Toro Co (TTC) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to The Toro Company’s first quarter earnings conference call. My name is Kelli [sp] and I’ll be your coordinator for today.

[OPERATOR INSTRUCTIONS.]

I would now like to turn the presentation over to your host for today’s conference, Mr. Michael J. Hoffman, President and CEO of The Toro Company. Please proceed, Mr. Hoffman.

Thank you, Kelli. Good morning, ladies and gentlemen, and greetings from our Minneapolis headquarters. I’m pleased to welcome you to our earnings conference call for the first quarter of fiscal 2006.

Joining me this morning are Steve Wolfe, our CFO; Tom Larson, Treasurer; and John Wright, Director of Investor Relations.

Before we begin, as always, let me review our Safe Harbor policy. Please keep in mind that during the call we’ll make certain predictive statements to assist you in understanding the Company's results. You all aware of the difficulties in making these predictive statements in a highly seasonal and cyclical business.

The Safe Harbor portion of the Company's press release, as well as SEC filings, detail 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 be found in the Investor Information section of our corporate website, thetorocompany.com.

Now, on to the highlights for our first quarter ended February 3rd. It’s been another unpredictable winter, with unseasonably warm weather here in the Midwest, with perhaps the exception of last week. However, those of you who live in the East Coast might have experienced heavy snowfalls from the Mid-Atlantic to New England a couple of weeks ago, including a record 27 inches in New York’s Central Park.

Increased retail sales of Toro Show Throwers have reminded people that winter is certainly not over. Combined with the early season snowfalls, these recent storms put us in a position to restock retailers later this fiscal year.

While it was snowing up north, the weather certainly wasn’t top of mind for the attendees at the 77th Annual Golf Industry Show earlier month in Atlanta. Despite being forced to relocate from New Orleans due to Hurricane Katrina, the show was very well attended and gave Toro another opportunity to showcase our industry leadership.

We launched the show with a great press conference that highlighted many new, innovative golf course maintenance and irrigation products. From that point forward, our booth was wall to wall with golf course superintendents and owners who expressed optimism for the upcoming season.

It’s clear that these customers want to make their courses look and play great, and we believe Toro’s in the best position to deliver the products and services they’ll need to run their businesses effectively and profitably, all of which bodes well for our business this season.

The same optimism was prevalent at several other industry trade shows we attended the first quarter for landscape and irrigation contractors, and rentals customers were equally optimistic about their businesses and the outlook for this season.

With that said, let’s turn to the results of our first quarter. Last November, as we entered the third and final year of our 6+8 profitability and growth initiative, we were confident that the momentum generated from our ongoing focus on Lean and no-waste process improvements would continue, and it has.

While our first quarter is historically a smaller seasonal period, net earnings rose nearly 28% to a record $14.3 million, up from $11.2 million last year. Earnings per diluted share were $0.32 compared with $0.23 on a post-split basis. All in all, our focus on driving profitability in conjunction with strong sales growth in the international markets resulted in a solid first quarter performance.

Net sales for the quarter rose 6.6% to $369.6 million, up from $346.9 million for the same period last year. A significant contributing factor in this performance was an increase of nearly 34% in sales of residential and professional products to international customers. Toro continues to gain strength around the world in our core markets as we offer turf maintenance and irrigation solutions to meet the needs of our global customers in various geographic regions.

In addition, the acquisition of Hayter, Ltd. in the United Kingdom last February continued to prove it’s value to our growth equation. All told, another very strong quarter in our international business is further evidence that our long-term strategy to mitigate domestic weather and business risks by more geographic balance in our portfolio is sound.

Let’s turn now to our segment results. In the Professional segment, sales rose 3.4% to $253.6 million. The largest driver of this revenue growth was international sales of new and existing equipment and irrigation products. This growth was balanced and widely distributed across virtually all geographic regions.

Our Toro and Hayter branded commercial and golf maintenance lines of equipment led the way, supported by sales increases in micro-irrigation products for agricultural use, and contractor-installed residential and commercial irrigation systems that are sold under the Toro and Irritrol brands.

Domestically, segment revenue declined slightly due to shipping closer to retail and the management of our field inventory. However, we anticipate excellent customer acceptance of recently launched innovative new products and services here in the U.S. and around the world. And as I mentioned earlier, optimism was high at the Atlanta Golf Show. And those who lead in the industry, like Toro, stand to benefit most.

Although new golf construction in 2006 is expected to be relatively flat in the U.S., activity is brisk in other regions abroad. Renovation work also continues as courses are driven to improve the appearance and playability for their customers. And Toro’s ready to respond with innovative new products, like the ReelMaster 5010 fairway mower with it’s dual precision adjustment cutting units, or our versatile Sand Pro Power Bunker Rakes that allow operators to switch among 17 different attachments in less than one minute each.

And in the irrigation area, customers are excited about our new cost effective expandable network of golf decoder control system. It can operate up to 3200 stations using Toro’s exclusive SitePro software.

Earnings for the Professional segment rose 7.2% to $41.7 million, with impacts from commodity costs continuing to be offset through pricing and efficiencies from our Lean manufacturing efforts.

On the other side of our business, the Residential segment took the lead during the quarter in revenue and profitability growth. Net sales rose 12.8% to $108.2 million, once again fueled by the Hayter acquisition and strong growth in the international sales of Toro walk power mowers and riding products, particularly lawn and garden tractors.

Down under in Australia, sales of Pope-branded home solutions, particularly irrigation products, increased with improved weather conditions and the launch of several new line extensions such as garden tools.

Comparatively, domestic shipments were down slightly for the quarter due in part to the introduction of new Lawn-Boy walk power movers during the first quarter last year, and due to the timing of initial stocking orders.

And while sales of Toro branded riding products in the U.S. were down for the quarter, our press release in early January announcing the introduction of a new line of Toro lawn and garden tractors was welcome news from dealers and the Home Depot.

A selection of these tractors will be offered in all Home Depot stores under an exclusive brand licensing agreement, a move that will position them as “the” home center destination for a wide range of Toro products, including lawn and garden tractors, TimeCutter Z riding mowers, walk power mowers, snow throwers, irrigation products, hand-held outdoor equipment and more. It’s a long list.

Earnings in the Residential segment for the first quarter were $5.1 million, up 16.1% from the previous year due to favorable product mix and some price improvements.

Now, let’s take a closer look at our operating results for the quarter. Gross margin was 35.7%, up slightly from 2005, and arresting the decline we’ve seen over the last several quarters. We are pleased with our long-term focus strategies to improve our profitability through pricing and Lean efforts, and they’re moving our gross margin now in the right direction.

SG&A expense as a percent of net sales declined to 29% versus 29.5% the previous year. And again, we’re encouraged by this trend as we stay the course in our proven business strategies, and continue to leverage efficiency and productivity gains from 6+8.

In the first quarter we benefited from lower administrative expenses and warranty costs. However, while focusing on overall SG&A leverage, there are certain areas where we intend to spend more. Part of our long-term strategy is to increase investments in R&D to support our growth goals, and this quarter was no exception.

Moving beyond SG&A, interest expense rose slightly for the quarter to $4.2 million, compared to $3.7 million the previous year, due to higher interest rates and slightly higher average borrowing levels.

I’m also pleased to report that our balance sheet remains strong as a result of better asset management.

Receivables were basically flat with last year against the rise in net sales at 6.6%. Net inventories at the close of the quarter rose 7% to $296 million, with the bulk of that increase coming from the Hayter acquisition.

Now, let me share a brief review of our business outlook. As I’ve already mentioned this morning, the majority of our resell activity still lies ahead. We are encouraged by the general optimism among our customers and the abundance of new products that have been or will be launched throughout the year.

Assuming that there are no widespread extremes in the economic and environmental factors, all indications point to a solid spring selling season. Although this is a small quarter, we are definitely off to a good start in the new year, and in a position to benefit from share in overall market growth.

As always, our strategy is to focus on the year and continue to take the long view. Therefore, we are reaffirming our earnings outlook for fiscal 2006 and expect net earnings per diluted share to grow 12% to 15% on sales growth of 8%. For the second quarter, we currently expect to report net earnings per diluted share of $1.42 to $1.48.

So, let me stop now so that we can move to answering any questions that you may have. Kelli?

Thank you. [OPERATOR INSTRUCTIONS.] Jim Lucas of Janney Montgomery Scott.

Can we spend a minute on the gross margin side? I mean, that’s-- you mentioned it briefly in your prepared remarks, but that was probably one of the bigger surprises. It was nice to see that trend reverse.

And can you add a little bit of color of price versus the internal initiatives, the productivity, of what is driving gross margins? But more important, where you see that trend the remainder of this year, specifically the price versus commodity gap.

Jim, this is Steve. How are you this morning?

All right. How are you?

A couple things. First, I would reiterate one of the comments that Mike made earlier. You’ve got to keep in mind this is a small quarter.

Right.

So, trying to draw any conclusions for the rest of the year on the quarter is difficult to do.

But, when you boil through all those things you’ve talked about, what’s really happening here is our commodity prices are not accelerating at the same rate that they had in the past. Some are still going up, but they’re going up slower. So, some of the things we’ve been doing from a Lean standpoint and from a no-waste standpoint are starting to net to the positive.

Coupled with that is we had higher plant volumes this quarter, so our absorption was up pretty significantly for the quarter, too.

So, though it’s good news for the first quarter, I would caution you about drawing any conclusions for the year. And we think the flat to slightly up guidance we gave you for the fiscal year still is where we want to stay for now and we’ll look at that as time goes on.

So, there still are some commodity pressures when you look at corrugated and rubber, and steel has settled a little bit. We don’t know if that’s done moving around, but it’s settled down a little. Resins, as you know, are still pretty volatile. So, for now, we’re going to stick with the guidance that we had-- that we put out at the beginning of the year.

All right. And this is not meant to be a slight in any way, but you are known for being conservative with your guidance. And as you’re looking out for the remainder of this year, especially entering the important second quarter, and you look at potentials of what could go right on the positive, whether it’s weather, favorable end markets, or on the margin side, if you look at the top line versus margins, where do you see internally in terms of your stretch targets, where you think that there could be a positive?

Well, I think-- Jim, this is Mike. The fact is, as we keep coming back to, this is a very small quarter. And if you look back to last year, we sat here in a similar situation and there was a relatively high level of optimism and we faced some, as you would say, some significant challenges. Passed the test, but managed through the challenges Mother Nature and some other challenges that came our way.

And so, maybe we are a bit conservative. But at this point in time, at this point in the season, that is very appropriate for us to do that. And we will, as we move through the second quarter and as things-- the outlook starts to change, if it does change, we certainly will share that. But at this point in time, we think our guidance is sound.

Okay. And switching gears quickly, we got a very good update at the golf show. The buzz there was very positive. I mean, you guys clearly showed the industry leadership. But, on the landscape contracting, the other big market, can you give any type of anecdotal evidence of what you’re seeing there in terms of what gives you optimism of continued strong growth in that important market for you?

Sure. There were shows for those businesses as well in the first quarter. The GIE show took place. And that was also for Toro and for our Exmark brand a very strong show. We had significant new products that was introduced in both areas there. That always plays a part in driving our results and our growth.

I think the-- as we look at those markets last year, they got off to a bit of a slow start; again, because of some of the challenges that we faced with the weather in the spring. I think the optimism is relatively high in those areas as well.

And so, I think our competitive position is sound. Beside this, it would sum up the landscape business, which is an important part of our business. It’s been one of the important growth drivers as we talk about Toro growing at 8% as we shared with you. That’s double what we think kind of the industry’s growing. And a key part of that has been taking share and the landscape business is well positioned to do that.

And Jim, just like you saw at the Golf show, a lot of new products. When we look at Exmark and we look at our Toro brand in the landscape contracting product list, it’s pretty long. So, we feel like we’ve got a lot of new things we’re going to introduce to the marketplace that’s going to help us continue to be the leader there.

Well, following up on that parallel then, one of the things that I think has become evident in the golf market is that there is a pent up demand for equipment. Not only is innovation driving some of that demand, but just the need to upgrade the equipment. Are there-- have you seen any type of similar parallel trends on the landscaping side?

I think it’s-- this is Mike. I think it’s the equipment usage pattern is a little different on the landscape side. The equipment tends to get used up more quickly because it’s running 10 hours a day 5 to 7 days a week. And so, you have a little less of that-- you know, the replacement cycle’s quicker and so you have a little less of that-- I’ll say pent up demand.

Now, some of the equipment may have been-- some of the purchases from last year may have been delayed because of the way the season started, which could factor into the growth this year.

Eric Bosshard of Midwest Research.

Can you give us a sense within the International business of the organic growth taking place there? And then within that, talk about what you’re seeing go on in terms of market growth, as well as market share expansion?

Sure. Well, the first thing I would say is that most of our growth is coming organically, not from the Hayter acquisition. That certainly has been a plus for us. And the fact is that, if we looked at the results of the first quarter, it’s coming from all markets; it’s coming from Europe, it’s coming from Asia, it’s coming from South America. It’s related to the-- you know, golf continues to be a growth driver for that business.

In Europe, we’ve got a strong focus on improving our position on the ground side, as well as the consumer side of the business, where our shares are relatively low. And so, there’s a lot of potential for share expansion there as we provide the right products for the International market. And that’s a strong focus by Dennis Himan, our General Manager of the International Division and his team.

So, we don’t think there’s any reason to think the International growth should slow down. It should remain strong as we drive both-- as I said, both share growth and participate in the market growth around the world.

Are the market growth rates accelerating or just maintaining at a strong pace over there? What do you see going on in terms of end market demand?

I would say we don’t see a lot of acceleration, but there’s stronger growth rates. And again, as I said, a key part of our strategy is driving our share growth as part of that. So, we see new golf development continuing to be a factor, particularly as-- South America, in Asia, Eastern Europe. And so, that’s a fueling the international growth.

Then the other part of that is-- maybe I’m repeating myself, but getting more focused on the business and really providing the products that those customers want, that often are different than the products we make in the U.S. And so, our focus for many years was to take the products we make in the U.S. and ship them to Europe or ship them around the world.

And by and large, that works on the golf side of the business, but when you move outside of golf into the grounds market or the consumer market, you really have to start looking at doing things differently. And we are doing that and we are creating new products that really serve those markets and that allows us to go in and take share growth.

Okay. And then secondly, you mentioned within the progress on the SG&A line in the quarter that you were likely to have some incremental R&D expense going forward. Can you put some numbers or direction around magnitude of expanded R&D you think the business needs and the pace, timing and funding behind that?

This is Steve. We’ve had-- I think we have the last several years talked about the need to continue to have a bevy of new products. Innovation really is the lifeblood of the Company. So, we started back in ’02, ’03 with an initiative to increase our spending on engineering. And I think if you look back at those years we were in-- we’ve increased maybe a tenth of a percent, 2.7, 2.8, 2.9. Last year we were closer to 3%, which translates to about $52 million. And our plan for this year is to add another $7 or $8 million on top of that. So, I think we’d be just under $60 million in terms of R&D spending for F’06. So, we certainly see the need for that and the benefit of that, and we’ll continue to fund that in our budgets as we go forward.

And Eric, this is Mike. To press the acid-- kind of the acid test of that spending is the new products we drive. And we use the metric of-- or the goal of driving at least to 35% of our revenues from new products introduced this year to the prior two. And as we look out to the future, we see that continuing to ratchet up the next couple years as a result of the spending that Steve just talked about.

Okay. And then I guess last, related to that, can you talk about the relative profitability of the new products that you showed off so effectively in Atlanta, how that would compare to the existing portfolio?

That’s a little difficult to do given the number. But, in general, it depends on the product and it depends on the innovation that you bring, and it depends on the value-added that the customer sees in those products through their eyes.

So, as a general rule, the reason we like innovation and new products is you can get more price and more margin out of those products until the competition catches up. So, that’s what drives the need to continually be putting new products into the marketplace.

But, there’s no rule of thumb to say that the new greens mower is 5 or 10 gross margin points higher than the old one, or the new bunker rake?

No.

No, it just goes product by product.

Seaver Wang of Utendahl Capital Partners.

Just have some additional questions about new products. You had mentioned in the previous call that you would probably exceed the 35% of sales from new products. Can you give us an idea of what the ratio is between new products for Professional and for the Residential segments?

Well, that’s a good question, Seaver. I don’t have that here with me. We can go back and look. But I would say both segments have good-- as Steve said, a good bevy of new products coming. And I’ve got a long list sitting here in front of me.

In the Consumer side of the business we’ve got the second year of the Lawn-Boy walk power mower that we launched at the Home Depot that’s gaining momentum. We just talked with you all about the tractor strategy. The licensing agreement from a brand standpoint with the Home Depot is products we will buy and then sell in the dealer channel. And so, those-- that business has got some excitement around it.

As well as the landscape contractor business has a new diesel Z Master coming, and a whole new line of midsize walk behinds. Exmark has almost a completely new line of products, including some categories they haven’t been in with products they call the Navigator and Frontrunner. These are products that are targeted to a collection market in one case, or a more rural market in the other.

Our irrigation group has a long list of new products for the Residential Commercial side of the business, as well as the new products we just introduced a couple of weeks ago at the golf show.

And then the product I mentioned earlier in the Commercial side of the business, a whole new line of golf fairway mowers, a whole new line of sand trap bunker rakes, as well as products that are more around the electronic tools area with a complete management system. And a new 18-inch walk greens mower.

So, we have a long list of new products this year that will pull us up over our goal. And as we look forward to F’07 and F’08 our intention is to keep that up there.

Okay. And for the new tractors that are going to be in Home Depot, what’s kind of the long-term goal of I guess those product lines? You traditionally hadn’t been as strong in tractors. And I mean, you’ve got I think one Z mower in there. Is there a strategy to try to kind of change into a ratio of higher Z mowers than just regular tractors, or do you have an idea of what that’s going to be like in say 3 to 5 years?

Well, we’re just getting started. And we’re excited about the relationship we have with the Home Depot, as well as taking these tractors to our dealers who have been asking for them for some time. And you go back in the Company’s history, at one time we had a much stronger tractor position when we bought the Wheel Horse brand, and that kind of eroded away.

So, this gets us back in the tractor game now. We do believe that the future is very much about zero-turn radius mowers, our Z mowers, that will complement the tractor business, whether that’s for the consumer or the landscape contractor or the professional business. And as we’ve said to you in the past, we have focused a lot of effort around Z mowers and will continue to do that for both the consumer business and the professional business and intend to stay a leader in that area.

[James Bank] of Sidoti & Company.

First question. Did you have share buybacks this quarter?

Yes, we did. I think we told you at the beginning of the year we had 1.8 million left on our authorization from an ’05 board authorization. We would buy those pretty much throughout the year to use--.

--Right--.

--That authorization up. And that we’re on that schedule. We bought a little over 600,000 shares during the quarter, during the first quarter. So, we’re pretty much on the schedule we gave you at the last call.

Okay. 600,000. Okay, great. I just wanted to break out the organic growth.

Other than that, your other revenue lines seemed to do extremely well year-over-year. I mean, I know this is probably a subject nobody really touches on, but did you two owned distributors do much better than you might have anticipated?

No, not really.

Okay. I just noticed the 35% revenue growth.

Well, you’re in the other segment.

I’m sorry?

You’re in the other segment.

Right.

Yes.

Since you changed the distribution reporting segment and you kind of--.

--Yes. I mean, we’ve had some distributors in there we owned in one year, we didn’t in the other. The comparison is a little goofy when you look at that. But, the-- year-over-year, there wasn’t any big pick-up for the distributors.

Okay. Now, back on the International and doing very well, is there any way you might be able to break out what Hayter did within that International performance of the 34% growth?

We do not-- we’ve not typically disclosed that. You can kind of look at the International piece and see how much that was up. Hayter was a good portion of that. But, we’ve not broken that number out.

Okay. Let’s see. I guess the only other question I had then is, and again, I didn’t-- as the other gentleman said, I don’t want this to sound slighted in any way. And with your guidance of $1.42 to $1.48, consensus was $1.52. That potentially could change.

But, was there any kind of sales and profitability mix that moved to the first quarter and possibly away from the second quarter that led to that guidance that you all gave slightly under the consensus?

Well, no. I think-- again, as we’ve said, we are really taking the-- looking at the year, taking the long view.

And when you look at this business, it’s kind of the first half of our fiscal year is very much about kind of the sell-in to the market, and the second half is a lot about the reorders. And so you go back and compare it to last year, we had a strong sell-in and then things started getting challenging, let’s say.

And so, as we look at it this year, we believe we’re on track for a solid year. The second and third quarter, as always, are the bigger quarters and they’ll be very telling. But, orders look sound and so we think we’re in a good position.

Okay. Okay, great. That’s very helpful. All right. That’s it. Thank you very much.

Sam Darkatsh of Raymond James.

A couple of questions. Steve, first let’s start with the cash flow statement. There’s a line that says there’s a $12 million source of funds from excess tax benefits from share-based arrangements. I’m guessing that has something to do with Ken’s deferred comp shares. But, can you help explain that and was there any-- can you parse out whether there was any P&L impact to that line item?

Your guess is right. That has to do with distribution of his deferred comp that he’s earned. That program, as you know, is a performance-based program, so it’s only earned if the Company performs. He’s paid into that or had contributions in the form of [inaudible] stocks since ’99 I think we started that program. So, with what’s happened with the prices of stock, he’s done-- that program has done very well.

So, when he withdraws that-- first of all, we expense the cost of the shares when they’re vested and when he earns them. So, we’ve done that over the years and all that expense is behind us. When he makes a distribution, or the Company makes a distribution to him, that’s now a taxable event to him and we get a tax deduction for the difference between the fair value and the cost basis. So, what you’re seeing in the balance sheet there is the benefit from the tax deduction that we get.

So, does that run through the P&L or that’s just the difference between the tax books and the accounting books?

The P&L [hit to it] in this particular accounting period and there won’t be any going forward. It’s a balance sheet item.

Got you. Second question. I guess this would also be for you, Steve. The EBIT contribution of Toro credit, both in this quarter year-over-year and then how should we expect that to look for the year?

It’s probably-- I don’t have that to be honest with you. But the year I think, if I remember right, is about $3 million that it contributes. So, it may be $6 - $700,000 this quarter. It may vary a little quarter to quarter, but I’d say first quarter, if I had to guess, somewhere in the $5 - $600,000 range and $3 million for the year.

Got you. Third question. I think some of the other questioners might have been dancing around this a little bit. Your second quarter guidance of the $1.42 to $1.48, if we assume that just for that same sort of 8-ish percent revenue growth, that would imply, I think, that gross margins would either be down year-over-year or SG&A would be up year-over-year, or some combination of the two for the quarter. Is that how we should look at it? And then what would be the reasoning for that, specifically since it would be a differential from the Q1 trends?

Yes. Again, as Mike has mentioned and I mentioned, be careful taking Q1 and taking that out for the year.

But, your assumption is probably right. Second quarter margins may be down a little and then picked up in the third and fourth. Because you remember the big increases in several of our commodities, steel, were in the back half of the year last year. So, as we get into those same comparison quarters this year, it’ll help us from a comparison standpoint. So, you may see a little drop in margin. Again, it depends on mix in the second and then it’ll be picked up in the third and the fourth.

So, the gross margin will be down year-over-year and then picked back up in the third and fourth quarter. SG&A, will there be leverage in SG&A in the second quarter, or will that inflate as a percent of sales?

No, I would stay with the same guidance that we gave you for the year. And there may be some slight improvement in SG&A.

Okay. Last question. And you might have touched on this and, if you did, I apologizes. How would you characterize the dealer inventory levels at present heading into the season?

I think we would say dealer inventories are in good shape. That’s something we watch very closely. As last year, the-- this is the time that we build up inventory in anticipation of it moving out in April, May, June. And if that-- Mother Nature is cooperative, as always that will take place and we’ll see the strong reorder. If like last year, we faced some headwinds there, then we’ll manage through that. But, dealer inventories are in good shape.

If I recall, last year dealer inventories were a little on the high side heading into the season because of the new products. Are they-- as best you can ascertain kind of flat on a year-over-year basis?

I don’t have that in front of me, Sam, but I believe they’re comparable.

And folks, we have no more questions at this time.

[OPERATOR INSTRUCTIONS.]

And folks, there are no further questions. You may proceed with your closing remarks.

Well, let me just say thank you once again, ladies and gentlemen, for joining us today and for the thoughtful questions. As always, we appreciate your attention and ongoing support as we enter our key selling period of what appears to be an atmosphere of pretty good optimism and something we can build on. So, we appreciate it. Have a great day and goodbye.

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

Thank you.