CECO Environmental Corp.

Benton L. Cook - Interim Chief Financial Officer and Corporate Controller Jeffrey Lang - Chief Executive Officer, President and Director

Ajay Kejriwal - FBR Capital Markets & Co., Research Division Peter J. Skibitski - Drexel Hamilton, LLC, Research Division Sean K.F.

Hannan - Needham & Company, LLC, Research Division

Good morning, everyone. Joining us on the call this morning will be our Chairman, Jason 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, 2012. 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.

Today's presentation will also include references to certain non-GAAP financial measures. We have reconciled the comparable GAAP and non-GAAP numbers in today's press release.

Before I turn the call over to Jeff, I would like to comment on a few key financial results. For the second quarter of 2013, net sales increased by 28.3% to $44.4 million compared to $34.6 million in the same period of 2012.

Gross profit increased by 36.2% to $14.3 million compared to $10.5 million in 2012. Gross margin, as a percentage of sales, increased to 32.2%, compared to 30.3% for the same quarter of 2012.

Operating income decreased to $3.3 million in 2013 compared to $4.3 million in 2012. Non-GAAP operating income adjusted for transaction-related costs, including legal, accounting, banking, retention payments, earn-out expenses and amortization of intangibles related to recent acquisitions increased to $6.2 million compared to $4.4 million or 40.9% improvement.

Operating margin decreased to 7.4% from 12.4%. Non-GAAP operating margin, adjusted as noted, increased to 13.9% compared to 12.4%.

Net income increased to $3 million in 2013 compared to net income of $2.5 million in 2012. Non-GAAP net income, adjusted as noted, increased to $5.5 million compared to $2.5 million.

Net income per diluted share was $0.17 in 2013 compared to $0.15 in 2012. Non-GAAP net income per diluted share, adjusted as noted, increased to $0.30 in 2013 compared to $0.15 in 2012.

2013 net income is increased by research and development income tax credits related to prior open tax years. Bookings were $46.5 million compared to $40.9 million in 2012, an increase of 13.7% and backlog, as of June 30, 2013, was $77.9 million compared to $59.5 million as of December 31, 2012 and $58.9 million, as of June 30, 2012.

For the 6-month period ended June 30, 2013 compared to the 6 months ended June 30, 2012, net sales increased by 16.6% to $78.8 million as compared to $67.6 million in the same period of 2012. Gross profit increased by 23.2% to $25.5 million compared to $20.7 million.

Gross margin increased to 32.4% compared to 30.6%. Operating income decreased to $6.6 million in 2013 compared to $8 million in 2012.

Non-GAAP operating income, adjusted as noted for the 6-month period, increased to $10.8 million compared to $8.2 million, a 31.7% improvement. Operating margin decreased to 8.4% from 11.8%.

Non-GAAP operating margin, adjusted as noted, increased to 13.7% compared to 12.1%. Net income increased to $5.3 million in 2013 as compared to net income of $4.5 million in 2012.

Non-GAAP net income, adjusted as noted, increased to $8.7 million compared to $4.6 million. Net income per diluted share was $0.29 in 2013 compared to $0.27 in 2012.

Non-GAAP net income per diluted share, adjusted as noted, increased to $0.248 in 2013 compared to $0.28. Bookings were $84.1 million compared to $71.6 million in 2012, an increase of 17.5%.

And now I'd like to turn the call over to our CEO, Jeff Lang.

Excellent, Ben. Thank you.

Good morning, everyone, and thank you for your participating in CECO's Q2 2013 earnings call. We appreciate your continuing interest in CECO Environmental as we execute on our global growth and operational strategies to ensure that our premier technologies continue expanding in all end markets.

Q2 was a solid operating performance for us, while integrating 2 significant smart accretive acquisitions and putting the framework in place for the completion of our most transformative acquisition of Met-Pro. Our goal continues to be to build a global technology platform in our air pollution control product recovery and related sectors.

We're positioning the company to create an excess of $300 million in revenues for 2014, given our core business and our M&A activities, along with our definitive commitments. We continue to build a stronger and more diverse global end market customer base, which will ensure we grow and prosper through various business climates, while not limiting our growth to 1 market or 1 region.

A quick note on the platform. Based on CECO, Met-Pro Aarding and Adwest, 2012 actual numbers, you can easily see that we are moving.

We are moving rapidly to exceed that $300 million of revenues for 2014. This is something we've been aspiring to for the past 3 years.

We are now in the final stages of completing the Met-Pro transaction, with both companies having their special shareholder meetings on Monday, August 26, with the expected closing a couple of days thereafter. We're very excited about how Met-Pro will accelerate CECO's progress in building the technology platform within the -- within our sectors.

Both teams have been successfully working together on integration plans over the past 3 months. I feel the integration will be very standard and typical, and we're excited about Met-Pro's management team, their outstanding portfolio and product technologies.

CECO will become the technology leader in our core markets, with Tier 1 industrial brands. Regarding Met-Pro and the integration, here are a few things that we're focused on: consolidating our main offices to creating a more efficient, lean back office for our divisions; consolidating while growing our air pollution control and product recovery technology businesses; expanding our fluid handling business, which is classified under the global pump business of Met-Pro; launching Met-Pro's excellent products into China, such as Flex Clean and dual scrubbers, excellent products; number five, consolidating to grow our 3 global filtration technology businesses; six, the senior management team and organization is in place.

We've had many excellent integration planning sessions and we're ready to go. We now have a base business platform in excess of $300 million, with aspirations to achieve increasing levels of revenues, EBITDA and EPS for our shareholders.

I'm excited to say that the CECO Met-Pro management team has made a significant progress over the last 3 months to prepare us for the future together and being ready to operate as one great company very soon. Some comments on our results.

I'm excited about our position. Bookings for the year are up 17% versus last year, including organic and recent acquisitions.

Gross profit is trending well. Our backlog is up to almost $80 million, an all-time high for CECO in size, with very good gross margin built in.

Of the $10.8 million in adjusted operating income year-to-date, recent acquisitions contributed roughly $1.7 million to that. Of the $80 million in backlog we currently have to date, roughly $16 million came from Aarding and Adwest, our recent acquisitions.

Year-to-date June revenues reached $79 million, and obviously, as Ben pointed out, 13.7% operating margin of sales, we are very excited to be in the 13% range of operating margin, but are still focused on margin expansion as we continue growing globally. Our acquisitions are helping our revenue and operating income growth.

Much of it was acquisition related as well as organic related. Please note in Q2, CECO had approximately $2.7 million of M&A related one-time expenses.

That is why we are reporting non-GAAP adjusted earnings in Q2 and will be throughout the rest of the year and some of 2014. We will continue to have some additional legal accounting, banking and other related expenses in Q3 as we formally close on the excellent merger and acquisition transaction in late August.

Some comments about the bookings. We're very excited that our bookings are up of 17.5%, right around $84 million versus year-to-date June of $71 million.

So a 17.5% increase. The Aarding acquisitions clearly helped our bookings growth.

Just a footnote on our bookings. Please note that we've integrated the Aarding and FLEXTOR divisions to create 1 natural gas business unit.

At the same time, we integrated CECO abatement, our legacy RTO business with Adwest, the new RTO business we acquired. Although these acquisitions are helping our bookings growth materially, we've co-mingled both of these acquisitions into legacy CECO businesses for scale, product offering and some product substitutions to capture more orders at better margins.

So either way you look at it, we're very excited about our bookings growth and our backlog strength going forward. We're pleased with our business quotation activity levels, our gross profit expansion reaching over 32% for the first time, operating margins well into the 13% range.

Coupled with strong global growth performance and operational excellence, we achieved $0.48 year-to-date in non-GAAP EPS or $0.40 if we subtract our R&D tax credits for the quarter. A brief comment around taxes for Q2.

We had a favorable gain of $1.9 million from an R&D tax credit for previous years and 1/2 of 2013, at the same time incurring $400,000 in related third-party expenses to complete these tax credits, which equates to a $1.5 million gain in net income, and that equates to roughly $0.08 of EPS for the quarter. Going forward, we will continue to focus on utilizing U.S.

R&D tax credit opportunities for CECO as planned and Met-Pro focuses on these as well. Separately, CECO China is on track to obtain a technology tax rate improvement from the China Ministry going forward.

We're excited about these tax credit opportunities for CECO. And more importantly, validates the special product technologies CECO provides globally to our customers.

I'd like to share a few comments about our order intake for Q2 that we've won and we're very excited about. We received a $5.7 million order from ExxonMobil through our fuel technology division for U.S.

refinery. We received a $2.2 million from General Motors for an engineered ventilation system in Tennessee.

Our EFFOX group won a $1.7 million order for URS, a power plant in New Jersey. Adwest Technologies received a $1.2 million order from SA Recycling, application plant in California.

We received a $1.1 million cyclone technology order for Wison Engineering, a petrochemical plant in China. Fisher-Klosterman, our Louisville cyclone division received a $1 million order from Clorox for a U.S.A.

chemical plant. Aarding picked up a $700,000 dollar order for a plant in California.

TVA placed a $650,000 dollar order with EFFOX for a damper diverter application for a plant in the USA, and we also received a couple of $500,000 orders from a silicon technology plant in China. So that gives you a little flavor of some of the orders we're receiving around the world in some of our divisions that had a very good Q2.

Now I'd like to chat a little bit about the individual business units to give you a flavor for how they're doing. Our contract services and parts group, which falls under our recurring revenues, saw some uptick in Q2.

Q3 is tracking better than Q2 for our services and parts business, and our aspirations are to show significant growth year-over-year in revenue and operating income. Those are our aspirations and our objective.

I would like to advise you that our contract services group is tracking $4 million in revenue below last year. So our aspirations -- and we have confidence that they'll pick that up in the second half and make that up.

That's our aspiration and our focus for the second half regarding contract services. Our traditional power business, EFFOX, which has a premier reputation in the utilities around the world, continue their excellent performance in Q2, with the best-in-class utilities investing in upgrading their systems.

EFFOX revenue and operating income are up solidly year-over-year, and are on plan for hitting their 2013 objective. Also, our natural gas utility business, Aarding and FLEXTOR had a very good -- had a solid Q2.

Our natural gas division activity is gaining momentum globally, and the integration of Aarding and FLEXTOR into CECO's natural gas business unit is complete. The Aarding acquisition is complete, and our global leaders of that business are contributing to CECO's global growth.

We couldn't be more excited about our global opportunities in the natural gas sector. CECO has 2 excellent global utility businesses to take advantage of the traditional power sector growth globally and the emerging natural gas power sector that is growing globally.

We feel we're in a good position. Given the global demand for electricity, we'll grow 50% for the next 25 years.

Strategically, we are positioned very well for long-term growth. Our cyclone technology division and scrubber group, which goes under the name of Fisher-Klosterman and Buell, is up year-over-year, and activity is seeing some upside in the refinery, chemical, petrochemical and some of the largest industries in the U.S.A and to some degree, globally.

These moves represent FKI and Buell Technologies, which had a favorable operating income for Q2, and we believe in 2013, they'll have a very good year. Our Busch international business, which provides fume exhaust technology and mist eliminator systems, has declined for the year as the metal industries is soft.

Several projects have been delayed. Although this is a niche business for us, Busch is moving fast to reshape their strategy in selling more of the CECO technology into other industries beyond metals.

Some comments about China. CECO China is showing solid activity.

Operating income growth and bookings are flat for the year. We're investing in growing the China air pollution control and product recovery market, as the air and water problems of China are significant and long-term opportunities for CECO.

We believe bookings in Q3 and Q4 will put us above last year's so we're very optimistic about China. We're in the process of launching Met-Pro's Flex-Kleen and dual scrubber technology into China, and that will be ready to go at closing.

Therefore, also, the Adwest RTO technology products were launched in China in Q2. Met-Pro will be a perfect fit for our CECO China sales entity and fabrication framework.

Ray De Hont and I are working diligently, ensuring we move fast, to launch those products into China. We're committed to the growth long-term, and yes, we're seeing the China Ministry taking action to correct their long-term air quality problems.

As announced, our M&A plans have solidified, and we're very excited about our platform strategy. Adwest Technologies, we closed on December 31, is now fully integrated into CECO.

Aarding, a premier natural gas engineering equipment provider, which we closed on February 28, is now completely integrated with CECO, and we couldn't be more excited about that pure play global business Aarding brings to CECO. And very importantly, the MetPro acquisition is clearly on track, with the shareholder meeting scheduled for August 26, and the official closing a few days after.

We believe the air pollution control and product recovery portion of these businesses will easily integrate and fit very well into CECO's global technology platform to drive global revenues, recurring services, parts and earnings growth for the shareholders long term. And also, we believe the merger of the 2 companies will provide significant opportunities for our fluid handling business, our filtration business and the purification business, which we couldn't be more excited about, and Ray De Hont and I are working on those strategies everyday.

Our business platform and our management team at CECO, in general, are positioned very well, and we feel we're executing on our core strategies that we've been sharing with you for quite a while now. The platform is coming together, and have aspirations for earnings growth for our shareholders, and we're excited about our future, and I look forward now to opening up for any questions you may have.

So on Met-Pro, there's good update. Sounds like you're nearing closure here in the next couple of weeks.

So to the extent you can, maybe update us on the cost synergies. I know you've had those integration meetings in the last couple of months.

So talk maybe a little bit about that $9 million initial goal you had, how do you feel about that, especially given you've had meetings since that initial announcement.

Yes. We're very focused on that $9 million cost synergies, and we believe we'll be able to achieve that by year end 2014, and that comes in a host of areas, which we've shared during the April announcement.

There's plant optimization, opportunities to improve the efficiency and cost structure of the combined businesses. There's main office consolidations.

There's China growth opportunities. We have 3 -- combined, we have 3 filter businesses that could be consolidated and run more efficiently and under a common leadership and common divisional approach, and that's just a few of them.

There's $15 million, $20 million of potential unencumbered real estate that could be a part of that as well. Then the other side of the equation, which we really haven't messaged too much, is the revenue synergies, which we believe are very exciting between the 2 companies.

So we're very focused on that, Ajay.

Does it sounds like you feel better about that goal based on all the follow-up meetings that you've had so that's good. Then you talked about the top line synergies, and I know you had some remarks initially about the fluid pump lines and then the filtration businesses and Met-Pro has good positions there.

Maybe talk a little bit about acquisition opportunities. I mean, that's just a very fragmented market still.

So how should we be thinking about those 2 lines?

We're very focused on that. We think given the global fragmentation of the markets that CECO and Met-Pro serve, there's a host of smart accretive opportunities.

There's fluid handling opportunities that Ray De Hont and I are focused on. There's industrial filtration opportunities both on the recurring revenue side and the new engineered filter side, and there's several engineered technologies that we think could fit our air pollution product recovery.

So in general, there's probably half a dozen things that we're focused on right now that could make good accretive sense for the new company for CECO, Met-Pro.

Good. And then maybe on the quarter, gross margins remaining nicely above 32% even on higher revenues.

Comment on what's driving that, is it project selection, mix of revenues? And then how we should think about the rest of the year?

I think -- Ajay, I think, we'll be very consistent with our gross profit and operating margins for the rest of the year. Those are our aspirations.

Our organization, as well as Met-Pro's, we're continually focusing on gross profit and margin expansion. Can we get a little bit more gross profit in the selling process, in the front-end process?

Can we improve the project execution side of the equation with better focus, better metrics? So both companies are very focused on margin expansion, and I'd like to think we'll remain very consistent, where we are with gross profit.

But at the same time, rest assured, we're very focused on bringing in more business to the organization, and we want to be very balanced in how we bring in new business opportunities, the intake of orders and balancing our margin expectation. So we're trying to accomplish both.

Good, and last one for me before I pass it on. So on the tax rate, I thought you said something about R&D tax credits later this year, maybe next, and then Met-Pro utilizing China tax credits.

So how should we think about the tax rate longer term? I mean, does it go down below the 29% that, at least, I've been modeling in or is 29% still the longer-term placeholder rate?

Yes, good question, and we spent a lot of time optimizing our tax base. Last couple of years, the last couple full years, we've been around 29%.

Those are numbers we find pretty attractive. In Q1, we hit 34%.

In Q2, we are virtually 1% or 2%, given the strong R&D tax credits that fell through and improved. Year-to-date, we're at 18%, our tax rate.

In Q3, given some of the nondeductible M&A-related expenses, we could see an abnormally high tax rate in Q3. So that's what we're thinking that Q3 will be abnormally high.

However, Q4 should normalize, and next year, we'd like to be in that 29% range again, where we were potentially lower, given the R&D, the research and development technology tax rate we're going to be getting approval for in China, plus Aarding will grow and that's a 25% tax rate. So 2014, 2015, we'd like to be much more attractive, but in Q3, we're going to see an uptick in our tax rate.

So Jeff, you generated close to $80 million in revenues through the first half of the year. I think, previously, you talked about doing maybe $180 million to $200 million or close to $190 million excluding Met-Pro.

What's your updated thoughts on that?

Pete, we don't publish guidance. Kind of looking at the historical trends, given the acquisitions that are in place that are doing well, given the merger with Met-Pro in the end of the month, we're kind of thinking that trends are going to be -- we're going to grow.

We've always said we want to grow 10% to 15% top line with the blends of organic and inorganic revenues, and I think that's playing out, and I think we're going to see a lot more momentum going into Q3 and Q4. Those are our aspirations, plus the Met-Pro acquisition on top of that.

So those are our general comments, Pete. And also, at the same time, our backlog of $80 million is at an all-time high.

And we think within 6 months, we can process that so you can build that into your modeling to develop our revenue profile for the rest of the year.

Okay, okay. So $190 million, if we exclude MetPro, that may be a little bit high?

Yes, yes. And we're -- I'd love to give you a specific answer, Pete, but we're at this juncture.

We're not prepared to give guidance. Maybe as we get larger, we can provide guidance to our shareholders.

But right now, we're not in that framework to provide specific guidance. You've studied CECO.

You know what we're capable of.

Okay. How about -- can you give us the revenue that Aarding and Adwest contributed in the quarter?

That will be in our Q, our filings on Friday, but it was probably in the $15 million range.

Okay, okay, got it. Okay, let's see.

And then give us a sense, I mean, I know, organically, revenue is down in the first quarter. It seems like it's improved here a bit in the second quarter.

What's your sense going -- we're into August now and we have results to June. Are things kind of feeling incrementally better through August in terms of your customer base in the U.S.

in particular or about the same or just trying to get a sense of what you're feeling in the economy?

Right now, we're feeling we have a pretty strong quotation backlog that we measure our sales dashboard and the strength of our quote log. That kind of determines how we're feeling about activity, and I would say we're feeling pretty -- we have a pretty robust sales dashboard.

It's probably slightly better than it was at the beginning of the year, and your question is very valid. We understand what the acquisitions are doing to our business.

We're very focused on our organic growth, domestically and in China. We continually focus on organic growth, and that is the priority for CECO.

And we're pretty -- we're very excited about the accretive acquisitions and the impact they've had on our revenue, our bookings and our backlog, and we couldn't be more excited about joining forces with Met-Pro, but we are focused on growing organically. And we think we're going to be able to accomplish that in the rest of the year in 2014.

Now Jeff, you mentioned a few things in terms of collapsing some operations and getting some benefits in terms of some of the back office, really kind of optimizing what your -- how you're operating today, but you're really running a lot of different separate businesses. And I would suspect that there's probably a good level of inefficiency that you can continue to drive out so I just want to see if I could get a little bit more of a summary perspective on additional synergies or additional efforts that you're taking in order to drive your business perhaps to get a little bit of a better output from your structure, and when you might start doing that as more of a concerted effort.

Yes, good point, good question. We've been doing quite a bit of that over the past 2 years, integrating the business, providing operational excellence.

One of the things that we're very focused on and where businesses -- how businesses measure how they're doing is SG&A as a percent of sales. We've been at 18.5% of SG&A for the past couple of years.

Year-to-date, June, we're at 18.7% SG&A as a percent of sales. That is the metric that's very important to determine how efficiently we're running as a percent of sales, given the multitude of business units that we have and other companies have.

However, we continually push the envelope in that area. We are trying to merge more businesses together.

Met-Pro will be feathered together with CECO in our air pollution controls segment and our filtration businesses. We see there's a lot of revenue and streamlining synergies there.

To your point, Sean, the Busch -- our Busch international business, our Abatement and our Adwest businesses are merging together to form a common platform versus having separate businesses. So we are working diligently to do that to bring the businesses together to sell more of CECO's technologies while lowering our SG&A.

So that's very important to us to drive earnings. Aarding and FLEXTOR has now merged into one operating unit, whereas 6 months ago, they were separate.

So we will continue to do that, and your observation is correct. But I think we've done a lot of it to bring out some nice SG&A efficiencies.

But we have some more to do going through 2013, and that is part of our operational excellence journey.

That's very helpful. And then separately, you talked a little bit about the bookings in China.

I was looking, Jeff, If you could elaborate a little bit more in terms of what's driving the expectations for that to pick up. Is it explicitly via products coming through the Met-Pro acquisition?

Or how do we think about that uptick in your expectations there?

Well, for one, there's millions of manufacturing plants in China that need to improve their air processes, their fugitive emissions, their fume exhaust, their air quality. That's the framework that drives our market focus and our continued investment in China.

We're going on our 9th year in China, Sean. We have an excellent sales organization and manufacturing and a complete organization.

It generates good operating income, above average actually. Now we're focused on -- we launched RTOs into China, the Adwest RTO.

So we're trying to sell and manufacture in China, RTOs into China. We're selling EFFOX stamper and diverters into China now, whereas a couple of years ago, we were not.

Ray De Hont and I are working diligently to launch the Flex-Kleen dust collector technology and the dual scrubber to China, which is taking place. That's going to drive the business.

We probably, in the last 2 years, doubled our sales engineering capacity in China to take advantage of that growing market. So it's a major investment.

The demand for air quality is growing. We have a premier product technology base to harvest that market with, and it's going to take a little time.

Potentially, we can do some smart bolt-on acquisitions if it makes good sense, but all the things lead up to continued investment in growing the China market.

Okay, that's helpful. And then last question, when you look at your backlog, Jeff, how much of that is -- would you expect to recognize in '13 versus '14 or forward?

Good question. Typically, within 6, 7, 8 months, we could turn our backlog.

So I would like to say a major portion of that, we could realize by year end 2013, but there will be a portion of that, that would end up falling out in Q1 of '14.

Just a follow-up. Jeff, would you mind actually giving us the revenue by segment?

We don't provide that. We don't provide that on the earnings call, Pete.

You may see more color on that around Friday when we send out the Q.

Okay, okay. And then is there a number we should have for third quarter deal expenses?

We can adjust it out in a separate line, but can you give us a sense maybe should they be similar to the second quarter or up a bit or...

Yes, yes. I think they should be consistent with Q2, and hopefully, by the end of Q3, the complete M&A related expenses will fall out, and we'll go into Q4 without them.

So yes, probably, I would benchmark Q2 perhaps a little bit more, slightly a little bit more, but I think that's a good benchmark, Pete.

Thank you very much for joining CECO's call today. We appreciate your interest, and we look forward to continued involvement with you.

Have a good day.