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Leggett & Platt, Inc. (NYSE:LEG)

Q3 2008 Earnings Call

October 17, 2008 9:00 am ET

Executives

Dave DeSonier - Vice President of Strategy & Investor Relations

Dave Haffner - President & Chief Executive Officer

Karl Glassman - Chief Operating Officer

Matt Flanigan - Chief Financial Officer

Susan McCoy - Director of Investor Relations

Analysts

Mark Rupe - Longbow Research

Chad Bolen - Raymond James

Keith Hughes - SunTrust

John Baugh - Stifel Nicolaus

Joel Havard - Hilliard Lyons

Operator

Welcome to the Leggett & Platt third quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to David DeSonier.

Dave DeSonier

Good morning and thank you for taking part in Leggett & Platt’s third quarter conference call. I am Dave DeSonier, the Vice President of Strategy and Investor Relations and with me today are the following: Dave Haffner, our CEO and President; Karl Glassman, our Chief Operating Officer; Matt Flanigan, our CFO; and Susan McCoy, our Director of Investor Relations.

The agenda for the call is as follows. Dave Haffner will start with a summary of the major statements we made in yesterday’s press release. Karl Glassman will discuss trends in our various markets. Dave will then address our outlook for the remainder of 2008 and finally, the group will answer any questions you have.

This conference 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 is available from the IR portion of Leggett’s website.

In addition, I need to remind you that 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 section in our 10-K entitled Forward-Looking Statements.

I will now turn the call over to Dave Haffner.

Dave Haffner

I’d like to start this morning with some personal remarks before I get into the details of the quarter and as all of you well know, these are very unusual financial times, possibly the most difficult any of us have ever seen. On behalf of Leggett’s Senior Leadership and Directors, I would like to remind our employees, customers and investors of some of the things that distinguish this company.

First we have a highly experienced and well tenured management team. Our senior leaders including in our segment heads are among the most seasoned in all of the industries that we participate in. These leaders know how to manage well and whether tough times. Second we have always been a financially conservative bunch and find ourselves by design and to be honest also by fortuitous timing in an attractive financial position.

Over the first nine months of this year we’ve been selling less profitable businesses giving us more cash to work with. We are also not heavily leveraged and have substantial available credit. Third, we now how to quickly reduce spending, control costs and manage inventories, meanwhile strengthening our relationships with our many valued customers and historically we’ve grown market share in tough economic times; in part because our customers know that we are going to be there to meet their needs.

When we control costs and get smaller on the peoples side, we don’t do it in an unintelligent way. We let attrition help us first and we’ve been doing that. Then we pull back to reduced work weeks in some locations and we are already doing that. In some locations we know we must move to reduce staff, we are already doing so. Those things said however, our managers know we must keep the critical, best and most productive people and finally we believe in clear direct and candid communication. In tough times we believe that that is even more important.

Now moving onto the prepared remarks for the quarter; yesterday we reported third quarter earnings per share of $0.20. Earnings per share from continuing operations adjusted to exclude non-recurring items were $0.34. In the third quarter of 2007, earnings from continuing operations were $0.36. The year-over-year decrease primarily reflects lower unit volumes due to soft demand in several markets and higher LIFO expense.

Sales from continuing operations increased 4% versus third quarter of last year. Inflation related price increases and market share gains more than offset weak demand in our decision to exit some specific sales volume with unacceptable margins.

During the third quarter, we continue to successfully implement selling price increases to recover higher steel cost and by quarter end, the majority of the necessary increases were in pace. Additionally our vertical integration, specifically into the melt furnace and rod mill at our Sterling operation has continued to give us a significant advantage in this market.

Late in the third quarter, our markets weakened appreciably as consumers reigned in spending during this unprecedented period of credit concerns and stock market volatility. Despite this extremely challenging environment, we are very pleased with the progress we’ve made this year relative to our strategic plan and remain focused on the initiatives that we can control.

During the third quarter we completed four of the targeted divestitures including the sale of the Aluminum Product Segment in July in wood, plastics and the dealer portion of Commercial Vehicle Products, all in late September. We received after-tax cash proceeds of $388 million for the four businesses, not counting the subordinated notes and prepared stock we received in conjunction with the Aluminum sale.

We are in discussions with potential buyers for the three remaining divestitures, which are storage products, fibers and coated fabrics and expect their successful disposition, once credit markets improve. We have concluded that our store fixtures business unit in its current form is not capable of meeting our return requirements. As a result, we intent narrow the unit scope to focus primarily on the metals part of the fixtures industry, in alignment with Leggett’s core competency of producing steel and steel related products.

We plan to eliminate additional store fixture production facilities, effect changes to senior management, reduce unit over head, purge remaining customer accounts with unacceptable margins and trim annual revenues to a range of approximately $250 million to $275 million. We do not expect to incur significant impairment charges related to these activities.

This metal focused operation will be position to deliver returns of at least cost-of-capital levels and it is considered a core business within our portfolio. As such, it’s primarily focus is to generate free cash and improve profit while minimizing the use of capital. In this very turbulent financial environment, our financial profile is especially notable.

Our balance sheet remains in excellent condition. We ended the quarter with net debt of approximately 28% of net capital, which is below the low end of our long-term targeted range of 30% to 40%. We have $375 million of additional availability and four years remaining on our $600 million bank facility and we have no significant maturities of long-term debt until 2012.

We generated $77 million of cash from operations during the third quarter and except comfortably more than $300 million of operating cash for the full-year. This is below our previous full-year estimate primarily due to a temporary increase in working capital. Week market conditions and higher costs will likely result in higher year-end levels of inventories and receivables than previously expected. We are aggressively managing our operations to reduce these levels.

We repurchased a record $7.9 million shares of our stock during the quarter, largely with divestiture proceeds bringing our full-year total to nearly $14 million shares. Year-to-date, our shares outstanding have declined by 7%. We also declared the third quarter dividend of $0.25 per share, representing a 39% increase of last year’s third quarter dividend. The current dividend yield is approximately 5.9%, which was based upon $17 stock price.

This year marks the 37 consecutive annual dividend increase for Leggett at an average compound growth rate of over 14%. In the near-term, we should need approximately $275 million of cash annually to fund dividends and capital expenditures. We fully expect to consistently meet these priorities with operating cash flow.

As we have consistently stated, we plan to use the majority of the divestiture proceeds to repurchase shares, but we may complete those purchases at a slower pace than originally anticipated, as we carefully monitor economic conditions. Returning cash to our shareholders remains at key priority and we expect share repurchases to consistently be one means by which that will be accomplished.

With those comments, I’ll turn the call over to Karl Glassman, who will discuss the segments in more detail.

Karl Glassman

In the residential furnishing segment, same location sales increased 3% in the third quarter. Inflation-related price increases and market share gains in certain product categories more than offset the weak end markets experienced in many parts of the segment. Third quarter EBIT and EBIT margins increased versus the prior year. This increase primarily reflects higher sales and operating improvements resulting from past restructuring activities.

Our residential markets have been weak for the past few quarters, but softened further in late September. Several positive factors that we’ve discussed in prior quarters continue to offset some of the market declines.

Our U.S. bedding components operations have benefited from significant market share gains this year related to innersprings. Lower innersprings imports as a result of anti-dumping investigations, the deverticalization of a strong regional bedding manufacturer and relative strength of innerspring mattresses at lower to middle price points are some of the factors that have led to our share gains.

Our new patented Verticoil Innerspring continues to be in very high demand. This is a better value product for our bedding customers with higher earnings contribution for Leggett. We’ve also gained market share in our furniture components business.

Earlier this year, we entered into an agreement with Berkline, a major manufacturer of upholstered furniture to develop and produce the required mechanisms that they had previously manufactured for themselves. These positive developments are recurring in what are arguably the weakest conditions that some of our markets have experienced in decades and should position us very well once economic conditions improve.

In commercial fixturing and components same location sales declined 16% in the third quarter primarily from reduced capital spending by retailers and our decision in the store fixtures business to walk away from sales with unacceptable margins. EBIT and EBIT margins also decreased versus the prior year primarily reflecting the lower sales and the higher restructuring-related cost.

In industrial materials, same location sales were 47% in the quarter primarily from the pass-through of higher steel costs and increased sales of steel billets. These improvements were partially offset by continued softness in various end markets.

EBIT and EBIT margins increased versus third quarter 2007 primarily due to higher sales including billet sales and operating improvement. In specialized products, same location sales decreased slightly in the second quarter.

Growth in European and Asian automotive, as well as machinery, was offset by lower volume in North American automotive and the fleet portion of commercial vehicle products. EBIT and EBIT margins were lower than in the third quarter of last year primarily due to sales reductions in certain markets and higher steel costs with limited recovery.

As a final comment, all of our segments to use the FIFO method for valuing inventory and adjustment is made at the corporate level to convert about 60% of our inventories to our LIFO method. These are primarily our domestic steel related inventories.

Significant steel cost increases during 2008 have resulted in an estimated LIFO expense in continuing operations of approximately $47 million for the full year, of which $19.7 million was recognized in the third quarter. We increased our full year estimate during the quarter primarily due to expectations for year-end inventory valuations to be higher than previously anticipated. This full year revision caused the larger than forecasted third quarter charge.

With those comments I’ll turn the call back over to Dave.

Dave Haffner

Thank you, Karl. As we announced in yesterday’s press release 2008 earnings per share from continuing operations, excluding non-recurring items are expected to be between $1 and $0.15. This guidance anticipates weak fourth quarter market demand $12 million of LIFO expense and a tax rate of approximately 41%. Sequentially fourth quarter sales are expected to decline approximately $200 million due to lower anticipated unit volume.

Sales from continuing operations for the full year are projected to be approximately 3% lower than in 2007. Inflation-related price increases and market share gains are expected to be offset by weak market demand and the deliberate elimination earlier this year of approximately $100 million of unprofitable sales from the company’s store fixtures business.

We spent much of September reviewing every business unit’s strategic plan, which were the result of a new strategic planning process implemented earlier this year. This process will help guide our long-term decisions about each business unit, including its opportunities and its role in our portfolio. We are very comfortable with our strategic direction and are absolutely committed to the continued execution of our plan.

We believe our actions are reestablishing Leggett as a stronger and more profitable company. Our goal is to consistently generate total shareholder returns of 12% to 15% per year, on average and with those comments I will turn the call back over to Dave DeSonier.

Dave DeSonier

That concludes our prepared remarks. We appreciate your attention and we will be glad to try to answer your questions. In order to allow everyone an opportunity to participate, we request that you ask your single best question and then voluntarily yield to the next participant. If you have additional questions, please re-enter the queue and we’ll answer as many questions as you have. Randy we are ready to begin the Q-and-A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Rupe - Longbow Research.

Mark Rupe - Longbow Research

On the benefit that you’ve had in the residential furnishing segment, with the innerspring dumping, you’re sort of doing very well, the verticalization of a customer, all of those have obviously benefited this year offsetting some other end market weakness. Do you have any idea when some of that might lap going into next year and I’m curious to learn if how much of an impact on the positive side they are offsetting this year or in the current environment I would say.

David Haffner

The answer the first question is they would lap to a significant degree in the first quarter of ’09, but then we would have trade link benefit into the second and third quarter as the COG to those imported down the innersprings start to levitate, so it will roll actually through the third quarter of next year.

As it relates to trends, it’s a challenge. We’ve seen a significant reduction in demand, in the last few weeks of September, first couple of weeks of October and the way that we look at it is in the second quarter of this year, our innerspring sales were up approximately 13%. We believe at that time the market was off about 10%; the best intelligence we have.

Third quarter we believe the market was off 10% to 12% and our innerspring sales were up 15%. Now, admittedly our September sales were only up 2%. Our October sales through the first two weeks were off about 6%. We believe the industry is probably off north of 20% in units. We don’t know, this is so fluid and the falloff has been so dramatic, it’s tough for us to get a handle on. We certainly are outperforming the industry significantly, probably by a 20 point delta.

Operator

Your next question comes from Chad Bolen - Raymond James.

Chad Bolen - Raymond James

Karl, you gave us a couple of statistics there; would you walk through for us, I guess in residential furniture, bedding and office furniture, what was the year-over-year change in sales and units where you can give it to us?

Karl Glassman

Chad, as I’ve broken this out in the past, I’ll do it again. The buckets of residential in third quarter, U.S. spring in dollar sales was up about 18%. Remember there was significant steel inflation, so innerspring units up in that 15% range; box springs were negatives moving with the market trend. So, it’s tough to sort out the dollars versus the units.

International spring, dollar is up about 12%, units are 14% with some real weakness in Europe as we walked away from some business that was unacceptable margins and admittedly the European economies weekend as the third quarter grew long.

Furniture in total, sale is up about 10%, good story there. Our hardware mechanism sales in units were up 2% in a mix between domestic and international. Now some of the other furniture categories were off in units more than that. We believe the furniture side of macro industry is off in the 10% range in the third quarter, probably closer to 15% maybe 20% as we speak.

Consumer products in dollars was off about 10%, carpet cushion was off about 8% in dollars and 8% in units, so that was somewhat normalized. So, I gave you a little bit of a flavor for the residential categories.

I’m sorry, office was off. Office we have a little bit of moving parts. Office was off about 2% to 3%. We have some challenges in trying to gather that data. There’s some inflation, not as extreme as exist in the residential categories. Offset, when we sold the Aluminum business some office aluminum-base business that we had moved with aluminum and then later on the gains from our Chinese acquisition that hasn’t anniversaries yet, so sort the whole thing out and we get 2% to 3% in units which is even a good number. So, the chair side of office continues to perform pretty well in this environment.

Chad Bolen - Raymond James

And as just my follow-up, I guess when looking at the Q4 guidance sales down about 10%, what are the assumptions there by a business segment?

Karl Glassman

Chad, it’s all over the board. Probably to step back a little bit and give you a flavor of our forecast in methodology, what happens is in the early stages of last week, each branch and business unit forecasted the fourth quarter based on the trends that they saw at that moment. There is significant volatility in that forecast because of softening demand overlaid by raw material inflation, some of that from a sequential there has been a gain in our average unit selling prices as we pass-through inflation.

Certainly, year-on-year comp there’s significantly more inflation in those numbers, but if I sort everything out and try to pin it down to units, it’s about a 15% negative demand. Now that’s very significant by business, by region in the world, but 15% is about as good a number as I can give you in units.

Operator

Your next question comes from Keith Hughes - SunTrust.

Keith Hughes – SunTrust

Just to switch to raw materials, given the moves down in scrap steel prices in the last couple of months, is it fair to assume the $47 million LIFO charge is not going to reoccur in 2009?

Karl Glassman

Keith, I would say that is a fair statement.

Keith Hughes – SunTrust

And how long is lower scrap and I guess potentially lower rod when it comes out with it. When will it start to show up in the income statement for you guys?

Karl Glassman

Well, there is a lot of dynamics, Keith as it relates to steel and you know that steel market pretty well. There are different dynamics in the flat products versus the long products being the rod and wire business. Both of them are being impacted by a reduction in scrap prices. From our perspective, the flat products or purchase products, the long products are partially manufactured partially purchased.

So as scrap decreases, it will ultimately end up as somewhat of a reduction in selling price at some point in the future, certainly not in the fourth quarter. We have higher valued inventories in place at this point and we never priced the peak of that raw material inflation either. So, if it is showing up in the fourth quarter, in our fourth quarter forecast to more directly answer the question and we’ll continue to get benefit to the degree that we can maintain some spread, remember that we lagged going up and should rightfully lag going down.

Keith Hughes – SunTrust

And a final question, you talked about the plan on the store fixtures, roughly $250 million in sales. As you began the process or reviewing this business, was it about $400 million? Is that correct?

Karl Glassman

No, it was higher than that. It depends on when you consider beginning the review. That business has performed so terribly over the last number of years, the review has been ongoing, but if we look at store fixture sales alone, going back to 2006 it was about $540 million, 2007 it had dropped about 500 as we started walk away from some business close locations.

2008 its about $375 million to $380 million business, but on a run rate, its closer to about $325 million as we close facilities, pushed out some of that business, about $100 million of unacceptable margin price business, so today our run rate is about 325.

Operator

Your next question comes from John Baugh - Stifel Nicolaus.

John Baugh - Stifel Nicolaus

A couple of things; have you witnessed the 15% unit decline in any quarter in your memory?

Karl Glassman

No, John I don’t think, no.

John Baugh - Stifel Nicolaus

I’m curious on the range of guidance, you mentioned your methodology of forecasting and how you got all the units together. Where is that 15% assumption of down units? Would that to be the mid point of that guidance range, help me with the range?

Karl Glassman

I would say that it’s not in the mid point. Typically that it would be today we are being conservative, we have no visibility. John, I’m going to admit something that I’ve been taught never to admit, we don’t know. The thing is demand has falling off so significantly in such a short period of time that we are trying to give as accurate guidance as we possibly can. I’m an optimist, so I personally believe it might be slightly conservative, but we don’t know.

Dave Haffner

Yes, John, this is Dave. I’ve consistently said we’re tired of having our friends disappointed, so it could be conservative. It is not at the mid point of what rolled up, but we truly do not know. Our people that are developing the data at the profit center points really don’t know. So, we could be accused of being a bit conservative and I hope that this way it comes out, but we just don’t know.

John Baugh - Stifel Nicolaus

On store fixtures, as you go through this restructuring or whatever you want to call it, how easy or difficult is it to say “we’re not going to make wood shelving or plastic or deposits or whatever that you’re doing there; we’re only going to make metal”. Have you breach that topic with your current customer base? Will they continue to buy metal component shelving from you to the same degree they have. Kind of walk me through that thought process and how you thought about that?

Dave Haffner

Oh you need to put an average on that, we will be participating at a more moderate right in wood.

Karl Glassman

John, when we started the analysis of our store fixtures business, if you look at store fixtures as one of the components of Fixtures and Display, so just store fixtures, the business is really broken into three parts; there is Wood, there is metal, there is distribution.

Metal, is historically been a much more stable business for us. It’s a business that’s much more predictable, longer runs, better aligned with Leggett’s core competency. The Metal business had not disappointed us in the recent past, maybe at a couple ranges, but overall our manufacturing operations, our customer base, everything is very stable in metal and it aligns perfectly with Leggett. The store fixtures metal business gives a significant amount purchasing leverage to the rest of Leggett, so metal is really well aligned.

When we started to do the analysis wood is where we really disappointed ourselves. Wood is much more challenging. It’s a product that by the nature of the raw material is more fluid, the production runs are shorter, it has a much more custom element to it and there was a time that we thought well maybe we just need to get out of the wood business because of this history of disappointment and the reality is when we look at our top 20 store fixtures accounts, 13 of them are dependent on us for a combination of metal and wood. We are not getting out of the wood business.

We see that a downsized wood strategy combined with our metal strategy is a significant competitive advantage. What we really meant to announce yesterday is we are reducing our wood manufacturing footprint, but we are going to continue to get a contribution out of our wood operation. So, if the real benefit in Store Fixtures is the combination of those two.

Now I think we would be concerned about our pure wood ply customer. We’re after those combined metal and wood in that strategy and as we downsize, we’re continuing to do that profitability by customer and we are continuing to push some unattractive business of the bench.

The key for that business is we expect 2009 to be a very, very difficult year in store fixtures. We need to make sure that our manufacturing capacity is full and we’re comfortable with these changes that will take place in the fourth quarter that we’ll be properly positioned.

John Baugh - Stifel Nicolaus

So, at wood or you simply eliminating capacity or are you reducing skews, complexities, what…?

David Haffner

We’re reducing numbers of facilities and we’re reducing complexity at the same time.

Operator

Your next question comes from Joel Havard - Hilliard Lyons.

Joel Havard - Hilliard Lyons

Dave the divisions, the operating units that are sort of on the blot now you’ll said, don’t see too much of an impairment, what about the other side of that? Is there a best guess at this point on any possible gains on that and the timing given what’s going on that might qualify not as a best guess, but as a wild guess.

David Haffner

Yes, okay Joel that should be sort of a wild guess. Relative to the gain potential, we’re not anticipating that in this and we haven’t seized of these activities. So we continue to suffer from credit tightness and the proposed purchase prices and things like that. We know we’ll significantly exceed in total our $400 million target that we put out there significantly. We suspect that there isn’t going to be a significant amount of gain on those of the three, but just getting something close to book value will be a very handsome amount above our $400 million total. Let Matt comment on it to.

Matt Flanigan

Joel, I’ll just add that on the balance sheet that you have got there for the press release, the assets held for sale if you take the asset categories deduct the little bit of liabilities associated with those, it’s about $91 million that is reflected at the end of September. Now that includes some other things, not just those three business units, but that’s a good proxy for all of the things we still have that we are working to monetize.

David Haffner

Yes, and with regard to timing Joel, who knows we still have a significant amount of discussion going on a couple of those. On the other hand, we wanted to take a more conservative approach and we don’t want to give them away. They are generating a significant amount of EBITDA, as we speak and while we know the valuations and multiples if you want to short cut or have it come down in this market, we just not feel terribly compelled to give them away. They are still for sale and we are continuing to negotiate, but gosh I wish I can tell you when they would get down.

Joel Havard - Hilliard Lyons

Matt one more follow-up for you; is their reduction kind of done here and where did this last chunk primarily come from?

Matt Flanigan

Yes, it did largely come from the proceeds from the asset sales. As you know we bought 8 million shares during the quarter.

Joel Havard - Hilliard Lyons

I mean where did you direct it, which area?

Matt Flanigan

Commercial paper is where that we got applied and a 28% debt-to-cap approximately in the third quarter. As you know that’s below our long-term comfort zone of 30%, running up to 40 but we wouldn’t do that, but closer to 30% and at the end of the second quarter we were about 31%. So in the spirit of being conservative with all of the economic headwinds that started blowing particular in the quarter we wanted to make sure we were well positioned and that took our leverage to about 28% at the end of the third quarter.

Operator

Your final question comes from Keith Hughes - Suntrust.

Keith Hughes – Suntrust

You have talked about some higher temporary inventory or higher temporary working capital and the cash flow equation for this year; could you discuss that in a little more detail please?

David Haffner

Yes, Keith. I’ll let Karl give some comment on it too. Inventory is the predominant piece of that variant. Even though we’ve seen our receivables go up a bit, I think that’s a direct function of the times that we’re in and we’ve taken into consideration our reserves accordingly for that, but inventory is where that big bubble is and I used the word managed inventories as I talk through this, because some things I know Karl and the operating people have a very high priority on and Karl you want to comment on it.

Karl Glassman

Yes Keith. The inventories in part are inflated and the primary reason is pure inflation. On a year-on-year basis those inventories have a higher cost because of steel inflation.

Keith Hughes – Suntrust

This is not units?

Karl Glassman

No it’s primarily dollars. We are not overly concerned about the unit inventory that we have in place, but in this environment with demand falling off the way that it has, today’s point, we will be reducing our inventories as the border goes on.

Keith Hughes – Suntrust

The second question on the stores fixtures business; with this $250 million business you’re going to have now, what products are you no longer going to produce. I assume given its going to be metal centric and dollars is going to be a big specific way of the business, but what else will you be in a big way.

Karl Glassman

It’s not a significant change in products produced; it’s more a change in the mix between metal and wood and then some specific wood only business that we are walking away from, but I can’t say from a delineation stand point that we were making one which in the past that we are not going to make in the future. It’s more a rebalancing of the mix recognizing that metal is what we’re good at, metal historically has been a very stable business for us, but there is some ancillary wood business that is pretty darn good when you roll it into total.

Keith Hughes – Suntrust

So, when you look at the business as it’s going to be structured, what type of margins has it is historically put up, what’s remaining?

Karl Glassman

In the metal side of the business, it’s been in that 10% range; depends on customers, depends on location, depends on…

Keith Hughes – Suntrust

10% EBIT?

Karl Glassman

Yes, going forward we should have that expectation, that that business we are very confident. In 2009 the way they we’ll have the business structured will cover our cost to capital.

Operator

Thank you and at this time Mr. DeSonier there are no further questions. I’ll turn it back over to you.

Dave DeSonier

As I said we appreciate your time and your attention and we’ll be talking to you next quarter. Thank you.

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Source: Leggett & Platt, Inc Q3 2008 Earnings Call Transcript
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