CECO Environmental Corp. 2013 Q3 Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2013. CECO provides environmental technology, air-pollution control, fluid-handling, filtration, product-recovery, contracting and component products globally through four reportable segments: Engineered Equipment Technology and Parts, Met-Pro, Contracting/Services and Component Parts.
Results include Aarding Thermal Acoustics from February 28, 2013 and Met-Pro from its August 27, 2013 acquisition date. Accordingly, reported comparisons are affected by acquisition timing.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Net sales | $49.8 million | $33.1 million | $128.6 million | $100.7 million |
| Gross profit | $14.6 million | $10.5 million | $40.0 million | $31.2 million |
| Gross margin | 29.3% | 31.7% | 31.1% | 31.0% |
| Operating income/(loss) | $(3.4) million | $4.3 million | $3.3 million | $12.3 million |
| Operating margin | (6.8)% | 12.8% | 2.6% | 12.2% |
| Net income/(loss) | $(1.5) million | $3.3 million | $3.8 million | $7.8 million |
| Diluted EPS | $(0.07) | $0.19 | $0.20 | $0.47 |
Q3 2013 operating results included $4.0 million of acquisition and integration expense, $2.0 million of amortization and earn-out expense, $0.5 million of Met-Pro valuation adjustments and a $2.5 million legal reserve. Management reported non-GAAP operating income of $5.6 million for Q3 and $16.4 million for the nine-month period, compared with $4.3 million and $12.5 million, respectively, on the comparable non-GAAP basis.
The effective tax rate was a benefit of 60.7% in Q3 and 38.0% for the first nine months, primarily reflecting research and development tax credits and other permanent differences.
Cash flow, liquidity and debt
- Cash provided by operating activities was $10.4 million for the first nine months, down from $13.8 million in 2012.
- Investing cash use was $105.0 million, including $80.0 million for Met-Pro, $24.4 million for Aarding and $0.5 million for capital expenditures.
- Financing activities provided $85.2 million, primarily from $92.0 million of borrowings. The company paid $3.0 million of dividends and repurchased $2.4 million of common stock.
- Cash declined to $13.6 million at September 30, 2013 from $23.0 million at December 31, 2012. Approximately $6.2 million was held outside the United States, principally in China.
- Approximately $90 million was outstanding under the new senior secured credit facilities, compared with no borrowings at December 31, 2012. The facilities include a $65 million term loan, a $70.5 million U.S. revolving facility and a $19.5 million multicurrency revolving facility.
- The credit agreement requires a consolidated leverage ratio below 2.75 and fixed-charge coverage ratio above 1.25. CECO reported compliance with its covenants at September 30, 2013 and expected continued compliance.
- Management stated that operating cash flow, existing cash and available revolver capacity should fund anticipated needs for at least the next twelve months, although longer-term liquidity depends on future operating performance and cash flow.
Material changes versus the prior comparable period
- Q3 sales increased 50.4% and nine-month sales increased 27.7%, primarily from Adwest, Aarding and one month of Met-Pro results.
- Excluding acquisitions, management stated that revenue decreased by approximately $4.9 million for the nine-month period, principally because of order delays.
- Gross profit increased, but Q3 gross margin declined 240 basis points, primarily because of lower margins at Effox; nine-month gross margin was approximately flat.
- Operating income declined sharply because of acquisition-related costs, higher amortization, legal reserves and Met-Pro-related valuation adjustments.
- Contracting/Services revenue declined to $4.4 million in Q3 and $13.5 million for nine months, from $5.6 million and $19.5 million, respectively. The segment reported a nine-month operating loss of $1.3 million versus income of $2.5 million.
- Backlog increased to $100.4 million at September 30, 2013 from $59.5 million at December 31, 2012; management attributed approximately $17.0 million to Aarding and $25.0 million to Met-Pro.
- Shares issued increased materially to fund acquisitions. Approximately 7.7 million shares were issued in the Met-Pro transaction, and 180,000 shares were repurchased from the CEO in September for $2.4 million.
Outlook, commentary, risks and unusual items
Management did not provide specific numerical revenue or earnings guidance. It expects opportunities from stricter environmental regulations, increased pollution-control spending, growth in China and India, aftermarket activity and operational improvements. Sales historically peak in the fourth quarter because customers use annual capital budgets and schedule maintenance during holiday shutdowns.
- Key execution risks include integrating Met-Pro, achieving expected synergies, managing substantially higher debt and complying with credit-facility covenants.
- Fixed-price contracts expose CECO to cost-estimation errors, project delays, scope changes, subcontractor performance, weather and labor availability. Revenue is primarily recognized using the percentage-of-completion method.
- Met-Pro is subject to asbestos-related litigation. There were 175 pending cases at September 30, 2013; the company believes insurance coverage is adequate but notes that insurer solvency and coverage positions are outside its control.
- Other matters include a union pension claim of up to $5.3 million plus interest, a Valero product-liability claim alleging damages of up to $75 million, and other product-liability litigation. The filing states that the ultimate costs cannot be predicted.
- CECO accrued a $2.5 million legal reserve at September 30, 2013. The company also disclosed a pending Met-Pro shareholder class-action settlement subject to court approval.
- Acquisition accounting remained preliminary and could change materially as purchase-price valuations and related tax balances were finalized.
- Internal controls were considered effective at a reasonable-assurance level, while integration of Met-Pro’s financial reporting controls was still in process.
Important facts for investors to verify
- Whether Met-Pro integration produces the expected revenue, margin and synergy benefits after a full reporting period.
- Debt balances, available revolver capacity, required amortization and compliance with the 2.75 leverage and 1.25 fixed-charge coverage covenants.
- Underlying operating performance excluding acquisition, amortization, valuation and legal charges, while recognizing that non-GAAP measures are not GAAP substitutes.
- Conversion of the $100.4 million backlog into revenue and cash, including exposure to fixed-price contract losses and project delays.
- Final purchase-price accounting for Met-Pro and Aarding, including goodwill, intangible assets, deferred taxes and earn-out obligations.
- Developments in asbestos, pension, product-liability and shareholder litigation, including insurance coverage and potential additional reserves.
- Sustainability of cash dividends in light of increased debt, working-capital needs and credit-agreement restrictions.