CECO ENVIRONMENTAL CORP annual report, FY2019

CECO Environmental Corp. 2019 Form 10-K Summary

Business context and reporting period

CECO Environmental Corp. is a global provider of industrial air-quality, emissions-management, fluid-handling, filtration, and engineered solutions. Its three reportable segments are Energy Solutions, Industrial Solutions, and Fluid Handling Solutions. The filing covers the fiscal year ended December 31, 2019, with comparative results for 2018 and 2017. CECO operated with approximately 830 full-time employees and served approximately 4,800 active customers across global markets.

Key financial metrics

Metric	2019	2018	Change
Net sales	$341.9 million	$337.3 million	+1.3%
Gross profit	$114.1 million	$111.5 million	+2.3%
Gross margin	33.4%	33.1%	+30 bps
Operating income	$18.0 million	$10.0 million	+79.9%
Operating margin	5.3%	3.0%	+230 bps
Net income (loss)	$17.7 million	$(7.1) million	Improved
Diluted EPS	$0.50	$(0.21)	Improved
Cash flow from operations	$10.2 million	$22.0 million	Down $11.7 million
Capital expenditures	$5.7 million	$3.1 million	Higher

Fourth-quarter 2019 net sales were $89.4 million, gross profit was $30.0 million, and net income was $8.4 million, compared with fourth-quarter 2018 net sales of $93.9 million, gross profit of $29.8 million, and net income of $0.9 million.

Non-GAAP operating income increased to $28.2 million from $24.1 million, and non-GAAP operating margin increased to 8.2% from 7.1%. The filing excludes selected acquisition, divestiture, restructuring, amortization, and other items from these measures; these measures are supplemental to, not substitutes for, GAAP results.

Segment sales: Energy Solutions $210.3 million, Industrial Solutions $91.3 million, and Fluid Handling Solutions $40.2 million.
Segment operating income: Energy Solutions $33.9 million, Industrial Solutions $5.7 million, and Fluid Handling Solutions $5.6 million.
Backlog: $216.6 million at December 31, 2019, versus $182.1 million at December 31, 2018; substantially all was expected to be delivered within 12 to 18 months.
Liquidity: Cash and cash equivalents were $35.6 million, compared with $43.7 million at year-end 2018. Working capital was $64.3 million, and the current ratio was 1.56.
Debt: Total borrowings under the Credit Facility were $65.5 million, including $48.8 million of term debt and $18.5 million of revolving borrowings, compared with $74.5 million at year-end 2018.
Credit availability: Amount available based on borrowing limitations was $82.3 million at year-end 2019.
Equity: Shareholders’ equity increased to $193.0 million from $178.6 million.
Dividends and repurchases: Dividend payments remained suspended and no shares were repurchased during 2019.

Material changes versus the prior comparable period

Sales increased modestly, driven primarily by higher volume in industrial air-pollution products and midstream oil-and-gas products. Excluding the impact of 2018 divestitures, organic sales increased by $13.9 million.
Gross margin expanded by 30 basis points, while selling and administrative expense declined to 25.1% of sales from 25.9%.
Energy Solutions operating income rose 17.7%, supported by product mix, lower amortization, and the absence of a 2018 operating loss associated with Zhongli.
Industrial Solutions sales increased 13.1%, but operating income declined 9.5% due primarily to increased sales, marketing, and product-innovation investments and acquisition-related costs.
Fluid Handling Solutions sales declined 11.6% and operating income declined 27.3%, reflecting divestitures of Keystone and Strobic and lower sales volume.
Operating cash flow declined primarily because of increased accounts receivable, costs in excess of billings, and lower other liabilities.
CECO entered into a new Second Amended and Restated Credit Agreement in June 2019. The agreement extended maturity to June 2024, reduced interest rates, increased revolving commitments to $140 million, and revised financial covenants. The company reported compliance with all applicable covenants.
The 2019 tax benefit of $4.4 million included a benefit related to finalizing the tax position associated with the 2018 Zhongli divestiture. Tax incentives also reduced the tax provision by approximately $3.5 million.
CECO adopted ASC 842 lease accounting, recording approximately $13.3 million of operating lease right-of-use assets and liabilities and a $4.6 million after-tax adjustment to beginning equity. The adoption did not materially affect operations or liquidity.

Guidance, outlook, commentary, risks, and unusual items

The filing does not provide specific 2020 revenue, earnings, margin, or cash-flow guidance. Management’s strategy emphasizes global growth, operational excellence, margin expansion, increased aftermarket and recurring revenue, and expansion in Asia. Management expects demand to benefit from stricter environmental regulations, natural-gas infrastructure investment, power-generation upgrades, industrialization, and customer spending on emissions-control systems.

Management stated that operating cash flow, existing cash, and available borrowings were expected to fund anticipated uses of cash for at least the next twelve months.
Estimated 2020 pension contributions were approximately $1.5 million, although actual requirements may vary with investment performance, interest rates, and regulatory requirements. The defined-benefit plan was underfunded by $8.9 million at year-end.
Material risks include fixed-price contract cost overruns, project delays or cancellations, backlog conversion risk, volatility in oil and gas spending, raw-material and subcontractor costs, tariffs, foreign currency movements, competition, customer credit risk, and dependence on subcontractors and suppliers.
Debt-related risks include variable interest rates, financial covenants, the need to refinance or repay debt, and the scheduled $53.5 million of principal payments in 2024.
Goodwill and indefinite-lived intangible assets totaled approximately $166.3 million, or 40.8% of total assets. No impairment was recorded in 2019, but impairment testing depends on projected revenue, profitability, discount rates, terminal growth, and market multiples.
The company reported 209 pending asbestos-related cases at December 31, 2019. Management believes insurance coverage is adequate and does not expect the pending cases to materially affect liquidity, financial condition, or results, subject to case volume, settlement amounts, and insurer coverage.
Restructuring expense was $1.1 million in 2019, primarily related to measures in China to simplify operations and reduce manufacturing capacity. Acquisition and integration expense was $0.5 million, and loss on divestitures was $0.1 million.
Auditor BDO USA, LLP issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2019.

Most important facts for investors to verify

Whether the $216.6 million backlog converts to revenue and cash flow on schedule, particularly given $6.7 million of prior backlog cancellations in 2019.
Whether operating cash flow improves after the 2019 working-capital outflow and supports scheduled debt amortization.
Progress in reducing leverage and compliance with the Credit Facility’s maximum net leverage ratio, which tightens over time.
Whether Energy Solutions’ improved profitability offsets weaker performance in Fluid Handling Solutions and the investment-related pressure in Industrial Solutions.
The sustainability of the 2019 tax benefit and the company’s normalized effective tax rate absent divestiture-related benefits and tax incentives.
Potential impairment exposure for goodwill and indefinite-lived intangible assets, as well as the effect of fixed-price contract estimates and raw-material costs on margins.
Future pension contributions, asbestos litigation developments, warranty claims, and other contingent obligations.