Ceco Environmental Corp Q4 FY2023 Earnings Call

Good morning, and welcome to the CECO Environmental Conference Call. All participants will be in a listen-only mode. After today's presentation, there'll be an opportunity to ask a question. Please note, this event is being recorded. I would now like to turn the conference over to Steven Hooser, Investor Relations. Please go ahead.

Thank you, Kevin, and thank you all for joining us on the CECO Environmental fourth quarter 2023 earnings call. On the call, with me today is Todd Gleason, Chief Executive Officer; and Peter Johansson, Chief Financial and Strategy 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, which is on our website at cecoenviro.com. The presentation materials can be accessed through the Investor Relations section of the website. I'd also like to caution investors regarding forward-looking statements. Any statements made in today's presentation that are not based on historical fact are forward-looking statements. Such statements are based on certain estimates and expectations and are subject to a number of risks and uncertainties. Actual future results may differ materially from those expressed or implied by the forward-looking statements. We encourage you to read the risks described in our SEC filings included on Form 10-K and the end of year, December 31, 2023. Except to the extent required by applicable securities 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 will also include references to certain non-GAAP financial measures. We provide the comparable GAAP and non-GAAP numbers in today's press release and provide non-GAAP reconciliations in the supplemental tables in the back of the slide presentation. And with that, I'd now like to turn the call over to Chief Executive Officer, Todd Gleason. Todd?

Thanks, Steven, and to our audience, thank you for your interest and continued support. If you would, please turn to Slide number 3, which is entitled Q4 and full year 2023 earnings highlights. I'm going to start with an overarching comment that we delivered an outstanding quarter and a tremendous full year. We are proud of the financial records in 2023, of course, but even more excited to advance our leadership positions in industrial air, industrial water, and the energy transition. With that, let's review the slide. On the left side of the slide, we list a number of key accomplishments that I will quickly review. The right side of the slide compares our full year results against our most recent full year guidance, which we provided in November 2023. As the green check marks indicate, we achieved or exceeded each of our key financial targets as we closed the year. As we outlined in today's press release, CECO delivered multiple financial records during the fourth quarter. Our quarterly and full year financial performance showcased strong continued growth, which is a result of our world-class teams delivering for our global customers every day. We continue to invest in our people, our processes, and our solutions to ensure we meet or exceed customer requirements with respect to their needs. Thank you, Team CECO, for your customer-first focus and accountability for performance. Now, let's review some of our fourth quarter and full year highlights. The section on the left of the slide captures some of those achievements that we delivered this year. I am pleased to share that our fourth quarter revenues represent the highest quarterly sales in the company's history. The prior company record for sales was last quarter in Q3 2023, so we continue to maintain steady sales growth. We also delivered the highest gross profit and adjusted EBITDA dollar levels in our history. Backlog as of December 31 was $371 million, up 19% when compared to the same period last year, and is the highest year-end backlog in our company's history. Even as we continue to transition our portfolio to more short and mid-cycle sales, orders for the year yielded a book-to-bill of approximately 1.1%. So, in short, it has been a solid performance from our businesses ensuring that we continue to drive great growth. And with our sales pipeline of over $3.5 billion, we expect to maintain our solid bookings trajectory. The combination of our record year-end backlog as well as the very strong sales pipeline and our overall execution gives us the confidence and visibility to raise our previously announced full year 2024 guidance, which I will cover in more detail soon. Switching gears to our investment strategy, 2023 was another year of significant steps being taken in CECO's transformational journey. We deployed approximately $60 million in growth capital, with much of it targeted towards the completion of three acquisitions. We are pleased with the transactions we completed in 2023 as they continue to deliver outstanding financial performance while also adding top-notch talent, new technologies, and further round out our very well-positioned market leadership, and given the strong free cash flow we delivered, we maintain a very healthy balance sheet. Now please turn to Slide 4 and let's review a snapshot of CECO's fourth quarter and full year 2023 financial results. Peter will cover many of these financial figures and metrics in more detail in a few minutes. However, let me highlight a few areas. I will mostly stick to the right of the slide which covers full year 2023, as Peter will spend a little bit more time on the fourth quarter results. The panel on the left side of the slide provides a snapshot of CECO's fourth quarter financials, all of which are very strong. CECO's full year orders of $583 million represent the highest annual bookings level in our company's history, continuing a trend of outstanding orders growth which drove year-over-year growth of 11%. As a reminder to our audience, we have been growing orders steadily since the second half of 2020, so this is definitely not just a 12-month phenomenon, but rather a continuation of positive change to deliberately convert global customer and market demand into CECO bookings. And as always, I caution against focusing on quarterly bookings because there are many factors that influence the timing of an order, including the mix shift of our long, mid, and short-cycle sales. Internally, we focus on full year outlook and results. Sales of $545 million was also the highest annualized levels for CECO, producing a year-over-year growth rate of 29%, which follows full year 2022 sales of over 30%. Additionally, as I mentioned previously, fourth quarter sales were a record level for any quarter in the company's history. For the full year 2023, organic sales growth was approximately 22%. Full year adjusted EBITDA of approximately $58 million was up 37% year-over-year. This result produced adjusted EBITDA margins for the year of 10.6%, an increase of approximately 60 basis points year-over-year. As a reminder, full year margins would have expanded 110 basis points if not for a favorable insurance item in 2022. Additionally, we expect our annual G&A investments to level off a bit, which we expect will deliver higher conversion on future top line growth. Adjusted EPS in the year of $0.75 was up modestly versus full year 2022, as our 2023 EPS overcame approximately $0.20 of higher interest expense. Finally, we generated $36.2 million of free cash flow in the year. We overcame a slow start to 2023, that if you recall, saw negative cash in Q1. In the second half, we delivered about $40 million of free cash flow as we managed working capital very well. Our businesses are doing a great job driving that working capital which allows us to maintain our disciplined capital allocation strategy focused on organic growth and programmatic M&A. So, to conclude this slide, just tremendous records and outstanding results. Now please turn to Slide number 5. In previous earnings and investor presentations, we have articulated how we have transformed our portfolio over the past several years. We introduced this new slide to help capture that ongoing transformation. In 2021, shortly after I joined CECO, we outlined a high level strategy to transition from a portfolio which had been heavily dependent on long cycle and very cyclical legacy energy markets. Our goal was to increase our percentage of shorter cycle sales mix as well as reduce our percentage of business mix that was tied to cyclical long cycle business. As the slide shows, our current portfolio is exceptionally balanced. Industrial Air currently accounts for approximately 40%, while Industrial Water and Energy Transition are each around 30%. We have also increased our short-cycle sales to approximately 30%. This transition has occurred while we have delivered tremendous growth and performance. Our full year sales are 72% higher in 2023 when compared to 2020 levels and our backlog is up an eye-popping 103% over that same period. Importantly, we have delivered outstanding shareholder value. Since mid-2020, which is when I joined the company, CECO has delivered over 250% of shareholder value in both stock price and market capitalization growth. I can assure you that management is very aligned with shareholders. We take this very seriously. It is also rewarding to be recognized by Fortune Magazine as one of America's Most Successful Public Companies as noted on the top right corner of the slide. Our employees and global partners are proud of our success, so this recognition is appreciated. We expect to continue to deliver outstanding growth while we advance our portfolio through deliberate investments in organic and programmatic M&A. I'm not going to read all the comments on Slide number 6, but let's go there. I'll make a few points. First, we introduced a very similar slide a few years ago. We articulated that we would drive both tactical and strategic actions to deliver consistent growth and shareholder returns while we steadily transform our portfolio. We believe we have been very transparent with our goals and objectives and also feel we have delivered on our commitments. While you have to constantly adjust to market trends, headwinds, and other challenges, we did what we said we would do and this updated slide represents a similar high-level summary of our ongoing goals and intentions. From left to right, we expect to build off our foundational accomplishments as we turn our attention to the key actions we expect to drive in 2024 to maintain our strong growth and long-term shareholder value creation. Our commitment to high performance requires a real balance of initiatives to drive that short to medium-term result as well as longer-term capital allocation programs to ensure we are positioning CECO for sustainable future performance. Each of these investments, for lack of a better word, ensures we continue to build commercial excellence, operational excellence, and also we utilize our capital to maximize returns. These initiatives, along with ongoing investments in culture and talent, are the heartbeat of our operating model. As we position for future years, we will provide updates on our progress against these programs and commitments, as well as other details on more granular initiatives. Now please turn to Slide number 7 and let's review guidance. As I mentioned in my earlier remarks and as you saw in our press release that we issued earlier today, we are pleased to share an update to our full year 2024 guidance. While we understand there are always unknowns and market dynamics that create pause with respect to forecasting in this environment, we believe CECO is in a unique position with better-than-average visibility to maintain growth. CECO's leadership in Industrial Air, Industrial Water, and Energy Transition will continue to benefit from investments in reshoring industrial production, sustainable infrastructure growth, global energy transition to new and renewable sources, and specific governmental investment programs such as the CHIPS Act and others. The combination of these positive market dynamics, coupled with our record backlog and great sales pipeline, gives us the confidence to raise full year 2024 guidance at this time. With respect to full year 2024 orders, we maintain a consistent outlook for a book-to-bill greater than 1%. With our robust sales pipeline being fueled by the mega themes I just articulated, we expect very strong bookings. As we always remind the investment community, our quarterly bookings levels might ebb and flow a bit, but for the full year, we expect to drive a positive book-to-bill. We are increasing our full year revenue guidance to between $590 million and $610 million, representing about 10% growth year-over-year at the midpoint. The updated 2024 full year guidance is compared to previously communicated outlook of between $575 million and $600 million, an improvement to both the low and the high end of the range. For adjusted EBITDA, we are updating the range to be between $67 million to $70 million for the full year 2024. This outlook would be up over 20% versus 2023 at the midpoint, representing further margin expansion for the year of about 75 basis points to 100 basis points. The current guidance is compared to the previously communicated outlook of between $65 million to $70 million. On free cash flow, we reaffirm our expectation to maintain between 50% to 70% of EBITDA as our free cash flow target. So, to conclude, we raise our full year 2024 outlook to reflect our expectations given our tremendous backlog coupled with our commercial and operational excellence programs which will drive robust growth and further operating margin expansion. We also entered the new year with a very healthy balance sheet which gives us added optionality as we execute on our programmatic M&A capabilities. I will now hand it over to Peter and he will walk you through more detail on our financials as well as some additional color on our capital deployment and cash management in the quarter and upcoming periods.

Thank you, Todd. I am very pleased today to be able to present to all in attendance another set of solid financial results for Q4 and full year 2023, results that continue to demonstrate the strength of our performance and conviction in our strategy and operating model. As we exit 2023 on a high note, we are entering 2024 with confidence that CECO is in a stronger position and poised to deliver another year of excellent performance. Now, please turn with me to Slide number 9 where I'll present a more detailed picture of CECO's Q4 2023 results. Orders for the quarter of $128.3 million were the sixth highest for any quarter in company history and concluded a year in which CECO booked orders of $583 million, an all-time high. We continue to execute against a sales pursuit pipeline at all-time high levels, with strong conversion of the opportunities that reached the bid for order phase. When compared to the same period last year, orders in the quarter were down 15%, and this was mostly driven by a significant individual order booked in the Energy Transition segment that raised Q4 2022 significantly and approximately $30 million worth of orders that were expected in Q4 that have moved into Q1 2024, part of the ebb and flow in our orders that Todd referred to previously. Revenues for the quarter of $153.7 million, a 32% increase over Q4 2022, were the highest for any quarter in company history, continuing a four-quarter trend of record-setting revenues benefiting from continued strong conversion of CECO's growing backlog and the positive impact of the Wakefield, Transcend, and Kemco acquisitions. Organic growth in the quarter was approximately 25%. Gross profit was $53 million in the quarter, a 41% increase over the prior year period and a record level resulting from higher shipments and higher margins. Margins were higher year-over-year by over 220 basis points and 570 basis points sequentially, driven by favorable mix and steady and improving execution. Full year gross profit of $171 million delivered a margin of 31.4%, a 105 basis point improvement for the full year. Adjusted EBITDA for the quarter was up 49% year-over-year to $19.4 million, a margin of 12.6%, and a 140 basis point improvement from Q4 2022, reflecting strong conversion on incremental revenue of approximately 17%. Both GAAP and non-GAAP operating income were up over 48% over the prior year period. Adjusted EPS was up year-over-year as operational performance overcame the headwinds from higher interest expense. A quick comment on the year-over-year decline in GAAP EPS in the quarter. This decline was mostly driven by one-time items booked in the quarter related to tax allowances for select international legal entities. We do not anticipate this to recur. Now let's turn to Slide 10 for more details on CECO's order progression. With Q4 and full year 2023 results complete, CECO has continued our track record of double-digit growth and the run of eight consecutive quarters with orders greater than $100 million, delivering a record year-end backlog of $371 million. For the full year 2023, the order intake was balanced across Air, Water, and Energy Transition and averaged $146 million per quarter. Orders for the second half of 2023 of $275 million were essentially equal to the total for all of 2020. And for the 2020 through 2023 period, CECO's orders CAGR is a very healthy 28%. And with the $3.5 billion opportunity pipeline our teams are actioning, this gives us confidence the trend will continue through 2024. Now moving to Slide 11, for a more detailed review of revenue. We finished 2023 with record revenues of $545 million following a record-breaking sales quarter of approximately $154 million representing the seventh consecutive quarter with revenues above $100 million and a level over 2 times that of the COVID era bottom which occurred in the first quarter of 2021. The three-year revenue CAGR is a strong 20% and yet this figure trails the orders CAGR for the same period, further underpinning our 2024 growth outlook. Whilst our M&A activity has been a tailwind to revenue, with all three businesses acquired in 2023 growing at or above their respective deal models, it is important to note that the year-over-year organic growth for the company has been 22%. Now please turn to Slide 12 for a quick review of backlog and backlog trends. CECO finished Q4 of 2023 with a backlog of $371 million representing a 19% increase year-over-year, of which we expect at least 70% to convert to revenue in 2024. The sequential decline in backlog of $23 million resulted from the combination of record sales in the quarter and lower than expected booking levels in the quarter given the previously mentioned delay in some bookings that moved to Q1 of 2024. On the bar chart showing backlog development, I would like to highlight that CECO's average quarter-end backlog balance for 2023 was $378 million. This represents a 30% increase year-over-year for another year with an annualized book-to-bill revenue ratio of 1.1% in line with prior years. Let's move to Slide 13 and we'll discuss gross profit and EBITDA. Starting on the left side of the page, gross profit delivery for the fourth quarter was a record $53.2 million, a 41% increase over fourth quarter of 2022, continuing a trend of 30% or greater year-over-year increases. Gross profit margin in the quarter was 34.6%, up 570 basis points from the prior quarter and 220 basis points from fourth quarter 2022. The year-over-year margin expansion was driven by strong project execution and favorable mix, and sequential improvement was supported by the completion of a handful of low-margin projects and progress against supply chain challenges, both items which we highlighted in our Q3 2023 earnings call. Full year gross profit of $171 million represented a 33% increase over full year 2022, a 105 basis point margin expansion. The results in the quarter and for the full year give us confidence that the path we have charted for a return to the historical gross profit margin of 33% is well within our reach. Moving to the right-hand side of the page, let's quickly cover adjusted EBITDA. In Q4 2023, CECO delivered a company record $19.4 million of EBITDA. This result is a 49% year-over-year improvement representing a 12.6% margin, a 140 basis point improvement over the prior quarter on higher volumes, and favorable mix. On a trailing 12-month basis, adjusted EBITDA was nearly $58 million, a 30% increase over the prior 12-month period for a margin of 10.6%, up approximately 60 basis points. Excluding a one-time benefit from an insurance settlement in Q1 2022, year-over-year margin expansion will be closer to 110 basis points for a second consecutive year. I am pleased by the margin expansion we have delivered in the quarter, the full year, and since 2021, as we are balancing our investments in growth, building our organization for the long run, and driving margin improvement simultaneously. We expect to continue to realize the benefits of earlier investments in our platform and functional resources, our operating model, and our supporting business systems which will enable continued growth and profitability improvements. I am also seeing the benefits from our Global Corporate Services teams and the acquisitions which we have completed and are expected to continue further margin expansion in 2024 and beyond. Let's head to Slide 14 now for a quick review of our cash position and liquidity. As a result of our extremely strong cash generation, after a slow start to the year, CECO finished Q4 2023 with $55.4 million in cash, an increase of $9 million from year-end 2022. This is after funding three acquisitions, increasing CapEx by $5 million, and incurring $7 million higher interest payment expense in the year. Cash from operations was up 51%, or $15 million year-over-year, and net borrowings were lower by $21 million from a year ago. For the full year, CECO deployed $60 million in growth capital for M&A and CapEx, $51.5 million and $8.4 million respectively, and still we ended the year with a net debt to EBITDA ratio of a very healthy 1.4 times, a figure well below our max allowable levels. Net debt on December 31 was approximately $78 million, which although was an increase of $20 million over year-end '22, we still have increased our liquidity and available investment capacity by over $42 million and we now sit with availability of capital of $116 million. Now please turn to Slide 15 and I'll briefly review capital deployment in the year. On the left-hand side of the page is a brief overview of the two acquisitions we closed in the first half of 2023, Wakefield Acoustics in the UK, and Transcend Solutions in Texas. The integration of both companies is well underway, with the prior management teams fully intact and fully engaged. We remain very bullish on the growth prospects for both businesses and we are already seeing strong evidence of their abilities to double in size in the next two-plus years. In fact, Wakefield will achieve this milestone in only the first year. Each company is a niche specialist with unique technical and applications differentiation that yields a strong margin profile and a defensible competitive position. After three plus quarters within CECO, both companies are already realizing the benefits of being part of a larger organization with greater resources and a global reach. In the fourth quarter, we completed the acquisition and initiated the build-out of a new production facility that will enable Wakefield Acoustics to double its capacity and capitalize on a new growth opportunity in the data center backup power segment. We identified this opportunity during our due diligence and it has materialized even faster than expected. The expected commercial synergies across our Peerless business and the Transcend acquisition are starting now to be realized as we are winning new opportunities across our full range of the gas and liquid separation portfolio. The investment in expanding the Transcend rental vessel fleet is proceeding with expected returns in 2024. Our most recent acquisition, Kemco Systems, a leading industrial water solutions provider to the food processing and industrial laundry end markets, closed in mid-August. The integration is moving along nicely and our early post-closing impressions are very positive and highly supportive of our investment thesis, and I look forward to sharing more about this acquisition in the coming quarters. Turning to a few highlights from CapEx spend for the year. In 2023, our spend was $8.4 million, which is elevated compared to prior years as we continue to make select investments in growth and productivity in the USA and Korea, to expand our India organization which has doubled in headcount in 2023, and in IT, primarily in cyber and data security infrastructure and ERP migrations. That concludes my summary of CECO's fourth quarter and full year 2023 financial results, a quarter and a year in which the company and our teams delivered a series of record-after-record results. Before I turn the microphone back over to Todd, let me reiterate how pleased I am with these results. We have delivered record-breaking orders, revenues, and profits in the year and still maintained our backlog at record levels. As we look forward, with a robust opportunity pipeline of approximately $3.5 billion and continued strong quotation activity, we feel very confident in the outlook for 2024 and for future growth. And now back over to Todd, who will take you through some additional commentary on our outlook and his concluding remarks.

Thanks, Peter. And a lot of good detail with respect to our financials and various insights into our performance. We're going to go to the final section and then our summary slide. Please turn to number 17. As we enter 2024 and now we've had a few months to really assess the current operating environment, I would say that many of the headwinds and tailwinds that we expected remain much the same. We have strong momentum from our acquisitions in many areas associated with industrial expansion. We remain bullish with respect to our growth prospects in high-growth markets, and our global pipeline is at an all-time high. Conversely, we continue to see more delays in customer project start-ups, but they do seem to be moving forward once their overall project is organized. We have been dealing with higher interest rates for over a year and of course, we all have been overcoming challenges in supply chains for several years. These challenges continue, but are less disruptive. We are monitoring various geopolitical items as well because those can have a variety of impacts. And finally, we are attracting incredible talent, but the labor market remains tough in certain areas. Now please turn to Slide number 18. We already walked through this slide, but we felt it was good just to reiterate our guidance for the full year. We are committed to double-digit sales growth and adjusted EBITDA growth of approximately 20%. We have good visibility into our current backlog and expect our sales pipeline will yield solid bookings growth in the year. Now let's quickly advance to Slide number 19. This is a little bit of a new analysis concerning our targeted margin goals. We felt it was important to outline our plans to achieve 15% adjusted EBITDA margins over the next few years. We start with the reference on the left side of the slide, that historically, CECO had sales of between $325 million to $350 million, and adjusted EBITDA margins of around 9%. We have grown to our current level of $545 million in revenue and 10.6% adjusted EBITDA margins in the most previous year. Over the next few years, we aim to grow sales to over $700 million and adjusted EBITDA margins of over 15%. As the margin walk demonstrates, we expect 150 basis points of margin expansion will be driven by gross margin expansion to between 33% and 34% or higher. This will be driven by better portfolio mix via organic and inorganic investments. Additionally, another 150 basis points is expected to be driven by our ongoing investments in lean deployment and supply chain excellence. We have a large opportunity across our enterprise in these areas. And finally, another 150 basis points of margin expansion is expected to come via strong G&A leverage. As we grow our top-line, we expect to simply expend fewer relative dollars in G&A. This conversion will add nice EBITDA margin expansion. We believe this balanced approach to driving higher margins is important and as our margins expand, we continue to execute on our growth strategy and we believe CECO will obtain a higher valuation which will further reward our shareholders. Now please turn to Slide 21 which is our summary slide. I would like to again thank our global teams for their commitment to customer-first. Our results have been outstanding and we are proud of our record growth in profitability. We remain committed to our strategic and accretive M&A program and we are pleased to share our raised guidance outlook. In summary, we have been and will continue to transform CECO. Our leadership positions in Industrial Air, Industrial Water, and the Energy Transition are very well positioned, and we are proud that our critical applications and solutions are protecting people, protecting the environment, and protecting our customers' investment in their industrial equipment. We're now happy to open it up for questions. So, with that, I'll hand it back over to the operator.

Thank you. We'll now begin the question-and-answer session. Our first question comes from Rob Brown with Lake Street Capital Markets. Your line is open.

Good morning, and congratulations on all the progress.

Thanks, Rob.

I just wanted to get a little bit into the business pipeline and what you're seeing there and what areas are sort of stronger or weaker and maybe some color on the order that shifted into this year.

I'll start. This is Todd, and that's a great question. We're fortunate that our portfolio is balanced. The trends we discussed earlier, particularly regarding the reshoring of industrial production, remain robust. Some industrial markets are thriving while others have stabilized. However, there's ample evidence in various public reports indicating that investment in manufacturing continues in North America, Europe, and beyond. Both Industrial Air and Industrial Water sectors are looking exceptionally strong. Additionally, our strategic investments in programmatic mergers and acquisitions have opened up numerous geographical opportunities for us, which is enhancing our expanding pipeline. This is an opportune moment to focus on the ongoing investments in areas such as natural gas and global oil and gas infrastructure, especially as energy investments begin transitioning to new gases and carbon capture technologies. There's a heightened emphasis on renewable energy, which connects back to industrial production since wind and solar energy heavily rely on industrial resources. We maintain confidence that these sectors remain strong, and we aren't observing any reduction in these essential programs.

Okay. Great. Thank you. And then you talked a little bit about Wakefield doubling since you bought it, and a big data center kind of that opportunity there. Maybe you could just give some more color on what that data center opportunity is and how you see that playing out?

For Wakefield, there is an opportunity in packaging backup power generators. We create custom acoustic enclosures along with the necessary control systems for these generator packages, which we supply to data centers in Ireland and the U.K., with new prospects opening up in mainland Europe. This business is expanding significantly, which is why we acquired a second facility. We're relocating Wakefield's core industrial products to a site close to the existing one, allowing us to dedicate a single location to the acoustic enclosures. Given the rising demand for AI computing, cloud services, and data storage, the data center market in Europe is experiencing robust growth.

Okay. Great. Thank you. I'll turn it over.

One moment for our next question. Our next question comes from Aaron Spychalla with Craig-Hallum Capital Group. Your line is open.

Yeah. Good morning. Thanks for taking the questions. First on margins, anything in particular driving the strong fourth quarter? I know you kind of talked about mix, and I appreciate the slide on the margin progression in the deck, but can you just talk about some of the confidence in those drivers, maybe where you're at with some of those programs on lean and supply chain excellence and just how you're thinking of the margin cadence for 2024?

I'll pass it over to Peter shortly, but I want to remind everyone that our fourth quarter margins, particularly at the gross margin level, are usually our strongest. This is partly due to the dynamics of projects wrapping up at the end of the year. As we finalize several programs, it enables our teams and processes to capture adjustments from throughout the year in the fourth quarter. This typically results in a slight increase. We see this as an opportunity to improve our processes going forward. Moreover, we are making significant strides in our operational efficiency. We're continuously working on small and medium initiatives to enhance our effectiveness. Conditions have stabilized somewhat, although supply chain challenges and geopolitical issues continue to affect shipping. However, their impact has lessened as we finished the year. We've noticed that material costs have started to stabilize, and our pricing remains robust. Therefore, we have strong visibility to our margins in the backlog as we enter 2024, which gives us confidence that we are on track for 100 to 150 basis points of expansion in both gross margins and EBITDA margins as we move into 2024.

And Aaron, we had some good delivery of aftermarket orders in the quarter, which have a higher gross margin than original equipment or project revenues. We also had a very strong quarter from our fluids business, that also has, relative to the portfolio, higher gross margin and the addition of Kemco. Kemco had a very solid fourth quarter. Kemco gross margins are well above company average. So, those three components, in addition to the execution items Todd mentioned, contributed. As we move through the year, our focus on driving recurring revenue and aftermarket and the benefits of acquisitions should provide an overall lift. But that fourth quarter true-up does exist within many of the projects that we operate. It's customer-driven as well as internally driven. Many customers want to accelerate close-outs at year-end and we resolve open issues with them which can have a beneficial impact.

Understood. Thanks for the color. And then maybe second just on the energy platform, can you, you talked a little bit about it, but can you expand on just the growth you're seeing there? What's driving that between kind of legacy and the energy transition? And maybe just touch on the pause on LNG exports. It sounds like that might push out some potential orders, but maybe the greater focus on emissions. Just talk about if that could help other areas of your business.

Energy has some cyclicality to it, with periods of rapid activity followed by slower times. LNG serves as an example of this trend, where investment remains strong, but there are fluctuations. Our focus is on diversifying and gaining more control over our future in the aftermarket sector. We recently secured our largest aftermarket order of $9 million, spanning two years, which we expect to yield around $4.5 million in revenue each year. This represents what we consider a long-term renewal of our aftermarket business. Additionally, the acquisition of Transcend enhances our consistent aftermarket offerings related to separation media. We are actively diversifying into areas like carbon capture and other emerging investments in energy infrastructure and solutions. Our teams are adeptly positioning themselves for ongoing trends within our energy businesses and even beyond traditional energy, such as providing separation and filtration solutions for naval destroyers and turbine propulsion. Moreover, there are emerging investment opportunities in nuclear energy that could positively affect our performance in 2024 and 2025. Our key focus remains on global diversification across end markets, reducing our dependence on just a few themes like we did in the past. We are seeing steady performance from legacy energy sectors, but our broader range of investments allows us to pursue new global themes that we believe hold significant growth potential.

Great. I appreciate that color. Thanks for taking the questions and congrats on the progress.

Thanks, Aaron.

One moment for our next question. Our next question comes from Bobby Brooks with Northland Capital Markets. Your line is open.

Good morning, everyone. Thank you for addressing my question. The growth in the pipeline has been a significant factor demonstrating the business's development. It has increased, with the $3.5 billion figure reflecting a $5 million rise from the third-quarter call. During a virtual fireside chat, Peter indicated that CECO's customers haven't yet benefited from the government stimulus programs like the CHIPS Act or the Investment in Infrastructure Act. Consequently, CECO has not experienced those advantages from the government stimulus so far. Am I correct in understanding that the $500 million increase in the pipeline over the quarter is partially due to those funds beginning to reach customers and projects moving through, or if not, what was the primary reason for that increase?

One factor contributing to additional opportunities entering the funnel is the release of funds, with both CHIPS Act programs being announced and money flowing, as well as developments in infrastructure. However, a significant portion of this activity is taking place internationally. We see strong opportunities in the Middle East, India, Southeast Asia, Korea, and China. Although China's economic slowdown has mainly impacted residential and consumer spending, industrial spending remains robust, prompting necessary investments in asset renewals, which we are currently benefiting from. Our DS21 business in Korea is experiencing exceptional order inquiries from both domestic and international customers, and U.S. investments in energy are beginning to pick up speed as the coal phase-out progresses more quickly than anticipated.

Got it. That's really good information. Regarding the Wakefield data center opportunity, my understanding is that it's primarily focused on selling to European markets.

It's only the European market, and in fact, it's only the U.K. and Ireland today. We have an opportunity and are working on expanding that into the areas around Paris, Frankfurt, Amsterdam, Madrid, and Milan.

There's a unique dynamic because the situation differs from the North America data center power, supply, and backup power, which can be better located in more rural areas, while in Europe, these are situated in urban centers. The noise mitigation has to be managed differently. As we see it, Wakefield is an excellent example of an acquisition where we believe that by investing capital and international resources, we can at least double their top-line revenue, if not more. We have demonstrated this in just one year of ownership of Wakefield. To remind everyone, out of the eight acquisitions we've made, nine since 2020, we anticipate that at least half of those will double their top-line revenue within 18 months of acquisition, if they haven't already. We are investing growth capital into these businesses, which are not focused on cost synergies, and not necessarily on growth synergies. While we do leverage growth synergies across our platforms to optimize resources, market access, global expansion, and customer relationships, we are identifying businesses that we believe have the potential for significant growth with the right investment. This is evident with Wakefield, which has previously been geographically limited, and we are now expanding its reach.

Got it. So, you wouldn't necessarily try to bring the Wakefield solutions to the North American data center market, because…

Bobby, if they call us, we'll be happy to, and if there is opportunities. But I would say, Peter's answer will be, because already anticipating it, we have a lot of opportunity in markets that we have a strong reputation and across all of Europe. And for right now, I think we have a really good and smart focus on that region.

Okay, I understand. That makes sense. I have one last question. You mentioned that the strong pipeline and backlog contributed to the increase in guidance, but the adjusted increase in sales guidance only slightly narrowed the adjusted EBITDA. This still suggests about 75 to 100 basis points of year-over-year margin improvement. Could you explain what led to the difference between the raised revenue outlook and the narrowed EBITDA outlook?

It's early in the year, and we appreciate the visibility we have. Our aim for the full year is to balance our investment strategies to support ongoing growth. I've often mentioned that I'm fortunate to be the CEO of an amazing global team committed to a strong culture. We are well-positioned in key areas that matter to our customers regarding air, water, and energy transitions. They consistently rely on us to safeguard their employees, the environment, and their capital investments. Ultimately, our focus is on maintaining solid growth while ensuring consistent margin expansion. We are optimistic about reaching our targets, and as we progress through the year, we'll continue to review these expectations.

Got it. Thanks for the color, Todd and Peter. I really appreciate it. I'll go back to the queue.

Thanks, Bobby.

Yeah. Appreciate it.

One moment for our next question. Our next question comes from Jim Ricchiuti with Needham and Company. Your line is open.

Hi. Thanks. Just relative to the outlook, the preliminary outlook you gave back in November, is this simply having a better line of sight, you're a little further into '24 or are there some areas of the business that maybe are trending a little stronger than you expected back in November? Just in terms of the outlook for '24?

We're now 90 days beyond our initial guidance and have gained more visibility, especially as we are two-thirds into the first quarter. We have a clearer view of our pipeline for 2024 than we did in November. Our execution at the end of the fourth quarter was strong, and we're not struggling to identify performance opportunities. We're committed to investing appropriately in growth, and no area of our business is lacking capital. We're implementing a solid plan focused on both revenue growth and operational excellence. We are just a few months into the year and feel encouraged by what we see, which gives us the confidence to slightly adjust our outlook even before releasing our first quarter results. Our goal remains to provide the investment community with our best assessment of balanced growth investments and the expected results from those investments, all while continuing to adhere to our operational strategies. Additionally, we are beginning to outline our pipeline for potential M&A this year, which, while not included in our guidance, is part of our thinking as we consider exciting opportunities. We believe that if we choose to pursue these investments with our balance sheet, they will yield positive results. While challenges persist, they are consistent with those we've managed over recent quarters.

I understand your recommendation to focus on the annual results, but you mentioned that in previous years, Q1 has shown some seasonal weakness and that a larger portion of revenue typically comes in the second half of the year. Is there any reason to believe that 2024 will not follow the same patterns we've observed in the past?

There are certain factors in the first quarter that are quite unique. There’s often a reset in various areas, particularly concerning cash flow, which makes it easier to anticipate free cash flow. This includes outflows for incentives and tax payments. Additionally, the start of the year tends to be a bit slower, particularly for customers returning from holidays in North America, Asia, and elsewhere. These significant holidays act as a restart for the year, leading to a temporary slowdown. However, we are pleased with the trajectory as we transition from the fourth quarter. We definitely see strong year-over-year opportunities that weren’t present last year. The first quarter presents some unique characteristics that are more structural than seasonal. Moreover, the fourth quarter orders, being one of the best in our company's history with $128 million in orders, were affected by the timing, pushing some of those orders into the first quarter. We believe we began the first quarter with a solid outlook for potentially strong bookings, and we're optimistic that there won't be further delays into the second quarter, which would enhance our visibility for performance in the second half of the year.

Got it. Final question for me is, and Peter, you may have alluded to this, but I wanted to just ask about the step-up in SG&A expense that we saw in Q4, but I thought I heard you talk about some leveling off of some of the G&A expense, I don't know if that's what you're referring to.

Yeah. G&A spend will level up. The big step-up in the fourth quarter was the acquired business.

Okay.

There were some organic investments, but they were modest and they're leveling up. It was the acquired business that drove a large portion of that increase.

Thank you. Congrats on the year.

Thank you.

One moment for our next question. Our next question comes from Bill Dezellem with Tieton Capital Management. Your line is open.

Thank you. I only have a couple of questions. The first one is, in your slide deck you referenced an improving macro environment. Would you talk in more detail to that? And then secondarily, share with us your perspective on your M&A pipeline and how you're envisioning pricing today versus what you've seen in the past.

The improving macro environment is mainly tied to developments in Europe, where the situation is getting better. European economies are facing much lower inflation and might be the first to see a rate cut. We're noticing a resurgence in demand in several markets that had been slower at the end of the previous year. In terms of macroeconomic conditions, the U.S. and Asia remain steady and strong. We have experienced a pause in our M&A pipeline. The fourth quarter was a deliberate pause for us as we were exploring opportunities, but we had nothing ready to close. We needed to focus on our integration with Kemco and work on improving our balance sheet, which we successfully accomplished. Now, we find ourselves in a strong position with increased liquidity and a moderate leverage of 1.4 times, allowing us to be prepared to deploy capital. We have started to ramp up our development of opportunities with ideas in the pipeline for the first quarter, and we anticipate that you will see the beginning of significant capital deployment in the second quarter.

And how about pricing? What are you seeing there relative to past levels?

Same or lower.

Thank you, and congratulations on a great quarter.

Thanks, Bill. We appreciate the ongoing support from all our investors. I wanted to add to the M&A discussion because it's important for our investors to understand. We have walked away from twice as many deals as we have completed. This is common practice; companies build pipelines, start analyzing opportunities, build relationships, and then realize that pricing expectations, cultural fit, or product categories may not align. There are various reasons companies assess deals and decide against them, and we have done this every year during our M&A activities. Regarding pricing, if the economic returns don't meet our standards or those of our shareholders, we won't proceed. So, if we are paying either a higher or lower multiple, it's because it's a good match for our portfolio.

Thank you. One moment for our next question. Our next question comes from Amit Dayal with H.C. Wainwright. Your line is open.

Hey. Good morning, guys. Just going back to the international revenue.

Hey, Amit.

Hey. Good morning. How much of 2024 outlook is going to be international revenues and is this going to be supportive to margins? Do you think you can get better pricing on offerings in those markets versus the U.S.?

International markets are projected to account for approximately a third to 40% of our business. Regarding margins, they are primarily influenced by the end market and the specific application. We achieve higher margins in challenging applications across all our brands, irrespective of the geographical opportunity. In the U.S., Asia, the Middle East, and Europe, we do not encounter a low-margin region or business segment. Instead, we have brands within our company that exhibit varying levels of leadership and competitive advantage, resulting in margins that may be under pressure or not. With that in mind, when we consider the international landscape, there are significant investments in industrialization happening in India, Southeast Asia, and the Middle East as these regions aim to diversify their economies. They prioritize best-in-class technologies and only consider alternatives when necessary. Best-in-class technology commands a global price, which serves as our initial benchmark. While this pricing strategy may not suit every customer, it applies to the majority of those we serve.

Understood. Thank you. And just one last one. With respect to the sales and backlog and pipeline, are you seeing synergies for the different product segments within the customers? Basically what I'm trying to ask is, like, now you have a broader offering or product portfolio, are you seeing the same customers buying more of your products versus previously?

Well, we don't consciously seek to cross-sell. We have organized our business in a way that ensures that we have end market and application focus. We may use select customer relationships in one business to open doors for another business, but we don't have an incentive built into our comp system or our management model to drive a cross-sell. And that's on purpose. Now there are certain and select customers that approach us and ask to do business with more than one brand or one business and we accommodate that and we support that completely. And we see that in very few but important end markets, one being semiconductor and another being automotive production, or automotive and component production, where across brands we see a need and we have had the opportunity to combine multiple brands in front of a customer, but we've not organized a sales force to do that and we've certainly not deployed a strategy to do that.

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

Thanks, Amit.

This concludes the Q&A portion of today's conference. I would now like to turn the conference back over to Todd Gleason for any closing remarks.

Yeah. Thanks for all the good questions. I appreciate everyone's interest and we went over today, so we're happy to always try to be available, which of course we'll continue to be as we go forward. Really pleased with our performance. Look forward to meeting and seeing a lot of you if you're at the upcoming TD Securities Conference as well as the Roth Conference, both of which are in California in the next handful of weeks. So, we hope that you reach out to your representatives and we have a chance to sit down and catch up. We look forward to speaking with everyone again when we release our first quarter results in May. So, with that, I'll just thank everybody for their time and their interest, and we look forward to speaking with you soon. Take care.

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