CECO Environmental Corp. — Form 10-Q Summary
Business Context and Reporting Period
CECO Environmental Corp. is a global provider of industrial air-quality, energy, fluid-handling and filtration solutions. The filing covers the three and nine months ended September 30, 2017, with results compared with the corresponding 2016 periods. Reportable segments are Energy, Environmental, and Fluid Handling and Filtration.
Financial Performance and Key Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $85.0 million | $101.6 million | $271.5 million | $317.0 million |
| Gross profit | $27.1 million | $33.7 million | $87.5 million | $99.2 million |
| Gross margin | 31.9% | 33.2% | 32.2% | 31.3% |
| Operating income | $5.6 million | $10.5 million | $16.2 million | $24.9 million |
| Operating margin | 6.6% | 10.3% | 6.0% | 7.9% |
| Net income attributable to CECO | $3.0 million | $5.8 million | $8.6 million | $13.0 million |
| Diluted EPS | $0.09 | $0.17 | $0.25 | $0.38 |
Revenue declined 16.3% in the third quarter and 14.4% for the first nine months. The Energy and Environmental segments declined, while Fluid Handling and Filtration increased sales by 35.3% in the quarter and 15.8% year to date. Orders booked were $71.0 million in the quarter and $242.2 million year to date, down from $96.2 million and $325.1 million, respectively.
Non-GAAP operating income was $5.3 million in the quarter and $24.8 million year to date, compared with $14.4 million and $38.2 million in the prior-year periods. Non-GAAP operating margins were 6.2% and 9.1%, versus 14.2% and 12.1%.
Operating results included $2.5 million of warranty expense and $2.0 million of legacy design repair costs during the first nine months, compared with $0.4 million of warranty expense in the prior-year period. Third-quarter amortization and earn-out expense was a net benefit of $0.5 million, including a $3.9 million earn-out valuation benefit related to the Zhongli acquisition. The nine-month earn-out benefit was $5.7 million.
Cash Flow, Liquidity and Capital Structure
- Cash used in operating activities was $1.1 million in the first nine months of 2017, compared with $52.9 million provided in 2016.
- Cash used in investing activities was $0.4 million, primarily for $0.8 million of capital expenditures, partly offset by asset-sale proceeds.
- Cash used in financing activities was $20.6 million, including $9.2 million of debt repayments, $7.4 million of earn-out payments and $7.8 million of dividends.
- Cash and cash equivalents were $24.6 million at September 30, 2017, down from $45.8 million at December 31, 2016. Restricted cash was $0.9 million.
- Working capital was $65.4 million, and the current ratio was 1.57 to 1.
- Total debt was $116.9 million, including $115.3 million under the U.S. Credit Facility and $1.6 million under the Aarding Facility. Debt was $123.2 million at December 31, 2016.
- Unused credit availability was $70.9 million before borrowing limitations and $34.3 million based on borrowing limitations. Letters of credit outstanding totaled $20.8 million.
- The weighted-average borrowing rate was 3.60% at September 30, 2017. Management estimated that a hypothetical 10% change in borrowing rates would affect annual earnings and cash flows by approximately $0.3 million.
Material Changes and Management Outlook
- Energy revenue decreased 28.0% year to date, primarily from weaker solid-fuel power-generation demand in China and temporary overcapacity in gas-turbine markets in Europe and Asia.
- Environmental revenue decreased 13.7% year to date because of lower refinery-related activity and deferred customer maintenance and capital expenditures.
- Fluid Handling and Filtration revenue increased 15.8% year to date, supported by international demand and stronger North American industrial markets.
- Backlog was $153.9 million at September 30, 2017, down from $197.0 million at December 31, 2016. The company removed $9.7 million of previously reported inactive orders. Backlog is not a GAAP measure and may be cancellable.
- Management planned to implement a restructuring program in the fourth quarter intended to reduce annual costs by approximately $5 million to $7 million and exit non-core or low-critical-mass products.
- The company’s Board subsequently suspended quarterly dividend payments, effective with future dividends, to preserve cash for investment in people, systems and product innovation. The September 2017 quarterly dividend of $0.075 per share had already been paid.
- The Credit Facility was amended in October 2017 after the reporting date. The amendment increased the maximum consolidated leverage ratio to 3.75 through March 31, 2019, with later step-downs, and added capital-expenditure restrictions for 2018 and 2019. The company reported compliance with covenants as of September 30, 2017.
Risks, Contingencies and Unusual Items
- Key risks include weak energy and refinery markets, order delays or cancellations, fixed-price contract cost overruns, warranty and product-liability claims, raw-material inflation, acquisition integration, substantial debt, covenant compliance, foreign-exchange movements and regulatory or economic changes.
- Asbestos-related litigation involved 223 pending cases at September 30, 2017. Management believes insurance coverage is adequate and does not currently expect a material adverse effect, but coverage and claim volume are outside the company’s control.
- The company is disputing an insurer’s claim for reimbursement of defense costs related to the Valero products-liability matter and is pursuing counterclaims.
- Management identified no goodwill or intangible-asset impairment during the period. Accounts receivable doubtful-account expense increased to $2.2 million year to date from $0.3 million in 2016.
- The company expects adoption of the new revenue-recognition standard on January 1, 2018 using the modified retrospective method, but had not completed its assessment of the impact. The new lease standard is expected to materially increase reported assets and liabilities, without a material liquidity effect.
- Disclosure controls and procedures were deemed effective as of September 30, 2017, with no material changes in internal control over financial reporting.
Investor Verification Checklist
- Verify whether the planned restructuring achieves the stated $5 million to $7 million annual cost reduction and assess associated implementation charges.
- Monitor cash conversion, working-capital requirements and the sustainability of liquidity following negative operating cash flow.
- Review leverage, covenant calculations, capital-expenditure restrictions and refinancing requirements through the September 2020 Credit Facility maturity.
- Assess whether the Energy and Environmental market weakness is temporary and whether backlog converts to revenue without cancellations or margin deterioration.
- Evaluate the impact of warranty, legacy repair and bad-debt costs on normalized margins.
- Confirm the effect of the January 2018 revenue-recognition adoption and subsequent lease-accounting adoption on reported results and balance-sheet leverage.
- Track asbestos claims, insurer coverage and the Valero insurance dispute for potential changes in exposure.