LYDALL, INC. OVERVIEW AND OUTLOOK
Business
Lydall, Inc. and its subsidiaries (collectively, the "Company" or "Lydall") design and manufacture specialty engineered nonwoven filtration media, industrial thermal insulating solutions, and thermal and acoustical barriers for filtration/separation and heat abatement and sound dampening applications. Lydall principally conducts its business through three reportable segments: Performance Materials, Technical Nonwovens and Thermal Acoustical Solutions, with sales globally. The Performance Materials ("PM") segment includes filtration media solutions primarily for air, fluid power, life science and industrial applications ("Filtration"), and gasket and sealing solutions, thermal insulation, energy storage, and other engineered products ("Sealing and Advanced Solutions"). The Technical Nonwovens ("TNW") segment consists of Industrial Filtration products that include nonwoven rolled-goods felt media and filter bags used primarily in industrial air and liquid filtration applications as well as Advanced Materials products that include nonwoven rolled-good media that is used in other commercial applications and predominantly serves the geosynthetics, automotive, industrial and medical markets. Advanced Materials products also include automotive rolled-good material for use in the Thermal Acoustical Solutions segment manufacturing process. Nonwoven filter media is used to satisfy increasing emission control regulations in a wide range of industries, including power, cement, steel, asphalt, incineration, food, and pharmaceutical. The Thermal Acoustical Solutions ("TAS") segment offers innovative engineered products to assist in noise and heat abatement within the transportation and industrial sectors.
Recent Developments
The impact of the novel strain of the coronavirus identified in late 2019
("COVID-19") has grown throughout the world, including in all global and
regional markets served by the Company. Governmental authorities have
implemented numerous measures attempting to contain and mitigate the effects of
COVID-19, including travel bans and restrictions, quarantines, social distancing
orders, shelter in place orders and shutdowns of non-essential activities. The
Company's manufacturing facilities are located in areas that have been affected
by the pandemic and the shutdowns. The Company's China facilities carried out a
planned shut down in conjunction with the lunar New Year in late January which
was extended to late February as a result of government imposed restrictions.
The facilities did not resume operations until late February and ramped back up
moderately in line with customer demand. As of the date of this report, all of
the Company's plants in China are operating and all of its automotive customer
plants in China have re-opened. The Company has not, to date, experienced any
significant disruption it its supply chains in China since resuming operations.
Beginning in late March 2020 , the Company ramped down its Thermal Acoustical
Solutions operations in North Carolina , as well as in France and Germany
coinciding with the shutdown of its major automotive customers' facilities in
those regions. In addition, the Company has experienced slowdowns in its
Performance Materials facility in Pennsylvania and its Technical Nonwovens
facility in South Carolina as a result of those facilities' exposure to
automotive end market applications. The resumption of production in all of these
regions is dependent on the Company's customers resuming operations.
It is also likely that the global automotive industry will experience
significantly lower demand for new vehicle sales as a result of the global
economic slowdown caused by the COVID-19 pandemic because new vehicle sales are
highly dependent on the strength of the consumer. If unemployment remains at a
high level, new vehicle sales will likely be significantly lower than historical
and previously projected sales levels.
In contrast, the Company has been deemed an essential supplier to certain
customers which has driven incremental demand in select specialty filtration
product lines in its Performance Materials business which is a leading producer
of media used in N95 respirator, surgical, and medical masks. In addition, the
Technical Nonwovens business in Canada is a leading supplier of nonwoven
products used in medical wipes, pads, and gowns. In response, the Company has
re-prioritized its manufacturing capabilities in North America and Europe to
focus on serving customers for these products.
The Company has been actively monitoring the global outbreak and spread of
COVID-19 and taking steps to mitigate the potential risks to the Company posed
by its spread and related circumstances and impacts. The Company continues to
assess and update its business continuity plans in the context of this pandemic.
The Company has taken precautions to help keep its workforce healthy and safe,
including establishing the Lydall Emergency Preparedness Team ("LEPT"),
implementing strict travel restrictions, enforcing rigorous hygiene protocols,
increasing sanitization efforts at all facilities and implementing remote
working arrangements for the vast majority of its employees who work outside the
plants.
31-------------------------------------------------------------------------------- The Company has also taken significant measures to reduce its overall cash expenditures, including the furlough or lay-off of hourly/salary plant workers and select furloughs of corporate and other salaried employees, the deferral of company contributions to its pension plans and matching contributions under the Company's 401(k) defined contribution plan, the reduction of purchase obligations for raw materials and the reduction/delay of non-critical capital spending. With these actions initiated in early 2020, the Company has reduced its monthly cash expenditures and plans to continue to do so as long as the COVID-19 pandemic continues. In addition to the significant measures taken to reduce and contain costs, the Company has taken recent action to provide additional liquidity, primarily including the incremental$20.0 million draw down on its amended credit facility in March. During the first quarter, the Company generated$26.7 million of net cash provided by operations and had cash on hand of$87.8 million atMarch 31, 2020 . OnMay 11, 2020 , the Company amended its$450 million senior secured revolving credit agreement ("2018 Credit Agreement"). See Note 6. "Long-term Debt and Financing Arrangements" to the Condensed Consolidated Financial Statements and Item 2, "Liquidity and Capital Resources" for highlights of the key amended terms and conditions. The recent automotive production ramp down across most of the world will also impact the Company's daily working capital significantly. The Company has experienced working capital cash flow improvements in March and April but does not expect the benefits to continue in May and beyond if the production ramp down continues. Upon restart, the Company would expect an initial cash outflow to support working capital requirements in the first month followed by a few months of benefit afterwards, resulting in a neutral impact over that period. The Company is also pursuing, wherever it qualifies, governmental assistance during this time. For example, the Company is working with local governments to take advantage of specific programs including wage recovery provided by social programs inEurope and is deferring domestic employer payroll tax and other payments under the provisions of the Coronavirus Aid, Relief and Economic Security ("CARES") Act. Additionally, the Company is seeking to take advantage of governmental programs to receive cash, for example, through theMain Street Lending Program, to help defray operating costs. The Company cannot guarantee that it will qualify for, or receive, any of the assistance that it is pursuing. The spread of COVID-19 and the measures taken to constrain the spread of the virus have had, and will continue to have, a material negative impact on the Company's financial results, and such negative impact may continue well beyond the containment of such outbreak. There is inherent uncertainty in the assumptions the Company uses to estimate its future liquidity due to the impact of the COVID-19 outbreak. In addition, the magnitude, duration and speed of the global pandemic is uncertain. Consequently, the impact on the Company's business, financial condition or longer-term financial or operational results is uncertain. Under Accounting Standards Update (ASU) 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40), or ASC 205-40, the Company has the responsibility to evaluate whether conditions and/or events raise substantial doubt about its ability to meet its future financial obligations as they become due within one year after the date that the financial statements are issued. Given the expected impact of the COVID-19 pandemic and economic slowdown on the Company's business, the Company revised its forecast and evaluated its liquidity position and ability to comply with financial covenants in itsMay 11, 2020 Amended Credit Agreement as of the date of the issuance of the consolidated financial statements. Based on this evaluation, management believes, despite the expected impact of COVID-19 on the Company's business, that the Company's financial position, net cash provided by operations combined with its cash and cash equivalents, borrowing availability under its 2018 Credit Agreement, and theMay 11, 2020 Amended Credit Agreement as described in Item 2, "Liquidity and Capital Resources", will be sufficient to fund its current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months. 32
--------------------------------------------------------------------------------
First Quarter 2020 Highlights
Below are financial highlights comparing Lydall's quarter ended
• Net sales were
2019, a decrease of
sales is summarized in the following table:
Components (in thousands) Change in Net Sales Percent Change Acquisitions and divestitures $ 513 0.2 % Parts volume and pricing change (12,535 ) (5.7 )% Change in tooling sales (3,230 ) (1.5 )% Foreign currency translation (2,246 ) (1.0 )% Total $ (17,498 ) (8.0 )%
• Gross margin was 19.2% in the first quarter of 2020, compared to 19.3% in
the first quarter of 2019. Gross margin from the TAS segment lowered
consolidated gross margin by approximately 140 basis points primarily due
to unfavorable product mix on reduced volume of higher margin acoustical
parts, increased labor costs and unfavorable absorption of fixed costs
related to plant ramp downs in response to the COVID-19 pandemic. The TNW
segment reported flat gross margin but, based on segment mix, was negative
to consolidated gross margin in the quarter by approximately 30 basis
points. The Performance Materials segment favorably impacted consolidated
gross margin by approximately 160 basis points, primarily driven by
increased demand for face mask media in response to the COVID-19 pandemic
coupled with favorable material costs in the first quarter of 2020
compared to the first quarter of 2019. The COVID-19 pandemic had an
unfavorable impact of approximately 50 basis points on Lydall's
consolidated gross margin, principally impacting the Thermal Acoustical
Solutions and, to a lesser extent, the Technical Nonwovens segments.
• Operating loss was
income of
quarter 2020 goodwill and other long-lived asset impairment charges in the
Performance Materials segment of
are included in operating income for Q1 2020 and Q1 2019 and impact the
comparability of each quarter:
Q1 2020 Q1 2019
Operating
Components (in thousands except per income Operating
share amounts) effect EPS impact income effect EPS impact
Impairment of goodwill and
long-lived assets (61,109 ) $ (3.35 ) - $ -
Strategic initiatives expenses (1,908 ) $ (0.08 ) (841 )
TNW restructuring expenses - $ - (376 )$ (0.02 ) • Net loss was$(56.4) million , or$(3.25) per diluted share, in Q1 2020
compared to net income of
2019.
Liquidity
Cash was $87.8 million at March 31, 2020 , compared to $51.3 million at December
31, 2019 . Net cash provided by operations was $26.7 million in the first quarter
of 2020 compared to $14.4 million in the first quarter of 2019, with the
improvement primarily driven by increases in payable days across Lydall
operations. At the end of the first quarter the Company drew down an incremental
$20 million on its Amended Credit Facility. On May 11, 2020 the Company amended
its 2018 Credit Agreement. See Note 6. "Long-term Debt and Financing
Arrangements" to the Condensed Consolidated Financial Statements and Item 2,
"Liquidity and Capital Resources" for highlights of the key amended terms and
conditions.
33--------------------------------------------------------------------------------
Results of Operations
All of the following tabular comparisons, unless otherwise indicated, are for
the quarters ended
Net Sales Quarter Ended In thousands Q1-20 Q1-19 Percent Change Net sales$ 200,527 $ 218,025 (8.0 )% Net sales for the first quarter of 2020 decreased by$17.5 million , or 8.0%, compared to the first quarter of 2019. This decrease was primarily due to lower net parts sales of$10.6 million , or 4.8% of consolidated net sales, in the Thermal Acoustical Solutions segment, driven by temporary plant ramp downs across all of its operations beginning in mid-March as the Company's large OEM customers closed plants of their own due to the COVID-19 pandemic, and included decreased net tooling sales of$3.3 million in the first quarter of 2020 compared to the first quarter of 2019. The Technical Nonwovens segment reported a decrease in net sales of$8.2 million , or 3.8% of consolidated net sales, driven by reduced demand in the industrial filtration market, primarilyChina and, to a lesser extent, the US andEurope . These decreases to net sales were partially offset by increased Performance Materials net sales of$0.6 million , primarily due to increased sales in its air filtration market, driven by demand for face mask media in response to the COVID-19 pandemic. Foreign currency translation had a negative impact on net sales of$2.2 million , or 1.0% of consolidated net sales, primarily impacting the Technical Nonwovens and Thermal Acoustical Solutions segments by$0.8 million and the Performance Materials segment by$0.6 million . Cost of Sales Quarter Ended In thousands Q1-20 Q1-19 Percent Change Cost of sales$ 161,959 $ 175,969 (8.0 )% Cost of sales for the first quarter of 2020 decreased by$14.0 million , or 8.0%, compared to the first quarter of 2019. The decrease was driven by decreased net sales of$17.5 million , primarily due to plant ramp downs in the Thermal Acoustical Solutions segment and, to a lesser extent, the Technical Nonwovens segment on reduced demand in the industrial filtration market due to the COVID-19 pandemic. Additionally, favorable raw material commodity costs across all segments and favorable product mix in the Performance Materials and Technical nonwovens segments drove lower cost of sales in the first quarter of 2020 compared to the first quarter of 2019. These decreases to cost of sales were partially offset by increased direct labor and unfavorable absorption of fixed costs caused by the plant ramp downs in the Thermal Acoustical Solutions segment driven by the COVID-19 pandemic. Foreign currency translation decreased cost of sales by$2.0 million , or 1.1%, in the first quarter of 2020 compared to the first quarter of 2019. Gross Profit Quarter Ended In thousands Q1-20 Q1-19 Percent Change Gross profit$ 38,568 $ 42,056 (8.3 )% Gross margin 19.2 % 19.3 % Gross margin for the first quarter of 2020 decreased 10 basis points compared to the first quarter of 2019. The Thermal Acoustical Solutions segment negatively impacted consolidated gross margin by approximately 140 basis points driven by unfavorable product mix on reduced volume of higher margin acoustical parts. Additionally, increased direct labor and unfavorable absorption of fixed costs caused by the plant ramp down drove further gross margin reduction in the first quarter of 2020 compared to the first quarter of 2019. The Technical Nonwovens segment reported flat segment gross margin as favorable product mix and lower raw material commodity costs were completely offset by inventory write-off costs of$0.9 million , or 50 basis points of consolidated gross margin, related to a flood in one of its European facilities. The Company is pursuing a claim with its insurer to recover this loss. The flat Technical Nonwovens segment margin negatively impacted consolidated gross margin by approximately 30 basis points due to consolidated segment mix. The Performance Materials segment favorably impacted consolidated gross margin by approximately 160 basis points, primarily due to favorable product mix, driven by increased demand for face mask media in response to the COVID-19 pandemic combined with favorable raw material commodity costs. 34 --------------------------------------------------------------------------------
Selling, Product Development and Administrative Expenses
Quarter Ended
In thousands Q1-20 Q1-19 Percent Change Selling, product development and administrative expenses$ 33,027 $ 33,006 0.1 % Percentage of sales 16.5 % 15.1 % Selling, product development and administrative expenses for the first quarter of 2020 were essentially flat, but increased 140 basis points as a percentage of net sales, compared to the first quarter of 2019. Increased corporate strategic initiatives expenses of$1.1 million and higher bad debt expense of$0.4 million were mostly offset by decreased salaries of$0.8 million and lower consulting expense of$0.5 million in the first quarter of 2020 compared to the first quarter of 2019. Selling, product development and administrative expenses increased 140 basis points as a percentage of net sales compared to the first quarter of 2019 due to the drop in sales related to the COVID-19 pandemic in the last month of the first quarter of 2020. Impairment ofGoodwill and Other Long-Lived Assets Quarter Ended In thousands Q1-20 Q1-19 Dollar Change Impairment of goodwill and other long-lived assets$ 61,109 $
-
During the first quarter of 2020, the Company recorded a goodwill impairment charge of$48.7 million in the Performance Materials segment. Reduced expected demand in automotive and other end markets due to the COVID-19 pandemic resulted in a reduction in sales and cash generation projections as compared to prior projections for the reporting units. As a result of these revised projections and changes in other Company and market-based inputs to the determination of fair value, the carrying value of the Performance Materials reporting unit exceeded its fair value by 48.7 million, resulting in the impairment charge. As a result of the COVID 19 pandemic and the Company's action plan to address the risks associated with it, the Company accelerated certain strategic actions. One such action was a review of a low-performing European plant within the Performance Materials segment. As a result of a strategic shift regarding this plant, the Company performed an impairment assessment on the long-lived assets of the plant. The impairment test concluded that the asset group was not recoverable, and the Company then determined that carrying value of the asset group exceeded its fair value and recorded a long-lived asset impairment charge of$12.4 million .
Pension Plan Settlement Expense
Quarter Ended
In thousands Q1-20 Q1-19 Dollar Change
Employee benefit plans settlement expenses
385
In the first quarter of 2020, the Company settled the pension obligation of theInterface Sealing Solutions, Inc. Pension Plan ("pension settlement") through lump sum distributions to participants or by irrevocably transferring pension liabilities to an insurance company through the purchase of a group annuity contract. The settlement, funded with pension plan assets, resulted in a settlement expense of$0.4 million in the first quarter of 2020 related to the recognition of accumulated deferred actuarial losses.
Interest Expense
Quarter Ended
In thousands Q1-20 Q1-19 Percent Change
Interest expense $ 2,857 $ 3,628 (21.3 )%
Weighted average interest rate 4.4 % 4.2 %
The decrease in interest expense for the quarter endedMarch 31, 2020 compared to the quarter endedMarch 31, 2019 was due to lower borrowings related to continued debt pay down combined with a reduction to interest expense due to the favorable interest 35 --------------------------------------------------------------------------------
rate differential between the
Other Income/Expense, net
Quarter Ended
In thousands Q1-20 Q1-19 Dollar Change
Other (income) expense, net $ (418 ) $ 399 $ (817 )
The increase in other income, net, for the quarter ended March 31, 2020 compared
to the quarter ended March 31, 2019 was primarily related to foreign currency
gains recognized on the revaluation of cash, trade payables and receivables and
intercompany loans denominated in currencies other than the functional
currencies of the Company's subsidiaries.
Income Taxes
The Company's effective tax rate for the first quarter of 2020 was 3.5% compared to an effective tax rate of 22.0% for the first quarter of 2019. During the first quarter of 2020 the Company had a pre-tax loss primarily resulting from impairment charges of$61.1 million . The impairment charges significantly impacted the Company's effective tax rate because$48.7 million of the impairment charges related to non-deductible goodwill, resulting in a low effective tax rate for the first quarter of 2020 when in a pre-tax loss position. Additionally, the effective rate was negatively impacted by valuation allowance activity of$0.3 million . The effective rate in the first quarter of 2019 was negatively impacted by valuation allowance activity of$0.3 million , partially offset by an uncertain tax position release due to statutory expiration of$0.2 million and geographical mix of earnings. The Company and its subsidiaries file a consolidated federal income tax return, as well as returns required by various state and foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities, including such major jurisdictions asthe United States ,Canada ,China ,France ,Germany ,Hong Kong ,India ,the Netherlands , and theUnited Kingdom . With few exceptions, the Company is no longer subject toU.S. federal examinations for years before 2016, state and local examinations for years before 2015, and non-U.S. income tax examinations for years before 2013. The Company's effective tax rates in future periods could be affected by an increase or decrease in earnings in countries where tax rates differ fromthe United States federal tax rate, the relative impact of permanent tax adjustments on earnings from domestic operations, changes in net deferred tax asset valuation allowances, including valuation allowances on loss carryforwards in which no tax benefit can be recognized, stock vesting, pension plan terminations, the completion of acquisitions or divestitures, changes in tax rates or tax laws and the completion of ongoing tax planning strategies and audits. 36
--------------------------------------------------------------------------------
Segment Results
The following tables present net sales information for the key product and service groups included within each operating segment as well as other products and services and operating income by segment, for the quarter endedMarch 31, 2020 compared with the quarter endedMarch 31, 2019 . Net sales by segment: Quarter Ended In thousands Q1-20 Q1-19 Dollar Change Performance Materials Segment: Filtration$ 25,887 $ 23,934 $ 1,953 Sealing and Advanced Solutions 39,333 40,646 (1,313 ) Performance Materials Segment net sales 65,220 64,580 640 Technical Nonwovens Segment (1): Industrial Filtration 31,369 42,364 (10,995 ) Advanced Materials (2) 26,034 23,242 2,792 Technical Nonwovens Segment net sales 57,403 65,606 (8,203 ) Thermal Acoustical Solutions Segment: Parts 77,321 84,576 (7,255 ) Tooling 6,440 9,737 (3,297 ) Thermal Acoustical Solutions Segment net sales 83,761 94,313 (10,552 ) Eliminations and Other (2) (5,857 ) (6,474 ) 617 Consolidated Net Sales$ 200,527 $ 218,025 $ (17,498 ) Operating income by segment: Quarter Ended Q1-20 Q1-19 Operating Operating In thousands Operating Income Margin % Operating Income Margin % Dollar Change Performance Materials (3)$ (56,941 ) (87.3)% $ 1,459 2.3%$ (58,400 ) Technical Nonwovens (1),(2),(4) 3,813 6.6% 4,734 7.2% (921 ) Thermal Acoustical Solutions 5,628 6.7% 9,491 10.1% (3,863 ) Corporate Office Expenses (8,068 ) (6,634 ) (1,434 ) Consolidated Operating Income$ (55,568 ) (27.7)% $ 9,050 4.2%$ (64,618 )
(1) The Technical Nonwovens segment reports the results of Geosol through the
date of disposition of
(2) Included in the Technical Nonwovens segment and Eliminations and Other is
Solutions segment for the quarters ended
(3) Included in the Performance Materials segment is
charges related to goodwill and other long-lived assets for the quarter ended
quarters ended
(4) Included in the Technical Nonwovens segment is
of intangible assets amortization for the quarters ended
2019, respectively.
Performance Materials
Segment net sales increased $0.6 million in the first quarter of 2020 compared
to the first quarter of 2019. The increase was primarily due to increased net
sales in filtration of $2.0 million as demand in the air filtration market for
face mask media in response to the COVID-19 pandemic grew. These increases to
net sales were partially offset by decreased sealing and advanced
37
--------------------------------------------------------------------------------
solutions net sales of $1.3 million as these products partially serve the
automotive industry and were impacted by lower demand due to automotive customer
shutdowns in the first quarter of 2020 related to COVID-19 and ultimately led to
a marginal impact on total net sales related to the pandemic. Foreign currency
translation had a negative impact on segment net sales of $0.6 million , or 0.9%,
in the first quarter of 2020 compared to the first quarter of 2019.
The Performance Materials segment reported an operating loss of $(56.9) million
in the first quarter of 2020, compared to operating income of $1.5 million in
the first quarter of 2019. The change in operating income of $58.4 million was
primarily driven by goodwill and other long-lived asset impairment charges of
$61.1 million in the first quarter of 2020. After adjusting for the impairment
charges, the Performance Materials segment reported adjusted operating income of
$4.2 million . The impairment charges were partially offset by higher gross
margin of 260 basis points, primarily due to favorable product mix driven by
increased demand for face mask media in response to the COVID-19 pandemic,
combined with lower raw material commodity costs and favorable material
productivity in the first quarter of 2020 compared to the first quarter of 2019.
After excluding the impairment charges, selling, product development and general
administrative expenses were favorable by 150 basis points as a percentage of
segment net sales in the first quarter of 2020 compared to the first quarter of
2019, primarily driven by decreased consulting and travel expenses.
Technical Nonwovens
Segment net sales decreased$8.2 million , or 12.5%, in the first quarter of 2020 compared to the first quarter of 2019. Foreign currency translation had a negative impact on segment net sales of$0.8 million , or 1.2%, in the first quarter of 2020 compared to the first quarter of 2019. Industrial filtration net sales decreased$11.0 million , or 26.0%, primarily driven by decreased demand across all regions, coupled with the negative impact of foreign currency. Advanced materials net sales increased$2.8 million , or 12.0%, driven by increased demand inNorth America , and more specifically, increased geosynthetic and medical product sales inCanada in the first quarter of 2020 compared to the first quarter of 2019. The Technical Nonwovens segment reported operating income of$3.8 million , or 6.6% of net sales, in the first quarter of 2020, compared to$4.7 million , or 7.2% of net sales, in the first quarter of 2019. The decrease in operating income of$0.9 million and operating margin of 60 basis points was primarily attributable to higher selling, product development and general administrative expenses of 60 basis points as a percentage of segment net sales compared to the first quarter of 2019. This increase as a percentage of net sales was primarily due to the$8.2 million reduction in sales, while selling, product development and general administrative expenses actually decreased$0.6 million , primarily driven by lower salaries and benefits expense of$0.6 million in the first quarter of 2020 compared to the first quarter of 2019. Gross margin was flat over the comparable period as favorable product mix and lower material commodity and productivity costs were completely offset by inventory write-off costs of$0.9 million , or 160 basis points, associated with a flood in one of the Company's European facilities and lower customer pricing in the first quarter of 2020 compared to the first quarter of 2019. The Company is pursuing a claim with its insurer to recover the loss associated with the inventory write-off loss.
Thermal Acoustical Solutions
Segment net sales decreased$10.6 million , or 11.2%, in the first quarter of 2020 compared to the first quarter of 2019. Foreign currency translation had a negative impact on segment net sales of$0.8 million , or 0.9%, in the first quarter of 2020 compared to the first quarter of 2019. The decrease was driven by plant ramp downs across all of the Thermal Acoustical Solutions businesses as the Company's large OEM customers closed their own plants due to the COVID-19 pandemic. The Thermal Acoustical Solutions segment reported operating income of$5.6 million , or 6.7% of net sales, in the first quarter of 2020, compared to operating income of$9.5 million , or 10.1% of net sales, in the first quarter of 2019. The decrease in operating income of$3.9 million and operating margin of 340 basis points was primarily due to lower gross margin of 280 basis points and, to a lesser extent, increased selling, product development and administrative expenses as a percentage of net sales. Gross margin erosion was driven by unfavorable product mix of approximately 90 basis points on reduced volume of higher margin acoustical parts. Additionally, labor and overhead costs increased by approximately 210 basis points, primarily related to unfavorable absorption, partially offset by reduced, outsourcing and expedited freight expenses within theNorth America andEurope facilities. This decrease to gross margin was partially offset by favorable raw material commodity costs and productivity costs in the first quarter of 2020 compared to the first quarter of 2019, partially offset by lower customer pricing. Selling, product development and administrative expenses decreased$0.1 million , or 60 basis points as a percentage of net sales as decreased salaries of$0.2 million were essentially offset by increased bad debt expense of$0.2 million in the first quarter of 2020 compared to the first quarter of 2019. 38
--------------------------------------------------------------------------------
Corporate Office Expenses
Corporate office expenses for the first quarter of 2020 were$8.1 million , compared to$6.6 million in the first quarter of 2019. The increase of$1.4 million was primarily due to increased corporate strategic initiatives expenses of$1.1 million , higher accrued cash incentive compensation of$0.3 million and increased insurance expenses of$0.3 million , partially offset by decreased professional service costs of$0.3 million in the first quarter of 2020 compared to the first quarter of 2019.
Liquidity and Capital Resources
The Company assesses its liquidity in terms of its ability to generate cash to fund operating, investing and financing activities. The principal source of liquidity is operating cash flows. In addition to operating cash flows, other significant factors that affect the overall management of liquidity include capital expenditures, investments in businesses, strategic transactions, income tax payments, debt service payments, outcomes of contingencies, foreign currency exchange rates and employee benefit plan funding. The Company manages worldwide cash requirements by considering available funds among domestic and foreign subsidiaries. The Company expects to finance its 2020 operating cash and capital spending requirements from existing cash balances, cash provided by operating activities and through borrowings under the Credit Facility, as needed.
At
The Company's continued access to sources of liquidity depends on multiple factors, including global economic conditions, the COVID-19 pandemic's effects on its customers and their production rates, the condition of global financial markets, the availability of sufficient amounts of financing, its operating performance and its credit ratings. The Company borrowed$20 million under the revolver portion of its Facility, during the first quarter of 2020, in order to increase its cash position and preserve financial flexibility in light of the impact of the COVID-19 outbreak on its results of operations and liquidity. The Company is taking further actions to improve its liquidity, including capital expenditure and operating expense reductions and increased management and oversight of its working capital.
Financing Arrangements
2020 Amendment to the 2018 Credit Agreement
OnMay 11, 2020 , the Company amended its$450 million senior secured revolving 2018 Credit Agreement (''2020 Amendment"). The principal purpose of the Amendment was to modify certain financial maintenance covenants contained in the 2018 Credit Agreement, at least one of which the Company expected to fail as early as the second quarter of 2020 as a result of the impact of COVID-19. Key amended terms and conditions include:
• The maximum Consolidated Net Leverage Ratio, applicable on the last day of
each fiscal quarter, is 6.5:1 through the period ending
stepping down to 4.50:1 for the period ending June 30, 2021 through the
period ending March 31, 2022 , and 3.50:1 for the period ending June 30,
2022 and thereafter;
• The minimum Consolidated Fixed Charge Coverage Ratio, applicable on the
last day of each fiscal quarter, is 1.10:1 on a trailing twelve month
basis through the period ending
distinct quarterly basis for the quarters ended
June 30, 2021 , and on a trailing twelve month basis beginning with the period endingSeptember 30, 2021 and thereafter; • The amended terms also provide that the Company maintain cash and cash
equivalents balances of
• The term loan facility is
is $170 million for a total overall facility of $314 million . The
accordion feature has been eliminated, and there is no change to the
maturity date;
• There is a floor on the Base and Eurocurrrency Rate of 1%;
• The range for the Applicable Rate, as determined based on the Company's
Consolidated Net Leverage Ratio, and added to the Base Rate Committed
Loans is 2.00% to 3.25% and the range for the Applicable Rate added to
Eurocurrency Rate Committed Loans and Letters of Credit is 3.00% to 4.25%;
• The quarterly fee is 0.375% on the unused portion of the revolving
commitment; and
39--------------------------------------------------------------------------------
• The Company will pay an amendment fee to the Lenders based on their
commitment levels.
The Company believes that its liquidity resources including the 2020 Amendment
to the 2018 Credit Agreement are sufficient to meet its working capital needs
and other cash requirements.
2018 Credit Agreement
The 2018 Credit Agreement increased the available borrowing from $175 million to
$450 million and added three additional lenders and extended the maturity date
from July 7, 2021 to August 31, 2023 .
Under the terms of the 2018 Credit Agreement, the lenders provided up to a $450
million credit facility (the "Facility") to the Company, including a term loan
commitment of $200 million and revolving loans to or for the benefit of the
Company and its subsidiaries of up to $250 million . The Facility was secured by
substantially all of the assets of the Company.
Interest was charged on borrowings at the Company's option of either: (i) Base
Rate plus the Applicable Rate, or (ii) the Eurodollar Rate plus the Applicable
Rate. The Base Rate is a fluctuating rate equal to the highest of (a) the
federal funds rate plus 0.50%, (b) the prime rate as set by Bank of America , and
(c) the Eurocurrency Rate plus 1.00%. The Eurocurrency Rate means (i) if
denominated in LIBOR quoted currency, a fluctuating LIBOR per annum rate equal
to the London Interbank Offered Rate; (ii) if denominated in Canadian Dollars,
the rate per annum equal to the Canadian Dollar Offered Rate; or (iii) the rate
per annum as designated with respect to such alternative currency at the time
such alternative currency is approved by the Lenders. The Applicable Rate is
determined based on the Company's Consolidated Leverage Ratio (as defined in the
2018 Credit Agreement). The Applicable Rate added to the Base Rate Committed
Loans ranged from 0.00% to 1.25%, and the Applicable Rate added to Eurocurrency
Rate Committed Loans and Letters of Credit ranged from 0.75% to 2.00%. The
Company paid a quarterly fee ranging from 0.15% to 0.275% on the unused portion
of the revolving commitment. The Company has entered into multiple interest rate
swaps to convert a portion of the Company's one-month LIBOR-based borrowings
from a variable rate to a fixed rate. See Note 7, "Derivatives".
The Company is permitted to prepay term and revolving borrowings in whole or in
part at any time without premium or penalty, subject to certain minimum payment
requirements, and the Company was generally permitted to irrevocably cancel
unutilized portions of the revolving commitments under the 2018 Credit
Agreement. The Company is required to repay the term commitment in an amount of
$2.5 million per quarter beginning with the quarter ending December 31, 2018
through the quarter ending June 30, 2023 .
The 2018 Credit Agreement contained covenants required of the Company and its
subsidiaries, including various affirmative and negative financial and
operational covenants. The Company was required to meet certain quarterly
financial covenants calculated from the four fiscal quarters most recently
ended, including: (i) a minimum Consolidated Fixed Charge Coverage Ratio, which
requires that at the end of each fiscal quarter the ratio of (a) consolidated
EBITDA to (b) the sum of consolidated interest charges, redemptions,
non-financed maintenance capital expenditures, restricted payments and taxes
paid, each as defined in the 2018 Credit Agreement, may not be lower than 1.25
to 1.0; and (ii) a Consolidated Net Leverage Ratio, which required that at the
end of each fiscal quarter the ratio of consolidated funded indebtedness minus
consolidated domestic cash to consolidated EBITDA, as defined in the 2018 Credit
Agreement, could not be greater than 3.5 to 1.0. The Company was in compliance
with all covenants at March 31, 2020 .
At March 31, 2020 , the Company had $288.5 million of borrowings outstanding and
standby letters of credit outstanding of $1.9 million . The borrowings
outstanding included a $143.6 million term loan, net of $0.4 million in debt
issuance costs being amortized to interest expense over the debt maturity
period.
In addition to the amounts outstanding under the Facility, the Company has
various foreign credit facilities totaling approximately
InNovember 2018 , the Company entered into a five year interest rate swap agreement with a bank which converts the interest on a notional$139.0 million of the Company's one-month LIBOR-based borrowings under its 2018 Credit Agreement from a variable rate, plus the borrowing spread, to a fixed rate of 3.09% plus the borrowing spread. The notional amount reduces quarterly by fluctuating amounts throughAugust 2023 . InApril 2017 , the Company entered into a three-year interest rate swap agreement with a bank which converts the interest on a notional$60.0 million of the Company's one-month LIBOR-based borrowings under its 2018 Credit Agreement from a variable rate, plus the borrowing spread, to a fixed rate of 1.58% plus the borrowing spread. The notional amount reduced quarterly by$5.0 million throughMarch 31, 2020 and is now settled. These interest rate swap agreements were accounted for as cash flow hedges. Effectiveness of these derivative agreements are assessed quarterly by ensuring that the critical terms of the swaps continue to match the critical terms of the hedged debt. 40
--------------------------------------------------------------------------------
Operating Cash Flows
Net cash provided by operating activities in the first three months of 2020 was$26.7 million compared with$14.4 million in the first three months of 2019. In the first three months of 2020, net loss and non-cash adjustments were$15.4 million compared to net income and non-cash adjustments of$16.6 million in the first three months of 2019. SinceDecember 31, 2019 , net operating assets and liabilities decreased by$11.4 million , compared to the first three months of 2019 when net operating assets and liabilities increased$2.2 million fromDecember 31, 2018 . The decrease sinceDecember 31, 2019 was primarily due to an increase of$21.1 million in accounts payable. This was partially offset by increases of$7.8 million in accounts receivable. The increase in accounts payable was primarily driven by the timing of vendor payments, including capital expenditures within all segments of the Company. The increase in accounts receivable was primarily due to higher net sales in the first quarter of 2020 compared to the fourth quarter of 2019.
Investing Cash Flows
In the first three months of 2020 and 2019, net cash used for investing activities consisted of capital expenditures of$9.2 million . In the first three months of 2020 net cash used for investing activities was partially offset by$1.7 million in cash inflows for collections of finance receivables under the Company's receivable financing arrangements.
Financing Cash Flows
In the first three months of 2020, net cash provided by financing activities was$18.4 million compared to net cash used for financing activities of$7.1 million in the first three months of 2019. The Company made debt repayments of$4.5 million and$7.1 million in the first three months of 2020 and 2019, respectively. In the first three months of 2020, the Company borrowed$20.0 million from its Amended Credit Facility as a precautionary measure in light of the uncertainty caused by COVID-19. The Company held$2.9 million in proceeds from servicing receivables owed to the banking institution which was paid in early April. Critical Accounting Estimates The preparation of the Company's consolidated financial statements in accordance with accounting principles generally accepted inthe United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Note 1 "Significant Accounting Policies" of the "Notes to Consolidated Financial Statements" and Critical Accounting Estimates in Item 7 of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , and the "Notes to Condensed Consolidated Financial Statements" of this report describe the significant accounting policies and critical accounting estimates used in the preparation of the consolidated financial statements. The Company's management is required to make judgments and estimates about the effect of matters that are inherently uncertain. Actual results could differ from management's estimates. In the first quarter of 2020, the Company recorded a goodwill impairment charge of$48.7 million , and a long-lived asset impairment charge of$12.4 million , both in the Performance Materials reporting unit. See Note 5, "Impairments ofGoodwill and Other Long-Lived Assets", to the "Notes to Condensed Consolidated Financial Statements" of this report for additional discussion of the facts and circumstances surrounding and critical estimates made regarding the impairment charges.
There have been no other significant changes in the Company's critical
accounting estimates during the quarter ended
41--------------------------------------------------------------------------------
© Edgar Online, source
