Back to GetFilings.com

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

For the Fiscal Year Ended December 31, 2002

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to              Commission File Number: 1-7665

LYDALL, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (860) 646-1233

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x  No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes x  No ¨

On March 12, 2003, the aggregate market value of the Registrant’s voting stock held by nonaffiliates was $137,347,481.

On March 12, 2003, there were 16,078,730 shares of Common Stock outstanding, exclusive of treasury shares.

DOCUMENTS INCORPORATED BY REFERENCE

Parts II and III incorporate information by reference from the definitive Proxy Statement distributed in connection with the Registrant’s Annual Meeting of Stockholders to be held on May 8, 2003.

The exhibit index is located on pages 20-22.

Table of Contents

INDEX TO ANNUAL REPORT ON FORM 10-K

Year Ended December 31, 2002

The information called for by Items 5, 10, 11, 12 and 13, to the extent not included in this document, is incorporated herein by reference to such information included under the captions “Equity Compensation Plan Information,” “Board of Directors,” “Director Compensation,” “Executive Compensation,” “Securities Ownership of Directors, Certain Officers and 5 Percent Beneficial Owners,” “Certain Relationships and Related Transactions with Directors” and “Transactions with Management” in the Company’s definitive Proxy Statement distributed in connection with the 2003 Annual Meeting of Stockholders.

Table of Contents

PART I

Lydall, Inc. and its subsidiaries are hereafter collectively referred to as “Lydall,” the “Company” or the “Registrant.”

Item 1. BUSINESS

Lydall designs and manufactures specialty engineered air and liquid filtration media, automotive thermal and acoustical barriers, passive and active industrial thermal and insulating solutions and certain medical filtration and bioprocessing components for demanding thermal/acoustical and filtration/separation applications.

The Company has defined the Thermal/Acoustical Segment and Filtration/Separation Segment as its core businesses and has developed a long-term strategy to concentrate primarily on these businesses. In accordance with this strategic focus, Lydall completed a restructuring program in 2001 discontinuing its Paperboard Segment, including divestment of the materials-handling business and the closing of its Connecticut boxboard plant. During 2002, the Company paid all remaining liabilities previously accrued for the fiberboard operation, sold certain assets and recorded a final non-cash charge to write-off the remaining assets that could not be sold.

The Company serves a number of market niches. Lydall’s products are primarily sold directly to customers through an internal sales force and distributed by the Company’s distribution operation or via common carrier. The majority of the Company’s products are sold to original equipment manufacturers and tier-one suppliers. The Company competes through high-quality, specialty engineered products and superior customer service. Lydall has a number of domestic and foreign competitors for its products, most of whom are either privately owned or divisions of larger companies, making it difficult to determine the Company’s share of the markets served.

Sales to the automotive market represented 47 percent of Lydall’s net sales in both 2002 and 2001 and 51 percent in 2000. Lydall’s thermal and acoustical products are used on a variety of automotive platforms and various other applications. Sales to Ford Motor Co. and DaimlerChrysler AG were $45.3 million and $32.9 million, or 18 percent and 13 percent of Lydall’s net sales in 2002, respectively. No other single customer accounted for more than 10 percent of the Company’s net sales in 2002.

Foreign and export sales were 34 percent of the Company’s net sales in 2002, 30 percent in 2001 and 37 percent in 2000. Export sales are concentrated primarily in Europe, Asia, Mexico and Canada and were $32.2 million, $25.6 million and $27.7 million in 2002, 2001 and 2000, respectively. Foreign sales were $53.0 million, $40.7 million and $67.8 million for the years ended December 31, 2002, 2001 and 2000, respectively. Foreign operations generated after-tax income (losses) of $3.5 million, $1.8 million and ($19.8 million) (the loss in 2000 includes a loss on disposition of two unprofitable German operations of $19.3 million), for the years ended December 31, 2002, 2001 and 2000, respectively. Total foreign assets were $44.3 million at December 31, 2002 compared with $32.3 million at December 31, 2001 and $36.2 million at December 31, 2000.

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Reports on Form 8-K and all amendments to those reports are made available free of charge through the Investor Relations section of the Company’s website (www.lydall.com) after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (the Commission).

SEGMENTS

Lydall has organized its business into two primary reportable segments – Thermal/Acoustical and Filtration/Separation. All other businesses are aggregated in Other Products and Services. Segments are defined by the grouping of similar products and services.

Thermal/Acoustical

Lydall’s thermal and acoustical barriers, temperature-control units and insulating products protect, control and insulate within temperature environments ranging from -459°F (-237°C) to +3000°F (+1649°C).

Lytherm^® and Manniglas^® products are employed as linings for ovens, kilns and furnaces, in glass and metal manufacturing, and in consumer appliances, as well as heating, ventilation and air-conditioning systems.

Lydall’s automotive thermal and acoustical barriers, including ZeroClearance^®, AMS^®, dBLyte^® and Lytherm^® products, are comprised of organic and inorganic fiber composites, fiber-and-metal combinations and all-metal components that are used in cars, trucks, sport-utility vehicles and vans. The Company holds patents on several of these products, which are employed on both

1

Table of Contents

the interior and exterior of the vehicle passenger cabin and within the engine compartment and around such components as exhaust systems, fuel tanks, heat and air-conditioning ducts, batteries and electronic components.

At the very coldest temperatures (approaching absolute-zero), Cryotherm^® cryogenic materials, composed of 100 percent inorganic fibers, are used for super-insulating applications. These applications include tanker trucks that transport liquid gases, stationary and portable cryogenic storage vessels and fuel tanks for vehicles powered by liquid natural gas.

Lydall’s industrial thermal business designs and manufactures high precision, specialty engineered temperature-control equipment for demanding semiconductor, pharmaceutical, medical, laser and industrial applications.

Thermal/Acoustical Segment net sales, before elimination of intersegment sales, represented 59 percent of the Company’s net sales in 2002, 56 percent in 2001 and 61 percent in 2000. Additionally, total sales generated by the international operation of the Thermal/Acoustical Segment accounted for 23.5 percent, 20.2 percent and 35.5 percent of segment net sales in 2002, 2001 and 2000, respectively.

Filtration/Separation

The Filtration/Separation Segment includes air and liquid filtration products for industrial and consumer applications, as well as vital fluids management systems for medical and biopharmaceutical applications.

Lydair^® high-efficiency air filtration media range in filtering efficiencies from 45 percent ASHRAE through all HEPA grades to the highest ULPA grade and filter particles as small as 0.1 micron. Uses for these products include industrial and commercial heating, ventilating and air-conditioning systems, cleanspace applications and consumer products.

Lydall also produces liquid filtration media, sold under the Lypore^® and Actipure^® trademarks, used for industrial and residential water purification, in high-efficiency hydraulic oil and lubrication filters for off-road vehicles, trucks and heavy equipment.

The Company’s vital fluids management systems are sold by its Charter Medical, Ltd. subsidiary (Charter Medical). Charter Medical designs and manufactures specialty blood and cell therapy products and Bio-Pak^™ sterile flexible containers for use in biopharmaceutical processing. In addition, its medical filter components are employed in blood filtration devices such as cardiotomy reservoirs and autotransfusion filters.

Net sales from the Filtration/Separation Segment, before elimination of intersegment sales, represented 29 percent of the Company’s net sales in 2002 compared with 30 percent in 2001 and 26 percent in 2000. In addition, total sales generated by the international operation of the Filtration/Separation Segment accounted for 24.2 percent, 23.0 percent and 16.9 percent of segment net sales in 2002, 2001 and 2000, respectively.

Other Products and Services

The largest component of Other Products and Services is Lydall’s transport, distribution and warehousing business. This business specializes in time-sensitive shipments and has an in-depth understanding of the special nature and requirements of the paper and printing industries. Other Products and Services also include electrical insulation, assorted specialty products and battery separator materials sold in Europe.

Other Products and Services net sales, before elimination of intersegment sales, were 13 percent of the Company’s net sales in 2002 compared with 15 percent in 2001 and 2000.

Discontinued Operations

In February 2001, the Company discontinued the Paperboard Segment, which consisted primarily of the Southern Products and Lydall & Foulds operations.

The results of the Paperboard Segment have been excluded from continuing operations for all years presented. In the fourth quarter of 2002, the Company recorded an after-tax charge of approximately $220 thousand, or $.01 per diluted share for additional costs incurred during the phase-out period. See Note 6 in “Notes to Consolidated Financial Statements.”

GENERAL BUSINESS INFORMATION

Lydall holds a number of patents, trademarks and licenses. While no single patent, trademark or license is critical to the success of Lydall, together these intangible assets are of considerable value to the Company.

2

Table of Contents

The Company’s business is generally not seasonal; however, results of operations may be impacted by shutdowns at our automotive customers that typically occur in the third quarter of each year. Lydall maintains levels of inventory and grants credit terms that are normal within the industries it serves. The Company uses a wide range of raw materials in the manufacturing of its products. The majority of raw materials used are available from a variety of suppliers that could be substituted as necessary.

Lydall invested $6.5 million in 2002, $6.9 million in 2001 and $8.3 million in 2000, or approximately 3 percent of net sales for each year, to develop new products and to improve existing products. Most of the Company’s investment in research and development is application specific; very little is pure research. There were no significant customer-sponsored research and development activities during the past three years.

Lydall’s backlog was $26.8 million at December 31, 2002, $21.1 million at December 31, 2001 and $26.3 million at December 31, 2000. Backlog at January 31, 2003 was $28.5 million. The increase in backlog at December 31, 2002 compared to December 31, 2001 was primarily the result of increases in orders from the automotive market, additional Ossipee operation backlog in 2002 and the strengthening of the Euro in 2002 versus 2001. These increases were partially offset by reductions in backlog in the Filtration/Separation Segment. The decrease in backlog from December 31, 2000 to December 31, 2001 was primarily the result of a change in the methodology used to calculate backlog. There are minimal seasonal aspects to Lydall’s backlog as of the end of the Company’s fiscal years.

No material portion of Lydall’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any governmental body.

Lydall believes that its plants and equipment are in substantial compliance with applicable federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. Additional measures to maintain compliance with presently enacted laws and regulations are not expected to have a substantially adverse effect on the capital expenditures, earnings or competitive position of the Company. For information relating to an environmental proceeding involving the Company, please refer to Note 14 in “Notes to Consolidated Financial Statements.”

As of December 31, 2002, Lydall employed 1,241 people. Four unions with contracts expiring on March 31, 2005 represented 62 of the Company’s employees in the United States. Lydall considers its employee relationships to be satisfactory and did not have any actual or threatened work stoppages due to union-related activities in 2002. All employees at the Company’s facility in France are covered under a National Collective Bargaining Agreement. Certain salaried and all hourly employees at the German operation are also covered under a National Collective Bargaining Agreement.

There are no anticipated operating risks related to foreign investment law, expropriation, inflation effects or availability of material, labor and energy. The Company’s foreign and domestic operations limit foreign currency exchange transaction risk by completing transactions in their functional currencies whenever practical or through the use of foreign currency forward exchange contracts when deemed appropriate.

CAUTIONARY NOTE CONCERNING FACTORS THAT MAY AFFECT FUTURE RESULTS

This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. In general, any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements within the meaning of Section 21E. Without limiting the generality of the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” and other similar expressions are intended to identify forward-looking statements. Investors should be aware that such forward-looking statements are intended to provide management’s current expectations for the future operating and financial performance of the Company based on assumptions believed to be valid at the time. Thus, such expectations are inherently subject to a number of risks and uncertainties that could cause the actual results of the Company to differ materially from those reflected in forward-looking statements. In addition to general economic conditions and market trends, some of the important factors which could cause actual results to differ materially from those anticipated include: a major downturn of the United States or European automotive markets, raw-material pricing and supply and new-product introductions (see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Note Concerning Factors That May Affect Future Results” for a more detailed discussion of these factors).

3

Table of Contents

Item 2. PROPERTIES

The principal properties of the Company as of December 31, 2002 are situated at the following locations and have the following characteristics:

Properties numbered 2, 3, 9, 10 and 11 are leased; all others are owned. For information regarding lease obligations, see Note 14 in “Notes to Consolidated Financial Statements.” Lydall considers its properties to be in good operating condition and are suitable and adequate for its present needs. All properties are being appropriately utilized consistent with experience and demand for the Company’s products. In addition to the properties listed above, the Company had several additional leases for sales offices and warehouses in the United States, Europe, Japan and Singapore.

Item 3. LEGAL PROCEEDINGS

No significant legal proceedings were instituted or settled in the fourth quarter of 2002. See Note 14 in “Notes to Consolidated Financial Statements” for additional information on legal proceedings.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the fourth quarter of 2002.

4

Table of Contents

EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of Lydall, Inc., together with the offices presently held by them, their business experience since January 1, 1998, and their ages as of March 12, 2003, the record date of the Company’s 2003 Annual Meeting, are as follows:

5

Table of Contents

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

PRICE RANGE OF COMMON STOCK AND DIVIDEND HISTORY

The Company’s Common Stock is traded on the New York Stock Exchange under the symbol LDL. Shares totaling 5,346,200 and 6,131,300 were traded during 2002 and 2001, respectively. The table below shows the range of reported sale prices on the New York Stock Exchange Composite Tape for the Company’s Common Stock for the periods indicated. As of March 12, 2003, the record date for the Company’s 2003 Annual Meeting, 1,499 stockholders of record held 16,078,730 shares of Lydall’s Common Stock, $.10 par value. As of the record date, there were no shares outstanding of the Company’s Preferred Stock, $1.00 par value.

The Company’s domestic revolving credit facility contains restrictions that limit the amount of dividends (whether in cash, securities or other property, unless payable solely in additional shares of the Company’s capital stock) that can be paid to external shareholders of its capital stock each fiscal year. Currently, the Company does not pay a cash dividend on its Common Stock and does not anticipate doing so in the foreseeable future. Cash will be reinvested in operations.

Information regarding equity compensation plan information is incorporated by reference to the definitive Proxy Statement of Lydall filed with the Commission in connection with its Annual Meeting of Stockholders to be held on May 8, 2003.

6

Table of Contents

Item 6. SELECTED FINANCIAL DATA

FIVE-YEAR SUMMARY

The results of operations of the discontinued Paperboard and Wovens Segments have been excluded from the Selected Financial Data table for all applicable periods. The Paperboard and Wovens Segments’ balance sheet items have been excluded from calculations of the “Performance and other ratios” section for all periods presented, except for the current ratio.

7

Table of Contents

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY NOTE CONCERNING FACTORS THAT MAY AFFECT FUTURE RESULTS

This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. In general, any statements contained in this report that are not statements of historical fact may be deemed to be forward-looking statements within the meaning of Section 21E. Without limiting the generality of the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” and other similar expressions are intended to identify forward-looking statements. Investors should be aware that such forward-looking statements are intended to provide management’s current expectations for the future operating and financial performance of the Company based on assumptions believed to be valid at the time. Thus, such expectations are inherently subject to a number of risks and uncertainties that could cause the actual results of the Company to differ materially from those reflected in forward-looking statements. In addition to general economic conditions and market trends, some of the important factors which could cause actual results to differ materially from those anticipated include, but are not limited to, the following:

A Major Downturn of the United States or European Automotive Markets – Although Lydall’s automotive sales are not solely contingent on the strength of the automotive market, a significant downturn of the United States or European automotive industries could have a substantial impact on Lydall’s results. The Company can also be affected when automotive manufacturers discontinue production of specific models that contain Lydall’s products. Conversely, Lydall benefits from the introduction of new models that contain the Company’s products. Approximately 47 percent of Lydall’s total net sales in 2002 were to the automotive market. Lydall’s automotive products are thermal and acoustical barriers employed both inside and under the body of vehicles. Most of Lydall’s products are supplied to meet unique, niche applications. Lydall may have a number of components on a particular automotive platform and applications can range across all types of vehicles from sport-utility models to trucks, vans and cars. Thus, there is no direct correlation between the number of Lydall products sold and the number of vehicles being built by automotive manufacturers. Slight fluctuations in automotive production have relatively little effect on Lydall’s business; however, a major downward shift could prevent Lydall from achieving its anticipated results.

Raw Material Pricing and Supply – Raw material pricing and supply issues affect all of Lydall’s businesses and can influence results in the short term. The Thermal/Acoustical Segment uses aluminum to manufacture most automotive heat shields. Volatility in aluminum prices could impact the Thermal/Acoustical Segment’s profitability where the Company is selling its products under long-term agreements with fixed sales prices.

New Product Introductions – Improved performance and growth is partially linked to new product introductions planned for the future. The timing and degree of success of new product programs could impact Lydall’s anticipated results.

Lydall does not undertake to update any forward-looking statement made in this report or that may from time to time be made by or on behalf of the Company.

CONSOLIDATED RESULTS OF OPERATIONS

Net sales

For the year ended December 31, 2002, Lydall recorded net sales of $253.5 million compared to $223.6 million for the year ended December 31, 2001, an increase of $30.0 million, or 13.4 percent. The improvement in net sales was attributable to increases in sales volumes across all core businesses. These increases were driven by new platform and product awards in the automotive business and new business gains in filtration and bioprocessing coupled with the incremental sales added by the Ossipee operation, acquired in October 2001, and the impact of foreign currency translation of approximately 1.3 percent.

In 2001, the Company generated $223.6 million in net sales compared with $261.1 million for the year ended December 31, 2000. The decrease in net sales was primarily the result of the divestment of two German operations at the end of the third quarter of 2000. Those operations contributed $34.3 million in sales for 2000. After adjusting net sales for this divestment, as well as the

8

Table of Contents

divestments of a gasket business during the first quarter of 2000, a fiberboard operation at the end of the first quarter of 2001 and the acquisition of the Ossipee operation in the fourth quarter of 2001, net sales for 2001 and 2000 were $220.3 million and $220.2 million, respectively. As adjusted, net sales for the Thermal/Acoustical Segment for 2001 improved over 2000 primarily due to increased automotive sales. This increase was offset by a decline in net sales from the Filtration/Separation Segment and Other Products and Services due to lower demand for air filtration products and the slow down in the economy, which reduced sales of the Company’s industrial substrate products.

Gross margin

Lydall recorded gross margin for the year ended December 31, 2002 of 25.7 percent compared with 28.0 percent for the year ended December 31, 2001. Although the Company realized an increase in net sales in 2002 from 2001, several items negatively impacted gross margin. These items included a significant operating loss at the Columbus operation (described more fully below) in the fourth quarter of 2002, an increase in tooling sales which typically have low or no gross margin, sales mix changes in other thermal products and start-up costs associated with the Newport News Distribution Center. In addition, order deferrals for air filtration and bioprocessing products in the fourth quarter led to under-absorption of factory overhead. These negative events combined to more than offset the significant improvement in the operating performance of the vital fluids and industrial thermal businesses and gross margin improvement from increased sales volumes of automotive products.

The Company recorded gross margin for the year ended December 31, 2001 of 28.0 percent compared with 26.3 percent for the year ended December 31, 2000. The Company improved its gross margin despite lower sales volumes primarily due to the sale of the unprofitable German operations at the end of the third quarter of 2000 and the achievement of operational efficiencies, particularly within the Thermal/Acoustical Segment.

Selling, product development and administrative expenses

Selling, product development and administrative expenses were $46.7 million, or 18.4 percent of net sales for 2002, compared with $47.6 million, or 21.3 percent for 2001. The 2001 amount includes $1.3 million of goodwill amortization, which in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” is no longer amortized. Adjusting the 2001 amount for the goodwill amortization, selling, product development and administrative expenses increased $.4 million, or less than 1 percent in 2002 from 2001. Increases from the addition of the Ossipee operation and additional accruals for incentive compensation under the Company’s Economic Value Added (EVA) Program were substantially offset by controlled spending, targeted headcount reductions and minimized usage of external consulting. Selling, product development and administrative expenses were $47.6 million for 2001 compared with $49.7 million for 2000 due to the disposition of several operations and the Company’s continued focus on controlling these costs.

Impairment and restructuring charges

During the fourth quarter of 2002, the Company recorded a final pre-tax non-cash charge of $.3 million, or $.01 per diluted share related to the closed fiberboard operation. This charge represented the write-off of the remaining assets that could not be sold.

During 2001, the Company recorded a pre-tax charge of $3.4 million, or $.13 per diluted share for closing costs, severance benefits and impairment of assets held for sale related to the closing of the fiberboard operation. On April 2, 2001, the Company sold certain assets of this business for approximately $1.9 million and announced that the operation would be closed.

Other income and expense

For the year ended December 31, 2002, Lydall recorded other expense of $.8 million, consisting primarily of interest expense of $.9 million, offset by net foreign currency transaction gains of $.1 million. Interest expense for 2002 was $.1 million less than interest expense for 2001, primarily due to lower debt levels and interest rates.

For the year ended December 31, 2001, Lydall recorded other expense of $1.5 million, consisting primarily of interest expense of $1.0 million. Interest expense for 2001 was $.2 million less than interest expense for 2000, primarily due to lower debt levels and interest rates.

For the year ended December 31, 2000, other expense amounted to $25.0 million. The two major components of this amount were a $29.7 million loss on the disposition of two German operations and an offsetting gain of $6.1 million on the sale of the gasket business.

9

Table of Contents

Income taxes

The effective rate on income from continuing operations for the year ended December 31, 2002 was 32.6 percent compared to an effective rate of 29.9 percent in 2001. The effective tax rate for 2002 was impacted favorably by benefits derived from tax-exempt export income, state income tax credits realized during the year, as well as the favorable resolution of tax issues in a tax audit. The effective tax rate for 2001 was impacted favorably by the settlement of a tax audit during the year. For 2003, the Company expects its effective tax rate to be approximately 35 percent.

The effective tax rate on loss from continuing operations for the year ended December 31, 2000 was a benefit of 39.5 percent. The 2000 tax rate reflected a tax benefit on the consolidated loss for the year and additional benefits derived from exempt Foreign Sales Corporation income and state income tax credits.

SEGMENT RESULTS

Thermal/Acoustical

Net sales for the Thermal/Acoustical Segment for 2002 were $150.4 million compared with $125.7 million for 2001, an increase of $24.7 million, or 19.6 percent. The increase in segment net sales was primarily driven by increased automotive product and tooling sales for new platforms and the full year impact of the Ossipee operation, which was acquired in the fourth quarter of 2001. The impact of foreign currency translation increased segment net sales by approximately 1.6 percent for 2002.

Sales to the automotive industry accounted for approximately 80 percent of total segment net sales in 2002. Strong performance by the Company’s Gerhardi operation in Germany as new platforms such as the BMW Mini, the BMW 7 Series and new business with Nissan contributed to the increase in segment net sales for 2002. Growth in Europe is expected to remain strong going forward. In December 2002, the Company announced a $16.0 million expansion to support new business from French original equipment manufacturers. The new facility, to be located in St. Nazaire, France, is anticipated to come online in 2004 and is expected to provide the additional capacity needed to support the Company’s European customers.

Industrial thermal/acoustical products account for approximately 20 percent of total segment net sales and include the sales of the Ossipee operation acquired in 2001. Sales of these products are particularly sensitive to economic conditions, and as a result, posted only modest revenue gains in 2002 resulting from new business in building materials and market share gains in the appliance market.

For 2002, operating income was $20.4 million compared to $18.4 million in 2001, an increase of $2.0 million, or 11.0 percent. The increase, excluding goodwill amortization of $1.0 million in 2001 no longer amortized under FAS 142, was $1.0 million. Operating margin for 2002 was 13.6 percent of segment net sales compared to 14.7 percent in 2001. The increase in operating income for 2002 was the result of increased automotive sales, the realization of operational improvements at the Green Island operation and the addition of the Ossipee operation. Additionally, the impact of foreign currency translation increased segment operating income by approximately 1.3 percent for 2002. Operating margin was negatively impacted by sales mix changes in other thermal products, higher tooling sales that carry low or no margin and the significant operating loss at the Columbus operation (described more fully below) in the fourth quarter of 2002.

Net sales for the Thermal/Acoustical Segment for 2001 were $125.7 million compared with $158.5 million for 2000, a decrease of $32.7 million, or 20.7 percent. Operating income increased by $1.7 million, or 9.9 percent from 2000. The decrease in segment net sales was primarily the result of the divestment of two unprofitable German operations at the end of the third quarter of 2000. Those operations contributed $34.3 million in sales for 2000. In addition, the divestments of the fiberboard operation and the gasket business negatively impacted segment net sales year over year. Offsetting these declines was the acquisition of the Ossipee operation during the fourth quarter of 2001. Adjusted for acquisitions and dispositions, segment net sales were $123.7 million for 2001 compared with $122.6 million for 2000, an increase of approximately 1 percent.

Sales to the automotive industry accounted for approximately 80 percent of total segment net sales in 2001. For the year ended December 31, 2001, Lydall increased its continuing automotive business by approximately 4 percent through the success of new products, increased content on key platforms and increased sales to the European market.

10

Table of Contents

Industrial thermal/acoustical products accounted for approximately 20 percent of total segment net sales in 2001. Sales of these products are particularly sensitive to economic conditions. Accordingly, sales and margins declined during 2001 compared with 2000 due to lower demand in the commercial building products market. In addition, during October 2001, this business completed its acquisition of the Ossipee operation, complementing its existing passive thermal business.

Filtration/Separation

For 2002, Filtration/Separation Segment net sales increased $6.1 million, or 9.2 percent to $72.8 million from $66.6 million in 2001. This increase was primarily driven by increased sales of air filtration products in Europe, liquid filtration products in the United States, as well as increases in the bioprocessing and blood management businesses. The impact of foreign currency translation increased segment net sales by approximately 1.3 percent for 2002.

Sales of filtration products increased approximately 9.9 percent in 2002 from 2001 levels. The increase was driven by new business gains of the Company’s microglass air filtration products in Europe, strong year over year growth of carbon filter media for liquid filtration and the introduction of membrane composite media. This increase for 2002 was achieved in spite of soft commercial and industrial and semiconductor markets.

Sales of vital fluids products increased approximately 7.1 percent for 2002 compared to 2001. Increased market share and market growth for Charter Medical’s flexible containers for bioprocessing applications and a 20 percent increase in blood and cell therapy products contributed to the increase. In addition, Charter Medical received regulatory approval for certain of its blood management products in 2002 allowing for distribution in Europe and Canada. These increases were partially offset by lower demand for cardiotomy reservoir components during the year.

Operating income improved $3.3 million, or 46.0 percent to $10.6 million for 2002 compared with $7.3 million for 2001. Operating margin as a percent of segment net sales also improved to 14.6 percent in 2002 from 10.9 percent in 2001. The improvement in operating income for the year resulted from increases in sales volume in the filtration and vital fluids businesses, material and labor cost reduction efforts, controlled selling, product development and administrative expenses and approximately $.3 million due to the absence of goodwill amortization. Foreign currency translation did not have a significant impact on segment operating income.

For 2001, Filtration/Separation Segment net sales declined $1.3 million, or 1.9 percent to $66.6 million compared with 2000. Operating income declined by approximately $3.0 million, or 28.9 percent for 2001 compared with 2000.

Sales of air filtration products declined approximately 6 percent from 2000 to 2001 due principally to softness in domestic commercial construction and declines in new cleanspace construction in Asia. This decrease was partially offset by stronger sales of air filtration products in Europe and increased revenues of higher growth liquid filtration products. Operating income declined due to lower sales volume.

Sales of vital fluids management systems were flat for the year 2001 compared with 2000 primarily due to bioprocessing order deferrals in the fourth quarter of 2001. For the full year, sales of Bio-Pak^TM containers nearly doubled year 2000 levels. Operating income was negatively impacted primarily due to write-offs of blood management products during the second quarter of 2001.

Other Products and Services

Segment net sales were $32.2 million for 2002, a decrease of $1.1 million, or 3.3 percent from $33.3 million in 2001. Segment net sales declined primarily due to the divestment of the fiberboard operation in the first half of 2001. After removing the related sales impact of the fiberboard operation from 2001, segment net sales increased by approximately $.1 million. This increase primarily related to additional revenues provided by the Newport News Distribution Center, which were partially offset by a decline in sales of the Company’s economically sensitive specialty products in 2002 from 2001. Operating income increased $2.6 million from a loss of approximately $.4 million in 2001 to income of $2.2 million in 2002, including charges of $.3 million and $3.4 million recorded in 2002 and 2001, respectively, related to the closure of the fiberboard operation. Excluding these impairment charges, operating income decreased $.5 million in 2002 compared to 2001 primarily due to start-up costs associated with the Newport News Distribution Center.

11

Table of Contents

Segment net sales were $33.3 million for 2001, a decrease of $5.5 million, or 14.3 percent from $38.8 million in 2000. Segment net sales declined primarily due to the divestment of the fiberboard operation in the first half of 2001. Operating income decreased $4.3 million to a loss of $.4 million over the same period. The decline in operating income primarily related to impairment and restructuring charges of $3.4 million recorded in connection with the closure of the fiberboard operation. In addition, the Company incurred additional costs in the fourth quarter of 2001 related to start-up activities at the Newport News Distribution Center.

Discontinued Operations

In February 2001, the Company discontinued the Paperboard Segment, which consisted primarily of the Southern Products and Lydall & Foulds operations.

In the fourth quarter of 2002, the Company recorded an after-tax charge of $.2 million, or $.01 per diluted share for additional costs incurred during the phase-out period.

The results of the Paperboard Segment have been excluded from continuing operations for all years presented. See Note 6 in “Notes to Consolidated Financial Statements.”

Columbus Operation Matter

On November 15, 2002, Lydall disclosed its identification and correction of an accounting irregularity at its Columbus, Ohio automotive operation. Shortly thereafter, the Company restated its financial statements and filed amended Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2001, June 30, 2001 and September 30, 2001, as well as, its Annual Report on Form 10-K for the year ended December 31, 2001. In connection with the completion and audit of the year-end financial statements, the Company and PricewaterhouseCoopers LLP, its independent auditor, identified additional potential adjustments at the Columbus operation and, accordingly, conducted additional audit and forensic procedures. The procedures identified additional potential adjustments that, if recorded, would impact reported earnings both positively and negatively. Management and the Company’s Audit Review Committee considered the combined net impact for each quarter of 2001 and 2002 and for the full year 2001 and concluded that such effects were significant only to the second quarter of 2002. Accordingly, the Company restated its financial statements and amended its Quarterly Report on Form 10-Q for the quarter ended June 30, 2002. The impact of correcting these inaccuracies was to increase cost of sales by approximately $255 thousand and to decrease selling, product development and administrative expenses by $24 thousand for the quarter and six months ended June 30, 2002. The total impact of the adjustments was to reduce income from continuing operations and net income by approximately $146 thousand.

The accounting irregularity that occurred in 2001 and a temporary increase in factory throughput during the first nine months of 2002 acted to mask ongoing shop floor inefficiencies and poor management of labor and material costs. Those conditions, the disruption related to the termination in late 2002 of the employees involved in the irregularity and the cost of corrective actions implemented by Thermal/Acoustical Group management significantly impacted the Columbus operation’s financial performance in the fourth quarter of 2002.

LIQUIDITY AND CAPITAL RESOURCES

The Company ended 2002 with $2.6 million in cash and cash equivalents compared with $1.0 million as of December 31, 2001.

Net cash provided by operating activities in 2002 was $18.4 million compared with $16.1 million in 2001. The increase of $2.4 million for 2002 reflects improved operating performance partially offset by a $5.9 million contribution to the Company’s defined benefit pension plans and an increase in working capital. In 2001, net cash provided by operating activities decreased $1.1 million to $16.1 million compared to $17.2 million in 2000. The decrease in cash flow during 2001 was primarily attributable to changes in working capital items.

Net cash used for investing activities was $14.1 million in 2002 compared to $15.2 million in 2001. For 2002, capital expenditures totaled $14.2 million, exclusive of a purchase of foreign assets of $1.7 million not yet settled in cash as of December 31, 2002.

12

Table of Contents

Acquisition activities used $1.1 million in cash as certain contingent events associated with the acquisition of the Ossipee operation were met in 2002. Proceeds from sales of assets classified as held for sale provided $1.0 million in cash. Cash used for investing activities was $15.2 million in 2001 compared to $5.4 million in 2000. For 2001, capital expenditures totaled approximately $11.9 million and acquisition activities used $18.7 million in cash. These expenditures were partially offset by proceeds from the sale of the Southern Products operation, a favorable settlement of a net equity adjustment related to the acquisition of the Gerhardi operation and proceeds from the sale of certain assets of the fiberboard operation.

In 2002, net cash used for financing activities was $2.8 million compared with $2.1 million in 2001. For the years ended December 31, 2002 and 2001, debt was reduced by $3.9 million and $3.2 million, respectively. Proceeds from stock option exercises were approximately $1.1 million in both 2002 and 2001. The Company did not repurchase any of its Common Stock in 2002 or 2001. Currently, the Company has no plans to repurchase its Common Stock except to offset shares granted under Lydall’s stock option plans, as deemed appropriate and within the confines of the Company’s credit agreements, as applicable.

Cash requirements for 2003 will include the funding of ongoing operations, contributions to the Company’s defined benefit pension plans, capital expenditures, debt service and acquisitions, if completed. Capital spending for 2003 is expected to be approximately $24.8 million, including approximately $7.0 million for the Thermal/Acoustical Segment’s European expansion. However, in accordance with the Company’s domestic revolving credit facility, capital expenditures in excess of $20.0 million require approval by the participating banks. The Company expects to finance its 2003 cash requirements from cash provided by operating activities and through borrowings on its existing credit agreements.

At the end of 2002, total indebtedness was $25.9 million, or 16.6 percent of the Company’s total capital structure. The Company continually explores its core markets for suitable acquisitions. Strategic acquisitions, if completed, would be financed under the credit facility described under “Financing Arrangements” below or other forms of financing, as required. Given appropriate acquisition opportunities, the Company would consider increasing its total debt to total capitalization ratio above current levels.

At December 31, 2002, the Company’s significant contractual obligations to make future payments under contracts were as follows:

In addition to the above contractual obligations, the Company utilizes letters of credit in the ordinary course of business and to satisfy self-insurance security deposit requirements. Outstanding letters of credit were $2.4 million and $2.1 million as of December 31, 2002 and 2001, respectively. The Company does not expect any material losses to result from these instruments, as performance is not expected to be required. See Notes 3 and 14 in “Notes to Consolidated Financial Statements” for additional information regarding contractual obligations.

Financing Arrangements

The Company amended and restated its $50 million domestic revolving facility with a group of five banking institutions on May 13, 2002. Under the new arrangement, the Company may borrow up to $50 million, or the equivalent in certain other foreign currencies. This facility, which has a maturity date of September 30, 2005, was renewed under terms and conditions similar to those previously in place under the prior agreement. Amounts borrowed under this agreement are required to be paid in full by September 30, 2005, unless the agreement is extended through amendment or renegotiation. The rate of interest charged on outstanding loans can, at the Company’s option, subject to certain restrictions, be based on the prime rate or at rates from 100 to 175 basis points over a Eurocurrency loan rate. The basis point spread over the Eurocurrency rate is based on the Company’s leverage ratio. Under the arrangement, the ongoing commitment fee varies from 25.0 to 37.5 basis points of the maximum amount

13

Table of Contents

that can be borrowed, net of any outstanding borrowings and net of amounts beneficiaries may draw under outstanding letters of credit. The loan agreement contains restrictions that limit the amount of dividends (whether in cash, securities or other property, unless payable solely in additional shares of the Company’s capital stock) that can be paid to external shareholders of its capital stock each fiscal year. The loan agreement also contains restrictive financial covenants primarily related to indebtedness, leverage ratio, fixed charge coverage ratio, capital expenditures, EBITDA (adjusted for certain non-recurring transactions) and net worth. At December 31, 2002, the Company was in compliance with these financial covenants, as well as, all non-financial covenants contained in the loan agreement. At December 31, 2002, $13.8 million was outstanding under this facility.

The Company also has a Euro-denominated term loan, with an outstanding balance of $7.3 million, which bears interest equal to Euro LIBOR plus a percentage based on the Company’s calculated leverage ratio.

Certain foreign subsidiaries of the Company have available lines of credit totaling $12.3 million, of which $4.8 million, with an interest rate of 4.6 percent, was outstanding as of December 31, 2002.

Management believes that current financing arrangements provide sufficient capacity to meet working capital requirements and fund future capital expenditures, as required.

CRITICAL ACCOUNTING POLICIES

The preparation of the Company’s consolidated financial statements in accordance with accounting principles generally accepted in the 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 at the date of the financial statements; and the reported amounts of revenues and expenses during the reporting periods. Note 1 in “Notes to Consolidated Financial Statements” describes the significant accounting policies 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. The most significant areas involving management judgments and estimates are described below.

Intangible Assets and Goodwill

In accordance with accounting principles generally accepted in the United States of America, the Company accounts for its business acquisitions under the purchase method whereby the assets and liabilities of acquired businesses are recorded at their estimated fair values at the dates of acquisition. Goodwill represents the costs in excess of fair values assigned to the underlying net assets of acquired businesses. The Company has goodwill recorded, net of accumulated amortization, of $30.9 million and $29.8 million at December 31, 2002 and 2001, respectively.

Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (FAS 142) requires that goodwill and other intangible assets determined to have indefinite lives are not amortized, but rather are subject to annual impairment tests in accordance with the specific guidance and criteria described in the standard. The identification and measurement of goodwill impairment involves the estimation of the fair value of reporting units (as defined in FAS 142), including the related goodwill. The estimates of fair value of reporting units are based on the best information available as of the date of the assessment, which incorporate management assumptions about expected future cash flows as well as other factors.

Future cash flows can be affected by numerous factors including changes in economic, industry or market conditions, changes in the underlying business or products of the reporting unit, changes in competition and changes in technology. Any changes in key assumptions about the business and its prospects, changes in any of the factors discussed above or any other factors could affect the fair value of one or more of the reporting units resulting in an impairment charge. Such a charge could have a material adverse effect on the Company’s reported financial condition and results of operations. Although no goodwill impairment has been recorded to date, there can be no assurance that future goodwill impairments will not occur. See Note 5 in “Notes to Consolidated Financial Statements.”

14

Table of Contents

Pensions

The Company accounts for its defined benefit pension plans in accordance with Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions,” (FAS 87) which requires that amounts recognized in financial statements be determined on an actuarial basis. The determination of such amounts is made in consultation with the Company’s outside actuaries based on information and assumptions provided by the Company. A substantial portion of the Company’s pension amounts relate to its defined benefit plans in the United States.

A significant element in determining the Company’s pension expense is the expected return on plan assets. Based on our review of market trends, actual returns on plan assets and other factors, the Company lowered the expected long-term rate of return on plan assets from 9.25 percent to 8.75 percent for determining 2003 pension expense. The expected long-term rate of return on assets is applied to the value of plan assets at the beginning of the year and this produces the expected return on plan assets that is included in the determination of pension expense for that year. The difference between this expected return and the actual return on plan assets is deferred, within certain parameters, as discussed below. The Company continually assesses its assumed long-term rate of return and will adjust such rate as deemed appropriate.

At the end of each year, the Company determines the discount rate to be used to calculate the present value of plan liabilities. The discount rate is an estimate of the current interest rate at which the pension liabilities could be effectively settled at the end of the year. In estimating this rate, the Company looks to rates of return on high-quality, corporate debt instruments. At December 31, 2002, the Company determined this rate to be 6.75 percent; a decrease of 50 basis points from the rate used at December 31, 2001 and 75 basis points from that used at December 31, 2000. Increases or decreases in the discount rate result in decreases and increases, respectively, in the projected benefit obligation. The net effect of changes in the discount rate are deferred within certain parameters, as discussed below.

FAS 87 requires that gains or losses (as defined in FAS 87) be deferred unless the unrecognized net gain or loss at the end of a year exceeds a “corridor” (as defined in FAS 87). If the deferred gain or loss exceeds the corridor at the end of the year, then the amount in excess of the corridor is amortized over a period equal to the average remaining service period of active employees expected to receive benefits. As of December 31, 2002, the net deferred loss exceeded the corridor. Consequently pension expense for 2003 is expected to include amortization of a portion of the deferred loss in excess of the corridor. The amount of amortization in future years will be dependent on changes in the components of the deferred loss amount, particularly actual return on plan assets in relation to the estimated return on plan assets, as well as future increases or decreases in the discount rate.

For the years ended December 31, 2002 and 2001, the Company recognized pension expense of $1.5 million and $1.1 million, respectively. As discussed above, the Company has lowered its expected return on plan assets to 8.75 percent. In addition, the reduction in the discount rate to 6.75 percent and the lower than expected return on plan assets in 2002 have increased the deferred loss subject to amortization. These factors are expected to negatively impact pension expense in 2003. See Note 10 in “Notes to Consolidated Financial Statements.”

Income Taxes

The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” (FAS 109) which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. FAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of a deferred tax asset will not be realized.

Deferred tax assets, net of valuation allowance, related to future tax benefits arising from deductible temporary differences and tax carryforwards are $12.7 million and $9.8 million at December 31, 2002 and 2001, respectively. Management believes that the Company’s earnings during the periods when the temporary differences become deductible will be sufficient to realize the related net future income tax benefits. For those jurisdictions where the projected operating results indicate that the ability to realize the future benefits is uncertain or not likely, a valuation allowance has been provided.

15

Table of Contents

In assessing the need for a valuation allowance, the Company estimates future taxable income, considering the feasibility of ongoing tax planning strategies and the realizability of tax loss carryforwards. Valuation allowances related to deferred tax assets can be impacted by changes to tax laws, changes to statutory tax rates and future taxable income levels. In the event the Company were to determine that it would not be able to realize all or a portion of its deferred tax assets in the future, the Company would reduce such amounts through a charge to income in the period that such determination was made. Conversely, if the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of the net carrying amounts, the Company would decrease the recorded valuation allowance and record an increase to income in the period that such determination was made. See Note 13 in “Notes to Consolidated Financial Statements.”

RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of Statement of Financial Accounting Standards No. 123” (FAS 148). FAS 148 provides alternative methods of transition for entities that voluntarily change to the fair value method of accounting for stock-based compensation and amends the disclosure provisions of Statement of Financial Accounting Standards No. 123 to require certain disclosures about the effects of the Company’s accounting policy decisions with respect to stock-based employee compensation in both annual and interim financial reporting. The Company adopted the disclosure requirements of FAS 148 effective December 31, 2002. See Notes 1 and 9 in “Notes to Consolidated Financial Statements” for the disclosures related to the Company’s method of accounting for stock-based compensation.

In November 2002, FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45) was issued. FIN 45 provides guidance on guarantors’ accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. The accounting guidelines are applicable to guarantees issued after December 31, 2002 and require that the Company record a liability for the fair value of such guarantees on the balance sheet. The disclosure requirements are applicable for financial statements issued after December 15, 2002. The Company does not have any material guarantee obligations that are within the scope of the initial recognition and measurement requirements of FIN 45 as of December 31, 2002, nor has it issued any material guarantees since December 31, 2002. Additionally, the Company does not have any material product warranty or other guarantee contracts required to be disclosed under this interpretation as of December 31, 2002.

In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (FAS 146). This statement provides guidance on significant issues associated with the recognition, measurement and reporting of costs associated with exit and disposal activities and is effective for exit and disposal activities that are initiated after December 31, 2002. The adoption of this standard may impact the timing and recognition of future exit and disposal activities, depending on the nature of the actions initiated.

Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (FAS 144). FAS 144 establishes the reporting and accounting for the impairment or disposal of long-lived assets. The adoption of this standard did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

OTHER KEY FINANCIAL ITEMS

Cash and cash equivalents – Cash and cash equivalents increased to $2.6 million as of December 31, 2002 compared with $1.0 million as of December 31, 2001.

Receivables – Receivables, net of the allowance for doubtful receivables, were $39.9 million at the end of 2002 compared with $35.5 million at the end of 2001. The increase was primarily related to the increased operating performance of the Company during 2002 compared with 2001.

16

Table of Contents

Inventories – Inventories were $32.7 million at December 31, 2002 compared with $27.9 million at December 31, 2001. The increase was primarily related to additional tooling inventory in process, which is related to future automotive business and inventory builds to support the Company’s current orders in backlog.

Working capital and current ratio – Working capital increased to $44.6 million at December 31, 2002 compared with $36.3 million at December 31, 2001. The ratio of current assets to current liabilities in 2002 increased to 2.09 from 2.02 in 2001. The increase was primarily due to increases in accounts receivable and inventories in response to improved operating performance.

Capital expenditures – Capital expenditures were $14.2 million in 2002, $11.9 million in 2001 and $19.8 million in 2000. Capital spending for 2003 is expected to be approximately $24.8 million.

Total debt to total capitalization – Total debt to total capitalization decreased to 16.6 percent in 2002 compared with 18.9 percent in 2001 as Lydall reduced its outstanding debt.

Stockholders’ equity – Stockholders’ equity increased to $130.0 million at December 31, 2002 from $118.6 million at December 31, 2001. On a per share basis, Stockholders’ equity increased to $8.09 at December 31, 2002 from $7.42 at December 31, 2001.

Dividend policy – The Company’s domestic revolving credit facility contains restrictions that limit the amount of dividends (whether in cash, securities or other property, unless payable solely in additional shares of the Company’s capital stock) that can be paid to external shareholders of its capital stock each fiscal year. Currently, the Company does not pay a cash dividend on its Common Stock and does not anticipate doing so in the foreseeable future.

Item 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Lydall is exposed to market risk related to changes in foreign currency exchange rates and interest rates.

FOREIGN CURRENCY RISK

Lydall has sales and manufacturing activities in foreign countries. As a result, financial results could be affected by factors such as changes in foreign currency exchange rates or economic conditions in the foreign markets where the Company distributes its products. The Company’s primary currency exposure is to the Euro and, to lesser degrees, the Japanese Yen and the British Pound Sterling.

Lydall’s foreign and domestic operations limit foreign currency exchange transaction risk by completing transactions in their functional currencies whenever practical. In addition, Lydall periodically enters into foreign currency forward exchange contracts to mitigate exposure to foreign currency volatility. The Company had no material foreign currency forward exchange contracts during 2002 or 2001. Lydall utilizes bank loans and other debt instruments throughout its operations. To mitigate foreign currency risk, such debt is denominated primarily in the functional currency of the operation maintaining the debt.

INTEREST RATE RISK

The Company’s interest rate exposure is most sensitive to fluctuations in interest rates in the United States and Europe, which primarily impact interest paid on its debt. At December 31, 2002, the Company had $18.6 million outstanding on various lines of credit with variable interest rates. The weighted average interest rate paid on this debt was 3.5 percent in 2002 and 4.2 percent in 2001. A 10 percent change in the weighted average interest rate on the Company’s variable rate debt would be immaterial to the Company’s consolidated financial position, results of operations or cash flows.

As of December 31, 2002, the Company also had $7.3 million outstanding on a five-year term loan with a variable interest rate. In July 1999, Lydall entered into an interest rate swap agreement to convert the variable base rate component of the interest rate on the term loan to a fixed rate of 3.45 percent, thereby taking advantage of favorable long-term borrowing rates in Europe.

17

Table of Contents

The weighted average interest rate on long-term debt, including the effect of the interest rate swap described above, was 3.7 percent for the year ended December 31, 2002 compared with 4.0 percent for 2001.

In January 2003, Lydall entered into an interest rate swap to convert the variable base rate on certain borrowings with an initial principal amount of $6.0 million under its domestic credit facility to a fixed rate; taking advantage of the favorable interest rate environment in the United States. The swap, with a final maturity on September 15, 2005, requires Lydall to pay a fixed base rate of 2.2 percent on the outstanding borrowings and has scheduled maturity dates that are identical to the payment schedule of the borrowings.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The response to this Item is contained under Item 15 “Exhibits, Financial Statement Schedules and Reports on 

Form 8-K.”

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

18

Table of Contents

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding the Directors of Lydall required by Section 16 of the Exchange Act are incorporated by reference to the definitive Proxy Statement of Lydall filed with the Commission in connection with its Annual Meeting of Stockholders to be held on May 8, 2003. Information regarding the executive officers of the Company is contained on page 5 of this report.

Item 11. EXECUTIVE COMPENSATION

Information regarding the compensation of Lydall’s Directors and executive officers is incorporated by reference to the definitive Proxy Statement of Lydall filed with the Commission in connection with its Annual Meeting of Stockholders to be held on May 8, 2003. The Proxy Statement includes the Compensation and Stock Option Committee Report to Stockholders, found on pages 21 through 23, and the comparative performance graph located on page 24, therein.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information regarding beneficial ownership of Common Stock by certain beneficial owners and by certain senior management of the Company is incorporated by reference to the definitive Proxy Statement of Lydall filed with the Commission in connection with its Annual Meeting of Stockholders to be held on May 8, 2003.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions with Lydall’s Directors and management is incorporated by reference to the definitive Proxy Statement of Lydall filed with the Commission in connection with its Annual Meeting of Stockholders to be held on May 8, 2003.

Item 14. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, including the Company’s President and Chief Executive Officer and Executive Vice President – Finance and Administration, Chief Financial Officer, have conducted an evaluation within the past 90 days of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the President and Chief Executive Officer and Executive Vice President – Finance and Administration, Chief Financial Officer concluded that the disclosure controls and procedures were effective in ensuring that all material information required to be filed in this annual report has been made known to them on a timely basis and that it has been properly recorded, processed, summarized and reported, as required.

Changes in Internal Controls

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its last evaluation, except as set forth below. During the evaluation no material weaknesses were identified. In February 2003, the Company completed its investigation of the accounting irregularity at its Columbus operation. During the investigation, the Company determined that two individuals acting in collusion had circumvented the local internal control system. PricewaterhouseCoopers LLP, the Company’s independent auditors, determined that the actions of the two individuals resulted in a significant deficiency in the operation of the internal controls at this operation and reported this to the Company’s Audit Review Committee. These two individuals were terminated by the Company during the course of the investigation.

19

Table of Contents

PART IV

Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

Other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable or are presented in “Notes to Consolidated Financial Statements” and therefore have been omitted.

20

Table of Contents

a) 3, Exhibits Included Herein or Incorporated by Reference:

21

Table of Contents

The Company did not file any Reports on Form 8-K during the quarter or year ended December 31, 2002.

22

Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Lydall, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Lydall, Inc. in the capacities and on the dates indicated.

23

Table of Contents

CERTIFICATIONS

I, Christopher R. Skomorowski, certify that:

24

Table of Contents

CERTIFICATIONS

I, Walter A. Ruschmeyer, certify that:

25

Table of Contents

STATEMENT OF MANAGEMENT RESPONSIBILITY

The consolidated financial statements of Lydall, Inc. and its subsidiaries are the responsibility of the Company’s management and have been prepared in accordance with accounting principles generally accepted in the United States of America.

Management is responsible for the integrity and objectivity of these statements, including the effect of certain estimates and judgments, and fulfills this responsibility primarily by establishing and maintaining an internal control structure that is designed to provide reasonable assurance that Company assets are safeguarded, transactions are executed in accordance with management’s authorization and that the Company’s financial records may be relied upon for the purpose of preparing financial statements and related disclosures. That system is continuously monitored and assessed by direct management review and by the Company’s internal audit function.

For 2002, Lydall’s Board of Directors appointed independent accountants who audited the Company’s financial statements. Their accompanying report is based on audits conducted in accordance with auditing standards generally accepted in the United States of America, which include the consideration of the Company’s internal controls to establish a basis for determining the nature, timing and extent of audit tests to be applied.

The Audit Review Committee of the Board of Directors, which consists of directors who are neither officers nor employees of the Company, is responsible for the oversight of the work performed by our independent accountants, oversight of the work performed by our internal auditors, as well as overseeing our internal control systems and financial reporting processes. The Audit Review Committee meets regularly with management, the independent accountants and the internal auditors to review financial reporting, internal accounting controls, and auditing matters. Both the independent accountants and internal auditors have direct and private access to the Audit Review Committee.

F-1

Table of Contents

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and

Stockholders of Lydall, Inc.:

In our opinion, the financial statements listed in the index appearing under Item 15(a)(1) on page 20, present fairly, in all material respects, the consolidated financial position of Lydall, Inc. and its subsidiaries at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) on page 20, presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 5 in “Notes to Consolidated Financial Statements,” effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”

F-2

Table of Contents

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial statements.

F-3

Table of Contents

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements.

F-4

Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS