Lydall, Inc.
Q4 2015 Earnings Call Transcript

Published: 25 Feb 2016

[Operator:]

Good morning and welcome to the Lydall announce Fourth Quarter and Year-End 2015 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 David Glenn. Please go ahead, sir.

[David Glenn:]

Thank you, Denise. Good morning everyone and welcome to Lydall's 2015 fourth quarter earnings conference call. Joining me on today’s call 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 and provide an overview of current business conditions. Scott will follow with a more summary of our financial performance and discuss the key drivers by segment. Once complete, we’ll open the line for Q&A. As you may be aware, our quarterly earnings were released yesterday, so you can follow along with today's call, please reference the presentation slides entitled, Q4 2015 Earnings Conference Call, which can be found at lydall.com in the Investor Relations section. As noted on slide two 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 annual report on Form 10-K under cautionary note concerning forward-looking statements for further information. In addition, during this conference call, we will be making reference to non-GAAP financial measures. A reconciliation to GAAP financials can be found in the appendix of this presentation I just referenced. With that, I’d now like to turn the call over to Dale.

[Dale Barnhart:]

Thank you, David. Good morning everyone and thank you for joining us today. I am very pleased to report we had another strong quarter and a great 2015 during, which we delivered record earnings. This consistent year-over-year progress, we have made gives me continued confidence that we're on the right track to achieve our 2018 long-term vision, for profitable growth that includes the goal of $800 million in revenue and an operating margin target of 15%. Slide three outlines the key takeaways for both the year and the quarter. I will cover the key points for 2015 and Scott will take you through the fourth quarter results when he provides a more detailed summary of our financial performance. Total net sales year-on-year increased 1.3% to $522.8 million, excluding the impact of the divestiture that we completed in the first quarter of 2015. As we have experienced for most of the year, foreign currency translation had an unfavorable impact of nearly 5%. Adjusting for these factors, we delivered organic growth of 3% for the consolidated company. This was tempered given the challenging year in our Performance Materials segment, which was down approximately 6% organic. Importantly, all of our other segments experienced very strong organic growth ranging from 7% to 11% year-over-year. With respect to profitability, adjusted gross margin increased by 180 basis points to 23.3% and adjusted operating margin improvement 160 basis points to 10.3% over the prior year. This performance reflects favorable product mix, lower raw material costs, continuous improvement through Lean Six Sigma and execution on our synergy programs within Industrial Filtration. For the full year, adjusted EPS, which excludes one-time nonrecurring expenses was a record $2.10 per share, an increase of 20.7% over the prior year. Moving on to a few other matters, in the fourth quarter the Company reported a $1.4 million non-cash intangible asset impairment charge relating to our Solutech operation, which is part of our Performance Materials segment. Since the 2008 acquisition of this technology, we have been working on commercializing membrane filtration products. Because of delays in the ramp up of these products on several key applications, accounting requirements lead us to record this impairment charge in the fourth quarter. This charge notwithstanding, we still believe in the technology for use in filtration as our membrane has high flow rate, ability to capture more particles due its depth and a superior ability to repel oil and water. We continue to work on driving adoption of air sulfur [ph] intake filtration in natural gas fired turbines and we are pursuing other opportunities, including applications for high-end vehicle cabin air filtration and energy storage. Both of which are in late stage development and product qualification. Second, with respect to the ongoing and previously mentioned investigation related to the possible violations of German anti-trust laws, we continue to work with the German Federal Cartel Office. The investigation is progressing and we are hopeful that we will have more substantive update on this matter sometime later this year. Despite our regular communications with the German authorities, we are still unable to estimate either the timing or the amount of the liability associated with the matter. But we will continue to provide updates, should there be any material development. Third during 2015 we spent $20.6 million deploying capital. This level of approximately 50% higher than we spent the previous year and we anticipate that spending at this greater rate will continue in 2016. Our additional investments are focused on attractive growth and productivity opportunities that we'll begin to materialize in 2016 and position us well for future success. One of the largest investments was for a state-of-the-art high-speed line support our Metal segment being awarded new business in North America from Fiat Chrysler and Honda. Turning to slide four, this is an overview of our long-term growth strategy, which includes four key drivers; new product development, Lean Six Sigma, geographic expansion and M&A. With respect to new product development, all of our businesses are focusing on developing next-generation solutions. To highlight one example of product innovation, our Fiber segment will start delivering an integrated flooring product for the interior cabin of pickup trucks in mid-2016. This product enters us into Class A interiors segment, where we will provide our first molded product with surfaces that the consumer can regularly see and touch. Our flooring is a one-piece molded fiber solution that significantly improves product durability styling, while also offering acoustical insinuation [ph]. We are encouraged by the prospects of extending this Class A capabilities in traditional applications over time. As it relates to Lean Six Sigma we continue to identify new ways to operate more efficiently. Our Performance Materials segment has an excellent illustration of this. This business despite decreased year-on-year top line was able to achieve gross margin expansion through lean activities such as reduced machine change over time and the implementation of pull systems for inventory control. The benefits of these activities will fully be realized once growth in this business accelerates. As you may have seen we recently announced that we have that we have Paul Marold to be the new president of our Performance Materials segment. Paul brings extensive knowledge in filtration industry experience with successful track record in sales, marketing and operational excellence, and a proven ability to drive profitable growth. We look forward to his future contributions. Moving on to geographic expansion, we have been working to ramp up our volume in our Thermal/Acoustic Metals facility in China. While this new facility was a drain on profitability in 2015, we expect at a minimum to achieve breakeven for 2016 as we continue to increase product volume in support of new product launches. Consistent with our general operating philosophy, we will continue to be judicious with our capital investment and grow the China business in a measured rate to meet or exceed our operating margin expectation of 15% or greater. Lastly with respect to M&A, I have previously communicated both for my financial and organizational resource perspective, we have the means, the wherewithal and strong desire to execute additional acquisitions, primarily in the filtration and specialty engineering materials spaces. With a robust pipeline, target pipeline and although we cannot predict the timing, we expect to put our balance sheet to good use through selective and well executed M&A. Turning to slid five with respect to the business conditions, although it is early in the year, we have seen relatively stable demand for our products to date, at levels consistent with the second half of 2015. Within our automotive business, current visibility suggests that the overall demand in global automotive market remains healthy. Light vehicle production in North America and Europe is forecast to increase in 2016 and our planned new product platform launches throughout the year, giving me confidence that we remain well-positioned. With respect to China, we are excited about the opportunity to ramping up our operations, so that we can participate in one of the largest automotive markets in the world. Looking to our filtration and engineering materials business, Performance Materials show continuous softness in demand principally due to sustained pressure oil is placing on our energy-related products. Consistent with what we saw last year, demand for filtration products in North America has been light and Asia remains challenging as we continue to face highly competitive environment. Conversely, we continues to see experience strong demand in Europe. While the industrial filtration business is typically characterized by a strong first half and second half due to seasonal filtration replacement cycles, we have seen a slightly slower start to the year in North American filtration. We're cautiously optimistic around the timing of orders for these products. Our supply of non-filtration rolled-good media to our fibers business continues to be very strong. Before I turn it over to, I want to reiterate, we're extremely proud of our performance during 2015. And I would like to congratulate our employees for their terrific execution. As a result of their efforts, we remain on track for achieving our 2018 vision. With that, I now turn the call over to Scott.

[Scott Deakin:]

Thank you, Dale good morning everyone. I'll provide a brief overview of our consolidated financial highlights for the question and then speak to the performance of our segments individually. Returning to slide six, consolidated sales were $131.4 million in the fourth quarter of 2015, excluding the divestiture of Vital Fluids, unfavorable foreign currency translation and an increase in tooling sales, organic sales grew 6.7% in the fourth quarter of 2015, compared to the fourth quarter of 2014. Gross margin for the quarter increased 240 basis points to 22.2%. This strong expansion reflects continued favorable product mix, reduced raw material costs and continued productivity improvements. Our adjusted operating margin for the quarter was 9% up 270 basis points compared to Q4 2014. Fourth quarter earnings per diluted share were $0.31 compared to $0.34 of earnings in the prior year. While adjusting for the one-time impact of discrete income tax changes in the previously mentioned non-cash intangible asset impairment, earnings per share rose by 39% to $0.46. For 2015, the reported effective tax rate was 34.9%, adjusting the rate to exclude one-time nonrecurring items related state tax law changes, the effective rate would have been closer to 33%. While these tax law changes were unfavorable to 2015 they will have a positive impact on our rate going forward. For 2016 we anticipate our full-year effective rate will fall somewhere in the low 30s. Moving to the balance sheet, our liquidity continues to remain very strong. Cash at year-end was $75.9 million compared to $62.1 million at year-end 2014. Total debt at the end of the quarter was $20.5 million which from a leverage perspective puts us at a debt to EBITDA ratio of approximately 0.3 times, giving us plenty of financial flexibility. As previously communicated, we continue to feel that we'd be comfortable carrying the leverage upto 2.5 times debt-to-EBITDA and are willing to put our balance sheet to good use on selective acquisitions in order to complement organic growth. Finally, we spent approximately $20.6 million in capital expenditures in 2015 and we expect total capital expenditures to be in the range of $25 million to $30 million in 2016, as we continue to invest at a higher rate than usual in support of attractive growth and productivity opportunities. That concludes my summary level financial review for the fourth quarter and I'll now walk through the financial highlights by segment. Turning to slide seven, I'll start with our Thermal/Acoustical Metals business. Among our most global businesses, metal specializes in providing molded under hood and underbody thermal and acoustical solutions for vehicles. During the fourth quarter 2015, total sales were $41.4 million, an increase of 7.7% compared to Q4 2014. Organic part sales growth of 6.6% and the quarter was strong as foreign currency translation continue to impact the reported results. For the full year of 2015, segment level sales declined by 2.2%. Similar to our fourth quarter results however, organic growth for the full year was solid [ph] at 6.5%. From a geographic standpoint, the majority of this growth was experienced in North America given the launch of several new platform applications. Looking at operating margin, Performance segment level margin decreased 100 basis points in the fourth quarter to 7.7%, reflecting the near-term impact of greater mix of lower margin tooling sales. For the full year, adjusted operating margin decreased by 60 basis points, impacted by unfavorable tooling sales mix as well as now resolved material sourcing efficiencies at our Chinese operation, that occurred primarily in the first half of the year. The China facility in 2015 negatively impacted operating margin for the segment by approximately 120 basis points. As previously indicated, we anticipate that this facility will achieve at least breakeven profitability in 2016. Slide 8 shows our Thermal/Acoustical Fibers business performance. The segment provides molded acoustical solutions, primarily for vehicle underbody application and principally in North America. Part sales increased 21.6% to $34.9 million in the fourth quarter of 2015 compared to the same period in 2014. Quarter-on-quarter growth was driven by robust end market demand, coupled with a favorable comparison to Q4 2014, as a key customer experience the planned facility shut down during that period. Part sales increased 8.9% to $135.6 million for the full year 2015 compared to the full-year 2014. Organic growth was very strong in both periods at 21.5% and 8.7% respectively, as we continue to win new business and experience increased demand from the platforms we serve. Operating margin in the quarter of 25.7% and for the full year of 26.7%, increased substantially compared to the same periods of 2014. Margin improvement to these levels was primarily due to increased volume and the associated absorption of fixed cost, a favorable mix of product [ph] sales and labor efficiencies driven through the progression of Lean Six Sigma. Moving to slide nine, I will now cover our Performance Materials segment. This business provides specialty filtration and insulation solutions to a variety of end markets globally. Net sales in the fourth quarter were $23.9 million compared to $27.1 million in the prior year. Excluding foreign currency translation, organic sales declined 7.5%. For the full-year, sales decreased by 12.4% to $101.5 million and again, excluding foreign currency translation, organic sales declined 6.4%. The reduction in sales for both the quarter and the year is attributable to lower demand across all product segments driven primarily by softness in North America and Asian filtration markets and lower demand for insulating products that serve energy-related applications. European growth however, for this business was solid across all segments in the quarter. Despite reduced sales volumes, segment level adjusted operating margin increased by 130 basis points to 8.7% in the fourth quarter of 2015 compared to the fourth quarter of 2014. This driven primarily by lean based operational improvement and tight cost controls. Slide 10 covers Industrial Filtration. This business focuses on providing needle felt filtration solutions, primarily for the global industrial air segment in non-woven rolled-good media for various commercial applications. The business achieved sales of $34.9 million in the fourth quarter of 2015 and contributed $139.1 million in total sales for the full-year. Organic sales growth for both the quarter and the year was strong at 18.7% and 10.9% respectively. Turning to fourth quarter, increased sales in the U.S. and China offset weaker demand for filtration products in Europe, the latter largely driven by near-term foreign exchange pricing pressure. Sales of non-filtration rolled-good media primarily to our Fibers segment favorably impacted both the current period and full-year. Total intercompany sales between these segments was $13.8 million in 2015. Segment level operating margin was 6.8% in the quarter, 150 basis point improvement over the fourth quarter of 2014. For the full-year, our operating margin improved 220 basis points to 9.7% over the adjusted 24 [ph] operating margin reflecting increased absorption from our synergy programs with fibers and also favorable raw material savings. This concludes my comments, and I'll now turn the call back to Dale.

[Dale Barnhart:]

Thank you, Scott. To summarize, we finished with a good quarter in both growth and margin improvement, capping what has been an excellent year. Our results confirm, we remain on the right path to achieve our 2018 long-term vision for profitable growth. Our end markets are stable and we continue to remain focused on executing new product development, implementing Lydall's Lean Six Sigma, driving geographic expansion 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:]

[Operator Instructions] We have a question from Robert Majek from CJS. Please go ahead, sir.

[Robert Majek:]

Good morning.

[Dale Barnhart:]

Good morning, Rob, how are you?

[Robert Majek:]

You mentioned that the company is experiencing stable demand entering 2016 relative to the back half of 2015. Could you maybe break that down more and give us that comparison by segment and perhaps your expectations for the full year?

[Dale Barnhart:]

Well, the automotive market as we see today is robust. I mean, as I mentioned on the script, we are seeing growth in both sales and factory production in Europe and North America. With that, we've gained new applications in both of those regions of the world, and therefore we anticipate that in the first quarter and the full year, if the industry holds true to that that we will have improvement year-over-year in our automotive space. With regard to Industrial Filtration, we started a little slow in North America on the filtration, but some of that is product mix. We're seeing a lower revenue value with actual material that we're producing yards of material are stable or slightly increasing and at a little better margins. So all in all we're not too nervous about Industrial Filtration in North America and it continues to benefit by supplying product to our fibers business in automotive. In Europe and Asia we were actually seeing a little bit of uptick in the first part of the year on Industrial Filtration. For the full year, I think what we have to watch in Industrial Filtration is our business in China. Right now we can see it two different ways; one, we've all heard about the economic pressure that's going on in China, so that could have a negative impact. But on the other hand what we produce in China Industrial Filtration is for pollution control. I think we all know that China has a major issue there as far as pollution control and if the government continues to enforce their clean air standards, despite a slowdown in the economy we could see an upturn in our business in China. Today as we sit in China our backlog is stronger than it was the same period last year, but we are seeing some customers delay some releases on that. So all-in-all, we feel good about our 2016. Then Performance Materials, again a little slow start in North America in filtration and in our energy-related products that are impacted by low oil prices. We're continuing to see that, but we will be lapping that pretty soon and we expect that that will be stable with 2015. Europe is a bright spot for us, it continues to be strong. Our operations in Europe are now running 24/7. We've added a shift there and we're actually supplying some product out of North America to support the demand we're seeing in Europe. So we're cautious, we're really watching that business. We're quite excited about the new leader we have for Performance Materials and I think that individual Paul Marold will bring a great insight into how we can return growth to that business. Once we do because of the lean initiatives that we've driven in that business, we'll leverage that very well to the bottom line.

[Robert Majek:]

Thank you that was helpful. And on your international expansion plans for the Thermal/Acoustical Fibers business. Could you just give us a little more color on the potential opportunity investment size and the timing?

[Scott Deakin:]

Well, we have sales people on the ground now both in Asia and in Europe to start promoting the product, calling on the OEMs both in Europe and in China to promote our molded products. The process is when companies come out with new platform, they will request different companies to quote and so we're making sure that we're getting on that list to be able to quote on new platforms and we'll start to have process. I mean, one of the nice things that occurred in 2015 was that our fibers group worked with other metals group in Germany to win a award that's being produced in North America on a major German OEM for molded wheel well. So we've already made that contact in Germany and we'll continue to support that. As far as timing of revenue Rob, it's really going to be 2018 or 2019 just because of the time that it takes for a new platform to be designed and launched and go into production. As far as the capital investment, our process for our molded fiber products for automotive, it has two steps. One, we start with needle felt and we have capacity both in Europe and Asia to support that rolled goods through industrial filtration. So the capital investment we required would be molding lines to put in place. We have brick-and-mortar in place both in Europe and China that can receive these molding lines and the molding lines investment are about $2 million. And the amount of revenue varies depending upon the size of part and so on that we're running. So for incremental capital investment, we could see very significant opportunity. So we're excited about it, we have a great track record in North America, we deliver very high quality and innovative products in that space. We see no reason why we shouldn't be able to win applications in Europe and in China.

[Robert Majek:]

Great. And you touched on a little bit already, but given the recent results in Performance Materials and Paul Marold's appointment. Can give us an update on your overall strategy to improve performance in that segment and if that's changed at all?

[Dale Barnhart:]

We have improved performance in that, through Lean Six Sigma, so we're very happy with the operational performance, so the focus has to be on top line growth. Then that's what Paul brings to the space, he has an in-depth knowledge of not only filtration, but nonwoven materials. He has experience with worked for Ahlstrom for several years, which is one of the global leaders in wetlaid nonwoven applications from filtration to life sciences to medical. And he's going to bring that back to the organization. We are clearly focused and we have line of sight of some key opportunities that we're going through qualification now with OEMs that if we're successful, we'll have a dramatic impact in the last half of the year this year and would drive sales growth into that business. But as we've learned and which really drove the impairment on the membrane, on Solutech is the only commercial license cycle on some of these new filtration opportunities, just take a long time. But we're cautiously optimistic that 2016 will be the turning point for that business as it relates to top line.

[Operator:]

[Operator Instructions] Our next question is from Edward Marshall from Sidoti & Company. Please go ahead, sir.

[Edward Marshal:]

Hey, guys how are you?

[Dale Barnhart:]

Very well. How are you, Ed?

[Edward Marshal:]

I'm good, thanks. So I won't ask you to reiterate kind of the automotive industry data that's out there. But if I think about the build rates and then I kind of think about some of the new products you're introducing. I'm curious if there is a way to measure the opportunity from maybe, call it percent of penetration or maybe content growth that you're going to have with some of these things like the interior flooring in intra [ph]?

[Dale Barnhart:]

Yeah, we really don't qualify that for the market, but we're relatively confident that year-over-year, we should see decent revenue growth both in the fibers and metals business because of some of the applications we've won. I mean, that's what's driven the significant increase in capital spend has been principally in the fibers area, in the metals area, as we've put in a whole new line for the molded flooring project in fibers, and high-speed, automated line for large dual wall parts that we won at Fiat Chrysler and Honda.

[Edward Marshal:]

So this, I would assume the general host of characters, are they pretty much the same customers in each of the two divisions? I mean, I think your fibers division there's large customer? Or is it split among multiple different suppliers or customers rather for the product?

[Dale Barnhart:]

Well, the flooring product is what's one of our major customers on the fiber side. As I said Fiat Chrysler and Honda; Honda is - we're gaining share with Honda, so they've been a customer of ours for a while, but this is a significant pickup with our penetration into Honda. And it's been a ongoing strategy of the metals business, not only to sell dual wall products, which we're doing, but also to penetrate some of the Asian and European transplants that have been here for a while in the U.S. We're also have been successful in winning new fiber applications outside of the one major OEM we have.

[Edward Marshal:]

By the way the tooling sales that you've incurred in the question you said they were related to these two business lines, correct? If I look at the organic sales comparison in the last page of the release, I'm assuming that's what you're kind of exiting out of the organic assumption there?

[Scott Deakin:]

No. The capital, two different things. The capital spend, it was for the high-speed line for those two particular applications that we talked about. The tooling is for various parts across the entire business from China to Germany, France and the U.S. where we're getting new parts that we won and this is tooling that the customer pays for and owns that we put in our process to produce the part. So that tooling really does support the organic growth of our business going forward.

[Edward Marshal:]

I mean, is the China drag done from a tooling perspective. I mean, I think it was a 50 basis points drag in this quarter or are you anticipating that kind of to leak into Q1?

[Dale Barnhart:]

Well, we should be improving substantially, actually in the fourth quarter we had won multiple - we were actually profitable in China. I mean, the good news is one of the big sources of the underperformance in 2015 was our delay in getting local OEMs to approve local sourcing of raw material and we spent - we paid quite a premium for importing metal from Germany to support the startup, that's behind us now. Plus we're seeing more volume come into the plant. So we're quite excited about the ramp up there. It will be at a minimum breakeven for the full year?

[Edward Marshal:]

And that's behind you as of when, the sourcing because --

[Scott Deakin:]

It's behind us now. It is behind us. We may have a little bit of products or material still in inventory that with our P&L as we absorb it. But as far as any material coming in from Germany, that has ended. We're using --

[Edward Marshal:]

The 50 basis points challenge in Q4 that was the last of it and then maybe some inventory adjustments as you forward?

[Scott Deakin:]

Well and also just to ramp up, I mean, we're still ramping up. Each moth volume is going up and until we get to a certain point in volume we'll need that to ensure stability as far as ongoing profitability of that business. And we're encouraged, we're seeing that.

[Edward Marshal:]

Got it. Then finally, I wanted to talk about may capital deployment. In the absence of acquisitions, I mean, how you return some of cash that you generate? Then with the absence of having to pay down much debt, I mean I think you only have pocket change left. What's your thirst for deal, I mean I know we talk about this I know you'd make acquisitions, but how thirsty are you actually to go out and actually just execute a deal just because of sake of having to do it and having the availability of cash.

[Dale Barnhart:]

It is a high priority, it's where I'm spending a lot of my personal time today is on our organic growth and our inorganic growth programs. At the same time, we also are very sensitive that in doing an acquisition, we have to do one that will give a good return for our shareholder. So while we're very anxious to do one, we're also very anxious to do a good deal. As I mentioned we do have a very good pipeline now of some very interested opportunities that we are aggressively pursuing.

[Edward Marshal:]

Could you kind of talk about whether that's a domestic opportunity or an international opportunity?

[Dale Barnhart:]

It wouldn't be appropriate for me to say at this time.

[Edward Marshal:]

Got it. Thanks very much.

[Dale Barnhart:]

Thank you.

[Operator:]

Since showing no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

[Dale Barnhart:]

Again, I thank everybody for participating and we had an excellent 2015 and we will continue to drive continuous improvement in our business going forward. Thank you.

[Operator:]

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