Nature of Operations

The Toro Company is in the business of designing, manufacturing, and marketing professional turf maintenance equipment and services, turf and agricultural micro-irrigation systems, landscaping equipment, and residential yard and irrigation products worldwide. We sell our products through a network of distributors, dealers, hardware retailers, home centers, mass retailers, and over the Internet. Our businesses are organized into two reportable business segments: professional and residential. A third segment called "other" consists of a company-owned domestic distributorship and corporate activities, including corporate financing activities. Our emphasis is to provide innovative, well-built, and dependable products supported by an extensive service network. A significant portion of our revenues has historically been, and we expect it to continue to be, attributable to new and enhanced products.
The Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) for the first quarter of fiscal 2009 should be read in conjunction with the MD&A included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2008.

RESULTS OF OPERATIONS

Overview

For the first quarter of fiscal 2009, our net sales were down 16.2 percent, as compared to the first quarter of fiscal 2008. Shipments of most professional segment products were down due to decreased demand and customers' reluctance to place orders as a result of the global recessionary conditions. International sales were also down 17.7 percent, as compared to the first quarter of fiscal 2008, due also to the recessionary conditions affecting key international markets, as well as a stronger U.S. dollar that negatively impacted net sales by approximately $12 million. Partially offsetting the sales decline was a slight increase in residential segment sales of 0.7 percent for the quarter comparison, led by strong demand of snow thrower products and additional product placement for a new line of walk power mowers. Our net earnings declined 63.9 percent for the first quarter of fiscal 2009 to $6.7 million, compared to the first quarter of fiscal 2008. This decrease was primarily the result of lower sales volumes and lower gross margin due to production cuts, unfavorable product mix, and higher commodity costs in the first quarter of fiscal 2009 compared to the same period last fiscal year.
During this tough economic environment, we have been reducing expenses and continuing efforts to reduce working capital. As a result of these actions, our selling, general, and administrative (SG&A) expenses were down 10.7 percent and our inventory levels decreased 19.3 percent for the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008, which also contributed to a decline in short-term debt of $60.8 million as of the end of the first quarter of fiscal 2009 compared to the end of the first quarter of fiscal 2008. We also declared a cash dividend of $0.15 per share during the first quarter of fiscal 2009.
We expect the global recession to continue for at least the remainder of our fiscal year and, given the ongoing deteriorating economic conditions, our financial results for the remainder of the fiscal year are particularly uncertain. However, we believe we are well positioned to manage through this challenging environment because of actions we have taken to improve operating efficiency and asset utilization, as well as reducing expenses. On February 11, 2009, we announced the reduction of our worldwide salaried and office workforce by approximately 100 employees, suspension of regularly scheduled salary increases, a reduction of officers' salaries, changes in our vacation policy, and four furlough days - all for the remainder of fiscal 2009.
Our net sales and earnings for the first quarter of our fiscal year are typically lower than other quarters; therefore, the results of our first quarter are not necessarily an indicator of spring season sales trends. Our focus as we enter our peak selling season is on generating customer demand for our innovative new products, while keeping production closely aligned with expected shipment volumes. We will continue to keep a cautionary eye on the global economies, retail demand, field inventory levels, commodity prices, weather, competitive actions, and other factors identified below under the heading "Forward-Looking Information," which could cause our actual results to differ from our outlook.

Net Earnings

Net earnings for the first quarter of fiscal 2009 were $6.7 million, or $0.18 per diluted share, compared to $18.6 million, or $0.47 per diluted share, for the first quarter of fiscal 2008, net earnings per diluted share decrease of 61.7 percent. The primary factors contributing to this decrease were lower sales volumes and a decline in gross profit, somewhat offset by a decrease in SG&A expense and a lower effective tax rate.
The following table summarizes the major operating costs and other income as a percentage of net sales:

                                                                      Three Months Ended
                                                                January 30,        February 1,
                                                                   2009               2008
Net sales                                                              100.0 %            100.0 %
Cost of sales                                                          (65.2 )            (63.2 )
Gross margin                                                            34.8               36.8
Selling, general, and administrative
 expense                                                               (30.7 )            (28.9 )
Interest expense                                                        (1.3 )             (1.2 )
Other income, net                                                        0.2                0.4
Provision for income taxes                                              (1.0 )             (2.5 )
Net earnings                                                             2.0 %              4.6 %

Net Sales

Worldwide consolidated net sales for the first quarter of fiscal 2009 were $340.2 million compared to $405.8 million in the first quarter of fiscal 2008, a decrease of 16.2 percent. Worldwide professional segment net sales were down 22.3 percent as shipments for most product categories were hampered by decreased demand resulting from the global economic recession. Worldwide sales of golf maintenance equipment and irrigation systems were down significantly, as well as sales of professionally installed residential/commercial irrigation products and landscape contractor equipment. Residential segment net sales were slightly up by 0.7 percent for the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008. This increase was led by strong demand for snow thrower products in North America as a result of heavy snow falls during the winter season of 2008/2009. In addition, improved product placement for a new and broader line of walk power mowers benefited residential segment net sales, which was offset by a decline in shipments of riding products due mainly to our customers' efforts to reduce field inventory levels by ordering product closer to retail demand. International sales were down 17.7 percent, as compared to the first quarter of fiscal 2008, due also to the recessionary conditions affecting key international markets, as well as a stronger U.S. dollar compared to other currencies in which we transact business that accounted for approximately $12 million of our sales decline for the quarter.

Gross Profit

As a percentage of net sales, gross profit for the first quarter of fiscal 2009 decreased to 34.8 percent compared to 36.8 percent in the first quarter of fiscal 2008. This decline was due to the following factors: (i) higher manufacturing costs from lower plant utilization as we cut production in an effort to lower inventory levels, combined with a decline in sales volumes; (ii) significantly lower sales of our higher-margin professional segment products;
(iii) higher average commodity costs in the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008; and (iv) a stronger U.S. dollar compared to other currencies in which we transact business. Somewhat offsetting those negative factors were price increases introduced on most products and a decrease in freight expense.

Selling, General, and Administrative Expense

Selling, general, and administrative expense for the first quarter of fiscal 2009 decreased $12.6 million, or 10.7 percent, compared to the same period last fiscal year. However, SG&A expense as a percentage of net sales increased to 30.7 percent in the first quarter of fiscal 2009 compared to 28.9 percent in the first quarter of fiscal 2008 due to fixed SG&A costs spread over lower sales volumes. The decline in SG&A expense was primarily attributable to overall reduced spending in response to the continuing worldwide recessionary economic conditions and lower profit sharing and incentive compensation expense. Somewhat offsetting those declines were increased costs incurred for workforce adjustments and higher bad debt expense.

Interest Expense

Interest expense for the first quarter of fiscal 2009 decreased 10.8 percent compared to the first quarter of fiscal 2008 due to lower average debt levels and a decline in average interest rates.

Other Income, Net

Other income, net for the first quarter of fiscal 2009 was $0.8 million compared to $1.7 million for the same period last fiscal year, a decrease of $0.9 million. The decrease was due primarily to lower currency exchange rate gains, a decline in financing revenue, and lower interest income in the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008.

Provision for Income Taxes

The effective tax rate for the first quarter of fiscal 2009 was 33.7 percent compared to 35.4 percent in the first quarter of fiscal 2008. The decrease in the effective tax rate was primarily the result of the reinstatement of the domestic research tax credit and the tax impact of foreign currency exchange rate fluctuations.

BUSINESS SEGMENTS

We operate in two reportable business segments: professional and residential. A third reportable segment called "other" consists of a company-owned distributorship in the United States, corporate activities, and financing functions. Segment earnings for each of our two business segments is defined as earnings from operations plus other income, net. Operating loss for the "other" segment includes earnings (loss) from a company-owned domestic distributorship, corporate activities, including corporate financing activities, other income, and interest expense.

The following table summarizes net sales by segment:

                                                                Three Months Ended
(Dollars in thousands)                      January 30,       February 1,
                                               2009              2008          $ Change       % Change
Professional                               $     229,369     $     295,047     $ (65,678 )        (22.3 )%
Residential                                      107,024           106,325           699            0.7
Other                                              3,779             4,427          (648 )        (14.6 )
Total*                                     $     340,172     $     405,799     $ (65,627 )        (16.2 )%

* Includes international sales of:         $     130,391     $     158,457     $ (28,066 )        (17.7 )%

The following table summarizes segment earnings (loss) before income taxes:

                                                  Three Months Ended
    (Dollars in thousands)    January 30,       February 1,
                                 2009              2008          $ Change       % Change
    Professional             $      30,129     $      51,516     $ (21,387 )        (41.5 )%
    Residential                      4,840             3,818         1,022           26.8
    Other                          (24,816 )         (26,499 )       1,683            6.4
    Total                    $      10,153     $      28,835     $ (18,682 )        (64.8 )%

Professional

Net Sales. Worldwide net sales for the professional segment in the first quarter of fiscal 2009 were down 22.3 percent compared to the first quarter of fiscal 2008. Shipments declined for most domestic and international product categories due to decreased demand and customers' reluctance to place orders as a result of the continued worldwide recessionary economic conditions, which has resulted in lower field inventory levels for our domestic businesses. Worldwide sales of golf maintenance equipment and irrigation systems were significantly down for the first quarter comparison as customers delayed investments in new equipment at existing golf courses and new golf course construction slowed. In addition, sales of professionally installed residential/commercial irrigation systems were down due to ongoing weakness in the housing and commercial construction markets. Sales of landscape contractor equipment were also down for the first quarter comparison due mainly to timing of production for new products.

Operating Earnings. Operating earnings for the professional segment were $30.1 million in the first quarter of fiscal 2009 compared to $51.5 million in the first quarter of fiscal 2008, a decrease of 41.5 percent. Expressed as a percentage of net sales, professional segment operating margins decreased to 13.1 percent compared to 17.5 percent in the first quarter of fiscal 2008. These profit declines were primarily attributable to lower gross margins due to the same factors discussed previously in the Gross Profit section. Higher SG&A expense as a percentage of net sales also adversely affected operating earnings, which was due mainly to fixed SG&A costs spread over lower sales volumes.

Residential

Net Sales. Worldwide net sales for the residential segment in the first quarter of fiscal 2009 were up slightly by 0.7 percent compared to the first quarter of fiscal 2008. This increase was led by strong demand for snow throwers in North America as a result of heavy snow falls during the winter season of 2008/2009. In addition, improved product placement for a new and broader line of walk power mowers benefited residential segment net sales, which was offset by a decline in shipments of riding products due mainly to our customers' efforts to reduce field inventory levels by ordering product closer to retail demand.

Operating Earnings. Operating earnings for the residential segment increased $1.0 million, or 26.8 percent, in the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008. Expressed as a percentage of net sales, residential segment operating margins increased to 4.5 percent compared to 3.6 percent in the first quarter of fiscal 2008. This increase was due to lower SG&A expense as a percent of net sales from a decline in spending for marketing, warehousing, and engineering as a result of budget reductions, as well as a slight increase in gross margins primarily from lower freight expense.

Other

Net Sales. Net sales for the other segment include sales from our company-owned domestic distributorship less sales from the professional and residential segments to that distribution company. In addition, elimination of the professional and residential segments' floor plan interest costs from Toro Credit Company are also included in this segment. The other segment net sales decreased $0.6 million, or 14.6 percent, in the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008, due mainly to a reduction in the elimination of floor plan interest costs as a result of lower receivables with Toro Credit Company and a reduction in rates.

Operating Losses. Operating losses for the other segment were down $1.7 million or 6.4 percent for the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008. This loss decrease was primarily attributable to a decline in profit sharing and incentive compensation expense, somewhat offset by costs incurred for workforce adjustments and higher bad debt expense.

FINANCIAL POSITION

Working Capital

We have taken proactive measures to help us manage through the tough economic environment that continued to persist through the first quarter of fiscal 2009, including adjusting production plans, controlling costs, and managing our assets. As such, our financial condition remains strong. We are continuing to place additional emphasis on asset management with our GrowLean initiative, with a focus on: (i) ensuring strong profitability of our products and services all the way through the supply chain; (ii) minimizing the amount of working capital in the supply chain; and (iii) maintaining or improving order replenishment and service levels to end users.

Receivables as of the end of the first quarter of fiscal 2009 were down 13.6 percent compared to the end of the first quarter of fiscal 2008. Our average days sales outstanding for receivables improved to 68 days based on sales for the last twelve months ended January 30, 2009, compared to 71 days for the twelve months ended February 1, 2008. Inventory was also down as of the end of the first quarter of fiscal 2009 by 19.3 percent compared to the end of the first quarter of fiscal 2008, and average inventory turnover improved 5.9 percent for the twelve months ended January 30, 2009 compared to the twelve months ended February 1, 2008.

Liquidity and Capital Resources

Our businesses are seasonally working capital intensive and require funding for purchases of raw materials used in production, replacement parts inventory, capital expenditures, expansion and upgrading of existing facilities, as well as for financing receivables from customers. We believe that cash generated from operations, together with our fixed rate long-term debt, bank credit lines, and cash on hand, will provide us with adequate liquidity to meet our anticipated operating requirements. We believe that the funds available through existing financing arrangements and forecasted cash flows will be sufficient to provide the necessary capital resources for our anticipated working capital needs, capital expenditures, debt repayments, quarterly cash dividend payments, and stock repurchases for at least the next twelve months.

Cash Flow. Our first fiscal quarter historically uses more operating cash than other fiscal quarters due to the seasonality of our business. Cash used in operating activities for the first three months of fiscal 2009 was $2.5 million higher than the first three months of fiscal 2008 due primarily to a decline in accounts payable and accrued liabilities, as well as lower net earnings. Somewhat offsetting those unfavorable factors was a lower increase in receivables and inventory levels for the first three months of fiscal 2009 compared to the first three months of fiscal 2008. Cash used in investing activities was lower by $0.9 million compared to the first quarter of fiscal 2008, due to a decrease in purchases of property, plant, and equipment in the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008. Cash provided by financing activities was also lower by $30.0 million compared to the first quarter of fiscal 2008, due to a substantial decline in short-term debt for the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008, somewhat offset by lower levels of repurchases of our common stock for the first quarter comparison.

Credit Lines and Other Capital Resources. Our businesses are seasonal, with accounts receivable balances historically increasing between January and April, as a result of higher sales volumes and payment terms made available to our customers and decreasing between May and December when payments are received. The seasonality of production and shipments causes our working capital requirements to fluctuate during the year. Our peak borrowing usually occurs between January and April. Seasonal cash requirements are financed from operations and with short-term financing arrangements, including a $225.0 million unsecured senior five-year revolving credit facility that expires in January 2012. Interest expense on this credit line is determined based on a LIBOR rate plus a basis point spread defined in the credit agreement. In addition, our non-U.S. operations maintain unsecured short-term lines of credit of approximately $16 million. These facilities bear interest at various rates depending on the rates in their respective countries of operation. We also have a letter of credit subfacility as part of our credit agreement. Average short-term debt was $12.0 million in the first quarter of fiscal 2009 compared to $55.2 million in the first quarter of fiscal 2008, a decrease of 78.2 percent. This decline was due mainly to a decrease in working capital needs in the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008 as a result of lower levels of accounts receivable and inventory, as previously discussed, as well as lower levels of repurchases of our common stock during the first quarter of fiscal 2009 compared to the same period last fiscal year. As of January 30, 2009, we had $215.8 million of unutilized availability under our credit agreements.
Significant financial covenants in our credit agreement include interest coverage and debt-to-capitalization ratios. We were in compliance with all covenants related to our credit agreements as of January 30, 2009, and expect to be in compliance with all covenants during the remainder of fiscal 2009.

Off-Balance Sheet Arrangements and Contractual Obligations

Our off-balance sheet arrangements generally relate to customer financing activities, inventory purchase commitments, deferred compensation arrangements, and operating lease commitments. Third party financing companies purchased $43.5 million of receivables from us during the first three months of fiscal 2009, and $68.6 million was outstanding as of January 30, 2009. See our most recently filed Annual Report on Form 10-K for further details regarding our off-balance sheet arrangements and contractual obligations. No material change in this information occurred during the first three months of fiscal 2009.

Inflation

We are subject to the effects of inflation and changing prices. In the first quarter of fiscal 2009, average prices paid for commodities we purchase, namely steel and steel components, were higher compared to the first quarter of fiscal 2008, which hampered our gross margin rate in the first quarter of fiscal 2009 compared to the first quarter of fiscal 2008. Somewhat offsetting those higher costs was a decline in average prices paid for fuel and petroleum-based resins. We will continue to closely follow the commodities that affect our product lines, and we anticipate average prices paid for commodities in fiscal 2009 to be equal to or slightly higher than the average prices paid in fiscal 2008, if commodity costs continue to trend similar to the first quarter of fiscal 2009. We plan to attempt to mitigate the impact of inflationary pressures by engaging in proactive vendor negotiations, reviewing alternative sourcing options, and internal cost reduction efforts.

Significant Accounting Policies and Estimates

See our most recent Annual Report on Form 10-K for the fiscal year ended October 31, 2008 for a discussion of our critical accounting policies.

New Accounting Pronouncements to be Adopted

In April 2008, the Financial Accounting Standards Board (FASB) finalized Staff Position No. 142-3, "Determination of the Useful Life of Intangible Assets" (FSP 142-3). This position amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." FSP 142-3 applies to intangible assets that are acquired individually or with a group of other assets and both intangible assets acquired in business combinations and asset acquisitions. We will adopt the provisions of FSP 142-3 on November 1, 2009, as required.
In December 2007, the FASB issued SFAS No. 141 (Revised 2007), "Business Combinations." SFAS No. 141R applies to all business combinations and requires most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired to be recorded at "full fair value." This statement also establishes disclosure requirements that will enable users to evaluate the nature and financial effects of the business combination. We will adopt the provisions of SFAS No. 141R to any business combination occurring on or after November 1, 2009, as required.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures concerning fair value. We adopted the provisions of SFAS No. 157 for financial assets and liabilities and nonfinancial assets and liabilities measured at fair value on a recurring basis during the first quarter of fiscal 2009, as required. We will adopt the provisions of SFAS No. 157 for nonfinancial assets and liabilities that are not required or permitted to be measured on a recurring basis during the first quarter of fiscal 2010, as required. We are currently evaluating the requirements of SFAS No. 157 and, we do not expect the unadopted requirements of this new pronouncement will have a material impact on our consolidated financial condition or results of operations.
No other new accounting pronouncement that has been issued but not yet effective for us during the first quarter of fiscal 2009 has had or is expected to have a material impact on our consolidated financial statements.

Forward-Looking Information

This Quarterly Report on Form 10-Q contains not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and that are subject to the safe harbor created by those sections. In addition, we or others on our behalf may make forward-looking statements from time to time in oral presentations, including telephone conferences and/or web casts open to the public, in press releases or reports, on our web sites, or otherwise. Statements that are not historical are forward-looking and reflect expectations and assumptions. We try to identify forward-looking statements in this report and elsewhere by using words such as "expect," "strive," "looking ahead," "outlook," "optimistic," "plan," "anticipate," "estimate," "believe," "could," "should," "would," "may," "possible," "intend," and similar expressions. Our forward-looking statements generally relate to our future performance, including our anticipated operating results and liquidity requirements, our business strategies and goals, and the effect of laws, rules, regulations, and new accounting pronouncements and . . .