CECO Environmental Corp.

Good morning and welcome to the SECO Environmental Third Quarter 2020 Earnings Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Matt Eckel, Chief Financial Officer of SECO Environmental. Please go ahead. Thank you for joining us on the SECO Environmental third quarter 2020 conference call. On the call today is Todd Gleason, Chief Executive Officer, and myself, Matt Eckel, Chief Financial Officer. Before we begin, I'd like to note that we have provided a slide presentation to help guide our discussion. The call will be webcast along with our earnings presentation on our website at cecoenvironment.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 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, 2019. 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 reconcile 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 turn the call over to Todd.

Thanks, Matt, and good morning. We appreciate you joining us today. As we navigate through the COVID pandemic, we continue to focus on the health and safety of our employees, customers, and communities. We hope all of you are safe and healthy as well. Let's get into the materials. Please turn to slide three. It has been a busy and informative time for me since I joined SECO in early July. I've had the opportunity to engage with many of our employees and external constituents. Here are some observations and updates on what I see as someone still relatively new to SECO, asking a lot of questions and evaluating the opportunities. We will delve into the financials and markets in more detail in a minute, but like many companies, we have seen a dramatic pause from the COVID-related market impact. We are regularly monitoring customer and market information. We would acknowledge that certain markets would still have been challenging this year regardless of the pandemic, such as oil and gas refining. But overall, we estimate over 80% of our orders decline is attributable to customers slowing down capital spending and pausing various projects because of COVID. It reminds many of us of the financial crisis in 2008 and 2009, or the sudden impact from events like 9-11. We remain confident that as markets steadily recover, we are in very good position to rebound too. I've highlighted a few market comments on the slide, but we will touch on these a little later in the materials. I continue to be energized by the tremendous talent at SECO. Our employees are focused and engaged and want to drive success for our customers. At the core of our strength is the 300 plus engineers and application specialists, which comprise approximately 40% of our workforce. Our engineering team is the heart and minds of SECO. They have a passion for solving our customers' emissions and water issues, and their expertise is at the core of SECO's value internally. In short, they are solution providers. We will continue to leverage this core advantage as we drive growth and new markets and partnerships. The bottom section of the slide points to some new or heightened areas of focus that we have been driving and introducing since my arrival. There was a solid foundation in place for many of these items, so my job, in many cases, is to help prioritize and push for results. We must and we will make more progress driving recurring revenue. We are putting new metrics in place to evaluate our recurring revenue streams and working to build new capabilities and incentives to drive results. And, like most companies, we continue to advance our operational excellence programs to drive productivity and streamline processes. And finally, We have done some good work with adjacent markets, but not enough. We can utilize our leadership position to build new relationships and revenue streams. We will continue to apply new processes and resources to drive new growth. It's time that SECO steps up our game on providing more leadership and detail around environmental, social, and governance, or ESG programs. I frequently joke with our staff that we are like an honor roll student that hasn't shown up to take the test. ESG starts with disclosure and broadens with leadership action. We have a great story to tell. We just need to start telling it. In essence, we're going to show up for the test. I have assembled a talented cross-functional leadership team to drive our ESG initiative. More to come on this later, too. And we have a robust strategy and business transformation program underway. SECO has many opportunities for sustainable growth and market expansion. both organically and inorganically. We will have a detailed strategy and execution plan to follow as a result of our recently kicked off work. Let's keep moving. Please turn to slide number four. On the top section, we provide a summary of our financial results. Orders were approximately $67 million, which was down 40% year over year. Customers in oil and gas refining and other energy sectors continue to delay spending. Sales of $77 million was down 9%. Both order and sales reflect the reality of the markets and timing of projects and are not at the levels we strive to deliver. Gross margins were 32% and EBITDA came in around $7 million. Finally, adjusted earnings per share was 11 cents and free cash flow was $6 million. Our trailing 12-month free cash flow is up $2 million compared to the preceding 12-month periods. Despite the challenging operating environment, our SECO team continues to execute very well, and I want to thank them for their efforts to focus on health and safety while delivering for our customers. The middle section of the slide highlights key market commentary. We have a diversified portfolio with a view of many industrial markets. Discussions with our customers and channel partners, as well as our levels of proposals, bids, and general market trends provides many insights. We would suggest that refining is at or near the worst thought of its experience in my business lifetime. Our products in this category aren't discretionary, so as these customers begin to ramp up production or even address various maintenance and repair programs, we believe we will see a strong rebound here. We are already starting to see more studies and engineering assessments, so perhaps we are on the front end of the steady climb from the bottom. Time will tell. Midstream oil and gas has also been largely halted as a result of the energy slowdown. We are starting to see more project bids and believe this market will continue to show pockets of recovery as well. In industrial air, we saw very encouraging signs in the quarter. Our orders were up 60% versus the previous quarter and up double digits versus the third quarter of 2019. No doubt markets will remain choppy and uncertain in the near term. But we are starting to see good growth in various markets and expect trends to continue to improve. As we position for 2021 and beyond, the focus remains on execution, cost management, and of course starting to drive the initiatives I have discussed on the previous slide. Now please turn to slide number five, which provides detail on orders by market. On the left side of this slide, you can see the market and orders numbers associated with our energy segment products and solutions. And on the right side, you will see the industrial and fluid handling figures. I won't read all the numbers by sub-market, but instead make some high-level comments. Sequel orders and refining market were down 85% year-over-year. Our team has served this market for decades and has rarely to never seen this level of drop-off in the market. We believe this market has bottomed out and are starting to see higher levels of engineering studies and RFQs. Simply put, our products are not discretionary in this space and this end market will steadily rise. Midstream and power generation also witnessed double-digit declines. Some of the reasons for year-over-year declines are the result of delays in capital spending, but some are also related to the very difficult comparable to third quarter 2019, which saw extremely high project bookings. and in our industrial solutions and fluid handling segments, we saw some mixed results year over year, but very good sequential growth. We believe those markets continue to improve. Let's turn to slide six to look at additional market commentary. This is a new slide for our earnings report. Let me hit some highlights. On the left side, we have listed our long cycle business exposure. These are energy markets that typically go into backlog and turn to revenue over a nine to 18 month timeframe. and on the right side are shorter cycle markets that are at least 50% faster to convert from order to full revenue. Starting with some highlights on the long cycle markets. Refinery, we believe, as we've said, is at the bottom. We are well positioned for recovery as our FCC cyclones are mission critical. This market has deferred maintenance given the slowdown in demand and capital constraints and will rebound. Midstream oil and gas has had a surplus of supply for some time, and as we expected, this market was going to be slower heading into 2020. CECO continues to do a nice job offsetting the slower midstream market by expanding new products and new market penetration and water separation, and also U.S. naval contracts. Power generation in natural gas has stabilized, and electricity demand continues to rise. We believe the COVID pandemic delayed this market recovery given the market had been in decline for several years. We are well positioned with leading solutions in noise attenuation and NOx emissions. On the shorter cycle side, our industrial solutions comprise leading air quality solutions to combat pollution to ensure equipment runs efficiently while protecting the environment. We continue to see improvement in sequential orders. In fluid handling or pumps and filters, There continues to be a mixture of recovery and delay. We have focused on improving quality and delivery and will start to increase our investment and growth as we believe our solutions will be in demand. Finally, in PowerGen solid fuel, we have a large install base that we will continue to serve with replacement systems. This market is the only one in secular decline, but our Apex Major JV is well positioned to serve the large market and is a small percent of our revenues. Thanks for your time letting me go through this material. I will now hand it over to Matt, who will give more detail on our financial results. Thanks, Todd.

I'll start with slide eight and orders. At $67 million of orders, we are disappointed at the levels, but understand the market situation we are facing is choppy. There were several bright spots as industrial markets started gaining momentum in September. Activity in semiconductor, wood manufacturing, automotive all provided a 40% sequential lift for industrials. and our fluid handling business, primarily driven by pumps, was on par with its peers, growing 8% sequentially. Energy, on the other hand, was relatively flat sequentially and averaging just $40 million in orders per quarter. Refinery markets have been hit the hardest with just over $10 million of bookings in the last six months. To put that in perspective, year-to-date orders are down 32 million or 63% year-over-year. Our Emtrol-Buehl branded FCC cyclones serve this market and as both the large integrated and independents continue to preserve CapEx, this business has been struggling. What is certain is that our customers are deferring maintenance CapEx that they will have to circle back to resolve in the near future. We've weathered this cycle in 2017 and our conviction of a market snapback is high. To the right, revenue is up 3% sequentially and did not progress as we had anticipated. Customers continue to delay engineering and site commissioning work as they battle a resurgence As a reminder, greater than 80% of our revenue is recognized on a percentage of completion basis. As customers and suppliers slow down, so does the execution of our backlog. Progress, especially in Europe, the Middle East, and India, have stalled, weighing on the progression of our large oily water separation project. The end user and EPC are resolving scheduling differences, keeping this project from moving faster. Similar situations are occurring domestically, where our industrial services business is at less than 50% of its pre-COVID levels due to restrictions on customer site access. Moving to slide nine, our backlog is at 189 million, which is down 8% sequentially and 20% year-over-year. Unfortunately, in the quarter, we did de-book two U.S. projects. One of these orders was put on hold beyond 12 months, and another has been canceled. Both projects were relayed to manufacturers that support the aerospace industry, which is extremely hard hit from the COVID pandemic. We remain in great relations with these customers and expect to be re-awarded when this market returns. Neither project has progressed, thus there were no revenue or costs associated with these cancellations. As the operating team here navigates this push-pull period of COVID, I'm very much pleased with their execution. Despite the ever-changing customer schedules and scope, we are maintaining our margins and cash flows through purposeful execution. Moving on to slide 10 and our key profitability measures. Our gross margins were at 32% in the quarter, which is down two points sequentially and year-over-year, primarily due to project mix. As suggested last quarter, a few higher margin projects have come to completion and replaced with larger jobs with margins below our SECO average, putting pressure on our margin rates. One of those jobs being the large double-digit Middle Eastern project previously mentioned. As you can expect, in the areas we can control, we are pruning costs in our plants and driving productivity to offset the project mix. Hitting on non-GAAP operating income and adjusted EBITDA, both measures were down sequentially and year-over-year driven by volume and margin. I'm pleased with the proactiveness with which we've taken out costs in response to this downturn. As of the end of Q3, we've executed on all of the $10 million annualized cost savings target communicated in Q2. To put this in perspective, Since the beginning of the year, we've executed on a furlough, cut wages, shuttered three facilities, exited a lost business, and eliminated 20% of our global workforce. As an asset-light company that prides itself on being people deep, we don't take these actions lightly. These have been aggressive cuts, and it's been a tough year. However, our focus has to be on cash preservation while maintaining our market share through the next 12 months. As a final point, our actions over the last three years to simplify SECO By reducing ERPs and legal entities, consolidating business units, and investing in technology and process has made us nimbler and enabled us to make these cost cuts faster. Had we not made the investment in prior years, we would be in a much different position. We continue our simplification journey, and just this past quarter, we've closed two more entities and another ERP, further reducing our SG&A footprint. A special thanks to our IT leadership team and the arting management team for overcoming an ERP implementation during the middle of a pandemic. As we start our 2021 AOP planning process, we have already built contingency plans to right-size the company further if markets don't recover. And the automation activities we've invested in today will serve us well tomorrow. To say the least, this team is prepared. Now on to slide 11, which summarizes several of the metrics already discussed. Instead of reading the page, I'll briefly point out three highlights. First, with revenue down 9% and EBITDA down 13%, our decremental EBITDA margins were strong at 14% year-over-year. Despite lower volume and gross margin, our SG&A cost reductions preserved EBITDA at 9.4%. Non-GAAP SG&A was $18 million in the quarter and down $3 million from Q1 of 2020 when we began our cost-cutting efforts. We are laser focused on costs through this COVID period with already greater than $10 million in annualized savings achieved. Second, GAAP earnings per share was a loss of one penny and down six cents year-over-year on approximately $3 million of expenses associated with M&A integration, executive transition, and severance-related expenses. On a non-GAAP basis, EPS was a positive 11 cents and down one cent year-over-year on volume and project mix offset by SG&A and interest expense. Final point, regarding tax, we still anticipate a 25% non-GAAP tax rate for total year 2020. Pushing on to slide 12, Wharton Capital is down sequentially to $41 million on a very positive quarter for AR collections. Our project RIP has grown, but primarily on our large Middle Eastern project that has back-end loaded milestones. We are executing this project well and look forward to its progression in the coming quarters. Due to the strong air activity, free cash flow bounced back in Q3, generating $6 million in the quarter. On a TTM basis, free cash flow is 15.1, which is up $2.9 million from the previous trailing 12 months. Cash flow is a paramount to the SECO business model, and I'm pleased to see our TTM as a percentage of EBITDA at 46%, with aspirations to exceed 65%. Concluding on slide 13, our balance sheet is healthy, and we are prepared to weather this pandemic. We paid down $2 million of debt in the quarter, and our bank-defined leverage ratio is a comfortable 1.8 turns. And our net leverage remains sub-one with ample capacity. Keeping it crisp and to the point, I'll turn it back to Todd.