CECO Environmental Corp. 2014 Q3 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 unaudited three- and nine-month periods ended September 30, 2014, with comparison to the same periods in 2013. Effective January 1, 2014, operations were organized into Air Pollution Control, Energy, and Fluid Handling and Filtration segments.
CECO acquired HEE Environmental Engineering on August 13, 2014, and SAT Technology on September 26, 2014. Their results were consolidated from the acquisition dates.
Financial performance and key metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $63.3 million | $49.8 million | $187.1 million | $128.6 million |
| Gross profit | $21.1 million | $14.6 million | $62.2 million | $40.0 million |
| Gross margin | 33.3% | 29.3% | 33.3% | 31.1% |
| Operating income (loss) | $5.2 million | $(3.4) million | $17.9 million | $3.3 million |
| Operating margin | 8.3% | (6.8)% | 9.6% | 2.6% |
| Net income (loss) | $3.7 million | $(1.5) million | $11.2 million | $3.8 million |
| Diluted EPS | $0.14 | $(0.07) | $0.43 | $0.20 |
Non-GAAP operating income was $8.2 million in Q3 2014 versus $5.6 million in Q3 2013, with non-GAAP operating margin of 12.9% versus 11.4%. For the first nine months, non-GAAP operating income was $26.3 million versus $16.5 million, and non-GAAP operating margin was 14.1% versus 12.8%. Adjustments primarily included acquisition and integration costs, amortization and earn-out expenses, legal reserves, and certain valuation adjustments.
- Orders booked were $69.9 million in Q3 and $191.2 million for the first nine months, versus $48.0 million and $132.4 million, respectively, in the prior-year periods.
- Backlog was $106.2 million at September 30, 2014, compared with $98.5 million at December 31, 2013.
- Cash provided by operating activities was $6.3 million for the first nine months, compared with $10.4 million in 2013.
- Capital expenditures were $0.8 million. Investing cash flow was $(1.5) million, including $8.2 million of acquisition payments and $7.5 million of proceeds from asset sales.
- Cash declined to $18.0 million from $22.7 million at December 31, 2013. Approximately $12.0 million of cash was held outside the United States.
- Total debt was $84.3 million at September 30, 2014, down from $89.1 million at year-end 2013. The weighted-average borrowing rate was 2.23%.
- Unused credit availability was $67.0 million, including $63.8 million under the principal Credit Facility. The company was in compliance with its debt covenants.
- Quarterly dividends of $0.05 per share for the first quarter and $0.06 per share for each of the second and third quarters were paid during 2014. Future dividends remain subject to board and lender approval.
Material changes versus the prior comparable period
- Sales increased 27.1% in Q3 and 45.5% for the first nine months, primarily because Met-Pro, acquired in August 2013, contributed substantially more revenue in the 2014 periods.
- Gross margin improved by 4.0 percentage points in Q3 and 2.2 percentage points for the first nine months, reflecting improved product mix, manufacturing improvements, and the comparative weakness of Effox-Flextor in Q3 2013.
- Operating results improved materially as 2013 included $4.0 million of Q3 acquisition and integration expense and $2.5 million of legal reserves. Q3 2014 included $0.1 million and $0.3 million, respectively, for these items.
- Fluid Handling and Filtration sales increased to $17.6 million in Q3 from $6.9 million and operating income increased to $4.3 million from $0.6 million, primarily due to Met-Pro.
- Air Pollution Control sales increased to $27.7 million from $23.4 million, while Energy sales declined to $18.0 million from $19.2 million. Nine-month Energy operating income declined to $5.8 million from $6.9 million.
- Other expense increased because of foreign-exchange losses on an intercompany loan, including a $1.7 million impact in Q3 and $1.9 million for the first nine months.
- Interest expense increased to $0.8 million in Q3 and $2.3 million for the first nine months, primarily due to debt incurred for the Met-Pro acquisition.
- The Q3 tax provision included a $1.5 million net benefit related to research and development tax credits earned in 2013. The nine-month effective tax rate was 19.8%, compared with a tax benefit and negative 38.0% effective rate in the prior-year period.
Guidance, outlook, risks and unusual items
The filing does not provide formal numerical revenue or earnings guidance. Management expects demand to benefit from tightening environmental regulations, global pollution-control requirements, energy-efficiency needs, and growth in China and India. Management stated that sales typically peak in the fourth quarter because customers use annual capital budgets and industrial facilities conduct holiday-season maintenance.
Management believes operating cash flow, cash on hand and available borrowings will be sufficient for anticipated uses of cash for at least the next twelve months. Longer-term liquidity and covenant compliance depend on future operating performance, cash flow, economic conditions and other factors.
- On November 3, 2014, after the reporting date, CECO acquired Emtrol for $32.0 million in cash and agreed to issue approximately 454,000 common shares valued at $6.0 million.
- On November 4, 2014, CECO signed an agreement to acquire substantially all assets of Zhongli in China. The target was reported to have approximately $28.0 million of annual revenue; closing was subject to Chinese government approval.
- Met-Pro asbestos-related litigation had 196 pending cases at September 30, 2014, compared with 173 at December 31, 2013. Management believes insurance coverage is adequate and does not expect a material adverse effect, but outcomes depend on claim volume, case characteristics and insurer coverage.
- CECO recorded a $0.5 million settlement charge related to a Valero products-liability lawsuit and a $0.2 million recovery from a supplier. An insurer separately sought recoupment of defense costs, which CECO is disputing.
- Fixed-price contracts, project delays or cancellations, subcontractor performance, raw-material prices, seasonality, foreign exchange, acquisition integration, leverage, regulation, competition and litigation remain principal risks.
- The company adopted no foreign-exchange contracts outstanding at September 30, 2014. A hypothetical 10% change in the weighted-average borrowing rate was estimated to affect annual earnings and cash flow by approximately $0.2 million.
Most important facts for investors to verify
- Whether the substantial sales and earnings growth is sustainable after accounting for Met-Pro and the new HEE and SAT acquisitions.
- Progress on integrating acquisitions, realizing margin expansion, and managing amortization and earn-out costs.
- Operating cash conversion, working-capital requirements, and the effect of contract assets and billings on liquidity.
- Debt reduction, covenant headroom, interest-rate exposure, and financing needs related to subsequent acquisitions.
- Fourth-quarter seasonality, backlog conversion, order trends, and the quality and cancellation risk of the $106.2 million backlog.
- Final purchase accounting for HEE and SAT and the financial impact of the subsequent Emtrol and Zhongli transactions.
- Developments in asbestos, products-liability and insurer-related litigation, including whether insurance remains adequate.