Luxfer Group' CEO Discusses Q3 2013 Results - Earnings Call Transcript

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Luxfer Group (NYSE:LXFR) Q3 2013 Earnings Conference Call November 14, 2013 8:30 AM ET


Brian Purves – Chief Executive and Executive Director

Andrew Beaden – Group Finance Director and Executive Director


Luke Folta – Jefferies

Philip Gibbs – KeyBanc Capital


Welcome to the Luxfer Group third quarter conference call. We will first hear from Luxfer Chief Executive, Brian Purves, who will provide a market overview for the quarter; followed by Group Financial Director, Andy Beaden, who will review the financial performance for the quarter and year-to-date. Brian will then return to sum up and offer an outlook. After that, Brian and Andy will take your questions.

To make sure that as many questioners as possible get a chance to speak in the time allotted, we request that you initially ask only one question. After you have heard the answer, we will give you the opportunity for a follow-up question. If you would like to ask additional questions, our operators will 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 third quarter of 2013. I will take you through the summary results and the market situation, Andy Beaden will go through the detail of the financials, and after a statement on the outlook we will take your questions.

During the quarter, our European operations which have been struggling all year, and cooler July and August with low production due to the dearth of orders. We did however see an uplift in September, and in the quarter with a better order book, and that gives us some confidence that European businesses will show some improvement in the fourth quarter.

Although our overall revenue is up on the prior year, mainly due to our strong performance from our North American business units, the growth is within the cylinder business and the operating margins here remain rather lower than in the specialty materials businesses. The weaker mix is the main reason that the group’s trading profit is 2.3 million lower than in quarter three last year.

Despite the lower operating profit, with the benefit of the work that we have been doing to reduce the marginal tax rate, adjusted EPS of $0.35 was close to the consensus forecast for the quarter. In looking at the [IFRS profit] since the prior year, it is important to remember that there is between 2 million and 3 million per annum of incremental cost being incurred as a direct consequence of our listing last October, so which is one-off expenditure such as the costs of implementing of Sarbanes Oxley.

Looking at the slide covering sales revenue movement, Slides 5 and 6, these track from the 2012 third quarter result, at the top of the schedule, through to the 2013 result at the bottom. So in Slide 5, in our Elektron division, the headline sales revenue line is again heavily influenced by the reduction in rare earth surcharges as the cost of, in particular, cerium has now collapsed to less than 4% of its peak, albeit, it's still rather higher than it started out at 2010.

Stripping the movement of the surcharge out, underlying sales are actually higher by some 4.3% versus a year ago, the first time this year that we have been ahead of prior, but leading the division 4.8% down underlying over the year-to-date. While welcome, the main revenue improvement in the quarter was in our magnesium recycling business, which does bring relatively low margins. The European arm of our high margin zirconium business remained quite weak in the quarter. Nonetheless, I do feel it is still significant that net Elektron revenues are no longer declining against prior year. The rare earth surcharge is now at such a low level that should costs stay where they are, this factor will be much less important to understand the actual revenue movements in 2014.

Turning to Slide 6, the cylinder business enjoyed another good quarter in terms of overall demand. Sales revenue was up by 11.5% from prior year, despite low levels of activity in our European aluminum facilities, particularly in July and August. The main story continues to be the growth and demand for composite cylinders, mainly in alternative fuel, but also in the important self-contained breathing apparatus or SCBA market. This quarterly year-on-year increase in revenue is a little lower than in the first half, but the year-to-date improvement is a healthy 13%.

Demand for cylinders in Europe remains well lower last year, when we enjoyed very strong demand for medical cylinders following the award of U.K. home oxygen therapy contracts. Unexpectedly weak demand for large specialty gas cylinder cylinders, however, has been quite hurtful so far this year. These cylinders are bought by the gas companies with the electronics industry being the biggest end-user. And such lulls in demand have happened before, usually not lasting longer than a year.

The SCBA demand mainly for firemen's breathing apparatus is still very strong and justifies our recent decision to build additional capacity for these portable cylinders, which capacity will go on-stream mid-2014. In the US, the new 2013 NIOSH standards for SCBA kits are expected to be issued later this months with an end February 2014 cut off date for selling kits made to 2007 standard.

Turning to Slide 7 and our strategic growth projects, on alternative fuel cylinders, the profitability of our [Indiscernible] continues to improve, although still a little below the average for the division. There is much excitement in the gas containment industry about the prospective growth in the use of CNG to power class 8 trucks in the US, and we are working to develop a range of large auto products to service that emerging market.

On gas transportation modules, demand for these continues to grow and our joint-venture with GTM Technologies, which is largely focused on North America is building an impressive order book and invoiced $3 million worth of gas transportation models during quarter three. We received a small positive contribution from the profits of the JV in Q3, and expect that to grow in quarter four.

We are building these modules for Europe and certain other markets ourselves, and we are in discussions over a first contract to supply modules for a virtual pipeline to a large mining operation. The application is again the delivery of gas to allow the conversion of power generation equipment from diesel to CNG. Between alternative fuel cylinders and systems and gas transportation modules, we have invoiced $37 million worth of sales to date this year. So we remain on track to generate our target, over $50 million of sales, from the overall alternative fuel business stream in 2013, up from around $20 million in 2012.

On magnesium and civil aircraft, following the publication of the minutes of the International Materials Fire Test Working Group, stating that the FAA would now allow the use of magnesium alloys in aircraft seats, subject to special conditions. To our perception there is a raised level of interest in these materials across the aerospace industry. [Indiscernible] we used to sell additional quantity of so-called aerospace alloys in to Formula 1 motor sport, until the material was banned along with a number of so-called other exotic materials of few years ago. The rules governing that sport seem to change quite often, and we’re told that magnesium alloys will be back on the approved list for the 2015 season.

Andy Beaden will now take you through some of the financial detail.

Andrew Beaden

Thank you, Brian, and welcome everyone to the call. Brian covered the divisional sales analysis. And my first slide, Slide 9, shows how that consolidates the group revenue changes for Q3. Total revenue was $119.9 million for Q3, with net revenue of $118.3 million and the rare earth chemical surcharge was down to only $1.6 million. The group's underlying revenue was up 8% or $8.8 million, excluding the surcharge reduction of $3.7 million and adjusting for FX translation a positive $0.3 million.

Turning to the trading profit results on Slide 10, Brian talked through the factors affecting the revenue and sales changes in the quarter, in line with the sales changes as cylinders profits were higher, up 5%, to $4.2 million, and Elektron’s were lower down 20% to $9.8 million. Trading margin in gas cylinders was 6.5%, which was lower than prior year. This was despite small added value composite cylinders being sold, and was due to several other factors, being negative FX transaction differences of $0.3 million, and lower utilization of European cylinder plants due to demand weakness in that region in the start of the quarter.

Elektron’s margin at 17.6% was lower than in Q3 2012 due mainly to the weaker sales mix, and also low utilization issues in the zirconium UK facility. As I explained in Q2, we have one more European magnesium recycling business of lower grade alloys, and so volumes and revenues were much stronger for that plant. But this is a low margin business when compared to zirconium chemicals and magnesium sheet and powder, where demand was much weaker.

For Q3 2013, group trading profit was therefore $14 million versus $16.3 million for Q3 2012. Trading profit was particularly weak during the summer months, though demand in Europe did improve later in the quarter.

Turning to the full income statement on Slide 11. The total gross margins were lower, with Q3 2013 at 24.2% versus 25.9% for last year. If you measure this on a net revenue basis, excluding the surcharge, then the margin was 24.5% versus 27.1% for Q3 2012. This 2.6% change being mainly due to the change in sales mix by division. With stronger underlying sales, in total the absolute gross profit was in fact was only $0.6 million lower at $29 million when compared to Q3 last year. Administrative expenses were $1.6 million higher in the quarter. The main reason was $1 million of additional cost relating to the additional ex-Dynetek businesses, and the expansion of the AF cylinder business stream, and we also incurred 0.7 million of extra administrative costs in the quarter linked to now being a public company, which mainly relates to the SOX implementation, and a non-cash amortization of equity incentive awards post IPO, the fair value of these being linked to the share price.

We also had $0.3 million of restructuring and exceptional cost with the bulk being Elektron division cost savings. Operating profit, which is after those restructuring and exceptional items, was $13.7 million for Q3 2013 versus $16.3 million for Q3 2012. Net interest cost was $1.4 million versus $1.5 million last year, a lower number due to lower borrowings.

The non-cash IAS 19 pension finance accounting charge was $0.9 million, the same as last year. The effective tax rate for Q3 was 26% versus 32% last year. We are making tax savings in the U.K. through utilization of past tax losses, and benefiting from the new Patent Box allowances. Plus we have tax losses in Canada, which are shielding the AF profits now being made from that plant. The effective tax rate year-to-date is now 30%, and this is our best estimate for the year-end rate.

Net income for Q3 2013 was $8.4 million. When adjusted for exceptional items and excluding the IAS 19 finance costs, it was $9.3 million and this is $0.35 ADS. We have been targeting $0.34 to $0.36 per ADS. Last year Q3 net income was $10.1 million on the same basis. For reference, adjusted EBITDA was $18.3 million compared to $19.9 million for Q3 last year.

Year-to-date trading profit is now $24.2 million, $8.2 million down year-to-date in 2012. Based on the past four quarters, the LTM trading profit is $60.3 million.

The next Slide, number 12, shows the consolidated balance sheet. Overall invested capital in the operating businesses is now $201.8 million, net of the pension deficits of $74.9 million as of September 30, 2013. The point in time pension deficits fell by $21.8 million from $96.7 million at the end of 2012. This being due to better asset returns, slightly higher bond yields along with our own deficit repayments.

In Q4, we have undertaken a derisking exercise to reduce the size of the US pension liabilities through offering cash settlements to [members]. Early indications are this has been relatively successful, as around $11 million of liability is being settled funded with the plant’s own assets and our normal contributions in 2013. Under IFRS this will lead to a Q4 actuarial settlement charge of approximately $1 million in the group’s income statement, which will be disclosed in restructuring and other expenses, and low trading profit.

Net assets or shareholders equity of the group has risen to $176.2 million, up $27.4 million from the end of 2012. Net debt, debt minus cash is now $25.6 million, and our £70 million or $110 million banking facilities remain undrawn.

Turning to the cash flow on Slide 13. Our operating cash flows in Q3 2013 were a positive $13.3 million. And this was after paying $2.4 million of corporation tax. Looking at investment cash flows, we made investments of $6.2 million in CapEx, the largest single investment being in the expansion of our large composite cylinder production facilities at Riverside, cylinders that are used in CNG and AF markets. We also invested further in our US gas transportation modules joint-venture, which is using large composite type 3 cylinders, to fund its expansion as it ramps up production activities. The investment there was made by a secure debt of $3.5 million.

Cash flow before financing was therefore a positive $3.6 million. After paying dividends and net interest of $3.8 million, net cash flow was an outflow of $0.2 million. The next slide shows return on invested capital, which was 21% in the quarter compared to 26% for Q3 2012, lower due to lower profits and the post IPO capital structure.

Thank you. And I will now hand you back to Brian for sum up.

Brian Purves

Thanks Andy. In summary then, quarter three, started weakly in Europe, and while September was better, the overall quarter was at the bottom end of our expectations on operating profit. As indicated, we are currently experiencing reduced volumes on certain Elektron product streams and generally our European focused business units are suffering from weak demand. While cylinders is overall showing strong revenue growth, the net impact of the mix change on group profitability is currently negative. We did however deliver the expected result on EPS.

Looking at the balance of 2013, we’re assuming only a modest improvement in European demand during the remaining weeks of 2013. Accordingly, while we do expect Q4 to show an improvement over Q3, and indeed are targeting it to March Q4 last year, we see little opportunity to move away from the bottom end of our forecast range on trading profit. It is pleasing however that the work that we have been doing to improve our marginal tax rates is paying off, and so we’re more optimistic that our EPS figure will be at least mid-range.

Extended weakness in European automotive demand and the deeper than expected US military cuts mean that the Elektron division will end the year well down on 2012, although the gap is narrowing. We remain confident that the cylinder division will show strong revenue and profit growth over the year. With a good uplift in operating margin to above 7%, despite the hopefully temporary weakness in European demand for aluminum specialty gas cylinders.

For 2014 we are cautiously optimistic with an expectation of continued strong growth in cylinders driven again by CNG and breathing air cylinder and at least some recovery in Elektron progressively through the year. Despite approving some hefty capacity improvements in 2013, we expect to undershoot our capital expenditure forecast for this year, but the carryover expenditure will mean that our 2014 capital spend is likely to remain above $25 million. Our main focus remains on delivering medium to long-term potential for the business driven largely by our strategic projects, and there is no change to our positive view on those.

Thank you and we will now take your questions.

Question-and-Answer Session


(Operator instructions) Your first question comes from the line of Luke Folta of Jefferies.

Luke Folta - Jefferies

Good morning gentlemen.

Brian Purves

Hi, Luke. Good morning.

Luke Folta - Jefferies

The first question I have, when I was reading through the release, I -- and there was a comment in there about increasing expenditures on the cylinder expansion, and I wanted to just understand was there something incremental that you are doing from what we had -- you already announced last quarter, or you are just referring to the way it flows through over the next couple of quarters? I think it was a $7 million figure you talked about spending over the next six months?

Brian Purves

Yes. It is not incremental Luke. It is just -- it is just in trade at the moment, and capacity increases on the alternative fuel side, we got some benefit early in the third quarter, but the rest doesn’t come on-stream until during quarter one next year. So we are still spending money on that. Now on the SCBA side, the additional capacity takes a bit longer to get in, and won’t have that available until the middle of next year. So there is nothing incremental. It is just referring back to the fact they are approved and they are currently in process.

Luke Folta - Jefferies

Okay. And then also in the release there was a comment about some pricing pressure you noted in the quarter, although it was unclear on which products you were talking about and then, I guess, in addition to that can you just talk about what you are expecting in terms of Elektron division pricing into next year. It seems like that has been weak most of the year, but now it is -- we might be starting to pick up some steam and end the year stronger, is there an opportunity for improvement in that side?

Brian Purves

Well, we certainly -- we haven’t completed our budgeting process for 2014 yet, but we’re certainly targeting an improvement in Elektron in 2014. I think at this point in time with quite a few things still floating around, our expectation is that that will be a relatively modest improvement until we see just what degree of recovery there will be in the European markets in particular.

But on the pricing pressure front, we are seeing a lot of pricing pressure around the group, both on the cylinder side and on the Elektron side. The comment refers specifically to the zirconium side of the business, where we have encountered quite a degree of aggressiveness from [Indiscernible] on pricing. Not to say that we have conceded very much, but it is a drag on obviously rebuilding the volumes if the customers are quite aggressive on price.

So going forward into 2014, we’re still being a little bit circumspect about how quickly we recover the volume that we have lost over the past two or three years.

Luke Folta - Jefferies

Okay. And if I could, just one quick further one, there was some expectation that there could be a [chem cat] order by the end of the year, could you just give us an update on what is happening there on those projects?

Brian Purves

That work continues. We are still in advanced discussions. Of course we are a supplier -- material supplier to the catalyst manufacturer, who is then supplying the -- we believe is petrochemical application on the petrochemical applications new plant. So it is quite a lot of things floating around there, but our customer tells us that they have built this contract into their budget for next year, and we’re still hopeful that we will get some good news on that around about the end of this year.

The supply of material will not commence until the earliest towards the back end of 2014, and that is one of the things which is still floating around in terms of expectations for the Elektron division next year. So we’re pretty confident about it, but the timing is still floating around a little bit.

Luke Folta - Jefferies

Okay. Thank you.


(Operator instructions) The next question comes from the line of Philip Gibbs of KeyBanc Capital.

Philip Gibbs - KeyBanc Capital

Good morning guys.

Brian Purves

Hi Phil.

Andrew Beaden

Hi Phil.

Philip Gibbs - KeyBanc Capital

I had a question largely just on the guidance. In your previous report you had discussed the second half being better from a trading profit perspective than the first half, that appears that it is not going to happen at this point largely because of the pressured cylinders business, just really curious about what happened, and maybe relative to that prior view?

Brian Purves

Certainly [Indiscernible] where we are today from a quarterly goal then it is the European cylinder business, and particularly the aluminum business, which is worse than we had talked it would be. July and August in those businesses was pretty poor. August is never a good month because France shuts down for August, but the UK plant had a very poor July and August, and so the delta between where we thought we would be and where we actually are is actually the European cylinder business.

So it doesn’t affect our view that cylinders will show very good growth in both revenue and profit this year. It is just not going to be quite as good as we had talked it would be.

Philip Gibbs - KeyBanc Capital

Okay. It seems like your CapEx for this year is going to be a bit -- a bit lower, just two question to that, what are you targeting now for a full year rate, I believe before we were looking for something around 25 million, and which projects in particular are moving into ’14? Thanks.

Brian Purves

We are only talking about the tune of a couple of million dollars thereabouts. I think our forecast for the company was a little higher than 25.

Andrew Beaden

It was about 30 million, I think Phil. Of course we have invested via the JV, so in the quarter, we actually invested nearly $10 million. Obviously only $6 million, $6.2 million directly in our own plants, and indirectly we were investing in the JV for the gas transportation module business. So when you bring that in as well, we are still going to be up over $25 million plus level of investments across the whole business, but it could be -- and we’re still targeting around, you know, low to mid 20s, maybe for the main businesses. But it won’t be at the 30 million for the Luxfer businesses anymore. It will certainly be between 20 and 25.

Brian Purves

With the [Indiscernible] slippage into next year, and the fact that quite a bit of the [Indiscernible] improvement expenditure in cylinders is going to fall into 2014. Where otherwise our expectation might have been the 24 -- it would have been below $25 million. It is now likely above $25 million.

Philip Gibbs - KeyBanc Capital

Thank you.


At this time there are no further questions. I will now turn the call to Brian Purves for any additional or closing remarks.

Brian Purves

Well, if there is nobody else in the queue, I will just thank everyone for participating, and we look forward speaking to you again early next year.


A recording of this conference call will be available for replay in about few hours, and will remain accessible until the next quarterly report is released. To hear the recording call (800) 585-8367 in the US, 0 (800) 917-2646 in the UK, or press 1-404-537-3406 in other countries. Enter conference ID code 795-89156 when prompted. This information will also be available on the Luxfer Group website at Thanks for participating in today’s conference call. You may now disconnect.

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