The Toro Company — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended August 1, 2014; comparisons are to periods ended August 2, 2013. Fiscal year ends October 31. Amounts below are in millions except per-share data and percentages. Toro designs, manufactures, and markets professional turf, irrigation, landscaping, construction, and residential outdoor equipment and products.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $567.5 | $509.9 | $1,758.6 | $1,659.1 |
| Gross profit | $202.1 | $178.0 | $630.1 | $596.1 |
| Operating earnings | $72.0 | $58.6 | $243.5 | $222.3 |
| Net earnings | $50.0 | $40.1 | $163.0 | $149.9 |
| Diluted EPS | $0.87 | $0.68 | $2.82 | $2.53 |
| Gross margin | 35.6% | 34.9% | 35.8% | 35.9% |
| Operating margin | 12.7% | 11.5% | 13.8% | 13.4% |
| Net margin | 8.8% | 7.9% | 9.3% | 9.0% |
Q3 sales rose 11.3% and net earnings rose 24.7%; nine-month sales increased 6.0% and net earnings 8.7%. Q3 diluted EPS growth was 27.9%; nine-month diluted EPS growth was 11.5%. Share repurchases added approximately $0.02 and $0.07 per diluted share to Q3 and year-to-date EPS, respectively.
Segment sales: Q3 Professional sales increased 11.9% to $384.7 million and Residential sales increased 13.0% to $175.7 million. Nine-month Professional sales rose 3.4% to $1,208.7 million and Residential sales rose 11.7% to $533.7 million. Q3 segment pretax earnings increased 23.7% in Professional and 24.1% in Residential; nine-month increases were 4.8% and 16.9%, respectively.
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $164.2 million, versus $158.1 million. Investing used $51.5 million, including $53.2 million of capital expenditures; financing used $118.7 million. Cash declined $5.1 million from fiscal year-end to $177.9 million.
- At August 1, 2014, current assets were $759.7 million and current liabilities were $459.7 million. Total debt was approximately $225.1 million: $1.3 million short-term/current and $223.8 million long-term.
- Cash exceeded reported debt by approximately $47.0 million. Toro reported $149.4 million of unused availability under its credit agreements, including a $150 million unsecured revolving facility expiring July 2015. It had $1.1 million of short-term borrowings and $13.5 million of letters of credit outstanding.
- Management said cash generation, cash on hand, and financing arrangements should be sufficient for expected needs for at least 12 months. Toro reported compliance with debt covenants and stated it was not restricted from dividends or repurchases under the facility’s debt-to-EBITDA threshold.
- Nine-month repurchases of common stock were $100.5 million and dividends paid were $33.9 million. The Q3 dividend increased 42.9% year over year, to $0.20 per share from $0.14.
Material changes and management commentary
- Q3 gross margin improved 70 basis points, reflecting product mix, price realization, and cost-reduction efficiencies; higher steel and resin prices and a supplier rework issue partly offset the gains. Nine-month gross margin declined 10 basis points, due mainly to mix, commodities, currency, and the rework issue.
- SG&A increased in dollars but fell 50 basis points as a percentage of sales in both comparison periods, primarily due to higher sales volumes and lower warranty expense. Spending on marketing, engineering, product development, and incentive compensation increased.
- Professional growth reflected demand for golf and grounds equipment, irrigation, landscape contractor equipment, and micro-irrigation; Q3 also benefited from a rebound in certain large turf products affected by Tier 4 timing in the prior-year quarter. Residential growth was supported by snow thrower preseason shipments after heavy 2013/2014 snowfall and stronger zero-turn mower demand.
- Australian sales weakened due to weather and foreign-exchange effects. International sales increased 2.1% in Q3 and 1.1% year to date; currency movements added about $1.1 million to Q3 sales but reduced year-to-date sales by about $4.2 million.
- Inventory at quarter-end rose $34.8 million, or 13.5%, year over year as Toro built stock for anticipated Q4 demand and Tier 4-related products. Accounts payable increased $44.7 million, or 36.0%, on recent purchases. Average inventory for the first nine months was nevertheless down $18.3 million, or 5.6%, year over year.
- Interest expense declined, principally due to higher capitalized interest on projects. The Q3 effective tax rate was 29.4%, versus 30.5%, helped by a discrete tax accounting-method benefit. The nine-month rate rose to 31.7% from 31.0%, partly because the prior-year period included a research tax-credit benefit.
Outlook, risks, and contingencies
- No specific full-year sales or earnings forecast is stated. Toro’s final-year Destination 2014 goals included $100 million of annual organic revenue growth and a 12% operating margin by fiscal year-end; Q3 and year-to-date operating margins were 12.7% and 13.8%.
- Management anticipated limited, but continuing, commodity-cost inflation for the remainder of fiscal 2014 compared with fiscal 2013 and described measures to mitigate cost increases, including sourcing, material substitution, efficiency actions, and selective pricing.
- Key disclosed risks include seasonality and weather-driven demand, economic and consumer conditions, commodity and component costs and availability, competition, product quality and new-product acceptance, foreign currency, international operations, Tier 4 compliance and supplier availability, dealer financing, and the ability to achieve Destination 2014 goals.
- Red Iron, Toro’s 45%-owned inventory-financing joint venture, had a $450 million secured revolving facility. Toro’s investment was $16.6 million; it had not guaranteed Red Iron’s debt. Toro’s product repurchase commitment was capped at $7.5 million per calendar year, with $0.4 million of maximum recourse for specified receivables at quarter-end.
- Toro reported ordinary-course product liability, environmental/asbestos, commercial, employment, and patent matters. Management believed any resulting liability would not materially affect results, financial position, or cash flows. A supplier component rework issue affected certain walk power mowers; the filing does not quantify its total financial effect.
- Disclosure controls were deemed effective, and Toro reported no material change in internal control over financial reporting during the quarter. The new revenue-recognition standard was scheduled for adoption November 1, 2017; impact and transition method were still under evaluation.
Important facts for investors to verify
- Whether elevated quarter-end inventory converts to sales as expected in Q4, and whether working-capital needs or product availability change.
- How much of Q3 growth reflects sustainable demand versus Tier 4 timing, snow-related shipments, and seasonal preseason stocking.
- Whether commodity inflation and the walk-mower supplier rework issue continue to pressure margins or require additional costs.
- Progress toward fiscal 2014 Destination 2014 goals and the effect of share repurchases on per-share results.
- Subsequent changes in credit availability, covenant headroom, dealer financing through Red Iron, and any material developments in litigation or contingencies.