Joy Global 10-K 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
T ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED October 29, 2010
£ 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 001-09299
JOY GLOBAL INC.
(Exact Name of Registrant as Specified in Its Charter)
Registrant’s Telephone Number, Including Area Code: (414) 319-8500
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Preferred Stock Purchase Rights
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes T No £
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 £ No T
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 T No £
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 registrant’s 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. T
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes T No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filed or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” 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 Act).
Yes £ No T
The aggregate market value of the voting and non-voting common stock held by non-affiliates, as of April 30, 2010 the last business day of our most recently completed second fiscal quarter, was approximately $5.9, billion, based on a closing price of $56.80 per share.
The number of shares outstanding of registrant’s common stock, as of December 7, 2010, was 103,620,460.
Documents incorporated by reference: the information required by Part III, Items 10, 11, 12, 13, and 14, is incorporated herein by reference to the proxy statement for the registrant’s 2011 annual meeting of stockholders.
Joy Global Inc.
ANNUAL REPORT ON FORM 10-K
For The Year Ended October 29, 2010
This document contains forward-looking statements, which are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When used in this document, terms such as “anticipate,” “believe,” “estimate,” “expect,” “indicate,” “may be,” “objective,” “plan,” “predict,” “should,” “will be,” and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements are based upon our expectations at the time they are made. 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. 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, including in Item 1A, “Risk Factors,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.” 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.
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. Our underground mining machinery segment (“Joy Mining Machinery” or “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. Our surface mining equipment segment (“P&H Mining Equipment” or “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 40%, 45%, and 42% of our consolidated net sales for fiscal 2010, 2009, and 2008, respectively. Aftermarket sales, which includes revenues from maintenance and repair services, diagnostic analysis, fabrication, mining equipment and electric motor rebuilds, equipment erection services, training, and sales of replacement parts, account for the remainder of our consolidated sales for each of those years.
We are the direct successor to a business begun over 125 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.
At the beginning of 2010, we completed the integration of Continental Crushing and Conveying by combining this segment into our Underground Mining Machinery and Surface Mining Equipment segments. Crushing and conveying results related to surface applications are reported as part of the Surface Mining Equipment segment, while total crushing and conveying results are included in the Underground Mining Machinery segment to reflect the overall management responsibility for this product line. Eliminations include the surface applications of crushing and conveying included in both operating segments. Prior year segment results, bookings and backlog have been recast to reflect this change.
Underground Mining Machinery
Joy is the world’s largest producer of high productivity underground mining machinery for the extraction of coal and other bedded materials. We have significant facilities in Australia, South Africa, the United Kingdom, China, and the United States as well as sales offices and service facilities in India, Poland, and Russia. Joy products include: continuous miners; shuttle cars; flexible conveyor trains; complete longwall mining systems (consisting of powered roof supports, an armored face conveyor, and a longwall shearer); continuous haulage systems; battery haulers; roof bolters; crushing equipment; and conveyor systems. Joy also maintains an extensive network of service and replacement parts distribution centers to rebuild and service equipment and to sell replacement parts and consumables in support of its installed base. This network includes five service centers in the United States and eight outside the United States, all of which are strategically located in major underground mining regions.
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 1.2 to 6.5 meters 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 and armored face conveyors, 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.
Flexible conveyor trains (FCT) – FCT’s 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 FCT’s 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.
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.
Feeder breakers – Feeder breakers are a form of crusher that use 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.
Conveyor systems – Conveyor systems are used in both above- and under-ground applications. The primary component of a conveyor system is the terminal which itself comprises a drive, discharge, take-up and tail loading section.
High angle conveyors – The Continental high angle conveyor is a versatile method for elevating or lowering materials continuously from one level to another at extremely steep angles. One of the differentiating factors of the Continental technology is the use of the proprietary fully equalized pressing mechanism which secures material toward the center of the belt while gently, but effectively, sealing the belt edges together. The high angle conveyor has throughput rates ranging from 0.30 to 4,400 tons per hour.
Joy’s service and support infrastructure quickly and efficiently provides customers with high-quality parts, exchange components, repairs, rebuilds, whole machine exchanges, and services. Joy’s 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. Joy’s business is particularly sensitive to conditions in the coal mining industry, which accounts for substantially all of Joy’s sales. Other drivers of cyclicality include product life cycles, new product introductions, governmental regulations, competitive pressures and industry consolidation.
Surface Mining Equipment
P&H is the world’s 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 logistics and a full range of life cycle management service support for its customers through a global network of P&H MinePro Services® operations strategically located within major mining regions. In some markets, P&H MinePro Services also provides electric motor rebuilds and other selected products and services to the non-mining industrial segment. P&H also sells used electric mining shovels in some markets.
Products and Services:
Electric mining shovels – Mining shovels are primarily used to load copper ore, coal, iron ore, oil sands, gold, and 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 typically feature larger dippers, 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. Dippers 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&H’s draglines are equipped 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 blasthole drill creates a pattern of holes to contain the explosives. 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 9 7/8 to 17.5 inches in diameter and can exert a pull down force up to 150,000 lbs.
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 equipment’s 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 customer’s application of our equipment. Under each 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.
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:
For each Alliance Partner, we enter into an agreement that provides us with the right to distribute certain Alliance Partners’ products in specified geographic territories. Specific sales of new equipment are typically based on “buy and resell” arrangements or are direct sale from the Alliance Partner to the ultimate customer with a commission paid to us. The type of sales arrangement is typically agreed at the time of the customer’s commitment to purchase. Our aftermarket sales of parts produced by Alliance Partners are generally made under “buy and resell” arrangements. To support Alliance Partners’ products in certain geographic regions, we typically hold in inventory Alliance Partners’ parts.
P&H’s businesses are subject to cyclical movements in the markets. Sales of original equipment are driven to a large extent by commodity prices and demand. Copper, coal, oil sands, gold and iron ore mining accounted for approximately 90% of total P&H sales in recent years. Rising commodity prices and demand 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 and/or demand can result in the removal of machines from mining production, and thus dampen demand for parts and services. Conversely, significant increases in commodity prices and/or demand can result in higher use of equipment and generate requirements for more parts and services.
Operational Excellence - Joy Global Business System
In order to become a world class company serving the mining industry, we have developed the Joy Global Business System as an extension of our operational excellence initiatives.
The Joy Global Business System is:
The major objectives of the Joy Global Business System are:
All of our business segments are subject to moderate seasonality, with the first quarter of our fiscal year generally experiencing lower sales due to a decrease in working days caused by the U.S. 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 29, 2010, we employed 11,900 employees worldwide, with 5,600 employed in the United States. Collective bargaining agreements or similar type arrangements cover 37% of our U.S. workforce and 30% of our international employees. In 2011, union agreements are to expire for 3% of our employees with the largest covering the AMICUS union at our facilities in the United Kingdom and the Teamsters Union at our facility in Meadowlands, Pennsylvania.
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 net sales for 2010.
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.
Joy’s continuous miners, longwall shearers, powered roof supports, armored face conveyors, continuous haulage systems, shuttle cars, and battery haulers compete with similar products made by a number of established and emerging worldwide manufacturers of such equipment. Joy’s rebuild services compete with a large number of local repair shops and also compete with various regional suppliers in the sale of replacement parts for Joy equipment.
P&H’s shovels and draglines compete with similar products produced by one significant competitor and with hydraulic excavators, large rubber-tired front-end loaders, and bucket wheel excavators made by several international manufacturers. P&H’s large rotary blasthole drills compete with several worldwide drill manufacturers. As high productivity mining becomes more widely accepted internationally, especially in emerging markets, global manufacturing capability is becoming a competitive advantage, but it is still most important to have repair and rebuild capability near the customer’s operations. P&H MinePro Services competes with a large number of primarily regional suppliers in the sale of parts.
Joy and P&H compete on the basis of providing superior productivity, reliability, and service that lowers the overall cost of production for their customers. 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 original equipment and aftermarket products and services. Customer orders included in backlog as of October 29, 2010 represent contracts to purchase specific original equipment, products or services by customers who have satisfied our credit review procedures. Through October 31, 2008, backlog related to our Surface Mining Equipment division was recorded with a letter of intent and deposits to secure production slots. During the third quarter of fiscal 2009, we recorded a $605.9 million adjustment to our backlog based on our new booking policy requiring a contract. The following table provides backlog by business segment as of our fiscal year end. These backlog amounts exclude customer arrangements under long-term equipment life cycle management programs. Such programs extend for up to 13 years and totaled approximately $987.2 million as of October 29, 2010. Sales already recognized by fiscal year-end under the percentage-of-completion method of accounting are also excluded from the amounts shown.
Of the $1.8 billion of backlog, approximately $170.7 million is expected to be recognized as revenue beyond fiscal 2011.
The increase in backlog for our Underground Mining Machinery division as of October 29, 2010 as compared to October 30, 2009 was primarily related to increased demand for original equipment and aftermarket products and services globally. The increase in backlog for our Surface Mining Equipment division was primarily due to increased new orders for electric mining shovels as the global economy continues to recover.
The decrease in backlog for our Surface Mining Equipment division as of October 30, 2009 as compared to October 31, 2008 was due to the $605.9 million backlog adjustment during the third quarter of 2009 and decreased bookings in most markets as a result of our customers’ cautious global economic outlook for mined commodities. The decrease in Underground Mining Machinery is primarily correlated to decreased demand for U.S. underground coal.
Eliminations include the surface applications of crushing and conveying included in both operating segments.
We utilize a supplier risk management monitoring process to analyze our suppliers to determine holistic risk of production disruption as it relates to procurement of materials. Based on the results of the continuous evaluations, we partner with our suppliers to address issues identified. We believe this process gives us greater clarity into the drivers of supplier performance and provides us with early indications of potential supplier issues.
Joy purchases electric motors, gears, hydraulic parts, electronic components, castings, forgings, steel, clutches, and other components and raw materials from outside suppliers. 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.
Patents and Trademarks
We own numerous patents and trademarks and license technology from others relating to our products and manufacturing methods. We have also 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 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 recorded cost of patents and trademarks by segment are as follows:
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 $29.8 million, $22.3 million, and $16.4 million for 2010, 2009, and 2008, respectively.
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.
Compliance with environmental laws and regulations did not have a material effect on capital expenditures, earnings, or our competitive position in 2010. Because these requirements are complex and, in many areas, rapidly evolving, there can be no guarantee against the possibility of additional costs of compliance. However, we do not expect that our future 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 2011.
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 Securities and Exchange Commission.
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 that could adversely affect our business. A significant reduction of our international business due to any of these risks would adversely affect our sales. In 2010, 2009, and 2008, approximately 56%, 50%, and 52%, respectively of our sales were derived from sales outside the United States. Risks faced by our international operations include:
We expect that the percentage of our sales occurring outside the United States will increase over time largely due to increased activity in China, India, and other emerging markets. The foregoing risks may be particularly acute in emerging markets, where our operations are subject to greater uncertainty due to increased volatility associated with the developing nature of the economic, legal, and governmental systems of these countries. If we are unable to successfully manage the risks associated with expanding our global business or to adequately manage operational fluctuations, 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 Joy’s 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&H’s original equipment sales are subject to cyclical movements based in large part on changes in coal, copper, 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. As a result of this cyclicality, we have previously experienced significant fluctuation in our business, results of operations, and financial condition. We expect that cyclicality in our equipment manufacturing business may cause us to experience further significant fluctuation in 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. We compete on the basis of product performance, customer service, availability, reliability, productivity, and price. Many of our customers are large global mining companies that have substantial bargaining power, and 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 than us and, as a result, may have broader product offerings and greater access to financial resources. As a result, certain of our competitors may pursue aggressive pricing or product strategies that may cause us to lose sales or reduce the prices we charge for our original equipment and aftermarket products and services. These actions may lead to reduced revenues, lower margins, and/or a decline in market share, any of which may adversely affect our business and results of operations.
We are largely dependent on the continued demand for coal, which is subject to economic and climate related risks.
Over two-thirds of our revenues come from our coal-mining customers. Many of these customers supply coal for steel production and/or as fuel for the production of electricity in the United States and other countries. Demand for steel is affected by the global level of economic activity and economic growth. The pursuit of the most cost effective form of electricity generation continues to take place throughout the world. Coal combustion generates significant greenhouse gas emissions and governmental and private sector goals and mandates to reduce greenhouse gas emissions may increasingly affect the mix of electricity generation sources. Further developments in connection with legislation, regulations or other limits on greenhouse gas emissions and other environmental impacts or costs from coal combustion, both in the United States and in other countries, could diminish demand for coal as a fuel for electricity generation. If lower greenhouse gas emitting forms of electricity generation, such as nuclear, solar, natural gas or wind power, become more prevalent or cost effective, or diminished economic activity reduces demand for steel, demand for coal will be reduced. When demand for coal is reduced, the demand for our mining equipment could be adversely affected,
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, particularly if credit market conditions worsen. Furthermore, there can be no assurance that refinancings or asset dispositions 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 impose 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 be certain 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.
Significant changes in our actual investment return on pension assets, discount rates and other factors could affect our results of operations, equity and pension funding requirements in future periods.
Our results of operations may be affected by the amount of income or expense that we record for our defined benefit pension plans and certain other retirement benefits. We measure the valuation of our pension plans annually as of our fiscal year end in order to determine the funded status of and our funding obligation with respect to such plans. This annual valuation of our pension plans is highly dependent on certain assumptions used in actuarial valuations, which include actual and expected return on pension assets and discount rates. These assumptions take into account current and expected financial market data, other economic conditions such as interest rates and inflation, and other factors such as plan asset allocation and future salary increases. If actual rates of return on pension assets materially differ from assumptions, our pension funding obligations may increase or decrease significantly. Our funding obligation is determined under governmental regulations and is measured based on value of our assets and liabilities. An adverse change in our funded status due to the volatility of returns on pension assets and the discount rate could increase our required future contributions to our plans, which may adversely affect our results of operations and financial condition.
For a more detailed discussion regarding how our financial statements may be affected by pension and other retirement plan accounting policies, see “Critical Accounting Policies - Pension and Postretirement Benefits and Costs” on page 33 within Item 7 of this Form 10-K.
Our continued success depends on our ability to protect our intellectual property, which cannot be assured.
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.
Demand for our products may be adversely impacted by regulations related to mine safety.
Our principal customers are surface and underground mining companies. The mining industry has encountered increased scrutiny as it relates to safety regulations primarily due to recent high profile mine accidents. Current or proposed legislation on safety standards and the increased cost of compliance may induce customers to discontinue or limit their mining operations, and may discourage companies from developing new mines, which in turn could diminish demand for our products.
Demand for our products may be adversely impacted by environmental regulations impacting the mining industry or electric utilities.
Many of our 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. The high cost of compliance with environmental regulations may also cause 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, such as natural gas, and renewable energy technologies as a source of electric power. As a result of these factors, demand for our mining equipment could be adversely affected by environmental regulations impacting the mining industry or altering the consumption patterns of electric utilities.
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. If we are not able to pass raw material or component price increases on to our customers, our margins could be adversely affected. Any of these events could adversely affect our business, financial condition, or results of operations.
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. Collective bargaining agreements or similar type arrangements cover 37% of our U.S. workforce and 30% of our international employees. In 2011, collective bargaining agreements are scheduled to expire for 3% of our employees. As such, we cannot provide assurance that disputes, work stoppages, or strikes will not arise in the future. In addition, when existing collective bargaining agreements expire, we cannot be certain 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.
A material disruption to one of our significant manufacturing plants could adversely affect our ability to generate revenue.
We produce most of our original equipment and aftermarket parts for each product type at a limited number of principal manufacturing facilities. If operations at one or more of these significant facilities were to be disrupted as a result of equipment failures, natural disasters, power outages or other reasons, our business, financial conditions, or results of operations could be adversely affected. Interruptions in production could increase costs and delay delivery of some units. Production capacity limits could cause us to reduce or delay sales efforts until capacity is available.
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 meet our customers’ expectations, or the industry’s expectations, on mine productivity, the demand for our mining equipment could be substantially 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 and silica related 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 be certain 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 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 customer relationships and technical expertise provided by our management team and our professional personnel.
We rely on significant customers, the loss of one or more of which could adversely affect our operating results, financial condition and existing business.
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 34% of our sales for 2010. 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 acquisitions, joint ventures, start ups or other structures. 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 or expenditures and our management’s time and attention, and may not create value for us or our stockholders.
Item 1B. Unresolved Staff Comments
Item 2. Properties
As of October 29, 2010, 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
Joy Mining also operates warehouses in Nashville, Illinois; Brookwood, Alabama; Henderson, Kentucky; Pineville, West Virginia; Green River, Wyoming; Carlsbad, New Mexico; Price, Utah; Lovely, Kentucky; Norton, Virginia; and Witbank, South Africa. All warehouses are owned except for the warehouses in Nashville, Illinois; Henderson, Kentucky; Price, Utah; Lovely, Kentucky; and Tychy, Poland, which are leased. In addition, Joy Mining has sales offices in Mt. Vernon, Illinois; Eagle Pass, Texas; Abington, Virginia; Secunda, South Africa and Kolata, India. Joy Mining also has a smart services and training facility at Witbank, South Africa.
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, while the others are leased. In addition, P&H leases sales offices throughout the United States and in principal surface mining locations in other countries, such as Chijuajua, Mexico and Kolkata, India.
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 our results of operations on a quarter-to-quarter basis, based upon our case evaluations and the availability of insurance coverage we believe that the outcome of such legal and other matters will not have a material adverse effect on our consolidated financial position, results of operations, or liquidity.
During the Chapter 11 reorganization of our Predecessor Company, in 1999 through the filing of a voluntary petition under Chapter 11 of the United States Bankruptcy Code, the Wisconsin Department of Workforce Development (“DWD”) filed claims against Beloit Corporation (“Beloit”), a former majority owned subsidiary, and us in federal bankruptcy court seeking “at least” $10 million in severance benefits and penalties, plus interest, on behalf of former Beloit employees. DWD’s claim against Beloit included unpaid severance pay allegedly due under a severance policy Beloit established in 1996. DWD alleges that Beloit violated its alleged contractual obligations under the 1996 policy when it amended the policy in 1999. The Federal District Court for the District of Delaware removed DWD’s claims from the bankruptcy court and granted summary judgment in our favor on all of DWD’s claims in December 2001. DWD appealed the decision and the judgment was ultimately vacated in part and remanded. Following further proceedings, DWD’s only remaining claim against us is that our Predecessor Company tortiously interfered with Beloit’s employees’ severance benefits in connection with Beloit's decision to amend its severance policy. We concluded a trial on DWD’s remaining claim during the week of March 1, 2010. On September 21, 2010 the court granted judgment in our favor. DWD then filed a post-judgment motion asking the court to change its decision. We await a ruling on DWD’s latest motion. If the court denies DWD’s motion, we expect that DWD will file an appeal with the United States Court of Appeals for the Third Circuit. We do not believe these proceedings will have a significant effect on our financial condition, results of operations, or liquidity.
Because DWD's claims were still being litigated as of the effective date of our Plan of Reorganization, the Plan of Reorganization provided that the claim allowance process with respect to DWD's claims would continue as long as necessary to liquidate and determine these claims.
Item 4. Reserved
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 needed.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the Nasdaq Global SelectMarket under the symbol “JOYG.” As of December 2, 2010, there were approximately 91,000 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 did not make any purchases of our common stock, par value $1.00 per share, during fiscal 2010. Under our share repurchase program, management is authorized to repurchase up to $2.0 billion in shares of common stock in the open market or through privately negotiated transactions until December 31, 2011. The dollar amount of shares that may yet be purchased under the program is $883.4 million.
The following graph sets forth the cumulative total shareholder return, including reinvestment of dividends on a quarterly basis, on common stock during the preceding five years, as compared to the cumulative total returns of the Standard and Poor’s (“S&P”) 500 Composite Stock Index and the Dow Jones United States Commercial Vehicle Truck Index (“DJUSHR”). The DJUSHR was known as the Dow Jones U.S. Total Market Heavy Machinery Index until December 20, 2004. This graph assumes $100 was invested on October 31, 2005, in Common Stock, the S&P 500 Composite Stock Index, and the DJUSHR.
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. Prior to fiscal 2007 our fiscal year end was 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. 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
(1) – In February 2008, we acquired N.E.S. Investment Co. and its wholly owned subsidiary, Continental Global Group, Inc. (“Continental”), a worldwide leader in conveyor systems for bulk material handling in mining and industrial applications.
Item 7. Management’s 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 2010, 2009, and 2008. For a more complete understanding of this discussion, please read the Notes to Consolidated Financial Statements included in this report.
We have been manufacturing mining equipment for over 125 years. We operate in two business segments: Underground Mining Machinery, comprised of our Joy Mining Machinery business and Surface Mining Equipment, comprised of our P&H Mining Equipment business. Joy is a leading producer of high productivity 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 major producer of walking draglines and large rotary blasthole drills, used primarily for surface mining of copper, coal, iron ore, oil sands, and other minerals.
In addition to selling original equipment, we provide parts, components, repairs, rebuilds, diagnostic analysis, 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.
Bookings for 2010 were $3.9 billion, an increase of 39% from $2.8 billion, excluding $250.9 million and $63.2 million of order cancellations for original equipment and aftermarket parts and service, respectively, in 2009. The 2010 bookings included the $108.9 million favorable effect of foreign currency translation. The increase in bookings consisted of a $708.6 million increase in original equipment and $385.7 million increase in aftermarket parts and service. The increase in both original equipment and aftermarket orders reflects our customers’ commitment to both brown field and green field projects as the global demand for commodities continues to increase, most significantly in emerging markets.
Net sales for 2010 totaled $3.5 billion, compared with $3.6 billion in 2009, and included a $138.5 million favorable effect of foreign currency translation. The decrease in net sales was the result of a $201.6 million decrease in original equipment shipments, partially offset by $127.6 million increase in aftermarket parts and service. In 2009, shipments increased on declining order rates as we reduced backlog while meeting scheduled delivery dates. Net sales for the underground equipment business decreased by 6.7% in 2010 compared to 2009, while net sales for the surface mining equipment business increased by 4.0%.
Operating income was $697.1 million in 2010, compared to $702.3 million in 2009 and included a $20.9 million favorable effect of foreign currency translation. The decrease in operating income was primarily the result of decreased sales volumes and increased retiree benefit costs of $36.1 million. These unfavorable items were partially offset by favorable pricing realization and the mix of products sold, decreased material input costs and elimination of severance and related expenses of $14.4 million recorded in 2009.
Net income was $461.5 million or $4.40 per diluted share in 2010, compared with $454.7 million or $4.41 per diluted share in 2009.
The commodity end-markets have strong fundamentals and a positive outlook despite slow economic recovery in the industrialized countries and slower growth in the emerging markets, particularly China, which results from efforts to balance economic growth while containing inflation.
After recovering beginning in the second half of 2009 and continuing into 2010, copper demand hit an all-time high in June of 2010 and continues to run well above its prior five year range. This was not driven by China alone, and in fact, China demand has leveled from 2009 while demand from the rest of the world has increased significantly since the beginning of 2010. Copper prices have moved steadily up during 2010 in response to both increasing demand and limited capacity to expand mine production in the near term. The longer term outlook is further impacted by the continued trend of declining ore grades.
The seaborne demand for both thermal and metallurgical coal continues to be driven by China, India, and the other emerging markets. China continues to import coal at an annualized rate of more than 140.0 million metric tons, up from imports of 104.0 million metric tons last year. India also continues to import more coal, with its imports expected to triple during the next five years. In addition to emerging market demand, coal burn has been increasing in Europe and stockpiles there have been drawn down. Seaborne thermal coal prices have been increasing on the projection that continued demand growth from the emerging markets will keep supply under pressure.
U. S. coal production year to date is flat with last year, but with an improving trend in more recent months. Based on the recent trend, coal demand is on pace to recover from last year. In addition, the favorable U.S. dollar exchange rate is increasing export opportunities for both thermal and metallurgical coal. U.S. coal production has been restricted by safety and permitting issues and is mostly flat while demand continues to improve. This has resulted in increasing prices across all regions since the first of this year.
Similar to copper, global demand in 2010 for iron ore and metallurgical coal has come mostly from increases in steel production outside of China. Prices for both metallurgical coal and iron ore have been rising in recent months and should see continued upward pressure as demand growth resumes from the emerging markets. China has started to relax power rationing in the major steel-making province of Hebei, and this resulted in steel production increases in October. In addition, India’s imports of metallurgical and thermal coal are expected to rebound after weather related slowing.
Inventories in the industrial sector of the developed countries were substantially reduced during 2009 as companies adjusted to lower demand volumes, and the replenishment of those inventories will add further upside to commodity demand as economic recovery continues. In addition, China and India have included significant infrastructure programs in their next five year plans. India plans to spend $350.0 billion over the next three years for infrastructure projects. A major focus will be on power generation, with capacity additions expected to double by 2012. China’s plan focuses on the development of the western provinces and on second and third tier cities. Fixed asset investment is targeted to grow at 20% per year and includes the build out of the electricity grid in the western provinces, which alone could add a million tons to annual copper demand.
Based on this outlook, mining companies are realizing strong demand and prices, with the expectation of significant increases in demand during the next 3 to 5 years. As a result, they are making major increases in their capital expenditures for mine expansions. Mining companies have announced capital expenditures that are up 30% to 35% this year, and are approaching the levels of 2008. In addition, announced capital expenditures for 2011 are expected to rise another 15% to 20%.
Our outlook is defined by increases in mine production rates as the end use demand for commodities continues to improve and by significant increases in mining company capital budgets as they begin expansion programs to meet higher levels of future demand. Our order rates for original equipment are correlated with the growth in mining company capital expenditures, and therefore the increase in mining company capital budgets provides a strong outlook for mining equipment. Mining companies are transitioning their focus from expanding existing mine capacity to adding major new mines, or from brown field to green field projects, as a major part of their increased capital expenditures. The green field projects are generally larger, and often involve multiple machines, and this is increasing the list of qualified machine prospects that we track. This list has been increasing during the year, and continued the upward trend in the fourth quarter. Green field projects have longer lead times, and are unlikely to start reaching equipment decisions until later in 2011. The transition from brown field to green field projects could constrain order rate growth over the next couple of quarters.
We are increasing our production schedules to keep pace with growing customer demand. Based on both market fundamentals and the discussions directly with our customers, we are confident that this is the early stage of another multi-year expansion of the mining industry. Therefore we are also stepping up our own capital spending to ensure we will have the machines that our customers will need in their expansion programs. More importantly, we want to get this capacity in as early as possible to enable its utilization as industry growth unfolds.
The following represents regions or countries included in our discussion within the Underground Mining Machinery Segment:
Results of Operations
2010 Compared with 2009
The following table sets forth 2010 and 2009 net sales as derived from our Consolidated Statement of Income:
Underground Mining Machinery net sales for 2010 were $2.1 billion compared to $2.3 billion for 2009, and included a $223.2 million decrease in original equipment sales, partially offset by a $71.3 million increase in aftermarket sales. Net sales in 2010 increased by $92.9 million due to the effect of foreign currency translation. Original equipment sales decreased by $182.8 million in the United States and $61.5 million in Australasia, primarily due to decreased longwall equipment shipments in both regions. Original equipment sales also decreased in South Africa by $112.9 million, primarily due to decreased room and pillar and longwall mining equipment shipments. These decreases were partially offset by a $115.8 million increase in original equipment sales, primarily of longwall equipment, in China. Aftermarket sales were up in all regions, but most significantly in South Africa, primarily due to complete machine rebuilds.
Surface Mining Equipment net sales for 2010 were $1.52 billion compared to $1.46 billion for 2009, and included a $63.9 million increase in aftermarket sales, partially offset by a $5.7 million decrease in original equipment sales. Net sales in 2010 increased by $45.6 million due to the effect of foreign currency translation. The decrease in original equipment was primarily due to decreased electric mining shovel and drill sales and decreased crushing and conveying equipment sales, which were partially offset by increased alliance sales. The increase in aftermarket sales was primarily related to increased repair and rebuilds in all regions, with the exception of emerging markets.
The following table sets forth 2010 and 2009 operating income as derived from our Consolidated Statement of Income:
Operating income for Underground Mining Machinery was $433.9 million in 2010, compared to operating income of $461.0 million in 2009. Operating income was favorably impacted in 2010 by $18.5 million due to the effect of foreign currency translation. Operating income was unfavorably impacted by $46.7 million associated with lower sales volumes, $22.1 million of increased retiree benefit expense, $9.0 million of warranty and performance penalties and $5.8 million of product expense, primarily made up of research & development costs. Partially offsetting these decreases in operating income were higher margins related to price realization and the mix of products sold, favorable material input costs, and the benefit of prior year cost reduction programs. Operating income in 2009 was reduced by $9.0 million for severance and related expenses not repeated in 2010.
Operating income for Surface Mining Equipment was $336.2 million in 2010, compared to operating income of $322.2 million in 2009. Operating income was favorably impacted in 2010 by $2.5 million due to the effect of foreign currency translation. Operating income was favorably impacted by higher sales volumes, favorable material input costs of $7.1 million, and the benefit of prior year cost reduction programs. These increases were partially offset by $11.4 million of increased retiree benefit expense. In addition, cancellation income of $8.5 million was recorded in 2009 and not repeated in 2010.
Product Development, Selling and Administrative Expense
Product development, selling and administrative expense was $480.6 million, or 14% of sales, in 2010, compared to $454.5 million, or 13% of sales, in 2009. These expenses were unfavorably impacted by $17.8 million due to the effect of the foreign currency translation. Product development, selling and administrative expense increased in 2010 due to $22.4 million of increased retiree benefit costs and $7.2 million of increased performance based compensation, partially offset by the benefit of cost saving initiatives implemented in 2009. Administrative expense also included increased severance and related expenses of $14.4 million in 2009 that was not repeated in 2010.
Net Interest Expense
Net interest expense was $16.8 million in 2010, compared to $24.7 million in 2009. Net interest expense decreased primarily due to interest earned on increased cash and cash equivalents.
Provision for Income Taxes
Income tax expense was $217.5 million in 2010, with an effective tax rate of 32.0%, compared to income tax expense of $228.0 million in 2009, with an effective tax rate of 33.4%. The main drivers of the variance in tax rates when compared to the statutory rate of 35.0% were the geographic mix of earnings and the utilization of tax credits and tax holidays offset by increased state income taxes and establishment of valuation reserves.
A net discrete tax benefit of $3.4 million was recorded in 2010, compared to net discrete tax expense of $8.2 million in 2009. A review of uncertain income tax positions was performed throughout 2010 and 2009 and a net benefit of $4.4 million and $1.8 million, respectively, was recorded.
2009 Compared with 2008
The following table sets forth 2009 and 2008 net sales as derived from our Consolidated Statement of Income:
Underground Mining Machinery net sales for 2009 were $2.3 billion compared to $2.0 billion for 2008, which included a $255.3 million increase in original equipment sales and a $22.2 million increase in aftermarket sales. 2009 net sales decreased by $125.1 million due to the effect of foreign currency translation. Original equipment sales in the Americas increased by $194.6 million primarily as a result of increased sales of room and pillar application equipment and roof supports used in longwall system applications. Original equipment sales also increased in South Africa by $111.0 million due to increased demand for equipment used in both room and pillar and longwall applications and by $66.6 million associated with increased crushing and conveying equipment sales primarily due to the Continental acquisition made on February 14, 2008. Therefore 2008 only included eight and one-half months of the Continental net sales. Original equipment sales decreased by $74.9 million in Eurasia primarily due to decreased roof support sales, while original equipment sales in China decreased by $43.8 million primarily due to lower continuous miner and armored face conveyor sales. Aftermarket sales were flat or slightly down in all markets with the exception of the United States.
Surface Mining Equipment net sales for 2009 were $1.5 billion which included a $43.9 million decrease in original equipment sales and a $36.7 million decrease in aftermarket sales. 2009 net sales decreased by $36.2 million due to the effect of foreign currency translation. Original equipment sales, primarily consisting of electric mining shovel sales, decreased in China and Canada, partially offset by increased sales in the United States and Australia. Reduced production activity by our customers translated into lower aftermarket products and service revenues with decreased sales of $63.4 million in the United States, partially offset by increased sales of $25.4 million and $22.7 million in Chile and Canada, respectively.
The following table sets forth 2009 and 2008 operating income as derived from our Consolidated Statement of Income:
Operating income for Underground Mining Machinery was $461.0 million in 2009, compared to $364.7 million in 2008. Operating income was unfavorably impacted in 2009 by $26.7 million due to the effect of foreign currency translation. Operating income was favorably impacted in 2009 by $72.0 million of increased sales and improved price realization, $13.5 million of decreased purchase accounting related to the conveying business, lower material costs, spending control measures and the benefits associated with operating excellence initiatives, and inclusion of the conveyor business for all of 2009 as compared to eight and a half months in fiscal 2008. These increases were partially offset by the cost incurred in connection with various cost reduction actions and the effect of a higher mix of original equipment.
Operating income for Surface Mining Equipment was $322.2 million in 2009, compared to $250.1 million in 2008. The increase in operating income was primarily due to favorable price realization, reduced material costs, spending control measures, and $8.5 million of cancellation income. In addition, 2008 operating income was unfavorably impacted by a $22.7 million charge for the cancellation of a maintenance and repair contract in Australia and a $5.5 million charge for retiree benefit costs associated with the execution of the Steelworkers agreement in Milwaukee.
Corporate expense increased by $6.9 million primarily due to increased professional service fees, recruiting and relocation fees associated with the filling of senior management positions, and an increase in equity incentive based performance compensation.
Product Development, Selling and Administrative Expense
Product development, selling and administrative expense was $454.5 million, or 13% of sales, in 2009, as compared to $441.5 million, or 13% of sales, in 2008. The increase in product development, selling and administrative expense was primarily due to $14.4 million of severance and other related expense associated with various cost reduction initiatives implemented during 2009. The increase in corporate expense outlined previously and general inflationary increases were offset by the favorable impact of $23.7 million due to foreign currency translation and the spending controls put in place.
Provision for Income Taxes
Income tax expense for 2009 was $228.0 million, compared to income tax expense of $154.0 million in 2008. The effective income tax rates from continuing operations were 33.4% and 29.2%, for 2009 and 2008, respectively. The main drivers of the variance in tax rates when compared to the statutory rate of 35% were the geographic mix of earnings with the corresponding net favorable differences in foreign statutory tax rates and the utilization of tax credits and tax holidays offset by increased state income taxes and tax account corrections.
A net discrete tax expense of $8.2 million was recorded in 2009, as compared to a net discrete tax benefit of $10.4 million in 2008. A review of uncertain income tax positions was performed throughout 2009 and 2008 as part of the overall income tax provision and a net benefit of $1.8 million and $3.5 million, respectively, was recorded on a global basis.
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 2010, 2009, and 2008 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, 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, 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 policies that most frequently require us to make estimates and judgments, and therefore are critical to the understanding of our results of operations.
We recognize revenue on aftermarket products and services when the following criteria are satisfied: persuasive evidence of an arrangement exists, product delivery and title transfer has occurred or the services have been rendered, the price is fixed and determinable, and collectability is reasonably assured. We recognize revenue on long-term contracts, such as for the manufacture of mining shovels, drills, draglines, roof support systems and conveyor systems, using the percentage-of-completion method. We generally recognize revenue using the percentage-of-completion method for original equipment. 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. Approximately 87% of our sales in 2010 were recorded at the time of shipment of the product or delivery of the service, with the remaining 13% of sales recorded using percentage of completion accounting.
We have life cycle management contracts with customers to supply parts and service for terms of 1 to 13 years. These contracts are established based on the conditions the equipment will be operating in, the time horizon that the program will cover, and the expected operating cycle that will be required for the equipment. Based on this information, a model is created representing 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 machine’s long-term maintenance requirements. Under these contracts, customers are generally billed monthly based on hours of operation or units of production achieved by the equipment, with the respective deferred revenues recorded when billed. Revenue is recognized in the period in which parts are supplied or services provided. These contracts are reviewed quarterly by comparison of actual results to original estimates or most recent analysis, with revenue recognition adjusted appropriately for future estimated costs. If a loss is expected at any time, the full amount of the loss is recognized immediately.
We have certain customer agreements that are multiple element arrangements as defined by the Accounting Standards Codification (“ASC”) No. 605-25 “Multiple-Element Arrangements”. The agreements are assessed for multiple elements based on the following criteria: the delivered item has value to the customer on a standalone basis, there is objective and reliable evidence of the fair value of the undelivered item, and the arrangement includes a general right of return relative to the delivered item and delivery or performance of the undelivered item is considered probable and substantially in the control of the vendor. Revenue is then allocated to each identified unit of accounting based on our estimate of their relative fair values.
Revenue recognition involves judgments, including 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 method for all inventories. We evaluate the need to record valuation adjustments for inventory on a regular basis. Our policy is to evaluate all inventories 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.
Goodwill and Other Intangible Assets
Intangible assets include drawings, patents, trademarks, technology, customer relationships and other specifically identifiable assets. Indefinite-lived intangible assets are not being amortized. Indefinite lived intangible assets are evaluated for impairment annually or more frequently if events or changes occur that suggest impairment in carrying value, such as a significant adverse change in the business climate. As part of the impairment analysis, we use the discounted cash flow model based on royalties estimated to be derived in the future use of the asset were we to license the use of the trademark or tradename. No impairment was identified as part of our fourth quarter impairment testing of our indefinite lived intangible assets. Finite-lived intangible assets are amortized to reflect the pattern of economic benefits consumed, which is principally the straight-line method. Intangible assets that are subject to amortization are evaluated for impairment if events or changes occur that suggest impairment in carrying value. No impairment was identified related to our finite-lived intangible assets.
Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired in a business combination. Goodwill is assigned to specific reporting units, which we have identified as our operating segments, and tested for impairment at least annually, during the fourth quarter of our fiscal year, or more frequently upon the occurrence of an event or when circumstances indicate that a reporting unit’s carrying amount is greater than its fair value. Goodwill is tested for impairment using the two-step approach, in accordance with ASC No. 350, “Intangibles – Goodwill and Other.” The determination of an impairment requires the valuation of the respective reporting unit, which we estimate using the discounted cash flow model and market approach.
The discounted cash flow model involves many assumptions, including operating results forecasts and discount rates. Inherent in the operating results forecasts are certain assumptions regarding revenue growth rates, projected cost saving initiatives and projected long-term growth rates in the determination of terminal values. We performed our goodwill impairment testing in the fourth quarter of 2010 and no impairment was identified. A one percentage point increase in the discount rate used to determine the fair value of the reporting units would not cause the carrying value of the respective reporting unit to exceed its fair 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 management’s 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
Pension and other postretirement benefit costs and liabilities are dependent on assumptions used in calculating such amounts. The primary assumptions include factors such as discount rates, expected return on plan assets, mortality rates and rate of compensation increases, discussed below:
Discount rates: We generally estimate the discount rate for pension and other postretirement benefit obligations using a process based on a hypothetical investment in a portfolio of high-quality bonds that approximate the estimated cash flows of the pension and other postretirement benefit obligations. We believe this approach permits a matching of future cash outflows related to benefit payments with future cash inflows associated with bond coupons and maturities.
Expected return on plan assets: Our expected return on plan assets is derived from reviews of asset allocation strategies and anticipated future long-term performance of individual asset classes. Our analysis gives appropriate consideration to recent plan performance and historical returns; however, the assumptions are primarily based on long-term, prospective rates of return.
Mortality rates: Mortality rates are based on the RP-2000 mortality table.
Rate of compensation increase: The rate of compensation increase reflects our long-term actual experience and its outlook, including consideration of expected rates of inflation.
Actual results that differ from the assumptions are accumulated and amortized over future periods, and therefore, generally affect recognized expense and the recorded obligation in future periods. While we believe that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect our pension and other postretirement plan obligations and future expense.
Future changes affecting the above assumptions will change the related pension benefit or expense. As such, a 0.25% change in the discount rate and rate of return on net assets would have the following effects on projected benefit obligation and pension expense, respectively, as of and for the fiscal year ended October 29, 2010:
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. Additionally, we analyze our ability to recognize the net deferred tax assets created in each jurisdiction in which we operate to determine if valuation allowances are necessary based on the “more likely than not” criteria.
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. As of October 29, 2010, there were $68.8 million of valuation allowances against pre-emergence net operating loss carryforwards. All future reversals of pre-emergence valuation allowances will be recorded to additional paid in capital.
Liquidity and Capital Resources
The following table summarizes the major elements of our working capital as of:
We currently use trade working capital and cash flow from operations as two financial measurements to evaluate the performance of our operations and our ability to meet our financial obligations. We require trade working capital investment because our service model requires us to maintain certain inventory levels in order to maximize our customers’ machine reliability. This information also provides management with a focus on our receivable terms and collectability efforts and our ability to obtain advance payments on original equipment orders. As part of our continuous improvement of purchasing and manufacturing processes, we continue to strive for alignment of inventory levels with customer demand and current production schedules.
Cash provided by operations for 2010 was $583.5 million as compared to $452.0 million provided by operations for 2009. Cash provided by operations was unfavorably impacted by increased contributions to retiree benefit plans of $86.6 million and an increase in accounts receivable primarily due to increased sales in the fourth quarter of 2010. Cash provided by operations was favorably impacted by increased customer advance payments due to original equipment bookings in excess of shipments, and increased accounts payable due to process improvements.
Cash used by investment activities for 2010 was $74.9 million as compared to $104.0 million used by investment activities for 2009. The decrease in cash used by investment activities for 2010 was driven by decreased capital expenditures of $20.6 million due to the delay in restarting capital projects which were put on hold during 2009 and the prior year acquisition of Wuxi Shengda Machinery Co., Ltd., a Chinese manufacturer of longwall shearing machines.
Cash used by financing activities for 2010 was $185.1 million as compared to $107.6 million used by financing activities for 2009. The increase in cash used by financing activities for 2010 was driven by the $144.4 million repayment of the term loan in conjunction with execution of the new revolving credit facility, partially offset by the prior year repurchase of outstanding stock of $13.7 million.
We expect 2011 capital spending to be approximately $150.0 million. Capital projects will be focused on expanding service center capabilities globally and the increase of our manufacturing capabilities in the emerging markets.
In addition to capital expenditures for the repair, replacement, and upgrading of existing facilities, we have commitment and letter of credit fees under our revolving credit facility and biannual interest payments due to holders of our Senior Notes issued in November 2006. We also have a net unfunded pension and other post-retirement liability of $461.1 million as of October 29, 2010. In order to address these liquidity needs we have:
We believe that cash generated from operations, together with cash and cash equivalents and borrowings available under our credit facility, provide us with adequate liquidity to meet our operating requirements, including pension contributions, debt service requirements and planned capital expenditures.
On October 27, 2010 we entered into a $500.0 million unsecured revolving credit facility (“Credit Agreement”) set to expire on November 3, 2014. We recorded a pre-tax charge of $0.3 million related to deferred financing costs associated with the termination of our $400.0 million unsecured revolving credit facility that was set to expire on November 10, 2011. Under the terms of the new agreement we pay a commitment fee ranging from 0.25% to 0.5% on the unused portion of the revolving credit facility based on our credit rating. Outstanding borrowings bear interest equal to the London Interbank Offered Rate (“LIBOR”) (defined as applicable LIBOR rate for the equivalent interest period plus 1.75% to 2.75%) or the Base Rate (defined as the highest of the Prime Rate, Federal Funds Effective Rate plus 0.5%, or Eurodollar Rate plus 1.0% ) at our option. The Credit Agreement requires the maintenance of certain financial covenants including leverage and interest coverage ratios. The Credit Agreement also restricts payment of dividends or other return of capital when the consolidated leverage ratio exceeds a stated level.
On October 22, 2010, we repaid the $131.3 million remaining balance of the $175.0 million term loan which was used to fund our acquisition of Continental. We recorded a pre-tax charge of $0.4 million related to the deferred financing cost on the term loan that was initially due October 31, 2011.
At October 29, 2010, there were no direct borrowings under the Credit Agreement. Outstanding letters of credit issued under the Credit Agreement, which count toward the $500.0 million credit limit, totaled $181.9 million. At October 29, 2010, there was $318.1 million available for borrowings under the Credit Agreement.
In November 2006, we issued $250.0 million aggregate principal amount of 6.0% Senior Notes due 2016 and $150.0 million aggregate principal amount of 6.625% Senior Notes due 2036 (“Notes”) 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 significant domestic subsidiaries. The Notes were issued in a private placement under an exemption from registration provided by the Securities Act of 1933 (“Securities Act”), as amended. In the second quarter of 2007, the Notes were exchanged for similar notes registered under the Securities Act. At our option, we may redeem some or all of the Notes at a redemption price of the greater of 100% of the principal amount of the Notes to be redeemed or the sum of the present values of the principal amounts and the remaining scheduled interest payments using a discount rate equal to the sum of a treasury rate of a comparable treasury issue plus 0.3% for the 2016 Notes and 0.375% for the 2036 Notes.
Advance Payments and Progress Billings
As part of the negotiation process associated with original equipment orders, there are generally advance payments obtained from our customers to support the procurement of inventory and other resources. As of October 29, 2010, advance payments and progress billings were $376.3 million. As orders are shipped or costs incurred, the advanced payments and progress billings are reclassified to revenue on the consolidated income statement.
We sponsor pension plans in both the U.S. and other countries. The significance of the funding requirements of these plans are largely dependent on the actual value of the plan assets, the investment returns on the plan assets, actuarial assumptions, including discount rates, and the impact of the Pension Protection Act of 2006. During 2010, we contributed $117.4 million to our world wide retiree benefit plans compared to $30.8 million during 2009. We expect to make contributions of between $135.0 million to $145.0 million to our U.S. plans and non-U.S. plans in 2011.
Stock Repurchase Program
Under our share repurchase program, management is authorized to repurchase up to $2.0 billion in shares of common stock in the open market or through privately negotiated transactions until December 31, 2011. During 2010 we did not repurchase any shares, but in 2009 and 2008, we repurchased approximately $13.7 million of common stock representing 608,720 shares and $307.7 million of common stock representing 6,040,727 shares, respectively. In the future we will continue to include share repurchases as a discretionary use of cash in combination with our dividend policy and acquisition strategy.
Off-Balance Sheet Arrangements
We lease various assets under operating leases. The aggregate payments under operating leases as of October 29, 2010 are disclosed in the table of Disclosures about Contractual Obligations and Commercial Commitments below. No significant changes to lease commitments have occurred during 2010. We have no other off-balance sheet arrangements.
Disclosures about Contractual Obligations and Commercial Commitments
The following table sets forth our contractual obligations and commercial commitments as of October 29, 2010:
New Accounting Pronouncements
Our new accounting pronouncements are set forth under Item - 15 Exhibits and Financial Statements Schedules of this annual report and are incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Volatility in commodity price risk and foreign exchange rates can impact our earnings, equity, and cash flow. From time to time we undertake transactions to hedge this impact. 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, commodity, and foreign exchange rates. In accordance with our policy, we do not execute derivatives that are speculative or that increase our risk from commodity price or foreign exchange rate fluctuations.
Commodity Price Risk
We purchase certain raw materials, including steel and copper, that are subject to price volatility caused by systematic risks. Although future movements in raw material prices are unpredictable, we manage this risk through periodic purchases of raw materials and passing some or all price increases to our customers. At October 29, 2010, we were not a party to any commodity forward contracts.
Foreign Currency Risk
Our significant 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 2010, we realized a gain of $5.7 million arising from foreign currency transactions. Foreign exchange derivatives at October 29, 2010 were in the form of forward exchange contracts executed over the counter. There is a concentration of these contracts held with Bank of America, N.A., which maintains an investment grade rating.
We have a risk-averse Foreign Exchange Risk Management 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. We hedge two categories of foreign exchange exposures: assets and liabilities denominated in a foreign currency, which include future committed receipts or payments denominated in a foreign currency and certain U.S. functional currency entity balance sheet accounts denominated in local currencies. 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 29, 2010 is analyzed in the following table of dollar equivalent terms:
The following tables present our forward exchange contract balances with an aggregate notional amount greater than $10.0 million.