Leggett & Platt Inc Q3 FY2023 Earnings Call

Greetings. Welcome to Leggett & Platt Third Quarter 2023 Webcast and Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Cassie Branscum, Senior Director of Investor Relations. Thank you. Ms. Branscum, you may begin.

Good morning, and welcome to Leggett & Platt's Third Quarter Earnings Call. With me on the call today are Mitch Dolloff, President and CEO; Ben Burns, Executive Vice President and CFO; Steve Henderson, Executive Vice President and President of the Specialized Products and Furniture, Flooring & Textile Products segments; Tyson Hagale, Executive Vice President and President of the Bedding Products segment; Susan McCoy, Senior Vice President of Investor Relations; and Kolina Talbert, Manager of Investor Relations. The agenda for our call this morning is as follows: Mitch will start with a summary of the main points we made in yesterday's press release and discuss operating results. Ben will cover financial details and address our outlook for the remainder of 2023, and the group will answer any questions you have. This conference call is being recorded for Leggett & Platt and is copyrighted material. This call may not be transcribed, recorded, or broadcast without our express permission. A replay will be available on the Investor Relations section of our website. We posted to the IR section of our website yesterday's press release and a set of slides that contain summary financial information along with segment details. Those documents supplement the information we discuss on this call, including non-GAAP reconciliations. Remarks today concerning future expectations, events, objectives, strategies, trends, or results constitute forward-looking statements. Actual results or events may differ materially due to a number of risks and uncertainties, and the company undertakes no obligation to update or revise these statements. For a summary of these risk factors and additional information, please refer to yesterday's press release and the sections in our most recent 10-K and subsequent 10-Q entitled Risk Factors and Forward-Looking Statements. I'll now turn the call over to Mitch.

Good morning, and thank you for participating in our third quarter call. I would like to start the call by thanking our employees for their tremendous efforts in what was another challenging quarter. Ongoing weak demand impacted our Bedding products and Furniture, Flooring & Textile Products segments, but it was partially offset by continued demand strength in our Specialized Products segment. Sales in the quarter were down 9% versus third quarter 2022 from lower volume and raw material-related price decreases. Acquisitions added 2% to sales. Third quarter earnings per share were $0.39. This includes $5 million or $0.03 per share of gain from the sale of real estate. Excluding this item, adjusted earnings per share were $0.36. Earnings decreased year-over-year, primarily from lower metal margin in our Steel Rod business and lower volume in our residential end markets. These decreases were partially offset by lower incentive compensation and bad debt expense. Cash flow from operations was $144 million, up $78 million versus the third quarter of 2022. We are lowering our full year guidance to reflect continued volatility in the macroeconomic environment, continued low consumer demand in residential end markets, and the modest impact we've experienced so far from the UAW strike on our Automotive business. We are focused on anticipating and adapting to market changes, improving operating efficiency, driving strong cash management, and engaging with our customers on new product opportunities. We are evaluating opportunities across our businesses, including further integration of our specialty foam and innerspring operations that are expected to support improved profitability, a strong balance sheet, and continued shareholder returns. Now moving on to segment results and demand trends. Sales in our Bedding Products segment were down 17% versus the third quarter of 2022. Demand in the U.S. Bedding market remains soft, but relatively stable sequentially. We continue to anticipate full year mattress consumption to be down high single digits. In the quarter, we saw a modest sequential improvement in innerspring and mattress units, but we expect a deceleration in units sequentially in the fourth quarter due to normal seasonality. Metal margin expanded to its highest point in mid-2022 and narrowed as expected. We still anticipate metal margin to be down mid-teens versus 2022. While our commercial teams continue to evaluate customer opportunities and commercialize new products, soft demand remains the largest headwind to profits. In the near term, we continue to drive operational efficiencies, especially in our Specialty Foam business to help offset soft volume. Additionally, we believe meaningful opportunities to increase profitability exist and are evaluating a number of possibilities, including the further integration of our Specialty Foam and Innerspring Operations I mentioned a moment ago, which should drive manufacturing savings and product development gains, optimizing our production and distribution capacity to service our customers effectively and efficiently, and enhancing our value proposition to our customers through expanded product capabilities and growing content at attractive price points. Sales in our Specialized Products segment increased 10% versus the third quarter of 2022, driven by the Hydraulic Cylinders acquisition completed in August of last year and volume growth in Aerospace and Automotive. The UAW strike had minimal impact on our Automotive business in the third quarter. So far in the fourth quarter, the sales impact has been approximately $5 million. As the strike continues and potentially broadens to additional OEM facilities, the impact on the industry remains uncertain and unpredictable. As the situation evolves, we are maintaining communications with our customers and positioning ourselves to quickly react and support their needs. Sales in our Furniture, Flooring & Textile Products segment were down 11% versus the third quarter of 2022, driven by soft demand across the segment. Sales in Home Furniture, Fabric Converting, and Flooring were down year-over-year but roughly in line with second quarter levels. Work furniture demand has softened modestly with slower activity in European markets. In geo components, demand continued to soften in home improvement retail and civil construction end markets. We expect demand across the segment to decelerate sequentially in the fourth quarter due to normal seasonality. With that, I'll now turn the call over to Ben.

Thank you, Mitch, and good morning, everyone. In the third quarter, we generated cash from operations of $144 million, a $78 million increase versus the third quarter of 2022. This increase reflects our sharp focus on working capital management. We ended the quarter with adjusted working capital as a percentage of annualized sales of 14.2%, which improved from both last year's third quarter and sequentially from the second quarter. Cash from operations is still expected to be $450 million to $500 million in 2023. We ended the third quarter with total debt of $2 billion, including $171 million of commercial paper outstanding and no significant maturities until November 2024. Net debt to trailing 12-month adjusted EBITDA was 3.15x at quarter end. As anticipated, the ratio increased modestly from last quarter, but we expect to continue to comfortably meet our debt covenant requirements and maintain sufficient liquidity. We are focused on maintaining investment-grade debt ratings and expect this ratio to improve as earnings increase over time, and we use excess cash to pay down debt. Total liquidity was $595 million at September 30, comprised of $274 million cash on hand and $321 million in capacity remaining under our revolving credit facility. In August, our Board of Directors declared a third quarter dividend of $0.46 per share, $0.02 or 4.5% higher than last year's third quarter dividend. We continue to deploy our cash in a balanced and disciplined manner. For the full year 2023, we expect capital expenditures of approximately $110 million to $130 million, dividends of approximately $240 million, and minimal spending for acquisitions and share repurchases as we prioritize debt reduction in the near term. Our long-term priorities for use of cash remain unchanged. They include an order of priority funding organic growth, paying dividends, funding strategic acquisitions, and repurchasing shares with available cash. As announced yesterday, we are lowering our full year sales and earnings guidance due to lower-than-expected volume primarily in our Furniture, Flooring & Textile and Bedding Products segments. We are not seeing the fourth quarter improvement in upholstered furniture end markets that was previously anticipated. As we moved through the third quarter, demand continued to soften in home improvement retail, civil construction, and trade rod and wire applications. This guidance does not include impacts from the UAW strike on our Automotive business beyond what we have experienced so far due to uncertainties around the duration and severity of the strike. 2023 sales are now expected to be $4.7 billion to $4.75 billion or down 8% to 9% versus 2022. This guidance reflects volume at the midpoint down mid-single digits with Bedding products down high single digits, Specialized Products up high single digits, and Furniture, Flooring & Textile Products down low double digits. The guidance also assumes the impact of deflation and currency combined is expected to reduce sales mid-single digits and acquisitions completed in 2022 should add approximately 2% to sales in 2023. 2023 earnings per share are now expected to be in the range of $1.45 to $1.55, including approximately $0.07 per share of gain from net insurance proceeds we expect to recognize for the year and $0.03 per share of gain from the sale of real estate being recognized in the third quarter. Full year adjusted earnings per share are now expected to be $1.35 to $1.45. EPS guidance assumes a full year effective tax rate of 24%, depreciation and amortization of approximately $185 million, net interest expense of approximately $85 million, and fully diluted shares of $137 million. Based upon this guidance framework, our full year adjusted EBIT margin range is expected to be 7.0% to 7.3%. Important drivers of margin improvement going forward will be stronger volume, continued efficiency and cost improvements, pricing discipline as raw material costs fluctuate, and innovative products. We are committed to maintaining our long-held financial strength and creating long-term value for our shareholders. As is always the case, we achieve our success because of our employees' hard work and dedication at all levels of the company. With those comments, I'll turn the call back over to Cassie.

Thank you, Ben. Operator, we're ready to begin Q&A.

Our first question is from Susan Maklari with Goldman Sachs.

Thank you. Good morning, everyone. I want to start on the Specialized segment. Perhaps a couple of things in there as we think about Auto, especially. I guess, first, can you talk about your ability to return to volumes as the strike eventually hits full resolution and OEMs start getting back to work? How should we think about that potentially coming through the business? And then I also noticed in the release you mentioned that you had consolidated some facilities in there. Any thoughts on one, the impact on the margin perhaps this quarter, but two, just how we should think about the cost structure of that business and any further improvements or things that you can do there?

Yes, I'll address all those points. Let's begin with the UAW impact. Things seem to be improving with tentative agreements among the major U.S. auto manufacturers, although these still need approval from union members. There's still some uncertainty, but the situation appears to be getting better than previously expected. Our guidance is a bit challenging due to the differing impacts of the strike on the three OEMs across various facilities. The third quarter's impact on us was minimal, and so far in the fourth quarter, particularly in October, the significance has also been low. This is mainly for three reasons. First, the impact varies by facility among OEMs. Second, we've all learned from the supply chain challenges during the pandemic, and we've been cautious to avoid repeating past mistakes when responding to the strike. As labor returns and facilities resume operations, the transition back to normal won't be instant, but if we continue on our current path, any slowdown should be manageable. We've incorporated what we’ve observed in our order book into our outlook, so there may be slight downturns, but if conditions stabilize positively, business should continue progressing well. Regarding the consolidation, it's a good example of our ongoing efforts to enhance operating efficiency and restructure costs within the automotive sector. We identified that we had two facilities in Asia producing the same type of product, one being smaller and the other larger, and we've successfully merged them. This consolidation did affect our costs in the third quarter but is expected to yield positive gains moving forward. While it might not have been a massive consolidation, it demonstrates our commitment to seizing these opportunities. The automotive industry's outlook remains strong with low inventories and an aging vehicle fleet. There are market dynamics affecting forecasts, especially in light of the UAW strike and fluctuations in China, yet the long-term projections are favorable. Additionally, our team has been making substantial progress in addressing earlier production challenges in the U.S. While there’s still work ahead, we've advanced significantly and are focused on improving margins across the business. We’ve likely recovered about 85% of our inflation-related costs, and with some commodity prices decreasing, we feel optimistic about our outlook and will continue to pursue margin enhancements.

Okay. That was very helpful color. I think you hit it all. So well done. My second question is maybe thinking a bit more about the guidance. Can you talk to what has and what has not changed within that as we think about the fourth quarter and where you are today versus your expectations?

Yes, sure, happy to do that. I know it can be a little bit confusing. But Ben, do you mind checking to see that?

Yes, sure. Susan, thanks for the question. Yes. So maybe let's talk about first what has not changed. So innerspring and mattress volumes mostly are unchanged, and we've seen stable demand there. Also, we've got continued strong demand in our businesses within the Specialized segment. Switching to what has changed. Fourth quarter improvement in upholstered furniture end markets has not materialized as that market expected. So that impacts not only our Home Furniture business but also our Fabric Converting business and also Specialty Foam where we supply foam buns to upholstered furniture manufacturers. In the Geo Components business, civil construction continues to be softer than anticipated as project funding releases keep getting pushed out. We think that's a timing issue, but still haven't seen the momentum there we expected. Also, continued softening in our home improvement retail has also impacted our Geo-components business and also impacts our Flooring business as well. And then lastly, I would say related to Bedding, we've seen lower Trade Rod and Wire demand as well as continued declines in our wire grid volumes. So a lot of different things moving there, but those are the key highlights.

Okay. That's helpful. And then I'm going to sneak one more in for you. The improvement in working capital continues to be very impressive. And you did not change your outlook for cash generation despite having taken the earnings down again for this year. Can you talk to the ability to continue to drive that cash generation and other levers that perhaps you can pull if the demand doesn't come back as we're hoping for?

Sure, Susan. Yes, that's another great question. So we definitely had some really good cash generation in the third quarter. As we've talked about, our portfolio has really gone through some dynamic times over the last couple of years with working capital as a result of supply chain challenges and inflated costs, but our teams have really done a good job of managing inventory where that was built up in 2022 and then the demand started to weaken. And so we've continued to bring that inventory down and driven cash as a result of that. We also have done a good job of focusing on our receivables. I think our receivables are in about as good a shape as they've been in a long time, in payables as well. So really looking at all levers from a working capital perspective and saw a really good performance in the third quarter. With that said, we do think there's a little bit more improvements that we can look at going forward. So as you think about cash generation for the fourth quarter, we feel good about getting to that $450 million to $500 million in operating cash. So those are really the things that we're focused on, and the teams have done a great job.

Our next question is from Bobby Griffin with Raymond James.

I guess first I want to talk about the Bedding Products segment. It's more just a longer-term question. A lot has changed in that segment over the last, call it, 18 months, especially with the spread coming down. So if we're in a world where the spread on Rod stays where it is today or is under a little bit further pressure, would volumes come back in a recovery scenario? What is the margin profile of that business in that type of setup? We used to think of that business as a 10-ish, 9-ish, probably 11-ish EBIT margin business. What could it be if the spread doesn't ever go back to those all-time high levels?

Bobby, this is Tyson. I'll answer your question. There have been numerous changes in the past 18 months, including significant supply chain and demand issues. Looking ahead, we believe the fundamental margin profile still exists, although we have work to do. The main challenge is volume, and a key aspect will be how the recovery unfolds, where it originates from, and what types of products we need to focus on to enhance the integration and operational efficiencies in our Specialty Foam business, which is crucial for us. Additionally, we are committed to effectively serving our customers from our manufacturing and distribution operations, as well as advancing our product development and the commercialization of new offerings, especially with content enhancements. Despite the ongoing market changes, we have various initiatives we believe will help us achieve the same margin levels as before.

Okay. And then I think this is the second time you guys have called out about the potential of sort of facilities rationalization or just some work you're doing inside the ECS business and looking at some different options. Is there a time frame to kind of complete that initial dive through where we could think about maybe the potential impact from some of these changes? Or are we still in the early innings of looking at all the different options?

Bob, I believe we are still in the early stages. It's a valuable question, especially regarding the changes in the Bedding market. We need to evaluate how to adjust our outlook and take necessary actions to ensure we are enhancing profitability, generating strong cash flow, and providing returns to shareholders. That's our focus right now, and we have more work ahead of us. The consolidation in Automotive is a good small example of this effort. We will assess other areas of the business, notably in Bedding, as we've mentioned previously. Tyson, do you have anything to add? I realize there's not much more we can disclose at this time.

Sure. We're working on a few initiatives in Specialty Foam. I can't recall if we've mentioned them previously, but we're focused on optimizing our operations. We have some facilities on the West Coast, where we're looking to simplify our processes, and we're also addressing some issues in the southeastern part of the United States. Additionally, we had to pause the integration of Specialty Foam into LNP, which is part of a broader effort since Leggett acquired the ECS business, involving the combination of four companies. There's still a significant amount of work that needs to be completed, so it's just the beginning.

Okay. That's helpful. Lastly, Ben, we've discussed maintaining investment grade a few times. I understand you don't have a specific leverage target, but I'd like to rephrase my question. What net leverage ratio do you believe would best support staying within the investment-grade range? I know you recently met with some credit rating agencies.

Yes, Bobby. Thanks for the question. Yes, like we've said, we don't have a formal target out there right now, but we really think about net debt-to-EBITDA, 2.5x or under as really that strong investment grade. So that's how we think about it.

All right. That's helpful. I appreciate the details and best of luck here in the fourth quarter.

Thank you, Bob.

Our next question is from Keith Hughes with Truist Securities.

I know it's kind of murky in the Automotive. But just directionally, if there was a settlement to this strike, given how far back in the supply chain you are, would you still feel some aftereffects of the events of the last couple of months in early 2024 before it got better? Is that kind of how it's going to work?

It's a great question. I wish I precisely knew the answer to that.

I'm not looking for anything specific. I'm just looking directionally...

Yes. No, it's a good question. I think that if it gets approved in the state that it is today, there's been some disruption for sure at the OEMs. But you're right, as we go back through the supply chain, we've been less impacted by that. So I think there might be a little bit of a pushout that may go into the early part of next year for that recovery, but I don't feel like it will be too significant for us or the industry. I think the fear that everyone had is if the extent and the time frame expanded, then I think as you went back through the supply chain, you'd have no choice but to start really slowing down production and dealing with labor issues. And then as we know from recent experiences, ramping that back up would be hard. So hopefully, I think we've gotten to a spot, again, if the contracts get approved, that there won't be too much disruption. I think right now, that forecast, IHS forecast and other outlooks for the market are probably a little sketchy given these dynamics, but I think the outlook is still positive. The demand is still there.

Okay. The Specialty Foam business in Bedding has outperformed U.S. spring for every quarter this year. Can you discuss whether this is due to gaining market share or if it's a reflection of the overall market? What are the dynamics at play between these two segments? I'm referring to unit performance.

Sure, Keith. This is Tyson. We discussed this last year when we focused heavily on our Specialty Foam business with our digitally native customers. This segment was significantly impacted compared to the broader U.S. bedding market. We recognized early in the recovery that it was essential to diversify our customer base. Our commercial team has been diligently working to identify opportunities, even in a challenging market, and they've made some progress. The improvements we've seen stem from gaining some successes despite the sluggish market, and diversifying our customer base is beneficial for us as the market starts to recover.

And that's in Foam, you're referring to, correct?

I'm referring to Foam, yes.

Yes. And for the final point on this, can you provide details about the largest customers in Specialty Foam and what percentage of Foam sales they represented?

It's kind of a tough question to answer, Keith, but going back into history, it was more concentrated like with the digitally native customer list. Don't want to get into how many that represented. But we still have some key customers, but we are growing that as we try to diversify the customer base.

Yes. So Tyson, is it right to say, I mean, at the time of acquisition, as you said, focused on the D&B is still a decent list of them. I mean, it wasn't just one or two. And as that segment of the market has struggled a little bit, the team has done a good job of diversifying our customer base.

Our next question is from Peter Keith with Piper Sandler.

I wanted to ask about the metal margin. You did call that out as an impact to EPS. Is there any way to quantify that impact on EPS year-on-year? And then on a related note, you've talked about some weakening demand with rod and wire. What's been the direction of the metal margin just in the last couple of weeks to months?

Peter, this is Tyson. I'll jump in. So it was expected, but year-over-year metal margin decline was a major driver of the decline in the Bedding EBIT. But that was expected, like I said, because we're really comparing against last year when it was at its highest after the run up in scrap and Rod through the second and third quarters last year. We did call out the softness that we're seeing and that is a combination of both volume just being lower, what we're selling to the trade, but also the mix of what we're selling, more trending towards lower carbon applications, which is at a lower price side than high carbon rod. So we're seeing, I think we'd say still stability in overall Metal Margin. It's really kind of where we expected it. But our mix of product that we're selling to the trade is on the lower end, and so that does have an impact on us.

Tyson, maybe just a couple of points I'll add on there and just you called it out, but in the middle of last year was sort of the historical highs for that spread. And so we expected it to come down, what we say teens, which is where it is, but that still remains at very, very high levels and has been relativelystable, I think, as we go through there. And then the other thing, our focus really is on consumption of our rod internally, right? It just depends on the spring volume and some of the other things that we do. So the trade is almost an ancillary market for us. And sometimes, it's stronger. And sometimes it's weaker, it's coming a little bit weaker, but it's not really a part of our strategy. It's more a part of capacity utilization. Is that the right way to think about it? That's the right.

Okay. And so if I can put that together, I guess you're still looking for mid-teens decline in margin, but does that shift to lower price presumably lower margin Rod change that outlook at all?

No, I don't think so. We still expect that. And that is what has been covered. That is part of our updated guidance for the Bedding having just that lower carbon part of the mix for the fourth quarter.

Okay. All right. Good enough. And then pivoting over just to the pricing environment because demand in Bedding and Furniture and the like has remained weak. Obviously, there's some commodity deflation. But what's the competitive pricing environment like? Has that intensified as companies are perhaps looking to drive production to keep the factories running?

It's always a competitive market, especially during challenging times like these, and we must stay vigilant. We need to monitor our customer service and the value we provide closely. Overall, commodities are down from last year but remain relatively stable at this time. As we mentioned, we anticipate some modest deflation in the fourth quarter, but that's where we stand at the moment.

Yes. And I think you said this before, I mean, we have to be competitive but we also need to deliver value to our customers in different ways, whether it's through our ability to service them throughout the country or through innovation. And I think that holds up true in our own furniture business as well.

Okay. Great. One last question just on the leverage ratio. I guess as a follow-up to Bobby's question. So you had talked about kind of an ideal leverage ratio of 2.5x. Is there a threshold that you would like to avoid in order to maintain that investment-grade rating? I guess 3.5x comes to mind, but I want to make sure my thinking is level set.

Yes. I think that's a good way to think about it. Obviously, our leverage is a little bit higher than we'd like. We're at 3.15x at the end of the third quarter, which is up modestly from last quarter at 3.10x. But we believe we're at or near the peak. We think fourth quarter will look a lot like third quarter. So that metric should be about in that range. And really, the thing that we look at too is our debt covenant in that calculation. So that's a little bit more favorable to us. So there's a little bit more headroom there than the 3.15x indicates. So that's really a few of the key points that we take a look at from a leverage perspective.

And our final question is a follow-up from Susan Maklari with Goldman Sachs.

There's just a couple of things that I wanted to follow up on. One is when you think about the weakness that you highlighted within furniture, the residential furniture, and flooring in those segments, how do you think about that relative to health of the consumer and what we're seeing within the consumer overall? I would say one of the things we're hearing this earnings season is that some of those higher-end consumers are actually relatively stronger, would you say that you're seeing some of that? And if you are, what could that imply for a pickup in some of those businesses in the coming quarters?

Yes, great question, Susan. I'll start, Tyson, and then you can jump in. You're right that consumers are still spending. The economy is performing better than we expected at the start of the year, and it seems like a softer landing is becoming more probable. However, consumers are directing their spending towards travel and services rather than consumer durables. After a focus on home spending during the pandemic, there’s now a noticeable shift away from that, which is affecting remodeling and certain housing markets. So, we're getting mixed signals. Spending continues, sentiment is improving, but it remains relatively weak. The job market is still strong, which fosters some confidence. However, we're beginning to see credit balances rise slightly while savings are starting to dip. Inflation is still high and interest rates have increased, leading to some economic concerns. I'm also a bit worried about the return of student loan payments, which could act as a drag going forward. Nonetheless, with the robust job market and current spending trends, I remain cautiously optimistic that consumer strength will persist. For us, it’s about whether we can achieve a more normal balance between service and travel spending and durable goods.

No, not really, Mitch. I mean I think you had it. The consumer focus away from the home and just also the general housing trends kind of suggests more of the same of what we've seen. So we're continuing to plan for slow but stable levels of demand. And I guess back to your question, Susan. The high end, I think, is more consistent. That's what we hear from our customers and the way we feel about it as well, but it's still slow. And I think overall, we probably think that part of the market would also start to recover first. But yes, generally, I think Mitch is kind of more of the same.

Yes, I feel there was some optimism at the beginning of the year that residential markets would start to recover around the middle of the year, but that didn't happen. There was also hope for stronger home furniture sales in the fourth quarter, which also did not materialize. Consequently, I think there is a level of concern about being overly optimistic until we see actual changes in demand. That's why we are trying to navigate the current environment. We believe volume will return, hopefully sooner rather than later, but predicting exactly when is challenging.

Yes. Okay. I appreciate the color. And one last thing. When you think about the business overall and the potential for some continued deflation on the commodity side, do you think that you can continue to hold price cost positive across most of those businesses? Any thoughts there?

Yes, I believe we have done an excellent job managing the situation through both inflation and deflation. Many of our businesses operate on contracts and their price adjustments are tied to indexes, although there might be some delay in those adjustments. Overall, we have successfully navigated these challenges, and if we experience some modest deflation, it should positively impact our margin percentage as well. This has been a factor affecting it, too. Therefore, I am confident in our ability to maintain that.

Okay. All right. Well, thanks for answering all the questions, and good luck with everything.

Thank you very much, Susan.

Thank you for joining us and your interest in Leggett & Platt. Have a great day.

Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.