Toro Co: Form 10-Q for the period ended Aug 2, 2024

This Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide a reader of our Condensed Consolidated 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 the context indicates otherwise, the terms "company," "TTC," "we," "our," or "us" refer to The Toro Company and its consolidated subsidiaries. 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, 2023. 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 as follows:

• Company Overview
• Results of Operations
• Business Segments
• Financial Position
• Non-GAAP Financial Measures
• Critical Accounting Policies and Estimates

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 "Cautionary Note Regarding Forward-Looking Statements" located at the beginning of this Quarterly Report on Form 10-Q for more information.

Non-GAAP Financial Measures

Throughout this MD&A, we have provided financial and liquidity measures that are not calculated or presented in accordance with United States ("U.S.") generally accepted accounting principles ("GAAP") ("non-GAAP financial measures," "adjusted" before specified financial measures, and "non-GAAP liquidity measures"), as information supplemental and in addition to the most directly comparable financial measures presented in this Quarterly Report on Form 10-Q that are calculated and presented in accordance with U.S. GAAP. We believe that these non-GAAP financial measures, when considered in conjunction with our Condensed Consolidated Financial Statements prepared in accordance with U.S. GAAP, provide investors with useful supplemental financial information to better understand our core operational performance and cash flows. These non-GAAP financial measures, however, should not be considered superior to, as a substitute for, or as an alternative to, and should be considered in conjunction with, the most directly comparable U.S. GAAP financial measures. Reconciliations of non-GAAP financial measures to the most directly comparable reported U.S. GAAP financial measures are included in the section titled "Non-GAAP Financial Measures" within this MD&A.

COMPANY OVERVIEW

The Toro Company is in the business of designing, manufacturing, marketing, and selling professional turf maintenance equipment and services; turf irrigation systems; landscaping equipment and lighting products; snow and ice management products; agricultural irrigation systems; rental, specialty, and underground construction equipment; and residential yard and snow thrower products. Our purpose is to help our customers enrich the beauty, productivity, and sustainability of the land. Sustainability is integrated into our enterprise strategic priorities of accelerating profitable growth, driving productivity and operational excellence, and empowering our people. Our focus on alternative power, smart connected, and autonomous solutions, as well as our continued efforts to address sustainability-focused matters, including environmental, social, and governance priorities, are disclosed in our most recent Sustainability Report.

We sell our products worldwide through a network of distributors, dealers, mass retailers, hardware retailers, equipment rental centers, and home centers, as well as online and 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 net sales 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. We classify our operations into two reportable business segments: Professional and Residential. Our remaining activities are presented as "Other" due to their insignificance, as described in greater detail within the section titled "Business Segments" in this MD&A.

Macroeconomic Driven Caution

As summer progressed, we saw macroeconomic factors drive more caution from homeowners and dealers than originally anticipated. These factors included general consumer uncertainty, continued high interest rates, and the current geopolitical environment. This uptick in caution resulted in trade-down activity and purchase deferrals, which led to lower-than-expected shipments of Residential and Professional segment lawn care products during July. Continued macroeconomic driven caution could cause adverse effect on our results of operations, financial position, or cash flows.

Productivity Initiative

During the first quarter of fiscal 2024, we announced our AMP initiative, which is a multi-year initiative intended to result in annualized cost savings of at least $100 million by fiscal 2027, driven by sustainable supply-base, design-to-value, and route-to-market transformation. We intend to reinvest a portion of the savings from this initiative to further accelerate innovation and long-term growth.

Fiscal 2023 Impairment

At the end of the third quarter of fiscal 2023, we recorded an impairment charge of $18.0 million related to the indefinite-lived Spartan trade name intangible asset reported under the Professional segment. Further, during the same period, we recorded an impairment charge of $133.3 million related to goodwill of the Intimidator reporting unit also reported under the Professional segment. Subsequent to these impairment charges, the remaining balance of the indefinite-lived Spartan trade name intangible asset is $81.1 million and the remaining balance of goodwill for the Intimidator reporting unit is $30.5 million. These impairment charges are included in the Non-cash impairment charges caption on the Condensed Consolidated Statements of Earnings (Loss). These impairment charges resulted in a $36.7 million income tax benefit (deferred tax asset) associated with the remaining tax deductible basis in goodwill and other intangible assets.

RESULTS OF OPERATIONS

Overview

Consolidated net sales for the third quarter of fiscal 2024 were $1,156.9 million, up 6.9 percent compared to $1,081.8 million in the third quarter of fiscal 2023. For the first nine months of fiscal 2024, consolidated net sales were $3,507.8 million, down 1.7 percent compared to $3,570.0 million from the same period in the prior fiscal year.

Professional segment net sales for the third quarter of fiscal 2024 were $880.9 million, a decrease of 1.7 percent compared to $896.3 million in the third quarter of the prior fiscal year. For the first nine months of fiscal 2024, Professional segment net sales were $2,643.0 million, a decrease of 7.1 percent compared to $2,845.7 million in the prior fiscal year comparable period.

Residential segment net sales for the third quarter of fiscal 2024 were $267.5 million, an increase of 52.6 percent compared to $175.3 million in the third quarter of the prior fiscal year. For the first nine months of fiscal 2024, Residential segment net sales were $843.2 million, an increase of 19.5 percent compared to $705.8 million in the prior fiscal year comparable period.

Net earnings for the third quarter of fiscal 2024 were $119.3 million, or $1.14 per diluted share, compared to a net loss of $15.0 million, or $0.14 net loss per diluted share, for the third quarter of fiscal 2023. Net earnings for the first nine months of fiscal 2024 were $329.0 million, or $3.14 per diluted share, compared to $259.4 million, or $2.46 per diluted share, in the comparable fiscal 2023 period.

Adjusted net earnings for the third quarter of fiscal 2024 were $123.7 million, or $1.18 per diluted share, compared to $99.4 million, or $0.95 per diluted share, for the third quarter of fiscal 2023. Adjusted net earnings for the first nine months of fiscal 2024 were $337.5 million, or $3.22 per diluted share, compared to $369.4 million, or $3.50 per diluted share, in the comparable fiscal 2023 period.

We continued our history of paying quarterly cash dividends and increased our cash dividend for the third quarter of fiscal 2024 by 5.9 percent to $0.36 per share compared to $0.34 per share paid in the third quarter of fiscal 2023. We also repurchased shares of our common stock under our Board authorized repurchase program, thereby reducing our total shares outstanding. As a result of the combination of quarterly cash dividends and share repurchases, we returned $221.8 million of cash to our shareholders during the first nine months of fiscal 2024.

Field inventory levels were slightly higher as of the end of the third quarter of fiscal 2024 compared to the end of the third quarter of fiscal 2023, primarily due to increased shipments of lawn care equipment to our mass channel partners and increased shipments of construction and golf and grounds products driven by improved manufacturing output, partially offset by significant reductions of dealer field inventories of lawn care equipment in both the Professional and Residential segments.

Our order backlog represents unfulfilled customer orders at a point in time. Our order backlog (including shipments beyond 12 months) was lower as of the end of the third quarter of fiscal 2024 compared to the end of the fourth quarter of fiscal 2023 primarily due to improved manufacturing output. Our order backlog remains significantly elevated over what the company would consider normal, due to demand for underground construction and golf and grounds products continuing to outpace production of such products.

Net Sales

Consolidated net sales for the third quarter of fiscal 2024 were $1,156.9 million, up 6.9 percent compared to $1,081.8 million in the third quarter of fiscal 2023. This increase was primarily driven by higher shipments of Residential segment products and net price realization, partially offset by lower shipments of Professional segment products. For the year-to-date period of fiscal 2024, consolidated net sales were $3,507.8 million, down 1.7 percent compared to $3,570.0 million from the same period in the prior fiscal year. This decrease was primarily driven by lower shipments of Professional segment products, partially offset by higher shipments of Residential segment products.

Net sales in international markets decreased by $16.8 million and $65.3 million for the third quarter and year-to-date periods of fiscal 2024, respectively. The decreases for the third quarter and year-to date comparisons were primarily due to lower shipments of both Residential and Professional segment products.

Changes in foreign currency exchange rates resulted in a decrease in our net sales of approximately $0.5 million and $7.3 million for the third quarter and year-to-date periods of fiscal 2024, respectively.

The following table summarizes our results of operations as a percentage of consolidated net sales:

Gross Profit and Gross Margin

Gross profit for the third quarter of fiscal 2024 was $402.8 million, up 8.2 percent compared to $372.4 million for the third quarter of fiscal 2023. Gross margin was 34.8 percent for the third quarter of fiscal 2024 compared to 34.4 percent for the third quarter of fiscal 2023, an increase of 40 basis points. The increase in gross margin for the third quarter comparison was primarily due to productivity improvements and net price realization, partially offset by higher material and manufacturing costs and product mix.

Gross profit for the year-to-date period of fiscal 2024 was $1,200.3 million, down 3.8 percent compared to $1,248.0 million for the same period of fiscal 2023. Gross margin was 34.2 percent for the year-to-date period of fiscal 2024 compared to 35.0 percent for the prior year comparable period, a decrease of 80 basis points. The decrease in gross margin for the year-to-date comparison was primarily due to higher material and manufacturing costs and product mix, partially offset by productivity improvements.

Selling, General, and Administrative ("SG&A") Expense

SG&A expense increased $14.5 million, or 6.0 percent, for the third quarter of fiscal 2024 and increased $15.4 million, or 2.0 percent, for the year-to-date period of fiscal 2024 compared to the same respective periods of fiscal 2023. As a percentage of net sales, SG&A expense decreased 20 basis points for the third quarter of fiscal 2024 and increased 80 basis points for the year-to-date period of fiscal 2024, respectively, compared to the same respective periods of fiscal 2023. The decrease in SG&A expense as a percentage of net sales for the third quarter comparison was primarily due to net sales leverage and lower marketing costs, partially offset by higher incentive expenses. The increase in SG&A expense as a percentage of net sales for the year-to-date comparison was primarily due to lower net sales volume and higher incentive expenses, partially offset by lower marketing costs.

Non-Cash Impairment Charges

We recorded non-cash impairment charges of $151.3 million within our Professional segment related to Intimidator in the third quarter and year-to-date period of fiscal 2023. No impairment charges were recognized in the third quarter or year-to-date period of fiscal 2024.

Interest Expense

Interest expense decreased $0.5 million and increased $3.6 million for the third quarter and year-to-date periods of fiscal 2024, respectively, compared to the same respective periods of fiscal 2023. The decrease in interest expense for the third quarter comparison was primarily due to lower average outstanding borrowings. The increase in interest expense for the year-to-date comparison was primarily due to higher average interest rates.

Other Income, Net

Other income, net increased $5.1 million and $5.3 million for the third quarter and year-to-date periods of fiscal 2024, respectively, compared to the same respective periods of fiscal 2023. The increase in other income, net for the third quarter comparison was primarily due to a net gain on divestiture. The increase in other income, net for the year-to-date comparison was primarily due to net gains on divestitures and higher income from our Red Iron join venture.

Income Tax Provision (Benefit)

The effective tax rate for the third quarter of fiscal 2024 was 17.3 percent compared to 47.6 percent in the third quarter of fiscal 2023, primarily due to the prior year tax impact from non-cash impairment charges and a more favorable geographic mix of earnings in the current fiscal year period. The effective tax rate for the year-to-date period of fiscal 2024 was 18.5 percent compared to 17.3 percent in the same period of fiscal 2023, primarily due to the prior year tax impact from non-cash impairment charges and lower tax benefits recorded as excess tax deductions for stock-based compensation in the current fiscal year period, partially offset by a more favorable geographic mix of earnings in the current fiscal year period. The adjusted effective tax rate for the third quarter of fiscal 2024 was 18.0 percent, compared to an adjusted effective tax rate of 19.0 percent in the third quarter of fiscal 2023, primarily driven by a more favorable geographic mix of earnings. The adjusted effective tax rate for the year-to-date period of fiscal 2024 was 19.3 percent, compared to 20.6 percent in the same period of fiscal 2023, primarily driven by a more favorable geographic mix of earnings.

Net Earnings (Loss)

Net earnings for the third quarter of fiscal 2024 were $119.3 million, or $1.14 per diluted share, compared to a net loss of $15.0 million, or $0.14 net loss per diluted share, for the third quarter of fiscal 2023. Adjusted net earnings for the third quarter of fiscal 2024 were $123.7 million, or $1.18 per diluted share, compared to $99.4 million, or $0.95 per diluted share, for the third quarter of fiscal 2023, an increase of 24.2 percent per diluted share. Net earnings for the first nine months of fiscal 2024 were $329.0 million, or $3.14 per diluted share, compared to $259.4 million, or $2.46 per diluted share, for the same period of fiscal 2023. Adjusted net earnings for the first nine months of fiscal 2024 were $337.5 million, or $3.22 per diluted share, compared to $369.4 million, or $3.50 per diluted share, for the same year-to-date period of fiscal 2023, a decrease of 8.0 percent per diluted share. The increase in net earnings per diluted share for the third quarter comparison was primarily due to the prior year non-cash impairment charges and higher Residential segment earnings in the current fiscal year period. The increase in net earnings per diluted share for the year-to-date comparison was primarily due to the prior year non-cash impairment charges and higher Residential segment earnings in the current fiscal year period, partially offset by lower Professional segment earnings in the current fiscal year period.

BUSINESS SEGMENTS

We operate in two reportable business segments: Professional and Residential. Segment earnings for our Professional and Residential segments are defined as earnings from operations plus other income, net. Our remaining activities are presented as "Other" due to their insignificance. Operating loss for our Other activities included earnings (loss) from our wholly-owned domestic distribution company, Red Iron joint venture, corporate activities, other income, and interest expense. Corporate activities include general corporate expenditures, such as finance, human resources, legal, information services, public relations, and similar activities, as well as other unallocated corporate assets and liabilities, such as corporate facilities and deferred tax assets and liabilities. The following tables summarize net sales for our reportable business segments and Other activities:

(Dollars in millions)

(Dollars in millions)

The following tables summarize segment earnings (loss) for our reportable business segments and operating (loss) for our Other activities:

(Dollars in millions)

(Dollars in millions)

Professional Segment

Segment Net Sales

Worldwide net sales for our Professional segment for the third quarter of fiscal 2024 decreased 1.7 percent compared to the third quarter of fiscal 2023. This decrease was driven primarily by lower shipments of snow and ice management products, lawn care equipment, and compact utility loaders, partially offset by higher shipments of golf and grounds products and underground construction equipment, along with net price realization. Worldwide net sales for our Professional segment for the year-to-date period of fiscal 2024 decreased 7.1 percent compared to the same period of fiscal 2023. This decrease was driven primarily by lower shipments of zero-turn mowers and snow and ice management products, partially offset by higher shipments of underground construction equipment and golf and grounds products.

Segment Earnings

Professional segment earnings for the third quarter of fiscal 2024 increased 1,174.6 percent compared to the third quarter of fiscal 2023, and Professional segment earnings margin increased to 18.8 percent from 1.5 percent for the third quarter of fiscal 2023. The increase in Professional segment earnings margin for the third quarter comparison was primarily due to the prior year non-cash impairment charges, productivity improvements, product mix, and net price realization, partially offset by higher material and manufacturing costs and lower net sales volume. Professional segment earnings for the year-to-date period of fiscal 2024 increased 22.0 percent compared to the same period of fiscal 2023, and Professional segment earnings margin increased to 17.8 percent from 13.5 percent for the year-to-date period of fiscal 2023. The increase in Professional segment earnings margin for the year-to-date comparison was primarily due to the prior year non-cash impairment charges, productivity improvements, and product mix, partially offset by higher material and manufacturing costs and lower net sales volume.

Residential Segment

Segment Net Sales

Worldwide net sales for our Residential segment for the third quarter of fiscal 2024 increased 52.6 percent compared to the third quarter of fiscal 2023. The increase in Residential segment net sales was primarily driven by higher shipments to our mass channel. Worldwide net sales for our Residential segment for the year-to-date period of fiscal 2024 increased 19.5 percent compared to the same period of fiscal 2023. The increase in Residential segment net sales was primarily driven by higher shipments to our mass channel, partially offset by lower shipments of snow products.

Segment Earnings

Residential segment earnings for the third quarter of fiscal 2024 increased 757.9 percent compared to the third quarter of fiscal 2023, and Residential segment earnings margin increased to 12.2 percent from 2.2 percent in the third quarter of fiscal 2023. The increase in Residential segment earnings margin for the third quarter of fiscal 2024 was largely due to net sales leverage, productivity improvements, and net price realization primarily driven by lower floor plan costs, partially offset by product mix and higher material and manufacturing costs. Residential segment earnings for the year-to-date period of fiscal 2024 increased 43.2 percent compared to the same period of fiscal 2023, and Residential segment earnings margin increased to 10.9 percent from 9.1 percent in the year-to-date period of fiscal 2023. The increase in Residential segment earnings margin for the year-to-date period of fiscal 2024 was largely driven by net sales leverage and productivity improvements, partially offset by product mix and higher material and manufacturing costs.

Other Activities

Other Net Sales

Net sales for our Other activities includes sales from our wholly-owned domestic distribution company net of intersegment sales from the Professional and Residential segments to the distribution company. Net sales for our Other activities in the third quarter of fiscal 2024 decreased by $1.7 million compared to the same period in fiscal 2023. Net sales for our Other activities in the year-to-date period of fiscal 2024 increased by $3.1 million compared to the same period in fiscal 2023.

Other Operating Loss

The operating loss for our Other activities for the third quarter of fiscal 2024 increased $8.7 million compared to the third quarter of fiscal 2023. The operating loss for our Other activities for the year-to-date period of fiscal 2024 increased $22.5 million compared to the same period in fiscal 2023. The increased operating loss for the third quarter of fiscal 2024 was primarily due to higher corporate expenses. The increased operating loss for the year-to-date period of fiscal 2024 was primarily due to higher corporate expenses and higher interest expense.

FINANCIAL POSITION

Working Capital

Our ongoing goal is to maintain requisite inventory levels to meet our anticipated production requirements, avoid manufacturing delays, and meet the demand for our products, as well as working to ensure service parts availability for our customers. Accounts receivable as of the end of the third quarter of fiscal 2024 increased $141.6 million, or 36.2 percent, compared to the end of the third quarter of fiscal 2023, primarily driven by increased shipments to our mass channel, as well as payment terms to that channel. Inventory levels were down $30.7 million, or 2.8 percent, as of the third quarter of fiscal 2024 compared to the third quarter of fiscal 2023, primarily due to a reduction in lawn care equipment finished goods balances and a reduction in work-in-process balances, partially offset by higher balances of compact utility loaders and snow and ice management products. Accounts payable increased $30.4 million, or 7.5 percent, as of the end of the third quarter of fiscal 2024 compared to the end of the third quarter of fiscal 2023, primarily due to the timing of material purchases.

Cash Flow

Cash Flows from Operating Activities

Net cash provided by operating activities for the first nine months of fiscal 2024 was $329.8 million compared to $154.7 million for the first nine months of fiscal 2023. This increase was mainly due to net favorable fluctuations in working capital during the current fiscal year period compared to the prior fiscal year period.

Cash Flows from Investing Activities

Net cash used in investing activities for the first nine months of fiscal 2024 was $43.4 million compared to $119.2 million for the first nine months of fiscal 2023. This decrease was primarily driven by lower purchases of property, plant, and equipment, lower cash outflows for acquisitions, and higher cash inflows from divestitures in each case during the current fiscal year period compared to the prior fiscal year period.

Cash Flows from Financing Activities

Net cash used in financing activities for the first nine months of fiscal 2024 was $260.5 million compared to $82.4 million for the first nine months of fiscal 2023. This increase was mainly due to changes in activity under the revolving credit facility and higher stock repurchases in each case during the current fiscal year period compared to the prior fiscal year period.

Liquidity and Capital Resources

As of August 2, 2024, we had available liquidity of $818.4 million, consisting of cash and cash equivalents of $221.1 million, of which $127.8 million was held by our foreign subsidiaries, and availability under our revolving credit facility of $597.3 million. We believe our current liquidity position, including the funds available through existing, and potential future, financing arrangements and forecasted cash flows from operations will be sufficient to provide the necessary capital resources for our anticipated working capital needs, payroll, and other administrative costs, capital expenditures, lease payments, purchase commitments, contractual obligations, acquisitions, investments, establishment of new facilities, expansion and renovation of existing facilities, financing receivables from customers that are not financed with Red Iron or other third-party financial institutions, contingent consideration payments, debt repayments, interest payments, quarterly cash dividend payments, and common stock repurchases, all as applicable, for at least the next twelve months.

Indebtedness

Our debt arrangements are described in further detail in our Annual Report on Form 10-K for the fiscal year ended October 31, 2023. The following is a summary of our indebtedness:

(Dollars in millions)

As of August 2, 2024, we had no outstanding borrowings under our revolving credit facility and $2.7 million outstanding under the sublimit for standby letters of credit, which resulted in $597.3 million of unutilized availability under our revolving credit facility.

We are in compliance with our debt covenants and other requirements of our revolving credit facility and term loan credit agreements, indentures, and private placement note purchase agreements.

Cash Dividends

Our Board of Directors approved a cash dividend of $0.36 per share for the third quarter of fiscal 2024 that was paid on July 11, 2024. This was an increase of 5.9 percent over our cash dividend of $0.34 per share for the third quarter of fiscal 2023. We expect to continue paying our quarterly cash dividend to shareholders for the remainder of fiscal 2024.

Share Repurchases

During the first nine months of fiscal 2024, we repurchased 1,178,074 shares of our common stock in the open market under our Board authorized repurchase program, thereby reducing our total shares outstanding. As of August 2, 2024, 5,771,417 shares remained available for repurchase under our Board authorized repurchase program. We expect to continue to repurchase shares of our common stock throughout the remainder of fiscal 2024, depending on our cash balance, debt repayments, market conditions, our anticipated working capital needs, the price of our common stock, and/or other factors.

Customer Financing Arrangements

Our customer financing arrangements are described in further detail in our Annual Report on Form 10-K for the fiscal year ended October 31, 2023. There have been no material changes to our customer financing arrangements during the first nine months of fiscal 2024.

Inventory Financing

We are party to inventory financing arrangements with Red Iron, HCFC, and other third-party financial institutions which provide inventory financing to certain dealers and distributors of certain of our products in the U.S. and internationally.

The net amount of receivables financed for dealers and distributors under the arrangement with Red Iron for the nine month periods ended August 2, 2024 and August 4, 2023 were $1,882.3 million and $2,160.8 million, respectively. The total amount of net receivables outstanding under the arrangement with Red Iron as of August 2, 2024, August 4, 2023 and October 31, 2023 were $927.8 million, $1,010.5 million and $1,019.0 million, respectively. The total amount of receivables due from Red Iron to us as of August 2, 2024, August 4, 2023 and October 31, 2023 were $28.6 million, $30.4 million and $34.4 million, respectively.

The net amount of receivables financed for dealers and distributors under the arrangements with HCFC and the other third-party financial institutions for the nine month periods ended August 2, 2024 and August 4, 2023 were $442.0 million and $367.6 million, respectively. The total amount of net receivables outstanding under the arrangements with HCFC and the other third-party financial institutions as of August 2, 2024, August 4, 2023, and October 31, 2023 were $228.5 million, $187.2 million, and $234.7 million, respectively.

Inventory Repurchase Agreements

We have entered into a limited inventory repurchase agreement with Red Iron and HCFC under which we have agreed to repurchase certain repossessed products, up to a maximum aggregate amount of $7.5 million in a calendar year.

Additionally, as a result of our financing agreements with the other third-party financial institutions, we have also entered into inventory repurchase agreements with the other third-party financial institutions. Under such inventory repurchase agreements, we have agreed to repurchase products repossessed by the other third-party financial institutions. As of August 2, 2024, August 4, 2023, and October 31, 2023, we were contingently liable to repurchase up to a maximum amount of $30.2 million, $118.8 million, and $32.2 million, respectively, of inventory related to receivables under these inventory repurchase agreements.

Our financial exposure under these inventory repurchase agreements is limited to the difference between the amount paid to Red Iron, HCFC or other third-party financing institutions for repurchases of inventory and the amount received upon subsequent resale of the repossessed product. We have repurchased immaterial amounts of inventory pursuant to such arrangements for the nine months ended August 2, 2024 and August 4, 2023. However, a decline in retail sales or financial difficulties of our distributors or dealers could cause this situation to change and thereby require us to repurchase financed product, which could have an adverse effect on our results of operations, financial position, or cash flows.

NON-GAAP FINANCIAL MEASURES

We have provided in this Quarterly Report on Form 10-Q certain non-GAAP financial measures, which are not calculated or presented in accordance with U.S. GAAP, as information supplemental and in addition to the most directly comparable financial measures that are calculated and presented in accordance with U.S. GAAP. We use these non-GAAP financial measures in making operating decisions and assessing liquidity because we believe they provide meaningful supplemental information regarding our core operational performance and cash flows, as a measure of our liquidity, and provide us with a better understanding of how to allocate resources to both ongoing and prospective business initiatives. Additionally, these non-GAAP financial measures facilitate our internal comparisons to both our historical operating results and to our competitors' operating results by factoring out potential differences caused by charges and benefits not related to our regular, ongoing business, including, without limitation, certain non-cash, large, and/or unpredictable charges and benefits; acquisitions and dispositions; legal judgments, settlements, or other matters; and tax positions. We believe that these non-GAAP financial measures, when considered in conjunction with our Condensed Consolidated Financial Statements prepared in accordance with U.S. GAAP, provide investors with useful supplemental financial information to better understand our core operational performance and cash flows. These non-GAAP financial measures should not be considered superior to, as a substitute for, or as an alternative to, and should be considered in conjunction with, the most directly comparable U.S. GAAP financial measures. The non-GAAP financial measures may differ from similar measures used by other companies.

Reconciliation of Non-GAAP Financial Measures

The following table provides a reconciliation of the non-GAAP financial performance measures used in this report to the most directly comparable measures calculated and reported in accordance with U.S. GAAP for the three and nine month periods ended August 2, 2024 and August 4, 2023:

(Dollars in millions, except per share data)

38

1 On January 13, 2022, we completed our acquisition of Intimidator Group. Acquisition-related costs for the nine month period ended August 4, 2023 represent integration costs.

2 In the first quarter of fiscal 2024, we launched a significant productivity initiative named AMP, as discussed in more detail under the heading "Company Overview-Productivity Initiative" in this section. We considered the nature, frequency, and scale of this initiative compared to our prior productivity initiatives when determining that the expenses associated with AMP, unlike our prior productivity initiatives, are not common, normal, recurring operating expenses and are not representative of our ongoing business operations. Productivity initiative charges for the three and nine month periods ended August 2, 2024 primarily represent third-party consulting costs, product-line exit costs, asset write-offs, and compensation for fully-dedicated AMP personnel, partially offset by a gain on divestiture.

3 At the end of the third quarter of fiscal 2023, the company recorded non-cash impairment charges within our Professional reportable segment related to the Intimidator operating segment, as discussed in more detail under the heading "Company Overview-Fiscal 2023 Impairment" in this section.

4 The accounting standards codification guidance governing employee stock-based compensation requires that any excess tax deduction for stock-based compensation be immediately recorded within income tax expense. Employee stock-based compensation activity, including the exercise of stock options, can be unpredictable and can significantly impact our net earnings, net earnings per diluted share, and effective tax rate. These amounts represent the discrete tax benefits recorded as excess tax deductions for stock-based compensation during the three and nine month periods ended August 2, 2024 and August 4, 2023.

Reconciliation of Non-GAAP Liquidity Measures

We define free cash flow as net cash provided by operating activities less purchases of property, plant, and equipment, net of proceeds from insurance claim. Free cash flow conversion percentage represents free cash flow as a percentage of net earnings. We consider free cash flow and free cash flow conversion percentage to be non-GAAP liquidity measures that provide useful information to management and investors about our ability to convert net earnings into cash resources that can be used to pursue opportunities to enhance shareholder value, fund ongoing and prospective business initiatives, and strengthen our Condensed Consolidated Balance Sheets, after reinvesting in necessary capital expenditures required to maintain and grow our business. The following table provides a reconciliation of non-GAAP free cash flow and free cash flow conversion percentage to net cash provided by operating activities, which is the most directly comparable financial measure calculated and reported in accordance with U.S. GAAP, for the nine month periods ended August 2, 2024 and August 4, 2023:

(Dollars in millions)

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

There have been no material changes to our critical accounting policies and estimates since our Annual Report on Form 10-K for the fiscal year ended October 31, 2023. Refer to Part II, Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations", and Part II, Item 8, Note 1, Summary of Significant Accounting Policies and Related Data, within our Annual Report on Form 10-K for the fiscal year ended October 31, 2023 for a discussion of our critical accounting policies and estimates.

We are exposed to market risk stemming from changes in foreign currency exchange rates, interest rates, and commodity costs. We are also exposed to equity market risk pertaining to the trading price of our common stock. Changes in these factors could cause fluctuations in our earnings and cash flows. There have been no material changes to the market risk information regarding equity market risk included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2023. Refer to Part II, Item 7A, "Quantitative and Qualitative Disclosures about Market Risk", within our Annual Report on Form 10-K for the fiscal year ended October 31, 2023 for a complete discussion of our market risk. Refer below for further discussion on foreign currency exchange rate risk, interest rate risk, and commodity cost risk.

Foreign Currency Exchange Rate Risk

We are 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, costs associated with foreign plant operations, and purchases from suppliers. Our primary foreign 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. Because our products are manufactured or sourced primarily from the U.S. and Mexico, a stronger U.S. dollar and Mexican peso generally have a negative impact on our results from operations, while a weaker U.S. dollar and Mexican peso generally have a positive effect.

To reduce our exposure to foreign currency exchange rate risk, we enter into various derivative instruments to hedge against such risk, authorized under a company policy that places controls on these hedging activities, with counterparties that are highly rated financial institutions. 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. Our worldwide foreign currency exchange rate exposures are reviewed monthly. The gains and losses on our derivative instruments offset the changes in values of the related underlying exposures. Therefore, changes in the values of our derivative instruments are highly correlated with changes in the market values of underlying hedged items both at inception and over the life of the derivative instrument. For additional information regarding our derivative instruments, refer to Note 16, Derivative Instruments and Hedging Activities, in our Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

The foreign currency exchange contracts in the table below have maturity dates in fiscal 2024 through fiscal 2026. All items are non-trading and stated in U.S. dollars. As of August 2, 2024, the average contracted rate, notional amount, fair value, and the gain (loss) at fair value of outstanding derivative instruments were as follows:

(Dollars in millions, except average contracted rate)

Our net investment in foreign subsidiaries translated into U.S. dollars is not hedged. Any changes in foreign currency exchange rates would be reflected as a foreign currency translation adjustment, a component of accumulated other comprehensive loss in stockholders’ equity on the Condensed Consolidated Balance Sheets, and would not impact net earnings.

Interest Rate Risk

Our interest rate risk relates primarily to fluctuations in variable interest rates on our revolving credit facility and term loan credit agreements, as well as the potential increase in the fair value of our fixed-rate long-term debt resulting from a potential decrease in interest rates. We generally do not use interest rate swaps to mitigate the impact of fluctuations in interest rates. We have no earnings or cash flow exposure due to interest rate risks on our fixed-rate long-term debt obligations. Our indebtedness as of August 2, 2024 includes $524.2 million of gross fixed-rate long-term debt that is not subject to variable interest rate fluctuations, $470.0 million of gross variable rate debt under our term loan credit agreements. We had no outstanding borrowings under our variable rate revolving credit facility.

Commodity Cost Risk

Most of the commodities, components, parts, and accessories used in our manufacturing process and end-products, or to be sold as standalone end-products, are exposed to commodity cost changes. These changes may be affected by several factors, including, for example, demand; inflation; deflation; changing prices; foreign currency fluctuations; tariffs; duties; trade regulatory actions; industry actions; and changes to international trade policies, agreements, and/or regulation and competitor activity, including antidumping and countervailing duties on certain products imported from foreign countries, such as certain engines imported into the U.S. from China.

Our primary cost exposures for commodities, components, parts, and accessories used in our products are with steel, aluminum, petroleum, and natural gas-based resins, linerboard, copper, lead, rubber, engines, transmissions, transaxles, hydraulics, electrification components, and others. Our largest spend categories for commodities, components, parts, and accessories are generally steel, engines, hydraulic components, transmissions, resin, aluminum, and electrification components, all of which we purchase from several suppliers around the world. We generally purchase commodities, components, parts, and accessories based upon market prices that are established with suppliers as part of the purchase process and generally attempt to obtain firm pricing from most of our suppliers for volumes consistent with planned production and estimates of wholesale and retail demand for our products.

In any given period, we strategically attempt to mitigate potential unfavorable impact as a result of changes to the cost of commodities, components, parts, and accessories that affect our product lines through our productivity initiatives; however, our productivity initiatives may not be as effective as anticipated depending on macroeconomic cost trends for commodities, components, parts, and accessories costs and/or other factors. Our productivity initiatives include, but are not limited to, collaborating with suppliers, reviewing alternative sourcing options, substituting materials, SKU rationalization, utilizing Lean methods, engaging in internal cost reduction efforts, and utilizing tariff exclusions and duty drawback mechanisms, all as appropriate. When appropriate, we may also increase prices on some of our products to offset changes in the cost of commodities, components, parts, and accessories. To the extent that commodity and component costs increase and we do not have firm pricing from our suppliers, or our suppliers are not able to honor such prices, and/or our productivity initiatives and/or product price increases are less effective than anticipated and/or do not fully offset cost increases, we may experience a decline in our gross margins.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we are required to apply our judgment in evaluating the cost-benefit relationship of possible internal controls.

Our management evaluated, with the participation of our Chairman of the Board, President and Chief Executive Officer and our Vice President, Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chairman of the Board, President and Chief Executive Officer and our Vice President, Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of such period to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chairman of the Board, President and Chief Executive Officer and Vice President, Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the three month period ended August 2, 2024 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

We are affected by risks specific to us, as well as factors that affect all businesses operating in a global market. The material risk factors known to us that could materially adversely affect our business, reputation, industry, operating results, or financial position or could cause our actual results to differ materially from our anticipated results or other expectations, including those expressed in any forward-looking statement made in this report, are described in our most recently filed Annual Report on Form 10-K, Part I, Item 1A. "Risk Factors." There has been no material change in those risk factors.