CECO Environmental Corp. 2018 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
CECO Environmental is a global provider of air-quality, fluid-handling and engineered industrial solutions serving energy, industrial, power generation, oil and gas, petrochemical, water and wastewater, and other niche markets. The filing covers the unaudited quarter and six months ended June 30, 2018, with comparisons to the corresponding 2017 periods.
Operations are reported in three segments: Energy Solutions, Industrial Solutions and Fluid Handling Solutions. During the first quarter of 2018, the company realigned and renamed its reportable segments to better reflect its strategy and end markets.
Key Financial Metrics
| Metric | Three months ended June 30, 2018 | Three months ended June 30, 2017 | Six months ended June 30, 2018 | Six months ended June 30, 2017 |
|---|---|---|---|---|
| Net sales | $81.1 million | $93.9 million | $155.2 million | $186.5 million |
| Gross profit | $27.2 million | $28.5 million | $53.1 million | $60.4 million |
| Gross margin | 33.5% | 30.4% | 34.2% | 32.4% |
| Income from operations | $2.6 million | $9.3 million | $14.7 million | $10.6 million |
| Operating margin | 3.2% | 9.9% | 9.5% | 5.7% |
| Net income (loss) | $(0.9) million | $5.5 million | $4.9 million | $5.5 million |
| Diluted EPS | $(0.03) | $0.16 | $0.14 | $0.16 |
Non-GAAP operating income was $5.2 million, or 6.4% of sales, in the second quarter, compared with $9.4 million, or 10.0%, in the prior-year quarter. For the six-month period, non-GAAP operating income was $9.2 million, or 5.9% of sales, compared with $19.5 million, or 10.5%, in 2017. The company excludes items such as amortization and earnout expenses, divestiture-related items, restructuring, executive transition, facility exit and legacy design repair costs.
Segment Performance
- Energy Solutions: Second-quarter sales declined to $51.1 million from $52.5 million; six-month sales declined to $91.1 million from $106.2 million. Operating income declined to $5.9 million from $10.5 million in the quarter and to $9.5 million from $14.4 million year to date.
- Industrial Solutions: Second-quarter sales declined to $18.3 million from $22.8 million; six-month sales declined to $36.1 million from $46.1 million. Operating income declined to $1.3 million from $1.9 million in the quarter and to $2.6 million from $4.7 million year to date.
- Fluid Handling Solutions: Second-quarter sales declined to $11.8 million from $18.3 million; six-month sales declined to $28.0 million from $34.2 million. Operating income declined to $2.2 million from $4.1 million in the quarter and to $5.4 million from $7.5 million year to date.
Orders booked increased to $100.4 million in the second quarter and $195.4 million in the first six months, compared with $87.2 million and $171.2 million, respectively, in 2017. Backlog was $200.0 million at June 30, 2018, compared with $168.9 million at December 31, 2017.
Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $35.6 million at June 30, 2018, compared with $29.9 million at December 31, 2017. Including restricted cash, total cash was $35.8 million.
- Operating cash flow was $9.9 million for the first six months, compared with $1.7 million in 2017.
- Investing cash flow was $30.2 million, primarily reflecting $30.7 million of proceeds from divestitures and $0.6 million of capital expenditures.
- Financing cash flow was negative $34.1 million, primarily reflecting $30.8 million of debt repayments and $3.8 million of revolving-credit repayments.
- Total debt was $80.9 million at June 30, 2018, down from $114.8 million at December 31, 2017. The remaining term-loan balance is due at maturity in September 2020, with no scheduled current maturities after the company’s prepayments.
- Unused credit availability was $69.2 million, although availability subject to borrowing limitations was $24.7 million. Letters of credit outstanding totaled $21.8 million.
- Working capital was $71.7 million, with a current ratio of 1.65 to 1. The company was in compliance with its debt covenants at June 30, 2018.
The company suspended dividend payments beginning in November 2017. Future dividends remain discretionary and are subject to board approval and covenant compliance.
Material Changes and Unusual Items
- CECO sold Strobic Air Corporation on March 30, 2018, and the Keystone Filter brand on February 28, 2018. The transactions generated an estimated combined gain of $11.1 million and $30.7 million of net cash proceeds during the first six months.
- Revenue declined primarily because of the divestitures and lower volumes in natural-gas turbine exhaust systems, refinery-related products, wet scrubbers, mist eliminators and pumps.
- Gross margins improved because 2017 included $2.0 million of legacy design repairs and higher warranty costs; these benefits did not offset lower sales and reduced operating leverage.
- Second-quarter operating income was adversely affected by the absence of a $5.7 million earnout adjustment benefit recorded in the second quarter of 2017.
- The second-quarter effective tax rate was 317.1%, and the six-month rate was 52.7%, driven by discrete tax adjustments, including taxes on unremitted foreign earnings, return-to-provision adjustments and permanent book-tax differences related to a divestiture.
- Adoption of the new revenue standard did not result in a material opening retained-earnings adjustment. Revenue is recognized over time for most Energy and Industrial contracts and generally at shipment for Fluid Handling products.
Outlook, Risks and Contingencies
The filing provides no formal numerical revenue, earnings or margin guidance. Management expects to continue focusing on its core energy, industrial and fluid-handling markets and expects benefits from its restructuring program, but results remain dependent on order conversion, project execution and market conditions.
- Key operating risks include fixed-price contract cost overruns, delays or cancellations, subcontractor performance, warranty and product-liability claims, raw-material prices and tariffs, competition, cyclicality and regulatory changes.
- CECO had 203 asbestos-related cases pending at June 30, 2018, compared with 218 at December 31, 2017. Management believes insurance coverage is adequate and that the pending cases are not expected to have a material adverse effect, but coverage and claim volumes are outside the company’s control.
- The company expects the adoption of the new lease standard in 2019 to materially increase reported assets and liabilities, without a material expected impact on the income statement or liquidity.
- Debt is exposed to LIBOR and EURIBOR fluctuations. The company uses an interest-rate swap; management estimates that a hypothetical 10% change in the weighted-average borrowing rate would affect annual earnings and cash flows by approximately $0.2 million.
- Management concluded that disclosure controls were effective as of June 30, 2018, and reported no material changes in internal control over financial reporting.
Investor Verification Checklist
- Verify whether the higher orders and backlog convert into revenue and margin improvement, particularly in Energy and Industrial Solutions.
- Assess the sustainability of improved gross margins after the nonrecurrence of 2017 repair and warranty costs.
- Monitor debt repayment capacity, the September 2020 term-loan maturity, covenant headroom and borrowing availability subject to limitations.
- Review the final accounting for the 2017 Tax Act before the fourth quarter 2018 measurement-period deadline and the effect of unusually high effective tax rates.
- Track post-closing adjustments and collection of the $1.9 million receivable from the Keystone divestiture.
- Evaluate asbestos litigation developments, insurance coverage and any changes in claim frequency or settlement costs.
- Reconcile management’s non-GAAP operating results to GAAP results and confirm that excluded items do not recur at materially different levels.