The Toro Company (NYSE:TTC) Q2 2023 Earnings Call Transcript

The Toro Company (NYSE:TTC) Q2 2023 Earnings Call Transcript June 8, 2023

The Toro Company misses on earnings expectations. Reported EPS is $1.25 EPS, expectations were $1.52.

Operator: Good day ladies and gentlemen, and welcome to The Toro Company’s Second Quarter Earnings Conference Call. My name is Tanya, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. 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 our second quarter earnings presentation to supplement our earnings release and general investor presentation. On our call today are Rick Olson, Chairman and Chief Executive Officer; Angie Drake, Vice President and Chief Financial Officer; and Jeremy Steffan, Director of 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 presentations, 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 delivered record top and bottom line results in the second quarter. Net sales were up 7% and reported net adjusted diluted earnings per share were up 48% and 26% respectively over last year. Our top line growth was driven by strong professional segment performance, especially in the key areas of construction and golf and grounds, where we achieved volume gains from increased production along with continued robust demand. Our ability to increase output was driven by our disciplined operational execution and efficiencies gained from continued supply chain improvements. For our Residential segment, sales volumes were pressured by unfavorable weather patterns and macroeconomic factors.

Once again, the actions we have taken to diversify our portfolio and leverage our scale proved beneficial and we delivered overall net sales growth in the quarter. Moving to our bottom line performance, our team delivered a 250 basis point improvement in adjusted operating earnings as a percentage of net sales for the quarter year-over-year. This positive result was driven by net price realization, favorable mix and productivity gains. While we remained in an inflationary environment, the overall rate continued to slow with notable improvements in freight costs. We delivered strong results in the quarter while also positioning the company for long-term profitable growth.

60V: Our market leadership is built on a foundation of long-term customer relationships and offering the best innovative products. This foundation is central to delivering on our purpose of helping our customers enrich the beauty, productivity and sustainability of the land. An example of this leadership is the extension of our commitments to the National Recreation and Park Association Business Council. This partnership explores, shares and deploys solutions that benefit both parks and recreation and the business sector, with an ultimate goal to build stronger communities. We’re excited to continue working closely with the council as we strive to solve common challenges together in a way that enhances the quality of life for all.

Another example is our recent selection as turf partner for Bay Hill Club & Lodge, as well as Latrobe Country Club, two courses connected with the legendary Arnold Palmer. We are honored to partner with these story clubs as they continue Mr. Palmer’s legacy of providing a top-notch experience for members, guests, and golf professionals. We delivered a strong first half of the year and we believe we are well positioned to carry that momentum into the second half. While the macro environment remains dynamic we are accustomed to growing our business for long-term success through all kinds of economic and weather cycles. We intend to continue operating with our hallmark discipline and resiliency while advancing our strategic priorities. With this focus, we expect to grow our market leadership in both the near-term and the long-term.

With that, I will turn the call over to Angie for a more detailed review of our second quarter financial results.

Angie Drake: Thank you, Rick, and good morning everyone. As Rick said, we delivered strong performance in the second quarter achieving record net sales and diluted EPS amid a backdrop of unfavorable weather patterns and very dynamic operating environment. This performance highlights the benefits of our attractive and broad portfolio with the large majority of our solutions geared to professional end markets. We grew overall consolidated net sales for the quarter to $1.34 billion an increase of 7.2% compared to last year. Reported EPS was $1.59 per diluted share, up 28.2% from $1.24. Adjusted EPS was $1.58 per diluted share, up 26.4% from $1.25. Professional segment net sales for the second quarter were $1.07 billion, up 15.4% year-over-year.

This increase was primarily driven by higher shipments of products broadly across the segment with notable strengths for construction and golf and grounds products and net price realization. Professional segment earnings for the second quarter were up 37.6% to $227.5 million. When expressed as a percentage of net sales, earnings for the segment were 21.3%, up from 17.9%. The year-over-year increase was primarily due to net price realization, favorable product mix, productivity improvements, and net sales leverage. This was partially offset by higher material and manufacturing costs. Residential segment net sales for the second quarter were $265.8 million, down 16.8% compared to last year. The decrease was primarily driven by lower shipments of products broadly across the segment, partially offset by net price realizations.

Residential segment earnings for the quarter were down 38.7% to $22.7 million. When expressed as a percentage of net sales earnings for the segment were 8.6%, down from 11.6%. The year-over-year decrease was primarily driven by lower sales volumes, higher marketing expense, and higher manufacturing costs. This was partially offset by net price realization and lower freight costs. Turning to our operating results, our reported and adjusted gross margins were both 35.8% for the quarter, up from 32.4% and 32.5% respectively. The year-over-year improvement was primarily due to net price realization, favorable product mix and productivity improvements partially offset by higher material and manufacturing costs. SG&A expense as a percentage of net sales for the quarter was 19.5% compared to 18.8% in the same period last year.

This increase was primarily driven by higher marketing expense, partially offset by net sales leverage. Operating earnings as a percentage of net sales for the second quarter were 16.3% on both a reported and adjusted basis. This compares to 13.7% and 13.8% respectively in the same period last year. Interest expense for the quarter was $14.7 million, up $6.7 million from the same period last year. This increase was primarily due to higher average interest rates. The reported and adjusted effective tax rates for the second quarter were 20.6% and 21.1% respectively compared to 20.6% and 20.8%. Turning to our balance sheet as of the end of the second quarter, accounts receivable were $462 million, up 5% from a year ago, primarily driven by higher international net sales and partially offset by lower Residential segment net sales.

Inventory was $1.1 billion, up 26% compared to last year. This increase was primarily due to higher finished goods, work in process and service parts, largely driven by inflation and component supply constraints, so essentially from the end of the first quarter of fiscal 2023, inventory was relatively flat, but our composition improved with work in process slightly lower. Accounts payable were $515 million, down 9% compared to a year ago, primarily driven by a reduction in inventory purchases. Year-to-date free cash flow was a $1.3 million use of cash. This was primarily driven by seasonal working capital needs, including higher work in process and service parts levels as we continued to navigate current supply chain dynamics and better serve our customers.

It also reflects the timing of capital expenditures with $63 million spend year-to-date compared to $36 million in the same period last year. We’ve remained well within our one to two times target gross debt-to-EBITDA leverage ratio and are committed to maintaining our investment grade credit rate. 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 recent actions, including our plan to deploy $150 million in capital expenditures this year to fund new product investments, advanced manufacturing technologies and capacity for growth.

Our dividend payout increase of 13% over last year and our return of nearly $25 million to shareholders year-to-date through share repurchases. As we look ahead to the second half of the fiscal year, we expect continued strong demand for our innovative products in key professional segment markets. We are also encouraged by the incremental supply chain improvements that we expect will continue to enable increased production for our construction and golfing grounds products. At the same time, we will continue to closely monitor macro-economic dynamics and we’ll be prepared to remain agile through a range of possible outcomes in the near-term. With this backdrop and based on our current visibility, we are narrowing our full year fiscal 2023 net sales and adjusted diluted earnings per share guidance ranges.

For fiscal 2023, we now expect net sales growth in the range of 7% to 8% compared to 7% to 10% previously. This reflects expectations for a continuation of improved production rates for construction and golf and grounds products. This also includes anticipated volume reductions for our Residential segment as well as for professional products sold to homeowners due to unfavorable weather patterns experienced year-to-date and macroeconomic trends. This also assumes more normal weather patterns in the second half of the year. We continue to expect Professional segment net sales to grow at a rate higher than the total company average for the full year. For the Residential segment we now expect fiscal 2023 net sales to be down mid-teens as a percentage compared to fiscal 2022.

We continue to anticipate a more typical quarterly sales cadence with Q2 and Q3 being our larger quarters. Looking at profitability, we continue to expect gross margin improvement in fiscal 2023 compared to fiscal 2022. With the revision to our net sales guidance, we now expect our gross margin in the second half of the year to be lower than the first half of the year. This is primarily driven by anticipated manufacturing inefficiencies as we adjust production volumes to demand for products geared to homeowners and work to improve our inventory position as we close out the year. We expect these manufacturing inefficiencies to be partially offset by productivity gains and net price realization. In addition, for the full year, we continue to expect improvement in total company and Professional segment adjusted operating earnings as a percentage of net sales compared to last year.

We now expect a lower earnings margin for the Residential segment for the full year as compared to last year. This is a reflection of the expected reduction in volume. For our other activities categories, we expect the third quarter and the fourth quarter of fiscal 2023 to be similar to the average quarterly run rate of the first half of the year. In line with our revised net sales expectations, we are narrowing our full year adjusted EPS guidance range to $4.70 to $4.80 per diluted share from the previous range of $4.70 to $4.90. This adjusted diluted EPS estimate excludes the benefit of the excess tax deduction for share-based compensation. Additionally, for the full year, we now expect depreciation and amortization of about $125 million to $130 million, interest expense of about $57 million and free cash flow conversions of approximately 90% to 100% of reported net earnings.

We continue to expect an adjusted effective tax rate of about 21%. Turning to the third quarter of fiscal 2023, we expect total company net sales to grow at a rate slightly below the low end of our full year guidance range. For the Professional segment, we expect a net sales growth rate similar to the second quarter growth rate for that segment. For the Residential segment, we expect a meaningful reduction in the third quarter net sales year-over-year given the dynamics we mentioned. From a profitability perspective for the third quarter, we expect gross margins and adjusted operating earnings margins on a total company basis to be similar to the same period last year. For the Professional segment, we expect the third quarter earnings margin to be similar to slightly higher than the same period last year.

For the Residential segment, we expect the third quarter earnings margin to be lower than the same period last year, driven by expected lower volume and associated manufacturing inefficiencies as we adjust production to demand. We expect our third quarter adjusted diluted earnings per share to be slightly higher than they were for the same period last year. We believe we will continue to realize the benefits of a diversified portfolio of products that address attractive end markets bolstered by our extensive distribution and support network. Even with the current and expected future macro and weather dynamics, we expect to deliver 12% to 14% growth year-over-year in our full year adjusted diluted EPS, a testament to these benefits and our engaged team.

We are building our business for long-term profitable growth and remain confident in our ability to drive the same value for all stakeholders. With that, I’ll turn the call back to Rick.

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Q&A Session

Rick Olson: Thank you, Angie. As we enter the second half of the fiscal year, we are encouraged by the expected continuation of strong demand across key professional segment markets, in an improving supply chain situation, and the arrival of seasonably warmer weather. We believe we are well positioned in each of the attractive end markets we serve with our innovative product lineup supported by the best team of employees and channel partners. I would like to share some additional color on order backlog as this has been a topic of interest. Traditionally, order backlog has not been a meaningful metric for our company, given typically shorter lead times for our products. As previously reported, our order backlog was $2.3 billion at the end of fiscal 2022.

For historical perspective, our order backlog at the end of fiscal 2020 was $370 million. While some of the increase can be attributed to the growth of our business and overall inflation and seasonal variation can also be a factor, the current balance remains significantly elevated over what we would consider normal. The majority of our backlog continues to be for construction and golf and grounds products in our Professional segment. This is a result of the robust demand we’ve experienced for these products, coupled with a high level of supply chain disruption that has contributed to extended order fulfillment and influenced customer order patterns. Importantly, we achieved volume growth across these categories during the second quarter with disciplined execution supported by an improving supply chain.

At the same time, we continue to experience significant demand for these products. With this pace of new orders, our open order book at the end of the second quarter increased slightly compared to the end of the first quarter, remains higher than the balance at the end of fiscal 2022. Given this dynamic, we expect backlog to remain elevated throughout and beyond this fiscal year. Our team remains focused on optimizing output and reducing lead times to support our customers and return backlogs to a more normal level as soon as possible. Turning to the broader economy, we continue to keep an eye on monetary policy actions, the geopolitical environment and inflation. We’re also monitoring overall business and consumer confidence and spending patterns.

In addition, we’re watching developments in the banking sector including any tightening of credit conditions. As part of our normal business practice, we leverage our scale and banking relationships to offer access to attractive financing options for our channel and end customers. We expect this funding will continue to operate smoothly and believe the credit quality of our customers remain strong. We’re keeping in close contact with our banking partners as we continue to monitor developments. 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 robust demand to continue supported by multi-year public and private infrastructure investments.