The Toro Company — Q3 2016 Form 10-Q
Reporting period: Fiscal third quarter and nine months ended July 29, 2016; comparisons are with the corresponding periods ended July 31, 2015. The unaudited results are seasonal and should not be annualized.
Business context
Toro designs, manufactures, and markets professional turf, irrigation, landscaping, snow and ice management, agricultural micro-irrigation, construction, and residential yard-care products. It sells through distributors, dealers, retailers, and other channels. Professional and Residential are its principal operating segments.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $601.0M | $609.6M | $1,923.8M | $1,910.1M |
| Gross profit | $216.6M | $216.4M | $702.5M | $667.4M |
| Operating earnings | $82.0M | $79.4M | $290.9M | $262.3M |
| Net earnings | $55.8M | $53.3M | $200.8M | $178.0M |
| Diluted EPS | $1.00 | $0.94 | $3.58 | $3.13 |
| Gross margin | 36.0% | 35.5% | 36.5% | 34.9% |
| Operating margin | 13.6% | 13.0% | 15.1% | 13.7% |
| Net margin | 9.2% | 8.7% | 10.4% | 9.3% |
Q3 sales declined 1.4%, while net earnings rose 4.7%; nine-month sales increased 0.7% and net earnings increased 12.8%. Diluted EPS increased 6.4% and 14.4%, respectively. Share repurchases contributed an estimated $0.01 and $0.06 to Q3 and year-to-date diluted EPS.
- Segments: Professional sales rose 1.4% in Q3 and 3.6% year to date; pre-tax earnings rose 8.3% and 13.0%. Residential sales fell 4.6% and 4.9%; pre-tax earnings fell 37.9% and 6.7%.
- Cash flow: Nine-month operating cash flow was $288.9M, versus $168.0M. Investing used $29.3M, including $34.6M of capital expenditures; financing used $105.8M. Cash increased $151.0M from fiscal-year beginning to $277.2M.
- Balance sheet and liquidity: At July 29, cash was $277.2M, current assets $885.5M, and current liabilities $513.4M. Current and long-term debt on the balance sheet totaled approximately $357.3M. Management separately reports a $19.8M note to former BOSS owners; investors should verify its balance-sheet classification. There was no short-term debt outstanding. The company reported $148.8M of unused availability under credit agreements, after $10.5M of letters of credit.
- Capital returns: Nine-month share repurchases were $69.2M and dividends paid were $49.5M. The quarterly dividend was raised 20% to $0.30 per share.
Material changes and management commentary
- Margin improvement drove earnings growth. Management attributed higher gross margin primarily to lower commodity costs, productivity improvements, and favorable segment mix; year-to-date results also benefited because the prior-year BOSS inventory fair-value charge did not recur.
- Professional growth came from golf equipment, irrigation, and rental and specialty construction products. Residential weakness reflected lower mower demand, variable weather, and low early-season snowfall. International sales declined 7.1% in Q3 and 5.1% year to date; unfavorable currency movements reduced consolidated sales by about $6.1M and $29.2M, respectively.
- Other income increased year to date, including foreign-exchange gains, higher Red Iron equity earnings, a litigation settlement recovery, and a gain on the Northwestern U.S. distribution business sale.
- Inventory fell $23.1M year over year and receivables fell $25.4M, partly because more customers financed through Red Iron. Average net working capital as a percentage of sales rose to 16.4% from 15.9%.
Outlook, risks, and unusual items
- No specific fiscal 2016 earnings or sales forecast is provided. Management expects approximately $60M of fiscal 2016 capital expenditures and says cash generation, cash on hand, and financing arrangements should cover anticipated needs for at least the next 12 months. About $125M of cash and short-term investments held by foreign subsidiaries was not available for domestic operations unless repatriated.
- The three-year Destination PRIME initiative targets organic revenue growth of at least 5% annually, operating earnings above 13% of sales by fiscal 2017, and average net working capital below 13% of sales by fiscal 2017.
- Principal sensitivities include weather and seasonal demand, economic conditions, foreign exchange, commodity and component prices, channel inventory and credit availability, competition, product quality, and execution of new products and growth initiatives. The company uses derivatives to manage currency exposure, not for speculation; it also has LIBOR-linked debt exposure.
- Ordinary-course litigation includes product liability, asbestos and environmental claims, commercial and employment disputes, and patent cases. Management believes potential losses will not materially affect results, financial position, or cash flows. Warranty liability was $81.4M at quarter end, up from $78.7M a year earlier.
- Subsequent event: the board declared a two-for-one stock split, distributed as a 100% stock dividend, for shareholders of record September 1, 2016. Richard M. Olson was elected CEO effective November 1, 2016, with Michael J. Hoffman remaining as Chairman.
Key facts for investors to verify
- Whether Professional growth and margin gains can offset continued Residential weakness and currency pressure.
- Progress against the Destination PRIME targets, particularly working capital, which was 16.4% of sales versus the stated goal below 13%.
- Debt presentation and total obligations, including the separately described BOSS seller note, and compliance with credit covenants.
- Red Iron’s continued availability and terms of dealer financing; Toro owns 45% of the venture and has a product-repurchase obligation capped at $7.5M per calendar year.
- Effects of weather, commodity costs, foreign exchange, litigation, and warranty estimates on future performance.