Luxfer Holdings' CEO Discusses Q4 2012 Results - Earnings Call Transcript

Mar.12.13 | About: Luxfer Holdings (LXFR)

Luxfer Holdings PLC (NYSE:LXFR)

Q4 2012 Earnings Conference Call

March 12, 2013 08:30 ET

Executives

Brian Purves - Chief Executive

Andy Beaden - Group Finance Director

Analysts

Julian Mitchell - Credit Suisse

Luke Folta - Jefferies

Neil Morgan – Marathon

Jason Brocious - KeyBanc Capital Markets

Stefan Mykytiuk - Pike Place Capital

Operator

Welcome to the Luxfer Group’s Fourth Quarter Conference Call. We will first hear from Luxfer Chief Executive, Brian Purves, and will provide a market overview followed by Group Finance Director, Andy Beaden, he will review financial performance for the quarter and full year of 2012. Brian will then return to sum up and offer an outlook. After that, Brian and Andy will be glad to take your questions. To make sure that as many questioners as possible get a chance to speak, we request that you initially ask only one question. After you have heard the answer, we will give you the opportunity to ask a follow-up question. If you would like to ask additional questions, our operators will be glad to place you back in line. We thank you for your cooperation. We now turn the call over to Brian Purves.

Brian Purves

Thank you. Good afternoon, ladies and gentlemen, and welcome to the Luxfer conference call on the fourth quarter of 2012. I will take you through the headline results. Andy Beaden will go through the detail in the financials, and after a brief statement on the outlook, we will take questions.

The quarterly result as shown on slide four was in line with our guidance and expectations with underlying sales revenue up by some 10% and EBITDA $1.6 million better than prior year. We generated better than forecast EPS on the strong cash flow. As flagged, we incurred some restructuring costs in quarter four largely due to the actions being taken of the newly acquired Dynetek business in support of our 100-day integration project.

On the full year, the good quarterly result brought the year-on-year growth and underlying sales revenue to 7%, on full year EBITDA to a record $83.5 million, some $3 million better than the prior year. Within the overall result, it is pleasing to note the relatively greater improvement in the results of the cylinder division. Our pro forma EPS at $1.58 per ADS was simply ahead of our guidance. And over the year, we delivered a very strong cash flow recovering much of the balance sheet impact of rare earth prices that we had incurred in 2011 on top of the good operating performance.

On slide six, looking at sales revenue the slight cracks from the 2011 result at the top of the schedule due to the 2012 result at the bottom. In our ELEKTRON division, the sales revenue line is dominated by the reduction in rare earth surcharges. As the costs of, in particular, Cerium has collapsed to only 10% of its peak although still several times the cost per kilo from the start of 2010. Stripping the movements in the surcharge out, underlying sales growth was some 5%, with gains in industrial catalysis and high-performance magnesium alloys. Defense sales actually held up well boosted by one-off export orders, (what) has been flagged, auto-catalysis was down affected by high costs, customers minimizing stock levels, and particularly latterly a weak European automotive sector. Of the larger European auto markets, only the UK looks relatively healthy at this point. Elsewhere in the world, automotive is better and aerospace is still generally strong.

The continued decline in rare earth prices has to be handled very carefully to avoid the potentially damaging effect of stock-based loans. The Chinese have issued new export quotas for 2013 and these seem little different from 2012. The Lynas, the Australian rare earth miner is finally in production at their Malaysian plant and has promised us production samples before the end of this month for the purpose of approving the material. As I have said before, the reduction in rate earth surcharge is to be welcomed. This is eliminating a potential cost disadvantage of rare earth containing materials, and any purchase cost advantage of Chinese-based manufacturers with access to rare earths at cheaper domestic prices. Elsewhere in the ELEKTRON, sales of high-performance magnesium alloys grew by 15% over quarter four 2011. On the sales of magnesium photo engraving sheet finished the year very strongly some 7% up on quarter four of 2011.

Turning to the cylinder business, the cylinder business enjoyed a good quarter year in terms of both demand and business improvement. Sales revenue was up by some 13% with the main story being that our alternative fuel manufacturing facilities newly expanded by the Dynetek acquisition were quickly filled. Full year sales were up by some 9%. And Europe demand for ultra lightweight medical composite cylinders was very strong through the year, following the award of UK regional home oxygen therapy service contracts to various gas companies at the end of 2011.

Encouragingly, the U.S. SCBA market, mainly for fireman’s breathing apparatus showed improvement for the second successive year after some years of decline. Our Superform business suffered somewhat from a reduction in government investment on major rare earth projects, and was particularly affected by underlying weak demand for two high end automobile customers.

Turning to new products and market development, in the area of alternative fuel, we are winning a lot of business in the growing alternative fuel market. Under our newly acquired facilities in Canada and Germany, we are quite full in quarter four. Our 100-day post acquisition program has removed a lot of overhead costs from the Dynetek business, along with cutting purchase costs and otherwise improving margins. So, what remains to be done to eliminate operating losses by the end of quarter one 2013, we believe that we are on target to do just that, where we have had the opportunity to negotiate pricing for 2013, we also have been moving prices where we can. Only one large customer unfortunately quite large one has prices protected until the start of 2014.

To meet the anticipated demand, we need to de-bottleneck the business by installing more aluminum liner capacity. The Board has signed off a $3.5 million investment at our Riverside plant, which will deliver some increased capacity in the middle of this year with more coming on at the start of 2014. The biggest new area for us is seriously entering into the market for high capacity gas transportation modules. Demand for these modules with a selling price in the hundreds of thousands of U.S. dollars is buoyant, and we have committed substantial resources towards meeting the demand that we see in 2013 and 2014.

On the magnesium in civil aircraft following the encouraging statement regarding the use of magnesium in the airplane cabins issued by the FAA last August, we were aware that work is progressing on a standardized laboratory skill tests that will allow seat manufacturers, in particular, to test the various magnesium alloys for flammability. At the meeting of the Fire Safety Materials Working Group in Washington last week, it is reported that they decided to ask for several external laboratories to independently confirm their internal results. This will unfortunately add some months into the process before approval for the use of magnesium alloys can realistically be expected, but we do still expect that to happen.

At this point, I don’t believe that we are losing anytime in getting to market as we are aware of much work being done in parallel with the FAA approval process on magnesium containing seat designs. On diesel catalysis, while we and our JV partner, Rhodia believe that we have the best technical solution to the tightening emission control is on diesel engines. Commercial success is being held back, because the product contains Cerium. At current prices, this shouldn’t be too much of a problem, but memories of the selling prices for Cerium at the peak of the rare earth price spike are still fresh. We never seem unlikely to take a major slice of the initial designs to meet the Euro 6 regulations coming in, in 2014, but sales are increasing and we remain of the view that we will progressively win market share provided the price of Cerium continues to fall.

Moving to page on industrial catalysis, 2012 was a year of good progress with additional customers on more repeat business than ever before. We expect further growth in 2013 and a decision to be made later this year or at least one major contract or supply in 2014. Our ultra lightweight composite medical oxygen cylinders enjoyed their best of the year in 2012 largely off the back of winning business from every one of the companies that won tenders to provide regional home oxygen therapy in the UK at the end of 2011. Our penetration of other European medical markets remains in general much lower from the UK and we see this as an opportunity to further grow this sector.

Our efforts majoring on the economic and patient benefits of the high or full pressure of 300 bar or roughly 4350 PSI that our composite cylinders can take. On bio-absorbable alloys, we are currently commissioning Phase 1 of our new quasi clean room and facility to manufacture the Synermag bio-absorbable alloys at our Manchester alloy plant, although supplying only prototype material at this stage, the facility is already meeting its running costs. As far as we are aware, the clinical trials on the cardiovascular stent are going to plan.

On smartflow following a redesign, the cycle testing of our prototype smartflow regulator is achieving excellent results. We now have to get our Nottingham plant certified to the internationally quality standard for a manufacturer of medical devices, ISO 13485. Once the testing regime for smartflow is completed and only then testing of the intelligent oxygen system or IOS device can start, but this is the lengthy process and we now believe the 2015 is a realistic date for commercialization, around 12 months later than previously thought.

As with any portfolio, some elements are ahead of plan, some on plan, and some behind. Bearing in mind, the tight regulatory frameworks within which we operate and that we are working with partners, overall we are happy with the progress made over the last six months. Between our Riverside California plant and the two Dynetek operations, we are now looking to generate over $50 million of sales from this alternative fuel business stream in 2013, up from less than $20 million in 2012 with only a half year contribution from Dynetek and around $10 million higher when I indicated for 2013 during the quarter three conference call.

Andy Beaden, Group Finance Director, will now give you more details on the financials.

Andy Beaden

Thank you, Brian, and welcome everyone to the call. Brian covered the divisional sales analysis. And my first slide, slide 11 shows how that consolidates to the group revenue changes for Q4 and the full year. Total revenue was $130 million for Q4, 2012 and net revenue, excluding the surcharges was $125.7 million. And the total revenue for the full year is $511.6 million with the net revenue $471.1 million. The chemical surcharge therefore for rare earths was $4.3 million for Q4 and $40.5 million for the year. That compares to $70 million for 2011.

The Group’s underlying revenue growth, excluding surcharge changes and adjusting for FX translation and Dynetek’s Q4 2011 revenue was a growth of 9.9% or $11.3 million to Q4 when compared to Q4, 2011, and 7% or $30.4 million of growth for the full year when compared to 2011.

Slide 12 shows the trend in sales for Q4, 2012 by geographic region. You can see the U.S. and Asia-Pacific have grown, Asia-Pacific growing the fastest. As a percentage, Europe shrunk and Africa is much lower, just a specific ELEKTRON automotive customer who is based in South Africa, whose both volumes and revenue are down and the revenue there is started by a change in the rare earth surcharges as well.

Turning to the trading profit results on slide 13, Brian talked through the factors affecting the revenue and sales changes in the quarter and year. Both divisions increased trading profits in Q4. The main increase came from the ELEKTRON division with its profits up 14.6% to $11.8 million and gas cylinders up 2.4% to $4.3 million. However, Q4 2012 was still the best quarter for gas cylinders since 2010. The main profit driver was sales growth. The gas cylinders’ result is also just despite absorbing the loss-making Dynetek operations, which are now being turned around, and that division was also hit by an $0.5 million of FX transaction losses from the weaker euro to sterling exchange rates in that period. Group trading profits was $16.1 million versus $14.5 million for Q4 2011.

2012 full year trading profit was $68.8 million, $2.8 million better than 2011. For the year, ELEKTRON’s trading profit was slightly down by 2.4, and it is gas cylinders that has improved year-on-year by 32.8%. Groups, combination of sales growth and prudent manufacturing efficiencies and better sales margins.

Turning to the full year income statement on slide 14, the gross margins were stronger this year to Q4 2012 at 23.9% and full year at 24.6%. Trading profit margin for Q4 was 12.4% and the full year was 13.4%, both also improved on 2011. Operating profit, which is after restructuring and other unusual items was 7% higher at $14 million for Q4, 2012 versus $13.1 million for Q4, 2011. This led to a full year operating profit of $66.7 million, being $0.5 million or 1% ahead of the prior year.

In Q4 and for the year too, we had $2.1 million of restructuring and other exceptional costs, which included redundancy costs of $1.3 million. These costs mainly related to the integration of Dynetek, but we also made headcount reductions at Superform to improve profitability. The other $0.8 million of costs related to the IPO and principally non-cash accounting charges in relation to management share option awards on market price IPO awards made at the IPO strike price of $10. The fair value of these was $1.5 million with 40% vesting on the IPO and the remainder over the next three years. Below operating profits, we have charged $1 million in Q4 in relation to the acquisition costs of Dynetek, including acquisition costs paid a reduction in negative goodwill following a review of its tangible assets to acquisitions. This brings the annual costs for acquisition and disposal activity to $0.8 million.

Finance costs are lower both in the quarter by an $0.6 million and the full year by $2.5 million due to lower borrowing, which results to repaying the bank debt following the IPO, and a very strong operating cash flow performance in 2012 reducing bank borrowings. Finance costs were also higher last year due to financing rare earth inventories.

The tax effective rate for the quarter was 15% and the full year was 28%. Last year, it was 9% for the quarter and 24% for the full year. However, the increase relates to non-cash deferred tax accounting charges. I can now confirm that we believe we have retained our $50 million, ₤30 million of tax losses in the UK holding company post the IPO by not triggering the change of controls. And these can be used over time to help reduce the cash taxes paid in the UK. Though the tax charge in the income statement for 2012 was $17 million, the current tax for the amount relating to corporation taxes payable was only $11.1 million for 2012, below 20% of pre-tax profits.

Net income the Q4 2012 was $9.9 million and adjusted for exceptional items was $12.7 million. Full year net income was therefore $43.4 million and adjusted for exceptional items was $45 million versus $43.4 million for 2011. Earnings per ADS for Q4 was $0.37 and the pro forma earnings per ADS for 2012 was therefore $1.58 per ADS based on assuming a total of 26.8 million potential ADSs. This is based on the facts we currently have $13.4 million of ₤1 ordinary shares outstanding, which excludes any shares under the employee share option schemes. For reference, adjusted EBITDA was $20 million for Q4 2012 and $83.5 million for the year.

The next slide number 15 shows the consolidated balance sheet. Overall, invested capital in the operating businesses was $172.1 million, net suspension deficits of $97 million as of the 31st December 2012. The slide shows the key changes since 2011. The acquisition of Dynetek added $11.2 million of operating assets being paid for out of cash. The IPO raised $61.7 million of cash net of costs and we used $47.2 million to repay bank debts. Trading activities therefore added $22.9 million to net assets and reduced net debt by further $37.1 million. Net debt is debt minus cash and is now $23.3 million as of the 31st December 2012. This is unusually low due to its holding $40 million of cash, which is available for reinvestments in our strategic growth projects as we move them forward.

Our banking facilities are un-drawn. We also agreed with the banking parties to a number of debt modifications, which demonstrate the bank support for the group its management team and strategy. These include relaxing covenant calculations around CapEx investments and dividend payments a long way of reporting in U.S. dollars and significantly releasing the group from the security documents making the facilities unsecured. Our note holders agreeing to the same changes, so all the debt is now unsecured pricing, maturity dates, and the size of the facilities remain unchanged with the un-drawn bank facilities being ₤70 million or $105 million at $1.50 to sterling exchange rate.

Turning to cash flow on slide 16, our operating cash flows in Q4 2012 were positive $17.3 million. And this means that full year, we generated $69 million of cash. Compared to 2011, we generated $29.1 million. Working capital reductions helped being an inflow of $5.7 million for 2012 versus an outflow of $24.8 million in 2011, which is due to rare earths’ funding requirements.

Looking at CapEx, with $9.3 million spent in Q4, 2012, we entered the year with CapEx spend of $19.3 million. The cash flow cost in 2012 of Dynetek was $11.8 million, an $0.8 million of this was acquisition costs, and they are shown in the operating cash flows under IFRS presentation and $11 million in investing cash flows, which were paid to debt and equity holders for the actual business. Cash flow before financing was $39.6 million for the year. The next slide shows return on invested capital, which was an exceptional 31% for the quarter and 28% for the year.

Finally, turning to slide 18 and other financial issues, group pension accounting deficits under IFRS totaled $97 million, including a UK deficit of $77 million as of the 31st December 2012. Work is completed on the actuarial funding valuation of our UK defined benefit pension plan, which will be valued as at April 2012. The actuarial funding deficit to spin with the accounting calculation and remediation program has been agreed with the trustees although it still have to go to the UK regulator. The new deficit remediation program is earnings related, just as the existing one is and is capped at the same £5 million circa, $8 million grant. IFRS accounting for pensions is changing. We have included detailed information on the impacts in our Q4 release documents.

In summary, the main impact is an additional $4 million per year non-cash finance charge and a net income impact due to this of circa $3 million per annum. This will impact both 2013 and lead to a similar restatement for 2012. We will add this charge back for our adjusted net income calculations. There is no real impact on adjusted EBITDA, no impact on cash, no on the deficit calculations. Finally, the strengthening of the U.S. dollar to sterling will have a negative impact on us now, but we are reporting in U.S. dollars. It reduces the dollar value of our UK profits. The impact is approximately $1.5 million to trading profit for every $0.10 change in the exchange rate. Thank you. And I will now hand you back to Brian to sum up.

Brian Purves

Thank you, Andy. In summary then, quarter four was in line with expectations on the sales and operating profit and ahead on EPS and cash generation. Our return on invested capital already outstanding actually increased to above 30%. Our full year 2012 was also in line with our guidance. As flagged in the previous call, there was undoubtedly an element of benefit from rising rare earth prices in the quarter three 2011 result causing it to be well above trend, and so the underlying improvement in 2012 is actually greater than the headline numbers of gas.

The summary then, the Board is very pleased with our quarter four result and with the full year 2012 result, which was our best ever from these group of businesses. The outlook for 2013 remains positive with expected substantial growth in our presence in the market for alternative fuel containment overcoming the likelihood that defense will be down and European automotive is likely to remain weak for at least the first half of the year. In quarter one the alternative fuel activity is mainly about build with sales income grew more strongly quarters two to four. European automotive is particularly weak. Accordingly, we are guiding the market to expect our first quarter to be lower than our recent run rate around the $1 million to $2 million down on quarter four of 2012, albeit closely followed by what we expect will be a much stronger quarter two.

For the full year, we have not at this stage will see a recovery of the quarter one result, particularly with the uncertainties over the effect of sequestration on the exchange rate moving against us. And so we are lowering our guidance for the year to an increase in operating profit of between $4 million and $7 million. In many respects, the economic environment remains challenging with our diversification as the major strength. Our growth projects on our portfolio, but there is only reason of what we expect changes to the expectant scale and timing of individual projects, but we remain happy with the overall performance. I am very happy with the increased near-term expectations from the alternative fuel and gas transportation sectors. Most of our key ratios such as operating return on sales, return on capital, operating cash flow, and leverage look very healthy and the business is in good shape. Thank you.

And we will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Julian Mitchell with Credit Suisse.

Julian Mitchell - Credit Suisse

Hi, thank you. Yes, my questions on the organic sales growth outlook for the gas cylinders segment, I just wondered if you expected that stay off again around 9% this year and also what your Dynetek revenue assumptions are for 2013? Thank you.

Brian Purves

Well, on the cylinders side, we are actually expecting rather double-digit growth in the sales revenue, whereas with the ELEKTRON, it’s likely to be in the low single-digits. So, overall, the group figure will be high single-digit figure. So, the alternative fuel side is such a strong driver that we do expect cylinders’ revenue growth to be double-digit this year. It’s not particularly feasible to isolate Dynetek, because we have already started mixing and marching the production within the facilities, but they made a run-rate revenue of about $20 million in the 2011 calendar year before we acquired them. We would expect that to probably nearly double in the course of the coming year.

Julian Mitchell - Credit Suisse

Thank you.

Operator

Your next question comes from the line of Luke Folta with Jeffries.

Brian Purves

So, Luke, good morning.

Luke Folta - Jefferies

I just had a question on the outlook for the $4 million to $7 million increase that you are expecting in operating profit, is this forecast assume generally flat ELEKTRON performance for the year?

Brian Purves

Yes, it does.

Luke Folta - Jefferies

Okay. So, do you have, I mean, you talked about the alternative fuel cylinders sales volumes began, do you have visibility at this point to be able to make the call that the strength that you are seeing in alternative fuels and just the general cylinder business in general should be enough to drive that sort of full year results or is it, I guess, I am trying to just get a sense of what the conviction is on the second half on performance?

Brian Purves

Yeah, there are still, I mean the ELEKTRON side is flat as I said, which means that there are some markets which are in there, which are making reasonable progress in order to compensate for the decline in the defense sales, military programs in particular, and for the weaker automotive side. Now, we are assuming a little bit of a pickup in the European automotive in the second half of the year. And that’s still a bit subjective, which is one reason why we are being a little cautious on the outlook. As you will recall, we won’t operate with a very high order bank across the group as a whole. However, the alternative fuel side is a bit different and that we do have a lot of contractual business there and much of which we picked up with Dynetek was on which we had ourselves. Well, they are not volume committed, there are supply arrangements, and we are working on the basis of customer forecast. So, we have got a pretty high degree of confidence that we will see the sort of level of growth that we are talking about in the alternative fuel side. Such uncertainties do remain and there are still uncertainties are really more elsewhere in the business, I would say that the European automotive and the timing of the pickup there is still a bit of question mark.

Luke Folta - Jefferies

Okay. And then Andy, you talked a lot about the tax, the deferred tax assets, can you give us some sense of what the tax rate should look like for ‘13 given that you can now utilize those?

Andy Beaden

Yeah, I mean, I think the income statement one is going to be the actual accounting charge still around 30%, especially as we are of course a lot of the opportunities that Brian spoke about on gas transportation are actually in North America, where the tax rates are much higher than in the UK and Europe. So, that counterbalances any tax saving, but the cash cost, which to me is more important really is going to be much lower than that between really in low 20s, I’d expect the cash cost to the business. So, accounting wise, 30% were cash costs low 20s.

Luke Folta - Jefferies

Okay, I’ll get back in line. Thank you.

Brian Purves

Thank you.

Operator

Your next question comes from the line of Neil Morgan with Marathon.

Brian Purves

Hi, Neil.

Neil Morgan - Marathon

Yeah, hi. Just wanted to ask about the environmental catalysis product, I think you said in the press release that growth has slowed up towards the end of 2012 compared to the sort of gangbusters rate it started off in 2012 at? I was just wondering if you couldn’t tell us why that’s the case? And I think you have mentioned it, but I can’t recall can you just let me know how much of a driver of growth environmental catalysis will be in 2013 please? Thanks.

Brian Purves

Just to clarify, Neil, you are talking Neil, what we would tell the industrial catalysis, so the chemical…

Neil Morgan - Marathon

Yeah, yeah, but I think it is their industrial catalyst with an environmental benefit, is that right?

Brian Purves

Yes, that’s correct. We are classifying that was environmental, because they are doing an environmental job or they are more environmentally friendly and what they replace. I mean, that is one of our strategic growth drivers and we remain as convinced about that as we have been for sometime now. We were looking for substantial additional growth in 2013 on the sales revenue. But in the nature of that business, it is slow bard I mean we have been working at this for at least 6 or 7 years. And it progresses the increases in the number of customers we are dealing with and then you start to see more repeat business coming through. So, we are looking for something like a 50% up increase in the revenue that was into that market in 2013, but that will get us to a volume, which is somewhere south of 300 tons. And the contract that I mentioned for supply in 2014 that itself is a 300 ton contract. So, if we win that contract or our customers win that contract and places a supplier with us, then you would be looking at euros worth of 2013 demand falling into a single contract in 2014 hopefully on top of everything else. So, it is expected to grow, it’s still a bit lumpy, but it’s expected to grow substantially in 2013 and then much more cheaply in 2014.

Neil Morgan - Marathon

Okay, so a similar question that if so as published in the good Q4 ‘12 that closely, because it’s a lumpy business at this stage or lumpy project or contract-driven business at this stage?

Brian Purves

Yes, that’s correct. I mean, even in December what was a 10 ton contract that slipped out of December and into January, and that is the difference. So, it is still lumpy. We are dealing now with 6 or 7 different customers, but by no means, is it sort of steady month-by-month demand. It’s 10 tons here, 20 tons there, it is lumpy. But obviously as we increased the penetration of that market, increased the customer base, it will start to get more smooth, but we do see a good year-on-year growth.

Neil Morgan - Marathon

Okay. And second and final question, so on the gas cylinders’ business, you have obviously got pretty reasonable pricing leverage in that business in a sense that if you can raise the – if you can raise revenues by I don’t know I think you said double-digit growth in 2013, you should see significant percentage growth in operating profit? Am I reading that correctly?

Brian Purves

Yeah, I mean, the margins on the cylinder side of the business as you know are lower than on the specialty materials side. The alternative fuel market is one where we are trying to break into the market and really persuade it or the composite technology is the best to go for. So, the prices there are not yet mature and the margins in that area while perfectly acceptable are lower than average, but the rate of revenue growth means that we do expect to drag quite significant additional profitability through. And bear in mind, my earlier comments that we expect the ELEKTRON to be reasonably flat year-on-year, really pretty much all of the group growth and profits that we are holding out the guidance for is going to come from the cylinder business and much of that will come from the alternative fuel sector, which is driving the top line.

Neil Morgan - Marathon

Okay, thank you.

Operator

Your next question comes from the line of Jason Brocious with KeyBanc Capital Markets.

Jason Brocious - KeyBanc Capital Markets

Hi, good afternoon gentlemen.

Brian Purves

Hi.

Jason Brocious - KeyBanc Capital Markets

Hi. I was just wondering if you could talk a bit about the margin compression we saw in ELEKTRON during the 4Q as a percent of base revenues compared to the first to the third quarters?

Brian Purves

Well, the automotive demand and the defense demand, which are two of the elements that are growing little bit softer, are higher than average margins. So, that’s for group, but the business, it does of a certain degree of doing employing in it. So, individual quarter result, I wouldn’t put too much emphasis on. We tend to look at it over along the timeframe than that, because in individual contracts and mix changes can make quite a difference in the individual quarter.

Jason Brocious - KeyBanc Capital Markets

In the magnesium extruded products that you buy, you have pointed out as being strong in the fourth quarter, are those I mean above average margin, below average?

Brian Purves

Those are spot on average for the ELEKTRON division. So, they are above average for the group as a whole. That obviously is another developing market and we only installed the new extrusion press there just over a year ago. It’s we are breaking into the market. And of course one of the bigger applications for the output from that press will be once the FAA approved the use of magnesium in civil airliners. The extrusion market that we are aiming for is in the aerospace market. We are selling quite increasing products today, but it’s mainly into defense and military applications, but we do see that as one of the type of material that we are supplying to the civil airliner market once the approval comes through. So, the revenue in the extrusion side is growing quite nicely from a small very base today. So, it’s still not a major product line. That will take another three or four years to get it to the equivalent on some of the other major lines.

Jason Brocious - KeyBanc Capital Markets

Okay. And I think you guys had indicated previously your long-term margin goal for cylinders is double-digits, I mean, do you see that is possible for the second half of ‘13?

Brian Purves

No, I think that was too early. When I said that and we are talking multi-year program. So, I think 2016 maybe run rate and 2015 that’s more realistic on that front not next year, especially not when we are still developing a major market like alternative fuel.

Jason Brocious - KeyBanc Capital Markets

Okay. And just one final one, could you just kind of, from a business flow perspective, just kind of explain your comments that 1Q ‘12 will be a build quarter in cylinders and you will see more of a – more sales flow through second quarter and beyond? Could you just kind of explain that a bit?

Brian Purves

Well, for example, I mean, previously we haven’t done a great deal of business on these gas transportation modules. But what these are large ISO freight containers, which contain quite a large quantity of our alternative fuel cylinder, all sort of wired in together to provide bulk gas transportation system. But previously, we would have been supplying these cylinders into other customers who will be making up the units. And now effectively we are going to be supplying the units, so that extends the pipeline if you like adding a number of weeks between the start of the process and the selling point. So, you got extension, you lose, and what you lose is a few weeks when you are entering into the market. If we were still selling to other customers, the sales of the cylinders would grow in Q1. Well, of course, we are taking the additional time to manufacture them into end units that would take until Q2 to get them out very simplistically.

Jason Brocious - KeyBanc Capital Markets

Okay. So, you’ve got – so basically you’ve got the orders in hand and I mean, 1Q will be – you’ll be putting these units together and 2Q will see the sales flow through and should lumpiness kind of subside from there on now, should be more – more than even growth type trajectory?

Brian Purves

Yes, the Q1 is when you take a bit of a one-off hit, because you are extending the supply pipeline. Obviously, as the growth of the business comes through, you get a smaller hit in subsequent quarters, but the Q1 is the main one, yes.

Jason Brocious - KeyBanc Capital Markets

Okay, thank you.

Operator

Your next question comes from the line of Julian Mitchell with Credit Suisse.

Julian Mitchell - Credit Suisse

Thanks. I just had a couple of follow-ups on the balance sheet and the cash flow outlook. So, just on the cash flow, your free cash flow in the full year ‘12 was about $50 million against adjusted net income of about $45 million. When you think about 2013, are there any major moving parts that should cause the free cash flow to fall below net income in terms of say a CapEx spike or you think that’s mostly behind you?

Andy Beaden

Yeah. Well, Julian, our guidance on CapEx is from high 20 to low $30 million for this year, which is significantly up than last year as we invest in areas like the transportation systems and alternative fuel and the other growth projects. So, that will be a difference. Last year, we had a cash inflow from working capital, which was down to that underlying business is actually growing. It was down to rare earth costs falling. In the normal year of growth, you would expect a natural outflow to support the increase in revenue. So, that’s (sort of been) at $7.5 million inflow that would be an outflow in the ratio of the sales growth. And those two items you’ll find will change the free cash flow generation and bring it back to a figure which is quite a bit lower than 2012, where it’s also due with investments in the growth side of the business.

Julian Mitchell - Credit Suisse

Got it, thanks. And then just on the balance sheet, the net debt to EBITDA is obviously very low at the end of the year?

Andy Beaden

Yeah.

Julian Mitchell - Credit Suisse

I understand you have some cash outflows or some cash hits in the ‘13, but you feel with your balance sheet structure even adjusting for those items, you are thinking about further acquisitions like Dynetek?

Brian Purves

I’ll take on that one Julian. Yes, I mean, we are interested in further acquisitions and we are keeping an eye on the potential in that side. We are very happy with the way that Dynetek is coming through. We are very pleased with the timing on that one. So, we just have to be careful about what and where, but we are quite keen to do that. And we’d be delighted if we could do another one in the course of the next 12 months, but there is nothing specifically in the pipeline at the moment we are just keeping an eye open and looking at few possibilities.

Julian Mitchell - Credit Suisse

Thanks. And then just finally on the automotive end market that you are selling into, so it sounds like your guidance kind of embeds it down first half and then sort of flattish second half or you are expecting a sort of a big bounce back in the second half in automotive in your guidance?

Brian Purves

Well, we are certainly we are not expecting a big bounced by, but we are expecting if you like in the end to this de-stocking cycle and a better second half than the first half. It’s difficult to predict quite when these things come around, but we do think the real come around. And we are being reasonably cautiously hope in our expectation, but we are expecting a better second half than first. I wouldn’t go quite surprised to say bounced by, but certainly an end to de-stocking and a moderate pick up in the underlying demand.

Julian Mitchell - Credit Suisse

Great, thank you.

Operator

(Operator Instructions) Your next question comes from the line of Stefan Mykytiuk with Pike Place Capital.

Stefan Mykytiuk - Pike Place Capital

Hello, good morning. Couple of questions. I guess, first, the guidance the improvement in profit of $4 million to $7 million, which excludes the ‘13 restructuring costs, right that’s 4%?

Andy Beaden

Yeah.

Stefan Mykytiuk - Pike Place Capital

Okay. Now, are we adding that to the adjusted number on 2012 or the unadjusted, in other words, are you – should I add that to the $83.5 million of adjusted EBITDA?

Andy Beaden

No, you should add it to the operating profit of $66.7 million to get you to the operating profit before finance costs.

Brian Purves

We have already addressed it in the $83.5 million which is not affected by the $2.1 million.

Andy Beaden

So, if you are working down your income statement with saying that the operating profit, which is after exceptionals, the guidance of that would be $4 million to $7 million better in 2013.

Stefan Mykytiuk - Pike Place Capital

Okay. So, in other words, the $12 million that’s on the reported 2012 number is not the adjusted?

Andy Beaden

Yeah.

Brian Purves

That’s correct.

Andy Beaden

On the adjusted, we have given guidance $2 million to $4 million.

Stefan Mykytiuk - Pike Place Capital

Okay. I didn’t know if the $2 million to $4 million, because you are saying you are going to have some restructuring costs in ‘13 as well, aren’t you?

Andy Beaden

We are only forecasting very small assuming that no major.

Brian Purves

On the contrary, we have no plans at the moment for restructuring costs in 2013.

Stefan Mykytiuk - Pike Place Capital

Okay, got you. And then with your – in terms of kind of the cadence of the year though you are saying Q1 will be down from Q4 and then Q2 will be better than Q1 and better than Q4?

Brian Purves

Yes.

Stefan Mykytiuk - Pike Place Capital

Okay, but it still implies you are going to exit the year, the second half you are going to be at much higher run rate than kind of the reported for the year?

Brian Purves

It’s really Q2 through Q4 we expect to be that we see that all much stronger than Q1.

Andy Beaden

Yeah.

Stefan Mykytiuk - Pike Place Capital

Right, right, okay. And then in terms of, I am sorry…

Brian Purves

We just mentioned specifically quarter two, because it’s so close to hand.

Stefan Mykytiuk - Pike Place Capital

Right, okay. And then in terms of the free cash flow, I think there was a question about free cash flow versus earnings in 2013, obviously you are saying CapEx is going to be higher than depreciation by $12 million or $14 million or something like that, the working capital is going to be a use of funds, it looks like your working capital is around 25% of sales. So, is that a good number take 25% of the increase in revenues in ‘13 as a…

Andy Beaden

Well, it’s more 20% on a normalized basis.

Stefan Mykytiuk - Pike Place Capital

Okay, okay. And then cash taxes are pretty probably it looks like based on my numbers $5 million or $6 million less than the reported taxes due to the…?

Andy Beaden

Yeah.

Stefan Mykytiuk - Pike Place Capital

Okay, I am with you.

Andy Beaden

Thanks very much.

Brian Purves

Okay, probably we have time for just one more.

Operator

Your final question comes from the line of Luke Folta with Jefferies.

Luke Folta - Jefferies

Thanks guys for allowing next couple of more just quickly your lockup period is expiring here in early April, can you just give us some thoughts on what we should expect there, are we planning a formal secondary?

Brian Purves

Well we have given some thoughts here because the lockup goes and I think on the 2nd of April. But I did have a (ring around) to the larger of the pre-existing shareholders and there really isn’t a level of selling interest to justify secondary offering. So, we are – we are not planning one at this stage, we obviously have the possibility of doing that at some first group stage. But I think that there will be little interest in doing that until such time as the share prices as well the higher than it is at the moment.

Luke Folta - Jefferies

Great and just lastly can you talk about what’s your thoughts are for dividend policy for next year – for this year?

Brian Purves

Well, we continue with our $0.10 on ADS which at the current price is pretty much on the targeted yield of 3% or so and we will not review that as a Board as and why the circumstances that causes to do so. So, at the moment our anticipation is that we will continue to pay at a quarterly $0.10 dividend through 2013.

Luke Folta - Jefferies

Thanks a lot, gentlemen.

Brian Purves

Okay thank you very much everyone. We will speak to you and not too distant time actually on the quarter one results at some point in May. Thank you.

Operator

Thank you. This concludes today’s conference call you may now disconnect.

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