Lydall Inc. Q3 2008 Earnings Call Transcript

Nov. 3.08 | About: Lydall, Inc. (LDL)

Lydall Inc. (NYSE:LDL)

Q3 2008 Earnings Call

November 3, 2008 10:00 am ET

Executives

Tom Smith - VP and CFO

Dale Barnhart - President and CEO

Analysts

John Franzreb - Sidoti & Company

John Walthausen - Walthausen & Company

Operator

Good day and welcome to the Lydall third quarter financial results conference call. Today's call is being recorded. At this time, I would like to turn the conference over to Vice President, Chief Financial Officer and Treasurer, Mr. Tom Smith. Please go ahead, sir.

Tom Smith

Thank you. Good morning everyone, and thank you for joining us today. Dale Barnhart, Lydall's President and Chief Executive Officer will briefly review the company's performance for the third quarter ended September 30, 2008. We will then open the lines for questions.

Participants should note that additional information, including a presentation outlining key financial data for the third quarter ended September 30, 2008, supporting today's discussion can be found at lydall.com in the Investor Relations section.

Before we begin, I want to inform our listeners that any information discussed in this call, which may be forward-looking in nature, is made available pursuant to the Safe Harbor provision or forward-looking statements as defined in the Securities laws. Lydall's businesses are subject to a number of risk factors, which may cause actual results to differ materially from those anticipated in the forward-looking statements.

For information identifying some of these important risk factors, I refer you to Lydall's annual report on Form 10-K and Forms 10-Q in the MD&A section under Cautionary Note Concerning Factors that may affect future results and also under risk factors. Also this call is fully accessible to interested investors and the media and intended to comply with all the requirements of our public disclosure under Regulation FD. I will now turn the call over to Dale Barnhart. Dale?

Dale Barnhart

Thank you, Tom and good morning everyone. Net sales for Lydall in Q3, '08 were $71.1 million compared to $77.3 million for the same period in '07. Income from continuing operations for Q3, '08 was $1.7 million, or $0.10 per share, equivalent to our Q3, '07 EPS.

As previously announced, we sold our transport business on September 19, the gain from the sale was $900,000. Including the gain from the sale of transport and income from transport for the period of Q3, net income was $2.7 million or $0.16 per share, compared to $1.9 million in Q3 '07, or $0.11 per share. Included in the Q3 '07 was $0.04 per share charge related to statutory tax rate change in Germany. Year-to-date, our EPS from continued operations was $0.46, compared to $0.38 in Q3 '07, net income or 53 earnings per share versus 41 earnings per share in '07.

Our gross margins for Q3 '08 declined 6/10ths of a point to 20.9, compared to Q3 '07. This was due principally to our lower margins in our thermal acoustics business driven by automotive demand.

SG&A was $11.8 million, 16.6% of sales for Q3 '08, compared to $12.8 million, or 16.6% of sales for the same period in '07. Excluding the impact of foreign currency, expenses decreased $1.2 million, primarily due to lower incentive expense.

Net cash from operations in Q3 '08 was $3.4 million compared to $9.6 million in Q3 '07. Timing was principally the reason for the significant drop in cash from operations in Q3 '08 versus Q3 '07. Our past two receivables remain in line, and we were really impacted by collections of large tooling programs and other items in Q3 '07.

Our thermal acoustic business, which is, again, principally driven by the automotive had negative impact in Q3 '08 compared to Q3 '07. Automotive production in North America was down 16.4%. Our sales of our global automotive business were down $6.4 million in Q3 '08 compared to Q3 '07 or 16.8%.

Our gross margin declined 3.3 points on our global automotive business driven by North American automotive decline and raw material increases in our European business. Our operating income for the global automotive business was down $2.4 million in Q3 '08 compared to Q3 '07.

In Q3 '08, we did announce the consolidation plan to close our St. Johnsbury, Vermont, automotive facility and consolidate all of our operations in our Hamptonville, North Carolina operation. Restructuring expense for the program will be $7.5 million to 8 million for the expected annual savings of $3.5 million.

In the fourth quarter of '08 we will be recording restructuring expense of 1.6 million related to the consolidation of our automotive facility. Performance materials continue to have good performance compared to prior year, our revenue was up $700,000, or 2.6% driven principally by energy and industrial segment, or electrical products, and cryogenic or liquid natural gas.

Our gross margins were up 2.5 points driven by pricing action taken by the business, our Lean Six Sigma initiatives, and product mix. Operating income for the quarter was up 700,000 or 18.9%. So as we continue to focus on our performance materials, which is operating in a good market space, we are seeing good performance year-over-year both on revenue, and more importantly, on our operating income increase.

When we look at our other products and services segment, Affinity continues to be negatively impacted by the down turn in the semiconductor market Lack of capital investment in the period Q3 '08, our revenue was down 50% compared to Q3 '07 operating loss of $437,000.

On a positive note, our vital fluids business continues to be positively impacted by turnaround and performance of the business and the fact that it is operating in a space that has not been negatively impacted by much of the economic issues that we are facing today in other markets.

Our revenue was up $700,000 or 18.3% for the period Q3 '08 versus Q3 '07. Our gross margin was up 8.5 points and our operating income was up $400,000 or 690%. We continue to be very pleased with the performance of turnaround business and the fact that it is operating in an excellent space.

Our balance sheet continues to be very strong and the organization has performed well in this tough economic climate. Our cash from operations was $3.4 million in the quarter. We ended the quarter with 28.3 million of cash in the bank with no debt. We believe that positions us well as we go forward to not only invest in our growth initiatives, but also to be able to deal with any economic uncertainty we may see over the next several period.

With that, I will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question from John Franzreb with Sidoti & Company.

John Franzreb - Sidoti & Company

Good morning, Dale.

Dale Barnhart

Good morning, John, how are you doing?

John Franzreb - Sidoti & Company

Good. I want to start a little bit on the auto business, what percentage of your consolidated revenues is auto sales now running at?

Dale Barnhart

54%.

John Franzreb - Sidoti & Company

54%, and the margin you recorded in the quarter, and I have looked back, and there was some close margins in 2004, but it was extremely low, is that all absorption issues, or is there something else going on there?

Dale Barnhart

Principally driven by the automotive business and it is absorption, through the first half John, we were able to maintain our contribution margins and gross margins by actions the business took to take cost out. The volume decline got to the point in the third quarter, where our fixed cost was starting to have an impact in the automotive and also raw material increases in Europe.

John Franzreb - Sidoti & Company

Is there anything going on in pricing in that segment?

Dale Barnhart

Contractually, we usually have year-over-year price down agreements with the OEMs and your opportunity to change pricing comes when you have new products and new platforms coming out, so you reestablish the price for given products.

John Franzreb - Sidoti & Company

Are you getting any intelligence on next year, or what that is going to look like?

Dale Barnhart

I think your intelligence and everybody's intelligence in this call is probably as good as ours. We track CSM data, which is widely used by the automotive industry, which not only gives you historical data, but tries to forecast production based on what the automotive manufacturers input to their model.

For this year, we have been discounting that every quarter, and even with the discount, we have been coming up short. So, '08 has surprisingly declined at such a rapid rate that even with discounting our own discounting, we have not been able to anticipate what is going on.

The one right news I did here last week coming in Friday was that Ford had increased the production of their F-150 pickup trucks and actually called a couple of thousand employees back to one of their Michigan operations.

Your guess is as good as mine. Have we yet hit bottom yet? I do not know, but we have been very cautious about trading in the fourth quarter and as we go into Q1 '09.

John Franzreb - Sidoti & Company

Okay. Could you give us your thoughts about a potential GM-Chrysler combination, how that impacts your business model?

Tom Smith

It would be fine for us. We have a strong position with Chrysler, and we have a growing position with GM. The consolidation would probably result in the drop of discontinuance of some models. Overall, our relationship with Chrysler is very good, and our relationship with GM is growing, and we are winning some of their new small car platforms, so, it would be good for us. Particularly if they come out of this financially strong, that would be a positive for Lydall.

John Franzreb - Sidoti & Company

Okay. Now, I will ask one last question and then let somebody else come in. In the performance materials business, the heavy energy industrial sales were relatively strong. Could you talk a little bit about what is going on in that market, some color there?

Tom Smith

Yes, a couple of things. One, we make an insulating paper that is used in wiring for transformers, and the infrastructure in North America is surely in need of replacement. So, there is a strong demand for replacement transformer. That is driving that. So, regardless of the economy, we expect that to continue.

Then the other is related really to the energy markets. We make a material that is used in insulating materials from cryogenic things used especially in transporting of the natural gas, and we have seen a continued demand there.

Not only demand in the market, but when we restructured our performance materials for last year in picking up the Green Island products, Green Island was pretty much focused in on North America, consolidating with performance material was picked by our Asian sales team, and they are now promoting that product, and I believe we are starting to see some benefit of global promotion of the Cryo product.

John Franzreb - Sidoti & Company

Okay. Thanks. I will get back into the queue.

Tom Smith

Thank you. John.

Operator

(Operator Instructions). We will take our next question John Walthausen with Walthausen & Company.

John Walthausen - Walthausen & Company

Yes. Good Morning.

Tom Smith

Hey, John, I have not heard from you in a while.

John Walthausen - Walthausen & Company

Yes, that is right. I was trying to be dormant for a bit, but your price is awfully attractive. First of all, congratulations on a good quarter in a difficult time and also congratulations on selling the Logistics, I think that was a good move.

I wanted to follow up on a couple of points. The opportunities with cryogenic, you are saying that it relates to natural gas. Is that in the process of transporting liquefied natural gas or where is that playing in?

Dale Barnhart

Most of it is transporting of liquid natural gas. Some of it is used in stationary storage of liquid natural gas as well.

John Walthausen - Walthausen & Company

Is that a substantial opportunity at this point relative to what you have been able to realize in the past with that product line?

Dale Barnhart

I mean that market is growing here.

Tom Smith

I do not think we have any opportunity to double the market if that is what…

John Walthausen - Walthausen & Company

Okay. I am just trying to get a fix around that. On the filtration side, you have not broken that here exactly, but we have been into a number of good quarters of growth there. Can you talk about what the end markets are proportionally and what the outlook is for that over the next few quarters?

Tom Smith

Air filtration makes up approximately two-thirds of our overall filtration media.

John Walthausen - Walthausen & Company

Right.

Tom Smith

The balance is liquid, and liquid is where we are really focusing a lot of our growth and liquid being mostly filtration media for hydraulics fluids, and we have done a nice job in growing share in that segment.

The air segment, again, we are in the high end air filtration media in HEPA and ULPA ranges. In the first half of this year, we saw actually some strength in clean room jobs in Asia. Our core other air filtration business has been pretty stable.

So, in the markets we are in right now, air filtration is pretty stable, and actually in the third quarter, our revenue was about flat in air filtration. We saw a slight pick up in Q3 in liquid filtration. Year-over-year, though, we are seeing more significant increase as we gain share with some of the new products that were coming out.

As we go forward, John, now and as we mentioned, one of the areas that we would want to invest in is new products and applications for both air and liquid filtration to expand our presence in that area.

The global markets, based on all the analysis we have done, are growing at about two times GDP, and we believe in some of the life sciences and other areas with the new product launches that we may be able to come up with and/or acquisitions, we could see much higher growth rate.

John Walthausen - Walthausen & Company

Okay. When you say invest in, you mentioned the acquisitions, but are there internal investments that we are making now that should bear fruit in growing that business?

Tom Smith

Absolutely; we continue to proliferate our product line for liquid filtration with different blends that we come up with. We continue to invest in the infrastructure within that business to increase our capacity.

We do have some pretty exciting organic new product development programs going on as it relates to water filtration that we hope to be launching within the next two years, and it really is a revolutionary product development. Then, in addition to that, we will be looking at possible acquisitions.

John Walthausen - Walthausen & Company

Okay, good. The two smaller businesses, Vital Fluids is clearly doing a lot better, and congratulations for that. It is a relatively small part of the business, and of course, Affinity is trading quite at up and down cycle and now it is hurting. Do either of them hold the potential for being developed into businesses that can be meaningful to you or should they be part of this perhaps situations that might be exited in due time?

Tom Smith

Vital Fluids for sure has the opportunity to be a very significant factor for Lydall going forward. We have recently approved some internal investment to dramatically increase the capacity we have for the disposable bags for the biopharmaceutical space.

That is the space that is growing right now at anywhere between 25% and 30% a year, which obviously is a very robust market and one that we believe with our operational improvements and the strengthening of our overall organization, including our new product development group and with the capital investment, we will have substantial growth out of that business going forward.

Today, we are principally in North America with that, and we have a similar market opportunity in Europe, so, there is a great opportunity for expanding that.

Affinity is in the capital goods market, and what goes with that is the swings to capital good. It is a space to be in right now. It can be a positive contributor to us going forward. Will it grow to the significance of a vital fluids or performance materials, probably not?

John Walthausen - Walthausen & Company

Okay, and on the vital fluids, I am glad to hear your enthusiasm. It seems to me in earlier years, there was difficulty in substantially differentiating your product from competitors. Have you been able to make progress on that so that you feel that you can command premium prices in the market?

Tom Smith

Yes, I believe so. First of all, we had to take stock of ourselves and make sure we had operations and processes in place to provide high quality products in a timely manner, and we have done that. I say we have done that in continuous improvement of our operation and you always have room for improvement. We made substantial strides. We have lot more improvement we can make, which is to strengthen the company.

Beyond that, prior to make any investment I mentioned earlier to capital goods to increase our capacity and the disposable bags for the biopharmaceutical, we did an extensive market survey to try to assess what the market requires, what unmet needs there were not only in product design, but in services, and we believe we have come up with a growth strategy that is sustainable and of great value in the marketplace, both for marketplace and for vital fluid.

Anytime you see a business increase their gross margin 8.5 points or 850 basis points, it is pretty significant. That is a combination of both operational improvement and addressing new product launch.

John Walthausen - Walthausen & Company

Good, it is helpful. Then the final question is with cash building up, can you talk about how you prioritize the use of cash?

Tom Smith

Well, first and foremost is that we have the ability to invest in some of these growth opportunities, we have mentioned and we happened to be participating in some pretty attractive spaces and we believe in today's economic climate as far as acquisition. Cash should be able to deliver a pretty good value in an acquisition price, so we want to invest in our growth both organically and through acquisitions.

Secondly, with the economic climate we are in right now, we are going to make sure that we maintain a certain portion of that cash and handle anymore economic hiccups we may see going forward, so I think its really prudent to be conservative in that position to make sure we are not in the situation where we may have problem also.

We think wise investment in organic and acquisitions can lead to the type of growth both in revenue and more importantly EPS that our shareholders want to see.

John Walthausen - Walthausen & Company

On the acquisition front, because I can not put it a in your shoulders Dale, but via Lydall, as with many other corporations, the record of acquisitions has been mixed. Would you characterize your endeavors there to be strictly oriented towards building on an existing franchise or would you consider new more peripherally related ventures?

Dale Barnhart

We want to build on existing franchises. We want to be able to build in market spaces where we have a presence that are attractive markets for us, not only for us, today but present an opportunity for profitable growth.

John Walthausen - Walthausen & Company

Good, thank you very much.

Dale Barnhart

You are welcome.

Operator

(Operator Instructions). We will take a follow-up from John Franzreb with Sidoti & Company.

John Franzreb - Sidoti & Company

Tom, could you just talk a little bit that the tax rate jumped up in the quarter, what is going on there, what should we be using to not only Q4, but maybe taking it to 2009?

Tom Smith

Yes, for the year, we are looking for a 37.5% to 30.5%. Just a couple of things in quarter. We had a small charge related to the tax charge related to the Saint Johnsbury closure, just some that we are not going to be able to utilize there.

Two, just with the lower level of income that we certainly have from some of our permanent items that have a bigger impact on the rate, so, nothing really significant there.

John Franzreb - Sidoti & Company

What should we be using a steady state rate next year?

Tom Smith

Yes, I mean I would start with 37.5 now, but we have not really calculated that out yet.

John Franzreb - Sidoti & Company

Okay. Dale, you mentioned some spend. What do you expect your CapEx to finish this year and what spending increase or decrease are we thinking about in 2009?

Tom Smith

CapEx spending for the rest of the year should be in line pretty much with what we have been doing so far this year. We are actually in the process of finalizing our plans for next year pretty much as we speak. So, we do not have that number yet.

John Franzreb - Sidoti & Company

On relative basis, would you expect it to be up or down?

Tom Smith

It will be flat to down. We will be conservative with capital going into the year because of the uncertainty of the economic environment we are in.

John Franzreb - Sidoti & Company

Okay. I do not know if I heard you right, but I think you said one of the uses for cash is acquisitions. Given where the stock is trading, why would not the repurchase of stock be more desirable than maybe taking on another problem?

Tom Smith

Well, I do not view this as taking another problem. I would view it as taking on an opportunity to grow. It is tempting to go out and do that and do a stock repurchase, but at this point, I just think there is going to be better growth initiatives we can invest in both organically and through acquisitions in order to give a better shareholder returns.

John Franzreb - Sidoti & Company

On what EBITDA multiples you are looking at right now?

Dale Barnhart

For acquisition? Well, we would not disclose that. Obviously, we will not disclose this when we are involved in the active acquisition.

John Franzreb - Sidoti & Company

No, just a general range of what they are pricing at?

Tom Smith

No better than they were a couple of years ago.

John Franzreb - Sidoti & Company

Okay, Tom. All right, that is it for me. Thanks a lot.

Tom Smith

Thanks, John.

Operator

At this time, we have no further questions in our queue. I would like to turn the conference back over to Mr. Barnhart for any additional comments or closing remarks.

Dale Barnhart

I just want to thank everybody for calling in and listening and one of the gentleman asking the questions, maybe comment about good performance in Q3. I do believe in the economic conditions we are in, and the decline we have seen in the automotive business our performance was good. I would not say great, would always like to see growth quarter-over-quarter, but given the conditions we are in, solid performance.

It is the testament to our focus on continuous improvement, use of Lean Six Sigma tools. Recently somebody asked us about contingency plans, and I would say in a continuous improvement operation, we continue to plan as your day-today operations, because we are always looking at improving day-to-day. Our organization is well in tune to do that.

In addition, we do have the fortune of operating in some goods spaces, and we will continue to put all our best efforts to maximize return in the markets that we are in. Thank you very much.

Operator

This does conclude today's conference. Thank you for your participation. You may now disconnect.

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