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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 Chart Industries Inc. 2019 Third 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.
The company’s supplemental presentation 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 following the conclusion of the call until Thursday, October 24, 2019. The replay information is contained in the company’s press release.
Before we begin, the company would like me to remind you that statements made during the call that are not historical in fact are 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. The company undertakes no obligation to update publicly or revise any forward-looking statements.
I would now like to turn the conference call over to Jill Evanko, Chart Industries’ CEO.
Thanks Kevin. Good morning everyone and thank you for joining us today to go through our third quarter 2019 results and our current outlook for 2020. Joining me today is John Bishop, our Chief Operating Officer who has responsibility for Chart business services, investor relations, business development, and acquisition integration. You’ll hear from John later in the call about the progress of our integration efforts on both VRV and Air-X-Changers, including an update on our original Air-X-Changers cost synergy assumptions of $20 million to a revised number of $29 million, still within the original timeframe of the first 12 months of ownership.
We’ll walk through to our supplemental presentation that was released this morning. Starting on Slide 2, this represents how we think about our business opportunities, many of which are driven by what our customers are telling us underscored with profitable growth. We are focused on our industrial gas and energy end markets supported by the elements in A through E around the circle.
Letter A is the growth machine for our business over the next seven to 10 years, the global LNG infrastructure build out. The focus of the activity is small scale LNG as well as transportation and associated fuelling stations, which you’ll hear about today. Letter B is our innovative solutions, including our process technology as well as our upfront engineering and design. In the third quarter, we signed an MOU with AG&P to develop LNG infrastructure globally with a focus on India. With our previously signed MOU with IOCL, we now are working directly with two of the leaders in the Indian city gas network development.
Letter C represents the only reason some of you listen to this call. With updated timelines from certain customers and leaps towards FID in the third quarter, we are bullish on our order pipeline through 2020 for big LNG. We are excited that with Tellurian’s recently revised project timing for Driftwood compared to our underway Calcasieu Pass work, we have an extended up cycle beyond the originally assumed three years. Of course, we will address the billion dollar question of how much FID is left, but I’m going to make you listen to the core parts of the business first.
What is commonly missed about our business is the underlying growth machine our distribution and storage industrial gas customers that are on long-term agreements. This is part of the Letter D driving the business. While the broader macro sentiment toward industrials is uncertainty, in particular in light of the ongoing trade situation, we are confident in our underlying industrial forecast for 2020 in part because of these LTAs.
In the third quarter, we completed negotiations with two of our top three customers to extend our agreements. The total annual revenue associated with these two customers is on average $85 million. Additionally, we are in discussions about signing up another customer to a long term agreement, which would be the first with this customer who has recently significantly grown in the industrial gas space through consolidations in the industry. I will hold this fantastic progress on specialty markets until later in the deck.
Finally to close the circle, Letter E. You heard our drumbeat of 80/20 of cost synergies through integration, of driving sourcing savings of over $6 million, of continued focus on productivity. All of this will continue as part of our culture and year-to-date 2019, we have achieved over $13 million of annualized cost savings in addition to integration synergies, all of which will be fully seen in 2020. We will share with you today the additional cost savings we see ahead of us in Q4 2019.
Macro themes support our continued strong order book in particular driven by the LNG infrastructure build globally and specialty markets, as shown on Slide 3. As I mentioned on last quarter’s earnings call, I am pleased when we receive multiple $1 million-plus orders within a quarter, which demonstrates the broad-based growth and multiple levers we have to pull to support our organic growth. In the third quarter, we received 33 orders greater than $1 million with eight each in E&C Cryo, E&C Fin-Fans, and D&S West, and nine in D&S East.
The third quarter orders of $286.2 million included a $6.6 million air cooler award on the last day of the quarter, expanding our equipment content to air coolers on Venture Global’s Calcasieu Pass project. Also within the quarter we received an order for $5 million with one customer for hydrogen applications, a $2.7 million order for pipe related to a space application, a $9.2 million order for a hydrogen recovery system in an ammonia plant, and a $7.5 million for IMB, the part of VRV that produces shale and tube heat exchangers. This is just to name a few. The third quarter orders were up 8.5% over the same period in 2018, which included an E&C quick ship order of $5.7 million as well as a $12 million space launch application order in D&S West.
Fourth quarter has started off on the right foot with verbal receipt yesterday of a $9 million award for a power plant project in the Caribbean. Additionally, we were awarded a $23 million project for a PDH separation system for which $1.3 million was booked in the third quarter and the remaining is expected to be booked in the fourth quarter once full notice to proceed is given.
September was the highest order month of the quarter of E&C Cryo and E&C Fin-Fans, which trends well for our 2020 outlook. Additionally, September was the highest month of the quarter for industrial gas orders with our major customers, a leading indicator for how we think about 2020 growth. As we have said in the past, packaged gas in D&S is a leading indicator for the rest of that business. In the third quarter, packaged gas orders were $65.6 million, an increase over Q2 of 12.4% and an increase over Q3 2018 of 7.8%.
We anticipate 3% baseline industrial gas growth in 2020 as indicated by our majors before any of the higher specialty market growth. Third quarter 2019 specialty market orders of $46 million were 56% higher than the same quarter of 2018 and 54% higher than the second quarter of 2019, with record order levels in lasers and hydrogen. Specialty market sales of $40 million in the quarter were 6% higher than the prior year, contributing to our total Q3 2019 revenue of $358 million. This order activity contributes to our total record backlog of $755.6 million.
Flipping to Slide 4, we continue to see significant growth in the global LNG infrastructure build-out where we play across the value chain. Throughout today, you will hear about how the global nature of LNG will positively impact our business over the next decade. Currently, we are pursuing LNG related projects in 71 countries around the world. Before we go into how these countries are intending to utilize LNG and how that impacts Chart, let’s discuss the strength and order opportunities in small scale LNG terminals, fueling stations and associated transportation, both marine and over the road, including trailers.
The third quarter of 2019 was a record quarter for LNG fueling station orders with 19 stations booked compared to only three in the third quarter of 2018. The strong third quarter of 2019 contributed to our year-to-date total orders for 41 fueling stations compared to 21 year-to-date in 2018. Much of the increase in activity this year has been driven by the European Union presenting new emission reduction standards for heavy duty vehicles earlier this year. The new regulation requires carbon dioxide emissions from HDVs to be reduced by 30% by 2030.
Within the quarter, there were multiple notable fueling stations that opened with Chart’s equipment and process. The Nordic energy company, Gasum, opened its fourth station in Sweden. Gasum is planning to create a network of 50 new filling stations for heavy duty vehicles in the Nordics by the early 2020s. At the end of September, a new station was opened in Poland by Bisek-Asfalt, an industrial company that provides construction products and services. Bisek-Asfalt’s chairman shared that he expects to expand the company’s fleet of LNG trucks to 50 within the next 12 months. The company also shared at the opening ceremony that Chart has won the tender to supply the next LNG terminal due to our technology and ability to supply a complete solution, including installation and servicing.
While many of the stations being built by Chart are LNG, our stations can also be equipped with a CNG module to cover fueling requirements for the complete spectrum of natural gas powered vehicles. Of the 19 stations booked in the third quarter, two were LCNG stations in India.
Fueling station infrastructure also contributes to growth in our LNG over the road trucking business. Earlier this year, we signed two long-term agreements with heavy duty truck manufacturers to sole source our LNG fueling tanks for this application and we’re partnering with our customers on new solutions. Additionally, we are seven months into our development of our HLNG vehicle tank line in Italy and expect production to begin there by the end of the first quarter of 2020, which will even better serve our European customers from a lead time and cost standpoint. Third quarter LNG vehicle tank orders were 87% higher than the second quarter of 2019 and the highest quarter of the year.
Also picking up pace in the third quarter was our activity around LNG marine applications in part driven by the proximity of the January 1, 2020 IMO regulations. In the quarter, we were awarded a contract by LGM Engineering to supply four LNG fuel tanks for their marine fuel gas systems that will power chemical tankers with clean burning natural gas. This is part of Gloryholder LGM’s contract with Wuhu Shipyard to supply LNG fuel gas systems for two LNG powered tankers being built for Rederi AB Donsötank. This follows an order earlier this year for marine tanks that will be used in the first two river-to-sea LNG fueled ships in China.
Continuing in the innovative vein that is Chart’s engineering core competency, we have designed in conjunction with our customer, Babcock LGE, an apparatus that prevents oil rundown into the bottom or cold section of the heat exchanger at low flow conditions. This will be utilized in Babcock LGE’s Ecosmart technology for onboard LNG re-liquefaction systems on LNG ships. We are pleased to be filing a joint patent application with Babcock on this.
Babcock supplies their Ecosmart LNG re-liquefaction package to be used onboard new build LNG carriers to preserve the cargo in transportation. Cargo boil-off is around 0.1% per day with an average voyage of 14 days .As part of what we offer with Babcock, we assist in ensuring the best economics for each vessel with our skid-mounted braised aluminum heat exchanger being critical to the performance of the package.
Transportation applications continue to drive demand for our trailers. As you may remember, 2018 was a record trailer order year for Chart and as an example of the continued demand, through the third quarter of 2019 our year-to-date trailer orders are ahead of the year-to-date 2018 orders.
Before we move to other global LNG activity, I’d like to just give an anecdote about the magnitude of the global infrastructure build-out that is underway. We recently quoted on two tenders for a country in Europe’s armed forces for over €50 million strictly for tank containers with pumps and generators for fuel service. While this would be a 2020 award, it gives you a sense of the opportunity worldwide for us.
As you just heard, the EU regulatory emissions standards reduction is driving certain clean energy infrastructure development. We are also seeing increased government and regulatory body interest in this decarbonization trend across the globe. Slide 5 is a visual that demonstrates a subset of countries and governments around the world that have taken a position on a cleaner future. On the far right-hand side of the slide are high LNG growth countries: Japan, Papua New Guinea, Philippines and Vietnam. Recently we received a reach-out from the government of Papua New Guinea indicating that they are interested in potentially working with us as they develop their national energy master plan, which should include monetization of stranded gas fields for power generation. They are considering small scale LNG as well as transportable modularized LNG containers for shipment.
Vietnam is one of the most public proponents of LNG with the country’s total LNG demand estimated to reach 10 million tons per year by 2030 The Vietnamese government is looking at a $5 billion LNG project in the southern Binh Thuan province which would include an import terminal and gas-fired power plant. The intent is that this facility would import from the United States. We are working with members of a consortium of companies, including Energy Capital Vietnam, to participate in the development. We are currently bidding on a variety of downstream applications in the region with our trailers, isotanks, and re-gas station offerings.
Now onto Japan. Japan has imported LNG for over 50 years and just recently announced that $10 billion would be invested by public and private sectors to encourage broader use of LNG around the world. This funding would support processing plants, receiving terminals and power generation. In September, I visited multiple LNG customers and potential customers in Tokyo and Osaka. Not only is the intent there, the action is well underway with companies such as JGC, Chiyoda, Toyo, Marubeni, Osaka Gas, and Jera.
Speaking of Marubeni, Osaka Gas and Jera, these are three of the 17 shortlisted companies for spot LNG, for which Bangladesh could purchase 1 million tons of LNG next year. Petrobangla is in charge of LNG imports into Bangladesh and shortlisted 17 companies from an original set of 43. Currently the country has two floating storage and re-gas units and they are building a land-based terminal that can handle 7.5 Mtba of LNG. It is also noteworthy that we currently work with over half of the shortlisted companies, including some of those mentioned, as well as Cheniere, Petronas, and Chevron.
And of course, India continues to go LNG gangbusters both from a macro perspective as well as our specific order activity in the region. Just this morning, we received another synergy order in India for $1 million for a vaporization package. India expects an increase of $17 billion of spend in the next eight years on the city gas distribution networks and includes an increase in the number of LCNG fueling stations to over 9,000 from 1,800 today.
Our MOUs with IOCL and AG&P have proven to be effective already. In the third quarter, IOCL awarded us the cold box for their Panipat refinery expansion. Additionally, AG&P has awarded us six CNG stations in India. Bishop will share more specifics around our India potential when he discussed our VRV and Air-X-Changers integration update shortly.
All of this activity underscores the continuing need for both LNG supply as well as the local infrastructure to support those geographies looking to either import or be self sufficient on natural gas. Let’s segue into what activity we are seeing in both small scale and big LNG by flipping to Slide 6.
Over 40 countries currently count on oil or diesel for more than 25% of their electricity needs and nearly all of them rely on oil imports for power generation. With small scale growth expected to be between 12% and 15% in the next 15 years, we expect to continue to exponentially increase small scale terminal order rates in the coming months.
On the table on Slide 6, there are now 12 potential projects shown as compared to the prior 10. As I’ve said many times before, this is not the full set of our order potential but select projects that we are sharing to give you a sense of the possibilities in the market being bid on today. The total Chart content for these projects shown here is over $150 million. I’ve bolded three projects to give you some more specifics.
On October 4, the Department of Energy announced the issuance of an order approving LNG exports from the Eagle Jacksonville project, number six on the slide. The Eagle Jax project plans to export small scale quantifies of LNG as well as serve the domestic market and provide LNG as a shipping fuel. Eagle also received the final environmental impact statement from FERC in late September to construct the facility.
Number nine on the slide is the Caribbean power plant project for which we received a verbal order yesterday. We will supply tanks, re-gas systems, and vacuum jacketed pipe out of both our U.S. and European locations.
Finally, Mexico is a market where small scale LNG is very appealing. Natural gas is cheap and plentiful in Mexico, coming from Texas, western regions and offshore, but the pipeline infrastructure for distribution to the end users is limited. The delivery cost of LNG is as much as 10 per Mmbtu less than the diesel equivalent. There is an existing base of customers and demand is growing with small industrial complexes, power generation, over the road transportation and mining . Much like what we have seen in the Caribbean, we believe the region is ripe for virtual pipeline applications but instead of importing LNG, our customer base is proposing projects to liquefy this surplus natural gas. Row 12 has not just one customer working with us in the region but rather multiple opportunities in various stages of progress.
Now moving to big LNG, I’ll go through the project updates on our pipeline first and then discuss the elephant in the room, which has people asking, how much FID remains in the cycle? Starting with the five projects for which we anticipate revenue in 2020, as shown on Slide 7, quickly moving past Row 1, we are on track to complete the Golar Gimi FLNG project on schedule in Q1 2020. Row 2 is Venture Global’s Calcasieu Pass project which we booked in March of 2019 and received final notice to proceed in September. The timing of the project has a small shift in revenue from fourth quarter of 2019 into 2020. Based on the current project schedule, we anticipate just over $100 million of revenue in 2020 with the remaining in the first half of 2021. It should also be noted that on September 30, our E&C Fin-Fans group was awarded a $6.6 million order from [indiscernible] for air coolers on this project.
Moving to Tellurian’s Driftwood project, shown in Row 3, Tellurian and Petronet LNG entered into an expanded MOU increasing their investment in the Driftwood project to 5 Mtpa or a $2.5 billion equity investment. This brings further momentum toward FID of Phase 1, or 16.6 million tons per annum, which is now expected in the first half of 2020 with only 4 million tons per annum remaining to get to FID. While the change in schedule impacts our 2020 big LNG revenue upside potential, it extends our number of up cycle years, so our big LNG up cycle begins in 2020 with the delivery of equipment for the Calcasieu Pass project and, given the updated Driftwood timing, extends our number of years inclusive of big LNG in the cycle through 2023.
Row 4 is Cheniere’s Corpus Christi Stage 3 project, which we estimate to move to FID in 2020. We have shown a very conservative revenue potential for 2020 on this slide. As always, Cheniere thoughtfully moves its projects ahead with very diligent scheduling, as evidenced by their on-time delivery of prior projects. Additionally in September, Cheniere completed gas supply agreements with EOG Resources. EOG has agreed to sell natural gas to Cheniere over a period of approximately 15 years, beginning in early 2020. Cheniere has indicated that this transaction is expected to support Corpus Christi Stage 3.
Row 5 on the slide is Venture Global’s Plaquemines project. On September 30, VG received FERC approval for the building of Plaquemines as well as the affiliated Gator Express natural gas pipeline system. Just yesterday the DOE issued the order approving exports of LNG from Plaquemines. As a reminder, PGNAG has already committed to 2.5 million tons per annum from Plaquemines.
On Slide 8, which is our traditional big LNG project opportunity list, we have already discussed the first five shown. Instead of adding commentary to each, I will just move to number six which links directly to the Vietnam discussion. In the third quarter, LNG LPD announced its first Magnolia-related off take MOU with Delta Offshore Energy and in conjunction with the Bac Lieu provincial government in Vietnam. The intent of the term sheet is to work to executing a binding SPA for 25% of Magnolia’s original 8 million tons per annum, which could become 8.8 Mtpa if FERC approves their request to increase the capacity of the terminal. Exxon is moving ahead with the Mozambique project and we are pursuing the opportunity for gas treatment, wall cryo storage, and air cooled heat exchangers.
IPSMR continues to gather steam with two new international oil companies validating the process in the third quarter after years of work with our Chart team. This brings us to three IOCs that have validated process for use in their project and also brings credibility to off takers on projects utilizing our technology. Additionally, we are starting to see a larger future opportunity for making existing facilities more efficient. As LNG pricing becomes more and more competitive, existing terminals will need to find ways to lower costs. With our processing equipment, there are many ways to retrofit at fairly low cost that we believe will contribute to more creative approaches from current operators.
How much FID remains? Slide 9 shows continued LNG growth with the market ranges predicting between 4% and 7% CAGR through 2030. At this pace, we will outpace the record supply capacity brought online in 2018 and 2019 by the year 2022. With two to three-year project timelines, additional supply must FID in the next 12 months. The left-hand side of the slide shows 19 projects that had supply brought online in 2018 and 2019. We had equipment on 13 of these 19 projects which were ordered in the years 2012 through 2015.
The best way to think about this is there is a misperception out there that there is a finite amount of FID that will happen. While there certainly is competition in the market right now and speed through Q3 of 2020 to FID is going to make or break some projects, remember that we’re talking about quarters in a long ball, meaning a 20 to 30-year game. By example, just a couple of weeks ago FERC granted Kinder Morgan a permit to put the first train at their 2.5 Mtpa Elba Island facility into commercial use, and one week thereafter the first of 10 proposed liquefaction trains went into commercial service. Twenty of our cold boxes will be used in that facility, originally booked through Shell. The initial authorization to import for the Elba Island facility was issued in 1972. The project received approval to renovate and re-commission 2000, DOE export authorization in 2012, and FERC approval in 2016, so you can get a sense of the length of time and of the naysayers on this type of project. I would encourage you to have a longer view towards how these projects may come online and from a Chart perspective, we are more than happy with the longer big LNG up cycle.
I’ve already given you a sense of the industrial gas long term agreement progress we have made, so let’s move on to the above-10% growth spaces, our specialty markets on Slide 10. Let me start by reiterating our third quarter specialty market order strength of $46 million, a 56% increase over Q3 of 2018. Many of you have asked us the size of the market potential for our products in these spaces, John included, and while we have done so in pieces in the past, we are sharing the multi-billion dollar potential that these applications represent on Slide 10. Obviously many of these are new and so are starting from a relatively small base, but the speed of the end users’ adoption for higher performing, more efficient and more economic solutions will continue to increase the utilization of our products in these applications.
Since we had record order levels for hydrogen lasers in Q3, let me take a moment to describe some of the elements of size of the market and how we play in each. Hydrogen is one of those markets that for decades people have said, does that really make sense? Well of late, meaning in the first nine months of 2019, we have seen an abundance of hydrogen-related projects move forward related to industrial processes, power generation, and transportation. With the cost of renewables declining and government policies to decarbonize, the Hydrogen Council is predicting $2.5 trillion in sales and an increase in hydrogen demand by 10x by 2050.
As we talked about on our first quarter earnings call, FCEV passenger cars and associated stations are taking off, in particular in California, and we predict this to continue. Our large industrial gas customers have built multiple fueling stations already. Air Liquide has built over 100 and Air Products have involvement in over 150 hydrogen fueling projects.
Regarding lasers, we continue to be an innovation leader. An example of this is our prototype [indiscernible] 7200 trailer which includes new pump technology capable of filling tanks installed in laser applications without having to vent them. The traditional venting process can take up to 30 minutes and therefore it delays delivery time and wastes product. The customer receives benefits including faster deliveries, automated features to help standardize tank fill processes, and dual purpose delivery capability, again just another example of our engineering excellence in a fast-growing market.
Our specialty markets continue to expand Since we introduced the group of applications to you in the first quarter, we have added water treatment systems which are CO2 and oxygen opportunities primarily for odor and disinfection. In recent months, we have seen municipalities across the United States exploring oxygen ozone systems for these applications. We have already received an order for a water treatment system from the City of Denver and have several others in queue with other municipalities.
Now you have a sense of our conviction in our markets and how 2020 is setting up from a demand perspective, John will take you through our margin expansion within our organic business and the significant progress already made in our acquisition integration.
Thanks Jill. As you’ve heard for the past 12 months, we are hyper focused on continuing to execute on margin expansion activities, both within our VRV and Air-X-Changer integrations as well as in our core business. In the core business, as shown on Slide 11, we have taken actions that will give us $13.3 million of full year cost synergies which we anticipate in our 2020 results. The red text on the slide are specific actions that we have taken during the third quarter. Additionally, we have further actions underway in the fourth quarter that we expect to add an incremental $5 million of savings to 2020. All of these are excluding the revenue and cost synergies from our acquisition integrations, which also contributed significant bottom line impacts. Additionally, our high margin aftermarket service and repair business is over 15% of the total revenue in the third quarter, up from 2018’s 13.5% of revenue.
Now flipping to Slide 12, both of our major acquisitions from the past 12 months - VRV, which closed November 15, 2018 and Air-X-Changers, which closed July 1, 2019 - are performing above our original expectations in different ways.
Starting with our most recent addition, AXC, we have completed projects to deliver over 60% of our original $20 million of cost synergies, including completing the facility consolidations at Tulsa eight months ahead of schedule, and more importantly the team has identified additional cost savings from the combination of our air cooled product lines and therefore we are increasing our cost synergy target from $20 million to $29 million, still to be achieved within our first 12 months of ownership.
While I primarily focused our Air-X-Changer integration discussion around cost synergies, there are meaningful revenue opportunities as well, and I’ll elaborate on two of these that we expect to be realized beginning in early 2020. First, with our broad portfolio of air cooled heat exchangers completed with the addition of AXC, we have a product option for nearly every scenario in the field, yet up until now we’d focused primarily on the North American market, as had AXC. Leveraging our VRV manufacturing facilities in Europe and India, we are expanding production to be closer to international opportunities that we previously did not bid on. As an example, we expect to produce our first air cooler in India early in the first quarter of 2020.
Second, the air cooler is the only part of a compression package that end users do not have direct access to an online configuration and quoting system. We are developing one and are currently piloting the program with one customer and expect to roll it out broadly within the next three months. This program will improve our customers’ experience by delivering products faster with less steps in our customers’ idea to delivery cycle.
Of course, anyone with M&A experience has learned to typically discount revenue synergies because they rarely achieve expectations. VRV has also proven to be an exception to this. We have 12 new customers from this combination that have brought over $8 million of revenue synergies, a number which keeps going up. As part of the revenue synergies, VRV has brought access to the previously impenetrable Indian market and other regions of Southeast Asia. The third quarter of 2019 has record India orders. As we’ve said since we shared our acquisition of VRV about a year ago, which gave us a foothold in the region, India will be a geography that sees significant activity in the LNG infrastructure build-out. This is further evidenced by this week’s announcements from energy majors Total and Exxon Mobile, taking a direct interest in the Indian gas distribution and infrastructure and working with IOCL respectively.
Beyond the traditional cost and revenue synergies are the fact that these acquisitions further support an element of our strategy, which is to utilize our broad geographic manufacturing footprint to be more agile with our capacity and capabilities around the globe. Through the AXC transaction, we acquired high quality engineering capabilities in Hyderabad, India. As part of our global resourcing effort, all four of our segments will be building engineering capabilities in India focused in Hyderabad. All of these integration related examples support what we call Chart Smart. offering customers global optionality and access, reducing lead times, and in turn support further margin expansion.
Both the margin expansion and the integration efforts are positively impacting our gross margin and SG&A. Gross margin as a percentage of sales of 28.3% for the third quarter of 2019 increased 150 basis points over the second quarter 2019. This reflects our year-to-date cost-out activities, and on an adjusted basis 28.8% is the highest of the year. SG&A continues to trend positively with the addition of Air-X-Changers to the Chart product portfolio. Similar to Chart’s legacy businesses, AXC business runs with low SG&A as a percentage of sales. Third quarter 2019 SG&A of $57.9 million includes restructuring and transaction-related costs as well as commercial settlement costs; however, on a normalized basis, third quarter 2019 SG&A was $48.4 million or 13.5% of sales, which is the lowest at Chart since the fourth quarter of 2012.
The two bolded comments on Slide 12 are important takeaways as they positively impact our 2020 outlook as we shift to that part of the discussion. I’ll now hand it back to Jill to close our formal comments with a review of third quarter EPS and updated 2019 and 2020 outlooks.
Thanks John. Slide 13 shows our third quarter adjusted EPS of $0.77, an increase of 13% over the second quarter of 2019. Row 1 is comprised of $7.4 million of restructuring and transaction related costs or $0.17 of EPS, and these are the costs associated with the margin expansion activities previously described as well as remaining transaction costs from the Air-X-Changers deal. Row 2 relates to $1.4 million of integration costs or $0.03 of EPS, and Row 3 is $2.3 million of other one-time costs or $0.05 of EPS. These costs relate to two specific commercial settlements that were completed in the quarter. One was related to a longstanding commercial topic from 2012 on a specific price issue for one model tank The second related to commercially agreeing with an EPC on ownership of contractual requirements from a previously completed joint project.
Flipping to Slide 14, our 2019 guidance includes second half 2019 revenue and earnings from the completed Air-X-Changers acquisition and includes additional interest and share count from our completed strategic financing activities. Our guidance assumes LNG project revenue in 2019 from Calcasieu Pass and Gimi projects which is subject to project timing. We are updating our revenue guidance to an expected range of $1.33 billion to $1.35 billion for the full year of 2019, reflecting timing of orders that will book and ship within 2019 but will positively impact 2020. We expect full year adjusted earnings per diluted share to be in a range of $2.70 to $2.90 per share on approximately 34.7 million weighted average shares outstanding. This excludes any restructuring and transaction related costs and assumes our effective tax rate to be approximately 21%.
We are expecting Q4 order activity to be significant. We have line of sight to three potential orders over $20 million each as well as the Caribbean power plant order already discussed. Additionally, we continue to expect more LNG fueling station orders and strength in trailers to the end of the year, setting up a strong 2020.
Moving to Slide 15, let’s run through the market and business outlook for 2020. While there is a view that industrial markets are softening, we have the benefit of playing in a variety of end markets beyond strictly industrial that impact our outlook, as you can see on the page. Additionally, we have specific already booked orders, as you can see in the fourth column, as well as organic activities that drive above-market revenue growth.
Our D&S businesses have industrial exposure, and while we are taking a cautious stance on industrial production activity into the first half of 2020, we benefit from long-term agreements with the industrial gas majors. Indications from the majors is above 3% average growth in 2020, in some cases up to 5%, so we are taking the low end of that range. D&S East and West each are forecasted to have above-market growth given the drivers that we have already discussed today on infrastructure build-out in specialty markets.
OUR E&C businesses’ base markets of natural gas processing, upstream and midstream are expected to decline in 2020, partially offset by single-digit growth in downstream and fans. In E&C Cryo, refining, petrochem, and small scale LNG are expected to grow above 10%. The specific projects totaling 4133 million, shown in the fourth column, are comprised of already booked orders that have specific delivery schedules associated with them. A is the Caribbean project discussed earlier; B is Calcasieu Pass, and C is the 2020 portion of the air cooler order we received this past second quarter.
These assumptions roll into our 2020 outlook, as shown on Slide 16. Splitting the outlook into two parts is important as the base does not require any additional big LNG orders. In the base case, our total revenue growth is expected to be 21% to 24% with 13% to 15% organic growth, including Calcasieu Pass. This results in expected base revenue between $1.615 billion and $1.68 billion. We expect full year adjusted earnings per diluted share to be in a range of $4.75 to $5.25 per share on approximately 35.8 million weighted average shares outstanding. 2020 timing is consistent with prior year seasonality, where the first quarter of the year tends to be the lowest. Additionally, Calcasieu Pass is weighted to the back half of the year.
The upside outlook assumes booking additional big LNG orders based on current assumed timelines for FID, as we discussed earlier in the call. In this scenario, revenue would be expected to be in the range of $1.72 billion to $1.79 billion and associated adjusted earnings per diluted share to be in a range of $5.45 to $6.15, also on approximately 35.8 million weighted average shares outstanding. In both scenarios, our 2020 tax rate is assumed at 21%.
One of the comments we constantly get is, wow, that’s a significant increase, there must be a lot of risk to this. I reiterate that we have purposely split the outlook for 2020 to base, which does not require any additional big LNG orders or revenue in the year to achieve, and the upside case.
I’d like to conclude my prepared remarks with a summary of our organic growth and adjusted EPS trends the past few years on Slide 17. In 2017, organic growth was 5%; in 2018,13.4%, and we are anticipating mid-single digits in 2019. In 2017, adjusted EPS was $0.96, in 2018 $2.02, and anticipating $2.70 to $2.90 in 2019.
I’ll now turn it back to Kevin to open it up for questions.
[Operator instructions]
Our first question comes from Martin Malloy with Johnson Rice.
Good morning.
Hey Marty.
I like the new motto.
Thank you.
You’re welcome. I wanted to ask about the 2020 guidance and your description of the end markets for re-gas storage distribution around the world. It sounded pretty optimistic to me. I’m just trying to gauge the degree of conservatism that might be in your guidance for the D&S East and West growth rates from ’19 to ’20.
Yes, we’ve taken a kind of the down the fairway approach on the base case for 2020 here, so I think there’s areas that we have some conservatism in but other areas that there’s a little risk in, so I would say that there is more upside to the D&S businesses than there is downside, and there’s probably a little more downside to the E&C businesses than there is upside.
Okay, then with regards to the IPSMR technology, you’re now got three IOCs, I think, that have validated it.
Correct.
Could you maybe talk a little bit about the timing and prospects for when we might see a potential opportunity there for you?
We’re obligated under our confidentiality agreements not to share who those IOCs are or where they are in terms of projects and potential utilization of IPSMR, so I’m a little restricted to what I can tell you on that. Suffice it to say that they’ve put as much effort in the past three to five years to validate the process and so we would expect that that’s not for naught, and we would think that in the next few years we’ll be able to officially announce something to you guys on which one and what the project is for.
Okay, thank you.
The next question comes from Conner Lynagh with Morgan Stanley.
Thanks, morning guys.
Hey Conner.
I just wanted to dive in a little more on that comment you made. What would be the drivers, what makes you think there’s more upside on the D&S side and more downside on E&C? Which of these--maybe if we’re looking at Slide 15 here, which of these markets do you think would be driving those differential outlooks?
I think if you look at Slide 15 on the D&S side, there is some more potential on the industrial gas side, and that’s really around their refurbishing of existing tanks versus new builds and new purchases, so that 3% could be 4 or 5%. Certainly LNG infrastructure, both in the east and the west, is an area that we’re seeing more and more joint packages of our D&S product with our E&C product, so we’re excited about what the potential is there. Then the long term agreements with our two sole source customers on the over the road trucking business, that really could take off a little bit faster as some of these creative solutions that we referenced on the call come into play. I can’t give too much detail on that, but there is a next-generation potential on the LNG over the road trucking tanks that could increase 2020 as well.
Okay, thanks. That’s helpful. Also, just wanted to ask, it seems like there’s some decent margin expansion implied in the 2020 base case outlook. Can you just talk through--I imagine some of that is mixed with some of the big LNG cryo content, but can you just talk through at a high level how much is mix, how much is self help, just any other factors that are driving that?
Yes, so let me step back and just walk through 2020 briefly. You have tens of millions of dollars from our 2019 cost-out actions, and then you’ve got this first 12 months of nearly $30 million out of Air-X-Changers, so those two are absolute dollars dropping through. We also have some benefits that we didn’t call out specifically which are included in the organic growth related to price in D&S as well as the sourcing savings that we’ve achieved already and are in the bag, so that’s--I wouldn’t call that mix, I’d call that activities in the bag and ready to go.
Then, there is an element of mix on the big LNG projects that give us an absorption benefit, so while they’re not priced differently than our traditional packages, we get benefit through our facility on absorption, which does help the mix perspective. I’d say if you were to split it percent, self-help is 60, 70% of that, and then the rest would be mix.
Got it, thanks. I’ll turn it back.
Our next question comes from Eric Stine with Craig Hallum.
Hi Jill, hi John.
Hey Eric.
Just wanted to talk about you’re targeting the $1 billion big LNG awards, and I think on Page 2 of the release you talked about second half. Given the timing or how you see things playing out, it’s fair to say that that does not include Driftwood, and then if that is the case, if my math is right, that means that there is something else in there that you are seeing beyond Corpus Christi Stage 3 and Plaquemines. Any color there would be helpful.
Sure. The billion we see includes Phase 1 of Driftwood for about $375 million to $400 million, which would be booked--we expect to be booked in late Q2 of 2020. We do have others on the horizon but from a level of confidence perspective, these are the ones that we feel have the best opportunity to FID in the timeframe we’ve laid out. But if you took the full gamut of the projects that we know we have content on, this number is considerably higher than what’s shown here.
Okay, that’s helpful. Then just wanted to turn to India quickly. I know you’ve got your line with IOCL and AG&P. Curious, I know that the government has, I believe it’s 250 designated areas that they are looking to build out in the country, and curious--I mean, your two current partners, what their coverage is of that--of those areas, and then just curious what your ultimate plans are in terms of how many partners would you eventually like.
There are seven--you’re correct, there is actually 300 city gas licenses that are out there right now. There are seven, “developers”, two of them being AG&P and IOCL, that have the majority of the gas network regions. IOCL and AG&P probably--I would say out of the total 300 would be in the 40 to 50, somewhere in that range of having ownership of the licenses. Our target on India would be to have two other partners as well that would cover more of the city gas network, but what we are finding is that actually if that doesn’t happen from an MOU perspective, it’s actually happening through some of the other activity in the market. For example, the Exxon Mobile announcement this week of their MOU with IOCL, they have other areas that they’re developing and they’re looking to go to, so there’s other avenues that we’re having exposure to some of these city gas network regions.
Okay, thanks a lot.
Thank you.
Our next question comes from Rob Brown with Lake Street Capital.
Good morning.
Hey Rob.
Another question on your 2020 outlook. I think you took the Air-X business down quite a bit. How is the visibility there, what’s the backlog, and how would you characterize the risk in that business at this point?
I think we have taken it down to what I would consider to be a very conservative view for 2020. What we’re hearing from our customers directly is that this is not a cliff type of situation, that there’s been a little softening in the last few months. We haven’t seen a dramatic drop-off ourselves in order activity that would say that we should go any further own on our outlook on revenue. The customers are telling us--we have a couple big customers telling us they’re seeing 2020 look just like 2019, which is a tad bit of a surprise given what you hear in the market; then we have a few other customers saying we expect January for everything to take back off. So the sentiment of our customer base is actually more positive than what you’re hearing in the market in the areas that Air-X-Changers plays, so we have taken a fairly conservative view on the revenue side and associated earnings with that.
I would want to make one other point, is that when we did the Air-X-Changers acquisition, we understood where the point in the revenue cycle, etc., so all the things that we said about Air-X-Changers when we bought it still ring true - gross margin accretive out of the gate. Q3 was nearly 31% gross margin in that business directly accretive to it. ROIC 13% by Year 2, we still see that happening.
Okay, great. Then maybe some more color on the additional $9 million in cost synergies that you identified here, what does that consist of and what’s the timing of that?
We have identified additional opportunities in terms of where we make what and taking costs out there, leveraging our Mexico JV for certain aspects of the building. We have already in the bag additional sourcing savings that we have not--we hadn’t previously included in our model, and last but probably not least is the reductions around how quickly we were able to streamline some of the moves in the facility consolidations and understand what we can do in terms of better performance, shorter lead times and with less infrastructure.
Great, thank you. I’ll turn it over.
Thanks.
Our next question comes from John Walsh with Credit Suisse.
Good morning. I guess a question around the balance sheet and the free cash flow. Obviously you had very strong conversion in the quarter, so a good cash quarter there. I think the leverage, you’re still--at least last quarter, you’re still sitting at north of 3. What’s the priority right now as you think about capital allocation and where the balance sheet sits?
Our net leverage came down to about 3.22 at the end of Q3. Our priority is to get that net leverage down in the 2s. We expect that it will be at 2.5 by midyear of 2020 and it’ll decline very quickly thereafter, in particular around some of the big LNG cash flows coming in. Already in Q4, we had a very strong first week of collections just in the organic business as well, so you won’t see us go and do a large M&A style deal, we’re just going to drive the debt down.
Got you. Looking at Slide 16, I don’t know if this is math we can do because we’re just dealing with parts of the projects and whole numbers and ranges here, but did anything move in terms of the mix? As I look at some of those projects you call out, if I try to back into what the implied margin is just using your tax rate and your share count, they are moving around a little bit, so I don’t know if there was just some mix to call out or if that’s not actually math we can do because these are just meant to be representative ranges of what could play out in that year.
Yes, it’s more the latter. You won’t be able to do that math, and there’s a couple reasons for that. We do peanut butter spread certain things so we don’t give our customers’ margins directly away, and a lot of that also relates to what’s the content on a project, does it have a heavy hydrocarbon removal system, does it have this structure, does it have technology, so you wouldn’t be getting there if you try to back into it using Slide 16.
The other thing I would point out on that slide is the prior look started off of a base outlook from our June of 2018 investor day for 2020, so it was from a while back and then we walked it in May to get to a range, an early 2019 look at 2020. The current look walks from our expected 2019 up to 2020, so there’s a difference in share numbers, there’s all kind of moving pieces that went into this.
Okay, great. Appreciate the color, thank you.
Our next question comes from Patrick [indiscernible] with JP Morgan.
Hi, good morning Jill, good morning John. Thanks for taking my call. Just had a couple follow-ups on that Slide 16. If you could help me understand the walk. It seems like from the 1380 to 1400, the old base to the new 1615 to 1680, I’m guessing that Harsco, that 270 to 275 came down to something in the low 200s just annualizing your number there, and then I’m guessing the delta to get you to the new number, if that’s true, is also a little bit of softness in the base business. Just want to confirm what kind of absolute revenue number you’re expecting for the Harsco business next year in the guide, and I think you said it’s conservative so I’m guessing it’s probably around where I just said, and then what’s causing the lower base business number, if you could point to any specific areas or end markets, that’d be helpful.
On the Harsco Air-X-Changers business, we have it modeled between 190 and 200 on the revenue side, and then with respect to comparing the base business, I’m not sure you can really do that from looking at the prior versus the current because they are two different walks. We don’t have softness in the base business, we’re still seeing that 15% growth including Calcasieu, and the margin mix is a blended look here.
Okay, I can follow up with that after. Maybe just asked directly on margins, what are you guys assuming for margins in 2020 on the base case outlook?
In terms of gross margins in 2020, we’re averaged about 30% for the business.
And then for operating margins?
Just over 12%.
Okay, that’s helpful. Any update on the free cash flow outlook for 2019 and then 2020, if possible to give kind of an early view on that?
We don’t guide to the free cash flow outlook, but you can use Q3 as a proxy for Q4 and probably a little bit better than that. With respect to 2020, the cash flow is going to be--you can take 2019 as the base and then you can add a piece of the Calcasieu project, so you can say about 50% of the Calcasieu project comes in by the first half of the year and then another 25% cash comes by the end of the year.
Okay, got it. I may have missed this at the beginning, but at least versus our estimates, I think D&S West was a little bit softer than we were modeling. Maybe we just mis-modeled it, but just curious what you’re seeing there, if it was in line with your expectations or deviated at all. Again, it could be just us mis-modeling it, for the quarter I’m talking about.
For the quarter, are you talking about order standpoint or a margin standpoint?
I was just talking about revenue and margin versus our numbers, it was a little bit softer. I don’t know what your estimates were going into the quarter, so it’s tough to say how it fell versus your own expectations. Just curious if you could provide any color on that.
Yes, D&S West was, I would say, average for the quarter in terms of our expectations, so it didn’t blow the roof off but it wasn’t an epic failure. From the standpoint of any of the drivers, that created a little softness versus what you might have had. I don’t know what your number was, but there were two things that were timing related. One is we had a specific negotiation happening in July and August that created timing on orders for one major customer that we expect those orders to be in Q4 versus Q3. Then the other piece is we had a little bit of hold on China-related activity in D&S West. In particular, and it’s not a big number, but we had about $3 million of cryo-bio related product that is being held and can’t go into the country until the tariff situation is resolved, and that’s at about 50% margin, so a little bit of impact there to your gross margin number.
Got it, helpful color. Then last one, if I could squeeze one in, just clean-up, the other income you reported in the quarter in the P&L, what is that? There’s $3 million of other income.
We have certain mark-to-market activity that goes through there. There’s certain related activity from joint ventures that we have, so it’s not anything--there’s not anything unusual in there. It’s just standard activity in terms of JVs and mark-to-market.
Okay, so that’s included in the $0.77? I just need to get familiar with how you guys are--the adjusted framework, that’s included in that $0.77?
That’s included in there, yes.
Okay, that’s helpful. Thanks for the time, appreciate it.
Our next question comes from Walter Liptak with Seaport Global.
Thanks, good morning. I wanted to ask a follow-on question to the fourth quarter and just understand the timing issue with the big LNG projects. I wonder if we’ve learned anything, if we should expect timing to change for Venture Global in 2020, can this shift around from quarter to quarter, and if there’s anything on percentage of completion that we should be thinking about as that revenue starts to flow through the income statement.
Until we have a specific project timeline from the customers themselves, anything we give on big LNG is an estimate of timing, so let me be explicitly clear that while--we have a project schedule on Calcasieu, we won’t expect that to change, but until we have project schedules on anything else, there is the possibility they do move.
Okay. The 2020 guidance, when we’re thinking about the low end, it went down to $4.75 from $5.05 at the low end. How did you create that range to get to the low end? Where would we see the incremental negatives? Is it around the compressed natural gas in Air-X or is it around timing of big LNG? Where is the risk?
Let me just step back. I think you’re trying to walk from the prior, which was based off of June 2018’s original. We put an early look in May of 2020 out, and the world has considerably changed since May in terms of the macroeconomic situation, so I’m actually pretty darn pleased that we’re plus or minus 5% to what we said in May for the following year. From the walk, go back to Page 16 and that’s exactly where we are right now and how we think about going off of 2019 to 2020. It’s not looking at $5.05 versus $4.75, it’s here’s where we sit today as of 2019 and here’s how we get to 2020.
A range is a range. There’s a lot of things that go into a range. I think there’s a misperception that you should take the midpoint all the time. There’s things that can happen to get you to the low end, things that go to the high end, so we feel like $4.75 is the low end and pretty darn conservative, and $5.25 would be the start of the line based on where we sit right now.
Okay, fair enough. In the press release and some of your commentary, you talked about the strong September. I wonder if you can identify what the timing issue was. Was it around trade-related things or was it just end of the quarter timing and trying to get orders booked?
No, actually I viewed it as a pretty positive sign because it’s atypical that in the third quarter, that the last month of the quarter is the strongest. There’s a piece of that that goes to my comment from the prior question, that July and August we were in some negotiations on extending agreements, etc., where orders slowed until those agreements were completed ,so there’s probably a little bit of that in September, but other than that it’s just we’re seeing good trends. In October to date, I’m very, very pleased with the first to the 16th order activity.
Okay, great. Okay, thank you.
Our next question comes from Tom Hayes with Northcoast Research.
Good morning, thanks for taking my questions. Just real quickly, Jill, maybe on the over the road trucking opportunity, does that still remain primarily an European opportunity or is that starting to expand in the U.S. as well?
It’s still primarily European, Tom. The two other geographies that we’ve done a lot of legwork on are India and Japan. Our fingers are crossed that one customer in particular in Asia starts doing commercial production in late 2020, so we have a little bit of line of sight to that but nothing that we’re able to share yet The brunt of 2020 will still be Europe.
Okay. Then maybe on the small scale opportunities, because we’ve spent a lot of time talking about that today, if you could just remind us as far as the timeline from a backlog perspective through the P&L, I know the large LNG projects could be multiple years, so if you could just kind of reference what a small scale project may look like as far as timeline.
The average timeline for an operator to get a small scale facility up historically has been 16 months from start to finish. These operators are trying to do it a lot faster. In some cases we’re quoting on things that are nine to 12 months in length, so I think you’re going to see that get shorter and shorter. For us, the average is about nine months from order to completion of our part of it.
And you guys still use percentage of completion accounting for the small scale projects?
Depending on the size of the project and the construction, yes.
Okay. All right, thank you.
Our next question comes from Pavel Molchanov with Raymond James.
Thanks for taking the question. Given that following the Harsco deal, you have much greater leverage to the North American oilfield activity arena than before, I’m curious if you’ve thought about a sensitivity to oil prices, for example if WTI increases by $5, $10, what kind of revenue uplift, all else being equal, should people expect under that type of scenario?
Pavel, this is John. The overall revenue that that’s contributing to the segment is still--and frankly to the company, is still quite small, and so we don’t see it really shifting things materially one way or the other. The business actually tends to shift with respect to natural gas production, some of which is driven by oil price growth, but generally we just don’t think that that analysis is going to be something that dictates how the business ultimately flows. When you see an increase in natural gas production, that incremental growth will drive a little bit more activity levels for us, but we have actually been impressed the way that the business has held in now without natural gas production growth growing as much, so I’m not sure that ultimately that sensitivity analysis is going to give you guys any more predictability just given the relative size and the fact that the business doesn’t quite move like that.
Okay. In relation to the three upside scenario large projects that you’ve outlined for 2020, do any of those, to your knowledge, depend on a resolution of the Chinese tariff on U.S. LNG?
None of them. All have stated that they’re not dependent on the China resolution.
Okay, very helpful. Thanks.
Our next question comes from Craig Shere with Tuohy Brothers.
Good morning, thanks for fitting me in. Slide 15 is very helpful. I have two questions on that. The first is specialty market growth in 2020 seems to kind of sidestep potential longer term breakout in a couple of your business lines that could eventually be $100 million-plus revenue each. Are we just being conservative with the 11% growth in 2020 or is 2020 just too early to see material traction on some of these nascent markets?
We’re being conservative on specialty markets. We’ve tried to give a down the middle total guide for 2020, so that’s an area that certainly has more potential than what we’ve built in.
Great, and then in terms of the add-on to the base case on Slide 15, a number of investors have expressed to us some skepticism about Driftwood, Plaquemines or Magnolia in 2020. There’s various opinions about that. If we assume that just worst case doesn’t happen for now, if we think about Corpus Stage 3, Freeport Train 4 content and other large global FID projects where you could have content on many of them, small scale LNG growth that could be in advance of what’s in your base case, and also what you mentioned on the call about improvements in existing large scale liquefaction facilities, helping them with their processes, could all of this kind of nickels and dimes some a bit more total to maybe $100 million revenue in 2020, even without those huge projects?
Yes, those other scenarios could total to around that range, certainly.
And that would be additive to that Slide 15?
That would be additive, yes.
Great, thank you.
I’m not showing any further questions at this time. I’d like to turn the call back over to Jill Evanko.
Thanks. As you heard today, we are extremely bullish on the coming years’ global infrastructure build-out for LNG as well as excited about the longer up cycle resulting from the unique timing of our order book serving big LNG. I want to conclude not only by thanking all of our global team members at our 27 locations for executing the quarter results but also to share what is an exciting news headline for the Chart Industries of today and the future, as shown on Slide 18. Our very own Kim Van of Energy and Chemicals Fin-Fans won our contest, which had 378 suggested slogans that best describe Chart to our stakeholders. Going forward, we hope you come to know Chart as Cooler By Design.
Thank you all for your time today, and goodbye.
Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day.