Toro Co (TTC) 2003 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Toro Company fourth quarter year-end conference call. During the presentation, all participants will be in the listen-only mode. Afterwards, we will come back to take question and answer session. At that time, if you have a question, please press the one followed by the four on your telephone. This conference is being recorded, Wednesday, December 10th, 2003. I would like to turn the conference over to Mr. Ken Melrose, Chairman and Chief Executive Officer, Toro Company. Please go ahead, sir.

Thank you, Frank. Good morning, ladies and gentlemen. Greetings from our Minneapolis headquarters. I'm pleased to spend this time with you on the call. With me this morning to assist in the question and answer session we have Steve Wolfe, our Chief Financial Officer, Tom Larson, our Assistant Treasurer and Steve Keating, Director of Investor Relations. Also joining me are our two Group Vice Presidents, Tim Ford and Mike Hoffman, who are in charge of all of our businesses.

Let's begin, but first let me review the safe harbor policy that's a part of all of our calls. As usual, I would ask you to keep in mind that during the call, we'll make certain predictive statements to assist you in understanding the company's results. You're all aware of the difficulties in making predictive statements in a highly seasonal and cyclical business. The company's 10-K details some of the important risk factors and may cause actual results to differ from those in our predictions. Our press release, written release was issued this morning by PR Newswire and can also be found in the industrial information section of our corporate website, www.toro.com. The information required to be disclosed about any non-GAAP results which may be discussed during this call is available in the press release.

While it's hard to believe that another successful fiscal year has come to an end and holiday season is just around the corner. [ Inaudible ] on the centers on the East Coast as many of you painfully know and significant snowfall before Christmas typically means strong demand for snow throwers. We even got our share of snow yesterday in the twin cities. Field reports corroborate the spike in expected retail demand in our eastern markets and snow thrower field inventory will position us well for next fall's pre-season shipments. It's also the time of year when we partner with grounds keepers at the football bowls such as the Rose Bowl and the Super Bowl as well as other major sports venues to help them prepare the turf for safe and functional play.

Please follow along, if you will with your copy of this morning's press release as I review the highlights for the fiscal year and the fourth quarter ending October 31st, 2003. We are indeed pleased today to report both record net earnings and sales for our fiscal year. We posted net earnings of $81.6 million, or $3.12 per diluted share, compared to $35.3 million and $1.37 per diluted share in fiscal 2002. For your information, a more realistic comparison shows fiscal 2003 earnings were approximately 34% ahead of fiscal '02 when you exclude the cumulative effect of change in accounting principal in the previous year. This is reflected in the press release tables, namely the consolidated statement of earnings.

For our top line, our net sales for fiscal '03, were $1.496 million or actually $1,496 million, up 7% from fiscal '02 and for the quarter, net sales were $310.3 million, up nearly 13% from 275.4 million in the same period last year. With double digit gains coming from both our professional and residential business segments. Net earnings for the quarter were $5.6 million or 21 cents per diluted share, compared to $5 million or 19 cents per diluted share for the same quarter in fiscal '02. Results of the fiscal 2003 fourth quarter included an after-tax restructuring and other expense charge totaling 1 cent per diluted share resulting from additional expenses for our Oxford, Mississippi plant closing which we announced in the third quarter. And as well, fiscal 2002's fourth quarter included a restructuring and other income benefit, having the net effect of $1 million after tax or 4 cents per diluted share.

Of course, the pivotal news for this year is that with our strong 2002 results, Toro achieved its 5.5% profit after-tax goal for our three-year profit improvement initiative. We were not only successful in moving the company to a high-ranking position on a profit after-tax basis among our peer companies, but we solidly engrained in our culture a mentality of profit and process improvement. We now have the momentum to move forward to the next generation initiative that will leverage our gains in 5x5 and fuel stronger revenue growth. I'll tell you more about this three-year program in a moment. But let's now get into the businesses to take a look at how these results break down by segment.

All business segments, in fact, rebounded after the cold, wet start to the season and finished strong despite the sluggish economy throughout the year. First looking at the professional segment, as you can see from the press release, compared to fiscal '02, our sales increased 7.8% to $929.4 million. The gains in both the quarter and the year came from a solid increase in our landscape contractor equipment business with strong contributions from new products in both the X-Mark and Toro brands. For the full year, worldwide sales grew in all major product categories and benefited from slightly positive currency exchange rates. Earnings were up 31.4% to $146.8 million compared with fiscal '02. This increase was due primarily to reaping the benefits from our ongoing 5x5 profit improvement efforts, lower currency support costs and lower product costs resulting from the transfer of certain production to lower cost facilities.

Our operating earnings for the quarter were impacted by the write-down of certain automated manufacturing equipment that was used for product assembly. This equipment is being phased out as we are moving to a more cost effective manufacturing process.

In the residential segment, both annual set sales and income were up, sales were up $506.5 million, up 6.8% compared with fiscal '02 and operating earnings for the segment, which total 55.5 million, also were up 6.8%. However, expenses associated with lowering production during the summer to better balance Toro's inventory levels with demand impacted operating earnings for the quarter. For the quarter and the year, the increase in residential segment sales came largely from growth and more shipments. Successful promotional programs and continued strong retail demand in both dealer and mass channels boosted more sales. We are also pleased for the growth in our time cutter-Z riding mowers and the strong initial stocking orders for the powerMax 2 stage snow throwers. In fact, snow thrower shipments were quite strong worldwide and contributed to a strong increase for the international residential sales segment in the fourth quarter. Let's move away from the results in our primary segments so I can give you a short review of our operations.

Our gross margin for the fiscal year was 35.8%, up 1.1 percentage points of net sales from 34.7% in fiscal '02. Gross margins improved in most areas as a result of the company's ongoing process improvement, cost reduction efforts and the net effect of transferring production to lower cost plans. SG&A expenses for fiscal '03 were 27.0% of net sales compared to 26.9% in '02, essentially the same rate. Interest expense declined $3.5 million for fiscal year due to lower average borrowing levels and the use of earnings to retire debt. Net inventories at the end of fiscal '03 totaled $228.9 million, up only 2% compared with $224.4 million at the end of fiscal 2002. And the increase reflected the impact of higher foreign currency exchange rates. Net receivables at the end of fiscal '03 totaled $280.1 million compared with $255.7 million at the end of fiscal 2002. The increase was primarily the result of higher overall sales, but as well as the impact of the change in foreign currency exchange rates on international receivables.

Now let me give you some perspective on our business outlook for fiscal '04. Our successful completion of 5x5 now sets the stage for a strong transition to our next three-year profitability and growth initiative. We're calling this 6 plus 8. We will leverage the creativity and energy of our employees to continue improving Toro's after-tax profitability above 6% which we are designating by the 6 plus in the 6 plus 8 name. While also accelerating top line growth to average at least 8% by 2006. But the 8 in the 6 plus 8 to build a stronger growth engine, we'll be investing in significantly higher levels in areas and initiatives such as energy, technology and new development as well as business and brand development. This will actually increase SG&A in the short run a bit, but will be offset somewhat by continued efforts to contain expenses and increase efficiency in other SG&A areas. Moreover, our plan is to continue our efforts to improve the profit yield through the implementation of lean manufacturing concepts and our plants and a no-waste campaign in the office environment. The increased investment toward revenue growth will affect, to some degree, our 2004 profit growth but not at the rates we've experienced the last couple of years. Nonetheless, for fiscal 2004, we expect to deliver, again, at least a 10% to 12% increase over fiscal $2003's $3.12 in diluted earnings per share but with net sales growth in the range of 7% to 9%. As always, we are tempering our initial outlook because of the inevitable uncertainties related to whether in the economy and global geopolitical issues. Keep in mind that our major seasons have yet to begin as well. However, as our 2003 results demonstrate, we are dedicated to achieving our financial goals regardless of the overall business conditions. For the first quarter of fiscal 2004, typically a smaller revenue period for us, we expect to report diluted earnings per share of somewhere between 15 and 20 cents on a net sales level that is commensurate with our fiscal 2003 first quarter sales.

Let me stop now so that we can move into answering any questions you may have.

Ladies and gentlemen, if you would like to register a question, press the one followed by the four on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, press the one followed by the three. One moment, please, for the first question. Our first question comes from Jim Lucas, Janney Montgomery & Scott, please proceed.

Thanks. Good morning, guys.

Good morning. How you doing this morning, Jim?

I'm doing all right. A couple of questions here. First, if we could look at gross margins in the quarter. The line in the press release is they declined as a result of the previously mentioned unplanned manufacturing expenses. Could you help quantify that for us and put a little more color around that, please?

When we move to our plant from -- irrigation production from Riverside to Juarez, we ended up with equipment that made a lot of sense under the cost structure in Riverside but we found in the Juarez environment a better manufacturing process that made the equipment of questionable use. And so we decided we would write that off. This is -- this is not atypical When, as we go along with our product line when we find either the tooling is not performing up to snuff or we don't need the equipment that we had initially purchased for the production. So in these instances, we either write the equipment and tooling down or we write them off. This is what happened in this particular case.

Okay. And if we could switch gears below the operating line, the tax rate came in 25% in the quarter. Can you talk a little bit about what's going on there and what your outlook for the tax rate is in '04?

Sure. I'll let Steve tell you about the tax rate. I don't know quite what you mean.

I don't think it is, Jim. I can take another look at that. But I can tell you what’s going on as we go into '04. We will have more of our profit improvement coming domestically versus internationally. And the big tax benefit we get is the more income that we get that's run through the [ Inaudible ] internationally is one of the reasons we've been able to drive our tax rate now. As our domestic income grows faster, the rate goes up. You'll see a little of that in '04. We also had some credits in '03 that will expire. We will tell you, you probably ought to bump the rate maybe half a % for 04 from 32.5 to 33.

Switching gears to the 6 plus 8 initiative, I'll have to refrain from the natural response of 14 that when you look at growing the top line at 8%, how -- can you add more color of where you want to focus on growing the top line?

Sure. What we did is we looked at our business opportunities in each category and we saw particularly with underserved markets or markets where we had low shares and yet the products and the distribution channel, the customer base is our cup of tea. So we thought if we would push harder at growing our share, that this ought to be relatively low risk, something that we know how to do. We just need to put more effort and investment. Whether it's a marketing programs like in the Rescom irrigation business or new products which might be more in the Lawnboy brand camp, things like that where we've said, this is our business. And it's not like acquiring a brand new business that we don't know much about. We know about these product needs and these markets and we're established in order to go after more share. So a lot of it is going after business that we think that we can get by just doing a more intense job of producing and marketing for the customers. So that's a piece of it. We've also said we need to spend more money to improve the product lines with more innovation. That's kind of our heritage, build a better mouse trap, improve our gross margins, create additional value adds to the customer. So we bumped our engineering technology, R&D, new product development area considerably for '04 versus '03. In fact, we're probably going to spend between $10 million and $15 million more than we normally would against specific markets and product lines. In order to just improve the growth engine over the three-year period.

Okay. When you talk about some of the underserved markets with the low share, could you give us a couple of examples of what types of markets you're referring to?

Well, I mentioned two. We have, for example, we have very high share in golf irrigation, but we don't particularly have a very high share in residential, commercial irrigation. And yet when you look at the manufacturing and the distribution and the engineering of the two product lines, they're very similar. But we have focused more of our energies historically in golf irrigation than we have for the commercial or residential part.

Okay.

Lawnboy, we have, because it's been too integrated in the Toro environment, we haven't put enough energy. And that's still a very strong variant, in fact, some of our customer groups have researched the brand and found that it's a top, still, leading lawn and garden brand. So it's there, available, we think, for us to become much more aggressive, strengthen the product line. Certainly in our power mowers first. And in other areas as well. When we first bought Lawnboy, the power mowers were bigger than Toro's. Certainly that isn't the case today. Because we haven't put as much dedication and focus as we need to. We think this is a brand we can rebuild, both with innovation and better customer relationships. So that's another example. There are some European markets as well that we think we're underserving and that we can capitalize on. These things aren't going to happen overnight. But we have to start the investment somewhere. And I think because 5x5 was such a bottom line cost and expense reduction effort, we haven't fueled as much long-term growth initiatives as we now think we have the opportunity to, and plus because of the much better earnings power of our business structure, we'll have a lot more leverage by getting additional growth. We think this can catapult us, if I can use that word, over the next three years to an even better profitability picture and show more growth to boot.

Okay. The final question, sorry to monopolize the time here, with regards to the balance sheet, you ended the year in very good shape. If you look at what the strong cash balance, your net debt to cap ratio is about 11%. What, besides investing in the growth initiatives, are some of the opportunities to re-invest the balance sheet?

Well, as we've said before, we'd love to find some other bolt on acquisitions like X-Mark which is a fairly large one for us or even small ones that we've done in the last couple of years that have added either new technology or a very important product line for us, whether it's irrigation or the equipment side. We think there are opportunities to do this. We have -- we've talked to various candidates. It's just a matter of working that through. But strategically, we think we can continue to be more important to our various customer constituents by bringing more breadth in our line. We can become a more complete supplier of product needs to customers, whether they're golf course superintendents or contractors. Or municipalities. We think there's just some opportunities that, obviously, we can't be very specific about at this point that would make a great deal of difference to us long term.

Okay. Thank you very much.

Our next question comes from the line of Jeff Shriner from MS Capital Management. Please proceed with your question.

Good morning, gentlemen.

Good morning.

I heard a little bit of an answer on capex guidance. Also in terms of the capex guidance, how much would you say in terms of investment would be split next year between R&D and capital goods that you need to purchase or equipment?

If you look at historically, we've had capex somewhere in the 35 to 40, 45 million range. We're going to end '03 at about 45 million. And our plan for '04 will be in the range of 49 plan-wise. Now, we typically have a larger plan than we end up getting spent. So a good guideline to use would be 35 to 40 in capex and a depreciation amortization of probably about the same, maybe just a little less. Now, I don't have the breakdown you ask in terms of the pieces of that. But that would be the total capex.

Okay.

I can tell you that the R&D, new product engineering piece of that, will increase in the high teens as a %. We typically spend about $50 million in new product developments or engineering and R&D. And we may get close to 60 million if all the projects that we're looking at come to fruition and that we can make good judgments on spending towards them. So that's uncharacteristically high and is a bigger piece of -- it's not capital, so it's not in the capex numbers. But it's a bigger percent of what we would normally spend in capex. Than normal. And the capex, as Steve said, is basically kind of a normal level that we've been spending the last few years.

And is the reason increasing the R&D in terms of new product development and things of that nature, I hear you talking about some new opportunities out there that maybe just haven't been fully developed on Toro's side. Is it possibly that we're coming to the life cycle end of a couple of Toro products that need to be updated to get the sales boost that may be needed?

No. I think it was more of a situation over the last three years we were very prudent, everyone in the company was focused on trying to find ways to contribute to the 5x5 effort. And I think this is always in the case at Toro, as is the case in other companies as well, the marketing engineering people in each division always have a list of very good new product opportunities. But they have to draw a line somewhere. And we've been drawing the line higher up than we will here in the future. Because we're going to be more aggressive and we'll have more projects and more innovation that will require more spending. So that's what, you know, we've gone through three years of, we haven't milked the product lines or the brands by any stretch of the imagination. We continued to invest in all of our lines. But we always have some projects that, for budgetary reasons and priority reasons don't get done. And we think we just need to be more aggressive and more liberal with our approval of more projects.

All right. Also in terms I heard possibly there had been discounting done this year, some promotional activity with some of the different products. Could we see pricing increases year-over-year on those, maybe ending promotional or some mix-shift change to possibly enhance gross margins coming into '04?

We're not going to be increasing prices materially in most of the areas. We will in selected areas. That's been fairly consistent practice over the last few years. I mean, there are some businesses where it's just not feasible to raise prices. So we've, again, I think Lee Manufacturing will help us a lot drive waste out of the whole company and improve our gross margins without raising prices. I'm not sure what you're referring to, though, when you say we've been discounting some products or promoting that we may cease to do that in the future. Can you be more specific?

Oh, I apologize, sir. I believe I thought I heard you say that on the call. I was trying to say if I had heard correctly. In terms of the discounting promotions. I thought that had been mentioned earlier in the call today.

If I said that, and this is obviously scripted pretty tightly, I didn't intend to. That has not been the case. We haven't been -- I mean, we promote products in marketing programs as usual, in a normal way, but we haven't been discounting to inordinately to get rid of something. We've actually had a very good year at getting our products sold through, particularly in the fall with a late, strong season, making our inventories very solid as we go into '04.

Okay. Thank you very much for that clarification. Just one other question here. In terms of the leanness at the factory you've been talking about, over the last few years have we possibly through the 5x5 initiative cut costs to the Max at this particular point going into '04. Is that affecting the flow-through down to the earnings per share line?

I don't think we'll ever say we've cut costs to the Max. What lean will do is shift us to be more productive and the outcropping of more productivity identifying ways to eliminate waste will result in lower cost. The lean manufacturing effort is a massive effort that we're doing in all, I guess, ten of our plants. And we'll see further cost reductions that come from that. Probably more as we crank up than you'll see in '04. It's just like 5x5. We initiated maybe a little less sophisticated cost reduction programs in our plants. We got a little traction in '01, more in '02 and a lot in '03. This will happen again with lean as we bring that on. We started it actually in one of our plants in this completed fiscal year and they have gotten quite a bit of a good benefit already from lean. If that answers your question, we'll go back to it if you want. I want to say, what I think you heard me say, what I did say, we had successful promotional programs for Powermore shipments for quarter in the year for comparison. So those were normal promotional programs that were, in most cases, sponsored by our dealers and the Home Depot. The Home Depot is our largest walk power mower customer. So when they want a promotion, father's day, mother's day, fall season, then we participate. That's what I was referring to.

Okay. Thank you very much for going back that, sir and helping me out with that. That's all my questions. Thank you, gentlemen.

Ladies and gentlemen, as a reminder, to register a question, press the one, four. Our next question comes from Dick Henderson from Pershing. Please proceed with your question.

Yes, good morning, gentlemen. Ken, on the 6 X 8 program, if we focus on the 8, I would think that perhaps we aren't using any contribution from acquisitions in that number.

That's correct.

In response to a prior question in terms of pricing flexibility, there's a minimal amount of that in it. In the 8. So that kind of brings you down to unit growth and mix. Can you kind of comment on the mix issue?

Sure. I can comment. I can't be very specific, but we can, if you just look at the very specific growth initiatives and they are very specific, and I've mentioned to Rescom Irrigation and Lawnboy, I can include the governmental sales, GSA military state contracts, again, where we have lower share than we would commensurately with golf equipment, large turf equipment sales, but basically the same equipment engineering process, distribution and so forth. We will continue to grow the residential side as we become more important to the Home Depot. And we'll continue to show that in '04. They will embrace our zero turning radius mower more aggressively in '04. We will have mower growth just because we'll have more skus. But this is not necessarily part of the accelerated growth. But you will see growth coming in residential because of our partnership with the Home Depot and some strong programs with our dealer bases as well. But you'll see some new products in our landscape contractor business, which has been a very nice industry growth business, into double digits for several years. It's slowing, but it's still very strong. And we continue to be a leader in that segment. So that piece will be strong, I think, the international business, particularly now in Asia, China, Japan is starting to strengthen and Europe where we have, I think, opportunity in both residential and the irrigation side. I'm not being qualitative on purpose, it's just that I don't --

You're answering the question because basically what you're really counting on is strong unit growth, based on those initiatives.

Real growth. It's growth that's indirectly generated.

Let me go back to the pricing. Steel prices are rising and oil has stayed at much higher levels than most observers have thought and those are2 important raw materials. You can get enough from lean manufacturing and selective increases to offset those, Ken?

Yes, we can and we will.

Question on the allocation of the incremental $10 million to $15 million that you expect to spend on the new program. How is that allocated between the gross profit in the SG&A? Just rough.

Well, you mean how is it --

In other words, in modeling the company, where do these expenses, you know, let's just say you had $100, how much percent would go to impact gross profit and how much would impact SG&A?

Most of it would be SG&A. It's going to be more brand advertising, more market programs, more product development.

Kind of 75/25,80/20/just kind of rough.

I would say at least 75%. The 8, trying to get the growth up to an average growth rate of 8% is going to be pretty much oriented to spending in our various disciplines. Yes, the lean manufacturing effort may create some opportunities to reduce price. And, therefore, get more growth. We don't have that built into the '04 plan. But we do have built in the plan that all of the -- I shouldn't say all -- but most of the savings we realize from lean we will fund specific new projects, again, not to be repetitive, but whether that's going after the government equipment area with more strength, with more products or Lawnboy, those initiatives will be spent in the SG&A area. That's where that will show up. And the gross margins will go up so you'll get some offset. I mean, once all is said and done, though, I always want to come back to it, we're still going to be focused on double digit earnings growth when all is said and done.

Right. Last question. And don't take it as trying -- for me trying to get too cute, on the outlook on the first quarter, you said that you ended -- business strengthened as the year went on, you ended strong, you got the snow in the northeast. You mentioned snow throwers, sales are strong pretty much across the board, including international. And you had the dollar weaken, actually fall off a cliff versus the Euro. How can you have a flat sales forecast?

Well, a big part of it is last year the Home Depot ran -- they tried to stimulate sales earlier than normal. So they ran a big promotion in the February period and maybe they even started in some markets in January. So we had to ship quite a bit of Walk Power mowers in January to support that. They're not going to do that this year. Our shipments to the Home Depot in January will be very light. And the forecast is that -- when the year is over, we'll have grown that business again. But they've just shifted their promotional dollars and efforts to later in the season. And so that just means that instead of a January shipment, you'll get it somewhere down the road. In February or later.

But the inherent, the other businesses basically are rising, you know, 5% or 6% or whatever.

They are, but I would also tell that you because of the snow thrower pent-up demand that was created by last year's snowfall, all the snowfalls that you got last year --

Right.

-- in the east, we were shipping much more snow product in the late summer and early fall to restock our dealers and our distributors. And also started retailing much earlier. So more of the seasoned shipments of snow throwers are occurring in the fourth quarter of the year we just finished as opposed to the first quarter. Now, with this last snow, we've -- we have sat around and tried to figure out if we can build more snow throwers for that, because the demand has been so strong that we're finding in some markets in the east where we have very little inventory as I said in my earlier statement. But, again, based on what we have planned and have reported, the snow business for this season has been disproportionally moved earlier so we're not getting in the first quarter what we might have gotten if we hadn't had the big snow or the pent-up demand.

So you'll get it in the fourth quarter of this new fiscal '04? You should.

It looks to us now that the fourth quarter will be similar to this last year's fourth quarter.

Right.

Because there will be very little snow throwers in inventory around the country.

Now, getting back on to this expenses associated with the new initiative, is that kind of equally distributed over the year, in which case it's going to be disproportionately negative for seasonally soft quarters like the first and the fourth? Is that fair?

Well, very little of that has shown up, will show up in the first quarter. It's just because it takes a while to get traction. The engineering, for example, we have to hire some more engineers for certain projects. Well, we're -- they're starting to come on board and that probably won't get completed in the first quarter. So we'll have less in the first quarter. By the fourth quarter, what we're going to do, we've resourced to 100%. We won't be sitting around at the beginning of the fourth quarter deciding, well, let's put some more money against this project and then build up the resources. We'll have made those decisions much earlier and for the most part, we already have. You'll see a big impact in the third quarter and some in the second quarter as we ramp up. Of course, those quarters are strong, so they will be less significant as a percent of sales. So I would say the answer to your question is, no, you won't see much penalty or much additional spending against that in the first quarter but you will in the fourth quarter because we'll have the full quarter's worth of spending in a quarter that's a lower than average quarter like the first.

Okay. Thank you.

You're welcome.

Mr. Melrose, there are no further questions at this time.

Before Ken closes up, I'd like to, Jim Lucas go back to your tax questions. I was looking at the full year, you were talking about the fourth quarter. That did have to do with some credits that we had that were larger at the end of the year than we had anticipated up through the first nine months and we had to book the adjustment for that all in the fourth quarter. You're right, it was a 25% rate, fourth quarter this year versus last. So that could have impacted the rate for the quarter.

What does that mean for '04, does it mean anything?

Is that helpful, Jim?

He can't answer.

Oh, okay. All right. Thank you, Frank. Once again, thank all of you for joining us today and for your thoughtful questions. I would be remiss if I didn't say, we are darn proud of the employees of Toro and the results they achieved for the company in fiscal '03. We do appreciate your attention and ongoing support as we take the company to the next level of profit improvement and shareholder value and we wish all of you a happy holiday and lots of snowfall. Thanks very much.

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. Have a good day.