Business Context and Reporting Period
CECO Environmental Corp. filed this unaudited Form 10-Q for the three months ended March 31, 2022. CECO provides engineered environmental and industrial solutions addressing air and water emissions, fluid handling, separation, filtration, thermal acoustics, dampers and expansion joints. Operations are reported through Engineered Systems and Industrial Process Solutions.
Financial Performance and Position
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Net sales | $92.4 million | $71.9 million | Up 28.5% |
| Gross profit | $26.4 million | $24.4 million | Up 8.2% |
| Gross margin | 28.6% | 33.9% | Down 530 basis points |
| Operating income | $5.2 million | $3.1 million | Up $2.1 million |
| Operating margin | 5.6% | 4.3% | Up 130 basis points |
| Net income attributable to CECO | $2.8 million | $1.2 million | Up $1.6 million |
| Diluted EPS | $0.08 | $0.03 | Up $0.05 |
| Non-GAAP operating income | $7.8 million | $5.0 million | Up 56% |
| Non-GAAP operating margin | 8.4% | 7.0% | Up 140 basis points |
Orders booked increased to $160.9 million from $92.1 million. Backlog rose to $283.2 million at March 31, 2022, compared with $213.9 million at December 31, 2021; substantially all backlog was expected to be delivered within 12 to 18 months.
- Engineered Systems revenue increased 26.1% to $57.0 million, while segment operating income increased to $6.5 million from $6.2 million.
- Industrial Process Solutions revenue increased 16.1% to $35.5 million, while segment operating income increased to $4.1 million from $3.8 million.
- Gross margin declined because of inflation, supply-chain challenges and lower project-margin mix, partially offset by price increases.
- Selling and administrative expense declined to $18.6 million from $19.4 million, including a $2.5 million favorable insurance settlement.
- Income tax expense was $1.1 million, and the effective tax rate was 28.3%, compared with 29.8% in the prior-year quarter.
Cash Flow, Debt and Liquidity
- Operating cash flow was negative $0.2 million, compared with $9.9 million of operating cash flow in Q1 2021, primarily because of working-capital changes, including a $19.0 million increase in accounts receivable and a $3.3 million increase in inventories.
- Investing cash flow was negative $20.2 million, principally reflecting $19.6 million of cash paid for the General Rubber acquisition and $0.7 million of capital expenditures.
- Financing cash flow was positive $19.9 million, primarily from net borrowings used to fund the General Rubber acquisition, partially offset by a $0.9 million distribution to noncontrolling interests.
- Cash, cash equivalents and restricted cash totaled $30.3 million at March 31, 2022, including $28.4 million of cash and cash equivalents, compared with $32.0 million of combined cash and restricted cash at December 31, 2021.
- Working capital was $79.2 million, and the current ratio was 1.60 to 1.00.
- Total debt was $84.7 million, net of unamortized debt discount, compared with $63.8 million at December 31, 2021. The increase primarily reflected acquisition financing.
- Borrowings included $43.0 million of term debt, $32.6 million drawn on the revolving facility and $10.9 million of joint-venture term debt. The weighted-average stated borrowing rate was 2.87%.
- Available credit was $59.9 million based on borrowing limitations, with $17.3 million of outstanding letters of credit. The company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue, operating income and attributable net income increased substantially, but gross margin contracted by 530 basis points.
- Operating cash conversion deteriorated, with operating cash flow declining by $10.1 million year over year.
- Debt increased by approximately $20.9 million, primarily to finance the General Rubber acquisition.
- On March 7, 2022, CECO, through its Effox-Flextor-Mader joint venture, acquired General Rubber, LLC for approximately $19.7 million in cash and issued the former owners a 10% interest in the joint venture valued at approximately $5.0 million. General Rubber contributed $0.7 million of revenue and $0.3 million of net income during the quarter.
- Acquisition and integration expense increased to $1.0 million from $0.1 million, and restructuring expense was $0.1 million versus none in the prior-year quarter.
- Foreign currency translation produced a $0.5 million loss in Q1 2022 versus a $0.1 million gain in Q1 2021.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal annual revenue or earnings guidance. Management expects supply-chain challenges, raw-material shortages and inflationary pressures affecting materials and labor to continue for the foreseeable future. CECO has implemented price increases and material surcharges and has sought alternate sources of supply, but stated that these actions may not fully mitigate future disruptions.
- COVID-19 continues to create uncertainty for operations, suppliers, customers, workforce availability and end markets.
- Fixed-price contracts expose the company to cost overruns, project delays and potential losses if estimates prove inaccurate.
- Higher interest rates may increase costs because most debt interest is indexed to SOFR. Management estimated the annual earnings and cash-flow impact of a hypothetical 10% change in the weighted-average borrowing rate at approximately $0.3 million.
- Asbestos-related litigation totaled 240 pending cases at March 31, 2022, compared with 223 at December 31, 2021. Management believes insurance coverage is adequate and that pending cases are not expected to have a material adverse effect, but coverage and claim volumes remain uncertain.
- Goodwill increased by $20.7 million from the General Rubber acquisition. No interim impairment-triggering events were identified during the quarter, but impairment assessments remain sensitive to revenue, operating profit, terminal growth and cost-of-capital assumptions.
- On May 3, 2022, after quarter-end, CECO acquired Compass Water Solutions for approximately $12.5 million using cash and debt. The transaction was not included in the reported Q1 results, and purchase accounting disclosures were incomplete when the filing was issued.
- Management stated that disclosure controls were effective as of March 31, 2022, with no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the significant order intake and $283.2 million backlog convert to revenue at expected margins.
- Whether pricing actions offset inflation, supply-chain costs and labor pressures sufficiently to restore gross margin.
- The sustainability and quality of operating cash flow as receivables and inventories remain elevated.
- Post-acquisition leverage, covenant compliance and available borrowing capacity, including the effect of the Compass acquisition.
- Integration performance and final purchase accounting for General Rubber and Compass Water Solutions.
- Developments in asbestos claims, insurance coverage and other litigation or warranty contingencies.
- The effect of SOFR-based borrowing costs, foreign-exchange movements and continuing COVID-19 or other macroeconomic disruptions.