Jul 31, 2016
Executives
Ken Webster - VP, CFO Sam Thomas - Chairman, President, CEO Bill Johnson - COO
Analysts
Eric Stein - Craig-Hallum Rob Brown - Lake Street Capital Nicholas Chen - Alembic Global Chase Jacobson - William Blair Pavel Mochanov - Raymond James Walter Liptak - Seaport Global
Operator
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 calling 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 4. The replay information is contained in the Company's earnings release.
Before we begin the Company would like to reminder 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 statements.
For furthermore information about important factors that could cause actual results to differ materially from those expressed or imply 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 publicly or revise any forward-looking statements. I would now like to turn conference call over to Ken Webster, Chart Industries’ Vice President and CFO.
You may begin your conference.
Ken Webster
Thank you, Jonathan. Good morning everyone.
I would like to thank all of you for joining us today. I would begin by giving you brief overview of our second quarter results and outlook for the remainder of 2016.
Then 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 cost 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 of 2015 earnings would have been $0.60 per diluted share excluding the $0.04 per diluted share impact, facility shutdown and severance cost from cost reduction initiative 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 in our Energy & Chemicals or E&C business as customers continued to delay projects and competitive pressures remain challenging for the few new built E&C 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 the prior year quarter.
Overall gross profit was up largely due to record E&C short lead-time replacement equipment opportunities which were supported by our new Lifecycle aftermarket service offering. Contract expiration fees related to project development in our E&C business contributed as well.
The impact from the short lead-time opportunities and contract expiration fees contributed approximately $31 of 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 business, 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 E&C 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 E&C’s gross profit in the quarter, which led to significant margin improvement.
In our D&S business second quarter sales increased 6.4% compared to the second quarter of 2015 to $129.6 million led by strong sales in our U.S. and European operation.
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.
D&S gross margins were 25.6% compared with 23.4% the prior year quarter. The margin increased due to favorable volume in U.S.
and Europe as well as lower restructuring cost and prior year included cost associated with the shutdown of our Owatonna facility. In BioMedical, second quarter sales were $56.3 million, a decrease of 1.4% when compared to the prior year quarter.
The second quarter of 2015 included revenues recognized from 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 D&S Asia and E&C and higher restructuring related cost due to cost reduction initiatives.
The impact from all of these items added $6.7 million in SG&A cost during the current quarter. These increases were partially offset by lower payroll and benefits, professional services and travel cost associated with our cost reduction initiatives.
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, strong D&S and BioMedical orders in the second quarter.
Our E&C orders and backlog remained weak and do not currently support our original sales guidance. E&C 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 forecasted 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 per diluted share on approximately 30.9 million weighted average shares outstanding.
This excludes the impact from any restructuring cost or unusual items. I will now turn the call over to Sam Thomas.
Sam Thomas
Thank you, Ken, and good morning everyone. During the quarter we had record short lead-time opportunities for replacement equipment and our natural gas processing and petrochemical market.
The 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 strength.
These projects were executed very successfully, aided by our newly established short Lifecycle aftermarket business, while providing customer equipment to meet customer replacement needs is something we’ve done for years. Chart Lifecycle brings additional skills and resources to fulfilling the time sensitive and challenging equipment needs to our customers and demanding operational context.
We continue to see interest from our customers in a wide variety of service plan offered by that group. Overall order trends remain strong in our D&S business.
Within our industrial business, we’re seeing opportunities in nice areas like hydrogen fuel cell and space launch industry. Within the U.S.
and Europe, we are currently seeing the benefit and availability of LNG for power generation and marine application. As oil prices remain low and new capacity comes online, global oversupply of LNG, petrochemical feed stocks and natural gas liquids are hindering our E&C business as customers defer capital spending in the near term.
Although there are number of large plants in the bidding pipeline, the timing of those, are difficult to predict, the curve estimates projecting late 2017 or early 2018 timeframe. 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 managing team in China has done an excellent job focusing on cost reduction and working capital initiative. We generated $49 million of operating cash this quarter making this another consecutive quarter of 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’re actively pursuing acquisitions that will provide synergistic opportunities for further diversification for our portfolio. We’re also reinvesting in our manufacturing facilities to consolidate operations or redesign plant layout for reduced costs and improve efficiencies.
Although we continue to face the 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 by maintaining our capabilities in order to be well prepared for the next up-cycle.
I’d now like to comment on specific highlights for each of the businesses. Within Energy & Chemicals, we booked $53 million in orders during the second quarter.
This is up from the first quarter of 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 E&C remains weak as project 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 E&C results in the second half.
Expected capital spending for upstream projects is paused as the current market is oversupplied for natural gas and natural gas derived petrochemicals. In the near-term, our biggest challenge within E&C is winnings orders in a very compressed market to reestablish our backlog.
As a result of continued headcount reductions in the business, our next biggest challenging retaining the employees to ensure we can address opportunities as markets improved. We are addressing these challenging including shifting resources into new E&C Lifecycle aftermarket business and providing engineering resources to our other business segments as needed.
We’re 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 IP SMR LNG liquefaction process technology and brace heat exchanger offering.
We recognize some value in the project development side of the business related to those offerings this quarter through contract expiration fees on longer-term projects which have been postponed. Interest of project developers in-charged 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 & 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 U.S.
we secured a $16 million order on emerging energy applications and received the remaining portion of the Indian LNG Import Terminal Awards that 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 in the quarter increased by 0.2% to $252.5 million. Our D&S downstream LNG equipment business continued to benefit from growing supply of LNG as import terminals are installed for remote power generation and green fueling.
In our European operations, we have local record backlog levels due to the increased build-out of LNG as the source power generation in remote areas around the globe we’re seeing particularly strong interest in LNG trailers and all parts of EMEA. D&S 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’re seeing low-cost competition driving down pricing. However we believe our core competencies and innovative product offering 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 by military respiratory equipment in North America. In addition we’ve received strong respiratory tender offers in Europe compared to the prior year quarter.
In North American respiratory we’ve lost traction as a result of legacy product, warranty issues and challenges in our sales and marketing channel. During the second quarter we hired a new BioMedical President who brings the experience and capabilities to further improve the business.
We still like this space and we’re confident we have the right aim to deliver for the future. In our Life Sciences business, we’ve experienced record sales volume over last year as a result of new products particularly Vario cryogenic freezers.
We’ve also benefited at least in the short-term from weaker competition as one of our competitors was acquired out of bankruptcy in the prior year. Overall, our Life Science brand is well recognized in the market and 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 trend. We’ve experienced moderate weakness in the China hospital Market however we believe this is temporary.
In order to grow this segment of business, we’re focusing on high-growth niche areas for our smaller package oxygen generation system; product development around specific applications for nitrogen should also provide growth opportunities. Overall, we plan to focus heavily on operational improvements during this down-cycle in the energy segment.
In order to leads these improvements, we’re pleased we announced the addition of Bill Johnson as President and COO earlier this month. Bill’s extensive operational background and M&A experience will allow us to continue our focus in these areas.
I’d like to formally introduce Bill on the call today and give him a chance to make a few remarks. Bill, I’ll turn the call over to you.
Bill Johnson
Thank you, Sam, and good morning everyone. I’m very excited to be part of the Chart team’s Board 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, better acquaint myself with our day-to-day operation and people. My primary focus will be to further increase operating efficiencies, improve working capital and development growth strategies.
Despite the current energy market condition, Chart has demonstrated that it is well positioned to weather these headwinds as a result of 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 for the participants to be able to ask questions.
Operator
[Operator Instructions]. Our first question comes from the line of Eric Stein from Craig-Hallum.
Your question please.
Eric Stein
Good morning, everyone. Maybe we can just start, the quick ship business and the Lifecycle, the after-market business, this quarter and that’s a fairly new initiative, this quarter, a huge up-tick in the short lead-time business.
I mean should we view this quarter as it was really just, I mean, 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?
Sam Thomas
The opportunities were significant in the past quarter. There is no question that our Lifecycle initiatives and closer contact with customers of current and long-term customers are enhanced, these number of orders we received.
It’s too early to say that this is something that we should expect on a quarter-on-quarter basis but certainly it has encouraged us that this is a good avenue for us to pursue to try and make the earnings stream from our Energy & Chemicals business are predictable.
Eric Stein
Got it. And just to confirm, in the new guided range, I mean, is it, 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?
Sam Thomas
It would be a minimal component.
Eric Stein
Okay. Good.
Maybe just sticking with that, I mean can you just talk about, I know the market is extremely competitive right now. Maybe just talk about why you’re winning that business, I mean, maybe your competitive advantage is that, I know you’ve got the furnace and you can make larger cores but maybe some of the other things that make you a leader in a way you’re winning that business?
Sam Thomas
We’ve gone through a period where both natural gas processing plants and petrochemical plants have been run at very high capacity utilization. And we’re finding that many of those customers are interested in after-market services, life predictive maintenance or scheduled replacement of heat-exchangers that have been run in high reserve.
And that’s really the avenue that we’re pursuing. Something relatively new but it’s also something because of the development work we’ve done, embraced the market exchangers.
We’re a very attractive partner for these customers in making sure they have reliable operating plans.
Eric Stein
Okay, got it. Maybe last one from me, just on guidance.
I know you talked about that Magnolia, you’ve 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.
Sam Thomas
I think we’ve got an overall, besides the areas we’ve highlighted as being problem areas more orders. The general industrial marketplace is not overly exciting.
However we are forecasting improved results, continuing to improve results in both our D&S business particularly in North America and Europe, and to a lesser extent China, and continued improving performance in our BioMedical business. So, it’s not all gum and glue, there are some good positives there.
But we do feel strongly that at this part of the cycle its wise not to point our guidance too high.
Eric Stein
Got it. Okay.
Thanks a lot.
Operator
Thank you. Our next question comes from the line of Rob Brown from Lake Street Capital.
Your question please.
Rob Brown
Good morning.
Sam Thomas
Hi Rob.
Rob Brown
Hi. I think you mentioned the LNG business was in the D&S segment was actually up in the quarter.
Could you give that number again in terms of that growth-rate? And then the second part of that is what sort of the opportunity that’s driving that and where are you at in the development of that opportunity?
Ken Webster
Rob I think we’re saying the growth rate was up in LNG over the prior quarter last year, same quarter. LNG as a part of D&S revenues has represented about 25% of D&S orders of sales.
And that has remained pretty consistent here this year. But that was relative to the prior year quarter.
Sam Thomas
In terms of how we’re driving the opportunity, as you know our D&S business produces equipment for the distribution and storage of cryogenic liquids including LNG. And as LNG liquid has become more readily available, the completion of significant new capacity, both in Australia and the U.S., we’ve seen LNG become more freely traded particularly in Europe where because of the tax regime on diesel fuel and also environmental considerations associated with marine market, people are going ahead and investing in downstream distribution capabilities for LNG.
So, while having an excess supply currently and forecasted for the next couple of years of LNG liquid. First hurts our E&C business, it benefits the distribution and storage segment as these distribution application move forward.
And the things that we’re seeing right now are remote power generation and marine applications that we’re putting in infrastructure. We expect that would continue to grow.
Rob Brown
Okay, good, great color. And then on the China, how much of the backlog is from China at this point?
Sam Thomas
We believe the D&S backlog which is a number here - it’s roughly $40 million.
Rob Brown
Okay, great.
Operator
Thank you. Our next question comes from the line of Nicholas Chen from Alembic Global.
Your question please.
Nicholas Chen
Congrats 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?
Sam Thomas
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 in order to significantly improve our service levels in order to produce costs.
Nicholas Chen
That’s great, very helpful. And then just finally, if you could discuss any sort of additional cost reductions you might be looking at, whether in the form of headcounts or more of closing facilities?
Sam Thomas
There is potential savings from closing [indiscernible] that had started up during growth opportunities, there is some additional headcount depending on where we trend. But we feel that it’s not appropriate to take dramatic actions on headcount at this point because we want to make sure that we continue the opportunity and capabilities that we have developed.
But we are working hard at new growth opportunities and new ways to expand into adjacent business.
Nicholas Chen
That's great. And then just in terms of the guidance, E&C margins look pretty weak for the second half of 2016.
When should we see more normalized margins there?
Sam Thomas
Good question.
Ken Webster
You’ll see more normalized margins within a few months after we start to see the backlog in E&C growth.
Nicholas Chen
That’s helpful. Thanks so much, guys.
I’ll jump back into the queue.
Operator
Thank you. Our next question comes from the line of Chase Jacobson from William Blair.
Your question please.
Chase Jacobson
Hi, good morning, Bill, welcome.
Bill Johnson
Good morning.
Chase Jacobson
So, I just wanted to follow-up on that last answer, actually. So you talked about E&C margin, maybe normalizing when orders start getting better and backlog returns.
Clearly, it’s tough to predict. But I mean, your market commentary kind of suggests maybe there are some opportunities out there.
So, do you expect that the backlog starts to turn in E&C over the next couple of quarters?
Sam Thomas
I think it will take, I don’t think there will be significant improvement in E&C backlog, in the remaining quarters of 2016 unless we get a big order, which really is a tongue-n-cheek way of saying I have no idea.
Chase Jacobson
Okay. And then Ken, can you just parse out the $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 I mean, if it’s related to project timing of what you were working on, I would imagine you had visibility into that?
Ken Webster
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 just 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 tamper our second half projections where we’re in today.
Chase Jacobson
Okay. And the closeout fees, how does that - how is that accounted for, I mean, just more of a general question.
Does that come through as revenue equal to gross profit?
Ken Webster
Yes.
Chase Jacobson
Okay. And then last question on the chemical side, nice to see you guys got another ethylene award.
What’s the outlook there? I know there are some more ethylene plants being planned.
And how much more competitive is the - I thought the U.S. ethylene market in this wave versus the wave we saw a few years ago?
Sam Thomas
Well, at the sort of good part, these 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 there was a low level of petrochemical activity worldwide except the U.S. I would expect that in the next wave we’ll see the same level of competition that we saw in the second half of the previous wave.
Chase Jacobson
Okay. Thank you.
Operator
Thank you. Our next question comes from the line of Pavel Mochanov from Raymond James.
Your question please.
Pavel Mochanov
Hi, thanks for taking the question. Back to Magnolia, the previous timetable that you guys laid out was kind of an FID, by the end of the year.
And I realize it’s getting delayed by, is there any sense of what the timetable for getting that project sanctioned might look like or is it completely hazy?
Sam Thomas
We have based our guidance and commentary on public comments by the folks at Magnolia. So, I would defer to their comments to get more insight.
Pavel Mochanov
Okay, fair enough. On your backlog, what percentage or dollar value, do you still have related to petro China in your current backlog figure?
Ken Webster
I’d the petro China backlog is minimal at this point as far as China backlog. And I think we referenced it’s about $40 million of D&S China backlog today.
I would say the petro China is a small piece of that.
Pavel Mochanov
Okay.
Sam Thomas
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’ve been performing to schedule on.
Pavel Mochanov
Okay. Appreciate the responses, guys.
Thanks.
Sam Thomas
Thank you.
Operator
[Operator Instructions]. Our next question comes from the line of Walter Liptak from Seaport Global.
Your question please.
Walter Liptak
Hi, thanks. I just wanted to ask a follow-up on the guidance and the Lifecycle business.
I wonder why there was not more visibility into the back half.
Sam Thomas
Our visibility in the E&C business has typically been based on percent of completion and accounting on large project which have been in backlog, there is lesser band. And over the past couple of quarters our earnings with E&C because of the lack of larger long-term projects make us more dependent for orders that are received and turned into shipment within the quarter.
Currently the backlog is soft. We’re delivering second half of the year, hence our conservative approach.
We are investing in our Lifecycle business and it has promised opportunities but we also think it’s too early to get overly excited about it or try and predict it with certainty.
Walter Liptak
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?
Sam Thomas
Pretty well all accounted for.
Walter Liptak
Okay. Great, thank you
Operator
Thank you. And this does conclude the question-and-answer session of today’s program.
I’d like to hand the program back to Sam Thomas for any further remarks.
Sam Thomas
Thank you, Jonathan. In conclusion I’d like to say that we’re obviously very pleased with the results for the quarter.
And a large number of Chart employees were extraordinarily for us to deliver the results and cash flow that we’ve achieved. We’ve got some real bright spots in our business, the improving quality of earnings in BioMed and market growth there; a strong performance of Distribution & Storage in North America and Europe.
The improvement in LNG downstream opportunities for distribution and storage are highlight. 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 life down and we’ve really had no increased clarity on what year we need new LNG export facilities, before orders move forward. It’s 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 sale and earnings and remain very confident in the future. So, thank you very much for participating today.
Goodbye.
Operator
Thank you, ladies and gentlemen for your participation in today’s conference. This does conclude the program.
You may now disconnect. Good day.