The Toro Company — FY2016 Form 10-K
Reporting period: Fiscal year ended October 31, 2016; the filing also reports fourth-quarter results. Amounts are in U.S. dollars. Per-share data reflects the September 2016 two-for-one stock split.
Business context
Toro designs, manufactures, and markets professional turf and landscape equipment, irrigation and lighting systems, snow and ice management products, specialty construction equipment, and residential lawn and snow products. Fiscal 2016 sales were 71% Professional, 28% Residential, and 1% Other. The company sold its Northwestern U.S. distributorship in November 2015 and operated one domestic distributorship for the remainder of the year.
Financial performance and liquidity
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Net sales | $2,392.2 million | $2,390.9 million | +0.1% |
| Gross margin | 36.6% | 35.0% | +160 bps |
| Operating earnings | $334.4 million | $299.1 million | +11.8% |
| Net earnings | $231.0 million | $201.6 million | +14.6% |
| Diluted earnings per share | $2.06 | $1.78 | +15.7% |
| Operating cash flow | $361.9 million | $236.9 million | +52.8% |
- Gross-margin improvement reflected lower commodity costs, productivity gains, and a more favorable Professional segment mix. SG&A rose 0.6%; the effective tax rate declined to 30.1% from 30.7%.
- Professional sales rose 4.0% to $1,705.3 million; operating margin improved to 20.6% from 18.8%. Residential sales fell 7.8% to $669.1 million; operating margin declined to 11.0% from 11.7%.
- Fourth-quarter sales were $468.4 million versus $480.8 million; net earnings were $30.2 million versus $23.6 million, and diluted EPS was $0.27 versus $0.21.
- Cash and cash equivalents were $273.6 million at year-end, including $105.5 million held by foreign subsidiaries that was not available for U.S. operations without repatriation and related taxes. Total debt was $353.9 million, down from $378.0 million; debt-to-capitalization fell to 39.2% from 45.0%.
- The company had no borrowings under its $150 million revolving facility and reported $150.8 million of unused availability under credit agreements, net of outstanding letters of credit. It reported covenant compliance and expected to remain compliant in FY2017.
- Year-end current assets were $779.0 million and current liabilities $463.8 million. Inventory was $307.0 million, down 8.2% year over year; receivables were $163.3 million, down 7.8%. Average net working capital was 15.9% of sales versus 16.0%.
- Capital expenditures were $50.7 million. Financing uses included $112.0 million for share repurchases and $65.9 million of dividends. Quarterly dividends rose 20% in FY2016 to $0.15 per share; the company announced a further increase to $0.175 for FY2017’s first quarter.
Changes, outlook, and management commentary
- Professional growth, led by golf, landscape contractor, rental and specialty construction products, and irrigation, was largely offset by weaker Residential demand. Low snowfall reduced snow-product demand; unfavorable currency movements reduced reported sales by about $30.6 million and international sales declined 5.1%.
- Destination PRIME’s annual organic revenue-growth goal is at least 5%; Toro achieved 0.1% in FY2016, below target. It exceeded its FY2017 operating-margin goal of at least 13%, reporting 14.0% in FY2016. Its working-capital goal is 13% of sales or lower by FY2017 year-end; FY2016 stood at 15.9%.
- Management planned FY2017 capital expenditures of approximately $65 million, expected average net working capital as a percentage of sales to decline, and anticipated slightly higher commodity prices than in FY2016. The filing does not provide a specific FY2017 sales or EPS forecast.
- Backlog fell 13.4% to $92.4 million, mainly because of weak snowfall and lower pre-season snow-product orders; Toro expected to fill the backlog early in FY2017. Domestic Professional field inventory was higher year over year, while Residential field inventory was lower.
- After year-end, Toro agreed to acquire Regnerbau Calw GmbH, a professional irrigation equipment manufacturer, subject to customary conditions and then expected to close in FY2017’s first quarter. Red Iron financing agreements were amended in November 2016, extending the joint venture term to 2024 and increasing its credit facility from $450 million to $550 million.
- CEO Richard Olson succeeded Michael Hoffman in November 2016. The company identified weather, foreign exchange, commodity costs, economic and competitive conditions, customer inventory and financing availability, supplier concentration, regulation, product liability, litigation, and cybersecurity as material risks. The Home Depot accounted for approximately 11% of consolidated gross sales in FY2016.
Unusual items and contingencies
- Other income increased to $15.4 million from $10.7 million, including foreign-currency contract gains, a $1.3 million litigation recovery, and higher Red Iron equity earnings. The lower tax rate also reflected favorable prior-year adjustments and the permanent extension of the federal research credit.
- Potential inventory repurchase obligations under dealer and distributor financing arrangements were capped at $10.4 million at year-end; maximum end-user financing credit-collection exposure was $4.9 million. Management reported only immaterial historical inventory repurchases.
- Toro was involved in ordinary-course product, patent, environmental, employment, and commercial litigation. Management stated that any liability was not expected to materially affect consolidated results, financial position, or cash flows. It also reported ongoing evaluation and cleanup at a limited number of current or former properties.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management and the auditor concluded controls were effective as of October 31, 2016.
Important facts for investors to verify
- Whether Professional growth and improved margins can offset Residential weakness, currency headwinds, and weather-driven volatility.
- Progress toward FY2017 Destination PRIME working-capital and organic-growth objectives, and whether the planned inventory reductions preserve customer service and replenishment.
- The assumptions behind warranty accruals, given higher FY2016 claims experience, and the adequacy of inventory reserves if demand or product mix weakens.
- Liquidity and covenant headroom, repayment of the $110.5 million floating-rate term loan due by October 2019, and the availability and terms of Red Iron financing.
- The consequences of the Regnerbau Calw acquisition and amended Red Iron agreements, including integration, financing, and execution risks.
- Exposure to The Home Depot, contingent financing obligations, and the outcomes of pending patent, product-liability, and environmental matters.