CECO Environmental Corp. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2013; unaudited results compared with the corresponding 2012 periods. CECO provides air-pollution control equipment, engineered systems, contracting and services, and component parts across industrial markets and multiple geographic regions.
Financial performance and condition
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $44.4 million | $34.6 million | $78.8 million | $67.6 million |
| Gross profit | $14.3 million | $10.5 million | $25.5 million | $20.7 million |
| Gross margin | 32.2% | 30.3% | 32.4% | 30.6% |
| Operating income | $3.3 million | $4.3 million | $6.6 million | $8.0 million |
| Operating margin | 7.4% | 12.4% | 8.4% | 11.8% |
| Net income | $3.0 million | $2.5 million | $5.3 million | $4.5 million |
| Diluted EPS | $0.17 | $0.15 | $0.29 | $0.27 |
- Cash flow: Operating cash flow was $8.1 million for the first six months, versus $8.6 million in 2012. Investing cash flow was $(24.6) million, principally reflecting the $24.4 million cash acquisition of Aarding. Financing cash flow was $(1.4) million, including $1.8 million of dividends.
- Liquidity: Cash and cash equivalents were $5.1 million at June 30, 2013, down from $23.0 million at December 31, 2012. The U.S. revolving facility had no borrowings, $23.5 million of borrowing availability, and $1.5 million of outstanding trade letters. The Netherlands subsidiary had $1.6 million of borrowings.
- Debt and covenants: CECO reported compliance with its debt covenants. The U.S. facility was amended to extend the revolver maturity to April 1, 2014 and increase the maximum commitment to $25 million, subject to availability.
- Balance sheet: Total assets increased to $117.6 million from $94.1 million, primarily due to the Aarding acquisition. Total liabilities were $44.5 million and shareholders’ equity was $73.1 million at June 30, 2013.
- Backlog: Backlog was $77.9 million at June 30, 2013, compared with $59.5 million at December 31, 2012; approximately $13.3 million related to Aarding.
Material changes versus the prior comparable period
- Second-quarter sales increased 28.5%, and first-half sales increased 16.5%, driven principally by the Adwest and Aarding acquisitions. Aarding and Adwest contributed approximately $10.7 million of Q2 sales and $14.8 million of first-half sales.
- Gross margins expanded by 190 basis points in Q2 and 180 basis points for the first half, reflecting a shift toward higher-margin work in the Engineered Equipment Technology and Parts Group and Contracting/Services Group.
- Operating income and operating margin declined despite higher sales because of $2.3 million of Q2 and $3.4 million of first-half acquisition-related expenses, as well as higher amortization of acquired intangible assets.
- On a non-GAAP basis, excluding acquisition-related expenses and acquired-intangible amortization, operating income was $6.2 million in Q2 and $10.8 million for the first half, with margins of 13.9% and 13.7%, respectively, versus 12.4% and 12.1% in the comparable periods.
- The Contracting/Services Group experienced lower sales and operating income, while Component Parts sales were modestly higher but profitability declined because of competitive pricing pressure. Engineered Equipment Technology and Parts produced the principal growth and profit improvement.
- The effective tax rate for the first half was 18.8% versus 39.0% in 2012. Results benefited from approximately $1.4 million of previously unrecognized research and development tax credits and a further $0.6 million estimate increase for 2012 and 2013 credits, partly offset by $0.4 million of related fees. Excluding the 2009–2011 credits, management estimated the first-half effective tax rate at approximately 40.0%.
Guidance, outlook, risks and unusual items
- CECO expected to close its proposed acquisition of Met-Pro Corporation in the third quarter of 2013, subject to shareholder approvals and other customary conditions. The transaction was valued at approximately $210 million, or $13.75 per share, and was expected to be funded partly with new debt.
- Committed Met-Pro financing consisted of a $65 million senior secured term loan and up to $60 million of revolving facilities, with the company anticipating aggregate senior facilities of approximately $155 million. Management stated that the transaction would require significant additional debt.
- Management believed operating cash flow, existing cash, available revolver capacity, and committed acquisition financing would fund anticipated needs for at least the next twelve months, but future liquidity and covenant compliance would depend on operating performance and economic conditions.
- Management cited opportunities from tightening environmental regulations, international expansion, and demand in China and India. Sales historically peak in the fourth quarter, and results may be seasonal.
- Principal risks include fixed-price contract cost overruns, project delays or cancellations, subcontractor performance, raw-material and labor costs, acquisition integration, financing availability, competition, regulatory and economic conditions, and dependence on future cash flow.
- Material contingencies included a union pension withdrawal claim of up to $5.3 million plus interest, a product-liability matter with claimed damages of up to $75 million, and another product-liability case seeking aggregate damages of $11 million plus interest and costs. No reserves had been recorded for these matters as of June 30, 2013.
- An ongoing non-public SEC investigation concerning activities of a former director remained unresolved; the company stated that it was cooperating and had recorded no reserve.
- The acquisition of Aarding included $5.2 million of employment-contingent consideration and potential earn-out payments of up to approximately $7.2 million through 2017. Related compensation and earn-out expense was recognized in 2013.
Important facts for investors to verify
- Completion, financing, final terms, and integration results of the proposed Met-Pro acquisition.
- Post-acquisition leverage, debt covenant headroom, and the effect of substantially higher interest and financing costs.
- Conversion of the $77.9 million backlog into revenue and cash, including contract-margin performance and project delays.
- Sustainability of reported margins after excluding acquisition expenses, amortization, and one-time research and development tax benefits.
- Resolution and potential financial exposure from the disclosed legal proceedings, pension claim, and SEC investigation.
- Ability to maintain liquidity after the Aarding cash acquisition, dividends, working-capital investment, and anticipated Met-Pro funding requirements.