CECO Environmental Corp. 2019 Q3 Form 10-Q Summary
Business context and reporting period
CECO Environmental Corp. is a global provider of industrial air-quality, energy, pollution-control, fluid-handling and engineered solutions. The company reports three segments: Energy Solutions, Industrial Solutions and Fluid Handling Solutions. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods.
Financial performance and key metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $85.3 million | $88.3 million | $252.5 million | $243.5 million |
| Gross profit | $28.8 million | $28.7 million | $84.1 million | $81.8 million |
| Gross margin | 33.8% | 32.5% | 33.3% | 33.6% |
| Operating income | $4.1 million | $(10.4) million | $11.0 million | $4.3 million |
| GAAP operating margin | 4.8% | (11.8%) | 4.4% | 1.8% |
| Non-GAAP operating income | $7.0 million | $6.5 million | $18.6 million | $15.7 million |
| Non-GAAP operating margin | 8.2% | 7.4% | 7.4% | 6.4% |
| Net income | $1.9 million | $(12.9) million | $9.3 million | $(8.1) million |
| Diluted EPS | $0.05 | $(0.37) | $0.26 | $(0.23) |
- Q3 sales decreased 3.4%, primarily due to the 2018 divestiture of Zhongli and lower selective catalytic reduction sales. Nine-month sales increased 3.7%; management reported 7.8% organic growth excluding 2018 divestitures.
- Orders booked were $115.7 million in Q3 and $316.0 million for the first nine months, compared with $97.5 million and $292.9 million, respectively, in the prior-year periods.
- Backlog was $237.8 million at September 30, 2019, up from $182.1 million at December 31, 2018. Customers cancelled $6.7 million of previously reported backlog during the first nine months.
- Cash flow from operations was $(0.6) million for the first nine months, versus $3.6 million provided in the prior-year period. Capital expenditures were $3.7 million.
- Cash, cash equivalents and restricted cash totaled $30.2 million at September 30, 2019, including $29.0 million of cash and cash equivalents. Cash declined from $44.4 million, including restricted cash, at December 31, 2018.
- Total debt under the Credit Facility was $67.5 million, including $49.4 million of term debt and $20.0 million drawn on the revolver, net of $1.9 million of unamortized discount. Total debt, less current portion, was $65.0 million.
- The June 2019 amended Credit Facility extends maturity to June 2024, reduces interest rates and increases revolving commitments to $140.0 million. Unused credit availability was $108.5 million, or $70.0 million based on borrowing limitations. The weighted-average stated borrowing rate was 4.04%.
- Working capital was $54.5 million, with a current ratio of 1.53 to 1. The company was in compliance with its debt covenants at September 30, 2019.
Material changes versus the prior comparable period
- Profitability improved substantially because the Q3 2018 period included a $15.1 million non-cash impairment loss associated with Zhongli. No comparable Q3 2019 divestiture loss was recorded.
- Gross margin improved in Q3 due to product mix but declined modestly for the nine-month period due to product mix.
- Selling and administrative expense declined in absolute dollars, while the nine-month ratio improved to 25.9% from 27.1%.
- Interest expense declined to $1.3 million in Q3 and $4.3 million for the nine months, from $1.7 million and $5.4 million, respectively, primarily due to lower debt balances and borrowing costs.
- Energy Solutions nine-month sales increased to $154.6 million and operating income increased to $23.3 million. Industrial Solutions sales increased to $65.9 million, but operating income declined to $3.9 million due to increased sales and marketing investment. Fluid Handling Solutions sales and operating income declined to $31.9 million and $4.7 million, respectively, partly because of divested businesses.
- The company adopted new lease accounting guidance in 2019, recognizing approximately $13.3 million of operating lease right-of-use assets and liabilities and recording a $4.6 million net-of-tax beginning-equity adjustment. Management stated that the adoption did not materially affect operations or liquidity.
Outlook, commentary, risks and unusual items
The filing does not provide explicit full-year revenue, earnings or cash-flow guidance. Management highlighted increased bookings, backlog growth and organic sales growth, but cautioned that backlog may be cancelled or may not translate into revenue or profitability.
- The nine-month effective tax rate was negative 38.1% because of a $4.4 million discrete tax benefit related to finalization of a tax position associated with the 2018 Zhongli divestiture. This benefit is unusual and should not be assumed to recur.
- Restructuring expense was $0.7 million in Q3 and $1.0 million for the nine months. Amortization and earnout expense was $2.2 million and $6.5 million, respectively.
- Key operating risks include fixed-price contract losses, cost overruns, project delays or cancellations, subcontractor performance, raw-material prices and tariffs, competition, regulatory changes, cyclicality, foreign exchange, debt refinancing and integration or restructuring execution.
- The company had 206 pending asbestos-related cases at September 30, 2019. Management believes insurance coverage is adequate and does not expect the cases to have a material adverse impact, but notes that claim volumes, insurer financial condition and coverage positions are outside its control.
- The company had $11.5 million of outstanding letters of credit and $11.0 million of bank guarantees under foreign facilities, plus $3.4 million of guarantees under a Netherlands facility.
- Interest-rate exposure is primarily tied to LIBOR and EURIBOR. Management estimated that a hypothetical 10% change in the weighted-average borrowing rate would affect annual earnings and cash flows by approximately $0.3 million.
Important facts for investors to verify
- Whether higher bookings and the $237.8 million backlog convert into revenue, cash generation and acceptable contract margins.
- The sustainability of improved operating margins excluding divestiture-related charges, restructuring, amortization and other non-GAAP adjustments.
- Working-capital conversion, particularly accounts receivable, contract assets, payables and operating cash flow, which was negative for the first nine months.
- Debt repayment capacity, revolver utilization, covenant headroom and the $35.0 million scheduled debt payment in 2024.
- The extent to which the $4.4 million tax benefit and other unusual items affected reported nine-month net income.
- Exposure to fixed-price contracts, project execution, cancellations, raw-material costs, foreign exchange and asbestos litigation.