Toro Co Q2 FY2021 Earnings Call

Good day, ladies and gentlemen, and welcome to The Toro Company's Second Quarter Earnings Conference Call. My name is Jonathan, and I will be the coordinator facilitator for today. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Julie Kerekes, Treasurer and Senior Managing Director of Investor Relations for The Toro Company. Please go ahead, Ms. Kerekes.

Thank you and good morning. Our earnings release was issued this morning and a copy can be found in the Investor Information section of our corporate website thetorocompany.com. On our call today are Rick Olson, Chairman and Chief Executive Officer; and Renee Peterson, Vice President and Chief Financial Officer. We begin with our customary forward-looking statement policy. During this call, we will make forward-looking statements regarding our business and future financial and operating results. You are all aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our earnings release, as well as our SEC filings, detailed some of the important risk factors that may cause our actual results to differ materially from those in our predictions. Please note that we do not have a duty to update our forward-looking statements. In addition, during this call, we will reference certain non-GAAP financial measures. Reconciliations of historical non-GAAP financial measures to reported GAAP financial measures can be found in our earnings release or on our website. We believe these measures may be useful in performing meaningful comparisons of past and present operating results, to understand the performance of our ongoing operations and how management views the business. Non-GAAP financial measures should not be considered superior to or a substitute for the GAAP financial measures presented in our earnings release and this call. With that, I will now turn the call over to Rick.

Thanks, Julie, and good morning. The Toro Company delivered very strong results for the second quarter of fiscal 2021, driven by robust broad-based demand across our Professional and Residential segments. Our team continued to execute well in this dynamic environment, managing the supply chain challenges affecting our industry and the global economy and working together with our channel partners to serve customers and fulfill retail demand. As a result, net sales for the second quarter were up 24% year-over-year. Professional segment net sales increased 25%, continuing the growth trend for this segment and setting a new record. The increase was primarily driven by a strong demand for golf, landscape contractor, irrigation, and rental and specialty construction products. Our lineup of innovative products combined with increasing business confidence in the economic recovery helped fuel exceptional demand. Residential segment net sales for the second quarter were up 20% year-over-year, setting another record. This growth was led by a strong demand for zero-turn riding mowers and our all-season Flex-Force 60-volt home solutions products. In addition, enhanced retail placement boosted sales of our snow equipment and late season snowstorms helped clear the channel. The introduction of innovative new residential products, coupled with the refreshed marketing and expanded mass retail distribution, continue to strengthen our brand and drive growth for this segment. We also set records for earnings in both segments this quarter, as we drove productivity and operational synergies enterprise wide. Professional earnings were up 57% and Residential earnings grew 24%. Reflecting on the outstanding results this quarter, we note three prevailing themes. First, demand has been exceptionally strong. We see this continuing for the foreseeable future, albeit with year-over-year growth rate comparisons that will ultimately stabilize off a higher base. This demand is driven by improving consumer and business confidence, coupled with public and private investment priorities and current lifestyle trends. We expect to capitalize on these drivers with our commitment to new product development, best-in-class distribution channels and a strong balance sheet that provides the financial flexibility to invest in the future. Second, along with the exceptionally strong demand, we've seen escalating supply chain and inflation challenges. These challenges are not unique to The Toro Company and are having a global impact. Our teams have worked effectively to keep up with increased demand, while navigating the current supply chain environment. We've also focused on mitigating material, freight and wage inflationary pressures through productivity and synergy initiatives, disciplined expense control and market-aligned pricing actions. We will continue to prioritize important investments to support growth. Third, we're leveraging our strong balance sheet to position the company for future growth. As we continue to generate strong free cash flow, we are allocating capital to best drive value for all stakeholders. This year, we've made strategic investments in technology accelerators through the acquisitions of TURFLYNX and Left Hand Robotics. These teams have immediately helped us advance our innovation roadmap. At the same time, we've continued to invest organically in key technologies, including alternative power, smart connected, and autonomous. As an example, our expanding line of Flex-Force 60-volt products will soon include a battery powered two-stage snow thrower, which is ready to launch and is generating a lot of excitement in the field. Our healthy cash flow also allows us to return capital to shareholders, while maintaining ample liquidity. Year-to-date, we've paid down $100 million of debt, invested $107 million in share repurchases and paid out $57 million in dividends. While we worked to capitalize on this period of great growth, we remain committed to our employees and channel partners and continue to diligently manage and mitigate COVID-related risks. We're keeping the health and safety of our team in the forefront while executing operationally to get the right products to the right places at the right time. Through the So We Can campaign, we're incenting our employees to get vaccinated. We extend sincere thanks to both our team and our channel partners for their continued commitment to keeping each other safe, while also going above and beyond to meet the needs of our customers. Looking ahead, we remain focused on our enterprise strategic priorities of accelerating profitable growth, driving productivity and operational excellence and empowering people. We will continue to execute against these priorities to position the company for long-term sustainable growth. I'll discuss our outlook further following Renee’s more detailed review of our financial results. With that, I will turn the call over to Renee.

Thank you, Rick, and good morning, everyone. Our record second quarter was driven by robust demand across our Professional and Residential segments, coupled with strong operating performance. We grew net sales by 23.6% to $1.15 billion. Reported EPS was $1.31 per diluted share, up from $0.91 last year. Adjusted EPS was $1.29 per diluted share, up from $0.92 in the prior year. Moving to our segment results for the quarter. Professional segment net sales were up 25.3% to $828.4 million. This increase was primarily due to strong demand for golf, landscape contractor, irrigation, and rental and specialty construction products, slightly offset by lower sales of underground construction equipment driven by supply chain disruptions that impacted product availability and continued softness in oil and gas markets. Professional segment earnings were up 57.3% to $167.1 million. And when expressed as a percent of net sales increased 410 basis points to 20.2%. This increase was primarily due to productivity improvements, including COVID-related manufacturing inefficiencies in the second quarter of last year that did not repeat, net price realization and volume leverage partially offset by higher commodity costs. Residential segment net sales were up 20.2% to $315 million. This increase was primarily driven by strong retail demand for zero-turn riding mowers due to new and enhanced products, higher sales of Flex-Force battery electric products, mainly driven by successful new product introduction and higher shipments of snow equipment as a result of late season snowstorms and expanded retail placement. Residential segment earnings were up 23.9% to $46 million. And when expressed as a percent of net sales, up 40 basis points to 14.6%. The increase was primarily driven by productivity improvements, including COVID-related manufacturing inefficiencies in the second quarter of last year that did not repeat, net price realization and product mix, partially offset by higher commodity costs. Turning to our operating results for the second quarter, we reported gross margin of 35.1%, an increase of 210 basis points from the prior year. Adjusted gross margin was 35.1%, up 170 basis points. These increases were primarily due to productivity improvements, net price realization and favorable mix, partially offset by higher commodity costs. SG&A expense as a percent of net sales decreased 10 basis points to 19.4%. This favorable performance was primarily driven by volume leverage and lower indirect marketing expenses, partially offset by higher incentives due to improved performance and the reinstatement of certain costs that had been part of the company's fiscal 2020 pandemic driven expense reductions. Operating earnings as a percent of net sales increased 220 basis points to 15.7%. And adjusted operating earnings as a percent of net sales increased 170 basis points, also to 15.7%. Interest expense was down $1.5 million to $7.1 million, driven by reduced debt and lower interest rates. The reported effective tax rate was 19.8% and the adjusted effective tax rate was 20.9%. Now turning to the balance sheet and cash flow. At the end of the second quarter, our liquidity remained consistent at $1.1 billion. This included cash and cash equivalents of $500 million and full availability under our $600 million revolving credit facility. We have no significant debt maturities until April of 2022. Accounts receivable totaled $391.2 million, down 2.3% from a year ago, primarily driven by channel mix. Inventory was down 12% from a year ago to $628.8 million, primarily as a result of increased demand. Accounts payable increased 28.8% from last year to $421.7 million. This was primarily due to increased purchases of components, as well as more normalized expenses. Year-to-date free cash flow was $292.4 million with a conversion ratio of 115%. This positive performance was largely the result of higher earnings and lower working capital driven by higher payables and reduced inventory levels. Our disciplined capital allocation strategy fueled by our strong balance sheet includes investing in organic and M&A growth opportunities, maintaining an effective capital structure and returning cash to shareholders. Our capital priorities remain the same and include reinvesting in our businesses to support sustainable long-term growth, both organically and through acquisition, returning cash to shareholders through dividends and share repurchases and maintaining our leverage goals to support financial flexibility. As the midpoint of the fiscal year, demand momentum is strong. And our leadership position in the markets we serve is solid. Like many other companies, we are continually adjusting through these dynamic times. The economy is experiencing a surge in demand, while supply is struggling to keep pace. In the long run, we expect the positives from the heightened demand trends across our markets to endure and outweigh the near-term pressures. While we continue to drive productivity and synergies and take appropriate market-based pricing actions, our operating margins in the second half of our fiscal year will be pressured. This is driven by the escalation in supply chain and inflationary challenges, as well as material, freight and wage inflation, which we expect will result in manufacturing inefficiencies and higher input costs relative to our prior guidance. With that backdrop, we are updating our full year fiscal 2021 guidance. We now expect net sales growth in the range of 12% to 15%, up from 6% to 8% previously. We expect professional and residential segment net sales growth rates to be similar to the overall company with residential trending slightly ahead of professional. This is due to the strong demand we continue to see across our businesses. Looking at overall profitability, we continue to expect adjusted operating earnings as a percent of net sales for the full year to be slightly higher than fiscal 2020. This reflects a strong performance in the first half coupled with a more challenging supply chain and inflationary environment in the second half. Given our strong balance sheet and future growth expectation, we are increasing our estimated capital expenditures for the year to $130 million, up from $115 million. This aligns with our priorities of investing in key technology areas and ensuring we have the capacity to meet future growth. Based on current visibility, we now expect full year adjusted EPS in the range of $3.45 to $3.55 per diluted share. This increase reflects the robust demand environment, while also taking into account the near-term supply chain and inflationary pressures. We anticipate the impact of these pressures to be the most pronounced in the third quarter before our mitigating actions are more fully realized. We expect adjusted EPS per diluted share in the fourth quarter to be similar to fiscal 2020, against a very strong Q4 of last year. Looking to the rest of the fiscal year, we remain excited about the broad-based demand for our products. We are well positioned as we continue to execute on our long-term strategic priorities and invest in innovation to capitalize on future growth opportunities. I'll now turn the call back to Rick.

Thanks, Renee. As we look ahead to the remainder of the year, we're watching a number of key drivers in our end markets. For residential and certain professional businesses, continuing consumer interest in home investments, for landscape contractors, capital investments, including catch-up purchases of prior deferrals, driven by improved business confidence. For golf, continued strong momentum in general, the reopening of international courses and the return of resort golf. For grounds equipment, the prioritization of outdoor space maintenance and improvement by municipal and other tax supported entities. For underground, increased government support and funding for infrastructure spending. This includes broadband build-out, alternative energy investments and critical need infrastructure rehab and replacement. For rental and specialty construction, strong demand by both professional contractors and homeowners. For snow and ice management, channel demand is given lower end-of-season inventory levels. In short, these end market drivers should continue to support robust demand. Our biggest challenge for the remainder of the year will be our ability to produce at the desired rate, given the supply chain constraints we are facing. We believe the constraints will improve as key commodity availability normalizes, global vaccination rates improve, COVID restrictions ease and logistical capacity finds a balance. We anticipate demand will remain strong even after supply chain constraints ease. At that point, we expect to be in a position to rebuild field inventory levels across our channels. Our operations team remains committed to doing everything possible to meet the increased production demands. With our team's dedication, our innovative suite of products and our market leadership, as well as our consistently strong cash flow to support growth investments, we are well positioned to capitalize on this demand opportunity. We're also well-positioned to capitalize on electrification trends, given our expertise and leadership across our markets. We are committed to developing electric products that offer both power and durability with no compromise on performance. For example, in March, our 60 volt personal pace recycler mower was named Editor's Choice by Popular Mechanics in their evaluation of electric lawn mowers. Build quality and cut quality were cited as the two reasons Toro mowers have received more Editor's Choice awards than any other brand. In addition to the residential Flex-Force line, we have an increasing number of professional battery-powered products, including our all-electric Greensmower and lithium-ion Workman utility vehicle. Sustainability is fundamental to our enterprise strategic priorities and our focus on alternative power, smart connected and autonomous technologies is embedded as part of our sustainability strategy. It's the right thing to do and provides the opportunity for our company to create value for all stakeholders while helping our customers achieve their sustainability goals. A recent win highlights this focus: one of our European channel partners, a distributor of Reesink Group, was awarded a four-year preferred supplier agreement and fleet partnership with the City of Amsterdam. The city has an objective of zero emissions by 2030, and we are excited to partner with them in achieving this goal. Another example is our new 20-year partnership with the National Links Trust in Washington D.C. Their mission is to protect and promote accessible and affordable municipal golf courses to positively impact communities. We are honored to support this mission together with our distributor of turf equipment and supply company, as well as our longtime partner Troon, the world's largest golf management company. Involvement in this project exemplifies who The Toro Company is: a team focused on long-term caring relationships, our communities and the environment. In closing, we're optimistic as we begin the second half of our fiscal year. We believe our updated guidance appropriately reflects the risks we face in the current operating environment, while also accounting for the robust demand we expect. We have strong momentum across our businesses and are well positioned to capitalize on future growth drivers. As always, our extended team is the key to The Toro Company's long-term success. Thank you to our employees for your dedication and resilience, to our channel partners, customers and shareholders for your continued support. With that, Renee and I will take your questions.

Thank you. Our first question comes from the line of Sam Darkatsh from Raymond James. Your question please.

Good morning, Rick; good morning, Renee. How are you? Three questions, if I may. The first, you mentioned that your production constraints should ease in the coming months. I'm more interested in potential inflation in raw materials and components next year. I think you normally do your negotiations with your vendors in that August, September area, which suggests that there might be further pressure for next year. Can you talk around that in terms of whether you see maybe even more inflation next year or has that already been the worst of it? To that last point, could you help us with respect to what volume growth was versus price in the second quarter, and then prospectively within your 12% to 15% sales growth guidance for the year, Renee? So the incremental price—I'm sorry, the incremental sales growth guidance is mostly price or it's mostly volume? I'm just trying to get a sense of when you decided to raise your expectations for sales for this year, presumably for the back half. How much of that was volume versus price? And then my last question, I'll defer to others. Thanks.

Good morning, Sam. Very well.

Yes, as we look at inflation, as you know it is a global issue that we're dealing with. In particular, Sam, we're seeing inflation that was higher than our initial expectations and we have tried to factor that into our guidance for this year. Steel and resin are particular raw materials where we're seeing more of that inflation, as well as some freight and wage inflation. As we look forward, we do expect for the second half for inflation to continue going into next year. Part of it depends on how the economy unfolds; there are differing points of view on inflation, some see it as more of a temporary blip, others see it as longer-term. What we will do is continue to focus on the things we can do to mitigate to the best of our ability. We feel very fortunate that we had a strong pipeline of synergy and productivity efforts across the enterprise. We will manage costs prudently, take market-based pricing actions and look at promotions and other marketing programs as well. We'll have to see how next year unfolds, but we also see demand remaining very strong and the business fundamentals look encouraging going forward as well. On the question about volume versus price, we did take market-based pricing actions within the year and we'll look at if additional market-based pricing actions are required. The majority of the growth in the quarter was volume-based. As inflation becomes clearer to us, we'll determine what further actions are needed for the rest of the year. We do not start with price; we start with what we can do internally to try to control costs. Demand looks to remain strong for the remainder of the year and beyond.

Thanks, Sam.

Got you. And then on my last question, the residential business was up 20% in the quarter, which is terrific obviously. I'm trying to reconcile that with the growth that was cited by Home Depot and Tractor Supply, which were well in excess of 20%. I think they were both talking about 30% plus. First off, what was going on there? How to reconcile the difference, especially knowing that you talked about additional placements too?

I can't speak specifically to the Home Depot and Tractor Supply numbers that you're quoting. We had an exceptionally strong quarter from a residential perspective. The stay-at-home effect probably extended even further than we expected at this point. We expect that effect to wane at some point. But the fundamental actions we've taken continue to drive growth. We're pleased with our growth at all the places you're mentioning. The work we've done with refreshing the product line, expanding placements and building the brand and messaging have been very effective from our perspective.

Thank you both. Thank you.

Thank you. Our next question comes from the line of Tom Mahoney from Cleveland Research. Your question please.

Hi, good morning. I had two questions. First, is there a way to characterize the production speeds you guys are able to achieve now relative to pre-COVID levels?

I would say without a specific percentage, we're still largely in the COVID operation mode. Our manufacturing operations have actually improved efficiency and productivity relative to where we were nine months ago. But we're still in a position where we've got social distancing on our assembly lines; we've stretched those out and there are certain practices we have to continue to follow from a safety standpoint that result in some inefficiencies. We are seeing improvement both in optimizing that process and as we get additional associates vaccinated that helps us with additional flexibility. So we've seen a nice improvement in our own productivity and efficiency internally and we expect that to continue as the pandemic situation improves and we get more people vaccinated.

I would add that we have seen some impact from the supply chain disruption that has been escalating as we went through the year and we're managing that very well. The team is doing an excellent job, but that causes additional disruption, such as stopping and starting assembly lines, which builds in additional inefficiencies. As that improves, we should also expect to see improved manufacturing because of that as well.

Okay. And then just to follow up on the residential point you were making. Is there any sign in the demand as spring has progressed of interest in home spending waning, whether it's mix or if you look at volume on a sequential basis? And along with that, any change in appetite from retailers or dealers to take inventory in the residential side?

We really have not seen that trend diminish at this point. We continue to have very strong demand in our residential segment. The efforts we've done over the last several years to reboot that business are fundamental drivers that will continue beyond the pandemic. Remember that comparisons are off a high base from last year and through fiscal 2020. We continue to build on top of what seemed like a very high base and the effects of staying at home continue. Field inventory is lower than we would like to see, and the willingness to take inventory is very high; the field is hungry for inventory at this point.

Great. Thank you very much.

Thank you. Our next question comes from the line of Tim Wojs from Baird. Your question please.

Hey good morning, everybody. Maybe dovetailing on the last question, how would you characterize broader field inventory levels versus normalized level? I'm trying to understand what a rebuild opportunity is for you over the next 12 months.

As you'd expect with very strong demand over the last several periods and with some supply constraints, our field inventory is lower than we would like to see at this point. That's true across our businesses in both segments. So there is opportunity and willingness to refill the field inventory, and that's another capacity or opportunity that's out there for us.

And just given the demand environment and some of the supply constraints, is that something you think really falls more into fiscal 2022 than this year?

Realistically as we forecast forward, that's something that perhaps starts to happen at the end of fiscal 2021, but certainly into the first portion of 2022.

Okay, great. And then on the supply chain, from a component perspective, where are you seeing the tightest constraints? Any color on how you're positioning yourselves to make sure you're getting your fair share of components from your suppliers?

Our operations team is doing a remarkable job, working from our longstanding relationships with suppliers and key partners. We had re-upped contracts and focused on key suppliers as partners, giving us a strong base. The major drivers are basic commodities. Steel is our number one commodity; relative to last year at this time, the market index was up substantially. We don't see the full extent because of our contracts, but it's a major driver of cost increases. Resin is another, up materially from last year, and was affected by events such as the weather in Texas that disrupted supply. Those raw materials are taking longer to rebalance than normal. Other factors include getting the supplier workforce back, operating safely in a COVID environment and responding to rapidly returning demand.

Okay, great. Good luck on the rest of the year guys. Thanks.

Thank you.

Thank you.

Thank you. Our next question comes from the line of David MacGregor from Longbow Research. Your question, please.

Yes. Good morning, everyone. My first question is on the supply chain. What's your best estimate of the total quarterly expense you are incurring right now as a result of the supply chain and labor disruptions? Just trying to get a sense of how much of this goes away once the world normalizes.

I don't think we can give you that number exactly. What we do see is the strongest effects in the second half, with the full effects in the third quarter. Some mitigation actions will not be fully realized until the fourth quarter. So we expect the peak effects of inflationary factors in the third quarter. The good news is the fundamental demand continues and we believe that will persist long after we work through the supply chain issues.

When we look at the total year, we do expect our operating margins to be up slightly for the year. We also expect Professional margins to be up and Residential margins to be similar or down slightly. So we're encouraged when you look at the total year, and as our guidance reflects, EPS will be up year-over-year as well.

Okay. And drilling into SG&A, you noted the reinstatement of certain costs that had been reduced in 2020. How much more of those 2020 reductions will be returning in the second half of this year? Can you quantify that?

We don't have an exact number. There are certainly returns of costs we reduced in 2020, such as salary adjustments and other items. Travel and entertainment was reduced and will still be at a lower level. Incentives are a significant change year-over-year because in fiscal 2020 we reduced incentives based on performance and expectations, and for 2021 we are adjusting those up, which you saw some impact of in Q2 and you'll see for the rest of the year. Volume also impacts SG&A; part of SG&A is variable with volume and with volume being up, some of those costs increase. It's difficult to break out precisely, but it's included in our guidance.

I want to ask about the increase in CapEx and market share. Competitively, you have a fulfillment advantage over smaller players. Do you have the capacity to take share right now? Are you taking share, and if so, where in the business?

We do have capacity to take share and we are taking share in a number of places. That goes back to the work we did with our supply chain and advanced planning. It's not only the ability to supply product, but it's driven by innovations and changes we've made to our products that excite customers. The 60-volt Flex-Force is becoming an appreciable part of our business. The underground business had huge opportunity with 5G, the recognition that there's a broadband gap, and infrastructure investment for underground utilities, telecommunications and repair are strong. We didn't talk a lot about golf, but golf has seen a tremendous surge through the pandemic and there's evidence that's sustained at a higher level. Year-to-date numbers for golf are up significantly, and even compared to the 2017-2019 period it's up nicely. These drivers leave courses in good financial shape and wanting to invest in equipment and irrigation systems.

So to be clear, are you saying you're gaining share in the golf business?

The golf market has been a low single-digit growth business over time. We have steadily taken share, and that trend continues. It's not a dramatic fast-paced move, but it is consistent, steady share improvement.

Great. And last for me, on underground construction: you reported sales declines in the second quarter which was a bit of a surprise. What's going on in that business and how's that reflected in your guidance? Is it timing around Q2 and you expect stronger underground in the second half?

The demand for underground is incredibly strong. We've mentioned in prior quarters that oil and gas softness is a factor, but the main issue now is the supply side. It's about producing products to meet demand. If we had been able to fully produce across the quarter you wouldn't have seen the decline. So it's very strong demand and long-term significantly stronger drivers for that business.

To tie to the CapEx question, our increase in CapEx is focused on capacity and technology. In some cases we can enhance production capacity and productivity with targeted capital investments. We have a strong balance sheet and that offers us the opportunity to invest. Our top priority is profitable growth both organic and through M&A, and we view these investments as good for the future because we expect demand to remain strong for some time.

All right. Thanks very much, Rick. Thanks, Renee. Good luck for this quarter.

Thank you. Our next question comes from the line of Ross Gilardi with Bank of America. Your question, please.

Good morning, guys. Hey Rick, can you talk a little bit about within that 20% growth in Residential, how the growth in gas-powered equipment compares to electrified product and what is your general split of gas versus electric on a last twelve months basis or however you'd choose to break it out?

We tend to think in categories. The zero-turn category was very strong. The 60-volt lithium-ion portion was a significant and notable contributor to the growth. We don't break down exact percentages publicly, but battery has become a significant driver and is one of the fastest growing areas. It remains a relatively small portion of the overall business but is growing quickly. The key message is it's a no-compromise choice compared to gas, and that message has resonated with customers.

You also said snow contributed positively at the end of the quarter, which is more weather-driven. Given that retailers seemed to grow faster and some competitors grew faster in the quarter, could some of the lag be tied to gas-powered equipment losing share to electric?

No. Snow was an important part of our business and actually throughout the entire snow season. We've taken market share in many snow categories and demand for our battery-powered snow products has been strong. We're introducing a two-stage battery-powered snow product and are excited about its prospects. We feel very positive about snow and are taking share there.

Broadly within outdoor power equipment, it's hard to see how gas is taking share from electric. Would you agree with that or no?

Gas is still by far the dominant power source for most equipment beyond trimmers and handheld products. Gas remains the largest component. As we expand our channels and product offerings, we can continue to take share within gas while building out our electric offerings.

Renee, on the ability to control costs: Toro has a solid record managing cost structure. With raw material inflation, do you have to accept a natural level of SG&A inflation over the next six to 12 months as the economy reopens? As you add capacity and reinstate personnel, travel and trade shows return, can you really hold back SG&A to offset input cost inflation?

We won't necessarily offset all the cost inflation with SG&A. First and foremost, we will invest in technology and innovation regardless of the economic environment. We'll make good choices about other SG&A, but we are seeing a slight benefit from SG&A rate due to leverage. Many of the things you mentioned are happening; some volume-related SG&A will increase with volume. The larger offsets for inflation will be continued productivity focus. We also have some benefit from product mix and we will take market-based pricing decisions as required. All of these actions will help offset inflation beyond SG&A alone.

Lastly on underground construction: is the issue primarily lack of capacity on your end, or are you depending on constrained suppliers for components? You mentioned oil and gas as a source of weakness; what portion of the business is tied to oil and gas?

The constraints are industry-wide: common components such as engines, hydraulics and fasteners are part of the root constraints right now. Suppliers are not fully up to speed. Oil and gas is a small portion of our underground business, low single digits for The Toro Company. Pipelines are part of the business, and as oil prices stay higher we're seeing some oil-related activity that uses our equipment beyond pipelines as well.

Okay. Thank you very much.

Thank you. Our next question comes from the line of Mike Shlisky with Colliers Securities. Your question, please.

Hey, good morning guys. Congrats on what I think is your first $1 billion sales quarter. I want to follow up on earlier questions in a different way: were there any pull-forwards of orders or deliveries to some of your customers anticipating higher prices or shortages later in the year?

No. In fact, it would probably be the opposite in many cases where we couldn't fully fulfill orders; those orders remain for future fulfillment. In these circumstances there can be a piling on of orders, but when you sort that out, demand remains strong into the future. There is no material pull-forward element.

Got it. Also, on inventory levels: you had an all-time record quarter over $1 billion, but inventories are flat year-over-year and about flat from two years ago. Would you have had higher inventories at the end of the quarter if you could have, and how much more would you have invested if you didn't have shortages?

Yes, we would have built inventory up given the demand we're seeing. To clarify, while inventory levels are similar to two years ago, finished goods are down quite significantly and that imbalance is due to supply chain challenges. We are investing to mitigate where we can, but the supply chain is struggling to meet higher demand. Over time we would rebuild inventory to more normal levels and a healthier mix within inventory, but that will take time given continued strong demand this year and into next year.

Okay. One golf question: are you seeing bifurcation between munis and private courses? Munis seem to have large budgets and private courses may be more constrained with weddings and events limited. Any differentiation in trends between muni and private?

We have not seen differentiation. If anything, there's been emphasis on private course investment as well. If the golf course is open, it needs to be maintained, so equipment gets used regardless of the recession or pandemic. If you defer purchases, you eventually have to make them up. Coming out of the prior recession we saw significant makeup purchases. It's encouraging to see munis come back strong and parks prioritized for green spaces. Even where municipal budgets are constrained, the public is prioritizing parks and green spaces because of the value they've provided over the last year.

Okay. That's great color, Rick. Thanks so much. I'll pass it along.

Thank you.

Thank you.

Thank you. And our final question today is a follow up from the line of David MacGregor from Longbow Research. Your question, please.

Thanks for taking the follow-up. Quick question on capital allocation and share repurchases: you had a big spend in the second quarter. How are you thinking about the cadence of repurchases over the balance of the year? Ultimately, do you think we'll return to 2017-2018 levels of total spending, or could repurchases exceed those levels this year?

Our capital allocation priorities remain the same. We will focus on long-term profitable growth, both organically and through acquisition. We will grow our dividend as earnings grow. Share repurchases are a later priority but we will repurchase shares to offset dilution and remain disciplined. As the pandemic recovers, we'll feel more comfortable holding less cash on the balance sheet. You can expect us to act in that manner. If we see attractive growth opportunities with higher returns, we'll invest there first; otherwise we'll invest in share repurchases.

How are you thinking about M&A in that context? Buying another business might also mean acquiring their fulfillment problems, but taking a long-term view, are you pursuing platforms for growth? How's the pipeline?

We're always looking at long-term value. Capacity might be a factor given short-term constraints, but ultimately we'll look for acquisitions that add long-term value to the company.

Okay. Thank you very much.

Thank you.

Thank you. This concludes the question-and-answer session of today's program. I'd like to hand the program back to Julie Kerekes for any further remarks.

Thank you for your questions and interest in The Toro Company. We look forward to talking with you again in September to discuss our results for the third quarter of fiscal 2021.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.