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Executives

Michael Olsen - EVP, CFO and Treasurer

Michael Sutherlin - CEO and President

Sean Major - EVP, General Counsel and Secretary

Analysts

Andy Kaplowitz - Barclays Capital

C. Schon Williams - BB&T Capital Markets

Henry Kirn - UBS Securities

Robert McCarthy - Robert W. Baird

Ann Duignan - JPMorgan

Charles Brady - BMO Capital Markets

Ted Grace - Susquehanna Financial Group

Seth Weber - RBC Capital Markets

Joy Global Inc. (JOY) F4Q11 Earnings Conference Call December 14, 2011 11:00 AM ET

Operator

Please standby. Good day and welcome to the Joy Global Incorporated Fourth Quarter 2011 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Mike Olsen, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Michael Olsen

Thank you. 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 the call this morning is Mike Sutherlin, President and Chief Executive Officer; and Sean Major, Executive Vice President, General Counsel and Secretary.

This morning, I will begin with some brief comments which expand upon our press release and which provide some additional background on the results for our fourth quarter. Mike Sutherlin will then provide an overview of our operations and our market outlook. After Mike's comments, we will conduct a question-and-answer session.

During the session, we ask you to limit yourself to one question and one follow-up question before going to the back of the queue. This will allow us to accommodate as many questioners as possible.

During the call today, we 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 the understanding of 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 spend a few moments reviewing the fourth quarter of the 2011 fiscal year. The fourth quarter and the full year results included number of items which make a comparison to the prior year period difficult. In the press release, we’ve provided information in a format to allow the reader to compare the current quarter and fiscal year with the prior year period on a consistent basis.

My comments this morning will address current quarter results for the most part on a historical basis, excluding the LeTourneau Mining results, acquisition transaction costs, the International Mining Machinery equity income and incremental interest expense. I will then summarize these items at the end of my remarks.

Bookings in the fourth quarter were $1.3 billion and were 22% higher than they were last year. This increase in bookings was a result of a 25% increase in original equipment bookings and a 20% increase in aftermarket orders. The increase in aftermarket bookings continues the trend we have seen for the last nine quarters. The increase in aftermarket bookings was very broad with a 24% increase for the underground mining equipment business and a 16% increase in surface mining equipment.

The increase in original equipment orders was not as broad based, with surface mining equipment, original equipment bookings more than doubling, with orders being received across most geographic regions and for all commodities.

Original equipment bookings for the underground mining equipment business were approximately 24% less than they were a year ago. However, $45 million of the $65 million decrease in bookings were due to the impact of translating the beginning backlog of the quarter’s original equipment with the weaker U.S. dollar last year compared to a stronger dollar at the end of the current quarter.

With the exception of the roof support product line, where no large system orders were received in either period, orders remained strong across the other product lines.

Our investor website contains two graphs which track rolling fourth quarter new order trends by business for both original equipment and aftermarkets. The graphs reflect the continued increase in aftermarket orders for both businesses and for OE bookings for the surface mining equipment business with the leveling for the underground OE orders.

Net sales in the fourth quarter were $1.2 billion and were 18% higher than they were a year ago. Both the businesses continued with strong revenue growth with the surface mining equipment business having a 21% increase in net sales while the underground business had a 15% increase. The positive revenue trends for the aftermarket business continued with increased sales of 20% and 16% for the surface and underground mining equipment businesses respectively.

Higher aftermarket sales were reported at all markets. Original equipment revenue benefitted from the strong OE bookings over the last several quarters with the surface equipment business reporting a 33% increase in net sales while the underground equipment business was up 15%. Strong OE shipments were reported across all commodities that were mined with our equipment.

Operating profit in the fourth quarter was $282 million with a 23% return on net sales, compared to $227 million with a 22% return on net sales in the fourth quarter last year. The underground mining equipment business had an exceptionally strong quarter with the return on sales percentage in excess of 25%.

During the quarter, the majority of the variables went in the right direction, as the underground equipment business benefitted from a favorable sales mix, both between OE and aftermarket, but also a favorable sales mix within the OE product lines.

The underground business also benefitted from favorable overhead absorption due to the increased manufacturing production, offsetting the increased spending for selling, engineering and administrative expenses. The surface mining equipment business had a strong quarter with almost a 22% return on sales.

The surface business also benefitted from favorable sales mix and positive overhead absorption but was unfavorably affected by a foreign currency charge during the quarter.

Net income from continuing operations, including acquisition-related results, was $195 million, or $1.83 per fully diluted share for the fourth quarter, compared to $146 million, $1.39 per fully diluted share last year. Net income from continuing operations in the current quarter benefitted from the increase in operating profit and the decrease in the effective tax rate from 34% last year to 31.7% this year.

The improvement in the effective tax rate was due to reduction in discrete tax adjustments, a favorable change in mix of geographic earnings and the implementation of tax planning initiatives. Despite this improvement in the current quarter’s effective tax rate compared to last year, the 31.7% in the fourth quarter was higher than the tax rate we expected for the quarter when we provided earnings guidance at the end of the third quarter.

The increase in the effective tax rate was primarily due to the $2.8 million of discrete tax charges recorded in the third – in the current quarter. For the 2012 fiscal year, we expect the effective tax rate to be between 29% and 31%

Net income in the current quarter was adversely affected by a $7 million increase in interest expense and an increase in fully diluted outstanding shares from 105.4 million shares last year to 106.7 million shares for the current quarter.

Cash flow from operations was $151 million in the current quarter, compared to $211 million a year ago. The decrease in cash provided by operations was due to an increase in inventories to support anticipated increased shipments, partially offset by an increase in accounts payable.

During the quarter, the company issued $500 million worth of ten-year notes with a call provision in the event that IMM acquisition is not completed. Approximately $240 million worth of additional IMM shares were purchased during the current quarter which brought our ownership of the outstanding shares of IMM to approximately 28%.

For the full year, 2011 had $1.4 billion of acquisition expenditures and $1 billion of cash generated from the issuance of $500 million of ten-year notes and a $500 million bank term loan. At the end of October, $866 million was on deposit in an escrow account to partially fund the purchase of the remaining outstanding shares of IMM.

In addition, during the 2011 fiscal year, progress continued to be made in connection with the company’s unfunded pension liability, which decreased over the last two years from $579 million at the end of October 2009 to $332 million at the end of October 2011.

Turning to the acquisition related results, the fourth quarter included bookings and net sales from the LeTourneau Mining acquisition of $116 million and $102 million respectively. Operating profit from LeTourneau was $17 million in the fourth quarter which included $8.8 million of purchase accounting depreciation and amortization charges, $5.6 million of which were associated with the write-up of inventories and the value assigned to the beginning backlog which will be completely amortized within the first year after the acquisition.

The current quarter also included $6.2 million of acquisition transaction costs and a $7 million increase in interest expense associated with acquisition financing. In addition, the fourth quarter included $3.4 million of equity income associated with an estimate of our share of the IMM profits.

In summary, with all of the moving parts in the quarter, there were five items which were not anticipated as we began the fourth quarter. Three resulted in charges to net income, and two were benefits to net income.

The incremental charges and their EPS impact were acquisition transaction charges associated with the early financing of the anticipated IMM purchase accounted for $0.04 a share. The discrete tax charges mentioned above were $0.03 a share. And the incremental interest expense associated with putting the IMM financing in place ahead of schedule totaled $0.02 a share.

The incremental benefits in the fourth quarter that weren’t anticipated were: the equity income associated with the IMM shares that we held which amounted to $0.02 a share and a gain on the sale of an excess property associated with the LeTourneau business, which benefitted the quarter by $0.01 a share.

With that, now let me turn the discussion over to Mike Sutherlin.

Michael Sutherlin

Yeah, thank you, Mike and let me add my welcome to those on the call. As I look at the quarter, two things stand out. First is that our core businesses continued to deliver very strong operating leverage. We were helped by price realization and a favorable mix with more aftermarket, but favorable overhead absorption in our factories and service centers was a major contributor.

Some of this is the outcome of higher production levels, that also comes from our operational excellence programs that continue to lean out and streamline our manufacturing processes. I believe that operational excellence will be a long term contributor to operating leverage and therefore it’s gratifying to see it come through.

Second is the effectiveness of our M&A activities, both strategically and on their contribution to incremental results. We did two transactions this year and are well along to toward the third, and LeTourneau’s contributions for just over five months have offset both the deal costs and the purchase accounting charges.

This makes a strong statement on the quality of our M&A capability and demonstrates the impact that a strategically focused high quality addition can make both from day one and over the long term. So we’re very pleased with that.

Bookings were solid, especially under market uncertainties. P&H continues with very strong bookings for original equipment. The Joy original equipment bookings were down from last year as Mike reviewed, most of that results with backlog adjustments for FX movements. It’s worth nothing that since neither this year or last year’s fourth quarter have bookings on major longwall systems, they represent a strong base level for underground business with projects providing the upside.

To that point, we continue to see strong prospects in the pipeline, particularly over the next couple of quarters. Both Joy and P&H had very strong aftermarket bookings. This comes from a larger working fleet and tougher working conditions but it also comes from our drive to convert aftermarket from transactions to programs.

These programs were undoubtedly up to smart services. We proved the value of smart services in South Africa and we will be bringing into other major markets in 2012, including the United States and Australia.

A strong aftermarket is more important element to us for bookings. Not only is it sustainable over the cycle but it supports machine reliability that creates preference for original equipment. So for us it’s the start and not the end of the process.

So with that, I’d like to turn to reviewing the markets that we serve. In my view, there are too many headlines about macro headwinds. If you look at the details behind these headlines, we continue to see positives as well as negatives.

The global PMI index is at its lowest level in two years but is still positive. The China PMI index is barely staying above the cost of a level of 50. The manufacturing output has shown improvement in October and November. Inflation in China is starting to come down and Beijing was beginning to lose some lending requirements.

U.S. industrial capacity utilization remains in the mid 70% range and inventories remain historically low in terms of days of supply. In fact, industrial wholesale inventories remain at their lowest level in the last 20 years in days of supply.

The steel industry announced price increases of about 4% to get hot rolled coil prices to $700 a ton and these prices seem to be sticky with more mills falling in line.

It surely contains an element of slowing but more importantly, I read in a settling in and around a little or no growth levels while waiting for the macros to provide stronger positive signals. As a result, I see this as more risk to upside than to downside.

If we move to the industrial fundamentals, we get a more positive picture. Chinese destocking of coal and copper in the first half of the year has turned into restocking in the second half. Second half, the imports of coal and copper are running ahead of last year and domestic coal production is also strong.

India has allowed its coal stockpiles of power plants to drop to dangerously low levels. This is compounded by the continued pattern of shortfalls in domestic production. This combination will drive a significant return to exports going forward.

And the U.S. export growth is real. For example, South Korea is buying more coking coal from the U.S. and from Australia for the first time in 20 years. And India’s return to the seaborne markets will redirect South African exports and leave the U.S. to fill the supply void to Europe.

Not only are there positive demand elements but supply continues to be challenged. The Southern obsolescent index that’s a measure of the linear strength is at its fourth highest level ever and suggests a second year in a row of heavy rains in Australia and Indonesia. As a result, Queens (ph) state government has lowered its projection for coal exports by 8% for the current year ending next June.

Steel production is down in China by over 15% since last summer. Steel inventories are down over 11%, and therefore, the production decline is almost all driven by dealer inventory reductions. Dealers were forced to reduce stocks when credit was tightened and they should begin to rebuild those stocks with the start of looser credit policies.

From this perspective, the upside is much clear, being at the timing is not. Our customers are working close to full capacity and have long lead times to bring new mine capacity online. We are convinced that stronger demand growth will return before new mine capacity can reach the market.

Unlike 2008, our customers have strong balance sheets and significant cash available. And this time they can be strategic about investing over the cycle. The industry learned the consequences of stopping and restarting projects and no one wants to do that again. Therefore we are seeing increases in 2012 CapEx guidance from at least three of the major mining houses and expect more to come as 2012 guidance is released over the next couple of months.

Mining investment spend was up 30% year over year in the third quarter and we expect that rate to moderate going forward. Mining CapEx budgets should be up 10% or so in 2012 and the rollover of actual spend will add to that. At the same time, the industry will be cautious and measured. The existing projects will proceed, especially the strategic greenfield projects.

However, there will probably be slowing in new projects entering the pipeline until the macros provide a clearer positive direction.

We could also see some slowing in aftermarket demand as customers respond to the current sluggish conditions by keeping supply balance with demand. However, larger installed base and tougher working conditions combined with more program based aftermarket revenues should support year over year aftermarket growth for us, even if that growth moderates.

In 2012, we will focus on long term growth and operating efficiencies. We will continue to deliver on our commitments to customers. This includes maintaining our strategic growth programs, and to do this, we are increasing our capital budget to $200 million. This capital budget will be roughly split between manufacturing capacity and field service infrastructure.

Based upon committed backlog and the market outlook, we expect 2012 revenues to be between $5.3 billion and $5.5 billion. We’re committed to continuing to deliver operating leverage of 25% and that will translate into earnings per fully diluted share of between $7 and $7.40. This guidance includes LeTourneau, which is expected to contribute $400 million to revenues and $0.41 to earnings per share. The latter includes $0.08 of purchase accounting charges that will be ongoing and $0.07 of purchase accounting charges that will roll off by the end of LeTourneau’s first year. And this guidance does not include IMM or any future acquisition related costs.

To close, I just want to remind investors of the normal seasonal impact of our first quarter. Because of the large number of holidays and the year-end break in the southern hemisphere, we would see reduced manufacturing and shipment days in the quarter.

Shipments and overhead absorption will be impacted while most of our costs will continue to be incurred. This will depress revenues and margins sequentially but we expect them to be in line with our guidance on a year over year basis.

So with that, I’d like to turn the call back to Nancy for our Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions). And we’ll go to the first caller that is Andy Kaplowitz with Barclays Capital.

Andy Kaplowitz - Barclays Capital

So Mike, obviously your tone changed a little bit on this conference call, and this press release versus past calls. How much of this tone change really is just uncertainty of the macro increasing versus talking to the customers, because as you noted, they are rolling out their 2012 CapEx and that looks pretty good. And then just I’ve been telling with that -- what is the risk to the leveling off comments you made about bookings? What’s the risk that it gets worse than that or do you have pretty good confidence that it’s leveling off or better?

Michael Sutherlin

The tone change is really driven by both our outlook for the market fundamentals and discussions with customers. And customers are very positive today about continuing to move their projects down the pipeline. They have CapEx budgets that are either going to be similar or above last year. They’re going to have a rollover of actual spend from last year. Cash balances are good, balance sheets are good.

However, longer the macro conditions stay muddled, the more attentive our customers are going to become, then they are very likely to continue funding those projects today. In six to 12 months from now, they’re going to continue funding projects despite lack of global economic growth. So – and part of our tone is based on the fact that the current conditions won’t support robust CapEx by the industry for the long term. It may support it for the next six months and may support it for little bit longer. But eventually, the CapEx by the industry has got to line up with the macros. So the macros either have to improve or the CapEx has got to come in line.

So the tone change is really around the fact that the situation we have today between customer commitment to CapEx and the backlog environment is not sustainable over the longer term. So it really is driven by that.

The leveling off of the order rate, I think that would be positive for us in terms of leveling the order rate takes away the downside I think -- with our backlogs and lead times, I think, it continues to give us lot of visibility of the markets going forward and really wouldn’t have an adverse impact on our business, if the order rate is just leveled for a while. So I read that as to be a net positive for our business.

Andy Kaplowitz - Barclays Capital

Okay. Mike, I lumped two questions in there, so I’ll get back in queue. Thanks.

Operator

And we’ll go next to Schon Williams from BB&T Capital Markets.

C. Schon Williams - BB&T Capital Markets

I wonder if you could just comment – you mentioned that capacity is fairly tight at your customers. I wondered if you could talk about your own capacity situation as we look out into 2012 given the guidance. And maybe along with that, if you could just address how the robust CapEx spend for next year fits into the right equation (ph). Thanks.

Michael Sutherlin

We certainly will continue to look at 2012 as bumping up toward the limit of our capacity. We’re not going to be putting in 110% of capacity. We certainly are pushing the limits of our existing capacity. We do have our next factory in Tianjin for underground equipment business. It’s under construction in China. And the CapEx that we’ve announced is part of continuing to build out our capacity to meet the current needs of the industry, both from a original equipment standpoint but also from going aftermarket standpoint.

So we feel that the plan we have with existing capacity this year, the addition capacity that will come on in China later this year and the capacity that we’ll be adding under our CapEx plans, both the CapEx we got this year and the rollover from last year, I think, will keep us ahead of the market.

C. Schon Williams - BB&T Capital Markets

Just as a follow up, given that the buildout will occur over the course of 2012, I mean, does that imply you’ll need to be doing more outsourcing in 2012 versus 2011? And how should I think about – does that actually mean we could see incremental margins maybe even worse than the 25% you put out there, just to help me put that in perspective?

Michael Sutherlin

Yeah, I’ll talk about the outsourcing and let Mike give you some insights on the operating leverage. But our strategy has been to use outsourcing to keep us from building capacity into the peak of the cycle. So today we are running outsourcing that’s sort of in the low 20% of our production capacity range, out of 20% and 25%. In 2008, we were up to 35%.

We do that for a number of reasons. One, we do want to take the peak off the cycle in terms of not building capacity into that peak. But we also have a strategy of not building capacity to the structural fabrications as long as we can find outsourcing capability that gives us good quality, good delivery and it keeps us from having to build that capacity ourselves. And we do that because it’s lower value add and we do that because it is more driven by the cycle, it’s more focused to support original equipment demand and aftermarket demand. So it is a more cyclical part of our manufacturing process.

So we are outsourcing today. We are outsourcing in the low 20% range which is not untypical for us and we’d probably do a little bit more outsourcing over the next couple of years just as we try to hedge where the cycle is going to be going. And with that, I’ll let Mike give you some insights on what the incremental margins are going to be as a result of that.

Michael Olsen

Yes, as we’ve talked in the past, as Mike has outlined, we need to have a strategy that utilizes outsourcing. You will recall back in the peak of 2008, outsourcing rose to the mid 30% range of our total direct labor hours. Our financial model anticipates that as we see a ramp up in revenue, we will, in fact, have an increase in that outsourcing percentage and that, in fact, factored into the establishment of our target incremental profitability of the 20%.

So the outsourcing will not put pressure on that incremental profitability percentage. If the outsourcing turns out to be a lower percentage, then what we are anticipating – what would happen is there would actually be some upward pressure on that incremental profitability. But as we anticipate executing the plan to utilize outsourcing in an orderly fashion, we’re very, very comfortable with that incremental profitability percentage of 25%.

C. Schon Williams - BB&T Capital Markets

Thanks for the update.

Operator

And we’ll take the next question from Henry Kirn from UBS.

Henry Kirn - UBS Securities

I guess, first on the smart services, can you talk about the current market share of the aftermarket on your installed base, maybe at least directionally, how smart services can impact share? And maybe with that, is smart services really designed to gain share or is it improved pricing and margin potential in the aftermarket?

Michael Sutherlin

Both good questions, we have – we started the development of our smart services of late in South Africa. We did that because the market there is a more contained market. So it allowed us to do -- work with the normal start-up issues and get things going smoothly. So today we have smart services contracts with about 80% of the customer base in South Africa. So they have seen the benefits of smart services. They realize what it brings to their operations. And the adoption rate has been good.

We’ve not moved it into the other markets too quickly because we want to make sure that we can support as we move into those markets. However, some customers that are operating in South Africa want it in the other markets in which they operate. So we are moving it in 2012 into the U.S. and into Australia. So those are two large markets for us and smart services would be a key addition.

We look at smart services as an extension of our life cycle management programs, cost per ton kind of programs. And we do that to continue to add scope and capability to those programs. Life cycle management programs do a lot of good things for us. They allow us to higher capture rate of the aftermarket because it’s all rolled into those contracts. It’s a more stable revenue stream because it’s much more predictable than transaction-based aftermarket.

And it forces us to be aligned with the customer. So we are worried about parts availability a lot more. And we plan parts change-outs and we plan maintenance and we plan rebuilds. And we just do a much better job of that and therefore the machine is one of the higher level of reliability. That higher reliability and higher capture rate makes the life cycle management programs a good addition to our aftermarket but it also creates a preference for our original equipment – the reliability of our machines in the fleet are above the average and that’s a build positive for our customers.

So we look at smart services as just adding to the capability we ought to have in our life cycle management programs. And it’s all about monitoring equipment to, adds conditions to identify parts that need to be changed out before breakdown. It’s designed to look at the condition, degradation to plan and rebuilds more effectively. And it’s designed to monitor the mean time between failure and feedback and that in the engineering to improve some of the component designs. And it’s designed to connect them to our customers’ purchasing operations so that we can help them plan the purchase our parts to support their equipment in the field and do that more effectively.

So the bottom line is it helps us in a lot of ways. But it’s not just a margin improvement, we get good margins on our life cycle management programs, we get predictable margins and revenue streams and we get a stronger and better relationship with the customers. So all those things are long term positive for our business.

Operator

And we’ll move next to Robert McCarthy from Robert W. Baird.

Robert McCarthy - Robert W. Baird

Could you talk with a little more granularity, Mike, about what you’re seeing specifically in China and share with us what share of total revenue of China accounted for in FY’11?

Michael Sutherlin

I’ll give you like a view of China we’ll look at that -- the number on that – the China percentage. China continues to be a good strong market for us. We see China, though, as a market that’s got a number of different segments to it. The high growth that we are participating in, is driven by the new mines that are going – in the northern Shanxi, and Inner Mongolian provinces and in places where (indiscernible) Erdos in that region. Those are our big mines, high production mines up to 2 million tons a month. They are generally underground mines. And that’s driven growth for our original equipment that we import into China.

The majority of China production is in the eastern provinces. It’s deep underground, difficult conditions, a lot of gas – lot of difficult geological conditions, not to unlike Central Appalachia in the United States. So they’ve had a real struggle in increasing production out of the eastern provinces. We still represent 60% to 70% of the country’s production volume. So we see growth in the western provinces, it’s driving demand growth for our Joy branded equipment for underground and to a lesser extent, our P&H branded equipment for surface mines. We see that continuing as mine expansion moves out west. And we see they march to further western provinces as a long term extension of that trend, the mine in better provinces, so the Ningxia province is south west to Inner Mongolia and it will be a surface mining province not to unlike the PRB but the rail lines are another 1000 kilometers further west to get there.

And we see that trend in China is driving equipment demand for us. But we also see the struggle with the smaller mines to keep their production growing in pace with the majors in the country and that’s driving the consolidation mechanization of those mines, which is sort of the basis for the IMM acquisition is to participate in that conversion and growth in that sector. So we see China coal demand continue to be strong but not necessarily strong enough to meet the overall demands of the power and the industrial applications in China. But we also see the imports to continue to be at high levels. We expect those imports to sort of to be in the 120, 130 ton range this year. And that sort of is consistent with – down little bit from last year but pretty consistent and we expect that, that trend of strong imports to continue.

So all our growth in China domestic production, not enough to keep up the imports of coal are going to be a consequence of that. But China has also been a market with a lot of starts and stops we’ve seen – we see parts order to come out of China lump together and we’ll get those as big orders two or three times a year rather than monthly orders, like we’ve got other places that’s driven weekly orders. Original equipment projects tend to be surges as well and so we’ve got – it appears like last year we didn’t have a lot of orders from Sheng Wang (ph) as they were working through processes with the Shanxi to look at their internal efficiencies and work our ways to improve that.

We expect them to be back into strong order patterns and strong expansion patterns here in 2012. So China continues to be a good market for us. It continues to be a market that’s not necessarily smooth and leveled and a market with opportunities for import as well as domestically for this equipment.

Robert McCarthy - Robert W. Baird

I guess, Mike, the point of my question was more to drive to the commentary about tying order rates to the macro and the steady slowing that we’ve seen in China over the past months. The release talks about seeing rebuilding of inventory. But I guess, my question, I am trying to translate this into what you are seeing in current and near term order booking activity, particularly aftermarket.

Michael Sutherlin

Yeah, the aftermarket for us in China continues to be really strong aftermarket with especially strong in 2011, we expect that to continue. So it is driving good aftermarket growth for our business. Tianlong is a company that has a lot of equipment for the number of mines that it operates, so it’s an equipment rich company and I think that’s part of the study that they have done is to determine how they can be more efficient in the utilization of their assets. And that slowed down the original equipment demand a little bit as they began to look for better turnarounds on repairs and other kind of things to improve their equipment utilization. But the aftermarket has been particularly strong and we think that, that’s going to continue.

The original equipment demand will continue to move up when they sort of settle down on the base level of equipment and we expect that to be translated into possible rate share in the first half of 2012.

Robert McCarthy - Robert W. Baird

And except for transient effects, you haven’t really seen any negative impact on real time on demand. I think you’ve got big program issues in Shanghai?

Michael Sutherlin

Yes. Now we really don’t have – we are still putting equipment to work there, production rates are going up. The buildout of electricity grid in the western provinces is driving some incremental demand there. Like in the U.S., we see industrial production in China to be better off than their overall GDP numbers. And that helps us as well. And lot of the coal demand in China, about 40% of the coal demand goes into industrial processes, not into power generation.

Robert McCarthy - Robert W. Baird

And then just a quickie follow up. By the way, we still want to hear that China number. The $50 million increase in your CapEx plans for ’12, I gather that’s not something new but rather something you pull forward from presumably ’13. What is that?

Michael Olsen

Are you talking about the capital expenditure number?

Robert McCarthy - Robert W. Baird

Yes.

Michael Olsen

Yeah, actually we have been talking for a period of time where we were looking at the capital expenditures for the next couple of years at 150 million a year. In 2011, the capital expenditures came in at about $111 million primarily associated with the acquisition of the project. And so the number that we have in 2012 is a catch-up of the delay that we had in 2011 plus a couple of institutional projects.

In addition to that, in connection with the China numbers that you were asking about, it’s an interesting phenomena. As Mike had indicated, we did, in fact, see some softening of the BOE demand in China. But in connection with total sales and total bookings, we saw an increase. For a number of years, we have been running at China at roughly 10% of what our sales were. China is now starting to bump up closer to 15% of our sales. And what’s really the big driver in 2011, as Mike alluded to, was the aftermarket business which really plays to the strength of our strategy and it does a number of things. One, it begins to reflect the building of the installed base of equipment that has been taking place over the last five to 10 years and also the increased production that’s coming off of that equipment.

And so we feel very positive about that. We also believe that there is a fair amount of pent-up original equipment demand that should, in fact, begin to shake itself loose. So despite softening on the OE side in 2011, our revenue and profitability in China was better in 2011 than it was in 2010.

Robert McCarthy - Robert W. Baird

Narrowed fairly but significant amount. Thanks. Appreciate the clarification.

Operator

And we’ll take the next question from Ann Duignan from JPMorgan.

Ann Duignan – JPMorgan

Can one of you address the inventory buildup at the end of the year? I know you said that it’s an anticipation of higher sales. But was that the specific customers requesting delayed shipments or have you seen any cancellations? Is there anything more in that number rather than just buildup for future demand?

Michael Sutherlin

I’ll give you a comment, I’ll turn over to Mike will provide a real broader view on that. But we did have some inventory tied up in late specification changes on some new model equipment that was going out to the market. And some of that was just a reconciliation between what the customers ordered and what they thought they ordered and those changes were made late in the manufacturing process and late in our fiscal year and with a quite few machines, six or eight machines that should have shipped and didn’t ship as a result of that.

So there is some inventory in spite of that, but that certainly doesn’t explain all the inventory increase. I will leave it to Mike to give you the rest.

Michael Olsen

As you take a look at the inventory build, there is really a number of factors coming into play. There is the delay in some shipments that fell out of our fourth quarter, really if you went through them on an individual basis, I suspect, you’d see very little that was driven by customer request. I think that there were issues that we were unable to meet some of those delivery dates and they slipped out. Probably by this point in time, a number of those piece of equipment have actually already been shipped.

The other two main areas of drivers and probably the bigger drivers of that inventory is one, to support the increase in production and sales volumes that we are anticipating for the 2012 fiscal year. If you take a look at the backlog, there is a number of longwall systems that are in that backlog that will, in fact, be delivered in the 2012 fiscal year, the backlog that’s in place for electric mining shovels is at an all time record and inventory is being brought on board to support that activity levels.

And the other thing is that we begin to increase our presence in the emerging markets and one of the key elements of our strategy is the aftermarket support that we provide for the equipment that we put in place. And so as we get more and more equipment in place in the installed base, in these emerging markets, there is, in fact, inventory that is required to support them from an aftermarket perspective. So it’s really those two areas that are the drivers behind the increase in inventory.

Ann Duignan – JPMorgan

Okay. Thank you. That was good color. And then separately as a follow up. Could you just give us an update – little bit more detail on IMM and the range of outcomes and timelines that you are thinking about? Just a little bit more deep dive on that transaction please.

Michael Sutherlin

We are obviously in waiting regulatory approval on IMM. The current phase that we are in by the 12-month timeline expires sometime before the end of this year, I think the 22nd or something of December. So at that point, they will give us a decision that they’ll move into phase three on the review process. So we are hopeful that, we’ll get a positive outcome here before the holidays. But certainly at this point, we are sort of in wait mode and waiting on the regulatory approval. And otherwise getting prepared to run the tendering process for the remaining shares we have I think 14 days from regulatory approval to pick up the tendering month process. So we’ve got to do some work in a preparation for that and we are in process on that and hopeful that this will come together here before the year end and be able to get out and completed.

So beyond that, we continue to have meetings with their management in anticipation and begin to talk about onboarding invitation, and number of kind of issues that you would do as pre-planning for bringing a company like IMM onboard. But nothing formals it can be done until we get the approval and complete the tendering process.

Ann Duignan – JPMorgan

And is there any risk can you remind, not getting approval?

Michael Sutherlin

There is always some risk. I think it’s in the discussions we’ve had with the regulators, the questions have been relatively straightforward. Nothing surprising, nothing alarming in the questions they’ve asked as part of their review process. So we’ve had meetings with customers. We’ve had meetings with the government officials – particularly provincial government officials that are affected by the acquisition in places where IMM has active, for example, areas where they have a strong customer concentration. And we continue to get positive and favorable responses in those categories.

So we don’t have anything that tells us that there is pockets of resistance in the areas that anti-monopoly review people would be testing to as part of their review process. So it’s hard to be overly conclusive – it’s hard to be overly confident until we actually get the final answer. But we certainly hopeful, cautiously optimistic and we don’t have anything that suggests that there are issues out there that are concerning or alarming at this time.

Operator

And we’ll move next to Charlie Brady from BMO Capital Markets.

Charles Brady - BMO Capital Markets

Hey I just want to go to a comment you just said a moment ago on the electric mining shovels. Did I hear you correctly that backlog is at an all-time high.

Michael Olsen

Yes.

Charles Brady - BMO Capital Markets

Can you quantify the number of shovels in backlog?

Michael Olsen

I don’t know if we can or not. We typically have not disclosed the number of shovels in backlog.

Charles Brady - BMO Capital Markets

Fair enough. Would these ship all in ’12 or are you – you have backlog for shipments beyond ’12 for shovels?

Michael Olsen

The majority of those would, in fact, ship in 2012, there would be a couple that would go over into the 2013 (ph) fiscal year.

Charles Brady - BMO Capital Markets

And can you just give me some more granularity on the commentary about the, I guess, moderation in the aftermarket growth rate? Maybe put some color or brackets around what you are thinking given in light of your guidance or revenue being up 20% to 25% year on year in ’12 of the aftermarket is a closer in revenue recognition. And I am just trying to square that up with your comments.

Michael Sutherlin

My comments are really driven by the fact that our customers have demonstrated the quick response to market conditions. And as we’ve looked at past cycles, 2008, for example, but we looked at 2007 in the United States, which was a period of soft demand in the U.S. for equipment, customers reacted very quickly to align production with demand and do not fill excess stocks at the mine site, not to build excess stocks at the ports or the power generating plants.

So we see that quick response in entirety on the part of the industry. And as the markets continue to be sluggish, I think that there is a reasonable concern expectation that some of that demand will begin to slow down a bit and customers will begin to pull back on some production levels to keep their supply aligned. And as a result of that, it will be that hard drive to increase production that we saw in 2011. 2011 was a year where everybody was all out trying to drive production increases. We think 2012 will be more measured, more cautious and the production increase and not the production, so they’re not going to decline and we are going to add more equipment to the fleet and that will be positive impact on aftermarket. But there is some reasonable basis for being concerned about how much upside there is to the aftermarket in 2012.

I think we tried to reflect that in our guidance by talking about the aftermarket, we will continue to grow but at a possibly moderated growth.

Charles Brady - BMO Capital Markets

Would you expect to grow still in double digits, or single digit?

Michael Sutherlin

Probably our downside is sort of at the border between the two.

Charles Brady - BMO Capital Markets

And then just on IMM, do you have any expectation to continue buying additional shares in the market prior to getting an approval on the deal? And within your guidance for ’12, is there a – what’s the equity income assumption from the current ownership of IMM?

Michael Sutherlin

We actually can’t buy any more shares. Once you get over 30% of direct share ownership, you are in violation of the outcome approval process. And so we are limited on the shares we have right now. We could probably buy a few more shares but we are fundamentally kept on the shares we combined. The Jordan shares are subject to MOFCOM approval. So those don’t count right now.

And then Mike will have to tell us how we are treating the equity recognition on IMM for guidance.

Michael Olsen

Yeah, we actually do not have any of the IMM equity income in the guidance. That’s a requirement of the accounting rules. Once we got above the 20% the accounting rules require us to switch to the equity accounting method. So to make sure that there was a little noise in the guidance is possible what we made the election to do is not include any IMM equity income in our 2012 guidance. And once the IMM transaction is completed, on our next earnings call, we would then update our guidance to include the results that we expect from IMM.

Operator

And we will move next to Ted Grace from Susquehanna.

Ted Grace - Susquehanna Financial Group

Thanks guys. I was hoping to come back to – how you doing? I was hoping to come back to some of Mike’s comments. I know you mentioned that you see existing projects moving ahead and you foresee the potential for slowing of new projects. So if you could maybe speak to the prospect list at this point and kind of where you’ve exited fourth quarter and maybe how that compared the end of the third quarter and where that number might have hit in 2011?

Michael Sutherlin

We saw the prospect list come down just slightly at the end of the third quarter, roughly leveled at the end of the third quarter. We’ve seen that prospect list stay roughly leveled here as we close the fourth quarter, so that there is a little bit of movement, I think, in both cases. There is a little bit of adjustment down but it’s relatively minor. So the prospect list looks really pretty good right now and the prospect list of what we expect to see over the next 12 months in terms of equipment bookings.

My comments were really around continuing to add projects in the pipeline under conditions of uncertainty. One thing for customers to complete what they start as the other thing, then to continue to add new projects into the pipeline without little bit more clarity on where the market is going to be going.

Certainly as we get into 2012, we’re going to get clarity as we go into the year and that will probably clean this up in the first or second quarter but right now, the belief is that they’re going to focus more on finishing what they have in the pipeline rather than spending lot of resources on the next wave of projects and I think we will see that. The good news is that they will continue to pushing forward on the projects in the pipeline which will tie back to our order outlook and our prospect list – those are the things that will come due order decisions here over the next 12 months and unlikely so. That part of thing is positive. The period beyond that is more uncertain, a comment I made earlier that our customers are not going to keep ploughing money into capacity additions until they start to see some positive improvement in the macros. So they’re not going to do it over the long term, and might do it for the next six to 12 months. But eventually they’re going to be in to dial back until the macros start to show some stronger positive indicators.

Ted Grace - Susquehanna Financial Group

Okay. That’s very helpful. And then just within the prospect list, did you see any kind of noticeable shifts between client bucks or the global miners, the juniors regionally that that would be notable?

Michael Sutherlin

Now that there is strong growth there in copper and particularly in South America, there is a lot of budgets that are tied to copper in South America. There is a strong growth in iron ore, not just in Western Australia and South America but also in Africa, there is quite a bit of focus on Africa being the third major iron ore producing province in the seaborne market. And we’re starting to see time for investments around that. Coal markets are focused on – we continue to see a lot of strength in Australia. And we started to see some juniors that have major projects coming up in Australia. Longer lead time, and they’re not on our prospect list yet because they are still early in the engineering planning, permitting phases. But we certainly see those starting to firm up on the horizon. And the bigger projects, multiple shovels, multiple drive line kind of projects.

So we do see a lot of that – those projects with the juniors are probably more susceptible to market demand and financing capability than the projects by the majors. But certainly they are out there and we see quite a few of those particularly in Australia. So…

Ted Grace - Susquehanna Financial Group

That’s great. And then the second thing I was just hoping to quickly ask is just in terms of thinking about free cash flow next year, could you give us any kind of sense for how we might want to think about that?

Michael Sutherlin

I’ll let Mike give that.

Michael Olsen

Yes, I think what expectation should be is in that range, north of $500 million before capital expenditures. So the free cash flow after CapEx would be between $300 million and $400 million.

Ted Grace - Susquehanna Financial Group

Okay. Great. That’s helpful guys. Thanks very much. Best of luck.

Michael Sutherlin

And then Nancy, I think given the time here, (inaudible) maybe we’ll talk the last question.

Operator

Okay. And the last question will come from Seth Weber from RBC Capital.

Seth Weber - RBC Capital Markets

Hey, thanks. Good morning guys. Thanks for squeezing me in here. So surface margins were little bit in light of what we were looking for. Have you noticed any change in the competitive market there and how should we think about the pricing that you are seeing – I mean, you’re obviously booking a lot of shovels here but how should we think about pricing of these shovel orders that are going into backlog?

Michael Sutherlin

Yeah, the surface margins are impacted by the fact that we – on the surface equipment we have a fairly strong percentage of long term maintenance and repair contracts. In the underground, we run quite a few cost per ton programs. Those cost per ton programs generally have annual adjustments so that we are working with the customers. So those get tuned up on an annual basis.

On the surface equipment side, it’s been traditional to have long term contracts with escalator calls is built in. So because of that it takes a little bit longer to roll pricing through into the contract, it eventually gets through the contracts and those two things run in parallel. But in inflationary period, or the deflationary periods, there is a timing disconnect between the escalator calls that’s what’s happening in the marketplace. So we have a lag effect that, that has impacted the P&H business in 2011 in terms of being able to roll pricing into their up market. The transaction based up rolls pretty quickly. The program based, the maintenance repair contracts, it takes a few more quarters that to roll through. So we should see some benefit in 2012 that we didn’t get in 2011. But certainly 2011 was impacted by that.

On the equipment side, we only continue to release strong outlooks and we continue to drive price realization in the surface equipment business. And so we don’t see an issue with that. For original equipment, we do see the timing impact on the aftermarket.

Seth Weber - RBC Capital Markets

Okay. That’s helpful. And I guess just, Mike Olsen, on the cash flow, the advance payments line went kind of neutral this quarter. I mean, is that going to be a source of cash next year do you expect?

Michael Olsen

As we take a look at the projected cash flows for next year, we would anticipate that we would some opportunities on the inventory side to generate cash there as we better manage those inventories. And then we expect that the advance payments would be pretty much neutral as you go into the next year. We had very, very strong OE bookings activity in 2011, would not expect the same level of incremental year over year increases. And that incremental year over year increases is what drove the positive advance payments for 2011.

We are expecting very strong OE bookings in 2012 but really would not expect the same level of incremental increases. So make it a little benefit on the advance payment side is certainly not to the level that we saw in 2011.

Michael Sutherlin

Just to close out on the call, I just want to reiterate that we see ourselves as an operationally and financially efficient business. And we continue to be focused on growth and strategy and execution. And we think that these factors, both the efficiency factors and the strategic focus will continue to deliver value to our shareholders. So we look forward to, then again, talking to you at the end of our first quarter. Thank you very much.

Operator

That concludes today’s presentation. Thank you for your participation.

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