CECO Environmental Corp. — Q2 2014 Form 10-Q Summary
Business context and reporting period
CECO Environmental Corp. is a global environmental technology company serving air pollution control, energy, fluid handling and filtration markets. The filing covers the three and six months ended June 30, 2014, with comparative periods ended June 30, 2013. Results include the August 2013 acquisition of Met-Pro for the first time in a full six-month period and the February 2013 acquisition of Aarding.
Effective January 1, 2014, the Company reported three segments: Air Pollution Control, Energy, and Fluid Handling and Filtration. Management noted that sales typically peak in the fourth quarter due to customer capital-budget timing and seasonal maintenance activity.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $66.6 million | $44.4 million | $123.8 million | $78.8 million |
| Gross profit | $21.4 million | $14.3 million | $41.2 million | $25.5 million |
| Gross margin | 32.1% | 32.2% | 33.3% | 32.4% |
| Operating income | $7.2 million | $3.3 million | $12.7 million | $6.6 million |
| Operating margin | 10.8% | 7.4% | 10.3% | 8.4% |
| Net income | $4.5 million | $3.0 million | $7.5 million | $5.3 million |
| Diluted EPS | $0.17 | $0.17 | $0.29 | $0.29 |
Q2 sales increased 50.0% year over year, while six-month sales increased 57.1%. Q2 non-GAAP operating income was $9.9 million, or 14.9% of sales, compared with $6.2 million, or 13.9%, in the prior-year quarter. Six-month non-GAAP operating income was $18.1 million, or 14.6% of sales, compared with $10.8 million, or 13.7%.
Interest expense increased to $0.7 million in Q2 and $1.5 million for the six-month period, primarily because of acquisition-related borrowings. The effective tax rate was 28.9% in Q2 and 31.5% for the six-month period, compared with 1.6% and 18.8%, respectively, in the prior-year periods. The 2013 tax expense benefited from research and development tax credits.
Cash flow, liquidity and debt
| Balance sheet or cash flow item | June 30, 2014 | December 31, 2013 |
|---|---|---|
| Cash and cash equivalents | $17.8 million | $22.7 million |
| Total debt | $79.2 million | $89.1 million |
| Current portion of debt | $7.0 million | $9.9 million |
| Total shareholders’ equity | $175.6 million | $170.4 million |
| Unused total credit availability | $77.6 million | $72.9 million |
- Six-month operating cash flow was $1.8 million, down from $8.1 million in 2013.
- Investing activities provided $6.4 million, primarily from $7.1 million of proceeds from property and asset sales; the prior-year period used $24.6 million, largely for the Aarding acquisition.
- Financing activities used $13.1 million, including $10.1 million of debt repayments, $2.8 million of dividends and $1.0 million of share repurchases.
- Cash decreased by $4.9 million during the first six months. Approximately $11.0 million of cash was held outside the United States.
- The senior secured credit facility had $69.2 million of unused availability, excluding other non-U.S. facilities, and matures in August 2018. The weighted-average borrowing rate was 2.22% at June 30, 2014.
- The Company was in compliance with its debt covenants, including a consolidated leverage ratio below 2.75 and fixed-charge coverage ratio above 1.25.
Material changes versus the prior comparable period
- Met-Pro contributed approximately $23.2 million of Q2 sales and $42.4 million of six-month sales, materially driving consolidated growth and adding the Fluid Handling and Filtration segment.
- Fluid Handling and Filtration sales increased to $16.7 million in Q2 from $1.2 million and to $32.1 million for six months from $2.9 million, primarily because of Met-Pro.
- Air Pollution Control sales increased to $32.9 million in Q2 from $24.1 million and to $59.7 million for six months from $44.6 million. China and Adwest contributed to growth, while domestic FKI and Busch sales declined.
- Energy sales declined to $16.8 million in Q2 from $19.0 million, and Energy operating income declined to $1.6 million from $3.1 million. Six-month Energy operating income declined to $4.0 million from $5.4 million.
- Acquisition and integration expense declined to $0.2 million in both 2014 periods from $2.3 million in Q2 2013 and $3.4 million for the six-month period, while amortization and earn-out expense increased to $2.4 million and $4.9 million, respectively.
- Backlog was $96.0 million at June 30, 2014, compared with $98.5 million at December 31, 2013. Orders booked were $57.7 million in Q2 and $121.3 million for six months, compared with $46.5 million and $84.1 million, respectively.
Outlook, risks, contingencies and unusual items
Management expects environmental regulation, global pollution-control investment, energy-efficiency initiatives and tightening Chinese air-quality standards to support demand. The Company intends to pursue global growth, operational improvements, aftermarket expansion, and future bolt-on acquisitions. No specific quantitative earnings or revenue guidance was provided.
- Management stated that operating cash flow, cash on hand and available borrowings should fund anticipated needs for at least the next twelve months, but future liquidity and covenant compliance depend on operating performance, economic conditions and other factors.
- Fixed-price contracts create risks that actual costs may exceed estimates. Project delays, cancellations, subcontractor performance, scope changes, weather and labor availability may affect profitability.
- There were 186 pending asbestos-related cases as of June 30, 2014, compared with 173 at December 31, 2013. The Company believes insurance coverage is adequate and does not expect a material adverse impact, subject to claim volume, claim characteristics and insurer coverage.
- A subsidiary faces a Valero products-liability lawsuit alleging damages of approximately $36 million, with plaintiffs generally alleging losses not exceeding $75 million. No reserve had been recorded as of June 30, 2014.
- The Met-Pro merger-related shareholder litigation was approved for settlement on June 10, 2014 and was fully resolved without remaining liability to the Company.
- Finite-life intangible amortization is expected to total $3.4 million for the remainder of 2014, $7.1 million in 2015, $6.1 million in 2016, $5.2 million in 2017 and $4.0 million in 2018.
- The Company adopted neither of the newly issued revenue-recognition or discontinued-operations standards during the period. It was evaluating the impact of the revenue standard, which was effective for annual periods beginning after December 15, 2016.
- Disclosure controls and procedures were evaluated as effective as of June 30, 2014, with no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Met-Pro integration produces sustainable organic growth and margins after acquisition-related amortization and earn-out costs.
- Whether the Energy segment’s Q2 revenue and operating-income declines are temporary or reflect deteriorating demand or execution.
- Cash conversion and working-capital trends, given operating cash flow of only $1.8 million despite $7.5 million of six-month net income.
- Debt reduction progress, variable-rate exposure, covenant headroom and the ability to refinance or repay debt as scheduled.
- The development, insurance coverage and potential exposure associated with asbestos claims and the Valero litigation.
- Whether the $96.0 million backlog converts into revenue and acceptable profit, considering cancellation and subcontractor risks.
- The sustainability of dividends and share repurchases, which remain subject to board discretion and lender consent.