CECO Environmental Corp. (CECO) Q4 2012 Earnings Report, Transcript and Summary

A very good day to you ladies and gentlemen, and welcome to the Q4 2012 CECO Environmental Earnings Conference Call hosted by Benton Cook, Interim Chief Financial Officer. And my name is Gary, I'm your event coordinator today. [Operator Instructions] The conference is being recorded for audio replay purposes. I would like to hand over to Benton to begin. Over to you.

Thank you. Good morning, everyone. Thank you for joining us this morning. 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 and annual results. For the fourth quarter of 2012, net sales were $34.3 million as compared to $37.8 million in the same period of 2011. This year-over-year decrease was related to timing on projects, the process and schedule for project completion with conversion to the revenue in the period. Gross profit was relatively unchanged at $11.2 million, compared to $11.3 million. Gross margin increased to 32.7%, compared to 29.9% for the same quarter in 2011. Operating income increased to $4.4 million in 2012 as compared to $3.8 million in 2011, a 15.8% improvement. Operating margin increased to 12.8% from 10.1%. Net income was $3.1 million, compared to net income of $2.7 million, a 14.8% improvement. Income per diluted share was $0.18, compared to $0.17. Backlog as of December 31, 2012 was $59.5 million, compared to $54.9 million as of December 31, 2011. Bookings in the fourth quarter were $26.3 million, compared to $37.4 million in 2011. Additionally, projects that were in the quotation and award process were delayed from closing in Q4 of 2012. CECO has been seeing an increasing booking trends in Q1 of 2013. Cash and cash equivalents were $23 million as of December 31, 2012, compared to $12.7 million as of December 31, 2011, and we are continuing with no bank debt on our balance sheet as of December 31, 2012. On further note, for Q4, on December 31, 2012, CECO completed the acquisition of Adwest Technologies, Inc., a leader in the design and manufacture of regenerative thermal oxidizers. Adwest generated approximately $12 million in revenue in 2012, and their entire management team will continue in their role for CECO. Financial highlights for the year ended December 31, 2012 compared to the year ended December 31, 2011 include: net sales decreased by 2.9% to $35.1 million as compared to $39.2 million; gross profit increased by 11% to $42.4 million, compared to $38.2 million in 2011; gross margin increased to 31.4% from 27.4%, approximately 4 basis points; operating income increased to $16.7 million in 2012 as compared to $12.4 million in 2011, a 34.7% improvement; operating margin increased to 12.4% from 8.9%; net income was $8.9 million, compared to net income of $8.3 million; net income per diluted shares was $0.65, compared to $0.51; and year-to-date bookings were flat at around $39.7 million, compared to $39.8 million in 2011. On further note, subsequent to 2012's year end, on March 4, 2013, CECO announced the acquisition of Aarding Thermal Acoustics B.V., one of the world's world leaders in natural gas turbine exhaust systems and silencer applications. Headquartered in the Netherlands, they have a significant global sales footprint. Aarding generated revenues of approximately $34 million U.S. dollars in 2012. Aarding's excellent management team will continue in their leadership roles and will lead CECO's expanding global natural gas business. And now I'll turn the call over to our CEO, Jeff Lang.

Thank you, Ben. Good morning, everybody. Thank you for participating in the CECO Q4 and Full Year 2012 Earnings Call today. We appreciate your continuing interest in CECO Environmental Corporation. As you can see, CECO had a good -- another good quarter and excellent full year of profitability for our shareholders and employees. Our core organic business is very strong, coupled with the 2 recent strategic acquisitions. We are now moving into the $190 million to $200 million revenue range, which is pretty exciting for us. We are pleased with our position, and growth is a priority. 2012, we continued to focus on our core strategies of profitable growth, operational excellence, building a high reoccurring revenue model, acquisitions, global growth and margin expansion. And the CECO team, we believe, is heading in the right direction and are very motivated to continue growing and improving our business for our shareholders. Some comments about last year. We booked $139 million last year, similar to that number in 2011, but at the same time grew our profitability significantly. We see our current quotation activity very strong, and we also see Q1 coming in favorably with intake of orders and so we're pretty excited about this year. We're anticipating a solid organic growth year, coupled with the 2 acquisitions to drive continued earnings for our shareholders. Last year, we had $0.65 of EPS, compared to $0.51 the previous year. That's a 27% year-over-year increase of earnings growth, and the team's aspirations are to continue growing that this year. Now I'd like to comment on some of the businesses in 2012. Our parts business grew very well last year. They had a record year in revenue and operating margins, and we see that continuing. This is one of our core reoccurring revenue businesses that targets large, general industries domestically. Our traditional utility business, EFFOX, had a record year in growth and margin expansion, and their activity at this point in time is very strong. Thirdly, we continue to make very good progress in our global natural gas utility segment. Now that the Aarding and Flextor group is in place, we're optimally positioned for the exciting gas turbine growth going out around the world today and over the next couple of decades. I'm sure you've read the March 4 press release regarding Aarding and their wonderful technology and their position in the global natural gas sector. Fourthly, our Contract Services group last year had new highs in profitability, and we are finished with the Contract Services group transformation into becoming a high reoccurring revenue model at high margins. So we're pretty excited about the contract services business going into this year and the future. Our FKI Cyclone Technology business had a pretty solid year. Domestically, they had a very good year in Asia. They had a pretty solid year as well. Our refinery technology group, Buell, that services the global refinery market saw a little bit of a downturn in 2012, so we're working diligently to show additional growth in our refinery business -- our refinery cyclone business in 2013. Our China business is strong. We had year-over-year bookings increase, and we continue investing in sales talent and introducing new products into the China market for CECO. We're starting our eighth full year in China. It's been all-organic growth. And we continue to grow this business organically, and we have an excellent team in place. We just recently introduced the RTO technology into the China market, with sales in fabrication capacity, which was led by the Adwest Technology -- Adwest Technology acquisition in December. Strategically, CECO has diverse markets to sell into, which favorably balances our business model. Refineries, petrochemical, traditional utilities and now the growing natural gas utilities, metals, large industries and we're seeing a pickup in our high reoccurring revenues into the general industries. We see our business in the 35% -- going forward in the 35% to 40% reoccurring revenue and around 65% -- 60% to 65% in the Engineering Equipment side of our business. And we're not tied to one segment or one particular industry since it's a strategy to prepare us for a multitude of economic conditions that all businesses face today. Regarding 2012, I'd like to amplify 3 operating metrics and achievements that the team has been focusing on to help us win and we will continue to focus on to grow our business and improve our earnings for our shareholders. Number one is operating income. We had $16.7 million last year of operating income, compared to $12 million the previous year. So the team is very focused on improving operating income. Number two, gross profit. We had 31.4% of gross profit last year, compared to 27.4% the previous year. So we're very focused on improving our sales pricing and keeping our operating cost and cost of goods low. And finally, cash flow. We had $16.8 million in cash flow last year, compared to $8.7 million the previous year. So I want to thank the team for their meticulous focus on executing projects, working capital and improving cash flow for our shareholders. And I'm confident this will continue going into the future. I'd like to share a few orders we received in the last 3 or 4 months to give the audience a flavor of the intake of business we're seeing. Our Buell cyclone order -- our Buell cyclone division received a $2.5 million order for a Flint Hills refinery in the USA. The Buell cyclone division also received a $1 million order for Ecopetrol America located in Canada. A couple of months ago, we received an order from Honda out of Mexico for a regenerative thermal oxidizer for around $900,000. Caterpillar placed an order with us for around $700,000 to our Contract Services group in Tennessee. Duke Energy placed a $700,000 order with our utility group for a damper diverter for one of their power plants. Alstom India placed a $500,000 order with our natural gas group, Flextor, for an operation facility in India. Procter & Gamble placed a $500,000 order with our Contract Services group in the USA here. Burns & McDonnell placed a $400,000 order. And Babcock & Wilcox placed a $400,000 order with EFFOX, our utility group. And then [indiscernible] Power placed a $300,000 order with our natural gas power group for a facility in the USA. So there's a flavor of the kind of orders we're receiving globally and domestically and the type of blue chip customers we're receiving these orders from. Now I'd like to comment a little bit on M&A that CECO has been focused on. The team, the business and the board has been keenly focused on selective M&A for several years to enhance our technology and our portfolio domestically and globally and, of course, being accretive to our 30% gross margin standard and our 10% operating margin standard as a base. As previously mentioned, we have several M&A opportunities in various stages, and we're excited to communicate today that we closed on 2 excellent transactions in the last 60 days. Good news number one, we closed on Adwest Technologies located in California on December 31. Adwest is an excellent regenerative thermal oxidizer company with 30 years of experience. We're anticipating $50 million of revenue -- additional revenues to CECO this year as a result of that. And that's a perfect complementary fit to our business in North America and Asia. Good news number two, on February 28, we closed on Aarding, which -- based in the Netherlands, which is an outstanding technology provider of natural gas turbine exhaust systems and silencing systems in the $35 million revenue range. We've been working on this acquisition for one year, and the board and myself and the organization have been tied to due diligence, starting this business and getting a high comfort level. We have an outstanding and successful strategic global alliance with Aarding that has been in place for 3 years, so we're very comfortable with the Aarding acquisition. It's a great fit. It certainly bolsters our global growth trajectory because it's 100% global in business. And we view Aarding as a significant year-over-year EBITDA growth opportunity, fueled by the natural gas plants that are being added all around the world as we speak. All the players in the natural gas industry have a high regard for Aarding Technology. It fits our strategy. It's highly complex engineered business with a few competitors. It's accretive to CECO's gross profit, operating margins. And again, it helps our global model. And also, it fits our relatively asset-light facility model that we're going forward on, with 50% external manufacturing and 50% internal manufacturing. So it's an asset-light business. And Aarding has a great global subcontracting model all around the world. And lastly, Aarding is truly a global business, with sales coming from most all countries around the world that are adding natural gas utility into their power grid. The Aarding acquisition drives significant revenue synergies for CECO and expense energies to our current Flextor natural gas division, which we believe could double in size for the next few years and collectively, this enhances the accretion of the Aarding investment. As a footnote, although Aarding sales are global in nature, they're based in the Netherlands which has a 25% tax rate, which will help drive down CECO's total effective tax rate as a business. We also see the Adwest and the Aarding as an easy integration play for CECO. We've been working with Aarding for 3 years. We know each other quite well. We've already started some integration plans, but we don't see that as heavy lifting. In this process of these acquisitions, CECO currently has no debt after these acquisitions. Therefore, we have significant capacity for additional M&A opportunities to continue growing and acting on accretive opportunities that the board and management are focused on. And also, these acquisitions will give us a higher EBITDA base to help fund future financing and M&A opportunities that make good sense to CECO. And we are looking at other opportunities as we've stated over the past 3 years and also, to take advantage of the global and domestic fragmented air pollution control sector. As a second footnote, in 2013, given the Aarding transaction, we should be seeing a one-time M&A legal, auditing and banking expenses in the first quarter as a result of the acquisition. And we want to make sure you build that into your modeling. Regarding details of Aarding, which I'm sure you've read in the press release but I'll reinforce it, we paid $24 million in cash; we have $7 million in a 5-year earn-out, which is quite friendly to CECO; $7.8 million in stock, which is roughly 760,000 shares to the Aarding team; and we also have built in, and I applaud the Aarding team for this construct, and I also applaud the CECO team, we have a $5 million bank guarantee on a retention process for the management team. So there's a lot of protection and belt suspenders in this process over the next 5 years. And it's been a very smart purchase agreement, and I applaud the CECO team for putting this together. It was a 12-month process, and had met all of our CECO M&A criteria. Also, the natural gas and [indiscernible] utility business will balance our portfolio. We now have the Aarding and Flextor natural gas business, which will be quite strong and growing, and we now have our EFFOX traditional utility business. So we're well positioned to serve the global needs of the growing demand for power, which we see could be in the tune of 50% over the next 20 to 25 years. So we feel we're positioning the company very well for the future. Going forward and looking out 12 months, CECO has an addition -- CECO now has an additional $45 million to $50 million of favorable new revenues to bolt on to our business that has great technology, strong markets and accretive. And so we're very excited to get into that $200 million range of revenues as a business. As we've stated over the past few years, our short-term goal is to get into that $250 million revenue range and $1 EPS. And we want to do that through global growth, differentiated technology, building a high reoccurring revenue business, and at the same time, driving our PE multiple to enhance our shareholders. And that's our aspiration, and we hope to continue paying dividends. And as you see by our announcement, we just -- the board just approved a $0.05 dividend per share. So in closing, we are very excited about our outlook in our business model. We hope you gain confidence in our strategies and our team's ability to execute. So thank you, and I'd like to open it up for questions.

[Operator Instructions] We do have our first question from the line of Ajay of FBR Capital Markets.

So congratulations on getting the 2 deals done here in quick succession. You've added about 35% of the company. But on a pro forma basis, you still have very little debt if not no debt. And arguably, your capacity for acquisitions is higher now because of the EBITDA from these deals. So maybe talk from a capital allocation perspective. How should we be thinking about additional deals? It sounded like there's more in the pipeline. I mean, would there be any limiting factors? Meaning, would there be a lot of integration effort involved with these 2 deals that would take mind share? Or is it more of the availability in the right kind of deals for you?

I think the first short answer is, the integration of Aarding and Adwest, Ajay, should be relatively soft and easy. They complement our businesses, we've been working with them for a while. So I don't see that as a complex event. I think over the next 3 or 4 months, that integration will go quite smooth and favorably. Regarding future opportunities, as you know, Ajay, globally and domestically, the air pollution control technology sector is fragmented. It's probably hyper-fragmented compared to other industries, and there's a lot of opportunities out there. And we're looking at a handful. The board studies them quarterly or actually monthly. And we have -- as we've stated for 3 years, we have -- we always several in the queue that we're studying and going through due diligence side and would like consider going forward on. But we have pretty strict capitalization guidelines. We have pretty strict M&A requirements so that deals are accretive. They're good fit. They bolster our technology, but I think capitalization opportunities are pretty good for us. And typically, the 3:4:1 EBITDA to debt has been good rules of thumb that we follow. But I think there's a lot of opportunities for CECO in 2013 and 2014.

Good. And it sounds like you have a nice portfolio of products in the natural gas sector with Aarding and Adwest. So maybe talk about would be areas of interest for you. Is that building out further in natural gas? Or are there other end markets you should be looking at?

I think there's a few other markets. I think for 2013, I think our natural gas portfolio is in good shape. Our traditional utility business is in good shape. If there's a few items that we could bolt on to build out the systems in both of those, we will do that. And there's a couple of things we are looking at. As we've stated, there are some things we're looking at to continue growing our reoccurring revenue side of the business, the parts and the services, to get us into that 30%, 35%, 40% gross profit. And as you know, Ajay, one of our core strategy is to build a high reoccurring model to scale us through any type of economic cycle and outperform our peers. So but I'll also say there's other air pollution control type of businesses and product recovery type of businesses that we would like to add to our portfolio that exists. So there's a few more products -- and a few more -- and a couple of other companies that we're looking at.

Good. And then maybe on Aarding, if you can talk about the synergies with Flextor. Sounds like you have complementary product lines, and they are a very big international presence. So just color on what synergy should we expect here over time.

Yes. Quite a bit. It's a great fit. It passed all our tests. The number one, Aarding standalone is clearly accretive to our business, favorably accretive. Number two, the Flextor division that's been participating in the natural gas arena for 20 years has the ability to, in my view, at least double in size in the next few years as the Aarding engine pulls all this global business into CECO. So there's significant revenue synergies for Flextor, and that's part B of the equation. And there is some -- thirdly, there is some cost synergies in blending the Aarding, Flextor and EFFOX businesses together. But we purchased Aarding for a long-term growth engine, but there are additional revenue synergies and cost synergies. And fourthly, we have an excellent business model in China that I think could help accelerate Aarding's growth in the Pacific Rim.

Good. And maybe one more for me before I pass it on. So in the prepared remarks, I think you mentioned timing on projects that hurt fourth quarter sales. Maybe talk a little bit about that. I mean, any color on what project should we expect those revenues to show up in the first quarter? And it seems like gross margins come in very -- at high levels in the fourth quarter. What should be the expectation on the base business in 2013?

Well, number one, Ajay, our bookings are up nice -- I mean, our backlog is up nicely. We're $60 million today versus $55 million a year ago. And actually, it's greater than that if you look at some of the businesses we kind of deemphasized. So and secondarily, we had probably 4 or 5 projects that we thought we were in position to be awarded in Q4, both domestically and in China. And those orders that were still in good shape on will be left to us in Q1 or Q2. And actually, some of those -- a couple of those have already been awarded to us. So I see Q1 being strong from a bookings perspective. Our overall activity and RFQ metrics are strong. And as we've stated for several years, we want to be in the minimum of 10% to 15% year-over-year revenue growth both organically in terms of acquisition. So we're looking for a very solid organic growth here in 2013, maybe slightly above average.

And then gross margins on the base business?

Well, we certainly don't want to take any points off the board. So we're going to hold the line on gross profit from 2012, but we also think there's some upside. There's some upside synergies in pricing, there's some upside synergies in costing and cost of operations. So we don't want to dilute any of that. We hope we can improve on our gross profit. At the same time, we want to be very aggressive in bringing in business. So it's a fine line of balancing gross profit improvement and bringing in a lot of revenues. So I would say we will at least hold the line in 2013 maybe slightly above.

Our next question comes from the line of Rob Stone of Cowen.

So I wonder if you could comment. You said that there's only a handful of competitors in the natural gas space. Now that you have Aarding and Flextor combined, what do you think CECO's competitive position is relative to others?

Strong, global. I think when you put up a natural gas power plant, it's -- you're putting in complex, highly differentiated engineered equipment. And there's probably 3 or 4 players that the OEMs look to or the major EPC firms look to, to buy. You have to have a strong track record. You have to be able to meet page -- 20, 30 pages of specifications. So I think it would put us in the top 3 globally, and in the next 2 to 3 years, we'd like to see ourselves being the leader.

Okay. And you mentioned that the transaction was going to trigger some one-time expenses in Q1 could you or Benton, quantify that.

Good question. We're working on that, Rob. And we figured you -- all the questions we cover that. We haven't calculated the exact value, but it's coming in and we would like to report that in Q1. So -- but maybe in the next couple of weeks, we'll have a better answer, but we'll try and dimension that for you and some of the other research analysts in the next few weeks. But it will be a one-time event, and we are working on that.

So excluding the impact of one-time costs, your expense run rate went up a little bit in the fourth quarter and now you've added on 2 businesses. So how should we think about the run rate of operating expenses perhaps as we exit Q1 and things are normalized for the acquisitions?

Rob, we hit $25.4 million in total SG&A operating expense last year. And that was almost the same amount in 2011, around $25.4 million. We don't see -- we have added some sales engineering and some business development folks to drive revenues, but we think we can hold the line on that 18.8% of SG&A as a percent of sales and at the same time, the Adwest and Aarding organizations are similar or relatively similar to us. So we think we're going to be able to hold the line in SG&A as a percent of sales, given CECO's core business along with the 2 acquisitions.

Okay. Excellent. And finally, the Aarding corporate headquarters benefits your blended tax rate. Do you have a thought on what the range of effective tax rate might be for '13?

We've been working on that. I'm glad you brought that up. The team is doing a very good job on our effective tax rate. The last 2 years, we've been around 29% of effective tax rate. So that's pretty good. The previous 2 years, '09 and '10, we're in that 35% to 37%. So the team's very focused on that. I do think our forward tax rate should be equal to or better for several reasons: one, Aarding brings us 25% effective tax rate, and that's a big chunk of business. Two, we're expecting more revenues and income out of China, which is a 25% or less effective tax rate. And thirdly, the team has been zooming in meticulously on these research and development taxation credits that the U.S. government provides. We picked up some in '12, and we're rigorously working on picking up more in 2013. So I would just say the general direction of our effective tax rate should be equal to or better than we see today.

Okay. You mentioned China and that was actually going to be my final question. You said the China business is strong. If you have the figures handy, could you say how much China contributed to 2012 revenues overall?

Rob, I'd probably need to double check that. I know our bookings year-over-year in China were up. That was a positive. I do know some of the projects didn't get completed, so I'm not sure if it exceeded the income levels that we budgeted for. But at the same time, we think we're going to get roughly 10% of our earnings -- 10% of our revenues this year from China and that's typically at a much higher operating margin, which drives income and a lower tax rate. But we're pretty bullish on what we're going to pickup in China in 2013 and '14. But it was probably similar -- last year was probably similar to 2011 or maybe...

And the impact of the Chinese government, they've announced some plans to work harder on their air pollution problem overall. But beyond the announcement of those goals, do you see concrete action coming from the government to solve their air quality problems?

We've seen a slow and steady seriousness out of China to improve a lot of their plans. So yes, our activity for cyclones is up. Product recovery activity is up. We just launched RTOs a few -- a couple of months ago. We already have half a dozen serious regenerative thermal oxidizer activity, and our filtration business is on the upswing. So I would say the fundamentals for China are very good for our sector, and we're going to continue investing organically and potentially to some bolt ons to grow that. So the answer would be, yes.

Our next question comes from the line of Larry Schnurmacher of Morgan Stanley.

Maybe there's a simpler way to ask some of these other questions. The 2 new acquisitions, do you have a sense, an idea, a target of how they're going to add to earnings per share this year?

Larry, we've been studying that. We think it's going be positive. We don't give guidance. But if you were -- both of those businesses are accretive to our metrics. So if you look at our gross profit or operating margin or SG&A, those acquisitions are accretive and more specifically, the Aarding because that's the bigger of the 2. So if you model it with some decent growth, 7.5%, 10% or 15%, and you add in the core metric set of data point in your accretion modeling, you'll -- you should come up with something pretty solid. But we don't give guidance. But we acquired the business because it is accretive and it's going to add to our EPS.

And the next question comes from the line of Steve Shaw of Sidoti.

Hey, Jeff, can you provide any color on what kind of free cash flow the 2 acquisitions provide?

Probably should be pretty consistent with our current cash flow rates. We haven't published that, but it's very cash flow friendly. It's probably equal to or accretive to what CECO has been generating for cash flow. But we haven't published that, Steve.

[Operator Instructions] And we have no further questions at this time.

Thank you for joining the CECO earnings call. We appreciate that. Take care.

Thank you very much, ladies and gentlemen. That now concludes your conference call for today. You may now disconnect. Thank you very much.