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Executives

Steve Wolfe - VP and CFO

Mike Hoffman - Chairman and CEO

Analysts

Jim Lucas - Janney Montgomery Scott

Sam Darkatsh - Raymond James

James Bank - Sidoti & company

Jim Barrett - C.L. King & Associates

Mark Rupe - Longbow Research

Toro Company (TTC) F3Q09 (Qtr End 06/31/09) Earnings Call August 20, 2009 11:00 AM ET

Operator

Welcome to the Toro Company third quarter Earnings Call. My name is [Jerry] and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (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, Mr. Steve Wolfe, Vice President and Chief Financial Officer of the Toro Company. Please proceed Mr. Wolfe.

Steve Wolfe

Well, thank you, Jerry, and good morning, everyone. Joining me this morning for our third quarter earnings conference call are Mike Hoffman, Chairman and Chief Executive Officer, Tom Larson, Vice President and Treasurer, and John Wright, Director of Investor Relations.

We begin with our customary forward-looking statements policy. Please keep in mind that during the call we'll make certain forward-looking statements, which are intended to assist you in understanding the company's results. You're all aware of the inherent difficulties, risks and uncertainties and making predictive statements, particularly in the current environment.

So the Safe Harbor portion of the company's earnings release, as well as SEC filings, detail some of the important risk factors that may cause actual results to differ from those that are in our predictions. Our earnings release was issued this morning by Business Wire and can also be found in the Investor section of the corporate website thetorocompany.com.

With that opening, I'll now turn it over to Mike.

Mike Hoffman

Thank you, Steve, and good morning everyone. For Toro and the industry this has been a year marked by many challenges. As we near the end of our primarily selling season, economic conditions have shown little sign of improvement and continue to significantly impact our top and bottom-line results.

Now despite these pressures, we're executing soundly in areas such as spending control, inventory management and working capital improvement. Steve and I will shed further light on those in just a minute, but first let me share our overall results, and then Steve will discuss our segment and operating performance.

As you saw in this morning's release, we reported that net sales were down 19.8% to $394.9 million for our third quarter. On the earnings front, we posted net income of $19.8 million for the quarter or $0.54 per share, compared to $0.99 per share in the same period last year.

The earnings decline for the quarter includes several one-time charges for our workforce adjustments, a valuation allowance for deferred tax assets and legal matters. Together these add up to $0.15 per share on an after-tax basis.

For the first nine months, net sales were down 19.7% to $1,234.9 million. In addition, net earnings for the first ninth months were $63.4 million or $1.73 per share, down from $3.06 per share in the comparable fiscal 2008 period.

When looking at our markets, the themes discussed earlier this year are still true today, that is the softness continues with limited near-term recovery. Like many companies, our sales have been impacted by the deferral of large capital equipment purchases, particularly in golf, along with new course construction and large renovation projects being delayed.

This has resulted in a contracted market with increased competitive pressure. I am pleased to say we're effectively dealing with many challenges we face and are actually holding or gaining share across our markets, a testament to our talented people, strong products and a great group of partners building solid end-user customer relationships, from depo to dealers to golf and grounds equipment and irrigation distributors around the world, they make a real difference.

Speaking of golf, I'm sure many of you watched the PGA Championship last week that drew crowds of near 40,000 for practice rounds and the four-day tournament. That culminated with South Korean Y.E. Yang coming from behind to win his first major and the first by an Asian-born golfer. This will be good for golf in Asia and good for golf around the world. For us this tournament was especially rewarding as it took place here in Minnesota at Hazeltine National Golf Club, where Toro is proud to be the official supplier of turf and irrigation systems.

As you might expect, golf course conditions are critical to the success of such events, so a lot of credit goes to certified golf course superintendent Jim Nicole and his team who did a fabulous job of preparing the course and dealing with the challenging conditions.

I should also mention that Jim is a new user of Toro Turf Guard wireless soil sensors and is realizing the many benefits of this technology, including more accurately managing turf [health] and water usage. So on behalf of the entire Toro organization, we congratulate Jim and his team and look forward to helping them as they prepare Hazeltine National to host the 2016 Ryder cup.

In contrast to the Professional segment, our residential business has been relatively positive. We experienced a reasonable spring and benefited from several new product offerings at dealers and our primarily mass retailer. What we are seeing is a mother nature has to a certain extent, helped offset the poor economy.

Taking into consideration the state of our markets and many uncertainties, we've been working hard to manage through these tough times. Here are a few concrete examples. We have achieved double-digit growth in retail sales of walk power mowers, with demand strengthening even in the third quarter. Overall for the company, we've taken aggressive actions to reduce costs and adjust output to drive both Toro and field inventory lower. These measures have particularly impacted the production output at our plants producing professional equipment and irrigation products.

We've taken a hard look at our manufacturing and warehousing operations and will be closing our Lincoln, Nebraska distribution facility and integrating it into our Beatrice Nebraska manufacturing location. This action will provide a leaner, more efficient manufacturing and logistics model going forward.

We continue to closely analyze our SG&A spending, and are working to take costs out of the system. This includes a full spectrum of measures from further reducing our workforce in line with sales to calling out all employees to find innovative ways to do more with less. The workforce action just mentioned involved the recent elimination of additional office and salaried positions to those announced in February.

And finally, I would like to comment briefly on the third year of our GrowLean initiative. While disappointed we won't make our revenue and profitability goals set three years ago, we are making good progress in driving our working capital to less than 20% of sales for into the teens. We added this significant initiative through the GrowLean objectives in fiscal 2007 to improve working capital as a percent of sales by more than 10 percentage points and have continued to find ways to reduce inventory and receivables and to increase our payables.

Additionally, just last week we announced the creation of Red Iron Acceptance under a new joint venture with TCF Inventory Finance to provide floor plan and open account financing, along with a new trade payables program to offer financing to our supply chain partners. Both will have a positive impact on our working capital initiative.

I'll now turn it back over to Steve to review our segment and operating results.

Steve Wolfe

Thank you, Mike. Let's start by covering our segment results. In our core professional business, worldwide sales for the quarter were down 27.3% to $260.9 million. Without question the length of the recession has dampened results across the board. For instance in the golf market, well actual rounds played are essentially flat year-over-year, course revenues and memberships are down. As a result, many customers have delayed equipment purchases with discussions about golf course renovations and irrigation system upgrades being put off as well.

On a worldwide basis, new course construction in Asia is faring reasonably well, with Europe and the Middle-East still slow. On a positive note, a recent independent tracking service suggests that we are increasing our share position in most product areas. Additionally when asked what equipment superintendents plan to purchase in the near future they said Toro more than any other brand.

Now while the pace of decline in the building construction market has somewhat stabilized, sales of professionally installed residential and commercial irrigation products remain relatively weak. As we discussed in recent quarters, this category has been and continues to be impacted by the ongoing recession. What's more, this trend has a negative impact on sales of compact utility loaders and trenchers.

In the landscape contractor category, shipments were down as landscapers limited purchases of new equipment. In spite of the professional markets contraction we have actually been able to realize share gains through our commitment to new product innovation. In fact, new product acceptance has been very new for our new Toro Grandstand stand on mower and next generation line up Toro and Exmark commercial zeroturn mowers.

Our investment in the water management business also continues. We're enjoying excellent success from our new Toro Precision Series spray nozzles and the micro irrigation market our new line of Toro Aqua-TraXX premium drip tape is gaining ground as agricultural growers intensify their focus on conserving water and improving crop yields.

For the year-to-date, net sales in the professional segment were down 26.7% to $800.6 million. Earnings in the professional segment for the third quarter were $39.4 million, down 44.6% from the previous year. The decline was mainly due to significantly lower sales and higher manufacturing variances from production cuts. For the first nine months professional segment earnings totals $126.4 million, down 42.4% from the previous year.

Now let me shift gears to the residential side, where our worldwide sales for the quarter were actually up 1.2% to $126.2 million. As Mike alluded to, the story here has been relatively positive considering the many challenges our end customers are experiencing. What this tells us is our focus on innovation and the right product line are truly helping drive retail demand.

Performance in the quarter was fueled by strong domestic shipments for our new lineup of steel deck walk power mowers due to additional product placement. This has enabled greater market penetration and provided a solid lift in a down economy.

Another area of retail strength has been riding products, where our new platform of Toro TITAN zero-turn mowers saw increased demand. With the focus on performance and productivity at affordable price, we believe these machines are extremely appealing to today's value driven customer. Great for large acreage owners, this new lineup has positioned us to better capture customers at attractive price points.

Somewhat offsetting these gains were significant declines in snow thrower sales. As mentioned in the release this was mainly due to timing of the introduction of a new line of Toro Snow products which are expected to ship later in the year. Also impacting the results for the quarter were lower international sales on account of poor economic conditions and currency fluctuations. For the year-to-date net sales in the residential segment declined 1.6% to $416.8 million.

Meanwhile, earnings in the residential segment for the third quarter were $10.7 million, up nicely from the previous year. The increase was primarily driven by a reduction in SG&A spending and lower commodity costs. For the first nine months, residential segment earnings totaled $32.1 million up 15% from the prior year.

Now to our key operating results starting with gross margin; Margin for the quarter declined by 1.4 percentage points to 33.9%.This was the result of production cuts from lower sales volumes and unfavorable product mix due to proportionally higher residential sales. These negative impacts were somewhat offset by lower commodity costs. Year-to-date margins decreased 2.3 percentage points to 33.5%. SG&A expenses for the quarter were down $16.7 million, but increased as a percent of sales to 23.9% compared to 22.5% in the same period last year.

For the first nine months, SG&A expenses were down $52 million, but increased as a percentage of sales to 24.4% compared to 23% last year. SG&A spending was down as a result of tighter cost controls, although not enough to keep up with lower sales volumes. The other expense line was up $3.7 million for the quarter, mainly due to account for a several one time expenses for legal matters. This was somewhat offset by higher foreign currency gains compared to the loss last year.

Interest expense declined 4.7% for the quarter and 11.6% year-to-date. The decrease was primarily the result of lower average levels of outstanding debt and reduced interest rates. Our effective tax rate for the quarter was 36.6%, compared to 34.2% in the third quarter of last year. The increase was due to a valuation allowance and the fact that we're no longer benefiting from losses related to foreign subsidiary. This was slightly offset by the reinstatement of the federal research and engineering tax credit. For the full fiscal year of '09 we now expect our tax rate to be approximately 35.8%.

Moving now to the balance sheet; the results of our discipline in working capital have been significant. While earnings are down from the prior year, our ongoing efforts have resulted in continued strong cash flow from operations. Across the enterprise, accounts receivable were down $95.1 million or 26.1% for the third quarter. Given our commitment to our working capital goals, we have been able to further reduce inventory in the quarter by nearly $50 million, or 24.2% from last year's improvement.

You may recall, last week we announced the formation of Red Iron Acceptance, a new joint venture that we've entered into with TCF Inventory Finance to provide financing for our distributor and dealer channel partners. This not only provides the long-term program for channel financing, but also frees up substantial capital to be redeployed for more strategic purposes.

In the area of trade payables, we recently initiated a Supply Chain Finance program that will help us drive improvement in the third leg of our working capital stool. This Supply Chain Finance program provided by PrimeRevenue, and the Wells Fargo Trade Bank, will allow us to lengthen our payable terms while providing attractive cash flow and financing options for our suppliers, a great win-win for both sides.

So while we found the economic environment to be extremely challenging for our revenue and profitability elements of our GrowLean initiative, we are very much on track to achieve our goal of reducing working capital into the teens. The [resulting] cash flow benefits of these specific actions will enable us to continue to deploy capital for acquisitions as opportunities become available along with regular dividends and repurchases.

During the third quarter, we did repurchase 1.6 million shares for roughly $50 million. We now have 5.3 million shares remaining on our Board authorization. This wraps up our results for the third quarter.

And let me turn it back to Mike for some discussion on our outlook.

Mike Hoffman

Well, I don't need to say too many more times these are difficult times and they remain a great deal of uncertainly and one thing will get moving in the right direction. And that's exactly what we've been experiencing this year and is reflected in our guidance in this morning's released. We continue to expect fiscal 2009 revenues to decline about 18% from fiscal 2008. However, based on the one-time charges mentioned earlier, we now expect net earnings per share for fiscal 2009 to be approximately $1.53 to $1.63 for the year.

We have learned this year that we need to be more flexible and disciplined as we make choices in such an uncertain world. Additionally, we must and will remain true to our commitment to innovation.

As you've seen earlier this year, and as Steve shared, we've introduced several new products across all of our businesses for our markets that we serve, from zeroturn mowers and the Toro Grandstand to our industry leading Precision Series Spray Nozzles to the soon to be released new line of Toro snowthrowers. These products and many others are capturing the attention of our customers and we will continue to invest in innovation for the long-term viability and growth of Toro.

Based on public's desire for solutions to critical water management issues, for more beautiful landscapes and expanded recreational venues, we face a future with many opportunities. For example, just last week both golf and rugby were selected by the Executive Board for the Olympic Committee for inclusion into the 2016 Olympic Games. Final approval is in October of these turf-based sports as official Olympic events, which would be good for turf industry around the world as countries prepare to compete.

So in closing, our focus remains on the quarter ahead and finishing the fiscal year to properly position us for 2010. We expect little if any market recovery in the near term. We're confident in the actions we've taken to navigate through these demanding times. However, we know there is still much work to be done and we'll take the lessons we learned this year and incorporate them into our planning for the next fiscal year.

With that, let's open it up for your questions, so back to you, Jerry.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Jim Lucas with Janney Montgomery Scott. Please proceed.

Jim Lucas - Janney Montgomery Scott

Couple of questions; Steve, first, on that $0.15 you alluded to three different buckets that fell within. Was that fairly evenly distributed or can you give us some more color of where exactly that hit in the quarter?

Steve Wolfe

Yes, we don't break that out, Jim. When you've got litigation and all those types of things involved in that we just say its $0.15 in total and don't break down the pieces.

Jim Lucas - Janney Montgomery Scott

I'm just trying to figure out in terms of the headcount reduction and the tax piece, were those two combined somewhat comparable or …

Steve Wolfe

You'll find when you look at the consolidated P&L.

Jim Lucas - Janney Montgomery Scott

Yes.

Steve Wolfe

You find these expenses in three different categories.

Jim Lucas - Janney Montgomery Scott

Right.

Steve Wolfe

Restructuring ends up running through SG&A. The legal matters end up running through the other expense and income line, and the tax allocation ends up running through the through the tax line so you've got them split into three different pieces in the P&L.

Jim Lucas - Janney Montgomery Scott

No other way to ask that one. With these two new events from a working capital management standpoint, the formation of Red Iron where a lot of company seem to be stepping away from third party financing, it's somewhat unique to hear, somebody like moving toward it. I was wondering how this came about, but even more so I was wondering if you could give us a little bit more color on this new payable solution that you've come up with.

Mike Hoffman

Let me make just a comment first on how this came about. And then turn it over to Steve to maybe add some color and talk about the payable side. The fact is that, when you go back to literally when we were completing our six plus eight initiative. One of the things that came out of that as we headed into the GrowLean initiative was in the third leg on the stool and really looking at our working capital, and as we looked at Toro versus our peer set, it wasn't particularly attractive. And certainly one of those elements is your receivables. And so it's a credit to Steve and Tom Larson, but they took a hard look at that and said, well, some of our receivables are being sold through a third party. Some of them are on our books, and maybe there is a better solution. I think the solution that they found was an excellent one that keeps us directly involved in the JV context but leverages a third party who has a significantly lower cost of capital. As Steve said earlier, it very much is a win-win and it is going to move our working capital in the right direction so, no. I'll let Steve add some comments.

Steve Wolfe

The only other thing I would add to that is you said you are not seeing people going towards financing. Just understand these receivables will go off our books and will be on the joint venture's books. So it's not adding additional financing assets on our books. In fact it is going the other way. It is taking advantage of the ones we do have on our books and putting them into a joint venture where we share with the value of that. So on the trade payable side, Jim, you've heard us talk in terms of working capital about receivables and inventory, and as you look at our books we've done a relatively good job in both of those areas in terms of getting our effort towards working capital in the teens. We've said probably the biggest opportunity moving forward is now payables.

So Tom and his team have been working on this with PrimeRevenue and Wells Fargo and what it basically does is allows them to get hooked up electronically on their receivables from Toro. We're able to go lengthen our payables terms to those suppliers and they can get their cash up front if they choose to do so at a very attractive rate, basically at a Toro-type borrowing rate. So we get our longer terms, helps our working capital, they're able to get their cash up front if need be at a Toro type of a rate so it's good for both of us.

Jim Lucas - Janney Montgomery Scott

All right. Very unique solution, no doubt. As we turn the focus here still on the balance sheet, I mean, clearly you guys have done a good job, making a positive out of a negative in this environment with the cash you're generating, and balance sheet in good shape, about to get even stronger with that additional cash you're about to receive on the receivables side. So where, from a capital allocation standpoint, I mean, you've been consistently buying back stock. You've talked about acquisitions for some time, but there has not been a lot that we've seen in terms of the fruits of the labor. So could you talk a little bit about your acquisition strategy here going forward?

Mike Hoffman

Jim, this is Mike, and I'll make a couple of comments. We still have a good appetite for acquisitions. And I would say that, there has been a lot of labor, as you say, we just haven't necessarily seen the fruits. And as you know, with acquisitions you don't have total control over something like that, takes two. So, we continue to work the process. It is still at the top of our list from a strategy standpoint of where we would want to deploy that capital. We will just continue to work it and look for the right opportunities, to help fuel our future growth.

Jim Lucas - Janney Montgomery Scott

And as you look at the pipeline you're building, is it more domestic than international or would you be focused more on the international side?

Mike Hoffman

Well, we've said that, as we look at, our portfolio changing, that we would probably lean more towards a professional acquisition than a residential acquisition, we would lean towards an international acquisition probably more so than domestic. But that's one of those things, it depends on what the acquisition and opportunity is.

So in a perfect world, if there was a significant international, professional opportunity, we certainly would have a lot of appetite for that. And we've got people now dedicated to the process, which wasn't true a couple of years ago. So that helps making sure we keep those ideas and opportunities percolating, but again, as I said earlier, it comes back to the [text two] on the acquisition side.

Jim Lucas - Janney Montgomery Scott

And how many people do you have dedicated today, just to follow up on that comment?

Mike Hoffman

I guess, I'd say we went from zero to 2.5. That's dedicated. Certainly we pull the division people into this. We pull, Steve and myself into this, but we do have a business development area now that is working it.

Operator

Your next question comes from the line of Sam Darkatsh with Raymond James. Please proceed.

Sam Darkatsh - Raymond James

Couple of questions here; first off, I know you haven't gone through your formal planning meetings as of yet, as it relates to looking ahead into fiscal year 2010, but can you give us a sense directionally at least of what input cost look like pricing and restructuring savings at least directionally so we can start to plug that into our assumptions?

Steve Wolfe

We will give you more detail as we always do at the December call, Sam. There are couple things I would say, the big wildcard obviously, continues to be what's the top-line going to look like and when is the market going to recover, and how much of that will we see in F'10. That is very much a work-in-process trying to figure out what that is going to be and what type of a number we're going to plan against.

Now having said that, we know some things that we've done, we can plan on for F'10 and a lot of that is our cost structure reduction that we've been working on now for the last six to nine months, ever since this financial meltdown and economic meltdown started. Then we talked to you, I think at the last conference about the things we had done in terms of early retirements, reductions, things like that, pay reductions, freezing salaries, vacation schedule, and we told you that was going to be about a $15 million savings in '09.

As we now project that forward along with the other items that Mike talked about that we did in the last couple of weeks, we are probably talking a $20 million number. So that will give you some idea at least of what we are baking in at this point.

The other big pieces are commodities, what happened to commodity costs. We are seeing some recovery, obviously from where we were in the first half of this year. So we are looking at steel, we are looking at resins, the things that impact us to a great degree, and we are seeing some benefit but you're also reading in the marketplace where those things are going to start going up again. So, those are kind of still up in the air, but things that we are looking at this point.

Mike Hoffman

And Sam, let me add to Steve's comments, you asked about pricing and certainly as the markets have contracted this year, that has put more pressure on pricing and so as we look to F'10, I guess I would say, we'll be cautious on pricing and some of that will be correlated with what we expect to happen in each individual market. We hope to see these markets at some point, some time, start to grow but I think we'll see growth expectations for F'10 and we will discuss that more in December. General market growth, we're not expecting a major bounce.

Now with that said, as always, pricing is also related to innovation and where we can bring real increased value with some of the new products that certainly gives us a chance to enhance our margins, more than any other way.

Sam Darkatsh - Raymond James

When you are saying pricing, you'll be cautious, does that mean to say that that you think that there might be price degradation next year, even if slight?

Mike Hoffman

I think I would say as we looked at what happened this year, and this year certainly has been under more pressure than we've seen in any time in decades. The pricing has held up okay. I mean, there's certainly been some pressure there, but as we look to F'10, I think hopefully less so. So I think that has stabilized and hopefully can start moving back in the right direction.

Sam Darkatsh - Raymond James

When you are saying, Steve, the restructuring savings and/or discretionary spending pullbacks of the $20 million, what part of the $20 million is incremental to 2009 and what part of the $20 million will be recognized in 2009? I'm just trying to get a sense of what's to come next year.

Steve Wolfe

The incremental 10 over 9 is probably in the $4 million to $5 million range. We said 15 for '09 and we think the additional five will be incremental.

Sam Darkatsh - Raymond James

And that's structural, or is that pare back of discretionary spending that might return…

Steve Wolfe

No. We will do our best to make sure it doesn't return. That will be the leverage point when the top-line starts to grow again. If we've got that cost level at the right level, that's when you see the benefit. So our job will be to make sure that that doesn't come back.

Sam Darkatsh - Raymond James

And the input costs, if they remain flat from where they are right now, do you anticipate deflation in 2010?

Mike Hoffman

We don't anticipate that. At this point.

Sam Darkatsh - Raymond James

Last question, your cash balance was high based on historical, seasonal trends and it doesn't sound like you would have received the cash benefit yet from the Red Iron JV, I don't think. Why would it be higher? Is this a new level that we should be focusing on? Or how should we look at the cash balance on the balance sheet?

Steve Wolfe

You're right. The Red Iron amounts are not in there. What that is, there is two things, one, asset management, which we've been talking about all along, lowering our receivables and inventory levels. And the other piece is the level of stock repurchase that we've done this year versus last year. So, the two together results in higher cash at the end of the quarter.

Sam Darkatsh - Raymond James

Should we then assume a much higher than prior seasonal trends in terms of cash as a percent of sales on the balance sheet or is it just kind of an anomalous calendar thing?

Steve Wolfe

Not if our acquisition guys, do their job, we won't have that cash, so, the answer is no. We're not trying to set a new high mark for cash. We want to put cash to work and get a better return on it than sitting in the bank today at 1%.

Operator

And your next question comes from line of Eric Bosshard with Cleveland Research Company. Please proceed.

Unidentified Analyst

This is actually Mark in for Eric. A real quick, foreign currency within quarter, how much of an impact?

Steve Wolfe

It was about five points on the international piece.

Unidentified Analyst

Benefit?

Steve Wolfe

No. Lowered sales by about 5%...

Unidentified Analyst

And then next in the professional segment, less, a little bit of an improvement or less worse this quarter versus the second quarter, comparison was significantly more difficult. Can you talk about specifically where were the better trends? You're not talking about things getting better. But it looks like things did improve slightly in the quarter. Any particular areas of improvement, US, non-US that we should know about?

Mike Hoffman

Mark, I guess I'd say there's not, I think our landscape business has been, with some of the new products like the Grandstand has been and the new [mid-mountain Z's] has been slightly better. But all-in there's not a dramatic difference between golf and equipment and irrigation. Inventories have been run down and we're hopeful. Steve and I were talking with one of our distributors earlier this week and they are starting to get some signs that things may start to turn. But at this point we're headed into the low of part of the season. So that's more comment, commentary and not something that we can forecast off of very easily.

Unidentified Analyst

In terms of the non-US business, similar improvement quarter-to-quarter, despite the FX headwind. Is there anything you’re seeing outside the US that has you encouraged? I know you mentioned Asia is holding up okay. Or is your European golf business or European landscape contractor business improving?

Mike Hoffman

The international picture looks similar in the quarter as it does year-to-date. And as you know some of those markets went into the recession, the world recession, if you will, later. I mean, Asia didn't necessarily go into a recession, it's still growing but maybe not quite as higher rates. So there may be particularly in Europe, Spain and the UK have been more challenged versus some of the other countries there, so they were more first in. Spain was tied to, obviously like here it was tied to housing in the UK to some degree. So it is really the same story that capital equipment being stretched out, can only stretch it so far, and so that does provide some encouragement as we look towards next year, and is starting to see some recovery.

Unidentified Analyst

You mentioned I think in the release, inventory levels at a decade low. Can you talk about specifically inventory levels in the channel, specifically on the pro side of the business? Just trying to get a sense for what we should think shipments are going to look like to start the season in 2010, how clean is inventory out there, if you can give us some directional color that would be great.

Mike Hoffman

Yes, I just would say on both our residential side and the pro side, field inventories are down significantly year-over-year. They are down double digits in both categories. So whether people are operating leaner and that puts some pressure on us as it’s been started to turn how flexible we need, are going to need to be to respond to hopefully an uptick in demand. I don't have a good comparison, I know we said for Toro our inventories are at a decade low level, and I would say the field inventories are at a several year low level and so that's a good signal. As demand starts to improve, we'll see that move quickly back through the need to produce more.

Operator

Your next question comes from the line of James Bank with Sidoti & company. Please proceed

James Bank - Sidoti & company

Steve, just a quick follow-up to a question Sam had, I didn't quite catch it in regard to the lean initiatives that you guys have in place and how your SG&A should look as we look forward. Is this something that we could maybe assume, could stay flat as a percentage of sales, or do you think there's still room for this to come down, even though if one would want to expect volume to increase in the [out-year]?

Steve Wolfe

It depends on what time period you're talking about here. For year-end the cast is kind of set or the dye is kind of set. There's not a whole lot more we can do for year-end. So that will be the challenge for F'10. How do we start getting SG&As back down again? And quite frankly leveraging SG&A, you can cut so much to leverage, you really need to start growing again and getting the top-line growing, so we've got more volume that we're spreading those costs across. So the goal as it had been through five by five and six plus eight to reduce SG&A expenses, is still there and we're still working on that. It gets much more difficult when the top-line is going down rather than going up.

James Bank - Sidoti & company

I don't know if you disclose this, but what percentage of the receivables was on your books that are now probably going to leave to go to this third-party financing?

Steve Wolfe

If you look at our receivable numbers today, roughly $90 million of that will go into the JV. [Number of the JV] we'll have two pieces; it will have the receivables that are on our books, TCC and open account that we're financing on our books today will go into the venture as well as what's the new purchases that today are going to a third-party financing source will start going through the JV. So that won't move in total, but the only thing it affects our balance sheet is the $90 million to $95 million that I mentioned.

James Bank - Sidoti & company

The way it works, there's no offset liabilities, so in effect you're just getting an infusion of roughly $2.50 in cash per share.

Steve Wolfe

That's correct. I didn't do the math on the per share, but we're getting $95 million and the liability goes into the JV. Now there is some ownership sharing there, so you have liability to the extent that you have equity ownership, but you don't have the dollar for dollar receivables on your books like we have now.

James Bank - Sidoti & company

Now just back to the end markets. In the past, I know you guys [involved] in there for quite a while. In the past, how long have these replacement cycles extended for? What's the record, I guess we should say?

Mike Hoffman

I wish we had a good answer for you on that, James. You talk about this year, this economic environment; we haven't seen it for 30 years, maybe somewhat worse than back then. And back then the professional side of our business was very, very small and think back to the Toro Company, what they were going through in the early '80s, we were literally working through a survival issue, some of it our own doing with building too many snowthrowers and the economic environment. So we don't have good history to know how long that might take. I wish we did, but the fact is we don't. And so, we're just listening closely to our channel partners, and talking with end-users to try to get an idea of when they're going to start to change their behavior

James Bank - Sidoti & company

I guess, getting a little bit more detail, we all know how bad state budgets are, projected to probably get worse next year. And I think we're all aware of the commercial property market and where that's headed. Does this have any type of an impact on your professional business next year?

Mike Hoffman

Certainly your first point is a good one. We think the state issues, budget issues, will have an impact. That will be somewhat of a headwind for us in fiscal 2010. Again, we hope to see golf start to come back. Golf was earlier in, if you will. The state budgets tend to be more of a lagging issue. You're right. There will be some pressure on that next year. That's a smaller part of the commercial portfolio, but there will be some pressure there. So, we'll have to work hard as we did this year to make sure we take share in a potentially contracting market.

James Bank - Sidoti & company

I guess historically what's going on with the commercial property markets. Has this been something historically that impacts you guys or is it just may be a little bit of noise?

Mike Hoffman

Relative to the commercial markets, that's probably more; I won't say noise, it certainly does impact our residential, commercial irrigation piece of business more than anything else, but we talk about commercial irrigation, commercial properties being built, but that's been shutdown for a while now. So year-over-year, we don't expect to see any real impact there.

James Bank - Sidoti & company

Moving quickly to other revenue, with the distribution consolidation, does that impact that top-line at all?

Steve Wolfe

Yes, this is Steve. Yes, it does. As we go direct, yet though our distributors end up working as reps. And that no longer goes through the sales line. So, yes, that will have an impact.

James Bank - Sidoti and company

So for the other revenue assumptions for modeling purpose going forward we should probably just drop it and then keep it flat?

Steve Wolfe

Something that.

James Bank - Sidoti and company

Okay, and then last question is your [D&A] in the quarter seemed a bit late for where you were for the rest of the year and I was just wondering if there was something behind that.

Steve Wolfe

No; nothing unusual. We may be down a little bit just because last year our CapEx was in the high 40s and we had a lot of projects and things going on last year. We won't be quite that high, but nothing unusual going on there.

James Bank - Sidoti and company

Okay, all right, great. And your CapEx for the year is about 40?

Steve Wolfe

Yes, low 40s.

Operator

And your next question comes from the line of Jim Barrett with C.L. King & Associates. Please proceed.

Jim Barrett - C.L. King & Associates

Steve, could you start off by talking a little bit about Red Iron? Will your distributors and selected dealers, will they get more access to credit with Red Iron than they are currently getting, if for example they go through a third party? I'm just trying to understand from their standpoint how it benefits them specifically?

Steve Wolfe

Yes, we would hope so. You're going to have a closer relationship with them for one, the ones that aren't on your books today. So you're going to have a closer relationship. The real key probably to the dealer is he’s going to have a dedicated line, where with our third party supplier they may be sharing part of that line today with other manufacturers. So the fact that we are just financing Toro and Toro branded products through the joint venture, they're going to have a line that's dedicated to them just for that product and that should give them more credit overall.

Jim Barrett - C.L. King & Associates

But if a distributor has a certain level of credit quality, I would assume that Red Iron will have the same standards as a third party or am I…?

Steve Wolfe

Yes, I would hope so, exactly.

Jim Barrett - C.L. King & Associates

All right.

Steve Wolfe

We did this one to have kind of a proprietary product here, if you will, that we have input on in and how we run it. And on the other hand, you've got to have your standard underwriting guidelines, so that when you turn into economic downturns you don't end up with a big problem through the joint venture. It's fair to say you may have more formal underwriting guidelines under this new arrangement than we had when it was just within the Toro company and not that there was any issue with that. We've never had any major bad debt issues, but you will have a more formal underwriting process because you've got a partner in this joint venture. But we don't see that as an obstacle, we think the fact that you've got a proprietary product will be an advantage.

Jim Barrett - C.L. King & Associates

I see, okay. The legal charges in the quarter, do they refer to the legal matters summarized in the second quarter of? Thank you. I assume there's nothing beyond that, is that…?

Steve Wolfe

Some of those are, Jim, and some aren't. We've got a mixture in there.

Jim Barrett - C.L. King & Associates

And then finally, Mike, could you talk a little bit about the used equipment market? How much of a concern is that, how much share, whether it’d be in golf or the commercial landscape segment has that gained in this downturn?

Mike Hoffman

Certainly. Not surprisingly, the demand for used equipment is up. Now as you take a step back and say this industry, particularly the golf industry has been starting to mature a bit in the used equipment. If you want to take a step back, it wasn’t that long ago it looked more like the auto industry 20 years ago when you could buy a new or very well-used car and today you can get a car that's, one-year lease, two-year leas, three-year lease and so it's created more levels of product.

And that's happening not to that degree perhaps, but that's happening in our industry as well. And so as these courses, I'll use golf as an example, as these courses by fleets and keep them, especially, the A-courses keep them for three, four years and then roll those out and historically they might have kept them for eight or ten years and then wouldn't be much left, that that's creating a secondary market.

Now the fact is that's good for the brand all in because ultimately these assets have to get used up. The key is making sure that Toro is from a brand standpoint is winning relatively better than competition. And one of the good things that that we do know from the kind of studying and getting to know the used equipment market better, partnership with our distributors, is that Toro products, particularly in the golf market hold up better and retain their value better.

And so that creates additional profit opportunity for our channel. So there was no, as this fleet mentality started to build over the last few years, there was always going to be a need to use up those assets. And that's happening and certainly the downturn has created even more of an opportunity there. But we see that in partnership with our distributors as just that, as an opportunity, not an issue.

Operator

And your next question comes from the line of Mark Rupe with Longbow Research. Please proceed.

Mark Rupe - Longbow Research

Just following up on the equipment replacement cycle commentary, I know it's difficult to look back on it, but it's very different from the residential side, but on the professional side is there anything you can point to that says, it got to have to snap back at some point in time because of usage or anything like that. And then just secondly, any kind of commentary you can point to on how big percentage of your business is parts related or recurring?

Mike Hoffman

On the first question, we continue to talk with our channel partners and distributors and end-to-end users and so using golf again as an example, a lot of these courses had their budgets approved, but then just put in a holding pattern. As the golf course becomes more confident that they're not going to see more attrition members and some members come back and strengthen, then we think more budgets will be released. Now they absolutely have to go out and buy the new equipment. So we don't have really a black and white answer for you there, Mark, but again, we listen to these customers, get very close to them, and so there are signal, signs that their capital budgets will be put back in place and they will start to spend some money. So we think that's a positive.

On the parts side, we don't break that out. I think we have said, not surprisingly like the discussion we just had on used equipment. We've seen parts do relatively better than new whole goods as some customers extended, working to extend their life cycles and certainly that's good business for us, not enough to make up for the whole goods contraction. So, I guess that would probably sum up.

Operator

And this concludes the question-and-answer session of today's conference. Sir, please proceed with closing remarks.

Mike Hoffman

Well, thank you ladies and gentlemen for taking the time to be part of our call today. We will look forward to working through the fourth quarter, and meeting with you in December to report on our fourth quarter results. Thank you, and have a great day.

Operator

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

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Source: Toro Company F3Q09 (Qtr End 06/31/09) Earnings Call Transcript
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