Joy Global 10-K 2006
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED October 28, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD From to
Commission File number 1-9299
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b -2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
The aggregate market value of the voting and non-voting common stock held by non-affiliates, as of April 28, 2006 the last business day of our most recently completed second fiscal quarter, based on a closing price of $65.69 per share, was approximately $8.0 billion.
The number of shares outstanding of registrants common stock, as of December 13, 2006, was 113,154,724.
Joy Global Inc.
ANNUAL REPORT ON FORM 10-K
For The Year Ended October 28, 2006
This document contains forward-looking statements. When used in this document, terms such as anticipate, believe, estimate, expect, indicate, may be, objective, plan, predict, will be, and the like are intended to identify forward-looking statements. Forward-looking statements involve risks and uncertainties and are not guarantees of future performance. Actual results may differ for a variety of reasons, many of which are beyond our control. Forward-looking statements are based upon our expectations at the time they are made. Although we believe that our expectations are reasonable, we can give no assurance that our expectations will prove to be correct. Important factors that could cause actual results to differ materially from such expectations (Cautionary Statements) are described generally below and disclosed elsewhere in this document. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the Cautionary Statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Our principal businesses involve designing, manufacturing, marketing and servicing large, complex machines. Significant periods of time are necessary to design and build these machines. Large amounts of capital must be devoted by our customers to purchase these machines and to finance the mines that use them. Our success in obtaining and managing a relatively small number of sales opportunities, including our success in securing payment for such sales and meeting the requirements of warranties and guarantees associated with such sales, can affect our financial performance. In addition, many mines are located in undeveloped or developing economies where business conditions are less predictable. Factors that could cause actual results to differ materially include:
Factors affecting our customers purchases of new equipment, rebuilds, parts and services such as: production capacity, stockpile levels and production and consumption rates of coal, copper, iron ore, gold, oil sands and other ores and minerals; the cash flows and capital expenditures of our customers; the cost and availability of financing to our customers and their ability to obtain regulatory approval for investments in mining projects; consolidations among customers; changes in environmental regulations; work stoppages at customers or providers of transportation; and the timing, severity and duration of customer buying cycles, particularly for original equipment.
Factors affecting our ability to capture available sales opportunities, including: our customers perceptions of the quality and value of our products and services as compared to our competitors products and services; our ability to commit to delivery schedules requested or required by our customers; whether we have successful reference installations to display to customers; customers perceptions of our financial health and stability as compared to our competitors; our ability to assist customers with competitive financing programs; the availability of steel, castings, forgings, bearings and other materials; and the availability of manufacturing capacity at our factories.
Factors affecting general business levels, such as: political and economic turmoil in major markets such as the United States, Australia, Brazil, Canada, Chile, China, Russia and South Africa; environmental and trade regulations; commodity prices; and the stability and ease of exchange of currencies.
Factors affecting our ability to successfully manage and complete sales we obtain, such as: the successful transition to a new enterprise software system at our surface mining equipment business; the timely renegotiation of expiring collective bargaining agreements with our unionized workers; the accuracy of our cost and time estimates for major projects and long-term maintenance and repair contracts; the adequacy of our systems to manage major projects and our success in completing projects on time and within budget; our success in recruiting, hiring and retaining managers and skilled employees in the areas where we operate; wage stability and cooperative labor relations; plant capacity and utilization; and whether acquisitions are assimilated and divestitures completed without notable surprises or unexpected difficulties.
Factors affecting our general business or financial position, such as: unforeseen patent, tax, product (including asbestos-related and silicosis liability), environmental, employee health and benefits, or contractual liabilities; changes in pension and post-retirement benefit costs; nonrecurring restructuring and other special charges; changes in accounting or tax rules or regulations; reassessments of asset valuations for such assets as receivables, inventories, fixed assets, intangible assets and deferred tax assets; and leverage and debt service.
We describe these and other risks and uncertainties in greater detail under Item 1A Risk Factors below.
Item 1. Business
Joy Global Inc. (we and us) is a leading manufacturer and servicer of high productivity mining equipment for the extraction of coal and other minerals and ores. Our equipment is used in major mining regions throughout the world to mine coal, copper, iron ore, oil sands and other minerals. We operate in two business segments: underground mining machinery (Joy Mining Machinery or Joy) and surface mining equipment (P&H Mining Equipment or P&H). Joy is a major manufacturer of underground mining equipment for the extraction of coal and other bedded minerals and offers comprehensive service locations near major mining regions worldwide. P&H is a major producer of surface mining equipment for the extraction of ores and minerals and provides extensive operational support for many types of equipment used in surface mining. Sales of original equipment for the mining industry, as a class of products, accounted for 31%, 37% and 39% of our consolidated sales for Fiscal 2004, Fiscal 2005 and Fiscal 2006, respectively. Aftermarket sales, which includes revenues from maintenance and repair services, mining equipment and electric motor rebuilds, equipment erection services and sales of replacement parts, account for the remainder of our consolidated sales for each of those years. Because these aftermarket sales generally include a combination of various products and services, it would be impracticable to determine whether any other class of products or services could be considered to exceed 10% of our consolidated revenues in any of the past three fiscal years.
We are the direct successor to a business begun over 120 years ago and were known as Harnischfeger Industries, Inc. (the Predecessor Company) prior to our emergence from protection under Chapter 11 of the U.S. Bankruptcy Code on July 12, 2001.
Underground Mining Machinery
Joy is the worlds largest producer of high productivity underground mining machinery for the extraction of coal and other bedded materials. It has significant facilities in Australia, South Africa, the United Kingdom, and the United States as well as sales offices and service facilities in China, India, Poland, and Russia. Joy products include: continuous miners; longwall shearers; powered roof supports; armored face conveyors; shuttle cars; flexible conveyor trains; complete longwall mining systems (consisting of powered roof supports, an armored face conveyor and a longwall shearer); and roof bolters. Joy also maintains an extensive network of service and replacement parts distribution centers to rebuild and service equipment and to sell replacement parts in support of its installed base. This network includes six service centers in the United States and eight outside of the United States, all of which are strategically located in major underground mining regions.
During Fiscal 2006, we completed the acquisition of the net assets of the Stamler business. The addition of Stamler provided complementary products such as feeder breakers, continuous haulage systems and battery haulers to the Joy business. Stamler had sales offices and warehouse facilities in many of the same locations as Joy and P&H throughout the world.
Products and Services:
Continuous miners Electric, self-propelled continuous miners cut material using carbide-tipped bits on a horizontal rotating drum. Once cut, the material is gathered onto an internal conveyor and loaded into a haulage vehicle or continuous haulage system for transportation to the main mine belt.
Longwall shearers A longwall shearer moves back and forth on an armored face conveyor parallel to the material face. Using carbide-tipped bits on cutting drums at each end, the shearer cuts a meter or more of material on each pass and simultaneously loads the material onto the armored face conveyor for transport to the main mine belt.
Powered roof supports Roof supports perform a jacking-like function that supports the mine roof during longwall mining. The supports advance with the longwall shearer, resulting in controlled roof falls behind the supports. A longwall face may range up to 400 meters in length.
Armored face conveyors Armored face conveyors are used in longwall mining to transport material cut by the shearer away from the longwall face.
Shuttle cars Shuttle cars, a type of haulage vehicle, are electric-powered with umbilical cable, rubber-tired vehicles used to transport material from continuous miners to the main mine belt where self-contained chain conveyors in the shuttle cars unload the material onto the belt. Some models of Joy shuttle cars can carry up to 22 metric tons of coal.
Flexible conveyor trains (FCT) FCTs are electric-powered, self-propelled conveyor systems that provide continuous haulage of material from a continuous miner to the main mine belt. The FCT uses a rubber belt similar to a standard fixed conveyor. The FCTs conveyor belt operates independently from the track chain propulsion system, allowing the FCT to move and convey material simultaneously. Available in lengths of up to 570 feet, the FCT is able to negotiate multiple 90-degree turns in an underground mine infrastructure.
Roof bolters Roof bolters are roof drills used to bore holes in the mine roof and to insert long metal bolts into the holes to reinforce the mine roof.
Feeder breakers Feeder breakers are a form of crusher that uses rotating drums with carbide-tipped bits to break down the size of the mined material for loading onto conveyor systems or feeding into processing facilities. Mined material is typically loaded into the Feeder Breaker by a shuttle car or battery hauler in underground applications and by haul trucks in surface applications.
Battery haulers Battery haulers perform a similar function to shuttle cars. Shuttle cars are powered through cables and battery haulers are powered by portable rechargeable batteries.
Continuous haulage systems The continuous haulage system provides a similar function as the FCT in that it transports material from the continuous miner to the main mine belts on a continuous basis versus the batch process used by shuttle cars and battery haulers, but it does so with different technology. It is made up of a series of connected bridge structures that utilize chain conveyors that transport the coal from one bridge structure to the next bridge structure and ultimately to the main mine belts.
Joys aftermarket infrastructure quickly and efficiently provides customers with high-quality parts, exchange components, repairs, rebuilds, whole machine exchanges and services. Joys cost-per-ton programs allow its customers to pay fixed prices for each ton of material mined in order to match equipment costs with revenues, and its component exchange programs minimize production disruptions for repair or scheduled rebuilds. Both programs reduce customer capital requirements and ensure quality aftermarket parts and services for the life of the contract. Joy sells its products and services directly to its customers through a global network of sales and marketing personnel.
The Joy business has demonstrated cyclicality over the years. The primary drivers of the cyclicality are commodity prices (particularly coal prices) and coal production levels. Joys business is particularly sensitive to conditions in the coal mining industry, which accounts for substantially all of Joys sales. Other drivers of cyclicality include product life cycles, new product introductions, competitive pressures and industry consolidation.
Surface Mining Equipment
P&H is the worlds largest producer of electric mining shovels and a leading producer of rotary blasthole drills and walking draglines for open-pit mining operations. P&H has facilities in Australia, Brazil, Canada, Chile, China, South Africa, and the United States, as well as sales offices in India, Mexico, Peru, Russia, the United Kingdom and Venezuela. P&H products are used in mining copper, coal, iron ore, oil sands, silver, gold, diamonds, phosphate, and other minerals and ores. P&H also provides a wide range of parts and services to mines through its P&H
MinePro Services distribution group. In some markets, electric motor rebuilds and other selected products and services are also provided to the non-mining industrial segment. P&H also sells used electric mining shovels in some markets. In November 2005, P&H sold The Horsburgh & Scott Co., a subsidiary that made industrial gears and mechanical gear drives for a range of industrial markets.
Products and Services:
Electric mining shovels Mining shovels are primarily used to load copper ore, coal, iron ore, other mineral-bearing materials and overburden into trucks or other conveyances. There are two basic types of mining loaders - electric shovels and hydraulic excavators. Electric mining shovels feature larger buckets, allowing them to load greater volumes of material, while hydraulic excavators are smaller and more maneuverable. The electric mining shovel offers the lowest cost per ton of mineral mined. Its use is determined by the size of the mining operation and the availability of electricity. P&H manufactures only electric mining shovels rather than mechanically driven shovels. Dippers (buckets) can range in size from 12 to 82 cubic yards.
Walking draglines Draglines are primarily used to remove overburden to uncover coal or mineral deposits and then to replace the overburden as part of reclamation activities. P&Hs draglines weigh from 500 to 7,500 tons, with bucket sizes ranging from 30 to 160 cubic yards.
Blasthole drills Most surface mines require breakage or blasting of rock, overburden, or ore using explosives. A pattern of holes to contain the explosives is created by a blasthole drill. Drills are usually described in terms of the diameter of the hole they bore. Blasthole drills manufactured by P&H bore holes ranging in size from 8 5/8 to 22 inches in diameter.
P&H MinePro Services provides life cycle management support, including equipment erections, relocations, inspections, service, repairs, rebuilds, upgrades, used equipment, new and used parts, enhancement kits and training. The term life cycle management refers to our strategy to maximize the productivity of our equipment over the equipments entire operating life cycle through the optimization of the equipment, its operating and maintenance procedures and its upgrade and refurbishment. Each life cycle management program is specifically designed for a particular customer and that customers application of our equipment. Under each life cycle management program, we provide aftermarket products and services to support the equipment during its operating life cycle. Under some of the programs, the customer pays us an amount based upon hours of operation or units of production achieved by the equipment. The amount to be paid per unit is determined by the economic model developed on a case-by-case basis, and is set at a rate designed to include both the estimated costs and anticipated profit. Through life cycle management contracts, MinePro guarantees availability levels and reduces customer operating risk.
P&H MinePro Services personnel and MinePro distribution centers are strategically located close to customers in major mining centers around the world, supporting P&H and other brands. P&H sells its products and services directly to its customers through a global network of sales and marketing personnel. The P&H MinePro Services distribution organization also represents other leading providers of equipment and services to the mining industry and associated industries, which we refer to as Alliance Partners. Some of the P&H Alliance Partner relationships include the following companies:
P&Hs businesses are subject to cyclical movements in the markets. Sales of original equipment are driven to a large extent by commodity prices. Copper mining, coal mining and iron ore mining combined accounted for over 80% of total P&H sales in recent years. Rising commodity prices typically lead to the expansion of existing mines, opening of new mines or re-opening of less efficient mines. Although the aftermarket segment is much less cyclical, severe reductions in commodity prices can result in the removal of machines from mining production, and thus dampen demand for parts and services. Conversely, significant increases in commodity prices can result in higher use of equipment and generate requirements for more parts and services.
Both of our business segments are subject to moderate seasonality, with the first quarter of the fiscal year generally experiencing lower sales due to a decrease in working days caused by the Thanksgiving and year-end holidays.
Financial information about our business segments and geographic areas of operation is contained in Item 8 Financial Statements and Supplementary Data and Item 15 Exhibits and Financial Statement Schedules.
As of October 28, 2006, we employed approximately 8,900 people with approximately 4,500 employed in the United States. Unions represent approximately 54% of our U.S. employees under collective bargaining agreements. We believe that we maintain generally good relationships with our employees.
Joy and P&H sell their products primarily to large global and regional mining companies. No customer or affiliated group of customers accounted for 10% or more of our consolidated sales for Fiscal 2006.
Joy and P&H conduct their domestic and foreign operations under highly competitive market conditions, requiring that their products and services be competitive in price, quality, service and delivery. The customers for these products are generally large mining companies with substantial purchasing power.
Joys continuous miners, longwall shearers, powered roof supports, armored face conveyors, continuous haulage systems, feeder breakers and battery haulers compete with similar products made by a number of both established and emerging worldwide manufacturers of such equipment. Joys rebuild services compete with a large number of local repair shops. Joy competes with various regional suppliers in the sale of replacement parts for Joy equipment.
P&Hs shovels and draglines compete with similar products and with hydraulic excavators, large rubber-tired front-end loaders and bucket wheel excavators made by several international manufacturers. P&Hs large rotary blasthole drills compete with several worldwide drill manufacturers. A manufacturers location is not a significant advantage or disadvantage in this industry, but it is important to have repair and rebuild capability near the customers operations. P&H MinePro Services competes with a large number of primarily regional suppliers in the sale of parts.
Both Joy and P&H compete on the basis of providing superior productivity, reliability and service that lower the overall cost of production for their customers. Both Joy and P&H compete with local and regional service providers in the provision of maintenance, rebuild and other services to mining equipment users.
Backlog represents unfilled customer orders for our products and services. The customer orders that are included in the backlog represent commitments to purchase specific products or services from us by customers who have satisfied our credit review procedures. The following table provides backlog by business segment as of the fiscal year end. These backlog amounts exclude customer arrangements under long-term equipment life cycle management programs. Such programs extend for up to thirteen years and totaled approximately $507.1 million as of October 28, 2006. Sales already recognized by fiscal year-end under the percentage-of-completion method of accounting are also excluded from the amounts shown.
The change in backlog for Underground Mining Machinery from October 29, 2005 to October 28, 2006 reflects the acquisition of Stamler in the 4th quarter of Fiscal 2006 offset by more sales than orders for continuous miners and shuttle cars. The increase in backlog for Surface Mining Equipment over the same period reflects more orders than sales for new machines and parts. Of the $1.3 billion of backlog, approximately $127.9 million is expected to be recognized as revenue beyond the Fiscal 2007 year.
The change in backlog for Underground Mining Machinery from October 30, 2004 to October 29, 2005 reflects more orders than shipments for continuous miners, shuttle cars and shearers. The increase in backlog for Surface Mining Equipment over the same period primarily reflects more orders than sales for new machines and parts partially offset by more sales than orders in service. Of the $1.1 billion of backlog, approximately $77.1 million was expected to be recognized as revenue beyond the Fiscal 2006 year.
Joy purchases electric motors, gears, hydraulic parts, electronic components, castings, forgings, steel, clutches and other components and raw materials from outside suppliers. Although Joy purchases certain components and raw material from a single source, alternative suppliers are generally available for all such items.
P&H purchases raw and semi-processed steel, castings, forgings, copper and other materials from a number of suppliers. In addition, component parts such as engines, bearings, controls, hydraulic components and a wide variety of mechanical and electrical items are purchased from a group of pre-qualified suppliers.
Consistent with Fiscal 2004 and 2005, worldwide steel prices rose in Fiscal 2006 in response to higher demand caused by continued higher consumption in emerging market countries, such as China. Due to the continued increases in steel prices, steel price increases and surcharges are still being added both directly and indirectly by suppliers of castings, forgings and other products. Although problematic in previous years, we did not experience any issues in being able to obtain steel on a timely basis in Fiscal 2006.
Patents and Licenses
We own numerous patents and trademarks and have patent licenses from others relating to our products and manufacturing methods. Also, we have granted patent and trademark licenses to other manufacturers and receive royalties under most of these licenses. While we do not consider any particular patent or license or group of patents
or licenses to be material to either of our business segments, we believe that in the aggregate our patents and licenses are significant in distinguishing many of our product lines from those of our competitors. The remaining duration of our patents and licenses range from less than one year to 20 years and averages approximately fifteen years.
Research and Development
We are strongly committed to pursuing technological development through the engineering of new products and systems, the improvement and enhancement of licensed technology, and related acquisitions of technology. Research and development expenses were $10.4 million, $8.5 million and $6.3 million for Fiscal 2006, Fiscal 2005, and Fiscal 2004, respectively, not including application engineering.
Environmental, Health and Safety Matters
Our domestic activities are regulated by federal, state and local statutes, regulations and ordinances relating to both environmental protection and worker health and safety. These laws govern current operations, require remediation of environmental impacts associated with past or current operations, and under certain circumstances provide for civil and criminal penalties and fines as well as injunctive and remedial relief. Our foreign operations are subject to similar requirements as established by their respective countries.
We believe that we have substantially satisfied these diverse requirements. Because these requirements are complex and, in many areas, rapidly evolving, there can be no guarantee against the possibility of sizeable additional costs for compliance in the future. However, we do not expect that our compliance with environmental laws and regulations will have a material effect on our capital expenditures, earnings or competitive position, and do not expect to make any material capital expenditures for environmental control facilities in Fiscal 2007 or Fiscal 2008.
Our operations or facilities have been and may become the subject of formal or informal enforcement actions or proceedings for alleged noncompliance with either environmental or worker health and safety laws or regulations. Such matters have typically been resolved through direct negotiations with the regulatory agency and have typically resulted in corrective actions or abatement programs. However, in some cases, fines or other penalties have been paid.
For information on the risks faced by our international operations, see Item 1A, Risk Factors.
Our internet address is: www.joyglobal.com. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act available free of charge through our website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Item 1A. Risk Factors
Our international operations are subject to many uncertainties, and a significant reduction in international sales of our products could adversely affect us.
In addition to the other risk factors below, our international operations are subject to various political, economic and other uncertainties which could adversely affect our business. A significant reduction of our international business due to any of these risks would adversely affect our sales. In Fiscal 2006, 2005 and 2004, approximately 51%, 55% and 54% of our sales were derived from sales outside the United States. Risks faced by our international operations include:
If we are unable to successfully manage the risks associated with expanding our global business or to adequately manage operational fluctuations internationally, it could adversely affect our business, financial condition or results of operations.
The cyclical nature of our original equipment manufacturing business could cause fluctuations in our operating results.
Our business, in particular our original equipment manufacturing business, is cyclical in nature. The cyclicality of Joys original equipment sales is driven primarily by commodity prices, product life cycles, competitive pressures and other economic factors affecting the mining industry such as company consolidation. P&Hs original equipment sales are subject to cyclical movements based in large part on changes in copper, coal, iron ore, oil and other commodity prices. Falling commodity prices have in the past and may in the future lead to reductions in the production levels of existing mines, a contraction in the number of existing mines and the closure of less efficient mines. Decreased mining activity is likely to lead to a decrease in demand for new mining machinery. We expect that cyclicality will likely cause us to experience further significant fluctuation in our business, results of operations and financial condition in the future.
As a result of this cyclicality, we have previously experienced significant fluctuation in our business, results of operations and financial condition. Since emerging from bankruptcy in 2001, our operating income has ranged from an operating loss of $14.1 million in Fiscal 2002 (which included $53.6 million in fresh start accounting charges) to operating income of $442.4 million in Fiscal 2006, and our net sales have ranged from a low of $1.1 billion for Fiscal 2002 to a high of $2.4 billion for Fiscal 2006.
Our continued success depends on our ability to protect our intellectual property.
Our future success depends in part upon our ability to protect our intellectual property. We rely principally on nondisclosure agreements and other contractual arrangements and trade secret law and, to a lesser extent, trademark and patent law, to protect our intellectual property. However, these measures may be inadequate to protect our intellectual property from infringement by others or prevent misappropriation of our proprietary rights. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do U.S. laws. Our inability to protect our proprietary information and enforce our intellectual property rights through infringement proceedings could adversely affect our business, financial condition or results of operations.
Our manufacturing operations are dependent upon third party suppliers, making us vulnerable to supply shortages and price increases, and we are also limited by our plant capacity constraints.
In the manufacture of our products, we use large amounts of raw materials and processed inputs including steel, engine components, copper and electronic controls. We obtain raw materials and certain manufactured components from third party suppliers. Our ability to grow revenues is constrained by the capacity of our plants, our ability to supplement that capacity with outside sources, and our success in securing critical supplies such as steel and copper. To reduce material costs and inventories, we rely on supplier arrangements with preferred vendors as a source for just in time delivery of many raw materials and manufactured components. Because we maintain limited raw material and component inventories, even brief unanticipated delays in delivery by suppliers, including those due to capacity constraints, labor disputes, impaired financial condition of suppliers, weather emergencies or other natural disasters, may adversely affect our ability to satisfy our customers on a timely basis and thereby affect our financial performance. This risk increases as we continue to change our manufacturing model to more closely align production with customer orders. In addition, recently, market prices of some of the raw materials we use, in particular steel, have increased significantly. If we are not able to pass raw material or component price increases on to our customers, our margins could be adversely affected. In fiscal 2004, 2005 and 2006, we instituted price increases to offset, in part, the impact of higher steel prices. We cannot be certain that we will be able to maintain these price increases. Any of these events could adversely affect our business, financial condition or results of operations.
We operate in a highly competitive environment, which could adversely affect our sales and pricing.
Our domestic and foreign manufacturing and service operations are subject to significant competitive pressures. Many of our customers are large global mining companies that have substantial bargaining power and require our equipment to meet high standards of availability, productivity and cost effectiveness. In addition, some of our sales require us to participate in competitive tenders where we must compete on the basis of various factors, including performance guarantees and price. We compete directly and indirectly with other manufacturers of surface and underground mining equipment and with manufacturers of parts and components for such products. Some of our competitors are larger and may have greater access to financial resources.
Demand for our products may be adversely impacted by regulations affecting the mining industry or electric utilities.
Our principal customers are surface and underground mining companies. Many of these customers supply coal as a power generating source for the production of electricity in the United States and other countries. The operations of these mining companies are geographically diverse and are subject to or impacted by a wide array of regulations in the jurisdictions where they operate, including those directly impacting mining activities and those indirectly affecting their businesses, such as applicable environmental laws and an array of regulations governing the operation of electric utilities. As a result of changes in regulations and laws relating to the operation of mines, our customers mining operations could be disrupted or curtailed by governmental authorities. The high cost of compliance with mining and environmental regulations may also induce customers to discontinue or limit their mining operations, and may discourage companies from developing new mines. Additionally, government regulation of electric utilities may adversely impact the demand for coal to the extent that such regulations cause electric utilities to select alternative energy sources and technologies as a source of electric power. As a result of these factors, demand for our mining equipment could be substantially affected by regulations adversely impacting the mining industry or altering the consumption patterns of electric utilities.
Labor disputes and increasing labor costs could adversely affect us.
Many of our principal domestic and foreign operating subsidiaries are parties to collective bargaining agreements with their employees. We cannot assure you that any disputes, work stoppages or strikes will not arise in the future. In addition, when existing collective bargaining agreements expire, we cannot assure you that we will be able to reach new agreements with our employees. Such new agreements may be on substantially different terms and may result in increased direct and indirect labor costs. Future disputes with our employees could adversely affect our business, financial condition or results of operations.
Our business could be adversely affected by our failure to develop new technologies.
The mining industry is a capital-intensive business, with extensive planning and development necessary to open a new mine. The success of our customers mining projects is largely dependent on the efficiency with which the mine operates. If we are unable to provide continued technological improvements in our equipment that meets our customers expectations, or the industrys expectations, on mine productivity, the demand for our mining equipment could be substantially affected.
We are largely dependent on the continued demand for coal.
Over two-thirds of our revenues come from our coal-mining customers. Many of these customers supply coal as fuel for the production of electricity in the United States and other countries. The pursuit of the most cost effective form of electricity generation continues to take place throughout the world. If a more economical form of electricity generation is discovered or developed or if a current alternative source of energy such as nuclear power becomes more widely accepted or cost effective, the demand for our mining equipment could be adversely affected.
We are subject to litigation risk, which could adversely affect us.
We and our subsidiaries are involved in various unresolved legal matters that arise in the normal course of operations, the most prevalent of which relate to product liability (including asbestos related and silicosis liability), employment and commercial matters. In addition, we and our subsidiaries become involved from time to time in proceedings relating to environmental matters. Also, as a normal part of their operations, our subsidiaries may undertake contractual obligations, warranties and guarantees in connection with the sale of products or services. Some of these claims and obligations involve significant potential liability.
Product liability claims could adversely affect us.
The sale of mining equipment entails an inherent risk of product liability and other claims. Although we maintain product liability insurance covering certain types of claims, our policies are subject to substantial deductibles. We cannot assure you that the coverage limits of our insurance policies will be adequate or that our policies will cover any particular loss. Insurance can be expensive, and we may not always be able to purchase insurance on commercially acceptable terms, if at all. Claims brought against us that are not covered by insurance or that result in recoveries in excess of insurance coverage could adversely affect our business, financial condition or results of operations.
If we are unable to retain qualified employees, our growth may be hindered.
Our ability to provide high quality products and services depends in part on our ability to retain our skilled personnel in the areas of senior management, product engineering, servicing and sales. Competition for such personnel is intense and our competitors can be expected to attempt to hire our skilled employees from time to time. In particular, our results of operations could be adversely affected if we are unable to retain the customer relationships and technical expertise provided by our management team and our professional personnel.
We rely on significant customers.
We are dependent on maintaining significant customers by delivering reliable, high performance mining equipment and other products on a timely basis. We do not consider ourselves to be dependent upon any single customer; however, our top ten customers collectively accounted for approximately 30% of our sales for the 2006 fiscal year. Our sales have become more concentrated in recent years as consolidation has occurred in the mining industry. The consolidation and divestitures in the mining industry may result in different equipment preferences among current and former significant customers. The loss of one or more of our significant customers could, at least on a short term basis, have an adverse effect on our business, financial condition or results of operations.
We may acquire other businesses or engage in other transactions, which may adversely affect our operating results, financial condition and existing business.
From time to time, we explore transaction opportunities which may complement our core business. These transaction opportunities may come in the form of an acquisition, joint venture, start up or other structure. Any such transaction may entail any number of risk factors including (without limitation) general business risk, integration risk, technology risk and market acceptance risk. Additionally, any such transaction may require utilization of debt, equity or other capital resources and our managements time and attention, and may not create value for us or our stockholders.
We require cash to service our indebtedness, which reduces the cash available to finance our business.
Our ability to service our indebtedness will depend on our future performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors. Some of these factors are beyond our control. If we cannot generate sufficient cash flow from operations to service our indebtedness and to meet our other obligations and commitments, we might be required to refinance our debt or to dispose of assets to obtain funds for such purpose. There is no assurance that refinancings or asset dispositions could be effected on a timely basis or on satisfactory terms, if at all, or would be permitted by the terms of our debt instruments.
Our unsecured revolving credit agreement contains certain financial tests. If we do not satisfy such tests, our lenders could declare a default under our debt instruments, and our indebtedness could be declared immediately due and payable. Our ability to comply with the provisions of our unsecured revolving credit agreement may be affected by changes in economic or business conditions beyond our control.
Our unsecured revolving credit agreement contains covenants that limit our ability to incur indebtedness, acquire other businesses and imposes various other restrictions. These covenants could affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. We cannot assure you that we will be able to comply with the foregoing financial ratios or covenants or, if we fail to do so, that we will be able to obtain waivers from our lenders.
Item 1B. Unresolved Staff Comments
Item 2. Properties
As of October 28, 2006 the following principal properties of our operations were owned, except as indicated. Our worldwide corporate headquarters are currently housed in 10,000 square feet of leased space in Milwaukee, Wisconsin. All of these properties are generally suitable for the operations currently conducted at them.
Underground Mining Machinery Locations
Surface Mining Equipment Locations
(1) Under a month to month lease.
(2) Under a lease expiring in 2007.
(3) Under a lease expiring in 2008.
(4) Under a lease expiring in 2009.
(5) Under a lease expiring in 2010.
(6) Under a lease expiring in 2011.
(7) Under a lease expiring in 2018.
* Property includes a warehouse.
Joy also operates warehouses in Meadowlands, Pennsylvania, Green River, Wyoming; Pineville, West Virginia; Brookwood, Alabama; Carlsbad, New Mexico; Price, Utah; Norton, Virginia; Lovely and Henderson, Kentucky; Nashville, Illinois; Emerald, Moss Vale, Thornton and Lithgow, Australia; Siberia, Russia; and Chirimiri, India. All warehouses are owned except for the warehouses in Price, Utah; Lovely and Henderson, Kentucky; Nashville, Illinois; Moss Vale and Thornton, Australia; and Siberia, Russia, which are leased.
P&H also operates warehouses in Cleveland, Ohio; Hibbing and Virginia, Minnesota; Charleston, West Virginia; Negaunee, Michigan; Gilbert, Arizona; Hinton, Sparwood, Labrador City, Fort McMurray and Sept. Iles, Canada; Iquique and Calama, Chile; Johannesburg, South Africa; and Puerto Ordaz, Venezuela. The warehouses in Hibbing, Fort McMurray, Johannesburg, and Calama are owned; the others are leased. In addition, P&H leases sales offices throughout the United States and in principal surface mining locations in other countries.
Item 3. Legal Proceedings
We and our subsidiaries are involved in various unresolved legal matters that arise in the normal course of operations, the most prevalent of which relate to product liability (including over 1,000 asbestos and silica-related cases), employment and commercial matters. Although the outcome of these matters cannot be predicted with certainty and favorable or unfavorable resolutions may affect the results of operations on a quarter-to-quarter basis, we believe that the outcome of such legal and other matters will not have a materially adverse effect on our consolidated financial position, results of operations or liquidity.
From time to time we and our subsidiaries become involved in proceedings relating to environmental matters. We believe that the resolution of such environmental matters will not have a materially adverse effect on our consolidated financial position, results of operations or liquidity.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of Fiscal 2006.
Executive Officers of the Registrant
The following table shows certain information for each of our executive officers, including position with the corporation and business experience. Our executive officers are elected each year at the organizational meeting of our Board of Directors, which follows the annual meeting of shareholders, and at other meetings as appropriate.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
Our common stock is traded on the Nasdaq National Market under the symbol JOYG. As of October 28, 2006, there were approximately 25,000 shareholders of record. The following table sets forth the high and low sales prices and dividend payments for our common stock during the periods indicated.
We made the following purchases of our common stock, par value $1.00 per share, during the fourth quarter of the fiscal year covered by this report:
Item 6. Selected Financial Data
The following table sets forth certain selected historical financial data on a consolidated basis. The selected consolidated financial data was derived from our Consolidated Financial Statements. During the first quarter of Fiscal 2002, we amended our bylaws to adopt a 52- or 53-week fiscal year and changed our fiscal year-end date from October 31 to the Saturday nearest October 31. Each of our fiscal quarters consists of 13 weeks, except for any fiscal years consisting of 53 weeks that will add one week to the first quarter. This change did not have a material effect on our revenue or results of operations for Fiscal 2002. On December 18, 2006 we further amended our bylaws so that starting in Fiscal 2007, our fiscal year-end date will be the last Friday in October. The selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements appearing in Item 8 Financial Statements and Supplementary Data and Item 15 Exhibits and Financial Statement Schedules.
RESULTS OF OPERATIONS
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Consolidated Financial Statements and related notes. References made to years are for fiscal year periods. Dollar amounts are in thousands, except share and per-share data and as indicated.
The purpose of this discussion and analysis is to enhance the understanding and evaluation of the results of operations, financial position, cash flows, indebtedness, and other key financial information of Joy Global Inc. and its subsidiaries for Fiscal 2006, Fiscal 2005, and Fiscal 2004. For a more complete understanding of this discussion, please read the Notes to Consolidated Financial Statements included in this report.
We are the direct successor to businesses that have been manufacturing mining equipment for over 120 years. We operate in two business segments: Underground Mining Machinery, comprised of our Joy Mining Machinery business ("Joy''), and Surface Mining Equipment, comprised of our P&H Mining Equipment business ("P&H''). Joy is the world's largest producer of high productivity electric-powered underground mining equipment used primarily for the extraction of coal. P&H is the world's largest producer of high productivity electric mining shovels and a leading producer of walking draglines and large rotary blasthole drills, used primarily for surface mining copper, coal, iron ore, oil sands and other minerals.
In addition to selling new equipment, we provide parts, components, repairs, rebuilds, diagnostic analysis, fabrication, training and other aftermarket services for our installed base of machines. In the case of Surface Mining Equipment, we also provide aftermarket services for equipment manufactured by other companies, including manufacturers with which we have ongoing relationships and which we refer to as "Alliance Partners.'' We emphasize our aftermarket products and services as an integral part of lowering our customers' cost per unit of production and are focused on continuing to grow this part of our business.
Demand for new equipment is cyclical in nature, being driven by commodity prices and other factors. Original equipment sales have ranged from $316.4 million in Fiscal 2001 to $937.8 million in Fiscal 2006. Our aftermarket business has shown more consistent growth since Fiscal 2001 with sales ranging from $799.8 million in 2001 to $1.5 billion in Fiscal 2006. Aftermarket represented about 61% of our 2006 revenues. Along with record revenues in Fiscal 2006, our backlog has also continued to grow. Our backlog of $1.1 billion as of October 29, 2005 increased to $1.3 billion as of October 28, 2006. The continued strength of commodity markets, including copper, iron ore, oil and international coal, support our belief in sustained demand for original equipment and aftermarket services.
Sustained demand for our equipment and aftermarket services globally has led to further expansion plans in Fiscal 2006. During Fiscal 2006, the surface mining business made additional investments in the Milwaukee facility that will increase shovel capacity by 40%. The underground mining business is making a significant investment in China, with an expansion of a current service center in Baotou and the construction of a manufacturing facility in Tianjin. In Fiscal 2006 we also completed the acquisition of the Stamler business. The Stamler acquisition is in-line with our acquisition strategy of adding mining-related products and services that integrate into our existing businesses.
Fiscal 2006 results continue to show the strength of this current cycle. Although the long-term outlook from coal in the United States is favorable, there currently is a temporary softness due to weather-related demand and we have experienced a decline in orders for U.S. underground mining equipment. Market conditions remain strong across other commodity markets including international underground coal.
Approximately 85% of our sales in Fiscal 2006 were recorded at the time of shipment of the product or delivery of the service. The remaining 15% of sales was recorded using percentage of completion accounting, a practice we follow in recognizing revenue on the sale of long lead-time equipment such as electric mining shovels, walking draglines and roof supports. Under percentage of completion accounting, revenue is recognized on firm orders from
customers as the product is manufactured based on the ratio of actual costs incurred to estimated total costs to be incurred. We generally receive progress payments on long lead-time equipment.
Our gross profit margin in Fiscal 2006 increased to 31.4% from 29.2% in Fiscal 2005 due to the continued strength of commodity markets, a better mix of original equipment and disciplined cost control. The major components of our cost of sales are manufacturing overhead, labor and raw materials such as steel. In recent years, we have been adversely affected by increases in the cost of raw materials, especially steel. In Fiscal 2006, steel surcharges have continued to be added both directly and indirectly from our suppliers.
Results of Operations
2006 Compared with 2005
The following table sets forth Fiscal 2006 and Fiscal 2005 net sales as derived from our Consolidated Statement of Income:
Total net sales for Fiscal 2006 increased by $474.2 million, or 24.6%, over Fiscal 2005 net sales. Net sales in the United States increased by $300.8 million, or 34.6%, and international net sales rose by $173.4 million, or 16.4%. Reflecting the continued overall strength of commodities, original equipment revenues increased by approximately 30.8% to $937.8 million in Fiscal 2006, accounting for 39.0% of total revenues for the year. Aftermarket sales, which include sales of parts and services, increased approximately 20.9% to $1.5 billion for Fiscal 2006.
The increase in net sales for Underground Mining Machinery in Fiscal 2006 compared to Fiscal 2005 was the result of a $151.5 million increase in shipments of original equipment combined with a $141.0 million increase in aftermarket products and service. With the exception of roof supports sales, which were flat with Fiscal 2005, increases in original equipment sales were reported across all original equipment product lines. The United States represented $117.4 million of the increase in original equipment sales. Increases in aftermarket net sales were reported in all of our markets. Aftermarket sales increases ranging from approximately 12% in the United States to approximately 34% in emerging markets served out of the United Kingdom reflected the high level of coal mining activity on a global basis and more specifically, from our international markets.
The increase in net sales for Surface Mining Equipment in Fiscal 2006 compared to Fiscal 2005 was the result of a $69.5 million increase in original equipment combined with a $112.2 million increase in aftermarket parts and service. Increases in original equipment sales were reported in the United States, Australia, Chile, Venezuela, South Africa and China offset by decreased equipment sales in Canada and Mexico. Almost two-thirds of the original equipment increase related to electric mining shovels. Increases in aftermarket sales were reported for all of our significant markets. Aftermarket sales increases ranging from approximately 19% in South Africa to approximately 50% in Canada reflected the high level of copper, coal mining, and iron ore mining activity on a global basis and the high level of oil sands mining activity in Canada.
The following table sets forth Fiscal 2006 and Fiscal 2005 operating income as derived from our Consolidated Statement of Income:
Operating income as a percentage of net sales for Underground Mining Machinery increased from 16.5% in Fiscal 2005 to 21.6% in Fiscal 2006. A more profitable mix of original equipment sales accounted for 2.3 percentage points of the change. Product development, selling and administrative expenses were up approximately $11.7 million in Fiscal 2006, but were down 2.3 percentage points in comparison to net sales year over year.
Operating income as a percentage of net sales for Surface Mining Equipment increased from 14.4% in Fiscal 2005 to 16.9% in Fiscal 2006. A more profitable mix of original equipment and aftermarket sales contributed to 2.1 percentage points of the increase. Product development, selling and administrative expenses were up approximately $17.1 million in Fiscal 2006, but were down 0.4 percentage points in comparison to net sales year over year.
Product Development, Selling and Administrative Expense
Product development, selling and administrative expense for Fiscal 2006 was $321.8 million as compared to $297.9 million for Fiscal 2005. The increase in product development, selling and administrative expense was due primarily to a $11.3 million increase in pension expense and $12.1 million increase in selling expenses related to increased business activity and general inflation, offset by $11.2 million decrease in legal expense associated with an arbitration award and associated legal fees incurred in Fiscal 2005.
Interest expense for Fiscal 2006 decreased to $5.7 million as compared to $15.2 million for Fiscal 2005. This decrease was principally due to our repurchase of substantially all of our 8.75% Senior Subordinated Notes in June 2005 offset by direct borrowings during the second half of Fiscal 2006 under our revolving credit agreement. The direct borrowings under our revolving credit agreement were used to finance our common stock repurchase program and our fourth quarter acquisition of the Stamler business. Cash interest paid in Fiscal 2006 and Fiscal 2005 was $4.7 million and $16.5 million, respectively.
Provision for Income Taxes
Our consolidated effective income tax rates from continuing operations for Fiscal 2006 and Fiscal 2005 were 7.9% and 35.4%, respectively. Consolidated income tax expense from continuing operations decreased to $35.5 million in Fiscal 2006 as compared to $80.5 million in Fiscal 2005. The main drivers of the variance in effective tax rates and income tax expense were the reversal of certain U.S. and Australian valuation reserves, Subpart F earnings, U.S. State income taxes, increased global profitability and mix of earnings year over year and differences in local statutory tax rates.
A review of income tax valuation reserves was performed as part of the analysis of the Fiscal 2006 income tax provision and a tax benefit of $110.4 million was recorded relating to the reversal of certain valuation reserves, principally of $95.6 million applicable to U.S. deferred income tax assets and $12.5 million related to certain valuation reserves applicable to our Australian consolidated tax group.
2005 Compared with 2004
The following table sets forth Fiscal 2005 and Fiscal 2004 net sales as derived from our Consolidated Statement of Income:
Total net sales for Fiscal 2005 increased by $528.1 million, or 37.7%, over Fiscal 2004 net sales. Net sales in the United States increased by $230.4 million, or 36.0%, and international net sales rose by $297.7 million, or 39.2%. Reflecting the cyclical upturn in commodities, original equipment revenues increased by approximately 65% to $716.8 million in Fiscal 2005, accounting for 37.2% of total revenues for the year. Aftermarket sales, which include sales of parts and services, increased approximately 26% to $1,210.7 million for Fiscal 2005.
The increase in net sales for Underground Mining Machinery in Fiscal 2005 compared to Fiscal 2004 was the result of a $188.5 million increase in shipments of original equipment combined with a $123.7 million increase in aftermarket products and service. The primary increases in original equipment sales were $77.3 million, $67.1 million and $43.3 million in the emerging markets served out of the United Kingdom, the United States and Australia, respectively. The increase in original equipment sales reflects the continuing strong activity levels for new equipment for both replacement of existing equipment and for new mining capacity. Increases in aftermarket net sales were reported in substantially all of our markets. Higher aftermarket sales in the United States accounted for approximately 60% of the overall increase in aftermarket sales. Approximately 40% of the increase in aftermarket sales was due to the increase in repair parts sales, another 40% due to complete machine rebuilds and the remaining increase was due to component repairs. The strong level of aftermarket sales in Fiscal 2005 reflected the continued high level of coal mining activity on a global basis.
The increase in net sales for Surface Mining Equipment in Fiscal 2005 compared to Fiscal 2004 was the result of a $90.7 million increase in original equipment combined with a $125.2 million increase in aftermarket parts and service. Increases in original equipment sales were reported in Canada, Mexico, Russia, Australia, Venezuela and Chile. Approximately 40% of the original equipment sales increase was due to shipments of electric mining shovels to Canada and approximately 20% was due primarily to shipments of electric mining shovels to Russia, with the remainder attributable to the other markets. Increases in aftermarket sales were reported for nearly all of our markets. Approximately 73% of the aftermarket sales increase was due to the higher repair parts sales, with the remaining increase due to higher aftermarket service sales. The strong level of both original equipment and aftermarket sales in Fiscal 2005 reflects the continued high level of activity in the mining of copper, coal, iron ore, oil sands and gold.
The following table sets forth Fiscal 2005 and Fiscal 2004 operating income as derived from our Consolidated Statement of Income:
Operating income as a percentage of net sales for Underground Mining Machinery increased from 11.1% in Fiscal 2004 to 16.5% in Fiscal 2005. The higher volume of sales favorably impacted operating income in Fiscal 2005. Increased production activity allowed for higher levels of manufacturing overhead absorption that exceeded the increase in the variable overhead spending in the United States, United Kingdom and Australia. Product development and selling expenses were essentially flat year over year, and were down significantly as a percent of revenues. These favorable impacts were partially offset by $10.5 million in administrative expenses primarily related to an increase in legal expense associated with an arbitration award and associated legal fees and compensation expense related to performance-based incentives.
Operating income as a percentage of net sales for Surface Mining Equipment increased from 9.2% in Fiscal 2004 to 14.4% in Fiscal 2005. This improvement in profitability was due primarily to an $8.7 million improvement in the relationship between manufacturing overhead spending and manufacturing overhead absorption, partially offset by a $15.0 million increase in product development, selling and administrative expenses.
Product Development, Selling and Administrative Expense
Product development, selling and administrative expense for Fiscal 2005 was $297.9 million as compared to $273.0 million for Fiscal 2004. The increase in product development, selling and administrative expense was due primarily to a $4.2 million increase in compensation expense associated with performance-based incentive programs, approximately $4.4 million for an arbitration award and approximately $2.6 million for the implementation of the SAP enterprise software system, as well as the impact of general cost inflation. Product development, selling and administrative expense as a percentage of sales for Fiscal 2005 decreased to 15.5% as compared to 19.5% in Fiscal 2004.
Interest expense for Fiscal 2005 decreased to $15.2 million as compared to $24.3 million for Fiscal 2004. This decrease was principally due to our repurchase of substantially all of our 8.75% Senior Subordinated Notes in June 2005. There were no direct borrowings under our revolving credit agreement at the end of Fiscal 2005. Cash interest paid in Fiscal 2005 and Fiscal 2004 was $16.5 million and $22.0 million, respectively.
Provision for Income Taxes
Our effective consolidated income tax rates from continuing operations for Fiscal 2005 and Fiscal 2004 were approximately 35.4% and 41.5%, respectively. For Fiscal 2005, the consolidated income tax rate approximated the statutory rate of 35%. Consolidated income tax expense from continuing operations increased to $80.5 million in Fiscal 2005 as compared to $39.3 million in Fiscal 2004. The increase in income tax expense is primarily attributable to the substantial increase in our pre-tax income. Additionally, the consolidated income tax expense and effective income tax rate for Fiscal 2004 were negatively impacted by a $13.4 million increase in our deferred tax valuation reserves relating to Australian corporate income taxes that was not repeated in Fiscal 2005.
Reorganization items include income, expenses and losses that were realized or incurred by the Predecessor Company as a result of its decision to reorganize under Chapter 11 of the Bankruptcy Code.
Net reorganization items for Fiscal 2006, Fiscal 2005 and Fiscal 2004 consisted of the following:
Critical Accounting Policies
Our discussion and analysis of financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates and judgments, including those related to bad debts, excess inventory, warranty, intangible assets, income taxes, performance-based incentive programs and contingencies. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.
We believe the accounting policies described below are the ones that most frequently require us to make estimates and judgments, and therefore are critical to the understanding of our results of operations:
We generally recognize revenue at the time of shipment and passage of title for sales of products and at the time of performance for sales of services. We recognize revenue on long-term contracts, such as the manufacture of mining shovels, drills, draglines and roof support systems, using either the percentage-of-completion or inventory sales methods. When using the percentage-of-completion method, sales and gross profit are recognized as work is performed based on the relationship between actual costs incurred and total estimated costs at completion. Sales and
gross profit are adjusted prospectively for revisions in estimated total contract costs and contract values. Estimated losses are recognized in full when identified.
We have life cycle management contracts with customers to supply parts and service for terms of 1 to 13 years. These contracts are set up based on the projected costs and revenues of servicing the respective machines over the specified contract terms. Accounting for these contracts requires us to make various estimates, including estimates of the relevant machines long-term maintenance requirements. Under these contracts, customers are generally billed monthly and the respective deferred revenues are recorded when billed. Revenue is recognized in the period in which parts are supplied or services provided. These contracts are reviewed periodically and revenue recognition is adjusted appropriately for future estimated costs. If a loss is expected at any time, the full amount of the loss is recognized immediately.
Revenue recognition involves judgments, assessments of expected returns, the likelihood of nonpayment, and estimates of expected costs and profits on long-term contracts. We analyze various factors, including a review of specific transactions, historical experience, credit-worthiness of customers and current market and economic conditions, in determining when to recognize revenue. Changes in judgments on these factors could impact the timing and amount of revenue recognized with a resulting impact on the timing and amount of associated income.
Inventories are carried at the lower of cost or net realizable value using the first-in, first-out (FIFO) method for all inventories. We evaluate the need to record adjustments for inventory on a regular basis. Our policy is to evaluate all inventory including raw material, work-in-process, finished goods, and spare parts. Inventory in excess of our estimated usage requirements is written down to its estimated net realizable value. Inherent in the estimates of net realizable value are estimates related to our future manufacturing schedules, customer demand, possible alternative uses and ultimate realization of potentially excess inventory.
Intangible assets include drawings, patents, trademarks, technology and other specifically identifiable assets. Indefinite-lived intangible assets are not being amortized. Finite-lived intangible assets are amortized to reflect the pattern of economic benefits consumed which is principally the straight-line method. Intangible assets are evaluated for impairment annually, or more frequently if events or changes occur that suggest impairment in carrying value.
We record accruals for potential warranty claims based on prior claim experience. Warranty costs are accrued at the time revenue is recognized. These warranty costs are based upon managements assessment of past claims and current experience. However, actual claims could be higher or lower than amounts estimated, as the amount and value of warranty claims are subject to variation as a result of many factors that cannot be predicted with certainty.
Pension and Postretirement Benefits and Costs
We have pension and postretirement benefits and expenses which are developed from actuarial valuations. These valuations are based on assumptions including, among other things, discount rates, expected returns on plan assets, retirement ages, years of service, future salary increases, and future health care cost trend rates. Future changes affecting the assumptions will change the related pension benefit or expense.
Deferred taxes are accounted for under the asset and liability method whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using statutory tax rates. Deferred income tax provisions are based on changes in the deferred tax assets and liabilities from period to period, adjusted for certain reclassifications under fresh start accounting. Additionally,
we analyze our ability to recognize currently the net deferred tax assets created in each jurisdiction in which we operate to determine if valuation allowances are necessary because realizability of the tax assets is deemed to not be more likely than not.
As required under the application of fresh start accounting, the release of pre-emergence tax valuation reserves was not recorded in the income statement but instead was treated first as a reduction of excess reorganization value until exhausted, then intangibles until exhausted, and thereafter reported as additional paid in capital. Consequently, a net tax charge will be incurred in future years when these tax assets are utilized. We will continue to monitor the appropriateness of the existing valuation allowances and determine annually the amount of valuation allowances that are required to be maintained.
Similar to the treatment of pre-emergence deferred tax valuation reserves, amounts reserved pre-emergence relating to future income tax contingencies also require special treatment under fresh start accounting. Reversals of tax contingency reserves that are no longer required due to the resolution of the underlying tax issue and were recorded at the emergence date will first reduce any excess reorganization value until exhausted, then other intangibles until exhausted, and thereafter are reported as an adjustment to income tax expense. Consistent with prior years, we have reviewed the amounts so reserved and adjusted the balances to the amounts deemed appropriate with the corresponding adjustment reported as an income tax benefit.
We estimate the effective tax rate expected to be applicable for the full fiscal year during the course of the year on an interim basis. The estimated effective tax rate contemplates the expected jurisdiction where income is earned (e.g. United States compared to non-United States) as well as tax planning strategies. If the actual results are different from these estimates, adjustments to the effective tax rate may be required in the period such determination is made. Additionally, discreet items are treated separately from the effective rate analysis and are recorded separately as an income tax provision or benefit at the time they are recognized. To the extent recognized, these items will impact the effective tax rate in aggregate but will not adjust the amount used for future periods within the same fiscal year.
Liquidity and Capital Resources
Working capital and cash flow are two financial measurements that provide an indication of our ability to meet our financial obligations. We currently use a combination of cash generated by operations and borrowings on our line of credit to fund continuing operations.
The following table summarizes the major elements of our working capital at the end of Fiscal 2006 and Fiscal 2005:
Our businesses are working capital intensive and require funding for purchases of production and replacement parts inventories. The primary drivers of our working capital increase are inventory and accounts receivable, which was due to the continued strong growth of both our businesses.
In addition, cash is required for capital expenditures for the repair, replacement and upgrading of existing facilities. We have debt service requirements, including commitment and letter of credit fees under our revolving credit facility. We believe that cash generated from operations, together with borrowings available under our credit facility, provides us with adequate liquidity to meet our operating and debt service requirements and planned capital expenditures.
In response to continued worldwide demand for mining equipment, we have committed to make investments in both our surface and underground mining operations. The surface mining business has committed to a $16.6 million investment in Milwaukee. The additional investment is expected to increase shovel capacity production by 40%. The underground mining business is focusing its growth in China and Poland. The Baotou facility which already functions as a service center for the underground business, is expanding by approximately 30,000 square feet, to provide expanded repair and rebuild capacity. The Tianjin facility, with a planned current investment of approximately $3.0 million, will carry out manufacturing for both original equipment and spare parts for use worldwide and is expected to be completed by early Fiscal 2007. The facility in Poland will be a combined service center and manufacturing facility with a planned opening date in late Fiscal 2007.
Cash provided by operations for Fiscal 2006 was $330.4 million as compared to $201.3 million provided by operations for Fiscal 2005. The increase in our cash provided by operating activities was primarily attributable to the increase in net income and the decrease in contributions to our pension plans partially offset by the excess income tax benefit from the exercise of stock options. The adoption of SFAS 123(R) caused a reclassification of the excess income tax benefits from the exercise of stock options from an operating activity inflow to a financing activity inflow.
Cash used by investment activities for Fiscal 2006 was $154.8 million as compared to $35.7 million used by investment activities for Fiscal 2005. The primary driver of the increase in the use of cash by investing activities was the acquisition of the Stamler business during the fourth quarter of 2006. The increase in capital expenditures in Fiscal 2006 as compared to Fiscal 2005 of $10.3 million was primarily due to our expansion efforts globally. For Fiscal 2007, we anticipate capital expenditures between $60 million and $65 million, primarily for the upgrade of existing facilities, completion of SAP implementation, and other projects.
On July 31, 2006, we completed the acquisition of the net assets of the Stamler mining equipment business from the Oldenburg Group, Inc. for approximately $117 million in cash. Stamler manufactures products used primarily in underground coal mining applications, including feeder breakers, battery haulers, and continuous haulage systems. The Stamler business is in line with our previously stated objective of adding bolt on products and services to our existing businesses.
Cash used by financing activities for Fiscal 2006 was $214.4 million as compared to $250.8 million used by financing activities for Fiscal 2005. The cash used by financing activities for Fiscal 2006 primarily consisted of the purchase of treasury stock of $295.5 million offset by the net borrowings under our revolving credit facility. The cash used by financing activities in Fiscal 2005 primarily resulted from the repurchase of approximately $200 million of our 8.75% Senior Subordinated Notes at a cost of $224.5 million.
During Fiscal 2005, we contributed $60.2 million to our worldwide pension plans compared to $95.4 million during Fiscal 2004. As a result of the additional contributions in Fiscal 2005, no contributions to the U.S. plans was required in Fiscal 2006. We also do not expect any required contributions in Fiscal 2007. However, we currently believe we will make voluntary contributions for our employee pension plans in the range of $15 million to $20 million in Fiscal 2007, primarily to plans outside of the United States. Beyond Fiscal 2007, the investment performance of the plans assets and the actual results of the other actuarial assumptions and most importantly, the impact of the Pension Protection Act of 2006 (PPA) will determine the funding requirements of the pension plans. We do not believe the PPA will have a significant effect on our near-term pension contributions.
On November 10, 2006, we amended our $400.0 million unsecured revolving credit facility (Credit Agreement) to extend the facility through November 10, 2011 and also amend certain financial covenants. The $400 million unsecured credit facility entered into as of October 28, 2005, replaced the previous $275.0 million facility scheduled to expire on October 15, 2008. We recorded a pre-tax charge of $3.3 million related to deferred financing costs associated with the $275.0 million facility in Fiscal 2005. Outstanding borrowings under the Credit Agreement bear interest equal to LIBOR plus the applicable margin (.5% to 1.25%) or the Base Rate (defined as the higher of the Prime Rate or the Federal Funds Effective Rate plus 0.50%) at our option. We pay a commitment fee ranging from 0.125% to 0.25% on the unused portion of the revolving credit facility based on our credit rating. The Credit Agreement requires the maintenance of certain financial covenants including leverage and interest coverage. On October 28, 2006, we were in compliance with all financial covenants in both the Credit Agreement and amended Credit Agreement.
At October 28, 2006, there were $97.0 million outstanding direct borrowings under the Credit Agreement. Outstanding letters of credit issued under the Credit Agreement, which count toward the $400 million credit limit, totaled $113.9 million. At October 28, 2006, there was $189.1 million available for borrowings under the Credit Agreement.
In 2002, we issued $200 million par value 8.75% Senior Subordinated Notes due March 15, 2012. During Fiscal 2005, we purchased approximately all $200.0 million principal amount of Senior Subordinated Notes through a tender offer and in several open market purchases. These transactions, which resulted in a $29.1 million loss on repurchase, consisted of approximately $224.5 million of cash payments and the required write-down of unamortized finance costs of $4.6 million.
During Fiscal 2006, our credit rating was upgraded by both Standard and Poors and Moodys. Standard and Poors credit rating increased from BB+ to BBB- with an outlook of Stable. Moodys credit rating increased from Ba1 to Baa3 with a continued outlook of Stable. These higher credit ratings provide us with greater flexibility to access financing on the open market as our business circumstances justify.
In November 2006, we issued $250.0 million of 6% Senior Notes due 2016 and $150.0 million of 6.625% Senior Notes due 2036 with interest on the notes being paid semi-annually in arrears on May 15 and November 15 of each year, starting on May 15, 2007. The notes are guaranteed by each of our current and future subsidiaries that guarantee our debt under the Credit Agreement. Proceeds from these offerings are being used for the repayment of outstanding revolver balances, additional share repurchases and general corporate purposes.
Stock Repurchase Program
In November 2005, we commenced purchases under our stock repurchase program. Under the program, management was authorized to repurchase up to $300 million in shares in the open market or through privately negotiated transactions over the 24-month period ending May 31, 2007. Due to our continued ability to generate operating cash flow, the board of directors authorized an increase to the authorized amount of repurchases to $1.0 billion and an extension of the program through December 31, 2008. We repurchased approximately $295.5 million of common stock, representing 6,146,752 shares, under the program in Fiscal 2006.
Off-Balance Sheet Arrangements
We lease various assets under operating leases. The aggregate payments under operating leases as of October 28, 2006 are disclosed in the table of Disclosures about Contractual Obligations and Commercial Commitments
below. No significant changes to lease commitments have occurred since October 29, 2005. We have no other off-balance sheet arrangements.
We sponsor pension and other post retirement benefit plans for certain employees. See notes 10 and 11 under Item 8 of this annual report for information regarding these plans.
Disclosures about Contractual Obligations and Commercial Commitments
The following table sets forth our contractual obligations and commercial commitments as of October 28, 2006:
Market Conditions and Outlook
The outlook for the majority of our customers markets remains strong as increasing demand for coal, copper and iron ore reflects global economic growth. The development of Chinas industrial complex and related infrastructure continues at a rapid pace. As the demand for commodities continues to increase in China, the modernization of the mining industry to high productivity equipment is expected to follow. Copper prices have recently seen some pullback but continue to be well above production costs, and iron ore prices are expected to increase further in Fiscal 2007. New copper developments continue to be announced and put into production, mainly due to inventories remaining at historically low levels. Current oil prices continue to support additional developments in the oil sands of Canada. All of these factors combine to support the companys belief that global demand for mining equipment and aftermarket services could continue to grow for an extended duration.
One exception is the temporary softness in U.S. coal. A number of our U.S. coal customers have announced either production curtailments, or the deferral of previously planned production increases. As a result, Joy Minings fourth quarter new orders from U.S. underground coal customers declined by nearly one-third from a year ago. We see no evidence of an improvement going into early Fiscal 2007. The softness in this market has been largely weather-related and as such it is difficult to forecast an eventual upturn. However, the long-term supply and demand situation for coal in the U.S. is favorable, based on the announcements for new coal-fired power plants, the age of existing coal mines, the accelerated retrofitting of existing plants with scrubbers, and a variety of new coal technology projects.
Market conditions in the other commodity markets served by our customers are strong. This is reflected in worldwide underground coal markets producing a double-digit increase in total quarterly orders, before inclusion of orders from the Stamler acquisition and despite the significant fall-off in orders from the U.S. In surface mining markets, orders for mining shovels were very strong in the fourth quarter with orders being received in each of copper, iron ore, oil sands and non-U.S. coal industries.
New Accounting Pronouncements
Our new accounting pronouncements are set forth under Item 8 of this annual report and are incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Volatility in interest rates and foreign exchange rates can impact our earnings, equity and cash flow. From time to time we undertake transactions to hedge this impact. Under governing accounting guidelines, a hedge instrument is considered effective if it offsets partially or completely the impact on earnings, equity and cash flow due to fluctuations in interest and foreign exchange rates. In accordance with our policy, we do not execute derivatives that are speculative or that increase our risk from interest rate or foreign exchange rate fluctuations.
Interest Rate Risk
We are exposed to market risk from changes in interest rates on long-term debt obligations. We manage this risk through the use of a combination of fixed and variable rate debt (See Note 4 Borrowings and Credit Facilities). At October 28, 2006 we were not party to any interest rate derivative contracts.
Foreign Currency Risk
Most of our foreign subsidiaries use local currencies as their functional currency. For consolidation purposes, assets and liabilities are translated at month-end exchange rates. Items of income and expense are translated at average exchange rates. Translation gains and losses are not included in determining net income (loss) but are accumulated as a separate component of shareholders' equity. Gains (losses) arising from foreign currency transactions are included in determining net income (loss). During Fiscal 2006, we incurred a gain of $0.1 million arising from foreign currency transactions. Foreign exchange derivatives at October 28, 2006 were in the form of forward exchange contracts executed over the counter. There is a concentration of these contracts held with LaSalle Bank, N.A. as agent for ABN Amro Bank, N.V. which maintains an investment grade rating.
We have adopted a Foreign Exchange Risk Management Policy. It is a risk-averse policy under which significant exposures that impact earnings and cash flows are fully hedged. Exposures that impact only equity or do not have a cash flow impact are generally not hedged with derivatives. There are two categories of foreign exchange exposures that are hedged: assets and liabilities denominated in a foreign currency, which include net investment in a foreign subsidiary, and future committed receipts or payments denominated in a foreign currency. These exposures normally arise from imports and exports of goods and from intercompany trade and lending activity.
The fair value of our forward exchange contracts at October 28, 2006 is analyzed in the following table of dollar equivalent terms: