Chart Industries Inc (GTLS) 2016 Q2 法說會逐字稿

Good morning and welcome to the Chart Industries Inc. 2016 second quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. As a reminder, today's call is being recorded. You should have already received the Company's earnings release that was issued earlier this morning.

If you have not received the release, you may access it by visiting Chart's website at www.Chartindustries.com. A telephone replay of today's broadcast will be available following the conclusion of the call until Thursday, August 4th. The replay information is contained in the Company's earnings release.

Before we begin, the Company would like to remind you that statements made during this call that are not historical in fact are forward-looking statements.

Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied in the forward-looking statement. For further information about important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements, please refer to the information regarding forward-looking statements and risk factors included in the Company's earnings release and latest filings with the SEC. These filings are available through the Investor Relations section of the Company's website or through the SEC website, www.SEC.gov.

The Company undertakes no obligation to update or publicly or revise any forward-looking statements. I would now like to turn the conference call over to Ken Webster, Chart Industry's Vice President and CFO. You may begin your conference.

Thank you, Jonathan. Good morning, everyone.

I would like to thank all of you for joining us today. I will begin by giving you a brief overview of our second quarter results and outlook for the remainder of 2016 and Sam Thomas, Chairman and CEO will provide comments on current market and order trends we see in each of our business segments. Sam will also introduce Bill Johnson, who, as you know, recently joined us as President and Chief Operating Officer and will provide a few comments as well.

Net income for the second quarter of 2016 was $21.2 million or $0.68 per diluted share. This included severance costs from cost reduction initiatives and acquisition-related retention recorded in the quarter of approximately $2.1 million. Excluding these items, second quarter 2016 earnings would have been $0.72 per diluted share. This compares with net income of $17.2 million or $0.56 per diluted share for the second quarter of 2015.

Second quarter 2015 earnings would have been $0.60 per share excluding the $0.04 per diluted share impact at facility shutdown and severance costs from cost reduction initiatives and acquisition-related retention in that period.

Sales for the quarter were $247.1 million, a decrease of 8.6% from the prior year quarter. This was due to a decline in our energy-related sales and energy and chemicals or ENC business as customers continued to delay projects and competitive pressures remain challenging for the new build projects that are moving forward at this time. Our gross profit for the quarter was $87 million or 35.2% of sales, compared with $74.9 million or 27.7% of sales in the prior year quarter.

Overall gross profit was up largely due to record ENC short lead time replacement equipment opportunities which were supported by our new life cycle after-market service offering.

Contract expiration fees related to project development in our ENC business contributed as well. In fact, from the short lead time opportunities and contract expiration fees contributed approximately $31 million to gross profit in the quarter. Orders received in the second quarter totaled $270.3 million and were up 35.6% from first quarter 2016, primarily due to a number of projects received across all of our businesses, which Sam will provide details on later.

In addition, first quarter orders tend to be down compared to subsequent quarters as a result of seasonality in the industries we serve.

Backlog at the end of the second quarter was $392.5 million which is up 2.6% from first quarter 2016. In the ENC business, second quarter sales were $61.2 million, a decrease of 33% when compared to the prior year quarter. The decline was due to continued weakness and upstream natural gas processing, petrochemical, and LNG markets.

Gross margins were 52.1% in the quarter compared with 30.3% in the same quarter of 2015.

As I mentioned, the impact from the short lead time opportunities and contract expiration fees contributed about $31 million to ENC's gross profit in the quarter which led to the significant margin improvement. In our DNS business, second quarter sales increased 6.4% compared to the second quarter of 2015, to $129.6 million led by strong sales in our US and European operations. Year-over-year LNG-related sales increased 16% and bulk industrial sales increased 15%. These increases were partially muted by lower packaged industrial gas sales across all regions.

DNS gross margins were 26.5% compared with 23.4% the prior year quarter.

The margin increase is due to favorable volume in the us and Europe as well as lower restructuring costs the prior year included costs associated with the shutdown of our Owatonna facility.

In biomedical, second quarter sales were $56.3 million, a decrease of 1.4% when compared with the prior year quarter. The second quarter of 2015 included revenues recognized in a large commercial oxygen generation project and our respiratory business is down slightly period to period. These decreases were partially offset by our life sciences product line which had a record revenue quarter boosted by new products.

Biomedical gross profit margin increased to 38.8% in the quarter compared with 32.8% for the same period in 2015 due to favorable product mix and lower warranty expense. SG&A expense for the quarter was $48.9 million, up $3.3 million or 7.2% compared with the same quarter a year ago. Variable short-term compensation expense was up and accelerated in the current quarter compared to the prior-year period, reflective of our strong operating income this quarter.

In addition, we increased our bad debt reserves in both DNS Asia and ENC and had higher restructuring related costs due to cost reduction initiatives. The impact from all of these items added $6.7 million in SG&A costs during the current quarter. These increases were partially offset by lower payroll and benefits, professional services, and travel costs associated with our cost reduction initiative.

Income tax expense was $11 million for the second quarter of 2016 and represented an effective tax rate of 35.9% compared with $6.9 million the prior year quarter or an effective tax rate of 28.7%. The increase in the effective tax rate for the current quarter is primarily a result of tax losses in China for which no benefit is recorded. Let me move on to our outlook for the remainder of the year. Despite the better than anticipated results and strong DNS in biomedical orders in the second quarter, our ENC orders and backlog remain weak and do not currently support our original sales guidance. ENC orders have continued to be weak here in July as well.

Given these developments, we now expect full-year 2016 sales to be in the range of $850 million to $900 million with diluted earnings per share still in the original range we previously forecast, given the favorable margin performance we had in the second quarter. But we have now narrowed that to be in a range of $0.75 to $0.95 cents per diluted share on a fractionally $30.9 million weighted average shares outstanding.

This excludes the impact from any restructuring cost or unusual item. I will now turn the call over to Sam Thomas.

Thank you, Ken. Good morning, everyone. During the quarter, we had record short lead time opportunities for replacement equipment and our natural gas processing and petrochemical markets.

These short lead time opportunities are typically critical shutdown situations to our customers which require us to respond immediately to supply replacement equipment. Although the timing of these events is not predictable, they are recurring in nature, and are an important part of our business and service to customers highlighting our unique capabilities and competitive strengths. These projects were executed successfully, aided by our newly established Chart Lifecycle after-market business while providing customer equipment to meet customer replacement needs is something we have done for years, Chart Lifecycle brings additional skills and resources to fulfilling the time sensitive and challenging equipment needs of our customers in demanding operational context. We continue to see interest from our customers in a wide variety of service plans offered by that group.

Overall, order trends remain strong in our DNS business. Within our industrial business, we are seeing opportunities in each areas like hydrogen fuel cell and space launch industries. Within the US and Europe, we are currently seeing the benefit and availability of LNG for power generation and marine application.

As all prices remain low and new capacity comes online, global oversupply of LNG petrochemical feed stocks and natural gas liquids are hindering our ENC business as customers defer capital spending in the near term.

Although there are a number of large plants in the bidding pipeline, the timing of those are difficult to predict with current estimates projecting late 2017, early 2018 time frames. Until government policy is defined and capacity overhangs are absorbed, we continue to struggle in China in terms of LNG adoption for vehicle fueling. Our management team in China has done an excellent job focusing on cost reduction and working capital initiatives.

We generated $49 million of operating cash this quarter, making this another consecutive quarter a solid cash flow generation. We continue to focus on working capital improvements as part of our long-term strategic initiatives and are making great strides in reducing inventory particularly in China. Our cash balance at the end of June was $213 million and we currently have no borrowings on our $450 million revolving credit facility. We are actively pursuing acquisitions that will provide synergistic opportunities to our portfolio.

We are also reinvesting in our manufacturing facilities to consolidate operations or redesign plant layout to reduce costs and improve efficiencies. Although we continue to face a constricted energy environment and macroeconomic challenges in China, our industry and regional diversification help offset the impact. As we look forward in the business, we continue to focus on improving our cost structure but maintaining our capabilities in order to be well-prepared for the next upcycle.

I would now like to comment on specific highlights for each of the businesses. Within energy and chemicals, we booked $53 million in orders during the second quarter. This is up from the first quarter, 2016 orders of $8.8 million and included record short lead time opportunities that were mentioned earlier and a $10 million order for an ethylene plant. Despite our second quarter results, the near term outlook for ENC remains weak as projects continue to be deferred.

For example, our production on the previously announced Magnolia LNG project is currently delayed beyond 2016, resulting in a lower forecast for ENC results in the second half. Expected capital spending for upstream projects is paused, as the current market is oversupplied with natural gas and natural gas, Petra chemicals.

In the near term, our biggest challenge within ENC is winning orders in a very compressed market to re-establish our backlog. As a result of continued head count reductions in the business, our next biggest challenge retaining key employees to ensure we can address opportunities as markets improve. We are addressing these challenges including shifting resources into new ENC life cycles after-market business and providing engineering resources to our other business segments as needed.

We are committed to meeting customer needs now and into the future and will remain on the forefront when the market returns. We are also well-positioned with our IPS/MR/LNG liquefaction process technology and (inaudible) heat exchanger offerings. We recognize some value in the project development side of the business related to those offerings this quarter through contract exploration fees, longer term projects which have been postponed.

Interest of project developers and Chart's range of LNG liquefaction solutions remain high longer term although investment decisions continue to slip out into the future at present. In our distribution and storage business, we booked orders of $156 million in the second quarter, up 11.9% from our first quarter 2016 orders of $139.4 million. In the US, we secured a $16 million order for an emerging energy application, and received the remaining portion of the Indian LNG Import Terminal Awards we booked in the first quarter.

In Europe, we received an $8 million order for LNG storage tanks related to an LNG terminal where we expect further related equipment orders in the near term. As a result of these projects, ending backlog during the quarter increased 5.2% to $252.5 million.

Our D&S downstream LNG equipment business continues to benefit from growing supply of LNG . As import terminals are installed to support marine fueling. In our European operations, we have local record backlog levels due to the increased build-out of LNG as a source power generation and remote areas around the globe.

We are seeing particularly strong interest in LNG trailers in all parts of AMEA. DNS Asia is scaling back its workforce and making good progress in order to right-size the business, but the China market remains challenging and extremely competitive as I indicated earlier. As major industrial customers consolidate, the future impact may put downward pressure on our industrial business until purchasing habits are defined, particularly in North America. In Europe and China, we are seeing low cost competition driving down pricing.

However, we believe our core competencies and innovative product offerings will help minimize these risks.

Moving on to biomedical, second quarter orders of $61.2 million were up $51.1 million in the first quarter 2016 as we received an award for approximately $7 million to supply military respiratory equipment in North America. In addition, we received strong respiratory orders or offers in Europe compared to the prior year quarter.

In North American respiratory, we lost traction as a result of legacy product, warranty issues and challenges in our sales department and marketing channel. During the second quarter, we hired a new biomedical approximately who brings the experience and capabilities to further improve the business. We still like this base and we are confident we have the right team to deliver for the future.

In our life sciences business, we have experienced record sales volume over the last year as a result of new products, particularly Vario cryogenic freezers. We have also benefited at least in the short term from weaker competition as one of our competitors was acquired out of bankruptcy the prior year.

Overall, our life science brand is well recognized in the market and is well-positioned to grow in emerging regions. For the commercial small scale air separation business, prospects in the near term remain relatively flat to down from recent order trends. We have experienced moderate weakness in the China hospital market, however we believe this is temporary.

In order to grow this segment of business, we are focusing on high growth in each areas for our smaller package oxygen generation systems, product development around specific applications for nitrogen should also provide growth opportunities. Overall, we plan to focus heavily on operational improvements during this downcycle in the energy segment. In order to lead these improvements, we are pleased to announce the addition of Bill Johnson as President and COO earlier this month.

Bill's extensive operation background and AMEA experience will allow us to continue our focus in these areas. I would like to formally introduce Bill on the call today and give him a chance to make a few remarks. Bill, I will turn the call over to you.

Thank you, Sam. Good morning, everyone. I am very excited to be part of the Chart team and look forward to meeting many of you over the coming months.

Over the next few months, I plan to learn more about the business and industries we participate in along with visiting our manufacturing facilities to better acquaint myself with our day-to-day operations and people. My primary focus will be to further increase operating efficiencies, improve working capital, and develop growth strategies. Despite the current energy market conditions, Chart has demonstrated it is well-positioned to weather the headwinds as a result of the diverse industries we participate in.

Our growth opportunities are exciting and I will be continuing to work with our teams on improving operational efficiencies to improve the short-term results, create new paths for growth, and better position us when the energy industry recovers. With that, I would now open it up for questions.

Jonathan, please provide instructions to the participants to be able to ask questions.

Certianly. (Operator Instructions). Our first question is from the line of Eric Stine from Craig-Hallum. Your question, please?

Good morning, everyone. Maybe we can just start, the quick ship business and the Lifecycle, the after-market business, this quarter and it is a fairly new initiative. This quarter, a huge uptick in the short lead time business. I mean should we view this quarter as it was really just, a lot of it was timing and you had a lot of projects hit in this quarter or maybe just how much did that Lifecycle after-market business have an impact in this quarter?

The opportunities were significant in the past quarter. There is no question that our life cycle initiatives and closer contact with customers, current and long-term customers enhanced the number of orders we received. It is too early to say that this is something that you should -- that we should expect on a quarter on quarter basis. But simply it has encouraged us that this is a good avenue for us to pursue to try and make the earnings stream from our energy and chemicals business more predictable.

Got it. And just to confirm, in the new guided range, I mean even though it is becoming a more regular part of your business, is it fair to say that you are not -- there is no quick ship business in guidance for the remainder of the year.

It would be a minimal component.

Okay. Good. Maybe just sticking with that, I mean can you just talk about -- I know the market is extremely competitive right now. You know, maybe just talk about why you are winning that business. Maybe your competitive advantage -- I know you have got the furnace and you can make larger cores but maybe some of the other things that make you a leader in why you are winning that business.

We have gone through a period where both natural gas processing plants and petrochemical plants have been run at very high capacity utilization. And we are finding that many of those customers are interested in after-market services like predictive maintenance or scheduled replacements of heat exchangers that have been run in (inaudible).

That is really the avenues that we are pursuing. Something relatively new but it is also something because of the development work we have done in (inaudible) exchangers, we are a very attractive partner for these customers in making sure they have reliable operating plants.

Okay. Got it. Maybe last one for me, just on guidance. I know you talked about that Magnolia, you have taken that out. China is still tough. I mean are there any other factors, going into that guidance range, because I know it implies that you are a little more cautious on the second half relative to what you were earlier in the year.

I think we have got an overall -- besides the areas we have highlighted as being problem areas for orders, the general industrial marketplace is not overly exciting, however, we are forecasting improved results, continuing to improve results in both our DNS business, particularly in North America and Europe and to a lesser extent in China and continued improving performance in our biomedical performance.

It is not all doom and gloom. There are some good positives there. We do feel strongly that at this point in the business cycle, it is wise not to point our guidance too high.

Mm-hmm. Got it. Okay. Thanks a lot.

Thank you. Our next question comes from the line of Rob Brown from Lake Street Capital. Your question, please?

Good morning.

Hi, Rob.

Hi. I think you mentioned the LNG business was in the DNS segment was up in the quarter. Could you give that number again in terms of that growth rate. The second part of that is what is sort of the opportunity that is driving that and where are you at in the development of that opportunity?

Rob, I think we are saying the growth rate was up in LNG over the prior quarter last year, the same quarter. LNG is a part of DNS revenues as represented about 25% of DNS order of sales. That has remained pretty consistent here this year. But that was relative to the prior year quarter.

In terms of characterizing the opportunity, as you know, our DNS business produces equipment for the distribution and storage of cryogenic liquids including LNG . And as LNG liquid has become more readily available with completion of significant new capacity on both in Australia and the US, we have seen LNG become more freely crated, particularly in Europe where, because of the tax regime on diesel fuel and also environmental considerations associated with marine markets, people are going ahead and investing in downstream distribution capability for LNG .

So while having an excess supply currently and forecasted for the next couple of years of LNG liquid, hurts our ENC business, it benefits the distribution and storage segment as these distribution applications move forward. And the things we are seeing right now are remote power generation and marine applications that we are putting in infrastructure for. We expect to see that continue to grow.

Okay, good. Great color. And then on the China -- how much of the backlog is from China at this point?

I believe the DNS backlog which is -- a number here --

-- roughly $40 million.

That is right.

Thank you. I will turn it over.

Our next question comes from the line of Nicholas Chen from Alembic Global.

Congratulations on a nice quarter and thanks for taking my question. First question, can you guys just opine a little bit on your capital allocation priorities at the moment?

Priority number one is generate cash. But in terms of capital allocation, we look at being prepared to make acquisitions, number one. And number two, to invest in our existing manufacturing -- within our existing manufacturing footprint to give us technological capabilities or to significantly improve our service level. Or to reduce costs.

That is great. Very helpful. And then just finally, if you can discuss cost reductions you might be looking at, whether it is in the form of head counts or closing facilities.

But we feel that it is not appropriate to take dramatic action on head count at this point because we want to make sure that we continue the opportunity and capabilities that we have developed. So we are working hard at new growth opportunities and new way to expand into adjacent areas.

That's great. And then just in terms of the guidance, ENC margins look pretty weak for the second half of 2016. When should we see more normal margins there?

Good questions. You will see more normalized margins within a few months after we start to see the backlog in the ENC grow.

That is helpful. Thanks so much, guys. I will jump back into the queue.

Thank you. Our next question comes from the line of Chase Jacobson from William Blair. Your question, please?

Hi, good morning. Bill, welcome. I just wanted to follow up on that last answer, actually. So you talked about ENC margin, maybe normalizing when orders start getting better and backlog turns. Clearly, it is tough to predict. But your market commentary suggests maybe there is some opportunities out there. So do you expect that the backlog starts to turn in ENC over the next couple quarters?

I think it will -- I do not think we will see significant improvements in backlog. In the remaining quarters of 2016, unless we get a big order. Which really is a tongue in cheek way of saying I have no idea.

Okay. And then Ken, can you just parse out $31 million, how much of it was short lead time items, how much of it was the closeout fees and was any of that in your guidance? Because if it is related to project timing of what you were working on, I would imagine you have visibility into that.

Yes, I would respond to that just that roughly two-thirds of that perhaps a bit more, perhaps as much as 80% was related to short lead time items. There was, however, some of those items that had been in our guidance that we assumed would come during the second half. And while we were successful in responding very quickly and moving them into the second quarter, it led us to temper our second half projection for ENC.

Okay. And the closeout fees, how does that -- how is that accounted for? Just more of a general question. Does that come through as revenue equal to gross profit?

Yes.

Okay. And then last question on the chemical side, nice to see you guys got another ethylene award. What is the outlook there -- I know there are some more ethylene plants being planned. How much more competitive is the us ethylene market in this wave versus the wave we saw a few years ago.

Well, at the -- for a good part, at least 50% of the last wave, we experienced increased competition from both Japanese and European suppliers. Largely due to the strength of the dollar but also the fact that there was a low level of petrochemical activity worldwide except in the US. I would expect that in the next wave, we will see the same level of competition we saw in the second half of the previous wave.

Okay. Thank you.

Thank you. Our next question comes from the line of Pavel Mochanov from Raymond James.

Thanks for taking the question. Back to magnolia, the previous timetable you laid out was kind of an FID, by the end of the year. I realize it is getting delayed by -- is there any sense of what the timetable for getting that project sanctioned might look like or is it completely hazy?

We have based our guidance and commentary on public comments by the folks at Magnolia. So I would defer to their public comment to get more insight.

Okay. Fair enough. On your backlog, percentage or dollar value, do you still have related to petro China in your current backlog figure?

I would say the petro China backlog is minimal at this point as part of the China backlog. I think we referenced about $40 million of DNS China backlog today. I would say the petro China is a small piece of that.

I can give the further color that petro China current orders in backlog would be recent orders, number one and covered by deposits; so that they are orders that they have been performing to schedule on. Okay. Appreciate the responses, guys. Thanks.

Thank you.

Thank you. (Operator Instructions). Our next question comes from the line of Walter Liptak from Seaport Global. Your question, please?

Hi, thanks. Just wanted to ask a follow-up on the guidance and the Lifecycle business. I wonder, you know, why there was not more visibility into the back half.

Well our visibility in the ENC business has typically been based on percent of completion accounting on large projects which have been in backlog. There is less of that. And over the past couple of quarters, our earnings within ENC because of the lack of larger, long-term projects, make us more dependent for orders that are received and turned into shipments within the quarter.

Currently the backlog is soft for delivery in the second half of the year. Hence our conservative approach. We are investing in our Lifecycle business. We think it has promising opportunities. But we also think it is too early to get overly excited about it or try and predict it with certainty.

Okay. That makes sense. The contract expiration fees then, are we through most of those through this year or are there more coming up in the back half?

Pretty well all accounted for.

Okay. Great, thank you.

Thank you. And this does conclude the question and answer session of today's program. I would like to hand the program back to Sam Thomas for any further remarks.

Thank you, Jonathan. In conclusion, I would like to say that we are obviously very pleased with the results for the quarter and a large number of Chart employees worked extraordinary hard to deliver the results and cash flow that we have achieved. We have got some real bright spots in our business of the improving quality of earnings and biomedical and market growth there, the strong performance of distribution and storage in North America and Europe.

The improvements in LNG downstream opportunities for distribution and storage are highlights. The stabilization of our business in China is also a highlight. But we have to contrast that with the fact that as oil prices take another leg down and we really had no increased clarity on what year we need new LNG export facilities to -- before orders move forward, it is hard for us to get overly enthusiastic about forecasting profit growth going forward.

Having said that, we are working hard at alternative ways to deliver growth in sales and earnings. And remain very confident in the future. So thank you very much for participating today. Good-bye.

Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.