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TTC > SEC Filings for TTC > Form 10-Q on 5-Jun-2013All Recent SEC Filings

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Form 10-Q for TORO CO


5-Jun-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Nature of Operations

The Toro Company is in the business of designing, manufacturing, and marketing professional turf maintenance equipment and services, landscape equipment and lighting, turf irrigation systems, agricultural micro-irrigation systems, rental and construction equipment, and residential yard and snow removal products. We sell our products worldwide 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. Our Distribution segment, which consists of our company-owned domestic distributorships, has been combined with our corporate activities and is shown as "Other." 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 will continue to be, attributable to new and enhanced products. We define new products as those introduced in the current and previous two fiscal years.

This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with the MD&A included in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended October 31, 2012.

RESULTS OF OPERATIONS

Overview

Our results for the second quarter of fiscal 2013 were positive with a net sales increase of 1.9 percent and a net earnings increase of 13.9 percent, each as compared to the second quarter of fiscal 2012. Year-to-date net earnings increased 23.7 percent in fiscal 2013 compared to the same period in the prior fiscal year on a net sales increase of 3.0 percent. Sales for our professional segment increased 8.9 percent in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 due to strong pre-season demand for our landscape contractor equipment resulting from customer optimism for the upcoming selling season and newly introduced products, increased shipments of golf and grounds equipment in Europe and Asia, higher sales of our micro-irrigation products from continued market growth and demand for our drip irrigation solutions in agricultural markets, and price increases on some products. For the year-to-date period of fiscal 2013, professional segment net sales were up 11.6 percent also due to strong demand in our first quarter of fiscal 2013 for products manufactured prior to the phase in of applicable Tier 4 emission requirements that resulted in price increases for such products. Additionally, increased sales and demand in the rental market, as well as incremental net sales from acquisitions, contributed to our professional segment net sales growth in fiscal 2013. Residential segment sales were down 13.2 percent and 12.8 percent for our second quarter and year-to-date periods of fiscal 2013, respectively, compared to the same periods in the prior fiscal year due to lower shipments and demand for walk power mowers and riding products primarily from unfavorable weather conditions this year compounded by favorable early spring weather conditions in 2012. Additionally, lower shipments of snow thrower products due to the lack of snowfall for the winter of 2012/2013 during the primary selling season contributed to the decrease of our residential segment net sales for the year-to-date comparison, which was somewhat offset by higher sales of Pope products in Australia due to increased demand for irrigation products as a result of drought conditions. Our net earnings growth in the second quarter and year-to-date periods of fiscal 2013 resulted primarily from an improvement of our gross margin rate of 180 basis points and 210 basis points for the second quarter and year-to-date periods of fiscal 2013, respectively, compared to the same periods last fiscal year, higher sales volumes, and a decrease in our tax rate due to the retroactive reenactment of the domestic research and development tax credit in our first quarter of fiscal 2013. However, our selling, general, and administrative (SG&A) expense as a percentage of net sales was up by 50 basis points and 40 basis points in the second quarter and year-to-date periods of fiscal 2013, respectively, compared to the same periods last fiscal year.

Although our overall financial condition remains strong, our inventory levels increased 23.6 percent as of the end of the second quarter of fiscal 2013 compared to the end of the second quarter of fiscal 2012 as we built inventory in anticipation of strong demand for products impacted by Tier 4 emissions requirements, and higher residential segment inventory levels due to lower sales volumes. Our receivables increased 12.8 percent, as of the end of the second quarter of fiscal 2013 compared to the end of the second quarter of fiscal 2012 due to a higher proportion of sales that were not financed with Red Iron. We increased our second quarter cash dividend by 27.3 percent from $0.11 to $0.14 per share compared to the quarterly cash dividend paid in the second quarter of fiscal 2012.

Our multi-year initiative, "Destination 2014" will take us to our centennial in 2014 and into our second century. This is our third year of this four-year initiative, which is intended to focus our efforts on driving our legacy of excellence through building caring relationships and engaging in innovation. Through our Destination 2014 initiative financial goals, we strive to achieve $100 million in organic revenue growth each fiscal year and 12 percent operating earnings as a percentage of net sales by the end


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of fiscal 2014. We define organic revenue growth as the increase in net sales, less net sales from acquisitions that occurred in the most recent four quarters.

In January 2013, we entered into an agreement to acquire a Chinese micro-irrigation company, subject to applicable regulatory approvals and other customary closing conditions. We expect to close the transaction by the end of fiscal 2013.

Our financial results for the first half of fiscal 2013 were solid, and we are optimistic about the remainder of the fiscal year. 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 economic environment, retail demand, field inventory levels, commodity prices, weather conditions, competitive actions, expenses, and other factors identified below under the heading "Forward-Looking Information," which could cause our actual results to differ from our anticipated outlook.

Net Earnings

Net earnings for the second quarter of fiscal 2013 were $78.4 million, or $1.32 per diluted share, compared to $68.8 million, or $1.13 per diluted share, for the second quarter of fiscal 2012, resulting in a net earnings per diluted share increase of 16.8 percent. Year-to-date net earnings in fiscal 2013 were $109.8 million, or $1.85 per diluted share, compared to $88.7 million, or $1.46 per diluted share, in the same comparable period last fiscal year, resulting in a net earnings per diluted share increase of 26.7 percent. The primary factors contributing to our earnings improvements were an increase in our gross margin rate, higher sales volumes, and a decrease in our effective tax rate, somewhat offset by an increase in SG&A expense. In addition, second quarter and year-to-date fiscal 2013 net earnings per diluted share were benefited by approximately $0.03 per share and $0.05 per share, respectively, compared to the same periods in fiscal 2012, as a result of reduced shares outstanding from repurchases of our common stock.

The following table summarizes the major operating costs and other income as a percentage of net sales:

                               Three Months Ended      Six Months Ended
                              May 3,       May 4,      May 3,     May 4,
                               2013         2012        2013       2012
Net sales                        100.0 %      100.0 %    100.0 %   100.0 %
Cost of sales                    (64.2 )      (66.0 )    (63.6 )   (65.7 )
Gross margin                      35.8         34.0       36.4      34.3
SG&A expense                     (19.1 )      (18.6 )    (22.1 )   (21.7 )
Operating earnings                16.7         15.4       14.3      12.6
Interest expense                  (0.6 )       (0.6 )     (0.7 )    (0.7 )
Other income, net                  0.4          0.3        0.4       0.2
Provision for income taxes        (5.4 )       (5.1 )     (4.4 )    (4.1 )
Net earnings                      11.1 %       10.0 %      9.6 %     8.0 %

Net Sales

Worldwide consolidated net sales for the second quarter of fiscal 2013 were $704.5 million, up 1.9 percent compared to the second quarter of fiscal 2012. For the year-to-date period of fiscal 2013, net sales were $1,149.1 million, up 3.0 percent from the same period in the prior fiscal year. Worldwide professional segment net sales were up 8.9 percent and 11.6 percent for the second quarter and year-to-date periods of fiscal 2013, respectively, compared to the same periods in the prior fiscal year. Sales for our professional segment increased due to strong pre-season demand for our landscape contractor equipment resulting from customer optimism for the upcoming selling season and newly introduced products, increased shipments of golf and grounds equipment in Europe and Asia, higher sales of our micro-irrigation products from continued market growth and demand for our drip irrigation solutions in agricultural markets, and price increases on some products. For the year-to-date period of fiscal 2013, professional segment net sales were up also due to strong demand in our first quarter of fiscal 2013 for products manufactured prior to the phase in of applicable Tier 4 emission requirements that resulted in price increases for such products. Specifically, additional Tier 4 emission requirements began to phase in for our products manufactured after January 1, 2013, having diesel engines greater than 25 but less than 75 horsepower. As a result, during the first quarter of 2013, we implemented price increases for our products subject to such Tier 4 emission requirements in order to cover the additional cost associated with the new technologies. Consequently, our professional segment net sales in the first quarter of fiscal 2013 were significantly higher than we experienced in the past or expect to experience in the future, except as may potentially be realized in connection with the phase in of additional future requirements. The result was strong demand prior to price increases going into effect for products now subject to Tier 4 emission requirements. Additionally, increased sales and demand in the rental market, as well as incremental net sales from acquisitions of $3.2 million and $6.4 million for the second quarter and year-to-


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date periods of fiscal 2013, respectively, contributed to our professional segment net sales growth. Residential segment net sales were down 13.2 percent and 12.8 percent for the second quarter and year-to-date periods of fiscal 2013, respectively, compared to the same periods in the prior fiscal year due to lower shipments and demand for walk power mowers and riding products primarily from unfavorable weather conditions this year compounded by favorable early spring weather conditions in 2012. Additionally, lower shipments of snow thrower products due to the lack of snowfall for the winter of 2012/2013 during the primary selling season contributed to the decrease of our residential segment net sales for the year-to-date comparison, which was somewhat offset by higher sales of Pope products in Australia due to increased demand for irrigation products as a result of drought conditions. International net sales were up 7.4 percent and 1.9 percent for the second quarter and year-to-date periods of fiscal 2013, respectively, compared to the same periods in the prior fiscal year due to increased shipments of golf and grounds equipment in Europe and Asia. However, changes in currency exchange rates resulted in a reduction of our net sales of approximately $4.3 million and $4.7 million for the second quarter and year-to-date periods of fiscal 2013, respectively. Field inventory levels were up as of the end of the second quarter of fiscal 2013 compared to the end of the second quarter of fiscal 2012 due to increased orders from strong demand prior to price increases going into effect for products subject to Tier 4 emission requirements, as well as a late start to spring, whereas last year we experienced strong preseason demand from early spring weather conditions.

Gross Profit

As a percentage of net sales, gross profit for the second quarter of fiscal 2013 increased 180 basis points to 35.8 percent compared to 34.0 percent in the second quarter of fiscal 2012. Gross profit as a percent of net sales for the year-to-date period of fiscal 2013 increased 210 basis points to 36.4 percent compared to 34.3 percent for the year-to-date period of fiscal 2012. These improvements were primarily due to a higher proportionate share of product sales that carry higher average gross margins, price increases on some products, cost reduction efforts, and slightly lower commodity prices, somewhat offset by changes in currency exchange rates that hampered our gross margin growth rate.

Selling, General, and Administrative Expense

SG&A expense increased $5.9 million, or 4.6 percent, for the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 and increased $12.9 million, or 5.3 percent, for the year-to-date period of fiscal 2013 compared to the year-to-date period of fiscal 2012. As a percentage of net sales, SG&A expense increased 50 basis points and 40 basis points for the second quarter and year-to-date periods of fiscal 2013, respectively, compared to the same periods in the prior fiscal year. These increases were primarily attributable to incremental SG&A costs from acquisitions of approximately $2 million and $4 million for the second quarter and year-to-date periods of fiscal 2013, respectively, an increase in warehousing expenses related to our new distribution facility in Ankeny, Iowa, plus higher inventory levels, an increase in engineering from investments in new product development, and higher health insurance expense. These increases were somewhat offset by a decline in product liability expense from favorable claims experience and a decrease in incentive compensation expense.

Interest Expense

Interest expense for the second quarter and year-to-date periods of fiscal 2013 decreased slightly, by 0.4 percent and 2.3 percent, respectively, compared to the same periods last fiscal year due to lower average debt levels.

Other Income, Net

Other income, net for the second quarter and year-to-date periods of fiscal 2013 increased $0.9 million and $1.9 million, respectively, compared to the same periods last fiscal year primarily due to higher income from our equity investment in Red Iron and a decrease in foreign currency exchange rate losses.

Provision for Income Taxes

The effective tax rate for the second quarter of fiscal 2013 was 32.6 percent compared to 34.1 percent for the second quarter of fiscal 2012. The effective tax rate for the year-to-date periods of fiscal 2013 and 2012 was 31.3 percent and 34.0 percent, respectively. The reductions in the effective tax rate were primarily the result of the retroactive reenactment of the domestic research and development tax credit.


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BUSINESS SEGMENTS

As described previously, we operate in three reportable business segments:
Professional, Residential, and Distribution. Our Distribution segment, which consists of our company-owned domestic distributorships, has been combined with our corporate activities and elimination of intersegment revenues and expenses that is shown as "Other" in the following tables. Operating earnings for our Professional and Residential segments are defined as operating earnings plus other income, net. Operating loss for "Other" includes operating earnings
(loss), corporate activities, other income, net, and interest expense.

The following table summarizes net sales by segment:

                                                  Three Months Ended
                                      May 3,      May 4,
(Dollars in thousands)                 2013        2012      $ Change    % Change
Professional                         $ 496,436   $ 455,945   $  40,491        8.9 %
Residential                            201,390     231,897     (30,507 )    (13.2 )
Other                                    6,660       3,643       3,017       82.8
Total*                               $ 704,486   $ 691,485   $  13,001        1.9 %

* Includes international sales of:   $ 212,005   $ 197,386   $  14,619        7.4 %




                                                     Six Months Ended
                                       May 3,        May 4,
(Dollars in thousands)                  2013          2012       $ Change    % Change
Professional                         $   825,580   $   739,779   $  85,801       11.6 %
Residential                              322,337       369,505     (47,168 )    (12.8 )
Other                                      1,230         6,036      (4,806 )    (79.6 )
Total*                               $ 1,149,147   $ 1,115,320   $  33,827        3.0 %

* Includes international sales of:   $   353,596   $   346,848   $   6,748        1.9 %

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

                                      Three Months Ended
                          May 3,      May 4,
(Dollars in thousands)     2013        2012      $ Change    % Change
Professional             $ 112,275   $  98,701   $  13,574       13.8 %
Residential                 24,679      28,518      (3,839 )    (13.5 )
Other                      (20,637 )   (22,827 )     2,190        9.6
Total                    $ 116,317   $ 104,392   $  11,925       11.4 %




                                       Six Months Ended
                          May 3,      May 4,
(Dollars in thousands)     2013        2012      $ Change    % Change
Professional             $ 173,013   $ 140,792   $  32,221       22.9 %
Residential                 36,833      41,126      (4,293 )    (10.4 )
Other                      (50,131 )   (47,440 )    (2,691 )     (5.7 )
Total                    $ 159,715   $ 134,478   $  25,237       18.8 %


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Professional

Net Sales. Worldwide net sales for the professional segment in the second quarter and year-to-date periods of fiscal 2013 increased 8.9 percent and 11.6 percent, respectively, compared to the same periods in the prior fiscal year. Sales for our professional segment were up due to strong pre-season demand for our landscape contractor equipment resulting from customer optimism for the upcoming selling season and newly introduced products, increased shipments of golf and grounds equipment in Europe and Asia, higher sales of our micro-irrigation products from continued market growth and demand, as well as additional manufacturing capacity that increased production and enabled higher sales for our drip irrigation solutions, and price increases on some products. For the year-to-date period of fiscal 2013, professional segment net sales were up also due to strong demand in our first quarter of fiscal 2013 for products manufactured prior to the phase in of applicable Tier 4 emission requirements, as previously discussed. Additionally, increased sales and demand in the rental market, as well as incremental net sales from acquisitions of $3.2 million and $6.4 million for the second quarter and year-to-date periods of fiscal 2013, respectively, contributed to our professional segment net sales growth. Field inventory levels were also up as of the end of the second quarter of fiscal 2013 compared to the end of the same period in the prior fiscal year due to increased orders from strong demand prior to price increases going into effect for products subject to Tier 4 emission requirements, as well as a late start to spring, whereas last year we experienced strong preseason demand from early spring weather conditions.

Operating Earnings. Operating earnings for the professional segment in the second quarter and year-to-date periods of fiscal 2013 increased 13.8 percent and 22.9 percent, respectively, compared to the same periods in the prior fiscal year. Expressed as a percentage of net sales, professional segment operating margin increased to 22.6 percent compared to 21.6 percent in the second quarter of fiscal 2012, and fiscal 2013 year-to-date professional segment operating margin also increased to 21.0 percent compared to 19.0 percent in the same period last fiscal year. These profit improvements were attributable to higher sales volumes, an increase in gross margins primarily from the same factors discussed previously in the Gross Profit section, and lower SG&A expenses as a percentage of net sales for the year-to-date comparison due to the leveraging of fixed SG&A costs over higher sales volumes.

Residential

Net Sales. Worldwide net sales for the residential segment in the second quarter and year-to-date periods of fiscal 2013 decreased 13.2 percent and 12.8 percent, respectively, compared to the same periods in the prior fiscal year. The sales decreases were largely due to lower shipments and demand for walk power mowers and riding products primarily from unfavorable weather conditions this year compounded by favorable early spring weather conditions in 2012 that accelerated sales of residential spring products into our second quarter of fiscal 2012. For the year-to-date comparison, shipments of snow thrower products were down due to the lack of snowfall for the winter of 2012/2013 during the primary selling season, which was somewhat offset by higher sales of Pope products in Australia due to increased demand for irrigation products as a result of drought conditions in that region. Our residential segment field inventory levels were higher as of the end of the second quarter of fiscal 2013 compared to the end of our second quarter of fiscal 2012 as a result of the aforementioned lack of snowfall during the primary selling season for the winter of 2012/2013, coupled with the late start to spring in 2013.

Operating Earnings. Operating earnings for the residential segment in the second quarter and year-to-date periods of fiscal 2013 decreased 13.5 percent and 10.4 percent, respectively, compared to the same periods in the prior fiscal year due to lower sales volumes. However, expressed as a percentage of net sales, residential segment operating margin was even at 12.3 percent in both second quarters of fiscal 2013 and 2012, and fiscal 2013 year-to-date residential segment operating margin increased to 11.4 percent compared to 11.1 percent in the same period last fiscal year. The increase in operating margin for the year-to-date comparison was primarily attributable to an improvement in gross margin mainly as a result of cost reduction efforts and lower commodity costs, somewhat offset by higher SG&A expenses as a percentage of net sales due to fixed SG&A costs over lower sales volumes.

Other

Net Sales. Net sales for the other segment include sales from our wholly owned domestic distribution companies less sales from the professional and residential segments to those distribution companies. The other segment net sales for the second quarter of fiscal 2013 increased $3.0 million compared to the second quarter of fiscal 2012 due to a decline in sales eliminated in the other segment from reduced shipments to our company-owned distribution companies. For the year-to-date period of fiscal 2013, the other segment net sales decreased $4.8 million compared to the same period in the prior fiscal year due to strong professional segment sales in the first quarter of fiscal 2013, mainly for products manufactured prior to the phase-in of applicable Tier 4 emission requirements, as previously discussed, to our wholly owned distribution companies that are eliminated in our other segment.


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Operating Losses. Operating losses for the other segment decreased $2.2 million in the second quarter of fiscal 2013 compared to the second quarter of fiscal 2012 due to a decline in product liability expense from favorable claims experience and a decrease in incentive compensation expense, somewhat offset by higher health insurance expense. For the year-to-date period of fiscal 2013 compared to the same period last fiscal year, operating losses for the other segment were up $2.7 million primarily due to an increase in the elimination of gross profit previously recorded with respect to sales of our products to our wholly owned distribution companies as a result of higher inventory levels at those distribution companies and an increase in health insurance expense, somewhat offset by lower product liability expense and incentive compensation.

FINANCIAL POSITION

Working Capital

Throughout the second quarter of fiscal 2013, our average working capital increased mainly due to higher average inventory levels as we built inventory in anticipation of higher demand for our products prior to the phase-in of applicable Tier 4 emission requirements, as well as lower sales for our residential segment from unfavorable weather conditions. We intend to continue our efforts on efficient asset management, with a focus on minimizing the amount of working capital in the supply chain, adjusting production plans, and maintaining or improving order replenishment and service levels to end users. We define average net working capital as accounts receivable plus inventory less trade payables as a percentage of net sales for a twelve month period.

Receivables as of the end of the second quarter of fiscal 2013 increased 12.8 percent compared to the end of the second quarter of fiscal 2012 due to a higher proportion of sales that were not financed with Red Iron. Our average days sales outstanding for receivables were slightly up, to 35 days based on sales for the twelve months ended May 3, 2013, compared to 34.5 days for the twelve months ended May 4, 2012. Inventory levels as of the end of the second quarter of fiscal 2013 also increased by 23.6 percent compared to the end of the second quarter of fiscal 2012. Our inventory levels were up as we built inventory in anticipation of strong demand for products impacted by Tier 4 emissions requirements before they went into effect, as well as higher residential segment inventory levels due to lower shipments and demand from the late spring weather in 2013, whereas last fiscal year we experienced strong preseason demand as a result of favorable early spring weather conditions. In addition, accounts payable increased as of the end of our second quarter of fiscal 2013 by $7.3 million, or 3.7 percent, driven by higher levels of inventory. The combination of these increases resulted in a higher average net working capital as a percentage of net sales for the twelve months ended May 3, 2013 of 16.3 percent compared to 14.9 percent for the twelve months ended May 4, 2012.

Liquidity and Capital Resources

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