Good day, ladies and gentlemen. And welcome to The Toro Company’s Full Year Fourth Quarter Earnings Conference Call. My name is Katherine, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s 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, Nicholas Rhoads, Director of Investor Relations for The Toro Company. Please proceed, Mr. Rhoads.

Thank you and good morning. Our earnings release was issued this morning by Business Wire and a copy of the earnings release can be found in the Investor Information section of our website, thetorocompany.com. On our call today are Rick Olson, Chairman and Chief Executive Officer; and Renee Peterson, Vice President, Treasurer and Chief Financial Officer. We begin with our customary forward-looking statement policy. During this call, we will make forward-looking statements regarding our business and future financial and operating results. You all are aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our earnings release as well as our SEC filings, detail some of the important risk factors that may cause our actual results to differ from those in our predictions. Please note that we do not have a duty to update our forward-looking statements. In addition, during this call, we will reference certain non-GAAP financial measures. Reconciliations of historical non-GAAP financial measures to reported GAAP financial measures can be found in our earnings release or on our website. The company believes these measures may be useful in performing meaningful comparisons of past and present operating results to understand the performance of its ongoing operations and how management views the business. Such non-GAAP financial measures should not be considered superior to, as a substitute for, or as an alternative to and should be considered in conjunction with the GAAP financial measures presented in our earnings release in this call. With that, I will now turn the call over to Rick.

Thanks and good morning. Thanks to the dedicated efforts of our employees and global channel partners, we delivered strong 2019 results that included record net sales and earnings per share. Results were primarily driven by the transformational Charles Machine Works acquisition, strong demand for BOSS professional snow and ice management equipment, solid residential snow throwers sales, and positive contributions from our landscape contractor and specialty construction businesses. In the context of weather-related headwinds and trade policy uncertainty, we delivered on our financial guidance. We met our net sales guidance and we are at the high end of our adjusted earnings per share expectations for the year. For the full year, we generated record net sales and exceeded the $3 billion mark for the first time. We also delivered earnings per share of $3, up 12.4% over prior year. In a year where we closed our largest acquisition, we were still able to return cash to shareholders, while investing in our people, productivity and future profitable growth. Turning to our core operating performance for the year, our Professional segment generated revenue of $2.4 billion, reflecting incremental contributions from The Charles Machine Works acquisition, as well as strong retail demand and new product introductions from BOSS, Exmark and our rental and specialty construction business. In the second quarter, we completed the acquisition of Charles Machine Works, a market leader with products covering a full lifecycle of underground pipe and cable. This includes horizontal directional drills, walk and ride trenchers, compact utility loaders, vacuum excavators, asset locators and pipe rehabilitation solutions. With these enhanced underground construction capabilities, we can better provide services to our customers who profitably -- while profitably and purposefully growing our business. Charles Machine works, through its family of businesses, with iconic brands such as Ditch Witch, American Augers, Trencore,…

Thank you, Rick, and good morning, everyone. We have reported revenue of $3,138 billion in 2019, a 19.8% increase from 2018. This was largely driven by strong Professional segment revenue led by The Charles Machine Works acquisition, BOSS snow and ice products, and Exmark branded turf equipment. Diluted EPS totaled $2.53 for the full year, compared to $2.50 in 2018. Adjusted diluted EPS increased 12.4% to $3. For the quarter, revenue increased to $734.4 million, primarily driven by The Charles Machine Works acquisition, Boss product sales and channel demand for new golf product introductions in the quarter. This include the real mass Greensmaster and Groundsmaster mowers and Outcross vehicles. Diluted EPS was $0.35, compared to $0.36 last year. Adjusted diluted EPS increased 50% to $0.48. For the year, Professional segments net sales increased 25.5% to $2.443 billion. For the fourth quarter, Professional segment net sales increased 46.9% to $588.2 million. The sales growth was mainly driven by the acquisition of Charles Machine Works, which added incremental sales of $465.2 million for the year and $194.7 million for the quarter. Excluding The Charles Machine Works’ acquisition, legacy Professional segment sales were up 1.6% for the year. Professional segment earnings for 2019 were $380.9 million, compared with $399.8 million in the same period last year, primarily reflecting higher expenses related to The Charles Machine Works acquisition. This included one-time purchase accounting adjustments and the impact of our strategic decision to wind down The Tory branded underground construction portfolio in the third quarter. Professional segment earnings for the fourth quarter were $61.2 million, essentially flat with the fourth quarter of last year. Residential segment net sales for 2019 were up 1% to $661.3 million, reflecting higher net sales of walk power mowers, snow throwers and parts. For the fourth quarter, Residential segment net…

Thanks, Renee. Building on the record performance in 2019, our 2020 guidance reflects a full year of Charles Machine Works, anticipated volume growth, continued product introductions and additional productivity gains. Total company revenue for 2020 is forecasted to be about $3.6 billion, an increase of nearly 15%. This reflects growth in both our Professional and Residential segments. Our adjusted diluted earnings per share for 2020 is forecasted to be in the range of $3.33 to $3.40 on higher volume and improved productivity. For the first quarter, we expect adjusted diluted earnings per share of approximately $0.58. Keep in mind that even with The Charles Machine Works acquisition, our business remains seasonal and our first and fourth quarters are typically smaller. Let’s review prospects for our various businesses, starting with the Professional segment. Strong pre-season bookings and early winter conditions in key markets have helped our snow and ice management business get off to a good start. We expect growth from our BOSS -- from BOSS during the season with continued success of the Snow Raider. Additionally, new truck models favor incremental demand for new snowplows and ice management equipment. The outlook for our Underground business is encouraging with strong market growth opportunities such as the 5G wireless build out. Our family of Ditch Witch products are the contractor tools of choice to support this expansion in major cities and to connect rural customers with high speed internet. 5G deployment which is in its infancy requires substantially more fiber infrastructure than past wireless broadband solutions. Our new product introductions such as the JT24 directional drill, offer our customers the power, productivity and versatility they are looking for in support of fiber installation projects. We have the right brands and products to support the full lifecycle of pipe and cable from install…

[Operator Instructions] And our first question comes from Josh Chan with Baird. Your line is open.

Hi. Good morning, Rick, Renee and Nick.

Good morning, Josh.

Good morning.

Good morning. Just wanted to start off with the Tractor Supply comment that you made at the end, Rick, just wondering how impactful it might be in terms of your 2020 guidance and how should we think about the timing of that agreement kind of pulling through?

Tractor supply is a significant driver of our results for 2020. We will really start to see the shipments hit in -- beginning in the second quarter and into the third quarter, so it’s not as much impact in the first quarter. And just from a market standpoint, it really extends our reach into geographies that have not been as well served. We have a strong dealer network, but from a mass standpoint, it really -- Tractor Supply continues on into more rural and smaller town environments. So we are very excited about it and it looks like it’s going to be a great partnership.

All right. Yeah. Thanks for that. And if I can switch to the Professional segment, looking at the margins in the quarter, I know that there are some non-recurring impacts that you outlined in the press release, but they kind of split between the Corporate and Professional segments. So I wonder how should we think about some of the non-recurring charges and how much did that impact that Professional segment margins in particular this quarter?

Sure. Josh, if you look at our earnings release and our reconciliation of non-GAAP information, just speaking maybe to the operating line, the operating earnings line, we have got roughly about $80 million of one-time expenses in 2019. I would take that and probably split that about 25% of that goes to other and then about the remainder 75%, goes to the Professional segment. So that would be a good split for you to use.

All right. Thanks. And then, if I look into 2020 for Professional margins, I guess, you -- how much synergies are you expecting from Charles Machine Works? And then I would assume that you would expect that the rest of the business to also have improved margins, is that the right way to think about it?

Yeah. It is. We guided to in our IR package that we do expect gross margins to improve as we look at 2020. And what we would expect from just a synergy standpoint, first of all, is we have talked about $30 million of synergies spread kind of ratably over three years. We really feel good about our situation with synergies. We have stepped back and looked at it more holistically across the organization. So to the point that you were making, it’s not all going to show up just in the Professional segment is, we actually see improvement, the way we are approaching it across the entire organization. So we should also consider though as we look at margins for next year. We just talked about Tractor Supply a great partnership and we are really excited about that. However, just keep in mind the Residential margins are a little bit less than we would see and we also have a full year of Charles Machine Works, which also has a little bit of a negative impact on overall margins.

All right. Yeah. That makes sense. And then, I think, last one for me, does your guidance assume any stock buybacks in the year?

Yeah. There is some limited buybacks. As you know, we have focused our post Charles Machine or acquisition and paying down our debt. And we have really are ahead of our original schedule for that. So we feel good about that. So all things being equal we would look at share repurchases a little bit later in the year.

All right. Great. Yeah. Thanks for the color and thanks for your time.

Thank you.

Thanks, Josh.

Thank you.

Thank you. And our next question comes from Mike Shlisky with Dougherty & Company. Your line is open.

Good morning, guys.

Good morning, Mike.

Hi, Mike.

Maybe just first follow quickly on Tractor Supply. Assuming there’s going to be some organic tailwind, given you have to sell into almost 2,000 stores in the spring time. But as far as what’s being sold in the stores, I mean, is there probably going to be some higher acreage customers in those stores? Is there any way to kind of bracket for us whether you will see margins that are kind of maybe not the same as Professional but a little bit higher than the average Residential given that there might be some heavy duty price there?

Yeah. I think we are -- as we said before we are very excited about Tractor Supply and we would expect the margins to be somewhere in those categories. You are right since they do tend to have higher concentrations in rural areas. There is a lot of interest in our Z line, for example. But we also have a complete line of the turf products and potential to expand on that as well. So, it will be quite a complete line there and will tend to focus more on products for larger properties, but we will have the complete product line there as well.

Okay. And then just with your construction equipment, what I have been seeing at least heavy construction side that a lot of companies have kind of range in production this winter to get their dealership inventories in line with their retail sales outlook. Can you comment on how you feel about your inventories at Charles Machine Works and your other construction products and if there’s a change you have to pull back on the production just to kind of start the year or do you feel pretty good about where inventories stand today?

We actually feel good about construction in our, excuse me, about inventory in our construction categories. As you know, last year we had some strong new product introduction, so there is a lot of excitement about those new products from a sales and retail standpoint. So we have a good flow there. So we -- our inventories are in good shape from a construction standpoint -- from a specialty construction standpoint. And just keep in mind, we are in small segments, specialty segments of construction, so this is not -- we are not talking about bulldozers and excavators and so forth. This is for either very specialized applications or for more landscape contractor, smaller scale type of operations that are driven by different construction factors.

Sure. Of course. Right. Maybe one last one for me, I’d like to get a little more color from you on the organic growth outlook for 2020. I guess, first, do you feel like you are going to get some good organic growth from Charles Machine Works? And then, secondly, from a broader perspective, can you give us any kind of number or range as to where -- as to what you think we should be modeling for organic growth overall next year?

Yeah. I would just, Renee, can comment on what we can talk about specifically with regards to organic growth. But we feel quite optimistic pretty much across the Board on our markets. And there are obviously factors like weather that we can’t control. But the factors that we can control, we feel very good about. We have a lot of new products that are entering the market. There’s optimism in some degree in every market that we have got. Golf rounds, for example, started this last year through the spring, I think, in June. I mean, it’s June or May, down 4% year-to-date. And as of the last data that we saw through, I believe, October, they were in positive territory. So they made up tremendous ground during the season. That’s obviously a nice revenue trend for the golf courses and helps to provide funding for new projects and new equipment. So pretty much across the Board. We see some positives that we feel good about. And Charles Machine Works grew their business and we expect to continue to grow their business in roughly the same rates of The Toro Company has been growing mid-single digits type of growth longer term.

Okay.

Yeah. I will just add on to that if I may from an overall standpoint. If we look at it maybe from a segment point of view, we would look at Pro being mid single-digit type of growth rate, pretty solid as we look forward. From a Residential standpoint, we normally would guide to GDP type of growth. We do expect that to be greater as we talked about with the Tractor Supply partnership being in its initial year. And then, overall, Charles Machine Works, as Rick was just talking about, we would expect to be basically that mid single-digit type of growth rate. Again, more including them now for a full year where we only had a partial year in 2019.

Got it. Perfect. Thanks so much, guys. I will pass it along. Appreciate it.

Thank you.

Thanks, Mike.

Thank you. And our next question comes from David MacGregor with Longbow Research. Your line is open.

Yes. Good morning, everyone.

Good morning.

Hi, David.

Just to build on the last question on inventories, which was very specific with regard to construction, wonder if you could just talk about the bigger inventory number on the balance sheet, because it seems to be up fairly substantially, obviously, some of that is CMW, some of it is probably new products that you have talked a lot about, some of it is going to be raw material inflation. But is there any way to parse that out a little bit for us and give us a little bit of a better feel for sort of the composition of that increase?

Yeah. David, the biggest piece by far is Charles Machine Works…

Sure.

…just given the size. And as we had talked about in the past, we do see opportunities to improve Charles Machine Works’ working capital, so that’s by far the biggest piece of it. I would also though say, going into 2019, we do have a great line up with new products and so we are anticipating a real strong introductions, typical with the past, we would have some inventory build as we go into new product introductions, and then, we talked about Tractor Supply as well. And in all honesty, as we ended 2019 from a legacy perspective, we started extremely strong with a very strong Q1. You might remember, we had 10% sales growth overall for the company.

Yeah.

And then, the remainder of the year, weather wasn’t as favorable. Everyone is very optimistic going into the year. So there’s probably some impact just from the wet weather that we saw in 2019 as well.

Okay. Thanks for that. Just with regard to tariffs, can you just update us on kind of the carryover impact into 2020?

Yeah. As we look at tariffs, so some of the latest changes that had occurred were primarily focused on the list for which for us was not very impactful for, so kind of a minimal impact for that. We are just looking at tariffs being about flat year-over-year. We talked about in the past for us it’s somewhat hard to segment tariffs from -- in tariff related inflation, because we are more of an assembler of products versus a pure manufacturer. Many of the times we get the tariff kind of indirectly when we are purchasing the product or the parts from one of our suppliers. So it’s hard pressed to break out the exact impact of tariffs. But we are thinking, it’s going to be about flat year-over-year. So maybe something will get resolved that would be beneficial. We can certainly hope for that.

Yeah. Hopefully. Just on the Walk Power mowers, down on the fourth quarter, I guess, we have talked about the sort of battery powered mower secular growth pattern in the past, but just trying to get a sense of whether -- we have finally got to the point where maybe sort of gas powered walk mowers starting to lose more share to the battery-powered product and your -- that particular product category is just succumbing to the secular trends in battery-powered?

Yeah. The battery-powered portion has been a small but one of the faster-growing segments of the lawn and garden and the walk power mower segment. We have now a very solid 60-volt lithium-ion battery package and we are seeing nice response from customers on that, very positive feedback. So we think that as it settles in, it will be another power source and a lot of the focus will go towards the overall features and benefits of the product, and that’s where we feel very positive about our offerings and our options. So it has been a growing segment. Gas-powered products are not going to go away in the near future, but we will have an offering of what customers want, whether it’s battery or whether it is gas. And we will maintain and have maintained our market share, and the battery offering will be and has been part of that, beginning this year.

In that case, do you think, Rick, you may have just lost share in walk power mowers?

No. We didn’t. We actually maintained our share in a really tough environment. So it was tough for all competitors, meaning it gets very competitive in that environment and we maintain our share in walk power mowers.

So the category…

Yeah. I think the whole industry was probably down in part related to weather.

Yeah.

That’s what I was trying to get at. Last question for me is just you talked about the Flex-Force lithium-ion product that you are rolling out. I guess how do you build retail and distribution support for that product now?

Well, we have had strong support. I can tell you from a math standpoint. They will continue to get placements with our mass partners. For me, personally, one of the areas of surprise is in our dealer network, it had a very strong response especially after the initial introduction and the reputation started to generate the feedback from our dealers has been very positive. I think they were surprised that the number of customers that came in looking for battery-powered options. They have not historically been as strong in the battery area. So, I think, that’s kind of a new and interesting development for us.

Good. Thanks very much. Good luck.

Thank you.

Thank you.

Thank you. And our next question comes from Joe Mondillo with Sidoti and Company. Your line is open.

Hi. Good morning, everyone.

Good morning.

Hi, Joe.

So a couple questions, so just to clarify, Renee, regarding one of the initial questions on the Q&A, regarding the adjusted Professional income, you made a statement regarding the full year fiscal 2019. I was curious, is that sort of 75-25 breakout similar in the fourth quarter or is that at all any different?

Yeah. It would. What it really relates to some of the management actions are split more between the other end Pro where most of the acquisition-related items fall more directly. So, it -- I mean, it’s a reasonable split. It is the split for the year. But it would be reasonable for the quarter, too, Joe.

Okay. And then, so I am just trying to think in terms of the Professional business, the legacy Professional business, the last couple few quarters have been pretty tough, obviously, a couple quarters ago, the weather was not favorable at all. I am just curious, if we have a scenario where weather sort of reverts at all closer back to sort of a norm. How does that -- how should the business progress in that situation? You are going to have an easier comp, but then how were you thinking about inventories in the channel? Are inventories higher than normal because of the weather last year, any color behind how you are thinking about the outbreak?

Yeah. So, I think, to summarize this last year, anything that had to do with growing grass or mowing or outdoor activities was really challenged from the early spring all the way through midsummer. And so that cuts across many different categories for us. So that’s one of the more challenging years. I think it was the wettest year on record in Minnesota at least and for much of the Midwest. So that was kind of the thread of challenge that ran through our businesses this year. If we return to a more normal weather pattern, we have modeled the required inventory and the effect on inventory in our plan now. So that’s really what is built into our plan and we also build in some flexibility to respond to a greater or less than. And the key is really to do exactly that to stay responsive to what’s happening in real time and be able to adjust our requirement, our production and supply chains as quickly as possible, so that we stay nimble and that’s been the key to Toro for a long time.

So, do you think the inventories in the channel are a little high, and if so, would it sort of be maybe a little weaker performance earlier in the year and as those inventories get absorbed maybe stronger performance especially given the comps that you have maybe towards the back half of the year, is that a fair way of…

Yeah.

… looking at it or?

Yeah. We have a few categories where inventory is a little bit higher but not outside of the range of what we have seen before. So, that’s all built in to our plan. So, that’s the flow that we have built in to our plan for 2020. It really acknowledges where there are those isolated cases.

Yeah. And as you said, Rick, I mean, that is an area we are very used to dealing with that and kind of ebb and flow that comes with that. And we always make sure that we are focused on retail and keeping the sale in good shape. So, it’s not at all out of the ordinary. And as we have talked about in the past, sometimes things can move between quarters for us. So, we always encourage people to look over the total year where you get the best perspective from our performance.

Okay. And then at the Residential segment, you saw another pretty good quarter in terms of margin. Just curious what drove that and did you see any, I know, I think, you called out in the third quarter that you saw some tariff recovery income. Did you see any of that type of income in the fourth quarter?

Yeah. Nothing out of the ordinary, Joe. We did see the impact of -- we had commented on pricing and productivity initiative. So we saw that impact a little bit more concentrated. And as you think about it, we have said we were going to expect margins to improve more in the second half of the year and we saw that sequentially. But there weren’t any unusual onetime items. We did see, though, commodities moderate and deflate a little bit in the quarter. But more than anything was pricing and productivity.

Okay. And then two last questions, one on free cash flow. Just in terms of working capital expectations?

Yeah.

You stated that you are anticipating earnings to free cash flow conversion of about 100% this year.

Right.

Just wondering what -- how that translates into working capital. And then last question just on the tax rate, wondering what you are anticipating for that?

Okay. So, first of all, on working capital, we would expect that as we go into year-end, we would see -- year-end 2020 that working capital come down. We do believe, structurally, Charles Machine Works is at a higher working capital rate. We think, over time, we will see some improvement there. And we had a number of items that were driving our working capital, in particular inventory, to be a little bit higher at year end that we don’t necessarily anticipate, part of it being just the weather, part of it being the new products, the whole host of new product introductions that we have, and then, again, tractor supply being new to us. So we would expect working capital at year-end to be coming down and trending lower. From a tax rate standpoint, we would expect the adjusted effective tax rate to be 20.5% or thereabout for next year.

Okay. Thanks. Thanks for taking my questions.

Thank you.

Thank you.

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

Good morning, Rick, Renee, Nick. How are you?

Good morning. Hello?

Hi, Sam. Doing well.

Happy holidays to each of you. It’s just -- most of my questions have been asked and answered. I just have a couple of housekeeping items. The guidance for ‘20, the EPS guidance, the $3.33 to $3.40, what does that imply for GAAP EPS?

We do not guide to GAAP and part of it is we just don’t feel, especially with the areas around the stock -- excess tax benefit from stock comp, it’s very difficult to try to estimate when options will be exercised really. So that’s part of the reason why we consider that to be a non-GAAP item. So, we haven’t provided GAAP guidance.

The obvious follow-up then is how do we figure the 100% free cash flow conversion since I am guessing that’s based on reported net income?

We try to give you the elements associated with it. We just talked about working capital a moment ago, as well as capital expenditures. We expect to be about $100 million. We -- I am trying to think we -- D&A we had put in in guidance as well. So we got -- D&A we expect to be about $95 million. We tried to give you the elements.

But can you quantify working capital or put a little bit more meat on the bone in terms of that?

Yeah. We haven’t quantified it specifically. We just said that we would expect it to decrease from where it’s at today at year end.

Okay. So then should we assume that free cash flow would be up on a year-on-year basis at least?

Yeah.

Okay.

Yeah. As we were at 90% this year, we said 100% in our EPS, I think, we are growing with the entire year of Charles Machine Works, so, yes.

So, in terms of dollars though, free cash flow will be up year-on-year?

Yeah. Correct.

Okay. And then my final question, the Professional organic in the fourth quarter was down. Now I know it was at more difficult comparison, this has been talked about already I think on this call. Are you expecting or assuming that organically professional will be down again in the first quarter, again, I am looking at the comparison and it looks similar. And then, if you could be more specific, Rick, in terms of what specific categories you are seeing the headwinds in Pro right now, organically especially knowing that snow is so strong? I know you mentioned anything that has to do with cutting, but if you could be more specific in terms of where you are seeing it, so we can flag it as it progresses?

I think we touched on it a couple of times, but the inventory areas would be in the LCE area. So we would be making sure we get those at the point where we want them to be. A little bit in international and a bit in irrigation. And there’s not a lot -- for irrigation, the first quarter, if not -- there’s not a lot of retail drive during the quarter, so it’s always a little tough anyway. But those are some of the elements where it’s coming from, so international, LCE inventory and a bit of irrigation.

And the organic growth expectations or organic sales expectations for Pro in the first quarter would be similarly pressured as it was in the fourth?

I think that’s fair to say. Yes.

Okay. Thank you each of you, and again, very happy holidays to you and your family.

Thank you. Thank you, Sam.

Thank you.

Thank you. Our next question comes from the Tom Mahoney with Cleveland Research. Your line is open.

Hi. Good morning.

Hi, Tom.

Good morning.

Traditionally, you guys been able to achieve or realize price in the Pro segment and certainly with tariffs, I think, that’s been a part of the story over the last 12 months or 18 months. Can you talk about whether there’s price in the Pro segment in ‘19 and if you expect that number to be similar or more or less as you look into fiscal ‘20?

Yeah. We typically over time get between 1% and 2% price in the last year and a half or so. We talked about the need to be on the high end of that due to some of the high input cost increase that we had. So the -- some of those are not as strong in 2020. So we would not expect quite as much price during 2020, but we would still be staying in that range of 1% to 2% price realization.

Okay. And then you mentioned that a change in Red Iron. Is that a -- is it purely an accounting change or is there any change in, in terms of how any impact on the dealer network or any incremental benefits for them as you make a change there?

Yeah. No. There’s no impact externally at all. And it’s really from just geography on the P&L. But we wanted to point it out to assist with modeling. That’s really moving from an -- our equity investment being other income to really being a -- increase in net sales, because of a lower sales deduct is the driver to that. So it just moves between geography and the P&L, but no fundamental change other than that and no impact externally.

Understood. Thank you.

Okay. Thank you.

Thank you. This concludes the question-and-answer session. Mr. Rhoads, please proceed to closing remarks.

Thank you for your questions and interest in The Toro Company. We look forward to talking again in the New Year to discuss our first quarter results. Thanks everybody.

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