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Executives

Sara Leuchter Wilkins - VP, IR and Corporate Communications

Michael S. Olsen - Chief Accounting Officer

Michael W. Sutherlin - CEO and President

Analysts

Terry Darling - Goldman Sachs

Charles Brady - BMO Capital Markets

Ann Duignan - JP Morgan

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

Henry Kirn - UBS

Andy Kaplowitz - Lehman Brothers

Joel Tiss - Buckingham Research

Robert F. McCarthy Jr., - Robert W. Baird

Seth Weber - Bank of America Securities

Barry Bannister - Stifel Nicolaus

Joy Global, Inc. (JOYG) Q3 FY08 Earnings Call September 3, 2008 11:00 AM ET

Operator

Good morning. My name is Cynthia, and I'll be your conference operator today. At this time I'd like to welcome everyone to Joy Global Incorporated Third Quarter 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]. Thank you. I'll now like to turn today's call over to Sara Wilkins, Vice President of Investor Relations and Corporate Communications for Joy Global. Please go ahead ma'am.

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

Good morning, and welcome everyone. Thank you for participating in today's conference call and for your continued interest in our company.

Joining me on today's call are Mike Sutherlin, President and Chief Executive Officer of Joy Global; Jim Tate, our Chief Financial Officer; Mike Olsen, our Chief Accounting Officer; Sean Major, our General Counsel and Secretary, and Gene Furman [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 third 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 - Chief Accounting Officer

Thank you, Sara. Let's take a minute and review some of the highlights from our third quarter results.

After exceeding $1 billion of new orders for the first time in the company's history in the second quarter of 2008, bookings in the third quarter totaled $1.5 billion, an $872 million increase over bookings in the third quarter last year. This increase was a result of a $410 million and a $350 million increase in new orders, for the surface mining equipment business and the underground mining equipments business respectively, combined with a $112 million of bookings for the crushing and conveyor business. This growth represents a 147% increase for the surface mining equipment business, and an 89% increase for the underground mining machinery business.

Orders for new equipment were up over $700 million, while the aftermarket bookings were up $170 million or 40%. The increase in orders for underground mining equipment was led by the continuing recovery in the North American market while the improvement for the surface mining equipment was achieved across most of our global markets.

Backlog at the end of the third quarter was almost $3 billion and was more than $1.3 billion greater than backlog at the beginning of the 2008 fiscal year.

Net sales for the third quarter were $904 million, compared to $622 million in the third quarter last year. Excluding sales from the Continental acquisition of $85 million, net sales increased by 32% over last year. Sales increased by 33% and 30% for the surface equipment and underground equipment businesses, respectively.

At the same time, original equipment shipments were 61% greater than a year ago, as new machine sales have begun to reflect the strength [of original equipment orders for the last several quarters.

Aftermarket sales for the current quarter were 35%, 24% excluding crushing and conveyor sales, greater than they were in the third quarter of 2007. Sales were higher than a year ago in most of the company's markets, led by strength in the U.S. underground market and for surface mining equipment in North and South America.

Operating profit in the current quarter was $134 million or 14.8% of net sales, compared to $110 million or 17.7% of net sales a year ago. The decrease in the return on net sales percentage from a year ago was due to $5.8 million charges for purchase accounting, related to the Continental acquisition, a $5.3 million charge associated with the settlement and extension of a labor agreement at the surface mining equipments main U.S. manufacturing facility, a $5.2 million foreign exchange costs, primarily associated with the valuation of the Chilean peso, and a $12.4 million increase in the company's variable performance-related compensation expense.

Net income for the current quarter was $113 million or $1.03 per share, compared to $73 million or $0.66 per share last year. The current quarter tax rate was only 12% of income before tax.

During the current quarter, we benefited from a discrete tax credit of $23.4 million or $0.22 per share, associated with the recognition of foreign tax credits from previous periods, which now can be recognized as the company's U.S. taxable income exceeds the benefits of its net operating losses.

Working capital at the end of the third quarter, excluding cash, was $588 million compared to $611 million at the end of the 2007 fiscal year. The increase in inventories to support the anticipated increased sales over the next several quarters was offset by additional advance payments from customers, while increase in accounts payable was primarily responsible for the decrease in working capital from the beginning of the year.

Cash flow from operations in the current quarter was $142 million compared to $150 million in the same quarter last year, reflecting the company's continuing ability to generate positive cash flows during all stages of the business cycle.

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

Michael W. Sutherlin - Chief Executive Officer and President

Thank you, Mike and I'd like to add my welcome to those on the call. We were obviously very pleased with the record level of orders and shipments that we had this quarter. We are gratified that our customers continue to expand their decision of horizons to purchase our equipment and believe they do so because of the high levels of machine reliability we are able to achieve with the strong aftermarket infrastructure and effective life cycle management programs.

As a result, those customers are now placing orders for underground equipment into 2010 and for surface equipment well into 2011. Our strongest order growth rate came from the U.S. underground business, which contributed almost two-thirds of the underground orders booked this quarter.

Order bookings were up well over four-fold on original equipment with record bookings of our continuous miners and shuttle cars. U.S. aftermarket orders were also strong, up 70% from last year. This is partially due to the fact that our U.S. underground business was just starting to recover in last year's third quarter. However, orders this quarter were at record levels and primarily reflect the resurgence in the U.S. market.

We are even more pleased that we have been able to significantly increase our realizable capacity in response to demand. Original equipment shipments were up more than 40% across both Joy and P&H businesses, and aftermarket revenues were up more than 20% before adding in Continental.

Speaking of Continental, they've reported a sequential gain in margins from last quarter and its integration continues to be in line with our expectations.

On our last earnings call, we mentioned contract negotiation on a P&H [ph] reopening with our union in Milwaukee. We are not only able to conclude those negotiations successfully, we are also able to extend the contract through August of 2012. It contributed a portion of the settlement to a defined contribution plan and this is an important step in moving our workforce from defined benefit to defined contribution.

Only last week we announced that we signed a definitive agreement to purchase Wuxi Shengda, a Chinese manufacturer of longwall shearing machines. This is a small company, but one with a strong brand and a significant growth potential. It was also below the size limit for Central Government approval that was therefore doable. We have repeatedly said that we cannot be successful in China by serving only the top few customers. Wuxi Shengda gives us the access to provincial mining companies and significantly expands our market reach in China.

Despite the many things that went well this quarter, profitability was an issue. Some of this was a result of conscious decisions to better enable us to take advantage of future market opportunities. This includes decisions to increase the investment in R&D programs that will lead to significant new revenues streams and decisions to carry a higher cost needed to support the start-up of manufacturing in China.

As anticipated, Continental purchasing accounting was lower this quarter but still significant. However these charges will decline on an... it will decline to an annual run rate of about $6 million for our next fiscal year.

On top of these items, we had a number of costs tied to specific events of the quarter. The union settlement to the defined contribution plan was an important step in the right direction although it required expansion in the current quarter.

Majority of the foreign exchange charges came from Chile and results from our expanding business level in that country impacted by the recent weakening of the peso. This is a transaction-related expense, and we have modified our hedge program to significantly mitigate this going forward.

We believe we're clear of the event-driven charges we have experienced the last couple of quarters and expect the next quarter's profit leverage to return to the 20% plus range.

But before going into guidance, I would like to review our markets since they largely determine the long-term value of this business. When we look at the fundamentals, such as commodity, supply and demand and our customer specific mine expansion plans, we continue to see significant strength in our equipment demand across all geographies and all commodities.

Although there have been recent price corrections in some index-traded commodities, contracts for physical delivery continued to be priced at consistently higher levels. While the Central Appalachia coal index was floating with the $100 level, we saw several of the U.S. customers sign multi-year thermal coal supply contracts at prices in the low triple digits with one customer citing the specific price of $125 a ton.

Across the Pacific, China is experiencing the worst series of power shortages in over four years. The average stockpile levels remained below three days and a recent report indicated that 39 of the county's power generating plants were down due to lack of coal. And this occurred during the industrial low and a build-up to the Olympics.

China has further reduced the amount of export licenses for the remainder of this year to about half of that of the year ago. It has also imposed a 10% duty to further restrict exports. As a result, the Australian spot price jumped almost $8 to $164 a ton. And one of the major diversified miners recently announced plans to double the Australian production by 2015.

The met coal market will remain in significant deficit for several more years and pricing continues to increase as a result. Recent met coal sales to India have touched $400 a ton while the general price remains around $350, both well above the benchmark of $305. Two of our customers recently signed five and ten-year met coal supply contracts to lock in current pricing levels.

Conversely, coal end-users are aggressively investing in their suppliers to provide surety of supply and to hedge against future price increases. The prices being paid are running in the mid $200 a ton range into perpetuity for the suppliers met coal production. This is 2.5 times the price of just a year ago and is higher than most coal analysts have in their long-term models.

All of these economics and commercial moves indicate that both coal producer and end-user expect the market to remain in supply deficit for several more years.

Like met coal, iron ore has not been able to meet the demand for steel, which continues to grow at 5% to 6% a year. Iron ore prices almost doubled this year and are set for another meaningful next year. Despite the strong increase in contract prices, spot prices continue to run 50% or more higher than the benchmark. And as with coal, end-users are investing in new sources to gain surety of supply.

In contrast to other commodities, copper is an index-traded commodity and its price is down to a six-month low. Despite this price weakness, inventories are not down, because production is up 3.5%. Production is suffering from the increasingly normal effects of labor, weather and declining grades. Of relevant is that the current price is still about twice the cost of production in the upper cost quartile and therefore continues to provide very strong economics.

In addition, greenfield copper projects require long lead time to develop and current expansions have based upon the market outlook for 2011 and beyond rather than being driven by current index prices. That's why copper and oil sands are seeing recent declines in their commodity prices but the current oil prices are still multiples above the cost of production. As a result, oil sands investment will reach $20 billion this year, up 20% from last year and double that of just three years ago.

More important to us and validating the market fundamentals, a list of qualified prospects continues to stay at historically high levels, despite, the number of record quarterly bookings. This indicates that our customers continue to add new projects at rate at least equal to this year's exceptionally strong order rates. This longer-term view of the project pipeline is the basis for our belief that equipment demand will remain strong for several more years. It also supports our conviction to continue to increase our capacity to catch up to and keep pace with this market demand.

I would like to conclude my comments by returning to our fiscal 2008 guidance. We have a limited ability increase capacity in the short time remaining this year except for plans that were put into place a year ago or longer and those were previously considered in setting our prior year's... setting our prior guidance.

As I said earlier, we expect our incremental profit leverage to return to the 20% plus range in the fourth quarter. But this must be applied to a somewhat lower base as we blend in the Continental starting margins and as we continue to invest in R&D programs and China manufacturing start-up.

As a result, our operating earnings will remain in the previous guidance range. But EPS is now expected to be higher by the $0.22 favorable tax adjustment we recognized this quarter.

Therefore we continue to expect revenues between $3.3 and $3.4 billion and expect earnings per fully diluted share to now be between $3.37 and $3.52.

With that I would like to open the call to questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from Terry Darling with Goldman Sachs.

Terry Darling - Goldman Sachs

Thanks. Good morning, Mike.

Michael W. Sutherlin - Chief Executive Officer and President

Hi Terry how are you?

Terry Darling - Goldman Sachs

Still looks like the surface margins in the quarter, and I think if we exclude the currency, the union pension contribution to China and the R&D costs. Still looks like margins were down 100 basis points year-over-year despite the 33% top line growth. And wonder if you can get into a little bit on... was there a mix effect? Are we seeing a little bit of lag between steel prices hitting you and the prices going through or any other factors that may have caused that?

Michael W. Sutherlin - Chief Executive Officer and President

Excuse me, Terry. I will give you some like overview comments and then Olsen can... more of the specifics. But generally speaking, we are... other than the items that we listed, we are seeing the original equipment portion of... weighting of original equipment and the overall revenue stream get higher as we continue to ramp up that potion of our business. The aftermarket growth has been good but the original equipment continues to grow at a faster rate. So we are getting a mixed impact on those margins. And we continue to... we put in the announcement we continue to carry certain costs that are dedicated to ramping up China manufacturing and higher R&D programs, as R&D programs being concentrated on the Ultra Class dragline and the in-pit crushing equipment. So Mike, you can give a little bit more granularity on some of the weighting on the P&H margins.

Michael S. Olsen - Chief Accounting Officer

Yes, I think that as you look at the P&H operations, one of the issues that impacted the third quarter is the variable compensation program that the company had in place that tied into really two critically measures: one is profitability and the other one is the effective management of investment and more specifically, working capital.

The surface mining equipment business has done a good job in both of these areas, especially good in the working capital management and that variable compensation has increased in the third quarter, a bit of a catch up from where we had been accruing throughout the year, until we had to get it up to the run rate for the full. And there has, in fact, been some expense and costs incurred in connection with what we are seeing in the steel costs. There has been some additional variances associated with that steel cost, as the business is putting in plan to mitigate that impact going forward. But there was some impact on that in the third quarter and then the other issue is the, and I think you may have touched up on this. Another issue is the costs are being incurred in establishing the business in China.

Terry Darling - Goldman Sachs

Mike can you actually quantify that lag effect from the steel prices and when do you think we move back to parity or in the positive territory on that, given the strength of end markets, I know the efforts you're making to do that?

Michael W. Sutherlin - Chief Executive Officer and President

Yes. Let me just touch on one more cost element that we had in P&H in the third quarter and that was lower than anticipated absorption of overhead in some of our service operations. At current production rates, we have seen some delays in getting machines broken loose from production to go into rebuild process. And so we've got geared up and capacity weighting for that and we get some delays from customers in giving those machines over to us.

So we do have a little bit lower overhead absorption in some of the service operations that are impacting the bottom line. Steel cost of P&H, we've had some very modest purchase price variances at P&H in the third quarter, sort of in couple of million dollars or so range. So it was very significant. As we map out the impact of steel cost on our backlog. When looking at on original equipment margins, we're looking at those margins to remain flat through 2009 as we work through the backlog with higher steel costs. We make those up in other parts of the business. And then beyond that we begin to get some relief as we get into 2010.

Terry Darling - Goldman Sachs

Is that a way across the business or a way just on surface side margins flat in '09, that kind of comment.

Michael W. Sutherlin - Chief Executive Officer and President

That comment was surface. But you will see a similar pattern in the underground business. With the underground business you probably are going to see flattish OE margins through the first half of 2009 in the surface business through most of 2009. So there is a little bit of a timing difference but we will see very little improvement in OE margins in 2009 because of the roll-through of the higher steel costs. And as we pick that up in other parts of business, some in aftermarkets, some in other areas of efficiency improvement. But then as we get into latter half of 2008, we will start to get some relief on the Joy side in 2010. Then we will start to get some relief on the P&H side.

Terry Darling - Goldman Sachs

Okay, one more and I'll get off here. Like your commentary in the press release about the order rates were 1.5 maybe is little punchier relative to maybe what's normalized, but the normalized running above industry capacity. Is that a number closer to a billion in your mind or where is that number?

Michael W. Sutherlin - Chief Executive Officer and President

Yes I mean in broad range is that probably sort of the area we think the normal run rate is going to fall into. I mean if you go look at the order rates this year and you put those in either dollar ranges or unit ranges they are just astronomically high compared to where we have been in historically. So there is a surge of orders coming in. Our lead times are stretching out. I think our competitors' lead times are stretching out. So and as they do, the customers are really focused on trying to lock in delivery slots for their future expansion programs.

Now, so we see some of that beginning to settle into a more sustainable run rate. Now you also have to be cautious that we have extremely lumpiness in some of our order rates. So when we talk about sort of being in... I don't see the order rate going up from $1.5 billion to $2 billion over the long-term as we're probably sort of staying in the $1 billion to $1.5 billion range. But it's going to be lumpy. So quarter-by-quarter you got to expect quite a bit of volatility in that.

Terry Darling - Goldman Sachs

Understood, Thanks very much.

Michael W. Sutherlin - Chief Executive Officer and President

Yes thank you.

Operator

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

Charles Brady - BMO Capital Markets

Hi Thanks. Good morning. From the purchase accounting in 4Q, I know you mentioned you'll gain into a $6 million annual run-rate in '09, or hitting that run rate in 4Q, what should we expect for that?

Michael W. Sutherlin - Chief Executive Officer and President

That'shalfway in between.

Charles Brady - BMO Capital Markets

Okay. And then on the Canadian expansion, when does that capacity come on line?

Michael W. Sutherlin - Chief Executive Officer and President

We'll see the actual physical capacity coming on line in the latter half of 2009, but there's a ramp-up phase on, probably is going to be 2010 before you see any appreciable impact of that on the revenue line.

Charles Brady - BMO Capital Markets

Okay. As you talk to your customers, and you look at what the U.S. coal pricing has been, obviously pulled back somewhat but still at a obviously very high elevated level. As you talk to your customers out there at what point, give us a sense based on history, would we see on a coal decline before you think that, that would have some impact, meaningful impact on order activity, for you guys? I mean so where would coal have to go, up or down?

Michael W. Sutherlin - Chief Executive Officer and President

We went through the... in the U.S. we went through the weakening conditions in the U.S. underground market and starting in late 2006 into the after the first half of 2007. And during that period we definitely saw that as prices went... central Appalachian prices went below 60, we saw the expansion programs begin to slow down. As it went below 50 we saw the mines go down to maintenance, essential maintenance levels only and some of those mines actually begin to come offline to take excess capacity, out of the chain, supply chain.

So, if you look at that and you look at the increase that our customers have experienced in their costs, fuel increases, labor increases things like that, you got to expect those numbers to be today, same numbers in the $60 to $70 range, rather than the $50 to $60 range. So, on top of that I think the customers' expectations have been guff-sub [ph]. So, I don't think that, for example, $100 a ton coal is necessary for our customers to aggressively expand their production. And I think that the... what's the expansion programs if coal were to get down to in the $70 to $80 range, I think we see those expansion programs continue.

But, that's pure speculation because you're never sure what the customers' behavior is going to look like. So, if you just look at the economic models and apply that to costs two years later, that's the numbers you'd be looking at. It still gives us quite a bit of cushion between current pricing levels and where we think the customers will begin to slow down their capacity expansions.

Charles Brady - BMO Capital Markets

Thanks.

Michael W. Sutherlin - Chief Executive Officer and President

Thank you, Charlie.

Operator

Your next question comes from Ann Duignan with JP Morgan.

Ann Duignan - JP Morgan

Hi, good morning.

Michael W. Sutherlin - Chief Executive Officer and President

Hi, good morning.

Ann Duignan - JP Morgan

And, just a clarification first, your outlook for your revised tax rates. Is that in perpetuity or is that just through 2008 or is there some timeframe on that tax rate?

Michael W. Sutherlin - Chief Executive Officer and President

Yes. It's for the next several years. I mean perpetuity is a long time. But, it is for the next several years, more than 2008, certainly and probably, the next five to six years anyhow.

Ann Duignan - JP Morgan

Okay. That's helpful. We were using higher ones. And then, stepping back and talking a little bit about your capacity expansion plans, is it fair for us, when we're looking at our models for '09, is it fair for us to start to think about a more permanent mix shift to OEM versus aftermarket?

Michael W. Sutherlin - Chief Executive Officer and President

Well, the process are working on our five year plans right now and as we model out, where we think that's going to happen over the next five years. We continue to see a stronger growth in the original equipment part of our business versus the aftermarket and that doesn't diminish the imports of the aftermarket growth because we still see that growth being very strong in the mid-teens sustainably over a long period of time. And so, but the original equipment should grow at a higher rate as customers bring more projects and expand their production more rapidly. As we look at this going forward, we can see the original equipment to aftermarket begin... continue to... that ratio continues to move down, it's currently in the high 50%, 57%, 58% of our revenues coming from the aftermarket. And we can see that declining to the low 50s over the next several years based upon the growth in the original equipment shipment level.

Ann Duignan - JP Morgan

Okay. That's very helpful, thank you. And what kind of opportunities, I know you said that your backlog is about halfway through next year, some of it will realize that higher pricing for higher input costs and going into '09 into 2010, the remainder of the business, what opportunities... do you have more opportunities to raise prices in the aftermarket, perhaps than you do in the original equipment? Is that where you'll make it up?

Michael W. Sutherlin - Chief Executive Officer and President

Yes. Well we went through the period of rapid steel cost increases in 2004, 2005. We had backlog... original equipment backlog at the time as well and we're able to jumpstart the process by focusing price increases on both original equipment but on aftermarket, the aftermarket right now will have a faster roll-through. So we'll see somewhere around the two to three month lag in the realization of aftermarket price increases where with the original equipment, we have to work through existing backlog in existing contract terms.

On the P&H side, in particular, we have some contracts, because of the longer lead times we have some contracts that were booked in, for example, in 2006 and those don't have as much protection for escalation as we would like. And so, we do have some near term issues we're going to work through, but there are some prices we're going to offset that and aftermarket is obviously one of the areas that's got to carry higher share of the lows.

The benefit we saw in 2004, 2005 is that when the original equipment pricing kicks in it sort of has a double effect and we really got a lot of benefit out of those two streams combining at some point and each one adding to the other. So we'll get some relief from the aftermarket the near term, we'll get some relief in the original equipment later on. And together we think that we'll be significantly ahead of the cost curve when that happens.

Ann Duignan - JP Morgan

Okay. Thank you and one really quick question, your inventories, as we measure them, based on hand, at about 124 days down from about 161 last year. How sustainable is the current rate, was there anything that we should be careful as we look forward in terms of inventories?

Michael W. Sutherlin - Chief Executive Officer and President

The current rate, we've been working on operations, excellence programs in ways to improve the efficiency of our internal operations and those programs continue to yield results facility by facility. So we are getting some benefits, it's not consistent across all facilities but where we have implemented some of the operations excellence program, we've got an advantages in throughput and cycle times and that's really benefited the inventories.

However at this point, we're trying to buy as much steel as we can as early as we can to lock down the prices. And so, at the same time we try to get our processes more efficient and realize some inventory benefit. We're buying as much steel as we can and putting on the rail, we'll have steel on the ground sometimes, four to six months before we needed for machine build but we want that extra time to hedge against any ongoing steel cost increase pressure. So it's little bit of mix right now and you probably will see a lot of additional improvement in inventories here in the near term and we'll get past these steel cost issues. But over the longer-term, we believe the inventories still come down, and that we believe that long-term objective actually is going down below the 100 day level.

Ann Duignan - JP Morgan

Okay, that's great. Thank you very much, I appreciate it.

Operator

Your next questions come form Michael Gallo with C. L. King.

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

Hi. Good morning.

Michael W. Sutherlin - Chief Executive Officer and President

Hi Mike.

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

Question I have as we look at the U.S. market, obviously you've seen a significant acceleration in the orders over the last couple of quarters, coming out of the trough of that market. You talked I guess initially about some mine expansion and certainly a lot of the coal companies have talked about that as well. I was wondering if you are starting to hear any of the U.S. customers talk about any significant greenfield operations here again given the current pricing outlook? Thank you.

Michael W. Sutherlin - Chief Executive Officer and President

We see with... in the U.S. market we see discussions around both greenfield project expansions and brownfield project expansions. Our larger more established customers are right now focusing more on the brownfield expansions and we've seen a number of our customers who have talked about and are talking to us adding another longwall to an the existing longwall mine going from two longwall sections to three or from one to two.

And they are doing that because that's the fastest way for them to take advantage of the current market conditions. At the same time we're seeing some greenfield project expansions and the greenfield project expansions tend to be associated with like the next tier down level of customers who are... don't have as much brownfield opportunity and therefore are looking for opening new mines and we're seeing a lot of that as well. If you look at one of our major Eastern customers who have placed some significant orders for continuous miners.... we can see about half of those going into their existing mines and half of those going into new mines and they're either opting to have plans to open. So we've got a range of things with most of our existing customers doing mostly brownfield but some greenfield and then the greenfield beginning to new or more, not new but smaller more aggressive customers going after greenfield projects at this point.

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

Great,that's very helpful and then just a final question, I was wondering if you've seen the current consolidation ultimately being favorable for you and the equipment supplier or perhaps some other customers get larger and are able to perhaps negotiate more favorable aftermarket terms et cetera. I was just wondering if you can give some color on that. Thank you.

Michael W. Sutherlin - Chief Executive Officer and President

Yes, we see two sides to the consolidation story really. In the long term, we believe that consolidation is good for us because we have very, very extensive aftermarket programs, life cycle management programs. We're investing in the expansion of those programs to capabilities we call, smart services and we believe the larger customers have better appreciation for those and are willing to work with us to implement those programs in their operations. And we see that on and across the... across all operations kind of a focus with the major customers. So we think that's an advantage to us.

The disadvantage of consolidation is that once the two companies merge, one company acquires another company, the first thing they do is conserve cash to pay down debt. So we go through a near term period of 12 months, 24 months where expansion programs get slow down as they conserve cash pay down debt and get their balance sheet back in line. So it is a little bit of near-term, long-term, deal with the near-term... sometimes not being positive, in the longer term we think it's very positive for us.

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

Yes, that's very helpful, thank you.

Michael W. Sutherlin - Chief Executive Officer and President

Thank you.

Operator

Your next question comes from Henry Kirn with UBS.

Henry Kirn - UBS

Good morning guys.

Michael W. Sutherlin - Chief Executive Officer and President

Good morning Henry, how are you?

Henry Kirn - UBS

Good. Quick question about cash flow. How do you view use of cash flow going forward and what would hold you back from becoming more aggressive in buying back shares at these levels?

Michael W. Sutherlin - Chief Executive Officer and President

I think we've been consistent in saying that our preference for use of cash is growing our own business and doing that through capital expenditures, secondly doing acquisitions that are synergistic and good bolt-ons. I think that we continue to demonstrate that we're selective about doing that and that is a good use of cash because of the good asset they have within our business. We've seen that with Stamler, now we are seeing it with Continental and we'll see it with Wuxi Shengda as well, being more aggressive with our share buybacks we have... we've been running under a 10(b) 5 one plan, and we would like to be more aggressive in share buybacks but we've got get into an open window to revise that.

We're looking at that plan, and one of my questions is why aren't we buying more shares? And so, we've got to go back and tune up that plan but certainly we believe there is value in buying shares in current market conditions. And we would like to be buying shares consistently over a long period of time because we're cash generated... we'll have a need to returning cash to shareholders, next year and five years from now as well as we do today. So I think you'll see us, not get suddenly more aggressive, I think you'll see us revised our buyback programs to be more active in the market for buying back shares consistently quarter-after-quarter.

Henry Kirn - UBS

That makes sense. And on M&A side how do you view the pipeline wherein you disclosed Wuxi, are there more similar deals in China or elsewhere that could be interesting?

Michael W. Sutherlin - Chief Executive Officer and President

China is an interesting market because there is lot of... it's relatively fragmented at this point with a lot of companies, machinery companies that have been spun off by their parent mining bureaus back in the days when China ran fully integrated mining bureau. So there is a struggle for those guys to see how they're going to survive and what role they're going to play, so there are opportunities in China of mining. Both mining itself and mining equipment is considered a national resource in China. So, bigger companies that have to go into Central Government approval process which is very protracted and there is not a whole lot of interest in letting Western companies go in and buy what they call their national resources.

So probably you'll see in China us continue to look for smaller companies that we could put together to form a significant presence in that market, utilizing our technology to grow their product ranges and to improve their product performance and take advantage of some organic growth on top of acquisitive growth in China.

Other markets out... we continue to like bolt-on acquisitions. We like Stamler, we like Continental. We certainly see an opportunity to do more of those and we are constantly pursuing those opportunities. It took us three years from first discussions to close out, Stamler took us probably about the same time to do Continental. So to get good acquisitions and to get those on reasonable terms is not something that you can do at an accelerated pace and I've experienced it. So we'll continue to be in the market, we'll continue to aggressively look for opportunities, talk to a lot of people trying to get something over the line. But at the same time we're looking for the right step and reasonable pricing and we'll be selective of that what it takes so.

Henry Kirn - UBS

That's helpful. Thanks a lot.

Michael W. Sutherlin - Chief Executive Officer and President

Thanks Henry.

Operator

Your next question comes from Mark Koznarek with Cleveland Research.

Unidentified Analyst

Hi guys. Kurt Alder [ph] in for Mark.

Michael W. Sutherlin - Chief Executive Officer and President

Hihow are you?

Unidentified Analyst

Good. I was wondering if you could provide some information on the approximate size of the market to local Chinese shares and either units or dollars. And how that would compare to the market for Western made shears?

Michael W. Sutherlin - Chief Executive Officer and President

Well. China has got a market for shearing machines, I am going to give you some just really ballpark numbers but 200 shearing machines a year sold in China, 250 maybe but there are very, very small machines mostly and a number of the shearing machines will go at price points of $0.5 million revenue. And if you look at high-end shearing machine for us that's the $3 plus million and you look at the market outside of China as a market that is probably 70, 80 shearing machines a year or something like that. But again in China, as you get a much larger number and a much smaller size and it's just different market, lot of it is driven by old established mines that were built around the smaller Chinese equipment. We see that group of provincial companies will migrate to larger, higher volume operations if they had the equipment to do that. And we think that's one of the great opportunities we have with this Shengda acquisition is to extend their product range and work with the customer to migrate up from the existing size operations to a larger more efficient operations.

Unidentified Analyst

Okay great. And then a quick follow-up, could you give an approximate growth rate for locally made Chinese mining equipment?

Michael W. Sutherlin - Chief Executive Officer and President

I don't really have the number for that. I can tell you that the China production levels continue to grow at around 10% a year. So, you got to assume that the equipment businesses in total are probably growing at that rate as well 10% to 12% a year.

Unidentified Analyst

Okay great. That's helpful, thanks.

Operator

Your next question comes from Andy Kaplowitz with Lehman Brothers.

Andy Kaplowitz - Lehman Brothers

Can you hear me okay?

Michael W. Sutherlin - Chief Executive Officer and President

Yes hi Andy, how are you?

Andy Kaplowitz - Lehman Brothers

Good. So, I am just wondering about potential revenue growth going forward. I mean you did 32% year-over-year growth in the quarter and your order book continues to extend out and so why shouldn't we be forecasting something like that as we look into 2009 and maybe even beyond. What are the limitations of the growth?

Michael W. Sutherlin - Chief Executive Officer and President

Well the limitations of the growth that we have right now are tied to our ability to get capacity online and do that efficiently, now that we could double the growth rate of bringing our capacity online. But we don't have the internal resources to do that, so then we bring a lot of people on board, bring in new people to fill critical new capacity. We run the risk of them understanding how we run our business and how we want these facilities to be set up.

We've chosen to build in China rather than incrementally build in places like Milwaukee or Western Pennsylvania. So it is a more intensive build-out process because we think that's strategically where we want to be positioned in five years and 10 years from now, so we are willing to take a little bit more pressure in the near-term to do that. But primarily we are limited by the number of our own people that we can put on these expansion projects. We're limited by the number of machines that we can get; we have a lot of specialized, we could pick-up in today's market, we can pick-up oil mills and correlate [ph] pretty easily, some cancellations from other customers.

Some of the equivalent we have particularly on the P&H side is very specialized, it's a make to order kind of equipment, and the people we buy from have a long lead time. There is a lot of things here that limit our ability just to rapidly expand our capacity. We keep talking to customers about their projects. And so far the customers have been willing to extend their decision horizons out to make their decisions beyond their current lead times and that's been working for them and for us. And so it's provided a workflow situation. We do need to grow capacity, to try to get those lead times back down into more reasonable range. But as much as we've tried to add capacity the growth rate accelerates faster than we add capacity. When we were adding the China capacity and planning that out, we were looking at a market that was not nearly as hot and robust as the market is today. We were... I don't think anybody is expecting thermal coal prices above $150 a ton or met coal prices well above $300 a ton, in all of the acceleration of expansion by our customers as a result of that.

So, it's a fit and start kind of a process but it's just sort of driven off by best few of the market in trying to catch up and then being help for them because the market is growing, it goes to another growth surge in and gets ahead of us again. And that's sort of the process we went through that. I am not willing to just throw bodies at capacity because that's going to be inefficient and wind up with the wrong capacity in a wrong locations and it will not be efficient and that's not good for our business for long run.

Andy Kaplowitz - Lehman Brothers

That's helpful. Maybe if I can go back to margins for one second. If I look at 2009 and beyond and I looked back at what you did for instance in P&H in 2007, you had good margins in 2007 in that business. Obviously now it's reflective of sort of the strength in '06. Going forward you are going to be putting on lower cost capacity and I think Mike you said that you'll start to see the impacts of that in late '09 and that's what you said correct?

Michael W. Sutherlin - Chief Executive Officer and President

That's correct.

Andy Kaplowitz - Lehman Brothers

And so, I guess the way I'm thinking about is given that the market is as stronger, probably stronger than it was back in '06, why should the margins be materially lower and shouldn't they be materially higher even when we get to open these new factories and they are running at their run-rate in that surface business as we get towards the latter half of 2009 and 2010?

Michael W. Sutherlin - Chief Executive Officer and President

You are absolutely right in that, that is our plan right now is to meaningfully expand our margins in both the surface and underground business. We have some near term limitations on how rapidly we can do that because of orders and backlog and those, some of those orders and backlog do not have enough capability just to go in and re-price those. We also deal with long-term customers that are only repeat customers. So we have to... we are in negotiations with customers on making adjustments to some of the orders and backlog. But that's within the limits of preserving customer goodwill and we're not just going to, we can't legally and we wouldn't from a business standpoint just walk away from a contract we have singed.

Customers understand that they are benefiting and that we shouldn't be harmed at a time when they are benefiting and they've been receptive to discussions we've had with them. We're not sure what those outcomes are going to be but right now as we look at it without any customer concessions, we're going to go through a period in 2009, where we won't get as much relief because we have commitments in backlog that we have to work through, you get past that and I think you'll see that the margins will show a noticeable improvement once you get past the restraints that we have in the current backlog. Some of those backlog situations may improve as we try to find a workable solution with our customers and if they understand that we're suffering from some of the same factors that they are benefiting from. So they are not totally unreceptive to our discussions.

Andy Kaplowitz - Lehman Brothers

Thank you. So you think the material pickup happen sort of late '09 and 2010 as it stands right now?

Michael W. Sutherlin - Chief Executive Officer and President

That's correct.

Andy Kaplowitz - Lehman Brothers

Thank you.

Michael W. Sutherlin - Chief Executive Officer and President

Probably from... realistically, we got to probably look at 2010 before we really begin to see an improvement in margins, and I think you'll see in 2010 those margins begin to catch up not just improve on an annual basis of 2010. I think you'll see that they'll more than catch up for the periods that we had to work to in 2009.

Andy Kaplowitz - Lehman Brothers

Okay thanks.

Michael W. Sutherlin - Chief Executive Officer and President

Yes thanks, Andy.

Operator

Your next question comes from Joel Tiss with Buckingham.

Joel Tiss - Buckingham Research

Hey guys. How are you doing?

Michael W. Sutherlin - Chief Executive Officer and President

Hi Joel, how are you?

Joel Tiss - Buckingham Research

All right. Can you just talk very quickly from, if you've made any changes along the lines with your... of your competitors with moving to letters of intent to take orders on still taking cash down payments?

Michael W. Sutherlin - Chief Executive Officer and President

We have revised or and have revised our terms and conditions and we are not looking at letters of intent but we are looking for contracts with re-pricing provisions. And effectively we're doing as others are doing and getting price flexibility. We prefer to have contracts, it's too easy for somebody to give a letter of intent even with the down payment and we would like to know that the decision has been properly embedded within a customers' organization at the right approval. So we're looking for contracts with reopened and escalation clauses built in and we're looking at escalation formulas that are not tried to published indexes but a reflective of our own costs.

So we feel pretty good that the changes we've made will give us protection for orders we're booking today that those will... it will give us more than adequate protection for future price escalations and would accommodate the fact that we've got longer lead times. We have some customers that are talking to us today about machine delivery slots going out as far as 2013. So the horizon, as the horizon stretches out the risk of cost changes gets amplified. So for lot of reasons we've made the same change and we feel pretty good that's going to take this issue as we go into 2009, during the last time we have to go through there.

Joel Tiss - Buckingham Research

And just as quick back on Andy's question. If including the increased presence in China and the Continental acquisition which all have structurally a little bit lower margins. Do you still think that as we get out further out into 2011 or whatever that you can still have higher margins than you would have overall, as an overall company, than you had at the best point before?

Michael W. Sutherlin - Chief Executive Officer and President

Yes I mean the answer to that is yes but, we expect our Joy and P&H businesses to consistently improve their margins and get those margins up in the low 20% range. We think that the Continental technology is not quite, at the level of Joy and P&H technology but we expect that business to get into the high-teens. In China, we think there is opportunity to... more things like sewing machines in China we think there is opportunities to make margin that are comparable to the Joy worldwide margins. We've got to do little bit of work with the business to grow it and to deal some streamline of the internal processes. But we certainly think that the opportunities are subdued. If you weigh that altogether, you get a business that's got the potential of delivery margins in the low 20% range.

Joel Tiss - Buckingham Research

Well thank you, and then last you mentioned that prices were above extraction costs and the marginal extraction costs. Can you give us a sense of where you think those marginal extraction costs to offer copper and to met coal?

Michael W. Sutherlin - Chief Executive Officer and President

Yes coal's hugely very robust but the Eastern U.S. coal the extraction costs like in Central App are, today as we look at our customers, we see numbers in the low $50 range, $50 to $55 a ton range. So that depends upon the customers blend between surface and underground but certainly $50 to $55 in Central Appalachia is a good average cost of production number.

As we look at places like Australia the underground operations in Australia we will be looking at costs that are close $60 to $70 a ton range. So couple of data points there that's probably helpful. If you look at PRB cost production, PRB continues to be $8 or $9 a ton.

As we look at copper you got two factors with copper and that's the cost of production and the effect of netbacks. We see right now, if we look at the profile of the cost across the entire copper industry, we see the 90th percentile of customers that are operating at the 90th percentile which means they have costs higher than 90% of the other customers.

We see those guys operating at cost levels of around $1.75 or so a ton, $60 to $75 a ton. The majority of the market is offering a lot less than that so... and typically and sort of in the range of $0.90 or so $0.75 to a $1 somewhere in that range. On a netback basis many of our customers by the time they sell off their buy product like gold, molybdenum they are operating a cost that, that are virtually just pennies per pound, literally 4 to 6 per pound in some cases. So what we see, is we see that there are some relatively high marginal cost still good at today's copper prices. But the better operators operate it at costs that are probably only like a third or quarter of the current copper price.

Joel Tiss - Buckingham Research

Thank you so much.

Michael W. Sutherlin - Chief Executive Officer and President

Yes thank you, Joel.

Operator

Your next question comes from Robert McCarthy with Robert W. Baird.

Robert F. McCarthy Jr., - Robert W. Baird

Good morning, everybody. I have to admit, with all the discussion of operating margin expectations I am a little confused on where it all nets out. You have told us that you expect original equipment margins to be flat through next year on one side of the business for P&L first half or so on the other side. But that you will be able to get margin expansion out of aftermarket and internal efficiency efforts, I believe that translates into higher margin next year overall than you are generating this year, is that indeed what you are trying to communicate Mike?

Michael W. Sutherlin - Chief Executive Officer and President

Exactly. Yes.

Robert F. McCarthy Jr., - Robert W. Baird

Okay, and you also told us to despite the pressure that you are seeing on original equipment margins including in the quarter the actual dollar deficit was matter of $2 million to $3 million right?

Michael W. Sutherlin - Chief Executive Officer and President

Our P&H business that's correct yes.

Robert F. McCarthy Jr., - Robert W. Baird

Is it materially different on the underground side?

Michael W. Sutherlin - Chief Executive Officer and President

It was a little larger on the underground side but you can see that on our underground business we have quicker pricing power on the aftermarket that we do in the surface business, surface carries a number of long-term, what we call maintenance to repair contracts.

Robert F. McCarthy Jr., - Robert W. Baird

Right.

Michael W. Sutherlin - Chief Executive Officer and President

At the underground business we had higher material cost increases but those didn't get reflected in the margins because they were able to offset those with pricing running through the aftermarket part of their business in particular.

Robert F. McCarthy Jr., - Robert W. Baird

Okay. On an overall basis combining both sides of the business, would it be your expectation that the dollar variance would decline in the coming quarter, in the October quarter?

Michael W. Sutherlin - Chief Executive Officer and President

Yes, we think it will.

Robert F. McCarthy Jr., - Robert W. Baird

Okay. And I read that as, if we're wrong about it getting narrower in the fourth, then we have some conviction about it getting narrower by the first quarter?

Michael W. Sutherlin - Chief Executive Officer and President

Right.

Robert F. McCarthy Jr., - Robert W. Baird

Okay. So when you are talking about flat margins, you're not talking necessarily about flat income? Right?

Michael W. Sutherlin - Chief Executive Officer and President

No.

Robert F. McCarthy Jr., - Robert W. Baird

But I mean, because you're expecting significant absolute growth in machine shipments, right?

Michael W. Sutherlin - Chief Executive Officer and President

I am talking specifically about machine margins of revenue less standard cost per machine being flat through, like our surface business being flat through next year as we work through the backlog against the steel costs that we've seen.

Robert F. McCarthy Jr., - Robert W. Baird

And margin as... when you say that, when you use margin in that sense you mean the dollar margin or the percentage margin return on sales?

Michael W. Sutherlin - Chief Executive Officer and President

Percentage margin.

Robert F. McCarthy Jr., - Robert W. Baird

Percentage margin return on sales, okay. And if you'd humor me, just two other brief things, I think I heard you say that you're working to accelerate the launch of your Ultra Class dragline and if I got that right, what kind of a timeframe are we now talking about?

Michael W. Sutherlin - Chief Executive Officer and President

We have... most of our dragline opportunities that we map out and they are relatively large number. We're looking at somewhere around 15 to 20 dragline opportunities at this point. Most of those are going to be undertaken by poor customers. So you got a market where you have poor customers that will dominate the majority of the market and you got a few other customers that have the opportunity for one or two. And the poor customers that we've talked to, are looking for dig dates around 2011. And to get dig dates around 2011, we have to have an order certainly by the first half of 2009 to be able to make the 2011 dig date.

Robert F. McCarthy Jr., - Robert W. Baird

Okay, thank you. And I am also curious about the commentary regarding China startup costs. I mean the message is they ran a bit higher than expected. Is this a function of unforeseen cost elements or is it a function of you trying to accelerate when that capacity comes on line?

Michael W. Sutherlin - Chief Executive Officer and President

No. What we did is when we dealt our first facility for Joy in China and the project plan on the P&H facility along the same lines. But when we got into detailed engineering, we found that we had to... I think on the Joy facility, we had to drive something like... I don't know 200 piles to support the weight of that building was planned to take.

We had into the P&H engineering, we had to drive somewhere around 1500 piles to support the heavier overhead cranes and heavier machines and stuff that go along with the P&H manufacturing process. So that facility construction phase was pushed back because we had to do a lot more fund in the engineering and we had to go to another higher level of approval in China.

So we redirected some of those machines that were scheduled to go to China, we moved those into Milwaukee to replace the old machines that were limping home at the time had a lot of downtime and these replaced those. Some part of the overhead that we are seeing in China is, that we... that facility is not fully loaded with machines. We're still moving machines into that facility that were ordered to backfill for the machines that we moved into Milwaukee last year.

Robert F. McCarthy Jr., - Robert W. Baird

Okay.

Michael W. Sutherlin - Chief Executive Officer and President

We have a lot of moving pieces and the bottom line is the facility is running about six months behind our original project plan at this point. When we talk about covering all the line over the next day or six to nine months by... but certainly by through the first half of next year we will be ramped up and in production by the middle of next year. But we've been running a little bit behind and that's caused us very a higher cost out because we have people on the ground that are scheduled to start working and we don't have machines in all cases ready from them to work on.

Robert F. McCarthy Jr., - Robert W. Baird

Okay, I get it. Thank you.

Michael W. Sutherlin - Chief Executive Officer and President

Thanks Rob.

Operator

Your next question comes from Steve Barger with KeyBanc Capital Market.

Unidentified Analyst

Good morning everybody this is actually Joe Bakson [ph] for Steve.

Michael W. Sutherlin - Chief Executive Officer and President

Hi, Joe.

Unidentified Analyst

Can you guys just talk a little bit more about the Wuxi acquisition and how that ties into your Joy Light strategy?

Michael W. Sutherlin - Chief Executive Officer and President

Well. It actually doesn't tie into our Joy Light strategy. What our intent is just to keep the Wuxi at arms length. We've moved one of our senior guys out of the UK into China and reporting to him will be our normal Joy business and then the Wuxi. And the reason we want to keep Wuxi separate is that it has a customer base that's pretty different in level of sophistication technology and other things from our Joy business and it's almost like it's a different industry. So if you could imagine that you had an industrial products group, selling to a whole different set of customers it's almost to that context. What we've always been concerned about is imparting the Joy technology to that business without overwhelming them with too much technology and driving the costs up.

So we got to give them some better technology but just enough to keep them at the head of the competitive back in China and that's our plan right now. So we will grow that business off of its all base, we will use some technology transfer but we will not blend the two businesses. Joy Light is a product that right now we are scheduled to introduce with the Joy business sort of moving from the top tier customers and moving down and that's rather than starting at the low end and trying to use it at that point. We still think that Wuxi Shengda business nor their customers have the level of sophistication to use even the Joy Light equipment at this point. That market for that... where Wuxi Shendga operates in, they still have a high proportion of hydraulically powered sewing machines, not all of those sewing machines are electric powered. Lot of the mines are not electrified. So there is lot differences there, with the Joy Light is going to stay with the major Joy business in China, that's based in Shenzhen at this point.

Unidentified Analyst

That's good color thanks. Can you also just talk about the order tempo throughout the quarter trying to get a sense if the strengthening of the dollar or some of the recent declines in commodity prices that change the overall order pattern throughout the quarter?

Michael W. Sutherlin - Chief Executive Officer and President

No, our customers look at such long lead times that near term, this doesn't have very much of a effect. Very much on the major like original equipment orders, I mean literally we are in discussions with customers about delivery slots about equipment specifications. We may be in on our shop, for example, we may be in discussions with customers for 6 to 12 months before we actually book the order with us, for multiple machine orders or some of the major longwall projects we may be in discussions for two years as that project moves down the project pipeline with the customer. So near term fluctuation in the price really has very little impact on our business and very little impact on the order rates in our business.

Now we will see some adjustments in places like Central App and with the smaller mining companies that are doing more incremental production in selling on the spot market, there will be a little bit of volatility there, but that's relatively small portion of our overall business.

Unidentified Analyst

Great. Thank you.

Michael W. Sutherlin - Chief Executive Officer and President

Yes, thank you.

Operator

Your next question comes for Seth Weber with Bank of America Securities.

Seth Weber - Bank of America Securities

Hi. Good afternoon, everybody. Quick clarification and a quick question, just on the compensation expense was that the bonus expense, was that skewed towards the surface business or is that split fairly evenly surface and underground?

Michael W. Sutherlin - Chief Executive Officer and President

It is actually everywhere in the underground business. Last year we had a bit on our working capital based measure and for a few years we were accelerating our margins pretty rapidly and we were able to get a reasonable bonus payouts without significantly improving working capital. Last year both businesses did not to get their working capital targets and we didn't pay full bonus payout. If you remember the Joy business was struggling with the weakness in the U.S. underground market on top of that.

So last year on our underground business we did not payout bonuses in our underground business last year as a result of that, we did but it was small, small fraction. Surface business had a reduced payout, so this year the bonus payments were relatively above businesses but they were more significantly in the Joy underground business because they came off of effectively a zero base last year.

Seth Weber - Bank of America Securities

Okay thanks for that and then just my question is on the capacity adds, Mike in the past you've talked about adding kind of mid to high-teens capacity volume per year maybe pulling forward some of the shovel capacity that you have planned out to 2012. Can you give us... can you put some numbers around what types of the volume you are looking at, bring online over the next several years and whether you are going to pull forwards on these plans that you have out into the out years?

Michael W. Sutherlin - Chief Executive Officer and President

Our objective in our forward plan is tied around growing our real capacity, not constant dollar capacity at numbers that are sort of in the low to middle teens rate. So we're looking at sort of in the mid-teens area of real capacity growth and along with that we would grow our outsourcing suppliers at commensurate rates, so we would expect to keep the ratio of both greenfield [ph] and what we sent out about the same as it is today.

We've got the first P&H plant that's coming online and it'll be ramping up in the second half of this year. We got the second plant that'll, as following up by about a year, and we're looking at next steps beyond that. We also are stepping up investments in our existing facilities to get those more efficiently. If you look our P&H Phase 1 expansion in Milwaukee, we spent $20 million and retooled our rotating factory, place where we make shafts and gears et cetera. And we've got just a tremendous amount of benefit out of that. So it will go in and improving the internal processes or yield capacity for us effectively, yield capacity. So we would look for real capacity growth sort of in that mid-teen range over the next several years. We're looking at pulling our some of the programs forward, we don't have specific hard numbers on that. So we still are working on how we would do that but without any definitive green light get it done at this point.

Seth Weber - Bank of America Securities

Okay. Thanks very much.

Michael W. Sutherlin - Chief Executive Officer and President

Yes,thank you.

Operator

Your next question comes from Barry Bannister with Stifel Nicolaus.

Barry Bannister - Stifel Nicolaus

Just a clarification for a question, historically your model has been more cost plus, so were your salesmen just working off of steel prices or did you leave your bids on the table for too long in terms of new business booked that caused due to underestimate the cost of steel?

Michael W. Sutherlin - Chief Executive Officer and President

Well. We booked a lot of the orders that we're dealing with, we booked in 2006. So in 2006 we were not looking at accelerated fuel costs. As we got into the second half of 2007 and began to see what was happening with iron ore and nickel, we realized that we were going to get to roll through on steel cost, so we made some adjustments. The pricing also made adjustment to terms in contracts to allow us to at least pass through surcharges, but, a lot of the stuff that we're going to be dealing with in 2009 was stuff that was booked in 2006 and an early 2007 before we were aware of the accelerated steel costs.

Now in terms of leaving contracts on the table, we update those pretty consistently. As costs change we don't leave things out on the table for long period of time and get stuck with those. And so it was just a matter of the steel costs surge coming through and booking orders at a time before it was obvious to us how much the steel cost are going to increase and the impact it was going to have on us.

Barry Bannister - Stifel Nicolaus

Andsorry to beat the dead horse on these margin issues, but, to hit the mid-point of sales guidance and do $3.35 billion this year up 32%, to hit the mid-point of EPS guidance and do around 322, your operating margin would be about 16.0 that's EBIT margin Joy and P&H as a percentage of sales after corporate. That compares to the '06, '07 average of about 18.5. But it is interesting that to hit the mid-point of guidance in... of a consensus in '09 with 25% sales growth you'd only need a 17 margin. Earlier you said you'd get to 20 by 2010 as a goal that's an awfully big number, but it is consistent with your historical margins versus sales. So are you telling us that the EBIT margin has a shot at a 20 level by '10 as a number?

Michael W. Sutherlin - Chief Executive Officer and President

Our long-term objective, I'm not sure about the 20% by 2010 but if we run out our plans over the next five years, we expect those margins to be in the low 20s by the end of that five-year period. I can't tell you right now what that, where that puts us in 2010. Some of that's going to be influenced by the pace of acquisitions as well. And before we acquired Continental our margins targets were higher for any point in our planning horizon. Continental we think we've then improved those margins significantly but they start at a lower level. So at the start we average those in at lower level of build up and by 2010 we will be at a high enough level with Continental to get back where we were with just drawing P&H before we did that acquisition.

So there are a number of factors that are going on there. But certainly our objective is to get to the low 20s in the next five years. And I don't know, the consensus for 2007 is something that you guys said is not necessarily are right up to 2009, it's something you guys said is not our internal plans. And certainly we saw some... we talked in the last couple of calls about some one time cost or cost that relate to specific events that we all think are repeatable. So as we look at our plans for 2009, we correct for those things in setting the base from which we expect to improve earnings on a year-over-year basis. So the earnings improvement should be a little bit better next year because we're making up for some deficiencies we had in performance this year.

Barry Bannister - Stifel Nicolaus

And just to clarify two things, the EBIT margin after corporate is the margin you are talking about, not EBIT margin before corporate or EBITDA margin?

Michael W. Sutherlin - Chief Executive Officer and President

That's correct.

Barry Bannister - Stifel Nicolaus

Okay. And then just the other clarification was, you had a $12.4 million bonus payment in the quarter. It sounded like part of that was a catch-up and we didn't get a clear figure on what the run rate would be for the bonus around? And then secondly, you said that the purchase accounting adjustment of $5.8 million will decline to about $1.5 million by mid '09. Is that about peeling off $1 million a quarter of purchase accounting charges?

Michael W. Sutherlin - Chief Executive Officer and President

We'llpurchase because it's easier. But the purchase accounting should... by the first quarter of our fiscal 2009 purchase accounting should be at that annual run rate. So we'll see another step down in the fourth quarter and then by the first quarter of next year it will be at the run rate that averages about $6 million a year.

On the bonus, we've had bonus expenses that have been up during the course of this year pretty consistently. So we have... it's a high number because we're coming off of the lower bonuses last year and then our underground business, we, in fact, had essentially zero bonus last year.

And so the incremental is a pretty high as a result of that. In our business last year as we got closer to at the end of the year we were unwinding bonus reserves because as we got closer we realized that we weren't gong to make the target that we took some reductions in those bonus target. I don't have the numbers in front of me but if my guess is we might have taken some reduction of bonus in our targets in the third quarter of last year, and that's accentuated the difference between third quarter last year and third quarter this year. But the accrual rates we're doing our bonuses have been pretty consistent during the course of this year.

Barry Bannister - Stifel Nicolaus

Can you give us a clear flavor though of the delta from $12.5 million numbers we look to 4Q in the first half '09?

Michael W. Sutherlin - Chief Executive Officer and President

What we would be... what our bonus run rate is going to be.

Barry Bannister - Stifel Nicolaus

Yes, if you can.

Michael W. Sutherlin - Chief Executive Officer and President

I don't actually have those numbers. I can't tell you, I'd hesitate to guess because it would just be a speculative guess at this point.

Barry Bannister - Stifel Nicolaus

Thanks.

Michael W. Sutherlin - Chief Executive Officer and President

Yes.

Operator

Your final question comes from Charlie Brady with BMO Capital Markets.

Charles Brady - BMO Capital Markets

Thanks. Just the quick one. Any update on the CFO position and where that's going?

Michael W. Sutherlin - Chief Executive Officer and President

Yes it's been excruciatingly slow... we've had a couple of good interviews, we screened out a few people that we didn't think were quite right for us. We've got another interview to do next week and we would like to be in a position where we had two or three people that we feel are real... a good strongly qualified short list and then go to our final round and make our final decisions. So I think we're reasonably close to being able to just getting to get to a decision point. And I am hoping that here by into September. So we will have already announced what our decision is and what the timeline looks like but at closer it's not nearly as best as we'd like for sure.

Charles Brady - BMO Capital Markets

Thanks.

Michael W. Sutherlin - Chief Executive Officer and President

Thanks Charlie.

Operator

At this time there are no further questions. I would like to turn the call back over to management for closing remarks.

Michael W. Sutherlin - Chief Executive Officer and President

This is Mike Sutherlin. I would just like to close by just thanking everybody for joining us on the call today. I would also like to remind you that our businesses will be in Las Vegas at MineExpo on Monday through Wednesday, the 22nd through 24th of September and you will be able to see them a lot of the equipment and technology on display there. It is the industry's largest trade show, it happens only four years. So it is a real great opportunity to get a little up close in personal view of the industry. And I also like to invite you to join us either in person or by webcast for an analyst presentation that we'll do from MineExpo, on the morning of Tuesday, September 23rd. So with that again thank you very much and we will sign off.

Operator

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

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