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 three reportable business segments: professional, residential, and distribution. A company-owned distributorship, which consists of our distribution segment, has been combined with our corporate activities and financing functions. 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 second quarter of fiscal 2009 should be read in conjunction with the MD&A included in our Annual Report on Form 10-K (Item 7) for the fiscal year ended October 31, 2008.

RESULTS OF OPERATIONS

Overview

For the second quarter of fiscal 2009, our net sales were down 21.7 percent compared to the second quarter of fiscal 2008. Year-to-date net sales were also down by 19.6 percent compared to the same period last fiscal year. Shipments of most professional segment products were significantly down due to decreased demand and customers' reluctance to place stocking orders largely as a consequence of the global recessionary conditions, which also resulted in lower field inventory levels for our domestic businesses. Residential segment net sales were also down by 4.7 percent and 2.8 percent for the second quarter and year-to-date periods of fiscal 2009, respectively, compared to the same periods in the prior fiscal year due mainly to a decline in shipments of riding products, which was somewhat offset by an increase in sales of walk power mowers as a result of additional product placement at a key retailer for a new and broader line of walk power mowers. International net sales declined 24.8 percent and 21.6 percent for the second quarter and year-to-date periods of fiscal 2009, respectively, from the same periods in the prior fiscal year, due also to reduced demand as a result of the recessionary conditions affecting our key international markets, as well as a stronger U.S. dollar that negatively impacted net sales by approximately $12 million and $24 million for the second quarter and year-to-date periods of fiscal 2009, respectively. Our net earnings declined 41.3 percent and 46.5 percent for the second quarter and year-to-date periods of fiscal 2009 to $36.9 million and $43.6 million, respectively, compared to the same periods in the prior fiscal year. These decreases were primarily the result of lower sales volumes and lower gross margin due to higher commodity costs, production cuts, and unfavorable product mix in the second quarter and year-to-date periods of fiscal 2009 compared to the same periods last fiscal year.
During this difficult 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 $22.7 million and $35.3 million for the second quarter and year-to-date periods of fiscal 2009, respectively, compared to the same periods in the prior fiscal year. In February 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 inventory levels also decreased 18.7 percent for the second quarter of fiscal 2009 compared to the second quarter of fiscal 2008, which also contributed to a decline in short-term debt of $118.6 million as of the end of the second quarter of fiscal 2009 compared to the end of the second quarter of fiscal 2008. We declared a cash dividend of $0.15 per share during the second quarter of fiscal 2009, which was equivalent to the cash dividend we declared in the first quarter of fiscal 2009 and each quarter of fiscal 2008.
We expect the global economic slow-down to continue for at least the remainder of our fiscal year and to continue to have a negative impact on our financial results for fiscal 2009. However, we believe we are well positioned to manage through this challenging environment because of the actions we have taken to improve operating efficiency and asset utilization, as well as reducing expenses. Our continued focus is on generating customer demand and aggressively driving retail sales for our innovative 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 second quarter of fiscal 2009 were $36.9 million, or $1.00 per diluted share, compared to $62.8 million, or $1.60 per diluted share, for the second quarter of fiscal 2008, net earnings per diluted share decrease of 37.5 percent. Year-to-date net earnings in fiscal 2009 were $43.6 million, or $1.18 per diluted share, compared to $81.4 million, or $2.07 per diluted share, last fiscal year, net earnings per diluted share decrease of 43.0 percent. The primary factors contributing to these declines 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             Six Months Ended
                                             May 1,         May 2,         May 1,        May 2,
                                              2009           2008           2009          2008
Net sales                                       100.0 %        100.0 %        100.0 %       100.0 %
Cost of sales                                   (67.7 )        (64.3 )        (66.7 )       (63.9 )
Gross profit                                     32.3           35.7           33.3          36.1
Selling, general, and administrative
 expense                                        (20.5 )        (19.6 )        (24.6 )       (23.2 )
Interest
expense                                          (0.9 )         (0.8 )         (1.0 )        (1.0 )
Other income (expense), net                       0.3           (0.2 )          0.2           0.1
Provision for income
taxes                                            (3.8 )         (5.3 )         (2.7 )        (4.2 )
Net earnings                                      7.4 %          9.8 %          5.2 %         7.8 %

Net Sales

Worldwide consolidated net sales for the second quarter and year-to-date periods of fiscal 2009 were down 21.7 percent and 19.6 percent, respectively, from the same periods in the prior fiscal year. Worldwide professional segment net sales were down 29.2 percent and 26.4 percent for the second quarter and year-to-date periods of fiscal 2009, respectively, compared to the same period in the prior fiscal year as shipments for most product categories were hampered by decreased demand largely resulting from the global economic recession. Worldwide sales of golf maintenance equipment and irrigation systems were down significantly, as were sales of professionally installed residential/commercial irrigation products and landscape contractor equipment. Residential segment net sales also decreased by 4.7 percent and 2.8 percent for the second quarter and year-to-date periods of fiscal 2009, respectively, compared to the same periods in fiscal 2008 due mainly to a decline in worldwide shipments and decreased demand for riding products. Somewhat offsetting these declines were an increase in sales of walk power mowers as a result of additional product placement at a key retailer for a new and broader line of walk power mowers, as well as strong demand for snow thrower products in North America as a result of heavy snow falls during the winter season of 2008/2009 for the year-to-date comparison. International net sales for the second quarter and year-to-date periods of fiscal 2009 were down 24.8 percent and 21.6 percent, respectively, from the same periods in the prior fiscal year due also to reduced demand as a result of the recessionary conditions affecting our 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 and $24 million of our net sales decline for the second quarter and year-to-date periods of fiscal 2009, respectively.

Gross Profit

As a percentage of net sales, gross profit for the second quarter of fiscal 2009 decreased to 32.3 percent compared to 35.7 percent in the second quarter of fiscal 2008. Gross profit as a percent of net sales for the year-to-date period of fiscal 2009 also decreased to 33.3 percent compared to 36.1 percent for year-to-date period of fiscal 2008. These declines were due to the following factors: (i) higher average commodity costs; (ii) increased manufacturing costs from lower plant utilization as we cut production due to a decline in sales volumes, combined with efforts to lower inventory levels; (iii) lower sales of our higher-margin products; and (iv) a stronger U.S. dollar compared to other currencies in which we transact business, in each case in the second quarter and year-to-date periods of fiscal 2009 compared to the same periods in the prior fiscal year. 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 decreased $22.7 million, or 18.2 percent, for the second quarter of fiscal 2009 compared to the second quarter of fiscal 2008. SG&A expense decreased $35.3 million, or 14.6 percent for the year-to-date period of fiscal 2009 compared to the year-to-date period of fiscal 2008. SG&A expense as a percentage of net sales for the second quarter and year-to-date periods of fiscal 2009 increased to 20.5 percent and 24.6 percent, respectively, compared to 19.6 percent and 23.2 percent for the second quarter and year-to-date periods of fiscal 2008, respectively, 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, as well as lower profit sharing and incentive compensation expense of $1.8 million and $5.5 million for the second quarter and year-to-date periods of fiscal 2009, respectively, compared to the same periods in the prior fiscal year. Somewhat offsetting those declines were increased costs incurred for workforce reductions of $2.1 million and higher bad debt expense of $1.3 million, mainly for the year-to-date comparison.

Interest Expense

Interest expense for the second quarter and year-to-date periods of fiscal 2009 was down 18.4 percent and 14.8 percent, respectively, compared to the same periods in the prior fiscal year as a result of lower average short-term debt levels and a decline in average interest rates.

Other Income (Expense), Net

Other income, net for the second quarter and year-to-date periods of fiscal 2009 increased $2.3 million and $1.4 million, respectively, compared to the same periods in the prior fiscal year. These increases were due to foreign currency exchange rate gains this year compared to foreign currency exchange rate losses last year, somewhat offset by a decline in financing charge revenue and lower interest income.

Provision for Income Taxes

The effective tax rate for the second quarter of fiscal 2009 was 34.2 percent compared to 35.0 percent for the second quarter of fiscal 2008. The effective tax rate for the year-to-date period of fiscal 2009 was 34.2 percent compared to 35.1 percent for the same period in the prior fiscal year. 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, somewhat offset by a valuation allowance for foreign net operating losses and prior years' provision adjustments of $0.6 million.

BUSINESS SEGMENTS

As described previously, we operate in three reportable business segments:
professional, residential, and distribution. Company-owned domestic distributorships, which consists of our distribution segment, has been combined with our corporate activities and financing functions that is shown as "Other" in the following tables. Operating earnings for our professional and residential segments are defined as earnings from operations plus other income, net. Operating loss for "Other" includes earnings (loss) from operations, corporate activities, including corporate financing activities, other income, net, and interest expense.

The following table summarizes net sales by segment:

                                                       Three Months Ended
(Dollars in thousands)                May 1,         May 2,
                                       2009           2008          $ Change       % Change
Professional                         $ 310,377     $   438,650     $ (128,273 )        (29.2 )%
Residential                            183,557         192,549         (8,992 )         (4.7 )
Other                                    5,918           7,311         (1,393 )        (19.1 )
Total *                              $ 499,852     $   638,510     $ (138,658 )        (21.7 )%

* Includes international sales of:   $ 148,756     $   197,770     $  (49,014 )        (24.8 )%

                                                        Six Months Ended
(Dollars in thousands)                May 1,         May 2,
                                       2009           2008          $ Change       % Change
Professional                         $ 539,746     $   733,697     $ (193,951 )        (26.4 )%
Residential                            290,581         298,874         (8,293 )         (2.8 )
Other                                    9,697          11,738         (2,041 )        (17.4 )
Total *                              $ 840,024     $ 1,044,309     $ (204,285 )        (19.6 )%

* Includes international sales of:   $ 279,147     $   356,227     $  (77,080 )        (21.6 )%

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

                                                  Three Months Ended
        (Dollars in thousands)    May 1,        May 2,
                                   2009          2008        $ Change       % Change
        Professional             $  56,859     $  96,907     $ (40,048 )        (41.3 )%
        Residential                 16,581        20,782        (4,201 )        (20.2 )
        Other                      (17,383 )     (21,083 )       3,700           17.5
        Total                    $  56,057     $  96,606     $ (40,549 )        (42.0 )%

                                                   Six Months Ended
        (Dollars in thousands)    May 1,        May 2,
                                   2009          2008        $ Change       % Change
        Professional             $  86,988     $ 148,460     $ (61,472 )        (41.4 )%
        Residential                 21,421        24,563        (3,142 )        (12.8 )
        Other                      (42,199 )     (47,582 )       5,383           11.3
        Total                    $  66,210     $ 125,441     $ (59,231 )        (47.2 )%

Professional

Net Sales. Worldwide net sales for the professional segment in the second quarter and year-to-date periods of fiscal 2009 were down 29.2 percent and 26.4 percent, respectively, compared to the same periods last fiscal year. Shipments declined for most domestic and international product categories due to decreased demand and customers' reluctance to place stocking orders as a result of the continued worldwide recessionary economic conditions, which also resulted in lower field inventory levels for our domestic businesses. Worldwide sales of golf maintenance equipment and irrigation systems were significantly down 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 decreased demand largely as a result of ongoing weakness in the housing and commercial construction markets. Sales of landscape contractor equipment were also down due to the recessionary economic conditions, but were somewhat offset by positive customer response to new product introductions.

Operating Earnings. Operating earnings for the professional segment in the second quarter and year-to-date periods of fiscal 2009 decreased 41.3 percent and 41.4 percent, respectively, compared to the same periods last fiscal year. Expressed as a percentage of net sales, professional segment operating margin decreased to 18.3 percent compared to 22.1 percent in the second quarter of fiscal 2008, and the fiscal 2009 year-to-date professional segment operating margin decreased to 16.1 percent compared to 20.2 percent from the same period last fiscal year. 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 second quarter and year-to-date periods of fiscal 2009 were down 4.7 percent and 2.8 percent, respectively, compared to the same periods last fiscal year. These sales declines were due mainly to lower worldwide shipments and reduced demand for riding products. Somewhat offsetting these declines were an increase in sales of walk power mowers as a result of additional product placement at a key retailer for a new and broader line of walk power mowers, as well as strong demand for snow thrower products in North America as a result of heavy snow falls during the winter season of 2008/2009 for the year-to-date comparison.

Operating Earnings. Operating earnings for the residential segment in the second quarter and year-to-date periods of fiscal 2009 decreased 20.2 percent and 12.8 percent, respectively, compared to the same periods last fiscal year. Expressed as a percentage of net sales, residential segment operating margin decreased to 9.0 percent compared to 10.8 percent in the second quarter of fiscal 2008, and fiscal 2009 year-to-date residential segment operating margin decreased to 7.4 percent compared to 8.2 percent last fiscal year. These profit declines were primarily attributable to lower gross margins due mainly to higher average commodity costs in the first half of fiscal 2009 compared to the first half of fiscal 2008 and unfavorable product mix. Somewhat offsetting the profit decline was lower SG&A expense as a percent of net sales from a decline in spending for marketing, administration, warehousing, and engineering expenses as a result of budget reductions.

Other

Net Sales. Net sales for the other segment include sales from our wholly owned domestic distribution company 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. Net sales for the other segment were down for the second quarter and year-to-date periods of fiscal 2009 compared to the same periods last fiscal year by $1.4 million, or 19.1 percent, and $2.0 million, or 17.4 percent, respectively, as a result of reduced demand due to the domestic economic recession, as well as a reduction in the elimination of floor plan interest costs as a result of lower receivables with Toro Credit Company and a reduction in interest rates.

Operating Losses. Operating losses for the other segment were down for the second quarter and year-to-date periods of fiscal 2009 by $3.7 million, or 17.5 percent, and $5.4 million, or 11.3 percent, respectively, compared to the same periods last fiscal year. The loss decreases were primarily attributable to the following factors: (i) overall reduced spending in response to the economic downturn; (ii) foreign currency exchange rate gains this year compared to foreign currency exchange rate losses last year; and (iii) decreased interest expense, previously discussed. For the year-to-date period of fiscal 2009 compared to the year-to-date period of fiscal 2008, the other segment operating loss was also impacted by a decline in profit sharing and incentive compensation expense, somewhat offset by costs incurred for workforce reductions 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 second quarter of fiscal 2009, including adjusting production plans, controlling costs, and managing our assets. As such, our financial condition remains strong. We continue to place additional emphasis on asset management with our GrowLean initiative, with a focus on: (i) achieving 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 second quarter of fiscal 2009 were down 25.5 percent compared to the end of the second quarter of fiscal 2008 due in part to the decrease in net sales. Our average day's sales outstanding for receivables improved to 69 days based on sales for the last twelve months ended May 1, 2009, compared to 71 days for the twelve months ended May 2, 2008. Inventory was also down as of the end of the second quarter of fiscal 2009 by 18.7 percent compared to the end of the second quarter of fiscal 2008, and average inventory turnover improved 9.9 percent for the twelve months ended May 1, 2009 compared to the twelve months ended May 2, 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, payroll and other administrative costs, 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. The first half of our fiscal year historically uses more operating cash than the second half of our fiscal year due to the seasonality of our business. Cash used in operating activities for the first six months of fiscal 2009 was $38.4 million lower than the first six months of fiscal 2008 due primarily to a lower increase in receivables and inventory levels for the first six months of fiscal 2009 compared to the same period last fiscal year, which was somewhat offset by a decline in net earnings and a lower increase in accounts payable and accrued liabilities for the first six months of fiscal 2009 compared to the same period last fiscal year. Cash used in investing activities was lower by $4.5 million compared to the first six months of fiscal 2008, due mainly to a decrease in purchases of property, plant, and equipment in the first six months of fiscal 2009 compared to the first six months of fiscal 2008. Cash provided by financing activities was also lower by $84.0 million compared to the first six months of fiscal 2008, due to a substantial decline in short-term debt for the first six months of fiscal 2009 compared to the first six months of fiscal 2008, somewhat offset by lower levels of repurchases of our common stock for the first six-month 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. As of May 1, 2009, we had $32.9 million of outstanding short-term debt and $10.1 million of outstanding standby letters of credit. Average short-term debt was $27.5 million in the first six months of fiscal 2009 compared to $103.0 million in the first six months of fiscal 2008, a decrease of 73.3 percent. This decline was due mainly to a decrease in working capital needs in the first six months of fiscal 2009 compared to the first six months 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 six months of fiscal 2009 compared to the same period last fiscal year. As of May 1, 2009, we had $198.7 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 May 1, 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 and contractual obligations generally relate to customer financing activities, inventory purchase commitments, deferred compensation arrangements, and operating lease commitments. Third party . . .