CECO Environmental Corp. 2018 Form 10-K Summary
Business Context and Reporting Period
CECO Environmental Corp. filed its Form 10-K for the fiscal year ended December 31, 2018, filed March 7, 2019. CECO provides engineered industrial air-quality, pollution-control, fluid-handling, pump, filtration and related aftermarket solutions through three segments: Energy Solutions, Industrial Solutions and Fluid Handling Solutions. Approximately 33% of 2018 revenue was derived from products or services ultimately delivered outside the United States.
The filing presents audited consolidated results for 2018, 2017 and 2016. Fourth-quarter 2018 net sales were $93.9 million, gross profit was $29.8 million and net income attributable to CECO was $0.9 million, or $0.03 diluted earnings per share.
Key Financial Metrics
| ($ in millions, except per-share data) | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $337.3 | $345.1 | (2.2%) |
| Gross profit | $111.5 | $113.2 | (1.5%) |
| Gross margin | 33.1% | 32.8% | +30 bps |
| Operating income | $10.0 | $8.0 | +24.6% |
| Operating margin | 3.0% | 2.3% | +70 bps |
| Net loss attributable to CECO | $(7.1) | $(3.0) | Loss increased |
| Diluted loss per share | $(0.21) | $(0.09) | Unfavorable |
| Operating cash flow | $22.0 | $6.6 | +$15.4 |
| Capital expenditures | $3.1 | $1.0 | +$2.1 |
Non-GAAP operating income was $24.1 million, or 7.1% of sales, compared with $28.3 million, or 8.2%, in 2017. Non-GAAP net income attributable to CECO was $10.2 million, or 3.0% of sales, compared with $9.5 million, or 2.8%, in 2017. These measures exclude specified acquisition, amortization, divestiture, restructuring, impairment and other items and should not be viewed as substitutes for GAAP results.
| Segment | 2018 Sales | 2017 Sales | 2018 Operating Income |
|---|---|---|---|
| Energy Solutions | $211.2 million | $189.0 million | $28.4 million |
| Industrial Solutions | $75.4 million | $87.8 million | $5.6 million |
| Fluid Handling Solutions | $50.7 million | $69.2 million | $8.4 million |
Cash and cash equivalents were $43.7 million at December 31, 2018, compared with $29.9 million at year-end 2017. Working capital was $57.0 million, down from $66.1 million. Total unused credit availability was $50.7 million, including outstanding letters of credit of $29.3 million.
Total debt was $74.5 million, down from $114.8 million. CECO prepaid $36.2 million of its term loan during 2018; the remaining $76.1 million principal balance was scheduled for final payment in September 2020. The weighted-average interest rate on outstanding borrowings was 5.27% at year-end, compared with 4.08% in 2017. The company was in compliance with its debt covenants.
CECO suspended dividends in November 2017 and paid no dividends in 2018. No shares were repurchased during 2018. Goodwill and indefinite-lived intangible assets totaled $170.4 million, or 43.4% of total assets.
Material Changes Versus Prior Comparable Period
- Consolidated sales declined $7.8 million, primarily because 2018 divestitures contributed $9.3 million of sales versus $34.6 million in 2017. Excluding divestitures, sales increased $30.5 million, or 17.4%.
- Energy Solutions sales increased 11.7% and operating income increased 95.0%, supported by higher sales of emissions-reduction systems, refinery cyclone products and oily-water separation equipment.
- Industrial Solutions sales decreased 14.1% and operating income decreased 30.9%, primarily due to lower sales of scrubbers, bioreactor solutions, ventilation ductwork and related equipment.
- Fluid Handling Solutions sales decreased 26.7% and operating income decreased 42.9%, principally due to the divestitures of Keystone Filter and Strobic Air.
- GAAP operating income improved despite lower revenue, partly because 2017 included $7.2 million of goodwill and tradename impairment and $1.9 million of restructuring expense. 2018 included a $4.4 million net loss on divestitures.
- Net loss increased because 2018 income tax expense was $9.6 million, including approximately $7.0 million of tax expense from permanent differences associated with divestitures. The reported effective tax rate was 385.2%.
- Operating cash flow improved substantially, while investing cash flow of $38.3 million was driven primarily by $35.1 million of divestiture proceeds and $6.3 million from asset sales. Financing activities used $44.9 million, primarily for debt repayment.
- Backlog increased to $182.1 million from $168.9 million. Excluding divestitures, backlog increased by $31.5 million.
Guidance, Outlook, Management Commentary and Risks
Management did not provide a specific quantitative 2019 revenue or earnings outlook in the filing. Management’s stated priorities include operational excellence, margin expansion, growth in aftermarket and recurring service revenue, global market expansion, safety leadership and active portfolio management. The company expects cash flows from operations, existing cash and available borrowings to fund anticipated needs for at least the next twelve months, subject to operating performance and economic conditions.
- Demand is expected to benefit from industrialization, tighter environmental regulations, natural-gas infrastructure investment, power-generation projects, refinery and petrochemical activity, and demand for aftermarket services.
- Key operating risks include fixed-price contract cost overruns, inaccurate percentage-of-completion estimates, project delays or cancellations, subcontractor performance, raw-material and steel-price inflation, tariffs, labor availability and product warranty claims.
- Energy-price volatility, global economic weakness, foreign-exchange movements, political and regulatory changes, tariffs and international operating risks could reduce customer capital spending or margins.
- Debt and variable-rate borrowing create refinancing, covenant and interest-rate risk. The term loan’s scheduled maturity in September 2020 is a significant liquidity consideration.
- The company has significant goodwill and intangible assets that remain sensitive to changes in projected revenue, margins, discount rates and market multiples.
- CECO reported 208 asbestos-related cases pending at December 31, 2018. Management believes insurance coverage is adequate and does not expect the pending cases to materially affect results, liquidity or financial condition, but litigation outcomes and insurer coverage remain uncertain.
- The defined-benefit pension plan was underfunded by $8.8 million at year-end. Estimated 2019 pension contributions were approximately $0.5 million, while future funding requirements may vary.
- Approximately 140 employees were represented by unions, with certain collective-bargaining agreements expiring between May 2019 and May 2022.
Management and BDO USA, LLP reported effective internal control over financial reporting as of December 31, 2018, and BDO issued unqualified opinions on the consolidated financial statements and internal controls.
Most Important Facts to Verify
- Verify the company’s ability to refinance or repay the $76.1 million term-loan balance due in September 2020 while maintaining leverage and fixed-charge coverage compliance.
- Track whether Energy Solutions growth and backlog conversion offset the revenue loss from the divested businesses.
- Assess the sustainability of reported margins, particularly the decline in non-GAAP operating margin from 8.2% to 7.1%.
- Review cash conversion, contract assets and liabilities, receivable collections, customer credit quality and fixed-price project estimates.
- Monitor raw-material, tariff, subcontractor and warranty costs and their effect on gross margins.
- Evaluate goodwill and indefinite-lived intangible asset impairment sensitivity, especially because these assets represented 43.4% of total assets.
- Review asbestos litigation developments, insurance coverage, pension funding requirements and multiemployer-plan withdrawal exposure.
- Confirm the balance-sheet and disclosure effects of the company’s January 1, 2019 adoption of the new lease accounting standard.