The Toro Company — Q1 FY2013 Form 10-Q
Reporting period: Three months ended February 1, 2013; comparison is with the three months ended February 3, 2012. Toro designs, manufactures, and sells professional turf, landscaping, irrigation, rental and construction, and residential yard and snow-removal products. Results are seasonal; management cautions that first-quarter performance should not be annualized or treated as an indicator of spring sales. Per-share and share-count data reflect the 2012 two-for-one stock split.
Financial performance
- Sales: $444.7 million, up 4.9% year over year. Professional segment sales rose 16.0% to $329.1 million; Residential sales fell 12.1% to $120.9 million. International sales declined 5.3% to $141.6 million.
- Profit and margins: Gross profit was $165.8 million, with gross margin rising to 37.3% from 34.6%. Operating earnings were $46.2 million, or 10.4% of sales, versus $34.0 million and 8.0%. Net earnings increased 57.6% to $31.4 million; diluted EPS was $0.53 versus $0.33. The effective tax rate declined to 27.7% from 33.8%.
- Segment performance: Professional pretax earnings increased 44.3% to $60.7 million, with operating margin of 18.5% versus 14.8%. Residential pretax earnings declined 3.6% to $12.2 million, though its operating margin improved to 10.0% from 9.2%. “Other,” including corporate activities and eliminations, had a $29.5 million pretax loss, compared with $24.6 million.
- Cash flow: Operating activities used $23.5 million, compared with $16.3 million used in the prior-year quarter, mainly due to increased working-capital needs, especially inventory. Investing activities used $5.7 million; financing activities used $36.3 million, including $33.2 million of share repurchases and $8.2 million of dividends. Cash declined by $65.2 million during the quarter to $60.7 million.
- Liquidity and debt: At February 1, cash was $60.7 million; current assets were $665.9 million and current liabilities $427.5 million. Long-term debt was $223.5 million, with $0.3 million current debt and no short-term facility borrowings. Toro reported $149.5 million of unused availability under its credit agreements, was in covenant compliance, and stated that available funding and forecast cash flows should cover needs for at least 12 months.
- Working capital: Inventory was $335.7 million, up 23.2% from a year earlier; receivables rose 2.7%. Management cited prebuilding ahead of Tier 4-related product changes, acquisition-related inventory, and higher snow-thrower inventory.
Changes and drivers versus the prior-year quarter
- Professional sales benefited from strong demand for products manufactured before Tier 4 emission-related price increases took effect, new products, acquisitions contributing $5.2 million in sales, and growth in micro-irrigation. Management said the resulting first-quarter sales were unusually high compared with past and expected future quarters, apart from possible future regulatory transitions.
- Residential sales were pressured by limited snowfall and weaker snow-thrower shipments and retail demand. Australian irrigation-product sales benefited from drought conditions.
- Gross margin improved due to sales mix, price increases on some products, cost reductions, and slightly lower commodity prices. SG&A rose 6.2% to $119.6 million, including $4.4 million of acquisition-related costs and $2.3 million of higher warehousing expense.
- Higher earnings reflected improved gross margin, sales volume, and the lower tax rate; lower shares outstanding also benefited diluted EPS by approximately $0.01.
Outlook, risks, and unusual items
- Goals and outlook: Toro’s Destination 2014 initiative targeted $100 million of annual organic revenue growth and operating earnings equal to 12% of sales by fiscal 2014. These are stated goals, not a specific quarterly or full-year earnings forecast. Management’s near-term focus was the peak selling season, customer demand, and aligning production with shipments.
- Acquisition: In January 2013, Toro agreed to acquire a Chinese micro-irrigation company, subject to regulatory approvals and customary closing conditions; management expected closing in Q3 FY2013.
- Risks: Management highlighted weather and demand volatility, economic weakness (particularly in Europe), commodity and component costs, foreign exchange, competition, customer credit availability, and execution of Tier 4 compliance. It warned that Tier 4-related buying patterns could create abnormal period-to-period sales fluctuations. Management expected commodity prices for the remainder of FY2013 to be approximately level with or slightly above FY2012 averages.
- Contingencies: Toro disclosed ordinary-course litigation, including a Canadian class action alleging inaccurate lawnmower horsepower labeling. Management did not then expect the Canadian case to materially adversely affect annual results or financial condition, but said an unfavorable outcome could be material to a particular period. Toro also disclosed product liability, environmental, asbestos, commercial, employment, and patent matters.
- Other exposures: Toro’s 45% Red Iron financing-joint-venture investment was $16.4 million. Toro had a product repurchase commitment capped at $7.5 million per calendar year and limited recourse of up to $0.3 million. Derivative instruments produced a net loss of $3.9 million in earnings for the quarter on contracts not designated as hedges; approximately $1.3 million of hedge losses in accumulated other comprehensive loss were expected to be reclassified into earnings over the next 12 months.
- Capital returns: The quarterly dividend increased 27.3% to $0.14 per share. Toro repurchased 776,912 shares under its existing program during the quarter, for cash purchases of $33.2 million in the cash-flow statement, and authorized a new 5-million-share repurchase program.
Important facts for investors to verify
- Whether the unusually strong Professional sales ahead of Tier 4 price increases pulled demand forward and how subsequent sales and field inventories developed.
- Whether elevated inventory converted to sales and cash during the peak season, and whether working-capital use and operating cash flow normalized.
- Progress toward Destination 2014 targets and the sustainability of gross-margin gains, especially as commodity costs and acquisition expenses evolve.
- Completion, integration, and financial contribution of the proposed Chinese micro-irrigation acquisition.
- Developments in the Canadian horsepower-labeling litigation and any changes to warranty, product-liability, or other contingency exposures.
- Liquidity, covenant compliance, and capital returns if sales, weather, or working-capital needs differ from management’s expectations.