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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, 2004

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 (§229.405 of this chapter) 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. ¨

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

On June 30, 2004, the aggregate market value of the Registrant’s voting stock held by nonaffiliates was $153,173,035 based on the New York Stock Exchange closing price on that date. For purposes of this calculation, the Registrant has assumed that its directors and executive officers are affiliates.

On February 24, 2005, there were 16,154,710 shares of Common Stock outstanding, exclusive of treasury shares.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates information by reference from the definitive Proxy Statement distributed in connection with the Registrant’s Annual Meeting of Stockholders to be held on April 21, 2005.

The exhibit index is located on pages 22-23.

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INDEX TO ANNUAL REPORT ON FORM 10-K

Year Ended December 31, 2004

The information called for by Items 10, 11, 12, 13 and 14, to the extent not included in this document, is incorporated herein by reference to such information included under the captions “Corporate Governance,” “Equity Compensation Plan Information,” “Board of Directors,” “Stockholder Communications with Directors,” “Director Compensation,” “Fiscal Year 2004 Board Fees,” “Compensation and Stock Option Committee Report on Executive Compensation,” “Performance Graph,” “Plan Descriptions,” “Stock Option Tables,” “Summary Compensation Table,” “Securities Ownership of Directors, Certain Officers and 5 Percent Beneficial Owners,” “Compensation Committee Interlocks and Insider Participation,” “Transactions with Management” and “Principal Fees and Services” in the Company’s definitive Proxy Statement to be filed with the Securities and Exchange Commission and distributed in connection with Lydall Inc.’s 2005 Annual Meeting of Stockholders.

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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 automotive thermal and acoustical barriers, passive and active industrial thermal and insulating solutions, air and liquid filtration media, medical filtration media and devices and biopharmaceutical processing components for demanding thermal/acoustical and filtration/separation applications.

The Company serves a number of market niches. Lydall’s products are primarily sold directly to customers through an internal sales force and distributed via common carrier or the Company’s distribution operation. 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 innovative products and exceptional 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 2004 and 2002 and 48 percent in 2003. Lydall’s thermal and acoustical products are used on a variety of automotive platforms and in various other applications. Sales to DaimlerChrysler AG were $39.6 million or 13.5 percent of Lydall’s net sales in 2004. No other single customer accounted for more than 10 percent of the Company’s net sales in 2004. The Company has substantially completed the consolidation of the domestic automotive manufacturing operations during 2004. This consolidation supports long-term growth strategies for this business and is expected to improve flexibility, lower costs and utilize overall capacity of existing facilities more effectively.

Foreign and export sales were 47 percent of the Company’s net sales in 2004, 37 percent in 2003 and 34 percent in 2002. Export sales are primarily to Europe, Asia, Mexico and Canada and were $51.2 million, $33.0 million and $32.2 million in 2004, 2003 and 2002, respectively. Foreign sales were $86.2 million, $67.6 million and $53.0 million for the years ended December 31, 2004, 2003 and 2002, respectively. The increase in export sales was primarily related to increased automotive sales to Canada and increased filtration and passive thermal sales to Asia during 2004. The increase in foreign sales during 2004 was primarily related to increased sales from our German automotive operation and incremental sales from our new St. Nazaire facility.

Foreign operations generated operating income of $4.2 million, $5.4 million and $4.6 million for the years ended December 31, 2004, 2003 and 2002, respectively. Total foreign assets were $90.4 million at December 31, 2004 compared with $73.6 million at December 31, 2003 and $44.3 million at December 31, 2002.

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and Proxy Statements are made available free of charge through the Investor Relations section of the Company’s Internet website at www.lydall.com after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (the Commission) and are also available on the Commission’s website at www.sec.gov.

The Company’s Code of Ethics and Business Conduct for all employees and its Code of Ethics for the Chief Executive Officer, Senior Financial Officers and All Accounting and Financial Personnel can be obtained free of charge on the Company’s website under the Corporate Governance section or by contacting the Office of the General Counsel, P.O. Box 151, One Colonial Road, Manchester, CT 06045-0151.

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. Reconciling Items include Corporate Office operating expenses and intercompany eliminations. 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), depending on the application.

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Lydall’s automotive thermal and acoustical barriers, including ZeroClearance^®, AMS^®, dB-Lyte^®, dBCore^® 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 that can be employed on both the interior and exterior of vehicle passenger cabins and within the engine compartment and around such components as exhaust systems, fuel systems, heat and air-conditioning ducts, power trains, batteries and electronic components.

The Company’s passive thermal business features products such as LyTherm^® and Manniglas^® that are employed as linings for ovens, kilns and furnaces in glass and metal manufacturing and in consumer appliances, as well as heating, ventilating and air-conditioning systems. At the very coldest temperatures (approaching absolute-zero), CryoTherm^® cryogenic materials, composed of 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 systems for vehicles powered by liquid natural gas.

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

Thermal/Acoustical Segment net sales, before elimination of intersegment sales, represented 62.7 percent of the Company’s net sales in 2004, 62.1 percent in 2003 and 59.3 percent in 2002. Additionally, total net sales generated by international operations of the Thermal/Acoustical Segment accounted for 33.2 percent, 27.5 percent and 23.5 percent of segment net sales in 2004, 2003 and 2002, 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 standards and filter particles as small as 0.1 micron. Uses for these products include industrial and commercial heating, ventilating and air-conditioning systems, clean space applications and consumer products.

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

The Company’s Vital Fluids business designs and manufactures specialty blood transfusion and cell therapy products and Bio-Pak^® sterilized disposable bioprocessing containers, which provide for containment of media such as cell tissue cultures, saline solutions and diagnostic fluids for bioprocessing applications. In addition, its medical filter materials are employed in traditional blood filtration devices such as cardiotomy reservoirs and autotransfusion filters.

Net sales from the Filtration/Separation Segment, before elimination of intersegment sales, represented 27.8 percent of the Company’s net sales in 2004 compared with 27.6 percent in 2003 and 28.7 percent in 2002. In addition, total net sales generated by the international operation of the Filtration/Separation Segment accounted for 31.2 percent, 28.5 percent and 24.2 percent of segment net sales in 2004, 2003 and 2002, respectively.

Other Products and Services

The largest component of Other Products and Services (OPS) is Lydall’s transport, distribution and warehousing businesses. These businesses specialize in time-sensitive shipments and warehouse management services and possess an in-depth understanding of the special nature and requirements of the paper and printing industries. OPS also includes assorted specialty products.

OPS net sales, before elimination of intercompany sales, were 10.2 percent of the Company’s net sales in 2004 compared with 11.0 percent in 2003 and 12.7 percent in 2002. There were no significant sales generated outside of the United States for OPS.

Discontinued Operations

In February 2001, the Company’s Board of Directors adopted a plan to discontinue the operations of the Paperboard Segment, consisting principally of the Southern Products and Lydall & Foulds operations. Accordingly, the operating results of this discontinued Segment were segregated from continuing operations and reported as discontinued operations. During the third quarter of 2003, the Company recorded a pretax charge of $1.3 million, or $.05 per diluted share for additional shutdown costs and the write-off of the remaining book value of these assets. In the fourth quarter of 2002, the Company recorded a pretax charge of approximately $0.4 million, or $.01 per diluted share for additional costs incurred during the shutdown period.

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In 2004, Lydall sold its Lydall & Foulds properties located in Manchester, CT. Under the direction of the Connecticut Department of Environmental Protection, there is an ongoing environmental program of groundwater sampling and soils remediation that will take place over the next five years, which is estimated to cost $0.3 million, which was previously accrued as part of the discontinuance of the Paperboard Segment.

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.

The Company’s business is generally not seasonal; however, results of operations are impacted by shutdowns at the Company’s European operations and at its North American and European 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 generally available from a variety of suppliers that could be substituted as necessary.

The Company invested $8.5 million in 2004, $7.3 million in 2003 and $6.5 million in 2002, 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 $42.9 million at December 31, 2004, $37.4 million at December 31, 2003 and $26.8 million at December 31, 2002. Backlog at January 31, 2005 was $42.2 million. The increase in backlog at December 31, 2004 compared with December 31, 2003 was mainly due to the increase in North American automotive orders related to new product launches as well as an increase in European automotive orders. The increase in backlog at December 31, 2003 compared with December 31, 2002 was primarily the result of increased backlog for the German automotive business related to delayed production at a customer, as well as the strengthening of the Euro in 2003 compared with 2002. 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 environmental laws and regulations are not expected to have a material adverse effect on the capital expenditures, earnings or competitive position of the Company.

As of December 31, 2004, Lydall employed approximately 1,400 people. Four unions with contracts expiring on March 31, 2005 represent approximately 70 of the Company’s employees in the United States. All employees at the Company’s facilities in France are covered under a National Collective Bargaining Agreement. Certain salaried and all hourly employees at the operation in Germany are also covered under a National Collective Bargaining Agreement. Lydall considers its employee relationships to be satisfactory and did not have any actual or threatened work stoppages due to union-related activities in 2004.

There are no significant anticipated operating risks related to foreign investment law, expropriation, inflation effects or availability of material, labor or energy. The Company’s foreign and domestic operations limit foreign currency exchange transaction risk by completing transactions in 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,” “projects,” “expects,” “estimates,” 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 that could cause actual results to differ materially from those anticipated include: a major downturn of the North American or European automotive markets, raw-material pricing and supply and new-product

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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).

Item 2. PROPERTIES

The principal properties of the Company as of December 31, 2004 are situated at the following locations and have the following characteristics:

Properties numbered 2, 3, 7, 10, 11, 12 and 13 are leased; all others are owned. For information regarding lease obligations, see Note 15 in “Notes to Consolidated Financial Statements.” Lydall considers its properties to be in good operating condition and suitable and adequate for its present needs. All properties are being appropriately utilized consistent with experience and demand for the Company’s products. During 2004, related to the restructuring of the domestic automotive operations of the Company, the product manufacturing operations at the Columbus facility were consolidated into other domestic automotive facilities and as of December 31, 2004, the property is being utilized as a warehouse and shipping facility. The Company expects that the warehousing and shipping of product from the Columbus facility will cease during 2005; however, the Company has an operating lease commitment for this property through May 2006, which it is seeking to sublease. See Note 7 in “Notes to Consolidated Financial Statements” for additional information. In addition to the properties listed above, the Company had several additional leases for sales offices and warehouses in the United States, Europe and Asia.

Item 3. LEGAL PROCEEDINGS

On July 18, 2003, a lawsuit was filed in the Superior Court in Hartford, Connecticut by the Company against a former employee. On November 2, 2004 the Connecticut Superior Court rendered its decision on this matter, fully sustaining the Company’s claims against the former employee. The Court held an additional hearing at which it found the former employee to be liable to the Company for actual damages, punitive damages and payment of the Company’s attorney fees. The Court’s rulings have been appealed by the former employee. At this time, the Company cannot determine the amount of potential reimbursement it may receive for damages and legal fees nor can it estimate the potential costs associated with the appeal. However, these matters may have a material impact on the future results of operations and cash flows of the Company.

In March 1986, the United States Environmental Protection Agency notified a former subsidiary of the Company that it and other entities may be potentially responsible in connection with the release of hazardous substances at a landfill and property located adjacent to a landfill located in Michigan City, Indiana. Related to settlement discussions previously disclosed, during the fourth quarter of 2004, the Company made a payment of approximately $150 thousand, which was previously accrued, in exchange for a full site release and has received reimbursement from its insurance carriers. The settlement of this transaction did not have a material impact on the Company’s financial position, results of operations or cash flows.

See Note 15 in “Notes to Consolidated Financial Statements” for discussion of other contingencies and environmental matters.

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 2004.

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EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of Lydall, Inc. or its subsidiaries, together with the offices presently held by them, their business experience since January 1, 2000, and their age as of February 24, 2005, the record date of the Company’s 2005 Annual Meeting, are as follows:

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PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

PRICE RANGE OF COMMON STOCK AND DIVIDEND HISTORY

The Company’s Common Stock is traded on the New York Stock Exchange (NYSE) under the symbol LDL. Shares totaling 8,381,400 and 6,413,600 were traded on the NYSE during 2004 and 2003, respectively. The table below shows the range of reported sale prices on the NYSE Composite Tape for the Company’s Common Stock for the periods indicated. As of February 24, 2005, the record date for the Company’s 2005 Annual Meeting, 1,575 stockholders of record held 16,154,710 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.

STOCK REPURCHASE PROGRAM

In August 2003, the Company’s Board of Directors approved a Stock Repurchase Program (the “Repurchase Program”) to mitigate the potentially dilutive effects of stock options and shares of restricted and unrestricted stock granted by the Company. Under the Repurchase Program, shares may be purchased by the Company up to the quantity of shares underlying options and other equity-based awards granted after January 1, 2003 under shareholder approved plans. The Company intends to take advantage of the safe harbor protections afforded by Rule 10b-18 promulgated under the Exchange Act, and to engage in future repurchase activity in accordance with the provisions of the Exchange Act. The table below sets forth information with respect to shares of common stock repurchased by the Company during the quarter ended December 31, 2004.

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Item 6. SELECTED FINANCIAL DATA

FIVE-YEAR SUMMARY

All prior periods presented have been restated to reflect the Company’s change in accounting method from the LIFO method to the FIFO method on January 1, 2004 for those operations that were using the LIFO cost method. See Note 5 in “Notes to Consolidated Financial Statements.” The results of operations of the discontinued Paperboard Segment have been excluded from the Selected Financial Data table for all applicable periods. The Paperboard Segment’s balance sheet items have been excluded from calculations of the “Performance and other ratios” section for all applicable periods, except for the current ratio. See Item 15 “Exhibits, Financial Statement Schedules” for additional information. See additional discussion under Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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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,” “projects,” “expects,” “estimates,” 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 that could cause actual results to differ materially from those anticipated include, but are not limited to, the following:

A Major Downturn of the North American 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 North American or European automotive industries or a major decline in production of specific vehicles on which Lydall has significant content 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 2004 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 not necessarily a direct correlation between the number of Lydall products sold and the number of vehicles being built by automotive manufacturers.

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 and other metals to manufacture most automotive heat shields. Volatility in metals 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.

OVERVIEW

Lydall’s thermal/acoustical and filtration/separation businesses are in markets that present good growth opportunities and we expect the businesses to grow over the long term, primarily through the introduction of new products and penetration of new markets.

The Company has substantially completed the consolidation of the domestic automotive manufacturing operations as of December 31, 2004. This consolidation supports long-term growth strategies for this business and is expected to improve flexibility, lower costs and utilize overall capacity of existing facilities more effectively. The total pretax costs related to the restructuring effort recorded during 2004 were $5.1 million and approximately $0.2 million is expected to be incurred to finalize this effort during 2005. Although the significant consolidation activities are substantially complete, the Company expects that during the early part of 2005 there will continue to be some impact related to streamlining processes at the two remaining locations and maximizing synergies of the production activities that were relocated and realigned during this process.

The opening of the automotive facility located in St. Nazaire, France during 2004 provided much needed relief to the overcapacity issues that the automotive operation in Germany had been experiencing for some time. This new facility is strategically located to complement the Company’s operations in Germany, enabling Lydall to service all major European automotive manufacturers. The transfer of production of certain parts began in the second quarter of 2004. As of December 31, 2004, most platforms scheduled to be transferred from Germany had been moved and were in full production at the new facility, with the remaining transfers to be completed during the first quarter of 2005. The operation experienced an operating loss of approximately $2.3 million during 2004 primarily related to its start-up activities. As these start-up activities have been largely completed, the Company expects the operation to reach profitability in 2005.

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Similar to other public companies, the completion of internal projects in order to comply with the requirements of Section 404 of the Sarbanes-Oxley Act required the Company to devote internal resources and incur substantial external costs related to the use of consultants and for increased audit fees. The Company incurred approximately $3.9 million in external consulting and audit costs during 2004 related to this initiative. Although the Company expects these costs to decline from 2004 levels, they are expected to continue to have a material impact on the results of operations and cash flows going forward.

In January 2005, the Charter Medical, Ltd. subsidiary of Lydall announced a product recall of certain of its blood transfer and storage products upon the discovery of procedural deficiencies in the sterilization validation process. Although neither the Company nor Charter Medical has been notified of any adverse events or reports from customers with regard to these products, Charter Medical believed it was prudent to voluntarily recall the products. The current estimated cost of the recall and resultant corrective actions is approximately $0.5 million to $0.6 million based upon product quantity and return estimates provided by customers and internal cost estimates. To the extent that actual product quantity and returns differ from the estimates originally provided to Charter Medical, the actual cost of the recall could differ from the original estimate. The Company recorded $0.5 million of expense related to this matter during the fourth quarter of 2004. The Company further expects that the impact of this recall on 2005 sales revenues will be less than $1.0 million.

CONSOLIDATED RESULTS OF OPERATIONS

Net Sales

For the year ended December 31, 2004, Lydall recorded net sales of $292.4 million compared with $271.4 million for the year ended December 31, 2003, an increase of $21.0 million, or 7.8 percent. Foreign currency translation, which was primarily related to the continued strengthening of the Euro during 2004, increased net sales by approximately 2.8 percent. After adjusting for foreign currency translation, net sales growth was primarily attributable to sales improvements in the automotive, air filtration and Industrial Thermal businesses. Additionally, increased sales of blood transfusion and cell therapy products contributed to the overall sales improvement. These increases were partially offset by lower sales of Vital Fluids traditional blood filtration materials and products for bioprocessing applications and a reduction in revenues from the trucking operations of the transport business.

For 2003, the Company generated $271.4 million in net sales compared with $253.5 million for the year ended December 31, 2002, an increase of $17.9 million, or 7.0 percent. Foreign currency translation, which was primarily related to the strengthening of the Euro during 2003, increased net sales by approximately 4.4 percent. After adjusting for foreign currency translation, net sales growth was primarily attributable to increased sales from the automotive business during the first three quarters of 2003 and continued improvement in sales of active thermal products. Additionally, sales of passive thermal products, liquid filtration products, blood transfusion and cell therapy products and products for bioprocessing applications, as well as improved revenues from the warehousing operations of the transport business contributed to the overall sales improvement. These increases were partially offset by lower sales of air filtration products, traditional blood filtration materials and specialty products as well as a reduction in revenues from the trucking operations of the transport business.

Gross Margin

Lydall recorded total gross margin for the year ended December 31, 2004 of $57.5 million compared with $64.4 million for the year ended December 31, 2003, a decrease of $6.9 million, or 10.6 percent. Gross margin as a percent of net sales was 19.7 percent compared with 23.7 percent for the year ended December 31, 2003. There were several contributing factors to the reduction in gross margin in 2004 compared with 2003: (1) costs incurred associated with the restructuring of the domestic automotive operations; (2) start-up gross margin performance of the St. Nazaire automotive operations; (3) production inefficiencies at the domestic and German automotive operations; and (4) production inefficiencies and the cost of the product recall at the Vital Fluids operations. These negative impacts were partially offset by improved gross margin contribution from the air and liquid filtration, Industrial Thermal and transport businesses.

Lydall recorded total gross margin for the year ended December 31, 2003 of $64.4 million compared with $64.9 million for the year ended December 31, 2002, a decrease of $0.5 million, or 0.8 percent. Gross margin as a percent of net sales was 23.7 percent compared with 25.6 percent for the year ended December 31, 2002. Although net sales for the Company increased during 2003 from 2002, several factors unfavorably impacted total gross margin and gross margin as a percent of net sales. These factors included costs related to the consolidation of the Vital Fluids operations; lower year-over-year operating performance at the Columbus operation; higher fixed overhead costs; operational inefficiencies at several facilities; and changes in sales mix at certain operations.

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Selling, Product Development and Administrative Expenses

Selling, product development and administrative expenses were $57.2 million, or 19.6 percent of net sales for 2004 compared with $50.5 million, or 18.6 percent of net sales for 2003. The primary drivers of the increase in selling, product development and administrative costs were increased costs related to Sarbanes-Oxley Section 404 compliance of $3.3 million; increased legal costs related to legal fees associated with litigation against a former employee and the investigation of allegations made by this former employee of $1.9 million; and increased bonus expense of $1.8 million primarily related to the improved performance of the filtration business. In addition, the Company made investments in product development and sales and marketing efforts, increasing spending in these areas by approximately 17 percent and 18 percent, respectively, compared with 2003 levels. These cost increases were partially offset by cost savings achieved by the elimination of the operating group structure in 2003. Additionally, during 2003 charges of approximately $1.5 million were incurred for the consolidation of the Company’s e-commerce function, outside professional fees related to the investigation at the Columbus operation, severance related to the elimination of the group organizational structure and fees for tax projects and retained searches, which did not recur during 2004.

Selling, product development and administrative expenses were $50.5 million, or 18.6 percent of net sales for 2003 compared with $46.8 million, or 18.5 percent of net sales for 2002. Selling, product development and administrative costs were negatively impacted by several factors during 2003 that caused the increase in overall costs; however, these costs remained in-line as a percent of net sales. The significant items that negatively impacted selling, product development and administrative charges during 2003 as compared with 2002 were: charges for the consolidation of the e-commerce function, increased salaries, increased pension and other employee benefit costs, severance associated with the elimination of the group organizational structure, fees for retained searches, outside professional fees related to the investigation at the Columbus operation, increased investment in research and development activities and consulting fees related to Sarbanes-Oxley compliance. These cost increases and one-time charges were partially offset by lower Economic Value Added (EVA) bonus expense during 2003 as compared with 2002.

Restructuring Activities

As part of a strategic evaluation initiated in the fourth quarter of 2003, the Company implemented a plan to respond to the automotive market demands for increasingly faster, technologically advanced, cost-effective solutions. As a result, the Company consolidated the operations of the Columbus manufacturing operation into existing Lydall facilities. This consolidation within the automotive manufacturing operations supports long-term growth strategies for this business and is expected to position the Company to more efficiently respond to current and projected market demands. The consolidation of the automotive business is expected to improve flexibility, lower costs and utilize overall capacity of existing facilities more effectively. The Company initiated the process of transferring equipment and product lines during the first quarter of 2004 and these restructuring activities were substantially completed at the end of 2004.

Related to this restructuring plan, the Company recorded pretax charges of $5.1 million during 2004. The Company recorded a pretax charge to cost of sales of $0.3 million for the acceleration of depreciation on certain assets during December 2003. Additionally, during December 2003 the Company recorded an after-tax charge of approximately $0.5 million related to the write-off of state deferred tax assets that are not expected to be realized as a result of the restructuring. The expected remaining pretax charges of approximately $0.2 million are primarily comprised of facility exit costs and will be recorded primarily in cost of sales.

Approximately 95 percent of all restructuring costs incurred were recorded in cost of sales and 5 percent were recorded in selling, product development and administrative expenses. Approximately 85 percent of restructuring costs were recorded in the Thermal/Acoustical Segment and 15 percent were recorded as Corporate Office expenses, which for segment reporting purposes are included under Reconciling Items.

In November 2000, the Company’s Board of Directors formalized a plan to dispose of the fiberboard operation. During 2002, the Company paid all remaining liabilities previously accrued, sold certain assets and recorded a final pretax charge of approximately $0.3 million to write-off the remaining assets that could not be sold.

Interest Expense

For the years ended December 31, 2004, 2003 and 2002, Lydall recorded interest expense of $1.2 million, $1.0 million and $0.9 million, respectively. The increase in interest expense during both 2004 and 2003 was primarily related to correspondingly higher average debt levels in each sequential year.

Other Income and Expense

For the years ended December 31, 2004, 2003 and 2002, other income and expense is primarily related to investment income and net foreign currency transaction gains and losses.

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Income Taxes

The effective income tax rate on income from continuing operations for the year ended December 31, 2004 was 28.9 percent compared with an effective rate of 34.4 percent in 2003. The effective tax rates for 2004 and 2003 were impacted favorably by benefits derived from the recognition of deferred tax assets in a foreign jurisdiction as well as tax-exempt export income. The 2004 effective rate was negatively impacted by certain state franchise and alternative taxes, which do not directly fluctuate with the level of income. The 2003 effective tax rate was negatively impacted by a valuation allowance established against deferred tax assets for state income tax credits and net operating losses primarily related to the closure of the Columbus, Ohio facility. The effective tax rate on income from continuing operations for the year ended December 31, 2002 was 32.5 percent. 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 a tax audit.

For 2005, the Company expects its effective tax rate to be approximately 35 to 37 percent.

In 2004, the American Jobs Creation Act (AJCA) was signed into law. The AJCA was brought about largely in response to a 2003 ruling by the World Trade Organization (WTO), which found that the Extraterritorial Income program (ETI) as provided for in the United States Internal Revenue Code represented a prohibited export subsidy under the WTO Agreement on Subsidies and Countervailing Measures. The AJCA provides for certain tax benefits for U.S. manufacturers that are intended to offset the phase-out, and ultimate elimination, of the ETI benefit. During 2004 and 2003, the ETI benefit decreased the Company’s effective tax rate by approximately 46.3 and 2.7 percentage points, respectively. At this time the Company is unable to determine the exact impact that the AJCA will have on future financial results; however, it is not expected that such changes will have a material impact on the Company’s results of operations and cash flows in future periods.

SEGMENT RESULTS

Thermal/Acoustical

Net sales for the Thermal/Acoustical Segment for 2004 were $183.4 million compared with $168.4 million for 2003, an increase of $15.0 million, or 8.9 percent. The impact of foreign currency translation increased segment net sales by approximately 3.2 percent for 2004. After adjusting for the impact of foreign currency, sales growth during the year was attributable to increased sales in the automotive business, continued improvement in sales of active thermal products and increased sales of passive thermal products.

Sales to the automotive industry accounted for approximately 76 percent of segment net sales in 2004 and increased approximately 2.3 percent on a constant currency basis from 2003. The increase in automotive sales was primarily related to new product launches domestically and in Europe and increased tooling sales related to these products and future production program launches. Additionally, the new St. Nazaire facility added incremental sales volume during 2004.

Industrial thermal products accounted for approximately 24 percent of segment net sales in 2004. Sales of industrial thermal products, which include both passive and active systems, showed strong growth during 2004, increasing by 17.1 percent from 2003 sales levels. Active thermal products sold under the Affinity^® product line had record sales performance in 2004 with an overall increase of approximately 23.2 percent from 2003 related to strong sales to the semiconductor market. Sales of passive insulating products used in building and appliance applications also showed solid improvement in 2004, with sales to the appliance market increasing by approximately 17.5 percent and sales of materials used in building products improving by approximately 6.2 percent from 2003 levels.

Net sales for the Thermal/Acoustical Segment for 2003 were $168.4 million compared with $150.4 million for 2002, an increase of $18.0 million, or 12.0 percent. The impact of foreign currency translation increased segment net sales by approximately 5.0 percent for 2003. After adjusting for the impact of foreign currency, sales growth was attributable to increased sales in the automotive business and continued improvement in sales of active thermal products.

Sales to the automotive industry accounted for approximately 80 percent of segment net sales in 2003 and 2002 and increased approximately 3.7 percent on a constant currency basis from 2002. The increased sales performance in the automotive business substantially occurred during the first three quarters of 2003 as part sales were up sharply from 2002 levels. In the fourth quarter of 2003, a decline in part and tooling sales partially offset the gains recorded through the first three quarters of the year. Reductions in content on the new model of Lydall’s previously largest platform and the end of model year production on certain other platforms were the primary drivers of the sales fall off at the end of 2003.

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Industrial thermal products accounted for approximately 20 percent of segment net sales in 2003 and 2002. Sales of industrial thermal products, showed strong growth in the Affinity^® product line and in passive insulating products used in building and appliance applications during 2003.

For 2004, segment operating income was $7.3 million compared with $19.7 million in 2003, a decrease of $12.4 million, or 63.0 percent. Segment operating margin for 2004 was 4.0 percent of segment net sales compared with 11.7 percent in 2003. The impact of foreign currency translation increased segment operating income by approximately 1.4 percent for 2004. The declines in segment operating income and margin primarily related to domestic restructuring charges recorded of $5.1 million; full year start-up performance of the St. Nazaire operations, which had increased operating losses of approximately $1.9 million during 2004 compared with 2003; and lower operating performance of $6.9 million primarily related to: (1) production inefficiencies of the domestic automotive operations caused by disruptions related to the transfer of production to other plants as part of the domestic restructuring program; (2) overcapacity challenges and related production inefficiencies at the German operation; and (3) new-product launch issues during the year at the St. Johnsbury operation. These declines were partially offset by improved operating income from higher sales of the Industrial Thermal business of approximately $1.2 million and cost savings from the elimination of the group structure at the end of 2003.

For 2003, segment operating income was $19.7 million compared with $20.3 million in 2002, a decrease of $0.6 million, or 3.2 percent. Segment operating margin for 2003 was 11.7 percent of segment net sales compared with 13.5 percent in 2002. The impact of foreign currency translation increased segment operating income by approximately 3.1 percent for 2003. The declines in segment operating income and margin primarily related to the significant downshift in the automotive business during the latter half of 2003, where lower sales volume, operational inefficiencies and increased overhead costs severely impacted operating results. Lower year-over-year operating performance at the Columbus operation also contributed to the decline. Additionally, a charge for the acceleration of depreciation of certain assets of the Columbus operation during the fourth quarter, related to the planned shutdown of the manufacturing operations in 2004, also impacted operating results. These declines were partially offset by improved income and margins in the Industrial Thermal businesses as sales of building materials and appliance application products and active thermal products sold to the semiconductor market showed distinct improvements during 2003.

Filtration/Separation

In 2004, Filtration/Separation Segment net sales increased $6.3 million, or 8.5 percent to $81.2 million from $74.9 million for 2003. The impact of foreign currency translation increased segment net sales by approximately 3.1 percent for 2004. After adjusting for the impact of foreign currency, the increase in segment net sales from 2003 levels was related to stronger sales of air filtration media, higher sales of blood transfusion and cell therapy products and, to a lesser extent, increased sales of liquid filtration materials. These increases were partially offset by lower sales of traditional blood filtration materials sold to medical device manufacturers and a reduction in sales of products for bioprocessing applications.

Sales from the air filtration businesses in the United States and Europe were substantially higher during 2004 specifically related to increased orders for cleanroom projects in Asia. Sales of liquid filtration products increased modestly from 2003 as water filtration and industrial fluid filtration products, sold under the ActiPure^® and LyPore^® trademarks, continued to have sustained growth and acceptance in consumer and industrial applications.

Sales of Vital Fluids’ products decreased approximately 9.1 percent for 2004 compared with 2003. This decrease was related to the decline in sales of traditional blood filtration materials sold to original equipment manufacturers as these markets continued an expected decline that began in late 2002, as well as a decrease in sales of products for bioprocessing applications. These decreases were partially offset by an increase in blood transfusion and cell therapy products sales related to launches of new platelet sampling products during 2004.

In 2003, Filtration/Separation Segment net sales increased $2.1 million, or 2.9 percent to $74.9 million from $72.8 million for 2002. The impact of foreign currency translation increased segment net sales by approximately 4.9 percent for 2003. After adjusting for the impact of foreign currency, the decrease in segment net sales from 2002 levels was related to lower sales of air filtration media in the United States and declining sales of traditional blood filtration materials sold to medical device manufacturers. These declines were partially offset by higher liquid filtration product sales and growth in sales of blood transfusion and cell therapy products and products for bioprocessing applications.

Sales of air filtration media in the United States were substantially lower during 2003 compared with 2002. Specifically, sales of LydAir^® were down year-over-year due to an overall softness in the commercial heating, ventilating and air-conditioning (HVAC) market and sales of membrane composite products used in consumer vacuum products were lower. Sales of liquid filtration products increased as water filtration and industrial fluid filtration products, sold under the ActiPure^® and LyPore^® trademarks, enjoyed sustained growth and acceptance in consumer and industrial applications.

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Sales of Vital Fluids’ products decreased approximately 2.6 percent for 2003 compared with 2002. This decrease was related to the declining sales of traditional blood filtration materials sold to original equipment manufacturers. The decrease was partially offset by increases in blood transfusion and cell therapy products related to launches of new products during 2003 and growth in sales of the Company’s Bio-Pak^® sterilized disposable bioprocessing containers.

Segment operating income increased $2.2 million, or 25.6 percent to $11.0 million for 2004 compared with $8.8 million for 2003. Segment operating margin as a percent of segment net sales also increased to 13.6 percent in 2004 from 11.7 percent in 2003. The impact of foreign currency translation increased segment operating income by approximately 3.3 percent for 2004. The improvements in segment operating income and margin related to improved margin performance of the air filtration businesses through higher sales volume, cost reductions and improved absorption of overhead costs and margin contribution increases from blood transfusion and cell therapy products due to higher sales volumes. These increases in operating income were partially offset by lower margin performance of traditional blood filtration products due to continued lower sales volumes. Additionally, a nonrecurring charge of $0.5 million was recorded by the Vital Fluids operations in December 2004 related to a product recall of certain blood transfer and storage products. Nonrecurring charges for severance associated with the elimination of the group organizational structure and costs related to the consolidation of the Vital Fluids operations had a negative impact on operating income and margin for 2003.

Segment operating income declined $1.6 million, or 15.4 percent to $8.8 million for 2003 compared with $10.4 million for 2002. Segment operating margin as a percent of segment net sales also decreased to 11.7 percent in 2003 from 14.3 percent in 2002. The impact of foreign currency translation increased segment operating income by approximately 3.7 percent for 2003. The declines in segment operating income and margin related to lower margin performance of the domestic air filtration business and traditional blood filtration products primarily due to lower sales volumes, as well as nonrecurring charges for severance associated with the elimination of the group organizational structure and costs related to the consolidation of the Vital Fluids operations in the second quarter of 2003.

Other Products and Services

Net sales of OPS were $29.9 million and $29.8 million for 2004 and 2003, respectively. Although net sales of OPS were relatively flat with 2003, within these businesses, increased sales of specialty products and higher revenues from the warehousing operations of the transport business were substantially offset by a decrease in revenues from the trucking operations of the transport business. The increased performance from the warehousing operations was related to its growth and expanded capacity levels. The decline in revenues from the trucking operations was primarily the result of a customer rationalization program.

Net sales for OPS were $29.8 million for 2003, a decrease of $2.4 million, or 7.3 percent from $32.2 million in 2002. This decline in net sales primarily was a result of decreased sales of specialty products and a reduction in revenues from the trucking operations due to the general softness in the overall economy during 2003. These sales declines were partially offset by increased revenues from the warehousing operations; as the Newport News Distribution Center continued to perform at improved operating levels from its start-up performance in 2002.

Operating income from OPS increased $0.5 million, or 20.9 percent to $2.5 million in 2004 from $2.0 million in 2003. Operating margin was 8.2 percent of net sales in 2004 compared with 6.8 percent in 2003. The increase in operating income and margin primarily related to the trucking and warehousing operations of the transport business. These gains were a result of the trucking operations customer rationalization program and the warehousing operations expanded operations and service levels, which were both achieved while holding overall administrative costs relatively constant.

Operating income from OPS decreased $0.2 million, or 7.0 percent to $2.0 million in 2003 from $2.2 million in 2002. Operating margin was 6.8 percent of net sales for both 2003 and 2002. The decrease in operating income primarily related to the significant reduction in specialty products and the weakness in the trucking operations of the transport business. The overall reduction in gross margin for these businesses was partially mitigated by controlled administrative costs.

Discontinued Operations

In February 2001, the Company discontinued its Paperboard Segment that consisted primarily of the Southern Products and Lydall & Foulds operations. In the third quarter of 2003, the Company recorded an after-tax charge of approximately $0.8 million, or $.05 per diluted share for additional shut down costs and the write off of the remaining assets of the Paperboard Segment. In the fourth quarter of 2002, the Company recorded an after-tax charge of $0.2 million, or $.01 per diluted share for additional costs incurred during the shutdown period.

LIQUIDITY AND CAPITAL RESOURCES

The Company ended 2004 with $1.6 million in cash and cash equivalents compared with $3.0 million as of December 31, 2003. Additionally, the Company held $2.5 million in restricted cash as of December 31, 2003.

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Operating Cash Flows

Net cash provided by operating activities in 2004 was $18.1 million compared with $21.3 million in 2003. For 2004, the net loss was offset by the add-back of depreciation and amortization, non-cash expenses, and overall favorable cash flow changes in operating assets and liabilities, which resulted in continued strong cash flows from operating activities in 2004.

Investing Cash Flows

Net cash used for investing activities was $21.9 million in 2004 compared with $18.2 million in 2003. For 2004, capital expenditures totaled $24.7 million compared with $15.9 million in 2003. The increase in capital expenditures in 2004 as compared with 2003 primarily related to machinery and equipment purchases for the new St. Nazaire operation and the expansion of the Hamptonville operation as part of the domestic automotive restructuring program. The Company deposited $2.5 million in a restricted cash account at the end of 2003 related to the leasing arrangement for the new operating facility in St. Nazaire, France. The restriction was lifted during the first quarter of 2004.

Financing Cash Flows

In 2004, net cash provided by financing activities was $2.6 million compared with net cash used for financing activities of $1.9 million in 2003. Cash borrowings exceeded repayments in 2004 by $4.1 million and were used to fund operations, capital expenditures and to a lesser extent stock repurchases. Proceeds from common stock issuances were approximately $1.4 million in 2004 and $1.0 million in 2003. The Company repurchased $2.8 million of its Common Stock in 2004 and did not repurchase any of its Common Stock in 2003. As of December 31, 2004, approximately 413,000 shares remained eligible for repurchase under the Repurchase Program.

Financing Arrangements

The Company amended its $50 million domestic revolving credit facility with a group of five banking institutions on February 1, 2005. The credit agreement’s new maturity date is February 1, 2009 and the significant amendments to the agreement were filed on a Current Report on Form 8-K dated February 9, 2005. Additionally the amendment is attached to this Annual Report on Form 10-K as Exhibit 10.10. The modifications made to the restrictive and financial covenants were effective for the quarter ended December 31, 2004. Therefore, as of December 31, 2004, the Company was in compliance with all restrictive and financial covenants contained in the credit agreement, as amended, and $12.9 million was outstanding under the facility.

The Company has a Euro-denominated term loan with a total outstanding balance of $10.2 million. This loan 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 $10.2 million, of which $6.0 million was outstanding as of December 31, 2004.

As of December 31, 2004, the Company had unused borrowing capacity of approximately $39.1 million under various credit facilities; of which, approximately $13.0 million was available as of December 31, 2004, due to certain restrictive debt covenants. Management believes that current financing arrangements provide sufficient capacity to meet working capital requirements and fund future capital expenditures.

The Company does not have any off-balance sheet financing arrangements.

During September 2004, the Company finalized the capital lease arrangement related to the building and land of the automotive facility in St. Nazaire, France. The agreement, completed with the leasing subsidiaries of two French banks, calls for the Company to lease the facility for 12 years, and provides an option to purchase the facility at the end of the lease for a nominal amount. As of December 31, 2004, the Company has recorded a $6.4 million capital lease obligation related to this agreement.

Future Cash Requirements

At the end of 2004, total indebtedness was $38.1 million, or 20.9 percent of the Company’s total capital structure. Cash requirements for 2005 are expected to include the funding of ongoing operations, capital expenditures, share repurchases and debt service. Capital spending for 2005 is expected to be approximately $18.0 million to $20.0 million. The Company expects to finance its 2005 cash requirements from cash provided by operating activities and through borrowings under its existing credit agreements. The Company expects to contribute approximately $3.2 million to its defined benefit pension plans during 2005. 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” above or other forms of financing, as required.

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Contractual Obligations

The following table summarizes the Company’s significant obligations as of December 31, 2004, and the effect such obligations are expected to have on the Company’s liquidity and cash flows in future periods. This table excludes amounts already recorded on the Consolidated Balance Sheet as current liabilities as of December 31, 2004:

Purchase obligations in the table above are primarily related to contracts to purchase aluminum at various automotive operations ($9.1 million in 2005). Additionally, purchase obligations include estimated microfiber purchases under variable purchase commitments that require a certain percentage of materials utilized in production to be purchased from a specific supplier ($11.0 million 2005). Purchase orders or contracts for normal purchases of raw materials and other goods and services are not included in the table above. The Company is not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. For purposes of this table, contractual obligations for purchase of goods or services are defined as agreements that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transactions. The Company does not have significant agreements for the purchase of raw materials or other goods specifying minimum quantities or set prices that exceed expected requirements. Capital lease obligations exclude interest of approximately $2.1 million.

In addition to the above contractual obligations, the Company utilizes letters of credit in the ordinary course of business for security deposit requirements. Outstanding letters of credit were $2.2 million and $2.1 million as of December 31, 2004 and 2003, respectively. See Notes 3 and 15 in “Notes to Consolidated Financial Statements” for additional information regarding contractual obligations.

CRITICAL ACCOUNTING ESTIMATES

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 as of 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

The Company accounts for business acquisitions under the purchase method whereby the assets and liabilities of acquired businesses are recorded at their estimated fair values at the date of acquisition. Goodwill represents the costs in excess of fair values assigned to the underlying net assets of acquired businesses. The Company had goodwill recorded of $30.9 million at December 31, 2004 and 2003.

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 not be 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 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.

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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 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 a future impairment of goodwill will not occur. See Note 6 in “Notes to Consolidated Financial Statements.”

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 pension cost and the related obligations recognized in the consolidated 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 cost is the expected return on plan assets. Based on a review of market trends, actual returns on plan assets and other factors, the Company’s expected long-term rate of return on plan assets of 8.75 percent was used in determining 2004 and 2003 pension cost and will be utilized for determining 2005 pension cost. 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 cost 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 evaluates its expected 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, as well as the following year’s pension cost. 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, 2004, the Company determined this rate to be 5.9 percent, a decrease of 35 basis points from the rate used at December 31, 2003 and 85 basis points from that used at December 31, 2002. Increases or decreases in the discount rate result in decreases and increases, respectively, in the projected benefit obligation. The net effect on pension liabilities from changes in the discount rate is 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, 2004, the net deferred loss exceeded the corridor. Consequently pension cost for 2005 will 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, 2004 and 2003, the Company recognized pension cost of $2.4 million and pension cost of $1.5 million for 2002. As discussed above, the Company lowered the discount rate to 5.9 percent for purposes of determining 2005 pension cost. Pension cost for 2005 is expected to be approximately $2.6 million. See Note 12 in “Notes to Consolidated Financial Statements.”

In April 2004, the federal Pension Funding Equity Act (the “Act”) was enacted. The Act provides a two-year relief from the significant pension contribution requirements that have evolved from the low interest rates utilized to determine the current liability for pension plans. In the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, the Company disclosed that pension funding for 2004 would approximate $1.7 million. The relief provided under the Act reduced the Company’s required contributions for 2004 to approximately $0.1 million. The Company expects to contribute approximately $3.2 million to its defined benefit pension plans during 2005.

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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 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 were $24.2 million and $21.4 million at December 31, 2004 and 2003, 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.

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 in tax law, changes in statutory tax rates and future levels of taxable income. 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 was 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 14 in “Notes to Consolidated Financial Statements.”

Unremitted earnings of foreign subsidiaries have been included in the consolidated financial statements without giving effect to the United States taxes that may be payable on the distribution to the United States because it is not anticipated such earnings will be remitted to the United States. If remitted, the additional United States tax liability could be material.

The Company’s effective tax rates in future periods could be adversely affected by earnings being lower or higher than anticipated in countries where tax rates differ from the United States federal rate, the relative impact of permanent tax adjustments on higher or lower earnings from domestic operations, changes in deferred tax asset valuation allowances, and/or by changes in tax law or interpretations thereof.

In 2004, the American Jobs Creation Act (AJCA) was signed into law. The AJCA was brought about largely in response to a 2003 ruling by the World Trade Organization (WTO), which found that the Extraterritorial Income program (ETI) as provided for in the United States Internal Revenue Code represented a prohibited export subsidy under the WTO Agreement on Subsidies and Countervailing Measures. The AJCA provides for certain tax benefits for U.S. manufacturers that are intended to offset the phase-out, and ultimate elimination of the ETI benefit. During 2004 and 2003, the ETI benefit decreased the Company’s effective tax rate by approximately 46.3 and 2.7 percentage points, respectively. At this time the Company is unable to determine the exact impact that the AJCA will have on future financial results; however, it is not expected that such changes will have a material impact on the Company’s results of operations and cash flows in future periods.

RECENTLY ISSUED ACCOUNTING STANDARDS

In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (FAS 151). FAS 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. Additionally, FAS 151 requires that allocation of fixed production overhead to inventory be based on the normal capacity of the production facilities. The provisions of FAS 151 are applicable to inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this statement is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (FAS 123R). The standard, which is effective for awards issued after June 15, 2005 and all awards prior to the effective date that remain unvested on the effective date, requires that all equity-based compensation be recorded in the consolidated financial statements at the grant date fair value. The Company expects to utilize the modified retrospective method of adoption and apply the standard to all interim periods in 2005. The adoption of FAS 123R will have a material impact on the Company’s results of operations, however, the ultimate impact of the adoption of FAS 123R is not yet able to be reliably determined.

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In December 2004, FASB issued Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets, an amendment to APB Opinion No. 29” (FAS 153). The Statement eliminates the exception to measure exchanges at fair value for exchanges of similar productive assets and replaces it with a general exception for exchange transactions that do not have commercial substance. FAS 153 is effective for nonmonetary exchanges in fiscal periods beginning after June 15, 2005. The adoption of this statement is not expected to have a material effect 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 decreased to $1.6 million as of December 31, 2004 compared with $3.0 million as of December 31, 2003.

Restricted cash – The Company held $2.5 million in a restricted cash balance at the end of 2003. This balance was required related to the leasing arrangement for the new operating facility in St. Nazaire, France. The restriction was lifted during the first quarter of 2004.

Accounts receivable – Accounts receivable, net of the allowance for doubtful receivables, were $49.9 million at the end of 2004 compared with $40.8 million at the end of 2003. The increase was primarily related to higher sales at the automotive and industrial thermal operations in the fourth quarter of 2004 as compared with the last quarter of 2003.

Inventories – Inventories were $40.1 million as of December 31, 2004 compared with $34.0 million as of December 31, 2003. The increase was primarily related to increased production at the automotive facilities related to higher sales volume and 2005 backlog and the beginning of production at the new operating facility in St. Nazaire, France.

Working capital and current ratio – Working capital of $54.2 million at December 31, 2004 was relatively unchanged from $55.1 million at December 31, 2003. The ratio of current assets to current liabilities in 2004 decreased to 2.2:1 from 2.6:1 in 2003.

Capital expenditures – Capital expenditures were $24.7 million in 2004, $15.9 million in 2003 and $14.2 million in 2002. Capital spending for 2005 is expected to be approximately $18.0 million to $20.0 million. The increase in capital expenditures in 2004 as compared with 2003 primarily related to machinery and equipment purchases for the new St. Nazaire operation and the expansion of the Hamptonville operation as part of the domestic automotive restructuring program.

Total debt to total capitalization – Total debt to total capitalization increased to 20.9 percent in 2004 compared with 15.3 percent in 2003. The increase was primarily due to the St. Nazaire capital lease obligation, which was entered into during 2004.

Stockholders’ equity – Stockholders’ equity increased to $144.5 million at December 31, 2004 from $143.6 million at December 31, 2003. On a per share basis, Stockholders’ equity increased to $8.95 at December 31, 2004 from $8.82 at December 31, 2003.

Dividend policy – Currently, the Company does not pay a cash dividend on its Common Stock and does not anticipate doing so in the foreseeable future. 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.

Lydall’s significant market risk exposures relate 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 a lesser degree, the Japanese Yen and British Pound Sterling.

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Lydall’s foreign and domestic operations limit foreign currency exchange transaction risk by completing transactions in local functional currencies whenever practicable. In addition, Lydall periodically enters into foreign currency forward exchange contracts to mitigate exposure to foreign currency volatility. 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 impact interest paid on its debt. At December 31, 2004, the Company had $26.1 million outstanding on various loans and lines of credit with variable interest rates. The weighted average interest rate paid on this debt was 3.7 percent in 2004 and 4.2 percent in 2003. A 10 percent change in the weighted average interest rate on the Company’s variable rate debt would not have a significant impact to the Company’s consolidated financial position, results of operations or cash flows.

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.

The weighted average interest rate on long-term debt, including the effect of the interest rate swaps described above, was 4.0 percent for the year ended December 31, 2004 compared with 3.9 percent for 2003 and 3.7 percent for 2002.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The response to this Item is contained under Item 15 “Exhibits, Financial Statement Schedules.”

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

None.

Item 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, including the Company’s President and Chief Executive Officer and Vice President, Chief Financial Officer and Treasurer, conducted an evaluation as of December 31, 2004 of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e)). Based on that evaluation, the President and Chief Executive Officer and Vice President, Chief Financial Officer and Treasurer concluded that the disclosure controls and procedures were effective in ensuring that all material information required to be disclosed in the reports the Company files and submits under the Securities and Exchange Act of 1934 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 over financial reporting during the Company’s fourth quarter ended December 31, 2004 that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. See “Management’s Report on Internal Control Over Financial Reporting” on page F-1, which is incorporated by reference to this Item, for further discussion of management’s assessment of internal controls related to Section 404 of the Sarbanes-Oxley Act.

Item 9B. OTHER INFORMATION

On October 4, 2004, the Company entered into a Severance Agreement with Kevin T. Longe, Vice President, General Manager, Filtration/Separation. This employment agreement is being filed as Exhibit 10.24 to this Annual Report on Form 10-K.

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PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required by this Item is incorporated by reference from the sections entitled “Board of Directors,” “Corporate Governance,” “Stockholder Communications with Directors,” “Director Compensation” and “Fiscal Year 2004 Board Fees” of the definitive Proxy Statement of Lydall to be filed with the Commission in connection with its Annual Meeting of Stockholders to be held on April 21, 2005. Information regarding the Executive Officers of the Company is contained on page 5 of this report.

Item 11. EXECUTIVE COMPENSATION

Information required by this Item is incorporated by reference from the sections entitled “Compensation and Stock Option Committee Report on Executive Compensation,” “Performance Graph,” “Summary Compensation Table,” “Plan Descriptions” and “Stock Option Tables” of the definitive Proxy Statement of Lydall to be filed with the Commission in connection with its Annual Meeting of Stockholders to be held on April 21, 2005.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND   MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information required by this Item is incorporated by reference from the sections entitled “Equity Compensation Plan Information” and “Securities Ownership of Directors, Certain Officers and 5 Percent Beneficial Owners” of the definitive Proxy Statement of Lydall to be filed with the Commission in connection with its Annual Meeting of Stockholders to be held on April 21, 2005.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required by this Item is incorporated by reference from the sections entitled “Transactions with Management” and “Compensation Committee Interlocks and Insider Participation” of the definitive Proxy Statement of Lydall to be filed with the Commission in connection with its Annual Meeting of Stockholders to be held on April 21, 2005.

Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information required by this Item is incorporated by reference from the section entitled “Ratification of Appointment of Independent Auditors,” subsection “Principal Fees and Services” of the definitive Proxy Statement of Lydall to be filed with the Commission in connection with its Annual Meeting of Stockholders to be held on April 21, 2005.

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PART IV

Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

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.

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

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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.

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Lydall is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). With the participation of the Chief Executive Officer and the Chief Financial Officer, management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004 as required by Rule 13a-15(c) under the Securities Exchange Act of 1934. The Company utilized the criteria and framework established by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission in Internal Control – Integrated Framework in performing this assessment. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2004. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.

Lydall’s independent auditor, PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004 as stated in their report, which appears on page F-2 of this Annual Report on Form 10-K.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Stockholders of Lydall, Inc.:

We have completed an integrated audit of Lydall, Inc.’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements and financial statement schedule

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Lydall, Inc. and subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 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) 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 financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements 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 to the consolidated financial statements, the Company changed its method of inventory costing in 2004.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting, appearing on page F-1, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

_________________________________

PricewaterhouseCoopers LLP

Hartford, Connecticut

March 15, 2005

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CONSOLIDATED STATEMENTS OF OPERATIONS

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

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CONSOLIDATED BALANCE SHEETS

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

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CONSOLIDATED STATEMENTS OF CASH FLOWS