CECO Environmental Corp. 2017 Q2 Form 10-Q Summary
Business context and reporting period
CECO is a diversified global provider of engineered technologies for energy, environmental, and fluid handling and filtration markets. The filing covers the three and six months ended June 30, 2017, with comparisons to the corresponding 2016 periods. The financial statements are unaudited.
- Reportable segments: Energy; Environmental; and Fluid Handling and Filtration.
- Common shares outstanding at August 2, 2017: 34.6 million.
- Management stated that the company is not concentrated in a single industry or customer and operates globally.
Financial performance and key metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $93.9 million | $112.3 million | $186.5 million | $215.4 million |
| Gross profit | $28.5 million | $33.9 million | $60.4 million | $65.5 million |
| Gross margin | 30.4% | 30.2% | 32.4% | 30.4% |
| Operating income | $9.3 million | $8.6 million | $10.6 million | $14.4 million |
| Operating margin | 9.9% | 7.7% | 5.7% | 6.7% |
| Net income attributable to CECO | $5.5 million | $4.1 million | $5.5 million | $7.2 million |
| Diluted EPS | $0.16 | $0.12 | $0.16 | $0.21 |
- Non-GAAP operating income was $9.4 million in Q2 and $19.5 million for the six-month period, compared with $13.0 million and $23.9 million, respectively, in the prior-year periods. Non-GAAP operating margins were 10.0% and 10.5%, versus 11.6% and 11.1%.
- Six-month operating cash flow was $1.7 million, down from $44.1 million in 2016. Capital expenditures were $0.6 million, resulting in approximate positive free cash flow of $1.0 million before financing and other items.
- Cash and cash equivalents were $27.2 million at June 30, 2017, compared with $45.8 million at December 31, 2016. Restricted cash was $1.2 million.
- Working capital was $60.6 million, and the current ratio was 1.51 to 1.
- Total debt was $114.8 million, including $107.0 million of long-term debt and $7.7 million of current maturities. The weighted-average borrowing rate was 3.47%.
- Unused credit availability was reported at $73.7 million before borrowing limitations and $53.7 million based on borrowing limitations. U.S. letters of credit outstanding totaled $20.7 million.
- The company paid $5.2 million of dividends during the first six months and declared a quarterly dividend of $0.075 per share.
Material changes versus the prior comparable period
- Q2 sales declined 16.4%; six-month sales declined 13.4%. Energy sales fell 29.2% in Q2 and 22.1% for the six-month period, while Environmental sales fell 14.3% and 11.4%, respectively.
- Fluid Handling and Filtration was a relative bright spot, with sales increasing 19.1% in Q2 and 6.7% for the six-month period; operating income increased to $4.1 million and $7.5 million, respectively.
- Energy operating income increased in Q2 because of a $5.7 million earn-out fair-value adjustment, but declined for the six-month period. Excluding that adjustment, Energy performance was adversely affected by lower volume, warranty costs, and legacy design repairs.
- Gross margin improved despite lower sales, primarily because of project mix. The improvement was partly offset by $1.6 million of Q2 warranty expense and $1.8 million of legacy design repairs. Six-month warranty expense was $2.4 million and legacy design repairs were $2.0 million.
- Selling and administrative expense increased to $21.4 million in Q2 and $44.7 million for the six-month period, reflecting executive transition costs, additional personnel investments, and the absence of a $1.0 million life-insurance settlement recognized in 2016.
- Orders booked declined to $87.2 million in Q2 and $171.2 million for the six-month period, compared with $108.8 million and $228.9 million in the prior-year periods. Backlog was $167.9 million at June 30, 2017, down from $197.0 million at December 31, 2016, including removal of $9.7 million of inactive customer orders.
- Debt declined by $8.4 million from year-end, primarily from term-loan repayments. The China Facility loan of approximately $1.3 million was fully repaid in Q2.
Outlook, commentary, risks, and unusual items
Management expects demand opportunities from natural gas infrastructure, emissions-control requirements, industrialization, and aftermarket services. However, the filing does not provide formal quantitative revenue, earnings, or cash-flow guidance.
- Management described weaker near-term demand in solid-fuel power generation, natural-gas turbine exhaust systems, and refinery-related markets. It characterized weakness in China’s solid-fuel market and gas-turbine market overcapacity as temporary, but timing of recovery is uncertain.
- Legacy product-design issues generated significant warranty and repair costs. Management believes corrections and accrued costs are adequate, but stated that additional risk remains until all repairs are satisfactorily assessed.
- Contracts are frequently fixed-price and use percentage-of-completion accounting. Cost overruns, delays, scope changes, subcontractor performance, labor availability, and inaccurate estimates could reduce margins or cause losses.
- The company remains exposed to interest-rate risk, foreign currency movements, raw-material and labor-cost inflation, cyclical customer capital spending, contract cancellations, competition, acquisition integration, and substantial debt obligations. A hypothetical 10% change in the weighted-average borrowing rate was estimated to affect annual earnings and cash flows by approximately $0.3 million.
- The June 2017 credit agreement amendment modified EBITDA and fixed-charge calculations and the leverage covenant. The maximum consolidated leverage ratio remains 3.25 through March 31, 2019, then declines to 3.00. The company reported compliance with all debt covenants at June 30, 2017.
- There were 221 pending asbestos-related cases at June 30, 2017. Management believes insurance coverage is adequate and that the cases will not materially affect financial condition, liquidity, or results, but coverage and insurer solvency remain contingencies.
- Valley Forge Insurance Company is pursuing claims related to defense costs in the Valero litigation; CECO is disputing the claims and pursuing counterclaims.
- CECO adopted accounting updates affecting goodwill impairment, stock compensation, inventory, and other areas. The stock-compensation adoption produced a $0.4 million discrete tax benefit and a $0.1 million reduction to retained earnings.
- The company expects to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method. Its evaluation was not complete at the filing date. The new leases standard is expected to materially increase balance-sheet assets and liabilities, although management does not expect a material liquidity impact.
- Disclosure controls and procedures were evaluated as effective, with no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether order bookings and backlog stabilize or continue declining, particularly in the Energy and Environmental segments.
- The recurrence and ultimate cost of warranty claims and legacy design repairs.
- Whether the $5.7 million Q2 earn-out income adjustment is nonrecurring and how future earn-out liabilities will affect earnings and cash flow.
- Operating cash conversion, working-capital requirements, and the company’s ability to fund dividends, debt amortization, earn-out obligations, and pension contributions.
- Compliance with leverage and other credit-facility covenants, including the scheduled reduction in the maximum leverage ratio after March 31, 2019.
- The impact of adopting revenue-recognition and lease-accounting standards on reported revenue, contract assets and liabilities, debt-like obligations, and operating metrics.
- Potential exposure from asbestos claims, the Valero-related insurance dispute, fixed-price contracts, and other product-liability or contract contingencies.