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Edited Transcript of TTC earnings conference call or presentation 22-Aug-19 3:00pm GMT

Q3 2019 Toro Co Earnings Call

BLOOMINGTON Aug 28, 2019 (Thomson StreetEvents) -- Edited Transcript of Toro Co earnings conference call or presentation Thursday, August 22, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Heather M. Hille

The Toro Company - Director of IR & External Communications

* Renee J. Peterson

The Toro Company - VP, Treasurer & CFO

* Richard M. Olson

The Toro Company - Chairman, President & CEO

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Conference Call Participants

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* David Sutherland MacGregor

Longbow Research LLC - CEO and Senior Analyst

* Joseph Logan Mondillo

Sidoti & Company, LLC - Research Analyst

* Joshua Kenneth Wilson

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Thomas Lloyd Hayes

Northcoast Research Partners, LLC - MD & Senior Research Analyst

* Thomas Mcnally Mahoney

Cleveland Research Company - Research Associate

* Timothy Ronald Wojs

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to The Toro Company's third quarter earnings conference call. My name is Crystal, and I will be your coordinator for today. (Operator Instructions) 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, Heather Hille, Director of Investor Relations and External Communications for The Toro Company. Please proceed, Ms. Hille.

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Heather M. Hille, The Toro Company - Director of IR & External Communications [2]

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Thank you and good morning. Our earnings release was issued this morning by Business Wire, and a copy of the earnings release, including a reconciliation of non-GAAP financial measures, 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, Treasurer and Chief Financial Officer.

We begin with our customary forward-looking statement policy as well as information regarding non-GAAP measures. During this call, we will make forward-looking statements regarding our business and future financial and operating results. You all are aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our earnings release as well as our SEC filings detail some of the important risk factors that may cause our actual results to differ from those in our predictions. Please note that we do not have a duty to update our forward-looking statements.

Our earnings release and this related call contains certain non-GAAP measures. Given the significance of Charles Machine Works and the closure of this acquisition on April 1, 2019, we have revised our definition of non-GAAP financial measures to exclude the impact of onetime costs associated with acquisitions, including transaction and non-reoccurring integration costs and one-time purchase accounting adjustments that are not operational in nature. Additionally, we have revised our definition of non-GAAP financial measures to exclude the impact of our new underground construction business strategy, including charges related to inventory write-downs, anticipated inventory retail support activities and accelerated fixed asset depreciation. These revisions to our definition of non-GAAP financial measures are in addition to the previously excluded impact of the excess tax deduction for share-based compensation and U.S. tax reform. The company believes these measures may be useful in performing meaningful comparisons of past and present operating results to understand the performance of its ongoing operations and how management views the business. Reconciliations of adjusted non-GAAP measures to reported GAAP financial measures are included in the schedule contained in our earnings release. Such non-GAAP measures should not be considered superior to, as a substitute for, or as an alternative to and should be considered in conjunction with the GAAP measures presented in our earnings release and this related call.

With that, I will now turn the call over to Rick.

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Richard M. Olson, The Toro Company - Chairman, President & CEO [3]

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Thank you, Heather, and good morning to all of our listeners. This morning, we are pleased to announce solid third quarter results. Net sales for the quarter increased 27.9% to $838.7 million. Third quarter net earnings per share were $0.56, while adjusted earnings per share rose to $0.83. Year-to-date, net sales increased to $2.4 billion with earnings of $2.18 per share and adjusted earnings of $2.52 per share.

Our professional segment sales grew 40% for the quarter, driven by strong demand for products from the Charles Machine Works acquisition, along with good showings from our snow and ice management, rental and specialty construction businesses. For the first 9 months, professional sales grew 20%. While the residential business enjoyed strong pre-season shipments of snowthrowers in the quarter, poor weather conditions continued to challenge our turf products, resulting in 11% decline in sales. However, high channel demand for snow products and strong sales of walk power mowers early in the year delivered a slight improvement in sales year-to-date. Overall, it was a good quarter.

We continue to prudently manage expenditures, improve product availability and invest in innovation. Additionally, we benefited from net price realization and efforts to improve supplier performance. Our team's dedication and consistent execution have us on track to deliver positive results for the year. Following a brief commentary on our businesses through the first 9 months, Renee will discuss our financial and operating results in more detail.

Our strong third quarter showing in the professional segment was led by our construction businesses that capitalized on significant new product introductions as well as solid performances from many established products. I will be mentioning 5 new brands from the Charles Machine Works acquisition. The first is HammerHead that serves the pipe rehab and replacement market. Recently, HammerHead launched their blue light technology, which applies LED light secure pipe liners. This approach is up to 5x faster than conventional methods.

We also introduced the new family of Toro TRX tracked walk-behind trenchers featuring Intelli-Trench that automatically adjusts track speed based on the trenching conditions. These innovations represent real advancements in productivity and ease of use that our customers will value.

Our additional new construction brands include Ditch Witch, makers of an extensive range of underground construction and skid steer equipment; American Augers and Trencor that provide large-scale underground equipment; Radius, a family of aftermarket tools for all sizes and brands of horizontal directional drills. Existing products from the Ditch Witch, Radius, American Augers, Trencor and Toro lines are all seeing strong demand. Looking ahead, our construction businesses are planning to introduce a number of new offerings during the International Construction & Utility Equipment exposition and the Green Industry Expo in October.

As anticipated, last winter's above-average snowfall in the Midwest helped drive strong bookings of our BOSS snow and ice management equipment. Demand for the new Snowrator has been very strong. Customers appreciate its ability to turn a multi-person job of plowing and salting sidewalks into a 1-person operation.

Improved weather conditions helped golf rounds played break even for June. New products, including the Outcross and the Groundsmaster 1200, continued to perform well in the golf, sports fields and grounds markets. During the quarter, our products supported 3 prestigious tournaments: the PGA Championship at Bethpage Black Course in New York; the KPMG Women's PGA Championship at Hazeltine National Golf Club in Minnesota; and the Open Championship at Royal Portrush in Northern Ireland.

Like golf, our irrigation businesses saw improved retail in July. However, unfavorable weather conditions early in the year forced project delays. While conditions have improved, a number of irrigation projects have moved into fiscal 2020.

Weather was also a headwind for our landscape contractor businesses. However, they continued to see solid demand from large national accounts. The new GrandStand and Staris stand-ons continue to sell well, as do our new turf management products.

For the residential segment, walk power mower and rider sales were lower in the quarter as a result of unfavorable weather. Strong pre-season snow shipments during the quarter and positive walk power mower sales early in the season generated the small year-to-year improvement.

Next, our international businesses enjoyed a good quarter led by the expanded construction line, commercial applicator products, regionalized demand for our golf equipment and irrigation products, plus increased snowthrower sales. As you can see from the results, we are pleased with the immediate positive impact of the Charles Machine Works acquisition and the results of our integration progress to date. As we head into the fall selling season, we are optimistic about our prospects for successfully closing out fiscal 2019.

I will now turn the call over to Renee for a more detailed discussion of our financial results.

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [4]

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Thank you, Rick. Net sales for the quarter were $838.7 million compared to $655.8 million a year ago, an increase of 27.9%. We also delivered net earnings of $60.6 million or $0.56 per share compared to $0.73 per share in the third quarter last year. Adjusted net earnings for the quarter were $89.8 million or $0.83 per share versus $73.5 million or $0.68 per share last year. This is an adjusted earnings per share increase of 22.1%.

Year-to-date net sales were up 15.6% to $2.4 billion. We achieved net earnings of $235.7 million for the first 9 months. This equates to $2.18 per share compared to $2.14 per share a year ago. Adjusted net earnings for the first 9 months were $272.4 million or $2.52 per share. This compares to adjusted net earnings of $255.9 million or $2.35 per share last year. This is an adjusted earnings per share increase of 7.2%.

For the quarter, professional segment sales were up 40.3% to $676.8 million led by demand for our construction and snow and ice management products. Year-to-date professional segment sales were up 20% to $1.9 billion, fueled by demand in our construction, landscape contractor and snow and ice management businesses. Professional earnings for the quarter totaled $81.6 million, down 16.5% from last year. Year-to-date professional segment earnings were $319.7 million, down 5.6% from last year. Professional segment earnings for both periods include purchase accounting adjustments related to the acquisition of Charles Machine Works and the impact from our strategic decision to wind-down the Toro-branded underground construction portfolio.

The integration of the Charles Machine Works businesses is progressing well, and our synergies and debt repayment plan are on track. We are pleased by the results to date and are confident that this transformational acquisition will deliver even greater results in the future.

Third quarter residential sales decreased 11% to $148.2 million due to weather-related soft demand for walk power mowers and riders relative to an unusually strong demand in the prior year. Year-to-date residential sales increased by about 1% due to net price realization, solid demand for snow products and walk power mower sales that occurred earlier in the year. Earnings in the residential segment for the quarter totaled $16.2 million. Year-to-date earnings were $51.3 million.

Moving to our operating results. Gross margin as a percent of sales for the third quarter decreased 390 basis points to 31.7%. Adjusted gross margin for Q3 was 35.9%, an increase of 30 basis points from last year. As we anticipated, we are seeing gross margin improvement in Q3 as commodities begin to moderate. For the quarter, pricing and productivity offset the impact of inflation and trade-related costs. In Q3, we also realized the benefit of tariff recovery efforts that previously were expected to occur in Q4. Year-to-date gross margin decreased by 390 basis points to 33.4%. Adjusted gross margin year-to-date was 35.3%.

While we prudently managed spending, SG&A as a percent of sales did increase for the quarter to 22.9% due to the acquisition of Charles Machine Works. In addition, overall SG&A was lower than expected due to the timing of key investments. We continue to anticipate second half SG&A spend to be consistent with prior expectations. Year-to-date SG&A as a percent of sales is 21.7%. Overall, Q3 reported operating earnings as a percent of sales were 8.8%. Adjusted Q3 operating earnings as a percent of sales were 13.4%. For the first 9 months, reported operating earnings as a percent of sales were 11.7% and year-to-date operating earnings as a percent of sales were 14.2%.

Interest expense increased by $4.3 million for the quarter and by $6.2 million year-to-date. The increase is due to additional debt to fund the Charles Machine Works acquisition. The reported tax rate for the third quarter was 14.9%. The adjusted tax rate for third quarter was 18.1%. For the first 9 months, the reported tax rate was 15.3%. The adjusted tax rate for the first 9 months was 19.5%. The company now expects its full year adjusted tax rate to be about 20%.

Accounts receivable at the end of the third quarter were $312.2 million, up 42.3% from last year. Net inventories were $620.6 million, up 70.3% from last year. Trade payables were $304.7 million, up 33% from the comparable period last year. These increases were largely driven by the acquisition of Charles Machine Works.

In summary, Q3 was a good quarter. I will now turn the call back to Rick to discuss our outlook.

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Richard M. Olson, The Toro Company - Chairman, President & CEO [5]

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Thank you, Renee. Fiscal 2019 has been a good year for Toro through 3 quarters, and we are confident that our businesses are well positioned to successfully close out the year.

First, construction sales have been strong to date, and we have a solid order base for the fourth quarter. The integration of the Charles Machine Works businesses is going very well. In late July, we hosted the annual meeting of Ditch Witch dealers from around the world at our corporate headquarters in Minnesota. Dealers were enthused by the new business strategy announced during the event. The strategy significantly broadens the dealer product portfolio, adding large horizontal directional drills and trenchers produced by American Augers and Trencor. The new strategy increases dealer scale, making them more competitive and able to serve customers at an even higher level. It positions the company for strong growth well into the future.

We will be launching innovative new products for both our dealer and rental markets at the major trade shows this fall. A new 5-year forecast just released by the American Rental Association projects rental revenues to continue to climb and surpass the $71 billion mark by 2023. We are pleased with our strong position in the rental, underground and specialty construction markets and the opportunities for substantial long-term growth.

Turning to our snow and ice management business. Our BOSS team has seen record preseason bookings. With favorable fall weather and winter snow, this should result in outstanding sales for the season. BOSS is known for innovative and high-quality products as well as the exceptional customer service our best-in-class dealers provide. New introductions in the truck industry suggests increase prospects for snowplow and ice removal sales.

Next, our golf equipment business should see modest improvement during the fourth quarter as more favorable weather conditions are bringing golfers and revenues back to the clubs. We hope to see fourth quarter equipment retail return to more normal seasonal levels as courses respond favorably to our latest innovations.

While a number of golf irrigation projects have been postponed until 2020, the launch of the Lynx 7.0 central control system later this fall should generate strong interest. Lynx 7.0 provides customers with industry-leading precision and control. Such customer-valued innovation will help maintain our market leadership in golf irrigation.

Fall traditionally brings retail opportunities for our landscape contractor businesses. We have announced new fall retail programs targeting acreage owners that are generating a positive response. Our productivity-boosting GrandStand multi-force platform will be even more versatile with the launch of dethatcher and aerator attachments. Productivity is critical to contractors' success and is a key selling point of our entire landscape equipment line.

Our residential business also sees opportunities in the fourth quarter. In May, we launched our 60-volt Flex-Force line of lithium-ion battery-powered products, including a full-featured Toro Recycler mower, a powerful trimmer and blower, as well as new single-stage snowblowers. Customer demand and product reviews of the line have been strong. The Flex Force snowblower and redesigned gas-powered Power Clear line should further extend our leadership position in snow.

Finally, our international businesses are experiencing broad acceptance of our recent product introductions, including the Groundsmaster out-front and towable rotary motors, new electric and battery-powered greensmowers, and the revolutionary Outcross. Our international team is also preparing to launch the new 60-volt Flex-Force line and to expand our leadership position in zero turn riders with the additional models featuring our popular MyRide suspension.

All said, we are well positioned to close out the year in a positive way. We now expect full year revenue to exceed $3.1 billion and have narrowed our adjusted net earnings per share guidance to be about $2.92 to $3, from about $2.90 to $3. We will give full year guidance for fiscal 2020 during our next call in December.

As we drive to deliver a successful year, we will remain focused on our strategic priorities and be prepared to respond to changing market conditions. I want to thank our employees, distributors, dealers and channel partners around the world for their commitment and hard work. Together, we will finish the year strong and set the stage for a successful 2020.

This concludes our formal remarks, and we will take questions at this time.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from David McGregor from Longbow Research.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [2]

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I guess just to start, when you provided guidance for the third quarter, you had called out $0.70 to $0.75. You posted $0.83 today. I guess, can you just bridge us kind of the upside you saw versus your expectations and what the biggest deltas were?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [3]

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Yes. I think what we saw is really strong gross margin performance within the quarter. We saw price and productivity offset costs related to either the tariffs or general inflationary costs. We did see commodities moderate and really solid execution by the Toro team. We had expected gross margin to improve as we went through the second half, but we did see a little more improvement in the quarter, and in particular, related to some duty recovery that originally we thought we would recognize in Q4, and we were able to recognize that in Q3. That would be just the one thing that would be a little bit different as we look through the remainder of the year. That would be probably one of the biggest factors, as well as just continuing to manage expenses prudently as we always do. We're a company that has to deal with sometimes variability between quarters, and we always encourage people to look a little longer term. And we did see some benefits from specific SG&A investments that did not occur in Q3, but we would still expect them to occur for the year, assuming the rest of the year progresses as planned. So we've included all of that in our guidance as well.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [4]

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Okay. And you lowered your full year revenue guidance. You had previously been talking about a mid-single-digit organic growth within that. Is that kind of the low single digits now? Or is there any Charles Machine Works' reductions in that guidance?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [5]

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Yes. There would be no Charles Machine Works reductions in that guidance. And our guidance for the fourth quarter really reflects -- in addition to some of the timing things that Renee referred to, the fact is that has been a difficult retail environment, and it still is somewhat a soft retail environment. We do have programs out there to spur retail growth, but we want to make sure we see some data points on those before we conclude their effectiveness. And then in the fourth quarter, we will also, from an earnings standpoint, experience some higher manufacturing variance as we make sure that we rightsize the inventory by the end of the year, and that's really a balance of the production levels within our plants and the other factors that we bring in as well.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [6]

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Okay. Just last one for me, you called out the costs associated with the wind-down of the horizontal drill trencher lines. Were there any associated revenue headwinds from that transition in the quarter?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [7]

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Not within the quarter. It's fairly minimal overall, the wind-down of that business, but we didn't see an impact just based on the timing of when we made the announcement for the quarter.

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Operator [8]

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And our next question comes from Tom Mahoney from Cleveland Research.

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Thomas Mcnally Mahoney, Cleveland Research Company - Research Associate [9]

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I wanted to ask about -- just sizing the moving pieces inside of inventory up 70%, what is the contribution of Charles Machine Works inside of that number?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [10]

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Yes, Tom, from an EPS perspective or from a revenue? I'm sorry I didn't hear the...

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Thomas Mcnally Mahoney, Cleveland Research Company - Research Associate [11]

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Within the inventory number up 70% year-over-year, how much of that is just kind of purely just having Charles Machine Works this year versus last year?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [12]

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Yes. The vast majority of all the working capital increases are driven by Charles Machine Works, and that is certainly the same from an inventory perspective. As Rick had mentioned, we did see some increase in our inventory in our legacy business. Part of it we had discussed in the prior call was to make sure we were a good supplier and that we could also manage some of the supplier issues. And we had better product availability and certainly did a better job in managing supplier issues in the quarter. As we go into Q4, as Rick mentioned, we will ensure that we're looking forward and adjusting those inventory levels as we close out the year. And that's why we've included a little bit more manufacturing variance in our overall estimate really as we reduce ours to address inventory.

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Thomas Mcnally Mahoney, Cleveland Research Company - Research Associate [13]

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And do you expect those to be across the Pro business as well as the residential segments? Or is it focused in one or the other?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [14]

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I would say it's probably across the board. Some of our products are built in a shared production environment, so it's not specific to one versus the other.

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Thomas Mcnally Mahoney, Cleveland Research Company - Research Associate [15]

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Okay. And my other question relates to price realization. So inside of the kind of core legacy Toro revenue growth in 2019, can you give us some at least directional guidance on how much price contributed there? And then your initial expectations for what 2020 could look like in terms of raising price?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [16]

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Sure. So from a overall standpoint, what we've stated in the past is that Toro typically recognizes or realizes about 1 to 2 points of price realization, more of that in the professional business than in the residential business. In this particular year, we knew that price was going to be a bigger component, and we would say it's probably -- it varies by business, but it's probably about double the normal range that we would see. And as we look forward for next year, we're still working through our plan, but we would not expect to see the same increases from a price standpoint that we saw within 2019. We would expect that to moderate. We always price to market, not to cost. But certainly, the cost environment drove some of the price increases that we saw across the industry in 2019.

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Operator [17]

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Our next question comes from Sam Darkatsh from Raymond James.

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Joshua Kenneth Wilson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [18]

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This is Josh filling in for Sam. A couple of housekeeping items for me first. What was the split of the charges in the quarter between the segments?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [19]

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For the onetime charges?

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Joshua Kenneth Wilson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [20]

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Yes.

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [21]

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What you can see is consistent with how we report it in the past, in the professional segment, you would see the impact of the purchase accounting. So the inventory step-up, the intangibles, those are all in the professional segment. And then primarily within the other segment, you would see more the SG&A-related charges, the transaction expenses, which were minimal in the quarter, and then acquisition integration expenses would be in the other segment.

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Joshua Kenneth Wilson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [22]

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Got it. And Charles Machine Works sales in the quarter?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [23]

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Yes. We don't break that out. That will be part of the professional segment. But just to give you some guidance on that, if you think about the run rate for Charles Machine Works, we talked about the businesses being similar to our professional businesses, so in the mid-single-digit sort of range, and they have been beating that on a run-rate basis. So we're pleased with the sales so far from Charles Machine Works, and it certainly contributed.

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Joshua Kenneth Wilson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [24]

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Got it. And then regarding your gross margin guidance, I noticed in the slide, you removed the commentary that you expected a year-on-year improvement in the back half in all businesses. Am I reading too much into that? Or was -- were there certain businesses that are maybe underperforming your margin expectations previously?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [25]

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No. I think it's more of just generalizing the comment versus being a specific. I think we still expect to see gross margin improvement. As we close out the year, it's a small quarter, and so there always can be some adjustments that occur. But there's nothing dramatic that is changing overall.

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Joshua Kenneth Wilson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [26]

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And given that you realize the tariff offsets earlier, would it be fair to say that your gross margin expectations for the second half are higher than they were before? Or were the inventory cuts you talked about also incremental to your prior expectations?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [27]

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Yes. The tariff recovery or the duty recovery actually is an item that we had planned in Q4, and we recognized the true-up of that in Q3. So that actually would decrease the gross margins for Q4 as well as the manufacturing variance would reduce the gross margin in the quarter as we end up -- end the year. However, we still expect gross margin for Q4 to improve year-over-year, so we're still expecting to see acceleration of the improvement we saw in Q3, just some timing differences that we'll recognize in Q4.

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Operator [28]

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Our next question comes from Tim Wojs from Baird.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [29]

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I guess, maybe just, Rick, as you kind of look at -- I know you're going to take down some or right size some production in the fourth quarter to control your own inventories, but I guess, what would you need to see at retail to kind of be comfortable that inventory in the channel doesn't kind of go into next season at a higher level?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [30]

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Yes. We actually feel good about our field inventory at this point. If you take the season so far and the challenge that has been there for the entire market with the start of spring being late and pretty terrible conditions through the bulk of summer, we adjusted our production and responded appropriately. So we have some categories that are a little bit higher than we'd like to see at this point in the season. But also, there is opportunity yet to sell through the rest of this year. So that's where our focus is. And we have some signs that weather patterns are improving. And in some cases, if we have a slow spring in some businesses, that could mean opportunities for the fall if the grass continues to grow during the summer. And it was not a drought, so there's a lot of moisture in the system, and that kind of bodes well for good response to the fall programs. We just haven't seen the data points yet to be able to be confident in that yet.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

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Okay. Okay. That sounds good. And then as we think about the synergies for Charles Machine Works and just the realization, now that you're kind of 6 months in, I think initially, $30 million of synergies, and I think the idea was you recognize that ratably over 3 years. Any change to that time line now that you've kind of been in the business and have started to make some changes?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [32]

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Yes, we did say $30 million, and I can say a few things. We are more confident in the $30 million than we were when we reported that initially. We have had tremendous progress with the team. The cross-functional team is a stellar group and they are making great progress with the synergies. And we've identified synergies that we would say are ahead of track. Those are not fully realized yet, so we'll give a more full report at the end of the year. But I would describe them as we're confident in the numbers that we've provided. We are on track or ahead of track, but we just haven't seen those within our operations yet. And one thing I would also add is the partnership with Bain Consulting has been extremely helpful to us from just the process that they brought to the table. So we have a very strong team from both Charles Machine Works and Toro, in combination with a very strong team from our outside partners that's helped us with benchmarking and helped us execute very quickly on the opportunities.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [33]

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Okay. Okay, great. That's helpful. And then I guess, as we look forward into 2020 or just being more a normalized basis, free cash flow historically has been closer to $100 million, maybe slightly better than $100 million. I noticed some variances this year, but is that still a kind of a similar kind of normalized expectation for free cash flow?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [34]

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Yes. I think as we look forward, you would expect that to be over time, each year can vary. We'll give more specific guidance as we go into 2020 related to the following year, but there's nothing fundamental that's changing. We'll always look, though, at where we can see those opportunities to invest. And there are times that we spend a little bit more in CapEx, as an example, than other years. So we just haven't made those decisions yet for next year. But over time, you would expect us to return to that profile of about 100% conversion.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [35]

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Okay. And then, sorry, last housekeeping question. Just Renee, do you have a point number for what the Charles Machine Works inventory increase was year-over-year?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [36]

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We did not break that out specifically, but it was the majority of the increase -- I mean, the vast majority of the increase is related to Charles Machine Works.

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Operator [37]

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Our next question comes from Joe Mondillo from Sidoti & Company.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [38]

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Just wanted to, first, confirm on the EPS guidance just wanted to make sure that the new guidance versus the prior guidance is sort of apples-to-apples in terms of how you adjust for one-time items?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [39]

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Yes. It would be apples-to-apples. The only difference at all, Joe, is that during Q3, we recognized the impacts of the decision to wind-down the construction business from a Toro perspective, and we have included that as an item that we adjust out. That actually happened in the quarter. So that would be really the only difference that you would see. So I think you should consider them to be apples-to-apples. That's our intent.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [40]

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Okay, great. And then just trying to -- I know you don't want to necessarily maybe quantify, but the core professional segment, could you give us a direction? Or the CMW, obviously, acquisition makes up such a big contribution. Where is the growth going relative -- I know the second quarter was hampered by the markets and the challenges that you've seen. Is there any way you can provide any more detail on what sort of growth you actually saw on the third quarter?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [41]

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Sure, yes. From a legacy professional standpoint, that business has also been strong for the year, especially given some of the field challenges from a market standpoint. And if you take that portion of the business on its own, we would have had earnings per share growth with those businesses. So it was good. I mean a couple of areas I'd specifically call out. BOSS is having a tremendous year coming off of a strong snow season last year. They had record pre-season bookings and great response for the new products. The Snowrator that came from a previous acquisition, L.T. Rich, has had tremendous response. Siteworks, the introduction of the TXL 2000 much higher-capacity compact utility loader has been very strong. So our traditional legacy Toro business is also moving along very nicely.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [42]

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Is it -- over the last 2 quarters, in the second quarter and third quarter, is it fair to say that growth has been a little sub-average just given all the challenges that you've seen with weather?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [43]

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I think we're in the range that we historically have been in. As we got into the weather, maybe you see that obviously in our revenue numbers, so the revenue did come off a little bit. I think that's the natural outcome of the market condition. But I think the positive thing is the Toro company has been -- there's been a weather impact for the entirety of the history of the company, and our teams know how to respond in those situations. So the expense management and those types of things that Renee talked about, that are just part of our DNA. So I think the team responded well to the conditions, drove as much sales as possible, and then managed our SG&A and expenses appropriately.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [44]

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All right. And I just want to confirm, Renee. In terms of the onetime items, you pointed out that the -- I think it's the $29 million of acquisition-related costs, none of that hit in the professional segment?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [45]

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The $29 million related to, I'm sorry, Joe?

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [46]

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Acquisition-related costs? I thought that you said that, that was in the corporate line, but that seems extremely large for it to not hit the professional.

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [47]

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No. Let me clarify it, please. So for the professional segment, you would see the impact of -- the inventory step-up and all of the intangible amortization, that would go through the professional segment, as well as the impact from the wind-down of the underground Toro business, that would all go through professional. What I intended to say, if I didn't say it correctly, in the other segment, that's where you would see the acquisition integration costs. So some of -- more in the SG&A area as well as the transaction costs, and the transaction costs were primarily earlier in the year. There might have been a little bit that went through this quarter, but it's mostly acquisition integration that you would see in the other segment in this quarter.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [48]

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Okay. And I don't know if you break -- I didn't see that broken out in the press release, but you have -- how much was that, that hits the corporate or the sort of SG&A line? Just curious...

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [49]

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Yes. We didn't break that out specifically. We did add a little more detail on our statement of cash flow related to some of the step-up and intangible amortization that might be helpful.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [50]

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Okay. So when I look at the reconciliation table, you have $29 million and then a $9 million item. Most of that is in the professional segment?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [51]

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Most of the difference in the adjusted versus recorded gross margin would be in the professional segment. Most of the SG&A is in the other segment.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [52]

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Okay. And then I wanted to ask about the residential margin that you saw, was pretty strong. It was one of the strongest that we've seen in over a year. What drove that? And is that sort of anywhere sustainable? Or how do you think about that?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [53]

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Yes, no. They did have a good quarter, I agree with you. And a piece of it were the items we talked about earlier, starting to see some commodity moderation. They did have price realization, which as you know, from our past discussions, is really a challenge within the residential segment. However, a fair amount of the duty recovery that we saw in Q3 that we originally have planned in Q4 would have related to the residential segment. So that piece would not repeat as we go forward. It was really a true-up of some of the duty that we have seen year-to-date.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [54]

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And can you quantify that for us?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [55]

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Yes. I could say between -- from a timing standpoint overall, between the duty recovery and the SG&A timing, it would be several million dollars and roughly split about 50-50. I mean they're roughly about the same.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [56]

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Okay. And then just lastly, just wanted to confirm when you said the tax rate 20%, is that the adjusted tax rate for the year? And how do you think about tax rate for the upcoming year?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [57]

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Yes. That would be the adjusted tax rate for the year. I mean, we would expect the tax rate, now that we've gotten through some of the tax reform and the associated guidance with it, to continue in roughly the same level. However, I will say every year, we do have some discrete items, and we saw a little bit of that this quarter as well. Those are very difficult to predict and cause a little bit of volatility in the tax rate. But we feel like we've at least gotten all of the tax reform impacts included going forward now, and we had a full year at the lower rate from a U.S. standpoint.

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Operator [58]

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And our next question comes from Tom Hayes from Northcoast Research.

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Thomas Lloyd Hayes, Northcoast Research Partners, LLC - MD & Senior Research Analyst [59]

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Rick, just kind of broadly speaking on the new 60-volt battery mower line, since -- I guess it was a good start to the product offering. Is there further SKUs that you can add to that going forward? Or is there kind of a smaller limit to the number of mowers you can bring to market with that battery power?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [60]

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Yes. We've -- right now, we have a really nice package, if you think about the walk power mower, the blower, the trimmer, and now, the snowthrower. And the reports from performance of all those products are very good. The thing I would point out, especially with the mower, is that it's a bit different experience than some of the other battery products that are out there because you pick up the features of our walk power mowers that are found on the gas products as well. So you have the Personal Pace features, and it really gives you a more full experience -- Toro experience than some of the other products that are on the market. So customers have really responded well to that. The reviews are good. Our dealers, in fact, are doing very well with it. The only thing that has been a challenge is it was more of a mid-year introduction, so we probably won't see the full impact until spring of next year.

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Thomas Lloyd Hayes, Northcoast Research Partners, LLC - MD & Senior Research Analyst [61]

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Okay, great. And then maybe on the Charles Machine Works, I think that the rental association came out with their -- good outlook for that market. Does the Charles Machine Works fall into the rental equipment market? If you could just remind us of that.

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Richard M. Olson, The Toro Company - Chairman, President & CEO [62]

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Yes, they do. Particularly the -- what they call the mini skid steer line, similar to our compact utility loaders, the Dingo line under the Toro brand name. And then they also have trenchers and other rental products, trenchers being one of the larger categories that would fall into rental. So their rental is a significant portion of their business.

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Thomas Lloyd Hayes, Northcoast Research Partners, LLC - MD & Senior Research Analyst [63]

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Okay. And then just for Renee, as far as the uses of cash, I know you guys temporarily put a hold on share buyback to focus on debt repayment. Is the expectations that will continue at least for the next couple of quarters?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [64]

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Yes. We will -- we've paid down to date about $300 million in debt overall, and we'll continue to focus on that. But we'll look at -- we'll continue our focus on capital investments internally as well. But we would expect that, at least for the next quarter or so, we'll probably focus on debt repayment. Beyond that, we'll give some guidance as we go into 2020 on what our capital allocation priorities will be.

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Operator [65]

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And we do have a follow-up from Joe Mondillo from Sidoti & Company.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [66]

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Just a couple of minor items that I just wanted to ask about. The expectation on DNA, including the purchase amortization going forward, just wondering what sort of run rate would be?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [67]

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Yes. We didn't specifically give guidance on that. What we did do, Joe, is to try to help, because we recognize it is a substantial change year-over-year, is on the statement of cash flow, we tried to at least break out so you could start to see the full quarter impact of DNA. Most of the step-up in inventory, we'll see for this year. Most of that will be worked through by the end of the year. And some of the intangible amortization certainly have longer lives than that. But you get back to a more normal level after we get through that inventory step-up is the big change year-over-year.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [68]

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So I think you broke that out on the cash flow, right? So I think DNA was $19 million or so for the quarter. Is that a normalized level?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [69]

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No. I think -- well, I think we broke out the PP&E depreciation as well as then the intangible amortization and the inventory step-up. I would say that the intangible amortization, if you look at it, that's -- those will probably continue roughly at that rate, and depreciation and amortization does move around a little bit, but is probably more constant as well.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [70]

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Okay. And then I was wondering about sort of onetime costs that's going to hit the P&L in fourth quarter, and if you expect anything in fiscal '20?

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [71]

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Yes. In fourth quarter, there will continue to be some integration-related costs, not a huge magnitude, but there will be some integration-related costs on an ongoing basis as we work through, as Rick was talking about, to put the plans in place to execute on the synergies. We still have more work to do in that arena. As we look forward to 2020, we'll get that guidance as part of 2020, but we'll start to see some of those costs start to ramp down as well.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [72]

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Okay. And then lastly, the non-operating income line has been trending higher than last year, just wondering if there is anything else in there beyond the financing arm, or how can we think about that? I guess just wondering about that.

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Renee J. Peterson, The Toro Company - VP, Treasurer & CFO [73]

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So certainly, Red Iron, which is the joint venture that you mentioned, is the biggest portion of that. But there are some integration-related non-operating items that we were able to complete in the quarter that did yield a benefit. We wouldn't necessarily expect those to continue at the same rate, but there were some early items that we did manage to close out, and we consider them non-operating.

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Operator [74]

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And I am showing no further questions from the phone lines. I'd now like to turn the conference back over to Heather Hille for any closing remarks.

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Heather M. Hille, The Toro Company - Director of IR & External Communications [75]

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Thank you for your questions and interest in The Toro Company. We look forward to talking with you again in December to discuss our results for the fiscal year and provide our outlook for fiscal 2020. Thank you.

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Operator [76]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.