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Leggett & Platt (NYSE:LEG)

Q3 2010 Earnings Call

October 22, 2010 9:00 a.m. ET

Executives

David DeSonier – VP, Strategy and IR

Dave Haffner – President and CEO

Karl Glassman – EVP and COO

Matt Flanigan – CFO

Susan McCoy – Director, IR

Analysts

Budd Bugatch – Raymond James & Associates

Mark Rupe - Longbow Research

John Baugh – Stifel Nicolaus

Keith Hughes – SunTrust

Robert Kelly – Sidoti & Company

Operator

Good morning and welcome to the Leggett & Platt's Third Quarter 2010 Earnings Call. [Operator Instructions.] It is now my pleasure to introduce your host, David DeSonier, Vice President of Strategy and Investor Relations for Leggett & Platt Inc. Thank you. Mr. DeSonier, you may begin.

David DeSonier

Good morning and thank you for taking part in Leggett & Platt's third quarter conference call. I'm 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, the Chief Operating Officer; Matt Flanigan, our CFO; and, Susan McCoy, our Director of Investor Relations.

The agenda for the call this morning is as follows: Dave Haffner will start with the summary of the major statements we made in yesterday's press release, Karl will provide operating highlights, Dave will then address our outlook for the full year, 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 expressed permission. A replay is available from the IR portion of Leggett's website. We've posted to the IR portion of the website a set of PowerPoint slides that contains summary financial information. Those slides supplement the information we discuss on this call, including non-GAAP reconciliations.

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'll now turn the call over to Dave Haffner.

Dave Haffner

Good morning, and thank you for participating in our call. Yesterday, we reported third quarter results. For the quarter, sales from continuing operations increased 7% over the prior year, reflecting a combination of unit volume growth and previously implemented price increases that partially recovered higher steel costs.

Certain of our key markets, primarily related to residential furnishings, weakened noticeably in the third quarter. As a result, our third-quarter sales were lower than those of second quarter, which rarely occurs. Though aggregate unit volume increased 6% in the third quarter as compared to the third quarter of 2009, this was much slower paced than the 15% unit growth experienced during the first half of 2010. We believe the stronger consumer demand during the first half of the year was driven in part by larger income tax refunds and home purchase incentives.

Third quarter 2010 earnings from continuing operations were $0.31 per share, down from $0.34 in the third quarter of 2009. Several factors, including higher net LIFO expense and higher raw materials costs, led to the decrease. These declines were partially offset by the year-over-year growth in unit volumes, a lower effective tax rate, and a lower share count.

As we discussed throughout last year, in 2009 we experienced a quarterly mismatch in the recognition of LIFO benefits versus the LIFO impact associated with the consumption of higher-cost steel. In the third quarter of 2009 we recognized a net LIFO benefit of approximately $11 million. As anticipated, that benefit did not recur this year. Instead, in the third quarter of 2010 we recognized a net LIFO expense of approximately $4 million.

Raw material costs have temporarily increased beyond the amounts anticipated when we implemented price increases in the second quarter. However, we are seeing costs begin to retreat to expected levels. In September, we completed the seventh and final divestiture that we identified as part of the strategic realignment announced in late 2007.

The divestiture program has reshaped Leggett by narrowing our primary focus to businesses with distinct competitive advantages, value-added engineering and manufacturing operations, and significant barriers to entry. These seven divestitures collectively generated $433 million of after-tax cash proceeds, exceeding the original $400 million goal.

The company's primary financial objective is to consistently achieve total shareholder return within the top one-third of the S&P 500. Since 2008, when we implemented our new strategy, we have comfortably exceeded this goal. Longer term, we believe that modest sales growth, continued merchant improvement, our dividend yield, and stock buybacks will enable us to continue to attain this goal. And, our financial profile remains strong.

We ended the quarter with net debt at 25% of net capital, which is below our long-term targeted range of 30% to 40%. We currently have more than $400 million available and 1.5 years remaining on our $600 million bank facility. And we have no significant fixed-term debt maturities until 2013.

Our cash balance at the end of the second quarter was $277 million. We generated $91 million of cash from operations during the quarter. Working capital remains at a favorable 14.2% of sales, and reflects our ongoing focus on optimizing returns.

We repurchased 500,000 shares of our stock during the quarter, at an average price of $21.15 per share, bringing year-to-date purchases to 4.7 million shares. Share repurchases are a key element in achieving our TSR goal. For the full year, we expect now to purchase between 6 million and 8 million shares.

The dividend is another crucial element of our TSR performance. In August, we increased the quarterly dividend by 3.8%, to $0.27 per share per quarter. At yesterday's closing price of $22.99, the current dividend yield is 4.7%.

Operating cash in 2010 should once again comfortably exceed the amount required to fund dividends and capital expenditures. For the full year, we expect operating cash to exceed $300 million.

And with those comments, I'll turn the call over to Karl, who will provide some operating highlights. Karl?

Karl Glassman

Thank you Dave. Good morning. I'd like to quickly discuss a few major topics. You will find segment details in yesterday's press release and in the slide presentation on our website.

As Dave mentioned, certain of our markets weakened during the third quarter. This was most pronounced within residential furnishings. Third quarter sales in the segment were flat with prior year. Steel-related price inflation was offset by unit volume declines in several key businesses.

In our U.S. springs business, inner spring unit volumes decreased 9% in the third quarter, and box spring units declined 4%, reflecting a notable slowing of the end market versus earlier quarters this year. Unit volumes also declined versus the prior year in our international spring, fabric converting, and carpet underlay businesses.

In our furniture hardware business, unit volumes increased in the third quarter, due primarily to market share gains and relative strength in motion upholstery. But the rate of increase slowed significantly versus earlier quarters this year as demand for upholstered furniture has softened in recent months. Lower unit volumes in the segment led to slight reductions in EBIT and EBIT margins versus third quarter last year.

In the commercial fixturing and components segment, office furniture industry demand has stabilized and continues to show early signs of improvement. We experienced strong growth during the quarter in our office components business, with sales up 20%, primarily from new programs that we have been awarded.

Revenues of our store fixtures business were roughly flat during the third quarter. As we mentioned on last quarter's conference call, seasonality within our store fixtures business shifted this year, with more volume in the first and second quarters and less in the third quarter, as retailers have increased remodeling activity and reduced new store construction.

EBIT and EBIT margins in the commercial fixturing and component segment decreased versus third quarter last year. The benefit from sales growth in office components was offset by several factors including higher raw material cost and a less favorable sales mix within our store fixtures business.

Third quarter sales in our industrial materials segment increased 6%. Growth from steel-related price inflation and slightly higher unit volumes were partially offset by a small divestiture. EBIT and EBIT margins decreased, primarily due to higher raw material cost versus third quarter of 2009.

In the third quarter of 2009, we reduced inventories to match lower demand. This caused us to consume a high level of internally produced rod, which resulted in lower raw material cost and atypically high EBIT and EBIT margin levels within the segment last year.

All parts of the specialized product segment grew in the third quarter. In our automotive businesses, comps became more difficult, as we anniversaried last year's stimulus activity. But sales still grew approximately 35% in the third quarter.

This improvement reflects strong growth in all our major global markets we serve, including North America, Europe, and Asia. Industry forecasts continue to anticipate production growth in all of these markets this year and in 2011.

Our machinery and commercial vehicle products business also posted very strong growth during this most recent quarter.

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

Dave Haffner

Thank you Karl. We have revised our full year EPS guidance to the lower half of our prior range. We now expect earnings of between $1.10 and $1.20 per share. Sales for 2010 are anticipated to be between $3.3 billion and $3.35 billion, which includes raw material related price increases that are contributing only minimal earnings.

While we are disappointed with the softening in third quarter performance of a few of our business units, and are tactically addressing those, we are very pleased with many of the business units and their continued progress in this challenging environment.

And to reiterate a point I've made before, as part of our longer term focus, we continue to concentrate on our new product development efforts to ensure new value-creating concepts can be presented to our customers in the future.

And with those comments, I'll now turn the call back over to Dave Desonier.

David DeSonier

That concludes our prepared remarks. We thank you for 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 reenter the queue and we will answer all the questions you have.

Operator, we're ready to begin the Q&A.

Question-and-Answer Session

Operator

Thank you. We'll now begin the question and answer session. [Operator Instructions.] Our first question today is from the line of Budd Bugatch with Raymond James. Please proceed with your question.

Budd Bugatch – Raymond James

The question I guess is just let's focus a little bit on residential and kind of give us the color of what's going on now. And the one outlier there it looks like the reacquisition of a key customer has given you, at least in the furniture side of components, some good business. When does that anniversary? And obviously bedding is an area of significant focus to see what's going on there. And Karl, maybe you can give us a little color on that.

Karl Glassman

As regards the furniture hardware question, and recollecting a customer, that was broader than a single customer. It was a market share gain based on reestablishing ourselves as the premium quality supplier worldwide of furniture hardware mechanisms in that some of our customer base, both in China and the U.S., have started to deal with some quality problems with some competitors' product. So they have decided that the lower price isn't always the best economic value. We really star to anniversary a good bit of that in the first quarter of next year, so 4Q we should continue to see share gains.

As regards bedding, certainly a disappointment. We think that the market during the quarter was down in that 4% to 5% range, which would correlate to our box spring business statistics. The sales levels were about constant. July-August variance through the first week of September all equally negative. Post Labor Day, almost fell off the table.

So the latter part of the third quarter was more difficult, resulting in those disappointing statistics. In part what happened is in the early part of the third quarter, we started to experience some market share losses in inner springs and that related to some opportunistic purchases by our domestic customers, as we had implemented price increases and the euro-dollar exchange rate hit that low of $1.20 early in the quarter, that a group of them opportunistically purchased some European units primarily from Germany and Turkey.

That cost us probably 300 basis points. We have now regained that share with the euro-dollar exchange rate being in the $1.40 range, and the raw material inflation in Europe was a little bit later than it was in North America. So we're not happy that we lost that share. We're happy that we've regained it. We will continue to pick up that share as the fourth quarter progresses. We have commitments for all of the business, but with business being so soft right now not all of it is in the house, so to speak.

As it relates to current demand, shipments through yesterday evening, it looks like our inner spring shipments fourth quarter, which would be the first 14 shipping days, are down about 5% year-on-year.

Budd Bugatch

I see. So a little bit of improvement. Explain to us, though, we've seen some very good performance from the real high-end guys, the specialty guys, and we thought all year the market was working in a barbell way - low end and high end were doing with the middle having a rougher time. Is that now changed and the low end is seeing an issue as well, with the high end still performing okay? And can you kind of help us understand what's going on in the bedding arena from your perspective?

Karl Glassman

Very good point, Budd. We saw early in the year, and we spoke of this, the barbell shape or bifurcation, where we were seeing real strength in the ultra-premium price points, both alternative sleep and inner spring, and seeing relative strength in the promotional side of the business. And what's happened to us more recently, started to see it post-Fourth of July and then more significantly post-Labor Day, that promotional part of the business is lacking, costing us units, associated overhead recovery, and then also the connectivity to our industrial materials demand. So still continued strength at the high end. It's a loss of momentum in the low end.

This is an odd year in that as long as we chart statistics, none of us can remember a year where our average unit shipments per day sales were at its peak in February and March, where historically, that's in August and September. It is a very very odd year. We think that there was some early demand that may have been related to very high tax refunds, which tends to drive promotional, which tends to drive those February-March timeframes. So your point's well taken, Budd. It softened at the low end and the middle is still as it has been for the last two or three years, vacant in the market.

Budd Bugatch

Just my final follow up. Is there any inventory issues in the channel that worry you?

Karl Glassman

Certainly not in bedding. That is, as working capital intelligent businesses we participate in that there's - that value chain is really smooth, so there's nothing there. In furniture it's probably a greater issue, affects us less than most folks, and it's a greater issue we believe in case goods within upholstery and if it is an issue in upholstery it tends to be more in stationary where there's been a market share reduction in stationary. Motion continues to sell pretty well. We think that there might have been a little bit of inventory build in imported motion furniture as people became very very concerned about the lack of receipt of goods from Asia, double ordered, and then now all of a sudden business slowing a little bit. But we think that's minor, and if there was a little bubble there, it probably worked itself through the system in the third quarter. Certainly not an issue on the domestic upholstery side, as you can imagine.

Operator

Thank you. Our next question is from the line of Mark Rupe with Longbow Research. Please proceed with your question.

Mark Rupe - Longbow Research

I know that you're not discussing 2011 detail or anything, but given the first half's strength and I think you cited in Budd's question about the anniversarying of some of the custom customer wins on the furniture component side. Any color on where the most significant challenges are from a comparison standpoint maybe in the first couple of quarters and if there's any margin implications as a result of that?

Karl Glassman

Mark, I think you hit right on it, that we're not giving 2011 guidance. We're just very early in the throes of making our way through that data, but at this point, I personally expect that the comps will be more difficult, certainly in residential furnishing in the first half of next year because of this pull-forward of demand. We'll probably have the same situation in our store fixtures business, where we had probably an abnormally strong first quarter and first shipping month of the second quarter. For I don't know how many years we talked about a stronger back half and so we're kind of wearing that out a little bit. But the comps definitely will be more difficult in the first half of next year. Not to say that there won't be growth and certainly we do not think there are any margin implications in that. We expect continued, steady, slow growth.

Mark Rupe

Okay, and I know that on margins that you've done a lot on the cost side. Should we assume, if volumes were flat, just in general, that margins would hold, or continue to improve?

Karl Glassman

You should expect that they'll continue to improve. We're continuing to fine tune our cost structure. Evidence of that in our store fixtures business, we announced in the third quarter the closure of one of the two remaining wood store fixtures plants, trying to take more capacity offline. It's a facility in Colorado that is one wonderfully talented group of people that were working as hard as they could. It needed volume. That volume didn't materialize. We promised our investors that we would become less patient in the future than we maybe had been in the past, and we are that. So we are continuing to attack our cost structure. That's evidence of it, but it's broader-based in other parts of the company.

Mark Rupe

If I could sneak one more in real fast, Dave does the softer period in the back half change the appetite for growth investments into next year and beyond?

Dave Haffner

No, it really doesn't. We're more critical than we have been in the past as you know. We're on the hunt. We're looking for opportunities for the right acquisitions for the right investment opportunities for some generic products that we're developing. So no, we're still looking for that type of growth.

Operator

Our next question is from the line of John Baugh with Stifel Nicolaus. Please proceed with your question.

John Baugh – Stifel Nicolaus

My question, I guess going back to inner spring and the market share loss in the quarter. Obviously we had the threat from China a while back, but I can't recall ever hearing imports from Europe showing up as an issue, and I'm just curious how easy or difficult it is for your customers to make that switch out. I assume the quality is better coming out of Germany than, say, China, but I'm just a little surprised that they can change their source of supply that quickly and not disrupt their operations. I'd love some color about your customers, their flexibility to do that again in the future since you don't control exchange rates.

Karl Glassman

It's relatively easy in the promotional generic lines for them to make that change, and your assumption is correct. The quality from Europe, both Germans and the Turks, is relatively high. They produce on modern equipment. That's not an issue. As long as the product is placed in generic lines where the component itself isn't branded they can pretty easily substitute.

What happens, though, is that when demand weakens in Europe, as it did in the second quarter, around all the financial engineering in the European markets, that capacity becomes available. Then currency exchange allows that capacity to be displaced. So there has always been some number of inner springs that come in from Europe. It just peaked in the early part, or I should say all, of the third quarter. But it's opportunistic.

Again, a major part of that was the timing of raw material inflation where there was a disconnect where in North America we saw raw material inflation early second quarter. Didn't experience it until late second quarter in Europe.

So you combine all of those things, weak European demand, an abnormal currency exchange rate, and a disconnect in inflation, and there was a window that allowed for some of our customers to walk through, and it was a unique set of circumstances.

John Baugh

And as a follow up to that, the timing between your pricing and then raw materials went up further than you thought, historically you've tried to - and been very successful at - recapturing all inflation with your pricing. But I guess with a very weak market and then this exchange rate and foreign competition, you couldn't take an additional price step during the quarter to offset the inflation. And now with raw material coming back down, I guess you won't need to, so we just sort of lost two or three months of margin. Is that the right way to think about it?

Karl Glassman

It is the right way to look it. Remember that historically we've talked about knocking off the peak of inflation and not giving up the trough. And that's what happened in the third quarter. That peak admittedly was a little higher than we expected and that raw material inflation held on a little longer than we thought that it might. It has mitigated with the weak demand, with productivity numbers being what they are and the steel manufacturers need to continue to produce. So it was a third quarter phenomenon. We are more fully recovered now than we were in the third quarter.

John Baugh

What was the scrap rod spread in Q3 year-over-year and how is that trending for fourth quarter?

Karl Glassman

It's trending about flat. It's widened a little bit. As relates to the spread or middle margin into the fourth quarter it should widen a little bit more but scrap costs are dropping and it really depends on how long the selling price of those long products will hold. We think that they will. So the spread should widen slightly.

Operator

Next question is from the line of Keith Hughes of SunTrust. Please proceed with your question.

Keith Hughes – SunTrust

You gave us the revenue guidance for the year and we can interpolate the fourth quarter. Could you just speak generally among the divisions what you're expecting in the fourth quarter on revenue? Residential versus commercial versus industrial in the fourth quarter.

Susan McCoy

Keith, I'll just jump in real quick while they're looking for the fourth quarter detail to let you know that implied for the full year residential would be up a few points, low-single-digit sort of range. Commercial would be up call it mid-single-digits. Industrial up maybe 10% or so and remember for the full year that's got quite a bit of inflation in it. And specialized up ballpark 25% or so. That's what the midpoint of the full year guidance would imply.

Keith Hughes

Okay. So that sounds like in residential we're going to be down mid to high single digits based on the model you're putting out, so are you just taking the trends you've seen in September or maybe more October and just projecting those out for the year? Is that kind of what we're doing?

Dave Haffner

Yes is the answer to the last question. In residential what I'm giving you is a year-on-year, not sequentially. We're modeling residential down in the 12%-13% range.

Keith Hughes

You talked about what you thought the mattress industry was doing in the third quarter. We don't have the full quarter numbers from ISPA, but just tell me where you think your numbers - I think you're going to be a little different than what ISPA is probably going to tell us for the quarter. Can you tell me what you think the differences are?

Karl Glassman

Through the first two months of the quarter, which you're right they have not announced September, they showed mattress units up about 6% consolidated, tough July, stronger August. We believe the market for the quarter, as I said, was down in that 4% to 5% range. The delta of that is a disconnect in the reporters versus the non-reporters. As Budd's question indicated, the very high end is selling.

There's a high percentage of the high end manufacturers that are reporters. So that kind of skews things. It's telling to us that when ISPA put out their full year forecast just recently for mattress units they forecasted the full year at 5.5% growth through August. The year-to-date, using their statistics, which we take issue with, are 11%. So they're saying through August, 11.1% growth of the reporters and an indicated growth full year of 5.5% for the whole market. Well, no matter how you look at it that shows a declining market in the remaining four months. So we'll see. It's all guestimates by a whole lot of people trying to do their best.

Operator

Our next question is from the line of Robert Kelly of Sidoti & Company. Please proceed with your question.

Robert Kelly – Sidoti & Company

Any issue or risk with what looks to be a pretty soft 4Q for the residential side of the business? You talk about prices for your raw materials coming down. Any risk that you would have to maybe discount or give back some price?

Karl Glassman

No. We feel pretty comfortable that we're properly priced. Our customers certainly know that inflation was a real issue in the third quarter and as that inflationary pressure is mitigated somewhat that they know that we weren't fully recovered. So we don't have any expectation that there will be pressure to reduce prices.

Robert Kelly

Any way you can quantify both the year-over-year and the sequential increase in raw materials and how it impacted your cost of goods sold?

Susan McCoy

No. We haven't quantified the year over year impact of that.

Operator

[Operator Instructions.] Thank you. There appear to be no followup questions at this time. I will now turn the floor back to management for closing comments.

Karl Glassman

Actually, I want to clarify an issue. I was trying to do math on the fly, which is always dangerous for a spring salesman. Our current forecast on sales in residential year on year fourth quarter is up 3%. I apologize for that. I was looking at cross tables. Even when I said it it didn't make sense.

David DeSonier

If anybody needs follow up call me or Susan on that. And we appreciate your attention. We'll talk to you again next quarter.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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