Lydall, Inc.
Q2 2020 Earnings Call Transcript

Published: 2 Aug 2020

[Operator:]

Good day, and welcome to the Lydall Second Quarter 2020 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After towards presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Brendan Moynihan, Vice President Investor Relations. Please go ahead.

[Brendan Moynihan:]

Thank you, Elisa. Good morning, everyone, and welcome to Lydall's second quarter 2020 earnings conference call. Joining me on today's call are Sara Greenstein, President and Chief Executive Officer; and Randy Gonzales, Executive Vice President and Chief Financial Officer. Sara will begin the call with a high-level overview of the quarter, how we weathered the impacts of the COVID-19 pandemic, and how Lydall has further solidified its position as a world leader in Specialty Filtration. Randy will follow with a review of our financial performance and discuss the key business drivers by segment. Sara will then conclude the call with a brief discussion on the current outlook for the remainder of 2020 and how we are well positioned for long-term growth. At the end of their remarks, we'll open the line for questions. Our quarterly earnings release was issued along with the filing of our quarterly Form 10-Q. Both are available on our Investor Relations website, ir.lydall.com and can be used as referenced for today's call along with the Q2, 2020 earnings conference call presentation, which can be found at lydall.com in the Investor Relations section. As noted on Slide 2 of this presentation, any comments made on this conference call that may constitute forward-looking statements are made available pursuant to the Safe Harbor provision as defined in the securities laws. Please also refer to the cautionary note concerning forward-looking statements within Lydall's Form 10-Q for further information. In addition, we will be referring to non-GAAP financial measures during this conference call. A reconciliation to GAAP financials can be found in the appendix of the presentation I just referenced. With that, I'll turn the call over to Sara.

[Sara Greenstein:]

Thank you, Brendan. Good morning, everyone, and thanks for joining us. Our second quarter performance reflects the earnings potential of this business. We aggressively managed our cost structure to address historic declines in the automotive industry, while simultaneously redeploying resources to meet surging demand for critical filtration applications and strengthened our liquidity position. As a global leader in specialty filtration, we responded to the call, producing some of the most highly sought-after products in the world for the fight against COVID-19. Lydall has proven it has the capability and agility required to pivot quickly to meet the market's demand. Turning to Slide 3. While the immediate demand is for life-saving personal protective equipment or PPE, significant demand is also emerging for high-efficiency filtration products for the assurance of healthy buildings and indoor spaces. Indoor air quality is the ongoing defense against coronavirus. The U.S. Center for Disease Control recently released guidance to commercial building owners recommending upgrading the pre-filter stage of HVAC equipment to filters rated MERV 13 or higher, which capture the submicron-size airborne viruses. The State of New York recently announced the government buildings and large public malls across New York should not reopen until these filters are installed. With decades of experience in developing and manufacturing high-performance filtration media, Lydall is well positioned to address this need through its existing product portfolio. The next evolution in the production of high-efficiency filtration media requires unique fine fiber assets to provide exceptional performance at the submicron level. With the combination of the long-term structural shift in demand for these higher performance products, and the localization of supply chains for critical materials, which are essential for national security and public health. Lydall recently announced strategic investments in two new fine fiber meltblown production lines that will be located at our Rochester, New Hampshire facility. These assets provide Lydall, the ability to produce superior fine-fiber meltblown media to improve indoor air quality while allowing end-user customers to minimize capital investment to their HVAC systems, all while reducing energy consumption. Last Friday, we celebrated these investments at a groundbreaking ceremony with our employees, our partners and local, state and federal officials. The first of these two lines will be operational by the end of this year and the other in full production before the end of the second quarter of 2021. Also, in June, we secured a $13.5 million commitment from the U.S. Department of Defense, which helps underwrite these critical investments. With the completion of these lines, our Rochester facility will be the largest site for fine-fiber meltblown production in the United States, supporting the domestic manufacturing of approximately 1.7 billion N95, respirators or 6.5 billion surgical masks each year. The Rochester facility will also be the home to our Center of Excellence for innovative, high-performance filtration solutions addressing indoor air quality for buildings, including hospitals, nursing homes, schools, offices, restaurants, malls and our homes. These investments reaffirm that specialty filtration is and will remain a cornerstone of Lydall's growth, expansion and strategy moving forward. Specialty filtration solutions go well beyond PPE, by providing us a tremendous opportunity, to enhance our ability, to protect places and spaces, by improving indoor air quality. Moving to Slide 4, you can see that we saw a 20% increase in filtration sales in the second quarter compared to the prior year, a trend we expect to continue throughout 2020 and to improve beyond as each of the two additional fine-fiber meltblown assets come online. Specialty filtration is an important and growing market, and with our global footprint, and rigorous approach to innovation, Lydall has a strong competitive advantage. In our Technical Nonwovens segment, we quickly adapted to address challenges created by the pandemic. In the second quarter, in partnership with the New York City Economic Development Corporation, we rapidly engineered, tested and qualified nonwoven material used in medical gowns. We delivered a large order of this new product to the New York City Department of Health to support first responders and medical personnel in New York. Our team has also developed new applications for needle-punch felt to be used in face masks and other PPE. Additionally, in TNW, despite the external headwinds resulting from the pandemic, we aggressively managed cost and maintained a flat EBITDA margin despite 25% lower sales. COVID-19 had a material impact on our Thermal Acoustical Solutions business. With our automotive OEM customers ceasing production in mid-March, TAS saw a historic decline in volumes across North America and Europe. The team responded quickly and decisively, immediately reducing production at those facilities. In late May, with OEMs coming back online, our factories managed production commensurate with our customers' demands. Our team has worked tirelessly to uncover every opportunity, investing in new equipment, securing long-term contracts with seven of the largest facemask manufacturers in North America, contributing to the production of medical gowns and even sowing facemasks at our facilities that were affected by the OEM shutdowns. I believe that our response to this situation has been world-class, and I am incredibly proud of our employees around the world who came together to deliver extraordinary results in this unprecedented an ever-changing environment. Most importantly, we continue to operate safely as the pandemic ensues. Our employees have shown incredible resilience and commitment during these challenging times, and I want to thank all of them for their contributions. With that, I will now turn the call over to Randy to cover second quarter results.

[Randall Gonzales:]

Thank you, Sara. Turning to Slide 5, I'll briefly cover some key highlights for the second quarter and then provide an overview of our operating segment results. As a reminder, we will be discussing adjusted financial metrics, including adjusted EBITDA by segment. A complete reconciliation to comparable GAAP numbers is provided in the press release and earnings presentation. Second quarter 2020 net sales of $146.2 million decreased 33.8% or $74.7 million from the same period in 2019. Organically, sales decreased 31.7% or $70 million, impacted by COVID-19 pandemic related shutdowns, which, as Sara mentioned, primarily impacted our Thermal Acoustical Solutions business and, to a lesser extent, our Technical Nonwovens and Performance Materials sealing businesses. The strong dollar was a headwind on foreign sales, reducing consolidated revenue by $2 million or 0.9 percentage points and tooling sales were down $2.6 million or 1.2 percentage points. Within the quarter, we saw very strong results in our Performance Materials filtration segment where sales grew by 20% from prior year, driven by exceptional demand for specialty filtration products, including media for N95 respirators and surgical masks to support the fight against COVID-19. Despite significant headwinds on sales, adjusted EBITDA for the second quarter was $11.4 million or 7.8% of sales. EBITDA margins expanded substantially in Performance Materials and Technical Nonwovens, even on lower sales, but were offset by margin compression in Thermal Acoustical Solutions. We were able to rapidly flex our cost structure and reduce overhead expenses by almost $15 million compared to prior year, while simultaneously leveraging resources to support surging demand for filtration products. This mitigated the impact to EBITDA, which was down $13.9 million on a sales decline of $74.6 million or a drop-through of 18.6%. Interest expense of $4.5 million was up from prior year and prior quarter, driven by changes to our credit agreement discussed in the last quarterly call as a result of a higher interest rate and onetime fees. For the full year, we expect interest expense to be about $16 million. The second quarter effective tax rate of 9.2% was impacted by foreign income taxes and valuation allowances. For the quarter, adjusted loss per share was $0.27 compared to adjusted earnings per share of $0.41 in the second quarter 2019. Before we discuss segment results, I'd like to highlight our continued focus on liquidity. Turning to Slide 6. Cash flow from operations was $13.7 million in the second quarter and $40.4 million year-to-date, up from $36.2 million last year. Aggressive management of working capital has contributed over $11 million in cash flows this year. We also took advantage of payroll tax deferrals under the CARES Act. On a trailing 12-month basis, through the second quarter of 2020, free cash flow expanded to $60 million from $38 million in the same period last year. This was accomplished through disciplined management of working capital and CapEx reductions, enabling us to grow our cash balance to $92.5 million at the end of the second quarter. Combined with available credit of $24 million, our total liquidity is $116 million, which provides us sufficient flexibility to navigate the current economic environment. In the near term, we plan to hold elevated cash levels for ongoing operations and to fund key investments such as the Performance Material meltblown expansion projects, Sara mentioned at the beginning of this call. Capital spending in the second quarter was $6.3 million and $15.5 million year-to-date, including approximately $4 million related to the meltblown capacity expansion. We expect full year 2020 capital spend to be in the range of $35 million to $40 million, including spending on new meltblown capacity, a portion of which will be offset by the previously announced U.S. government commitment. We continue to forecast debt repayment of $12 million in 2020. Moving to Slide 7. I'll discuss our segment results, starting with our TAS automotive solutions segment. Second quarter sales in this business were $37.4 million, with parts sales down $53.2 million or 62% compared to the prior year period, driven by automotive OEM factory shutdowns in both Europe and North America. These shutdowns resulted in a 90% reduction in global part sales in April. As major manufacturers resumed production in mid-to-late May, volumes ramped, and by the end of June, our North American and European factories had returned to approximately 80% of prior year production rates. Notably, after experiencing slowdowns in the first quarter, part sales in our China operations were up 3% net of FX compared to second quarter 2019. Tooling sales of $5 million were down $2.6 million compared to prior year, and foreign exchange reduced segment sales by $300,000. EBITDA in the TAS segment was significantly impacted by lost volume due to COVID-19. In total, EBITDA declined by $13.1 million on sales that dropped $55.8 million resulting in a margin drop-through of 23.5%. This performance was achieved by quickly addressing our cost structure, which included reducing direct labor, overhead and administrative expenses in reaction to the drastic reduction in sales. Moving to Slide 8. I will cover our Performance Materials segment which includes the specialty filtration and engineered sealing solutions subsegments. Sales of $58.5 million were down $6.6 million or 10.2% compared to second quarter of 2019. Filtration sales grew 19.8% or $4.9 million, led by sales of specialty filtration solutions, including media for N95 respirators and surgical masks. This was more than offset by a 28.6% decline in Sealing and Advanced Solutions, which was impacted by slower demand in agricultural, construction and automotive end markets. Second quarter adjusted segment EBITDA margin of 19.5% expanded by 470 basis points from last year on favorable mix of higher-margin filtration products, cost management actions, operational and material productivity and benefits from previously announced reduction in forced actions. Slide 9 covers our Technical Nonwovens segment. Sales in the second quarter of 2020 were $52 million, down 24.7% from prior year. Industrial Filtration sales were down $9.3 million or 24%, with softer industrial demand across all regions. Of note, while China sales were down compared to prior year, they did increase sequentially from first quarter. Advanced Materials sales declined $7.8 million, including $3.2 million of lower automotive-related intercompany sales to Thermal Acoustical Solutions. In terms of profitability, adjusted segment EBITDA margin of 18.8% was up 260 basis points from prior year, aided by insurance recovery of $1.3 million related to a flood loss recorded in the first quarter 2020. Adjusted for this onetime benefit, second quarter EBITDA margin is 16.3%, essentially flat from prior year, with lower volume being offset by cost reduction actions, including furloughs, material productivity and lower selling and administrative expenses. That concludes our review of the second quarter segment results. In summary, we demonstrated our ability to flex our cost structure while ramping up filtration production, all in the midst of broad economic uncertainty, positioning us well for the future as volumes recover. I'll now turn it back to Sara for her closing comments.

[Sara Greenstein:]

Thank you, Randy. So as we move into the second half of the year, our focus remains on meeting the needs of our customers, driving more value for our shareholders and the health and well-being of our employees. We will continue to prioritize markets where we provide unique technologies and applications and have a distinct competitive advantage. Turning to Slide 10. We continue to see strong demand for Performance Materials filtration products and anticipate meltblown filtration media for N95 respirators, surgical masks and air filtration systems will contribute incremental sales of $10 million to $12 million in the second half of the year. In addition, Lydall continues to be at the forefront of discussions with government agencies and leaders around the globe regarding investments to further increase our filtration media capacity, addressing the need for high-quality, localized supply chains for critical PPE applications. In Technical Nonwovens, we anticipate softer sales and Industrial Filtration to continue as the industrial outlook remains uncertain. In our Advanced Materials business, we are seeing strong construction activity, driving seasonally robust demand for geosynthetics and continued demand for medical-related nonwoven products, which will be partially offset by lower sales to automotive end markets. We anticipate the North American and European automotive markets will recover in similar fashion to what we experienced in China. While the timing and the magnitude of the recovery by region remains uncertain, we believe auto production will begin to stabilize in the third quarter, albeit at volumes in the second half of 2020 lower than the same period in 2019. This will most directly impact our Thermal Acoustical Solutions business, and to a lesser degree, the sealing business within Performance Materials. Slide 11 outlines our near-term focus areas, which will enable us to be a stronger, healthier and more innovative company over the long term. As one of the world's top producers of specialty filtration materials, we will continue to meet demand for supplies that are critical to frontline and first-responder personnel, while continuing to drive innovative solutions. At our Rochester, New Hampshire facility, we are establishing a center of excellence to develop new, high-performance and environmentally sustainable filtration media with a wide variety of applications. To ensure that Lydall remains at the forefront of the next wave of innovation, we have secured partnerships with some of the world's leading manufacturing and chemical engineering companies to jointly advance specialty filtration technologies. We expect strong demand for filtration media for N95 respirators and surgical masks will last through 2022. And even after the pandemic is behind us, we fully expect the emphasis on well-established domestic manufacturers of PPE to remain. In parallel, as economies around the world reopen, our fine fiber meltblown investments will allow us to expand our product portfolio to new, higher performance, clean air applications that address indoor air quality. When it comes to high-performance filtration solutions, what's inside matters, and Lydall is the leader at producing the media inside these critical applications. Over the past two quarters, we have demonstrated our ability to navigate unprecedented economic conditions and adapt quickly to market shifts. And I have full confidence that we will continue to do so as COVID-19 evolves and the products required to fight this pandemic change. As I shared during our previous earnings call, in many ways, COVID-19 has accelerated changes that were already underway at Lydall, sharpening our strategic focus on value-added specialty engineered materials and filtration products. Our decades of experience in these areas, along with a strong heritage of innovation, deeply ingrained customer and supplier relationships, and a world-class team positions Lydall to win. Although many unknowns related to COVID-19 remain, I am very confident in our ability to deliver long-term shareholder value through our focus on creating a cleaner, safer and quieter world, and I believe that Lydall's best days are ahead. With that, let's open the call for questions.

[Operator:]

Thank you [Operator Instructions] The first question today comes from Chris Moore of CJS. Please go ahead.

[Stefanos Crist:]

Good morning, this is Stefanos Crist calling in for Chris.

[Randall Gonzales:]

Good morning, Stefanos.

[Stefanos Crist:]

Good morning. First question, is it reasonable to assume that Q3 margins could be modestly better than Q2? And what are the most important puts and takes to consider when we think about margins going forward?

[Randall Gonzales:]

So, I think with the recovery of automotive that we expect in Q3 versus a very difficult Q2, Stefanos. I think on a consolidated basis, you can expect that. I think maintaining the extremely strong margins that we saw in both PM and TNW in Q2 into Q3, I don't know if we'll be able to maintain those kind of margins just because of the aggressive cost actions that we did take. As volumes recover across the board, we will have to add back some of the variable cost that we took out very quickly in Q2. So in short, on a consolidated basis, yes, you should see some improvement, but maybe not across the board by segment.

[Stefanos Crist:]

Got it, that makes sense. And then other than the COVID-related shutdowns, what are the biggest wildcards for the second half of 2020?

[Sara Greenstein:]

Yes, I would say, I mean as you well know, just the uncertainty that is ensuing as to what's going to happen across the globe as it relates to both COVID and then the local and/or regional decisions around the economy and shutdowns, I mean, it really depends upon the country that we are talking about. We're seeing China come back pretty stable and strong. I think in the U.S., as you might imagine, there is quite a bit of tumult continuing, and in Europe, it's just managing each day. What we've done, I think very well, and therefore, I fully expect us to continue to do is to be able to flex our production to our customers' needs and have a stable supply-chain, in place, in order to be able to do that. And so, regardless of the wildcards that might come, which I certainly am not smart enough to predict, where I have confidence is in our ability to respond to them.

[Stefanos Crist:]

That make sense, thank you very much. And I’ll jump back in queue.

[Operator:]

[Operator Instructions] The next question today comes from Shawn Kim of Gabelli Funds. Please go ahead.

[Shawn Kim:]

Hi, good morning, thanks for taking my question. Just curious how much of the variable costs taken out over the past few months to be permanent?

[Randall Gonzales:]

So certainly - so we referenced $15 million of cost of overhead costs that we took out in Q2, Shawn. A large portion of that, about $9 million of that is variable cost. So, I would say that some of the overhead piece of the fixed overhead and the SG&A that remains, of course, some of that is permanent. So we did take significant cost action in the Thermal Acoustical Solutions business that affected both fixed cost and SG&A. When, the facilities were shutdown, just to get our cost in line with volumes. So certainly, some of that is permanent. So out of the $15 million, I would estimate $3 million to $5 million of that is going to be a permanent cost reduction.

[Shawn Kim:]

Okay, great that was really helpful. And then I had another question. You guys obviously spent a lot of time talking about your filtration media for PPE and all the great things you guys are doing there. When you look at your TAS segment - does the team have a long-term goal in reducing automotive exposure for the entire business? Or are you guys currently satisfied with the 40% plus exposure you have today?

[Sara Greenstein:]

Sure, good question. So, we are in the process of finalizing our kind of near and long-term strategy. And at the point that we roll that out, I think there will be a lot more specifics to the answer of your question. But the quick answer is, we have been on that path for quite some time in terms of broadening our exposure to other end markets while holding - hold serve if you will, on the automotive piece. I think what the exciting thing that the second quarter taught us is, we have that ability, we have that portfolio and this business demonstrated the value of that - of the diversification of the portfolio. And in addition, we are making improvements in our automotive business that is value creating. So, if you look to the future, I fully expect that we will compete in areas that we know we can win in. And if there are pockets of that in the automotive side, it will be where we have highly engineered products that we can extract fair value for. And as we identify other opportunities like we have in specialty filtration. We will certainly focus there. Long-winded answer to - we've got a strong portfolio. It's demonstrated its earnings power. We know that - where we need to focus, and we will focus where we can win.

[Shawn Kim:]

Terrific, thanks for the color, appreciate it. And best of luck for the remainder of the year.

[Sara Greenstein:]

Thank you.

[Randall Gonzales:]

Thanks Shawn.

[Operator:]

The next question today comes from Arvind Sanger of Geosphere. Please go ahead.

[Arvind Sanger:]

Thank you, good morning. I wanted to understand that you're talking Sara, in Slide 11 about some of the strategies. One of the things you talk about is the N95 demand expected through 2022. My question is, what happens if there is a vaccine by the end of this year or early next year? How do you anticipate the N95 investments that you're making admittedly with government money, but how do you expect that to generate returns over the next couple of years? How do you bet on something like that, not knowing how quickly things might turn?

[Sara Greenstein:]

Sure, so a couple of things. First and foremost, we have sufficient demand to fill the additional capacity that we're bringing online and have secured long-term contracts for the majority of that. So my confidence in stating that through 2022 there is a direct result of that, Arvind. And simultaneously establishing the center of excellence that is working on creating the next-generation air applications for places and spaces is very active right now. And with the policy changes and recommendations and requirements like I, cited regarding upgrades of HVAC filtration media. I have full confidence that regardless of what happens, with the N95 and surgical mask market, which I would argue there is ample demand for even postpandemic, because of the local supply chains that are being established in countries around the world that the applications of specialty air filtration solutions will be every bit as critical and sustainable long-term.

[Arvind Sanger:]

So that brings me I guess, to a related question, which is how much of the current demand is met by imported, especially from China? So I guess we should think about even pre-COVID market being much larger post-COVID, given that there is likely to be a much more make locally requirement. How much in the U.S. was being met by - imported primarily from China demand?

[Randall Gonzales:]

Arvind, let me start. So according to the data we have from 2019, the baseline period prepandemic, for N95 respirators this is N95 respirators only. Of the U.S. demands, the vast majority of that was met outside of the U.S. So estimated at probably 25% or less was U.S. production for that U.S. demand. So now during the pandemic and the post-pandemic period, that's going to flip-flop. And so, the supply of the product from - it's going to be as much capacity as the U.S. has online. So when we start coming online, then it's going to be probably 75% U.S. to 25% outside of the U.S. only because of the fact that there's just not enough capacity to meet the demand.

[Arvind Sanger:]

Got it. And then the second bullet point in your Slide 11 was about expanding the product portfolio for the indoor quality clean air applications. Is that organic or is that inorganic? What kind of opportunities do you see in that market?

[Sara Greenstein:]

Arvind, it is organic. And we make the products today as part of our existing product portfolio and capability for MERV-rated HEPA, ULPA air-grade filters. And we are working as we increase our capacity to innovate off of the current product portfolio as the criteria and standards continue to increase. And we are actively engaged with the standard setting and regulatory bodies, which - who are setting those criteria because we've got the scientific expertise to do so.

[Arvind Sanger:]

Great, thank you.

[Randall Gonzales:]

Thank you, Arvind.

[Brendan Moynihan:]

Thanks, Arvind.

[Operator:]

[Operator Instructions] Showing, no further questions, this concludes our question-and-answer session. The conference has now also concluded. Thank you for attending today's presentation. You may now disconnect.