Good morning, and welcome to the CECO Environmental Corp. Second Quarter 2019 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Matt Eckl, CFO. Please go ahead..

Thank you for joining us on the CECO Environmental Second Quarter 2019 Conference Call. On the call today is Dennis Sadlowski, Chief Executive Officer; and myself, Matt Eckl, Chief Financial Officer. Before we begin, I'd like to note that we provide a presentation to help guide our discussion.

The call will be webcast along with our earnings presentation on our website at cecoenviro.com. The presentation material 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 facts 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 on Form 10-K for the year ended December 31, 2018.

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've reconciled the comparable GAAP and non-GAAP numbers in today's press release as well as the supplemental tables in the back of the slide deck. And with that, I'll pass the ball to Dennis. .

increasing operating efficiency and cost savings with reduced emissions to the environment. China has been a good market for CECO, and we're following nearly a dozen additional methanol production facilities being planned for construction over the next 3 years. When they move forward, we'll be ready to exploit CECO's strong technology leadership.

Finally and before moving on, I want to mention an important Q2 win that we announced in a recent media release. The order is for equipment to treat seepage water at a major crude oil storage facility in the Middle East.

In short, CECO will manage the engineering, design and delivery of a treatment system to separate sludge from oil production water by removing contaminants such as oil, solids and harmful chemicals so that it can safely be injected back where it originally came from or discharged to a surface water body.

I want to thank David Barker and Paneer Sudarhothi [ph] for their commercial and technical leadership in closing this win for CECO Environmental against strong competitors.

Beyond the terrific and determined work of the CECO team, this win was only achievable because of our experience in similar applications, ability to integrate critical technologies into customer-specific solutions and reputation for end-to-end execution. Next, let's turn to Slide 7, which covers our end market outlook.

I'll give you the bottom line upfront. Our end markets are large, diversified and currently generally healthy and growing. I want to reemphasize that CECO is a key and growing contributor to low-carbon economy that encompasses our served end markets. And we're helped by 3 undeniable trends that are driving our end markets.

One, customers need clean, safe and cost-effective solutions. Two, natural gas is growing as a complementary enabler of intermittent renewables. And three, industrial expansion is expected to have sustainable clean air solutions.

I want to begin this morning in the lower right of the pie chart with fluid handling and then, as in the past, move counterclockwise. I chose to start with industrial fluid handling because this promising sector had a disappointing quarter after having been solid for the past 2 years.

On the one hand, we remain optimistic that fluid handling end markets will continue to grow, and we remain well positioned with our targeted niche offering in this segment. On the other hand, we're disappointed in the orders in Q2.

We are making the necessary investments to recommit ourselves to serving customers and remove production constraints so that this segment can once again be a driver of growth and cash flow for CECO. And moving counterclockwise, Industrial Solutions is next.

This segment serves the air quality improvement needs across a range of production environments. We had a breakout first quarter, with orders returning to their historical range during Q2. We like what we're seeing and hearing in this market, and our project pipeline remains very positive.

Outside the U.S., our new sales adds are seeing solid demand for air quality improvement products and expect to build on our small base. This sector tends to be a bit lumpy even in a growth period, so trajectory of orders is not always a straight line, but I still feel good about the outlook.

Next, at the top of the pie, the refinery segment outlook continues active and steady, and our team continues to maintain the market-leading position for FCC Cyclones. Moving on, our team in the midstream oil and gas market segment had a strong second quarter.

The previously mentioned seepage water treatment win is included in the bookings comparables and contributed to the strong Q2 orders. The midstream oil and gas market offers us good prospects in the areas of gas pipeline, LNG, process water and gas separation. Continuing along to our largest market segment, gas power gen.

Green shoots continue to push through the surface, albeit at a bit more slowly than what we would prefer. Coming from a low point, the market trend is positive and, I'm sure, will show successes as new orders are committed.

And finally, at the bottom of the pie chart, our team continues to focus on successfully supporting the installed base of the coal power gen market with damper upgrades even as 6 gigawatts are planned to be retired this year in the U.S. alone. Our exposure to this market is less than 4%.

So in sum, our served end markets are large and generally healthy. We're working very hard to achieve our target of 2x the market for growth, and I remain confident that we have the team in place to deliver. And with that, I'll turn things over to Matt. Matt, take it away..

marketing, product innovation and sales, and are already paying dividends that can be exemplified in our orders growth.

A few examples of our marketing investments are the increased brand awareness and digital content that can be evidenced in our CECO website, targeted marketing campaigns, our significantly improved search engine results and increased media output. We have a great deal of activity in product innovation.

We've added fresh legs to our product development teams, including a chief technology officer, director of product development for Industrial Solutions, a VP of engineering for fluid handling; and bolstered our China, Dubai and India design engineering hubs. We've generated hundreds of new ideas to serve our customers better.

And over a dozen of those ideas, we've committed R&D dollars to explore and develop. In sales, we've added market-based sales managers, added territory sales managers across the U.S. heartland where a preponderance of our volume comes from and relocated 2 of our all-star sales leaders to China and India to help grow those platforms for CECO.

This reinvestment is part of our 4-3-3 operating strategy, so we can keep pace with our competition and even get ahead of market trends and customers' needs. Turning to Slide 12. Our detailed financials reflect the dampened revenue from the second quarter.

I've already touched on most of these metrics, but there's a few areas I'd like to add some color. First, GAAP operating income was down 23% or $600,000 from the second quarter of 2018 through a combination of project mix, higher investment spend and restructuring costs in China.

Second, GAAP diluted earnings per share was $0.15 and more than doubled from a year ago. The primary driver for the increase was due to a $4.4 million favorable tax benefit associated with the 2018 divestiture of Zhongli.

I want to commend our Tax Director, Mike Murphy, for his exceptional work applying a great tax treatment to an already complex divestiture to yield an exceptional result. That's over $4 million of cash in CECO's pocket next year after we file the return.

Slide 13 shows that as we anticipate, our cash flow rebounded in the second quarter but still not to the best of our abilities. While a positive source at $1.7 million in cash flow, the results were modest, and we know we have more to do in this area.

On the left, our trade working capital shows a $4 million sequential improvement over the last quarter. While we remedied our AR in the quarter, our project WIP grew. On the right, we generated $1.7 million of free cash flow in the quarter.

More specifically, cash flow from operations was up $2.5 million but offset by CapEx spend in our pumps [ph] ] facility and on ERP projects, totaling $800,000 in the quarter.

At a 28% conversion rate in Q2 and negative 7% on a TTM basis, we will be making a big push on project billing and WIP in the second half of this year to achieve our cash flow expectations.

Next up is Slide 14, which highlights the work we've done to substantially reduce our debt since the Peerless acquisition and the strengthening of our balance sheet. I'm pleased to announce that as of June 11, we closed on our new credit agreement that rebalances our term and revolver debt to provide greater flexibility for the future.

I thought I'd share a few highlights under the new agreement. The new facility provides for $190 million of available credit at attractive terms for CECO.

Specifically, the agreement reduces our interest margin by 50 bps, extends our term to 2024, increases our revolver capacity, removes many restrictive covenants and provides for several flexible features for future M&A.

In addition, the facility adds new global banking partners, HSBC and BMO, and reduces the red tape in responding to our customers' complex international bonding requirements. The new deal exemplifies our 4-3-3 operating strategy because it increases the speed at which we can serve customers and it simplifies CECO's treasury management.

I personally want to thank our syndicate lending partners and specifically our lead agent, Bank of America, for their support and collaboration throughout the process to get this deal done. Wrapping up my comments today, I'll turn to Slide 15, which addresses our 2021 financial targets.

As Dennis opened, we remain committed and on track to achieve these targets. While the sluggish second quarter revenue puts pressure on Q2, our execution, backlog and investments keep us on track to exceed our 2021 financial targets that deliver top-tier shareholder returns.

Starting in the upper-left hand quadrant, our goal is to organically outgrow our markets 2 times over time. Driven by our outside-in leadership, we continue to decisively outgrow our markets in orders. TTM revenue is also outperforming and above the targeted green zone despite the dampened Q2 results.

This metric demonstrates that our investments are taking shape and we're taking market share and aggressively implementing our 4-3-3 operating strategy. Moving to the right. Our EBITDA rate is largely driven by revenue and the operating leverage achieved on growth.

With revenue down sequentially, our EBITDA dipped to 7%, but our TTM remains at 9.4% and up 2 points versus the prior period. With our solid backlog and healthy markets, I remain convinced in our ability to achieve our 2021 targets. Next is return on tangible capital, which continues to be a testament to our asset-light operating model.

We improved sequentially and are up 20 points year-over-year to a healthy 44%. The ongoing progress gives me real confidence because our teams are staying laser focused on delivering cash earnings on a low asset base. Finally, on the lower left-hand side is our free cash flow conversion rate, which rebounded this past quarter.

But at a negative 7% on a TTM basis, we must do better. While the second half push will be focused on project WIP, our long-term challenge is consistently executing on this key metric. The key to achieving consistency for CECO is project management visibility from contract through completion.

Our simplification efforts are a big part of such consistency. I'm pleased we've eliminated 6 ERPs and converged our many processes. But we have a ways to go towards a streamlined, scalable system that manages the project life cycle from terms negotiation to design and production through working capital administration.

To wrap up, I'm really pleased with the organization's execution, the financial foundation that we've built to achieve growth and excited about the markets we serve. We're on track to meet our 2021 targets and to keep on growing. With that, I'll turn it back over to Dennis..

Thanks, Matt, and well done. Before opening up the call to your questions, I want to turn to Slide 16 and wrap up our remarks with some thoughts on our market position. The execution of our 4-3-3 operating strategy is well underway and has placed CECO Environmental in an ideal position to take advantage of growing end markets.

We continue to demonstrate accelerating market success and are becoming the go-to resource for our customers as they entrust us on challenging service and mission-critical projects.

Our competitive edge is derived at the intersection of superior product technology, deep application understanding for end-to-end solutions and our talented team of responsive professionals. This team loves to compete and win in the market. Our end markets remain strong and are growing.

Looking to the horizon, we are more likely to experience a tailwind. And please keep in mind, the longer-term catalyst of our market is the developing low-carbon economy, which has created a social and regulatory imperative for customers to seek sustainable, clean, safe and efficient solutions.

Internally, guided by our 4-3-3 operating strategy, we continue to root out and eliminate complexity. We've become a much more streamlined, interconnected and efficient organization. Legal entities, ERPs and bank accounts have been significantly reduced, and the cash required for working capital has decreased.

In short, we're much more agile and capable of executing with speed and accuracy. Externally, we've become much more outside in-oriented and market responsive, and we recognize the challenge of doing that in a dynamic marketplace. This means that we must target staying ahead of our customers' requirements.

We're addressing that through our 4-3-3 operating strategy by making innovation a priority. I'm pleased with the steady progress to that end as we see more focus on the connectedness of our products and solutions via digital technologies in the so-called Internet of Things.

We've also reduced and refinanced our debt with a new $190 million credit facility agreement that provides substantial financial capacity and flexibility to support our growth aspirations. As you know, we've placed a premium on organic growth, and that's not changing.

And we are now much better prepared to seize high-value opportunities that can compound our progress through targeted M&A. I previously mentioned that we have a more stringent strategic process that aligns any such actions.

Acquisitions have to be a direct complement toward both our mission, our value proposition and enhance the long-term financial targets. These are exciting times for CECO. And that's why I'm confident that we remain right on track to achieve our 2021 targets for top-tier shareholder returns.

As Matt discussed, the track to top-tier returns involves aggressive metrics. We know what must be done, and our entire team is highly motivated to produce results. We have our sights set on the 2021 targets, not as the finish line but as a milestone for continually improving the organization. Now I'd like to open up the call to your questions.

Operator?.

[Operator Instructions] And our first question comes from Chris Van Horn of B. Riley FBR. Please go ahead..

Good morning. Thanks for taking my call..

Hi, Chris, good morning..

Hi, Chris..

So on the 33% gross margins, it looks like despite lower revenue, you've been able to hold those up. It sounds like we -- aftermarket mix was part of the driver but also some of your operational controls.

Is that a good run rate to think about as we head through 2019 and into 2020 just given that you have been able to operationally withstand some of this revenue headwind?.

It is. 2018 was 33%. Q1 was 33%. Q2 was 33%. And we try to stay in the range of 32% to 34%. We'd like to push that higher over time, but that is a good range..

Okay. Got it.

And then if I think about the backlog, do you see it generally as some higher-margin work relative to historical averages?.

We see a mixed bag. So obviously, aftermarket is higher content. Nat gas power gen does have its pricing pressure. But on the average, that's why we say a range of 32% to 34%..

Okay. Got it. And then just on the project delays, it sounds like it's mainly due to timing.

But I'm just curious, is there any change in scope, any change in dollar amounts and maybe any more specifics on what's driving those delays?.

Yes. That's a great question. The delays, no major change in the scope. If so, those would oftentimes warrant a change order, which would benefit us, of course. As far as those delays go, they are mostly timing really tied to site commissioning delays.

If you have a large balance of plant, sometimes we're a smaller piece of that, which will push something out. And when they slow production, we slow production. And then on top of that, it could also be engineering design changes, some things that they need to work around that maybe has to do with geography or logistics..

And Chris, if I can add, the reality is it's just a handful of projects that contributed to the delays. And we did have 1 or 2 of them with some design changes and the like that moved both the time line contractually but also some things we got change orders for in the process. So that's kind of typical normally in some of the larger projects.

But in this case, the fact is that it also pushed the time lines out on the customers' end..

Okay. It makes sense. Thanks for the time. I’ll jump in the queue..

Thanks, Chris..

Our next question comes from Amit Dayal of H.C. Wainwright. Please go ahead..

Good morning, guys. Thank you for taking my questions.

In -- with respect to the sequential drop in the Energy Solutions segment, is this due to exposure to 1 or 2 customers? Or is this generally across the board for that segment?.

Yes. Thanks, Amit, and thanks for joining us. What you're referring to, I'm sure, is that the revenue declined there, and it was the energy segment where a number of the customer delays contributed to revenue shortfall even as backlog has been growing and building once again. That's one of the things I just mentioned to Chris' question as well.

It is a small handful of projects. In a couple of cases, I think there are areas where the industry is tight with people. And so if the customer and/or other related products are falling off the pace, it can delay our overall execution and revenue recognition. But we're keeping up. Our customer metrics look to be improving on time and the like.

So unfortunately, this just moves the backlog a little further out and extends that into the future..

Understood.

And then with respect to the backlog, can you provide some sense of the time line to recognize this backlog as revenues?.

Yes. So as Dennis said, about a handful of jobs totaling around $5 million to $6 million that flowed out of Q2, and those will be parsed out over the second half and 2020. And that's when we expect to recognize the revenue over the next 3 quarters..

And for the aggregate, our -- we have -- like to think about the business in the aggregate in short cycle, the fluid handling segment, which means bookings to revenue in a 30-day-ish cycle. The industrial segment is a little more mid-cycle, so 3 to 9 months on average, although again, that can range from very quick to a little longer.

And in the energy segment, in the 9 to 15 months to full revenue recognition. As I think you're aware, with our POC revenue recognition, in some cases, we can get revenue beginning immediately, but it's smoothened out until the end of the project..

Yes. That was what I was actually looking for. Really appreciate it.

And exposure to China in relation to this backlog, any other metrics? I mean how are we positioned there with these recent headlines related to tariffs, et cetera? Is there some level of risk in meeting some of these metrics, et cetera?.

Well, I think it's a good question because as you saw, we chose to highlight one of our key wins today from China. And China has been an important market for CECO.

We've been solidly entrenched for the last 15 years and have the teams executed fairly well in the context of what's happening in the local market and as well what's -- in the context of what's happening in kind of U.S.-China trade relations.

Having said that, most of our business in China is made in China for China, a lot of it engineered as well locally and what we do with support from our technical hubs in the key product areas. And so we're somewhat -- have a look of a Chinese company when we're in China. So we haven't seen much impact from any of what's gone on to date.

Yesterday's noise and news around currency also directly wouldn't have a huge exposure for us because we have limited import to the U.S. from China at this point. But you can't say for sure where that uncertainty might take us. In the big picture, market's developing.

China is committed to improving air quality, and that is the reason we're still very constructive on China overall..

Appreciate that.

And Matt, maybe for you, are there any other GAAP benefits expected over the next few quarters?.

Could you restate the question? When you say GAAP, I didn't....

You've got the tax benefit to your net income this quarter.

Anything like that coming into play over the next few quarters?.

No. From a tax perspective, we've actually suggested for people to go ahead and model in a 25% effective tax rate for the next few quarters. That's where we think we'll end up for the full year on a normalized basis.

We know that on a pretty regular basis, our tax rate can be somewhat lumpy because of the pretax income size, as well as outstanding items with those divestitures, acquisitions, earnouts or, in this case, this quarter, this post-divestiture action that yielded a nice benefit. So for modeling purposes, we always suggest people model in 25% right now..

That’s all I have. Thank you so much..

Thanks, Amit..

Thanks, Amit..

[Operator Instructions] And our next question will come from Gerry Sweeney of Roth Capital. Please go ahead..

Hey, good morning Dennis and Matt..

Good morning, Dennis..

Good morning, Dennis..

Just wanted to dig a little - dig in a little bit on the order side. Obviously, they're increasing, and they've been doing quite well especially in this most recent quarter. But midstream was up about $20 million quarter-over-quarter, and industrial was down, but they certainly had a breakout quarter in Q1.

How much visibility do you have into these orders or these pipelines? Are you -- is this a little bit more onetime? Or is this truly breakout? Should we see some more consistent growth? Just trying to figure this out a little bit. It's a little bit lumpy from end market to end market over the last couple of quarters..

Yes. Well, my optimism in outlook stems from -- directly from our sales pipeline that, throughout the year, has been improving even despite uncertainty that's creeping into the market. It's not kind of the same across all product segments, all reporting segments, but we have seen a steadily improving pipeline throughout the year.

And those projects then tend to gestate at their own rate. And with that, I mentioned power gen probably 4 or 5 months ago with green shoots that we're seeing in the market. We've seen then some awards go to the big OEM players, to GE, Siemens, Mitsubishi.

And as those work their way through, many of them have not been awarded in terms of the emissions control, the noise management, a solution set that we do have not yet been awarded. And we think if those work their way through the market, there'll be some good activity.

There is pressure developing in the fluid handling segment, where our Mefiag product line is largely geared towards filtration for plating. And a lot of the plating has been investment towards automotive, and the automotive investment cycle is maybe coming down from a hill.

But other than that, we still see a number of favorable conditions that we think we can execute into..

Got it.

And then I know your longer-term target is, I think, to grow 2x the market, right? But as you make CECO more nimble given some of the friction in the business, how much of the growth are we seeing today as maybe market growth versus CECO being better positioned to capture more sales? Is this that you're growing with the market, and then there's more upside from creating less friction? Or just any thoughts on that front?.

It's very difficult to measure the market in terms of a specific quarter.

But the indications that we have are in many of our key segments that our hit rate and our execution of having people in the right place, having added people into new territories, India, China, Europe as well as in the key energy segments is that we absolutely are improving our hit rate and improving the number of views that we get into the market.

And so while it's always a little bit lumpy, as we've mentioned before, on the project side of the business, I do think that, that execution, it's one of the things that I think the team is getting right. The value selling that the team is doing is helping us maintain good margins across a broad mix of the portfolio.

And those are some of the things then that we're using to invest in new product development that's beginning to also take shape as well for the future..

So to summarize, market growth, but your investments in -- on sales, marketing, et cetera, you're starting to see improved hit rates across the board?.

Yes. And I think that that's the case. The market is still growing but modestly. As you look at our outlook chart, all of that refers to what we think we see in the context of our outlook, how our sales pipeline is developing and modest improvement and growth. And armed with that, we are still executing into that to try and outgrow the market..

Great. Thank you very much. I appreciate it..

Yeah. Thanks, Gerry..

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

Okay. Well, thank you all again for joining us. Despite dampened revenue in the quarter, I think the team is executing to keep us on track to a strong future. I look forward to our next update in about 90 days or so. So good day, all..

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