Toro Co (TTC) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Toro Company third quarter analyst earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. At that time, if you have a question, press the one, followed by the four on your telephone. As a reminder, this call is being recorded Tuesday, August 26, 2003. I would now like to turn the conference over to Mr. Ken Melrose, Chairman and Chief Executive Officer. Please go ahead, sir

Thank you very much. Good morning, ladies and gentlemen. Pleased to spend this time with you on the call. We have Steve Wolfe, our Chief Financial Officer, and Tom Larson, our Assistant Treasurer, and Steve Keating, Director of Investor Relations, with us to assist me in the Q&A.

So let's begin. The Safe Harbor Statement -- I'll read that. That's the normal material that I always read. Just to ask that you keep in mind that during the call we'll make certain predicted statements to assist you in understanding the company's results. You are all aware of the difficulties of making predictive statements in a highly seasonal and cyclical business. Our company’s 10Kdetails some of the important risk factors that may cause actual results to differ from those in our predictions. The news release was issued this morning by PR Newswire and can be found in the investor information section of our corporate website.

The information required to be disclosed about non-GAAP measures discussed during this call is available in the news release which includes the schedule and reconciles our GAAP results with results excluding certain items. Even though under regulation G it is more cumbersome to provide non-GAAP measures, we believe presenting such measures (commits) a more meaningful comparison of our operating results and performance from one year to another.

It's been a busy summer for us here at Toro. Our maintenance equipment and irrigation systems have kept thousands of golf courses lush and green, as well as major venues like Yankee Stadium, Disney’s Wide World of Sports and the Indy 500 grounds. It is hard to believe the seasons are changing and we've turned our attention to helping the NFL and college fields like Princeton University, Notre Dame and the Rose Bowl get ready for the 2003 season.

Please follow along with your copies of the earnings release as I review the highlights for the third quarter. While the economy continues to be sluggish, we are pleased to report that Toro posted net earnings of $27 million for the quarter. That's compared to $21.9 million for the previous year's first quarter. That's an increase of 27% over the same period last year.

Results for the quarter included an after tax restructuring charge of $1 million or 4 cents per diluted share. Related to the closing of our two cycle engine plants in Oxford, Mississippi. Net sales for the quarter were $394.5 million. That's up 5% from $375.6 million for the same period in fiscal '02. Gains came from both our professional and residential business segments. Favorable foreign currency exchange rates in Europe, Canada and Australia continue to have a slightly positive impact on our sales.

I'll go through the earnings per share numbers as in the past showing how the reported earnings, or our GAAP numbers, differ from the adjusted ones or the non-GAAP or pro former figures. Just keep in mind that the per share figures for fiscal '02 are adjusted for our two for one split of the company's common stock that was effective April 1st, this year. So if you look at the tables in your press release, you'll see on the first line our GAAP numbers that we reported, a diluted earnings per share, up $1.03 versus last year's third quarter of 84 cents. That's a 23% increase.

Then we incurred, in the closing of the Oxford, Mississippi plant, a restructuring charge of 4 cents. We had no adjustments last year at this time. So the adjusted diluted earnings per share come down to $1.07 versus 84 cents, or the non-GAAP increase would be 27% in our earnings. For the nine-month period we reported net earnings of $76 million, up (150%) from $30.3 million for the same period. Net sales are up 5.5% at 1.186 billion compared to just about 1.124 billion. In our comparison you'll recall earnings reported per share (inaudible) for the nine months included some fairly significant charges that occurred in the first quarter of 2002.

So turn back, if you will, to the tables again, and you'll see for the nine months as we have reported year-to-date for nine months earnings per share on a GAAP basis $2.92 compared with $1.17 of the last year's nine months. That's 150% increase, which has a lot of things going on last year that makes that comparison so favorable. So if you work down the table, you'll see, first of all, for the last year's nine months we had a cumulative affect of a change of an accounting principle.

That is goodwill treatment and the impairment charge. That equaled 95 cents per share. Also, we had, in the same year, and we reported the same news release, a restructuring and other income expense of 26 cents of charge, and that related to the closing of our Riverside, California, and Evansville, Indiana, plant. Looking at the nine months for this year, you see 3 cents of restructuring and other expense.

That's a combination of 4 cents we just reported for this quarter due to the Oxford closing. And then a reversal of the balance of our reserve for the Murraybridge Australia closing that occurred last year. So that netted out to 3 cents. Then there was a one-time federal tax refund of 7 cents that occurred last year from an old tax report, or audit, for an old year, and that came back to profit for the last year's nine months.

Lastly, the legal settlement of a patent infringement suit, which was settled favorably for us, ended up adding 8 cents to our earnings for our first nine months here, this year. So when you do all the math, you end up with an adjusted diluted earnings per share for '03 nine months of $2.87. That has a more operating compared to oranges to oranges of $2.31 for last year's nine months. And that's a 24% increase. Again, fairly consistent with how our operations have improved over each quarter this fiscal year.

Toro 5x5 profit initiative, which set out to significantly improve our after-tax profitability by fiscal '03 was, once again, instrumental, as you would expect, in our strong third quarter performance. These results combined with a solid first half performance and the continued success of several new product introductions, put us on track to meet our goals despite the economy and above average rain falls in many of our eastern markets.

Now, let's take a look how these results break down by our segments. I will talk about professional first. As you can see from the press release, our professional segment sales increased 3.7% to $244.1 million while earnings per up 21.2% to $42.2 million. The gains came from strong initial stocking orders and customer acceptance of new landscape contractor equipment in both the X Mark and Toro brands, as well as favorable effects of currency.

In addition, the sales of new golf greens mowing equipment and service parts and the Toro brand at professional irrigation products continued to be strong throughout the quarter. In the residential area, after the cool, wet spring in several key markets, that I mentioned earlier, we experienced a nice pickup in residential sales during the third quarter, which ended up at $129 million. That outpaced the same period last year by 7.6%.

In addition the favorable effects of the currency phenomenon, shipments to dealers and particularly to the home center and mass market channel were strong for new walk-power mowers, riding mowers and two-stage snow products were also ahead of last year. These gains were offset somewhat by the decline in shipments of home solutions and retail irrigation products. Residential earnings were $14.9 million for the quarter, up 22.3% from last year. Another strong showing of our continuing efforts to improve the profitability in this segment.

And our last segment, distribution, you will note that sales in this area for the third quarter declined from $50.5 million last year to $43 million, or a 15% reduction. This was due primarily to the sale of one of our company-owned distributors, the one in Texas. That became effective the end of calendar 2002. Now, let me move away from our segment results and review -- give you a short review of our operations. I would like to talk a little further about the closure of our plant in Oxford, Mississippi. That's where we manufacture two cycle engines for lawn mowers and snow throwers. The close was not part of our overall plant rationalization strategy (inaudible), plant closings in the past few years have been. Rather, it was the result of stricter emissions requirements from the EPA impacting two-cycle lawn mower engines.

We worked extensively with the EPA and ultimately determined there was simply no economically viable alternatives to comply with the new regulations. Therefore, we had to discontinue producing these engines on December 31st last year. Our two-cycle snow thrower engines remain compliant and will continue to be manufactured, but its location is yet to be determined at this point.

Our gross margin in the third quarter of 2003 was 37.2%, up from 34.3% in the same period last year. The significant improvement margin was driven by, basically, three things. First, the favorable mix of products sold during the quarter. Second, it was due to our on going cost reduction efforts as part of 5x5. Third, positive manufacturing variances that were created by transferring the manufacture of certain products to our facilities in El Paso and Juarez, plus closing our facilities in Riverside and Evansville, Indiana as part of our long-term plant rationalization strategy.

Also note that the absence in 2003 of the start-up costs we incurred in Juarez, during the same period last year creates a comparison that's favorable to this fiscal year. Now, working down the P&L, a closer look at the various expense categories show that SG&A expenses for the quarter were 25.6% of net sales. That compares with a 24.6% of net sales in the (fiscal 2002) third quarter. So we're up one whole percentage point as a percent of sales. But it's important to note that while we remain committed to driving down certain components of this category, over the long term these savings will be partially offset by aggressive spending, which we're now doing, and marketing information technology and engineering, which will help secure our long-term growth and viability.

Interest expense for the quarter was down almost 11% compared with last year due to lower average borrowing levels, and net inventories, which totaled $236 million were up 12.8% from an unusually low level, the same period last year. This increase is due primarily to lower than expected sales in consumer products and the impact of exchange rates on international inventories. Lastly, receivables were up slightly at $373.2 million for the quarter. That compares with $341.9 million for the same period last year.

Higher overall sales, sales late in the third quarter and the impact of foreign currency exchange rates on international receivables all make up that increase. So just to make some comments here of the business outlook, I would say that this is another chapter in a year that began strong, and we expect to end strong. The improvements from three years of dedication and hard work in our 5x5 initiative, also supported by greater investments and new product development, brand building, and customer care, have really given us a platform to continue these productivity and efficiency gains into the next fiscal year and beyond. As we look ahead, further efforts to streamline our business processes will benefit the company, along with sustainable improvements, we have already achieved in distribution efficiency, supply chain management and capacity utilization. So based on all of this, we are raising our fiscal 2003 guidance and expect to report net earnings per diluted share in the range of $3.08 to $3.10 for the full fiscal year. Please note that in keeping with the new regulations regarding GAAP, this forecast includes the benefit from the aforementioned patent infringement settlement, recorded in the first quarter, as well as the year-to-date net restructuring expenses as shown in the press release. So let me stop now. I appreciate your attention while we move into answering questions that you may have.

Thank you. Ladies and gentlemen, if you would like to register for a question, please press the one, followed by the four on the telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw the registration, please press the one, followed by the three. If you are using a speaker phone, please lift your handset before entering your request. One moment, please, for the first question.

Our first question comes from the line of Susan Rafael from Janney Montgomery & Scott

Good morning, guys. It is actually Jim Lucas calling in. How is everyone?

Hope you're feeling better.

Thank you. A couple of questions. I apologize, I missed the first half of the presentation. The question is centered around the balance sheet. If you look inside some of the inventory build going into the fourth quarter, more specifically, the debt to cap continues to come down as you guys have generated cash flow. Can you talk about what the use of that cash might be?

Okay, Jim. I'll let Steve answer that question for you.

Hey, Jim.

Hi, Steve.

We worked hard at that, although our inventory levels were up a little at the end of the third quarter, as you've seen. It would be the same items we talked to you about before. One, re-invest to grow the company would be our first priority. How ever that may be, in terms of improving your operations, looking for acquisitions which we continue to do. Unfortunately, we have not found any significant ones in the last six or eight months or so. The topline growth, seasonal debt, working capital needs would be another use of those funds. We would continue to buyback shares to fund our incentive programs to keep our share level even. So those are the three or four main areas we'll be using that cash for.

Okay. And the acquisition environment, is it lack of properties you're seeing or is it more a function of valuations still being a little higher than what you're willing to pay?

I think it is a little of each. The valuations, obviously, are always an issue. Companies that are doing well that you want to buy tend to want a significant premium price. It's tough to make those things work. On the other hand, if you've got companies that aren't doing as well that you might want to acquire, the ownership there isn't as likely to want to sell at a depressed price. They're going to hang on and try and improve the operations. You've got some valuation issues. There aren't a lot of properties out there right now. I’d say it’s a combination of both.

Okay. From a longer term perspective, you talked about the process improvement. Clearly, that's shown up in the gross margin line. 5x5 has proven to be successful for you and, clearly those continuance improvement mindset continues to develop at the company. Now it seems like gross margins, the low hanging fruit, has been harvested here, but now it seems SG&A is the next area to tackle. Can you talk a little bit about what you're doing to make those improvements going forward?

Well, thanks for asking, Jim. I kind of suspected that people would begin asking what's after 5x5. And have we gotten all there is to be got. As 5x5 comes to a close, we have begun to think about what we're going to do as another initiative for the next, let's say, three years because we want to keep the momentum going. It won't go by itself. So we have to drive that. So we've been developing a new plan with new goals and strategies that will keep all the employees engaged in helping us raise (the borrow) and profitability. I would say you could expect a new initiative will have more focus on growth and organizational leverage, and we will have more details for you in our year-end report on that. But as it relates to the two points you mention, margin expansion and SG&A reduction, I would say that we will continue to get more margin improvement.

It is not going to come from the dramatic kind when we move our plants to more cost efficient locations or to close plants, but it will come from eliminating more waste on a very conscientious and planned methodology in all of our business systems.

So we expect to continue to drive costs and waste out of our operations. But as you mentioned, we will focus more attention on SG&A, and so we'll address leveraging our SG&A more. But I would say that you should keep in mind that we'll continue to -- a strong investment in R&D and engineering and information systems, customer care and development, they all occur in SG&A.

There are other areas in SG&A where we could, in a more focused effort, ratchet those down. So I think in a way in the spirit of your question, we will still get margin improvement. We'll get some SG&A improvement as we continue to invest in both our people and our systems to help us manage the business better.

Okay. Well, congratulations on a good quarter. Keep up the good work.

Thanks, Jim.

Our next question comes from the line of Chris Hanrahan from Sigma Capital.

Hi, there. You mentioned foreign currency effect. I was wondering if you could quantify that. I know your topline was up 5%. What was the foreign currency benefit?

Hi, Chris. Steve Wolfe. Yes, we can. It is small dollars. Maybe a point to a point and a half on sales on the P&L stand point. So it's not big dollars. And you end up, to some extent -- the dollars that go with that increased bottom line aren't as great because as we talked to you on previous calls, we have gone out and hedged quite a bit of that currency. This is mostly Euro, some Australia dollar exposure. We hedged a lot of that earlier in the year against our plan rates. So we didn't get all the benefit of the upside. So the sales dollar number is a point, point and a half. The profit number is 2, 3 cents, something like that.

2 to 3 cents, and then 3.5% to 4% on the topline growth, ex-foreign currency?

Yeah. Take a point and a half off, yeah

Okay. Point and a half. Okay. Goodwill and other assets just on the balance sheet up a couple million sequentially. Did you guys do any small acquisitions during the quarter?

We did have one small acquisition of a company out in New Jersey that's in the irrigation, rain sensor business. A very small company, a couple entrepreneurs to add to our irritation line.

Can you quantify the topline impacts on the quarter from that acquisition?

Very small. Just getting started. I would guess -- this is a guess. Somewhere in the million, million and a half range.

Okay. I wanted to ask about the whole inventory receivables, just kind of where they're at, with your day's inventory up ten year-over-year, your receivables up about twice the clip as your rate of sales. You mention something at the end of the quarter last -- a push. It sounds like a sell into the channel. Can you explain to me what happened there again?

Sure. Would be glad to. Let's start on the inventory side. A couple things you need to keep in mind. First, we do our comparison versus '02. If you go back and look historically, '02 was an outstanding year. We were chasing product all year to meet demand. With a couple of new introductions and to distribution channels, we had trouble keeping up with the demand last year. The end of '02 inventories were unusually low.

We got the benefit in '02 of the cash flow impact of that, but it sets us up for a very difficult comparison in '03. So for foundation, keep that in mind. We do have the impact of exchange. Again, we have to convert our foreign subs inventories to U.S. dollars and the exchange rates affect that, which made a slight impact. Then we built to a schedule that was more aggressive than the sales flow ended up coming in for. So we've had some carry over inventory through the end of the third quarter. You couple that with some leveling of production in our commercial plants. You add it all up. Inventories are higher than we would like to see them.

Now, I would tell you based on our projection for year end, and I think I told you this at the end of the second quarter call, also, that our projection, if we had our sales numbers, you’ll see that inventory (inaudible) pretty significantly by year end. We'll be back more in line with where we were last year. It will be over last year's, but not the GAAP we had here at the end of the third quarter

Okay. So can you dove-tail that into your cash flow expectations, obviously, that's affected cash flow for year-to-date. What do you expect for the full year?

If you look back historically again, '02 was one of the best free cash flow years we’ve ever had, we were up in the hundred million dollar range. We won't get all the way back that far. We will have higher earnings. Our capex will be higher. As we adjust our receivables and inventory, I would expect the '03 numbers to come in somewhere in the 75% to 80% of where we were in '02. So it would still be a very strong year, not quite as high as '02.

So the full year '03 numbers will be 75% to 80% of '02 on an operating cash flow?

Free cash flow basis.

Okay. I spoke with Steve on this. I wanted to ask you. Going through your last 10-Q you mentioned reversing warranty reserves. Did you guys do any of that this quarter?

We did our normal adjustments for full rate changes and anything that we see we would normally adjust in our warranty accruals.

Could you quantify that, Steve?

No. I don't have the numbers with me. You can give me a call. We can talk about that.

Okay. Thank you.

Ladies and gentlemen, as a reminder to register for a question, it's the one, followed by the four. Our next question comes from the line of Dick Henderson from Pershing LLC (ph). Please go ahead.

Hi, guys. Good quarter. Ken, a couple things. First of all, your sales have kind of been up in the 5% area in the last couple of quarters. Granted currency, 1%. So, let's say 4. How would the 4% compare with the markets?

You mean how --

In other words, were you gaining market share, or was there mix in there? It is kind of a gut feel kind of question.

Well, I would say our shares are holding -- we probably are still building share in our landscape contractor business as our increases are moving ahead of the market. Our walk power mower business has been increasing higher than what the--our trade association (inaudible),reports. Our tractor business is losing a share.

It has been slowly declining. On the other hand, we're replacing our lost tractor business with the turning radius mower business. So that's hard to guess because we don't see the kind of breakout for residential Z(ph) mowers versus tractors, but we do know we're losing share in the traditional tractors. We believe that we are increasing share in this new kind of riding mower that has a zero turning radius.

How about the trend in pricing? Could you comment on what you see there? Is it getting better, the same, or worsening, your pricing flexibility?

We've been operating for the last several years that, by and large, we can't increase prices. We certainly can increase prices in the residential segment. We work hard with our channel partners to keep our prices the same each year. We'd like to raise them, but there's a lot of pressure not to do so. In the professional side where we have clear product superiority or we are able to make some introductions of products that have significant or innovative features, we're able to improve our margins by -- with higher prices because we don't have a lot of competition, at least for a period of time until competition catches up. But, by and large, our prices do not increase.

Our average price increase corporately this year is probably, like, 1%. Again, I'm taking a guess. In some areas, it's been as much as 2. By and large, it's pretty much the same as last year. I'd say that's the way our competitors are. We don't see competition raises prices either.

Right. What's your sense, Ken, with your friends from Deere have made substantial progress in turning their business around? Is that a good thing, bad things, or what?

It is a good thing. They had some tough sledding, just as we've gone through that ourselves. They have done well. They're having a very good year, and they're particularly having a dynamite year with the Home Depot, with the introduction of their new 100 series lawn tractor.

That's been a great piece of their growth. We're very much attuned to that phenomenon because we did the same thing the year before, with the Home Depot, in creating a product line that was much lower in price points, much more attractive, and we ended up getting three-digit percent growth rates for our category last year, as they are, perhaps, doing in the riding mower business this year. Of course, I'd rather be selling a $2,000 ticket item than a $300 ticket item and experiencing that kind of growth, but, nonetheless, they have done very well in that area. That's been a big part of their growth, I'm sure.

Right. The other question I had was at the three-quarter poll excluding all items, you're at 287. You indicated that you'd probably do the 308 to 310 for the year. So let's take 309. I think I heard you say you've got new products. You're doing well. You're gaining share. You expect incremental improvement from your 5x5 program. You’re going to start focusing on your SG&A. The economy has picked up. Obviously, we don't know what's going to happen with the weather. I see numbers out there that give you a credit for growth next year of anywhere between 4% to 8%. Is there something I'm missing that is kind of operational that's going to hit you or hurt your earnings next year that would suggest that those estimates are realistic?

Well, we think the estimates are realistic, but we always assume that weather will be relatively normal throughout the world. It never is. There are areas that have great weather for our business, and there are areas that are dry or -- like you've had in the east, too much rain this year. So that's been-- a hurt to our growth, the economy, 9/11. The whole golf business. There have been a lot of things that have happened in this 5x5 period whereby our growth has not been up to where we would like it to be.

That's one reason why we're going to focus harder on growth because, in the last three years we focused so hard on profitability yield, just because we didn't think we were where we needed to be. We're getting closer to that now. We'll have a much more balanced focus in the years going forward.

Right. But how can -- if the economy does pick up and with all these adverse things, you know, that have happened, you're able to generate 4% or so revenue growth and, you know, it looks like we're going to have an improved environment next year, and your margins are expanding and your free cash flow is high, which means your debt should continue to drop or your share count should continue to decline. Why would you only get a 4% increase in earnings and consider that realistic?

4% increase earnings or growth?

Dick Henderson No. In earnings.

For next year?

Yeah. I'm just commenting that, if you're correct --

We don't think we will. We're not saying that.

No, no. I'm not trying to box you in a corner to get it -- to get a forecast. All I'm saying is, it seems to me that those numbers are too low.

the numbers that you're talking about --

I just wanted to know whether or not, in my earnings model, am I missing something that somebody else knows that is going to -- that would be kind of a cost or something like this that, perhaps, would hurt your earnings next year. What I'm hearing you say is that you don't know what's going to happen, but you don't know of anything that's going to happen.

I don't know of anything that --

Would hurt your earnings?

That would hurt our earnings, other than the kinds of --

Yeah. That's not in your control.

But the things that are in our control, I would say, are growth ought to be higher than 4% topline, and we'll get into the double digits in earnings growth.

Right. With normal leverage.

With normal leverage. As I said earlier, we'll continue to improve on the yield, but we want to get the growth rate up beyond the 4% to 5%, and we'll make a more concerted effort. I'm looking at three years now because I tend to make significant changes in your business system. It takes -- you start something. You don't see much occurring in the first year. You'll see it in the later years. But I would agree with what you have said. We should get better growth and more leverage to the bottom line as a result.

Okay. Ken, last question. When do you think you'll have a firm outline on this post-5x5 program that you can kind of talk to us about?

Well, as I said earlier, in the next quarter, the end of the year release, we will have a much more detailed explanation of what that's going to look like and what we expect from it

Okay. Thanks a lot.

I'm not showing any further questions at this time. I'll turn the conference back to you.

Ken Melrose. Well, let me close. Again, thanking all of you for your attention and thoughtful questions today. Just to summarize, we remain bullish for the remainder of '03 and, certainly, our business prospects for '04. I hope I made that clear in the last part of the Q&A. We appreciate your attention and on going support of the company and we look forward to getting back with you in three or four months, at the end of the year. Thank you, all.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.