Form 10-Q TORO CO For: Aug 04

September 8, 2017 6:02 AM
Table of Contents


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
ý      Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the Quarterly Period Ended August 4, 2017
 
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  ý  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  ý  No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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)
 
 
Emerging growth company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

The number of shares of the registrant’s common stock outstanding as of August 31, 2017 was 107,768,170.
 


Table of Contents

THE TORO COMPANY
INDEX TO FORM 10-Q
 
 
 
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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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
 
 
August 4,
2017
 
July 29,
2016
 
August 4,
2017
 
July 29,
2016
Net sales
 
$
627,943

 
$
600,980

 
$
2,016,549

 
$
1,923,819

Cost of sales
 
401,158

 
384,363

 
1,279,970

 
1,221,361

Gross profit
 
226,785

 
216,617

 
736,579

 
702,458

Selling, general, and administrative expense
 
139,001

 
134,664

 
428,929

 
411,576

Operating earnings
 
87,784

 
81,953

 
307,650

 
290,882

Interest expense
 
(4,750
)
 
(4,646
)
 
(14,309
)
 
(14,021
)
Other income, net
 
5,349

 
3,480

 
12,916

 
11,865

Earnings before income taxes
 
88,383

 
80,787

 
306,257

 
288,726

Provision for income taxes
 
19,979

 
24,965

 
72,388

 
87,962

Net earnings
 
$
68,404

 
$
55,822

 
$
233,869

 
$
200,764

 
 
 
 
 
 
 
 
 
Basic net earnings per share of common stock
 
$
0.63

 
$
0.51

 
$
2.16

 
$
1.83

 
 
 
 
 
 
 
 
 
Diluted net earnings per share of common stock
 
$
0.61

 
$
0.50

 
$
2.10

 
$
1.79

 
 
 
 
 
 
 
 
 
Weighted-average number of shares of common stock outstanding — Basic
 
108,456

 
109,966

 
108,434

 
109,946

 
 
 
 
 
 
 
 
 
Weighted-average number of shares of common stock outstanding — Diluted
 
111,457

 
112,112

 
111,460

 
112,154


Shares and per share data have been adjusted for all periods presented to reflect a two-for-one stock split effective September 16, 2016.

See accompanying Notes to Condensed Consolidated Financial Statements.


THE TORO COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
(Dollars in thousands) 
 
 
Three Months Ended
 
Nine Months Ended
 
 
August 4,
2017
 
July 29,
2016
 
August 4,
2017
 
July 29,
2016
Net earnings
 
$
68,404

 
$
55,822

 
$
233,869

 
$
200,764

Other comprehensive income (loss), net of tax:
 
 

 
 

 
 

 
 

Foreign currency translation adjustments
 
12,300

 
(5,753
)
 
13,017

 
(4,803
)
Cash flow derivative instruments, net of tax of $(2,262), $652, $(2,236), and $(1,000), respectively
 
(3,062
)
 
667

 
(1,100
)
 
(1,925
)
Other comprehensive income (loss)
 
9,238

 
(5,086
)
 
11,917

 
(6,728
)
Comprehensive income
 
$
77,642

 
$
50,736

 
$
245,786

 
$
194,036


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)
 
 
August 4,
2017
 
July 29,
2016
 
October 31,
2016
ASSETS
 
 

 
 

 
 

Cash and cash equivalents
 
$
335,026

 
$
277,243

 
$
273,555

Receivables, net
 
221,551

 
202,389

 
163,265

Inventories, net
 
349,022

 
327,114

 
307,034

Prepaid expenses and other current assets
 
42,550

 
39,658

 
35,155

Total current assets
 
948,149

 
846,404

 
779,009

 
 
 
 
 
 
 
Property, plant, and equipment, gross
 
890,585

 
833,664

 
838,036

Less accumulated depreciation
 
663,659

 
612,788

 
615,998

Property, plant, and equipment, net
 
226,926

 
220,876

 
222,038

 
 
 
 
 
 
 
Long-term deferred income taxes
 
59,754

 
65,216

 
57,228

Other assets
 
25,779

 
26,148

 
23,422

Goodwill
 
202,678

 
195,016

 
194,782

Other intangible assets, net
 
106,258

 
110,785

 
108,093

Total assets
 
$
1,569,544

 
$
1,464,445

 
$
1,384,572

 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

 
 

Current portion of long-term debt
 
$
23,056

 
$
22,627

 
$
22,484

Accounts payable
 
211,453

 
172,156

 
174,668

Accrued liabilities
 
309,385

 
318,628

 
266,687

Total current liabilities
 
543,894

 
513,411

 
463,839

 
 
 
 
 
 
 
Long-term debt, less current portion
 
308,793

 
331,641

 
328,477

Deferred revenue
 
24,964

 
11,958

 
11,830

Other long-term liabilities
 
31,971

 
29,585

 
30,391

 
 
 
 
 
 
 
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 107,883,039 shares as of August 4, 2017, 109,289,956 shares as of July 29, 2016, and 108,427,393 shares as of October 31, 2016
 
107,883

 
109,290

 
108,427

Retained earnings
 
578,558

 
505,131

 
480,044

Accumulated other comprehensive loss
 
(26,519
)
 
(36,571
)
 
(38,436
)
Total stockholders’ equity
 
659,922

 
577,850

 
550,035

Total liabilities and stockholders’ equity
 
$
1,569,544

 
$
1,464,445

 
$
1,384,572


Shares and per share data have been adjusted for all periods presented to reflect a two-for-one stock split effective September 16, 2016.

See accompanying Notes to Condensed Consolidated Financial Statements.


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THE TORO COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
(Dollars in thousands)
 
 
Nine Months Ended
 
 
August 4,
2017
 
July 29,
2016
Cash flows from operating activities:
 
 

 
 

Net earnings
 
$
233,869

 
$
200,764

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

 
 

Non-cash income from finance affiliate
 
(7,566
)
 
(7,302
)
Provision for depreciation, amortization, and impairment loss
 
47,713

 
46,332

Stock-based compensation expense
 
9,691

 
7,723

Provision for deferred income taxes
 
(2,121
)
 
256

Other
 
71

 
(464
)
Changes in operating assets and liabilities, net of effect of acquisitions:
 
 

 
 

Receivables, net
 
(54,935
)
 
(23,699
)
Inventories, net
 
(34,069
)
 
3,428

Prepaid expenses and other assets
 
(7,625
)
 
(2,108
)
Accounts payable, accrued liabilities, deferred revenue, and other long-term liabilities
 
86,991

 
79,055

Net cash provided by operating activities
 
272,019

 
303,985

 
 
 
 
 
Cash flows from investing activities:
 
 

 
 

Purchases of property, plant, and equipment
 
(36,572
)
 
(34,601
)
Proceeds from asset disposals
 
74

 
232

Distributions from finance affiliate, net
 
4,617

 
3,594

Proceeds from sale of a business
 

 
1,500

Acquisition, net of cash acquired
 
(24,181
)
 

Net cash used in investing activities
 
(56,062
)
 
(29,275
)
 
 
 
 
 
Cash flows from financing activities:
 
 

 
 

Repayments of short-term debt
 

 
(1,161
)
Repayments of long-term debt
 
(19,158
)
 
(20,713
)
Proceeds from exercise of stock options
 
9,756

 
19,691

Purchases of Toro common stock
 
(96,059
)
 
(69,189
)
Dividends paid on Toro common stock
 
(56,926
)
 
(49,488
)
Net cash used in financing activities
 
(162,387
)
 
(120,860
)
 
 
 
 
 
Effect of exchange rates on cash and cash equivalents
 
7,901

 
(2,882
)
 
 
 
 
 
Net increase in cash and cash equivalents
 
61,471

 
150,968

Cash and cash equivalents as of the beginning of the fiscal period
 
273,555

 
126,275

Cash and cash equivalents as of the end of the fiscal period
 
$
335,026

 
$
277,243


See accompanying Notes to Condensed Consolidated Financial Statements.


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THE TORO COMPANY AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (Unaudited)
August 4, 2017
 
Note 1 — 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 United States generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. Unless the context indicates otherwise, the terms “company,” “Toro,” “we,” “our” or “us” refer to The Toro Company and its consolidated subsidiaries. All intercompany accounts and transactions have been eliminated from the unaudited Condensed Consolidated Financial Statements.

In the opinion of management, the unaudited Condensed Consolidated Financial Statements include all adjustments, consisting primarily of recurring accruals, considered necessary for the fair presentation of the company's financial position, results of operations, and cash flows for the periods presented. Since the company’s business is seasonal, operating results for the nine months ended August 4, 2017 cannot be annualized to determine the expected results for the fiscal year ending October 31, 2017.
 
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 to Consolidated Financial Statements included in the company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2016. The policies described in that report are used for preparing quarterly reports.
 
Accounting Policies
 
In preparing the Condensed 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 promotion and incentive accruals, incentive compensation accruals, income tax accruals, inventory valuation, warranty reserves, earn-out liabilities, allowance for doubtful accounts, pension and post-retirement accruals, self-insurance accruals, useful lives for tangible and definite-lived intangible assets, and future cash flows associated with impairment testing for goodwill, indefinite-lived intangible assets 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 Condensed Consolidated Financial Statements are prepared. Changes in those estimates will be reflected in the Consolidated Financial Statements in future periods.

Note 2 — Acquisition

Effective January 1, 2017, during the first quarter of fiscal 2017, the company completed the acquisition of all the outstanding shares of Regnerbau Calw GmbH ("Perrot"), a privately held manufacturer of professional irrigation equipment. The addition of these products broadens and strengthens the company's irrigation solutions for the sport, agricultural, and industrial markets. The acquisition was funded with existing foreign cash and cash equivalents.

The purchase price of this acquisition was allocated to the identifiable assets acquired and liabilities assumed based on estimates of their fair value, with the excess purchase price recorded as goodwill. As of August 4, 2017, the company has not yet finalized the purchase accounting for the acquisition, but expects to finalize such purchase accounting in the fourth quarter of fiscal 2017. This acquisition was immaterial based on the company's consolidated financial condition and results of operations.

Note 3 — 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 primarily provides

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inventory financing to certain distributors and dealers of the company’s products in the United States. On November 29, 2016, during the first quarter of fiscal 2017, the company entered into amended agreements for its Red Iron joint venture with TCFIF. As a result, the amended term of Red Iron will continue until October 31, 2024, subject to two-year extensions thereafter. Either the company or TCFIF may elect not to extend the amended term, or any subsequent term, by giving one-year written notice to the other party.

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. The company and TCFIF each 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 $550 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 August 4, 2017 was $21.7 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.

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 receivables financed for dealers and distributors under this arrangement for the nine months ended August 4, 2017 and July 29, 2016 were $1,466.5 million and $1,389.5 million, respectively.

As of July 31, 2017, Red Iron’s total assets were $428.9 million and total liabilities were $380.8 million.

Note 4 — 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:
 
 
August 4,
2017
 
July 29,
2016
 
October 31,
2016
(Dollars in thousands)
 
 
 
Raw materials and work in process
 
$
88,440

 
$
88,581

 
$
90,463

Finished goods and service parts
 
318,940

 
302,573

 
274,929

Total FIFO value
 
407,380

 
391,154

 
365,392

Less: Adjustment to LIFO value
 
58,358

 
64,040

 
58,358

Total inventories, net
 
$
349,022

 
$
327,114

 
$
307,034

 
Note 5 — Goodwill and Other Intangible Assets

The changes in the net carrying amount of goodwill for the first nine months of fiscal 2017 were as follows:
(Dollars in thousands)
 
Professional Segment
 
Residential Segment
 
Total
Balance as of October 31, 2016
 
$
184,338

 
$
10,444

 
$
194,782

Goodwill acquired
 
6,678

 

 
6,678

Translation adjustments
 
1,080

 
138

 
1,218

Balance as of August 4, 2017
 
$
192,096

 
$
10,582

 
$
202,678



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The components of other intangible assets as of August 4, 2017 were as follows:
(Dollars in thousands)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
Patents
 
$
15,155

 
$
(11,419
)
 
$
3,736

Non-compete agreements
 
6,890

 
(6,764
)
 
126

Customer-related
 
87,507

 
(17,812
)
 
69,695

Developed technology
 
30,232

 
(26,180
)
 
4,052

Trade names
 
30,096

 
(5,889
)
 
24,207

Other
 
800

 
(800
)
 

Total amortizable
 
170,680

 
(68,864
)
 
101,816

Non-amortizable - trade names
 
4,442

 

 
4,442

Total other intangible assets, net
 
$
175,122

 
$
(68,864
)
 
$
106,258


The components of other intangible assets as of October 31, 2016 were as follows:
(Dollars in thousands)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
Patents
 
$
15,151

 
$
(10,866
)
 
$
4,285

Non-compete agreements
 
6,886

 
(6,681
)
 
205

Customer-related
 
84,353

 
(14,434
)
 
69,919

Developed technology
 
28,648

 
(23,712
)
 
4,936

Trade names
 
28,715

 
(4,235
)
 
24,480

Other
 
800

 
(800
)
 

Total amortizable
 
164,553

 
(60,728
)
 
103,825

Non-amortizable - trade names
 
4,268

 

 
4,268

Total other intangible assets, net
 
$
168,821

 
$
(60,728
)
 
$
108,093


Amortization expense for intangible assets during the third quarter of fiscal 2017 was $2.5 million, compared to $2.5 million for the same period last fiscal year. Amortization expense for intangible assets during the first nine months of fiscal 2017 was $7.4 million, compared to $8.1 million for the same period last fiscal year. Estimated amortization expense for the remainder of fiscal 2017 and succeeding fiscal years is as follows: fiscal 2017 (remainder), $2.4 million; fiscal 2018, $8.0 million; fiscal 2019, $7.1 million; fiscal 2020, $6.6 million; fiscal 2021, $6.2 million; fiscal 2022, $6.1 million; and after fiscal 2022, $65.4 million.
 
Note 6 — Stockholders’ Equity

Accumulated Other Comprehensive Loss

Components of accumulated other comprehensive loss (“AOCL”), net of tax, are as follows:
 
 
August 4,
2017
 
July 29,
2016
 
October 31,
2016
(Dollars in thousands)
 
 
 
Foreign currency translation adjustments
 
$
18,089

 
$
29,636

 
$
31,430

Pension and post-retirement benefits
 
6,683

 
4,881

 
6,359

Cash flow derivative instruments
 
1,747

 
2,054

 
647

Total accumulated other comprehensive loss
 
$
26,519

 
$
36,571

 
$
38,436



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The components and activity of AOCL for the first nine months of fiscal 2017 are as follows:
(Dollars in thousands)
 
Foreign Currency
Translation
Adjustments
 
Pension and
Post-retirement
Benefits
 
Cash Flow
Derivative
Instruments
 
Total
Balance as of October 31, 2016
 
$
31,430

 
$
6,359

 
$
647

 
$
38,436

Other comprehensive loss (income) before reclassifications
 
(13,341
)
 
324

 
2,092

 
(10,925
)
Amounts reclassified from AOCL
 

 

 
(992
)
 
(992
)
Net current period other comprehensive loss (income)
 
(13,341
)
 
324

 
1,100

 
(11,917
)
Balance as of August 4, 2017
 
$
18,089

 
$
6,683

 
$
1,747

 
$
26,519


The components and activity of AOCL for the first nine months of fiscal 2016 are as follows:
(Dollars in thousands)
 
Foreign Currency
Translation
Adjustments
 
Pension and
Post-retirement
Benefits
 
Cash Flow
Derivative
Instruments
 
Total
Balance as of October 31, 2015
 
$
24,328

 
$
5,386

 
$
129

 
$
29,843

Other comprehensive loss (income) before reclassifications
 
5,308

 
(505
)
 
2,140

 
6,943

Amounts reclassified from AOCL
 

 

 
(215
)
 
(215
)
Net current period other comprehensive loss (income)
 
5,308

 
(505
)
 
1,925

 
6,728

Balance as of July 29, 2016
 
$
29,636

 
$
4,881

 
$
2,054

 
$
36,571


For additional information on the components reclassified from AOCL refer to Note 12, Derivative Instruments and Hedging Activities.

Note 7 — Stock-Based Compensation

Stock Option Awards

Under The Toro Company Amended and Restated 2010 Equity and Incentive Plan, as amended and restated (the “2010 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 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 executive officers and other employees are subject to accelerated expensing if the option holder meets the retirement definition set forth in the 2010 plan. In that case, the fair value of the options is expensed in the fiscal year of grant because generally 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 executive 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 and non-employee directors 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 weighted-average valuation assumptions for options granted in the following fiscal periods:
 
 
Fiscal 2017
 
Fiscal 2016
Expected life of option in years
 
6.02
 
5.97
Expected stock price volatility
 
22.15%
 
24.04%
Risk-free interest rate
 
2.03%
 
1.80%
Expected dividend yield
 
1.01%
 
1.24%
Weighted-average fair value at date of grant
 
$12.55
 
$8.79

Performance Share Awards

Under the 2010 Plan, 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 fiscal 2017 and 2016 was $54.52 and $38.89, respectively. No performance shares awards were granted during the second or third quarter of fiscal 2017 or 2016.

Restricted Stock and Restricted Stock Unit Awards

Under the 2010 plan, restricted stock and restricted stock unit awards are generally granted to certain employees that are not executive officers. 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 unit awards granted during the first nine months of fiscal 2017 and 2016 was $65.86 and $41.84, respectively.

Note 8 — Per Share Data

Reconciliations of basic and diluted weighted-average shares of common stock outstanding are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
August 4,
2017
 
July 29,
2016
 
August 4,
2017
 
July 29,
2016
(Shares in thousands)
 
 
 
 
Basic
 
 

 
 

 
 

 
 

Weighted-average number of shares of common stock
 
108,456

 
109,966

 
108,417

 
109,910

Assumed issuance of contingent shares
 

 

 
17

 
36

Weighted-average number of shares of common stock and assumed issuance of contingent shares
 
108,456

 
109,966

 
108,434

 
109,946

Diluted
 
 

 
 

 
 

 
 

Weighted-average number of shares of common stock and assumed issuance of contingent shares
 
108,456

 
109,966

 
108,434

 
109,946

Effect of dilutive securities
 
3,001

 
2,146

 
3,026

 
2,208

Weighted-average number of shares of common stock, assumed issuance of contingent shares, and effect of dilutive securities
 
111,457

 
112,112

 
111,460

 
112,154


Shares and per share data have been adjusted for all periods presented to reflect a two-for-one stock split effective September 16, 2016.


10

Table of Contents

Incremental shares from options and restricted stock units are computed by the treasury stock method. For the third quarter of fiscal 2017, there were no options to purchase shares of common stock that were excluded from diluted earnings per share because they were anti-dilutive. Options to purchase 33,536 shares of common stock during the third quarter of fiscal 2016 were excluded from diluted net earnings per share because they were anti-dilutive. Options to purchase 443,003 and 487,742 shares of common stock during the first nine months of fiscal 2017 and 2016, respectively, were excluded from diluted net earnings per share because they were anti-dilutive.

Note 9 — 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 the company-owned domestic distributorship, 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 August 4, 2017
 
Professional
 
Residential
 
Other
 
Total
Net sales
 
$
468,564

 
$
152,127

 
$
7,252

 
$
627,943

Intersegment gross sales
 
6,577

 
78

 
(6,655
)
 

Earnings (loss) before income taxes
 
$
97,368

 
$
11,360

 
$
(20,345
)
 
$
88,383

(Dollars in thousands)
 
 
 
 
 
 
 
 
Three months ended July 29, 2016
 
Professional
 
Residential
 
Other
 
Total
Net sales
 
$
427,784

 
$
167,815

 
$
5,381

 
$
600,980

Intersegment gross sales
 
6,134

 
92

 
(6,226
)
 

Earnings (loss) before income taxes
 
$
89,096

 
$
12,767

 
$
(21,076
)
 
$
80,787

(Dollars in thousands)
 
 
 
 
 
 
 
 
Nine months ended August 4, 2017
 
Professional
 
Residential
 
Other
 
Total
Net sales
 
$
1,451,269

 
$
550,651

 
$
14,629

 
$
2,016,549

Intersegment gross sales
 
23,767

 
270

 
(24,037
)
 

Earnings (loss) before income taxes
 
314,545

 
62,965

 
(71,253
)
 
306,257

Total assets
 
$
852,919

 
$
207,452

 
$
509,173

 
$
1,569,544

(Dollars in thousands)
 
 
 
 
 
 
 
 
Nine months ended July 29, 2016
 
Professional
 
Residential
 
Other
 
Total
Net sales
 
$
1,361,829

 
$
550,330

 
$
11,660

 
$
1,923,819

Intersegment gross sales
 
24,100

 
289

 
(24,389
)
 

Earnings (loss) before income taxes
 
292,311

 
64,494

 
(68,079
)
 
288,726

Total assets
 
$
803,414

 
$
215,509

 
$
445,522

 
$
1,464,445


The following table summarizes the components of the loss before income taxes included in “Other” shown above:
 
 
Three Months Ended
 
Nine Months Ended
 
 
August 4,
2017
 
July 29,
2016
 
August 4,
2017
 
July 29,
2016
(Dollars in thousands)
 
 
 
 
Corporate expenses
 
$
(22,174
)
 
$
(19,903
)
 
$
(72,385
)
 
$
(68,270
)
Interest expense, net
 
(4,750
)
 
(4,646
)
 
(14,309
)
 
(14,021
)
Other
 
6,579

 
3,473

 
15,441

 
14,212

Total Other loss before income taxes
 
$
(20,345
)
 
$
(21,076
)
 
$
(71,253
)
 
$
(68,079
)


11

Table of Contents

Note 10 — 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 its risk of being a defendant in patent infringement litigation. The company is currently involved in patent litigation cases, including cases by or against competitors, where it is asserting and defending against claims of patent infringement. Such cases are at varying stages in the litigation process. The company records a liability in its Condensed 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.

Note 11 — Warranty Guarantees

The company’s products are warranted to ensure customer confidence in design, workmanship, and overall quality. Warranty coverage is generally 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 the company's 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. Service support outside of the warranty period is provided by authorized distributors and dealers at the customer's expense. The company sells extended warranty coverage on select products for a prescribed period after the original warranty period expires.

The changes in accrued warranties were as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
August 4,
2017
 
July 29,
2016
 
August 4,
2017
 
July 29,
2016
(Dollars in thousands)
 
 
 
 
Beginning balance
 
$
81,993

 
$
79,658

 
$
72,158

 
$
70,734

Warranty provisions
 
11,208

 
10,869

 
38,003

 
36,673

Warranty claims
 
(11,381
)
 
(11,894
)
 
(29,682
)
 
(28,596
)
Changes in estimates
 
(662
)
 
2,780

 
679

 
2,602

Ending balance
 
$
81,158

 
$
81,413

 
$
81,158

 
$
81,413



12

Table of Contents

Note 12 — 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’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.

To reduce its exposure to foreign currency exchange rate risk, the company actively manages the exposure of its foreign currency exchange rate risk by entering into various derivative instruments, authorized under company policies that place controls on these hedging activities, with counterparties that are highly rated financial institutions. The company’s policy does not allow the use of derivative instruments 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 hedging activities primarily involve the use of forward currency contracts to hedge most foreign currency transactions, including forecasted sales and purchases denominated in foreign currencies. The company may also utilize forward currency contracts or cross currency swaps 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 fluctuations. Decisions on whether to use such derivative instruments are primarily based on the amount of exposure to the currency involved and an assessment of the near-term market value for each currency.

Cash Flow Hedging Instruments

The company recognizes all derivative instruments as either assets or liabilities at fair value on the Condensed Consolidated Balance Sheets and formally documents relationships between cash flow hedging instruments and the related hedged transactions, as well as its risk-management objective and strategy for undertaking cash flow hedging instruments. This process includes linking all cash flow hedging instruments to the forecasted transactions, such as sales to third parties, foreign plant operations, and purchases from suppliers. Changes in fair values of outstanding cash flow hedging instruments, except the ineffective portion, are recorded in other comprehensive income within accumulated other comprehensive loss ("AOCL") on the Condensed Consolidated Balance Sheets, until net earnings is affected by the variability of the cash flows of the hedged transaction. Gains and losses on the cash flow hedging instrument representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in net earnings. The Condensed Consolidated Statements of Earnings classification of effective cash flow hedge results is the same as that of the underlying exposure. Results of cash flow 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 cash flow 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 the cash flow hedge’s inception, and on an ongoing basis, whether the cash flow hedging instruments have been highly effective in offsetting changes in the cash flows of the hedged transactions and whether those cash flow hedging instruments 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 cash flow hedge, the company discontinues cash flow hedge accounting prospectively. When the company discontinues cash flow 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 cash flow hedge accounting is discontinued and the derivative remains outstanding, the company carries the derivative at its fair value on the Condensed Consolidated Balance Sheets, recognizing future changes in the fair value in other income, net. For the third quarter of fiscal 2017, the company did not discontinue cash flow hedge accounting on any forward currency contracts designated as cash flow hedging instruments. For the nine months ended August 4, 2017, the company recognized immaterial gains on forward currency contracts reclassified into earnings as a result of the discontinuance of cash flow hedge accounting. As of August 4, 2017, the notional amount outstanding of forward contracts designated as cash flow hedging instruments was $125.8 million.


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Table of Contents

Derivatives Not Designated as Cash Flow Hedging Instruments

The company also enters into foreign currency contracts that include forward currency contracts to mitigate the remeasurement of specific assets and liabilities on the Condensed Consolidated Balance Sheets. These contracts are not designated as cash flow 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 Condensed Consolidated Statements of Earnings together with the transaction gain or loss from the hedged balance sheet position.

The following table presents the fair value of the company’s derivative instruments and Condensed Consolidated Balance Sheets location:
 
 
Fair Value at
 
Fair Value at
 
Fair Value at
(Dollars in thousands)
 
August 4, 2017
 
July 29, 2016
 
October 31, 2016
Derivative assets:
 
 

 
 

 
 

Derivatives designated as cash flow hedging instruments
 
 

 
 

 
 

Prepaid expenses and other current assets
 
 

 
 

 
 

Forward currency contracts
 
$
1,998

 
$
114

 
$
1,535

Derivatives not designated as cash flow hedging instruments
 
 

 
 

 
 

Prepaid expenses and other current assets
 
 

 
 

 
 

Forward currency contracts
 
166

 
532

 
432

Total assets
 
$
2,164

 
$
646

 
$
1,967

Derivative liabilities:
 
 

 
 

 
 

Derivatives designated as cash flow hedging instruments
 
 

 
 

 
 

Accrued liabilities
 
 

 
 

 
 

Forward currency contracts
 
$
5,173

 
$
2,070

 
$
973

Derivatives not designated as cash flow hedging instruments
 
 

 
 

 
 

Accrued liabilities
 
 

 
 

 
 

Forward currency contracts
 
1,481

 
402

 
792

Total liabilities
 
$
6,654

 
$
2,472

 
$
1,765


The following tables present the impact of derivative instruments on the Condensed Consolidated Statements of Earnings for the company’s derivatives designated as cash flow hedging instruments for the three and nine months ended August 4, 2017 and July 29, 2016, respectively:
 
 
Effective Portion
 
Ineffective Portion and Excluded from 
Effectiveness Testing
 
 
Gain (Loss) 
Recognized in OCI on
Derivatives
 
Location of Gain (Loss)
Reclassified from 
AOCL into Income
 
Gain (Loss) Reclassified 
from AOCL into Income
 
Location of Gain 
(Loss) Recognized in 
Income on Derivatives
 
Gain (Loss) Recognized 
in Income on Derivatives
(Dollars in thousands)
 
August 4,
2017
 
July 29,
2016
 
 
 
August 4,
2017
 
July 29,
2016
 
 
 
August 4,
2017
 
July 29,
2016
Three months ended
 
 
 
 
 
 
 
 
 
 
Forward currency contracts
 
$
(3,531
)
 
$
983

 
Net sales
 
$
153

 
$
(192
)
 
Other income, net
 
$
(179
)
 
$
(69
)
Forward currency contracts
 
469

 
(317
)
 
Cost of sales
 
96

 
(931
)
 
 
 
 

 
 

Total derivatives designated as cash flow hedging instruments
 
$
(3,062
)
 
$
666

 
Total
 
$
249

 
$
(1,123
)
 
Total
 
$
(179
)
 
$
(69
)

14

Table of Contents

 
 
Effective Portion
 
Ineffective Portion and Excluded from 
Effectiveness Testing
 
 
Gain (Loss) 
Recognized in OCI on
Derivatives
 
Location of Gain (Loss)
Reclassified from 
AOCL into Income
 
Gain (Loss) Reclassified 
from AOCL into Income
 
Location of Gain 
(Loss) Recognized in 
Income on Derivatives
 
Gain (Loss) Recognized 
in Income on Derivatives
(Dollars in thousands)
 
August 4,
2017
 
July 29,
2016
 
 
 
August 4,
2017
 
July 29,
2016
 
 
 
August 4,
2017
 
July 29,
2016
Nine months ended
 
 
 
 
 
 
 
 
 
 
Forward currency contracts
 
$
(3,685
)
 
$
(1,647
)
 
Net sales
 
$
2,219

 
$
1,809

 
Other income, net
 
$
190

 
$
162

Forward currency contracts
 
2,585

 
(537
)
 
Cost of sales
 
(1,227
)
 
(1,930
)
 
 
 
 

 
 

Cross currency contracts
 

 
255

 
Other income, net
 

 
(94
)
 
 
 
 

 
 

Total derivatives designated as cash flow hedging instruments

 
$
(1,100
)
 
$
(1,929
)
 
Total
 
$
992

 
$
(215
)
 
Total
 
$
190

 
$
162


As of August 4, 2017, the company expects to reclassify approximately $2.4 million of losses from AOCL to earnings during the next twelve months.

The following table presents the gain/(loss) of derivative instruments on the Condensed Consolidated Statements of Earnings for the company’s derivatives not designated as cash flow hedging instruments:
 
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
Location of Gain (Loss) 
 
August 4,
2017
 
July 29,
2016
 
August 4,
2017
 
July 29,
2016
(Dollars in thousands)
 
 
 
 
 
Forward currency contracts
 
Other income, net
 
$
(4,513
)
 
$
788

 
$
(3,959
)
 
$
(553
)
Cross currency contracts
 
Other income, net
 

 
(8
)
 

 
(191
)
Total derivatives not designated as cash flow hedging instruments
 
 
 
$
(4,513
)
 
$
780

 
$
(3,959
)
 
$
(744
)

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 Condensed Consolidated Balance Sheets.

The following table shows the effects of the master netting arrangements on the fair value of the company’s derivative contracts that are recorded in the Condensed Consolidated Balance Sheets:
(Dollars in thousands)
 
August 4, 2017
 
July 29, 2016
 
October 31, 2016
Derivative assets:
 
 

 
 

 
 

Forward currency contracts
 
 

 
 

 
 

Gross amounts of recognized assets
 
$
2,164

 
$
885

 
$
2,264

Gross liabilities offset in the balance sheets
 

 
(239
)
 
(297
)
Net amounts of assets presented in the Consolidated Balance Sheets
 
$
2,164

 
$
646

 
$
1,967

Derivative liabilities:
 
 

 
 

 
 

Forward currency contracts
 
 

 
 

 
 

Gross amounts of recognized liabilities
 
$
(6,654
)
 
$
(2,475
)
 
$
(1,765
)
Gross assets offset in the balance sheets
 

 
3

 

Net amounts of liabilities presented in the Consolidated Balance Sheets
 
$
(6,654
)
 
$
(2,472
)
 
$
(1,765
)


15

Table of Contents

Note 13 — 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 flows), 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 and cash equivalents balances are valued at their carrying amounts in the Condensed 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 unfunded deferred compensation liability is primarily subject to changes in fixed-income investment contracts based on current yields.
 
Assets and liabilities measured at fair value on a recurring basis, as of August 4, 2017, July 29, 2016, and October 31, 2016 are summarized below:
(Dollars in thousands)
 
 
 
Fair Value Measurements Using Inputs Considered as:
August 4, 2017
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 

 
 

 
 

 
 

Cash and cash equivalents
 
$
335,026

 
$
335,026

 
$

 
$

Forward currency contracts
 
2,164

 

 
2,164

 

Total assets
 
$
337,190

 
$
335,026

 
$
2,164

 
$

Liabilities:
 
 

 
 

 
 

 
 

Forward currency contracts
 
$
6,654

 
$

 
$
6,654

 
$

Deferred compensation liabilities
 
760

 

 
760

 

Total liabilities
 
$
7,414

 
$

 
$
7,414

 
$

(Dollars in thousands)
 
 
 
Fair Value Measurements Using Inputs Considered as:
July 29, 2016
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 

 
 

 
 

 
 

Cash and cash equivalents
 
$
277,243

 
$
277,243

 
$

 
$

Forward currency contracts
 
646

 

 
646

 

Total assets
 
$
277,889

 
$
277,243

 
$
646

 
$

Liabilities:
 
 

 
 

 
 

 
 

Forward currency contracts
 
$
2,472

 
$

 
$
2,472

 
$

Deferred compensation liabilities
 
1,275

 

 
1,275

 

Total liabilities
 
$
3,747

 
$

 
$
3,747

 
$


16

Table of Contents

(Dollars in thousands)
 
 
 
Fair Value Measurements Using Inputs Considered as:
October 31, 2016
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 

 
 

 
 

 
 

Cash and cash equivalents
 
$
273,555

 
$
273,555

 
$

 
$

Forward currency contracts
 
1,967

 

 
1,967

 

Total assets
 
$
275,522

 
$
273,555

 
$
1,967

 
$

Liabilities:
 
 

 
 

 
 

 
 

Forward currency contracts
 
$
1,765

 
$

 
$
1,765

 
$

Deferred compensation liabilities
 
1,149

 

 
1,149

 

Total liabilities
 
$
2,914

 
$

 
$
2,914

 
$


The company measures certain assets and liabilities at fair value on a non-recurring basis. Assets acquired and liabilities assumed as part of acquisitions are measured at fair value. There were no transfers between Level 1 and Level 2 during the three and nine months ended August 4, 2017 and July 29, 2016, or the twelve months ended October 31, 2016.

Note 14 — Subsequent Events

The company has evaluated all subsequent events and concluded that no subsequent events have occurred that would require recognition in the Condensed Consolidated Financial Statements or disclosure in the Notes to the Condensed Consolidated Financial Statements.


17

Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Unless expressly stated otherwise, the comparisons presented in this MD&A refer to the same period in the prior fiscal year. Our MD&A is presented in six sections:

·                  Company Overview
 
·                  Results of Operations
 
·                  Business Segments
 
·                  Financial Position
 
·                  Critical Accounting Policies and Estimates
 
·                  Forward-Looking Information
 
This 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, 2016. 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.

COMPANY OVERVIEW

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 products, snow and ice management products, agricultural micro-irrigation systems, rental and specialty construction equipment, and residential yard and snow thrower products. We sell our products worldwide through a network of distributors, dealers, hardware retailers, home centers, mass retailers, as well as online (direct to end-users).

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.

Shares and per share data have been adjusted for all periods presented to reflect a two-for-one stock split effective September 16, 2016.

RESULTS OF OPERATIONS

Overview

For the third quarter of fiscal 2017, our net sales increased 4.5 percent with a net earnings increase of 22.5 percent, as compared to the third quarter of fiscal 2016. Year-to-date fiscal 2017 net earnings increased 16.5 percent compared to the same period in the prior fiscal year on a net sales increase of 4.8 percent. Professional segment net sales increased 9.5 percent for the third quarter comparison, primarily due to strong demand for our landscape contractor zero-turn radius riding mowers, continued growth in our golf and grounds business, and increased irrigation sales due to our Perrot acquisition that closed in the first quarter of fiscal 2017. Professional segment net sales increased 6.6 percent for the year-to-date comparison, primarily due to increased demand for golf and grounds products, new product releases in our landscape contractor business, increased shipments of our professional snow and ice management products, and growth in our rental and specialty construction business. Residential segment net sales were down 9.3 percent for the third quarter comparison, mainly due to a transition in the timing of our Toro Days sales promotion to the second quarter of fiscal 2017, increased sales of our professional grade zero-turn radius riding mowers to homeowners with acreage, and weakened demand for our steering wheel zero-turn radius riding mowers. Residential segment net sales increased 0.1 percent for the year-to-date comparison, primarily due to higher sales of our residential snow products due to favorable snowfalls in the first quarter of fiscal 2017 and strong demand for our walk-power mowers, primarily offset by decreased sales of our zero-turn radius riding mowers due to weakened demand for our steering wheel zero-turn radius riding mowers and increased sales of our professional grade zero-turn radius riding mowers to homeowners with acreage.

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Changes in foreign currency exchange rates resulted in a reduction of our net sales of approximately $0.5 million and $6.5 million for the third quarter and year-to-date periods of fiscal 2017, respectively.

Our net earnings growth in the third quarter and year-to-date periods of fiscal 2017 was primarily attributable to increased sales while leveraging selling, general & administrative expenses ("SG&A"), as well as a lower effective tax rate, mainly driven by the adoption of ASU No. 2016-09, Stock-based Compensation ("ASU 2016-09"), in the first quarter of fiscal 2017. We currently expect the adoption of ASU 2016-09 to continue to benefit our effective tax rate for the remainder of fiscal 2017 such that the effective tax rate is anticipated to be lower than the effective tax rate we experienced during fiscal 2016. The adoption of ASU 2016-09 can add variability to our provision for income taxes, mainly due to the timing of stock option exercises, vesting of restricted stock units, and the trading price of our common stock.

We increased our cash dividend for the third quarter of fiscal 2017 by 16.7 percent to $0.175 per share compared to the $0.15 per share cash dividend paid in the third quarter of fiscal 2016.

Inventory levels increased $21.9 million, or 6.7 percent, as of the end of the third quarter of fiscal 2017 due primarily to inventory increases to support strong forecasted Professional segment sales, as well as increases due to the acquisition of Perrot that closed in the first quarter of fiscal 2017. Accounts receivable increased $19.2 million, or 9.5 percent, largely due to increased sales and the acquisition of Perrot that closed in the first quarter of fiscal 2017. As of the end of the third quarter of fiscal 2017, field inventory levels were lower for both the Professional and Residential segments when compared to the prior fiscal year period.

Our current multi-year employee initiative, “Destination PRIME,” which began with our 2015 fiscal year, continues our journey into our second century. This is our final year of this three-year initiative, which 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 strive to achieve our goals by pursuing a progression of annual milestones. 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 13 percent or less by the end of fiscal 2017. We define average net working capital as net accounts receivable plus net inventory less accounts payable as a percentage of net sales for a twelve month period.

Net Sales

Worldwide consolidated net sales for the third quarter of fiscal 2017 were $627.9 million, up 4.5 percent compared to $601.0 million in the third quarter of fiscal 2016. The net sales increase for the quarter comparison was primarily due to strong demand for our Professional segment landscape contractor zero-turn radius riding mowers, strong sales of our golf and grounds mowers, and increased irrigation sales due to our acquisition of Perrot that closed in the first quarter of fiscal 2017, partially offset by lower sales of Residential segment walk-power and zero-turn radius riding mowers mainly due to a transition in the timing of our Toro Days sales promotion to the second quarter of fiscal 2017, increased sales of our professional grade zero-turn radius riding mowers to homeowners with acreage, and weakened demand for our steering wheel zero-turn radius riding mowers. For the year-to-date period of fiscal 2017, net sales were $2,016.5 million, up 4.8 percent from the same period in the prior fiscal year. The year-to-date increase was primarily due to strong demand for products in our golf and grounds business, well-received new product releases in our Professional segment landscape contractor businesses, increased shipments of professional and residential snow and ice management products, continued growth in our rental and specialty construction businesses, and high demand for our Residential segment walk-power mowers, partially offset by decreased sales of our zero-turn radius riding mowers due to weakened demand for our steering wheel zero-turn radius riding mowers and increased sales of our professional grade zero-turn radius riding mowers to homeowners with acreage.

International net sales were up 9.8 percent and 4.8 percent for the third quarter and year-to-date periods of fiscal 2017, respectively. The net sales increase for the third quarter comparison was primarily due to sales from our Perrot acquisition that closed in the first quarter of fiscal 2017, increased sales of our Professional segment landscape contractor and Residential segment zero-turn radius riding mowers, and growth of our golf and grounds business, partially offset by lower sales of Residential segment walk-power mowers. The net sales increase for the year-to-date period comparison was mainly due to increased irrigation sales from our Perrot acquisition, along with increased Pope-branded irrigation product sales due to favorable weather conditions in Australia, growth of our golf and grounds business, and increased shipments of Professional segment landscape contractor equipment, partially offset by lower sales of our Residential segment walk-power and zero-turn radius riding mowers. Both periods of fiscal 2017 were negatively impacted by changes in foreign currency exchange rates.


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The following table summarizes the major operating costs and other income as a percentage of net sales:
 
 
Three Months Ended
 
Nine Months Ended
 
 
August 4, 2017
 
July 29, 2016
 
August 4, 2017
 
July 29, 2016
Net sales
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
 
63.9

 
64.0

 
63.5

 
63.5

Gross profit
 
36.1

 
36.0

 
36.5

 
36.5

Selling, general, and administrative expense
 
22.1

 
22.4

 
21.2

 
21.4

Operating earnings
 
14.0

 
13.6

 
15.3

 
15.1

Interest expense
 
(0.8
)
 
(0.8
)
 
(0.7
)
 
(0.7
)
Other income, net
 
0.9

 
0.6

 
0.6

 
0.6

Provision for income taxes
 
3.2

 
4.1

 
3.6

 
4.6

Net earnings
 
10.9
%
 
9.3
%
 
11.6
%
 
10.4
%

Gross Profit

As a percentage of net sales, gross profit for the third quarter of fiscal 2017 was 36.1 percent, up 10 basis points when compared to the third quarter of fiscal 2016. The third quarter comparison results were up primarily due to the impact of segment mix and productivity improvements, which were partially offset by higher commodity and freight costs. Gross profit as a percentage of net sales for the fiscal 2017 year-to-date period was 36.5 percent, consistent with the same period last fiscal year. The year-to-date comparison results were also primarily due to productivity improvements and the impact of segment mix, offset by higher commodity and freight costs, as well as unfavorable foreign currency exchange rates.

Selling, General, and Administrative Expense

SG&A expense increased $4.3 million, or 3.2 percent, for the third quarter of fiscal 2017 and increased $17.4 million, or 4.2 percent, for the year-to-date period of fiscal 2017. As a percentage of net sales, SG&A expense decreased 30 basis points and 20 basis points for the third quarter and year-to-date periods of fiscal 2017, respectively. The decrease as a percentage of net sales for the third quarter comparison was primarily due to lower warranty and direct marketing expenses, partially offset by higher incentive expense attributable to improved expected company performance in fiscal 2017. SG&A expense as a percentage of net sales for the year-to-date comparison was down compared to the prior fiscal year, mainly due to lower administrative and direct marketing expenses, partially offset by higher incentive expense as mentioned in the quarter comparison.

Interest Expense

Interest expense for the third quarter and year-to-date periods of fiscal 2017 increased by 2.2 percent and by 2.1 percent, respectively, when compared to the prior fiscal year comparative periods.

Other Income, Net

Other income, net for the third quarter and year-to-date periods of fiscal 2017 increased by $1.9 million and by $1.1 million, respectively, compared to the same periods last fiscal year. The increase in the third quarter comparison was driven by foreign currency exchange rate gains. The increase in the year-to-date period of fiscal 2017 was mainly due to foreign currency exchange rate gains, partially offset by a litigation recovery and the sale of our Northwestern U.S. distribution company, both of which occurred in the first quarter of fiscal 2016 and did not repeat in fiscal 2017

Provision for Income Taxes

The effective tax rate for the third quarter of fiscal 2017 was 22.6 percent compared to 30.9 percent in the third quarter of 2016. The effective tax rate for the year-to-date period of fiscal 2017 was 23.6 percent compared to 30.5 percent in the same period of fiscal 2016. The decrease in the third quarter of fiscal 2017 was primarily driven by discrete tax items, including favorable one-time adjustments related to prior years and a $2.9 million benefit related to share-based compensation due to the adoption of ASU 2016-09 in the first quarter of fiscal 2017. The decrease in the year-to-date period of fiscal 2017 was primarily driven by a discrete tax benefit of $18.9 million, related to share-based compensation. The adoption of ASU 2016-09 can add variability to our provision for income taxes, mainly due to the timing of stock option exercises, vesting of restricted stock units, and the trading price of our common stock.

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Net Earnings

Net earnings for the third quarter of fiscal 2017 were $68.4 million, or $0.61 per diluted share, compared to $55.8 million, or $0.50 per diluted share, for the third quarter of fiscal 2016, resulting in a net earnings per diluted share increase of 22.0 percent. Year-to-date net earnings in fiscal 2017 were $233.9 million, or $2.10 per diluted share, compared to $200.8 million, or $1.79 per diluted share, in the prior fiscal year comparative period, resulting in a net earnings per diluted share increase of 17.3 percent. The primary factors contributing to the net earnings increase for the third quarter and year-to-date comparative periods included leveraging SG&A expense over higher sales volumes and a lower effective tax rate, mainly driven by the adoption of ASU 2016-09 in the first quarter of fiscal 2017. 

BUSINESS SEGMENTS

We operate in three reportable business segments: Professional, Residential, and Distribution. Our Distribution segment, which consists of our company-owned domestic distributorship, 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
(Dollars in thousands)
 
August 4, 2017
 
July 29, 2016
 
$ Change
 
% Change
Professional
 
$
468,564

 
$
427,784

 
$
40,780

 
9.5
 %
Residential
 
152,127

 
167,815

 
(15,688
)
 
(9.3
)%
Other
 
7,252

 
5,381

 
1,871

 
34.8
 %
Total net sales*
 
$
627,943

 
$
600,980

 
$
26,963

 
4.5
 %
 
 
 
 
 
 
 
 
 
* Includes international net sales of:
 
$
139,434

 
$
126,975

 
$
12,459

 
9.8
 %
 
 
Nine Months Ended
(Dollars in thousands)
 
August 4, 2017
 
July 29, 2016
 
$ Change
 
% Change
Professional
 
$
1,451,269

 
$
1,361,829

 
$
89,440

 
6.6
%
Residential
 
550,651

 
550,330

 
321

 
0.1
%
Other
 
14,629

 
11,660

 
2,969

 
25.5
%
Total net sales*
 
$
2,016,549

 
$
1,923,819

 
$
92,730

 
4.8
%
 
 
 
 
 
 
 
 
 
* Includes international net sales of:
 
$
472,317

 
$
450,577

 
$
21,740

 
4.8
%

The following table summarizes segment earnings (loss) before income taxes:
 
 
Three Months Ended
(Dollars in thousands)
 
August 4, 2017
 
July 29, 2016
 
$ Change
 
% Change
Professional
 
$
97,368

 
$
89,096

 
$
8,272

 
9.3
 %
Residential
 
11,360

 
12,767

 
(1,407
)
 
(11.0
)%
Other
 
(20,345
)
 
(21,076
)
 
731

 
3.5
 %
Total earnings before income taxes
 
$
88,383

 
$
80,787

 
$
7,596

 
9.4
 %