Notes to Condensed Consolidated Financial Statements (Unaudited)
January 28, 2022
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and notes required by United States ("U.S.") generally accepted accounting principles ("GAAP") for complete financial statements. Unless the context indicates otherwise, the terms "company," "TTC," "we," "our," or "us" refer to The Toro Company and its consolidated subsidiaries. All intercompany accounts and transactions have been eliminated from the unaudited Condensed Consolidated Financial Statements.
In the opinion of management, the unaudited Condensed Consolidated Financial Statements include all adjustments, consisting primarily of recurring accruals, considered necessary for the fair presentation of the company's consolidated financial position, results of operations, and cash flows for the periods presented. Due to seasonality within the industries in which the company's businesses operate and the current COVID-19 pandemic, among other factors, operating results for the three months ended January 28, 2022 cannot be annualized to determine the expected results for the fiscal year ending October 31, 2022.
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 calendar 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 regarding the company's basis of presentation, refer to the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in the company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2021. The policies described in that report are used for preparing the company's quarterly reports on Form 10-Q.
Impact of COVID-19 Pandemic
In March 2020, the World Health Organization declared the novel coronavirus ("COVID-19," "virus," or "the pandemic") outbreak a global pandemic. COVID-19 has negatively impacted public health and portions of the global economy, significantly disrupted global supply chains, and created volatility in financial markets. The continuing implications of COVID-19 on the company remain uncertain and will depend on future developments, including any adverse impact due to additional variants of the virus; its impact on market demand for the company's products; its impact on the company's employees, customers, and suppliers; the range of government mandated restrictions and other measures; and the success of the COVID-19 vaccines and their effectiveness against the virus and related variants. This uncertainty could have a material impact on accounting estimates and assumptions utilized to prepare the Condensed Consolidated Financial Statements as of and for the three months ended January 28, 2022 and in future reporting periods, which could result in a material adverse impact on the company's consolidated financial position, results of operations, and cash flows.
Accounting Policies and Estimates
In preparing the Condensed Consolidated Financial Statements in conformity with U.S. GAAP, management must make decisions that impact the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures, including disclosures of contingent assets and liabilities. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. Estimates are used in determining, among other items, sales promotion and incentive accruals, incentive compensation accruals, income tax accruals, inventory valuation, warranty accruals, allowances for current expected credit losses, pension accruals, self-insurance accruals, legal accruals, right-of-use assets and lease liabilities, useful lives for tangible and finite-lived intangible assets, future cash flows associated with impairment testing for goodwill, indefinite-lived intangible assets and other long-lived assets, and valuations of the assets acquired and liabilities assumed in a business combination or an asset acquisition, when applicable. These estimates and assumptions are based on management’s best estimates and judgments at the time they are made and are generally derived from management's understanding and analysis of the relevant and current circumstances, historical experience, and actuarial and other independent external third-party specialist valuations, when applicable. 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 economic environment. Management adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with certainty, including those impacted by COVID-19, actual amounts could differ significantly from those estimated at the time the Condensed Consolidated Financial Statements are prepared.
New Accounting Pronouncements Adopted
In December 2019, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences. The amended guidance also clarifies and simplifies other aspects of the accounting for income taxes under accounting standards codification Topic 740, Income Taxes. The amended guidance was adopted in the first quarter of fiscal 2022 and did not have a material impact on the company's Condensed Consolidated Financial Statements.
In January 2020, the FASB issued ASU No. 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815), which clarified that before applying or upon discontinuing the equity method of accounting for an investment in equity securities, an entity should consider observable transactions that require it to apply or discontinue the equity method of accounting for the purposes of applying the fair value measurement alternative. The amended guidance was adopted in the first quarter of fiscal 2022 and did not have a material impact on the company's Condensed Consolidated Financial Statements.
New Accounting Pronouncements Not Yet Adopted
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides temporary optional guidance to ease the potential burden of accounting for reference rate reform due to the cessation of the London Interbank Offered Rate, commonly referred to as "LIBOR." The temporary guidance provides optional expedients and exceptions for applying U.S. GAAP to contracts, relationships, and transactions affected by reference rate reform if certain criteria are met. The guidance was effective upon issuance on March 12, 2020 and the provisions of the temporary optional guidance provided by the ASU may be elected on a prospective basis from the beginning of an interim period that includes the issuance date of the ASU through December 31, 2022, when the reference rate reform activity is expected to be substantially complete. In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope, to provide supplemental guidance and to further clarify the scope of the amended guidance. At this time, the company does not have receivables, hedging relationships, or operating lease agreements that reference LIBOR or another reference rate expected to be discontinued; and therefore, the company has not applied the optional practical expedients under this ASU to these classes of assets. On October 5, 2021, the company entered into an amended and restated credit agreement and at such time, the company concluded that the optional practical expedients provided by the ASU would not be elected as the required criteria were not met. The amended and restated credit agreement includes a transition clause in the event LIBOR is discontinued and the company's other fixed-rate financing agreements do not reference LIBOR or another reference rate expected to be discontinued. As such, the company does not expect the transition of LIBOR to have a material impact on the company's Condensed Consolidated Financial Statements; however, a review of other contracts and agreements is underway and is expected to be completed prior to December 31, 2022.
The company believes that all other recently issued accounting pronouncements from the FASB that the company has not noted above, will not have a material impact on its Condensed Consolidated Financial Statements or do not apply to its operations.
Intimidator Group
On January 13, 2022 ("closing date"), pursuant to an equity interest purchase agreement ("equity agreement"), the company acquired the privately-held Intimidator Group ("Intimidator"). Intimidator primarily designs, manufactures, markets, and sells a commercial-grade line of zero-turn mowers under the Spartan Mowers brand, which are intended to provide innovative turf management solutions to landscape contractors and other customers who require a commercial-grade solution. The acquisition of Intimidator broadened the company's Professional reportable segment and expanded its manufacturing footprint and dealer network.
The Intimidator acquisition was structured as an equity purchase, pursuant to which the company acquired 100 percent of the equity interests of the legal entities that comprised Intimidator, with the legal entities continuing as surviving entities and wholly-owned subsidiaries of the company. As part of the acquisition, the company also acquired the real property used by Intimidator that was owned by an affiliate of Intimidator. The aggregate preliminary cash consideration was $398.9 million ("purchase price") and remains subject to certain customary adjustments based on, among other things, the amount of actual cash, debt, and working capital in the business of Intimidator at the closing date. Such customary adjustments are expected to be completed during fiscal 2022. Additionally, the aggregate preliminary cash consideration remains subject to contingent consideration through the end of calendar year 2022, in the event of certain qualifying tax changes. As a result, the company could be subject to additional cash purchase consideration for an amount not to exceed $15.0 million and remittance of such contingent consideration, if required, is due by March 15, 2023. As of January 28, 2022, no liability was recorded within the
Condensed Consolidated Balance Sheets for the contingent consideration as the contingency is not probable or estimable. If amounts were recorded for the contingent consideration during the 12 month provisional measurement period allowed under the accounting standards codification guidance for business combinations as a result of a qualifying tax change, the aggregate preliminary cash consideration would be increased by the amount of the contingent consideration with a corresponding increase in the goodwill recognized for the acquisition. The company funded the preliminary purchase price with borrowings under its existing unsecured senior revolving credit facility and cash provided by operating activities. For additional information regarding the company's unsecured senior revolving credit facility utilized to fund the purchase price, refer to Note 6, Indebtedness.
Preliminary Purchase Price Allocation
The company accounted for the acquisition in accordance with the accounting standards codification guidance for business combinations, whereby the aggregate preliminary purchase price was allocated to the acquired net tangible and intangible assets of Intimidator based on their fair values as of the closing date. The company believes that the information available as of the closing date provides a reasonable basis for estimating fair values of the assets acquired and liabilities assumed; however, the company is continuing to finalize these amounts. Thus, the preliminary measurements of the fair values of the assets acquired and liabilities assumed within the preliminary purchase price allocation are subject to change as additional information becomes available and as additional analysis is performed. The company expects to finalize its preliminary valuation and complete the allocation of the preliminary purchase price as soon as practicable, but no later than one year from the closing date of the acquisition, as required.
The following table summarizes the allocation of the preliminary purchase price to the fair values assigned to the assets acquired and liabilities assumed. These preliminary fair values are based on internal company and independent external third-party valuations and are subject to change as certain asset and liability valuations are finalized:
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(Dollars in thousands) | | January 13, 2022 |
Cash and cash equivalents | | $ | 2,601 | |
Receivables | | 6,788 | |
Inventories | | 36,006 | |
Prepaid expenses and other current assets | | 511 | |
Property, plant and equipment | | 26,825 | |
Right-of-use assets | | 349 | |
Goodwill | | 155,638 | |
Other intangible assets: | | |
Indefinite-lived trade name | | 99,100 | |
Finite-lived trade names | | 3,260 | |
Finite-lived customer-related | | 81,300 | |
Finite-lived backlog | | 2,250 | |
Accounts payable | | (10,142) | |
Accrued liabilities | | (2,662) | |
Short-term lease liabilities | | (102) | |
Long-term lease liabilities | | (247) | |
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Total fair value of net assets acquired | | 401,475 | |
Less: cash and cash equivalents acquired | | (2,601) | |
Total preliminary purchase price | | $ | 398,874 | |
The goodwill recognized is primarily attributable to the expected future cash flows, the value of the workforce, and expected synergies, including customer and dealer growth opportunities, expanding existing product lines, and cost reduction initiatives. Key areas of expected cost synergies include increased purchasing power for commodities, components, parts, and accessories, and supply chain consolidation. The goodwill resulting from the acquisition of Intimidator was recognized within the company's Professional segment and is the primary driver for the increase in the company's Professional segment goodwill to $566.4 million as of January 28, 2022. The acquisition was considered an asset acquisition for income tax purposes and as a result, the goodwill arising from the transaction is deductible.
Other Intangible Assets Acquired
The allocation of the preliminary purchase price to the net assets acquired resulted in the recognition of $185.9 million of preliminary value for other intangible assets as of the closing date. The preliminary fair values of the acquired trade names, customer-related, and backlog intangible assets were determined using the income approach whereby an intangible asset's fair value is equal to the present value of future economic benefits to be derived from ownership of the asset. The useful lives of the other intangible assets were determined based on the period of expected cash flows used to measure the fair value of the
intangible assets adjusted as appropriate for entity-specific factors including legal, regulatory, contractual, competitive, economic, and/or other factors that may limit the useful life of the respective intangible asset. As of the closing date, the acquired finite-lived intangible assets had a weighted average useful life of 9.5 years. The preliminary fair values of the trade names were determined using the relief from royalty method, which is based on the hypothetical royalty stream that would be received if the company were to license the respective trade name and were based on expected future revenues from the respective trade name. The weighted-average useful life of the finite-lived trade name intangible assets was determined to be 9.8 years as of the closing date. The preliminary fair values of the customer-related and backlog intangible assets were determined using the excess earnings method and were based on the expected operating cash flows attributable to the respective intangible asset, which were determined by deducting expected economic costs, including operating expenses and contributory asset charges, from the revenue expected to be generated from the respective intangible asset. As of the closing date of the acquisition, the weighted-average useful life of the customer-related and backlog intangible assets were determined to be 9.7 years and 9 months, respectively.
Results of Operations
Intimidator's results of operations are included within the company's Professional reportable segment in the company's Condensed Consolidated Financial Statements from the closing date. Intimidator's operations had an immaterial impact on the company's Professional reportable segment net sales and segment earnings for the three month period ended January 28, 2022. Unaudited pro forma financial information is not disclosed as the Intimidator acquisition was not considered material to the company's consolidated results of operations.
The company's businesses are organized, managed, and internally grouped into segments based on similarities in products and services. Segment selection is based on the manner in which the company's chief operating decision maker organizes segments for making operating and investment decisions and assessing performance. The company has identified twelve operating segments and has aggregated certain of those operating segments into two reportable segments: Professional and Residential. The aggregation of the company's segments is based on the segments having the following similarities: economic characteristics, types of products and services, types of production processes, type or class of customers, and method of distribution. The company's remaining activities are presented as "Other" due to their insignificance. The company's Other activities consist of the company's wholly-owned domestic distribution company, the company's corporate activities, and the elimination of intersegment revenues and expenses.
The following tables present summarized financial information concerning the company’s reportable business segments and Other activities (in thousands):
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Three Months Ended January 28, 2022 | | Professional | | Residential | | Other | | Total |
Net sales | | $ | 672,885 | | | $ | 255,402 | | | $ | 4,363 | | | $ | 932,650 | |
Intersegment gross sales (eliminations) | | 5,417 | | | 15 | | | (5,432) | | | — | |
Earnings (loss) before income taxes | | 93,272 | | | 31,760 | | | (37,885) | | | 87,147 | |
Total assets | | $ | 2,486,201 | | | $ | 444,549 | | | $ | 322,295 | | | $ | 3,253,045 | |
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Three Months Ended January 29, 2021 | | Professional | | Residential | | Other | | Total |
Net sales | | $ | 650,223 | | | $ | 217,700 | | | $ | 5,063 | | | $ | 872,986 | |
Intersegment gross sales (eliminations) | | 6,642 | | | 16 | | | (6,658) | | | — | |
Earnings (loss) before income taxes | | 116,816 | | | 32,108 | | | (13,098) | | | 135,826 | |
Total assets | | $ | 1,952,536 | | | $ | 345,185 | | | $ | 577,417 | | | $ | 2,875,138 | |
The following table presents the details of operating loss before income taxes for the company's Other activities:
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| | Three Months Ended | | |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | | | |
Corporate expenses | | $ | (32,828) | | | $ | (11,303) | | | | | |
Interest expense | | (7,013) | | | (7,522) | | | | | |
Earnings from wholly-owned domestic distribution companies and other income, net | | 1,956 | | | 5,727 | | | | | |
Total operating loss | | $ | (37,885) | | | $ | (13,098) | | | | | |
The following tables disaggregate the company's reportable segment net sales by major product type and geographic market (in thousands):
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Three Months Ended January 28, 2022 | | Professional | | Residential | | Other | | Total |
Revenue by product type: | | | | | | | | |
Equipment | | $ | 570,871 | | | $ | 244,589 | | | $ | 3,147 | | | $ | 818,607 | |
Irrigation | | 102,014 | | | 10,813 | | | 1,216 | | | 114,043 | |
Total net sales | | $ | 672,885 | | | $ | 255,402 | | | $ | 4,363 | | | $ | 932,650 | |
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Revenue by geographic market: | | | | | | | | |
United States | | $ | 530,734 | | | $ | 202,567 | | | $ | 4,363 | | | $ | 737,664 | |
International countries | | 142,151 | | | 52,835 | | | — | | | 194,986 | |
Total net sales | | $ | 672,885 | | | $ | 255,402 | | | $ | 4,363 | | | $ | 932,650 | |
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Three Months Ended January 29, 2021 | | Professional | | Residential | | Other | | Total |
Revenue by product type: | | | | | | | | |
Equipment | | $ | 575,775 | | | $ | 205,923 | | | $ | 3,942 | | | $ | 785,640 | |
Irrigation | | 74,448 | | | 11,777 | | | 1,121 | | | 87,346 | |
Total net sales | | $ | 650,223 | | | $ | 217,700 | | | $ | 5,063 | | | $ | 872,986 | |
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Revenue by geographic market: | | | | | | | | |
United States | | $ | 501,860 | | | $ | 174,382 | | | $ | 5,063 | | | $ | 681,305 | |
International countries | | 148,363 | | | 43,318 | | | — | | | 191,681 | |
Total net sales | | $ | 650,223 | | | $ | 217,700 | | | $ | 5,063 | | | $ | 872,986 | |
Contract Liabilities
Contract liabilities relate to deferred revenue recognized for cash consideration received at contract inception in advance of the company's performance under the respective contract and generally relate to the sale of separately priced extended warranty contracts, service contracts, and non-refundable customer deposits. The company recognizes revenue over the term of the contract in proportion to the costs expected to be incurred in satisfying the performance obligations under the separately priced extended warranty and service contracts. For non-refundable customer deposits, the company recognizes revenue as of the point in time in which the performance obligation has been satisfied under the contract with the customer, which typically occurs upon change in control at the time a product is shipped. As of January 28, 2022 and October 31, 2021, $24.6 million and $24.1 million, respectively, of deferred revenue associated with outstanding separately priced extended warranty contracts, service contracts, and non-refundable customer deposits was reported within accrued liabilities and other long-term liabilities in the Condensed Consolidated Balance Sheets. For the three months ended January 28, 2022, the company recognized $2.5 million of the October 31, 2021 deferred revenue balance within net sales in the Condensed Consolidated Statements of Earnings. The company expects to recognize approximately $8.6 million of the October 31, 2021 deferred revenue amount within net sales throughout the remainder of fiscal 2022, $7.7 million in fiscal 2023, and $5.3 million thereafter.
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5 | Goodwill and Other Intangible Assets, Net |
The company's acquisition of Intimidator on January 13, 2022 resulted in the recognition of $155.6 million and $185.9 million of preliminary goodwill and other intangible assets, respectively. For additional information on the company's acquisition of Intimidator, refer to Note 2, Business Combination.
Goodwill
The changes in the carrying amount of goodwill by reportable segment for the first three months of fiscal 2022 were as follows:
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(Dollars in thousands) | | Professional | | Residential | | Other | | Total |
Balance as of October 31, 2021 | | $ | 411,079 | | | $ | 10,601 | | | $ | — | | | $ | 421,680 | |
Goodwill acquired | | 155,638 | | | — | | | — | | | 155,638 | |
Translation adjustments | | (321) | | | (57) | | | — | | | (378) | |
Balance as of January 28, 2022 | | $ | 566,396 | | | $ | 10,544 | | | $ | — | | | $ | 576,940 | |
Other Intangible Assets, Net
The components of other intangible assets, net as of January 28, 2022, January 29, 2021, and October 31, 2021 were as follows (in thousands):
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January 28, 2022 | | Weighted-Average Useful Life in Years | | Gross Carrying Amount | | Accumulated Amortization | | Net |
Patents | | 9.9 | | $ | 18,291 | | | $ | (14,858) | | | $ | 3,433 | |
Non-compete agreements | | 5.5 | | 6,921 | | | (6,885) | | | 36 | |
Customer-related | | 16.0 | | 322,296 | | | (66,325) | | | 255,971 | |
Developed technology | | 7.0 | | 87,427 | | | (45,748) | | | 41,679 | |
Trade names | | 13.7 | | 10,762 | | | (3,038) | | | 7,724 | |
Backlog and other | | 0.7 | | 6,640 | | | (4,390) | | | 2,250 | |
Total finite-lived | | 13.5 | | 452,337 | | | (141,244) | | | 311,093 | |
Indefinite-lived - trade names | | | | 289,704 | | | — | | | 289,704 | |
Total other intangible assets, net | | | | $ | 742,041 | | | $ | (141,244) | | | $ | 600,797 | |
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January 29, 2021 | | Weighted-Average Useful Life in Years | | Gross Carrying Amount | | Accumulated Amortization | | Net |
Patents | | 9.9 | | $ | 18,275 | | | $ | (14,123) | | | $ | 4,152 | |
Non-compete agreements | | 5.5 | | 6,908 | | | (6,851) | | | 57 | |
Customer-related | | 18.2 | | 239,816 | | | (51,747) | | | 188,069 | |
Developed technology | | 7.7 | | 59,017 | | | (36,230) | | | 22,787 | |
Trade names | | 15.3 | | 7,563 | | | (2,684) | | | 4,879 | |
Backlog and other | | 0.6 | | 4,390 | | | (4,390) | | | — | |
Total finite-lived | | 15.3 | | 335,969 | | | (116,025) | | | 219,944 | |
Indefinite-lived - trade names | | | | 190,643 | | | — | | | 190,643 | |
Total other intangible assets, net | | | | $ | 526,612 | | | $ | (116,025) | | | $ | 410,587 | |
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October 31, 2021 | | Weighted-Average Useful Life in Years | | Gross Carrying Amount | | Accumulated Amortization | | Net |
Patents | | 9.9 | | $ | 18,283 | | | $ | (14,670) | | | $ | 3,613 | |
Non-compete agreements | | 5.5 | | 6,914 | | | (6,872) | | | 42 | |
Customer-related | | 18.2 | | 239,679 | | | (62,617) | | | 177,062 | |
Developed technology | | 7.0 | | 87,473 | | | (43,348) | | | 44,125 | |
Trade names | | 15.4 | | 7,524 | | | (2,969) | | | 4,555 | |
Backlog and other | | 0.6 | | 4,390 | | | (4,390) | | | — | |
Total finite-lived | | 14.6 | | 364,263 | | | (134,866) | | | 229,397 | |
Indefinite-lived - trade names | | | | 190,644 | | | — | | | 190,644 | |
Total other intangible assets, net | | | | $ | 554,907 | | | $ | (134,866) | | | $ | 420,041 | |
Amortization expense for finite-lived intangible assets for the three months ended January 28, 2022 and January 29, 2021 were $6.5 million and $4.9 million, respectively. Estimated amortization expense for the remainder of fiscal 2022 and succeeding fiscal years is as follows: fiscal 2022 (remainder), $27.2 million; fiscal 2023, $32.7 million; fiscal 2024, $30.7 million; fiscal 2025, $28.2 million; fiscal 2026, $27.2 million; fiscal 2027, $22.7 million; and after fiscal 2027, $142.4 million.
The following is a summary of the company's indebtedness:
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(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | October 31, 2021 |
$600 million revolving credit facility, due October 2026 | | $ | 400,000 | | | $ | — | | | $ | — | |
$270 million term loan, due October 2026 | | 270,000 | | | — | | | 270,000 | |
$200 million term loan, due April 2022 | | — | | | 100,000 | | | — | |
$300 million term loan, due April 2024 | | — | | | 180,000 | | | — | |
3.81% series A senior notes, due June 2029 | | 100,000 | | | 100,000 | | | 100,000 | |
3.91% series B senior notes, due June 2031 | | 100,000 | | | 100,000 | | | 100,000 | |
7.8% debentures, due June 2027 | | 100,000 | | | 100,000 | | | 100,000 | |
6.625% senior notes, due May 2037 | | 124,055 | | | 123,993 | | | 124,040 | |
Less: unamortized discounts, debt issuance costs, and deferred charges | | 2,701 | | | 2,645 | | | 2,798 | |
Total long-term debt | | 1,091,354 | | | 701,348 | | | 691,242 | |
Less: current portion of long-term debt | | 100,000 | | | 9,992 | | | — | |
Long-term debt, less current portion | | $ | 991,354 | | | $ | 691,356 | | | $ | 691,242 | |
Principal payments required on the company's outstanding indebtedness, based on the maturity dates defined within the company's debt arrangements, for the remainder of fiscal 2022 and succeeding fiscal years are as follows: fiscal 2022 (remainder), $0.0 million; fiscal 2023, $0.0 million; fiscal 2024, $0.0 million; fiscal 2025, $27.0 million; fiscal 2026, $643.0 million; fiscal 2027, $0.0 million; and after fiscal 2027, $425.0 million. Typically, the company's revolving credit facility is classified as long-term debt within the Condensed Consolidated Balance Sheets as the company has the ability to extend the outstanding borrowings under the revolving credit facility for the full-term of the facility. However, if the company intends to prepay a portion of the outstanding balance under the revolving credit facility within the next twelve months, the company reclassifies the portion of outstanding borrowings under the revolving credit facility that the company intends to repay within the next twelve months to current portion of long-term debt within the Condensed Consolidated Balance Sheets. As of January 28, 2022, the company reclassified $100.0 million of outstanding borrowings under the revolving credit facility to current portion of long-term debt within the Condensed Consolidated Balance Sheets as the company currently intends to repay this amount within the next twelve months.
Inventories are valued at the lower of cost or net realizable value, with cost determined by the first-in, first-out ("FIFO") and average cost methods for a majority of the company's inventories. All remaining inventories are valued at the lower of cost or market, with cost determined under the last-in, first-out ("LIFO") method. As needed, the company records an inventory valuation adjustment for excess, slow-moving, and obsolete inventory that is equal to the excess of the cost of the inventory over the estimated net realizable value or market value for the inventory depending on the inventory costing method. Such inventory valuation adjustment is based on a review and comparison of current inventory levels to planned production, as well as planned and historical sales of the inventory. The inventory valuation adjustment to net realizable value or market value establishes a new cost basis of the inventory that cannot be subsequently reversed.
On January 13, 2022, with the acquisition of Intimidator, the company acquired $36.0 million of inventory, based on preliminary fair value purchase accounting adjustments. For additional information on the company's acquisition of Intimidator, refer to Note 2, Business Combination.
Inventories, net were as follows:
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(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | October 31, 2021 |
Raw materials and work in process | | $ | 383,285 | | | $ | 226,979 | | | $ | 335,325 | |
Finished goods and service parts | | 584,274 | | | 530,415 | | | 538,332 | |
Total FIFO and average cost value | | 967,559 | | | 757,394 | | | 873,657 | |
Less: adjustment to LIFO value | | 135,487 | | | 82,087 | | | 135,487 | |
Total inventories, net | | $ | 832,072 | | | $ | 675,307 | | | $ | 738,170 | |
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8 | Property, Plant and Equipment, Net |
Property, plant and equipment assets are carried at cost less accumulated depreciation. The company generally accounts for depreciation of property, plant, and equipment utilizing the straight-line method over the estimated useful lives of the assets. Buildings and leasehold improvements are generally depreciated over 10 to 40 years, machinery and equipment are generally depreciated over two to 15 years, tooling is generally depreciated over three to five years, and computer hardware and software and website development costs are generally depreciated over two to five years. Expenditures for major renewals and improvements, which substantially increase the useful lives of existing assets, are capitalized. Costs associated with general maintenance and repairs are expensed as incurred within cost of sales or selling, general and administrative expense in the Condensed Consolidated Statements of Earnings depending on the nature and use of the related asset. Interest is capitalized during the construction period for significant capital projects.
On January 13, 2022, with the acquisition of Intimidator, the company acquired $26.8 million of property, plant, and equipment, based on preliminary fair value purchase accounting adjustments. For additional information on the company's acquisition of Intimidator, refer to Note 2, Business Combination.
Property, plant and equipment, net was as follows:
| | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | October 31, 2021 |
Land and land improvements | | $ | 57,924 | | | $ | 56,808 | | | $ | 57,690 | |
Buildings and leasehold improvements | | 326,137 | | | 299,566 | | | 308,217 | |
Machinery and equipment | | 529,289 | | | 500,410 | | | 522,012 | |
Tooling | | 221,646 | | | 231,728 | | | 220,966 | |
Computer hardware and software | | 97,629 | | | 102,357 | | | 97,485 | |
Construction in process | | 95,448 | | | 58,346 | | | 85,722 | |
Property, plant, and equipment, gross | | 1,328,073 | | | 1,249,215 | | | 1,292,092 | |
Less: accumulated depreciation | | 820,524 | | | 792,068 | | | 804,361 | |
Property, plant, and equipment, net | | $ | 507,549 | | | $ | 457,147 | | | $ | 487,731 | |
| | | | | |
9 | Product Warranty Guarantees |
The company’s products are warranted to provide assurance that the product will function as expected and to ensure customer confidence in design, workmanship, and overall quality. Standard warranty coverage is generally provided for specified periods of time and on select products’ hours of usage, and generally covers parts, labor, and other expenses for non-maintenance repairs. In addition to the standard warranties offered by the company on its products, the company also sells separately priced extended warranty coverage on select products for a prescribed period after the original warranty period expires. For additional information on the contract liabilities associated with the company's separately priced extended warranties, refer to Note 4, Revenue.
At the time of sale, the company recognizes expense and records an accrual by product line for estimated costs in connection with forecasted future warranty claims. The company's estimate of the cost of future warranty claims is based primarily 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, and the historical length of time between the sale and resulting warranty claim. The company periodically assesses the adequacy of its warranty accruals based on changes in these factors and records any necessary adjustments if the cost of actual claims experience indicates that adjustments to the company's warranty accrual are necessary. Additionally, from time to time, the company may also establish warranty accruals for its estimate of the costs necessary to settle major rework campaigns on a product-specific basis during the period in which the circumstances giving rise to the major rework campaign become known and when the costs to satisfactorily address the situation are both probable and estimable. The warranty accrual for the cost of a major rework campaign is primarily based on an estimate of the cost to repair each affected unit and the number of affected units expected to be repaired.
The changes in accrued warranties were as follows:
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | | | |
Beginning balance | | $ | 116,783 | | | $ | 107,121 | | | | | |
Provisions | | 17,194 | | | 16,695 | | | | | |
Acquisitions | | 1,940 | | | — | | | | | |
Claims | | (15,911) | | | (15,186) | | | | | |
Changes in estimates | | (146) | | | 153 | | | | | |
Ending balance | | $ | 119,860 | | | $ | 108,783 | | | | | |
| | | | | |
10 | Investment in Finance Affiliate |
The company and TCF Inventory Finance, Inc. ("TCFIF"), a subsidiary of The Huntington National Bank, are parties to the Red Iron joint venture ("Red Iron"), the primary purpose of which is to provide inventory financing to certain distributors and dealers of certain of the company’s products in the U.S. These financing 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. The company has also entered into a limited inventory repurchase agreement with Red Iron, under which the company has agreed to repurchase certain repossessed products, up to a maximum aggregate amount of $7.5 million in a calendar year. The company's financial exposure under this limited inventory repurchase agreement is limited to the difference between the amount paid for repurchases of repossessed product and the amount received upon the subsequent resale of the repossessed product. The company has repurchased immaterial amounts of inventory under this limited inventory repurchase agreement for the three months ended January 28, 2022 and January 29, 2021.
Under separate agreements between Red Iron and the dealers and distributors, Red Iron provides loans to the dealers and distributors for the advances paid by Red Iron to the company. The net amount of receivables financed for dealers and distributors under this arrangement for the three months ended January 28, 2022 and January 29, 2021 were $528.1 million and $511.3 million, respectively. As of January 28, 2022, Red Iron’s total assets were $496.9 million and total liabilities were $443.3 million. The total amount of receivables due from Red Iron to the company as of January 28, 2022, January 29, 2021, and October 31, 2021 were $28.1 million, $13.1 million and $31.0 million, respectively.
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. At inception, the company and TCFIF each contributed a specified amount of the estimated cash required to enable Red Iron to purchase the company’s inventory financing receivables and to provide financial support for Red Iron’s inventory financing programs. Red Iron borrows the remaining requisite estimated cash utilizing a $625.0 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 January 28, 2022, January 29, 2021, and October 31, 2021 was $24.1 million, $23.0 million, and $20.7 million, respectively. The company has not guaranteed the outstanding indebtedness of Red Iron.
| | | | | |
11 | Stock-Based Compensation |
Compensation costs related to stock-based compensation awards were as follows:
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | | | |
Stock option awards | | $ | 1,828 | | | $ | 2,058 | | | | | |
Performance share awards | | 1,621 | | | 827 | | | | | |
Restricted stock unit awards | | 1,147 | | | 960 | | | | | |
Unrestricted common stock awards | | 629 | | | 671 | | | | | |
Total compensation cost for stock-based compensation awards | | $ | 5,225 | | | $ | 4,516 | | | | | |
Stock Option Awards
Under The Toro Company Amended and Restated 2010 Equity and Incentive Plan, as amended and restated (the "2010 plan"), stock options are granted with an exercise price equal to the closing price of the company’s common stock on the date of grant, as reported by the New York Stock Exchange. Options are generally granted to executive officers, other employees, and non-employee members of the company’s Board of Directors ("Board") on an annual basis in the first quarter of the company’s
fiscal year but may also be granted throughout the fiscal year in connection with hiring, mid-year promotions, leadership transition, or retention, as needed and applicable. Options generally vest one-third each year over a three-year period and have a ten-year term but in certain circumstances, the vesting requirement may be modified such that options granted to certain employees vest in full on the three-year anniversary of the date of grant and have a ten-year term. Compensation cost equal to the grant date fair value determined under the Black-Scholes valuation method is generally recognized for these awards over the vesting period. Compensation cost recognized for other employees not considered executive officers and non-employee Board members is net of estimated forfeitures, which are determined at the time of grant based on historical forfeiture experience. Stock options granted to executive officers and other employees are subject to accelerated expensing if the option holder meets the retirement definition set forth in the 2010 plan. In that case, the fair value of the options is expensed in the fiscal year of grant because generally, if the option holder is employed as of the end of the fiscal year in which the options are granted, such options will not be forfeited but continue to vest according to their schedule following retirement. Similarly, if a non-employee Board member has served on the company's Board for ten full fiscal years or more, the awards will not be forfeited but continue to vest according to their schedule following retirement. 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 various inputs and assumptions under the Black-Scholes valuation method. The expected life is a significant assumption as it determines the period for which the risk-free interest rate, stock price volatility, and dividend yield must be applied. The expected life is the average length of time in which executive officers, other employees, and non-employee Board members are expected to exercise their stock options, which is primarily based on historical exercise experience. The company groups executive officers and non-employee Board members for valuation purposes based on similar historical exercise behavior. Expected stock price volatility is based on the daily 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. The expected 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.
The table below illustrates the weighted-average valuation assumptions used under the Black-Scholes valuation method for options granted in the first three months of the following fiscal periods:
| | | | | | | | | | | | | | |
| | Fiscal 2022 | | Fiscal 2021 |
Expected life of option in years | | 6.19 | | 6.21 |
Expected stock price volatility | | 23.76% | | 23.26% |
Risk-free interest rate | | 1.30% | | 0.55% |
Expected dividend yield | | 0.93% | | 0.86% |
Per share weighted-average fair value at date of grant | | $22.58 | | $19.38 |
Performance Share Awards
Under the 2010 plan, the company grants performance share awards to executive officers and other employees under which they are entitled to receive shares of the company’s common stock contingent on the achievement of performance goals of the company, which are generally measured over a three-year period. The number of shares of common stock a participant receives can be increased (up to 200 percent of target levels) or reduced (down to zero) based on the level of achievement of performance goals and will 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 cost is recognized for these awards on a straight-line basis over the vesting period based on the per share fair value, which is equal to the closing price of the company's common stock on the date of grant, and the probability of achieving each performance goal. The per share weighted-average fair value of performance share awards granted during the first quarter of fiscal 2022 and 2021 was $98.41 and $90.59, respectively.
Restricted Stock Unit Awards
Under the 2010 plan, restricted stock unit awards are generally granted to certain employees who are not executive officers. Occasionally, restricted stock unit awards may be granted, including to executive officers, in connection with hiring, mid-year promotions, leadership transition, or retention. 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. Compensation cost equal to the grant date fair value, net of estimated forfeitures, is recognized for these awards over the vesting period. The grant date fair value 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 unit awards and estimated forfeitures are determined on the grant date based on historical forfeiture experience. The per share weighted-average fair value of restricted stock unit awards granted during the first three months of fiscal 2022 and 2021 was $99.94 and $91.51, respectively.
Unrestricted Common Stock Awards
During the first quarter of fiscal 2022 and 2021, 6,453 and 8,070 shares, respectively, of fully vested unrestricted common stock awards were granted to certain Board members as a component of their compensation for their service on the Board and were recorded within selling, general and administrative expense in the Condensed Consolidated Statements of Earnings. Additionally, our Board members may elect to convert a portion or all of their calendar year annual retainers otherwise payable in cash into shares of the company's common stock.
Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss ("AOCL"), net of tax, within the Condensed Consolidated Statements of Stockholders' Equity were as follows:
| | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | October 31, 2021 |
Foreign currency translation adjustments | | $ | 25,525 | | | $ | 14,112 | | | $ | 19,535 | |
Pension benefits | | 3,899 | | | 5,106 | | | 3,899 | |
Cash flow derivative instruments | | (3,810) | | | 12,958 | | | 2,562 | |
Total accumulated other comprehensive loss | | $ | 25,614 | | | $ | 32,176 | | | $ | 25,996 | |
The components and activity of AOCL, net of tax, for the three month periods ended January 28, 2022 and January 29, 2021 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | Foreign Currency Translation Adjustments | | Pension Benefits | | Cash Flow Derivative Instruments | | Total |
Balance as of October 31, 2021 | | $ | 19,535 | | | $ | 3,899 | | | $ | 2,562 | | | $ | 25,996 | |
Other comprehensive (income) loss before reclassifications | | 5,990 | | | — | | | (6,641) | | | (651) | |
Amounts reclassified from AOCL | | — | | | — | | | 269 | | | 269 | |
Net current period other comprehensive (income) loss | | 5,990 | | | — | | | (6,372) | | | (382) | |
Balance as of January 28, 2022 | | $ | 25,525 | | | $ | 3,899 | | | $ | (3,810) | | | $ | 25,614 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | Foreign Currency Translation Adjustments | | Pension Benefits | | Cash Flow Derivative Instruments | | Total |
Balance as of October 31, 2020 | | $ | 24,508 | | | $ | 5,106 | | | $ | 4,648 | | | $ | 34,262 | |
Other comprehensive (income) loss before reclassifications | | (10,396) | | | — | | | 6,312 | | | (4,084) | |
Amounts reclassified from AOCL | | — | | | — | | | 1,998 | | | 1,998 | |
Net current period other comprehensive (income) loss | | (10,396) | | | — | | | 8,310 | | | (2,086) | |
Balance as of January 29, 2021 | | $ | 14,112 | | | $ | 5,106 | | | $ | 12,958 | | | $ | 32,176 | |
For additional information on the components reclassified from AOCL to the respective line items in net earnings for derivative instruments refer to Note 16, Derivative Instruments and Hedging Activities.
Reconciliations of basic and diluted weighted-average number of shares of common stock outstanding were as follows:
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
(Shares in thousands) | | January 28, 2022 | | January 29, 2021 | | | | |
Basic | | | | | | | | |
Weighted-average number of shares of common stock | | 105,015 | | | 108,103 | | | | | |
Assumed issuance of contingent shares | | 22 | | | 19 | | | | | |
Weighted-average number of shares of common stock outstanding - Basic | | 105,037 | | | 108,122 | | | | | |
| | | | | | | | |
Diluted | | | | | | | | |
Weighted-average number of shares of common stock outstanding - Basic | | 105,037 | | | 108,122 | | | | | |
Effect of dilutive shares | | 1,011 | | | 1,072 | | | | | |
Weighted-average number of shares of common stock outstanding - Diluted | | 106,048 | | | 109,194 | | | | | |
The effect of dilutive shares from stock option awards and restricted stock unit awards is computed under the treasury stock method. Stock option awards to purchase 466,338 and 268,778 shares of common stock during the first quarter of fiscal 2022 and 2021, respectively, were excluded from the computation of diluted net earnings per share of common stock because they were anti-dilutive.
Litigation
From time to time, the company is party to litigation in the ordinary course of business. Such matters are generally subject to uncertainties and to outcomes that are not predictable with assurance and that may not be known for extended periods of time. Litigation occasionally involves claims for punitive, as well as compensatory, damages arising out of the use of the company’s products. Although the company is self-insured to some extent, the company maintains insurance against certain product liability losses. The company is also subject to litigation and administrative and judicial proceedings with respect to claims involving asbestos and the discharge of hazardous substances into the environment. Some of these claims assert damages and liability for personal injury, remedial investigations or clean up and other costs and damages. The company is also occasionally involved in commercial disputes, employment or employment-related disputes, and patent litigation cases in which it is asserting or defending against patent infringement claims. To prevent possible infringement of the company’s patents by others, the company periodically reviews competitors’ products. To avoid potential liability with respect to others’ patents, the company reviews certain patents issued by the U.S. Patent and Trademark Office and foreign patent offices. The company believes these activities help minimize its risk of being a defendant in patent infringement litigation.
The company records a liability in its Condensed Consolidated Financial Statements for costs related to claims, including future legal costs, settlements, and judgments, where the company has assessed that a loss is probable and an amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range, the company records the most probable estimate of the loss or the minimum amount when no amount within the range is a better estimate than any other amount. The company discloses a contingent liability even if the liability is not probable or the amount is not estimable, or both, if there is a reasonable possibility that a material loss may have been incurred. In the opinion of management, the amount of liability, if any, with respect to these matters, individually or in the aggregate, will not materially affect the company's consolidated results of operations, financial position, or cash flows.
In situations where the company receives, or expects to receive, a favorable ruling related to a litigation settlement, the company follows the accounting standards codification guidance for gain contingencies. The company does not allow for the recognition of a gain contingency within its Condensed Consolidated Financial Statements prior to the settlement of the underlying events or contingencies associated with the gain contingency. As a result, the consideration related to a gain contingency is recorded in the Condensed Consolidated Financial Statements during the period in which all underlying events or contingencies are resolved and the gain is realized.
Litigation Settlement
On November 19, 2020, Exmark Manufacturing Company Incorporated ("Exmark"), a wholly-owned subsidiary of the company, and Briggs & Stratton Corporation (“BGG”) entered into a settlement agreement (“Settlement Agreement”) relating to the decade-long patent infringement litigation that Exmark originally filed in May 2010 against Briggs & Stratton Power Products Group, LLC (“BSPPG”), a former wholly-owned subsidiary of BGG (Case No. 8:10CV187, U.S. District Court for the District of Nebraska) (the “Infringement Action”). In the Infringement Action, Exmark alleged that certain mower decks manufactured by BSPPG infringed an Exmark mower deck patent. Despite favorable judgments in the Infringement Action in favor of Exmark, including with regard to awarded damages, actions by BGG during the second half of calendar year 2020 put in jeopardy the certainty and timing of the eventual receipt of the damages awarded to Exmark in the Infringement Action, including (i) the filing by BGG and certain of its subsidiaries for bankruptcy relief under chapter 11 of title 11 of the United States Bankruptcy Code (“BGG Bankruptcy”); (ii) the sale of substantially all the assets (but not certain liabilities, including the Infringement Action) of BGG and its subsidiaries to a third-party pursuant to Section 363 of the United States Bankruptcy Code; and (iii) a petition filed by BGG for a panel rehearing of the United States Court of Appeals for the Federal Circuit's decision in the Infringement Action (“Rehearing Petition”).
As a result, on November 19, 2020, Exmark entered into the Settlement Agreement with BGG which provided, among other things, that (i) upon approval by the bankruptcy court, and such approval becoming final and nonappealable, BGG agreed to pay Exmark $33.65 million (“Settlement Amount”), (ii) BGG agreed to immediately withdraw the Rehearing Petition and otherwise not pursue additional appellate review regarding the Infringement Action, and (iii) after receipt of the Settlement Amount, Exmark agreed to release a supersedeas appeal bond that had been obtained by BGG to support payment of the damages awarded to Exmark in the Infringement Action. On November 20, 2020, BGG filed a motion to withdraw the Rehearing Petition and on December 16, 2020, the bankruptcy court approved the Settlement Agreement. During January 2021, the first quarter of fiscal 2021, the Settlement Amount was received by Exmark in connection with the settlement of the Infringement Action and at such time, the underlying events and contingencies associated with the gain contingency related to the Infringement Action were satisfied. As such, the company recognized in selling, general and administrative expense within the Condensed Consolidated Statements of Earnings during the first quarter of fiscal 2021 (i) the gain associated with the Infringement Action and (ii) a corresponding expense related to the contingent fee arrangement with the company's external legal counsel customary in patent infringement cases equal to approximately 50 percent of the Settlement Amount.
The company enters into contracts that are, or contain, operating lease agreements for certain property, plant, or equipment assets utilized in the normal course of business, such as buildings for manufacturing facilities, office space, distribution centers, and warehouse facilities; land for product testing sites; machinery and equipment for research and development activities, manufacturing and assembly processes, and administrative tasks; and vehicles for sales, service, marketing, and distribution activities. Contracts that explicitly or implicitly relate to property, plant, and equipment are assessed at inception to determine if the contract is, or contains, a lease. Such contracts for operating lease agreements convey the company's right to direct the use of, and obtain substantially all of the economic benefits from, an identified asset for a defined period of time in exchange for consideration. The lease term begins and is determined upon lease commencement, which is the point in time when the company takes possession of the identified asset, and generally includes all non-cancelable periods. Lease expense for the company's operating leases is recognized on a straight-line basis over the lease term and is recorded within cost of sales or selling, general and administrative expense within the Condensed Consolidated Statements of Earnings as dictated by the nature and use of the underlying asset. The company does not recognize right-of-use assets and lease liabilities, but does recognize expense on a straight-line basis, for short-term operating leases which have a lease term of 12 months or less and do not include an option to purchase the underlying asset.
Lease payments are determined at lease commencement and generally represent fixed lease payments as defined within the respective lease agreement or, in the case of certain lease agreements, variable lease payments that are measured as of the lease commencement date based on the prevailing index or market rate. Future adjustments to variable lease payments are defined and scheduled within the respective lease agreement and are determined based upon the prevailing market or index rate at the time of the adjustment relative to the market or index rate determined at lease commencement. Certain other lease agreements contain variable lease payments that are determined based upon actual utilization of the identified asset. Such future adjustments to variable lease payments and variable lease payments based upon actual utilization of the identified asset are not included within the determination of lease payments at commencement but rather, are recorded as variable lease expense in the period in which the variable lease cost is incurred.
Right-of-use assets represent the company's right to use an underlying asset throughout the lease term and lease liabilities represent the company's obligation to make lease payments arising from the lease agreement. The company accounts for operating lease liabilities at lease commencement and on an ongoing basis as the present value of the minimum remaining lease payments under the respective lease term. Minimum remaining lease payments are generally discounted to present value based the estimated incremental borrowing rate at lease commencement as the rate implicit in the lease is generally not readily determinable. Right-of-use assets are measured as the amount of the corresponding operating lease liability for the respective operating lease agreement, adjusted for prepaid or accrued lease payments, the remaining balance of any lease incentives received, unamortized initial direct costs, and impairment of the operating lease right-of-use asset, as applicable.
The following table presents the lease expense incurred on the company’s operating, short-term, and variable leases:
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | | | |
Operating lease expense | | $ | 6,165 | | | $ | 4,974 | | | | | |
Short-term lease expense | | 1,415 | | | 580 | | | | | |
Variable lease expense | | — | | | 17 | | | | | |
Total lease expense | | $ | 7,580 | | | $ | 5,571 | | | | | |
The following table presents supplemental cash flow information related to the company's operating leases:
| | | | | | | | | | | | | | |
| | Three Months Ended |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 |
Operating cash flows for amounts included in the measurement of lease liabilities | | $ | 4,567 | | | $ | 4,682 | |
Right-of-use assets obtained in exchange for lease obligations | | $ | 14,881 | | | $ | 293 | |
The following table presents other lease information related to the company's operating leases:
| | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | October 31, 2021 |
Weighted-average remaining lease term of operating leases in years | | 6.6 | | 6.9 | | 6.6 |
Weighted-average discount rate of operating leases | | 2.56 | % | | 2.78 | % | | 2.71 | % |
The following table reconciles the total undiscounted future cash flows based on the anticipated future minimum operating lease payments by fiscal year for the company's operating leases to the present value of operating lease liabilities recorded within the Condensed Consolidated Balance Sheets as of January 28, 2022:
| | | | | | | | |
(Dollars in thousands) | | January 28, 2022 |
2022 (remaining) | | $ | 13,618 | |
2023 | | 16,571 | |
2024 | | 15,101 | |
2025 | | 12,992 | |
2026 | | 7,965 | |
Thereafter | | 23,862 | |
Total future minimum operating lease payments | | 90,109 | |
Less: imputed interest | | 8,507 | |
Present value of operating lease liabilities | | $ | 81,602 | |
| | | | | |
16 | Derivative Instruments and Hedging Activities |
Risk Management Objective of Using Derivatives
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, costs associated with foreign plant operations, and purchases from suppliers. The company’s primary currency exchange rate exposures are with the Euro, the Australian dollar, the Canadian dollar, the British pound, the Mexican peso, the Japanese yen, the Chinese Renminbi, and the Romanian New Leu against the U.S. dollar, as well as the Romanian New Leu against the Euro.
To reduce its exposure to foreign currency exchange rate risk, the company enters 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. The company’s policy does not allow the use of derivative instruments for trading or speculative purposes. The company has also made an accounting policy election to use the portfolio exception with respect to measuring counterparty credit risk for derivative instruments and to measure the fair value of a portfolio of financial assets and financial liabilities on the basis of the net open risk position with each counterparty.
The company’s hedging activities primarily involve the use of forward currency contracts to hedge most foreign currency transactions, including forecasted sales and purchases denominated in foreign currencies. The company uses derivative instruments only in an attempt to limit underlying exposure from foreign currency exchange rate fluctuations and to minimize earnings and cash flow volatility associated with foreign currency exchange rate fluctuations. Decisions on whether to use such derivative instruments are primarily based on the amount of exposure to the currency involved and an assessment of the near-term market value for each currency.
The company recognizes all derivative instruments at fair value on the Condensed Consolidated Balance Sheets as either assets or liabilities. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as a cash flow hedging instrument.
Cash Flow Hedging Instruments
The company formally documents relationships between cash flow hedging instruments and the related hedged transactions, as well as its risk-management objective and strategy for undertaking cash flow hedging instruments. This process includes linking all cash flow hedging instruments to the forecasted transactions, such as sales to third-parties and costs associated with foreign plant operations, including purchases from suppliers. At the cash flow hedge’s inception and on an ongoing basis, the company formally assesses whether the cash flow hedging instruments have been highly effective in offsetting changes in the cash flows of the hedged transactions and whether those cash flow hedging instruments may be expected to remain highly effective in future periods.
Changes in the fair values of the spot rate component of outstanding, highly effective cash flow hedging instruments included in the assessment of hedge effectiveness are recorded in other comprehensive income within AOCL on the Condensed Consolidated Balance Sheets and are subsequently reclassified to net earnings within the Condensed Consolidated Statements of Earnings during the same period in which the cash flows of the underlying hedged transaction affect net earnings. Changes in the fair values of hedge components excluded from the assessment of effectiveness are recognized immediately in net earnings under the mark-to-market approach. The classification of gains or losses recognized on cash flow hedging instruments and excluded components within the Condensed Consolidated Statements of Earnings is the same as that of the underlying exposure. Results of cash flow hedging instruments, and the related excluded components, of sales and costs associated with foreign plant operations, including purchases from suppliers, are recorded in net sales and cost of sales, respectively. 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.
When it is determined that a derivative instrument is not, or has ceased to be, highly effective as a cash flow hedge, the company discontinues cash flow hedge accounting prospectively. The gain or loss on the dedesignated derivative instrument remains in AOCL and is reclassified to net earnings within the same Condensed Consolidated Statements of Earnings line item as the underlying exposure when the forecasted transaction affects net earnings. When the company discontinues cash flow hedge accounting because it is no longer probable, but it is still reasonably possible that the forecasted transaction will occur by the end of the originally expected period or within an additional two-month period of time thereafter, the gain or loss on the derivative instrument remains in AOCL and is reclassified to net earnings within the same Condensed Consolidated Statements of Earnings line item as the underlying exposure 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 immediately recognized in net earnings within other income, net in the Condensed Consolidated Statements of Earnings. In all situations in which cash flow hedge accounting is discontinued and the derivative instrument remains outstanding, the company carries the derivative instrument at its fair value on the Condensed Consolidated Balance Sheets, recognizing future changes in the fair value within other income, net in the Condensed Consolidated Statements of Earnings.
As of January 28, 2022, the notional amount outstanding of forward currency contracts designated as cash flow hedging instruments was $287.5 million.
Derivatives Not Designated as Cash Flow Hedging Instruments
The company also enters into foreign currency contracts that include forward currency contracts to mitigate the remeasurement of specific assets and liabilities on the Condensed Consolidated Balance Sheets. These contracts are not designated as cash flow hedging instruments. Accordingly, changes in the fair value of hedges of recorded balance sheet positions, such as cash, receivables, payables, intercompany notes, and other various contractual claims to pay or receive foreign currencies other than the functional currency, are recognized immediately in other income, net, on the Condensed Consolidated Statements of Earnings together with the transaction gain or loss from the hedged balance sheet position.
The following table presents the fair value and location of the company’s derivative instruments on the Condensed Consolidated Balance Sheets:
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(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | October 31, 2021 |
Derivative assets: | | | | | | |
Derivatives designated as cash flow hedging instruments: | | | | | | |
Prepaid expenses and other current assets | | | | | | |
Forward currency contracts | | $ | 5,451 | | | $ | 1,294 | | | $ | 189 | |
Derivatives not designated as cash flow hedging instruments: | | | | | | |
Prepaid expenses and other current assets | | | | | | |
Forward currency contracts | | 1,491 | | | 178 | | | 133 | |
Total derivative assets | | $ | 6,942 | | | $ | 1,472 | | | $ | 322 | |
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Derivative liabilities: | | | | | | |
Derivatives designated as cash flow hedging instruments: | | | | | | |
Accrued liabilities | | | | | | |
Forward currency contracts | | $ | — | | | $ | 14,763 | | | $ | 1,260 | |
Derivatives not designated as cash flow hedging instruments: | | | | | | |
Accrued liabilities | | | | | | |
Forward currency contracts | | 118 | | | 2,200 | | | 872 | |
Total derivative liabilities | | $ | 118 | | | $ | 16,963 | | | $ | 2,132 | |
The company entered into an International Swap Dealers Association ("ISDA") Master Agreement with each counterparty that permits the net settlement of amounts owed under their respective contracts. The ISDA Master Agreement is an industry standardized contract that governs all derivative contracts entered into between the company and the respective counterparty. Under these master netting agreements, net settlement generally permits the company or the counterparty to determine the net amount payable or receivable for contracts due on the same date or in the same currency for similar types of derivative transactions. The company records the fair value of its derivative instruments at the net amount on its Condensed Consolidated Balance Sheets.
The following table presents the effects of the master netting arrangements on the fair value of the company’s derivative instruments that are recorded on the Condensed Consolidated Balance Sheets:
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(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | October 31, 2021 |
Derivative assets: | | | | | | |
Forward currency contracts: | | | | | | |
Gross amount of derivative assets | | $ | 8,118 | | | $ | 1,472 | | | $ | 423 | |
Derivative liabilities offsetting derivative assets | | (1,176) | | | — | | | (101) | |
Net amount of derivative assets | | $ | 6,942 | | | $ | 1,472 | | | $ | 322 | |
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Derivative liabilities: | | | | | | |
Forward currency contracts: | | | | | | |
Gross amount of derivative liabilities | | $ | (159) | | | $ | (16,970) | | | $ | (4,853) | |
Derivative assets offsetting derivative liabilities | | 41 | | | 7 | | | 2,721 | |
Net amount of derivative liabilities | | $ | (118) | | | $ | (16,963) | | | $ | (2,132) | |
The following table presents the impact and location of the amounts reclassified from AOCL into net earnings on the Condensed Consolidated Statements of Earnings and the impact of derivative instruments on the Condensed Consolidated Statements of Comprehensive Income for the company's derivatives designated as cash flow hedging instruments for the three months ended January 28, 2022 and January 29, 2021:
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| | Three Months Ended |
| | Gain (Loss) Reclassified from AOCL into Earnings | | Gain (Loss) Recognized in OCI on Derivatives |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | January 28, 2022 | | January 29, 2021 |
Derivatives designated as cash flow hedging instruments: | | | | | | | | |
Forward currency contracts: | | | | | | | | |
Net sales | | $ | (118) | | | $ | (2,097) | | | $ | 5,670 | | | $ | (7,694) | |
Cost of sales | | (151) | | | 99 | | | 702 | | | (616) | |
Total derivatives designated as cash flow hedging instruments | | $ | (269) | | | $ | (1,998) | | | $ | 6,372 | | | $ | (8,310) | |
The company recognized immaterial gains and losses within other income, net in the Condensed Consolidated Statements of Earnings during the first quarter of fiscal 2022 and fiscal 2021, respectively, due to the discontinuance of cash flow hedge accounting on certain forward currency contracts designated as cash flow hedging instruments. As of January 28, 2022, the company expects to reclassify approximately $2.1 million of gains from AOCL to earnings during the next twelve months.
The following tables present the impact and location of derivative instruments on the Condensed Consolidated Statements of Earnings for the company’s derivatives designated as cash flow hedging instruments and the related components excluded from effectiveness testing:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Gain (Loss) Recognized in Earnings on Cash Flow Hedging Instruments |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 |
Three Months Ended | | Net Sales | | Cost of Sales | | Net Sales | | Cost of Sales |
Condensed Consolidated Statements of Earnings income (expense) amounts in which the effects of cash flow hedging instruments are recorded | | $ | 932,650 | | | $ | (632,174) | | | $ | 872,986 | | | $ | (557,950) | |
Gain (loss) on derivatives designated as cash flow hedging instruments: | | | | | | | | |
Forward currency contracts: | | | | | | | | |
Amount of gain (loss) reclassified from AOCL into earnings | | (118) | | | (151) | | | (2,097) | | | 99 | |
Gain (loss) on components excluded from effectiveness testing recognized in earnings based on changes in fair value | | $ | (926) | | | $ | 97 | | | $ | 162 | | | $ | 185 | |
The following table presents the impact and location of derivative instruments on the Condensed Consolidated Statements of Earnings for the company’s derivatives not designated as cash flow hedging instruments:
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
(Dollars in thousands) | | January 28, 2022 | | January 29, 2021 | | | | |
Gain (loss) on derivatives not designated as cash flow hedging instruments | | | | | | | | |
Forward currency contracts: | | | | | | | | |
Other income, net | | $ | 1,242 | | | $ | (3,478) | | | | | |
Total gain (loss) on derivatives not designated as cash flow hedging instruments | | $ | 1,242 | | | $ | (3,478) | | | | | |
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17 | Fair Value Measurements |
The company categorizes its assets and liabilities into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Estimates of fair value for financial assets and financial liabilities are based on the framework established in the accounting guidance for fair value measurements. The framework defines fair value, provides guidance for measuring fair value, and requires certain disclosures. The framework discusses valuation techniques such as the market approach (comparable market prices), the income approach (present value of future income or cash flows), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The framework utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. The three levels are defined as follows:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Unobservable inputs reflecting management’s assumptions about the inputs used in pricing the asset or liability.
Recurring Fair Value Measurements
The company's derivative instruments consist of forward currency contracts that are measured at fair value on a recurring basis. The fair value of such forward currency contracts is determined based on observable market transactions of forward currency prices and spot currency rates as of the reporting date.
The following tables present, by level within the fair value hierarchy, the company's financial assets and liabilities that are measured at fair value on a recurring basis as of January 28, 2022, January 29, 2021, and October 31, 2021, according to the valuation technique utilized to determine their fair values (in thousands):
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| | | | Fair Value Measurements Using Inputs Considered as: |
January 28, 2022 | | Fair Value | | Level 1 | | Level 2 | | Level 3 |
Assets: | | | | | | | | |
Forward currency contracts | | $ | 6,942 | | | $ | — | | | $ | 6,942 | | | $ | — | |
Total assets | | $ | 6,942 | | | $ | — | | | $ | 6,942 | | | $ | — | |
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Liabilities: | | | | | | | | |
Forward currency contracts | | $ | 118 | | | $ | — | | | $ | 118 | | | $ | — | |
Total liabilities | | $ | 118 | | | $ | — | | | $ | 118 | | | $ | — | |
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| | | | Fair Value Measurements Using Inputs Considered as: |
January 29, 2021 | | Fair Value | | Level 1 | | Level 2 | | Level 3 |
Assets: | | | | | | | | |
Forward currency contracts | | $ | 1,472 | | | $ | — | | | $ | 1,472 | | | $ | — | |
Total assets | | $ | 1,472 | | | $ | — | | | $ | 1,472 | | | $ | — | |
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Liabilities: | | | | | | | | |
Forward currency contracts | | $ | 16,963 | | | $ | — | | | $ | 16,963 | | | $ | — | |
Total liabilities | | $ | 16,963 | | | $ | — | | | $ | 16,963 | | | $ | — | |
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| | | | Fair Value Measurements Using Inputs Considered as: |
October 31, 2021 | | Fair Value | | Level 1 | | Level 2 | | Level 3 |
Assets: | | | | | | | | |
Forward currency contracts | | $ | 322 | | | $ | — | | | $ | 322 | | | $ | — | |
Total assets | | $ | 322 | | | $ | — | | | $ | 322 | | | $ | — | |
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Liabilities: | | | | | | | | |
Forward currency contracts | | $ | 2,132 | | | $ | — | | | $ | 2,132 | | | $ | — | |
Total liabilities | | $ | 2,132 | | | $ | — | | | $ | 2,132 | | | $ | — | |
Nonrecurring Fair Value Measurements
The company measures certain assets and liabilities at fair value on a non-recurring basis. Assets and liabilities that are measured at fair value on a nonrecurring basis include long-lived assets, goodwill, and indefinite-lived intangible assets, which would generally be recorded at fair value as a result of an impairment charge. Assets acquired and liabilities assumed as part of a business combination or asset acquisition are also measured at fair value on a non-recurring basis during the measurement period allowed by the accounting standards codification guidance for business combinations and asset acquisitions, when applicable. For additional information on the company's business combination and the related non-recurring fair value measurement of the assets acquired and liabilities assumed, refer to Note 2, Business Combination.
Other Fair Value Disclosures
The carrying values of the company's short-term financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and short-term debt, including current maturities of long-term debt, when applicable, approximate their fair values due to their short-term nature. As of January 28, 2022, January 29, 2021 and October 31, 2021, the company's long-term debt included $424.1 million, $424.0 million and $424.0 million of gross fixed-rate debt that is not subject to variable interest rate fluctuations. The gross fair value of such long-term debt is determined using Level 2 inputs by discounting the projected cash flows based on quoted market rates at which similar amounts of debt could currently be borrowed. As of January 28, 2022, the estimated gross fair value of long-term debt with fixed interest rates was $499.1 million compared to its gross carrying amount of $424.1 million. As of January 29, 2021, the estimated gross fair value of long-term debt with fixed interest rates was $524.3 million compared to its gross carrying amount of $424.0 million. As of October 31, 2021, the estimated gross fair value of long-term debt with fixed interest rates was $517.9 million compared to its gross carrying amount of $424.0 million. For additional information regarding long-term debt with fixed interest rates, refer to Note 6, Indebtedness.
The company has evaluated all subsequent events and concluded that no subsequent events have occurred that would require recognition in the Condensed Consolidated Financial Statements or disclosure in the Notes to the Condensed Consolidated Financial Statements.