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Edited Transcript of CECE earnings conference call or presentation 6-May-20 12:30pm GMT

Q1 2020 CECO Environmental Corp Earnings Call

Cincinnati May 25, 2020 (Thomson StreetEvents) -- Edited Transcript of CECO Environmental Corp earnings conference call or presentation Wednesday, May 6, 2020 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dennis Sadlowski

CECO Environmental Corp. - CEO & Director

* Matthew Eckl

CECO Environmental Corp. - CFO

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Conference Call Participants

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* Amit Dayal

H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst

* Christopher Ralph Van Horn

B. Riley FBR, Inc., Research Division - Analyst

* Michael Joseph Cikos

Needham & Company, LLC, Research Division - Associate

* Tate H. Sullivan

Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the CECO Environmental conference call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Matt Eckl, Chief Financial Officer of CECO Environmental. Please go ahead.

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Matthew Eckl, CECO Environmental Corp. - CFO [2]

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Thank you for joining us on the CECO Environmental First Quarter 2020 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 have provided a slide presentation to help guide our discussion. The call will be webcast along with our earnings presentation on our website at cecoenviro.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 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 turn the call over to Dennis.

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [3]

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Good morning, everyone, and thank you for joining our call. I hope that you and your loved ones have been in good health throughout the COVID-19 pandemic. And like all of you, I look forward to better times ahead.

On this call, I'll take some time at the outset to discuss CECO's response and adjusted posture to successfully navigate the COVID-19 pandemic and its economic fallout. To use a generic sports analogy, we've strengthened our defense and refocused our offense. Next, I'll summarize our first quarter performance which, with our team's strong execution, delivered solid results despite the accelerating social and economic changes and challenges emerging from the pandemic. Following that, I'll touch on our end markets and what we're seeing in the midst of the world's effort to mitigate and contain the spread of the virus. Matt will then discuss our financial details, after which I'll share a couple of examples of the work our teams continue to drive ahead despite the global economic shutdown. That will lead us into the Q&A session, where we'll address your questions.

As we jump in, I want to emphasize that CECO has already taken several decisive actions in response to these unprecedented times while maintaining our commitment to progress through superior execution. Let's begin with Slide 3, which shows our 4-3-3 Operating Strategy that successfully guided our execution since late 2017 and into much of the first quarter. The 4-3-3 Operating Strategy was a blueprint for transforming CECO Environmental into a vibrant growth company. In executing the blueprint, we built a solid foundation of strength and agility. That foundation gives us the confidence to pivot to an operating posture that allows us to proactively navigate through the COVID-19 health pandemic and its economic fallout. Quite simply, under the 4-3-3 strategy, we built the plan, executed the plan and delivered results. The strength, agility and results from our execution put us in a strong position headed into these uncharted waters with an asset-light business model, a robust $200 million-plus backlog, a geographically distributed organization and a very healthy balance sheet.

I've referred to the 4-3-3 operating strategy in soccer terms as an offensive-minded approach to winning at CECO. Adding to that analogy is a graphic on Slide 4. You can see our 4 value creation enablers were akin to forward-looking defense solidifying the core of the company. At the midfield line was our 3 compelling end markets, driven by the industry's need for sustainable solutions in the world's growing low-carbon economy. And leading our offense were the 3 core growth platforms: engineered equipment, industrial air quality and specialty pumps.

COVID-19 triggered the need for a major short-term pivot. To paraphrase famous boxer Mike Tyson, "Everybody has a plan until they get punched in the mouth." And for just about every business, including CECO, the COVID-19 pandemic was that punch. Now I'm no boxer, but let me follow up on Tyson's quote, specifically to say that even when punched in the face, fundamentally sound and growth-oriented businesses like CECO are expected to be resilient enough to withstand a blow and then quickly and confidently adapt their posture to forge progress. So in this altered state of the world, that's exactly what we've done.

Bringing things back to my favorite soccer analogy, I want to share how CECO has adapted to what we're calling a 4-4-2 formation, which is depicted graphically on Slide 5. This formation features a strength in defense and a refocused offense. It's not a long-term strategy, but it will guide us in making continued progress in this challenging world environment. I want to emphasize this point. Our capability and capacity to plan and execute is a compelling difference maker in serving our customers and creating value for our investors. The fact is that while we all may be moving through the same storm, we are not all in the same boat.

Starting on the defensive left-hand side, we've instituted a number of proactive steps that reflect both the right thing to do by our people and the smart thing to do for our organization. Collectively, these 4 actions increase our operating headroom and give us considerable flexibility going forward. First, to protect the health and safety of our workforce, all of our office positions have been instructed to work from home. In our manufacturing plants, all deemed to be essential in this pandemic period, have instituted added hygiene and distancing measures while we continue to execute customer orders. Navigating the mandated shelter-in-place orders has been a challenge, especially in some of the manufacturing locations and with our field work at customer sites. But we've remained operational across the business, and I believe it's a tribute to our customer-focused mentality and the strength and commitment of the entire global CECO team.

Second, the senior leadership team and the Board have taken temporary compensation reductions. We see this as a proactive measure until we get a better read on the direction of a post-COVID world. We also cut a number of staff positions from our central administrative functions to generate savings going forward.

Third, we've instituted a rolling furlough across the U.S. workforce during the first 6 weeks of Q2, which we believe will be an especially hard-hit period. All of our U.S. associates are taking a mandated 2 weeks of unpaid time off. I want to pause here and recognize and thank our leadership and every CECO U.S. associate for finding the strength to maintain superior execution and service to our customers during this difficult window of time. While our actions didn't materially influence our first quarter results, rolled up, it represent a reduction in savings of about $3.5 million to our second quarter fixed operating costs.

Our fourth action was to draw down $40 million of cash on our line of credit and keep these liquid funds in our bank account. It's a precaution but a smart one that provides considerable flexibility to act with speed as the global economy evolves from the COVID-19 pandemic. I want to emphasize that we are monitoring customer and vendor activity as the prevailing restrictions and start-up guidelines on economic activity, and we're prepared with actionable plans to take additional measures to strengthen our defense and refocus our offense.

In the midfield are our 4 value creation enablers. More than ever, each enabler is a multiplier of value creation for CECO Environmental. Even with our office staff restricted to work from home, they're staying true to our outside-in mindset and staying actively engaged with customers. And we continue to drive simplicity as we adjust and prioritize how we do business in the near term.

CECO continues to maintain investments in product innovation because we have to stay ahead of what our customers need and be ready to supply solutions as markets recover. And finally, we remain well positioned to manage our portfolio and continue evaluating M&A targets that further our environmental mission.

On the far right is the forward tip of our offense, market-oriented sales and marketing efforts aimed at exploiting our competitive advantage to grow share in the active pockets of our energy and industrial end markets. I'll go into more detail on our end markets shortly, but I want to touch on the pockets of activity that our 4-4-2 strategy is targeting. We're well positioned with a diverse set of served end markets and see promising activity even in this heart of the pandemic in food and beverage, semiconductor production and processed water. Our team has developed improved digital content and remains connected to drive share growth from these targeted areas. And we're encouraged about the potential infrastructure investments in the United States as part of an effort to get people working and the economy growing. Our team is ready with targeted specialty pump and air quality products and solutions to serve industries like asphalt production, which would see a surge in demand with infrastructure investments by the federal government.

Before summarizing our first quarter results, I'd like to add that our leadership team has experience with challenging economic conditions. We've proved that by successfully navigating the micro-recession that simultaneously hit both power gen and refinery end markets back in 2017. Obviously, we're now facing unprecedented conditions that are broader and deeper than the micro-recession. Its rough sledding in the global economy, but our experience and extensive playbook of tactics is an invaluable, intangible asset. And that, along with our focus on superior execution, is why I'm confident that CECO's 4-4-2 posture will enable us to see healthy progress during this period of uncertainty.

Now let me jump into our first quarter results on Slide 6, which once again demonstrate our ability to execute despite the pandemic's accelerating social and economic changes that challenged us during the quarter. New orders came in at $76 million, up 12% from Q4, with sequential orders up double digit in all 3 of our reporting segments after a down final quarter of 2019. Of value to note is that while the pandemic slowed project order decisions across the board, our orders remained steady into the final weeks of March, even as shelter-in-place requirements became more widespread. From a year ago, orders were off almost 22%.

Revenue came in at $80 million. Albeit after a very solid start to the year, revenue moderated down 10% sequentially and 6% year-over-year. The COVID-19 pandemic definitely muted our revenue growth as bottlenecks associated with the unprecedented lockdowns drove customer delays and supply chain interruptions. I'll mention here that our backlog remains a robust $209 million and we expect to see its conversion to revenue continue. Given the current circumstances, the timing of conversion may fluctuate as some customers modify their project schedules.

It was good to see, even with lower revenue, our team's track record of strong execution produced a healthy gross margin of 35%, which is up both sequentially and year-over-year. The higher gross margin helped offset the lower volume and resulted in an adjusted EBITDA of $7.4 million or 9.2% of sales. CECO also generated solid free cash flow of $6 million in the quarter. We continue to focus on converting profitable projects into investable free cash flow with even more vigor going into the crisis.

Q1 was a challenging period of accelerating change as the weeks went on. It definitely tested us, and I'm proud to say that our consistent and high-caliber execution allowed us to earn solid results. We also confidently pivoted our operating posture with an updated tactical plan to ensure that CECO Environmental continues to deliver healthy progress.

Turning to Slide 7, I'll provide some brief insights regarding the outlook of our end markets. Clearly, the outlook for our overall end markets has changed. And until we see what a restart looks like, we'll proceed with an abundance of caution. Our global footprint, broad set of technologies and active interaction with customers provides us with a powerful lens to see, understand and adjust to restarting markets on a sector-by-sector basis. Fortunately, CECO competes in a diverse set of end markets, and as part of our pivot, we've turned more attention towards promising pockets like food and beverage, semiconductor fabrication and process water treatment. And much of our portfolio serves critical industries and infrastructure, where capital and maintenance can be deferred but not ignored completely. So while today's commerce is in uncharted and rough waters, we're still executing with confidence and strength into our key end market segments.

Referring to the left side of Slide 7, the served energy segment markets are still active with longer-term projects that we've been tracking for at least 6 to 9 months. We expect to see refinery projects progressing towards new orders, gas separation and process water projects being awarded and even some new gas power demand moving ahead. We have a little exposure to upstream oil in the U.S. so we don't anticipate any direct hits there. And it's too early to conjecture what kind of second-order effects will come from the massive drops in oil price and demand. What we do know is that most energy companies have announced substantial CapEx reductions for the remainder of 2020, which is why we've adapted our posture for a challenging market going forward. The global sales team is closely monitoring client projects that remain active in our sales pipeline.

Down the right side of the pie are the industrial markets served by both our Industrial and our fluid handling solutions segments. Both serve a diverse set of industrial applications, with a heavy focus coming from North American customers. Coming into the year, our pipeline of activity was improving, and our sales team appeared to be hitting stride in finding solutions for our customers. And in both segments, we converted a good portion of wins to grow our market share in the first quarter.

The sales pipeline has pushed out a number of industrial markets, but several key pockets are active and expanding. Industrial air quality and filtration solutions for the food and beverage producers have seen a pickup in near-term activity. And as I mentioned earlier, we're working with several asphalt plants in preparation of demand increases from potential federal investments and infrastructure.

In summary, even with much of the world on stay-at-home orders, we are still making progress with customers in key industries and on critical infrastructure projects. Our sales teams are making more prospecting-type calls than usual as they're using their lack of windshield time effectively. There's no doubt that customers have become more disciplined and deliberate with their spending decisions but project orders are being awarded. And we're still adding to our significant sales pipeline with new leads generated by our digital content.

In closing, I'll say that it's still early and it would be quite speculative to forecast the other side of the COVID storm. Until we see more clarity on the horizon, we'll remain in our 4-4-2 posture with a strengthened defense and a refocused offense. I'll emphasize that we intend to exploit our competitive advantages in the attractive pockets of activity that exist today and the opportunities from restarting the economy that will emerge tomorrow. I'm fully confident that CECO is up to the challenge in every way.

And with that, I'll turn things over to Matt. Matt, take it away.

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Matthew Eckl, CECO Environmental Corp. - CFO [4]

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Thanks, Dennis. Before starting, I want to say that I hope that you have all weathered the pandemic with a minimum of personal hardship and professional disruption. It's been a challenge for families dealing with stay-at-home orders and a test for businesses and it's certainly good to see some countries and U.S. states taking the initial steps to getting working again.

In discussing CECO's financial results for the first quarter, I'll also provide some additional detail about our pivot to strengthen our defense and refocus our offense. I share Dennis's confidence that with our continued execution, the 4-4-2 formation we've pivoted to will drive healthy progress.

Let's start with Slide 9, which shows that despite the accelerating spread of the COVID-19 virus, our sequential orders improved in all 3 segments. As the bar chart on the left-hand side shows, overall orders increased 12% sequentially and decreased 22% year-over-year. Energy orders were subdued, especially in the refinery area where capital expenditures stalled as the slump in oil prices slowed the award process. Orders in Industrial Solutions were solid, and while not matching last year's extraordinary first quarter, it did beat our historical range of $18 million to $22 million per quarter.

Fluid handling bounced back on the strength of our pumps business, while our Mefiag filtration products are still weighed down by lower automotive demand. The bar chart on the right shows that revenue came in at $80.5 million, reflecting a decline of 10% sequentially and 6% year-over-year. But for COVID-19, this metric could have been measurably different as subcontractor shutdowns in Canada and Italy pushed approximately $5 million to $10 million in revenue out in the second quarter and second half.

As for our CECO production facilities, all are up and running, serving customers today. Our pumps facility in Telford, Pennsylvania was temporarily shut down. But after an appeal to the state and some great work by our team, we were granted a waiver as an essential business after 5 days. The financial impact was minor, pushing just 300,000 of shipments into Q2. The comment is meant to highlight the fortitude of our operations team to serve our customers. Anthony Carbo, our plant manager, worked tirelessly with our legal and HR teams to file the paperwork, solicit decisions and prepare a safe place to work for employees. Our employees want to work and serve our customers. I'm so proud of their bias for action.

Moving on to Slide 10. Our backlog remains at a healthy $209 million. Given the difficulty engaging when and how our end markets will reboot, we're obviously pleased to have this bank's future revenue. Conversion from backlog to revenue is expected to be a bit slower than in the recent past until the bottlenecks from the pandemic are alleviated. We're staying on top of projects and monitoring their progress. Based on current conditions, our backlog appears secure.

Now on to Slide 11. The chart shows that despite the first quarter's lower revenue, the execution by our team delivered healthy gross margins. Our gross margin improved to 35.2%, which is up 1.6 points sequentially and 2.2 points year-over-year. Our commercial team continues to sell the value of our capabilities to customers, often commanding higher pricing. This, coupled with superior project execution by our ops team, is driving margins higher. Non-GAAP operating income and adjusted EBITDA, while better than some previous quarters over the past year, nevertheless sequentially declined by 35% and 27%, respectively. Not surprisingly, the first quarter's lower revenue was the culprit, tempered by higher margins and cost savings.

Next up is Slide 12, which provides our detailed financials for the first quarter of 2020. I'll say it again, our execution led to solid results, despite the accelerating impact of COVID-19. I've already touched on several of these metrics so I'll highlight a few brief items. Earnings per share was $0.10 on a GAAP basis and $0.15 on a non-GAAP basis, both $0.05 and $0.03, respectively, led by higher gross margins, decreased tax and decreased interest expense. Our non-GAAP tax rate was 25% in the quarter and we anticipate maintaining that rate through 2020.

In wrapping up this slide, I want to take a minute to quantify the proactive measures we announced in our April 7 press release. The compensation reductions and our organizational streamlining will generate approximately $1.5 million of run rate savings, while the U.S. furlough will reduce expenses by approximately $2 million in the second quarter specifically. To be clear, there is no benefit to the first quarter results. I'll emphasize 2 other things. First, these actions are temporary and will be influenced going forward by how our markets play out; second, we're fully prepared to take additional actions to reduce expenses if warranted.

Pushing on to Slide 13. I'm pleased with the $6 million of free cash flow generated during the first quarter. We benefited from diligent AR collections across the enterprise and the receipt of a large upfront cash inflow from a sizable Middle Eastern project. In Q2, we'll be managing our project milestones carefully as that same large project's cash outflows to vendors may create a Q2 timing headwind.

I'll now turn to Slide 14, which summarizes our healthy balance sheet. The bar chart on the left shows the steady work we have done in using our operating cash flows to drive down our debt every quarter. As Dennis mentioned earlier, we conservatively decided to draw down $40 million from our revolving credit facility to supplement the company's already strong cash position. In doing so, our banking covenants are unimpacted, and we still have access to $70 million of undrawn funds. We made this decision in late March and given the unprecedented situation that was evolving, we believe that flexibility was of the utmost importance. In short, our drawdown exemplifies our intention to be good stewards of CECO's assets. To date, we have not touched these reserves and they remain in the bank.

In the home stretch of my comments today, I'll go to Slide 15, which addresses our progress towards our 2021 financial targets. These targets are intended to measure the progress of our commitment to deliver top-tier returns. The 2021 financial targets were established to be a self-imposed challenge within the bounds of historical economic conditions and not the conditions of the global COVID-19 pandemic and fallout. This unforeseen situation puts us in a position to reevaluate the timing to achieve the target zone. We still see CECO as a top-tier return company, and we'll reaffirm the timing of achieving these targets once governmental restrictions on commerce are removed and visibility to energy markets improves.

Here is where we stood after Q1. As you will see, we are able to improve in a few targeted areas. Starting in the upper left quadrant, our goal is to organically outgrow our markets 2x over time. After meeting this target for an extended period, we clearly fell short on the way to last quarter as revenue and orders contracted, especially in March. Moving to the right, our EBITDA rate is largely driven by revenue and the operating leverage achieved our growth. Even with value selling, cost savings and superior execution, we could not overcome the revenue decline. Our EBITDA came in at 9.2%, which is below the target range of 12% to 14%. Next is return on tangible capital. On the considerable strength of our asset-light business model, we continued to meet this target with a TTM return of 51%. Lastly, on the lower left-hand side is our free cash flow conversion rate, which was 81% during Q1 and 78% on a TTM basis, right in the middle of our target range. Again, this goes to consistent execution in our asset-light business model.

To wrap up, we were pleased with the execution in the first quarter. We're now, however, in the uncharted waters of the COVID-19 pandemic. And as Dennis mentioned, every company is navigating the same storm but we are not all in the same boat. That's why we're confidently committing ourselves to healthy progress.

With that, I'll turn things back to Dennis.

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [5]

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Thank you, Matt. Before moving on to your questions, I want to highlight the great work being done by the CECO team in both executing projects in the field and railing in new wins during the pandemic's economic restrictions. In highlighting their great work, I'll focus on 2 projects: a nice win during the last week of the quarter and an essential customer project that we've been executing on-site throughout the quarter and into May.

I'll start with the ongoing project, one of many we continue to execute, which is shown on Slide 16. CECO booked this project in late 2018 as part of a gas power plant output and efficiency increase. We had previously completed work on 2 of 3 turbines in 2019 at this Michigan power plant, with work on the third unit underway during the spring of this year. Increasing the plant's electric production meant that the emission control systems had to be upgraded to handle increased NOx and CO output. CECO was contracted to design, build and install the emission controls and reduction systems so that the generating plant would continue to meet regulatory requirements while producing higher levels of power.

CECO's technology and teamwork, our competitive advantage, were demonstrated on this project as it involved complex design and installation issues under tight scheduling and a unique multi-pollutant catalyst product. Our expertise included a proprietary and patented system to handle the increased ammonia that the plant would have as part of its VOC reduction system. The plant upgrade, along with CECO's part of the project, was in the final stage when COVID-19 turned into a global pandemic. Not completing this work on schedule would mean that the plant wouldn't produce its obligated supply of electricity during the higher-demand summer months.

As you know, Michigan was hard hit by the COVID-19 virus, and strict limitations on travel and work were imposed. But this vital project was allowed to continue so we continued as well. CECO was managing up to 30 workers on site, and they had to adjust to CDC distancing and hygiene guidelines and cumbersome travel and lodging restrictions. Our team in the field hasn't missed a beat, proving that our execution can adapt to changing situations and still be superior. We're scheduled to finish up in May, part of a great brownfield upgrade, and I'm particularly proud of the CECO field team for their resilience.

One other quick highlight is reflected on Slide 17, demonstrating that our team was out winning new orders throughout the quarter and into late March when the public health and economic implications of COVID-19 were gaining steam. This project win supports the needs of a global manufacturer of key ingredients for foods, beverages and even pharmaceuticals, and therefore, it's considered an essential business during the pandemic. This customer's facility, located in Indiana, produces ingredients like starches that are derived from corn grain that yields a byproduct of fine particulate or dust that must be controlled and captured to assure safety and comply with environmental standards.

When the facility cyclone needed replacement and upgrading, they turned to CECO's Fisher-Klosterman brand. This was an uncontested win because the customer was loyal to our value proposition of high-quality products and engineered solutions to fit their specific operating requirements. This project was a classic win-win-win: customer maintained safety and has lower maintenance requirements, the environment is protected by the high-efficiency cyclone, and CECO exploits its competitive advantage in a pocket of activity essential even during the pandemic. Right now, CECO team is already underway with the engineering design.

Closing today's call with Slide 18, a summary of our products and services representing competitive advantages that will be exploiting in the pockets of activity that exist throughout our end markets. And I'll remind everybody that a reputation for not only providing sustainable solutions but also for doing what others can, through our technical capabilities and innovative products, gives us a distinct edge during the restart and recovery periods of our end markets. CECO's solutions for a cleaner, safer world are valued by industry to meet government regulations and improve the safety, efficiency and profitability of their operations. Not even the mighty COVID-19 virus can change this basic need of industries throughout the world.

In wrapping up, we had a solid first quarter despite the accelerating pandemic. We used our experience in strong position to decisively pivot to a different operating posture that strengthened our defense with the proactive cost actions to provide operating headroom and flexibility. And we refocused our offense to exploit our competitive advantages to win share in the pockets of activity that remain active in our markets. The COVID-19 pandemic has dealt everyone a challenging hand of cards. The winners, will be those who play their cards to the maximum potential. At CECO, the entire team is determined to be one of those winners and is committed to healthy progress through superior execution.

And now we welcome your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from Chris Van Horn with B. Riley FBR.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [2]

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Hope everyone is doing well. I was wondering if you could maybe update us on the real-time environment, how April is going with some of the states announcing restarts and some industrial end markets starting to ramp back up.

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [3]

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Yes. So first off, throughout the period, our operations have all remained active, with the offset of a brief shutdown in one of our pump's facilities that was down for about a week. So from the standpoint of executing backlog, most things are progressing. We're seeing some signs also in Europe that things, even in the most affected countries, are starting to come back.

From the point of view of market and activity, there's a mixed bag there. On the one hand, the very long-cycle larger projects seemed to be progressing. Where our content is part of a major investment in critical infrastructure, we see activity progressing there. On the short cycle, we still see some decent demand in pockets that I mentioned on the call, albeit with a very murky outlook. And in the middle there, in the mid-cycle, April was probably, as we anticipated, are going to be part of the rougher part of the period in that things were accelerating towards various shutdowns into March and starting to then pick back up here as hopefully as we come into May.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [4]

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Okay, got it. And you mentioned in the shift to the 4-4-2 strategy, market share seems to be on the offensive side here. So in some of our conversations, we're hearing that some smaller competitors are being more challenged than maybe others. And so do you see that as an opportunity in terms of taking share from your competitors as well as is there any M&A opportunity that you see in the pipeline?

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [5]

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So Chris, thanks for the question. Number one, we remain committed to growth. And while the overall environment is filled with various headwinds, we also have defined part of that growth that's 2x the market. And we can only accomplish growth ahead of the market by taking market share. And so we continue to focus on the active pockets. We stand tall. We're competing with strength. A number of the areas that you know about, with our backlog, our team, our global reach, our distributed workforce give us those kinds of differentiated strengths.

I -- we haven't seen anything of the smaller guys, so to speak, fall by the wayside. But it's pretty early. And if you recall back with the middle of the power gen downturn, we did lose to a couple of competitors that we'd regularly see on gas turbine exhaust systems and related type project activity. So time will tell, but we feel good about our position, strength of the balance sheet, the activity of the sales team and the continued adds to our sales pipeline. And on balance, they balance that out with. A lot of that pipeline is still stretching out as customers and people become much more deliberate about the timing of how they see some of those investments going forward.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [6]

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Okay, got it. And then lastly for me, I imagine you're seeing a lot of deferrals and possible cancellations of projects and awards. Is there a timing? I imagine there's a timing difference between some of those deferrals. And is there any visibility that you can give us from your customers of what they're thinking about as we head through 2020?

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [7]

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So I'll just say, start with, we -- through the end of Q1, no material cancellations. We continued to monitor projects throughout, have had projects put on temporary hold or slowed down as a result of other things that customers can't get done in this current environment. As far as visibility beyond that, it really is a mixed bag. Even in the refinery segment, we see some customers starting to talk about, "Hey, our output is relatively low right now. Maybe now is the time to pull some major maintenance brownfield project forward and get things done while we can." Some of the pure plays make real good money on the spreads that have widened right now. And then on the other hand, as you know and as would anticipate, a lot of companies are sitting and trying to delay their projects in order to conserve their own view and understanding of what happens next.

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Operator [8]

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The next question comes from Amit Dayal with H.C. Wainwright.

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Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [9]

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So with respect to the 2Q '20 outlook for the immediate near term, market is calling for 20% to 30% GDP decline in the quarter. So in that environment, how should we expect it to fare? And what would results, at a high level, potentially look like sequentially?

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [10]

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Yes. So we have not -- never provided short-term guidance. And with the amount of uncertainty out in the world, I think it would be the most intelligent thing to say, yes, Q2 has a lot of uncertainty, and for that, I probably can be accurate. At the same time, you should note that we entered the second quarter with $209 million of backlog, very healthy. All of our operations are active. We have a cost saving furlough of 2 weeks for all of our U.S. associates underway. Revenue continues through our operations, which will lead to operating income and the like, and progress probably similarly to what we're seeing in Q1 with speed bumps that we have to navigate. So it's an environment in Q2 that we're very fortunate we come into as we did at the beginning of the year, with a variety of strength and good backlog, good team, good focus from external to internal. And more than that, it's still been something that we navigate on a daily basis.

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Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [11]

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Understood. On the cost-cutting side, are any of these costs you have eliminated for the near term, are they going to be permanent changes? Or will you potentially sort of ramp those back as the market opens?

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Matthew Eckl, CECO Environmental Corp. - CFO [12]

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Yes, the way I'd divide that up would be a mix of onetime temporary and run rate savings. So of the $3.5 million we spoke to in the prepared remarks, $2 million is specific to Q2, that would be tied to the furlough and $1.5 million is run rate savings. So some of that would be temporary, the wage cuts until we get past the COVID-19 crisis and the Board cost cuts that took place as well. $1.5 million on a run rate basis is -- annualized would be $6 million. So those are the breakdown between what's Q2 and what's run rate savings.

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [13]

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I would add specific to what Matt's saying is, these are actions which we think are still proactive, proactive actions that give us the headroom and flexibility to continue to sense what's happening in the market and then adjust and adapt and continue to take appropriate action going forward.

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Operator [14]

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Our next question comes from Mike Cikos with Needham & Company.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [15]

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First question I had for you was around your gross margin strength. I understand you guys are selling the value here. But I just wanted to know, was there anything onetime that benefited this quarter? I know that the gross margins put up this quarter were above what you guys have historically been doing. Just trying to gauge the sustainability of this 35% gross margin target you have here now.

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Matthew Eckl, CECO Environmental Corp. - CFO [16]

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Yes. We had a really good quarter, most of it tied to project execution. We did see some productivity in our plant from the investments we made in fluid handling. We still believe 32% to 34% of the appropriate for modeling based on historical average, we did outperform in this quarter. It wasn't onetime. All 3 segments did really good in the quarter.

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Michael Joseph Cikos, Needham & Company, LLC, Research Division - Associate [17]

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Okay. And then the follow-up I had for you guys. I know that there were some comments in the prepared remarks as well as far as management's experience during the prior micro-recession. But if we were using that, let's say, as a template, understanding we're in uncharted territories here, can you give us an idea of what markets came back first? Or I guess, what we should be watching as a potential indication of things maybe improving for CECO's end markets?

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Matthew Eckl, CECO Environmental Corp. - CFO [18]

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The 2 end markets that occurred in the micro-recession were the power gen market. We're still in the fourth year of that downturn as new nat gas gigawatt is just not returned. At the same exact time, we had a 30-year downturn in refinery utilization hit 90% in the U.S., and nobody was making turnarounds or investments in refinery CapEx. And our refinery turned back within about 5 quarters quickly and almost violently, where we went from $10 million bookings over a 10-month period to $20 million over a $3 million period -- or sorry, a 3-month period. So it turned back fairly quickly and that was a 30-year dip.

This occasion, as far as COVID-19, what I'd tell you, Mike, is its all markets that we play in that are likely impacted by the pandemic. And to say that one is going to respond quickly, there's lots of research out there as to who thinks that what's going to return faster, and I don't have a good perspective on that just yet. It's quite uncertain. But Dennis maybe has a comment on outlook that he'd like to add.

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [19]

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Well, just the one thing, whether return is always going to be an interesting question because we have a very diverse set of end markets that we cover that there are quite a few critical infrastructure and key industries that are still active today. And I mentioned a few of those on the prepared remarks earlier here this morning, places like food and beverage. The food supply, you see a lot of people actually having to pick up and step up their demand. The semiconductor manufacturers and with tech being strong and all of us still working from home, demand there is likely strong as well. We anticipate the investments will likely continue.

So there's a variety of these areas that are strong as we speak, relatively speaking. There's movement. There's activity. We're actually being called out to do even some site walk-throughs to assess new project activity in some of these areas. So it isn't just what comes back first but some things that are still active today, and we like our positioning there.

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Operator [20]

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(Operator Instructions) The next question will come from Tate Sullivan with Maxim.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [21]

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Following up that comment on refining and cyclone specifically, Dennis. Are the cyclones -- well, first on refining, I mean, if worst-case scenario, we come out of this and oil prices stay low, what is -- can you remind me of the replacement cycle for cyclones for existing refineries, please? And I mean, is it totally dependent on the output levels, too?

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [22]

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So our key product into the refinery market are cyclones in the catalytic cracking process. And what we are doing is recycling a fine powder catalyst back into the system, very high-value, high-efficiency cyclones. They vary in size from large to very, very large. We have, by all means, the leading global market share, strongest technical team. And so replacement isn't necessarily that much driven by localized output but it is by conditions because you're circulating a product that has an erosion effect. And so whether there's an input feedstock change or there's some wearing out as a cycle. But our product is a 10-year design life, probably has a 20-year full life with a variety of aftermarket opportunities within that period. And right now, we do see activity that's progressing from the planning stage up and over to the -- into more order stage as we see right now.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [23]

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Okay. And the cyclone specs, is it a completely different type of cyclone because it don't have the catalyst for food and beverage end market? And are there other industrial end markets for cyclones, if you can...

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [24]

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Yes. So we also have a substantial array under our Fisher-Klosterman brand of industrial cyclones that do everything from high-purity polysilicon for the solar industry, clean room type stuff for pharma as well as a lot in any other industry where you see a high degree of dust or related activity from wood, from corn, et cetera. And that's a big part -- a key piece often of an overall industrial air quality system.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [25]

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Okay. Matt, can you -- on the slide on the leverage covenants in the existing credit facility and just is the key metric to focus on, but then you have meaningful cushion over that, the bank-defined leverage ratio.

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Matthew Eckl, CECO Environmental Corp. - CFO [26]

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Yes, we actually published it. And I think the -- let me pull up the exact slide. But on the debt page of our -- we actually published the gross leverage ratio. We have a fixed charge covenant as well, but we're being asset-light so far away from that. And it's really just the gross leverage. I think our current -- we're sitting at 1.5 and that goes all the way up right now to 3.5 is our covenant currently.

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Tate H. Sullivan, Maxim Group LLC, Research Division - Senior VP & Senior Industrials Analyst [27]

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To 3.5. Okay, that's what I got. Okay, just wanted to confirm.

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Operator [28]

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Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Dennis Sadlowski, Chief Executive Officer of CECO Environmental.

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Dennis Sadlowski, CECO Environmental Corp. - CEO & Director [29]

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Yes. Guys, thank you again for joining our call. I just want to reinforce that even in this challenging period for the world, challenging period for the company, the leadership team at CECO is committed to healthy progress through superior execution. And I think through the first quarter and into today, we're demonstrating that fairly well.

This morning on the way in, I heard one of the lead analysts on CNBC talk about what are the winners who are going to come out of this segment, those are going to be the companies with strong balance sheet, positive cash flows and a good management team. And I'd like to think that we'll be one of those winners because we absolutely come into this with a strong balance sheet, we continue to demonstrate positive cash flows, and I like the team around me and how they're executing. So thanks again for joining the call. We'll talk again in 90 days.

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Operator [30]

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