The Toro Co. Q1 2008 Earnings Call Transcript

Toro Company (TTC)

Q1 FY08 Earnings Call

February 21, 2008, 11:00 AM ET

Executives

Michael J. Hoffman - President and CEO

Stephen P. Wolfe - CFO, VP, Finance

Analysts

Sam Darkatsh - Raymond James

Seaver Wang - Utendahl Capital Partners

Jim Lucas - Janney Montgomery Scott

James Bank - Sidoti & Company

Presentation

Operator

Good day ladies and gentlemen and welcome to the Toro Company First Quarter Earnings Conference Call. My name is Maria and I will be your audio coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.

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

Michael J. Hoffman - President and Chief Executive Officer

Thank you Maria. Good morning ladies and gentlemen and thank you for joining us for our first quarter earnings conference call. Here with me this morning are Steve Wolfe, our Chief Financial Officer; Tom Larson, Treasurer; and John Wright, Director of Investor Relations.

Let's begin with our forward-looking statement policy. Please keep in mind that during the call we will make certain forward-looking statements as of today, 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 predictive 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 in our predictions.

Our earnings release was issued this morning by Business Wire and can also be found in the investor information section of our corporate web site, thetorocompany.com. Here in the upper Midwest, the snow season started early and it has yet to let up. We are seeing considerable snowfall with several significant events to date. In fact major storms have occurred not only here in the US but also throughout Canada, driving strong retail activity for Toro's snowthrowers across North America.

At the same time, on the Professional side of our business, golf customers are already looking to spring and warmer weather. Earlier this month, we returned from the annual Golf Industry Show in Orlando where once again we introduced several innovative new products and feature enhancements to our line-up. Toro has long held the leadership position in this important industry where our domestic customer sentiment for the upcoming season is cautiously optimistic. We've also been very successful in leveraging our strong brand recognition in growing international golf business.

We had an opportunity to visit with a number of our international customers during the show and they remain quite positive about the golf business. As a result, they continue to invest in Toro's turf maintenance equipment and irrigation systems for renovations and new course constructions around the world. We will talk more about some of these new products and other developments in a moment.

First, let's take a closer look at our consolidated results for the first quarter ended February 1, 2008. This is a small quarter where we prepare for the selling season ahead. Early indications show we are off to a solid start with a strong product lineup. Even so, we are sharply attuned to the uncertain environment and are managing for the potential effects of a weakening economy.

Let me touch on a few of the highlights from this morning's earnings release. First, net sales rose 7% for the quarter to $405.8 million. These gains occurred in both our Professional and Residential segments, with the majority of the increases once again coming from outside the US. An ongoing strategy has been to raise the international portion of our total revenue to 30% or more. This is now benefiting us as the domestic market slows, but the international markets remain strong. Overall, international sales rose 19.5% compared to the first quarter last year. Excluding the effect of currency, international sales grew over 13% in the quarter driven by the growth in the golf and grounds markets, and new products we've launched during the past two years.

Earnings from operations increased 15.2%. We had a slight decline in gross margin, but benefited nicely from an improvement in selling, general and administrative expenses both as a percent of sales. Although we had a higher tax rate in the quarter, we finished with an improvement in earnings per share of 6.8% or $0.47.

Finally, I want to highlight the improving position in accounts receivable and inventory. As you know, we're increasing our focus to reduce both items throughout the supply chain as part of our GrowLean initiative to improve working capital and asset management. We believe our inventories and field inventory levels combined with forecasted retail demand position us well for the months ahead.

While that's an overview for the first quarter, now let's review the segment results. Worldwide sales for the Professional segment rose 7.7% to $293.2 million. As I mentioned earlier, revenue growth was exceptionally strong outside the US, where new golf course construction continued to drive demand for our innovative irrigation systems and turf maintenance equipment. At this year's Golf Industry Show, once again we unveiled new product offerings to strengthen Toro's worldwide market leadership.

First, we are very excited about the new Turf Guard wireless soil monitoring system, our most recent acquisition. This new technology measures soil moisture, salinity and temperature, then transmits the data to a web-based interface. Our customers can use the data to analyze turf conditions and determine the most cost-effective and environmentally responsible irrigation methods to maintain healthy turf.

The bottom line, this system will help customers use less water and less energy. Second, New ProCore Aerators help reduce [inaudible] and build stronger root systems while offering greater productivity to the golf course superintendents. These new aerators when coupled with our new core processor, result in a labor saving one pass operation.

Third, we introduced a new line of Workman mid-duty vehicles with a suspension system that offers a superior ride in all applications. And finally the new Groundsmaster 5900 series, Toro's next generation of 16-foot wide rotary mowers. These are all new from the ground up with precise maneuverability and four-wheel drive [ph].

Shifting gears to the landscape contractor market. Domestic equipment sales were down slightly due to distribution changes. Also, field inventory levels of these products continue to decrease as part of our ongoing lean and asset management efforts. Overall, field inventory is much improved over last year. On the product side, we're excited to have several new introductions for the landscape and irrigation contractor. For the irrigation contractor, we introduced the Irritrol I-PRO spray heads and nozzles for greater irrigation efficiency, part of our precise irrigation strategy.

For landscape contractors, we developed a new Toro Stand on mower. This machine, which will be released in late 2008, caters to contractors who seek a compact machine with exceptional handling. And finally the new Toro TRX series of Tract walk-behind trenchers provide significant benefits to rental yards and contractors. We just introduced this new product at the Renault show last week. These are just some of the innovations creating enthusiasm within our distribution channels and generating interest among our customers.

For the Professional segment, pre-tax earnings rose 8.6% to $52.5 million attributable to higher sales, favorable currency exchange rates and improved product mix. In the Residential segment, worldwide sales were up 6.2% for the quarter to $108.2 million. Given the kind of snowy winter weather we prefer, shipments of Toro snowthrowers here in the U.S and in Canada were up significantly to dealers in our [inaudible] retailer. We also enjoyed strong worldwide increases for the Toro TimeCutter Z, zero-turning radius mowers in anticipation of the selling season ahead and continued growth in the Z market. As you will remember from our earlier calls, we have gained valuable floor space at dealers and our major retailer last year for this time saving family of products, and expect their popularity will continue to outpace traditional line and garden tractors. In contrast, [inaudible] shipments declined for the quarter.

As you might expect, our retail partners are exercising caution in light of the challenging economy and have shifted their orders closer to retail demand. Subsequently earnings in the Residential segment declined $1.6 million mainly due to lower gross margins as a result of higher freight expense and additional investments and tooling for new products.

Now let's talk about the key operating results. Then we'll turn to our outlook for the remainder of the year. As mentioned we experienced a slight decline in gross margins mainly reflecting higher freight cost. We improved our leveraging of SG&A during the quarter. SG&A expense improved to 28.9% compared to 29.6% last year. And even with the SG&A as a percentage of sales being lower, we increased marketing spending and made additional investments in engineering, which were both up over the first quarter of last year.

Interest expense for the quarter rose 8.8%, long-term debt was up over the previous year due to a bond placement in April of 2007 and as a result short-term debt declined for the quarter. Effective tax rate for the quarter was 35.4% compared to 28.2% in the first quarter of last year. You'll remember last year we experienced a positive impact on our tax rate from the retroactive extension of the federal research and engineering tax credit. For 2008, this tax credit has expired once again and the outlook is unclear as to if and when the Federal Government may extend it. Given this uncertainty, we now expect our tax rate for the year to be 35.4%.

Our balance sheet is in excellent shape with inventory being down nearly 4% and accounts receivable down 3.5% from a year ago. Throughout our GrowLean initiative, we've been focusing on becoming more intentional about asset management, and we are developing enhanced tracking and reporting systems to help us reach our working capital goal. And finally our continuing strong cash flow has allowed us to return additional value to shareholders to dividends and share repurchases. In December our Board of Directors authorized an increase in quarterly dividend from $0.12 to $0.15 per common share, a 25% increase over the prior year. During the quarter, we also purchased 590,000 shares of common stock with $31.8 million and now have 544,000 shares remaining on our current authorization.

We expect repurchase activity during the year will result in a reduction of average diluted shares outstanding similar to what we've seen in the past few years.

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

In the area of margin and SG&A, we expect our fiscal 2008 gross margin to be flat to slightly improved over last year, and we expect SG&A as a percent of sales to be flat to slightly unfavorable compared to the prior year. Therefore, we now expect to report an 8% to 10% increase in net earnings per share for fiscal 2008 and revenue growth of 2% to 4%. For the upcoming second quarter, we anticipate net earnings per share of $1.87 to $1.93.

That concludes our formal remarks for the Toro Company's fiscal 2008 first quarter. So, now let's open it up for your questions. Maria, back to you.

Question and Answer

Operator

[Operator Instructions] The first question comes from the line of Eric Bosshard with Cleveland Research. Please proceed.

Unidentified Analyst

Good morning, this is Mark standing in for Eric.

Michael J. Hoffman - President and Chief Executive Officer

Good morning Mark.

Unidentified Analyst

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

Michael J. Hoffman - President and Chief Executive Officer

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

Unidentified Analyst

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

Michael J. Hoffman - President and Chief Executive Officer

Well the first thing it starts with is having the right products, and so the new products we are going to introduce certainly position us very well to continue to take