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Luxfer Holdings PLC (LXFR)

Q1 2020 Earnings Call· Tue, Apr 28, 2020

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Transcript

Operator

Operator

Good morning. My name is Brandi and I will be your conference operator today. Welcome to Luxfer’s 2020 First Quarter Earnings Conference Call. All lines have been placed on mute. After the speakers’ remarks, there will be a question-and-answer session. Now I will turn the call over to Mary Reed from Luxfer. Mary, please go ahead.

Mary Reed

Management

Thank you, Brandi. Welcome to Luxfer’s first quarter 2020 earnings call. We’re happy to have you all with us today. I’m Mary Reed from Luxfer and with me today is Alok Maskara, Chief Executive Officer; and Heather Harding, our Chief Financial Officer. On today’s call, we will provide details on our first quarter 2020 performance as outlined in the press release issued yesterday. Today’s webcast is accompanied by a presentation that can be accessed at luxfer.com. Please note, any references to non-GAAP financials are reconciled in the appendix of this presentation. Before we begin, a friendly reminder 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. Now, let me turn the call over to Alok.

Alok Maskara

Management

Thank you, Mary. Welcome, everyone. During this call, I will provide an overview of our first quarter performance and a summary of Luxfer response to the COVID pandemic. After that, our CFO, Heather Harding, will provide details of our recent financial performance and provide estimated guideposts for the rest of the year 2020. Before I summarize our Q1 results, I would like to thank all our employees for continuing to serve our customers and shareholders during these unprecedented times. The safety of our employees, our customers and the communities in which we work and live remains our number one priority. During this pandemic, we have taken significant additional measures to enhance safety protocols as we continue to operate most of our facilities to deliver essential products to our customers. I am proud of the company's performance culture, which ensures that we continue to safely operate our essential factories while we also achieve significant cost reduction to mitigate the impact of COVID. Now please turn to slide 3 for a summary of the first quarter’s financial results. Luxfer’s first quarter 2020 financial results were impacted by the challenging industrial macro conditions declined 10.5%. Our first quarter EBITDA declined 18.4% to $15.1 million as we were unable to fully offset the gross margin impact of lower sales with cost reductions. Our adjusted diluted EPS for the fourth quarter was $0.30 down 25%. Our balance sheet remains in good shape. Our net debt to EBITDA ratio was 1.4 times at the end of the quarter, which is significantly lower than the level at which any of our financial covenants become relevant. During the quarter, we used $7 million in cash, which is a reduction compared to our cash usage of $11 million in the first quarter of 2019. As a reminder, we usually…

Heather Harding

Management

Thanks, Alok and good morning everyone. Let's walk through the first quarter financial results on slide 8. First quarter reported sales of $103.8 million declined 13.8%. Excluding the impact of the Czech recycling divestiture, core sales declined 10.5% including a 1.1$ impact of unfavorable foreign exchange. The quarterly sales decline was primarily due to lower demand in passenger autos, zirconium catalyst and other industrial products. Consolidated adjusted EBITDA for the quarter of $15.1 million was down $3.4 million or 18.4% from the prior year. Despite the volume decline, the company executed on the transformation plan and delivered approximately $1 million of net cost reductions in the quarter despite unfavorable reserves related to the transportation market downturn. We continue to execute favorable pricing actions to offset material inflation. For a deeper dive into our two product segment results, please turn to slide 9. Elektron sales of $51.2 million declined a 11.1% from the prior year, excluding the impact of the 2019 Czech recycling business divestiture. The sales decline is primarily due to weakness in catalysis and magnesium aerospace products, coupled with unfavorable timing in MRE products. Resulting EBITDA of $11.6 million declined 17.1%. Gas Cylinder segment sales declined 9.9% primarily due to lower passenger auto and industrial cylinders demand, coupled with fire extinguisher product exits. These declines were partially offset by the continued growth in alternative fuel products. Resultant EBITDA of $3.5 million, declined 22.2%. Now, let's review our balance sheet and cash flow metrics on slide 10. We ended the first quarter with a strong balance sheet. Net debt totaled $91.5 million at the end of the quarter and our net-debt-to-EBITDA ratio was 1.4 times. Our first quarter operating working capital percent of sales did increase sequentially from year-end. However, this increase was exacerbated by macro conditions, as business units…

Alok Maskara

Management

Thank you, Heather. Please turn to slide 13. Let me wrap up by recapping that we serve niche attractive end markets with proprietary products and technology. Our transformation plan has delivered results and we'll continue to make a positive impact for the next few years. After the transformation plan is complete, we have plenty of runway to create more shareholder value by deploying the Luxfer business excellence standard toolkit to drive improvement in growth and productivity. Once again, I want to thank all our employees around the world for safely operating our facilities while putting our customer first. Thank you for listening. We will now take questions.

Operator

Operator

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

Chris Moore

Analyst

Okay. Yeah, maybe to start with the – on the positive side, so the high-pressure aluminum cylinders, can you maybe just give the sense in terms of kind of what your maximum production capacity is there?

Alok Maskara

Management

At this stage, we had surgeon orders and we do have capacity to move production from industrial cylinders to medical cylinders, but I think to answer your question broadly, we are talking about $5 million to $10 million for the year annually on the maximum that we will get out of that incremental volume term.

Chris Moore

Analyst

Got you. Okay. And in terms of the MRE, it’s – it sounds like you're starting to see some increased demand there. Is that -- you expect that to kind of peak in Q2 or continue through the year from what you're seeing at this stage?

Alok Maskara

Management

It does depend on how the unfolds in the next few months but we definitely. But we definitely have strong orders going into Q2 and if the situation continues then extend into Q3 and Q4. I think that's where some of the uncertainty comes in process questions, so just we’re not sure on how long this would continue and what nature of this extent.

Chris Moore

Analyst

Got it. All right. On SoluMag just in your estimation where does the price of oil need to be in order for SoluMag to be a meaningful part of Luxfer revenue?

Alok Maskara

Management

You know in the Permian which is where our new product is working and it's working quite well. I mean that's one reason why our Q1 sales were flat year-over-year. Again, I’m not an expert Chris. But we hear numbers such as that it needs to be around $30 to $40 a barrel BTI crude bar. There’re going to be folks to invest in new wells and drilling in the Permian. But to go to the outer industry experts who might have a better view, we are holding back and looking at that as needs to be $30 to $40 which is what we hear from customers as well.

Chris Moore

Analyst

Got it. That's helpful. All right. I appreciate it. I'll jump back in line. Thanks guys.

Alok Maskara

Management

Thanks, Chris.

Operator

Operator

Thank you. Your next question comes from Sarkis Sherbetchyan from B. Riley FBR.

Sarkis Sherbetchyan

Analyst

Just a quick question on some of the capacity. You mentioned I think you've temporarily suspended some operating capacity can you maybe talk about how much you've taken off line and what product categories?

Alok Maskara

Management

Yeah. Sarkis so most of the capacity and in fact all the capacity that we have taken out right now is all in the automotive sector which was really hard hit as our customers both in Europe and US have suspended operations. So they can – as you know passenger automotive has around less than 10% of our revenue. So that kind of a capacity which we have taken offline. And it’s just a short-term setback as far as we are concerned. So as these customers start operating again, we would be looking to start that back up.

Sarkis Sherbetchyan

Analyst

Got it. And can you maybe help us understand what that implies for maybe the cost structure, right. Does it help you kind of conserve cash just kind of help us frame what that means.

Alok Maskara

Management

Yeah. So I guess the first thing when we look at this as a good prudent exercise because we don't want to build up finished goods inventory. We usually ship our customer demand, which is good practice for us not to hopeful and build inventory versus cost. Yeah, it absolutely helps us with our cost structure both variable and fixed cost since we’re actively following employees and with some other government incentives in UK and US, we're able to take advantage of any, whether it's PPP or the CARES Act pull that altogether , it helps both in our fixed and variable cost aspects. And finally for us it does allow us to do some preventive maintenance and a few other things in the factories while the lines are down. All of these are still lines with good track record and good customer demand historically and we think in the future.

Sarkis Sherbetchyan

Analyst

Thanks for that. And in the prepared remarks, I think Heather mentioned V-shaped recovery after 2Q. Can you maybe help us understand what the assumptions are backing up that statement?

Alok Maskara

Management

Sure. I think Heather mentioned the U-shape recovery after Q2. And Sarkis, none of us are experts. Some of this is what we are hearing directly from our customers. And most people expect that beyond the immediate impact of production shutdown due to COVID. Demand will recover, but it will not be a V-shaped recovery, I guess, that’s one way to look at it. So if Q2 is going to be our weakest, we don’t expect Q3 to come back and be normal again. We think that would be a prolonged recovery period going towards the end of the year. And the core assumptions are around ISM, around new vehicle SARs, just looking at those metrics and looking at what the current predictions lead us. But there’s huge amount of uncertainty here, Sarkis, as you can imagine, hence we poured our guidance out for the rest of the year, see how things will move out in the next three months.

Sarkis Sherbetchyan

Analyst

Got it. Thanks for that. Okay. So U-shaped, not V-shaped, my mistake on that. I’ll hop back into the queue. Thank you.

Alok Maskara

Management

Thanks, Sarkis.

Operator

Operator

[Operator Instructions] Your next question comes from the line of Michael Leshock of KeyBanc Capital.

Michael Leshock

Analyst

Good. So you alluded to Defense and First Responder sales to be flattish year-over-year in 2020. And you said you saw – you said 1Q saw a lower start to the year, which led to the decline in the quarter. But I would have expected to see some year-over-year growth here, just given the nature of the COVID response. Can you talk about what is dragging that segment down or what comps you faced last year?

Alok Maskara

Management

Yeah, these are just timing of some large orders and as you know, SCBA and medical oxygen are often driven by some large tenders. So we had a slow start which we anticipated and was part of our original thought process. Where we are right now is we saw strong orders in March and March was a growth month and we expect that to continue. So we had a good recovery from January, February slow start, we’re wrapping up production and into have a strong backlog getting into the rest of the year.

Michael Leshock

Analyst

Okay. And are there any lingering supply disruptions just given the COVID impact specifically in electron from Chinese-based raw materials?

Alok Maskara

Management

Not anymore. When we sort of talked about in March they were, so to be fair there were supply disruptions at the beginning of the quarter and that was baked into our guidance when we talked to you in March. But that seems to have recovered faster than we would have anticipated. Those were around our zirconium product line, those were around some of our defense product lines and also obviously buy a lot of our magnesium from China. Now, the supply disruptions did lead us to have a bit extra inventory in the quarter, but there is no sort of current sales impact on lingering sales impact going into 2Q for us.

Michael Leshock

Analyst

Okay. And then, just lastly for me, I understand the CapEx revisions just given the near-term uncertainties but just wondering if you're being too aggressive in the sense of meeting your long-term goals in improving new product momentum, and we’re hearing some other with similar aspirations a bit more balance in their CapEx cuts? And so I'm just wondering how that impacts the timeline on your investment goals?

Alok Maskara

Management

Sure. So I think if you take a step back from two years ago the company has to spend $18 million to $20 million in capital. And as we have reduced the number of facilities from 20 down to 5 or so that is automatic reduction in capital that happens when you have fuel facilities for maintaining CapEx. So that was of course in our guidance at the beginning of the year. As we go forward that’s sort of a line in the sand that we can revisit as it moves along. We're not cutting back on any growth projects. We're not cutting back on any necessary customer upgrades. We're simply looking at higher amount of payback when we look at productivity projects and in some cases when the demand is down, we don't necessarily need to upgrade the capacity right now. We can defer some of those. So, are we being too aggressive right now? I hope you're right, maybe we're too aggressive, then we can revisit in Q3 and Q4 and look back at those things. But given the current situation, we just thought it was prudent to be very conservative at least for the time being.

Michael Leshock

Analyst

Okay. And just one more actually what products are in your pipeline right now going forward in what markets – what end markets would they be in?

Alok Maskara

Management

In the medical field we have talked about our zirconium products which have had some early successes and there's more in the pipeline there. So, in the [indiscernible] business, that's clearly an area that we continue to invest in, that is still moving ahead. We are not retrenching back from that. If you look at from a gas cylinder perspective on the alternate fuel side, the type 4 cylinders which have led to a lot of growth. We’re clearly coming up with the next generation and more expansion of the current product lines in that that’s been a good growth driver for us as well. In addition, on the military and the defense side, we have the decontamination product line which I’ve talked about earlier, that didn’t have much of an impact in Q1, but based on auto rate, Q2, Q3, Q4 that will add to significant revenue and we are coming up with next generation of product on decontamination putting that together. So, among the arsenal of many others we are working on, those are the three I would highlight, alternate fuel type for cylinders, the zirconium for medical applications and the decontamination in our US military.

Michael Leshock

Analyst

Got it. That's helpful. Thank you.

Operator

Operator

Your next question comes from the line of Craig Irwin of ROTH Capital.

Craig Irwin

Analyst

Hi, good morning and thanks for taking my questions. So look your mention of the alternative fuels market is a nice dovetail into my first question. So, can you discuss the puts and takes on revenue growth either sequentially or year-over-year in the gas cylinders business are there specific product lines that you would call out for strength? And is there anything strategic you're doing there that you might be able to share with us that's impacting the revenue progression?

Alok Maskara

Management

Sure. So the alternative fuel as you know has been a growth engine. In Q1 despite all the – right, it was still a growth engine, but fortunately as we go into Q2 lot of our customers who make less than half. I mean they have shut down their production in response. So, we expect Q2 to be a meaningful decline and we expect that to be temporary because orders and things are not going revenue progression. The largest decline we had was on passenger auto production I mean which clearly given the market condition some big things we have considered as it takes a backseat for now and we need to deal with the current situation. And that would be kind of the longer term strategic aspiration of ours, which is probably as well. Weathering through the current situation, but in there we have been able to get some nice new smaller customers and continue to work with our larger auto customers to get into next generation more profitable type opportunity. And then finally on long-term sort of a new project horizon perspective, our L7X based medical cylinders, which is something I highlighted for disaster relief and COVID, I mean that’s been doing well and that’s going to continue getting us growth. And by four cylinders which we used for the next-generation alternative fuel those seem to be doing very well as well. And that’s going to continue looking at growth forward. There was some disruption in Q1 on just supply disruption based on products that we get from overseas, but I think that was minor. Going forward the new products growth momentum on alternative fields and the backlog and defense would all contribution towards why we still feel optimistic about gas cylinder.

Operator

Operator

Thank you. An encore recording of this conference call will be available in about two 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 July of 2020 when the company discusses its 2020 second quarter financial results. This ends the Luxfer conference call.