The Toro Company — Q2 2016 Form 10-Q
Reporting period: Three and six months ended April 29, 2016, compared with the periods ended May 1, 2015. Toro designs, manufactures, and markets professional and residential outdoor equipment and related products. Its business is seasonal; management cautions that first-half results should not be annualized.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $836.4 million | $826.2 million | $1,322.8 million | $1,300.5 million |
| Gross profit | $303.2 million | $282.0 million | $485.8 million | $451.0 million |
| Operating earnings | $155.1 million | $138.5 million | $208.9 million | $182.9 million |
| Net earnings | $105.7 million | $93.8 million | $144.9 million | $124.7 million |
| Diluted EPS | $1.89 | $1.64 | $2.58 | $2.18 |
| Gross margin | 36.2% | 34.1% | 36.7% | 34.7% |
| Operating margin | 18.5% | 16.8% | 15.8% | 14.1% |
- Q2 sales rose 1.2%; net earnings rose 12.7%, and diluted EPS rose 15.2%. First-half sales increased 1.7%; net earnings increased 16.2%, and diluted EPS increased 18.3%.
- Professional segment sales grew 7.7% in Q2 and 4.7% year to date, driven by landscape contractor equipment, golf and grounds products, and specialty construction. Residential sales fell 11.1% and 5.0%, respectively, reflecting weather, lower zero-turn mower demand, and weaker snow-product demand.
- Gross-margin gains reflected lower commodity costs, productivity, pricing, and favorable mix. Professional products generally carry higher margins than Residential products. Foreign exchange partly offset these benefits.
- SG&A rose 3.2% in Q2 and 3.3% year to date; as a share of sales, it increased 0.4 and 0.3 percentage points, respectively. Management cited self-insured benefit accruals and warehousing costs associated with higher inventory.
Cash flow, balance sheet, and capital
- First-half operating cash flow was $137.2 million, versus $95.2 million a year earlier. Investing cash outflow was $23.8 million, versus $230.0 million, which included the prior-year BOSS acquisition. Financing cash outflow was $66.0 million, compared with $68.6 million.
- Cash and equivalents were $174.6 million at April 29, 2016. Capital expenditures were $22.6 million. The company repurchased $41.0 million of shares and paid $33.0 million in dividends during the first half.
- Total debt on the balance sheet was approximately $361.2 million, including $23.3 million current and $337.9 million long-term debt; there was no short-term debt outstanding. The filing also describes a $20 million note to the former BOSS owners; investors may wish to confirm its classification in reported debt.
- The company had a $150 million revolving credit facility, $147.5 million of availability after letters of credit, and reported compliance with its covenants. Management said available liquidity and forecast cash flows should meet anticipated needs for at least 12 months.
- Inventory was $369.1 million, up $27.6 million (8.1%) from the prior-year quarter-end. Receivables were $329.8 million, down $21.8 million (6.2%), partly because more customers financed through Red Iron. Average net working capital was 16.6% of trailing-twelve-month sales, compared with 15.6% a year earlier.
- The quarterly dividend increased 20% to $0.30 per share. Repurchases reduced diluted EPS by approximately $0.04 in Q2 and $0.05 year to date, according to management.
Outlook, risks, and unusual items
- Management’s Destination PRIME goals are at least 5% organic revenue growth each fiscal year of the three-year initiative, operating earnings above 13% of sales by fiscal 2017, and average net working capital below 13% of sales by fiscal 2017. These are stated goals, not specific fiscal 2016 earnings guidance.
- Management reported higher field inventories and plans to focus on asset utilization and reducing working capital while maintaining order replenishment and service. It anticipated slightly lower average prices for some commodities and components during the remainder of fiscal 2016.
- Foreign exchange reduced sales by approximately $9.9 million in Q2 and $23.6 million year to date. International sales were up 0.5% in Q2 but down 4.3% year to date.
- Year-to-date other income benefited from higher Red Iron equity earnings, a litigation settlement recovery, currency gains, and a gain on the sale of the Northwestern U.S. distribution business. That non-material divestiture closed in November 2015. The prior-year comparison also included BOSS inventory fair-value charges that did not recur.
- Risks highlighted include weather and seasonality, currency movements, commodity costs, inventory and channel demand, competition, product quality and litigation, and availability of dealer financing. The company is involved in ordinary-course litigation, including patent, product, asbestos, and environmental matters; management did not expect these matters, individually or in aggregate, to materially affect results, financial position, or cash flows.
- The company uses currency derivatives to manage exposures, not for trading. Derivative losses and gains can affect earnings and other comprehensive income. Management reported no material change in interest-rate risk disclosures.
- Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether elevated Residential and channel inventories convert to retail demand or require discounting, production adjustments, or additional working capital.
- Progress toward the Destination PRIME growth, operating-margin, and working-capital goals; the filing does not give specific full-year 2016 earnings guidance.
- How much reported earnings growth is sustainable after considering settlement, divestiture, currency, and prior-year acquisition-accounting effects.
- The composition and repayment schedule of reported debt, including the BOSS seller note, and ongoing covenant headroom.
- Red Iron financing capacity and the company’s related repurchase and recourse exposures, as well as developments in pending litigation and warranty costs.