Toro Co (TTC) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Toro Company first quarter earnings conference call. My name is Maria and I will be your audio coordinator for today. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

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

Thank you, Maria. Good morning, ladies and gentlemen, and thank you for joining us for our first quarter earnings conference call. Here with me this morning are Steve Wolfe, our Chief Financial Officer; Tom Larson, Treasurer; and John Wright, Director of Investor Relations. Let's begin with our forward-looking statement policy. Please keep in mind that during the call we'll make certain forward-looking statements as of today which are intended to assist you in understanding the company's results. You're all aware of inherent difficulties, risks and uncertainties of making predictive statements. So the Safe Harbor portion of the company's earnings release, as well as the SEC filings, detail some of the important risk factors that may cause actual results from differ from those in our predictions.

Our earnings release was issued this morning by business wire and can also be found in the investor information section of our corporate website, thetorocompany.com. Here in the upper midwest the snow season started early and it has yet to let up. We've a seen considerable snowfall with several significant events to date. In fact, major storms have occurred not only here in the U.S. but also throughout Canada, driving strong retail activity for Toro snow throwers across North America. The same time, on the professional side of our business, golf customers are already looking to spring and warmer weather. Earlier this month, we returned from the annual golf industry show in Orlando where, once again, we introduced several innovative new products and feature enhancements to our line-up.

Toro has long held the leadership position in this important industry where our domestic customer's sentiment for the upcoming season is cautiously optimistic. We've also been very successful in leveraging our strong brand recognition in growing international golf business. We had an opportunity to visit with a number of our international customers during the show and they remain quite positive about the golf business. As a result, they continued to invest in Toro's turf maintenance equipment and irrigation systems for renovations and new course construction around the world. We'll talk more about some of these new products and other developments in a moment.

First, let's take a closer look at our consolidated results for the first quarter ended February 1, 2008. This is a small quarter where we prepare for the selling season ahead. Early indications show we're off to a solid start with a strong product line-up. Even so, we're sharply attuned to the uncertain environment and are managing for the potential effects of a weakening economy. Let me touch on a few of the highlights from this morning's earnings release.

First, net sales rose 7% for the quarter to $405.8 million. These gains occurred in both our professional and residential segments with the majority of the increases once again coming from outside the U.S. An ongoing strategy has been to raise the international portion of total revenue to 30% or more. This is now benefiting us as the domestic market slows but the international markets remain strong. Overall, international sales rose 19.5% compared to the first quarter last year. Excluding the effect of currency, international sales grew over 13% in the quarter driven by the growth in the golf and grounds markets and new products we've launched in the past two years. Earnings from operations increased 15.2%.

We had a slight decline in gross margin but benefited nicely from an improvement in selling general and administrative expenses both as a percent of sales. Although we had a higher tax rate in the quarter, we finished with an improvement in earnings per share of 6.8% or $0.47. Finally, I want to highlight the improving position in accounts receivable and inventory. As you know, we're increasing our focus to reduce both items throughout the supply chain as part of our grow lean initiative to improve working capital and asset management. We believe our inventories and field inventory levels combined with forecasted retail demand position us well for the months ahead. Well, that's an overview for the first quarter. Now, let's review the segment results.

Worldwide sales for the professional segment rose 7.7% to $293.2 million. As I mentioned earlier, revenue growth was exceptionally strong outside the U.S. where new golf course construction continued to drive demand for our innovative irrigation systems and turf maintenance equipment. At this year's golf industry show, once again we unveiled new product offerings to strengthen Toro's worldwide market leadership. First, we're excited about the new Turf Guard wireless soil monitoring system, our most recent acquisition. This new technology measures soil moisture, salinity and temperature and transmits the data to a web-based interface. Our customers can use the data to analyze turf conditions and determine the cost-effective and environmentally responsible irrigation methods to maintain healthy turf. The bottom line, this system will help customers use less water and less energy.

Second, the new ProCore Fairway Aerators help build stronger root systems while offering greater productivity to the golf course superintendent. These new aerators, when coupled with our new core processor, results in a labor-saving one-pass operation. Third, we introduced a new line of workman mid duty vehicles with a suspension system that offers a superior ride in all applications and, finally, the new Groundsmaster 5900 series, Toro's next generation of 16 foot wide rotary mowers. These are all new from the ground up with precise maneuverability and four-wheel drive.

Shifting gears to the landscape contractor market, domestic equipment sales were down slightly due to distribution changes. Also, field inventory levels of these products continue to decrease as part of our ongoing lean and asset management efforts. Overall, field inventory is much improved over last year. On the product side, we're excited to have several new introductions for the landscape and irrigation contractor.

For the irrigation contractor, we introduced the [Irritrol I-PRO] spray head and nozzles for greater irrigation efficiency, part of our precise irrigation strategy. For landscape contractors, we developed a new Toro stand-on mower. This machine, which will be released in late 2008, caters to contractors who seek a compact machine with exceptional handling. Finally, the new Toro TRX series of track to walk-behind trenchers provides significant benefits to rental yards and contractors. We just introduced this new product at the rental show last week. These are just some of the innovations creating enthusiasm within our distribution channels and generating interest among our customers.

For the professional segment, pretax earnings rose 8.6% to $52.5 million, attributable to higher sales, favorable currency exchange rates and improved product mix. In the residential segment, worldwide sales were up 6.2% for the quarter to $108.2 million. Given the kind of snowy winter weather we prefer, shipments of Toro snow throwers here in the U.S. and in Canada were up significantly to dealers in our major home center retailer. We also enjoyed strong worldwide increases for the Toro TimeCutter Z zero turning radius mowers in anticipation of the selling season ahead and continued growth in the Z market. As you'll remember from our earlier calls, we've gained valuable floor space at dealers and our major retailer last year for this time saving family of products and expect their popularity will continue to outpace traditional lawn and garden tractors. In contrast, walk power mower shipments declined for the quarter. As you might expect, our retail partners are exercising caution in light of the challenging economy and have shifted their orders closer to retail demand. Subsequently, earnings in the residential segment declined $1.6 million mainly due to lower gross margins as a result of higher freight expense and additional investments in tooling for new products.

Now, let's talk about the key operating results, then we'll turn to our outlook for the remainder of the year. As mentioned, we experienced a slight decline in gross margins, mainly reflecting higher freight costs. We improved our leveraging of SG&A during the quarter, SG&A expense improved to 28.9% compared to 29.6% last year. Even with SG&A as a percent of sales being lower, we increased marketing spending and made additional investments in engineering which were both up over the first quarter of last year. Interest expense for the quarter rose 8.8%, long-term debt was up over the previous year due to a bond placement in April of 2007 and, as a result, short-term debt declined for the quarter. Our effective tax rate for the quarter was 35.4% compared to 28.2% in the first quarter of last year. You'll remember last year we experienced a positive impact on our tax rate from the retroactive extension of the federal research and engineering tax credit.

For 2008, this tax credit has expired once again and the outlook is unclear as to if and when the federal government may extend it. Given this uncertainty, we now expect our tax rate for the year to be 35.4%. Our balance sheet is in excellent shape with inventory being down nearly 4% and accounts receivable down 3.5% from a year ago. Throughout our go lean initiative, we've been focusing on becoming more intentional about asset management and we're developing enhanced tracking and reporting systems to help us on reach our working capital goal. And finally, our continuing strong cash flow has allowed us to return additional value to shareholders through dividends and share repurchases.

In December, our board of directors authorized an increase from $0.12 to $0.15 per common share, a 25% increase over the prior year. During the quarter, we also purchased 590,000 shares of common stock for $31.8 million and now have 544,000 shares remaining on our current authorization. We expect that our repurchase activity during the year will result in a reduction of average diluted shares outstanding similar to what we've seen in the past few years. Now, let's discuss our outlook for the season.

I want to stress once again that while we have built some positive momentum, we're also mindful of the domestic economy. We're joining our channel partners in aggressively driving retail while managing inventory levels, and we will closely track retail velocity as the season plays out. So, while the international business is solid, the domestic market is expected to be somewhat soft and we're not immune to that weakness. Even with those challenges, I'm confident in our competitive position. Given the number of new products we introduced the last three years, including this year, our level of new product sales is at the highest it has been in the past decade. These innovative products developed specifically to meet customer needs put use strong platform to continue increasing market share.

In the area of margin and SG&A, we expect our fiscal 2008 gross margin to be flat to slightly improved over last year and we expect SG&A as a percent of sales to be flat to slightly unfavorable compared to the prior year. Therefore, we now expect to report an 8 to 10% increase in net earnings per share for fiscal 2008 on revenue growth of 2 to 4%. For the upcoming second quarter, we anticipate net earnings per share of $1.87 to $1.93. That concludes our formal remarks for the Toro Company's fiscal 2008 first quarter. Now, let's open it up for your questions. Maria, back to you.

(OPERATOR INSTRUCTIONS) The first question comes from the line of Eric Bosshard with Cleveland Research. Please proceed.

Good morning. This is Mark standing in for Eric.

Good morning, Mark.

First question, obviously a solid 1Q beat, but you lowered revenue and EPS guidance for the year. Is there anything here in February that you're seeing that's causing some concern or is it just simply the headlines that everyone's reading each and every day?

I think we're all reading a similar headlines and so, as you step back a quarter, certainly the economic environment is softer than it was 90 days ago. We're being mindful of that. We're heading into the heart of our selling season and kind of the March through June time period and so we're going to be very focused on driving retail kind of in spite of some of the -- as you say the headlines, but we recognize that as, in fact, I guess the word is headwind that we're facing.

Can you add some color on exactly what you're doing to drive retail? Is it lower prices, increased promotions?

Well, the first thing it starts with is having the right products and so the new products we've introduced certainly position us very well to continue to take share, so it is the right products at the right price points. As part of that then, we certainly look across the businesses at what other ways could we accelerate some of the retail so in the residential area certainly there are promotions we look at using. Not necessarily different than prior years. We may accelerate some of those on the professional side. It may be as much about just working with customers to try to get their commitments earlier so we can count on those.

Are you seeing anything different with your distribution channel, the overall financial stability of the dealer network, anything that would be a cause of concern today versus maybe 90 days ago?

No.

And finally, your snow op performance in the first quarter, does your full-year guidance include the expected sell and strengthen sell in that we should see in the third and fourth quarter due to low inventory out in the channel?

Well, it does. Certainly snow is -- goes on the side of the ledger that is a strength, or a positive factor offset by some of the other factors. Remember, snow is a very small part of our business. So, we like the business. It's been strong in the U.S., or I should say North America. It hasn't been particularly strong in Europe. They haven't had the kind of snowfalls we've had here. So, we're counting on some is improvement there but there are other things on the other side of the ledger.

Thanks, guys.

Thanks, Mark.

Your next question comes from the line of Sam Darkatsh with Raymond James. Please proceed.

Morning, Sam.

Hi, Steve. How are you? I unfortunately signed on a little late so I apologize if these questions are redundant based on your earlier remarks. Receivables being down with sales being up, is that indicative of things slowing down as the quarter progressed or was that a matter of better collections or how should I look at that?

This is Steve, Sam. A couple of things there. Mike mentioned field inventory and how good a shape field is in. Receivables is a very good proxy for field inventory. So, field is down; therefore, receivables are down. Depends on the mix of sales. How many sales went out to Toro credit company financed products and what what went out to GE. You got to look at that. The other piece is the timing. If it goes out earlier in the quarter versus later in this quarter, you may collect those one period over the other. The other piece on receivables is you'll remember a year ago we had a little higher receivables than we did the prior year and we worked that through the first six months, so the comparison there would be a little better this time period but it is a little of all of those things.

Taking the sales assumption from a three to five to a two to four, is it something you're literally seeing in your order book or is it, again, just a reading the press clippings and listening to the nightly news?

Sam, this is Mike. I think -- our orders are solid. The fact is we've said the first and second quarter are largely about sell in and the retail that follows after that peak season influences strongly the business we'll get in the third quarter and fourth quarter is used for some adjustment, if you will. And so we certainly see the timing moving a little closer to market, the retail timing, and so we're going to, you know, watch that closely. There's nothing that we haven't seen softness, if you will, or the retail softness, but it is early in -- it is just almost too early to answer that question. So, we're being cautious, I think.

Any change to your assumptions in terms of price realization? Selling price realization this year still 1% to 2%?

Yes.

Okay. And then the last thing, again, I caught this a little bit maybe mid sentence. You mentioned that the landscape contractor business was soft. And that was due to a change in distribution. Could you help explain what that means

We're constantly looking at our distribution models and what's going on competitively. What we need to do for the future. Some of our dealer businesses, we have now gone in some territories to a commissioned basis versus a two-step basis. So, when you do that, that can have an impact based on how it flows in, what inventory you have to take back to convert to that model. But it is basically going to a more commissioned type base selling model than a two-step distribution model.

How long does that transition take before you see more normalized demand patterns?

Well, this we're just starting. Actually this was the first couple of steps. This will probably be over a couple of years before we get through the whole -- it is mostly domestic by the way. It could be a period of a couple three years before we get through the whole country.

Got it. Thank you, gentlemen.

Your next question comes from the line of Seaver Wang with Utendahl. Please proceed.

Hi. Good morning. Quick question. Do you guys have contingency plans with say later on the year there's even greater headwinds that you can increase the amount of lean initiatives, depending on how great the headwinds are to kind of offset that?

I see. This is Mike. I think it is fair to say we're working lean hard and have been for the last several years. And it is as much a case of trying to anticipate where the revenues are going to end up and then how we need to adjust whether that's adjust our production in a timely basis all the way back through the areas of SG&A. I think it is probably fair to say as we've improved our performance over the last several years, that gets a little harder. We just have to be even more diligent about looking at those spending levels. I think one of the things we've demonstrated again over the last several years is even facing some, I guess some challenges on the revenue side. We have kept -- stayed committed to our investment in the area of engineering and driving the new products and we will continue to do that. But back to your question, can we do more with lean? That's an ongoing journey. We're working lean very hard.

Okay. And quick question, I'm sorry, I got cut off in the call earlier and had to dial back in so I might have missed this. Do you have a full year tax rate assumption?

Yes, this is Steve. 35.4 is our year's rate right now. And that, as Mike mentioned, has to do with the R&E credit. Our rate for '08 for the first quarter only had two months of the R&E credit in it. Just the November/December time period. It didn't get renewed so we can't book anything for the rest of the year until that is renewed. So, 35.4 is what we have.

One other assumption we should probably get on the table to add to Mike's comments is our cash flow from operating activities and when you look at that for the quarter, we're obviously using cash given the seasonal nature of our business. But when you look at operating activities for the year to go along with Mike's activities or assumptions, we would expect that to be up slightly, modestly from last year's number and we should also see Cap Ex which is the other piece. When we talk about free cash, we talk about cash from operating activities less CapEx. That will be up slightly, too. But we would expect the cash piece of it from operating activity to be up higher than CapEx. So, we would have a slight improvement to free cash flow for the year.

Okay. The R&E tax credit, would you say there is a fairly high probability that by say midyear that something would happen there?

It is the government. So, I don't think I would even speculate on that. I don't know. They have renewed it, whether they will or not, we'll have to see.

Okay, thank you.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Jim Lucas with Janney Montgomery Scott. Please proceed.

Thanks. Good morning, guys.

Good morning, Jim.

This is -- I'll apologize in advance for asking somewhat of the same question in a different way but just trying to get to the heart of things here. You made a commentary in your prepared remarks about managing for a potential weakening economy and was hoping you might be able to expand a little bit upon that of what exactly is underlying the comment. Then secondly, when we take a look here at the low end and high end of your guidance, if you could perhaps expand a little bit upon what would need to go right for you to be at the upper end, what type of kind of worst-case scenarios you're building in for the lower end of the expectations? Maybe if you could just talk around that a little bit so that could help all of us understand what the thought process is going into the important spring season.

Jim, this is Mike. I'm not sure we'll be able to make that a whole lot clearer. I think it is fair to say that when we talk about the economic environment that has particularly a strong impact on our residential business, which again represents a smaller part of our portfolio today than it did a number of years ago. And that's been an intentional strategy. So, if consumer spending falls off, whether there still will be customers that will need to buy because their product simply doesn't work, those customers that have maybe a more discretionary position about whether they buy a new walk power mower or buy a new Z mower may delay that purchase. So, that would be probably the one area that has the most concern and we have good metrics around that and we'll be watching that carefully as the season now kind of begins in earnest and we'll be working with our retailer, like the Home Depot and our dealers, to really manage that and track retail velocity. But that, we know, will be one of the areas that will be challenged. The other one would be probably in our irrigation business.

On the residential commercial side of our irrigation business, an important business that we've been kind of rebuilding, if you will, and today we have, from a product standpoint, a strong position that we've had at any time in the recent past so that bodes well on a competitive basis versus the others out there. On the other hand, that business is tied probably more directly to housing and even some of the water restrictions that have gone on. So, within the U.S. market, that is a, that's certainly a challenge that we're managing through. You contrast that to the international market, whether it's for golf, whether that's for the residential commercial business as infrastructure gets built around the world. We're still counting on that as we look out for, through the remainder of F '08. I'm not sure that's helping you a lot but I think the most significant challenge we see is on the residential side of the business that it impacts residential equipment business as well as the residential irrigation business.

Jim, this is Steve. I would just add to that the predicting that consumer spending habit going forward and do they spend, do they close their wallet and not spend. Building a production schedule around probably our most seasonal piece of our business in some ways, snow may be a little more. As you know, if that season really goes, we have to have a lot of that product built and ready to ship so figuring out how much of that you prebuild until you see how much retail you're going to get just complicates that whole thing. So, the consumer piece of that, to me, is a very key piece. International, as Mike said, is going to be relatively stable and really our domestic commercial business ought to be okay. It is what happens with that residential piece and what happens with the landscape piece.

That's very helpful. Thank you for the color there. Just again trying to understand the thought process behind it. And if we could just switch gears. The [Rescom] irrigation piece, the product line, if you could expand a little bit upon what you've done to potentially help you regain some of the lost share that's occurred over the last several years. And finally, with regards to the regional weather commentary, we've got a drought in the southeast. We've had the snow as you well know and in parts of the country where the snow has occurred, if it you could just talk about how that potentially could paint the picture for the landscape contracting business.

Okay. Well, I'll start with the residential commercial irrigation business. As I said a few minutes ago, it is much improved. As you know, there was a time when we were certainly the number one position there and that business kind of got away from us and we're working very hard to kind of earn that back. And it starts with the right products and relationships with our customers and the quality that goes with those products. We're introducing more new innovative products probably the most significant one this year that's been a gap in our line for -- we've had some products from a really competitive position, has been the rotor and residential commercial irrigation, the sprinkler, rotor, if you will, is one of the key components. In fact, if you contrast it to our golf business where we have the rotors, the 835 and 855 rotors that have been just absolute winners in the market place in their performance and the ability to put water on precisely and so we've now, we have a new rotor this year that we'll be manufacturing in our Juarez plant that will be very competitive in the market place and so, and it goes beyond that. We have new spray heads for and we have products under the Toro brand as well as our other residential commercial brand Irritrol, and we have more in the works in the new product development pipeline, if you will. So, the residential commercial business is really sound from a product and distribution and relationship standpoint. The issue there is primarily one of market. And so we know that will come back in time and we'll be well-positioned to take advantage of it.

On the snow side, certainly the snow is here that the U.S. and Canada have for the professional side of our business have helped many landscapers. They've driven incremental revenue in their areas where we've had the snowfalls. Now, that's not 100%. It depends on what kind of a contract the landscape contractor put together with their customer. So, those that have a per occurrence plowing, if you will, are doing quite well. Those that put a contract in place on a one number, I'll do it how many times it takes, they probably have a little additional cost but they're still in a good position. So, we think throughout particularly the northeast and the midwest, those landscape contractors are going to be in good shape and we should see that reflected in their purchases as we head into spring.

Okay. Great. Thank you very much.

Thanks, Jim.

Your next question comes from the line of James Bank with Sidoti & Co. Please proceed.

Good morning, James.

Hi. How are you?

Good.

Good. Yes, actually I wanted to circle back to the landscape contractors but your last comment answered the question. I'm really left with two. How many -- you have 540,000 shares left in your purchase program?

That's correct.

Okay. Maybe -- can we assume a new authorization on the Horizon?

Yes. We're always looking at cash usage and where we apply that and we will continue to do that. A lot of things go into that in terms of timing and stock price but we will -- we should expect to see the diluted shares go down relatively the same as you have the last couple of years.

Okay.

When that happens and we use up the rest of that authorization, we will go back to the board and get a new authorization like we have the last couple of years. Similar type of pattern.

Okay. And secondly, in regards to your grow lean initiative, and please correct me if I'm wrong, from what I understand, 8% is really the top line percent you're looking for. The top line growth. Can we then assume possibly an acquisition is really what's going to have to happen in the next year or maybe in this year to really drive the top line up there kind of given what you guys did in '07 and I guess the revised guidance this morning. Is that something I can assume then in '09 to get the top line growing again?

James, this is Mike. I think we have -- and this is always the challenge between goals and guidance. It is the grow lean goal to get to a compounded 8%. Now, when you look back at our results for '07 and our projected results for '08 that is going to make that very difficult. And we don't know how fast the, if you will, the economic environment will improve. With that said, we are and continue to look much more systematically and consistently at acquisition opportunities and we will pursue those as appropriate. We'll not force them. We'll not do anything stupid, but we believe there are some good opportunities that would couple well with Toro and help us accelerate the top line growth which, as you know, acquisitions you can't necessarily just plug them in each quarter or each year. We'll keep working it and we'll let you know when we have something more.

Okay. Great. Just a follow-up on that, would that being something International, domestic or really when you find something very strategic that can be synergistic to your business?

What we've said in the past, we continue to want to grow our international portfolio. If we find an attractive one internationally, we can pursue that. We continue to want to grow our professional portfolio. So, for the right acquisition that was an international professional opportunity, that would be great. Maybe what we'll find is international residential opportunity comes at us one way and a domestic professional opportunity comes at us another way. Then we'll have to look at that again, the leaning there would probably be on the professional side. The bottom line is we're looking comprehensively across all of our businesses and over the fence, if you will, to some degree to -- what are the -- what are the companies -- where are the companies and who are they out there that would fit well with Toro and could ultimately drive higher shareholder value.

Okay. Terrific. Thank you.

Thanks, James.

At this time, there are no further questions. I would now turn the call back over to Mike Hoffman, Chairman and CEO for final remarks.

Thank you, Maria. Thank you once again, ladies and gentlemen, for your questions. We appreciate your confidence and trust in the Toro Company and we will look forward to talking with you again in May with our second quarter and mid-year results. Thanks and have a great day.