Lydall, Inc.
Q1 2016 Earnings Call Transcript

Published: 4 May 2016

[Operator:]

Good morning and welcome to the Lydall First Quarter 2016 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Chad McDaniel, Senior Vice President and General Counsel. Please go ahead.

[Chad McDaniel:]

Thank you, Cleo and good morning everyone, welcome to Lydall's first quarter 2016 earnings conference call. Joining me on the call today are Dale Barnhart, President and Chief Executive Officer; and Scott Deakin, Executive Vice President and Chief Financial Officer. Dale will start the call with comments about the continued progress we’re making in executing our long-term strategy as well as provide an overview of current business conditions. Scott 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. As you may be aware, our quarterly earnings press release and 10-Q quarterly report were released yesterday, so that you can follow along with today's call, please reference the Q1 2016 Earnings Conference Call Presentation, which can be found on our website 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 pursuing to the Safe Harbor provision as defined in securities laws. Please also refer to Lydall’s report on Form 10-K under cautionary note concerning forward-looking statements for further information. In addition, during this call, we will be making reference to non-GAAP financial measures. A reconciliation to GAAP financials will be found on the appendix in the presentation I just referenced. With that, I'll now turn the call over to Dale.

[Dale Barnhart:]

Thank you Chad, good morning everyone and thanks for joining us today. I am very pleased to report that we had an excellent start to the year and our continued progress gives me confidence that we remain on the right path to achieve our 2018 long term vision for profitable growth that includes $800 million in revenue and operating margin of 15%. Slide 3 outlines are recently published financial results for net sales, operating margins and earnings per share. Our diluted earnings per share were $0.54, up 29% versus first quarter 2015 adjusted earnings per share of $0.42. On a GAAP basis first quarter 2015 diluted earnings per share were $1.11 which included $0.69 per share gain related to the sale of the Vital Fluids business. Reported net sales grew approximately 2% to $129.7 million, excluded from these numbers is the 2015 divestiture of our Vital Fluids business which had a 1.3 percentage point impact on quarter-to-quarter sales, also excluded foreign currency translation of 1 point. The company delivered organic sales growth of 2.9%, with strong organic growth across three of the company's four segments our results were principally the result of continued strength in the automotive markets, coupled with share gains on several platforms. Moreover we delivered organic growth of nearly 6% in our performance material segment, largely driven by early signs of recovery and the Air Filtration markets. Despite continued growth in the inner company's supply of material to the Fiber segment industrial filtration posted a decline in organic sales was 6.8% as softness in power generation markets dampened the demand for the segments filtration products. Which respect to profitability adjusted gross margin increased by 340 basis points to 25% and operating margin improved 260 basis points over the prior year to 10.5%. This performance reflects the benefit from lower raw material cost, favorable product mix and further progression on the company's Lean Six Sigma continues improvement programs. Moving on to a couple of other matters, first with respect to the ongoing investigation related to the possible violations of the German anti-trust laws, we continue to actively work with the German Federal Cartel Office. While we expect to bring this matter to conclusion sometime in 2016, we are unfortunately still unable to fully estimate the specific timing or quantify the liability associated with the matter. Second, with a 30% increase in capital expenditures in Q1 2016 versus Q1 2015, we continue to progress in our deployment of strategic capital across the company. Notable including growth and productivity investments made in both our fibers and metals operations. For the full year 2016 we expect to invest between $25 million and $30 million in capital for strategic growth and operation improvement programs. 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. First with respect to M&A, we are previously communicated from both a financial and organizational resource perspective, we have the means, wherewithal, strong desire and proven track record to execute additional acquisitions, focused primarily in the filtration in the specially engineering materials spaces. We have a robust target pipeline and although we cannot predict specific timing we are encouraged by our various pursues, and expect to put our balance sheet to good use through selective and well executed M&A. With respect to Lydall Lean Six Sigma we have already benefited from significant improvements over the past years and we continue to look at new ways to operate more efficiently to serve our customers. During the first quarter we continue to execute on the strategy and realize the additional operating margin expansion over the prior year across all of our businesses. Together with favorable mix and raw material savings realized from beneficial market conditions as well as the results of strategic sourcing programs, company delivered increment of gross profit on organic sales of more than 135%. In terms of international growth our newest operation in China for the metal segment continues to progress with a solid base of customer demand. With supplier qualification issues behind us and the installation of a second press largely completed. We are seeing marked improvement in the financial performance in this facility and expect to achieve at least breakeven and operating income for the full year of 2016. As a reminder this facility at a 120 basis points dragged on the metals full year operating margin in 2015. Finally as previously discussed, one of the best examples of progress in the new product development existing in our Fibers segment, where we will start delivering later this summer an integrated flooring product for the interior cabin of several pickup truck models. The product enters us into Class A interiors segment, where we will provide our first molded product with surfaces that consumers can regularly see and touch. Our flooring is a one-piece molded fiber solution that significantly improves product durability and styling, while also offering acoustical attenuation. Turning to Slide 5, with respect to business conditions although it is early in the year, we continue to see generally stable demand for our products with pockets of continued strength and improvement offset by some other pockets of softness. Within our automotive business current visibility suggest that overall demand and global automotive market remains healthy, light vehicle production both in North America and Europe is forecasted to increase by mid-single digits in 2016 and our planned new product and platform launches throughout the year give me confident that we remain well positioned to not only grow with the market, but to continue to capture platform share. With respect to China, we're excited to be ramping up our operations so that we can progressively participate in one of the largest automotive markets in the world. In our performance material segment, while demand for installation for our products remains muted due to the continued softness in liquid natural gas markets, we saw some early signs of improvement in demand in other product lines. Particularly for air filtration markets, moreover share gains in Europe remain at highlight for this segment. Finally, in our industrial filtration segment, we continue to benefit from solid pull through on our non-filtration product demand as part of the successful implementation of our acquisitions synergy programs. We are facing headwinds in certain markets given tight competitive environment coupled with softness in demand from power generation customers. To wrap up my comments, we are very pleased with our performance in the first quarter which demonstrated both growth in excess of end markets as well as exceptional margin expansion, and I'm very proud of the work of the Lydall team. We continue to operate well, allowing us to take full advantage of favorable market conditions. The team looks forward to delivering another year of solid performance in 2016. With that I'll now turn the call over to Scott.

[Scott Deakin:]

Thank you, Dale and good morning everyone. Today, I'll provide a brief overview of our consolidated financial highlights for the quarter and then speaks to the performance of our segments individually. Turning to Slide 6, in the first quarter of 2016, the company achieved net sales of $129.7 million, an increase of 1.9% over the prior year. There were several discrete items affecting this growth. First, the divestiture of the company's Vital Fluid segment which occurred on January 30, 2015, had an unfavorable impact on the quarter-on-quarter sales comparison of 1.3%. Second, foreign currency translation reduced our quarterly comparison by 1 percentage point principally due to differences between the euro and U.S. dollar. Third, tolling sales which reflect requirements for customer funded capital associated with new platform launches, particularly in our metal segment, we're up 1.3% over the prior year. Considering these factors that company posted net organic growth of 2.9%. This was principally the result of continued strength in automotive markets, where Lydall enjoyed the favorable quarterly comparison given a plant shutdown at a key customer in the first quarter of 2015 as well as growth in excess of market realized through platform share gains. Performance materials also had a solid growth quarter-on-quarter given promising signs of recovery in the air filtration markets. Our only area of softness at the segment level as Dale noted, was seen in the industrial filtration segment within demand and power generation market and a tighter near-term competitive environment outpaced the continued strength and inter-company demand from thermal acoustical fibers. In terms of profit our adjusted operating margin for the quarter was 10.5% up 260 basis points compared to the Q1 2015, adjusted operating margin, this gain was driven by several positive factors including the effect of strategic sourcing programs in an environment of generally attractive commodity pricing, favorable absorption on increased sales, beneficial mix and continued progress of our Lydall's Lean Six Sigma program. The effective tax rate for the quarter was 33.1% compared to 35.9% in the first quarter of 2015. We continue to anticipate our effective tax rate going forward will fall somewhere in a range of mid to low 30s. Diluted earnings per share were $0.54 compared to adjusted earnings of $0.42 in the first quarter of 2015. Reported GAAP diluted EPS was a $1.11 in the first quarter of 2015 which reflected the gain on the divestiture of Vital Fluids of $0.69 per diluted share. Moving to the balance sheet, our liquidity remains strong. At the end of the quarter, cash was $69.5 million after reflecting a further pay down of our debt of $10 million during the quarter. At the end of the quarter our remaining debt was $10.1 million. Finally as it relates to capital expenditures we spend approximately $9.6 million through the first three months of the year compared to $7.4 million in the prior year. For the full year 2016, we expect total capital expenditures to be in the range of $25 million to $30 million. Moving to Slide 7, I'll discuss our segment results. I'll start with our Thermal Acoustical Metals business. This is our global automotive segment which specializes and providing under hood and under body engineered thermal solutions for vehicles. This business delivered healthy organic sales growth of 5.6% during the quarter, net part sales increased $1.8 million or approximately 5% compared to the prior year, tooling sales were also up significantly in the first quarter of 2016 given the timing of new product launches, while operating profit dollars were flat relative to prior year segment operating margin declined 90 basis points in the quarter to 8.5%. Favorable material cost were offset by the mix impact of low margin tooling sales in the quarter, coupled with what we believe to be short-term operating inefficiencies as a business ramps up to support growth across all regions. Slide 8, referred to our Thermal Acoustical Fibers business, similar to Thermal Acoustical Metals this business serves the automotive industry and provides molded polyester acoustical solutions, primarily for underbody application for vehicles in North America. Segment level sales were $35.9 million in the quarter which was a significant increase over the reported $31.1 million in the prior year, while tooling sales decreased modestly in a quarter, part sales were up significantly on relative growth in the automotive sector and favorable positioning and well performing platforms, notably including sales to one customer who had a planned shutdown in the first quarter of 2015. The revenue strength in the segment drop through nicely to profit as operating margin in the quarter increased by 600 basis points quarter-on-quarter to 28.8%, reflecting favorable absorption, material pricing and lean based continuous improvements. Moving to Slide 9, I'll cover our performance material segment which provides specialty filtration and installation to a variety of end markets globally. Net sales of first quarter increased 5.3% quarter-on-quarter to $26.4 million, improving on several prior quarters of headwinds and performance material market, the business saw encouraging early signs of improvement in the air filtration during the quarter. Together with termination buys [ph] in life science filtration by a certain customer due to a discontinuation of certain raw materials used in the production process. These two product lines saw quarter on quarter gains of 13.9% and 17.7%, respectively, conversely thermal installation products which were sold in the market serving liquid natural gas applications facing further declines as these end markets continue to be soft. Segment level operating margin improved by nearly 3 points to 8.1% during the quarter as a result of leverage on the increase sales and the effect of continuous improvement programs. Slide 10, covers the industrial filtration segment, this business focuses and providing needle felt filtration solutions, primarily for the global industrial air filtration segment in non-woven rolled-good media for various commercial applications. For the first quarter of 2016 sales were $31.2 million and operating margin was 12.6%, our intercompany sales of rolled-good to Lydall's fiber segment remain strong, sales of the unit filtration products were down in the quarter, primarily as a result of general softness in the power generation market where these products were sold, coupled with otherwise tightening competition. Conversely sales of the segments other filtration production remain healthy, creating a favorable mix on profit. This together with favorable material cost and lean improvements, contributed to the 340 basis point improvement in the segment operating margin. This concludes my comments regarding Lydall's financial performance for the quarter. I'll now turn the call back to Dale.

[Dale Barnhart:]

Thank you, Scott. To summarize, we had another excellent quarter. Our end markets are stable and we continue to remain focused on executing new product development, implementing Lydall Lean Six Sigma, and putting our very strong balance sheet to good use. With that, I'll turn the call back over to the operator to begin our question-and-answer session.

[Operator:]

Thank you. We'll now begin the question-and-answer session. [Operator Instructions] The first question comes from Robert Majek from CJS Securities. Please go ahead.

[Robert Majek:]

You touched on it in your prepared remark but I was hoping you could give us little more color on the weakness you're seeing in the power generation end market and what you are seeing in Q2, has it leveled off here or are we likely to see further sequential revenue decline?

[Dale Barnhart:]

What we're seeing is -- what's driving the power generation market softness. One we are seeing a slowdown in new major products or commissioning of new co-fire power plans particularly in North America and we had anticipated that, we know that that’s a trend in that space. But what we are seeing is the delay in the replacement cycle, I think utilities are pushing off some of the expenses that they have as it relates to replacement filters, so that’s the primary impact in North America. And also we are seeing a similar decline in push out of orders in China as it relates to the overall macro-economic issues in that country. Going forward in the second quarter we actually see a second quarter at or slightly better than first quarter revenue in that’s space.

[Robert Majek:]

And corporate expense were up a million or so year-over-year and it sounds like the increase was almost personal cost, what would behind those expenses and how much of that was possibly one time in nature?

[Scott Deakin:]

Hey Robert, let’s say all of it was really one time in nature, about half of it was related to compensation expenses, principally equity based compensation and the second piece was related to some professional fees that as you know were really one time in nature, and we’ll see a little bit of that going to the second quarter, but it will start to equal out after that point.

[Robert Majek:]

Great and the fibers business continues to generate solid margin, if volumes holds here, can you give us an update on how sustainable margins are at this level in the near term?

[Dale Barnhart:]

I think the longer term as we have always said we think that the margins will probably drift down some. Right now we had exceptional volume in that space and positive material impact in the first quarter, but we expect for the full year the margins in that business will be comparable to what we had in 2015. You may see some quarter-to-quarter swings, but on the full year we should be able to deliver the operating margins we had last year.

[Robert Majek:]

Great and on the lower volume material cost, can you quantify the benefit there and how many quarters of benefit we have until that lapses?

[Scott Deakin:]

Yes, we have about -- call it about $2 million of commodity based savings in the quarter, coupled with probably about another $1.5 million, it's related to material productivity and then if you take that commodity piece you’ll see similar kinds of benefits into the second quarter. And then we will start to see it reduced down into the third and fourth quarter.

[Operator:]

The next question comes from Edward Marshall of Sidoti & Co.

[Edward Marshall:]

I wanted to ask you about the metal segment, in the margin I guess specifically, I'd say it probably wasn’t as strong as I thought maybe you entered the year with and especially with sales up 10% year-over-year. So I assume maybe it was still the sourcing issue that’s lingering around there, maybe some disruptions from the second press going in the, maybe you could talk me through what happened with the year-over-year decline in the margin and then maybe discuss some of the geographic or maybe platforms that was responsible for the growth as we moved into Q1?

[Dale Barnhart:]

First of all, it was the material issue in China is behind this and it had no impact on the quarter-to-quarter performance. If anything it would have been positive because we do have that issue behind us. The significance of erosion in the margin was due to a couple of things; one, we are launching several new platforms in North America, one for the Chrysler Pacifica, they are in line where we have a significant content and during year ramp up of a product, you have inefficiencies because you are not running at full rate, you’re running at sample rates and so on. That’s pretty much behind us now as we’re going into the second quarter we’re pretty much running at rate now, so that inefficiency should be behind us. In addition, one of our European site wasn’t running quite as well as it should. We had had some issues with excessive overtime due to what was reported as illness from the flu in that location of the world, that seems to be behind us and then we are addressing that on a longer term basis as we continue to focus lean in that area. As far as some other new platforms I mentioned the Chrysler Pacifica which is a very exciting platform for us, we have also won significant contract on the Honda Civic and we are providing that product on that platform now that our -- one of our European operations and our North American operation and they have significantly increased their demand on us. So we hope to see that to continue for the balance of the year. And then in the second half in the Fibers -- you are talking metals, so those are the key platforms that we won and things are, I think should be improving as we go forward.

[Edward Marshall:]

So this is your low watermark for the year, as far as the margin in the metals?

[Dale Barnhart:]

We think so. We will be disappointed if we don’t see quarter-on-quarter improvement.

[Edward Marshall:]

The conversion to -- in the metals business to say double wall insulators, first is that what you are referencing when you talked about the Chrysler Pacifica, I thought that was more of a late 2017 driver? And then can you talk about maybe the timing of how that ramps up and maybe the percentages of new vehicle rollout that you anticipate that's you are going to be on?

[Dale Barnhart:]

So the last point of percentage of new -- I don't have that off to top of my head, but we can get that to you latter Ed. But as it relates to the Pacifica, yes, those are all dual wall applications and they are large parts. It's one of the platforms that required us to make the $5 million investment in a new high speed line to produce that product. So, again that's part of the inefficiencies we had in the first quarter, as that new asset was ramping up and we're trying it, you’re really not running at full rate. So the Chrysler Pacifica is very significant application for us and it's starting to be sold now, it's being advertised on TV and we expect it to be a really good winner for us going forward.

[Edward Marshall:]

Because that you're reducing the amount of competition by moving to double wall insulators, because I think there is only one other competitor that does this. How does this effect to your pricing and therefore margin as you progress and get ramped up, can you circumvent some of the OEM pressures to pricing as a result or is this just another product line that you make and just have less competitions so it’s more of a sales driver for volume.

[Dale Barnhart:]

Ed, there are more than just one principal competitor, I mean, ElringKlinger is our strongest global competitor, but they are probably four or five others that can compete with dual wall technology. As far as pricing it’s the creativity and the relationship we have with the OEMs, and you know that these parts of custom designed for the space that they’re in and our application and engineering team in Detroit is excellent in working with the customers and speed at design and delivering those designs and then going into production and really with flawless launches, so that's a key driver. Does this have margin expansion? Absolutely. It's a higher value product, it is higher more engineered product, the maturity of the glass insulating material that we used in between the layers of metals is produced in our performance material. So, again more margin for Lydall corporate. So -- and it is the strategy of the business and we've taken it to where it’s over 50% of our product sales now or the higher value dual wall applications.

[Edward Marshall:]

And lastly, I’ll touched on maybe capital deployment. You reduced debt almost to nothing, I guess in second quarter that will probably go to zero. As you look at spending 25 million to 30 million, which I guess is quite high for Lydall on a historic basis, first what are you building and secondly, what are your thoughts from a capital deployment now that you're moving towards in net cash positions or rather a cash -- a debt free balance sheet rather.

[Dale Barnhart:]

Obviously, we've focused on the 25 million to 30 million we work on this year. As we talked about, principally that's in our metals and fibers businesses based on the new programs we've won, so that's why you're seeing numbers that are higher than what I -- sort of through the cycle run rate would be. We had higher numbers also in '15, but you will start to see in '17 that'll start to work its way down to '15 kind of level going forward. Beyond that I think we've been pretty open around what our capital deployment priorities are, first is around M&A and we're pursuing that very actively, you will see some other things in terms of pension de-risking that are small by comparison and then beyond that we're looking at other things like dividends in the long-term, but you won't see us keep pursuing those actively here in the next few years.

[Edward Marshall:]

Thanks very much guys.

[Operator:]

[Operator Instructions]. We have another question from Edward Marshall of Sidoti & Co.

[Edward Marshall:]

Just a follow up, your guidance rate on the million, 15% Op margins, do you want to put a timeframe as to when you anticipate that, you expect to kind of achieve that, as probably I assume it's probably moving and has a lot of moving pieces to your business, but any help or clarification?

[Dale Barnhart:]

One of the key elements to get there as we’ve stated all along will be achieving -- acquiring a 100 million and 150 million of revenue through our M&A activity. So, it's hard to predict when that would happen, as Scott said, we have a very active pipeline, we think we have some very interested opportunities ahead of us, but we really can't predict that. If we look at your businesses between now and 2018 we would say that they range anywhere from 4% to 6% organic growth over that period so you can do the math and that would show you where we would be as far as the 15% operating margin, we're doing very well against that I mean, at 10.5% in the first quarter we continue to make improvements there, as we get some of these inefficiencies behind us, as you noted in the metals business that will continue to improve. So I feel very comfortable where we -- for us achieving that by 2018, again with the uncertainty of timing of acquisitions, it's really hard to say exactly when we'll be there. But by 2018 I'm confident we will

[Edward Marshall:]

Do you think that you can get to a higher margin ex-M&A opportunities because that is sometimes dilutive to the margin initially like -- for instance your filtration business was. Do you think your margins expectations could be even higher ex-M&A or --?

[Dale Barnhart:]

Again, I don't want to -- obviously, we're going to strive to continue to go past that, but I would say right now if you're looking at it, stick to our vision of 815 and hopefully we’ll surprise you.

[Edward Marshall:]

Thanks very much, guys. Have a great afternoon.

[Dale Barnhart:]

Thank you.

[Operator:]

[Operator Instructions] Excuse me, this concludes our question-and-answer session. I'd like to turn the conference back over to Dale Barnhart for any closing remarks.

[Dale Barnhart:]

I want to thank everybody for the participation on the call and most importantly thank the Lydall team for another excellent quarter. Thank you very much.

[Operator:]

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