CECO Environmental Corp. — Form 10-Q Summary
Reporting period: Three months ended March 31, 2020; filed May 6, 2020. Results are unaudited and should be read with the 2019 Form 10-K. CECO provides engineered industrial air-quality, energy, pollution-control, and fluid-handling solutions through Energy Solutions, Industrial Solutions, and Fluid Handling Solutions segments.
Financial Performance and Position
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $80.5 million | $86.0 million | Down 6.4% |
| Gross profit | $28.3 million | $28.4 million | Down 0.4% |
| Gross margin | 35.2% | 33.0% | Up 220 basis points |
| Operating income | $4.2 million | $4.9 million | Down 13.3% |
| Operating margin | 5.2% | 5.7% | Down 50 basis points |
| Net income | $3.4 million | $1.9 million | Up 83.1% |
| Diluted EPS | $0.10 | $0.05 | Improved |
| Operating cash flow | $7.0 million | $(13.7) million | Improved $20.7 million |
- Non-GAAP operating income was $6.3 million, or 7.8% of sales, versus $7.2 million, or 8.4%, in Q1 2019. The adjustment primarily excludes acquisition-related amortization and restructuring expenses.
- Interest expense declined to $1.0 million from $1.5 million, primarily due to lower interest rates under the June 2019 credit agreement.
- Income tax expense was $0.8 million in both periods; the effective tax rate declined to 18.6% from 31.1%.
- Cash, cash equivalents, and restricted cash totaled $84.1 million at March 31, 2020, including $82.5 million of cash and cash equivalents, compared with $37.0 million and $35.6 million, respectively, at December 31, 2019.
- Working capital was $109.9 million, versus $64.3 million at December 31, 2019; the current ratio increased to 2.01 from 1.56.
- Total Credit Facility borrowings were $108.0 million, net of unamortized debt discount, versus $65.5 million at December 31, 2019. The increase primarily reflects a $40.0 million COVID-19-related revolving-credit draw in late March.
- Unused borrowing availability was $71.1 million at March 31, 2020, subject to borrowing limitations. The Company was in compliance with its debt covenants.
Material Changes Versus Q1 2019
- Energy Solutions sales decreased $4.6 million to $50.6 million, primarily due to lower custom-designed cyclone-system sales in refinery markets. Segment operating income declined to $8.6 million from $9.3 million.
- Industrial Solutions sales increased $1.5 million to $20.4 million, while operating income rose to $1.5 million from $0.6 million, driven by clean-air pollution-control and ventilation technologies.
- Fluid Handling Solutions sales decreased $2.5 million to $9.5 million, and operating income declined to $1.6 million from $2.4 million, primarily due to lower filtration and pump-solutions sales.
- Orders booked declined to $75.7 million from $97.3 million, reflecting weakness in refinery, midstream oil and gas, and pollution-control markets and the COVID-19 slowdown in March.
- Backlog declined to $208.9 million at March 31, 2020 from $216.6 million at December 31, 2019. Substantially all backlog was expected to be delivered within 12 to 18 months, but customers may cancel or delay orders.
- Gross margin improved because of product mix, but selling and administrative expenses increased to 27.3% of sales from 24.7%, reflecting lower volume, investments in sales personnel, and the final settlement of a commercial dispute.
- Comprehensive income was $1.1 million, versus $2.6 million, primarily because of a $2.3 million foreign-currency translation loss in 2020.
Outlook, Risks, Contingencies, and Unusual Items
- Management stated that COVID-19 had not produced a material adverse effect on results or financial position as of March 31, 2020, but the full effect remained uncertain and could not be estimated for fiscal 2020.
- Some U.S. operations were designated essential and remained open. The Company reported temporary disruptions at certain facilities and suppliers, and heightened risks of work stoppages, supply-chain disruption, project delays, customer cancellations, and weaker demand.
- Management implemented temporary salary reductions, reduced corporate costs, and a rolling two-week furlough of U.S.-based employees during the six-week period beginning April 6, 2020.
- The Company drew $40.0 million on its revolver as a precautionary liquidity measure. Substantial debt is variable-rate, and the scheduled Credit Facility balance is due at maturity in June 2024. A hypothetical 10% change in the weighted-average borrowing rate was estimated to affect annual earnings and cash flows by approximately $0.4 million.
- COVID-19 triggered an interim qualitative impairment assessment. Management concluded that goodwill and indefinite-lived intangible assets were not impaired at March 31, 2020, but noted that the related assumptions remain subject to significant uncertainty.
- Restructuring expense was $0.4 million in Q1 2020. No divestiture loss was recorded, compared with a $0.1 million loss in Q1 2019.
- Asbestos-related litigation included 187 pending cases at March 31, 2020, compared with 209 at December 31, 2019. Management believed insurance coverage was adequate and that pending cases were not expected to have a material adverse effect, subject to uncertainties regarding claim volume, case severity, and insurer coverage.
- The Company deferred further defined-benefit-plan contributions for the remainder of 2020 until January 2021. The plans’ unfunded liability was $8.7 million at March 31, 2020.
- The CARES Act could affect taxes, payroll costs, and liquidity, but the filing stated that it was unclear whether or how the Company would benefit.
- Key risks include fixed-price contract cost overruns, revenue-estimate revisions, backlog cancellations or delays, energy-market weakness, supplier and subcontractor disruptions, international and foreign-exchange exposure, cybersecurity, litigation, covenant compliance, and the duration and severity of COVID-19.
Investor Verification Checklist
- Verify the pace of order bookings, backlog conversion, cancellations, and customer payment collections after March 31, 2020.
- Assess the effect of COVID-19 on revenue recognition estimates, project costs, margins, suppliers, subcontractors, and operating cash flow.
- Monitor revolver borrowings, available capacity, scheduled debt maturities, interest rates, and compliance with the Consolidated Net Leverage Ratio covenant.
- Review subsequent impairment testing for goodwill and indefinite-lived intangible assets, particularly under changing revenue, profit, terminal-growth, and cost-of-capital assumptions.
- Track the status and insurance coverage of asbestos litigation and other legal, warranty, contract, and tax contingencies.
- Evaluate whether the reported improvement in gross margin and operating cash flow is sustainable or primarily reflects temporary mix and working-capital movements.