CECO Environmental Corp. 2017 Form 10-K Summary
Business Context and Reporting Period
CECO Environmental provides engineered environmental, energy, air-quality, fluid-handling and filtration solutions through three reportable segments: Energy, Environmental, and Fluid Handling and Filtration. The company serves power generation, oil and gas, petrochemical, industrial, water and wastewater, and other niche markets globally.
This Form 10-K covers the fiscal year ended December 31, 2017, with quarterly information for the fourth quarter. The filing was signed March 9, 2018. Approximately 32% of 2017 sales were generated outside the United States, and no customer represented 10% or more of consolidated revenue.
Key Financial Metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $345.1 million | $417.0 million | Down 17.3% |
| Gross profit | $113.2 million | $134.9 million | Down 16.1% |
| Gross margin | 32.8% | 32.4% | Up 40 basis points |
| Operating income (loss) | $8.0 million | $(25.6) million | Improved $33.6 million |
| GAAP operating margin | 2.3% | (6.1)% | Improved |
| Net income (loss) | $(3.0) million | $(38.3) million | Improved $35.2 million |
| Diluted loss per share | $(0.09) | $(1.12) | Improved |
| Cash flow from operations | $6.6 million | $69.6 million | Down $63.0 million |
| Cash and cash equivalents | $29.9 million | $45.8 million | Down $15.9 million |
| Total debt | $114.8 million | $123.2 million | Down $8.4 million |
| Backlog | $168.9 million | $197.0 million | Down 14.3% |
Non-GAAP operating income was $28.3 million, or an 8.2% margin, compared with $52.7 million, or a 12.6% margin, in 2016. Non-GAAP net income attributable to CECO was $9.5 million, or 2.7% of sales, compared with $33.5 million, or 8.0%, in 2016.
Fourth-quarter 2017 sales were $73.5 million, gross profit was $25.6 million, and GAAP operating loss was $8.2 million. Fourth-quarter net loss attributable to CECO was $11.6 million, or $0.34 per diluted share.
Material Changes Versus Prior Comparable Period
- Sales declined primarily because of lower demand for solid-fuel power generation and natural-gas turbine exhaust systems in Energy, and lower refinery-related and ventilation duct-work activity in Environmental.
- Energy revenue fell 26.5% to $149.5 million and segment operating income fell 61.9% to $9.0 million.
- Environmental revenue fell 17.0% to $127.3 million and segment operating income fell 12.7% to $13.7 million.
- Fluid Handling and Filtration revenue increased 12.0% to $69.2 million; segment operating income improved to $14.7 million from a $36.2 million loss, largely because 2016 included $48.7 million of goodwill and intangible impairment charges.
- Gross margin improved modestly because of favorable project mix, despite $3.0 million of warranty expense and $2.0 million of legacy design repairs.
- Operating results benefited from substantially lower impairment charges: $7.2 million in 2017 versus $57.9 million in 2016. The 2017 charge included $4.4 million of goodwill impairment at the Zhongli reporting unit and $2.7 million of tradename impairments.
- Operating cash generation deteriorated sharply, partly reflecting $7.8 million of earnout payments, lower billings in excess of contract costs, and higher payments of accounts payable and accrued expenses.
- The company made $11.2 million of long-term debt repayments and $4.3 million of term-loan prepayments during 2017, while debt remained significant relative to cash balances.
Liquidity, Debt and Capital Allocation
Working capital was $66.1 million at year-end, with a current ratio of 1.61. Reported unused credit availability was $68.1 million before borrowing limitations and $18.7 million after such limitations. The principal term loan had scheduled principal payments of $8.5 million in 2018, $10.0 million in 2019 and $96.4 million in 2020.
The company was in compliance with the financial covenants under its primary Credit Facility at December 31, 2017. However, the Netherlands-based Aarding subsidiary was not in compliance with certain covenants; the company settled its $2.8 million overdraft in March 2018 and planned to exit or consolidate that facility. The primary Credit Facility requires a consolidated leverage ratio below 3.75 and fixed-charge coverage above 1.25, subject to future step-downs in the leverage threshold.
The board suspended quarterly dividend payments on November 6, 2017. Dividends declared during the first three quarters totaled $0.225 per share, and $7.8 million was paid during the year. No common-stock repurchases occurred during 2017.
Guidance, Outlook, Management Commentary and Risks
- Management expects the restructuring program to reduce annual costs by approximately $7 million and refocus the portfolio, including exiting non-core and low-critical-mass products. Restructuring expense was $1.9 million in 2017, primarily in the fourth quarter.
- Management’s strategy emphasizes operational excellence, margin expansion, aftermarket and recurring revenue growth, global market coverage, and leveraging an installed equipment base exceeding $5 billion.
- Most 2017 backlog was expected to be completed in 2018, but backlog is not a GAAP measure and may be canceled or delayed. The company removed $12.6 million of previously reported orders during 2017 because of customer inactivity.
- The company expects cash from operations and available borrowings to fund anticipated uses for at least the next twelve months, but future liquidity depends on operating performance, cash conversion, debt refinancing and covenant compliance.
- Fixed-price contracts and percentage-of-completion accounting expose results to cost overruns, delays, subcontractor performance and revisions to estimated contract profitability.
- Goodwill and indefinite-lived intangible assets totaled $186.6 million, or 42.6% of total assets. Several reporting units had limited valuation headroom, increasing the risk of future impairment charges if revenue or operating-profit assumptions weaken.
- The Tax Cuts and Jobs Act produced a provisional $6.4 million transition-tax charge and a $4.8 million deferred-tax remeasurement benefit. The company stated that the accounting remained subject to finalization.
- There were 218 asbestos-related cases pending at year-end. Management believed insurance coverage was adequate and did not expect a material adverse effect, but coverage and claim volumes remain uncertain.
- The company had an underfunded pension plan, with estimated 2018 pension and retiree-health contributions of approximately $0.8 million and $24,000, respectively.
Most Important Facts for Investors to Verify
- Whether the restructuring program achieves the targeted $7 million of annual savings and improves Energy-segment profitability.
- Whether sales, backlog conversion and operating margins stabilize after the 2017 volume decline.
- Whether the company can meet the substantial 2020 debt maturities and maintain compliance with progressively tighter leverage covenants.
- The effect of weak operating cash flow, customer billing terms, receivable collections and the $5.3 million note payable associated with the China property sale.
- The sensitivity of goodwill and tradename valuations to revenue and operating-profit assumptions, particularly for reporting units with only 2% to 6% valuation headroom.
- The final accounting effects of the Tax Cuts and Jobs Act and the impact of the January 1, 2018 revenue-recognition adoption.
- Potential changes in asbestos litigation, insurance coverage, warranty claims and other product-liability matters.