Ceco Environmental Corp Q4 FY2020 Earnings Call

Good morning and welcome to the CECO Environmental conference call. All participants will be in listen-only mode. After today’s presentation there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Matt Eckl, Chief Financial Officer of CECO Environmental. Please go ahead.

Thank you for joining us on the CECO Environmental fourth quarter 2020 conference call. On the call today is Todd Gleason, Chief Executive Officer, and myself, Matt Eckl, Chief Financial Officer. Before we begin, I'd like to note that we have provided a slide presentation to help guide our discussion. The call will be webcast along with our earnings presentation on our website at cecoenviro.com. The presentation materials can be accessed through the Investor Relations section of the website.

Thanks, Matt. Throughout much of 2020 we started our earnings calls by thanking our dedicated employees, their families, and our great customers and operating partners. It has been a challenging time as the entire world has been forced to navigate the global pandemic and adjust how we work and interact. We are very pleased with how Team CECO has come together to embrace new technologies, processes, and adhere to rigorous COVID policies to ensure health and safety. So once again thank you for all you do to ensure we deliver for our customers and drive value for all constituents. As is highlighted on Slide 3 and in our press release this morning, CECO delivered strong results in the fourth quarter of 2020. Let's quickly review the facts and figures and later Matt will provide more color around some of these numbers. Orders were up mid-teen levels both sequentially and year-over-year as we booked $77 million in the fourth quarter. Getting back on the orders growth trajectory is always a positive but even more important as we saw reductions in our backlog. We look to turn the corner on this trend early in 2021 as we believe our orders growth will continue. Sales were $83 million which did reduce backlog because it was obviously higher with new orders. The fourth quarter sales results were down 7% versus 2019 but they were up sequentially 7% over Q3 2020. Our project teams continued to execute very well despite the challenges of COVID restrictions.

Thanks, Todd. I'll start with Slide 6 and orders. At $77 million of orders we are pleased to see all three segments grow sequentially and year-over-year. While we are still below our pre-COVID averages, we see markets improving as Power Gen and refinery markets start spending on deferred CAPEX. Industrial customers seem less concerned by the outcome of the U.S. election and COVID. December was a very strong orders month at CECO as confidence factors grew amongst our customers. Doubling down on Todd's comments, our pipeline continues to expand and reached $1.9 billion, a new high in my four years plus, mostly driven by our push into new adjacent markets like EV production and industrial wastewater. Energy booked $46 million in Q4, up over 16% versus our trailing 12-month average, which we believe is an inflection point as the economic pressures of COVID subside. $9 million came from our refinery-based FCC cyclones, which were up triple-digit both year-over-year and sequentially. While the $9 million level is not yet back to our historical averages, we are pleased that we had year-over-year improvement in this category because for the full year we were down 50%. We are growing more confident this will be an area of strong orders growth in 2021. Industrials and Fluid both printed their second consecutive quarter of orders growth. Industrials was a bit more pronounced at 11% growth sequentially. We're very encouraged by the progress this team is making with wind and electric vehicle manufacturing and food and beverage in the quarter. Fluid grew on par with its peers at 5% sequential and 1% year-over-year. We like the trend coming out of COVID, but we won't be fully satisfied until orders are well above $10 million per quarter. While we are seeing our distributors start to restock, a positive sign, our end markets, including oil and gas, hospitality, and aquaculture, are still cautious until mobility and tourism improve. On the right, revenue grew 7% sequentially on energy backlog conversion. Simply put, end users constructing plants in Asia and the U.S. have started to gain momentum, while Europe and Middle East jobs are still experiencing COVID delays. I am pleased with the health and the execution of our backlog. While covering revenue, we want to take a minute to address a new metric we intend to report on a quarterly basis that we're highlighting as short cycle sales. Details are steadier and typically higher margin. They turn from booked order to sale in less than four months, sometimes much faster. This metric represents the combination of sales via aftermarket replacement parts, recurring contracts and services, and distribution-based short cycle sales. In Q4, short cycle sales were $17 million and $71 million for the full year. That's approximately 23% of our total revenue. If you look at the CECO portfolio today, our products don't necessarily lend themselves toward a high percentage of predictable recurring sales because many of our largest sales-related areas come from our customers’ CAPEX budgets.

Thanks Matt, and I echo your remarks and appreciate your perspective after you have helped CECO navigate some challenging markets several times over the past four years. I have mentioned on both earnings calls since my arrival how capable and dedicated the CECO team is and that comes through in your assessment of the continued hard work. Let's wrap up with the next few set of slides, please turn to Number 16. The top section points to the 2020 review from an orders and backlog perspective. As we've already mentioned, orders were down 27% for the year. We estimate that COVID-related market impacts drove at least 80% of that decline. And the fact that orders were up in Q4, we think demonstrates that we are well-positioned for market recovery. Unfortunately, this order decline for full year 2020 means we enter 2021 with 15% less backlog or project revenue. This will put some pressure on the first two quarters, which is why we are stressing that orders growth, cash flow generation, and margin conversion are key indicators of how well we are turning the corner as COVID impacts start to subside. The middle section reiterates a series of strengths we have highlighted before. With approximately 40% of our professional staff being engineers or application specialists CECO is uniquely positioned as a leader in key environmental and industrial process sectors. We will continue to build off this expertise. We are also extremely asset light, which means we have a certain amount of flexibility when end markets ebb and flow. Both of these qualities allow us to invest for growth in a focused manner. And we expect to generate strong free cash flow in 2021. So our already healthy balance sheet will be in great shape; we have the right pieces of our portfolio. For the bottom of the slide, we highlight that we are committed to delivering financial results that reflect our improved cost structure and recovering markets. There may be a quarter or two in early 2021 where revenues are lower from our reduced starting backlog but we expect to rebuild that backlog throughout the year and deliver. We are close to finalizing our new enterprise strategy. We will have a strong focus on CECO's leading technology platforms that represent our best position for sustained growth. Within CECO we have 10 to 12 platforms that span air filtration and quality management, gas and liquid separation, and industrial processes and flow. So we are better positioned for organic investment and these markets will continue to provide sustainable growth. We will also focus on adding more short cycle revenue platforms to CECO over time to add more balance to our portfolio. A couple of examples of current organic investments would be our water treatment platform where we recently introduced reverse osmosis, de-sanding and desalting technology, which rounds out our ability to serve our Middle East customers' produced oily water separation needs. Prior to this year, the scope of work CECO could bid on was limited to separation internals only, not a full customer solution. Another would be our advanced analytical services and training team that we just launched based out of Houston, Texas. This group of experienced service engineers targets our Brownfield customers and comes with a Rolodex of new service customers. Their focus is repairing, calibrating, and testing analyzers and continuous emissions monitoring systems, or CEMS, that are installed in the field today. Listening to our customers we understand CAPEX is tight and they need to keep their current systems operational. We expect the services team to rapidly become a multi-million dollar business in a short period of time. So we look forward to sharing our more comprehensive enterprise strategy in the near future. This will provide investors with a roadmap for how we will steadily elevate our position as an environmentally focused, diversified industrial. Please turn to Slide 17; you may remember the slide image on the top left from our Q3 earnings presentation. We wanted to reiterate that as we navigate 2021—which again we expect to show solid orders and backlog growth—that CECO is much better positioned for strategic investments and higher margin results. Bottom line, back in 2017 we saw a sudden decline in end markets, but CECO was not yet officially organized internally nor did we have a strong balance sheet at that time. Today we have much more robust systems and processes and a better balance sheet as an enabler, not a detractor. As we see market growth, we will be stronger and more agile. Please turn to Slide 18. We remain committed to these financial targets, especially as markets recover and become more normalized. Revenue growth of at least 5% is something we believe our leading platforms can deliver. We also believe we are closer to realizing 13% EBITDA margins, especially when we get our backlog back to 2019 levels. So these financial targets are well within reach. Finally, we expect to generate solid free cash flow in 2021, always a key goal of our organization. Now let's wrap up on Slide 19. It has been a unique 12-plus months. Our focus on delivering for our customers is always important and we remain committed to doing so while maintaining health and safety. We have been aggressive with cost management and improved our operational efficiencies. As Matt highlighted, this has been a steady focus for CECO and we are in better position than ever. We saw nice momentum in the fourth quarter in key energy markets and we expect much of that to continue. We look forward to articulating more of our key initiatives and strategic priorities. This will help to focus CECO towards a clearer and executable growth program, and our investors can track the progress. We thank you for your support, interest, and your time today. With that, we will open up the line for questions.

And the first question comes from Jim Ricchiuti with Needham & Company.

Hi, good morning. Just had a question about the short cycle business and the metric you're providing. What I was curious about is, is that short cycle business more weighted toward maintenance-related revenue or is it more the traditional business?

Yeah. Hey, good morning Jim, Todd here. I'll start and then hand it over to Matt who's done a lot of work with his team on assembling the data and information behind it. It does include maintenance and repair, but it also is, I'll use your word, more of a classic or standard set of businesses as well. Businesses that when we book the potential order, we book the sale, we produce and ship the product relatively quickly. So it does also include some of our product lines and businesses such as our pumps business. So it's a combination of a few things: aftermarket repair parts, the small area of our businesses where we do have some recurring revenue, and then our sort of short cycle book-to-ship businesses like our fluid handling.

Got it, do you guys use this as something of a leading indicator for the business?

You know, maybe yes, I think that's a good way to look at it. One of the reasons we want to put a spotlight on it is for the following. Historically, as an organization we have talked about recurring revenue but never really provided real metrics around things like recurring revenue. We are going to grow our recurring and services revenue, but we never really put specific numbers to it. We wanted to put a real number out there that we expect to talk about and potentially even provide more color quarter-over-quarter and year-over-year. It is an indicator, for sure, of the general industry, especially in our industrial businesses where we do have a bit more of a short cycle space.

Jim, I would just add one thing: the majority of our business is CAPEX spend. We really want to drive maintenance spend with our customers. So pumps, filters, ductwork, services with the customer, repairs—all higher margin business that are deemed short cycle. That's what's all-inclusive in that metric.

And last comment, not to continue to pile on to the answer, but you highlighted a new services team offering that you're launching this year, and you're excited about that. I think your ability to not only show the metric and talk about how you're driving those results, but then really add very specific—even if they are somewhat small—initiatives that you're doing within your businesses provides more clarity to investors about where you're taking organic investment to start and potentially other investments down the road to continue to grow. We do want to find a more sustainable revenue profile for the organization. Got it, that makes sense. And just a question on the backlog: could you give any perspective in terms of the margin profile of the backlog, also in light of the comments you made about the fact that you'll be building backlog but there's going to be some pressure in the first couple of quarters of the year?

Yeah, as we look at backlog margins right now, Jim, they're reflective of our Q4 margin rate, maybe a little bit pressured. In the last two or three quarters as some of the bookings on the energy side have come in, we've seen some pricing pressure there. But for the most part, we're executing through cost measures and executing for our customers to increase those margins as we deliver them.

Got it, thanks. I will step back in the queue.

Thanks, Jim.

And the next question comes from Amit Dayal with H.C. Wainwright.

Good morning and thank you. With respect to this analytic services business, as part of your recurring revenue effort, is this product ready to go or does it need some more development?

Not a product, it's a services team. It is an expansion to many of the relationships we already have with existing Brownfield customers. These are existing facilities, predominantly in the energy space, and we're starting with a regional focus. We believe in the focus area that we are hiring for and that we're leveraging our relationships, as well as the service technicians for this specific space. We specifically call that continuous emissions monitoring. That's a broad but important category. There's a lot of data analytics and many component parts. So it's not a product offering as much as it's a technical service offering and we're ready to go; we're going to build out the team as we prove out the momentum.

And we already have the test equipment, the trucks, and the men.

Understood. Roughly, do you have an estimate of how big this opportunity is within the existing customer base?

It's a fairly large opportunity. In other companies that are in this space, they've shown a propensity to grow relatively steadily. We're starting here, so in the year it's a relatively small number. We believe, though, that this could easily be in the next few years a solid double-digit millions of dollars of revenue as we continue to invest and grow.

Just a last one from me: as the economy comes back and your backlog starts building again, do you expect some of the costs you took out of the business to come back in again based on the group's needs going forward?

In 2021, we will absolutely see some increases because of variable pay and healthcare costs. You can't take Q4 and annualize that out. But I did provide color in my remarks that we think it's around $18 million per quarter, which is well below the $21 to $22 million per quarter we had previously. We don't expect to increase our cost structure materially. To achieve 13% or greater EBITDA margins we need growth. We're tracking utilization of our application engineers and project management team, which will increase as the backlog grows, but we're going to maintain our margin ranges. So I don't see the cost structure having to grow too much or requiring a ton of investment.

That's all I have, guys. Thank you so much.

Thanks for asking.

Thank you.

And the next question comes from Bill Rosalo with Titan Capital.

Thank you, a couple of questions. First of all, you'd mentioned that you have the highest pipeline that you've had in several years. Is that due to the market expanding or is that really CECO-specific initiatives that are leading to that?

Good morning, Bill. I'll hand it over to Matt, who with his team has done a tremendous amount of work analyzing the historical perspective as well as how we model this pipeline. We're getting better at it every day. It's our largest pipeline and I think it's indicative of a couple things. Number one, we feel that we continue to maintain our performance and our position in markets, attributable to how we continue to invest in those markets internationally. We're expanding into adjacent markets consistently, which provides more market scope for us to add into the pipeline. Number two, we saw a fair amount of deferrals and opportunities over the last 12 to 18 months associated with COVID. If you think about where our historic pipeline has been, getting from a previous peak of about $1.7 billion up to $1.9 billion is partly a natural increase associated with higher levels of deferment from previous periods. COVID was a unique environment and we didn't own all these businesses 10-plus years ago when the financial crisis hit, so we're seeing a combination of deferred opportunities plus our expansion into adjacent markets and our investment in being a leader.

Great, thanks.

And Matt is nodding that I hit the answer, so we are good with that.

Okay, thank you. How do you see or believe that the Biden administration's approach to environmental regulation enhances your air and water business? Can you talk through whether that sets up a headwind or tailwind?

We're learning quickly what some opportunities could look like. We're interested in areas of environmental and water, so we're keen to learn more about what our customers are being asked to do and want to do in this space. Infrastructure investment could be interesting for the economy and for industrial companies like ours. Internationally and domestically, as businesses move past pandemic constraints, potentially coupled with new investments in infrastructure and environmental regulation, those could be positives. Our pipeline suggests we have unique opportunities in these areas.

And lastly, what additional insights would you like to share about your refinery customers—their behaviors, signals, and turnaround plans—and how would you characterize them today versus normal if we had not gone through the COVID-related oil price downturn?

We do a lot of feed studies for independents and integrated refiners globally. The feeds are driving more leads and our pipeline higher, particularly internationally. India is a market where companies are moving forward with large projects. In the U.S., independents' CAPEX budgets are down 30% to 40% year-over-year as they continue to cut because mobility and transportation remain affected by COVID. What we're seeing is a shift from new plants to maintenance and conversions—for example, renewable diesel conversions—and the CAPEX they deferred last year is starting to come back. You can't defer equipment forever; systems will break down. Leading indicators are positive for us. Crack spreads have risen from April till today and are in the band of the last five-year average, which is good and suggests some reinvestment back into the business. Several leading indicators show refineries headed back up, and we're excited about that.

Matt, taking your comment one step further, are you sensing that at least in 2021 you will have a larger share of the CAPEX budget?

We believe that there will be a larger share of the CAPEX budget for all refineries. We don't comment on the share of our wins of those orders that are placed.

Bill, we've talked about this before. In 2020 the balloon of CAPEX got smaller, and the air in the balloon was pushed more to maintenance that maybe we didn’t benefit from. This year that air in the balloon may have gotten larger, and even if it didn't, we believe that air is being pushed over to our side of the maintenance CAPEX arena for 2021. We already feel like we're seeing that opportunity set.

Thank you both.

Thank you, Bill.

And the next question comes from Tate Sullivan with Maxim Group.

Hi, thank you. Good morning. You mentioned electric vehicle production during your comments. Where are you in the sales process with this opportunity? Are you already doing projects, and is it a global opportunity or U.S. right now? Please provide specifics if you can.

Yes to all of the above. We're actively bidding on new opportunities; it's a growing space with expansion internationally. Domestically we've won some projects recently and we are very close to some attractive projects internationally as well. We look at new builds and plant conversions—automotive and other industries converting to EV manufacturing require a fairly large CAPEX build-out, and we're benefiting from that as well.

As a follow-up, can you give an example of what type of equipment you provide to EV industrial customers? I imagine NOx emissions might not be the main issue—do they have an environmental angle and can you provide examples?

Think VOCs and dust collection. Two good examples are RTOs and dust collectors. We're cleaning the air and eliminating volatile organic compounds that are generated in those environments.

Thanks. Separate question: I saw in your 10-K that percent of revenue from outside the U.S. is 35% in 2020. Should people going forward associate you as a growing international company? You mentioned Middle East opportunities—can you frame that discussion?

It ebbs and flows. Two years ago it was close to 50:50. Our Energy business drives a lot of that year-in, year-out. If you have refinery or power orders in Europe or other regions, that moves the destination of sales. So it ebbs and flows with our energy business; it's not necessarily a reflection of the future. We do believe international is strong right now.

Thank you both.

Thanks, Tate.

And this is a follow-up from Jim Ricchiuti with Needham & Company.

Hi, just as it relates to the last question, I know the business ebbs and flows between domestic and international, but is there any additional color as to where you're seeing some recovery in market? Have you noticed more of a recovery or strengthening in the U.S. market in Q4, or is it still tougher to tell because it depends on various projects you're targeting?

In Q4, in the energy sector we saw increases in India and China. In our industrial sector, North America is the strongest. We're seeing opportunities across Europe and recently added an international sales manager there to grow our industrial and fluid handling capabilities. Energy in North America is a bit choppy right now.

Got it. And again, I know the market is still fairly unsettled as we're in this gradual recovery, but I'm wondering how you're looking at inorganic growth opportunities. How active is the activity right now? Is the pipeline building, are you looking actively, or are you being more cautious in the current environment?

We're building a very focused funnel for analysis. There are opportunities out there that align with our strategy. As we advance our strategic thinking—both organically and around our portfolio—we want a funnel of opportunities that match where we think markets are going and where we can expand leadership positions. We're focused on adding more repeatable, sustainable short cycle businesses. We're not transacting anything right now; we're focused on strategy and organic opportunities. But we're building a funnel and feel really good about our strategic plans so that when we're ready to execute, it will be very clear internally and externally what we're focusing on and why.

Got it, thank you.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Todd Gleason for any closing remarks.

Yeah, thank you. I appreciate your time and interest today. Let me double down on comments thanking Team CECO, all of our customers and partners. We navigated a very challenging year and I'm proud of our results, but more importantly I'm proud of the commitment that our employees and everyone associated with our organization showed as we made tough decisions and faced challenges. There was no playbook 12 months ago. We appreciate all those efforts. We hope everyone continues to stay focused, healthy, and safe. We look forward to speaking with everybody soon. With that, enjoy the day and we'll talk to you soon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.