CECO Environmental Corp. — Q1 2017 Form 10-Q Summary
Business context and reporting period
CECO is a diversified global provider of engineered technologies for the energy, environmental, and fluid handling and filtration markets. Its products include emissions-control, filtration, separation, exhaust, pump, and industrial process systems. The filing covers the unaudited three months ended March 31, 2017, compared with the same period in 2016.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $92.7 million | $103.2 million | Down 10.2% |
| Gross profit | $31.9 million | $31.6 million | Up 1.1% |
| Gross margin | 34.5% | 30.6% | Up 390 bps |
| Operating income | $1.4 million | $5.8 million | Down $4.5 million |
| Operating margin | 1.5% | 5.6% | Down 410 bps |
| Net income attributable to CECO | $38 thousand | $3.1 million | Down $3.1 million |
| Diluted EPS | $0.00 | $0.09 | Down $0.09 |
| Cash flow from operations | $4.7 million | $9.4 million | Down $4.7 million |
Non-GAAP operating income was $10.0 million, or 10.8% of sales, compared with $10.9 million, or 10.6%, in Q1 2016. The company excludes amortization and earn-out expenses, executive transition costs, facility exit costs, and certain valuation adjustments from this measure.
Cash and cash equivalents were $45.0 million at March 31, 2017, including $28.9 million held by non-U.S. subsidiaries. Working capital was $68.8 million, and the current ratio was 1.52 to 1. Total debt was $119.4 million, consisting primarily of $118.1 million under the Credit Facility and $1.3 million under the China Facility. Debt declined from $123.2 million at December 31, 2016. Available credit was $40.2 million based on borrowing limitations, while total stated unused availability was $71.3 million.
Financing activities used $5.3 million, including $4.0 million of debt repayments and $2.6 million of dividends. Capital expenditures were $0.4 million. The company paid a quarterly dividend of $0.075 per share.
Material changes versus the prior comparable period
- Sales declined primarily because of lower demand for solid-fuel power generation, natural-gas turbine exhaust, and refinery-related products.
- Orders booked fell to $84.0 million from $120.1 million, reflecting weaker demand and lower customer facility utilization.
- Backlog declined to $184.2 million at March 31, 2017, from $197.0 million at December 31, 2016; $4.1 million of previously reported acquired backlog was canceled.
- Gross margin improved because of a more favorable project and product mix, despite lower sales volume.
- Selling and administrative expenses increased to $23.3 million from $20.9 million, driven by $0.9 million of executive transition costs, $0.2 million of facility exit costs, and additional selling and finance personnel.
- Amortization and earn-out expense increased to $7.3 million from $4.8 million, primarily because of a $3.9 million fair-value adjustment to the Zhongli earn-out liability, compared with $0.8 million in Q1 2016.
- Interest expense decreased to $1.7 million from $2.1 million due to debt repayments.
- The company reported a $0.5 million income tax benefit versus $1.4 million of tax expense in Q1 2016. The 2017 benefit included a $0.4 million discrete tax benefit from adopting ASU 2016-09.
Segment results
| Segment | Q1 2017 sales | Q1 2016 sales | Q1 2017 operating income | Q1 2016 operating income |
|---|---|---|---|---|
| Energy | $41.1 million | $47.9 million | $1.6 million | $5.2 million |
| Environmental | $35.9 million | $39.1 million | $5.1 million | $4.7 million |
| Fluid Handling and Filtration | $15.8 million | $16.6 million | $3.3 million | $3.2 million |
Guidance, outlook, risks, and unusual items
The filing does not provide quantified full-year revenue or earnings guidance. Management expects growth opportunities from natural-gas infrastructure, emissions regulation, cleaner power generation, aftermarket services, and expansion in Asia. The company continues to emphasize operational excellence, margin expansion, recurring aftermarket revenue, and selective bolt-on acquisitions.
Management cautions that backlog may not convert into revenue because of cancellations, project delays, contractor and subcontractor performance, scope changes, weather, labor availability, and contract profitability risks. Other disclosed risks include fixed-price contract cost overruns, economic and industry weakness, raw-material price volatility, acquisition integration, substantial debt, refinancing, regulation, competition, seasonality, foreign exchange, and litigation.
The company was in compliance with its debt covenants at March 31, 2017. The Credit Facility requires a consolidated leverage ratio below 3.25 and a fixed-charge coverage ratio above 1.25; the leverage threshold was scheduled to tighten to 3.00 on October 1, 2017. Scheduled debt principal payments total $6.7 million for the remainder of 2017 and $95.7 million in 2020.
There were 228 asbestos-related cases pending at March 31, 2017. Management believes insurance coverage is adequate and that the cases will not materially affect financial condition, liquidity, or results, but notes that outcomes depend on claim volume, claim characteristics, and insurer solvency and coverage positions. The company is also disputing an insurer’s claim for reimbursement of defense costs related to the Valero litigation.
The company adopted ASU 2016-09, resulting in a $0.1 million reduction to retained earnings for forfeiture accounting and a $0.4 million discrete tax benefit. It expects the future lease standard to materially increase recognized right-of-use assets and liabilities but does not expect a material liquidity impact. Revenue-recognition implementation remained ongoing.
Investor verification points
- Verify the sustainability of the improved 34.5% gross margin amid declining sales, orders, and backlog.
- Assess whether the $3.9 million Zhongli earn-out fair-value adjustment is non-recurring and how future earn-out payments may affect cash flow.
- Monitor debt repayment requirements, covenant headroom, interest-rate exposure, and the October 2017 leverage-ratio tightening.
- Evaluate conversion of the $184.2 million backlog into revenue, including cancellations and fixed-price contract profitability.
- Review cash generation relative to dividends, scheduled debt payments, pension contributions, and potential acquisitions.
- Track asbestos claims, the Valero-related insurer dispute, and any changes in insurance coverage or accrued liabilities.