Luxfer Holdings PLC (LXFR) 2014 Q1 法說會逐字稿

Welcome to the Luxfer's first quarter earnings conference call. We will first hear from Chief Executive Officer 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 all questioners as possible get a chance to speak, we request that you initially ask one question. After you have heard your 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 into line. We thank you for your cooperation. We now turn the call over to Brian Purves.

Thank you and good morning, ladies and gentlemen, and welcome to the Luxfer conference call on the first quarter of 2014. I will take you through the summary results and the market situation and then Andy will go through the detail of the financials.

Trading during the first quarter was mixed with the Elektron materials business reporting some modest increases in demand and shipping a higher than usual quantity of industrial catalyst products. The cylinders result, however, partly due to the market issues flagged in March, was depressed. Our overall revenue was modestly up on quarter one 2013, but the mix of sales and incremental costs (inaudible) our profits are down. Adjusted fully-diluted EPS of $0.28 was $0.04 below the consensus forecast for the quarter.

Looking at the sales revenue movement, slides 5 and 6 track from the 2013 first quarter result at the top of the schedule through to the 2014 result at the bottom.

So looking first at Elektron on slide 5, the comparison year over year is increasingly less affected by the rare earth surcharge, which is now only $2.3 million lower than prior year. We have started the process of eliminating the surcharge altogether, building it into the base price of the material. Stripping out the surcharge and also exchange rate movements, underlying sales are higher by $4.3 million or 8.5% versus a year ago. Perhaps $1 million of the increase is in one-off industrial catalysis sales and the increase is net of perhaps $1 million loss of military [powder] sales due to the outage at the countermeasure flare customer facility that occurred in late February, but the net improvement is spread over several markets, including aerospace alloys and auto engraving plate.

Looking at slide 6 on cylinders, cylinders had a weaker quarter in terms of overall demand. Net of exchange rate movements, revenue was down $3.8 million, or 5.6% on last year, with continuing low levels of activity in our European aluminum facilities. Unexpected demand for composite SCBA cylinders in the US was held back by the delayed NIOSH standard approvals, while alternative fuel sales were dominated by the shipments of modules for the Australian virtual pipeline contract with a lower than usual level of vehicle conversion business taken on.

We strongly believe that the underlying demand for SCBA kits, mainly for firemen's breathing apparatus, is currently very strong in the US. But the requirement to retest all the new 2013 standard kits is reported by our customers to have caused a frustrating deferral of equipment purchases quite outside their or our control. The SCBA or life-support market is our single biggest market sector with nearly $60 million of mainly composite cylinder sales in 2013.

Two of our breathing apparatus customers have announced that certain kits have now been approved, but we are aware that other kits and other manufacturers are still awaiting approval. Accordingly, we may see some pick up during Q2 as customers start to ship the new sets, but a full recovery and any catch-back of deferred cylinder sales is likely to be over quarter three and quarter four.

Turning to slide 7 and strategic growth projects. In alternative fuel cylinders, while there remains much excitement over the future prospects for compressed natural gas, particularly to power class 8 trucks in the US, the quarter saw a lower level of activity in both North America and Europe where during the quarter we also lost some sales into the Turkish bus market following a price increase to one customer. This increase had been applied to the rest of the market on the acquisition of Dynetek, but on this contract we were inhibited until the start of this year by contractual commitments. These things do happen and we are committed to maximizing the price for what we believe to be premium products, even if that means occasionally losing a piece of business.

We announced our range of Type 4 cylinders at the Alternative Clean Transportation or ACT Expo in Long Beach this week, although only one derivative is currently on sale with the bulk of the range still under development. We expect to be in the market with a 26-inch product manufactured at our new Utah plant during the third quarter.

On gas transportation modules our total alternative fuel sales in the quarter of $14 million were dominated by shipments under the Australian virtual pipeline contract previously announced. Encouragingly, the publicity around that contract has elicited a good deal of interest in the Australian market and we are being asked to quote for other opportunities in the mining sector there.

Luxfer GTM Technology, our joint venture in North America on bulk gas containers, also launched new products at the ACT Expo targeted at servicing the requirement for smaller quantities of gas being hauled to remote locations by pick-up trucks.

On magnesium in civil aircraft we exhibited at the Aircraft Interiors Expo in Hamburg last month, the first time that we have had the opportunity to do so since the FAA announcement on the possible use of magnesium alloys. And there was a great deal of interest in our exhibits and in those on the Zim Flugsitz stand, which included some of the Elektron alloy parts being used in their magnesium-containing seats which were announced in March. As promised, the FAA has now published on their website the laboratory scale flammability test for magnesium alloys used in aircraft seat construction. All 228 pages of this document can be accessed by putting FAA and then PC-13-52 on Google.

Meanwhile, we continue to work on ways to improve the so-called buy-to-fly ratio by, for example, water jet cutting plate material into shapes nearer to finished component form.

Although not on the slide, we have also achieved a further small step towards our IOS oxygen delivery system. With the approval of our quality system at our UK cylinder plant to the ISO 13485 medical devices standard.

Andy 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 into the Group revenue changes for Q1.

Total revenue was $123.3 million for Q1 2014 with net revenue of $122.4 million. And the rare earth chemical surcharge was only $0.9 million. The Group's underlying revenue was up 0.4% or $0.5 million, excluding surcharge changes and adjusting out for the positive $2.7 million FX translation difference with Elektron's increase in net revenue offsetting the disappointing fall in gas cylinders revenue.

Slide 10 shows the trend in sales for Q1 2014 by geographic region. You can see, though the total sales are slightly up, Europe and North America are both down in Q1 2014 compared to Q1 2013, with Asia-Pacific sales up dramatically as a result of the CNG virtual pipeline contract sold to Australia.

Turning to the trading profit result on slide 11, Brian talked through the facts affecting revenue and sales changes in the quarter. Gas cylinders trading profit for the first quarter of 2014 was $1.6 million, a decrease of $3.6 million or 69% from the $5.2 million trading profit for the first quarter of 2013.

In addition to the total divisional sales revenue being down in the quarter, we had an adverse mix of sales compared to Q1 2013 as a result of lower composite cylinder sales for self-contained breathing apparatus and large aluminum industrial gas cylinder sales for specialty gas containment.

We are also incurring costs for product development and marketing of new products in the AF and medical markets. Elektron's trading profit of $10.7 million in Q1 2014 was $1 million higher than in Q1 2013. Sale margins were generally stable and the profit increase was because of stronger sales in the quarter. The trading profit margin was slightly improved at 18.7% compared to 18% in Q1 2013 are the results of better utilization of the European plants on the back of stronger sales demand.

The Group's average margin fell to a return on sales of 10% from 12.2% on the back of the reduced profits in gas cylinders. For Q1 2014 Group trading profit was therefore $12.3 million versus $14.9 million for Q1 2013.

Turning to the full income statement on slide 12, the gross margins were slightly higher with Q1 2014 at 23.4% versus 23.1% for last year. Gross profit was therefore $0.6 million higher at $28.9 million. But with administration and distribution costs being higher, trading profits overall was lower. Admin and distribution costs were higher because of the increased activity in terms of marketing, IP and product development in both divisions, with a lot of activity going on on the strategic growth projects in the quarter. We did not have any restructuring and exceptional costs in Q1 2014.

Operating profit, which is after restructuring and other exceptional items, was therefore also $12.3 million versus $14.5 million for Q1 2013. In Q1 2014 we did charge $0.2 million of costs below operating profits in relation to the acquisition of the new Utah facility which we have written off under IFRS.

The notional IS-19 retirement benefit finance charge was $0.7 million, $0.2 million lower than Q1 2013 as a result of reduced pension deficits. Interest costs relating to our debt facilities was $1.4 million versus $1.5 million last year and the effective tax rate was 28% versus 31.4% last year.

Net income for Q1 2014 was $7.2 million compared to $8.3 million for Q1 2013, but adjusted for exceptional items and excluding the IS-19 finance cost was $8 million and this is $0.30 per ADS. The fully dilutive equivalent was $0.28. For reference, adjusted EBITDA was $16.9 million compared to $18.7 million for Q1 last year.

The next slide, number 13, shows the consolidated balance sheet. Overall, invested capital in the operating businesses was $239.7 million net of the pension deficits of $74.1 million as at the 31st of March, 2014. The pension deficits increased by $6.5 million from the $67.6 million at the end of 2013. This was mainly due to lower corporate bond yields which are used to discount the pension liabilities and therefore increase their present value and the deficits in the UK and the US.

Net assets or shareholder's equity of the Group fell to $190.2 million, down $1.5 million from the end of 2013. Net debt, debt minus cash, was $45.6 million. Our revolving credit banking facilities remained undrawn in Q1. And in the quarter we announced their extension to April 2019 and their increase in size to $150 million of committed facilities. The movements of the balance sheet are shown separately in the slide for the acquisition of the Type 4 AF composite facility in Utah.

Turning to cash flow on slide 14, our operating cash flows in Q1 2014 were a positive $1.3 million, down on Q1 2013 $9.6 million as a result of lower profits and higher working capital. The working capital increased due to a number of factors, but the large virtual pipeline contract in Australia did add at least $5 million to working capital in the quarter.

Investment cash flows were a spend of $6 million in the quarter. We invested $6.4 million in Q1 2013. CapEx in property, plant and equipment was lower at $3.1 million versus $3.9 million in Q1 2013. The up-front cash paid in March to buy the new Utah facility was $2.7 million. Cash flow before financing was therefore an outflow of $4.7 million compared to an inflow of $3.2 million for Q1 2013. After paying dividends and interest of $3.9 million and the additional arrangement fees on the extended bank facilities of $1.3 million, net cash flow for Q1 2014 was an outflow of $9.9 million. Net cash at the end of the quarter was therefore $18.5 million.

The next slide shows return on invested capital. The lower profits in the gas cylinders division and the higher working capital as I highlighted earlier have impacted both the numerator and denominator in the calculation with the ratio being low for the quarter at 15% return after tax. The last 12 months' average ratio was 20%.

Thank you. I'll now hand you back to Brian to sum up.

Thank you, Andy.

In summary then, we had a decent quarter in the specialty materials side of the Group with good sales in industrial catalysts offsetting the shortfall in military powders and progress being seen in a number of key markets. Gas cylinders, however, is currently being held back by some market issues in North America while European demand remains generally weak. Additionally, we are incurring heavier than usual development costs in that division.

On the outlook, the headwinds seen in quarter one are likely to persist in quarter two, albeit the SCBA issue could well lessen while the countermeasure flare issue is likely to be worse because of the partial impact on Q1. Overall, we remain positive about the outlook for both divisions during the second half of 2014. But by the time we get through quarter two it is likely that there will be insufficient time to catch back the shortfall that will have appeared in cylinders results. We're basing our market views partly on public statements by our customers on how they see their year shaping up.

Heavy expenditure and product development costs will continue during quarter two when additionally we will have the start-up costs at our new Utah facility, but our focus is on delivering the medium- to long-term potential for the business.

There's a lot going on in the alternative fuel sector at the moment and there is little doubt that the market is currently overcrowding and needs to see some of the predicted growth in demand to balance things out. But here again, we should take a long-term view. If the use of compressed natural gas grows in the way that it is generally accepted to, the shape of the market and the supplier base is likely to change and the focus will switch to reliability volume capability, strength and innovation and customer service, all factors that we believe will strengthen our hand, particularly once we have, as we intend to, the broadest product offering into the sector covering both Type 3 and Type 4 products.

Thank you and we will now take questions.

(Operator instructions). Luke Folta, Jefferies.

Good morning, gentlemen.

Hi, Luke.

Hi, Luke.

So I guess firstly on the cylinders. You had a forecast out there previously, as of last quarter, that we could potentially see something like $70 million to $75 million in sales in that business this year. I'm just curious what -- like what events transpired that I guess changed the view and the outlook for that sector over that time period? And can you I guess give us your updated views on what you think -- what the opportunity might be for you this year with the new capacity ramping?

Just to clarify, you're talking about the alternative fuel element of the division?

Yes, that's right.

Yes. Well, we are actually are not down on our alternative fuel revenues in the quarter. In fact, it's the best quarter that we've had I think ever in alternative fuel. It's just that within that it's dominated by this big contract that we have and the underlying level of demand that we've seen in the vehicle conversion side has been somewhat lower than in the previous four quarters. But our top-line revenue is actually better than any quarter than in 2013. So, we still think a reasonable prospect of certainly beating the revenue that we achieved in the AF sector last year. I'll be a little circumspect about quite how much will beat it by because I think, to some extent, it's going to dependent on whether or how many of these larger contracts we win in the balance of the year.

Now there are, I think -- there's a shortfall in the market at the moment and in part that's driving a few pricing issues. So, we do have to figure that we may have to give something on pricing to win back some of that volume. But we do have other work in hand on more contracted business in the vehicle conversion side to boost the revenues in the balance of the year.

So, I certainly would be a bit -- probably reluctant to repeat the $75 million as of today, but I still think that we can exceed last year's number and possibly get quite close to that, but we've got a lot of work to do between now and the end of the year.

Okay. Alright. And then just a follow-up. Can you talk about what the cost impact was from some of the product development and other, I guess, launch activities that you're doing in the cylinders business? And then also, what sort of drag should we expect from the Utah facility in the second quarter?

Yes. I mean on the cylinder side we're certainly incurring some quite hefty costs on the IOS project and I mentioned the quality standard that we achieved in the quarter. It takes a lot of time and effort and consultancy to get to that position. There's a lot of physical development work going on. And the Type 4 product that we are developing at the moment, again, there's a lot of cost and effort goes into that and we are trying to develop a fairly broad product range in a fairly short period of time. Normally in the business we would be developing new derivatives only occasionally. And each time you do it there's a significant cost associated, including with the testing regime and getting the various approvals acquired. So, that's going to be quite hefty in quarter two as well. But as I said, we expect to be starting to produce and sell some of that range in the third quarter so the costs will reduce Q3 and Q4 onwards. And between those two elements alone we're certainly talking, I think, a $1 million in the quarter.

The facility in Utah will be a few hundred thousand dollars in terms of its costs before we get it into production and start to recover the overheads. Of course we bought that quite late in -- well, we even started the first quarter of--.

Certainly. And it just went through, the deal, in March finally.

Yes. So there's very little impact to quarter one. But quarter two we'll be picking up the net costs of that business and reorganize and get ready for the production to start at some point in Q3. So, there will be several hundred thousand dollars on top of the development costs that we talked about.

Alright, I'll turn it over. Thank you.

(Operator instructions). Phil Gibbs, KeyBanc Capital Market.

Good morning, Brian, Andy. Actually, good evening to you guys.

The question was on the cylinder side, just on the year-on-year comparison, 1Q to 1Q. You had talked about the European -- I think it was more of an overhead absorption issue and industrial, the SCBA weakness, just as far as it impacted the mix, and then you just noted product development was about $1 million. But, just wanted to see what the impacts of those three things were as an order of magnitude, the biggest hit on the business.

The European market, as you know, has been pretty depressed for aluminum cylinders, but the industrial cylinders is the one which hurts us the most because they're big, specialty cylinders, a good margin business and it's very much at the top end of the margins on the aluminum side. And the first quarter sales into the industrial sector in Europe were the lowest that we've seen, really, since the recession in 2009.

And the story that would explain why that is, we've had the occasional comment from customers in their results about cutting back on capital investment and, for them, that's what this is. This is a capital asset that they buy in. And so that sector alone was $2.5 million down on prior year. And the sort of margins that we make on it, that's a significant impact. So, that was probably the single biggest effect.

SCBA is a big, big market for us. Again, within composite cylinders it's at the higher end of the spectrum on return. And so the fact that we've had deferral of sales in the quarter, it does hurt. And on that one at least we do, I think, have a prospect that that will be recovered because we do think it's a deferral of sales and once the new generation kits, our new standard kits that are out there, then sales will be increasingly good as we go through the year. So, we are expecting some catch back of that one in the third and fourth quarter, albeit that we are still subject to capacity constraints on that side with the capacity improvements that we have announced on the portable cylinders not really coming into effect until towards the end of the third quarter.

Okay. So maybe is it fair to say that they all could be the European piece, the European industrial piece, the SCBA and the product development could all be $1 million headwinds in themselves year on year?

Yes.

Okay.

Yes. Okay.

And then just as a follow-up, as we head into the second quarter here, it sounds like industrial catalysis potentially a little bit weaker, the defense piece a little bit weaker. Fair to say that Elektron is down a little bit quarter on quarter and cylinders potentially rebounds a little bit because of the SCBA?

Well, I think we're certainly expecting to have some improvement in SCBA, but quite how much and when we're still not sure about. And we will have the Utah facility, of course, coming in, which will pull some of this back. So, I don't think we're looking at a great deal of change net/net Q2 over Q1. There will be a few pluses and minuses, but we think Q2, there's no particular reason why net it should be much different from Q1. But, there are quite a number of things that we think will fall away after the second quarter and there are -- at least one thing, which is the SCBA which should start to reverse and give us higher than expected sales in the second half of the year.

The military powder side, the latest news I have on that is that the customer has restarted production in a very low key way and is just absorbing some stock to test his new process. So, I think we do expect that to be back in production in the third and fourth quarters albeit that the market is anyway depressed, as we've reported previously.

So I think all in all, coming back to what we said in the document, the Elektron side we think we see fairly steady improvement over prior year and we're relatively comfortable with that over the course of the year. But with cylinders, by the time we get to the half year we are going to be quite a bit down on prior year. It's just looking a major challenge to pull that back in the remaining months of the year, particularly given the fact that Q3 and Q4 contain a number of holiday periods, which always tends to affect the revenues.

I really appreciate all of that. That's fantastic, Brian. Thanks very much.

Okay.

(Operator instructions). Luke Folta, Jefferies.

Hi, guys.

Hi.

Can you talk about what the impact of the Chemcat order was on 1Q? I understand you might not want to get overly specific on it, but I'm just trying to get a sense of what the quarter-over-quarter comp could be associated with that.

It's not huge, Luke. I did actually say in the revenue variance that about $1 million of the -- the catalysis sales in Q1 were about $1 million higher than our average rate and I was just saying that that isn't necessarily going to be the case every quarter this year. They're still pretty lumpy, so occasionally we get good quarters and quarter one was a good quarter. We're not necessarily counting on that, but there is an underlying level of industrial catalysis there that we're seeing quite regularly, it's just that quarter one was about $1 million higher than the average rate. And of course you have to then apply a margin on that, but it is a pretty good margin product in common with most of our Elektron materials.

Okay. And then I guess back to alternative fuels. When you look at market conditions currently, is it more a function of the demand growth isn't quite what you expect it to be so far this year, or is it more a function of more capacity's come in and there's -- I guess your share of it is less than what you had initially thought? Understanding you're still growing the business, but just relative to first -- against prior expectations.

I think the market -- to my best knowledge, the market is quiet in quarter one and we've had a number of people say that to us. So although everyone is very much of the belief that the market is on a long-term, high-growth curve, quarter one was pretty quiet. And then within a fairly quiet market there was a lot of price competition for what was available. We did lose some market share because we walked away from some of that price competition.

So, I think it's a combination of a couple of things. We do expect the market to come back and be much stronger in the second half of the year. We do expect to recover some of that market share. But of course, at the moment we are only selling the Type 3 product into that market, the metal-lined product, which is more heavily focused towards the bus market than the truck market. And the truck market is -- and I suppose is increasingly switching towards Type 4 product and we need to have our Type 4 product in the market to be able to win a decent share of that business.

Okay. And I know it's difficult to expect, I mean in a growing market like this, your capacity expansion to exactly match new demand growth. And I'm sure it's going to be lumpy over time. There's going to be periods of tightness and periods of looseness like we saw. But at this current period, do you think it's a function of -- I mean when you talk to customers on it, is it a function of maybe there was some inventory built last year and now they don't necessarily need the order at the moment and they could be back later, or is it just the demand of run rate at this point isn't -- it just isn't high enough to support a larger inflection?

I'm struggling, really, to give you much more than I have.

Okay.

There's certainly been no mention that's been mentioned to me about high stocks. I mean, it's actually been the -- the comments I've relayed have been relayed third party from converters who are saying the market is quiet. They are not getting the business. So it's not like the converters have a lot of stock on their hands or they're not buying from the cylinder manufacturers. It's that there were fewer vehicle conversions being undertaken in the quarter and therefore the requirement for cylinders in aggregate was lower. And for what demand there was, there has been a lot of price competition and there's been quite a few switches in sourcing during the quarter driven by that.

Understood. Okay. A last one just on European auto. I'm not sure how long of a visibility that you have there, but any comments from your customers or indications you're seeing out there that supports a better second half versus first half?

Well, in terms of European automotive, which is where we really have the issues, we haven't sold much more into the auto cat market than we did a year ago. But we do sell into the market various ceramic products which are used in things like oxygen sensors in vehicle management systems and sales of those have been rising over the past few months. And when we talk about leading indicators which make us think that the market is on its way back, it's really that that we're referring to. Of course, there are all of the external analyst forecasts out there that say that the market is in recovery, but that's some more concrete evidence that we have that the market is picking up. And we see these ceramic sensors for the engine management systems as being a bit of a leading indicator. So, our sales of those are up at the moment. Just as yet our auto cat sales are not, but we do think that we have a reasonable prospect to see an increase in the back of the year.

Okay. Thanks a lot.

Okay.

Phil Gibbs, KeyBanc Capital Markets.

Yes, I'm pretty much all set. Luke asked about the European automotive situation and I think you guys addressed that pretty well. Just had a -- just was curious; are you guys on the JSF at all in any of your products?

A little bit, yes. We do some of our superform parts go onto the KSF. There's not a big revenue exposure, though.

Okay. I was just curious if that was picking up at all or that was still sort of in the low-rate production (inaudible).

Yes, it's not a big exposure at the moment. We'll probably get a little bit of magnesium on it as well. The Typhoon or the Eurofighter is a bigger exposure today and that is stable at the moment because the production has been stretched out, but they're kind of hoping to win more export business with that one and we'd like that to happen because, certainly otherwise, the middle of 2015 I think they run out of business.

Thank you.

At this time there are no further questions. Gentlemen, do you have any closing remarks?

No, that's fine. Thank you, ladies and gentlemen. We are disappointed in the quarter one results, but the majority of the effect is these sort of issues that we flagged in the call in March. We do expect the majority of those effects still to be there in quarter two, but the underlying momentum will be restored, we believe, in the second half. So, thank you much and we'll speak to you again in three months' time.

Thank you. An encore recording of this conference call will be available in about two hours. To hear the recording, please dial 800-585-8367 in the United States. In other countries, call 404-537-3406. This information will also be available on Luxfer Group website at www.luxfer.com. Thank you for participating in today's conference call. You may now disconnect your lines at this time.