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Chart Industries, Inc. (NASDAQ:GTLS)

Q3 2008 Earnings Call Transcript

October 31, 2008, 10:30 am ET

Executives

Michael Biehl – EVP, CFO and Treasurer

Sam Thomas – Chairman, President and CEO

Analysts

James West – Barclays Capital

Jeff Spittel – Natixis Bleichroeder

Chris Agnew – Goldman Sachs

Greg McKinley – Dougherty

Operator

Good morning and welcome to the Chart Industries, Inc. 2008 third quarter conference call. (Operator instructions)

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 retrieve it by visiting Chart’s website at www.Chart-Ind.com. A telephone replay of today’s broadcast will be available following the conclusion of the call until November 14. 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 are not historical in fact and are forward-looking statements. Forward-looking statements involve risks and uncertainties that can cause actual events or results to differ materially from those expressed or implied in the forward-looking statements. For further information about important factors that can 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 which is www.SEC.gov. The company undertakes no obligation to update policies or revise any forward-looking statement.

I would now like to turn the conference call over to Michael Biehl, Chart Industries Executive President and Chief Financial Officer. You may begin your call.

Michael Biehl

Thanks, Shawn. Good morning everyone. I would like to thank you all for joining us today. I’ll begin by giving you a brief overview and highlights of our third quarter results then Sam Thomas, our Chairman, President and Chief Executive Officer will provide highlights of the operating results for each of our business segments and then I’ll finish up by discussing our outlook for the balance of 2008.

We’re pleased with our third quarter results. Sales for the quarter were $188.8 million and represented an increase of 15% compared to net sales of $163.7 million a year ago. The sales growth of over $25 million was led by our Energy and Chemicals segment but we also had positive sales growth in BioMedical. Net income for the quarter rose to $20.4 million or $0.70 per diluted share a significant increase over the $12.1 million in net income or $0.42 per diluted share reported a year ago. We should note the third quarter of 2008 included $0.5 million in non reoccurring costs or a penny per diluted share related to the repurchase and retirement of 6.8 million of the company’s 9-1/8% Senior Subordinated Notes. As a result of these purchases that eliminated a portion of our high cost debt, it is expected to reduce net interest expense by approximately $0.5 annually going forward.

Our gross profit for the quarter was $66.2 million compared with $45.4 million a year ago. This increase was again led by our Energy and Chemicals segment due to improved project mix and execution but also due to performance incentives and change orders earned during the quarter. In addition our BioMedical segment contributed to the margin expansion due to higher volume and improved pricing.

SG&A expenses for the quarter were $26.8 million or 14.2% of sales compared with $20.9 million or 12.8% of sales for the same quarter a year ago. The increase was primarily the result of higher employee related expenses including variable incentive compensation due to improved operating performance particularly at E&C and higher marketing and sales cost to support our business growth.

Amortization expense for the quarter was $2.8 million or 1.5% of sales compared to $2.6 million or 1.6% of sales for the prior year quarter reflecting additional amortizable intangible assets from an acquisition earlier this year.

The quarter had a foreign currency loss of $2.1 million compared with foreign currency gain of $500,000 for the same quarter a year ago. The weakening of the Euro and the Czech Koruna against the dollar during the latter part of the quarter impacted transactions denominated in those currencies.

Income tax expense was $8.8 million for the quarter and represented an effective tax rate of 30% compared with $4.3 million for the prior year quarter representing an effective tax rate of 26.3%. The lower tax rate in the third quarter of last year was primarily the result of an adjustment to decrease the full year 2007 annual effective tax rate to 31% from 34%, which resulted in unusually low tax rate during the third quarter of 2007.

From a cash flow standpoint, we continued to generate strong cash flow from operations through the third quarter with our cash balance at $149 million at the end of the quarter, that’s after paying $6.8 million to repurchase the portion of our Senior Subordinated Notes during the quarter. Cash provided by operations for the quarter was $59.6 million compared with cash provided by operations of $45.8 million for the prior year quarter. The increase was primarily due to higher net income and customer advances due to timing of progress billings under existing contracts. Cash used in investing activities for the quarter was $2.9 million compared with $4.9 million for the same quarter in 2007. Capital expenditures for the quarter were $2.9 million compared with $5 million a year ago. Capital expenditures during both quarters were primarily used for continued facility automation and improvements to lower cost and support our backlog.

For the quarter cash used in financing activities was $6.3 million, which included $6.8 million Senior Subordinated Notes repurchase. This compared with cash provided by financing activities of $5.7 million for the same period in 2007.

The company’s strong balance sheet financial performance resulted in a credit rating upgrade by Standard & Poor's during the quarter. S&P has raised our credit ratings including our overall corporate rating, bank debt, and Senior Subordinated Notes, which validates our operating and financial achievements to date.

Given our overall strong cash position of $149 million at the end of the quarter, availability of over $76 million on our revolver portion of our senior credit facility and continued focus on operating improvements we are well positioned to fund our working capital requirements and support future growth in this uncertain market environment. We have no principal payments during our long-term debt until the fourth quarter of 2012 with more than adequate coverage on our debt covenants and our revolving credit facility extends until the fourth quarter of 2010.

I’ll now turn the call over to Sam Thomas who will review our operating results and business segment highlights.

Sam Thomas

Thank you Michael and good morning everyone. We are pleased with our third quarter operating results which again were led by our Energy and Chemical segment. At Energy and Chemicals, or E&C, sales grew by 35% to $78.9 million for the quarter compared with $58.4 million for the same quarter in the prior year. E&C gross profit margin increased to 39.2% in the quarter compared to 24.2% for the same period in 2007. You will recall that the results in 2007 period were impacted by some complex one time long-term installation projects as well as other fixed price contracts where were incurred escalating raw material and labor costs. Conversely, the 2008 quarter benefited from our project mix that includes significant work on LNG liquefaction and petro-chemical projects. In addition performance incentives and change orders were earned on several projects improving margins by about 2%. These performance incentives for early project completion or validation of improvements in project execution which have contributed to the significant improvements in margin at E&C over the last several quarters. We also had improvements in margin in braised aluminum heat exchangers during the quarter due to increased throughout and several quick shift emergency orders.

At our Distribution and Storage segment, or D&S, sales were about the same at $85.0 million compared to $85.1 million for the third quarter of 2007. Lower volume in bulk tanks was largely offset by increases in package gas, favorable currency translation and a small acquisition in Germany, which closed in April 2008. D&S gross profit margin increased slightly to 30.9% in the quarter compared to 30.8% a year ago.

Our BioMedical segment sales for the quarter increased to $24.9 million from $20.2 million for the same quarter in the prior year. All product lines contributed to the sales increase. Both medical respiratory and biological storage systems product sales increased due to higher volume particularly in biological storage systems where we are seeing strong growth in both domestic and international markets. In addition price increases in medical respiratory also contributed to the improvement.

BioMedical gross profit margin increased to 36.1% in the quarter compared with 30.2% a year ago. The improvement in margin was due to higher volume and continued shift to higher value added customer solutions for biological storage system sales as well as price increases in the medical respiratory product line.

Backlog at September 30, 2008, was $461.8 million 8% greater than the year ago period but down 7% from the June 30, 2008, level of $498.1 million. Orders at E&C during the quarter were $46.3 million compared with $85 million in the second quarter and $51.1 million in the first quarter of 2008. You should all know by now that E&C orders can be affected by the timing of large projects and it is not unusual to see order intake vary significantly from quarter-to-quarter. We believe the current global credit crisis will impact the timing of some projects but the fundamental demand drivers remain in place.

Orders to D&S in the quarter were $93.8 million compared to a very strong second quarter of $115.4 million and $91.1 million for the first quarter of 2008. If you recall, the second quarter was one of the strongest quarters for order intake in recent history for D&S and included several large engineered tank orders.

The orders during the third quarter of 2008 were still very strong compared with earlier quarters. D&S backlog is $144.2 million at the end of September just slightly down from the $146.5 million backlog at June 30, 2008. The strong industrial gas business, particularly in the developing industrial economies provides a strong underlying growth demand driver for D&S.

BioMedical orders in the quarter were $23.7 million compared to $26.7 in the second quarter and $22.7 million in the first quarter of 2008. Orders have returned to more normal levels here in the third quarter after an unusually strong second quarter for medical respiratory orders in Europe.

The credit crisis is creating a lot of uncertainty around demand and project timing. We recognized that these are challenging economic times requiring the ability to identify challenges and opportunities early and respond quickly. We have taken appropriate action today and will continue to do so. We continue to have a strong competitive position in our markets and we have proven that we are resourceful at finding new applications for our products such as natural gas fueling tanks and clean coal applications among others.

Our experienced management team has managed in difficult business cycles as well as periods of significant growth. Although these are challenging times, based on our flexible experienced work force good relationships with our customers and suppliers we’re well prepared and confident that we will come through these uncertain times with an even stronger and more successful business.

Mike will now provide you with an updated outlook for 2008.

Michael Biehl

Thanks Sam. Based on year-to-date results, current order backlog and fourth quarter expectations we are reaffirming our previously announced earnings per share guidance while adjusting our sales forecast. Our net sales for 2008 are now expected to be slighter lower in the range of $750 million to $770 million compared with previous guidance of $770 million to $800 million. Our full year diluted earnings per share is still expected to be in the range of $2.55 to $2.65 per diluted share, which is based on an effective tax rate of 30% and approximately 29.1 million weighted average shares outstanding. Although projected revenue will be lower, we believe the reduction will be offset by continued strong operating performance. We have good liquidity and strong cash generation and we are uniquely positioned to successfully handle a wide range of challenges and opportunities.

Thank you for participating in our conference call. This concludes our prepared remarks. Shawn please open up the lines for questions and provide the participants with instructions for doing so.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of James West from Barclays Capital. Your line is open.

James West – Barclays Capital

Hi, good morning Sam and Michael.

Michael Biehl

Good morning James.

Sam Thomas

Good morning.

James West – Barclays Capital

Sam last quarter in the Q&A we talked a little about of two of your major customers that recently either announced plans for new projects this will be Energy World Corporation and I believe, Bechtel that recently and won an award in Australia. So, I wondered if perhaps we could just start by talking about those two customers in light of the current economic if those programs are going forward, or there has been delays, any changes at all there?

Sam Thomas

The Bechtel projects are unchanged. There are large projects so there is some time period involved for them to go fully through the field studies but both Bechtel and their customer primarily ConocoPhillips seem to be saying that these projects will go forward and that they have the cash to do them. So at this point those are still very positive. In the case of Energy World they are similarly positive that the economics are still very attractive. What is unknown is in the credit environment is project financing. and what that means is how quickly projects will move forward. There has been a fair amount of general press about the coal bed methane projects in Queensland and I think the view is still very positive that the projects make economic sense. But certainly with the credit issues that is that question of will we go forward with final investment decisions right now as opposed to a few months down the road when credit markets open up again.

James West – Barclays Capital

Okay understood. Then Sam on the D&S business, it seems at least in my mind that this will be the most – or could be the most impacted by a recessionary environment in an environment where we see significant economic weakness given your exposure to some of the more emerging economies how do you think that that business would perform?

Sam Thomas

I think it will continue to perform very well. We have seen in distribution and storage there has been shifts in mix. We have been selling quite a few tanks for large projects at these emerging economies build out infrastructure but overall the view is very positive. Again when you have the credit environment and the macro news releases the tendency is for people – for our customers to pull back on capital expenditure but as things settle down for them to move forward because fundamentally these projects are economically sound. So we remain confident that activity is not going to stop. That the growth of these industrial economies will continue and that we continue to be very well positioned. Similarly in the United States there is plenty of uncertainty about U.S. economic activity levels but our customers continue to say, the industrial gas companies, that their gas volumes are rising, they’re bringing new production online that will drive new tank sales.

James West – Barclays Capital

Okay and then just one last follow up if I may. Given in light of this credit environment I know that at one point at least over the last couple of quarters as you have looked at acquisitions, pricing on acquisitions is still bit fairly high. Have you seen that come in at least at this point now and if so would you be willing to step in and make a couple of acquisitions?

Sam Thomas

We will. We think that the uncertainty created by this environment particularly if there is tightness in credit, positions Chart very effectively. We remain very close to our customers and markets and have a strong watch list of companies that we’re interested in acquiring and we will continue to solicit for opportunities to add companies that can increase our value proposition. We think that this is going to be a good environment as to whether we will make acquisitions in the next three months or over the next eighteen months, I’m not prepared to call the timing.

James West – Barclays Capital

Okay. Thanks Sam.

Sam Thomas

Thank you.

Operator

The next question comes from the line of Jeff Spittel from Natixis Bleichroeder. Your line is open.

Jeff Spittel – Natixis Bleichroeder

Good morning guys.

Sam Thomas

Good morning Jeff.

Jeff Spittel – Natixis Bleichroeder

If we could drill down a little bit on the Distribution and Storage Distribution and Storage segment if you look back at I guess prior periods of softness economically in the global environment, could you talk a little bit about how that business performed in that environment and then I guess what has changed, obviously you had more backlog and visibility there but how do I guess weigh those different forces as we look at 2009?

Sam Thomas

Several significant differences. Going into the previous downturn in the late 98, 99 time frame, we had quite a bit more customer owned inventory on the ground and thinner backlogs. We’re also very much solely a U.S. based manufacturer, probably at that time over 85% of our sales were in the U.S. for Distribution and Storage, and the U.S. downturn on capital spending downturn from the industrial gas companies was severe because they had been spending at a fairly high level of capital expenditures as a percentage of sales. Throughout the most recent expansion period we have seen far more tempered spending and far better inventory control by all of the gas majors in fact as we talked about the acquisition earlier of BOC by Linde and the subsequent sale of the package gas operation of Linde to Airgas that we have actually gone through an inventory reduction period during 2008. So, we actually see the underlying volumes better in the U.S. because of less of a cyclical swing. There is new capacity coming on of their separation plants in the U.S. Our growth has been driven far more by emerging market growth particularly China and central Europe. We continue to believe that that will be strong moving forward. We are far more globally focused than we were. And finally at that time going into the previous recession, Chart had just made a large acquisition and had redundant manufacturing facilities. So it had to go through a redundancy program and a consolidation of facilities. So we really feel we’re in a much better positioned business now. We’re also added quite a few newer high margin products. We have a fairly broad product offering that enables our customers and their end customers to actually save on distribution costs. Finally, the – our raw material position – going into the previous recession, our raw materials particularly iron-nickel and stainless steel were at fairly high levels and increasing in price. As you know, we’re had a fairly significant correction in nickel and other metals commodity prices. So we are well positioned there as well.

Jeff Spittel – Natixis Bleichroeder

I appreciate the color there. Shifting to the large scale LNG market, the BG proposed deal for Queensland that we saw earlier in the week, is this I guess the beginning of a potential trend there where this is what the catalyst is where the larger players in that market with the largest balance sheets can come in, make acquisitions, maybe even scale up some of these development plans and is that potentially a catalyst for moving things along on a little bit of a shorter time frame over the next few years.

Sam Thomas

Quite possibly. Certainly the global energy companies have the cash and balance sheets to go forward without significant outside project financing. These projects still make very strong economic sense, but in addition to the very large scale projects there is also potential with some reasonable credit availability that smaller scale projects can go forward that would be very economically attractive. I think that we continue to believe that the development of a global network natural gas industry with LNG as a very large part of it will develop both on the large scale, medium, and small scale fronts.

Jeff Spittel – Natixis Bleichroeder

Okay, thanks very much. I appreciate it.

Sam Thomas

Thank you.

Operator

Your next question comes from the line of Chris Agnew from Goldman Sachs. Your line is open.

Chris Agnew – Goldman Sachs

Thank you very much good morning. Touching on FX, you made some comments about what happened in the quarter but given the volatility, how should we think how FX is impacting both revenue and profitability going forward. If you could maybe frame how we should think about it. Thanks.

Sam Thomas

We have – looking at primarily the Euro versus the dollar where the biggest impact has been, we had roughly a 20%, 25% correction. Our business in the Czech public is currently running at roughly $100,000 sales rate and earning EBIT margins in the – I believe it is about 11% range. It is going to be impacted by the translation of currencies. You know, I remind you that that we’re fairly effectively naturally hedged on many of these issues but it will impact, it will have lower U.S. dollar earnings as a result of that. We have come back to what I consider to be more or less purchasing power parity for the industrial markets when you’re in the 120 to 130 range of dollar versus Euro. It will have an impact but we are well positioned to adjust to it.

Chris Agnew – Goldman Sachs

And then touching on your comments on the credit crisis affecting demand and timing, is there any distinction between your different business segments, any differentiation by geography in terms of the way your customers, it is affecting your customers behavior and thinking?

Sam Thomas

I think in the short term what we see is that when the news and the press is particularly negative we are strident [ph] that smaller businesses react and will simply delay their purchases for a day or a week or a month. The underlying drivers remain strong. So we expect them to largely come back into the market. And depending on the financial strength of our medium scale and large scale customers as to whether they are going out for financing, I suspect that that’ll be the greatest determinant over the next three months of whether a deal projects for a few months or go forward.

Chris Agnew – Goldman Sachs

And is there any distinction in terms of Europe versus Asia versus U.S. or is it more customer behavior?

Sam Thomas

I would say I have seen no really clear distinction globally. There are – there is obviously more momentum in Asia going forward but there is every bit of sensitivity and attention to the credit markets in Asia and Western Europe that we see in the United States.

Chris Agnew – Goldman Sachs

Okay thanks and then final question on just on commodity costs. How much are you able to benefit as commodity costs or input costs are going down or have you got sort of automatic escalators if you can help us sort of think through how that works? Thanks.

Sam Thomas

It varies by business and I think it is best to view them in terms of timing issues. So that for instance within our Distribution and Storage business, roughly 40%, 50% of our sales are governed with surcharge formulas that are three months trailing averages. So in times of decline we would tend to have a three to five month pickup of perhaps 1% at the gross margin line as a result of those changes. Our Energy and Chemicals business is primarily fixed priced contracts but we are typically fairly well hedged on those materials to minimize risk. So you don’t see a great deal of change going through. In our BioMedical business it is primarily fixed prices which tend to be changed on a six month or annual basis and that the benefit over the first half of the year would be pickups. I think the most important issue we have is that we have managed our inventories very effectively so that we are able to get better pricing fairly quickly coming through and we continue to manage it aggressively.

Chris Agnew – Goldman Sachs

Excellent. Thank you.

Operator

(Operator instructions) Your next question comes from the line of Greg McKinley from Dougherty. Your line is open.

Greg McKinley – Dougherty

Good morning.

Michael Biehl

Good morning Greg.

Sam Thomas

Hi Greg.

Greg McKinley – Dougherty

Good morning. I like to maybe get your thoughts around how if at all you have changed your investment outlook in your business. Have you seen enough indication customers’ capital expenditure plans and their anticipated order rate to the point that you are considering making changes in your capital expenditure and how are you thinking about managing sort of overall capacity on your end of it as there is more uncertainty from your customers?

Sam Thomas

We continue to view that on a daily or weekly basis based on the uncertainty and any pullback from our customers or changes in outlook we react very quickly. So we have already acted to pull back on discretionary spending on things like inter-company travel and we pull back on capital expenditures particularly those nice to have things as opposed to the productivity improvement ones. When we look at fundamental structural investments, we talked previously about looking at additional capacity for a number of our businesses based on demand, going out and meeting capacity in the late 2009, 2010 timeframe. We would – we pulled back on those decisions until we have a clear picture of what the timing is, whether it effectively means a three month, six month or, twelve month delay in some of those projects. So I feel very good that we’re on top of making those decisions. We are not committed for any large capacity increases or large capital expenditures early in 2009 at the moment.

Greg McKinley – Dougherty

Thank you. Could you also talked a little about your backlog in terms of what are the – what is the flexibility or possibility for customers to actually cancel some projects out of that backlog of our how once that backlog is booked, how depending upon the prevailing credit environment how much could we see the project – the project timing of some of those orders that have already been placed. How much could that move?

Sam Thomas

Both historically and on the basis of going through a careful review of our backlog and speaking to our customers we think that is very low probability of any significant cancellations.

Greg McKinley – Dougherty

Thank you.

Sam Thomas

Thank you Greg.

Operator

There are no further questions at this time. Do you have any closing remarks.

Michael Biehl

Yes. I just like to thank everyone for joining our call today. We appreciate your confidence during these uncertain times in the market. We continue to see significant opportunity based on the strength of our business model, liquidity, cash generation capacity, and the fundamental design drivers for our products. Thank you very much.

Operator

So this concludes today’s conference call. You may now disconnect.

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Source: Chart Industries, Inc. Q3 2008 Earnings Call Transcript

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