Toro Co (TTC) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to The Toro Company second-quarter earnings conference call. My name is Clarissa. I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (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. Kurt D. Svendsen, Director of Investor and Public Relations for The Toro Company. Please proceed, Mr. Svendsen.

Thank you and good morning, everyone. Joining me this morning for our second-quarter earnings call are Mike Hoffman, Chairman and Chief Executive Officer; Steve Wolfe, Chief Financial Officer; and Tom Larson, Vice President and Treasurer. Let me now begin with our customary Forward-Looking Statement policy.

Please keep in mind during the call we will make certain forward-looking statements which are intended to assist you in understanding the Company's results. You are all aware of the inherent difficulties, risks and uncertainties in making predicative statements. So the Safe Harbor portion of the Company's earnings release, as well as SEC filings, detail some of the important risk factors that may cause actual results to differ from those and their predications. 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.

With that, I will turn the call over to Mike.

Thank you, Kurt, and good morning, everyone. Before discussing results for the quarter, I would like to take a minute to recognize Steve Wolfe, who, as you know, is retiring from Toro at the end of July, making this his last earnings call. During his 10 years, Steve's insight and steady guidance helped the Company weather two recessions, create a culture of financial discipline, and dramatically reduce our working capital as a percent of sales, efforts that will greatly benefit Toro long into the future. I personally will miss Steve's clear vision, wise counsel, and most of all his friendship. We've shared over a quarter century together and seen Toro transform to the strong enterprise it is today.

Steve was a great CFO partner to my predecessor, Ken Melrose for eight years, and he has been so with me the last six years. So on behalf of our board and all our employees, I would like to thank Steve for his leadership and many noteworthy contributions, and we wish him and his wife, [Cindy], well as they now journey into retirement.

Turning to the second quarter, net sales grew over 12%, fueled by strong growth in our Professional businesses with earnings per share up over 40%. For the first six months, net sales increased 13.5% with earnings-per-share improving by 46%. Steve will discuss our financial and operating results in more detail later in the call.

As we said in our earnings release, we are pleased with our performance for the quarter, despite a persistently cold spring. Being in a seasonal business, weather plays a critical role in the overall demand for our products, as well as timing of purchases.

If you recall at this time last year, we were talking about favorable weather in March and April, particularly in the Midwest and Northeast, that drove strong Residential retail in those months. The opposite is happening this year.

While our Residential business got off to a good start in southern states, most other regions of the country have experienced slow retail activity given the cool, wet weather. In spite of the delayed spring selling season, we remain confident in our overall strength and have raised our outlook for the year.

I would now like to take a minute and provide an update on business and market trends, starting with our core golf business where we have experienced significant sales growth of maintenance equipment and irrigation systems worldwide, improved customer optimism translated into more activity around large package deals and projects with Toro winning the largest share. A key to our competitive advantage is innovation. The industry sees Toro investing in new technologies to help customers solve problems, increase productivity, and produce better course conditions.

For example, on the equipment side, new product acceptance has been excellent. Earlier this year we introduced the new TriFlex and e-Flex greensmowers and went on the road to share firsthand the features and benefits of these machines with golf course customers. The events have been extremely well received with many customers making purchase decisions on the spot.

As for golf irrigation, orders have been quite strong with many brand switches to Toro. Customers are very impressed with the integration of the Lynx central Control system and Turf Guard wireless soil sensors, which has given a lift to both products.

Similarly, successful demos of our R Series sprinkler conversion assemblies, which enable the replacement of a competitive sprinkler drive without changing the body or piping, are leading to early adoption for this new product.

On the international front, new golf development is gaining momentum around the world, particularly in China, Korea and Southeast Asia. In fact, a few of us have the opportunity to visit China in April and met with a number of golf course architects and management companies. Activity is at a very high level with many new projects under construction or in planning. This was further confirmed at the KPMG Golf Business Forum in Dubai where many architects and designers were planning or seeking information for future projects.

As both events clearly demonstrated, golf continues to grow in global popularity, this trend certainly aided by the acclaim received by rising stars in professional golf. For the first time in 17 years, all four major championships are currently held by players outside the United States, with all coming from the EMEA, where golf growth is showing promise. And announced earlier this week, France will host The Ryder Cup in 2018, only the second time the event has been held on the continent.

As a global leader, we believe we are in a strong position to take advantage of the growth in the worldwide golf market.

Moving to the landscape contractor and grounds category, many northern market landscape professionals entered the spring more optimistic, having come off a healthy snow season and improving economic environment. With cash in their pockets and an aging equipment fleet, they drove strong retail sales performance for the quarter. Helping sales of both Exmark and Toro-branded products in the quarter with strong interest in our powerful lineup of new products, including Exmark's light-commercial Pioneer Series mower.

In a related market, the municipal sports field and grounds side of the business continues to build momentum. Under pressure from reduced budgets and staff, stressed municipalities have been turning to Toro for innovation to help them increase productivity. This includes the Groundsmaster 5900 with a 16-foot cutting path and the Groundsmaster 360 rotary mower with its unique four-wheel steering and unmatched maneuverability.

Another positive has been the federal government segment, which is small for Toro, but where we are growing our competitive position and building brand strength with purchasing managers.

Shifting to Residential, weather was a big factor for the quarter. The initial sell-through got off to a good start in southern states, but poor conditions in late March and April had a significant impact on retail. While overall Residential sales were sluggish, strong response to our new line of TimeCutter and TITAN zero-turn models helped offset the decline in walk power mowers. May is shaping up better with weather finally breaking in northern markets, just in time for our popular "Toro Days" promotional event, which runs through Sunday. Early indications have been positive, and we are working closely with the channel to keep product moving.

From a marketing standpoint, we are driving consumer activity through weather-triggered online advertising and seeing success from our new "Engineered for Everyone" TimeCutter Z brand commercial airing nationally. In a highly competitive environment, some have taken too aggressive in what we might consider in some cases to be misleading marketing campaigns.

Despite the challenge, we responded well and believe we are actually holding or taking share in key categories through our focus on quality, dependability and innovation. Even with a slow recovery in the housing market, our Residential and Commercial irrigation businesses posted a strong quarter. The fact that many of our new irrigation technologies, such as Toro's Precision Series nozzles or Irritrol's Climate Logic controller, were designed for retrofit applications or existing system upgrades is presenting an opportunity for growth.

In addition, many of these products and others have been approved for water conservation rebates for their energy efficiency and water saving benefits, helping drive traffic and increased shelf space over the competition.

In an entirely new category for Toro, the recent acquisition of Unique Lighting Systems is getting off to a solid start. We've made steady progress toward systems integration, hired several key positions to support marketing and sales efforts, and received excellent customer response to dozens of spring training programs across the country.

In a small but growing segment for Toro, our micro irrigation business is making great strides. Recent investments into additional capacity contributed to solid sales growth for the quarter. Coupled with expansion of our dealer base and a strong farm economy, this business is in an excellent position as acceptance for these precision irrigation products grows on a global basis.

As for construction of our new micro-irrigation facility in Romania, the project is tracking as planned with the initial production slated to begin in the fall.

And lastly, our rental business continues to expand and grow. Purchases among national accounts and independent rental outlets have been strong throughout the spring, driven by increased equipment utilization and customers having better cash flow to replace aging equipment. The successful launch of our new STX stump grinder has provided good brand exposure and open opportunities with new rental accounts. All-in, our rental strategy, including the acquisition of US Praxis and many new internally developed machines puts us in a great position to grow the rental business.

I will now turn it over to Steve to review our financial results for the quarter and first six months.

Thanks, Mike, and good morning, everyone. Let me start with a summary of our financial results.

As Mike mentioned earlier, net sales for the quarter grew over 12% to $631.6 million, fueled by strong gains across all Professional businesses on improved market conditions and strength of new products.

On the earnings front, we delivered net income of $60.3 million or $1.88 per share compared to $1.34 last year. For the year-to-date, net sales were up 13.5% to $1,014,800,000, and we reported net earnings of $77.5 million or $2.41 per share.

Now to our segment results, starting with Professional, where sales for the quarter were up a significant 19.7% to $418.3 million. Year-to-date, sales are up by a similar rate of 20.3% to $676.6 million. Worldwide orders for golf equipment and irrigation systems were up nicely for both periods. Drivers included increased project activity, new golf construction around the world, and better year-over-year availability for golf and grounds products. Shipments of landscape maintenance equipment were up on strong acceptance for new products and improved market conditions. Micro-irrigation also contributed to the growth on increased production capacity and strong demand for drip systems, mainly in Eastern Europe and the US. Net earnings in the Professional segment for the quarter totaled $85.6 million, up 26.6% over last year. The earnings improvement was driven by the leveraging of fixed expense over larger sales volumes, offset by higher commodity and freight costs. For the first six months, Professional segment earnings were $123.5 million, up 32.2% from the prior year period.

Turning to the Residential segment, sales for the quarter were down slightly to $209.6 million. Year-to-date, sales were up 1.9% to $332.9 million. Sales for both periods were impacted by lower orders of walk power mowers due to unfavorable spring weather that delayed purchases.

On a positive note, shipments of riding products were strong for the quarter comparison on solid customer response to our new line of innovative zero-turn mowers and better product availability. Demand for Pope branded irrigation products in Australia was high due to abnormally low sales in the first quarter that shifted to the second quarter because of early-season flooding.

Net earnings in the Residential segment for the quarter totaled $26.5 million, up 5.7% from last year. Favorable product mix from a new platform of zero-turn riders benefited earnings, which was somewhat offset by higher freight and material costs. For the first six months, Residential segment earnings were $37.9 million, down 1.6% from the prior year period.

Now to our key operating results. For both the quarter and year-to-date, gross margin expanded 50 basis points to 33.8% and 34.5% respectively. The margin improvement was mostly driven by overall favorable mix. That is strong Professional sales growth combined with delayed Residential sales, along with lower manufacturing variances. Higher freight expense and raw material costs, namely resins, copper, rubber and hydraulics, were a negative drag on margins for both periods.

For the full year, we still expect gross margin to be flat to slightly improved. SG&A expense further improved as a percent of sales by 150 basis points for the quarter and 110 basis points for the first six months on leveraging fixed SG&A over higher sales volumes.

Going forward we still expect some SG&A improvement compared to the prior year. Operating earnings increased 200 basis points as a percent of sales for the quarter to 14.8%. For the first six months, operating earnings increased 160 basis points as a percent of sales to 11.9%. Interest expense declined 2% for the quarter comparison. For the year-to-date, interest expense was down 2.5% due to lower average debt levels. Our effective tax rate for the quarter was 33.4% compared to 33.6% last year.

For the first six months, the tax rate declined 100 basis points from last year to 32.6%, mostly the result of the retroactive reinstatement of the federal research and engineering tax credit. For the full year, we expect our tax rate to be 33% to 33.5%.

Turning to the balance sheet, Accounts Receivable for the quarter rose $17.7 million or 6.8% on higher sales volumes. Factoring out currency, which accounted for approximately $11 million of the increase, receivables would have been up only slightly for the period.

On the other hand, I am sure you are all wondering about our inventory as inventories increased $85.4 million over last year. If you recall last year, our inventories were too low as we entered the spring selling season, and we experienced availability issues due to unanticipated demand. This year, to be a better supplier to our customers, we planned to increase inventory. However, not to the level where we ended the second quarter.

About 25% of our overall quarter increase was the result of Residential finished goods, still in Toro inventory because of the late start to spring. Several other factors contributed to the rise in inventory, including foreign exchange rates and acquisitions.

The good news is finished goods inventory is under our control with greater flexibility to deploy the products where needed as retail demand breaks. As the weather starts to improve and products move through channel and retail, we are confident that inventory levels will return to a more normal level.

And on a final point, trade payables increased by $31.3 million or 18.3%, resulting from increased production at manufacturing facilities and continued sourcing efforts.

In closing, I would like to say it has been a pleasure and an honor to serve as CFO of The Toro Company for the last 14 years and to be able to work with all our stakeholders over that time. I will miss the discussions, the investor trips and many business relationships, and most of all I will miss all the friendships that come out of that experience. And for that, I thank you all and for your ongoing support of The Toro Company.

So with that, I'll turn it back to Mike for some concluding comments.

Thank you, Steve. So, as you can see, Toro is off to an excellent start for the year, and I can say I'm proud of our employees and our channel partners for all they've done to help us deliver such strong results. In our business, we are always mindful of the weather, and this year Mother Nature has challenged us with a late spring. While it is not clear how much the cool, wet weather will impact our business, we remain optimistic as our talented team is focused on executing in the marketplace. Weather and commodities will be challenges across the industry, but a high level of product innovation positions us well to continue taking share in key categories. Taking all this into account, we have increased our full-year guidance for both revenue and earnings. We now expect fiscal 2011 net earnings to be about $3.60 per share on a revenue increase of between 10% and 12%.

As you can see from our results announced this morning and what we expect for the remainder of the year, we are making progress towards our destination 2014 goals of revenue growth and probability. We are very early into the initiative and have years to go until our centennial in 2014, but it's great to get off to a good start.

So this concludes our formal remarks. Now we would like to open it up for your questions.

(Operator Instructions). Sam Darkatsh, Raymond James.

Good morning, Mike, Steve. How are you? Steve, congratulations on your retirement, and your placement is going to have some big shoes to fill. So best wishes to you in your next chapter.

Thank you. I appreciate that.

Three questions if I might. First off, although you are taking your guidance for the year higher, based on the $0.30 beat in the second quarter, I guess the inference is that the second-half guidance comes down versus prior expectations. You mentioned some commodity inflation, some weather, maybe some sellthrough concerns. I'm guessing maybe taking production down a little bit based on Residential inventories. Could you put a little bit more color as to the second-half expectations versus your prior plan?

Sure. Well, the guidance for the topline is actually up second half. What is down is earnings, and that is because of some of the things that you mentioned. One is commodity pressure. We know we are going to have some commodity pressure as things continue to increase.

Second is the shift back between -- mix between Residential and Professional, and as the Residential business comes back as the weather warms up, that will have a negative impact on margins because margins are lower there. So you put the two of us together, weather obviously we don't know what is going to happen with the weather, but it's primarily freight costs, commodities and then the change in the mix between Residential and Professional.

Which leads me into my next question, which would be commodities. If -- looking at our spot rates are and your conversations with your suppliers, if commodity prices remain static with where they are right now, what is a ballpark -- where should we look at for commodity inflation for fiscal year '12 over '11?

To be honest with you, we are not -- we are starting to look at that. We're probably not far enough along yet to give you any input into '12. We'll obviously have to look at what happens to costs, and as we have told you all along, we price the market not necessarily cost. Cost is a consideration. But we are really just getting going on that, so it's too early to comment on where we are.

Last question, Mike, if I could ask you to look at the second-quarter results versus your internal plan, you gave us what an EPS might be, and obviously you exceeded it. Where were you pleasantly surprised, particularly where you would have looked at this quarter from a February standpoint?

Connecting this with Steve's earlier remarks, one of the things that happened obviously our revenues are trending favorable, and we have not raised that for the year. Certainly we saw additional strength in the golf market, and as we've shared many times in the past, the Professional business is relatively more profitable. And so, as that mix shifted to the Professional side on those relatively higher revenues, that certainly resulted in some very good numbers. However, as Steve said, we will face kind of a little bit of the reverse of that as we head into the second half.

So golf would be at the top of the list. I would also say the landscape contractor business all-in is strong and favorable, and that's more of a plan -- somewhat more of a planned purchase, maybe not as much as golf, but relatively more than the homeowner deciding to go out and buy a new lawnmower or rider on Saturday morning.

So both of those parts of the business, both of those legs on the stool, if you will, remain very favorable, and we are facing the Mother Nature impact on the Residential business. We think that's more of a delay that those customers that didn't buy in April will buy in May or June. Some of that depends on as moisture continues to fall around the country, around the world, and I'll tell you we're seeing that already. May is off to a very good start compared to May of last year. Now we have some ground to make up, so we will have to see how that plays out over the next 60 days.

Thank you much.

Jim Lucas, Janney Capital.

Good morning, guys. This is [Mike Worley] sitting in for Jim. Steve, congratulations on your great career. I was wondering, Mike, if you can give us any update on the CFO search.

Yes. The update would be it continues.

Any expectations on timing?

Obviously we're going to manage this to Steve's timing, and as we said in the earlier announcement, Steve has been very good as a [twirl] leader to help us through the challenges we face in '09 and the recovery, but we also want to honor his wishes. So we are working diligently to get that completed over the next 60 days.

Okay. Moving on to the commodity and freight cost pressures. Are they still accelerating those pressures into the third quarter, or were they -- will they be about the same, but they just won't have the offset at a professional strength in 3Q?

I guess we've come back at this point and say they are not accelerating a lot, or they are not -- (inaudible) they're not accelerating. There's a number of commodities we look at. So it's a question of, well, what's going on with oil prices, and it goes up a little bit and it falls back, and that impact on resins. Steel has not changed a lot here recently.

Some of this ties to kind of the overall health of the worldwide economic environment, and that's been okay. But we don't see a lot of acceleration now. As the earlier question was asked, we've got to start factoring this into our 2012 thinking, and we think we can manage. At this point we pretty much believe we can manage through the remainder of the fiscal year. The 2011, as you know, that ends at the end of October, much of that inventory has already been produced. It's more I guess I will say a strategic question as we look to 2012 and beyond.

Okay. And then just onto the landscape contractors, you mentioned that they got off to a little bit of a slow start. Am I to assume that you mean that by the end of the quarter it was more what you're expecting, just a little bit of delay from the start of the quarter?

If I said that, then I didn't say that quite right. So clearly what has got off to a slow start is the Residential business simply customer support cutting their lawns March and April, many northern markets like they were last year that are now cutting their lawns in May and June, and we hope that will drive that retail activity. But the landscape contractor business overall has done quite well. Its retail is tracking nicely ahead of last year for both our brands, and so we are very much encouraged by that business. But we still expect that to continue as the year plays out.

Okay. Any updates on the M&A pipeline?

Very active. Doing a lot of things on the M&A side in terms of exploring, trying to find the right deal obviously. As we've said all along, we are not interested in doing a deal just for the sake of doing a deal. So I would say lots of activity, some small, some medium-sized, and we are well positioned in terms of ability to do those. So it's a matter of finding the right deal at the right price.

Thanks a lot, guys.

Robert Kosowsky, Sidoti & Co.

Good morning, Kurt, Steve and Mike. How are you guys doing? And Steve, congratulations on the retirement, too.

I appreciate that.

Just a question. Was there any pull forward in Professional sales, or do you think demand is just more vibrant than you were thinking?

Again, we have put a great deal of focus on retail, and we believe that if you take care of retail, everything else will take care of itself. So to your point, no. Field inventories are in excellent shape as they have been over the last number of quarters. And so it wasn't a case of our revenue is up because we just pushed it into the field. For both the Commercial and Residential business, field inventory is in excellent shape as I said.

You see -- one of the things you see on our receivables is them being a little bit down, but that is as much about business mix. As we sell more Professional products, particularly commercial and landscape products, that moves to our joint venture, Toro Red Iron, contrasted to some of our Residential products, which will sit on our books for a little while, so that's one of the reasons you see that. But overall, the field inventory is in excellent shape, and it wasn't a case of our revenues being up just because we pushed it out into the field.

That's really helpful. And then also I know you are kind of cautious to talk about 2012, but do you have any thoughts on price increases? Because I know we saw a good 15% increase from (inaudible), and we have some more expensive engines coming down the pike, and I was just wondering your thoughts on that and your thoughts on just, I guess, commodities, which people already asked you about, too.

Right. So I think Steve said it well. We are always looking -- we are really getting into our planning process for 2012. Remember, our fiscal year starts November 1, so a little earlier than the calendar year.

And certainly what has been going on with our cost with commodities will be factored into that. There are -- as we've said many times, as you look across our portfolio, we have relatively more -- I will say pricing latitude, if you will, on the Professional side of the business versus the Residential side of the business. Part of that is because when you have a product at a specific price point, like $299 or $399, it is not that you want to see that move up $10 or $20. It doesn't resonate quite as well with the consumer.

So much work is being done there. We will be getting back to you, will talk more about this at least foreshadow it when we get to the third-quarter call in August. But at this point we recognize the commodity issues out there as do many of the other people in the industry, and so there certainly will be some price impact regarding the price that you commented on one of the other players -- I don't know where that's coming from, and we certainly would not expect that.

What about on the engine piece? Can engines be more expensive given the emission standard change?

So some of that, yes. There will be some impact on engines as a result of emissions. Some of those emissions are already in place. Like in California, the carb standard is already in place. EPA will follow. And, as we've talked to that as to our Residential business on the Professional side, that's more of a 2013 as Tier 4 comes into place.

The fact is the other part of engines, not just emissions, but it ties back to commodities, what's going to happen with aluminum and steel, what's going to happen with currencies, the yen and yuan strength. So all those will be considered, we think. As we said earlier, we can manage through the remainder of 2011. This will certainly -- we will be thinking a lot about this as we look at 2012.

Okay. And then I guess one last question on micro-irrigation. Are you getting more interest in your product now just given the increase in commodities? Is this kind of like a -- farmers kind of think these are long-lived price increases. It is another -- increasingly looking for more efficient irrigation techniques?

The answer to that is yes. And not just because of commodities, I think as some commodity prices go up, it opens up new categories. So when corn is $2.00 an acre, not so interesting to look at a relatively more invested irrigation system. When corn is exponentially higher than that, it becomes much more interesting to be able to know that you can control the output much better and not rely on Mother Nature or some of the other alternatives.

So I think beyond that there's just the long-term we need to manage water better. The vast majority of water that is used around the world is used in agricultural irrigation. 70%, 80% of the water consumed is used in agricultural irrigation. And so we need to be better at applying that water, moving from relatively inefficient flood technologies to highly efficient micro-irrigation.

Okay. Cool. Thank you very much, and good luck with the rest of the year.

Eric Bosshard, Cleveland Research.

This is Omar Aleem in for Eric. Good morning, guys. Two questions for you. You addressed inventory a bit. Just to follow-up on that, in terms of the balance of the year, you mentioned working through it, should we expect kind of as we work through the end of this quarter, is this -- would you get towards normalized level of inventory through the quarter, is this something we should think that may overhang through the balance of the year, and then you get to normal in the fourth quarter. How should we think about the timing?

You would get back to normal at year-end, at the year-end. We will work this down over the next six months, and our latest projections that we have shown will show that we are in very good shape at the end of the fiscal year. So it will take us the spring weather obviously to get through to get rid of the walkers and things that are in the pipeline, but plans would say we will be back to very manageable levels at year-end.

Great. Secondly, you had mentioned sales in consumer being better in May. Obviously the April weather the comparison was tough, and the weather seems like it was worse than most expected. Is the improvement you're seeing snapback from April, or I guess the broader question is, do you think there has been any kind of permanently lost sales for the season based on what happened in April?

I think we would say it depends on the category and how we're performing both from an impact of weather, as well as competitively with new products and so on.

So if we use walk power mowers as a bit of a bellwether, it will take more than me to get all the way back to where we were last year. And, as we look at -- as we look out over the next couple of months, we think that's doable. I'm not sure we will get things all the way back to -- for walk power mowers to last year's levels but get close to it, which will be okay.

So, again, it's one of those that depends -- May alone will not offset the decline we saw in March and April, last year's March and April. We had six weeks of extraordinarily good weather, and May is going to be better. We are comping much better, and that's continuing to accelerate. We are just not sure it will get all the way there. We may need June a little more to get that done.

So do you still think it is possible to get back towards where you thought sales could be for the season in total, do you think that is still possible?

The answer to that would be yes. Again, you have to include all elements, and so when you put all the product categories together, so we've had a favorable snow season. That's a plus where the riding zero-turn mowers are doing quite well. That's a plus. We've got some work to do on walk power mowers to catch up, so.

And again, we're very focused on retail, and we're very focused on our relative share position, how we are doing, and we think those are all okay. We are not -- our share is strong. We're in good partnerships with people and dealers, and so, as the market recovers and the business grows, we will get our share of that, and things will be okay.

Great. Thank you, guys.

At this time I would like to turn the call over to Mike Hoffman for closing remarks.

Thank you. Let me say thank you, again, to Steve for the last time publicly on a call. In August he will be listening, and I'm sure he will have some feedback for us after that is concluded. We will just thank all of you for listening and for your interest in Toro and your thoughtful questions, and all of you have a good day. Take care.

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