Leggett & Platt - Q4 2022

Transcript

Operator (participant)

Greetings, welcome to the Leggett & Platt Q4 2022 Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Susan McCoy, Senior Vice President of Investor Relations. Thank you. You may begin.

Susan R. McCoy (SVP of Investor Relations)

Good morning. Thank you for taking part in Leggett & Platt's fourth quarter conference call. On the call today are Mitch Dolloff, President and CEO, Jeff Tate, Executive Vice President and CFO, Steve Henderson, Executive Vice President and President of the Specialized Products and Furniture, Flooring & Textile Products segments, Tyson Hagale, Senior Vice President and President of the Bedding Products segment, and Cassie Branscum, Senior Director of IR. 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 and demand trends. Jeff will cover financial details and address our outlook for 2023, and the group will answer any questions you have. This conference call is being recorded for Leggett & Platt as private 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.

We posted to the IR portion of Leggett's the website yesterday's press release and a set of PowerPoint slides that contain summary financial information along with segment details. Those documents 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 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.

Mitch Dolloff (President and CEO)

Good morning, thank you for participating in our Q4 call. Leggett & Platt's diverse portfolio of businesses, strong cash discipline, and the ingenuity and agility of our employees helped us deliver solid results in 2022 despite weak demand in residential end markets. Sales grew 1% in 2022 to a record from continuing operations of $5.15 billion, primarily from acquisitions. Organic sales were flat, with volume declines of 7% and negative currency impact of 2% offset by raw material-related selling price increases of 9%. Acquisitions net of divestitures added 1% to sales growth.

Volume declines were driven by demand softness in residential end markets, partially offset by growth in automotive and industrial end markets. 2022 EBIT was $485 million, a decrease of $111 million versus 2021 EBIT, a decrease of $83 million versus 2021 adjusted EBIT, primarily from lower volume, lower overhead absorption from reduced production, operational inefficiencies in specialty foam, and higher raw material and transportation costs and operational inefficiencies in automotive.

These decreases were partially offset by metal margin expansion in our steel rod business and pricing discipline in the Furniture, Flooring & Textile Products segment. EBIT margin was 9.4%, down from 2021's EBIT margin of 11.7% and adjusted EBIT margin of 11.2%. Earnings per share in 2022 was $2.27, a decrease of 23% versus EPS of $2.94 in 2021, and a decrease of 18% versus adjusted EPS of $2.78. Cash flow from operations was $441 million, a 63% increase versus 2021.

The current global macroeconomic environment and its impact on the consumer negatively impacted our Q4 results. Sales were $1.2 billion, EBIT was $91 million, and earnings per share was $0.39. Sales in the quarter were down 10% versus Q4 2021, primarily from lower volume and currency impact, partially offset by raw material-related price increases. Acquisitions added 2% to sales. The volume decline was driven by continued demand softness in residential end markets, partially offset by growth in automotive, aerospace, and hydraulic cylinders.

EBIT decreased 40% versus Q4 2021, primarily from lower volume and lower overhead absorption as we intentionally kept production in our steel rod business below demand to reduce inventory levels. These declines were partially offset by metal margin expansion. As a result of these impacts and inflation, EBIT margin was 7.6%, down from 11.4% in the fourth quarter of 2021. Earnings per share decreased 49% versus fourth quarter 2021. During the year, we completed four strategic acquisitions.

In late August, we acquired a leading global manufacturer of hydraulic cylinders for heavy construction equipment with operations in Germany, China, and the U.S., and annualized sales of approximately $100 million. This acquisition builds scale in our hydraulic cylinders growth platform and brings us into an attractive segment of the market that aligns well with trends in automation and autonomous equipment. Also in August, we acquired a small textiles business that converts and distributes construction fabrics for the furniture and bedding industries with annual sales under $10 million.

In early October and mid-December, we acquired two Canadian-based distributors of products used for erosion control, storm water management, and various other applications with combined sales of approximately $50 million. We have successfully expanded our textiles business over the years through small strategic acquisitions that leverage textile supply chain expertise in attractive end markets. Now moving on to the segments. Sales in our Bedding Products segment were down 19% versus fourth quarter of 2021 and decreased 4% for the full year.

Demand in the U.S. bedding market softened during the fourth quarter as macroeconomic impacts on consumer spending persisted. We expect demand in 2023 to remain consistent with levels experienced in 2022, with relatively consistent sequential volumes continuing in the first half of the year and modest increases in the second half of the year. Volume in U.S. Spring was down 22% in 2022, which is comparable to the domestic mattress market.

After a mid-single-digit share loss early in the pandemic related to supply shortages, we estimate that our share of the innerspring mattress market has remained stable over the last two years despite a volatile environment. Consistent demand is assumed in 2023, we expect to increase production after limiting output in 2022 to align inventory with lower demand levels. Strong trade demand for rod and wire provided earnings benefit in the H1 of the year. Trade rod demand slowed considerably in the back half of 2022, and as a result, we cut production significantly to reduce inventory.

Steel rod production in 2023 is expected to be in line with 2022, but remain well below normal levels. We expect higher internal consumption to offset lower trade demand. Increased Metal margin provided earnings benefit throughout the year, but to a lesser extent in the latter part of the year as steel prices softened. While it is difficult to predict steel pricing, we anticipate continued softening in 2023. We expect rod pricing and Metal margins to remain at historically elevated levels due to higher conversion costs.

Demand in European bedding has stabilized in recent months, and we expect demand in 2023 to be relatively flat with 2022. The actions we took in 2022 to reduce inventory across the segment have brought levels back in line with those needed to support current demand. With the capacity we have in place, we are prepared to respond quickly to changing demand, and we remain focused on servicing customer requirements. Full year 2022 segment earnings were significantly impacted by difficulties experienced in our specialty foam business.

About 2/3 of the earnings challenge in specialty foam was a result of low demand, which dropped quickly in the fourth quarter of 2021 and remained at depressed levels throughout 2022. Demand was impacted from three areas. The first being the general bedding market decline of approximately 20% following demand surges in 2020 and 2021, and chemical shortages in 2021. The second was channel-focused. Finished goods production in specialty foam is weighted heaviest to digitally native brands, which declined more than the overall market due to changes in consumer privacy laws and customer cash constraints.

Finally, we suffered share loss from a small number of customers, with sales shifting from finished goods to components in some cases. Specialty foam earnings were also impacted by the volatile chemical supply environment. Like all other foam producers, we experienced significant chemical inflation through the course of 2021, and costs remained at historically high levels in 2022. Given the level of material costs, efficiently pouring and converting foam is of even greater importance than normal. However, because of high demand in 2021 and chemical shortages, our first priority became servicing customers.

Between paused integration and the need to service customers, we have not operated at target material efficiency levels. Material inefficiencies at these high chemical costs had a detrimental impact on earnings. While it will take some time to see improvements in specialty foam, especially with the continued challenging demand environment, we're confident in our recovery plan and are making progress. Our team has a strong pipeline of opportunities influenced by our specialty foam technologies.

We've also focused on driving improvement in material margins through both process and equipment changes. We remain confident that our specialty foam business will drive long-term, profitable growth for the segment and are placing our highest level of attention on short-term improvements in sales and material management. Sales in our Specialized Products segment increased 15% versus fourth quarter of 2021 and were up 12% for the full year. The January forecast for global automotive production shows approximately 4% growth in the major markets in 2023.

While improving year-over-year, automotive industry production forecast could remain dynamic as supply chain, macroeconomic, geopolitical, and COVID impacts bring continued volatility. Cost recovery is continuing in automotive, and we expect to make further progress in 2023. In our aerospace business, we expect continued strong demand in 2023. However, raw material and labor shortages are creating some volatility across the industry. End market demand in hydraulic cylinders is strong, and order backlogs in both the material handling and heavy construction equipment market segments remain at elevated levels.

Demand is expected to remain strong into the H1 of 2023, with some potential slowing in the back half of the year as backlogs ease. Sales in our Furniture, Flooring & Textile Products segment were down 12% versus Q4 2021 and up 3% for the full year. Home furniture demand slowed during the quarter at both the mid and high end of the market, and customer backlogs largely have been depleted. Demand at lower price points remained extremely weak, and customers across all price points are working to reduce inventory levels. This demand softness also impacted volume and fabric converting.

We expect lower market volume through at least the H1of 2023. Work furniture sales decreased in the Q4 as contract demand slowed and demand for products with residential exposure continued to soften. We expect this trend to continue into 2023. In flooring products, residential demand has softened modestly with the slowing housing market and lower home improvement activity. Hospitality demand is slowly improving but remains well below pre-pandemic levels.

Geo Components demand remains solid heading into 2023, particularly in the civil construction market and to a somewhat lesser extent in retail. As we move through 2023, we are focused on improving the things that we can control and continuing to mitigate the impacts of market challenges on our business. We are working with our customers on new product opportunities, continuing our focus on improving operating efficiency and driving strong cash management. Our financial strength gives us confidence in our ability to successfully navigate challenging markets while investing in long-term opportunities.

Finally, I would like to thank our employees for your strength, tenacity, and dedication to driving long-term results. Your commitment to our values results in the collaboration, agility, and ingenuity required to drive our company forward despite challenging macroeconomic circumstances. Each of you is key to our continued success. I'll now turn the call over to Jeff.

Jeff Tate (EVP and CFO)

Thank you, Mitch, and good morning, everyone. In 2022, we generated cash from operations of $441 million, $170 million higher than the $271 million we generated in 2021. This large increase reflects a much smaller use of cash for working capital, partially offset by lower earnings. Working capital increased significantly in 2021 due to restocking efforts following inventory depletion in 2020, but increased to a much lesser extent in 2022 as we return to inventory levels more reflective of current demand.

This improvement was partially offset by a decrease in accounts payable as purchases slowed due to lower volume and our efforts to reduce inventory levels. We ended the year with adjusted working capital as a percentage of annualized sales of 15.3%. Cash from operations is expected to be $450 million to $500 million in 2023 as we continue to focus on optimizing working capital in a softer macroeconomic environment. Our long-term priorities for use of cash are consistent and unchanged.

They include an order priority, funding organic growth, paying dividends, funding strategic acquisitions, and share repurchases with available cash. Total capital expenditures in 2022 were $100 million, reflecting a balance of investing for the future while controlling our spending. We raised our annual dividend for the 51st consecutive year in 2022, honoring our ongoing commitment to return value to our shareholders. In November, our board of directors declared a quarterly dividend of $0.44 per share, $0.02 or 5% higher than last year's fourth quarter dividend.

At an annual indicated dividend of $1.76, the yield is 4.7% based upon Friday's closing price, one of the highest among the Dividend Kings. We used $83 million during the year for the four strategic acquisitions that Mitch discussed earlier. With the deleveraging we accomplished over the past few years, share repurchases returned as one of our uses of cash in 2022. During the year, we used $60 million to repurchase 1.7 million shares at an average price of $35.94. We used our commercial paper program to repay $300 million of 3.4% 10-year bonds that matured in August.

We ended the year with net debt to trailing twelve month adjusted EBITDA of 2.66 times and total liquidity of $1 billion. Our strong financial base gives us flexibility when making capital and investment decisions. We remain focused on cash generation while maintaining our balance sheet strength and deploying capital in a balanced and disciplined manner. Now moving to the 2023 full year guidance. 2023 sales are expected to be $4.8 billion-$5.2 billion, or down 7% to up 1% versus 2022, reflecting macro uncertainty across our markets.

Volume at the midpoint of our guidance is expected to be down low single digits, with Bedding Products down low single digits, Specialized Products up high single digits, and Furniture, Flooring, and Textile Products down low single digits. The guidance also assumes the impact of deflation and currency combined is expected to reduce sales mid-single digits. Acquisitions in 2022 should add approximately 3% to sales growth in 2023.

Volume growth is expected to continue in automotive, aerospace, hydraulic cylinders, and Geo Components, with declines expected in work furniture, home furniture, adjustable beds, and trade sales of steel rod and drawn wire. We expect generally stable demand in our other bedding businesses, reflecting continued low volume levels. 2023 earnings per share are expected to be in the range of $1.50-$1.90. The midpoint primarily reflects lower metal margins in our steel rod business, lower volume in some of our businesses, and moderate pricing pressure from deflation.

Based upon this guidance framework, our 2023 full year EBIT margin range is expected to be 7.5%-8%. Earnings per share guidance assumes a full year effective tax rate of 24%, depreciation and amortization of approximately $200 million, net interest expense of approximately $85 million, and fully diluted shares of 137 million. For the full year 2023, we expect capital expenditures of approximately $100 million, in line with 2022. Dividends of approximately $240 million and spending for acquisitions and share repurchases are expected to be minimal as we focus on conserving cash.

While we're not providing quarterly guidance, we do expect Q1 earnings to be down meaningfully versus Q4 2022, primarily due to the timing of performance-based compensation accruals, which are typically highest in first quarter, as well as normal seasonality in some of our businesses. We expect a continuation of normal seasonality with higher earnings in the Q2 and Q3 of the year.

In closing, while the macro-economic environment remains challenging, especially in the first half of the year, Leggett is well positioned to navigate these challenges with continued operating and financial discipline. We are keenly focused on strong cash generation, our enduring fundamentals give us confidence in our ability to continue creating long-term value for our shareholders. With those comments, I'll turn the call back over to Susan.

Susan R. McCoy (SVP of Investor Relations)

That concludes our prepared remarks. We thank you for your attention and we'll be glad to answer your questions. Operator, we're ready to begin the Q&A session.

Operator (participant)

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for your questions. Our first questions come from the line of Susan Maklari with Goldman Sachs. Please proceed with your question.

Susan Maklari (Senior Equity Research Analyst)

Thank you. Good morning, everyone.

Mitch Dolloff (President and CEO)

Good morning, Susan.

Susan Maklari (Senior Equity Research Analyst)

My question is, you know, thank you for all the details in the prepared comments. I think it was very helpful. When you think about the efforts in specialty foam and you walk through some of those changes that you're making, can you give us a sense of where you are within that process and how we should be thinking about the benefits of that starting to flow through to the results perhaps later this year? Or is it something that'll be more of a 2024 event?

Mitch Dolloff (President and CEO)

That's a great question, Susan, thanks for listening in on the comments. I know it was long, we wanted to try and provide some clarification there. Tyson, I'll let you comment on ECS. I know you've been working, you know, really diligently with the team there to assess where we are and put some recovery plans in place.

Tyson Hagale (SVP and President of the Bedding Products segment)

Sure thing. Good morning, Susan. I'll start with the commercial side of our plans. You know, as was noted in the prerecorded re-remarks, it's tough in a slow demand environment, especially where we've weighted our business historically. Our commercial team has done a really good job, even in the slow environment, building our commercial pipeline and looking at opportunities to diversify our customer base.

Despite, some near-term headwinds just with the overall market slowness, I feel good about our pipeline there, and especially because we're able to Really return and our customers are interested in returning to looking at some of our Specialty Foam technologies. When chemicals got really short, our development team really had to pivot and spend more of their time and resources working on formulations just to make sure we could continue servicing our customers.

As those have improved, as our constraints have eased and our customers have returned to looking at differentiation and other new product introductions, we've been able to get back to that as well. I feel good about our pipeline, both from the quality of leads and opportunities that we have, and those are developing throughout the year. We'll start to see some of the benefits in the back half of the year, I think from some of the business that we're being awarded.

Still overall, with slow demand and the full benefit probably coming into next year, but also the fact that we're using our specialty foam technologies as part of those projects as well. On the commercial side of things, that's how I would feel about it. The operations which we've mentioned as well, working through challenges there. I feel good about the team that's being put together, both from, the team that came along with the acquisition and then also filling in some gaps along the way. We're in a good place with our operational leadership.

Some of the things that we've talked about, I think before as well, just being able to really get back to the integration of four companies now being brought under the LPP umbrella. You know, a heavy focus just on our overall data and process control, and I feel good about the steps we're taking there. I think we'll see those really take hold as we move through the year. We're also investing and rolling out an improved IT system that's already underway, but we're being not cautious, but realistic about the timeframe to install the IT system across all of our specialty foam business.

We also, during the pandemic, made investments in equipment, especially focused on automation and helping us control material efficiency. That equipment is starting to arrive, but like a lot of investments over the last couple of years, lead times are pretty long. Even as they start to show up, it'll take some time to get it integrated and up and running to full efficiency. I would say back half of this year and into next year, we'll start to see more of the benefits from our equipment investments. I know that was a lot, but just to give you a little bit of a frame of reference, both on the commercial and operational side, just how things are rolling out.

Susan Maklari (Senior Equity Research Analyst)

Yeah. No, that's very helpful. Thank you. I guess, you know, following up on that, as we do think about the outlook that you gave us for 2023, especially as it does relate to some of the different parts of the bedding business, how are you thinking about the cadence of the margins in that segment for this year? When you think about normal seasonality on top of some of these company specific dynamics that are coming through, any thoughts on how we should be thinking about where that margin eventually gets to and the path of getting from where we are today to that endpoint?

Mitch Dolloff (President and CEO)

Susan, Cassie, do you have any detail there that you'd like to share?

I think for us, the biggest, one of the biggest impact is, you know, what happens from a scrap-to-rod spread. You know, it's really difficult to precisely predict that. You know, we have anticipated some contraction over the course of the year. You know, that's probably that and volume would be the biggest impacts.

Susan Maklari (Senior Equity Research Analyst)

Okay.

Tyson Hagale (SVP and President of the Bedding Products segment)

I'll just end this with one more comment.

Susan Maklari (Senior Equity Research Analyst)

Yes.

Tyson Hagale (SVP and President of the Bedding Products segment)

Yes, we do see the market returning to more normal seasonal patterns.

Mitch Dolloff (President and CEO)

Yeah.

Tyson Hagale (SVP and President of the Bedding Products segment)

Also, you know, we talked about this before as well, but over the course of the last year, as demand was soft, but we were also really intentional about bringing down our inventory. Our production was below even the demand level so that we could control that, which is tough to do in a slow demand environment. Our team really did a good job in pushing that through, even towards the end of the year. I think even as we get back to this year and more seasonal patterns, we should be back to a place where we're producing and have better overhead recovery, because that was a real challenge for us over the last year.

Mitch Dolloff (President and CEO)

Yeah, particularly at the end of the year. I think that's a great point, Tyson. If we looked at the first half of the year, call it, or even a little longer, we had really strong trade rod volume, right? Now we're anticipating that to be, you know, a little bit lower than last year, but pretty similar, but much more consistent, right? As opposed to the big high levels we had the first part of the year and low in the last half of the year. Similarly, as you said, with just overall production being more similar. I think it would just be a bit more normalized hopefully than what we saw last year.

Susan Maklari (Senior Equity Research Analyst)

Okay. That's very helpful.

Susan R. McCoy (SVP of Investor Relations)

Yeah. Susan, a little bit specific on your margin question. We talked about lower first quarter expectations for the company overall. That holds true with bedding, with a return to more seasonal patterns as we move through the year. That also holds true to bedding with, again, their historically highest seasonal quarter has been third quarter. A step up in margins as we move through the year is from a margin percentage perspective, what we're showing.

Susan Maklari (Senior Equity Research Analyst)

Okay. Okay, that's very helpful. I'll get back in the queue. Thank you.

Operator (participant)

Thank you. Our next question has come from the line of Keith Hughes with Truist Securities. Please proceed with your questions.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Thank you. I guess what you had indicated the slow start to the year in the Q1. Are you still planning to see rod production curtailments into the Q1? Is that playing a role?

Mitch Dolloff (President and CEO)

Morning, Keith. Good question. Tyson, I'll just let you handle that one.

Tyson Hagale (SVP and President of the Bedding Products segment)

Sure. Good morning, Keith. Yes, you know, really, Keith, that's something that at this point we're planning really throughout the year. As we got into the back half of 2022 and we saw trade demand slow, we had to take more aggressive action in the back half of the year. It was really heavily weighted towards the third and fourth quarter in pulling our production down, especially in the Q4. Overall, through the course of this year, we expect things to be relatively consistent from a total production standpoint, but more evenly balanced throughout the year.

Mitch Dolloff (President and CEO)

Tyson, if we looked at it from sequentially from the fourth quarter of 2022 to the first quarter of 2023, we would see increased production.

Tyson Hagale (SVP and President of the Bedding Products segment)

That's right.

Mitch Dolloff (President and CEO)

If we looked at it year-over-year, we'd see significantly lower production because it was so strong in Q1 of 2022. Is that the right way to think about it?

Keith Hughes (Managing Director and Senior Equity Research Analyst)

I think that's the right way to think about it. Okay. I mean, if that's the case, I'm a little confused with the, you know, why the EPS is gonna be so much lower. I know there's seasonal change. It always seasonally, your EPS comes down from fourth to first, given the seasonality in the business. It seems like some higher production would be offsetting that. Are you assuming the metal margin steps down a lot in the first quarter?

Tyson Hagale (SVP and President of the Bedding Products segment)

Versus last year, we're starting to, we are expecting and experiencing some modest decline in overall metal margin, especially compared to the first part of last year when the conflict in Ukraine and just overall market capacity constraints really drove things up higher in the first part of the year. It's overall relatively modest, but still less than the first half of last year when we look at our production and metal margin.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Okay. Are you assuming for the guidance for 2023, are you assuming those metal margins deteriorate all through the year? kind of where do they end up at the end of the year?

Tyson Hagale (SVP and President of the Bedding Products segment)

Sure. Through the course of the year, we have some modest compression. It's really hard to predict. It's been especially difficult over the last couple of years.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Right.

Tyson Hagale (SVP and President of the Bedding Products segment)

For the full year, yes, it down modestly as we move through the year. If we looked at the year in total, 2023 versus 2022, on a percentage basis, we would expect right now metal margin to be down in the mid-teens.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Down mid-teens, okay. Would the-- is there more of an emphasis in the second half of the year on that?

Tyson Hagale (SVP and President of the Bedding Products segment)

Slightly more, but still relatively consistent as we get through the back half of the year.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Okay.

Mitch Dolloff (President and CEO)

Digging a little deeper here, maybe I should. In the, you know, first, I guess, probably three quarters, we saw metal margins continuing to expand, and then in the Q4 contracted a little bit with like.

Tyson Hagale (SVP and President of the Bedding Products segment)

10% in the fourth quarter.

Mitch Dolloff (President and CEO)

Exactly.

Tyson Hagale (SVP and President of the Bedding Products segment)

Right.

Mitch Dolloff (President and CEO)

nothing's tanking. It's just, you know, moderating a bit.

Tyson Hagale (SVP and President of the Bedding Products segment)

That's right. Fourth quarter was a little difficult as an indicator just because I think the overall steel market was soft. People got to the end of the year, and there was quite a bit of uncertainty, people were bringing inventory or consumers bringing inventories down, might be a little tough to predict, especially started off 2023, scrap's been a little higher in demand, prices have been going up, conversion costs remain high. It's still pretty dynamic in trying to predict, but that's I think that's right, Mitch.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

One final question. Sorry to hog the call here. In particular, the low end of the range is a pretty substantial reduction in EPS from what we saw in 2022. If you had to kind of list one, two, three, the biggest drivers for that, what would those be for the reduction?

Tyson Hagale (SVP and President of the Bedding Products segment)

Susan, Cassie, you guys wanna take that?

Cassie Branscum (Senior Director of IR)

Keith, as always, volume is the driver.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Okay.

Cassie Branscum (Senior Director of IR)

We're trying to predict what's happening with metal margin, and frankly, nobody knows that.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Right.

Cassie Branscum (Senior Director of IR)

We have our assumption built into the forecast, but if it drops more than we're expecting, then that's also meaningful downside.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Number one would be volume, and then things like metal margin and maybe some deflation would be, you know, secondary drivers. Is that a fair statement?

Cassie Branscum (Senior Director of IR)

Yes, that's a fair statement. It definitely leads with volume. That's where probably the greatest amount of uncertainty exists in this environment. It could be up, it could be down. That's why we've got such a wide range.

Keith Hughes (Managing Director and Senior Equity Research Analyst)

Okay. All right. Thank you very much.

Cassie Branscum (Senior Director of IR)

Sure.

Mitch Dolloff (President and CEO)

Thank you, Keith.

Operator (participant)

Thank you. Our next question comes from the line of Bobby Griffin with Raymond James. Please proceed with your questions.

Bobby Griffin (Managing Director, Consumer Equity Research Analyst)

Good morning, everybody. Thanks for taking my questions. Appreciate the detail there on the metal margins. Always hard to predict, but helpful to know what the underlying assumption is in the guidance. I guess first, Mitch, I wanted to ask about Specialized Products and, you know, where you guys are in the journey of the cost recovery and kind of what's embedded for 2023. I was admittedly a little surprised to kind of see them step back down sequentially despite a little bit better volume sequentially.

Understand that there is a lot moving around inside that segment. Maybe just kind of given how each business is recovering at a different rate, can you talk about what the drivers would be kind of for those margins in 2023 and where you and the company are on the journey of trying to get back the very high margins that you guys used to be able to do in those businesses?

Mitch Dolloff (President and CEO)

Sure. Good morning, Bobby. Steve, I'll make a few comments, then invite you to join in as well. Yeah, it is a little bit dynamic for sure. You know, we continued to see strong volume gains in Specialized across all three of the businesses expect those to continue as we go into 2023. We definitely had some impacts in the fourth quarter, particularly in automotive. We had a little bit higher material costs, as you mentioned. We've been working on those. Also some labor inflation, particularly where we had increased overtime premiums in China when the COVID restrictions were lifted.

There was the large outbreak there that certainly impacted us, like it did the rest of the country pretty much. We saw a big surge in our employees, you know, had to not come to work. That led to additional overtime for some of those. That was a bit of a one-off there. I would say in automotive overall, I don't wanna go in too much detail here, but we continue to make good progress in the pricing recovery, like in the cost recovery. I'd say that we got about 60%-65% of it recovered in 2022, with the balance we expect to come in 2023.

We've talked about that. You know, it's a, you know, challenging thing to accomplish. The team has done a great job, and we're confident in our ability to close that. We have made really good progress there. From the outlook for production in automotive to the major markets forecast to be up about 3.6% year-over-year, which is good. Continued progress. It continues to be dynamic, right? There's supply chain labor shortages throughout the supply chain at the OEM level as well. Making progress. Continue to see really low inventories and vehicles, age rates, you know, at very high levels of around 12 years or so in the U.S.

I think that outlook is good. We see that kind of, you know, 3%-4% growth forecasted for the next, you know, three years or so, 2023 to 2025. I would just remind too the folks that, you know, if we look at the forecast for major market production in 2023 is about 70 million vehicles just below that, you know, with improving. Back in 2019, which is actually a down year, is still 75 million. We're still below where we were pre-pandemic, but I think what it does provide is a long-term tailwind for the recovery in the automotive market.

I think we've seen the really strong backlogs in hydraulic cylinders, and that's, you know, I think a strong benefit for our business there. We also see strong demand in aerospace, although, you know, it's hard to start anything up really fast, especially with the long lead times that we see there. I think that those tailwinds and the outlook for all three of those businesses is very positive for us. Steve, let me pause my rambling there and let you chime in as well.

Steve Henderson (EVP and President of the Specialized Products and Furniture, Flooring and Textile Products segments)

Yeah. Good morning, Bobby. I think, Mitch, you hit most of it. You know, in hydraulics, we have seen, you know, orders continue to increase as the OEMs recover their production challenges, and we expect, you know, that to continue through the year. As Mitch said, we're hopeful that that'll carry on into the second half of the year. We did have a few operational challenges that the team has done a really good job of dealing with. Looking for, you know, continued growth there. You know, in aerospace, air travel continues to recover. We don't see business travel recovering until 2025, so there's still some tailwinds there.

That kind of, as Mitch has alluded to, you know, the operation performance across the supply chain is kind of similar to automotive as they look to ramp back up. You know, we're seeing the same types of order changes and cancellations, short lead times, and other things that are making it really challenging to respond. The, you know, long-term fundamentals are definitely there for continued growth in aerospace.

Bobby Griffin (Managing Director, Consumer Equity Research Analyst)

Thank you. I appreciate the detail. Mitch, maybe on CapEx, just, you know, thinking out a little further, is there a catch-up period that's gonna have to come on capital spending? I guess I'm just asking, you know, in the context that I think pre-COVID, this was a $140 million-$150 million a year CapEx business, at least in 2019. We're now coming up on two years of just $100 million, and it's running well below D&A. As the business has changed where the capital requirements are just not as much, or is there gonna be kind of a cap catch-up period here if the economy improves, that we have to kind of spend a little bit more to, you know, on the capital side?

Mitch Dolloff (President and CEO)

Yeah, that's a great question, Bobby. Thanks for asking that. You know, I don't see that there's a big catch-up. We haven't been constraining any kind of critical investment. In fact, you know, we've had some things like, for example, IT, that we've had to increase our investment, and we think that those are critical to do, and we continue to do so. I think, you know, historically, the biggest use of CapEx comes in Bedding, U.S. Spring historically as well. I think we've done a good job of managing that a little bit differently.

Not that we don't invest in capacity or in innovation. We'll continue to do so, but we think we can do that a little bit more efficiently. The second one would be in automotive.

I think part of the impact there has been, with all the volatility, there's been just less new programs starting, some of that has been pushed out as well. It's not like it's gonna get pushed out. It's just gonna change the whole timeframe. You don't get double the investment in one year. It's just gonna change the timeframe a little bit. You know, I think we probably will, you know, hopefully, as we get back to a stronger growth environment, increase our CapEx some, but I don't see any big catch up or big surge that will negatively impact us.

Bobby Griffin (Managing Director, Consumer Equity Research Analyst)

Thank you. I appreciate the details, and best of luck.

Mitch Dolloff (President and CEO)

Thanks, Bobby.

Operator (participant)

Thank you. As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from the line of Peter Keith with Piper Sandler. Please proceed with your question.

Matt Egger (Equity Analyst)

Good morning. This is Matt Egger on for Peter. Thanks for taking our questions. First off for me, we're just curious what happens to gross profit dollars if we see commodity-led price decreases? Maybe you can compare it to what you would expect to see now versus what historically happened with the LIFO accounting change. That's my first one.

Mitch Dolloff (President and CEO)

Okay, thanks. Good question. I'll take the easy part of it and then turn it over to Susan McCoy or Cassie Branscum for the LIFO piece. I think in general, you know, we've talked about, as inflation has occurred throughout the last two years, that we've been successful in passing it on, but largely passing on the $ amounts, right? For the most part, that's had a drag on our margin. I think as we see deflation and we pass that along to our customers, we see that same $ change, but we shouldn't see a big impact in our margin profile. You know, there's some pluses and minuses. Some of that is timing around what kind of inventory we have, and for the most part, we're in very good shape there.

Don't have a lot of high cost inventory. Sometimes timing around how it moves through our supply chain or how contractual agreements work. Overall, I think it, you know, should stand up to reflect what we've been commenting on as we've passed on the inflation, that we've done that largely on a dollar basis, and we expect to see the same thing as we see a little bit of deflation as well. Susan, Cassie, anything you would add to that?

Susan R. McCoy (SVP of Investor Relations)

Yeah. LIFO, our favorite topic. It's actually directionally very predictable in an inflationary environment. LIFO will, without fail, generate expense. In a deflationary environment, as predictably, it would generate a benefit. You know, that's just high level what to expect. Thankfully, we don't have to deal with that anymore.

Matt Egger (Equity Analyst)

Great. Thanks. Then secondly, can you walk us through the Furniture segment and maybe explain why the year-over-year volumes in Furniture are starting to kinda drop off?

Mitch Dolloff (President and CEO)

Yeah, sure. Steve, I'll ask you to jump in there. You know, it's really a couple of dynamics. I mean, after a big surge in home furniture that we saw over, you know, last year and into the beginning of this year, we really saw that soften across the industry. That shouldn't really be new news. If we look at work furniture, that is probably the change, where after being so soft, we saw a strong recovery in the first three quarters of 2022, really started to see the contract business, which had been recovering, slow down in the fourth quarter. That's probably the biggest change there. Steve, I'll let you chime in as well.

Steve Henderson (EVP and President of the Specialized Products and Furniture, Flooring and Textile Products segments)

Thanks. Good morning. From a home furniture perspective, the answer is, you know, much, much lower retail demand. We had seen the low end drop, we saw the mid and high price points drop even further than what we expected. That's led to some fairly significant inventory levels, which we couldn't see earlier in 2022, and we expect those to be worked off here, hopefully in the first half of 2023, and start to return to a more, you know, normalized demand level. From a work furniture perspective, as Mitch said, you know, our customers are reporting, you know, volume declines in incoming contract orders.

That's really driven by the surge of, you know, back to office that they saw, and that's worked its way through. Now they're seeing a little bit more, lower level of return to office trends, particularly in Americas, which is lowering that demand. Then you can add on top of that, the, you know, the retail residential slowdown that we spoke to from a home furniture perspective. Those are the two, you know, big issues that are impacting work furniture at this point in time.

Mitch Dolloff (President and CEO)

Yeah. Steve, if I remember right, the BIFMA forecast, which would be for North America, was down about 8% or so for this year.

Steve Henderson (EVP and President of the Specialized Products and Furniture, Flooring and Textile Products segments)

Okay. Eight or... Yeah, eight or nine.

Mitch Dolloff (President and CEO)

Yeah. Yeah. In line with industry dynamics there, unfortunately. As we've mentioned before, the fabric converting side of our textiles business also moves along largely with bedding and home furniture, so we see that down. What does not is the geotextiles component side of that, and we see that driven by construction industry to be continue to be strong as we go into 2023.

Tyson Hagale (SVP and President of the Bedding Products segment)

Great. Thank you all.

Mitch Dolloff (President and CEO)

Thank you.

Operator (participant)

Thank you. Our next question has come from the line of Susan Maklari with Goldman Sachs. Please proceed with your questions.

Susan Maklari (Senior Equity Research Analyst)

Thank you. My first question is on input costs, we've touched a bit on this across the questions. Can you give us a sense of what you're actually seeing in the various inputs, maybe outside, especially of the metal margins, and how you're thinking about the puts and takes there for 2023?

Mitch Dolloff (President and CEO)

Yeah, I'll make a general comment and then, Tyson, Steve, ask you to join in. You know, Susan, I think that we see inflation moderating. Maybe in some things we see a little bit of deflation kicking in, but we don't see any really significant declines across the board, in fact, really anywhere that I can think of. I think it remains, you know, I think for the large part, commodity costs are remain at elevated levels, are generally, you know, neutralizing or starting to come down a little bit, but we just don't see huge declines. Tyson, anything different you'd see in chemicals or anything else?

Tyson Hagale (SVP and President of the Bedding Products segment)

You know, mostly the same as what you just said, Mitch. You know, we've talked quite a little bit about metal margins, but, you know, part of the reason why that's been difficult to predict is because of our conversion costs. You know, not just the scrap input cost, but the cost of everything else that goes to converting that into rod. You know, energy costs, the consumables, you know, and refractories and electrodes, everything else, those have increased significantly as well. When all of those input items that even go into our overall costs are increasing as well, it becomes difficult to predict. Overall, I agree with what you said, Mitch. There's, you know, some general moderation in some of those costs.

On chemicals, we've seen some of that as well, some moderation, but not, you know, dropping off a cliff because of a lot of the same issues. Energy costs being high. There's still global constraints around certain types of chemicals and just overall capacity in the market to produce, you know, still makes it difficult to see exactly where those will land. It's been relatively stable.

Mitch Dolloff (President and CEO)

Yeah. Okay, thanks. Steve, I think that holds up pretty much across Specialized Products that we don't see a lot of change there. Maybe, you know, as in flooring and Textiles can be a little bit more dynamic. Anything that you would add?

Steve Henderson (EVP and President of the Specialized Products and Furniture, Flooring and Textile Products segments)

No, I would just say most of the inputs are stabilizing, but, you know, we have seen, you know, relatively few signs of deflation outside of, you know, certain types of steel. Like Tyson said, resins, chemicals or other things, you know, remain at an elevated level. There's a lot of talk of them coming down, but we haven't, we haven't seen that turn into reality at this point.

Susan Maklari (Senior Equity Research Analyst)

Okay. I have one more which is on the cash flow side of things. Can you talk about the ability to generate cash this year even when we think about the EPS guide that you have put out there? Maybe just, you know, any commentary on some of the uses of that cash. You did several small acquisitions in 2022. How is that pipeline coming together? Perhaps how are you thinking about the opportunities there or other uses of the money?

Mitch Dolloff (President and CEO)

Yeah, sure. That's a great question, Susan. Jeff, I'll chime in first and then ask you to come in on the uses. You know, Susan, I feel really confident about our cash flow generation. You saw it this year. I think even though we've seen, you know, a lot of our businesses volume levels low, I think we feel a little bit more stability as we talked about with inflation and things like that. The teams have done an incredible job managing our working capital, in particular, as we've, you know, even as the pandemic hit and the first part of the crisis hit, just improving our receivables management. We continue to maintain that in a really good spot.

We talked about how we worked through the second half of the year, in particular the fourth quarter, to bring down inventory levels to align with the slower demand. You know, taking, you know, a lot of time out of the rod mill was painful from a margin standpoint, but it certainly got us to the right place from a cash flow and from an inventory standpoint. We're starting in a really good position there. In, I think, hopefully a little bit less volatile arena, it'll be a little bit easier to manage that working capital. I expect inventory especially, I expect to see less volatility there. Then the other thing you probably noticed is that our payables were down significantly as we ended the year. Not surprising, right?

As we're taking down inventory, we're buying less. I think from a working capital standpoint, we're in a very good position to manage that. You know, while we wish we had more volume, they'll continue to drive cash through the company. You know, Jeff mentioned our CapEx, we expect it to be pretty consistent with where we were in 2022. I don't think we have any big plans for acquisitions at this time or share repurchases. Continue to focus on funding the dividend. Jeff, let me turn it over to you. Anything that I missed?

Jeff Tate (EVP and CFO)

Thanks, Mitch, good morning, Susan. Just a couple other comments I would make. You know, Susan, as you look at the company's history of operating cash flow and the ability to have that operating cash flow exceed our CapEx spend as well as our dividend support, you know, we have been able to exceed that 33 out of the past 34 years. With the one year that we did not was when we needed to replenish the inventory, which we talked about earlier in 2021. We've got a strong, you know, trend of being able to demonstrate that ability to do so. Mitch mentioned earlier, on the CapEx side, we feel reasonably comfortable there with the $100 million that we're guiding towards. In terms of our acquisitions, you know, we spent $83 million in 2022 on acquisitions.

You can expect that number to be lower in 2023. We spent $60 million in 2022 on share repurchases, and you can definitely expect that number to be lower in 2023 as well. As we discussed in the prepared remarks, you know, definitely minimal participation and activity around share repurchases as well as M&A activity for the upcoming year.

Susan Maklari (Senior Equity Research Analyst)

Okay. Thank you very much, and good luck.

Jeff Tate (EVP and CFO)

Thank you.

Mitch Dolloff (President and CEO)

Thank you, Susan.

Operator (participant)

Thank you. There are no further questions at this time. I would now like to turn the floor back over to Susan McCoy for any closing comments.

Susan R. McCoy (SVP of Investor Relations)

Thank you for joining us today. We'll speak to you again on May 2 after we report first quarter results. If you have questions, please contact us using the information in yesterday's press release. Thank you.

Operator (participant)

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.