The Toro Company (NYSE: TTC) — FY2013 Form 10-K
Reporting period: Fiscal year ended October 31, 2013, with fourth-quarter results included. This is an annual filing, not a standalone quarterly report. Financial amounts below are in U.S. dollars.
Business context
Toro designs, manufactures, and markets professional turf and landscape equipment, irrigation and lighting systems, agricultural micro-irrigation products, rental and construction equipment, and residential lawn and snow products. Fiscal 2013 sales mix was 70% Professional, 29% Residential, and 1% Other. Sales outside the United States were 30.1% of consolidated sales.
Financial performance and position
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Net sales | $2,041.4 million | $1,958.7 million | +4.2% |
| Gross margin | 35.5% | 34.4% | +1.1 percentage points |
| Operating earnings | $230.7 million | $205.6 million | +12.2% |
| Net earnings | $154.8 million | $129.5 million | +19.5% |
| Diluted earnings per share | $2.62 | $2.14 | +22.4% |
| Operating cash flow | $221.9 million | $185.8 million | +19.4% |
Gross margin benefited from price increases, cost reductions, favorable product mix, and lower commodity costs; unfavorable foreign exchange and under-absorbed manufacturing costs partly offset the gains. SG&A rose 5.7% to $494.1 million, increasing to 24.2% of sales from 23.9%. Net income also benefited from a lower effective tax rate (31.7% versus 34.0%), higher other income, and share repurchases. The domestic research tax credit was retroactively reinstated for FY2013; management expected its expiration to raise the FY2014 tax rate.
Professional sales increased 7.2% to $1,425.3 million, with operating earnings of $254.4 million and a 17.9% margin. Residential sales declined 2.1% to $594.4 million, while operating earnings rose to $62.0 million and margin improved to 10.4%. Weak snow and spring weather reduced residential demand. Other segment operating loss was $89.7 million, versus $93.7 million.
At year-end, cash and cash equivalents were $183.0 million; total assets were $1,002.7 million; long-term debt, including current portion, was $223.5 million; and stockholders’ equity was $358.7 million. Debt-to-capitalization was 38.4%, down from 41.9%. Toro had no short-term borrowings under its credit lines and $147.9 million of unused availability under its revolving credit arrangements. Operating cash flow funded $49.4 million of capital expenditures; financing outflows included $99.6 million of share repurchases and $32.5 million of dividends. Year-end cash increased to $183.0 million from $125.9 million.
Average inventory rose 14.3%, inventory turnover declined to 4.42 from 4.93, and average net working capital was 16.6% of sales versus 15.2%. The company attributed inventory growth to Tier 4 product demand planning, rental and construction expansion, and weaker residential sales.
Fiscal fourth-quarter sales were $382.4 million versus $339.3 million a year earlier; net earnings were $5.0 million versus $0.3 million. Toro’s results are seasonal, with the second quarter typically the largest sales and earnings quarter.
Material changes and notable items
- Record annual sales exceeded $2 billion for the first time; earnings and margins improved despite lower Residential sales.
- Foreign exchange movements reduced FY2013 sales by approximately $13 million.
- Other income included a $3.1 million net litigation recovery, contributing to the year-over-year increase in other income.
- Toro acquired a Chinese water-efficient micro-irrigation business for a net purchase price of $3.5 million; $1.4 million was payable in FY2014. Acquisitions contributed $6.4 million of incremental sales.
- Year-end backlog fell 26.4% to $91.2 million from an unusually elevated $123.9 million in FY2012, largely because customers had ordered ahead of Tier 4-related price increases.
- The annual dividend was $0.56 per share, and approximately $99.6 million was spent on repurchases. In December 2013, Toro raised the FY2014 first-quarter dividend to $0.20 per share and increased its dividend guideline to 30–40% of three-year average EPS.
Outlook, risks, and contingencies
Management expected FY2014 sales to rise in both Professional and Residential. It anticipated continued micro-irrigation, landscape contractor, rental, and construction growth; golf sales were expected to be flat to slightly higher. Toro expected gross margin and net earnings per share to improve, but cited higher commodity costs and competitive pricing as constraints. It planned approximately $65 million in FY2014 capital expenditures and expected average inventory to be slightly lower, with net working capital as a percentage of sales below FY2013.
Key risks include weather-driven demand and seasonal inventory exposure; economic weakness and customer access to credit; reliance on The Home Depot, which represented about 10% of consolidated gross sales; competition and product acceptance; commodity and component cost or supply disruption; currency movements and international-market uncertainty; Tier 4 compliance, cost, and pricing effects; and operational disruption, cyber/security, regulatory, product-liability, and litigation risks.
Contingencies included up to $10.2 million of inventory repurchase exposure under financing arrangements and $1.7 million maximum credit-collection exposure under certain end-user financing recourse agreements. Toro disclosed ordinary-course litigation, environmental matters, and patent disputes; management did not expect the matters described to materially affect consolidated results, financial position, or cash flows. A Canadian lawnmower horsepower-marketing class action settlement was approved and became final in October 2013, with settling defendants agreeing to pay CAD $4.2 million in aggregate.
The company reported compliance with its credit covenants, effective disclosure controls and internal control over financial reporting, and received an unqualified independent auditor opinion on the financial statements and internal controls.
Important facts for investors to verify
- Whether FY2014 growth and margin expectations were achieved, particularly given weather, Tier 4 pricing, competition, and higher commodity costs.
- Whether elevated inventory and working capital converted into sales and cash flow without increased discounting or obsolescence.
- The sustainability of earnings growth after the research tax credit benefit and litigation recovery, and the effect of the expected higher FY2014 tax rate.
- Exposure to The Home Depot, dealer/distributor financing availability, and the limited inventory repurchase and credit recourse commitments.
- Debt covenant headroom, liquidity, planned capital spending, and the balance between dividends and share repurchases.