Joy Global F4Q09 (Qtr End10/30/09) Earnings Call Transcript

Dec.16.09 | About: Joy Global (JOY)

Joy Global Inc. (JOYG) F4Q09 Earnings Call December 16, 2009 11:00 AM ET

Executives

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

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

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

Analysts

Jerry Revich - Goldman Sachs

Andy Kaplowitz - Barclays Capital

Ann Duignan - JPMorgan

Charlie Brady – BMO Capital Markets

Michael W. Gallo - C.L. King

Henry Kirn - UBS

Robert F. McCarthy - Robert W. Baird

Seth Webber - RBC

Mark Koznarek – Cleveland Research

Operator

Good morning. My name is Amanda and I will be your conference operator today. At this time, I would like to welcome everyone to the Joy Global Incorporated fiscal fourth quarter 2009 earnings conference call. (Operator instructions) I would now like to turn the call over to Michael Olsen, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Michael S. Olsen

Good morning and welcome, everyone. Thank you for participating in today’s conference call and for your continued interest in our company. Joining today on the 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 fourth quarter and fiscal year 2009. 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 fourth quarter and the fiscal year. In our current earnings release, we have modified the supplemental schedules to hopefully provide more useful information for our shareholders. On a revised supplemental schedules, we had removed the depreciation and amortization information. We have received a call from an analyst requesting this information. It will be included in our annual report on Form 10-Q which we will be filing at the beginning of next week but in the meantime, we will post depreciation and amortization information for the fourth quarter and full year on our website. I am sorry for any inconvenience that this may have caused.

New orders received during the 2009 fiscal year totalled $2.8 billion compared to $4.9 billion of new orders received in 2008. During the 2009 fiscal year, there were $300 million of backlog cancellations, primarily during the first and second quarters, and a $600 million backlog adjustment reduction at the beginning of the third quarter to reflect the company's revised policy for adding original equipment orders to backlog at its surface mining equipment business.

Original equipment new orders in 2009 were $882 million before a $251 million cancellation and were 68% less than they were in 2008, reflecting the softness in the majority of the copper markets in which our equipment is used.

After market orders were $1.9 billion before a $63 million cancellation, over half of which were associated with new machine erection associated with the original equipment, which was cancelled in 2009, compared to $2.1 billion in the 2008 fiscal year. This 8% decline in after market orders was primarily associated with decreased after market demand for the surface mining equipment business where the customers mining non-coal commodities responded earlier to the decline in demand for their products.

Backlog at the end of 2009 was $1.5 billion compared to $3.2 billion backlog at the end of October 2008 which included the $300 million of orders which were cancelled in 2009 and the $600 million third quarter backlog adjustment.

Fiscal 2009 net sales increased to $3.6 billion from $3.4 billion in 2008. This improvement in net sales was driven by an 11% increase in net sales for the underground mining equipment business almost all of which was associated with increased original equipment shipments and a 19% increase in crushing and conveying net sales, the majority of which was associated with the continental sales being reported for the full year in 2009 compared to just over eight months in 2008.

These sales increases more than offset a 6% decline in net sales for the surface mining equipment business. The increase in original equipment in the underground mining equipment segment was due to the significant increases in new machine sales reported in the United States and South Africa.

Operating income in 2009 was $702 million compared to $551 million in the 2008 fiscal year. Return on sales was 20% and 16% for the 2009 and 2008 fiscal years respectively.

The improvement in operating profit in 2009 was due to the increase in sales volume, favourable price realization, improvement in supply chain management, and cost control initiatives. The 2009 fiscal year was adversely affected by a $22 million charge changes in foreign currency translation rate, and $14 million of severance and related costs, while the 2008 fiscal year included a $23 million charge for the cancellation of a repair and maintenance contract and $14 million of incremental first-year purchase accounting amortization charges associated with the continental acquisition. Both operating profit and return on sales percent increased in 2009 compared to 2008 for all three of the company's businesses.

Fully diluted earnings per share were $4.41 in 2009 and $3.45 in 2008. EPS in 2009 benefited from both the improvement in profitability as well as from the reduction in the average outstanding shares from $108.4 million in 2008 down to $103.1 million in 2009. The effective tax rates were 33.4% in 2009 and 29.2% in 2008, which benefited from the discrete tax adjustment.

For the full year, cash generate by operations was $452 million in 2009, compared to $577 million in 2008. Fiscal 2008 benefited by a $215 million increase in advanced payments and a $82 million increase in accounts payable, while 2009 benefited from improved profitability and a $109 million reduction in accounts receivable and a $78 million reduction in inventory.

Turning to the fourth quarter, bookings in the fourth quarter totalled $684 million compared to $1.2 billion reported in the fourth quarter last year. The press release went into quite specific details discussing fourth quarter bookings compared to last year and through the third quarter of this year, including tables that would provide information concerning orders received in 2008 which were subsequently removed from backlog. I will not rehash that information at this time as I believe the press release information has covered this topic very thoroughly. However, I would like to clarify that the surface mining equipment business did receive an order for an electric mining shovel in the fourth quarter.

Net sales for the fourth quarter were $963 million and were $68 million less than the record quarterly sales which were just over $1 billion in the fourth quarter last year. Original equipment sales declined by 9%, primarily driven by lower new machine sales for the surface mining equipment business while aftermarket sales were 4.5% less in the current quarter than they were a year ago, with the decline evenly spread through all three businesses.

Looking at individual business segments, underground equipment was off 3%, the surface equipment sales were down 10%, and sales for the crushing and conveying business decreased 20% on a lower sales base to start with.

Operating income was $184 million in the current quarter compared to $192 million last year with the return on sales of 19% for both periods. The downward pressure on income in the current quarter provided by the reduction in net sales and the $11 million of severance and other costs associated with cost reduction initiatives were offset by favourable price realization and effective supply chain management.

Net income in the current quarter was $124 million, that's $1.20 per fully diluted share, compared to $118 million, or $1.11 per fully diluted share a year ago. The current quarter benefited from a $5.6 million on an after-tax basis of approximately $0.04 per share recovery from the company's reorganization process. In addition, as is the case for the full year, fourth quarter EPS benefited from both the improvement in profitability and a reduction in the average shares outstanding, from $106 million last year to $103.4 million in the current quarter. The effective tax rate was 32.7% in the current quarter compared to 36.2% in the fourth quarter last year, which included an unfavourable discrete tax adjustment of $13 million.

Going forward, we expect our effective tax rate will be between 33% and 34%.

During the fourth quarter, $239 million of cash flow was generated from operations compared to $243 million a year ago. The reduction in advanced payments and accounts payable were more than offset by reduction in accounts receivable and inventories. At the end of October 2009, the company had cash and cash equivalents of $472 million and had reduced net debt from $366 million a year ago to $72 million at the end of the current fiscal year. However, the company's unfunded pension liability increased from $286 million at the end of the 2008 fiscal year to $576 million at the end of the 2009 fiscal year. This increase in the unfunded pension liabilities is driven by the significant reduction in the discount rate used to calculate the present value of future pension obligations. For the 2010 fiscal year, we expect our worldwide pension contributions to be between $70 million and $90 million.

Let me stop at this point and turn the discussion over to Mike Sutherlin.

Michael W. Sutherlin

Thanks, Mike and first, let me add my welcome to those on the call. Secondly, I'd like to congratulate the entire Joy Global team for their continuing success in improving the processes and profitability of this business. In addition to record revenues and earnings, process efficiency initiatives and cost reduction programs allowed us to deliver record profitability this year. I would also like to add a welcome to Randy Baker as President and Chief Operating Officer of P&H. Randy has spent most of his career in the mining equipment industry but spent the last few years at [Case New Holland], where he made impressive improvements in the ag equipment business. We are looking forward to Randy adding his leadership at P&H and as part of our executive leadership team.

Profitability did benefit as we shipped backlog with more recent pricing but this was mitigated by a higher mix of original equipment and restructuring costs this year. We also benefit from gains in leaning out processes from supply chain improvement and from stringent cost controls.

The impact of process efficiency improvements can be seen through the reduction of some key working capital categories. Both accounts receivable and inventories are down this year on higher sales with days outstanding improving and in fact, inventory is down for the second consecutive quarter and I expect this trend to continue in 2010.

We are taking the next step in the integration of Continental crushing and conveying by merging it into our Joy and P&H businesses. This will improve efficiencies and give us a more focused channel to market.

The improvements we are making are sustainable, as can be seen from the decremental operating leverage that is implied in our guidance for 2010. We therefore feel that we enter 2010 as a more efficient business and better prepared to respond to the market conditions as they unfold.

So let's take a look at 2010 and first to the markets -- the impact of the emerging markets has been very dramatic, both in moderating the trough and in being the early driver of recovery in commodity demand. China, and to a lesser extent, India, have been the primary drivers for global commodity demand all year. Total imports into both countries have not only been at record levels but they are up by orders of magnitude.

Copper imports into China have been at record levels while strategic inventories were built, while copper demand outside of China has been improving but the year-over-year comps remain negative. Iron ore production is up due to continued high levels of steel production in China, plus the return of exports to other steel producing countries.

Although they continue at high levels, there have been signs of recent moderation in China import rates. Some of this is the effect of the national holidays in October but there is also continuing concern regarding how much growth China can sustain on domestic programs alone.

As much as 70% of the China economy is driven by exports and therefore sustained growth in China will require the return of industrial production in the OECD countries. We have seen industrial production outside of China improve since it bottomed in the spring. However, the improvement to date has primarily resulted from the completing of inventory reduction efforts which occurred in late summer. Since then, sales out of production have replaced sales out of inventory. As an example, steel production ex China has moved from around 40% of capacity to over 60% of capacity. But the demand has stalled since then, indicating little growth beyond the inventory destocking effect.

The emerging markets started the early recovery in commodity demand and they will continue to be a major factor. Demand has been increased further as industrial production in the OECD countries is increasing to offset inventory reduction, but it will take a continued growth in industrial production in the OECD countries to provide the basis for sustainable commodity demand growth and we have yet to see that.

At the same time, sea born commodity prices continue to increase. Sellers into the [met coal] spot market are increasingly sold out, driving [met coal] substantially above its benchmark for the year to $180 per metric ton. Sea born thermal coal has also moved above its benchmark and is now at $80.

More importantly, buyers are expecting the sea born thermal market to remain tight. Discussions are underway to set next year's benchmark and producers are indicating they expect that price to be in the $80 to $90 range. This is supported by recent transactions with some production being contracted into 2011 at $90 and into 2012 at $100.

Iron ore spot prices have climbed steadily and are now at $100, more than 60% above their lows last February. Copper has more than doubled from its low at the end of last year and is selling above $3, with price expectations rising against tight markets at least through 2011.

All of these price movements in the sea born markets indicate a relatively thin balance between supply and demand and are additionally being driven by three factors. First, the continued strong demand from the emerging markets; second, the expectation of the start of sustained demand recovery in the OECD countries; and more importantly, demand recovery beyond the end of destocking.

And third, the realization that excess mine capacity is dramatically less than excess industrial capacity, that mine expansion projects have been on hold for the past year and therefore that supply may already be slipping behind demand expectations.

There may be continued uncertainty about the timing and the early strength of recovery in the OECD countries but there is no doubt that we are near and moving closer to the start of that recovery. As a result and to capture the upside, our customers are starting the processes for the net round of mine expansion. CapEx announcements have been up significantly and further customer announcements are expected to continue that trend.

And customers are continuing to validate engineering and reconfirm delivery slots in preparation for reactivating projects they have had on hold.

We expect that our customers will maintain their discipline and expansion projects will be approved through their normal annual capital budgeting processes. Orders resulting from these approvals will come in calendar 2010 and typically not before February.

Our incoming orders have been reasonably stable at a $2.8 billion run-rate for the last four quarters. With an improving outlook, we believe this will be the cyclical floor.

Emerging markets have consistently surprised to the upside and we expect that that will continue. We will see commodity demand improvement from the OECD countries that at least reflects the end of inventory destocking. These factors alone will support meaningful increases in commodity demand in mine expansions and in equipment orders.

With all of that considered, we believe that 2010 will be a year of improving order rates. Although industrial production beyond destocking seems choppy at best, that growth will eventually come and be the basis for longer term growth in commodity demand. New orders will not provide much upside to 2010 because of the long order to delivery time for original equipment and because of a more steady rate of improvement in after market orders, which are tied to base production levels.

We also expect original equipment orders will return to the lumpy pattern of the last cycle based upon the size and timing of underlying projects.

So with that, to the numbers -- and we have previously indicated that decremental operating leverage would be in the lower 30% range for 2010. We are able to do that despite a late change in the discount rate that added $36 million more to pension expense. We were able to do this because our stronger performance in 2009 will carry forward into 2010.

We expect revenues in 2010 to be between $2.8 billion and $3 billion, with fully diluted earnings per share to be between $2.65 and $3.05. We expect stable cash flows and are budgeting CapEx of $100 million as we accelerate strategic investments to come online earlier in the next growth phase.

And with that, I will turn the call over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Jerry Revich, Goldman Sachs.

Jerry Revich - Goldman Sachs

Mike, your customers' budgets point to a 20% CapEx increase in 2010. Do you expect new equipment orders to exceed shipments by the same magnitude in 2010 or do you need some more visibility before you can make that assessment?

Michael S. Olsen

We are going to need more visibility. What we have seen is the early announcements are the ones that are announcing more robust CapEx. We've only got a few announcements out so far, so until we see a more comprehensive pattern of customer announcements, it's going to be hard to tell what the overall CapEx spend will be for 2010 and it is also going to take a little time to go through those CapEx announcements to understand how much of that is going to be equivalent versus other infrastructure around new mine expansion.

So I think CapEx is going to be up significantly from the 2009 levels. It will be a good start on the mine expansion in this next phase but I think it's really too early to say that the average of the announcements so far are going to indicate the upside on the equipment order rates.

Jerry Revich - Goldman Sachs

And Mike, you highlighted international coal as a strong source of orders next year -- I'm wondering if you can rank orders of us where China stacks up on that list relative to Australia, India, South Africa.

Michael S. Olsen

Certainly by far on our list, China and Australia are at the top of the list. We still see India as a country with a lot of potential but also with a lot of bureaucracy that slows that process down and South Africa has constraints in their export infrastructure. At the current point, it's rail capacity constrained so we don’t really see exports out of South Africa growing dramatically in 2010.

Jerry Revich - Goldman Sachs

And lastly, the Continental merger into joint P&H, can you talk about what kind of cost savings opportunities you see and can you provide some more detail on which product lines will get folded into which businesses, or how are you allocating between joint P&H?

Michael W. Sutherlin

The cost savings on Continental are reflected in our 2010 guidance. I don’t have the details on exactly where that cost is coming out but there are layers of, for example, layers of management that are coming out and integration of facilities, particularly in the aftermarket area.

Right now our plans are to run that as a portion of the Joy underground business, with P&H as an exclusive dealer for all the surface applications, so we are not going to split the manufacturing of the product line but we will split the representation for sales and after market service, so we will use P&H as a dealer for Joy relative to the surface applications and Joy will be a manufacturer in some of the crushing and conveying equipment.

Jerry Revich - Goldman Sachs

Thank you very much.

Michael W. Sutherlin

And that's also going to be reflected in next year as we do our segment reporting, we are going to be reporting surface underground segments next year.

Jerry Revich - Goldman Sachs

Thank you.

Operator

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

Andy Kaplowitz - Barclays Capital

Mike, have you started to see any of the $600 million or so of letter of intents that you took out of backlog last quarter come back yet? And if not, when do you expect those to come back?

Michael W. Sutherlin

We are currently -- if we look at our prospect list that we were looking at a year ago, even six months ago, the prospect list that we were working on was a smaller list. It's grown pretty significantly over the last six months, or a little more. As the customer confidence continues to grow and the market outlook, in that list of prospects, they are all driven off projects -- in that list of prospects, we see a good mixture of projects that involve equipment that was on some of the previous LOIs and also projects that were not in the LOI list, so it's not all LOIs that we looked at in our prospect list but it's not all other projects as well -- it's a relatively decent mixture between the two and we continue to believe on the LOIs that we retain a pretty significant advantage not only from the deposits that are continuing to be available to our customers but just the [inaudible] that they made on those orders and their letters of intent remain valid, so we feel pretty confident on the LOI portion.

I don’t have the percentage breakdown right now but if I look at the list, it probably is in the 50-50, 60-40 kind of range. I can't quite tell you which -- if it's beyond 50-50, I can't tell you which is the larger segment.

Andy Kaplowitz - Barclays Capital

Okay, that's fair and Mike, you still have a minor amount of cancellations in the quarter, it looks like. Where are they still? Are they still sort of in North America, in coal and in copper? And where are they what is going on in North American market?

Michael W. Sutherlin

There's some residual cleanup in the U.S. coal markets in North America and these are actually -- these are orders we have had there. They are firm, non-cancelled orders but some of the smaller operators that are in the backlog still have some stuff that requires cleanup and that's a split between the Joy and the Continental businesses, primarily in U.S. underground markets. But it's [noise level] stuff at this point and we still might have a little bit of cleanup to do as we go through the subsequent quarters.

Andy Kaplowitz - Barclays Capital

But noise level stuff, nothing big, you expect?

Michael W. Sutherlin

That's right.

Andy Kaplowitz - Barclays Capital

Okay, just one other real quick one -- so you did have just clarifying one surface OE shovel in the quarter, not none? And it just seems like the service business is maybe chugging a little bit behind the underground business -- is that fair? And why?

Michael W. Sutherlin

Both the surface and underground, we are seeing our customers look at the market from a stability standpoint, although there's a lot of factors out there that are looking very positive today, our customers in the transactions that they are involved with, our customers continued to see a relatively thin incremental volume behind the current pricing levels. So when a customer goes out and then tries to contract for a decent volume that would justify him returning another section of his mine to production, they are not able to get a long enough term commitment at today's prices around those volumes. The prices are there but the volumes just aren’t and so -- and it's still a lot of the volume has been coming out of China. Our customers are generally -- when we talk to them, they will tell you that they really would like to see more demand out of U.S., Europe and other industrialized countries to provide more balance, so it's not all just China. And so we see our customers continuing to move forward and they continue to plan, a little bit tentative right now based upon the thin volumes underlying those prices.

We see probably more tentativeness around bringing on available production now than we do on longer term expansion projects. There's much more confidence that the longer term projects are going to be needed in one or two or three more years. There is less concern that additional production is needed in the next couple of quarters. Those longer term projects also require more approval work, more engineering work, and they are just -- they will take a little longer for those orders to hit the market.

Andy Kaplowitz - Barclays Capital

That's great. I'll get back in queue. Thank you.

Operator

Your next question comes from the line of Ann Duignan with JPMorgan.

Ann Duignan - JPMorgan

My first question is really back on the expected increase in CapEx by your customers. You know, given your experience through cycles, when a customer announced increases in CapEx for expansion and given your comments on a lot of infrastructure work that needs to occur first, what's the normal lag between when CapEx pick up their -- when customers take up their CapEx budgets and when they actually place orders for your equipment?

Michael W. Sutherlin

We'll see in any given year we'll see customer CapEx that will on the surface business, we will see somewhere around 30%, 30% to 40% of their CapEx go to equipment, the rest of it goes to plants and other infrastructure kind of investment. When we see the CapEx though, we will generally see orders come in the next year. We will start to see order placements February and it will run routinely through the year. They won't just give us a slug of orders in February and nothing for the rest of the year.

In the LOIs that we took out of backlog, there's quite a bit of pre-work done on those projects. They had already been approved -- and these were large, reputable major diversified mining companies so they had done the engineering work, they have done a lot of the pre-permitting work. They've got those projects already approved and in the capital budgeting process so those are relatively far along and we expect those probably accelerate as projects come to orders.

But I don’t think we are going to see all infrastructure in 2010 and no cap. I think we will see a good percentage of equipment orders place in 2010 as well, but again the typical pattern is to see orders starting in February and running through about October or November and then they sort of go quiet as they go through their annual capital budgeting processes.

Ann Duignan - JPMorgan

Okay, that's very helpful just from a kind of modelling standpoint. And then my follow-up question is just on your -- you made note of the fact that you are raising CapEx to $100 million as you reactivate strategic projects. Is that -- should we read into that that the realization that maybe you were a little bit slow in increasing capacity in the last cycle, or are you doing something different this cycle that you didn’t do last cycle?

Michael W. Sutherlin

Well, I think there are two elements to that -- one is that we were in fact slow in releasing CapEx in the last cycle and the whole emerging market story was much more tentative in 2003, 2004, began to gain credibility in 2005, 2006, so we were late in adding CapEx. We also had some excess capacity that we started to cycle with and we got a little bit complacent because of the amount of excess capacity we had we thought would be enough and it just wasn’t. At this time, we see that longer term trend going well above the capacity capability that we have today and we've got in a long-term answer, more capacity. We've got a strategic initiative around transforming our manufacturing base and continuing to flip to our investment in the emerging markets where we see the long-term growth in commodity demand and commodity production.

So in some of those transformations of capacity have good, strong justifications without any volume increase, so the combination of all those, [let's say that] this is the right time to start those processes, we are going to need the capacity but we also can cost justify those projects just on the incremental cost improvements.

Ann Duignan - JPMorgan

And should we be looking at one or other of the segment's receiving more [minutes] per share of that $100 million or is it kind of equally spread?

Michael W. Sutherlin

It is probably equally spread. We'd be working off a campus concept in China in our Tianjin campus in China. We will continue to build that out. And so one of the things we are working on in gearing and transmissions and we will see more components and those product lines go into that but there is some overlap between the two businesses and we will gain some economy of scale by being able to work out some campus operations rather than discrete dedicated to one business or the other.

But on balance, I think you will see some pretty strong investments in both businesses.

Ann Duignan - JPMorgan

Okay. Thank you, I appreciate that. I'll get back in line. Thanks.

Operator

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

Charlie Brady – BMO Capital Markets

Mike, in terms of the backlog, how much of that ending October backlog is next 12 months work?

Michael S. Olsen

As you look at that backlog, a very, very large percentage of that backlog will be delivered in the next 12 months. I don’t have the exact number in front of me but certainly 90% or higher would be delivered in the next 12 months.

Charlie Brady – BMO Capital Markets

Okay, and then as you look at the bookings in the Q4 sequentially, particularly on the underground, the Joy after-market business, up 20% sequentially. You know, a pretty healthy sequential increase. Would you expect that magnitude, at least on the after-market business, to kind of stay in that range for at least the next couple of quarters until things equalize a little bit? Or is there something in there that maybe made a pop in the fourth quarter?

Michael W. Sutherlin

This was in and around some programs, like resale programs and a few other things, so I think we've got a larger portion of orders in our fourth quarter that are not necessarily routine day-in, day-out orders. And as I think it would be wrong to assume that that can be extrapolated.

If you look at our third quarter, the order rates, [inaudible] order rates were down in the underground business, so in the international market like China, for example, we'll get big slugs of order from [Shenwa], we'll get after market orders only three or four times during the year and each one of those would be a relatively big slug, and then it works around their budgeting process and national holidays and Chinese New Year and a lot of things like that.

So if you look at the third and fourth quarters together, you'd probably get a better feel for that business than looking just specifically at the fourth quarter. I think there was some stuff in the fourth quarter that was catching up to things that were running behind earlier in the year but yeah, 20% -- you know, historically our growth rate in the aftermarket has been like in the low teens kind of rate and I don’t expect that number to jump above that here any time soon, and I still think that that's going to be high single digits, low teens. It is still going to be the right longer term growth rate for the after-market business.

Charlie Brady – BMO Capital Markets

Back on the CapEx spending in 2010, how much of that is going towards after-market infrastructure build-out? You started on that path and the market stopped and then you backed away -- is that included in that $100 million?

Michael W. Sutherlin

Yeah, it is and that's probably in the range of 30% to 40% of that going to after-market. Probably closer to 40 -- we've got several service center upgrades in some service centers in the emerging markets that we are looking at so there's a healthy portion of that that goes to after-market.

Charlie Brady – BMO Capital Markets

Thanks. I'll hop back in the queue.

Operator

Your next question comes from the line of Michael Gallo, C.L. King.

Michael W. Gallo - C.L. King

My question is on the North American market -- as you look to 2010, and really into 2011, what are your expectations on when we should start to see more meaningful recovery in that market, to what extent can the export market start to suck up some of the excess coal stockpiles, and how much do you expect a cyclical recovery to be negatively impacted by the increasingly difficult regulatory environment, particularly for new coal plant builds? Thank you.

Michael W. Sutherlin

That was a relatively wide-ranging question. We look at the North American coal markets to not be a high growth market in the long-term. I mean, the U.S. market is relatively an industrially mature market. We've got a very established electricity generating infrastructure. We are just not going to see the high growth rates in the U.S.

Now, over the next 12 to 18 months, we've got some headwinds because of excess coal in the stockpiles that have to be worked down. As I look at the U.S. market, the U.S. market looks particularly difficult right now but it is sort of at the worst of its point in the cycle as well. We've got electricity demand that is down because of low industrial production levels. We've got gas demand that is down and therefore gas prices are low and storage is full because of low industrial production. So a lot of the outlook for coal in the U.S. and coal demand in the U.S. is really dependent upon improvement in the industrial production sector. And we need that for higher electricity demand and we need it for higher direct natural gas demand.

As we look at exports, exports are very viable, particularly with the weak U.S. dollar. We see the international prices continue to be comparatively attractive and as the dollar stays weak, I think you will see exports pick up quite bit. But exports tend to get stronger when the dollar is weak and they get -- they reduce as the dollar gets stronger, so a lot of that depends on the dollar weakness and as I look at the U.S. market, I think that there are some up-sides with export. I think there's some up-side with met coal. I also believe that the regulatory environment is going to be challenging but if I look at places like Europe, Europe is right now has 50 gigawatts of coal fired power generating capacity in planning permitting, 22 gigawatts here in the U.S. Europe has already gone through the cycle of trying to figure out how they are going to generate power without coal and what they find, they can't do it. They don’t want to be dependent on Russian gas. They can't generate enough renewable power so they are back to looking at coal and heavy investments in carbon capture and storage.

I am confident that in the U.S., we are going to get the same conclusion as we need fossil fuels in our fuel mix, even natural gas has to be -- has to have carbon captured and stored to meet these long term climate change objectives. So we are just going to have invest in carbon capture and storage and make that a commercially viable technology. That commercially viable technology will then allow the utilities to get down to cost and cost will I think in the long-term favour coal over natural gas. Natural gas prices are particularly low right now. There's a lot of talk about unlimited supplies in natural gas in the U.S. but from my experience, I can tell you that most drilling programs need $6 to $7 gas to be cost justified. Production at $4 is okay. Drilling programs to replenish production needs higher prices. I think coal will continue to be competitive.

At the end of all that, I just don’t see coal as being a high growth market in the U.S. -- again, it's more of a 1%, 2% a year kind of growth market, 1% to 1.5%. And there will be years it will be better than that but on the long-term average, it's really going to be a modest growth market.

Michael W. Gallo - C.L. King

Okay, and then second question I have is just as we look at the cash balances again, building up on the balance sheet, certainly going to be a good free cash flow generator again here in fiscal 10. What kind of alternatives should we start to look at for that cash -- restarting the buy-back something you might look at? Are there acquisition opportunities that are starting to present themselves again? Just uses of that cash going forward. Thank you.

Michael W. Sutherlin

We are always going to favor reinvestment in our own business over other uses of cash so we would definitely the higher amount of CapEx is going to be a primary focus for our cash that we have. We are going to look at opportunistic and strategic acquisitions. We certainly would like to do some more bolt-on acquisitions. We would like to do some more acquisitions of businesses in China to complement the investment we've already made there. Those are smaller kinds of acquisitions typically and things that could be financed out of our own cash flow, so those would be the primary uses of cash flow. At this point, we are not anticipating reactivating the share buy-back program but we are constantly looking at that and that may change through time. But at this point, we would not plan to reactivate the share buy-back program.

Michael W. Gallo - C.L. King

Thank you.

Operator

Your next question comes from the line of Henry Kirn with UBS.

Henry Kirn - UBS

Could you talk a little about pricing on new equipment in the market -- where it's stronger, where it's softer, either by equipment type or by geography?

Michael W. Sutherlin

Well, we were pretty aggressive in pricing 2007, 2008 as we were sort of catching up to those highly accelerated steel costs. We've got pricing levels at decent points right now, and you see that from our numbers. Going forward, we still have a really strong objective to continue to have our margins on the equipment we are quoting today to be higher margins than we have on average in our backlog, and have our backlog margins to be higher than the margins we have in recent shipments. So we continue to believe that we can continue to build the margins. We think that even in today's market conditions, we should be able to continue to build margins. Some of that will be through internal process improvements but we have seen a price elasticity in the market that is virtually negative [and we start] trying to use price as an offensive advantage, you'd just end up driving the price and the margins down to unbelievably low levels, so we've been pretty consistent in the up-cycle. We've been pretty consistent in current market and we keep delivering value that our customers appreciate, so right now we believe that we can maintain the pricing levels we currently have. We don’t expect to be able to raise prices until we see more strength in the market but right now we believe we are able to maintain margins and to improve them maybe a little bit.

Now if the question is around what else is going on in the market, there's a lot of competitive pressure. We I think are pretty disciplined. Not everybody is disciplined. We see that. We see the [parties] getting a lot more active on the after-market side, some projects tend to be strategic and there's a lot more pricing activity around strategic projects, and so it is a difficult market from that standpoint but we continue to be pretty disciplined in how we look at that and continue to follow our long-term strategies at this point.

Henry Kirn - UBS

That's really helpful. And not to beat the China horse to death but I'll do it anyway -- what percentage of sales in China are the higher end equipment versus the Joy light equipment and how are they trending? Is there a difference in the market growth profiles [today]?

Michael W. Sutherlin

We've pretty much have removed Joy light in China when we made the [Shangda] acquisition. A year ago, we acquired Shangda, which was a small company manufacturing [inaudible] machines in China. And we didn’t feel that it was going to be productive to try to sell three different brands in that market, so we have the Joy brand that is imported, or some -- partially assembled in China, and we have the Shangda brand that goes into the local -- lower end local market, primarily provincially owned mining companies.

The market in China is really strong right now. China's production is behind. They continue to close down some mining operations to rectify safety problems but in the process of doing that, they are changing the structure of ownership and those mines are being taken over by larger companies. Those larger companies are consolidating a number of smaller mines. We redeveloping those reserves with new mine complexes and so it's a longer term conversion process and therefore it's going to be two or three years before we see that production come back into the market.

But in the meantime, China keeps pushing for more and more production and the best way they can give production is through higher levels of productivity, and the top end companies can't expand their number of mines fast enough to solve the country's problems, so they are looking at the middle tier, smaller state-owned companies and the provincially owned companies to improve the productivity on a per mine basis.

So everybody is in the process of upgrading equipment, trying to get more production with better equipment, more upgraded equipment. So both businesses are seeing robust demand for their equipment. We are seeing some customers want to re-fleet from Chinese made shearing machines to imported shearing machines to get the incremental production. In the Shangda business, we are seeing customers wanting to refleet from hydraulic to electric shearing machines to get more production, so China continues to be a really strong market, particularly right now with imports up dramatically. They are pushed even harder to increase their production levels, which always drives them back to being more efficient.

So we feel pretty good about China. We feel pretty good about our position in China, both as -- a company that is manufacturing some equipment there, as a company that can assemble equipment in China, as a company that owns a Chinese manufacturing company and is [inaudible] into the market as well.

Henry Kirn - UBS

That's helpful. Thanks a lot.

Operator

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

Robert F. McCarthy - Robert W. Baird

I wonder first if I could ask you for some help on some segmentation, both in terms of $11 million of restructuring expenses and also in terms of the expected -- how do we think about the incremental pension expense next year? Is that going to be -- does that get charged to the segments or does that show up in corporate? How is that handled?

Michael S. Olsen

The pension expense actually will be allocated back to the businesses. It won't be a perfect answer but it will be approximately associated with their sales levels. Like I said, that won't be exact but that would certainly be an approximation. The restructuring, the larger portion of the restructuring charges in 2009 were in the underground business and in the Continental business. And a smaller portion was in the surface mining equipment business.

Robert F. McCarthy - Robert W. Baird

Is there any reason, Mike, you can't just give us the numbers?

Michael S. Olsen

I actually could give you the numbers if I had them. I'll give you a rough approximation -- the surface business was a couple of million dollars. The Continental business was about $5 million, and underground was the rest, about $7 million. They won't be exact numbers but they will be plus or minus 10%.

Robert F. McCarthy - Robert W. Baird

None of that shows up in unallocated corporate?

Michael S. Olsen

None of it does.

Robert F. McCarthy - Robert W. Baird

Okay. And Mike, in the press release, the commentary about incremental margins, that would apply to all-in numbers, including unallocated corporate? Or is that the total of the segments before unallocated?

Michael S. Olsen

No, that would be for Joy Global in total and then as we looked at the individual businesses, their decremental percentages actually would vary a little bit. And some of that would be based off of the expected product mix that we would be looking at, some of it would be driven off of the overhead absorption that would be associated with each of the businesses, because each of the businesses will in fact have a different cost structure, so the blended decremental percentages that we have guided would be for Joy Global in total.

Robert F. McCarthy - Robert W. Baird

Okay, and the other question I wanted to ask had to do with India -- your primary competitor has been more positive on the prospects there, in part because they of course booked a couple of large shovels in some of their traditional smaller drag line business, but they are positioning it as a fundamental change underway based on recent election results and the -- but developing or -- the developing opportunity for non-Indian players to come into that market and develop resources there.

Mr. Sutherlin, in your remarks on the other hand, you again -- you know, India bureaucracy, nothing happening. Can you help me -- maybe a little color -- understand what really is happening there now and what your competitive position is? I mean, do you expect to be able to -- you know, they are the long-term supplier. Can you compete effectively with them in that market?

Michael W. Sutherlin

Our view in India right now is that it is at a transition point. It has typically been a market that has government owned mining operations, a heavy, heavy focus on purchasing bureaucracy, a lot of the activity going into China is tied to businesses that are state owned, quasi-state owned, previously stated owned businesses that have certain advantages and so that's been a market that has been structured around that.

The market has also been dominated by a much smaller equipment which is traditionally what those mines have used. They are starting to see some larger equipment go in and the larger equipment is I think still at the emergent stage. We are also starting to see India admit that they can't increase mine production to keep up with the demand to burn coal in the country. We have seen them slow down the development of a couple of power plant projects because they don’t believe they have the coal to burn on those projects, which affects our ability to deliver electricity. The Chairman of Coal India recently said that India could be importing 200 million tons of coal by 2012 -- all that is sort of forcing them to re-look at how they approach their resource extraction processes and we are starting to see contract mining and other companies, mining companies in discussions in India for projects which they would take over and mine as projects where they have licenses, like they would have a license in South Africa.

So there is an impending structural change in India and we have equipment on the ground in India, we have a robust support activity on our surface equipment, based upon equipment that was sold in the late 1990s through [a world bank tender]. We have a lot of activity in and around underground equipment that we have been running underground equipment sets in India and that's increasing, so we have a strong presence in India. The changeover from government run to privately run mining operations would be a real advantage to us because the focus would then be on cost of ownership and productivity rather than purchasing price.

So I think that India has got a lot of positives in the longer term. It's hard to see in the next one or even two years how much of that change is going to translate down into hard incremental [order rates] and that is probably some of the questionable aspects of my comments -- it's just a timing on when India is actually going to make that transformation. But you can see it starting and you know that it is going to have the three, four, five years from now, it will be dramatically different. The question is how much different is it going to be in 2010 and 2011?

Robert F. McCarthy - Robert W. Baird

Exactly. Thanks, Mike.

Operator

Your next question comes from the line of Seth Webber with RBC.

Seth Webber - RBC

One question and a couple of clarifications -- the question is with your margin assumptions, can you talk to us about what you are assuming for input costs for this year for '010 for steel specifically, and whether you are putting escalators in the new contracts that you are writing?

Michael W. Sutherlin

I'll talk about the contracts and let Mike give you more specifics on the cost assumptions that goes into our plan. We are right now we are pricing shovels based upon the expected delivery date, so we have a shovel right now that we get an order for and let's say that order is a normal 12-month order to delivery cycle, we would buy steel at the front-end and we would then protect ourselves from steel price increases, so for those contracts, we would have relatively standard fixed price orders, fixed to delivery and we would price it to be able to cover costs that we anticipate through delivery.

We got trapped last time because orders started stretching out because of capacity constraints, so we were getting orders that were running two and three years ahead. And if we got a large product order that required equipment to be spaced out over that period of time, we would then definitely put escalators in. We modeled this out pretty extensively and we feel confident that escalators that include the surcharge we get from our suppliers would allow us to maintain profitability over that lead time and our objective has always been to deliver a shovel with the same margin we thought we were going to get when we took the order. So the models indicate that if we add a normal escalator indexes and add surcharges on top of that, that we could stay [whole], so those are in our contracts right now. Right now we don’t have contracts that run that far out so it's not really applicable to the stuff we have in backlog but certainly as lead times extend out, we would certainly have that kind of protection built in.

And then I'll give it to Mike and he'll give you a little bit more granularity on cost assumptions built into our margins for 2010.

Michael S. Olsen

As we put together the budgets for the 2010 fiscal year, those budgets in fact would include the costs that we are expecting for the various elements of our equipment manufacturing process. They in fact will be different based on the commodity and actually will have some difference based on the geographic location as well. We actually are not in a position where we will be able to talk to you about that in detail because we are actually in those negotiations with those material suppliers and if I would walk you through who we expect to have increased costs for, that would certainly give them a bit of an advantage in the negotiation but we do in fact have models that reflect some cost increases for materials but at the same time, we also have in that model where we are expecting our supply chain to end up with lower costs for some of the materials that go into our products but because of the negotiation process, I'm just not willing to walk you through that in detail.

Seth Webber - RBC

Okay. Thanks for that, and just a couple of clarifications -- can you talk about on a relative basis your profitability in China, how that compares to your other regions? And then the other clarification would be on the Joy aftermarket business, the growth sequentially, was that up in the U.S. as well or was the U.S. still down sequentially in the aftermarket business? Thank you.

Michael W. Sutherlin

The profit margins we are getting in China are very consistent with our worldwide average margins in our business. We don’t have a business in China that runs at lower margins. The composition sometimes changes where we may get variations on a specific product line, we may get some product lines that have better margins but on average as we look at that as a business segment, the margins are very, very comparable and probably slightly above average for both the surface and underground businesses.

Then with the order improvement distribution question, I'll give it to you, Mike. The increase in the Joy orders for the aftermarket, does that include increases in the U.S.?

Michael S. Olsen

Yes, it would.

Michael W. Sutherlin

So those increase for Joy were pretty broadly based across all our segments, including the U.S.

Operator, we probably have time for one more question and then we probably have to wrap up the call.

Operator

Your final question is from Mark Koznarek with Cleveland Research.

Mark Koznarek – Cleveland Research

Your revenue outlook is in the guidance is down 17% to 22%. Would you expect China and developing region revenue activity also to be down versus strictly developed regions?

Michael W. Sutherlin

We expect the strength in the international markets to be -- those markets to be up. We certainly expect China to have a good strong year in 2010, and offset the declines in other markets. We don’t expect very much in the way of order rates out of the U.S. coal markets, for example. We expect some orders but they will be relatively modest, down pretty significantly year over year. We have shipped off a lot of the backlog into the U.S. market during 2009, so we are going to be in a position where we are not going to see a lot of original equipment revenues in the U.S. in 2010 and that's got to be made up by stronger growth in places like China. We also expect the markets that feed into China, like Australia, to have a strong year in 2010. So we are not looking at every market to be down. We are looking at a balance of between strong markets in and around those in the emerging markets and those that feed the emerging markets and down years in markets that, like the U.S. coal market that is soft right now, or the copper markets which are just starting to recover and whether we are going to get year over year growth in those markets or not, I am not quite sure but they will be an improving market during the year.

Mark Koznarek – Cleveland Research

Okay, and so then if we think about China mostly being an underground market, does that imply that the revenue decline for the underground business is likely to be less than the surface in 2010?

Michael S. Olsen

I'm not sure that you would be able to draw that conclusion because there were some specific large transactions, for example, that took place in South Africa in 2009 on the underground side with the shipment of a big long haul system that we would not anticipate being replaced in 2010. And so my expectation is there would not be a significant difference in the two business segments as we look to 2010.

Mark Koznarek – Cleveland Research

Okay, and then the final thing about this outlook is, is there are any currency expectation in there?

Michael S. Olsen

The currency expectation is that the rate that we use for 2010 were the rates that existed as of the end of October of 2009, so if the dollar strengthened or weakened off of that point, then that would in fact drive some of the results for 2010. We did in fact see a pretty significant mitigation of the foreign currency impact and actually a little bit of a reversal as the dollar weakened compared to if you'll recall this time last year as the dollar was strengthening, we had some pretty loud impacts on our bookings in the fourth quarter last year. This year in the fourth quarter, that currency impact was pretty minimal.

Mark Koznarek – Cleveland Research

Mike, what does that mean -- if currency actually stays at this October level, what would that imply? Would that be a net contribution to the revenues in 2010? If that's your assumption, does revenue from foreign exchange add a couple of points of growth into 2010?

Michael S. Olsen

It would probably benefit 2010 slightly.

Mark Koznarek – Cleveland Research

Okay. Just -- okay, modest increase. All right. Very good. Thanks very much.

Michael W. Sutherlin

I think with that, we will wrap up the call and just take a minute here to summarize -- we do look at 2010 to be a transforming year for us. It's going to be a year of lower revenues but improving orders and we are going to carry some strong performance momentum into 2010 and we are going to use that to delivery very solid results but at the same time, we are going to continue to invest in the future. We see the longer term and even beyond 2010 to be a very strong outlook for this industry and for this business, so we are going to continue to invest in leaning out processes and upgrading and transforming our manufacturing capabilities. We are going to continue to invest in new product developments, particularly around game-changing technology. So we believe the combination of delivering strong results and continuing to invest in the future gives us the best overall return for our shareholder and we think that is in the best interest of the shareholder. So that is our plan for 2010. It will be a challenging and transforming year but we think we are going to be able to do some very good things during 2010, so again I think everyone for their interest in Joy Global and thanks for participating in this call. Bye.

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