The Toro Company (TTC) Earnings Call Transcript & Summary

We're happy to have The Toro Company join us again at our Global Industrial Conference this year. Toro is an equipment manufacturer. They've got leading positions in end markets like golf, commercial landscape, specialty construction, snow, irrigation and then also residential markets. From the company, on stage with me is Chairman and CEO, Rick Olson. We have Angie Drake, who's CFO, down here; and then we've got Jeremy Steffan, who's Director of IR, in the front row. So I think Rick has got a few slides he'll run through, and then we'll do some Q&A. So the floor is yours.

Thanks a lot, Tim. And first of all, I just want to say thank you to everyone in the room for being here at 4:40 in the afternoon. We appreciate it. We thought we might have a little bit of a light crowd, but it's great to see you all here. I think this is -- Tim, you said this is session #11 for you. So I'm sure you can keep it fresh here as we go too.

Need a beer.

It's not long. So first of all, I just want to start out a little bit. I just have a few slides, and then we'll go right into the conversation. But a couple that I do want to cover, you're familiar with safe harbor, I'm sure. First of all, to get the best idea of who The Toro Company is, if you're not familiar with The Toro Company, it's best to just look at our mission, vision, purpose and really who we are. I know this is kind of a pass-through slide in a lot of decks, and you kind of say, yes, yes, yes, whatever. It's kind of those. This is deeply what we believe, and this was what has driven us for 109 years. And it's why I've been with The Toro Company that long. Not quite that long, 37 years, 37 of 109. First of all, it's our purpose. We exist to help our customers succeed. And we do that by helping our customers enhance the beauty, the productivity or the sustainability of the land. And for our residential customers, that's helping them to create a beautiful yard and garden that their family can enjoy. For our professional customers, which are 3/4 of our customers, it's really helping them succeed in business, even a small business, helping them to feed their families essentially. Our vision is to earn the right to be the market share leader in every arena where we participate, and we're driven to do that. We are incredibly focused on winning in the marketplace. We do that by introducing incredibly cool, innovative products and solutions to our customers, supporting them like they've never experienced before through multiple generations. And the thread that runs through all of this is relationships. And we have relationships that are literally 100 years old. The very first golf customer that we have, Minikahda Country Club, has been a continuous customer for 100 years. And those are the kinds of relationships that we seek in all of our avenues. The performance, if you look over the last decade, the CAGR of revenue is just under 9% with improvement in EPS of just under 14% or under 15% and return on invested capital of 24%, just to give the high-level numbers. The thing that's important to understand, if you're a casual -- if you're casually familiar with The Toro Company, you might be thinking a lawnmower company because you see one of our 4,000 dealers or have another opportunity to encounter our products at mass retail, et cetera. So most people think of the brand, if they're not familiar with some of our segments as a residential brand. And that's true, but it's really shifted. And in my time, it's really flip-flopped. So when I started, it was primarily a residential company. Over the course of my career, it's flipped to be primarily a professional company, which means the products are going into a business context to be used as part of a business model. And just lastly, just to point out a few of the characteristics. First of all, the products that we make are essential. If the grass is growing, it has to be maintained. On the turf side of things, if it has to be maintained, it consumes a portion of our products. And if that's true, it has to be replaced in some normal frequency of cycling. We have a large percentage of installed base that's a replacement product. So think about golf courses, think about residential homeowners, think about the drills, horizontal directional drills, trenchers, those all get replaced and have high-wear components that get -- need to be replaced on a regular cycle. We have an incredible network of distribution and distributor partners, ranging from the residential types that I talked about previously, but extending into those deep relationships on the underground construction business, the golf business, golf, municipalities, landscape contractors, that's really a strong thread through the company as well. Innovation has been who we have been from the start. That's the last thing that goes. If we're doing any kind of expense cuts or we're tightening budgets, we are very, very hesitant to cut investments in innovation. That has served us well as a company as we launch out of any kind of cycle. We always have a great product, and we're going through the most exciting transition of our careers right now focused on the transition of alternative power from internal combustion engines to electric and hybrid solutions; secondly, smart and connected products; and thirdly, autonomous and robotics. And we're overweighted in our investments in each of those areas, and we're seeing the fruits of those investments right now. And that's it, just a display of our brands.

Great. Thank you for that, Rick. If anybody has any questions, you can e-mail [email protected] or just raise your hand. Maybe just to start on the R&D side, one of the hallmarks that you guys have had is really the commitment to R&D over the last, probably, what, 10 or 15 years. I think you spent over $150 million last year. I have to believe that's more than some of your competitors actually generate in revenue.

It is. Yes.

And so just -- you kind of went through the 3 priorities that you were kind of talking to. Can you kind of talk through how you're thinking about each -- both battery, autonomous and connected products? How you're investing in those? And then just maybe talk about the cross-functionality of how those kind of -- those 3 kind of layers go across the product portfolio for Toro?

Yes. Maybe start with the last part first. We -- one of the areas of focus, first of all, as we've made acquisitions, we've been able to be very efficient about the research and development dollars that are coming into the total pool. And our focus is, even though we're in multiple different businesses, that may look like a completely different business if you see it standalone, the underlying technology, we've been very deliberate and successful in leveraging across those product lines. So we're able to take, for example, the entire matrix of all of our power requirements of all of our equipment, find the groupings of similar types of product requirements and duty cycles, create power systems that are specific to those areas and then leverage them across those categories. So it's -- it wouldn't be a surprise to see them show up in high-volume areas. But it is surprising to our customers in more niche type of markets to have products show up with incredible technology that underlies those products, and it's possible because we leverage across the different businesses.

Okay. And I think batteries is always kind of top of mind, especially because we're all consumers, and we all have lawn and garden equipment. We see the kind of shift to batteries. How do you think about the long-term kind of optionality around autonomous? Because when we do a lot of survey work with golf courses and contractors and things, their number one issue is labor. And so how can you, through maybe robotics or autonomous, kind of solve some of those big labor pinch points that a lot of your customers wind up having?

Yes. It's really an issue that cuts across all of our professional customers, the shortage of labor and especially the shortage of skilled labor and the ability to retain those employees. So it starts really on that second area of investment, which is smart products. So having our products -- making sure our products are doing more to take some of the skill level requirements down for the operators. That's kind of step one. And then autonomous is the logical extension of that. And we believe that most of our categories on the professional side will need an autonomous solution at some point, and we're well along in that process. On the golf course side, where we have an expanding beta test going on, it's actually a beta test plus of autonomous fairway mowing, that's a very successful multiple platforms that we're moving forward across the robotic line. But that's an area of transformation that's happening.

Okay. And when you think about new technologies, you're obviously a market leader today in a lot of the niches that you're in. Do new technologies allow you to gain more share within those markets? Does it grow the pie in terms of how big those markets become? How should we kind of as investors think about how these kind of technological changes kind of filter in through the P&L?

I think there is -- there are some substitutions. So over time, there's a transition taking place with the core customers in some categories to zero-exhaust emission solutions. I think the other aspect, which I think is really interesting is as we transition from internal combustion engines and hydraulic drive systems or mechanical drive systems to electric, it opens up an entire new arena for us for innovation -- for us in innovation. So the ability to control the motors more precisely, programmatically to be able to do more with the machines. So we see the ability to offer more to our customers, and that does expand the customer base that's interested in those types of solutions.

And do you kind of think of it as like here's your customer and here's what they're spending. And so if you can take -- if you can eliminate gas by moving to batteries, you get some of that. And if you can eliminate some labor because you can move them to robotics, you get some of that. And so over time, like you should have more of their kind of share of wallet, if you will, because you're just adding more and more and more value to that customer base?

Exactly. So if we -- any time we can add more value for the customer, there is a substitution opportunity. So if you look at the pie of professional customer budget, labor is oftentimes a huge portion of that. So if you can take some of that portion of the pie, fuel is typically a large portion. If you can take some of that piece of the pie, you group those together, we provide a better solution, and that starts to justify a higher investment to have a return on that investment, taking a bigger piece of the overall budget.

Yes, exactly. Okay. Great. And then, I guess, just when you're thinking about like legislation, how important is California banning small engines or New York kind of saying, you can't have backpack blowers and things like that? I mean is that something you see as a kind of a building kind of tailwind in the business? Or do you think it's still kind of more of a one-off kind of municipality or state kind of situation?

We've really chosen to take an approach that we are indifferent about that. We've taken some time in a number of years to prepare so that we were ready for the transition that took place in California. It's actually still taking place or will take place in '24. So that's been our approach. Historically, not everything that happens in California spreads across the entire United States. So we don't necessarily see that happening immediately. We've chosen to take the approach to be prepared for that because we believe it's -- those are options that all of our customers are going to want as we go forward.

Okay. Okay. And then could you maybe talk about how you've approached the commercial side of battery? You Revolution line is more of a -- kind of looks more like a standard mower or a standard ride-on, kind of plug it in, use it all day, plug it back in. A lot of your competitors have just 12 battery packs on a mower, and you have these battery farms that contractors need to invest in. So how have you kind of approached the market on the commercial side from a battery perspective? And is your approach kind of unique? Or are other people kind of doing that as well?

Yes, the approach that we have taken is really the result of really working to understand our customers' requirements and understanding what they want to do. What they want to do is kind of what they're doing today except battery. So the -- we found that there's not a lot of interest in swapping batteries in and out, managing the battery charging system, et cetera. They want to be done for the day, pull in, plug it in, come back in the morning, unplug it, go out and work. And that's -- that really relates even back to the comments about the workforce and the challenges with the workforce. So that has been our focus. We have an all-day no-compromise platform in the Revolution Series that we introduced this year, and it's been very well received for those very purposes. And the strongest feedback is that we're not messing around with battery switch-outs and things like that where things can go wrong.

Okay. There's a question here from the audience. What do you think electric penetration rates can get to? I don't know if it's overall or if you want to take it by kind of subsegment.

Yes. If you've seen our ESG report, we've set a target of 20% by 2025. And our part in that process has been to create options, internal combustion and electric options in each of our product categories. And we're well along in that process certainly through the residential area into contractors and golf. The piece that we have less control under is the general consumer uptake for electric. And I think you see a little bit of discussion taking place about EVs, et cetera, right now. So that's less predictable for us. But our part is going to be to make sure that we make those products available, and we're encouraging that transition.

Okay. Any questions from the audience? All right. Here.

How do you think about the international expansion?

International.

International expansion?

Yes.

We continue to see many opportunities in categories. For example, the underground and construction business, we have very high market share in the United States, but less outside of the United States. So those are -- that's one example where we see a lot of opportunity. Some of the environmental and sustainability solutions that we have, there's greater interest in other parts of the world. So that's a great opportunity to move forward with those in markets that are -- that have even higher demand. So we see a lot of opportunity internationally.

Can you go and talk about the residential side of the business, what you see there, where you're seeing maybe [indiscernible]

Yes, we -- the residential business has been a very important and very helpful part of our portfolio. If you go all the way back to the financial crisis, some of the professional businesses actually paused in their purchases. The residential business was fantastic during that, some very high growth rates, driven by conditions in the marketplace, the fact that people were also spending more time in their homes. The pandemic, same story. The residential business was an absolute champ in 2020, 2021, grew by more than 20% for 2 years in a row. We've repeatedly said in our earnings calls, we don't expect the residential business to continue to grow at 25% indefinitely. It's going to return more to mid or lower single-digit type of growth. And we've seen that happening and it happened fairly abruptly in June of this year. So that's what we reported in our third quarter. We expect that to return to a more normal long-term run rate, low single digits GDP plus a few percentage plus our share gain over time. Residential business is strong. Homeownership obviously drives that. And there's a strong demand, shortage of homes, in fact, right now.

Maybe dovetails into a question I have is -- in conjunction with your last earnings, you talked about a new relationship with Lowe's. Could you maybe just talk a little bit about how that developed and kind of how you see that kind of ramping over time? And maybe what does Lowe's give you that -- did you kind of view Lowe's as kind of a market expansion opportunity? Or is it you're kind of moving to Lowe's and then eventually Home Depot kind of gets -- kind of phased out?

We -- the first thing I want to make clear is we value all of our relationships with every mass retail partner we have in all of our dealers. So we're always sensitive to any impact on all of our channel partners in any decision that we make. We just saw with Lowe's that this was an opportunity, and the timing was right relative to where our strategic focus was and the opportunities that they provided. But it doesn't say anything about how we feel about our other partners. We feel very strongly and positively about them and are grateful for them.

Okay. Is the assortment different? Or is what you're going to highlight in the assortment different at Lowe's versus Depot?

Yes. Typically, we would have a combination of SKUs that cut across multiple channels and a few that would be specific to specific channel partners.

Okay. And is there any way to kind of put numbers around how big Lowe's could be over time? Or is that too far?

That's probably too far.

Okay. And then, I guess, staying in the residential business, just as we move away from gas and towards battery, you've had some kind of different competitors that have kind of gotten to the space, whether it's EGO or RYOBI. How do you kind of view Toro's position relative to -- I don't know if you call it the power tool guys, but just some of these more kind of battery-operated power tool manufacturers that have kind of gotten -- started to get into lawn and garden tools?

I think, first of all, it's just -- it's good. We had similar conversations earlier today, and it's good to just realize this is a very competitive part of our market under any circumstances. It always has been. The -- there are new competitors, but there's a base of competitors that have been there for some time. And with regard to where some of the newer competitors are coming from, they come from a base of strength of existing power tools, et cetera. We come from a different base of long tenure within the outdoor equipment side of things. So we're going to play to our strengths, and I'm sure they're going to play to theirs, but that's the position where we come from.

Okay. And then a question here from the audience. Just what is your market share in battery? Is it similar to your market share in gas?

Battery depends on the segments. For example, in the golf course market, we would have lead market share. Some of the commercial markets, lead market share. The closer you get to the small products like handheld products, that number goes down.

Okay. Okay. And then when you -- when we think about Charles Machine Works, I think you did the acquisition almost 5 years ago. Can you just give us an update just kind of where the integration of that business is? I mean, it was by far the biggest acquisition you've ever done. You had about $30 million of synergies identified over 3 years. Just kind of where do we stand on the Charles Machine Works business relative to that kind of initial base case acquisition model?

The acquisition of Charles Machine Works has been absolutely fantastic. And the best thing that happened is we got Angie, our CFO, through that process, who's been a great addition to our team. It has added for us a dimension. We were in the underground business. There was a Toro line of horizontal directional drills that we acquired 8 or 10 years before we made the Charles Machine Works acquisition. So we knew the market, and we knew the desirability and fit of the market for us. What we were unable to do using our typical formula is break into the market due to the relationships and the things I talked about when we started. Ditch Witch has those decades-long relationships. And I use the example, if we were an underground contractor and we have the street, the Shoreline Boulevard here, shutdown from 10:00 at night until 5:00 in the morning, you remember when you have your Ditch Witch partner come out and help you get out of a jam in the middle of the night, so that the road opens up at 5:00 in the morning. That transcends pure pricing, spec comparisons in a purchase model. So those are the kinds of relationships that they have. They're very similar to our golf market in that regard. And with regard to synergy progress, we exceeded the $30 million of synergy. And the process that we went through in integration helped set us up to be very healthy as we enter the pandemic, and I'm very grateful for that. We had coincidentally completed contracts with our steel suppliers and other suppliers that helped us weather the storm through the pandemic better than others. So it's been a fantastic piece driven by different end markets and drivers that help us to stabilize the business as well.

Yes. I mean, can you talk a little bit about the end markets? I mean, you've got -- I think telecom and utilities are two of the biggest ones. Obviously, construction. There's a lot of legislative kind of tailwinds around 5G deployments and infrastructure activity and those types of things. So how do you think of just about the long-term kind of growth outlook for Charles Machine Works with those types of kind of -- those types of incentives kind of going into their end markets?

We feel very positively about the runway opportunity for Charles Machine Works. And those drivers, the elements that give us confidence are very public, so you can Google the things that we just talked about and see the investments that are sitting there to be put in practice, if you will, through contracts. When we -- at the time of the acquisition, we talked about the core utility work that's always being done with the incredible driver of the 5G build-out, which is still in the early phases. And for some that are not as familiar, 4G, for example, you may have an antenna one every 10 miles in some cases in fairly open circumstances. In 5G, you may need an antenna every 400 feet. So all of that infrastructure has to be put in place to really fully realize the benefits of 5G. All of those points have to be connected back to the trunk system with fiber optics. So that was kind of the starting place of something that's a little bit different. You layer on top of that what happened in the pandemic, which was a realization that there's a digital divide, the haves and the have-nots of broadband, and how that enables people to participate in work remotely or whatever it is, and massive investment in broadband and bringing that to the far reaches globally. You layer on top of that the Inflation Reduction Act and other similar legislation around the world driven towards utilities, upgrades, the clean energy build-out, and that's probably the last piece is on top of that. All of what we're talking about with clean energy, charging systems, offshore, wind, solar farms, et cetera, all of that is connected using our products.

That's great. That's great. There's a question here from the audience. You mentioned on your slides that a lot of your equipment is replacement-oriented, it's usage-based. How do your end markets, your end customers kind of react to market volatility or downturns, recessions, those types of things?

Yes. The -- one of the things that we say, if you take the turf side of things, is grass doesn't know that there's a recession. So if you own a golf course and you're feeling a little uncertain about the economy, you don't have the choice of not maintaining your golf course until things get better. If you're going to have a golf course that's open, it has to be maintained at the highest level. If you do that, you consume a portion of that equipment every time you use it, which means it has to be replaced. So you can delay a little bit, but you can't get too far off of your replacement cycle or you end up with a deficit of equipment like we're in today and like we're working through with the back-order situation.

Okay. Okay. And then just maybe on the M&A environment. I mean, you talked about Charles Machine Works kind of setting you up for just the playbook and synergies kind of setting you up for kind of going into this kind of COVID-induced pullback. Does it also kind of give you more confidence to do bigger acquisitions? You have kind of like a playbook now where you've done it successfully with one or 2 acquisitions and now you can apply it to others.

It definitely does. We literally have the playbook on how we go about those. So it gets -- given us a lot of confidence in our ability to execute those. We did so with the technical acquisitions in 2020, Left Hand Robotics and TURFLYNX in the robotics area. Those were relatively easy due to the size. We did the same with Ventrac in 2021, has become an incredible piece of our business, using the same playbook and very naturally helping to facilitate the integration. We did so with Spartan as well, which is a more recent acquisition. So it does give us confidence. I think it's not as important that we're shooting for very large acquisitions. It's that we're always in the process and we're always looking for the perfect fit. It starts with the strategy. It starts with us identifying a product category or a market that we're interested in playing in, where we know we can win. And then we look at who the potential partners are that we'd like to -- that we would be interested in talking with.

And do you see M&A as more of a kind of a horizontal play where you're kind of consolidating market share? Or do you see -- do you still see opportunities to get into new markets via M&A?

We -- I just had this discussion where we've built out our strategy and M&A team at The Toro Company. And so I had this discussion with the new person, Jason Baab, who's leading that. And at the kind of company level, we should always be open to -- is there another leg on the stool where we could win, use our assets and our expertise to win. Our main focus is with our core businesses to find opportunities where they can win and add to help serve those end customers better. So it's really starting there with our existing verticals, if you will. We will be open to something that is a little bit further away, but there's a way we could win. But I think that's more of a discussion at the company level.

Okay. Okay. And then just the last question on the M&A side, just with technology. Is that also -- I mean is there opportunities for you to go out and acquire emerging technologies like you did with Left Hand? Are there a lot of those types of acquisitions that you can do?

There are. And for example, in the underground space, that's an area where there's a lot of development taking place to improve those processes. You could really look across all of our individual verticals for opportunities. The biggest opportunity is usually cutting across a multiple of our businesses to apply it to multiple businesses.

Okay. We're out of time. So please join me in thanking the Toro team for being here with us.

Thank you.