Luxfer Holdings PLC (LXFR) Q1 2017 Earnings Report, Transcript and Summary

Welcome to the Luxfer Group First Quarter 2017 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 financial performance. Brian will then return to sum up and offer an outlook. After that, Brian and Andy will be glad to take your questions. [Operator Instructions] Thank you for your cooperation. We will now turn the call over to Brian Purves.

Thank you. Good morning ladies and gentlemen, and welcome to the Luxfer conference call on the first quarter of 2017. Turning to Slide 4, the headlines for the quarter are as we expected, the business did bounce back strongly from the difficulties experienced in the fourth quarter. Our earnings result was actually above our expectations. Our magnesium business was able to increase deliveries in a number of key areas although order cover and defense remains patchy. Cylinders delivered a strong result with European medical demand higher than we have seen for some time and encouragingly we are seeing much improved order intake in the sectors that were depressed at the end of 2016. And this underpins our guidance for the full-year with 2017 EBITDA and EPS expected to be at least 10% up on prior year. Turning to Slide 5, our adjusted free diluted EPS of $0.27 was material above consensus, although $0.03 below quarter one last year. The EBITDA of $15.3 million is at the run-rate that we would need to hit our full-year guidance. Although we did have a modest benefit from one customer putting forward orders from April into March as we they a sales push at the end of their year-end. So, we recorded an improved profit over prior year despite alternative fuel sales being some $3 million lower. The main reason why divisional revenue is down on prior year. In Elektron we started supplying flameless Russian heaters under the new supply contract awarded late last year. The previous contract having been for five years, as indeed this one is, the new prices are higher than previously. Divisional profit remains lower than prior year, but in net terms this can be largely explained by the different timing of various catalysis orders between last year and this. Sterling was still relatively strong at this point last year, so exchange differences are still dragging down our reported U.S. dollar revenues. This effect seems likely to continue through most of the second quarter, but then disappear. On Slide 6 it was particularly pleasing to see our magnesium business having a strong start to the year despite still being short of defense work in some areas. We are seeing improved order flow from the U.S. Military and these orders should progressively strengthen our defense sales, particularly in the second half. In cylinders following destocking by one major customer through most of 2016, European demand for composite medical cylinders look rather stronger in 2017. Demand for our alternative fuel cylinders is better than prior year, but you will recall that at the present time of depressed oil prices, margins are relatively tight in this sector and the low volume remains above our breakeven point following the rightsizing undertaken in 2015. We have already won some additional contract business with a major bus manufacturer for 2018 that should push revenues in that sector. Our Superform revenues are still down on prior year as the business walks through a turnover of contracts. But we are gearing up to increase sales of formed goods in the second half of the year as the new contracts come online. Foreign exchange was a benefit to profit in quarter 1 and even though sterling is around 5% stronger recently, it remains well going on the first half of 2016 and we expect this ForEx benefit to the profitability of our exports into the eurozone to continue and to grow through 2017 as our hedge position improves. On Slide 9, for a standing start in late 2015, we sold $4 million worth of SoluMag alloy to the North American oil and gas industry in 2016, despite the low level of exploration activity. Although from a low base, so as in quarter one 2017 were 50% up on prior year. The bulk of the sales to-date have been for fracking spheres, as shown in the illustration, although we're also supplying material for use in plugs and sliding sleeves. Responding to requests from customers, we have now developed and launched three new derivatives of the SoluMag alloy to expand the range of their usefulness to the industry. The high ductility version is ideal for expanding plugs, while the high strength version will cope with extreme pressures. While it has been a challenge, we have also developed a version that will dissolve in the relatively freshwater found in a minority of wells. On the right side of the schedule, in the middle of last year Biotronik launched their magnesium scaffold product, branded Magmaris, in several countries and the product remains in its launch phase. We expect our royalty income to grow steadily in 2017 albeit there is a lag of around two quarters from Biotronik's underlying sales. Encouragingly we are told that the clinical feedback to-date indicates an extremely low life incidence of post-operation thrombosis, something that can plague nonmetallic in body devices. Slide 8, although there is little new to report, I am happy to confirm that we continue to work on three components with different manufacturers for possible inclusion of our alloys in the new aircraft seat designs. We remain very optimistic of getting at least one of those parts approved into a production seat during 2017. Slide 9. Our investment program to increase capacity of Superform in the U.K. is well underway and we have recently taken on lease of a new 60,000 square foot facility that will become our center of excellence for lightweight closure assemblies, that is doors, trunks and hoods targeting the luxury and performance car market. We have an expanded range of high-strength aluminum and magnesium alloys on offer and the new facility will have a robotic hemming, a adhesive queuing equipment, heat treatment ovens, and laser inspection equipment. We expect to use around half of the capacity as soon as it is available later this year on contracts already on the books. Andy Beaden will now take you through some of the detail on the quarter 4 financials -- quarter 1 financials.

Thank you, Brian, and welcome everyone to the call. My first set of slides will cover the sales analysis for the quarter. Total revenue for Q1 2017 was $103.4 million compared to the $108.8 million in Q1 2016. FX translation was a negative $3.7 million, with underlying group revenue lowered by $1.7 million. Gas cylinders underlying revenue was 4.7% lower, but Elektron was 2.1% higher. This was ahead of both consensus and our own initial expectations and represents a significant recovery over the demand disruption experienced in the second half of 2016. More importantly order cover in the Elektron division has also significantly improved for the second half of 2017, with firm orders now placed for scheduled shipments starting Q3-Q4 2017 which we will cover in the outlook. Slide 12 covers gas cylinders. The cylinder underlying revenue for Q1 2017 was $2.7 million less than a year earlier. Shipments for the U.S. self-contained breathing apparatus market are those still lower than the very strong Q1 2016 did mark a recovery over the last two quarters 2016 helped by a major customer pulling forward order requirements from early Q2 2017. In the early part of last year self-contained breathing apparatus demand was boosted by all our major U.S. customers working through some significant order backlogs. This year we are expecting a more flattened level of demand in that U.S. market. There will also been a pick-up in the European medical sector with sales of our advanced L7X range of cylinders now higher in Q1 2016 with both our composite hoop-wrapped and aerospace-created aluminum alloy products showing improvement. And major European medical customer that was destocking in 2016 appears to have rebalanced their cylinder portfolio and is now indicating a stronger level of demand in 2017. AF sales were however a little weaker in the quarter with some knock-on impact from consolidation in the industry which resulted in composite cylinder sale revenue overall being lower than in Q1 2016. Superform revenue remains compressed as expected, while we gear up the new major work due to start with Ferrari and other high-end automotive OEMs expecting to lead to higher performing part sales in the second half of 2017 when they begin to manufacture their new models. Now on to Slide 13. Elektron underlying revenue for Q1 was higher by 2.1%, largely as a result of an encouraging recovery in the sales of flameless MRE heaters in the Luxfer Magtech business with the start of the new contracts in January and following the shortage of orders in the second half of 2016. Those sales are still a little subdued for other Luxfer Magtech products. Some new orders on the chemical detection side have now been received for manufacture starting in Q2 with sales shipment therefore in the second half of this year. SoluMag sales were higher, whilst aerospace alloy demand held up really well. Magnesium photo engraving sales were relatively flat, arresting the decline of recent quarters as we completed transition of major customers to direct selling accounts. Despite the stable shipments of automotive catalysis materials, overall catalysts sales were down as expected due to the scheduled timing of chemical catalysis shipments in 2017. Recent order intake for chemical catalysis was excellent with shipment timings on these large orders in the latter part of 2017. Slide 14 shows trend in sales for Q1 2017 by geographic region. It shows the fall in sales was mainly relating to North America with quarterly changes on shipments to the U.S. self-contained breathing apparatus market and chemical catalysis and a weaker quarter for AF. U.S. defense-related products however performed better with several products now back to prior year levels. Europe held up well with medical sector showing meaningful improvement. Whilst these markets continue to be negatively impacted by FX translation, it is pointing to a positive outlook in our European sales as we export out of the U.K. and start to benefit from more favorable transaction rates. Turning to the trading profit and adjusted EBITDA results on Slide 15, the trading profit at $10.5 million, the trading margin was 10.2% with the lower Elektron profits still offsetting another increase in cylinder profit. The most significant factor was the timing of repeat chemical catalysis orders, which are expected to impact later in 2017 positively, but boosted the earlier part of 2016. This year cylinders benefited from cost saving initiatives across the division and a higher medical demand in Europe. FX was not a major variance in the quarter, they -- was negative on gas cylinders and positive on Elektron. Adjusted EBITDA was $15.3 million, though reduced on Q1 2016, still a major bounce back from the $10.2 million for Q4 2016 driven by a good level of cylinder profits and recovery in some magnesium markets. Adjusted EBITDA margin was 14.8%, just marginally down on Q1 2016, but if I actually look back 2 years comfortably ahead of the first quarter of 2015, which was at 13.2% on a similar level of profitability. Slide 16 covers net income and EPS. In the quarter, there was only one exceptional item to note. We were able to release the remaining provision of $0.4 million in relation to remediation works, which were completed at the former -- our former Redditch manufacturing site in March. The site itself was sold in Q1 2016 generating an exceptional profit of $2.1 million. This meant the operating profit was $10.7 million for Q1 2017 against $13.8 million for Q1 2016, but to be clear the 2016 results have included the exceptional gain on that property. Statutory IFRS net income for Q1 2017 was a net profit of $6.6 million compared to $8.7 million for Q1 2016. Adjusted for exceptional items and excluding the IAS 19 pension finance cost, Q1 2017 was an underlying net profit of $7.2 million compared to $8.1 million for Q1 2016. The effective tax rate on the adjusted net income was 24.2% against 25.7% for Q1 2016. The rate was helped by stronger profits in the U.K. which were taxed at much lower rates. Adjusted diluted EPS was therefore $0.27 for Q1 2017 compared to $0.37 for Q1 2016 providing dividend cover in excess of 2x the quarter, this result being better than we originally expected and provides a strong foundation to our annual guidance. The next Slide 17 is on liquidity and capital resources. Detailed slides on the balance sheet and cash flow can be found in the appendices. So, the key points are as follows; return on invested capital for quarter was a respectable 13% after tax, consistent with the 13% achieved in Q1 last year. Net debt, debt minus cash was $105.9 million full over the year-end 2016 position of a $107.4 million, though slightly higher than what it was a year ago. The net debt-to-EBITDA ratio was at 2x close to the peak we're expecting for this year, and would expect it to fall later in 2017. In the quarterly release, you will also see that the total equity and the net asset position improved from December year-end rising to a $153.4 million with the pension deficit falling to below $60 million at $57.4 million through the benefit improved asset returns. Finally, we had an excellent third quarter on cash, much better than last year. The Q1 2017 operating cash flow after taxation a positive $9.6 million versus $3 million in 2016. Net cash flow before financing was $6.2 million, well up on the $3.7 million for Q1 2016. Thank you. I will now hand you back to Brian to sum up.

Thank you, Andy. Turning to Slide 19 then, overall, we were confident that the low order cover experienced at the end of 2016 was largely temporary. It is clearly a relief to see that belief vindicated in a much stronger Q1 result representing a significant and rapid recovery from the problems of the previous few months, particularly in our magnesium business. Our adjusted EPS result is better than consensus, but we recognize that being $0.03 down on prior year remains unsatisfactory and we are doing everything that we can to make the 2017 outcome more robust through a combination of sales activity and cost control. Order cover for Elektron's decontamination products remains low despite the regular reports from around the world on the continuing threat from the use of chemical agents. We have however received much improved order flow in most other areas, including flameless Russian heaters, chemical detection kits, military powders and industrial catalysts. Increasingly the weaker pound sterling against the euro should be beneficial to the profitability of our exports into mainland Europe. Accordingly, we continue to expect to be able to improve profitability by at least 10% over the year, hopefully by close to the 2015 level. Finally, as an update on the recruitment process, following last year's announcement that I will retire in 2017, the board expects to update shareholders on progress at the AGM in London on May the 23rd. Thank you and we will now take questions.

[Operator Instructions] Our first question comes from the line of Julian Mitchell of Credit Suisse.

This is actually [Jason] on for Julian. I guess our first question would be on your guidance. It sounds like a lot of things were more incrementally positive especially in terms of the cadence of orders, I was just wondering if there was an offset of negative news that you guys received that made you keep your guidance the same or if this is a little bit of conservativism and not wanting to be too backend loaded for the year?

Well, I think we hope that it is conservative, but bear in mind that we had a pretty rough finish to last year. And as reporting here, we all know reporting on three months, so I think it's little early for us to get carried away. The Q1 result we were very pleased with. There were probably a couple of cents in there which was done to customers with the accelerating their demand into Q1. So, we start off Q2 a little behind, but we are more and more confident with the royalty that's coming in. It's not necessarily incremental to what we expected, but it's firming up the views that we had that the market would come back to us. So, we're certainly on a increasing level of confidence that we can get to the guidance that we outlined, but I think we'd want to see another quarter under our belts before we think about revising it.

Got it. That's very clear. And just as a quick follow-up on FX, I know that the exchange rates are pretty nice, are you guys keeping your guidance roughly similar for how much benefit you'll realize on the FX or are there any changes that you would like to highlight on your outlook on that front?

We're still looking at $2 million to $3 million benefit.

Got it.

Yes.

Thank you very much.

Okay, thanks.

Our next question comes from line of Phil Gibbs of KeyBanc.

On the cylinders side, can you talk a little bit about where the order pull forward was, I think you discussed that a couple of times in your script and then also discuss what appears to be more aggressive competitive dynamics in alternative fuels?

Sure. The order pull forward, that wasn't a major factor, but it is a factor was that the 31st of March was the year-end of one of our SCBA customers and we believe they had quite a big sales push to maximize their year-end result and pull there and a lot more stock from us at the end of March than we expected. And not just from straight out of Q2 as we start which is why I said earlier on we're just a little bit cautious about that imply, but it's a couple of cents more, it's not a major issue. Of course, we're less than halfway through Q2, so we would hope to make it -- as much of that up as possible. On the alternative fuel side on dimension consolidation of the industry really what we're talking about there is the merger last year of Agility Fuel Systems and Hexagon's, so the type four-cylinder manufacturer, they are manufacturing operations addressing automotive. What was meant is that the combined entity now has an in-house manufacturer of these type 4 CNG cylinders. Accordingly, any vehicle conductor or assembler that uses Agility services and to -- what a type 4 cylinder, the in-house preference is to switch to the Hexagon cylinder rather than ours. So, we have -- we sort of lost one customer that way where when they were independent of Agility they were buying our cylinders, but when they moved their conversion to Agility, Agility kind of default put them into the Hexagon cylinders. So, it does take a little bit of revenue out. It's not in the -- it's not a major factor at the moment because the margins not an area as we've highlighted before with the market still in a state of flux which are oil level. The margins are relatively low. So, it's not a big profit impact to us. We still have run-rate of revenue which is well above the breakeven point in that business and we continue to win other business with OEMs who don't rely on vehicle converter. So, we're quite confident that we'll rebuild that, and in particular we won one major contract with a bus manufacturer which will restore a lot of the lost revenue albeit not until the start of 2018. There's a lot of business out there that we talked to get quick on that.

So, with all that said, is this first quarter level a decent run-rate for that alternative fuels top line or is there a little bit more kind of run-off to go?

Well, there's about $6.5 million revenue in AF in Q1, so that would give us about $25 million, $26 million in the full-year. And I hope we've got a couple of -- $2 million or $3 million better than that by winning new business. Well, it's -- so to say it's well above the breakeven point, but we got the business to with the downsizing that we did in 2015. Under our areas of positivity in there, our Luxfer GTM JV in North America which was designed to address the bulk gas transport market and which has switched into once more devices, fuel sales and portable hydrogen, that is now doing quite well and recording profits and taking a lot of cylinders from us. So that's an area which is growing quite rapidly and is a much more successful area for us than the bulk gas certainly would have been.

Okay. That's all for that. And then last question from me is just on the momentum in Q1 versus Q4 or the ramp in revenue in Elektron certainly a fairly substantial incremental margin and improvement in profitability, can you talk a little bit about what drove that quarter-on-quarter with the mix change in the business and then if I'm right in what you're saying in terms of maybe some of the flares business still got to come?

Yes, I think we flagged in the Q4 call where we saw improvement coming along and as we said at that time, there was a new flare contract awarded round about September to one of our customers, but the production for that only started in April. So, it didn't really have an impact on Q1, but we talk progressively for that the benefit to the military powders from Q2 onwards. The flameless heaters, as you will recall, last year the industry got taken by surprise, but there was no add-on from the military above the contractual minimum. And so, everyone was very short of orders to manufacture in the last few months. As of Jan 1, we have started the new contract year on the new contract with higher prices and with the same minimum demand as previously, which is $30 million a year. And we have been advised by all three of the wheel manufacturers that we supply that the military have confirmed that there will be an add-on this year and that will be in fact a little larger than the one that we saw in 2015. So that's a big delta, not in Q1 but the add-on of Q1 but for later quarters. And the -- for engraving plate, the Graphic Arts, if you recall we -- to some extent shot ourselves a little bit in the foot with the claiming by moving more of our customers in North America on to direct sales, and as a consequence we had distributors destocking in the second half of last year and that process is now finished, and the Graphic Arts sales are back at more normal levels. Those factors aggregated together along with a little bit of a positive delta on SoluMag all got material benefits to the top line and bottom line.

Yes, and in from Q4 to Q1, Phil, zirconium had the improved sales line as well, particularly in Europe. So, the European sales were improved, driven by automotive ceramic demand. And even your actual auto catalysis demand was improved on quarter-on-quarter.

[Operator Instructions] I'm showing no further questions at this time. I would now like to turn the floor back over to Mr. Purves for any additional or closing remarks. All right, thank you ladies and gentlemen. We are very pleased to see the business bounce back the way that it has in quarter 1. This will probably the last call that I do if things go according to plan. So, it's my great pleasure working with you all over the years. I look forward to continuing to monitor the health and the growth of the business going forward. Thank you and goodbye.

Thank you, Brian.

An audio recording of this conference call will be available in about two hours. Telephone numbers to access the recording will be available on the Luxfer group website at www.luxfer.com. Thank you.