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Lydall, Inc. (NYSE:LDL)

Q1 2009 Earnings Call Transcript

April 30, 2009 10:00 am ET

Executives

Tom Smith – VP, CFO and Treasurer

Dale Barnhart – President and CEO

Analysts

John Walthausen – Walthausen & Company

Operator

Good day and welcome to the Lydall first quarter 2009 financial results conference call. Today's call is being recorded. At this time, I would like to turn the call over to the Vice President and Chief Financial Officer, Mr. Tom Smith. Please go ahead.

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 first quarter ended March 31, 2009. We will then open the lines for questions.

Participants should note that additional information, including a presentation outlining key financial data for the first quarter ended March 31, 2009, 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 Form 10-Q in the MD&A section under Cautionary Note Concerning Factors That May Affect Future Results and also Risk Factors. Also this call is fully accessible to interested investors and the media and is intended to comply with all the requirements of a public disclosure under Regulation FD.

I will now turn the call over to Dale Barnhart. Dale?

Dale Barnhart

Thank you, Tom. And good morning, everybody. The global recession negatively impacted all of Lydall’s business units in the first quarter of 2009. Lydall’s net sales for the quarter were $54.3 million compared to $89.9 million for the same period in 2008, a decline of 40%. Thermal/Acoustical segment, which primarily serves the automotive market, sales were lower by 47.6% in Q1 2009 compared to Q1 2008. Performance Materials and Other Products segments reported a sales decline of 24.9% and 41.2% respectively for the first quarter of 2009 compared to the same period in 2008.

As a result of the decline in revenue, Lydall recorded a net loss of $4.5 million or $0.27 per diluted share, which includes a pretax restructuring expense of $2.1 million or $0.08 per diluted share related to the consolidation of the North American automotive operation. Excluding the impact of these restructuring expenses, net loss was $3.2 million or $0.19 per diluted share for the first quarter of 2009. Net income was $3.2 million or $0.19 per diluted share for the first quarter of 2008.

Gross margin for the first quarter of 2009 was 11% compared to a gross margin of 23.2% for the first quarter of 2008. During the quarter, as we did throughout 2008, Lydall was proactive in bringing cost in line with revenue and reduce total workforce by another 7.5% in the first quarter. Irrespective of that reduction in headcount, we were unable due to the dramatic drop in revenue absorbed all of the fixed costs in the businesses, which had a dramatic impact on our gross margin.

All the businesses were impacted, but the Thermal/Acoustical driven by the decline in automotive production had the largest negative impact on gross margin. In addition, gross margin was impacted by 380 basis points due to restructuring charges out of the North American consolidation program. In Q1 of 2008, we also had a favorable gross margin impact due to a one-time replacement part opportunity that we had in Europe.

Selling and development expenses were down $2.7 million or 17% in Q1 ’09 compared to Q1 ’08, reflecting our cost containment programs. We had 15% reduction in personnel in selling, product development and admin since the end of Q1 2008. In addition, we had lower salary, wages and incentive charges in the quarter.

From a cash standpoint, first quarter of 2009 we consumed cash of $3.7 million for operations compared to first quarter of 2008 where we generated cash of $8.2 million. Two primary causes for the decline in cash generation. One was the operating income decline in the first quarter of 2009 and one is, quite frankly, poor performance than we would have liked to see in managing our inventories in the first quarter.

At the end of the first quarter of 2009 compared to the end of the first quarter of 2008, we had an inventory increase of $5.9 million. Two primary factors drove that increase. One was a planned increase in finished goods to support the consolidation of our North American automotive facilities. The other was an increase in our raw material, as we could not cut off the supply of raw material in our Performance Materials and particularly in our European automotive sector quick enough as the volume dropped. It is something that we are focused on and we expect to improve as we go forward. We had no borrowings on the credit facility at the end of the quarter. At the end of the quarter, we had $7.5 million of cash.

Now, looking at the different segments and impacts on those segments, Performance Materials, which is made of our filtration and industrial thermal products, Q1 ’09 sales were $22.4 million compared to Q1 ’08 of $29.8 million. If we look at the filtration – operating income, operating income for the first quarter of 2009 was $1.3 million compared to $4.6 million for the first quarter of 2008. Again, dramatically impacted by decline in sales.

Filtration products net sales were down $3.2 million due to lower end demand for air filtration products, not only with the end products demand down that our OEMs see, but there was also inventory adjustment in the channel during the first quarter of ’09. Also looking at the first quarter of ’09 compared to the first quarter of ’08, we had no clean room projects in the first quarter of ’09 due to the weakness in the semiconductor and LCD market capital investment, principally in Asia.

In the industrial thermal insulation products group, we saw a decline of $3.2 million. Our energy and industrial sales were lower by $1.6 million due to lower demand in electrical and cryogenic markets and due to the softness in the building and appliance markets in North America, principally in North America. We saw a decline of $1.6 million in that sector.

During the first quarter, we continued to integrate the DSM Solutech acquisition and the commercialization of the new products. We did experience some start-up cost in the first quarter of 2009, but those were to be expected. We have targeted four key new product line launches or grades developments for air filtration, which are key to our success. It’s good to note that in the first quarter of this year, three of those four grades have been developed and qualified and are ready for sale. The final grade should be finalized in the second quarter of this year. And we are aggressively campaigning the product utilizing our existing sales force in filtration with our existing customer base.

On the Thermal/Acoustical segment, which again is principally servicing the automotive industry, first quarter of ’09 sales were $26.9 million compared to first quarter of ’08 of $51.3 million, a decline of $24.4 million. Obviously, that had a dramatic impact on our operating income, as did the expense we are incurring for the consolidation of our North American automotive facilities. Q1 ’09 operating loss for that sector was $4.3 million compared to an operating income of $4.7 million, or a swing of $9 million for this period compared to the same period last year.

Our automotive parts sales were down $17.8 million in the quarter, driven by significant production declines both in the US and Europe. CSM, which is an independent industry data source, estimates that the production was down 45% in the US and Europe in Q1 ’09 compared to Q1 ’08. Excluding the short-term replacement opportunity I referred to earlier, our parts net sales were down 38% in Q1 ’09 compared to Q1 ’08, indicating share gain through new product launches and model mix sales in the first quarter of ’09.

The restructuring charges that were taken in the first quarter were $2.9 million. It is important to note that the automotive team has done an excellent job in managing the consolidation. We’ve accelerated the completion of a soft consolidation from the third quarter into the second quarter. And we reduced the overall expense of the consolidation by $400,000 due to the acceleration. We continue to expect the savings of $3.5 million to $4.0 million on an annualized basis as we complete that consolidation.

Another significant point because of our strength in the market, our product capability and our financial stability at this point, we have been winning application from weaker competitors and that we’ll have an impact as we go forward. And then I’m sure it’s on everybody’s mind the status of Chrysler and potential filing for bankruptcy and GM situation, we have been selected by both Chrysler and GM to participate in a receivables insurance program that has been managed by Citibank, funded by the US government. We have completed the process of the application. Our invoices have been submitted, and we are waiting for final approval from Citibank on acceptance into that program.

Our current receivables outstanding with Chrysler today are $2.3 million. With General Motors, they are $0.5 million. And for the most part, those receivables are current. None of them are past due.

Looking at Other Products and Services, which is comprised now of new business units, vital fluids and Affinity. Vital fluids revenue for the first quarter of 2009 was $3.1 million compared to $4.2 million for the first quarter of ’08, a change of – a decline of $1.1 million. What’s driving the decline there is lower sales of blood filtration and bioprocessing products. Blood filtration products are being impacted by a dramatic decline in elective surgeries, which is where that product is used. And also, we believe there are some inventory adjustments in the channels, as everybody is watching their cost in this recessionary time.

The impact on operating income was a loss of $400,000 in the first quarter versus income of $300,000 in the first quarter of ’08. The loss was not driven all just by revenue decline. We actually saw an improvement in contribution margins in the business year-to-year due to some of the lean actions we are taking. But we are investing in SG&A and development. As we mentioned last year, one of our key growth initiatives, as we go forward, is the development of full line of bioprocessing disposable bags. We are making investments in manufacturing equipment and development of the complete product line. So those are planned investments that we anticipate excellent returns as we go forward.

Affinity is a business that produces chillers, principally for the semiconductor industry, continued to see significant decline in revenue, driven by the lack of capital spend by semiconductor producers. In the first quarter of 2009, net sales were $2.3 million compared to the first quarter of 2008 of $5.0 million. Again, as we’ve done in all of our businesses, we have been very aggressive in trying to keep our cost in line with the volume.

We had a reduction of headcount over the last year of 47% in that business. We continue to look at driving lean initiatives through the business and improving our operating performance. One example is we are in the process of outsourcing a non-critical production item of electrical control boxes to people who specialize in that, which will reduce our working capital requirements, provide state-of-the-art technology, and reduce our overall product cost.

From an operating income, an operating loss of $400,000 in the first quarter of ’09 compared to an operating loss of $500,000 in the first quarter of ’08, actually a positive change of $100,000 and driven principally by headcount reductions, lean processes, as we continue to focus to improve that business.

Overall, as we have throughout ’08 and in the first quarter, we will through the balance of the year continue to manage our business to look at bringing cost in line with revenue, managing cash and working capital will be key for us. Lean Six Sigma continues to be a vital tool for us. We continue to see productivity gains in businesses, even as revenues fall. And it will be a key tool as we look at improving our overall working capital, reducing inventories and improving our cash flow generation going forward.

I already mentioned that in the first quarter we had headcount reduction of another 7.5%, as we continue to be tenacious in looking at areas to improve our cost position. And that was another 93 individuals that left our organization through the first quarter. After we made the very difficult decision of having all base salaries for North American employees reduced by 3%, and the company has suspended its 401(k) match again to look at every areas of potential for cost reduction.

As we go forward, I am very confident that we are making tough, difficult decisions in using the lean tools to improve our core businesses such that when we see economic recovery, we will leverage that upside very well to the bottom line.

With that, I’ll open it up to any questions.

Question-and-Answer Session

Operator

(Operator instructions) And we’ll take our first question from John Walthausen with Walthausen & Company.

John Walthausen – Walthausen & Company

Yes, good morning.

Dale Barnhart

Hi, John, how are you doing?

John Walthausen – Walthausen & Company

Pretty well, pretty well. Some good things here in spite of all the bad news that everybody is reporting. I guess I wanted to touch base. You had talked about four new products, I think all in the filtration. I wasn’t sure whether they are related to – well, could you just talk about what they relate to, that they are significant new products, whether it brings you into different capabilities or different markets?

Dale Barnhart

Yes, I’d be glad to, John. You’re right, I wasn’t real clear. Those four new grades that are being developed are part of the Arioso product line, which is a result of the acquisition of DSM Solutech. And that is a membrane air filtration media. And it does – it will as we get the four grades out, get us into other HEPA and ULPA applications and segments that we are not in today. One of significance is dust collection or industrial applications, where we don't have high market penetration today. We believe this product has durability, flexibility and a cost point that will be attractive in that segment.

John Walthausen – Walthausen & Company

Good. The other question I had was on SG&A. It’s down significantly of course year-over-year, but up a bit from where you are running in the third and fourth quarter, that in spite of the fact that you’ve all done the right thing and taken reduced compensation. Can you talk about what the factors are behind that?

Dale Barnhart

I would suspect – I don’t have a definitive answer for that, but I know we’ve had increased severance cost and other expenses associated with the consolidation so that that would impact SG&A. And we’ve had severance expenses as it relates to other admin individuals.

John Walthausen – Walthausen & Company

Okay. And then finally, with regard to DSM, you had mentioned that there were some startup costs in the quarter. Could you give some idea of what the scope of those were and whether we expect those to increase as we get into the subsequent quarters where they should start to narrow?

Dale Barnhart

We don’t expect them to increase. They are pretty much in line with what we anticipated when we made the acquisition. There were some charges as it relates to inventory write-ups and valuations and intellectual property, all things that tend to happen when you do an acquisition. But we had a clear focus on the four grades that we needed to develop, and we actually – the first three were completed on time and actually ahead of schedule. So we feel very good about that. Going forward, we don’t anticipate any significant increase in the startup cost than what we have in our operating plan for that unit. And in fact, we expect that business unit to be on target with their plan for operating income goals for this year.

John Walthausen – Walthausen & Company

Okay, good. Thanks an awful lot.

Dale Barnhart

Thank you, John.

Operator

And there are no questions in queue at this time. (Operator instructions) Again, there are no further questions. I’ll turn the call back over to our presenters.

Dale Barnhart

Okay. I want to thank everybody for participating. And we look forward to another call in about 90 days.

Operator

And that does conclude our conference for today. Thank you for your participation.

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