Luxfer Holdings PLC (LXFR) 2015 Q2 法說會逐字稿

Welcome to the Luxfer second-quarter conference call. We will first hear from Chief Executive Brian Purves, who will provide a market overview, followed by Group Finance Director Andy Beaden, who will review financial performance. Brian will then return to sum up and offer an outlook. After that, Brian and Andy will be glad to take your question.

To make sure that as many questioners as possible get a chance to participate, we request that you initially ask only one question. After you've 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 now turn the call over to Brian Purves.

Thank you. Good morning, ladies and gentlemen, and welcome to the Luxfer conference call on the second quarter of 2015.

Turning to slide 4, we were reasonably happy with our progress in quarter 2. Sales revenue is up by some 8% before the impact of exchange rates. Unfortunately, the key exchange rates that affect us have moved by an excess 20% over the last 12 months, and we are for the moment depressing the underlying improvements in revenue and profits.

The alternative fuel sector remains a problem for us, but increasingly less so, while the other factors that caused us problems in 2014 are performing much better this year, with the important North American SCBA sector up by a quarter. And demand for US military product is much improved, albeit from the low point of 2014.

Our most recent acquisition continues to perform well, with $6.8 million of sales in the quarter. Adjusted fully diluted EPS of $0.28 was $0.01 ahead of consensus and also $0.01 ahead of Q2 last year. We made some good progress on reducing working capital in the quarter, with the result that cash generation in the quarter was (inaudible) for some time.

Turning to slide 5, the North American market for SCBA kits is, as we expected, well up on prior year, with most, although not all, manufacturers having their kits approved to the new standards.

We did suffer a 10-day outage at our Riverside composite plant at the end of May when an electrical arc burned out a number of distribution panels. Market disruption, however, was minimal, although it did result in additional costs.

Although this year will still be lower measured against historical averages, sales of military players have been well up on last year. The second quarter last year was particularly weak because of an accident at one of our customers' plants. So the underlying improvement year on year is likely to be more like 25% rather than the 50% that we've seen to date.

Although we saw a brief rise in oil prices, these have fallen right back again, and we see no reason to be optimistic over the near-term sales to oil and gas industry. And in some sectors, the outlook for switching from diesel to CMG. While we remain confident that this will be an important market for us in the long term, we remain clear that rationalizing our production facilities is the right thing to do at this time.

The current weakness of the euro is hurting margins on sales out of our UK business units to the extent that we are unhedged. Despite the euro having declined by over 20% against the dollar over the last 12 months, euro zone inflation is still almost zero. So pricing to recover the impact will be a challenge.

We are seeing sales of our magnesium alloys lower this year, with it appears military and helicopter build or refurbishment rates having been cut back. Build rates of similar alignments, however, are still very healthy, and that is the sector that we are targeting for future growth.

We had a better quarter on industrial catalysts, but orders in this sector are still quite intermittent.

Turning to slide 6, our program to rationalize our alternative fuel manufacturing facilities is well underway. The Utah facility is now inactive to take four-cylinder production is being done at our Riverside plant. We are well advanced in obtaining the customer and regulatory approvals required to manufacture type III cylinders for the European market at our Calgary plant. Calgary management have demonstrated the good ability to control costs in line with demand. And at Riverside, the alternative fuel plant is alongside our highly automated portable composite facility with the ability to show overheads and flex direct label to mature operations.

Our German plant is scheduled to close at the end of this year, and we are working to minimize the level of stock that will have to be transferred. Although the Boston trash truck centers continue to throw off opportunities, the bulk gas transportation sector remains quite weak.

Manufacturing assets that are likely to be redundant are being written down, with most of that happening in quarter one. Cash costs, mainly for severance payments, are taken into account as they are committed. As we announce the closure of Luxfer Germany to the workforce during quarter two, provision has now been made for those costs, although the bulk of the cash will be spent in quarter four.

We are likely to continue losing money in alternative fuel during the balance of 2015, but our plans to enable the group in 2016 to have a profitable global air business even with or at or around the current price.

Moving to SUB161, the start-up virtual pipeline customer in Australia. This business got into difficulties last year as a result of engineering problems with the infrastructure of their project designed to supply large quantities of natural gas to mining operators in the Kalbarri region of Western Australia, where our pipeline access is very limited. Our trade receivable was at risk, but all involved parties believed that there could be a way forward for the business, and a recapitalization was achieved in early July. Luxfer is now a shareholder in the business, and we have appointed a director to the Board.

The business is now essentially debt-free, and we are working with them to prove the concept of the virtual pipeline incorporating our gas transportation modules to the nine operators.

Turning to the revenue side and the Elektron first, the [cilium] surcharge has disappeared from our pricing structure. Stripping out the surcharge and also exchange rate movements, sales in the quarter are up by 9.6%, mainly due to Luxfer Magtech, which continues to perform as expected. Underlying sales from other sectors are, however, also up by 1.9% from prior year. As mentioned before, aerospace alloy sales are down at the moment, and also sales of automotive catalyst material in the quarter. Encouragingly, however, sales of military players are well up year on year. Also, those of our Czech recycling plant and the photo-engraving products.

On slide 9, the cylinder business improved in quarter two, with the North American SCBA market well up. But the division was still suffering from reduced alternative fuel demand, and the European business is being impacted by adverse exchange rates. Ignoring the impact exchange rates, however, non-alternative fuel revenues were up 5.8% over prior year. Alternative fuel sales in the quarter totaled $8.2 million, down from the $11 million last year partly due to exchange rate movements, but well up on the $5 million seen in the first quarter of 2015, with the improvement coming in North America. European medical composite sales were stronger, and also Superform increased sales in both tooling and formed goods.

On slide 10, we give an update on a couple of our strategic growth projects. Following the Aircraft Interiors Expo in Hamburg last April, where prototype seating containing our Elektron alloys was on display. We have seen an upsurge in interest from manufacturers of aircraft components. We are confident that the question marks over the, to them, new material have been removed, and all that remains is to get the first application off the ground.

Our innovative medical oxygen delivery system, designed for frail-category home oxygen therapy patients is currently in low-volume production in order to have a population of market-ready devices from which to draw performance statistics. While the [frees] are available, we will seek CE approval for the product, which is sufficient to allow sale in some markets. We additionally need medical authority, regulatory approvals in a number of countries including the UK, but obtaining these is not presenting us a process as I understand it can be with the FDA in the US. Accordingly, the first meaningful sales of this device are expected to be in 2016, and we are excited about getting close to the launch of this important product for us.

Andy Beaden will now take you through some of the detail in the Q2 results.

Thank you, Brian, and welcome, everyone, to the call. Brian (inaudible) the divisional sales analysis, and my first slide, slide 12, shares how that consolidates into the group revenue changes to Q2 2015. Total revenue for Q2 2015 was $122.8 million, with no (inaudible) rare earth chemical surcharge now required. And this compares to $121.3 million net revenue for Q2 2014.

Underlying group net revenue was in fact up $8.9 million, with FX translation being a negative $7.4 million. Luxfer Magtech, which was acquired at the end of July 2014, added $6.8 million in the quarter, and we had a positive movement in the other trading revenue of $2.1 million. The $2.1 million represents, in fact, a $4.2 million increase in revenues across the continuing group, with stronger composite cylinder sales and growth in magnesium products, less negative FX translation -- transaction differences of $0.8 million and a $1.3 million net reduction in AF revenue. Revenue in North America in AF being slightly up. We will see later this underlying growth, that to some reasonable improvement in underlying profits, though tempered by the FX headwinds. Through the analysis, I will look to break out the FX impact to show the underlying trading.

Slide 13 shows trending sales for Q2 2015 by geographic region, which follow a similar trend to what we saw in Q1 2015. The sales in North America well up, with strong, self-contained breathing apparatus sales, the addition of Luxfer Magtech sales, and other magnesium sales improving in areas such as military players and placed products. Asia-Pacific continues to lag against last year with weaker AF sales and some softening in Chinese markets.

Turning to our trailing profits and adjusted EBITDA results on slide 14, the Q2 2015 group trading profit was $11.7 million, up $0.5 million on Q2 2014. At constant exchange rates, trading profit was up $1.9 million. Half of this improvement was down to the inclusion of Luxfer Magtech, and the rest was attributable to a better underlying performance in both divisions. FX changes have a $1.4 million negative impact on this profit number. Despite the FX headwinds, both the divisions also improved when compared to Q1 2015.

Elektron's results at $10 million was $0.5 million ahead of Q2 last year. The underlying profits improvement was in fact $1.5 million, with FX differences here a negative $1 million. Luxfer Magtech was the major contributor to this improvement, but magnesium products sales growth also helped in areas like the military players. This more than offset a weakness in zirconium chemical sales and also a weaker aerospace quarter.

Adjusted EBITDA for Elektron was $13 million compared to Q2 2014's $12.3 million. The adjusted EBITDA for Elektron was $1.8 million, or 16% up, when measured at constant exchange rates was $1.1 million negative FX differences. The EBITDA margin of the division was 21.6%, just down on Q2 2014 but an improvement on Q1 2015's 20.9%.

Gas cylinders trading profits at Q2 2015 was $1.7 million, the same as Q2 2014. At constant exchange rates, profits were up $1.4 million. FX had a $0.4 million negative impact.

Though [air] remains a drag on the division, with losses still close to $1 million in the quarter, the rest of the division achievement improved profit results thanks in part to Superform sales improving and the composite cylinder sales growing in self-contained breathing apparatus in medical markets.

Adjusted EBITDA was $3.7 million, slightly down on Q2 2014, again, a result of the negative FX differences. For Q2 2015, group adjusted EBITDA was therefore $16.7 million, compared to $16.2 million for Q2 last year. And also a sequential improvement on Q2 2015, which was $15.4 million. Adjusted EBITDA at constant exchange rates was up $2.1 million, or 14% on Q2 2014. The group's EBITDA margin was 13.6%, compared to 13.3% for Q2 2014. At a EBITDA level, the FX impacts was a negative $1.6 million, being slightly higher than the trading profit impact due to additional FX differences on translation and depreciation.

For the half year, adjusted EBITDA is therefore $32.1 million against $33.1 million for the half-year 2014. At (technical difficulty) rates, the adjusted EBITDA is up $1.9 million, FX differences reducing results by $2.9 million.

Turning to the full income statement from slide 15, we have covered revenue and trading profit already, so I will not repeat our analysis on those items. Gross margin is up in the quarter at 23.7% versus 22.4% for Q2 2014. This reflects the benefits of Luxfer Magnetek, Inc. and growth in areas like magnesium products and composite cylinders.

Distribution costs at $2.2 million for Q2 2015 are flat compared to Q2 2014. Admin expenses are higher at $14.8 million. However, this is more than explained by the additional overhead of Luxfer Magtech, with other admin costs slightly lower due to cost savings. In the quarter, we have charged $2.9 million to restructuring and similar expenses.

This all relates to the restructuring of the AF businesses. After $2.9 million, $1.2 million is active write-downs, and $1.7 million relates to restructuring costs where the cash spend will be spread over Q2 to Q4 this year.

Operating profits, after restructuring and other exceptional items, was therefore lower at $8.8 million for Q2 versus $10.4 million for Q2 2014. The low operating profit -- I have broken out the elements of the IFRS finance charges being as follows. Net interest of $1.9 million -- that's $0.3 million increase result of increased debt to finance the Luxfer Magtech acquisition. The notional IS19 retirement finance charge, which is $0.8 million, which is $0.1 million higher, a result of the higher pension deficit at the start of Q2. Plus $0.1 million for the notional interest charge on deferred acquisition consideration; this is the same as last year's Q2.

In the appendices to this presentation, it's worth noting we disclosed our non-GAAP reconciliations for adjusted EBITDA -- adjusted nat gas. And you can see that we struck out figures for restructuring costs, acquisition and disposal items on the IAS19 finance charges.

The underlying tax rate was circa 27%, but the restructuring costs in Germany did not lead to a tax credit due to tax losses in Germany leading to a much higher statutory tax rate, which you see being reported. The underlying tax rate is in fact very similar to Q2 last year, which was 28%.

Statutory net income for Q2 2015 was $3.1 million, compared to $5.7 million net income for Q2 2014. But adjusted for exceptional items and excluding the IAS19 finance charge, Q2 2015 was an underlying net income of $7.6 million, the same as last year.

Fully diluted adjusted EPS was therefore $0.28 for Q2 2015, compared to $0.27 for Q2 2014. The slight improvement is the result of a lower diluted share count. The adjusted EPS was at the top of the range of the Wall Street consensus.

The next slide, number 16, shows the consolidated balance sheet. It reconciles the key changes from December 2014 to June 2015. Overall invested capital and operating businesses was $273 million net of the pension deficits of $80.1 million as at 30 June, 2015. The pension deficits have fallen over $10 million from the 2014 year-end position. This being the result of a higher discount rate using liabilities due to higher bond yields and seeing the benefits of cash payments into the plans.

Net debt, which is debt minus cash, was $98.4 million, down from the $106.8 million at the year-end 2014 thanks to a stronger cash flow. FX differences due to the stronger US dollar reduced net assets by $2.2 million, and the year-end -- the year-to-date rationalization activity reduced assets further by $9.9 million net of tax.

Turning to the cash flow on slide 17 -- it's a very strong cash quarter. Our operating cash flows in Q2 2015 were a positive $16.4 million compared to Q2 2014's negative $4.7 million. Working capital was an inflow in Q2 2015 of $4.2 million with reduced receivables and inventories. Actions continue into 2015 to reduce working capital further, with potential for further inventory reductions in the latter part of the year.

Investment cash flows were a net spend of $3.3 million in the quarter. We invested $4.1 million in Q2 2014. CapEx in property, plants, and equipment at $2.6 million was lower as we managed cash flow, and capitalization of intangibles was $0.7 million. Cash flow before financing was therefore an inflow of $13.1 million, compared to an outflow of $8.8 million for Q2 2014.

Other revolver drawings were high for the quarter, and we did have surplus cash at the end of the quarter. The total cash balance was $58.3 million. We plan to utilize some of this to repay revolver drawings in Q3. We received $0.2 million from employee share plans, buying in new shares, and we spent $1.7 million on our own share buyback program.

So in summary, we may progress on profitability in Q2 in both divisions when compared to recent trading, and this was despite the currency headwinds. The restructuring of the AF operations continues, with some upside achieved in North American sales. On the cash side, the quarter was very strong and will remain on track for a much-improved year in terms of trading cash generation.

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

Thank you, Andy. Turning to slide 19, summarizing quarter two there, the underlying performance of the cylinder business is improving, with North American SUBA returning to growth and progress being made on improving sales and cutting costs in the alternative fueling business stream. Improvement is, however, somewhat masked by exchange rate movements.

Despite those adverse exchange rates, the specialty materials side of the group reported a higher result from this time last year, even with some key markets below par. Overall, our adjusted result was actually slightly ahead of consensus, and our cash performance was very good.

Turning to the outlook for the divisions, the weakness of the euro is hurting profitability of our European operations on top of a continuing lackluster euro zone economy. Nevertheless, the electron division remains on track to have a good year, helped by the addition of Luxfer Magtech.

The North American side of the cylinder business has recently strengthened. AF losses are unlikely to be completely eliminated until very late this year, but non-AF markets are on a very strong re-up, and we expect this to continue in the balance of the year. We are looking to add value to our medical products in Europe in 2016, and this should help our European cylinder business.

On 21, on the outlook for the group, the outlook is in line with our earlier indications. We still have more work to do in cost reduction in alternative fuel, but the other markets that were badly affected by external factors in 2014 are coming due. The focus on working capital is starting to pay off, and we remain confident of further improvements in our return on capital.

While the weakness of the euro and indeed of the euro zone economy is troublesome, we continue to believe that we can drive a net improvement in group profitability over 2014 and with a rising trend into 2016.

Thank you, and we will now take your questions.

(Operator Instructions) Luke Folta, Jefferies.

A number of questions here, sort of all over the place. I guess, firstly, could you just give us a reminder on what you think the total cost savings of the restructuring efforts you are doing in alternative fuels will be? And I guess in the second quarter, how much of that has been captured so far?

Well, we are trying to go from a situation where we are at a run rate of losses, which was several million dollars last -- (inaudible) second half last year. It was a run rate of several million dollars.

We lost about $1.5 million in the first quarter this year. We do start to put $1 million in Q2, with most of the restructuring actions in North America having taken place in terms of shutting down the Utah facility, but without the benefit of transferring production from Germany into the Canadian operation.

I think that probably that we shouldn't get any worse than that in the remaining two quarters of the year of cash losses, but it probably won't be a huge amount better unless we win some surprise business. But the plan would be that as of January 1 next year, with the German operation closed and with production transferring to Canada and/or the UK, that the worst case for 2016 would be breakeven. So year on year, you can walk that through into roughly a $4 million improvement in 2016 over current, is what we are aiming for, with 2015 being a little bit better than 2014.

All right, that's great. Thank you. Also, there are some comments around some weakness on the aerospace alloys part of the magnesium business. And that's been an area that's been pretty strong, I recall, over the last several quarters. So can you just give us some sense of what's changed there?

Yes, you're right. It has shown year-on-year growth for several years now, the same alloys that we are intending to read across into the similar airline sector. But right at the moment, certainly, in that quarter two, we saw demand for military programs starting a bit. As you know, we are heavily into the helicopter industry. And some of the build rates on the military helicopters, those programs have been stretched out a bit. So this is a one-play call office as reduced for the moment. So it's purely military helicopter demand that we are seeing at the moment, a bit down. And that's just unusual because we are seeing steady growth in that market for several years. And we talk but it's no more than a short-term effect. But from the military side, I guess, that was a (inaudible) for another 12 to 18 months at least.

Okay. And so you are thinking that you've stepped down into this lower run rate for the next 12 to 18 months, or we're going to be on the decline for the next 12 to 18 months?

No, I think we step down to a lower run rate -- slightly lower run rate for the next 12 to 18 months. And we found a mid-tier impact on this. It's just a little disappointing to see a temporary setback. But bear in mind, this is exactly the same alloys that we are targeting the cylinder (inaudible) market with -- we'd obviously hoped for the -- start to pick up that at some point in 2016.

Okay. All right. And then the medical oxygen product that you are developing -- and I appreciate the update on the timeline and your thoughts there. But just as we think about the costs associated with doing the initial production testing, because now you're having to ramp up to -- I think if I recall correctly, you're probably going to have to ramp this up to a pretty easy production rate in order to qualify the test units. So you just give us a sense on what sort of drag that is having on costs now and then through the remainder of the year? Clearly something that will reverse in the future.

Yes, I think the cost of the program has been running at approximately GBP1 million a year, so $1.5 million -- $1.6 million give or take. We are producing, I think, about 200 of these devices to do the statistical testing. So in itself, that's not a major cost, and most of those should be available for sale once the product is approved. But that's the representative run rate, if you like, of the ongoing cost of the program. Certainly in the coming year and last year -- pretty much last year as well.

The -- there will obviously be some launch costs -- marketing expenses and such like, but I would think that will probably run through the first quarter of next year before it starts being a net benefit when sales commence.

Okay. And just couple of more quick ones if I could, the SCBA market -- it's nice to see that the headwinds there have subsided. But as we move into 2016 -- might be able to look this up, but are you able to give us some sense of how much you think the lost sales were this year just given the regulatory delays? That's not going to be an issue next year, so I imagine that will be a nice step up in sales there even if demand remains flat. But any color there would be helpful.

Okay. I think it was 2014 numbers that were quite heavily depressed by the regulatory problems. There might've been a small degree of start-up pains in quarter one, but pretty much the year to date in 2015 because I think probably a little higher than it would've been because we have started to catch back some of the sales there were lost in 2014.

So when you look at the number being 25%, 27% up on prior year, we probably expect that to continue through the balance of this current year. But some of that will be catch-back of 2014 lost sales.

So for 2016, I think it's only reasonable that we won't get a further big hike in growth because we will get catch-back in this year, and presumably that will be done by the end of the year. So I think 2016 is likely to be fairly modest increase over 2015. And then we will see probably growth again in 2017 according to the modeling that we and our customers have.

Okay, thanks for the clarification. Last one, just looking at the comments you made around the sterling-euro FX impact into hedge, we can get some sense of what the magnitude of that could be, given you provided us your sales there. But it's unclear exactly where you put the hedge on. So anything you could tell us here to help us understand the magnitude if that were to reset today how that would impact the business?

Hi, Luke; it's Andy. Yes, planning against sterling and, I guess, the dollar, with sterling euro that's issued for several years. So over time, we've been deteriorating not just in the stock price but the hedges that we have in place, and they continue to deteriorate with not one single hedge rate.

I think our blended rate at the moment is around [1.30] sterling to euro. The euro is moving to about [1.42]. So there's probably another potential $4 million or $5 million dollars impact if all our rates reset. Of course, we've got hedges going right out into 2016. So it's quite a long time to go. And then on top of that, we do have the power clearly to target price increases. So they just take time. So there are a number of other levers that we can pull to look to mitigate the potential long-term margin impact if, in theory, the euro stayed its current weak position.

But just to reassure everyone, Luke, we have factored in continuing weak euro in 2016 when we have considered the gains that we have out there. We will have a job of work to do to catch back the shortfall through pricing. I very much doubt that we will be able to do all of that in one year.

As I pointed out, the background inflation rate in the euro zone is still very near zero. 0.2%, something like that. So all else being equal, it would take several years really to see an inflationary impact come through. But we will set ourselves the objective of recovering at least some of the impact through pricing and other improvements in the business in all the revenue streams. Meaning that we think that we can overcome that sort of gross impact Andy was talking about. But it is a significant additional potential impact if we get fully exposed to that euro $1.42 level in 2016. The best you can say about it is that we've got the time to plan for it and to do what we can about it.

All right, gentlemen. That's all very helpful. Thanks very much, and I guess I'll see you next week.

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

Okay. I will assume that Luke a little naughtily managed to ask everybody's questions into one go. So thank you very much, ladies and gentlemen. And we will speak to you again with the Q3 results in early November. Thank you, goodbye.

An encore recording of this conference call will be available in about two hours. You can access the recording on the Luxfer Group website at www.luxfer.com. Thank you for participating in the call. You may now disconnect your lines, and have a wonderful day.