CECO Environmental Corp (CECO) 2015 Q1 法說會逐字稿

Good day and welcome to the CECO Environmental first-quarter 2015 earnings conference call. Today's conference is being recorded. At this time I'd like to turn the conference over to Shawn Severson. Please go ahead, sir.

Great. Thank you. Good morning, everyone. Thank you for joining us on CECO Environmental's conference call and webcast to discuss our financial results for the three months ended March 31, 2015. I remind everybody that there is a presentation, and we will be referring to it throughout the call today. So I encourage you to download it on CECO's website.

On the call with me today are Jeff Lang, CEO and President, and Ed Prajzner, our Chief Financial Officer. Jeff and Ed will be reviewing the financial results and will also provide an update on the Company's strategy and outlook. Following our prepared remarks, we will open up to questions. The call is being webcast and can be accessed at CECO's website at cecoenviro.com. The webcast will be posted on CECO's website for replay approximately two hours following the end of the call. The replay will stay on site for on-demand review over the next several months.

Before we begin, I would like to caution investors regarding forward-looking statements. Any statements made in today's presentation that are not based on historical fact, such statements are based on certain estimates and expectations and are subject to a number of risks and uncertainties. Actual future results may vary materially from those expressed or implied by the forward-looking statements. We encourage you to read the risks described in CECO's SEC filings, including CECO's annual report on Form 10-K for the year ended December 31, 2014. Except to the extent required by applicable security laws, we undertake no obligation to update or publicly revise any of the forward-looking statements that we make here today, whether as a result of new information, future events, or otherwise.

Today's presentation also contains non-GAAP financial measures. For purpose of Regulation G, a non-GAAP financial measure is a numerical measure of historical or future financial performance that excludes amounts that are included in the most directly comparable measure calculated and presented in accordance with GAAP and the statement of income, balance sheet or statement of cash flows or equivalent statements. In accordance with the requirements of Regulation G, the table of the appendix and the presentation slides represents the most directly comparable GAAP financial measure and reconciles non-GAAP adjusted EBITDA to comparable GAAP measure. Adjusted EBITDA is not calculated in accordance with GAAP and should not be considered supplemental to and not as a substitute for or superior to financial measures calculated in accordance with GAAP.

Now I'd like to turn the call over to Jeff to begin the discussion.

Good morning. Thank you, Sean. Thank you, everybody, for joining the CECO Environmental conference call and webcast to discuss the financial results for Q1. We appreciate your continuing interest as we continue our journey to build a premier company and grow our global business.

As many of you know, we announced earlier this week that we are acquiring PMFG, and I want to reiterate our excitement regarding that transaction. We're going to focus primarily on first-quarter results during the call, but I encourage you to review the transcript regarding PMFG and the associated slide deck from our call earlier this week.

I'll provide an overview of the quarter, some brief financial highlights, and Ed Prajzner, our Chief Financial Officer, will discuss the financial results in much more detail. I'll then close with an update on the business and some other strategic comments for the quarter. Let's begin with slide 6.

Revenue in the quarter increased $23.8 million to $81 million or 41.6% higher than last quarter and is 6% higher sequentially. This is another record for CECO, and it was driven by a combination of organic growth and revenue from acquisitions.

On an organic basis, revenue grew approximately 9% on a constant currency basis. Acquisitions in the quarter contributed $20.5 million compared to the previous year.

On a consolidated basis, bookings were a record $93.9 million for the quarter, up 47% compared to last year's $63.6 million. On an organic basis, I'm pleased to announce that bookings were up approximately 9% and demonstrates the fact that our sales excellence in the OneCECO initiative are paying dividends. Further, this equates to a favorable book-to-bill ratio of approximately 1.16.

Our backlog remains very strong, reaching a record level of $153 million in the quarter, up from $140 million in the prior quarter. This is also another record for CECO and continues to signal that we are gaining traction in our organic growth initiatives. GAAP net income decreased to $0.2 million in the quarter compared to $3 million last year, and GAAP net income per diluted share was $0.01 in the quarter compared to $0.12 last year. Non-GAAP net income increased to $5.7 million in the quarter compared to $5 million last year, and non-GAAP net income per diluted share came in at $0.21 in the quarter compared with $0.19 the previous year.

Moving on to slide 7, gross profit in the quarter was $21 million compared to $19.7 million a year ago, an increase of $1.2 million. Gross profit margin shifted in the first quarter to roughly 26% from 34.5% a year ago and roughly 30% in the prior quarter. As expected, and as communicated last quarter, the two midsized 2014 acquisitions of Emtrol and Zhongli, in addition to the very large strategic Saudi Arabia energy project that we began recording shipment on in late 2014, caused our gross margin to shift in the quarter.

We, however, are expecting the full integration synergies from these acquisitions to be realized this year. That, combined with the completion of the Saudi project by the middle of the year, will allow us to improve our gross margins in the second half of 2015.

In addition, given the reduced SG&A footprint that comes with our acquired businesses, we are confident that we will also get back to our normalized operating income aspirations as we progress.

With respect to the energy sector, our Effox business unit also had a below average quarter, which compared to a very good Q1 of 2014 and showed some tough comparables. Effox is experiencing demand issues in their target market of solid fuels. We are working diligently to improve the situation. Effox has a new President in place who has an excellent background in building aftermarket revenue businesses and profitability in global energy businesses.

Our non-GAAP operating margin of 9.3% decline from last year's 14.5% and 10.4% in the prior quarter. The decline in operating margin was largely due to lower gross margin discussed in the previous message. SG&A as a percent of revenue was [17%] compared to 20% in the prior year period, a favorable reduction of 360 basis points.

Adjusted EBITDA in the quarter was $8.6 million, down from $9.4 million last year and $9.7 million in the fourth quarter.

In summary, we achieved record revenues, bookings and backlog. Although operating margins are currently below our long-term aspirations, we will continue our focus on high-margin revenues, our continued focus on operational excellence and manufacturing optimization.

That being said, we continue to show solid year-over-year progress in our key financial metrics while positioning the Company for forward growth.

Please move on to slide 8. I would like to provide you with an update on the business conditions and our strategic initiatives. We believe the overall end market conditions are relatively unchanged from the prior quarter. Bright spots included global natural gas power business and global downstream refinery activity as well as petrochemical. We also believe our sales excellence initiative and our OneCECO sales activities are improving as demonstrated by our favorable bookings in the quarter.

Results in the environmental segment, which has been renamed from the air pollution control group, continued to gain momentum. In particular, our global cyclone business had a very strong bookings quarter with a number of orders closing in the quarter. A number of other businesses in the environmental sector had solid results, driven by our sales excellence and some of the OneCECO initiatives. We continue to focus and try to make improvements within our gross profit within the environmental sector.

Conditions in our energy segment are mixed. Strong global demand for the natural gas turbine power generation is being slightly offset by the weaker domestic demands for solid fuel. However, demand in markets such as Asia have increased and are experiencing growth in solid fuels. In more mature markets, for instance the USA, we are shifting our focus to more aftermarket retrofits and services, which we believe is an important revenue driver in these geographic regions.

Our fluid handling sector is doing solidly and saw a modest improvement in bookings. We've added some very critical sales leadership resources in the fluid handling and filtration segment as well.

Additionally, aftermarket sales and continued operational excellence have contributed to meaningful margin improvements in that sector. We are now expecting improved sales excellence for the rest of the year in that sector.

The integration of Zhongli and Emtrol are progressing very well and are ahead of plan. I'm very pleased with the traction and progress of these two sizable acquisitions, and we expect the integration to be 100% complete by the end of Q2. Therefore, the CECO team will be completely focused on the CECO PMFG integration later in Q3 and Q4.

As many of you know, we have made significant investments in our aftermarket sales strategy to drive recurring revenues, and this continues to gain momentum. In addition to adding aftermarket sales resources, we are adding a corporate aftermarket strategy leader to help accelerate the divisions growing their aftermarket business and in efforts to harvest our sizable installed base in a more strategic fashion. Aftermarket recurring revenue remains a very important strategic initiative for CECO as it adds stability to our revenues, carries attractive margins and enhances our connectivity with our customer base.

As we announced earlier this week, we will be acquiring PMFG. This is a major strategic event for CECO, and I'm very excited by the business opportunity going forward. It is a perfect strategic fit for CECO.

Moving on to slide 9. We've outlined some of the key transaction benefits with PMFG. What I thought I would do is give you the three quick takeaways on PMFG. For further information, please refer to the Monday transcript regarding the PMFG acquisition.

First, we believe the strong strategic fit of the two organizations provides a very unique opportunity for CECO. We believe this transaction is a tremendous opportunity to improve our competitive position, drive more organic sales and truly leverage our larger footprint. Second, this combination is extremely attractive from both a sales and cost synergy perspective. Third, this is a key step in the evolution of CECO as we strive to build a premier organization, and this transaction is critical to positioning us as a market leader in the environmental and energy value train with scale, size and depth.

On page 10, please note the pro forma of the combined businesses is in the neighborhood of $500 million in revenue. With that, I would refer you to the transcript as mentioned before for more detail of that transaction.

Before I turn the call over to Ed, I want to reiterate that we remain intensely focused on driving organic growth through our sales excellence initiative, and we believe the addition of PMFG will create an even more -- more opportunities to drive revenue and organic growth. We have an excellent team in place, and we are very focused on executing our plan.

I will now turn the call over to Ed for a more detailed review of the financial results for the quarter.

Thank you, Jeff, and good morning, everyone. As mentioned earlier, I will highlight in a little more detail both the GAAP and non-GAAP performance for the quarter, particularly regarding our segments.

As a reminder, our non-GAAP adjustments include acquisition and integration expenses, the impact of acquisition to asset valuation adjustments on the income statement which results in higher depreciation, amortization and earnout expense. Our non-GAAP presentation is intended to provide better trend analysis and assessment of our core business performance.

We have included in the slides slide 12 through 15 historical perspectives sequentially. Jeff has discussed the quarterly results, so I'm going to move directly to the segment section of the presentation beginning on page 16.

So, commencing on page 16, revenue in our environmental segment was $41.7 million, up 56% from $26.7 million in the prior year period. Bookings were very strong at $51 million, driven primarily by our global cyclone division. On an organic basis, we estimate bookings were up approximately 15%. However, we did experience a bit of margin erosion in the quarter due to some of the lower margin business being processed as Jeff discussed earlier, and this is a top priority for us improving this area.

Moving on to slide 17, revenue in our energy segment was $24.3 million, up 58% from $15.3 million in the prior year period. The higher revenue was driven by the strong bookings in the third quarter of 2014. That is the large strategic natural gas power generation project, and at least this project is expected to be completed in the third quarter of this year.

Moving on to slide 18, revenue in our fluid handling segment was $15.2 million, down slightly on a year-over-year and sequential basis. Bookings were, however, up modestly, and gross margin improved in the fluid handling business over the same period of last year.

Lastly, moving on to slide 19 on our balance sheet, cash and cash equivalents at March 31, 2015, were $18.9 million versus $19.4 million as of year-end. Outstanding borrowings under our credit facilities and term loans were $114.6 million as of March 31, 2015 compared to $114.2 million as of year-end. Although we did pay down term debt during the quarter, we borrowed under our revolving credit facility. Our effective tax rate for the quarter was approximately 30% versus 35% in the same period of last year.

With that, I will turn the call back over to Jeff before we open it up to your questions.

Thanks, Ed. Although we are not satisfied with our operating margin in Q1, we do know that they are temporary and based on strategic decisions. We were pleased with the revenue and bookings in the quarter and were optimistic that Q2 and the remainder of 2015 will be much better given our record level of backlog. We continue to execute on our core objectives that we've talked about for several years.

We continue to implement our strategic initiatives around three core operating segments and building a great foundation to increase shareholder value in 2015 and well beyond. As discussed in our previous earnings call, we now have a broader and stronger portfolio today than we did a year ago. The addition of PMFG is expected to play a critical role in that strategy with a substantial platform to reach our midterm aspiration of in excess of $100 million in EBITDA and well over $1 million in revenue.

In conclusion, I believe we've made solid progress in the quarter, and our focus remains on driving profitable growth and creating long-term shareholder value. I'm very pleased with where our Company is positioned. We have an excellent management and leadership team in place. We look forward to embracing the PMFG team into the CECO family. We have the right platform and focus and team in place to make CECO a premier company.

I would now like to open it up for any questions you may have.

(Operator Instructions) Brian Drab, William Blair.

First question is, can you give just a little more detail regarding what surprised you with the Emtrol and Effox margins? It sounded like clearly there is timing of shipment of certain orders, but also a demand issue at Effox. You know, is price coming down in these businesses, or can you give us some kind of -- a little more confidence that this was just a blip??

I wouldn't say I was surprised. I would just say Effox has been going through a transformation. They enjoyed a ton of domestic high-margin business for a long time. That's tapered off some, and the team now is relatively pursuing the global markets. We need to move a little bit faster in Asia, a little bit faster in India. We are gearing up on the aftermarket side and the retrofit side domestically, and that's starting to help a little bit. We put in a new leader that has a lot of global and aftermarket experiences. So it's a transformation of the business.

As that business has flattened out a little bit domestically, we just need to move faster on the sales side with Effox and Zhongli in Asia where we are rebranding the Effox/Zhongli damper diverter business, which will help accelerate activity in Asia. We have a lot of sales activity in India now, and we are excited about where that business is going. They are going through a transformation.

On the Emtrol/Buell side, that business is actually performing very well. The intake of business actually has exceeded our expectations. There are some legacy cyclone businesses that had a little bit lower gross margin that we are processing through. At the end of the day, we think the Emtrol/Buell business is going to be one of our premier businesses around the world. It's an asset-light business. It has a very low working capital and has an excellent team. We are just going through some -- we're just processing some low margin projects. But I'm very excited about where they are going to be in the future.

Okay. And how is price trending in these businesses, and I guess can you make any broader comment on price and the trends you saw in the quarter?

Relative to the pricing we can obtain from our end markets, Brian? Or --?

Let me broaden the question and we've been -- you gave us some good detail regarding the operating environment in the first quarter, and it sounds like it's a little better than would have expected given some of your end market exposure and what we are seeing from other companies with broad energy exposure. But so, that's kind of the background for my question is, in this tough operating environment, are you finding that you are having to give up some price to move equipment and you know ship orders?

No, I don't think there is an overarching comment about price realization or price degradation. I think it's pretty similar to how it's been in the past year or so. I would say on these large energy projects that we are pursuing globally through Aarding, those are probably 2 or 3 points below the typical CECO run rate. But these are $3 million, $4 million, $5 million, $6 million project. These carry terrific gross profit dollars, but they are probably in the 25%, 26% range.

However, the Emtrol/Buell, occasionally we have to make some concessions. They are the leader in the cyclone technology business within the refinery. We are trying to be sensitive to some of the legacy pricing, but I think long-term there is some -- there will be price realization in the Emtrol/Buell business. There will be fabrication and manufacturing opportunities as well. So I think we are just getting started with the Emtrol/Buell marketing and the pricing strategy. But as far as the integration goes, they are already operating as one team. They are moving globally as a unit, and I'm very pleased with the traction of the Emtrol/Buell business. We need to make sure we get through some of the low margin projects and keep working on price realization and some cost out opportunities.

Okay. And then moving into the second quarter in terms of gross margin, it sounded like we should be expecting gross margin to be under pressure through the second quarter because your comment was that it should improve in the second half. Is it fair to conclude that we should model kind of flat gross margin from first quarter to second quarter?

Correct. You are absolutely correct and then we are looking for some nice -- some solid uplift in the second half of 2015 and more so in 2016.

Do you think you can get back to that 30% -- kind of 30% to 32% range in the second half of 2015?

Probably not. I think the legacy CECO business clearly will move up a little bit. But one of the things that we've started to message a quarter ago is we have roughly $100 million now of really nice business between the Emtrol, the Zhongli and the large natural gas projects out of Aarding that are probably a few points below our normal run rate, but it's still excellent business. We strategically want that business, and further, those businesses have a leaner operating footprint, which ultimately should get us back to those operating margins that we are aspiring to. So I hope that gives you a little color around the margin outlook.

Yes, that helps. And then I'm looking at the consensus forecast for revenue for the rest of the year and I'm wondering if you can give us any comments here. I see $84 million in revenue for the second quarter, $84 million in the third quarter, $86 million in the fourth quarter. Can you give us any comment regarding how you feel about that forecast and how attainable those types of numbers are?

We study that quite a bit, Brian, and I read the consensus as well. I think we finished 2014 with a pro forma of around $3.25 million, $3.27 million. I think if you put on a normalized organic growth rate with that, I think that puts us probably right in that [350] range, which is the consensus. So our aspiration would be to hit that or exceed that.

Okay. Thanks very much.

(Operator Instructions) Gerry Sweeney, ROTH Capital.

Good morning. Just to follow up, as you are looking at the bookings, as we go forward, do you have a -- how do the margins look in the bookings on a go forward basis, and when do we start to see that? Are they in the 30% to 33% range, or are we looking below that just as a follow-up to the previous questions?

Jerry, it's Ed. As Jeff just explained, there is a little lower expectation in that booking as Jeff alluded to with the -- that will come through here in the second quarter or second half and going forward. The new acquisitions, having the lower margin expectations, although the lower SG&A profile as well, in addition to the large natural gas projects. So yes, there is a little lower expectation in that backlog than the historical questions.

And then as you were talking about the SG&A and then your aspirations to the operating margins, can you give us a little bit of -- a little bit more detail in exactly what those aspirations are and maybe a stairstep process or process from today to how you -- to what those targets are in the future?

When we acquire a business that we've studied and evaluated for many years, we recognize their gross profit profile. We recognize their SG&A profile. We want to make sure over a reasonable time period, 2015 is the integration year. We are going to pull up some nice synergies on the revenue and cost out, and those businesses that have a couple of points of lower gross profit margin, they also have a couple of points of lower SG&A footprint.

So, we still believe as we migrate through the integration and the growth in 2015, 2016 and 2017, they will have the capacity to reach our operating margin aspiration. It just takes a little time to get to that level.

And but what is that the operational margin number?

Well, as you can see, we are tracking at that 10% operating margin range for the first half. The numbers pretty well spell that out. Long-term we have aspirations to be a 15% operating margin business. That's what we'd like to achieve with our portfolio, with our pricing strategies, with our leverage, with our asset-like footprint and our very attractive lean operating model. So that's going to take us time to achieve that, but that's what the management team is focused on, and we have some work to do to get there.

Okay. And then finally, switching over to aftermarket, you know how was the aftermarket business in general in the first quarter? Any weaknesses in certain areas? I think there was a little bit of some pressure points in maybe the second half of last year. Maybe it was the air pollution control business. But curious as to how that continues to move forward. Longer-term, you are shooting for 40%, so maybe a little background on that.

Good question. Thank you. We talked about that monthly about our aftermarket and reoccurring revenue growth strategy. Every business unit is very focused on that. We've added a lot of capacity to grow the aftermarket business. The IT team is very focused on making sure we have the installed base and the customer database to assure we can provide the sales focus. The team here is going to start publishing more data on the reoccurring revenue versus the operating versus the original equipment metrics. Our aspiration is 40% over the midterm. Jerry, you are correct. We are probably in north of a third right now. So you are going to see a little more color around that. We're going to be investing in an aftermarket Director of Strategy to help accelerate the divisions, and I would say the aftermarket business is as strong today as it's ever been at CECO. We're excited to work with the PMFG team later in the year to expand the combined $5 billion of installed base. But it is probably our top three -- one of our top three priorities for growth going forward.

But when we launch our Q2 earnings, you're going to see a little more color and metrics around reoccurring revenue versus original equipment.

Got it. Thanks a lot. I appreciate it.

Scott Graham, Jefferies.

Just wanted to ask a couple of questions about some statements that you made, Jeff, as you were answering some questions and what have you. I'm sure I can figure this out, but I just kind of wanted to hear it from you. When you say kind of $350 million revenue territory via applying a normal organic growth number, what is the organic growth number you are thinking of?

We've not published organic growth numbers, Scott. You know, we clearly want to be equal to or better than other industrial technology companies, and I think the $350 million number was what was published by the consensus of the research analysts, and that that was the $350 million number. And that reflects probably (multiple speakers)

I'm with you. I get it completely. And when you say you want to be a 15% operating margin business, are you talking about operating margin before amortization?

That would be on a non-GAAP operating margin basis, correct.

Okay. Great. That's really all I had. Thank you.

That does conclude today's question-and-answer session. I'll turn the conference back over to management for any closing remarks.

Thank you for joining our call today. We'll talk again next quarter.

That does conclude today's conference. Again, thank you for your participation.