Edgar Filing: TORO CO

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended August 3, 2018

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period from to

THE TORO COMPANY

(Exact name of registrant as specified in its charter)



Delaware	1-8649	41-0580470
(State of Incorporation)	(Commission File Number)	(I.R.S. Employer Identification Number)

8111 Lyndale Avenue South

Bloomington, Minnesota 55420

Telephone Number: (952) 888-8801

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer x	Accelerated filer o

Non-accelerated filer o	Smaller reporting company o
(Do not check if a smaller reporting company)
	Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

The number of shares of the registrant’s common stock outstanding as of August 31, 2018 was 105,530,994.

Table of Contents

THE TORO COMPANY

INDEX TO FORM 10-Q



		Page Number

PART I.	FINANCIAL INFORMATION:

Item 1.	Financial Statements

	Condensed Consolidated Statements of Earnings (Unaudited)	3

	Condensed Consolidated Statements of Comprehensive Income (Unaudited)	3

	Condensed Consolidated Balance Sheets (Unaudited)	4

	Condensed Consolidated Statements of Cash Flows (Unaudited)	5

	Notes to Condensed Consolidated Financial Statements (Unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	36

Item 4.	Controls and Procedures	37

PART II.	OTHER INFORMATION:

Item 1.	Legal Proceedings	38

Item 1A.	Risk Factors	38

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 6.	Exhibits	41

	Signatures	42

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings (Unaudited)

(Dollars and shares in thousands, except per share data)



	Three Months Ended						Nine Months Ended
	August 3, 2018			August 4, 2017			August 3, 2018			August 4, 2017
Net sales	$	655,821		$	627,943		$	2,079,347		$	2,016,549
Cost of sales	422,168			401,158			1,317,399			1,279,970
Gross profit	233,653			226,785			761,948			736,579
Selling, general and administrative expense	140,759			139,001			431,859			428,929
Operating earnings	92,894			87,784			330,089			307,650
Interest expense	(4,676		)	(4,750		)	(14,214		)	(14,309		)
Other income, net	5,057			5,349			12,951			12,916
Earnings before income taxes	93,275			88,383			328,826			306,257
Provision for income taxes	14,266			19,979			95,924			72,388
Net earnings	$	79,009		$	68,404		$	232,902		$	233,869

Basic net earnings per share of common stock	$	0.75		$	0.63		$	2.19		$	2.16

Diluted net earnings per share of common stock	$	0.73		$	0.61		$	2.14		$	2.10

Weighted-average number of shares of common stock outstanding — Basic	105,751			108,456			106,474			108,434

Weighted-average number of shares of common stock outstanding — Diluted	108,070			111,457			108,930			111,460

See accompanying Notes to Condensed Consolidated Financial Statements.

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in thousands)



	Three Months Ended						Nine Months Ended
	August 3, 2018			August 4, 2017			August 3, 2018			August 4, 2017
Net earnings	$	79,009		$	68,404		$	232,902		$	233,869
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments	(4,373		)	12,300			(2,164		)	13,017
Derivative instruments, net of tax of $485; $(2,262); $1,318; and $(2,236), respectively	1,449			(3,062		)	2,430			(1,100		)
Pension and retiree medical benefits	85			—			416			—
Other comprehensive income (loss), net of tax	(2,839		)	9,238			682			11,917
Comprehensive income	$	76,170		$	77,642		$	233,584		$	245,786

See accompanying Notes to Condensed Consolidated Financial Statements.

Table of Contents

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Balance Sheets (Unaudited)

(Dollars in thousands, except per share data)



	August 3, 2018			August 4, 2017			October 31, 2017
ASSETS
Cash and cash equivalents	$	250,871		$	335,026		$	310,256
Receivables, net	219,469			221,551			183,073
Inventories, net	364,497			349,022			328,992
Prepaid expenses and other current assets	38,187			42,550			37,565
Total current assets	873,024			948,149			859,886

Property, plant and equipment, gross	915,667			890,585			885,614
Less accumulated depreciation	666,165			663,659			650,384
Property, plant and equipment, net	249,502			226,926			235,230

Deferred income taxes	43,590			59,754			64,083
Goodwill	225,369			202,678			205,029
Other intangible assets, net	107,700			106,258			103,743
Other assets	35,572			25,779			25,816
Total assets	$	1,534,757		$	1,569,544		$	1,493,787

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current portion of long-term debt	$	—		$	23,056		$	26,258
Accounts payable	229,041			211,453			211,752
Accrued liabilities	282,634			309,385			283,786
Total current liabilities	511,675			543,894			521,796

Long-term debt, less current portion	312,481			308,793			305,629
Deferred revenue	25,087			24,964			24,761
Deferred income taxes	1,728			—			1,726
Other long-term liabilities	33,542			31,971			22,783

Stockholders’ equity:
Preferred stock, par value $1.00 per share, authorized 1,000,000 voting and 850,000 non-voting shares, none issued and outstanding	—			—			—
Common stock, par value $1.00 per share, authorized 175,000,000 shares; issued and outstanding 105,297,097 shares as of August 3, 2018, 107,883,039 shares as of August 4, 2017, and 106,882,972 shares as of October 31, 2017	105,297			107,883			106,883
Retained earnings	568,385			578,558			534,329
Accumulated other comprehensive loss	(23,438		)	(26,519		)	(24,120		)
Total stockholders’ equity	650,244			659,922			617,092
Total liabilities and stockholders’ equity	$	1,534,757		$	1,569,544		$	1,493,787

See accompanying Notes to Condensed Consolidated Financial Statements.

Table of Contents

THE TORO COMPANY AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)



	Nine Months Ended
	August 3, 2018			August 4, 2017
Cash flows from operating activities:
Net earnings	$	232,902		$	233,869
Adjustments to reconcile net earnings to net cash provided by operating activities:
Non-cash income from finance affiliate	(8,564		)	(7,566		)
Distributions from finance affiliate, net	6,162			4,617
Provision for depreciation and amortization	41,908			47,713
Stock-based compensation expense	8,588			9,691
Deferred income taxes	20,381			(2,121		)
Other	(83		)	71
Changes in operating assets and liabilities, net of effect of acquisitions:
Receivables, net	(34,996		)	(54,935		)
Inventories, net	(33,554		)	(34,069		)
Prepaid expenses and other assets	(6,065		)	(7,625		)
Accounts payable, accrued liabilities, deferred revenue and other long-term liabilities	32,690			86,991
Net cash provided by operating activities	259,369			276,636

Cash flows from investing activities:
Purchases of property, plant and equipment	(51,938		)	(36,572		)
Proceeds from asset disposals	—			74
Investment in unconsolidated entities	(6,417		)	—
Acquisitions, net of cash acquired	(31,202		)	(24,181		)
Net cash used in investing activities	(89,557		)	(60,679		)

Cash flows from financing activities:
Payments on long-term debt	(19,757		)	(19,158		)
Proceeds from exercise of stock options	10,165			9,756
Payments of withholding taxes for stock awards	(3,884		)	(3,747		)
Purchases of Toro common stock	(151,481		)	(92,312		)
Dividends paid on Toro common stock	(63,808		)	(56,926		)
Net cash used in financing activities	(228,765		)	(162,387		)

Effect of exchange rates on cash and cash equivalents	(432		)	7,901

Net (decrease)/increase in cash and cash equivalents	(59,385		)	61,471
Cash and cash equivalents as of the beginning of the fiscal period	310,256			273,555
Cash and cash equivalents as of the end of the fiscal period	$	250,871		$	335,026

See accompanying Notes to Condensed Consolidated Financial Statements.

Table of Contents

THE TORO COMPANY AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

August 3, 2018

Note 1 — Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and notes required by United States ("U.S.") generally accepted accounting principles ("GAAP") for complete financial statements. Unless the context indicates otherwise, the terms "company," "Toro," "we," "our," or "us" refer to The Toro Company and its consolidated subsidiaries. All intercompany accounts and transactions have been eliminated from the unaudited Condensed Consolidated Financial Statements.

In the opinion of management, the unaudited Condensed Consolidated Financial Statements include all adjustments, consisting primarily of recurring accruals, considered necessary for the fair presentation of the company's Consolidated Financial Position, Results of Operations, and Cash Flows for the periods presented. Since the company’s business is seasonal, operating results for the nine months ended August 3, 2018 cannot be annualized to determine the expected results for the fiscal year ending October 31, 2018.

The company’s fiscal year ends on October 31, and quarterly results are reported based on three-month periods that generally end on the Friday closest to the quarter end. For comparative purposes, however, the company’s second and third quarters always include exactly 13 weeks of results so that the quarter end date for these two quarters is not necessarily the Friday closest to the calendar month end.

For further information, refer to the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in the company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2017. The policies described in that report are used for preparing quarterly reports.

Accounting Policies

In preparing the Condensed Consolidated Financial Statements in conformity with U.S. GAAP, management must make decisions that impact the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures, including disclosures of contingent assets and liabilities. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. Estimates are used in determining, among other items, sales promotion and incentive accruals, incentive compensation accruals, income tax accruals, inventory valuation, warranty reserves, earn-out liabilities, allowance for doubtful accounts, pension and post-retirement accruals, self-insurance accruals, useful lives for tangible and definite-lived intangible assets, and future cash flows associated with impairment testing for goodwill, indefinite-lived intangible assets and other long-lived assets. These estimates and assumptions are based on management’s best estimates and judgments at the time they are made. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors that management believes to be reasonable under the circumstances, including the current economic environment. Management adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with certainty, actual amounts could differ significantly from those estimated at the time the Condensed Consolidated Financial Statements are prepared. Changes in those estimates will be reflected in the Consolidated Financial Statements in future periods.

United States Tax Reform

On December 22, 2017, the United States enacted Public Law No. 115-97 ("Tax Act"), originally introduced as the Tax Cuts and Jobs Act, to significantly modify the Internal Revenue Code. The Tax Act reduced the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent, created a territorial-type tax system with an exemption for foreign dividends, and imposed a one-time deemed repatriation tax on a U.S. company's historical undistributed earnings and profits of foreign affiliates. The tax rate change is effective January 1, 2018, resulting in a blended statutory tax rate of 23.3 percent for the fiscal year ended October 31, 2018. Among other provisions, the Tax Act also increased expensing for certain business assets, created new taxes on certain foreign sourced earnings, adopted limitations on business interest expense deductions, repealed deductions for income attributable to domestic production activities, and added other anti-base erosion rules. The effective dates for the provisions set forth in the Tax Act vary as to when the provisions will apply to the company.

In response to the Tax Act, the U.S. Securities and Exchange Commission ("SEC") provided guidance by issuing Staff Accounting Bulletin No. 118 ("SAB 118"), which has since been codified by the release of Accounting Standards Update ("ASU") No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. ASU 2018-05

Table of Contents

allows companies to record provisional amounts during a measurement period with respect to the impacts of the Tax Act for which the accounting requirements under Accounting Standards Codification ("ASC") Topic 740 are not complete, but a reasonable estimate has been determined. The measurement period under ASU 2018-05 ends when a company has obtained, prepared, and analyzed the information that was needed in order to complete the accounting requirements under ASC Topic 740, but cannot exceed one year.

As of August 3, 2018, the company has not completed the accounting for the effects of the Tax Act. However, the company has estimated the impacts of the Tax Act in its annual effective tax rate, and has recorded provisional amounts for the remeasurement of deferred tax assets and liabilities and the deemed repatriation tax.

While we have recorded provisional amounts for the items expected to most significantly impact our financial statements this year, our evaluation is not complete and, accordingly, we have not yet reached a final conclusion on the overall impacts of the Tax Act. The company needs additional time to obtain, prepare, and analyze information related to the applicable provisions of the Tax Act. The actual impact of the Tax Act may differ from the provisional amounts, due to, among other things, changes in interpretations and assumptions the company has made, guidance that may be issued, and changes in the company's structure or business model.

Note 2 — Acquisitions

L.T. Rich Products, Inc.

Effective March 19, 2018, during the second quarter of fiscal 2018, the company completed the acquisition of substantially all of the assets of, and assumed certain liabilities for, L.T. Rich Products, Inc., a manufacturer of professional zero-turn spreader/sprayers, aerators, and snow and ice management equipment. The addition of these products broadens and strengthens the company’s Professional segment solutions for landscape contractors and grounds professionals.

The purchase price of this acquisition was allocated to the identifiable assets acquired and liabilities assumed based on estimates of their fair value, with the excess purchase price recorded as goodwill. As of August 3, 2018, the company has not yet finalized the purchase accounting for this acquisition, but expects to finalize such purchase accounting within one year from the date of acquisition. Additional purchase accounting disclosures have been omitted given the immateriality of this acquisition in relation to the company's Consolidated Financial Condition and Results of Operations.

Regnerbau Calw GmbH

Effective January 1, 2017, during the first quarter of fiscal 2017, the company completed the acquisition of all the outstanding shares of Regnerbau Calw GmbH ("Perrot"), a privately held manufacturer of professional irrigation equipment. The addition of these products broadened and strengthened the company's irrigation solutions for the sport, agricultural, and industrial markets. The acquisition was funded with existing foreign cash and cash equivalents. The purchase price of this acquisition was allocated to the identifiable assets acquired and liabilities assumed based on estimates of their fair value, with the excess purchase price recorded as goodwill. This acquisition was immaterial based on the company's Consolidated Financial Condition and Results of Operations.

Table of Contents

Note 3 — Investment in Joint Venture

In fiscal 2009, the company and TCF Inventory Finance, Inc. ("TCFIF"), a subsidiary of TCF National Bank, established Red Iron Acceptance, LLC ("Red Iron"), a joint venture in the form of a Delaware limited liability company that primarily provides inventory financing to certain distributors and dealers of the company’s products in the United States. On November 29, 2016, during the first quarter of fiscal 2017, the company entered into amended agreements for its Red Iron joint venture with TCFIF. As a result, the amended term of Red Iron will continue until October 31, 2024, subject to two-year extensions thereafter. Either the company or TCFIF may elect not to extend the amended term, or any subsequent term, by giving one-year written notice to the other party.

The company owns 45 percent of Red Iron and TCFIF owns 55 percent of Red Iron. The company accounts for its investment in Red Iron under the equity method of accounting. The company and TCFIF each contributed a specified amount of the estimated cash required to enable Red Iron to purchase the company’s inventory financing receivables and to provide financial support for Red Iron’s inventory financing programs. Red Iron borrows the remaining requisite estimated cash utilizing a $550 million secured revolving credit facility established under a credit agreement between Red Iron and TCFIF. The company’s total investment in Red Iron as of August 3, 2018 was $23.0 million. The company has not guaranteed the outstanding indebtedness of Red Iron.

The company has agreed to repurchase products repossessed by Red Iron and the TCFIF Canadian affiliate, up to a maximum aggregate amount of $7.5 million in a calendar year. Under the repurchase agreement between Red Iron and the company, Red Iron provides financing for certain dealers and distributors. These transactions are structured as an advance in the form of a payment by Red Iron to the company on behalf of a distributor or dealer with respect to invoices financed by Red Iron. These payments extinguish the obligation of the dealer or distributor to make payment to the company under the terms of the applicable invoice.

Under separate agreements between Red Iron and the dealers and distributors, Red Iron provides loans to the dealers and distributors for the advances paid by Red Iron to the company. The net amount of receivables financed for dealers and distributors under this arrangement for the nine months ended August 3, 2018 and August 4, 2017 were $1,525.3 million and $1,466.5 million, respectively.

As of July 31, 2018, Red Iron’s total assets were $463.8 million and total liabilities were $412.6 million.

Note 4 — Inventories

Inventories are valued at the lower of cost or net realizable value, with cost determined by the last-in, first-out ("LIFO") method for a majority of the company's inventories and the first-in, first-out ("FIFO") method for all other inventories. The company establishes a reserve for excess, slow-moving, and obsolete inventory that is equal to the difference between the cost and estimated net realizable value for that inventory. These reserves are based on a review and comparison of current inventory levels to the planned production, as well as planned and historical sales of the inventory.

Inventories were as follows:



(Dollars in thousands)	August 3, 2018		August 4, 2017		October 31, 2017
Raw materials and work in process	$	105,239	$	88,440	$	100,077
Finished goods and service parts	326,059		318,940		295,716
Total FIFO value	431,298		407,380		395,793
Less: adjustment to LIFO value	66,801		58,358		66,801
Total inventories, net	$	364,497	$	349,022	$	328,992

Table of Contents

Note 5 — Goodwill and Other Intangible Assets

The changes in the net carrying amount of goodwill for the first nine months of fiscal 2018 were as follows:



(Dollars in thousands)	Professional Segment			Residential Segment			Total
Balance as of October 31, 2017	$	194,464		$	10,565		$	205,029
Goodwill acquired	20,393			—			20,393
Translation adjustments	(17		)	(36		)	(53		)
Balance as of August 3, 2018	$	214,840		$	10,529		$	225,369

The components of other intangible assets as of August 3, 2018 were as follows:



(Dollars in thousands)	Gross Carrying Amount		Accumulated Amortization			Net
Patents	$	18,247	$	(12,103	)	$	6,144
Non-compete agreements	6,883		(6,776		)	107
Customer-related	89,745		(22,444		)	67,301
Developed technology	31,097		(28,165		)	2,932
Trade names	2,331		(1,760		)	571
Other	800		(800		)	—
Total amortizable	149,103		(72,048		)	77,055
Non-amortizable - trade names	30,645		—			30,645
Total other intangible assets, net	$	179,748	$	(72,048	)	$	107,700

The components of other intangible assets as of October 31, 2017 were as follows:



(Dollars in thousands)	Gross Carrying Amount		Accumulated Amortization			Net
Patents	$	15,162	$	(11,599	)	$	3,563
Non-compete agreements	6,896		(6,775		)	121
Customer-related	87,461		(18,940		)	68,521
Developed technology	30,212		(26,939		)	3,273
Trade names	2,330		(1,637		)	693
Other	800		(800		)	—
Total amortizable	142,861		(66,690		)	76,171
Non-amortizable - trade names	27,572		—			27,572
Total other intangible assets, net	$	170,433	$	(66,690	)	$	103,743

Amortization expense for intangible assets during the third quarter of fiscal 2018 was $1.8 million, compared to $2.5 million for the same period last fiscal year. Amortization expense for intangible assets during the first nine months of fiscal 2018 was $5.4 million, compared to $7.4 million for the same period last fiscal year. Estimated amortization expense for the remainder of fiscal 2018 and succeeding fiscal years is as follows: fiscal 2018 (remainder), $1.8 million; fiscal 2019, $6.7 million; fiscal 2020, $6.2 million; fiscal 2021, $5.8 million; fiscal 2022, $5.6 million; fiscal 2023, $5.2 million; and after fiscal 2023, $45.8 million.

Table of Contents

Note 6 — Stockholders’ Equity

Accumulated Other Comprehensive Loss

Components of accumulated other comprehensive loss ("AOCL"), net of tax, are as follows:



(Dollars in thousands)	August 3, 2018			August 4, 2017		October 31, 2017
Foreign currency translation adjustments	$	23,467		$	18,089	$	21,303
Pension and post-retirement benefits	1,596			6,683		2,012
Cash flow hedging derivative instruments	(1,625		)	1,747		805
Total accumulated other comprehensive loss	$	23,438		$	26,519	$	24,120

The components and activity of AOCL for the first nine months of fiscal 2018 are as follows:



(Dollars in thousands)	Foreign Currency Translation Adjustments		Pension and Post-Retirement Benefits			Cash Flow Hedging Derivative Instruments			Total
Balance as of October 31, 2017	$	21,303	$	2,012		$	805		$	24,120
Other comprehensive (income) loss before reclassifications	2,164		—			(5,302		)	(3,138		)
Amounts reclassified from AOCL	—		(416		)	2,872			2,456
Net current period other comprehensive (income) loss	2,164		(416		)	(2,430		)	(682		)
Balance as of August 3, 2018	$	23,467	$	1,596		$	(1,625	)	$	23,438

The components and activity of AOCL for the first nine months of fiscal 2017 are as follows:



(Dollars in thousands)	Foreign Currency Translation Adjustments			Pension and Post-Retirement Benefits		Cash Flow Hedging Derivative Instruments			Total
Balance as of October 31, 2016	$	31,430		$	6,359	$	647		$	38,436
Other comprehensive (income) loss before reclassifications	(13,341		)	324		2,092			(10,925		)
Amounts reclassified from AOCL	—			—		(992		)	(992		)
Net current period other comprehensive (income) loss	(13,341		)	324		1,100			(11,917		)
Balance as of August 4, 2017	$	18,089		$	6,683	$	1,747		$	26,519

For additional information on the components reclassified from AOCL to the respective line items within net earnings for the company's cash flow hedging derivative instruments, refer to Note 12, Derivative Instruments and Hedging Activities.

Table of Contents

Note 7 — Stock-Based Compensation

The compensation costs related to stock-based awards were as follows:



	Three Months Ended				Nine Months Ended
(Dollars in thousands)	August 3, 2018		August 4, 2017		August 3, 2018		August 4, 2017
Stock option awards	$	1,310	$	1,431	$	3,725	$	4,200
Restricted stock units	666		572		2,321		1,723
Performance share awards	1,047		1,059		2,012		3,230
Unrestricted common stock awards	—		—		530		538
Total compensation cost for stock-based awards	$	3,023	$	3,062	$	8,588	$	9,691

During the first nine months of fiscal years 2018 and 2017, 8,388 and 11,412 shares, respectively, of fully vested unrestricted common stock awards were granted to certain members of the company's Board of Directors as a component of their compensation for their service on the Board of Directors and are recorded in selling, general and administrative expense in the Condensed Consolidated Statements of Earnings. No shares of fully vested unrestricted common stock awards were granted during the second or third quarters of fiscal years 2018 and 2017.

Stock Option Awards

Under The Toro Company Amended and Restated 2010 Equity and Incentive Plan, as amended and restated (the "2010 plan"), stock options are granted with an exercise price equal to the closing price of the company’s common stock on the date of grant, as reported by the New York Stock Exchange. Options are generally granted to executive officers, other employees, and non-employee members of the company’s Board of Directors on an annual basis in the first quarter of the company’s fiscal year. Options generally vest one-third each year over a three-year period and have a ten-year term. Other options granted to certain employees vest in full on the three-year anniversary of the date of grant and have a ten-year term. Compensation expense equal to the grant date fair value is generally recognized for these awards over the vesting period. Stock options granted to executive officers and other employees are subject to accelerated expensing if the option holder meets the retirement definition set forth in the 2010 plan. In that case, the fair value of the options is expensed in the fiscal year of grant because generally the option holder must be employed after the last day of the fiscal year in which the stock options are granted in order for the options to continue to vest following retirement. Similarly, if a non-employee director has served on the company’s Board of Directors for ten full fiscal years or more, the awards vest immediately upon retirement, and therefore, the fair value of the options granted is fully expensed on the date of the grant.

The fair value of each stock option is estimated on the date of grant using the Black-Scholes valuation method with the assumptions noted in the table below. The expected life is a significant assumption as it determines the period for which the risk-free interest rate, stock price volatility, and dividend yield must be applied. The expected life is the average length of time in which executive officers, other employees, and non-employee directors are expected to exercise their stock options, which is primarily based on historical exercise experience. The company groups executive officers and non-employee directors for valuation purposes based on similar historical exercise behavior. Expected stock price volatilities are based on the daily movement of the company’s common stock over the most recent historical period equivalent to the expected life of the option. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury rate over the expected life at the time of grant. Dividend yield is estimated over the expected life based on the company’s historical cash dividends paid, expected future cash dividends and dividend yield, and expected changes in the company’s stock price.

The following table illustrates the weighted-average valuation assumptions for options granted in the following fiscal periods:



	Fiscal 2018	Fiscal 2017
Expected life of option in years	6.04	6.02
Expected stock price volatility	20.58%	22.15%
Risk-free interest rate	2.21%	2.03%
Expected dividend yield	0.97%	1.01%
Per share weighted-average fair value at date of grant	$14.25	$12.55

Table of Contents

Performance Share Awards

Under the 2010 Plan, the company grants performance share awards to executive officers and other employees under which they are entitled to receive shares of the company’s common stock contingent on the achievement of performance goals of the company and businesses of the company, which are generally measured over a three-year period. The number of shares of common stock a participant receives will be increased (up to 200 percent of target levels) or reduced (down to zero) based on the level of achievement of performance goals and vest at the end of a three-year period. Performance share awards are generally granted on an annual basis in the first quarter of the company’s fiscal year. Compensation expense is recognized for these awards on a straight-line basis over the vesting period based on the per share fair value as of the date of grant and the probability of achieving each performance goal. The per share weighted-average fair value of performance share awards granted during the first quarter of fiscal 2018 and 2017 was $65.40 and $54.52, respectively. No performance share awards were granted during the second or third quarters of fiscal 2018 and 2017.

Restricted Stock Unit Awards

Under the 2010 plan, restricted stock unit awards are generally granted to certain employees that are not executive officers. Occasionally, restricted stock unit awards may be granted, including to executive officers, in connection with hiring, mid-year promotions, leadership transition, or retention. Restricted stock unit awards generally vest one-third each year over a three-year period, or vest in full on the three-year anniversary of the date of grant. Such awards may have performance-based rather than time-based vesting requirements. Compensation expense equal to the grant date fair value, which is equal to the closing price of the company’s common stock on the date of grant multiplied by the number of shares subject to the restricted stock unit awards, is recognized for these awards over the vesting period. The per share weighted-average fair value of restricted stock unit awards granted during the first nine months of fiscal 2018 and 2017 was $63.47 and $65.86, respectively.

Note 8 — Per Share Data

Reconciliations of basic and diluted weighted-average shares of common stock outstanding are as follows:



	Three Months Ended		Nine Months Ended
(Shares in thousands)	August 3, 2018	August 4, 2017	August 3, 2018	August 4, 2017
Basic
Weighted-average number of shares of common stock	105,751	108,456	106,457	108,417
Assumed issuance of contingent shares	—	—	17	17
Weighted-average number of shares of common stock and assumed issuance of contingent shares	105,751	108,456	106,474	108,434
Diluted
Weighted-average number of shares of common stock and assumed issuance of contingent shares	105,751	108,456	106,474	108,434
Effect of dilutive securities	2,319	3,001	2,456	3,026
Weighted-average number of shares of common stock, assumed issuance of contingent shares, and effect of dilutive securities	108,070	111,457	108,930	111,460

Incremental shares from options and restricted stock units are computed under the treasury stock method. Options to purchase 740,720 shares of common stock during the third quarter of fiscal 2018 were excluded from diluted net earnings per share because they were anti-dilutive. For the third quarter of fiscal 2017, there were no options to purchase shares of common stock that were excluded from diluted earnings per share because they were anti-dilutive. Options to purchase 412,302 and 443,003 shares of common stock during the first nine months of fiscal 2018 and 2017, respectively, were excluded from diluted net earnings per share because they were anti-dilutive.

Table of Contents

Note 9 — Segment Data

The presentation of segment information reflects the manner in which management organizes segments for making operating decisions and assessing performance. On this basis, the company has determined it has three reportable business segments: Professional, Residential, and Distribution. The Distribution segment, which consists of a wholly-owned domestic distributorship, has been combined with the company’s corporate activities and elimination of intersegment revenues and expenses that is shown as "Other" in the following tables due to the insignificance of the segment.

The following tables present the summarized financial information concerning the company’s reportable segments:



(Dollars in thousands)
Three Months Ended August 3, 2018	Professional		Residential		Other			Total
Net sales	$	482,494	$	166,513	$	6,814		$	655,821
Intersegment gross sales	6,772		90		(6,862		)	—
Earnings (loss) before income taxes	$	97,716	$	16,002	$	(20,443	)	$	93,275



(Dollars in thousands)
Three Months Ended August 4, 2017	Professional		Residential		Other			Total
Net sales	$	468,564	$	152,127	$	7,252		$	627,943
Intersegment gross sales	6,577		78		(6,655		)	—
Earnings (loss) before income taxes	$	97,368	$	11,360	$	(20,345	)	$	88,383



(Dollars in thousands)
Nine Months Ended August 3, 2018	Professional		Residential		Other			Total
Net sales	$	1,546,536	$	521,189	$	11,622		$	2,079,347
Intersegment gross sales	23,894		253		(24,147		)	—
Earnings (loss) before income taxes	338,607		58,019		(67,800		)	328,826
Total assets	$	919,800	$	207,930	$	407,027		$	1,534,757



(Dollars in thousands)
Nine Months Ended August 4, 2017	Professional		Residential		Other			Total
Net sales	$	1,451,269	$	550,651	$	14,629		$	2,016,549
Intersegment gross sales	23,767		270		(24,037		)	—
Earnings (loss) before income taxes	314,545		62,965		(71,253		)	306,257
Total assets	$	852,919	$	207,452	$	509,173		$	1,569,544

The following table presents the details of the Other segment operating loss before income taxes:



	Three Months Ended						Nine Months Ended
(Dollars in thousands)	August 3, 2018			August 4, 2017			August 3, 2018			August 4, 2017
Corporate expenses	$	(21,597	)	$	(22,174	)	$	(67,094	)	$	(72,385	)
Interest expense	(4,676		)	(4,750		)	(14,214		)	(14,309		)
Other income	5,830			6,579			13,508			15,441
Total Other segment operating loss before income taxes	$	(20,443	)	$	(20,345	)	$	(67,800	)	$	(71,253	)

Table of Contents

Note 10 — Contingencies — Litigation

The company is party to litigation in the ordinary course of business. Such matters are generally subject to uncertainties and to outcomes that are not predictable with assurance and that may not be known for extended periods of time. Litigation occasionally involves claims for punitive, as well as compensatory, damages arising out of the use of the company’s products. Although the company is self-insured to some extent, the company maintains insurance against certain product liability losses. The company is also subject to litigation and administrative and judicial proceedings with respect to claims involving asbestos and the discharge of hazardous substances into the environment. Some of these claims assert damages and liability for personal injury, remedial investigations or clean up and other costs and damages. The company is also typically involved in commercial disputes, employment disputes, and patent litigation cases in which it is asserting or defending against patent infringement claims. To prevent possible infringement of the company’s patents by others, the company periodically reviews competitors’ products. To avoid potential liability with respect to others’ patents, the company regularly reviews certain patents issued by the United States Patent and Trademark Office and foreign patent offices. Management believes these activities help minimize its risk of being a defendant in patent infringement litigation. The company is currently involved in patent litigation cases, including cases by or against competitors, where it is asserting and defending against claims of patent infringement. Such cases are at varying stages in the litigation process.

The company records a liability in its Condensed Consolidated Financial Statements for costs related to claims, including future legal costs, settlements and judgments, where the company has assessed that a loss is probable and an amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range, the company records the most probable estimate of the loss or the minimum amount when no amount within the range is a better estimate than any other amount. The company discloses a contingent liability even if the liability is not probable or the amount is not estimable, or both, if there is a reasonable possibility that a material loss may have been incurred. In the opinion of management, the amount of liability, if any, with respect to these matters, individually or in the aggregate, will not materially affect its Consolidated Results of Operations, Financial Position, or Cash Flows.

Note 11 — Warranty Guarantees

The company’s products are warranted to ensure customer confidence in design, workmanship, and overall quality. Warranty coverage is generally for specified periods of time and on select products’ hours of usage, and generally covers parts, labor, and other expenses for non-maintenance repairs. Warranty coverage generally does not cover operator abuse or improper use. An authorized company distributor or dealer must perform warranty work. Distributors and dealers submit claims for warranty reimbursement and are credited for the cost of repairs, labor, and other expenses as long as the repairs meet the company's prescribed standards. Warranty expense is accrued at the time of sale based on the estimated number of products under warranty, historical average costs incurred to service warranty claims, the trend in the historical ratio of claims to sales, the historical length of time between the sale and resulting warranty claim, and other minor factors. Special warranty reserves are also accrued for major rework campaigns. Service support outside of the warranty period is provided by authorized distributors and dealers at the customer's expense. The company sells extended warranty coverage on select products for a prescribed period after the original warranty period expires.

The changes in accrued warranties were as follows:



	Three Months Ended						Nine Months Ended
(Dollars in thousands)	August 3, 2018			August 4, 2017			August 3, 2018			August 4, 2017
Beginning balance	$	84,268		$	81,993		$	74,155		$	72,158
Warranty provisions	12,038			11,208			39,827			38,003
Warranty claims	(13,071		)	(11,381		)	(31,787		)	(29,682		)
Changes in estimates	(40		)	(662		)	1,000			679
Ending balance	$	83,195		$	81,158		$	83,195		$	81,158

Table of Contents

Note 12 — Derivative Instruments and Hedging Activities

Risk Management Objective of Using Derivatives

The company is exposed to foreign currency exchange rate risk arising from transactions in the normal course of business, such as sales to third party customers, sales and loans to wholly owned foreign subsidiaries, foreign plant operations, and purchases from suppliers. The company’s primary currency exchange rate exposures are with the Euro, the Australian dollar, the Canadian dollar, the British pound, the Mexican peso, the Japanese yen, the Chinese Renminbi, and the Romanian New Leu against the U.S. dollar, as well as the Romanian New Leu against the Euro.

To reduce its exposure to foreign currency exchange rate risk, the company actively manages the exposure of its foreign currency exchange rate risk by entering into various derivative instruments to hedge against such risk, authorized under company policies that place controls on these hedging activities, with counterparties that are highly rated financial institutions. The company’s policy does not allow the use of derivative instruments for trading or speculative purposes. The company has also made an accounting policy election to use the portfolio exception with respect to measuring counterparty credit risk for derivative instruments, and to measure the fair value of a portfolio of financial assets and financial liabilities on the basis of the net open risk position with each counterparty.

The company’s hedging activities primarily involve the use of forward currency contracts to hedge most foreign currency transactions, including forecasted sales and purchases denominated in foreign currencies. The company uses derivative instruments only in an attempt to limit underlying exposure from foreign currency exchange rate fluctuations and to minimize earnings and cash flow volatility associated with foreign currency exchange rate fluctuations. Decisions on whether to use such derivative instruments are primarily based on the amount of exposure to the currency involved and an assessment of the near-term market value for each currency.

The company recognizes all derivative instruments at fair value on the Condensed Consolidated Balance Sheets as either assets or liabilities. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as a cash flow hedging instrument.

Cash Flow Hedging Instruments

The company formally documents relationships between cash flow hedging instruments and the related hedged transactions, as well as its risk-management objective and strategy for undertaking cash flow hedging instruments. This process includes linking all cash flow hedging instruments to the forecasted transactions, such as sales to third parties, foreign plant operations, and purchases from suppliers. At the cash flow hedge’s inception and on an ongoing basis, the company formally assesses whether the cash flow hedging instruments have been highly effective in offsetting changes in the cash flows of the hedged transactions and whether those cash flow hedging instruments may be expected to remain highly effective in future periods.

Changes in the fair values of the spot rate component of outstanding, highly effective cash flow hedging instruments included in the assessment of hedge effectiveness are recorded in other comprehensive income within AOCL on the Condensed Consolidated Balance Sheets and are subsequently reclassified to net earnings within the Condensed Consolidated Statements of Earnings during the same period in which the cash flows of the underlying hedged transaction affect net earnings. Changes in the fair values of hedge components excluded from the assessment of effectiveness are recognized immediately in net earnings under the mark-to-market approach. The classification of gains or losses recognized on cash flow hedging instruments and excluded components within the Condensed Consolidated Statements of Earnings is the same as that of the underlying exposure. Results of cash flow hedging instruments, and the related excluded components, of sales and foreign plant operations are recorded in net sales and cost of sales, respectively. The maximum amount of time the company hedges its exposure to the variability in future cash flows for forecasted trade sales and purchases is two years. Results of cash flow hedges of intercompany loans are recorded in other income, net as an offset to the remeasurement of the foreign loan balance.

When it is determined that a derivative instrument is not, or has ceased to be, highly effective as a cash flow hedge, the company discontinues cash flow hedge accounting prospectively. The gain or loss on the dedesignated derivative instrument remains in AOCL and is reclassified to net earnings within the same Condensed Consolidated Statements of Earnings line item as the underlying exposure when the forecasted transaction affects net earnings. When the company discontinues cash flow hedge accounting because it is no longer probable, but it is still reasonably possible that the forecasted transaction will occur by the end of the originally expected period or within an additional two-month period of time thereafter, the gain or loss on the derivative instrument remains in AOCL and is reclassified to net earnings within the same Condensed Consolidated Statements of Earnings line item as the underlying exposure when the forecasted transaction affects net earnings. However, if it is probable that a forecasted transaction will not occur by the end of the originally specified time period or within an additional two-month period of time thereafter, the

Table of Contents

gains and losses that were in AOCL are immediately recognized in net earnings within other income, net in the Condensed Consolidated Statements of Earnings. In all situations in which cash flow hedge accounting is discontinued and the derivative instrument remains outstanding, the company carries the derivative instrument at its fair value on the Condensed Consolidated Balance Sheets, recognizing future changes in the fair value within other income, net in the Condensed Consolidated Statements of Earnings.

As of August 3, 2018, the notional amount outstanding of forward contracts designated as cash flow hedging instruments was $243.5 million.

Derivatives Not Designated as Cash Flow Hedging Instruments

The company also enters into foreign currency contracts that include forward currency contracts to mitigate the remeasurement of specific assets and liabilities on the Condensed Consolidated Balance Sheets. These contracts are not designated as cash flow hedging instruments. Accordingly, changes in the fair value of hedges of recorded balance sheet positions, such as cash, receivables, payables, intercompany notes, and other various contractual claims to pay or receive foreign currencies other than the functional currency, are recognized immediately in other income, net, on the Condensed Consolidated Statements of Earnings together with the transaction gain or loss from the hedged balance sheet position.

The following table presents the fair value and location of the company’s derivative instruments on the Condensed Consolidated Balance Sheets:



(Dollars in thousands)	August 3, 2018		August 4, 2017		October 31, 2017
Derivative assets:
Derivatives designated as cash flow hedging instruments
Prepaid expenses and other current assets
Forward currency contracts	$	2,324	$	1,998	$	1,014
Derivatives not designated as cash flow hedging instruments
Prepaid expenses and other current assets
Forward currency contracts	869		166		27
Total assets	$	3,193	$	2,164	$	1,041
Derivative liabilities:
Derivatives designated as cash flow hedging instruments
Accrued liabilities
Forward currency contracts	$	—	$	5,173	$	1,563
Derivatives not designated as cash flow hedging instruments
Accrued liabilities
Forward currency contracts	—		1,481		703
Total liabilities	$	—	$	6,654	$	2,266

The company has entered into an International Swap Dealers Association ("ISDA") Master Agreement with each counterparty that permits the net settlement of amounts owed under their respective contracts. The ISDA Master Agreement is an industry standardized contract that governs all derivative contracts entered into between the company and the respective counterparty. Under these master netting agreements, net settlement generally permits the company or the counterparty to determine the net amount payable or receivable for contracts due on the same date or in the same currency for similar types of derivative transactions. The company records the fair value of its derivative instruments at the net amount in its Condensed Consolidated Balance Sheets.

Table of Contents

The following table shows the effects of the master netting arrangements on the fair value of the company’s derivative contracts that are recorded in the Condensed Consolidated Balance Sheets:



(Dollars in thousands)	August 3, 2018			August 4, 2017			October 31, 2017
Derivative assets:
Forward currency contracts
Gross amounts of recognized assets	$	3,349		$	2,164		$	1,055
Gross liabilities offset in the balance sheets	(156		)	—			(14		)
Net amounts of assets presented in the Consolidated Balance Sheets	$	3,193		$	2,164		$	1,041
Derivative liabilities:
Forward currency contracts
Gross amounts of recognized liabilities	$	—		$	(6,654	)	$	(2,266	)
Gross assets offset in the balance sheets	—			—			—
Net amounts of liabilities presented in the Consolidated Balance Sheets	$	—		$	(6,654	)	$	(2,266	)

The following tables present the impact and location of the amounts reclassified from AOCL into earnings on the Condensed Consolidated Statements of Earnings and the impact of derivative instruments on the Condensed Consolidated Statements of Comprehensive Income for the company's derivatives designated as cash flow hedging instruments for the three and nine months ended August 3, 2018 and August 4, 2017:



	Three Months Ended
	Gain (Loss) Reclassified from AOCL into Earnings					Gain (Loss) Recognized in OCI on Derivatives
(Dollars in thousands)	August 3, 2018			August 4, 2017		August 3, 2018		August 4, 2017
Derivatives designated as cash flow hedging instruments
Forward currency contracts
Net sales	$	(170	)	$	153	$	1,435	$	(3,531	)
Cost of sales	137			96		14		469
Total derivatives designated as cash flow hedging instruments	$	(33	)	$	249	$	1,449	$	(3,062	)



	Nine Months Ended
	Gain (Loss) Reclassified from AOCL into Earnings						Gain (Loss) Recognized in OCI on Derivatives
(Dollars in thousands)	August 3, 2018			August 4, 2017			August 3, 2018			August 4, 2017
Derivatives designated as cash flow hedging instruments
Forward currency contracts
Net sales	$	(3,482	)	$	2,219		$	2,625		$	(3,685	)
Cost of sales	610			(1,227		)	(195		)	2,585
Total derivatives designated as cash flow hedging instruments	$	(2,872	)	$	992		$	2,430		$	(1,100	)

The company recognized immaterial gains within other income, net in net earnings during the third quarter and first nine months of fiscal 2018 due to the discontinuance of cash flow hedge accounting on certain forward currency contracts designated as cash flow hedging instruments. For the third quarter and first nine months of fiscal 2017, the company did not discontinue cash flow hedge accounting on any forward currency contracts designated as cash flow hedging instruments. As of August 3, 2018, the company expects to reclassify approximately $1.6 million of gains from AOCL to earnings during the next twelve months.

Table of Contents

The following tables present the impact and location of derivative instruments on the Condensed Consolidated Statements of Earnings for the company’s derivatives designated as cash flow hedging instruments and the related components excluded from effectiveness testing:



	Gain (Loss) Recognized in Earnings on Cash Flow Hedging Instruments
	August 3, 2018								August 4, 2017
(Dollars in thousands) Three Months Ended	Net Sales			Cost of Sales			Other Income, Net		Net Sales		Cost of Sales			Other Income, Net
Total Consolidated Statements of Earnings income (expense) amounts in which the effects of cash flow hedging instruments are recorded	$	655,821		$	(422,168	)	$	5,057	$	627,943	$	(401,158	)	$	5,349
Gain (loss) on derivatives designated as cash flow hedging instruments:
Forward currency contracts
Amount of gain (loss) reclassified from AOCL into earnings	(170		)	137			—		153		96			—
Gain (loss) on components excluded from effectiveness testing recognized in earnings based on changes in fair value	$	132		$	(92	)	$	—	$	—	$	—		$	(179	)



	Gain (Loss) Recognized in Earnings on Cash Flow Hedging Instruments
	August 3, 2018								August 4, 2017
(Dollars in thousands) Nine Months Ended	Net Sales			Cost of Sales			Other Income, Net		Net Sales		Cost of Sales			Other Income, Net
Total Consolidated Statements of Earnings income (expense) amounts in which the effects of cash flow hedging instruments are recorded	$	2,079,347		$	(1,317,399	)	$	12,951	$	2,016,549	$	(1,279,970	)	$	12,916
Gain (loss) on derivatives designated as cash flow hedging instruments:
Forward currency contracts
Amount of gain (loss) reclassified from AOCL into earnings	(3,482		)	610			—		2,219		(1,227		)	—
Gain (loss) on components excluded from effectiveness testing recognized in earnings based on changes in fair value	$	31		$	(210	)	$	—	$	—	$	—		$	190

The following table presents the impact and location of derivative instruments on the Condensed Consolidated Statements of Earnings for the company’s derivatives not designated as cash flow hedging instruments:



	Three Months Ended					Nine Months Ended
(Dollars in thousands)	August 3, 2018		August 4, 2017			August 3, 2018		August 4, 2017
Gain (loss) on derivatives not designated as cash flow hedging instruments
Forward currency contracts
Other income, net	$	2,111	$	(4,513	)	$	1,495	$	(3,959	)
Total gain (loss) on derivatives not designated as cash flow hedging instruments	$	2,111	$	(4,513	)	$	1,495	$	(3,959	)

Table of Contents

Note 13 — Fair Value Measurements

The company categorizes its assets and liabilities measured at fair value into one of three levels based on the assumptions (inputs) used in valuing the asset or liability. Estimates of fair value for financial assets and financial liabilities are based on the framework established in the accounting guidance for fair value measurements. The framework defines fair value, provides guidance for measuring fair value, and requires certain disclosures. The framework discusses valuation techniques such as the market approach (comparable market prices), the income approach (present value of future income or cash flows), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The framework utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 provides the most reliable measure of fair value, while Level 3 generally requires significant management judgment. The three levels are defined as follows:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3: Unobservable inputs reflecting management’s assumptions about the inputs used in pricing the asset or liability.

Recurring Fair Value Measurements

The company's derivative instruments consist of forward currency contracts that are measured at fair value on a recurring basis. The fair value of forward currency contracts is determined based on observable market transactions of forward currency prices and spot currency rates as of the reporting date. There were no transfers between levels for the company's recurring fair value measurements during the three and nine months ended August 3, 2018 and August 4, 2017, or the twelve months ended October 31, 2017.

The following tables present, by level within the fair value hierarchy, the company's financial assets and liabilities that are measured at fair value on a recurring basis as of August 3, 2018, August 4, 2017, and October 31, 2017, according to the valuation technique utilized to determine their fair values:



(Dollars in thousands)			Fair Value Measurements Using Inputs Considered as:
August 3, 2018	Fair Value		Level 1		Level 2		Level 3
Assets:
Forward currency contracts	$	3,193	$	—	$	3,193	$	—
Total assets	$	3,193	$	—	$	3,193	$	—
Liabilities:
Forward currency contracts	$	—	$	—	$	—	$	—
Total liabilities	$	—	$	—	$	—	$	—



(Dollars in thousands)			Fair Value Measurements Using Inputs Considered as:
August 4, 2017	Fair Value		Level 1		Level 2		Level 3
Assets:
Forward currency contracts	$	2,164	$	—	$	2,164	$	—
Total assets	$	2,164	$	—	$	2,164	$	—
Liabilities:
Forward currency contracts	$	6,654	$	—	$	6,654	$	—
Total liabilities	$	6,654	$	—	$	6,654	$	—

Table of Contents



(Dollars in thousands)			Fair Value Measurements Using Inputs Considered as:
October 31, 2017	Fair Value		Level 1		Level 2		Level 3
Assets:
Forward currency contracts	$	1,041	$	—	$	1,041	$	—
Total assets	$	1,041	$	—	$	1,041	$	—
Liabilities:
Forward currency contracts	$	2,266	$	—	$	2,266	$	—
Total liabilities	$	2,266	$	—	$	2,266	$	—

Nonrecurring Fair Value Measurements

The company measures certain assets and liabilities at fair value on a nonrecurring basis. Assets and liabilities that are measured at fair value on a nonrecurring basis include long-lived assets, goodwill, and indefinite-lived intangible assets, which would generally be recorded at fair value as the result of an impairment charge. Assets acquired and liabilities assumed as part of acquisitions are measured at fair value.

Other Fair Value Measurements

The carrying values of the company's short-term financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and short-term debt, including current maturities of long-term debt, when applicable, approximate their fair values due to their short-term nature.

Note 14 — Subsequent Events

The company has evaluated all subsequent events and concluded that no subsequent events have occurred that would require recognition in the Condensed Consolidated Financial Statements or disclosure in the Notes to the Condensed Consolidated Financial Statements.

Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. Unless expressly stated otherwise, the comparisons presented in this MD&A refer to the same period in the prior fiscal year. Our MD&A is presented as follows:

•Company Overview

•Results of Operations

•Business Segments

•Financial Position

•Non-GAAP Financial Measures

•Critical Accounting Policies and Estimates

•Forward-Looking Information

We have provided non-GAAP financial measures, which are not calculated or presented in accordance with accounting principles generally accepted in the United States ("GAAP"), as information supplemental and in addition to the financial measures presented in this report that are calculated and presented in accordance with GAAP. This MD&A contains certain non-GAAP financial measures, consisting of adjusted net earnings, adjusted net earnings per diluted share, and an adjusted effective tax rate as measures of our operating performance. Management believes these measures may be useful in performing meaningful comparisons of past and present operating results, to understand the performance of our ongoing operations, and how management views the business. Reconciliations of adjusted non-GAAP financial measures to the most directly comparable reported GAAP financial measures are included in the section titled "Non-GAAP Financial Measures" within this MD&A. These measures, however, should not be construed as an alternative to any other measure of performance determined in accordance with GAAP.

This MD&A should be read in conjunction with the MD&A included in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended October 31, 2017. This discussion contains various "Forward-Looking Statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and we refer readers to the section titled "Forward-Looking Information" located at the end of Part I, Item 2 of this report for more information.

COMPANY OVERVIEW

The Toro Company is in the business of designing, manufacturing, and marketing professional turf maintenance equipment and services, turf irrigation systems, landscaping equipment and lighting products, snow and ice management products, agricultural irrigation systems, rental and specialty construction equipment, and residential yard and snow thrower products. We sell our products worldwide through a network of distributors, dealers, mass retailers, hardware retailers, home centers, as well as online (direct to end-users). We classify our operations into three reportable business segments: Professional, Residential, and Distribution. Our Distribution segment, which consists of our wholly owned domestic distributorship, has been combined with our corporate activities and elimination of intersegment revenues and expenses and is presented as "Other."

We strive to provide innovative, well-built, and dependable products supported by an extensive service network. A significant portion of our net sales has historically been, and we expect will continue to be, attributable to new and enhanced products. We define new products as those introduced in the current and previous two fiscal years.

RESULTS OF OPERATIONS

United States Tax Reform

On December 22, 2017, the United States ("U.S.") enacted Public Law No. 115-97 ("Tax Act"), originally introduced as the Tax Cuts and Jobs Act, to significantly modify the Internal Revenue Code. The Tax Act reduced the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent, created a territorial-type tax system with an exemption for foreign dividends, and imposed a one-time deemed repatriation tax on a U.S. company's historical undistributed earnings and profits of foreign affiliates. The tax rate change was effective January 1, 2018, resulting in a blended statutory tax rate of 23.3 percent for the fiscal year ended October 31, 2018. Among other provisions, the Tax Act also increased expensing for certain business assets, created new taxes on certain foreign sourced earnings, adopted limitations on business interest expense deductions, repealed deductions for income attributable to domestic production activities, and added other anti-base erosion rules. The effective dates for the provisions set forth in the Tax Act vary as to when the provisions will apply to Toro.

Table of Contents

In response to the Tax Act, the SEC provided guidance by issuing Staff Accounting Bulletin No. 118 ("SAB 118"), which has since been codified by the release of Accounting Standards Update ("ASU") No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. ASU 2018-05 allows companies to record provisional amounts during a measurement period with respect to the impacts of the Tax Act for which the accounting requirements under Accounting Standards Codification ("ASC") Topic 740 are not complete, but a reasonable estimate has been determined. The measurement period under ASU 2018-05 ends when a company has obtained, prepared, and analyzed the information that was needed in order to complete the accounting requirements under ASC Topic 740, but cannot exceed one year.

As of August 3, 2018, we have not completed the accounting for the effects of the Tax Act. However, we have estimated the impacts of the Tax Act on our annual effective tax rate, and have recorded provisional amounts for the remeasurement of deferred tax assets and liabilities and the deemed repatriation tax.

While we have recorded provisional amounts for the items expected to most significantly impact our financial statements this year, our evaluation is not complete and, accordingly, we have not yet reached a final conclusion on the overall impacts of the Tax Act. We need additional time to obtain, prepare, and analyze information related to the applicable provisions of the Tax Act. The actual impact of the Tax Act may differ from the provisional amounts, due to, among other things, changes in interpretations and assumptions we have made, guidance that may be issued, and changes in our structure or business model. Please reference the sections below titled "Provision for Income Taxes" and "Net Earnings" within this MD&A for further information regarding the impacts of the Tax Act on us for the three and nine month periods ended August 3, 2018.

Reconciliations of adjusted non-GAAP financial measures to the most directly comparable reported GAAP financial measures are included in the section titled "Non-GAAP Financial Measures" within this MD&A.

Overview

For the third quarter of fiscal 2018, our net sales increased 4.4 percent, as compared to the third quarter of fiscal 2017. Year-to-date fiscal 2018 net sales increased 3.1 percent compared to the same period in the prior fiscal year. Professional segment net sales increased 3.0 percent for the third quarter comparison, primarily due to strong retail demand and successful new product introductions for our landscape contractor zero-turn radius riding mowers, sales of new products as a result of our acquisition of L.T. Rich Products, Inc. ("L.T. Rich"), and strong channel demand for our rental and specialty construction equipment. These net sales increases were partially offset by lower shipments of our Professional snow and ice management products due to the timing of preseason orders compared to the prior fiscal year. Professional segment net sales increased 6.6 percent for the year-to-date comparison, primarily driven by strong channel demand and a successful new product introduction for our landscape contractor zero-turn radius riding mowers, continued growth in our golf and grounds businesses, sales of new products as a result of our acquisition of L.T. Rich, strong channel demand for our rental and specialty construction equipment, increased shipments of our ag-irrigation products due to favorable weather conditions in key regions, increased sales of our Perrot-branded irrigation products, and increased shipments of our snow and ice management products. Residential segment net sales increased 9.5 percent for the third quarter comparison, mainly due to strong retail demand for walk power mowers and zero-turn radius riding mowers, as well as the successful introduction of a redesigned line of our Hayter-branded walk power mowers and increased sales of our Pope-branded irrigation products. These net sales increases were partially offset by lower shipments of our snow products due mainly to the timing of preseason orders compared to the prior fiscal year. Residential segment net sales decreased 5.4 percent for the year-to-date comparison, primarily due to fewer shipments of snow products due to below average snowfall early in the fiscal 2018 season, as well as decreased sales of zero-turn radius riding mowers and walk power mowers mainly due to unfavorable spring weather conditions. The fiscal 2018 year-to-date Residential segment decrease was partially offset by increased sales of our Pope-branded irrigation products and the successful introduction of a redesigned line of our Hayter-branded walk power mowers.

Changes in foreign currency exchange rates resulted in an increase of our net sales of approximately $2.0 million and $15.2 million for the third quarter and year-to-date periods of fiscal 2018, respectively.

Net earnings for the third quarter of fiscal 2018 were $79.0 million compared to $68.4 million for the third quarter of fiscal 2017. Adjusted net earnings for the third quarter of fiscal 2018 were $73.5 million compared to $65.5 million for the prior year comparative period, an increase of 12.2 percent. Our net earnings growth for the third quarter of fiscal 2018 was primarily attributable to leveraging our selling, general, and administrative ("SG&A") expenses over higher sales volumes, which resulted in a reduction of SG&A expense as a percentage of net sales of 70 basis points for the third quarter comparison. Net earnings for the first nine months of fiscal 2018 were $232.9 million compared to reported net earnings of $233.9 million in the comparable fiscal 2017 period. This decrease was primarily due to the one-time impacts of the Tax Act during the current fiscal year period. Adjusted year-to-date fiscal 2018 net earnings were $255.9 million compared to adjusted net earnings of $215.0 million in the comparable fiscal 2017 period, an increase of 19.0 percent. The adjusted net earnings growth for the year-to-date period of fiscal 2018 was

Table of Contents

primarily attributable to increased sales while leveraging SG&A expenses, as well as higher gross margin. Reconciliations of adjusted non-GAAP financial measures to the most directly comparable reported GAAP financial measures are included in the section titled "Non-GAAP Financial Measures" within this MD&A.

We increased our cash dividend for the third quarter of fiscal 2018 by 14.3 percent to $0.20 per share compared to the $0.175 per share cash dividend paid in the third quarter of fiscal 2017.

Inventory levels increased $15.5 million, or 4.4 percent, as of the end of the third quarter of fiscal 2018, primarily due to higher work in process inventory mainly driven by manufacturing supply challenges and planned production to support forecasted Professional segment sales. Accounts receivable decreased $2.1 million, or 0.9 percent, primarily due to timing of sales for channels not financed with Red Iron and the impact of foreign currency exchange rates. As of the end of the third quarter of fiscal 2018, field inventory levels were lower primarily due to lower Professional and Residential segment snow and ice management product inventory due to late snowfall in the second quarter of fiscal 2018, as well as strong retail demand for Residential segment walk power mowers and zero-turn radius riding mowers throughout the key growing season. These field inventory decreases were partially offset by higher field inventory for our landscape contractor zero-turn radius riding mowers driven by strong channel demand.

Three-Year Employee Initiative - "Vision 2020"

Our current multi-year employee initiative, "Vision 2020", which began with our 2018 fiscal year, focuses on driving profitable growth with an emphasis on innovation and serving our customers, which we believe will generate further momentum for the organization. Through our Vision 2020 initiative, we have set specific goals intended to help us drive organic revenue and operating earnings growth.

Organic Revenue Growth

We intend to pursue strategic growth of our existing businesses and product categories with an organic revenue goal to achieve at least five percent or more of organic revenue growth in each of the three fiscal years of this initiative. For purposes of this goal, we define organic revenue growth as the increase in net sales, less net sales from acquisitions that occurred in the current fiscal year.

Operating Earnings

Additionally, as part of our new Vision 2020 initiative growth goals, we have set an operating earnings goal to increase operating earnings as a percentage of net sales to 15.5 percent or higher by the end of fiscal 2020.

Net Sales

Worldwide consolidated net sales for the third quarter of fiscal 2018 were $655.8 million, up 4.4 percent compared to $627.9 million in the third quarter of fiscal 2017. The net sales increase for the quarter comparison was primarily due to strong retail demand for Residential walk power mowers and zero-turn radius riding mowers, strong retail demand and successful new product introductions for our landscape contractor zero-turn radius riding mowers, sales of new products as a result of our acquisition of L.T. Rich, strong channel demand for our rental and specialty construction equipment, the successful introduction of a redesigned line of Hayter-branded walk power mowers, and increased sales of our Pope-branded irrigation products. These net sales increases were partially offset by lower shipments of our Professional and Residential segment snow and ice management products mainly due to the timing of preseason orders compared to the prior fiscal year. For the year-to-date period of fiscal 2018, worldwide consolidated net sales were $2,079.3 million, up 3.1 percent from the same period in the prior fiscal year. The year-to-date net sales increase was primarily due to strong channel demand and a successful new product introduction for our landscape contractor zero-turn radius riding mowers, continued growth in our golf and grounds businesses, sales of new products as a result of our acquisition of L.T. Rich, strong channel demand for our rental and specialty construction equipment, increased shipments of our ag-irrigation products due to favorable weather conditions in key regions, increased sales of our Professional snow and ice management products, and increased sales of our Perrot-branded and Pope-branded irrigation products. These net sales increases were partially offset by fewer shipments of Residential snow product due to below average snowfall early in the fiscal 2018 season, as well as decreased sales of Residential zero-turn radius riding mowers and walk power mowers due to unfavorable spring weather conditions.

Net sales in international markets increased by 2.2 percent and 5.1 percent for the third quarter and year-to-date periods of fiscal 2018, respectively. The net sales increase for the quarter comparison was mainly due to increased shipments of our golf and grounds equipment, strong demand for our ag-irrigation products, increased sales of our Pope-branded irrigation products, and the successful

Table of Contents

introduction of a redesigned line of our Hayter-branded walk power mowers. These increases were partially offset by fewer shipments of Residential segment zero-turn radius riding mowers and walk power mowers due to unfavorable weather conditions across Europe and Australia during the third quarter of fiscal 2018. The net sales increase for the year-to-date period of fiscal 2018 was primarily due to strong demand for our ag-irrigation products, increased sales of our Perrot-branded and Pope-branded irrigation products, increased shipments of our Professional segment and Residential segment zero-turn radius riding mowers, strong demand for our rental and specialty construction equipment, and the successful introduction of a redesigned line of our Hayter-branded walk power mowers. Changes in foreign currency exchange rates positively impacted our international net sales by approximately $2.0 million and $15.2 million for the third quarter and year-to-date periods of fiscal 2018, respectively.

The following table summarizes the major operating costs and other income as a percentage of net sales:



	Three Months Ended				Nine Months Ended
	August 3, 2018		August 4, 2017		August 3, 2018		August 4, 2017
Net sales	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales	(64.4	)	(63.9	)	(63.4	)	(63.5	)
Gross profit	35.6		36.1		36.6		36.5
Selling, general and administrative expense	(21.4	)	(22.1	)	(20.7	)	(21.2	)
Operating earnings	14.2		14.0		15.9		15.3
Interest expense	(0.7	)	(0.8	)	(0.7	)	(0.7	)
Other income, net	0.7		0.9		0.6		0.6
Provision for income taxes	(2.2	)	(3.2	)	(4.6	)	(3.6	)
Net earnings	12.0	%	10.9	%	11.2	%	11.6	%

Gross Profit

As a percentage of net sales, gross profit for the third quarter of fiscal 2018 was 35.6 percent, a decrease of 50 basis points when compared to the third quarter of fiscal 2017. This decrease was primarily due to the impact of unfavorable commodity and freight costs, manufacturing supply challenges, and the negative impact of segment mix, partially offset by improved net price realization and productivity efforts. Gross profit as a percentage of net sales for the fiscal 2018 year-to-date period was 36.6 percent, an increase of 10 basis points when compared with the prior fiscal year comparative period. The year-to-date comparison results were driven by improved net price realization, favorable foreign currency exchange rate fluctuations, and the positive impact of segment mix, partially offset by unfavorable commodity costs and manufacturing supply challenges.

Selling, General, and Administrative Expense

SG&A expense increased $1.8 million, or 1.3 percent, for the third quarter of fiscal 2018 and increased $2.9 million, or 0.7 percent, for the year-to-date period of fiscal 2018. As a percentage of net sales, SG&A expense decreased 70 basis points for the third quarter of fiscal 2018 and decreased 50 basis points for the year-to-date period of fiscal 2018. The decrease as a percentage of net sales for the third quarter comparison was primarily due to leveraging of expenses over higher sales volume, partially offset by increased engineering expense. The decrease as a percentage of net sales for the year-to-date comparison was primarily due to lower incentive compensation expense and the leveraging of expenses over higher sales volume, partially offset by increased engineering expense.

Interest Expense

Interest expense decreased by 1.6 percent and 0.7 percent for the third quarter and year-to-date periods of fiscal 2018, respectively.

Other Income, Net

Other income, net for the third quarter of fiscal 2018 decreased $0.3 million when compared to the third quarter of fiscal 2017. The decrease was primarily due to lower gains realized on foreign currency exchange rate fluctuations, partially offset by higher interest income on marketable securities and higher earnings from our equity investment in Red Iron. Other income, net was flat for the year-to-date period of fiscal 2018, mainly due to higher interest income on marketable securities and higher earnings from our equity investment in Red Iron, partially offset by lower gains realized on foreign currency exchange rate fluctuations and costs incurred for litigation settlements.

Table of Contents

Provision for Income Taxes

The effective tax rate for the third quarter of fiscal 2018 was 15.3 percent compared to 22.6 percent in the third quarter of 2017. The decrease for the third quarter of fiscal 2018 was primarily driven by a $9.0 million benefit resulting from the reduction in the federal corporate tax rate from the enactment of the Tax Act on all items other than the excess tax deduction for share-based compensation and the provisional remeasurement of deferred tax assets and liabilities, which resulted in a non-cash discrete tax benefit of $1.2 million. Additionally, the third quarter decrease was driven by a $2.1 million year-over-year increase in the benefit of the excess tax deduction for share-based compensation, which includes a $2.2 million unfavorable impact on the benefit due to the reduction in the federal corporate tax rate. These decreases were partially offset by the provisional calculation of the deemed repatriation tax, which resulted in a discrete tax charge of $0.7 million, payable over eight years. The adjusted effective tax rate for the third quarter of fiscal 2018 was 21.2 percent, compared to an adjusted effective tax rate of 25.9 percent in the same period last year. The decrease for the third quarter of fiscal 2018 was driven by the benefit resulting from the reduction in the federal corporate tax rate from the enactment of the Tax Act. The adjusted effective tax rate for the third quarter of fiscal 2018 excludes a benefit of $5.0 million for the excess tax deduction for share-based compensation and a benefit of $0.5 million for an adjustment to the one-time charges associated with the Tax Act recorded in the first quarter of fiscal 2018. The adjusted effective tax rate for the third quarter of fiscal 2017 excludes a benefit of $2.9 million for the excess tax deduction for share-based compensation.

The effective tax rate for the year-to-date period of fiscal 2018 was 29.2 percent compared to 23.6 percent in the same period of fiscal 2017. The effective tax rate was significantly impacted by the enactment of the Tax Act for the year-to-date period of fiscal 2018. The increase was driven by the provisional remeasurement of deferred tax assets and liabilities, which resulted in a non-cash discrete tax charge of $19.3 million, and the provisional calculation of the deemed repatriation tax, which resulted in a discrete tax charge of $13.3 million, payable over eight years. In addition to these one-time charges resulting from the Tax Act, the increase in the effective tax rate was driven by a $9.2 million year-over-year decrease in the benefit of the excess tax deduction for share-based compensation, which includes a $4.2 million unfavorable impact on the benefit due to the reduction in the federal corporate tax rate. These increases were partially offset by a benefit of $31.9 million resulting from the reduction in the federal corporate tax rate on all items other than the excess tax deduction for share-based compensation. The adjusted effective tax rate for the year-to-date period of fiscal 2018 was 22.2 percent, compared to an adjusted effective tax rate of 29.8 percent in the same period of fiscal 2017. The adjusted effective tax rate for fiscal 2018 excludes one-time charges associated with the Tax Act of $32.6 million and a benefit of $9.6 million for the excess tax deduction for share-based compensation. The adjusted effective tax rate for fiscal 2017 excludes the benefit of $18.9 million for the excess tax deduction for share-based compensation.

Net Earnings

Net earnings for the third quarter of fiscal 2018 were $79.0 million, or $0.73 per diluted share, compared to $68.4 million, or $0.61 per diluted share, for the third quarter of fiscal 2017. The primary factors contributing to the net earnings increase for the third quarter comparison included increased net sales, a decrease in SG&A expense as a percentage of net sales, and a lower effective tax rate. Adjusted net earnings for the third quarter of fiscal 2018 were $73.5 million, or $0.68 per diluted share, compared to $65.5 million, or $0.58 per diluted share, for the third quarter of fiscal 2017, an increase of 17.2 percent per diluted share. The third quarter of fiscal 2018 adjusted net earnings excludes a benefit of $5.0 million, or $0.05 per diluted share, for the excess tax deduction for share-based compensation and one-time charges associated with the Tax Act of $0.5 million. The third quarter of fiscal 2017 adjusted net earnings excludes a benefit of $2.9 million, or $0.03 per diluted share, for the excess tax deduction for share-based compensation. In addition, as a result of reduced shares outstanding from repurchases of our common stock, third quarter fiscal 2018 net earnings per diluted share and adjusted net earnings per diluted share were benefited by approximately $0.02 per diluted share.

Year-to-date net earnings in fiscal 2018 were $232.9 million, or $2.14 per diluted share, compared to $233.9 million, or $2.10 per diluted share, in the prior year comparative period. Net earnings for the year-to-date period of fiscal 2018 were significantly impacted by the enactment of the Tax Act. As previously mentioned, the impact from the enactment of the Tax Act was driven by the provisional remeasurement of deferred tax assets and liabilities, which resulted in a non-cash discrete tax charge of $19.3 million, and the provisional calculation of the deemed repatriation tax, which resulted in a discrete tax charge of $13.3 million, payable over eight years. The unfavorable impact of these one-time charges was partially offset by a benefit of $27.7 million resulting from the reduction in the federal corporate tax rate. Adjusted net earnings for the year-to-date period of fiscal 2018 were $255.9 million, or $2.35 per diluted share, compared to $215.0 million, or $1.93 per diluted share, for the prior year comparable period, an increase of 21.8 percent per diluted share. The year-to-date period of fiscal 2018 adjusted net earnings excludes one-time charges associated with the Tax Act of $32.6 million, or $0.30 per diluted share, and a benefit of $9.6 million, or $0.09 per diluted share, for the excess tax deduction for share-based compensation. The comparable period of fiscal 2017 adjusted net

Table of Contents

earnings excludes a benefit of $18.9 million, or $0.17 per diluted share, for the excess tax deduction for share-based compensation. In addition, as a result of reduced shares outstanding from repurchases of our common stock, year-to-date fiscal 2018 net earnings per diluted share and adjusted net earnings per diluted share were benefited by approximately $0.05 per diluted share.

BUSINESS SEGMENTS