TORO CO - Quarter Report: 2015 July (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

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

 

For the Quarterly Period Ended July 31, 2015

 

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

 

For the Transition Period from            to           

 

THE TORO COMPANY

(Exact name of registrant as specified in its charter)

 

 

8111 Lyndale Avenue South

Bloomington, Minnesota  55420

Telephone number: (952) 888-8801

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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

 

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

 

 

Table of Contents

 

THE TORO COMPANY

INDEX TO FORM 10-Q

 

			Page Number
PART I.	FINANCIAL INFORMATION:
Item 1.	Financial Statements
		Condensed Consolidated Statements of Earnings (Unaudited) – Three and Nine Months Ended July 31, 2015 and August 1, 2014	3
		Condensed Consolidated Statements of Comprehensive Income (Unaudited) – Three and Nine Months Ended July 31, 2015 and August 1, 2014	3
		Condensed Consolidated Balance Sheets (Unaudited) – July 31, 2015, August 1, 2014, and October 31, 2014	4
		Condensed Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended July 31, 2015 and August 1, 2014	5
		Notes to Condensed Consolidated Financial Statements (Unaudited)	6-17
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	17-27
Item 3.		Quantitative and Qualitative Disclosures about Market Risk	27-28
Item 4.		Controls and Procedures	29
PART II.	OTHER INFORMATION:
Item 1.		Legal Proceedings	29
Item 1A.		Risk Factors	29
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 6.		Exhibits	31
		Signatures	32

 

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PART I.  FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings (Unaudited)

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

 

		Three Months Ended						Nine Months Ended
		July 31,			August 1,			July 31,			August 1,
		2015			2014			2015			2014
Net sales		$	609,615		$	567,540		$	1,910,068		$	1,758,551
Cost of sales		393,225			365,460			1,242,707			1,128,417
Gross profit		216,390			202,080			667,361			630,134
Selling, general, and administrative expense		136,985			130,043			405,079			386,620
Operating earnings		79,405			72,037			262,282			243,514
Interest expense		(4,587		)	(3,629		)	(14,071		)	(11,065		)
Other income, net		2,798			2,390			7,515			6,220
Earnings before income taxes		77,616			70,798			255,726			238,669
Provision for income taxes		24,292			20,785			77,689			75,701
Net earnings		$	53,324		$	50,013		$	178,037		$	162,968
Basic net earnings per share of common stock		$	0.96		$	0.89		$	3.19		$	2.88
Diluted net earnings per share of common stock		$	0.94		$	0.87		$	3.13		$	2.82
Weighted-average number of shares of common stock outstanding — Basic		55,310			55,965			55,739			56,494
Weighted-average number of shares of common stock outstanding — Diluted		56,552			57,320			56,953			57,800

 

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in thousands)

 

		Three Months Ended						Nine Months Ended
		July 31,			August 1,			July 31,			August 1,
		2015			2014			2015			2014
Net earnings		$	53,324		$	50,013		$	178,037		$	162,968
Other comprehensive (loss) income, net of tax:
Foreign currency translation adjustments		(3,534		)	(620		)	(10,648		)	541
Derivative instruments, net of tax of $(379), $531, $(526), and $891, respectively		(1,055		)	446			(2,394		)	1,036
Other comprehensive (loss) income		(4,589		)	(174		)	(13,042		)	1,577
Comprehensive income		$	48,735		$	49,839		$	164,995		$	164,545

 

See accompanying notes to condensed consolidated financial statements.

 

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THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Balance Sheets (Unaudited)

(Dollars in thousands, except per share data)

 

		July 31,			August 1,			October 31,
		2015			2014			2014
ASSETS
Cash and cash equivalents		$	110,335		$	177,894		$	314,873
Receivables, net		227,806			215,595			158,158
Inventories, net		350,194			293,761			274,603
Prepaid expenses and other current assets		39,743			33,764			33,580
Deferred income taxes		43,339			38,735			42,822
Total current assets		771,417			759,749			824,036
Property, plant, and equipment		802,305			770,758			760,192
Less accumulated depreciation		581,983			567,930			554,997
		220,322			202,828			205,195
Long-term deferred income taxes		26,364			25,951			26,075
Other assets		25,317			22,226			21,429
Goodwill		194,727			91,812			91,851
Other intangible assets, net		121,804			25,261			23,829
Total assets		$	1,359,951		$	1,127,827		$	1,192,415
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current portion of long-term debt		$	23,279		$	140		$	6,640
Short-term debt		5,189			1,134			20,818
Accounts payable		169,927			168,956			124,271
Accrued liabilities		300,576			289,519			248,691
Total current liabilities		498,971			459,749			400,420
Long-term debt, less current portion		358,053			223,800			347,316
Deferred revenue		11,324			11,102			10,947
Deferred income taxes		7			5,969			—
Other long-term liabilities		26,423			14,474			25,005
Stockholders’ equity:
Preferred stock, par value $1.00 per share, authorized 1,000,000 voting and 850,000 non-voting shares, none issued and outstanding		—			—			—
Common stock, par value $1.00 per share, authorized 175,000,000 shares; issued and outstanding 54,835,233 shares as of July 31, 2015, 55,705,894 shares as of August 1, 2014, and 55,678,419 shares as of October 31, 2014		54,835			55,706			55,678
Retained earnings		439,085			368,020			368,754
Accumulated other comprehensive loss		(28,747		)	(10,993		)	(15,705		)
Total stockholders’ equity		465,173			412,733			408,727
Total liabilities and stockholders’ equity		$	1,359,951		$	1,127,827		$	1,192,415

 

See accompanying notes to condensed consolidated financial statements.

 

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THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)

 

		Nine Months Ended
		July 31,			August 1,
		2015			2014
Cash flows from operating activities:
Net earnings		$	178,037		$	162,968
Adjustments to reconcile net earnings to net cash provided by operating activities:
Non-cash income from finance affiliate		(6,223		)	(5,598		)
Provision for depreciation, amortization, and impairment loss		45,944			38,104
Stock-based compensation expense		7,815			8,478
Increase in deferred income taxes		(2,096		)	(43		)
Other		(67		)	2
Changes in operating assets and liabilities, net of effect of acquisitions:
Receivables, net		(74,916		)	(59,774		)
Inventories, net		(67,902		)	(53,716		)
Prepaid expenses and other assets		(5,563		)	1,167
Accounts payable, accrued liabilities, deferred revenue, and other long-term liabilities		92,985			72,625
Net cash provided by operating activities		168,014			164,213
Cash flows from investing activities:
Purchases of property, plant, and equipment		(37,544		)	(53,228		)
Proceeds from asset disposals		77			161
Distributions from finance affiliate, net		1,928			2,324
Acquisitions, net of cash acquired		(198,329		)	(715		)
Net cash used in investing activities		(233,868		)	(51,458		)
Cash flows from financing activities:
(Repayments of) increase in short-term debt		(16,283		)	300
(Repayments of) increase in long-term debt		(3,831		)	18
Excess tax benefits from stock-based awards		7,808			8,536
Proceeds from exercise of stock options		8,615			6,813
Purchases of Toro common stock		(90,993		)	(100,507		)
Dividends paid on Toro common stock		(41,794		)	(33,871		)
Net cash used in financing activities		(136,478		)	(118,711		)
Effect of exchange rates on cash and cash equivalents		(2,206		)	857
Net decrease in cash and cash equivalents		(204,538		)	(5,099		)
Cash and cash equivalents as of the beginning of the fiscal period		314,873			182,993
Cash and cash equivalents as of the end of the fiscal period		$	110,335		$	177,894
Supplemental disclosure of cash flow information:
Debt issued in connection with an acquisition		$	31,161		$	—

 

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THE TORO COMPANY AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

July 31, 2015

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and notes required by U.S. generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. Unless the context indicates otherwise, the terms “company” and “Toro” refer to The Toro Company and its consolidated subsidiaries. In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments, consisting primarily of recurring accruals, considered necessary for a fair presentation of the financial position and results of operations. Since the company’s business is seasonal, operating results for the nine months ended July 31, 2015 cannot be annualized to determine the expected results for the fiscal year ending October 31, 2015.

 

The company’s fiscal year ends on October 31, and quarterly results are reported based on three-month periods that generally end on the Friday closest to the quarter end. For comparative purposes, however, the company’s second and third quarters always include exactly 13 weeks of results so that the quarter end date for these two quarters is not necessarily the Friday closest to the calendar month end.

 

For further information, refer to the consolidated financial statements and notes included in the company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2014. The policies described in that report are used for preparing quarterly reports.

 

Accounting Policies

 

In preparing the consolidated financial statements in conformity with U.S. GAAP, management must make decisions that impact the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures, including disclosures of contingent assets and liabilities. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. Estimates are used in determining, among other items, sales promotions and incentives accruals, incentive compensation accruals, inventory valuation, warranty reserves, earn-out liabilities, allowance for doubtful accounts, pension and postretirement accruals, self-insurance accruals, useful lives for tangible and intangible assets, and future cash flows associated with impairment testing for goodwill and other long-lived assets. These estimates and assumptions are based on management’s best estimates and judgments at the time they are made. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors that management believes to be reasonable under the circumstances, including the current economic environment. Management adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with certainty, actual amounts could differ significantly from those estimated at the time the consolidated financial statements are prepared. Changes in those estimates will be reflected in the consolidated financial statements in future periods.

 

Acquisition

 

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

 

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

 

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

 

		July 31,
(Dollars in thousands)		2015
Inventory		$	14,106
Prepaid expenses		266
Property, plant, and equipment		13,689
Intangible assets		107,700
Goodwill		103,028
Current liabilities		(9,299		)
Purchase price		$	229,490

 

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

 

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

 

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

 

Stock-Based Compensation

 

Stock Option Awards

 

Under the company’s amended and restated equity and incentive plan, stock options are granted with an exercise price equal to the closing price of the company’s common stock on the date of grant, as reported by the New York Stock Exchange. Options are generally granted to executive officers, other employees, and non-employee members of the company’s Board of Directors on an annual basis in the first quarter of the company’s fiscal year. Options generally vest one-third each year over a three-year period and have a ten-year term. Other options granted to certain non-officer employees vest in full on the three-year anniversary of the date of grant and have a ten-year term. Compensation expense equal to the grant date fair value is generally recognized for these awards over the vesting period. Stock options granted to officers and other employees are subject to accelerated expensing if the option holder meets the retirement definition set forth in the company’s amended and restated equity and incentive plan. In that case, the fair value of the options is expensed in the fiscal year of grant because the option holder must be employed as of the end of the fiscal year in which the options are granted in order for the options to continue to vest following retirement. Similarly, if a non-employee director has served on the company’s Board of Directors for ten full fiscal years or more, the awards vest immediately upon retirement, and therefore, the fair value of the options granted is fully expensed on the date of the grant.

 

The fair value of each stock option is estimated on the date of grant using the Black-Scholes valuation method with the assumptions noted in the table below. The expected life is a significant assumption as it determines the period for which the risk-free interest rate, volatility, and dividend yield must be applied. The expected life is the average length of time in which officers, other employees, and non-employee directors are expected to exercise their stock options, which is primarily based on historical experience. Separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. Expected volatilities are based on the movement of the company’s common stock over the most recent historical period equivalent to the expected life of the option. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury rate over the expected life at the time of grant. Dividend yield is estimated over the expected life based on the company’s historical cash dividends paid, expected future cash dividends and dividend yield, and expected changes in the company’s stock price.

 

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

 

		Fiscal 2015		Fiscal 2014
Expected life of option in years		5.94		6
Expected stock price volatility		29.67%		34.29%
Risk-free interest rate		1.61%		1.92%
Expected dividend yield		1.29%		1.25%
Grant date per share weighted-average fair value		$16.81		$18.69

 

Performance Share Awards

 

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

 

Restricted Stock and Restricted Stock Unit Awards

 

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

 

Per Share Data

 

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

 

		Three Months Ended				Nine Months Ended
		July 31,		August 1,		July 31,		August 1,
(Shares in thousands)		2015		2014		2015		2014
Basic
Weighted-average number of shares of common stock		55,310		55,965		55,724		56,477
Assumed issuance of contingent shares		—		—		15		17
Weighted-average number of shares of common stock and assumed issuance of contingent shares		55,310		55,965		55,739		56,494
Diluted
Weighted-average number of shares of common stock and assumed issuance of contingent shares		55,310		55,965		55,739		56,494
Effect of dilutive securities		1,242		1,355		1,214		1,306
Weighted-average number of shares of common stock, assumed issuance of contingent shares, and effect of dilutive securities		56,552		57,320		56,953		57,800

 

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

 

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Inventories

 

Inventories are valued at the lower of cost or net realizable value, with cost determined by the last-in, first-out (“LIFO”) method for most inventories and first-in, first-out (“FIFO”) method for all other inventories. The company establishes a reserve for excess, slow-moving, and obsolete inventory that is equal to the difference between the cost and estimated net realizable value for that inventory. These reserves are based on a review and comparison of current inventory levels to the planned production, as well as planned and historical sales of the inventory.

 

Inventories were as follows:

 

		July 31,			August 1,			October 31,
(Dollars in thousands)		2015			2014			2014
Raw materials and work in process		$	102,580		$	88,140		$	95,144
Finished goods and service parts		315,110			270,996			246,954
Total FIFO value		417,690			359,136			342,098
Less: adjustment to LIFO value		67,496			65,375			67,495
Total		$	350,194		$	293,761		$	274,603

 

Goodwill

 

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

 

		Professional			Residential
(Dollars in thousands)		Segment			Segment			Total
Balance as of October 31, 2014		$	80,946		$	10,905		$	91,851
Goodwill acquired		103,028			—			103,028
Translation adjustments		(46		)	(106		)	(152		)
Balance as of July 31, 2015		$	183,928		$	10,799		$	194,727

 

Other Intangible Assets

 

The components of other intangible assets were as follows:

 

(Dollars in thousands) July 31, 2015		Weighted-average Life (Years)		Gross Carrying Amount			Accumulated Amortization			Net
Patents		9.9		$	15,202		$	(10,003	)	$	5,199
Non-compete agreements		5.5		6,931			(6,071		)	860
Customer-related		19.1		84,618			(9,156		)	75,462
Developed technology		7.6		28,819			(19,704		)	9,115
Trade names		19.2		28,715			(2,410		)	26,305
Other				800			(800		)	—
Total amortizable				165,085			(48,144		)	116,941
Non-amortizable - trade names				4,863			—			4,863
Total other intangible assets, net				$	169,948		$	(48,144	)	$	121,804

 

October 31, 2014		Weighted-average Life (Years)		Gross Carrying Amount			Accumulated Amortization			Net
Patents		9.4		$	10,711		$	(8,942	)	$	1,769
Non-compete agreements		5.4		7,039			(5,315		)	1,724
Customer-related		10.7		8,650			(5,517		)	3,133
Developed technology		7.6		28,841			(16,869		)	11,972
Trade names		5.0		1,515			(1,165		)	350
Other				800			(800		)	—
Total amortizable				57,556			(38,608		)	18,948
Non-amortizable - trade names				4,881			—			4,881
Total other intangible assets, net				$	62,437		$	(38,608	)	$	23,829

 

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

 

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

 

Investment in Joint Venture

 

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

 

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

 

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

 

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

 

Warranty Guarantees

 

The company’s products are warranted to ensure customer confidence in design, workmanship, and overall quality. Warranty coverage is for specified periods of time and on select products’ hours of usage, and generally covers parts, labor, and other expenses for non-maintenance repairs. Warranty coverage generally does not cover operator abuse or improper use. An authorized company distributor or dealer must perform warranty work. Distributors and dealers submit claims for warranty reimbursement and are credited for the cost of repairs, labor, and other expenses as long as the repairs meet prescribed standards. Warranty expense is accrued at the time of sale based on the estimated number of products under warranty, historical average costs incurred to service warranty claims, the trend in the historical ratio of claims to sales, the historical length of time between the sale and resulting warranty claim, and other minor factors. Special warranty reserves are also accrued for major rework campaigns. The company sells extended warranty coverage on select products for a prescribed period after the factory warranty period expires.

 

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

 

		Nine Months Ended
		July 31,			August 1,
(Dollars in thousands)		2015			2014
Beginning balance		$	71,080		$	72,177
Warranty provisions		34,532			34,078
Warranty claims		(26,728		)	(25,052		)
Changes in estimates		(221		)	(1,510		)
Ending balance		$	78,663		$	79,693

 

Stockholders’ Equity

 

Accumulated Other Comprehensive Loss

 

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

 

		July 31,			August 1,			October 31,
(Dollars in thousands)		2015			2014			2014
Foreign currency translation adjustments		$	23,255		$	7,166		$	12,536
Pension and post-retirement benefits		5,195			3,754			5,266
Derivative instruments		297			73			(2,097		)
Total accumulated other comprehensive loss		$	28,747		$	10,993		$	15,705

 

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

 

(Dollars in thousands)		Foreign Currency Translation Adjustments			Pension and Postretirement Benefits			Cash Flow Derivative Instruments			Total
Balance as of October 31, 2014		$	12,536		$	5,266		$	(2,097	)	$	15,705
Other comprehensive loss (income) before reclassifications		10,719			(71		)	(6,694		)	3,954
Amounts reclassified from AOCL		—			—			9,088			9,088
Net current period other comprehensive loss (income)		$	10,719		$	(71	)	$	2,394		$	13,042
Balance as of July 31, 2015		$	23,255		$	5,195		$	297		$	28,747

 

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

 

(Dollars in thousands)		Foreign Currency Translation Adjustments			Pension and Postretirement Benefits			Cash Flow Derivative Instruments			Total
Balance as of October 31, 2013		$	7,778		$	3,683		$	1,109		$	12,570
Other comprehensive (income) loss before reclassifications		(612		)	71			450			(91		)
Amounts reclassified from AOCL		—			—			(1,486		)	(1,486		)
Net current period other comprehensive (income) loss		$	(612	)	$	71		$	(1,036	)	$	(1,577	)
Balance as of August 1, 2014		$	7,166		$	3,754		$	73		$	10,993

 

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Segment Data

 

The presentation of segment information reflects the manner in which management organizes segments for making operating decisions and assessing performance. On this basis, the company has determined it has three reportable business segments: Professional, Residential, and Distribution. The Distribution segment, which consists of company-owned domestic distributorships, has been combined with the company’s corporate activities and elimination of intersegment revenues and expenses that is shown as “Other” in the following tables due to the insignificance of the segment.

 

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

 

(Dollars in thousands)
Three months ended July 31, 2015		Professional			Residential			Other			Total
Net sales		$	421,994		$	175,977		$	11,644		$	609,615
Intersegment gross sales		10,365			222			(10,587		)	—
Earnings (loss) before income taxes		82,253			20,566			(25,203		)	77,616

 

Three months ended August 1, 2014		Professional			Residential			Other			Total
Net sales		$	384,678		$	175,717		$	7,145		$	567,540
Intersegment gross sales		11,964			128			(12,092		)	—
Earnings (loss) before income taxes		74,835			18,698			(22,735		)	70,798

 

Nine months ended July 31, 2015		Professional			Residential			Other			Total
Net sales		$	1,314,474		$	578,587		$	17,007		$	1,910,068
Intersegment gross sales		38,651			410			(39,061		)	—
Earnings (loss) before income taxes		258,727			69,131			(72,132		)	255,726
Total assets		846,400			226,835			286,716			1,359,951

 

Nine months ended August 1, 2014		Professional			Residential			Other			Total
Net sales		$	1,208,707		$	533,664		$	16,180		$	1,758,551
Intersegment gross sales		31,878			378			(32,256		)	—
Earnings (loss) before income taxes		244,665			60,654			(66,650		)	238,669
Total assets		616,305			186,079			325,443			1,127,827

 

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

 

		Three Months Ended						Nine Months Ended
		July 31,			August 1,			July 31,			August 1,
(Dollars in thousands)		2015			2014			2015			2014
Corporate expenses		$	(26,989	)	$	(22,101	)	$	(68,434	)	$	(62,448	)
Interest expense, net		(4,587		)	(3,629		)	(14,071		)	(11,065		)
Other		6,373			2,995			10,373			6,863
Total		$	(25,203	)	$	(22,735	)	$	(72,132	)	$	(66,650	)

 

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Derivative Instruments and Hedging Activities

 

The company is exposed to foreign currency exchange rate risk arising from transactions in the normal course of business, such as sales to third party customers, sales and loans to wholly owned foreign subsidiaries, foreign plant operations, and purchases from suppliers. The company actively manages the exposure of its foreign currency exchange rate market risk by entering into various hedging instruments, authorized under company policies that place controls on these activities, with counterparties that are highly rated financial institutions. The company’s hedging activities primarily involve the use of forward currency contracts, as well as cross currency swaps that are intended to offset intercompany loan exposures. The company uses derivative instruments only in an attempt to limit underlying exposure from foreign currency exchange rate fluctuations and to minimize earnings and cash flow volatility associated with foreign currency exchange rate changes. Decisions on whether to use such contracts are primarily based on the amount of exposure to the currency involved and an assessment of the near-term market value for each currency. The company’s policy does not allow the use of derivatives for trading or speculative purposes. The company also made an accounting policy election to use the portfolio exception with respect to measuring counterparty credit risk for derivative instruments, and to measure the fair value of a portfolio of financial assets and financial liabilities on the basis of the net open risk position with each counterparty. The company’s primary currency exchange rate exposures are with the Euro, the Australian dollar, the Canadian dollar, the British pound, the Mexican peso, the Japanese yen, the Chinese Renminbi, and the Romanian New Leu against the U.S. dollar, as well as the Romanian New Leu against the Euro.

 

Cash flow hedges. The company recognizes all derivative instruments as either assets or liabilities at fair value on the consolidated balance sheet and formally documents relationships between cash flow hedging instruments and hedged transactions, as well as its risk-management objective and strategy for undertaking hedge transactions. This process includes linking all derivatives to the forecasted transactions, such as sales to third parties and foreign plant operations. Changes in fair values of outstanding cash flow hedge derivatives, except the ineffective portion, are recorded in other comprehensive income (“OCI”), until net earnings is affected by the variability of cash flows of the hedged transaction. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in net earnings. The consolidated statements of earnings classification of effective hedge results is the same as that of the underlying exposure. Results of hedges of sales and foreign plant operations are recorded in net sales and cost of sales, respectively, when the underlying hedged transaction affects net earnings. The maximum amount of time the company hedges its exposure to the variability in future cash flows for forecasted trade sales and purchases is two years. Results of hedges of intercompany loans are recorded in other income, net as an offset to the remeasurement of the foreign loan balance.

 

The company formally assesses, at a hedge’s inception and on an ongoing basis, whether the derivatives that are designated as hedges have been highly effective in offsetting changes in the cash flows of the hedged transactions and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative is not, or has ceased to be, highly effective as a hedge, the company discontinues hedge accounting prospectively. When the company discontinues hedge accounting because it is no longer probable, but it is still reasonably possible that the forecasted transaction will occur by the end of the originally expected period or within an additional two-month period of time thereafter, the gain or loss on the derivative remains in AOCL and is reclassified to net earnings when the forecasted transaction affects net earnings. However, if it is probable that a forecasted transaction will not occur by the end of the originally specified time period or within an additional two-month period of time thereafter, the gains and losses that were in AOCL are recognized immediately in net earnings. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the company carries the derivative at its fair value on the consolidated balance sheets, recognizing future changes in the fair value in other income, net.  For the third quarter and year-to-date periods of fiscal 2015, there were immaterial losses on contracts reclassified into earnings as a result of the discontinuance of cash flow hedges. As of July 31, 2015 and August 1, 2014, the notional amount outstanding of forward contracts designated as cash flow hedges was $102.8 million and $108.6 million, respectively. Additionally, as of July 31, 2015 and August 1, 2014, the company had one cross currency interest rate swap instrument outstanding for a fixed pay notional of 36.6 million Romanian New Leu and receive floating notional of 8.5 million Euros.

 

Derivatives not designated as hedging instruments. The company also enters into foreign currency contracts that include forward currency contracts and cross currency swaps to mitigate the remeasurement of specific assets and liabilities on the consolidated balance sheet. These contracts are not designated as hedging instruments. Accordingly, changes in the fair value of hedges of recorded balance sheet positions, such as cash, receivables, payables, intercompany notes, and other various contractual claims to pay or receive foreign currencies other than the functional currency, are recognized immediately in other income, net, on the consolidated statements of earnings together with the transaction gain or loss from the hedged balance sheet position.

 

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

 

Asset Derivatives

Liability Derivatives

July 31, 2015

August 1, 2014

July 31, 2015

August 1, 2014

Balance

Balance

Balance

Balance

Sheet

Fair

Sheet

Fair

Sheet

Fair

Sheet

Fair

(Dollars in thousands)

Location

Value

Location

Value

Location

Value

Location

Value

Derivatives Designated as Hedging Instruments

Forward currency contracts

Prepaid expenses

$

2,957

Prepaid expenses

$

1,263

Accrued liabilities

$

1,986

Accrued liabilities

$

62

Cross currency contract

Prepaid expenses

—

Prepaid expenses

—

Accrued liabilities

243

Accrued liabilities

701

Derivatives Not Designated as Hedging Instruments

Forward currency contracts

Prepaid expenses

2,663

Prepaid expenses

261

Accrued liabilities

2

Accrued liabilities

412

Cross currency contract

Prepaid expenses

2,179

Prepaid expenses

61

Accrued liabilities

—

Accrued liabilities

—

Total Derivatives

$

7,799

$

1,585

$

2,231

$

1,175

 

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

 

																Location of Gain (Loss)		Gain (Loss)
								Location of Gain								Recognized in Income		Recognized in Income
		Gain (Loss)						(Loss) Reclassified		Gain (Loss)						on Derivatives		on Derivatives
		Recognized in OCI on						from AOCL		Reclassified from						(Ineffective Portion		(Ineffective Portion and
		Derivatives						into Income		AOCL into Income						and excluded from		Excluded from
		(Effective Portion)						(Effective Portion)		(Effective Portion)						Effectiveness Testing)		Effectiveness Testing)
(Dollars in thousands)		July 31,			August 1,					July 31,			August 1,					July 31,			August 1,
For the three months ended		2015			2014					2015			2014					2015			2014
Forward currency contracts		$	(654	)	$	952		Net sales		$	3,258		$	(369	)	Other income, net		$	280		$	(63	)
Forward currency contracts		(433		)	(216		)	Cost of sales		(817		)	61
Cross currency contracts		31			(292		)	Other income, net		(85		)	(212		)
Total		$	(1,056	)	$	444				$	2,356		$	(520	)

 

		July 31,			August 1,					July 31,			August 1,					July 31,			August 1,
For the nine months ended		2015			2014					2015			2014					2015			2014
Forward currency contracts		$	(950	)	$	1,694		Net sales		$	11,188		$	(1,140	)	Other income, net		$	563		$	(204	)
Forward currency contracts		(1,615		)	(333		)	Cost of sales		(1,808		)	93
Cross currency contracts		167			(330		)	Other income, net		(292		)	(439		)
Total		$	(2,398	)	$	1,031				$	9,088		$	(1,486	)

 

As of July 31, 2015, the company expects to reclassify approximately $0.8 million of gains from AOCL to earnings during the next twelve months.

 

The following table presents the impact of derivative instruments on the consolidated statements of earnings for the company’s derivatives not designated as hedging instruments.

 

				Gain (Loss) Recognized in Net Earnings
				Three Months Ended						Nine Months Ended
		Location of Gain (Loss)		July 31,			August 1,			July 31,			August 1,
(Dollars in thousands)		Recognized in Net Earnings		2015			2014			2015			2014
Forward currency contracts		Other income, net		$	(2,891	)	$	2,474		$	8,459		$	(553	)
Cross currency contracts		Other income, net		139			421			1,441			181
				$	(2,752	)	$	2,895		$	9,900		$	(372	)

 

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