Joy Global Q4 2008 Earnings Call Transcript

123jump.com Staff
11 Jan, 2009
New York City

The mining equipment maker sales surged 40% to a record $1 billion and net income was $118 million or $1.11 a share compared to $70 million or $0.64 a share last year. New orders were $1.2 billion. The company expects earnings per share between $3.60 and $4.00 in 2009.

Joy Global Inc ((JOYG))
Q4 2008 Earnings Call Transcript
December 17, 2008 11:00 a.m. ET

Executives

Sara Leuchter Wilkins - Vice President, Investor Relations and Corporate Communications
Michael Olsen - Executive Vice President, Chief Financial Officer and Treasurer
Michael Sutherlin - President and Chief Executive Officer

Analysts

Michael W. Gallo - C. L. King & Associates
Ann Duignan – J.P. Morgan
Andrew Kaplowitz - Barclays Capital
Charles Brady - BMO Capital Markets
Alex Blanton - Ingalls & Snyder LLC
Mark Koznarek - Cleveland Research Company
Henry Kirn – UBS
Seth Weber - Bank of America Securities
Jerry Revich - Goldman Sachs
Paul Bodnar - Longbow Research
Chris Weltzer - Robert W. Baird & Co.
Joe Bach - Keybanc Capital Markets
Alex – Buckingham Research Group
Barry Bannister - Stifel Nicolaus

Presentation

Operator

Good afternoon, my name is Suzette and I will be your conference operator today. At this time, I would like to welcome everyone to the Joy Global fourth 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. If you would like to ask a question during this time, simply press “*” then the number “1” on your telephone keypad. If you would like to withdraw your question, press the “#” key. Thank you. I would now like to turn the call over to Miss Sara Wilkins, VP of Investor Relations and Corporate Communications. Ms.Wilkins, you may begin your conference

Sara Leuchter Wilkins

Thank you Suzette. 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; Mike Olsen, our newly appointed Executive Vice President, Chief Financial Officer and Treasurer; Sean Major, our General Counsel and Secretary and Gene Furman, 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 fourth quarter and 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 Olsen

Thank you Sara. Let’s take a minute and review some of the highlights from our 2008 fiscal year and the fourth quarter in particular.

Bookings for the 2008 fiscal year totaled $4.8 billion compared to $2.9 billion in 2007. Of the $1.9 billion increase in new orders in 2008, $273 million resulted from the acquisition of the conveyor business of Continental Global Group. Excluding the Continental new orders bookings increased by 57% in 2008 with a 52% and 63% increase in new orders for the underground mining equipment business and surface mining equipment business respectively. For both the underground and surface mining equipment businesses the increase in bookings were led by significant original equipment orders, but also both businesses reported double-digit increases for after market orders as well.

Net sales in 2008 increased to $3.4 billion from $2.5 billion in 2007. The Continental acquisition contributed $251 million of this $900 million increase. Excluding the Continental sales, net sales increased 24% in 2008, with the underground equipment business increasing 22%, while the surface mining equipment business increased 27%. Both businesses reported increases in original equipment net sales in the mid-30% range with after market net sales increases of 22% and 12% for the surface and underground mining equipment businesses respectively.

Operating income increased from $473 million in 2007 to $551 million in 2008, which included a $23 million charge for a cancellation of a surface mining equipment repair and maintenance contract and $20 million of purchase accounting charges associated with the Continental acquisition. After these purchase accounting charges Continental contributed $10 million of operating profit during approximately eight months of the 2008 fiscal year.

Fully diluted earnings per share were $3.45 in 2008 and $2.51 in 2007. The effective tax rates were 29.2% in 2008 which benefited by discreet tax adjustment and 37.7% in 2007 which were adversely affected by discreet tax adjustment. Additionally, cash generated by operations increased from $382 million in the 2007 fiscal year to $577 million in the 2008 fiscal year. A substantial portion of the increase in cash flow was a result of the effective management of working capital during the year.

Now let’s turn to the fourth quarter.

The company experienced the effects of the turbulence in the financial market as we saw a significant strengthening of the US dollar relative to the other currencies in which we do business. The biggest impact, as you will hear a bit later, was on our bookings for the quarter which included the translation of the backlog at the exchange rate as of the end of the quarter. The impact on revenue and operating profit was far less significant during the quarter as these items were translated at average exchange rates that were in effect throughout the quarter and were calculated on a daily basis. However, as Mike Sutherlin will discuss in connection with our 2009 guidance, we can expect a significant impact on revenue and profitability in 2009 compared to the 2008 results if the current exchange rates stay the same throughout the 2009 fiscal year as they are currently.

Bookings in the fourth quarter totaled $1.2 billion and were made up of two components: $1.4 billion of new orders received, which was offset by a $200 million reduction to the translation of the backlog at the end of the quarter rates. The $1.4 billion of new orders compared to $967 million of new orders in the fourth quarter of 2007. Continental contributed approximately $75 million of this increase.

As mentioned in the earnings release issued earlier, both the surface and underground businesses had double-digit increases in bookings even after the reductions for backlog adjustments. The fourth quarter also included the cancellation of two electric mining shovels for the surface mining business.

Backlogs at the end of the 2008 fiscal year was $3.2 billion after the $200 million translation adjustment compared to $1.6 million at the end of 2007 and the backlog increased in each quarter during the 2008 fiscal year.

Net sales for the fourth quarter topped $1 billion for the first time and were 40% higher than net sales in the fourth quarter last year. Continental accounted for $93 million of the $296 million increase. The impact of the strengthening of the US dollar did not have as significant an impact on revenue as it did on bookings for the quarter and reduced current quarter revenue by approximately $20 million. The level of shipments of original equipment for both the underground and surface mining equipment businesses was the primary driver for the sales growth; however both businesses reported double-digit growth in the after market revenue.

Operating income was $192 million in the current quarter compared to $147 million last year. Continental made up $10 million of the $45 million increase in operating income.

Return on sales was 18.6% in 2008 and 20% in 2007. The change in the return on sales percentage was due to including the Continental results which included the $2.7 million of purchase accounting charges I discussed earlier, also at lower operating margins for the Continental business. And in addition, the impact in the change in sales mix at both the surface and underground businesses included a larger percentage of original equipment revenue.

Net income in the current quarter was $118 million, or $1.11 per fully diluted share compared to $70 million or $0.64 per diluted share last year. Net income was affected by the effective tax rate of 36.2% in the current quarter and 51.3% in the fourth quarter last year. Both periods included discreet tax adjustment charges, $13 million, or $0.12 a share this year, $18 million or $0.16 per share last year.

The cash tax rate was approximately 21% for the 2008 fiscal year and going forward we expect an effective tax rate to range between 32% and 33% with a cash tax rate in the mid-20% range.

During the fourth quarter, we generated $243 million of cash flow from operations compared to $172 million a year ago. Approximately $110 million of the current quarter operating cash flow was generated from the effective management of working capital.

During the fourth quarter, we repurchased approximately $266 million of outstanding shares, which brings the total shares repurchased to $1.1 billion under the $2 billion amount authorized by the Board of Directors.

At this time, now let me turn the discussion back to Mike Sutherlin.

Michael Sutherlin

Thank you Mike and just let me add my welcome to those on the call. I am pleased to have our new CFO on this call. Not only is he the best CFO for the job, but his knowledge of this company and the industry will be invaluable as we navigate through the challenges of the markets ahead.

We had an excellent quarter. Orders were strong and a near record. Shipments were a record and margins were back where they belong. Despite these superlatives, there are two aspects of the quarter that were even more important. First, the strong order rate for both original equipment and after market and second, the progress we are making to improve working capital efficiency. I will come back to these after reviewing our markets.

The continued weakening of the world’s economies is putting downward pressure on commodity demand and pricing and on our customers’ cash flows. Recent headlines are about customers reducing production, closing mines, having layoffs, cutting capital expenditures and in a couple of cases suspending dividends; however, the full story has another side. Our customers have been acting quickly and decisively to keep production in balance with demand and will continue to do so. This will keep from building excessive stockpiles or excess capacity, both of which would only prolong the recovery and act to depress prices. As they do so, customers are high-grading existing operations and are being more selective about expansion projects. The least efficient mines are being closed and the more compelling projects are moving forward.

Cuts in iron ore have reached 6% of worldwide production in response to lower steel production and to offset overstocking. Iron ores spot prices have already been cut in half and are now below contract. Contract prices are expected to come off by 20% which will still leave seaborne prices high after they have gone up 400% in the previous four years. Met coal will be similarly affected. If coal exports from China are a barometer, met coal prices could go down 40%, but it would still be at historically strong prices. Volume cuts will be mitigated by downgrading with lower quality returning to the thermal coal markets.

Thermal coal prices have held up better than other commodities and are ahead of a year ago levels. Thermal coal is used primarily for power generation and this demand varies the least with economic performance. In fact, power generation in the US has dipped into negative territory only three times in the past 50 years. Although this current recession may be the fourth, we can expect power demand to decline by 2% to 3% at the most. In addition, the next round of new power plants in the US and Europe will be coal fired and the US has as much as 15% to 20% of additional coal fired capacity through higher plant utilization. As a result, we think that coal use has a limited downside through this recession and that coal has the greatest upside here in recovery.

Copper prices are down significantly from their recent peak and from a year ago. Copper prices began to fall off the table in July, about the same time the speculative trades on the coal mix went from net long to net short; therefore copper prices may well be over corrected. Some customers believe so, while others are shedding high cost production. As a result, we have received shovel orders and also one cancellation for copper applications.

Although oil prices are down they are stabilizing well above the cash cost of oil sands production and therefore established producers will continue to operate at capacity. The justification for new projects is hampered by the high capital cost of the upgrader and therefore the customer for the next start up has decided to proceed with the mining part of the project and delay the upgrader. This quarter that customer showed confidence in this project by adding to the number of shovels they have on order.

Implied in this review of our end markets is the broad conviction that our customers have in the industry fundamentals. That was reinforced this quarter. The original equipment we booked came from existing projects that have been in the process for some time. Our equipment is some of the last capital to be purchased for major new projects and a justification to complete the project and operate the newest and most efficient mine is very compelling for our customer.

There are additional projects in the pipeline with equipment progressing toward the ordering decision. We expect to continue to book original equipment from existing projects going forward, but the pool is finite and these bookings will diminish with time. To partially compensate we expect a smaller and more selective list of active new projects based on the advanced work we are doing with our customers.

It was also encouraging to see the continued strength of our after market orders, because the after market is the largest and most important part of our business. We have historically experienced only modest reduction in after market revenues even with significant declines in original equipment and this was reconfirmed with the weakness in the US coal markets during 2006 and 2007. In addition, our growing fleet of equipment will provide added support to our after market revenues and therefore we believe our after market will be an important stabilizing force against the uncertainty ahead.

We had a couple of shovel cancellations this quarter. We know there are backlogs are not totally bullet proof, because they are ultimately based upon the credit worthiness of our customers and not just on the languages of the contract; however the associated process of customer fleet rationalization did much more to validate our backlog than to question it. All in, I believe these are very positive implications.

We entered 2009 with strong backlogs, but this is just one of the strengths we carry with us. We also have seen our working capital velocity improve dramatically. Advanced payments continue to build with backlog. More importantly, we have made significant progress in reducing the day sales and accounts receivable and the days’ production and inventory. The progress in accounts receivable is a result of attention to detail and increased resolve to our terms and conditions and inventories improving as our operational excellence programs build momentum. Not only does this reduce our working capital investment, but it also makes us a leaner, faster cycle business and both will be important in 2009.

2009 comes with very high levels of volatility and uncertainty. Although we are confident in our backlogs and feel we are a much leaner and more focused company, we must also position ourselves to deliver results over a wider range of possible outcomes. We have therefore taken the precautionary steps to conserve cash and restrict further increases in expenses and capital expenditures for the time being. This will not adversely impact 2009, but the flexibility could be important.

Not only are our markets evolving rapidly, but so too are our exchange rates. Exchange rate moves in the past two to three months have totally erased the trends over the past four to five years. Much of our manufacturing is done at international locations and even more of our after market activity is done in our international business units. Based on current exchange rates we expect the results of our foreign operations to translate back to 9% fewer US dollars compared to 2008. This will reduce our ability to deliver year-over-year revenue growth by $300 million and earnings growth by $60 million.

In setting our guidance we considered the strengths of our backlogs along with the uncertainty and the potential for deceleration in our markets. Current exchange rates are included in our guidance and we have not planned for any changes in those rates. Based on these factors, we expect our fiscal 2009 revenues to be $3.5 billion to $3.7 billion. Operating leverage should be near the top of our target range. With this and a slightly higher tax rate we expect to deliver earnings per fully diluted share between $3.60 and $4.00 in 2009.

When distributing this guidance through the year, you must remember that our first quarter is typically our lowest and that price and actions we took in 2008 will gain traction progressively during 2009.

Now I would like to turn the call over to questions. Suzette. Suzette, are you there?

Question-and-Answer Session

Operator

At this time, I would like to remind everyone in order to ask a question press “*” then the number “1” on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Michael Gallo with C. L. King.

Michael Sutherlin

Hi Mike.

Michael Gallo - C. L. King & Associates

The question that I have is just on the backlog, I mean obviously you had the cancellation of a couple of shovels in the quarter and the markets are evolving and evolving quickly. How do you get comfortable that the backlog is relatively secure? Then also, as kind of a second part to that question, do you anticipate any issues in collecting receivables as we come through the combination of a credit crunch on top of obviously a more difficult environment, particularly for some of the higher cost producers. Thank you.

Michael Sutherlin

Mike, I will answer the backlog issue and then let Mike deal with the collections part.

In today’s world, we are obviously in constant and repetitive discussions with customers about projects, project flow, project funding. Because our equipment is often purchased later in the life of the project, we are also able to see the spending rates that the customer has on those projects and so we have a lot of different barometers that we look at. But obviously the frequency of that check in process is much more intense today than it was even six months ago.

We had two customers that went through this fleet rationalization process and one was primarily an iron ore based customer who retained all of their shovel slots in our backlog. The other one was a copper customer that we had one cancellation from, but then validated the rest of the shovels we had in backlog. So, if you look at the risk in the market and the risk in backlog being driven somewhat by the commodity, somewhat by maybe the financial leverage of the customer, and somewhat by those two factors primarily, you would have to say that the fleet rationalization programs that we went through probably took away some of the higher risk elements that we have in backlog and it really gave us a lot more confidence. But, we are constantly talking to customers and revalidating and rechecking and reassessing the viability of those orders.

Certainly we don’t want to deliver a shovel that isn’t going to be paid for or the other remainder. We typically will have 70% of cash by the time we ship, but there is still the remainder that’s out and we certainly don’t want to start building the shovel that doesn’t have the ability to ship at the end. Some of the shovels are the same model, but unique in terms of features and options and configuration and so we are very cautious about starting to build on a shovel without having some additional validity from the customer about the ability to take at the end of the bill process.

Having said all that, I think our scrutiny and review and processes around backlog are much, much more intense today than they were even six months ago.

Having said that, it would be wrong to believe that there are no more cancellation potentials in backlog. I think that if there are any remaining potentials, I think there are a few, not many, but it would be wrong to assume that there are none. It is something that we work with every day and we feel more confident today about our backlog than we did just a few months ago.

With that I will turn it over to Mike to talk about the collection part of the process.

Michael Olsen

Yes, on the accounts receivable management we actually have an extremely robust process and it includes a number of activities. First of all, we in fact get advance payment throughout the bill process of equipment. We utilize letters of credit in those markets that in fact have risks, so that we have that payment assured before the product is shipped. We have a very well organized credit organization that is in contact with the credit department and accounts payable departments of our customers. They have a very robust process of communications where they monitor the collection of the routine accounts receivable items for parts and components that in fact are shipped.

We have a very high-level metric system in place where at every level of management the accounts receivable performance on a customer basis is reviewed. So, we are very, very proud of the effective results we have done in that accounts receivable collections on a timely basis and also in minimizing bad debt expense that the company has experienced down through the years and that result has been extraordinarily favorable for as long as I can remember and we are continuing to focus on those various processes.

Michael Gallo - C. L. King & Associates

Okay. Helpful contacts. Thanks a lot.

Michael Sutherlin

Thanks Mike.

Operator

Your next question comes from Ann Duignan with J.P. Morgan.

Michael Sutherlin

Hi Ann.

Ann Duignan – J.P. Morgan

Hey, good morning everybody. Mike, you noted in your commentary that customers are adjusting production faster this cycle than in prior cycles. While that is ultimately a good thing for the industry, wouldn’t this suggest that you could uncharacteristically see the after markets slow this cycle versus prior cycles?

Then my follow-up question is really around given that you are a very late cycle and kind of the last thing in the supply chain to get ordered, could you talk a little bit about what you are talking to your team about in terms of trough management and the expectations that you are setting for your organization in terms of how to manage, if and when, your business does ultimately see a downturn?

Michael Sutherlin

As we look at our markets, obviously cutting back on production early and minimizing the chances of over building and over building stockpiles and having them work through that at a later part in the recovery part of the cycle is good. Early cuts will level out the production rather than creating whipsaw effects and I think that’s ultimately very, very good for our business. The timing of the cuts was demonstrated in the weak US coal markets in 2006-2007 where we saw customers take production offline quickly and minimize the whipsaw effect of too much stockpiles later in the recovery part of that market. And so, we feel pretty good that the US coal market experience of 2006-2007 is an up-to-date barometer. Although our historic experience goes back a long way, we do have some recent experience that tells us that the after market will see moderated impact here compared to the original equipment.

Now, as our customer base today is a much more publicly traded customer base, this industry, even a decade ago, production was primarily in the hands of privately owned businesses or divisions of large multi-national energy corporations and they had a different mentality. Today, the production is held by publicly traded customers with reporting responsibilities to their investors and they are much more responsive to changes in the market.

I think that as we go forward we will see very quick responses. I think that the recent experience of the coal markets in the US in 2006-2007 give us confidence of how we can manage through that and we are also seeing our customers do a lot of high grading, so a lot of the mines that are coming off are marginal mines. Some of those are smaller mines. Like in a surface area there will be mines that are typically using hydraulic excavators rather than the electric rope shovels, so a less impact on us when the marginal mines come off production.

Again, we feel pretty good about our predictive capability and feel that, again, the after market will see only a modest impact in the cycle ahead and it will be a stabilizing force for us.

The late cycle impact, certainly we benefit as we enter 2009 with long backlogs and we have generally backlogs that roll out in the surface business through 2010 and then the underground business into 2010. So, as we go through 2009 we need to deliver those backlogs on the delivery schedules that we promised and with capacity increases that come on line in 2008 those delivery schedules will be up slightly from 2008, but at the same time we need to prepare for the markets that will exist after our backlog.

So part of our cut back in expenses right now is to, even though we are going to increase our shipment of real product in 2009 without increasing our expenses associated with that, until we can see more clearly where the market is going, that restriction on increase is sort of tied to the fact that if this increase in shipments is a temporary nature, if the declining rate of order receipts gives us less backlog in future years, we don’t want to be building expenses today. And then ultimately it depends on the extent and duration of the cycle, but ultimately we would, I think we have said this before, that our manufacturing strategy is based on cutting the capacity and cutting production in the high cost markets and we continue to wrap up production in our low cost markets, so when the time comes we would look at the higher cost to produce markets and begin to cut back in those areas in favor of low cost to produce markets and use that to rationalize our manufacturing rates.

I don’t know if that was a complete answer, but it does, I think, give you a flavor of what we are looking at in terms of after market and also the fact that we are very cognizant of the fact that if the order rate diminishes our business will slow at some point in the future. We need to start preparing early for that rather than wait until it happens and go off the end of the cliff.

Ann Duignan – J.P. Morgan

I appreciate the color. Do you have any sense, though, in terms of an expectation that you might have for the organization or for the business in terms of what you could deliver in trough margins this cycle versus prior cycles? I mean given all of the things that you have done and the fact that you have (inaudible) in low cost countries, would you anticipate that trough margins in the next cycle would be significantly higher than prior cycles or, if you could help us directionally that would be great.

Michael Sutherlin

Yes, we do believe those will be significantly higher. In our planning for the business we have done some downside scenario planning just to make sure that we understand, if the markets really deteriorated and we got into a worse case scenario, what that would do to our business and what kind of actions we would have to take. So we have gone through that in fairly extensive detail.

We also have said, previously, that we have an objective of maintaining EBIT margins in the double-digit range even in the trough of a cycle, so we would look at EBIT margins of 10% or higher in the trough of the market.

The downside scenario planning that we went through has convinced us that that is in fact a viable target to have.

Ann Duignan – J.P. Morgan

Okay. That’s very helpful, thank you. I don’t want to hog the questions, but one really quick question. As of what date is your currency set in your forecast? We have seen a lot of volatility in the dollar and that through the week.

Michael Sutherlin

Our currency is effective -- Mike Olsen has the specifics on that, but it is effectively set at the 2008 currency rates.

Michael Olsen

Yes, actually as you have seen those currency rates are moving around quite a bit. We set those rates as of the middle of November.

Ann Duignan – J.P. Morgan

Okay, thank you, that is very helpful.

Operator

Your next question comes from Andrew Kaplowitz from Barclays Capital.

Andrew Kaplowitz - Barclays Capital

Good morning everyone. Can you hear me okay? Mike Sutherlin, if you can talk about pricing of recent transactions, both pricing of transactions. Then have any customers come in and tried to renegotiate, let’s say, shovel and better and backlog. Can you give us more color on the conversations with customers around pricing?

Michael Sutherlin

Yes. We have been aggressively pushing pricing in response to steel cost increases and our customers understood that because many of them are producing iron ore met coal that is going into steel production, so they understood the increased raw material costs and steel making process.

At that time they were focused on increasing their production and as we told them we needed to raise prices they were very understanding of that. Today they want us to instantaneously reduce some of our pricing because fuel costs have come down. The steel costs that have come down have been more for the commodity kind of steels like hot roll coil steels that are built to forecast. We use very specialty high alloyed plate steel, in some cases very thick plate steel. In all cases very few suppliers that we go to; so we are looking at an environment where we expect steel costs to level rather than go down in the type of steels use. We have conveyed that to our customers and we have told them that the conditions of the market might allow us to stabilize pricing for a while, but it is not going to allow us to reduce pricing. We have been able to convince them of that to date.

Now we don’t intend to reduce the price of anything in backlog. We certainly did not get any relief on price when steel costs were going up and prices were fixed in our backlog and we would expect the same under current conditions.

When we went to our new contracts, we do have escalator clauses in those contracts and those escalator clauses are designed to give us target margins on the orders. The escalators will work in the up and the downside, so if we take an order today for delivery in 2011 we are protecting ourselves against changes in costs between now and then. If those costs go up we are protected, but if the costs go down the calculation works in both directions. Those escalator clauses might actually reduce some of the price of the units we shipped out of backlog in later years, but they won’t reduce the margin that we will get on those machines that ship out of backlog.

Andrew Kaplowitz - Barclays Capital

Great. Thanks. And the follow up is maybe the regional health of the markets right now; I mean obviously Russia seems like a concern. Are there any other areas that you would point out as being more worrisome? How do you look at it from a geographic perspective right now?

Michael Sutherlin

We look at risk and we are obviously doing a lot of work on this. We look at risk from two standpoints. One is we look at things like the commodities. Certainly some commodities have been under much greater price pressure and so that is an element we look at. We look at customer debt to equity and we have some customers that are relatively highly leveraged and that is a concern that we consider. Then start-up operations are a high concern because they have future production and no existing cash flow to work with. Those are the three things we look at.

Regionally Russia is at the top of our list. Russian steel production has cut way back. Met coal demand in Russia has been significantly reduced and we are continuing to monitor that. One of our cancellations did come out of the Russian market and it was a cancellation just because the customer did not have the wherewithal to proceed with the progress payments on the order. And so, Russia is our single biggest area that we have a concern with. The rest of the markets are generally multi-national, multi-regional companies, whether it is Australia, South Africa, US, South America, we feel pretty good about all those because of the more diversified companies that are working those markets.

The US, it has some smaller customers and some privately owned customers, and some start-up operations that we are monitoring very closely. So, it really, really gets down to probably some of the smaller operations in the US and Russia, so from a regional standpoint, is where we have the greatest amount of concern.

Andrew Kaplowitz - Barclays Capital

Mike, just really quickly on that, can you tell us how much of your current backlog right now is the small customers in the US and/or Russia?

Michael Sutherlin

I can’t tell you what the Russian backlog is. We do have some Russian backlog. The small customers, it is fairly minimal. In the last year or so we have been focusing our ordering on major customers that we believe will be good customers before, during and after the soft market conditions. As we have limited bill slots and we are forced to be selective, we naturally went to the bigger, more diversified customers with those bill slots and we minimized the amount of slots that went to the smaller customers.

I don’t really have the number for you, but it is down from where it would be traditionally. If you look at our business backlog over the last ten years, the ratio of the smaller customers is less today than it would have been.

The Russian market, I just don’t have the specifics. There are a few existing shovels that are going into the Russian market and some underground equipment that is scheduled for the Russian market. I just don’t have the specific numbers on that.

Andrew Kaplowitz - Barclays Capital

Okay, that’s fine. Thank you very much.

Operator

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

Michael Sutherlin

Hi Charlie.

Charles Brady - BMO Capital Markets

Hey Mike, good morning. Just given what is going on in the commodity markets and with your customers and the whole market in general, your thoughts on the dragline market currently versus where it was a few months ago? Any significance? I mean are your customers telling you that they are pushing out on the dragline outlook or how is that today?

Michael Sutherlin

Well, the dragline market has been a market that has been dominated by just a handful of customers, so there are dragline prospects. We don’t have 12, 15 customers with one or two draglines each. We have a high concentration of those dragline prospects in the hands of a few customers and those customers are the larger, diversified mining companies. With one exception they seem to be financially in a good position. From a business strategy standpoint they seem to be determined to continue to move ahead. They see this as an opportunity. So, we are seeing the normal progression of some of the dragline prospects.

On the other hand, some of those dragline prospects are with customers who are financially strained right now and those have pushed to the back burner. So, you take that prospect list and at this point, just from a very broad perspective, you would probably say about half of those are still active and the other half are probably sliding back to the back burner.

Charles Brady - BMO Capital Markets

Thanks. As a follow-up, on the two settled cancellations, when were those scheduled for delivery?

Michael Sutherlin

The earliest one was late 2009 and the other one was in 2010. I don’t have the exact time in 2010.

Charles Brady - BMO Capital Markets

That’s fine. Thanks.

Operator

Your next question comes from Alex Blanton from Ingalls & Snyder.

Michael Sutherlin

Hi Alex.

Alex Blanton - Ingalls & Snyder LLC

Alex Blanton. I have got some questions, also, on the dragline and shovel cancellation situation. You said earlier, based on the credit worthiness of the customer rather than the language of the contract. Now, I assume that you were referring to the Russian shovel that was cancelled because the customer couldn’t pay for it?

Michael Sutherlin

That is the case, but in any case if we don’t believe that the customer has the wherewithal to pay we are not going to be shipping a shovel out. So definitely the Russian order was -- there was no point in keeping the order in backlog and no point in pressing the customer on it, because of their inability to pay.

Alex Blanton - Ingalls & Snyder LLC

That was not my question. My question is what is the language of the contract that you referred to? What did the contract specify and did you have to waive the provision of the contract in order to do that?

Michael Sutherlin

Yes. The contracts we have call for no cancellation and no return of cash on deposit, the down payment and advanced payments.

Alex Blanton - Ingalls & Snyder LLC

Okay, no return of the deposit and…

Michael Sutherlin

Yes, we don’t return cash.

Alex Blanton - Ingalls & Snyder LLC

Right, I understand that, but there is a no cancellation contract that in fact can be cancelled, is that correct, at your discretion.

Michael Sutherlin

Yes.

Alex Blanton - Ingalls & Snyder LLC

All right. Because one of your competitors said on a recent call that his contracts were non-cancelable, they could not be delayed, and in his 30 years with the company that had never happened. But clearly circumstances dictate, is that the case? And will continue to do so? I mean no matter what the contract says, all right?

Michael Sutherlin

Exactly. I mean at the end we have two things that drive our thinking. Contract terms are contract terms and we live by those terms and our customers live by those terms. But, in the case of the Russian customer, we made the decision based upon the facts that we had that it wasn’t in our best interest to pursue that. It was in our best interest to go to court and file for breach of contract because we spend more money legally than we would be able to recover in all likelihood, so we thought that was just not the right course of action to take.

On other customers, if a customer comes in with a product in backlog we are constantly working with customers for changes in deliver slots. We do that all the time, in good times and bad times, but we have a finite number of customers. They are all repeat customers. We are not going to get a customer mad at us for the sake of the terms of the contract. We look at this from a business standpoint and we make the right business decision on a case-by-case basis. So we don’t move backlog in ways that harm us, but if one customer wants to move up and another customer wants to slide back we would work that to accommodate both customers and we have traditionally done that.

So we are not easy on backlog. We are not easy on terms and conditions. But we have also not come to the point that we are going to do things that are not good for the business because it is in the contract.

Alex Blanton - Ingalls & Snyder LLC

Well that certainly makes sense.

One more question. You said your forecast or guidance or whatever for 2009 on EPS was $3.60 to $4.00 and yet earlier you said that you were positioning for a wider range of possible outcomes. I thought when you said that that you were referring to some ranges that you would give, but these ranges don’t seem very wide considering the uncertainties. What do you base that range on? It is not a very wide range. It is only about 10%.

Michael Sutherlin

Right now we feel good about our backlogs going into 2009. We feel also good about the after market business. Again, we have got a fleet of machines working in the field. The level of those operations and the level of production products, the after market – under adverse conditions we would expect the after market to start slowing a bit, but not collapse.

So, if you look at 2009, we have got good backlog, we have got reasonable prospects for after market, but we are cutting back costs because if the original equipment order rates decline in 2009 we would have to also, during the course of the year, position ourselves for 2010. If 2010 is a different year than 2009 we need to be prepared for that. So part of what that preparation work is, is I think we have more confidence in 2009 from a numbers standpoint. We also need to end 2009 prepared for 2010, whatever that 2010 might look like.

Alex Blanton - Ingalls & Snyder LLC

Well, one of the customers in the mining area, Rio Tinto recently said that they are reducing their purchases, capital expenditures for this year, I mean for 2009 from $9 to $4 billion, of which $2 billion was maintenance and they would monitor the situation and if it didn’t improve they would reduce to the maintenance level in 2010 which would be into the $2 billion level from $4 billion in ’09. So, clearly some of the customers are planning some further cuts in 2010. How would that affect you?

Michael Sutherlin

Well, we go in to the markets ahead with good strong backlogs. Our surface equipment has backlogs through 2010; our underground has backlogs into 2010. That gives us some things to work with, but in a decelerating market there will be a point where, it depends on the duration of the decelerating market, but eventually you will get to the point where you have got to live at the rate of the incoming order rate, whatever that is. So, whether that is for us 2011 or 2012, there is a date out there at which incoming order rates determine the level of business not backlog.

So we are constantly trying to blend those two, but there is great uncertainty about how the market is going to perform going ahead. How much it is going to decelerate and how long the weak economic conditions are going to last. Those are not things that we can predict to any degree of certainty; so we are positioning ourselves to accommodate a wide range of outcomes as we look at those outlying years and be prepared for the worst and hope for the best.

We keep structuring our costs to deliver on our promises in 2009 and to position ourselves in 2010 and beyond to deliver the best performance we can for shareholders.

So, it is just something that is going to evolve during the course of 2009 and we are preparing, we are reading the markets, and we are ready to respond, but there is no certainty about what that is going to look like. You just have to take it as it comes.

Alex Blanton - Ingalls & Snyder LLC

Thank you.

Operator

Your next question comes from Mark Koznarek from Cleveland Research.

Michael Sutherlin

Hi Mark.

Mark Koznarek - Cleveland Research Company

Hi, good morning. Mike Olsen, congratulations. I have a question about the currency comments, because over the last many, many earnings releases and conference calls there has been virtually no commentary on currency. The comments are always that you did business in primarily US dollars and currency didn’t matter and even going through the SEC filings the only comments on currency have to do with, every now and then there is a comment on the expenses or comprehensive income. So, why is currency suddenly coming up as such a negative? That is $0.40 a share, what we are talking about, in terms of the operating income impact. Are you accounting for it differently, or what has changed?

Michael Sutherlin

What has changed, Mark, is that the dollar has been weakening over the last four to five years and that weakening has spread itself over that period of time to the point that in any given quarter there was not a significant impact. In the last quarter we saw the dollar strengthen and totally raise the last four or five years of weakening; so now it just kind of appeared we have the dollar moving at extremely strong rates and moving suddenly and all of a sudden we have, what would otherwise be reported over four or five years, is now something we have to deal with all at once. So there is no change in accounting, but it really does have to do with the extreme volatility of those foreign exchange rates over the recent few months.

Mike can give you more details.

Mark Koznarek - Cleveland Research Company

What would have been the positive impact of currency on earnings this past 12 months?

Michael Olsen

It is a couple of things. One, there was a significant impact on the bookings because of the backlog adjustment, which uses a currency rate at the point of time on the last day of the fiscal quarter and that is what caused the significant adjustment to the backlog, which then affected the bookings.

If you take a look at the 2008 fiscal year, the first three quarters, as Mike indicated, there was an adverse, very, very slight positive impact on both sales and net income. So slight that at the end of the day it was almost rounding. When you looked at the full year there was a positive impact on our results by $35 million worth of sales and keep in mind that this was on sales that were well in excess of $3 billion, so a very, very small number and its impact on operating profit for the full year was only $2.8 million, once again, a very, very small number. In any particular quarter it is really not a significant impact on the results.

When you looked at the fourth quarter, as I said in my comments, it impacted negatively because as the dollar began to strengthen in the fourth quarter it impacted on sales by decreasing those sales, when translated, to around $20 million and the impact on operating profit was to decrease operating profit of about $3 million. And to be clear, what this impact is associated with is the operating results that we do outside of the United States that in fact are denominated in local currencies and then those local currencies then are subsequently translated into US dollars. There will be a significant portion of the surface mining equipment business where their transactions are in fact denominated in dollars and they won’t have that exposure.

But on the underground side of the business and also on the Continental side of the business, as they do business in places like South Africa, Australia, and Eurasia, those transactions will be denominated, for the most part, in the local currencies, which subsequently have to be translated into US dollars.

Michael Sutherlin

In our after market now even if we manufacture shovels and ship out of Milwaukee in US dollars, the after market in the international regions are all in local currencies.

So Mark, in our guidance we have taken the exchange rate where it was at the middle of November, at that point in time and we do our guidance around that. We have made no provisions for changes in those exchange rates. Obviously, if the exchange rates, if the dollar continues to strengthen we are going to be under pressure to deliver the earnings that we have guided. If the dollar gets weaker we are going to get some relief, but we are not capable of predicting when, where, and how far the dollar is going to move.

Mark Koznarek - Cleveland Research Company

Okay. One follow-up on a prior question having to do with after market growth for next year and your confidence in that. As I look back at the ’07 results, the US underground business was a negative surprise. It weakened faster than you guys thought and by my estimation, it looked like the US underground revenues slowed from a teens growth in ’06 to less than 5% in ’07 and as we were going through that year there were negative revisions because of that; so what gives you guys the confidence that you think you have visibility for the next 12 months in keeping after market at a double digit rate?

Michael Sutherlin

In the US market example that we talked about, we saw our original equipment order rates decline by more than 60%, a 60% to 80% decline in original equipment order rates. We saw the after market order rate over that same period of time decline by single-digit rates. So, the numbers for the US market did swing pretty significantly, but it was driven by the original equipment rather than the after market and we just didn’t enter that period with as much backlog as we have now in the underground business. So we didn’t have the backlog to work with; very quickly it got down to the point where incoming orders drove the business and the overall results were more volatile. But, there was a difference between the after market and the original equipment.

Right now in our guidance we are assuming typical year-over-year after market growth in those numbers under the conditions we have in our guidance. But, we are also saying that if the market continues to slow and after market is under pressure it is likely to move like the US underground business did in 2006-2007 with reductions at a very small and certainly in single-digit rates rather than larger scale reductions which, under the worse case scenario, could affect our original equipment order rates going forward.

Mark Koznarek - Cleveland Research Company

So if I understood you, Mike, did you say that the range of expectations for after market next year could be single-digit to kind of mid-teens, like the mid-point of your range, but on the low end it could be a single-digit number in terms of after market growth?

Michael Sutherlin

Those are probably good assumptions.

Mark Koznarek - Cleveland Research Company

Okay. All right, thank you.

Operator

Your next question comes from Henry Kirn with UBS.

Michael Sutherlin

Hi Henry.

Henry Kirn – UBS

Good morning guys. I am wondering if you could talk about the uses of cash flow as we go into 2009. How do you look at buybacks? Would you continue to buyback shares or would you rather keep gunpowder on the sidelines?

Michael Sutherlin

We have always said that our default value is returning cash to shareholders for the share buyback program. In today’s market cash is king and we have got a little bit of a different philosophy right now and cash accumulation is number one on our priority list. We think that’s in the best interest of the shareholder, to make sure that we have a cash accumulation to provide all the cushion that we might need and so that is what we are doing right now. We have scaled back on a lot of CapEx, even some of the CapEx that we had approved we scaled back on, because it is growth related CapEx and some of that is service centers and different markets. And I will give you an example. We had a service center that we approved for the Russian market. Under current conditions we are not going to be spending money in that market until we get more confidence on where that is going. So there is a lot of other of those CapEx programs that we have scaled back on.

At this time, we will not be doing share buybacks for a while, until we have accumulated a significant amount of cash. We think there is more value in the markets heading for, more value by getting some very strategic acquisitions at some very good pricing. If the markets continue to deteriorate and some of the product lines that are out there come under pressure, then we think there is opportunities and we would like to have the cash build to be able to do that. I think that is consistent with where we have always been, saying that acquisitions, in the long run, are more beneficial to the shareholder than share buyback programs. But, we are not going to be aggressive.

The stock is massively under valued in my opinion, but it is still not the best use of our cash to go out there and buy stock and deplete our cash reserves at this point.

Henry Kirn – UBS

Is it possible to talk a little bit about how your suppliers are poised to handle the downturn? Could there be any challenges from suppliers who may be under some financial stress today?

Michael Sutherlin

Maybe Mike can talk about that. He is a little bit closer to that than I am.

Michael Olsen

Yes. What we have done over the last several months is we have instituted a formal review process for both our critical suppliers and also our critical subcontractors and what we are doing is we are assessing their current financial position and assessing their ability to continue to supply our needs and making certain that they have the financial strength to continue to buy the raw materials and maintain their facilities and so forth.

We have, in fact, come across a couple of situations where we have had to make changes because of concerns we have had, but for the most part we are comfortable with the financial position of key suppliers and also key subcontractors.

Henry Kirn – UBS

That’s helpful, thanks a lot.

Operator

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

Michael Sutherlin

Hi Seth.

Seth Weber - Bank of America Securities

Hey thanks. Good morning everybody. Mike, on your last call you talked about your intent to start raising prices on the after market business. Can you talk about your plans there and whether that has been successful?

Michael Sutherlin

Well, we have had price increases. In our fourth quarter we announced price increases for both surface and underground equipment in our fourth quarter, and because of backlog, even on aftermarket we will carry a few months of backlog. In some cases we have contracts with customers that define how those price increases roll in. We expect those price increases to gain traction through 2009 and not all of them instantaneously effective. But customers don’t like it, but they understand the importance of catching up our prices to the steel cost increases and it has been okay. So we feel good that those price increases will hold.

Seth Weber - Bank of America Securities

Okay. There was a question on the dragline market. Does your 2009 forecast assume that you get a dragline order at some point in the first half of the year say?

Michael Sutherlin

It doesn’t at this point. A dragline order and the engineering work that would have to go into that order at the front end would end up with a fairly insignificant impact on 2009. We really wouldn’t get into the sourcing manufacturing part of that project until late in the year. So an order in the first quarter even it wouldn’t have a big impact and even an order in the first half would have less of an impact in 2009.

Seth Weber - Bank of America Securities

Okay. And just lastly, the Wuxi acquisition is that going as expected? Can you talk about any traction that you are getting with that acquisition and what your outlook is for the Chinese market?

Michael Sutherlin

Yes, the Wuxi acquisition, actually we should be closing on that in the next day or two. There was some delay because the business is required to relocate as part of a regional economic development plan and the mechanics of the relocation are a little bit more difficult to work through than actually getting the acquisition done. So we will close on that in the next day or two, certainly before we break for the holidays.

Our people have been working – have been on site and doing the pre-work on this and we are streamlining. Their manufacturing and production rates are up. The market looks really strong there and we think there is a lot of upside.

The business that hasn’t been very efficient in manufacturing is a business that hasn’t been very effective in going to market; so we look along both sides in that business and we think the market conditions in China is still strong. Power demand is still up. Coal production is still required; particularly coal production for mechanical mines is still required to offset the township mines which still have the safety problems, which the government is still trying to close down. So, I think we feel better about that acquisition than when we made it and we feel that there is more upside than we had considered when we did the justification on it.

Seth Weber - Bank of America Securities

In total was your business in China up for the year, I guess for the year and then the fourth quarter?

Michael Sutherlin

For the year, I can’t tell you about the fourth quarter. But for the year the pattern of deliveries in China, OE deliveries and even the after markets, sometimes we will get a year’s worth of orders into three or four trounces during the year for some of the major customers, so they come in relatively large lumps. But for the year our China business is up. I just can’t tell you whether the fourth quarter was the same or not.

Seth Weber - Bank of America Securities

Okay. Thanks very much.

Operator

Your next question comes from Jerry Revich with Goldman Sachs.

Michael Sutherlin

Hi Jerry.

Jerry Revich - Goldman Sachs

Good morning. Mike Olsen, congratulations on your promotion.

Michael Olsen

Thank you.

Jerry Revich - Goldman Sachs

Mike Sutherlin, can we start with a quick question on the surface mining business. In the aftermarket piece you have had over 15% revenue growth per year over the past five years on single-digit production increases for your customers. Can you discuss why you expect the after market to be more sticky when production is getting cut than it was on the way up?

Michael Sutherlin

Part of that after market revenue growth comes from alliance products that we run on our surface equipment. Our underground equipment only sells and services its own equipment.

In surface we also represent other complimentary product lines in sales and service and some of the outside is coming from those alliance products that we have added to our revenue stream in the surface business. But, we have also worked very, very hard to translate our after market business from transactions to programs. So, we have more program-based businesses where we are maintaining equipment in the mines. We have multi-year maintenance and repair contracts and those things give us a higher capture rate on the after market. So, we have been building up that capture rate through time and we are seeing the benefits of that certainly in the markets we face.

Going ahead we feel good that the install base is going to continue to grow. Typically a shovel will begin to pick up noticeable after market demand in year three. And so, based upon the shovels we have delivered over the last several years, we will see that more shovels hit that three year time and add to the after market revenue base.

In all likelihood, if there are moves in some of these mining close downs or cutbacks require shovel moves then that is another generator of after market revenues. So, a lot of things go into the equation, but certainly we have been gaining our capture rate, we have been gaining with the alliance programs that we have and we have been gaining in the translation of the transaction based after market to program based after market.

Jerry Revich - Goldman Sachs

And Mike, the program based after market, is the revenue portion of that for you volume driven or operating hours driven? And also, what proportion of your after market business is now a program business?

Michael Sutherlin

The programs generally will be tied on the surface to operating hours would be more the norm. Underground it’s tons of production typically, and those programs also will have some minimums in there so that they don’t zero out. Those programs have been growing and we have been focusing on growing those programs. Certainly our support services initiative has helped that; it will help that going forward.

Today, across both businesses, the full up programs where we are managing the customer’s fleet are in the 20% of after market revenue range and growing. There is more of program based. If you broaden the definition of program and you include some sole source agreements we have with some customers, and you include some mark contracts, those numbers will get up into the 30% to 40% range or maybe a little bit more than 40% now.

Jerry Revich - Goldman Sachs

Got it, thank you and could you please update us on your order performance for November or quarter to date on a year-over-year basis across both businesses?

Michael Sutherlin

We don’t provide interim information. We only do quarterly information sir.

Jerry Revich - Goldman Sachs

Okay and lastly, can you please discuss the economics of the shovel order that was cancelled? Specifically what portion of the customer prepayment did you keep and how did the economics of that cancellation work out for you?

Michael Sutherlin

We don’t return cash. When it was worked out it was no harm, no foul from our standpoint. It was a good outcome for the customer and they viewed that as a goodwill accommodation on our part to work with them to find a good solution. But, there is no economic consequence to us from that cancellation. Actually it is a favorable economic consequence actually with no negative.

Jerry Revich - Goldman Sachs

It sounds like you made at least the margin that you would have made on the sale anyway.

Michael Sutherlin

It depends on the amount. The shovel was out and it depends on the amount of payments we have in. And so, yes, the shovel was cancelled because it was a further out shovel that didn’t have a lot of progress things associated with it, so that the real impact is not going to be noticeable for us.

Jerry Revich - Goldman Sachs

Okay. Thank you.

Operator

Your next question comes from Paul Bodnar with Longbow Research.

Michael Sutherlin

Hi Paul.

Paul Bodnar - Longbow Research

Hi. How are you? I have one question just on margins going forward. Before last time you gave a lot of clarity on what to expect on original equipment and after market. I know you guys said you haven’t really seen some of the steel prices start to reverse themselves and the higher alloy steels. But, if that does happen do these escalators end up just giving most of that back or when does that really kick in? I was wondering if you could just give us a little clarity on that.

Michael Sutherlin

I think we said that the earlier part of 2009 has some contracts that are fixed cost contracts. The latter part of 2009 has contracts that have surcharge past dues in them, and as we get out to 2010 we have contracts with escalators built in. The escalation clauses protect us. In the details of those contracts we are protected so that the margin at the time of delivery is not less than the margin that we had projected at the time we had contracted. So we have been pushing prices up that drive those margin expectations and then we have escalators in that protect us on the downside and also, if our costs go down it helps the customer. The way we have been able to position those escalators is that we are not going to t