Finning International
Annual Report 2009

Plain-text annual report

GeaRed fOR GROWTH fINNING INTeRNaTIONaL INC. 2009 ANNUAL REPORT In 2009, Finning delivered on its commitments to reduce its cost structure, generate significant free cash flow and strengthen its balance sheet. At the same time, the combination of Caterpillar’s quality product and Finning’s service commitment continued to differentiate us in the marketplace. With our unmatched product support capability, highly engaged employees, solid financial position, and improved operating leverage, finning is geared for growth. Monetary amounts in this annual report are in Canadian dollars unless noted otherwise. Finning at a glanCe SCoreCard FinanCial HigHligHtS letter to SHareHolderS CHairMan’S letter FinanCial ManageMent Canada SoutH aMeriCa united KingdoM Corporate reSponSibility FinanCial report board oF direCtorS Corporate oFFiCerS Corporate governanCe SHareHolder inForMation 2 3 4 6 9 10 12 14 16 18 20 88 89 90 inside back Cover andacollo Copper Mine, Chile Finning at a glanCe value propoSition to inveStorS • Exclusive rights to distribute Caterpillar equipment and parts in some of the most resource-rich territoriesin the world • Unmatched product support capability and customer relationships • Strong cash generating business model • Well positioned for growth Canada edMonton Fort MCMurray FINNINg (CANAdA) vanCouver • Mining (including oil sands) • Construction • power systems • oil & gas • pipelines • Forestry United Kingdom CannoCK FINNINg UK gROUP • Coal mining • Construction • Quarrying • Waste management • power systems • petroleum • Marine Bolivia antoFagaSta FINNINg SOUTh AmERICA Chile Uruguay Santiago argentina • Mining • Construction • power systems Finning International Inc. (TSX:FTT) is the world’s largest Caterpillar equipment dealer delivering unrivalled service to customers since 1933. Finning sells, rents, and services equipment and engines to help customers maximize productivity. Headquartered in Vancouver, Canada, the Company employs approximately 12,000 people and operates in Western Canada, Chile, Argentina, Bolivia,Uruguay, and the United Kingdom. 2 sCOReCaRd 2009 targetS 2009 ResULTs Free cash flow net debt to total capital ratio targeted Sg&a expense reduction Safety* $300 million low end of 40%-50% $150 million annually; revised to $200 million 0.48 $494 million 39% on track 0.24 * lost time injuries per 200,000 work hours 2009 HigHligHtS 2010 prioritieS Leaner cost structure Cash generation • generated record free cash flow of $494 million • reduced net debt to total capital ratio from 49% to 39% • achieved $110 million in targeted Sg&a cost reductions from 2008 levels • generated strong growth in mining product support revenues in all operations • achieved best ever safety performance • on track to achieve over $200 million in annual cost reductions from 2008 • approximately 70% of the reduction to be sustainable in the longer term • in excess of $200 million in free cash flow in 2010 • net rental expenditures to moderate at $100 - $150 million per year • net capital expenditures of $75 - $100 million in 2010 • Continue to improve key working capital metrics Balance sheet strength • net debt to total capital ratio in mid 30% by the end of 2010 Product support revenue growth • product support revenue to be up from 2009 eBIT margin improvement • operating leverage primarily from permanent Sg&a reductions and productivity improvements Hewden safety • Strategic review to be completed by the end of second quarter 2010 • Continuously improve safety performance 2009 Finning international inC. | 3 | FinanCial HigHligHtS year ended deCeMber 31 ($MillionS, exCept per SHare aMountS) 2009 2008 2007 Operating data (from continuing operations) revenue earnings before interest & income taxes (ebit) ebit before goodwill impairment* net income net income before goodwill impairment* diluted earnings per Share (epS) diluted epS before goodwill impairment* return on equity return on equity before goodwill impairment* earnings before interest, income taxes, depreciation and amortization (ebitda), excluding goodwill impairment Free Cash Flow Balance sheet data total assets invested Capital total Shareholders’ equity net debt to total Capital 4,737.5 207.0 130.8 0.77 5,991.4 236.7 388.1 96.0 247.4 0.55 1.43 5,662.2 455.8 280.1 1.55 8.3% 5.8% 14.8% 16.8% 474.7 493.9 712.5 23.2 783.7 (110.7) 3,671.4 2,693.8 1,515.7 4,720.4 3,174.1 1,567.1 4,134.2 2,794.8 1,617.8 39.3% 48.9% 40.8% From Continuing operations revenue ($ billionS) ebit ($ MillionS) net inCoMe ($ MillionS) diluted epS ($) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 0 6 . 7 5 . 9 4 . 3 4 . 7 4 . 2005 2006 2007 2008 2009 500 400 300 200 100 0 6 5 4 4 7 3 * 8 8 3 300 250 200 0 8 2 6 3 2 * 7 4 2 8 5 2 150 2 6 1 7 0 2 2005 2006 2007 2008 2009 100 50 0 1 3 1 2005 2006 2007 2008 2009 2.0 1.5 1.0 0.5 0.0 5 5 1 . * 3 4 1 . 1 3 1 . 0 9 0 . 7 7 0 . 2005 2006 2007 2008 2009 * 2008 results exclude the goodwill impairment charge of $151.4 million or $0.88 per share for Hewden. the results of operations of the uK tools Hire divison have been reclassified as discontinued operations for 2007, 2006 and 2005. the results of operations of the uK Materials Handling division have been reclassified as discontinued operations for 2006 and 2005. 4 FinanCial perForManCe by operationS ($ MillionS) Canada South america uK power Systems power Systems revenues are reported within other Finning divisions revenue by lineS oF buSineSS ($ MillionS) new equipment used equipment equipment rental product Support other revenue ebit 2009 2,386.6 1,489.6 861.3 796.3 2009 1,984.7 337.8 510.4 1,892.6 12.0 2008 3,216.9 1,501.6 1,272.9 896.9 41.9% 7.1% 10.8% 39.9% 0.3% 2009 98.3 153.7 (20.1) 2008 234.5 148.2 53.6 2008 2,928.6 431.8 712.8 1,899.5 18.7 48.9% 7.2% 11.9% 31.7% 0.3% From Continuing operations produCt Support revenue ($ MillionS) ebitda ($ MillionS) 2009 revenue by operationS 2,000 1,750 1,500 1,250 1,000 750 500 250 0 9 9 8 1 , 3 9 8 , 1 1 0 7 1 , 3 8 5 1 , 0 4 3 1 , 4 8 7 * 3 1 7 0 6 6 9 1 5 5 7 4 800 700 600 500 400 300 200 100 0 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 18% 32% 50% Canada FinSa uK group 2009 neW eQuipMent deliverieS by induStry ($) 1% 6% 3% 23% 47% 20% Mining ConStruCtion poWer SySteMS oil & gaS ForeStry otHer 2009 Finning international inC. | 5 | letter to SHareHolderS Mike Waites, president & Chief executive officer in last year’s letter to shareholders, i emphasized the importance of prudently managing our balance sheet while positioning the Company for future success and growth. given the uncertain economic times, i also articulated that we would prioritize generating significant cash flow with an intense focus on working capital management, a further reduction in rental fleet additions and a disciplined approach to capital spending. at the same time, we were determined to continue to provide the same great service and support that our customers expect. our decisions throughout 2009 were guided by these objectives and i am gratified to see our positive results. Successful execution briefly, these are the commitments we made and the results we achieved: • We committed to reduce our selling, general and administrative (Sg&a) expenses by $150 million annually over 2008. We have since raised our target to over $200 million and are well on our way towards achieving this goal, having realized $110 million of Sg&a cost savings in 2009. When business levels return, we expect 70 percent of this Sg&a reduction to be permanent. • We targeted over $300 million in free cash flow generation during the year and achieved a record of $494 million. this accomplishment underscores the focused efforts of our people as well as the tremendous cash generation capability of our business model. • our net debt to capital ratio was 49 percent at the end of 2008 and we committed to reducing it to the lower end of the 40-50 percent range. We reduced our net debt to capital ratio at the end of 2009 to 39 percent. We now expect it to be in the mid-30s by the end of the year and we continue to strengthen the balance sheet. • as part of our 2005 strategic plan, we had also committed to double product support revenues to $2.3 billion by 2010. overall, product support remained flat at $1.9 billion compared to 2008 despite the severe economic downturn, thus demonstrating the resiliency of this part of our business. While our product support revenue target for 2010 is impacted by recessionary conditions, we remain confident that we will reach this objective in the near-term. the large machine population owned by our customers continues to hold promising product support growth prospects. in fact, during 2009, product support revenues from our mining customers grew significantly across all operations over the prior year. We did underestimate the impact of the recession on non-mining customers; however, we expect that we are building a backlog of product support business with these accounts. Highlights from each of our regions included the following: • in Canada, all sectors showed significant weakness in 2009 and we restructured to operate our business with a lower fixed cost base and to drive greater efficiencies. 6 in doing so, we have taken steps to ensure customers continue to receive the highest levels of service and we maintained capacity to support higher activity levels. towards the end of the year, mining quotations and orders increased significantly. once volumes return, our Canadian operation is well positioned to achieve higher earnings due to a leaner cost structure and productivity improvements. • South america continued to deliver strong results as the impact of the recession was not nearly as significant as in the other regions. orders for new equipment eased off in all sectors, but product support continued to be robust. We opened a new parts distribution centre and a truck shop in Chile’s northern mining region as well as several other facilities to better support our customers and the growing machine population. overall, the outlook for Finning South america remains strong. Customers are placing large mining orders and we expect ongoing product support growth resulting from mining service contracts. • in spite of significant headwinds in the u.K. during 2009, the dealership has been successful in building market share in the heavy construction segments, including waste & recycling, quarrying, mining, and power systems. the dealership reduced Sg&a expenses and continued to contribute positive ebit. in 2010, the u.K. dealership will remain focused on these key market segments and their ongoing efforts to improve operating efficiencies. during 2009, we commenced a strategic review of our Hewden rental business in the u.K. with a view to assessing alternatives that optimize shareholder value. as part of our review, we have implemented a plan to reduce the size of the Hewden operation and we made progress toward improving operating efficiencies and profitability. parallel to this restructuring process, we are exploring an outright sale of Hewden and have received a number of expressions of interest. We anticipate a decision by mid-2010. geared for growth in many ways, 2009 will likely be remembered as a transformative year for our business. as the global recession unfolded, our executive team was challenged to act quickly and decisively. We immediately determined that it was critical to right-size the business to align with decreased demand and we took action across our operations. at the same time, we focused on ensuring that we would be well-positioned to be a stronger company as we emerged from the recession. this translates into a fundamentally different approach to our business underlined by a new operating model in Canada, a significant reshaping of our u.K. business and a decision to contain our investment in rental. as the worst of the recession appears to be behind us and the recovery is underway, we are now well positioned to maximize our earnings potential. Having been tried and tested during one of the most severe recessions in recent history, i can state with confidence that our business model has proven to be our greatest attribute. during a year in which customers in all industry segments significantly reduced their equipment orders, we were able to generate record cash flow and strengthen our balance sheet significantly. our business is capable of generating strong free cash flow. Cash flow from operations generally runs between $500 and $700 million per year. on a go forward basis, we would expect to invest a net amount of $100 - $150 million per year in our rental fleet, which is significantly lower than in past years. We also anticipate investing a net $100 million in fixed capital in an average year. after taking modest investments in rental fleet and fixed capital into account, as well as our enhanced focus on working capital management, we will continue to generate strong free cash flow to support dividend payments. as a result, significant cash will remain for debt reduction or growth opportunities. We see these growth opportunities in sectors which count on our considerable product support capabilities: mining, power systems and heavy construction. We are continuing to invest in our business to take advantage of opportunities that support the implementation of our strategy. For instance: • this year, we will go live with our new information system in Canada. by improving management information and the speed of decision making, this system will support us in achieving our goal to become a world class distribution company and service provider. the system will be implemented in FinSa and the uK next year. • We are proceeding with an investment in a shop at Fort McKay to support customers in the oil sands. the feasibility study is being completed and we will soon reach a decision on the size and functionality of this new facility. the strengthening and sustainment of commodity prices has given mining customers the confidence to continue to invest in their operations. From our perspective, the recovery is being led by mining and significant new equipment orders from Kearl in Canada’s oil sands and Codelco’s Ministro Hales mine in Chile are a testament to this. We expect a much improved order flow for new equipment and ongoing growth of product support revenue in mining. other sectors appear to be slower to recover, but we believe we have built a backlog of product support for these non-mining sectors. Finning people i would be amiss to convey our Company’s results without paying tribute to the extraordinary commitment of Finning employees. our achievements are dependent on our employees’ dedicated service to our customers and i thank each and every Finning employee for their continued support and engagement. under very challenging business conditions and the resulting impact on our workforce, Finning continued to build on its high employee engagement in 2009. a further demonstration of our employees’ dedication comes in the form of continuous improvement in our safety performance. during 2009, our overall accident frequency 2009 Finning international inC. | 7 | letter to SHareHolderS (Continued) relative price performance Finning International Inc. vs. S&P/TSX Composite Index dec 31, 2004 to dec 31, 2009 200 150 100 S&p/tSx Composite index Finning international inc. 50 31-DEC-04 31-DEC-05 31-DEC-06 31-DEC-07 31-DEC-08 31-DEC-09 In 2009, finning’s stock provided shareholders with a capital gain of 17% and dividends totaling $0.44 per share. Total return to shareholders was over 20%. excluding dividends, share value has grown at the following compound annual growth rates (CaGR): 5 years -1% 10 years 9% 20 years 8% rate continued its positive trend with a 37% decrease over prior year. despite our commitment to upholding the highest safety standards, we are deeply saddened by the tragic fatality of an apprentice, oliver padget Sandoval, at our Concepción branch in Chile. in response, we initiated a thorough investigation and implemented all resultant safety recommendations. We remain firmly committed to achieving the highest environment, health and safety standards in all of our operations. Subsequent to 2009, Chile suffered a severe earthquake with devastating consequences. We feel very fortunate that every one of our employees is safe and we thank them for the support they have given to each other, their families and their country as part of the ongoing recovery efforts. i will also take this opportunity to acknowledge the insightful guidance of our board of directors who provided invaluable support towards our efforts to successfully navigate through the recession. building on our Strengths in summary, Finning adeptly withstood the global economic downturn of 2009 both financially and operationally while continuing to invest in areas of strategic importance. We emerged from the past year with a tested management team, improved operating leverage and strong opportunities for future growth. Most importantly, we never lost sight of the key to our Company’s longstanding tradition of success: the Caterpillar quality product combined with Finning’s service commitment. going forward, we will continue to deliver on our promise of unrivalled service in order to differentiate ourselves from our competitors and earn our customers’ loyalty. Sincerely, Mike Waites president & Chief executive officer 8 CHairMan’S letter i will take this opportunity to thank my fellow directors for their valuable contributions last year. on behalf of the board, i would also like to thank Finning’s employees for their unwavering commitment throughout a challenging 2009. their dedicated efforts enabled us to meet and exceed key corporate targets while upholding our core values during one of the toughest economic downturns. For more information about our corporate governance policies, please review the Finning management proxy circular and visit the Company’s corporate governance section at www.finning.com. on behalf of the board of directors, douglas W. g. Whitehead Chairman of the board The Finning Board of directors’ foremost priority is to ensure the Company’s performance and results are maximized and communicated within a context of integrity and accountability. the board fulfills its duty towards maintaining the Company’s longstanding reputation for corporate governance excellence through active oversight and by working closely with Finning’s management team. in 2009, the board met with the Company’s executives six times in order to build on its best practices, ensure sound corporate governance and pursue opportunities for continuous and strategic improvement. in addition, the board of directors continued to support the company’s drive towards providing unrivalled services that earn customer loyalty. despite the challenging economic environment, the Company successfully executed on many of its key performance targets, further advanced its strategic priorities and strengthened its financial position. the board maintained the quarterly dividend of $0.11 per share, reflecting the Company’s financial strength and record free cash flow generation in 2009. the board remains committed to providing shareholders with an attractive dividend as part of the total shareholder return. 2009 Finning international inC. | 9 | FinanCial ManageMent Financial performance 2009 was a challenging year due to the economic downturn experienced throughout the world. revenues declined by 21% to $4.7 billion with lower revenues from all operations and all lines of business. ebit was down 47% to $207 million, and consolidated ebit margin decreased to 4.4% from 6.5% in 2008, after adjusting for the goodwill impairment charge recorded in 2008. the Company reacted quickly to the economic downturn by reducing its cost structure. basic earnings per share (epS) was $0.77 in 2009 compared to $0.56 in 2008. 2009 results included the following net non- recurring charges totaling $0.08 per share: • restructuring and severance costs of $37 million. epS impact = ($0.15) • new it system implementation costs of $19 million. epS impact = ($0.08) • gains on sale of certain properties primarily in Hewden and South america of $18 million. epS impact = $0.10 • one-time positive tax adjustment in the second quarter of $9 million. epS impact = $0.05. 2008 results included a goodwill impairment charge of $151 million or $0.88 per share relating to the Company’s investment in Hewden as well as other net non-recurring charges totaling $0.10 per share. record Free Cash Flow in 2009, Finning generated record free cash flow of $494 million compared to $23 million of free cash flow in 2008. Significant efforts by management to improve working capital levels as well as being selective on capital and rental asset additions more than offset the lower cash generated from operations. the strong free cash flow generated in 2009 was primarily used to reduce our debt levels resulting in a stronger balance sheet. the Company’s working capital requirements were significantly lower due to management actions to focus on credit and collections and to reduce inventories. We will continue to closely manage working capital levels going forward and improve the Company’s cash-to-cash cycle. efforts by the Company to be more selective in our spending resulted in much lower rental fleet additions. this combined with higher disposals of underutilized assets contributed $43 million of cash in 2009 compared to a net rental investment of $205 million in 2008. as we continue with our strategic shift to contain our investment in rental, we expect net rental expenditures to moderate from historical levels and will average in the $100 – $150 million range annually. Finning’s business has modest capital requirements, and the majority of our capital expenditures are discretionary. gross capital expenditures totaled $108 million and were comparable to 2008 levels. going forward, we expect annual net capital expenditures will average in the $75 - $100 million range. We expect to continue to generate strong free cash flow, and target over $200 million in free cash flow in 2010. “Our focus is to improve earnings performance and return on invested capital while maintaining a strong balance sheet. We have lowered our cost structure through sustainable cost reductions and productivity improvements. We have also decreased our asset base with disciplined working capital management and by directing rental and capital spending to strategic areas. As business volumes recover, we expect EBIT margins to improve in all operations.” dave smith executive vice president & Chief Financial officer 10 annual dividend per SHare $0.50 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 4 4 0 . 3 4 0 . * 4 4 0 . 6 3 0 . 8 2 0 . 2 2 0 . 2005 2006 2007 2008 2009 2010 * indicated dividend dividends Maintained We believe that an attractive dividend yield represents an important component of total shareholder return. in 2009 we maintained our quarterly dividend at $0.11 per share, a sound achievement considering the challenging market conditions. the indicated annual dividend is currently $0.44 per share, which represents approximately 2.4% dividend yield on a stock price of $18.00. Selective Funding of long- term Strategic initiatives We remain committed to funding our long-term strategic initiatives appropriately and ensuring that we have the capabilities to grow our business and provide our customers with the best product support in the industry. in 2009, we continued to invest in a new enterprise resource planning (erp) system which is key to assisting us in achieving our strategic goals. We are currently implementing and testing this new it system in Canada, where it is expected to go live in the second half of 2010. to support our growth strategy in the oil sands, we plan to build a new equipment service shop in Fort McKay, alberta. We are currently assessing the future demand for service in this region, and we expect to proceed with the Fort McKay investment in 2011. in South america, we have recently expanded our truck shop and built a new parts distribution centre in antofagasta, a key mining region in northern Chile. We will continue to invest in our product support infrastructure, including branches and component rebuild capabilities. Strong balance Sheet We used the record free cash flow generated in 2009 to strengthen our balance sheet. We reduced our debt by $429 million or 27% from the end of 2008. our net debt to total capital ratio decreased to 39%, a significant improvement from 49% at the end of 2008. We will continue to strengthen our financial position further, and expect the net debt to total capital ratio to decline to the mid 30% range by the end of 2010. Finning has adequate operating credit facilities that are committed until december 2011. at december 31, 2009, approximately $725 million was available under the committed facilities. Significant Sg&a Cost reductions on track one of our main focus areas in 2009 was to reduce our cost base and align expense levels with revenues. in 2009, total selling, general and administrative (Sg&a) expenses decreased by $183 million or 14% from 2008, as a result of lower sales volumes, aggressive cost management and the successful implementation of productivity improvement measures. the Canadian operations accounted for over half of the total Sg&a reduction in 2009 as they shifted to a more variable cost base and realigned facilities and resources to future revenue opportunities. Management took action when revenues declined due to the economic downturn. as a result of targeted cost reductions and productivity improvement initiatives, the Company was able to realize cost savings of $110 million in 2009. We are currently implementing additional Sg&a expense reduction measures, and are on track to achieve over $200 million in annual cost savings going forward when compared to 2008 levels. these amounts do not include costs that vary due to sales volumes. We expect at least 70% of these targeted cost reductions to be sustainable in the longer term. as a result of lower Sg&a levels, we expect 2010 ebit performance to improve modestly. 2009 Finning international inC. | 11 | Canada “With a much leaner cost structure and focus on operational excellence, we are well positioned to benefit from strong operating leverage as the economic recovery gains momentum. We are confident in our ability to grow the business and capture opportunities in product support and new equipment sales.” dave Parker president, Finning (Canada) 12 2009 performance 2009 was a challenging year for our Canadian operations as we managed through one of the toughest economic downturns in history. revenues declined 26% to $2.4 billion, impacted by recessionary conditions in all industries and lower volumes across all lines of business. new equipment sales dropped 39%, reflecting weaker demand from non-mining sectors and significantly lower deliveries to the oil sands compared to an exceptionally strong 2008. used equipment sales and rental revenues decreased by 20% and 24% respectively. total product support revenue proved to be more resilient, declining only 5%. While demand for parts and service in non-mining sectors was negatively affected by low equipment utilization and deferral of maintenance, product support in mining remained strong growing 30% over 2008. in the oil sands, where mining operations continued to run 24/7 with full utilization of their large equipment fleets, product support revenues were up 38%. in 2009, our Canadian operations took major steps to pull back on costs and align expense levels with revenues. Sg&a expenses decreased by 15%, and the Canadian operations incurred restructuring charges of approximately $20 million. unfortunately, we had to make difficult decisions to reduce Finning West edmonton branch, alberta, Canada our workforce by about 20% from the end of 2008. in addition, we implemented a plan to shift to a more variable cost base and align resources to future revenue opportunities. this resulted in a consolidation in our branch network from 12 to five regions in 2009. in addition to the above measures, other expense reduction and productivity improvement initiatives will result in $50 million in permanent Sg&a reductions in 2010. ebit from the Canadian operations was down 58% to $98 million as a result of a sharp decline in new equipment sales, lower gross profit due to pricing pressures, and higher restructuring and it implementation costs. the resulting leaner cost structure and productivity improvements will provide us with solid operating leverage to improve Canada’s earnings performance when business volumes pick up. operational excellence in 2009, Finning (Canada) focused on improving its business processes and launched many initiatives designed to enhance customer service and supplier transactions. to support our efforts to deliver unrivalled service, we implemented the Customer Service Commitment program, which guarantees on-time completion and pricing. We also continued Canada revenue ($ MillionS) Canada ebit ($ MillionS) Canada produCt Support revenue ($ MillionS) 3,500 3,000 2,500 2,000 1,500 1,000 500 0 , 7 1 2 6 3 3 9 2 , 3 1 6 2 , 0 5 0 2 , 7 8 3 , 2 2005 2006 2007 2008 2009 300 250 200 150 100 50 0 6 8 2 4 3 2 5 1 2 0 5 1 8 9 2005 2006 2007 2008 2009 2006 ebit excludes gains on sale of assets 1,000 800 600 400 200 0 2 8 9 5 3 9 6 0 9 3 7 8 2 1 7 2005 2006 2007 2008 2009 to improve productivity by becoming more efficient and innovative in how we deliver equipment, parts and service to customers. We made changes to our supply chain processes, including reducing time to invoice, centralizing branch support functions and improving parts and components forecasting. in addition, the new enterprise resource planning system, which will go live in Canada in 2010, will tremendously benefit our efforts towards achieving and sustaining operational excellence. Mining as the fastest growing business segment, mining has become an increasingly important part of Finning (Canada)’s business over the past few years. in addition to the oil sands, our long-standing mining customers include copper mines in the Kamloops area, coal mines in the elk valley and tumbler ridge regions of b.C. and the westerly regions of central alberta including grande Cache and Hinton, as well as the diamond mines in the northern territories. in 2009, this industry remained active, with mining customers accounting for 56% of all new equipment deliveries in Western Canada. While demand for new equipment decreased significantly from previous peak levels, the existing production fleets of heavy haul trucks and support equipment continued to operate fairly continuously throughout 2009, at most mines. this generated steady demand for parts and service and resulted in strong growth in mining product support revenues. We expect strengthening commodity prices to lead the recovery for mining, as evidenced by encouraging signs at the start of 2010. Quoting activity has picked up in the past couple of quarters, and there is an increased demand for heavy mining equipment and product support from the oil sands, coal and copper mining producers and contractors. recent announcements of significant mining deals further demonstrate our leading position as the largest heavy equipment supplier and service partner in the mining sector, including the oil sands. in 2010, we expect the expansion in metallurgical coal production to drive more equipment sales and product support opportunities. We look forward to introducing the new Caterpillar 795 (345 ton) electric drive off-highway truck, which will be tested on customer mine sites in 2010. our mining product support infrastructure and technical expertise give us a strong competitive advantage in providing parts, service, component remanufacturing, and machine overhauls. oeM remanufacturing, the Company’s component rebuild facility in edmonton, and our Centre of excellence in red deer, where we rebuild large equipment, remain the key elements of our mining support infrastructure in Western Canada. as part of our mining growth strategy, we are currently assessing future demand for shop and field services in the oil sands to determine the requirements for our planned Fort McKay facility. outlook new equipment orders have been improving in Canada, primarily in mining, where quoting activity and order intake are strong. We expect continued growth in mining product support, particularly in the oil sands. visibility in the non-mining sectors remains limited and we anticipate activity in the construction sector to be soft in 2010. oil & gas and forestry sectors are also likely to remain slow and we do not anticipate a meaningful improvement in these sectors until 2011. an increase in product support business is expected to precede demand for new equipment in these non-mining sectors as idled machines will be put back to work first. overall, 2010 will be a transition year for Finning (Canada). With a significantly reduced cost structure combined with a focus on operational excellence, the Canadian operations are in an excellent position to take advantage of the economic rebound. 2009 Finning international inC. | 13 | SoutH aMeriCa 2009 performance Finning South america had a very successful year in 2009 despite challenging business conditions. revenues of $1.5 billion were 1% lower compared to the record revenues of 2008. new equipment sales declined by 11% (16% in functional currency, u.S. dollar) as weak demand from the construction and power systems sectors offset growing new equipment sales to mining customers. driven by the active mining sector, product support revenues increased by almost 12% from 2008 (5% in functional currency). product support revenues in mining were up 9% in functional currency and contributed to solid ebit performance. ebit of $154 million was 4% higher than in 2008 (4% lower in functional currency). Supported by tight cost controls and continued strength in the higher margin product support business, ebit margins remained strong in 2009 at 10.3%. operational excellence our South american operations were proactive in adjusting to the realities of the global economic downturn having transitioned into an austerity mode at the end of 2008. this successfully executed plan allowed Finning South america (FinSa) to achieve very good results during a year marked by one of the toughest global Finning branch, Coquimbo, Chile recessions. in addition to controlling costs and managing inventory levels, FinSa advanced initiatives designed to improve operating efficiencies and create a high performance culture among employees. one of the key focus areas was the supply chain. our South american operations are located very far from Caterpillar’s factories and parts distribution centres, which adds considerable complexity to efficiently transporting machines, parts, and components to customers. as a result of its focused efforts, FinSa improved its forecasting capabilities, decreased landed costs of products and reduced its cash to cash cycle in 2009. Sustaining a high performance culture is another important element of our drive towards achieving operational excellence in South america. through ongoing investment in people development at FinSa, we have fostered a very capable management team and continuously raise the technical competencies of our mechanics. Mining Mining has always comprised the largest portion of FinSa’s business, and this sector grew even more dominant in 2009. While “We were able to deliver strong results even in these challenging economic times. Our outlook remains very solid. We have invested in world-class infrastructure, including branches, warehousing and truck rebuild capabilities, to continue to grow our product support business.” Juan Carlos Villegas president, Finning South america 14 SoutH aMeriCa revenue ($ MillionS) SoutH aMeriCa ebit ($ MillionS) SoutH aMeriCa produCt Support revenue ($ MillionS) 1,600 1,400 1,200 1,000 800 600 400 200 0 2 0 5 1 , 0 9 4 , 1 6 2 3 1 , 7 0 0 1 , 0 1 0 1 , 2005 2006 2007 2008 2009 160 120 80 40 0 4 5 1 8 4 1 7 2 1 9 0 1 3 9 2005 2006 2007 2008 2009 construction and power systems activity slowed down considerably, stronger copper and gold prices drove the mining industry. Mining accounted for about half of all new equipment sales and over 60% of FinSa’s total revenue in 2009. in 2009, 65% of total mining revenue was generated by product support, which is the ‘bread and butter’ of FinSa’s business and the main driver behind the strong results that our South american operations consistently deliver. FinSa currently has about 1,530 mining machines in its territory, with approximately 740 units supported under maintenance and repair contracts. this represents the largest fleet in the world supported by a single dealer. Mining product support generates a stable and resilient revenue stream. about 70% of all mining parts revenue and over 80% of all mining service revenue is derived from these mining service contracts. We currently have 25 service contracts, ranging in duration from one to over 10 years, with global copper and gold producers in South america. about 3,000 employees or 60% of FinSa’s workforce serve the mining industry, most of them supporting mining service contracts. the mining opportunities in this low-cost copper production region are significant. a copper price in excess of uS$2.00/lb makes it economically viable for most of our copper mining customers to proceed with planned projects and mine expansions. in the next three years, close to uS$1.5 billion is expected to be invested in equipment fleets by mining companies. FinSa is in an excellent position to capture a significant portion of this new equipment business in South america. recent large mining deals confirm that we are the leading heavy equipment supplier and service partner in the Chilean mining industry. We have long-standing relationships with our copper mining customers and have been very successful in meeting our customers’ needs for maximizing equipment availability and achieving the lowest cost per ton of material moved. our unmatched product support capability is key to this success, and we continue to invest in our product support infrastructure in South america, particularly in the antofagasta mining region of northern Chile. We have recently expanded our truck Shop and built a new parts distribution Centre in antofagasta. We have also opened a new Component rebuild Centre in buenos aires, argentina. 800 700 600 500 400 300 200 100 0 1 4 7 4 6 6 0 5 5 2 7 4 0 0 4 2005 2006 2007 2008 2009 outlook the mining industry is expected to remain strong in 2010. With the current copper and gold prices, the mining companies are back in growth mode, and new project planning is underway. the demand for large equipment is expected to rise, and we are actively quoting to mining customers. Construction and power systems sectors are starting to recover in Chile. Following the devastating earthquake in February, the Chileans will be rebuilding their damaged infrastructure as well as commercial and residential buildings. For 2010, construction activity in argentina is likely to remain soft while construction and power systems in bolivia continue to improve. For FinSa, the product support business is expected to stay strong in 2010. this will be driven primarily by existing mining service contracts. in non-mining sectors, equipment will remain well-utilized and continue to generate parts and service opportunities. overall, 2010 looks promising for our South american operations. We will continue to expand the Caterpillar equipment fleets in our territory, capture product support opportunities and take full advantage of the economic recovery. 2009 Finning international inC. | 15 | united KingdoM 2009 performance Finning uK group operates the Caterpillar equipment and power dealership in the u.K. as well as an equipment rental company, Hewden. Within the dealership, we operate two divisions: construction and power systems. the uK group’s revenues for 2009 were $861 million, down 32% from 2008, primarily due to challenging market conditions and a slowdown in the construction sector. revenues were down in all lines of business compared to 2008, reflecting very weak demand for equipment outside of coal mining and some power systems sectors. new and used equipment sales declined by 40% and 34% respectively from 2008. rental revenues were down 33% as a result of continued weakness in the construction sector and excess industry capacity. However, an improvement in new equipment orders during the fourth quarter of 2009 contributed to the u.K.’s first increase in equipment backlog since 2007. Sg&a costs declined from 2008 levels as a result of lower volumes, targeted cost reductions and productivity improvements. the uK group incurred an ebit loss of $20 million in 2009 due to lower Finning branch, Cannock, uK revenues in all lines of business and higher restructuring costs compared to the prior year. Hewden’s ebit loss of $40 million was partially offset by the dealership’s positive ebit of $20 million. dealership the dealership’s construction division has successfully segmented its markets into coal mining, quarrying, waste & recycling, scrap & demolition, and construction industries. Customers in these segments place greater value on equipment productivity and reliability, and on minimizing the total cost of ownership. Finning is uniquely positioned to meet these expectations by delivering best-in-class product support. through an increased focus on national accounts, Finning has built significant market share and earned strong customer loyalty in these segments in 2009. product support revenue for the construction division has been growing as a result of a concerted effort to tailor product support solutions to the various industry segments. our five-star Component rebuild Centre and oil lab, in particular, showcase the strength of Finning’s product support facilities. to continue to improve the level of service “Our equipment and engine sales and product support teams are focused on growth market segments where total solutions are adding value to customers. In a mature market like the U.K., our customers’ productivity and cost drivers are critically important. Through aggressive market sub- segmentation, we are creating new opportunities in coal mining, quarrying, heavy construction, waste & recycling and power & energy segments. We are extremely proud of our team completing 2009 with the best safety record ever achieved.” Andy Fraser Managing director, Finning uK group 16 delivered to our customers, we shifted some centralized service support functions back to the branches and further increased our investment in technical training for our mechanics. the uK’s ‘think big’ apprenticeship program testing results are placing its graduates in the top decile in the world. the product support business in the u.K. remained solid in 2009 supported by the active coal mining sector. product support revenues at the dealership declined by only 5% in local currency, a very modest decrease compared to other lines of business. Mining product support revenues were up 10% from 2008 in local currency. product support accounted for 34% of the dealership’s total revenue in 2009 compared to 27% in 2008. the power systems division is focused on the energy, marine, and petroleum sectors. notably, the uK group has established an outstanding reputation as a provider of advanced energy solutions. recognized as a Centre of excellence by Caterpillar, the electric power generation team offers customers much more than just engines. the group provides switch gear and control systems, engineering, procurement and construction, and other value-added services to data centres, power plants and other demanding applications. in the renewable energy field, Finning’s solutions convert biogas from sewage plants and landfills to energy and heat. our focus in marine is on successfully supporting customers in pleasure craft and off-shore vessels. in the petroleum sector, Finning sells and services power generation equipment to oil producers. the petroleum team recently won an exclusive contract with a major oil producer in the north Sea to support all of the company’s engines on all of its off-shore rigs. the power systems division in the u.K. had a successful year given the challenging market environment, with revenues down 6% in local currency from 2008 levels, and new engine sales holding up relatively well. power systems accounted for over half of the total new equipment deliveries in the u.K. in 2009. uK group revenue FroM Continuing operationS ($ MillionS) uK group produCt Support revenue FroM Continuing operationS ($ MillionS) 1,600 1,400 1,200 1,000 800 600 400 200 0 0 0 4 1 , 3 7 2 1 , 1 7 2 1 , 0 3 2 1 , 1 6 8 2005 2006 2007 2008 2009 300 250 200 150 100 50 0 3 5 2 5 4 2 8 3 8 2 2 2 7 1 2 2005 2006 2007 2008 2009 the dealership has reduced its expense levels through cost reductions and improved efficiencies through the successful completion of various cost savings initiatives. a shared services group was established to support the finance functions for the dealership and Hewden. other examples of sustainable cost reductions include an improved parts transportation network, fewer suppliers, and the consolidation of the general construction business and Finnpave within the construction division. in addition, increased focus on asset management has improved inventory turns and reduced accounts receivable. Hewden Hewden provides national rental solutions to a variety of uK customers. this market is currently very competitive and oversupplied. as a consequence, the business remained challenged by volume and pricing. Within this context, we have been driving a performance culture to achieve operational excellence. additionally, we have been implementing a recovery plan to reduce the size of Hewden and improve efficiency in rental excellence. the core elements of Hewden’s recovery plan include the disposal of underperforming assets, achievement of operational efficiencies, and greater customer-focus. in addition, the new enterprise resource planning system installed in 2007 provided us with much improved management tools. as a result, we have been able to significantly improve equipment fleet composition and machine utilization. We also streamlined our organization from our previous five divisions and five geographic regions down to three geographic regions. We have reduced expense levels and improved the management of repair costs. importantly, we are making inroads with our national account customers that favour our value proposition. parallel to driving improved operating performance at Hewden, we are exploring a potential sale of this operation, and have received a number of expressions of interest. We anticipate this strategic review will lead to a decision by mid-2010. outlook the uK dealership is a fundamentally strong business. it remained profitable throughout the economic downturn, and we see solid growth opportunities when market conditions begin to improve. looking ahead, we will continue to pursue opportunities for equipment sales and product support in heavy construction and power systems, where our product support capabilities add significant value and enable customers to obtain the most productivity from their machines. 2009 Finning international inC. | 17 | Corporate reSponSibility Finning supplied a turnkey landfill-gas-to-energy (lFgte) solution to Capital power consisting of three containerized g3520 landfill gas engines that generate 4.8MW of renewable energy using biogas captured from edmonton’s Municipal Solid Waste (MSW) at the Cloverbar landfill. Finning also has a maintenance contract for the complete system. TO OUr EmplOyEEs: We will foster a workplace where people’s actions are guided by: caring for each other’s safety and well-being, communicating openly, taking responsibility, empowering and trusting one another, and doing our best. TO OUr CUsTOmErs: We will provide the best solutions and value. TO OUr shArEhOldErs: We will deliver top quartile shareholder returns. OUr VAlUEs: We Care. We Communicate. We Take responsibility. We Empower. We Trust. We do Our Best. at Finning, our commitment to our employees, the environment and the community is underpinned by our Code of Conduct and reflected in our values. this commitment to uphold the highest environmental, health and safety standards; continuously inspire employee engagement; and, support our communities is an integral part of our corporate culture and something that all Finning employees contribute towards. in addition to our employees’ dedication, Finning’s board of directors also plays an active role by monitoring the activities across our operations to ensure consistency in meeting our world-class environment, health and safety (eH&S) standards. • identify, assess and minimize environmental risk through a regular audit program. • train employees on changes to environmental laws and regulation. • use suppliers who have high environmental standards and practices and routinely audit their performance. • establish and maintain environmentally acceptable methods for managing waste, reusing and recycling materials. • ensure that future development of our facilities reflect our commitment to environmental issues and energy efficient solutions. environment at Finning, managing our business in a manner designed to protect the environment is an integral aspect of being a socially responsible company. this operating philosophy is reflected in the following principles which govern our attitude, actions and performance in environmental matters: • adopt management practices and procedures which meet and exceed the environmental standards of each community. our commitment to the environment extends to all aspects of our operations and takes various forms including: • rebuilding equipment components in order to reduce waste, save energy, and decrease the consumption of raw materials required to produce new components. • being a world leader in providing renewable energy solutions that reduce greenhouse gas emissions. 18 • Working with Caterpillar to provide products, support and technologies to help customers reduce the levels of exhaust emissions and improve fuel efficiency. in 2009, Finning continued to build on our environmental practices with new initiatives in each of our operations: • Finning uK launched the eco-drive training course to educate customers about energy use and offer practical tips to reduce equipment fuel consumption. • Finning South america incorporated energy efficient technology in several branches, including solar energy to generate electricity and heat. • Finning (Canada) made a significant stride towards tracking environmental impacts and the performance across its operations by developing a centralized information system. Community involvement despite challenging economic times, Finning continued our strong tradition of investing in communities both locally and globally. Finning’s spirit of giving takes many forms, including charitable contributions through our Community investment program, cultural sponsorships and employee campaigns. through these different avenues, Finning supports a wide range of education and training, health and welfare, and arts and cultural programs and organizations. as part of our charitable giving in 2009, Finning proudly supported the construction of a new b.C. Children’s Hospital with a $1 million pledge that will help construct a new state-of-the-art-facility to improve the quality of care that critically ill children receive. in the u.K., the company encourages employees to undertake activities which will benefit charitable organizations, in many cases facilitating contributions and volunteer work with matching grants and other programs. in South america, Finning partners with local schools to support training and development programs. employee engagement We know that delivering unrivalled service to customers relies on high-performing employees so we work hard to attract and retain the very best. dedicated people who embody Finning’s core values have been the foundation of our success and are the key to achieving our future goals. accordingly, cultivating a culture of engagement is a high priority for our organization. For the past four years, Finning has participated in Caterpillar’s annual employee opinion survey (eoS) process. by helping to identify what is working well and where we can make improvements, the eoS plays a critical role in continually improving engagement at Finning. in 2009, 85 percent of employees responded to our annual survey. despite the impact of the economic challenges on our business and workforce, we continued to demonstrate improvements in areas that impact engagement. Here are a few highlights: While we are proud of our work to reduce ltis, we recognize that there is always room for improvement and continue to strive towards attaining our goal of zero injuries. our efforts to create a work environment that is completely incident-free continued in 2009 with the introduction of several new initiatives across Finning’s operations, including: • Finning (Canada) utilized a new on-line tool to report ‘near misses’ as part of its focus on identifying leading indicators of injury to help prevent accidents from occurring. • Finning South america launched the “living Safe” campaign to promote a culture of risk prevention by highlighting safety practices at work and at home in an engaging and educational way. • Finning uK implemented an “office Safety” campaign specifically designed to raise awareness of safety issues unique to an office environment. • scores improved in 9 of the 11 indices loSt tiMe injury FreQuenCy (lti)* 1.0 0.8 0.6 0.4 0.2 0.0 • our employee engagement score increased two percentage points, from 81 to 83 percent • our safety score surpassed the average score of Caterpillar dealers reflecting our employees on-going commitment to safety. Safety Finning has distinguished itself as an industry leader in safety standards due to our rigorous, company-wide focus on safety. our approach to maintaining this leadership position emphasizes management commitment and leadership, open communication, training, prevention, sharing best practices and continuous improvement of the safety of our operations. as a result of our dedication to maintaining a safe workplace, Finning continues to reduce the frequency of lost time incidents (ltis) — a key indicator of safety performance. in 2009, Finning achieved a 37 percent reduction in our lost time frequency rate compared to the previous year. 0 8 0 . 2 7 0 . 2 5 0 . 8 3 0 . 4 2 0 . 2005 2006 2007 2008 2009 *lost time injuries per 200,000 work hours 2009 Finning international inC. | 19 | FinanCial report ManageMent’S diSCuSSion & analySiS 21 ManageMent’S report to tHe SHareHolderS 49 auditorS’ report ConSolidated FinanCial StateMentS ten year FinanCial SuMMary 50 51 86 ManageMent’s Discussion & analysis this discussion and analysis of the financial results of finning international inc. (finning or the company) should be read in conjunction with the consolidated financial statements and accompanying notes. the results reported herein have been prepared in accordance with canadian generally accepted accounting principles (gaaP) and are presented in canadian dollars unless otherwise stated. additional information relating to the company, including the company’s annual information form, can be found on the seDar (system for electronic Disclosure and retrieval) website at www.sedar.com. results of oPerations Fourth Quarter overview ($ Millions) (% of revenue) Q4 2009 Q4 2008 Q4 2009 Q4 2008 revenue gross profit selling, general & administrative expenses other income (expenses) goodwill impairment earnings (loss) before interest and income taxes (eBit)(1) finance costs Provision for income taxes net income (loss) Basic earnings (loss) per share (ePs) earnings before interest, taxes, depreciation, and amortization (eBitDa)(1), excluding goodwill impairment free cash flow(1)(2) $ $ $ $ $ 1,135.1 301.5 (261.0) (10.5) 30.0 – 30.0 (18.8) 5.1 16.3 0.10 89.1 130.4 $ $ $ $ $ 1,566.7 422.0 (338.5) (16.6) 66.9 (151.4) (84.5) (21.7) (0.6) (106.8) (0.63) 152.8 151.7 26.5% (23.0)% (0.9)% 2.6% – 2.6% (1.6)% 0.4% 1.4% 26.9% (21.6)% (1.0)% 4.3% (9.7)% (5.4)% (1.4)% (0.0)% (6.8)% 7.8% 9.8% (1) these amounts do not have a standardized meaning under generally accepted accounting principles. for a reconciliation of these amounts to net income and cash flow from operating activities, see the heading “Description of non-gaaP Measures” below. (2) free cash flow is defined as cash flow provided by operating activities less net capital expenditures. fourth quarter consolidated revenue of $1.1 billion decreased 27.5% from the fourth quarter of 2008, with lower revenues in all operations, although most significantly from the company’s canadian operations. the decrease in revenues from the company’s canadian operations was largely due to 35.7% lower new equipment sales as a result of the economic downturn. Product support revenues reflected a decline of 5.1% in the fourth quarter of 2009 compared to the same period last year. although total product support revenues were down slightly in canada, product support revenues from mining increased 19.2%, offset by a slowdown in other sectors. REVENUE BY OPERATION ($ millions) 3 months ended December 31 REVENUE BY LINE OF BUSINESS ($ millions) 3 months ended December 31 EBIT BY OPERATION* ($ millions) 3 months ended December 31 *excluding Corporate and Other Operations and goodwill impairment 6 2 8 2 0 6 4 6 4 7 3 3 900 750 600 450 300 150 0 6 7 2 6 9 1 2008 2009 9 5 7 0 7 4 800 600 400 200 0 7 0 5 1 7 4 3 7 1 0 2 1 4 2 1 0 7 CANADA SOUTH AMERICA UK GROUP NEW EQUIPMENT USED EQUIPMENT EQUIPMENT RENTAL PRODUCT SUPPORT 2008 2009 5 4 OTHER 50 40 30 20 10 0 (10) 7 4 8 3 2 3 1 - CANADA SOUTH AMERICA 0 1 - 4 - 2008 2009 UK GROUP 2009 finning international inc. | 21 | ManageMent’s Discussion & analysis revenues from the company’s operations in south america decreased by 27.4% compared to the fourth quarter of 2008 (16.5% in functional currency, the u.s. dollar). this was primarily due to lower new equipment sales which were down 43.8% as a result of a pause in mining deliveries in the quarter, and weak demand from the construction and power systems sectors. Product support revenues declined 7.2% compared to the fourth quarter of 2008. However, in functional currency (the u.s. dollar), product support revenues were up 6.6% supported by strong mining activity. Mining product support revenue, in functional currency, was 5.9% higher in the fourth quarter of 2009 compared with the same period last year. in the u.K., revenues were down 29.0% over the fourth quarter of 2008 (21.8% in local currency). Market conditions in the u.K. remained soft in the fourth quarter, negatively impacting new and used equipment sales to the construction sector and rental revenues. Product support revenues were not affected to the same degree primarily due to an active coal mining sector and power system activity. the weaker economic conditions were reflected in lower new equipment sales (down 34.3%), rental revenues (down 20.2%) and, to a lesser extent, product support revenues (down 13.8%). overall, new equipment sales were down 38.1% compared with the fourth quarter of 2008, with lower volumes in all operations. Product support revenues in the fourth quarter of 2009 were down 7.0% compared with the same quarter last year. growth in product support revenues generated by the mining sectors in canada and south america were offset by continued weak demand for parts and service from other sectors. used equipment revenues were down 43.0% compared to the prior year’s fourth quarter. apart from the impact of the economic downturn, used equipment sales typically vary depending on product availability, customer buying preferences, and exchange rate considerations. rental revenues were 30.6% lower, down in all operations in the fourth quarter of 2009, particularly in canada and the uK rental business, Hewden. activity in the construction market in the u.K. remains depressed and as a result rental revenues were low. finning’s global order book or backlog (the retail value of new equipment units ordered by customers for future deliveries) was $0.6 billion at the end of the fourth quarter of 2009, up from the september 2009 level of $0.5 billion, and down from the December 2008 levels of $1.5 billion. new order intake increased by 2% compared to the fourth quarter of 2008, and was up 55% from the third quarter of 2009, driven by large equipment orders from the mining sector in canada and south america. new equipment orders in the fourth quarter of 2009 were the highest since 2008 in all operations. Earnings Before Interest and Taxes (EBIT) on a consolidated basis, eBit in the fourth quarter of 2009 was $30.0 million compared to an eBit loss of $84.5 million in the same period in 2008 primarily due to a goodwill impairment charge of $151.4 million related to Hewden recorded in the fourth quarter of 2008. excluding this goodwill impairment charge, discussed in more detail below, eBit in the fourth quarter of 2009 was 55.2% lower than 2008. gross profit decreased 28.6% to $301.5 million in the fourth quarter of 2009 compared with the fourth quarter of 2008, a result of 27.5% lower revenues due to weak economic conditions. Quarterly gross profit margin (gross profit as a percentage of revenue) of 26.5% was slightly down from the prior year. although the company experienced a shift in revenue mix to the higher margin product support business in all operations, this was more than offset by lower gross profit margins in new, used, and rental equipment revenues. Product support revenues made up 41.5% of total revenues in the fourth quarter of 2009, compared with 32.3% of total revenues in the same period last year. selling, general, and administrative (sg&a) costs were down $77.5 million or 22.9% in the fourth quarter of 2009 compared to the same quarter last year. Management has taken action to reduce the company’s costs in response to the economic downturn and continues to review its cost structure to ensure it is aligned with the level of business activity. fourth quarter results included restructuring and severance costs of $15.8 million and costs of $6.2 million related to the implementation of a new information technology (it) system for the company’s global operations. comparatively, fourth quarter 2008 results included restructuring and severance costs of $15.0 million and costs of $4.5 million related to the new it system. also included in the results for the fourth quarter of 2009 was a $11.5 million pre-tax gain on the sale of certain properties, primarily in Hewden and south america (Q4 2008: pre-tax gain of $2.9 million). the company’s eBit margin (eBit divided by revenues) was 2.6% in the fourth quarter of 2009, down from 4.3% in the fourth quarter of 2008 (excluding the goodwill impairment charge noted below), primarily due to lower revenues and lower gross profit margin from the company’s canadian operations, partially offset by higher gross profit margin contributed by the company’s south american and uK operations. sg&a costs declined significantly in the fourth quarter of 2009 compared with the same quarter last year, but the reduction was not as much as the decline in gross profit due to the fixed nature of certain costs. 22 ManageMent’s Discussion & analysis Major components of the eBit variance were: ($ Millions) 2008 Q4 eBit net change in operations foreign exchange impact Hewden goodwill impairment charge in 2008 Higher it system implementation costs in 2009 Higher gains on sale of certain properties in 2009 Higher restructuring costs in 2009 2009 Q4 eBit $ $ (84.5) (22.5) (20.5) 151.4 (1.7) 8.6 (0.8) 30.0 the company’s canadian operations experienced an eBit loss of $0.2 million in the fourth quarter of 2009, compared with eBit of $47.1 million in the comparable period last year, primarily as a result of higher restructuring and severance costs and lower revenues as noted above. in the fourth quarter of 2009, a plan was implemented which included a regional consolidation of branches across finning (canada)’s current 12 regions. the plan included a consolidation of branches into 5 regions which will result in a further rationalization of facilities and re-allocation of resources across these new regions. this plan, together with other productivity improvements, will be fully rolled out over the next few quarters and is expected to drive a further reduction of $50 million in expenses in the canadian operations in 2010, to total over $200 million for the company. as part of this plan, further headcount reductions were implemented in the fourth quarter. restructuring costs and severance of $11.3 million were incurred in the fourth quarter of 2009, compared with $8.0 million in the fourth quarter of 2008. eBit from the company’s south american operations of $32.4 million was 15.4% lower than the fourth quarter of 2008, primarily as a result of lower revenues. the uK operations experienced an eBit loss of $3.6 million in the fourth quarter of 2009, an improvement of 62.9% from the comparable period in 2008. in the fourth quarter of 2009, the uK dealership contributed eBit of $5.9 million (2008: $1.5 million), which was offset by a $9.5 million eBit loss (2008: $11.2 million) from the uK’s rental business, Hewden. During the year, the company performed its annual goodwill impairment tests and determined that goodwill was not impaired at December 31, 2009. in 2008, the company determined that the fair value of Hewden stuart Plc (Hewden) was less than its book value, which included goodwill recorded on acquisition. this determination resulted from a decline in market multiples and a reduction of fair value as determined using a discounted cash flow methodology due to a change in assumptions in order to reflect current market conditions. this resulted in a full goodwill impairment charge of $151.4 million for Hewden in the fourth quarter of 2008. a further discussion regarding the non-cash goodwill impairment charge can be found in the goodwill impairment section below. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and Free Cash Flow eBitDa, which management views as an indicator of a company’s operating performance and generation of operating cash flow, was $89.1 million in the fourth quarter of 2009 compared to $152.8 million in the fourth quarter of 2008 after excluding the 2008 goodwill impairment charge noted above. free cash flow is defined as cash flow provided by (used in) operating activities less net capital expenditures. the company’s free cash flow generated in the fourth quarter of 2009 was $130.4 million compared to $151.7 million in the comparable quarter last year. Finance Costs finance costs for the three months ended December 31, 2009 were $18.8 million compared with $21.7 million in the fourth quarter of 2008. the lower finance costs in the fourth quarter of 2009 were primarily the result of lower interest rates on both short term and long term debt. Provision for Income Taxes the effective income tax rate for the fourth quarter of 2009 was (45.1)% compared to (0.6)% in the comparable period in 2008. the effective tax rate for the fourth quarter of 2009 reflected losses incurred in high tax jurisdictions and lower capital gains tax rates applied to the sale of properties in the u.K. and south america, as well as higher income earned in lower tax jurisdictions. the effective tax rate for the fourth quarter of 2008 was impacted by the goodwill impairment charge, which was not deductible for tax purposes. in addition, the company benefited from lower capital gains tax rates applied to the sale of properties in the u.K. in the fourth quarter of 2008. Net Income finning’s net income was $16.3 million in the fourth quarter of 2009 compared with a net loss of $106.8 million in the comparative period in 2008. excluding the goodwill impairment noted above, net income would have been $44.6 million in the fourth quarter of 2008. Basic ePs was $0.10 per share in the fourth quarter of 2009 compared with the basic loss per share of $0.63 in the fourth quarter of 2008. excluding the goodwill impairment charge, basic ePs in the fourth quarter of 2008 was $0.26. lower revenues and gross profit from all lines of business contributed to the decline, partially offset by lower sg&a costs. 2009 finning international inc. | 23 | ManageMent’s Discussion & analysis annual overview revenue gross profit selling, general & administrative expenses other income (expenses) goodwill impairment eBit finance costs Provision for income taxes net income Basic ePs eBitDa, excluding goodwill impairment free cash flow ($ Millions) (% of revenue) 2009 2008 2009 2008 $ $ $ $ $ 4,737.5 1,329.6 (1,085.1) (37.5) 207.0 – 207.0 (67.6) (8.6) 130.8 0.77 474.7 493.9 $ $ $ $ $ 5,991.4 1,672.9 (1,268.0) (16.8) 388.1 (151.4) 236.7 (83.6) (57.1) 96.0 0.56 712.5 23.2 28.1% (22.9)% (0.8)% 4.4% – 4.4% (1.4)% (0.2)% 2.8% 10.0% 27.9% (21.1)% (0.3)% 6.5% (2.5)% 4.0% (1.4)% (1.0)% 1.6% 11.9% for the year ended December 31, 2009, revenues of $4.7 billion decreased 20.9% compared with 2008, with lower revenues from all operations. revenues from the company’s canadian operations decreased 25.8% in 2009 compared with 2008, when record annual revenues were achieved. the decline was largely due to lower new equipment sales as a result of the economic downturn. Product support revenues from the canadian operations in 2009 were slightly lower (4.7%) compared with 2008, although this was partly due to the discontinued collicutt fabrication business which contributed $37.4 million of product support revenue in 2008. Product support revenues from the mining sector continued to be strong and increased 30.2% over the prior year. the global economic downturn had only a modest negative impact on the results from finning south america and revenues were only slightly lower compared with 2008. in u.s. dollar functional currency, revenues decreased 6.6%, primarily in new equipment revenues. Product support revenues were up 5.0% in functional currency. new equipment and product support revenues contributed by the south american operations continued to reflect solid equipment sales and good product support activity, mainly with mining customers. in fact, the south american operations achieved record new equipment sales to the mining sector in 2009. challenging economic conditions continued throughout 2009 in the u.K. market. the company’s uK group’s revenues for 2009 were $861.3 million, down 32.3% from the prior year. this was partially due to translating the uK group’s pound sterling results into canadian dollars with a 9.2% stronger canadian dollar in 2009. in local currency, total revenues were 25.4% lower compared to those reported in 2008. revenues were lower in all lines of business compared with 2008, primarily new and used equipment sales, and rental revenues. this reflected a continued decline in the strength of the underlying u.K. economy, particularly in the construction sector. on a consolidated basis, new equipment sales were 32.2% lower than in 2008, and down in all operations in functional currency. Product support revenues were comparable with annual 2008 revenues, with lower service revenue offset by higher parts revenue. REVENUE BY OPERATION ($ millions) 12 months ended December 31 REVENUE BY LINE OF BUSINESS ($ millions) 12 months ended December 31 7 1 2 , 3 7 8 3 , 2 2 0 5 1 , 0 9 4 1 , 3 7 2 1 , 1 6 8 2008 2009 9 2 9 , 2 5 8 9 1 , 3,000 2,500 2,000 1,500 1,000 500 0 0 0 9 1 3 9 8 1 3 1 7 0 1 5 2 3 4 8 3 3 CANADA SOUTH AMERICA UK GROUP NEW EQUIPMENT USED EQUIPMENT EQUIPMENT RENTAL PRODUCT SUPPORT 9 1 2 1 OTHER 2008 2009 3,500 3,000 2,500 2,000 1,500 1,000 500 0 24 EBIT BY OPERATION* ($ millions) 12 months ended December 31 *excluding Corporate and Other Operations and goodwill impairment 300 250 200 150 100 50 0 (50) 5 3 2 4 5 1 8 4 1 8 9 4 5 0 2 - UK GROUP 2008 2009 CANADA SOUTH AMERICA ManageMent’s Discussion & analysis used equipment revenues were down 21.8% in 2009 compared with last year, and rental revenues were 28.4% lower in 2009 which primarily reflected lower activity in the uK rental business. the positive impact on company revenues due to the weaker canadian dollar relative to the u.s. dollar in 2009 compared with 2008 was approximately $110 million or 2%. Earnings Before Interest and Taxes (EBIT) eBit for the year ended December 31, 2009 was $207.0 million, compared to $388.1 million in 2008 (excluding the goodwill impairment charge of $151.4 million recorded in the fourth quarter of 2008). lower eBit in 2009 compared with 2008 was primarily due to lower revenues as a result of weak economic conditions and higher restructuring costs in 2009. gross profit of $1,329.6 million in 2009 decreased 20.5% over the prior year. gross profit as a percentage of revenue was 28.1%, up from 27.9% in 2008, primarily due to a shift in revenue mix to a higher proportion of product support revenues which generate higher margins. gross margins were down in all lines of business other than product support. sg&a costs were 14.4% lower in 2009 reflecting the implementation by management of cost reductions, productivity improvement measures, and as a result of lower sales volumes. the company achieved sg&a cost reductions and productivity improvements of approximately $110 million in 2009, roughly on track with our estimate of $120 million, and expects to achieve its target of over $200 million in annual cost savings compared to 2008 going forward. results for 2009 included restructuring and severance costs of $36.9 million and costs of $18.9 million related to the implementation of a new it system for the company’s global operations. comparatively, results for 2008 included non-recurring costs of $33.1 million related to the integration of collicutt energy services ltd (collicutt) and restructuring costs, and costs of $16.2 million related to the new it system. also included in the results for 2009 was an $18.3 million pre-tax gain on the sale of certain properties, primarily in Hewden and south america (2008: pre-tax gain of $19.9 million). the 2008 results were adversely impacted by the goodwill impairment charge of $151.4 million relating to Hewden. the company’s eBit margin was 4.4% in 2009, down from 6.5% in 2008 (adjusting for the goodwill impairment charge) due to the factors noted above. Major components of the annual eBit variance were: ($ Millions) 2008 eBit net change in operations foreign exchange impact Hewden goodwill impairment charge in 2008 Higher it system implementation costs in 2009 lower gains on sale of certain properties in 2009 collicutt integration and start-up costs in 2008 Higher restructuring costs in 2009 2009 eBit $ $ 236.7 (219.6) 46.6 151.4 (2.7) (1.6) 12.6 (16.4) 207.0 Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and Free Cash Flow eBitDa, which management views as an indicator of the company’s operating performance and generation of operating cash flow, was $474.7 million in 2009 compared to $712.5 million in 2008, after excluding the 2008 goodwill impairment charge noted above. the company’s free cash flow generated in 2009 was $493.9 million compared to $23.2 million in the prior year. all of finning’s operations have seen significant improvements in the generation of free cash flow in 2009 compared to the prior year. improvements to working capital and the reduction of rental equipment expenditures to align with demand have more than offset lower earnings. Finance Costs finance costs in 2009 were $67.6 million compared with $83.6 million in 2008. the lower finance costs in 2009 were primarily due to lower interest rates on both short-term and long-term debt. 2009 finning international inc. | 25 | ManageMent’s Discussion & analysis Provision for Income Taxes the effective income tax rate in 2009 was 6.2% compared to 37.3% in 2008. the lower effective tax rate in 2009 was primarily due to a one-time tax adjustment in the second quarter of 2009 resulting in an $8.5 million reduction in income tax expense as a result of a change in the estimated tax rate related to certain items that had been recorded directly to other comprehensive income in prior periods. the effective tax rate in 2009 was also lower due to a higher proportion of earnings from lower tax jurisdictions, a positive outcome related to a review by tax authorities, and the benefit from tax adjustments resulting from the closure of previously open tax years. the 2008 effective tax rate was higher due to the goodwill impairment charge recorded in the fourth quarter of 2008, which was not deductible for tax purposes. Management anticipates that for 2010, the consolidated effective tax rate will be in the low-to-mid-20%s. Net Income finning’s net income of $130.8 million in 2009 was higher than its net income of $96.0 million in 2008. excluding the goodwill impairment charge noted above, net income would have been $247.4 million in 2008. Basic ePs was $0.77 per share in 2009 compared with basic ePs of $0.56 in 2008. as noted above, the results from 2009 included non-recurring costs of $0.23 per share related to restructuring and severance costs and it implementation costs. these non-recurring costs were partially offset by an income tax recovery of approximately $0.05 per share related to the second quarter of 2009 change in the estimated tax rate noted above, and $0.10 per share of gains on sale of certain properties, primarily in Hewden and south america. the results for 2008 included $0.88 per share related to the Hewden goodwill impairment charge and $0.20 per share of other non-recurring costs related to the integration of collicutt, restructuring and severance, and it implementation, partially offset by $0.10 per share of gains on sale of certain properties (primarily Hewden). Foreign exchange Translation the company’s reporting currency is the canadian dollar. However, due to the geographic diversity of the company’s operations, a significant portion of revenue and operating expenses are in different currencies. the most significant currencies in which the company transacts business are the u.s. dollar, the canadian dollar, and the u.K. pound sterling. changes in the canadian dollar / u.s. dollar and canadian dollar / u.K. pound sterling relationship affected reported results on the translation of the financial statements of the company’s south american and uK group operations as well as u.s. dollar based earnings of the company’s canadian operations. compared to the fourth quarter of 2008, foreign exchange had a negative impact on consolidated revenues in the fourth quarter of 2009 of approximately $95 million due to a stronger canadian dollar relative to the u.s. dollar (12.8% stronger than the fourth quarter of 2008), and a 9.2% stronger canadian dollar relative to the u.K. pound sterling. as a result, net income was negatively impacted by approximately $0.10 per share in the fourth quarter of 2009 compared to the prior year’s fourth quarter. net income was positively impacted by approximately $0.19 per share for the full 2009 year compared to the previous year due to the weaker canadian dollar relative to the u.s. dollar (7.1% weaker than in 2008), partially offset by a 9.2% stronger canadian dollar relative to the u.K. pound sterling. the canadian dollar has recently been strongly correlated to commodity prices. if commodity prices weaken, the canadian dollar is likely to weaken. in this scenario, the company’s mining and oil sands business typically slows; however, the company benefits from u.s. dollar based revenues and earnings being translated into higher canadian dollar reported revenues and earnings due to the weaker canadian dollar, although lags may occur. the impact of foreign exchange due to the movement of the canadian dollar relative to the u.s. dollar and u.K. pound sterling is expected to continue to affect finning’s financial results. the sensitivity of the company’s net income to fluctuations in the average annual foreign exchange rates is summarized in the risk Management section of this MD&a. Investment in Foreign Operations assets and liabilities of the company’s self-sustaining foreign operations are translated into canadian dollars using the exchange rates in effect at the balance sheet dates. any unrealized translation gains and losses are recorded as an item of other comprehensive income and accumulated other comprehensive income. currency translation adjustments arise as a result of fluctuations in foreign currency exchange rates at the period end. the unrealized currency translation loss of $165.6 million recorded in 2009 resulted from the stronger spot canadian dollar against the u.s. dollar and the u.K. pound sterling of 14.5% and 5.5%, respectively, at December 31, 2009 compared to December 31, 2008. this was partially offset by $37.6 million of unrealized foreign exchange gains on net investment hedges. 26 ManageMent’s Discussion & analysis the following tables provide details of revenue and eBit contribution by operation and the foreign exchange impact for the three and twelve months ended December 31, 2009. three months ended December 31 ($ Millions) revenues – Q4 2008 foreign exchange impact operating revenue increase (decrease) revenues – Q4 2009 total revenue increase (decrease) – percentage increase (decrease) – percentage increase (decrease), excluding foreign exchange twelve months ended December 31 ($ Millions) revenues – 2008 annual foreign exchange impact operating revenue increase (decrease) revenues – 2009 annual total revenue increase (decrease) – percentage increase (decrease) – percentage increase (decrease), excluding foreign exchange three months ended December 31 ($ Millions) canada south america $ $ $ canada 826.0 (28.3) (195.9) 601.8 (224.2) (27.1)% (23.7)% canada $ 3,216.9 121.5 (951.8) $ 2,386.6 (830.3) $ (25.8)% (29.6)% south america uK group consolidated $ $ $ 464.3 (47.2) (80.1) 337.0 (127.3) (27.4)% (17.3)% $ $ $ 276.4 (20.3) (59.8) 196.3 (80.1) (29.0)% (21.6)% $ 1,566.7 (95.8) (335.8) $ 1,135.1 (431.6) $ (27.5)% (21.4)% south america $ 1,501.6 77.8 (89.8) $ 1,489.6 (12.0) $ (0.8)% (6.0)% uK group consolidated $ 5,991.4 110.9 (1,364.8) $ 4,737.5 $ (1,253.9) (20.9)% (22.8)% $ $ $ 1,272.9 (88.4) (323.2) 861.3 (411.6) (32.3)% (25.4)% goodwill uK group other impairment consolidated eBit – Q4 2008 foreign exchange impact operating eBit increase (decrease) eBit – Q4 2009 total eBit increase (decrease) – percentage increase (decrease) – percentage increase (decrease), excluding foreign exchange $ $ $ 47.1 (8.3) (39.0) (0.2) (47.3) (100.4)% $ $ $ 38.3 (12.2) 6.3 32.4 (5.9) (15.4)% $ $ $ (9.7) – 6.1 (3.6) 6.1 62.9% $ $ $ (82.8)% 16.4% 62.9% (8.8) – 10.2 1.4 10.2 – – $ $ $ (151.4) – 151.4 – 151.4 – $ $ $ (84.5) (20.5) 135.0 30.0 114.5 135.5% – 159.8% twelve months ended December 31 ($ Millions) eBit – 2008 annual foreign exchange impact operating eBit increase (decrease) eBit – 2009 annual total eBit increase (decrease) – percentage increase (decrease) – percentage increase (decrease), excluding foreign exchange canada 234.5 27.5 (163.7) 98.3 (136.2) (58.1)% $ $ $ south america uK group other impairment consolidated goodwill $ $ $ 148.2 18.2 (12.7) 153.7 5.5 3.7% $ $ $ 53.6 0.9 (74.6) (20.1) (73.7) (137.5)% $ $ $ (48.2) – 23.3 (24.9) 23.3 – $ $ $ (151.4) – 151.4 – 151.4 – $ $ $ 236.7 46.6 (76.3) 207.0 (29.7) (12.5)% (69.8)% (8.6)% (139.2)% – – (32.2)% 2009 finning international inc. | 27 | ManageMent’s Discussion & analysis results By Business segment the company and its subsidiaries operate primarily in one principal business, that being the selling, servicing, and renting of heavy equipment, engines, and related products in various markets worldwide as noted below. finning’s operating units are as follows: • • • • Canadian operations: British columbia, alberta, the yukon territory, the northwest territories, and a portion of nunavut. South American operations: chile, argentina, uruguay, and Bolivia. UK Group operations: england, scotland, Wales, falkland islands, and the channel islands. Other: corporate head office. the table below provides details of revenue by operations and lines of business: for year ended December 31, 2009 ($ Millions) new equipment used equipment equipment rental Product support other total revenue percentage by operations for year ended December 31, 2008 ($ Millions) new equipment used equipment equipment rental Product support other total revenue percentage by operations canada $ 1,015.8 202.2 224.4 935.2 9.0 $ 2,386.6 50.4% canada $ 1,670.6 252.8 296.6 981.8 15.1 $ 3,216.9 53.7% south america $ 656.0 41.9 47.9 740.8 3.0 $ 1,489.6 31.4% south america $ 737.6 37.2 58.8 664.4 3.6 $ 1,501.6 25.1% uK group consolidated $ $ 312.9 93.7 238.1 216.6 – 861.3 18.2% $ 1,984.7 337.8 510.4 1,892.6 12.0 $ 4,737.5 100.0% uK group consolidated $ 520.4 141.8 357.4 253.3 – $ 1,272.9 21.2% $ $ 2,928.6 431.8 712.8 1,899.5 18.7 5,991.4 100.0% revenue percentage 41.9% 7.1% 10.8% 39.9% 0.3% 100.0% revenue percentage 48.9% 7.2% 11.9% 31.7% 0.3% 100.0% the table below provides selected income statement information by business segment: for year ended December 31, 2009 ($ Millions) canada south america uK group other impairment consolidated goodwill revenue from external sources operating costs Depreciation and amortization other income (expenses) it system implementation costs other earnings before interest and taxes earnings before interest and tax – percentage of revenue – percentage by operations for year ended December 31, 2008 ($ Millions) revenue from external sources operating costs Depreciation and amortization $ 2,386.6 (2,125.7) (132.6) 128.3 $ 1,489.6 (1,299.4) (37.4) 152.8 (10.6) (19.4) 98.3 (5.6) 6.5 153.7 $ $ $ $ 861.3 (774.8) (97.5) (11.0) (2.4) (6.7) (20.1) $ $ – (25.4) (0.2) (25.6) (0.3) 1.0 (24.9) $ $ 4.1% 47.5% canada 10.3% 74.2% south america (2.3)% (9.7)% – (12.0)% uK group other impairment consolidated goodwill – – – – – – – – – $ 4,737.5 (4,225.3) (267.7) 244.5 (18.9) (18.6) 207.0 $ 4.4% 100.0% – – – – $ 5,991.4 (5,262.1) (324.4) 404.9 – – (151.4) (151.4) $ (16.2) (0.6) (151.4) 236.7 4.0% 100.0% $ 3,216.9 (2,801.8) (164.5) 250.6 $ 1,501.6 (1,313.8) (34.2) 153.6 $ 1,272.9 (1,099.8) (125.5) 47.6 $ $ – (46.7) (0.2) (46.9) (1.3) – – (48.2) $ $ (2.6) 8.6 – 53.6 $ other income (expenses) it system implementation costs other goodwill impairment earnings before interest and taxes earnings before interest and tax – percentage of revenue – percentage by operations (excluding goodwill) $ (7.9) (8.2) – 234.5 7.3% 60.4% $ (4.4) (1.0) – 148.2 9.9% 38.2% 28 4.2% 13.8% – (12.4)% – – ManageMent’s Discussion & analysis Canadian Operations the canadian operating segment includes finning (canada), the company’s interest in oeM remanufacturing company inc. (oeM), and a 25% interest in Pipeline Machinery international (PlM). finning (canada) sells, services, and rents mainly caterpillar mobile equipment in British columbia, alberta, the yukon territory, the northwest territories, and a portion of nunavut. the company’s end markets are comprised of mining (including the oil sands), construction, conventional oil and gas, forestry, and power systems. the table below provides details of the results from the canadian operating segment: for years ended December 31 ($ Millions) revenue operating costs Depreciation and amortization other expenses information technology system implementation costs restructuring costs and other earnings before interest and taxes (eBit) eBit – as a percentage of revenue – as a percentage of consolidated eBit (excluding goodwill impairment) earnings before interest, taxes, depreciation, and amortization (eBitDa) 2009 2,386.6 (2,125.7) (132.6) 128.3 (10.6) (19.4) 98.3 4.1% 47.5% 230.9 $ $ $ 2008 3,216.9 (2,801.8) (164.5) 250.6 (7.9) (8.2) 234.5 7.3% 60.4% 399.0 $ $ $ 2009 revenues of $2,386.6 million decreased 25.8% compared to 2008, when record annual revenues were achieved. the decline was largely due to lower new equipment sales resulting from the economic downturn. new equipment sales were 39.2% lower than 2008. new equipment orders in the fourth quarter of 2009 were the highest since 2008 which is positive, although strong deliveries in the last quarter of the year contributed to an overall decrease in backlog compared with the september 2009 level for the canadian operations. the existing backlog reflects future deliveries largely to mining customers scheduled to be made in 2010. Demand for construction and conventional oil and gas sectors remains soft. 2009 revenues from all lines of business in the company’s canadian operations were lower than in 2008. Product support revenues in 2009 were slightly lower (4.7%) compared with 2008, although this was mostly due to the discontinued collicutt fabrication business which contributed $37.4 million of product support revenue in 2008. in addition, in some sectors, customers were not fully utilizing their equipment and were deferring maintenance and repairs or in-sourcing some of this work. Product support revenues from the mining sector continued to be strong and increased 30.2% over the prior year. CANADA – REVENUE BY LINE OF BUSINESS ($ millions) 12 months ended December 31 2,000 1,500 1 7 6 1 , 1,000 500 0 6 1 0 1 , 2 8 9 5 3 9 3 5 2 2 0 2 7 9 2 4 2 2 NEW EQUIPMENT USED EQUIPMENT EQUIPMENT RENTAL PRODUCT SUPPORT 5 1 9 OTHER 2008 2009 2009 finning international inc. | 29 | ManageMent’s Discussion & analysis used equipment revenues were 20.0% lower than the prior year, also reflecting the slowdown in the general economy. rental revenues decreased 24.3% over 2008 and continued to be pressured by lower demand and competitive pricing in the market. foreign exchange had a positive impact of approximately $122 million on revenues in 2009 due to a 7.1% weaker canadian dollar relative to the u.s. dollar compared to last year. in canada, gross profit as a percentage of revenue was higher than in 2008 due to the shift in revenue mix to a higher proportion of product support revenues which typically return higher margins than new equipment sales. Product support revenues made up 39.2% of total revenues in 2009, compared with 30.5% of total revenues in 2008. the improvement in the gross profit margin due to a higher percentage of product support revenues was partially offset by lower gross profit margins in new, used, and rental equipment revenues. sg&a costs in 2009 were lower than 2008, reflecting lower salary and wages as a result of reduced headcount as well as actions taken to reduce discretionary expenses and improve efficiencies. Most discretionary expense levels are down over the prior year and cost savings from further actions taken in the fourth quarter of 2009 are expected to be fully realized in 2010. although sg&a costs were down in absolute terms, they were higher as a percentage of revenue compared to 2008 resulting from lower revenues and the fixed nature of certain costs that could not be reduced at the same rate as the revenue decline in 2009. included in other expenses were restructuring costs of $19.5 million incurred in 2009 (2008: $8.0 million). finning (canada)’s headcount was approximately 1,200 lower than september 2008, primarily due to downsizing its workforce in response to the downturn in the economy and aligning its costs with revenue levels. in the fourth quarter of 2009, a plan was implemented which included a consolidation of branches into 5 regions which will result in a further rationalization of facilities and allocation of resources across these new regions. this plan, together with other productivity improvements, will be fully rolled out over the next few quarters and is expected to drive a further $50 million in expenses out of the canadian operations in 2010. finning (canada) incurred $10.6 million of costs in 2009 (2008: $7.9 million) representing its share of the costs related to the implementation of a new information technology (it) system for the company’s global dealership operations. eBit totalled $98.3 million in 2009 compared with $234.5 million in 2008. eBit margin (eBit divided by revenues) was 4.1%, significantly lower than the eBit margin of 7.3% achieved in 2008. the reduction in eBit was primarily due to lower new equipment sales and higher restructuring and it implementation costs. this reduction was partially offset by lower sg&a costs from actions taken by the canadian operations. other Developments in the fourth quarter of 2009, finning (canada) and the international association of Machinists and aerospace Workers (iaM), vancouver lodge 692 (covering approximately 800 unionized employees located in British columbia), successfully settled a new two-year collective bargaining agreement which will expire in april 2011. finning (canada)’s collective bargaining agreement with the alberta division of the iaM – local lodge 99 will expire at the end of april 2010. negotiations with the alberta union will commence in Q1 2010. the company is committed to the collective bargaining process and to concluding a fair contract for its employees and for finning. the company continues to be involved in alberta labour relations Board proceedings with the iaM – local lodge 99 relating to finning (canada)’s outsourcing of component repair and rebuilding services to oeM in 2005. Decisions from the alberta labour relations Board are expected some time in 2010. in february 2010, finning (canada) secured a key mining equipment and product support agreement. imperial oil limited has chosen finning as a mining mobile equipment supplier for the Kearl oil sands project. the ten-year agreement includes the supply of caterpillar equipment, parts, specialized maintenance labour, and training. 30 ManageMent’s Discussion & analysis South America finning’s south american operation sells, services, and rents mainly caterpillar mobile equipment in chile, argentina, uruguay, and Bolivia. the company’s end markets are comprised of mining, construction, and power systems. the table below provides details of the results from the south american operations: for years ended December 31 ($ Millions) revenue operating costs Depreciation and amortization other income (expenses) information technology system implementation costs gain on sale of property, partly offset by restructuring costs (2008: restructuring costs) earnings before interest and taxes (eBit) eBit – as a percentage of revenue – as a percentage of consolidated eBit (excluding goodwill impairment) earnings before interest, taxes, depreciation, and amortization (eBitDa) 2009 1,489.6 (1,299.4) (37.4) 152.8 (5.6) 6.5 153.7 10.3% 74.2% 191.1 $ $ $ 2008 1,501.6 (1,313.8) (34.2) 153.6 (4.4) (1.0) 148.2 9.9% 38.2% 182.4 $ $ $ the global economic downturn had only a modest impact on the results of finning south america. 2009 revenues were only slightly lower compared with 2008. in u.s. dollar functional currency, revenues decreased 6.6%. foreign exchange had an approximately $78 million positive impact on the translation of those revenues, due to the 7.1% weakening of the canadian dollar relative to the u.s. dollar. 2009 revenues reflected softer new equipment sales partially offset by solid growth in product support activity, mainly with mining customers. in functional currency, new equipment sales and product support revenues from the mining sector were up 16.6% and 9.2%, respectively, over the prior year. in fact, the south american operations experienced record new equipment sales from the mining sector in 2009. this was more than offset by weaker demand in the power systems and construction sectors and as a result, new equipment sales in 2009 were down by 16.3% in functional currency. new order levels in the fourth quarter of 2009 were higher than any other quarter in 2009 and as a result, new equipment backlog as of December 31, 2009 was higher compared to the september 2009 level, but was roughly 60% the level of December 2008. Product support revenues continued to grow, and were 11.5% higher in 2009 (5.0% in functional currency) compared with 2008. growth in product support revenues continues to be primarily driven by the larger number of mining maintenance and repair contracts entered into in recent years and the higher number of caterpillar units operating in the field. in functional currency, gross profit decreased 7.9% in 2009 compared with last year, and in line with the revenue decline. as a percentage of revenue, gross profit was comparable with 2008 as a result of a shift in revenues to higher margin product support revenues, offset by lower margins on mining new equipment sales and rental revenues. Product support revenues made up 49.9% of total revenues in 2009, compared with 44.4% of total revenues in the last year. SOUTH AMERICA – REVENUE BY LINE OF BUSINESS ($ millions) 12 months ended December 31 800 700 600 500 400 300 200 100 0 8 3 7 6 5 6 1 4 7 4 6 6 7 3 2 4 9 5 8 4 NEW EQUIPMENT USED EQUIPMENT EQUIPMENT RENTAL PRODUCT SUPPORT 2008 2009 4 3 OTHER 2009 finning international inc. | 31 | ManageMent’s Discussion & analysis sg&a costs, in functional currency, decreased both in absolute dollars and as a percentage of revenue. the south american operations continued to benefit from ongoing cost savings programs. other income for 2009 included a $7.2 million pre-tax gain on the sale of a finning chile property in exchange for a new head office property. in addition, the company’s south american operations incurred costs of $5.6 million (2008: $4.4 million) related to the implementation of a new it system for the company’s global dealership operations. eBit from the company’s south american operations of $153.7 million was 3.7% higher than in 2008. in functional currency, eBit decreased 3.6% over the prior year. the lower eBit (in functional currency) in 2009 reflected lower new equipment revenues as a result of weaker demand from power systems and construction sectors, and lower new equipment and rental margins, partially offset by continued strong product support margins, and lower sg&a. eBit as a percentage of revenue for finning south america was solid at 10.3%, up from the eBit margin of 9.9% achieved in 2008. other Developments in february 2010, the company’s south american operations received a letter of intent from codelco, chile’s state-owned mining company, that includes the supply of 20 caterpillar 797 mining trucks and 15 pieces of support equipment, plus a ten-year maintenance and repair contract (Marc). the approximate value of the deal, including the maintenance services, is us$400 million. the letter of intent is subject to final project approval by codelco’s Board which is expected in mid 2010. the equipment will be delivered in the first half of 2011 to codelco’s Ministro Hales mine. United Kingdom (“UK”) Group the company’s uK group sells, services and rents mainly caterpillar mobile equipment in england, scotland, Wales, falkland islands, and the channel islands. the company’s end markets are comprised of mining, quarrying, construction, power systems, and rental services. the table below provides details of the results of the continuing operations from the uK group: for years ended December 31 ($ Millions) revenue operating costs Depreciation and amortization other income (expenses) information technology system implementation costs restructuring partly offset by gain on sale of properties (2008: gain on sale of properties partly offset by restructuring) earnings before interest and taxes (eBit) eBit – as a percentage of revenue – as a percentage of consolidated eBit (excluding goodwill impairment) earnings before interest, taxes, depreciation, and amortization (eBitDa) 2009 861.3 (774.8) (97.5) (11.0) (2.4) (6.7) (20.1) (2.3)% (9.7)% 77.4 $ $ $ 2008 1,272.9 (1,099.8) (125.5) 47.6 (2.6) 8.6 53.6 4.2% 13.8% 179.1 $ $ $ UK GROUP – REVENUE BY LINE OF BUSINESS ($ millions) 12 months ended December 31 600 500 400 300 200 100 0 32 0 2 5 3 1 3 7 5 3 8 3 2 3 5 2 7 1 2 2 4 1 4 9 NEW EQUIPMENT USED EQUIPMENT EQUIPMENT RENTAL PRODUCT SUPPORT 2008 2009 ManageMent’s Discussion & analysis the uK group’s revenues for 2009 were $861.3 million, down 32.3% from the prior year primarily due to challenging economic conditions which continued throughout 2009. in local currency, total revenues were 25.4% lower compared to those reported in 2008, reflecting a 9.2% stronger canadian dollar in 2009. revenues were lower in all lines of business compared with 2008, primarily in new and used equipment sales, and rental revenues. in local currency, in 2009, revenues from new equipment and product support were lower by 33.7% and 5.7%, respectively, compared with last year. this reflected a continued decline in the strength of the underlying u.K. economy, particularly in the construction sector. although new equipment orders continued to be lower than prior year levels, new orders in the fourth quarter of 2009 were the highest of any quarter in the year and contributed to the first increase in backlog over the past eight quarters for the uK operations. the new equipment backlog was higher compared to the september 2009 level, but was approximately 40% lower than the level at December 2008. rental revenues were also affected by the weak economic conditions in the uK and were down 26.4% in local currency compared with 2008. in response to Hewden’s weak operating results and the ongoing weak economic conditions in the u.K., a significant reorganization of Hewden, the uK group’s rental services operation, occurred in the first half of 2009. further streamlining of the Hewden depot network continued in the second half of 2009. as a result, Hewden’s overall cost structure has decreased and the rental fleet has been downsized. asset utilization has started to recover, and Hewden’s operating performance is expected to improve. gross profit, in local currency, in 2009 was lower compared with the prior year in absolute terms, which was generally in line with the sales decline, and as a percentage of revenue. the rental operations experienced lower margins in 2009 compared to last year due to lower utilization rates and pricing challenges as a result of a significant decline in u.K. construction market activities. Margins in most other lines of business were also down primarily due to weaker market conditions. Margins from product support activities, although slightly down compared to the prior year, continue to be solid. a higher proportion of revenues from product support as well as good margins from this line of business partially offset the impact of lower margins from rental revenues. sg&a costs were lower in 2009 compared with 2008 in absolute terms, but despite successful cost-cutting initiatives, higher as a percentage of revenue due to the fixed nature of some costs. Management has implemented a number of initiatives to reduce operating cost levels, dispose of surplus rental fleet in line with current market conditions, and improve the performance of other assets. further actions will be taken as needed to respond to market conditions. other expenses in 2009 included restructuring costs related to the integration of support services in the u.K. and depot restructuring. the organizational structure of the uK group was streamlined to provide a more consistent and effective service offering to customers at a reduced cost. in addition, in response to declining market conditions, the uK group incurred further restructuring and severance costs as staffing levels were reduced. in total, in 2009, the uK group incurred restructuring charges of $14.9 million (2008: $11.5 million). the initiatives noted above resulted in a reduction of approximately 750 employees since september 2008. Partially offsetting these restructuring charges in 2009 were pre-tax gains of $9.3 million related to the sale of certain properties at Hewden. the results for 2008 included a $19.2 million pre-tax gain on sale of certain Hewden properties. in 2009, the uK group incurred a loss before interest and tax of $20.1 million, compared with eBit of $53.6 million in 2008. the lower results in 2009 compared with the prior year were primarily due to lower revenues in all lines of business as well as higher restructuring and severance costs. eBit losses of $39.7 million were incurred in 2009 by the uK group’s rental business, Hewden (2008: eBit of $4.9 million), partially offset by a positive eBit of $19.6 million at the uK dealership (2008: $48.7 million). Management has initiated a strategic review of Hewden in 2009 which is progressing according to plan. one option is to continue with the implementation of a recovery plan to drive operational improvement at Hewden which is progressing well. the second option is to dispose of the Hewden operation and, as a result of exploring alternatives, the company has received expressions of interest from a number of parties. the company continues to explore both options and anticipates a decision by the end of the second quarter of 2010 which will be driven by the need to optimize shareholder value. 2009 finning international inc. | 33 | ManageMent’s Discussion & analysis Corporate and Other Operations for years ended December 31 ($ Millions) operating costs – corporate gain (loss) from equity investment ltiP mark-to-market Depreciation and amortization other expenses (income) information technology system implementation costs other income – gain on sale of property, partly offset by restructuring costs earnings before interest and taxes 2009 (22.9) (2.4) (0.1) (0.2) (25.6) (0.3) 1.0 (24.9) $ $ $ $ 2008 (25.8) 0.8 (21.7) (0.2) (46.9) (1.3) – (48.2) for the year ended December 31, 2009, corporate operating costs decreased to $22.9 million compared with $25.8 million in 2008 due to efforts by management to reduce costs and improve efficiencies. loss from equity investment in 2009 is from the company’s investment in energyst B.v., reflecting reduced activity levels as a result of the economic downturn in europe. in response to the downturn, energyst’s management has taken steps to reduce its cost structure and improve the operating performance of its european depot network, including downsizing its rental fleet. those actions are anticipated to improve profitability going forward. the company entered into a compensation hedge at the end of 2007 in order to offset the mark-to-market impact relating to certain stock-based compensation plans. the long-term incentive plan (ltiP) expense or income recorded at the corporate level primarily reflects the fair value impact of the compensation hedge in total. this amount primarily offsets the ltiP mark-to-market gains or losses recorded by the operating companies. other income for 2009 included a $1.7 million pre-tax gain on the sale of a property. in addition, the company incurred costs related to the ongoing implementation of a new information technology system for the company’s global operations. gooDwill impairment goodwill is assessed for impairment at the reporting unit level at least annually or as warranted by events or circumstances. any potential goodwill impairment is identified by comparing the fair value of a reporting unit to its carrying value. if the fair value of the reporting unit exceeds its carrying value, goodwill is considered not to be impaired. if the carrying value of the reporting unit exceeds its fair value, a more detailed assessment must be undertaken to determine the fair value of goodwill. a goodwill impairment charge is recognized to the extent that, at the reporting unit level, the carrying value of goodwill exceeds its fair value. the company determines the fair value of its reporting units using a discounted cash flow model corroborated by other valuation techniques such as market multiples. the process of determining these fair values requires management to make estimates and assumptions including, but not limited to, projected future sales, earnings and capital investment, discount rates, and terminal growth rates. Projected future sales, earnings, and capital investment are consistent with strategic plans presented to the company’s Board of Directors. Discount rates are based on an industry weighted average cost of capital. these estimates are subject to change due to uncertain competitive and economic market conditions or changes in business strategies. During the year, the company performed its annual goodwill impairment tests and determined that goodwill was not impaired at December 31, 2009. in 2008, the company determined that the carrying value of goodwill established on the acquisition of Hewden in 2001 exceeded its respective fair value. as a result, in 2008, the company recorded in other expenses a full goodwill impairment charge of $151.4 million. the company did not expect an income tax deduction from this non-cash goodwill impairment charge. the determination that the fair value of goodwill was less than its carrying value resulted from a decline in market multiples. it was also due to a reduction of fair value as determined using the discounted cash flow methodology, primarily due to a change in market assumptions principally from the increasing economic uncertainty in the global market. 34 ManageMent’s Discussion & analysis liQuiDity anD capital resources Management of the company assesses liquidity in terms of finning’s ability to generate sufficient cash flow, along with other sources of liquidity including cash and borrowings, to fund its operations and growth in operations. net cash flow is affected by the following items: • • • operating activities, including the level of accounts receivable, inventories, accounts payable, rental equipment, and financing provided to customers; investing activities, including capital expenditures, acquisitions of complementary businesses, and divestitures of non-core businesses; and external financing, including bank credit facilities, commercial paper, long-term debt, and other capital market activities, providing both short and long-term financing. Cash Flow from Operating Activities for the year ended December 31, 2009, cash flow after working capital changes was $546.4 million, compared with $278.1 million generated in 2008. throughout all operations, management has focused on improving cash cycle times and operating efficiencies while ensuring appropriate levels of working capital exist to support current activity levels. as a result, the company’s working capital investment in 2009 was $458.7 million lower compared with the prior year. the company generated proceeds on the disposal of rental assets in excess of additions in the amount of $43.2 million in 2009, compared with a net investment in rental assets of $204.8 million in 2008. this was an improvement from management’s annual guidance of under $50 million net investment spend in rental assets due to significant efforts by management to minimize rental fleet additions and dispose of underutilized assets. as a result of this focus on reducing rental expenditures and lower market demand, rental investment reduced significantly compared to 2008, particularly at the company’s canadian and Hewden operations. as a result of these items, cash flow provided by operating activities was $562.4 million in 2009, a significant improvement when compared to cash provided by operating activities of $72.7 million in 2008. eBitDa was $474.7 million in 2009 compared to $712.5 million in 2008, after excluding the 2008 goodwill impairment charge noted above. the company’s free cash flow generated in 2009 was $493.9 million compared to $23.2 million in 2008. the 2009 annual free cash flow exceeded management’s estimate provided in the third quarter of 2009 of close to $400 million due to a higher than expected level of collections from customers late in the year. all of finning’s operations have seen significant improvements in the generation of free cash flow compared to the same period in the prior year. improvements to working capital levels to align with demand and a reduction of rental equipment investments have more than offset lower earnings. Management anticipates generating positive free cash flow greater than $200 million in 2010 from continued disciplined and closely managed working capital management and strategic investments in capital and rental expenditures. this free cash flow is expected to be used for dividend payments and to continue to reduce debt as appropriate. the company’s Debt ratio (net debt to total capitalization ratio) at December 31, 2009 was 39.3%, and is expected to be in the mid 30% range by year end 2010. Cash Used For Investing Activities net cash used in investing activities in 2009 totalled $48.4 million compared with $198.1 million in 2008. the primary use of cash in 2008 related to the acquisition of collicutt for $135.8 million, net of cash received. in 2008, the company also increased its investment in energyst B.v. by $11.5 million, and acquired one cat rental store for $1.3 million. gross capital additions for the year ended December 31, 2009 were $107.8 million which is slightly higher compared with $100.4 million in 2008. capital additions in 2009 and 2008 reflect general capital spending to support operations. capital additions in 2009 included capitalized costs of $11.8 million related to the company’s new global it system (2008: $11.9 million). the company has committed to pay approximately $11 million over the next year for consulting and implementation support for the new global it system. all capital spending is being monitored closely by management. in 2009, the company paid approximately $12.3 million on the settlement of foreign currency swaps, and received proceeds of $32.3 million on the settlement of a cross currency interest rate swap, that was partially hedging the company’s investment in a foreign subsidiary. the company’s planned net capital expenditures for 2010 are projected to be in the range of $75 million to $100 million. net rental additions for 2010 are projected to be in the $100 million to $150 million range. the company believes that internally generated cash flow, supplemented by borrowing from existing financing sources, if necessary, will be sufficient to meet anticipated capital expenditures and other cash requirements in 2010. Management believes that the 2010 results will continue to generate strong cash flows as working capital requirements, capital expenditures, and investment in rental fleets continue to be actively managed. at this time, the company does not reasonably expect any presently known trend or uncertainty to affect its ability to access its historical sources of cash. 2009 finning international inc. | 35 | ManageMent’s Discussion & analysis Financing Activities as at December 31, 2009, the company’s short and long-term borrowings totalled $1.2 billion, a decrease of $0.4 billion, or 26.7%, from December 31, 2008, mainly as a result of strong free cash flow generation. to complement the internally generated funds from operating and investing activities, the company has approximately $1.2 billion in unsecured credit facilities. included in this amount, finning has committed bank facilities totalling approximately $955 million with various canadian, u.s., u.K., and south american financial institutions. the largest of these facilities, an $800 million global credit facility, matures in December 2011. as at December 31, 2009 approximately $725 million was available under these committed facilities and no long-term debt matures until December 2011. Based upon the availability of these facilities, the company’s business operating plans, and the discretionary nature of some of the outflows like rental and capital expenditures, the company believes it has sufficient liquidity to meet its operational needs. longer-term capital resources are provided by direct access to capital markets. the company is rated by both standard & Poor’s (s&P) and Dominion Bond rating service (DBrs). in 2009, the company’s long-term debt ratings were reconfirmed at a (low) by DBrs and BBB+ by s&P. the company’s short-term debt rating was reconfirmed by DBrs at r-1 (low). the company continues to utilize the canadian commercial paper market as well as borrowings under its credit facilities as its principal sources of short-term funding. the company’s commercial paper program is backstopped by the global credit facility. the maximum authorized limit of the company’s commercial paper program is $600 million. Dividends paid to shareholders in 2009 were $75.0 million, an increase of $1.0 million compared to 2008. the company had a share repurchase program in place until July 8, 2009. the company did not repurchase any common shares during 2009. for the year ended December 31, 2008, the company repurchased and cancelled 5,901,842 common shares at an average price of $24.99 for an aggregate amount of $147.5 million. in May 2008, the company issued two unsecured Medium term notes (Mtn). the 5-year, $250 million Mtn has a coupon interest rate of 5.16% per annum, payable semi-annually commencing september 3, 2008. the 10-year, $350 million Mtn has a coupon interest rate of 6.02% per annum, payable semi-annually commencing December 1, 2008. Proceeds from these issuances were used for debt repayment, including the repayment of the company’s $200 million 7.40% Mtn which matured in June 2008 as well as outstanding commercial paper borrowings. financing activities in 2008 also included a payment of $8.9 million on the settlement of a derivative that hedged future cash flows associated with the new Mtn issuances noted above. the company’s overall Debt ratio was 39.3% at the end of 2009, compared with 48.9% at the end of 2008. this ratio is lower than the prior year due to the strong free cash flow generation which contributed to the reduction in overall debt levels. Contractual Obligations Payments on contractual obligations in each of the next five years and thereafter are as follows: ($ Millions) 2010 2011 2012 2013 2014 thereafter total long-term debt – principal repayment – interest operating leases capital leases total contractual obligations $ $ 24.2 52.5 71.1 8.1 155.9 $ $ 168.0 52.3 56.6 2.2 279.1 $ $ – 45.2 39.4 1.2 85.8 $ $ 475.3 44.9 28.4 1.1 549.7 $ $ – 21.1 20.2 1.1 42.4 $ $ 348.4 94.8 137.9 13.7 594.8 $ 1,015.9 310.8 353.6 27.4 $ 1,707.7 the above table does not include obligations to fund pension benefits, although the company is making regular contributions to its registered defined benefit pension plans in canada and the uK in order to fund the pension plans as required. contribution requirements are based on periodic (at least triennial) actuarial funding valuations performed by the company’s (or plan trustees’) actuaries. for 2009, approximately $43 million was contributed towards the company’s defined benefit pension plans. currently, the company is expecting a higher level of required defined benefit plan contributions for 2010, at approximately $50-$55 million, as a result of changes in the global financial markets in the latter part of 2008. However, the actual level of contribution requirements for 2010 and the years that follow for the canadian and Hewden plans will not be known until later in 2010 following the completion of the December 31, 2009 canadian actuarial valuations and the December 31, 2008 Hewden actuarial valuation. Management anticipates any increase in funding requirements will be manageable. 36 ManageMent’s Discussion & analysis Employee Share Purchase Plan the company has employee share purchase plans for its canadian and south american employees. under the terms of these plans, eligible employees may purchase common shares of the company in the open market at the then current market price. the company pays a portion of the purchase price to a maximum of 2% of employee earnings. at December 31, 2009, 68% and 2% of eligible employees in the company’s canadian and south american operations, respectively, were contributing to these plans. the company has an all employee share Purchase ownership Plan for its employees in finning (uK) and Hewden. under the terms of this plan, employees may contribute up to 10% of their salary to a maximum of £125.00 per month. the company will provide one common share, purchased in the open market, for every three shares the employee purchases. at December 31, 2009, 27% and 13% of eligible employees in finning (uK) and Hewden, respectively, were contributing to this plan. these plans may be cancelled by finning at any time. effective January 1, 2010, the company has suspended the matching share element of the employee share Purchase ownership Plan in finning (uK) and Hewden. accounting estiMates anD contingencies accounting, valuation anD reporting changes in the rules or standards governing accounting can impact our financial reporting. the company employs professionally qualified accountants throughout its finance group and all of the operating unit financial officers have a reporting relationship to the company’s chief financial officer (cfo). senior financial representatives are assigned to all significant projects that impact financial accounting and reporting systems. Policies are in place to ensure completeness and accuracy of reported transactions. Key transaction controls are in place, and there is a segregation of duties between transaction initiation, processing, and cash receipt or disbursement. accounting, measurement, valuation, and reporting of accounts, which involve estimates and / or valuations, are reviewed quarterly by the cfo and the audit committee of the Board of Directors. significant accounting and financial topics and issues are presented to and discussed with the audit committee. Management’s discussion and analysis of the company’s financial condition and results of operations are based on the company’s consolidated financial statements, which have been prepared in accordance with canadian gaaP. the company’s significant accounting policies are contained in note 1 to the consolidated financial statements. certain policies require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and disclosure of contingent assets and liabilities. these policies may require particularly subjective and complex judgements to be made as they relate to matters that are inherently uncertain and because the likelihood that materially different amounts could be reported under different conditions or using different assumptions. the company has discussed the development, selection, and application of its key accounting policies, and the critical accounting estimates and assumptions they involve, with the audit committee. the more significant estimates include: fair values for goodwill impairment tests, allowance for doubtful accounts, provisions for inventory obsolescence, reserves for warranty, provisions for income tax, the determination of employee future benefits, the useful lives of the rental fleet and related residual values, costs associated with maintenance and repair contracts, and provisions for restructuring costs. the company performs impairment tests on its goodwill balances on at least an annual basis or as warranted by events or circumstances. During the year, the company performed its assessment of goodwill by estimating the fair value of operations to which the goodwill relates using the present value of expected discounted future cash flows. the company determined that goodwill was not impaired at December 31, 2009. in 2008, the company determined that the fair value of its investment in Hewden was less than its book value, primarily due to the higher cost of capital assumptions in the valuation methodology, reflecting year-end market conditions. as a result, in 2008, the company recorded a full goodwill impairment charge of $151.4 million. the goodwill impairment charge was non-cash in nature and did not affect the company’s liquidity, cash flows from operating activities, or debt covenants and is not expected to have any adverse impact on future operations. Due to the size, complexity, and nature of the company’s operations, various legal and tax matters are pending. in the opinion of management, none of these matters are expected to have a material effect on the company’s consolidated financial position or results of operations. income taxes the company exercises judgment in estimating the provision for income taxes. Provisions for federal, provincial, and foreign taxes are based on the respective laws and regulations in each jurisdiction within which the company operates. these complex laws and regulations are potentially subject to different interpretation between the company and the respective tax authority. Due to the number of variables associated with the differing tax laws and regulations across the multiple jurisdictions, the precision and reliability of the resulting estimates are subject to uncertainties and may change as additional information becomes known. future income tax assets and liabilities comprise the tax effect of temporary differences between the carrying amount and tax basis of assets and liabilities as well as the tax effect of undeducted tax losses, and are measured according to the income tax law that is expected to apply when the asset is realized or liability settled. assumptions underlying the composition of future income tax assets and liabilities include estimates of future results of operations and the timing of reversal of temporary differences as well as the tax rates and laws in each respective jurisdiction at the time of the expected reversal. the composition of future income tax assets and liabilities is reasonably likely to change from period to period due to the uncertainties surrounding these assumptions. 2009 finning international inc. | 37 | ManageMent’s Discussion & analysis DescriPtion of non-gaaP Measures eBit is defined herein as earnings before interest expense, interest income, and income taxes. eBitDa is defined as earnings before interest, taxes, depreciation, and amortization. free cash flow is defined as cash flow provided by (used in) operating activities less net capital expenditures. eBit, eBitDa, and free cash flow are measures of performance utilized by management to measure and evaluate the financial performance of its operating segments. eBitDa and free cash flow are measures commonly reported and widely used by investors as an indicator of a company’s cash operating performance and ability to raise and service debt. eBitDa is also commonly regarded as an indirect measure of operating cash flow, a significant indicator of success for many businesses and is a common valuation metric. Management believes that these measures provide important information regarding the operational performance of the company’s business. By considering these measures in combination with the comparable gaaP measures set out below, management believes that shareholders are provided a better overall understanding of the company’s business and its financial performance during the relevant period than if they simply considered the gaaP measures alone. eBit, eBitDa, and free cash flow do not have any standardized meaning prescribed by gaaP and are therefore unlikely to be comparable to similar measures presented by other issuers. accordingly, these measures should not be considered as a substitute or alternative for net income or cash flow, in each case as determined in accordance with gaaP. a reconciliation between eBitDa, eBit, and net income is as follows: ($ Millions) 2009 2008 2009 2008 three months ended December 31 twelve months ended December 31 earnings before interest, taxes, depreciation, and amortization, excluding goodwill impairment goodwill impairment earnings before interest, taxes, depreciation, and amortization (eBitDa) Depreciation and amortization earnings before interest and income taxes (eBit) finance costs Provision for income taxes net income a reconciliation of free cash flow is as follows: ($ Millions) cash provided by (used in) operating activities additions to capital assets Proceeds on disposal of capital assets free cash flow risK ManageMent $ $ $ $ 89.1 – 89.1 (59.1) 30.0 (18.8) 5.1 16.3 $ $ 152.8 (151.4) 1.4 (85.9) (84.5) (21.7) (0.6) (106.8) three months ended December 31 2009 128.5 (18.6) 20.5 130.4 $ $ 2008 177.2 (31.6) 6.1 151.7 $ $ $ $ 474.7 – 474.7 (267.7) 207.0 (67.6) (8.6) 130.8 $ $ twelve months ended December 31 2009 562.4 (107.8) 39.3 493.9 $ $ 712.5 (151.4) 561.1 (324.4) 236.7 (83.6) (57.1) 96.0 2008 72.7 (100.4) 50.9 23.2 finning and its subsidiaries are exposed to market, financial, and other risks in the normal course of their business activities. the company has adopted an enterprise risk Management (erM) approach in identifying, prioritizing, and evaluating risks. this erM framework assists the company in managing business activities and risks across the organization in order to achieve the company’s strategic objectives. the company is dedicated to a strong risk management culture to protect and enhance shareholder value. the processes within finning’s risk management function are designed to ensure that risks are properly identified, managed, and reported. the company discloses all of its key risks in its most recent annual information form (aif) with key financial risks also included herein. on a quarterly basis, the company assesses all of its key risks and any changes to key financial or business risks are disclosed in the company’s quarterly MD&a. also on a quarterly basis, the audit committee reviews the company’s process with respect to risk assessment and management of key risks, including the company’s major financial risks and exposures and the steps taken to monitor and control such exposures. changes to the key risks are also reviewed by the audit committee. 38 ManageMent’s Discussion & analysis financial Derivatives the company uses or may use various financial instruments such as forward and swap foreign exchange contracts, interest rate swaps, and equity hedges, as well as non-derivative foreign currency debt to manage its foreign exchange exposures, interest rate exposures, and stock-based compensation expense exposures (see note 4 of the notes to the consolidated financial statements). the company uses derivative financial instruments only in connection with managing related risk positions and does not use them for trading or speculative purposes. the company continually evaluates and manages risks associated with financial derivatives, which includes counterparty credit exposure. financial risKs anD uncertainties liQuiDity risK liquidity risk is the risk that the company will not be able to meet its financial obligations as they fall due. the company’s approach to managing liquidity is to ensure, as far as possible, that it will have sufficient liquid financial resources to fund its operations and meet its commitments and obligations. the company maintains bilateral and syndicated bank credit facilities, a commercial paper program, continuously monitors actual and forecast cash flows, and manages maturity profiles of financial liabilities. undrawn credit facilities at December 31, 2009 were $1,012 million (2008: $660 million), of which approximately $725 million (2008: $300 million) relates to committed credit facility. the company believes that it has reasonable access to capital markets which is supported by its investment grade credit ratings. Financing Arrangements the company will require capital to finance its future growth and to refinance its outstanding debt obligations as they come due for repayment. if the cash generated from the company’s business, together with the credit available under existing bank facilities, is not sufficient to fund future capital requirements, the company will require additional debt or equity financing in the capital markets. the company’s ability to access capital markets on terms that are acceptable will be dependent upon prevailing market conditions, as well as the company’s future financial condition. further, the company’s ability to increase its debt financing may be limited by its financial covenants or its credit rating objectives. although the company does not anticipate any difficulties in raising necessary funds in the future, there can be no assurance that capital will be available on suitable terms and conditions, or that borrowing costs and credit ratings will not be adversely affected. in addition, the company’s current financing arrangements contain certain restrictive covenants that may impact the company’s future operating and financial flexibility. marKet risK Market risk is the risk that changes in market prices, such as foreign exchange rates and interest rates, will affect the company’s income or the fair value of its financial instruments. the objective of market risk management is to manage and control market risk exposures within acceptable parameters. the company buys and sells derivatives in the ordinary course of business, and also incurs financial liabilities, in order to manage market risks. all such transactions are carried out within the guidelines set by the company’s global Hedging Policy approved by the audit committee. Foreign Exchange Risk the company is geographically diversified, with significant investments in several different countries. the company transacts business in multiple currencies, the most significant of which are the u.s. dollar (usD), the canadian dollar (caD), the u.K. pound sterling (gBP), and the chilean peso (clP). as a result, the company has foreign currency exposure with respect to items denominated in foreign currencies. the main types of foreign exchange risk of the company can be categorized as follows: translation exposure the most significant foreign exchange impact on the company’s net income is the translation of foreign currency based earnings into canadian dollars each reporting period. all of the company’s foreign subsidiaries are considered self-sustaining and report their operating results in currencies other than the canadian dollar. therefore, exchange rate movements in the u.s. dollar and u.K. pound sterling relative to the canadian dollar will impact the consolidated results of the south american and u.K. operations in canadian dollar terms. in addition, the company’s canadian results are impacted by the translation of its u.s. dollar based earnings. to the extent practical, it is the company’s objective to manage its exposure to currency fluctuations arising from its foreign investments. the company has hedged a portion of its foreign investments through foreign currency denominated loans and, periodically, through other derivative contracts. any exchange gains or losses arising from the translation of the hedging instruments are recorded, net of tax, as an item of other comprehensive income and accumulated other comprehensive income. cumulative currency translation adjustments, net of gains or losses of the associated hedging instruments, are recognized in net income when there is a reduction in the company’s net investment in the self-sustaining foreign operation. 2009 finning international inc. | 39 | ManageMent’s Discussion & analysis transaction exposure Many of the company’s operations purchase, sell, rent, and lease products as well as incur costs in currencies other than their functional currency. this mismatch of currencies creates transactional exposure at the operational level, which may affect the company’s profitability as exchange rates fluctuate. the company’s competitive position may also be impacted as relative currency movements affect the business practices and/or pricing strategies of the company’s competitors. the company is also exposed to currency risks related to the future cash flows on its non-canadian denominated short and long term debt. to the extent practical, it is the company’s objective to manage the impact of exchange rate movements and volatility on its financial results. each operation manages the majority of its transactional exposure through sales pricing policies and practices. the company also enters into forward exchange contracts to manage residual mismatches in foreign currency cash flows. sensitivity to variances in Foreign exchange rates the sensitivity of the company’s net earnings to fluctuations in average annual foreign exchange rates is summarized in the table below. a 5% strengthening of the canadian dollar against the following currencies for a full year relative to the December 31, 2009 month end rates would increase / (decrease) net income by the amounts shown below. a 5% strengthening of the canadian dollar against the following currencies from the December 31, 2009 month end rates would increase / (decrease) other comprehensive income by the amounts shown below. this analysis assumes that all other variables, in particular volumes, relative pricing, interest rates, and hedging activities are unchanged. currency usD gBP clP December 31, 2009 month end rates 1.0466 1.6918 0.0021 net income ($ tHousanDs) $ $ $ (17,000) 1,000 1,700 other comprehensive income ($ tHousanDs) $ $ $ (22,100) (17,000) – the sensitivities noted above ignore the impact of exchange rate movements on other macroeconomic variables, including overall levels of demand and relative competitive advantages. if it were possible to quantify these impacts, the results would likely be different from the sensitivities shown above. Interest Rate Risk changes in market interest rates will cause fluctuations in the fair value or future cash flows of financial instruments. the company is exposed to changes in interest rates on its interest bearing financial assets including cash and cash equivalents, instalment notes receivable, and cross currency interest rate swaps. the short term nature of investments included in cash and cash equivalents limits the impact to fluctuations in fair value, but interest income earned will be impacted. instalment notes receivable bear interest at a fixed rate thus their fair value will fluctuate prior to maturity, but absent monetization, future cash flows do not change. the fair value of the company’s cross currency interest rate swap will be impacted by relative changes in interest rates related to the two swapped currencies. as interest rates related to the swap are fixed, future cash flows do not change. subsequent to December 31, 2009, the company settled its cross currency interest rate swap. the company is exposed to changes in interest rates on its interest bearing financial liabilities including short and long term debt and variable rate share forward (vrsf). the company’s debt portfolio comprises both fixed and floating rate debt instruments, with terms to maturity ranging up to eight years. floating rate debt due to its short term nature exposes the company to limited fluctuations in changes to fair value, but finance expense and cash flows will increase or decrease as interest rates change. the fair value of the company’s fixed rate debt obligations fluctuate with changes in interest rates, but absent early settlement, related cash flows do not change. for reporting purposes the company does not measure any fixed rate long-term debt at fair value. the company is exposed to future interest rates upon refinancing of any debt prior to or at maturity. the company pays floating interest rates on its vrsf. Both fair value and future cash flows are impacted by changes in interest rates. the company manages its interest rate risk by balancing its portfolio of fixed and floating rate debt, as well as managing the term to maturity of its debt portfolio. at certain times the company may utilize derivative instruments such as interest rate swaps to adjust the balance of fixed and floating rate debt. 40 ManageMent’s Discussion & analysis Commodity Prices the company’s revenues can be indirectly affected by fluctuations in commodity prices; in particular, changes in expectations of longer-term prices. in canada, commodity price movements in the forestry, metals, coal, and petroleum sectors can have an impact on customers’ demands for equipment and product support. in chile and argentina, significant fluctuations in the price of copper and gold can have similar effects, as customers base their capital expenditure decisions on the long-term price outlook for metals. in the u.K., changes to prices for thermal coal may impact equipment demand in that sector. significant fluctuations in commodity prices could result in a material impact on the company’s financial results. With significantly lower commodity prices, demand is reduced as development of new projects is slowed or stopped and production from existing projects can be curtailed, both leading to less demand for equipment. However, product support growth has been, and is expected to continue to be, important in mitigating the effects of downturns in the business cycle. finning’s product support revenues typically contribute higher gross margins than new equipment sales. creDit risK credit risk is the risk of financial loss to the company if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the company’s cash and cash equivalents, receivables from customers, instalment notes receivable, and derivative assets. credit risk associated with cash and cash equivalents is managed by ensuring that these financial assets are held with major financial institutions with strong investment grade ratings and by maintaining limits on exposures with any single institution. an ongoing review is performed to evaluate the changes in the credit rating of counterparties. the company has a large diversified customer base, and is not dependent on any single customer or group of customers. credit risk is minimized because of the diversification of the company’s operations as well as its large customer base and its geographical dispersion. although there is usually no significant concentration of credit risk related to the company’s position in trade accounts or notes receivable, the company does have a certain degree of credit exposure arising from its derivative instruments relating to counterparties defaulting on their obligations. However, the company minimizes this risk by ensuring there is no excessive concentration of credit risk with any single counterparty, by active credit monitoring, and by dealing only with major financial institutions that have a credit rating of at least a- from s&P and a (low) from DBrs. stocK-BaseD compensation risK stock-based compensation is an integral part of the company’s compensation program, and can be in the form of the company’s common shares or cash payments that reflect the value of the shares. since canadian gaaP require certain stock-based compensation plans accounted for as liability-based awards to be recorded at intrinsic value, compensation expense can vary as the price of the company’s common shares changes. the company has entered into a derivative contract to partly offset this exposure, called a vrsf. a 5% strengthening in the company’s share price as at December 31, 2009, all other variables remaining constant, would have increased net income by approximately $1.0 million as a result of revaluing the company’s vrsf with a 5% weakening having the opposite effect. this impact partially mitigates changes in the stock based compensation expense; as the company’s share price changes, the intrinsic value impact related to the stock-based compensation liability is partially offset by the fair value impact related to the vrsf. contingencies anD guarantees Due to the size, complexity, and nature of the company’s operations, various legal and tax matters are pending. in the opinion of management, these matters will not have a material effect on the company’s consolidated financial position or results of operations. the company enters into contracts with rights of return, in certain circumstances, for the repurchase of equipment sold to customers for an amount based on an estimate of the future value of the fair market price at that time. as at December 31, 2009, the total estimated value of these contracts outstanding is $164.4 million coming due at periods ranging from 2010 to 2016. the company’s experience to date has been that the equipment at the exercise date of the contract is worth more than the repurchase amount. the total amount recognized as a provision against these contracts is $0.8 million. for further information on the company’s contingencies, commitments, guarantees, and indemnifications, refer to notes 24 and 25 of the notes to the consolidated financial statements. 2009 finning international inc. | 41 | ManageMent’s Discussion & analysis controls anD ProceDures certification Disclosure controls anD proceDures Management is responsible for establishing and maintaining a system of controls and procedures over the public disclosure of financial and non-financial information regarding the company. such controls and procedures are designed to provide reasonable assurance that all relevant information is gathered and reported to senior management, including the chief executive officer (ceo) and chief financial officer (cfo), on a timely basis so that appropriate decisions can be made regarding public disclosure. the ceo and the cfo, together with other members of management, have designed the company’s disclosure controls and procedures in order to provide reasonable assurance that material information relating to the company and its consolidated subsidiaries would have been known to them, and by others, within those entities. the company has a Disclosure Policy and a Disclosure committee in place to mitigate risks associated with the disclosure of inaccurate or incomplete information, or failure to disclose required information. • • the Disclosure Policy sets out accountabilities, authorized spokespersons, and finning’s approach to the determination, preparation, and dissemination of material information. the policy also defines restrictions on insider trading and the handling of confidential information. a Disclosure committee, consisting of senior management and external legal counsel, review all financial information prepared for communication to the public to ensure it meets all regulatory requirements and is responsible for raising all outstanding issues it believes require the attention of the audit committee prior to recommending disclosure for that committee’s approval. internal control over Financial reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting. Management have designed internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with canadian gaaP. there has been no change in the design of the company’s internal control over financial reporting during the quarter ended December 31, 2009, that would materially affect, or is reasonably likely to materially affect, the company’s internal control over financial reporting. regular involvement of internal audit and quarterly reporting to the audit committee and the company’s external auditors assists in providing reasonable assurance that the objectives of the control system are met. While the officers of the company have designed the company’s disclosure controls and procedures and internal control over financial reporting, these controls and procedures may not prevent all errors and fraud. a control system, no matter how well conceived or operated, can only provide reasonable, not absolute, assurance that the objectives of the control system are met. evaluation oF eFFectiveness as required by national instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings (ni 52-109) issued by the canadian securities regulatory authorities, an evaluation of the design and testing of the effectiveness of the operation of the company’s disclosure controls and procedures and internal control over financial reporting were conducted as of December 31, 2009, by and under the supervision of management, including the ceo and cfo. in making the assessment of the effectiveness of the company’s disclosure controls and procedures and internal control over financial reporting, management used the criteria set forth by the committee of sponsoring organizations of the treadway commission (coso) in Internal Control – Integrated Framework. the evaluation included documentation review, enquiries, testing, and other procedures considered by management to be appropriate in the circumstances. Based on that evaluation, the ceo and cfo have concluded that the company’s disclosure controls and procedures and internal control over financial reporting were effective as of December 31, 2009. 42 ManageMent’s Discussion & analysis selecteD Quarterly inforMation ($ Millions, excePt for sHare anD oPtion Data) Q4 2009 Q3 Q2 Q1 Q4 2008 Q3 Q2 Q1 revenue(1) canada south america uK group total revenue net income (loss)(1)(2) Basic earnings (loss) per share(1)(2)(3) Diluted earnings (loss) per share(1)(2)(3) total assets(1) long-term debt current non-current total long-term debt(4) cash dividends paid per common share common shares outstanding (000’s)(3) options outstanding (000’s) $ 601.8 337.0 196.3 $ 1,135.1 16.3 $ $ 489.9 376.9 206.4 $ 1,073.2 21.7 $ $ 582.0 363.0 219.9 $ 1,164.9 47.8 $ $ 712.9 412.7 238.7 $ 1,364.3 45.0 $ $ 826.0 464.3 276.4 $ 1,566.7 $ (106.8) $ 748.9 389.7 324.6 $ 1,463.2 64.8 $ $ 849.1 340.7 341.5 $ 1,531.3 67.2 $ $ 792.9 306.9 330.4 $ 1,430.2 70.8 $ $ 0.10 $ 0.13 $ 0.28 $ 0.26 $ (0.63) $ 0.38 $ 0.39 $ 0.41 $ 0.10 $ 3,671.4 $ 0.13 $ 3,892.4 $ 0.28 $ 4,357.3 $ 0.26 $ 4,639.6 $ (0.62) $ 4,720.4 $ 0.37 $ 4,604.4 $ 0.39 $ 4,603.8 $ 0.40 $ 4,527.8 $ 24.2 991.7 $ 1,015.9 $ 23.9 1,013.8 $ 1,037.7 $ 2.6 1,206.4 $ 1,209.0 $ 2.6 1,437.3 $ 1,439.9 $ 2.6 1,410.7 $ 1,413.3 $ 2.5 1,313.1 $ 1,315.6 $ 100.5 1,121.8 $ 1,222.3 $ 215.9 605.7 $ 821.6 $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.10 170,747 6,299 170,661 6,537 170,631 6,606 170,545 5,807 170,445 6,037 171,356 6,200 172,692 6,343 172,623 4,576 (1) on January 15, 2008 the company’s canadian operations purchased collicutt energy services ltd. the results of operations and financial position of collicutt have been included in the figures above since the date of acquisition. (2) the company performed its annual goodwill impairment review in the fourth quarter of 2008 and determined that the fair value of Hewden was less than its book value, which included goodwill on acquisition. as a result, the company recorded a full goodwill impairment of $151.4 million for Hewden in the fourth quarter of 2008. the negative impact on basic earnings per share (ePs) for the fourth quarter of 2008 was $0.89 per share (diluted ePs: $0.88 per share). the goodwill impairment charge was non-cash in nature and did not affect the company’s liquidity, cash flows from operating activities, or debt covenants and is not expected to have any adverse impact on future operations. the company did not expect an income tax deduction from this charge. (3) During 2008, the company repurchased 5,901,842 common shares at an average price of $24.99 as part of a normal course issuer bid. earnings per share (ePs) for each quarter has been computed based on the weighted average number of shares issued and outstanding during the respective quarter; therefore, quarterly amounts may not add to the annual or year-to-date total. (4) in the second quarter of 2008, the company issued two unsecured Medium term notes (Mtn); a five year $250 million Mtn and a 10 year $350 million Mtn. Proceeds from these issuances were used for debt repayment, including the repayment of a $200 million Mtn which expired in June 2008 as well as outstanding commercial paper borrowings. 2009 finning international inc. | 43 | ManageMent’s Discussion & analysis neW accounting PronounceMents changes aDopteD in 2009 (i) Goodwill and Intangible Assets effective January 1, 2009, the company adopted section 3064, Goodwill and Intangible Assets, issued by the cica. the new standard replaces section 3062, Goodwill and Other Intangible Assets and section 3450, Research and Development Costs. the new pronouncement establishes standards for the recognition, measurement, presentation, and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit- oriented enterprises. the new standard does not have a material impact on the company’s consolidated financial statements. (ii) Financial Instruments Disclosures effective December 31, 2009, the company has adopted the amendments to section 3862, Financial Instruments – Disclosures, which are effective for annual financial statements for fiscal years ending after september 30, 2009, and which enhance current disclosure requirements for financial instruments, as discussed further in note 4 to the consolidated financial statements. these amendments require disclosure of additional details about fair value measurements, including the relative reliability of the inputs used in those measurements, and about the liquidity risk of financial instruments. Future accounting pronouncements (i) Business Combinations in January 2009, the cica issued section 1582, Business Combinations, section 1601, Consolidations, and section 1602, Non-controlling Interests. these new standards are harmonized with international financial reporting standards (ifrs). section 1582 specifies a number of changes, including: an expanded definition of a business, a requirement to measure all business acquisitions at fair value, a change in the basis of measurement of non- controlling interests, and a requirement to recognize acquisition-related costs as expenses. section 1601 establishes the standards for preparing consolidated financial statements. section 1602 specifies that non-controlling interests be treated as a separate component of equity, not as a liability or other item outside of equity. the new standards will become effective in 2011. effective January 1, 2010, the company early adopted sections 1582, 1601, and 1602 in accordance with the transitional provisions. the adoption of sections 1601 and 1602 is not expected to have a material impact on the company’s consolidated financial statements. Whether the company will be materially affected by the new recommendations of section 1582 will depend upon the specific facts of business combinations, if any, occurring subsequent to January 1, 2010. (ii) Convergence with International Financial Reporting Standards in february 2008, canada’s accounting standards Board confirmed that canadian gaaP, as used by public companies, will be converged with international financial reporting standards (ifrs) effective January 1, 2011. the transition from canadian gaaP to ifrs will be applicable for the company for the first quarter of 2011 when the company will prepare both the current and comparative financial information using ifrs. While ifrs uses a conceptual framework similar to canadian gaaP, there are significant differences on recognition, measurement, and disclosures. the company commenced its ifrs conversion project in late 2007. the project consists of four phases: raise awareness; assessment; design; and implementation. With the assistance of an external expert advisor, the company completed a high level review of the major differences between canadian gaaP and ifrs as applicable to the company. While a number of differences were identified, the areas of highest potential impact included property, plant and equipment, certain aspects of revenue recognition, income taxes, employee future benefits, stock- based compensation, presentation, and disclosure, as well as the initial selection of applicable transitional exemptions under the provisions of ifrs 1 first time adoption. the company has not identified any further areas subject to significant change during subsequent phases of the transition project. the conversion project is on schedule, and a timetable for developing the opening balance sheet and comparative information preparation is in place for 2010. all activities required to be complete prior to January 1, 2010 were completed, including designation of all hedging arrangements in an ifrs-compliant manner. 44 ManageMent’s Discussion & analysis the current focus of the project is the identification of local level impacts for the opening balance sheet in each of the company’s operations, and finalization of the ifrs 1 transitional exemptions to be taken. the following summary of opening balance sheet transitional provisions to be adopted and their likely impacts indicates the progress of our work in each topic area identified as having a potential high impact. it is not an exhaustive list; if further transitional elections are found to be beneficial to the transition process as the opening balance sheet preparation progresses, then such exemptions may be taken. • • • Property, plant, and equipment: no transitional elections will be taken. the company will retain assets at historical cost upon transition rather than taking the allowed election to recognize assets at fair value. Employee future benefits: any unamortized defined benefit pension plan actuarial gains and losses accumulated at January 1, 2010 will be recognized in retained earnings in accordance with the ifrs 1 transitional exemption. the company’s future accounting policy choice under ifrs with respect to defined benefit pension plans is not yet confirmed, as this is an area subject to ongoing standard-setting activity by the iasB. Stock based compensation: ifrs 2, share Based Payments, encourages application of its provisions to equity instruments granted on or before november 7, 2002, if fair value information about these instruments had previously been publicly disclosed. as the fair value of the company’s instruments had not been historically disclosed, the company will not restate share based payment balances in relation to fully vested awards of share based payments. an immaterial opening balance sheet adjustment will be made to account for unvested share based payment plans upon transition. in addition to the key areas outlined above, the use of the following additional transitional exemptions, available under ifrs 1, has also been agreed by management and the audit committee: • • • Borrowing costs: Borrowing costs will not be capitalized retrospectively and the company will only capitalize borrowing costs for those assets whose capitalization commencement date is after the date of transition (January 1, 2010). Business combinations: the company will not retrospectively restate any business combinations; ifrs 3 will be applied prospectively to acquisitions after January 1, 2010. this date is consistent with the company’s adoption of the cica’s revised sections for business combinations, consolidations, and non controlling interests. Cumulative translation adjustments: all cumulative translation adjustments and associated cumulative hedging gains and losses will be transferred to retained earnings from accumulated other comprehensive income upon transition. Management continues to monitor standards to be issued by the international accounting standards Board (iasB), but it is difficult to predict the ifrs that will be effective at the end of the company’s first ifrs reporting period, as the iasB work plan anticipates the completion of several projects in calendar years 2010 and 2011. their projects on employee benefits, leases, and financial instruments are especially relevant to the company, and management will be monitoring any changes to these standards closely. the company’s transition plan includes a comprehensive training plan; initial training sessions have been provided to key finance personnel and management in all geographic regions, and further in depth sessions will be provided to relevant personnel throughout the implementation process. the Board of Directors have also participated in a comprehensive education session. an investor communication plan is under development and communication activities with internal stakeholders are in place and will be ongoing throughout 2010 and 2011. Management has also begun to consider the impact of the transition on the company’s business practices, systems, and internal control over financial reporting and anticipate that the most significant impact of ifrs on its compliance programme will be with regards to financial reporting controls. earnings coverage ratio the following earnings coverage ratio is calculated for the twelve months ended December 31, 2009 and constitutes an update to the earnings coverage ratio described in the company’s short form base shelf prospectus dated May 5, 2008. twelve months ended December 31, 2009 earnings coverage ratio(1) 3.1 (1) the earnings coverage ratio is calculated by dividing: (a) the company’s earnings from continuing operations before interest and taxes for the period stated; by (b) finance costs incurred over the period stated. 2009 finning international inc. | 45 | ManageMent’s Discussion & analysis outstanDing sHare Data as at february 19, 2010 common shares outstanding options outstanding outlooK 170,858,800 6,152,726 in each of the company’s regions, new equipment order intake in the fourth quarter was the highest since 2008. the resulting growth in backlog is mainly driven by the mining sector. Quotation activity continues to be strong in the mining sector, and the company expects this to result in mining orders in 2010. in non-mining sectors, the company has limited visibility of future revenues. in the construction, forestry, and oil and gas sectors, there is an excess supply of dealer inventory and market weakness is expected to continue for several more quarters. Product support revenues continue to grow in the mining sector in all operations as the equipment sold in recent years remains highly utilized. in all regions, there is an increase in equipment rebuild work and related quoting activity for large mining equipment. in non-mining sectors, where some customers are deferring maintenance and some equipment remains idle, the company believes that a backlog of product support is being accumulated. increased economic activity is expected to result in further product support growth. in canada, product support revenues continue to grow in the mining industry. the company is experiencing increased demand for equipment and product support from oil sands, coal, and copper mine producers and contractors. incremental business from government funded infrastructure initiatives is expected to positively impact the construction sector towards the end of 2010 and into 2011. Demand for conventional oil and gas equipment remains soft and no rebound is expected until late 2010. in south america, the company is actively quoting to mining customers and receiving new orders for large mining equipment. at current copper and gold prices, the mining industry is expected to remain strong. construction and power systems activity is forecast to increase in chile and to be flat in argentina in 2010. Mining contracts are expected to continue to drive product support growth throughout 2010. non-mining equipment remained well-utilized throughout the economic downturn and will also contribute to ongoing product support growth in south america. in the uK, market conditions are expected to remain soft. the company sees opportunities with coal mines, quarries, and large infrastructure customers for new equipment sales and product support. opportunities in power systems remain strong as evident from the high level of quoting activity for projects in the energy, marine, and oil & gas sectors. at Hewden, while a strategic review is underway, management continues to improve operating performance. fleet utilization has increased, while pressure on rental rates continues due to overcapacity in the industry. Hewden’s cash flow remains positive. the strategic review of Hewden is progressing according to plan and, in exploring alternatives, the company is receiving expressions of interest from a number of parties. the conclusion of this review is expected by the end of the second quarter of 2010 and will be driven by the need to optimize shareholder value. in 2010, revenues are expected to be slightly below 2009, with lower new equipment sales partly offset by slightly higher product support revenues. sg&a expenses will continue to decrease, albeit at a slower pace than in 2009. as a result, we expect to see a modest improvement in eBit in 2010. on a consolidated basis, free cash flow in 2010 is expected to be in excess of $200 million. it will be lower than in 2009 as the company begins to purchase equipment to fill orders for mining customers and stock up certain models of other equipment for anticipated sales. the net debt to capital ratio is expected to be in the mid-30% range by the end of 2010. the company has targeted sg&a expense reductions of over $200 million in 2010 compared to 2008 expense levels and is on track to meet this goal. february 23, 2010 46 ManageMent’s Discussion & analysis selecteD annual inforMation ($ Millions, excePt for sHare Data) total revenue(1) net income (loss)(1)(2) before goodwill impairment goodwill impairment from continuing operations from discontinued operations total net income Basic earnings (loss) per share(1)(2)(3) before goodwill impairment goodwill impairment from continuing operations from discontinued operations total basic ePs Diluted earnings (loss) per share(1)(2)(3) before goodwill impairment goodwill impairment from continuing operations from discontinued operations total diluted ePs total assets(1) long-term debt(4) current non-current cash dividends declared per common share 2009 4,737.5 130.8 – 130.8 – 130.8 0.77 – 0.77 – 0.77 0.77 – 0.77 – 0.77 3,671.4 24.2 991.7 1,015.9 0.44 $ $ $ $ $ $ $ $ $ $ 2008 5,991.4 247.4 (151.4) 96.0 – 96.0 1.44 (0.88) 0.56 – 0.56 1.43 (0.88) 0.55 – 0.55 4,720.4 2.6 1,410.7 1,413.3 0.43 $ $ $ $ $ $ $ $ $ $ 2007 5,662.2 280.1 – 280.1 (2.0) 278.1 1.57 – 1.57 (0.01) 1.56 1.55 – 1.55 (0.01) 1.54 4,134.2 215.7 590.4 806.1 0.36 $ $ $ $ $ $ $ $ $ $ (1) on July 31, 2007, the company’s u.K. subsidiary, Hewden stuart Plc, sold its tool Hire Division. results from the tool Hire Division qualify as discontinued operations and have been reclassified to that category for all periods presented. included in the loss from discontinued operations in 2007 is the after-tax gain on the sale of the tool Hire Division of $0.1 million. revenues and assets from the uK tool Hire Division have been excluded from the figures above. on January 15, 2008 the company’s canadian operations purchased collicutt energy services ltd. the results of operations and financial position of collicutt have been included in the figures above since the date of acquisition. (2) the company performed its annual goodwill impairment review in the fourth quarter of 2008 and determined that the fair value of Hewden was less than its book value, which included goodwill on acquisition. as a result, the company recorded a full goodwill impairment charge of $151.4 million for Hewden in the fourth quarter of 2008. the goodwill impairment charge was non-cash in nature and did not affect the company’s liquidity, cash flows from operating activities, or debt covenants and is not expected to have any adverse impact on future operations. the company did not expect an income tax deduction from this charge. (3) During 2008, the company repurchased 5,901,842 common shares at an average price of $24.99 as part of a normal course issuer bid. During 2007, 3,691,400 common shares were repurchased at an average price of $27.82. (4) in 2008, the company issued two unsecured Medium term notes (Mtn); a five year $250 million Mtn and a 10 year $350 million Mtn. Proceeds from these issuances were used for debt repayment, including the repayment of a $200 million Mtn which expired in June 2008 as well as outstanding commercial paper borrowings. 2009 finning international inc. | 47 | ManageMent’s Discussion & analysis forWarD-looKing DisclaiMer this report contains statements about the company’s business outlook, objectives, plans, strategic priorities and other statements that are not historical facts. a statement we make is forward-looking when it uses what we know and expect today to make a statement about the future. forward-looking statements may include words such as aim, anticipate, assumption, believe, could, expect, goal, guidance, intend, may, objective, outlook, plan, project, seek, should, strategy, strive, target, and will. forward-looking statements in this report include, but are not limited to, statements with respect to: expectations with respect to the economy and associated impact on the company’s financial results; the estimated annualized cost savings and anticipated restructuring charges related to actions taken by the company in response to the economic downturn; the potential outcome of the company’s strategic review of Hewden; expected revenue and eBit growth; anticipated effective tax rate; anticipated generation of free cash flow (including projected net capital and rental expenditures), and its expected use; anticipated defined benefit plan contributions; and expected target range of Debt ratio. all such forward-looking statements are made pursuant to the ‘safe harbour’ provisions of applicable canadian securities laws. unless otherwise indicated by us, forward-looking statements in this report describe our expectations at february 23, 2010. except as may be required by canadian securities laws, we do not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise. forward-looking statements, by their very nature, are subject to numerous risks and uncertainties and are based on several assumptions which give rise to the possibility that actual results could differ materially from our expectations expressed in or implied by such forward-looking statements and that our business outlook, objectives, plans, strategic priorities and other statements that are not historical facts may not be achieved. as a result, we cannot guarantee that any forward-looking statement will materialize. factors that could cause actual results or events to differ materially from those expressed in or implied by our forward-looking statements include: general economic and credit market conditions; foreign exchange rates; commodity prices; the level of customer confidence and spending, and the demand for, and prices of, our products and services; our dependence on the continued market acceptance of caterpillar’s products and caterpillar’s timely supply of parts and equipment; our ability to continue to implement our cost reduction initiatives while continuing to maintain customer service; the intensity of competitive activity; our ability to raise the capital we need to implement our business plan; regulatory initiatives or proceedings, litigation and changes in laws or regulations; stock market volatility; changes in political and economic environments for operations outside canada; with respect to Hewden, not being successful in generating the expected improvements in the underlying business performance or not being able to successfully negotiate and complete a transaction on terms acceptable to the company or at all. forward-looking statements are provided in this report for the purpose of giving information about management’s current expectations and plans and allowing investors and others to get a better understanding of our operating environment. However, readers are cautioned that it may not be appropriate to use such forward-looking statements for any other purpose. forward-looking statements made in this report are based on a number of assumptions that we believed were reasonable on the day we made the forward-looking statements. refer in particular to the Market outlook section of the MD&a. some of the assumptions, risks, and other factors which could cause results to differ materially from those expressed in the forward-looking statements contained in this report are discussed in the company’s current annual information form (aif) in section 4. We caution readers that the risks described in the aif are not the only ones that could impact us. additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also have a material adverse effect on our business, financial condition, or results of operations. except as otherwise indicated by us, forward-looking statements do not reflect the potential impact of any non-recurring or other unusual items or of any dispositions, mergers, acquisitions, other business combinations or other transactions that may be announced or that may occur after the date hereof. the financial impact of these transactions and non-recurring and other unusual items can be complex and depends on the facts particular to each of them. We therefore cannot describe the expected impact in a meaningful way or in the same way we present known risks affecting our business. 48 ManageMent’s rePort to tHe sHareHolDers the accompanying consolidated financial statements and Management’s Discussion and analysis (MD&a) are the responsibility of finning international inc.’s management. the consolidated financial statements have been prepared in accordance with accounting principles generally accepted in canada which recognize the necessity of relying on some of management’s best estimates and informed judgements. the company maintains an accounting system and related controls to provide management with reasonable assurance that transactions are executed and recorded in accordance with its authorizations, that assets are properly safeguarded and accounted for, and that financial records are reliable for preparation of financial statements. the company’s independent auditors, Deloitte & touche llP, have audited the consolidated financial statements, as reflected in their report for 2009. the Board of Directors oversees management’s responsibilities for the consolidated financial statements primarily through the activities of its audit committee. the audit committee of the Board of Directors is composed solely of directors who are neither officers nor employees of the company. the committee meets regularly during the year with management of the company and the company’s independent auditors to review the company’s interim and annual financial statements and MD&a. the audit committee also reviews internal accounting controls, risk management, internal and external audit results, and accounting principles and practices. the audit committee is responsible for approving the remuneration and terms of engagement of the company’s independent auditors. the audit committee also meets with the independent auditors, without management present, to discuss the results of their audit and the quality of financial reporting. on a quarterly basis, the audit committee reports its findings to the Board of Directors, and recommends approval of the interim and annual consolidated financial statements. the consolidated financial statements and MD&a have, in management’s opinion, been properly prepared within reasonable limits of materiality and within the framework of the accounting policies summarized in note 1 of the notes to the consolidated financial statements. M.t. Waites President and chief executive officer february 23, 2010 vancouver, Bc, canada D.s. smith executive vice President and chief financial officer 2009 finning international inc. | 49 | auDitors’ rePort to the shareholDers oF Finning international inc. We have audited the consolidated balance sheets of finning international inc. as at December 31, 2009 and 2008 and the consolidated statements of income, comprehensive income, shareholders’ equity and cash flow for the years then ended. these financial statements are the responsibility of the company’s management. our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with canadian generally accepted auditing standards. those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. an audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. an audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. in our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at December 31, 2009 and 2008, and the results of its operations and its cash flows for the years then ended in accordance with canadian generally accepted accounting principles. Deloitte & toucHe llP, chartered accountants february 23, 2010 vancouver, Bc, canada 50 consoliDateD stateMents of incoMe for years ended December 31 ($ tHousanDs, excePt sHare anD Per sHare aMounts) revenue new equipment used equipment equipment rental Product support other total revenue cost of sales gross profit 2009 2008 $ 1,984,727 337,806 510,439 1,892,571 11,998 4,737,541 3,407,972 1,329,569 $ 2,928,643 431,804 712,791 1,899,483 18,704 5,991,425 4,318,542 1,672,883 selling, general, and administrative expenses 1,085,035 1,267,963 other expenses (income) (note 2) goodwill impairment (note 16) earnings before interest and income taxes finance costs (notes 3 and 4) income before provision for income taxes Provision for income taxes (note 6) net income earnings per share (note 9) Basic Diluted Weighted average number of shares outstanding Basic Diluted 37,514 – 207,020 67,608 139,412 8,589 130,823 0.77 0.77 $ $ $ 16,801 151,373 236,746 83,636 153,110 57,114 95,996 0.56 0.55 $ $ $ 170,607,892 170,993,485 172,361,881 173,318,957 the accompanying notes to the consolidated financial statements are an integral part of these statements. 2009 finning international inc. | 51 | 2009 2008 $ 197,904 622,641 62,563 993,523 207,030 2,083,661 32,604 691,120 482,777 41,469 94,254 245,550 $ 3,671,435 $ 162,238 749,941 8,624 24,179 944,982 991,732 110,147 108,888 2,155,749 $ $ $ 109,772 840,810 102,607 1,473,504 288,102 2,814,795 11,671 987,835 470,859 38,344 99,278 297,593 4,720,375 193,635 1,316,818 3,187 2,643 1,516,283 1,410,727 96,296 129,965 3,153,271 557,052 33,509 (293,869) 1,218,994 1,515,686 $ 3,671,435 554,966 25,441 (176,444) 1,163,141 1,567,104 4,720,375 $ consoliDateD Balance sHeets December 31 ($ tHousanDs) assets current assets cash and cash equivalents (note 19) accounts receivable service work in progress inventories (note 10) other assets (note 11) total current assets finance assets (note 12) rental equipment (note 13) land, buildings, and equipment (note 14) intangible assets (note 14) goodwill (note 16) other assets (note 11) liaBilities current liabilities short-term debt (note 3) accounts payable and accruals income tax payable current portion of long-term debt (note 3) total current liabilities long-term debt (note 3) long-term obligations (note 17) future income taxes (note 6) total liabilities commitments and contingencies (notes 23 and 24) shareholDers’ eQuity share capital (note 7) contributed surplus accumulated other comprehensive loss retained earnings total shareholders’ equity approved by the Directors: M.t. Waites, Director D.W.g. Whitehead, Director the accompanying notes to the consolidated financial statements are an integral part of these statements. 52 consoliDateD stateMents of coMPreHensive incoMe for years ended December 31 ($ tHousanDs) net income other comprehensive income (loss), net of income tax currency translation adjustments unrealized gains on net investment hedges tax recovery (expense) on net investment hedges foreign currency translation and gain (losses) on net investment hedges unrealized gains (losses) on cash flow hedges realized losses on cash flow hedges, reclassified to earnings tax recovery (expense) on cash flow hedges gains (losses) on cash flow hedges 2009 2008 $ 130,823 $ 95,996 (165,606) 55,594 (18,040) (128,052) 10,318 2,657 (2,348) 10,627 60,536 496 1,658 62,690 (11,851) 1,565 3,375 (6,911) comprehensive income $ 13,398 $ 151,775 consoliDateD stateMents of sHareHolDers’ eQuity accumulated other comprehensive income (loss) ($ tHousanDs, excePt sHare aMounts) shares amount share capital contributed surplus foreign currency translation and gains/(losses) on net investment Hedges gains/ (losses) on cash flow Hedges retained earnings total Balance, January 1, 2008 comprehensive income (loss) issued on exercise of stock options issued for acquisition (note 15) repurchase of common shares (note 7) stock option expense Dividends on common shares 176,131,879 – 199,627 15,403 $ 571,402 – 2,260 398 $ 15,356 – (341) 65 $ (223,661) $ 62,690 – – (8,562) $ 1,269,544 $ 1,624,079 151,775 95,996 (6,911) 1,919 – – 463 – – (5,901,842) – – (19,094) – – – 10,361 – – – – – – – (128,402) – (73,997) (147,496) 10,361 (73,997) Balance, December 31, 2008 comprehensive income (loss) issued on exercise of stock options stock option expense Dividends on common shares Balance, December 31, 2009 170,445,067 – 301,733 – – 170,746,800 $ 554,966 – 2,086 – – $ 557,052 $ 25,441 – (121) 8,189 – $ 33,509 $ (160,971) $ (15,473) $ 1,163,141 $ 1,567,104 13,398 (128,052) 130,823 1,965 – – – 8,189 – (74,970) – (74,970) (4,846) $ 1,218,994 $ 1,515,686 10,627 – – – $ (289,023) $ the accompanying notes to the consolidated financial statements are an integral part of these statements. 2009 finning international inc. | 53 | consoliDateD stateMents of casH floW for years ended December 31 ($ tHousanDs) operating activities net income add items not affecting cash Depreciation and amortization future income taxes stock-based compensation gain on disposal of capital assets (note 2) goodwill impairment other changes in working capital items (note 19) cash provided after changes in working capital items rental equipment, net of disposals equipment leased to customers, net of disposals cash flow provided by operating activities investing activities additions to capital assets Proceeds on disposal of capital assets Proceeds on settlement of derivatives acquisition of businesses (notes 11,15 and 16) cash used in investing activities Financing activities increase (decrease) in short-term debt increase (decrease) in long-term debt Payment on settlement of derivative issue of common shares on exercise of stock options repurchase of common shares (note 7) Dividends paid cash provided by (used in) financing activities effect of currency translation on cash balances increase in cash and cash equivalents cash and cash equivalents, beginning of year cash and cash equivalents, end of year see supplemental cash flow information, note 19 2009 2008 $ 130,823 $ 95,996 271,107 (7,685) 11,520 (18,313) – 1,632 389,084 157,310 546,394 43,166 (27,203) 562,357 (107,808) 39,342 20,020 – (48,446) 7,663 (344,477) – 1,965 – (74,970) (409,819) (15,960) 88,132 109,772 197,904 $ 326,095 9,822 16,924 (19,892) 151,373 (816) 579,502 (301,369) 278,133 (204,800) (652) 72,681 (100,417) 50,954 – (148,639) (198,102) (198,147) 589,861 (8,914) 1,919 (147,496) (73,997) 163,226 10,107 47,912 61,860 109,772 $ the accompanying notes to the consolidated financial statements are an integral part of these statements. 54 notes to tHe consoliDateD financial stateMents December 31, 2009 and 2008 1. SIGNIFICANT ACCOUNTING POLICIES these consolidated financial statements have been prepared in accordance with canadian generally accepted accounting principles (gaaP) and are presented in canadian dollars, unless otherwise stated. the significant accounting policies used in these consolidated financial statements are as follows: (A) PRINCIPlES OF CONSOlIDAtION the consolidated financial statements include the accounts of finning international inc. (“finning” or “company”), which includes the finning (canada) division, finning’s wholly owned subsidiaries, and its proportionate share of joint venture investments. Principal operating subsidiaries include finning (uK) ltd., finning chile s.a., Hewden stuart plc (“Hewden”), finning argentina s.a., finning soluciones Mineras s.a., finning uruguay s.a., and finning Bolivia s.a. the company’s principal joint ventures are oeM remanufacturing company inc., in which finning owns 100% of the voting shares, and Pipeline Machinery international (PlM), in which finning has a 25% interest. for interests acquired or disposed of during the year, the results of operations are included in the consolidated statements of income from, or up to, the date of the transaction, respectively. (B) USE OF EStImAtES the preparation of consolidated financial statements in accordance with canadian gaaP requires the company’s management to make estimates and assumptions about future events that affect the reported amounts of assets, liabilities, revenues, expenses, and disclosure of contingent assets and liabilities. actual amounts may differ from those estimates. significant estimates used in the preparation of these consolidated financial statements include, but are not limited to, fair values for goodwill impairment tests, allowance for doubtful accounts, provisions for inventory obsolescence, reserves for warranty, provisions for income tax, the determination of employee future benefits, the useful lives of the rental fleet and related residual values, costs associated with maintenance and repair contracts, asset retirement obligations, and provisions for restructuring costs. (C) FOREIGN CURRENCy tRANSlAtION transactions undertaken in foreign currencies are translated into canadian dollars at exchange rates prevailing at the time the transactions occurred. account balances denominated in foreign currencies are translated into canadian dollars as follows: • • Monetary assets and liabilities are translated at exchange rates in effect at the balance sheet dates and non-monetary items are translated at historical exchange rates. exchange gains and losses are included in income except where the exchange gain or loss arises from the translation of monetary items designated as hedges, in which case the gain or loss is deferred and accounted for in conjunction with the hedged asset. financial statements of foreign operations, all considered self-sustaining, are translated from the functional currency of the foreign operation into canadian dollars as follows: • • • assets and liabilities are translated using the exchange rates in effect at the balance sheet dates. revenue and expense items are translated at average exchange rates prevailing during the period that the transactions occurred. unrealized translation gains and losses are recorded as an item of other comprehensive income and accumulated other comprehensive income. cumulative currency translation adjustments are recognized in net income when there is a reduction in the net investment in the self-sustaining foreign operation. the company has hedged some of its investments in foreign subsidiaries using derivatives and foreign currency denominated borrowings. exchange gains or losses arising from the translation of these hedging instruments are accounted for as items of other comprehensive income and presented in the accumulated other comprehensive loss account on the consolidated balance sheet. these exchange gains or losses are recognized in net income when there is a reduction in the net investment in the self-sustaining foreign operation. (D) CASh AND CASh EqUIvAlENtS short-term investments, consisting of highly rated and liquid money market instruments with original maturities of three months or less, are considered to be cash equivalents and are recorded at fair value, which approximates cost. (E) INvENtORIES inventories are assets held for sale in the ordinary course of business, in the process of production for sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of services. inventories are stated at the lower of cost and net realizable value. cost is determined on a specific item basis for on-hand equipment, and on a weighted average cost basis for parts and supplies. the cost of inventories includes all costs of purchase, conversion costs, and other costs incurred in bringing inventories to their existing location and condition. in the case of internal service work in progress on equipment, cost includes an appropriate share of overhead costs based on normal operating capacity. 2009 finning international inc. | 55 | notes to tHe consoliDateD financial stateMents 1. SIGNIFICANT ACCOUNTING POLICIES (continued) (F) OthER ASSEtS investments in which the company exercises significant influence, but not control, are accounted for using the equity method. a long-term investment is considered impaired if its fair value falls below its cost, and the decline is considered other than temporary. (G) INCOmE tAxES the asset and liability method of tax allocation is used in accounting for income taxes. under this method, temporary differences arising from the difference between the tax basis of an asset and a liability and its carrying amount on the balance sheet are used to calculate future income tax assets or liabilities. future income tax assets or liabilities are calculated using tax rates anticipated to be in effect in the periods that the temporary differences are expected to reverse. the effect of a change in income tax rates on future income tax assets and liabilities is recognized in income in the period that the change becomes substantively enacted. (h) FINANCE ASSEtS finance assets comprise instalment notes receivable and equipment leased to customers on long-term financing leases. instalment notes receivable represents amounts due from customers relating to financing of equipment sold and parts and service sales. these receivables are recorded net of unearned finance charges. Depreciation of equipment leased to customers is provided in equal monthly amounts over the terms of the individual leases after recognizing the estimated residual value of each unit at the end of each lease. Depreciation is recorded in cost of sales in the consolidated statement of income. (I) RENtAl EqUIPmENt rental equipment is available for short and medium term rentals and is recorded at cost, net of accumulated depreciation. cost is determined on a specific item basis. rental equipment is depreciated to its estimated residual value over its estimated useful life on a straight-line or on an actual usage basis. Depreciation is recorded in cost of sales in the consolidated statement of income. (j) CAPItAl ASSEtS land, buildings, and equipment are recorded at cost, net of accumulated depreciation. Depreciation of capital assets is recorded in selling, general, and administrative expenses in the consolidated statement of income. Buildings and equipment are depreciated over their estimated useful lives on either a declining balance or straight-line basis using the following annual rates: Buildings general equipment automotive equipment 2% - 5% 10% - 33% 20% - 33% intangible assets with indefinite lives are not amortized. intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives, which range to a maximum period of ten years. amortization is recorded in selling, general, and administrative expenses in the consolidated statement of income. (K) GOODwIll goodwill represents the excess cost of an investment over the fair value of the net assets acquired and is not amortized. (l) ASSEt ImPAIRmENt the company reviews both long-lived assets to be held and used and identifiable intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the assets, whereas assets to be disposed of are reported at the lower of carrying amount or fair value less estimated selling costs. as a result of the continuing weak economic performance of the company’s uK subsidiary, Hewden, management performed an impairment analysis on Hewden’s long-lived assets and identifiable intangible assets with finite lives in the fourth quarter of 2009. the deterioration in the global economic environment in the last quarter of 2008 triggered the requirement for an impairment analysis on the company’s long-lived assets and identifiable intangible assets with finite lives as at December 31, 2008. Based on management’s analysis in 2009 and 2008, it was determined there was no impairment of these assets at that time. 56 notes to tHe consoliDateD financial stateMents goodwill and intangible assets with indefinite lives are subject to an annual assessment for impairment unless events or changes in circumstances indicate that the value may not be fully recoverable, in which case the assessment is done at that time. goodwill and intangible assets with indefinite lives are assessed primarily by applying a fair value-based test at the reporting unit level. the fair value is estimated using the present value of expected future cash flows. the company also considers projected future operating results, trends, and other circumstances in making such evaluations. an impairment loss would be recognized to the extent the carrying amount of goodwill or intangible assets exceeds their fair value – see note 16. (m) lEASES leases entered into by the company as lessee are classified as either capital or operating leases. leases where all of the benefits and risks of ownership of property rest with the company are accounted for as capital leases. equipment under capital lease is depreciated on the same basis as capital assets. gains or losses resulting from sale/leaseback transactions are deferred and amortized in proportion to the amortization of the leased asset. rental payments under operating leases are expensed as incurred. (N) ASSEt REtIREmENt OBlIGAtIONS the company recognizes its legal obligations for the retirement of certain tangible long-lived assets. the fair value of a liability for an asset retirement obligation is recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. the associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and then amortized over the estimated useful life. in subsequent periods, the asset retirement obligation is adjusted for the passage of time and any changes in the amount or timing of the underlying future cash flows through charges to earnings. a gain or loss may be incurred upon settlement of the liability. (O) REvENUE RECOGNItION revenue recognition, with the exception of cash sales, occurs when there is a written arrangement in the form of a contract or purchase order with the customer, a fixed or determinable sales price is established with the customer, performance requirements are achieved, and ultimate collection of the revenue is reasonably assured. revenue is recognized as performance requirements are achieved in accordance with the following: • • • • revenue from sales of equipment is recognized at the time title to the equipment and significant risks of ownership passes to the customer, which is generally at the time of shipment of the product to the customer; revenue from sales of equipment includes construction contracts with customers that involve the design, installation, and assembly of power and energy equipment systems. revenue is recognized on a percentage of completion basis proportionate to the work that has been completed which is based on associated costs incurred; revenue from equipment rentals and operating leases is recognized in accordance with the terms of the relevant agreement with the customer, either evenly over the term of that agreement or on a usage basis such as the number of hours that the equipment is used; and revenue from product support includes sales of parts and servicing of equipment. for sales of parts, revenue is recognized when the part is shipped to the customer or when the part is installed in the customer’s equipment. for servicing of equipment, revenue is recognized as the service work is performed. Product support is also offered to customers in the form of long-term maintenance and repair contracts. for these contracts, revenue is recognized on a basis proportionate to the service work that has been performed based on the parts and labour service provided. Parts revenue is recognized based on parts list price and service revenue is recognized based on standard billing labour rates. any losses estimated during the term of the contract are recognized when identified. (P) StOCK-BASED COmPENSAtION the company has stock option plans and other stock-based compensation plans for directors and certain eligible employees which are described in note 8. stock-based awards are measured and recognized using a fair value-based method of accounting. for stock options granted after January 1, 2003, fair value is determined on the grant date of the stock option and recorded as compensation expense over the vesting period, with a corresponding increase to contributed surplus. for stock options granted prior to January 1, 2003, the company recorded no compensation expense and will continue to use the intrinsic value-based method of accounting for those stock options. When stock options are exercised, the proceeds received by the company, together with any related amount recorded in contributed surplus, are credited to share capital. compensation expense which arises from fluctuations in the market price of the company’s common shares underlying other stock-based compensation plans (net of hedging instruments) is recognized in selling, general, and administrative expense in the consolidated income statement with the corresponding liability recorded on the consolidated balance sheet in long-term obligations. (q) EmPlOyEE FUtURE BENEFItS the company and its subsidiaries offer a number of benefit plans that provide pension and other benefits to many of its employees in canada and the u.K. these plans include defined benefit and defined contribution plans. the company’s south american employees do not participate in employer pension plans but are covered by country specific legislation with respect to post employment benefit plans. the company accrues its obligations to employees under these arrangements based on the actuarial valuation of anticipated payments to employees. 2009 finning international inc. | 57 | notes to tHe consoliDateD financial stateMents 1. SIGNIFICANT ACCOUNTING POLICIES (continued) (q) EmPlOyEE FUtURE BENEFItS (CONtINUED) Defined benefit plans: the cost of pensions and other retirement benefits is determined by independent actuaries using the projected benefit method prorated on service and management’s best estimates of assumptions including the expected return on plan assets and salary escalation rate, along with the use of a discount rate as prescribed under canadian institute of chartered accountants (cica) section 3461, Employee Future Benefits. for the purpose of calculating the expected return on plan assets, those assets are valued at fair value. Past service costs from plan amendments are amortized on a straight-line basis over the expected average remaining service life of employees active at the date of amendment. actuarial gains and losses arise from differences between actual experience and that expected as a result of economic, demographic, and other assumptions made. these include the difference between the actual and expected rate of return on plan assets for a period, and differences from changes in actuarial assumptions used to determine the accrued benefit obligation. the excess of the net accumulated actuarial gains or losses over 10% of the greater of the accrued benefit obligation and the fair value of the plan assets is amortized on a straight-line basis over the expected average remaining service life of the active employees covered by the plans. upon adoption of cica 3461 on January 1, 2000, a transitional asset or obligation was determined for each plan as a result of the new standard. the company is amortizing these transitional amounts on a straight-line basis over 13 years for the finning (canada) and Hewden plans and over 14 years for the finning (uK) plan, representing the average remaining service period of employees expected to receive benefits under the benefit plans as of January 1, 2000, the transition date. Defined contribution plans: the cost of pension benefits includes the current service cost, which comprise the actual contributions made by the company during the year. these contributions are based on a fixed percentage of member earnings for the year. (R) COmPREhENSIvE INCOmE, FINANCIAl INStRUmENtS, AND hEDGES Comprehensive inCome comprehensive income comprises the company’s net income and other comprehensive income and represents changes in shareholders’ equity during a period arising from non-owner sources. other comprehensive income includes currency translation adjustments on the company’s net investment in self-sustaining foreign operations and related hedging gains and losses, unrealized gains and losses on available-for-sale securities, and hedging gains and losses on cash flow hedges. the company’s comprehensive income, components of other comprehensive income, and accumulated other comprehensive income are presented in the statements of comprehensive income and the statements of shareholders’ equity. FinanCial assets and FinanCial liabilities ClassifiCation the company has made the following classification of its financial assets and financial liabilities: • • • cash equivalents are classified as Held for trading. they are measured at fair value with realized and unrealized gains and losses reported in net income. accounts receivable, instalment notes receivable, and supplier claims receivable are classified as loans and receivables. they are measured at amortized cost using the effective interest rate method. at December 31, 2009 and 2008, the recorded amount approximates fair value. short-term and long-term debt and accounts payable are classified as “other financial liabilities”. they are measured at amortized cost using the effective interest rate method. at December 31, 2009 and 2008, the measured amount approximates fair value, with the exception of long- term debt. the estimated fair value of the company’s long-term debt as at December 31, 2009 and 2008 is disclosed in note 4. transaction costs directly attributable to the acquisition or issue of a financial asset or financial liability (except those held for trading) are included in the carrying amount of the financial asset or financial liability, and are amortized to income using the effective interest rate method. Derivatives all derivative instruments are recorded on the balance sheet at fair value. embeDDeD Derivatives Derivatives may be embedded in other financial instruments (host instruments). embedded derivatives are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host instrument, the terms of the embedded derivative are the same as those of a stand-alone derivative, and the combined contract is not classified as Held for trading. these embedded derivatives are measured at fair value on the balance sheet with subsequent changes in fair value recognized in income. the company has not identified any embedded derivatives that are required to be accounted for separately from the host contract. 58 notes to tHe consoliDateD financial stateMents hedges the company utilizes derivative financial instruments and foreign currency debt in order to manage its foreign currency and interest rate exposures, and stock-based compensation expenses which fluctuate with share price movements. the company uses derivative financial instruments only in connection with managing related risk positions and does not use them for trading or speculative purposes. the company determines whether or not to formally designate, for accounting purposes, eligible hedging relationships between hedging instruments and hedged items. this process includes linking derivatives to specific risks from assets or liabilities on the balance sheet or specific firm commitments or forecasted transactions. for hedges designated as such for accounting purposes, the company formally assesses, both at inception and on an ongoing basis, whether the hedging instrument is highly effective in offsetting changes in fair value or cash flows associated with the identified hedged items. When derivative instruments have been designated as a hedge and are highly effective in offsetting the identified hedged risk, hedge accounting is applied to the derivative instruments. the ineffective portion of hedging gains and losses of highly effective hedges is reported in income. the accounting treatment for the types of hedges used by the company is described below. Cash flow heDges the company uses foreign exchange forward contracts and collars to hedge the currency risk associated with certain foreign currency purchase commitments, payroll, and associated accounts payable and accounts receivable for periods up to a year in advance. the effective portion of hedging gains and losses associated with these cash flow hedges is recorded, net of tax, in other comprehensive income and is released from accumulated other comprehensive income and recorded in income when the hedged item affects income. When a hedging instrument expires or is sold, or when a hedge is discontinued or no longer meets the criteria for hedge accounting, any accumulated gain or loss recorded in other comprehensive income at that time remains in other comprehensive income until the originally hedged transaction affects income. When a forecasted transaction is no longer expected to occur, the accumulated gain or loss that was reported in other comprehensive income is immediately recorded in the income statement. gains and losses relating to forward foreign exchange contracts that are not designated as hedges for accounting purposes are recorded in selling, general, and administrative expenses. from time to time, the company uses derivative financial instruments to hedge interest rate risk associated with future proceeds of debt. as at December 31, 2009, approximately $7.5 million of net gains (net of tax) included in accumulated other comprehensive income are expected to be reclassified to current earnings over the next twelve months when earnings are affected by the hedged transactions. fair value heDges changes in the fair value of derivatives designated and qualifying as fair value hedging instruments are recorded in income along with changes in the fair value of the hedged item attributable to the hedged risk. generally, if a hedging relationship no longer meets the criteria for hedge accounting, the cumulative adjustment to the carrying amount of the hedged item is amortized to income based on a recalculated effective interest rate over the remaining expected life of the hedged item, unless the hedged item has been derecognized in which case the cumulative adjustment is recorded immediately in the income statement. net investment heDges the company typically uses forward contracts, cross-currency interest rate swaps, and foreign currency debt to hedge foreign currency gains and losses on its long-term net investments in self-sustaining foreign operations. the effective portion of the gain or loss of such instruments associated with the hedged risk is recorded in other comprehensive income each period. these gains or losses will be recorded in income when there is a reduction in the company’s net investment in the self-sustaining foreign operation. the company uses the forward rate method for net investment hedges where derivative financial instruments are used. the company uses the spot method, as required, when the company uses debt to hedge foreign currency net investments. (S) ChANGE IN ACCOUNtING POlICIES (i) goodwill and intangible assets effective January 1, 2009, the company adopted section 3064, Goodwill and Intangible Assets, issued by the cica. the new standard replaces section 3062, Goodwill and Other Intangible Assets and section 3450, Research and Development Costs. the new pronouncement establishes standards for the recognition, measurement, presentation, and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. the new standard does not have a material impact on the company’s consolidated financial statements. (ii) financial instruments Disclosures effective December 31, 2009, the company has adopted the amendments to section 3862, Financial Instruments – Disclosures, which are effective for annual financial statements for fiscal years ending after september 30, 2009, and which enhance current disclosure requirements for financial instruments, as discussed further in note 4 to the consolidated financial statements. these amendments require disclosure of additional details about fair value measurements, including the relative reliability of the inputs used in those measurements, and the liquidity risk of financial instruments. 2009 finning international inc. | 59 | notes to tHe consoliDateD financial stateMents 1. SIGNIFICANT ACCOUNTING POLICIES (continued) (t) COmPARAtIvE FIGURES certain comparative figures have been reclassified to conform to the 2009 presentation. (U) FUtURE ACCOUNtING PRONOUNCEmENtS (i) Business combinations in January 2009, the cica issued section 1582, Business Combinations, section 1601, Consolidations, and section 1602, Non-controlling Interests. these new standards are harmonized with international financial reporting standards (ifrs). section 1582 specifies a number of changes, including: an expanded definition of a business, a requirement to measure all business acquisitions at fair value, a change in the basis of measurement of non-controlling interests, and a requirement to recognize acquisition-related costs as expenses. section 1601 establishes the standards for preparing consolidated financial statements. section 1602 specifies that non-controlling interests be treated as a separate component of equity, not as a liability or other item outside of equity. the new standards will become effective in 2011. effective January 1, 2010, the company early adopted sections 1582, 1601, and 1602 in accordance with the transitional provisions. the adoption of sections 1601 and 1602 is not expected to have a material impact on the company’s consolidated financial statements. Whether the company will be materially affected by the new recommendations of section 1582 will depend upon the specific facts of business combinations, if any, occurring subsequent to January 1, 2010. (ii) convergence with international financial reporting standards in february 2008, canada’s accounting standards Board confirmed that canadian gaaP, as used by public companies, will be converged with ifrs effective January 1, 2011. the transition from canadian gaaP to ifrs will be applicable for the company for the first quarter of 2011 when the company will prepare both the current and comparative financial information using ifrs. 2. OTHER EXPENSES (INCOME) other expenses (income) include the following items: for years ended December 31 ($ tHousanDs) gain on sale of properties (a) restructuring (b) Project costs (c) gain on sale of other properties 2009 (16,501) 36,970 18,857 (1,812) 37,514 $ $ 2008 (19,210) 20,496 16,197 (682) 16,801 $ $ the tax recovery on other expenses for the year ended December 31, 2009 was $14.7 million (2008: $7.3 million). (a) in 2009, the company’s uK subsidiary, Hewden, sold certain properties for cash proceeds of approximately $16.7 million (2008: $37.8 million), resulting in a pre-tax gain of $9.3 million (2008: $19.2 million). in 2009, the company’s south american subsidiary, finning chile s.a., sold a property in exchange for a new head office property. this new property was recorded at approximately $10.6 million which was the fair value of the old property at the time of exchange. the transaction resulted in a pre-tax gain on sale of approximately $7.2 million. (b) in 2009, the company incurred other restructuring and severance costs of $23 million globally in 2009 (primarily in the company’s canadian operations) in response to market conditions (2008: $9 million). in addition, the company’s uK operations incurred restructuring costs of approximately $1 million in connection with the integration of business support services (2008: $8 million). the uK operations also incurred costs of approximately $11 million in 2009 related to the restructuring of Hewden’s nationwide depot network (2008: $3 million). (c) Project costs incurred in 2009 and 2008 relate to the implementation of a new information technology system for the company’s global operations. 60 notes to tHe consoliDateD financial stateMents 3. SHORT-TERM AND LONG-TERM DEBT December 31 ($ tHousanDs) short-term debt long-term debt: Medium term notes 4.64%, $150 million, due December 14, 2011 5.16%, $250 million, due september 3, 2013 6.02%, $350 million, due June 1, 2018 5.625%, £115 million (2008: £125 million) eurobond, due May 30, 2013 other term loans (a) less current portion of long-term debt total long-term debt 2009 2008 $ 162,238 $ 193,635 149,813 249,258 348,427 193,495 74,918 1,015,911 (24,179) 991,732 $ 149,718 249,057 348,241 222,122 444,232 1,413,370 (2,643) 1,410,727 $ (a) other term loans include u.s. $66.6 million and £nil million (2008: u.s. $291.0 million and £10.0 million) of unsecured borrowings under committed bank facilities that are classified as long-term debt, and other unsecured term loans primarily from supplier merchandising programs. other loans also include £1.7 million (2008: £2.4 million) of rental equipment financing secured by the related equipment, with varying rates of interest from 5.8% – 6.8% and maturing on various dates up to 2011. sHort-terM DeBt short-term debt primarily consists of commercial paper borrowings and other short-term bank indebtedness. the company maintains a maximum authorized commercial paper program of $600 million which is utilized as the company’s principal source of short-term funding. this commercial paper program is backstopped by credit available under an $800 million committed credit facility. in addition, the company maintains certain other committed and uncommitted bank credit facilities to support its subsidiary operations. as at December 31, 2009, the company had approximately $1,240 million (2008: $1,300 million) of unsecured credit facilities, and including all bank and commercial paper borrowings drawn against these facilities, approximately $1,012 million (2008: $660 million) of capacity remained available, of which approximately $725 million (2008: $300 million) is committed credit facility capacity. included in short-term debt is foreign currency denominated debt of u.s. $150.7 million (2008: u.s. $29.0 million) and £nil million (2008: £32.7 million). the average interest rate applicable to the consolidated short-term debt for 2009 was 1.5% (2008: 4.5%). long-terM DeBt the company’s canadian dollar denominated Medium term notes (Mtns) are unsecured, and interest is payable semi-annually with principal due on maturity. the company’s £115.0 million (2008: £125.0 million) 5.625% eurobond is unsecured, and interest is payable annually with principal due on maturity. in the fourth quarter of 2009, the company redeemed £10 million ($17.3 million) of the 5.625% eurobond at an average price of £102.80. the company recorded a pre-tax charge of approximately $0.9 million (recorded in finance costs), reflecting the recognition of deferred financing costs and other costs associated with this purchase. in May 2008, the company issued two unsecured Mtns. the 5-year, $250 million Mtn has a coupon interest rate of 5.16% per annum, payable semi-annually commencing september 3, 2008. the Mtn was priced at $99.994 of its principal amount to yield 5.163% per annum. the 10-year, $350 million Mtn has a coupon interest rate of 6.02% per annum, payable semi-annually commencing December 1, 2008. the Mtn was priced at $99.936 of its principal amount to yield 6.028% per annum. Proceeds from these issuances were used for debt repayment, including the repayment of the company’s $200 million 7.40% Mtn which matured in June 2008 as well as outstanding commercial paper borrowings. the company has an $800 million unsecured syndicated revolving credit facility, maturing in December 2011. the facility is available in multiple borrowing jurisdictions and may be drawn by a number of the company’s principal operating subsidiaries. Borrowings under this facility are available in multiple currencies and at various floating rates of interest. at December 31, 2009, $142.5 million (2008: $538.4 million) was drawn on this facility, including commercial paper issuances. 2009 finning international inc. | 61 | notes to tHe consoliDateD financial stateMents 3. SHORT-TERM AND LONG-TERM DEBT (continued) long-terM DeBt rePayMents Principal repayments on long-term debt in each of the next five years and thereafter are as follows: ($ tHousanDs) 2010 2011 2012 2013 2014 thereafter finance costs finance costs as shown on the consolidated statement of income comprise the following elements: for years ended December 31 ($ tHousanDs) interest on debt securities: short-term debt long-term debt loss on interest rate derivatives interest income on tax reassessment other finance related expenses, net of sundry interest earned finance costs $ $ 24,179 167,976 – 475,329 – 348,427 1,015,911 2009 2008 $ $ 4,347 55,499 59,846 2,232 (3,529) 9,059 67,608 $ $ 15,866 61,495 77,361 1,578 – 4,697 83,636 4. FINANCIAL INSTRUMENTS overvieW finning and its subsidiaries are exposed to market, credit, liquidity, and other risks from its use of financial instruments. the enterprise risk Management process within the company’s risk management function is designed to ensure that such risks are identified, managed, and reported. on a quarterly basis, the audit committee reviews the company’s process with respect to risk assessment and management of key risks, including the company’s major financial risks and exposures and the steps taken to monitor and control such exposures. changes to the key risks are reviewed by the audit committee. the audit committee also reviews the adequacy of disclosures in the company’s annual information form, Management’s Discussion and analysis, and consolidated financial statements. this note presents information about the company’s exposure to credit, liquidity, and market risks and the company’s objectives, policies, and processes for managing these risks. creDit risK credit risk is the risk of financial loss to the company if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the company’s cash and cash equivalents, receivables from customers, instalment notes receivable, and derivative assets. exposure to CreDit risk the carrying amount of financial assets and service work in progress represents the maximum credit exposure. the exposure to credit risk at the reporting date was: December 31 ($ tHousanDs) cash and cash equivalents accounts receivable service work in progress supplier claims receivable instalment notes receivable Derivative assets 62 2009 197,904 622,641 62,563 40,121 32,126 29,499 984,854 $ $ 2008 109,772 840,810 102,607 62,912 38,852 84,599 1,239,552 $ $ notes to tHe consoliDateD financial stateMents Cash anD Cash equivalents credit risk associated with cash and cash equivalents is managed by ensuring that these financial assets are held with major financial institutions with strong investment grade ratings and by maintaining limits on exposures with any single institution. an ongoing review is performed to evaluate the changes in the credit rating of counterparties. aCCounts reCeivable, serviCe work in progress, anD other reCeivables accounts receivable comprises trade accounts and non-trade accounts. service work in progress relates to unbilled work in progress for external customers and represents the costs incurred plus recognized profits, net of any recognized losses and progress billings. the company has a large diversified customer base, and is not dependent on any single customer or group of customers. credit risk is minimized because of the diversification of the company’s operations as well as its large customer base and its geographical dispersion. the company makes estimates for allowances that represent its estimate of potential losses in respect of trade and other receivables. the main components of this allowance are a specific loss component that relates to individually significant exposures, and a collective loss component established for groups of similar assets in respect of losses that may have been incurred but not yet specifically identified. the collective loss allowance is estimated based on historical data of payment statistics for similar financial assets, adjusted for current economic conditions. the maximum exposure to credit risk for trade receivables at the reporting date by geographic location of customer was: December 31 ($ tHousanDs) canada u.K. chile argentina Bolivia uruguay other impairment losses the aging of trade receivables at the reporting date was: December 31 ($ tHousanDs) not past due Past due 1 – 30 days Past due 31 – 90 days Past due 91 – 120 days Past due greater than 120 days total 2009 310,172 123,151 109,193 37,125 4,782 1,484 5,689 591,596 $ $ 2008 397,738 176,062 156,483 47,917 5,021 3,074 8,213 794,508 $ $ 2009 2008 gross allowance gross allowance $ $ 411,699 123,118 36,656 6,094 38,229 615,796 $ $ 804 1,223 1,153 745 20,275 24,200 $ $ 527,331 172,473 65,498 12,323 44,037 821,662 the movement in the allowance for doubtful accounts in respect of trade receivables during the period was as follows: for years ended December 31 ($ tHousanDs) Balance, beginning of year additional allowance receivables written off foreign exchange translation adjustment Balance, end of year 2009 27,154 12,675 (13,388) (2,241) 24,200 $ $ $ $ $ $ 176 284 1,618 2,127 22,949 27,154 2008 28,229 12,331 (13,408) 2 27,154 the allowance amounts in respect of trade receivables are used to record possible impairment losses unless the company is satisfied that no recovery of the amount owing is possible; at that point the amount is considered not recoverable and is written off against the financial asset directly. 2009 finning international inc. | 63 | notes to tHe consoliDateD financial stateMents 4. FINANCIAL INSTRUMENTS (continued) Derivative assets the company does have a certain degree of credit exposure arising from its derivative instruments relating to counterparties defaulting on their obligations. However, the company minimizes this risk by ensuring there is no excessive concentration of credit risk with any single counterparty, by active credit monitoring, and by dealing only with major financial institutions that have a credit rating of at least a- from standard & Poor’s and a (low) from DBrs. liQuiDity risK liquidity risk is the risk that the company will not be able to meet its financial obligations as they fall due. the company’s approach to managing liquidity is to ensure, as far as possible, that it will have sufficient liquid financial resources to fund its operations and meet its commitments and obligations. the company maintains bilateral and syndicated bank credit facilities, a commercial paper program, continuously monitors actual and forecast cash flows, and manages maturity profiles of financial liabilities. undrawn credit facilities at December 31, 2009 were $1,012 million (2008: $660 million). the company believes that it has reasonable access to capital markets which is supported by its investment grade credit ratings. the following are the contractual maturities of non-derivative and derivative financial liabilities. the amounts presented represent the future undiscounted principal and interest cash flows and therefore do not equate to the carrying amount on the consolidated balance sheet. ($ tHousanDs) non-derivative financial liabilities short-term debt unsecured Mtns eurobond unsecured bank facilities other term loans capital lease obligations accounts payable and accruals (excluding derivative liabilities below) Derivatives cross currency interest rate swap(1) Pay gBP (fixed) receive caD (fixed) interest rate swaps Pay usD (fixed) receive usD (floating) forward foreign currency contracts and swaps sell caD Buy usD sell gBP Buy usD sell clP Buy usD sell usD Buy clP share forward sell Buy carrying amount December 31, 2009 2010 2011-2012 2013-2014 thereafter contractual cash flows $ (162,238) (747,498) (193,495) (69,730) (5,188) (19,262) $ (163,567) (40,930) (10,944) (21,421) (3,439) (8,118) $ – (224,900) (21,888) (16,798) (2,015) (3,386) $ – (305,040) (205,501) (32,597) – (2,130) $ – (444,815) – – – (13,731) (743,672) (743,672) – – – – 26,079 (600) – (5,669) – – 325 – 747 – 2,348 (4,517) 5,888 (2,076) 375 (98,347) 92,655 (15,701) 16,022 (40,022) 40,817 (25,118) 27,307 (26,144) – $ $ – – $ (9,034) 11,775 (930) 172 – – – – – – – – – – (9,034) 11,775 (128,611) 166,602 – – – – – – – – – – (30,314) – $ $ – – – – – – – – – – – – canadian dollar (caD) united states dollar (usD) British pound (gBP) chilean peso (clP) (1) subsequent to December 31, 2009, the company settled its cross currency interest rate swap. 64 notes to tHe consoliDateD financial stateMents MarKet risK Market risk is the risk that changes in market prices, such as foreign exchange rates and interest rates, will affect the company’s income or the fair value of its financial instruments. the objective of market risk management is to manage and control market risk exposures within acceptable parameters. the company buys and sells derivatives in the ordinary course of business, and also incurs financial liabilities, in order to manage market risks. all such transactions are carried out within the guidelines set by the company’s global Hedging Policy approved by the audit committee. foreign excHange risK the company is geographically diversified, with significant investments in several different countries. the company transacts business in multiple currencies, the most significant of which are the u.s. dollar, the canadian dollar, the u.K. pound sterling, and the chilean peso. as a result, the company has foreign currency exposure with respect to items denominated in foreign currencies. the main types of foreign exchange risk of the company can be categorized as follows: tRANSlAtION ExPOSURE the most significant foreign exchange impact on the company’s net income is the translation of foreign currency based earnings into canadian dollars each reporting period. all of the company’s foreign subsidiaries are considered self-sustaining and report their operating results in currencies other than the canadian dollar. therefore, exchange rate movements in the u.s. dollar and u.K. pound sterling relative to the canadian dollar will impact the consolidated results of the south american and u.K. operations in canadian dollar terms. in addition, the company’s canadian results are impacted by the translation of its u.s. dollar based earnings. to the extent practical, it is the company’s objective to manage its exposure to currency fluctuations arising from its foreign investments. the company has hedged a portion of its foreign investments through foreign currency denominated loans and, periodically, through other derivative contracts. any exchange gains or losses arising from the translation of the hedging instruments are recorded, net of tax, as an item of other comprehensive income and accumulated other comprehensive income. cumulative currency translation adjustments, net of gains or losses of the associated hedging instruments, are recognized in net income when there is a reduction in the company’s net investment in the self-sustaining foreign operation. During 2009, the company received proceeds of $32.3 million on the settlement of a £90 million cross currency interest rate swap that hedged the company’s uK investments. subsequent to December 31, 2009, the company received proceeds of $26.0 million on the settlement of the remaining £60 million cross currency interest rate swap. tRANSACtION ExPOSURE Many of the company’s operations purchase, sell, rent, and lease products as well as incur costs in currencies other than their functional currency. this mismatch of currencies creates transactional exposure at the operational level, which may affect the company’s profitability as exchange rates fluctuate. the company’s competitive position may also be impacted as relative currency movements affect the business practices and/or pricing strategies of the company’s competitors. the company is also exposed to currency risks related to the future cash flows on its non-canadian denominated short and long term debt. to the extent practical, it is the company’s objective to manage the impact of exchange rate movements and volatility on its financial results. each operation manages the majority of its transactional exposure through sales pricing policies and practices. the company also enters into forward exchange contracts to manage residual mismatches in foreign currency cash flows. exposure to Foreign exChange risk the currencies of the company’s financial instruments were as follows: December 31 (tHousanDs) caD usD gBp clp 2009 cash and cash equivalents accounts receivable short-term and long-term debt accounts payable and accruals net balance sheet exposure cross currency interest rate swap foreign forward exchange contracts and swaps 10,669 310,759 (754,355) (253,054) (685,981) 131,276 (98,347) 85,712 46,834 (217,315) (197,520) (282,289) – 118,838 39,515 72,137 (116,061) (104,720) (109,129) (60,000) (9,281) 7,950,752 49,970,186 – (32,303,749) 25,617,189 – (6,166,140) 2009 finning international inc. | 65 | notes to tHe consoliDateD financial stateMents 4. FINANCIAL INSTRUMENTS (continued) exposure to Foreign exChange risk (Continued) December 31 (tHousanDs) cash and cash equivalents accounts receivable short-term and long-term debt accounts payable and accruals net balance sheet exposure cross currency interest rate swaps foreign forward exchange contracts and collars caD usD gBP clP 2008 22,076 377,032 (912,311) (310,433) (823,636) 328,190 166,459 58,353 79,025 (319,990) (522,651) (705,263) – (137,567) 848 99,298 (169,220) (130,249) (199,323) (150,000) – 4,702,208 72,432,169 – (50,658,822) 26,475,555 – 3,388,336 sensitivity analysis a 5% strengthening of the canadian dollar against the following currencies for a full year relative to the December 31, 2009 month end rates would increase / (decrease) net income by the amounts shown below. a 5% strengthening of the canadian dollar against the following currencies from the December 31, 2009 month end rates would increase / (decrease) other comprehensive income by the amounts shown below. this analysis assumes that all other variables, in particular volumes, relative pricing, interest rates, and hedging activities are unchanged. December 31 currency ($ tHousanDs) usD gBP clP 2009 other comprehensive income 2008 other comprehensive allowance net income net income $ $ $ (17,000) 1,000 1,700 $ $ $ (22,100) (17,000) – $ $ $ (22,500) (2,200) 700 $ $ $ (11,800) (17,200) – a 5% weakening of the canadian dollar against the above currencies relative to the December 31, 2009 month end rates would have an equivalent but opposite effect on the above accounts in the amounts shown on the basis that all other variables are unchanged. interest rate risk changes in market interest rates will cause fluctuations in the fair value or future cash flows of financial instruments. the company is exposed to changes in interest rates on its interest bearing financial assets including cash and cash equivalents, instalment notes receivable, and cross currency interest rate swaps. the short term nature of investments included in cash and cash equivalents limits the impact to fluctuations in fair value, but interest income earned will be impacted. instalment notes receivable bear interest at a fixed rate thus their fair value will fluctuate prior to maturity but, absent monetization, future cash flows do not change. the fair value of the company’s cross currency interest rate swap will be impacted by relative changes in interest rates related to the two swapped currencies. as interest rates related to the swap are fixed, future cash flows do not change. subsequent to December 31, 2009, the company settled its cross currency interest rate swap. the company is exposed to changes in interest rates on its interest bearing financial liabilities including short and long term debt and variable rate share forward (vrsf). the company’s debt portfolio comprises both fixed and floating rate debt instruments, with terms to maturity ranging up to eight years. floating rate debt due to its short term nature exposes the company to limited fluctuations in changes to fair value, but finance expense and cash flows will increase or decrease as interest rates change. the fair value of the company’s fixed rate debt obligations fluctuate with changes in interest rates, but absent early settlement, related cash flows do not change. the company does not measure any fixed rate long-term debt at fair value. the company is exposed to future interest rates upon refinancing of any debt prior to or at maturity. the company pays floating interest rates on its vrsf. Both fair value and future cash flows are impacted by changes in interest rates. the company manages its interest rate risk by balancing its portfolio of fixed and floating rate debt, as well as managing the term to maturity of its debt portfolio. at certain times the company utilizes derivative instruments such as interest rate swaps to adjust the balance of fixed and floating rate debt. 66 notes to tHe consoliDateD financial stateMents proFile at the reporting date the interest rate profile of the company’s interest-bearing financial instruments was as follows: December 31 ($ tHousanDs) Fixed rate instruments financial assets financial liabilities variable rate instruments financial assets financial liabilities 2009 2008 $ $ $ $ 58,205 (960,255) (902,050) 197,904 (263,300) (65,396) $ $ $ $ 105,269 (1,009,768) (904,499) 109,772 (664,743) (554,971) Fair value sensitivity analysis For Fixed rate instruments the company does not account for any fixed rate financial assets and liabilities at fair value through the income statement, and the company does not currently have any derivatives designated as hedging instruments under a fair value hedge accounting model. therefore a change in interest rates at the reporting date would not affect net income. an increase of 1.0% in interest rates for a full year relative to the interest rates at the reporting date would have decreased equity by approximately $1.6 million (2008: $4.8 million) with a 1.0% decrease having the opposite effect. net inCome sensitivity analysis For variable rate instruments an increase of 1.0% in short-term interest rates for a full year relative to the interest rates at the reporting date would have decreased net income by approximately $0.4 million (2008: $3.6 million) with 1.0% decrease having the opposite effect. this analysis assumes that all other variables, in particular foreign currency rates, remain constant. other risk the company’s revenues can be indirectly affected by fluctuations in commodity prices; in particular, changes in expectations of longer-term prices. in canada, commodity price movements in the forestry, metals, coal, and petroleum sectors can have an impact on customers’ demands for equipment and product support. in chile and argentina, significant fluctuations in the price of copper and gold can have similar effects, as customers base their capital expenditure decisions on the long-term price outlook for metals. in the u.K., changes to prices for thermal coal may impact equipment demand in that sector. significant fluctuations in commodity prices could result in a material impact on the company’s financial results. stocK-BaseD coMPensation costs risK stock-based compensation is an integral part of the company’s compensation program, and can be in the form of the company’s common shares or cash payments that reflect the value of the shares. since canadian gaaP require certain stock-based compensation plans accounted for as liability-based awards to be recorded at intrinsic value, compensation expense can vary as the price of the company’s common shares changes. the company has entered into a derivative contract to partly offset this exposure, called a vrsf. the vrsf is a derivative contract that is cash-settled at the end of a five-year term, or at any time prior to that at the option of the company, based on the difference between the company’s common share price at the time of settlement and the execution price plus accrued interest. at December 31, 2009 and 2008, the vrsf relates to 1.7 million common shares at a price of $28.71 plus interest maturing in 2012. a 5% strengthening in the company’s share price as at December 31, 2009, all other variables remaining constant, would have increased net income by approximately $1.0 million (2008: $0.9 million) as a result of revaluing the company’s vrsf with a 5% weakening having the opposite effect. this impact partially mitigates changes in the stock based compensation expense; as the company’s share price changes, the intrinsic value impact related to the stock-based compensation liability is partially offset by the fair value impact related to the vrsf. fair values the following fair value information is provided solely to comply with financial instrument disclosure requirements. the company cautions readers in the interpretation of the impact of these estimated fair values. the classification of fair value measurements is based upon a fair value hierarchy that reflects the significance of the inputs used in making the measurements. the level within which the fair value measurement is categorized is based upon the lowest level of input that is significant to the measurement. level inputs are as follows: level 1 – quoted prices in active markets for identical securities level 2 – significant observable inputs other than quoted prices included in level 1 level 3 – significant unobservable inputs 2009 finning international inc. | 67 | notes to tHe consoliDateD financial stateMents 4. FINANCIAL INSTRUMENTS (continued) fair values (continueD) as of December 31, 2009, all of the inputs used to value finning’s financial instruments were level 2, except cash and cash equivalents that were designated within level 1 of the fair value hierarchy. the company did not identify any level 3 measurements as of December 31, 2009. the company did not move any instruments between levels of the fair value hierarchy during the year ended December 31, 2009. the fair value of accounts receivable, instalment notes receivable, short-term debt, and accounts payable approximates their recorded values due to the short-term maturities of these instruments. the fair values of the derivatives below approximate the amount the company would receive or pay to transfer such contracts to a third party: notional value term to Maturity fair value receive (Pay) (tHousanDs) Balance sheet classification 2009 Foreign exchange cross currency interest rate swaps Pay gBP fixed / receive caD fixed other assets – long-term forwards and swaps buy usD / sell caD forwards buy usD / sell clP forwards sell usD / buy clP forwards buy usD / sell gBP accounts payable and accruals other assets – current other assets – current other assets – current gBp 60,000 December 2020 usD 88,530 usD 39,000 usD 24,000 usD 15,309 1-8 months 1-2 months 1-12 months 1-3 months interest rates interest rate swaps long-term incentive plans variable rate share forward accounts payable and accruals usD 11,250 1-2 years long-term obligations caD 48,809 november 2012 $ (26,144) 2008 Foreign exchange cross currency interest rate swaps Pay gBP fixed / receive caD fixed other assets – long-term forwards buy usD / sell caD swaps sell usD / buy caD forwards buy usD / sell clP forward sell usD / buy clP collars sell usD / buy clP other assets – current accounts payable and accruals accounts payable and accruals accounts payable and accruals accounts payable and accruals gBP 150,000 usD 129,321 usD 253,000 45,000 usD 34,889 usD 24,000 usD December 2020 1-13 months 1-6 months 1-2 months 1-12 months 1-12 months accounts payable and accruals usD 11,250 1-3 years interest rates interest rate swaps long-term incentive plans variable rate share forward long-term obligations caD 48,809 november 2012 $ (26,876) long-terM DeBt the fair value of the company’s long-term debt is estimated as follows: December 31 ($ tHousanDs) long-term debt 2009 2008 Book value Fair value Book value fair value $ 1,015,911 $ 1,058,466 $ 1,413,370 $ 1,336,351 the following methods and assumptions were used to determine the fair value of each class of assets and liabilities recorded at fair value on the consolidated balance sheet: CASh AND CASh EqUIvAlENtS (lEvEl 1) the fair value of cash and cash equivalents is determined using quoted market prices in active markets for foreign denominated cash and cash equivalents. 68 $ $ $ $ $ $ 26,079 (5,669) 747 2,348 325 (600) $ $ $ $ $ $ $ 66,417 18,182 (3,389) (487) (6,240) (3,352) (1,045) notes to tHe consoliDateD financial stateMents DERIvAtIvE INStRUmENtS (lEvEl 2) the fair value of derivative instruments is determined using present value techniques applied to estimated future cash flows. these techniques utilize a combination of quoted prices and market observed inputs. Where appropriate, fair values are adjusted for credit risk based on observed credit default spreads or fair market yield curves for counterparties when the instrument is an asset and based on finning’s credit risk when the instrument is a liability. finning’s credit risk is derived from yield spreads on finning’s market quoted debt. the fair value of foreign currency forward contracts, interest rate swaps, and cross currency interest rate swap is determined by discounting contracted future cash flows using a discount rate derived from swap curves for comparable assets and liabilities. contractual cash flows are calculated using a forward price at maturity date derived from observed forward prices. vARIABlE RAtE ShARE FORwARD (lEvEl 2) the fair value of the variable rate share forward is determined based on the present value of future cash flows required to settle the share forward which are derived from the current share price, actual interest accrued to date and future interest cost to termination of the share forward. future interest cost is derived from market observable forward interest rates and contractual interest spreads. 5. MANAGEMENT OF CAPITAL the company’s objective when managing capital is to maintain a flexible capital structure which optimizes the cost of capital at an acceptable risk. the company includes shareholders’ equity, cash and cash equivalents, short-term and long-term debt in the definition of capital. the company manages its capital structure and makes adjustments to it in light of changes in economic conditions and the risk characteristics of its underlying assets. in order to maintain or adjust the capital structure, the company may purchase shares for cancellation pursuant to normal course issuer bids, issue new shares, issue new debt, repay debt, issue new debt to replace existing debt with different characteristics, or adjust the amount of dividends paid to shareholders. the company monitors the following ratios: net debt to total capitalization and dividend payout ratio. net debt to total capitalization and dividend payout ratio are non-gaaP measures which do not have a standardized meaning prescribed by gaaP and therefore may not be comparable to similar measures presented by other issuers. net debt to total capitalization is calculated as short-term and long-term debt, net of cash and cash equivalents (net debt) divided by total capitalization. total capitalization is defined as the sum of net debt and all components of shareholders’ equity (share capital, contributed surplus, accumulated other comprehensive loss, and retained earnings). Dividend payout ratio is calculated as the indicated annual dividend declared per share divided by basic earnings per share from continuing operations for the preceding twelve month period. the company’s strategy is to manage, over a longer-term average basis, to the target ranges set out below. the company believes that these target ratios are appropriate and provide access to capital at a reasonable cost. as at and for years ended December 31 ($ tHousanDs, excePt as noteD) components of Debt ratio cash and cash equivalents short-term debt current portion of long-term debt long-term debt net debt shareholders’ equity net debt to total capitalization Dividend payout ratio 2009 2008 $ (197,904) 162,238 24,179 991,732 $ 980,245 $ 1,515,686 $ $ $ (109,772) 193,635 2,643 1,410,727 1,497,233 1,567,104 company targets 35 - 45% 25 - 30% 2009 39.3% 57.1% 2008 48.9% 77.2% Due to changes in capital markets, economic, and business conditions, the company has marginally reduced its net debt to total capitalization target from the previous target of 40-50%. the company will maintain targets in the future that it believes provide flexibility to manage its business through the economic cycle while maintaining an investment grade credit rating to enable access to the debt capital markets at a reasonable cost. the actual ratio is lower than the prior year due to the significant cash flow from operations which was utilized to reduce overall debt levels. 2009 finning international inc. | 69 | notes to tHe consoliDateD financial stateMents 5. MANAGEMENT OF CAPITAL (continued) as a result of lower earnings, the dividend payout ratio in 2009 is above the company’s target; however, management believes that the company’s target of 25-30% is still appropriate over a longer term and has the cash flow available to fund the dividend at this level. over time, the company expects to return to this payout range. the dividend payout ratio in 2008 was impacted by the non-cash goodwill impairment charge in 2008. excluding the impact of this charge, the dividend payout ratio in 2008 would have been 29.9%, within the company target. covenant the company is subject to a maximum net debt to total capitalization level pursuant to a covenant within its syndicated bank credit facility. as at December 31, 2009 and 2008, the company is in compliance with this covenant. 6. INCOME TAXES Provision for incoMe taxes as the company operates in several tax jurisdictions, its income is subject to various rates of taxation. the components of the company’s income tax provision are as follows: for years ended December 31 ($ tHousanDs) Provision for income taxes current canada international future canada international 2009 2008 $ $ (11,862) 27,908 16,046 5,279 (12,736) (7,457) 8,589 $ $ 38,663 8,629 47,292 (4,037) 13,859 9,822 57,114 the provision for income taxes differs from the amount that would have resulted from applying the canadian statutory income tax rates to income from continuing operations before income taxes as follows: for years ended December 31 ($ tHousanDs) combined canadian federal and provincial income taxes at the statutory tax rate increase / (decrease) resulting from: lower statutory rates on the earnings of foreign subsidiaries recovery related to items previously charged to other comprehensive income income not subject to tax non-taxable capital gain non-deductible stock-based compensation goodwill impairment other Provision for income taxes 2009 2008 $ 40,917 29.35% $ 46,010 30.05% (17,892) (12.83)% (17,349) (11.33)% (8,513) (4,083) (3,370) 1,454 – 76 8,589 $ (6.11)% (2.93)% (2.42)% 1.04% – 0.06% 6.16% – (2,953) (11,937) 1,932 43,126 (1,715) 57,114 $ – (1.92)% (7.81)% 1.26% 28.17% (1.12)% 37.30% future incoMe tax asset anD liaBility included in other assets on the consolidated balance sheets are a current future income tax asset and long-term future income tax asset of $48.8 million (2008: $66.9 million) and $1.5 million (2008: $2.5 million), respectively. 70 notes to tHe consoliDateD financial stateMents temporary differences and tax loss carry-forwards that give rise to future income tax assets and liabilities are as follows: December 31 ($ tHousanDs) future income tax assets: accounting provisions not currently deductible for tax purposes loss carry-forwards other stock-based compensation goodwill of foreign subsidiaries future income tax liabilities: Derivative financial instruments capital, rental, and leased assets employee benefits other net future income tax liability 2009 2008 $ $ 52,862 3,563 7,373 1,004 64,802 (6,272) (65,909) (47,366) (3,806) (123,353) (58,551) $ $ 63,696 6,435 4,203 1,172 75,506 (6,663) (81,767) (46,267) (1,364) (136,061) (60,555) the company has recognized the benefit of the following tax loss carry-forwards available to reduce future taxable income and capital gains expiring through 2015 for canada and available indefinitely for international, with the exception of argentina, which expire through 2015 ($7.2 million): December 31 ($ tHousanDs) canada international 2009 1,700 10,638 12,338 $ $ 2008 19,809 5,571 25,380 $ $ 7. SHARE CAPITAL the company is authorized to issue an unlimited number of preferred shares without par value, of which 4.4 million are designated as cumulative redeemable preferred shares. the company had no preferred shares outstanding for the years ended December 31, 2009 and 2008. the company is authorized to issue an unlimited number of common shares. the company had a share repurchase program in place until July 8, 2009. the company did not repurchase any common shares during 2009. the company repurchased and cancelled 5,901,842 common shares during 2008 as part of a normal course issuer bid. these shares were repurchased at an average price of $24.99, which was allocated to reduce share capital by $19.1 million and retained earnings by $128.4 million. a shareholders’ rights plan is in place which is intended to provide all holders of common shares with the opportunity to receive full and fair value for all of their shares in the event a third party attempts to acquire a significant interest in the company. the company’s dealership agreements with subsidiaries of caterpillar inc. are fundamental to its business and any change in control must be approved by caterpillar inc. the plan provides that one share purchase right has been issued for each common share and will trade with the common shares until such time as any person or group, other than a “permitted bidder”, bids to acquire or acquires 20% or more of the company’s common shares, at which time the plan rights become exercisable. the rights may also be triggered by a third party proposal for a merger, amalgamation or a similar transaction. in May 2008, the rights plan was extended for three years such that it will automatically terminate at the end of the company’s annual Meeting of shareholders in 2011 unless further extended by the shareholders prior to that time. the plan will not be triggered if a bid meets certain criteria (a permitted bidder). these criteria include that: • • • the offer is made for all outstanding voting shares of the company; more than 50% of the voting shares have been tendered by independent shareholders pursuant to the takeover Bid (voting shares tendered may be withdrawn until taken up and paid for); and the takeover Bid expires not less than 60 days after the date of the bid circular. 2009 finning international inc. | 71 | notes to tHe consoliDateD financial stateMents 8. STOCK-BASED COMPENSATION PLANS the company has a number of stock-based compensation plans in the form of stock options and other stock-based compensations plans noted below. stocK oPtions the company has several stock option plans for certain employees and directors with vesting occurring over a three-year period. the exercise price of each option is based on the closing price of the common shares of the company on the date of the grant. options granted after January 1, 2004 are exercisable over a seven-year period. options granted prior to January 1, 2004 are exercisable over a ten-year period. under the 2005 stock option Plan, the company may issue up to 7.5 million common shares pursuant to the exercise of stock options. at December 31, 2009, 1.5 million common shares remain eligible to be issued in connection with future grants under this stock option Plan. Details of the stock option plans are as follows: for years ended December 31 options outstanding, beginning of year granted exercised cancelled options outstanding, end of year exercisable at year end 2009 weighted average exercise price $ $ $ $ $ $ 23.72 14.64 6.51 26.63 22.94 22.01 options 6,037,270 978,703 (301,733) (414,786) 6,299,454 3,827,509 2008 Weighted average exercise Price $ $ $ $ $ $ 20.99 29.83 10.47 26.85 23.72 17.54 options 4,656,402 1,853,100 (209,832) (262,400) 6,037,270 2,726,492 in 2009, long term incentives for executives and senior management were a combination of both stock options and performance share units (2008: primarily in the form of stock options). in the second quarter of 2009, the company granted 978,703 common share options to senior executives and management of the company (2008:1,853,100 common share options). the company’s practice is to grant and price stock options only when it is felt that all material information has been disclosed to the market. the company determines the cost of all stock options granted since January 1, 2003 using the fair value-based method of accounting for stock options. this method of accounting uses an option-pricing model to determine the fair value of stock options granted which is amortized over the vesting period. the fair value of the options granted has been estimated on the date of grant using the Black-scholes option-pricing model with the following weighted-average assumptions: Dividend yield expected volatility risk-free interest rate expected life 2009 grant 2008 grant 1.78% 38.45% 3.66% 5.5 years 1.27% 25.44% 4.25% 5.5 years the weighted average grant date fair value of options granted during the year was $5.07 (2008: $8.35). total stock option expense recognized in 2009 was $8.2 million (2008: $10.4 million). the following table summarizes information about stock options outstanding at December 31, 2009: options outstanding options exercisable number outstanding 503,369 1,321,153 1,448,732 3,026,200 6,299,454 weighted average remaining life weighted average exercise price 0.9 years 5.2 years 3.3 years 4.9 years 4.2 years $ $ $ $ $ 6.56 14.99 19.75 30.67 22.94 number outstanding weighted average exercise price 503,369 380,802 1,448,732 1,494,606 3,827,509 $ $ $ $ $ 6.56 15.84 19.75 30.97 22.01 range of exercise prices $6.23 - $8.50 $14.64 - $16.27 $19.75 - $19.82 $25.85 - $31.67 72 notes to tHe consoliDateD financial stateMents otHer stocK-BaseD coMPensation Plans the company has other stock-based compensation plans in the form of deferred share units, performance share units, and stock appreciation rights that use notional common share units. these notional units are valued based on the company’s common share price on the toronto stock exchange and are marked to market at the end of each fiscal quarter. in December 2007, the company entered into a variable rate share forward (vrsf) with a financial institution to hedge a portion of its outstanding deferred share units and vested share appreciation units, reducing the volatility caused by movements in the company’s share price on the value of these stock-based compensation plans – see note 4. Details of the plans are as follows: DIRECtORS direCtors’ deFerred share unit plan a (ddsu) the company offers a Deferred share unit Plan (DDsu) for members of the Board of Directors. under the DDsu Plan, non-employee Directors of the company may elect to allocate all or a portion of their annual compensation as deferred share units. these units are fully vested upon issuance. these units accumulate dividend equivalents in the form of additional units based on the dividends paid on the company’s common shares. units are redeemable for cash or shares only following cessation of service on the Board of Directors and must be redeemed by December 31st of the year following the year in which the cessation occurred. the value of the deferred share units when converted to cash will be equivalent to the market value of the company’s common shares at the time the conversion takes place. non-employee Directors of the company were allocated a total of 21,690 deferred share units in 2009 (2008: 39,512 share units), which were granted to the Directors and expensed over the calendar year as the units are issued. ExECUtIvE deFerred share unit plan a (dsu-a) under the Dsu-a Plan, senior executives of the company may be awarded deferred share units as approved by the Board of Directors. this plan utilizes notional units that are fully vested upon issuance to the executives. these units accumulate dividend equivalents in the form of additional units based on the dividends paid on the company’s common shares. units are redeemable only following cessation of employment and must be redeemed by December 31st of the year following the year in which the cessation occurred. no units have been awarded under the Dsu-a Plan since 2001. deFerred share unit plan b (dsu-b) under the Dsu-B Plan, executives of the company may be awarded performance based deferred share units as approved by the Board of Directors. this plan utilizes notional units that become vested at specified percentages or become vested partially on December 30th of the year following the year of retirement, death, or disability. these specified levels and vesting percentages are based on the company’s common share price at those specified levels exceeding, for ten consecutive days, the common share price at the date of grant. vested deferred share units are redeemable for a period of 30 days after cessation of employment, or by December 31st of the year following the year of retirement, death, or disability. the notional deferred share units that have not vested within five years from the date that they were granted expire. only vested units accumulate dividend equivalents in the form of additional units based on the dividends paid on the company’s common shares. no units have been awarded under the Dsu-B Plan since 2005. perFormanCe share unit plan (psu) in May 2009, the Board of Directors approved a new Performance share unit Plan (Psu Plan) for executives. under the Psu Plan, executives of the company may be awarded performance share units as approved by the Board of Directors. this plan utilizes notional units that become vested dependent on achieving future specified performance levels. vesting of the awards is based on the extent to which the company’s average return on equity achieves or exceeds the specified performance levels over a three-year period. vested performance share units are redeemable in cash based on the common share price at the end of the performance period. only vested units accumulate dividend equivalents in the form of additional units based on the dividends paid on the company’s common shares. compensation expense for the Psu Plan is recorded over the three-year performance period. the amount of compensation expense is adjusted over the three-year performance period to reflect the current market value of common shares and the number of shares anticipated to vest based upon the company’s forecast three-year average return on equity. executives of the company were allocated a total of 341,253 performance share units in 2009, based on 100% vesting (2008: nil). 2009 finning international inc. | 73 | notes to tHe consoliDateD financial stateMents 8. STOCK-BASED COMPENSATION PLANS (continued) the specified levels and respective vesting percentages are as follows: Performance level Below threshold threshold target Maximum average return on equity (over three-year period) Proportion of Psus vesting < 12% 12% 15% 17% or more nil 25% 100% 150% Details of the deferred share unit and performance share unit plans, which reflect the valuation changes, excluding the impact of the vrsf hedge, are as follows: for year ended December 31 units outstanding, beginning of year additions exercised outstanding, end of year liaBility ($ tHousanDs) Dsu-a Dsu-B 25,212 684 (8,463) 17,433 716,211 19,221 (164,942) 570,490 Balance, beginning of year expense (income) exercised Balance, end of year $ $ 359 73 (142) 290 $ $ 10,206 1,928 (2,618) 9,516 for year ended December 31 units outstanding, beginning of year additions exercised outstanding, end of year liaBility ($ tHousanDs) Dsu-a 57,179 867 (32,834) 25,212 Dsu-B 1,139,700 16,365 (439,854) 716,211 Balance, beginning of year expense (income) exercised Balance, end of year $ $ 1,639 (319) (961) 359 $ $ 32,664 (9,860) (12,598) 10,206 2009 DDsu 264,442 43,064 – 307,506 $ $ $ $ 3,768 1,362 – 5,130 2008 DDsu 294,033 52,226 (81,817) 264,442 8,427 (2,540) (2,119) 3,768 $ $ $ $ psu total – – – – – – – – 1,005,865 62,969 (173,405) 895,429 $ $ 14,333 3,363 (2,760) 14,936 Psu total – – – – – – – – 1,490,912 69,458 (554,505) 1,005,865 $ $ 42,730 (12,719) (15,678) 14,333 as at December 31, 2009 and 2008, all outstanding deferred share units (Dsu-a, Dsu-B, DDsu) have vested. as at December 31, 2009, none of the performance share units (Psu) were vested. mANAGEmENt ShARE APPRECIAtION RIGhtS (SAR) PlAN Beginning in 2002, awards under the sar Plan were granted to senior managers within canada and the u.K. and are exercisable over a seven-year period. the exercise price is determined based on the company’s common share price on the toronto stock exchange on the grant date. under the sar Plan, awards are expensed over the vesting period of three years when the market price of the company’s common shares exceeds the exercise price under the plan for vested units. changes, either increases or decreases, in the quoted market value of common shares between the date of grant and the measurement date result in a change in the measure of compensation for the award and will be amortized over the remaining vesting period. the sar Plan uses notional units that are valued based on the company’s common share price on the toronto stock exchange. 74 notes to tHe consoliDateD financial stateMents no sar units have been issued to management since 2005. Details of the sar plans, excluding the impact of the vrsf hedge, are as follows: for years ended December 31 units outstanding, beginning of year exercised cancelled outstanding, end of year vested, beginning of year vested exercised cancelled vested, end of year liaBility ($ tHousanDs) Balance, beginning of year expense (income) exercised Balance, end of year strike price ranges: 2009 2008 645,604 (81,754) (89,186) 474,664 645,604 – (81,754) (89,186) 474,664 836,875 (162,351) (28,920) 645,604 711,102 122,105 (162,351) (25,252) 645,604 $ $ 216 699 (198) 717 $ $ 11,443 (9,378) (1,849) 216 $13.03 - $16.22 suMMary – iMPact of stocK-BaseD coMPensation Plans changes in the value of all deferred share units, performance share units, and share appreciation rights is a result of fluctuations in the company’s common share price, management’s estimate of achieving performance targets, and the impact of new issues, including stock options, partially offset by the impact of the vrsf hedge. the net impact was an expense of $11.5 million in 2009 (2008: $16.9 million). 9. EARNINGS PER SHARE Basic earnings per share (ePs) is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated to reflect the dilutive effect of exercising outstanding stock options by applying the treasury stock method. for years ended December 31 ($ tHousanDs, excePt sHare anD Per sHare aMounts) 2009 Basic earnings per share: net income effect of dilutive securities: stock options Diluted earnings per share: net income and assumed conversions 2008 Basic earnings per share: net income effect of dilutive securities: stock options Diluted earnings per share: net income and assumed conversions income shares Per share $ $ $ $ 130,823 – 130,823 170,607,892 385,593 170,993,485 95,996 – 95,996 172,361,881 957,076 173,318,957 $ $ $ $ 0.77 – 0.77 0.56 – 0.55 2009 finning international inc. | 75 | notes to tHe consoliDateD financial stateMents 10. INVENTORIES December 31 ($ tHousanDs) on-hand equipment Parts and supplies internal service work in progress inventories 2009 589,983 326,481 77,059 993,523 $ $ 2008 $ $ 1,013,204 384,112 76,188 1,473,504 for the year ended December 31, 2009, on-hand equipment, parts, supplies, and internal service work in progress recognized as an expense amounted to $2,972.8 million (2008: $3,776.2 million). for the year ended December 31, 2009, the write-down of inventories to net realizable value, included in cost of sales, amounted to $35.3 million (2008: $20.8 million). 11. OTHER ASSETS December 31 ($ tHousanDs) other assets – current: future income taxes (note 6) supplier claims receivable income taxes recoverable Prepaid expenses current portion of finance assets (note 12) value added tax receivable Derivative assets (note 4) other other assets – long-term: accrued defined benefit pension asset (note 20) investment in energyst B.v. (a) Derivative assets (note 4) future income taxes (note 6) other 2009 2008 $ $ $ $ 48,803 40,121 35,826 29,350 23,479 12,400 3,420 13,631 207,030 174,538 27,687 26,079 1,534 15,712 245,550 $ $ $ $ 66,889 62,912 45,081 21,980 29,344 7,868 18,182 35,846 288,102 157,028 34,655 66,417 2,521 36,972 297,593 (a) the company accounts for its 25.4% investment in energyst using the equity method of accounting. in 2008, the company increased its interest in energyst by purchasing 36,455 new shares that were issued from treasury for cash of $11.5 million (eur 7.6 million). as a result, the company’s equity interest in energyst increased to 25.4% from 24.4%. 12. FINANCE ASSETS December 31 ($ tHousanDs) instalment notes receivable equipment leased to customers less accumulated depreciation total finance assets less current portion of instalment notes receivable 2009 32,126 29,253 (5,296) 23,957 56,083 (23,479) 32,604 $ $ 2008 38,852 2,676 (513) 2,163 41,015 (29,344) 11,671 $ $ Depreciation of equipment leased to customers for the year ended December 31, 2009 was $5.0 million (2008: $0.4 million). 76 notes to tHe consoliDateD financial stateMents 13. RENTAL EQUIPMENT December 31 ($ tHousanDs) cost less accumulated depreciation 2009 2008 $ 1,261,387 (570,267) 691,120 $ $ $ 1,621,494 (633,659) 987,835 rental equipment under capital leases of $19.6 million (2008: $40.4 million), net of accumulated depreciation of $10.2 million (2008: $6.5 million), are included above, of which $6.8 million was acquired during the year. Depreciation of rental equipment for the year ended December 31, 2009 was $211.9 million (2008: $273.0 million). 14. CAPITAL ASSETS lanD, BuilDings, anD eQuiPMent December 31 ($ tHousanDs) land Buildings and equipment 2009 accumulated depreciation cost net book value 2008 accumulated depreciation cost net book value $ 62,761 636,546 $ 699,307 $ – (216,530) $ (216,530) $ 62,761 420,016 $ 482,777 $ $ 71,224 610,253 681,477 $ $ – (210,618) (210,618) $ $ 71,224 399,635 470,859 land, buildings, and equipment under capital leases of $11.8 million (2008: $12.1 million), net of accumulated depreciation of $3.0 million (2008: $2.9 million), are included above, of which $1.2 million was acquired during the year. Depreciation of buildings and equipment for the year ended December 31, 2009 was $42.3 million (2008: $44.4 million). intangiBle assets December 31 ($ tHousanDs) subject to amortization customer contracts and related customer relationships software indefinite lives Distribution rights 2009 accumulated cost amortization net book value 2008 accumulated amortization cost net book value $ $ 13,349 54,888 68,237 $ (6,766) (20,648) (27,414) $ 6,583 34,240 40,823 646 68,883 – (27,414) $ $ 646 41,469 $ $ $ 12,879 44,844 57,723 (3,248) (16,777) (20,025) $ 646 58,369 $ – (20,025) $ 9,631 28,067 37,698 646 38,344 the company acquired intangible assets subject to amortization of $14.4 million in 2009 (2008: $18.9 million). the additions in 2009 primarily related to costs incurred in connection with the development of software to be used internally. amortization of intangible assets subject to amortization for the year ended December 31, 2009 was $8.4 million (2008: $6.8 million). certain intangible assets are considered to have indefinite lives because they are expected to generate cash flows indefinitely. 2009 finning international inc. | 77 | notes to tHe consoliDateD financial stateMents 15. ACQUISITION on January 15, 2008, the company’s canadian operation, finning (canada), acquired all of the issued and outstanding common shares of collicutt energy services ltd. (collicutt), a canadian oilfield service company. the purchase was accounted for under the purchase method of accounting. the results of collicutt’s operations have been included in the consolidated financial statements since that date. the purchase price of collicutt totaled $136.4 million. the purchase price was funded through $84.3 million in cash and 15,403 common shares of the company with a value of $0.4 million, acquisition costs of $6.9 million were incurred and paid on the transaction and the company repaid $44.8 million of collicutt’s existing bank debt, resulting in aggregate consideration of $136.4 million. the following table summarizes the fair value of the assets acquired and liabilities assumed at the date of acquisition. ($ tHousanDs) cash inventories other current assets future income taxes – current Property, plant, and equipment intangible assets goodwill total assets acquired current liabilities future income taxes – long-term total liabilities assumed net assets acquired $ $ 159 29,914 20,985 4,203 99,255 6,670 10,282 171,468 18,320 16,795 35,115 136,353 the intangible assets acquired consist primarily of customer relationships and non-competition agreements. customer relationships valued at $4.4 million are being amortized on a straight-line basis over their estimated life of three years, and non-competition agreements valued at $1.9 million are being amortized on a straight-line basis over their estimated life of seven years. the goodwill was assigned to the canada operating segment and is not deductible for tax purposes. 16. GOODWILL the change in the carrying amount of goodwill is as follows: December 31, 2009 ($ tHousanDs) goodwill, beginning of year acquired (a) foreign exchange translation adjustment goodwill, end of year December 31, 2008 ($ tHousanDs) goodwill, beginning of year acquired (a) (note 15) goodwill impairment (b) Disposed foreign exchange translation adjustment goodwill, end of year canada south america uK group consolidated $ $ $ $ 43,811 – – 43,811 $ $ 35,377 1,276 (5,202) 31,451 canada south america 33,431 10,380 – – – 43,811 $ $ 28,504 40 – – 6,833 35,377 $ $ $ $ 20,090 – (1,098) 18,992 $ $ 99,278 1,276 (6,300) 94,254 uK group consolidated 189,164 – (151,373) (1,428) (16,273) 20,090 $ $ 251,099 10,420 (151,373) (1,428) (9,440) 99,278 (a) in 2009, the company acquired the remaining issued and outstanding common shares of finning servicio especializado s.a., a machine repair, recovery, and reconditioning company based in chile for cash of approximately $3 million. as a result, the company now holds 100% of the issued and outstanding common shares. in 2008, the company acquired the assets and business operations of fort saskatchewan rentals inc., an equipment rental company based in alberta, canada for cash of approximately $1.3 million, and all of the issued and outstanding common shares of collicutt, as described in note 15. (b) there was no goodwill impairment identified in 2009 following the company’s annual impairment review. in 2008, the company performed its annual goodwill impairment review and determined that the fair value of Hewden was less than its book value, primarily due to increasing economic uncertainty in the global market and the higher cost of capital assumptions in the valuation methodology. as a result, the company recorded a goodwill impairment of $151.4 million. 78 notes to tHe consoliDateD financial stateMents 17. LONG-TERM OBLIGATIONS December 31 ($ tHousanDs) stock-based compensation (note 4 and 8) leasing obligations (a) (note 23) employee future benefit obligations sale leaseback deferred gain asset retirement obligations (b) other 2009 41,797 12,086 23,974 6,990 3,010 22,290 110,147 $ $ 2008 41,425 16,975 20,311 7,854 1,119 8,612 96,296 $ $ (a) capital leases issued at varying rates of interest from 0.2% – 25.3% and maturing on various dates up to 2026. (b) asset retirement obligations relate to estimated future costs to remedy dilapidation costs on certain operating leases in the u.K. and are based on the company’s prior experience, including estimates for labour, materials, equipment, and overheads such as surveyor and legal costs. to determine the recorded liability, the future estimated cash flows have been discounted using the company’s credit-adjusted risk-free rate of 4%. should changes occur in estimated future dilapidation costs, revisions to the liability could be made. the total undiscounted amount of estimated cash flows is $13.4 million, and the expected timing of payment of the cash flows is estimated to be over the next thirty years. 18. CUMULATIVE CURRENCY TRANSLATION ADJUSTMENTS the company’s principal subsidiaries operate in three functional currencies: canadian dollars, u.s. dollars, and the u.K. pound sterling. the company experiences foreign currency translation gains or losses as a result of consolidating the financial statements of self-sustaining foreign operations. these unrealized foreign currency translation gains or losses are recorded in the accumulated other comprehensive income/loss account on the consolidated Balance sheet. currency translation adjustments arise as a result of fluctuations in foreign currency exchange rates between period ends. the cumulative currency translation adjustment for 2009 mainly resulted from the stronger canadian dollar relative to the u.s. dollar (14.5% stronger), and the u.K. pound sterling (5.5% stronger), at December 31, 2009 compared to December 31, 2008. the exchange rates of the canadian dollar against the following foreign currencies were as follows: December 31 exchange rate u.s. dollar u.K. pound sterling for years ended December 31 average exchange rates u.s. dollar u.K. pound sterling 2009 1.0466 1.6918 2009 1.1420 1.7804 2008 1.2246 1.7896 2008 1.0660 1.9617 2009 finning international inc. | 79 | notes to tHe consoliDateD financial stateMents 19. SUPPLEMENTAL CASH FLOW INFORMATION non casH WorKing caPital cHanges for years ended December 31 ($ tHousanDs) accounts receivable and other inventories – on-hand equipment inventories – parts and supplies accounts payable and accruals income taxes changes in working capital items coMPonents of casH anD casH eQuivalents December 31 ($ tHousanDs) cash short-term investments cash and cash equivalents interest anD tax PayMents for years ended December 31 ($ tHousanDs) interest paid income taxes paid 2009 2008 $ $ 205,647 372,155 62,635 (482,348) (779) 157,310 2009 $ $ 110,672 87,232 197,904 $ $ $ $ (159,284) (112,587) (43,045) 82,560 (69,013) (301,369) 2008 105,905 3,867 109,772 2009 2008 $ $ (57,714) (7,763) $ $ (83,569) (94,767) 20. EMPLOYEE FUTURE BENEFITS the company and its subsidiaries in canada and the u.K. have defined benefit pension plans and defined contribution pension plans providing retirement benefits for most of their permanent employees. the defined benefit pension plans include both registered and non-registered pension plans that provide a pension based on the members’ final average earnings and years of service while participating in the pension plan. • • • in canada, defined benefit plans exist for eligible employees. final average earnings are based on the highest 3-5 year average salary and there is no standard indexation feature. effective July 1, 2004, non-executive members of the defined benefit plan were offered a voluntary opportunity to convert their benefits to a defined contribution pension plan. the registered defined benefit plan was subsequently closed to all new non-executive employees, who are eligible to enter one of the company’s defined contribution plans. effective January 1, 2010, the defined benefit plan will also be closed to new executive employees, who will be eligible to join a defined contribution plan. Pension benefits under the registered defined benefit plans’ formula that exceed the maximum taxation limits are provided from a non-registered supplemental pension plan. Benefits under this plan are partially funded by a retirement compensation arrangement. finning (uK) provides a defined benefit plan for all employees hired prior to January 2003. final average earnings are based on the highest 3-year period and benefits are indexed annually with inflation subject to limits. effective January 2003, this plan was essentially closed to new employees and replaced with a defined contribution pension plan. Hewden has two defined benefit plans that are open to eligible management and executive members by invitation only. final average earnings are based on the highest 3-year period and benefits are indexed annually with inflation subject to limits. the defined contribution pension plans in canada are registered pension plans that offer a base company contribution rate for all members. the company will also partially match employee contributions to a maximum additional company contribution of 1% of employee earnings. the defined contribution pension plan in the uK offers a match of employee contributions, within a required range, plus 1%. the company’s south american employees do not participate in employer pension plans but are covered by country specific legislation with respect to indemnity plans. the company has recorded a liability to employees based on an actuarial valuation of anticipated payments to employees. an amount of $5.3 million was expensed in 2009 (2008: $4.3 million) for a total obligation at December 31, 2009 of $24.0 million (2008: $20.3 million). 80 notes to tHe consoliDateD financial stateMents the expense for the company’s benefit plans, primarily for pension benefits, is as follows: for years ended December 31 ($ tHousanDs) Defined contribution plans net benefit plan expense Defined benefit plans current service cost, net of employee contributions interest cost actual loss (return) on plan assets actuarial (gains) losses employee future benefit costs before adjustments to recognize the long-term nature of employee future benefit costs Adjustments to recognize the long-term nature of employee future benefit costs: Difference between expected return and actual return on plan assets for year Difference between actuarial loss recognized for year and actual actuarial gain or loss on accrued benefit obligation for year Difference between amortization of past service costs for year and actual plan amendments for year amortization of transitional obligation / (asset) Defined benefit costs recognized total canada uK hewden total canada uK Hewden total 2009 2008 $ 21,887 $ 1,581 $ 112 $ 23,580 $ 21,163 $ 1,104 $ 159 $ 22,426 $ 5,494 19,963 $ 2,891 20,345 $ 842 9,069 $ 9,227 49,377 $ 7,014 18,474 $ 3,713 24,329 $ 1,436 10,324 $ 12,163 53,127 (31,134) 70,283 (71,177) 146,173 (24,984) 49,128 (127,295) 265,584 42,184 (60,837) 86,407 (99,297) 33,859 (30,120) 162,450 (190,254) 64,606 98,232 34,055 196,893 6,835 15,152 15,499 37,486 13,630 49,791 16,430 79,851 (62,505) (115,187) (45,539) (223,231) (66,921) (143,263) (47,401) (257,585) 64,060 100,941 30,693 195,694 298 (588) (137) (427) 298 (647) (143) (492) (19) (1,034) 1,143 90 (19) (1,140) 1,259 100 11,594 $ 33,481 3,138 $ 4,719 4,090 $ 4,202 18,822 $ 42,402 8,669 $ 29,832 (881) 223 1,769 $ 1,928 9,557 $ 31,983 $ total cash payments for employee future benefits for 2009, which is made up of cash contributed by the company to its defined benefit plans and its defined contribution plans was $42.8 million and $23.6 million, respectively (2008: $49.3 million and $22.4 million, respectively). 2009 finning international inc. | 81 | notes to tHe consoliDateD financial stateMents 20. EMPLOYEE FUTURE BENEFITS (continued) information about the company’s defined benefit plans is as follows: for years ended December 31 ($ tHousanDs) accrued benefit obligation Balance at beginning of year current service cost interest cost Benefits paid actuarial (gains) losses foreign exchange rate changes Balance at end of year plan assets fair value at beginning of year actual return (loss) on plan assets employer contributions employees’ contributions Benefits paid foreign exchange rate changes fair value at end of year funded status – plan surplus/(deficit) unamortized net actuarial loss unamortized past service costs contributions remitted after valuation date unamortized transitional obligation/asset accrued benefit asset/ (liability) (a) canada uK hewden total canada uK Hewden total 2009 2008 $ 267,253 7,237 19,963 (20,338) 70,283 – $ 344,398 $ 290,273 4,107 20,345 (19,825) 146,173 (23,367) $ 417,706 1,200 9,069 (9,550) $ 131,010 $ 688,536 12,544 49,377 (49,713) 265,584 (33,009) $ 171,215 $ 933,319 49,128 (9,642) $ 318,152 8,708 18,474 (17,244) (60,837) – $ 267,253 $ 400,820 6,179 24,329 (14,191) (99,297) (27,567) $ 290,273 $ 169,964 2,346 10,324 (9,053) (30,120) (12,451) $ 131,010 $ 888,936 17,233 53,127 (40,488) (190,254) (40,018) $ 688,536 $ 257,629 $ 302,621 $ 117,867 $ 678,117 $ 298,994 $ 407,486 $ 159,086 $ 865,566 31,134 12,454 1,744 (20,338) – $ 282,623 71,177 20,428 1,216 (19,825) (20,170) $ 355,447 24,984 10,691 358 (9,550) (7,761) 127,295 43,573 3,318 (49,713) (27,931) $ 136,589 $ 774,659 (42,184) 16,369 1,694 (17,244) – $ 257,629 (86,407) 22,018 2,466 (14,191) (28,751) $ 302,621 (33,859) 11,980 910 (9,053) (11,197) $ 117,867 (162,450) 50,367 5,070 (40,488) (39,948) $ 678,117 $ (61,775) $ (62,259) $ (34,626) $ (158,660) $ (9,624) $ 12,348 $ (13,143) $ (10,419) 116,404 156,126 63,179 335,709 63,115 71,196 35,697 170,008 1,472 (5,583) (1,435) (5,546) 1,769 (6,496) (1,655) (6,382) 2,188 1,663 849 4,700 2,934 1,659 897 5,490 (63) (3,866) 2,264 (1,665) (83) (5,129) 3,543 (1,669) $ 58,226 $ 86,081 $ 30,231 $ 174,538 $ 58,111 $ 73,578 $ 25,339 $ 157,028 (a) the accrued benefit asset or liability is classified in either other assets or long-term obligations, respectively, on the consolidated balance sheets. included in the above accrued benefit obligation and fair value of plan assets at the year-end are the following amounts in respect of plans that are not fully funded: for years ended December 31 ($ tHousanDs) canada uK hewden total canada uK Hewden total 2009 2008 accrued benefit obligation fair value of plan assets funded status – plan deficit $ 342,433 277,522 $ 64,911 $ 417,706 355,447 $ 62,259 $ 171,215 136,589 $ 34,626 $ 931,354 769,558 $ 161,796 $ 219,457 205,180 $ 14,277 $ $ – – – $ 118,702 105,409 $ 13,293 $ 338,159 310,589 $ 27,570 for measurement purposes, assets and liabilities of the plans are valued as at november 30. Plan assets do not include direct investment in common shares of the company at December 31, 2009 and 2008. 82 notes to tHe consoliDateD financial stateMents Plan assets are principally invested in the following securities at november 30, 2009: equity fixed-income real estate the significant actuarial assumptions are as follows: Discount rate – obligation Discount rate – expense expected long-term rate of return on plan assets rate of compensation increase estimated remaining service life (years) canada 5.50% 7.50% 7.00% 3.50% 9-11 2009 uK 5.50% 7.20% 7.00% 4.00% 14 canada uK hewden 54.1% 38.7% 7.2% 60.3% 39.7% – 61.3% 38.7% – 2008 hewden canada uK Hewden 5.50% 7.20% 7.25% 4.00% 12 7.50% 5.80% 7.25% 3.50% 8-11 7.20% 6.20% 7.00% 4.00% 14 7.20% 6.20% 7.25% 4.00% 13 Discount rates are determined based on high quality corporate bonds at the measurement date, november 30. Market conditions and the economic environment resulted in significantly lower corporate bond yields at november 30, 2009 than at november 30, 2008 as corporate spreads have narrowed significantly over the past year. the accrued defined benefit pension obligations and expense are sensitive to changes in the discount rate, among other assumptions. as an indication, if yields were lower, the accrued defined benefit pension obligations as presented in this note would be higher. as an indication of the sensitivity of finning’s defined benefit pension obligation, if the discount rates were 0.25% lower at november 30, 2009, the accrued defined benefit pension obligation presented would have increased by approximately $9 million for finning (canada)’s plans, £11 million for the finning uK plan, and £5 million for the Hewden plans. Defined benefit pension plans are country and entity specific. the major defined benefit plans and their respective valuation dates are: Defined Benefit Plan last actuarial valuation Date next actuarial valuation Date canada – Bc regular & executive Plan canada – executive supplemental income Plan canada – general supplemental income Plan canada – alberta Defined Benefit Plan finning uK Defined Benefit scheme Hewden stuart Pension scheme Hewden Pension Plan December 31, 2006 December 31, 2006 December 31, 2006 December 31, 2008 December 31, 2008 December 31, 2008 January 1, 2008 December 31, 2009 December 31, 2009 December 31, 2009 December 31, 2009 December 31, 2011 December 31, 2011 January 1, 2011 21. ECONOMIC RELATIONSHIPS the company distributes and services heavy equipment, engines, and related products. the company has dealership agreements with numerous equipment manufacturers, of which the most significant are with subsidiaries of caterpillar inc. Distribution and servicing of caterpillar products account for the major portion of the company’s operations. finning has a strong relationship with caterpillar inc. that has been ongoing since 1933. 2009 finning international inc. | 83 | notes to tHe consoliDateD financial stateMents 22. SEGMENTED INFORMATION the company and its subsidiaries have operated primarily in one industry during the year, that being the selling, servicing, and renting of heavy equipment, engines, and related products. the reportable operating segments are as follows: • • • • Canadian operations: British columbia, alberta, the yukon territory, the northwest territories, and a portion of nunavut. South American operations: chile, argentina, uruguay, and Bolivia. UK Group operations: england, scotland, Wales, falkland islands, and the channel islands. Other: corporate head office. for year ended December 31, 2009 ($ tHousanDs) canada south america uK group other impairment consolidated goodwill revenue from external sources operating costs Depreciation and amortization other income (expenses) it system implementation costs other earnings before interest and taxes finance costs Provision for income taxes net income identifiable assets capital assets gross capital expenditures(1) gross rental asset expenditures $ 2,386,642 (2,125,706) (132,614) 128,322 $ 1,489,600 (1,299,386) (37,405) 152,809 $ 861,299 (774,788) (97,480) (10,969) $ – (25,446) (182) (25,628) $ (10,574) (19,421) $ 98,327 (5,616) 6,532 $ 153,725 (2,388) (6,780) (279) 1,012 $ (20,137) $ (24,895) $ $ 1,651,206 $ 307,627 $ 55,129 $ 118,071 $ 1,034,074 $ 123,791 $ 45,265 $ 20,549 $ 924,567 91,509 $ 8,534 $ 35,559 $ $ $ $ $ 61,588 1,319 – – $ $ $ $ – – – – – – – – – – – $ 4,737,541 (4,225,326) (267,681) 244,534 (18,857) (18,657) $ 207,020 (67,608) (8,589) $ 130,823 $ 3,671,435 $ 524,246 $ 108,928 $ 174,179 for year ended December 31, 2008 ($ tHousanDs) canada south america uK group other impairment consolidated goodwill $ 3,216,946 (2,801,877) (164,489) 250,580 $ 1,501,633 (1,313,753) (34,217) 153,663 $ 1,272,842 (1,099,805) (125,447) 47,590 (7,921) (8,181) – $ 234,478 (4,388) (1,040) – $ 148,235 $ (2,581) 8,617 – 53,626 $ 2,094,186 $ 278,171 $ 143,269 $ 296,166 $ 1,350,929 $ 115,626 47,940 $ 76,715 $ $ 1,135,352 114,811 $ 15,234 $ 161,803 $ $ $ $ $ $ $ $ 4 (46,709) (208) (46,913) (1,307) – – (48,220) $ 139,908 595 – – $ $ $ $ – – – – $ 5,991,425 (5,262,144) (324,361) 404,920 (16,197) – (604) – (151,373) (151,373) (151,373) $ 236,746 (83,636) (57,114) $ 95,996 $ 4,720,375 $ 509,203 $ 206,443 $ 534,684 – – – – revenue from external sources operating costs Depreciation and amortization other income (expenses) it system implementation costs other goodwill impairment (note 16) earnings before interest and taxes finance costs Provision for income taxes net income identifiable assets capital assets gross capital expenditures(1) gross rental asset expenditures (1) includes capital leases 84 notes to tHe consoliDateD financial stateMents 23. CONTRACTUAL OBLIGATIONS future minimum lease payments due under capital lease contracts and payments due under various operating lease contracts are as follows: for years ended December 31 ($ tHousanDs) 2010 2011 2012 2013 2014 thereafter less imputed interest less current portion of capital lease obligation total long-term capital lease obligation operating leases 71,064 56,614 39,377 28,457 20,218 137,916 353,646 $ $ capital leases 8,118 2,156 1,230 1,065 1,065 13,731 27,365 (8,103) 19,262 (7,176) 12,086 $ $ $ 24. COMMITMENTS AND CONTINGENCIES (a) Due to the size, complexity, and nature of the company’s operations, various legal and tax matters are pending. in the opinion of management, these matters will not have a material effect on the company’s consolidated financial position or results of operations. (b) the company has committed to pay approximately $11 million over the next year for consulting and implementation support for a new information technology system solution for its global operations. 25. GUARANTEES AND INDEMNIFICATIONS the company enters into contracts with rights of return, in certain circumstances, for the repurchase of equipment sold to customers for an amount based on an estimate of the future value of the fair market price at that time. as at December 31, 2009, the total estimated value of these contracts outstanding is $164.4 million coming due at periods ranging from 2010 to 2016. the company’s experience to date has been that the equipment at the exercise date of the contract is worth more than the repurchase amount. the total amount recognized as a provision against these contracts is $0.8 million. the company has issued certain guarantees to caterpillar finance to guarantee, on a pro-rata basis, certain borrowers’ obligations. the guarantees would be enforceable in the event that the borrowers defaulted on their obligations to caterpillar finance, to the extent that any net proceeds from the recovery and sale of collateral securing repayment of the borrowers’ obligations is insufficient to meet those obligations. as at December 31, 2009, the maximum potential amount of future payments that the company could be required to make under the guarantees, before any amounts that may possibly be recovered under recourse or collateralization provisions in the guarantees, is $12.6 million, covering various periods up to 2014. as at December 31, 2009, the company had no liability recorded for these guarantees. as part of the tool Hire Division’s Purchase and sale agreement, finning had provided indemnifications to the third party purchaser, covering breaches of representation and warranties as well as litigation and other matters set forth in the agreement. claims may be made by the third party purchaser under the agreement for various periods of time depending on the nature of the claim. the maximum potential exposure of finning under these indemnifications is 50% of the purchase price. as at December 31, 2009, finning had no material liabilities recorded for these indemnifications. in connection with the sale of the Materials Handling Division in 2006, the company provided a guarantee to a third party with respect to a property lease. if the lessee were to default, the company would be required to make the annual lease payments of approximately $1.0 million to the end of the lease term in 2020. as at December 31, 2009, the company had no liability recorded for this guarantee. in the normal course of operations, the company has several long-term maintenance and repair contracts with various customers which contain cost per hour guarantees. During the year, the company entered into various other commercial letters of credit in the normal course of operations. 2009 finning international inc. | 85 | ten year financial suMMary for years ended December 31 ($ tHousanDs excePt Per sHare Data) revenue(1) canadian operations south american operations uK operations Hewden uK group international operations total consoliDateD earnings before interest and tax (eBit)(1)(2) as a percent of revenue net income(1)(2) as a percent of revenue earnings Per coMMon sHare(1)(2) Basic Diluted DiviDenDs total common share Per common share cash flow after working capital changes cash flow per share gross capital expenditures ratios asset turnover ratio net debt to total capitalization(3) Debt to equity(3) liabilities to equity(3) Book value per common share return on average shareholders’ equity(1)(2) coMMon sHare Price High low year end common shares outstanding (thousands) revenue per employee net income per employee(2) nuMBer of eMPloyees canada south america uK Hewden uK group international total 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 $ 2,386,642 $ 1,489,600 603,678 $ 257,621 $ 861,299 $ – $ $ 4,737,541 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 207,020 4.4% 130,823 2.8% 0.77 0.77 74,970 0.44 546,394 3.20 108,928 1.13 39% 0.78:1 8.88 8.3% 19.06 10.15 16.68 170,747 396,414 10,947 4,144 4,954 1,472 1,311 2,783 70 11,951 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 3,216,946 1,501,633 879,777 393,065 1,272,842 4 5,991,425 236,746 4.0% 95,996 1.6% 0.56 0.55 73,997 0.43 278,133 1.63 206,443 1.35 49% 1.03:1 9.19 5.8% 31.15 12.09 14.25 170,445 439,899 7,048 5,061 4,988 1,647 1,859 3,506 65 13,620 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,936,229 1,325,582 946,938 453,489 1,400,427 6 5,662,244 455,847 8.0% 280,107 4.9% 1.57 1.55 64,446 0.36 404,427 2.30 77,819 1.36 41% 0.73:1 9.19 16.8% 33.50 23.10 28.66 176,132 440,642 21,798 4,618 4,638 1,445 2,098 3,543 51 12,850 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,612,597 1,009,906 796,080 434,650 1,230,730 6 4,853,239 373,708 7.7% 236,187 4.9% 1.32 1.31 49,159 0.275 460,210 2.57 89,370 1.22 40% 0.72:1 9.07 15.8% 23.90 18.05 23.90 179,090 392,605 18,726 4,106 3,865 1,354 3,487 4,841 44 12,856 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,049,675 1,007,341 830,412 440,852 1,271,264 – 4,328,280 257,955 6.0% 161,672 3.7% 0.91 0.90 39,097 0.22 478,757 2.68 81,111 1.15 46% 0.87:1 7.92 11.8% 20.70 16.13 18.57 178,404 377,554 12,810 3,316 3,377 2,471 3,603 6,074 38 12,805 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,562,584 869,893 717,877 685,930 1,403,807 15 3,836,299 271,933 7.1% 114,946 3.0% 0.73 0.72 31,181 0.20 247,422 1.40 106,202 1.15 50% 1.03:1 1.48:1 7.50 11.0% 17.70 14.43 17.50 176,780 338,918 9,360 2,936 3,203 2,373 3,724 6,097 44 12,280 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,456,357 561,964 934,193 640,757 1,574,950 24 3,593,295 255,168 7.1% 131,951 3.7% 0.86 0.84 27,816 0.18 384,210 2.47 89,657 1.09 42% 0.79:1 1.48:1 6.16 14.3% 16.60 11.50 15.00 155,510 314,953 11,566 2,717 2,456 2,387 3,804 6,191 45 11,409 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,269,275 444,644 828,246 665,266 1,493,512 55 3,207,486 277,783 8.7% 132,253 4.1% 0.86 0.84 23,100 0.15 472,804 3.05 47,426 1.05 37% 0.60:1 1.33:1 6.00 15.7% 14.43 9.83 12.78 155,160 327,462 13,502 2,548 1,817 1,578 3,813 5,391 39 9,795 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,398,623 448,005 804,084 587,482 1,391,566 8,849 3,247,043 241,601 7.4% 103,917 3.2% 0.69 0.67 15,155 0.10 445,623 2.94 51,180 1.25 47% 0.87:1 1.53:1 5.12 14.1% 10.18 6.05 10.00 151,632 331,230 10,601 2,629 1,516 1,553 4,066 5,619 39 9,803 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,214,516 474,145 682,162 – 682,162 89,209 2,460,032 165,263 6.7% 73,391 3.0% 0.48 0.47 15,452 0.10 357,780 2.36 15,284 1.18 57% 1.04:1 1.75:1 4.51 10.5% 6.93 4.93 6.35 151,580 477,120 14,234 2,326 1,390 1,404 – 1,404 36 5,156 certain comparative figures have been reclassified to conform to the 2009 presentation. in addition, financial data has been restated to incorporate common share subdivision occurring during the ten year period. (1) on July 31, 2007, the company’s u.K. subsidiary, Hewden stuart Plc. (Hewden) sold its tool Hire Division. results from that operation have been reclassified to discontinued operations for the years ended December 31, 2007, 2006, and 2005. on september 29, 2006, the company’s u.K. subsidiary, finning (uK) sold its Materials Handling Division. results from that operation have been reclassified to discontinued operations for the years ended December 31, 2006, 2005, and 2004. therefore, revenue, eBit, net income, earnings per common share, and return on average shareholders’ equity reflect results from continuing operationss for those years. (2) in 2008, the company performed its annual goodwill impairment review and determined that the fair value of Hewden was less than its book value, which included goodwill on acquisition. as a result, the company recorded a full goodwill impairment charge of $151.4 million ($0.88 basic and diluted loss per share) for Hewden in the fourth quarter of 2008. (3) in 2008, the net debt to total capitalization calculation was changed to include cash and cash equivalents in the definition of net debt; accordingly, net debt to total capitalization for years 1999 - 2007 has been restated. equity ratio for years 2001 to 2003 included non-controlling interest that was treated as equity. equity ratio for 2000 year does not include investment in Hewden. 86 for years ended December 31 ($ tHousanDs excePt Per sHare Data) revenue(1) canadian operations south american operations uK operations Hewden uK group international operations total consoliDateD earnings before interest and tax (eBit)(1)(2) as a percent of revenue net income(1)(2) as a percent of revenue earnings Per coMMon sHare(1)(2) Basic Diluted DiviDenDs total common share Per common share cash flow after working capital changes cash flow per share gross capital expenditures ratios asset turnover ratio net debt to total capitalization(3) Debt to equity(3) liabilities to equity(3) Book value per common share return on average shareholders’ equity(1)(2) coMMon sHare Price High low year end common shares outstanding (thousands) revenue per employee net income per employee(2) nuMBer of eMPloyees canada south america uK Hewden uK group international total 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 ten year financial suMMary $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,386,642 $ 1,489,600 $ 4,737,541 603,678 257,621 861,299 – 207,020 4.4% 130,823 2.8% 0.77 0.77 74,970 0.44 546,394 3.20 108,928 1.13 39% 0.78:1 8.88 8.3% 19.06 10.15 16.68 170,747 396,414 10,947 4,144 4,954 1,472 1,311 2,783 70 11,951 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 3,216,946 1,501,633 879,777 393,065 1,272,842 4 5,991,425 236,746 4.0% 95,996 1.6% 0.56 0.55 73,997 0.43 278,133 1.63 206,443 1.35 49% 1.03:1 9.19 5.8% 31.15 12.09 14.25 170,445 439,899 7,048 5,061 4,988 1,647 1,859 3,506 65 13,620 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,936,229 1,325,582 946,938 453,489 1,400,427 6 5,662,244 455,847 8.0% 280,107 4.9% 1.57 1.55 64,446 0.36 404,427 2.30 77,819 1.36 41% 0.73:1 9.19 16.8% 33.50 23.10 28.66 176,132 440,642 21,798 4,618 4,638 1,445 2,098 3,543 51 12,850 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,612,597 1,009,906 796,080 434,650 1,230,730 6 4,853,239 373,708 7.7% 236,187 4.9% 1.32 1.31 49,159 0.275 460,210 2.57 89,370 1.22 40% 0.72:1 9.07 15.8% 23.90 18.05 23.90 179,090 392,605 18,726 4,106 3,865 1,354 3,487 4,841 44 12,856 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,049,675 1,007,341 830,412 440,852 1,271,264 – 4,328,280 257,955 6.0% 161,672 3.7% 0.91 0.90 39,097 0.22 478,757 2.68 81,111 1.15 46% 0.87:1 7.92 11.8% 20.70 16.13 18.57 178,404 377,554 12,810 3,316 3,377 2,471 3,603 6,074 38 12,805 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,562,584 869,893 717,877 685,930 1,403,807 15 3,836,299 271,933 7.1% 114,946 3.0% 0.73 0.72 31,181 0.20 247,422 1.40 106,202 1.15 50% 1.03:1 1.48:1 7.50 11.0% 17.70 14.43 17.50 176,780 338,918 9,360 2,936 3,203 2,373 3,724 6,097 44 12,280 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,456,357 561,964 934,193 640,757 1,574,950 24 3,593,295 255,168 7.1% 131,951 3.7% 0.86 0.84 27,816 0.18 384,210 2.47 89,657 1.09 42% 0.79:1 1.48:1 6.16 14.3% 16.60 11.50 15.00 155,510 314,953 11,566 2,717 2,456 2,387 3,804 6,191 45 11,409 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,269,275 444,644 828,246 665,266 1,493,512 55 3,207,486 277,783 8.7% 132,253 4.1% 0.86 0.84 23,100 0.15 472,804 3.05 47,426 1.05 37% 0.60:1 1.33:1 6.00 15.7% 14.43 9.83 12.78 155,160 327,462 13,502 2,548 1,817 1,578 3,813 5,391 39 9,795 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,398,623 448,005 804,084 587,482 1,391,566 8,849 3,247,043 241,601 7.4% 103,917 3.2% 0.69 0.67 15,155 0.10 445,623 2.94 51,180 1.25 47% 0.87:1 1.53:1 5.12 14.1% 10.18 6.05 10.00 151,632 331,230 10,601 2,629 1,516 1,553 4,066 5,619 39 9,803 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,214,516 474,145 682,162 – 682,162 89,209 2,460,032 165,263 6.7% 73,391 3.0% 0.48 0.47 15,452 0.10 357,780 2.36 15,284 1.18 57% 1.04:1 1.75:1 4.51 10.5% 6.93 4.93 6.35 151,580 477,120 14,234 2,326 1,390 1,404 – 1,404 36 5,156 certain comparative figures have been reclassified to conform to the 2009 presentation. in addition, financial data has been restated to incorporate common share subdivision occurring during the ten year period. (1) on July 31, 2007, the company’s u.K. subsidiary, Hewden stuart Plc. (Hewden) sold its tool Hire Division. results from that operation have been reclassified to discontinued operations for the years ended December 31, 2007, 2006, and 2005. on september 29, 2006, the company’s u.K. subsidiary, finning (uK) sold its Materials Handling Division. results from that operation have been reclassified to discontinued operations for the years ended December 31, 2006, 2005, and 2004. therefore, revenue, eBit, net income, earnings per common share, and return on average shareholders’ equity reflect results from continuing operationss (2) in 2008, the company performed its annual goodwill impairment review and determined that the fair value of Hewden was less than its book value, which included goodwill on acquisition. as a result, the company recorded a full goodwill impairment charge of $151.4 million ($0.88 basic and diluted loss per share) for those years. for Hewden in the fourth quarter of 2008. (3) in 2008, the net debt to total capitalization calculation was changed to include cash and cash equivalents in the definition of net debt; accordingly, net debt to total capitalization for years 1999 - 2007 has been restated. equity ratio for years 2001 to 2003 included non-controlling interest that was treated as equity. equity ratio for 2000 year does not include investment in Hewden. 2009 finning international inc. | 87 | BoarD of Directors ricarDo Bacarreza santiago, chile President of Proinvest s.a. Director since 1999 Member of audit committee and Pension committee James e.c. carter edmonton, alberta, canada Director of ePcor utilities inc., clark Builders, the climate change emissions Management corporation and careers: the next generation Director since 2007 Member of audit committee and environment, Health and safety committee hon. DaviD l. emerson, p.c. vancouver, British columbia, canada Director of stantec inc., timberWest forest corporation chair of the alberta Premier’s council for economic strategy, chair of the energy Policy institute of canada, co chair of the Prime Minister’s advisory council for Public service renewal Director since 2008 Member of audit committee and Pension committee Kathleen m. o’neill toronto, ontario, canada Director of tMx group inc., arc energy trust, invesco trimark funds and canadian tire Bank, a subsidiary of canadian tire corporation Director since 2007 chair of Pension committee and a member of, and the designated ‘financial expert’ for audit committee and a member of Human resources committee conraD a. pinette vancouver, British columbia, canada Director of a&W revenue royalties income fund, canfor corporation, northgate Minerals corporation and timberWest forest corporation Director since 1992 chair of corporate governance committee and a member of Human resources committee and Pension committee John m. reiD vancouver, British columbia, canada Director of Methanex corporation Director since 2006 chair of audit committee and a member of corporate governance committee anDrew h. simon, oBe Bougy-villars, switzerland Director of exova group plc, sgl carbon se supervisory Board, travis Perkins plc and Management consulting group plc Director since 1999 Member of audit committee and environment, Health and safety committee Bruce l.turner santiago, chile President and chief executive officer of apoquindo Minerals inc. and turner Minerals s.a. Director since 2006 chair of environment, Health and safety committee and a member of Human resources committee and corporate governance committee michael t. waites vancouver, British columbia, canada President and chief executive officer, finning international inc. Director since 2008 Member of environment, Health and safety committee Douglas w.g. whiteheaD vancouver, British columbia, canada Director of Ballard Power systems inc., inmet Mining corporation, international forest Products ltd. and Belkorp industries Director since 1999 chairman of the Board of Directors John m. willson vancouver, British columbia, canada Director of nexen inc. and garaventa (canada) ltd. Director since 2000 lead Director, chair of Human resources committee and member of corporate governance committee Please refer to the corporation’s management proxy circular for detailed biographies of finning directors. 88 corPorate officers michael t. waites PresiDent anD cHief executive officer finning international inc. DaviD e. parKer PresiDent finning (canaDa) anDrew s. Fraser Managing Director finning grouP (uK) anna p. marKs senior vice PresiDent, corPorate controller finning international inc. thomas m. merinsKy vice PresiDent, treasurer finning international inc. J. gail sexsmith corPorate secretary finning international inc. DaviD s. smith executive vice PresiDent anD cHief financial officer finning international inc. Juan carlos villegas PresiDent finning soutH aMerica 2009 finning international inc. | 89 | corPorate governance the corporation’s Board of Directors and management are committed to the highest standards of good corporate governance and understand that such standards are central to the efficient and effective operation of the corporation in a manner that ultimately enhances shareholder value. BoarD manDate anD composition the Board of Directors has overall responsibility for the corporation’s business conduct. the Board fulfills this responsibility both directly and by delegating certain authority to Board committees and to the corporation’s senior management. the Board of Directors is currently made up of 11 members. all directors, other than Michael t. Waites (who is the President and chief executive officer of the corporation) and Douglas W.g. Whitehead (who was the former President and chief executive officer) are independent. in addition, in order to ensure that the Board can function independently from management, the corporation has separated the role of chairman of the Board and chief executive officer. to ensure objectivity, the Board has appointed an independent lead Director, John M. Willson, and the Board further ensures its independence by convening independent director-only in camera sessions at every Board Meeting. finally, each year the Board, facilitated by the corporate governance committee, formally reviews its own performance, the performance of each committee of the Board, the performance of the chairman of the Board, the performance of each individual director (peer assessment) and the performance of the chief executive officer. committees oF the BoarD oF Directors there are currently five standing committees of the Board of Directors: the audit committee, the corporate governance committee, the environment, Health and safety committee, the Pension committee and the Human resources committee. each committee operates in accordance with Board-approved terms of reference. the audit committee the audit committee provides assistance to the Board of Directors in fulfilling its oversight responsibility to the shareholders with respect to the corporation’s: financial statements; financial reporting process; systems of internal and disclosure controls; internal audit function; external audit function; financial arrangements and liquidity; and risk identification, assessment and management program. it is the responsibility of the committee to maintain an open avenue of communication between itself, the external auditors, the internal auditors and management of the corporation. in performing its role, the committee is empowered to investigate any matter brought to its attention, with full access to all books, records, facilities and personnel of the corporation. it is also empowered to retain outside counsel or other experts as required. the corporate governance committee the corporate governance committee provides assistance to the Board by providing focus on corporate governance programs and in establishing and monitoring corporate governance principles that will enhance corporate performance. the committee has oversight for the corporation’s code of conduct. in addition, the committee manages the evaluation process to monitor the effectiveness of the Board, its committees and individual directors and has responsibility for establishing a process for identifying, recruiting, appointing and re-appointing directors and succession planning for the chairman of the Board. the committee also has responsibility for providing on-going development of current Board members. the environment, health and safety committee the environment, Health & safety committee provides assistance and counsel to the Board and management of the corporation in its drive towards attaining and maintaining a high level of performance in areas relating to the environment, health and safety. the committee also seeks to ensure, through corporation management, that the corporation’s employees and contractors enjoy a safe and healthy workplace. the pension committee the Pension committee provides assistance to the Board in overseeing the corporation’s pension plans, including registered pension plans and supplemental pension arrangements. this oversight includes the responsibility to analyze policies and strategies developed by management in the area of pensions and to review the corporation’s performance with respect to meeting its fiduciary obligations as they relate to the corporation’s pension plans. the human resources committee the Human resources committee provides oversight of the design of the corporation’s compensation programs and policies and also provides recommendations to the Board of Directors on key compensation and human resources matters. the committee makes recommendations to the full Board of Directors with respect to executive and key employee continuity, succession planning, and any changes to the corporation’s executive compensation program which the committee considers to be necessary from time to time. the Corporation’s management proxy circular issued in connection with the 2010 Annual meeting of Shareholders and the corporate governance section of the Corporation’s website provide a full discussion of Finning’s corporate governance policies and practices. 90 StoCK exCHangeS the common shares of Finning international inc. are listed on the toronto Stock exchange. Symbol: Ftt auditorS deloitte & touche llp vancouver, Canada SoliCitorS borden ladner gervais llp vancouver, Canada Corporate Head oFFiCe Suite 1000-666 burrard Street vancouver, british Columbia Canada v6C 2x8 telephone: 604-691-6444 aNNUaL GeNeRaL MeeTING May 13, 2010 2:00 pm pacific time the Fairmont Hotel vancouver 900 West georgia Street vancouver, british Columbia Corporate inForMation the Company prepares an annual information Form (aiF), which is filed with the securities commission or similar bodies in all of the provinces of Canada. Copies of the aiF and annual and Quarterly reports are available to shareholders and other interested parties on request or can be accessed directly from Finning’s website at www.finning.com inveStor inQuirieS inquiries relating to shares or dividends should be directed to the Company’s registrar and transfer agent. inquiries relating to the Company’s operating activities and financial information should be directed to Mauk breukels, director, investor relations and Corporate affairs. telephone 604-331-4934 email: investor_relations@finning.ca regiStrar & tranSFer agent CoMputerSHare truSt CoMpany oF Canada Vancouver Computershare 510 burrard Street 2nd Floor vancouver, b.C. v6C 3b9 Toronto Computershare 100 university avenue 11th Floor toronto, ontario M5j 2y1 Phone north america 1-800-564-6253 international 514-982-7555 Website www.computershare.com email service@computershare.com SHareHolder inForMation ForWard-looKing diSClaiMer this report contains statements about the Company’s business outlook, objectives, plans, strategic priorities and other statements that are not historical facts. a statement we make is forward-looking when it uses what we know and expect today to make a statement about the future. Forward-looking statements may include words such as aim, anticipate, assumption, believe, could, expect, goal, guidance, intend, may, objective, outlook, plan, project, seek, should, strategy, strive, target, and will. Forward-looking statements in this report include, but are not limited to, statements with respect to: expectations with respect to the economy and associated impact on the Company’s financial results; the estimated annualized cost savings and anticipated restructuring charges related to actions taken by the Company in response to the economic downturn; the potential outcome of the Company’s strategic review of Hewden; expected revenue and ebit growth; anticipated effective tax rate; anticipated generation of free cash flow (including projected net capital and rental expenditures), and its expected use; anticipated defined benefit plan contributions; and expected target range of debt ratio. all such forward-looking statements are made pursuant to the ‘safe harbour’ provisions of applicable Canadian securities laws. unless otherwise indicated by us, forward-looking statements in this report describe our expectations at February 23, 2010. except as may be required by Canadian securities laws, we do not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise. Forward-looking statements, by their very nature, are subject to numerous risks and uncertainties and are based on several assumptions which give rise to the possibility that actual results could differ materially from our expectations expressed in or implied by such forward-looking statements and that our business outlook, objectives, plans, strategic priorities and other statements that are not historical facts may not be achieved. as a result, we cannot guarantee that any forward-looking statement will materialize. Factors that could cause actual results or events to differ materially from those expressed in or implied by our forward-looking statements include: general economic and credit market conditions; foreign exchange rates; commodity prices; the level of customer confidence and spending, and the demand for, and prices of, our products and services; our dependence on the continued market acceptance of Caterpillar’s products and Caterpillar’s timely supply of parts and equipment; our ability to continue to implement our cost reduction initiatives while continuing to maintain customer service; the intensity of competitive activity; our ability to raise the capital we need to implement our business plan; regulatory initiatives or proceedings, litigation and changes in laws or regulations; stock market volatility; changes in political and economic environments for operations outside Canada; with respect to Hewden, not being successful in generating the expected improvements in the underlying business performance or not being able to successfully negotiate and complete a transaction on terms acceptable to the Company or at all. Forward-looking statements are provided in this report for the purpose of giving information about management’s current expectations and plans and allowing investors and others to get a better understanding of our operating environment. However, readers are cautioned that it may not be appropriate to use such forward-looking statements for any other purpose. Forward-looking statements made in this report are based on a number of assumptions that we believed were reasonable on the day we made the forward-looking statements. refer in particular to the Market outlook section of the Md&a. Some of the assumptions, risks, and other factors which could cause results to differ materially from those expressed in the forward-looking statements contained in this report are discussed in the Company’s current annual information Form (aiF) in Section 4. We caution readers that the risks described in the aiF are not the only ones that could impact us. additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also have a material adverse effect on our business, financial condition, or results of operations. except as otherwise indicated by us, forward-looking statements do not reflect the potential impact of any non-recurring or other unusual items or of any dispositions, mergers, acquisitions, other business combinations or other transactions that may be announced or that may occur after the date hereof. the financial impact of these transactions and non- recurring and other unusual items can be complex and depends on the facts particular to each of them. We therefore cannot describe the expected impact in a meaningful way or in the same way we present known risks affecting our business. By using paper made from post-consumer recycled content, the following resources have been saved. www.finning.com 

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