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Executives

Kurt Svendsen – Director of Investor and Public Relations

Michael Hoffman – Chairman and CEO

Blake Grams – VP, Corporate Controller

Tom Larson – VP and Treasurer

Analysts

Mark Rupe – Longbow Research

Mark [ph] – Cleveland Research

Michael Wherley – Janney Montgomery Scott

Josh [ph] – Raymond James

Robert Kosowsky – Sidoti & Company

Jim Barrett – CL King & Associates

The Toro Company (TTC) F3Q2011 Earnings Call August 18, 2011 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to The Toro Company Third Quarter Earnings Conference Call. My name is Elisa [ph] and I will be your coordinator for today. At this time, all participants are in 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. Kurt Svendsen, Director of Investor and Public Relations of The Toro Company. Please proceed, Mr. Svendsen.

Kurt Svendsen

Thank you Elisa and good morning everyone. Joining me this morning for our third quarter earnings call are Mike Hoffman, Chairman and Chief Executive Officer; Tom Larson, Vice President and Treasurer; and Blake Grams, Vice President and Corporate Controller.

Let me now begin with our customary forward-looking statement policy. Please keep in mind, during the call we will make certain forward-looking statements, which are intended to assist you in understanding the company's results. You are all aware of the inherent difficulties, risks and uncertainties in making predictive statements. 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 in our predictions. Our earnings release was issued this morning by Business Wire and can also be found in the Investor Information section of the corporate website, thetorocompany.com.

With that, I will turn the call over to Mike.

Michael Hoffman

Thanks Kurt, and good morning everyone. As you know Steve Wolfe, who served as Toro’s CFO for the past 14 years retired at the end of July after more than 25 years with the company. I’m sure Steve is listening today from his cabin in northern Minnesota. I speak for everyone at Toro in saying we have deep gratitude for Steve’s many contributions and steady leadership.

Without question his financial stewardship played a significant role in putting the company in a great position for his successor now to help drive future growth and profitability. We are very excited to welcome Renee Peterson as Toro’s next Chief Financial Officer and Vice President of Finance. Renee joins us from Eaton Corporation, where she most recently served as Vice President of Finance and planning for the company’s largest standalone business Eaton’s $4 billion truck and automotive segments.

Renee, a native of Minnesota, is a smart, genuine and focused individual, attributes that make her a great cultural fit here at Toro. She brings extensive experience in providing financial leadership for global businesses, along with a proven track record for championing innovative approaches in process improvements and cost controls. She is well prepared to help further our ongoing drive to expand our global reach and improve sales and profits as part of our destination 2014 initiative. Renee starts next Monday and looks forward to meeting with you in the months ahead.

Turning to our results for the third quarter, net sales grew over 9% to $501 million, driven by balanced growth across both our professional and residential businesses, with currency having a positive impact of about 2 percentage points in the quarter. On the earnings front, we posted net income of $35.1 million or $1.11 per share compared to $1.01 per share last year, while sales and earnings per share were records for the third quarter.

And if not for an unusually large rework issue, the quarter’s earnings would have been much better. As we reported this morning, quarterly earnings were negatively impacted by a pre-tax charge of $4.5 million or $0.09 per share on an after-tax basis to account for an one-time expense related to walk power mower rework issue.

For the first nine months, net sales were up 12% to $1,515.9 million, and we reported earnings of $112.6 million or $3.51 per share. While pleased with our results for the quarter, what is most impressive is what we accomplished despite a couple of negative macro trends that challenged both Toro and our customers. In addition to increasingly sluggish economic conditions, ongoing adverse weather has been a significant headwind. At the end of our second quarter, we were talking about a late cool spring, and May is starting to show promise.

Whether then turning cooler than normal in many parts of the US followed by extreme temperatures in July. Southern markets for example have faced excessive heat and moderate to severe drought conditions, resulting in dormant grass that doesn’t require mowing thus slowing retail. Fortunately some of our Northern markets experienced mentionable rainfall that kept the turf growing.

So before I take you through our segment results to discuss a few headlines within our businesses, I would like to take a minute and provide an update on a couple of recent acquisitions. Back in late June we acquired Lawn Solutions to add key product categories in turf renovation to our global line up, including aerators, seeders, power rakes and brush cutters.

This deal provides a strategic fit across multiple brands and extends our offering in the landscape, rental, municipal and golf markets. I’m pleased to say the integration is tracking smoothly, and we are starting to launch some of these products in the rental channel, where we have received a great response. Additionally products from last year’s US Praxis acquisition are gaining strength with national account customers, and we look to extend these products more broadly among rental outlets and independent dealers.

In regards to Unique Lighting, which closed in January, systems integration is near completion. We feel very good about what we have accomplished that will set us up nicely for 2012. We are well positioned to expand sales and profitability in this new category given Unique’s brand strength, Toro’s broad distribution channel and aggressive efforts in new product development, including controls and LED technologies.

Selectively, these new products are resonating well with customers and have strengthened our product portfolio and market position. While relatively small in different stages of integration, each new offering will help drive future growth.

Now to our segment results starting with professional, sales for the quarter increased by almost 9% to $346 million, led by demand for golf equipment, micro irrigation solutions, and rental products. Year-to-date, sales were up a significant 16.2% to $ 1,022.5 million. Net earnings for the professional segment in the quarter totaled $64.3 million, up slightly from $62.7 million last year. Net earnings as a percent of sales were down for the quarter on product mix and increased commodity and fuel costs.

For the first nine months, professional segment earnings were $187.9 million, up 70 basis points as a percent of sales over last year. Looking at our golf business, which continues to perform well, unfavorable weather conditions in some markets have put a strain on golf grounds and revenues. Nonetheless, pent-up demand and new golf growth in emerging markets have contributed to strong worldwide shipments of golf equipment thus far in most areas.

Multicrore spending in large packaged projects have increased over fiscal 2010 levels as customers replace ageing equipment and embrace our innovative new products. Our tracking shows we are closing sales at a higher percentage this year, and taking accounts previously held by competitors. Another positive is request from customers for financing are up slightly from last year at this time, which indicates improved quoting activity in the market and good potential for fall business.

We believe Toro is performing better than the market and strengthening our position in key categories and regions. For golf irrigation, year-to-date projects continue to be strong. The linked central control system has made a big difference, and is gaining serious traction. What once was an area of some weakness has become another point of strength.

Additionally, sales of Turf Guard wireless soil sensors have seen a nice lift. On the international front, Asia continues to enjoy the highest concentration of new golf development, particularly in China and Korea. Although recently showing some signs of slowing, Asia will remain a target for new course construction long into the future. In Western Europe where many countries have mature golf markets like the US, orders from existing courses, mainly in Germany and France are picking up somewhat given increased demand from postponed purchases in the last two years, and some changes made last year to distribution and customer care.

As we often talk about our many valued relationships, I’m pleased to share that Toro recently extended its agreement as the preferred supplier of equipment in irrigation for the PGA European tour, continuing a successful partnership that began in 2000. Through this relationship, we provide product support and expertise to ensure all venues on the European tour are in top condition for tournament play.

Moving to the landscape contractor and grounds category, after a strong first half our business like most of the industry experienced a slight retail slowdown over the last three months. This can be attributed to a variety of external factors, including adverse weather in key sales regions, continued fluctuation in fuel prices and a sluggish economy. Nonetheless, landscape retail remains ahead of last year’s pace. Our channel partners and end-user customers maintain an optimistic outlook related to current and future retail performance, and product confidence is extremely high.

We received a very positive feedback on our Toro and Exmark stand on mowers, especially pertaining to operator comfort and quality of cut. We have also been pleased by the significant the level of retail momentum building for our electronic fuel injection products, which enable contractors to realize significant fuel savings.

As for municipalities, they continue to cope with the soft economy. Tax revenues have improved somewhat, and more states still face budget deficit challenges. Last month, we hosted Grounds Professional [ph] here at our headquarters. Most attendees on the municipal side reduced staff last year and projected their portion of new budgets would be flat. But on a positive note, state and local governments are making purchases of highly productive large rotary mowers, including new products like our innovative Groundsmaster 360.

Even though the economy and housing market remains soft, our residential and commercial irrigation business has done well in making up business lost earlier in the year due to the poor weather. Our success is based on strong support from distribution and industry-leading innovation that is helping advance our position in this critical space.

Irritrol's new CLIMATE LOGIC weather based controller is exceeding expectations, and Toro’s Precision Series Nozzles are growing in popularity and capturing the attention of water districts, and those who write project specifications. Recently we partnered with one water provider, who purchased and gave away more than 55,000 Precision Series Nozzles to residents as part of a conservation program that is projected to save more than 390 million gallons of water over a five-year period. This particular program won a best management practices award from the California Municipal Utilities Association, and received additional funding to extend the program between September and October before resuming in 2012.

On the micro-irrigation business side we experienced significant growth in the quarter as additional capacity helped serve the improving agricultural economy and growing acceptance for drip technologies. Toro’s patented Aqua-Traxx product is building momentum in the US, where we have earned the leadership position with growers as a reliable, high precision means of controlling water and other agricultural inputs.

For example, Toro was recently selected to supply the micro-irrigation system to what will be the largest greenhouse vegetable project ever built in California. On a global basis, demand has been strong in Europe and Asia, particularly in the Ukraine and Russia. You may remember that we broke down [ph] earlier this year on a new micro-irrigation plant in Romania to expand capacity and address the growing acceptance of agricultural drip irrigation in this region. The plant is expected to come on line in the first half of September, both on schedule and on budget.

Turning to the residential segment, sales for the quarter improved 8.6% to $147.5 million. Year-to-date sales were up 3.8% to $480.4 million. Net earnings in the residential segment for the quarter totaled $4.6 million, down from $10.7 million last year. The earnings decline was primarily due to a walk power mower rework and higher commodity and freight expense. For the first nine months, residential segment earnings were $42.5 million, down from $49.2 million in the prior year period.

Once again adverse weather conditions proved to be a drag on the quarter that dampened sales of walk power mowers and lining products. While shipments in both categories were down in the quarter, riders for the year have performed well with innovations like the TimeCutter SS which is taking share and enjoying positive retail for the year.

With the smart speed feature this product plays a key role in differentiating Toro on the sales floor, and provides customers another valid reason to buy Toro. Driving much of our growth in the quarter was significant global demand for snow products resulting from last year’s heavy snowfalls that helped clear inventory.

International sales were also stronger on improved orders from Hayter branded products in Europe, and Pope branded products in Australia. As mentioned earlier, we did experience a disappointing quality issue in the quarter involving a large portion of this year’s rear wheel drive walk power mowers. While not a safety issue, this created a significant challenge for our channel partners, which essentially had to hold product until units were fixed.

I’m pleased to say our team with tremendous help from our dealers and key retailers acted quickly and executed the necessary inspection and rework plan to correct the problem and minimize the impact to our customers. We know quality is a key driver to earning our customer’s trust and we never take this for granted. We remain committed to building innovative high-quality products, and we will be renewing our efforts around quality with some internal changes.

When an issue does arise, our customers know that we will do what is right to ensure their trust in our brands and products. Moving to our key operating results for the quarter, gross margin declined by 170 basis points to 33.5% with the largest factor being rework costs associated with the mower issue. About 75% of the $4.5 million rework impacted gross margin. Also impacting margins for the quarter were increased commodity costs like steel and resin, along with higher freight expense.

For the first nine months, margins decreased 20 basis points to 32.2%. For the full year, we expect gross margins to be flat with last year as a percent of sales. SG&A expense further improved as a percent of sales by 90 basis points for the quarter and 100 basis points for the year through leveraging fixed SG&A costs over higher sales volumes. For the full year, we still expect some SG&A improvement as a percentage of sales.

Operating earnings decreased 80 basis points as a percent of sales for the quarter to 10.9%, but improved by 80 basis points as a percent of sales for the first nine months at 11.6%. Interest expense was up slightly for the quarter comparison. Year-to-date interest expense was down slightly due to the lower average debt levels.

Our effective tax rate for the quarter was 32.9%, down 280 basis points compared to last year. Through the first 9 months, our tax rate was 170 basis points lower at 32.7%. The decline in both periods mostly reflects the retroactive reinstatement of the federal research and engineering tax credit. For the full year, we expect our tax rate to be about 33% to 33.5%.

Moving to the balance sheet, accounts receivable for the quarter rose $28.9 million or 17% on higher sales volumes. Currency accounted for approximately $8 million of the increase, and higher sales related to accounts not sold to Red Iron contributed the rest. Net inventories were up $55.2 million or 31.1% over last year. Looking at the total increase of $55 million, more than half is residential products due to the sales impact of unfavorable weather and about $10 million came from currency. As you recall, inventory at the end of our second quarter was up $85 million in part due to the late spring.

We were able to work through some of that inventory, but the weather and softening economy created challenges, which prevented us from making as much progress as we would have liked. On a positive note, while up somewhat in residential continues to be in good shape. Trade payables were up by $8.7 million or 7.4% resulting from increased levels of production.

So turning to our outlook for the remainder of the year, our summer selling season is winding down, and overall we are encouraged with our performance year-to-date. We can’t help but wonder what they could have been. Some challenges like spring and summer weather and the sluggish economy were out of our control, but some were self inflicted. So now in our fourth quarter we are intent on finishing the year strong and positioning the business for the upcoming fiscal year and the start of the next selling season.

As for the upcoming snow season, which is hard for many others to think about at this time of the year, we have picked up additional placement at a major retailer, dealer bookings are solid, and preseason retail is off to a great start. Overall Toro is positioned well with a strong electric, single stage, and two stage line-up.

As we said in our release, we’re reaffirming the guidance we issued at the end of the second quarter that being we continue to expect earnings for fiscal 2011 to be about $3.60 per share on a revenue increase of approximately 10% to 12%. Between now and the next call, we will be attending key industry trade shows like the GIE Expo in October, and the Irrigation Association show in December. We look forward to connecting with our customers as we launch several near products, including the new Lawn Solutions line up.

So this concludes the formal remarks. We would now be happy to take your questions. So Elisa back to you.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from the line of Mark Rupe from Longbow Research. Please proceed.

Mark Rupe - Longbow Research

Hi guys. Mike, on the gross margin, you mentioned that obviously the rework expense was a big part of that, but could you walk through again the components of the decline? It looks like if the rework is all through the cost of goods, it looks like that's maybe 80 basis points to 90 basis points of the 170 basis points kind of, is that right?

Michael Hoffman

I think 75% of the cost hit gross margin. The balance hit SG&A and warranties.

Mark Rupe - Longbow Research

So that – is that behind you now I assume?

Michael Hoffman

It is thankfully behind us.

Mark Rupe - Longbow Research

Okay, and then as far as the outlook, as far the commodities, I know that, it’s pretty clear on the last call that commodities will be higher in the back half. How should we think about commodities and the higher freight going into, I guess the fourth quarter, and into the early next year on the flow?

Michael Hoffman

Well, I think, relative to as we wrap up the year that’s reflected in our guidance. So, as we’ve said we will work to have our gross margins remain kind of flat through the rest of the year now. Much of that inventory has been built. As we think about commodities, and you know, commodities move in one direction, and then they move in another direction. As we think about commodities for 2012, that’s something we’re building our plans around right now looking at – as we said before we don’t price to cost, but we look at what’s going on in the industry, and so as we project commodities for 2012 that will be factored into our pricing strategy as always. So in the fourth quarter is when we start moving out with some of the 2012 pricing and setting the stage for next season’s spring business if you will.

Mark Rupe - Longbow Research

Okay, and then on the Professional segment, you said golf was strong, but then you said that product mix was a little bit of issue on the margins, just trying to look at the two and where am I missing, some in golf typically higher margin or was it something else within golf or something else that brought the product mix being I guess more unfavorable?

Michael Hoffman

Yes, within the Professional segment we have some things like factoring in the acquisition of Unique put some pressure on the margins. All-in golf as you know is one of the stronger, more profitable businesses, and so – but there's still some moment even within that area. But I would leave it at golf is very healthy.

Mark Rupe - Longbow Research

Okay. Well, you called out Asia being – showing signs of slowing. I mean, how material in the big picture is that, that comment?

Michael Hoffman

Yes. When we look at Asia, which we talked about before, it's relatively – all-in, it's less than 5% of our revenues, still obviously very important, because a large part of that is golf, and the most headwind, if you will, we faced in Asia this year was a result of the Tsunami in Japan. Japan is a very large golf market, and certainly we have great relationships there especially with some of the larger multi-course accounts and they not surprisingly, they backed off purchases this year and we very much expect those to come back in 2012.

Mark Rupe - Longbow Research

Perfect. Thanks guys. Good luck.

Michael Hoffman

Thanks Mark.

Operator

Your next question comes from the line of Eric Bosshard from Cleveland Research. Please proceed.

Mark - Cleveland Research

Good morning everyone. This is Mark [ph] stepping in for Eric.

Michael Hoffman

Hi Mark.

Mark - Cleveland Research

I guess, first question, can you just revisit inventory and can you give us – I think your previous expectation was, it would be worked down by the end of 2011. How do you sit today, how do you think inventory will look at the end of the year, and then I guess – go ahead and answer that question first?

Michael Hoffman

Well, certainly, Mother Nature has not – plays a role, has not cooperated, since we talked on our last call in May to the degree we would have hoped. That's certainly a part of it. So we didn't work it off quite as fast as we would have liked. So it will be up, and I think, when we talk about inventory, we put this into kind of our working capital context, and as you've seen we worked very hard to drive our working capital down as a percent of sales when we look at this on an average basis, and like we talked with you, because of the nature of our business with a couple of big quarters and a couple of relatively smaller quarters, we tend to want to look at the year and want to look at the year from a working capital standpoint.

So, all-in, and inventories plays a significant role in that, we ended last year on an average working capital of 13.9%. That will be up closer to 15%; still good and still very much in with how we talked about, how we’re going to manage working capital. So, it’s not – it didn’t work out quite as fast, particularly on the Residential side as we would have hoped, but it’s I would characterize not a – we don’t consider it a problem, because it feels a bit of an opportunity. Then, as I said on the remarks, field inventory, well, up a little bit, particularly because we shipped in snow, but riders are up a little bit, and it is mostly on the Residential side. All-in, field inventory is still in very good shape. So, we think, it’s manageable.

Mark - Cleveland Research

In terms of the third quarter, can you kind of give us a sense for maybe what played out better than expected and what played out worse than expected. I guess, sales, year-to-date are up 12%; you’re holding it 10% to 12%, which implies maybe a little pressure in the fourth quarter. Receivables were up. Can you just walk through how the quarter played out, did you see strength towards the end of the quarter, where was the strength, where was the weakness during the quarter versus kind of your expectations 90 days ago?

Michael Hoffman

Yes, I think, we would sum it up that as we talked to you in May, the macro factors, if you will, weather was relatively worse, the economy was relatively worse than we would have expected or hoped, if you will, and so that puts some pressure on all the businesses, it puts more pressure on if you will, the Residential business because those decisions are made real-time as opposed to get over to the golf end of the business, and those are more planned purchases, if you will, in golf.

So, golf held up better. There is some relatively more pressure on the landscape contractor side and the most pressure on the Residential side. So, now we have a bit of an offset on the Residential side because while the spring and summer weather was not particularly favorable, the strong snow season we had last year and the early demand we're seeing for snow this year that pulled up some of that product. So, that goes on the positive side of the ledger, but snow can't make up for the total of walk power mowers and riders. And as I said on the remarks, while shipments are down on riders, retail year-to-date is ahead of the pace of last year on riders. So, that's a plus.

Mark - Cleveland Research

In regard to 2012, I was hoping you could give a little bit of color on how you're thinking about next year. I think in 2010, and then here in 2011, you started off with pretty limited sales growth outlooks and have far exceeded the initial outlook. So, curious how you're thinking about 2012 from a sales and margin perspective. Any color you can give would be helpful.

Michael Hoffman

Well, we won't provide a lot of color, Mark, but we'll certainly do that in much more depth when we have our next call in December. Now with that said, like others we're trying to anticipate to what degree the economic environment will improve or worsen. That certainly will influence our forecasting. We still have our Destination 2014 goals in place. So, while we'll certainly exceed our revenue goal this year, well exceed the $100 million, it'd be closer to $200 million. That $100 million is still in place, $100 million for 2012.

On a year-over-year comp basis, snow, we’re going to be comping against a strong year, still relatively smaller part of our business. On the other hand, spring and summer products, particularly in the residential arena, should be easier to comp. The hope would certainly be that weather is not as much of a negative headwind as it was in 2011. So that should go on the positive side of the ledger. Some of the acquisitions that while smaller still will move us in the right direction as we move in 2012.

Commodities, that’s something we are looking at closely and trying to – that will tie to some degree into the economic recovery. And so, if the recovery continues or strengthen, we know we’ll see some commodity pressures and we got to factor that in, we’re all guessing a bit at that. We have the Romania plant coming online. So, we are going to look unless we face a significant downturn in the economy and obviously, there are signs that could happen, but unless we really faced that we think we would look at 2012 favorably. Again, we’ll talk in more depth when we get on the call with you in December.

Mark - Cleveland Research

Okay. Thanks guys.

Michael Hoffman

Thank you Mark.

Operator

Your next question comes from the line of Jim Lucas from Janney and Capital. Please proceed.

Michael Wherley - Janney Montgomery Scott

Hello, this is Mike Wherley filling in for Jim this morning. How are you guys doing?

Michael Hoffman

Good morning Mike.

Michael Wherley - Janney Montgomery Scott

First off, I’m just curious what you guys are hearing from your Professional end markets, both the dealers and end users. You've had a nice rebound this year, but, just sort of wondering what you’re hearing from them right now.

Michael Hoffman

Well, as I said earlier, Mike, the golf market, I’ll say the worldwide golf market remains very solid, it’s not slowed down and now whether that – again, as we talked just a minute ago about the economic environment whether that changes, we’ll be watching that closely, domestically and around the world. So, I think golf remains relatively positive, and one of the things that we’ve talked with you about in the past is when we hit ‘09 golf was the most impacted, which was very unusual historically in economic downturns, and our hope is maybe we could, if things slow down a bit, golf still remains solid, but something we’re watching closely.

Certainly, the landscape contractor, as I said, retail-wise, we’re ahead year-to-date over last year, so that’s a plus. There is always a little bit of a concern there. Fuel prices impact particularly that business more. Now they’re softening and so that hopefully will remain positive and will comp well versus last year and set ourselves up nice for 2012. In the residential business, it had the most variability, and again, we’re heading into the snow season, that should be a positive given what happened last year spring and summer for residential next year.

That will be a forecast or a guess around again, around those two macro factors being, Mother Nature, that should comp positive and a bit of the economic environment. There will be as we head into preparing for that, we’ll be out to industry shows now over the next 90 days, we’ll learn a lot, we’ll be launching new products, and, again, we’ll have a better sense and talk with you in more depth about that in December.

Michael Wherley - Janney Montgomery Scott

Okay, on the micro irrigation front, if the Romania plant can be fully operational in September or when would that happen?

Michael Hoffman

Well, it’s a staged startup and so these are extrusion lines, very sophisticated extrusion lines that are put in. So it will start producing product in September, but lines will continue to be added probably over the next 12-plus months. So, it will – to be – I don’t know what fully utilized is, but it will have some – we built the plant with some room for expansion, but it will be significantly utilized as we move into 2012.

Michael Wherley - Janney Montgomery Scott

And do you see that the near-term impact of that plant as growing those sales or just sort of taking what was being produced in Italy or something else?

Michael Hoffman

Yes, both. We’ve added lines over the last couple of years in the US here and down in one of our Southern plants and shipped a lot of that product all the way to Europe and to Eastern Europe, and so now we’ll be able to produce that product in-market, which is a plus and free up then that capacity in the US for the US, Mexico, South American markets. But, it should accomplish both for us.

Michael Wherley - Janney Montgomery Scott

Okay, and then just last, I was just wondering what you can tell us about the freight cost, was that an unexpected thing or was that worst than last quarter as far as the impact on margins?

Blake Grams

Mike, this is Blake Grams, so I’ll talk to that. So, we had a kind of double-whammy on the freight, so obviously with diesel prices increasing during the year, that’s obviously hit us worse in the back half of the year. And then also as we export products overseas, this cost of shipping those products overseas has also seen a very significant increase over this year as the export economy has continued to grow in the US and imports coming in and such.

Then obviously, with the rework issue we had, we had moving a lot of products multiple times, unfortunately, which also caused some freight challenges with us. So, with the moderation of gas and diesel prices as of late, we hope we’ll see a little bit of positive impact as we go forward, but it was definitely a real challenge for us, and probably little bit worse than we expected as we came into the year.

Michael Wherley - Janney Montgomery Scott

Okay. That helped a lot. Thanks a lot guys.

Michael Hoffman

Thank you Michael.

Operator

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

Josh - Raymond James

Good morning gentlemen. This is Josh [ph] filling in for Sam. How are you?

Michael Hoffman

Good morning Josh. Well, thank you.

Josh - Raymond James

Good, a couple of questions, first kind of around 2012, do you have any sense of what inventory strategies might be at the dealers and the retailers in the coming season?

Michael Hoffman

When you say inventory strategies, as we have discussed, we think field inventory is in good shape, right. It's up a bit with snow but that's moving as we speak. And our focus, as we've talked many times, focus is on retail. If you take care of retail everything else takes care of itself. So, we wouldn't expect to see dealers on the Residential side or the Professional side try to drive a material change in their inventory levels. I mean, not sure they can; that was certainly an issue that we worked on as we put this working capital initiative in place through 2009, 2010. Now, it goes much farther, we won't have the inventory there to support the sales. So, no, we’re in good shape there and we wouldn’t expect to see any significant change there.

Josh - Raymond James

Okay, and then looking at your product portfolio, where do see your vitality index into the coming year?

Michael Hoffman

Vitality index – oh, you are talking about the new products?

Josh - Raymond James

As a percent of sales?

Michael Hoffman

As a percent of sales. Well, it probably won’t be quite at the level 2011 – and, again, remember this is a three year run rate, it will still be very strong. Our goal has long been to be over 35% on a three-year average, and we’ll be well above that in 2012, some place probably in the, I guess at this point, a little bit mid-40s.

Josh - Raymond James

Okay, and then, a bit of housekeeping, just to clarify the reiterated guidance of $3.60, does that include or exclude the $0.09 item this quarter from the rework?

Blake Grams

It includes the cost.

Josh - Raymond James

It does include it, okay. Thank you very much.

Michael Hoffman

Thank you Josh.

Operator

Your next question comes from the line of Robert Kosowsky from Sidoti & Company. Please proceed.

Robert Kosowsky - Sidoti & Company

Hi, good morning Mike. How are you doing?

Michael Hoffman

Good morning Rob.

Robert Kosowsky - Sidoti & Company

Just quick question, do you have an estimate for what you think the retail lawn and garden market was down in the quarter or kind of what it’s going to be trending towards declining for the year?

Michael Hoffman

I apologize, I don’t, but we can get back to you on that. Certainly we’ve – snow, we think will be as I said, will be a positive. We heard some discussion that it will be in that neighborhood of 10%. As I mentioned earlier that riders for us all-in are comping positive, walkers are obviously comping negative, and that’s I think a sign, a bit more of the riders being a bit more of a planned purchase, and walkers being maybe a little more influenced by what’s going on weather-wise. And we see that, we look at this data by kind of usually [ph] US but across the US by region, and areas that have had more problematic weather comped negatively. A good example, the Midwest comped very poorly through the spring period, not surprisingly, right now down in Texas, which is enduring a really painful drought. We’re not comping there right now. So all-in, walkers will probably be under the most pressure if you will.

Robert Kosowsky - Sidoti & Company

Okay thanks. That is helpful. And then I noticed in like the segment breakdown, it looks like other income was $5 million favorable comparison versus last year, like $16.7 million versus $21.4 million, and I was just wondering what the drivers were in that line item and why it was down?

Blake Grams

Hi Rob, this is Blake, I’ll answer that question for you. So, as we looked at last year at this time, obviously our sales [ph] were accelerating at that time, so, the incentive expense was kind of little bit more back-loaded last year as we continued to do much better than we expected. This year, we’re not doing as well compared to our plan levels, so the levels of those payouts will be lower and kind of trending the other way kind of the back half of the year.

So, the biggest portion of that was the incentive expense is lower than it was a year ago, and a good chunk of that expense is recorded in the other segment. A couple of things were kind of in there. We had some one-time items for product liability last year, which didn’t repeat itself this year plus our distribution profitability is recorded in that line and this year we have one more distribution company that we own and both of our two companies are doing better than they were last year. And also our Red Iron investment is in that line, and as it gets into the second year of operations full level of profitability compared to kind of startup mode last year that business is also doing better than last year. So, all those items kind of led to a lesser loss in the quarter as it was last year.

Robert Kosowsky - Sidoti & Company

Okay. Lots of puts and takes?

Michael Hoffman

Yes, exactly.

Robert Kosowsky - Sidoti & Company

And then, I was also wondering, what was acquisition revenue in the Professional segment?

Michael Hoffman

You know, acquisition revenue is less than 1%. It’s a small part this year. Obviously, we expect that to be a little more of an accelerator next year.

Robert Kosowsky - Sidoti & Company

Okay, and then a couple of quick questions. You mentioned you picked up snow placement for next year with big boxes, was there a one particular big box, was there a particular pipeline fill that was going on in this quarter that maybe kind of inflated the revenue because of that?

Michael Hoffman

Well, not because of that. I would say we have certainly shipped year – as we mentioned, we shipped year-over-year snow a little earlier, that’s driven as much by field inventories were very depleted, and while we’re still in August, people are buying snow throwers as we speak as we talk to dealers and we talk to depot and so. If they’re going to be buying snow throwers, we need to be there so that did pull the shipments forward a bit.

Robert Kosowsky - Sidoti & Company

Okay, and then as far as the product rework expense, what exactly was the issue and did it affect Toro brand or different brand, and then is there any risk for like products, like warranty claims coming down the road?

Michael Hoffman

Yes, it’s a good question. We think we factored all the expense in that we will face. It was a disappointing issue, it was a case where we made an engineering change to improve the product, and these things happen sometimes, not very often to this magnitude that for whatever reason we missed catching an unintended consequence. So, as I said earlier, it’s not a safety issue, it was a fairly easy fix, but because of the quantity of replacing a couple of screws, because of the quantity of the mowers involved in bringing them back, as Blake talked about the freight expense and everything else, it just turned out to be a very expensive rework.

We were very appreciative with our partners, depot and dealers that helped get us through it, but at the end of the day, it certainly is one of those things where you're building equity, brand equity, or you are borrowing it. We probably borrowed some, but most of the product was fixed long before customers saw it. So, we're dealing with those units that did get sold. That was very much the smaller part of the quantity if you will. I don't think it will have any significant brand impact. It’s just an expensive lesson.

Robert Kosowsky - Sidoti & Company

Okay, was it the Toro brand or can be…

Michael Hoffman

I am sorry. Yes, only it was the Toro rear wheel drive mowers only.

Robert Kosowsky - Sidoti & Company

Okay, and then finally, I think you mentioned some new electric mowers maybe in the landscaper side to lower fuel costs. Can you kind of maybe just talk about longer-term, where you see electric mowers going, and kind of maybe on the retail side as well?

Michael Hoffman

Let me be clear. That’s not an electric mower. It's an electronic fuel injection system that is on the engine that allows the unit to leverage its fuel use far more. So it's still a gas powered product. But to your question on electrics, we continue to invest in alternative fuel strategies. So, for example, we're right around the corner for starting production on the first lithium-ion battery-powered walk greens mower. So, whether it's the golf arena, or the landscape contractor business, or the consumer business, you will see more and more alternative fuel, and a number of those will be battery-powered kind of products in the market from Toro in the future.

Robert Kosowsky - Sidoti & Company

Okay, thanks. And good luck with the conversations with customers in the next 90 days.

Michael Hoffman

Thank you Rob.

Operator

Your next question comes from the line of Jim Barrett with CL King & Associates. Please proceed.

Jim Barrett - CL King & Associates

Hi, good morning everyone.

Michael Hoffman

Good morning Jim.

Jim Barrett - CL King & Associates

Mike, could the Asian demand, I heard your comments as it related to Japan, but I believe you indicated Chinese and Korean markets were moderating, is that temporary in nature or do you see that the start of a more secular trend in those two markets?

Michael Hoffman

Well, here’s how I would answer that. There certainly has, and this is not the first time it’s happened in China where golf growth was building some momentum and then in different times the Chinese government gets involved and may slow things down. But we started from the position that there are approximately 500 golf courses in China for 1.3 billion people and there are 16,000 in the US for 300 million people, and so while we want to do the extrapolation madness, I think that would extrapolate to 69,000.

It’s fair to say that long into the future there will be likely golf growth in China. As well as some of the other parts of Asia, Korea is a solid golf market we expect that to continue for the next few years. I was talking with some of our international folks just earlier and even in some other parts of Southeast Asia, Thailand and Vietnam we continue to see some positive signs. So Asia golf will continue to be a growth driver for us we believe, and then as I said Japan will recover next year and that’s significant as there is, I don’t have the number here in front of me, but there is 2,000 or 3,000 golf courses in Japan, and they really did not surprisingly, because of the tsunami they did pullback and we would expect that recovery and they continue to cut the golf courses, so we expect that recovery in 2012.

Jim Barrett - CL King & Associates

Okay good. And when we look at the golf market overall I know one of your two competitors highlighted earlier in the year higher volumes in their golf business, aside from your sheer performance in golf can you give us an update on the competitive dynamics within the golf category or is that pretty much remain the status quo?

Michael Hoffman

I think it is – well, it’s obviously very competitive with the – there are two – there are three significant players on the equipment side and two, if you will in the irrigation side and something we watch very closely. So I guess, I would just sum it up by saying the market is improving, if you will from, I know it’s low in 2009 and our share is improving with that, may be to, even a slightly more favorable position.

So we feel very good about our current share positions, something that we’re very focused on. Winning in that arena is all about product innovation, giving the customers better solutions and then being, being very committed to the aftermarket service. We have a wonderful set of distributors here in the US and around the world that also give us, we believe competitive advantage.

Jim Barrett - CL King & Associates

Okay, and last and least, the rework issue here in the US did that result in any out of stocks at retail or any impact on revenues in the quarter?

Blake Grams

Well, that certainly already been, to whatever degree it was, it’s there. It’s hard to measure that. This was, as I said, these were the rear wheel drive products. At the same time, we still have front wheel drive products on the floor and Lawn-Boy products on the floor at depot. Did it have – did the customer choose not to buy a Toro, buy something else as a result. We handled this – the team handled this very fast, very aggressively, and so while at the end of the day, it didn’t help, we don’t think it had any material impact on retail.

Jim Barrett - CL King & Associates

Okay. Thank you very much.

Michael Hoffman

Thank you Jim.

Operator

At this time, we have no further questions in the queue. This does conclude the question-and-answer portion of the call. I would like to turn the call back over to Mr. Svendsen for closing remarks.

Michael Hoffman

Well, I’ll close Elisa, and thank you, and we thank all of our folks for listening and for your questions, as well as your interest in Toro. So we look forward to talking with you again in December, and we’ll discuss with you our year-end results and our outlook for 2012. Thanks very much. Have a great day.

Operator

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

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