Chart Industries, Inc.

Good morning, and welcome to the Chart Industries, Inc. 2021 Third Quarter Results Conference Call. All lines have been placed on mute to prevent background noise. After the speaker's remarks, there will be a question and answer session. The company's release and 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 will be available following the conclusion of the call until Thursday, October 28, 2021. The replay information is contained in the company's press release. Before we begin, the company would like to remind you that statements made during this call that are not historical, in fact, are forward-looking statements. 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 Joe Ivanko, Chart Industries CEO.

Thanks, Gigi. Good morning, everyone, and thanks for joining us today for our third quarter 2021 earnings call and update to 2022 outlook. With me today is Joe Brinkman, a Chart Industrial Gas veteran and now our CFO, who will take you through the quarterly results later in the call. Today's discussion is twofold and similar to what you've heard, I'm certain, from other companies. First, the near-term macro challenges that we faced in the third quarter, their impacts on our quarter, and what actions we have and continue to take in order to manage through it and come out with a structurally higher margin profile amidst what we expect to be record-setting years ahead. And second, the continued strong broad-based order activity we're seeing for which all indicators suggest underlying demand for our products will continue. So starting on slide four of the supplemental deck that was released today, our third quarter 2021 orders of $350 million demonstrated continued demand across the business and were significantly above our expectations coming into the quarter, which were around 300 million-ish, considering that we did not expect nor did we get any large local faction orders within the third quarter. This quarter's order level was 33 percent above the third quarter of 2020, and brings our year-to-date order levels 53 percent higher than the first nine months of 2020. Additionally, specialty products orders grew over 100 percent this quarter versus the third quarter of 2020, and over 150 percent for the year-to-date timeframes. Cryotank Solutions has also shown impressive growth in these periods, growing 35 percent for the quarter and 53 percent for the nine months. Third quarter orders contributed to our fourth consecutive record backlog quarter, with backlog now over $1.1 billion, stepping up our confidence in our 2022 outlook, as well as now seeing a trend to quarterly consistency at this higher level of order activity. Going to the left-hand side of slide four, which demonstrates what we believe is our expected new normal quarterly order levels, what in pre-COVID and pre-clean energy times, or 2016 through 2019, was an average of $238 million of orders a quarter, is now consistently above $300 million a quarter. A few additional items to note around our order activity in the quarter. We booked 60 orders in the third quarter that were greater than $1 million each and 152 of those this year. The third quarter was our second one in a row with 60 orders greater than $1 million. We also had 21st of kinds and orders with 65 new customers. Year to date through the third quarter of 2021, all of our specialty products categories orders have exceeded their respective full year 2020 order levels. So said differently, in our first nine months of this year, those specialty products orders, all those categories are above the full 12 months of 2020. Q3 beverage orders were up 68% over Q3 of 2020, which is quick book and ship business and quoted with current material cost levels. So a section of this business that has not experienced the margin erosion from escalating material costs. We are beginning to see somewhat of a recovery, albeit later than we had anticipated, in our traditional oil and gas markets, inclusive of upstream and natural gas compression, evidenced by air-cooled heat exchangers having the two highest months of orders in the year of 2020, 2021, excuse me, in August and September, and the third quarter of 2021 being the highest order quarter of the year for air-cooled heat exchangers. Another example of our products being agnostic to the molecule, so we're positioned to benefit as oil recovers while the energy transition continues. So now let's turn to the details on the cost burdens and what actions have been taken to offset the expected continued drag from higher than anticipated costs on slide five and six. While we expect the third quarter of 2021 was the bottom in terms of the negative margin impact from these cost challenges, as some of them have been completely mitigated while others persist and will gradually improve with offsetting actions taken, we expect subsequent quarters margin improves yet we also are tempering our next quarter outlook both for sales timing shifts as well as for the cost pressures. We previously indicated that we anticipated that in the third quarter of 2021, we would need to monitor whether material costs and availability were improving or getting worse and then respond quickly. Things did get worse in the quarter, and despite the strong order and backlog growth, supply chain labor and logistics issues weighed on our results. We responded quickly with surcharges, additional price increases, and operational cost reductions yet none of our in-quarter actions were immediately impactful to margins within the quarter itself. We are currently projecting the timing of backlog and pricing surcharges, as well as normalized labor and operational efficiencies resulting thereof to result in a stair-step return to typical margins with step one of the staircase starting in Q4 and continuing through to Q2 2022, which is incorporated into our 2022 outlook. Let's step back and get into the challenges and what we've done about them. Slide 5, row 1, shows how material costs continued to rapidly increase in the third quarter of 2021, increasing another 12% in stainless steel, 18% in aluminum, and 24% in carbon steel from June 30th to September 30th. We implemented a broad price increase on July 1st, yet given the timing of our backlog and the in-quarter cost increases, we did not see much offset in Q3. Additionally, we added a surcharge to all new orders starting in the middle of the third quarter of 2021, and have already issued another price increase in October 2021. Our project-based work allows for current material pricing and bid validity, so all of those quotations have been updated as well. The second row shows the supply chain disruptions, whether port congestion, availability of drivers, trucks, containers, materials. Obviously, none of this is chart-specific, and our teams did work to minimize the sales timing shifts due to supply chain disruption. This furthered, though, the grab of safety stock where we could, in turn impacting near-term free cash flow. Speaking of availability of drivers and trucks, the third row shows an often less discussed but highly disruptive, unanticipated challenge that we faced from August 11th until October 7th. Force majeure was issued to industrial gas customers, including us, from our industrial gas supplier on nitrogen and argon allocations due to their need to respond to the resurgence of COVID-19 oxygen needs, in particular in the United States. While we were in the privileged position to use one of our own cryogenic trucks from our leasing fleet and hire a certified driver through our distribution network to deliver gas to keep our production running, this disruption certainly added cost and inefficiencies to our operations. On a positive note, this force majeure has been lifted as of October 7th, and allocations are currently back to normal. Moving to slide six, row four, we face the issues of availability and cost of labor, including COVID-19 labor impacts. We believe we have taken enough actions to not have the fourth quarter impacted by the labor challenges, with the exception of the direct labor hourly wage increase, which is not temporary, and put in place in the third quarter in response to our need to retain and hire a significant number of production team members. We hired 372 people in the quarter, and over 98 percent are still with us. While we will continue to incur the wage increases, we also, in the quarter, utilize sign-on incentives which negatively impacted expenses but are not embedded into the base pay. The second labor challenge, which has dramatically improved in October to date, was the resurgence of COVID-19 through our U.S. manufacturing facilities. From August 1st to September 30th, we had an average of 3.7 percent of our production workforce at key facilities in the United States out with COVID by week. Month to date in October, we have had very few direct labor in these shops out. This created additional operational inefficiencies changes to schedules, and additional shifts with our direct labor covering different areas of the shop. We had two of our production facilities briefly disrupted by Hurricane Ida during the quarter with lost work time. These were temporary impacts, had no ongoing or permanent damage or impact. And finally, we anticipate and have planned for ongoing Chinese energy enforcement at our locations in China. We have numerous mitigation strategies in place as needed, but at this time, our China operations will have weekly power supply changes as either five normal, two restricted, or four normal, three restricted, which, if the current situation remains throughout the quarter, will allow us to hit our Q4 midpoint China forecast, barring no further restrictions. We've been continually responding to the material cost changes as well as the other cost changes through price increases and surcharge. You can see on slide seven the increases to material costs on the top half of the slide. Since the beginning of the year, increases of 33%, 40%, and 65% in stainless aluminum and carbon steel, respectively, are three main raw material categories. The first 20 days in October, we have seen stabilization in carbon and stainless steel, yet aluminum continues to increase in cost and decrease in availability, given the situation with magnesium. With that said, and before I get into the necessary pricing and surcharges we have put in place and the rationale for the differences between the approaches, Let me address our comfort level on safety stock. As you're aware, since the beginning of the year, we've been adding safety stock where it makes sense, temporarily driving inventory balances higher than typical and thus impacting free cash flow. Yet this strategic decision has allowed us to not have had any material missed deliveries for our customers. For example, we've locked in certain one- and two-year contracts, securing the first half of 2022 with cost savings compared to current levels based on the timing of when we secured the inputs. Regarding pricing, we do not anticipate material cost to increase as they did respectively from the end of Q2 to the end of Q3. When we saw this, we implemented a surcharge effective mid-quarter in addition to the pricing changes implemented July 1st and the re-quoting of all material for open bids on projects with bid validity timing. Even with these changes, that was not enough to keep up with the rapidly accelerating costs. Therefore, we have implemented another price increase into effect for all new orders, which will be both temporary and permanent depending on the product. We've worked with and continue to work with our industrial gas customers that are under long-term agreements to assist us with utilizing the material cost pricing mechanism in those agreements more frequently, considering these inflationary times persist where a quarterly lag in the adjustment mechanism just isn't effective in hyperinflationary times. And to our customers who have been fantastic to work with on this and support our longstanding relationships, This mechanism will return to their regular schedule, whether quarterly or semiannually, as macro conditions temper. A big thank you to each of them that have been working with us to ensure we are able to deliver their product as desired, but do so without negative harm to our business. And a second thank you to those who are working with pre-price increase backlog to appropriately support additional material pass-through costs for certain existing orders in our backlog. You will note that we have structured these increases in two different manners that's on purpose. The first is that some of our pricing will remain at higher levels after the cost situation tempers and returns to normal, which would be a typical action on our part periodically to adjust pricing. The second is around surcharges, which are temporary, albeit indefinitely temporary at this time. So we will have certain price stickiness while being fair to our customers as they're working to be fair to us. I'm now going to hand it over to Joe to take you through our structural cost actions and the third quarter results before I talk about our 2022 outlook.

Thanks, Jill. Slide 8 shows certain organic structural costs and capacity actions. What you see on the slide captures two goals, the first to operationally reduce costs and the second to ensure we have the appropriate capacity in the appropriate locations to meet our customers' lead time demands. On the left-hand side of the page, you can see a subset of our cost reduction actions taken or underway in the third quarter. This is certainly not a comprehensive list. We have consolidated our Tulsa air cooler production to our Beasley, Texas manufacturing location, creating a flexible manufacturing facility in our Tulsa location, which is in various stages of starting up, depending on the product line. Adding the flexible lines in Tulsa gives us access to skilled talent, and allows us to move bottleneck production from other locations. For example, our move of vacuum-insulated pipe and sub-assemblies from New Prague, Minnesota is complete, and the associated benefits are anticipated to begin in the fourth quarter of 2021. The same Beasley location is set to house our Houston repair and services business, which over the course of the next few months will consolidate from our standalone Houston repair site. You can see some of the other efficiency moves underway on the slide, both in the U.S. and in Europe. Lastly, we continue to refine our SG&A structure with specific position eliminations taken in the quarter. On to slide nine, third quarter 2021 sales of 328.3 million increased over 20% over the third quarter of 2020, and organically 13.4%. As a reminder, the third quarter of 2020 included approximately $25.6 million of venture global Calcasieu Pass sales, and the second quarter, 2021, had approximately $5 million, while the third quarter of 2021 had no associated Big LNG revenue. Excluding sales from the Big LNG project in the respective periods, organic revenue increased 25.2% in the third quarter of 2021 when compared to the third quarter of 2020. and 13.6% year-to-date 2021 when compared to year-to-date 2020. Third quarter 2021 sales included records and sequential quarterly growth in specialty products and crowd tank solutions. CTS sales increased 14.7% sequentially from the second quarter of 2021 and 10% versus the same time last year, while specialty products increased 9.5% sequentially from the second quarter of 2021 and 108.8% from the third quarter of 2020. Repairs, service, and leasing and specialty products comprise 49.7% of our total net sales, the second quarter in a row at approximately 50%, and compared to 34.1% for the full year of 2020. Our third quarter 2021 gross margin was negatively impacted by the cost Jill described. Reported gross margin as a percent of sales of 22.8%, included one-time costs associated with facility startup costs, integration, restructuring, and facility consolidation. When adjusted for the one-time costs, adjusted gross margin as a percent of sales was 26.5 percent, reflecting the cost burden we experienced within the quarter from the rapidly increasing freight, supply chain, and material costs. Adjusted gross margin as a percent of sales is flat to the third quarter of 2020. when excluding big LNG and a sequential decline from the second quarter of 2021. The challenges were less impactful to the adjusted gross margin as a percent of sales for specialty products and repair service and leasing. Specialty products adjusted gross margin as a percent of sales was just over 37%, consistent with the second quarter 2021 and indicative of the profile of that business. The specialty products business is predominantly either project-based pricing with near-term cost validity or product with faster book-to-ship timeframes, capturing more current costs in our ongoing pricing. Repair service and leasing adjusted gross margin as a percent of sales of 28.7 percent included restructuring charges related to our decision to consolidate the Houston, Texas repair facility. RSL adjusted gross margin was a sequential increase of 510 basis points in the second quarter of 2021, which had a low margin shipment from China backlog included in it. The most challenged gross margin and adjusted gross margin was in heat transfer systems. Given the heavy material content in the segment, lost production time, and higher margin project-based revenue recognition timing. Sequential second quarter 2021 to third quarter SG&A increases are driven by the additions of LA Turbine and Ad Edge. Jill will talk about the next few quarters, timing of cost offsets, and larger project margin impacts in a moment. Slide 10 shows our third quarter and year-to-date adjusted non-diluted earnings per share of 55 cents and $2.09 respectively, including any activity on our mark-to-market of our investments, which was a net positive impact in the third quarter as well as year-to-date. Adjustments to earnings per share related to specific one-time cost for restructuring, severance costs, start-up facilities and production lines, and other non-repeating items. We have not included add-backs from negative production or efficiency impacts from the challenges you hear about today, given that our guide anticipates certain continuance of them, as well as the timing around our expected offsets resulting from the structural actions you heard about. In an effort to be more time-sensitive to prepared remarks and Q&A, We have included segment-specific details and first-of-a-kind and new customer information in the appendix. Additionally, we frequently get the question of timing of the 10Q filing. We plan to file it later today.