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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning and welcome to the Chart Industries, Inc. Second Quarter 2018 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. The Company's earnings release 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, July 26th. 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 statements.
For further information about the important factors that could cause actual results to differ materially from those expressed or implied, 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. The filings are available through the Investor Relations section of 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 the conference over to Jill Evanko, Chart Industries' President, CEO and CFO. You may begin your conference.
Thank you, Michelle. Today, we'll provide details of our second quarter results, market and order trends, and an updated full year outlook. In order to facilitate the discussions on our second quarter 2018 results, we have included a supplemental deck as an exhibit to this morning's press release, which I'll reference throughout the call. The deck can be located on our website under Investor Relations.
Starting with our second quarter of 2018 results on Page 3 of the supplemental deck, sales of $319.9 million increased 14% over the first quarter of 2018. All three segment sales increased over the first quarter by 12% or more. Favorable market tailwinds combined with specific wins in LNG vehicle tanks for trucking in Europe, air cooled heat exchangers for natural gas processing and space applications are driving the increases. We expect favorable margins across each of our three segments to continue throughout the remainder of 2018.
Compared to the second quarter 2017, sales increased 34% or 14% organically. The year-over-year increase in revenue was driven by energy and chemical, increases in demand for equipment, for natural and industrial gas applications, distribution and storage, packaged gas volume, LNG vehicle tank, and increases in parts, repair and aftermarket as well as the release of the new portable oxygen concentrator in BioMedical. The growth in sales reflects continued strength in orders across all three business segments in the first half of 2018.
The second quarter of 2018 is our sixth consecutive quarter of sequential order growth with 12% growth over the first quarter of 2018, and sequential growth in orders in all three segments. Orders increased 43% or $107.7 million above the second quarter of 2017 and included $92.2 million of Hudson orders. Hudson had a $28 million orders for air cooled heat exchangers on a larger LNG project that is underway as well as a $13 million equipment orders for natural gas liquids fractionation project. A portion of the orders will ship in 2018 and remainders are expected to ship in 2019.
Additionally, we received a $12 million order in distribution and storage for liquid hydrogen storage vessels to be used in the private space industries for launch operations, an application that is growing for us. Gross profit for the second quarter of 2018 was $84.5 million or 26.4% in sales, compared to first quarter’s gross profit as a percent of sales of 27.6%. The sequential decrease in gross margin as a percent of sales was driven by $3.75 million of costs associated with the aluminum cryobiological tank recall earlier this year.
Excluding the recalled costs, gross margin as a percent of sales would have been sequentially higher than the first quarter of 2018. Earlier in the second quarter, we received several customer inquiries regarding the performance of our certain aluminum cryobiological tanks within our BioMedical segment that were manufactured at our New Prague, Minnesota BioMed facility. We determine that certain aluminum tanks manufactured at the facility during a 12-week period should be repaired or replaced. On April 23rd, we issued a recall notice for the impacted product lines with an estimated cost of $3.75 million.
Selling, general and administrative expenses for the second quarter of 2018 were $55.3 million inclusive of 1.4 million of transaction-related and restructuring costs, and net costs of $1.4 million related to the departure of the previous CEO. The departure of our former CEO occurred in mid-June and was not associated with any one single event. We’re actively searching for our next CFO. The leadership team of our three segment Presidents, our CHRO, and our Legal Vice President and Secretary will continue to execute on the strategy that was articulated at our Investor Day in early June with certain tweaks to drive growth and margin enhancement earlier in our three year horizon.
Additionally, we do not anticipate any material change to our three year outlook, due to recent news related to the divestiture of assets in the global industrial gas businesses in particular Praxair and Linde. Backlog of $527 million is a $38 million increase over the end of the first quarter of 2018 and a $66 million increase over the end of 2017. Similar to orders, backlog in each of the three segments increased sequentially this quarter as well as increasing over 44% in total over the second quarter of 2017 or 15% excluding Hudson.
Slide 4 shows the first half of 2018 results with the sales increase over the first half of 2017, up 36% and 15% organically. A significant increase in orders of $219 million and a 19% organic increase, drive further confidence in our second half of 2018 projections. Adjusted earnings per share increased from $0.22 to $0.78, driven by the favorable impact from full year 2017 restructuring actions, the Chinese DNS business returning to positive operating profit and additional volume across all three segments.
Slide 5 of the supplemental deck shows our second quarter 2018 and 2017 adjusted EPS as well as first half comparisons. Second quarter of 2018 reported EPS of $0.38 was an increase of $0.29 over the second quarter of 2017. Restructuring and transaction-related costs were $1.4 million in the quarter and added back $0.04 of EPS. The aluminum cryobiological tank recall had a $3.75 million cost to us in the quarter or $0.09 of earnings per share impact. The departure of our former CEO resulted in net severance costs of $1.4 million or $0.03 of impact.
As our average stock price of 62.82 for the second quarter was greater than our 20.24 notes conversion price of 58.725, our diluted share counts for GAAP reporting purposes increased by 287,000; however, we hedged our convertible note offering to offset this dilution which resulted in a $0.01 addition to our adjusted EPS. Therefore, adjusted EPS for Q2 of 2018 is $0.55 compared to $0.21 in Q2 of 2017.
Moving to our outlook for the full year of 2018 on Page 6 of the slide deck, guidance has previously and continues to include the impact from the revenue recognition accounting standard change which was adopted effective January 1, 2018, and which we expect to be immaterial on a full year basis. Sales guidance is expected to be in the range of $1.2 billion $1.25 million for the full year, an increase over prior guidance of $1.15 billion to $1.2 million. This increase reflects our past nine months of order strength as well as our first half 2018 sales performance.
We expect full year adjusted earnings per diluted share to be in the range of $1.85 to $2.05 per share on approximately 32 million weighted average shares outstanding. This excludes any restructuring and transaction related costs and does not incorporate any impact from the strategic evaluation of our oxygen related products. Prior EPS guidance was a $1.75 to $2 per share. We continue to expect our effective tax rate inclusive of benefits from Tax Cuts and Jobs Act to be 27%.
In the second quarter of 2018, our effective tax rate was 27.6% bringing the year-to-date rate to 27.3%. Included in the second quarter effective tax rate was a one-time discrete item of $425,000 related to entity structuring, and normalized for this item, the ETR would have been 25.9%. Our capital expenditure guidance for 2018 remains unchanged will be in the range of $35 million to $45 million. This guidance includes our typical maintenance capital of approximately $25 million to $30 million as well as our completed capacity expansions of our LNG vehicle tank line for $3 million.
Additionally, our capacity expansion in our Brazed Aluminum Heat Exchanger facility in La Crosse, Wisconsin will be complete in the next month and comprises $11 million of capital in 2018. As mentioned on our last earnings call, net leverage is continuing to decline from our strong cash flow generation from 2.96 as of March 31st to 2.81 as of June 30th. Historically, we’ve not share a non-GAAP measure for free cash flow. Given that it is key metric we utilized in managing the business, this quarter and going forward we will provide this information.
Slide 7 of the supplemental presentation shows our year-to-date free cash flow of $27.6 million, an increase of $47 million in the same period in 2017. Note that this does not include spend on acquisitions. In the first half of 2017, we spent $23.2 million for Hetsco. And in the first half of 2018, we spent $12.5 million for Skaff Cryogenics. Through our Chart business services, shared service processing centers, that has been established over the past year, we’ve improved processes and seen us leverage through receivables and payables and free cash flow. There are additional opportunities for us to pursue through business services, and we’ll focus on operational and supply chain improvements in 2018 and 2019.
Moving to our segment update and starting with BioMedical. At the end of the first quarter of 2018, we announced the review of our oxygen related businesses within our BioMedical segment inclusive of a possible divestiture of the business. We’ve no further update at this time on the progress of that strategic evaluation. BioMedical orders in the second quarter of $64 million were the highest in five years. Activity in respiratory order intake in Europe for our liquid and transportable oxygen concentrators, combined with the first full quarter of orders for the new portable concentrator drove a 28.7% increase in respiratory orders over the first quarter of 2018.
Second quarter BioMedical revenue increased 13% over the first quarter of 2018. In the quarter liquid oxygen tender activity picked up strength as did orders for on-site generation systems for industrial production plants as well as hospital systems in both China and Africa. As mentioned on our first quarter earnings call, end market activity and applications continue to be a tailwind for revenue growth in the BioMedical segment. These microeconomic trends combined with the strength in orders for the first half of 2018 drive our outlook for the BioMedical segment for the remainder of the year with expected high single digit full year growth over 2017.
We continue to expect sequential revenue growth in each quarters for the remainder of 2018, which is different than the segment typical lower fourth quarter seasonality. We discussed the release of our new portable oxygen concentrator in the first quarter indicating that in the first quarter we sold over 1,700 units to a large distributor. In the second quarter the order levels continued similarly and while our full year guidance does not include additional orders from this activity we do see second half upside potential from the early success of the portable concentrator.
A key highlight of the quarter and year-to-date performance of our BioMedical segment is the improvement in the SG&A cost structure. SG&A is down $2.4 million from the second quarter of 2017 and $600,000 from the first quarter of 2018. This is the result of the facility consolidation in early 2017 and rightsizing of our cost structure.
Now, moving to our energy and chemicals segment update, E&C segment sales of 100.8 million were up 12% compared to the first quarter of 2018. Strong demand for our air cooled heat exchanges continue. Orders for natural gas processing applications in the United States for the first half of 2018 were up over the first half of 2017. Hudson products contributed $47.5 million in sales, and 6.1 million of operating income in the quarter. Hudson orders of 92.2 million in the quarter were sequentially up 149% compared to the first quarter driven by the two previously described large orders received.
The Hudson integration into Chart continues to go smoothly with the recent large order demonstrating the potential revenue synergy opportunities available as a result of the acquisition. Achieved cost synergies to-date have been in the back office and supply chain and we’re continuing to work towards the full $7 million of annual run rate cost savings in addition to further revenue synergies. At our recent Investor Day, we shared our view on the timing of the balancing of the global supply and demand for LNG, which will drive LNG export facility orders.
We continue to base our view of the timing on the perspective that additional LNG will be needed in the 2022, 2023 time period. We believe we'll start to see large LNG liquefaction project orders in the first half of 2019. We do not include nor expect any large LNG liquefaction orders or associated revenue in our full year 2018 forecast. Many of the projects that we’re involved in have filed for and are waiting for approval which would drive the timing of our orders.
We track many LNG project opportunities and we’ll periodically provide updates on progress against those projects. Specifically, Driftwood LNG will utilize Chart’s IPSMR technology and is expecting FERC approval it the first half of 2019. Shortly, after the Driftwood project receives FERC approval, Chart expects to be given notices to proceed to facility equipment and process technology orders. Also in the second quarter of 2018, Cheniere filed for FERC on its stage-3 for Corpus Christi and is expected to utilize FERC equipment and IPSMR technology. Venture Global’s Calcasieu Pass for 10 million tons per annum is expected to utilize Chart’s brazed aluminum heat exchangers and cold boxes.
Moving to our distribution and storage segment activity, DNS sales of $157.4 million in the second quarter increased 21.3 million over the first quarter of 2018 and 19.8 million or 14% over the second quarter of 2017. Sequential increases are driven by strength in packaged gas in particular LNG vehicle tanks, standard and ISO tanks and GOFA trailers. The first half of 2018 for DNS had double digit sales growth over the first half of 2017 in all three geographic regions. DNS orders of $174 million were the highest in five years and the six quarter of sequential order growth for the segment.
Six consecutive quarters of sequential growth is the longest sustained order trend since 2002. Since the fourth quarter of 2017, strong demand for LNG fuelled heavy duty trucks has continued with first half related orders of over $25 million. Additionally, we’re also seeing a pipeline of bidding activity for LNG marine bunkering project for which orders will be received in 2019. Chart content on LNG marine bunkering project typically ranges between $5 million and $25 million per project.
Second quarter backlog for DNS of $261 million is the highest since the second quarter of 2015, and has increased in the U.S., Europe and Asia since the end of 2017. Gross margin as a percent of sales of 28.3% increased from 27.6% in the first quarter and 25.7% in the second quarter of 2017 reflecting certain productivity efforts in our manufacturing locations and improvement in our Chinese business. This reflects the results of our China facility consolidation and for DNS Chins contributes the past six months of positive operating income.
In the second quarter of 2018 in our DNS China business, we booked a $3.5 million order for 50 LNG ISO units and a $1.8 million LNG tank order. Given that a significant distribution network is required to move LNG from England to points of East Coastal receiving terminals in China. Market demand is increasing for LNG ISO tanks, trailers and storage tanks. Our DNS aftermarket repair and service business had sequential sales growth over the first quarter of 2018 of 6% and order growth of 27%. Compared to prior year, the second quarter of 2018 grew 25% in sales and 40% in orders in part driven by the additions of VCT Vogel and Skaff Cryogenics to our portfolio.
I will now open it up for questions. Michelle, please provide instructions to participants to be able to ask questions.
[Operator Instructions] Our first question comes from Matt Trusz of Gabelli & Company. Your line is open.
Jill, as you highlighted, there’s just a significant order growth in the first half of this year and coming from a diverse range of sources. As you see it today, do you see all these pieces coming together for the same cadence of growth to continue in the second half? And then of the opportunities you mentioned, are there specific drivers you’re focusing on?
So, yes we would expect to continue to see this level of orders, but normalized for the three specific large orders that I called out, in the DNS and the E&C segment. So if you do that and pull that through Q3 and Q4, we’d be at pretty similar levels. And then the second half of our question with respect to specific areas that we’ll focus on, we’re continuing to focus on our European LNG vehicle tank opportunities as well as some of the LNG bunkering and ship opportunities that I just described. On the E&C side of the business, we’re continuing to see demand on the natural gas processing side of the house as well as starting to see engineering work on the larger projects.
And then also congrats on your new role and the results you’ve had in the last year and a half. I was wondering if you could provide any more color on the recent transaction just with respect to reasons why the Board fired the prior CEO. It appeared I guess abrupt the external observers?
Yes. So, let me start by addressing the fact that this was not a one-off event. There was no financial fraud or any other type of unethical event that caused the change. The Board made a decision with respect to the prior CEO's leadership style, and while there’s never a good time for an executive change such as this, the decision was made to do at this point in time once they had decided to move ahead with it. The other element to this answer is that, the remainder of the senior leadership team that I just described on the call with the three segment presidents, our CHRO and our legal guy, we will continue to move forward with the strategy as we laid out, we all participated in developing that strategy that we talked about at Investor Day in early June, and now we plan to continue to execute upon it with no significant changes to what was described.
Our next question comes from Eric Stine of Craig-Hallum. Your line is open.
Maybe just on the LNG vehicle tanks I know in the prepared comments you talked about some specific wins, but obviously given your optimism, it's also is it the more broad market trend. So maybe just talk about, if you could, what you’re seeing there? And I also know in the past you’ve mentioned that you completed the expansion and it might not be that long before you need to look at another expansion so just maybe some thoughts on that as well?
Sure. So, yes the market is going very strong on that LNG vehicle tank side, in particular geographically in Europe, we’re not seeing it in U.S. or in China right now, but there’s future potential for that market to the size of that market to increase kind of from the 50 million to 75 million on annual year to another 40 on top of that if China starts to move in that direction. So, overall, we expect that level to continue for 2018 and through 2019.
Certainly, from a longer term outlook, we’re having conversations with our customers around what does the next five year level look like and that will drive our decision making around further capacity needs. Right now, with the completion of the capacity expansion in Georgia that I described, we do have enough capacity to fulfill the demand that we have already in backlog as well as the additional demand that we’re forecasting for 2018 and 2019. So, once we have a better view of the three years beyond the next two that would drive our decision making around further capacity needs.
And maybe just turning to China and just to confirm, I think you said it was profitable in the second quarter, but just curious about, is it still the expectation for the full year? And I know that that’s a key variable in your tax rate expectations for 2019? I think you said 22% for the overall in the past?
Correct, yes, so we continue to expect 22% starting for full year 2019, we do expect that operating profit positive will continue for the second half of the year. I will caveat my answer with when I say operating profit positive we’re not talking about millions of dollars, we’re talking about 100s of 1,000s of dollars versus larger numbers. So, we’re still writing the line there, but we’ve good actions in place that we’ll continue to drive that positive with the order trends in China and about 50 million in backlog there, we expect the volume to continue at levels that keep that positive.
Maybe last one for me just Hudson, I mean good to hear that air cooled heat exchanger order there. I mean is that the typical -- I mean, is this kind of a typical content level if you were to get world there? I mean, should we think about this as incremental to -- at the Investor Day you gave the big list and talked about if its IPSMR could be a 150 million to 500 million. Should we view Hudson as incremental to those types of projections?
You should, yes. So, what we provided at Investor Day did not have Hudson included in those numbers, and generally speaking using our kind of 20 million to 100 million additional increment depending on the size of the facility and the customer would be safety use for Hudson.
Our next question comes from Rob Brown of Lake Street Capital. Your line is open.
Sticking with Hudson, maybe you could just -- you kind of alluded to some of the revenue synergies possible there. Could you just kind of sketch out what might be some opportunities there? And what you’re seeing developed now that you’ve had it for a while?
Yes, absolutely. So, the most significant revenue synergy opportunity really is on these larger LNG projects, bringing Hudson through our relationship, our legacy E&C relationship with customers is what’s driving that. The other element is, Hudson does have a different set of top 10 customers on the air cooled side, then Chart legacy air cooled heat exchangers does. So that gives us opportunity from a cross selling perspective which would be smaller than the orders that we’ve described today but still considerable revenue upside opportunities. Historically, we’ve chosen to speak strictly to the cost synergies, but now that we’re seeing that leverage from the acquisition we felt good time to share that.
And then you talked a little bit about the service business or uptick strength. I guess now that you’ve had the acquisitions integrated. What are you seeing there? And what’s the opportunity for the service business growth going forward?
Yes, so, parts repair service, aftermarket as a lump number for Chart is about 13% of our total revenue right now. As we put out just in early June, we expect that to be over 20% of our revenue in the next three years. These acquisitions folded very nicely into our current parts, repair and service business within DNS. So for DNS, it’s definitely smaller than E&C in terms of the aftermarket side, but we’re expecting double digit growth on the parts, repairs, service side in 2018 in the DNS segment which is right in line with our expectations for what we had paid for these acquisitions.
Our next question comes from Martin Malloy of Johnson Rice. Your line is open.
First question, I just wanted to ask about the LNG bunkering facilities, and I know you’ve had strong demand in Europe. Are you starting to see bidding activities or opportunities outside of Europe? And are these related to IMO 2020?
So, the primary bidding activity we’re seeing is in Europe right now. So, I don’t want to oversell the other regions, but we are seeing a pretty active pipeline, can’t share the specifics around the given the customer confidentiality, but it is activity that’s picking up. To be clear and reiterate my earlier comment, these would be orders and activities starting in 2019, the driver is primarily the regulatory environment, so you’re correct on IMO 2020 being a driver, there’s a little bit of wait and see attitude right now in terms of whether the enforcement is going to happen in 2020, but certainly a very active pipeline, more active today than it was six months ago.
And then second question just on the E&C margins, maybe could you help us with what we should look for second half of the year what could be similar drivers. Was there any negative impact from the capacity expansion being finished up at La Crosse and Skaff in that? What can we -- what should we think about in terms of second half of the year for E&C margins?
So think about the full year for E&C about 24% to 25% on the gross margin side, and in terms of anything negative, the La Crosse facility continues to be doing great and we did not see anything negative from that capacity expansion, we’re very excited about that being completed. But if you look at first half to second half, we would expect 200 basis points of gross margin improvement in the second half over the first half in that segment.
Our next question comes from Walter Liptak of Seaport Global. Your line is open.
I wanted to ask you -- you’ve got into a lot of detail about the Hudson orders, but I wondered if I can just ask the question maybe in a different way. How much of the growth is market-related versus sales synergies? I am sure it’s probably a combination of both with higher production, but how much of these wins would Hudson have gotten without being part of Chart?
So, let me answer your question specifically to the two orders that we called out today. The $28 million order would not have happened if Hudson were not part of Chart, the $13 million order that would have happened. So, it’s kind of the specific ones that are synergistic from the acquisitions will be clear going forward on whether they would have had it or not but the 28 was definitely the result of being part of Chart.
And when you look out over the next six months, I think there’s a -- not favorable -- would you say there’s more opportunity just from the market picking up, the sector getting better or from sales synergies?
For the second half of the year I think it’s from the market more so than sales synergies, but for 2019 there’re specific projects that we’ve line of sight too, which we’re already in conversations about that are synergistic from the deal.
And then last, there hasn’t been any discussion about price cost yet but obviously your experienced material inflation. How did you feel about the price increases that were contractual or not contractual during the quarter? And what are you thinking about pricing in the second half?
So, we are -- in our forecast, we’ve included the levels of commodity pricing that we’ve seen in the second quarter, which on the majority of them have been at higher than typical level, so that’s reflected in our full year forecast. We do have mechanisms in DNS as well as in E&C that have come in form of protection for us around material escalation, but we also plan targeted price increases for pass-through starting in September in certain pockets of the business which our customers are aware of.
Our next question comes from Pavel Molchanov of Raymond James. Your line is open.
At the Analyst Day, we talked about the impact of at the time 25% steel tariff, as of two weeks ago there’s an additional 10% tariff on steel vis-à-vis China. Obviously, these things tend to compound, and I am curious kind of what the impact on cost of goods might be from this cumulative impact in the second half of the year and into 2019?
So as in my last answer around the protection that we’ve in our contracts as well as with the projects that we do in E&C gives us some air cover on that, also where we source from geographically makes a difference, we source quite a bit of our fuel in the United States and in Canada, there -- from -- built into our forecast perspective we’ve built 50 basis points of negative margins into the aggregate forecast, there’s certainly pockets around that which we don’t share the details on our spend.
But we have that -- we’ve mechanisms to cover that as well in some of the productivity areas that we’re working on. There depending on future tariffs and some of the discussions that are out in the news right now, could cause us to be thinking about where do we source as well as where do we ship from, the good part for us is we do have manufacturing locations in the key geographies that we need to be in and we’ve a flexible capacity to be able to accommodate to that.
And then just quick follow-up you may have mentioned it’s earlier, but the $28 million LNGO order in Hudson was that Cheniere’s Corpus Christi?
I can’t provide who that was, but it was for a larger LNG that’s already underway.
Our next question comes from Tom Hayes of Northcoast Research. Your line is open. Tom, if your telephone's muted, please unmute. There’re no further questions, so I'll just turn the call back over to Jill Evanko for any closing remarks.
Thank you, Michelle. Our second quarter and first half 2018 results reflect our productivity and execution in our favorable markets as well as the opportunities generated from our new product pipeline and recent acquisitions. The increase to our full year sales and EPS guidance reflects the first half strength as well as our expectations for strong second half of the year given the past nine months of order activity across all three of our business segments. Year-to-date free cash flow generation of $28 million continues to support our strong balance sheet and allows further investment in targeted strategic growth areas. Thanks everybody for joining us today. Good bye.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone, have a great day.