Luxfer Holdings PLC (LXFR) Q1 2019 Earnings Report, Transcript and Summary

Good morning. My name is Brandy, and I will be your conference operator today. Welcome to Luxfer’s 2019 First Quarter Earnings Conference Call. [Operator Instructions] Now I will turn the call over to Doug Fox, Luxfer’s Director of Investor Relations. Doug, please go ahead.

Thank you, Brandy and welcome. With me today are Alok Maskara, our CEO and Heather Harding, Luxfer’s CFO. First, Alok will provide a brief overview of the first quarter. Alok’s remarks will be followed by Heather’s review of the first quarter’s financial performance. Alok will then return for some closing comments. Today’s webcast is accompanied by a slide presentation, which can be found on Luxfer’s website. We will refer to these slides throughout our prepared remarks. Any references to non-GAAP financials are reconciled in the appendix of the presentation. Before we begin, please let me remind you that any forward-looking statements made about the company’s expected financial results are subject to future risks and uncertainties. Please refer to Slide 2 of today’s presentation for further details. After our prepared remarks, we have reserved time for questions and answers. Now let me turn the call over to Alok. Alok, please go ahead.

Thanks, Doug. Good morning, everyone. Thank you for joining us today. Please turn to Slide 3 for the summary of our performance for the first quarter of 2019. Luxfer’s first quarter’s results show that growth momentum underlying our end markets remains favorable. We maintained solid execution even in the face of some setbacks related to ongoing planned consolidations. We are continuing to drive high performance through our Luxfer Business Excellence Standard Toolkit known as Luxfer BEST, which focused on commercial excellence, new product development and lean manufacturing. For the quarter, Luxfer reported sales of $120.4 million, up 0.6% from a year ago. Excluding a $4.4 million headwind created from unfavorable movements in FX, growth for the quarter was 4.3%. Quarterly adjusted EBITDA of $18.5 million was down 3.6%, as the benefit of higher volume was offset by FX and temporary inefficiencies related to ongoing planned consolidations. Adjusted diluted earnings were up 8% to $0.40 per share, driven by lower depreciation, interest and taxes. Our net debt decreased $19 million or 20% from a year ago and increased from 2018 year end due to seasonal increase in working capital, higher spending on our transformation activities and higher bonus payouts. These higher cash needs contributed to an $11 million outflow of cash before financing activities Q1 results give us confidence in achieving approximately 8% earnings growth for full year 2019. Momentum across our businesses remains favorable, and we are on track to deliver our previously announced total net cost savings goal of $24 million by 2021. Now please turn to Slide 4 for some color around our growth. Strong sales in zirconium-based chemicals and alternative fuel gas cylinders were partially offset by a decline in disaster relief sales as expected and the impact of a strike at our French cylinder facility, which is moving towards closure as part of our transformation plan. An ongoing favorable industrial macro environment and increased sales of new products and applications drove the growth in zirconium products. Robust auto catalyst sales were supported by our focus on gasoline-based vehicles in Europe and the U.S. In addition, we are using our expertise in zirconium-based auto catalysis to offer solutions in the field of gas particulate filtration. This is a significant growth opportunity within auto catalysis that is targeted to meet new particulate matter emissions standard globally. For alternative fuel gas cylinders, higher volume from European bus system assembly operations which was expanded last year drove the growth. The assembly operation builds value-added systems that incorporate cylinders, instrumentations and controls for bus manufactures. We also continue to recover share in the U.S. by adding new customers for our innovative cylinder products and through sharper, more focused sales execution. Looking ahead, we are optimistic about driving higher future growth through recently streamlined joint ventures for gas transportation modules. In our Elektron segment, sales of our dissolvable SoluMag products were flat in Q1, as our key oil and gas customers are working through existing inventory. The timing of SoluMag sales were also impacted by the M&A activity of our customers and service partners. We remain bullish on the long-term potential of SoluMag, which includes adding new customers and broadening our product offerings. Now please turn to Page 5 for an update on our transformative footprint consolidation project. As a recap, over the past 2 years, we have successfully consolidated 4 facilities, and our transformation plan has delivered $9 million in net cost savings in 2018. This quarter, the net impact of our cost reduction activities was unfavorable, as we incurred approximately $2 million in temporary inefficiencies related to the relocation of manufacturing facilities. These inefficiencies were limited to our gas cylinder facility in Gerzat, France and our graphic arts facility in Madison, Illinois. In Gerzat, we faced a strike in early Q1 following our Q4 announcement of a project to close the site. The strike resulted in manufacturing inefficiency and disruption in fulfilling customer orders. More recently, we have reached a mutual agreement with our employees, which is now pending approval from local authorities. The site closure remains on track for June 2019, and we are ramping up production at our existing sites in the UK and U.S. to serve our global customers. The project to close the Gerzat facility is both complicated and difficult, yet we continue to believe that it remains in the best interest of our customers and our shareholders. Throughout the project, we will remain focused on ensuring that we properly serve our customers with high-quality products we are already manufacturing at our other sites. In the Madison facility, for our graphic arts business, we faced some post consolidation manufacturing start-up difficulties following the move of related operations from our Findlay, Ohio location in the fourth quarter. The consolidation resulted in temporary higher air freight, scrap and overtime cost to ensure that we met our customer needs. More recently, production has stabilized and the team is running additional shifts to satisfy the late order backlog. Overall, the inefficiencies we faced in Q1 should be substantially behind us by the end of the second quarter, and we remain on track for delivering $24 million of net cost reductions by 2021. In addition, we have increased our manufacturing leadership talent to minimize disruptions during future moves. Now please turn to Slide 6, and let me turn the call over to Heather for a deeper review of the financial performance for the first quarter.

Thanks, Alok and good morning everyone. First quarter sales were up 0.6% to $120.4 million as price and volume offset the negative impact of changes in FX translation. The volume growth primarily came in two areas, zirconium-based chemicals and alternative fuel gas cylinders. In zirconium, we maintained strong growth with our innovative offerings, both in auto and industrial catalysis application. For alternative fuel gas cylinders, we benefited from European cities and others requiring the use of clean-burning compressed natural gas in efforts to reduce pollution in city centers. Consolidated adjusted EBITDA totaled $18.5 million for the quarter, down $700,000 or 3.6% from the prior year. For the quarter, pricing offset material inflation, and the higher volume made a positive contribution of $1.2 million. Unfavorable FX reduced EBITDA by $0.5 million. And as Alok noted temporary inefficiencies of approximately $2 million offset cost reduction benefits for a net cost impact of $1.4 million in the quarter. Now please turn to Slide 7 for a review of our Elektron segment performance. First quarter sales for our Elektron segment increased 2.6% primarily on the strength of zirconium-based chemicals even though SoluMag sales remained flat. Also for the quarter, we had approximately $3 million in lower shipments of disaster relief products, reflecting less replenishment needs from reduced hurricane activity. Despite this headwind, segment volumes increased by $3.1 million. Sales also benefited from $800,000 in improved pricing. Changes in currency rates reduced sales by $2.3 million or 390 basis points. This lower level of disaster relief sales will also have a similar impact on the second quarter results, as replenishment following the exceptional level of hurricane activity in 2017 extended through the first half of 2018. Segment EBITDA for the first quarter increased $800,000 to $14 million or 6%. Pricing offset material inflation. The higher volumes and cost reductions net of related segment inefficiencies more than offset $400,000 of FX headwinds. Now let’s look at the gas cylinder segment performance on Slide 8. Net sales for gas cylinder segment were down 1.5% to $58.4 million for the quarter. Volume and price advanced a combined $1.2 million due largely to high growth in alternative fuel cylinders. Sales declined for aluminum and composite cylinders, substantially due to production interruptions in our French facility, which we estimate reduced shipments by approximately $2 million in the quarter. FX reduced sales growth by $2.1 million or 350 basis points. Quarterly adjusted EBITDA declined 25% to $4.5 million, notably as the temporary cost of closing and relocating our facility in France outweighed cost reductions. We are pleased to have reached an agreement on the terms and timing of the closure. The agreement now requires approval from local authorities. Let’s look at some other changes impacting the Q1 reported net income on Slide 9. For the first quarter of 2019, we incurred higher expenses in 3 areas namely, restructuring, M&A and share-based compensation. On restructuring, the $9 million of expenses primarily relates to the costs associated with the French facility closure. This project is the largest and most complex of the consolidations we are undertaking under our multiyear transformation plan. The charges are substantially related to employee severance cost and site decommissioning. For the quarter, we incurred $4.6 million in costs related to the Neo transaction, including $3.5 million for reimbursing Neo’s transaction-related expenses for the mutual termination agreement. These charges are in addition to the $3.7 million incurred in the fourth quarter of 2018 for a total of $8.3 million in expenses related to the terminated Neo transaction. Most of the cash outlaid for these expenses will occur in the second quarter of this year. Share-based compensation charges increased to $2.6 million for the quarter, up from $0.5 million last year. This increase relates to LTIP vesting of executive compensation and payouts driven by strong 2018 performance. In addition to these increases I covered, depreciation is $3.4 million with $1.2 million lower than prior year due to a reduced level of capital spending in the past few years and asset impairments due to restructuring project. Now let’s take a look at the key balance sheet and cash flow items on Slide 10. Net debt totaled $78.4 million, down from $97.8 million at the end of the first quarter of last year and up from $63.3 million at the end of 2018. In addition to funding our transformation, we had an increase in working capital in advance of potential Brexit. The first quarter also typically has greater cash needs for bonuses, employee taxes and related items. As a result, we had a net cash outflow before financing activities of $11 million. For 2019, we currently expect net debt to remain flat to prior year, as operating cash will be used to fund transformation needs. As a reminder, 2019 requires the largest cash outlay for our multiyear transformation plan. These results do not diminish our commitment to delivering on our goal of 100% cash conversion for the company. We expect to return to positive cash generation in the second half of this year. Even with the increase form year-end, working capital as a percent of sales at the end of the first quarter was still below our performance at the end of the same period in 2018. In addition, ROIC from adjusted earnings on a trailing 12-month basis was up significantly from 12.7% to 19%. Now, let me turn the call back over to Alok.

Thank, Heather. Please turn to Slide 11 for an update on Luxfer strategy. Over the past 2 years, Luxfer has made significant progress on its transformation plan and we expect to continue generating 8% to 10% earnings growth over the next 3 years. This earning growth would come from three strategic initiatives. First, we will deliver the remaining $15 million out of the total $24 million in cost reductions even though the net savings in 2019 will be lower due to temporary inefficiencies related to plant relocations. We are well on track to achieve this goal with other planned actions following the completion of our French operation consolidation. Second, we will drive higher performance through our Luxfer BEST operating system to deliver growth and higher productivity through continuous improvement. Recent progress on Luxfer BEST includes culture training for the company’s top 50 leaders and the recruitment of 6 new plant managers who have expertise in implementing and leading lean manufacturing. Third, we will continue optimizing our portfolio and effectively deploying capital to maximize shareholder value. We are making good progress on the divestiture of our magnesium recycling operation and expect to announce a transaction soon. We are confident that we have a good M&A process in place and are currently refreshening our pipeline. Now please turn to Slide 12. We experienced favorable momentum across much of our businesses in the first quarter of 2019, and we continue to gain incremental share by serving more of our customers’ need through innovative products and systems, such as our zirconium products for gas particulate filtration and our alternate fuel bus systems. In the second half of this year, other innovative product such as ECLIPSE SCBA high pressure cylinder will strengthen our market position. At the same time, we will continue to eliminate negative margin businesses to improve our bottom line. Equally important, we are making good progress on long-term business, cultural and footprint transformation that will lead to sustained GDP plus growth for the company. Beyond footprint consolidation, we are also enhancing our talent base, most recently, with the addition of several new plant managers, who are trained and experienced in lean manufacturing. All of this gives us greater confidence in our ability to deliver higher value for our shareholders. Overall, underlying macro trends continue to support a favorable outlook and our strategy of developing a high-performance culture is delivering results. Please turn to Slide 13 for a recap of the key investment considerations for Luxfer. We serve attractive end markets with highly engineered industrial materials using our proprietary technology and manufacturing processes. We have a strong balance sheet and a solid track record of strong cash conversion and disciplined capital allocation. The Luxfer transformation plan launched 18 months ago is on track and has demonstrated early successes, and we believe there are significant remaining opportunities for continued value creation at Luxfer. The best days of Luxfer are still ahead of us. Lastly, I want to thank all our employees around the world for their commitment and hard work to drive continuous improvement at Luxfer. Thank you for listening. We will now take questions.

Thank you. The floor is now open for questions. [Operator Instructions] And your first question is from Chris Moore of CJS Securities.

Hey, good morning, guys. Thanks for taking a few questions. Maybe could you just provide a quick kind of update review of the key elements in the $24 million in cost savings? And I think it sounds like this 4 facility consolidated at this point of time is – kind of how many to-date, how many in total and any other kind of key areas that are driving the savings?

Sure, Chris. So, I think overall on our transformation plan, we think 60% or so comes from consolidation of facilities and margin improvement related to that and 40% comes from G&A. So far, we have achieved $9 million in 2018, so we have $15 million to go. From a facility consolidation, we listed the 4 in the PowerPoint. If you look at kind of France and Findlay, which is underway and like solidly on track that gets us to about 6, and then we just obviously are going to look at continued improvements on our facilities, but are not ready to announce any further projects. At the same time, we are making good progress on overall G&A reduction as well, which is sort of the remaining 40% of the cost reduction. So, we feel on good on where we are despite the temporary additional cost we have to incur in Q1.

Got it. Any other plans that won’t be the same scope as France, but could have kind of similar issues in terms of ability to smoothly close without some kind of pushback?

We don’t think so. I mean, in France, obviously, there are different labor laws and like we have to deal with different regulatory environment there as well. I mean, that is the most complex and that’s the one that I think the team is handling quite well given the circumstances and some of the current challenges in France itself, but no, I don’t think there’s anything else in there. And we look at all of these as lessons learned and opportunities to do better, and clearly, with Jeff Moorefield now on Board and looking at ensuring that we have more safety stocks, better planning, so, again, obviously, we look at this as what can we do better in the future as well.

Got it, helpful. On the zirconium side, you talked about – I know, auto-catalysis has always been a big opportunity, but it sounds like it’s even becoming more into focus at this point in time. Can you just talk a little bit about the opportunity there?

Sure. And it has been a big opportunity, you are right. I think one thing that’s helping is just the macro environment, where – while for example, auto sales in Europe are down, the decline is essentially all limited to diesel-based vehicles and gasoline-based vehicles are doing well. We are fortunate that like near 100% of our exposure is in gasoline-based vehicles. So, the global macro environment kind of not working against us and is in fact helping as gasoline vehicles gain share versus diesel. Second, as we look at lost shares in the past based on our commercial excellence effort and some new products for new applications like a gas particulate filtration, we’ve made solid progress in recovering our relationships with the key customers out there. So, I think both of those makes us more pollution auto-catalysis going forward.

Got it. Thank you. Last question, just any – on the magnesium recycling divestitures, said it’s still on track for Q2. Is there any more specifics you can provide there?

No, it’s a small divestiture as you know. I mean, we have like an agreement at this stage that we are working through the final due diligence steps. We remain cautiously optimistic about closing it before the end of the quarter, probably at the tail end of the quarter. From an EBITDA perspective, our EBITDA is going to be near neutral. It’s more about like having the management and our teams more focused, and of course, we get a bit of cash that we can use towards our transformation activities.

Got it. Let me jump back in line. I appreciate it guys.

Thanks, Chris.

[Operator Instructions] Your next question comes from Phil Gibbs of KeyBanc Capital.

Hi, good morning, everyone.

Good morning, Phil.

So, I have a question in terms of the cost inefficiencies and maybe our previous question tackled this, but trying to get a little bit more color. So, are we to think that, that $2 million of impact will hang somewhat into the second quarter? Should we expect basically a repeat of Q1 in terms of those headwinds?

I would say it’ll be less than Q1, maybe $0.5 million to, so think of it like $1 million, $1.5 million in Q2. Obviously, we’re working and it’s still early in Q2, and the team is very focused on minimizing that. And we have made an intentional decision not to call those exceptional charges, because the strike was kind of a difficult situation, but we think it’s going to be less than $2 million, unsure whether it’s going to be – whether it’s going to be between $1 million to $2 million.

But yes, so you’re right, this is Heather, you’re right think there will be some hangover impact into Q2.

Okay. And then related to just the cash spending for the restructuring plan and the acquisition piece to Neo, I think Heather, you said that, that was $6 million in Q2. Any help you could give us on just the cash-related restructuring expenses we should expect outside of CapEx. I think CapEx should still be around $20 million this year if I’m not mistaken, but what are the other big pieces to the cash number and what is the timing flow?

Right, right, so yes, we are expecting capital in that $19 million, $20 million range for the year, so that’s not changed. When I think about timing and phasing over the year, as we talked about in the presentation, based on the current plan with regards to France, which is probably the biggest item that could swing some of the timing, based on the current timing, which is currently – we’re looking at a Q2 timing for that, we would not return to positive cash generation until Q3. If there is any slippage in the French project from June to July or anything like that, that could flip some of the cash between 2 and 3, but at this point based on our current timing, we’re still expecting a cash out – a net cash outflow in Q2 and then return to cash generation in 3 and 4. Other than the French facility and the acquisition expenses that we talked about, everything else is more kind of business as usual in terms of normal dividends, interest payment, tax payments, et cetera. There’s nothing else usual from a timing perspective.

So, you took the restructuring accrual in Q1 I think right of around $9 million, so that, that cash outflow though will be in Q2, Q3 basically and then you got the $6 million, so we’re talking about $15 million then roughly plus the CapEx?

That’s roughly correct like – we did have some restructuring accrual that we took in Q4. So again, it depends on some of the timing of when all the approvals come through with the local authority, so that’s why I – again, we’re assuming Q2, it could push, we’re a little bit on – at the mercy of when some of these approvals are obtained.

Okay. And Alok, if you could talk a little bit about SoluMag? It sounds like from your comments heavy – little bit heavy inventory right now, which is not unlike what we’re seeing kind of across the landscape right now to start the year, but I would think with strong completion activity in general and your ability to gain new customers that maybe this is the low for you, but maybe you could speak to that in terms of what you expect to see as the year progresses?

Yes. I mean, I’m hoping that’s on the low side, but as you know with the oil and gas, it’s really hard to get your arms around what’s the actual consumption versus what’s lying in inventory with the service providers. All indications are that right now they are just working through excess inventory, and yes, we are optimistic that like we’ll get back to our growth trends in that. We are very pleased with like expanding our portfolio of products and getting higher penetration in that. We are pleased with like greater penetration within existing customers and looking at new customers. And the new customer start-up just take us 6 to 9 months to get fully on board. So, we don’t think there’s inherently anything that pulls it back of SoluMag. But honestly, I was expecting a little better performance in Q1, so we need to take back the greenhouse thought and keep watching the order rates.

And then last question here is just the net cost savings, so you’ve got $15 million left to green, you’re actually a little bit behind that right now obviously with the start for the year and the near-term inefficiency, so you have – it’ll be incremental even more from here. But as you look at the year on whole, how much are you expecting to still see some of that cost savings this year or is it the growth basically just going to be driven by revenue? Thanks.

Yes. So, as we look at our net cost reduction perspective and outlook for 2019 based on the temporary inefficiencies, we’re expecting around 3-ish for 2019 is what we’re expecting and building into our plans.

Thanks, Heather.

[Operator Instructions] There are no further questions at this time. I will now turn the floor back over to Doug Fox for any closing or additional comments.

Thank you. Thank you, everybody, for joining us today. Our next regularly scheduled conference call will be at the beginning of August for our second quarter earnings. Meantime, Alok, Heather and I will be around for any additional questions you might have. Thank you. Have a great day.

An encore recording of this conference call will be available in about 2 hours. Telephone numbers to access the recording will be available on the Luxfer website at www.luxfer.com. Thank you for joining us today. The next regularly scheduled call will be in August when the company discusses its 2019 second quarter financial results call. This ends the Luxfer conference call.