Julian Mitchell - Credit Suisse Luke Folta - Jefferies Anthony Raab - Perimeter Capital Philip Gibbs - KeyBanc Capital Markets Neil Morgan - Marathon

Welcome to the Luxfer Group second quarter conference call. We will first hear from Luxfer Chief Executive, Brian Purves, who will provide a market overview; followed by Group Finance Director, Andy Beaden, who will review financial performance. Brian will then return to sum up and offer an outlook. After that, Brian and Andy will be glad to take your questions. To make sure that as many of you as possible get a chance to speak, we request that you initially ask only one question. After you have heard the answer, we will give you the opportunity to ask a follow-up question. If you would like to ask additional questions, our operators will be glad to place you back in line. We thank you for your cooperation. We now turn the call over to Brian Purves.

Thank you. Good afternoon, ladies and gentlemen, and welcome to the Luxfer conference call on the second quarter of 2013. I will take you through the headline results, Andy will then go through the detail of the financials, and after a brief statement on the outlook we will take your questions. We had hoped to see more of an uplift during the second quarter, but in the end the improvement was minimum. Our European focused business units in both divisions remain short of orders, while North America remains generally strong and the global cylinder business is growing well. The operating margin in cylinders remains rather lower than in the specialty materials businesses. And accordingly, the group's trading profit is $2.6 million lower than quarter two of last year, although $0.4 million up on quarter one of this year. Adjusted EPS was $0.37, was around $0.02 lower than the consensus forecast for the quarter. In looking at the half year, adverse profit remains at $5.9 million. It is important to note that there is around $2 million of incremental cost being incurred, as a direct consequence of our listing last October, so which is one-off expenditure such as SOX implementation. Looking at the sales revenue movement, Slides 5 and 6, track from the 2012 second quarter result, at the top of schedule, through to the 2013 result at the bottom. In our Elektron division, the headline, sales revenue line is again dominated by the reduction in rare earth surcharges as the cost of, in particular, cerium has collapsed now to around 5% of its peak. Although, it's still around twice the cost a kilo that it was at the start of 2010. Stripping the movement in the surcharge out, underlying sales are lower by some 3.1% as to year ago. A…

Thank you, Brian, and welcome everyone to the call. Brian covered the divisional sales analysis. And my first slide, Slide 9, shows how that consolidates the group revenue changes for Q2. Total revenue was $123 million for Q2 2013, with net revenue of $120.4 million and the rare earth chemical surcharge was down to only $2.6 million. The group's underlying revenue was up 5.5% or $6.3 million, excluding the surcharge reduction of $8 million and adjusting for FX translation differences, a negative $1 million. This increase includes the benefit of the Dynetek operations purchased in Q3 2012. Pre-acquisition, the old Dynetek operations were averaging $5 million of cylinder revenues a quarter. Slide 10, shows trend in sales for Q2 2013 by geographic region. The change in sales mix in each region is more relevant this time. Thought U.S. defense sales were down, the net growth was in North America, this being a result of stronger composites on the sales. European sales would have been further down, except for increased low margin recycling business. Turning to the trading profit results, on Slide 11, Brian talked through the factors affecting revenue and sales changes in the quarter. In line with the sales changes, gas cylinders profits were higher, up 45.5% to $4.8 million, and Elektron's lower by 28%, down to $10.5 million. Operating margin in gas cylinders was higher than prior year with more added-value composite cylinders being sold. Elektron's margin was lower than in Q2 2012, with a weaker sales mix and lower utilization of higher added-value production facilities. For example, we have one more recycling business, and so volumes and revenues were much stronger for that plant, but this is a lower margin business when compared to the strength in chemicals or magnesium sheets and powder, where demand was weaker.…

Thank you, Andy. In summary then, quarter two, while an improvement over quarter one was below expectations on operating profit and EPS. As indicated, we are currently experiencing reduced volumes on certain Elektron product streams and generally in our European focused business units, suffering from weak demand. Our cylinders is overall showing strong revenue growth and margin improvement. The net impact of the mix change on group profitability is for the moment, negative. I said that we would reconsider the outlook for 2013, once we had the Q2 result and could see how the second half was looking, although we remain confident that the cylinder division will show a strong revenue and profit growth this year. The European market for aluminum cylinders remains weaker than we told. The prospect of a near-term recovery in European automotive demand has receded, along with the hope for restocking effect. And the U.S. military costs look to be deeper than expected. Quarter two was a little better than quarter one and both quarters were similar to Q3 and Q4 of 2012. We have had to pushback the timing of any recovery in European markets, and therefore see different reason for optimism, but our near-term profitability will improve by March from the current level in the balance of 2013. While we do expect positive improvement in cylinders, it appears quiet likely that the Elektron will for the moment go backwards, under the dual pressures of weak European markets and lower U.S. defense spending. It is likely therefore that there will be a continuation of an adverse mix effect seen in the first half. Accordingly, we expect 2013 second half profit result to be similar to last year, leading our expected full year trading profit as a reduction of between $5 million and $8 million against 2012. Our focus remains on delivering the unchanged medium-to-long term potential for the business, driven largely by our strategic projects. In that regard, the statement by FAA on the use of magnesium and the aircraft seating is very satisfying. Being the result of many years of effort by magnesium Elektron staff, creating the interest and pushing for a renewed look at a material that's hard in more primitive forms, been rejected by the civil aerospace industry decades ago. While much work remains to be done before this outcome is likely to lead to significant incremental sales, it is a significant achievement, on this evidence that we can deliver on strategic projects in pursuit of our longer-term objective to broaden the base of the business. We are achieving a significant improvement in the Cylinder division, even with a weak European market and we fully expect the contribution from the Elektron to recover in due course. Thank you. And we will now take questions.

(Operator Instructions) Our first question comes from the line of Julian Mitchell with Credit Suisse.

Just a quick question. You've got sort of a $10 million delta, I guess in your old and new trading profit guidance. So I just wonder, if you could pause that out at all. Is it all in Elektron? Is there some in Gas Cylinder? And then I guess within Elektron or overall, what's the split of that $10 million between military and European industrial automotive?

I'll do my best, but certainly the cylinder business has a little bit of a contribution to it, because the demand on the European facility here in Nottingham is really quite weak at the moment. That includes the big industrial cylinders, specialty gas cylinders, which we sell to the major gas companies. And most of them seem to have shut up on capital expenditures at the moment. And these are quite big chunky items, good margin business, so that's a little bit hopeful. And we haven't reckoned on seeing that current rate for this year, but we now think that might be the case. But the majority of the impact is in the Elektron division. Certainly, the last time that we spoke to the market, we were quite explicit that we were assuming our recovery in the European automotive sector. To the extent, I think it would encourage a restocking effect and progressive commentary on the European market has just been worse every time. So we really don't see that happening though in 2013. Obviously, it is going to happen at some point, but we don't really see it happening in 2013 now, so that's gone. And then, finally, we are a bit disappointed that it's seems that the impact of sequestration on the military purchases is going to be harsher than we had feared. Now, that's not certain, but we think we've got to take a downside view on that. And it would appear that there were being harsher in cutting back on purchases to get stocks down than we had originally hoped that it would be, given by the guidance that they've given us on the plan to reduce stocks progressively through the middle of 2015.

And then just my follow-up would be, on your European sales, overall was down about 6% year-on-year in Q2. Does the revised guidance embeds that stays down year-on-year in Q3 as well as Q4? Do you think you'll be sort of at a flatter run rate exiting this year?

I don't have the details in front of me, but I would expect it to be pretty flat. The Elektron numbers which might be down on the North American flare business. Well, as I say, still the prospect of the orders coming in would change that, but at the moment it looks like they'll be down. So European side, I think, shouldn't be any worse and flat, but it's not much likely to the better, I think.

Your next question comes from the line of Luke Folta with Jefferies.

Couple of questions here on CNG, if you looked at the CapEx that you've authorized for this year, I think historically we've talked in terms of what your total revenue capacity would be. Can you give us a sense of, after these investments, what the revenue capacity would be and how that would break up between the larger CNG tanks and the portable tanks?

The AF capacity increases that we're putting in, which are largely linked to liner capacity, we will have enough lined capacity with the acquisition of Dynetek. Well, that capacity comes on stream in two phases. The first phase, which has just come on stream is worth about $7 million of revenue per annum. And the second stage, which comes in at the start of next year is an incremental roughly $10 million of revenue on AF. The expenditures that we have announced on the portable cylinders, the SCBA cylinders, although at $7.5 million, that is an across-the-board investment in all parts of the process, and that will generate incremental sales potential of certainly north of $10 million. Not quite sure of the size figure, but something north of $10 million. And that is an investment in across-the-board on liners, on wrapping, heat treatment and all the rest of it.

And just a follow-up, as far as Elektron margins are concerned in the auto-catalyst business. I understand that there is a margin impact because of mix, those are higher value products and also some impact from utilization. But I wanted to get a sense, is any of the margin impact due to pricing or is that largely been stable?

The pricing is pretty stable. We've thrown the odds and spent it in their on quantity discounts. But I'm not concisions of any price reductions as such. I mean the margins on the product remain at the target level. So essentially all we need is for volumes to come back and that will drive the profitability up quite quickly. In essence what we have is a relatively high fixed cost base in the chemical business and high margins on the products. So when we lose volume and they can come back quite quickly with the volume returning.

Your next question comes from the line of Anthony Raab with Perimeter Capital.

I was hoping, you can help us understand or help us size the opportunity for revenue in the GTM joint venture?

The GTM business, I'll say it's a JV and we're going to equity account for our share of the profit. So the actual revenues that it makes we will not be consolidating. We will be reporting the revenues on the cylinders that we sell into the business, indeed just as we do today. So the added value they add on, I mean the bulk of the cost of the modules is in the cylinders, but they do obviously have added value and added profitability. So in addition to making the dual profit on the cylinders we will take our 49% share of the added-value that they generate, which is not insignificant. We do think it's well worthwhile and we'll get a good payback. But it also, of course, ties in a major customer for our cylinders. The revenue potential for the GTM business in terms of the modules that it sells, I think we're looking at several tens of millions of dollars. I can quite easily see that getting towards a $30 million business in 2014.

So what do you think the return is on that investment?

Well, it's to full extent depends on the mix of sales and to whether it's outright purchase or leasing, but our customers in this business that really want to lease their facilities. On the accounting for the leased products it's going to be quite different. The majority of the business that we are seeing at the moment, the majority of the orders that we're taking are for outright sale. And so the return on those will be relatively immediate and I think that we will make very good return on our equity investment. I would talk that the payback on that substantially less than two years.

And maybe one more related to that, what's the timing? I mean when do you think that JV will see its first sales?

Well, it has made some sales already. We did enter this JV earlier in the year without naming the partner, so you just know that we've decided to go public with the partnership. But we have been working with them, generating all the group there for last several months. And so I can say that in July for example, I know that they have shipped eight modules containing our cylinders and they have built up quite a significant order group, such that we hope to see some quite significant sales of modules in the second half of this year. The only issue really being, one of ramping up the production to make sure that they can satisfy the customer demand because we're taking the business to a different scale to anything that's been out before, even though our partner has been in this business since 2007.

And then on the magnesium front, I think you said it might be a while until we see any revenue, but could you help quantify that or put a finer point on that?

Well, what we have said previously is that with the lead time on getting material built into a seat design, that realistically it's unlikely that we will sell more of prototype material during 2014. So I think it's more likely to be the middle of 2015 before we might see some of the first new designs coming to the market with magnesium components built into it. And then you could expect progressive increase after that, depending, what penetration that we make on replacing aluminum. But we've always said right from the start that we believe that this market has the potential to generate, at least an incremental $20 million of revenue to us once it has reached the relative level of maturity. And we'll start that process, I would think, round about the middle of 2015, depending on the discussions that we have with the seat manufactures including commercial negotiations between now and that point.

Your next question comes from the line of Philip Gibbs with KeyBanc Capital Markets.

First question is just on the European automotive market. The production momentum there looks like it's getting a little, I would say, less bad. So is your situation, your outlook on the lack of restocking, Brian, more or less related to within your own competitive situation?

Well, it's always difficult for us to analyze that one precisely. I mean, are we ascribing the bulk of the issue to the market, and yes, I think it is getting less bad, but it's getting less bad for the people who had expected it to. And in general, of course, Q3 in absolute terms is the lowest production quarter, just because of the normal seasonality. So I mean it could be that we see some restocking in the fourth quarter, but we don't feel confident enough to include that in our forecast. So we're assuming that's been pushed back now until 2014.

And can you give us a sense of what the biggest portion of your reduction and full year guidance, I know you mentioned the moving pieces, but is it 65% Europe, 35% U.S. defense, just so we can have an idea of really where you made the changes?

I think top of the head, and this is top of the head, I would say that the military is worth a $2 million of that $10 million delta that we talked about earlier on. So majority of it is Europe. And the majority of it, within that, is the Elektron business and the automotive sector, because in the automotive sector we had assumed the pickup in demand and the restocking effect and we're now assuming that neither of those happens. But we also have a decline in the European cylinder outlook versus where we were three months ago. I think that's probably lost about $1 million as well.

And now, on some of your longer-term new products such as your Chemcat and your magnesium hard stance, anything that you could tell us there as far as your expectations for those two products?

Just that they are going the way that we expected they would and there is nothing really to report at the moment. As you know, these are long-term projects, their periods are very long. The chemical catalysis, in particular, there is still a huge amount of what's going on with perspective customers on product supplying them with prototype material for them to test and build into pilots operations. And we are still in commercial discussions with the couple of those customers who have quite substantive long-term contracts. Now, we still hope that there would be something to say more on that before the end of this year. But right at the moment there isn't anything, any progress to report. But you shouldn't get worried about that. There is still a lot of activity under the surface.

Your next question, it's a follow-up from the line of Luke Folta with Jefferies.

So Ford reported that they're going to start using alternative gas cylinders in some of their F-150 line and I imagine some other vehicles as well and I'm sure some of the other manufacturers are doing the same. Can you give us a sense of what Luxfer's participation might look like in that segment of the vehicle market over time?

Well, we certainly are developing certain designs that would be capable of being used in such vehicles. Strategically, supplying into the volume, automotive sector is not a priority, because in the long-term their ability to generate margins is really quite tough, and so in the automotive sector we prefer to deal with the converters or the lower volume manufacturers such as bus manufacturers. But we will have products available and we will be certainly having commercial discussions with people like Ford over the 150, over our cylinders. But at the end of the day, we don't sell a few vehicle cylinders. And the automotive industry will have to meet our price, the payback, all the investment that we put into this area. So I'm not holding out to a great deal of prospect that that will be a major revenue generator for us, but we're certainly be taking a good look at it and we will have products available as long as people are willing to pay the premium for this sort of product that we can sell them.

And then just one last one, regarding the new joint venture in the bulk gas side, did you disclosed, and I'm sorry, if I missed it, your percentage ownership in that joint venture?

It's 49%.

And then can you talk about, again, how the accounting work, so are you going to be selling cylinders to the JV and that revenue should show up in Luxfer's P&L and then when they make a profit on the unit, some of that profit gets booked as equity income, is that how it works?

Yes, absolutely. You're absolutely right. So we will just carry on recognizing our cylinder sales to the JV, but we will recognize the additional profits, almost as additional margin from our 49% share of their profits. We also, if they lease cylinders or require additional funding, we would recognize an additional income relating to that where we have helped fund that and that's what this additional, up to $10 million of additional funding that we've put in place for supply chain funding and leasing. And it is leasing that would come through our interest line and the funding comes through the operating line.

So essentially we'll end up boosting the margin on the AF cylinder sales, if it's an outright sale.

And for the outright sales, how should we think about margins in that business? Is that's going to be something, kind of, similar to the Gas Cylinders business?

I think that the added-value they put in, I think is a ballpark. We probably want to work on then to trying to generate somewhere 20% margin on their sales. But the added-value is obviously limited. The quantity of the cylinders that go into these, the value, the bulk of the value in the product is in the cylinders. The added-value is rather less than the value of the cylinders that goes in.

So you're saying 20% of their value-added revenue in that situation?

Yes.

Your next question comes from the line of Neil Morgan with Marathon.

Couple of quick questions, both on strategically important areas. But just following up on the magnesium in planes and the news that that we've got through which is good. A couple of questions there, firstly, has there been any reaction from the seat manufacturers? And secondly, do you get any visibility over other competitors who pass the lab test, which are now seen as satisfactory or would you not know if anyone who is looking to make a similar alloy would have something, which has passed those lab tests?

First of all, the meeting that I referred to, the international materials fire testing group, alongside the minutes which are on the website, there is also a list of the attendees at that session, two-day session that was held here at Manchester and it runs to 94 people. So it's a pretty extensive industry review body. Now, I don't recognize all of the names, all the companies that were there, but certainly there were obviously from the names listed, there were 18 people there from the airframe manufacturers, there were eight from seating manufacturers, four from airlines and eight from various civil authorities around the world. So not just FAA, but the CAA was there along with Transport Canada and Singapore Air authority as well. So it was very, very wide body. And as far as the seating people are concerned, it's our belief that they have been working for sometime in the full expectation that this result would take place. Otherwise, we could never really explain why they were willing to do the work and take prototype equipment materials from us over the last 10 to 12 months in preparation. So I am pretty happy that this will be an accelerator boost to our work with them to develop the ultra-light weight seating designs. Having said that, we still have to go through our commercial negotiations with them. We haven't obviously got to the point where we committed to them what price we are prepared to supply large volumes of material at, and with just deadlines proves that it will stay. So there is a lot of work still to do commercially as well as them to complete their design work. But we do think that this is now very widely known and they will widely anticipate it. And in terms of our competitors, I mean that the tests have been done using essentially our aerospace alloys on the one hand, generally available commercial alloys on the other, and so at the moment our alloys pass the test and the generally commercial available alloys do not. There are other alloys out there that might pass the flame test. A calcium based alloy might pass the flame test. However, my base is that, it's unlikely to pass the erosion requirements or crush requirements. It doesn't have the aerospace certification that our alloys already have. So at the moment there's no visibility of our direct competitor for that field, which is not to say there might not be one. But we have no visibility of one at the moment, so at least we have a significant head start

And just one follow-up, you mentioned the Chemcat products, I mean, it's great to hear that lots of work is still going on. You're still in discussion with companies, quiet substantial in term contracts. But so taking that, is there still a delta between a H1 '13 performance and H1 '12, because I know in Q1 '12, the cost of sales of these products, when you don't have a long-term contracts are particularly lumpy? I think you had some decent lumpiness in the comparative period of '12, but don't know if you have it in '13, so where that's been the delta?

Certainly, at one stage we had hoped for a net increase in sales, '13 over '12 and we're not now expecting that. So it's not a major element of the delta that we talked about. But certainly as you say, it is still lumpy and some lumps that we might have thought that would have fallen to '13, now look like they will fall into '14 instead, but it's not a major contributor.

Our next question comes from the line of Julian Mitchell with Credit Suisse.

I just wanted to double check, well, let's say, 12 months from now, what the annual sort of revenue run rates in terms of capacity is in AF after the sort of second phase of CapEx comes on stream?

I would suggest that it's somewhere of $70 million or thereabouts, where we're seeking to deliver at least $50 million this year. I may have a part year impact of Phase 1 of the additional capacity. So I think that it's somewhere north of $70 million, somewhere between $70 million and $80 million a year, in terms of our capacity based on the current mix of sales in term prices.

And then lastly, you talked about obviously the weakness in European and some U.S. defense business, how does that change your outlook on restructuring spend? I mean are you planning to book many more restructuring charges from this point?

No. I mean, we don't see in the late of the financial results, we are making efforts to trim the cost, but there is no major structuring required. The situation that we're looking at, we believe is a temporary one and while we may have some small bits and pieces there are no major restructurings that we are anticipating would be required. I mean essentially we're just suffering from weakness in some markets. And we need volumes to return to get back on upward trend across the board. We have no reason as we sit here to believe that won't happen. So most of the businesses have a lot of cost trimmed out of them over the years. So it isn't great deal of path to go out anyway, but we have no perception that we need to take a big slice to cost. And so I don't anticipate much more the way we're structuring cost this year.

At this time, we have no further questions. And I'd like to turn the floor back to over to management for any closing remarks.

Okay, well, thank you very much, ladies and gentlemen. I know the results are a little bit disappointing, but please stay focused on the long-term prospect for the business, which we still believe is very, very positive. And we will speak to you again in three months time. Good bye.

Thank you. And recording of this conference call will be available in about two hours. For information about how to access this recording, please visit the Luxfer website at www.luxfer.com. Thank you for participating in Luxfer's second quarter call. You may now disconnect.