Luxfer Holdings PLC

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

Thank you, Stephanie. Welcome to Luxfer's Third Quarter 2020 Earnings Call. We're happy to have you all with us today. I'm Mary Read from Luxfer. And with me today is Alok Mascara, Chief Executive Officer, and Heather Harding, our Chief Financial Officer. On today's call, we will provide details on our third quarter 2020 performance, as outlined in the press release issued yesterday. Today's webcast is accompanied by a presentation that can be accessed at luxford.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 the Safe Harbor Statement on slide 2 of today's presentation for further details. Let me turn the call over to Alok.

Thanks, Mary, and welcome, everyone. I hope you and your families remain healthy during these turbulent and uncertain times. Before I discuss our third quarter performance and provide an update on our transformation strategy progress, I want to thank our 1,500 employees around the world for working hard to ensure the health and safety of all our colleagues and their families while always putting our customers first. I am proud of our team's discipline and steadfast adherence to operating procedures as we navigate the COVID pandemic. While several of our end markets remain challenged, we have been executing with agility as we recalibrate our cost structure to current demand levels while also positioning Luxfer to fully capitalize on recovery. With that, let me provide some highlights that sum up our quarterly performance and strategic focus. First, we delivered solid Q3 financial results despite challenging end market conditions, and we are seeing sequential improvement across our businesses. Second, we generated very strong cash flow, further bolstering our already robust balance sheet. This gives us greater optionality as we invest in organic growth enablers and pursue potential inorganic opportunities. Third, we executed our transformation plan and made meaningful progress on initiatives to drive growth through new product development and commercial excellence. I will provide more details on these themes and our CFO, Heather Harding, will then review our financial performance in greater depth and share guideposts for the remainder of 2020. Now please turn to slide three for a summary of our third quarter financial results. We delivered solid third quarter results as we addressed the impact of COVID-related macro conditions on our end markets with a focus on controlling costs and driving free cash flow. Total sales of $90.4 million declined 15.6% on a year-over-year basis, but we saw sequential improvements compared to the 21.1% decline in the second quarter. Third quarter adjusted EBITDA of $14.2 million declined 15%, helped by cost actions to mitigate the gross margin impact of lower volumes. Our adjusted diluted EPS for the third quarter was 25 cents, down 31% as compared to the prior year. During the quarter, our focus on working capital resulted in $25.6 million of cash generation, including $1.4 million in cash restructuring expenses. This enabled us to reduce our net debt to $59.3 million compared to net debt of $82.4 million at the end of the second quarter. Our net debt to EBITDA ratio improved to 1.1 times at the end of September, which is significantly below our covenants. Our balance sheet remains strong with additional liquidity from $150 million of an undrawn revolving credit facility, providing us a lot of financial and strategic flexibility. We are currently operating most of our facilities at reduced capacity to serve the evolving needs of our customers and are encouraged by the sequential improvements in demand. All our locations are operating with additional COVID safeguards, and as the number of positive cases continues to rise, the health of our employees, our customers, and our communities remains our number one priority. Now, please turn to slide four for an overview of how Luxfor has adapted to the new normal. Over the eight months since the COVID pandemic began, we have effectively adapted and innovated better ways to serve our customers. We have retooled our manufacturing operational procedures, rearranged shift patterns, and enabled remote work where possible to minimize the number of people in our facilities at any given time. We continue to limit the number of visitors to our facilities while making face masks and social distancing mandatory for all personnel. Some of our procedures are likely to result in more permanent change as we continue to adapt to an ever-evolving external landscape. If there is a silver lining, The pandemic allowed us to accelerate many of our lean initiatives, and I believe Luxfor will be better positioned to capture growth in the future. Given the current environment, our customers are shifting preference towards a localized supply chain. Luxfor is a beneficiary of this shift as most of our manufacturing is in region for the region. For example, U.S.-based manufacturing generates greater than 90% of its sales in the U.S., and a similar situation is true in Europe. Lastly, greater remote connectivity allows for increased access to a broader talent pool as physical locations become less relevant for certain roles and positions. We will continue to leverage the skills and talent of our dispersed workforce even after the pandemics. Let's now review our revenue performance by end markets on slide five. As a reminder, our current sales can be classified into three approximately equal end user markets. Defense, first response, and healthcare. Transportation, which is a combination of alternative fuel, aerospace, and automotive. And general industrial. Before we review the performance of each, let me give you a sense of the shifting demand patterns we saw during the quarter. There was a gradual sequential improvement in sales after the very low levels experienced in April and May. Order rates continued to improve modestly in July and August, but plateaued in September, especially in the US. Two factors that may be impacting order patterns or uncertainty surrounding US elections, which would be typical for defense orders, and the recent uptick in COVID cases across the country. We are closely monitoring our order rates and will execute additional countermeasures if business conditions deteriorate. In the defense first response and healthcare markets, sales declined roughly 8% for the third quarter. We saw increased demand for our disaster relief products and chemical response kits, but that was offset by a decline in cylinder sales for fire extinguishers and SCBA. Sales in transportation declined 19% in the third quarter. Demand for luxury passenger auto improved modestly, and our auto catalyst products grew year over year. However, Demand for aerospace applications weakened during the quarter as manufacturers implemented additional production cuts in response to a protracted slump in air travel. Alternative fuel returned to growth during the quarter, and we remain optimistic that this trend will continue going forward. Sales in the general industrial end market declined 19%, which is a meaningful sequential improvement from the 27% decline in Q2. The sales decline was broad-based and impacted most of our industrial products. However, we are encouraged by the sequential month-over-month improvement as the quarter progressed. As expected, there were virtually no Solumag sales during the quarter. Despite our strong position, we expect Solumag sales to remain challenged for the rest of the year. Now, please turn to slide six for an update on our transformation strategy. We are successfully executing our transformation strategy with discipline and are creating incremental value for our shareholders. Successful completion of the simplification phase has significantly improved our balance sheet. The lower fixed cost enables us to better navigate the COVID pandemic and benefit from future recovery. Phase two of the transformation plan covers improvement in our high performance culture and lean operations. Phase three is focused on growth through organic means and through portfolio optimization. We remain committed to completing the transformation plan and creating incremental value as market recovers. Over the next few minutes, I would like to share some examples that will drive success for phase two and three of the transformation plan, starting with a review of our environmental, social, and governance slide seven. Despite the challenging economic landscape, we have increased attention on developing sustainability initiatives that position us for a stronger recovery and long-term success. we are pleased to report that we will be publishing our first-ever Environmental, Social, and Governance report in the coming weeks. Our ESG report discusses key subjects of interest to our shareholders, such as the establishment of our 2025 Environmental Protection Goals, disclosures of social statistics, and an overview of our governance structure. Our upcoming ESG report highlights our long-term sustainability activities and explains how these activities are driving our performance. The purpose of this report is to initiate consistent reporting on ESG matters, improve our transparency and disclosure, and formulate the basis for an informed conversation between us and our stakeholders. We realize that non-financial reporting is important to our stakeholders. As such, we hope that by periodically publishing an ESG report, we are creating a different platform through which we can connect about the ways we are creating value for all our stakeholders, including employees, customers, communities, the environment, and shareholders. We also hope that increased transparency in this regard can be a tool to promote our resilience and will strengthen our ability to emerge stronger post-COVID. Now, please turn to slide eight for an example of one of our growth initiatives. As many of you know, our zirconium products are often used in the formulation of three-way catalysts for catalytic converters in gasoline-powered automobiles. Environmental consideration and changes in emissions regulations are increasing the content per vehicle of our products. In addition, shift from diesel to gasoline in Europe is offsetting the shift from internal combustion engine to electric vehicles for companies like us that are focused on gasoline-based products. To further capture growth from this end market, We have recently launched a new nanotechnology-based product for gas particulate filtration. This new product utilizes our strong IP position and unique technology to deliver exceptional catalytic and filtration properties to our customers while minimizing any exhaust back pressure to optimize performance. We are optimistic that this new product and our other existing products for gasoline particulate filtration will drive strong organic growth. We expect this product category to ultimately make up over one-third of our autocatalytic product sales. Now, please turn to slide nine for an example of our success in the area of hydrogen fuel cell vehicles. When it comes to hydrogen fuel cell vehicles for public buses and medium to heavy duty trucks, Luxfer is well positioned with 30 plus years of experience in hydrogen storage technology. Our competitive advantage in hydrogen is based on industry leading lightweight cylinder technology and our capability for advanced systems design, manufacturing and testing. We have a proven track record in partnering with customers to deliver hydrogen first, including the world's first hydrogen double-decker bus, the first commercially available hydrogen garbage truck, and the first hydrogen-based train in the UK. We manufacture these lightweight cylinders in our state-of-the-art alternative fuel facilities in California and Canada. which also make cylinders for compressed natural gas-based vehicles. Our systems are designed and assembled in our Nottingham, UK facility using just-in-time development and manufacturing techniques. While this is a nascent industry and sales of our hydrogen storage products make up only about 1% of our total sales, we are excited about the growth potential in this space and will continue to invest in building our hydrogen innovation and manufacturing capability. Now, please turn to slide 10 for an example of one of our lean manufacturing initiatives. Our LuxForum Magtech Cincinnati facility historically only manufactured flameless ration heaters and self-heating meals and beverages. But more recently, It has started the production of chemical response kits after the consolidation of our factory in Riverhead, New York. The expanded size and scope of the Cincinnati factory has generated scale economies. This has created the opportunity for us to deploy more lean talent and invest in manufacturing automation. The recent successful launch of new chemical response kits for decontamination and the COVID-related higher demand for emergency response has placed additional strain on this facility. To satisfy our significantly increased customers' need, our team had to recruit a large number of temporary employees. Attracting, training, and retaining temporary employees during COVID has been a challenge, so we have recently installed an automated packaging line for our self-heating meals to reduce the need for additional workforce. The new line will also increase the quality and consistency of our heater meal products while reducing the expected delivery time for our customers. The Cincinnati example is just one of the many lean automation transformations that is taking place in Luxor facilities post the recent footprint consolidations. Fewer larger factories are allowing us to deploy more lean resources and invest smartly to better serve our customers and increase productivity. Our internal manufacturing scorecard shows significant improvement in safety, quality, delivery, cost, and cash in our factories. These improvements will generate attractive returns and allow us to efficiently serve our customers. Let me turn the call over to Heather Harding, the first chief financial officer, for details on the transformation plan results and a summary of our third quarter financials.

Thanks, Alok, and good morning, everyone. Thanks for joining us today. Following Alok's review of the strategic elements of our multi-year transformation, I wanted to summarize the financial impacts of this plan on slide 11. Our focus on cost reductions and waste elimination has resulted in $18 million of net cost savings through the third quarter. In addition to cost reduction, the smaller footprint in our manufacturing has reduced our annual operating capital requirements by approximately $5 to $6 million from our historical levels, further improving our cash generation. Our overall lower cost structure will deliver incremental profitability as our end markets recover. We remain on track to deliver our committed $24 million of net cost reduction by the end of next year. However, based on the strength of our Q3 performance, we now expect to deliver an additional $1 million in savings this year for a total of $6 to $7 million in savings in 2020. Now let's walk through the third quarter financial results summary on slide 12. Third quarter reported sales of 90.4 million declined 15.6% year over year, primarily due to the COVID-related impact in our transportation and industrial end markets. Consolidated adjusted EBITDA for the quarter of 14.2 million was down 15% versus the prior year. Despite the volume decline, the company executed on the transformation plan and delivered approximately $2.8 million of net cost reductions in the quarter. There were several one-time events in the quarter that impacted our results. The quarterly adjusted EBITDA was positively impacted by approximately $600,000 of net favorable non-recurring items, including a net benefit from a customer contract in the gas cylinder segment, and partially offsetting charges in the electron segment for obsolete processes and agency contract. The quarterly adjusted effective tax rate was negatively impacted by $900,000 for the change in Canada tax rates affecting our deferred tax asset position. For a deeper dive into our two product segments, let's turn to slide 13. Electron sales of 45.4 million declined 14.2% from the prior year. The sales decline was primarily due to weakness in magnesium aerospace graphic arts, and industrial products, partially offset by strength and heater meals and chemical response kits. EBITDA declined 36.5% to 6.6 million due to lower sales performance and a net $1.2 million charge for one-time non-recurring items. Gas cylinder segment sales declined 17% to $45 million as COVID impacted European luxury auto, aerospace, and industrial products with alternative fuel returning to growth. EBITDA of $7.6 million increased 21% from the prior year, as cost reductions offset the sales volume decline, and profitability included a $1.8 million net benefit from one-time non-recurring items. Now let's review our key balance sheet and cash flow metrics on slide 14. We ended the third quarter with a stronger balance sheet. Our net debt improved to $59.3 million, leading to a net debt to EBITDA ratio of 1.1 times. Third quarter operating working capital of $89 million, with $17 million lower than Q2. The resulting operating working capital as a percent of sales was 24.6%, which is slightly better than our prior year and level. This performance reflects the results of our working capital initiatives. which were primarily focused on aligning inventory to current demand levels. We expect to maintain most of these working capital improvements through the fourth quarter. We generated $25.6 million in free cash flow, a record for the third quarter, using approximately $1.4 million in cash for restructuring activities. This compares favorably to our prior year's third quarter performance of $1.2 million cash outflow. On a trailing 12-month basis, We delivered 11.8% ROIC from adjusted earnings. Our balance sheet is solid and we're generating positive free cash flow. We remain well positioned for strong cash conversion in 2020 and beyond. Now I'd like to review our capital allocation priorities in slide 15. It's mentioned earlier in the call, we expect our cash conversion to average 100% of our net income through disciplined capital allocation. We are in great financial position with a strong balance sheet and ample liquidity to take further steps to drive profitable growth. This includes strategically evaluating our business portfolio and identifying options to drive additional shareholders. Our primary focus of capital allocation will be creating value through internal execution, which includes funding of new product innovation and talent development. We continue to fund our transformational cost savings initiative With expected cash costs of approximately $40 million through the end of this year, we expect 2020 CapEx to be in the $8 to $10 million range. We remain open to strategic acquisitions to supplement our organic growth. Our focus will be on businesses that provide one or more of the following criteria. A leading position in industrial material niches. The ability to expand our business and key product categories, markets, or geographies. strong engineering, IP, or critical process technologies, significant synergies, and a strong cultural fit. We would expect ROIC to meet our hurdle threshold within three years. We will continue to return cash to shareholders via dividends. As a reminder, we've paid out over $90 million in dividends since 2013, including 3.4 million in the recent third quarter. During our June Annual General Meeting, we received approval from our shareholders for share buyback. However, we're not initiating a program at this point given market uncertainty. In the interest of transparency, let me provide our views on some of the key assumptions for the remainder of the year on slide 16. The challenging current market environment is having a significant impact on our businesses. For the fourth quarter, we expect total revenue to remain essentially flat on a sequential basis. Importantly, this is despite our typical Q4 seasonality, where we often experience a sequential sales decline from the third quarter. We expect both defense and transportation in market sales to improve slightly from Q3 levels. Given the seasonal impact, we expect industrial and market sales to decline sequentially, consistent with prior year. We remain focused on our cash initiatives for the year. we will ensure working capital and capital expenditure plans are aligned to current conditions without sacrificing investment in future growth and productivity initiatives. Building on our significant cash generation in Q3, we expect the cash generated in the fourth quarter to be used towards planned outflows, as well as a modest inventory bill driven by seasonality and potential Brexit impact. For the year, free cash flow would convert at more than 100%. With our strong balance sheet, we remain confident in our ability to successfully navigate current market conditions and position Luxfer to capture growth as markets recover. Now I'll turn the call back over to Alok for a wrap-up.

Thank you, Heather. Please turn to slide 17. Let me wrap up by recapping that we serve attractive niche 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 even more shareholder value by deploying the Luxfor Business Excellence Standard Toolkit to drive operational improvement and to accelerate growth. Once again, I want to thank all our employees around the world for safely operating our facilities while maintaining our commitment to always putting our customer first. Thank you for listening. We will now take questions.

At this time, if you would like to ask a question, please press star, then the number one on your telephone keypad. Again, that is star, then the number one on your telephone keypad to ask a question. Your first question comes from the line of Chris Moore with CJS Securities.

Hey, good morning, guys. Thanks for taking a few questions. Yeah, I just want to make sure I'm looking at the cost savings correctly. You talked about, you know, some COVID cost reductions to be permanent and then kind of trying to understand is that incremental to the transformation plan that's happening now or is that incorporated in there or kind of any detail you could give us on the COVID cost reductions that could be permanent would be helpful.

Sure. So Chris, I think from COVID perspective, we have quite a bit of cost reduction that we have to do just to offset the gross margin impact. But putting that aside, both cost decreases and higher cost. So each of our factories is spending more for sanitization, cleaning, inefficiencies. And we have savings, whether it's things like travel, supply chain, transportation. The total commitment on $24 million does not change. So that remains our net cost savings. What we are more optimistic is once growth recovers next year and some of the one-time COVID-related costs are behind us, we will generate additional better drop-through when the growth recovers. But a simple way to look at it, let's keep the cost outnumbered at 24, and you know, any upside in future comes from better gross margin on sales that come back.

Gotcha. All right. Thank you. On the revenue side, how much visibility do you have into fiscal 21 with respect to the decontamination kits and the heater meals?

We'll have more visibility by the end of the year. So at this point, we do expect the sales to continue going into next year at the same level as what we had in 2020. But by end of the year, we'll have more confirmation in terms of confirmed orders. But right now, we expect that to continue.

Got it. And obviously, new product development, important. Does R&D spending need to increase much over the coming quarters in order to take advantage of the opportunities that you're seeing at this point?

Not really. I think we, as you know, we spend right about 1%, and I think numbers are going to remain in that range. You know, we've been very efficient, and we've been very focused on fewer, bigger projects, and that seems to be paying off without the need to significantly increase our R&D spend. So I think we should think about that 1% for the near future.

Got it. And last one from me. Any Brexit thoughts at this point in time? Is there any potential near-term impact that that might be had on Luxor?

Hey, Chris, I'll take that one. Good morning. You know, overall, certainly we feel like we've planned for this a couple times, depending on the nature of the project over the last, I think, four years or so. Certainly from our perspective, we feel like we've done the proper planning that we don't think will be disadvantaged any more than any other business depending on what logistical or new, you know, administrative requirements are enacted. We have, as I mentioned, we are looking at some key inventory, you know, positions and making sure that on some key items that we will likely build a little bit up in the fourth quarter. And, frankly, we think some of our key customers may be, you know, may be looking at that as well. So, overall, we don't view it as a significant material, you know, impact to us as we get to the end of the year.

Got it. I appreciate it. I'll jump back in line. Thanks, guys.

Thanks, Chris. Thank you. Your next question comes from Craig Irwin with Roth Capital Partners.

Good morning, and thanks for taking my questions. Good morning, Craig. One of the things I really like about Luxfer is you have an array of interesting – growth opportunities in front of you, right? Everything from alternative fuels to new particulates technology in automotive catalysis to even things in medical markets, right? Can you maybe list your top opportunities for expanding 2021 contribution to the top line? Can you maybe sort of expand on the the proportionate impact or maybe rank the impact from a dollar perspective and what you're looking for to get confidence there to be more bullish because it seems like you're – generally conservative, which I know is just the way you operate, but, you know, if you could maybe describe what you're waiting for from your customers to get more confidence that these will all be a larger contribution.

Thanks, Craig. You know, from our perspective, you know, it's hard to talk about growth given the steep COVID-related impact, but putting macro aside, I think the area that we are most bullish is alternative fuel right now. And that's especially true with hydrogen, but also true for compressed natural gas. You know, that's a product line that's more than tripled over the past few years. And we already have a strong backlog of orders going into next year. So we feel quite confident. We work with some great partners to supply these solutions around the world. So Keep in mind, also, we are very focused on large buses and heavy to medium-duty trucks. We don't play in the passenger auto market, which means we are very specialized and capture fair or more than our fair share of growth in that space. Second, I would put our zirconium product lines. That's where the gas particulate filtration belongs. That's where we have quite a bit of the medical opportunities that go into pharmaceutical industry. And that's where also we have some industrial new product coating based on similar nanotechnology that we talked about. So I think that's the other piece we feel very confident about, continuing to drive growth in that space. The third area that I would highlight would be something that Chris mentioned earlier, is just decontamination, decontamination kits, which are the ones made in our Cincinnati facility that we highlighted. You know, another growth area for us, another place where we have unique proprietary technology and very high market share. So those would be our one, two, and three. Alternative fuel, zirconium products, and finally the decontamination grid.

Thank you. So if I could ask a follow-up on the alternative fuels side. So UPS is one of the most vocal customers in this market. You know, unfortunately, not a big customer for Luxfer, right? But they've gone out there and said multiple times on the record that their Class 8 trucks, they operate them on alternative fuels because even though they have higher maintenance costs, they still have well superior economics to conventional diesel trucks, right? The emissions regulations that are coming online and tightening and tightening for diesel are really pushing things in the direction of alternative fuels. So the reason I reference UPS is are you seeing strength predominantly in the big rig market in Class A trucks, or are you seeing broad strength across, you know, people looking for last-mile delivery solutions, people looking for small fleet, basically service organizations, and everything in between, or is there that same sort of concentration of up towards the larger vehicles that tend to go back to depots.

So thanks for bringing it up. I mean, UPS on itself may not be a big customer, but there are others which run similar route-based delivery networks. If you think of companies such as Waste Management or nowadays Amazon, all of these run route-based networks. And public buses have a similar system. So those are clearly our target customers. And we do supply some to UPS, although our competition probably has greater share in that specific customer base. Our current sales are more around route-based, kind of, you know, last-mile delivery-type opportunities. But we are seeing increasingly, like, you know, more and more companies looking at large Class 8 vehicles as well. But majority of our current sales are in medium, like, you know, chassis frame and looking at these which are more last-mile delivery going back to the service networks. We remain optimistic about the flaccid heavy-duty trailers as well, but that's more of a nascent industry right now.

Understood. And then just as a follow-up here, there have been a couple of very large contracts given in the last year. think one of them was a $500 million contract on a systems level, right? And there's been chatter about others, right? Amazon is a name that's out there. Can you maybe describe for us the tempo of procurement activity in this market? Do you see many, many contracts that are out there in the at a systems level, I guess, in the many hundreds of millions or a few hundred million that come back to Luxfer?

So globally, I think, yes. We do see quite a few systems contracts. And keep in mind that we assemble our own systems in UK. So there we participate directly in the systems market, and we see a very healthy pipeline. Now, You know, some folks are optimistic about those opportunities converting into dollars. Some may be less optimistic. We for one are quite optimistic on that level. It would come down to larger players like Amazon on the final decision that they make on their fleet. So far, CNG-based vehicles seem to meet all the environmental standards. They have excellent economics. given the delta between CNG and diesel is still pretty viable despite the changes in oil price. And frankly, from an environmental perspective, given that a lot of electricity is generated through coal or natural gas anyway, this has very good environmental impact as well. So yeah, we remain very optimistic. And while we can't commit to a number of either 100 or 500, I mean, it's in that range. And some single opportunities from larger customers itself could just be in that range on its own as well. So it's definitely an exciting opportunity. We have tripled the sales here, and we are prepared for sales to continue going up, and we'll keep investing in capacity and technology.

That's fantastic progress. That's really good to hear. So my next question is – Everybody understands why you're de-emphasizing fire extinguishers. It's obviously the right move for the company. But the impact on the top line and the duration of this impact is something where, you know, it's been a little bit difficult to model. Can you maybe describe for us what you expect the revenue impact to be for you over the next, you know, handful of quarters? How long does this last? And when does it start to show through? in margins as these products are shed?

Yeah, so first of all, you're right. I mean, it is absolutely strategically the right thing for us to do. This was a low-margin aluminum cylinder that hang on the wall where our lightweighting value proposition wasn't really valued by the customer. Right now, we look at this as about a little over a million dollars a quarter type impact, Craig, and we expect this to start lapping itself by kind of in early 2021. So we have another couple of quarters of this million dollar a quarter type impact going forward.

Excellent. Thanks for taking my questions. I'll take the rest of my questions offline. Congrats on the progress. Thanks, Craig.

Again, if you would like to ask a question, please press star, then the number 1 on your telephone keypad. That's star 1. question from Sarkis Shibabashan with B-Ready Securities.

Good morning, and thanks for taking my question here.

Hi, Sarkis. How are you?

Well, thank you. So, I just first wanted to get a better understanding on the gross margin level of the quarter. Heather, maybe if you could talk about what the one-time inside Electron, you know, if that had an impact or if there was just simply a mixed impact, and then I have a few more.

Yeah, good morning, Marcus. So, in terms of the one-timers, you know, the bulk of the one-timers from a cost perspective did hit gross profits. So over a million dollars of that one-time cost, net cost, did hit gross profit. And that obviously impacted Electron. So if you, on a restated basis, Electron EBITDA would have been, you know, north of like 17%, excluding the items. So that's certainly a big hit. When you think about the gross margin, I know our reported gross margin is just over 20%. When you pull out the impact of the one-timers, We were closer to 21.7, which, you know, certainly we're still obviously impacted by the COVID sales decline. But if you look sequentially relative to Q2, we posted, you know, some nice margin improvement on the gross margin line, just purely looking at an operating basis. So hopefully that gives you some indication of kind of the impact of our cost reduction programs and how we're, you know, working through all the efficiency items in our plants.

Yeah, it does. Thanks for that. And I think you mentioned in the prepared remarks, you'd expect sales to kind of remain flattish here sequentially. You know, maybe if you can talk about what you're seeing regarding order rates and maybe by, you know, either end markets. And then, you know, if you can maybe comment on the margin structure you'd anticipate, should that be kind of in line with what we saw this quarter and or improving given kind of your cost out? Just help us understand that.

Sure. So I'll start with the order rates. You know, it's still quite uncertain and our visibility remains less than ideal or less than before. But if I think of defense in a broad bucket, I mean, order rates are strong there. And there is typically an election year pause, which we anticipated and are facing. So putting that aside, You know, order rates remain strong, and we are bullish about, you know, getting that to be slightly growing part of, you know, Q4 and going forward, as Heather mentioned. Transportation, you know, aerospace is weaker. Automotive is a little better. Alternative fuel is going to grow, as we talked about. So net-net, I think that's going to become a growth area for us going forward as well. Industrial is the one where it's most challenging. For two reasons, Q4 is sequentially lower for industrial, so we are gonna face that. And that's where I think we have seen more just bouncing along the bottom. It's not getting worse, but we haven't seen things getting a lot better either. So that's the one which we are facing uncertainty and looking at how do we take this forward. From margin structure perspective, While in general our margins are pretty comparable across the board, you know, when industrial is very healthy margin, the auto that's coming back is lower margin than aerospace. So that does have a negative mixed impact to us, kind of partially offset by defense being stronger. So net-net, if we put the picture together, I would expect margins to remain stable going forward, excluding the one-time impact that Heather already mentioned. you know, some of the cleanup things that we did in Q3. Heather, anything to add to that? Or Sarkis, if that answered your question?

The only thing I might add, Alok, is that the last part of, I think, his question was around cost reduction. So certainly, you know, in our deck, we talked about we've increased this year's cost reductions from six to six to seven. So we're pulling, you know, we're pulling some forward. So obviously, Given the fact that we've posted, I think it's four and a half million year to date, you could certainly model in continued cost reductions that we do expect to deliver in the fourth quarter.

That's super helpful. And I guess just to kind of build off of that thought process, Heather, is Is the SG&A run rate of this quarter kind of the appropriate to look at going forward given kind of the cost out or, you know, were there anything unusual to consider for that number not to be kind of the typical number going forward?

Yeah, I think from that perspective, I think the SG&A is pretty indicative. You know, there's always a bit of quarterly things that happen. But overall, I would say it's pretty indicative for you to use going forward.

Okay, thank you. I'll take the rest offline.

Thanks, Marcus.

Thank you. Again, if you would like to ask a question, please press star, then the number one on your telephone keypad. Your next question is from Michael Leshock with KeyBank.

Hey, guys. Good morning.

Good morning, Michael.

So first, just on the SCBA timing, you called that out as it was impacting sales in the quarter. I thought a majority of that was behind us, at least pre-COVID. If you could kind of talk about what happened there and when you expect to realize the sales.

Sure. So I think on SCBA, the pre-COVID disruptions were more around some certification, and that's clearly behind us. I think right now what we are facing in SCBA is we work very closely with our key customers, which you know who they are. And each of us are just having a bit of a supply chain challenge in retooling our factories for COVID, ensuring social distancing. So we have had some timing-related issues in that case. And just unfortunate case of everybody operating under the new normal with COVID. But these are factories where people are often standing shoulder to shoulder doing assemblies and kits, and everybody had to just retool all their operations. So they're more just operational supply chain related delays that we hope to be able to catch up in Q4 and Q1 going forward. Through overtime, we can work and things like that. But there's not a demand issue at all.

Got it. That's helpful. And then moving on the M&A front, just out of curiosity, would you be targeting multiple niche transactions or would you favor a larger deal?

You know, I mean, I think we've talked about bolt-ons are what we are going to focus on. You know, from our perspective, we're not against a larger transaction, but given past experience and where we think we can add significant value, it's going to be around niche in markets, players where, you know, they have strong market position, similar to what we have, good attractive margins. But no, we're not looking at a big, large type transaction. Our focus is going to remain on bolt-on things where we can get significant synergies and fits with a theme of, like, riches are in niches. So we'll continue pursuing those. But at the same time, valuations, at least in transactions, have not come down and there's still a lot of money from private equity. So not suggesting that anything is going to be imminent here.

Is there an end market that you might target more than another?

You know, our strength on defense, obviously, is something that we like quite a bit. So the whole force category, I mean, we like aerospace. There are niches within industrial that we like. So, no, not specifically, but, you know, we try to, not increase complexity of Luxfer. Alternative fuel is an area that we like quite a bit. So it's just going to be areas which we feel we are strong in and areas where one plus one is greater than two.

Got it. Appreciate all the detail. Thank you.

Thanks, Michael.

Thank you. Your next question comes from Phil Gibbs with KeyBank Capital Markets.

Thank you. Alok, when you talk about the gasoline particulate filtration opportunity, I think your pitch says two and a half times sales increase in 2011, excuse me, 2021 versus 2019. How much of that growth did you get in 2020? Because presumably you've been growing this year in that as well. So I'm trying to gauge that.

Yeah, so we are growing. Now keep in mind that two and a half times sales is starting from a low base. So not all our sales are going into gas particulate filtration. And entitlement will be about 30% of our AutoCAD sales going into gas particulate filtration. This year, I would say, which is kind of consistent with our previous rule, we only talk about new products when we reach about a million dollars in sales. So that's where we would be this year.

You're going to be about a million dollars in sales in this year. Okay. Okay. And so that we, should we consider that that level you were at in 2019 as well? So this is going from about a million to two and a half.

2019 was close to zero. So there's 2020 million dollars, all new sales.

Okay. Got it.

Part of the overall auto cat, which, you know, like, you know, it's a one third of our total zirconium sales.

And Heather, you talked a little bit about the cost savings. Clearly this quarter was very strong in that regard. Do you expect incremental cost savings relative to the 3Q baseline, or is the number that you increased mostly based on the year-to-year comparison? So I'm trying to just understand if there's incremental relative to this past September quarter.

Right. So certainly, you know, as you know, when we measure the cost reductions, it is based on year over year. So we would expect a continuation of those programs into Q4. We've taken some significant, you know, cost actions here in the last two quarters. And so we're always looking for additional opportunities. But I don't expect, you know, significant sequential cost reductions from three to four. You know, it's continuation of our current cost plan, of our cost reduction plan.

Thank you.

Thanks, Val.

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 at Luxfor's website at www.luxfor.com. Thank you for joining us today. The next regularly scheduled call will be February of 2021. when the company discusses its 2020 fourth quarter financial results. This ends the Lux for Conference call. You may now disconnect.