Andy Kaplowitz - Barclays Capital

How much of the $606 million that you removed from backlog was 2010 orders? I know you said most of it was 2011 and beyond. You know, was there a decent portion that was 2010?

Michael W. Sutherlin

No, not a decent portion of 2010 -- 10% to 15%, sort of in that range. It was -- and it was the later part of 2010.

Andy Kaplowitz - Barclays Capital

Gotcha, because where I am going with this, Mike, is you know, at the end of this year, we might be left with I don’t know, something like $1.5 billion in backlog, ex the $600 million and if I just look at consensus and revenue for 2010, it’s much higher than that and I am just trying to get some additional color on 2010, you know, given where your backlog is now.

I know there is a good amount of book [inaudible] business you can do, especially in the after market, but have you sort of -- I assume you have a better picture on what 2010 looks like, so any color you could give us would be helpful.

Michael W. Sutherlin

Well, I think we’ve done a pretty good job of giving you some background without getting into guidance for 2010 but certainly if I look at the last three quarters, incoming order rates for this business before cancellations and adjustments have been remarkably consistent for the three quarters and so I feel pretty good that that’s a signal of stabilization around those levels. So if you annualize that, that’s the level that we are going to converge to in the second half of the year. So we are looking at the first half of the year of backlog depletion, conversion to the level of incoming order rates in the second half and you can sort of work those numbers and get some idea of what that might look like.

The good news for us is that that level of incoming orders is higher than we had put into our worst-case scenario modeling when we looked at the downside scenario. We were expecting those numbers to be lower than they are and so far they are holding up at a better level than we had expected and with some positives out of the international market, you know, we’re hopeful that that might be more representative of what we are going to see in the downside of the cycle.

Andy Kaplowitz - Barclays Capital

So Mike, is it fair to say that if I take you know, roughly $650 million in new awards a quarter and try and annualize that, that might be some representation of what you might do on the downside in revenues, you know, assuming stabilization in the global economy?

Michael W. Sutherlin

Yeah, without getting into forecasting and trying to anticipate a market which is always risky, I think you’ve got to look at the last three quarters and the stability of the numbers around those last three quarters I think is pretty indicative of a stable income, level of incoming orders. I think if you work with that, that’s the best shot we have right now, looking at the market right now, that’s the best view we have without being hopeful of order increases and the timing of those which we don’t feel comfortable we can predict.

Andy Kaplowitz - Barclays Capital

I understand, but it’s fair to say that the 40% down that you were thinking, maybe that’s going to turn out to be too conservative?

Michael W. Sutherlin

Yeah, I think that’s right and the order rate was 680 before cancellations, and I think the last couple of quarters were in and around the 700 number, so you sort of have to look at the net new -- I mean, the new orders coming in rather than the net after cancellations to get a barometer of what the market is today.

Andy Kaplowitz - Barclays Capital

I understand. Thank you.

Operator

Your next question comes from the line of Robert F. McCarthy with Robert W. Baird.

Robert F. McCarthy - Robert W. Baird

Mike, in an environment in 2010 where you might see something like a 20% revenue decline, I assume -- I mean, you’ve had some very positive things to say about after-market. It’s not really the swing factor but it sounds like you think a significant improvement in order rates could materialize in the next few quarters and -- I mean, if that happens, can that business be flat if the total business is down 20%?

Michael W. Sutherlin

Well, no, I wouldn’t go so far as to say flat. We will see --- we should see, we expect to see improvement in the after-market, particularly in the copper markets. We are seeing just much more activity and that’s north and south, the U.S. and the South American copper markets, as those mines activity begins to pick up. We are seeing more and more after-market. There’s been some cannibalization in North America, there’s been some redistribution of mine site inventories to other operations in South America, so there’s a replenishment factor and I feel pretty good that we are going to start to see a decent recovery in after-market going into that copper market, U.S. and Canadian iron ore is going to look better and I think will benefit there. It’s not a huge market for us so we’ve got -- can’t over-factor that. But on the other side, I still think we have some downside risk in the central Appalachian market. You know, that market has declined in volume more than the 6% decline we had seen in the order rate bookings, and those bookings have held up remarkably well all year, better than I expected. But I am still nervous that there is still more downside in the central app after-market bookings levels.

Robert F. McCarthy - Robert W. Baird

Central and northern app would be the -- coal would be the largest end market for after-market for you guys? Largest installed base?

Michael W. Sutherlin

I think that would be right, yes.

Robert F. McCarthy - Robert W. Baird

Yeah, okay. And then you know, just for clarity purposes, I wonder, Mike, do you have a, or can you tell us what impact currency had on bookings and backlog for the company in the quarter?

Michael S. Olsen

Yes, actually we can. It had actually a positive impact on the bookings number, very, very slight, between $10 million and $15 million. The reason for that inconsistency is you’ll recall several quarters ago we went through that detailed discussion of the currency impact on the beginning backlog being retranslated, and so the bookings themselves were actually negatively affected but that negative impact was more than offset by the adjustment of the beginning of the quarter backlog.

Sales were adversely affected by foreign currency translation by $42 million and operating profit was adversely affected by $44.5 million. So smaller numbers than what we have seen in recent quarters.

Robert F. McCarthy - Robert W. Baird

But there would have been a -- I guess you answered that. Okay, thank you, Mike.

Operator

Your next question comes from the line of Barry Bannister with Stifel Nicolaus.

Barry Bannister – Stifel Nicolaus

Your cash flow impact of the swing and advance payments still looking at minus $300 million this year, and are you still looking for cash from operations around 280?

Michael S. Olsen

It’s difficult to forecast that exactly but those numbers are certainly in the ballpark. We had a good cash flow month, quarter in the third quarter where we had a $95 million inventory reduction. We’re anticipating that that inventory management will continue in the fourth quarter. We did in fact have a $90 million reduction in advanced payments, barring a significant up-tick in original equipment orders, we expect those advanced payments to continue to decline. So you’re in the ballpark.

Barry Bannister – Stifel Nicolaus

And on the subject of margins, I am still a little bit confused. A lot of your OE shipments were pre-crisis bookings, when booking rates were much higher. You mentioned that North America had fallen, that international was 12 to 18 months lagged. It’s hard to see how OE would benefit from that anytime soon but a lot of your 22% EBITDA margin is derived from pricing actions and cost controls related to OE. So if OE is going to be weak for a somewhat extended period of time, then shouldn’t we view this as peak margins and you once spoke of a 10% floor, hopefully better than that, but what do you see as a floor by 2010, 2011 on the margin side?

Michael W. Sutherlin

Well, we talked before in the business about our objective to keep EBIT margins above 10% at the trough. And when we modeled that out, we were at a level where the margins were not as high as they are today. We also had a deeper trough in our model. As we look at the incoming order rate and sort of project what that might look like as another view of the trough in the cycle, then I think you have to begin to look at decremental margins rather than absolute EBIT margin targets. And so we have been working our downside scenario around decremental margins sort of in that 30%, 35% range over the cycle. And so I think that’s a more relevant number because if this business troughs out at a higher level than we had modeled before, then the EBIT margins should logically be at a higher level as well.

Barry Bannister – Stifel Nicolaus

But going back to Andy’s question, if you do level out around $2.8 billion of revenues with some match to your bookings rate, and a book-to-bill around 1, and if your EBIT margin is around 14 instead of 10 at the trough, that’s EBITDA of 16, then we’re talking about $2 of earnings. So are you leaning towards that for 2011 guidance?

Michael W. Sutherlin

We haven’t gone far enough to look at guidance issues for 2011. So much of that depends on not just the projections of what the market is going to look like but some of the restructuring actions that we take, I mean, if we do some facility rationalizations, that can have a more positive impact on the 2010 numbers, getting some of those costs out by doing that then if we don’t. And a lot of those things are still in evaluation and we haven’t reached any final conclusions, so I think if you take the 30% to 35% decremental margins and run those down between our current shipping levels and what you are projecting for 2010, I don’t know what those numbers are off-hand but that probably will get you pretty close to where we will end up in our range as we look at 2010 but it’s still too early for us to feel comfortable that we have a handle on 2010. Revenues are certainly not on the earnings levels yet.

Barry Bannister – Stifel Nicolaus

Good comeback, by the way, from a year ago this quarter when you had all those margin difficulties.

Michael W. Sutherlin

Yeah, we are glad not to have to explain that.

Barry Bannister – Stifel Nicolaus

Thanks. Bye.

Operator

Your next question comes from the line of Steve Barger with Keybanc Capital.

Analyst for Steve Barger - Keybanc Capital

This is actually Joe [Vox] filling in for Steve. Could you help us out on the surface operating margin performance in the quarter? I’m just trying to understand what might be sustainable as we look into 4Q and then into 2010?

Michael W. Sutherlin

As I said, we’ve been catching up our margins during -- starting in 2007, we fell behind commodity cost increases and because lead times were extended, we were working real hard to catch those up and our pricing levels were at fairly high levels to try to get caught up. As those -- and by 2008, I think we actually had a couple of price increases in 2008. But as we looked at that stuff rolling into backlog, particularly the earlier stuff rolling into backlog, we are seeing good margins and the kind of margins we think that this business should earn over the cycle.

Now, the complication is if I look at our backlog, I think we have pretty representative prices on the equipment we have in backlog and we are pretty adamant about not giving up margin here as we look at quotes or proposals for new projects and we have seen -- this industry has got a tremendously steep price elasticity curve and we don’t want to go down that path. Having said that, I think that there are some particularly favorable factors that happened at the surface business this quarter that gave us better margins than you would expect. I wouldn’t extrapolate off the margins you saw in the third quarter for the surface business. I think there’s a couple of million dollars of cancellation charges that were taken down to the profit line in the third quarter that -- for P&H. There were some favorable close-out adjustments that we had on some of the AC equipment that we delivered, the newness of that equipment was -- the manufacturing process went better than we thought and they had some favorable adjustments but I think you have to sort of look at the average here over the first half -- I mean the first three quarters of the year and try to interpolate somewhere in there about what a more reasonable estimate of sustainable margins might be but certainly the third quarter would I think Barry made the comment, it may represent peak margins. Unusual circumstances, you know, the stars lined up on P&H and I do think that that’s not a representative number for the surface business.

Analyst for Steve Barger - Keybanc Capital

That’s good color. Thanks, Mike. My last question is in regards to just cash management here and priorities for cash. Now that it seems like sentiment is starting to slowly improve in the market, are you willing to be more inquisitive or go back to the stock buy-backs?

Michael W. Sutherlin

Well, I think that as we put our plans together for the board and submit those to the board for year-end, we are -- certainly one of the things we are looking at is on some of the capacity expansion projects that we had approved and put on hold and we are looking at whether this is the time to go back in and reactivate those, not because they give us volume increases because they are a part of that transformation of our manufacturing footprint and other kinds of strategic benefits and we don’t want to lose the momentum around that because that’s long-term, important to our business and so we are looking at that.

Certainly we are in a market today where acquisitions would, you know, from a pricing standpoint, you would think that they would be more attractive and I don’t know, we always are out there looking, we’re talking to people and I don’t think the -- maybe in the last six months the uncertainty of the market would have probably made us stay away from the table today. I think we feel pretty good that the market is stabilized and probably doesn’t have as much downside risk, so we would probably be more actively in discussions if something came our way but too uncertain to tell that for sure.

But stock buy-backs, I think in -- as we look at the market right now, we haven’t made a decision on where we are with the stock buy-back program, other than we are not actively in the market buying back shares and I don’t expect us to be in the market to buy back shares in the near future for sure.

Analyst for Steve Barger - Keybanc Capital

Thank you.

Operator

Your next question comes from the line of Charlie Brady with BMO Capital Markets.

Charlie Brady – BMO Capital Markets

Mike, on the after-market, as you look through into 2010 and [obviously the OE] is going to drop off pretty meaningfully, do you see the after-market side getting back -- I guess where do you see it getting back to? Up to high 60s again, just because of the drop-off in OE? Or do you not see the after-market coming back as quickly to where you are not going to see that kind of rise in the percentage?

Michael W. Sutherlin

Well, I think that the after-market as a percentage of sales will grow back here in this phase of the cycle but as we look at our own plans and models, if we go back and look at our history, you will see the after-market at one point was 70% of revenues. I don’t think that we are looking at a market that is that bad that we would see that much of a fall-off in the original equipment revenue stream that caused that to happen, so to get back above 60, I would see that to be reasonably possible. To get in the mid- to high-60s, we may not get that level. Hopefully we will get that level because the original equipment demand will prevent that from happening, not because the after-market doesn’t have strength of its own but because the original equipment revenue stream will be stronger than we anticipated.

Charlie Brady – BMO Capital Markets

Well how much of that -- if we get up to say 60%, I mean, do you have an idea of -- how much does that mitigate on the margin side, you know, decremental margins because of your under-absorption from the lack of the OE business? I guess relative to the last cycle as well would be --

Michael W. Sutherlin

Yeah, yeah -- no, we -- the after-market obviously helps us with overhead absorptions both in our service facilities as well as in our factories. The margins between original equipment and after-market are not all that dramatically different. We’re not a loss leader business, so on the margin line, it’s helpful but I don’t think you can read in that we sell original equipment for extremely low margins that make all of our profit on after-market. We’re not that kind of business. I think the overhead absorption is a factor but we’ve brought in a lot of the outsourcing -- we were up to 35% or higher on the outsourcing component of our production hours at last year and some of that is being brought back in and we have more of that to do, so that will be a buffer on the decremental margins. And then as we look out at the original equipment demand, that original equipment demand is holding up better than we had anticipated so far. It’s hard to be certain it will forever but right now, it’s holding up better and there’s still prospects out there that we are working on, so we feel pretty good that the original equipment may not drop down to the level that we had put in our worst-case scenario.

So you put all that stuff together and I think that we have a reasonable plan on how we are going to hold margins together at modest decremental levels as we go through this cycle.

Charlie Brady – BMO Capital Markets

Great, thanks.

Michael W. Sutherlin

Operator, if we can have time for one more call and then probably -- we’re past our hour as it is, so maybe one more call and then we’ll call it a finish.

Operator

Your next question comes from the line of Mark Koznarek with Cleveland Research.

Mark Koznarek – Cleveland Research

A question on the central App coal situation. You know, obviously demand is weak, in part because of the economy but also in part because of fuel substitution with natural gas, and you mentioned a 12 to 18 month lag in the U.S. coal recovery, and what kind of natural gas assumptions would that contemplate and can you help bracket what some alternatives would be if gas stays flat, where we are today based on over-supply situation -- does that further extend that lag? Then again, if gas gets back to more normalized levels, would that accelerate the recovery? Can you just help us understand that dynamic a little?

Michael W. Sutherlin

Yeah, hopefully. First of all, central App is a market of two types of coal. As difficult as the thermal coal markets are in central App, we’re seeing activity improve on the met coal as the steel industry globally and even in the U.S. is starting to increase its production levels. So the positive for central App is that they have a high exposure to met coal, so you’ll see some of that production increase to take advantage of those markets. Thermal coal is just -- it’s a tough market right now. Part of it is electricity demand is just down. Part of that is driven by very low rates of industrial utilization in the U.S., the 65% level. It’s coming back but the numbers are still below 70% utilization in the industrial sector. That’s also a driver for gas demand and one of the reasons we have a tremendous amount of gas and storage today is because there’s no industrial demand for natural gas -- very low industrial demand, so it’s not just a plentiful supply but it’s low industrial demand. And with the -- as the economy recovers, that demand will ship pretty quickly.

The other factor for natural gas is that the depletion rates on the natural gas wells, particularly the new shale plate, that depletion rates are dramatically fast -- 18 months is a typical average. And the drilling part of it, I still have connection to the oil and gas drilling business through one of the boards I am on and in that industry, there still is a rule of thumb that no one is starting drilling programs with natural gas prices below $7. That’s sort of the threshold for economics there.

So you think that $7 and say well if natural gas depletes because there’s no drilling and the drilling numbers are down dramatically, there’s an increase in recount in the U.S. but it’s all around oil drilling, not around gas drilling. So you say I’ve got to have $7 gas before I start drilling and in the meantime, the economy gets a little better and industrial demand picks up, you can see the supply/demand situation change really, really quickly. Seven-dollar gas is going to get you back on a BTU equivalent basis that will get back to prices in central App that are closer to $80 a ton.

So I think that we have an unusual situation because a number of factors that have just reduced the demand of gas at a time when we had some improvement in supply and now we have storage capacity absolutely full. I don’t think that that’s sustainable and I don’t think that there’s enough gas out there without drilling programs that can get their $7 per million BTU levels, and so I think that this is going to be correcting itself over the next 12 months.

That doesn’t mean that the thermal coal markets are going to -- are instantly going to get better because we still need to have improved electricity demand in the U.S. to help that as well, but I don’t think that this is a forever situation. I think this is a point-in-time situation that’s worst-case and it’s got some factors in there that will help correct itself here over the next 12 months.

Mark Koznarek – Cleveland Research

Okay, so that’s sort of the operating assumption you have built into your comments about the revenue decline potential for next year?

Michael W. Sutherlin

A lot of it is driven off this U.S. market not being -- and the improvement in the -- we have -- the softness in the U.S. market, I just don’t see the U.S. market getting better here through the end of next year. On the international market, there’s a lot of signs that would indicate that that’s going to start to improve but the improvement won’t happen soon enough to avoid the revenues going down in 2010. We just won't get the order rates and be able to convert those into shipments into the international markets fast enough to eliminate that problematic issue.

Mark Koznarek – Cleveland Research

Okay, Mike. Thanks very much.

Michael W. Sutherlin

Okay, thanks. And Operator, if we -- maybe some closing comments and just -- I know we’ve been a little bit over an hour in the call and I appreciate everybody staying on the line. I do appreciate your participation in the call and also your interest in Joy Global and we look forward to talking to you again in our fourth quarter earnings call. Thank you very much.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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Source: Joy Global F3Q09 (Qtr End 7/31/09) Earnings Call Transcript
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