Toro Co (TTC) 2004 Q2 法說會逐字稿

Welcome to the Toro Company's second-quarter earnings release conference call. During the presentation all participants will be in listen-only mode. Afterwards we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded Tuesday, May 25, 2004. I would now like to turn the conference over to Ken Melrose, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you very much, Paul. Good morning, ladies and gentlemen. Greetings from our Minneapolis headquarters and it is time again for our second-quarter conference call. Here with me this morning to assist in the question and answer component is Steve Wolfe, our Chief Financial Officer and Tom Larson, our assistant treasurer. And our group Vice President, Tim Ford and Mike Hoffman who head up all of our businesses. So before we begin let me once again review our Safe Harbor policy. Please keep in mind that during the call we will make certain predictive statements to assist you in understanding the Company's results.

You are 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 that may cause actual results to differ from those in our predictions. Our press release was issued this morning by PR newswire and can also be found in the investor information section of our corporate website thetorocompany.com.

May is nearly over, and we are about to turn the corner to summer, the season when Minnesotans like us spend most of our time in the great outdoors. Happily I can tell you the weather is behaving much better than last year and is fueling a more robust buying atmosphere in most of our markets, which I might add the whole industry is enjoying. As you know our second quarter is traditionally our strongest. And I am pleased to report that the Toro Company delivered its best quarterly performance in our ninety- year history. So now I invite you to follow along with your copy of this morning's press release as I review the highlights for our second quarter which ended April 30, 2004.

We reported an increase of 24 percent over the previous year net earnings and earnings per share. Net earnings for the quarter were $52.2 million compared to $42 million even for the same period last year. And earnings per diluted share were $2 compared to last year's $1.61. This was due primarily to higher volumes, improved margins and the favorable effects of our foreign currency. For the first six months net earnings were up 26 percent to $61.5 million or $2.36 cents per diluted share. For the same period last year we reported earnings of $1.89 per diluted share which included a onetime gain of 8 cents, resulting from a legal settlement.

Such a strong sign in the first half of the year reflects our ability to leverage and sustain the gains from our previous profit improvement initiative, that is 5X5, and carried forward into our new profitability and growth initiative we call 6+8. Even though we've only begun our journey into 6+8, we are already seeing benefits from the change in our culture and mindset brought about buying lean and no waste methods in our manufacturing and office environments.

From the production floor to corporate headquarters to offices around the world, countless project teams are engaged in making improvements in efficiency, margins and customer satisfaction. The savings from these efforts allow us to increase investments in innovation and new product development, services and branding, all focused to increase our revenue growth, market leadership and shareholder value.

On the top line we also turned in record net sales of $548 million, and that is up 10.5 percent from the same period last year. And for the first six months sales were $861.6 million, which compared to $792 million, up 9 percent compared to the same period in 2003. The effect of foreign currency for the six months was 8/10 a percent -- excuse me it was 1.2 percent for the six months and 8/10 of a percent for the quarter.

Favorable spring weather patterns, as I mentioned earlier coupled with an increased optimism about the economy contributed to the higher-than-expected shipments in the United States as well as abroad. In addition much of the increase in shipments was driven by innovative new products introduced in the past two years most notably our family of zero turning radius riding mowers for the landscape contractor market, and our enhanced offering of off power mowers for the dealer in the mass channel.

In addition, we experienced stronger shipments to almost all of our professional and international markets. Now let's turn to the businesses to see how these results break down by our segments. Our second-quarter sales in the professional segment were up 7.8 percent to $338.5 million across both product categories. The landscape contractor business was particularly strong for new products like the Z mowers continue to generate increased demand, and for the second quarter in a row international turned in double-digit sales improvement over the same periods last year. Even without the foreign currency effects, operating earnings for the professional segment rose 13.1 percent to $71.7 million compared with the second quarter of 2003.

Margins increased from continued product cost reduction efforts, lower warranty expense and favorable foreign currency effects. In the residential segment second-quarter sales climbed 13 percent to $195 million, fueled by retail demand for our new model in our family of Toro brand walk power mowers. And unlike our first half of 2003, retail promotions were more seasonally aligned this year to boost our second-quarter shipments.

International sales in our residential segment increased 6.6 percent, primarily due to strong demand for the well-established Pope brand of irrigation products in Australia. This innovative family of do-it-yourself solutions helps one out of every three Australian households caring for what they call their gardens. Slower demand for riding product however mitigated to some extent the overall increase in international sales.

Second-quarter operating earnings for the residential segment were $26.7 million, up 9.7 percent compared to the same period last year. Sales growth in this case outpaced earnings improvement, primarily due to a shift in the sales mix towards lower margin products.

In our distribution segment, sales were up 27 percent to $44.9 million. Earnings for the quarter rose to 1.6 million from 0.6 million or $600,000 last year due in part to increased sales and to continual improvements in asset management, as well as operating performance. Now let's turn our attention from the business segments to operations and the improvements that have resulted from our continued efforts to leverage expenses and more closely manage our cost structure.

Our gross margin for the second quarter was 36.3 percent compared with last year's at this time, 35.4, a 9/10 of a percent increase. As I mentioned earlier, the cost management disciplines we implemented over the past few years and the lean manufacturing efforts currently underway continue to reward us throughout the early months of 6+8. The improvements in our gross margins are a direct result of the tremendous number of employees who are engaged in lean manufacturing initiatives. Through their efforts todate we have been able to offset the rising cost of steel and other commodities. Our intent is to stay ahead of its impact on margin by maintaining our aggressiveness and our continuous improvement efforts.

We are also seeing tangible results from our 6+8 initiative in the area of SG&A expenses, which were 21.4 percent of net sales for the quarter down from 22.4 percent, a full one point from the previous year. Our administrative expenses have remained flat in the face of measurable sales increases so far this year. And we continue to follow our plan to increase investments in new product development and other growth initiatives. Engineering investments increased nearly 18 percent during the quarter. But this was more than offset by lower cost of bad debt and distributor change expenses.

Our balance sheet today is in a very strong position with little short-term debt. Interest expense was down 14.3 percent to $600,000 as earnings were used to retire debt and lower our average borrowing levels. Thanks to our increased focus on asset management, both net receivables and net inventories were down for the quarter. These improvements are reflected in our cash flow and our working capital. Net receivables were $484.8 million, essentially the same as this period last year even though our sales revenues were up quite nicely. While net inventory at the end of the quarter totaled $238.5 million, that's down from $260 million last year.

Lastly, I would like to address our recent attempt to repurchase up to 10 percent of our outstanding shares through a Dutch Auction tender offer during the quarter. Throughout the auction period the stock price rose and broke through the established price ceiling as I'm sure all of you know. As a result, only about 55,000 shares were tendered of the 2.5 million in we were seeking. We appreciate the confidence the market these displayed in our share price, we still need to utilize our strong cash flow to the benefit of our shareholders, and we will be discussing other alternatives with our Board later on this third quarter.

Let me now turn the business outlook as we look forward. Our six months' results from the strengths in all of our markets continue to fuel our optimism. They provide strong evidence of the momentum we were able to carry forward into our 6+8 profitability and growth initiative. But this is just the beginning, and we are confident that we will continue to reap the benefits of our lean manufacturing and business improvement efforts. Weather of course, it is always an uncertainty and may change the landscape in the months ahead; another uncertainty of course, lies in rising commodity prices. We have no plans in this fiscal year at least to pass along these increases, and we plan to accelerate our lean manufacturing initiatives in order to absorb them.

So if they become higher than planned, we may want to consider a price hike. Our 6+8 profitability and growth initiative has positioned us well for continued improvement in our financial performance. On the 6+ or profitability side of the equation, we expect further expansion of gross margins through new efficiencies in sourcing and manufacturing. Improvements in SG&A will be mostly offset by increased investments in engineering with information systems, trend development and customer care. Many of these initiatives for our fiscal year have had a ramp up period in the first half and now are gaining full strength as we go into the second half.

Most of these improvements are evidenced in productivity gains, which take longer to be realized than expense savings. Now on to 8 for growth side of the 6+8 equation, we plan to spend more than $50 million in fiscal '04 to drive growth and meet a goal of 35 percent or more of revenue from new products. Growth will also come from focusing on new or underserved markets, such as sports fields, government agencies, mass retailers, contractor installed irrigation and our international markets. In addition, we will invest to build our Lawn-Boy brand to take advantage of new market opportunities and residential products.

On a cautionary note, as we move past the peak of our season sometime now in the third quarter, we will be very mindful of the buildup of field inventories. In our industry, which may be not to dissimilar from other industries when business is very good there is a tendency to maintain high rates of shipments too long into the season and to not anticipate early enough the falloff in demand. While we do share industries overall enthusiasm we will move forward prudently to ensure no excess inventory in the field as the season winds down.

Our third quarter is on target and in line with analyst expectations, and in our fourth quarter we will have a strong snow thrower sell in. Shipment improvements may in our turf categories may affect top line growth somewhat. All things considered, we are raising our fiscal 2004 guidance once again. We expect net sales to increase between 8 and 10 percent, and earnings per share to increase somewhere between 18 and 23 percent. That translates to $3.68 to $3.84 in earnings per share for the year as compared to the $3.12 per diluted share we achieved in fiscal '03.

I must say, if I can, let me add this postscript. All of this good news has been possible by the dedication and engagement of all Toro employees in our profitability and growth initiatives. Let me stop now so that we can move to answering any questions you may have. I will turn it back to Paul.

(OPERATOR INSTRUCTIONS) Jim Lucas with Janney Montgomery Scott.

First, if we could just delve in a little bit on the investment side, I think this is the first time you talked about a spend level. Wanted to make sure I heard you correctly but $50 million is what you plan on spending for investing in the brands new product engineering in 2004?

The investment in new product development, we are planning to spend $50 million as I said maybe in the previous conference call. It was taking a little longer for us to get traction in our accelerated development efforts. But the 50 million is not towards a brand. It's not towards marketing programs. It is all focused on engineering and R&D. That compares to about $41 million last year. I think that's right. Yes. Everyone is shaking their heads.

And in terms of the brands looking at for instance, if we just delve down into Lawn-Boy in particular, what type of increased spend are you looking for in that category the nonengineering investments?

Well, we've added more brand advertising for Lawn-Boy. We are working harder at, as again we've talked about and expanding our distribution. I don't have the numbers, and they would be small because it is still just getting started. But it is substantially more than what we have been spending on the last few years. And then, of course, we have added quite a bit of spending in new product development against not only the walk power mower category of Lawn-Boy but barring other new product categories, as well. We know that for Lawn-Boy to become a strong, viable brand with light distribution, we're going to need a full complement of lawn and garden products.

If we take a step back, you made the comment that in terms of the engineering spend it has taken a little bit longer to get started there. If we look in addition to the higher commodity costs in the second half, would it be a safe assumption that the rate of margin expansion in the first half will probably not be seen in the second half?

If you are you talking about gross margins?

Both gross margin and well obviously SG&A is going to depend on how strong the top line comes in, so yes, I guess specifically gross margins.

Well, we are still seeing the effects of steel. And now a few other commodities like rubber that is starting to rise above our plan level. At the same time we are doing better in our process reengineering and our manufacturing facilities to kind of keep those new unexpected costs in check. On the whole they will probably not quite offset each other, and you may not see continued margin improvements over the next six months because we have the first. But it will still be better than last year, and as far as SG&A goes, what you didn't see the first half -- and I just mentioned that briefly in my comments -- you didn't see some of the increase in investment in the first half because it was just getting going. So we were able to start whittling down some of the administrative costs early on. And you would, of course, see maybe some improvement in SG&A. But it may not be a full percentage point.

Okay. Thanks.

Rob Schwartz with JL Advisers.

Congratulations on a great quarter. Two questions. First of all can you just talk a little bit about the acceleration in sales last quarter if the trend does continue in May. And then I would like to talk a little bit more about the balance sheet and just on the share repurchase authorization assuming there is no Dutch Auction or anything of that nature, what the current share repurchase authorization is and what the capacity could be.

And the first part of your question was?

Sales trends you are guiding, the last quarter was unbelievable -- if you could update us on the month of May, if trends are continuing and met.

Trends are continuing; nothing seems to be slowing down, and so we are -- that's one reason why we -- you know the weather for May has been generally good everywhere. And again, last year's May was very wet in the east. We still have droughts in the mountain states but we had that last year, too, so that is more comparable in terms of last year's versus this year's weather. By and large May is not a whole lot different from April. It is we are in the height of our season. Things are retailing very robustly. The inventories are doing very well.

As far as the Dutch Auction, our stock price went above the $60 range. So we didn't get what we had hoped. But nonetheless, we still want to do some sort of aggressive stock repurchase in the absence of any major acquisition. So we'll go to the Board with some alternatives, but we would still like to just to pick a number -- try to take buy back 3 million shares. So we have an authorization with them for open market purchases that was concomitants with the Dutch Auction of one million shares. So we're going to look at alternative ways to at least get some sort of effort going throughout the rest of the year to repurchase up to 3 million shares or in that neighborhood.

Great, and your current guidance for the 18 to 23 percent EPS growth this year, does that assume any successful completion of repurchase activity?

It assumes the completion of one million share repurchase. That is kind of still on the books. We still have that authorization, but like I said we would like to have more. And anything beyond the one million, though, is not in our guidance.

Congratulations again on an unbelievable quarter.

(OPERATOR INSTRUCTIONS) Jim Lucas with Janney Montgomery Scott.

Jim, as you have a pretty successful first year implementing lean throughout the organization; you made a lot of cultural transformation with 5 by five proven successful, now 6+8. Can you talk about, maybe just one or two things the main takeaways you've learned in this process? And how you are applying it to the business going forward, whether it's from working capital management, (indiscernible) starting the top line margin et cetera?

Just to be clear about 5 by five versus 6+8, 5 by five as a focus on margin improvement and cost reduction was very project oriented. Every group focused on taking costs out on kind of a project way of looking at it. Lean is, as you know, is much more of a process orientation. Looking at your process, breaking it apart and putting it back together by eliminating waste. And we just started that. We started in one plant the latter half of last fiscal year, but for the most part we really didn't get going on process reengineering or lean manufacturing if you will, until this Fall. So we have a lot of ways to go over the three-year period to find productivity and cost and expense reduction through just reinventing our processes.

So we think that we are just seeing the tip of the iceberg, so to speak in that initiative. We have moved to lean manufacturing, which we call no waste in the offices. That's a little more difficult to see immediate cost reduction gains. But we are finding as teams and departments are finding more better processes to be more productive, I think it will take maybe a year or more to translate those productivity gains into actual dollar gains.

We are seeing some dollar reductions, but I think most of the gains are productivity, which means we are faster, departments are delivering better customer service to other departments or customers outside the company. And so we are more effective. We may not be more efficient in the early goings, but so I think that has been the lag. The SG&A part, that comes from no waste in terms of dollar reductions may not be as robust in '04 as it will be in '05 and '06.

And with (indiscernible) looking at the 8 side a lot of opportunities in terms of penetrating new markets; we are seeing better economy, clearly doing a better job of the build inventory management, which is very nice to hear. As you are looking at just in general the when the first quarter was reported you talked about very strong competence in the dealer channel. As you exited the second quarter and were seeing a good start to May, what is the overall tone out there, the barometer, if you will?

The kind of scary thing is that everyone is optimistic. Our competitors are optimistic. Our dealers, the Home Depot and our other big box retailers are -- everyone is very optimistic, and that is why I made this cautionary note that when everyone is so optimistic and the engine manufacturers are building 15 to 20 percent more engines, I get a little nervous. Because I don't want to end the season with lots of inventory out in the field that we didn't shutoff early enough. So we are trying to be a little more cautious than maybe we have been before.

We're caught up in the euphoria, and we are very optimistic from what is being retailed today. But we know that last year the second half of the season -- the June, July, August even in September that period was very good. The weather turned very favorable, particularly in the east. A lot of that pent-up demand was earned, came to fruition in the latter half, which didn't get retailed particularly in the east coast. So we don't want to go overboard, and yet we don't want to miss business either. So it is kind of a tricky process. But something that we're going to be very attentive to in the third quarter.

Okay. Thanks a lot.

James Leonard (ph) with Leonard Management.

I am just going to ask you a few more questions about the 6+8 and see if I understand properly. Where does it take here some of your metrics in say three to four years, you're operating margins or your return on assets or however you folks measure your performance on this?

The two measures of the 6+8 are overt as the return on sales, the profitability rate. And that has to do with the 6 number, the 6 plus number. And by 2006, we want to be well into 6 percent or more earnings per dollar of share, per dollars of revenue. So 5 by five got us to 5.5 percent. That's what we did last year. And this year we wanted to get as close to 6 and move into 6 and how that might meter out over the three years. 6+8 is 2004, 5, and 2006 initiative. So we expect our profitability rate to go from 5.5 well into the 6 percent, 6 plus percent over the three years. So that metric and the other is we want to achieve at least 8 percent growth each of these three years. That's the 8.

Now if we do that we will have a much stronger financial P&L statement on the balance sheet. That doesn't necessarily, although it does to some degree drive a better balance sheet, but we will have through this three-year period a very strong asset management component. Haven't talked much about that. We were pretty attentive to asset management over the 5 by five period. But we will continue to drive down systems inventories and try to bring cash out to cash in that gap closer. As we do that our EVA will grow nicely, and our return on invested capital would be much stronger. But 6+8 really focuses the organization on growth and profitability. Management will also be focused on asset management and that will improve the balance sheet.

Where does it take you on your asset management side? Where does it take you on return on assets or however you like to measure your asset efficiency?

We're debating this. Just one second. We don't really have a very good number to answer your question definitively. That may be something that Tom or Steve may want to get back to you because we can tell you what return on assets were, have done over the last three years and what we might expect them to be going forward, but that is not in front of me at the moment.

Let me ask it a little different way, then. When you make your capital expenditures, your $50 million or however it's going to be or you make an acquisition, how do you, what kind of metrics do you use to see if this fits your asset return criteria?

Our internal rate of return hurdle is 15.5 percent. Our cost of capital is in the ninth, I guess isn't it? On the one hand anything we can do that returns better than our cost of capital is helps the shareholder. But all of our projects have to exceed 15 percent in terms of internal rate of return or our return on investment. Whether it's a new engineering projects or IS or IT proposal or capital request for new plant and equipment. So that is our requirement 15, 15.5 percent or greater.

If using that same standard, what effective return do you have on your assets right now then, your total assets?

Return on equity is 21 percent. (inaudible) We also look at return on average net assets. That's going to be lower than 21 percent, but.

Well I guess I am trying to figure out how that relates to that 15 to 15.5 percent, whether you are getting better returns than you are currently receiving or you are diluting your return on assets.

Can we go get some different material here and give you a call back?

Certainly.

We are not -- we have a book of information here, and it's probably buried in it somewhere. But it is not at the top of mind at the moment.

Okay. Thank you.

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

Okay, well if there are no further questions let me just thank all of you for your attention. We appreciate your joining us today and for your thoughtful questions. Obviously we continue to be pleased with our financial performance. Our outlook for the remainder of the year continues to be very strong. And we appreciate your ongoing interest and support. So thank you very much for joining us this morning, and we will look forward to our conversations in three months.

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