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Executives

Mike Hoffman – Chairman and CEO

Steve Wolfe – VP, Finance and CFO

Analysts

Jim Lucas – Janney Montgomery Scott

Eric Bosshard – Cleveland Research Company

Sam Darkatsh – Raymond James

Seaver Wang – Utendahl Capital Partners

James Bank – Sidoti and Company

Jim Barrett – CL King & Associates

The Toro Company (TTC) F3Q08 (Qtr End 08/01/08) Earnings Call Transcript August 21, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to The Toro Company third quarter earnings conference call. My name is Shameeka and I'll be your coordinator for today. At this time, all participants are on a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator instructions) I would now like to turn the presentation over to your host for today's conference, Mr. Michael J. Hoffman, Chairman and Chief Executive Officer of The Toro Company. Please proceed.

Mike Hoffman

Thank you, Shameeka. And good morning, ladies and gentlemen, and thank you for joining us for our third quarter earnings conference call. Here with me this morning are Steve Wolfe, our Chief Financial Officer; Tom Larson, Treasurer; and John Wright, Director of Investor Relations.

Let's begin with our forward-looking statement policy. Please keep in mind that 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 our corporate website, thetorocompany.com. Before I turn it over to Steve who will review the financial results for the third quarter, I’d like to take a few minutes to update you on our business and the progress we’ve made on key issues mentioned during our second quarter call.

As you know, we’ve worked through a good portion of the prime selling season in an environment that has been challenging for Toro and the entire industry. While Mother Nature has been somewhat more favorable these last few months, we’ve been even more impacted by the effects of a weak domestic economy and increase commodity and fuel costs. Even so our business remains sound, our financial health is strong, and we are managing through these difficult economic conditions.

Let me make a few comments on where we’ve made progress in the quarter. First, we’re aggressively pursuing retail through targeted programs and spending. With the best distribution network in the business, we are collaborating to drive retail activity, extent our customer base, and strengthen our competitive position. Aside from retain programs, one of the contributors to our sales growth in the Professional business for the quarter was the introduction of new products.

For example, we are pleased to say we began shipping our all new 16-foot Groundsmaster 5900 series rotary mower, which retails for over six figures. However, in a time when budgets may be stretched, productivity is extremely important and this product delivers it mowing an acre in less than five minutes. It also comes with a climate-controlled cab, onboard diagnostics, and many other features. This product replaces the industry standard, the Toro 580-D, first introduced in 1989. And we’ll again raise the bar in productivity, durability, and operator comfort and control.

With these new and our existing products, we believe we are holding or gaining share in nearly every major category. I did mention last quarter that we experienced some share erosion in the Walk Power Mower business. We’ve closed the gap the last couple of months and are now close to being on track with the industry.

The second point, as we discussed on our last call, is that both our inventory here at Toro and our field inventory levels are much improved versus the same time last year. We’ve been even more proactive this year and have made adjustments sooner to better match customer demand. These gains are also a reflection of our increasing focus on inventory management and working capital.

And finally, we are taking appropriate measures to drive out waste, control expenses, and improve productivity, without compromising our ongoing investments in marketing and engineering. We continue to increase investments in engineering even in an environment where we expect sales to be flat with the prior year. And in fiscal 2008, we increased our marketing expense and ran new Toro brand commercials throughout the country.

With that, I’d like to now turn it over to Steve to review our financial results for the third quarter and year-to-date.

Steve Wolfe

Thank you, Mike, and good morning to everyone. I’m going to give you a topline financial review starting with the quarter. Third quarter, our net sales were up nearly 3% to $492.6 million. The sales growth was mainly due to the strength of our international business as well as increases in shipment snow products, particularly in North America. And earnings in the third quarter were $38.2 million or $0.99 per share. This is a small decrease on a per share basis compared to the last year’s position.

For the quarter, net earnings were dampened by gross margin at the gross margin level as a result of increased raw material and freight costs and lower production volumes. For the first nine months, net sales were $1,536.9 million. This is down slightly when you compare it to the prior year. During the year, our international business was up 12% due to strong demand for golf maintenance and golf irrigation systems along with favorable currency. For the year-to-date we’ve posted net earnings of $119.6 million and that’s $3.06 per diluted share.

With that overview, now let me turn to our segment results, starting with the Professional segment. Professional worldwide sales for the third quarter were up 5.9% to $351.6 million. International once again led the way with strong sales growth in most Professional categories, while domestic Professional sales were down slightly under difficult market conditions. A portion of this increase was influenced by price increases that went into effect August 1 for certain products.

Within the golf market, worldwide demand for maintenance equipment and precision irrigation systems remained strong. Meanwhile, sales declined significantly for professionally installed residential and commercial irrigation products due to the continuing weakness in the housing market and other economic pressures. On a year-to-date basis, net sales for Professional segment were up 2.2% to $1,074.7 million.

Earnings in the Professional segment for the third quarter were $71.1 million, up slightly from the prior year. The slight improvement for the quarter was attributable to higher sales, product mix, and favorable currency, which was largely offset by rising material costs and freight and lower production volume. For the year-to-date, Professional segment earnings totaled $220.2 million, which is down 3.3% from the prior year period.

Shifting now to the Residential segment, worldwide sales were down less than 1% to $132.1 million. With our ongoing international growth objective, we experienced strong worldwide demand for riding products in Europe and Canada, along with increased shipments for our popular Pope branded products in Australia. Also up for the quarter were shipments of snow thrower products in North America, as pre-season orders in the third quarter were stronger due to lower field inventory levels and accelerated demand heading into the upcoming snow season. Offsetting some of these gains were lower domestic shipments of Walk Power Mowers due to poor economic conditions.

For the year-to-date, net sales for Residential declined 4.6% to $441.6 million. Third quarter net earnings in the Residential segment were $3.4 million, down 58.3% from the previous year. And the year-to-date Residential segment earnings totaled $27.3 million, down 31.8%. While we continue to experience challenges in our Residential business, we are taking appropriate actions to manage cost pressures, drive retail demand, and improve our share position as we prepare for fiscal ’09.

Now let me turn to operating results before I turn it back to Mike. Gross margin decreased by 180 basis points for the quarter due to rising commodity and freight costs and lower production volumes. These were somewhat offset by favorable currency and product mix. For the year-to-date, our gross margin is down 60 basis points compared to last year for the same reasons that I just mentioned.

SG&A expenses for the quarter were up by $300,000, but decreased to 22.5% of net sales, down from 23.1% last year. The improvement was a result of lower incentive expenses, somewhat offset by higher spending for marketing and engineering investments. Year-to-date our SG&A expenses were 23% of net sales compared to 22.6% the prior year. SG&A expenses were higher mainly due to increased investments in marketing and engineering to grow our business for the long-term, which were somewhat offset by lower incentive expenses.

Interest expense declined by $300,000 for both the quarter and the year, and this decline for both periods was largely due to lower interest rates. And our effective tax rate was 34.2% compared to 33.4% for the third quarter of last year. As we’ve mentioned on our previous calls, we continue to experience negative impact on our tax rate this year due to the December ’07 expiration of the Federal Research and Engineering credit, which is yet to be renewed.

On a very positive note, our balance sheet remains very healthy. Our accounts receivable were down $14.8 million or 3.9% at the end of the quarter. And as Mike mentioned earlier, our inventory position has much improved with net inventories down by $31.7 million or 15%. And finally, I’m pleased to report that the cash generated from operating activities increased by $42 million for the first nine months, which we used to repurchase $1.4 million common shares in the quarter.

That’s it for the quarter and year-to-date. So I’ll turn it back to Mike.

Mike Hoffman

Thank you, Steve. And before I share our outlook for the remainder of the year, let me touch on a few key strategies that are important for our position as we move into the future. First, we continue to have a healthy stream of new products that deliver quality performance and durability. Some of these products like our ProCore aerators, Workman MDX utility vehicles, and Aqua-Traxx PBX micro irrigation drip are major upgrades to existing lines helping protect our positions.

Others like the Dingo TRX trencher, ProCore Processor and soon to be delivered stand-on mower for landscape contractor professionals move us into totally new categories and will drive incremental sales growth. Second point is we are committed to innovation as evidenced by the more than $250 million invested over the last five years in research and new product development.

One focus is to pursue technologies and ideas to help customers increase productivity and use fuel resources like water and fuel. Consistent with our emphasis on innovation in the environment, we recently celebrated the tenth anniversary of our Center for Advanced Turf Technology or CATT team. This important cross divisional team of engineers and agronomists is critical to our future as they discover new ways to deliver greater value to our customers. This is a significant milestone for us, but it’s only the beginning as we look across the entire marketplace to identify long-term trends and technologies that will drive future growth.

The third point is we are strengthening our position in the water management business, as global concerns surrounding water availability and usage increased the demand for our water saving irrigation technologies. Beyond our drive to bring new product innovations to market, we are also forging relationships and learning from customers around the world.

For instance, we recently hosted our third annual WaterSmart Symposium to increase understanding and discover new ways to use water more efficiently and responsibly. For Toro, this is part of our ongoing effort to provide education on the importance of copper water management and position the company as the leading provider of precision irrigation systems. If you want to learn more about this global event featuring speakers like legendary golfer and golf course architect Jack Nicklaus, please go to www.torowatersmart.com.

And the last point I’d like to comment on is how we are encouraged by the growth in our international business. This trend continues to bode well for us. Not only do we expand our global presence, but it also gives us a more diversified portfolio to help offset the challenges in the domestic market. And as we are witnessing today with all eyes being focused on the excitement in Beijing, we are pleased to have our products being used throughout the main stadium, forestry park and the baseball field. So all in, we remain confident our strategies will drive long-term growth and allow us to bring innovative solutions to customers worldwide.

Now let’s turn to our outlook for the remainder of the year. We expect market conditions to remain difficult. In particular, we are paying close attention to the volatile commodity markets. This is a formidable challenge as we deal with the cause of inflation for steel, resins, aluminum and other commodities. As you know, this impacts almost everything we manufacture.

Our efforts to address this issue have been focused on working with suppliers and their price increases, proving productivity and gaining efficiencies through our lean initiative. However the recent acceleration of commodity costs has made it tough for us to maintain our current pricing. As a result, we’ve recently implemented price increases on many products. For Toro, the decision to raise prices is something we evaluate and reevaluate. We are always sensitive to the impact price increases have on our customers. We pride ourselves on the ability to manage cost pressures while providing innovative and high quality products to our customers.

We’ll also continue to manage cost issues by working closely with our partners to improve the overall supply chain efficiency. Additionally, we are taking appropriate measures to improve our inventory position and drive retail demand through continued commitment to innovation and its benefit to the customer.

An example of combining innovation, design through manufacturing and improve supply chain efficiency is the development of our new next generation commercial Zero Turn Mower. This product is on track and is expected to reach production readiness in this quarter. However, depending on final qualifications, some or all of these shipments could move into the first quarter of the next fiscal year. We will manage the process closely and we look forward to updating you on this innovative new product in December.

Taking all these factors into account, we continue to expect fiscal 2008 net sales to be roughly equal to fiscal 2007 net sales, and now expect net earnings per share to be down 6% to 9% from the $3.40 per share reported for fiscal 2007.

Let me finish by saying that we remain encouraged by the passionate efforts of all of our employees and channel partners to manage costs, improve efficiencies, and strengthen relationships around the world. Our business is sound, our cash flow remains strong, and we continue to invest prudently in our business for the long-term health of the company.

That concludes the summary of the Toro Company’s fiscal 2008 third quarter. Now let’s open it up for your questions. Shameeka?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from the line of Jim Lucas of Janney Montgomery Scott. Please proceed.

Jim Lucas – Janney Montgomery Scott

Thanks. Good morning guys.

Mike Hoffman

Good morning, Jim.

Steve Wolfe

Good morning, Jim.

Jim Lucas – Janney Montgomery Scott

First question on, Steve, FX, what was the contribution in the quarter?

Steve Wolfe

For the quarter it was about $7 million and instead of being up – hand on a second – instead of being up 15%, the international side would have been up about 9%. So you’ve got 9% organic growth. The rest was FX, which is $7.5 million.

Jim Lucas – Janney Montgomery Scott

Okay.

Steve Wolfe

For the year-to-date, it was – we were up 12%. Half of that FX, or little over $27 million.

Jim Lucas – Janney Montgomery Scott

Okay, that’s helpful. And gross margins, if you could dive a little bit deeper into the 180 basis points erosion in the quarter, you called out a couple of things. If you look at the commodity and freight, and so the inflation side versus the lower production volumes, what was just the ballpark, the contribution of the margin degradation between those two factors?

Steve Wolfe

Yes. By far, the biggest factor are commodities and freight with what’s going on with things like steel and the things we’ve been talking about often on for the last year. And with diesel prices due to what’s happened to oil. The production side of it, the hours side, it certainly was a factor, but it pales in comparison to the commodity piece. And it’s something we’re continuing to deal with and figure out for the rest of the year where we are going to end up, but the bulk of it was the commodity side.

Jim Lucas – Janney Montgomery Scott

Was it two-thirds a third or was it greater than that?

Steve Wolfe

No, that’s probably – even greater percent was commodities than that.

Jim Lucas – Janney Montgomery Scott

Okay. All right. The main thing trying to get a handle on is what the gross margin picture looks like going into next year and that’s why I wanted to get a better feel for what is going on from a production standpoint. When you go back and you talk about some of the things that you are doing to combat the inflation side of the equation, besides the new products comprising – I know it’s too early for you to talk about 2009, but just directionally I’m trying to understand where gross margins are heading.

Steve Wolfe

Yes. It’s – you’re right, we are not going to talk about it and we’re not here today to talk about ’09. As we’ve gone through this – and we’ve done a pretty, we think, a reasonable job in terms of putting off a lot of these commodity increases through – particularly through fiscal ’08 as we’ve seen prices go up significantly. And keep in mind, we buy a lot of steel, for example, we buy a lot of component steel pieces. So we don’t necessarily see the increase as soon as it hits the marketplace. We are now – in this third quarter we’ve seen the full impact of a lot of those increases, which is why we’ve had such a big number here. And as we’ve looked at that, going back to try and figure out as we’re doing our ’09 planning – and we do get ready to talk about – we think for the first nine months of the year, commodities have cost us probably about $15 million more than we had expected in our initial plans. And if you run the math on that, it says that for the year, that’s probably going – we feel the full effects of all these things. It’s going to be closer to $30 million for the year. So, as we finish up not only looking into ’09, but looking into ’08, we’ve got to look at our options there for the rest of the year. We did put a price increase in place 1st of August, which I mentioned earlier, that will help us offset some of that. But we’re going to need to look at everything we can in terms of making sure that we get our margins in as better shape as we can, given what’s going on with these commodities. But we know that’s going to be a very strong headwind for the rest of the year as well as going into ’09.

Jim Lucas – Janney Montgomery Scott

Okay. And with regards to the fourth quarter, it wasn’t that long ago that you guys were actually losing money sometimes and it has at least turned profitable on a consistent basis. But when you look at the fourth quarter of what you are seeing now versus what you had talked about three months ago, is it primarily inflation? Is it topline that you’ve seen slowing in the fourth quarter or increased investments? Can you just talk a little bit about what you are seeing besides the inflation headwind going into the fourth quarter?

Steve Wolfe

Let me just make a comment and I’ll let Mike comment on that. The profitability difference obviously is commodities. And we are going to have more – we envision more costs just because we are seeing the full impact of all of these as we move into [ph] the last part of the year.

Mike Hoffman

Well, I think Steve has hit the main point. It is the concern about commodities. It is – there are other factors there. It’s obviously a small quarter for us. We have new products in development. One of those planned in the fourth quarter that could swing either side. We ended up pulling up some snow because of increased demand in the third quarter. And the replenishment of that as retail gets underway in the fourth quarter will depend somewhat on the consumers’ buying behavior. So while we are prepared to do that, that may be in the fourth quarter or that may – part of that may move into the first quarter. So when you look at those – all of those factors and you – again, you consider it’s a small quarter, you can see what happens.

Steve Wolfe

The other factor maybe, Jim, in that is that, as we’ve said all along, we try and manage our field inventory. We’re not looking just to hit a year-end number, we are watching field inventory. So depending on what happens with retail, that could drive some different things too.

Jim Lucas – Janney Montgomery Scott

Absolutely. And then, Steve, just a final point on the tax rate, which did – was up year-over-year, but you showed a sequential decline. It had been running around 35%. Any comment about tax rate going forward?

Steve Wolfe

It’s – well, going forward, you can use where we ended the nine months at least for now, the 30, 34 (inaudible). And the two things affecting that is the new manufacturing credit isn’t as advantageous to us as the old foreign income credit was, and then with that the R&E credit. R&E credit has not been renewed. So it’s a combination of the two.

Jim Lucas – Janney Montgomery Scott

Okay, great. Thank you very much.

Operator

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

Eric Bosshard – Cleveland Research Company

Good morning.

Mike Hoffman

Good morning, Eric.

Steve Wolfe

Hi, Eric.

Eric Bosshard – Cleveland Research Company

Guys, a couple of things. First of all, on the material cost crusher, could you just clarify, Steve, it seemed like you characterized that the cost inflation was incremental relative to what you expected? Could you confirm that? And then just take one step back to define how much the material cost inflation is this year that you are dealing with?

Steve Wolfe

I can answer the first. So I said is $15 million for the nine months over what we had planned. And as we do the math for the fourth quarter, we think that’s going to be $30 million for the full fiscal year.

Eric Bosshard – Cleveland Research Company

And the first question – the first question, can you define it all how much, I mean, is the inflation for the year? I obviously assume something coming into the year. Can you at all give us a sense of what the full year inflation experience would be?

Steve Wolfe

No, I can’t at this point.

Eric Bosshard – Cleveland Research Company

Okay. Secondly, can you quantify at all the pricing, the August pricing, the magnitude of that and what the expected contribution and timing will be from that?

Steve Wolfe

That’s quite difficult to do to be honest with you. We know there was some impact just because as you know, as talking to customers as you take orders, you get some feel for that. We think it helped us certainly get to where we were in the third quarter. We don’t think it was a major issue for the quarter. Any time you’ve got a price increase, you’re going to have a segment of customers, you’re going to take advantage of that. And – but try and quantify that dollar-wise, we would just say it helped us get to the number that we ended up at.

Eric Bosshard – Cleveland Research Company

And related to that, the price increase of – what do you expect the net of that? What should – is this a couple percent on the whole business, just thinking to frame what the gross benefit should be expected to be from the price increases?

Mike Hoffman

Eric, this is Mike. The price increases that were put in place August 1st were largely in the Professional side of the business. And as we’ve talked with all of you in the past, certainly we have more pricing latitude there than on the consumer side. And some of that’s driven by the certain price points we want to hold and the timing and season that we tend to deal with pricing there more on the change as we go into the next season. And the best way to do that is with new products. With that said, if you said how much impact will those price increases have on the overall business in the fourth quarter, I’m not going to be very precise here. It will be less than – I believe more than three and less than four. And that would be a rough guess on my part.

Eric Bosshard – Cleveland Research Company

And that’s impacting the Professional side of the business or some products within the Professional side of the business?

Mike Hoffman

Yes. But I’m saying that number is across the company. I’m weighting it. I’m not putting it against the whole company.

Eric Bosshard – Cleveland Research Company

And do you have any sense of what the price realization because I know there’s been some other price this year. Was there a couple points of price benefit that was realized in the third quarter?

Mike Hoffman

Well, there was – the new pricing was put in place last year. And yes, we had some price realization if you go back to the start of the fiscal year. And if you had to pick a number, you’d probably pick a couple of points.

Eric Bosshard – Cleveland Research Company

The Residential margins weakened materially in the quarter and you’ve had a battle the last few years and made some progress last year in restoring margins in that business and now we took kind of a material step down this quarter. And I know there is a lot of moving parts. But how are you thinking about where and how the profitability that business goes from where we are today?

Mike Hoffman

We are looking obviously very hard at that full business. That business has been under the – certainly the most pressure along with the Residential part of the freshly installed irrigation business and tied to housing. And so when the market contracts as much as it did and we have to take all the hits in adjusting the volumes, manufacturing hits, everything goes with that. It does put real pressure on the profitability. With that said, we are very committed to getting that business healthier in the long run, and well, hopefully the short run, but certainly as we look forward to the future. It certainly starts with the right products and working with our channel whether that’s our large retailer or dealers, and we will ultimately make some changes. But I’m not going to be able to give you much more clarity beyond – we understand it’s an issue and we are working on it.

Eric Bosshard – Cleveland Research Company

Do you feel like you’ve got a road map of structural change that can be made, that can materially improve the profitability of the business? Or are we going to continue to fight the sort of tactical quarter-to-quarter fights to try to restore profitability?

Mike Hoffman

Yes. I think long-term we have a good road map certainly in the short run. And some of this is hived to this. The overall economic environment will face some headwinds there.

Eric Bosshard – Cleveland Research Company

And then lastly, the pricing initiatives are coming at a point in time where demand kind of across the whole portfolio is seeing pressure, and some areas we are seeing some growing competitive traction. How do you think about how price increases will influence the progress that you pointed out that you are making in market share across the business?

Mike Hoffman

Well, as I said in the earlier comments, we look at every business, every major category, and in certain areas we have good data, other areas we have maybe continued work to do to really understand. But I would say our intelligence is pretty sound. So when I say we’ve held or gained share in major categories, that’s we think pretty well supported, whether that’s industry data or that’s going out and working with our channel partners to really get a sense of what’s going on in the marketplace. And so while you say there’s some – as the markets have shrunk somewhat, the competitive pressure ratchets up. Yet I would tell you that whether it’s on the Professional side of our business, in commercial or irrigation, or it’s even the Residential side of our business, we do not believe we have lost ground to competition this year with the qualifier maybe a little bit around the Walk Power Mowers, worse at the end of last quarter, clearly better at the end of this quarter. So it’s a fight out there right now just because of the environment.

Eric Bosshard – Cleveland Research Company

Great. Thank you.

Operator

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

Sam Darkatsh – Raymond James

Good morning, Mike. Good morning, Steve. How are you?

Mike Hoffman

Good morning, Sam.

Steve Wolfe

Good, Sam.

Sam Darkatsh – Raymond James

I’m little confused, I’m sorry. The price increase, Mike, that went through August 1, was that a supplemental, like kind of mid-season or post-season price increase, and then there would be perhaps another price increase coming for the ’09 season or was this just an acceleration of the timing of an ’09 price increase?

Mike Hoffman

Well, it is a price increase that took place earlier than we would normally make that change. And again if you look back, over time we’ve tended to make our price changes once a year, while it’s not without precedent, when we had to deal with this same kind of commodity volatility back in the ’04, ’05 time period, we ended up taking some interim price increases. So that’s what took place here. We are going to continue to look at – we don’t price to cost clearly. Obviously cost influences what we do as it does the whole industry. And the whole industry is feeling the pressure of these commodity problems that we’re seeing around steel and a lot of the other commodities. And so this price increase was certainly not planned when we started the fiscal year. We had to do that because of obviously the environment. And now we’re looking forward as we move through the rest of ’08 and thinking about ’09, and what are we going to have to do. We don’t price to cost. We price to what we think the market will bear. We tend to be the pricing leaders in many categories. And so if we price than competition prices, then the value proposition remains at least vis-à-vis competition the same. If they don’t and they use that as an opportunity to buy share, that’s something that we are going to have to obviously look at. So it’s tough to be exactly precise with that question when you go across all the different kind of businesses we are dealing with.

Sam Darkatsh – Raymond James

Well, let’s ask it this way then. As commodity prices flatten out from present day levels, do you anticipate having to go back to the market with subsequent price increases in a few months where you would regularly raise prices for next season?

Mike Hoffman

And we will probably have additional pricing actions that will be taken going forward as we head into the next year without that being kind of universal across all the businesses.

Sam Darkatsh – Raymond James

Got you. Now talk about productivity, what is your projected productivity either as a percent of COGS or a percent of sales, however you want to define that, for fiscal year ’08? And then do you anticipate similar levels in ’09 from what you saw this year?

Mike Hoffman

If you are asking, Sam, what we’ve commented on in the past on kind of lean savings, we might pull out of the work we are doing in the plants. I think we’ve shared in the past that that’s been upwards of $10 million. This year it will be a little less than that, still substantial, probably not enough to offset the kind of pressures we’re seeing again back to the commodities as well as the fuel cost.

Sam Darkatsh – Raymond James

And this year it was less than that because of lower unit production, because of where the savings were identified more so on the working capital side than on the P&L side, perhaps next year might be better in terms of productivity? How should we look at the go-forward productivity on a lean basis or on an overall productivity basis?

Mike Hoffman

Well, I don’t have – I’m not going to be able to quantify it for you. I will say one of the – you know, we continue to work in all of our plants to drive the lean initiatives. I would also say that the flexibility we’ve worked hard to build into the plants was one of the reasons we were, along with the businesses, making decisions more timely that we were able to do what we did with inventory this year. We certainly took hit from a manufacturing variance standpoint. But the fact is that our plants are – have built in more flexibility. That doesn’t necessarily translate to hard lean savings, but it does translate to our ability to deal with inventory fluctuations more quickly. So – I don’t know, Steve, if you want to comment to that?

Steve Wolfe

The only thing I would say is – the other thing is, productivity is really a function of what can you get done in a year’s time period in terms of projects to add the flexibility Mike is talking about and make the plants more flexible. And that is an ongoing effort that we’ve had in place now for quite sometime. Obviously as you go – the further you go that you have to dig deeper and deeper, but that has provided us good offset to these cost increases over the years. And we’ll be in that same type of ballpark that Mike mentioned in the prior couple of years at 10 million range as we go into the next year. But we’ll constantly be watching that to see what are those projects and what are they going to return to the bottom line to help us offset this situation that we’re in today with commodity.

Sam Darkatsh – Raymond James

Next couple questions. I understand and respect the fact that your planning for ’09 is not completed and as a result, you may decide to talk directionally about these topics instead of specifically. If – as it stands right now since you are still trying to extract the whole lot of inventories from the channel, what would your initial thoughts be in terms of unit production as it relates to sales next year, perhaps not putting actual numbers on it in terms of whatever percent sales growth? But 80%, 90% of sales would be production – I’m just trying to get a sense of how much inventory you’re looking to take out next year or how much unit production will come off this year?

Steve Wolfe

That’s hard to answer without having an ’09 plan to the point that we’re ready to talk about it. And that will depend on a number of things. What kind of price do you get? What do you think your sales increase is going to be for ’09? Are you going to have a unit reduction, because if you don’t have unit increases, you’ve got price increases? We’ve got to get all that in a form that we are ready to talk to you about before we get into that, Sam.

Sam Darkatsh – Raymond James

Would you anticipate that free cash flow will exceed net income next year?

Steve Wolfe

Hopefully, yes. Free cash flow as we define it, and we define free cash flow as the cash from operations less CapEx, has been pretty strong, pretty consistent year-in and year-out. And it will be again this year despite the fact that we’re down a bit. So yes, we would hope that’s the case.

Sam Darkatsh – Raymond James

Okay. And last question would be on your Pro business, it looks like it re-accelerated this quarter on a local currency basis and as a result of the golf business largely. Was that just like one or two projects that happened to hit this quarter or is that more of a sustainable longer tailed situation?

Mike Hoffman

I think if you look at the international business over the last three quarters, it was very strong in the first quarter I think including FX up almost 20%. It was much lower at the end of the second quarter, and kind of right in the middle at the end of the third quarter. But you’re right, it is given the amount of golf projects that are part of that business, you can have some kind of peaks and valleys in significant projects shipped. With that said, that business continues to be healthy and the projects continue to happen around the world, and we continue to be very encouraged by the overall international business as part of the portfolio.

Sam Darkatsh – Raymond James

Thank you.

Mike Hoffman

Thanks, Sam.

Operator

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

Mike Hoffman

Good morning, Jim.

Steve Wolfe

Jim?

Operator

It appears that he is out of the queue. Your next question is going to come from the line of Seaver Wang. Please proceed.

Seaver Wang – Utendahl Capital Partners

Hi. Can I just get – I just want to nail this down. For the fourth quarter, what could affect that would be continued snow sales and – or re-volumes [ph] and then also a new product that might get shifted to the fourth quarter – I mean, to the first quarter of ’09?

Mike Hoffman

Hi, good morning, Seaver. We have a new generation of riding Z Mower literally approaching production here within weeks. And as we move through that and its production readiness and qualification, it’s not impossible that that could move into the – we’re talking weeks, it could move into the first quarter of fiscal ’09. So that certainly is a factor as we provide our outlook for the fourth quarter. Steve mentioned earlier, field inventory, we use the fourth quarter to set up the next year. Things have been tracking. We’re going to continue to monitor that and make sure we keep field inventory healthy. You mentioned snow, and that we shipped a significant amount of snow in the third quarter, well, in the fourth quarter as well, but it begs the question on how much replenishment [ph] over and above that will get into fourth quarter and then obviously the commodity issues that we’ve talked much about.

Seaver Wang – Utendahl Capital Partners

And this has been – this is already incorporated in your guidance. The shifting of the new product line if you ship the first quarter instead of the fourth quarter? Is that the range?

Mike Hoffman

Yes, that’s fair. One question I get is, given the size of the quarter, the range of the guidance that we needed to provide, it’s a little wider than it would have been for last year at this same time because of that –

Seaver Wang – Utendahl Capital Partners

Okay, thanks.

Mike Hoffman

Thanks, Seaver.

Operator

Your next question comes from the line of James Bank of Sidoti and Company. Please proceed.

James Bank – Sidoti and Company

Good morning.

Mike Hoffman

Good morning, James.

Steve Wolfe

Hi, James.

James Bank – Sidoti and Company

I was wondering if I could just get an idea of the product mix for your Residential group in the quarter in the international side clearly.

Steve Wolfe

International side was up pretty significantly from the Residential international piece of that business. Our international markets were all up I think double digits, maybe with a reduction of one. So it was riders and walkers in Europe I think were fairly strong. The thing that was not strong in Europe was snow. They did not have a good snow year last year in Europe. So, that was done. But the walker and rider side of the business had a good quarter.

Mike Hoffman

We also had – we have a brand, Residential brand in Australia under the – that was called Pope. And that was also very strong for us in the quarter. So I think that combination – you know, Europe for lawn and garden, not snow; Canada reflected the US snow demand, so it was strong; and then the Pope piece out of Australia.

James Bank – Sidoti and Company

Okay. But primarily the strength in the Residential side is coming from Europe?

Steve Wolfe

Yes.

James Bank – Sidoti and Company

Okay. Now is there any – and I apologize if this was asked, didn’t get everything before me. But – any concern with the Western European nations slowing a little bit?

Mike Hoffman

Always a concern. It’s something we’re carefully monitoring the – we haven’t felt that impact yet. We know that there has certainly been a housing issue in the UK and to what degree will that creep over on to the continent. So we look around the world, to what degree will the US economy influence the rest of the world. But your point is a good one. We are watching Western Europe and trying to anticipate what impact that might have as we look forward.

James Bank – Sidoti and Company

Now did they – the fact that they primarily use the electric mowers as opposed to the internal combustion, is that on any time of a different replacement cycle than what we have here in the US?

Steve Wolfe

We don’t know the answer to that, James. The fact is, in that residential market, we are very, very small piece of pie. Most of our European businesses is – almost international is Professional. And so – it certainly is a factor because it is a piece. It is a piece, but it’s a small piece.

James Bank – Sidoti and Company

Okay. Now coming back domestically, the field inventory for lawn and garden – not snow, just lawn and ground, how would you describe the health of that?

Mike Hoffman

Very good. Better than – significantly better than last year. And last year was not a problem.

James Bank – Sidoti and Company

Sounds good. And distribution, it is my understanding you only own one distributor now that’s in your other revenue line, or is it two still?

Steve Wolfe

That’s two actually. What’s happening with the other revenue line is the – we sold off a part of one of those two. So, the number comparisons from ’07 added in ’07 numbers, doesn’t have it in ’08. So you are seeing a negative spread there because we sold that off to one of our adjacent distributors.

James Bank – Sidoti and Company

Okay. So just a piece. Okay. So, would you probably see something like what we just saw in the July quarter and in the October quarter for that segment?

Steve Wolfe

Yes.

James Bank – Sidoti and Company

Okay. And if I could just – I know that the first line of question was trying to get some sort of an outlook into fiscal 2009. I would like to do that. There’s little over a month left in your fourth quarter and it’s barely even 5% of your net income. So, trying to focus on next year, copper seems to be flat year-to-date, aluminum is down considerably, steel is still up 60% year-to-date but is not flat. To me, it’s really hard to believe the raw material is going to do the exact same thing that they did this year. I don’t know what would push that given the globe is beginning to slow. So, is there – I think with some of your answering, it seems to be that there is a bit of optimism on your side that ’09 should reflect a better year than ’08. Is that fair for me to assume?

Steve Wolfe

We would hope you’re exactly right. We don’t know that and we’re still trying to figure out what’s the prudent planning position to take. Was this a short-term easing of these commodities? Is it a medium-term? Is it long-term? So we are trying to work through all of that as we put our ’09 plan together to figure exactly what’s the best thing to do here.

James Bank – Sidoti and Company

Okay. Fair enough. Thank you. That’s all I have.

Mike Hoffman

Thanks, James.

Operator

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

Jim Barrett – CL King & Associates

Good morning, everyone.

Mike Hoffman

Good morning, Jim.

Steve Wolfe

Hi, Jim.

Jim Barrett – CL King & Associates

I’ve got accidentally disconnected earlier. But Mike, if it wasn’t touched upon, I heard your comments about the residential market in Europe. Any changes in the golf market internationally versus the US? Could you discuss by region the demand for golf equipment?

Mike Hoffman

Yes. Thanks, Jim. The golf business clearly has been stronger outside the US. And we’ve commented on that in previous calls. And I would say that it’s probably been strongest in Asia and in some of the more developing markets. The Eastern Europe has been strong, even South America. Western Europe clearly is more like the US. It’s developed. And so while it’s still a very good business there and there are new golf courses being developed in Spain and other areas, not to the degree of those other markets I mentioned. So if you – I guess if you looked around the world, the US is probably the largest market and the slowest market. And that’s not a surprise given this environment. Asia would be on the other end of the continuum.

Jim Barrett – CL King & Associates

I know you have a number of competitors in that market as well as in commercial landscaping, but how would you characterize the recent price increases taken by competitors? Are competitors focusing on margin or are they focusing on market share?

Mike Hoffman

And that’s – you find that to go across the board. These price increases just went into effect, say, August 1. And we tend to be in many of our businesses the pricing leader. Sometimes others are out there before us. Oftentimes they follow us. And that’s something we’re going to have to keep our eye on. As we deal with this and make changes to price, we need to see how that plays out in the marketplace, because clearly we are committed to keeping and growing our market share and we have to look at how competitors respond. We certainly know that competitors are facing the same issues we’re facing with steel and all the other commodity pressures. What they do, something we just have to be watchful.

Jim Barrett – CL King & Associates

Okay. And then secondly on a separate subject, the company's plan to reduce working capital below 20% of sales, can you give me a sense as to what is the time frame under which that will be achieved and what sort of steps will be required to make that happen?

Mike Hoffman

We put that goal in place at the end of our first quarter call a year and a half ago. And while I would say to you we’ve made some progress, I don’t think we are satisfied with the progress we’ve made. And so we continue to put more focus on that in working with the businesses, in working with operations to see if we can accelerate that improvement in working capital. And again it’s not as we evaluate our performance versus peers, appropriate peers, we can see there is clearly an opportunity for us. When we put the goal out there 18 months ago, we said we’re probably not going to get this done in our grow-lean initiative time frame, which would end at the end of next year. So probably it’s going to take another year into ’10. And I think we’re still working towards that goal to accomplish that with – by that ’10 time frame.

Jim Barrett – CL King & Associates

Okay. Well, thank you very much.

Mike Hoffman

Thank you, Jim.

Operator

You have a follow-up question from the line of Jim Lucas. Please proceed.

Jim Lucas – Janney Montgomery Scott

Thanks. I wanted to ask a growth related question. If you back couple years ago, one of the things to focus on accelerating the top line growth was going after underserved markets, whether municipal grounds, etc. Can you just kind of give us an update of what initiatives – what progress you made and any current initiatives of areas that are still somewhat underrepresented?

Mike Hoffman

Jim, this is Mike. And I guess I would start with – we continue to put strong focus on businesses like our grounds business that we talked about we think as an opportunity. And as I had said earlier, in most of these businesses, we have held or grown share. And another good example kind of ties to that is the residential and commercial irrigation business. But we once had a significantly higher market share and are slowly earning more of that back, so underserved by us. Now with that said, a number of these markets are under pressure just from the overall economic environment. And so people are fighting hard for what share is out there. It makes it more difficult to do than in an expanding market. So I would tell you, we continue to make progress I think in – ultimately (inaudible) test for us is market share in those markets. And the two main ones would be grounds and residential and commercial irrigation.

Jim Lucas – Janney Montgomery Scott

Okay. Thank you.

Mike Hoffman

Thanks, Jim.

Operator

Your next question comes from the line of Lee Hicks of Farallon Capital. Please proceed.

Mike Hoffman

Good morning, Lee. I think we’ve lost Lee.

Operator

Mr. Hicks, please unmute your line. Mr. Lee Hicks, your line is now open. There are no further questions at this time.

Mike Hoffman

Well, thank you, Shameeka. And once again, thanks for all of you for your questions and interest in the Toro Company. These are challenging times and we need to carefully manage both short-term issues and obviously long-term strategy to help the company drive shareholder value. So we appreciate your confidence and trust in our company, and we look forward to talking with you again in December to discuss our year-end results. Thank you and have a good day.

Operator

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

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Source: The Toro Company F3Q08 (Qtr End 08/01/08) Earnings Call Transcript
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