Luxfer Holdings PLC Q1 FY2020 Earnings Call

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.

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.

Thank you, Mary. Welcome, everyone. During this call, I will provide an overview of our first quarter performance and a summary of Luxfer's 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, which 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 have negative cash generation in the first quarter due to business seasonality and timing. Our return on invested capital finished above 15%. For the full year 2020, our ability to provide reliable forecast and guidance is impacted by the unprecedented volatility in our end markets and customer demand due to COVID. When we issued our full year guidance in early March, we had considered the immediate impact of the COVID outbreak in China, but we had not anticipated the impact of the global COVID pandemic. Given the current global uncertainties, we are withdrawing our full year financial guidance. Now, please turn to slide 4 for an overview of the employee and customer actions being implemented at Luxfer to address the significant impact of the COVID pandemic. As a company, our performance culture and strong focus on safety is allowing us to responsibly deal with the COVID pandemic. We have activated our crisis response plan and are executing the necessary steps to maintain business continuity. We are working even more closely with our customers to understand their changing demands and expectations so that we can appropriately prioritize our own efforts. Based on customer demand, we are increasing our production capacity in some locations, while we have suspended operations at other sites. In all locations, we have implemented enhanced sanitization and cleaning protocols, while increasing employee training and awareness for hand-washing and infection control as per the CDC and NHS guidelines. We have re-evaluated and retooled our operations to enable safe social distancing by changing shift schedules and production floor layouts. We have been able to maintain enough stock of safety and disinfecting supplies, sometimes with the help of our large customers and our facility in China. When possible, our employees are working remotely from home enabled by our previously implemented cloud-based IT and telecommunication infrastructure. Overall, we are confident that we have provided greater protection for our employees, customers and communities in which we serve, while adequately fulfilling the essential needs of our customers. Given the diverse end markets we serve, let's review the related revenue impact on slide 5. As a reminder, our current sales can be classified into three approximately equal end markets: Defense, First Response and Healthcare; Transportation and Industrial. Before we review the performance of each end user segment, let me give you a sense of the shifting demand patterns during the quarter. At the beginning of the quarter, we anticipated and experienced lower year-on-year industrial sales due to ongoing industrial downturn and also lower defense sales given the expected timing of a few large orders. Towards the end of the first quarter, we started experiencing significant contraction in our transportation and markets as many of our customers in the U.S. and Europe suspended their production in response to COVID. In addition, we saw further weakness in our industrial demand as oil prices declined and some of the industrial customers further reduced production. We did see an increase in defense demand towards the end of the quarter and we expect the Defense end user's sales to remain strong in the near-term. Despite the strength in March, the Defense, First Response, and Healthcare end market saw a decline of 7.1% for the full quarter due to the anticipated slower start to the year. Sales in our Transportation end market declined 15.2% in the quarter. Demand for passenger autos worsened during the quarter and we also saw a decline in some aerospace applications. Alternative fuel sales continue to grow year-over-year, but we expect those sales to slow down in the second quarter as many of our customers have suspended operations during the COVID outbreak. We expect to see continued declines in Transportation for the remainder of the year as demand for auto isn't expected to recover in the near-term and aerospace demand is likely to remain soft. Our Industrial end markets sales declined 9.4% in the quarter. The lower ISM PMI index coupled with the COVID crisis is having a significant negative impact, while SoluMag's oil and gas sales were flat year-over-year in the quarter. We are not forecasting any significant near-term sales of this product until the WTI oil price sees a meaningful recovery. Now, please turn to slide 6 for a deeper review of specific Luxfer products used to fight the COVID crisis. Luxfer is proud to play a small role towards enabling the U.S. military, first responders and medical professionals to fight the COVID pandemic. Our heater mills and our flameless ration heaters are providing nutrition to U.S. military and disaster relief agencies in the field and often also in their home bases as many of the canteens have suspended operations to stop the spread of COVID. Our aluminum oxygen cylinders are a critical part of the medical infrastructure for patient care in field hospitals, temporary hospitals or homecare. We meet the world's highest-performing high-pressure aluminum cylinder for medical oxygen applications. Our lightweight high-pressure composite cylinders are a vital part of the first responders SCBA equipment, so that they always have access to lightweight oxygen supply and can confidently respond to emergencies without worrying about unsafe breathing conditions. Over the past few weeks, we have experienced an increased order rate for all three of these products. We are actively ramping up production to meet the high demand levels so that we can continue to supply these essential products to healthcare professionals and first responders. Now please turn to Slide 7, which highlights how our transformation plan has positioned us for success. Luxfer initiated the transformation plan in early 2018 with a goal of delivering greater value for our shareholders through simplification, growth, productivity and continuous improvement. In addition to delivering on those objectives, the transformation plan is also enabling Luxfer to weather the current COVID crisis. Our focus on cost reduction and waste elimination has added $15 million of net cost savings to our profitability in the first quarter, thus reducing the impact of current volume decline. The continuous improvement mindset in our workforce positions us very well to deliver for the cost action throughout the coming year. Our pay-for-performance culture has built a more nimble organization that is quick to react to current conditions and focus on business continuity for our customers while generating automatic cost savings when performance deteriorates. Our low-cost scalable IT infrastructure enabled fast adoption of remote working practices, which is critical given the global nature of operations and team members. In summary, we are facing unprecedented conditions and are confident that despite potentially adverse short-term financial results, we will continue strengthening the company for the long-term and emerge stronger through this crisis to recover growth and profitability. Now let me turn the call over to Heather Harding, Luxfer’s Chief Financial Officer for details on our financial results.

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 million impact of unfavorable foreign exchange. The quarterly sales decline was primarily due to lower demand in passenger autos, zirconium catalysts 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 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 were unable to fully execute improvement plans in light of declining sales. We remain committed to our improvement plans and expect favorable results to materialize in the second half of the year. We consumed $7 million free cash in the quarter, using approximately $2.6 million in cash for restructuring activity. This compares favorably to our prior year performance of consuming $11 million in cash for the first quarter of 2019. On a trailing 12-month basis, we delivered 15.4% ROIC from adjusted earnings. Our balance sheet remains solid and we are well-positioned for strong cash conversion in 2020. Given the significant market uncertainty, I wanted to review some downturn playbook action on slide 11. Given the unprecedented and volatile nature of the current market, we have initiated many actions to support our employees, customers, and shareholders. We’ve evaluated various downturn scenarios, and we first reviewed self-adjusting actions. These include volume-based savings in our manufacturing operations, lower management compensation and headcount optimization. Our current executive team target compensation will reduce by approximately 30% due to the pay-for-performance incentive plan. We reviewed all costs for discretionary reductions involving delaying hiring decisions, eliminating travel plans, accelerating MRO savings, and further reduction in professional services, training, and marketing spend. We expect around $2 million of savings from these efforts. We have re-evaluated our capital spending plans for reduction opportunities. As we began the year, we expected to spend $13 to $15 million of annual capital. In light of current demand profiles, we have looked to delay capacity upgrades and productivity projects while maintaining investments for growth. As a result, we expect a 30% to 50% capital reduction with the revised annual spend between $8 million to $10 million. As cash generation is a key consideration, we've explored additional cash preservation opportunities in addition to capital expenditure reductions. This includes partial suspension of our pension deficit funding, implementing furloughs and other headcount actions, reevaluating the timing of the share buyback program, and reconsideration of M&A. These efforts have potential cash upside of $2 million to $5 million. All of these items highlight our ability to take action to limit and contain the impact of the current macro conditions. As we look to the remainder of the year, we have withdrawn full-year financial guidance based on the unprecedented volatility and uncertainty in the market. We wanted to provide a guidepost for our full-year outlook on slide 12. Clearly, the current market environment will have a significant impact on the business. Our view is shaped by some key macro assumptions. First, we expect our Defense and First Responder product sales to be flat year-over-year. These products are used to combat the current COVID crisis. Next, we expect continued erosion in both Transportation and Industrial end markets. We are expecting the second quarter to be our weakest quarter of the year, and we're expecting a U-shaped recovery after Q2. In addition to the cost reductions already highlighted, we are focused on cash preservation as well. We expect to reduce our annual capital spend and spend less cash on pension deficit funding and restructuring. The resulting free cash flow excluding restructuring will be approximately 100% for the year. While the current market conditions represent a significant business challenge, we remain confident in our organization's ability to take the necessary steps to limit the impacts supported by our strong balance sheet position. Now I'll turn the call back over to Alok for a wrap-up.

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 will 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 customers first. Thank you for listening. We will now take questions.

Thank you. The floor is now open for your questions. Your first question comes from Chris Moore of CJS Securities.

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?

At this stage, we had surge 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.

Got you. Okay. In terms of the MRE, it sounds like you're starting to see some increased demand there. Do you expect that to peak in Q2 or continue throughout the year based on what you're observing at this stage?

It does depend on how this unfolds in the next few months, 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.

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?

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 for WTI crude. There are going to be folks to invest in new wells and drilling in the Permian. But to go to the outside 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.

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

Thanks, Chris.

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

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 offline and what product categories?

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 U.S. have suspended operations. So they can – as you know, passenger automotive makes up less than 10% of our revenue. So that kind of 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.

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.

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 according to customer demand, which is good practice for us not to overbuild and accumulate 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 the U.K. and U.S., we're able to take advantage of whether it's PPP or the CARES Act. All of these still align with good track records and good customer demand historically and we think in the future.

Thanks for that. And in the prepared remarks, I think Heather mentioned a U-shaped recovery after Q2. Can you maybe help us understand what the assumptions are backing up that statement?

Sure. I think Heather mentioned the U-shaped recovery after Q2. And Sarkis, none of us are experts. Some of this is what we are hearing directly from our customers. 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. 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 a huge amount of uncertainty here, Sarkis, as you can imagine, hence we pulled our guidance out for the rest of the year, to see how things will move out in the next three months.

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.

Thanks, Sarkis.

Your next question comes from the line of Michael Leshock of KeyBanc Capital.

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 Q1 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?

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 the January and February slow start. We’re ramping up production and have a strong backlog going into the rest of the year.

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

Not anymore. When we sort of talked about it in March, there 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 we buy a lot of our magnesium from China. Now, the supply disruptions did lead us to have a bit of extra inventory in the quarter, but there is no sort of current sales impact or lingering sales impact going into Q2 for us.

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 others 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?

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 an automatic reduction in capital that happens when you have fewer 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 amounts 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 it 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.

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?

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 medical business, that's clearly an area that we continue to invest in, that is still moving ahead. If you look at it 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 working on next-generation products in decontamination. Among the arsenal of many others we are working on, those are the three I would highlight: alternate fuel type 4 cylinders, zirconium for medical applications, and decontamination in our U.S. military.

Got it. That's helpful. Thank you.

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

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?

Sure. So the alternative fuel has been a growth engine. In Q1, despite all the challenges, it was still a growth engine, but unfortunately, as we go into Q2, a lot of our customers 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 to affect revenue progression. The largest decline we had was on passenger auto production, which clearly given the market conditions has taken a backseat for now. We need to deal with the current situation. That would be our longer-term strategic aspiration, which is to weather 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 opportunities. And then finally, on long-term, our L7X based medical cylinders for disaster relief and COVID have been doing well, and that’s going to continue to drive growth. The type 4 cylinders we use for next-generation alternative fuel also seem to be performing well and will continue to look at growth moving forward. There was some disruption in Q1 due to supply issues from overseas, but I think that was just minor. Going forward, the new product growth momentum on alternative fuels and the backlog and defense will all contribute toward why we still feel optimistic about gas cylinders.

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.