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Edited Transcript of TTC earnings conference call or presentation 6-Dec-18 4:00pm GMT

Q4 2018 Toro Co Earnings Call

BLOOMINGTON Dec 10, 2018 (Thomson StreetEvents) -- Edited Transcript of Toro Co earnings conference call or presentation Thursday, December 6, 2018 at 4:00:00pm 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 & Principal Accounting Officer

* Richard M. Olson

The Toro Company - Chairman, President & CEO

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Conference Call Participants

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* Joseph Logan Mondillo

Sidoti & Company, LLC - Research Analyst

* Robert Samuel Aurand

Longbow Research LLC - Analyst

* Samuel John Darkatsh

Raymond James & Associates, Inc., Research Division - 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 full year and fourth quarter earnings conference call. My name is Brian, and I will be your coordinator for today. (Operator Instructions) As a reminder, this conference call 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 contain certain non-GAAP measures consisting of adjusted net earnings, diluted net earnings per share and effective tax rate as financial measures of our operating performance. 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 operation and how management views the business.

Reconciliations of adjusted non-GAAP measures to reported GAAP financial measures are included in the schedules 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 report that the company delivered record sales and earnings results for fiscal 2018. These records include net sales of $2.6 billion, operating earnings of $373 million, net earnings of $271.9 million and earnings per share of $2.50. Inflationary and tariff pressures raised our input costs most notably for steel and freight rates. We've taken measures to offset these headwinds through sourcing strategies, productivity initiatives, strategic capital investments and price adjustments across the businesses. Professional products led the way with notable performances by our landscape contractor, golf, grounds, rental and specialty construction and snow and ice management businesses. The company's focus on creating and returning value to our shareholders remains steadfast as evidenced by our year-end earnings per share results along with the increased quarterly dividend that our board just approved.

Following a brief commentary on our businesses, Renee will discuss our financial and operating results in more detail. First, the strong retail and channel demand of our landscape contractor businesses generated earlier in the year continued through the quarter due to demand for our zero-turn riding mowers, including the new diesel line, favorable cutting conditions and the strong economy. These factors helped us capture a large number of fleet deals throughout the quarter. Our full range of innovative products, including a number of new additions through large enthusiastic crowds during the Green Industry and Equipment Expo in October. We will discuss some of these latest innovations later in the call.

Like the landscape contractor category, our golf and grounds equipment businesses wrapped up a good year with strong retail and channel demand during the fourth quarter. We continue to prevail in many competitive large golf package deals and saw rotaries and vehicles finish the year well at retail and the grounds market. As foreshadowed in previous calls, we executed 2 significant product launches during the quarter, including our revolutionary Outcross and the Groundsmaster 1200 pull-behind rotary. In September, the Outcross received the 2018 Innovation Award from the Federal Association of Garden Landscape and Sports Facilities at their annual trade fair in Germany. We are poised with exciting new golf and grounds products that will unveil during industry trade shows in January and February.

Our golf irrigation business delivered a similarly successful year finishing with strong project sales. We once again won a majority of course renovation projects, including many competitive conversions and new golf installations. The market continues to validate our offering of an option between satellite and 2-wire control systems, as we continue to see increased demand in both categories. Our INFINITY top accessible sprinklers also continued to sell at a healthy rate.

Moving to our rental and specialty construction businesses. Our rental partners enjoyed a good sales year with growth observed across all regions, particularly of our TX 1000 compact utility loader, tracked mud buggy and trenchers. Field inventory is currently higher but many channel partners are anticipating solid end-of-the-year retail following a strong construction season for contractors. Our exciting new Dingo TXL 2000 compact utility loader was officially launched at the GIE show in October. The TXL 2000 is our largest compact utility loader to date, featuring a 2000 pound rated operating capacity and unique telescoping arms. It has been named one of the Top 100 new products for 2018 by construction equipment magazine, an award aimed at recognizing new product innovations that provide more productivity and efficiency. Our tracked mud buggy also won a Top 50 new product award for 2018 buy Equipment Today magazine as one of the most intriguing new products for construction equipment owners and end-users. Our snow and ice management business enjoyed similar success on the fourth quarter based on strong demand from our channel as well as early season retail activity. Colder-than-normal temperatures in most regions and early snowfall in key areas helped drive demand. Response to our new products has been very positive. In spite of unfavorable late spring and and wet summer conditions, our residential and commercial irrigation business posted sales gains for the year. The launch of the new internet-enabled KD2 controller received a favorable response in the marketplace. In addition, our central control product lines achieved solid growth. Ag irrigation products delivered more modest growth for the year based on mixed regional results. Our leadership in promoting responsible use of water through innovative product solutions and customer education was recognized by the U.S. Environmental Protection Agency. For the third year in a row, Toro received an EPA WaterSense excellence award.

Turning to our residential segment. Preseason snowblower shipments and retail activity of our 2-stage line were up nicely in the quarter, thanks to the carryover effect of large snow events last spring, plus demand for our next generation Power Max HD line. Late-season retail activity on our TimeCutter zero-turn mowers was extended through the quarter due to favorable mowing conditions.

Finally, international sales made gains for the quarter and year on the strength of our professional equipment offerings. A number of new product introductions, fleet replacements and new products helped fuel the growth. I will now turn the call over to Renee to detail our financial and operating results.

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

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Thank you, Rick, and good morning, everyone. As we reported earlier this morning net sales for fiscal 2018 grew 4.5% to a record $2,618.7 million. We achieved record net earnings for the year of $271.9 million or $2.50 per share. This compares to fiscal 2017 net earnings of $267.7 million or $2.41 per share. Adjusted net earnings for the year were $290.1 million or $2.67 per share compared to adjusted net earnings of $248 million or $2.23 per share in 2017, an increase of 19.7%. Net sales for the quarter were $539.3 million compared to $488.6 million for the same period a year ago. We delivered net earnings of $39 million or $0.36 per share compared to $33.8 million or $0.31 per share in the fourth quarter of fiscal 2017. Adjusted net earnings for the quarter were $34.2 million or $0.32 per share compared to adjusted net earnings of $33 million or $0.30 per share for the fourth quarter of 2017, an increase of 6.7%. Please see the tables provided in our earnings release for reconciliation of non-GAAP, adjusted net earnings and adjusted diluted earnings per share to the comparable GAAP measures. For the year, we repurchased approximately 2.6 million shares of company's stock. At year-end, we had approximately 2.4 million shares remaining on our authorization. Earlier this week, the board increased our authorization by an additional 5 million shares.

Moving to results for our business segment. First, professional segment sales were up 7.5% to $1,947 million for the year. This includes sales growth of 11.1% for the quarter to $400.5 million. These strong sales results for both periods were fueled by solid demand across our professional businesses. Professional segment earnings were $400 million for the year, up 5.4% compared to fiscal 2017. Professional segment earnings for the quarter totaled $61.2 million, down from $65 million a year ago. Our residential segment sales for the year decreased 2.8% to $654.4 million. The fourth quarter saw residential sales increase 8.7% from a year ago to $133.2 million. Unfavorable winter conditions early in the year along with spring's late arrival in many parts of North America, negatively impacted sales of both snow and turf products and thus our results for the year.

Warmer weather and good precipitation during the second half of the year triggered demand for both the walk power and zero-turn riding mowers. Interest in our new next-generation Power Max snow throwers also helped drive shipments in the fourth quarter.

For the year, residential segment earnings decreased 13.2% to $64.8 million. Residential earnings for the quarter totaled $6.8 million compared to $11.7 million a year ago. Now to our operating results. Gross margin for the year decreased by 90 basis points to 35.9%. For the quarter, gross margin was 33.2%, down 450 basis points from a year ago. The full impacts of tariff, inflation and supply challenges were magnified during the fourth quarter by the relatively small size of the quarter, resulting in declines in both periods.

These results were partially offset by net price realization. While such pressures are continuing into fiscal 2019, we expect to improve the full year gross margin based on our strict focus on prudent sourcing, practices, productivity and cost improvement initiatives, strategic capital investments and selective price increases that take effect and drive the full year improvement.

SG&A expense as a percent of sales decreased by 90 basis points for the year and by 280 basis points for the quarter.

Prudent expense management, lower incentives and leveraging of costs over higher sales contributed to the improvement in both periods. For the year, SG&A improvements were offset in part by continued investments in our key strategic initiatives, including new product development. Following the strong SG&A improvement we achieved during fiscal 2018, we expect to maintain SG&A at a consistent rate of sales in fiscal 2019.

In spite of inflationary challenges, operating earnings as a percent of sales for the year were consistent with fiscal 2017 at 14.2%. For the quarter, operating earnings as a percent of sales were 8%, a decline of 170 basis points compared to the same period last year.

Interest expense decreased slightly for the year. The reported tax rate for fiscal 2018 was 27% compared to 24.2% last year. The adjusted tax rate for fiscal 2018 was 22.1% compared to the adjusted tax rate of 29.8% in the same period last year. For the full year, the tax rates were significantly impacted by the enactment of U.S. tax reforms as previously reported. The unfavorable impact of onetime charges associated with the provisional re-measurement of deferred tax assets and liabilities and the provisional calculation of the deemed repatriation tax were partially offset by the benefit resulting from the reduction in the federal corporate tax rate. For the fourth quarter, the reported tax rate was 10.4%, down from 27.9% in the same period last year. The adjusted tax rate for the fourth quarter was 21.5% compared to the adjusted tax rate of 29.7% in the same period last year.

For the quarter, the adjusted tax rate excludes the benefit of the excess tax deduction for share-based compensation, as well as adjustments to the provisional tax items reported in previous quarters of fiscal 2018. For fiscal 2019, the company estimates that its full-year adjusted effective income tax rate will be about 21.5%.

Turning to the balance sheet. Accounts receivable at the end of the year totaled $193.2 million, an increase of 5.5%. Net inventories were up 8.9% to $358.3 million. The increase reflects the impact of work in process along with planned increases to meet market demand and improve order fill rates.

Trade payables increased 21.2% to $256.6 million. At the end of the year, the company's 12 month average networking capital as a percent of sales improved to 13.7%. We ended the year with strong free cash flow of over $274 million. Capital expenditures for fiscal 2019 are planned to be approximately $85 million compared to about $90 million in fiscal 2018. As we plan to continue to invest in our facilities, new product tooling, new technology and production processes, we expect depreciation and amortization to be up slightly to approximately $64 million. In light of our consistently strong performance, the board declared a quarterly cash dividend of 22.5 cents per share or 12.5% increase from its previous quarterly dividend rate of $0.20 per share. This dividend is payable on January 9, 2019, to shareholders of record on December 20, 2018. In fiscal 2018, the company paid $85 million in dividends. When added to the repurchased common stock, we returned $245 million to our shareholders. These actions are consistent with our focus on returning value to shareholders. That said, our overall investment priorities remain the same. We will continue our disciplined approach to pursue opportunities that drive profitable growth, both organically and through value-added acquisitions. I will now turn the call over to Rick for his comments regarding our outlook.

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

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Thank you, Renee. We are pleased to have delivered record results in fiscal 2018 and believe fiscal 2019 should be another good year. We expect gross margins to improve for the full fiscal year. Cognizant of ongoing inflationary pressures on input costs, particularly in the first part of the year, we will continue to deploy sourcing strategies, productivity initiatives, capital investments in new technologies and price adjustments across businesses to mitigate these challenges, while investing in strategic imperatives, including new product development. In the coming months, we will be participating in leading industry trade shows at which we will unveil a number of new product and service innovations.

Let's review prospects for our various businesses in the new fiscal year. Our landscape contractor businesses are well positioned to extend their win streak with a broad equipment portfolio starring several new innovations. Some examples include a smaller more nimble 44-inch zero-turn rider, the new Ultra-Mix mortar mixing line and the recently acquired stand-on Z spray. Another notable addition that has generated a great deal of excitement is the new series of rugged stand-on mowers designed so the operator's positioned between the drive wheels. This new platform has a lower center of gravity, combined with the forward placement of the engine, gas tanks and operator to enhance weight distribution and deliver increased stability, traction and maneuverability. It also features an adjustable suspension system for operator comfort.

A full complement of decks from 32 to 60-inch cutting width deliver these superior quality of cut for which our products are known. We believe our expanded portfolio presents the industry's most expensive line of innovative solutions for landscape contractors. Our golf and grounds businesses are busy preparing significant product launches in the coming months during the Golf Industry and Sports Turf Managers Shows. Our golf business remains strong and ground sales should enjoy solid growth in 2019.

Park and municipal bid opportunities are plentiful, and we have committed additional sales resources to our sports fields and grounds efforts. The vehicle market is particularly healthy, and we are focused on continuing to take share with our Workman GTX line. We have new advanced golf offerings under wrap that we believe will be very well received by customers during their Golf Show unveiling.

The outlook for the rental and specialty construction business is encouraging as well. Industry sources project overall construction activity to remain strong with some moderation in the residential segment. The American Rental Association has revised their rental revenue growth projection upward. Their 5-year forecast updated in late October now forecasts equipment revenues in North America to grow by 4% to 6% each of the next 5 years. Our team is focused on outpacing that rate by continuing to offer exciting innovations that help clients increase productivity, like the new TXL 2000.

Furthermore, tax reform and a healthy economy have also helped customers increase budgets for equipment purchases. Early snow and icy conditions in key markets have helped our snow and ice management business get off to a good start in the new year. We expect continued growth from BOSS. The addition of the stand-on Snowrator along with recent introductions like the EXT extendable plow and rear-mounted plow, all present continued opportunities for growth. The early snow is also good for our residential business. The rugged new Power Max HD snowblowers further bolster our reputation as the strongest brand in the industry. As long as the snow continues to fall, we should enjoy solid winter sales, setting us up for a positive start to the spring. As always, we anticipate a variety of regionalized opportunities across businesses in the international arena. Interest is running high for our most recent introductions, including new irrigation controllers, rear discharge decks for GrandStand mowers, the Groundsmaster 1200, the ProLine H800 direct collect mower, the Outcross and additional new products soon to be announced at leading trade shows.

In summary, we remain steadfast in our focus on innovation, productivity and profitable growth as we pursue another successful year. While mindful of inflation and trade policy uncertainties, we stand ready to address any headwinds and make fiscal 2019 another strong year for Toro. Before closing, I want to thank our employees, channel partners for their contributions to the success we achieved in fiscal 2018 and for their continued commitments in the new year.

For fiscal 2019, the company expects revenue growth to exceed 5%, with approximately 1% of the growth attributable to our acquisition of a distributor partner in the first quarter of fiscal 2019. Adjusted net earnings for the year are expected to be about $2.90 to $2.95 per share. For the first quarter, the company expects adjusted net earnings to be about $0.48 to $0.50 per share, which includes an unfavorable one-time impact of $0.02 in the quarter related to acquisition costs. This concludes our formal remarks. We will take your 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 will come from the line of Joe Mondillo with Sidoti & Company.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [2]

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Just wanted to, sort of, touch on a little bit more on productivity improvements that you have in place. You mentioned that this is obviously expected to offset some of the challenges with the tariffs and higher costs and the CapEx was a little heavier than I expected in 4Q. Just wondering, sort of, could you talk a little more in color what you're doing there and how that's expected to drive growth in fiscal '19?

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

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Sure. Specific to the productivity one of the key areas is our lean initiative that we really relaunched more than a year ago, and it's really producing great results for -- so improving productivity within our plants. We also have very specific margin improvement teams that are working on various elements of our cost, working from a design standpoint, working with suppliers to consolidate repurchases and through standardization and really leveraging our buys. And then some of the areas of cost by quality, et cetera will also be part of that. So that's part of it. We also have very specific guidelines for each of our businesses to deliver productivity, and that's really from the productivity standpoint. Closely related to that is really working with our suppliers to ensure that we can -- we have the best negotiated options for -- in the context of the tariffs. So if we have suppliers that are subject to tariff, we want share in some of the expenses of the tariff, minimize that and then as commodities start to come down we want to make sure that we realize the benefit. For example, steel has already peaked and has started to come down, so we have to be aggressive to go after those reductions as well.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [4]

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So just a follow-up on that. I always regarded you guys as very high-quality operators continuously trying to improve efficiencies and what not. It seems like you guys have done a really great job over the years. How would you describe the difference since you have come in and, sort of, initiated -- you said you reinitiated the lean manufacturing process, I would have thought that would have already been in place. How would you describe, sort of, the differences that have taken place over the last 18 months or so compared to how things were being operated beforehand?

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

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I think really, the -- what I would call out is that our productivity and operational excellence is one of our key strategic initiatives. So we did a lot of work in lean early in the 2000s, as we went through the recession and we had layoffs in our plants. We lost some of our focus in that area and reduced some of our resources. But as we've gone out and reignited that effort, we really are getting a return that is better than the investment that we're making because we are reigniting a lot of knowledge base that's already there. So that's one example with lean where we're getting a return that's better than you would expect because we have a great base of lean knowledge, and our teams can jump right into cost improvement and process improvement projects with a good solid base of understanding of how to do that.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [6]

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Okay. And then, last question from me and I'll let everyone else have a chance. We've seen a lot of data showing how the housing sector is slowing quite significantly. Your business is highly correlated or at least tied to that part of the economy. You certainly haven't come through started your prepared commentary, and it probably -- you probably haven't seen it necessarily in your business. But I'm just wondering anecdotally or if you have seen anything in your business, how you're thinking about that? And can you -- have you seen anything or heard anything that have lead you to believe that maybe, we're slowing a bit in that sector and that it's affecting any of your business at all?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [7]

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No, we do a lot of work to look at correlations, and we know that there is some effect with housing. The fact is most of our business is really a replacement business from a residential side. So it's an additive component but it doesn't have a lot of immediate impact on our business from our analysis. The one area that is affected is the residential commercial irrigation area. So new homes that are built with irrigation systems, there would be an effect there. We have not seen that tied directly to a reduction in housing at this point, and it's a small portion of our business in total.

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Joseph Logan Mondillo, Sidoti & Company, LLC - Research Analyst [8]

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Okay. And then, just overall, just in terms of some of these signs that economy could be slowing, it's obviously, within all those markets -- financial markets here. Anything that, just in a broad sense of things, in terms of economy slowing or anything? Anything that you've seen or heard that lead you to believe this?

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Renee J. Peterson, The Toro Company - VP, Treasurer, CFO & Principal Accounting Officer [9]

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Yes, we would continue to look at all of the same indicators. I agree, there is a lot in the news. It's a dynamic environment. When you look at the strength of our fourth quarter, we're not seeing anything impacting our business today. And so we'll continue to monitor the economic indicators and then try to move proactively in that area. But we had from a sales growth standpoint a very strong quarter in Q4.

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Operator [10]

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And our next question comes from the line of Sam Darkatsh with Raymond James.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [11]

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A few questions, if I might. First off, as it relates to the fourth quarter, I don't like to spend a whole lot of time talking about this quarter for no other reason, it's a little bit out of season. But there were some fairly material variances in the quarter on a line item basis versus not only what we were looking for but I think consensus also, specifically around gross margin. Could you talk, Rick, about at least after August what variances versus your internal plan you saw as the quarter progressed?

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

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Yes. Sam, if I may start and then, Rick, please chime in, because I wanted to talk about the cost side and Rick will speak to the price side. We had as we went through fiscal 2018 moderated our expectations around gross margin - certainly when we started the year we didn't have any insight into the tariffs and some of the related inflation. And we had expected gross margin to be lower in Q4. To your question, it was a little bit lower than we had expected. We -- as we went into the quarter, we thought we would see a little more relief from commodities, in particular steel, but we do believe it has peaked and it's trending down but that was probably one of the areas where we didn't see that change happen as quickly. It is a small quarter to your point so it kind of magnifies the impact that you may see within any given year. And we do look -- as we look forward, we would expect gross margin in Q1 to sequentially improve. In addition, we continue to have some supply challenges that we talked about in the past. These aren't like a consistent supplier but with the economy being good and people needing to adjust their capacity levels to a higher growth rate, we have had challenges as you've read with other companies as well just getting that consistent supply of product to build our products the most efficiently. We have been able to produce everything we wanted to but sometimes, from a production standpoint, it's been a little bit of a challenge for our plants to be able to achieve that with less-than-optimal flow. And maybe you want to address the price piece?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [13]

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Sure. We did that, as we talked about previously, take a midyear price increase. We took an immediate increase on our service parts followed by a range of price increases in our various businesses. And we're still, as we have talked about, in a period of transition as we are in more of an inflationary period. So each of the businesses have a different rate at which that price is realized. The more transactional it is, the more quickly it's realized. But many of our businesses have larger quoted proposals that there are commitments to. There are national accounts commitments. There are residential retailers that have specific price points. So it's taken a while to work through the price improvements and that process continues. We'll now have a repricing going into the new year, and that we expect to see those as the markets really become more accustomed to in the inflationary environment versus one that has had very small price increases for some time.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [14]

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Which leads me into my next question. So your gross margin commentary in fiscal '19 is interesting in that you have a second half recovery on a year-on-year basis to the point where you feel comfortable now saying that gross margin for the year will be up. So how much of a second half recovery in gross margin are you baking into your guidance and how much visibility do you have in that especially in light of the fourth quarter gross margin softness that we saw?

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Renee J. Peterson, The Toro Company - VP, Treasurer, CFO & Principal Accounting Officer [15]

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Yes. From -- Sam, from a cost standpoint, we do expect that we're going to continue to be in an inflationary environment both from tariffs and -- for us it's more the related impacts of tariffs versus the direct impacts of tariff. And when you think about just the profile of when we saw that cost increase occur in 2018, we're more of an assembler of parts versus a pure manufacturer. So for us, there's -- that creates somewhat of a delay when input costs either go up or down. And they always seem to go up higher than they come down, though. Or faster than they come down. And as we went through 2018, we saw more of that impact in Q3 and then it accelerated in a smaller quarter in Q4. As we go through 2019 we expect in the first part of the year, when you think about year-over-year comparisons, we're still going to have some pretty significant headwinds from inflation. But as we go through the year, you kind of get to that point where the inflation is part of the baseline and we have higher realized price embedded in our guidance as well. So we'll start to see more of that price realization offsetting the inflation as we go through the year, and we do feel that we will see growth -- total year gross margin improvement for the year. But it's not going to necessarily occur in Q1.

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Richard M. Olson, The Toro Company - Chairman, President & CEO [16]

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Also the commodities that we talked about in several cases we believe had peaked. So the steel is starting to trend down. We'll start to see some of the benefit of that. Oil pricing is helpful to us in several different areas. Obviously, the resin part but also directly with our transportation cost as there are surcharges in some cases on our freight rates. So we'll start to see some of that benefit. So some of the headwinds from a pure commodity cost will actually improve. We'll start to realize some of the pricing and we'll see some of the benefits of our initiatives internally to offset the negatives.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [17]

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Can you help quantify first half versus second half year-on-year change in gross margin, knowing that, I mean, fourth quarter, we're coming off a quarter where you were off almost 5 points in year-on-year gross margin. Renee, can you help quantify a little bit the variances that -- or the year-on-year delta that we might expect in gross margin as the year progresses?

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Renee J. Peterson, The Toro Company - VP, Treasurer, CFO & Principal Accounting Officer [18]

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Yes, what I would say is, we expect Q1 sequentially to be up from Q4. So we do expect not necessarily year-over-year gross margin improvement but sequential improvement. And would expect for that basically to continue throughout the year. It is important to note that as you know, Sam, every quarter isn't the same for us just based on the size of the quarter and the mix of products that we're selling. So just looking at Q4 is more similar to Q1 from a size perspective. We expect sequential improvement and total year improvement for the year.

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Samuel John Darkatsh, Raymond James & Associates, Inc., Research Division - Research Analyst [19]

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Final question. I don't want to monopolize the call. On the SG&A side, your commentary was interesting that you're looking at SG&A flat on a percentage basis. It's been years since Toro has not levered SG&A especially in light of the fact that you're looking at least mid-single digit organic growth next year. So why the lack of leverage and how would that translate or transpire as the year progressed also?

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Renee J. Peterson, The Toro Company - VP, Treasurer, CFO & Principal Accounting Officer [20]

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I think a couple of points that I would make related to some -- In fiscal 2018, we saw a one-time impact of lower incentives because of our performance versus our internal plan, and we called that out because we would intend to restate -- reinstate, I should say, those incentives as we go into 2019. So that is a just a normal transition that will happen. We also feel it's important to continue to invest in new products and in R&D. And so that tends to flow more as a rate to sale. So we'll continue to look for those opportunities to leverage SG&A but we've seen really good improvement over a longer period of time, quite significant improvement in 2018. We want to maintain that improvement as we go into '19, but we also realized that we have the headwinds of reinstating the incentives, and certainly, our intent is to pay those incentives out with great performance in 2019.

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Operator [21]

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And our next question will come from the line of Robert Aurand with Longbow Research.

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Robert Samuel Aurand, Longbow Research LLC - Analyst [22]

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You were talking about the tariffs, can you give any breakdown between, kind of, pro segment, the residential segment? Would either segment see an outsized headwind from the tariffs?

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Renee J. Peterson, The Toro Company - VP, Treasurer, CFO & Principal Accounting Officer [23]

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Yes, no, we're not seeing disproportionate impact to either one of the segments. I will be honest with you, I mean, our biggest piece is more related to not the tariffs themselves, that I've mentioned, it's more the tariff related. One great example is steel. We don't buy a lot of steel that's subject to tariff. But all of the entire steel market moved on the implementation even a discussion of tariff. So for us, it's a bigger impact as just how the markets in general have moved related to the commodities versus a specific tariff. And it's pretty similar across both residential and professional.

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Robert Samuel Aurand, Longbow Research LLC - Analyst [24]

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Okay. You were just talking about the lower incentives. I mean, obviously, you saw an EBIT decline in the pro and residential businesses, and that was somewhat offset by a decline in your corporate other, which I assume is the incentives you're talking about. You said you're going to pay in 2019? Can you give us any quantification of that and how that's going to flow through in 2019?

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

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Yes. We don't necessarily quantify that impact but the other impact would be the impact of more corporate or management incentives. There are other incentives in the segments as well. But you see it across -- it is all in SG&A that you would see it. It's just -- yes and again, our intent would be to reinstate those and hopefully pay those out with a great 2019.

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Robert Samuel Aurand, Longbow Research LLC - Analyst [26]

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Okay. And I guess, just lastly, you're looking at the topline guidance for FY '19. I mean, is it over 5%? And if we, kind of, take away the 1% from the distributor, it gives us 4%. Given you're doing these price increases coming to the year, I mean, does that imply, kind of, minimal volume growth in fiscal year '19, and the most of that growth is going to be coming from pricing, I guess?

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Richard M. Olson, The Toro Company - Chairman, President & CEO [27]

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Yes, I think that is what you would infer from those numbers. The reality is, as we talked about with pricing, we're still on a transition period of realizing pricing, and we've built the business plan surrounding price increases, but it will be some combination of price increases and volume as the year goes on. So it's really the combination of the two. It's built primarily surrounding price increases, but as the year plays out, there will be some combination of volume and price.

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Renee J. Peterson, The Toro Company - VP, Treasurer, CFO & Principal Accounting Officer [28]

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And since we haven't taken price at the same level for a period of years, so I think we're also trying to sort through what impact does that have on purchasing habits. So as Rick said, kind of, time will tell.

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Robert Samuel Aurand, Longbow Research LLC - Analyst [29]

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Yes, have you seen any pull forward?

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Renee J. Peterson, The Toro Company - VP, Treasurer, CFO & Principal Accounting Officer [30]

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No.

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Richard M. Olson, The Toro Company - Chairman, President & CEO [31]

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No.

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Renee J. Peterson, The Toro Company - VP, Treasurer, CFO & Principal Accounting Officer [32]

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Nothing substantial.

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Operator [33]

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This concludes the question-and-answer session. Ms. Hille, please proceed to closing remarks.

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Heather M. Hille, The Toro Company - Director of IR & External Communications [34]

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Thank you for your questions and interest in Toro. We wish everyone a pleasant and safe holiday season and look forward to talking with you again in February to discuss our first quarter results. Thank you.

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Operator [35]

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