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| JOY > SEC Filings for JOY > Form 10-Q on 30-Aug-2012 | All Recent SEC Filings |
30-Aug-2012
Quarterly Report
The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and the related notes to the Condensed Consolidated Financial Statements in Item 1 of this Quarterly Report on Form 10-Q. Dollar amounts are in thousands, except share and per share data and as indicated.
Joy Global Inc. is a worldwide leader in high-productivity mining solutions. We manufacture and market original equipment and aftermarket parts and services for both underground and surface mining and certain industrial applications through two business segments: Underground Mining Machinery and Surface Mining Equipment. We are a major manufacturer of underground mining equipment for the extraction of coal and other bedded minerals and offer comprehensive service locations near major mining regions worldwide. We are also a major producer of surface mining equipment for the extraction of ores and minerals and we provide extensive operational support for many types of equipment used in surface mining. Our principal manufacturing facilities are located in the United States, including facilities in Pennsylvania, Wisconsin, Kentucky, Texas and Alabama and international facilities in China, the United Kingdom, South Africa, Canada, Chile and Australia.
International Mining Machinery
On July 11, 2011, we entered into a Share Purchase Agreement ("SPA") with TJCC Holdings Limited, a corporation controlled by The Jordan Company, L.P., to acquire approximately 41.1%, of IMM. IMM is a leading designer and manufacturer of underground coal mining equipment in China. On July 28, 2011, August 16, 2011 and September 2, 2011 we purchased shares on the open market representing an aggregate of approximately 28.1% of the total outstanding shares of IMM. On December 20, 2011, the Anti-monopoly Bureau of the Ministry of Commerce of the People's Republic of China approved the purchase of IMM shares covered by the SPA and the acquisition closed on December 29, 2011. At such time, we acquired a controlling interest in IMM which, when aggregated with earlier open market purchases, was approximately 69.2% of IMM's outstanding common stock. Upon closing, we recognized a $19.4 million gain on the re-measurement of our pre-existing equity interest in IMM. On January 6, 2012, in accordance with Rule 26.1 of the Hong Kong Takeovers Code, we commenced an unconditional cash tender offer to purchase the remaining outstanding IMM shares and options to purchase IMM shares that we did not own. On February 10, 2012, we completed the tender offer. As a result of the tender offer, our beneficial ownership of IMM common stock increased to approximately 98.9%, for which we had paid aggregate consideration of approximately $1.4 billion. On July 25, 2012, we effected the compulsory acquisition of the remaining shares under applicable provisions of the Cayman Island Companies Law, under which IMM is incorporated. We paid consideration of approximately $16.2 million to complete the compulsory acquisition, using the remaining cash held in escrow. The combined effect of these transactions resulted in our beneficial ownership of 100% of the common stock of IMM.
Operating Results
Bookings in the third quarter of 2012 were approximately $1.1 billion, a decrease of 25.1% from the prior year third quarter. Original equipment bookings decreased $367.1 million, or 48.2%, while aftermarket bookings increased $4.0 million or 0.6%. The Surface Mining Equipment segment original equipment bookings excluding LeTourneau decreased 65.8% and the Underground Mining Machinery segment original equipment bookings excluding IMM decreased 54.7%. Overall, original equipment orders declined primarily due to a soft coal market in the U.S. and China and an order for a roof support system in Russia in 2011 that did not reoccur in the current period. Original equipment bookings decreased in all regions with the exception of South Africa. Aftermarket bookings in Surface Mining Equipment excluding LeTourneau decreased 2.1% when compared to the prior year third quarter, while aftermarket orders in Underground Mining Machinery excluding IMM increased 1.7%. Aftermarket orders were also negatively impacted by the soft coal market. Foreign currency translation unfavorably impacted bookings by $61.7 million when compared to the prior year third quarter.
Net sales in the third quarter of 2012 were approximately $1.4 billion, compared to approximately $1.1 billion in the third quarter of 2011. The 22.2% increase in net sales in the current year third quarter includes a $77.8 million increase in aftermarket sales, primarily in parts and rebuilds, and a $174.6 million increase in original equipment sales, primarily due to acquisitions and shovels. Sales increased in most regions for both segments. Foreign currency translation unfavorably impacted sales by $35.0 million when compared to the third quarter of the prior year.
Operating income in the third quarter of 2012 increased by $63.5 million to $299.5 million, which represented a 25% incremental profitability on the increase in sales, as lower employee costs were partially offset by an increase in unfavorable manufacturing variances, and selling, engineering and administrative expenses. Incremental profitability is calculated by dividing the change in operating income by the change in net sales over a stated period. Management believes this is an important measure in determining the efficiency of our operations.
The results of LeTourneau's mining equipment business are included with our Surface Mining Equipment segment. For the third quarter of 2012, LeTourneau's mining equipment business had bookings of $91.7 million, net sales of $110.9 million and operating income of $20.1 million. Operating income was negatively impacted by $2.1 million for non-recurring purchase accounting charges, of which $1.5 million was attributable to the step-up of acquired inventories.
The results of IMM are included with our Underground Mining Machinery segment. For the third quarter of 2012, IMM had bookings of $64.6 million, net sales of $69.1 million and operating income of $2.8 million. Operating income was negatively impacted by $7.7 million for non-recurring purchase accounting charges, of which $3.2 million was attributable to the step-up of acquired inventories.
Net income from continuing operations attributable to Joy Global was $194.3 million or $1.82 per diluted share in the third quarter of 2012, compared to $171.8 million or $1.61 per diluted share in 2011.
Bookings in the first nine months of fiscal 2012 were approximately $3.7 billion, a decrease of 10.7% from the prior year nine month period. Original equipment bookings decreased $598.9 million or 27.6%, while aftermarket bookings increased $148.9 million or 7.3%. The Surface Mining Equipment segment original equipment bookings excluding LeTourneau decreased 33.3% while original equipment bookings for the Underground Mining Machinery segment excluding IMM decreased 43.6%. Overall, original equipment bookings declined primarily due to a weakening coal market in the U.S. and China and significant Australian and Russian bookings in the prior year that did not reoccur in the current year. Surface Mining Equipment aftermarket bookings excluding LeTourneau increased 5.9% when compared to the prior year while Underground Mining Machinery aftermarket bookings excluding IMM increased 2.9%. Aftermarket orders were stronger in all regions except North America and Eurasia. Foreign currency translation unfavorably impacted bookings by $93.6 million when compared to the prior year nine months.
Net sales in the first nine months of fiscal 2012 were approximately $4.1 billion, compared to approximately $3.1 billion in the first nine months of 2011. The 32.5% increase in net sales in the first nine months of 2012 includes a $284.5 million increase in aftermarket sales and a $712.9 million increase in original equipment sales. Sales increased in most regions for both segments. Foreign currency translation unfavorably impacted sales by $44.1 million when compared to the first nine months of the prior year.
Operating income in the first nine months of fiscal 2012 increased by $222.8 million to $846.7 million, which represented 22% incremental profitability on higher sales volume as a reduction in employee costs were partially offset by an increase in product development, selling and administrative expenses.
The results of LeTourneau's mining equipment business are included with our Surface Mining Equipment segment. For the first nine months of fiscal 2012, LeTourneau's mining equipment business had bookings of $304.4 million, net sales of $322.4 million and operating income of $43.8 million. Operating income was negatively impacted by $13.7 million for non-recurring purchase accounting charges, of which $11.5 million was attributable to the step-up of acquired inventories.
The results of IMM are included with our Underground Mining Machinery segment. From the date of acquisition and consolidation, IMM had bookings of $177.6 million, net sales of $166.9 million and operating income of $7.3 million. Operating income was negatively impacted by $25.4 million for non-recurring purchase accounting charges, of which $20.9 million was attributable to the step-up of acquired inventories.
Net income from continuing operations attributable to Joy Global was $554.7 million, or $5.19 per diluted share in the first nine months of fiscal 2012 compared to $436.0 million or $4.09 per diluted share in 2011.
Market Outlook
The demand for commodities has slowed, adjusting to weaker global economic growth. Recent economic data is mixed, but is generally consistent with low U.S. growth, Europe contracting and China decelerating. With demand slowing, recent capacity additions have created supply surpluses and depressed pricing for most commodities. Customers are responding by cutting capital expenditures, reducing overhead and trimming production. Production cuts have been greatest in U.S. coal, but the closure or reduction of higher cost coal mines is also in process in Australia and Russia.
As noted, U.S. coal has experienced the most severe decline, driven primarily by lower electricity demand and electricity generators switching to natural gas. Electricity demand in the U.S. was down over 5% during the winter heating season, which is greater than the 4% decline in 2009 that resulted from the global recession. On top of slowing demand, shale gas production has been expanding rapidly and creating a significant surplus of natural gas in the U.S. This has depressed natural gas prices to 10-year lows and also has increased the dispatch of gas fired generation onto the electricity grid. As a result, coal's share of electricity generation has dropped from 43% to 32% between 2006 and April of 2012 while the natural gas share increased from 18% to 32% over the same period. Coal production in the second calendar quarter was down by 104 million tons from the first calendar quarter on an annualized basis. It is estimated that cuts of 100 to 120 million tons are needed to balance the U.S. market. However, those reductions can be reduced if power generation is switched from natural gas back to coal.
Current natural gas prices are below the cost of drilling programs, and the number of rigs drilling for natural gas declined in August to the lowest level in over a decade. Natural gas prices need to be above $4.00 per million BTUs to generate adequate returns in most shale gas regions. This is supported by the futures strip, which trends up and moves above $4.00 per million BTUs by 2014. Various forecasts project natural gas prices approaching this level a year sooner. Natural gas switching reached a peak in April as prices dipped below $2.00 per million BTUs, but switching back to coal has occurred as natural gas prices recently moved toward $3.00 per million BTUs. The first beneficiary of coal switching is Powder River Basin coal, and its rail car loadings increased by 16% from June to July. The longer term confidence that our customers have in Powder River Basin demand is evidenced by the increased acreage that has been leased in the past few months. Coal switching will also benefit the Illinois Basin, Northern Appalachia and Central Appalachia, as natural gas prices move progressively from $3.00 per million BTUs to $4.50 per million BTUs.
It is believed that a significant portion of coal's share loss to natural gas can be recovered as natural gas prices increase. However, this may take a couple of years. In addition, most of the available excess capacity in power generation now resides in coal-fired units, and this will provide another upside for coal as power demand returns to normal levels. U.S. coal will also benefit from exports that tap into the growing demand in the seaborne markets. Europe is one of the main markets for U.S. Eastern coal, and its coal demand has been growing at 12%. In addition, two-thirds of its 36 gigawatts of new generating capacity will be coal-fired. U.S. customers also see Asia to be undersupplied in the long term. In response, they have announced increases in port capacity to 270 million tons to capture the expected opportunities in the export markets.
China's economy continues to decelerate. Demand for electricity was up 3% in May of 2012, compared to a growth rate of 10 to 11% a year ago. In addition to the effect of a slowing economy, recovery in hydropower generation has further reduced coal demand. Coal production in China has continued to increase as demand has slowed, further depressing prices. As prices dropped below $100 per tonne, imported coal gained an advantage over domestic production, and stockpiles at the domestic transfer point of Qinhuangdao increased and approached capacity. Higher cost domestic production was subsequently reduced and Beijing further mandated that domestic coal production be limited to 7% above 2011 levels. The month of July saw power demand rise 15% from June levels and 7% from last year. As a result, Qinhuangdao inventories have declined by 25% since early July, and seaborne prices have begun to recover.
Power generation in India is up 11% this year, while thermal coal imports are up 13%. Domestic production grew only 2.6% last year and it continues to fall well short of plan, putting more pressure on imports. The thinness of supply-demand was evidenced by a recent brownout that affected 600 million people, and many power plants continue to run with stockpiles of a week or less. In addition, India plans to add 97 gigawatts of coal-fired power generation over the next three to four years, requiring an additional 300 million tonnes of coal. As a result, India's coal demand will continue to be a main driver in the seaborne market.
Turning to other commodities, strong demand from China and production limitations has kept the copper market in deficit during the first half of the year. This supply deficit increased by over 350 thousand tons compared to the first half of last year. Although China imports are expected to slow, the copper market should remain in deficit during the second half of the year.
Although global steel production is expected to be up 3 to 4% this year, this growth has occurred in the first half of the year and steel production has leveled and is expected to remain flat in the second half. This will limit demand volumes for met coal and iron ore, favoring the lower cost producers for each commodity.
China produces 42% of the global iron ore supply, but ore grades at 20% keep costs high. As a result, China becomes a swing producer above its estimated profitability threshold of $120 per tonne. Despite the current dip in spot prices, the iron ore market should find support at the $120 per tonne level, and this will favor producers in Western Australia and South America.
A high percentage of China's met coal is mined from small mines in Shanxi province that have been the subject of safety campaigns, which has reduced supply of hard coking coal and increased costs by more than 40%. Additionally, increased use of large blast furnaces in China requires greater volumes of hard coking coal. The combination of these two factors will continue to increase met coal imports into China from the current level of 46 million tons annually.
Recent information indicates that commodity markets are stabilizing at current levels. It is expected that demand will remain relatively flat until a broader recovery in the global economy provides a catalyst for increased commodity demand and capacity expansion. In the meantime, most commodities are oversupplied or near balance. As a result, customers are slowing their capacity expansion projects. Projects already underway remain in process, but they are being slowed by additional engineering review and updated project plans. The next round of projects has been reduced, and there is an increased focus on brown field projects that have shorter time to first production and less project risk. Many larger greenfield projects have been pushed out beyond 2013. As a result, it is expected that announced capital budgets will be underspent this year, and that under current market conditions, spending for next year will be flat.
Company Outlook
The outlook for our business has continued to decline over the past quarter. Although the U.S. market has progressed in line with our expectations, the deceleration of China demand has deteriorated international markets more quickly and severely than previously expected.
The U.S. customers have adjusted quickly to their market conditions. Second quarter production was reduced on an annualized basis to a level in the range estimated to balance the market. We have seen natural gas prices start to move back to more normalized levels, and this has resulted in some switching back to coal. As a result, we see the U.S. coal market at the bottom, with opportunities to recover volume through return of power demand and switching back to coal. However, this will be a slow recovery, and therefore we must adjust to a structural change in the U.S. market. Natural gas will continue to be a competitive fuel, and this will force U.S. coal production into lower cost basins. We expect much of the production cuts in Central Appalachia to be permanent, but replaced by increases in the Illinois and Powder River basins.
The deceleration of China is also affecting those regions that are commodity exporters. Some projects no longer make the economic threshold, but most of the impact is to rationalize capital expenditures and to improve project returns though additional engineering and project management review. This results in project slowing, and in some cases, time gaps between the higher potential projects. As a result, we expect to experience greater lumpiness in original equipment bookings going forward.
Quarter Ended July 27, 2012 to Quarter Ended July 29, 2011
Net Sales
The following table sets forth the combined net sales included in our Condensed Consolidated Statement of Income.
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