Lydall, Inc.
Q2 2018 Earnings Call Transcript

Published: 2 Aug 2018

[Operator:]

Good day, everyone and welcome to the Lydall Announces Second Quarter 2018 Financial Results Conference Call. [Operator Instructions] And please note that today’s event is being recorded. I would now like to turn the conference over to Brendan Moynihan. Please go ahead.

[Brendan Moynihan:]

Thank you, William. Good morning, everyone and welcome to Lydall’s second quarter 2018 earnings conference call. Joining me on today’s call are Dale Barnhart, President and Chief Executive Officer and Randy Gonzales, Executive Vice President and Chief Financial Officer. Dale will start the call with comments about the continued progress we are making in executing our long-term strategy as well as provide an overview of current business conditions. Randy will follow with a review of our financial performance and discuss the key drivers by segment. At the end of our remarks, we will open the line for questions. Our quarterly earnings press release and Form 10-Q were released yesterday, so that you can follow along with today’s call, please reference to the Q2 2018 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 of GAAP financials can be found in the appendix of the presentation I have just referenced. With that, I will turn the call over to Dale.

[Dale Barnhart:]

Thank you, Brendan. Good morning, everyone and thanks for joining us. I am pleased to report sales growth in all segments with top line growth of 6.6% and organic sales growth of 2.3%. As expected, gross margin continued to be negatively impact by increased commodity costs, particularly for aluminum. In addition, EPS was negatively impacted by approximately $0.10 driven by unexpected shutdowns at Ford and other OEMs from a supplier fire impacting volumes in our thermal acoustic solutions business. While incremental manufacturing cost and thermal acoustic solutions presented a headwind compared to prior year, we are seeing sequential improvements from the first quarter of 2018. Finally, continued discipline on SG&A spending yielded a 100 basis points improvements in adjusted operating margins compared to prior year partially mitigating the reduction in gross margins. Adjusted earnings per share for the quarter, was $0.70 compared to $0.80 in the second quarter of 2017. Slide 3 outlines our recently published financial results for the second quarter of 2018. I will briefly cover the key highlights and Randy will take you through second quarter results in detail when he provides a summary of our financial performance. Second quarter 2018 net sales of $186.4 million increased 6.6% from the same period in 2017. Organic growth of 2.3% was led by Performance Materials segment organic growth of 3.8%, resulting from strong filtration sales and continued strength in thermal insulation. The technical non-wovens segment grew organically by 2.6% on gains in both industrial filtration and advanced materials applications. Thermal Acoustic Solutions business organic growth was essentially flat with OEM supplier shutdowns in North America from a supplier fire offset by strong demand in Europe and Asia. In particular, Thermal Acoustic China operations saw sales growth of nearly 50% compared to the prior year. On a volume basis, Lydall grew with or in excess of its applicable end markets in all segments. With respect to profitability, second quarter 2018 adjusted gross margin declined 520 basis points to 19.9% driven primarily by the Thermal Acoustic Solutions segment. Commodity inflation on aluminum was significantly compared to the same period in 2017, but was further aggravated by headwinds related to global tariffs and associated costs with shifting our North American supply from China to Europe. Gross profit was significantly impacted by OEM shutdowns in May related to a fire at an automotive supplier causing lost volume in under absorption of costs that was not recovered in the quarter. In addition, incremental manufacturing costs in Thermal Acoustic Solutions negatively impacted margins. The technical non-wovens and performance materials segments saw marginal reductions in the second quarter of 2018 gross margin. However, sequentially both businesses showed significant margin expansion compared to the first quarter of 2018. The overall decline in gross margin was partially mitigated by continued discipline on SG&A expenses, which on an adjusted basis decreased by 100 basis points as a percentage of net sales compared to the second quarter of 2017. The resulting adjusted operating margin of 7.7% was 420 basis points lower than prior period. Second quarter results included a tax rate of 13.7% compared to the second quarter 2017 rate of 28.7%. The reduction was driven primarily by lower U.S. corporate tax rate of 21% under the tax reform act enacted in December of 2017. Adjusted earnings, was $0.70 per share after excluding corporate strategic initiative expenses and ongoing restructuring expenses in the technical non-wovens segment. Turning to Slide 4, this is an overview of our long-term growth strategy, which includes four drivers, new product development, Lean Six Sigma, geographic expansion and M&A. I will focus on two areas today, geographic expansion and acquisitions. Geographic expansion continues to provide a solid foundation for growth with over 40% of the sales generated outside the United States. As I mentioned earlier, the thermal acoustic solution operation in China continues to ramp up, generating sales growth of nearly 50% compared to the second quarter of 2017, with healthy double-digit operating margins. The previously announced restructuring initiatives in technical non-wovens focused on consolidation of European and China manufacturing sites continues to be on track and we expect it to be substantially completed in late 2018. These initiatives will better leverage our business to be more efficient and further strengthen our scale and positioning in these markets. We estimate the total restructuring expense to be approximately $5 million with the run-rate synergy benefits of $5 million by 2019. To-date, approximately $2.1 million has been invested in this program, with remaining spending of approximately $2.9 million to be incurred largely in the second half of 2018 with limited spend in the first half of 2019. With respect to acquisitions, we recently announced the purchase of Precision Filtration division of precision custom coatings. This bolt-on acquisition in the Performance Materials segment is consistent with our strategy to expand our filtration product offerings. The precision filtration unit complements performance materials existing air filtration production capabilities adding high-quality mid to high efficiency filtration media in the commercial and residential HVAC markets. Production will be based on our Green Island, New York facility adding approximately $10 million in annualized sales to Performance Materials. As a reminder, we continue to focus on additional acquisition opportunities, building a pipeline of potential acquisitions and are actively pursuing new prospects. Turning to Slide 5, with respect to business conditions, overall, we believe the underlying fundamentals of our businesses remain generally favorable. On the supply side, we continue to see volatility in aluminum market. LME cash pricing for aluminum was highly volatile in the second quarter, spiking over 30% early in the quarter to $1.18 a panel with an average pricing slightly over $1 a pound, an increase of approximately 5% from the first quarter of 2018 average and up over 20% from the prior year. Combined with local premiums, duties, tariffs and transportation costs, aluminum cost in the Thermal Acoustic Solutions business represented a headwind of 140 basis points for Lydall. As a reminder, Lydall does have pass-through arrangements in place for approximately one half of the affected business volume. There is typically a 3 to 6 month lag on recovery. Finally, we are closely monitoring polyester fiber pricing, a key input cost to all Lydall business units and seeing some supply constraints on aramid fibers, an input for certain technical non-woven applications. On the demand side, the domestic automotive market continues to show favorable results in the second quarter of 2018 with U.S. light vehicle seasonally adjusted annual rates above 17 million units in June. Current forecast indicate 2018 will likely see light domestic vehicle production levels essentially flat. Western European volumes are forecasted to be flat to marginally up, while China projections are to grow at mid single-digits. Given this global outlook and the mix of applications and platforms in our product portfolio, we expect to slightly outpace the market on a volume basis. Looking into our Filtration and Engineering Materials businesses, Performance Materials end markets continue to show stability across all regions. Strong demand for our filtration products in the first quarter continued to trend positively in the second quarter of 2018 and we expect that to remain in the second half of the year. Fluid power filtration applications will continue to be a growth area for Lydall buoyed by strength in agriculture and construction end markets. Demand for life sciences and specialty insulation particularly cryogenic insulation products both remains solid. Finally, in our technical non-wovens segment, we are experiencing stable demand for both our advanced materials and industrial filtration products. In North America and China, the power generation markets remained healthy and overall demand for air and liquid filtration applications remain strong. The advanced materials end-markets also remain healthy with strong seasonal demand for geosynthetics. Globally, technical non-wovens has a robust backlog exiting the second quarter. With that, I will now turn the call over to Randy.

[Randy Gonzales:]

Thank you, Dale and good morning everyone. Turning to Slide 6, I will briefly cover our consolidated results and then provide an overview of our operating segment results. In the second quarter of 2018, the company achieved net sales of $186.4 million, an increase of 6.6% over the second quarter of 2017. Every segment grew organically in the quarter with consolidated organic growth of 2.3%, tooling sales of $7.3 million in Thermal Acoustical Solutions, an indicator of future parts sales, was up $1.9 million compared to the second quarter of 2017 contributing 1 point of growth. Favorable foreign exchange primarily the stronger euro contributed an additional 3.3 points of growth. Note that $1.6 million of sales growth in the second quarter of 2018 is related to the new accounting standard, which impacts the timing of revenue recognition with substantially all of this increase in tooling sales for Thermal Acoustical Solutions. As a reminder, under the new standard, Lydall predominantly recognizes tooling sales as costs are incurred over time in contrast to the prior practice of recognizing tooling revenues upon acceptance and delivery to the customer. The resulting impact to gross margin and operating income was $100,000. Reported second quarter gross margin of 19.4% was down 540 basis points from prior year. Excluding acquisition-related inventory step-up in Q2 ‘17, severance charges in Q2 ‘17 and restructuring charges in Q2 ‘18 adjusted gross margin of 19.9% was down 520 basis points. As Dale noted, gross margin was negatively impacted in Thermal Acoustical Solutions by higher aluminum cost, under absorption of fixed costs on lower OEM volumes, and higher manufacturing costs impacting margin by 450 basis points in the quarter. Consolidated operating margin for the second quarter was 6.6%, including $900,000 of expense related to restructuring activities and $1.2 million of expenses related to corporate strategic initiatives. Adjusted for these items, operating margin in the second quarter 2018 was 7.7%, down 420 basis points from prior year. Lower gross margin was offset by leveraged SG&A spending, which improved 100 basis points in the quarter and included 20 basis points of increased intangible amortization expenses. The effective tax rate for the second quarter of 2018 was 13.7% or 15 points lower compared with the same period in 2017 driven primarily by lower U.S. statutory tax rates. Geographic mix and benefits from discretionary pension contributions in the drove the rate below the 21% U.S. statutory rate. For the full year 2018, we now expect the consolidated ordinary tax rate to be in the range of 18% to 19%. Second quarter 2018 earnings per diluted share were $0.60 compared to $0.76 of earnings in the prior year. When adjusting for the strategic initiatives expense, inventory step up, restructuring and severance expenses, adjusted earnings per share of $0.70 was down $0.10 or 12.5% compared to adjusted EPS of $0.80 delivered in the second quarter of 2017. Cash flows provided by operations in the second quarter was $11.9 million compared with cash flow of $15.4 million in second quarter of 2017, with the reduction driven by strategic raw material inventory purchases and increased discretionary pension contributions made in the quarter. Our liquidity remains strong. At the end of the second quarter of 2018, cash was $50.6 million. Total outstanding debt from the credit facility at quarter end was $76.6 million for a net debt ratio of approximately 0.4x adjusted EBITDA positioning us well for future acquisition growth. As it relates to capital expenditures, Lydall spent $8.7 million in the second quarter of 2018, $3.2 million more than in second quarter 2017. Year-to-date spending of $16.4 million is up $1.3 million compared to the first half of 2017. We continue to invest in capacity and automation in Thermal Acoustical Solutions and capital expenditures related to the technical non-wovens site consolidation activity will ramp through 2018. Consistent with prior direction, we anticipate the 2018 capital spend to be in the $30 million to $35 million range with strategic growth in productivity spending in each of the three segments. Moving to Slide 7, I will recap Lydall’s year-to-date results. Through the first half of 2018, sales of $378.1 million grew 11.1% compared to the first half of 2017. Organic growth of 3.2% and favorable foreign exchange of 4.6% were complemented by growth of tooling sales of 3.3% or $11.3 million. Note that $7.6 million of growth in tooling sales is related to the new revenue recognition standard. Adjusted operating margin of 7.7% was down 340 basis points with previously discussed commodity headwinds, higher manufacturing cost and under absorption of cost in Thermal Acoustical Solutions driving the majority of this erosion. Including in these results is $700,000 or 20 basis points of incremental amortization from acquired companies compared to the same period last year. Moving to Slide 8, I will discuss our segment results. I will start with our Thermal Acoustical Solutions segment. This is our global automotive business, which specializes in providing innovative engineered thermal and acoustical solutions for vehicle under hood, under body, powertrain and exhaust applications. Second quarter sales in this business were $90.2 million, up 9.8%. Net part sales of $82.9 million were up $2.3 million or 0.3% organically compared to last year led by strong growth in China and Europe with domestic growth unfavorably impacted by OEM shutdowns in the quarter. Tooling sales of $7.2 million grew by $1.9 million in support of customer product launches, including $1.4 million related to the adoption of the new revenue recognition standard. Favorable foreign exchange, primarily the stronger euro, added 2.4 points to sales growth. Adjusted operating margin of 9.8% declined 810 basis points from second quarter 2017. Increased labor cost and outsourcing activity to support customer volume increases and product qualification impacted margins unfavorably by 400 basis points. In addition, higher aluminum pricing, up about 20% from the prior year period, combined with higher duties, tariffs and inbound freight contributed another 290 basis points headwind. Lower domestic volumes driven by OEM shutdowns and the associated under absorption were a $2.2 million drag on margin as well. As discussed in our first quarter results, we continue to see progress in the second quarter to address the ramp in customer volumes and equipment operating efficiencies. Commodity pricing remains uncertain for the remainder of 2018, particularly in the context of current global trade discussions, which we are actively monitoring. We continue to work on mitigating these impacts to the extent we are able through sourcing, customer negotiations and other initiatives. Moving to Slide 9, I will cover our Performance Materials segment. This segment provides specialty filtration and insulation solutions to a variety of end-markets globally. Sales grew organically by 3.8% in the second quarter to $31.2 million led by 6.9% growth or $1.3 million on higher filtration sales with both air and fluid power volumes up in the quarter. Specialty insulation sales were up 5.3% led by double-digit gains in low temperature cryogenic insulation products offset by modest reductions in other categories. Life sciences sales grew 8.5%. Foreign currency translation provided a favorable tailwind of 2.8% in the quarter. Second quarter operating margin eroded by 170 basis points to 11.2%, with higher labor cost and select pricing pressures driving the change. We have however seen operating margins expand by 310 basis points from the first quarter of 2018 period led by higher gross margin and lower SG&A expenses. Slide 10 covers our technical non-wovens segment. This segment produces air and liquid filtration media as well as other engineered products for use in various commercial applications such as geosynthetics, automotive, industrial and medical among others. For the second quarter of 2018, sales of $71.7 million were up $4.6 million, including $2.8 million of favorable currency translation. Organically, sales grew 2.6% or $1.8 million on improved demand from industrial filtration customers in Europe and North America. Gains in sales of Advanced Materials were driven primarily on higher demand for geosynthetics and specialty applications. From a profitability perspective, adjusted operating margin for the second quarter 2018 declined by 120 basis points to 9.8% compared to the same period in 2017 driven by $400,000 or 60 basis points of higher amortization and higher material costs, which were largely but not totally offset by higher selling price. As a reminder, adjusted operating income, excludes $900,000 or 130 basis points of expenses related to ongoing restructuring activities in the quarter compared to $300,000 or 50 basis points in the same period last year. As Dale noted earlier, with respect to the Texel and Gutsche acquisitions, the performance and integration of both businesses continues to be on track and we remain confident in the strategic supply and demand side leverage to be gained by the industry leading market position that we now enjoy. That concludes our review of the second quarter results. Through the first half of 2018, we saw solid top line growth of 11% driven by generally healthy demand in end-markets we serve. Entering the second half of the year, we have remained focused on continued improvement, operational performance in Thermal Acoustical Solutions, executing on our integration and restructuring in technical non-wovens and driving organic and inorganic growth across all business segments, leveraging these improvements on continued strength in our end markets positions us to deliver solid performance in 2018. With that, I will turn the call back to the operator to begin our question-and-answer session.

[Operator:]

[Operator Instructions] And our first questioner today will be Matt Koranda with ROTH Capital. Please go ahead with your question.

[Matt Koranda:]

Hi, guys. Good morning.

[Dale Barnhart:]

Good morning Matt.

[Randy Gonzales:]

Good morning, Matt.

[Matt Koranda:]

Just wanted to start out with thermal acoustic segment, is there a way to quantify the headwinds in terms of revenue and margin that you guys faced due to the shutdowns that were associated with the Meridian fire and then will those volumes essentially be made up in the second half? In your view, how does that sort of shake out for the rest of the year?

[Dale Barnhart:]

Well, as we said, the overall impact of those headwinds was about $0.10, so it was significant in both revenue and in operating income in the business we were initially informed that they would make that up in the third quarter as we sit here today, we don’t see all of that additional volume back in our orders, so but they’re still saying they are so what we’re hearing is they will, what we’re seeing is not fully recovering in the third quarter.

[Matt Koranda:]

Got it. So it sounds like maybe some may spill into Q4 just in terms of the volume pickup.

[Dale Barnhart:]

Yes. Well, it still could happen in the third quarter. I mean, they can change their schedules rapidly. I think it’ll depend upon how their end products in those it impacted Ford, Mercedes and Chrysler in content that we have with those 3 OEMs. It all depends how those platforms are selling and whether they’re moving or whether inventories are high in those different platforms in the markets. So it’s a fluid situation. But all indications are that the industry is going to continue at a healthy rate for the full year and those particular models that we’re on with those 3 OEMs tend to be pretty good sellers.

[Matt Koranda:]

Okay, got it. And then just in terms of the China ramp, I know you guys highlighted some really strong growth there but wanted to get a sense, I mean, have you observed any impacts at all sort of from some of the saber rattlings that’s been going on, on trade between our two governments? I mean any impact to your business in China in terms of the ramp-up or releases?

[Dale Barnhart:]

Not at all, because all of our business that we do in China, we source all the raw material in China and we supply to vehicle production in China so that’s one area where we’re immune to all the saber rattlings on tariffs and duties potential negative impact on tariffs could come in North America in that we do have content on the Mercedes SUVs and the BMW SUVs that are produced here in the U.S. and exported to China I think it’s about 20% of the volume that they produce goes to China. So that event that potentially could be an impact, but we’re not seeing any of it right now as you know, this whole tariff situation is very fluid and things are changing daily and it’s hard to predict what could happen.

[Matt Koranda:]

Got it. I guess what I was also getting at is there have been these reports or speculation that maybe the Chinese government may slow sort of certain permitting and approvals with U.S. businesses that are based in China. So you haven’t seen any sort of adverse impacts thus far?

[Dale Barnhart:]

No, as far as I know, all of our business in China are permitted and are approved so it’s not like we’re setting up a new operation I mean, the technical non-woven operations in China have been there for several years we are in the process of consolidating the one facility and we have all the approvals to do that and start producing in the new facility and likewise, the automotive business has been well established over the last 3 years and other than adding some capital for growth projects, there is no real expansion plan there so unless they come in and try to shut us down there is we see no reason why we shouldn’t continue to have the growth potential that we have in China.

[Matt Koranda:]

Okay, great. That’s helpful. And then just in terms of switching gears to the Performance Materials segment, just wanted to get a sense for the pricing environment there so are we getting enough pricing to stick in that segment to sort of offset the headwinds from polyester fiber going forward? I mean, how are those discussions proceeding and how should we think about sort of price cost on a go forward basis there?

[Randy Gonzales:]

Yes, Matt. All indications at this point is that the price increases generally are sticking some of the pricing pressure we saw in Q2 were the result of one specific situation from a particular customer. And so generally we think that the price increases are sticking and we will see that improvement in margins in the second half of the year as a result.

[Matt Koranda:]

Okay, got it. I will jump back in queue, guys. Thanks.

[Dale Barnhart:]

Thank you, Matt.

[Randy Gonzales:]

Thanks, Matt.

[Operator:]

And our next questioner today will be Edward Marshall with Sidoti & Company. Please go ahead with your question.

[Edward Marshall:]

Hey, Dale, Randy and Brendan. How are you?

[Dale Barnhart:]

Hi, good morning, Ed.

[Randy Gonzales:]

Good morning, Ed.

[Edward Marshall:]

Good morning. Good morning. So I was looking at the organic revenue in each of the businesses and then looking at the mix overall and to be honest the mix in each of the three businesses seem to be kind of a weaker mix in all three businesses. But I wanted to zero in on TAS for a second, specifically around tooling I mean you guys recorded pretty much the same amount that you have recorded in tooling for the last two full years in the first half of 2018. So, I wanted to get a sense is this the new way of recognizing tooling cost as you mentioned kind of in it or is this just a lot of new programs that are coming in?

[Dale Barnhart:]

Well, it’s a combination of both. Yes, it’s the new revenue recognition which accelerates some of the recognition of the revenue, but again it’s an indication of what we are seeing in the good news, bad news. In the U.S., we are launching 62 new parts this year, in Europe, 25, and in China, 21 and every one of those parts has specific tools associated with it and that’s what you are seeing. So, we have a very healthy ramp up of a lot of new products in 2018.

[Edward Marshall:]

And just to remind me, the margin associated with tooling is essentially zero?

[Dale Barnhart:]

It’s basically breakeven. Yes, it’s basically breakeven.

[Edward Marshall:]

Okay. And in the recorded cost of labor and other startup and over time and expedited freight along with the new programs, I think you have quoted about $3.5 million worth if I did the math right or 190 basis points, that’s over and beyond anything to do with tooling, that’s more about trying to get the processes and the productivity up to par?

[Dale Barnhart:]

Well, it also includes the raw material cost and cost associated with switching. I mean, one of the things that the business did was in anticipation of significant duties with aluminum coming out of China. We switched that product to a European supplier at a cost savings, but there was a lot of logistics cost associated – one-time cost associated with getting that Italian supplier up and running. So, that’s included. Those types of costs are also included in that figure.

[Edward Marshall:]

On an annual basis, should I think of any type of – when I look at tooling and just try to think that through, is there any type of seasonal impact where it maybe the first half of the year you will see a bigger or is this a longer tail and it’s more about kind of what you signed over the last couple of years and not something that’s seasonal in nature on an annual basis?

[Dale Barnhart:]

Tooling is seasonal at all. It all depends upon when the OEMs are planning to launch their new redesigns. So, we have startup production on several of these new parts that we are talking about going anywhere from July through January of ‘19. And as you see further, billing on the tooling will be when the parts really go into production. So no, there is no seasonality. There used to be always in the automotive business that they would launch all their new products in the fall of the year, so you would have that rushed. They have pretty much spread it out through the year now.

[Edward Marshall:]

Okay. And two more questions on that if I could. One, geographic, is there – in geographic, you had mentioned several different programs. Was the bulk of this anything – is the bulk of this in any one specific geographic area or is it the weighted average of the three territories you kind of indicated?

[Dale Barnhart:]

Well, the majority of the new parts are in North America in the U.S. site. We have 62 of them going there. We do have a healthy 25 and 21 both in Europe and in China. And for their size, those are significant. So, that’s the bright promise in the TAS business is all the new products we are launching this year creating a lot of consternation for us. I mean, part of the issue was probably about 30 of the parts were pushed from last year into this year with delays from the OEMs on their ramp-up. So we’re going to hit with a little more than what we thought. And as you look at the overall operational efficiencies, the one area that we’re still spending more money on to make sure we have capacity to deal with the new launches and the ongoing production is outsourcing. We’re still outsourcing parts to make sure we have available capacity in our Hamptonville site to handle both new product launches and the ongoing business.

[Edward Marshall:]

Got it. And so you booked about $21 million in tooling this year so far, what’s your estimate for 2019? Will it start to subside in the second half or is it a similar number?

[Dale Barnhart:]

For 2019, I really don’t have visibility into that, on what the tooling will be. I mean, this is...

[Edward Marshall:]

The remainder of ‘18. I’m sorry if I misquote.

[Dale Barnhart:]

The remainder of ‘18?

[Randy Gonzales:]

Ed, I think, generically, we will continue to see probably higher levels than in prior years. Part of the reason I hesitated on that is obviously we are all adjusting to the new revenue recognition standard, but certainly, we have a lot more parts to launch in the second half of the year, so it’s logical to expect that we would go ahead and be booking those revenues later in the year.

[Edward Marshall:]

Got it. You talked about earlier in the conversation, switching to price, you talked about half of the business being passed through 3, 6 months and I appreciate that and the comments you made around Performance Materials as it relates to the remainder of your business, the discussion about price have you actually started to see any of that price that you need to offset some higher raw materials flow through yet. It doesn’t appear that it does in the margin. So is that something that we should anticipate for the second half of ‘18, maybe into 2019 for the rest of the business?

[Randy Gonzales:]

Well, we have seen some of that in the technical non-wovens side of the business but you’re right, we’ll see for Performance Materials and technical non-wovens, you should see that benefit more starting in Q3 and into the second half of the year.

[Edward Marshall:]

Got it. And then the final question for me, I’m just curious about capital deployment. I understand you did a small bolt-on deal. I know debt is still a priority, but have you considered buybacks? How does the board will see authorization around buybacks and is that something you think you might look at as you look at capital deployment for the remainder of the year?

[Dale Barnhart:]

That will not happen in the remainder of the year. It’s something we may look at longer term for the balance of this year, we’re still focused on paying down the debt, taking care of the pension program, as we’ve mentioned several times, de-risking that, the capital investment for organic growth and still some M&A activity. So we still remain active in that area.

[Edward Marshall:]

Got it. Thanks very much for your comments guys. I appreciate it.

[Dale Barnhart:]

Thank you, Ed. I appreciate it.

[Operator:]

[Operator Instructions] And our next questioner today will be Chris Moore with CJS Securities.

[Chris Moore:]

Hi, good morning guys. Stay with the margins in the Thermal Acoustical for a second, the 400 basis points that you talked about in terms of labor, variable overhead, outsourcing, just trying to kind of get a rough sense in terms of how much would you associate that with kind of the heavy product launch now versus kind of general increases in labor, tight labor markets, etcetera, just trying to kind of get a feel for how to look at it moving forward?

[Dale Barnhart:]

I don’t have an exact number, but I would attribute the majority of the inefficiencies that we will see or challenges we will see, I should say, as the second half of the year will be based on these new product launches so it just takes time to go through all those and iterate them that’s why what we’re seeing what we saw on the second quarter and what we’ll see in the second half is higher than normal outsourcing expense using other resources to make sure they’re taking care of some of our production volume while we’re interrupting our lines to handle these new products so we won’t digest all of that until the end of the year. But what I can say that we saw in the second quarter, which we should see as we go forward is we are seeing our over time stabilize, if not go down we are seeing our scrap stabilize, if not go down. And in the first quarter, we had significant expedited freight as we were dealing with the production and handling the customer demand that has virtually gone away. So from that standpoint, we are seeing improvements. But the outsourcing will continue to be an additional expense that we don’t normally see to make sure we have the capacity to support the ongoing customer demand.

[Chris Moore:]

Got it. And that outsourcing is I mean reasonable to think it’s between now and the rest of the year? Is it based on what you are seeing at this point in time, is it you expect that to continue at this pace in ‘19 or how would you look at it?

[Dale Barnhart:]

No, I think it will continue through the end of the year and then we actually have some new capital coming on in ‘19, which will help relieve that. So there are two things that will help relieve it in 2019. These additional assets that will be going into production and the fact that we won’t be doing these 62 new part launches in North America in ‘19.

[Chris Moore:]

Got it, got it. The commodity cost side, I know you started up by saying uncertain the rest of the year just trying to understand logistics in terms of timing so you get you can basically cast 50% of the cost through on a 3 to 6 month lag. And the aluminum that you’re using in Q3, for example, when is that purchased, is that in Q2 or just trying to kind of looking at the price curve and trying to understand if what kind of position you might be in Q3, Q4?

[Dale Barnhart:]

It has to be. I don’t know specifically. We can get back to you on the specifics of that. But sure, it had to be committed in the first or second quarter to make sure that we had supply.

[Randy Gonzales:]

Yes, Chris, there’s I mean, there will be occasional exceptional circumstances where we may consider doing a strategic buy, but I mean, with all the volatility in the market, I think that’s a gamble at best.

[Dale Barnhart:]

Yes, we don’t do any hedging as it relates to any of the commodities.

[Chris Moore:]

Got it, got it. Last question just in terms of the small acquisition that you did, the $10 million annual sales, do you assume that it would be able to generate kind of close to normal Performance Materials margins or is it going to take a while for that to get there?

[Dale Barnhart:]

No, we should see a very positive impact very shortly. We do have to absorb some of the purchase accounting. But the nice thing is it’s a product line extension. So that additional product line we are selling to our existing customers, so there’s hardly any SG&A impact. So whatever we get from a gross margin standpoint will drop straight through. So it’s going to be a nice niche and it complements the product offerings we have today. So it’s really nice. And we’re actually in the process now. The equipment has been decommissioned at the owners and is being transported right now to our Green Island facility in New York and expect to be in full production before the end of the year.

[Chris Moore:]

Got it. Appreciate it, guys.

[Dale Barnhart:]

Thank you.

[Randy Gonzales:]

Thanks, Chris.

[Operator:]

And this will conclude our question-and-answer session. I would like to turn the conference back over to Dale Barnhart for any closing remarks.

[Dale Barnhart:]

Well, we want to thank everybody for joining us today, and we look forward to speaking with you again soon. Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.