Toro Co (TTC) 2017 Q3 法說會逐字稿

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 The Toro Company. Please proceed, Ms. Hille.

Thank you, and good morning. Our earnings release was issued this morning by Business Wire 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; and Renee Peterson, Vice President, Treasurer and Chief Financial Officer.

We begin with our customary forward-looking statement policy. During this call, we will make forward-looking statements regarding our business and future financial and operating results. You 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 announced 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 grounds 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 promotion and shifting demand within our zero-turn rider mower categories are the principal reasons for the drop. In the third quarter, solid demand for -- 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 9 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 2 latest series of zero-turn riders continue to attract high interest from both contractors and homeowners with acreage, resulting in strong channel and retail demand. The business has 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 activity in the grounds business fueled healthy demand for our mowing equipment, utility vehicles and irrigation offerings. Our new Workman GTX vehicle enjoyed continued success as 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 Cities' new major league soccer team. Our products will help prepare and maintain the pitch at the team's new 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 the renovation projects. A notable example is the selection of our Lynx control system and tee, 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 helped drive another strong quarter of our rental and specialty construction businesses. The Toro TX 1000 compact utility loader continues to excel and our new Tracked Mud Buggy is proving 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 meet channel demand. The promising preseason 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 helped somewhat offset the sales decline for the quarter. The snow activity, along with strong walk power mowers sales, contributed to residential's 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 offerings. 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 a 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 $2,017,000,000. We achieved net earnings of $233.9 million for the first 9 months or $2.10 compared to $1.79 per share a year ago.

Professional segment sales were up 9.5% for the quarter to $468.6 million, led by domestic demand for our landscape contractor and golf and grounds businesses, along with strong international results across all product categories. Year-to-date, professional sales were up 6.6% to $1,451,000,000, fueled by demand in our golf and grounds, landscape contractor 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 9 months, professional segment earnings were $314.5 million, up 7.6% compared to the same period last year.

Third quarter residential sales declined 9.3% to $152.1 million. As Rick indicated, a professional timing change and a shift in demand amongst our riding 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 $63 million, a 2.4% decrease compared to the first 9 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 and productivity somewhat offset by commodity costs. Gross margin for the first 9 months remained consistent with a year ago. These results were due primarily to favorable segment mix and productivity improvements, somewhat offset by increased commodity costs 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 30.9% last year. For the first 9 months, the tax rate was 23.6% compared to 30.5% for the same period in 2016. The favorable tax rate for both periods were driven by discrete 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 volumes.

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-month 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 strength 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 6 million shares outstanding under our authorization. Year-to-date, we have spent about 60 -- excuse me, $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 the fourth quarter and the year.

The momentum in our landscape contractor businesses have achieved -- that our landscape contractor businesses have achieved should carry through to year's end.

Just in time for contractors' fall and winter task, our MULTI FORCE stand-on machine's versatility is being enhanced with a power broom attachment. This new broom is designed to handle fall cleanup chores, detaching and the clearing of light snow from sidewalks and pavements. Contractors know they can count on Toro to stretch their investment dollar, help perform tasks more easily and increase productivity.

Based on existing orders and planned irrigation projects, our golf, ground -- golf and grounds businesses expect 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 the 2017 Greater & Greener Conference of the City Parks Alliance and host participants at our corporate headquarters. This is the largest international gathering of urban park leaders. Attendees are key players in the grounds equipment and irrigation market. This was a great opportunity for developing new and strengthening existing customer relationships.

We also recently received recognition for innovation involving mobile technologies. Our new Irritrol SMART Scape internet software for wireless management of irrigation and outdoor lighting systems received a Landscape and Irrigation magazine's new product award. The award recognizes achievement in innovation, marketability and application within the commercial landscape and irrigation markets.

Next, the construction, rental and utility markets are projected to remain strong through the rest of 2017 and beyond. Many leading rental accounts are investing in new locations and fleet expansion. These trends represent significant opportunities for our compact utility loaders and other rental and specialty construction offerings.

The BOSS snow and ice management business is well positioned to capitalize on similarly promising trends. New truck sales remain solid, economic conditions are positive and the BOSS line is in high demand. Based on strong preseason 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 mower that features another Toro first, our PoweReverse Personal Pace drive system, was well received this spring and summer. It is the first residential walk power mower to provide self-propelled power in reverse. This Toro exclusive should help extend our strong position in the walk power mower 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 salute 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.

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

Yes, sure. First of all, for our residential business, the market in general, we believe, grew -- is growing at a modest pace this year, and we are doing well in most of our categories. I think if you look for us, the -- in terms of the impact for this quarter, first off was the timing of our Toro Days, which happened in April instead of May this year, and we do -- we determined that date with our channel partners just relative to other promotions that happened throughout the year. The second factor really has to do with our Z area. And in the quarter, we saw more sales of our professional spec Zs going to homeowners with acreage based on some of terrific new product offerings, the Radius product from Exmark and the TITAN HD that -- from Toro. So those were a couple of the factors. And then the third one, I guess, I would ask is -- or add to that is the impact of the steering wheel Z, and we have seen a decline in our sales of the steering wheel Z. We introduced that in 2015 and we had a great sell-in. But over the last 1.5 years here, we determined that, that's more of a niche product for us, had strength 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 a Z -- the stick machine is a better option for those -- in most cases.

Okay. I also wanted to touch on the broader zero-turn market, both professional and consumer. I've also seen one of your competitors -- one of the sort of bigger ones trying to expand their capacity in their zero-turns. They're apparently seeing some growth that has bumped up against [behind] their current capacity. So I'm kind of curious, can you give us kind of 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 been -- has that comp kind of rolled over here by this point in the year?

I would say that the strength continues for Zs and for us. We tend to do better at the more valued higher end of the market both on the residential side and for the professional spec product, so -- but we've had really some terrific retail numbers in both Exmark and Toro, so especially stronger for the new TITAN and the Radius lines. The lowest entry of -- 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 Zs is continuing.

Okay. And then finally for me, on the golf business, I was kind of curious. Can you update us on kind of what inning you think we're in, 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.

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

Okay. Just to be clear, maybe just one for Renee, I mean golf is -- could be approaching half of your operating profit at this point, [a third or 2] of a half, I'd imagine. Am I in the right ballpark there?

I'm sorry, Mike?

Golf is half the operating...

No, I don't know that.

Almost up there at least.

It is on the high end of the profitability but it's not quite that substantial from an overall profitability standpoint.

Your next question comes from Jim Barrett with CL King & Associates.

Rick, I realize you're not ready to announce any new program to succeed 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?

Right. Well, we have, as you know, strategic plans that we start with when we look at our plans for the following year. We're in the process of the detailed planning for next year. But in general, I would say, barring economic changes that we're not foreseeing at this point, we see really a continuation of the trends that have flowed through this year. So we're overall, I think, as they say cautiously optimistic about next year, and the trends for businesses I think are good. Consumer confidence remains high as we talk about our golf customers have greater confidence to invest in projects. And we see some (inaudible) Our rental business, just looked at some industry numbers yesterday, I think projections for rental through the next year are 4% to 6% overall, and in the categories that we compete in, they're north of that.

I would just add as well. Internally, we'll keep the focus on productivity. We have really reinvested in lean. We've been a student of lean for many years. And more recently, I think we've kind of reinvigorated some of that investment in lean and we've been seeing some good results, and we'll continue to invest in lean. We see lots of opportunity to continue to refine. It's one of those journeys that never end. There's always more opportunity, but that is an area in particular, I think, we see opportunities to refine our operating performance.

Right. We'll have a lot more color on next year in December.

Understood. And Rick, your international business had an unusually good quarter. There are reports that for the first time in a very long time, international economic growth is picking up in a very broad way. Do you believe that international is adding 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're seeing domestically?

Right. Well, I spent a few years in the international business just a few years ago, and I can tell you from my recent conversations and exposure to our customers internationally, particularly in Europe, the outlook is more positive just with regard to potential GDP growth. This is really from my personal contact, but we're seeing, again, more confidence in pursuing projects. In our golf businesses, some of the -- obviously, the traditional areas of golf continue to be important markets for us like the U.K., Central Europe, for example. But also continued developments in places like Southeast Asia and then interesting places like portions of Africa where there are individual golf development projects happening. The bulk of our business remains in those areas that are strong golf markets today, and we see strength in those areas. And just I would agree with your premise that the international outlook looks more favorable than it has for the last couple of years.

Good. And then finally, as you evaluate the technology advancements 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 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. And 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 resources going towards that area as well going forward. To answer your question, we do believe it is important and we have a number of activities taking place in that area and the experience from our professional side has been very good.

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

I wanted to drill into the inventory that's up 7% year-over-year versus being down the last 2 quarters. Can you talk 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 down inventory year-to-date. And really when we looked at it last year and in the first half of the year, we felt our inventory last year was, frankly, too high, so we felt there were opportunities to bring that down. As we look at the remainder of the year, our sales have been increasing, and what we -- 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 -- position for next year. We also look at what's the right production efficiency level. So we feel comfortable with the inventory where it's at. We'll make assessments on where we think we will end the year as well, positioning ourselves in the appropriate level going into the year as well. Field inventory is in good shape, as Rick had commented in his remarks, both pro and residential and field inventories are down. So we feel we're 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 at year-end, we're anticipating we're going to see improved overall performance across working capital. It may be a mix of some improved performance on the tables and receivables, may have some higher inventory at year-end potentially. So it's going to be -- we'll make those trade-offs as we go through the year, but ensuring that we continue to have the right inventory levels. We can be a good supplier to our customers and that we're well positioned going into fiscal 2018. But we're not concerned. We feel the inventory is at a good level. We're 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?

Yes, there is modestly more snow inventory. We tend to -- what we tend to do is have a little bit more snow at this time of the year, but it's not a significant number, Tom, and what we tend to do is be well positioned. But as Rick had mentioned, it was a good but not great snow season last year. So it isn't a big driver to our inventory growth.

Your next question comes from Sam Darkatsh with Raymond James.

Three topics if I could, and the first 2, if you actually talked about it in the prepared remarks and I missed it, I apologize, The Toro Days promo timing, can you help quantify the impact of that on the quarter in terms of sales? And when might that promo occur next year? Would it be -- which quarter might that 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're down 9-plus this quarter. That gives you a little bit of an idea. It's not all that is due, obviously, to the Toro Days.

And why it's difficult to quantify, Sam, is this -- if there's a lot of factors. It's not just the timing and part of it is we happened to get lucky with the timing of Toro Days and the great weather as well. So it's hard to separate it. It's not just one factor.

We happened to hit a period of really excellent weather. And I know had we left it in the traditional spot in May, that was a period of about 3 weeks of colder than normal and wetter than normal conditions. So that probably helped us a little bit beyond just the shift in quarters. And regarding going forward, that's really a date and the timing for Toro Days is something that we negotiated with our channel partners and for -- we'll move it around for competitive reasons, but it's not something that we even established for next year at this time.

Got it. Second question. International sales were up 10%. How much of that was FX? Or what was the FX impact, I should say, Renee?

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

One of the things we should point out, Sam, 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. It has had the effect of building a stronger relationship with the sports fields and grounds businesses, and we're on track with the integration and leverage of that product across our channel to a greater extent.

My last question or topic at least would -- has to do with capital allocation. I noticed 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. We are at -- our optimal capital structure would be between 1 and 2x EBITDA, and that is more of a long term versus something we hold ourselves to 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 our focus. And as you know, many of the companies we look at are private companies. So timing is difficult to estimate, and then we've been increasing our dividend and we continue to do share repurchases as you know. As we remarked, we did do some 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 on our 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 was a international acquisition that we were able use some of that foreign cash. So that would be one of our areas that should we find more opportunities we'd use some of that foreign cash for.

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

I would -- Sam, I'd probably separate those 2. 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's happening in each of the markets that we're involved with and continue to monitor those. We have beefed up our M&A capabilities with the talent that we have there and the resources that we have, and we're very much interested in finding the right acquisitions. What we're not going to do is sacrifice our criteria that we use because we would rather use the cash for alternate means than 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 of it...

Yes, and related to share repurchases, we continue to be disciplined related to share repurchases. So Sam, we do run a DCF model associated with those. We purchased about -- like I said, about 143,000 shares within the quarter and feel like we're still adding value as we go forward, not at the same -- it's the lower dollar amounts. And maybe within the quarter, we've done sometimes in the past but we continue to feel that, that adds value to the shareholders.

Your next question comes from Jon Fisher with Dougherty & Company.

Two questions here. Just on the overall mix of business between professional and residential, this 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're on pace, another point or 2 shift towards professional. Given your kind of outlook commentary on trends expecting to continue, professional, strong; residential, modest, next fiscal year versus this fiscal year, is this kind of a pattern that we should expect from a mix shift where you shift a point or 2 each year to professional from residential? Or where is kind of that comfort level of overall mix between the 2 segments?

Right. Well, if you -- I mean, I've worked for The Toro Company for 31 years. And when I started, it was mainly a residential company. So the trend that you're talking about is part of a 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 standpoint, we have a preference in our targets for acquisition of professional businesses, international, water based is what we've communicated in our deck and in our conversation. So that we -- the consumer residential business is still very important for us, so I don't want to diminish that at all. But as we pursue our goals, professional businesses are an area that provide a lot of opportunity for us.

And then when we look at international, just overall, the business mix there, is that a higher than corporate average margin contributor? Or is international in line? Kind of what is 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 toward professional type margins.

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

Yes, we don't -- John, we don't give specific guidance on the segment margins. I can tell you that both the segments, both the professional and the residential businesses, are focused on improving their margins. And they, in particular, what we talked about in the residential segment is it's more difficult to get price. So where they really focus 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 margin, very focused on improving their quality, ways to reduce warranty or ways that they can certainly improve their customer satisfaction and improve their profitability. Productivity is important to them and ways to reduce costs is important to them. I mean, those are all things that everyone is focused on 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 2 businesses are complementary, so the ability to leverage our operations across the 2 businesses, the ability to leverage technology developments across both of the businesses, the leverage of the brands, the presence of the brands and residential is important to the overall company. So the 2 businesses for us are very complementary and both are -- both categories are very important to us.

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

My first question actually related to pricing. The net result in outdoor prices has been a benefit over the last couple of years. Just wondering how has that been trending. Is that now a headwind? 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 pricing, we try to emphasize that we really price to market not necessarily as a result of what our -- what we see with commodities. We need to work backwards from what's necessary in the market to compete. That being said, typically, we have said we get 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 -- but pretty consistent with what we would have anticipated and what we've built into our guidance. Joe, as we look forward, in particular, we've commented in the past and it continues to be the case, steel and resins have probably been where we've seen more of the impact for us. That being said, we do buy raw steel and resins. We also buy quite a bit of parts. So not everything we buy is raw materials but some of it we see more on a delayed impact as well. This year, we have guided to and continued to guide to gross margins being consistent with the prior fiscal year. If you look at how that compares to 2016, we saw quite a bit of margin expansion because we had the benefit of being able to get that pricing while we were in a favorable commodity environment. Going into this year, we anticipated and has proven to be the case that we were able to get some price but we also had some commodity headwinds as well. So I think we have included that in our guidance, and to date, that's kind have been the way that it's transpired as well.

So it seems like the fourth quarter guidance is -- or the annual guidance is implying that the fourth quarter is sort of in terms of margin expansion is getting worse. Is that one of the bigger headwinds? Is that becoming more of a headwind 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, while we're looking at is more over the total year, and so it's a small quarter for us and there's 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's some variability built into our plan for the start of the snow season. Also, variability in international. It's the 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 costs continue to grow. I know the second quarter was a little abnormally high in terms of year-over-year comps for certain reasons, but how do we think about sort of the management of corporate cost going into next year, considering that they were up pretty good this year?

Although not within the quarter in the other segment, they're not up within the quarter in Q3, so -- but are up year-to-date. And really how we look at that, there's a lot of things that flow through to other segments, so there are costs that we don't allocate out to the businesses. So from a sales standpoint, it tends to be our company-owned distribution and elimination 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, a number of our enterprise incentives associated with initiatives at the corporate level. Year-over-year, our company performance is stronger in several categories. Our sales growth last year was close to 0, and this year, we're at about 4.5%, 4.8%, so that we're 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're at a lower level. So I think in those 2 categories year-over-year, we're doing better. Those are really the bigger drivers to why we're up year-over-year versus any big cost investments that we're 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 a more normal level.

Okay, 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'd see margin expansion but you're 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've seen in the last couple of years and it seems like maybe that's not as big of a benefit as in past years, which is quite understandable at a point in time these sort of opportunities become a little less and less then maybe they start to re-accelerate. But where are we in terms of the opportunities related to the productivity improvements? This year seems like a light year. Do you think there's more opportunities going forward?

I'll just speak to the idea of productivity overall and maybe Renee can comment on some of the -- we'll have plus and minuses in our margin this year. But in terms of productivity overall, we believe that we have significant opportunity to gain productivity. Renee earlier mentioned our lean activities. That's something that we spend a lot of time on introducing in the early 2000s and we invested a lot in training and development in the early 2000s. As we went through the recession, it's 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 in the performance of those areas where we're applying it. And what we're seeing is really a multi-fold return on our investment because we have this latent base of people that have been trained and are certainly understanding and accepting a lean culture. So we believe there are lots of opportunities for us to reduce waste both in our operations traditionally, our manufacturing areas and also throughout really all of 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 lifeblood of our plants, but it's not just something that is a plant responsibility. So we are expecting every employee, whether they're part of the SG&A, cost floor -- the cost of goods sold, to be driving productivity. So when you look at our guidance, we are saying gross margins similar. We're saying that we are going to be able to offset the headwinds of commodities by driving productivity and -- with pricing, but we're also saying we're going to leverage SG&A. And so we are saying that we are going to be able to drive margin expansion across the organization. And I think productivity is a piece of that and continuing to invest in innovation and in 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're looking at is how do we better manage 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're not nearing the end of the productivity opportunities at all. But from a context of other ways that we can offset to improve our gross margin as well.

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

So I just have a follow-up. I'm a little confused still with the gross margins. If you're offsetting most of the material inflation with price, you're seeing still a favorable shift in the segments on the professional side of things and you're 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's also mix with regard to the specific product categories. So there are a couple of the dynamics that take place there as well that affect the overall results that they're really mixed within each of the segments as well.

Correct. Not every product within a segment is the same. So there's dynamics within a segment as well.

But even still, the professional segment overall is a higher-margin business and you're seeing roughly maybe 6% revenue growth out of that and pretty much 1% revenue growth out of residential this year. So you're 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 net benefit to, I would think anyways, I guess, I only have operating income here. I don't have the gross margin. So maybe there is something going on related to that.

Yes. Based on our analysis, we see the gross margin at this point and we've been guiding to a consistent gross margin number since we provided guidance as we went into the year, and that's what we'll continue to see when we go through the roll-up, and Q4 is a fairly small quarter. So at this point, I mean we shall see but I wouldn't anticipate it's going to shift dramatically.

Your next question comes from David MacGregor with Longbow Research.

This is Rob Aurand on for David MacGregor. I guess within the pro segment, strong 9.5% sales growth, can you talk about how much you're benefiting just from the overall market growth versus share gains?

Yes, it's really -- this year, it's really a combination of the 2. So we're seeing, as I'd mentioned, for example, to call out one area, the rental and specialty construction business. The market is growing, but I will also say that we are improving our position within that market. So that's the case really where both are happening. We believe, for example, within the professional category of these that we've 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're improving our position in most of those markets at the same time. Some of them are slower-growth markets but we continue to try and improve our market share in each of those markets.

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

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

Okay. And then kind of the opposite in residential where you saw a big sales decline, but margins held up, is that just kind of the 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 costs and actions that they're taking. So it's all of the above.

But it's true that the mix within that segment was -- had the same effect. It could be just the opposite in the...

Yes, it would. Absolutely, it would. Right because -- but it's less diverse because you just don't have quite as many businesses within residential so -- but yes, it would be the same.

The next question comes from Jon Fisher with Dougherty & Company.

Just on the other income line, the past few quarters, it's been pretty steady and kind of the mid to high 3s. 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 onetime impacts included in it just related to foreign currency.

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 the results for the fiscal year. Thank you.

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