Luxfer Holdings' CEO Discusses Q1 2013 Results - Earnings Call Transcript

May. 8.13 | About: Luxfer Holdings (LXFR)

Luxfer Holdings PLC (NYSE:LXFR)

Q1 2013 Earnings Call

May 1, 2013, 8:30 am ET

Executives

Brian Purves - Chief Executive, Executive Director

Andy Beaden - Group Finance Director, Executive Director

Analysts

Luke Folta - Jefferies

Julian Mitchell - Credit Suisse

Phil Gibbs - KeyBanc Capital Markets

Stefan Mykytiuk - Pike Place Capital

Operator

Welcome to the Luxfer Group first quarter conference call. We will first hear from Luxfer Chief Executive, Brian Purves who will provide a market overview followed by Group Finance Director, Andy Beaden, who will review financial performance for the quarter. 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, Laurie. Good afternoon, ladies and gentlemen, and welcome to the Luxfer conference call on the first quarter of 2013. I will take you through the headline results. Andy Beaden will go through the detail of the financials and after a brief statement on the outlook, we will take your questions.

The quarterly result was inline with our guidance and expectations with underlying sales revenue down by some 1.5%. Within the overall small reduction however, ELEKTRON is 14% down, while cylinders is 13% up. While the operating margin in the cylinder business is improving it remains much lower than the specialty materials businesses. Accordingly, the group's trading profit is $3.3 million lower than quarter one last year and around $1.2 million down on quarter four of last year. EPS of $0.35 was marginally better than the consensus forecast and cash flow was strong.

Looking at the sales revenue movement, slides five and six track from the 2012 first quarter result at the top of schedule through to the 2013 result at the bottom. In our ELEKTRON division, the headline sales revenue line is dominated by the reduction in rare earth surcharges. As the cost (inaudible), in particular cerium has collapsed to less than 10% of its peak, although it still will be much higher than at the start of 2010.

Stripping the movements in the surcharge out, underlying sales declined by some 14% with the majority of the decline in our zirconium automotive catalysis business. Although sales of magnesium powders for military players were also well done. After very strong sales in the fourth quarter of last year, sales of photo engraving sheets were also down in the first quarter but by the end of quarter the photo engraving order book was back at normal levels.

On rare earth generally, prices continued to drift downwards and this does create difficulties for us as we try to march the customer surcharge to input costs and avoid the need for stock write downs. In the long-term, however, lower rare earth costs makes several of our materials more competitive.

Lynas, the Australian rare earth miner is finally in production at their Malaysian plant and the reelection a few days ago of the incumbent Malaysian government removes one potential threat to the project. We are in the process of qualifying their materials.

The cylinder business enjoyed a good quarter in terms of both demand and business improvement. Sales revenue was up by some 13% on last year with the main story being that our alternative fuel cylinder manufacturing facilities recently expanded by the Dynetek acquisition were substantially pooled.

In Europe demand for medical cylinders was lower than this time last year when we had a very strong demand following the award of U.K. National Health Service home oxygen therapy contract to various gas companies at the end of 2011. Demand for specialty gas cylinders was also weaker and this is a high margin product but this is thought to be the gas company's managing their stocks rather than any weakness in the underlying markets mainly electronics.

Encouragingly, however, the U.S. SCBA market, mainly for our fireman's breathing apparatus is still showing improvement after several years of lackluster demand. Our customers tell us that many of the units purchased by fire brigades using federal grants post 9/11 are reaching the end of their operating lives. Export orders were also strong in this sector.

On new development, on alternative fuel cylinders, we are winning a lot of business in this growing market. On our (inaudible) facilities in the U.S.A., Canada and Germany we are quite full in quarter one. We are in the process of debottlenecking production of the aluminum liners which should increase capacity by the equivalent of our own $7 million per annum for the second half of this year and by a further up to $10 million per annum from the star of next year. The average price of these large cylinders is over $2,000.

Our post acquisition program removed a lot of overhead costs from the Dynetek businesses, along with cutting purchase costs and otherwise improving margins. While much work remains to be done to make the business acceptably profitable, especially on pricing, I am satisfied that we have achieved our initial objective to eliminate recurring operating losses by the end of quarter one 2013.

As I mentioned on the last call, what an exciting growth area for us is entering into the market for high capacity gas transportation modules. Demand for these modules appears to be growing very rapidly and we have committed substantial resources towards meeting the demand that we see in 2013 and 2014. This includes committing customer leasing facilities of up to $10 million although the vast majority of the near-term opportunities appear to be for outright sale.

At the end of quarter one, we have a quarter two order book of around 1,200 cylinders to be built into approximately 40 small gas transportation units. Amongst other applications, these are being used by oil and gas exploration companies to convert generators in remote locations from diesel to natural gas in pursuit of environmental improvement.

I stated on our last call, between our Riverside California plant and the two Dynetek operations, we are looking to generate over $50 million of sales from the overall alternative fuel business stream in 2013, up from circa $20 million in 2012 where we had only a part year contribution from Dynetek.

On magnesium we are aware that work is progressing in independent laboratories on the standardized laboratory skill tests that will allow manufacturers to test magnesium alloys for flammability. It will be some months before this work is completed but we remain confident that the use of magnesium alloys in civil aircraft interiors will be sanctioned before long. I attended the aircraft interiors exhibition in Hamburg last month where we demonstrated an ELEKTRON alloy based seat frame attracting considerable interest from many of the smaller seat manufacturers that we were not already working with.

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

Andy Beaden

Thank you, Brian, and welcome everyone to the call. Brian covered the divisional sales analysis and my first slide, slide nine says how that consolidates to the group revenue changes for Q1.

Total revenue was $122.4 million with net revenue of $119.2 million and the rare earth chemical surcharge was $3.2 million. Group's underlying revenue was down 0.3% or $0.4 million excluding the surcharge changes of $17.1 million and adjusting for the FX translation difference, a negative $1.5 million. ELEKTRON 's fall in net revenue being nearly offset by gas cylinders' increase.

Slide 10 shows the trend in sales for Q1 2013 by geographic region. The noticeable changes being North American revenues now being 45%, a change from 41% and Africa being lower due to reduction in the surcharge to South African order capped customers.

Turning to the trading profit results on slide 11, Brian talked through the factors affecting revenue and sales changes in the quarter. In line with sales changes, gas cylinders profits were higher up 27% to $5.2 million. ELEKTRON is lower by 31% down to $9.7 million. Operating margins were higher in both divisions but with ELEKTRON being on average a higher margin business, the group's average margin fell through return on sales of 12.2% from 12.9% from the back to reduced sales from ELEKTRON. The Q1 2013 group trading profit was therefore $14.9 million versus $18.2 million for Q1 2012 and $16.1 million dollars to Q4 2012. Guidance have been $14.1 million to $15.1 million.

Turning to the full income statement from slide 12. The gross margin was slightly lower for Q1 2013 at 23.1% versus 23.8% for last year, again mainly due to change in sales mix by division. Gross profits was therefore $5.4 million lower but with reduced admin and distribution costs trading profit was only $3.3 million lower. We did have $0.4 million of restructuring and exceptional costs, $0.2 million related to further rationalizations in gas cylinders and $0.2 million related to amortization of IPO share option costs. The amortization charge for the year for these cost is expected to be $0.5 million.

Operating profits, which is after restructuring and other exceptional items, was $14.5 million for Q1 2013 versus $18.2 million for Q1 2012. We have previously indicated that this would be similar to Q4 2012, which was $14 million. The low operating profits, the finance costs now having new line item which relates to the newly revised IAS 19 retirement benefit accounting standard. As I have previously explained, under IFRS accounting, we now need to disclose a notional finance charge in relation to our pension deficits, which is $0.9 million for both Q1 2013 and Q1 2012, 2012 being restated from last year with the opposite contra entry being an additional credit to reserves. There is no change in the deficit calculations nor cash payment plans from this accounting standard change.

Interest costs relating to our debt facilities was $1.5 million versus $1.7 million last year, a lower number due to lower borrowing. The effective tax rate is 31.4% versus 33.3% last year and net income for Q1 2013 was $8.3 million but adjusted for exceptional items and excluding the IAS 19 finance costs was $9.4 million. This is $0.35 per ADS. Last year, Q1 was $11.1 million on the same basis. For reference, adjusted EBITDA was $18.7 million compared $21.9 million for Q1 last year.

Turning to the balance sheet on slide 13. Overall, invested capital in the operating businesses is $182.3 million. Net suspension deficits of $79.8 million as after March 31, 2013. Pension deficits fell $16.9 million from $96.7 million at the end of 2012. This being due to better asset returns from slightly by higher bond yields. Net assets (inaudible) equity of the group has risen to $155.8 million, up $7 million from the end of 2012. Net debt, debt minus cash, is now $26.5 million. Our £70 million or circa $108 million banking facilities remain undrawn in the period.

Turning to cash flow on slide 14. Our operating cash flows in Q1 2013 were positive $9.6 million, the same as for Q1 2012. It is very normal for us to have a working capital outflow in Q1 and though lower than last year, this was is still $6.9 million. Looking at investment cash flows, we made investments of $6.4 million in the quarter, $3.9 million of normal internal CapEx and we also made an investment in North America of $2.5 million to grow the gas transportation market for CNG using composite cylinder technology with one of our strategic partners. The funds are being used for working capital and production facilities. Cash flow before financing was therefore $3.2 million. After paying dividends and interest of $3.9 million and some outstanding IPO cost of $0.3 million, net cash flow was an outflow of $1 million.

The next slide shows return on invested capital, which was 23% for the quarter compared to 26% for Q1 2012. Note these figures have also been restated for IAS 19.

Finally, turning to slide 16. I set out the quarterly impact of the restatement of 2012 for the changes in IAS 19 pension accounting. I will not lead through the detail though I am happy to take questions later on. We have decided to add back to finance costs for IAS 19 when calculating our own non-GAAP adjusted net income figures. As you can see, this aids better compatibility to our historic results as previously reported and to other companies reporting under U.S. GAAP that do not have to make this charge. These tables also show the impacts on result per ADFs using the share count as after December 31, 2012, which was equivalent to $26.8 million ADFs outstanding, that being based on $13.4 million ordinary shares outstanding.

Thank you. N will now hand you back to Brian to sum up.

Brian Purves

Thank you, Andy. In summary then, quarter one was in line with expectations on sales and operating profit and slightly ahead on EPS. As indicated, we are currently experiencing reduced volumes on certain ELEKTRON product streams, while cylinders are showing both revenue increases and the margin improvement. The overall impact of the mix change on profitability at the group level is, for the moment, negative. I am pleased that we achieved our objective to eliminate the recurring operating losses of the recently acquired Dynetek businesses by the end of quarter one.

The outlook for 2013 remains cautiously positive with expected substantial growth in our presence in the market for alternative fuel, containment and transportation, most likely to outweigh lower defense sales and the probability that European automotive will remain weak for several further months. Despite the weakness in these two markets, based on customer forecasts in other sectors, further growth in alternative fuel cylinder sales, especially for gas transportation modules and an expected recovery in the photo engraving plate market, we do see quarter two being stronger than Q1.

For the full year, while we remain nervous about the automotive market and about the potential impact of sequestration, we are retaining our previous guidance for the year to an increase in trading profit of between $2 million and $5 million. Based on our expectation of lower restructuring costs than in 2012, this would mean an equivalent operating profit improvement of between $3 million and $6 million. Clearly, this is based on us achieving a significant uplift in the second half and we will take another view once we see how the second quarter ends.

Thank you and we will now take questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Luke Folta of Jefferies.

Luke Folta - Jefferies

First question I had was, there seems like there is a lot of momentum around the alternative fuel tank market right now and you noted that there is a couple of different things you are doing to expand capacity there. I guess I just wanted to understand from higher-level, what would happen if sales in this business were dramatically ahead of ahead of you expect they would be over the next couple of years or so?

I guess I am just trying to get a sense of how fast could you expand capacity meaningfully? I know there are some things you are going to do with the liners this year and it seems like that Phase 2 which I am not totally certain that’s all about for January but I am just trying to get a sense of really how good the (inaudible) could be if this thing really takes off which it seems like its in the beginning works of doing so.

Brian Purves

Okay, well the liners are currently our bottlenecks. So that’s why we are focusing on increase lease capacity there. The reason it comes in phase is because there is more than one piece of equipment involved. We need some additional heat treatment capacity which is coming in the middle of the year and that gives us a slight increase, while not significant really, its $7 million per liner of revenue capacity but main piece of equipment is a new spinning machine which forms the ends of the liners and that won't be in place until the start of next year because basically its on a 12 month lead time.

A 12 month lead time is probably a reasonable rule of thumb to use in terms of, on quick thinking, to put additional from tube of a certainly liner capacity in place. When you look at these big composite cylinders, essentially when you bit analyze it though, there are two major elements to it. One is making the liners which we make in the main form aluminum tube and secondly the wrapping, the winding machines, which are of the carbon fiber tapered (inaudible). Those are probably available on a slightly shorter lead time. They are also able to be put into place in relatively small modules. So its not a major individual investment, perhaps $2 million per machine.

So we can move reasonably quickly but with a lifetime of somewhere between six and 12 months depending on where the bottleneck happens to be at the time. We also have to, of course, just have an eye watch the sustainable level of business in this industry is going to be. I am talking there particularly about the gas transportation modules. I think we were pretty happy that the fuel systems for trucks and buses will continue to grow for a really quite some time. There is no foreseeable end to that. But on the gas transportation modules, arguably we are going through, if you will excuse the pun, a bit of pipeline filled over the next couple of years and we are not quite sure whether market will settle down.

But at the moment we can't yet see the end to it. So we have declared that we expect to generate at least $50 million of sales from the business this year. By the time we get to the start of next year, we will have probably somewhere between $65 million and $70 million worth of capacity and hopefully we will be looking at further increases in the course of the second half of this year and '14 for even higher figures beyond that.

Luke Folta - Jefferies

That’s great. Thank you very much. Secondly, can you just give us an update on what the CapEx plans are for '13, what the total spend expectation is? If you have got any early read on '14, that would be helpful and just what the major projects are in that number? Thanks.

Andy Beaden

Luke, this is Andy. As I said, I think we are sticking to our guidance for '13 which is $28 million to $32 million in terms of expenditure. Not only we wouldn’t actually would say that is at the high end of a normal year, the size of businesses we have today. So we have not given guidance for 2014 yet but on a normal basis, even thinking about some of the opportunities we wouldn’t expect to be increasing above that, if anything dramatically changing the business.

Brian Purves

We do expect the later years to fall back to a lower base level, perhaps in the $20 million to $24 million range. Then the only overlay to that would be where we require to put additional capacity and to satisfy some of the strategic growth initiatives that we have been talking to the market about.

Andy Beaden

Which would, maybe if you remember, the big one is, if we decide to build or needed to build a new zirconium plant to say $15 million. But our normal expectation would be that that might be a lower CapEx spend year for other parts of the business and focusing more on making that one-off project.

Operator

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

Julian Mitchell - Credit Suisse

Yes. So the first questions would be just around the organic growth. Total company was down very slightly in Q1 year-on-year. It was about $0.4 million or something. When you think about the cadence for the next three quarters and the balance of the year, what are you assuming to the trend run rate on organic sales growth?

Brian Purves

Well, we see the further growth in the cylinder business. So that we, over the course of the year, we would still be hoping for double-digit growth in the cylinder top line. On the on the ELEKTRON side, we have flagged for some time that we expect that division to be a at best flat over the year. With the two markets of automotive in the European automotive and defense being down and best growth in other areas of the ELEKTRON business making that good.

Now that doesn’t tail obviously a pickup in the ELEKTRON numbers in the second half of the year. Not in defense because we have reckoned that that will be now fairly flat for the next couple of years but a bit of a pickup in automotive volumes and some improvement in other areas such as the aerospace alloys will bring that division back towards a level year. So the group's total outlined growth this year will basically be the cylinders growth divided by two because its roughly half of the group products.

Julian Mitchell - Credit Suisse

Got it, thanks. Just a follow-up. Within the photoengraving business, you mentioned orders have picked up a bit. Could you talk more generally about the trend in orders for your short cycle businesses in ELEKTRON excluding defense?

Brian Purves

Well, defense is pretty well flagged for the year. Automotive tends to operate on quite short lead times. So that one is more difficult. We do you get some forecast from customers but it is very much a case of probably short lead times. So we don’t know until much closer to the date what the level of demand is going to be there. So that’s the one where there is the big question mark.

On markets like photoengraving plate, they tend to be fairly stable. As you know, photoengraving plate is not one of our big growth areas. Its more of a stable cash cow business. On quarter one sometimes it is a s little bit flat especially if they have taken a lot of stock on in quarter four, approximately run off to Christmas, but they all do good there and thus give us a reasonably high level of visibility for the following quarter and that’s back at normal levels at the end of quarter one. So I think that quarters two, three and four will be back at a normal level for that and the quarter one production will be a bit of a one off.

Operator

Your next question comes from the line of Phil Gibbs of KeyBanc Capital.

Phil Gibbs - KeyBanc Capital Markets

How much of the margin improvement in the second half of '13 in ELEKTRON right now is baked into your forecast right now relative to where we were in the first quarter?

Andy Beaden

Well, there is fairly hefty uplift but its more of over on the forecast that we either get from our customers or an expectation that there will be some recovery in the European automotive, and certainly the last external forecast that I saw were predicting that that market would be progressively less down than the prior year until the fourth quarter ended up a little up on fourth quarter 2012. Normally, if we see that sort of cycle, we would see an end to the destocking and a commencement of restocking round about the third quarter of this year. So we are anticipating an uplift in our automotive volumes in the second half to eliminate some of the negativity that you see in the quarter one results.

Phil Gibbs - KeyBanc Capital Markets

Have you seen that automotive business stabilize yet on a sequential basis?

Andy Beaden

It has been pretty flat Q1 over Q4. So, we are not really seeing evidence of any further destocking. So hopefully that’s a sign that the market has bottomed. But the last Mainland European figures I saw, the last figures still showed a decline in the markets cumulatively. The only major market in fact which is growing very strongly is the U.K. where the numbers are up about 10% year-on-year but the Mainland Europe, its down about 15% or 16% and still dropping at the last that I saw. Those are sales figures, of course, rather than production and just production figures that we major on and that of course includes export. So, you can't take the pure registration numbers and read too much into that. But certainly, it is fairly flat at the moment and we anticipate a bit of an upturn in Q3, Q4.

Phil Gibbs - KeyBanc Capital Markets

Okay, just have one more if I could. Can you provide us an update on your liquidity right now and how much capital you would be comfortable dedicating to potential acquisition assuming the right candidate were available?

Brian Purves

Well, we have, I think Andy mentioned that our facilities which is roughly $100 million, are not drawn at all at the moment. We have about $25 million of cash on the balance sheet.

Andy Beaden

There is more than that at the moment, Brian. Its nearly $35 million to $40 million depending on how you look it up.

Brian Purves

So we have got plenty of fire power but traditionally our acquisitions have been in the $25 million type range and we could look at one that was a little larger than that. maybe twice as big but I think it is unlikely that we would look at single acquisitions if it was much more than that. There is nothing obviously in the pipeline just at the moment but we are keeping an eye on the market. When talking to people strategically, we have said that we would be prepared to live with the level of that cover in terms of EBITDA cover lifting it from the coverage of 0.25, 0.3 type level to maybe as high as two times as long as we felt that that was temporary if they are and one times is more the level at which Andy and I are comfortable operating the business going forward.

Phil Gibbs - KeyBanc Capital Markets

Perfect, and regarding the potential secondary given the fact that the ADR price has been fairly strong here in recent weeks. Is there any more update on the secondary front?

Andy Beaden

Well, I haven’t, in a bunch of these calls, I have not (inaudible) to the pre-existing shareholders and I don’t know (inaudible) all of them but they have all had the opportunity to call me and say that they have changed their minds and enough of them have done that. We are, however, encouraging the shareholders to keep their share in to the depository and convert them in to ADRs and I think that’s in process for several of them at the moment. So once that’s happened it will probably take another few weeks. We will do another survey to see what the level of interest is.

Operator

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

Stefan Mykytiuk - Pike Place Capital

Just a question on the JV. Can you just elaborate on what the JV is? Is some of that money you invested in the JV, is that offsetting CapEx? Or is it incremental to the CapEx program?

Brian Purves

Well, we have (inaudible). We basically lumped it in with the CapEx because it is essentially an investment in infrastructure. It is taken in the form of equity but it is to allow the business finance growth and its in a business that we have set up with a partner who is a specialist in this area of gas transportation modules. For commercial reasons, I am not willing to say who that partner is at the moment. We are still talking to customers and suppliers about the fact that we are now involved in the business but he is a specialist in this area and it enables us to get a bigger share of the profitability in these units rather than just making the profit on the outright cylinders. I suspect by the time we come to publish the half year returns that we will be required to make a fuller disclosure about who the partner is and what the structure is.

Andy Beaden

I think the point there, Stefan, is that if someone else talks about it how quickly can we expand. I think the issue is quickly can you take advantage of that greater demand and this type of investments, it was taking the lead enables us to move more quickly in this market and its all liked up with increasing capacity and exploiting the opportunity now and being ahead of the game.

Stefan Mykytiuk - Pike Place Capital

Okay, but in terms of how the JV works, you are providing the tank and are they providing, is there something they have proprietary around the modules or is it more around the marketing and the distribution end?

Brian Purves

Well, they are already in that market making the modules. We have previously been a supplier to them. So their expertise is putting the module together with all of the pipe work, the built in compressors and all of the things in the estimate. So they package the overall product and there is obviously an incremental profit stream over and above the volume of he cylinders. Our objective is to take a slice of that along with securing the fact that its our cylinders that get built into his modules.

Stefan Mykytiuk - Pike Place Capital

Great, okay. As you said at the beginning, Brian, that investment this quarters is baked into the overall CapEx?

Brian Purves

Yes. That’s our view, yes.

Stefan Mykytiuk - Pike Place Capital

Okay. Next question is just, I know you have touched on it on a few questions now but just in terms of the visibility into the improvement in trading profit in Q2, you talked about some of the order books improving specifically photoengraving. I would assume, as part of the improvement and the sequential improvement in trading profit, also the fact that you eliminated the losses at the Dynetek business.

Brian Purves

Yes. So a bit of it is that because although we, as I said, we did eliminate the recurring losses by the end of the first quarter. It is still obviously a drag on the overall margin of the cylinder division and the group. Until we get it this up to a level of profitability that we demonstrated in the rest of the cylinder business. That is going to take us a few more months to do that. We certainly by the second half 2014, I would expect that we should be in that sort of position but it will be a progressive improvement. It might be a bit lumpy, steppy at times but we are starting off where it is even low, its breakeven or a little better. It is still a drag on the overall margins and progressively we will be looking to change that to lift its operating margins to at least the same level as the rest of the cylinder business.

Stefan Mykytiuk - Pike Place Capital

Okay, and some of that is because of the pace? It is going to be paced on the pricing actions?

Brian Purves

Some of it will be but that tends to be focused round about the annual product price negotiations. So our next major opportunity there would be the start of 2014. We have taken so much at the start of 2013 but most of the contracts of the Dynetek business has are annual contracts. But there are other things that we can do to improve the margins in the mean time. Things that take a bit longer and some of the cost cutting measures that we took in the fourth quarter. But (inaudible) will to get in a progressive improvement.

Operator

At this time, there are no further questions. I will now return the call to management for any additional or closing remarks.

Brian Purves

Okay, well, thank you very much, ladies and gentlemen. We will speak to you again in about three months time. We are at a conference in New York in next week, in fact. So we may see a few of you at or around that conference. Thank you very much and good bye.

Andy Beaden

Well, thank you.

Operator

Thank you for participating in the Luxfer Group first quarter conference call. You may now disconnect.

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