The Toro Company (TTC) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to The Toro Company's Third Quarter Earnings Conference Call. My name is Chelsea 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 Toro Company. Please proceed, Ms. Hille.

Thank you and good morning. Our earnings release was issued this morning by BusinessWire and a copy can be found in the investor information section of our corporate website, thetorocompany.com. On our call today are Rick Olson, President and Chief Executive Officer; Renee Peterson, Vice President, Treasurer and Chief Financial Officer; and Tom Larson. We begin with our customary forward-looking statement policy. During this call, we will make forward-looking statements regarding our business and future financial and operating results. You 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. With that, I will now turn the call over to Rick.

Thank you Heather and good morning to all of our listeners. This morning, we are pleased to announce record third quarter results. Net sales for the quarter increased 4.5% to $627.9 million and net earnings per share rose 22% to $0.61 per share. Year-to-date sales increased 4.8% with earnings of $2.10 per share. Our professional segment sales grew 9.5% for the quarter driven primarily by domestic demand for our landscape contractor, golf and ground equipment along with strong international sales across our professional categories. Residential shipments declined 9.3% for the quarter, a change in the timing of our key annual spring promotions and shifting demand within our zero-turn riders mower categories are the principle reasons for the drop. In the third quarter, solid demand for walk power mowers and snow products contributed to our modest year-to-date growth. Overall, it was a strong quarter, following a brief commentary on our business through the first nine months of the fiscal year, Renee will discuss our financial and operating results in more detail. Our strong third quarter showing in the professional segment was led by our landscape contractor businesses. Our two latest of series zero-turn riders continue to expect high interest from both contractors and homeowners with acreage, resulting in strong channel and retail demand. The business is also benefited from solid retail of our heavy-duty walk power mowers and contractor acceptance of our updated stand-on mowers. We are pleased to offer a full range of innovative solutions for the services our contractor customers provide. Similarly, our extensive golf and grounds product offerings delivered a solid quarter. Positive trends in the golf market and consistent activities in the grounds business fueled healthy demand for our mowing equipment, utility vehicles and irrigation offerings. Our new Workman GTX vehicle enjoyed continued success of the golf and grounds markets responded positively to this innovative line. The appeal of our portfolio of grounds equipment and irrigation products was recently demonstrated by Toro being named the official turf equipment and irrigation partner of Minnesota United. The Twin City's new major league soccer team. Our products will help prepare and maintain the pitch at the teams’ will Allianz Stadium in St. Paul, which is scheduled to open in time for 2019 season. We are pleased to partner with Minnesota United and Allianz Stadium as we do with other premier sports venues around the world. As I mentioned, our golf irrigation business had a good quarter based on increased course installations and renovation projects. A notably example is this the selection of our Lynx control system and tee and fairway and green sprinklers for an extensive course revitalization project at the historic Leeds Castle Golf Club in Kent, England. They also installed Toro sprinklers for the club's croquet lawn and the famed gardens. The ongoing strength in construction helps drive another strong quarter of our rental and specialty construction businesses. The Toro TX1000 compact utility rotor continues to excel and our new track Mudbug is going to be a customer favorite. Next, the third quarter is typically a heavy shipping period for our BOSS snow and ice management business as channel partners gear up for the coming season. This year is no exception, our BOSS team is shipping at peak levels to new channel demand. The promising increased season activity is fueled by customer acceptance of our new product introductions and for BOSS quality overall. As mentioned in the opening, our residential business encountered some unique circumstances in the third quarter. First, our annual Toro Days promotion occurred in April instead of May. The earlier timing drew a portion of what would have been third quarter retail into the second quarter. Second, we saw increased sales of our professional grade riders to homeowners with acreage. Third, there was reduced demand for our zero-turn riders with steering wheels. Higher shipments of snow products as the channel prepares for the season ahead helps somewhat offset the sales decline for the quarter. The snow activity along with strong walk power mower sales contributed to residential modest year-to-date sales growth. Moving to our international businesses, we enjoyed a very good quarter. The professional segment led the way on the strength of sales related to our Perrot acquisition, as well as sales of our landscape contractor golf, grounds, rental and specialty construction offering. While the residential business enjoyed growth in certain regions overall sales were lower mainly due to weather and market conditions. The sales decline was somewhat offset by increased sales of zero-turn riders and Pope products in Australia. In total, we are pleased with the third quarter results. As we head into the fall selling season, we are well positioned with lower year-over-year field inventory of both residential and professional products. We are confident in our prospects for successfully closing out fiscal 2017. I will now turn the call over to Renee for more detailed discussion of our financial results.

Thank you, Rick, and good morning everyone. As we reported earlier this morning, net sales for the quarter were $627.9 million compared to $601 million for the same period a year ago. We also delivered net earnings of $68.4 million or $0.61 per share compared to $0.50 per share in the third quarter of fiscal 2016. Year-to-date net sales were up 4.8% to $2,017 billion. We achieved net earnings of $233.9 million for the first nine months or $2.10 per share compared to $1.79 per share a year ago. Professional segment sales were up 9.5% for the quarter to $468.6 million lead by domestic demand for our landscape contractor and ground businesses along with strong international results across all product categories. Year-to-date, Professional sales were up 6.6% to $1,451 million filled by demand in our golf and ground, landscape contracts and BOSS snow and ice management businesses. Professional earnings for the quarter totaled $97.4 million, up 9.3% compared to last year. For the first nine month professional segment earnings were $314.5 million, up 6.6% compared to the same period last year. Third quarter residential sales declined 9.3% to $152.1 million. As Rick indicated, our professional timing change and in demand amongst our writing offerings impacted third quarter sales. Year-to-date, residential sales increased slightly to $550.7 million. Earnings in the residential segment for the quarter totaled $11.4 million an 11% decrease from last year. Year-to-date earnings were $53 million a 2.4% decrease compared to the first nine months of fiscal 2016. Gross margin as a percent of sales for the third quarter increased 10 basis points to 36.1%. The improvement was mainly due to segment mix in productivity somewhat offset by commodity costs. Gross margin from the first nine month from the consistent with the year ago. These results were due primarily to favorable segment mix and productivity improvement somewhat offset by increased commodity cost and unfavorable currency exchange rates. We continue to expect gross margin for the year as a rate to sales to be similar to fiscal 2016. SG&A as a percent of sales decreased by 30 basis points for the quarter to 22.1% and decreased by 20 basis points year-to-date to 21.2%. We continue to expect total SG&A as a rate to sales to improve slightly from the prior year. Operating earnings as a percent of sales increased 40 basis points to 14% for the quarter and by 20 basis points to 15.3% year-to-date. Interest expense was up slightly by 2.2% for the quarter and by 2.1% year-to-date. Our effective tax rate for the quarter was 22.6% compared to 38.9% last year. For the first nine months. the tax rate was 23.6% compared to 30.5% for the same period in 2016. The favorable tax rate for both period were driven by discreet tax items. Including the adoption of the share based compensation accounting standard in fiscal 2017, which resulted in a discrete tax benefit of $18.9 million year-to-date. We now expect our tax rate for fiscal 2017 to be about 25%, which includes an estimated full-year discrete tax benefit related to share based compensation of approximately $19.3 million. Excluding this discrete item, our expected effective tax rate for the full-year would be about 30.5%. As a reminder, the new share based compensation accounting standard can add variability to the Company’s provision for income taxes, mainly due to the timing of stock option exercises, vesting of restricted stock units and our stock price. Turning to the balance sheet. Working capital increased on higher sales volume, accounts receivable for the quarter totaled $221.6 million up 9.5% compared to a year ago. Net inventories increased 6.7% for the quarter to $349 million. Third quarter trade payables were $211.5 million up 22.8% from a year ago. Our net working capital as a percent of sales stands at a 12 months rolling average of 14%, down from 16.4% a year ago. We are now increasing our free cash flow guidance to $240 million on the strengths of our operating performance and improvement in working capital for the year. During the third quarter, we repurchased approximately 143,000 shares of stock under our Board authorization and there is about six million shares outstanding under our authorization. Year-to-date, we have set about $96 million on total share repurchases and expect to spend at least as much in fiscal 2017 as we did last year. I will now turn the call back to Rick to discuss our outlook.

Thank you, Renee. To-date, fiscal 2017 has been another good year for Toro, we are on-track to successfully close out our fourth quarter and the year. The momentum that our landscape contractor businesses have achieved should carry through two years down. Just in time for contractors' fall and winter task, MULTI FORCE stand-on machine's versatility is being enhanced with a power broom attachment. This new broom is designed to handle fall clean up chores, detaching and the clearing of white snow from sidewalk containment. Contractors know they can count on Toro, to steps their investment dollar help perform, taps more easily and increase productivity. Based on existing orders and plant irrigation projects our golf and ground businesses expect to retail and channel demand to continue through the fourth quarter. The golf market has shown vigor and courses have demonstrated a willingness to invest in new equipment and irrigation projects. In July, we were pleased to sponsor 2017 Greater & Greener Conference of the City Parks Alliance and host participants at our corporate headquarters. This was the largest international gathering of urban park leaders, attendees are key players in the ground equipment and irrigation markets as well as a great opportunity for developing new and strengthening existing customer relationships. We also recently received recognition for innovation involving mobile technologies. Our new Integral Irritrol SMRTscape internet software for wireless management of irrigation and outdoor lighting systems received the Landscape & Irrigation Magazine's new product award. The award recognizes achievements in innovation, market ability and application within the commercial landscape and irrigation market. Next, the construction, rental and utility markets are projected to remain strong through the rest of 2017 and beyond. Many of the leading rental accounts are investing in new locations and fleet expansion. These trends represent significant opportunities for our compact utility rotors and other rental and specialty construction offering. The box, snow and ice management business is well positioned to capitalized on similarly promising trends. New truck sales remains solid, economic conditions are positive and the box line is in high demand. Based on strong pre-season orders the sales outlook is cautiously optimistic, following below average snowfall last year. Early snow would be a plus for our residential business. Our solid bookings and shipments have us and our channel partners well prepared for meeting snow thrower demand. We also anticipate continued spring product sales through the fall backed by our traditional fall promotional efforts. Our newest recycler walk power mowers that features another Toro First our power reverse personal pace drive system was well received this spring and summer. This is the first residential walk power mowers to provide self-propelled power in reverse. This Toro Exclusive should help extend our strong position in the walk power mowers market. All said, we are well positioned to close out the year in a positive way. We now expect revenue growth for fiscal 2017 to be at least 4.5% with earnings per share for the year of about $2.38. As always, we will remain flexible and prepared to respond to market conditions. As we prepare to wrap up this final year of our Destination Prime initiative, I want to take this opportunity to thank and salutes our employees, our distributors and channel partners around the world for their commitment and hard work that make our strong performance possible. Together, we will finish the year strong and set the stage for a successful 2018 and the launch of our next employee initiative that we will outline during the December call. This concludes our formal remarks. And we will take questions at this time.

[Operator Instructions]. Your first question comes from Mike Shlisky with Seaport Global. Your line is open.

Good morning guys. So I wanted to touch first on some of the trends we are seeing in the residential category and consumer in general. It looks like one of your engine providers had a tough quarter last week, one of the big box retailers and that's not one of your partner has also had tougher quarter last couple of days. So I was wondering if you can kind a give us your thoughts as to how you think Toro performed, I know you are little higher end than some of the merchant retailers, but kind of curious how your brand performed at the consumer level compared to your other big peers out there.

Sure. First of all for our residential business, the market in general, we believe is growing at a modest pace this year, and we are doing well and most of our categories. I think if you look for us, in terms of the impacts for this quarter, first off was the timing of our Toro Days, which happens in April instead of May this year and we determine that with our channel partners to just and group our relative to other promotions that happen throughout the year. The second factor really have to do with our ZE area. In the quarter, we saw more sales of our professional spec ZEs going to homeowners with acreage based on some terrific new products offerings, the Radius products from Exmark and the TITAN HD from Toro. So those were a couple of factors and then the third one I guess I would add to that is the impact of the Steering Wheel ZE and we have seen a decline in our sales of Steering Wheel ZE, we introduced that in 2015 and we had a great sell-in. But over the last year and half here, we determined that that’s more of niche product for us. We had strengths in some specific smaller regions, but not the broad appeal that we had hoped for. So that has had an impact for us, especially year-over-year, and we really feel for our customers that come in looking for ZE that fit machine as a better option for those, in most cases.

Okay. I just wanted to touch on the broader zero turn market both Professional and Consumer. I have also seen one of your sort of bigger ones trying to expand their capacity and their zero turns, they are currently seeing some growth that has bumped up against high end of their current capacity. So I’m kind of curious, can you just give your thoughts on the current state of the overall zero turn market. Is it still kind of gaining some overall white space share in the turf care market or has that kind of rolled over here at this point in the year?

I would say that the strength continues for ZEs and for us. We tend to do better at the more valued to higher end of the market both on the residential side and for the professional spec product, but we have had really some terrific retail numbers in both Exmark and Toro. So especially stronger for the new TITAN as a Radius lines. The lowest entry level portion of the market is much more competitive and that’s kind of more back and forth. We do better as you go up the line, but the overall trend with ZEs is continuing.

Okay, and then finally for me on the golf business, I was kind of curious, could you update us on kind of what inning you think we are in the irrigation system replacement cycle and on the broader golf turf care business, your thoughts as to whether that can keep on growing into 2018 in your business.

We continue to see real strength in the golf area and I think how we would describe it is, our customers have more confidence to make investments than they have through several years. In terms of replacement cycle for irrigation, we still believe that we are in the early innings, you can really as we talked about before go back to the 90's and early 2000s when golf courses were installed the original golf courses were developed. And the life span for an irrigation system is 15 to 20 years, so you can kind do the math in that regard as well.

Okay just to be clear, this is just for Renee, I mean golf could be approaching half of your operating profit at this point, a third to half I would imagine. Am I in my ballpark there?

I'm sorry Mike - no I don’t know.

Almost, off there at least.

It is on the high end of the profitability, but it’s not quite that substantial from an overall profitability stand point.

Okay, thanks so much guys. I will leave it there. I appreciate it.

Thank you.

Your next question comes from Jim Barrett with C.L. King & Associates. Your line is open.

Good morning everyone. Rick I realized you are not ready to announce any new program to success Destination Prime, but could you speak broadly as to where you see the emphasis should be placed in terms of achievable targets for the Company, whether that be margins returns or organic growth.

Well we have as you know strategic plans we start with when we look at our plans for the following year, we are in the process of the detail filings for next year, but in general I would say borrowing economics changes that we are not foreseeing at this point, we see really a continuation of the trends flow through this year. So we are overall I think as I say consciously optimistic about next year and trends for businesses are going to I think are good. Consumer confidence remains a high, as we talked about our golf customers have greater confidence to invest in projects and we see some opportunity, our rental business just looked at some industry numbers yesterday, I think projections for rentals through the next year are 4% to 6% overall and in the categories that we compete in and they are north of that.

I would just add as well, internally we will keep the focus on productivity, we have really reinvested in lien, we been a student lien for many years and more recently we have kind of reinvigorated some of that investment in lien and we have been seeing some good results and we will continue to do investment in lien. We see lots of opportunity to continue to refine, it’s one of those journeys that never ends, there is always more opportunity, but that is been area in particular I think we see opportunities to refine our operating performance.

We will have lot more color in next and December.

Understood and Rick your international business had an unusually good quarter, there are reports that sort of first time in a very long time internationally economic growth is picking up in a very broad way. Did you believe that international is at an inflection point and could you touch upon some of your top golf markets worldwide and are they sharing the same level of strength that you are seeing domestically?

All right. Well I have spent few years in the international business just a few years ago and I can tell you from my recent conversations and exposure to our customer internationally particularly in Europe the outlook is more positive just with regard to potential GDP growth, this is really from my personnel contact. we are seeing again more confidence in pursuing projects in our golf businesses. Obviously the traditional areas of golf continues to be important markets for us like the UK, Central Europe for example, but also continued developments in places like Southeast Asia and then interesting places like portions of Africa where there individual gold development projects happening. The bulk of our business remains in those areas that are strong golf markets today and we see strengthening of areas and just I would agree with your promise that the international outlook looks more favorable than it has through the last couple of years.

Good. And then finally as you evaluate the technology advancement happening in batteries, are you more encouraged that that will increasingly penetrate the Toro product line in various areas intermediate term or is battery technology still - or the power of battery still sufficiently weak that it’s not a practical solution?

We believe that batteries will become an increasingly important part of the market. I think you can look at other industries for example the automobile industry, transitioning more rapidly than people expected, but at the same time, it’s still a small portion of the overall market. On our Professional side, we see increasing acceptance of battery power and probably more importantly for us hybrid power for our commercial equipment and so we believe batteries will be important, we have significant resource going towards that area as well going forward. To answer your question, we do believe it is important and we have number of activities taking place in that area and the experience from our professional side has been very good.

Good. Well, thank you very much. I appreciate it.

Thank you.

Thank you.

Your next question comes from Tom Mahoney with Cleveland Research Company. Your line is open.

Hi. Good morning. I wanted to drill into the inventory that’s up 7% year-over-year versus could be down last two quarters. Can you talked about the moving pieces inside of that maybe your expectations for the fourth quarter?

Sure, sure Tom. As we look at our inventory levels, we have been bringing inventory year-to-date and really when we looked at it in the last year, in the first half of the year, we felt our inventory last year was frankly too high, so it’s also our opportunities to bring that down. As we look at the remainder of the year, our sales have been increasing and what our intent is to do is to position ourselves well going into the fourth quarter and also looking at the sales growth that we have for next year - positioned for next year. We also look at what is the right production efficiency level. So we feel comfortable with the inventory where as we will make assessments where we think will end the year as well positioning ourselves in the appropriate level going into the year as well. Field inventory is in good shape are Rick had commented in his remarks sold pro and residential, field inventories are down. So we feel we are in a good position. We did raise our total year free cash flow estimates and had commented it's really on the strength of our operating performance as well as overall working capital. We have seen good performance across all categories. So as year-end, we are anticipating we are going to see improved overall performance across working capital. It maybe a mix of some improved performance on a tables and receivables and may have some higher inventory at year-end potentially. So we will make our trade ups as we go through the year, but ensuring that we continue to have the right inventory levels, it can be a good supplier to our customers and that we are well positioned going into fiscal 2018. We feel the inventories are at good level, we are not concerned about it.

Great. And then is there any way to quantify the impact of snow if there are any swings in that position year-over-year within the inventory number?

No. There is modestly more snow inventory, what we will tend to is have a little bit more so at this time of the year. But it's not a significant number Tom and what we will tend to do is be well positioned, but as Rick had mentioned it was good, but not great snow season last year. So isn’t been a big driver to our inventory growth.

Thank you.

Thank you.

Your next question comes from Sam Darkatsh with Raymond James. Your line is open.

Good morning Rick, Renee, how are you?

Good morning Sam.

We are doing well.

Good. Three topics if I could, and the first two, if you actually talked about it in the prepared remarks and I missed it I apologize. The Toro Day's promo timing. Can you help to quantify the impact of that on the quarter in terms of sales and when might that promo occur next year, which quarter might it fall in?

Sure. We can't quantify that specifically, but one thing you may do is just look at residential sales in the second quarter versus the third quarter. So I believe sales in the second quarter were roughly 8% increase and we are down 9% plus this quarter. So it gives you a little bit of an idea, it’s not all that obviously to Toro Days.

And what is difficult to quantify it Sam, there is a lot of factors. It's not just the timing and then part that is, we happen to get lucky with the timing of Toro Days and great weather as well. So it's hard to separate, it's not just factor.

We happen to get a period of really excellent weather and I know had we less in a traditional spot in May and that was a period of about three weeks of colder than normal and weather than normal conditions. So that probably helped us a little bit beyond just the shifting quarters. And regarding going forward, that’s really a date and the timing for Toro Days, it’s something that we negotiate with our channel partners and we will move it around for competitive reasons, but it’s not something that we have even establish for next year at this time.

Got it. Second question international sales are up 10%. How much of that was FX or what was the FX impact I should say Renee?

Yes. The FX impact were still a negative, very small about 500k for the quarter. So we are starting to see that neutralize, but it still was a little bit of the negative drag for the quarter and year-to-date Sam that was about 6.5 million, so 0.3% year-to-date.

First thing we should point out them is the impact of Perrot. So that is now in our international results and that’s been really a terrific addition to our irrigation lineup that has had the effect of building a stronger relationship with the sports fields and grounds businesses and we are on-track with integration and leverage of that product across per channel to a greater extent.

My last question or topic, at least has to do with the capital allocation. I notice that this quarter you don’t have any net debt, I think for the first time in your modern history, best I can recollect. Can you remind us what your optimal capital structure is and then I have a follow-up to that.

Yes. Our optimal, capital structure would be between one and two times EBITDA and that is more of a long-term versus something we hold ourselves on a point in time basis. That being said, we continue to have the same capital allocation philosophy, we look first internally to internal growth opportunities ways to make ourselves more efficient and more productive internally. M&A continues to be focus and as you know something in the companies we look at our private companies, so timing is difficult to estimate and then we have been increasing our dividend and we continue to do a share repurchases as you know, as we remarked, we did this from share repurchases within the quarter about 143,000 shares and have spent about $96 million year-to-date on share repurchases. We do have some cash under balance sheet, there is some cash as a global company, we do have some cash outside of the U.S. as well, our foreign operations continue to do well and we look for opportunities such as Perrot, it was an international acquisition that we were able to use some of that foreign cash. So that would be one of our areas that should we signed more of those opportunities we would use some of that foreign cash for.

That leads me perfectly into my next question, at least philosophically. So even though, it’s not a large, you are buying stock back here and perceptively going forward as well. The stock right now is around 17 times EBITDA or they are about - it was notable that over the last quarter or so one of your large competitors Netafim was sold off at about 14 to 15 times EBITDA pre-synergies. And I guess, if press reports are accurate, it didn’t appear as though Toro was a serious bidder for Netafim. I’m trying to understand this at least philosophically, I also recognize that equating a small share repurchase activity with a $1.5 billion acquisition isn’t necessary apples-to-apples, but historically why are you favoring share repo at 17 times over the purchase of a significant competitor in an attractive end market at a material discount for that.

Sam I would tell that probably separate those two, so the first is a specific case with Netafim and we would not ever comment specifically on those transactions relative to us, but we are well aware of what is happening in each of the markets that we are involved with and continue to monitor those, we have these stuff our M&A capabilities with the talents that we have there and the resources that we have and we are very much interested in finding the right acquisitions. What we are not going to do is sacrifice our criteria that we use, because we would rather use the cash for alternate means and to make an acquisition that ultimately, strategically does not make sense for us. So that’s kind of the first part of it and for the second part...

And related to share repurchases, we continue to be disappointed related to share repurchases, so Sam we do run a DCS model, associated with those, we purchased about like I said about 143,000 shares within the quarter. And feel like we are just so adding value as we go forward. Not at the same it’s the lower dollar amount and may be within the quarterly we have done at sometimes in the past, but we continue to feel that that adds value to the shareholders.

Thank you very much. I appreciate the insight on that.

Thank you Sam.

Your next question comes from Jon Fisher with Dougherty and Company. Your line is open.

Thank you, good morning, I have few questions here. Just on the overall mix of business between professional and residential, obviously was a standout quarter was heavily skewed towards professional, last year the shift was a couple more points towards professional from residential, this year you are on pace another point or two shift towards professional. Given your outlook commentary on trends expecting to continue professional strong, residential modest in next fiscal year versus this fiscal year, is this kind of the pattern that we should expect from a mix shift where you shift a point or two each year to professional from residential or where is kind of that comfort level of overall mix between the two segments.

All right. I worked for the Toro Company for 31 years and when I started it was mainly a residential company, so that trend that you're talking about is part of the longer term trend to focus on some of the professional businesses relative to growth priorities. So what you're seeing as we've also stated from a strategic standpoints, we have a preference in our targets for acquisition of professional businesses, international water base as what we've communicated in our deck and in our conversation. So that the consumer residential business is very important for us, so I don’t want to diminish that at all, but as we pursue our goals professional businesses are an areas that provides a lot of opportunity for us.

Okay. Thank you. And then when we international, just overall the business mix there is that a higher than corporate average margin contributor or is international in line kind of what the margin mix benefit or drag from international?

Yes. International tends to be largely more of a pro business, a smaller component of residential. So, we tend to be more weighted towards professional type margins.

Okay. Thanks. And then final question just on the segment margins. We are on-track for residential operating margins to be down again year-over-year, I mean less of the decline than last year, but still down year-over-year. And professional operating margins looks like they are on pace to be up a little bit. From a residential operating margins standpoint kind of what should we expect for drivers or potential for margin expansion opportunities there?

Yes, Jon we don’t give specific guidance on the segment margins. I can tell you though, both segments both the professional and the residential businesses are focused on improving their margins. In particular what we talked about in the residential segment is its more difficult to get price, so where they really focused on improving their margins is through innovation, new product introductions are important to them, that’s an opportunity for them to get price by establishing a product at a new price point where they can potentially gain more margins. Very focused on improving their quality, ways to reduce warranty or ways that they can certainly improves our customer satisfaction and improve their profitability. Productivity is important to them, ways to reduce cost is important to them, I mean those are all things that everyone is focused, but in particular within the residential business are important ways for them to improve their profitability.

And those are some of the ways that the two businesses are complementary, so the ability to leverage our operations across the two businesses, the ability to leverage technology and development across both of the businesses, the leverage of the brands, the presence of the brands in residential is important to the overall company. So the two businesses for us are very complementary and both categories are very important to us.

Okay. Thank you very much.

Thanks, Jon.

Your next question comes from Joe Mondillo with Sidoti & Company. Your line is open.

Hi everyone. Good morning. My first question actually related to pricing. The net result and upper prices has been a benefit over the last couple of years. Just wondering how has that been trending, is that now a headwinds and how do we think about that over the next couple of quarters if we see this consistent sort of inflation in raw materials?

So, first of all with regard to the pricing we try to emphasize that we really price to markets not necessarily as a result of what we see with commodities we need to work backwards from what is necessary in the market to compete. That being said, typically we have said we gets between 1% and 2% in price and that’s been pretty consistent through the years. Specifically Renee on commodities.

Commodities have been a headwind for us this year and it's pretty consistent with what we would have anticipated and what we've built into our guidance. So as we look forward in particular we've commented in the past and it continues to be the case, feel and resins have probably been where we seen more of the impact for us. That being said, we do buy Rothfield and resins, we also buy quite a bit of parts, so not everything we buy is raw material, so some of it we see more in a delayed impact as well. This year, we have guided to and continue to guide to gross margins being consistent with prior fiscal year. If you look at how that compares to 2016, it's not quite a bit of margin expansion, because we have the benefit of being able to get that pricing why we were in a favorable commodity environment going into this year. We anticipated and its proven to be the case that we were able to get some price, but we also have some commodity headwinds as well. So I think we have included that in our guidance and to-date that kind of been the way that is transpired as well.

So it seems like the fourth quarter guidance is or the annual guidance is implying that the fourth quarter. It sort of in terms of margin expansion is getting worse is that one of the bigger headwinds, is that becoming more of a headwinds with the rising cost or is that something else within the business in terms of margin expansion in the fourth quarter.

Yes. I think in particular what we are looking at is more over is the total year and so it's small quarter for us and there is a quite a bit within a quarter that can cause variability within that quarter. We would expect to have a little bit more balance within the quarter between residential and professional.

It’s the start of the snow season, so there is some variability built into our plan for the start of the snow season. Also variability in international, its start of spring in Australia, I know that was a drag for us last year. And then year-over-year, it was a very strong turf quarter last year, exceptionally so, so we have a more difficult comp in that area as well.

Okay and your corporate cost continue to grow. I know the second quarter was a little normally high in terms of year-over-year comps for certain reasons, but how do we think about sort of the management of corporate costs going into next year considering that they were up pretty good this year.

Although not within the quarter in the other segment, they are not up within the quarter in Q3, but are up year-to-date and nearly how we look at that there is a lot of things that flowed through the other segment. So there are costs that we don't allocate out to businesses. So from a sales standpoint it tends to be our Company owned distribution and eliminated associated with that. We also have a number of our corporate costs associated with information technology, finance, Human Resources, et cetera. We also do accrue which we talked about last time, number of our enterprise incentives associated with the executives at corporate level. Year-over-year our Company performance is stronger in several categories. Our sales growth last year was close to zero and this year we are at about 4.5%, 4.8%. So that we are doing better overall in that category from an incentive standpoint. As well as our working capital performance last year, we were at a higher level of working capital this year, we are at a lower level. So I think in those two categories year-over-year were doing better. Those are really the bigger drivers to why we are up year-over-year versus any big costs investments that we are seeing at the corporate level. So it’s really, the prior year, we were adjusting down the incentives at the corporate level this year, they’re coming back to more normal level.

And then the last couple of years in addition to net pricing one of the biggest sort of margin expansion drivers especially when you look at last year, when you saw no revenue growth was productivity improvements and with the mix shift being favorable this year. You would think, you would see margin expansion, like you are not seeing a whole lot of margin expansion, I know the whole thing with net pricing. But productivity improvements was a big thing that you have seen in last couple of years and it seems like maybe that’s not as big of benefit as in past year, which is quite understandable. At a point in time, this sort of opportunities become a little less and last and then maybe they start to reaccelerate, but where are we, in terms of the opportunities relating to the productivity improvements, this year seems like a light year, do you think there is more opportunities going forward?

I will just speak to the idea of productivity overall and maybe Renee can comment on some of the plus and minuses and our margin this year. But in terms of productivity overall, we believe that have significant opportunity to gain productivity. Renee earlier mentioned our lien activities that something that we spent a lot of time on introducing in the early 2000s and we invested a lot in training and developments in the early 2000s. As we went through the recession at something that we reduced some resources going to that area. Within the last year, we have reinvested in that area and we are seeing the benefits of that and the performance of those areas where we are buying it, and what we are seeing is really a multi-fold return on our investments, because we have this latent base of people that have been trained and are certainly understanding and accepting of a lien culture. So we believe there are lots of opportunities for us to reduce ways both in our operations traditionally, our manufacturing areas and also through really of all the processes that we perform as a Company.

Yes and we continue across the organization to look at ways to drive productivity. So certainly within the operations that’s important. It is kind of the life blood of our plant, but it’s not just something that is the plant responsibility. So we are expecting every employee whether they are part of the SG&A for the cost of goods sold to be driving productivity. So when you look at our guidance, we are saying gross margins similar. We are saying that we are going to be able to offset that headwinds of commodities by driving productivity with pricing, but we are also saying, we are going to leverage SG&A. And so we are saying that we are going to be able to drive margin expansions across the organization and I think productivity is a piece of that and continuing to invest in innovation and growing the Company. So productivity I think is an important element and we do think there are lots of opportunities to continue to grow. Another area we are looking at as how do we better advantage inventory and so I think we see lots of opportunities ahead of us, for that we have to continue to focus and prioritize those opportunities, but I think there are many, that we have to still execute upon.

So to answer your question, we are not nearing the end of productivity opportunities at all from a context of other ways that we can offset or improve our gross margin as well.

Yes, I would say it’s more about choosing where to focus versus not having ample opportunities to chose from it. It’s we can’t do everything, so its making sure we are keeping the organization focused on those that drives the most benefit for us.

So I just have a follow-up on, I'm a little confuse still with the gross margins. If you're offsetting most of the material inflation with price, you are seeing still a favorable shift in segments and the professional side of things you are continuing to see consistent benefits from productivity improvements how are gross margins flat this year?

So one element of what you could be looking at is, at the highest level you have the mix between residential and professional, but within each of those categories there is also mix with regard to the specific product categories, so there are a couple of dynamics that take place there as well that effect the overall results that they really mix within each of those segments as well.

Correct, not every product within that segment is the same, so there is dynamics within a segment as well.

But even still professional segment overall is a higher margin business and you are seeing roughly may be 6% revenue growth out of that and pretty much 1% revenue growth out of residential this year. So you are still seeing a more favorable mix out of the higher margin segment, so even if there is something going on with internals, you would still think the mix is overall and that benefit to I would think anyways - I guess that only have operating income here, I don’t have the gross margins so maybe there is something going on that leads to that.

Based on our analysis, we see the growth margins - at this point we have been guiding to a consistent gross margin number since we provided guidance as we went into the year. And that’s what we continue to see when we go through the rollout. And Q4 is a fairly small quarter, so at this point, we shall see, but I wouldn’t anticipate it’s going to shift dramatically.

Okay. All right, thanks a lot. I appreciate it.

Thank you.

Thank you.

Your next question comes from Rob Aurand with Longbow Research. Your line is open.

This is Rob Aurand on for David MacGregor. I guess within the pro segment, strong number 5% sales growth. Can you talk about, how much you are benefiting just from the overall market growth versus share gains.

Truly, this year it’s really a combination of the two, so it’s being as I mentioned for example, we call out one area the rental and specialty construction business, the market is growing, but I will also say that if we are see our improving our position with that market. So that’s the case really where both happening, we believe for example within the professional categories of these that we talked about is a growing category and we are doing very well in that category as well relative to competition. So I would say, in most of the professional categories, it’s really a combination of varying degrees of growth of the market and we believe that we are improving our position in most of those markets at the same time. Still a little slower growth market but we continue to try and improve market share in each of those markets.

Okay. Thank you. And I know there has been a lot of discussion on margins, but I guess, just a follow-up to kind of clarify from here, so on pro you are seeing strong 9.5% sales growth, but you didn’t see that flow into any kind of operating margins expansion in the pro segment is that all because of commodity costs?

No, it’s not all commodity cost. What we are saying is there is couple of factors, certainly commodity costs, but that’s broader, I mean that’s not something that’s just a pro phenomena that’s across the enterprise. What we mentioned is, in addition to that within the pro segment there are number of a different product lines. I mean Rick just mentioned, some of them we have got everything from the rental business, so we have got specialty construction, we have got micro irrigation, we have got the turf equipment. We just had a number of different types of product offerings. Not everyone of those has exactly the same margin rate, they are all pro type margins, but there are just a variation within that product offering. So, especially within a quarter and even within a year you have different growth rates and you can drive overall a different blended margins.

Okay. And then kind of the opposite in residential where you saw big sales decline, but margins held up, is that just kind of mix that you weren’t seeing as much of the low the entry level product there?

It can be that as well as efforts to reduce cost and actions that they are taking. So, it’s all of those.

But it’s true that the mix within that segment would have a same effect that could be just the opposite.

Yes, it was. Absolutely. Right, but it’s for us diverse, because you just still have quite as many as businesses within residential. So, yes it would be the same.

Okay. Thank you.

Your next question comes from Jon Fisher with Dougherty and Company. Your line is open.

Thank you. I appreciate you taking the follow-up. Just on the other income line in the past few quarters it’s been pretty steady in kind of the mid to high threes, this quarter jumped out with a 5.5 roughly number. Was this quarter an anomaly or kind of when we look at the quarterly pace of other income should we kind of start modeling more of a step up closer to this level of other income on that line?

No, I think this quarter had some one-time impacts included in it, just related to foreign currency.

Okay. Thanks.

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

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. Thank you.