CECO Environmental Corp. — Q2 2016 Form 10-Q Summary
Business context and reporting period
CECO is a global provider of engineered environmental, energy, and fluid handling and filtration technologies. The filing covers the quarter and six months ended June 30, 2016, with comparative periods ended June 30, 2015. Operations are reported through Environmental, Energy, and Fluid Handling and Filtration segments. Results include PMFG, acquired September 3, 2015.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $112.3 million | $87.0 million | $215.4 million | $167.9 million |
| Gross profit | $33.9 million | $26.6 million | $65.5 million | $47.6 million |
| Gross margin | 30.2% | 30.6% | 30.4% | 28.4% |
| Operating income | $8.6 million | $4.5 million | $14.4 million | $7.5 million |
| Operating margin | 7.7% | 5.2% | 6.7% | 4.5% |
| Net income attributable to CECO | $4.1 million | $2.1 million | $7.2 million | $2.3 million |
| Diluted EPS | $0.12 | $0.08 | $0.21 | $0.09 |
| Operating cash flow | Not separately provided | Not separately provided | $44.1 million | $1.7 million |
Non-GAAP operating income was $13.0 million in Q2 and $23.9 million for the first six months, compared with $12.3 million and $19.8 million, respectively, in the prior-year periods. The company excludes acquisition and integration costs, amortization and earn-out expenses, certain valuation adjustments, and a $1.0 million insurance settlement gain in its reconciliation.
At June 30, 2016, cash and cash equivalents were $56.6 million, including $26.8 million held by non-U.S. subsidiaries. Working capital was $73.3 million and the current ratio was 1.46 to 1. Total debt was $152.5 million, including $16.6 million classified as current. Unused credit availability was $73.7 million before borrowing limitations and $42.6 million based on stated borrowing limitations. The company was in compliance with its debt covenants.
Six-month financing cash outflows included $16.2 million of debt repayments, $9.2 million of net revolving-credit repayments, $2.3 million of earn-out payments, and $4.5 million of dividends, partly offset by $11.0 million of sale-leaseback proceeds. The company paid a quarterly dividend of $0.066 per share.
Material changes versus the prior comparable period
- Q2 sales increased 29.1% and six-month sales increased 28.3%, primarily because PMFG contributed $25.0 million and $49.9 million, respectively.
- Energy segment sales and operating income increased substantially, supported by PMFG and improved segment gross margins. Six-month Energy sales rose to $100.8 million from $51.7 million, while operating income rose to $11.6 million from $0.6 million.
- Environmental sales were broadly flat for the six-month period, while operating income improved to $10.9 million from $9.2 million.
- Fluid Handling and Filtration sales and operating income declined because of temporary weakness in the North American industrial market.
- Gross margin improved for the first six months, primarily because PMFG generated above-average margins, but Q2 gross margin declined modestly year over year.
- Selling and administrative expenses increased to $41.1 million from $28.1 million for the six-month period, reflecting PMFG-related costs and expanded corporate support.
- Interest expense increased to $4.1 million from $2.1 million for the six-month period, primarily due to acquisition-related borrowings.
- Debt declined from $177.3 million at December 31, 2015 to $152.5 million at June 30, 2016, including a $10.3 million term-loan prepayment during Q2.
- Orders booked increased to $108.8 million in Q2 and $228.9 million for the first six months, compared with $74.6 million and $168.5 million, respectively. Backlog increased to $224.7 million from $211.2 million at December 31, 2015.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide formal quantitative earnings or revenue guidance. Management expects growth from environmental regulation, natural-gas infrastructure, global energy demand, aftermarket revenue, operational improvements, and selective bolt-on acquisitions. Management also emphasizes margin expansion, working-capital management, Asia expansion, and integration of PMFG.
- During Q2, the Zhongli division changed certain contracts from completed-contract accounting to percentage-of-completion accounting after implementing controls to track project costs and estimates. The change resulted in $8.2 million of percentage-of-completion revenue in Q2.
- The company recorded a $1.0 million life-insurance settlement gain in Q2 and the first six months.
- Two sale-leaseback transactions generated $11.0 million of proceeds but created a $5.0 million financing liability and a $5.7 million capital-lease obligation. The Denton transaction did not result in an impairment charge.
- The company entered into an agreement on July 12, 2016 to acquire the remaining interest in Peerless Propulsys for a $5.3 million promissory note; the transaction was expected to be recorded in Q3 2016.
- Management identified continuing material weaknesses in internal control over financial reporting, including revenue-recognition controls, controls over Zhongli and PMFG, staffing and accounting expertise, manual journal entries, information-technology controls, and purchasing segregation of duties. Remediation efforts had begun but the weaknesses were not remedied as of June 30, 2016.
- Key operating risks include fixed-price contract cost overruns, inaccurate percentage-of-completion estimates, project delays or cancellations, raw-material and labor-cost changes, acquisition integration, substantial debt, interest-rate and foreign-currency exposure, regulatory changes, competition, and economic weakness.
- The company reported 217 pending asbestos-related cases and believes insurance coverage is adequate under current conditions. PMFG shareholder litigation remained subject to a proposed settlement, with a final-approval hearing rescheduled for September 14, 2016.
- Goodwill and indefinite-lived intangible assets had no impairment in the six months ended June 30, 2016, but management disclosed sensitivity to revenue growth and EBITDA assumptions for certain reporting units.
Most important facts for investors to verify
- Whether PMFG integration produces sustained revenue, margin, and cash-flow benefits without further material acquisition-related costs.
- Progress in remediating the disclosed material weaknesses, particularly revenue recognition and controls at acquired operations.
- Compliance with the credit agreement as leverage requirements tighten, including the maximum leverage ratio declining to 3.00 by December 31, 2017.
- Whether backlog and bookings convert into revenue and acceptable margins, given fixed-price contracts and project execution risks.
- The sustainability of strong operating cash flow, which benefited materially from working-capital movements during the first six months.
- Exposure to impairment charges, earn-out obligations, litigation outcomes, foreign exchange, interest rates, and the obligations created by the sale-leaseback and capital-lease transactions.