Lydall, Inc.
Q3 2018 Earnings Call Transcript

Published: 11 Nov 2018

[Operator:]

Good day, everyone, and welcome to Lydall's Third Quarter Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Brendan Moynihan, Vice President of Financial Planning and Analysis and Investor Relations. Please go ahead.

[Brendan Moynihan:]

Thank you, Allison. Good afternoon, everyone, and welcome to Lydall's Third 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'll open the line for questions. Our quarterly earnings press release was released yesterday and Form 10-Q was filed today. So that you can follow along with today's call, please reference the Q3 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 to GAAP financials can be found in the appendix of the presentation, I've just referenced. With that, I'll turn the call over to Dale.

[Dale Barnhart:]

Thank you, Brendan. Good afternoon, everyone, and thanks for joining us. I'm pleased to report third quarter sales grew at almost 10% compared to prior year led by the acquisition of interface performance materials, which contributed $11.8 million of the revenue in the quarter. On a consolidated basis, Lydall's sales were up 2.8% organically. While we anticipated margin expansion from the second quarter, adjusted operating margin was down 110 basis points sequentially. Gross margins were impacted by lower-than-expected volume recovery in the thermal acoustical segment as OEM volumes lost in the second quarter related to the supplier issue were not fully recovered in the third quarter. We also saw anticipated headwinds in performance materials driven by unfavorable product mix, including a double-digit sequential decline in sales of cryogenics, specialty insulation products to China related to higher tariffs. Compared to the prior year, gross margin was down and continued to be negatively impacted by increased commodity cost, particularly for aluminum. Every product launch activity continued in Thermal Acoustical Solutions causing higher labor and overhead costs. While these incremental costs presented a headwind compared to prior year, we continue to see sequential improvements from quarter-to-quarter. Continued focus on SG&A spending partially mitigated the reduction in gross margins. Adjusted earnings per share for the quarter was $0.54 compared to $0.61 in the third quarter of 2017. Incremental amortization from acquisitions accounted for $0.05 of this variance. Slide 3 outlines our recently published financial results for the third quarter of 2018. I will briefly cover the key highlights, and Randy will take you through the third quarter results in detail when he provides a summary of our financial performance. Third quarter 2018 net sales of $197.9 million were a record for Lydall, increasing $17.8 million or 9.9% from the same period in 2017. Organic growth of 2.8% was led by Thermal Acoustical Solutions segment, which grew organically in all geographies, including organic growth of 17.9% in China. The Technical Nonwovens segment grew organically by 1.6% on higher activity and industrial filtration domestically and in Europe. Performance Materials reported sales were up 41.2% with precision filtration interface acquisitions contributing $13.4 million of top line growth, offset by FX headwinds and lower sales in the legacy business impacted by lower cryogenic insulation sales primarily in China where higher tariffs have dramatically impacted sales to cryogenic equipment suppliers. Third quarter 2018 adjusted gross margin declined 380 basis points to 18.7%, driven primarily by the Thermal Acoustical Solutions segment. Commodity inflation on aluminum continues to be a headwind compared to prior year. And while based index pricing was up only modestly, the domestic Midwest premium and conversion costs were up significantly from prior year. In addition, incremental manufacturing costs in the Thermal Acoustical Solutions negatively impacted margins. The Technical Nonwovens and Performance Materials segment saw marginal reductions in the third quarter of 2018 adjusted gross margins, driven by unfavorable product mix and material inflation, which was partially offset by higher price. The overall decline in gross margin was partially mitigated by continued discipline on SG&A expenses, which on an adjusted basis, improved by 90 basis points as a percentage of net sales compared to the third quarter of 2017. The resulting adjusted operating margin of 6.6% was 290 basis points lower than prior year, including 60 basis points for incremental amortization expense. Third quarter results included higher interest expense associated with higher debt for the interface acquisition. Adjusted earnings was $0.54 per share after excluding corporate strategic initiatives expenses, inventory step-up and ongoing restructuring expenses in the Technical Nonwovens segment. Turning to Slide 4. This is an overview of our long-term growth strategy, which includes 4 drivers

[Randall Gonzales:]

Thank you, Dale. Turning to Slide 6. I'd briefly cover our consolidated results, and then provide an overview of our operating segment results. Third quarter of 2018 consolidated sales were $197.9 million, up $17.8 million or 9.9% from third quarter of 2017. Acquisitions in the Performance Materials segment contributed 7.4 points of this growth while foreign exchange was a headwind of 1.1 points, primarily on weaker Canadian dollar and to a lesser extent, the euro. Tooling sales of $10.5 million in Thermal Acoustical Solutions, an indicator of future part sales, was up $1.3 million or 14.2% compared to third quarter 2017, contributing 0.8 points of growth. Year-to-date sales of $576 million was up 10.7% or 3.1% organically with acquisitions adding 2.6 points of growth and FX and tooling sales, each adding 2.5 points to the top line. Note that our year-to-date sales includes $6.8 million of sales related to the new accounting standard, which impacts the timing of revenue recognition, primarily for recognition of tooling sales and 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 net impact to gross profit was $1.3 million. Reported third quarter gross margin of 17.8% was down 440 basis points from prior year. Excluding inventory step-up related to the Interface acquisition in third quarter '18 and restructuring and severance charges in both periods, adjusted gross margin of 18.7% was down 380 basis points. The primary drivers of this reduction were in Thermal Acoustical Solutions where higher commodity costs drove 110 basis points, and higher labor and overhead costs drove an additional 140 basis points of consolidated gross margin erosion. Additional drivers in Technical Nonwovens and performance materials include unfavorable mix and higher material costs, partially offset by pricing. Consolidated operating margin for the third quarter was 4.9%, including $1.5 million of expenses related to corporate strategic initiatives, $1.4 million of inventory step-up and $500,000 of expenses related to restructuring activities. Adjusted for sales. The reported effective tax rate for the third quarter of 2018 was 24.5%. The rate was negatively impacted by an adjustment to the onetime repatriation tax on foreign earnings triggered by the Tax Reform Act and non-Deductible transaction expenses from the Interface acquisition. For the full year 2018, we continue to expect the consolidated ordinary tax rate to be the range of 18% to 19%. Third quarter 2018 earnings per diluted share was $0.36 compared to $0.62 of earnings in the prior year. When adjusting for strategic initiatives expense, inventory step-up, restructuring and severance expenses, adjusted earnings per share of $0.54 was down $0.07 compared to adjusted EPS of $0.61 delivered in the third quarter of 2017 with higher acquisition-related amortization contributing $0.05 of this difference. Cash flows provided by operations in the third quarter was $6.5 million compared with cash flow of $18.4 million in third quarter of 2017 with the reduction driven by lower net income and higher working capital driven by higher accounts receivables in the quarter. Year-to-date cash flow from operations was $14.5 million. Our liquidity remains strong. At the end of the third quarter of 2018, cash was $44.1 million. Total outstanding debt from the credit facility at quarter-end was $337.9 million for a net debt ratio of approximately 2.9x adjusted EBITDA. As it relates to capital expenditures, Lydall spent $3.7 million in the third quarter of 2018, down from $4.9 million spent in the third quarter of 2017. Year-to-date spending of $20 million is flat to prior year. We continue to invest in capacity and automation in Thermal Acoustical Solutions and capital expenditures to support new products and performance materials in Technical Nonwovens. Consistent with prior direction, we anticipate the 2018 capital spend to be in the $30 million to $35 million range with strategic growth and productivity spending in each of the 3 segments. Moving to Slide 7. I'll discuss our segment results. I'll 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, underbody, power train and exhaust applications. Third quarter sales in this business was $88.2 million, up 4.5%. Net part sales of $77.7 million were up $2.1 million or 3.3% organically compared to last year with growth in all regions, including China where sales grew almost 18% organically. Tooling sales of $10.5 million grew by $1.3 million or 14.2% in support of customer product launches. Unfavorable foreign exchange, primarily the weaker euro, reduced sales growth by 0.5 points. Adjusted operating margin of 9% declined 490 basis points from third quarter 2017. Aluminum costs while down sequentially from second quarter, were up from prior year, unfavorably impacting margins by 240 basis points, inclusive of index pricing, higher conversion premiums, logistics cost and additional tariffs. We continue to actively monitor commodity pricing given the dynamic context of current global trade discussions. The remaining change in margin was caused by continued operational disruptions as we launch new customer parts, resulting in higher outsourcing, labor and freight costs. We expect this activity to continue in the short-term and continue to look for ways to mitigate exposure but expect they will persist through the rest of the year. Moving to Slide 8. I'll cover our Performance Materials segment. This business provides specialty filtration in insulation solutions to a variety of end markets globally, and the addition of interface performance materials broadens the portfolio with engineered ceiling solution across industries. As a result, Lydall will report sales data under 2 new segments from this quarter going forward. The filtration segment consists of sales for air and liquid filtration applications, including filtration applications previously reported under the legacy Life Sciences segment. The Ceiling and Advanced Solutions segment encompasses the new interface performance materials, gasketing and ceiling applications as well as sales previously reported under the Thermal Insulation segment, which consisted of specialty insulation for high temperature and ultra-low temperature or cryogenic applications. Sales of $41.7 million were up $12.2 million or 41% compared to prior year. Note that reported sales growth includes $13.4 million or 45% related to the previously announced Precision Filtration and Interface acquisitions, and FX was a slide headwind. Resulting organic growth was down 3.8%, primarily on lower sales of cryogenic insulation, particularly in China where key customers have been impacted by higher U.S. tariffs and lower demand for their end products. Third quarter operating margin eroded by 310 basis points from the prior year to 7.5% adjusted for inventory step-up expenses. This also included $900,000 or 210 basis points of higher amortization expense. Excluding these items, operating margin was down 100 basis points, impacted by lower volumes of higher-margin cryogenic insulation sales, unfavorable mix infiltration, partially offset by lower SG&A expenses. As Dale mentioned, the Interface Performance Materials business is off to a solid start, contributing $11.8 million of sales in September with adjusted EBITDA performance in line with our expectations and accretive to the portfolio. Purchased accounting adjustments for inventory step-up of $1.4 million and incremental intangibles amortization of $900,000 reduced performance materials operating margin by 330 and 210 basis points, respectively. When we announced the acquisition in August, our preliminary expectation for inventory step-up was $3 million. We now anticipate the total to be $2 million with substantially all of this occurring in 2018 or approximately $600,000 in Q4. Intangible amortization has also been finalized, and we expect amortization of $3.5 million in 2018 or about $900,000 per month and $16.2 million in the full year of 2019. This is higher than our initial estimate communicated in August. So while we continue to expect the deal to be cash accretive in 2018, we expect it will be minimally accretive to reported EPS in 2019. Slide 9 covers our Technical Nonwovens 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 third quarter of 2018, sales of $73.1 million were up organically 1.6% or $1.2 million net of unfavorable foreign exchange of $1.4 million. Industrial filtration reported sales growth of 6.8% led by strong sales in Europe and North America, which was offset by lower sales in Advanced Materials, driven primarily by lower sales of needle felts to the automotive segment. From a profitability perspective, adjusted operating margin of 9.3% for the third quarter of 2018 declined by 270 basis points compared to the same period in 2017, driven by $300,000 or 40 basis points of higher amortization, unfavorable product mix and higher material costs, which were largely but not totally offset by higher selling price. As a reminder, adjusted operating income, excludes $500,000 or 70 basis points of expenses related to ongoing restructuring activities in the quarter compared to $200,000 or 30 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 third quarter results. Year-to-date top line growth has been favorable, driven by generally healthy demand in end markets we serve. As we finish the year, we remain focused on integrating the Interface acquisition into the performance materials portfolio completing our integration and restructuring in Technical Nonwovens and continued improvement in operational performance. Leveraging these improvements on continued strength in our end markets positions us to deliver solid performance in 2019. With that, I'll turn the call back to the operator to begin our question-and-answer session.

[Operator:]

[Operator Instructions] Our first question today will come from Edward Marshall of Sidoti. Please go ahead.

[Edward Marshall:]

Hi guys, good afternoon.

[Dale Barnhart:]

Good afternoon, Ed.

[Edward Marshall:]

So I wanted to start with the TAS segment if I could. The disruptions due to fire, I'm curious, it was - how much of that did you recover - was there recovery at all? Or any uptick in production?

[Brendan Moynihan:]

Yes. This is Brendan. Basically, it was about half of what we expected. So we had indicated in Q2, it was about $4 million of sales and about $2 million of margin, including absorption, and we recovered about $0.50 of that.

[Edward Marshall:]

Okay. And the anticipation that rest of that will come into the fourth quarter? Or have those purchase orders been placed?

[Brendan Moynihan:]

No. We're not seeing any activity would indicate an uptick in 4Q and recover the remainder.

[Edward Marshall:]

Got it. And when I think about the new vehicle introductions with Ford next year. They have the Escape, the Explorer, maybe the midsized Ranger, those are vehicles I - would make sense to me that you would be on. Is there any kind of comments that you can kind of talk about the product introductions in the - all the expenses that you're taking this year that might be related to those types of vehicles?

[Dale Barnhart:]

Those are - as far as all the new product launches, Ed, those Ford platforms are a relatively small portion of what we've seen. The majority of the new product platforms that we have been faced with this year that have impacted us is in the metal product line, and those are for various OEMs. GM, Honda, Chrysler.

[Edward Marshall:]

Got it. And you talked about the trend continuing that there is an improving trend from 2Q to 3Q in the overhead cost and the overhead expenses. You talked about the fact that they wouldn't roll off entirely through the remainder of the fourth quarter. But would we see the similar trend of improvement quarter-to-quarter on a sequential basis that we did in, say the first 3 quarters of this year?

[Brendan Moynihan:]

Just to clarify, Ed, you're talking particularly of the TAS.

[Edward Marshall:]

To the TAS segment. Correct. The overhead expenses that you're incurring. The expedited freight, the overtime, et cetera?

[Dale Barnhart:]

Yes. We should continue to see that. We did see improvement in the third quarter versus the second quarter. But principally, in the outsourcing expense, as we've gotten through, the third quarter was one of the larger quarters as far as volume of new product launches, a number of that were launching in the fourth quarter, drops dramatically. And as a result, we freed up some capacity and we brought in 2 to 3 high-volume components that we had outsourced through the year. They came back in towards the end of September. So we should expect to see continued reduction in outsourcing expense in the fourth quarter.

[Edward Marshall:]

Got it. And then as it relates to the aluminum, I'm curious, do you have any exotic aluminum kind of materials that you use that you can't source? Say, either domestically or from a - or even related to tariffs? I mean, is there anything that you can kind of - I'm trying to think through the inflation scenario in any way that you could mitigate that you might be seeing there aside from market activity?

[Dale Barnhart:]

We had one gray and I don't know what it was specifically, Ed, but it was originally sourced in China. And the only other source we could find was in Europe. So that's the one that - in this - I believe it was in the second quarter that we resourced from China to Italy. Still on a year-over-year increase, but at a lower rate than what we would've seen from China with the duties being imposed there. So that's the one sort of unique grade we have. We do have 2 major suppliers in North America, but what they've done is they've - they are raising their conversion in what they call their Midwest premium because the tariffs are creating a price umbrella for them, and there was also - we haven't seen too much of this, but some of the European aluminum suppliers are also using the tariffs as a mean to actually raise their prices to offset any impact of tariffs to them. So from our standpoint, in the United States, we still have limited capacity that can provide the type of products we have - need.

[Edward Marshall:]

Got it. And then finally, I just wanted to ask on performance materials. The cryogenic insulation. Does that represent the majority or the bulk of the detrimental margin on a year-over-year basis? Or the slide in your...

[Brendan Moynihan:]

Ed, you're talking the margin or the sales?

[Edward Marshall:]

The margin, obviously. Sales were up considerably, I guess, with the acquisition, but...

[Brendan Moynihan:]

Right, right. But specifically on the cryogenic insulation, sales were down year-over-year and sequentially double digits as we mentioned. The margin was impacted as a result of that because that's a relatively high margin product for us. And in addition, we also saw some unfavorable mix in the filtration segment between liquid and air filtration applications.

[Edward Marshall:]

Right. I guess, is this the run rate - I guess that's what I'm trying to get at. Is this the run rate? Because I imagine that it'll be a tough environment and a tough sell into China right now with the cryogenic insulation, and therefore, I might persist for a while. I'm trying to get a sense as to - is that responsible - that mix shift away from the cryogenic responsible for the majority of the decline in the margin within that business line?

[Brendan Moynihan:]

I guess that wouldn't classify it as the majority, but I think that you're spot on that unless the trade issues between the U.S. and China resolve, there will be some continued drag going forward on that particular product line.

[Operator:]

Our next question will come from Chris Moore of CJS Securities. Please go ahead.

[Christopher Moore:]

Maybe, Randy, just go back real quickly to the intangibles amortization. I don't know. I just want to make sure that I got those numbers correctly. And the $0.20 accretion that you were talking about in '19. That's going to be zero for '19. Is that right?

[Randall Gonzales:]

I'm sorry, Chris. Can you ask your question again?

[Christopher Moore:]

Okay. The larger amount of intangible amortization with respect to...

[Randall Gonzales:]

Yes. So we're expecting, I think, it's $13.9 million of amortization in '19.

[Brendan Moynihan:]

In '19, it'll be $16 million.

[Randall Gonzales:]

I'm sorry, $16 million in 2019. So that's higher than what we talked about in the August timeframe, right?

[Christopher Moore:]

Got you. Okay. I guess more of a big picture question from a gross margin standpoint. If you look at the many factors that have driven gross margins down since Q2 of '17, and then factor in the Interface acquisition, the Technical Nonwoven restructures coming to an end. What - I'm trying to get a feel for kind of what you guys view as kind of a new normal gross margin level 12 to 24 months from now?

[Brendan Moynihan:]

Yes, I guess, Chris, I'm not sure we want to put a specific number out there. I mean, generally, on the macro trends, we would anticipate in the longer term moving forward aluminum will come back to a more normal price. I think some of the tightness we're seeing in supply particularly on aramid fibers in Technical Nonwovens will hopefully resolve itself within the next, say, 6 to 12 months, and that should help us on recovering some margin there. And then in performance materials, I think you hit on it as we've said in the past, Interface is accretive on a gross margin, operating margin viewpoint to performance materials. So that will certainly help, and then the mix issues that we saw particularly in this quarter. We anticipate we'll go away moving forward as well. So I guess, we aren't - long answer, but we're not necessarily pegging a particular margin, but as we've alluded to in the past, overall, aspirational goal of 15% operating margin continues to be out there, and I think restated on an EBITDA margin, that will probably be closer to 19% or 20% going forward.

[Christopher Moore:]

Got you. Let me ask - if I'm looking at gross margins more near-term, from, say, Q4, from a visibility standpoint, sitting here today, how much variability is there in terms of still moving pieces between now and the end of December? And kind of how much ability is there to kind of target what Q4's gross margin will be?

[Randall Gonzales:]

Well, we don't give that type of guidance. But we do expect gross margins. If everything holds where they are today with the demand we think we have and what we're seeing in raw material cost as we sit here today, we would expect margins to improve in the fourth quarter.

[Christopher Moore:]

Got you. Yes. My question wasn't for a specific number. Just trying to understand which pieces kind of still were potentially causing variability, which could cause you to rise in December. So okay. And the last question, just in terms of the advanced materials, you kind of slowed down. You talked about it related to the needle felt sales to autos. Can you just talk about that a little bit further in terms of, is that a trend? Or kind of how you view it at this point?

[Randall Gonzales:]

Yes, so Chris, the - I mean, it is a trend in terms of the lower sales going from TNW to the automotive segment. I think that's consistent with what we have said in the past in terms of the volume of the fibers product line in TAS, the applications that we have.

[Christopher Moore:]

Understood, okay. Alright, I'll jump back in line. Thanks guys.

[Randall Gonzales:]

Thank you, Chris.

[Operator:]

[Operator Instructions] Our next question will come from Matt Koranda with Roth Capital Partners. Please go ahead.

[Matthew Koranda:]

Hey guys, thanks for taking the questions. Just want to start out with TAS. So in China, you guys alluded to, I think, mid-teens growth in the quarter despite a pretty choppy marketplace there. So could you just help us understand what about your customer or program mix enable that? And how should we sort of anticipate that trend going forward here?

[Dale Barnhart:]

Well, it's driven by new product winds we've had over the last 18 months, primarily with Western-related joint ventures in China. So we're supplying applications now either through a Tier 1 or directly to Shanghai. GM, I believe we have some Mercedes business in China, and also GM - and those are the primary 2 that we have right now. And it's all thermal, metal product that we are producing there.

[Matthew Koranda:]

Got it. And just in terms of your viewpoint going forward, I know the market's been a little choppy terms of production, but can you sort of sustain these growth rates in the environment that you're operating in there?

[Dale Barnhart:]

Well, I know that we'll sustain 17% quarter-on-quarter, but we still should be growing because regardless of what happens to the marketplace, we know, as we said before, we have relatively very low share, so winning 1 or 2 new applications has a significant impact on our base, which is relatively small right now.

[Matthew Koranda:]

Okay. And then sticking with the same segment, I mean, it seems like most of the drag in terms of operating margin in TAS is still metals and outsourcing just given the numbers you guys shared in the prepared remarks, but have you called out what fibers contributed in terms of the headwind in Q3? And just given your comments on aramid fiber and everything and other sort of rose in that segment, what are we anticipating in terms of the trend for the fiber side of the business going forward?

[Dale Barnhart:]

I don't have the supply - I can't quantify it for you. We can get back to you on the quantification, but in Q3, our fibers business was negatively impacted by when we talked about not recovering from the supplier issue in the second quarter. That did impact the Ford F series fiber product line, which was a pretty rich-margin product line. So that sales was down in the third quarter, and we're not seeing that recover in the fourth quarter. So that's volume that was just lost in the year. And then as we go forward, what we're seeing in that segment and that product category is continued price pressure from other competitors that are coming in, that are putting higher-than-normal price pressure on that product line.

[Matthew Koranda:]

Got it. Okay. So we should anticipate some further headwinds on that side of the business going forward. I guess, when you referenced, I think, Brendan referenced aramid supply issues may be resolving themselves within the next 6 to 12 months, could you elaborate on that statement a little bit more?

[Dale Barnhart:]

That's predominantly in the Technical Nonwovens area and driven by our power generation materials that we make for the power-generation market. Earlier in the year, we actually had a restricted supply, so everybody was scrambling for that. That seems to be relieving itself some right now, and there's been - because of lack of supply, or the shortage of supply, prices have gone up significantly, and we've been not able to recapture all of that increase in the price of our end product. It seems to be stabilizing now though, Matt, so going into '19, hopefully, we'll see leveling off of prices and increased availability of the product.

[Matthew Koranda:]

Okay. And then in Technical Nonwovens, I guess, why should Advanced Materials be seeing the year-over-year declines that it did in Q3? And I know you guys kind of call it out, maybe some auto-related softness and you did say geosynthetic was strong. So was that the only driver of sort of the year-over-year declines? And then just in terms of the outlook going forward, I mean, how should we be kind of factoring that into the growth outlook at least for the Advanced Materials side of that segment?

[Brendan Moynihan:]

Yes, Matt, specific in the quarter, auto was pretty much the big driver there. There wasn't a whole lot else driving that unfavorable comp. And as Randy alluded to, I think going forward, we're going to probably continue to see slightly lower volumes to the fibers business within automotive, and just to be clear on that, I mean, the automotive business has other supply sources available to them, and they used those and flex them up and down as required. We are - if the tariffs continue and escalate to 25% on Jan 1, we will then be seeing some higher costs for us to be bringing over some fibers from TNW China to TNW domestically here for use in the automotive business. So that's another thing we're monitoring very closely.

[Matthew Koranda:]

What would that do to the intercompany sales, I guess, just in terms of the sales from TNW to TAS, if that goes through in Jan 1?

[Dale Barnhart:]

One of the things we're looking to mitigate the downside of that is we are looking at qualifying the product in China at Texel - I mean, Canada, excuse me, so the product that we produce in China to run it on assets we have in our Canadian facility and if we're to do that, then we would just transfer that volume from China to Canada.

[Matthew Koranda:]

Can we do that between now and the year-end, or is that something that's going to take a little longer?

[Dale Barnhart:]

We're running through that process right now. Some of it will depend upon the qualification and approvals we'll need to get from the OEM, but from a Lydall standpoint, I'm pretty confident we'll be able to have a product - a qualified product running in Canada.

[Matthew Koranda:]

Okay, got it. Just a couple maybe for Randy. Just on the cash flow. Any sense for when I mean, there's been a big drag on cash this year given the working capital billed, and I think AR has been sort of one of the bigger drags. But when do we think that traverses? Is there an end in sight to that or and I guess, inventory also may be dragged down a little bit, but could you talk about sort of prospects of that reversing and timing?

[Randall Gonzales:]

Yes. We expect a big Q4, Matt, especially on our balance sheet where that the revenue recognition is hung up now in the balance sheet. It's called contract assets. So we're at record level of tooling. We do expect significant payments in tooling in Q4 as these products continue to launch. So Q4 reversal.

[Matthew Koranda:]

Okay. And the $8 million in benefit plan liabilities. Could you clarify that number there? And what that was?

[Randall Gonzales:]

The $8 million in benefit liabilities, I think, that's coming from the acquisition, right? From Interface.

[Matthew Koranda:]

Okay, I can follow-up on that offline if I needed. And then I think your guidance implies like a pretty decent size quarter-over-quarter uptick in CapEx, so just a little more color on sort of where that's being spent among the segments? Where are we seeing the most uptick?

[Randall Gonzales:]

So on the quarter-over-quarter CapEx?

[Matthew Koranda:]

Yes.

[Randall Gonzales:]

So I mean, we've continued to invest in the TNW restructuring. So there was a lot of expense there in the quarter, continued spending on these high-speed automated clients that have come on in the TAS business. So that's primarily what's been driving this.

[Brendan Moynihan:]

Yes. Matt, one of the things to keep in mind is we've kept the range constant at $30 million to $35 million, but we've also added Interface, so for the last 3, 4 months here we will probably have some capital requirements from Interface as well. So if you net that into, it's actually slightly lower than our prior guidance.

[Matthew Koranda:]

Okay. Alright, okay. I'll jump in queue guys, thanks.

[Brendan Moynihan:]

Thank you, Matt.

[Operator:]

Our next question is a follow-up from Edward Marshall of Sidoti. Please go ahead.

[Edward Marshall:]

Hi I just wanted to get a point of clarification if I could. You talked about the impact of the 25% tariffs on Jan 1. I'm curious, do you - can you quantify what that might do from a margin impact for you? If it were, say to go effect in Q3, but the margin would've done versus what it did on the reported basis?

[Randall Gonzales:]

Yes, Ed, we're sizing it up with what we're trying to understand is the 10% that did go into effect, to some degree we've been able to mitigate that because of the devaluation of the Chinese currency. So it's not been as big an impact, but part of like what Dale referred to is what our mitigation plan so that we don't get hit on January 1 to the same extent whether we qualify alternate suppliers, alternate locations along those lines. So I guess I hold back on quantifying anything at this point because we've got a bunch of mitigation plans in the works that we hope will spare us from part, probably not all of it, but at least part of it.

[Edward Marshall:]

Right. I guess, the question is what if you're unsuccessful in mitigating that risk? What the full impact would be to the business line?

[Dale Barnhart:]

We don't have that quantified, but we can get back to you.

[Edward Marshall:]

Okay. On - and then I just, the second follow-up I wanted to talk about is, you know we've talked about and this is specific to the TAS. We've talked about overhead cost. We've talked about aluminum, other pricing pressures that you might see, and then I guess I could throw tooling in there as well. I wanted to see if you could kind of bifurcate the difference between what may be a structural issues to the business into the margin? And then ultimately, what self-help can be done in the business in the near-term to kind of offset some of these obvious are here to stay, but maybe you can kind of walk us through what goes away, and when, and how to think about kind of the recovery in the TAS segment margin as we go forward?

[Randall Gonzales:]

So if you want to bifurcate, I mean, when we talk about operational efficiencies, and we mentioned that sequentially quarter-over-quarter, what we did see a reduction and was outsourcing as we continue to complete the product launches, Ed, I mean, we'll see reduction and over time as well. Don't necessarily want to put a number on it, but again, some of it is self-inflicted, and what you described as self-help that should improve again going into Q4. But a lot of the other structural stuff like you mentioned in terms of commodity costs that is here to stay in the near-term. So again, I mean, should see some sequential improvements in Q4 from the operational issues, but we'll also seek continued pressure on the commodity cost side going forward.

[Edward Marshall:]

But, but, okay. So maybe asking a different way. The product launches, when do they complete?

[Dale Barnhart:]

The fourth quarter is down substantially from the third quarter as far as the number of parts we're launching. It never actually goes away, but the third quarter was, yes, that they're all new parts so that's what we're in the business for. But the fourth quarter will be substantially lower than the third quarter in launches, and that's why at the end of September, we're able to bring back some pretty high-volume parts that we were outsourcing. So those are back in-house being run now.

[Edward Marshall:]

So if I step back, and I think about this, I mean, it doesn't sound like things are getting a lot worse, and you're kind of around the edge. You are looking at, say, improving specifics to looking at ways to mitigate some of the issues that you have. Some of it's going to be rolling off naturally as operations continue. So if I just think about, tell me if I'm right when I think about this. If I think about the third quarter at $0.54, it looks like the overhead cost was about $0.13 impact. I mean, the combined number there would be about $0.67. Is it right to annualize that and think about that as kind of a base scenario that we can kind of build our models off of as we start to think about the future? Knowing that there's not too much of a negative coming through, there's a few pieces here and there, but you're looking to mitigate them. I'm just trying to get a sense as to how to frame up 2019 and beyond.

[Brendan Moynihan:]

I think the math you're doing, Ed, is directionally correct. I mean, we've given you basis points, and I know you've dollarized those and put them into EPS. Again, those are year-over-year variances, so we're able to get back to an efficient operation in TAS similar to the level we reported in '17. Then I think your math is directionally correct.

[Edward Marshall:]

And then you would layer, I guess, interface on top of that as well? Is that required revenue that is coming in? It really probably didn't help the EPS all that much in Q3 imagine?

[Brendan Moynihan:]

And we only had one month of it. So certainly.

[Edward Marshall:]

Okay, great. I just wanted to kind of think about next year and how that might frame out. I appreciate your help, guys. Thanks very much.

[Operator:]

I'm showing no further questions. This will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Mr. Dale Barnhart for any closing remarks.

[Dale Barnhart:]

I want to thank everybody for joining us on the call, and I'm sure we will be speaking soon. Thank you.

[Operator:]

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