Joy Global, Inc. F2Q08 (Qtr. End 05/01/08) Earnings Call Transcript

Jul.17.08 | About: Joy Global (JOY)

Joy Global, Inc. (JOYG) Q2 FY08 Earnings Call May 29, 2008 11:00 AM ET

Executives

Sara Leuchter Wilkins - VP, IR and Corporate Communications

Michael S. Olsen - VP and Chief Accounting Officer

Michael W. Sutherlin - CEO and President

Analysts

Michael W. Gallo - C. L. King & Associates

Terry Darling - Goldman Sachs

Andrew Kaplowitz - Lehman Brothers

Charles Brady - BMO Capital Markets

Mark Koznarek - Cleveland Research Co.

Robert F. McCarthy - Robert W. Baird & Co.

Seth Weber - Bank of America Securities

Paul Bodnar - Longbow Research

Steve Barger - Keybanc Capital Markets

Alex Blanton - Ingalls & Snyder

Operator

Good morning. My name is Andrea. I will be your operator today. At this time, I would like to welcome everyone to the Joy Global, Inc., 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].

I will now turn the call over to Ms. Sara Wilkins, Vice President of Investor Relations and Corporate Communications. You may begin your conference.

Sara Leuchter Wilkins - Vice President, Investor Relations and Corporate Communications

Thank you, operator, and good morning everyone. My name is Sara Wilkins. I'm the Vice President of Investor Relations and Corporate Communications for Joy Global. Thank you for participating in today's conference call and for your continued interest in our company.

Joining me on today's call are Mike Sutherlin, President and Chief Executive Officer of Joy Global; Jim Tate, our Chief Financial Officer; Mike Olsen, our Chief Accounting Officer; Sean Major, our General Counsel and Secretary; and Gene Fuhrman [ph], our Corporate Controller.

This morning, Mike Olsen will begin with some brief comments which expand upon our press release and which provide the results of the second quarter of our 2008 fiscal year. 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, I would like to turn the call over to Mike Olsen. Please go ahead, Mike.

Michael S. Olsen - Vice President and Chief Accounting Officer

Thank you, Sara. Let's take a look at some of the more significant areas from our second quarter results. The second quarter saw a Joy Global top the $1 billion dollar level for the first time for the new orders. Bookings in the current quarter were $1.2 billion compared to $728 million in the second quarter of fiscal 2007. Included in the second quarter bookings number were new orders totaling $87 million from the Continental conveyor business which was acquired during February 2008.

Both the underground mining equipment and the surface mining equipment businesses had a record bookings quarter for new orders of $589 million and $557 million respectively. Excluding the benefit of the Continental booking, orders for new equipment increased 102% from the second quarter last year, while the after-market bookings grew at a 22% rate.

One of the favorable aspects of the current quarter's booking results is the broad geographic base for the strong performance. The recovery of the North American coal market that began a couple of quarters ago continued and strong levels of new orders outside of the U.S. were reported.

The company's backlog that has increased by over $200 million in each of the previous two quarters grew by over $500 million in the second quarter of 2008. This included a $133 million of backlog associated with the Continental acquisition. Both the underground and surface businesses backlog are now in excess of $1 billion.

Net sales for the second quarter were $843 million compared to $629 million a year ago. The current quarter net sales included $73 million of net sales from the Continental business. Excluding the Continental sales, net sales increased by 22% with a 40% increase in original equipment shipments and a 14% increase in after-market revenue.

During the second quarter, surface mining equipment sales increased by 37% while the underground mining machinery business reported a 12% increase in net sales. For the underground business, the softness in new orders in the North American coal market that we saw in the first three quarters of the 2007 fiscal year adversely affected net sales in the first two quarters of the 2008 fiscal year. However, this segment of the market is poised to benefit from the strong level of new orders received over the last three quarters.

Turning to earnings, the story is not nearly as straightforward as the discussions on new orders and net sales. Operating profit reported for the second quarter was $114.3 million and included three items which make a comparison to the prior year's results more complicated.

During the quarter, the surface mining equipment business recorded a pre-tax charge of $21 million associated with the early termination of a maintenance and repair contract associated with the first installation of a 19/20 [ph] dragline put in service in 1996. The company's view was that it could best continue to serve this global customer and remove significant uncertainty concerning its future financial results by terminating this contract.

In addition, the second quarter included two items associated with the Continental acquisition. The first is the operating profit before purchase accounting charges reported in the current quarter for Continental of $8.8 million, which was consistent with the company's expectations for the second quarter for Continental. The second item was the purchase accounting charges associated with this acquisition that was recorded in the current quarter totaling $11.1 million. These purchase accounting charges are normal after an acquisition and do not impact the company's cash flow.

Second quarter operating profit of $114.3 million included the net effect of these three items which reduced operating profit by $23.3 million and compares to operating profit of $121.6 million in the second quarter last year. Operating profit as a percentage of net sales was 13.6% in the current quarter and included a 4.2 reduction as a result of the three items discussed above, and compares to 19.3% for the second quarter last year.

The decrease in this percentage from a year ago was driven by the 22.5% return on sales realized by the underground mining machinery business in the second quarter last year, which compares to a lower, but still strong, 20.4% in the current quarter.

Working capital was $845 million at the end of the second quarter. This was $15 million and $61 million greater than at the end of January 2008 and October 2007 respectively. Working capital was increased by $48 million due to the Continental acquisition in the current quarter along with an increase in accounts receivable associated with an increase in a number of original equipment units were shipped late in the quarter, and the increase in the inventories to support the projected growth in sales volume in the second half of the 2008 fiscal year.

These increases were partially offset by a $45 million improvement in advance payment received in connection with new orders and the efficient management of trade accounts payable.

Now, let me turn the call over to Mike Sutherlin.

Michael W. Sutherlin - Chief Executive Officer and President

Thank you, Mike. I'd also like to add my welcome to those on the call. The value proposition for Joy Global is derived from two sources; first, the exceptionally strong market that we serve; and second, our ability to translate that market opportunity into revenue growth and earnings power. I'd like to take a few minutes to talk about each.

Despite the significant investments made by our customers over the last five years, their increase in mine production has not kept pace with the growth in commodity demand. As a result, all of the commodity markets we serve are currently extremely tight or in supply deficit. Commodity demand continues to grow as the emerging markets industrialize. That industrialization is led by but not limited to China and India.

We're also seeing significant infrastructure build in a wider range of countries including Russia, Indonesia, Turkey, Dubai, and Brazil to name a few. It will require a very significant step up in investment to enable mine capacity to catch demand, and thereafter, we'll require a higher sustainable level of investment to ensure mine capacity grows at pace with future demand.

The pressure on supply will be even greater in the near term as commodity buyers attempt to rebuild inventories. As a result, it could take three to five years or longer for commodity markets to regain the balance of supply with demand and this has caused commodity prices to skyrocket beyond historic highs.

The coal markets have gone through an unprecedented supply shock within the past year. Power plants in South Africa and China were taken offline because they ran out of coal, and it was not all weather related. India's average stockpile level was drawn down to seven days and China recently had 32 power plants offline again because of coal shortages.

Adding to this wide gap is the need to replenish stockpiles to more normal levels. Eskom, the state electric utility in South Africa has announced that it will buy an additional 45 million tons of coal over the next two years. India has stepped up its coal imports, and China has resumed restricted exports with an effective loss of 20 to 25 million tons a year form the seaborne market.

The rise in coal consumption is not limited to the emerging markets. Europe is currently building 10 gigawatts of new coal fueled power generating capacity and has an addition of 50 gigawatts in planning. The U.K. is on the verge of permitting its first new coal fueled power generating plant in 20 years.

And the U.S. is in the midst of the largest build out of coal-fired power generating capacity in 25 years. 20 gigawatts of new coal fueled power generating capacity is in construction or final stages of development and this capacity will come online by 2012, and will burn an additional 80 to a 100 million tons of coal a year.

In addition, the coal exporting countries, such as Russia, Indonesia and Thailand are increasing their domestic consumption of coal and this has limited their export capacity. And this is putting further pressure on coal supplies. As a result of these factors, coal markets are expected to be in deficit by 60 to 100 million tons this year. This supply shortage coupled with high prices is driving the acceleration of international expansion projects, primarily in Australia, South Africa and Russia, but also in the UK.

The only market worldwide with significant near-term upside capacity is the U.S. and it has taken advantage of the excessively tight conditions in the seaborne and coal markets. U.S. exports were up 10 million tons last year, are expected to be up another 20 million tons this year and should pass 100 million tons next year, up from 50 million tons just two years ago.

The international markets are setting coal prices in the U.S. and this is driving a new round of mine expansion projects. Indicative of the strength of this market, more than half of our original equipment orders in the second quarter came from North America.

Iron ore is the most undersupplied commodity, primarily because basic iron production has been growing at a compound rate of 7% per year for the last five years. This has driven up prices by almost four-fold in four years. Three customers supply 75% of the seaborne traded iron ore. And despite announced expansion projects that will increase their individual capacities by 30% to 70% by 2012, iron ore is expected to stay in deficit. In fact some analysts are projecting steel supply to be 20 to 30 million tons less than demand this year, due to shortages of raw materials.

The copper markets tell a similar story. Build-out of electricity grids in emerging markets should keep demand high. Demand in China alone is running 10% ahead of last year which was up 16%. China could push worldwide copper demand up 6% this year.

Exchange inventories have come down almost 30% so far this year and could continue to decline. The major announced expansion projects will add just over 4 million tons of copper supply by 2011, if they are completed on schedule, and if they reach their full production targets. However, demand should grow by a similar amount keeping inventories tight.

Keep in mind that this has occurred while the U.S. demand has been declining by 6% a year for the last three years. If the U.S. demand returns and it is expected to do so in 2009, the copper markets could be pushed into significant supply deficit.

And finally, oil sands production is also growing rapidly due to manageable regulations and very strong oil prices. Producer profits were up 18% last year and another $20 billion is expected to be invested in oil sands projects this year. More importantly, the oil sands are attracting the major oil companies. We now see this as one of the few sources of significant new reserves. The overall forecast for shovels going into this region has increased to 8 to 10 shovels for each of the next several years, up from 5 to 6 shovels per year in recent years.

How sustainable is commodity's demand in pricing? One view can be inferred from the ArcelorMittal's first stage investment to acquire Macarthur Coal, an Australian met coal producer. One assessment is that purchase price equates to met coal prices into perpetuity at over 75% of current contract prices. This is an extremely strong statement on the sustainability of prices and is made not by a speculator but by an industry leader.

So to recap, this market outlook says two things that are important; first that the industry fundamentals are much better today than they've ever been in this growth cycle, and if these fundamentals support my belief that we are entering a second lay of a long growth cycle in this industry.

Our conviction on the market is further supported by the detailed knowledge of projects in our customers' pipeline and where those customers are spending money. We have and will continue to build capacity to keep pace with demand from our customers.

P&H's first China factory on our Tianjin campus will come online this summer and should reach full production during the first half of our fiscal 2009. The next factory on the Tianjin campus is scheduled to be completed in mid-2010.

Our aftermarket is critical to our business model and we have also invested heavily in its expansion. We have recently completed a new facility in Poland and investment is in process on a new facility dedicated to smart service programs in South Africa, and new facility to serve the Hunter Valley in Australia and the major expansion of facilities supporting the oil sands. And we continue to plan and approve projects to sustain this expansion program.

Continental is and will continue to be a great acquisition for us. We based the acquisition on integrated solutions, leverage of our existing Joy and P&H mine site service organizations, and revenue pull-through from markets that have been under served by Continental.

We've seen very strong support for this value proposition from Continental, from Joy and P&H people and from our customers. As a validation of this strategy, we booked Continental's first conveyor order from Russia this quarter. And finally, P&H has been working under a five-year union contract that has a mid term re-opener for pension issues only. Both P&H and the union have been going through predefined process that includes fact finding, mediation and non-binding arbitration.

P&H and the union received the arbitrator's recommendation earlier this week and are scheduled to meet further for discussions. The company's objective continues to be focused on pension benefits that are competitive of local market benchmarks. We believe that is in the best interest of both sides to reach a reasonable settlement and are confident that we will do so.

I'm very pleased with the current position and the future of this business. We serve strong markets. We are driven by strategies that deliver customer and shareholder value, and we have a team and organization that have proven their ability to perform. We have and will continue to work against constraints and bottlenecks in our own facilities and in our supply chain.

We have demonstrated persistent and relentless pursuit of improvement that yield realizable capacity and will continue to do so. Although the constraints of capacity will limit our response in the short time remaining in this year, we still see upside in our second half results and are raising our guidance for the year.

We now expect revenues for fiscal 2008 to be up from our previous guidance of $3.1 billion to $3.3 billion and earning per share to be up from the $2.96 to $3.22 previously guided. We now expect revenues for fiscal 2008 full year to be between $3.3 billion and $3.4 billion, and earnings to be between $3.15 and $3.30 for fully diluted share.

So with that, I'll like to turn the call over to questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from the line of Michael Gallo with CL King.

Michael W. Gallo - C. L. King & Associates

Hi. Good morning. Question I have is on steel cost and steel availability, obviously as you've gone through the cycle, you've got very robust order book that you're going to have to fill here. I was wondering whether you expect to see any potential issues with steel availability. If so, what are you doing to alleviate those issues, and then given the expectation that steel prices will be up significantly, what are you doing to mitigate that? Thank you.

Michael W. Sutherlin - Chief Executive Officer and President

Yes, thanks Mike. I'll deal with this steel availability first and so far we have continued to have good availability of steel. That has not been an issue for us. If you go back to the late 2004 and into 2005 period where we... at that time we had shortages of steel and significant escalation of prices. Today we are seeing price movement in steel but availability continues to be good. So, we feel pretty good about that, and our discussions with the steel producers continue to support availability going forward.

Go back to the 2004-2005 period, we saw at that point significant increases in iron ore prices and met coal prices, and that translated into significant increases in steel costs for us. In some cases on specialty high alloy steals, those increases went above the 100%. Today, we're seeing extremely high prices for met coal and we are seeing another round of high prices for iron ore. So, with those raw material inputs, we know when we have been anticipating steel costs to go up by a significant amount.

We have modeled that into our business. We've modeled that into our quotations. We are aggressively pushing prices to stay ahead of what we expect those steel costs to be. We're not looking at this point at cost increases in our model of 10% or 15%, but significantly higher than that. We would rather err [ph] on the high side and the low side. We do in our surface business buy steel ahead. So, we will at any point in time have steel on the shop floor that covers the next nine to 12 months of production, and we buy steel particularly on our roof support and our underground segment.

We buy that as those orders are booked and we get advanced payments for customers. We will then order the steel and get a commitment from the steel company on price and delivery. There is risk associated with steel costs going forward and we are managing that through our backlog at this point and through our pricing formulas going forward. Go back to the last time we did this. We did a very good job of staying ahead of the steel costs. We were aggressive on prices. We are at the same position today. We are determined to get positive price realization.

So, as we see steel costs come through and as we update our forecasts on steel costs, we update our pricing formula. So, no, it's not risk free, but I think that we are in good position. We certainly have the procedures and practices we followed last time as a guide for us. So, overall, I think that we're going to stay ahead of this. We probably have an order or two occasionally we'll have to work some issues. But I think, on balance, we'll be ahead of the curve on this.

Michael W. Gallo - C. L. King & Associates

Okay, great. Thanks a lot and congratulations on a very good quarter.

Michael W. Sutherlin - Chief Executive Officer and President

Yes. Thanks Mike.

Operator

Your next question comes from the line of Terry Darling with Goldman Sachs.

Terry Darling - Goldman Sachs

Thanks. Mike, you may have partially answered this. But I just wonder if you could talk about incremental margins, if we look in this quarter and then maybe you can talk about the underground business in particular. And as you look forward, your guidance implication is the incremental growth in revenue sort of similar to incremental growth in EPS. And I think interest expense probably a little lower than we've thought, implying that you've taken some margin expectations down, maybe that's partly steel. But maybe you could talk about what's going on there and how you're feeling about shop floor productivity these days as well?

Michael W. Sutherlin - Chief Executive Officer and President

Yes, let me talk about the whole issue of production productivity margins and how that all interrelates. And start up by... first in our underground business, we got a discount to comparable there for our second quarter a little bit because in last year's second quarter we closed out a major longwall contract at a favorable adjustment at the end. We had some other mix issues in there that were more than favorable for us. And so, if you go look at that 22.2% margin that the underground business delivered last year operating margin, you'll see that it really is an exception to... although, their margins are generally very good and have stayed above 20%, that 22.2% was an exceptional quarter.

On general, we are looking at margin improvements on a machine-by-machine basis. So, we look at margin growth on same models. We look at the margin in backlog versus the margin in shipments and we see positive implications there. We do run into mix issues on occasions. So, on the near term of an individual, we'll get mix issues that are related. We are on our P&H business this year, we charged off the contract termination against their gross margin. So, they'll have an adverse effect on their gross margins due to that contract termination and that will carry through our year-end projections as well.

So, there is a number of things going on, but generally speaking, we continue to build margins. We're not building margins at the rates that we did earlier in the cycle where we saw fairly rapid improvement from mid-single digits up to high teens in operating profit margin. But we still are pushing those incrementals in the mid 20% range. This year, we said, we would be down lower in the range because of the investment in that China startup. But as that China production comes online, we've experienced and we expect that production to come online with a significant cost improvement over comparable incremental production capacity in the U.S. or in Europe. So, we feel pretty good that that's going to continue to allow us to build incremental margins.

Terry Darling - Goldman Sachs

So, beyond all those items, just the core shop floor productivity and supplier challenges you're feeling... you haven't gotten incrementally cautious on those items in the guidance here?

Michael W. Sutherlin - Chief Executive Officer and President

Well, our shop floor productivity, we've been putting a huge investment in programs we call operations excellence and we've really seen some really dramatic results on individual facilities. As we've rolled that out to more facilities, we go through the investment stage before we get the return stage. So, we feel really good that this is going to have a positive impact on our business. But as we model this out and as we cascade this out to other facilities, we're not going to... we're going to see the startup of the next facility offset the benefit from the last facility.

So, we're not really looking for a significant impact on this year, but we will see the impact in future years. And that's... if you walk through a facility before and after, it's just been a phenomenal improvement in efficiency, work flow and realizable capacity as well.

Terry Darling - Goldman Sachs

Okay. Thanks very much.

Michael W. Sutherlin - Chief Executive Officer and President

The bottom line is that not much margin... margins will improve this year, but we'll see more significant margin improvement start in 2009.

Operator

Your next question comes from the line of Andy Kaplowitz with Lehman Brothers.

Andrew Kaplowitz - Lehman Brothers

Good morning guys. Nice quarter.

Michael W. Sutherlin - Chief Executive Officer and President

Thanks Andy.

Andrew Kaplowitz - Lehman Brothers

I am just wondering about, I mean obviously you had very strong new awards in the quarter. I am wondering about the sustainability of those new awards going forward and maybe the upside potential there. I know it's lumpy. So, I guess maybe a two-fold question. Are there any big awards that were in the quarter and then the other part of that question is, when I look at the major mining companies, especially North America, nobody has really announced huge increases in CapEx spending plans to-date, but it seems like it's happening. So, maybe if you could just address that going forward.

Michael W. Sutherlin - Chief Executive Officer and President

Yes. The order rates this quarter were surprisingly diverse. We have... in the past quarters, we've had, for example, shovel bookings where we would get three, or four, or five shovels booked in one order. This quarter we had some multiple shovel orders, but the orders were much more widely spread among customers. So, we are seeing a little bit of a different characteristic. I think it's driven by the realization across our customer base that they are in a position where they have to significantly step up their capacity.

In the process of doing that you'll naturally look for brown field fuel expansion because of the near term return to production. Investment to production cycle is a lot shorter. If I can give you an example, I think CONSOL has announced that they have four to five mines where they can add another longwall to the existing longwall mine, go from one to two longwall systems or two to three and they can get that into production by the end of 2009, early 2010, where our new mine startup would be a three to five year horizon for them.

So, I think you're seeing that on both surface and underground. We're seeing that in all of our regions where the customers are now pushing primarily the focus on brown field in-pit expansions or near-pit expansions. So, I think that's why you're seeing a significant ramp-up in orders across the industry. But orders that are more diverse and not the large project orders we've seen in past quarters. We will go back to the greenfield projects, but I think we'll go through this acceleration phase and then we'll get back to the longer term greenfield project.

Andrew Kaplowitz - Lehman Brothers

And then Mike, how much are supplier constraints still affecting your business? And in 2009, could we do a lot better when it comes to the supplier constraints? Things like bearings, how much are they holding you back in 2008?

Michael W. Sutherlin - Chief Executive Officer and President

Well, we've... I guess it's interesting how critical the supply chain is for us and the industry. We have bearings. Our customers have problems getting tire availability. But we've all been able to somehow keep production growing despite that. So, we struggle with bearings, but we seem to get enough to get by. We'd like to have a little bit more breathing room. We'd like to get ahead of the curve more than we are. There are some other areas in terms of gear blanks and some other things that are critical and in short supply as well.

We continue to work with our suppliers. We continue to look at the long-term forecasting models with them. And we've done a good job of keeping them up to at least the minimum of our needs. We believe we can continue to do that. We'll continue in this business as we push to run it at capacity. We'll be de-bottlenecking from one bottleneck to another in our factories. We'll be doing the same with our suppliers. So, we'll always be up against supply issues and there are some like gear blanks and bearings and few other specialty items where we don't have a large number of alternative suppliers.

But even in other areas like castings and forges where there are alternative suppliers, those guys are feeling the benefit of a strong mining industry. So other mining equipment companies and other industrial companies are also increasing their demand in those suppliers as well. So, it is a challenge, but so far it's been manageable. Our conversations with our customers have been good and it looks like we'll be able to keep them running at least at a level with us. I don't know if we can get them ahead, but at least we can keep them up to pace with us.

Andrew Kaplowitz - Lehman Brothers

Okay, great. Thanks Michael. I'll get back in queue.

Michael W. Sutherlin - Chief Executive Officer and President

Thanks Andy.

Operator

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

Charles Brady - BMO Capital Markets

Thanks. Good morning. With respect to the exiting of the contract with P&H and more so in '09, now you're going to have absence of the margin drag from that contract, is there a meaningful step up in the margin at P&H with the absence of that contract?

Michael W. Sutherlin - Chief Executive Officer and President

Well, certainly we... part of our logic in working with the customer to terminate this contract was to take the projection of future losses and the risk associated with that, and translate that back into the termination. So, we've got that behind us, and that part of it will translate into future benefit. I wouldn't say that the number is significant, but it will translate into future benefit. Part of that termination is the... we're working with the customer on an agreement for parts supply and maintaining a discount that's comparable to the benefit they saw in the parts side.

So, we will have some additional discounts associated with their contract that will mitigate the upside. But even if that wasn't in there, the upside is not... I don't think it's large enough that you would see it in the P&H. So, it's not a big step up. It would be relatively modest and spread over the year. So, I think virtually unnoticeable.

Charles Brady - BMO Capital Markets

And with the purchase accounting charge of the $11 million from Continental in the quarter, should we assume that that's a run rate going forward or is there a step down in that that's going to be happening?

Michael W. Sutherlin - Chief Executive Officer and President

No, that begins to step down pretty significantly. We expect that Continental on an after purchase accounting basis to be pretty close to breakeven in the third quarter. We expect it to be accretive in the fourth quarter. And those purchase accounting charges will be in the $4 million to $7 million a year range next year. So it will get down to where it really is pretty insignificant way as we get into next year.

Charles Brady - BMO Capital Markets

Great. Thanks very much.

Michael W. Sutherlin - Chief Executive Officer and President

Okay. Thank you, Charlie.

Operator

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

Mark Koznarek - Cleveland Research Co.

Hi, good morning.

Michael W. Sutherlin - Chief Executive Officer and President

Hi Mark. How are you?

Mark Koznarek - Cleveland Research Co.

Good. Mike I would like to ask a question that's already been asked. but maybe a different way having to do with the second half margins because it looks like if you just work with your guidance range it suggests that the overall reported operating margin in the second half is going to be a little bit less than 18%. And in the current quarter, after you make these adjustments that we just talked about, the adjusted margin is over 19%. So, what I am wondering is it's pretty clear that your OE bookings have really picked up dramatically. And so is the margin swing simply an issue of product mix that you expect to ship, or is it raw material pressure, or is it some other factor?

Michael W. Sutherlin - Chief Executive Officer and President

Mark, I think it really is going to get down to two things. One is that... well, three things. One is that that on the, if you look at the Joy underground business we've seen a really strong up-tick in their original equipment orders. We have seen the start of strong order improvements for rebuilds. The parts orders are up, but they are not up as much, and that's pretty characteristic of the industry where the customers, as they expect capacity increases, they all get long lead time items locked in first. So, they'll go to the original equipment to get that order. They will get that rebuild slotted. And then they will begin to look at replenishing parts and updating their maintenance on their machines.

And so we haven't seen that after... that parts response on the Joy side. So we are... we see on Joy in the second half of the year that it will continue to be heavy on the original equipment and light on parts part of the business. We have Continental that we're blending in at margins that will be in the low teens. I think we have reported pre-purchase accounting margins for Continental in the second quarter were in the 12% to 13% range, and we sort of expect that. So that will that will weight us down a bit. And then there is simply some rounding. As we do guidance, we try to keep the round numbers and you sort of sometimes get caught up or whether you round up or round down.

So it really gets down to those three factors that have an impact. We're certainly not expecting margins, same machine margins to decline. We are not expecting adverse pressure on... from our supply chain or supplier cost to drag down margins in second half.

Mark Koznarek - Cleveland Research Co.

Okay. Related follow-up here Mike would be the nature of the revenue increase to the guidance, is it simply the reflection of higher expected raw material costs, or have you actually been able to de-bottleneck some facilities beyond prior expectations, because I was under the impression that you guys were basically sold out for the year and really just physically couldn't push out much more revenue than your previous guidance. So what actually led to the increase?

Michael W. Sutherlin - Chief Executive Officer and President

We're getting the increase from three areas that will play into this. One is that the capacity expansion that we put in at the Milwaukee facility for P&H that we finished at the end of 2006. We went through a longer period of de-bottlenecking that we found that some of the... there are some issues associated with some of the new machines we ordered and getting those up and running reliably. We also found that we had some existing machines that became overloaded as we increased flow through that area, and we had to go in and either rebuild or replace those machines to get the reliability up.

And now that capacity is really running quite a bit ahead of the initial expectations. So we started slow and we had to work through a longer process, but it really is being the pay off now. And then we're seeing a lot of that revenue growth coming from Joy as I do begin to get some of the benefits from their operations excellence program. And there is also the ramp up the time lag between getting orders in the second half of last year and getting those through production into delivery.

So we've always felt that Joy was going to be light in the first half and stronger in the second half as it went through the order to delivery cycle. Any the Joy business is a little bit higher margin business that helps us from that standpoint in the overall mix of earnings. But certainly, majority of that is coming from the Joy side. We're getting quite a bit of good benefit with P&H side. We started to see that already in the second quarter and we'll see that in the second half.

And then, Continental's forecast is a stronger second half. It turns out to have products that are just a little bit later in the up-cycle than Joy or P&H. So they have been a quarter or two behind in seeing the strength in the order rates. And we will translate that into some improved revenues in the second half as well.

Mark Koznarek - Cleveland Research Co.

You actually expect to ship more tons; it's not just a raw material inflation?

Michael W. Sutherlin - Chief Executive Officer and President

No, no. Yes, more tons of equipment. Yes.

Mark Koznarek - Cleveland Research Co.

Okay. Thanks very much.

Michael W. Sutherlin - Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Joel Tiss [ph] with Buckingham Research.

Unidentified Analyst

Hi guys. How is it going [ph]?

Michael W. Sutherlin - Chief Executive Officer and President

Hi, Joel. How are you?

Unidentified Analyst

Alright. First, can you talk a little bit about free cash flow numbers, if they have changed at all? I think I have sort of $300 million for 2008. And if you... once you get this Continental sounds like you are under pretty good control, what's the next focus? Are there are more acquisitions to do or you are going to look at more share buyback, or just a sense of what the priorities are?

Michael W. Sutherlin - Chief Executive Officer and President

Take the first half.

Michael S. Olsen - Vice President and Chief Accounting Officer

Yes, I think we are anticipating that the cash flow will be consistent with what our initial budget called for the 2008 fiscal year. What we would anticipate in the second half of the year is that there would be an increase in capital expenditures that when we put in place supporting the capacity expansion that you had referred to.

Michael W. Sutherlin - Chief Executive Officer and President

We had... Joel we had some just really good cash flow here the third quarter. And so far this year, we're going to give you [ph] some real benefits from advanced payments. But you can see... if you look down in below advanced payments you can see that we have seen like the growth in inventories begin to decline as we get more efficient with our processes, and we're starting to see some benefits from that as well. So, we expect the cash flow to sort of be in that $300 million to $400 million a year range, probably $400 million to $500 million, but $300 to $350 million a year of free cash flow for the year.

We are currently evaluating a new pension regulation and funding requirements. So, there is some things there that are on the horizon that we don't fully understand the impact, but it could potentially have some near-term impact on cash flow as well. But bottom line is we'll be generating significant cash flow going forward. We have a business development team in place and working on acquisition prospects and we are working on wide range of those. We would like to continue to do bolt-on acquisitions like Stamler or like Continental.

We would like do some field service expansions in some key markets to give ourselves a stronger presence in those markets. And we continue to work things in the pipeline in and around that. We have always said that China is on our list as well trying to get a base built in, in China in the next year for our customer there. All those are on the list. We are working on those. I don't think you're going to see us as a company that's going to announce an acquisition every three or four years. But we are not going to be announcing something every quarter either. But I think you will see that as we go forward we will have hopefully other things to bring to the investors and talk about how they are going to add value to our business.

Unidentified Analyst

Okay. That's great. And can you just talk a little bit about Russia and India. Those have been sort of great hopes for a long time and now it does seems like things are really happening there. Can you just give us a little more detail on what's unfolding or what you see maybe over the medium term? Thank you.

Michael W. Sutherlin - Chief Executive Officer and President

Russia has been... it's really been a real strong market for us here in the last 12 months or so. Russia has privatized the industry with the primarily vertical integration. So, most of the coal mining is done by either a power generators or steel companies. They are aggressive in expansion. They are looking at the export market as a strong source of cash flow. So we're seeing those mining expansion programs build up, quick response, decisions are made quickly capacity is deployed and new production quickly in Russia.

So, we are looking at extending our presence in Russia to in anticipation of what we see in the forecast to be. In Russia, market begin to look to life cycle management programs from us rather than this transaction based service and so we see that, that market moving in the direction that we believe it will is only good for us.

India is a market that's got significant upside but it is a market that is controlled by the government a very bureaucratic government. We are always hopeful but we are always cynical about the timeline on India. One of the differences that we are seeing now though is a number of mining blocks that have been leased to independent private companies these are ESSAR [ph], Tata and so I think we'll see the emergence of a private mining industry in India.

We saw that in the oil and gas business where they brought in Shells and BPs and the efficiency was so much greater than oil and natural gas commission that they've gravitate pretty quickly to using outside drilling contractors and oil companies really began to set the standard in India and that forced ONGC to be more efficient and to downsize because they just couldn't handle the projects all of themselves.

And I just see the same thing in the coal industry but I think it will translate over five years or longer, that could be something that we're going to see an instantaneous conversion. But, we are seeing the private companies get their contract signed and they're beginning to talk about equipment needs so, we're pretty hopeful that we'll see some improvement here probably in 2009 on the order rate side probably on the revenue side in 2010 and we are hoping that will translate into a longer term, more sustainable rate of improvement. But still skeptical in India.

Operator

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

Michael W. Sutherlin - Chief Executive Officer and President

Hi, Robert.

Robert F. McCarthy - Robert W. Baird & Co.

Yes, can you hear me?

Michael W. Sutherlin - Chief Executive Officer and President

Yes, I can hear fine.

Robert F. McCarthy - Robert W. Baird & Co.

Good morning.

Michael W. Sutherlin - Chief Executive Officer and President

Good morning.

Robert F. McCarthy - Robert W. Baird & Co.

I just thought it might be useful for everybody given the little bit of change in your segmentation, if we review quickly how the numbers work, it looks to me as if perhaps Stamler has been moved from Joy to crushing and conveying, but Joy is still recording the revenue because they are selling the product and that's what creates the inter-company elimination or is it more complicated than that?

Michael W. Sutherlin - Chief Executive Officer and President

Well, it's complicated enough then I am going to let Michael to answer this one for you.

Robert F. McCarthy - Robert W. Baird & Co.

Okay.

Michael S. Olsen - Vice President and Chief Accounting Officer

Yes, it actually is until we get a couple of quarters behind us and get everyone comfortable with how this is going to work. We are going to end up with the Joy underground and the P&H underground reflecting the sales to their customers, whether they although the crushing and conveyer products or whether there is a traditional products that they have in fact historically been selling.

Then the next [indiscernible] shipment of all crushing and conveyer products which as you correctly identified will then result in the elimination of the duplication of some of those sales. Now what will happen as we go forward is as more of the crushing and conveyor sales are going through the sales organization for Joy and for the sales organization of P&H the amount of sales that will have to be eliminated will in fact increase.

So again there's a day, what's going to happen is the underground mining segment and the surface mining segment will in fact reflect all products that in fact are going to their customers, the crushing and conveying segment is intended to identify the sale of all those products irrespective of which customers they go to.

Robert F. McCarthy - Robert W. Baird & Co.

But they are likely, crushing and conveying is likely to continue to have some sales to its traditional customers suffered from the other two segments.

Michael S. Olsen - Vice President and Chief Accounting Officer

That's correct and what will happen is those sales will be listed as customer sales if you will and their sales that are going to the Joy Mining Machinery Organization and the P&H Mining Equipment Organization will be listed as intra-company sales.

Robert F. McCarthy - Robert W. Baird & Co.

Right.

Michael S. Olsen - Vice President and Chief Accounting Officer

And then, there will in fact be the elimination to come up with the consolidated results.

Robert F. McCarthy - Robert W. Baird & Co.

Yes, okay. Thanks. I think that's just useful to make sure everybody is on the same page there. And then my second question had to do with operating margins in the surface business, the P&H and the release you of course identify start-up cost in China, development cost on a couple of major product initiatives as creating a drag on operating income there. So, can you help us with context were these a greater issue in the current quarter than they were in the first quarter? And are they at run rates that are representative of what we should expect over the next several quarters or are we ramping up if you will those sources of expense and will they need to go higher?

Michael W. Sutherlin - Chief Executive Officer and President

Well let's break that down a little bit. We have on the ramp up of our China manufacturing where we are building up that work force in anticipation of that facility coming online here this summer. So, the first quarter... the second quarter will be heavier expensed. The first quarter, that we are building the work force going through the training programs. We will begin to get that facility online in the second half then we should begin to see those expenses translate from overhead to direct labor. So that will reach a natural peak and then we'll go through another way but that is we'll bring on the next factory online.

And we have been ramping up our engineering investment associated with the Ultra Class Dragline in the in-pit crusher and we have been expanding the amount of people working on those projects so those costs will be up in the second quarter form the first quarter so we have, there is a little bit of different dynamics going on there based upon the resource of that.

Robert F. McCarthy - Robert W. Baird & Co.

And I am inferring from that Mike that you think the development cost will ramp up a bit higher yet in terms of the quarterly run-rate?

Michael W. Sutherlin - Chief Executive Officer and President

Probably not significantly higher than we have seen in the second quarter, I wouldn't say that second quarter is going to be absolutely a peak but I think its pretty close to the level that we would expect our things to pop out at [ph].

Robert F. McCarthy - Robert W. Baird & Co.

Okay, great thank you.

Operator

Your next question comes from the line of Seth Weber with Bank of America Securities.

Michael W. Sutherlin - Chief Executive Officer and President

Hi, Seth.

Seth Weber - Bank of America Securities

Hi, okay, it sounds like Mike that the surface orders did not include anything for any drag on product or any kind of drag on associated OE orders there, can you give your view on may be you what your customer indications are booking like on the dragline market? If there is a way to handicap when you think that might actually start to come back?

Michael W. Sutherlin - Chief Executive Officer and President

Well, we don't have any dragline orders in right now, if we see the industry transitioning from primarily relocating draglines to building new draglines and we're going through a period where there will be a little bit of bumps here as the customers transition into a longer horizon a decision with the new dragline. We see the new dragline market is being as a primary dragline business going forward seems very few relocations going forward. We've got that dragline market is reasonably segmented, we see the people that are going to be doing greenfield expansion projects as the primary buyers of new draglines, we see the dragline potential heavily skewed to four or five customers, we don't see that is broadly based where we might have dozen or more customers. So, it is a few customers that will be using, projects multiple draglines going forward.

We have had those customers in our facilities talking to our engineering people vice versa so we are not doing necessarily a co-development but we are doing a collaborative development of the dragline with the key customers in mind taking into consideration their expectations and needs in how they want to see this project go forward to give us back the best possible position on their program going forward.

So, I think you will begin to see some order activity of course it will be quotation activity, serious quotation activity later in the year but I wouldn't expect the dragline order until first half of fiscal 2009. In most cases, we're talking with customers about deliveries that are 2011 deliveries. We don't have a lot of these multiple dragline customers that are looking for something as quickly as I can get it. It's a greenfield project. The time to develop, 2011 is when they want the dragline and not sooner. So, we're working within their horizon as much as anything at this point.

Seth Weber - Bank of America Securities

Okay, thanks. And then just shifting gears back to the capacity expansion, is it possible to frame for us, what your new capacity ads will represent as incremental equipment or incremental aftermarket ability to supply on a percentage basis versus what you're doing today, whether it's an additional six or eight or ten shovels or an additional X% on the aftermarket?

Michael W. Sutherlin - Chief Executive Officer and President

Yes, we have... the order rates this quarter have been phenomenally good. We expect the order rates to continue to be strong. But we have a lumpiness factor and we're not going to expect to annualize the current order rate nor do we see the industry growing from the current order rate at high rates of growth. So, we are looking at an industry growth, sustainable growth rate of approaching 20% in the high teens, up to 20% of real growth in the industry.

We are driving our capacity plans to deliver that kind of real growth both for original equipment and aftermarket. We think the aftermarket growth is going to be slightly below the original equipment growth but more sustainable over the long run. So, those capacity plans are running out and reasonably good parallels between the two. We do expect quarters like this quarter where we have an exceptionally strong order stake and that will push the lead-times out. But we would like to get the lead-times worked down. We'd like to get capacity growing at a rate that's consistent, if not slightly better than the long-term industry growth rate. And we have said I think on the Analyst Call that we did last year that we are looking to get a 36 shovel capacity by 2012. We currently in this year, we're expecting to deliver 26 shovels. And so, it gives you a sort a marker in terms of real terms what that capacity build out would look like. But as we look today, we also believe that if we could get to those 36 shovels a year earlier that will probably be good for our business. So, we're not necessarily... we see the strength there. We see the strength in long term. So we are somewhere around in 2011-2012 we should be at that 36 shovel rate. And then everything else around that will grow at about the same rate of growth.

Seth Weber - Bank of America Securities

Okay, great. Just one last follow-up. Anything on the competitive pricing environment, are your competitors also matching prices and raising prices consistently as what you're doing?

Michael W. Sutherlin - Chief Executive Officer and President

To our knowledge where price is and the fact we've been aggressive in our pricing, we always get some pushback from customers but at the end the pricing has not been a problem for us. And so, we assume that the customers are pushing their prices as aggressively as we are but that's only an assumption. It is interesting; every one of our customers acknowledges that we're going to have to raise prices. I mean, these guys are primarily producing iron ore and metallurgical coal and thermal coal. They know what the price increases have been. They know how translations accounts for us. So, there is a not a fight about why your costs are going so much.

They know they're going to go up and they know that increases from...the price increases mostly are going to be significant. We get much more talk today about surety of supply than anything else and these guys are just really concerned that they can have a source of supply that they can rely on. So, that gives us a little bit of breathing room on price, but so far we remain determined to get positive price realization. We expect the steel cost to continue to build up this year. We've seen some pretty significant increases so far this year and we expect those to continue to rollout and by the end of the year we expect steel cost... we wouldn't be surprised if steel cost were up quite significantly from last year, and we are certainly modeling that out in our pricing formula.

Seth Weber - Bank of America Securities

Okay, thanks very much.

Michael W. Sutherlin - Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Paul Bodnar with Longbow Research.

Paul Bodnar - Longbow Research

Hi guys. Just a quick question, if you had any update on the equipment market, both in the underground and the surface side in the China, I know you talked about India and Russia already?

Michael W. Sutherlin - Chief Executive Officer and President

Yes, the China market continues to be a really good market for us. There is also a market that... it's got its challenge. I look at China like a war with lot of battles along the way. We certainly continue to see strength in our machinery business division when I say machinery I mean we were never a major supplier of things like roofs support into China, we focused more on things like, continues miners, shearing machines, armored face conveyors which have mechanical components high aftermarket components and the demand for our equipments continues to build. We saw the major customers transition last year from buying two or three shearing machines at a time to buying five or six so they stepped up their consumption rates and that there will be a provider a good news for us. We also see that top tier company's is only 20 companies or so in China that produces about 25% of the country's coal production. Ultimately we need to get down to that next year we are working on, plans and strategies to be there during life products and we are trying to get submitted now to use underground, looking at some acquisition possibilities and China.... that to give us acquisition relative to that next year customer.

So, we see the market in China to be a long-term growth market. We've... one of the customers who are in discussions with has started to talk about replacing Chinese shearing machines and importing shearing machines to replace those realizing... that in their market productivity is really important, reliability is critically and can't afford a lot of down time. You get to production rates up that market, so that market could at least be good for us but it's not just a simple easy market. You got to fight all the way through and it's tough and lot of Chinese manufacturing companies would like to sell for their bigger customers.

We would like to keep our position with the bigger customers and sell down to the next year. So it is a market with a lot of players lot of people trying to establish position and I think in the long-term you will see like it every other market.... rather say two or three major suppliers that will have to hindrance of the positions with key customers there, but making progress... but certainly long time from saying that we considered to be a market for us that we have our position, as well we are in other markets concerning to be a lot more up side in China.

Paul Bodnar - Longbow Research

Did you see shovel orders to China in the quarter as well and I know you said they are pretty?

Michael W. Sutherlin - Chief Executive Officer and President

No we did not. We had some really nice shovel orders into China last year and year before going in the both coal and copper production. But those... the size of the markets where the surface mining is little bit smaller 90% of coal is underground, copper is a small industry there. So, when we get an order for three or four machines we don't get that multiple times a year. We don't even get those kind of orders once a year also. We have got some pretty strong orders from China last year and late the year before and we probably will see the order rates. We have got things in the pipeline that we are not going see big order raised out of China this year. I hope... I think probably next year if we see a significant large orders coming up.

Paul Bodnar - Longbow Research

Okay and just quick question. Just on the same guidance, that tax rate was coming around 34% for the full year or any adjustment to that?

Michael W. Sutherlin - Chief Executive Officer and President

Mike?

Michael S. Olsen - Vice President and Chief Accounting Officer

Yes, I think as we review the tax rate over the second half of the year, we would anticipate that the rate certainly will not be above that 34% where we currently have a tax rate but its running at 33.5% and we believe that there is a better likely hood that rate may tick down a bit as opposed to a chance that rate would go, would go up. So we would anticipate a slight decrease in our effective tax rate of 33.5% for the first half of the year.

Paul Bodnar - Longbow Research

Okay and then do you have any guidance for the full year on the interest expense as well?

Michael S. Olsen - Vice President and Chief Accounting Officer

I really... I actually don't have that interest rate guidance at this point.

Paul Bodnar - Longbow Research

Okay thanks.

Operator

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

Steve Barger - Keybanc Capital Markets

Good morning. Two quick ones; one just wanted to clarify on the earlier capacity question. Thinking about your capacity going forward and understanding that you are going to get pricing material passthrough given the investments in the new found capacity from the shop floor, what kind of growth can you see in 2009 from a pure volume standpoint, is that the 20% that you are talking about or can you do better than that?

Michael W. Sutherlin - Chief Executive Officer and President

Yes, as we bring the... some of the internal process improvements online and we bring the P&H factory online, we should see real strong benefits in 2009. So, we should be at that 20% kind of range. And realizing that the P&H capacity is going to be ramping-up during the course of the year, so it will... by the end of year it will finish at full production. There will some ramp-up in first half. So by time we get to the second half of 2009, you should see that 20% year-over-year kind of real capacity increase, maybe a little bit less in the front half of the year as we ramp-up that new facility of P&H. But certainly our target is high teens in the longer term and we the internal market conditions we like to above that here in the near term in the next couple of years.

Steve Barger - Keybanc Capital Markets

Right. Okay. Perfect. And finally, can you talk about what your domestic customers are saying about the potential for cap and trade legislation kind of carbon tax and how that may affect their CapEx plans in the near or long-term or do you have any discussions like that?

Michael S. Olsen - Vice President and Chief Accounting Officer

Yes, hardly discussed the topic. Our U.S. customers are generally of the opinion that cap and trade can work if it has two things associated with, one is that; if the timing to implement in those caps is reasonable so that... reasonable to being determined by the time its going to take develop technology of our carbon capture and storage and coal conversion technologies in... and then sort of Caps have to be reasonable associated with the time it takes to bring those new technologies online.

And secondly; that the money that is derived from that gets re-funneled into the development of clean coal technologies so that in the long-term there is a benefit from the process. So it started a version to the cap and trade for say but its doing it in ways that are reasonable so that the industry doesn't get penalized in near term with unreasonable limits and secondly that the funds get channeled back into technology development that's good not only for the industry but basically good for the entire country because we are at a point where we cannot afford to dispense with the fuel source and equalize on it and I think its becoming a greater and greater reality among more and more people that you cant just choose our environmental compliance and eliminate fuel sources and fuel maintain at these comparative levis. So, that is

Steve Barger - Keybanc Capital Markets

I know I think that's absolutely right but do you think that the political decision makers are of the same mind there or are there more strict in terms of how they are viewing it I understand it's certainly in the process, what are the industry guys telling you?

Michael W. Sutherlin - Chief Executive Officer and President

I think that's more fierce I mean one of the barometers I look at is Europe. Three year ago Europe was absolutely committed to Kyoto they were going to have absolute compliance, they are going to do whatever it takes to develop a green industrial base including power generation, today they are building coal fueled power plant because they are afraid to rely on Russia for natural gas supplies both from availability and cost standpoint. So the reality sets in and they say well wait a minute we can't be too idealistic if we are going to have serve the needs of our population.

I think you will see the same here we are probably earlier in that process than they are at this point. Certainly our customers are getting a tremendous amount of relief with the export market today so the... what happens here in the near term in terms of coal fueled power plant is... its always important to us but without the export market, it will be a much more of a critical issue than is with the export markets and those can provide a great bridge here in the near term.

Steve Barger - Keybanc Capital Markets

All right thanks.

Michael W. Sutherlin - Chief Executive Officer and President

Yes, thank you.

Operator

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

Michael W. Sutherlin - Chief Executive Officer and President

Hi, Charlie. Hello?

Operator

Mr. Bradey your line is open.

Michael W. Sutherlin - Chief Executive Officer and President

We had him in the queue earlier so may be he got his question answered.

Operator

And your next question comes from Alex Blanton with Ingalls & Snyder.

Michael W. Sutherlin - Chief Executive Officer and President

Hey Alex.

Alex Blanton - Ingalls & Snyder

Good morning. Most of my questions have been asked but do you have any comment on your market share and how it might be changing here as demand is ramping up in the various products?

Michael W. Sutherlin - Chief Executive Officer and President

Well we believe we have obviously real strong markets and we... generally in our businesses have order to delivery lead times that are longer than number of our competitors. We believe that demonstrates the preference that our customers have for our equipment. We're driving real hard to keep capacity running, capacity growth growing fast and up that we can accommodate the needs of our customers.

Our customers have been really, really good in working with us on slot management, matching up our production capabilities, their projects, making sure that we try and cover for them, results of that has been... customers have been generally willing to place orders out further ahead to make sure that we would have production spots to meet their requirements. I don't see that there... certainly we don't see any market share erosion in our business even in the current up cycle as anything we see more of interest in talking further out to make sure that there we're following up the head to be able to accommodate.

And I ultimately I don't see that we are always trying to improve our market position in every one of our product lines but we also accept the reality that we have for our market positions and it would be hard to improve where they are, but we certainly don't see any downside in the market shares at this point.

Alex Blanton - Ingalls & Snyder

Okay and secondly follow-up is go back to what has been subject to number of questions and that is that in your guidance increase for the year you raised your sales guidance at the mid-range by 4.7% and EPS guidance by 4.4% and indicating no margin, no incremental margin improvement on the incremental sales and you have explained that variously as or primarily as a product in exchange is that correct?

Michael W. Sutherlin - Chief Executive Officer and President

There are a number of elements in there and certainly on the Joy underground side, we are seeing there original equipment order rates improve significantly more and faster than their aftermarket order rates which will have them... have a heavier original equipment portion in there shipping mix in the second half and they have been ramping up the original equipment out but we are thinking up the continental numbers in it as the GAAP [ph] results in lower margins that are drawing P&H businesses will have a downside effect and they will continue the P&H investment into the second half as we bring that China factory online. So there is a number of things that are going on here that are affecting the overall margins but on a machine model basis we continue to get the margin improvements between shipments that we made in the second quarter and the backlog we have for shipments in the second half of the year. As though there are other factors begin to have to have a downward affect on the margins when you put them all into one number.

Alex Blanton - Ingalls & Snyder

Okay just to be brief in it's the Joy underground original equipment ramping increasing which is dampening the margins relative to parts?

Michael W. Sutherlin - Chief Executive Officer and President

Right. Yes.

Alex Blanton - Ingalls & Snyder

Okay and its not any margin squeeze from cost increases... you seem to indicate previously that you are able to recover all of that with price. You are not getting squeezed on your raw material costs at all?

Michael W. Sutherlin - Chief Executive Officer and President

I mean we are under some pressure but we have been able to --

Alex Blanton - Ingalls & Snyder

No, under pressure but have you been able to deal with that and so the margin erosion that we're... not the margin erosion but the lack of incremental margin on the incremental sales is not due to a price cost squeeze, is that what you are saying?

Michael W. Sutherlin - Chief Executive Officer and President

That's there for the second half is right [ph].

Alex Blanton - Ingalls & Snyder

Okay, thank you.

Operator

There are no further questions at this time. Do you have any closing remarks, sir?

Michael W. Sutherlin - Chief Executive Officer and President

Well, just a quick comment in closing. First, I would like to just thank everyone for their time on the call. I would like to thank our shareholders for their continued support. I would like to thank the other investors for their interest in Joy Global and just close by saying that we look forward to again updating you on our performance at our third quarter earnings report. So thank you very much and good bye.

Operator

Ladies and gentlemen this concludes today's conference call. You may now disconnect.

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