CECO Environmental Corp. 2019 Q2 Form 10-Q Summary
Business Context and Reporting Period
CECO Environmental provides engineered air-quality, energy-chain, pollution-control, fluid-handling, and related industrial solutions through Energy Solutions, Industrial Solutions, and Fluid Handling Solutions segments. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Financial Performance and Position
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Net sales | $81.2 million | $81.1 million | $167.2 million | $155.2 million |
| Gross profit | $26.8 million | $27.2 million | $55.3 million | $53.1 million |
| Gross margin | 33.0% | 33.5% | 33.1% | 34.2% |
| Operating income | $2.0 million | $2.6 million | $6.9 million | $14.7 million |
| GAAP operating margin | 2.5% | 3.2% | 4.1% | 9.5% |
| Net income | $5.5 million | $(0.9) million | $7.4 million | $4.9 million |
| Diluted EPS | $0.15 | $(0.03) | $0.21 | $0.14 |
Non-GAAP operating income was $4.4 million in Q2 2019, with a 5.4% margin, versus $5.2 million and 6.4% in Q2 2018. For the first six months, non-GAAP operating income increased to $11.5 million from $9.2 million, and the margin improved to 6.9% from 5.9%.
- Six-month orders booked were $200.3 million, compared with $195.4 million in the prior-year period. Backlog was $208.8 million at June 30, 2019, versus $182.1 million at December 31, 2018; customers canceled $6.7 million of previously reported backlog during the quarter.
- Six-month operating cash flow was negative $11.3 million, compared with positive $9.8 million in 2018. The decline primarily reflected increases in accounts receivable, inventory, prepaid assets, and other working-capital items.
- Capital expenditures were $1.2 million in the first six months. Net cash used in investing activities was $1.2 million, compared with $30.2 million provided in 2018, when divestitures generated $30.7 million of proceeds.
- Cash, cash equivalents, and restricted cash totaled $30.0 million at June 30, 2019, including $28.8 million of cash and cash equivalents, versus $44.4 million of combined cash and restricted cash at December 31, 2018.
- Working capital was $60.9 million, with a current ratio of 1.61 to 1.
- Total debt was $75.0 million before the unamortized debt discount presentation, consisting of a $50.0 million term loan and $27.0 million revolver borrowing, less $2.0 million of debt discount. The weighted-average stated interest rate was 4.41%.
- Available credit under the facility was $97.3 million, or $66.6 million after borrowing limitations. The company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales were essentially flat year over year, while first-half sales increased 7.7%. Excluding divested businesses, management reported sales growth of 1.6% in Q2 and 13.4% for the first six months.
- Gross margin declined because of product mix. Q2 operating income decreased despite stable sales, while first-half operating income was reduced by the absence of the $11.1 million divestiture gain recognized in 2018.
- The Energy Solutions segment produced the strongest growth: first-half sales increased to $105.8 million from $91.1 million and operating income increased to $15.6 million from $9.5 million.
- Industrial Solutions sales increased modestly, but operating income declined to $0.5 million in Q2 and $1.1 million for the first six months because of higher sales and marketing investment and unfavorable mix.
- Fluid Handling Solutions sales and operating income declined in the reported periods, primarily because Keystone and Strobic revenues did not recur after their 2018 divestitures.
- On June 11, 2019, CECO entered a new senior secured credit facility. The agreement increased revolving commitments to $140.0 million, reduced stated interest rates, revised covenants, and extended maturity to June 11, 2024.
- Adoption of the new lease standard added approximately $13.3 million of operating lease right-of-use assets and liabilities and reduced beginning equity by $4.6 million net of tax, without a material effect on operations or liquidity.
Outlook, Commentary, Risks, and Unusual Items
The filing does not provide specific earnings, revenue, or margin guidance. Management cited demand and volume growth in refinery-related, midstream oil and gas, clean-air, and fume-collection products, but cautioned that backlog may be canceled or may not translate into future revenue or profitability.
- Q2 and first-half 2019 tax benefits of $4.2 million and $3.3 million, respectively, were unusual and primarily reflected a $4.4 million benefit from finalizing a tax position related to the 2018 Zhongli divestiture. These benefits materially increased net income and produced negative effective tax rates.
- CECO terminated its interest-rate swap in connection with the new credit facility and recognized approximately $0.2 million previously recorded in other comprehensive income.
- Risks include fixed-price contract cost overruns, project delays or cancellations, contractor and subcontractor performance, raw-material prices and tariffs, cyclicality, competition, regulatory changes, foreign exchange, litigation, warranty claims, acquisition integration, and the company’s debt burden.
- Asbestos-related litigation included 198 pending cases at June 30, 2019, compared with 208 at December 31, 2018. Management believes insurance coverage is adequate and that pending cases are not expected to materially affect financial condition, liquidity, or results, but outcomes and insurer capacity remain uncertain.
- Management stated that disclosure controls were effective as of June 30, 2019 and that there were no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether negative operating cash flow and working-capital usage improve as receivables, inventories, and contract balances convert to cash.
- The sustainability of Energy Solutions growth and whether Industrial Solutions investments improve segment profitability.
- Gross-margin trends, product mix, and the effect of customer cancellations on the $208.8 million backlog.
- Compliance with the new credit facility’s net leverage covenants and the company’s ability to manage the $35.0 million scheduled 2024 principal payment.
- The extent to which the $4.4 million tax benefit inflated reported Q2 and first-half net income and EPS.
- Potential exposure from asbestos claims, warranty matters, fixed-price contracts, and other contingencies.