Business context and reporting period
The Toro Company designs, manufactures, and markets professional turf, landscape, irrigation, rental and construction, and residential outdoor equipment. This unaudited Form 10-Q covers the quarter and six months ended May 3, 2013; comparisons are to the periods ended May 4, 2012. Results are seasonal, and management cautions against annualizing the first-half results.
Financial performance and position
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $704.5 million; +1.9% | $1,149.1 million; +3.0% |
| Gross margin | 35.8%, up 1.8 percentage points | 36.4%, up 2.1 percentage points |
| Operating earnings | $117.5 million; +10.3% | $163.7 million; +16.5% |
| Net earnings | $78.4 million; +13.9% | $109.8 million; +23.7% |
| Diluted EPS | $1.32, versus $1.13 | $1.85, versus $1.46 |
| Operating cash flow | $36.6 million, versus $89.5 million in the prior-year first half |
Quarterly net margin was 11.1%, versus 10.0%; first-half net margin was 9.6%, versus 8.0%. Lower costs as a share of sales, price increases, product mix, cost reductions and slightly lower commodity costs supported gross-margin growth. Higher SG&A expense partly offset the improvement. The effective tax rate fell to 32.6% for the quarter and 31.3% for the half, primarily following retroactive reinstatement of the domestic research and development tax credit. Share repurchases contributed approximately $0.03 and $0.05 to quarterly and first-half diluted EPS, respectively.
At May 3, 2013, cash was $80.3 million; total assets were $1.115 billion; and stockholders’ equity was $373.0 million. Debt was approximately $223.8 million, almost entirely long-term, with no short-term borrowings under credit facilities. Current assets were $791.3 million and current liabilities $498.6 million. The company reported $152.2 million of unused availability under its credit agreements and was in compliance with its covenants.
First-half operating cash flow declined $52.8 million year over year, mainly because receivables and inventory absorbed more cash. Investing activities used $24.1 million, including $19.5 million of capital expenditures; financing activities used $57.7 million, including $50.5 million for share repurchases and $16.4 million for dividends. Cash declined $45.5 million from fiscal-year opening levels. Inventory was $310.0 million, up 23.6% year over year; receivables were $307.8 million, up 12.8%.
Material changes and management commentary
- Professional-segment sales rose 8.9% for the quarter and 11.6% for the half, driven by landscape contractor demand, golf and grounds shipments, micro-irrigation growth, price increases, rental-market demand and Tier 4-related purchasing ahead of price changes. First-half professional sales also included $6.4 million from acquisitions.
- Residential sales fell 13.2% for the quarter and 12.8% for the half. Management cited unfavorable 2013 weather, comparison with early spring in 2012, and weak snow-thrower demand after a low-snowfall winter. Higher professional sales more than offset the residential decline.
- Management attributed higher working capital to inventory built for anticipated Tier 4 demand and weaker residential shipments. Average net working capital as a percentage of trailing 12-month sales rose to 16.3% from 14.9%.
- The quarterly dividend increased 27.3%, from $0.11 to $0.14 per share. The company repurchased approximately 386,000 shares under its existing authorization in the quarter.
Outlook, risks and contingencies
Management described first-half results as solid and expressed optimism about the remainder of fiscal 2013, while providing no specific full-year revenue or earnings forecast. Its “Destination 2014” goals include $100 million of annual organic revenue growth and operating earnings equal to 12% of sales by the end of fiscal 2014. Management expects commodity and component costs to be approximately equivalent to or slightly higher for the remainder of fiscal 2013 than in fiscal 2012, and cited vendor negotiations, sourcing alternatives, cost reductions and selective price increases as mitigations.
Key uncertainties include weather and retail demand, elevated field and company inventory, Tier 4 compliance and customer purchasing shifts, commodity and healthcare costs, foreign exchange, global economic conditions, competition, and availability of dealer financing. A proposed acquisition of a Chinese micro-irrigation company remained subject to regulatory approvals and other closing conditions; the company expected completion by fiscal year-end. The Canadian lawnmower horsepower-marketing class action remained pending; management did not expect an adverse outcome to materially affect annual results or financial condition, but said an unfavorable resolution could materially affect a particular period. The filing also describes ordinary-course product, environmental, commercial, employment and patent litigation.
Management reported effective disclosure controls as of quarter-end and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether professional-segment demand and Tier 4-related advance purchases persist, and whether elevated field and residential inventories lead to slower orders or discounting.
- Whether receivables and inventory convert to cash in the second half, given the sharp year-over-year decline in first-half operating cash flow.
- Progress on the proposed China acquisition, including regulatory approval, completion timing and integration costs.
- Developments in the Canadian class action and other product, environmental and patent matters.
- Whether fiscal 2013 results and subsequent performance support the Destination 2014 organic-growth and operating-margin goals.