The Toro Company (TTC) Earnings Call Transcript & Summary

Join us again this year at our Global Industrial Conference. Toro is an equipment manufacturer with leading positions in the golf, commercial landscape, specialty construction, snow irrigation and residential markets. And from the company, we have Chairman and CEO, Rick Olson; we have CFO, Renee Peterson; and then we have Angie Drake, who is the VP of Finance, in the front row over here. We're going to start with a couple of prepared remarks and slides, and then we'll hop into Q&A. So with that, I'll turn the floor over to Rick.

Okay. Thanks, Tim. I am Rick Olson. I'll mention a few things about the company, and we'll go into the Q&A. The first thing I wanted to share is just, really, to understand who The Toro Company is, you need to understand what drives us, what gets us up in the morning. And for us, our purpose is to get up in the morning with the idea of helping our customers be successful in enhancing the beauty, the productivity and sustainability of the land. And we do that through introducing incredibly cool, great solutions and products for our customers to help them achieve what they're trying to do. And we want to earn the right to be the market share leader in every market that we participate in. We do all of that through a thread of relationships that cut through all of our businesses. And when I say that, I'm talking about 100-year relationships. And as a 100 year -- 108-year-old company, we have relationships that go back multiple generations for more than 100 years. Just looking at the last decade, 2011 through '21, you can see our performance just under 8% combined annual growth rates, 14% growth in earnings per share CAGR and just under 25% return on invested capital. This has kind of accelerated since the greater frequency of acquisitions starting in 2015 and to a greater extent in 2019. So it's a little bit loaded towards the back end of that period. If you are somebody that casually knows The Toro Company, it's usually because of our residential business. But the residential business today, as you can see in the bottom 2 of these graphs, is about 25% of our business. 75% of our business is on the professional side. These are customers that make a living using our products or they're part of a business model. They tend to be planned capital purchases, and there are things like landscape contractors, golf courses, municipalities would fall into that category as well. Breaking that down a little bit further. About 28% of the total revenue for the company is the golf and grounds business -- excuse me, the grounds and landscape business. 26% is the underground business and construction. The greatest piece of that is from the acquisition in 2019 of Charles Machine Works and the brand that you're probably familiar with, Ditch Witch, that is the leader in underground drills, trenchers and everything that's underground, utilities, et cetera. And then you can see golf is still an important business for us from a revenue standpoint at 17%, followed by ag and micro-irrigation. So just a few things I would call out, especially in a time of uncertainty in the economy as we go forward. Our products are used for work, and they are essential. They're not optional products. If you think about a golf course, even if there is a recession, you can't choose to not maintain the golf course. And the grass for our residential customers or landscape contractors grows, whether -- whatever is happening with the economy or other factors. More than roughly 90% of our products are replacement products. So that is an installed -- that's on top of an installed base that turns over with a fairly regular period. We've got, really, an incredible distribution network across each of our businesses. It varies from mass -- the mass retailers on our residential side through some very -- dealers and distributors that have deep relationships with our golf and grounds customers on the professional side and the underground, especially. Innovation is a key part of our story. We've been focused on 3 particular innovation areas for the past 5 years. Number one is alternative power, which is primarily about battery conversion, but also hybrid technology. That's a key part of our portfolio. Number two, smart and connected products, products that do more for the operators, so the operators don't need the same level of skill connected to be able to do things as a multi-node system for our customers. And then finally, autonomous. So we've been overweight in these areas with our R&D and development, and we're really seeing the fruits of those labors now as we're introducing commercialized products in these categories. And all-season exposure, this is something that also has transformed in the company throughout the last decade and a little bit more at the -- in the period of the Great Recession. We really were looking at traditional turf Toro products. And through acquisitions, we have much greater and more even exposure across the seasons, so greater exposure with our BOSS acquisition to the winter. But more importantly, with the acquisition of Charles Machine Works, Ditch Witch, that's really not a seasonal business, and it's not really weather-dependent. So that really provides more consistency. And just an idea of the brands, about half of these brands have been through acquisition within the last -- since 2015. And I think you're probably familiar with many of them. So with that -- yes.

Great. Thank you so much. If anybody has any questions, feel free to raise your hand or you can e-mail [email protected].

Maybe just to start, Rick, you've got several different end markets. But as you kind of look at those product lines or end markets and golf, commercial landscape, those types of places, I mean, where -- as you look into next year, where do you have the most excitement? And I guess, where there's some places, maybe in residential, where you've seen a little bit of weakening?

Just to hit a few of the key markets. First of all, the underground market is a big driver for us, currently, and we expect that to be a strong driver well into the future. That's driven -- in 2019, we really talked about it being driven by the implementation of the 5G build-out or the 5G build-out, which is still probably only about at the 20% level. You can layer on top of that the realization during the pandemic that there's a broadband divide in the funding that's gone towards bringing fiber optics, basically, to every residence in the world. And then layer on top of that the infrastructure funding that was passed as part of the infrastructure bill, which has many elements of -- that directly hit these businesses. Whether it's the clean energy, grid build-out, charging stations, wind power, solar, all of that has to be connected back to the power grid, and it's all done with our equipment. Golf is the healthiest it's ever been. I've been with the company for 36 years, and it's the best time ever for golf right now, and including forward-looking. We know that there was obviously a boost during the COVID period. But even as that has really waned, the fundamentals of golf are better than ever. Golf courses are healthy backlogs for privates. Private golf courses are at a high, and new people entering that sports of different demographics and different ages really gives us a lot of confidence for the future. And that started before the pandemic. It was juiced by the pandemic, but it's really was happening before that. Residential continues to be strong. We grew by roughly 50% between 2019 and '21. But -- some of that was the pandemic, but the larger portion, really, was going out and getting new mass -- a new mass partner in Tractor Supply and, essentially, completely rebooting our product line, our branding, our messaging, our marketing. That's going to continue to drive that business as we're taking share in those categories. So those are just a few.

Those are just a few. And when you look at -- historically, you've been relatively a book-and-ship type business. But just given the supply chain challenges, you do have a bigger backlog kind of entering or kind of thinking about '23 than you normally have. So I know it's a big kind of question, but like as you look at '23 and you think about the visibility, what's in the backlog that gives you confidence that '23 could be a pretty good year?

Yes. To give you an idea of the scale, we report back orders at the end of our fiscal year. So we just -- I'm actually referring to October 31, 2021, when we reported it last. We normally have about $150 million of orders that are just in process when we end the year. We finished last year with $1.6 billion in back orders, so roughly 10x the normal level. Since then, our supply chain has gotten better, but the demand has just continued to come very strongly as it is today, driven primarily from the professional large categories. Largest portion of our backlog is in the underground and construction area. Second largest is golf and grounds. In the case of golf and grounds, many of those customers kind of paused in 2020. But then they came back with just, literally, in some cases, double the orders in 2021 and beyond. And I think the key thing to think about for us is our products, again, are not used for recreation. They're used as part of work that has to be done. And if the grass is growing, it's got to be maintained. So if you skip your capital purchases in '20, you've got to make up in that cycle somewhere because a portion of the equipment is consumed as part of just the normal usage of the equipment.

Right. Right. And then even within -- because we have seen areas where backlogs have kind of grown because customers have kind of scattered orders out to each individual company and trying to basically figure out which one they can get it from first. But I mean, if you look at golf, if you look at underground, I mean, do you think that's happening? I mean it seems like those are markets that are relatively fragmented. And if you've had the supply chain challenges you have, I would assume that your competitors as well.

Yes. Especially in those 2 important markets for us, we have market share leadership. So there are not -- first of all, there's just not a host of other places that you can go. So we've got roughly 50% market share in golf. We've got 50% roughly in the underground business that I talked about. We know that our other major competitor in each of those categories is going through the same kind of challenges that we are. So there aren't too many places you can go. We're actually very much focused on really trying to support our customers. In some cases -- many cases, helping them find used equipment, helping them keep their current equipment running with service parts, which has been a strong revenue stream for us, and even in some cases, helping them find a piece of competitive equipment just to make sure we can support them. Because fundamentally, that's our purpose, is to keep our customers successful.

Any questions from the audience? There's one here. So during recessions, which end markets do you normally see declines and by how much? And then how flexible are your costs in that type of [ different ] backdrop?

So we can look to a couple of the recent examples. And one thing that may be interesting in this, our residential business has been an absolute champ in periods of recession. So you can go back -- we're more familiar with the current recession for the last -- in the last couple of years. But if you go back to 2008, '09 an '10, those were record years for our residential business in their growth path. And why is that? Again, it comes back to the idea, it was a great summer for grass. Early spring, lots of requirements for usage of equipment. In some cases, people may have been laid off or something. So they cut their own grass, that type of thing. So residential is very strong. And then the typical cycle for our professional businesses is that they may pause, but then again, they have to make up for that. So even in 2008, 2009, part of 2009, where they did pause, pulled back on their capital investments, it came back very strongly in the following 2 years, where we were growing double digits following that. So there's just -- there's kind of no getting around that -- you need to replace the equipment.

Okay. There's another one here from the audience. Just what percentage of your sales get financed by your customers? And then how do you think about higher rates either impacting your customers or your own business?

So I can answer that question. We don't do financing, but a number of our customers do finance. I don't have any exact percentages. It's going to be more heavily weighted to the professional business as far as those who do finance, although some residential customers do as well. As far as the impact on rates, this is part of their business. So as Rick had said, it's really a product that is used for work. So they can't do their job without having the product. So what they typically will do, we'll build that into the cost of their service, and they'll adjust their service accordingly. So we normally don't see a big impact as far as their capital purchases because of the nature of how the product is used.

Okay. And then maybe just switching gears a little bit to R&D. One of the hallmarks of Toro has always been your commitment to R&D. And I think it's maybe declined once as a percentage of sales over the last like 10 or 15 years. But you spent $140 million on R&D last year. I mean, how are you -- what are the areas that you're focused? And I guess, how has that evolved over the last 3 to 5 years?

Sure. So the 3 areas of focus that we've had, really, 4 or 5 years now consistently are, number one, alternative power. So it's the -- it's a lot about battery conversion right now, but the #1 fairway mower, for example, today is a hybrid mower for golf courses. So hybrid is part of it, too. So number one, alternative power. Number two, smart and connected products, again, that do more for the operator. So the operator doesn't need the same level of skill. And then connecting systems together and we -- since we are the only supplier that has both irrigation and equipment for golf course and grounds, we can combine those technologies and provide information that are -- that help them do their job better. The people are managing those areas. So number one, alternative power; number two, smart connected; number three is autonomous and robotic. So we've been overweighting our R&D to these areas, and we've been challenging projects that don't contribute to these transitions. So a question here?

[indiscernible]

I think we learn -- yes, absolutely. Every -- we try to learn everything we can, even some of the challenges from a -- especially electric standpoint, battery electric standpoint. Autonomous has some challenges in any context, but we can be in a relatively more contained area where we can take a little bit -- I wouldn't say a risk, but we can push the envelope a little bit more. And so the answer to your question is, yes, we try to learn everything we can from automotive plus other industries like ag, where there's a lot of activity taking place, too. But for us, the biggest thing is, as a company with a number of business areas, we're really focus on trying to leverage those technologies across all of our businesses. So the $140 million, that's been increased through every acquisition. But when we do the acquisition, we can consolidate the common activities and then add new areas of technology. So it's much more efficient $140 million even -- than it is independently.

And can you -- do you have a follow-up?

[indiscernible]

Yes. The question is the impact on the channel. And one of the things I would say is I think our existing channels will continue to exist in that environment, but not all of our channel partners will be able to have the sophistication to be able to support those. So it does predict a little bit of sorting of our channel partners, those that will be able to support those technologies and those that will not.

On the kind of cross-sectional R&D, I mean, could you -- let's just maybe take alternative power, for example. I mean could you talk about what you're doing on the residential side and how that's influenced how you're doing on the commercial side, just in terms of battery technology and the use cases there?

Absolutely. So the residential business, we have our 60-volt Flex-Force system. That is -- at the heart of it is a terrific walk power mower lineup and now snow. We predicted -- I don't know, 10 years ago, we said things are going electric, but we'll never have electric snow that's as good as gas. We had a 2-stage last year, and it was a fantastic experience. So that's the core for us is the terrific core pieces for residential. We have not historically had products for a long time in some of the categories like chainsaws, pull saws, et cetera. All of that is pretty much additive to us. As we sell the battery system, those bare tools become attractive for our customers and easy to add on. And those are categories that are pretty much additive to us that we have not been major players in the past. And if you switch over to the commercial side, the thing that we have done is we literally took a wall of every product in the company and looked at the power requirements and made a matrix and circled groupings that were similar and then created systems that could be used across the different categories. So some of those are high volumes, some of them are low, but they have a similar profile. That's allowed us to just -- to introduce products in relatively niche categories that are just remarkable. If it's a powered Mud Buggy for the rental category, people and competitors walk up and say, "Well, how could you possibly do that, that level of development?" It's because it's very meticulously leveraged across other common profiles across the company. So it's -- back to the $140 million, it's a very efficient $140 million that it's really -- we're getting more return than we ever have.

Good. And I guess, on autonomous, how do you see that develop? I mean -- because we're talking a lot about batteries, but it seems like autonomous is really kind of the golden goose, if you will. How are you thinking about that becoming a commercial product, not only in the resi space, but even as you get into commercial and golf and those types of areas?

Yes. So residential, we'll be introducing our solution next summer, which is a free-of-a-boundary wire. So it's actually a vision-based system and combines a lot of technologies to be able to do that and excited about that independently. But on the professional side, if you look at the golf industry, today, we have our beta fully autonomous products operating on fairways. I think we just shut them down in the -- so we're moving them to Florida. And I mean, we're very excited about the results of what we're seeing so far in real-world conditions where real customers are using them, and we think that's just the start. And for us, it's really helped us to develop not only our internal capabilities, but we've partnered with a few people. And then more importantly, we've targeted acquisitions with technology that can be used across our company and especially in autonomous. So 2021, we acquired Left Hand Robotics in Longmont, Colorado. We acquired TURFLYNX in Portugal. Portugal happens to be a hot bed for autonomous. University of Lisbon has a discipline in robotics and autonomous. It's been very helpful for us from a talent standpoint. All that put together has provided a great base for us to, across the company, be able to provide autonomous solutions going forward. We're just starting to see the fruits of those labors.

Good. Good. Maybe just kind of turning to price. Historically, for as long as I've covered the company, Toro has always had the, I think, tagline has always been your price to market, right, not necessarily price to cost. So now that we're starting to see pricing flow through more meaningfully in the top line, we're starting to see maybe raw material costs starting to kind of plateau a little bit. Is there a margin opportunity as price/cost normalizes for Toro over the next 1 to 2 years?

Go ahead.

Yes. We are starting to see a benefit from that. I think when we entered the pandemic, we just saw such significant inflation. So I wouldn't say that, at that point in time, we were seeing that as a benefit. It was actually the opposite. But as you see us go through the last fiscal year, you've seen our gross margins improve, and we're starting to see that momentum as we go forward. So we would expect that to continue. We'll work very hard to capture cost-reduction opportunities when, at some point in time, costs start to normalize and hopefully see that as a margin expansion opportunity.

Historically, you haven't -- when you've taken price, have you had to give that back to the market?

Yes, we have not. Normally, what we would do -- we've not adjusted our list prices, you're correct. What we would tend to do if there is a particular competitive situation, we'll be pretty surgical and address that situation with some type of a marketing program or another type of discount that only relates to that situation versus changing our list price. So that would be our intent going forward.

So another question here from the audience. Just how would you characterize your incremental versus decremental margins?

So from an incremental margin perspective, you can look at our actual results historically, and it depends on the mix of business, too. If we're seeing the growth more from a professional standpoint, our incremental margins are greater than from a residential perspective. On a decremental standpoint, we do tend to see a greater decremental initially, and then we adjust accordingly. And one thing we would try to do is to continue our focus on innovation because if there is a time of difficulty from an economic perspective, our investment in innovation has allowed us to recover from that even stronger. So that would be one area that we probably would adjust more modestly. But we're used to having to adjust. Sometimes it relates to changes in the weather, unfavorable patterns. And we can do that pretty quickly.

Okay. There's another question here. Does the change -- does the technology development, does that encourage more industry consolidation at some point?

I think that the answer to that is probably speculation at this point. I think that it is going to be difficult for, especially smaller players, to be able to have the scale to do some of what needs to be done in those areas. So that's pure speculation. But I think it's going to be challenging to -- especially when you get into autonomous, there's a tremendous kind of hidden support system that's required to make those systems run. So that's speculation, but I think it's going to be a challenge for some players.

Have you seen that as you've kind of done some of the M&A transactions that you've done, like Intimidator Group, for example?

I think Intimidator had a great business, still does, standalone. But as they start to think about electrification, for example, the idea that they could be part of a bigger strategy from an underlying technology standpoint was something that was very attractive to them. So that's exactly right.

Okay. And then just maybe on the underground business, 5G and some of the utility work has really been a driver of that historically. Now you've got some of the legislation around infrastructure and Inflation Reduction Act and things like that. I mean, how are you prepping that business internally to be able to handle whatever type of increase you're expecting to see in those businesses?

Yes. Today, it's still -- we're still constrained by the supply chain suppliers, specifically, a few categories. Probably all companies are talking about chips and wiring harnesses, hydraulic components, et cetera. But we know that, that's going to continue to get better. It already has over this last year. So we are addressing what we know will be the next of those challenges. We know that labor capacity will be a challenge at some point. So we're working on things like automation in certain categories, making sure key constraints within the plant have been addressed like paint systems, again, welding, those types of things. And then we're always looking at footprint, making sure that we've got -- we can -- we have pretty good tools to project out into the future and make sure that we're not going to have our own constraints once the supplier situation gets better.

And then from an M&A perspective, you have -- Intimidator has been a relatively large deal. Charles Machine Works is a pretty large deal. I mean have -- I guess, how is the pipeline? And is it just coincidental that some of the deals that you've done recently are bigger? Or is it actually strategically something that you're trying to do more actively?

I wouldn't say that we are, as a pure priority, looking for larger deals. We have really done a mix of that throughout the last several years. So if you think about we did Ditch Witch, Charles Machine Works in 2019 and 2020; Ventrac, which has been a fantastic acquisition for us, driving really real growth at a profitable level. But then we came back and did a few smaller ones of Left Hand Robotics, TURFLYNX. We've, just this year, not only done Spartan, but we've done some smaller deals. VSI is a brine technology for our snow business that uses 60% less salt. It's a great environmental play. So it's really -- it starts with strategy for us. And if you think about the Intimidator Group, for example, we went looking for the perfect fit and complement with our businesses. And size was a consideration, but it's not the #1.

And I guess you have done more M&A. So I mean, how has the playbook kind of evolved in terms of integrating and going out and finding those acquisitions?

I'd say the playbook has evolved in one way that we've got -- we've gained a lot of confidence in our ability to integrate. Angie Drake, who's here, actually came with the Ditch Witch acquisition and was key to our integration there. So we can -- we look at companies a little bit differently with understanding what can be done and with a higher confidence level that we can do it successfully because we've -- so far, we have a very good track record since 2015.

Great. We're out of time. So please join me in thanking the Toro team for being here.

Thank you.