Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

x   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended July 31, 2015

 

o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Transition Period from            to           

 

THE TORO COMPANY

(Exact name of registrant as specified in its charter)

 

Delaware

 

1-8649

 

41-0580470

(State of Incorporation)

 

(Commission File Number)

 

(I.R.S. Employer Identification Number)

 

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  x  No  o

 

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  x  No  o

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer  o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o  No  x

 

The number of shares of common stock outstanding as of August 25, 2015 was 54,809,131.

 

 

 



Table of Contents

 

THE TORO COMPANY

INDEX TO FORM 10-Q

 

 

 

Page
Number

 

 

 

PART I.

FINANCIAL INFORMATION:

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Earnings (Unaudited) – Three and Nine Months Ended July 31, 2015 and August 1, 2014

3

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Unaudited) – Three and Nine Months Ended July 31, 2015 and August 1, 2014

3

 

 

 

 

Condensed Consolidated Balance Sheets (Unaudited) – July 31, 2015, August 1, 2014, and October 31, 2014

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended July 31, 2015 and August 1, 2014

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

6-17

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17-27

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

27-28

 

 

 

Item 4.

Controls and Procedures

29

 

 

 

PART II.

OTHER INFORMATION:

 

 

 

 

Item 1.

Legal Proceedings

29

 

 

 

Item 1A.

Risk Factors

29

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

30

 

 

 

Item 6.

Exhibits

31

 

 

 

 

Signatures

32

 

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Table of Contents

 

PART I.  FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings (Unaudited)

(Dollars and shares in thousands, except per share data)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

July 31,

 

August 1,

 

July 31,

 

August 1,

 

 

 

2015

 

2014

 

2015

 

2014

 

Net sales

 

$

609,615

 

$

567,540

 

$

1,910,068

 

$

1,758,551

 

Cost of sales

 

393,225

 

365,460

 

1,242,707

 

1,128,417

 

Gross profit

 

216,390

 

202,080

 

667,361

 

630,134

 

Selling, general, and administrative expense

 

136,985

 

130,043

 

405,079

 

386,620

 

Operating earnings

 

79,405

 

72,037

 

262,282

 

243,514

 

Interest expense

 

(4,587

)

(3,629

)

(14,071

)

(11,065

)

Other income, net

 

2,798

 

2,390

 

7,515

 

6,220

 

Earnings before income taxes

 

77,616

 

70,798

 

255,726

 

238,669

 

Provision for income taxes

 

24,292

 

20,785

 

77,689

 

75,701

 

Net earnings

 

$

53,324

 

$

50,013

 

$

178,037

 

$

162,968

 

 

 

 

 

 

 

 

 

 

 

Basic net earnings per share of common stock

 

$

0.96

 

$

0.89

 

$

3.19

 

$

2.88

 

 

 

 

 

 

 

 

 

 

 

Diluted net earnings per share of common stock

 

$

0.94

 

$

0.87

 

$

3.13

 

$

2.82

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of shares of common stock outstanding — Basic

 

55,310

 

55,965

 

55,739

 

56,494

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of shares of common stock outstanding — Diluted

 

56,552

 

57,320

 

56,953

 

57,800

 

 

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in thousands)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

July 31,

 

August 1,

 

July 31,

 

August 1,

 

 

 

2015

 

2014

 

2015

 

2014

 

Net earnings

 

$

53,324

 

$

50,013

 

$

178,037

 

$

162,968

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(3,534

)

(620

)

(10,648

)

541

 

Derivative instruments, net of tax of $(379), $531, $(526), and $891, respectively

 

(1,055

)

446

 

(2,394

)

1,036

 

Other comprehensive (loss) income

 

(4,589

)

(174

)

(13,042

)

1,577

 

Comprehensive income

 

$

48,735

 

$

49,839

 

$

164,995

 

$

164,545

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

 

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Balance Sheets (Unaudited)

(Dollars in thousands, except per share data)

 

 

 

July 31,

 

August 1,

 

October 31,

 

 

 

2015

 

2014

 

2014

 

ASSETS

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

110,335

 

$

177,894

 

$

314,873

 

Receivables, net

 

227,806

 

215,595

 

158,158

 

Inventories, net

 

350,194

 

293,761

 

274,603

 

Prepaid expenses and other current assets

 

39,743

 

33,764

 

33,580

 

Deferred income taxes

 

43,339

 

38,735

 

42,822

 

Total current assets

 

771,417

 

759,749

 

824,036

 

 

 

 

 

 

 

 

 

Property, plant, and equipment

 

802,305

 

770,758

 

760,192

 

Less accumulated depreciation

 

581,983

 

567,930

 

554,997

 

 

 

220,322

 

202,828

 

205,195

 

 

 

 

 

 

 

 

 

Long-term deferred income taxes

 

26,364

 

25,951

 

26,075

 

Other assets

 

25,317

 

22,226

 

21,429

 

Goodwill

 

194,727

 

91,812

 

91,851

 

Other intangible assets, net

 

121,804

 

25,261

 

23,829

 

Total assets

 

$

1,359,951

 

$

1,127,827

 

$

1,192,415

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current portion of long-term debt

 

$

23,279

 

$

140

 

$

6,640

 

Short-term debt

 

5,189

 

1,134

 

20,818

 

Accounts payable

 

169,927

 

168,956

 

124,271

 

Accrued liabilities

 

300,576

 

289,519

 

248,691

 

Total current liabilities

 

498,971

 

459,749

 

400,420

 

 

 

 

 

 

 

 

 

Long-term debt, less current portion

 

358,053

 

223,800

 

347,316

 

Deferred revenue

 

11,324

 

11,102

 

10,947

 

Deferred income taxes

 

7

 

5,969

 

 

Other long-term liabilities

 

26,423

 

14,474

 

25,005

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

Preferred stock, par value $1.00 per share, authorized 1,000,000 voting and 850,000 non-voting shares, none issued and outstanding

 

 

 

 

Common stock, par value $1.00 per share, authorized 175,000,000 shares; issued and outstanding 54,835,233 shares as of July 31, 2015, 55,705,894 shares as of August 1, 2014, and 55,678,419 shares as of October 31, 2014

 

54,835

 

55,706

 

55,678

 

Retained earnings

 

439,085

 

368,020

 

368,754

 

Accumulated other comprehensive loss

 

(28,747

)

(10,993

)

(15,705

)

Total stockholders’ equity

 

465,173

 

412,733

 

408,727

 

Total liabilities and stockholders’ equity

 

$

1,359,951

 

$

1,127,827

 

$

1,192,415

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

 

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)

 

 

 

Nine Months Ended

 

 

 

July 31,

 

August 1,

 

 

 

2015

 

2014

 

Cash flows from operating activities:

 

 

 

 

 

Net earnings

 

$

178,037

 

$

162,968

 

Adjustments to reconcile net earnings to net cash provided by operating activities:

 

 

 

 

 

Non-cash income from finance affiliate

 

(6,223

)

(5,598

)

Provision for depreciation, amortization, and impairment loss

 

45,944

 

38,104

 

Stock-based compensation expense

 

7,815

 

8,478

 

Increase in deferred income taxes

 

(2,096

)

(43

)

Other

 

(67

)

2

 

Changes in operating assets and liabilities, net of effect of acquisitions:

 

 

 

 

 

Receivables, net

 

(74,916

)

(59,774

)

Inventories, net

 

(67,902

)

(53,716

)

Prepaid expenses and other assets

 

(5,563

)

1,167

 

Accounts payable, accrued liabilities, deferred revenue, and other long-term liabilities

 

92,985

 

72,625

 

Net cash provided by operating activities

 

168,014

 

164,213

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property, plant, and equipment

 

(37,544

)

(53,228

)

Proceeds from asset disposals

 

77

 

161

 

Distributions from finance affiliate, net

 

1,928

 

2,324

 

Acquisitions, net of cash acquired

 

(198,329

)

(715

)

Net cash used in investing activities

 

(233,868

)

(51,458

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

(Repayments of) increase in short-term debt

 

(16,283

)

300

 

(Repayments of) increase in long-term debt

 

(3,831

)

18

 

Excess tax benefits from stock-based awards

 

7,808

 

8,536

 

Proceeds from exercise of stock options

 

8,615

 

6,813

 

Purchases of Toro common stock

 

(90,993

)

(100,507

)

Dividends paid on Toro common stock

 

(41,794

)

(33,871

)

Net cash used in financing activities

 

(136,478

)

(118,711

)

 

 

 

 

 

 

Effect of exchange rates on cash and cash equivalents

 

(2,206

)

857

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(204,538

)

(5,099

)

Cash and cash equivalents as of the beginning of the fiscal period

 

314,873

 

182,993

 

Cash and cash equivalents as of the end of the fiscal period

 

$

110,335

 

$

177,894

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Debt issued in connection with an acquisition

 

$

31,161

 

$

 

 

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Table of Contents

 

THE TORO COMPANY AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

July 31, 2015

 

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 U.S. generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. Unless the context indicates otherwise, the terms “company” and “Toro” refer to The Toro Company and its consolidated 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. Since the company’s business is seasonal, operating results for the nine months ended July 31, 2015 cannot be annualized to determine the expected results for the fiscal year ending October 31, 2015.

 

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 calendar month 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, 2014. 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. GAAP, 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, incentive compensation accruals, inventory valuation, warranty reserves, earn-out liabilities, allowance for doubtful accounts, pension and postretirement accruals, self-insurance accruals, useful lives for tangible and 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 at the time they are made. 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. Management adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with certainty, actual amounts could differ significantly from those estimated at the time the consolidated financial statements are prepared. Changes in those estimates will be reflected in the consolidated financial statements in future periods.

 

Acquisition

 

On November 14, 2014, during the first quarter of fiscal 2015, the company acquired substantially all of the assets (excluding accounts receivable) of the BOSS® professional snow and ice management business of privately held Northern Star Industries, Inc. Based in Iron Mountain, Michigan, BOSS designs, manufactures, and sells a broad line of snowplows, salt and sand spreaders, and related parts and accessories for light and medium duty trucks, all terrain vehicles (“ATVs”), utility terrain vehicles (“UTVs”), skid steers, and front-end loaders. Through this acquisition, the company added another professional contractor brand; a portfolio of counter-seasonal equipment; manufacturing and distribution facilities located in Iron Mountain, Michigan; and a distribution network for these products. Management believes that this acquisition positions the company to strengthen and grow its relationships with professional contractors, municipalities, and other customers by enabling the company to provide them with the innovative, durable equipment and high-quality service they need each season.

 

The purchase price of this acquisition was $229.5 million, which included a cash payment of $198.3 million and issuance of a note payable at fair value of $31.2 million. The company funded the acquisition with cash on hand, a $130.0 million term loan, and short-term debt under the company’s revolving credit facility.

 

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The purchase price of this acquisition was accounted for as a business combination using the acquisition method, which requires that, among other things, assets acquired and liabilities assumed, be recorded at their fair value as of the acquisition date using independent appraisals and other analyses. The excess of the consideration transferred over those fair values is recorded as goodwill. The following table presents the allocation of the purchase price to the acquired assets, liabilities, and goodwill.

 

 

 

July 31,

 

(Dollars in thousands)

 

2015

 

Inventory

 

$

14,106

 

Prepaid expenses

 

266

 

Property, plant, and equipment

 

13,689

 

Intangible assets

 

107,700

 

Goodwill

 

103,028

 

Current liabilities

 

(9,299

)

Purchase price

 

$

229,490

 

 

The goodwill recorded as part of the acquisition primarily reflects the value of the assembled workforce, cost synergies, expected future cash flows, and sales growth from integrating and expanding existing product lines. The amount of goodwill that is expected to be deductible for income tax purposes is $101.9 million. The goodwill and intangible assets have been allocated to the Professional segment.

 

During the first nine months of fiscal 2015, the company expensed $0.3 million of acquisition-related costs, which was recorded in selling, general, and administrative expense. The company also capitalized $0.4 million of debt issuance costs in other assets related to the $130.0 million term loan, which will be amortized over the term of the loan.

 

Operating results for this acquisition have been included in the company’s consolidated statements of earnings from the date of acquisition and are reflected in the Professional segment. The sale of BOSS products contributed $37.1 million and $82.4 million of net sales for the third quarter and year-to-date periods of fiscal 2015, respectively, and had an immaterial impact on net earnings for both the third quarter and year-to-date periods of fiscal 2015. Pro-forma results are not presented, as the acquisition was not considered material to the company’s consolidated results of operations.

 

Stock-Based Compensation

 

Stock Option Awards

 

Under the company’s amended and restated equity and incentive plan, stock options 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 executive officers, other employees, and non-employee members of the company’s Board of Directors on an annual basis in the first quarter of the company’s fiscal year. Options generally vest one-third each year over a three-year period and have a ten-year term. Other options granted to certain non-officer employees vest in full on the three-year anniversary of the date of grant 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. Stock options granted to officers and other employees are subject to accelerated expensing if the option holder meets the retirement definition set forth in the company’s amended and restated equity and incentive plan. In that case, the fair value of the options is expensed in the fiscal 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 options to continue to vest following retirement. Similarly, if a non-employee director has served on the company’s Board of Directors for ten full fiscal years or more, the awards vest immediately upon retirement, and therefore, the fair value of the options granted is fully expensed on the date of the grant.

 

The fair value of each stock option is estimated on the date of grant using the Black-Scholes valuation method with 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 in which officers, other employees, and non-employee directors are expected to exercise their stock options, which is primarily based on historical experience. 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 historical cash dividends paid, expected future cash dividends and dividend yield, and expected changes in the company’s stock price.

 

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The following table illustrates the assumptions for options granted in the following fiscal periods.

 

 

 

Fiscal 2015

 

Fiscal 2014

 

Expected life of option in years

 

5.94

 

6

 

Expected stock price volatility

 

29.67%

 

34.29%

 

Risk-free interest rate

 

1.61%

 

1.92%

 

Expected dividend yield

 

1.29%

 

1.25%

 

Grant date per share weighted-average fair value

 

$16.81

 

$18.69

 

 

Performance Share Awards

 

The company grants performance share awards to executive officers and other employees under which they are entitled to receive shares of the company’s common stock contingent on the achievement of performance goals of the company and businesses of the company, which are generally measured over a three-year period. The number of shares of common stock a participant receives will be increased (up to 200 percent of target levels) or reduced (down to zero) based on the level of achievement of performance goals and vest at the end of a three-year period. Performance share awards are generally granted on an annual basis in the first quarter of the company’s fiscal year. Compensation expense is recognized for these awards on a straight-line basis over the vesting period based on the per share fair value as of the date of grant and the probability of achieving each performance goal. The per share fair value of performance share awards granted during the first quarter of each of fiscal 2015 and 2014 was $65.68 and $60.19, respectively. No performance share awards were granted during the second and third quarters of fiscal 2015 or 2014.

 

Restricted Stock and Restricted Stock Unit Awards

 

Under the company’s amended and restated equity and incentive plan, restricted stock and restricted stock unit awards are generally granted to certain non-officer employees. Occasionally, restricted stock or restricted stock unit awards may be granted, including to executive officers, in connection with hiring, mid-year promotions, leadership transition, or retention. Restricted stock and restricted stock unit awards generally vest one-third each year over a three-year period, or vest in full on the three-year anniversary of the date of grant. Such awards may have performance-based rather than time-based vesting requirements. Compensation expense equal to the grant date fair value, which is equal to the closing price of the company’s common stock on the date of grant multiplied by the number of shares subject to the restricted stock and restricted stock unit awards, is recognized for these awards over the vesting period. The per share weighted-average fair value of restricted stock and restricted stock unit awards granted during the first nine months of fiscal 2015 and 2014 was $66.10 and $63.09, respectively.

 

Per Share Data

 

Reconciliations of basic and diluted weighted-average shares of common stock outstanding are as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

July 31,

 

August 1,

 

July 31,

 

August 1,

 

(Shares in thousands)

 

2015

 

2014

 

2015

 

2014

 

Basic

 

 

 

 

 

 

 

 

 

Weighted-average number of shares of common stock

 

55,310

 

55,965

 

55,724

 

56,477

 

Assumed issuance of contingent shares

 

 

 

15

 

17

 

Weighted-average number of shares of common stock and assumed issuance of contingent shares

 

55,310

 

55,965

 

55,739

 

56,494

 

Diluted

 

 

 

 

 

 

 

 

 

Weighted-average number of shares of common stock and assumed issuance of contingent shares

 

55,310

 

55,965

 

55,739

 

56,494

 

Effect of dilutive securities

 

1,242

 

1,355

 

1,214

 

1,306

 

Weighted-average number of shares of common stock, assumed issuance of contingent shares, and effect of dilutive securities

 

56,552

 

57,320

 

56,953

 

57,800

 

 

Incremental shares from options, restricted stock, and restricted stock units are computed by the treasury stock method. Options for the purchase of 157,299 and 153,651 shares of common stock during the third quarter of fiscal 2015 and 2014, respectively, were excluded from the diluted net earnings per share because they were anti-dilutive. For the year-to-date periods through the third quarter of fiscal 2015 and 2014, options for the purchase of 245,818 and 239,058 shares of common stock, respectively, were excluded from the diluted net earnings per share because they were anti-dilutive.

 

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Table of Contents

 

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:

 

 

 

July 31,

 

August 1,

 

October 31,

 

(Dollars in thousands)

 

2015

 

2014

 

2014

 

Raw materials and work in process

 

$

102,580

 

$

88,140

 

$

95,144

 

Finished goods and service parts

 

315,110

 

270,996

 

246,954

 

Total FIFO value

 

417,690

 

359,136

 

342,098

 

Less: adjustment to LIFO value

 

67,496

 

65,375

 

67,495

 

Total

 

$

350,194

 

$

293,761

 

$

274,603

 

 

Goodwill

 

The changes in the net carrying amount of goodwill for the first nine months of fiscal 2015 were as follows:

 

 

 

Professional

 

Residential

 

 

 

(Dollars in thousands)

 

Segment

 

Segment

 

Total

 

Balance as of October 31, 2014

 

$

80,946

 

$

10,905

 

$

91,851

 

Goodwill acquired

 

103,028

 

 

103,028

 

Translation adjustments

 

(46

)

(106

)

(152

)

Balance as of July 31, 2015

 

$

183,928

 

$

10,799

 

$

194,727

 

 

Other Intangible Assets

 

The components of other intangible assets were as follows:

 

(Dollars in thousands)
July 31, 2015

 

Weighted-average
Life (Years)

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Patents

 

9.9

 

$

15,202

 

$

(10,003

)

$

5,199

 

Non-compete agreements

 

5.5

 

6,931

 

(6,071

)

860

 

Customer-related

 

19.1

 

84,618

 

(9,156

)

75,462

 

Developed technology

 

7.6

 

28,819

 

(19,704

)

9,115

 

Trade names

 

19.2

 

28,715

 

(2,410

)

26,305

 

Other

 

 

 

800

 

(800

)

 

Total amortizable

 

 

 

165,085

 

(48,144

)

116,941

 

Non-amortizable - trade names

 

 

 

4,863

 

 

4,863

 

Total other intangible assets, net

 

 

 

$

169,948

 

$

(48,144

)

$

121,804

 

 

October 31, 2014

 

Weighted-average
Life (Years)

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Patents

 

9.4

 

$

10,711

 

$

(8,942

)

$

1,769

 

Non-compete agreements

 

5.4

 

7,039

 

(5,315

)

1,724

 

Customer-related

 

10.7

 

8,650

 

(5,517

)

3,133

 

Developed technology

 

7.6

 

28,841

 

(16,869

)

11,972

 

Trade names

 

5.0

 

1,515

 

(1,165

)

350

 

Other

 

 

 

800

 

(800

)

 

Total amortizable

 

 

 

57,556

 

(38,608

)

18,948

 

Non-amortizable - trade names

 

 

 

4,881

 

 

4,881

 

Total other intangible assets, net

 

 

 

$

62,437

 

$

(38,608

)

$

23,829

 

 

9



Table of Contents

 

During the second quarter of fiscal 2015, the company determined certain amortizable intangible assets were impaired based on its assessment that the carrying amount may not be recovered. Based on the company’s impairment analysis, the company wrote down $1.4 million of other intangible assets in the second quarter of fiscal 2015.

 

Amortization expense for intangible assets during the first nine months of fiscal 2015 was $10.0 million. Estimated amortization expense for the remainder of fiscal 2015 and succeeding fiscal years is as follows: fiscal 2015 (remainder), $2.8 million; fiscal 2016, $10.3 million; fiscal 2017, $9.5 million; fiscal 2018, $7.4 million; fiscal 2019, $6.6 million; and after fiscal 2019, $80.3 million.

 

Investment in Joint Venture

 

In fiscal 2009, the company and TCF Inventory Finance, Inc. (“TCFIF”), a subsidiary of TCF National Bank, established Red Iron Acceptance, LLC (“Red Iron”), a joint venture in the form of a Delaware limited liability company that provides inventory financing, including floor plan and open account receivable financing, to distributors and dealers of the company’s products in the U.S. and to select distributors of the company’s products in Canada. The initial term of Red Iron will continue until October 31, 2017, subject to unlimited automatic two-year extensions thereafter. Either the company or TCFIF may elect not to extend the initial term or any subsequent term by giving one-year notice to the other party. Additionally, in connection with the joint venture, the company and an affiliate of TCFIF entered into an arrangement to provide inventory financing to dealers of the company’s products in Canada.

 

The company owns 45 percent of Red Iron and TCFIF owns 55 percent of Red Iron. The company accounts for its investment in Red Iron under the equity method of accounting. Each of the company and TCFIF contributed a specified amount of the estimated cash required to enable Red Iron to purchase the company’s inventory financing receivables and to provide financial support for Red Iron’s inventory financing programs. Red Iron borrows the remaining requisite estimated cash utilizing a $450 million secured revolving credit facility established under a credit agreement between Red Iron and TCFIF. The company’s total investment in Red Iron as of July 31, 2015 was $19.2 million. The company has not guaranteed the outstanding indebtedness of Red Iron. The company has agreed to repurchase products repossessed by Red Iron and the TCFIF Canadian affiliate, up to a maximum aggregate amount of $7.5 million in a calendar year. In addition, the company has provided recourse to Red Iron for certain outstanding receivables, which amounted to a maximum amount of $0.7 million as of July 31, 2015.

 

Under the repurchase agreement between Red Iron and the company, Red Iron provides financing for certain dealers and distributors. These transactions are structured as an advance in the form of a payment by Red Iron to the company on behalf of a distributor or dealer with respect to invoices financed by Red Iron. These payments extinguish the obligation of the dealer or distributor to make payment to the company under the terms of the applicable invoice. Under separate agreements between Red Iron and the dealers and distributors, Red Iron provides loans to the dealers and distributors for the advances paid by Red Iron to the company. The net amount of new receivables financed for dealers and distributors under this arrangement for the nine months ended July 31, 2015 and August 1, 2014 was $1,117.7 million and $1,019.3 million, respectively.

 

As of July 31, 2015, Red Iron’s total assets were $383.7 million and total liabilities were $340.3 million.

 

Warranty Guarantees

 

The company’s products are warranted to ensure customer confidence in design, workmanship, and overall quality. Warranty coverage is for specified periods of time and on select products’ hours of usage, 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 company distributor or dealer must perform warranty work. Distributors and dealers 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 sells extended warranty coverage on select products for a prescribed period after the factory warranty period expires.

 

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Table of Contents

 

Warranty provisions, claims, and changes in estimates for the first nine months of fiscal 2015 and 2014 were as follows:

 

 

 

Nine Months Ended

 

 

 

July 31,

 

August 1,

 

(Dollars in thousands)

 

2015

 

2014

 

Beginning balance

 

$

71,080

 

$

72,177

 

Warranty provisions

 

34,532

 

34,078

 

Warranty claims

 

(26,728

)

(25,052

)

Changes in estimates

 

(221

)

(1,510

)

Ending balance

 

$

78,663

 

$

79,693

 

 

Stockholders’ Equity

 

Accumulated Other Comprehensive Loss

 

Components of accumulated other comprehensive loss (“AOCL”), net of tax, are as follows:

 

 

 

July 31,

 

August 1,

 

October 31,

 

(Dollars in thousands)

 

2015

 

2014

 

2014

 

Foreign currency translation adjustments

 

$

23,255

 

$

7,166

 

$

12,536

 

Pension and post-retirement benefits

 

5,195

 

3,754

 

5,266

 

Derivative instruments

 

297

 

73

 

(2,097

)

Total accumulated other comprehensive loss

 

$

28,747

 

$

10,993

 

$

15,705

 

 

The components and activity of AOCL for the first nine months of fiscal 2015 are as follows:

 

(Dollars in thousands)

 

Foreign
Currency
Translation
Adjustments

 

Pension and
Postretirement
Benefits

 

Cash Flow
Derivative
Instruments

 

Total

 

Balance as of October 31, 2014

 

$

12,536

 

$

5,266

 

$

(2,097

)

$

15,705

 

Other comprehensive loss (income) before reclassifications

 

10,719

 

(71

)

(6,694

)

3,954

 

Amounts reclassified from AOCL

 

 

 

9,088

 

9,088

 

Net current period other comprehensive loss (income)

 

$

10,719

 

$

(71

)

$

2,394

 

$

13,042

 

Balance as of July 31, 2015

 

$

23,255

 

$

5,195

 

$

297

 

$

28,747

 

 

The components and activity of AOCL for the first nine months of fiscal 2014 are as follows:

 

(Dollars in thousands) 

 

Foreign
Currency
Translation
Adjustments

 

Pension and
Postretirement
Benefits

 

Cash Flow
Derivative
Instruments

 

Total

 

Balance as of October 31, 2013

 

$

7,778

 

$

3,683

 

$

1,109

 

$

12,570

 

Other comprehensive (income) loss before reclassifications

 

(612

)

71

 

450

 

(91

)

Amounts reclassified from AOCL

 

 

 

(1,486

)

(1,486

)

Net current period other comprehensive (income) loss

 

$

(612

)

$

71

 

$

(1,036

)

$

(1,577

)

Balance as of August 1, 2014

 

$

7,166

 

$

3,754

 

$

73

 

$

10,993

 

 

11



Table of Contents

 

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. The Distribution segment, which consists of company-owned domestic distributorships, has been combined with the company’s corporate activities and elimination of intersegment revenues and expenses that is shown as “Other” in the following tables due to the insignificance of the segment.

 

The following table shows the summarized financial information concerning the company’s reportable segments:

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Three months ended July 31, 2015

 

Professional

 

Residential

 

Other

 

Total

 

Net sales

 

$

421,994

 

$

175,977

 

$

11,644

 

$

609,615

 

Intersegment gross sales

 

10,365

 

222

 

(10,587

)

 

Earnings (loss) before income taxes

 

82,253

 

20,566

 

(25,203

)

77,616

 

 

Three months ended August 1, 2014

 

Professional

 

Residential

 

Other

 

Total

 

Net sales

 

$

384,678

 

$

175,717

 

$

7,145

 

$

567,540

 

Intersegment gross sales

 

11,964

 

128

 

(12,092

)

 

Earnings (loss) before income taxes

 

74,835

 

18,698

 

(22,735

)

70,798

 

 

Nine months ended July 31, 2015

 

Professional

 

Residential

 

Other

 

Total

 

Net sales

 

$

1,314,474

 

$

578,587

 

$

17,007

 

$

1,910,068

 

Intersegment gross sales

 

38,651

 

410

 

(39,061

)

 

Earnings (loss) before income taxes

 

258,727

 

69,131

 

(72,132

)

255,726

 

Total assets

 

846,400

 

226,835

 

286,716

 

1,359,951

 

 

Nine months ended August 1, 2014

 

Professional

 

Residential

 

Other

 

Total

 

Net sales

 

$

1,208,707

 

$

533,664

 

$

16,180

 

$

1,758,551

 

Intersegment gross sales

 

31,878

 

378

 

(32,256

)

 

Earnings (loss) before income taxes

 

244,665

 

60,654

 

(66,650

)

238,669

 

Total assets

 

616,305

 

186,079

 

325,443

 

1,127,827

 

 

The following table summarizes the components of the loss before income taxes included in “Other” shown above:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

July 31,

 

August 1,

 

July 31,

 

August 1,

 

(Dollars in thousands)

 

2015

 

2014

 

2015

 

2014

 

Corporate expenses

 

$

(26,989

)

$

(22,101

)

$

(68,434

)

$

(62,448

)

Interest expense, net

 

(4,587

)

(3,629

)

(14,071

)

(11,065

)

Other

 

6,373

 

2,995

 

10,373

 

6,863

 

Total

 

$

(25,203

)

$

(22,735

)

$

(72,132

)

$

(66,650

)

 

12



Table of Contents

 

Derivative Instruments and Hedging Activities

 

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 exchange rate 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 primarily involve the use of forward currency contracts, as well as cross currency swaps that are intended to offset intercompany loan exposures. 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 primarily 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 does not allow the use of derivatives for trading or speculative purposes. The company also made an accounting policy election to use the portfolio exception with respect to measuring counterparty credit risk for derivative instruments, and to measure the fair value of a portfolio of financial assets and financial liabilities on the basis of the net open risk position with each counterparty. The company’s primary currency exchange rate exposures are with the Euro, the Australian dollar, the Canadian dollar, the British pound, the Mexican peso, the Japanese yen, the Chinese Renminbi, and the Romanian New Leu against the U.S. dollar, as well as the Romanian New Leu against the Euro.

 

Cash flow hedges. The company recognizes all derivative instruments as either assets or liabilities at fair value on the consolidated balance sheet and formally documents relationships between cash flow hedging instruments and hedged transactions, 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. Changes in fair values of outstanding cash flow hedge derivatives, except the ineffective portion, are recorded in other comprehensive income (“OCI”), 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 statements 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. Results of hedges of intercompany loans are recorded in other income, net as an offset to the remeasurement of the foreign loan balance.

 

The company formally assesses, at a hedge’s inception and on an ongoing basis, whether the derivatives that are designated as hedges have been highly effective in offsetting changes in the cash flows of the hedged transactions 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 AOCL 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 in AOCL are 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 consolidated balance sheets, recognizing future changes in the fair value in other income, net.  For the third quarter and year-to-date periods of fiscal 2015, there were immaterial losses on contracts reclassified into earnings as a result of the discontinuance of cash flow hedges. As of July 31, 2015 and August 1, 2014, the notional amount outstanding of forward contracts designated as cash flow hedges was $102.8 million and $108.6 million, respectively. Additionally, as of July 31, 2015 and August 1, 2014, the company had one cross currency interest rate swap instrument outstanding for a fixed pay notional of 36.6 million Romanian New Leu and receive floating notional of 8.5 million Euros.

 

Derivatives not designated as hedging instruments. The company also enters into foreign currency contracts that include forward currency contracts and cross currency swaps to mitigate the remeasurement of specific assets and liabilities on the consolidated balance sheet. These contracts are not designated as hedging instruments. 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.

 

13



Table of Contents

 

The following table presents the fair value of the company’s derivatives and consolidated balance sheet location.

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

July 31, 2015

 

August 1, 2014

 

July 31, 2015

 

August 1, 2014

 

 

 

Balance

 

 

 

Balance

 

 

 

Balance

 

 

 

Balance

 

 

 

 

 

Sheet

 

Fair

 

Sheet

 

Fair

 

Sheet

 

Fair

 

Sheet

 

Fair

 

(Dollars in thousands)

 

Location

 

Value

 

Location

 

Value

 

Location

 

Value

 

Location

 

Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward currency contracts

 

Prepaid expenses

 

$

2,957

 

Prepaid expenses

 

$

1,263

 

Accrued liabilities

 

$

1,986

 

Accrued liabilities

 

$

62

 

Cross currency contract

 

Prepaid expenses

 

 

Prepaid expenses

 

 

Accrued liabilities

 

243

 

Accrued liabilities

 

701

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward currency contracts

 

Prepaid expenses

 

2,663

 

Prepaid expenses

 

261

 

Accrued liabilities

 

2

 

Accrued liabilities

 

412

 

Cross currency contract

 

Prepaid expenses

 

2,179

 

Prepaid expenses

 

61

 

Accrued liabilities

 

 

Accrued liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives

 

 

 

$

7,799

 

 

 

$

1,585

 

 

 

$

2,231

 

 

 

$

1,175

 

 

The following table presents the impact of derivative instruments on the consolidated statements of earnings for the company’s derivatives designated as cash flow hedging instruments for the three and nine months ended July 31, 2015 and August 1, 2014, respectively.

 

 

 

 

 

 

 

 

 

 

 

 

 

Location of Gain (Loss)

 

Gain (Loss)

 

 

 

 

 

 

 

Location of Gain

 

 

 

 

 

Recognized in Income

 

Recognized in Income

 

 

 

Gain (Loss)

 

(Loss) Reclassified

 

Gain (Loss)

 

on Derivatives

 

on Derivatives

 

 

 

Recognized in OCI on

 

from AOCL

 

Reclassified from

 

(Ineffective Portion

 

(Ineffective Portion and

 

 

 

Derivatives

 

into Income

 

AOCL into Income

 

and excluded from

 

Excluded from

 

 

 

(Effective Portion)

 

(Effective Portion)

 

(Effective Portion)

 

Effectiveness Testing)

 

Effectiveness Testing)

 

(Dollars in thousands)

 

July 31,

 

August 1,

 

 

 

July 31,

 

August 1,

 

 

 

July 31,

 

August 1,

 

For the three months ended

 

2015

 

2014

 

 

 

2015

 

2014

 

 

 

2015

 

2014

 

Forward currency contracts

 

$

(654

)

$

952

 

Net sales

 

$

3,258

 

$

(369

)

Other income, net

 

$

280

 

$

(63

)

Forward currency contracts

 

(433

)

(216

)

Cost of sales

 

(817

)

61

 

 

 

 

 

 

 

Cross currency contracts

 

31

 

(292

)

Other income, net

 

(85

)

(212

)

 

 

 

 

 

 

Total

 

$

(1,056

)

$

444

 

 

 

$

2,356

 

$

(520

)

 

 

 

 

 

 

 

 

 

July 31,

 

August 1,

 

 

 

July 31,

 

August 1,

 

 

 

July 31,

 

August 1,

 

For the nine months ended

 

2015

 

2014

 

 

 

2015

 

2014

 

 

 

2015

 

2014

 

Forward currency contracts

 

$

(950

)

$

1,694

 

Net sales

 

$

11,188

 

$

(1,140

)

Other income, net

 

$

563

 

$

(204

)

Forward currency contracts

 

(1,615

)

(333

)

Cost of sales

 

(1,808

)

93

 

 

 

 

 

 

 

Cross currency contracts

 

167

 

(330

)

Other income, net

 

(292

)

(439

)

 

 

 

 

 

 

Total

 

$

(2,398

)

$

1,031

 

 

 

$

9,088

 

$

(1,486

)

 

 

 

 

 

 

 

As of July 31, 2015, the company expects to reclassify approximately $0.8 million of gains from AOCL 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.

 

 

 

 

 

Gain (Loss) Recognized in Net Earnings

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Location of Gain (Loss)

 

July 31,

 

August 1,

 

July 31,

 

August 1,

 

(Dollars in thousands)

 

Recognized in Net Earnings

 

2015

 

2014

 

2015

 

2014

 

Forward currency contracts

 

Other income, net

 

$

(2,891

)

$

2,474

 

$

8,459

 

$

(553

)

Cross currency contracts

 

Other income, net

 

139

 

421

 

1,441

 

181

 

 

 

 

 

$

(2,752

)

$

2,895

 

$

9,900

 

$

(372

)

 

14



Table of Contents

 

The company entered into an International Swap Dealers Association (“ISDA”) Master Agreement with each counterparty that permits the net settlement of amounts owed under their respective contracts. The ISDA Master Agreement is an industry standardized contract that governs all derivative contracts entered into between the company and the respective counterparty. Under these master netting agreements, net settlement generally permits the company or the counterparty to determine the net amount payable or receivable for contracts due on the same date or in the same currency for similar types of derivative transactions. The company records the fair value of its derivative contracts at the net amount in its consolidated balance sheets.

 

The following tables show the effects of the master netting arrangements on the fair value of the company’s derivative contracts that are recorded in the consolidated balance sheets:

 

 

 

Assets

 

Liabilities

 

 

 

Gross Amounts

 

Gross Liabilities

 

Net Amounts

 

Gross Amounts

 

Gross Assets

 

Net Amounts of

 

(Dollars in thousands)

 

of Recognized

 

Offset in the

 

of Assets Presented

 

of Recognized

 

offset in the

 

Liabilities Presented

 

July 31, 2015

 

Assets

 

Balance Sheet

 

in the Balance Sheet

 

Liabilities

 

Balance Sheet

 

in the Balance Sheet

 

Forward currency contracts

 

$

5,855

 

$

(235

)

$

5,620

 

$

(2,220

)

$

232

 

$

(1,988

)

Cross currency contracts

 

2,179

 

 

2,179

 

(243

)

 

(243

)

 

 

$

8,034

 

$

(235

)

$

7,799

 

$

(2,463

)

$

232

 

$

(2,231

)

 

 

 

Assets

 

Liabilities

 

 

 

Gross Amounts

 

Gross Liabilities

 

Net Amounts

 

Gross Amounts

 

Gross Assets

 

Net Amounts of

 

(Dollars in thousands)

 

of Recognized

 

Offset in the

 

of Assets Presented

 

of Recognized

 

offset in the

 

Liabilities Presented

 

August 1, 2014

 

Assets

 

Balance Sheet

 

in the Balance Sheet

 

Liabilities

 

Balance Sheet

 

in the Balance Sheet

 

Forward currency contracts

 

$

1,572

 

$

(48

)

$

1,524

 

$

(560

)

$

86

 

$

(474

)

Cross currency contracts

 

61

 

 

61

 

(701

)

 

(701

)

 

 

$

1,633

 

$

(48

)

$

1,585

 

$

(1,261

)

$

86

 

$

(1,175

)

 

Fair Value Measurements

 

The company categorizes its assets and liabilities into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Estimates of fair value for financial assets and financial liabilities are based on the framework established in the accounting guidance for fair value measurements. The framework defines fair value, provides guidance for measuring fair value, and requires certain disclosures. The framework discusses valuation techniques such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The framework utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. The three levels are defined as follows:

 

Level 1 — Unadjusted 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 in active markets; quoted prices for identical assets or liabilities 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 reflecting management’s assumptions about the inputs used in pricing the asset or liability.

 

Cash balances are valued at their carrying amounts in the consolidated balance sheets, which are reasonable estimates of their fair value due to their short-term nature. Forward currency contracts are valued based on observable market transactions of forward currency prices and spot currency rates as of the reporting date. The fair value of cross currency contracts is determined using discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs such as interest rates and foreign currency exchange rates. In addition, credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, such as collateral postings, thresholds, mutual puts, and guarantees, are incorporated in the fair values to account for potential nonperformance risk. The unfunded deferred compensation liability is primarily subject to changes in fixed-income investment contracts based on current yields. For accounts receivable and accounts payable, carrying amounts are a reasonable estimate of fair value given their short-term nature.

 

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Assets and liabilities measured at fair value on a recurring basis, as of July 31, 2015, August 1, 2014, and October 31, 2014 are summarized below:

 

(Dollars in thousands) 

 

 

 

 

 

 

 

 

 

July 31, 2015

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

110,335

 

$

110,335

 

$

 

 

Forward currency contracts

 

5,620

 

 

5,620

 

 

Cross currency contracts

 

2,179

 

 

2,179

 

 

Total assets

 

$

118,134

 

$

110,335

 

$

7,799

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Forward currency contracts

 

$

1,988

 

 

$

1,988

 

 

Cross currency contracts

 

243

 

 

243

 

 

Deferred compensation liabilities

 

1,775

 

 

1,775

 

 

Total liabilities

 

$

4,006

 

 

$

4,006

 

 

 

August 1, 2014

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

177,894

 

$

177,894

 

$

 

 

Forward currency contracts

 

1,524

 

 

1,524

 

 

Cross currency contracts

 

61

 

 

61

 

 

Total assets

 

$

179,479

 

$

177,894

 

$

1,585

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Forward currency contracts

 

$

474

 

 

$

474

 

 

Cross currency contracts

 

701

 

 

701

 

 

Deferred compensation liabilities

 

2,290

 

 

2,290

 

 

Total liabilities

 

$

3,465

 

 

$

3,465

 

 

 

October 31, 2014

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

314,873

 

$

314,873

 

$

 

 

Forward currency contracts

 

6,030

 

 

6,030

 

 

Cross currency contracts

 

831

 

 

831

 

 

Total assets

 

$

321,734

 

$

314,873

 

$

6,861

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Forward currency contracts

 

$

9

 

 

$

9

 

 

Cross currency contracts

 

536

 

 

536

 

 

Deferred compensation liabilities

 

2,141

 

 

2,141

 

 

Total liabilities

 

$

2,686

 

 

$

2,686

 

 

 

The company measures certain assets and liabilities at fair value on a nonrecurring basis. Assets acquired and liabilities assumed as part of acquisitions are measured at fair value. Refer to Acquisition Note for additional information. There were no transfers between Level 1 and Level 2 during the three and nine months ended July 31, 2015 and August 1, 2014, or the twelve months ended October 31, 2014.

 

Contingencies — Litigation

 

The company is party to litigation in the ordinary course of business. Such matters are generally subject to uncertainties and to outcomes that are not predictable with assurance and that may not be known for extended periods of time. Litigation occasionally involves claims for punitive, as well as compensatory, damages arising out of the use of the company’s products. Although the company is self-insured to some extent, the company maintains insurance against certain product liability losses. The company is also subject to litigation and administrative and judicial proceedings with respect to claims involving asbestos and the discharge of hazardous substances into the environment. Some of these claims assert damages and liability for personal injury, remedial investigations or clean up and other costs and damages. The company is also typically involved in commercial disputes, employment disputes, and patent litigation cases in which it is asserting or defending against patent infringement claims. To prevent possible infringement of the company’s patents by others, the company periodically reviews competitors’ products. To avoid potential liability with respect to others’ patents, the company regularly reviews certain patents issued by the United States Patent and Trademark Office and foreign patent offices. Management believes these activities help minimize

 

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its risk of being a defendant in patent infringement litigation. The company records a liability in its consolidated financial statements for costs related to claims, including future legal costs, settlements and judgments, where the company has assessed that a loss is probable and an amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range, the company records the most probable estimate of the loss or the minimum amount when no amount within the range is a better estimate than any other amount. The company discloses a contingent liability even if the liability is not probable or the amount is not estimable, or both, if there is a reasonable possibility that a material loss may have been incurred. In the opinion of management, the amount of liability, if any, with respect to these matters, individually or in the aggregate, will not materially affect its consolidated results of operations, financial position, or cash flows.

 

Subsequent Events

 

The company evaluated all subsequent events and concluded that no subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the notes to the consolidated financial statements.

 

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, landscaping equipment and lighting, agricultural micro-irrigation systems, rental and specialty construction equipment, and residential yard and snow thrower products. Beginning in fiscal 2015 with our acquisition of BOSS®, we also design, manufacture, and market professional snow and ice management products. Through this acquisition, we added another professional contractor brand; a portfolio of counter-seasonal equipment; manufacturing and distribution facilities located in Iron Mountain, Michigan; and a distribution network for these 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.” We strive 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, 2014. This discussion contains various “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and we refer readers to the section titled “Forward-Looking Information” located at the end of Part I, Item 2 of this report for more information.

 

RESULTS OF OPERATIONS

 

Overview

 

Our results for the third quarter of fiscal 2015 were positive with a net sales increase of 7.4 percent and a net earnings increase of 6.6 percent, each as compared to the third quarter of fiscal 2014. Year-to-date net sales and net earnings also increased by 8.6 percent and 9.2 percent, respectively, in fiscal 2015 compared to the same period in the prior fiscal year. Professional segment net sales increased 9.7 percent and 8.8 percent for our third quarter and year-to-date periods of fiscal 2015, respectively, compared to the same periods last fiscal year. The acquisition of the BOSS business resulted in incremental net sales for our professional segment of $37.1 million and $82.4 million for the third quarter and year-to-date periods of fiscal 2015, respectively. Professional segment net sales were also up due to the successful introduction of new products and continued growth and demand for our innovative landscape contractor and specialty construction products, partially offset by a decrease in sales of irrigation products primarily due to unfavorable weather conditions in key markets. Additionally, unfavorable foreign currency exchange rate fluctuations hindered our professional segment sales growth for both the third quarter and year-to-date periods of fiscal 2015. Residential segment net sales were slightly up, by 0.1 percent, for our third quarter of fiscal 2015 compared to our third quarter of fiscal 2014, and increased 8.4 percent for the year-to-date period of fiscal 2015 compared to the same period last fiscal year. Residential segment sales were up due to strong shipments and demand for our newly introduced riding and walk power mower products and expanded product placement, partially offset by a decrease in sales of snow thrower products primarily due to lower pre-season shipments in the third quarter of fiscal 2015 that are expected to ship in the fourth quarter of fiscal 2015 and unfavorable foreign currency exchange rate fluctuations. Our overall international net sales were down 3.5 percent and 4.6 percent for our third quarter and year-to-date periods of fiscal 2015, respectively, compared to the same periods last fiscal year due to unfavorable foreign currency exchange rates that

 

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decreased net sales by approximately $11 million and $30 million for the third quarter and year-to-date periods of fiscal 2015, respectively.

 

Our net earnings growth in the third quarter and year-to-date periods of fiscal 2015 was primarily attributable to increased sales and leveraging selling, general, and administrative (“SG&A”) costs over higher sales volumes, partially offset by a decrease in our gross margin rate and an increase in interest expense. Our effective tax rate for the third quarter comparison increased mainly due to a discrete benefit last year that was not duplicated this year. However, our tax rate for the year-to-date comparison decreased mainly due to the retroactive re-enactment of the domestic research tax credit in the first quarter of fiscal 2015 for calendar year 2014. We increased our third quarter cash dividend by 25 percent to $0.25 per share compared to the $0.20 per share quarterly cash dividend paid in the third quarter of fiscal 2014.

 

Inventory levels increased $56.4 million, or 19.2 percent, as of the end of the third quarter of fiscal 2015 compared to the end of the third quarter of fiscal 2014, mainly due to increased residential segment inventory levels as a result of anticipated strong demand for new products and incremental inventory of $21.9 million from the acquisition of the BOSS business. Receivables as of the end of the third quarter of fiscal 2015 increased $12.2 million, or 5.7 percent, compared to the end of the third quarter of fiscal 2014 as a result of higher sales volumes and incremental receivables from the acquisition of the BOSS business, which was partially offset by a decrease in international receivables due to lower foreign currency exchange rates. Field inventory levels were also up as of the end of the third quarter of fiscal 2015 compared to the end of the third quarter of fiscal 2014 primarily due to strong sales from new product introductions and anticipated retail demand.

 

Our new multi-year initiative, “Destination PRIME,” begins our journey into our second century. Similar to our previous Destination 2014 initiative, this three-year initiative is intended to help us drive revenue and earnings growth and further improve productivity, while also continuing our century-long commitment to innovation, relationships, and excellence. Through our Destination PRIME initiative, we will strive to achieve our goals by pursuing a progression of annual milestones. Each fiscal year we will set forth organic revenue growth and operating earnings goals, while continuing to focus on the progress we made through our previous initiatives, such as working capital. Our organic revenue growth goal is to achieve five percent or more of organic revenue growth each fiscal year during this initiative. We define organic revenue growth as the increase in net sales, less net sales from acquisitions that occurred in the current fiscal year. Our operating earnings goal is to raise operating earnings as a percentage of net sales to more than 13 percent by the end of fiscal 2017. Additionally, our working capital goal is to drive down average net working capital as a percentage of net sales to less than 13 percent by the end of fiscal 2017. We define average net working capital as accounts receivable plus inventory less trade payables as a percentage of net sales for a twelve month period.

 

Net Earnings

 

Net earnings for the third quarter of fiscal 2015 were $53.3 million, or $0.94 per diluted share, compared to $50.0 million, or $0.87 per diluted share, for the third quarter of fiscal 2014, resulting in a net earnings per diluted share increase of 8.0 percent. The primary factor contributing to our third quarter comparison earnings improvement was leveraging SG&A costs over higher sales volumes, partially offset by an increase in our effective tax rate and higher interest expense. Year-to-date net earnings in fiscal 2015 were $178.0 million, or $3.13 per diluted share, compared to $163.0 million, or $2.82 per diluted share, in the same comparable period last fiscal year, resulting in a net earnings per diluted share increase of 11.0 percent. The primary factors contributing to our earnings improvement for the year-to-date comparison were leveraging SG&A costs over higher sales volumes and a decline in our effective tax rate, somewhat offset by a decrease in gross margin rates and an increase in interest expense. In addition, third quarter and year-to-date fiscal 2015 net earnings per diluted share were benefited by approximately $0.01 per share and $0.05 per share, respectively, compared to the same periods in fiscal 2014, as a result of reduced shares outstanding from repurchases of our common stock.

 

The following table summarizes the major operating costs and other income as a percentage of net sales:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

July 31,
2015

 

August 1,
2014

 

July 31,
2015

 

August 1,
2014

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of sales

 

(64.5

)

(64.4

)

(65.1

)

(64.2

)

Gross margin

 

35.5

 

35.6

 

34.9

 

35.8

 

SG&A expense

 

(22.5

)

(22.9

)

(21.2

)

(22.0

)

Operating earnings

 

13.0

 

12.7

 

13.7

 

13.8

 

Interest expense

 

(0.8

)

(0.6

)

(0.7

)

(0.6

)

Other income, net

 

0.5

 

0.4

 

0.4

 

0.4

 

Provision for income taxes

 

(4.0

)

(3.7

)

(4.1

)

(4.3

)

Net earnings

 

8.7

%

8.8

%

9.3

%

9.3

%

 

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Net Sales

 

Worldwide consolidated net sales for the third quarter of fiscal 2015 were $609.6 million, up 7.4 percent compared to the third quarter of fiscal 2014. For the year-to-date period of fiscal 2015, net sales were $1.9 billion, up 8.6 percent from the same period in the prior fiscal year. Worldwide professional segment net sales were up 9.7 percent and 8.8 percent for the third quarter and year-to-date periods of fiscal 2015, respectively, compared to the same periods in the prior fiscal year. The acquisition of the BOSS business added $37.1 million and $82.4 million of net sales for the professional segment in the third quarter and year-to-date periods of fiscal 2015, respectively. Our professional segment sales were also positively impacted by higher shipments of landscape contractor and specialty construction equipment due to increased demand for our innovative product offerings and newly introduced products. Partially offsetting the sales growth in both the third quarter and year-to-date periods of fiscal 2015 compared to the same periods last fiscal year for the professional segment were lower irrigation sales due to unfavorable weather conditions, as well as unfavorable foreign currency exchange rate fluctuations. For the year-to-date period of fiscal 2015 compared to the same period last fiscal year, lower sales of micro-irrigation products, which were primarily due to foreign currency exchange rate changes and continued adverse political and economic conditions in certain key international regions, also partially offset professional segment sales growth.

 

Residential segment net sales were up 0.1 percent and 8.4 percent for the third quarter and year-to-date periods of fiscal 2015, respectively, compared to the same periods in the prior fiscal year. The sales increases in both periods for the residential segment were largely due to higher shipments from strong retail demand for our new platform of zero-turn riding mowers and walk power mowers, as well as expanded product placement for these new innovative products. However, these net sales increases were somewhat offset by a decrease in sales of snow thrower products due to lower pre-season shipments in the third quarter of fiscal 2015 that are expected to ship in the fourth quarter of fiscal 2015, including the introduction of new products. Sales of snow thrower products in Europe also declined due to the lack of snow fall in that region during the past two winter seasons. Additionally, unfavorable foreign currency exchange rate fluctuations hampered sales growth for our residential segment in both the third quarter and year-to-date periods of fiscal 2015.

 

Net sales for our other segment were up by $4.5 million for the third quarter of fiscal 2015 and $0.8 million for the year-to-date period of fiscal 2015 compared to the same periods last fiscal year due mainly to higher sales volumes driven by strong demand for commercial equipment at our company-owned distribution companies. International net sales were down, by 3.5 percent and 4.6 percent, for the third quarter and year-to-date periods of fiscal 2015, respectively, compared to the same periods in the prior fiscal year due to unfavorable foreign currency exchange rate fluctuations. Changes in foreign currency exchange rates resulted in a reduction of our net sales of approximately $11 million and $30 million for the third quarter and year-to-date periods of fiscal 2015, respectively. Field inventory levels were up as of the end of the third quarter of fiscal 2015 compared to the end of the third quarter of fiscal 2014 primarily due to strong sales from new product introductions and anticipated retail demand.

 

Gross Profit

 

As a percentage of net sales, gross profit for the third quarter of fiscal 2015 decreased slightly, by 10 basis points, to 35.5 percent compared to 35.6 percent in the third quarter of fiscal 2014 mainly due to unfavorable foreign currency exchange rate fluctuations, partially offset by a higher proportion of professional segment sales that carry higher average gross margins than our residential segment. Gross profit as a percent of net sales for the year-to-date period of fiscal 2015 decreased 90 basis points to 34.9 percent compared to 35.8 percent for the year-to-date period of fiscal 2014. This decrease was also primarily attributable to unfavorable foreign currency exchange rate fluctuations and the purchase accounting impact of the incremental charge for the sale of inventory that was written-up to fair value as a result of the acquisition of the BOSS business.

 

Selling, General, and Administrative Expense

 

SG&A expense increased $6.9 million, or 5.3 percent, for the third quarter of fiscal 2015 compared to the third quarter of fiscal 2014 and increased $18.5 million, or 4.8 percent, for the year-to-date period of fiscal 2015 compared to the year-to-date period of fiscal 2014. As a percentage of net sales, SG&A expense decreased 40 basis points and 80 basis points for the third quarter and year-to-date periods of fiscal 2015, respectively, compared to the same periods in the prior fiscal year. These decreases as a percentage of net sales were largely due to leveraging SG&A expense over higher sales volumes and lower marketing expense, partially offset by incremental SG&A costs from the acquisition of the BOSS business.

 

Interest Expense

 

Interest expense for the third quarter and year-to-date periods of fiscal 2015 increased $1.0 million and $3.0 million, respectively, compared to the same periods last fiscal year due to higher levels of debt as a result of borrowings that were used to pay the purchase price for the BOSS business.

 

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Other Income, Net

 

Other income, net for the third quarter and year-to-date periods of fiscal 2015 increased $0.4 million and $1.3 million, respectively, compared to the same periods last fiscal year primarily due to higher earnings from our equity investment in Red Iron and a decrease in foreign currency exchange rate losses.

 

Provision for Income Taxes

 

The effective tax rate for the third quarter of fiscal 2015 was 31.3 percent compared to 29.4 percent in the third quarter of 2014. This increase was mainly due to a discrete tax benefit for a change in tax accounting method in the third quarter of fiscal 2014 that was not duplicated this fiscal year, partially offset by higher earnings in lower tax jurisdictions. The effective tax rate for the year-to-date periods of fiscal 2015 and 2014 was 30.4 percent and 31.7 percent, respectively. The decrease in the effective tax rate for the year-to-date comparison was primarily the result of the benefit in the first quarter of fiscal 2015 for the retroactive re-enactment of the domestic research tax credit for calendar year 2014, as well as higher earnings in lower tax jurisdictions.

 

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.

 

The following table summarizes net sales by segment:

 

 

 

Three Months Ended

 

 

 

July 31,

 

August 1,

 

 

 

 

 

(Dollars in thousands)

 

2015

 

2014

 

$ Change

 

% Change

 

Professional

 

$

421,994

 

$

384,678

 

$

37,316

 

9.7

%

Residential

 

175,977

 

175,717

 

260

 

0.1

 

Other

 

11,644

 

7,145

 

4,499

 

63.0

 

Total*

 

$

609,615

 

$

567,540

 

$

42,075

 

7.4

%

 

 

 

 

 

 

 

 

 

 

* Includes international sales of:

 

$

136,626

 

$

141,649

 

$

(5,023

)

(3.5

)%

 

 

 

Nine Months Ended

 

 

 

July 31,

 

August 1,

 

 

 

 

 

(Dollars in thousands)

 

2015

 

2014

 

$ Change

 

% Change

 

Professional

 

$

1,314,474

 

$

1,208,707

 

$

105,767

 

8.8

%

Residential

 

578,587

 

533,664

 

44,923

 

8.4

 

Other

 

17,007

 

16,180

 

827

 

5.1

 

Total*

 

$

1,910,068

 

$

1,758,551

 

$

151,517

 

8.6

%

 

 

 

 

 

 

 

 

 

 

* Includes international sales of:

 

$

474,911

 

$

498,029

 

$

(23,118

)

(4.6

)%

 

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The following table summarizes segment earnings (loss) before income taxes:

 

 

 

Three Months Ended

 

 

 

July 31,

 

August 1,

 

 

 

 

 

(Dollars in thousands)

 

2015

 

2014

 

$ Change

 

% Change