Chart Industries, Inc. (GTLS) Earnings Call Transcript & Summary

Chart is a global manufacturer of highly engineered equipment, serving multiple applications in energy and industrial gas markets, growing exposure to various specialty markets, including hydrogen. Ms. Evanko started as President has been -- served as President and CEO since June 2018 after joining the company in 2017. Prior to Chart, she's done over 10 years at Dover Corporation holding multiple positions. Jill, thank you very much for joining us today.

Good afternoon, everyone. I'm going to run through a few slides here, just to convey a few key messages that we would like to get across and then David and I will have a few Q&A minutes together. So just by way of background at Chart Industries, we're engineering and manufacturers of a variety of different process technologies, and mission critical equipment that serves what we call a molecule-agnostic series of end markets. So we hit anything from industrial gases to traditional energy, clean energy, water treatment, carbon capture, just to name a few. We've been growing double digits for the last few years, and this growth has been fueled not only by macro tailwinds, but also by our differentiated unique product and solution offering that I'll talk a little bit about here momentarily. On the macro tailwind side, there's 4 that are positively impacting the business right now. Obviously, there's an increasing global need for energy. That's the first that you see on the page. Clean water access which in many cases around the world, folks don't have access to power, let alone to clean water. So we're seeing regulatory positive trends benefiting us as well as desalination. The third in everyone's current favorite of artificial intelligence, which really in turn, is driving a need for more energy, more or less electrification, critical mining, cooling, heat rejection, all of which we play in. And finally, population growth and aging infrastructure, which plays not only to the new build side of our business, but also to what we call Repair Service & Leasing or the aftermarket piece of the business. So these 4 key macro tailwinds have been driving our strong demand over the prior 12 months, and we anticipate to continue to do so. So how does that correlate to this differentiated unique offering that we have. I'm going to focus on the right-hand side of Slide 6 here and talk through how our flexible manufacturing strategy, which is that we make all of our products -- nearly all of our products in more than one location around the world is able -- making us able to deliver to multiple different geographies and multiple different customers. But really important here is that a lot of times we get asked the question, how do you serve so many different end markets without having to have so much different capacity or different manufacturing capabilities. And the key takeaway is that mission-critical equipment that you see here on the right-hand side of this slide, is used in the variety of different applications and end markets that I just described. So take, for example, an air cooled heat exchanger. Traditionally, 10 years ago, this would have primarily served the oil and gas end markets. Today, and just recently, in the second quarter, we booked a $40 million order for hyperscale data center that utilizes our air cooled heat exchangers. So that's a great example of not having to change manufacturing capacity and capability but to be able to serve a variety of different demand levers. Contributing to this capability portfolio and uniqueness that we have has been our Howden acquisition, which we closed on in March of 2023. Howden brought to us specialty compression as well as digital solutions and drove our aftermarket piece of the business to between 30% and 35% of our revenues. Since the Howden acquisition, we've accomplished multiple different actions and activities to drive the growth profile that we set out at the time, the margin profile, and we're working very focused and well on our way towards our net leverage target of 2 to 2.5x. And in a moment, I'm going to talk about what that means for debt paydown and debt paydown activities. But before I move off of Slide 7, I will focus on 3 items here. The first is that in 2023, as we had laid out when we announced the Howden acquisition, we divested 4 product lines from our portfolio, resulting in approximately $500 million of cash proceeds, which were used for debt paydown. We're consistently looking at our portfolio for anything else that is non-core and one piece of the original perimeter that we had defined for divesting still remains in our portfolio today. And that piece is something that we're currently underway in a divestiture process. In addition, we've achieved very strong commercial synergies driving record backlog. These have been over $950 million to date of Howden and Chart content bringing these orders into the order book. And we're well on the path to our cost synergy year 3 target of $250 million. Year 3 from the Howden acquisition ends on March 17, 2026, so just for a frame of reference. And then the aftermarket piece, as I've commented on already, has really been a great driver of not only of our growth, but also of the margin expansion as this is above combined company margin as we continue to grow the RSL segment. You can see the first half to second -- first half to first half '23 to '24, shown on Slide 8 for some key metrics. Orders grew 8%, sale 18%, and we expanded reported gross margin by 280 basis points. So as I commented, we're hyper-focused on debt paydown. This is critical as we continue to end 2024 and go to the end of 2025 focused on getting to that sub 2.5 net leverage ratio. That really drives from down to about $3 billion of debt between now and the end of 2025. I'm going to quantify and spend a little bit of time on the left-hand side of this page to give you a sense of what the debt activities and paydown and cash generation we have underway. Let me start with the bottom two categories on Slide 9. So these I would call programmatic and one-off cash generating activities. On the programmatic and the one-off side, ranging anywhere from partnering with someone on the lease business to supply chain financing to the divestitures and portfolio review that I just described, also to simplifying the balance sheet, which I'll touch on in a moment. These combined will generate between $100 million and $150 million approximately of cash for debt paydown. The rest is generated through operational actions and activities, which you can see range from accelerating our project milestones to cash. Trade working capital management, which we've achieved a reduction from 23% of sales to about 20% in the second quarter of 2024, and we anticipate that to drive down further. There's multiple others. The only other one I want to point to on the operational side is that in the last couple of years, we have significantly expanded our capacity in 3 locations to support the top line growth that we've achieved and anticipate achieving ahead. Those 3 capacity expansions are completed or completing in 2024. And so therefore, our capital expenditure spend going forward will be more normalized to a 2% to 2.5% of sales outlook. I'd point to as well, a question that we regularly receive, that our compensation as a management team and as a business, is related to debt paydown. So in our short-term incentive program, debt paydown and EBITDA are the 2 primary financial metrics. So moving ahead to Slide 10. You can see the net leverage ratio declining since the Howden acquisition by 0.82. In here, too, I want to stress that bank EBITDA and adjusted EBITDA by converging upon each other here. So you'll see very clean metrics going forward as we head into 2025. I point as well to the upper right-hand side of Slide 10, which is our November of 2024 convertible notes. And we anticipate that this will settle at maturity with cash for the principal and equity for the premium. What this does is for fourth quarter and going forward share count reduces our share count from approximately 47 million shares in the current state to just over 45 million. At the end of 2025, another simplification of our capital structure is set to mature, which is our preferred equity. And this will transfer into common equity at December 15, 2025. So not only multiple cash activities to drive the debt paydown but also balance sheet capital structure simplification. I'll take a moment also to reiterate our financial policy until we get into that target net leverage ratio range, which is that we will not do any material cash acquisitions or share repurchases until we hit that sub 2.5 target. So a little bit about the second half of 2024, broke this down on Slide 11 in 4 key areas, the first being our consistent book-to-bill of 1. This is across a year. We have major projects that come in and out in terms of the timing of a quarter. And so quarters can be lumpy. That's why we talk about consistent book-to-bill across a period of time. And this also is a one or more across a period of time driving our medium-term growth, which I'll return to. It's important to note that we've talked about the business looking very different today than it did 2 years ago or pre-Howden. I'll start with the aftermarket piece of the business now is over 30% of our annual sales. Pre-Howden, it was about 13% to 14%. So what that means is when we're talking about a book-to-bill, we're really talking about 70% of the business that has a book-to-bill or is anticipated to have a book-to-bill of greater than 1, whereas before, that would have been having to have that at a higher than 80% of any given year. We continue to see upside opportunities ahead, not just in the second half of '24, but into 2025 for data center opportunities and big LNG awards that are not currently in backlog. On sales, like any given year and is typical, our sales accelerate from Q3 to Q4, with Q4 being our highest sales quarter of any given year historically. We don't anticipate that trend to be any different this year, and we're seeing consistent activities across the segment. We're also doing some self-help activities to increase our throughput, and I'm going to talk about that just in a moment. There's nothing new to share on the margin remains consistently strong across the business, and we're continuing to look at optimizing our tax structure. So operational activities. This is a slide on Slide 12 that you can take home and read in all of your spare time. And what I'd point to is there's plenty of things that we can continue to do to shorten lead time, increase throughput and therefore, drive even more awards into backlog and they range from people to automation or Chart business excellence through our supply chain management and continuing to utilize the capacity that we have brought online and continue to bring online here at the end of 2024. So from a medium-term perspective, what you see on Slide 13 is no different than what we shared a year ago and shared over the summer. What you see here is from a pro forma 2023 base to a 2026 outlook. So we're reiterating this medium-term that you can see here across these 5 metrics, but I want to point out a couple of things here in terms of how we thought of the construct. The first on the medium-term is that this does not include any new big LNG projects that come into backlog from last September or September of '23. So anything that comes in is additive or a backstop depending on how you want to think about the medium-term construct. In addition to that, I want to point out the 2025, which we're very well positioned for, given the backlog that we have as of the end of the second quarter and also the coverage that we have from that backlog through 2025. For 2025, we anticipate an approximately 10% revenue growth over 2024. We also anticipate expanding margins and driving more operational cash than we have this year. So with that said, I'm going to turn to some upcoming activities here and then get some Q&A here with Dave. We have our Capital Markets Day, which we announced today, scheduled for November 12. There's registration information shown on Slide 14. And in this Capital Markets Day, we intend to share more specifics on 2025, we intend to share more details around the debt paydown to achieving that $3 billion target by the end of 2025 as well as a new longer-term growth outlook beyond -- far beyond what we've shared to date. And that really ties into the fact that we're a far less cyclical business today than we have been in the past, and we see growth continue through the cycle with the ability to take advantage, not only of the aftermarket but also of the full solution visibility that our backlog gives us. So with that, I'm going to sit down and chat with Dave here for a moment.

Thanks, Jill. So Jill, on your last quarter call, the second half was a little weaker than you initially anticipating. You just mentioned a couple of things are kind of lumpy. Can you just sort of walk us through a little bit what the changes were in the second half from before? I mean what -- there was a couple of moving parts in there, if you might just explain those a little bit?

Sure. So maybe to level set, I commented that we look very different today than we did even a few years ago, and one of those elements is that we historically had been sub-30% project-based business, and now we're over 70% of our business is project oriented, which is great from a combined content and dollar amount for our content into a project. It then elongates through the cycle from start of a project to finish of a project. And with that, in the high demand that we have, we have some moving pieces between a 6-year and 90-day type of quarter. We've also learned a lot, I'd say, over the last 18 months of being a combined business in terms of the fact that there are things that move on us between quarters and all of that. And that's what we've really tried to incorporate into our forward outlook, including the 10% for '25, which still gets us well to our medium-term reiterated target.

I mean it's a very different company now -- it's really, I mean, I think of it more of an industrial energy company. As you've kind of folded in Howden, what were some of the surprises for you? Because you can't know everything, but you go into an acquisition, it's eyes-wide-open as you can, but you're invariably going to learn something. So what about the customer base? What's been different about the customer base of Howden versus your own customer base? And -- has there been any -- I don't know, I'm just curious how that's working? Is there been any friction? Is that worked better than expected?

So it's been overall very positive in terms of the integration and bringing it into the business and achieving a lot of what we had set out to achieve, whether it's the aftermarket piece or more content of mission critical equipment. In terms of customers, we were more heavily weighted to a top 10 customer base as Chart legacy and Howden far less so in that respect. So it's given us a diversification of customers. One of the learnings that we've had that we have seen is Howden definitely had smaller size component sales and project-oriented was less big piece of the portfolio. But now they're a component into a larger project. And so making sure that all of the pieces and parts fit together between shops internally and all of that to be able to hit customer deliveries and lead times. We've come a really long way on that in terms of institutionalizing some of the lean tools that we've put in place. And we're still on our journey there, I would say.

And I know you've hit on a bunch of synergy targets, but have you been able to kind of close manufacturing facilities or consolidate -- where is that in that process?

We have consolidated a few facilities. We did that in 2023. We have one underway right now. And we also have been able to really structure the organization to what we're looking to accomplish in both ops as well as with the customer base. What I mean by that is we had 5 regions and just after the first 12 months, realized that having 5 regions just really had excess overhead, where we consolidated 2 of those 5 together and now have 4 that are more evenly sized between them. So we've had some benefits from cost structure, and we anticipate that we'll still continue to see more opportunities such as that ahead, especially as we hit year-end '24 and head into year 3 on renewal cycle from a calendar perspective and also continuing to have the right people in the right chairs.

So one of the reasons you did this acquisition was the aftermarket business, the healthy aftermarket business, you're trying to reduce cyclicality on the business itself and aftermarket certainly does that. So your RSL business is now, I think you said -- is that 30%, 35%, something like that. That's been growing fast than I would have expected. Can you maintain this kind of growth over the next few years? And I guess if you do that, you have to have -- that installed base has to grow with it. So help us understand a little bit what's in that, what's adding to that installed base from the Howden side that's continued to build that up outside of your -- maybe the traditional Chart products?

Yes. So the aftermarket piece of the business has been fantastic. I would call it a gem is how I would describe it. And continuing to grow very well. We see more synergies ahead on the aftermarket side and that is what you described as the Chart legacy installed base that we never were able to serve before we had Howden locations and field service teams. We're early in that journey to be able to serve those installed base from prior. In addition to that, we've now been able to repair and service competitors' technologies and equipment, and that's something that's started to benefit the RSL segment. And probably most impactful besides taking Howden's process around the pricing construct for the aftermarket business is related to having locations and people close to stations and preventive maintenance contracts. So LTSAs we've been able to pull in and increase year-over-year so far in the business.

So when you're saying service other competitors' products, is that mostly reciprocating compression and things like that? Or what are some of the...

So screw, piston, diaphragm, compression, all of those in terms of an existing customer that has a legacy piece of equipment with competitors. And then what that does is also pulls through spares and opportunities for new build too.

So you showed before your medium-term outlook didn't change at all. It does not include big LNG or some hydrogen hub. So naturally have to ask about the big LNG and hydrogen hubs upside to there. So what's your thought -- your latest thoughts on kind of big LNG kind of where that stands? I know you have an ISMR award that hasn't been -- I think you won it, but it's not in backlog. Could you just kind of walk us through some of the components of big LNG that could potentially be additive to that medium-term outlook?

Absolutely. So we specifically called out 3 projects that are not currently in backlog, but that we know we've been awarded. And the way that, that works is we wait for the customer to give us full notice to proceed or FID, however, the terminology that, that respective customer uses. Those projects of 3 total about $1.5 billion of Chart content. 2 of the 3 -- actually, no, 3 of the 3 will use the IPSMR process technology and associated equipment. The 2 more imminent, meaning across the next quarters and year are permitted or not needing to be permitted, i.e., an international project. And then the third is further away that doesn't yet have its permits. So those 3 would be additive if and when they come in, and we anticipate that a couple of those do progress here in the relatively near future. In terms of hydrogen hubs, what I would say in general on that is for -- outside of industrial gas majors and fully funded projects, we've seen a weight on the 45V or on the IRA in the United States. But outside of the United States, we've continued to see hydrogen projects taking hold and moving ahead with private funding primarily. So we would anticipate an outcome here from post-election of what that looks like. And then there's a catalyst if some of those hydrogen hub projects do move forward that currently aren't in our medium-term thinking or 2025 thinking.

So on the hydrogen side of its overseas versus the U.S., do you face more competition on the other in Europe, for instance, for -- when you look at the hydrogen hubs?

It really depends on the application that is being used. So we are able to serve gas and liquid hydrogen as a result of the Howden acquisition, bringing us gas. On liquefaction, it's really less -- there's really limited competition globally, so that's not really a geographic argument. But if you're doing a specific gaseous piece of equipment, there would be more competition outside of the United States.

IPSMR. This will be your first time that the first award for the IPSMR, no?

No. So IPSMR is used at Cheniere's Corpus Christi Stage 3 facility, which is well underway as well as NFE's facilities and numerous others, but those would be the two kind of ones people will recognize.

And just to dig into the [indiscernible] just so people understand, that's just one type of process for liquefaction, right? There are a couple of different ones like some -- how many different types of processes are there?

So we really run up against 2 others and the IPSMR, which is our organically designed technology, and that's focused on modular mid-scale. So trains that you can do 1 or 2 MTPA, get it started and then follow on. So it really returns faster to the operator. The competition, which is the historical competition from baseload would be ConocoPhillips or Air Products APCI process technologies. And those are on projects that are larger scale baseload style facilities. But the first international award that we just talked about for IPSMR is a major step forward for the industry in terms of it, not just being a U.S. Gulf Coast moving to the modularity approach to LNG.

Air Products is also a customer of yours in kind of a different part of your business. Does that present any conflicts in there?

It's interesting because it's always kind of been that way of customer and competitor. And we're very clear and we want to continue to be very clear for them for all of our industrial gas customers that the bright line for us strategically is that we don't want to produce our own or distribute the molecule itself. We'll support folks that are doing that, but that's not our business. We don't -- it's not our expertise.

You had record orders in the quarter for Specialty Products last quarter, the number of businesses in Specialty Products. Can you just kind of highlight what are kind of the drivers of that this quarter and maybe where you see that going? What are kind of the things that people -- what are the markets that investors should be paying attention to?

Yes. So today's point, there's a hodgepodge of different end markets within specialty, but they actually all in part, linked up together and have interlinkages. You've got hydrogen and helium, which is a key driver in general across the year for demand in specialty, water treatment, which has been gaining steam, still sub-5% of our portfolio, but something that -- a piece of the business that has had a lot of records in recent quarters. Carbon capture utilization and storage, which we have small scale and large-scale industrial technologies and associated equipment for that. We also have seen an increasing size in the CCUS orders as multiple different end market applicants look to use it, whether it's BioLNG, biogas or just traditional distilling and craft breweries, things like that. And then you have food and bev and space exploration and things like that. But the major drivers of specialty are going to be hydrogen, helium, water and carbon capture.

And that's the way you see that kind of on your next 2 to 3 years, that's where the focus is going to be?

Yes.

Are there other kind of bolt-ons in there to build out that business? Or are you -- do you think you can -- are you planning to grow that more organically in the Specialty Products?

So we have invested a lot inorganically and organically over the years in those particular end markets and feel great about the technology that we have in the portfolio. We've added 2 different water treatment technologies in the last 4 years, which treat all contaminants that are out there with a focus on PFAS, PFOS and arsenic. In addition to that, we've added in small-scale technology on carbon capture and large-scale cryogenic technology. So we're really well set to compete on CCUS. And then from the hydrogen, helium perspective, Cryo Technologies came into the portfolio a few years ago and links up really well with our equipment itself. So we don't see technology gaps right now, but we always are looking to ensure that R&D is working to get more efficient and be able to compete if there is something else that comes in and see if there's anything that's next-gen that we should be watching out for. But right now, we're really happy with the portfolio and continuing to review that at all points in time.

Just to step back real quick on the big LNG side. I know you don't want to talk about that much, but we have to talk about it. You said 32 projects in your -- kind of on your project list out there. How much of that is kind of U.S. versus international? And do you have kind of an idea in your mind of kind of time line wise, when you think some of those could start coming through?

Yes. It's about half and half. If you look at U.S. international and one of the things I'd point to on big LNG, in particular, that IPSMR, any process technology has to be validated by the operator of the facility, that's not something that happens in 3 or 6 months. That's something that's a multiyear process. And we have a couple of dozen of those qualifications already in-house. So that gives us a great starting position on the projects that haven't yet been talked about or are in that pipeline that you just referred to. And what I would say is that you have continued demand for LNG and gas is going to be part of the story going forward. Not just this story, but the world story as we work in the energy transition, we continue to see LNG demand growing and the need for the supply to get to -- you can pick your number of how many MTPA is going to be needed between now and 2030. But I think industry really has converged around the fact that there's more projects coming online, multiples in any given year between now and 2030.

You think you could see 1 or 2 next year?

Yes.

Okay. Last question on the AI data centers. Your Charts business is keeping things cool or cooling them or trying to keep them cool. AI data centers, I guess, naturally, they're going to get hot from all the data because we all need the AI, God knows what we're all using it for, but I don't know, you need it for something. So what's your kind of product line. What's your kind of moat on that business? Or what's your differentiated product that you see an opportunity for as that builds out?

What I love about this is it's just another -- it's a great example, as I mentioned, of products that originally served oil and gas. And this is the same product that's needed for cooling and it serves this application extremely well without having to go reengineer something. And so what you see in the data center world is these larger data centers, different locations for them and a foot race in a sense toward building them. With that, you need the capacity to serve them. We have that. And the technology that is trial cooling or cooling or heat rejection, which isn't competing against water technology or a different type of technology. It's just sometimes more optimal to go with heat rejections than another alternative solution because of temperature outside because of access to water, things like that. So we're really seeing an inroad into these markets based on that type of thing with the upside potential in the future being larger industrial applications, which would then pull more of our compression technology through and equipment through beyond just air coolers fans. And then even I think a little bit further out, but an interlinkage is to the CCUS offering where there's a potential for closed-loop cooling, and that's something that would serve us really well too.

Sure. It checks all the boxes on Chart. Jill, thank you very much.

Thanks, everyone.