The Toro Company (NYSE:TTC) Q1 2023 Earnings Call Transcript

The Toro Company (NYSE:TTC) Q1 2023 Earnings Call Transcript March 9, 2023

Operator: Good day ladies and gentlemen, and welcome to The Toro Company’s First Quarter Earnings Conference Call. My name is Jonathan, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s conference, Julie Kerekes, Treasurer and Senior Managing Director of Global Tax and Investor Relations. Please proceed, Ms. Kerekes.

Julie Kerekes: Thank you, and good morning, everyone. Our earnings release was issued this morning, and a copy can be found in the Investor Information’s section of our corporate website, thetorocompany.com. We have also posted a first quarter earnings presentation to supplement our earnings release and general investor presentation. On our call today are Rick Olson, Chairman and Chief Executive Officer; Renee Peterson, Vice President and Chief Financial Officer; Angie Drake, Vice President, Finance; and Jeremy Steffan, Director, Investor Relations. We begin with our customary forward-looking statement policy. During this call, we will make forward-looking statements regarding our plans and projections for the future. This includes estimates and assumptions regarding financial and operating results, as well as economic, technological, weather, market acceptance, acquisition-related and other factors that may impact our business and customers.

You are all aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our earnings release, as well as our SEC filings detail some of the important risk factors that may cause our actual results to differ materially from those in our predictions. Please note that we do not have a duty to update our forward-looking statements. In addition, during this call, we will reference certain non-GAAP financial measures. Reconciliations of historical non-GAAP financial measures to reported GAAP financial measures can be found in our earnings release and on our website in our investor presentation, as well as in our applicable SEC filings. We believe these measures may be useful in performing meaningful comparisons of past and present operating results and cash flows to understand the performance of our ongoing operations and how management views the business.

Non-GAAP financial measures should not be considered superior to or a substitute for the GAAP financial measures presented in our earnings release and this call. With that, I will now turn the call over to Rick.

Rick Olson: Thanks, Julie, and good morning, everyone. We began fiscal 2023 by delivering another record quarter with net sales up 23% and adjusted diluted earnings per share, up 49% over last year. We reported top line growth in both segments and continued to see strong demand for our innovative products, especially in key professional markets. Importantly, the supply chain continued to improve, which combined with our disciplined operational execution, drove manufacturing efficiencies and Professional segment volume growth. We achieved these results even with below-average snowfall in many key regions, a testament to our innovative product lineup and diversified portfolio. We also performed well on the bottom line, posting a 200 basis point improvement in adjusted operating earnings as a percentage of net sales year-over-year.

This was driven by net price realization and productivity gains. Our team and channel partners continued to operate with their hallmark dedication, creativity, and resiliency. These characteristics are serving us well now, and we expect will serve us well in the future. With the strong start to the year, we are reiterating our full-year net sales and adjusted diluted earnings per share guidance. In addition to delivering record results in the quarter, we kept our focus on positioning the company to capitalize on long-term growth opportunities. This includes our foundational strategy of investing in the key technology areas of alternative power, smart-connected, and autonomous solutions. We believe our ability to leverage these investments across our broad portfolio will provide a competitive advantage and position us to drive accelerated profitable growth.

For example, our HyperCell battery system is powering a growing suite of electric and hybrid solutions geared to professionals. This system was first introduced with the launch of our Toro-branded Revolution Series mowers and is now electrifying products across our professional portfolio. This includes Exmark-branded turf equipment, specialty construction solutions and many golf applications. This proprietary system provides reliable all-day run-time on a single charge with no compromise on performance. We also leveraged our 60-volt platform beyond our lineup of products geared to homeowners. Our new revolution series line of commercial-grade handheld tools runs on the Flex Force platform and expands our addressable market in the professional space.

These tools provide comfortable and quiet operation for contractors, while allowing increased productivity. These are just a few of the ways our prioritized focus on developing technology solutions is enabling accelerated new product development across our business. We also remained engaged with our communities, including our long-standing commitment to further education and advanced diversity in our industries. A few recent examples highlight this commitment. First, we announced a 5-year partnership with the Atlanta University Center Consortium to fund scholarships for black engineering students. We will also provide paid internship opportunities to further enhance student’s academic and professional development. We believe initiatives like these will help shape the future of our workforce.

Second, we extended our 25-year commitment of supporting First Tee, a nonprofit that helps young people develop character and life skills through the game of golf. The extension will include grants and equipment donations to support chapter initiatives and diversity efforts across the First Tee network. Fiscal 2023 is off to a great start. We expect to carry this momentum throughout the year as we execute against our enterprise strategic priorities of accelerating profitable growth, driving productivity and operational excellence and empowering people. I’ll discuss our outlook further following Renee and Angie’s more detailed review of our financial results and guidance. But before I hand the call over, I’d like to congratulate Renee on her upcoming retirement and Angie on her promotion to Chief Financial Officer.

Renee will transfer her CFO responsibilities to Angie after the following of our first quarter Form 10-Q. She will continue as Vice President, Finance until her retirement in July. During this time, Renee will support the transition and provide ongoing leadership for key enterprise and finance initiatives. Throughout her tenure as CFO, Renee skillfully manage the profitable growth of the company and kept a focus on driving outstanding value for all stakeholders. During her leadership, the company’s net sales grew from $1.9 billion in fiscal 2011 to $4.5 billion in fiscal 2022 with an impressive average return on invested capital of nearly 25%. On a personal note, I have deeply appreciated Renee’s steadfast support and trusted partnership. I wish her all the best on her well-deserved retirement.

Thank you, Renee. Moving forward, I’m excited to partner with Angie as we build our momentum and advance our strategic priorities. Angie is a proven and highly respected leader with a deep understanding of our culture and values. She has consistently demonstrated her ability to deliver results, including during her time as Chief Financial Officer of Charles Machine Works and more recently as Vice President of our Construction business. I have every confidence that Angie’s leadership will continue to drive our business forward, supported by a foundation of financial acumen, discipline, and excellence. Congratulations, Angie. With that, I’ll turn the call over to Renee.

Renee Peterson: Good morning, everyone, and thank you, Rick. I appreciate the kind words. It’s been an honor to be part of this incredible company and team for the past 12 years. I’d like to congratulate Angie on her promotion and echo Rick’s confidence in her leadership. It gives me great pride to lead the CFO position in such qualified hands. I would also like to thank our investors and analysts for your support and engagement during my tenure as CFO. Now, turning to our results. As Rick said, we delivered strong performance in the first quarter, achieving record net sales and adjusted diluted EPS in what remains a dynamic operating environment. We grew overall consolidated net sales to $1.15 billion, an increase of 23.2%, compared to the first quarter of last year.

Reported and adjusted EPS were $1.01 and $0.98 per diluted share, respectively, up from $0.66 for both in the first quarter a year ago. Professional segment net sales for the quarter were $880.7 million, up nearly 31% year-over-year. This increase was driven by higher shipments of products broadly across the segment, primarily due to strong demand and improvement in the supply chain, net price realization and incremental revenue from our first quarter fiscal 2022 acquisition of the Intimidator Group. Professional segment earnings for the first quarter were up 54% to $144.1 million and when expressed as a percentage of net sales, 16.4%. This was up from 13.9% in the first quarter last year. The year-over-year increase was primarily due to net price realization, net sales leverage, and productivity improvements.

This was partially offset by higher material freight and manufacturing costs and the addition of the Intimidator Group had a lower initial margin relative to the segment average. Residential segment net sales for the first quarter were $264.6 million, up 3.6% over last year. The growth was primarily driven by net price realization and higher shipments of zero-turn riding mowers, partially offset by lower shipments of snow products. Residential segment earnings for the quarter were up 19% to $37.8 million. And when expressed as a percentage of net sales, 14.3%. This was up from 12.4% in the first quarter last year. The year-over-year increase was primarily driven by net price realization and productivity improvements, partially offset by higher material freight and manufacturing costs and higher SG&A expense.

With that, I’ll turn the call over to Angie to continue outlining our operating results and to discuss our fiscal 2023 guidance.

Angie Drake: Thank you, Renee and hello, everyone. Before I begin, I would also like to congratulate Renee on her retirement and thank her for her support as I transition to my new role. I’m looking forward to building on the strong foundation Renee has built and working more closely with Rick and the investment community. Turning to our operating results. Our reported and adjusted gross margin were both 34.5% for the quarter, up from 32.2% for both in the same period last year. The year-over-year improvement was primarily due to net price realization and productivity improvements, partially offset by higher material, freight, and manufacturing costs and the addition of the Intimidator Group at a lower initial gross margin relative to the company average.

SG&A expense as a percentage of net sales for the quarter was 22.6%, compared to 22.4% in the same period last year. This increase was primarily driven by higher warranty expense, partially offset by net sales leverage. Operating earnings as a percentage of net sales for the first quarter were 11.9% on a reported and adjusted basis. This compares to 9.8% and 9.9%, respectively, in the same period last year. Interest expense for the quarter was $14.1 million, up $7.1 million from the same period last year. This increase was primarily due to incremental borrowings to fund the Intimidator Group acquisition and higher average interest rates. The reported and adjusted effective tax rates for the first quarter were 18.6% and 21.4%, respectively, compared to 20.2% and 20.9% in the same period a year ago.

Turning to our balance sheet and cash flows. Accounts receivable were $377 million, up 3% from a year ago, primarily driven by organic net sales growth. Inventory was $1.1 billion, up 36% compared to last year. This increase was driven by higher finished goods, work in process and service parts. In addition, this includes the impact of inflation. Accounts payable were $475 million, essentially the same as last year. Free cash flow in the quarter was a $91 million use of cash. This was primarily driven by additional working capital needs heading into the spring selling season. This also reflects higher work in process and service parts levels as we continue to navigate current supply chain dynamics. With the return to a more normalized quarterly net sales cadence, we expect the majority of our operating cash flow to be generated in the second half of the fiscal year.

This expectation aligns with typical patterns pre-pandemic. We remain well within our 1x to 2x target gross debt-to-EBITDA leverage ratio. This supports our strong balance sheet, which in-turn provides the financial flexibility to fund investments that drive long-term sustainable growth. Our disciplined approach to capital allocation remains unchanged with priorities that include making strategic investments in our business, both organically and through acquisitions, returning cash to shareholders through dividends and share repurchases, and maintaining our leverage goals. These priorities are highlighted by our actions, including our plan to deploy $150 million to $175 million in capital expenditures this year to fund new product investments, advanced manufacturing technologies and capacity for growth and our regular dividend payout increase of 13%, compared to last year.

As we look ahead to the remainder of the fiscal year, we expect continued strong demand for our innovative products, especially in key professional markets. While we expect the supply chain situation to remain dynamic, we are encouraged by the incremental improvements that are enabling increased production. With this backdrop and based on our current visibility, we are reaffirming our full-year fiscal 2023 net sales and adjusted diluted earnings per share guidance. For fiscal 2023, we continue to expect net sales growth in the range of 7% to 10%. We also continue to expect Professional net sales to grow at a rate higher than the total company average. For the Residential segment, we now expect fiscal 2023 net sales to be relatively flat to slightly down, compared to fiscal 2022 as a result of the below average snowfall totals this season.

In addition, we anticipate a more typical quarterly sales cadence with Q2 and Q3 being our larger quarters. Looking at profitability, we remain focused on improving our margin profile. With that focus, we continue to expect gross margin improvement in fiscal 2023, with margins in the second half of the year expected to be higher than the first half of the year. Additionally, we continue to expect improvement in overall adjusted operating earnings as a percentage of net sales, compared to last year with higher earnings margins expected for both segments on a year-over-year basis. We expect these margin improvements to be driven by net price realization, productivity improvements, and favorable mix. We maintain expectations for full-year adjusted EPS in the range of $4.70 to $4.90 per diluted share.

This adjusted EPS estimate excludes the benefit of the excess tax deduction for share-based compensation. Additionally, for the full-year, we continue to expect depreciation and amortization of about $130 million, interest expense of about $55 million and adjusted effective tax rate of about 21%, and free cash flow conversion of approximately 100% of reported net earnings. Turning to the second quarter of fiscal 2023. We expect total company net sales to grow at a rate higher than the full-year estimate. For the Professional segment, we expected Q2 net sales growth rate meaningfully higher than the total company full-year growth estimate, but lower than the Q1 growth rate, given a full-year has now lapsed since the . For the Residential segment, we expect a Q2 net sales growth rate slightly lower than the total company’s full-year growth estimates.

From a profitability perspective, for the second quarter, we expect year-over-year improvement in gross margin and adjusted operating earnings margin on a total company basis. For the Professional segment, we expect the second quarter earnings margin to be higher year-over-year, as well as higher sequentially from the first quarter of fiscal 2023. For the Residential segment, we expect the second quarter earnings margin to be higher year-over-year, but down sequentially from the first quarter of fiscal 2023. We continue to build our business for long-term profitable growth as we execute on our strategic priorities and focus on driving value for all stakeholders. With that, I’ll turn the call back to Rick.

Rick Olson: Thank you, Angie. Fiscal 2023 is off to a strong start, and we are well-positioned with innovative products, trusted brands, and extensive distribution and service networks. We expect continued benefits from our well-established market leadership, along with the essential nature and regular replacement cycle of our products. In addition, we expect to benefit from our substantial order backlog. Our team continues to operate with incredible agility to optimize output in the current environment. With this, we saw higher volumes across our Professional segment during the first quarter. At the same time, the exceptional demand we continue to see in key professional markets drove a slight increase in our backlog over and above the $2.3 billion balance at the beginning of the year.

Turning to the broader economy. We are keeping an eye on monetary policy actions, the geopolitical environment, and inflation. We are also watching overall business and consumer confidence and spending patterns. We believe we are well prepared to deliver positive results in this environment. I’ll now comment on the macro factors we are seeing in our end markets, which could impact future results. Starting with our Professional segment. For underground and specialty construction, we expect the current robust demand to continue, supported by multi-year tailwinds from public and private infrastructure investments. The need and support for broadband and alternative power build-outs, along with the aging infrastructure is driving exceptional demand in the utility construction and rental markets.

We believe we are prepared to capitalize on this demand with the most comprehensive product lineup in the industry. Additionally, we are encouraged by the supply chain improvements that enabled increased production for this business in the first quarter. For golf, we expect healthy course budgets will continue to fuel strong demand. In 2022, on-course participation was up for the fifth straight year with a net increase of 0.5 million golfers domestically. At the same time, the number of rounds played remained well above pre-pandemic levels. We are extremely well positioned in this attractive market as the only company to offer both equipment and irrigation solutions and as the long-standing market leader in both. This market leadership was on display at the Golf Industry Show in February.

We highlighted our autonomous fairway mower and a number of fully electric versions of our proven and popular machines. This included new battery-powered Groundsmaster and Greensmaster models and the Workman MDX Lithium. We also showcased our new IntelliDash golf course management platform. This platform provides superintendence with vital course and equipment data to simplify operations, increase productivity, and allocate resources more efficiently and effectively. For municipalities and grounds, we expect to see continued prioritization of green spaces and interest in zero-exhaust emission products, supported by healthy budget. We are well-positioned to serve this market with our deep relationships and growing suite of no-compromise sustainable solutions.

For snow and ice management, we will be watching to see how the late season snowfalls impact channel inventory levels. We continue to see customer demand exceed expectations for our new liquid de-icing products. These products enable increased productivity, while also significantly reducing the amount of salt required. For landscape contractors, we expect to see a more normalized seasonal cadence and we’ll be watching how spring weather patterns unfold. Landscape contractor budgets remain healthy in this large and growing end market. We are positioned well with our extensive channel and market leadership, including our 3 brands, Exmark, Toro and Spartan. For residential, commercial irrigation and lighting, demand for commercial projects remain strong.

We expect this will help offset any potential change in residential demand, depending on how consumer spending patterns and housing markets trend. For agricultural micro irrigation, we expect recent precipitation to improve drought conditions in key regions. Moving to the Residential segment. We are expecting demand to follow more typical seasonal trends. With this, we will be watching weather patterns, including the timing of spring, as well as moisture levels. We are also keeping an eye on consumer confidence. Importantly for us, we benefit from regular replacement cycles and the nondiscretionary nature of our products. We offer an innovative product lineup with an ever-increasing number of battery electric options. This includes our recently introduced robotic mower with wire-free navigation and a state-of-the-art vision-based localization system.

On top of that, we believe our extensive distribution network for residential products provides a competitive advantage. This network includes mass retailers, over 4,000 independent dealers and online platforms. It’s an exciting time to be part of The Toro Company. We are leveraging prioritized technology investments across our product lines, which we believe will drive value down and into the future for all stakeholders. These transformational investments, along with our outstanding team of employees and channel partners, position us well to build on our market leadership across our broad portfolio. On that note, I would like to thank our employees and channel partners for going above and beyond every day to support our customers and deliver great results.

You are the key to The Toro Company’s success. I would also like to extend my gratitude to our customers and shareholders for your continued support. With that, we will open up the call for questions.

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Q&A Session

Operator: And our first question comes from the line of Sam Darkatsh from Raymond James. Your question please.

Sam Darkatsh: Good morning, everyone. How are you?

Rick Olson: Good morning, Sam. Congratulations on the conference.

Sam Darkatsh: Thank you and speaking of congratulations, I’d like to echo Rick’s sentiments, Renee. It’s been wonderful working with you over the years. Best wishes with your next chapter and Angie well-deserved promotion and look forward to working with you going forward as well.

Angie Drake: Thank you.

Angie Drake: Thanks, Sam.

Sam Darkatsh: Just a couple, I guess, general topics, if I could. I think in your prepared remarks, Rick, you mentioned that there was a slight increase in your backlog sequentially from the 2.3 billion. If we could unpack that a little bit more, what are you seeing specifically with order cancellation rates, new order trends lead times, that sort of thing to give us a sense of what’s happening a little bit behind the scenes.

Rick Olson: If you start just overall looking at the backlog, we did €“ we actually had a really nice volume increase. It was actually a little bit better than we expected in the first quarter. So, we were on our plan from that regard. The biggest factor was just the demand continues to be very, very strong, especially coming from our residential side. Most of it coming from the underground, specialty construction part of our business and then followed by golf and grounds. And with regard to cancellation rate, extremely low, very, very small piece of loss of backlog at this point. So, we are €“ we expect those lines to converge out in the future where we start to make ground on the demand, but at this point, even though we had better output, demand was greater than expected as well.

Sam Darkatsh: And then your supply chain constraints that are continuing to improve, is that with both electronics and hydraulics or mostly hydraulics at this point? What sorts of components or trends in component supply are you seeing, Rick?

Rick Olson: On a broader base, the random issues have become better, but the several that we’ve talked about, which you refer to, specifically wiring harnesses. I think there’s a worldwide issue with supply of those, but we’re working very closely and believe me, very intensely with our suppliers there to improve that situation. We do see some improvement there. Hydraulics also improving more down to kind of the random misses in terms of shipments. Anything to do with electronics regarding chips, still a bit of an issue, but we’re seeing some improvement there as well. I think generally, the chip industry is seeing some improvements overall. So, it’s the same type of characters, right, as it was probably in our last discussion, but we’re seeing steady improvement.

And as we gain more confidence in the supply from the suppliers of those component parts, we are positioning ourselves to be able to take advantage of that improved supply with greater volume. We don’t believe our facilities will be the constraints in the near-term. We’ll be able to take advantage of that as it becomes available.

Sam Darkatsh: And then my last question, if I could sneak it in. The Resi segment surprised me and perhaps others in terms of in the quarter that it was better than expected. I think it might have been better than you were originally anticipating also where you thought it was going to be flat, both from a sales and a margin perspective, despite the fact that snow was soft. So, what was happening there? And then also reconcile that with it sounds like you’re taking down your expectations a little bit going forward for Resi in the year. If you could just help unpack what you’re seeing in that segment from a trend standpoint?