CECO Environmental Corp. (CECO) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 CECO Environmental Earnings Conference Call. My name is Janeida, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Benton Cook, CFO. Please proceed.

Good morning, everyone. Also joining us on the call this morning will be our Chairman, Phil DeZwirek; and our CEO, Jeff Lang. 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 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 vary materially from those expressed or implied by the forward-looking statements. We encourage you to read the risks described in our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2011. 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 you may hear today, whether as a result of new information, future events or otherwise. Before I turn the call over to Jeff, I want to make a few brief comments on the quarterly results. As you can see from our earnings release, our operational results both on a quarter-to-quarter and a year-over-year basis continue to be favorable. And now a brief review of a few key results for the quarter and 6 months. For the second quarter of 2012, net sales were $34.6 million as compared to $32.5 million in the same period of 2011, a 6% increase. Gross profit increased by 21% to $10.5 million compared to $8.7 million in 2011. Gross margin increased to 30.3% compared to 26.8% for the same quarter in 2011. Operating income increased to $4.3 million in 2012 as compared to $2.8 million in 2011, a 54% improvement. Operating margin increased to 12.4% from 8.6%. Net income was $2.5 million compared to net income of $2 million. Net income per diluted share was $0.15 compared to $0.12. Bookings increased by 22% to $40.9 million compared to $33.5 million in the same quarter of 2011. Cash and cash equivalents remain strong at $19.8 million compared to $12.7 million as of the end of the year, December 31, 2011, and we are remaining with 0 bank debt on our books -- on our balance sheet. And backlog as of June 30, 2012, was $58.9 million compared to $54.9 million as of December 31, 2011 and $52.6 million as of June 30, 2011. Financial highlights for the 6 months ended June 30, 2012 compared to the 6 months ended June 30, 2011 include: net sales decreased by 1% to $67.6 million as compared to $68.5 million; gross profit increased by 20% to $20.7 million compared to $17.2 million in 2011; gross margin increased to 30.6% from 25.1%; operating income increased to $8 million in 2012 as compared to $5.3 million in 2011, a 51% improvement; operating margin increased to 11.8% from 7.7%; net income was $4.5 million compared to net income of 32 -- $3.2 million; net income per diluted share was $0.27 compared to $0.20; and year-to-date bookings have increased by 7% to $71.6 million compared to $66.8 million in 2011. And now I'll turn the call over to our CEO, Jeff Lang.

Thank you, Ben. Good morning, everybody. Thank you for joining the CECO call today. As you can see, CECO had another good quarter. Our sales and operations continue to improve and we achieved our internal income -- gross profit, operating income goals for the quarter. We are focused -- we're extremely focused on improving our domestic and global bookings and revenues while staying within the new gross profit and margin targets we set at CECO a few years ago. In context of the quarter, I would like to highlight a couple of things that are exciting for us. Of particular importance, our gross margin exceeded 30%. I think that could be first time in a while. Our operating margin grew to almost 12% and I think it was 8% the year before. So we continued to improve our cash flow quarter-over-quarter. And we're real pleased that we delivered $0.15 EPS versus $0.12 last year, which is a 25% improvement. So the team's doing a good job. Incoming bookings, cash flow, operating income all showed sequential, significant positive trends in Q2 and we're pretty excited about the second half. It is important to note that our sales management focus and much of our product mix changes and our operating model changes is delivering favorable results for CECO and our shareholders. Our bookings reached -- bookings at almost $41 million for the quarter, that was one of our strongest quarters in many years, and I'm pleased to say the momentum is continuing into Q3 with some very nice sales wins in the U.S. and globally. Strategically, we made good progress diversifying CECO's products and technology across global markets and across numerous sectors. Refining, mining, utility, natural gas, petrochemical, steel and automotive and some of the largest plants in the world are our key end markets. So the team is doing a good job diversifying across these markets, and we're becoming less impacted by regulations, which has been our strategy. Some comments about our divisions. CECO China had a good Q2. As you know, we were a little slow in Q1, so Q2 bookings and projects picked up significantly in the air pollution control and product recovery markets there in China. We're very pleased about that with the bookings pickup. Some of the -- sorry? We continue to invest in China. This is our seventh full year in China. We're introducing new products into China this year. We've added several new sales engineers, and so we're in a good place right now. So we're looking for some strong organic growth coming out of China. And also, we recently upgraded and recruited a very strong general manager to run our CECO China business. So we're very excited about that. Our contract engineering services business, Kirk & Blum, continues to perform well and transform into a higher gross profit business and a higher operating model. So we're very excited about that team. Their operating income has probably tripled in the last few years, though we're seeing a little flatness in the revenues, but we're very pleased with the performance of our Kirk & Blum contract services group. Our global cyclone, which is principally the Fisher-Klosterman Buell division, is doing well. They're seeing significant upgrades and expansions domestically and globally, which is driving their RFQ activity right now. So that's in a very good place. What's driving that is the petrochemical, chemical, mining and some of the consumer product plant sectors that are expanding in North America. Our utility business, which is Effox-Flextor, the damper diverter expansion joint business of CECO, is having an excellent year, and what's driving that is the larger, stronger proactive utility plants are gearing up for the new U.S. regulations. And so the Effox-Flextor group is doing very well this year, showing excellent growth and excellent profitability. We're very pleased with that -- how that business is performing. Our component parts group, which is principally our parts and ducting and more of a reoccurring revenue division, is on pace for another good year, showing good growth, and we're pretty excited about that business. That business services the mid- to large general industries in the USA. And CECO's uniquely focused on building our reoccurring revenue business across the company, and it starts with that component parts and ducting business' growth. Our sales engineers continue to pursue attractive opportunities to enhance gross margin while creating end-user value and end-user solutions. And though we said this a few times, product differentiation, our great technology and creating competitive advantage is driving end-market customer solutions, and our goal is simply to bring in high-quality bookings year-over-year. CECO is executing on our objectives. We're very focused on our 5 objectives: profitable growth, domestically and globally; operational excellence in all our core processes; acquisitions; and developing our talent. We're starting our second year on our high-performance, general management business growth development program. So CECO is doing a very good job developing their general managers to grow our business. And I'd like to complement our HR community for leading that for us. They're doing a great job. And five, building an aftermarket parts and reoccurring revenue model. So with that, I'd like to comment on some of the significant orders we received in Q2. We probably received half a dozen or so major utility orders in Q2 totaling $12 million to $13 million. Most of those for the U.S.A., some of those for China and one for Saudi Arabia. And those orders were brought in from major, major industry customers. We received several large engineered ventilation system orders, over $1 million each, into the steel and aluminum sector and received several nice engineered ventilation systems into the large automotive plants that are expanding here in North America. We're seeing that trend taking place. We received several -- probably 4 or 5 significant cyclone orders for China, totaling $2 million to $2.5 million. Those were for chemical, polysilicon refinery plants that are expanding in China, and our activity in China is quite good. We sold a regenerative thermal oxidizer for an alternative fuels plant in the USA and, again, we hit the $41 million in bookings and that was pretty exciting for us, and we see that trend continuing. One of the attractive aspects of these bookings is they're in a diverse group of customer base. The automotive, we're seeing aluminum plants expand to -- which is being used more in the automotive manufacturing of cars. Refineries doing okay, chemical and consumer good products are expanding, and we're seeing some nice activity in the polysilicon plants, alternative fuels and gasification. So we're pretty pleased with our activity right now. It's actually up probably 10% or 15% compared to Q1. In summary, we're also excited CECO was recently included in the Russell 2000 index, which reflects our positive performance and continuing moving CECO to the forefront. Our aspirations are to continue paying dividends to our shareholders. And in Q2, we repurchased 62,000 shares of stock at roughly $450,000. With regard to our announced share buyback program that we initiated in 2011, we purchased a total of 154,000 shares of the 500,000 potential. We're executing on our commitments that we stated to you several years ago. Our aspiration is to become the clear global leader within the air pollution control technology sector and to continue to deliver significant earnings to our shareholders. I think CECO is positioned very well for the global and domestic markets and to see some excellent operating leverage going forward. All in all, it was a good quarter and the first half was rock solid, and we're very -- I'm very pleased with the CECO management team executing on our business plans. So with that, I'd be very happy to open up for any calls you may have.

[Operator Instructions] Your first question comes from the line of Michael Lew with Needham.

You mentioned bookings momentum has carried into this quarter. Do you expect the 3Q bookings to increase at the same 20%-plus pace as in the second quarter?

We'd like to think that. We typically don't give guidance on that, but the variables that we're looking at right now is our quotation activity is probably up 10% or 15% from Q1, so we're seeing some nice quotation activity across most all of our businesses. So we're confident in our outlook.

Okay. And you also had about 1/3 of the bookings this quarter driven by larger deals in the U.S, China and Saudi Arabia. Do you have similar types of large deals that you expect to book in the third quarter?

We do. We do. We are seeing some nice bookings coming in that are large in nature, so yes. We also studied our China activity last week quite well, and we're showing -- our China activity is much stronger today than it was 2 quarters ago and we're seeing -- we have 4 or 5 very large jobs, the multi-million dollar jobs which we typically haven't seen in the past couple of years. So we're feeling pretty confident about the quotation activity, Michael.

Okay. And can you also talk about the overall pipeline? How much is that up year-on-year? And like, can you put a number on it?

Regarding the backlog or regarding...

The pipeline, not the quotation, but the overall business you're pursuing right now. Like how much of it that's out there that you could win, let's say.

Well, those are interesting metrics and they're moving targets. It goes by division. If you're close rate is 25% or 30%, you're doing quite well in this global economy. So we probably can't give you an absolute number, but we will say we've made a lot of improvements in our sales engineers and our sales management. We have a great team out in the field, so our close rate regarding the pipeline should be equal to or better than our competitors.

And that number is 25%, is what you're -- currently.

That's a rough number. We probably could work on that a little bit, but that's a ballpark number, Mike.

Oh, okay. Yes, just the last question. The gross margins have been over 30% in 2012 and you also reached the 12% op margin level this quarter. Do you feel you can hold that to that level for the remainder of the year? And can we expect sales growth in the September quarter?

No. That's our aspiration. We probably over-performed in the first half with gross profit and operating -- as you know, we've stated some significant growth in gross profit over the past few years. Last year, it was 27%. This year, we've already hit 30%. So we're very focused on gross profit and operating margin, so it wouldn't surprise me if we continue improving that. However, I must say our primary focus in the organization is to show significant revenue growth. So we're very focused on growing RFQ activity. We're very focused on growing our bookings activity and translating that into revenue in the second half. So I'd say growing revenue -- growing good quality revenues right now is our top priority.

Your next question comes from the line of Dale Pfau with Cantor Fitzgerald.

Your bookings are up nicely year-over-year and your margins, in particular. Have you turned away business, some of the lower-quality business that you used to accept? And is this a function of your proposal activity? Or are you now catching a wave that finally some of these markets are waking up, particularly if we look at the industrial and the automotive in China? Could you just talk about that a little bit?

So I think the team is performing very well. From a sales management perspective, from a business growth, the team is performing well, Dale. Regarding your first point, we evaluate all RFQs rigorously, meticulously. And if we can bring in a job at a moderate to low gross profit and the team feels, through the execution of the project management stage, we can outperform and raise the gross profit, we'll go ahead and take it. That's our first order of business. We don't want to turn away business. But if -- some jobs are quite low and it may not make sense for our shareholders to do that.

Okay. When we look into the second half, with your stronger backlog, should we expect revenue growth over the first half and over the second half of last year?

I mean, Dale, that would be our aspirations. We typically don't give specific guidance regarding that. Maybe in a couple of years when we become much larger, we can -- have a little more scale, we can give guidance on a quarterly basis. But the things that we're looking at is our backlog from a year ago is up 12%. That's an important metric for us. Our bookings are up 7%-plus from a year ago. That's an important metric that drives revenues. And our quotation activity is up 10% to 15%. So those are 3 discrete variables we look at that have a positive impact on revenues in the second half and going into the first half of next year. So we're feeling pretty confident in the outlook.

Okay. And then sort of some just kind of housekeeping metrics. Could you give us a breakdown between parts, equipment and services in the quarter?

Yes, it's -- for the first half, it's pretty consistent. Our total parts business is probably in the 25% neighborhood; engineered equipment, 55%; and then our contract services, 20%. That's probably a reasonable mix and should firm up through the second half.

And then could you give me your top industries for both revenues and backlog?

Utilities, power sector, petrochemical, chemical, automotive and aluminum would be the first 4 or 5 out the gate.

And that's for both revenues and backlog.

Yes.

Okay. On the utility, as some of these utilities -- and there are some I know that are proceeding and there appear to be several who are not. Is that additional business that you could capture as we move forward in time? And how long do you think this stretches out? It's difficult for some of us to gauge how many people are doing in advance, how many people are going to get delayed, how many people are going to get exceptions and how many years this sort of upgrade is going to take.

Well, we're pretty optimistic about our utility business and we're pretty confident about this year and we're pretty confident about next year. At the same time, we're -- that's the coal-fired utility business domestically and that's the Effox-Flextor team, which does a great job. The other piece of that is, we're investing significantly in our natural-gas-powered sector. We're expanding that organically and potentially inorganically. We've added some excellent business development, sales talent to drive that. So as we shift into next year, we're going to see some nice natural gas turbine business for CECO. We've actually received a couple of very nice orders for natural gas turbine downstream applications in the last couple of months. So we continue to grow our natural gas turbine business activity. And our aspirations are for that piece of our business to become the same size as our coal-fired utility business in the next couple of years. So natural gas and coal-fired power, we're going to see some nice business today and for the next few years.

And this utility business, could you give me sort of a rough idea how much -- what percentage of revenues could that be over the next 6 to 12 months?

In total for utilities combined, it could become 1/3 of our business.

So that's sizable.

In the next couple of years, the 2 utility sectors, coal and natural gas, could reach 1/3.

And where is it now?

Probably 20%.

And one final question. It's nice to see automotive popping back up into the mix here. And are these plant expansions, are they reopening some of the plants that had been closed? And I know you had some significant market share. Are you retrofitting any of your own equipment out there?

Dale, all of the above. We're seeing activity in China. We're also seeing a ton of activity in North America. There's renovations, there's expansions, there's upgrades and there's restarts. We've had some plants that were mothballed and now they're being reopened. So the North American automotive sector is growing, and we're taking advantage of that. We're a part of that. We're also seeing a lot of business in aluminum. Aluminum plants expand because they're now becoming the material for making cars. So we're seeing a nice pickup in the metals, the aluminum side of the fence.

Your next question comes from the line of Ajay Kejriwal with FBR Capital Markets.

So good performance on gross margins, and we've had a couple of quarters here above 30%. Nice job there. But it sounded like in the second half, you're looking to grow revenues, which is a good thing. But then based on the backlog that you have, I mean, do you expect gross margins to be still in the 30% range? Or is there any other way we should be thinking about that?

We've been very focused on margin expansion and gross profit improvement for a few years now, Ajay, as you know. Our objectives are not to erode gross profit in whatever we do. So we are very focused on building our backlog and growing revenues. That's very important. However, we're not going to do that at the same time we erode gross profit. So our aspirations are to hold that firm and continue growing that into 2013.

Good. And then on China, so it sounds like you had a nice increase in the quotation activity, but maybe just any color on -- is that a function of the work that you're doing on the ground in terms of increasing your presence? Or are you seeing a pickup in the market there because all of the data points and the headlines are of a slowdown? So I wonder, all the good work that you're doing in terms of the feet on the ground, is that helping? Or are you seeing any pickup in the level of economic activity there?

Ajay, all of the above. First off, the air pollution control initiatives taking place in China are helping us. A lot of our products are in the product recovery piece. But we're moving towards our eighth year in China. We've been adding sales engineering capacity and getting the CECO brand name out there and the Fisher-Klosterman brand name and the EFFOX brand name out there and the CECO Filters brand names out there. So we've been doing a lot of blocking and tackling for the past 7 years that's having a positive impact, and we're seeing an uptick in the chemical, petrochemical, utility sector, refineries. And we're getting into some nice applications as well that we haven't been into in the past few years. We've had a nice MTO order for a couple of million dollars, of methane to olefin, in a refinery application; received a nice EFFOX damper order into the utility sector with several more to come in the next 6 months to 12 months. So I think all of the things are starting to line up for China for us.

Good. And then maybe one more for me on the cash balance. It's a nice buildup and it's a nice problem to have -- see the cash balance building up. But any thoughts on how we should think about acquisitions versus share repurchases and any comments on the acquisition pipeline?

Yes. First off, the team, the board and myself are very focused on M&A. We focus on it every day. We have numerous targets in the queue that we study, and CECO does have acquisition criteria to make sure we make good, smart, prudent acquisitions. So yes, there's quite a bit in the pipeline. We'd like to see some of those move into the formal LOI stage. That's our aspiration. And we're very focused on M&A. And as we said, a lot of -- our growth will be 10% to 15% a year and part of that will be part of acquisition, as well as good organic growth. So, Ajay, we're quite focused on M&A.

Your next question comes from the line of Rob Stone with Cowen and Company.

I'm wondering if you could comment on operating expenses and operating leverage. A lot of focus on improving execution within the organization over the last couple of years. How should we think about the run rate of expenses in the second half? And do you need to, in turn, start growing expenses again as you target faster top line growth?

Yes. Good question. As you know, for the past 2 or 3 years, we've been meticulously focused on our operating cost and our operating model and SG&A. The past few years, the team has done a very good job leaning that out. We're in that 17% to 18% range as a percent of sales, which is pretty solid. If you benchmark our peer groups, I think you'll find that to be we're outperforming our peer groups. A little deeper into your question, Rob, we think we can maintain the absolute number this year that we had last year. And I think you saw a little bit uptick -- a little uptick in the first half because we front-end-loaded our accruals this year, whereas last year, we back-end-loaded our accruals. So you're going to see the SG&A and operating cost normalize as we finish up the year. But the third piece of your question is we have invested in additional sales engineers domestically and globally. We have beefed up our sales management focus to drive sales, but at the same time we found a few other areas to streamline the organization to offset that. So we see -- aspirationally, we like to say we can stay flat to last year with SG&A and operating cost. But as we turn the corner in 2013, to your point, we may have to continue making investments to grow the business further.

A question regarding the tax rate. It came in a little bit higher than we were modeling. How should we think about that on a full year basis? If you see the nice uptick in China business, would that help you on the tax rate in the second half?

Yes. And that's why the tax rate is up to 39%. We'd like to see the tax rate much lower, in that 34% and 35% range. So I think with the uptick in bookings in Q2 and Q3 in China, that will shake out into revenue and operating income in the second half, which will drive the Asian mix higher to the U.S. mix and bring down the effective tax rate. So that's exactly what we're hoping will happen, Rob.

In terms of cash flow and cash management, I also noticed that your accounts receivable day sales outstanding, at least by my calculation, are the best they've been in quite a few quarters, below 50 days. Is that something related to peculiar timing this quarter? Or do you think you can keep it that tight going forward?

Thanks, Rob. Good observation. Six, 8 months ago, we launched a working capital initiative across the organization, and the general managers and the leadership team had been very focused on improving our working capital. So AR DSO has improved significantly. Working capital has improved. And as you can see, the cash flow from Q2 this year versus our cash flow last year, it's grown significantly. So there has been some working capital initiatives that we're working on, and it's starting to pay off. So I do think there's a little more room for improvement in the AR side and the DSO side and the DPO side. And so we're going to see some continued improvement in that area into the second half, but thanks for noticing that.

And any comment on -- you talked about the buybacks and potential M&A. How much do you need to spend on the maintenance CapEx and so forth for your factories this year?

Good question. We consolidated our manufacturing footprint the last few years, so we're in good shape. And when we consolidated, we utilized some of the CapEx from one facility that we closed into the current facilities that are performing at a much higher level. So we see CapEx remaining flat this year and next for your modeling purposes. So we don't see an uptick in that. And regarding M&A, we'll be using cash, debt and equity, all 3 of those, to acquire good, smart acquisitions.

Okay. My final question speaks to a couple of your aspirations for increasing contribution from both international and parts and service as a percent of total revenue. Any comments there?

Say that again, Rob. I'm sorry, it was breaking up.

You had in the past, I think, talked about continuing to grow the contribution by international business towards maybe 30% from around 25%, and growing parts and service in a similar fashion. Any update or color you could make on that?

Yes. Those continue to remain part of our core strategy. We're very focused on growing our aftermarket business and our component parts and ducting business, which is doing quite well. We've added some additional sales capacity to do that. We've also added sales capacity globally to beef up our global sales both in Asia and in India. So we continue to make changes and upgrades and investments there. So over the mid-term, as we move into that $200-million and $250-million range, it's imperative we get to, at least, 1/3 or 40% of our revenues to come from global to offset any cyclicality in our business, which we're moving away from quite well. So those are aspirations, and those remain part of the management focus, Rob.

[Operator Instructions] Your next question comes from the line of Joe Firth with Firth Associates.

One question. You've got a really good story to tell. What are you doing in the Investor Relations area to try to get your story out to more people?

Well, we've had some great research companies that are writing on CECO and we're doing -- we have planned non-deal road shows planned for the next few months to get out in front of investors and tell the CECO story. And of course, we were just brought into the Russell 2000. We think that will be an enabler as well, but there's a few things we're doing, Joe, to boost that.

And at this time, I am showing we have no further questions. I would now like to turn the call back over to Mr. Jeff Lang for any closing remarks.

Thank you very much for joining the CECO call, and we look forward to talking with you in the future.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.