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Toro Company 10-Q 2009 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For
the Quarterly Period Ended May 1, 2009
THE
TORO COMPANY
(Exact
name of registrant as specified in its charter)
8111
Lyndale Avenue South
Bloomington,
Minnesota 55420
Telephone
number: (952) 888-8801
(Address,
including zip code, and telephone number, including area code, of registrant's
principal executive offices)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes S No £
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
Yes £ No £
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes £ No S
The
number of shares of Common Stock outstanding as of May 29, 2009 was
35,892,142.
THE
TORO COMPANY
INDEX
TO FORM 10-Q
2
PART
I. FINANCIAL INFORMATION
Item
1. FINANCIAL STATEMENTS
Condensed
Consolidated Statements of Earnings (Unaudited)
(Dollars
and shares in thousands, except per share data)
See
accompanying notes to condensed consolidated financial
statements. 3
THE
TORO COMPANY AND SUBSIDIARIES
(Dollars
in thousands, except per share data)
See
accompanying notes to condensed consolidated financial
statements. 4
THE
TORO COMPANY AND SUBSIDIARIES
(Dollars in
thousands)
See accompanying notes to condensed
consolidated financial statements.
5
THE
TORO COMPANY AND SUBSIDIARIES
May
1, 2009
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q and do not include all
the information and notes required by accounting principles generally accepted
in the United States of America for complete financial statements. Unless the
context indicates otherwise, the terms “company” and “Toro” refer to The Toro
Company and its subsidiaries. In the opinion of management, the unaudited
condensed consolidated financial statements include all adjustments, consisting
primarily of recurring accruals, considered necessary for a fair presentation of
the financial position and results of operations. Certain amounts from prior
periods’ financial statements have been reclassified to conform to this period’s
presentation. Since the company’s business is seasonal, operating results for
the six months ended May 1, 2009 cannot be annualized to determine the expected
results for the fiscal year ending October 31, 2009. Additional factors that
could cause our actual results to differ materially from our expected results,
including any forward-looking statements made in this report, are described in
our most recently filed Annual Report on Form 10-K (Item 1A) and later in this
report under Item 2, Management’s Discussion and Analysis of Financial Condition
and Results of Operations– Forward-Looking Information.
The
company’s fiscal year ends on October 31, and quarterly results are reported
based on three month periods that generally end on the Friday closest to the
quarter end. For comparative purposes, however, the company’s second and third
quarters always include exactly 13 weeks of results so that the quarter end date
for these two quarters is not necessarily the Friday closest to the quarter
end.
For
further information, refer to the consolidated financial statements and notes
included in the company’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2008. The policies described in that report are used for preparing
quarterly reports.
Accounting
Policies
In
preparing the consolidated financial statements in conformity with U.S.
generally accepted accounting principles, management must make decisions that
impact the reported amounts of assets, liabilities, revenues, expenses, and the
related disclosures, including disclosures of contingent assets and liabilities.
Such decisions include the selection of the appropriate accounting principles to
be applied and the assumptions on which to base accounting estimates. Estimates
are used in determining, among other items, sales promotions and incentives
accruals, inventory valuation, warranty reserves, allowance for doubtful
accounts, pension and postretirement accruals, useful lives for intangible
assets, and future cash flows associated with impairment testing for goodwill
and other long-lived assets. These estimates and assumptions are based on
management’s best estimates and judgments. Management evaluates its estimates
and assumptions on an ongoing basis using historical experience and other
factors that management believes to be reasonable under the circumstances,
including the current economic environment. We adjust such estimates and
assumptions when facts and circumstances dictate. A number of these factors are
discussed in our Annual Report on Form 10-K (Item 1A. Risk Factors) for the
fiscal year ended October 31, 2008, which include, among others, the continued
recessionary economic conditions, tight credit markets, unfavorable foreign
currency exchange rate changes, higher commodity costs, and a decline in
consumer spending and confidence, all of which have combined to increase the
uncertainty inherent in such estimates and assumptions. As future events and
their effects cannot be determined with precision, actual amounts could differ
significantly from those estimated at the time the consolidated financial
statements are prepared. Changes in those estimates resulting from continuing
changes in the economic environment will be reflected in the financial
statements in future periods. Note 1 to the consolidated financial statements in
the company’s most recent Annual Report on Form 10-K provides a summary of the
significant accounting policies followed in the preparation of the financial
statements. Other notes to the consolidated financial statements in the
company’s Annual Report on Form 10-K describe various elements of the financial
statements and the assumptions made in determining specific
amounts. 6
Comprehensive
Income
Comprehensive
income and the components of other comprehensive income (loss) were as
follows:
Stock-Based
Compensation
The
company accounts for stock-based compensation awards in accordance with the
provisions of Statement of Financial Accounting Standards (SFAS) No. 123
(Revised 2004), “Share-Based Payment.” Option awards are granted with an
exercise price equal to the closing price of the company’s common stock on the
date of grant, as reported by the New York Stock Exchange. Options are generally
granted to directors, officers, and other key employees in the first quarter of
the company’s fiscal year. For all options granted during the first quarter of
fiscal 2009, the options vest one-third each year over a three-year period and
have a ten-year term. Compensation expense equal to the grant date fair value is
generally recognized for these awards over the vesting period. However, if a
director has served on the company’s Board of Directors for ten full fiscal
years or longer, the fair value of the options granted is fully expensed as of
the date of the grant. Similarly, options granted to officers and other key
employees are also subject to accelerated expensing if the option holder meets
the retirement definition set forth in The Toro Company 2000 Stock Option Plan.
In that case, the fair value of the options is expensed in the year of grant
because the option holder must be employed as of the end of the fiscal year in
which the options are granted in order for the option to continue to vest
following retirement. The company also generally issues performance share awards
to officers and other key employees in the first quarter of the company’s fiscal
year. The company determines the fair value of these performance share awards as
of the date of grant and recognizes the expense over the three-year vesting
period. Total compensation expense for option and performance share awards for
the second quarter of fiscal 2009 and 2008 was $1.2 million and $1.4 million,
respectively. Year-to-date compensation expense for option and performance share
awards through the second quarter of fiscal 2009 and 2008 was $2.1 million and
$3.3 million, respectively.
The
fair value of each share-based option is estimated on the date of grant using a
Black-Scholes valuation method that uses the assumptions noted in the table
below. The expected life is a significant assumption as it determines the period
for which the risk-free interest rate, volatility, and dividend yield must be
applied. The expected life is the average length of time over which the employee
groups are expected to exercise their options, which is based on historical
experience with similar grants. Separate groups of employees that have similar
historical exercise behavior are considered separately for valuation purposes.
Expected volatilities are based on the movement of the company’s common stock
over the most recent historical period equivalent to the expected life of the
option. The risk-free interest rate for periods within the contractual life of
the option is based on the U.S. Treasury rate over the expected life at the time
of grant. Dividend yield is estimated over the expected life based on the
company’s dividend policy, historical dividends paid, expected future cash
dividends, and expected changes in the company’s stock price. The following
table illustrates the assumptions for options granted in the following fiscal
periods.
The
weighted-average fair value of options granted during the first quarter of
fiscal 2009 and 2008 was $7.93 per share and $13.90 per share, respectively. The
fair value of performance share awards granted during the first quarter of
fiscal 2009 and 2008 was $28.62 per share and $58.96 per share, respectively. No
option or performance share awards were granted during the second quarters of
fiscal 2009 or fiscal 2008. 7
Inventories
Inventories
are valued at the lower of cost or net realizable value, with cost determined by
the last-in, first-out (LIFO) method for most inventories and first-in,
first-out (FIFO) method for all other inventories. The company establishes a
reserve for excess, slow-moving, and obsolete inventory that is equal to the
difference between the cost and estimated net realizable value for that
inventory. These reserves are based on a review and comparison of current
inventory levels to the planned production as well as planned and historical
sales of the inventory.
Inventories
were as follows:
Per
Share Data
Reconciliations
of basic and diluted weighted-average shares of common stock outstanding are as
follows:
Options
to purchase an aggregate of 1,853,681 and 715,135 shares of common stock
outstanding during the second quarter of fiscal 2009 and 2008, respectively,
were excluded from the diluted net earnings per share calculation because their
exercise prices were greater than the average market price of the company’s
common stock during the same respective periods. Options to purchase an
aggregate of 1,853,681 and 164,940 shares of common stock outstanding during the
year-to-date periods through the second quarter of fiscal 2009 and 2008,
respectively, were excluded from the diluted net earnings per share calculations
because their exercise prices were greater than the average market price of the
company’s common stock during the same respective periods.
8
Goodwill
The
changes in the net carrying amount of goodwill for the first six months of
fiscal 2009 were as follows:
Other
Intangible Assets
The
components of other amortizable intangible assets were as follows:
Amortization
expense for intangible assets during the first six months of fiscal 2009 was
$1.0 million. Estimated amortization expense for the remainder of fiscal 2009
and succeeding fiscal years is as follows: fiscal 2009 (remainder), $0.9
million; fiscal 2010, $1.7 million; fiscal 2011, $1.7 million; fiscal 2012, $1.6
million; fiscal 2013, $1.5 million; fiscal 2014; $1.1 million; and after fiscal
2014, $4.0 million.
Segment
Data
The
presentation of segment information reflects the manner in which management
organizes segments for making operating decisions and assessing performance. On
this basis, the company has determined it has three reportable business
segments: professional, residential, and distribution. Company-owned domestic
distributorships, which consists of our distribution segment, has been combined
with our corporate activities, financing functions, and elimination of
intersegment revenues and expenses that is shown as “Other” in the following
tables. 9
The
following table shows the summarized financial information concerning the
company’s reportable segments:
The
following table presents the details of the other segment operating loss before
income taxes:
Warranty
Guarantees
The
company’s products are warranted to ensure customer confidence in design,
workmanship, and overall quality. Warranty coverage ranges from a period of six
months to seven years, and generally covers parts, labor, and other expenses for
non-maintenance repairs. Warranty coverage generally does not cover operator
abuse or improper use. An authorized Toro distributor or dealer must perform
warranty work. Distributors, dealers, and contractors submit claims for warranty
reimbursement and are credited for the cost of repairs, labor, and other
expenses as long as the repairs meet prescribed standards. Warranty expense is
accrued at the time of sale based on the estimated number of products under
warranty, historical average costs incurred to service warranty claims, the
trend in the historical ratio of claims to sales, the historical length of time
between the sale and resulting warranty claim, and other minor factors. Special
warranty reserves are also accrued for major rework campaigns. The company also
sells extended warranty coverage on select products for a prescribed period
after the factory warranty period expires.
Warranty
provisions, claims, and changes in estimates for the first six-month periods in
fiscal 2009 and 2008 were as follows:
10
Postretirement
Benefit and Deferred Compensation Plans
The
following table presents the components of net periodic benefit costs of the
postretirement medical and dental benefit plan:
As of May
1, 2009, the company had contributed approximately $0.2 million to its
postretirement medical and dental benefit plan in fiscal 2009. The company
presently expects to contribute a total of $0.4 million in fiscal 2009,
including contributions made through May 1, 2009.
The
company maintains The Toro Company Investment, Savings and Employee Stock
Ownership Plan for eligible employees. The company’s expenses under this plan
were $3.8 million and $7.6 million for the second quarter and year-to-date
periods in fiscal 2009, respectively, and $3.8 million and $8.2 million for the
second quarter and year-to-date periods in fiscal 2008,
respectively.
The
company also offers participants in the company’s deferred compensation plans
the ability to invest their deferred compensation in multiple investment funds.
The fair value of the investment in the deferred compensation plans as of May 1,
2009 was $13.5 million, which reduced the company’s deferred compensation
liability reflected in accrued liabilities on the consolidated balance
sheet.
Income
Taxes
The
company is subject to U.S. federal income tax as well as income tax of numerous
state and foreign jurisdictions. The company is generally no longer subject to
U.S. federal tax examinations for taxable years before fiscal 2005 and with
limited exceptions, state and foreign income tax examinations for fiscal years
before 2004. The Internal Revenue Service is currently examining the company’s
income tax returns for the 2006 and 2007 fiscal years. It is possible that the
examination phase of the audit may conclude in the next 12 months, and the
related unrecognized tax benefits for tax positions taken may change from those
recorded as liabilities for uncertain tax positions in the company’s financial
statements as of May 1, 2009. Although the outcome of this examination cannot
currently be determined, the company believes adequate provisions have been made
for any potential unfavorable financial statement impact.
As
of May 1, 2009 and May 2, 2008, the company had $5.5 million of liabilities
recorded related to unrecognized tax benefits. Accrued interest and penalties on
these unrecognized tax benefits was $0.9 million as of May 1, 2009 and May 2,
2008. The company recognizes potential accrued interest and penalties related to
unrecognized tax benefits as a component of the provision for income taxes. To
the extent interest and penalties are not assessed with respect to uncertain tax
positions, the amounts accrued will be revised and reflected as an adjustment to
the provision for income taxes. Included in other long-term liabilities as of
May 1, 2009 was approximately $3.0 million of unrecognized tax benefits that, if
recognized, will affect the company’s effective tax rate.
The
company does not anticipate that total unrecognized tax benefits will change
significantly during the next 12 months.
Derivative
Instruments and Hedging Activities
In March
2008, the Financial Accounting Standards Board (FASB) issued SFAS No. 161,
“Disclosures about Derivative Instruments and Hedging Activities, an amendment
of FASB Statement No. 133.” SFAS No. 161 amends and expands the disclosure
requirements of SFAS No. 133 with the intent to provide users of financial
statements with an enhanced understanding of: (i) how and why an entity uses
derivative instruments; (ii) how derivative instruments and related hedged items
are accounted for under SFAS No. 133 and its related interpretations; and (iii)
how derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. The company adopted the
disclosure requirements of this statement beginning in its first fiscal quarter
ended January 30, 2009. 11
The
company is exposed to foreign currency exchange rate risk arising from
transactions in the normal course of business, such as sales to third party
customers, sales and loans to wholly owned foreign subsidiaries, foreign plant
operations, and purchases from suppliers. The company actively manages the
exposure of its foreign currency market risk by entering into various hedging
instruments, authorized under company policies that place controls on these
activities, with counterparties that are highly rated financial institutions.
The company’s hedging activities involve the primary use of forward currency
contracts. The company uses derivative instruments only in an attempt to limit
underlying exposure from foreign currency exchange rate fluctuations and to
minimize earnings and cash flow volatility associated with foreign currency
exchange rate changes. Decisions on whether to use such contracts are made based
on the amount of exposure to the currency involved, and an assessment of the
near-term market value for each currency. The company’s policy is not to allow
the use of derivatives for trading or speculative purposes. The company’s
primary foreign currency exchange rate exposures are with the Euro, the
Australian dollar, the Canadian dollar, the British pound, the Mexican peso, and
the Japanese yen against the U.S. dollar.
Cash flow hedges.
>SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities” requires companies to recognize all derivative instruments as either
assets or liabilities at fair value in the statement of financial position. The
company formally documents all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy for
undertaking hedge transactions. This process includes linking all derivatives to
the forecasted transactions, such as sales to third parties and foreign plant
operations. In accordance with SFAS No. 133, for derivative instruments that are
designated and qualify as a cash flow hedge, all changes in fair values of
outstanding cash flow hedge derivatives, except the ineffective portion, are
recorded in other comprehensive income, until net earnings is affected by the
variability of cash flows of the hedged transaction. Gains and losses on the
derivative representing either hedge ineffectiveness or hedge components
excluded from the assessment of effectiveness are recognized in net earnings.
The consolidated statement of earnings classification of effective hedge results
is the same as that of the underlying exposure. Results of hedges of sales and
foreign plant operations are recorded in net sales and cost of sales,
respectively, when the underlying hedged transaction affects net earnings. The
maximum amount of time the company hedges its exposure to the variability in
future cash flows for forecasted trade sales and purchases is two
years.
The
company formally assesses at a hedge’s inception and on an ongoing basis,
whether the derivatives that are used in the hedging transaction have been
highly effective in offsetting changes in the cash flows of the hedged items and
whether those derivatives may be expected to remain highly effective in future
periods. When it is determined that a derivative is not, or has ceased to be,
highly effective as a hedge, the company discontinues hedge accounting
prospectively. When the company discontinues hedge accounting because it is no
longer probable, but it is still reasonably possible that the forecasted
transaction will occur by the end of the originally expected period or within an
additional two-month period of time thereafter, the gain or loss on the
derivative remains in accumulated other comprehensive income (AOCI) and is
reclassified to net earnings when the forecasted transaction affects net
earnings. However, if it is probable that a forecasted transaction will not
occur by the end of the originally specified time period or within an additional
two-month period of time thereafter, the gains and losses that were accumulated
in other comprehensive income will be recognized immediately in net earnings. In
all situations in which hedge accounting is discontinued and the derivative
remains outstanding, the company carries the derivative at its fair value on the
balance sheet, recognizing future changes in the fair value in other income,
net. For the three and six month periods of fiscal 2009, there were no gains or
losses on contracts reclassified into earnings as a result of the discontinuance
of cash flow hedges. As of May 1, 2009, the notional amount outstanding of
forward contracts designated as cash flow hedges was $49.7 million.
Derivatives not
designated as hedging instruments under SFAS No. 133. >The company also
enters into forward currency contracts to mitigate the change in fair value of
specific assets and liabilities on the consolidated balance sheet. These
contracts are not designated as hedging instruments under SFAS No. 133.
Accordingly, changes in the fair value of hedges of recorded balance sheet
positions, such as cash, receivables, payables, intercompany notes, and other
various contractual claims to pay or receive foreign currencies other than the
functional currency, are recognized immediately in other income, net, on the
consolidated statements of earnings together with the transaction gain or loss
from the hedged balance sheet position. 12
The
following table presents the fair value of the company’s derivatives and
consolidated balance sheet location.
The
following table presents the impact of derivative instruments on the
consolidated statements of earnings for the company’s derivatives designed as
cash flow hedging instruments under SFAS No. 133 for the three and six months
ended May 1, 2009 and May 2, 2008, respectively.
As
of May 1, 2009, the company anticipates to reclassify approximately $1.8 million
of gains from AOCI to earnings during the next twelve months.
The
following table presents the impact of derivative instruments on the
consolidated statements of earnings for the company’s derivatives not designated
as hedging instruments under SFAS No. 133.
Fair
Value Measurements
In
September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements.” SFAS No.
157 introduces a framework for measuring fair value and expands required
disclosures about fair value measurements of assets and liabilities. The company
adopted the standard for financial assets and liabilities and nonfinancial
assets and liabilities measured at fair value on a recurring basis as of
November 1, 2008, and there was no financial statement impact resulting from the
adoption. We will adopt 13
the
provisions of SFAS No. 157 for nonfinancial assets and liabilities that are not
required or permitted to be measured on a recurring basis during the first
quarter of fiscal 2010, as required.
SFAS
No. 157 defines fair value as the exchange price that would be received for an
asset or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. SFAS No. 157 also establishes a
fair value hierarchy which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
The standard describes three levels of inputs that may be used to measure fair
value:
Level
1 — Quoted prices in active markets for identical assets or
liabilities.
Level
2 — Observable inputs other than Level 1 prices, such as quoted prices for
similar assets or liabilities; quoted prices in markets that are not active; or
other inputs that are observable or can be corroborated by observable market
data for substantially the full term of the assets or liabilities.
Level
3 — Unobservable inputs that are supported by little or no market activity and
that are significant to the fair value of the assets or
liabilities.
The
company utilizes the income approach to measure the fair value of its foreign
currency contracts. The income approach uses significant other observable inputs
to value derivative instruments that hedge foreign currency
transactions.
Assets
and liabilities measured at fair value on a recurring basis, as of May 1, 2009,
are summarized below:
Contingencies
Litigation
In
May 2006, the case was removed to federal court in the Southern
District of Illinois. In August 2006, the company, together with the other
defendants other than MTD Products Inc. (“MTD”), filed a motion to dismiss the
amended complaint. Also in August 2006, the plaintiffs filed a motion for
preliminary approval of a settlement agreement with MTD and certification of a
settlement class. In December 2006, another defendant, American Honda Motor
Company (“Honda”), notified the company that it had reached a settlement
agreement with the plaintiffs.
In
May 2008, the court issued a memorandum and order that (i) dismissed the RICO
claim in its entirety with prejudice; (ii) dismissed all non-Illinois state-law
claims without prejudice and with instructions that such claims must be filed in
local courts; and (iii) rejected the proposed settlement with MTD. The proposed
Honda settlement was not under consideration by the court and was not addressed
in the memorandum and order. Also in May 2008, the plaintiffs (i) re-filed the
Illinois claims with the court; and (ii) filed non-Illinois claims in federal
courts in the District of New Jersey and the Northern District of California
with essentially the same state law claims. 14
In
June 2008, the plaintiffs filed a motion with the United States Judicial Panel
on Multidistrict Litigation (the “MDL Panel”) that (i) stated their intent to
file lawsuits in all 50 states and the District of Columbia; and (ii) sought to
have all of the cases transferred for coordinated pretrial proceedings. In
August 2008, the MDL Panel issued an order denying the transfer request.
Additional lawsuits, some of which included additional plaintiffs, were filed in
various federal and state courts asserting essentially the same state law
claims.
In
September 2008, the company and other defendants filed a motion with the MDL
Panel that sought to transfer the multiple actions for coordinated pretrial
proceedings. In early December 2008, the MDL Panel issued an order that (i)
transferred 23 lawsuits, which collectively asserted claims under the laws of 16
states, for coordinated or consolidated pretrial proceedings, (ii) selected the
United States District Court for the Eastern District of Wisconsin as the
transferee district, and (iii) provided that additional lawsuits will be treated
as “tag-along” actions in accordance with its rules.
An
initial hearing was held in the United States District Court for the Eastern
District of Wisconsin in January 2009. At that hearing, the Court (i)
appointed lead plaintiffs’ counsel, and (ii) entered a stay of all litigation
for 120 days so that the parties could explore mediation. Formal mediation
proceedings commenced and on May 28, 2009, the Court extended the litigation
stay to August 28, 2009, and re-scheduled the status conference to September
2009. To date, more than 65 lawsuits have been filed in various federal and
state courts, which collectively assert claims under the laws of approximately
50 jurisdictions.
Management
continues to evaluate these lawsuits and is unable to reasonably estimate the
likelihood of loss or the amount or range of potential loss that could result
from the litigation. Therefore, no accrual has been established for potential
loss in connection with these lawsuits. Management is also unable to assess at
this time whether these lawsuits will have a material adverse effect on the
company’s annual consolidated operating results or financial condition, although
an unfavorable resolution could be material to the company’s consolidated
operating results for a particular period.
Management
continues to evaluate these lawsuits and is unable to reasonably estimate the
likelihood of loss or the amount or range of potential loss that could result
from the litigation. Therefore, no accrual has been established for potential
loss in connection with these lawsuits. While management does not believe that
these lawsuits will have a material adverse effect on the company’s consolidated
financial condition, an unfavorable resolution could be material to the
company’s consolidated operating results.
15
AND
RESULTS OF OPERATIONS
Nature
of Operations
The Toro
Company is in the business of designing, manufacturing, and marketing
professional turf maintenance equipment and services, turf and agricultural
micro-irrigation systems, landscaping equipment, and residential yard and
irrigation products worldwide. We sell our products through a network of
distributors, dealers, hardware retailers, home centers, mass retailers, and
over the Internet. Our businesses are organized into three reportable business
segments: professional, residential, and distribution. A company-owned
distributorship, which consists of our distribution segment, has been combined
with our corporate activities and financing functions. Our emphasis is to
provide innovative, well-built, and dependable products supported by an
extensive service network. A significant portion of our revenues has
historically been, and we expect it to continue to be, attributable to new and
enhanced products.
The
Management’s Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) for the second quarter of fiscal 2009 should be read in
conjunction with the MD&A included in our Annual Report on Form 10-K (Item
7) for the fiscal year ended October 31, 2008.
RESULTS
OF OPERATIONS
Overview
For the
second quarter of fiscal 2009, our net sales were down 21.7 percent compared to
the second quarter of fiscal 2008. Year-to-date net sales were also down by 19.6
percent compared to the same period last fiscal year. Shipments of most
professional segment products were significantly down due to decreased demand
and customers’ reluctance to place stocking orders largely as a consequence of
the global recessionary conditions, which also resulted in lower field inventory
levels for our domestic businesses. Residential segment net sales were also down
by 4.7 percent and 2.8 percent for the second quarter and year-to-date periods
of fiscal 2009, respectively, compared to the same periods in the prior fiscal
year due mainly to a decline in shipments of riding products, which was somewhat
offset by an increase in sales of walk power mowers as a result of additional
product placement at a key retailer for a new and broader line of walk power
mowers. International net sales declined 24.8 percent and 21.6 percent for the
second quarter and year-to-date periods of fiscal 2009, respectively, from the
same periods in the prior fiscal year, due also to reduced demand as a result of
the recessionary conditions affecting our key international markets, as well as
a stronger U.S. dollar that negatively impacted net sales by approximately $12
million and $24 million for the second quarter and year-to-date periods of
fiscal 2009, respectively. Our net earnings declined 41.3 percent and 46.5
percent for the second quarter and year-to-date periods of fiscal 2009 to $36.9
million and $43.6 million, respectively, compared to the same periods in the
prior fiscal year. These decreases were primarily the result of lower sales
volumes and lower gross margin due to higher commodity costs, production cuts,
and unfavorable product mix in the second quarter and year-to-date periods of
fiscal 2009 compared to the same periods last fiscal year.
During
this difficult economic environment, we have been reducing expenses and
continuing efforts to reduce working capital. As a result of these actions, our
selling, general, and administrative (SG&A) expenses were down $22.7 million
and $35.3 million for the second quarter and year-to-date periods of fiscal
2009, respectively, compared to the same periods in the prior fiscal year. In
February 2009, we announced the reduction of our worldwide salaried and office
workforce by approximately 100 employees, suspension of regularly scheduled
salary increases, a reduction of officers’ salaries, changes in our vacation
policy, and four furlough days – all for the remainder of fiscal 2009. Our
inventory levels also decreased 18.7 percent for the second quarter of fiscal
2009 compared to the second quarter of fiscal 2008, which also contributed to a
decline in short-term debt of $118.6 million as of the end of the second quarter
of fiscal 2009 compared to the end of the second quarter of fiscal 2008. We
declared a cash dividend of $0.15 per share during the second quarter of fiscal
2009, which was equivalent to the cash dividend we declared in the first quarter
of fiscal 2009 and each quarter of fiscal 2008.
We
expect the global economic slow-down to continue for at least the remainder of
our fiscal year and to continue to have a negative impact on our financial
results for fiscal 2009. However, we believe we are well positioned to manage
through this challenging environment because of the actions we have taken to
improve operating efficiency and asset utilization, as well as reducing
expenses. Our continued focus is on generating customer demand and aggressively
driving retail sales for our innovative products, while keeping production
closely aligned with expected shipment volumes. We will continue to keep a
cautionary eye on the global economies, retail demand, field inventory levels,
commodity prices, weather, competitive actions, and other factors identified
below under the heading “Forward-Looking Information,” which could cause our
actual results to differ from our outlook. 16
Net
Earnings
Net
earnings for the second quarter of fiscal 2009 were $36.9 million, or $1.00 per
diluted share, compared to $62.8 million, or $1.60 per diluted share, for the
second quarter of fiscal 2008, net earnings per diluted share decrease of 37.5
percent. Year-to-date net earnings in fiscal 2009 were $43.6 million, or $1.18
per diluted share, compared to $81.4 million, or $2.07 per diluted share, last
fiscal year, net earnings per diluted share decrease of 43.0 percent. The
primary factors contributing to these declines were lower sales volumes and a
decline in gross profit, somewhat offset by a decrease in SG&A expense and a
lower effective tax rate.
The
following table summarizes the major operating costs and other income as a
percentage of net sales:
Net
Sales
Worldwide
consolidated net sales for the second quarter and year-to-date periods of fiscal
2009 were down 21.7 percent and 19.6 percent, respectively, from the same
periods in the prior fiscal year. Worldwide professional segment net sales were
down 29.2 percent and 26.4 percent for the second quarter and year-to-date
periods of fiscal 2009, respectively, compared to the same period in the prior
fiscal year as shipments for most product categories were hampered by decreased
demand largely resulting from the global economic recession. Worldwide sales of
golf maintenance equipment and irrigation systems were down significantly, as
were sales of professionally installed residential/commercial irrigation
products and landscape contractor equipment. Residential segment net sales also
decreased by 4.7 percent and 2.8 percent for the second quarter and year-to-date
periods of fiscal 2009, respectively, compared to the same periods in fiscal
2008 due mainly to a decline in worldwide shipments and decreased demand for
riding products. Somewhat offsetting these declines were an increase in sales of
walk power mowers as a result of additional product placement at a key retailer
for a new and broader line of walk power mowers, as well as strong demand for
snow thrower products in North America as a result of heavy snow falls during
the winter season of 2008/2009 for the year-to-date comparison. International
net sales for the second quarter and year-to-date periods of fiscal 2009 were
down 24.8 percent and 21.6 percent, respectively, from the same periods in the
prior fiscal year due also to reduced demand as a result of the recessionary
conditions affecting our key international markets, as well as a stronger U.S.
dollar compared to other currencies in which we transact business that accounted
for approximately $12 million and $24 million of our net sales decline for the
second quarter and year-to-date periods of fiscal 2009,
respectively.
Gross
Profit
As a
percentage of net sales, gross profit for the second quarter of fiscal 2009
decreased to 32.3 percent compared to 35.7 percent in the second quarter of
fiscal 2008. Gross profit as a percent of net sales for the year-to-date period
of fiscal 2009 also decreased to 33.3 percent compared to 36.1 percent for
year-to-date period of fiscal 2008. These declines were due to the following
factors: (i) higher average commodity costs; (ii) increased manufacturing costs
from lower plant utilization as we cut production due to a decline in sales
volumes, combined with efforts to lower inventory levels; (iii) lower sales of
our higher-margin products; and (iv) a stronger U.S. dollar compared to other
currencies in which we transact business, in each case in the second quarter and
year-to-date periods of fiscal 2009 compared to the same periods in the prior
fiscal year. Somewhat offsetting those negative factors were price increases
introduced on most products and a decrease in freight expense. 17
Selling,
General, and Administrative Expense
Selling,
general, and administrative expense decreased $22.7 million, or 18.2 percent,
for the second quarter of fiscal 2009 compared to the second quarter of fiscal
2008. SG&A expense decreased $35.3 million, or 14.6 percent for the
year-to-date period of fiscal 2009 compared to the year-to-date period of fiscal
2008. SG&A expense as a percentage of net sales for the second quarter and
year-to-date periods of fiscal 2009 increased to 20.5 percent and 24.6 percent,
respectively, compared to 19.6 percent and 23.2 percent for the second quarter
and year-to-date periods of fiscal 2008, respectively, due to fixed SG&A
costs spread over lower sales volumes. The decline in SG&A expense was
primarily attributable to overall reduced spending in response to the continuing
worldwide recessionary economic conditions, as well as lower profit sharing and
incentive compensation expense of $1.8 million and $5.5 million for the second
quarter and year-to-date periods of fiscal 2009, respectively, compared to the
same periods in the prior fiscal year. Somewhat offsetting those declines were
increased costs incurred for workforce reductions of $2.1 million and higher bad
debt expense of $1.3 million, mainly for the year-to-date
comparison.
Interest
Expense
Interest
expense for the second quarter and year-to-date periods of fiscal 2009 was down
18.4 percent and 14.8 percent, respectively, compared to the same periods in the
prior fiscal year as a result of lower average short-term debt levels and a
decline in average interest rates.
Other
Income (Expense), Net
Other
income, net for the second quarter and year-to-date periods of fiscal 2009
increased $2.3 million and $1.4 million, respectively, compared to the same
periods in the prior fiscal year. These increases were due to foreign currency
exchange rate gains this year compared to foreign currency exchange rate losses
last year, somewhat offset by a decline in financing charge revenue and lower
interest income.
Provision
for Income Taxes
The
effective tax rate for the second quarter of fiscal 2009 was 34.2 percent
compared to 35.0 percent for the second quarter of fiscal 2008. The effective
tax rate for the year-to-date period of fiscal 2009 was 34.2 percent compared to
35.1 percent for the same period in the prior fiscal year. The decrease in the
effective tax rate was primarily the result of the reinstatement of the domestic
research tax credit and the tax impact of foreign currency exchange rate
fluctuations, somewhat offset by a valuation allowance for foreign net operating
losses and prior years’ provision adjustments of $0.6 million.
BUSINESS
SEGMENTS
As
described previously, we operate in three reportable business segments:
professional, residential, and distribution. Company-owned domestic
distributorships, which consists of our distribution segment, has been combined
with our corporate activities and financing functions that is shown as “Other”
in the following tables. Operating earnings for our professional and residential
segments are defined as earnings from operations plus other income, net.
Operating loss for “Other” includes earnings (loss) from operations, corporate
activities, including corporate financing activities, other income, net, and
interest expense. 18
The
following table summarizes net sales by segment:
The
following table summarizes operating earnings (loss) before income taxes by
segment:
Professional
Net
Sales. Worldwide
net sales for the professional segment in the second quarter and year-to-date
periods of fiscal 2009 were down 29.2 percent and 26.4 percent, respectively,
compared to the same periods last fiscal year. Shipments declined for most
domestic and international product categories due to decreased demand and
customers’ reluctance to place stocking orders as a result of the continued
worldwide recessionary economic conditions, which also resulted in lower field
inventory levels for our domestic businesses. Worldwide sales of golf
maintenance equipment and irrigation systems were significantly down as
customers delayed investments in new equipment at existing golf courses and new
golf course construction slowed. In addition, sales of professionally installed
residential/commercial irrigation systems were down due to decreased demand
largely as a result of ongoing weakness in the housing and commercial
construction markets. Sales of landscape contractor equipment were also down due
to the recessionary economic conditions, but were somewhat offset by positive
customer response to new product introductions. 19
Operating
Earnings. Operating earnings for the professional segment in the second
quarter and year-to-date periods of fiscal 2009 decreased 41.3 percent and 41.4
percent, respectively, compared to the same periods last fiscal year. Expressed
as a percentage of net sales, professional segment operating margin decreased to
18.3 percent compared to 22.1 percent in the second quarter of fiscal 2008, and
the fiscal 2009 year-to-date professional segment operating margin decreased to
16.1 percent compared to 20.2 percent from the same period last fiscal year.
These profit declines were primarily attributable to lower gross margins due to
the same factors discussed previously in the Gross Profit section. Higher
SG&A expense as a percentage of net sales also adversely affected operating
earnings, which was due mainly to fixed SG&A costs spread over lower sales
volumes.
Residential
Net
Sales. Worldwide
net sales for the residential segment in the second quarter and year-to-date
periods of fiscal 2009 were down 4.7 percent and 2.8 percent, respectively,
compared to the same periods last fiscal year. These sales declines were due
mainly to lower worldwide shipments and reduced demand for riding products.
Somewhat offsetting these declines were an increase in sales of walk power
mowers as a result of additional product placement at a key retailer for a new
and broader line of walk power mowers, as well as strong demand for snow thrower
products in North America as a result of heavy snow falls during the winter
season of 2008/2009 for the year-to-date comparison.
Operating
Earnings.
Operating earnings for the residential segment in the second quarter and
year-to-date periods of fiscal 2009 decreased 20.2 percent and 12.8 percent,
respectively, compared to the same periods last fiscal year. Expressed as a
percentage of net sales, residential segment operating margin decreased to 9.0
percent compared to 10.8 percent in the second quarter of fiscal 2008, and
fiscal 2009 year-to-date residential segment operating margin decreased to 7.4
percent compared to 8.2 percent last fiscal year. These profit declines were
primarily attributable to lower gross margins due mainly to higher average
commodity costs in the first half of fiscal 2009 compared to the first half of
fiscal 2008 and unfavorable product mix. Somewhat offsetting the profit decline
was lower SG&A expense as a percent of net sales from a decline in spending
for marketing, administration, warehousing, and engineering expenses as a result
of budget reductions.
Other
Net
Sales. Net sales
for the other segment include sales from our wholly owned domestic distribution
company less sales from the professional and residential segments to that
distribution company. In addition, elimination of the professional and
residential segments’ floor plan interest costs from Toro Credit Company are
also included in this segment. Net sales for the other segment were down for the
second quarter and year-to-date periods of fiscal 2009 compared to the same
periods last fiscal year by $1.4 million, or 19.1 percent, and $2.0 million, or
17.4 percent, respectively, as a result of reduced demand due to the domestic
economic recession, as well as a reduction in the elimination of floor plan
interest costs as a result of lower receivables with Toro Credit Company and a
reduction in interest rates.
Operating
Losses. Operating losses for the other segment were down for the second
quarter and year-to-date periods of fiscal 2009 by $3.7 million, or 17.5
percent, and $5.4 million, or 11.3 percent, respectively, compared to the same
periods last fiscal year. The loss decreases were primarily attributable to the
following factors: (i) overall reduced spending in response to the economic
downturn; (ii) foreign currency exchange rate gains this year compared to
foreign currency exchange rate losses last year; and (iii) decreased interest
expense, previously discussed. For the year-to-date period of fiscal 2009
compared to the year-to-date period of fiscal 2008, the other segment operating
loss was also impacted by a decline in profit sharing and incentive compensation
expense, somewhat offset by costs incurred for workforce reductions and higher
bad debt expense.
20
FINANCIAL
POSITION
Working
Capital
We have
taken proactive measures to help us manage through the tough economic
environment that continued to persist through the second quarter of fiscal 2009,
including adjusting production plans, controlling costs, and managing our
assets. As such, our financial condition remains strong. We continue to place
additional emphasis on asset management with our GrowLean initiative, with a
focus on: (i) achieving strong profitability of our products and services all
the way through the supply chain; (ii) minimizing the amount of working capital
in the supply chain; and (iii) maintaining or improving order replenishment and
service levels to end users.
Receivables
as of the end of the second quarter of fiscal 2009 were down 25.5 percent
compared to the end of the second quarter of fiscal 2008 due in part to the
decrease in net sales. Our average day’s sales outstanding for receivables
improved to 69 days based on sales for the last twelve months ended May 1, 2009,
compared to 71 days for the twelve months ended May 2, 2008. Inventory was also
down as of the end of the second quarter of fiscal 2009 by 18.7 percent compared
to the end of the second quarter of fiscal 2008, and average inventory turnover
improved 9.9 percent for the twelve months ended May 1, 2009 compared to the
twelve months ended May 2, 2008.
Liquidity
and Capital Resources
Our
businesses are seasonally working capital intensive and require funding for
purchases of raw materials used in production, replacement parts inventory,
payroll and other administrative costs, capital expenditures, expansion and
upgrading of existing facilities, as well as for financing receivables from
customers. We believe that cash generated from operations, together with our
fixed rate long-term debt, bank credit lines, and cash on hand, will provide us
with adequate liquidity to meet our anticipated operating requirements. We
believe that the funds available through existing financing arrangements and
forecasted cash flows will be sufficient to provide the necessary capital
resources for our anticipated working capital needs, capital expenditures, debt
repayments, quarterly cash dividend payments, and stock repurchases for at least
the next twelve months.
Cash
Flow. The first half of our fiscal year historically uses more operating
cash than the second half of our fiscal year due to the seasonality of our
business. Cash used in operating activities for the first six months of fiscal
2009 was $38.4 million lower than the first six months of fiscal 2008 due
primarily to a lower increase in receivables and inventory levels for the first
six months of fiscal 2009 compared to the same period last fiscal year, which
was somewhat offset by a decline in net earnings and a lower increase in
accounts payable and accrued liabilities for the first six months of fiscal 2009
compared to the same period last fiscal year. Cash used in investing activities
was lower by $4.5 million compared to the first six months of fiscal 2008, due
mainly to a decrease in purchases of property, plant, and equipment in the first
six months of fiscal 2009 compared to the first six months of fiscal 2008. Cash
provided by financing activities was also lower by $84.0 million compared to the
first six months of fiscal 2008, due to a substantial decline in short-term debt
for the first six months of fiscal 2009 compared to the first six months of
fiscal 2008, somewhat offset by lower levels of repurchases of our common stock
for the first six-month comparison.
Credit
Lines and Other Capital Resources. Our
businesses are seasonal, with accounts receivable balances historically
increasing between January and April, as a result of higher sales volumes and
payment terms made available to our customers and decreasing between May and
December when payments are received. The seasonality of production and shipments
causes our working capital requirements to fluctuate during the year. Our peak
borrowing usually occurs between January and April. Seasonal cash requirements
are financed from operations and with short-term financing arrangements,
including a $225.0 million unsecured senior five-year revolving credit facility
that expires in January 2012. Interest expense on this credit line is determined
based on a LIBOR rate plus a basis point spread defined in the credit agreement.
In addition, our non-U.S. operations maintain unsecured short-term lines of
credit of approximately $16 million. These facilities bear interest at various
rates depending on the rates in their respective countries of operation. We also
have a letter of credit subfacility as part of our credit agreement. As of May
1, 2009, we had $32.9 million of outstanding short-term debt and $10.1 million
of outstanding standby letters of credit. Average short-term debt was $27.5
million in the first six months of fiscal 2009 compared to $103.0 million in the
first six months of fiscal 2008, a decrease of 73.3 percent. This decline was
due mainly to a decrease in working capital needs in the first six months of
fiscal 2009 compared to the first six months of fiscal 2008 as a result of lower
levels of accounts receivable and inventory, as previously discussed, as well as
lower levels of repurchases of our common stock during the first six months of
fiscal 2009 compared to the same period last fiscal year. As of May 1, 2009, we
had $198.7 million of unutilized availability under our credit
agreements.
Significant
financial covenants in our credit agreement include interest coverage and
debt-to-capitalization ratios. We were in compliance with all covenants related
to our credit agreements as of May 1, 2009, and expect to be in compliance with
all covenants during the remainder of fiscal 2009. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||