CECO Environmental Corp. — Q2 2015 Form 10-Q Summary
Business context and reporting period
CECO is a global environmental technology company providing air pollution control, energy, fluid handling and filtration products and engineered services. This unaudited Form 10-Q covers the three and six months ended June 30, 2015, compared with the corresponding 2014 periods. Results include contributions from the 2014 acquisitions of HEE, SAT, Emtrol and Zhongli.
Key financial metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $87.0 million | $66.6 million | $167.9 million | $123.8 million |
| Gross profit | $26.6 million | $21.4 million | $47.6 million | $41.2 million |
| Gross margin | 30.6% | 32.1% | 28.3% | 33.3% |
| Operating income | $4.5 million | $7.2 million | $7.5 million | $12.7 million |
| Operating margin | 5.2% | 10.8% | 4.5% | 10.3% |
| Net income | $2.1 million | $4.5 million | $2.3 million | $7.5 million |
| Diluted EPS | $0.08 | $0.17 | $0.09 | $0.29 |
| Operating cash flow | Not separately provided | Not separately provided | $(0.1) million | $1.8 million |
Non-GAAP operating income was $12.3 million in Q2 and $19.8 million for the first six months, compared with $9.9 million and $18.1 million, respectively, in the prior-year periods. Non-GAAP operating margins were 14.1% and 11.8%, versus 14.9% and 14.6%.
At June 30, 2015, cash and cash equivalents were $17.1 million, down from $19.4 million at December 31, 2014. Total debt was $111.7 million, including $12.3 million classified as current. Unused credit availability was $72.7 million under the U.S. Credit Facility and $73.4 million including other non-U.S. facilities. The company was in compliance with its debt covenants.
Working-capital balances increased, including accounts receivable of $65.8 million and costs and estimated earnings in excess of billings of $31.8 million. Total assets were $416.7 million and shareholders’ equity was $180.6 million at June 30, 2015.
Material changes versus the prior comparable period
- Q2 sales increased 30.5% and six-month sales increased 35.6%, primarily from Emtrol and Zhongli acquisitions, as well as stronger Aarding and Buell-FKI results.
- APC sales increased to $41.8 million in Q2 and $83.5 million for the first six months; Energy sales increased to $27.3 million and $51.7 million, respectively. FHF sales increased modestly to $17.7 million and $32.9 million.
- Gross margins declined because of lower margins at Emtrol and Zhongli and weaker performance at Aarding and Effox-Flextor.
- GAAP operating income and net income declined despite higher revenue. Acquisition and integration expenses increased to $1.0 million in Q2 and $1.3 million year-to-date, while amortization and earn-out expenses increased to $6.7 million and $10.7 million.
- Zhongli recorded a Q2 operating loss of $1.8 million, including a $3.6 million fair-value adjustment to its earn-out liability. The six-month adjustment was $4.5 million, and the estimated Zhongli earn-out liability reached $21.6 million.
- Energy operating income declined materially to $0.2 million in Q2 and $0.6 million year-to-date, primarily due to Effox-Flextor weakness and Zhongli losses. FHF operating income improved to $4.4 million and $7.4 million.
- Operating cash flow decreased to negative $0.1 million, driven largely by lower earnings and increases in accounts receivable and contract assets. Financing activities used $4.3 million, including $3.5 million of dividends.
Guidance, outlook, risks and unusual items
The filing does not provide formal quantitative earnings or revenue guidance. Management emphasizes revenue growth, operational excellence, margin expansion, aftermarket growth, safety and expansion in China. Orders booked were $74.6 million in Q2 and $168.5 million year-to-date, compared with $57.7 million and $121.3 million in the prior-year periods. Backlog was $140.6 million at June 30, 2015, compared with $140.1 million at December 31, 2014.
CECO entered into an agreement to acquire PMFG for approximately $150 million of equity value, or $6.85 per share. Approximately 55% of the consideration was expected to be stock and 45% cash, subject to proration. Closing was expected in the third quarter of 2015, subject to shareholder and customary closing conditions. Financing commitments were obtained to fund the cash portion and amend the Credit Facility.
Key risks include integration of recent and pending acquisitions, substantial debt and refinancing needs, fixed-price contract cost overruns, contract delays or cancellations, working-capital requirements, foreign exchange and interest-rate exposure, regulatory and economic conditions, competition, and litigation. Four reporting units had limited goodwill valuation cushions, and management stated that failure to achieve its 2015 operating plan could result in material non-cash impairment charges.
There were 215 pending asbestos-related cases at June 30, 2015, compared with 195 at year-end 2014. Management believes insurance coverage is adequate and that the cases will not materially affect results, liquidity or financial condition, but acknowledges limited control over claim volume, claim nature and insurer coverage. A separate court ruling awarded approximately $0.6 million plus attorneys’ fees to Viron; the company is defending the claim.
Management reported that disclosure controls and procedures were not effective because a previously identified material weakness in internal control over financial reporting had not been fully remediated. The weakness related primarily to accounting personnel and oversight, income-tax accounting and segregation of duties. Management stated that the financial statements were fairly presented after additional procedures.
Important facts for investors to verify
- Completion, financing, dilution and integration effects of the PMFG acquisition.
- Progress in restoring gross margins and improving Zhongli and Effox-Flextor profitability.
- Conversion of backlog and orders into revenue and cash, particularly given negative year-to-date operating cash flow.
- Debt covenant compliance, interest-rate exposure, required amortization and available borrowing capacity.
- Potential goodwill, indefinite-lived intangible and definite-lived intangible impairment charges.
- Remediation and independent assessment of the material weakness in internal controls.
- Future changes in asbestos claims, Viron litigation and insurance coverage.
- Continuation of the $0.066 quarterly dividend, which remains subject to board discretion and lender consent.