Letter to Our Shareholders
For a decade, we have been successfully executing a strategy that has enabled the company to generate strong Total Shareholder Return, or TSR¹, while significantly improving operational performance. We remain committed to our primary financial goal of achieving TSR that ranks in the top third of the S&P 500 over rolling 3-year periods. We fell short of our goal in the most recent 3-year period, with performance just below the midpoint of the S&P 500. Though disappointing, we continue to believe our disciplined growth strategy and use of capital will support achievement of our top-third goal.
Sales grew by 5% in 2017, in large part from increasing content and market share gains. Profit margins were pressured by commodity inflation, leading to lower adjusted² earnings for the year. We increased the dividend for the 46th consecutive year, repurchased 3 million shares of our stock, and maintained our strong financial position, all of which align with our longstanding financial strategy.
As stated above, our primary financial goal, adopted in 2007, is to achieve TSR that ranks in the top third of the S&P 500 over rolling 3-year periods. We have achieved this goal in four of the eight 3-year periods since 2007 and have been very close in two other periods. Cumulatively, over the last 10 years we generated TSR of 15% per year, which ranked in the top 18% of the S&P 500. For the 3-year period that ended on December 31, 2017, we generated TSR of 7% per year on average, which placed us just below the midpoint of the S&P 500.
The table below shows the components of the TSR framework, including our targets and our actual performance for the most recent 3-year periods. We believe that attaining this targeted level of performance should enable us to consistently achieve our top-third TSR goal.
Strategy and Growth
For quite some time we have envisioned profitable revenue growth as the main driver of our TSR. During 2016 we increased our target for growth to 6-9% annually, on average. We expect growth to continue coming primarily from organic sources – opportunities we have developed within our Grow businesses (such as Automotive, Bedding, Adjustable Bed, Work Furniture, Geo Components, and Aerospace) along with market growth – and to be augmented by carefully screened, strategic acquisitions that meet our established criteria.
Recent Growth Sources should continue for at least the next few years. The combination of content gains, market growth, and small bolt-on acquisitions should enable us to achieve our growth target for the foreseeable future. To ensure continuing success, we have implemented a Growth Identification Process to generate additional growth opportunities in our current markets.
By better understanding our competitive strengths, customer needs, and market trends, we have widened our lens to seek further growth in current markets. In addition, we are utilizing our Styles of Competition to identify longer-term opportunities in new, faster-growing markets where we do not currently participate, but where we would have a sustainable competitive advantage. You can read more about each of these growth avenues in the front section of this annual report.
Margin improvement has been a large contributor to our historical TSR performance. Improvements over the past several years came primarily from utilizing available productive capacity to accommodate post-recession sales growth and from divestitures of low-margin businesses. With capacity utilization across our businesses at much higher levels and divestitures essentially complete, fewer opportunities remain for significant margin improvements. While our focus on portfolio optimization, continuous improvement, and operating efficiency will not change, we expect future margin increases to generate less TSR benefit.
Our priorities for use of cash have not changed. They are: 1) fund organic growth, 2) pay dividends, 3) fund strategic acquisitions, and 4) repurchase stock with available cash, if any remains. Our focus on balance sheet strength and commitment to dividend growth also has not changed. We recognize the importance of each of these factors to our long-term success, and we are committed to preserving these critical elements of Leggett’s financial strategy.
Precision Hydraulic Cylinders Acquisition
On January 31, 2018, we acquired Precision Hydraulic Cylinders (PHC), a leading global manufacturer of engineered hydraulic cylinders primarily for the materials handling market. The purchase price was $85 million. This business has current annual revenues of $81 million and represents an attractive new growth platform for us. The hydraulic cylinders market is one of a handful of new markets identified during the Styles of Competition analysis and growth process we began in 2016. PHC serves a market of mainly large OEM customers utilizing highly engineered, co-designed components with long product lifecycles, that represent a small part of the end product’s cost. This business aligns extremely well with the Critical Components style shared by many of our strongest performing operations.
Sales grew 5% in 2017, to $3.94 billion, and same location sales increased 6%. Volume grew 4% and raw material-related price increases and currency impact added 2%. Acquisitions also contributed 2% to sales growth but were more than offset by divestitures. Growth came primarily from new programs and added content in Automotive and market share gains in Adjustable Bed. Several other businesses, including European Spring, Geo Components, Work Furniture, and Aerospace also contributed to overall sales growth this past year. Weak demand in our U.S. Spring business was largely offset by increased content as we continue to place higher-value components in more of the mattresses that our customers produce.
Earnings per share from continuing operations were $2.14, including a net $.32 per share reduction from the Tax Cuts and Jobs Act and several smaller items. Adjusted² EPS from continuing operations was $2.46, a decrease of 1% versus $2.49 earned in 2016. The benefit from higher sales, a lower effective tax rate, and lower share count, was more than offset by higher steel costs, the lag associated with passing along ongoing steel inflation, and several smaller factors. EBIT margin (both reported and adjusted²) decreased to 11.9%, down versus 2016’s reported 13.9% and adjusted² 13.1%.
Impact from Tax Cuts and Jobs Act (TCJA)
2017 earnings included a net $50 million, or $.37 per share, charge for the estimated impact of the recently enacted TCJA. This is comprised of a $67 million tax charge related to the deemed repatriation of accumulated foreign earnings, a $9 million charge for accrual of foreign withholding taxes on expected future cash repatriations, and a $26 million tax benefit from the revaluation of net future tax liabilities at the new, lower U.S. federal tax rate. As provided in TCJA, the deemed repatriation tax will be paid over eight years.
We expect our 2018 effective tax rate to approximate 22%. This rate reflects the lower U.S. federal tax rate, our expected mix of domestic and foreign earnings, and the impact of state income taxes.
During 2018, we expect to repatriate approximately $300 million of cash currently held in foreign accounts. The timing and exact amounts of these cash repatriations are difficult to predict, and are, among other things, subject to local governmental requirements. In keeping with our longstanding priorities, repatriated cash will be used for: 1) organic growth involving capital expenditures and working capital investments, 2) dividends, 3) strategic acquisitions, and 4) share repurchases. In the short term, we may use a portion of that cash to repay $150 million of debt that matures in July 2018. We do not plan to pay a special dividend or undertake significant incremental share repurchases with this cash.
Dividends and Share Repurchases
We posted our 46th consecutive annual dividend increase in 2017, a record that only ten S&P 500 companies currently exceed. In May, we increased the quarterly dividend by $.02, or 6%, to $.36 per share. Dividends generated a 2.9% yield for investors during 2017, one of the highest yields among the companies that comprise the S&P 500 Dividend Aristocrats. Our target range for dividend payout is 50-60% of adjusted continuing operations EPS. Actual payout was 58% in 2017.
During the year, we repurchased 3.3 million shares of our stock and issued 1.7 million shares, largely for employee benefit plans. Shares outstanding decreased by 1.2%.
Sources and Uses of Cash
We generated $444 million of cash from operations during 2017. Each year, for over 25 years, our operations have produced significantly more cash than needed to fund capital expenditures and dividends. Major uses of cash in 2017 were consistent with our strategic priorities: they included $159 million for capital expenditures, $186 million for dividend payments, $39 million for acquisitions, and $155 million (net) to repurchase our stock.
In November, we issued $500 million of 10-year, 3.5% notes, and used the proceeds primarily to repay outstanding commercial paper. We also increased the borrowing capacity under our commercial paper program from $750 million to $800 million and ended the year with the full amount available. Net debt to net capital² was 33% at year end, the lowest level in three years and comfortably within our longstanding target range of 30-40%.
2020 Operating Targets
In 2016, we disclosed to investors for the first time a set of 3-year operating targets that were expected to result in achievement of our top-third TSR goal through 2019. With the earnings decline that we experienced in 2017, we are extending by a year and slightly modifying those longer-term targets. The 2020 operating targets are: 1) sales of $5 billion, 2) EBIT margin of 13%, and 3) EPS of $3.50. This EPS target reflects an anticipated 22% tax rate, incorporating the expected impact of the recent U.S. tax law change. These targets assume a stable macro environment that yields moderate demand growth. They also assume that content gains continue and that organic growth will be augmented by strategic acquisitions. The targets envision no significant inflation, deflation, currency fluctuation, or divestitures.
As always, we want to take this opportunity to thank our employees, customers, and investors for their efforts, support, and commitment in 2017.
The hard work and dedication of our 22,000 employees around the world are the keys to our long-term success. We will continue working diligently to exceed our customers’ expectations and merit our investors’ confidence in Leggett & Platt.
President and CEO
February 22, 2018
² Please refer to Non-GAAP Reconciliations page.
³ For the 3-year performance periods illustrated in the table, we generated 7%, 7%, and 5% growth from unit volume + acquisitions, offset 2%, 4%, and 3% by divestitures, commodity deflation, and currency.