Luxfer Holdings PLC (LXFR) 2013 Q3 法說會逐字稿

Welcome to the Luxfer Group's third-quarter conference call. We will first hear from Luxfer's 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 follow-up questions. 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.

Thank you. Good afternoon, ladies and gentlemen, and welcome to the Luxfer conference call in the third quarter of 2013. I will take you through the summary results and the market situation. Andy Beaden will go through the detailed financials. And after a statement on the outlook, we will take your questions.

Looking at the quarter, our European operations, which have been struggling all year, endured a poor July and August, with low production due to a death of our orders. We did, however, see an uplift in September and end-quarter with a better order book, and that gives us some confidence that the European businesses will show some improvement in the fourth quarter. Although our overall revenue is up from prior-year, mainly due to a strong performance from our North American business units, the growth is within the cylinder business. And 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 adverse profit variance 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, some of which is one-off expenditures, such as the costs of implementing Sarbanes-Oxley.

Looking at the slide -- turning to 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 Electron division, the headline Sales Revenue Volume 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 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-year; but leaving 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 that it is significant that net electron revenues are no longer declining against prior-year. The rare earth surcharge is now at such a low level; but should costs stay where they are, this factor will be much less important to understanding our sales 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% on prior-year, despite lower levels of activity in our European aluminum facilities, particularly in July and August. The main story continues to be the growth in 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 down on last year, when we enjoyed very strong demand for medical cylinders, following the award of UK home oxygen therapy contracts. Unexpectedly weak demand for large specialty gas cylinders, however, has also 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 come onstream mid-2014. In the US, the new 2013 NIOSH standards for SCBA kits are expected to be issued later this month, with an end-February 2014 cut-off date for selling kits made to the 2007 standard.

Turning to slide 7 and our strategic growth projects. On alternative fuel cylinders, the profitability of our ex-Dynetek operations continues to improve, although still a little below the average for the division. There is much excitement in the gas containment industry about the perspective growth in the use of CNG to power Class 8 trucks in the US. And we are working to develop a range of larger diameter products to service that in 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 over $3 million worth of gas transportation modules 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 of over $50 million of sales from the overall alternative fuel business stream in 2013, up from around $20 million in 2012.

Our 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. As an aside, we used to sell a decent quantity of so-called aerospace alloys into Formula One Motorsport until the material was banned, along with a number of so-called other exotic materials, a few years ago. The rules governing that sport seem to change quite often, and we are 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.

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, gas cylinders profits were higher, up 5%, to $4.2 million, and electrons 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 more 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 the demand weakness in that region in the start of the quarter.

Electrons 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 won 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 sheets and powder, where demand was much weaker. Q3 2013 -- 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 a full income statement on slide 11, the total gross margins were lower for 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 profits was, in fact, 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 costs 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 costs, with the bulk being electron 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 IS-19 pension finance accounting charge was $0.9 million, same as last year. The effective tax rate for Q3 was 26% versus 32% last year. We are making tax savings in the UK 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; but adjusted for exceptional items, excluding the IS-19 filings costs, (technical difficulty) $9.3 million, and this is $0.35 per 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 at Q3 last year. Year-to-date, trading profit is now $44.2 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 business is now $201.8 million, net of the pension deficits of $74.9 million as at the 30th of September, 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 deferred members. Early indications are that this has been relatively successful, with around $11 million of liabilities being settled, funded through the plan'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 would be disclosed in restructuring and other expenses below 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 GBP17 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 those large composite Type III cylinders to fund its expansion, as it ramps up production activities. The investment there was made by a secured 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 a quarter compared to 26% for Q3 2012, lower due to lower profits and the post-IPO capital expenditure.

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

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 electron 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 in Group profitability is currently negative. We did, however, deliver the expected result on EPS.

Looking at the balance of 2013, we were 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 match Q4 last year, we see little opportunity to move away from the bottom end of our forecast range on trading profit. It's pleasing, however, that the work that we have been doing to improve our marginal tax rates is paying off, and so we are more optimistic that our EPS figure will be at least mid-range.

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

On 2014, we are cautiously optimistic, with an expectation of continued strong growth in cylinders, driven again by CNG and breathing air cylinders, and at least some recovery in Electron progressively through the year. Despite approving some hefty capacity improvements in 2013, we expect to undershoot our capital expenditure forecasts 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 the 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.

(Operator Instructions). Luke Folta, Jefferies.

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

Yes. It's not incremental, though. It's just entering at the moment. And the capacity increases on the alternative fuel side, we got some benefit from early in the third quarter, but the rest of it doesn't come onstream until during quarter one next year. So we're still spending money on that. And then on the SCBA side, the additional capacity takes a bit longer to get in. And we won't have that available until the middle of next year.

So, there's nothing incremental. It's just referring back to the fact that they are approved and they are currently in process.

Okay. And then also in the release, there was a comment about some pricing pressure 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're expecting in terms of Electron division pricing into next year? It seems like that's been weak most of the year, but now we might be starting to pick up some steam and end the year stronger. Is there an opportunity for an improvement in that side?

Well, we're certainly -- we haven't completed our budgeting process for 2014 yet, but we're certainly targeting an improvement in Electron 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 -- 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 Electron side. I think the comment refers specifically to the zirconium side of the business, where we have incurred quite a degree of aggressiveness from wash quarters on pricing. Not to say that we've 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've lost over the past two or three years.

Okay. And if I could get just one quick further one. There was some expectation that there could be a KinCat order by the end of the year. Just give us an update on what's happening there on those projects?

That work continues. We're still in advanced discussions. Of course, we are a supplier to -- a material supplier to the catalyst manufacturer, who is then supplying the -- we believe it's petrochemical application. On the petrochemical application is a new plant. So there's quite a lot of things floating around there. But our customer tells us that they now have built this contract into their budget for next year, and we are 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 backend of 2014. And that's one of the things which is still floating around in terms of your expectations for the Electron division next year. So we're pretty confident about it, but the timing is still floating around a little bit.

Okay, great. Thank you.

(Operator Instructions). Phil 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's not going to happen at this point, largely because of the pressure cylinders business. Just really curious about what happened maybe relative to that prior review?

The -- certainly when you variance where we are today from a quarter ago, then it is the European cylinder business, and in particular, the aluminum business, which is worse than we had hoped it would be. July and August in those businesses was pretty poor. August is never a good month, because France sort of shuts down for August. But the UK plant did 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's just not going to be quite as good as we had had hoped it would be.

Okay. It seems like your CapEx for this year is going to be a bit lower. Just two questions 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 2014? Thanks.

We're only talking about the tune of a couple of million dollars thereabouts. I think our forecast for the current year was a little higher than $25 million. It was --

Yes, we started at $13 million, I think, Phil. Of course, we have invested via the JV. So, in the quarter, we actually invested near $10 million. Obviously, only 6 million $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're still going to be up at the $25 million-plus level of investment across the whole business. But it could be -- and we're still targeting around low to mid-20s maybe for the main businesses. But it won't be at the $30 million for the Luxfer businesses any more. It will certainly be between $20 million and $25 million.

I think with a small degree of slippage into next year, the fact that quite a bit of the plastic improvement expenditure in cylinders is going to fall into 2014; where otherwise, our expectation might have been that 2014 would have been below $25 million, it's now likely to be above $25 million.

Thank you.

At this time, there are no further questions. I'll now return the call to Brian Purves for any additional or closing remarks.

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

A recording of this conference call will be available for replay in about two 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 plus 1-404-537-3406 in other countries. Enter conference ID code 79589156 when prompted. This information will also be available on the Luxfer Group website at www.luxfer.com.

Thank you for participating in today's conference call. You may now disconnect.