For the Quarter Ending April 29, 2011
Item 2. Management’s Discussion And Analysis Of Financial Condition 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 irrigation systems, agricultural micro-irrigation systems, landscaping equipment and lighting, and residential yard and snow removal products. We sell our products worldwide 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. Our Distribution segment, which consists of our company-owned domestic distributorships, has been combined with our corporate activities and is shown as “Other.” 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 will continue to be, attributable to new and enhanced products. We define new products as those introduced in the current and previous two fiscal years.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the MD&A included in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended October 31, 2010.
RESULTS OF OPERATIONS
OVERVIEW
Our results for the second quarter of fiscal 2011 were positive with a net sales growth rate of 12.2 percent and a net earnings growth rate of 32.0 percent, each as compared to the second quarter of fiscal 2010. Year-to-date net earnings increased 37.0 percent in fiscal 2011 compared to the same period in the last fiscal year on a year-to-date net sales growth rate of 13.5 percent. Sales for all professional segment businesses increased due to higher demand resulting from improved economic conditions, better product availability, the successful introduction of new products, and strong demand for golf equipment and irrigation systems. Early orders for landscape contractor equipment, rebound of the rental market, and continued demand for our micro-irrigation products also contributed to the growth of professional segment sales. To meet increasing worldwide demand for micro-irrigation products for the agricultural market, particularly in Eastern Europe, we began construction of a new manufacturing facility in Romania with production anticipated to begin in late 2011. We expect this new facility in Romania to provide many advantages due to its central location, established transportation infrastructure, and access to skilled manufacturing resources. Residential segment sales decreased slightly for the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010 but increased 1.9 percent for the year-to-date period of fiscal 2011 compared to the same period last fiscal year. Cool, wet weather dampened sales of walk power mowers for both the second quarter and year-to-date periods of fiscal 2011 compared to the same periods in the prior fiscal year. These declines were somewhat offset by consumer demand resulting in strong orders for our new line of zero-turn radius riding mowers, as well as better product availability. Net earnings as a percentage of net sales rose to 9.5 percent and 7.6 percent in the second quarter and year-to-date periods of fiscal 2011, respectively, compared to 8.1 percent and 6.3 percent in the second quarter and year-to-date periods of fiscal 2010, respectively. Higher gross margins, leveraging of selling, general, and administrative (“SG&A”) expenses, and a lower effective tax rate also contributed to the earnings improvement.
We continued to focus on asset management and our financial condition remains strong. Our receivables increased by 6.8 percent as of the end of the second quarter of fiscal 2011 compared to the end of the second quarter of fiscal 2010. Our inventory levels also increased by 49.0 percent as of the end of the second quarter of fiscal 2011 compared to the end of the second quarter of fiscal 2010 as we prebuilt inventory in anticipation of expected higher demand for our products and product availability issues we experienced last year that we did not want to replicate this fiscal year, coupled with the impact of lower sales of some residential segment products due to unfavorable weather conditions. As of the end of our second quarter of fiscal 2011, our average net working capital (accounts receivable plus inventory less trade payables) as a percentage of net sales was 13.6 percent compared to 19.0 percent as of the end of our second quarter of fiscal 2010. We also increased our second quarter cash dividend by 11 percent from $0.18 to $0.20 per share compared to the quarterly cash dividend paid in the second quarter of fiscal 2010.
We are off to a good start with our new multi-year initiative, “Destination 2014” that will take us to our centennial in 2014 and into our second century. This four-year initiative is intended to focus our efforts on driving our legacy of excellence through building caring relationships and engaging in innovation. Through our Destination 2014 initiative financial goals, we will strive to achieve $100 million in organic revenue growth in each of fiscal 2011, 2012, 2013, and 2014, and 12 percent operating earnings as a percentage of net sales by the end of fiscal 2014. We currently believe that we will achieve our organic revenue growth goal of $100 million for fiscal 2011. We define organic revenue growth as the increase in net sales, less net sales from acquisitions that occurred in the current fiscal year.
We are optimistic that the positive momentum from our second quarter should continue through the remainder of fiscal 2011. 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 and the pace and degree of recovery, retail demand, field inventory levels, commodity prices, weather, competitive actions, expenses, and other factors identified below under the heading “Forward-Looking Information,” which could cause our actual results to differ from our anticipated outlook.
NET SALES
Worldwide consolidated net sales for the second quarter and year-to-date periods of fiscal 2011 were up 12.2 percent and 13.5 percent, respectively, from the same periods in the prior fiscal year. Worldwide professional segment net sales were up 19.7 percent and 20.3 percent for the second quarter and year-to-date periods of fiscal 2011, respectively, compared to the same periods in the prior fiscal year. Shipments for all professional segment businesses increased due to strong demand resulting from improved economic conditions, better product availability, and the successful introduction of new products.
Demand for golf equipment and irrigation systems was particularly strong due to golf development projects in key international markets and domestic renovation projects. Sales of landscape contractor equipment were also up due to positive customer response of new products and strong demand from professional contractors for the spring and summer mowing season, despite a slow start to spring in key markets. In addition, shipments of products from our Sitework Systems business were up as a result of the rebound in the rental market, as well as new products that were positively received by customers.
Micro-irrigation product sales also increased due to the continued growing market demand, particularly in Eastern Europe, and additional manufacturing capacity that increased production and sales of our water-conserving products. Residential segment net sales declined slightly for the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010, but increased 1.9 percent for the year-to-date period of fiscal 2011 compared to the same period in fiscal 2010.
Sales of riding products were strong due to continued demand for our new zero-turn radius riding mowers, as well as better product availability. However, shipments of walk power mowers were down for the second quarter and year-to-date periods of fiscal 2011 compared to the same periods last fiscal year as a result of cool, wet weather conditions in key markets.
International net sales for the second quarter and year-to-date periods of fiscal 2011 increased 19.5 percent and 14.6 percent, respectively, from the same periods in the prior fiscal year due in part to a weaker U.S. dollar compared to other currencies in which we transact business that accounted for approximately $4.7 million and $5.7 million of additional net sales for the second quarter and year-to-date periods of fiscal 2011, respectively.
BUSINESS SEGMENTS
As described previously, we operate in three reportable business segments: Professional, Residential, and Distribution. Our Distribution segment, which consists of our company-owned domestic distributorships, has been combined with our corporate activities and elimination of intersegment revenues and expenses that is shown as “Other” in the following tables. Operating earnings for our Professional and Residential segments are defined as operating earnings plus other income, net. Operating loss for “Other” includes operating earnings (loss), corporate activities, other income, net, and interest expense.
PROFESSIONAL
Net Sales.
Worldwide net sales for the professional segment in the second quarter and year-to-date periods of fiscal 2011 increased 19.7 percent and 20.3 percent, respectively, compared to the same periods in the last fiscal year. Shipments for all professional segment businesses increased due to strong demand resulting from improved economic conditions, better product availability, and the successful introduction of new products.
Demand for golf equipment and irrigation systems was particularly strong due to golf development projects in key international markets and domestic renovation projects. Sales of landscape contractor equipment were also up due to positive customer response of new products and strong demand from professional contractors for the spring and summer mowing season, despite a slow start to spring in key markets. In addition, shipments of products from our Sitework Systems business were up as a result of the rebound in the rental market, as well as new products that were positively received by customers. Micro-irrigation product sales also increased due to the continued growing market demand, particularly in Eastern Europe, and additional manufacturing capacity that increased production and sales of our water-conserving products.
Operating Earnings.
Operating earnings for the professional segment in the second quarter and year-to-date periods of fiscal 2011 increased 26.6 percent and 32.2 percent, respectively, compared to the same periods in the last fiscal year. Expressed as a percentage of net sales, professional segment operating margin increased to 20.5 percent compared to 19.3 percent in the second quarter of fiscal 2010, and fiscal 2011 year-to-date professional segment operating margin also increased to 18.3 percent compared to 16.6 percent from the same period in the last fiscal year. These profit improvements were primarily attributable to higher sales volumes and lower SG&A expenses as a percentage of net sales due to leveraging fixed SG&A costs over higher sales volumes.
RESIDENTIAL
Net Sales.
Worldwide net sales for the residential segment in the second quarter of fiscal 2011 decreased slightly, by 0.2 percent, compared to the second quarter of fiscal 2010. For the year-to-date period of fiscal 2011, worldwide net sales for the residential segment increased 1.9 percent compared to the same period last fiscal year. Sales of riding products were strong due to continued demand for our new zero-turn radius riding mowers, as well as better product availability. However, shipments of walk power mowers were down for the second quarter and year-to-date periods of fiscal 2011 compared to the same periods last fiscal year as a result of cool, wet weather conditions in key markets.
Although net sales of Pope products sold in Australia increased in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010, shipments of Pope products were down for the year-to-date comparison due to heavy rains and flooding in Australia that negatively impacted demand in the first quarter of fiscal 2011.
Net sales for the year-to-date period of fiscal 2011 compared to the same period last fiscal year were benefited by higher shipments of snow thrower products as a result of expanded product placement and strong demand driven by heavy snowfalls during the 2010/2011 winter season.
Operating Earnings.
Operating earnings for the residential segment in the second quarter of fiscal 2011 increased 5.7 percent compared to the second quarter of fiscal 2010. Expressed as a percentage of net sales, residential segment operating margin increased to 12.7 percent in the second quarter of fiscal 2011 compared to 12.0 percent in the second quarter of fiscal 2010. This profit improvement was primarily attributable to higher gross margins due to the same factors discussed previously in the Gross Profit section.
Operating earnings for the residential segment in the year-to-date period of fiscal 2011 were down by 1.6 percent compared to the same period in the prior fiscal year. Expressed as a percentage of net sales, residential segment operating margin also decreased to 11.4 percent for the year-to-date period of fiscal 2011 from 11.8 percent for the year-to-date period of fiscal 2010.
Higher SG&A expenses, mainly from an increase in warranty expense due to special provisions for product modifications incurred mainly in the first quarter of fiscal 2011, as well as overall higher fixed SG&A costs over essentially flat sales volumes, more than offset the improvement in gross margins for the year-to-date period of fiscal 2011 compared to the same period in the prior fiscal year.
OTHER
Net Sales.
Net sales for the other segment include sales from our wholly owned domestic distribution companies less sales from the professional and residential segments to those distribution companies. The other segment net sales for the second quarter and year-to-date periods of fiscal 2011 increased slightly, by $0.5 million and $0.4 million, respectively, compared to the same periods in the prior fiscal year.
Operating Losses.
Operating losses for the other segment were down for the second quarter and year-to-date periods of fiscal 2011 by $2.3 million, or 9.7 percent, and $0.3 million, or 0.6 percent, respectively, compared to the same periods in the last fiscal year. These loss declines were primarily attributable to the following factors: (i) improved profitability at our wholly owned domestic distribution companies; (ii) lower self-insured health care costs; and (iii) an increase in income from equity investments. Somewhat offsetting those factors was an increase in incentive compensation expense due to anticipated improved financial performance and higher foreign currency exchange rate losses.
